corporate governance in India – MBA lecture notes for students
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1) Overview of corporate Governance
Ownership and management patterns in businesses have changed phenomenally over decades. The number of stakeholders in every business has also multiplied. This has given rise to agency costs and ethical issues. However, whether it is the proprietor or the executive managing the business, the basic objective of wealth generation still remains. Even an owner needs to learn to govern. So how do we understand the concept of governance? Corporate governance represents the value framework, the ethical framework and the moral framework under which business decisions are taken. Corporate Governance may be defined as a set of systems, processes and principles which make sure that a company is governed in the best interest of all stakeholders. It is the system by which companies are directed and controlled. It make sure the commitment of the board in operate the company in a transparence manner for maximizing long-term value of the company for its shareholders. It is about promoting corporate sufficiency, transparence and accountability. In other words, ‘good corporate governance’ is nothing but ‘good business’.
2) Corporate Board
Corporate governance in India is the system by which companies are directed and managed. It influences how the objectives of the company are set and achieved, how risk is monitored and assessed, and how performance is optimized. Good corporate governance structures encourage companies to create value (through entrepreneurialism, innovation, development and exploration) and provide accountability and control systems commensurate with the risks involved. – (ASX Principles of Good Corporate Governance and Best Practices Recommendations, 2003)
3) Shaping Directorial
As corporations grow in size and complexity and are increasingly doing business in the global arena, it becomes essential for boards to uphold the highest standards of corporate governance and to perform their role effectively. There has been a constant transformation in corporate governance in Europe. Changes in the US have been more visible due to the impact of Sarbanes-Oxley Act. In India, with the advent of Clause 49, board structures have started to change; board committees are playing a more central role, and it is now a requirement for a majority of board directors to be independent. However, the reality is that most listed company boards have little experience of what it means to hear independent voices around the table and little appreciation of the value that a truly diverse group of directors can bring to board performance. As Indian companies participate in the global business arena alongside multinationals, there is a more widespread understanding of fiduciary responsibility and governance and expectations over governance standards will rise yet further.
4) Financial Institutions and Nominee Directors
The fundamental objective of corporate governance in India is the “enhancement of shareholder value, keeping in view the interests of other stakeholder”. This definition harmonizes the need for a company to strike a balance at all times between the need to enhance shareholders’ wealth whilst not in any way being detrimental to the interests of the other stakeholders in the company. The pivotal role in any system of corporate governance is performed by the board of directors. It is accountable to the stakeholders and directs and controls the Management. It stewards the company, sets its strategic aim and financial goals and oversees their implementation, puts in place adequate internal controls and periodically reports the activities and progress of the company in a transparent manner to the stakeholders.
5) Corporate Disclosure and Investor Protection
In India, the capital market is regulated by the Capital Markets Division of the Department of Economic Affairs of the Ministry of Finance. The division is responsible for formulating the policies related to the orderly growth and development of the securities markets (i.e. share, debt and derivatives) as well as protecting the interest of the investors. In particular, it is responsible for (i) institutional reforms in the securities markets, (ii) building regulatory and market institutions, (iii) strengthening investor protection mechanism, and (iv) providing efficient legislative framework for securities markets, such as Securities and Exchange Board of India Act, 1992 (SEBI Act 1992); Securities Contracts (Regulation) Act, 1956; and the Depositories Act, 1996. The division administers these legislations and the rules framed thereunder.
6) Corporate Reputation
The emerging global business environment has undergone extraordinary changes and raised challenges for existing business models to accommodate these changes. While globalization has been an advantage in business operations, it has also made corporations vulnerable to greater risk, abuse and fraud on a global scale. This emerging scenario has given rise to the serious issue of the inadequacies of governance and demands for new reforms, bringing new models of operation and re-evaluation of systems. In the United States, numerous numbers of corporate scandals including Enron’s accounting fraud, WorldCom’s accounting scandals and bankruptcy, destruction of natural environments due to oil spillage, etc. have occurred and many of them have suffered serious problems such as bankruptcy, corporate crisis, or loss of social credibility.
7) Corporate Governance in India and Regulatory
There are four primary financial regulators – Reserve Bank of India, Insurance Regulatory and Development Authority, Securities Exchange Board of India and Pension Fund Regulatory Development Authority in the Indian Financial System. The RBI is the apex body in the system. The governmental role is played by the Ministry of Corporate Affairs. Corporate governance in India specifies the relationship among various primary participants (shareholders, directors, and managers) in determining the directions and performance of corporations. Because insiders have an inherent informational advantage over outside stakeholders, it is required that the governance systems empower independent parties to monitor their behavior and reports. The legal and regulatory system of a country plays a crucial role in creating an effective corporate governance in India mechanism in a country, the development of markets and economic growth. The regulatory bodies in India have advocated comprehensive and rigorous corporate governance in India reforms which emphasize the importance of the credibility and integrity of the listed companies, the responsibilities of minority shareholders, and the necessity for information disclosure.
8) Globalisation and Corporate Governance in India
From the point of view of the firm, globalisation implies greater competition, but it also implies participation in more markets for inputs (including capital, intermediate goods and factors of production) and outputs. As these markets become more integrated, there will be strong pressure to adopt strategies and structures that make the firm as competitive as possible. Globalization of markets for intermediate products has had a major impact on the organization of firms. The opportunities for firms to engage in globally structured production through outsourcing, as well as multi-nationalization, induces firms to adopt new governance structures to manage the new production structures. Responding to increased opportunities and threats resulting from globalization in the market for final goods could also cause firms to consider reorganization of its corporate governance in India practices. Good corporate governance in India is critical for ensuring the efficiency of investment. It is also essential for attracting foreign investment.
9) Regulatory framework and Investor Protection
Investors are the main stake holders in a company. As shareholders, they are the ultimate owners of the company. An incorporated association operates on the principle of separation of ownership and management where the Board of Directors have to run the company keeping in view the shareholder’s interests. While the term shareholders is limited to people holding shares of the company, the term investors is broad taking into the purview all classes of investors. The company starts its business on the basis of investments made by different investors and as agents of the company, the board of directors should try to maximise shareholders wealth. When corporate fail to follow ethical practices, the people who suffer directly are the investors. Investor protection is the foundation of a healthy capital market. There are different categories of investors; small or retail investors, institutional investors and high net worth individuals. Not all of them need the same degree of protection. It is generally the small investors who considering his lack of financial literacy and lack of information need greater protection that’s why corporate governance in India here to solve these issue.
10) Corporate Social Responsibility
Every business has to incur a private cost and a social cost. Any business activity would involve the use of resources which are scarce and which have an opportunity cost. Rapid industrialization and urbanization has apart from bringing out economic development has also caused a lot of damage to the environment. The cost that the society has to bear in terms of pollution, deforestation, exploitation of resources is the social cost. While the private cost restricted to the firm, the social cost is borne by the society at large Sustainability in consumption pattern is essential if we are looking at long time existence and well-being of the human race and that of the earth’s resources. Ever increasing population coupled with excessive greed and unscrupulous consumption is putting a pressure on the environment and disturbing the ecological balance. Changing lifestyles, greater disposal incomes, influence of aggressive advertisements and conspicuous consumption have accelerated the consumption levels across nations. The life cycle of a product starts from its manufacture, packaging use and disposal all of which will have an ecological impact. A nation is considered developed on the basis of its capacity to spend or the propensity to consume. The gross domestic product (GDP) is one which the primary indicators used to gauge the health of a country’s economy. However, it is argued that it is not a correct measure as it encourages development at the cost of sustainability.
11) Majority Rule and Minority Protection
Doing business as an incorporated association is preferred vehicle over other forms of business organisation because of some definite advantages. There is tremendous scope for expansion and growth owing to easy access to finance. The advantage of incorporating a company and doing business is its liability factor. The liability of a shareholder for the losses incurred by the company is limited to the extent of unpaid amount on his shareholding. The relation between the company and its shareholders and the relation between the shareholders inter-se is primarily contractual in nature. The memorandum and articles of association of the company constitute the core of this contract and the corporate law provides the framework within which the contracts operate. The essence of this contractual relationship is that each shareholder is entitled to a share in the profits and assets of the company in proportion to his shareholding. Arising from this is the principle that the Board and the management of the company have a fiduciary responsibility towards each and every shareholder and not just towards the majority or dominant shareholder.
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