What are the pillars of good governance?

This article discusses the importance of corporate governance and the four pillars of good governance and how it is important in the present day corporate world.
Estimated Reading Time: 8 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]

Corporate Governance in the present scenario has gained a lot of limelight and has become a necessity for organizations to include the same in their policies. Good Corporate Governance stands on four pillars.

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.
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Pillars of Good Governance

The 4 pillars of corporate governance are as follows-

Transparency

Transparency is necessary for any company to work efficiently. Disclosures of all the important information to the shareholders of the company keeps such shareholders in the loop and ensures informed decisions from the company executives. Transparency as one of the primary pillars of good governance was also conveyed by the Kumar Mangalam Birla Committee, 1999. A company is considered to have transparency if the material information is available to those people whose decisions will be influenced by such information. The information should also be available in such a manner that it can be easily understood by the persons involved.

There are two kinds of disclosure requirements to ensure transparency in case of listed companies under Regulation 30 of the Listing Regulation, 2015-

  1. Events to be disclosed mandatorily- These kinds of disclosures are mandatory in nature. It does not matter whether they pass the materiality test or not, a company is bound to disclose such events. Some of these events are-
  2. Outcomes of board meetings;
  3. Change of directors or Key Managerial Personnel;
  4. Fraud;
  5. Mergers and acquisitions;
  6. Agreements which deviate from the ordinary course of business;
  7. Corporate debt restructuring, etc.
  8. Events to be disclosed on applying the materiality test- Some events are only to be disclosed depending on whether the meet the criteria of the materiality test. As per the materiality test, the criteria for material disclosures provides that any event which is not disclosed would lead to-
  9. Alteration of information available to public;
  10. A substantial reaction from the market if disclosed later on; and
  11. If the board of directors considers such event to be material in nature.

It is mandatory for companies to form a policy for determining materiality as per the Listing Regulations, 2015.

Accountability

Accountability at every level allows an organization to work efficiently. It is necessary not only in the case of government companies, but also other types of companies, especially, where the public’s capital is involved. This accountability is often dependent on the structure of the company as laid down in the Articles and Memorandum of Association of the company.

The mandatory segregation between the Board of Directors and shareholders helps in ensuring that the Directors who look after the governance of the company work in compliance with the company’s memorandum of association and articles of association, by making the governing body accountable to the shareholders. Furthermore, in companies where there is a segregation between the Board of Directors and the Management body, makes the management accountable to the governing body, thereby ensuring the prevention of misuse of powers.

Moreover, along with internal accountability, there is external accountability of the company to its various stakeholders like the government, environment, etc. The compliance with legal provisions makes sure that the company is being held accountable to the external stakeholders as well.

If there is no accountability in the company, it may fall prey to abusive directors who misuse the resources of the company for their own gain. It may also lead to family members holding key positions and benefitting themselves while fooling the stakeholders. Therefore, accountability is a must in any company.

Fairness and equity

Fairness allows for equitable treatment of the stakeholders inside-out, i.e. equitable treatment to the society as well. It is important for a company to give equitable treatment to all the stakeholders, and not merely the major shareholders. Even the employees and the minority shareholders should be treated fairly. For the protection of minority shareholders, there are certain provisions in the Companies Act, 2013.

  1. Section 235– The power to acquire the shares of dissenting shareholders-

This provision, r/w Section 232(7)(e) provides that exit offer has to be provided to the minority shareholders who have dissented to the scheme.  This is also known as minority squeezing out. Such offer is a lucrative exit offer which provides the dissenting shareholders with the same value at which the shareholders are being allotted new shares. This value is greater than the market value. It is the duty of the Tribunal to ensure that the offer is lucrative in nature.

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Where the majority holds at least 90% of the shares, they have the option to acquire the remaining 10% shares of the minority shareholders either at their own violation or at the request of such minority.

  • Section 236(8)- In such a case, if the price is negotiated at a higher value, the majority shareholders have to pay such value.
  • Oppression and mismanagement- The minority shareholders can also file a suit for oppression or mismanagement under Section 241 r/w Section 244, where they believe that such a scheme is against the interest of the company. A class action suit can also be filed under Section 245.
  • Duty of Court

Miheer Mafatlal v. Mafatlal Industries (1996)- The members of the class must satisfy that they are acting in a bona-fide manner and not coercing the minority to further their own interests. The Court has a duty to ensure that the scheme is fair and just for all the classes involved.

Mafatlal Industries Ltd. In re. (1995)- The Court has a substantial supervisory role to ensure that the scheme is not against the interests of the company.

  • Takeovers- The SEBI has power to appoint an investigating officer to see into the matter either on their own volition or at the request of persons whose interests are involved in a takeover.
  • Section 230– Aggrieved persons can file an application to the Tribunal under Section 230(12) of the Companies Act.

Responsibility

There are certain duties that are cast on the directors of a company which impose responsibility on the directors. Any contravention of such responsibilities would lead to the penalization of the directors involved. Section 166 of the Companies Act, 2013 prescribes the duties of a director as-

  1. To act as per the Articles of Association of the company;
  2. To act in good faith;
  3. To work for the benefit of the company;
  4. To not make any undue gains or benefits;
  5. To not assign the office to another person as per his own wishes.

Furthermore, there are certain provisions under the Companies Act, 2013 which impose the personal liability of a director, especially in cases of fraud under Section 447.

Advantages of ensuring good governance

  1. Prevention of legal liability- a company which is ethical and follows a good governance pattern will be able to prevent various kinds of legal liabilities, especially pertaining to fraud. Thereby, saving the company from various litigation costs.
  2. Company growth- it is evident from various studies that a good corporate governance structure leads to a better company growth. People are willing to invest in those companies which are able to gain their trust by having a good governance structure and balancing the interests of the stakeholders. This leads to higher stock prices due to greater demand and company growth.
  3. Reduction of risk- a good governance helps to reduce the risk in the company as the company policies are such that they are able to factor in changing circumstances.
  4. Better public image- a company which balances the interests of all the stakeholders also achieves a better public image, which consequently drives up profits of the company as well as the interest of investors in the company.

Conclusion

A growing company needs to incorporate the four pillars of good corporate governance into their policies. This will help in not only meeting the legal compliances, but also providing other advantages to the company. Even if the company is not a public company, which has to mandatorily meet with some of these requirements, it is advisable to integrate the pillars of good corporate governance in the functioning and the governance of the company.


[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).

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