Corporate governance is an era that has grown rapidly in the last few years. The global financial crisis, corporate scandals and collapses, and public concern over the apparent lack of effective boards and etc. have all contributed to explosion of interests in this area. Today every sector whether it is corporate, investment, public, voluntary or non-profit organizations are all placing more emphasis on good governance. Indeed corporate governance is now an integral part of everyday business life and is an ardent aspect of the corporate world.
Corporate governance has only relatively recently come to prominence in the business world. However, the theories underlying the development of corporate governance, and the areas it covers, date from much earlier and are drawn from a variety of disciplines including finance, economics, accounting, law, management, and organizational behavior. As corporations take center stage in almost every activity including investment, employment, and trade and production of goods and services, the manner in which they conduct their businesses creates issues of concern to the investors, creditors, employees and the society.
The various parties look towards formal (legal) and informal (non-legal) ways to protect their interests. The extent to which the formal or informal mechanism works to resolve the issues depends upon the corporate governance system of that particular jurisdiction. “Corporate governance varies from one jurisdiction to that of the other and even within a specific jurisdiction, overlapping features may be found”, (Gilson, 2005). The corporate governance system of a particular jurisdiction is shaped by various factors such as historical, legal, political and social factors of that particular jurisdiction.
Empirical studies particularly identify legal rules as critical factors in shaping a corporate governance system and this is perhaps because of the importance of legal mechanisms for investor’s protection. The studies by Rafael La Port et al. , (2000), are particularly important in this regard as they argue that countries such as U. S and U. K, which have strong legal rules for shareholder protection have market based corporate governance system. 1. 1 Defining Corporate Governance: There is no generally agreed-upon definition of corporate governance; however there have been several attempts to define the term: * The Organization of Economic Corporation and Development (OECD), (2004), defines corporate governance as “a set of relationships between a company’s management, its board of directors, its shareholders and the other stakeholders”. The essence of corporate governance is to address conflicts of interest commonly referred to as “agency costs” that arise out of the separation of ownership and control of companies. * According to the Cadbury committee, 1992, A Corporate governance is “the system by which companies are directed and controlled”.
It sets out the general principal rules that are to be followed by the companies in order to run there management with in the set norms and regulations. * “Corporate governance is a field in economics that investigates how to secure/motivate efficient management of corporations by the use of incentive mechanisms, such as contracts, organizational designs and legislation. This is often limited to the question of improving financial performance, for example, how the corporate owners can secure/motivate that the corporate managers will deliver a competitive rate of return”.
Mathiesen (2002). “Corporate governance-which can be defined narrowly as the relationship of a company to its shareholders or, more broadly, as its relationship to society”. Financial times (1997). Since corporate governance is the system by which business corporations are directed and controlled, its structure clearly specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholder and the other stakeholders and spells out the rules and procedures for making decisions on corporate affairs.
By doing this it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance.
Principles of corporate governance: Finance writer Leo Sun, refers some prominent key principles of corporate governance:
- a. Shareholder recognition as a key to maintain a company’s stock price. Good corporate governance seeks to make sure that all shareholders get a voice at general meetings and are allowed to participate.
- b. Stakeholder interests should also be recognized by corporate governance.
In particular, taking the time to address non-shareholder stakeholders can help your company establish a positive relationship with the community and the press. c. Board responsibilities must be clearly outlined to majority shareholders. All board members must be on the same page and share a similar vision for the future of the company.
- d. Ethical behaviour violations in favour of higher profits can cause massive civil and legal problems down the road. A code of conduct regarding ethical decisions should be established for all members of the board.
- e. Business transparency is the key to promoting shareholder trust. Financial records, earnings reports and forward guidance should all be clearly stated without exaggeration or “creative” accounting.
Importance of corporate governance: Governance is a term about which we hear a lot, especially in times of crisis. For corporations, when confronted with a hostile take – over bid, an ecological disaster, or the untimely death of the president, the governance role of the Board of Directors becomes a real and meaningful one.
When all is going well, too little seems to be done about crisis preventing and influence the overall direction of the corporation. There is clearly a need in many corporations for a new debate on corporate governance to address such issues as:
- What are the responsibilities of the firm to various stakeholders?
- Can competitive advantages be gained by building relationships with stakeholders?
- What standards of performance and behaviour are expected of the organization?
- What incentives are needed to encourage more socially and environmentally responsible results?
- What information and measurements are needed to set goals and to evaluate corporate social and environmental performance?
Monks and Minow, underscored the importance of corporate governance today stating that “the importance of corporate governance became dramatically clear in 2002 as a series of corporate meltdowns, frauds, and other catastrophes led to the destruction of billions of dollars of shareholder wealth, the loss of thousands of jobs, the criminal investigation of dozens of executives and record breaking bankruptcy filings”.
However corporate governance is important as it plays a vital role on following aspects:
- Economic Growth and Globalization
- Investors’ Confidence
- Enhance Company Performance
- Sustainable Growth
The objective of the present study is to discuss the meaning and purpose of director’s independence in corporate governance and its evolution in India. The focus of the study is on the liability of Independent Directors of a company and how it is followed or complied in Indian corporate system.
As all these issues have come into limelight after the SATYAM fraud was revealed, this study discusses the liability of Independent Directors with regards to the case study of SATYAM COMPUTERS in India.
Directors and Corporate
Governance in India: According to Mallin, (2012) India has a range of business forms, including public limited companies, which are listed on the stock exchange, domestic private companies and foreign companies. On the other hand India is following the global trend in reforming its corporate governance system.
However, as a former colony of Britain, India has a UK-style legal system and since the second half of the 19th century, Indian industry has generally followed an English common law framework of joint stock limited liability as referred by Goswami, (2000). As earlier mentioned, corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders and also the structure through which objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.
The focus of corporate governance in India is to impose disclosures and compliance, upgrade corporate governance practices and facilitate the integration of Indian business with their global counterparts. After much debate and controversy, in 2006 Securities and Exchange Board of India (SEBI) made it mandatory for publicly listed companies to follow the provisions of clause 49 of the listing agreement. (www. sebi. gov. in) A company is separate legal entity distinct from its shareholders. The major constituents of a company are its members, who are the ultimate owners and its directors.
It is an important feature of the company form of business, that there is a gap between the ownership and control over the affairs of the company. In real sense the members are the owners of a company, but it is being managed by the directors who are elected representatives of its members, because it is absolutely necessary for it to have a human agency called as the Company’s board of directors. Directors are a group of people comprising the governing body of a corporation. The shareholders of a corporation hold an election to choose people who have been nominated to direct or manage the corporation as a board.
The functions of directors involve a fiduciary duty to the corporation.
Need For Directors- Who is a Director?
A company being an artificial person cannot act by itself. It has neither a mind nor a body of its own. It must act through some human agency. The persons by whom the business of the company is carried on are termed as directors. The institution of the company is composed of two organs, the general body of shareholders and the board of directors. The board is the managerial body to whom is entrusted the whole management of the company.
Directors owe a duty to the members to exercise care, skill and diligence in discharge of their functions. (Garg, Gupta and Chawla, 2012) 2. 2 Statutory definition of Director:
According to section 2(13) of the Companies Act, 1956, “director” includes any person occupying the position of director by whatever name called.
Clause 49 of listing agreement by SEBI The clause 49 of the listing agreement by SEBI deals with corporate governance and lays down various processes and disclosures to be followed by all the companies.
It tells about the board composition, compensations, committees and management. As per Clause 49 of the Listing Agreements an independent director shall mean non-executive director of the company who:
- a) apart from receiving directors remuneration, does not have any material pecuniary relationships or transactions with the company, its promoters, its senior management or its holding company, its subsidiaries and associated companies;
- b) is not related to promoters or management at the board level or at one level below the board;
- c) has not been an executive of the company in the immediately preceding three financial years;
- d) is not a partner or an executive of the statutory audit firm or the internal audit firm that is associated with the company, and has not been a partner or an executive of any such firm for the last three years. This will also apply to legal firm(s) and consulting firm(s) that have a material association with the entity;
- e) is not a supplier, service provider or customer of the company. This should include lessor-lessee type relationships also; and
- f) is not a substantial shareholder of the company, i. e. owning two percent or more of the block of voting shares. But despite of these rules whether the director are independent or not is a debatable question and the present work will analyse it in regards with Satyam Computers which is regarded as the Indian Enron.
Role Of Independent Director: Directors play a vital role in the company and their role can be evaluated by discussing the following points as stated by Clarke, (2007):
Role in Corporate Governance: A corporation is the congregation of various stakeholders such as customers, employees, investors, shareholders etc. A corporation should be fair and transparent to its stakeholders in all transactions. This has become imperative in today’s globalized business world where corporations need to access global pools of capital, need to attract and retain the best human capital from various parts of the world, need to partner with vendors on mega collaborations and need to live in harmony with the community.
Unless a corporation embraces and demonstrates ethical conduct, it will not be able to succeed. Corporate governance is about the ethical conduct in business. In this regard, the managers make decisions based on a set of principles influenced by the values, context and culture of the organization. In India, the companies fill the Boards with the representatives of the promoters. These Directors may derive personal benefits rather than work for the benefit of the Company. This has posed great difficulties in the functioning of the company and is in contradiction of the principles of corporate governance.
Independence of the Board is critical to ensuring that the Board fulfils its oversight role objectively and holds the management accountable to the shareholders. Therefore, ensuring some independent members on the Board can uphold corporate governance principles. Protection of the Minority shareholder: The shareholders, especially the minority shareholders prefer coming to independent directors who provide transparency in respect of the disclosures in the working of the company as well as maintain a balance towards resolving conflict areas.
In evaluating the board’s or management decisions in respect of employees, creditors and other suppliers of major service providers, independent directors have a significant role in protecting the stakeholders interests. Risk Management and Review: It means identification, analysis and economic control of all such risks that may threaten assets, resources and earning capacity of the company. The risk may be financial, strategic or any other risks. The role of the Independent Director is to ensure that all the investment, funds, business transaction etc.
are heading in a right way and critically scrutinize the decision making process. Role in relation to the board: As members of Board, their role is similar to any other director; Independent Directors primarily provide inputs to all key-decisions, such as strategies, performance evaluation and risk evaluation, affecting the company. Significant contribution is expected when matters relating to the committee on which they are members are being discussed.
They should ensure that the Board addresses areas of concern on the running of the company and assist them in resolving the issues harmoniously. While the legal duties and objectives are the same as Executive Directors, the time devoted by independent Non-Executive Directors to the company’s affairs is significantly less and therefore the degree of care, skill and diligence is lower than that expected from Executive Directors, and this can be seen as a disadvantage by some. However, certain standard of care has to still be ensured.
As members of the Board, an Independent Director’s should, not only comply with the code of conduct but also establish, implement, monitor its adherence by other senior management and set an example for others. Improving Internal Control: The consummate internal control is the imperative requirement of the company. It activates the overall management policies and keeps them under the feasible ranges. The process of the internal control commences right from the birth of new policies by the Board of directors and continues to the bottom the organizational structure.
It includes development and operation of the management policies, administrative regulations, manuals, directives and decision, internal auditing etc. The responsibility of the independent directors is to act as supervisory body and monitor the internal control system. They must identify the imperfection in the internal control system and present them before the board to find suitable solutions to obviate them.
To maintain high standards in the market and excellent reputation in the public or investors, stricter adherence to the statutory laws is a pre-requisite for the company.
The postulates of good corporate governance require the Companies to enforce the multiple statutes and rules and regulations given there under. This facilitates the ultimate objective of protection of investors’ interest. The above stated roles though clarify the importance of director’s independence, but despite this, the directors are never regarded fully independent. Therefore whether there are pitfalls in the present laws or in the corporate management will be seen in the company stated below.
Current scenario in India:
In 2009, the pendulum swung both ways for India Inc.
There was much good news- corporate India came out of the global financial crisis smelling like a rose, with the Sensex surpassing its pre-crisis heights and India’s economic growth rates far exceeding most estimates (Satapathy ; Bharadwaj, 2009). However, 2009 was also a watershed year in the “bad news” category, with revelations of the biggest scandal in corporate India’s history at Satyam Computer Services and the travails of Nimesh Kampani relating to his service as an independent director at Nagarjuna Finance dominating the headlines and eroding confidence in corporate India both domestically and overseas (Banerji, 2009).
These events attracted significant public attention to an invited the scrutiny of India’s independent directors, and many of these independent directors took notice: at least 620 independent directors resigned from the boards of Indian companies in 2009- a figure that is, to our knowledge, by far without precedent globally. This exodus of independent directors highlighted a deep discomfort within corporate India with the very institution of independent directors in the context of companies controlled, directly or indirectly, by corporate founders, or promoters.
In spite of number of provisions provided in Indian laws to preserve the independence of independent directors, in reality, majority of the companies look at it only from the compliance point of view and have made use of number of loop holes to suit it to their needs. In some of the listed companies independent directors are related to each other. Some listed companies do not appoint new independent directors after the resignation of old independent directors on the plea that they are unable to find a suitable person.
Some listed companies circumvent the provisions of appointment of independent directors under the pretext that there are no entry and exit norms of independent Directors in terms of age, qualification etc. Some listed companies treat nominees of financial institutions and government as independent Directors. Currently a single independent director can be simultaneously found to working for more than a dozen companies.
Each company generally conducts close to 10 board meetings an year, 2- 4 audit committee meetings and one remuneration committee meeting. Some companies follow a policy of swapping wherein a director from company A works as an independent director in company B and vice versa. Press reports indicate that in a number of companies independent directors did not attend a single meeting during the year. Politicians are also known to interfere in the working of the PSU companies and hence completely tossing around the idea of independent directors.
Even the appointment of directors in PSU’s involves hectic lobbying. Hence the concept of independent directors being relatively new in India combined with the large number of listed companies (with numbers increasing each subsequent year), there is also a shortage of credible independent directors. Annual reports of many companies show that Independent Directors only fulfil regulatory requirements but in practice act as rubber-stamp of promoters.
Press reports indicate that in a number of companies Independent Directors did not attend a single meeting during the year. In some companies same Independent Directors continued for more than 15 years. This clearly leads to Corporate Failure in India which leads the work to the case study of Satyam Computers Scam.
A case Study:
Satyam Computer Services Satyam Computer Services Ltd. was founded in 1987 in Hyderabad, India, by B. Ramalinga Raju.
The company is a part of the Mahindra Group which is one of the top 10 industrial firms based in India. The company offers consulting and information technology (IT) services pning various sectors, and is listed on the New York Stock Exchange, the National Stock Exchange (India) and Bombay Stock Exchange (India). In June 2009, the company unveiled its new brand identity “Mahindra Satyam” subsequent to its takeover by the Mahindra Group’s IT arm, Tech Mahindra on April 13, 2009 (http://www. mahindrasatyam. com/).