Chapter Seven

Corporate Ethics: Good Governance

WHAT IS CORPORATE GOVERNANCE?

Corporate governance is typically perceived by academic literature as dealing with “problems that result from the separation of ownership and control.”¹ From this perspective, corporate governance would focus on: The internal structure and rules of the board of directors; the creation of independent audit committees; rules for disclosure of information to shareholders and creditors; and, control of management. Figure 7.1 explains how a corporation is structured.

DEFINITIONS OF CORPORATE GOVERNANCE

Though the concept of corporate governance sounds simple and unambiguous, when one attempts to define it and scan the available literature to look for precedence, one comes across a bewildering variety of perceptions behind the available definitions. The definition varies according to the sensitivity of the analyst, the context of varying degrees of development, and from the standpoint of academics versus corporate managements. However, there is an underlying uniformity in the thinking of all analysts that there is a definite need to eradicate corporate misgovernance and promote corporate governance at all costs. It is not only the stakeholders who are keenly interested in ensuring adoption of best governance practices by corporations, but also societies and countries worldwide.¹

Sir Adrian Cadbury, Chairman of the Cadbury Committee defined the concept thus: “Corporate governance is defined 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 objective of corporate governance is to ensure, as far as possible, the interests of its stakeholders—enable individuals, corporations and society. It will enable corporations realize their aims and attract investment. From the standpoint of States, it will strengthen their economies, even while discouraging fraud and mismanagement.²

Experts at the Organization of Economic Cooperation and Development (OECD) have defined corporate governance as “the system by which business corporations are directed and controlled”. The structure of corporate governance, according to them, “specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs”. Such specifications define company objectives, provide a means to achieve the objectives and monitors performance.³ OECD’s definition, incidentally is consistent with the one presented by the Cadbury Committee.

These definitions which are shareholder-centric capture some of the most important concerns of governments in particular and the society in general. These are (i) management accountability; (ii) providing adequate investments to management; (iii) disciplining and replacement of bad management; (iv) enhancing corporate performance; (v) transparency; (vi) shareholder activism; (vii) investor protection; (viii) improving access to capital markets; (ix) promoting long-term investment; and (x) encouraging innovation.

According to the World Bank corporate governance can be defined from two aspects, namely, corporation and public policy. Defining from the perspective of a corporation, corporate governance is relations between owners, management board and other stakeholders (the employees, customers, suppliers, investors and communities) where emphasis is given to the board of directors to balance their interests to achieve long-term sustained value. From a public policy perspective, corporate governance refers to providing for the survival, growth and development of the company, and at the same time, its accountability in the exercise of power and control over companies. The role of public policy is to discipline companies and simultaneously initiate minimization of differences between private and social interests.⁴ The OECD also offers a broader definition: “ … Corporate governance refers to the private and public institutions, including laws, regulations and accepted business practices, which together govern the relationship in a market economy, between corporate managers and entrepreneurs (‘corporate insiders’) on one hand, and those who invest resources in corporations, on the other.”⁵

Fewer concerns are more critical to international business and developmental strategies than that of corporate governance. A series of events over the last two decades have placed corporate governance issues at centre stage as of paramount importance both for the international business community and financial institutions. It has become the cynosure of all issues connected with corporations. Successive business failures and frauds in the United States, several high-profile scandals in Russia and the Asian crisis have brought corporate governance issues to the forefront in developing countries and transitional economies. Further, national business communities are gradually realizing the fact that there is no substitute for getting the basic business and management systems in place in order to be competitive in the global market and to attract investment.

DESIDERATA OF CORPORATE GOVERNANCE

The OECD has emphasized the following requirements of corporate governance:

Rights of Shareholders

The rights of shareholders that have been stressed as important for ensuring better corporate governance by all writers and organizations including the World Bank and Asia Pacific Economic Cooperation (APEC) include secure ownership of their shares, voting rights, the right to full disclosure of information, participation in decisions on sale or any change in corporate assets (including mergers) and new share issues. Shareholders have the right to know the capital structures of their corporation and arrangements that enable certain shareholders to obtain control disproportionate to their holding. All transactions should be at transparent prices and under fair conditions. Anti-takeover devices should not be used to shield the management from accountability. Institutional shareholders should consider the costs and benefits of exercising their voting rights.

Equitable Treatment of Shareholders

The OECD and other organizations such as the APEC have stressed the point that all shareholders including minority and foreign shareholders should get equitable treatment and have equal opportunity for redressal of their grievances and violation of their rights. Shareholders should not face undue difficulties in exercising their voting rights. Any change in their voting rights should be subject to a vote by shareholders. Insider trading and abusive self-dealing that are repugnant to the principle of equitable treatment of shareholders should be prohibited. Directors should disclose any material interests regarding transactions. They should avoid situations involving conflict of interest while making decisions. Interested directors should not participate in deliberations leading to decisions that concern them.

Role of Stakeholders in Corporate Governance

The OECD guidelines, as also others on the subject of corporate governance, recognize the fact that there are other stakeholders in corporations apart from shareholders. Apart from dealers, consumers and the government who constitute the stakeholders’ group, there are others too who ought to be considered. Banks, bondholders and workers, for example, are important stakeholders in the way in which companies perform and make decisions. Corporate governance framework should, apart from recognizing the rights of shareholders, allow employee representation on the board of directors, profit sharing, creditors’ involvement in insolvency proceedings, etc. Where there is such stakeholder participation, it should be ensured that they have access to relevant information.

Disclosure and Transparency

The OECD lays down a number of provisions for the disclosure and dissemination of key information about the company to all those entitled for such information. These may range from company objective to financial details, operating results, governance structure and policies, the board of directors, their remuneration, significant foreseeable risk factors and material issues regarding employees and other stakeholders. The OECD guidelines also spell out that annual audits should be performed by independent auditors in accordance with high quality standards.

Like the OECD, the APEC also provides guidelines on the establishment of effective and enforceable accountability standards, timely and accurate disclosure of financial and non-financial information regarding company performance.

Responsibilities of the Board

The OECD guidelines explain in detail the functions of the board in protecting the company, its shareholders and its other stakeholders. These functions would include concerns about corporate strategy, risk, executive compensation and performance, accounting and reporting systems, monitoring effectiveness and changing them, if needed.

APEC guidelines include establishment of rights and responsibilities of managers and directors.

The OECD guidelines focus only on those governance issues that arise due to separation between ownership and control of capital. Though these have limited focus, they are comprehensive, especially with reference to voting rights of institutional shareholders and obligations of the board to stakeholders. Though the APEC principles too reiterate them, they give foremost importance to disclosures. Again, instead of rights of shareholders, they reiterate the rights and also of the responsibilities of shareholders, managers and directors. To them, establishment of accountability standards is a separate principle by itself.

The broad objectives and principles of corporate governance may be the same to all societies, but when it comes to applying them to individual countries we have to reckon the peculiar features, socio-cultural characteristics, the history of its people, their value systems, economic system, political set-up, stage and maturity of development and even literacy rates. All these factors have an impact on both political and corporate governance systems. Superimposing the governance systems and procedures that are effective in mature Western democracies on transition economies will be inappropriate, ineffective and may even be inimical to the interests of the people these are intended to serve.

A HISTORICAL PERSPECTIVE OF CORPORATE GOVERNANCE

The seeds of modern ideas of corporate governance were probably sown by the Watergate scandal during the Nixon presidency in the United States. The need to arrest such unhealthy trends was translated into the legislation of the Foreign and Corrupt Practices Act of 1977 in America that provided for the establishment, maintenance and review of systems of internal control. In the same year, the Securities and Exchange Commission (SEC) proposed mandatory reporting on internal financial controls. In 1985, a series of high-profile business failures rocked the United States, which included the collapse of Savings and Loan. With a view to identifying the main causes of misrepresentation in financial reports and to recommend ways of reducing such incidences, the government appointed the Treadway Commission. The Treadway Report, published in 1987, highlighted the need for a proper control environment, independent audit committees and an objective internal audit system. As a result of this recommendation, the Committee of Sponsoring Organizations (COSO) came into being. COSO’s report in 1992 stipulated a control framework for the orderly functioning of corporations. Between the period 2000 and 2002, the revelations of corporate fraud in the United States were of such magnitude and inflicted such damage on investors that company reputations were irreparably destroyed and investor confidence dipped to a new low. The fraud and self-dealing revelations resulted in investigations by the Congress, the SEC, and the State Attorney General in New York and the emergence of the Sarbanes-Oxley Act (SOA) enacted into law on 30 July 2002.

A series of corporate scams and collapses in the late 1980s and the early 1990s made the United Kingdom realize that the existing rules and regulations were inadequate to curb unlawful and unfair practices of corporations. It was with this view a committee under the chairmanship of Sir Adrian Cadbury was appointed by the London Stock Exchange in 1991. The Cadbury Committee, consisting of representatives drawn from the echelons of British industry, was assigned the task of drafting a code of practices to assist corporations in England in defining and applying internal controls to limit their exposure to financial loss, from whatever cause it arose. The committee submitted its report along with the ‘Code of Best Practices’ in December 1992. In its globally well-received report, the committee elaborated the methods of governance needed to achieve a balance between the essential powers of the board of directors and their proper accountability. Though the recommendations of the committee were not mandatory in character, the companies listed on the London Stock Exchange were enjoined to state explicitly in their accounts, whether or not the code has been followed by them, and if not complied with, were advised to explain the reasons for non-compliance.

In India, the real history of corporate governance dates back to the year 1992, following efforts made in many countries of the world to put in place a system suggested by the Cadbury Committee. The corporate governance movement in India began in 1997 with a voluntary code framed by the Confederation of Indian Industry (CII). In the next three years, almost 30 large listed companies accounting for over 25 per cent of India’s market capitalization voluntarily adopted the CII code. This was followed by the recommendations of the Kumar Mangalam Birla Committee set up in 1999 by the Securities and Exchange Board of India (SEBI), culminating in the introduction of Clause 49 of the standard Listing Agreement to be complied with by all the listed companies in stipulated phases. The Kumar Mangalam Birla Committee divided its recommendations into mandatory and non-mandatory. Mandatory recommendations included such issues as the composition of board, appointment and structure of audit committees, remuneration of directors, board procedures, additional information regarding management, discussion and analysis as a part of the annual report, disclosure of directors’ interest, shareholders’ rights and the compliance level of corporate governance in the annual report. From 1 April 2001, over 140 listed companies accounting for almost 80 per cent of market capitalization were to follow a mandatory code which was in line with some of the best international practices. By April 2003, every listed company followed the SEBI code.

The Companies Amendment Act, 2000

Many provisions relating to corporate governance such as additional ground of disqualification of directors in certain cases, setting up of audit committees, Directors’ Responsibility Statement in the Directors’ Report, etc. were introduced by the Companies (Amendment) Act, 2000. Corporate governance was also introspected in 2001 by the Advisory Group constituted by the Standing Committee on International Finance Standards and Codes of the Reserve Bank of India under the chairmanship of Dr Y. V Reddy, the then Deputy Governor.

Naresh Chandra Committee, 2002

In the year 2002, a high-level committee was appointed to examine and recommend drastic amendments to the law involving the auditor-client relationships and the role of independent directors by the Department of Company Affairs in the Ministry of Finance and Company Affairs under the chairmanship of Naresh Chandra.

Narayana Murthy Committee, 2003

The Company Law Amendment Bill, 2003 envisaged many amendments on the basis of reports of the Naresh Chandra Committee and subsequently appointed the N. R. Narayana Murthy Committee. Both the committees have done an excellent job to promote corporate governance practices in India.

Dr J. J. Irani Committee Report on Company law, 2005

The Government of India constituted an Expert Committee on Company Law on 2 December 2004 under the Chairmanship of Dr J. J. Irani. Set up to structurally evaluate the views of several stakeholders in the development of company law in India in respect of the concept paper promulgated by the Union Ministry of Company Affairs, the J. J. Irani committee has made suggestions to reform and update the basic corporate legal framework essential for sustainable economic reform. The report has taken a pragmatic approach keeping in view the ground realities, and has sought to address the concerns of all the stakeholders to enable the adoption of internationally accepted best practices.

Recommendations of the J. J. Irani Committee

Some of the most significant recommendations of the Irani committee are:

• One-third of the board of a listed company should comprise independent directors.
• Allow pyramidal corporate structures, that is, a company which is a subsidiary of a holding company coul itself be a holding company.
• Give full liberty to the shareholders and owners of the company to operate in a transparent manner.
• The new company law should recognize principles such as ‘class actions’ and ‘derivative action’. There are proposals to devise an exit option for shareholders who have stayed with a company and not participated in a buy back scheme implemented earlier.
• Introduce the concept of One Person Company (OPC) as against the current stipulation of at least two persons to form a company.
• Allow corporations to self-regulate their affairs.
• Mandate publication of information relating to convictions for criminal breaches of the Companies Act on the part of the company or its officers in the annual report. Provide stringent penalties to curb fraudulent behaviour of companies.
• Disclose proper and accurate compilation of financial information of a corporation.

The history of corporate governance gives us an unforgettable lesson that vigilance and a continuing effort at building and strengthening it alone will give the investors the safetynet they require.

SIGNIFICANCE OF CORPORATE GOVERNANCE TO DEVELOPING COUNTRIES

Just as several developing countries are undergoing a process of economic growth, they are also witnessing a transformation in political and business relationships with regard to their industrial and commercial organizations, both in the private and public sectors. Economic and political compulsions are forcing them to move away from the hitherto closed, market-unfriendly and undemocratic set-ups to open, transparent, market-driven democratic systems. If they have to sustain long-term economic growth and development in such a situation, it is important that they establish good corporate governance mechanisms and practices that will enable their organizations realize maximum productivity and economic efficiency. Corporate governance systems and practices also will help them fight effectively corruption and abuse of power that are rampant in their societies and help them establish a system of managerial competence and accountability.

Nicolas Meisel has identified four priorities developing countries should concentrate on when they put into practice new forms of public and corporate governance. These are (i) since good and effective communication is a desideratum for the efficient functioning of any organization, they should not only enhance the quality of information, but also ensure that it is created fast and reaches the public speedily; (ii) ensure individual players maximum autonomy while seeing that they are accountable for their acts; (iii) if there is a hierarchical set-up to regulate private sector activities with a view to promoting public interest, new counterveiling powers should be set-up to fill this role; and (iv) the role of the State and how government officials are appointed to carry out the role, should be clearly defined in the interest of sustainable development.⁶

ISSUES IN CORPORATE GOVERNANCE

Corporate governance has been defined in different ways by different writers and organizations. Some define it in a narrow perspective to include in it only the shareholders, while others want it to address the concerns of all stakeholders. Some talk about corporate governance as being an important instrument for a country to achieve sustainable economic development, while some others consider it as a strategy for a corporate to achieve a long tenure and a healthy image. To people in developing societies and transitional economies, it is a necessary incentive to usher in more powerful and vibrant institutions of control. To some, it provides another dimension to corporate ethics and social responsibility of business. Thus corporate governance has become several things to several people. But to all, corporate governance is a means to an end, the end being long-term shareholder, and more importantly, stakeholder value. Thus, all authorities on the subject are one in recognizing the need for good corporate governance practices to achieve the end for which corporations are formed. They identify some governance issues as being crucial and critical to achieve these objectives. These are as follows.

Distinguishing the Roles of Board and Management

The constitutions of many companies stress and underline that business is to be managed ‘by or under the direction of’ the board. In such a practice, the responsibility for managing the business is delegated by the board to the CEO, who in turn delegates the responsibility to other senior executives. Thus, the board occupies a key position between the shareholders (owners) and the company’s management (day-to-day managers of the company’s resources). As per this arrangement, the board of a listed company has the following functions:

1. select, decide the remuneration and evaluate on a regular basis, and if necessary, change the CEO;
2. oversee (not directly, but indirectly) the conduct of the company’s business to evaluate whether or not it is being correctly managed;
3. review and, where necessary, approve the company’s financial objectives and major corporate plans and objectives;
4. provide advice and counsel to top management;
5. select and recommend candidates to shareholders for electing them to the board of directors;
6. review the adequacy of systems to comply with all applicable laws and regulations; and
7. review any other functions required by law to be performed.

Composition of the Board and Related Issues

The board of directors is a “committee elected by the shareholders of a limited company to be responsible for the policy of the company. Sometimes, full-time functional directors are appointed, each being responsible for some particular branch of the firm’s work.”⁷

The composition of the board of directors refers to the number of directors of different kinds who participate in the working of the board. Over time there has been a change as to the number and proportion of different types of directors in the board of a limited company. Figure 7.2 illustrates the usual composition of the board in recent times in most of the countries.

The Board of Directors of a company must have a optimum combination of executive and non-executive Directors with not less than 50 per cent of the Board comprising of non-executive Directors. The number of independent Directors should be at least one-third in case the company has a non-executive Chairman and at least half of the Board in case the company has an executive Chairman.

The SEBI-appointed Kumar Mangalam Birla Committee’s report defined the composition of the board thus: “The Committee recommends that the board of a company have an optimum combination of executive and non-executive directors with not less than fifty percent of the board comprising the non-executive directors. The number of independent directors (independence being as defined in the foregoing paragraph) would depend on the nature of the chairman of the board. In case a company has a non-executive chairman, at least one-third of the board should comprise independent directors and in case a company has an executive chairman, at least half of the board should be independent”.⁸

As shown in Fig. 7.2, for instance, an executive director is one who is an executive of the company and who is also a member of the board of directors, while a non-executive director has no separate employment relationship with the company. Independent non-executive directors are those directors on the board who are free from any business or other relationship, which could materially interfere with the exercise of their independent judgement in the process of decision making as a member of the board. An affiliated director or a nominee director is a non-executive director who has some kind of independence, impairing relationship with the company or the company’s management. For example, the director may have links with a major supplier or customer of the company, or may be a partner in a professional firm that supplies services to the company, or may be a retired top management professional of the company.⁹

Separation of the Roles of the CEO and Chairperson

The composition of the board is a major issue in corporate governance as the board acts as a link between the shareholders and the management and its decisions affect the performance of the company. Professionalization of family companies should commence with the composition of the board. All committees that studied governance practices all over the world, starting with the Cadbury Committee, have suggested various improvements in the composition of boards of companies.

It is now increasingly being realized that the practice of combining the role of the chairperson with that of the CEO as is done in countries like the United States and India leads to conflicts in decision making and that too much concentration of power in one person results in unsavoury consequences. In the United Kingdom and Australia, the CEO is prohibited from being the chairperson of the company. The role of the CEO is to lead the senior management team in managing the enterprise, while the role of the chairperson is to lead the board, one of the important responsibility of the board being to evaluate the performance of senior executives including the CEO. Combining the role of both the CEO and chairperson removes an important check on senior management’s activities. Besides, in large corporations, the job of the CEO as well as that of the chairman may be heavy and onerous and one person, with how much ever business acumen and astuteness, may not be able to deliver what he or she is expected to, competently, efficiently and objectively. That is the reason why many authorities on corporate governance recommend strongly that the chairman of the board should be an independent director in order to “provide the appropriate counterbalance and check to the power of the CEO”.¹⁰

Should the Board have Committees?

Many committees on corporate governance have recommended in one voice the appointment of special committees for (i) nomination, (ii) remuneration, and for (iii) auditing. These committees would lessen the burden of the board and enhance its effectiveness. According to the Bosch Report, committees, apart from having written terms of reference outlining their authority and duties, “should also have clear procedures for reporting back to the board, and agreed arrangements for staffing including access to relevant company executives and the ability to obtain external advice at the company’s expense.”¹¹

Appointments to the Board and Directors’ Re-election

As per the Company Law, shareholders elect directors to the Board. However, shareholders are a legion in large companies and also scattered, and to have them together to elect the directors will be expensive and time-consuming. Therefore, in actual practice, in most cases, the board or its specially constituted committee selects and appoints the prospective director and gets the person formally “elected” by the shareholders at the ensuing Annual General Body Meeting.

The shareholders in fact only endorse the board’s nominee and it is only in the rarest of rare cases that the shareholders refuse to ratify the board’s nominees for directorship. There are other issues of corporate governance in relation to the boards’ appointments such as: appointment of a nomination committee, terms of office, duties, remuneration and re-election of directors and composition of the board on which several committees have made their own recommendations.

Directors’ and Executives’ Remuneration

This is one of the mixed and vexed issues of corporate governance that first came to the centre-stage during the massive corporate failures in the United States between 2000 and 2002 and later reappeared with renewed vigour during the Wall Street crisis of 2008. Executive compensation has also in recent times become the most visible and politically sensitive issue relating to corporate governance.

The Cadbury Committee Report stressed that shareholders should be informed all details pertaining to board remuneration, especially directors’ entitlements, both present and future, and how these have been determined. Other committees on corporate governance have also laid emphasis on related issues such as ‘pay-for- performance,’ heavy severance payments, pension for non-executive directors, appointment of remuneration committee, and so on. ‘However, while controversy often surrounds the size or quantum of remuneration, this is not necessarily an issue of corporate governance—a payment that may be excessive in one context may be reasonable in another’. More important than the size and quantum of remuneration of top management, key issues of corporate governance would include (i) transparency, (ii) justifiability of the pay in the context of performance, (iii) the process adopted in determining it, (iv) severance payments, and (v) non-executive directors’ pensions.¹²

Disclosure and Audit

The OECD lays down a number of provisions for the disclosure and communication of ‘key facts’ about the company to its shareholders. The Cadbury Committee Report termed the annual audit as one of the corner stones of corporate governance. Audit also provides a basis for reassurance for everyone who has a financial stake in the company. Both the Cadbury Report and the Bosch Report stressed that the board of directors has a bounden responsibility to present to the shareholders a lucid and balanced assessment of the company’s financial position through audited financial statements. There are several issues and questions relating to auditing which have an impact on corporate governance. There are, for instance, questions such as (i) Should boards establish an audit committee? (ii) If yes, how should it be composed? (iii) How to ensure the independence of the auditor? (iv) What precautions are to be taken or what are the positions of the State and regulators with regard to provision of non-audit services rendered by auditors? (v) Should individual directors have access to independent resource? (vi) Should boards formalize performance standards? These questions are being answered with different perceptions and with different degrees of emphasis by various committees and organizations that have gone into and analysed these issues in depth.

Protection of Shareholder Rights and Their Expectations

This is an important governance issue which has considerable impact on the rights and expectations of shareholders. Corporate practices and policies vary from country to country. There are a number of questions relating to this issue such as: (i) Should companies adhere to one-share-one-vote principle always? (ii) Should companies retain voting by a show of hands or by poll? (iii) Can shareholder resolutions be ‘bundled’? That is, to place together before shareholders for approval a resolution that contains more than one discrete issue. (iv) Should shareholder approval be required for all major transactions? These questions have elicited answers with different emphases from various committees and organizations that have addressed these issues.

Dialogue With Institutional Shareholders

The Cadbury Committee recommends that institutional investors should maintain regular systematic contact with companies, apart from participating in general meetings of shareholders. They should use their voting rights positively, take a positive interest in the composition of the board of directors of companies in which they invest, and above all, recognize their rights and responsibilities as ‘owners’ who should act in the best interests of those whose money they have invested. Tehy should influence the standards of corporate governance by bringing about changes in companies when necessary, rather than by selling their shares. If institutional investors have to exercise their rights and carry out their responsibilities, companies have to provide them the required information and facilities for doing so.

Making a Socially Responsible Corporate—Investor’s Role

This is an issue that highlights a conflict between two schools of thought. One school of thought based on past experience, contends that institutional investors should act in the best financial interests of the beneficiaries. This is based on the assumption that socially responsible behaviour of corporations such as ecological preservation, anti-pollution measures and producing quality and environment-friendly products always enhance costs and thus reduce profits. But there is another school of thought which asserts environment friendliness and economic gains are not contradicting goals, but on the other hand, they benefit corporations in the long run and cite the examples of Ford Motors, Johnson & Johnson, Pfizer to prove their point. Much can be, and is being said, on both sides and though the last word is yet to be said on the issue, present thinking worldwide across continents and divergent societies strongly prefers corporations that are committed to the overall welfare of people in whose midst they work and make their gains.

MAJOR THRUST AREAS OF CORPORATE GOVERNANCE

The latest, revised OECD principles, place their thrust on six major areas of corporate governance: (i) they call upon governments to put in place an effective institutional and legal framework to support good corporate governance practices; (ii) they call for a corporate governance framework that protects and facilitates the exercise of shareholders’ rights; (iii) they strongly support equitable treatment of all shareholders including minority and foreign shareholders; (iv) they recognize the importance of the role of stakeholders in corporate governance; (v) they stress the importance of timely, accurate and transparent disclosure mechanisms; and finally (vi) they deal with board structures, responsibilities and procedures. All issues of corporate governance, of course, emanate from and centre around these six major thrust areas.

Need for and Importance of Corporate Governance

Many large corporations are multinational and/or transnational in nature. This means that these corporations have an impact on citizens of several countries across the globe. If things go wrong, they will affect many countries, albeit some more severely than others. It is, therefore, necessary to look at the international scene and examine possible international solutions to corporate governance difficulties.

Corporate governance is needed to create a corporate culture of consciousness, transparency and openness. It refers to a combination of laws, rules, regulations, procedures and voluntary practices to enable companies to maximize shareholders’ long-term value. It should lead to increasing customer satisfaction, shareholder value and wealth. With increasing government awareness, the focus is shifted from economic to the social sphere and an environment is being created to ensure greater transparency and accountability. It is integral to the very existence of a company.

Governance and Corporate Performance

Several studies in the US have found a positive relationship between corporate governance and corporate performance. That is, improved corporate governance is linked with improved corporate performance—either in terms of rise in share price or profitability. However, it would be overstating the case to say that these studies are conclusive, because other research has either failed to find a link or found it otherwise.

One difficulty in looking for statistical evidence of the value of good corporate governance is that governance is multi-dimensional. There are several different corporate governance mechanisms, which can inter-relate with and, sometimes, substitute for one another.

There are strong signs that the world’s business-ethical standards are becoming more stringent, and what constitutes good business practice is becoming clearer. Eleven years ago, Korn/Ferry International and the Columbia University Business School conducted a 20-country poll on 1,500 business executives. They were asked to look ahead and identify a list of the most important characteristics of the ideal corporate CEO for the year 2000. It was found that ‘ethics’ was right at the top of the list. Not anywhere else, but right at the top. The Conference Board in New York, together with the Institute of Business Ethics in London, did similar studies in 1992, and found 84 per cent of responding US firms had a corporate ethics code, followed by 71 per cent of UK firms, and 58 per cent for the rest. The figure for the UK grew particularly fast; four years earlier, it had been just 55 per cent. It seems that the business stress on ethics is a very Anglo-American phenomenon. As these two countries are arguably the trendsetters in the global economy, their way of doing business would eventually affect the rest of the world and, with innovations and modifications to suit different countries and markets, could even become the global norm.

In India too, there are several examples to illustrate the positive relationship between corporate governance and corporate performance, though this is the case with fewer companies and there is a long road to traverse for the entire Indian corporate sector as such. Among companies that have shown commendable success after introducing internationally acclaimed corporate governance practices are: Infosys Technologies Ltd that has consistently enhanced its performance and is a forerunner in espousing global governance standards; Tata Steel that which is recognized and rewarded not only in India, but also globally for its excellent corporate performance social commitment and activism; and Dr. Reddy’s Lab that which has excelled in all the important dimensions of corporate governance. There are several other group of companies belonging to the Tatas, Birlas, Murugappa’s, etc. in the private sector, and the oil companies in the public sector that have done India proud in the sphere of corporate governance.

Investors’ Preference for Good Governance

A recent large-scale survey of institutional investors found that a majority of investors consider governance practices to be at least as important as financial performance when they are evaluating companies for potential investment. Indeed, they would be prepared to pay a premium for shares in a well-governed company compared to a poorly governed company exhibiting familiar financial performance. In the US and the UK, the premium was 18 per cent while it was 27 per cent for Italian and 27 per cent for Indonesian companies (Global Investor Opinion Survey Key Findings, Mc Kinsey & Company, July 2002). Likewise, a survey by Pitabas Mohanty (Institutional Investors and Corporate Governance in India) has revealed that companies with good corporate governance records have actually performed better as compared to companies with poor governance records, and that institutional investors have extended loans to them easily. Another similar survey of institutional investors, globally, has also revealed governance to be an important factor in investment decision making

Significance of Corporate Governance to Developing Countries

Just as several developing countries are undergoing a process of economic growth, they are also witnessing a transformation in political and business relationships with regard to their industrial and commercial organizations, both in the private and public sectors. Economic and political compulsions are forcing them to move away from the hitherto closed, market unfriendly and undemocratic set-ups to an open, transparent, market-driven democratic system. If they have to sustain long-term economic growth and development in such a situation, it is important that they establish good corporate governance mechanisms and practices that will enable their organizations realize maximum productivity and economic efficiency. Corporate governance systems and practices also will help them fight effectively corruption and abuse of power that are rampant in such societies and enable them establish a system of managerial competence and accountability.

Nicolas Meisel has identified four priorities developing countries should concentrate on when they put into practice new forms of public and corporate governance. These are: (1) Since good and effective communication is a desideratum for the efficient functioning of any organization, they should not only enhance the quality of information, but also ensure that it is created fast and reaches the public speedily; (2) Ensure individual players maximum autonomy whilst seeing that they are accountable for their acts; (3) If there is a hierarchical setup to regulate private sector activities with a view to promoting public interest, new countervailing powers should be set up to fill this role; and (4) The role of the State and how government officials are appointed to carry out the role should be clearly defined in the interest of sustainable development (see Note 6).

STRATEGIES AND TECHNIQUES BASIC TO SOUND CORPORATE GOVERNANCE

Having understood the importance and significance of corporate governance to the growth and development of the corporate sector and orderly industrialization of a country, one should learn the various strategies and techniques necessary to ensure sound corporate governance practices. Some such strategies and techniques are found in several papers issued by the Basel Committee on Banking Supervision.¹³

The Basel Committee on Banking Supervision has issued papers on several topics such as principles for the management of interest rate risk (September 1997), framework for internal control systems in banking organizations (September 1998), enhancing bank transparency (September 1998) and principles for the management of credit risk (July 1999). Taken together, these documents have highlighted some strategies and techniques which are listed below:¹⁴

1. Corporations should cultivate values, develop codes of conduct and ethical behaviour and other standards of appropriate practices and put in place the system of governance with a view to ensuring their compliance.
2. A corporate strategy, appropriate and well-articulated, should be framed against which the success or otherwise of a business enterprise and the contribution of individual players can be measured.
3. Well-defined apportionment of responsibilities and assignment of decision making authorities, also specifying the hierarchy of required approvals from the level of employees to the board of directors.
4. Setting up a system to facilitate interaction and to ensure cooperation among senior management, the board of directors, and the auditors.
5. Establishing strong internal control systems, with both internal and external audit functions factored into it, risk management functions, which should be independent from business lines, and other checks and balances.
6. Ensuring a system monitoring of risk exposures where conflicts of interest are likely to arise including business relationships with borrowers connected to senior management, large shareholders, or key decision-makers within the firm (e.g., traders).
7. Instituting a scheme of financial and managerial incentives to act as a fillip to senior management, business line management and employees. These can be offered in the form of compensation, promotion and other means of recognition.
8. Ensuring the required information flows internally and to the public at large.

BENEFITS TO SOCIETY

Corporate governance brings to the society immensurable benefits. These benefits are as follows:

1. A strong and vibrant system of corporate governance can be a boon to society. Even in developing countries, where stocks of most firms are not actively traded on stock exchanges, adopting standards for transparency in dealing with investors and creditors is a major benefit to all stakeholders. Besides, it helps to prevent systemic banking crises.
2. Research has proved that in countries where strong corporate governance practices prevail, the system offers protections for minority shareholders and has led to large and highly liquid capital markets. Countries whose laws are based on not so mature legal traditions and on weak regulatory systems tend to evolve into a system in which most companies are controlled by dominant investors rather than a widely dispersed ownership structure. Hence, for countries that are trying to attract investors—whether domestic or foreign—corporate governance matters a great deal in getting the required funds out of potential investors.
3. It has been pointed out by many economists and management experts that competition in product markets as well as factor markets, especially for capital, act as constraints on unacceptable corporate behaviour. As a result, it promotes good corporate governance. In many developing countries, competition in products or goods markets is quite limited, especially where barriers exist. These ground realities further emphasize the importance of adopting the best possible corporate governance systems in countries where the market system is weak as in many developing countries, or yet to take proper shape as in many emerging economies. For instance, several Indian corporations that seek billions of dollars of foreign investments are prompted to put in their best corporate behaviour for that purpose.
4. Corporate governance is also an effective instrument for combating corruption. In many developing societies this is a very tough subject to deal with, since the tradition is very much ingrained in the system and could arouse political sensitivities and cause potential legal action. By following ethical and legal practices as envisaged by good governance, a serious attempt can be made to root out corruption and malfeasance.
5. Better corporate governance practices and procedures can bring about an improved management of the firm, especially in areas such as setting company strategy. Better corporate governance would also ensure that mergers and acquisitions are undertaken for strategic business reasons rather than for flimsy causes and that corporations’ compensation systems are made to reflect the performance of individual players.
6. Good corporate governance also would bring about improvements in management structure and systems. In many developing countries, there has been a tradition of involving the promoters directly in the management of the firms they helped to promote. For example, throughout Latin America and parts of Asia, including India, family business groups have been dominating business enterprises. However, this is now changing as a result of globalization, following the World Trade Organization’s liberalization rules, and the increasing integration of regional markets. Nowadays, firms in these countries are increasingly adopting modern management strategies, techniques and financial accounting systems. All of these inevitably lead to delegation of authority, paying increased attention to HR policies and use of modern management information systems, instead of the erstwhile centralized decision making structures.

BENEFITS TO CORPORATION

Good corporate governance secures an effective and efficient operation of a company in the interest of all stake-holders. It provides assurance that management is acting in the best interest of the corporation; thereby contributing to business prosperity through openness in disclosures and accountability. While there is only limited evidence to link business success to good corporate governance, good governance enhances the prospect for profitability. The key contributions of good corporate governance to a corporation include the following:

Creation and Enhancement of a Corporation’s Competitive Advantage

Competitive advantage grows naturally when a corporation or its services facilitate the creation of value for its buyers. Creating competitive advantage requires both the vision to innovate and the strategy to manage the process of delivering value. An effective board should be one that is able to craft strategies that fit the business environment of the corporation, is flexible to accommodate opportunities and threats, and to compete for the future. Corporations that develop their strategies by involving all levels of employees create widespread commitment to make the strategies succeed. Practical examples of strategies that create value to corporations are sales and marketing strategies, customer base and branding strategies. Coca Cola projects American values to its customers worldwide. Sony is reputed for the invention of new products. Johnson & Johnson and Procter & Gamble are world renowned as the largest manufacturers of quality personal hygiene products.

Enabling a Corporation Perform Efficiently by Preventing Fraud and Malpractices

The code of best practice—policies and procedures governing the behaviour of individuals of a corporation—form part of corporate governance. This enables a corporation to compete more efficiently in the business environment and prevents fraud and malpractices that destroy business from inside. Failure in management of best practice within a corporation has led to crises in many instances. The Japanese banks which made loans to property developers that created the bubble economy in the early 1990s, the foreign banks which granted loans to State-owned enterprises that became insolvent after the Asian financial crisis in 1997, and the demise of Barings are examples of managements not governing the behaviour of individuals in the corporation, leading to their downfall.

Providing Protection to Shareholders’ Interest

Corporate governance is a set of rules that focuses on transparency of information and management accountability. It imposes fiduciary duty on management to act in the best interests of all shareholders and properly disclose operations of the corporation. This is particularly important when ownership and management of an enterprise are in different hands, as in these corporations.

Enhancing the Valuation of an Enterprise

Improved management accountability and operational transparency fulfil investors’ expectations and enhance the confidence on management and corporations, increasing the value of these corporations.

Ensuring Compliance of Laws and Regulations

With the development of capital markets and increasing investment by institutional shareholders and individuals in corporations that are not controlled by particular shareholders, jurisdictions around the world have been developing comprehensive regulatory frameworks to protect investors. More rules and regulations addressing corporate governance and compliance have been and will be released. Compliance has become a key agenda in establishing good corporate governance. After all, corporate governance ensures the long-term survival of a corporation.

Contemporary Corporate Governance Situation

In the original concept of the company, the basis of corporate governance was shareholder democracy. Shareholders were relatively few and close enough to the board of directors to exercise a degree of control. Indeed in millions of smaller, tightly owned companies around the world, that is still the situation today.

But for major corporations, particularly those that have their shares listed on a stock exchange, the governance situation has practically changed. In many countries, the shares of public companies are now held by diverse shareholders—some by private individuals, some by institutional investors such as banks, pension funds and insurance companies, and some by other companies, who might have business relationships with the company. Ownership structures of major public companies around the world these days are often complex. The first step in understanding the reality of corporate governance in a given company is to understand the ownership structure and, hence, the potential to exercise power and influence over that company.

In the past, most institutional investors ignored their rights as shareholders, preferring to sell their shares rather than getting involved in challenging corporate performance. However, a trend in recent years has been for some institutional investors, particularly in the United States, Great Britain and Australia, to become proactive, calling for boards to produce better corporate performance, questioning directors’ remuneration, and calling for greater transparency on company finances and for more accountability from directors. Indeed, one US institutional investor, CalPERS (the Californian Public Employees Retirement System), has produced corporate governance guidelines for companies in France, Germany, Japan and the United States.

Growing Awareness and Societal Responses

The growing awareness of corporate governance around the world has been reflected in a plethora of official reports on the subject. These include the American Law Institute Report (1992), the Cadbury (1992), Greenbury (1995) and Hampel (1998) reports from the United Kingdom, the Hilmer report (1993) in Australia, the Vienot report (1995) in France, the King report (1995) from South Africa, the OECD report in 1998, as well as studies in Hong Kong, Singapore, Malaysia and elsewhere. In India, the corporate governance code was first laid out by the CII in the wake of interest generated by the Cadbury Committee report, followed by an in-depth study made by the Associated Chamber of Commerce (ASSOCHAM) and the SEBI. SEBI appointed the Kumar Mangalam Birla Committee and adopted its report in mid-2000. The Reserve Bank of India (RBI) also constituted its own committee to study problems and issues relating to corporate governance from the perspective of the banking sector. Based on the inputs from these committees, the Department of Company Affairs amended the Companies Act in December 2000 to include corporate governance provisions, which became applicable to all Indian companies effective from 1 April 2001.

Many of the official reports provide a code of best practices in corporate governance, detailing expectations on matters such as board structure, audit and audit committees, transparency in financial accounting and director accountability. Some institutional investors, particularly in the United States have also called for codes of corporate governance practices; the best known being the CalPERS’ Global Principles of Corporate Governance. Increasingly, to obtain access to international equity finance, companies around the world have to respond to the corporate governance requirements of these codes.

Meanwhile the debate on companies’ responsibilities to other stakeholders, other than their own shareholders, has been increasing in the United States and the United Kingdom; the Royal Society of Arts’ (RSA) Inquiry in the United Kingdom produced a study called ‘Tomorrow’s Company’ (1995), which suggested responsibilities to a wider range of stakeholders.

Further, most major companies now operate through group structures of wholly owned subsidiary companies, partly owned subsidiaries in which other external parties have a minority equity interest and associated companies in which the holding company has a significant, but not dominant holding. In addition, the globalization of business dealings has meant that major companies frequently engage in a variety of joint venture and other strategic alliances with other companies. The second step in understanding the reality of corporate governance in a given company is to understand the network of ownership throughout the group, identifying minority interests in group companies and partner interests in joint venture companies.

Other reasons for the growing concern about corporate governance include changing societal expectations about the social responsibility of private sector companies, the attention being paid to more participatory political systems at national government level and the potential of global communications and information technology to spread ideas and to provide information on companies. The past decade has also seen a massive increase in academic research on corporate governance. At the heart of the exercise of governance over companies is the governing body, typically called the board of directors. It is vital to appreciate the role of the board.

INDIAN MODEL OF CORPORATE GOVERNANCE

The Indian corporations are governed by the Companies Act of 1956 that follows more or less the UK model. The pattern of private companies is mostly that of a business concern closely held or dominated by a founder, his or her family and associates. Available literature on corporate governance and the way companies are structured and run indicate that India shares many features of the German/Japanese model, but recent recommendations of various committees and consequent legislative measures are driving the country to adopt increasingly the Anglo-American model. In terms of the legislative mechanisms, Indian government and industry constituted three committees to study corporate governance practices in the country and suggested measures for improvement based on what was globally recognized as ‘best practice’. Significantly, most of the recommendations of the three committees—the SEBI-appointed Kumar Mangalam Birla Committee (2000), the Government-appointed Naresh Chandra Committee (2003) and the SEBI’s Narayana Murthy Committee (2003) are remarkably similar to those of England’s Cadbury Committee and America’s Sarbanes-Oxley Act, in terms of their approaches and recommendations.

The thrust of the legislative reforms suggested by these committees and subsequent legislative actions adopted centre around the strengthening of external governance mechanisms. This would call for greater transparency of company accounts and their certification by independent auditors. Investors would have access to these transparent accounts, as envisaged the Anglo-American model. Investors continuing to remain in the company or quitting it will depend on the availability of accurate and reliable information. ‘Institutional reforms, including a strengthening of oversight committees and the development of a serious fraud office, are further evidence of the drive to seek external monitoring of corporate affairs’. With regard to reforms in internal mechanisms as in the case of board of directors it was recommended that non-executive directors should be given greater role, while checking the growth of non-executive directors, as seen in the Anglo-American practice.¹⁵

Further, experts point out that India has adopted the key tenets of the Anglo-American external and internal control mechanisms, in the wake of economic liberalization and its integration into the global economy. In the sphere of legislative framework, for instance, Indian government and regulators have been following more or less the recommendations of English and American committees on corporate governance. Moreover, a small number of high-profile Indian companies have adopted these recommendations on their own, mainly with a view to approaching international markets, the Anglo-American protocols on corporate governance.¹⁶ Thus corporate governance developments in India in recent years show a paradigm shift from the German/Japanese model to the Anglo-American model.

There are differences between the three models of corporate governance. The actual practices adopted by companies also vary. Ideas and practices of corporate governance are evolving fast around the globe. There is no preferred model of corporate governance.

In the Anglo-American model, all directors participate in a single board, comprising both executive and non-executive directors, in varying proportions. In the German model, there are two boards, of which the upper board supervises the executive board on behalf of stakeholders, and is societal-oriented. In this model, though the shareholders own the company, they do not entirely dictate the governance mechanism. They elect 50 per cent of the upper board, while the other 50 per cent is appointed by labour unions, giving employees a share in the governance of the company. In the Japanese model, shareholders and the main lending bank together appoint the president and the board of directors. The main bank has a substantial stake in the equity capital of the company. Indeed, given the entrance of high-calibre directors with relevant experience, appropriate board leadership and a shared vision for the company’s future, each of the models can prove effective, provided they are consistent with the overall corporate governance infrastructure in that country.

These various governance systems form a package of overall corporate control in each company law jurisdiction. It is vital to see the package as a whole. There has to be an integrated harmony between state legislation and regulatory infrastructure, stock market regulation and corporate self-regulation.¹⁷

WHAT IS ‘GOOD’ CORPORATE GOVERNANCE?

Recently, the terms ‘governance’ and ‘good governance’ are being increasingly used in development literature. Bad governance is being recognized now as one of the root causes of corrupt practices in our societies. Major donors, institutional investors, and international financial institutions provide their aid and loans on the condition that reforms that ensure ‘good governance’ is put in place by the recipient nations. As with nations, corporations too are expected to provide good governance to benefit all its stakeholders. At the same time, good corporations are not born, but are made by the combined efforts of all stakeholders, which include shareholders, board of directors, employees, customers, dealers, government and the society at large. Law and regulation alone cannot bring about changes in corporations and make them behave better to benefit all concerned. Directors and management, as goaded by stakeholders and inspired by societal values, have a very important role to play. The company and its officers, who, inter alia, include the board of directors and the officials, especially the senior management, should strictly follow a code of conduct, which should have the following desiderata:

Obligation to Society

A corporation is a creation of law as an association of persons forming part of the society in which it operates. Its activities are bound to impact the society as the society’s values would have an impact on the corporation. Therefore, they have mutual rights and obligations to discharge for the benefit of each other.

1. National Interest: A company and its management should be committed in all their actions to ensure that all their activities are beneficial to the development of the countries in which they operate.
2. Political Non-alignment: A company should be committed to supporting a democratic constitution and should not offer its funds to any political party or campaign.
3. Legal Compliances: The company should abide by the laws of the country in which it operates. It should abide by the tax laws of the nation and should pay all taxes imposed by the government as and when they become applicable.
4. Rule of Law: Fair, legal frameworks that are enforced impartially are very important for good governance. An impartial judiciary is an essential requisite for good governance.
5. Honest and Ethical Conduct: Every officer of the company should deal on behalf of the company with professionalism, honesty, commitment and sincerity as well as high moral and ethical standards.
6. Corporate Citizenship: A corporation should be committed to be a good corporate citizen not only in compliance with all relevant laws and regulations, but also by actively assisting in the improvement of the quality of life of the people in the communities in which it operates with the objective of making them self-reliant and enjoy a better quality of life.

   Such social commitment consists of initiating and supporting community initiatives in the field of public health and family welfare, water management, vocational training, education and literacy and encourages application of modern scientific and managerial techniques and expertise. The company should review its policy in this respect periodically in consonance with national and regional priorities. The company should strive to incorporate them as an integral part of its business plan and not treat them as optional or something to be dispensed with when inconvenient. It should encourage volunteering amongst its employees and help them to work in the communities. The company should develop social accounting systems and carry out social audit of its operations towards the community, employees and shareholders.

7. Ethical Behaviour: Corporations have a responsibility to set exemplary standards of ethical behaviour, both internally within the organization, as well as in their external relationships. Unethical behaviour corrupts organizational culture and undermines stakeholder value. The board of directors has a great moral responsibility to ensure that the organization does not derail from an upright path to make short-term gains.
8. Social Concerns: Corporations exist beyond the time of their founders, and have to set an example to their employees and shareholders. The company should not only think about its shareholders but also think about its stakeholders and their benefit. A corporation should not give undue importance to shareholders at the cost of small investors. They should treat all of them equally and equitably. The company should have concerns towards the society. It can help the needy people and show its concern by not polluting the water, air and land. The waste disposal should not affect any human or other living creatures.
9. Corporate Social Responsibility: Accountability to stakeholders is a continuing topic of divergent views in corporate governance debates. In line with developing an integrated model of governance for an ideal corporate, the emphasis should be laid on corporate social responsiveness and ethical business practices. These are not only the first small steps for better governance, but also the promise of a more transparent and internationally respected corporation of the future.
10. Environment-Friendliness: Corporations tend to be of an intervening, altering and transforming nature. For corporations engaged in commodity manufacturing, profit comes from converting raw materials into saleable products and vendible commodities. Metals from the ground are converted into consumer durables. Trees are converted into boards, houses, and furniture and paper products. Oil is converted into energy. In all such activities, a piece of nature is taken from where it belongs and processed into a new form. So companies have a moral responsibility to save and protect the environment. All the pollution standards have to be followed meticulously and organizations should develop a culture having more concern towards the environment.
11. Health, Safety and Working Environment: A company should be able to provide a safe and healthy working environment and comply in the conduct of its business affairs with all regulations regarding the preservation of the environment of the territory it operates in. It should be committed to prevent the wasteful use of natural resources and minimize the hazardous impact of the development, production, use and disposal of any of its products and services in the ecological environment.
12. Competition: A company should support the establishment of a competitive, open market economy in the country. It should also cooperate in efforts to promote the liberalization of trade by a country. It should not resort to unethical advertistments and practices in order to sell its products.
13. Trusteeship: The board of directors has the responsibility to act as trustees to protect the rights and interests of the shareholders as well as the company’s other stakeholders. They are duty bound to uphold the concept of equity. They have to ensure that the rights of all shareholders, large or small, foreign or local, majority or minority, are equally protected
14. Accountability: Accountability is a key requirement of good governance. Government institutions as well as private sector and civil society organizations must be accountable to the public and to their institutional stakeholders. In general, an organization or an institution is accountable to those who will be affected by its decisions or actions.¹⁸
15. Effectiveness and Efficiency: Corporations must concentrate on producing results that meet the needs of society while making the best and sustainable use of resources.
16. Timely Responsiveness: Good governance requires that institutions and processes try to serve all stakeholders within a reasonable timeframe. They should also address the concerns of all stakeholders and the society at large.
17. Corporations Should Uphold the Fair Name of the Country: When companies export their products or services, they should ensure that these are qualitatively good and are delivered on time. They have to ensure that the nation’s reputation is not sullied abroad during their deals, either as exporters or importers. They have to maintain the quality of their products, which should then become the brand ambassadors for the country.

OBLIGATION TO INVESTORS

That the investors, as shareholders and providers of capital, are of paramount importance to a corporation is such an accepted fact that it need not be overstressed here.

1. Towards Shareholders: A company should put in all possible efforts to enhance shareholder value and comply with laws that govern shareholder’s rights. Information should be disclosed to shareholders about all aspects of the company’s business in accordance with regulations.
2. Informed Shareholder Participation: A related issue of equal importance is the need to bring about greater levels of informed attendance and meaningful participation by shareholders in matters relating to their companies without, however, such freedom being abused to interfere with management decision. An ideal corporate should address this issue and relate it to more meaningful and transparent accounting and reporting.
3. Transparency: All decisions should be taken and enforced in an open manner. All rules and regulations must be followed. Efforts should be taken to ensure that information is freely available to those who are affected by decisions and their enforcement.
4. Financial Reporting and Records: A company should prepare and maintain accounts of its business affairs fairly and accurately in accordance with the accounting and financial reporting standards, and laws and regulations of the country in which the company conducts its business affairs.

Likewise, internal accounting and audit procedures shall fairly and accurately reflect all of the company’s business transactions and disposition of assets. All required information shall be accessible to the company’s auditors, non-executive and independent directors on the board and other authorized parties and government agencies. There shall be no wilful omissions of any transaction from the books and records, no advance income recognition and no hidden bank account and funds.

Such wilful material misrepresentation of and/or misinformation on the financial accounts and reports shall be regarded as a violation of the firm’s ethical conduct and invite appropriate civil or criminal action under the relevant laws of the land.

OBLIGATION TO EMPLOYEES

For too long, corporations in free societies had been adopting a ‘hire and fire’ policy in employment of men and women in their work places and hardly treated them humanely taking advantage of the fact that workers had a commodity, namely labour that was highly perishable with little bargaining power. But in the context of enhanced awareness of better governance practices, managements should realize that they have their obligations towards their workers too.

1. Fair Employment Practices: An ideal corporate should commit itself to fair employment practices, and should have a policy against all forms of illegal discrimination. By providing equal access and fair treatment to all employees on the basis of merit, the success of the company will be improved while enhancing the progress of individuals and communities. The applicable labour and employment laws should be followed scrupulously wherever they operate. That includes observing those laws that pertain to freedom of association, privacy, and recognition of the right to engage in collective bargaining, the prohibition of forced, compulsory and child labour, and also laws that pertain to the elimination of any improper employment discrimination.
2. Equal Opportunities Employer: A company should provide equal opportunities to all its employees and all qualified applicants for employment without regard to their race, caste, religion, colour, ancestry, marital status, sex, age, nationality, disability and veteran status. Its employees should be treated with dignity and in accordance with a policy to maintain a conducive work environment free of harassment, whether physical, verbal or psychological. Employee policies and practices should be administered in a manner that ensures that in all matters equal opportunity is provided to those eligible and the decisions are based on merit.
3. Encouraging Whistle Blowing: It is generally felt that if whistle-blower concerns had been addressed some of the recent disasters could have been avoided, and that in order to prevent future misconduct, whistle-blowers should be encouraged to come forward. So an ideal corporate is one that deals pro-actively with whistle-blowers making sure that employees have comfortable reporting channels and the confidence that they will be protected from any form of retribution. Such an approach will enhance the company’s chances to become aware of, and to appropriately deal with a concern before an illegal act has been committed, rather than after the damage has been done. If reporting is delayed, the company’s reputation can be seriously harmed and it can face a serious risk of prosecution with all its disastrous consequences. An ideal ‘whistle-blower policy’ would mean
   1. Personnel who witness an unethical or improper practice (not necessarily a violation of law) shall be able to approach the CEO or the Audit Committee without necessarily informing their supervisors.
   2. The company shall take measures to ensure that this right of access is communicated to all employees through means of internal circulars, etc. The employment and other personnel policies of the company should contain provisions protecting ‘whistle-blowers’ from unfair termination and other prejudicial employment practices.
   3. The appointment, removal and terms of remuneration of the chief internal auditor shall be subject to review by the audit committee.
4. Humane Treatment: Now corporations are viewed like humans and a similar kind of behaviour is expected of them. Companies should treat their employees as their first customers and above all as human. They have to meet the basic needs of all employees in the organization. There should be a friendly, healthy and competitive environment for the workers to prove their ability.
5. Participation: Participation by both men and women is the cornerstone of good governance. Participation could be either direct or through legitimate intermediate institutions or representatives. Participation needs to be informed and organized.¹⁸
6. Empowerment: Empowerment is an essential concomitant of any company’s principle of governance which stresses that management must have the freedom to drive the enterprise forward. Empowerment is a process of actualizing the potential of its employees. Empowerment unleashes creativity and innovation throughout the organization by truly vesting decision making powers at the most appropriate levels in the organizational hierarchy.
7. Equity and Inclusiveness: A corporation is a miniature of a society whose well-being depends on ensuring that all its employees feel that they have a stake in it and do not feel excluded from the mainstream. This requires all groups, particularly the most vulnerable, to have opportunities to improve or maintain their well-being.
8. Participative and Collaborative Environment: There should not be any form of human exploitation in the company. There should be equal opportunities for all levels of management in any decision making. The management should cultivate the culture where employees should feel they are secure and are being well taken care of. Collaborative environment brings peace and harmony between the working community and the management, which in turn, brings higher productivity, higher profits and higher market share.

OBLIGATION TO CUSTOMERS

A corporation’s existence cannot be justified without it being useful to its customers. Its success in the marketplace, its profitability and it being beneficial to its shareholders by paying dividends depends entirely on how it builds and maintains fruitful relationships with its customers.

1. Quality of Products and Services: The company should be committed to supply goods and services of the highest quality standards, backed by efficient after-sales service consistent with the requirements of customers to ensure their total satisfaction. The quality standards of the company’s goods and services should meet not only the required national standards but also endeavour to achieve international standards.
2. Products at Affordable Prices: Companies should ensure that they make available to their customers quality goods at affordable prices. While making normal profit is justifiable, profiteering and fattening on the miseries of the poor consumers is unacceptable. Companies should constantly endeavour to update their expertise, technology and skills of manpower to cut down costs and pass on such benefits to customers. They should not create a scare in the midst of scarcity or by themselves create an artificial scarcity to make undue profits.
3. Commitment to Customer Satisfaction: Companies should be fully committed to satisfy their customers and earn their goodwill to stay long in the business. They should respect in letter and spirit, warranties and guarantees given to their products and call back from markets, goods found to be sub-standard or harmful and replace them with good ones.

MANAGERIAL OBLIGATION

Managers are the kingpins of a corporation and play a pivotal role in ensuring that the policies of the company, as enunciated in the shareholders’ meetings and strategized by the board are translated into action for the benefit of all stakeholders. As such, they have a great deal of responsibility towards the corporation, as explained below.

1. Protecting Company Assets: The assets of the company should not be dissipated or misused but employed for the purpose of conducting the business for which they are duly authorized. These include tangible assets such as equipment and machinery, systems, facilities, resources as well as intangible assets such as proprietary information, relationships with customers and suppliers, etc.
2. Behaviour Towards Government Agencies: A company’s employees should not offer or give any of the firm’s funds or property as donation to any government agencies or their representatives directly or through intermediaries in order to obtain any favourable performance of official duties.
3. Control: Control is a necessary principle of governance that safeguards the freedom of management and enables it to be exercised within a framework of appropriate checks and balances. Control should prevent misuse of power, facilitate timely management response to change, and ensure that business risks are pre-emptively and effectively managed.
4. Consensus Oriented: The mediation of different interests in society to reach a consensus on what is in the best interest of the whole community is an essential facet of good governance. A good understanding of the historical, cultural and social contexts of a given society is essential to develop such a consensus.
5. Gifts and Donations: The company’s employees should neither receive nor make directly or indirectly any illegal payments, remuneration, gifts, donations or comparable benefits, which are intended to or perceived to obtain business or uncompetitive favours for the conduct of its business. However, the company and its employees may accept and offer nominal gifts, which are customarily given and are of a commemorative nature for special events provided the same is disclosed on time to the management.
6. Role and Responsibilities of Corporate Board and Directors: The role of the corporate board of directors as stewards of their stakeholders has gained significant importance in recent decades. Successive corporate failures, scams, debacles and other disasters have strengthened the demand for more transparency and accountability on the part of corporations. In the discharge of these onerous responsibilities, the corporate board has come to be regarded as the principal arbiter ensuring, on the one hand, that executive management creates wealth competently and through legitimate means, and on the other hand, such created wealth is equitably distributed to all shareholders after meeting the due aspirations of, and obligations to, other stakeholders.

   An ideal corporate calls for a greater role and influence for non-executive independent directors, a tighter delineation of independence criteria and minimization of interest-conflict potential and some stringent punitive punishments for executive directors of companies failing to comply with listing and other requirements.

7. Distinction between Direction and Management: It is necessary to distinguish the nature of the two basic components of governance, namely the policy making and oversight responsibilities of the board of directors and the executive and implementation responsibilities of corporate management comprising the managing director and his or her team of executives including functional directors. Executives who are also on the board as directors of the company in effect wear two hats, one as part of the board, and the other as part of the management. Directors derive their authority only when acting collectively as the board or when the board delegates specific authorities to be exercised as in the case of managing directors. Managers in the broadest sense of the term have the responsibility to execute the policies under the supervision of the board and for this purpose have the necessary authority to ensure compliance and implementation. An ideal corporate highlights this critical distinction particularly in the context of fixing responsibility for failure and the consequential liabilities that follow.
8. Managing Directors and Whole-Time Directors: Managing directors and other whole-time directors are required to devote whole or a substantial part of their time to the affairs of companies. And yet many of them serve as non-executive directors on several other boards. An ideal corporate affords the shareholders and stakeholders of the company the benefit of having their chosen executive’s full attention in the matters of the company. An ideal corporate must necessarily limit the nature and number of their other non-executive directorships.

The forgoing analysis of the duties, responsibilities and obligations of different stakeholders illustrates the complexities involved in the administration of modern corporations. Gone are the days when the society looked at corporations as forms of business enterprises working exclusively for the material benefit of its shareholders. With the broadening vision of modern thinkers and opinion makers and enhanced and heightened social values, it is now an unacceptable proposition that corporations exist purely for the profit of those who constituted it. They are expected to be transparent, accountable and even beneficial to the larger society. Their employees, consumers of their products, and associates in their business such as dealers and stockists, the communities surrounding their facilities and workstations are as important as those who contribute their capital. Corporations cannot any more ignore the concerns of the society such as the environment and ecology. And these concerns are no more community-based or country-specific. In a global village such as the one all of us are moving into, if a corporate has to survive, grow and wants to be counted, its vision should focus on the ways and means of becoming a responsible and responsive corporate citizen, and its mission could no more be myopic as it used to be in the past. The values, concerns, duties and responsibilities the society casts on the corporations are exemplified in the following beautifully formulated and well-articulated Credo of Johnson & Johnson (Box 7.1).

In the modern financial and business world, good corporate governance is not an optional extra. Good corporate governance is fundamental to raising capital, satisfying investors and running successful businesses in increasingly global markets. Good corporate governance is essential to all other stakeholders in the firm—employees, suppliers, customers, and bankers as well as to the local and national society for the provision of employment, the creation of wealth and the building of a modern state. Good corporate governance also encourages the levels of transparency, accountability and corporate social responsibility that is increasingly necessary for a modern nation.

LEGISLATIVE CHANGES

In the current era of globalization, Indian companies have to compete with global companies as well as inspire confidence in domestic and foreign investors. A legal framework that inspires confidence in investors, both domestic as well as foreign has become essential. The Department of Company Affairs (DCA) has taken several steps including legislative changes and modernization of services for the ease of investors. Several changes have been made to corporate law. The Companies Act, 1956, has been amended thrice since 1999 and some further amendments are under consideration to give effect to the policy of liberalization.

A bill was introduced by the Indian government in August 2001 to provide a legislative framework for the formation and conversion of cooperative business into companies. The bill was passed by the Parliament in 2001.The bill was introduced after deliberations by a high-level committee constituted by the government. The legislation is intended to provide primary producers an opportunity to produce and market goods in a professional manner by forming a new kind of business organization that would enhance their efficiency and competitiveness in global markets.

The government constituted a committee to examine the laws relating to the winding up of companies. A bill was passed in August 2001 which provided for the constitution of a company law tribunal called National Company Law Tribunal (NCLT). The jurisdiction and powers presently conferred on the Company Law Board (CLB) would be vested in the proposed national tribunal. This would result in the dissolution of the Company Law Board. It also envisaged replacement of the Board for Industrial and Financial Reconstruction (BIFR) by repealing the Sick Industries (Special Provision) Act, 1985, for accelerating the pace of revival.¹⁹ However, when the union cabinet gave approval for setting up the tribunals, it was challenged by the Madras Bar Association in the High Court which set aside the government’s order. On May 6, 2004, the Supreme Court admitted an appeal filed by the Centre challenging the order of the Madras High Court. According to experts, this would mean the setting up of the NCLT—a tribunal set up to take over the functions of the BIFR, AAIFR (Appelate Authority for Industrial and Financial Reconstruction), CLB, as well as the high courts, in the winding up of companies—may take some time.²⁰

INTRODUCTION OF REGULATIONS

Governance initiatives through regulation have also made significant strides in the country. SEBI has an ongoing programme of reforming the primary and secondary capital markets. SEBI was set up by the government in 1992 to counter the shortcomings found in the functioning of stock exchanges such as long delays, lack of transparency in procedures and vulnerability to price rigging and insider trading, and to regulate the capital market. SEBI, which has been made into a statutory body is authorized to regulate all merchant banks on issue activity, lay guidelines, supervise and regulate the working of mutual funds and oversee the working of stock exchanges in the country. In consultation with the government, SEBI has initiated a number of steps to introduce improved practices and greater transparency in the capital markets in the interest of the investing public. The stock exchanges in the country also mandate several statutory requirements through their listing agreements that every publicly traded company has to comply with. On the insistence of SEBI, stock exchanges have amended listing agreements to ensure that a listed company furnishes them annual statements showing the variations between financial projections and projected utilization of funds, which would enable shareholders to make comparisons between promises and performance.

Among the professions, the Institute of Chartered Accountants of India has emerged as a responsible body regulating the profession of public auditors, and counts among its achievements, the issue of a number of accounting and auditing standards. Constitution of an independent National Advisory Committee on Accounting Standards has been legislated by the amended Companies Act of 1999. Other professional bodies such as the Institute of Cost and Works Accountants of India and the Institute of Company Secretaries of India (ICSI) have helped in promoting and regulating a well trained and disciplined body of professionals who could add value to corporations in improving their management practices. The Institute of Company Secretaries of India has also taken a major initiative in constituting in 2001 a Secretarial Standards Board comprising senior members of eminence to formulate secretarial standards and best secretarial practices and develop guidance notes in order to integrate, consolidate, harmonize and standardize the prevalent diverse practices with the ultimate objective of promoting improved corporate governance. R. Ravi, the ICSI President informed the press on 30 January 2005 that the institute has mooted a proposal to the government to make mandatory secretarial standards (SS) issued by it on the lines of accounting standards issued by the Institute of Chartered Accountants of India. The ICSI has issued three SSs till now on board meetings, general meetings and payment of dividends, and one on registers and records is being finalized.²¹

As mentioned earlier, with the interest generated in the corporate sector by the Cadbury Committee’s report, the issue of corporate governance was studied in depth and dealt with by the CII, ASSOCHAM, and SEBI. The Corporate Governance Code in India was first promoted by the CII. Further, the SEBI constituted the Kumar Mangalam Birla Committee and adopted its report in mid-2000.

The Kumar Mangalam Birla Committee confined itself to submitting recommendations for good corporate governance and left it to SEBI to decide on the penalty provisions for non-compliance. In the absence of suitable penalty provisions, it has been difficult for the market regulator to establish good corporate governance. Some of the penalty provisions are not sufficient enough to discipline the corporations. For example, delisting of shares of the company is the penalty for non-compliance of the stipulated minimum of 50 in respect of the number of directors in the board that should be non-executive directors. This would hardly serve the purpose. In fact, this would be detrimental to the interest of the investors and to the effective functioning of the capital market.

Similarly, an audit committee, which is subservient to the board, may serve no purpose at all; and one which is in perpetual conflict with the board, may result in stalemates to the detriment of the company. If a company is to function smoothly, it should be made clear that the findings and recommendations of the audit committee need not necessarily have to be accepted by the board which is accountable to the shareholders for its performance and which, under Section 291 of the Companies Act, is entitled to ‘exercise all such powers, and do all such things as the company is authorized to exercise and do’.

However, some functional specialists are of the considered view that whenever there is a difference of opinion and the audit committee’s advice is ignored or overruled, the board should be required to place the facts before the general body of shareholders at their next meeting.

IMPLEMENTATION OF RECOMMENDATIONS OF BIRLA COMMITTEE REPORT

What Is Clause 49?

The SEBI monitors and regulates corporate governance of listed companies in India through Clause 49. This clause is incorporated in the listing agreement of stock exchanges with companies and it is compulsory for them to comply with its provisions. Stock exchanges endeavour to bring in corporate governance standards among companies by the introduction of Clause 49 in the listing agreement they enter into with them. SEBI issued Clause 49 in February 2000. All Group A companies had to comply with its provisions by 31 March 2001. All other listed companies with a minimum paid-up capital of Rs 100 million and net worth of Rs 250 million had to comply by 31 March 2002, and the remaining listed companies with a minimum paid-up capital of Rs 30 million or net worth of Rs 250 million had to comply by 31 March 2003.

Subsequently, on 29 October 2004, SEBI amended the original Clause 49 and issued a new Clause 49. All existing listed companies were directed to comply with the provisions of the new clause by 1 April 2005, which a sizable number of them did. However, it has already come into force for companies that have been listed on the stock exchange after 29 October 2004.

Provisions and Requirements of Clause 49

The provisions and requirements of Clause 49 are as follows:²²

• Composition of Board: The board should be composed of in the following manner: In case of full-time chairman, 50 per cent non-executive directors and 50 per cent executive directors.
• Constitution of the Audit Committee: The audit committee should have three independent directors with the chairman having sound financial background. The finance director and the head of the internal audit should be special invitees and a minimum of three meetings should be convened every year.
• Audit Committee: The audit committee is responsible for review of financial performance on half- yearly/annual basis; appointment/removal/remuneration of auditors; review of internal control systems and its adequacy.
• Remuneration of Directors: Remuneration of non-executive directors is to be decided by the board. Details of remuneration package, stock options, and performance incentives of directors should be disclosed to the shareholders.
• Board Procedures: The board should have at least four meetings a year. A director should not be a member of more than 10 committees and chairman of more than five committees across all companies.
• Management Discussion and Analysis Report: This should include (i) industry structure and developments; (ii) opportunities and threats; (iii) segment-wise or product-wise performance; (iv) outlook on the business; (v) risks and concerns; (vi) internal control systems and their adequacy; (vii) discussion on financial performance; and (viii) disclosure by directors on material, financial and commercial transactions with the company.
• Shareholders Information: The company should provide a brief resume of new/re-appointed directors, and submit quarterly results to stock exchanges to be placed on web-site and presented to analysts. Shareholders’/Investors’ Grievance Committee under the chairmanship of independent director, should have a minimum of two meetings a year. The company should report on corporate governance and get certificate from auditors on compliance of provisions of corporate governance as per Clause 49 in the listing agreement.²²
• Nominee Directors to be Independent Directors: Nominees of institutions that have invested in or lent to the company are deemed independent directors.
• New Provisions Incorporated in the New Clause 49: The board will lay down a code of conduct for all board members and senior management of the company to follow compulsorily.

The cash flow statements and financial statements will have to be certified by the CEO and the CFO. At least one independent director of the holding company will be a member of the board of a material non-listed subsidiary. In case a company follows a method of preparing financial statements that is different from the standard accounting standards, it should be disclosed in the financial statements and an explanation should be provided in the corporate governance report.

• CEO is Accountable for Company’s Risk Systems: Inspired by Sarbanes-Oxley Act, Clause 49 of listing agreement was scheduled to come into effect from 1 April 2005. However, bowing to demand from corporations, SEBI decided in the board meeting held on 23 March 2005, to defer the implementation of clause 49 till 31 December to provide listed entities, including public sector companies, giving time to appoint adequate number of independent directors and comply with norms. No special concession is to be extended to state owned enterprises which demanded exemption on this issue. SEBI felt that public sector undertakings are not looked upon as special class of companies. Under the new provisions, CEOs and CFOs in the country had been preparing for a litmus test. Beginning 31 December 2005, all CEOs and CFOs have embarked on massive documentation to meet the requirements of Clause 49 of SEBI’s listing agreement.
• Rules of the Game: CEOs and CFOs to be directly responsible for risk management (Provision 4C), and internal control systems (Section 5); Clause 49 is largely derived from the Sarbanes-Oxley Act; companies seek legal advice, they tap consultants to adopt new standards; companies want clarity on ‘material’ association of independent directors and fear new norms will lead to shortage of independent directors; companies will have to spend more time and money on compliance.

THE RESERVE BANK’S AND OTHER REGULATIONS

The Reserve Bank of India (RBI) also constituted its own Advisory Group on Corporate Governance under the aegis of the Standing Committee on International Financial Standards and Codes to view and recommend norms of corporate governance from the perspective of the banking sector. Based on the suggestions received from these committees, the DCA amended the Companies Act in December 2000 to include corporate governance provisions, which would be applicable to all companies. These new provisions came into effect from 1 April 2001.

The regulatory move is extended to non-listed companies also. The Companies Act is applicable to all Indian companies—both listed and unlisted. It incorporates recommendations of the Birla Committee report, including those related to non-executive directors, independent directors, composition of related party disclosures, audit committees, etc. The concept of ‘a deemed public company’ has been eliminated from the act and therefore, all companies now are either public or private. While most of the large companies are public, the committee’s requirements are applicable only to companies with a share capital of over Rs 50 million. Also, only a 100 per cent subsidiary of a foreign company can seek exemptions as a private company. The Companies Act has reduced the number of companies a person can be a director in from 20 to 15. The SEBI code also forbids them to sit on more than 10 committees or to chair more than 5. The intent is to ensure that all directors fulfil their obligations and contribute in a greater measure towards the company affairs.

The Companies Act now allows shareholders to participate in critical company resolutions through postal ballot. Until now, special resolutions required at least 75 per cent of the shareholders who are present at the meeting to vote. Hence, if 200 of a company’s 1,000 shareholders were present at a meeting, 150 votes were sufficient to pass a resolution. Under the new provision, however, all shareholders will be able to participate in the voting process. Of late, postal ballot has become a common practice and stock exchanges are informed almost on a daily basis about an impending postal ballot by companies. Recently, Hindustan Lever got the approval of BSE to transfer its Sewri plant and a polymer unit through postal ballot. Likewise, ITC got the approval to amend its objects clause to start a new business, ICICI Bank Ltd sought approval for its ADS issue, and Blue Dart wanted to sell its subsidiary, ACC, its Mancherial Cement unit, all using this postal ballot route to seek their shareholders’ approval.²³

SELF-REGULATION

Admittedly, some of the Indian companies compare most favourably with the best elsewhere in the world in the field of professional management and corporate governance. However, self-regulation lags in the area of corporate governance in the country and a vast majority of companies are languishing with outdated practices nurtured during the years of insulated economic environment that prevailed in the country for the better part of its post-independence history. The liberalization initiatives of the nineties have exposed the inefficiencies of many of these organizations which are now trying to come to terms with the paradigm shift in doing business.

PIONEERS IN GOOD GOVERNANCE PRACTICES

Industry Initiatives

Changing with the times, industry associations have taken the initiative to come up with guidelines for their member companies in the area of governance. A formal effort was initiated by the CII when it produced in 1998 a document titled Corporate Governance—A Desirable Code through a Task Force headed by Rahul Bajaj, which for the first time formally recognized the obligation of listed corporations to create corporate wealth and distribute it among all their stakeholders. The need for transparency in reporting and the imperatives of having independent non-executive directors who could protect the interests of shareholders were clearly articulated. A similar initiative was mounted by SEBI with the constitution of a committee under the chairmanship of Kumar Mangalam Birla. Its report recommending guidelines on corporate governance published in February 2000 is a well-balanced compendium of good practices that will stand corporations in good stead in their governance-improvement endeavours. These recommendations that have been categorized as mandatory have since been incorporated in the listing agreements of the stock exchanges. To this extent, this initiative may be termed part regulatory, part voluntary.

As a service to the corporate sector, the CII is putting together a roster of independent directors from which companies can choose their non-executive directors while constituting their boards. The CII will provide the necessary guidelines to choose good directors, screen them, and continue to monitor and rate them. This will help companies overcome the difficulties they face in identifying professionally competent and ethically sound non-executive directors.

The existing diversity and complexity of forms and patterns of corporate governance will continue and, very probably, increase with time. Alternative governance will be needed to improve the effectiveness of governance, to influence the healthy development of corporate regulation, and to understand the reality of the political processes by which companies are governed, rather than the structures and mechanisms through which governance is exercised. In any development, it will be important to avoid the polarities of governance based on an expensive bureaucracy of regulation and the adversarial clash of vested interests.

Corporate Initiatives

Several studies have pointed out that the movement to introduce corporate governance practices in the country has achieved commendable progress. In fact, the country has evolved a system and structure of corporate governance considered to be one of the best among all developing countries. Unlike several other emerging markets, Indian companies maintain their shareholding patterns, making it possible to identify the ownership affiliation of each firm easily. It is by and large a hybrid of the ‘outsiders systems’ and ‘insiders systems’ of corporate governance.

The legal framework for all corporate activities including governance and administration of companies, disclosures, shareholders’ rights, and dividend announcements has been in place since the enactment of the Companies Act in 1956 and has been fairly stable. The listing agreements of stock exchanges stipulate conditions and imposes continuous obligations to companies to align with best corporate governance practices.

It is well known that India has, for the past four decades and more, a fairly well-established regulatory framework. It also formed the basis for the evolution of corporate governance in the country. SEBI, the capital market regulator, has initiated several measures to promote corporate governance to fulfil the two objectives it was established for; namely: “investor protection and market development. For example, it has been instrumental in streamlining of the disclosure, investor protection guidelines, book building, entry norms, listing agreement, preferential allotment disclosures and lot more. Accounting system in India is well-established and accounting standards are similar to those followed in most of the advanced economies”.²⁴

According to a survey on corporate excellence carried out by Credit Lyonnais,²⁵ three Indian companies—Infosys, Hindustan Lever Limited and Wipro—are amongst Asia’s top 10 corporations in terms of good governance practices. ICICI, Cummins India, HDFC, Ranbaxy, Dr Reddy’s Lab, Orchid Chemicals and several Tata group companies also share this honour.

The Birla Group has already adopted corporate governance provisions. Non-executive directors now dominate the group’s company boards, and they have also constituted nomination, remuneration and audit committees.

Individual Initiatives

There were some outstanding initiatives in India from individual personalities even before the concept of corporate governance gained currency. J. R. D. Tata, from the time he took over till his death, ran the Tata industrial empire professionally, unlike other family-run businesses. Under his guidance, the Tata group produced some outstanding CEOs. His belief in keeping business and politics separate did give the group a great deal of credibility and brought him laurels, and won the trust of everybody. The man who believed in empowerment never craved for power, money or glory. He ensured that the House of Tatas followed corporate governance practices in all its forms, both in the letter and spirit. Tata was, and continues to be, a household name and his shareholders have always been happy with him.

Keshub Mahindra is another industrialist who like Tata, runs his empire professionally. He kept his daughters and relatives out of the boardroom. He has ensured that it is Mahindra & Mahindra (M&M) that is projected and not personalities. He has, like the Tatas, ensured that the business is divorced from politics. He has created a code of corporate governance for the company. Like Infosys, M&M’s annual report is pregnant with information.

N. R. Narayana Murthy is the new icon and undisputed king of the new economy. He shook the corporate world by giving his employees a stock option scheme (ESOPS) that saw many corporations taking a leaf out of Infosys’ book. Even before corporate governance became the buzzword, Infosys showed the way by giving detailed information and guidance reports in its 200-page plus annual report. So much so, that the SEC has been asking US companies to use the Infosys annual report as a role model. The man who has created hundreds of millionaires within and at the bourses has set such high standards that Infosys keeps getting awards for being the best run company, best at maintaining investor relations, best employer and so on. The ultimate tribute to Murthy was the Government of India bestowing on Infosys the Award for Excellence in Corporate Governance. By leveraging brainpower and sweat equity, Murthy has built a world-class software firm from the scratch.

Kumar Mangalam Birla who inherited a huge industrial empire challenged the conventional practices within the group companies when he took over in 1995. He has changed the culture of the group from being mainly a family run enterprise of old-timers to one with professional ethos. His group companies have been making extensive disclosures. Impressed by this young Birla’s initiative, the regulatory body, SEBI appointed him on a committee which is now known as the Kumar Mangalam Birla Committee on Corporate Governance.

Banks and Corporate Governance

Banks in India as corporations are as much required to be governed under corporate governance norms as other firms. Additionally, they are also covered under the internationally followed Basel Committee norms about which details are provided in the chapter on Banking and Corporate Governance.

The Basel Committee norms relate only to commercial banks and financial institutions. Banking and financial institutions stand to benefit only if corporate governance is accepted universally by industry and business, with whom banks and financial institutions have to interact and deal with. SEBI only partially attends to this need.

Realizing the importance of corporate governance to banks which are highly leveraged entities whose failures would pose large risks to the entire economic system, the RBI formed an Advisory Group on Corporate Governance that submitted its report in 2001. It also created aother committee called the Consultative Group of Directors of Banks/Financial Institutions (known as the Ganguly Committee) which submitted its report in 2002. The RBI, after due deliberations, acted based on the recommendations of both these reports, and this has considerably strengthened the corporate governance mechanism in banks.

Transparency in the Private Sector

The need for transparency, so far, appears to have been felt in the context of public authorities alone. Consequently, we have the Right to Information Act and a modification of the Official Secrets Act. While, there is no doubt that the government has to be completely transparent in its dealings since it deals with public money, privately managed companies also have a wide shareholder base. They also deal with large volumes of public money. The need for transparency in private sector is, therefore, in no way less important than in the public sector.

However, private companies use ‘competitive advantage/company interests’ as a pretext to hide essential information. Awarding of contracts, recruitments, and transfer pricing (for instance, through under/over invoicing of goods in intra company transfers) are the areas which require greater transparency. Environmental conservation, redressal of customer complaints and use of company resources for personal purposes are some of the other crucial areas, which call for greater disclosure. Relevant details about these must be available for public scrutiny. Fear of public scrutiny will ensure corporate governance based on sound principles both in the public as well as private sectors.

Initiatives of the Department of Company Affairs

In May 2000, the Department of Company Affairs invited a group of leading industrialists, professionals and academics to study and recommend measures to enhance corporate excellence in India. This Study Group in turn set up a task force under the chairmanship of Dr P. L. Sanjeev Reddy, which examined the subject of ‘Corporate Excellence through Sound Corporate Governance’ and submitted its report in November 2000. The Task Force in its recommendations identified two classifications, namely, essential and desirable, with the former to be introduced immediately by legislation and the latter to be left to the discretion of companies and their shareholders. Some of the recommendations of the task force include the following:

• greater role and influence for non-executive, independent directors
• stringent punishment for executive directors for failing to comply with listing and other requirements
• limitation on the nature and number of directorship of managing and whole-time directors
• proper disclosure to the shareholders and investing community
• interested shareholders to abstain from voting on specified matters
• more meaningful and transparent accounting and reporting
• tougher listing and compliance regimen through a centralized National Listing Authority
• highest and toughest standards of corporate governance for listed companies; and
• a code of public behaviour for public sector units.

Centre for Corporate Excellence

The Government of India has set up the Centre for Corporate Excellence under the aegis of the DCA as an independent and autonomous body as recommended by the Study Group. The centre would undertake research on corporate governance; provide a scheme by which companies could rate themselves in terms of their corporate governance performance; promote corporate governance through certifying companies who practise acceptable standards of corporate governance and by instituting annual awards for outstanding performance in this area. Government initiative in promoting corporate excellence in the country by setting up such a centre is indeed a very important step in the right direction. It is likely to spread greater awareness among the corporate sector regarding matters relating to good corporate governance, motivating them to seek accreditation from this body. The cumulative effect of the companies achieving such levels of corporate excellence would then no doubt be visible as the enhanced competitive strength of our country in the global market for goods and services.

The Award for Excellence in Corporate Governance, instituted in 1999 by the Ministry of Finance under the aegis of the DCA is sponsored by Unit Trust of India. For the very first year, the Award was presented to Infosys. A panel chaired by Justice P N. Bhagwati and comprising eminent persons unanimously selected Infosys Technologies (Limited) for the award for the year 1999. The panel commended the company thus: “Infosys is an ethical organisation whose value system ensures fairness, honesty, transparency, and courtesy to all its constituents and society at large”.²⁶ For the year 2000, the panel chaired by Justice M. N. Venkatachaliah unanimously selected The Tata Iron and Steel Limited (TISCO) for the award. This prestigious award was given to the company’s management for showing fairness, honesty, transparency and courtesy to all stakeholders and for its deep concern for the environment, pioneering social audit, taking good care of its employees and for driving change within the company in terms of knowledge management systems.

Corporate Restructuring

Substantive improvements have been made to the law. Improved laws now provide for the initiation of restructuring measures for a sick company at a much earlier stage of financial sickness. This has increased the chances of the company’s revival. Measures have also been enacted to rehabilitate workers and investors by setting up rehabilitation funds. The jurisdiction and powers relating to the winding up of works have been shifted to the National Company Law Tribunal.

With globalization and opening up of the economy, the need was felt that the Indian market should be geared to face competition not only from within the country, but also from abroad. Based on several recommendations, the Competition Bill was introduced in the Lok Sabha.

The Competition Bill, 2002 is a landmark development in economic legislation. The government had set up a high-level committee to examine the existing Monopolies and Restrictive Trade Practices (MRTP) Act, 1969, for shifting the focus of the law from curbing monopolies to promoting competition, and to suggest a modern competition law to suit Indian conditions in line with international developments.

Best Practices

The law governing corporations has been fine-tuned by amending the Companies Act to create the right ambience for the corporate enterprises to function effectively in the era of liberalization. With these amendments, corporations are now in a position to adopt the best practices in corporate governance in vogue elsewhere in the world. The DCA has adopted an ambitious programme to completely overhaul its services to the corporate sector by undertaking modernization and placing the services on the Internet. This is being done with a view to reducing the time and resources spent by corporations. The offices of the Registrar of Companies (ROC) curb malpractices that arise out of the situation and also tap the immense amount of economic data received through filing in ROC offices and through the cost audit branches in the DCA. Computerization and modernization is planned to be undertaken through private-public partnership.

A committee has been set up to look into issues relating to auditor-company relationship such as rotation of auditors/auditing partners, restrictions on non-audit work/fee, procedures for appointment of auditors, determination of audit fees, the role of independent directors and disciplinary procedures for accountants. The recommendations of the committee, when implemented, are expected to help improve the credibility of company accounts and the integrity of audit work. They would also help in strengthening the disciplinary mechanism against erring accountants.

Establishment of the Serious Fraud Office

The DCA has set up a Serious Fraud Office (SFO) as part of a new push to crack down on company fraud and improve corporate governance. The SFO will investigate economic crimes such as bribery by companies trying to win lucrative deals. The SFO which is to be part of the DCA will investigate company finances and prosecute them in cases where there have been violation of corporate laws.

The establishment of the SFO has come as part of a general climate of change in corporate governance in India. The government is contemplating to set up a National Centre for Corporate Governance as a joint initiative with the private sector. A committee is also recently commissioned to examine how to make the country’s businesses more transparent. The SFO will pass the case on to other authorities if there is evidence that other laws, such as banking laws or tax laws, have been broken.²⁷

Establishment of the National Foundation of Corporate Governance

To provide a platform to deliberate on issues that relate good corporate governance as key to sustainable wealth creation, the Indian government has taken a step forward in setting up National Foundation for Corporate Governance (NFCG). In September 2003, the Union Cabinet had given its consent for setting up NFCG as a Trust. The Foundation has since been registered as a trust with the objective of promoting good corporate governance in India.²⁸ Managing the trust will be a three-tier body comprising of a Governing Council, a Board of Trustees and an Executive Directorate.

The Foundation will work in synergy with the Investor Education and Protection Fund (IE&PF), a corpus used for investor awareness programmes in issues such as capacity building. Promoting investor associations will be a common activity between the two bodies.

Among the broad objectives of NFCG, is to provide research and training in the field of corporate governance. It would also be a source of financial or any other assistance for activities aimed at promoting corporate governance, including research and training. Besides, the US-based Global Corporate Governance Forum also supports the India-centric activities taken up by the various agencies.

Meanwhile, IE&PF on its part is setting up a prime database called ‘Investor Watch out’ on the lines of a similar concept in Europe that will help educate the investors and list the names of the erring companies.

In exercise of the powers conferred by Section 205 of the Companies Act, DCA has, in October 2001, established the IE&PF. The fund will get contributions from companies having unpaid dividend, matured deposits and debentures and share application money lying with them for seven years. The funds are to be utilized for promoting investors’ awareness and protection of their interests. A committee to administer this fund has already been constituted by the department. Recognizing the increasing concerns about the levels of corporate governance and ethical practices in the corporate sector, the DCA has undertaken active measures by promoting good corporate governance and enhancing the image of the corporate sector.

CORPORATE GOVERNANCE IN INDIA—A PERFORMANCE APPRAISAL

It is over a decade since the concept of corporate governance has become a passion with industry analysts in India. It has long passed the stage of being a fashion statement that it was in early 1990s, as its ideals have been propagated as the be-all and end-all of all corporate endeavour in the aftermath of economic liberalization in the country on one hand, and the then newly publicized Cadbury Report, on the other. All these got irretrievably intermixed to give the concept an aura and a halo. Now, after more than a decade down the line and with a lot of studies and in-depth research having been done by several committees, a reality check and analysis throw up a lot of somewhat unpalatable home truths.

Indian industry has come a long way since 1991. There has been a phenomenal growth both in the quality and number of corporations in the country. Some of them are implanting their footprints abroad and some worldwide objective research has shown that our corporations, albeit small in number, are second to none in terms of corporate governance standards. Companies like Infosys are on top of the heap. If the American capital market regulator, SEC, commend Infosys’ balance sheet as a role model to be emulated by US companies, it speaks volumes about our better governed corporations.

Sixty-three companies were short-listed for the conferment of the Government of India’s Award for Excellence in Corporate Governance for the period 1999 to 2001. The list was prepared on the bases of certain corporate governance criteria such as (i) governance structure, which includes composition of the board and committees of the board; (ii) disclosures in the annual report, which covers statutory disclosures and non-statutory disclosures; (iii) timeliness and content of information to the investors and the public, which take into account compliance with the listing agreement the concerned stock exchange, contents on Web site and grievance resolution ratio; and (iv) enhancement of shareholder value determined on the basis of share prices and return on net worth. The list of 63 corporations represents only a sample and is not exhaustive to cover all companies that are worthy enough to be short-listed. This implies that there are a sizeable number of corporations in the country that make serious efforts to adopt better corporate governance standards.

There is another perspective to the issue of the Indian corporate sector’s earnest attempt to put in place corporate governance practices. According to Tata Sons executive director, R. Gopalakrishnan, Indian firms have spent Rs 8,000 million so far on corporate governance. “In the last three years, the money paid to auditors has jumped to Rs 8,000 million from Rs 4,000 million. This, I would say, is arguably the cost of corporate governance”. He pointed out that industry groups like the Tatas and Birlas believed in the trusteeship concept of wealth.²⁹

Viewed from another angle, if many Indian industries are recognized across the world, it is also due to the image they have been projecting as successful corporations with good governance systems. In that sense the age of the Indian industry seems to have arrived. Two Indian companies—Infosys and Reliance Industries—are among the 44 global strategic partners, which have contributed their expertise and resources to the organization of the Annual Meeting of the World Economic Forum 2005. Infosys Chairman and Chief Mentor, N. R. Narayana Murthy was also one of the co-chairs in this prestigious annual event of the WEF held in Davos, Switzerland.³⁰

Performance appraisal of Indian Corporations

Corporate governance seems to have favourably impacted only a handful of corporations whose leaders imbued with its lofty ideals have taken them to such heights, while others have done nothing but cosmetic changes in the governance of their companies and seem to have satisfied themselves with their meagre attempts. Let us go into the details.

In the beginning of 2004, as part of the joint World Bank—IMF sponsored programme called the Report on the Observance of Standards and Codes, a corporate governance country assessment for India was carried out. The purpose of the report was to know to what extent Indian corporations practised corporate governance vis-à-vis the OECD principles of corporate governance (2004), considered a benchmark in this area by the World Bank.³¹

The report evaluated India’s compliance with each of the OECD benchmarked principles of corporate governance. The compliance level was placed into five classifications, namely, (i) ‘observed’, (ii) ‘largely observed’, (iii) ‘partially observed’, (iv) ‘materially not observed’, and (v) ‘not observed’’. Out of 23 OECD principles, Indian corporations have been found to be observing 10, while six were ‘largely observed’. Another six were placed under ‘partially observed’ category, while one was said to be ‘materially not observed’.³²

The assessment team had found Indian corporations ‘materially not observing’ one category of OECD principle that concerns facilitating all shareholders, including institutional shareholders, to exercise their voting rights. As per this principle, institutional shareholders are called upon to disclose their voting policy, explain when they act in a fiduciary capacity, and how they manage material conflicts of interest that may affect exercise of their key ownership rights.

Table 7.1 below presents a chart of the relevant OECD principles and the areas where the assessment team found Indian corporations to be only ‘partially observant’.

 

Table 7.1: Areas where Indian companies are ‘partially observant’ of the OECD Principles

OECD Principles	Partial Observance by Indian Corporations
Shareholders should be treated without discrimination	There is a grievance redressal mechanism available and shareholders can approach SEBI, the Company Law Board or the Investors Grievance Committee of concerned stock exchanges for redress of grievances. However, investors lack faith in the efficacy of legal remedies.
Insider trading to be prohibited	Though as per Indian law insider trading is a criminal offence, the enforcement is weak and ineffective.
Board/managers should disclose interests in corporations they manage	Misuse of corporate assets and abuse in related party transactions are common and have not been effectively tackled.
Mechanism for redressal for violation of stakeholders’ rights	Redressal for violation of shareholders rights can be sought at Civil and High Courts, but the Indian judiciary is well known to be slow and lethargic.
Annual independent audit, a necessity.	Auditors in India do provide consulting service to the auditee company depending on the level of audit fee, but lengthy disciplinary proceedings are common.
The board should exercise objective judgement	Multiple board membership is common and it affects board performance. Special training is required for audit committee members, as some of the member-directors may lack knowledge of accounts and company finance.

 

The report has made several policy recommendations, if a principle is less than fully observed. Some of the important policy recommendations are as follows:

1. Need for Sanction and Enforcement: The success or otherwise of a policy is dependent on not only the degree of compliance, but also the deterrent penalty provided for non-compliance. The existing provisions on sanctions in the Companies Act for violation of law are said to be inadequate, especially the measly fines imposed. For instance, at present stock exchanges cannot impose fines. If corporations are expected to carry out their business practices within the applicable laws and regulations, credible deterrents should also be there to impose sanctions and enforcements for non-compliance. The legal system should ensure that business practices are synchronized with the legal and regulatory framework, especially in relation to party transactions and insider trading.
2. Need for Clear Demarcation of Controls: Presently, the Indian regulatory framework distributes the responsibility of oversight of listed companies to three different quasi-legal agencies, namely, the DCA, the stock exchanges and the SEBI. The lack of clear demarcations of regulatory bodies and their functions leads to overlapping of controls and makes it possible for violators to play one against the other. The fragmented structure also leads to regulatory arbitrage and weaken enforcement. Considering the enormous size of India’s capital market, it is necessary to review this three-tiered supervision system and clearly demarcate the responsibility of each regulator. To avoid the multiplicity of the regulatory system, SEBI could be made the sole capital market regulator with powers of investigation and awarding penalty for violators.
3. Lack of Professionalism of Directors: Directors should improve their knowledge and skill. If boards are expected to be professional and competent, they must have a clear understanding of what is expected of them. Director training institutes can play a key role and expand the pool of competent potential candidates for directorship.
4. Role of Institutional Investors: Institutional investors acting in a fiduciary capacity do not play an effective role. They should be made to form a comprehensive corporate governance policy, including voting and board representation. There have been several instances in the Indian corporate history wherein thousands of poor investors have lost their hard-earned money, because the institutional nominees on the boards did not play other roles honestly.
5. Indian Boards Exhibit Poor Professionalism: The corporate governance reforms in India have been mostly on paper. This is very much reflected in the fact that most of the so-called ‘independent directors’ are nominated by the promoter groups in whose boards they are supposed to sit and help take independent and unbiased decisions!

   An analysis by L. C. Gupta and his team of researchers shows that a vast majority of the Indian listed companies have destroyed shareholder value. Whether or not a company has given proper attention to the interest of shareholders would ordinarily be reflected in two indicators of shareholders’ return, namely, dividends and capital appreciation.³³

   • The study shows that the great majority of Indian listed companies have, in fact, destroyed shareholder value.
   • Instead of severely punishing the guilty corporate managements, the Indian authorities let them go scot free.
   • Indian directors give only a lip service to corporate governance practices, as pointed out by Dilip Kumar Sen in his article quoted above. In India, like most other developing countries, corporations are managed as if they are the CEO’s personal properties. They are not concerned much about the welfare of all stakeholders, but care only about the interest of the principal shareholders. It is also a fact that many directors do not know that they are agents of shareholders and that they hold a fiduciary responsibility, apart from a position of trust and faith. Participation of non-executive directors in the board or its committee’s meetings is inversely proportional to the health of the bottom line. The more attractive the bottomline is, the lesser their participation.

   Most directors of companies do not consider it their responsibility to update their knowledge and understanding about the changes in laws and regulations that have been introduced, or the business model or current strategy of the company in which they are directors. If the company performed well financially, refusal to approve or object to any proposal of the management is considered incorrect and inappropriate.

6. Independent Directors Are Not So Independent: The Independence of independent directors seems to be only on paper. Most of the independent directors are hand-in-glove with the promoters. They rubber-stamp questionable decisions of promoters and ignore fund diversion and mismanagement in their companies. In several top companies, there are people who have remained as independent directors for as many as 20 to 30 years. In Reliance Industries, for example, these directors remained silent when the company made massive investment in other unlisted companies. A SEBI panel tried to stop this practice and proposed a limit (9 years) on their tenure. But Indian corporate bigwigs ‘intervened’ and lobbied for changes—finally, the limit is now with prospective effect.³⁴

Sen continues to assert that non-executive directors do not consider themselves as watch-dogs of shareholders. According to him, board rooms are generally filled up with ‘yes’ men who do not raise relevant questions and give their assent to all proposals put up by the management. It is a well-established fact that in the Indian corporate sector, a person is invited to become a non-executive director only if he or she enjoys the patronage of the chairman/CEO through old school connections social circuits or golf clubs.

With regard to nominee directors, it is seen that they too play a passive role at meetings except during a crisis. This has been proved time and again, when an objective analysis of corporate failures is made. It has also been observed by objective observers that in the Indian corporate sector what you preach on corporate governance you need not necessarily be practised in the company you manage. It is always for the other people. However, the same passive directors can become extremely vocal and are found to raise uncomfortable questions when the performance of the company is poor. In India, it is a tragedy that non-executive directorship is considered more as symbol of social status and connections than as a position of responsibility.

A couple of years after Indian corporations tom-tommed the virtues of good corporate governance practices, the revelations at Reliance, the country’s largest private sector company, show that a lot still needs to be done. To be sure, corporate governance levels have improved in the last five years, but Indian industry still finds itself on the opposing side.³⁵

In addition to what is revealed in the World Bank-IMF sponsored report, there are several other weaknesses that can be pointed out about the functioning of the Indian corporate sector. Some of the weaknesses are as follows:

1. Lack of a Whistle-Blower Policy: Last year SEBI had proposed that a whistle-blower policy should be made mandatory. However, after stiff resistance from the industry, it asked the N. R. Narayana Murthy panel to rework the policy. Later, the whistle-blower policy was made optional for companies.
2. Unlisted Investment Companies: This is the most confusing part of Indian industry and one that companies will protect tooth and nail. Companies and promoters have promoted thousands of unlisted subsidiaries. Many of them divert funds through these companies. The modus operandi is this: The listed company will give a loan (even interest-free) to these unlisted companies, which, in turn, will default repayment. A major chunk of these investment companies hold shares in their listed companies. In fact, promoters have floated several layers of such subsidiaries to hold their stakes in leading group companies. Most of corporate India, from the Tatas and Birlas, to Reliance, follows this practice.
3. Accounting Gimmicks: While there are some gaps in financial statements, corporate sources claim “We are now pretty close to the global best practices.” But this has to be taken with a pinch of salt. For instance, a study by Crisil in 2005 reclassified and sanitized the annual accounts of 616 manufacturing companies. It restated the accounts of 243 companies—and showed that their actual profits are different from what they had reported. Simply put, their books were cooked.³⁶
4. Poor Shareholder Participation: Corporate misgovernance in India would not have gone thus far and promoter families would not have ruled the roost this much, had there been a well-directed shareholder activism. The Indian investors, more than their counterparts elsewhere, are scattered, unorganized, mute and uninterested in the affairs of the company they have invested in, except for the dividends and all other annual gifts doled out to them. They give their consent most obligingly enabling unscrupulous managements to perpetrate their dynastic rule with glee and making corporate democracy a sham. Voices of dissent are few and rarely recorded. The worst part of it is that even large institutional shareholders rarely record their dissent, and if they found board decisions and practices unacceptable they simply sell their securities and quit, rather than fight and help establish better governance practices. No wonder there has been a sizeable erosion of investor confidence in the country with every scam coming to light.
5. Obliging Auditors: Another weak link in the wobbling chain of corporate governance in the country is that of the auditing profession. Obliging auditors help companies in window-dressing, manipulation of profit and loss accounts, hedging and fudging of unexplainable expenditures and resorting to continuous upward evaluation of assets to conceal poor performance. It is common knowledge that there is a dire need for independent auditors who are reputed and above board. Due to distrust in Indian auditors, most of the multinational companies in India have insisted that their parent companies’ auditors also audit their subsidiaries in the country. Things have started improving with the Institute of Chartered Accountants of India insisting on the profession adopting improved accounting practices, but there is a lot to be achieved.³⁷
6. Other Problems: There are of course, several other problems in the country’s capital market that are responsible for the poor record of corporate governance in the country. It has been mentioned earlier and it requires repetition in this context. A soft State, a lethargic and slow-moving judicial system, a value system that is indifferent to moral turpitudes, an inefficient market regulator and poor enforcement of rules and regulations have all combined together to ensure that though the ideal of corporate governance is kept on a high pedestal, it is but occasionally put into practice.

FUTURE OF CORPORATE GOVERNANCE IN INDIA

Although India has a long way to go to be ranked among the best in the world in corporate governance, the driver is exactly right. A large number of CEOs now realize that their companies need financial and human capital in order to grow to scales necessary to survive international competition. They also understand that such capital will not be available in a non-transparent corporate regime that is bereft of international quality of disclosures and accountability. It is precisely this realization, which drives the corporate governance movement in India, with greater chances of delivering substance than the ticking of mandated governance checklists.

It is important to note that there are still some lacunae in different aspects of corporate governance.

• India still has poor bankruptcy laws and procedures (legal and procedural barriers to good corporate governance).
• Indian accounting standards still do not mandate consolidation—although this is slated to change.
• Indian stock markets are still inefficiently run, and do not have adequate depth or width to give shareholders greater comfort.
• The Indian bond market is in its infancy. Pension funds need to invest much more in equity, and play an activist role. Mutual funds ‘need to walk the talk’ in corporate governance.

Even so, it is necessary to recognize that corporate India has gone a long way in the business of governance, especially in the last decade—and more so given its legacy of the past.

IMPETUS FOR THE GROWTH OF CORPORATE GOVERNANCE IN INDIA

Although corporate governance has been slow in making its mark in India, the next few years will see a flurry of activity. This will be driven by several factors:

1. Competition: Most important, is the force of competition. With the dismantling of licenses and controls, reduction of import tariffs and quotas, virtual elimination of public sector reservations, and a much more liberalized regime for foreign direct and portfolio investments, Indian companies have faced more competition in the second half of the 1990s than they did since independence. Competition has forced companies to drastically restructure their ways of doing business.
2. New Players’ Professionalism: Many companies and business groups that were on the top of the pecking order in 1991 have been relegated to the bottom. Simultaneously, new aggressive companies have clawed their way to the top. Therefore, they are more than willing to have professional boards and voluntarily follow disclosure standards that measure up to the best in the world.
3. Growth in Market Capitalization: There has been a phenomenal growth in market capitalization. This growth has triggered a fundamental change in mindset from the earlier one of appropriating larger slices of a small pie, to doing all that is needed to let the pie grow, even if it involves dilution in share ownership.
4. Foreign Portfolio Investors: One cannot exaggerate the impact of well-focused, well-researched foreign portfolio investors. These investors have steadily raised their demands for better corporate governance, more transparency and greater disclosure. Over the last two years, they have systematically increased their exposure in well-governed firms at the expense of poorly run ones.
5. Media Influences: India has a strong financial press, which will get stronger over the years. In the last five years, the press and financial analysts have induced a level of disclosure that was inconceivable a decade ago. This will increase and force companies to become more transparent—not only in their financial statements but also in matters relating to internal governance.
6. Influence of Banks and Financial Institutions: Despite serious lacunae in Indian bankruptcy provisions, neither banks nor financial institutions (FIs) will continue to support managements irrespective of performance. Already, the more aggressive and market-oriented FIs have started converting some of their outstanding debt to equity, and setting up merger and acquisition subsidiaries to sell their shares in under-performing companies to more dynamic entrepreneurs and managerial groups. This will intensify over time, especially with the advent of universal banking.
7. Realization of the Benefits of Corporate Governance: Ultimately, Indian corporations have appreciated the fact that good corporate governance and internationally accepted standards of accounting and disclosure can help them access the US capital markets. Until 1998, this premise existed only in theory. It changed with Infosys making its highly successful NASDAQ issue in March 1998. This was followed by five more US depository issues—ICICI (which is listed on NYSE), Satyam, Infosys, Rediff and Wipro. There are at least 10 companies presently gearing up to issue US depository receipts, and all of them will be listed either at NYSE or at NASDAQ. This trend has had two major beneficial effects. First, it has shown that good governance pays off, and allows companies to access the world’s largest capital market.³⁸ By the latest count, external commercial borrowings (ECBs) of Indian corporations during the financial year 2007–08 amounted to $33 billion, apart from an equivalent amount of foreign direct investment (FDI) inflows.^{39, 40} Second, it has demonstrated that good corporate governance and disclosures are not difficult to implement—and Indian companies can do all that is needed to satisfy US investors and the SEC. The message is now clear: It makes good business sense to be a transparent, well-governed company, incorporating internally acceptable accounting standards.
8. Impending Full Capital Account Convertibility: In a couple of years India will move to full capital account convertibility. When that happens, an Indian investor will seriously consider whether to put his or her funds in an Indian company or to place it with a foreign mutual or pension fund. That kind of freedom will be the ultimate weapon in favour of good corporate governance. Thankfully for India, the companies that matter have already seen the writing on the wall. Thus, it may not be wrong to predict that, in another couple of years India might have the largest concentration of well-governed companies in South and Southeast Asia.

SUMMARY

Corporate governance is typically perceived by academic literature as dealing with ‘problems that result from the separation of ownership and control.’ Sir Adrian Cadbury, Chairman of the Cadbury Committee defined the concept as “holding the balance between economic and social goals and between individual and communal goals”. Experts at OECD have defined corporate governance as “the system by which business corporations are directed and controlled”. All these definitions capture some of the most important concerns of governments in particular and the society. These are (i) management accountability; (ii) providing adequate investments to management; (iii) disciplining and replacement of bad management; (iv) enhancing corporate performance; (v) transparency; (vi) shareholder activism; (vii) investor protection; (viii) improving access to capital markets; (ix) promoting long-term investment; and (x) encouraging innovation. Corporate governance systems depend upon a set of institutions (laws, regulations, contracts, and norms) that create self-governing firms as the central element of a competitive market economy. “Governance is more than just board processes and procedures. It involves the full set of relationships between a company’s management, its board, its shareholders and its other stakeholders, such as its employees and the community in which it is located. The quality of governance is directly linked to the policy framework. In the 21st century, stability and prosperity will depend on the strengthening of capital markets and the creation of strong corporate governance systems” according to William Witherek (OECD 2000). The OECD has emphasized the following requirements of corporate governance:

1. Rights of shareholders
2. Equitable treatment of shareholders
3. Role of stakeholders in corporate governance
4. Disclosure and transparency
5. Responsibilities of the board.

APEC guidelines include establishment of rights and responsibilities of managers and directors.

The oft-quoted Cadbury Committee, submitted its report along with the ‘Code of Best Practices’ in December 1992. In its globally well-received report, the committee elaborated the methods of governance needed to achieve a balance between the essential powers of the board of directors and their proper accountability. Against the different issues in corporate governance, the benefits of good corporate governance to a corporation were highlighted to be the following:

1. Creation and enhancement of a corporation’s competitive advantage
2. Enabling a corporation to perform efficiently by preventing fraud and malpractices
3. Providing protection to shareholders’ interest
4. Enhancing the valuation of an enterprise
5. Ensuring compliance of laws and regulations.

In India, the real history of corporate governance dates back to the year 1992, following efforts made in many countries of the world to put in place a system suggested by the Cadbury Committee. In 2002, a high-level committee under the chairmanship of Naresh Chandra was appointed to examine and recommend drastic amendments to the law involving the auditor-client relationships and the role of independent directors by the DCA in the Ministry of Finance and Company Affairs. The Company Law Amendment Bill, 2003 envisaged many amendments on the basis of reports of the Naresh Chandra Committee and the subsequently appointed N. R. Narayana Murthy Committee. The Government of India constituted an Expert Committee on Company Law on 2 December 2004 under the Chairmanship of Dr J. J. Irani. It has come out with suggestions that will go far in laying a sound base for corporate growth in the coming years. SEBI monitors and regulates corporate governance of listed companies in India through Clause 49. This clause is incorporated in the listing agreement of stock exchanges with companies and it is compulsory for them to comply with its provisions, which include that for composition of the board, constitution of the audit committee, the audit committee, remuneration of directors, board procedures, and shareholders information.

In early 2004, a corporate governance country assessment for India was carried out as part of the joint World Bank-IMF programme of Report on the Observance of Standards and Codes. Past experience on governance issues in the country has shown that none of the corporate governance principles can be cast in stone and laid to rest forever. There is an ongoing need for constant review and course corrections to keep the country in the pink of health in terms of its corporate excellence. By a judicious mix of legislation, regulation and suasion, this task needs to be constantly addressed. With growing maturity and competitive compulsions, it should be possible to gradually reduce legislative interventions and increase regulatory compliance, with self-induced adherence to the best practice in this field. Till then, however, legislation and regulation to ensure at least certain minimum standard is inevitable. To facilitate such a graduation into better governance practices, globalization has opened up an array of opportunities to corporate India. To emerge successful in its new tryst with destiny, there are no soft options available, and the Indian corporate sector must necessarily turn to good governance in its pursuit of competitive excellence in a challenging international business environment.

KEY WORDS

Capitalism at crossroads • Corporate misgovernance • Securities scam • New economic policy • Closed economy • Sheltered market • Transparent governance • Globalization of the economy • Forces of competition • Market capitalization • Economic liberalization • Global concerns • Privatization of industries • Shareholder-centric definitions • Narrow perspective • Public policy perspective • Cynosure • Developing economies • Transition societies • Corporate democracy • Board process • Board procedures • Equitable treatment • Historical perspective • Executive remuneration • Institutional shareholders • Socially responsible corporate citizen • Corporate performance • Competitive advantage • Governance mechanisms • Societal responses • Environmental-friendly • Whistle-blowing • Human treatment • Credo • Clause 49 • Industry initiatives • Performance appraisal • Report card • Impetus for growth • Competition-driven • Institutional investors • Independent directors.

DISCUSSION QUESTIONS

1. Trace the evolution of corporate governance, both in the Western countries and in India. What are the factors that led to the increasing awareness of the need for corporate governance?
2. What do you understand by corporate governance? Has the need for it arisen only because of the ‘problems that result from the separation of ownership and control’?
3. What are the requirements of corporate governance as envisaged by the OECD?
4. Discuss the various issues in corporate governance. Are these issues universal? To what extent are these issues viewed differently in the context of developing/emerging economies?
5. What is the relevance of corporate governance? Do you think better governance practices boost corporate performance? Give illustrations.
6. Explain what constitutes good corporate governance from the context of different stakeholders.
7. What is Clause 49? Do you think that if Indian corporations comply with all the stipulations of Clause 49 we will have better corporate governance mechanism in India?
8. Review the present corporate governance practices in India. Do you think that things are likely to improve on this front in future?

FURTHER READINGS

1. Cadbury Committee Report, A Report by the Committee on the Financial Aspects of Corporate Governance. The committee was chaired by Sir Adrian Cadbury and issued for public comment on 27 May 1992.

2. The Combined Code of Best Practices in Corporate Governance, The Turnbull Committee Report, 1998.

3. The Committee on Corporate Governance, The Hampel Committee Report, 1998.

4. Confederation of Indian Industry, Desirable Corporate Governance: A Code, March 1998.

5. Greenbury Committee Report, 1994, Investigating Board Members Remuneration and Responsibilities.

6. Patterson Report: The Link Between Corporate Governance and Performance, 2001.

7. Principles of Corporate Governance: A Report by OECD Task Force on Corporate Governance, 1999.

8. Report of SEBI’s (N. R. Narayanamurthy) Committee on Corporate Governance, 2003.

Case Study
TATA STEEL—A COMPANY THAT ALSO MAKES STEEL

(This case study is based on reports in the print and electronic media, and is meant for academic purpose only. The author has no intention to sully the image of the corporate or executives discussed)

CELEBRATING AN EVENTFUL CENTENARY

On 26 August 2007, Tata Steel, India’s first private sector steel unit celebrated its well-deserved centenary jubilee. Established exactly a hundred years ago, the company has now transformed itself into a global giant, with a production capacity of almost 26 million tonnes against a mere 100,000 tonnes it started with in 1907. Tata Steel’s coveted history is “linked intrinsically to the genesis and growth of an industrial India”.¹

THE BEGINNING AND GROWTH

In the 1890s, Jamsetji Tata conceived of a dream project—a modern steel plant, with a state-of-the-art technology to produce one million tonnes of steel. Work on the steel plant commenced in 1907 in Jamshedpur which became operational in 1912. The capacity of the unit at the time of India’s independence was around a million tonnes and this was increased to around 2 million tonnes by 1960. With the policy of the Indian government to give priority to the public sector to reach the commanding heights of the economy, the company, like many others in the private sector, was not allowed to grow until the liberalization of the economy in 1991. In fact, at the height of the socialist fervour of the 1970s, there was even a suggestion to nationalize of Tata Steel taking resort to the Industrial Policy Resolution that permitted nationalization of any industry if needed in public interest. Fortunately, there was stiff opposition to the move from the public and the government of the day did not have the resources to pay adequate compensation to the shareholders of the company after nationalization, and the effort was aborted.

COMPANY PROFILE AND VISION

The World Steel Dynamics has rated Tata Steel as one of the best steel companies in the world based on an extensive study. Its turnover in financial year 2005 was Rs 16,053 million.

Tata Steel has articulated its strategic goals to take on new challenges while adhering to the values of Trusteeship, Integrity, and Respect for the Individual, Credibility and Excellence in co-creating its Vision 2007:²

• To seize the opportunities of tomorrow and create a future that will make it an EVA (economic value added) positive company.
• To continue to improve the quality of life of its employees and the communities it serves.
• To meet the future economic challenges, Tata Steel intends:
  • Creating wealth through growth in topline and improvement in shareholder value through its focus on revenue growth, EVA and market capitalization;
  • Becoming the most cost competitive steel maker through improving customer satisfaction, reduction in production cost and right sizings;
  • Broadening the stakeholder base for transparency, credibility and excellence; and
  • Fast tracking to achieve waste utilization to the level of world benchmark through cleaner processes, technological innovations, and making the city of Jamshedpur a zero-dumping city.

PRODUCT AND SERVICES

Steel business forms 86 per cent of the company’s turnover. Broadly, about 85 per cent of its products are sold in the domestic market and 15 per cent exported. Steel product groups are delivered to customers through direct supply channels and a network of hubs, stockyards and consignment agents. A unique selling feature of products initiated by the company keeping in mind the consumer, is the recommended consumer price arrived at with retailers’ inputs and displayed at every retail shop. The company has installed a toll-free customer care centre—a major step forward—both for pre- and post-sales services. In addition, three types of surveys gauge customer satisfaction. One method is to measure satisfaction level segment-wise using products and service attributes as parameters. House surveys are employed for this purpose. The second tool is an annual IMRB survey conducted by the Ministry of Steel, which is used for awarding the Prime Minister’s trophy for the best-integrated steel plant. It concentrates on the evolving needs of customers and their potential to influence referrals to other customers. A third method is an independent survey conducted biannually by an expert external firm.

FOCUS ON SELECT BUSINESSES AND CORE COMPETENCY

When Ratan Tata succeeded J. R. D. Tata as chairman, he ordered a comprehensive review of identifying and focusing on the core businesses of the group. It was then found that many of the well-established businesses of the group did not sync with the company’s major core competence, steel production, such as electronics, cement, soaps, pharmaceuticals and textiles. These were gradually phased out. Interestingly, there were suggestions that steel could be one of these!

Table 7.2 chronicles the important milestones of the company over the past 100 years.

 

Table 7.2 Milestones in the Growth of Tata Steel

1907	Establishment of Tata Iron and Steel Company in Jamshedpur
1911	Commencement of operation of a blast furnace production of the cast of pig-iron.
1912	First steel produced, The bar mills commenced rolling
1920	A slew of first-ever workers’ welfare measures in India introduced
1921	Tata Steel’s Jamshedpur Technical Institute opened with a strength of 23 students
1934	Profit sharing bonus introduced by the company for first time in India.
1937	Inauguration of the research and control laboratory
1947	Personnel Department set up, being the first for any Indian Industry
1951	Establishment of Community Development and Social Welfare Department
1955	Doubling of capacity to 2 million tonnes
1956	Joint consultations for ‘Working Together’ introduced
1958	On completion of 50 years of the company, the Jubilee Park built in the centre of the steel city, dedicated to the nation
1979	The Tata Steel Rural Development Society set up
1983	Modernization of the steel works in four phases covering a 15-year period commenced.
1991	J. R. D, Tata dedicates a multi-disciplinary sports complex
1995	3 million tonnes capacity achieved
1999	Environment programme to plant 1 million trees proposed, Green Millennium Countdown SAP and ERP systems brings in complete transparency to the workplace.
2000	Inauguration of the cold rolling mill complex
2002	New vision co-created with employee participation, EVA+’ prorgramme launched
2003	4 million tonnes capacity achieved; completion of 75 years of industrial harmony.
2004	Investments in NatSteel Asia, Singapore and MoU for 6 million tonnes project in Orissa
2005	5-million tonne steel plant at Chhattisgarh, 12-million tonne steel plant at Jharkhand, Doubling of Jamshedpur steel plant capacity to 10 million tones per annum (mtpa), Jamshedpur Steel works 5 mtpa expansion completed, Agreement with Carborough Downs. Australia for supply of clean coal. Setting up of Met Coke manufacturing facility in West Bengal
2006	Investments in Millennium Steel, Thailand Acquisition of Anglo-Dutch steel maker, Corus for US$ 12,1 billion, making Tata Steel, the biggest integrated steel producer in Asia and the fifth largest in the world.
2007	Centenary year, Corus-developed new technology tried in Tata Steel, Announcement of the Tata Steel Centenary Project with a corpus of Rs 1,000 million to benefit 40,000 tribals in Jharkhand, Orissa and Chhattisgarh.

HEAVY INVESTMENTS AND PROFITS

The steel industry earned very modest profits for several years of the last century. In the early 1980s, annual profits of Tata Steel were in the region of Rs 60 million. Since 1992, when the company started expansion and modernization, it had spent over Rs 100,000 million. But compared to the astronomical costs of expansion and acquisitions that took place in the aftermath of the country’s economic liberalization, these figures fade into insignificance. Moreover, consolidation of its activities and the new acquisitions have brought to the company immense benefits. For instance, for the first quarter of 2007–2008, Tata Steel reported an over six-fold leap in its consolidated profit after tax (PAT) at Rs 63,880 million, which incidentally reflects the profits earned with the acquisition of the Anglo- Dutch steel-maker, Corus Group, early in 2007.³

QUANTUM GROWTH PLANNED AND ACHIEVED

Right through its history, Tata Steel has earned profits every year and declared dividends. (In 2002, it was just one of five companies world over that earned a profit.) The present era of high profits has prepared the company to aim for quantum growth which requires huge investments. But money has not been a limiting factor for the growth of the company to consolidate its presence in Southeast Asia. Tata Steel bought over Singapore’s NatSteel in August 2004 for US$ 484.6 million and Thailand’s Millennium Steel in December 2005 for US$ 404 million. These two acquisitions added roughly 4 million tonnes to the company’s steel making capacity and Rs 90,000 million in turnover. But more importantly, these two with their operations in China, the Philippines, Vietnam, Thailand and Singapore enabled Tata Steel to build a significant presence in Southeast Asia and China, especially in automotive steel. It also gives the company the advantage of de-integrated production—produce the raw steel somewhere and finish it close to the market.⁴ Tata Steel also went on to buy out the London- based Corus Steel for US$ 12.1 billion in 2007, the biggest ever cross-border deal for an Indian company to date. Thus, Tata Steel which produced just 5 million tonnes of steel per year, bought over Europe’s second largest steel company, Corus with an annual steel making capacity of 18 million tonnes, to emerge as the world’s fifth largest steel producer.

INVESTMENT IN INDUSTRIAL RESEARCH ENHANCES QUALITY

To achieve higher growth in production and to reduce cost per unit, Tata Steel has invested heavily in industrial research. It has enabled the company to earn the proud position of the world’s cheapest producer of steel. There have been collaborative research projects with Indian Institute of Technology, Kharagpur, Indian Institute of Science, Bangalore and also with research institutions in Sweden, Germany and Japan. As a result, there has been a steep increase in the number of research papers published and intellectual property claims registered. Tata Steel spent a dollar per tonne of steel produced on R&D, which compares well with US$ 1.8 per tonne spent by leaders like Nippon Steel.

Such focus on development has helped Tata Steel strive continuously to improve the quality of its product mix and also to increase the share of branded products, both of which helped it to have better realizations for a given quantum of output. Combined with the success in achieving continuous increases in production through rising operational efficiency, and reduction in specific consumption of raw materials refractories, there is the twin advantage of handsome increases in labour productivity and a much more than proportionate increase in after tax profits. Of course, the steep increase in prices through the last few years has also contributed to this big jump in profit.

CLOSE ATTENTION TO HUMAN RELATIONS

At the root of the success of Tata Steel lies its close and continuous attention to human relations. The success of the management in regularly and continuously interacting with the union leaders has helped in resolving differences. “Succession of leaders believed that the temper of employees is as crucial as the temperature of the furnaces”.⁵ The tradition of maintaining a most cordial relationship with workers in the truest sense of trusteeship (wherein it is believed that the employer is ordained by God to take care of the interest of workers and hence the resources of the enterprise are entrusted to him) has been built by J. R. D. Tata on the very humane foundation laid by Jamsetji Tata, and it still continues.

Workers are involved in the decision making process at all levels—works level, departmental level and management level. To the extent possible, all efforts are made to ensure that decisions are taken unanimously. “The inclusion of all employees—Tata Steel has around 17,000 of them—in the decision making process gives them a sense of involvement, belonging and responsibility as well. It also gives them the feeling of having contributed to some improvement activity or the other”.⁶

 

The amicable relationship that exists between the management and workers of Tata Steel is to a great extent due to the proactive labour welfare activities initiated and implemented by the company, many of which were the first time pro-labour measures throughout the entire world (Table 7.3).

DOWNSIZING SANS TEARS

Among the most interesting and enduring of Tata Steel’s saga of growth is its seamless and successful efforts in downsizing. For producing just 2 million tonnes in 1994, Tata Steel employed as many as 80,000 workers, while when the company has increased its production multifold, it employs only about one-half of the workforce, showing the unviable employment situation then. When the company decided to reduce the unwieldy number of employees, the management evolved a then novel and humanistic voluntary retirement scheme (VRS) policy to ensure that it did not cause any heartburn amongst the affected workers. The company offered the displaced workers 1.2 times of their monthly salary for the rest of their service, in cheques. They were also given an insurance cover. In case of their death, their family would continue to receive the benefit. The company also spent a lot of time and money to identify those eligible to take the VRS. As a result of these strenuous efforts, “The number of employees has been reduced from 77,448 in 1994 to 52,167 in 2000, and to 39,658 in 2005”.⁷

PROTECTING CONSUMERS FROM STEEP INCREASES IN PRICES

Tata Steel is conscious of the imperative to protect consumers of steel from steeper price increases. With the high increase in the cost of basic inputs, such as coal, iron ore, scrap and petroleum products, there has been a focus on achieving cost-efficiencies. The company has been especially considerate to its bona fide customers for whom the prices are offered at around Rs 5,000 per tonne lower than market prices. With 70 per cent of products going directly to customers, this large section of consumers is treated with special concern. The company also strictly enforces its maximum retail price at the dealer end. To serve the domestic consumers better, Tata Steel also decided to limit exports last year to 15 per cent of total sales.

ADMINISTERING JAMSHEDPUR TOWNSHIP

It is well-known that Tata Steel has been administering the Jamshedpur town for the past eight decades, and anyone who visits the place is so impressed by its orderliness, extensive civic facilities and cleanliness that they would cite it as a model town. The company has been subsidizing around Rs 100 million for the administration of the township. The entire services relating to town administration, provision of transport services, running schools and hospitals are all done by the company. Tata Steel decided to launch a new company called JUSCO Ltd. (Jamshedpur Utilities & Services Company Ltd.) to handle power distribution, water supply and infrastructure maintenance. Jamshedpur is the first and the only Indian city where civic amenities and allied services are entirely managed by a corporate entity. It is interesting and significant to note that Jamshedpur is the “only city in South East Asia to have been selected by the United Nations to participate in the Global Compact Pilot Programme”.⁸ Spread over 64 km², Jamshedpur and has a population of 700,000 with 625 km of roads, and 22,000 residential flats and bungalows of Tata Steel. In addition there are around 15,000 buildings of Tata Motors and 5000 of other Tata companies. In the township, over the years, the quality of municipal services has been maintained at high levels. JUSCO, with its considerable accumulated expertise in town management, especially in water and sanitation businesses, intends to become a national leader in these businesses and to bid for and undertake projects in other parts of the country.

CONTINUOUS REBUILDING

A 100-year plant obviously has evolved with different technologies and makeshift arrangements. Understandably, it lacks the advantages of building a state-of-the-art plant in a greenfield site. Large sections are getting scrapped and rebuilt on a continuous basis. New blast furnaces are being built to make iron-making more efficient. Simultaneously, capacities for sintering and coking coal are being enhanced. Continuous efforts are being made to improve and improvise existing technologies and introduce newer technologies. In a recent interaction with the press in Kolkata, B. Muthuraman, Managing Director, Tata Steel, said “that the company may be trying a new technology which was being developed by Corus … The new technology would result in cost savings by enabling the use of iron ore fines and coal instead of coke”.⁹

“WE ALSO MAKE STEEL”

Tata Steel coined a beautiful slogan impregnated with a lot of meaning a decade ago. “We also make steel.” According to Muthuraman: “To me the statement represents everything Tata Steel does. It is pregnant with so much meaning and conveys a lot of things that making steel is not our only business, but a whole lot of other things define our business like corporate social responsibility, being ethical, spending effort and money on sports, having a green town caring for society …”

TATA’S SOCIAL CONCERN AND COMMITMENT

Overview of Tata Steel Corporate Social Responsibility: Tata Steel—CSR Initiatives

Tate Steel firmly believes that the purpose of an industrial organization is to improve the quality of life of people and the community it serves. Tata Steel commits itself to consistently promoting high ethical values, improvement, and innovation, participative management with customer and stakeholder focus, and emphasis on creating economic and social value.

Tata Steel’s Vision

Tata Steel’s vision statement tells it all, about what it stands for: “To seize the opportunities of tomorrow and create a future that will make us an EVA positive company. To continue to improve the quality of life of our employees and the communities we serve.”

We Generate Wealth for the Nation. What comes from the people must, to the extent possible, therefore get back to the people.

Jamsetji Nusserwanji Tata, 1903

The above quote succinctly illustrates the Tata ethos, and summarizes the guidelines laid down by Tata Steel’s founder, Jamsetji Nusserwanji Tata. A facet of the founder’s remarkable breadth of conception was his recognition that corporate social responsibility was fundamental to India’s drive for industrialization.

Tata Steel’s philosophy and commitment towards social responsibility is guided by its corporate policy.

The Corporate Social Policy of Tata Steel

Tata Steel believes that the primary purpose of a business is to improve the quality of life of people.

Tata Steel will volunteer its resources, to the extent it can reasonably afford, to sustain and improve healthy and prosperous environment and to improve the quality of life of the area in which it operates.¹⁰

ENVIRONMENTAL IMPROVEMENTS

Tata Steel uses suitable resources, technology and work ethics to reinforce its concern for the environment and its desire to conserve natural resources. “It is committed to reducing its environmental footprint and to achieve the target levels set by it”.

Apart from improving the general standard of rural population, Tata Steel has been dealing with the problems of education, health, hygiene, family welfare, agriculture extension, improving the welfare requirements, sports, games and culture. In addition to the above, it has also involved itself with the needs of the environmental improvements by way of bringing the awareness amongst masses of the benefits of land reclamation/rehabilitation and afforestation.

Intensive efforts have been made for the utilization of barren and subsided land, as also utilization of fire areas by large-scale plantations. Over 0.9 million saplings have been planted during the past 8 years with a survival rate of 70 per cent. Enormous experience has been gained in the process and every effort is being made to use even the smallest bit of land to provide a shade of greenery in the area.

Several measures have been taken for controlling water pollution by use of waste water for growing crops and vegetables, supply of drinking water to the colonies after proper treatment and launching a pisciculture programme using the village ponds. Several wells and tube wells have been constructed and repaired for the local population.

ENVIRONMENT CELL

Tata Steel created a separate Environment Cell that independently looks after matters of the environment and pollution control activities of the division. They have regular meetings every month to review pollution control activities. This cell is continually being expanded.

A laboratory to test air and water samples so as to monitor the environmental activities has been set up. The company appointed a team from CMRS, Dhanbad, to study the extent of pollution in their various establishments and to suggest action to be taken for reducing the pollution. A comprehensive programme of surface environmental studies with respect to air, water and noise has been undertaken. Appropriate steps are taken based on the studies conducted and their recommendations.

CORPORATE GOVERNANCE AT TATA STEEL

Good ‘corporate governance’ should be an integral part of all of the processes, not just (as often assumed) social responsibility and corporate citizenship. After all, a good corporate citizen needs to be accountable to stakeholders while conducting business as well as when investing in the community at a later date.

Tata Steel has gone some way in ensuring corporate governance at all stages of the business process. Every year the company aims to exceed its targets on the Employee and Customer Satisfaction Indexes, and the Corporate Citizenship Index. In order to improve its internal management systems, it has also adopted two systems of evaluation:

• Tata Code of Conduct—follows guidelines established by the UN Global Compact. A company signing to the Tata Code of Conduct entitles that company to use the Tata brand name. It prescribes principles by which all employees are expected to act.
• Audit Committee

SOCIAL INVESTMENT

Tata Steel’s social investment reflects its ‘after-profit’ practice, work in and for the community that is not directly related to the ‘business of business’. Again, Tata Steel has internal procedures that guide policy, meaning that community initiatives are seldom ad hoc. Given below are six of these initiatives or procedures:

1. Tata Council for Community Initiatives (TCCI): TCCI is a product of the Tata Group’s commitment to the community. It serves to help the Tata companies in their business-community relations, by drawing up ‘Tata Guidelines for Community Development,’ designing programmes, then implementing them. Programmes include training courses in which Tata companies conduct technical (IT, Vocational) training to members of the community. This is done with the help of company volunteers, often management staff. One of the projects involves the formation of a Tata Corps of Volunteers, under which employee volunteering plays an increasingly important role in developing business-community relations.
2. Tata Social Evaluation, Responsibility and Accountability (ERA): ERA is a procedure by which Tata’s community projects are evaluated for their impact on the target communities and their level of accountability. Although ERA is not independent of Tata, such procedures are influential in improving programme delivery and ensuring continuing self evaluation and learning.
3. Global Business Coalition (GBC): The Global Business Coalition on HIV/AIDS aims to check the growth of the disease with the help of over a hundred major international companies. Believing that business holds the necessary marketing skills, management and infrastructure to be able to raise awareness in rural communities, the GBC encourages companies to campaign with imagination and consistency.

   Tata Steel has done just that, and won an award in June 2003 for ‘Best Initiative’. Initially, Tata focused on educating employees, but now targets over 600 villages in the state of Jharkhand. This is done through the dissemination of mass media, as well as more inventive schemes, such as student workshops which employees are trained to deliver, or travelling street plays in local languages that reach the rural illiterate. Tata Steel paid for six condom-vending machines in the city of Jamshedpur in public places, which are also proving to be a success. At one of these locations, a busy coach station, there is also a clinic where passers-by can have free check-ups and learn more about HIV/AIDS.

4. Volunteer Database: A ‘Directory of Employee Volunteers’ was established by the Tata Group as an efficient way of matching jobs in the community with employee skills and interests. A corporate committee, consisting of a senior executive, union and government officials, interacts with the communities to ascertain their needs. This is done on a quarterly basis with senior citizens of each village, and biannually with target women’s groups.
5. Health Initiatives: Working with government to prioritize projects, Tata Steel’s involvement in health initiatives remains largely philanthropic, with the exception of the Global Business Coalition for HIV/AIDS awareness scheme. Tata Steel has invested in a local hospital which treats an average of 2,300 people per day. It has also bought specialist cancer-treating equipment, and part-finances the running of one blood bank, two rehabilitation centres and five homeopathic clinics. Donations to the clinics and centres are regular and on a long-term basis, which does indicate a move from ad hoc sponsorship to a more strategic social investment. This is organized by the Family Welfare Department.
6. Culture and Education: Education and Youth Development Programmes have built and maintained infrastructure for sports across Jharkhand. Over 1,500 young people are currently training at Tata Steel’s two sporting academies, six training centres or their Adventure Foundation. Awards are given to employees who excel in sports. A Tribal Cultural Centre was built in 1993 and a Jubilee Amusement Park in 2001 to enrich the cultural heritage of the city of Jamshedpur.

TATA STEEL’S CSR COMMITMENT IS IN THREE CORE AREAS

Tata Steel’s commitment to its CSR finds reflection in its adoption of the Corporate Citizenship Index, Tata Business Excellence Model and the Tata Index for Sustainable Development. Tata Steel spends 5–7 per cent of its profit after tax (PAT) on several CSR initiatives. The company’s CSR initiatives are spread across three core areas—employee welfare, the environment and the welfare of the community at large. Under this broad spectrum, diverse areas are covered. These include environment management, economic development, employee relations, civic amenities and community services, healthcare, sports and adventure, relief during natural calamities, education, arts and culture and social welfare.¹¹

Welfare Organizations

To achieve its broader objectives of improving the quality of life of the people, Tata Steel supports various social welfare organizations such as the Rural Development Society, Tribal Cultural Society, Tata Cultural Society, Tata Steel Foundation for Family Initiatives, National Association for the Blind, Shishu Niketan, School of Hope, Centre for Hearing Impaired Children and the Indian Red Cross Society.

The company has hosted 12 Lifeline Expresses in association with the Ministry of Railways, Impact India Foundation and the Government of Jharkhand and served over 50,000 people. It has also joined hands with village development committees in the Saraikela Kharsawa area to provide training to villagers. Tata Steel has also been actively involved in taking up integrated wasteland development programmes and watershed development programmes for rainfed areas.

Self-Help Groups

The company also supports women’s empowerment through self-help groups. These programmes cover 42 villages in the Gamharia block in Seraikela Kharsawa area. Tata Steel has also installed 2,600 tubewells to provide drinking water to over four lakh people.

Healthcare Projets

Some of the other CSR initiatives that the company has been involved in include facilitation of child education, immunization and child care. It has also invested in education by financing schools and colleges that teach nearly 10,000 students every year.

Global Recognition for Tata Steel’s Active Involvement in CSR

Tata Steel’s active involvement in CSR activities has earned for the company global recognition. In the past five years, Tata Steel was conferred the following distinguished awards:

1. Tata Steel-administered Jamshedpur is one amongst the six cities in the world chosen to participate in the UN Global Compact Cities Pilot Programme. The reason behind Jamshedpur being nominated into this international pilot project is the exceptional record of Tata Steel in the field of community development.
2. Tata Steel’s Sukinda chromite mines in Orissa was conferred the prestigious S.A 8000–2001 certification by Social Accountability International (SAI), USA. Social Accountability 8000:2001 Certification is a global verifiable standard for managing the workplace.¹²
3. Tata Steel is the only Indian manufacturing company to win the Asian Most Admired Knowledge Enterprises Award (MAKE), for two successive years, 2004 and 2005, for its relentless effort and contribution in the field of knowledge management.
4. Tata Steel ranks second in leadership development among companies in Asia Pacific, according to a study conducted by Hewitt Associates.
5. Tata Steel made a noteworthy beginning when it was conferred the ‘Shram Vir/Virangana’ award. This was the first time private sector companies were included within the ambit of the Prime Minister’s Shram Award Scheme.
6. Tata Steel was awarded the coveted Energy and Resource Development Institute Award for Corporate Social Responsibility in recognition of corporate leadership and citizenship and sustainable schemes of the company.
7. The National HRD Network’s Pathfinder Award 2004 in the CEO category was conferred on Tata Steel Managing Director, Mr B. Muthuraman, for steering a major transformation in the organization through people and processes.
8. Tata Steel’s works in Jamshedpur was conferred the prestigious Social Accountability (SA) 8000 Certification by Social Accountability International (SAI), USA in 2005.¹³
9. The Mother Teresa Award for Corporate Citizenship was conferred on Tata Steel for being a role model in Corporate Citizenship, for other companies and students of management to emulate, by Loyola Institute of Business Administration (LIBA), Chennai in 2005.
10. In 2007, the Tatas have been chosen for the internationally acclaimed Andrew Carnegie Medal of Philanthropy by the Carnegie Corporation of United States in recognition of their “longstanding commitment to philanthropic causes” which has contributed to “beneficial change in the lives of millions of people”.¹⁴

LOOKING TO THE FUTURE

Along with the TCCI’s project to formalize employee volunteering, Tata Steel also hopes to align more with global standards and initiatives. In 2001 Tata Steel produced a Corporate Sustainability Report following guidelines established by the Global Reporting Initiative. This is another step forward for the company looking to make its mark on the new corporate responsibility agenda.

KEYWORDS

Jamshedpur • Industrial policy resolution • Intrinsically linked • Economic value addition (EVA) • Toll-free customer care centre • Anglo-Dutch steel maker Corus • Downsizing sans tears • Integrated steel plant • Industrial research • Corporate social responsibility (CSR) • Global Business Compact (GBC) • Corporate governance • Global recognition • Self-help groups • Healthcare projects • Family initiatives • Looking to the future.

DISCUSSION QUESTIONS

1. How did Tata Steel achieve downsizing of the Jamshedpur Steel plant? Do you think it is an ideal policy for others to follow?
2. Jamshedpur city has been praised by people as a model city. What are the factors that have contributed to the evolution of the Steel City as a model city?
3. Explain Tata Steel’s CSR policy. In your assessment, to what extent the Tata Steel has put into practice its precepts of the CSR policy?

FURTHER READINGS

1. “After Corus,” Business India, 25 February 2007.

2. “Corporate Social Responsibility, Putting Principles Into Practice,” A Tata Steel Publication.

3. S. Elankumaran, Rekha Seal and Anwar Hashmi, “Transcending Transformation: Enlightening Endeavours at Tata Steel,” Journal of Business Ethics (Vol. 59, 2005): 109–119.

4. “India Inc’s Global Leap,” India Today, November 2006.

5. “Making Corus Work”, Businessworld, 19 February 2007.

6. S Mitra Mazumder, & T Ghoshal, “Strategies for Sustainable Turnaround of Indian Steel Industry,” available at www.ieindia.org/publish/mm/1003/Oct033mm2.pdf.

7. “Ratan Tata’s Global Quest,” Business World, 9 October 2006.

8. B. Sh. Saklatvala and K. Khosla, Jamsedji Tata, Builders of Modern India (New Delhi: Publications Division, Ministry of Information and Broadcasting, Government of India, 1970).

9. Tata Steel, “Setting Sustainability Standards,” available at www.tatasteel.com/corporatesustainability/default.asp

10. S. Viswanathan, “Tata Steel, Rolling Ahead, Gathering Moss,” Industrial Economist, 15–29 January and 30 January–14 February 2005.

11. http://icmr.icfai.org/casestudies/catalogue/BusinessEthics/BECG008.htm

12. www.capindia.org/op3_history.htm

13. www.hindu.com/thehindu/mp/2004/08/05/stories/2004080500190300.htm

14. http://icmr.icfai.org/casestudies/catalogue/BusinessEthics/Tata.htm.

15. www.hindu.com/2005/07/29/stories/2005072905991100.htm.

16. www.hindu.com/thehindu/mp/2004/08/05/stores/2004080500190300.htm

17. www.hinduonnet.com/2002/01/05/stories/2002010501821600.htm

18. www.rediff.com/money/2005/mar/17inter.htm

19. www.rediff.com/news/sep/24nandy.htm

20. http://in.rediff.com/news/oct/13assam.htm

21. www.rediff.com/business/sep/15tata.htm

22. www.synergos.org/globalgivingmatters/features/0503tatagroup.htm

23. www.tata.com

24. www.tata.com/o_beyond_business/community/index.htm