Updated: Nov 9, 2019
What is Corporate governance?
Corporate Governance refers to the way a corporation is governed. Corporate governance is the system of rules, practices, and processes by which a firm is directed and controlled. Corporate governance essentially involves balancing the interests of a company's many stakeholders, such as shareholders, senior management executives, customers, suppliers, financiers, the government, and the community. The board of directors is pivotal in governance, and it can have major ramifications for equity valuation. It is actually conducted by the board of directors and the concerned committees for the company’s stakeholder’s benefit. The board of directors is the primary direct stakeholder influencing corporate governance. Directors are elected by shareholders or appointed by other board members, and they represent shareholders of the company It is all about balancing individual and societal goals, as well as, economic and social goals. Corporate governance is based on principles such as conducting business with integrity and fairness, being transparent with regard to all transactions, making all the necessary disclosures and decisions.
Importance of corporate governance
Corporate India plays a pivotal role in facilitating nation building and efficient corporate governance is critical for bolstering India’s economic growth. Fundamentally, there is a level of confidence that is associated with a company that is known to have good corporate governance. The presence of an active group of independent directors on the board contributes a great deal towards ensuring confidence in the market. It is also known to have a positive influence on the share price of the company. Having a clean image on the corporate governance front could also make it easier for companies to source capital at more reasonable costs. There is increasing awareness and consensus among Indian investors to invest in companies which have a record of observing practices of good corporate governance. Corporate governance is considered as an important means for paying heed to investors’ grievances. Kumar Mangalam Birla Committee on corporate governance found that companies were not paying adequate attention to the timely dissemination of required information to investors in India. Though some measures have been taken by SEBI and RBI but much more required to be taken by the companies themselves to pay heed to the investor’s grievances and protection of their investment by adopting good standards of corporate governance.
According to Millstein Report (1998), the promotion and articulation of the four core standards of corporate governance to attract capital include: fairness, transparency, accountability and responsibility.
Issues in Corporate Governance in India
1. Stressed balance sheets:
The bad debt problem (NPAs), which has affected the corporate sector, is as much an outcome of bad corporate governance as it is due to the vagaries of the business cycle. Many expensive acquisitions were made in the last decade by companies without a proper approval from the shareholders. As a result, few of them paid off for the shareholders.
2. The composition of the Board:
The Companies Act, 2013 introduced several good corporate governance provisions such as, one-third of the company board should comprise of Independent Directors, the board should have at least one woman Director, the constitution of Audit Committee within the board etc. However, several companies still haven't appointed women directors on their boards while some of them have named the women family members or friends of promoters as directors.
3. Role of Independent Directors:
Independent Directors were supposed to enhance the accountability of the board to the shareholders. As part of the Audit Committees, they were to ensure that the financial disclosure process was carried out as per the law. However, it was observed that they had failed to make their mark on company boards. Many of them fail to stand up to promoters' decisions if they find it to be against the interest of all the stakeholders. The main reason for their weakness is their removal process - they can be easily removed by the promoters or majority shareholders, affecting their independence.
4. The conflict between promoters and management:
Since many companies are family owned enterprises, the promoters as majority shareholders continue to exercise disproportionate influence over business decisions. This sometimes leads to a conflict between the promoters and the management, which is responsible for the day-to-day functioning of the company. Recent instances of ousting of Tata group chairman by Tata Sons, and the forced exit of the CEO of Infosys, both due to differences between the top management and the promoters, have highlighted the weaknesses in our corporate governance norms. This conflict has also reflected the weaknesses in succession planning by the founders/promoters, many of them inherent inhibitions to let go of control over their companies.
5. Executive Compensation:
According to the new Companies Act, the nomination and remuneration committee of the Board (comprising a majority of independent directors) is to decide on the compensation to key employees. This needs to be approved by the shareholders. However, the top employees are paid exorbitant remuneration in certain instances where they allow a significant say to the promoters as quid pro quo. On the other hand, many small companies fail to offer competitive remuneration to attract talented professionals. Sometimes, exorbitant remuneration to the top employees can become an issue of conflict between promoters and management, like the case of Infosys.
Uday Kotak committee on corporate governance
SEBI has made corporate governance compulsory for certain companies. This is done to protect the interest of the investors and other stakeholders. Aiming to improve standards of corporate governance of listed companies, recently SEBI has set up a committee under chairman of Uday Kotak, chief of Kotak Mahindra bank. The panel include representatives of Corporate India, stock exchanges, professional bodies, investor groups, chambers of commerce, law firms, academicians and research professionals, and SEBI.
Recommendation of committee are as follows:
Listed firms with more than 40% public shareholding should have separate roles of chairperson and MD/CEO with effect from April 1, 2020.
Minimum board strength should be increased to 6 members and at least one woman should be appointed as an independent director.
At least half of board members to be independent directors at listed companies, while all directors must attend at least half of board meets.
Top 100 firms by market capitalisation should webcast shareholder meeting and all listed firms should have cash flow statement every six months.
Updated list of all credit ratings obtained by the listed entity must be made available at one place, which would be very helpful for investors and other stakeholders.
Top-500 listed companies should have risk management committee of boards for cyber security.
Yes Bank came under the central bank’s scanner over regulatory and governance issues under Mr. Rana Kapoor’s watch in 2015, when the RBI decided to conduct an asset quality review (AQR) to clean up the rising toxic loan problem in the country’s financial sector. As a result, several banks were forced to report loan divergences, i.e., the difference between the RBI’s assessment of bad loans and the one reported by the bank, in their quarterly results. At a time when most banks were struggling with rising bad loans, Yes Bank had managed to keep a check on its non-performing assets (NPAs). However, following the AQR review in 2015, RBI found out some serious issues related to loan divergence and NPAs at Yes Bank.
The main observations noted by RBI in 2015 AQR review were-
Yes Bank consistently showed NPAs below 2%. The gross NPAs reported by the bank in FY16 were at Rs 748.98 Crores. It turned out that the NPAs identified by RBI were at Rs 4925.68 Crores. A whopping 557% higher NPA was observed during the AQR review with respect to actual reported. The Gross NPA % disclosed by Yes Bank as on March 2016 stood at 0.76%. This Gross NPA actually should have been at 5.01% as per RBI observations.
RBI also observed very astounding deviation of 1166% for Net NPAs. The Net NPA % disclosed by Yes Bank was at 0.29% for Mar 2016, which according to RBI should have been 3.67%.
Basically, loan divergence is mere account jugglery and these things are not taken lightly by the regulator (i.e. RBI) when exposed. Sometimes banks extend loans to genuinely restructure a loan. At other times, it is done only to delay recognizing a problem..
Yes Bank share prices plummeted following the news of rating downgraded by Moody, ICRA and CARE. Yes Bank’s share price registered their two-year low of ₹147.00 apiece on the BSE on 29th November 2018. The share price of Yes bank as on date 31st October is Rs. 56/-
Please the below mentioned link to read the whole case:
Indigo / Interglobe Aviation Ltd.
Rahul Bhatia and Rakesh Gangwal founded IndiGo as a low-cost airline back in 2006. Bhatia worked in the hospitality sector while Gangwal, a US citizen was a senior executive at United Airlines.
Rakesh Gangwal has alleged that Rahul Bhatia’s entity Interglobe Enterprises, which has management control of the airline, has built an “ecosystem of other companies that would enter into dozens of related party transactions with the airline”. This was among several other allegations levelled by Gangwal into lapses of corporate governance including appointment of independent directors, powers of the Nomination and Remuneration Committee of the company’s board, among others.
Prior to the letter Gangwal sent to SEBI, Bhatia had written to the Board of IndiGo that Gangwal’s allegations into governance issues at the airline were part of a plot to “dilute” and “diminish” the control of Interglobe Enterprises in the airline. He also pointed out that the audit firm EY conducted a review of the related party transactions and did not find any “substantive” irregularities in it.
Almost two months after it first came to the fore, the tussle between IndiGo’s co-founders has escalated further with Rakesh Gangwal accusing Rahul Bhatia of “serious corporate governance lapses” and urging markets regulator SEBI to intervene. The Securities and Exchange Board of India (SEBI) asked IndiGo – India’s largest and most profitable airline – to respond to the concerns.
Hence, Corporate governance has earned its place as an essential tool in the management and growth of companies, and will continue to grow in importance as time goes on. It is advisable that all companies take steps to increase the quality of their corporate governance systems in order to improve the functioning of the business.