SCOPE AND IMPORTANCE OF CORPORATE GOVERNANCE

The article attempts to elaborate on the core concepts of corporate governance and its fundamental principles; relying on the underlying objectives, the author has tried to analyse corporate governance's importance in the current scenario and the scope of the benefits.
Estimated Reading Time: 10 minutes

Introduction

Corporate governance is the elaborate set of code prescribed to shape the company management both internally and externally; it is a technique within which the companies operate and manage their affairs more effectively to attract investors and outsiders. It encompasses various codes of practice to be accomplished by different market players; it is a tool that promotes sustainable growth, taking into consideration both economic and social aspects. Various scams and scandals depicted the business environment’s weakness led to the emergence of corporate governance worldwide; during the 19th century, it gained importance due to the global expansion of the business market.

The growing complexities in the market compelled the need for standardised procedures to manage the company affairs. The board’s illegalities in audit and decision-making were broadly questioned and turned out to be a significant concern in corporate governance strategies. The weaknesses detected in the company management through numerous economic scandals majority pointed out the mismanagement and defrauding in the audit accounts; thus, the code of standard corporate governance gave significant importance to setting up an effective board of directors and constituting audit committees 

The codes formulated shared different approaches in the dissemination of proper governance;

  1. Shareholder approach: advocates the best interests of all shareholders, with the primary objective of governing and controlling entities to maximise the wealth of shareholders by share price and dividend growth
  2. Stakeholder approach: Expresses the view that directors should run entities in the interests of all stakeholders of the company
  3. Pluralists approach: is concerned about the economic and social goals, it argues that the aim of corporate governance should be to recognise the interests of other individuals, companies and society’s interests in addition to the interests of shareholders of the company in the way entities are governed, directed and controlled
  4. Integrated approach: advocates the area of reporting and disclosure of information; it also takes the view that companies have a wide range of stakeholders whose views should be considered and that corporate governance should encourage participation by all the stakeholders

Different countries have adopted different approaches, whereas the core objective of managing the internal and external company affairs was universally accepted. Integrating the above approaches, the following core subjects refine the corporate governance code;

  1. Accountability
  2. Fairness
  3. Transparency
  4. Independence
  5. Sustainability
  6. Good board practices
  7. Control environment
  8. Board commitment
  9. Openness
  10. Reputation
  11. Stakeholder interface

What is Corporate Governance?

The following are some of the well-acclaimed definitions of corporate governance provided by different authors and committees;

According to Gabrielle O’Donovan, corporate governance is defined as,

An internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders, by directing and controlling management activities, with good business savvy, objectivity, accountability and integrity. where, sound corporate governance is reliant on the external market place commitment and legislation, plus a healthy board culture which safeguards policies and processes.”  

The Cadbury Committee, set up in 1991 by the Financial Reporting Council of London stock exchange, gave a more comprehensive definition of corporate governance. Accordingly, it defined as a “system by which companies are directed and controlled“,

Cadbury Committee

Cadbury Committee was one of the first and renowned committees formed to deliberate on corporate governance; after a debating period, they formed specific best practice codes to implement corporate governance. they are; 

  1. role of the board of directors
  2. role of non-executive directors
  3. appointment, remuneration and performances of the directors
  4. financial reporting and audit
  5. regulation of both insider and outsider dominated system of management

Organization of Economic Cooperation And Development (OECD)

In the international scale, the first organisation for corporate governance practices was formed by OEDC; it framed the first internationally accepted corporate governance standards in 1999. it is based in Paris with 29 member countries from all over the world. The standards formulated reflect certain principles of the Cadbury Committee Code; it lays importance to equitable treatment of shareholders, responsibilities of the board of directors, transparency and disclosure in accounts and audit importance of non-executive directors and corporate social responsibility listed companies. According to OECD “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the company’s objectives are set, and the means of attaining those objectives and monitoring performance are determined.”

Principles of Corporate Governance

OECD Organisation for Economic Co-operation and Development- principles of corporate governance initially adopted by the 30 member countries of the OECD in 1999, have become a reference tool for countries all over the world. These principles are the base for formulating corporate governance regulations in all the member countries. The abstracts of the principles formulated are as follows;

  1. An effective Board should head governance structure in the company management
  2. The board must identify the roles, responsibilities and duties of which they have to execute
  3. The board’s structure and other committees’ should be maintained in the appropriate combination of executives, executive directors, independent directors, and non-independent non-executive directors to prevent a group of individuals from dominating the board’s decision taking.
  4. Appropriate board committees should be formed to assist the board in the adequate performance of its duties.
  5. A formal and transparent procedure must be followed for appointment of directors and their successors; the criteria include traits such as skills, knowledge, experience, and independence, diversity on the board, including gender.
  6. The execution of all the directors’ responsibilities and the committees should be done with strong ethical standards and effectively.
  7. Dissemination of genuine pieces of information about the corporation’s affairs should be done effectively by the board promptly and appropriately. 
  8. The board should be transparent, fair and consistent in circumscribing the remuneration policy for directors and senior executives.
  9. The board should be accountable in all corporate affairs.
  10. The corporation must formulate and execute comprehensive risk management strategies to protect investors’ interest and maintain internal and external control.
  11. The board should present a fair, equitable and reasonable assessment of its financial, environmental, social and governance position, performance and outlook in its annual report.
  12. The audit committee must submit a timely audit report containing all the financial transactions to the management. 
  13. The internal audit committee should be practical, transparent and independent.
  14. The board should ensure the maintenance of a cordial relationship with shareholders and respect the interests.
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Key-Players of Corporate Governance

  1. The company or entity: An artificial person created by law with perpetual succession and a common seal but operating through the medium of directors.
  2. Directors: Custodians of the company assets, which are monitored and segregate to the shareholders at the time of winding up
  3. Managers/Executives: Those who handle the company assets and administrate the everyday business of the corporations
  4. Shareholders: Those that own the company shares, either from the private or public entities.
  5. Stakeholders: Different market participants 

Corporate Governance In India

Indian corporate governance scenario claimed light in the late 90s after liberalization; the 1994 progress in the Indian economy catalyzed the need for an applicable corporate governance code. Being the most significant emerging market comprising millions of shareholders, India demanded an effective corporate governance strategy to mitigate mismanagement in business houses concerning internal and external operations. On the other hand, failures in prompt and transparent accounting of audit in the annual report also led to a doomed scenario in the capital market, pressing the need for effective corporate governance strategies.

Harshad Factor

The following crafted the base for the legal code on corporate governance in India 

  1. The desirable corporate governance in India” – a code on the Confederation of Indian Industries,1998
  2. Report “Kumar Manglam Birla” on corporate governance published by the SEBI Committee in May 1999.
  3. Summary Report of the Consultative Group of Directors of Bank/Financial Institutions – by the Ganguly Committee in April 2002.
  4. Summary Report on corporate audit and governance prepared by the Nareen Chandler Committee in December 2002.
  5. The Code on Corporate Governance prepared by the SEBI Committee chaired by Narayanamurthy published on 8 February 2003.

Securities Exchange Board of India grounded the legislature factor of corporate governance in India in 1988 and the 2013 amendment of the Indian Companies Act; both provided more expansive and comprehensive provisions on corporate governance. 

Sebi Role In Corporate Governance 

The establishment of SEBI played a significant role in establishing norms for corporate governance in India; SEBI constituted two committees to make recommendations relating to India’s corporate governance, one in 2000, Kumar Manglam Birla committee, Narayana Murthy Committee in 2003. These committees made various essential recommendations which are summarised as

  •  Composition of Board
  •  Formation of Audit Committee
  •  Disclosure of relevant information to the shareholders

The recommendations of these committees form the foundation of the legal regime for corporate governance in India. In 2000 SEBI was directed to incorporate the Kumar Manglam Birla committee’s recommendations by inserting a new clause in the Equity Listing Agreement – i.e. Clause 49 and 35B. After prompt debating and revision through public comments, made modifications through relevant amendments in the Equity listing agreement; the added two clauses are Clause 35B and Clause 49 of the listing agreement. 

Clause 35B

Clause 35B was formulated to facilitate the active participation of shareholders in the company affairs and board affairs

  1. e-voting facilities or postal ballot facility to the shareholders
  2. resolutions taken should be passed at the general meeting
  3. notice of meeting to be sent to all members including auditors and directors through the post registered e-mail or courier and same to be posted in the official website
  4. the notice should contain all the necessary details on the subject matter of the meeting.

Clause 49 

Clause 49 of the equity listing agreement was formulated to incorporate the norms of corporate governance in the company’s internal matters; that includes the board of directors, audit committee, protection of shareholders, corporate social responsibility, etc. it consists of,

  1. The norms facilitating the protection of investors or shareholders; 
  2. The specified disclosures made at the annual general meeting regarding the duties and responsibilities of directors.
  3. Specifications on the board’s composition, its restrictions on independent directors, their tenure and corporate code of conduct, and whistleblowing policy.
  4. As per clause 49 (iii), the audit committee demands at least three members out of which 2/3rd members should be independent directors. 
  5. The members of the audit committee should have financial and accounting skills.
  6. The committee has to sit at least four times a year with a gap of not more than four months between two meetings.
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Scope Of Corporate Governance

It refers to how it influences the business inside out; generally, its scope is broader; it encompasses various development factors. It is solely about maintaining equilibrium between the individual or corporation and societal goals and economic and social developmental goals. 

Economic growth

Proper implementation of corporate governance norms enhances the country’s economic growth; 

  1. the regulations facilitating transparency, accountability, fairness, and equity in managing the company affairs internally and externally 
  2. Boosting the confidence of investors expedite buying and selling of securities which directly influences the maintenance of financial market liquidity 
  3. regulatory authorities of the corporation being professional, competent and fast in dealings promote market performance

Social responsibility

The primary objective of implementing corporate governance is to facilitate sustainable growth; the development of a business must encircle body economic and social development that corporate governance codes enable. 

  1. It acts as a tool for social construction where the companies practice both profit maximisation and social welfare, and these practical applications benefit the growth of social responsibility among corporates. 
  2. By providing reasonable corporate governance increase investor confidence leading to boost investments and income generation for the society.

Business expansion and development

An effective corporate governance strategy such as maintaining proper audit of accounts, efficiency in directors role, the cordial relationship among shareholders etc., ultimately impact business expansion and diversification. It is facilitated by;

  1. raising capital at a faster rate because of increased public confidence level  
  2. it causes a hike in demand and supply of stocks which reflects in the stock price increase
  3. minimise mismanagement inside corporation helping expansion of business

Increased efficiency, Lowered illegalities and mismanagement

  1. Well-regulated internal management with an appropriate number of executive, non-executive and independent directors avoid impartial decision making
  2. All piece of information, genuine and relevant are facilitated adequately to the market participants to mitigate defrauding
  3. Transparency in the appointment of executives and directors lower illegal and unfair governance
  4. Accountability of the board of directors and other executive promote a fair legal remedy to the aggrieved party
  5. Surveillance over the corporation affair by outside market players lower market illegalities

Importance Of Corporate Governance

  1. It ensures that a properly structured board of directors, capable of thinking and taking decisions fair and impartial, creates long-term faith between the company or the corporation and the external capital market participants.
  2. Recruiting independent directors with a wealth of expertise in different fields cause them to impose new ideas into business management, facilitating expansion and diversification, ultimately boosting the economy.
  3. Advancements in surveillance methods relating to an internal audit, monitoring financial data, and the board’s duties and responsibilities tend to influence the investor confidence in market investments.
  4. It rationalises the corporation’s internal and external management, and the risks involved in the financial market frame appropriate risk management policies through strategic thinking and methodology. 
  5. It promotes the adaptation of transparent and fair procedures in the appointment of directors, the audit of financial data, and the board’s duties, thereby increasing management integrity.
  6. Ensuring corporate governance codes and norms in company management improves its quality on global market grounds.
  7. It reduces illegal and defrauding practices affecting market stability and investor confidence in the capital market, also provides adequate mechanisms for grievance redressal.
  8. Solid and effective corporate governance helps cultivate ethical standards in management and company culture of integrity, facilitating an overall positive performance and sustainable growth.
  9. It regulations promote an excellent corporate culture with ethical standards and practice; it promotes healthy competition among companies.
  10.  It enhances corporate social responsibility in the economy, thus aiding for socio-economic growth of the country.

Conclusion

The encounters of economic transition and financial crises in developing and emerging market economies of various countries led to a good corporate governance code to maintain a stable market performance. Various concerns in the securities market have led to investor confidence failure. They have confirmed that a weak institutional framework for corporate governance is incompatible with sustainable financial market development and growth. Good corporate governance helps fill the loopholes, promote company growth and enhance investor confidence in the securities market. It helps lower the cost of capital and facilitates the development of company management. It also ensures the companies legal commitments and forms friendly relations among the market participants. Thus, it is evident that an improved corporate governance code helps evaluate and evaluate corporations’ competence in participating in the economic building. 

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