Concept of Corporate Governance in its Various Aspects | UPSC Mains Essay Preparation PDF Download

Concept of Corporate governance in its various aspects

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(1) Opening    —    Everybody who has anything to do with the corporate sector talks of corporate governance.

    —    Definition of corporate governance.

(2) Body    —    Structural and organisa-tional aspects.

    —    Composition of the board.

    —    Whether the Chairman should be different from the CEO of the company or not.

    —    Role of nominee directors.

    —    Personal competencies and qualities of individual direc

tors.

    —    Different committees of directors.

    —    Process of effectiveness.

(3) Closing    —    Only when the processes and systems are set up as a sequel to business needs, proper corporate gover-nance as a way of life in business and industry will take root.

The term corporate governance is much in use these days: everybody and anybody who has anything to do with the corporate sector talks of corporate governance. As is the case with anything popular, the term has almost become a rhetoric; like all rhetorics it is the most spoken and least meant.

Corporate governance can be defined as a set of systems and processes which ensure that a company is managed to the best interests of all the stake holders. The set of systems that help certain structural and organisational aspects: the processes that help corporate governance will embrace how things are done within such structures and organisational systems. When one talks of the stake holders it does not mean only shareholders: a company will typically have five stake holders, namely, employees, shareholders, customers, creditors and the community.

To be able to serve the best interests of all the stake holders, systems and processes have to be built keeping in mind the interests of each of the stake holders. Against this background one can analyse some of the aspects as underlined in the above definition of corporate governance.

The word ‘systems’ includes structural and organisational aspects that facilitate better corporate governance. It is well known that a company being an artificial and juristic entity cannot function by itself: the persona of a company is manifested through the board of directors. In fact, the most important body in the corporate sector is its board of directors. It is often said that the cause of corporate governance is served depending on how well the board of directors of a company is organised and structured. The Companies Act, 1956 does not exhaustively describe the powers and duties of the board. It can be said that some of the shareholders’ agreements talk more extensively about the power and duties of company boards than the Companies Act, 1956.

While dealing with the issues connected with the board of directors in the context of corporate governance the following aspects have to be borne in mind: (a) optimum size of the board; (b) optimum composition of the board in terms of both whole-time and part time directors; (c) whether the chairman of the board should be different from the CEO of the company; (d) the role of nominee directors; (e) personal competencies and qualifications of individual directors; (f) the frequency with which the composition of the board should be changed and (g) the different committees of the board.

Studies have revealed that out of the 12 directors only 3 or 4 should be whole time directors and the remaining part time directors. The ratios of whole time directors to part time directors should be heavily in favour of part time directors so as to ensure maximum independence of company boards.

The Cadbury Committee which went into the financial aspects of corporate governance in the U.K. had come out with a definitive recommendation that the chairman of the board should be a person different from the CEO of the company. It felt that this would ensure the right accountability of the CEO to the board and that the independence of the board to a large extent would be whittled down if the chairman and the CEO were one and the same person. But in the Indian context it will be advisable to have as chairman, a person of great stature and eminence who is not in the executive management of the company. This will ensure greater independence and credibility in board proceedings.

Although it is true to a large extent that pro-fessionalisation of company boards in India got accelerated with the induction of nominee directors by financial institutions (FIs), in many cases these nominees have remained content with safeguarding the interests of the FIs vis-a-vis the company.

There is a general impression that whenever a conflict arises between the interests of the term lenders (FIs) and that of the company, the nominees invariably safeguard only the interests of the term lenders. This impression is wholly erroneous. What is good for the company should be good for the FIs too. If the nominee directors ensure that things happen in the best interests of the company, rarely will the interests of the financial institutions and term lenders be jeopardised. After all, in the ultimate analysis, only if the company did well the investments of the public financial institutions will be protected. Hence, there is no question of a conflict of interest between the term lenders and the company.

To be an effective member on the board of a large company, besides stature and eminence one requires certain competencies. A company director, apart from having an independent mind, should have a close insight into how companies operate. It is also important that the company director should know the rudiments of Company Law besides a general up it has been found that a person will be active and agile even at the age of 70. Hence, it will be advisable for company boards to lay down a rule that directors should retire at the age of 70 or at the latest, at 75. Although the Companies Act, 1956 clearly lays down that one third of the directors should retire every year, the spirit behind this law has not been understood at all. Year after year, company directors retire and are re-elected, while there is a need for continuity in the board. It is also important that the members are changed at least every five years. This is to ensure that fresh blood and new thinking is infused into company boards which in a way also ensures their independence.

While the main board of a company should only deal with major policy decisions and the strategic directions that the company should take, it is important to have different committees of the board to have focused attention on various aspects of the company's working.

The need for different committees would depend on the size and complexity of the operations of the company. Typically a large company should have the following committees of directors — Management committee of directors; shares and securities transfer committee of directors; executive nomination and compensation committee of directors: investment committee of directors and audit committee.

The Cadbury Committee dealing with the financial aspects of corporate governance had recognised the importance of the audit function as an effective tool. In the Indian context, the public financial institutions also insist on the constitution of an audit committee of directors for companies of a certain size. A part time director is usually the chairman of the audit committee and normally the other members also are part time directors. The CEO is usually a permanent invittee to its meetings and the finance director is called upon to assist this committee. Statutory auditors and internal auditors are also invited to participate in the meetings and the exception reports of the internal audit department are discussed by this committee for detection and correction of systems failure and lack of adequate internal controls. Also statutory financial statements are vetted by the audit committee before being submitted it for the board's approval.

Typically the management committee of directors is headed by the CEO with other functional directors as members. For ensuring independence of the management decisions, part time directors also are inducted in equal number. The investment committee should have as its members nominee directors of financial institutions and banks and the chairman of the committee should be a part time director. This committee deals only with investments of the company other than for projects and acquisition of other companies. This set of directorial structure should facilitate better corporate governance of companies. 

While dealing with the management processes for ensuring that the best interests of the five stake holders are met effectively, the board along with its different committees and the CEO should devise the right type of processes for organisational effectiveness. These processes could be performance management systems, periodic business reviews, environmental audit, energy audit, security audit, secretarial and legal audit, bench marking customer satisfaction, bench marking employee satisfaction, having surveys against them and so on. In the ultimate analysis, among the five stake holders, the most important stake holder who can be used as an effective instrument to serve the interests of the other four stake holders is the employee. Once the employee needs of an organisation are effectively met with the right processes and structures the cause of corporate governance can be fulfilled effectively.

The company as a responsible corporate citizen cannot afford to ignore the  need for proper corporate governance. Only when the processes and systems are set up as a sequal to business needs, proper corporate governance as a way of life in business and industry will take root. No amount of legislation or governmental action can be a substitute for this.