What are corporate governance challenges?

The system of corporate governance has considerably evolved over the last few decades, with the recommendations of various committees like the Kumar Birla Committee, Narasimharao Committee, etc., there are still many aspects which pose threats and challenges to the proper governance of an organization.
Estimated Reading Time: 10 minutes

Introduction

Corporate Governance is the process of governing the corporate, creation of corporate policies, while keeping the vision and mission in mind, also while catering to the interests of all the stakeholders including, shareholders, employees, government, suppliers, customers, creditors, management, environment, etc. Corporate Governance, in its simplest sense means, a set of laws, rules and regulations to govern the functioning and growth of a business.

Corporate Governance has been enumerated by the Institute of Company Secretaries of India as-

Corporate Governance is the application of best management practices, compliance of law in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stakeholders”.[1]

Objectives of Corporate Governance

Sir Adrian Cadbury has discussed the objectives of Corporate Governance in Corporate Governance and Chairmanship: A Personal View (2002), as-

“…holding the balance between economic and social goals and between individual and communal goals. The governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals, the organisation and society.”

The following are the objectives of Corporate Governance are-

  1. To protect the stakeholder’s interest, including the interests of the community, government and environment.
  2. Triple Bottom Line- To take care of the three elements- economy, social and environmental which form a part of corporate social responsibility.
  3. Imposes on obligation on companies and businesses to follow the policies as well as statutory rules on corporate governance and which will bring value to the society as a whole.
  4. To protect the companies from the menace of corporate frauds and scams.
  5. To align business frameworks with human rights, environmental reforms, anti-corruption reforms, other statutes, etc.
  6. To separate ownership and power, by separating shareholders from governing bodies.

Role of Corporate Governance

The following is the role of Corporate Governance in a company-

  1. Creating policies- Creation of company policies in line with the mission and vision of the organization. It also has to be ensured that the policies and procedures established minimise risk to a great extent.
  2. Accountability at all levels- It has to ensure that there is a proper accountability of the board of directors and the management and that there are procedures in place to report malpractices within the company.
  3. Shareholder Meetings- One of the primary functions of corporate governance is to keep the shareholders in the loop regarding the status and ongoing practices of the company. The Board of directors are therefore, under a mandate due to corporate governance, to organize meetings with the shareholders to keep them updated about the organization.
  4. Meeting Legal Standards- the Company has to ensure that the policies and practices are in line with the legal standards required and are not in contravention with any legal statutes. There are many compliances, especially under the Companies Act, 2013, which have to be kept in mind. For example, the appointment of women directors and independent directors have to be ensured beyond a specific threshold.
  5. Creation of ethical practices- The Company policy and procedures has to be such that they maintain high ethical standards, by determining the acceptable behaviour in the organization. For example, emphasis on Corporate Social Responsibility, effective procedures to report harassment, etc. help in maintaining company ethics.
  6. Creation of culture within the company- The culture of the company refers to the manner the staff of the company interacts with one another. The body which is governing the company has the power to decide and create such a policy which influences the culture of the organization in a sustainable way.

Challenges of corporate governance

The corporate governance regulations have been evolving since some decades now. There are, however, still some challenges that are hindering the growth of corporate governance. These challenges are-

  1. Lack of mandatory regulations for unlisted companies– the primary document on corporate governance is mainly applicable for listed entities. It is not applicable to unlisted companies, whether public or private. This leads to a lack of compliances by such companies.
  2. Excessive remuneration of Directors– It can often be seen that the directors are paid excessive remuneration, even when the company is not producing any profits. This leads to the abuse of director’s power and takes away the capital from the company.
  3. Lack of regular meetings– the Board of Directors needs to meet regularly to ensure the smooth functioning of the company. There is a need for proper communication amongst the directors as well as the management to see the discrepancies in the companies functioning. Many directors not arrange regular meeting leading to a lack of communication and improper management.
  4. Lack of Transparency– The financial reporting of the company regarding the profits and losses should be unambiguous to provide a clear picture to the stockholders. However, many directors fudge these reports to show a different picture of the company misleading the shareholders. These sort of acts also open the company to various lawsuits, including criminal lawsuits. It is often argued by the management that the disclosure of certain kind of information would lead to the benefit of the competitors. They use this argument as an excuse for the non-disclosure of essential information.
  5. The unification of CEO and Chairperson– one major issue in the corporate governance regime in India is the lack of separation in the CEO and the Chairperson, leading to concentration of power in the hands of a single person. This leads to the misuse and abuse of power by such persons and the lack of accountability in the top management.
  6. Lack of CSR Activities– while the Companies Act, 2013 mandates CSR activities for particular companies, it leaves out a major share of the companies under this obligation. This leads to many companies abusing the resources provided by the society and not providing any value in return.
  7. Lack of accountability– accountability is a necessary element to ensure proper corporate governance. However, many companies fail to draft such policies which make each department accountable to one another. This creates loopholes for the management to act recklessly and cause loss to the shareholders.
  8. Violation of ethics– Ethics violation, though, may not be a violation of the law, may pose serious implications in the effective functioning of the company. Violation of ethical practices may lead to the loss in the stockholder’s trust and an overall loss to the community at large.
  9. Conflict of interests– many a times, the company management or the board may find itself at a conflict of interest. This may be a conflict in the director’s or manager’s personal and company’s interest. For example, a manager who oversees the management of an automobile company (running on fuel) may hold shares in the stocks of an electric automobile company, leading to a conflict of interest.
  10. Inefficient implementation– Many companies frame a good policy for corporate governance. The same is not implemented by the resistant managers effectively. This leads to a loss of reputation for the company, as well as it might lead to the company being exposed to lawsuits.
  11. Short terms of directors– While it is necessary for directors to retire every few years in order to weed out the inefficient governing body, it might lead to prioritization of short-term performance rather than long-term planning.
  12. Lack of diversity– diversity in the board and the management provides for different perspectives being put forward, and helps the company in seeing the problems from various angles. However, most companies don’t allow workers to be a part of the board, which is the norm in United Kingdom and helps in ensuring lowering pay inequality.
  13. Improper whistle blower mechanism– the whistle-blower mechanism recommended by the Indian statutes is still weak and requires anonymization and protection of the whistle blower. In India, the identity of a whistle-blower in the corporations can be easily identified. This leads to fear amongst the employees to report any malpractices, as their jobs are at stake.
  14. Family owned businesses– in India, family owned businesses are really common. The key positions, like director, manager, chairman, CEO, etc. are generally held by family members. This leads to the lack of balance between personal and company related-decisions. This may hinder the growth of the company and the persons working as the key-managerial personnel may utilize the opportunity to misuse their powers.
  15. Ambiguous legislations– there is a plethora of regulations governing the corporate governance for various companies. This allows for loopholes and confusion in the implementation of the regulations.
  16. Influence on independent directors– it can be seen in the corporate culture that the independent directors are influenced and may not work for the stakeholder’s interest. Furthermore, those independent directors who do work for the stakeholder’s interest are removed using the other director’s influence.
  17. Lack of involvement of Board of Directors– In some companies, the management takes over the entire company while the Board of directors overlook as the silent spectators, merely there to sign the paperwork. This gives too much power in the hands of the management and takes away from the rights of the shareholders.

Suggestions

In order to overcome the challenges of corporate governance, there is a need for changes in regulations as well as the corporate culture. The following suggestions are given for dealing with some of the corporate governance issues-

  1. Simplification of regulations– the regulations on corporate governance should be simplified and created into a code to remove any ambiguities and loopholes in the same. It will also increase the numbers of the companies complying with the regulations.
  2. Dynamic changes– the regulations pertaining to corporate governance should be reviewed frequently to ensure that they are up-to-date with the changing times and are able to cope with the external environment.
  3. Rule for unlisted companies- There is a need to change the regulations on corporate governance to also include unlisted companies. However, it should also be kept in mind that such companies may not be able to retain the high compliance costs, so the compliances should be created in such a manner that they do not discourage people from indulging in business via companies. There should be a proper code of conduct which helps the unlisted companies in guiding their own policies.
  4. Precautionary approach rather than Curative approach- The regulatory bodies should not merely react on the happening of frauds or scam, but play a pro-active role in ensuring that the companies meet the compliance requirements and act ethically. Rather than imposing lawsuits as a cure to scams, the regulatory body should ensure a proper vigilance which will act as a precaution and prevent scams and frauds.
  5. Awareness of corporate governance rules- the companies should ensure that the directors who look after the company’s governance are well familiar with the policies under effective corporate governance. This will help the companies to implement a robust mechanism for governing. Awareness must be created amongst the management as well as employees of the corporate governance policies.
  6. Role of independent directors- The independent directors play a significant role in the company to protect the interests of all shareholders. Independent directors must be thoroughly trained by proper institutions to act as the representative of all the stakeholders, while also promoting the growth of the company. The independent directors should also be knowledgeable about the niche of the business and not just general governance.
  7. Unambiguous regulations for transparency- There is a need to introduce a clear legislation for the disclosure requirements for both the listed as well as unlisted companies. Under the present regime of the material test, many directors get away without disclosing relevant information. Furthermore, there is a lot of ambiguity surrounding disclosure requirements for unlisted companies which needs to be resolved.
  8. Emphasis on ethical company values- the company values should be ethical and emphasised upon at both the managerial as well as the worker level. Only those people should be hired who match the values of the company. This emphasis should be laid upon during the recruitment as well as the retention process.
  9. Removal of nepotism- Many times, because of nepotism, incompetent individuals are hired, leading to a loss in the company. A company should move away from nepotism as much as possible and lay emphasis on the person’s skills rather than the family background. This will help in making the company more ethical and sustainable.
  10. A strong whistle-blower mechanism- Every company should have a strong whistle blower mechanism which protects the individuals reporting the malpractices. The identity of such whistle-blowers should not be disclosed and people should be made aware of the corporate whistleblowing policy.
  11. Focus on cyber-security- In the present age and era of information technology, it is necessary to take proper safeguards in protecting the company’s data from cyber-attacks. Many companies do not focus in upgrading their privacy systems regarding their client and employee information. This may lead to data breaches and compromise the integrity of the company, as well as attract lawsuits.
  12. Utilization of funds for compliances- Many companies hesitate to invest their funds for corporate governance compliance due to the short-sightedness. However, with increasing use of funds for meeting compliances, a company is bound to perform better in the long run.
  13. Pro-active role of shareholders- The shareholders of the companies may be non-participative in the Annual General Meetings and do not provide any pressure on the management to work efficiently. This can be solved by active participation of the management, especially in the appointment of board of directors, in order to choose those candidates who will work for the benefit of the stakeholders, and not abuse their powers by colluding with the management.

Conclusion

Corporate governance goes beyond just complying with the rules and regulations. It involves the working of the management for the maximization of the profit of the shareholders while also ensuring sustainable development of the company. The challenges posed towards corporate governance can only be dealt with an effective and robust system of legislations as well as a strong and ethical corporate culture. The need of the hour is to implement the corporate governance policies for all public companies, while also having significant participation from the shareholders, board of directors and not just the management.


[1] Dr. Sanjiv Agarwal, ETHICS IN GOOD CORPORATE GOVERNANCE, Tax Management India (2009), https://www.taxmanagementindia.com/visitor/detail_article.asp?ArticleID=545 (last visited Feb 3, 2021).

Most Read Articles

Hey there!

come here often?

Login To Come In