121 Corporate Governance in India: Developments and Policies ISMR

Corporate Governance in India: Developments and Policies

A. Importance of corporate governance in the capital market

Corporate governance (CG) represents “the set of checks and balances within the corporate structure that helps create
long-term value enhancement for stakeholders in a company.” (Varottil, 2009) The corporate scandals at Enron and
Worldcom and collapse of financial giants such as Bear Stearns, AIG and Lehman Brothers have underscored the
significance of corporate governance to the economy and have focused the attention of the policy makers the world
over on the CG standards in their respective countries.
Why is corporate governance so important to a country? There are two significant reasons. First, an orderly and transparent
business environment inspires confidence on the part of domestic and international investors. While making investment
decision, investors consider governance risk, which arises from the potential for lack of transparency, accountability
and enforceability in the marketplace, as one of the critical factors. Research suggests that foreign investors shy away
from countries characterized by weak shareholder protection and related legal institutions. Second, weak governance
systems often lead to serious problems; the 1997 East Asian crisis, for example, was partly attributed to the weak
institutions. The total indebtedness of countries affected by the crisis exceeded one hundred billion dollars. Similarly,
the failure of a large corporate can cost an economy dear; for example, the first year cost to the US economy caused
by the failure of Enron in terms only of stock price erosion has been estimated at $35 billion! In India, the focus on
corporate governance reforms came with the liberalization of the economy in early 1990s, motivated by the first reason
stated above rather than the second.
The initial impetus for CG reforms in India was provided by the industry, rather than the government. In 1998, a
voluntary Code of Corporate Governance was published (by Competition Commission of India), which was followed by
the establishment of the Kumar Mangalam Birla Committee on Corporate Governance by the Securities and Exchange
Board of India (SEBI). Over the past one and half decades, India has made significant strides in CG reforms, thereby
improving public trust in the market. These reforms have been well received by investors, including foreign institutional
investors (FIIs). Compelling evidence of the improving standards in India comes from the growing interest of foreign
portfolio investors (FPIs) in the Indian market. Foreign portfolio investment (equity and debt) in India rose from USD 2.1
billion in FY 1996 to USD 45.4 billion in FY 2015.
The governance reforms in India and the globalisation of the capital markets have been mutually reinforcing. While
continuing governance reforms have led to rising foreign investment, the globalisation of the capital markets has provided
an impetus towards a more stringent CG regime. How did capital market globalization improve corporate governance
regime? To market their securities to foreign investors, Indian companies making public offerings in India had to comply
with the CG norms with which investors in the developed world were familiar. Further, Indian companies listing abroad
to raise capital were subject to the stiff CG requirements that are applicable to companies listing on those exchanges.
However, such practices have remained confined to a few large companies and have not percolated to the majority of
Indian companies.

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 ISMR Corporate Governance in India: Developments and Policies 122

B. Where does India stand?

Doing Business is an annual publication of the World Bank, which presents a detailed analysis of global regulatory
systems, the efficacy of bureaucracy, and the nature of business governance worldwide. The report presents data for 189
economies and aggregates information from 10 areas of business regulation, namely:
1. Starting a business
2. Dealing with construction permits
3. Getting electricity
4. Registering property
5. Getting credit
6. Protecting minority investors
7. Paying taxes
8. Trading across borders
9. Enforcing contracts
10. Resolving insolvency
In terms of ‘ease of doing business’, India ranks 130 among 189 countries in 2015, which is four positions up from its
ranking in 2014 (Doing Business 2016).1 India’s relative ranking in all these 10 components of ‘ease of doing business’
in 2015 and 2016 are outlined in Table 1.

Table 1: India’s rank in “ease of doing business” and other indicators

Year Ease of Starting Dealing Getting Register- Getting Pro- Paying Trading Enforc- Resolv-
Doing a Busi- with Electric- ing Prop- Credit tecting Taxes across ing Con- ing Insol-
Business ness Con- ity erty Minority Borders tracts vency
struction Investors
Permits
2016 130 155 183 70 138 42 8 157 133 178 136
2015 134 164 184 99 138 36 8 156 133 178 136
Source: Doing Business 2016, World Bank

Clearly, India’s relative position is the best in the area of ‘protecting minority investors’, where it ranks eighth in
the world. While the indicator does not measure all aspects related to the protection of minority investors, a higher
ranking does indicate that an economy’s regulations offer stronger minority investor protections against self-dealing in
the areas measured. In the recent years, India has taken steps to strengthen minority investor protection by requiring
substantial disclosure of conflicts of interest by board members, increasing the remedies available in case of related-
party transactions, and introducing additional safeguards for the shareholders of privately held companies.
Protecting minority investors matters for the ability of companies to raise the capital they need to grow, innovate,
diversify and compete. Effective regulations define related-party transactions precisely, promote clear and efficient
disclosure requirements, require shareholder participation in major decisions of the company and set detailed standards
of accountability for company insiders.
India fared better than China, Brazil, and Russia with regard to ‘protecting minority investors’ (Table 2). Table 2 also
provides a comparative analysis of India’s score--vis-à-vis a select group of countries--on a number of parameters of
‘minority investors’ protection’

1
Doing Business 2016 takes into account data until June 2015.
The Doing Business 2015 rankings are adjusted based on 10 topics (business regulations)..

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123 Corporate Governance in India: Developments and Policies ISMR

Table 2: Country-wise ranking in terms of “protecting minority investors”

Parameters India China Brazil Russia USA UK

Protecting minority investors (rank) 8 134 29 66 35 4
Extent of disclosure index (0–10) 7 10 5 6 7.4 10
Extent of director liability index (0–10) 6 1 8 2 8.6 7
Ease of shareholder suits index (0–10) 7 4 4 7 9 8
Extent of conflict of interest regulation index (0–10) 6.7 5 5.7 5 8.3 8.3
Extent of shareholder rights index (0–10) 10 1 7 7.5 4 8
Extent of ownership and control index (0–10) 8 2 7 6 4.4 6
Extent of corporate transparency index (0–10) 6 8 8 6 5.4 8
Extent of shareholder governance index (0–10) 8 3.7 7.3 7 4.6 7.3
Strength of minority investor protection index (0–10) 7.3 4.3 6.5 5.7 6.5 7.8
Source: Doing Business 2016, World Bank

C. Recent reforms in CG framework for listed companies

Corporate governance in India was guided by Clause 49 of the Listing Agreement before the introduction of the
Companies Act of 2013. As per the new provision, the SEBI approved certain amendments in the Listing Agreement to
improve transparency in the transactions of listed companies and to empower minority stakeholders to influence the
decisions of the management. These amendments became effective from October 1, 2014.
During the current fiscal year (up to September 2015), the regulators focused on implementing the changes in the CG
framework. The SEBI took steps to ensure that companies comply with the new rules; the stock exchanges were directed
to take action against companies that did not comply with the new framework.
Some of the important developments and policy changes in the CG framework in the country during the period October
2014–September 2015 are summarised in this section.

Fine structure for non-compliance with Clause 49(II)(A)(1) (Appointment of Women Directors) of
the Listing Agreement:
The Companies Act of 2013, Section 149 (1) requires every company of a prescribed class to have “at least one
woman director”; the prescribed class comprises all listed companies (with some exceptions) and every other public
company having a paid up share capital of INR 100 crore or more, or, turnover of INR 300 crore or more. As regards
listed companies, this provision is reflected in the Clause 49 (II) (A) (1) of the Listing Agreement. Also, SEBI had
mandated that the appointment of woman directors to the board must happen no later than 1 April, 2015. If the listed
companies remain non-compliant after 1 April, 2015, stock exchanges have been mandated by SEBI to levy monetary
penalties starting June 30, 2015, while additional penal measures would be taken for those continuing to stay in default
(see table 3).

Table 3: Fine structure for non-compliance with Clause 49(II)(A)(1) of the Listing Agreement

Compliance Status Fine Structure

Listed entities complying between April 1, 2015 and June ` 50,000/-
30, 2015
Listed entities complying between July 1, 2015 and ` 50,000 + ` 1000/- per day w.e.f. July 1, 2015 until the date of
September 30, 2015 compliance
Listed entities complying on or after October 1, 2015 ` 1,42,000/- + ` 5000/- per day from October 1, 2015 until the date
of compliance

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 ISMR Corporate Governance in India: Developments and Policies 124

CAG review report on corporate governance compliance by central public sector enterprises:
CPSEs under the Ministry of Commerce and Industry, Ministry of Mines, Ministry of Tourism, Ministry of Urban
Development and Ministry of Textiles had been selected for the purpose of reviewing their adherence to the guidelines
issued by the SEBI and the Department of Public Enterprises (DPE). As such, the review covered 34 (excluding closed
companies and SPVs) companies under the jurisdiction of the aforesaid five ministries. The period of one year ended
March, 2014 was covered in the review. In the Corporate Governance chapter of the CAG’s report, which was
submitted to the Ministry of Corporate Affairs in March 2015, revealed that 18 out of these 34 CPSEs had not appointed
independent directors. A risk policy was yet to be developed in 9 CPSEs, and a model of code of conduct for the board
of directors was not circulated in 16 CPSEs. Delays of over six months were observed in filling the vacancies in the
board of directors of 8 CPSEs. The CAG report concluded that a large number of CPSEs did not comply with the DPE’s
CG guidelines, even though compliance was mandatory.

RBI gives CG direction to NBFCs:

In April 2015, the Reserve Bank of India (RBI) issued CG directions to the non-banking financial companies (NBFCs) in
order to regulate the credit system in India. These CG directions are applicable to all NBFCs, except the Systemically
Important Core Investment Companies as defined in the Core Investment Companies (Reserve Bank) Directions, 2011.
The key CG directions issued by the RBI are as follows:
I. Constitution of committees of board: The RBI directed all the applicable NBFCs to constitute an audit committee,
a nomination committee, and a risk management committee. The functioning of these committees will be guided
by the Companies Act, 2013.
II. Ensure fit and proper criteria: All applicable NBFCs were directed to establish a policy—with the approval of the
board of directors—to ascertain the fit and proper criteria of the directors at the time of appointment. Further, a
quarterly statement about the change of directors and a certificate from the NBFC’s managing director (MD) that
the fit and proper criteria of directors have been ascertained, have to be furnished to the RBI.
III. Disclosure and transparency: NBFCs are required to present to the board of directors a report about the progress
that has been made in establishing a risk management system and policy, and about conformity with the CG
standards. Additional disclosures are outlined in the annual financial statements, with effect from March 31,
2015.
IV. Rotation of partners of the statutory auditors’ audit firm: The new CG directions to the NBFCs require that the
partners of the chartered accountants’ (CA) firm conducting the audit should be rotated every 3 years, so that the
same partner does not audit the company continuously for more than 3 years.
V. Framing of internal guidelines: All applicable NBFCs are required to frame their internal guidelines on CG, with
the approval of the board of directors. These guidelines should be published on the company website for the
benefit of different stakeholders.

Establishment of Bank Boards Bureau to improve governance in PSU banks:

In the Union Budget 2015–2016, the government announced the establishment of the Bank Boards Bureau (BBB) to
improve governance in the public sector banks (PSBs). The BBB was established based on the recommendations of the
“Gyan Sangam,” a conclave of public sector banks (PSBs) and foreign investors (FIs) organised in the beginning of 2015.
The BBB, which will commence functioning from April 1, 2016, was established to strengthen the risk management
practices undertaken by the PSBs.
Revised road map for implementation of Indian Accounting Standards: The Ministry of Corporate Affairs, Government
of India, outlined the revised timeline for the implementation of the Indian Accounting Standards (Ind AS) for companies
other than banking and insurance companies, and NBFCs. The objective of the Ind AS is to ensure the transparent

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125 Corporate Governance in India: Developments and Policies ISMR

dissemination of financial reports to the users and to ensure the reports are comparable across the periods presented.
The implementation of the Ind AS will be a big step in the direction of better corporate governance in the country.
The Ind AS will be applied to companies as follows:
(i) On voluntary basis for financial statements for the accounting period beginning on or after April 1, 2015, with
comparatives for the period ending March 31, 2015 or thereafter;
(ii) On mandatory basis for the accounting period beginning on or after April 1, 2016, with comparatives for the
period ending March 31, 2016 or thereafter for the following companies:
(a) Companies whose equity and/or debt securities are listed or are in the process of listing on any stock
exchange in India or outside India, having net worth of ` 500 crore or more.
(b) Companies other than those covered in paragraph (ii) (a), having net worth of ` 500 crore or more.
(c) Holding, subsidiary, joint venture, or associate companies of companies covered under paragraph (ii) (a)
and (ii) (b).
(iii) On mandatory basis for the accounting period beginning on or after April 1, 2017, with comparatives for the
period ending March 31, 2017 or thereafter for the following companies:
(a) Companies whose equity and/or debt securities are listed or are in the process of being listed on any stock
exchange in India or outside India, having net worth of less than ` 500 crore.
(b) Companies other than those covered in paragraph (ii) and paragraph (iii)(a); i.e., unlisted companies
having net worth of ` 250 crore or more, but less than ` 500 crore.
(c) Holding, subsidiary, joint venture, or associate companies of companies covered under paragraph (iii) (a)
and (iii) (b).
However, companies whose securities are listed or are in the process of listing on small and medium enterprises
(SME) exchanges are not required to apply the Ind AS. Such companies will continue to comply with the existing
accounting standards, unless they choose otherwise.
(iv) Once a company opts to follow the Ind AS, it shall be required to follow the Ind AS for all subsequent financial
statements.
(v) Companies that are not covered by this roadmap will continue to apply the existing accounting standards
prescribed in the Annexure to the Companies (Accounting Standards) Rules, 2006.

D. Seminar on “Board Evaluation: An Imperative for Corporate Governance”

The National Stock Exchange of India Limited (NSE) organised a seminar on “Board Evaluation: An Imperative for
Corporate Governance” in Mumbai on March 30, 2015. The broad objective of this seminar was to familiarise the
directors of its listed companies—who constituted the bulk of the audience—with the relevance of board evaluation
exercises, the various options available for the same, and the associated implementation issues.
The conference included a keynote speech by Dr. Chris Pierce, CEO, Global Governance Services Limited and a panel
discussion. Dr. Pierce highlighted the opportunities and challenges of board evaluation, which provided several new
perspectives to the participants. The panellists in the subsequent panel discussion—Prof. N. Balasubramanian, Dr. Chris
Pierce, Deepak Satwalekar, and Cyril Shroff—discussed some of the potential challenges that corporates face during
board evaluation in the Indian context. They also shared some good practices related to board evaluations. The overall
view that emerged was that if one were to do the bare minimum for the sake of compliance, one would squander one
of the best opportunities to genuinely improve board effectiveness.

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 ISMR Corporate Governance in India: Developments and Policies 126

E. Quarterly briefings under the aegis of the NSE Centre for Excellence in Corporate Governance
In recognition of the important role that stock exchanges play in enhancing CG standards, the NSE established a Centre
for Excellence in Corporate Governance (NSE CECG) in December 2012. This is an independent expert advisory body
comprising eminent domain experts, academics, and practitioners. The committee meets from time to time to discuss
CG issues and developments. The Quarterly Briefing, a note that offers an analysis of an emerging or existing CG issue,
is based on these discussions. In 2015, the NSE CECG published four issues of the Quarterly Briefing on the following
topics:
a) Related-party transactions
b) Corporate governance in state-owned enterprises
c) Gender diversity on boards
d) Indian corporate board structure: Moving towards best practices
All the issues of Quarterly Briefing are available on the NSE website:
http://www.nseindia.com/research/content/res_NSE_CECG.htm

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