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Corporate Governance Codes in India Author(s): Lalita S. Som Reviewed work(s): Source: Economic and Political Weekly, Vol.

41, No. 39 (Sep. 30 - Oct. 6, 2006), pp. 4153-4160 Published by: Economic and Political Weekly Stable URL: http://www.jstor.org/stable/4418757 . Accessed: 24/05/2012 02:00
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Codes Corporate Governance

in

India

The debate on corporate governance in India derives significantlyfrom Anglo-Americanexperience, practice and literature. Indian CG codes based on the US and UK experience do not resolve specific governance issues plaguing Indianfirms. In spite of best efforts to assimilate and apply international CG practices, the values embeddedin our national culture have resulted in their desultory implementation. The article highlights those areas where Indian CG practices have diverged from international best practices and how these areas are proving to be challenges in promotinggood governance culture in India.
LALITAS SOM

he issue of corporategovernance(CG) gained promi- largeand mediumsize companies.But the rest have remained investment.In orderto sustaininnence with the publicationof Jensen and Meckling's imperviousto international investors'interestin Indianmarketsover the longarticle(1976) which triggereda body of theoretical and ternational of empiricalwork on the subject. During the 1970s and 1980s, term,and to spreadsuch interestacross a broaderspectrum a focuson CGissues(specificto India) and theoretical appliedresearchwork on CG was focused pri- listedcompanies, stronger marilyon US corporations. the early 1990s similarworkhad and how CG can be appliedto all listed firms is, amongother By beendonein otherdevelopedcountries suchas Japan, Germany, neededchanges, an imperative. this articleemphasisesthe andtheUnitedKingdom. This was quicklyfollowedby research Following this line of argument, relevance importance CGforIndia. considers and of It howIndian on CG in emergingmarkets. in India standardsin letter Thedebate corporate on thusdraws CG standardscompare with international governance heavily on Anglo-American and experience,literature practice.Indian andspirit, pointing out areas where espousal of international has sector regulators have been quick to assimilateand practices madelittle differenceandwhy those areasremain corporate CG apply international practicesbased on the latest available a challengefor the inculcationof good CG in India.The first whatcorporate brieflydescribes governance knowledge.But these practicesdo not necessarilysignal con- sectionof thisarticle of vergence in the values embedded in our national culture. is, the importance CG in general,as well as morespecifically Giventhe mannerin which Indian firms have evolved since in India.The second section deals with the structural features and the role that FIs have played, corporate of the Indian economy which have contributed to sticky independence, issues and problemsin Indiaare differentto those corporate to governance practicesdetriment the objectiveof good governhow Indian codes compare CG typically encountered abroad. Adopting international CG ance.The thirdsectionillustrates withoutsuitablemodification does not,therefore, withinternational standards codes.In concluding, article and the practices help to address or resolve specific governance issues plaguing deals with issues that pose challenges to good corporate the behaviourof Indian firms. Issues such as the effect of governance India. in ownershipconcentrationon shareholderrights, the role of activitybetweenbanksandnon-bank relationship-based corpoWhat Is Corporate Governance? in rations,its impacton creditorparticipation corporate goverfrom the Issuesof CGarisebecauseof the separation ownership of nance,the prevalenceof insidersand promoters, effect of social and corporateculture on disclosure, transparency and management controlin moderncorporations. economic and In CG contracts incomplete are and enforcement, cannot be resolved simply by transplanting parlance, issues arisewherever etc, international practices. CG of from agencyproblemsiexist.Giventhisseparation ownership India'sequitymarkets corporate and structures are controland the involvementof stakeholders, concernsthe CG governance well developedcompared otheremergingmarkets. to and stakeholders legitican Yet, they way in which other shareholders havebeen unableto bringabouta desiredchangein the quality matelyexercise influenceand exert effective controlover the of corporate and for The governance firm-performance thevastmajority actions of corporatemanagers/promoters. discipline of of listedcompanies. has Largecompaniesthatareexposedto inter- corporate governance developedas a way of ensuringthat: nationalmarketshave adoptedinternational standards that (a) investorsotherthanpromoters CG receive a fair return their on aregenerally morerigorous thanthoseappliedin India; these investment protecting but themagainstmanagement by expropriation are exceptionsto the norm. or use of the investmentcapitalto finance poor projects2and Therecent stockmarkets buoyed (b) otherstakeholders assured theirinterests properly are that are (2004-06)rallyintheIndian by an economic growthrate of 8 per cent and an increasing cateredfor. CG is a system by which firms are directedand on of of appreciation thepart globalinvestors India'svastpotential monitored. - droveoverseasinvestorsto buy a record$ 10.7 billion more Definitionsof corporate governancevary widely. They tend stocks than they sold in 2005; more than three times the net to fall into two categories.The first set of definitionsconcerns of that behaviour purchases local mutualfundsof $2.85 billion.All this helped itselfwitha setof behavioural patterns: is, theactual in push share prices significantlyhigher for a select group of of corporations, terms of such measuresas performance, Economicand PoliticalWeekly September30, 20064153

efficiency, growth, financial structure, and treatment of shareholders and other stakeholders. The second set concerns itself with the normative framework for governance: i e, the rules under which firms operate with such rules being influenced by external sources like the legal system, thejudicial system, financial markets, and factor (labour) markets. A comprehensive definition of corporate governance suggests that it is "the complex set of constraints that shape ex post bargaining over the quasi rents generated by the firm"3 which focuses on the division of claims. Following from that logic, CG is the complex set of constraints that determine quasi-rents (profits) generated by the firm in the course of relationships and shape ex post bargaining over them. This definition refers to both the determination of value-addition by firms and the allocation or sharing of such value among stakeholders that have legitimate relationships with the firm.4

among domesticfirms to compete with MNCs in unprotected


markets.10

CG in India In spiteof the fact thatadoptionof international practices CG has madelittle differencein India,CG still has the potentialto role in India's long-runand sustainable play a very important economic growth.Indiaeffectively began its move towardsa more open and market friendly economy in 1991. Since Indiahas seen a spectacular liberalisation, growthin the size of its stock markets,i e, numberof firms listed and the value of the shareslistedor the market The of capitalisation. importance CGis reflected thegrowth Indian in that havemade stockmarkets in the last decade.Duringthe capitalmarketboom of 1993-95, many companiesthat tappedthe capital marketfor funds defaultedin theircommitments simplyvanished.Hundreds and of obscurecompaniesmadepublicissues at largepremia,with the banksand misleadingprospectuses. help of obscureinvestment The managements these companiessiphonedoff more than of $ 2.2 billion, saddlingaround11 million small investorswith illiquidstocks of defunctcompanies.Moreover,the continued of preponderance firms with very low marketcapitalisation 80 reflectsa deep(around percentof the totallistedcompanies) rootedstructural flaw in Indiancapital markets.Too many of these cases represent outrightfraudand inefficiency;they call for effective externaland internalCG mechanisms. Liberalisation itsassociated and i developments,e, deregulation, internal external and liberalisation product of markets privatisation, as well as extensivefinancialliberalisation, havemadeeffective corporate governancemore crucial.These developmentshave meant that the availabilityof long-termfunds to firms from has developmentfinance institutions(mostly state-controlled) declinedmarkedly the past decadewhen the need for extrain firm finance has increasedsubstantially. The supply of extrafirm financeis now fulfilled mainlyby capitalmarketsand by syndicated loans from commercial banks. Cases of fraud, marketmanipulation (on (on corruption the partof regulators), thepartof securities and brokers) othermalpractices companies, (on the partof firms) in the equity marketcan rendercapital marketreformsdesultoryand lead to low investorconfidence. Fraudulent from companies usuallycrowdoutpublicinvestment equity marketsand the victims of generalinvestorapathyare "genuine" companies.Firms with poor governanceare forced to finance operationsand growthinterally to a much greater extent. This situationcan become particularly detrimental for smaller firmsandpose a seriousdevelopment in whichfirms trap find it difficult to fund their investmentprojectsas financial institutionshave atrophiedin importance and capital markets havebecomeinefficient.1l Independent effectivecorporate and institutions becomenecessary orderto restore thus in governance the credibility capitalmarkets facilitatethe flow of investof to mentfinanceto firms.International creditors alsoincreasingly are on to evaluating companies thebasisof thesecriteria-commitment and goodCG,shareholders rights,BoD, transparency disclosure. A good systemof corporate in governance Indiahaslongbeing as for recognised important the domesticeconomy,in thatit can raiseefficiencyandgrowth;particularly whenstockmarkets are playingan increasingly significantrole in financinginvestment. CG has implications the functioningof the Indianfinancial for system in terms of: betterallocationof capital over time; the Economicand PoliticalWeekly September30, 2006

Importance of CG
Worldwide the "corporation"is considered to be the essential engine driving the private sector economically. CG is critical to its competitive performance. CG is of particular importance at a time when interactions between companies and their capital suppliers are undergoing fundamental changes. Due to global deregulation and technological change, entrepreneursand companies areexposed to a wider and more complete range of capitalraising vehicles. For corporations, this means that they can supporta variety of R&D activities, spin-offs, capacity expansion and new firm creation. Greater competition for capital results in greater pressure for corporate economic performance and significant pressureson long-standing relationships with employees. Failure to adapt to efficient governance practices may well lead to restricted access to capital markets.5 On the other hand, globalisation means capital suppliers are encountering new opportunitiest6 improve their returns.They are willing to provide capital when they are confident that their growth rests on secure foundations.6 Research shows that in both OECD and emerging market countries, well-governed companies attract premium valuations.7 Better corporate governance standards make banks and rating agencies see companies in a better light. This means lower borrowing costs for well-governed firms.8 CG plays a critical role at every stage of the investment process. At the first stage in the investment process, effective property protection and secure methods of ownership registrationare basic corporate governance provisions that influence a firm's ability to mobilise capital. At the second stage, reliable and transparent disclosure is essential if the market is to allocate available funds efficiently among various competing ends. At the third stage, the procedures for corporate decision-making, the distribution of authorityamong company organs, and the design of incentive schemes are examples of governance arrangements that have to be in place to effectively monitor the capital that is handed over to firms.9 By demanding transparency in corporate transactions, in accounting and auditing procedures, and in all business transactions generally, CG attacks the supply side of the corruption relationship,especially in developing countries. Governancehelps to provide legitimacy for governments undertaking unpopular reforms by indicating to the public that the government is not merely cutting back on welfare spending, but is developing an effective corporate structure which will generate conditions for

further in growth.CG is important promoting greater efficiency

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ability of Indian firms to raise funds overseas and compete internationally, reducingthe likelihoodof a domesticfinancial crisisas well as an externalpayments crisis;andlayinga strong for foundation further openingof the capitalaccount.As India embarkson a high growth trajectory,larger currentaccount deficitswill come about,an effectiveCG systemwill ensurethat current account deficitscanbe financedwithlongertheselarger term and less speculativefunds, reducingthe chances of an external crisisin the future,even as capitalinflowsincreaseand restrictions slowly phasedout.The are capitalaccount remaining financial nextsectiondealswithsome structural featuresrelated to andlegalsystemsof theeconomywhichhavecontributed poor CG practicesin India.

group.Second,the aggregateholdingof all these entitiestaken is stake.In manycases, together typicallywell below a majority What thepromoter notevenbe thelargestsingleshareholder. may is makesthe promoters dominantshareholders that a large the chunkof the sharesis held by stateownedfinancialinstitutions which have historicallyplayed a passive role. The majorDFIs in Indiaplayeda significantrole in funding had corporate growth,duringa periodwhen equitymarkets not evolved to theircurrent dominant status.However,FIs did very little to monitor13 theirfirms,untilit was too late. Even in the of signsof financial distressin firms,FIsmadeavailable presence more funds to cover losses, thus furtherincreasingtheirdebtpolicyin India equityratios.Until 1991,theobjectiveof financial was to maximise loans for industrialdevelopment without FIs to adequate regard recoveryandmonitoring. werelax in their Structural Characteristics did because the government not duty of corporatemonitoring As be Indiawithstood Asianfinancial crisisof 1997-98compara- desirethatany of the existing managements disturbed. a the that well, butthe falloutfromthe crisis demonstrated the result, nominee directorsfrom banks and FIs colluded with tively their as sector could play an important role in transmitting managements corporate ignoring dualinterests debtandshareholders. divested shareholding legalinstitutions their and financialshocks and puttingthe financial sector at risk. Mis- FIsrarely provided matchesin the corporate sector'sbalancesheet brought light promoterswith preferentialrights (irrespectiveof corporate to both domestic and external vulnerabilities. The Asian crisis performance) helpingthem to hold on to theirshareholding.14 sectoris based Thelegalframework Indian showedthatthe deterioration creditworthiness large segin of corporate governing Act mentsof the corporate sectorsharplyincreasesnon-performing on commonlaw.Firmsaregoverned theCompanies (CA), by loans(NPLs).curtails new investment, contributes capital 1956 as amended.The CA is administered the Department and to by Law Affairs(DCA) andenforcedby the Company affectseconomicactivityas a whole. of Company flight,allof whichadversely With a comparatively level of foreign debt as a sourceof Board(CLB) and the companycourts.Listed companiesmust low fundsandIndia'sstrongforeignexchangereserveposition,the complywiththerulesandregulations prescribed theSecurities by of sectorto foreignexchangerisk and Exchange Board of India (SEBI) Act, 1992; with the exposure the Indiancorporate is lowatthispointof time.Other thanthis,onlygoodCGpractices Securities Contract Act, Act, (Regulation) 1956;theDepositories can help an economy to withstandsuch systemic crises. 1996; the Sick Industrial Companies(Special Provisions)Act India'scorporate sectorhas grownsteadilyover the pasttwo (SICA), 1985; and the listing rules. Changesin the legal and decadesin termsof number registered of framework the post-1991periodhave been key to in companiesandamount regulatory of paidup capital.The corporate sectorconsistsof closely held promoting burden, reducingthe regulatory greater competition, (privatelimited)and publiclyheld (publiclimited)companies, and, of late, strengthening corporategovernance,which will withapproximately in to 6,19,000registered companies 2004,about continueto be of crucialimportance India'sgrowthprospects. 40 per cent of which are in the manufacturing sector. Private Otherstructural featureof the Indianeconomy is concerned limited the of laws andprocedures. These are and comprise majority firmsin thecorporate withbankruptcy liquidation companies time consumingandcontribute poor governance to sector,but accountfor less than one-thirdof the total paid-up inadequate, of (bothpublicandprivate by management. capital.Government-owned enterprises Bankruptcy reorganisation large industrial few in numberbut large in size, organisationsis governed by the Sick IndustrialCompanies limited) are comparatively Act, 1985 andthe processis supervised accountingfor more than 25 per cent of the paid-upcapital. (SpecialProvisions) by The ownership India'scorporate of sectortendsto be concen- the Boardfor Industrial FinancialReconstruction and (BIFR). trated thehandsof firmpromoters to a lesserextent,small The latter in tendsto support rightsof existingmanagement the and and, investors.Focusing on the manufacturing over fully secured creditors.Liquidation sector, promoters' of old shareholders sharewas 48 per cent of the paid-upcapitalfor all companies poses even more seriousproblems.This is becausemost liquiin 2002 and as high as 71 per cent for government-owned dationcases takebetweenone to two decadesto completein the in the courts, enterprises.The prevalenceof cross-holdingsof ownership, Indian resulting a systemthatworksagainst interests makesIndia'ssystem of workers secured and fearsneither creditors. Sincemanagement togetherwith heavy ownerparticipation, of corporate control close to an"insider" Theshareof equity attachment bankruptcy, leadsto companies one. nor it fundinghighly held by small (public)investorsin India(32 per cent) is com- risky investments, which has several adverseconsequences.It to parable thatof the US andUK (countrieswith a pronounced raisesthe cost of credit,it debasesthe discipliningrole of debt "outsider" risksthe healthof the financialsector.Prosystem),inter-corporate holdingsin Indiaare much and it increasingly higher.In addition,financialinstitutions(FIs) in Indiahold a bably the principalreason is that the majorbanks and mutual muchsmallershareof equityas compared othercountries to and fundsareunder controlof thegovernment. the Theyarebuffeted havebeencharacterised largelypassiveshareholders, as ministries therefore and have mostly bycontradictory bythevarious pulls of The supportive managements' positions.12In the Indianbusiness difficultyin focusingon commercial accountability. governshareholders unstructured is for mentinvolvement raisesthe moralhazard also groups,theconceptof dominant problemwiththe two reasons.First,the promoters' is shareholding spreadacross financialinstitutions exposing themselvesto risky lendingand severalfriendsand relativesas well as corporate entities.It is activities,becausethey know thatthey will be bailedout by,the sometimes difficultto establishthe totaleffectiveholdingof this government,if they run into difficulties.15 These featuresare Economicand PoliticalWeekly September30, 2006

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of quintessential an inability to cede control and of shirking fromresponsibility. The following two sections deal with the codes of CG and how Indiameasuresup to these international practices.

(a) manyof these countrieshad historicalties with the Anglomodel (theircompanylaw is firmlyrootedin British American lack of success of previous companylaw) and (b) the apparent with interventionist regimeswhichhadsomeelementsassociated financialinothercorporate governancemodels. International stitutionshave also encourageddevelopingcountriesto adopt International Standards and Codes of CG the Anglo-American model.18 on are Good corporate are rootedin an appromarket Although capital pressures drivingconvergence governancesystems of of and combination legalprotection investors someform common governanceprinciples,international agreementon a priate of concentrated or The US and UK systemsrely more single modelof corporate governance, a single set of detailed ownership. Economists on strongerlegal protection,while the Germanand governance rules,is bothunlikelyandunnecessary. heavily as equity agree that therecannotbe a "one size fits all" standard unJapanese systemsarecharacterised moreconcentrated by 16 familiar cannotbe transplanted imposed,andbecause or ownership. practices An observer theinternational of scenecommented individualcompaniesand marketsare always subjectto local governance and that if corporategovernancecodes appearedin tradefigures, cultures, Furthermore, achieving good CG pressures practices. Britainwould have a far healthierbalance of payments.The generallyis moreexigentin emergingmarkets thanin advanced commentreflectedthe fact that the first corporate governance economies for a numberof reasons:corporateownershipin often in code of the moder era - thatwas instituted the UK by the emergingeconomiestends to be highly concentrated, in Bank of Englandand London Stock Exchange in 1992, and a few families,with only limitedownershipby minoritysharechaired SirAdrian Some holders,takeovermarketsare thin or non-existent,regulatory by Cadbury spawnedmanyimitators. of thosecodesaretheBoschReport, Australia (1995),theCardon inefficiencies, lack of judicial enforcement,lack of property and Report,Belgium (1998), the Dey Report,Canada(1994), the rights,contractviolations,asset stripping self-dealing,etc. Vienot Report,France(1999), the King Report,South Africa In reality,the rules-on-books CG regarding appearto be conNetherlands of but (1994),thePetersCommittee, (1997),theCorporate. vergingin responseto the pressures global competition; Governance Forumof Japan, of is slowerinmaterialising. of CG (1998), the Governance Spanish convergence actual practices much a Nevertheless set of universal are (1998), the Swedish AcademyReport,(1994), the Companies, guidingprinciples relevant Panelon Corporate German and In Governance, (2000), the Sarbanes- especiallyto transnationals multinationals. termsof the the of conof level, efforts functioning transnationals importance regulatory Oxley Report,US (2002), etc. At the tiultilateral to improve CG by establishinginternational standardswere vergencebecomescritical,when countrieshave differentcomand spearheaded the WTO and its membercountriesto develop panycodes, capitalmarket by caparequirements enforcement standardsthat sought to help firms expand across national bilities which transnationals use to theiradvantage arbito can boundaries. International was accountingbodies and nationalasso- trage.The firsteffortto offer a globalset of principles done ciationsof accountants have workedto developan internatior by the OECD19by attempting harmonise il to acrossits practices set of accountingstandards. addition,the World Bank, the 29 countrymembers,rangingfrom the US to South Korea. In mostof theregional the OECD, banks, UN andother development national or development agencieshaveeitherlaunched expanded Indian vs International CG Standards Therearenow morethan60 governance CGprogrammes. codes in 30 markets, numerous international activities InIndia legalframework regulating corporate of the for all codes, a vast number individualgovernanceor voting guidelinesproducedby indi- including governanceand administration companies, disof vidualinvestment institutions well as industry as codes.Thecore closures,and shareholders' rights has been in place since the content mostof thesecodescanbe broadly of classifiedintothree enactment CompaniesAct in 1956. Indiacan be considered of areas:(i) the independence the board,(ii) the responsibilities to be in the"post-transition of witha well definedandstable regime" of institutional investorsor shareholders, (iii) the transpar- corporate and of and governancestructure where the management and operation.17 is throughdue processdefinedby corporate law.20 ency of businessstructure enterprises The Cadbury Committeewas based on a formulafor goverThe Securitiesand ExchangeBoardof India (SEBI), an innance that has become the industrystandard it developeda dependentquasi-judicial, body, regulatesthe stock regulatory list of "bestpractice" standards whichcompanies exchanges. to in are governance governance Corporate requirements India largely were encouragedto aspire. Companieswere then requiredto based on recommendations the Cadbury Higgs Reports of and disclosehow they measured to the code, giving explanations andtheSarbanes-Oxley SEBIhasbeenproactive keeping Act. in up for any areasof non-compliance. formulaeschewedburden- India'scorporate Its in governancerules and regulations line with some regulation inflexiblelegislation;allowedcompaniesto best practicesaroundthe world. In 1999, SEBI appointedthe or be free to develop their own governancepractices;and, via Kumar BirlaCommittee recommend to Mangalam improvements for on framework. 2002, SEBI updated In disclosure, the responsibility improvement investors. to the corporate put governance with points,a trendtowardsconvergence its listingrequirements Clause49.21These listingrequireDespitedifferent starting of corporate some best governance regimeshas been developingin recent ments were again changed in 2004 to incorporate laid Act. years. This has happeneddue to firms adaptingand adjusting practices outin theSarbanes-Oxley SEBIhasalsoissued asa result theincreasing of and of to of globalisation integration capital regulations relating theacquisition significant shareholdings, to sharebuy-backs insidertrading. and and markets,the increasingexposureof policy-makers regional takeovers, Bankruptcy andglobalpolicy fora,and the impactof those on the mindsof anti-competitive laws are also in place.Thereis currently bill a leadersto reformis moreintensenow. Developingcountries are in Parliament revampthe Companies of 1956,whichwas to Act increasingly adopting the Anglo-American model because: amendedas recentlyas 2002.

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Economicand Political Weekly September30, 2006

All listedcompanieswere required be in compliancewith to Clause49 by December31, 2005. Companiesare required to their governancepracticesin a provideinformation regarding Governance section in the annualreportto separate Corporate shareholdersin which non-compliancewith any mandatory and requirements, the extent to which non-mandatory requirementshavebeenadopted, shouldbe highlighted. Clause49 also to withthe requires companies file a quarterly compliance report stockexchange. The stockexchangein turnis required file an to annualcompliance with SEBIfor each listedcompany.22 report The accompanying table highlightssome of the differences between International codes and the existing IndianCG CG best practices are codes: All divergencesfrom international associatedto the uniquestructural characteristics the Indian of economy as highlightedin the table. Challenges to Promoting Good CG The challengesto promoting good CG culturein Indiafaces a problemsat two distinctlevels i e, at the firm level and at the macroor extra-firm level. Thesefollow fromthe non-conducive structural of features the Indianeconomy.At the firm level, the most strikingandcommonlyagreedfailuresof CG practicesin Indiahavebeenthe widely perceived(a) ownership structure in companies,(b) failureof boards,(c) accountingpracticesand transparency.
Ownership structure in companies: In the private sector, most

largeIndiancompaniesarea hybridof family-owned conglomeratesandpubliclylistedcompanies. Indianconglomerates have beensuccessfulin competingagainstmultinational corporations costs andrationalising businesses.However,the by streamlining broadercorporategovernancestructurein Indian companies remains of generally poor.The endemicfeatures theseconglomeratesare:ownership management not segmented, and are there is informality governancepolicies and inadequate of controls, the ownershipstructureof individual companies within the is conglomerates usually opaque,often the controllingfamily retainscontrolby creatingcomplex crossholdingsamongsubtransactions sidiaries,related-party and, in among subsidiaries related of particular, lendingis opaque. Ownership Indian familycontrolledcompaniesis now moving into the second or third It that furtherreformsneed generation. is thereforeimperative to addressthe specific concernsfacing the family-ownedconIt that, among other things, glomeratestructure. is important focus on; voluntarily mechafamily-owned companies adopting nismsforgovernance thefamily'sownership of stake; forexample, creating familycouncilsthatdealwithfamilydisputes, reforming and companyboardsby increasingoverallboardindependence reducingthe numberof family member-directors; limitingthe role of family membersin senior management increasing and aroundthe ownershipstructure related-party and transparency transactions. Failureof boards:Boardsin Indiado not exist as institutions of governance trulyindependent and directors rarein Indian are of companies.There is a lack of clear understanding what is expectedfromthe directorsin termsof theirdutiesof care and loyalty to the company and its shareholders.In most cases therefore are directors simplyfor"rubber the stamping" decisions of management promoters. or Much needs to be done in terms and of improvement in theconstitution functioning theboards for andtheirregard minority shareholders' to rights.A key missing courts handle securities finance-related and crimes.Threeyears
Economic and Political Weekly September 30, 2006

ingredientis a strongfocus on directorprofessionalism. In addition to the law or other regulations spelling out the responsibilities of directors, they themselves should engage in the formulation of theirtasks and work procedures.The presence of FIs' nominees is the most distinctive feature of Indian corporate governance system, and consequently the "failure" of corporate governance in India is often seen as a failure of the FIs to safeguard the general shareholderinterest.The domestic financial institutions' nominee system has been widely criticised and there has also been a strong campaign to remove nominees from boards, furtherreducing the accountability of boards. FIs' nominees have been criticised on the grounds that their calibre is low, their contribution is minimal, and that they lack competence to understand the nature of the business. But the FIs' nominees lack the right incentives to perform their duties with enthusiasm. There has been a constant pressure on FIs for reform of the governance culture of Indian businesses. Consequently, the FIs decided on radical ideas of a block sale of their equity holdings to effect a management change in the interests of a company. But this idea did not meet with much success because of a strong business lobby backlash that has chosen to make the issue of institutional nominees central to the debate on governance on the grounds that their access to price-sensitive information make institutions insiders.26 Accounting practices and transparency: Although, FIIs have been responsible for improvements in disclosure standards,levels of disclosure remain poor, accounting standardsweak, and Indian corporate structures low in transparency. In India the level of disclosure is abysmal and creative accounting is extensive. The greatest drawback of financial disclosures in India is the absence of detailed reporting on related party transactions. At the level of the balance sheet, there is no requirement to report which investments and loans made by the corporationare to subsidiaries and associated companies. Auditor independence is another problem because of a large and segmented market in accounting services and the perceived powerlessness of auditors in the face of corporate pressure. Chartered accountants argue that despite the absence of consolidation, Indian financial statements give enough information for analysts to reconstruct the true picture of a group of companies. For most users of financial statements, however, the absence of consolidation27 leads to misrepresentation of the true picture of a business group as it does not disclose related party transactions or transactions with affiliated companies. There is also a further need for the harmonisation of Indian accounting system with an internationally accepted standardlike the US GAAP. At the extra-firm level, CG problems relate to (a) surveillance and enforcement mechanisms and the court system, (b) insufficient powers of SEBI to police violations of regulations, (c) lack of shareholder activism in India. Surveillance and enforcement mechanisms and the court system: Although laws in India are generally comparable to those in the UK, the court system is seen as inadequate to handle the volume of cases being broughtto trial.This results in delays in the delivery of justice. Verdicts are handed over 10 to 20 years after the incidences have occurred. Furthermore,corruption in the lower courts, delays the delivery of verdicts and increases the cost of litigation. Also, judges in lower courts who preside over murder trial are expected to be conversant with corporate law and preside over white-collar crimes like fraud. An amendment to the Companies Act of 2002 required the establishment of special

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Table: Corporate Governance - Differences between International and Indian Codes Shareholders' Rights Secure methodsof ownership registration shares. conveyor transfer Yes Shares tradedthrough stockexchange are held in dematerialised a formin the depositories. Companiesmust a maintain registerof shareholdersor outsourcethis functionto a share transferagent. Shares are freely transferable. Guarantee fundslargelyeliminate settlementrisk. Yes Allshares are equalwithin class. Indian one or VotingRights companiesto issue shares withmultiple votingrights dividends as longas such shares do notexceed 25 percent of sharecapitaland shareholders approvethe issuance. Non shares exist, butare not popular. votingpreferred Institutional investorsand theirvotingrights No Pensionfundsdo notplaya corporate role.TheUnit the Trust India of governance (UTI), LifeInsurance Company and are and investors aregovernment (LIC) the GeneralInsurance Company (GIC) the threelargestinstitutional owned.Together,they own 15-20 per cent of the listedsector.These institutions seldom exercise theirvoting directors to nominated the boardof theirportfolio rightsbutexertinfluence through companies. Yes No notarisation 48 no ProxyVoting required; registration hoursprior; postalballots. Cumulative Vote/Proportional Representation No Shareholder Yes Theannual be the Meetings/Other Rights generalmeeting(AGM) heldeveryyear,a noticeconvening meetingbe sent to allshareholders at least 21 days inadvanceof the meeting.Shareholders 10 or capital controlling percentof votingrights paid-up to calla specialorExtraordinary General at (EGM), quorum the AGM Meeting maynotsufficiently protect minority shareholders. Shareholders may inspectthe minutesof the AGM. Shareholder Protection Yes The legal structurefor corporategovernance in Indiaprovidesfor strong minority shareholderprotection Minority shareholder comparedwithother emergingmarkets.Clause 49 stipulatesthat there must be a board-level to director mustchairthiscommittee.In grievancecommittee addresssuch disputes,and thata non-executive India's framework for shareholder in shareholders theory legal provides strong minority protection. practice minority cannotalwaysgarnerthe strength exercise theirvotingrightstogether. to Share inthe profits the corporation of Yes The boardof directors and mustbe paidwithin days. 30 proposesthe dividend, the AGM approvesit.Dividends As for complaints abouttransfer shares and non-receipt dividendswhilethe redress rate has been an of of 95 impressive per cent, therewere stillover 1,35,000complaints pendingwiththe SEBI. Take-over Code Yes Increasing takeoveractivity. Insider and Prohibition Yes Criminal to due offence, butdifficult monitor to multiple Trading Self-Dealing listings. Yes Pre-emptive Rights Yes Acquisition morethan 15 percent of shares or votingrightsrequires acquirer makea publicoffering. of Changesin firm capitalstructure the to To approvea merger,underSEBI'sregulations shareholder a vote of 75 per cent is required. New capitalissues firstbe offeredto existingshareholders proportion theirshares of paid-up in to capital. Stakeholders Yes The corporategovernanceframework rights requiresthe boardof directorsto discuss materialissues regarding and other stakeholders.Civilcourts discourage creditorsfrom litigating issues relatingto on employees are governance,citing"indoor management" policy.Promoters noteligibleforstockoptions.Thereis no ceiling on how manystockoptionscan be issued. The optionsare tiedto specificperformance goals and vested over a timeperiod- typically threeto six years. The quality the information of varies markedly betweenthe firsttwo hundred listedcompaniesand the restof the market. Oversight of Management BoardStructure Directors Independent BoardMeetings Nomination Election Directors and of Committee Practices Disclosure and Transparency External Auditors Consolidated Statements Segment Reporting Disclosure PriceSensitiveInformation of

No Mandatory largecompaniesas of March for 2001 andformostsmallcompaniesin2003:Ifchairman also CEO, is >50 per cent; if not,>30 per cent. Despitethe requirement boardindependence,the availability trained for of in directors Indiais limited. independent No Theboardshouldmeet at leastfourtimesa year,boardquorum requires 33 percent of boardmembers that only ortwomembers,whichever greater, present.Thereis no provision specifieswhethernon-executive is be that or membersneed be present. independent No Founder/promoters controlling or shareholders Thereis limited generallyappointdirectors. scope for minority shareholders recommend to director nominees. No Mandatory largecompaniesas of March for 2001 and formost smallcompaniesin 2003. Yes No No Yes Annual statementsaudited.Auditors at appointed/removed AGM. Ifownership interest ?50 percent abridged data mandatory annualreport. in soon. Expectedto be implemented To the correspondent stock exchange and SEBI. SEBI's InsiderTradingRegulations,2002, requireevery companyto appointa complianceofficerwho is responsiblefor setting policies,procedures,and monitoring adherenceto the rulesforthe preservation "price of sensitiveinformation"preventinsider to Thereis no trading. of whichhamperssurveillance efforts. good legal definition insider trading, No provisions the Indian in for and governanceframework a investorrelationsprogramme to providea policy statementconcerning environmental issues and social responsibility. Minimum threedirectors members,withat least two-thirds the membersbeingindependent. of as of Clause49 does not prohibit contemporaneous the of services fromthe same entity. provision auditand non-audit sets Not withIAS.24 ICA123 out standardsmonitored SEBIand ICAI. in fullcompliance by remuneration is required annualreport. 2001, breakdown remuneration director info in In of must Aggregated by be provided. Clause49 requires listedcompaniesto disclose materially in transactions the Report on significant related-party Governancein the annualreport shareholders, to Corporate however,it does not definethe term"materially significant". To SEBIand stock exchanges when ownership crosses 5 percent. Thelawprescribes companieshaveto be ratedbyapproved that creditrating agencies beforeissuingsecurities. The weak enforcement mechanismin the country a key concern. is

OtherResponsibilities Audit Committee and Enforcement Accounting Standards Officers relatedDisclosures Company RelatedParty Transactions of Disclosure Ownership RiskManagement otherDisclosures and Environment25 Regulatory Bankand IIFReport,2006. Sources.World

No Yes Yes Yes Yes Yes

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afterthe amendment, governmentis still in the processof the identifyingand appointingqualifiedjudges.


Insufficientpowers of SEBI: Despite incorporating several posi-

in tive featuresandraisingthe standards the companylaw, and atthelevel of securities market theregulatory and their authority, has implementation proven to be challenging.This is partly because SEBI has insufficientpowers to police violationsof Althoughstock exchangesin Indiahave responsiregulations. bility for surveillance,they do not have the authorityto take Indian actionagainst errant strucpunitive companies. regulatory ture is segmentedwhere the authorityand responsibilityfor surveillance enforcement dividedamongvariousentities, and is betweenthe level of authority responand leadingto a mismatch The same fate awaits a proposedbill in Parliament to sibility. revampthe CompaniesAct of 1956 to simplifyprocedures by movingto a rules-based system.Whenandif the bill passes,the voluminousprovisionsin the currentact would be reducedby two-thirds from the presentroughly780 provisions.But it is unclearwho will have the authorityto set the rules. India's environment characterised a lack of is by corporate governance an infrastructure relatingto the surveillanceand enforcement and mechanisms the court system.28 There activism:in Indiais practically non-existent. Shareholder @wanadoo.fr are severalexplanations the lack of shareholder activismin Email:Lalita-Som for the Indianequity market.In India promoterstypically retain Notes controlof companiesby owning a small, yet significant.ownstake in companies.Sharesnot owned or controlledby 1 The principal-agenttheory is generally considered as the startingpoint ership for any discussion on corporategovernance.It recognises propertyrights the promoter his family and friendsare widely dispersed, and inside the corporationand the different ways in which relationsamong itdifficultfor tovoicetheirconcerns. shareholders making minority This owners, managers,directorsand other stakeholdersare structured. creditorsandemployees have AlthoughFII's increasinglyown a large numberof shares in theoryassumesthatshareholders, managers, Thisapproach contrasts different the Indiancompanies,in general,no single minorityshareholder regarding firm'sresources. preferences with the neoclassical financial theory, which looks at the corporationas ownsenoughshares significantly to influencechange.Therefore, a single entity dedicatedto profitmaximisation.Separationof ownership eventhough therearelawsthatempower shareholders controlling endemicfeatureof the modern andmanagement controlis a quintessential, 10percentof equity,thedispersed nature ownership shares of of limited liability corporation.In a firm owned entirely by an individual, all thenetbenefitsandcosts accrueto himor her.Conversely,in a diffusely makesit difficultfor minority to shareholders takea moreactive owned firm, the divergence between the accrualof benefit and costs is role in the management the company.Pensionand insurance of much largerfor the typical fractionalowner; he or she usually responds in and companies Indiaareownedby the government constitute by neglecting some tasks of ownership. Agency costs include the costs of structuring, a largepartof the state-ownedsector.The Indiangovernment monitoringand bonding a set of contractsamong agents has only recentlybegun allowing privatesector companiesto 2 with conflicting interests and asymmetric information. Journal Shleifer and Vishny, 'A Survey of CorporateGovernance', of the engagein theseactivities.The government strictlyregulates Finance, 52, June 1997, pp 737-84. in instruments whichpensionfundscan invest.Some companies 3 Luigi Zingales, 'CorporateGovernance', The New Palgrave Dictionary of Economics and the Law, Macmillan, London, 1998. like LIC and UTI have significantstakes in Indiancompanies 4 Stijn Claessens, 'Corporate Governanceand Development' World Bank butarenot activistshareholders. a resultin Indiathereis no As Report 2004. shareholder activism 5 I Millstein, Michel Albert, Sir AdrianCadbury,RobertDenham, Dieter largeinstitutional engagedin shareholder Feddersenand Nobuo Tateisi, 'Corporate Governance:ImprovingComits decisionslikeCalpers theUnitedStates. in through investment thetimetakento deliververdictsthrough courtsystem 6 petitivenessandAccess to CapitalinGlobalMarkets',OECDReport 1998. the Lastly, Confidence is established by the practice of good CG and the presence in Indiais inordinately for of basic building blocks like: an effective legal and regulatorysystem long.This actsas a deterrent minority that minimises the prospectsof their capital being squanderedor stolen; shareholders pursuelegal action againstcompanies. to a boardof directorsthatgenuinelyguardsshareholder interestsandvalue; In addition,lack of trainedstaff at the stock exchangesand properly audited accounts that give a real view of the company's SEBIto effectivelyscrutinise a compliance,the high transactions performance; fairvoting processthatallows themto be consultedbefore costs in boththe primary secondary and majorcorporatedecisions are taken;transparent corporatereportingthat making equitymarkets offers a real-world view of the company's future prospects; and the takeovers difficult,little competitionamongfinancialintermefreedomto sell their sharesat any time to the highest bidderwithoutany diaries and the state-runintermediaries and their significant complications or restrictions. amount badloans,whichaffecttheirabilityto actas monitors29 7 (i) Well-governed firms in Korea tradedat a premiumof 160 per cent of to poorly governed firms, a study by Koreanand US researchersfound. - have made the Indiancorporate governancedeficient. Conclusion Despitea long corporate history,the phrase"corporate governance" unknown untilthelate 1990sin India.Itcame remained to the fore due to a spate of corporatescandalsthat occurred Economicand PoliticalWeekly September30, 2006

The afterthe first phase of economic liberalisation. above disof cussionhas shownthatownershipconcentration, prevalence for lack of protection minority insidersandprincipal promoters, lack of strict enforcementrights of regulatory shareholders, are for authorities, disregard disclosurenormsandtransparency some of the endemic featuresof Indiancorporate governance sector's Indiancorporate regime.These featureshaverestricted progresson the pathof good governanceprinciples.Hence, it can be concludedthat despite India's best efforts to adoptthe has best international practices,their implementation reCG due mainedinadequate to reasonsof path-dependency. CG practicesthe worldover have evolved over time and are failures systemic and to stillevolvinginresponse various corporate and crises.The focus to datehas been on the structural process elementsof governance. to achievetrulyeffectivecorporate But governance,companiesneed to view this issue as a strategic to imposition challengeinsteadof simply responding recurring of new requirements.The task of adapting, refining and governance adjusting corporate practicesis an ongoingprocess. shouldtherefore consideredas "work be governance Corporate and shouldbe reviewedsystematically in progress" its practices BW and periodically.

(ii) An ABN/AMRO study showed thatBrazil-basedfirms with the best corporategovernance ratings garneredP/E ratios that were 20 per cent higherthanfirms with the worst governanceratings.(iii) A studyof S&P 500 firms by Deutsche Bank showed that companies with strong or improving corporate governance outperformed those with poor or deteriorating governancepracticesby about 19 per cent over a two-year period.(iv) A Harvard/Wharton studyshowedthatif aninvestorpurchased sharesin US firms with the strongestshareholderrights, and sold shares

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in the ones with the weakest shareholderrights, thatinvestorwould have earnedabnormalreturnsof 8.5 percent per year. (v) In a 2002 McKinsey survey, 6 institutionalinvestors said they would pay premiumsto own well-governed companies. 8 A study by InternationalFinance Corporation. 9 Bill Witherell, 'CorporateGovernanceand Responsibility:Foundations of MarketIntegrity', OECD, 2002. GovernanceReforms in Developing Countries', 10 Daryl Reed, 'Corporate Journal of Business Ethics, 3 (2002): 223-47. 11 L Som, StockMarketCapitalisationand CorporateGovernance, Oxford University Press, Delhi, 2006. 12 Sarkar and Sarkar, 1999, 'Large Shareholder Activism in Corporate Governance in Developing Countries: Evidence from India', IGIDR WorkingPaper. and was of 13 Thenature ineffectivemonitoring evidentin theproject appraisal evaluation,supervisionof projectsandmechanismsto anticipateproblems and take a proactiverole in tackling them throughmanagerial,technical which did not and/orfinancialassistance in time to projects/enterprises The at performas well as anticipated the time of projectappraisal. primary reason for the lack of adequate monitoring of enterpriseshas been the failureof theleaddevelopmentbanktoevolve mechanismsof coordination with the commercial banks, which provided working capital finance (Cherian 1996). 14 OmkarGoswami, 'The Tide Rises GraduallyCorporateGovernancein India', OECD Development Centre Seminars, 2001. 15 Goswami, Omkar, 'Legal and InstitutionalImpedimentsto Corporate Growth',Policy Reformsin India,OECD DevelopmentCentreSeminars, 1996. 16 Shleifer and Vishny, 'A Survey of CorporateGovernance', Journal of Finance, 52, June 1997, pp 737-84. 17 L Som, Stock Market Capitalisation and Corporate Governance, OxfordUniversity Press, Delhi, 2006. 18 Daryl Reed, 'Corporate GovernanceReforms in Developing Countries', Journal of Business Ethics, 3, 2002, pp 223-47. 19 The OECD offered guidelines under five headings; the rights of of the the shareholders, responsibilities shareholders, rightsof stakeholders, disclosure and transparency.the role and structureof the board.

20 MasahikoAoki, 1995, 'ControllingInsiderControl:Issues of Corporate Governancein TransitionEconomies' in MasahikoAoki and Hyung-Ki Kim (eds), Corporate Governance in TransitionalEconomies: Insider Control and the Role of Banks, EDI, World Bank. Clause 49 providesa list of non21 In additionto mandatory requirements, which promotes governancepractices such as mandatoryrequirements, for a committee,training boardmembers, creating boardlevel remuneration conducting board member evaluations and establishing whistle blower mechanisms. 22 A Report by InternationalInstitute of Finance, Washington, 2006. 23 The Instituteof CharteredAccountants of India. 24 International Accounting Standards. 25 SEBI is an independent quasi-judicialbody thatplays an active regulatory and developmentrole in India's securitymarket.The centralgovernment appoints the chairman and may nominate a maximum of nine other from public financialand members.The body is fundedby colnfiibutions institutional institutions,banksandthe governmentof India.The Ministry of Company Affairs (MoCA), regulatorslike RBI and SEBI and stock exchanges have surveillance functions. MoCA has surveillance responsibilityover unlisted. For listed companies, stock exchanges are consideredto be the first line of defence followed by SEBI. RBI oversees companies in the banking and financial sector. 26 JairusBanaji,2000, 'InvestorCapitalismand the Reshapingof Business in India', Queen Elizabeth House (QEH) WorkingPaper, No 54. JairusBanajiand GautamMody (2001), 'Corporate Governanceand the Indian Private Sector',QueenElizabeth House(QEH)Working Paper,No 73. 27 The 1997BhaveCommitteereport recommends consolidationof accounts, segment reporting,and deferred tax accounting. Consolidation would strengthen transparency helpingto disclose the trueextent of liabilities by within business groups, unearthingthe complex maze of cross-holdings which promoterfamilies have traditionallysecured and funded through controlovercorporate empires,andrevealingthetrueeconomicstrengthof individualgroupsthroughthe 'nettingout' of transactions (Banaji,2001). 28 A reportby InternationalInstitute of Finance, Washington, 2006. T Khannaand KrishnaPalepu, 'CorporateGovernance:Evidence from 29 Infosys and the Indian Software Industry' HarvardBusiness School Working Paper No 02-040, September 2001.

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