TABLE for a change in the corporate

 

 
TABLE OF CONTENTS
 
Abstract 2
Introduction. 3
Corporate
Governance and Independence of the Board of Directors. 4
Importance of Independence of Board of Directors in Corporate Governance  6
Corporate
Governance by Board of Directors in India. 7
Conclusion. 7
References. 8
 

                                                
                               

 

 

 

Abstract

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World over, analysts are intrigued by the
inability to anticipate internal crisis in time and act judiciously to put the business
back on track before complications become permanent. Even in India, the
attention has once again shifted to working of corporate boards as well as on
the discussion on the privileges and duties of members of the board following
the Satyam Scandal1
where the chairman had falsified the accounts of the company. The present paper
analyses certain significant policy issues concerning the independence of the
board of directors. Further, this paper strives to showcase India’s advancement
with respect to the implementation of global best practices for the
constitution and working of self-determining board of directors.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Introduction

Corporate Governance is a procedure that
is in place for the companies centred on various arrangements and values by
which a company is administered. These principles guarantee that the
organisation is run so as to attain prime productivity while also enriching the
company and the people involved as well as profiting the investors and
stakeholders in the long run. 

 

Owing to certain huge scandals in the
corporate sector, in world renowned companies along with the East Asian crisis
of the early nineties, the growing attempts of remodelling the existing
governance systems, worldwide. Around the world, one of the common factors in
all the biggest business disasters has been the “failure of the board of
directors of a corporation to detect internal crisis early on and act in a
timely manner to put the organization back on track before difficulties become
irreversible”.2 The
attention on the working of corporate boards along with a deliberation on the privileges
and accountabilities of board members has been renewed in India after Satyam
Computer Services failed to disclose assets, reportedly to the tune of Rupees
Seven Thousand Crore, over a period of seven years as admitted by Mr. Byrraju
Ramalinga Raju, the then Chairman of the company.3
The highly publicised corporate governance failure scams like the UTI scam,
Ketan Parikh scam4
along with the Satyam scam, which were relentlessly condemned by the
stakeholders, called for a change in the corporate governance machinery in the
country and to make it more transparent for everybody  involved.5

 

Therefore, it does not come as a
surprise that multiple efforts have been made to improve and modify corporate
boards of public enterprises to make them more adept, both operationally and
mechanically, to better relations between shareholders and managers or owners, after
each corporate scandal and the disaster that follows. These modifications have
included an entire array of changes and alterations developing over time to
assist with the constitution and working of corporate boards, the most vital of
which are principles intended to ensure freedom of the board from the inner
management and bettering the quality of board governance.

Corporate Governance and Independence of the
Board of Directors

The
source of the problem in the corporate governance machinery is due to the
difference of possession and control in public companies owned by a number of minor
and isolated shareholders who deputise their duty of looking after the daily
functioning of the corporation to professional managers. As these shareholders deem
it expensive and do not have the motivation to look after the management of the
company, there is a possibility of the managers acting in accordance with their
own vested interests instead of looking out for the shareholders. White-collar
deviousness inflicts agency costs, exhibited in unremarkable and frequently
untraceable activities undertaken by them like increasing the firm size further
than the prime level, incurring privileges and benefits, or encouraging
administrative arrogance, all of these prove to be extremely beneficial for
then as private individuals but add no value to the firm and are hence harmful
for the shareholders.

As per Section 1496
every company should have a Board of Directors which is made up of individual
directors. A public company should have at least three directors and a private
company should have at least two directors. However, in case of one man company
a single director is necessary. There cannot be more than fifteen directors. In
the case where a company wishes to appoint more than fifteen directors then it
must pass a special resolution. The Indian government may direct a category or
categories of companies who are to have at least one woman director. These
requirements have to be complied with within a year of enforcement of the 2013
Act. Each company should have at least one director who has lived in India in
the previous year for a minimum of 182 days.

The board
of directors play a particularly important role in administrative mechanisms by
lining up the interests of managers and shareholders. The key functions of the
board, are to outline and describe a company’s purpose, to make the necessary
blueprints and strategies to attain that purpose, to engage the chief
executive, to observe and evaluate the performance of the executive team and
lastly to gauge their own performance.7
The unanimously recognised opinion is that the board of directors, in
implementing these functions acts as fiduciaries of shareholders’ and other
stakeholders’ interest.

In
any case, the crux of the agency complications that a board facilitates differs
for companies with a big public sector shareholding from those with a more
concerted shareholding base. In big public sector shareholding companies mostly
based in the US and the UK, the board’s main function is that of “vertical
governance” that involves functioning in such a way which capitalizes
shareholders’ wealth and minimizes administrative deviousness8.
On the other hand, in businesses with concerted shareholding base, the board performs
“horizontal governance”, which basically entails facilitating among
the principal shareholders who make up the management, and the external
shareholders and avoid exploitation of the non-managerial shareholders.9
This right here is the prime example of the problem in corporate governance
faced by most of the developed countries and a lot of developing countries like
India. Here, businesses owned by families which belong to big business groups
overpower other corporations and family members with considerable stake in the
businesses work as major administrators and control the businesses.

All
in all, the board of directors is essentially responsible to make sure that the
rights of the shareholders are intact and are not exploited to serve the
personal needs of the administration or some major shareholder. The beneficiary
at the end should be the shareholder and not the internal management. This is
the reason why there’s a call for independent board of directors, world over.

Importance of Independence of Board of
Directors in Corporate Governance

There
is no doubt that in the twenty first century the clamour for board of directors
has become louder. This is especially evident in India where companies have
been employing board independence in the hopes of a marked improvement in the
performance of the company. However there is absolutely no empirical evidence
that board independence improves the performance in the company. This is true
not only in India but in countries where board independence has been a long standing
tradition such as United States. The practice of bringing in outside directors
rests more on faith rather than evidence. It cannot be attributed to any study
or practical example of marked improvement in performance. This is not to say
that there is absolutely no foreseeable benefit of having an independent board.
The results of studies10
have been varied, while some studies11
argue that independent boards improve performance in areas such as discrete
hiring and firing of Chief Executive Officers, hostile take overs and
determining Chief executive officers compensation other studies12
simply do not agree put forward the opinion that a higher number of inside
directors have better effect on performance of the company.13
These studies have advocated that state mandated director pushing for
independence do more damage to the company than good. The evidence for this in
developed countries such as US and UK with wide spread ownership is abundant
and hard to ignore. In Japan and Continental Europe where there is more
collective ownership, there is lesser evidence.

Corporate
Governance by Board of Directors in India

In
India, guidelines for the board of directors for all listed corporations are set
in place by the Companies Act14,
and some supplementary rules pertinent to certain registered companies are put
in place by The Securities and Exchange Board of India the Listing Agreement.15
This Clause was implemented in February 2000 due to certain observations made
by Kumara Managalam Birla16.

In
India the evidence is still coming in. The government mandated independence
came only in 2003 which was subject to revision in 2008. The evidence is
therefore based solely on data of large companies and their surveys. These
reports suggest that earning management is influenced by quality of directors.
This is manifested by their diligence, earnest and independence. This raises
the standard of work and the directors devote more time to find quality
solutions to issues faced by the company. Thus it is plainly evident that there
is a mismatch between policy making and ground reality. This gap has caused a
lot of confusion and ambiguity as to how to progress with this complex problem.
To what proportion in independence required if required at all. What is the
future of Independent boards?

The
answer is two-fold, the first being the logical and econometric solution to
find the usefulness and functionality of the process through a purely
mathematical point of view. This would depend on statistical growth and capital
gains for evidence. The second is the absence of a measurement to show
connection between board performance and board independence. There simply has
not been enough research as to how boards are different from each other and if
an independent board has the same quality or skilled people as an insider
board. Thus without such data and empirical evidence it becomes an extremely
onerous task to find the success of independent boards as opposed to insider
boards. Apart from this there is a further problem of the genuineness of the
independence. Being independent on paper and having actual independence are
very different. There exist many loopholes for companies to show inside men as
independent. 

Conclusion

Companies
with a good track record when it comes to corporate governance enjoy the trust
and assurance of their shareholders. Dynamic and autonomous directors paint an
optimistic picture of the company which in turns makes the prices of the shares
soar. One of the vital factors considered by foreign investors while investing
in the Indian market is to look at the corporate governance mechanism of
companies they are interested in investing.

The
Indian Companies Act of 2013 put into effect ingenious methods to maintain a balance
between statutory and governing alterations for the development of the
corporation whilst making sure that the foreign direct investment grows by
keeping in mind foreign customs and conventions. The provisions of the Act make
sure that there is more participation of the stakeholders in the decision
making which in turn makes the whole process very accessible and transparent.
This protects the rights and interests of the shareholders and increases
investment in the company as well.

Corporate
governance protects and benefits both the shareholders as well as the administration
of the company and ushers in a new era of financial safety and growth in India,
plummeting it into the league of the top economies of the world

 

 

 

 

 

 

References

Ø  Books
Referred

1)     
New
Company Law By S.C. Tripathi

2)     
Company
Law and Practice, 21st Edition, By G.K. Kapoor and Sanjay Dhamija

Ø  Database
Referred

1)     
SCC
Online

2)     
Manupatra

3)     
JSTOR

Ø  Legislation

1)     
The
Companies Act, 2013

2)     
The
Securities and Exchange Board of India Act, 1992

Ø  Cases
Referred

1)     
Satyam
Computer Services Ltd. Vs. Central Board of Direct Taxes and Ors, (2011) 15 SCC
522.

2)     
Bank of
India vs. Ketan Parikh and others, AIR 2008 SC 2361

Ø  Publications

1)     
Bhagat,
Sanjai & Bernard Black, “The Non-correlation between Board Independence and
Long- term Firm Performance”, The Journal of Corporation Law, 27: 231-27,
(2002).

2)     
Hermalin,
Benjamin E. & Michael S. Weisbach, “The Effects of Board Composition and
Direct Incentives on Firm Performance”, Financial Management 20: 101-12,
(1991).

3)     
Roe,
M., “The Institutions of Corporate Governance”, Discussion Paper No. 488,
Harvard Law School (2004).

4)     
Byrd,
J. & K. Hickman, “Do Outside Directors Monitor Managers? Evidence from
Tender Offer Bids”, Journal of Financial Economics (October, 1992).

5)     
Dahya,
J. & McConnell, “Board Composition, Corporate Performance, and the Cadbury
Committee Recommendation”, Working Paper No. 2003-003, Purdue University
(2003).

6)     
Jensen,
Michael, “The Modern Industrial Revolution, Exit, and the Failure of Internal
Control Systems”. The Journal of Finance (July, 1993).

7)     
Kumara
Managalam Birla Committee, “Report on Corporate Governance”, 1999.

8)     
The
Cadbury Committee, “Report on the Financial Aspects of Corporate Governance”,
1992.

9)     
McRitchie,
James, “Corporate Governance in India”, (May 12, 2015),
https://www.corpgov.net/2015/05/corporate-governance-in-india/.

 

 

 

 

 

 

 

 

1 Satyam Computer Services Ltd.
Vs. Central Board of Direct Taxes and Ors, (2011) 15 SCC 522.

2 Jensen, Michael, “The
Modern Industrial Revolution, Exit, and the Failure of Internal Control
Systems,” The Journal of Finance (July, 1993).

3 Id.at 3.

4 Bank of India vs. Ketan Parikh and others, AIR 2008 SC 2361.

5 McRitchie, James, ‘Corporate Governance
in India’, (May 12, 2015),
https://www.corpgov.net/2015/05/corporate-governance-in-india/.

6 The Companies Act, 2013.

7 The Cadbury Committee, ‘Report
on the Financial Aspects of Corporate Governance’, 1992.

8 Roe, M.,’The Institutions of
Corporate Governance’, Discussion Paper No. 488, Harvard Law School (2004).

9 Id. at 6

10 Byrd, J. & K. Hickman,’Do
Outside Directors Monitor Managers? Evidence from Tender Offer Bids’, Journal
of Financial Economics (October, 1992).

11 Dahya, J. & McConnell, ‘Board
Composition, Corporate Performance, and the Cadbury Committee Recommendation’,
Working Paper No. 2003-003, Purdue University (2003).

12 Bhagat, Sanjai & Bernard
Black, “The Non-correlation between Board Independence and Long- term Firm
Performance”, The Journal of Corporation Law, 27: 231-27, (2002).

13 Hermalin, Benjamin E. &
Michael S. Weisbach, “The Effects of Board Composition and Direct
Incentives on Firm Performance”, Financial Management 20: 101-12, (1991).

14 The Companies Act, 2013.

15 Clause 49, The Securities and
Exchange Board of India Act, 1992.

16 Kumara Managalam Birla
Committee, “Report on Corporate Governance”, 1999.

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