28. Corporate Governance in India – Business Environment

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CORPORATE GOVERNANCE IN INDIA

This chapter deals with corporate governance in all its aspects—what it is, its constitutents, its history and evolution, and the desirable conditions for practising it—and presents a score card on corporate governance as practised in India. After reading this chapter, we will clearly understand this most important subject, the practice of which leads to ethical business.

A series of corporate scams and collapses in the late 1980s and early 1990s made the United Kingdom realize that the existing rules and regulations were inadequate to curb unlawful and unfair practices of corporations. It was with this view that a committee under the chairmanship of Sir Adrian Cadbury was appointed by the London Stock Exchange in 1991. This Cadbury committee, consisting of representatives drawn from the echelons of British industry, was assigned the task of drafting a code of practices to assist corporations in England in defining and applying internal controls to limit their exposure to financial loss, from whatever cause it arose. The committee submitted its report along with the “Code of Best Practices” in December 1992. In its globally well-received report, the committee elaborated the methods of governance needed to achieve a balance between the essential powers of the Board of Directors and their proper accountability. Though the recommendations of the committee were not mandatory in character, the companies listed on the London Stock Exchange were enjoined to state explicitly in their accounts, whether or not the Code has been followed by them, and if not complied with, were advised to explain the reasons for non-compliance.

Corporate governance is typically perceived by academic literature as dealing with “problems that result from the separation of ownership and control.”1 From this perspective, corporate governance would focus on the internal structure and rules of the board of directors; the creation of independent audit committees; rules for disclosure of information to shareholders and creditors; and, the control of management. Figure 28.1 explains how a corporation is structured.

 

 

Figure 28.1 Separation of Ownership and Management

DEFINITIONS

The concept of corporate governance is associated with a bewildering variety of perceptions. Though there is a general consensus on the need to promote corporate governance and eradicate corporate misgovernance, the definition of corporate governance varies according to the sensitivity of the analyst, the context of varying degrees of development and from the standpoint of academics versus corporate managements.

Sir Adrian Cadbury, Chairman of the Cadbury Committee defined the concept thus: “Corporate governance is defined as holding the balance between economic and social goals and between individual and communal goals. The governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources.” The objective of Corporate Governance is to ensure, as far as possible, the interests of its stakeholders—enable individuals, corporations and society. It will enable corporations realize their aims and attract investment. From the standpoint of states, it will strengthen their economies, even while discouraging fraud and mismanagement.2

Experts at the Organization of Economic Cooperation and Development (OECD) have defined Corporate Governance “As the system by which business corporations are directed and controlled.” The structure of corporate governance, according to them, “specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the Board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs.” Such specifications define company objectives, provide a means to achieve the objectives and monitor the performance.3 OECD's definition, incidentally is consistent with the one presented by the Cadbury Committee.

All these shareholder-centric definitions capture some of the most important concerns of governments in particular, and the society in general: (i) Management accountability; (ii) Providing adequate investments to management; (iii) Disciplining and replacement of bad management; (iv) Enhancing corporate performance; (v) Transparency; (vi) Shareholder activism; (vii) Investor protection; (viii) Improving access to capital markets; (ix) Promoting long-term investment; and (x) Encouraging innovation.

According to the World Bank, corporate governance can be defined from two aspects—corporation and public policy. From the corporation perspective, corporate governance is relationship between owners, management board and other stakeholders (the employers, customers, suppliers, investors and communities), where the emphasis is given to the board of directors to balance their interests to achieve long-term sustained value. From a public policy perspective, corporate governance refers to providing for the survival, growth and development of the company, and at the same time, its accountability in the exercise of power and control over companies.4 According to some analysts on the subject, corporate governance principles can be used as a means of public policy with a view to disciplining the companies and at the same time lessening the differences that exist between private and social interests. The OECD also offers a broader definition: “…Corporate governance refers to the private and public institutions, including laws, regulations and accepted business practices, which together govern the relationship in a market economy, between corporate managers and entrepreneurs (‘corporate insiders’) on one hand, and those who invest resources in corporations, on the other.”5

Fewer concerns are more critical to international business and developmental strategies than that of corporate governance. A series of events over the last two decades have placed corporate governance issues at centre stage and as of paramount importance both for the international business community and financial institutions. It has become the cynosure of all issues connected with corporations. Successive business failures and frauds in USA, several high profile scandals in Russia and the crisis in Asia have all brought corporate governance issues to the forefront in the developing countries and transitional economies. Further, national business communities are gradually realizing the fact that there is no substitute for getting the basic business and management systems in place in order to be competitive in the global market and to attract investment.

DESIDERATA

The OECD has emphasized the following desirable conditions of corporate governance:

  1. Rights of shareholders: The rights of shareholders which have been stressed as important for ensuring better corporate governance by all writers and organizations including the World Bank and the Asia Pacific Economic Corporation (APEC) include secure ownership of their shares, voting rights, the right to full disclosure of information, participation in decisions on sale or any change in corporate assets (including mergers) and new share issues. Shareholders have the right to know the capital structures of their corporation and arrangements that enable certain shareholders to obtain control disproportionate to their holding. All transactions should be at transparent prices and under fair conditions. Anti-takeover devices should not be used to shield management from accountability. Institutional shareholders should consider the costs and benefits of exercising their voting rights.
  2. Equitable treatment of shareholders: The OECD and other organizations such as APEC have stressed the point that all shareholders including minority and foreign shareholders should get equitable treatment and have equal opportunity for the redressal of their grievances and violation of their rights. Shareholders should not face undue difficulties in exercising their voting rights. Any change in their voting rights should be subject to a vote by shareholders. Insider trading and abusive self-dealing that are repugnant to the principle of equitable treatment of shareholders should be prohibited. Directors should disclose any material interest regarding transactions. They should avoid situations involving any conflict of interest while making decisions. Interested directors should not participate in deliberations leading to decisions that concern them.
  3. Role of stakeholders in corporate governance: The OECD guidelines as also others on the subject of corporate governance recognize the fact that there are other stakeholders in corporations apart from shareholders. Apart from dealers, consumers and the government who constitute the stakeholders' group, there are also others who should be considered. Banks, bondholders and workers, for example, are important stakeholders in the way in which companies perform and make decisions. Corporate governance framework should, apart from recognizing the rights of shareholders, allow employee representation on board of directors, profit sharing, creditors' involvement in insolvency proceedings, etc. Where there is such stakeholder participation, it should be ensured that they have access to relevant information.
  4. Disclosure and transparency : The OECD lays down a number of provisions for the disclosure and dissemination of key information about the company to all those entitled for such information. These may range from company objective to financial details, operating results, governance structure and policies, the board of directors, their remuneration, significant foreseeable risk factors and material issues regarding employees and other stakeholders. The OECD guidelines also spell out that annual audits should be performed by independent auditors in accordance with high quality standards.

    Like the OECD, the APEC also provides guidelines on the establishment of effective and enforceable accountability standards, timely and accurate disclosure of financial and non-financial information regarding company performance. There can be several gray areas in corporate activities that may cause confusion to the management as to whether there is any need to disclose any specific issue or the other. The cardinal principle that should govern managers on such occasions is: When in doubt, disclose.

  5. Responsibilities of the board: The OECD guidelines explain in detail the functions of the Board in protecting the company, its shareholders and its other stakeholders. These functions would include concerns about corporate strategy, risk, executive compensation and performance, accounting and reporting systems, monitoring effectiveness and changing them, if needed.

APEC guidelines include establishment of rights and responsibilities of managers and directors. The OECD guidelines focus only on those governance issues which arise due to separation between ownership and control of capital. Though these have limited focus, they are comprehensive, especially with reference to voting rights of institutional shareholders and obligations of the board to stakeholders. Though the APEC principles too reiterate them, they give foremost importance to disclosures. Again, instead of rights of shareholders, they reiterate the rights and also the responsibilities of shareholders, managers and directors. To them, establishment of accountability standards is a separate principle by itself.

The broad objectives and principles of corporate governance may be the same to all societies, but when it comes to applying them to individual countries we have to reckon the peculiar features, socio-cultural characteristics, the history of its people, their value-systems, economic system, political setup, stage and maturity of development and even literacy rates. All these factors have an impact on both political and corporate governance systems. Superimposing the governance systems and procedures that are effective in mature Western democracies on transition economies will be inappropriate, ineffective and may even be hostile to the interests of the people these are intended to serve.

GOOD CORPORATE GOVERNANCE

The terms governance and good governance are being increasingly used in development literature. Bad governance is being recognized now as one of the root causes of corrupt practices in our societies. Major donors, institutional investors, and international financial institutions provide their aid and loans on the condition that reforms that ensure “good governance” are put in place by the recipient nations. As with nations, corporations too are expected to provide good governance to benefit all its stakeholders. At the same time, good corporations are not born, but are made by the combined efforts of all stakeholders, which include shareholders, Board of Directors, employees, customers, dealers, government and the society at large. Law and regulation alone cannot bring about changes in corporations to behave better to benefit all those concerned. Directors and management, driven by stakeholders and inspired by societal values, have a very important role to play. The company and its officers, who, inter alia, include the Board of Directors and the officials, especially the senior management, should strictly follow a code of conduct, which should have the following desiderata:

Obligation to Society

A corporation is a creation of law as an association of persons forming part of the society in which it operates. Its activities are bound to impact the society as the society's values would have an impact on the corporation. Therefore, they have mutual rights and obligations to discharge for the benefit of each other.

  1. National interest: A company and its management should be committed in all its actions to benefit the economic development of the countries in which it operates and should not engage in any activity that would militate against such an objective. A company should not undertake any project or activity detrimental to the nation's interest or those that will have an adverse impact on the social and cultural life patterns of its citizens. A company should conduct its business in consonance with the economic development of the country and the objectives and priorities of the nation's government and must strive to make a positive contribution to the realization of its goals.
  2. Political non-alignment: A company should be committed to and support a functioning democratic constitution and system with a transparent and fair electoral system and should not support directly or indirectly any specific political party or candidate for political office. The company should not offer or give any of its funds or property as donations directly or indirectly to any specific political party candidate or campaign.
  3. Legal compliances: The management of a company should comply with all applicable government laws, rules and regulations. The employees and directors should acquire appropriate knowledge of the legal requirements relating to their duties sufficient to recognize potential dangers. Violations of applicable governmental laws, rules and regulations may subject them to individual criminal or civil liability as well as disciplinary action by the company apart from subjecting the company itself to civil or criminal liability or even the loss of business. Legal compliance will also mean that corporations should abide by the tax laws of the nations in which they operate such as corporate tax, income tax, excise duties, sales tax, cesses and other levies imposed by respective governments. These should be paid on time and as per the required amount.
  4. Rule of law: Good governance requires fair, legal frameworks that are enforced impartially. It also requires full protection of rights, particularly those of minority shareholders. Impartial enforcement of laws requires an independent judiciary and regulatory authority.
  5. Honest and ethical conduct: Every officer of the company including its directors, executive and non executive directors, Managing Director, CEO, CFO and CCO should deal on behalf of the company with professionalism, honesty, commitment and sincerity as well as high moral and ethical standards. Such conduct must be fair and transparent and should be perceived as such by third parties as well. The officers are also expected to act in accordance with the highest standards of personal and professional integrity and ethical conduct at their place of work or while working on off-site locations where the company's business are located or at social events or at any other place where they represent the company. Honest conduct is a conduct that is free from fraud or deception. Ethical conduct is an ethical handling of actual or apparent conflicts between personal and professional relationship.
  6. Corporate citizenship: A corporation should be committed to be a good corporate citizen not only in compliance with all relevant laws and regulations, but also by actively assisting in the improvement of the quality of life of the people in the communities in which it operates with the objective of making them self-reliant and enjoy a better quality of life. Such social commitment consists of initiating and supporting community initiatives in the field of public health and family welfare, water management, vocational training, education and literacy and encourages application of modern scientific and managerial techniques and expertise. The company should review its policy in this respect periodically in consonance with national and regional priorities. The company should strive to incorporate them as an integral part of its business plan and not treat them as optional and something dispensed with when inconvenient. It should encourage volunteering amongst its employees and help them to work in the communities. The company should develop social accounting systems and carry out social audit of its operations towards the community, employees and shareholders.
  7. Ethical behaviour: Corporations have a responsibility to set exemplary standards of ethical behaviour, both internally within the organization, as well as in their external relationships. Unethical behaviour corrupts organizational culture and undermines stakeholder value. The Board of Directors has a great moral responsibility to ensure that the organization does not derail from an upright path to make short-term gains.
  8. Social concerns: Corporations exist beyond time and space. So they have to set an example to their employees and shareholders. New paradigm is that the company should think not only about its shareholders, but also about its stakeholders and their benefits. A corporation should not give undue importance to shareholders at the cost of small investors. They should treat all of them equally and equitably. The company should have concerns towards the society. It can help the needy people and show its concern by not polluting the water, air and land. The waste disposal should not affect any human or other living creatures.
  9. Corporate social responsibility: Accountability to stakeholders is a continuing topic of divergent views in corporate governance debates. In line with developing an integrated model of governance for an ideal corporate, the emphasis should be laid on corporate social responsiveness and ethical business practices. These are not only the first small steps for a better governance, but also the promise of a more transparent and internationally respected corporation of the future.
  10. Environment friendliness: Corporations tend to be of an intervening, altering and transforming nature. For corporations engaged in commodity manufacturing, profit comes from converting raw materials into saleable products and commodities. Metals from the ground are converted into consumer durables. Trees are converted into boards, houses, and furniture and paper products. Oil is converted into energy. In all such activities, a piece of nature is taken from where it belongs and processed into a new form. So companies have a moral responsibility to save and protect the environment. All the pollution standards have to be followed meticulously and organizations should develop a culture having more concern towards environment.
  11. Health, safety and working environment: A company should be able to provide a safe and healthy working environment and comply in the conduct of its business affairs with all regulations regarding the preservation of the environment of the territory it operates in. It should be committed to prevent the wasteful use of natural resources and minimize the hazardous impact of the development, production, use and disposal of any of its products and services in the ecological environment.
  12. Competition: A company should play its role in the establishment and support of a competitive, open market economy and cooperate in efforts to promote the progressive and judicious liberalization of trade and investment by a country. It should not covertly or overtly engage in activities, which lead to or support the formation of monopolies, dominant market positions, cartels and similar unfair trade practices. A company should market its products and services on its own merits and should not resort to unethical advertisements or include unfair and misleading pronouncements on competitors' products and services. Any collection of competitive information shall be made only in the normal course of business and shall be obtained only through legally permitted sources and means.
  13. Trusteeship: Corporations have both social and economic purposes. They represent a coalition of interests, namely, those of the shareholders, other providers of capital, business associates and employees. This belief, therefore, casts a responsibility of trusteeship on the company's Board of Directors. They are to act as trustees to protect and enhance shareholder value, as well as to ensure that the company fulfils its obligations and responsibilities to its other stakeholders. Inherent in the concept of trusteeship is the responsibility to ensure equity, that is, the rights of all shareholders, large or small, foreign or local, majority or minority, are equally protected.
  14. Accountability: Accountability is a key requirement of good governance. Not only governmental institutions, but also the private sector and civil society organizations must be accountable to the public and to their institutional stakeholders. Who is accountable to whom varies depending on whether decisions or actions taken are internal or external to an organization or institution. In general, an organization or an institution is accountable to those who will be affected by its decisions or actions. Accountability cannot be enforced without transparency and the rule of law.
  15. Effectiveness and efficiency: Good governance means that processes and institutions produce results that meet the needs of society while making the best use of resources at their disposal. The concept of efficiency in the context of good governance also covers the sustainable use of natural resources and the protection of the environment.
  16. Timely responsiveness: Good governance requires that institutions and processes try to serve all stakeholders within a reasonable timeframe. They should also address the concerns of all stakeholders and the society at large.
  17. Corporations should uphold the fair name of the country: When companies export their products or services, they should ensure that these are qualitatively good and are delivered in time. They have to ensure that the nation's reputation is not sullied abroad during their deals, either as exporters or importers. They have to ensure maintenance of the quality of their products, which should be the brand ambassadors for the country.

Obligation to Investors

That the investor as a shareholder and provider of capital is of paramount importance to a corporation is such an accepted fact that it need not be overstressed here.

  1. Towards shareholders: A company should be committed to enhance shareholder value and comply with all regulations and laws that govern shareholder's rights. The board of directors of the company shall and fairly inform its shareholders about all relevant aspects of the company's business and disclose such information in accordance with the respective regulations and agreements. Every employee shall strive for the implementation of and compliance with this in his/her professional environment. Failure to adhere to the code could attract the most severe consequences including termination of employment or directorship as the case may be.
  2. Informed shareholder participation: A related issue of equal importance is the need to bring about greater levels of informed attendance and meaningful participation by shareholders in matters relating to their companies without, however, such freedom being abused to interfere with management decision. An ideal corporate should address this issue and relate it to more meaningful and transparent accounting and reporting.
  3. Transparency: Transparency means that decisions taken and their enforcement are done in a manner that follows rules and regulations. It also means that information is freely available and directly accessible to those who will be affected by such decisions and their enforcement. It also means that enough information is provided and that it is provided in easily understandable forms and media.
  4. Financial reporting and records: A company should prepare and maintain accounts of its business affairs fairly and accurately in accordance with the accounting and financial reporting standards, and laws and regulations of the country in which the company conducts its business affairs. Likewise, internal accounting and audit procedures shall fairly and accurately reflect all business transactions of the company and disposition of assets. All required information shall be accessible to the company's auditors, non-executive and independent directors on the board, and other authorized parties and government agencies. There shall be no voluntary omissions of any transactions from the books and records, no advance income recognition and no hidden bank account and funds.

Such wilful material misrepresentation of and/or misinformation on the financial accounts and reports shall be regarded as a violation of the firm's ethical conduct and also will invite appropriate civil or criminal action under the relevant laws of the land.

Obligation to Employees

Since a long time, corporations in free societies had been adopting a “hire and fire” policy in employment of men and women in their work places and hardly treated them humanely taking advantage of the fact that workers have a commodity—labour—that is highly perishable with little bargaining power. But in the context of enhanced awareness of better governance practices, managements should realize that they have their obligations towards their workers too.

  1. Fair employment practices: An ideal corporate should commit itself to fair employment practices, and should have a policy against all forms of illegal discrimination. By providing equal access and fair treatment to all employees on the basis of merit, the success of the company will be improved while enhancing the progress of individuals and communities. The applicable labour and employment laws should be followed scrupulously wherever it operates. That includes observing those laws that pertain to freedom of association, privacy, and recognition of the right to engage in collective bargaining, the prohibition of forced, compulsory child labour, and also laws that pertain to the elimination of any improper employment discrimination.
  2. Equal opportunities for employees: A company should provide equal opportunities to all its employees and all qualified applicants for employment without regard to their race, caste, religion, colour, ancestry, marital status, sex, age, nationality, disability and veteran status. Its employees should be treated with dignity and in accordance with a policy to maintain a conducive work environment free of sexual harassment, physical, verbal or psychological. Employee policies and practices should be administered in a manner that ensures that in all matters equal opportunity is provided to those eligible and the decisions are merit-based.
  3. Encouraging whistle-blowing: It is generally felt that if whistle-blower concerns had been addressed, some of the recent disasters could have been avoided, and that in order to prevent future misconduct, whistle-blowers should be encouraged to come forward. So an ideal corporate is one that deals proactively with whistle-blowers and make sure that employees have comfortable reporting channels and are confident that they will be protected from any form of retribution. Such an approach will enhance the company's chances to become aware of, and to appropriately deal with, a concern before an illegal act has been committed rather than after the damage has been done. If reporting is delayed, the company's reputation can be seriously harmed and it can face a serious risk of prosecution with all its disastrous consequences. An ideal whistle-blower policy would mean:
    • Personnel who observe an unethical or improper practice (not necessarily a violation of law) shall be able to approach the CEO or the Audit Committee without necessarily informing their supervisors.
    • The company shall take measures to ensure that this right of access is communicated to all employees through means of internal circulars, etc. The employment and other personnel policies of the company should contain provisions protecting whistle-blowers from unfair termination and other prejudicial employment practices.
    • The appointment, removal and terms of remuneration of the chief internal auditor shall be subject to review by the Audit Committee.
  4. Humane treatment: Now corporations are viewed like humans and similar kind of behaviour is expected of them. Companies should treat their employees as their first customers and above all as humans. They have to meet the basic needs of all employees in the organization. There should be a friendly, healthy and competitive environment for the workers to prove their ability.
  5. Participation: Participation by both men and women is a key cornerstone of good governance. Participation could be either direct or through legitimate intermediate institutions or representatives. Participation needs to be informed and organized. This means freedom of association and expression on the one hand and an organized civil society on the other.
  6. Empowerment: Empowerment is an essential concomitant of any company's principle of governance that management must have the freedom to drive the enterprise forward. Empowerment is a process of actualizing the potential of its employees. Empowerment unleashes creativity and innovation throughout the organization by truly vesting decision-making powers at the most appropriate levels in the organizational hierarchy.
  7. Equity and inclusiveness: A corporation is a miniature of a society whose well-being depends on ensuring that all its employees feel that they have a stake in it and do not feel excluded from the mainstream. This requires all groups, particularly the most vulnerable, have opportunities to improve or maintain their well-being.
  8. Participative and collaborative environment: There should not be any form of human exploitation in the company. There should be equal opportunities for all levels of management in any decision making. The management should cultivate the culture where employees should feel secure and being well taken care of. Collaborative environment would bring peace and harmony between the working community and the management, which in turn, brings higher productivity, higher profits and higher market share.

Obligation to Customers

A corporation's existence cannot be justified without it being useful to its customers. Its success in the marketplace, its profitability and it being beneficial to its shareholders by paying dividends depends entirely as to how it builds and maintains fruitful relationships with its customers.

  1. Quality of products and services: A company should be committed regarding the supply goods and services of the highest quality standards, backed by efficient after-sales service consistent with the requirements of the customers to ensure their total satisfaction. The quality standards of the company's goods and services should meet not only the required national standards, but also should endeavour to achieve international standards.
  2. Products at affordable prices: Companies should ensure that they make quality goods available to their customers at affordable prices. While making normal profit is justifiable, profiteering and fattening on the miseries of the poor consumers is unacceptable. Companies should constantly endeavour to update their expertise, technology and skills of manpower to cut down costs and pass on such benefits to their customers. They should not create a scare in the midst of scarcity or by themselves create an artificial scarcity to make undue profits.
  3. Commitment to customer satisfaction: Companies should be fully committed to satisfy their customers and earn their goodwill to stay long in the business. They should respect in letter and spirit warranties and guarantees given to their products and call back from markets goods found to be sub-standard or harmful and replace them with goods ones.

Managerial Obligation

Managers are the kingpins of a corporation and play a pivotal role in ensuring that the policies of the company, as enunciated in the shareholders' meetings and strategized by the Board, are translated into action for the benefit of all stakeholders. As such, they have a great deal of responsibility towards the corporation, as explained below:

  1. Protecting company assets: The assets of the company should not be dissipated or misused but employed for the purpose of conducting the business for which they are duly authorized. These include tangible assets such as equipment and machinery, systems, facilities, resources as well as intangible assets such as proprietary information, relationships with customers and suppliers, etc.
  2. Behaviour towards government agencies: A company's employees should not offer or give any of the firm's funds or property as donation to any government agencies or their representatives directly or through intermediaries in order to obtain any favourable performance of official duties.
  3. Control: Control is a necessary principle of governance that the freedom of management should be exercised within a framework of appropriate checks and balances. Control should prevent misuse of power, facilitate timely management response to change, and ensure that business risks are pre-emotively and effectively managed.
  4. Consensus oriented: Good governance requires mediation of the different interests in society to reach a broad consensus on what is in the best interest of the whole community and how this can be achieved. It also requires a broad and long-term perspective on what is needed for sustainable human development and how to achieve the goals of such development. This can only result from an understanding of the historical, cultural and social contexts of a given society or community.
  5. Gifts and donations: The company's employees should neither receive nor directly or indirectly make any illegal payments, remuneration, gifts, donations or comparable benefits, which are intended to or perceived to obtain business or uncompetitive favours for the conduct of its business. However, the company and its employees may accept and offer nominal gifts, which are customarily given and are of a commemorative nature for special events provided the same is disclosed on time to the management.
  6. Role and responsibilities of corporate board and directors: The role of the corporate board of directors as stewards of their stakeholders has gained significant importance in recent decades. Successive corporate failures, scams, debacles and other disasters have strengthened the demand for more transparency and accountability on the part of corporations. In the discharge of these onerous responsibilities, the corporate board has come to be regarded as the principal arbiter ensuring, on the one hand, that executive management creates wealth competently and through legitimate means, and, on the other hand, such created wealth is equitably distributed to all shareholders after meeting the due aspirations of, and obligations to, other stakeholders.
      An ideal corporate calls for a greater role and influence for non-executive independent directors, a tighter delineation of independence criteria and minimization of interest-conflict potential and some stringent punitive punishments for executive directors of companies failing to comply with listing and other requirements.
  7. Distinction between direction and management: It is necessary to distinguish the nature of the two basic components of governance in terms of policy making and oversight responsibilities of the board of directors and the executive and implementation responsibilities of corporate management comprising the managing director and his or her team of executives including functional directors. Executives who are also on the board as directors of the company in effect wear two hats, one as part of the board, and the other as part of the management. Directors derive their authority only when acting collectively as the board or when the board delegates specific authorities to be exercised as in the case of managing directors. Managers in the broadest sense of the term have the responsibility to execute the policies under the supervision of the board and for this purpose have the necessary authority to ensure compliance and implementation. An ideal corporate highlights this critical distinction particularly in the context of fixing responsibility for failure and the consequential liabilities that follow.
  8. Managing and whole-time directors: Managing and other whole-time directors are required to devote entire or considerable amount of their time to the affairs of their companies. And yet many of them serve as non-executive directors on several other boards. An ideal corporate affords the shareholders and stakeholders of the company the benefit of having their chosen executive's full attention in the matters of the company. An ideal corporate must necessarily limit the nature and number of their other non-executive directorships.

The forgoing analysis of the duties, responsibilities and obligations of different stakeholders illustrates the complexities involved in the administration of modern corporations. Gone are the days when the society looked at corporations as forms of business enterprises working exclusively for the material benefit of its shareholders. With the broadening vision of modern thinkers and opinion makers and enhanced and heightened social values, it is now an unacceptable proposition that corporations exist purely for the profit of those who constituted it. They are expected to be transparent, accountable and even beneficial to the larger society. Their employees, consumers of their products, and associates in their business such as dealers and stockists, the communities surrounding their facilities and workstations are as important as those who contribute their capital. Corporations cannot any more ignore the concerns of the society such as the environment and ecology. And these concerns are no more community based or country specific. In a global village such as the one all of us are moving into, if a corporate has to survive, grow and wants to be counted, its vision should focus on the ways and means of becoming a responsible and responsive corporate citizen, and its mission could no more be myopic as it used to be in the distant past.

In the modern financial and business world, good corporate governance is not an optional extra. Good corporate governance is fundamental to raising capital, satisfying investors and running successful businesses in increasingly global markets. Good corporate governance is essential to all other stakeholders in the firm— employees, suppliers, customers, and bankers—as well as to the local and national society for the provision of employment, the creation of wealth and the building of a modern state. Good corporate governance also encourages the levels of transparency, accountability and corporate social responsibility that is increasingly necessary for a modern nation.

ISSUES IN CORPORATE GOVERNANCE

Corporate governance has been defined in different ways by different writers and organizations. Some define it in a narrow perspective to include in it only the shareholders, while others want it to address the concerns of all stakeholders. Some talk about corporate governance being an important instrument for a country to achieve sustainable economic development, while some others consider it as a corporate strategy to achieve a long tenure and a healthy image for the corporate. To people in developing societies and transitional economies, it is a necessary incentive to usher in more powerful and vibrant institutions of control. To some, it provides another dimension to corporate ethics and social responsibility of business. Thus, corporate governance has become several things to several people. But to all, corporate governance is a means to an end, the end being long-term shareholder, and more importantly, stakeholder value. Thus, all authorities on the subject are one in recognizing the need for good corporate governance practices to achieve the end for which corporations are formed. The following sections identify some governance issues being crucial and critical to achieve these objectives.

Distinguishing the Roles of Board and Management

The Constitutions of many companies stress and underline that business is to be managed “by or under the direction of” the board. In such a practice, the responsibility for managing the business is delegated by the board to the CEO, who in turn delegates the responsibility to other senior executives. Thus, the board occupies a key position between the shareholders (owners) and the company's management (day-today managers of the company's resources). As per this arrangement, the board of a listed company has the following functions:

  1. Select, decide the remuneration and evaluate on a regular basis, and when necessary, change the CEO;
  2. Oversee (not directly, but indirectly) the conduct of the company's business to evaluate whether or not it is being correctly managed;
  3. Review and, where necessary, approve the company's financial objectives and major corporate plans and objectives;
  4. Provide advice and counsel to top management;
  5. Select and recommend candidates to shareholders for electing them to the board of directors;
  6. Review the adequacy of systems to comply with all applicable laws and regulations; and
  7. Review any other functions required by law to be performed.

Composition of the Board and Related Issues

The Board of Directors is a “committee elected by the shareholders of a limited company to be responsible for the policy of the company. Sometimes, full-time functional directors are appointed, each being responsible for some particular branch of the firm's work.”6

The composition of Board of Directors refers to the number of directors of different kinds that participate in the work of the board. Over time there has been a change as to the number and proportion of different types of directors in the board of a limited company. Figure 28.2 illustrates the usual composition of the board in recent times in most of the countries.

The SEBI-appointed Kumar Mangalam Birla Committee's Report defined the composition of the Board thus “The Board of Directors of a company shall have an optimum combination of executive and non-executive directors with not less than 50% of the Board of Directors to be non-executive directors. The number of independent directors would depend whether the chairman is executive or non-executive.” However, had there been a non-executive Chairman, independent directors should constitute one-third of the Board, while if the Chairman were an executive, independent directors should form half of the Board.7

 

 

Figure 28.2 Types of Directors

 

As shown in Figure 28.2, for instance, an Executive Director is one who is an executive of the company and who is also a member of the board of directors, while a Non-executive Director has no separate employment relationship with the company. Independent non-executive directors are those directors on the board who are free from any business or other relationship which could materially interfere with the exercise of their independent judgement in the process of decision making as a member of the board. An affiliated director or a nominee director is a non-executive director who has some kind of independence, impairing relationship with the company or the company's management. For example, the director may have links with a major supplier or customer of the company, or may be a partner in a professional firm that supplies services to the company, or may be a retired top management professional of the company.8

Separation of the Roles of the CEO and Chairperson

The composition of the board is a major issue in corporate governance as the board acts as a link between the shareholders and the management and its decisions affect the performance of the company. Professionalization of family companies should commence with the composition of the board. All committees that studied governance practices all over the world starting with the Cadbury Committee have suggested various improvements in the composition of boards of companies.

It is now increasingly being realized that the practice of combining the role of the Chairperson with that of the CEO as is done in countries like the USA and India leads to conflicts in decision making and too much concentration of power in one person resulting in unsavoury consequences. In the United Kingdom and Australia, the CEO is prohibited from being the Chairperson of the company. The role of the CEO is to lead the senior management team in managing the enterprise, while the role of the Chairperson is to lead the board, one important responsibility of the board being to evaluate the performance of senior executives including the CEO. Combining the role of both the CEO and Chairperson removes an important check on the activities of the senior management. Besides, in large corporations, the job of the CEO as well as that of the Chairman is heavy and onerous and one person, however astute, may not be able to deliver what he is expected to, competently, efficiently and objectively. That is the reason why many authorities on corporate governance recommend strongly that the chairman of the board should be an independent director in order to “provide the appropriate counterbalance and check to the power of the CEO” (IFSA).9

Should the Board Have Committees?

Many committees on corporate governance have recommended in one voice the appointment of special committees for (i) nomination, (ii) remuneration and (iii) auditing. These committees would lessen the burden of the board and enhance its effectiveness. According to the Bosch Report, committees, apart from having written terms of reference outlining their authority and duties, “should also have clear procedures for reporting back to the board, and agreed arrangements for staffing including access to relevant company executives and the ability to obtain external advice at the company's expense.”10

Appointments to the Board and Directors' Re-election

As per the Company Law, shareholders elect directors to the Board. However, the shareholders are in great multitudes in large companies and also scattered, and to have them together to elect the directors will be expensive and time consuming. Therefore, in actual practice, in most cases, the board or its specially constituted committee selects and appoints the prospective director and get the person formally “elected” by the shareholders at the ensuing Annual General Body Meeting.

The shareholders in fact only endorse the board's nominee and it is only in rarest of rare cases that the shareholders refuse to ratify the board's nominees for directorship. There are other issues of corporate governance in relation to the boards' appointments such as appointment of a nomination committee, terms of office, duties, remuneration and re-election of directors' and composition of the board on which several committees have made their own recommendations.

Directors' and Executives' Remuneration

This is one of the mixed and vexed issues of corporate governance that occupied the centre stage during the massive corporate failures in the USA between 2000 and 2002. Executive compensation has also in recent times become the most visible and politically sensitive issue relating to corporate governance.

The Cadbury Report stressed that shareholders should be informed of all details pertaining to board remuneration, especially directors' entitlements, both present and future, and how these have been determined. Other committees on corporate governance have also laid emphasis on other related issues such as “pay-for performance”, heavy severance payments, pension for non-executive directors, appointment of remuneration committee and so on. “However, while controversy often surrounds the size or quantum of remuneration, this is not necessarily an issue of corporate governance—a payment that may be excessive in one context may be reasonable in another.” More important than the size and quantum of remuneration of top management, key issues of corporate governance would include (i) transparency; (ii) justifiability of the pay in the context of performance; (iii) the process adopted in determining it; (iv) severance payments and (v) non-executive directors' pensions.11

Disclosure and Audit

The OECD lays down a number of provisions for the disclosure and communication of “key facts” about the company to its shareholders. The Cadbury Report termed the annual audit as one of the corner stones of corporate governance. Audit also provides a basis for reassurance for everyone who has a financial stake in the company. Both the Cadbury Report and the Bosch Report stressed that the board of directors has a bounden responsibility to present to the shareholders a lucid and balanced assessment of the company's financial position through audited financial statements. There are several issues and questions relating to auditing which have an impact on corporate governance. There are, for instance, questions such as: (i) Should boards establish an audit committee; (ii) If yes, how should it be composed of; (iii) How to ensure the independence of the auditor; (iv) What precautions are to be taken or what are the positions of the state and regulators with regard to provision of non-audit services rendered by auditors; (v) Should individual directors have access to independent resource and (vi) Should boards formalize performance standards. These questions are being answered with different perceptions and with different degrees of emphasis by various committees and organizations that have gone into and analysed these issues in depth.

Protection of Shareholder Rights and Their Expectations

This is an important governance issue which has considerable impact on the rights and expectations of shareholders. Corporate practices and policies vary from country to country. There are a number of questions relating to this issue such as: (i) Should companies adhere to one-share-one-vote principle always; (ii) Should companies retain voting by a show of hands or by poll; (iii) Can shareholder resolutions be “bundled”, i.e. to place together before shareholders for approval a resolution that contains more than one discrete issue and (iv) Should shareholder approval be required for all major transactions. These questions have elicited answers with different emphasis from various committees and organizations that have addressed these issues.

Dialogue with Institutional Shareholders

The Cadbury Committee recommends that institutional investors should maintain regular systematic contact with companies, apart from their participation in general meetings of shareholders, use their voting rights positively, take a positive interest in the composition of the board of directors of companies in which they invest, and above all, recognize their rights and responsibilities as “owners” who should act in the best interests of those who have invested their money by influencing the standards of corporate governance and by bringing about changes in companies when necessary, rather than by selling their shares. If institutional investors have to exercise their rights and carry out their responsibilities, companies have to provide them the required information and facilities for doing so.

Making a Socially Responsible Corporate-investor's Role

This is an issue that highlights a conflict between two schools of thought. One school based on past experience contends that institutional investors should act in the best financial interests of the beneficiaries. This is based on the assumption that socially responsible behaviour of corporations such as ecological preservation, anti-pollution measures and producing quality and environment-friendly products always enhance costs and, thus, reduce profits. But there is another school of thought which asserts that environment friendliness and economic gains are not contradicting goals, but, on the other hand, these benefit corporations in the long run and cite the examples of Ford Motors, Johnson & Johnson, Pfizer and Dow Chemicals to prove their point. Much can be, and are being, said on both sides and though the last word is yet to be said on the issue, present thinking worldwide across continents and divergent societies strongly prefer corporations that are committed to the overall welfare of people in whose midst they work and make their gains.

The latest, revised OECD Principles place their thrust on six major areas of corporate governance: (i) They call upon governments to put in place an effective institutional and legal framework to support good corporate governance practices; (ii) They call for a corporate governance framework that protects and facilitates the exercise of shareholders' rights; (iii) They strongly support equitable treatment of all shareholders including minority and foreign shareholders; (iv) They recognize the importance of the role of stakeholders in corporate governance; (v) They stress the importance of timely, accurate and transparent disclosure mechanisms; and finally (vi) They deal with board structures, responsibilities and procedures. All issues of corporate governance, of course, emanate from and revolve around these six major thrust areas.

NEED FOR AND IMPORTANCE OF CORPORATE GOVERNANCE

Many large corporations are multinational and/or transnational in nature. This means that these corporations have impact on citizens of several countries across the globe. If things go wrong, they will affect many countries, albeit some more severely than others. It is, therefore, necessary to look at the international scene and examine possible international solutions to corporate governance difficulties.

Corporate governance is needed to create a corporate culture of consciousness, transparency and openness. It refers to a combination of laws, rules, regulations, procedures and voluntary practices to enable companies to maximize shareholders' long-term value. It should lead to increasing customer satisfaction, shareholder value and wealth. With increasing government awareness, the focus is shifted from economic to the social sphere and an environment is being created to ensure greater transparency and accountability. It is integral to the very existence of a company.

GOOD GOVERNANCE AND CORPORATE PERFORMANCE

Several studies in USA have found a positive relationship between corporate governance and corporate performance. That is, improved corporate governance is linked with improved corporate performance—either in terms of rise in share price or profitability. However, it would be overstating the case to say that these studies are conclusive, because other research has either failed to find a link or found it otherwise.

One difficulty in looking for statistical evidence of the value of good corporate governance is that governance is multi-dimensional. There are several different corporate governance mechanisms, which can interrelate with and, sometimes, substitute for one another.

There are strong signs that the world's business-ethical standards are becoming more stringent, and what constitutes good business practice is becoming clearer. Eleven years ago, Korn/Ferry International and the Columbia University Business School conducted a 20-country poll on 1,500 business executives. They were asked to look ahead and identify a list of the most important characteristics of the ideal corporate CEO for the year 2000. It was found that “ethics” was right at the top of the list. Not anywhere else, but right at the top. The Conference Board in New York, together with the Institute of Business Ethics in London, did similar studies in 1992, and found 84 per cent of responding U. S. firms had a corporate ethics code, followed by 71 per cent of UK firms and 58 per cent for the rest. The figure for UK grew particularly fast; 4 years earlier, it had been just 55 per cent. It seems that the business stress on ethics is a very Anglo-American phenomenon. As these two countries are arguably the trendsetters in the global economy, their way of doing business would eventually affect the rest of the world and, with innovations and modifications to suit different countries and markets, could even become the global norm.

In India too, there are several examples to illustrate the positive relationship between corporate governance and corporate performance, though this is the case with fewer companies and there is a long road to traverse for the entire Indian corporate sector as such. Among companies that have shown commendable success after introducing internationally acclaimed corporate governance practices are: Infosys Technologies Ltd that has consistently enhanced its performance and is a forerunner in espousing global governance standards; Tata Steel which is recognized and rewarded not only in India but also globally for its excellent corporate performance and equally commendable social commitment and activism; Reddy's Lab which has excelled in all the important dimensions of corporate governance. There are several other groups of companies belonging to the Tatas, Birlas, Murugappa's, etc. in the private sector and the oil companies in the public sector that have done India proud in the sphere of corporate governance.

INVESTORS' PREFERENCE

A recent large-scale survey of institutional investors found that a majority of investors consider governance practices to be at least as important as financial performance when they are evaluating companies for potential investment. Indeed, they would be prepared to pay a premium for the shares of a well-governed company compared to a poorly governed company exhibiting familiar financial performance. In the United States and the United Kingdom, the premium was 18 per cent while it was 27 per cent for Italian and 27 per cent for Indonesian companies.12 Likewise, a survey by Pitabas Mohanty (Institutional Investors and Corporate Governance in India) has revealed that companies with good corporate governance records have actually performed better as compared to companies with poor governance records “and institutional investors have extended loans to them easily”. Another similar survey of institutional investors, globally, has also revealed governance to be an important factor in investment decision making.

SIGNIFICANCE TO DEVELOPING COUNTRIES

Just as several developing countries are undergoing a process of economic growth, they are also witnessing a transformation in political and business relationships with regard to their industrial and commercial organizations, both in the private and public sectors. Economic and political compulsions are forcing them to move away from the hitherto closed, market unfriendly, undemocratic setups to open, transparent, market-driven democratic systems. If they have to sustain long-term economic growth and development in such a situation, it is important that they establish good corporate governance mechanisms and practices that will enable their organizations realize maximum productivity and economic efficiency. Corporate governance systems and practices also will help them fight effectively corruption and abuse of power that are rampant in such societies and help them establish a system of managerial competence and accountability.

Nicolas Meisel has identified four priorities the developing countries should concentrate on when they put new forms of public and corporate governance into practice. These are: (1) Since good and effective communication is a desideratum for the efficient functioning of any organization, they should not only enhance the quality of information, but also ensure that it is created fast and reaches the public speedily; (2) Ensure individual players maximum autonomy whilst seeing that they are accountable for their acts; (3) If there is a hierarchical setup to regulate private sector activities with a view to promoting public interest, new countervailing powers should be set up to fill this role; and (4) The role of the state and how government officials are appointed to carry out the role should be clearly defined in the interest of sustainable development.13

Benefits to Society

Corporate governance brings the following benefits to the society:

  1. A strong and vibrant system of corporate governance can be a boon to society. Even in developing countries where stocks of most firms are not actively traded, adopting transparent standards towards investors and creditors is a major benefit to all stakeholders, besides preventing systemic banking crises.
  2. Research has proved that in countries where strong corporate governance practices prevail, minority shareholders are protected and highly liquid capital markets emerge. Most companies in countries with poor laws, legal traditions and weak regulatory systems are controlled by dominant investors rather than a widely dispersed ownership structure. Hence, countries that require funds from foreign and domestic investors need to adopt corporate governance practices.
  3. Many economists and management experts point out that competition both in product markets and factor markets, especially for capital, prevents unacceptable corporate behaviour and promotes good corporate governance. In many developing countries where barriers exit, competition is quite limited. This emphasizes the importance of adopting the best possible corporate governance systems in developing and emerging economies where the market system is weak or yet to take a proper shape. For instance, several Indian corporations that seek billions of dollars of foreign investments are prompted to put in their best corporate behaviour for that purpose.
  4. Corporate governance is an effective instrument to eradicate corruption. In many developing economies this is a very tough subject to deal with, as corruption is very much deep-rooted in the system. Fighting it could arouse political sensitivities and cause legal action. Good governance that envisages ethical and legal practices can help in overcoming corruption and malfeasance.
  5. Better corporate governance practices and procedures help in managing the firm better, especially in setting company strategy and the like. It would also ensure that the companies resort to mergers and acquisitions more for strategic business reasons than for flimsy grounds. Likewise, it would ensure that the compensation systems match the performance of the individuals.
  6. Good corporate governance also ensures better management structures and systems. In many developing countries, promoters are directly involved in the management of the firms they help to promote. For example, throughout Latin America and parts of Asia including India, promoter families have been dominating business enterprises. However, in the wake of globalization and the increasing integration of regional markets, this trend is now changing. Nowadays, firms in these countries increasingly adopt modern management strategies, techniques and financial accounting systems. These changes inevitably lead to delegation of authority, increased attention to HR policies and use of modern management information systems, instead of the erstwhile centralized decision-making structures.

Benefits to Corporations

Good corporate governance secures an effective and efficient operation of a company in the interest of all stakeholders. It provides assurance that management is acting in the best interest of the corporation; thereby contributing to business prosperity through openness in disclosures and accountability. While there is only limited evidence to link business success to good corporate governance, good governance enhances the prospect for profitability. The key contributions of good corporate governance to a corporation include:

  1. Creation and enhancement of a corporation's competitive advantage: Competitive advantage grows naturally when a corporation or its services facilitate the creation of value for its buyers. Creating competitive advantage requires both the vision to innovate and the strategy to manage the process of delivering value. An effective board should be able to craft strategies that fit the business environment of the corporation and are flexible to accommodate opportunities and threats, and to compete for the future. Corporations which develop their strategies by involving all levels of employees create widespread commitment to make the strategies succeed. Practical examples of strategies that create value to corporations are sales and marketing strategies, customer base and branding strategies. Coca-Cola projects American values to its customers worldwide. Sony is reputed for the invention of new products. Johnson & Johnson and Procter & Gamble are world renowned as the largest manufacturers of quality personal hygiene products.
  2. Enabling a corporation perform efficiently by preventing fraud and malpractices: The code of best practice—policies and procedures governing the behaviour of individuals of a corporation—form part of corporate governance. This enables a corporation to compete more efficiently in the business environment and prevents frauds and malpractices that destroy business from inside. Failure in management of best practice within a corporation has led to crises in many instances. The Japanese banks that made loans to property developers that created the bubble economy in the early 1990s; the foreign banks which granted loans to state-owned enterprises that became insolvent after the Asian financial crisis in 1997; and the demise of Barings are examples of managements not governing the behaviour of individuals in the corporation leading to their downfall.
  3. Providing protection to shareholders' interest: Corporate governance is a set of rules that focuses on transparency of information and management accountability. It imposes fiduciary duty on management to act in the best interests of all shareholders and properly disclose operations of the corporation. This is particularly important when ownership and management of an enterprise are in different hands, as these are in corporations.
  4. Enhancing the valuation of an enterprise: Improved management accountability and operational transparency fulfil investors' expectations and confidence on management and corporations, and in return, increase the value of corporations.
  5. Ensuring compliance of laws and regulations: With the development of capital markets and the increasing investment by institutional shareholders and individuals in corporations that are not controlled by particular shareholders, jurisdictions around the world have been developing comprehensive regulatory frameworks to protect investors. More rules and regulations addressing corporate governance and compliance have been and will be realized. Compliance has become a key agenda in establishing good corporate governance. After all, corporate governance ensures the long-term survival of a corporation.

The latest, revised OECD Principles, place their thrust on six major areas of corporate governance. (i) They call upon governments to put in place an effective institutional and legal framework to support good corporate governance practices; (ii) They call for a corporate governance framework that protects and facilitates the exercise of shareholders' rights; (iii) They strongly support equitable treatment of all shareholders including minority and foreign shareholders; (iv) They recognize the importance of the role of stakeholders in corporate governance; (v) They stress the importance of timely, accurate and transparent disclosure mechanisms; and finally (vi) They deal with board structures, responsibilities and procedures. All issues of corporate governance, of course, emanate from and revolve around these six major areas.

THE INDIAN MODEL

Indian corporations are governed by the Company's Act of 1956 that follows more or less the UK model. The pattern of private companies is mostly that of closely held or dominated by a founder, his family and associates. Available literature on corporate governance and the way companies are structured and run indicate that India shares many features of the German/Japanese model, but recent recommendations of various committees and consequent legislative measures are driving the country to adopt increasingly the Anglo-American model. In terms of the legislative mechanisms, Indian government and industry constituted three committees to study corporate governance practices in the country and suggested measures for improvement based on what was globally recognized as “best practice”. Significantly, most of the recommendations of the three committees— the SEBI-appointed Kumar Mangalam Birla Committee (2000), the Government-appointed Naresh Chandra Committee(2003) and the SEBI's Narayana Murthy Committee—are remarkably similar to those of England's Cadbury Committee and America's Sarbanes– Oxley Act, in terms of their approaches and recommendations.

The thrust of the legislative reforms suggested by these committees and subsequent legislative actions adopted revolve around the strengthening of external governance mechanisms. This would call for greater transparency of company accounts and their certification by independent auditors. Investors would have access to these transparent accounts, as envisaged the Anglo-American model. Investors continuing to remain in the company or quitting it will depend on the availability of accurate and reliable information. “Institutional reforms, including a strengthening of oversight committees and the development of a serious fraud office, are further evidence of the drive to seek external monitoring of corporate affairs.” With regard to reforms in internal mechanisms as in the case of board of directors it was recommended that non-executive directors should be given greater role, while checking the growth of non-executive directors, as seen in the Anglo-American practice.14

Further, experts point out that India has adopted the key tenets of the Anglo-American external and internal control mechanisms, in the wake of economic liberalization and its integration into the global economy. In the sphere of legislative framework, for instance, Indian government and regulators have been following more or less the recommendations of English and American committees on corporate governance. Moreover, a small number of high-profile Indian companies have adopted on their own, mainly with a view to approaching international markets, the Anglo-American protocols on corporate governance.15 Thus, corporate governance developments in India in recent years show a paradigm shift from the German/Japanese model to the Anglo-American model.

There are primary distinctions between the three broad models of corporate governance, and within them the actual practices adopted by companies vary considerably. There is no one preferred model or set of corporate governance mechanisms. Moreover, ideas and practices are evolving fast in many countries. In the Anglo-American model, all directors participate in a single board, comprising both executive and non-executive directors, in varying proportions. In the German model, there are two boards, of which the upper board supervises the executive board on behalf of stakeholders, and is societal-oriented. In this model, though the shareholders own the company, they do not entirely dictate the governance mechanism. They elect 50 per cent of the upper board, while the other 50 per cent is appointed by labour unions, giving employees a share in the governance of the company. In the Japanese model, shareholders and the main lending bank together appoint the President and the board of directors. The main bank has a substantial stake in the equity capital of the company. Indeed, given the entrance of high calibre directors with relevant experience, appropriate board leadership and a shared vision for the company's future, each of the models can prove effective, provided they are consistent with the overall corporate governance infrastructure in that country.

These various governance systems form a package of overall corporate control in each company law jurisdiction. It is vital to see the package as a whole. There has to be an integrated harmony between state legislation and regulatory infrastructure, stock market regulation and corporate self-regulation. Moreover, the overall corporate governance package has to be consistent with the way that business is done and the reality of relationships in that culture.

History

In India, the real history of Corporate Governance dates back to the year 1992, following efforts made in many countries of the world to put in place a system suggested by the Cadbury Committee. The Corporate Governance movement in India began in 1997 with a voluntary code framed by the Confederation of Indian Industry (CII). In the next three years, almost 30 large listed companies accounting for over 25 per cent of India's market capitalization voluntarily adopted the CII code. This was followed by the recommendations of the Kumar Mangalam Birla Committee set up in 1999 by SEBI culminating in the introduction of Clause 49 of the standard Listing Agreement to be complied with all the listed companies in stipulated phases. The Kumar Mangalam Birla Committee divided its recommendations into mandatory and non-mandatory. Mandatory recommendations included such issues as the composition of board, appointment and structure of audit committees, remuneration of directors, board procedures, additional information regarding management, discussion and analysis as a part of the annual report, disclosure of directors' interest, shareholders' rights and the compliance level of corporate governance in the annual report. From 1 April, 2001, over 140 listed companies accounting for almost 80 per cent of market capitalization were to follow a mandatory code which was in line with some of the best international practices. By April 2003, every listed company followed the SEBI code.

  1. The Companies Amendment Act, 2000: Many provisions relating to corporate governance such as additional ground of disqualification of directors in certain cases, setting up of audit committees, Directors' Responsibility Statement in the Directors' Report, etc. were introduced by the Companies (Amendment) Act, 2000. Corporate governance was also introspected in 2001 by the Advisory Group constituted by the Standing Committee on International Finance Standards and Codes of the Reserve Bank of India under the chairmanship of Y.V.Reddy, the then Deputy Governor.
  2. Naresh Chandra Committee, 2002: In the year 2002, a high level committee was appointed to examine and recommend drastic amendments to the law involving the auditor client relationships and the role of independent directors by the Department of Company Affairs in the Ministry of Finance & Company Affairs under the chairmanship of Naresh Chandra.
  3. Narayana Murthy Committee, 2003: The Company Law Amendment Bill, 2003 envisaged many amendments on the basis of reports of the Naresh Chandra Committee and subsequently appointed the N R Narayana Murthy Committee. Both the Committees have done an excellent job to promote corporate governance practices in India.
  4. J. J. Irani Committee Report on Company Law, 2005: The Government of India constituted an Expert Committee on Company Law on 2 December, 2004 under the Chairmanship of J. J. Irani. Set up to structurally evaluate the views of several stakeholders in the development of company law in India in respect of the concept paper promulgated by the Union Ministry of Company Affairs, the J. J. Irani Committee has made suggestions to reform and update the basic corporate legal framework essential for sustainable economic reform.

Recommendations of the J. J. Irani Committee

  • One-third of the board of a listed company should comprise independent directors.
  • Allow pyramidal corporate structures that is, a company which is a subsidiary of a holding company could itself be a holding company.
  • Give full liberty to the shareholders and owners of the company to operate in a transparent manner.
  • The new company law should recognise principles such as ‘class actions’ and ‘derivative action’. There are proposals to devise an exit option for shareholders who have stayed with a company and not participated in a buy back scheme implemented earlier.
  • Introduce the concept of One Person Company (OPC) as against the current stipulation of at least two persons to form a company
  • Allow corporations to self-regulate their affairs.
  • Mandate publication of information relating to convictions for criminal breaches of the Companies Act on the part of the company or its officers in the annual reports provide stringent penalties to curb fraudulent behaviour of companies.
  • Disclose proper and accurate compilation of financial information of a corporation.
  • The history of corporate governance gives us an unforgettable lesson that vigilance and a continuing effort at building and strengthening it alone will give the investors the safetynet they require.

Clause 49

What Is Clause 49?

The Securities and Exchange Board of India monitors and regulates corporate governance of listed companies in India through Clause 49. This clause is incorporated in the listing agreement (LA) of stock exchanges with companies and it is compulsory for them to comply with its provisions. Stock exchanges endeavour to bring in corporate governance standards among companies by the introduction of Clause 49 in the listing agreement they enter into with them before they are being listed. SEBI issued Clause 49 in February 2000. All Group A companies had to comply with its provisions by 31 March, 2001. All other listed companies with a minimum paid-up capital of INR 100 million and net worth of INR 250 million had to comply by 31 March, 2002 and the remaining listed companies with a minimum paid-up capital of INR 30 million or net worth of INR 250 million had to comply by 31 March, 2003.

Subsequently, on 29 October, 2004 SEBI amended the original Clause 49 and issued a new Clause 49. All existing listed companies will have to comply with the provisions of the new clause by 1 April, 2005. However, it has already come into force for companies that have been listed on the stock exchange after 29 October, 2004.

Provisions and Requirements of Clause 49

The provisions and requirements of Clause 49 are as follows:

  • Composition of board: The board should be composed of in the following manner: In case of full time chairman, 50 per cent non-executive directors and 50 per cent executive directors.
  • Constitution of the audit committee: The Audit Committee should have three independent directors with the chairman having a sound financial background. The finance director and the head of the internal audit should be special invitees and a minimum of three meetings should be convened every year.
  • Audit committee: The Audit Committee is responsible for review of financial performance on half yearly/annual basis; appointment/removal/remuneration of auditors; review of internal control systems and its adequacy.
  • Remuneration of directors: Remuneration of non-executive directors is to be decided by the board. Details of remuneration package, stock options and performance incentives of directors should be disclosed to the shareholders.
  • Board procedures: The Board should have at least four meetings a year. A director should not be a member of more than 10 committees and chairman of more than 5 committees across all companies.
  • Management discussion and analysis report: It should include industry structure and developments; opportunities and threats; segment-wise or product-wise performance; outlook on the business; risks and concerns; internal control systems and its adequacy; discussion on financial performance and disclosure by directors on material, financial and commercial transactions with the company.
  • Shareholders information: The company should provide a brief resume of new/re- appointed directors, quarterly results to be submitted to stock exchanges and to be placed on Web site, presentation to analysts. Shareholders'/Investors Grievance Committee under the chairmanship of independent director; should have a minimum of two meetings a year. Report on corporate governance and a certificate from auditors on compliance of provisions of corporate governance as per Clause 49 in the listing agreement.
  • Nominee directors to be independent directors: Nominees of institutions that have invested in or lent to the company are deemed as independent directors.

New provisions incorporated in the new Clause 49

The board will lay down a code of conduct for all board members and senior management of the company to follow compulsorily.

The CEO and CFO will certify the financial statements and cash flow statements of the company. At least one independent director of the holding company will be a member of the board of a material non-listed subsidiary. The audit committee of the listed company shall review the financial statements of the unlisted subsidiary, in particular its investments.

If while preparing financial statements, the company follows a treatment that is different from that prescribed in the accounting standards, it must disclose this in the financial statements, and the management should also provide an explanation for doing so in the corporate governance report of the annual report.

CEOs' accountable for companies risk systems: Inspired by Sarbanes–Oxley Act, Clause 49 of listing agreement was scheduled to come into effect from 1 April, 2005. However bowing to demand from corporations, SEBI decided in the Board meet held on 23 March, 2005 to defer the implementation of Clause 49 till 31 December of the same year to provide listed entities, including public sector companies, time to appoint adequate number of independent directors and comply with norms. No special concession is to be extended to state-owned enterprises which demanded exemption on this issue. SEBI felt that PSUs are not looked upon as special class of companies. Under the new provisions, Chief Executive Officers (CEOs) and Chief Financial Officers (CFOs) in the country are preparing for a litmus test. Beginning 31 December, all CEOs and CFOs will embark on massive documentation to meet the requirements of Clause 49 of SEBI's listing agreement.

Rules of the game: CEOs, CFOs to be directly responsible for risk management (Provision 4C), internal control systems (Sec 5); Clause 49 is largely derived from the Sarbanes–Oxley Act; Companies seek legal advice, tap consultants to adopt new standards; Want clarity on “material’ association of independent directors; Fear new norms will lead to shortage of independent directors; Companies will have to spend more time and money on compliance.

Banks and Corporate Governance

Banks in India as corporations is as much required to be governed under corporate governance norms as other firms. Additionally, they are also covered under the internationally followed Basel Committee norms.

The Basel Committee norms relate only to commercial banks and financial institutions. Banking and financial institutions stand to benefit only if corporate governance is accepted universally by industry and business, with whom banks and financial institutions have to interact and deal with. SEBI only partially attends to this need.

Realizing the importance of corporate governance to banks which are highly leveraged entities whose failures would pose large risks to the entire economic system, the Reserve Bank of India formed an Advisory Group on Corporate Governance that submitted its report in 2001 and another called the Consultative Group of Directors of Banks/Financial Institutions (known as the Ganguly Committee) which submitted its report in 2002. The Reserve Bank of India, after due deliberations of both these reports, acted on their recommendations that have considerably strengthened corporate governance mechanism in banks.

Establishment of the Serious Fraud Office

The Department of Company Affairs has set up a Serious Fraud Office (SFO) as part of a new push to crack down on company fraud and improve corporate governance. The SFO will investigate economic crimes such as bribery by companies trying to win lucrative deals. The SFO which is to be part of the Department of Company Affairs will investigate company finances and prosecute them in cases where there has been violation of corporate laws. The establishment of the SFO has come as part of a general climate of change in corporate governance in India with a view to promoting better corporate governance practices in India in partnership with the Confederation of Indian Industry, Institute of Company Secretaries of India and the Institute of Chartered Accountants of India. The government has set up a National Centre for Corporate Governance as a joint initiative with the private sector. A committee is also recently commissioned to examine how to make the country's businesses more transparent.

The SFO will pass the case on to other authorities if there is evidence that other laws, such as banking laws or tax laws, have been broken.16

A Performance Appraisal

It is over a decade that the concept of corporate governance has become a passion with industry analysts in India. It has long passed the stage of being a fashion statement that it was in early 1990s, as its ideals having been propagated as the be-all and end-all of all corporate endeavour in the aftermath of economic liberalization in the country on one hand, and the then newly publicized Cadbury Report, on the other. All these got irretrievably intermixed to give the concept an aura and a halo. Now, after more than a decade down the line and with a lot of studies and in-depth research having been done by several committees, a reality check and analysis throw up a lot of somewhat unpalatable home truths.

Indian industry has come a long way since 1991. There has been a phenomenal growth both in the quality and number of corporations in the country. Some of them are implanting their footprints abroad and some worldwide objective research has shown that our corporations, albeit small in number, are second to none in terms of corporate governance standards. Companies like Infosys are on top of the heap. If the American capital market regulator, SEC, commend Infosys' balance sheet as a role model to be emulated by US companies, it speaks volumes about our better governed corporations.

Sixty-three companies were short-listed for the conferment of the Government of India's Award for Excellence in Corporate Governance for the period 1999 to 2001. The list was prepared on the bases of certain corporate governance criteria such as (i) Governance structure, which includes composition of the board and committees of the board; (ii) Disclosures in the annual report, which covers statutory disclosures and non-statutory disclosures; (iii) Timeliness and content of information to the investors and the public, which take into account compliance with the Listing Agreement with the concerned stock exchange, contents on Web site and grievance resolution ratio and (iv) Enhancement of shareholder value determined on the basis of share prices and return on net worth. These 63 corporations represent only a sample and this list is not exhaustive to cover all companies that are worthy enough for being short-listed. This implies that there are a sizeable number of corporations in the country that make serious efforts to adopt better corporate governance standards.

There is another perspective to the issue of the Indian corporate sector's ernest attempt to put in place corporate governance practices. According to Tata Sons executive director, R. Gopalakrishnan, Indian firms have spent INR 8,000 million so far on corporate governance. “In the last three years, the money paid to auditors has jumped to INR 8,000 million from INR 4,000 million. This, I would say, is arguably the cost of corporate governance.” He pointed out that industry groups like the Tatas and Birlas believed in the trusteeship concept of wealth.17

Viewed from another angle, if many Indian industries are recognized across the world, it is also due to the image they have been projecting as successful corporations with good governance systems. In that sense the Indian industry seems to have arrived. Two Indian companies—Infosys and Reliance Industries—are among the 44 global strategic partners, which are contributing their expertise and resources to the organization of the Annual Meeting of the World Economic Forum 2005. Infosys Chairman and Chief Mentor, N. R. Narayana Murthy is also one of the co-chairs in this prestigious annual event of the WEF held in Devos, Switzerland.18

Performance Appraisal of Indian Corporations

Corporate governance seems to have favourably impacted only a handful of corporations whose leaders imbued with its lofty ideals have taken them to such heights, while others have done nothing but cosmetic changes in the governance of their companies and seem to have satisfied themselves with their meagre attempts. Let us go into the details:

In the beginning of 2004, as part of the joint World Bank–IMF sponsored programme called the Report on the Observance of Standards and Codes, a corporate governance country assessment for India was carried out. The purpose of the Report was to know to what extent Indian corporations practised corporate governance vis-à-vis the OECD principles of corporate governance (2004), considered a benchmark in this area by the World Bank.19

The report evaluated India's compliance with each of the OECD benchmarked principles of corporate governance. The compliance level was placed into five classifications, namely, (i) “observed”, (ii) “largely observed”, (iii) “partially observed”, (iv) “materially not observed” and (v) “not observed”. Out of 23 OECD principles, Indian corporations have been found to be observing 10, while 6 were “largely observed’. Another six were placed under “partially observed” category, while one was said to be “materially not observed”.20

The assessment team had found Indian corporations “materially not observing” one category of OECD principle that concerns facilitating all shareholders, including institutional shareholders, to exercise their voting rights. As per this principle, institutional shareholders are called upon to disclose their voting policy, explain when they act in a fiduciary capacity, and how they manage material conflicts of interest that may affect exercise of their key ownership rights.

Table 28.1 presents a chart of the relevant OECD principles and the areas where the assessment team found Indian corporations to be only “partially observant”.

The Report has made several policy recommendations, if a principle is less than fully observed. The following are some of the important policy recommendations:

  1. Need for sanction and enforcement: The success or otherwise of a policy is not only the degree of compliance, but also deterrent penalty provided for non-compliance. The existing provisions on sanctions in the Companies Act for violation of law are said to be inadequate, especially the measly fines imposed. If corporations are expected to carry out their business practices within the applicable laws and regulations, credible deterrents should also be there to impose sanctions and enforcements for non-compliance. The legal system should ensure that business practices are synchronized with the legal and regulatory framework, especially in relation to party transactions and insider trading.
  2. Need for clear demarcation of controls: Presently, the Indian regulatory framework distributes the responsibility of oversight of listed companies to three different quasi-legal agencies, namely, the Department of Corporate Affairs (DCA), the stock exchanges and SEBI. The lack of clear demarcations of regulatory bodies and their functions leads to overlapping of controls and makes it possible for violators to play one against the other. The fragmented structure also leads to regulatory arbitrage and weaken enforcement. Considering the enormous size of India's capital market, it is necessary to review this three-tiered supervision system and clearly demarcate the responsibility of each regulator. To avoid the multiplicity of the regulatory system, SEBI could be made the sole capital market regulator with powers of investigation and award of penalty for violators.
  3. Lack of professionalism of directors: It is too well known that many Indian directors lack professionalism. Directors should improve their knowledge and skill. If boards are expected to be professional and competent, they must have a clear understanding of what is expected of them. Director training institutes can play a key role and expand the pool of competent potential candidates for directorship.

     

    Table 28.1 Areas Where Indian Companies are “Partially Observant” of the OECD Principles

    OECD principles Partial observance by Indian corporations
    Shareholders should be treated without discrimination There is a grievance redressal mechanism available and shareholders can approach SEBI, the Company Law Board or the Investors Grievance Committee of concerned stock exchanges for redress of grievances. However investors lack faith in the efficacy of legal remedies.
    Insider trading to be prohibited Though as per Indian law insider trading is a criminal offence, the enforcement is weak and ineffective.
    Board/managers should disclose interests in corporations they manage Misuse of corporate assets and abuse in related party transactions are common and have not been effectively tackled.
    Mechanism for redressal for violation of stakeholders' rights Redressal for violation of shareholders rights can be sought in civil and high Courts, but the Indian judiciary is well known to be slow and lethargic.
    Annual Independent audit, a necessity Auditors in India do provide consulting service to the auditee company depending on the level of audit fee, but lengthy disciplinary proceedings are common.
    The Board should exercise objective judgement Multiple board membership is common and it affects board performance. Special training is required for audit committee members as some of the member-directors may lack knowledge of accounts and company finance.

    Source: Adapted from Dilip Kumar Sen, “A Report Card That Does Not Impress”, The Hindu Business Line, 27 January, 2005. Reproduced with permission.

     

  4. Role of institutional investors: Institutional investors acting in a fiduciary capacity do not play effective role. They should be made to form a comprehensive corporate governance policy, including voting and board representation. There have been several instances in the Indian corporate history wherein thousands of poor investors have lost their hard-earned money, because the institutional nominees on the boards did not play other roles honestly.
  5. Indian boards exhibit poor professionalism: The corporate governance reforms in India have been mostly on paper. This is very much reflected in the fact that most of the so-called “independent directors” are nominated by the promoter groups in whose Boards they are supposed to sit and help take independent and unbiased decisions!
      An analysis by L.C. Gupta and his team of researchers shows that a vast majority of the Indian listed companies have destroyed shareholder value. Whether or not a company has given proper attention to the interest of shareholders would ordinarily get reflected in two indicators of shareholders' return, viz., dividends and capital appreciation.21
    • The study shows that the great majority of Indian listed companies have, in fact, destroyed shareholder value;
    • Instead of severely punishing the guilty corporate managements, the Indian authorities let them go scot free.

    Indian directors give only a lip service to corporate governance practices, as pointed out by Dilip Kumar Sen in his article quoted earlier. In India, like most other developing countries, corporations are managed as if they are CEO's personal properties. They are not concerned much about the welfare of all stakeholders, but care only about the interest of the principal shareholders. It is also a fact that many directors do not know that they are agents of shareholders and that they hold a fiduciary responsibility, apart from a position of trust and faith. Participation of non-executive directors in the board or its committee's meetings is inversely proportional to the health of the bottom line. If the bottom line is more attractive, lesser is the participation by them.

    Most directors of companies do not consider it their duty and responsibility to update their knowledge and understanding about the changes in laws and regulations that have been introduced or the business model or current strategy of the company in which they are directors. If the company performed well financially, refusal to approve or object to any proposal of managements is considered incorrect and inappropriate.

  6. Independent directors are not so independent: Independence of independent directors seems to be only on paper. Most of the independent directors are hand-in-glove with the promoters. They rubber-stamp questionable decisions of promoters and ignore fund diversion and mismanagement in their companies. In several top companies, there are people who have remained as independent directors for as many as 20–30 years. In Reliance industries, for example, these directors remained silent when the company made massive investment in other unlisted companies. A SEBI panel tried to stop this practice and proposed a limit (9 years) on their tenure. But Indian corporate bigwigs ‘intervened” and lobbied for changes finally, the limit is now with prospective effect.22

Sen continues to assert that non-executive directors do not consider themselves as watch-dogs of shareholders. According to him, Board rooms are generally filled up with “yes” men who do not raise relevant questions and give their assent to all proposals put up by the management. It is a well-established fact that in the Indian corporate sector, a person is invited to become a non-executive director only if he/she enjoys the patronage of the Chairman/CEO through old school connection or social circuit or golf club.

With regard to nominee directors, it is seen that they too play a passive role at meetings except during a crisis. This has been proved time and again, when an objective analysis of corporate failures is made. It has also been observed by objective observers that in the Indian corporate sector what you preach on corporate governance you need not necessarily practice in the company you manage. It is always for the other people. However, the same passive directors can become extremely vocal and are found to raise uncomfortable questions when the performance of the company is poor. In India it is a tragedy that non-executive directorships are considered more as a symbol of social status and connections than as a position of responsibility.

A couple of years after Indian corporations tom-tommed the virtues of good corporate governance practices, the revelations at Reliance, the country's largest private sector company and later on at Satyam Computers, show that a lot still needs to be done. To be sure, corporate governance levels have improved in the last 5 years, but Indian industry still finds itself on the opposing side.23

In addition to what is revealed in the World Bank–IMF sponsored Report, there are several other weaknesses that can be pointed out about the functioning of the Indian corporate sector. Some of the weaknesses are:

  1. Lack of a whistle-blower policy: Last year, SEBI had proposed that a whistle-blower policy should be made mandatory. However, after stiff resistance from the industry, it asked the N. R. Narayana Murthy panel to rework the policy. Later, the whistle-blower policy was made optional for companies.
  2. Unlisted investment companies: This is the most confusing part of Indian Industry and one that companies will protect tooth and nail. Companies and promoters have promoted thousands of unlisted subsidiaries. Many of them divert funds through these companies. The modus operandi: The listed company will give a loan (even interest-free) to these unlisted companies, which, in turn, will default repayment. A major chunk of these investment companies hold shares in their listed companies. In fact, promoters have floated several layers of such subsidiaries to hold their stakes in leading group companies. Most of corporate India, including the Tatas, Birlas and Reliance, follow this practice.
  3. Accounting gimmicks: While there are some gaps in financial statements, corporate sources claim “We are now pretty close to the global best practices.” But this has to be taken with a pinch of salt. For instance, a study by CRISIL reclassified and sanitized the annual accounts of 616 manufacturing companies. It restated the accounts of 243 companies and showed that their actual profits are different from what they had reported. Simply put, their books were cooked.24
  4. Poor shareholder participation: Corporate misgovernance in India would not have gone thus far and promoter families would not have ruled the roost this much, had there been a well-directed shareholder activism. The Indian investors, more than counterparts elsewhere, are scattered, unorganized, mute and uninterested in the affairs of the company they have invested in, except for the dividends and all other annual gifts doled out to them. They give their consent most obligingly enabling unscrupulous managements to perpetrate their dynastic rule with glee and making corporate democracy a sham. Voices of dissent are few and rarely recorded. The worst part of it is that even large institutional shareholders rarely record their dissent, and if they found board decisions and practices unacceptable they simply sell their securities and quit, rather than fight and help establish better governance practices. No wonder there has been a sizable erosion of investor confidence in the country with every scam coming to light.
  5. Obliging Auditors: Another weak link in the wobbling chain of corporate governance in the country is that of the auditing profession. Obliging auditors help companies in window-dressing, manipulation of profit and loss accounts, hedging and fudging of unexplainable expenditures and resorting to continuous upward evaluation of assets to conceal poor performance. It is common knowledge that there is a dire need for independent auditors who are reputed and above board. Due to distrust in Indian auditors, most of the multinational companies in India have insisted on their parent companies' auditors also audit their subsidiaries in the country. Things have started improving with the Institute of Chartered Accountants of India insisting on the profession adopting improved accounting practices, but there is a lot to be achieved.25
  6. Other Problems: There are, of course, several other problems in the country's capital market that are responsible for the poor record of corporate governance in the country. It has been mentioned earlier and it requires repetition in this context. A soft state, a lethargic and slow-moving judicial system, a value system that is indifferent to moral turpitudes, an inefficient market regulator and poor enforcement of rules and regulations have all combined together to ensure that though the ideal of corporate governance is kept on a high pedestal, it is only occasionally put into practice.

Impetus for the Growth of Corporate Governance in India

Although corporate governance has been slow in making its mark in India, the next few years will see a flurry of activity. This will be driven by several factors:

  1. Competition-driven: Most important, is the force of competition. With the dismantling of licenses and controls, reduction of import tariffs and quotas, virtual elimination of public sector reservations, and a much more liberalized regime for foreign direct and portfolio investments, Indian companies have faced more competition in the second half of the 1990s than they did since independence. Competition has forced companies to drastically restructure their ways of doing business.
  2. New players' professionalism: Many companies and business groups that were on the top of the pecking order in 1991 have been relegated to the bottom. Simultaneously, new aggressive companies have clawed their way to the top. Therefore, they are more than willing to have professional boards and voluntarily follow disclosure standards that measure up to the best in the world.
  3. Growth in market capitalization: There has been a phenomenal growth in market capitalization. This growth has triggered a fundamental change in mindset from the earlier one of appropriating larger slices of a small pie, to doing all that is needed to let the pie grow, even if it involves dilution in share ownership.
  4. Foreign portfolio investors: One cannot exaggerate the impact of well-focused, well-researched foreign portfolio investors. These investors have steadily raised their demands for better corporate governance, more transparency and greater disclosure. Over the last 2 years, they have systematically increased their exposure in well-governed firms at the expense of poorly run ones.
  5. Media influences: India has a strong financial press, which will get stronger with the years. In the last five years, the press and financial analysts have induced a level of disclosure that was inconceivable a decade ago. This will increase and force companies to become more transparent—not just in their financial statements but also in matters relating to internal governance.
  6. Influence of banks and financial institutions: Despite serious lacunae in Indian bankruptcy provisions, neither banks nor financial institutions (FIs) will continue to support managements irrespective of performance. Already, the more aggressive and market-oriented FIs have started converting some of their outstanding debt to equity, and setting up merger and acquisition subsidiaries to sell their shares in under-performing companies to more dynamic entrepreneurs and managerial groups. This will intensify over time, especially with the advent of universal banking.
  7. Realization of the benefits of corporate governance: Ultimately, Indian corporations have appreciated the fact that good corporate governance and internationally accepted standards of accounting and disclosure can help them access the US capital markets. Until 1998, this premise existed only in theory. It changed with Infosys making its highly successful NASDAQ issue in March 1998. This was followed by five more US depository issues—ICICI (which is listed on NYSE), Satyam, Infosys, Rediff and WIPRO. There are several companies presently gearing up to issue US depository receipts, and all of them will get listed either at NYSE or at NASDAQ. This trend has had two major beneficial effects. First, it has shown that good governance pays off, and allows companies to access the world's largest capital market. By the latest count, external commercial borrowings of Indian corporations (ECBs) during the financial year 2009–10 during September 2009–January 2010 amounted to USD 9.1 billion, apart from an equivalent amount of FDI inflows.26 Second, it has demonstrated that good corporate governance and disclosures are not difficult to implement—and Indian companies can do all that is needed to satisfy US investors and the SEC. The message is now clear: it makes good business sense to be a transparent, well-governed company, incorporating internally acceptable accounting standards.
  8. Impending full capital account convertibility: Moreover, in a few years India will move to full capital account convertibility. When that happens, an Indian investor will seriously consider whether to put his funds in an Indian company or to place it with a foreign mutual or pension fund. That kind of freedom will be the ultimate weapon in favour of good corporate governance. Thankfully for India, the companies that matter have already seen the writing on the wall. Thus, it may not be wrong to predict that, in another couple of years India might have the largest concentration of well-governed companies in South and Southeast Asia.
SUMMARY
  • Corporate governance is typically perceived by academic literature as dealing with “problems that result from the separation of ownership and control.”
  • Sir Adrian Cadbury, Chairman of the Cadbury Committee defined the concept as “holding the balance between economic and social goals and between individual and communal goals”. Experts at OECD have defined corporate governance as “the system by which business corporations are directed and controlled”. All these definitions capture some of the most important concerns of governments in particular and the society. These are (i) management accountability; (ii) providing adequate investments to management; (iii) disciplining and replacement of bad management; (iv) enhancing corporate performance; (v) transparency; (vi) shareholder activism; (vii) investor protection; (viii) improving access to capital markets; (ix) promoting long-term investment and (x) encouraging innovation.
  • Corporate governance systems depend upon a set of institutions (laws, regulations, contracts and norms) that create self-governing firms as the central element of a competitive market economy. Governance is not just board processes and procedures but involves the entire gamut of relationships between a company's management, its board, its shareholders and its other stakeholders, such as its employees and the community in which it is located. The quality of governance is directly linked to the policy framework. In the twenty-first century, stability and prosperity will depend on the strengthening of capital markets and the creation of strong corporate governance systems. The OECD has emphasized the following requirements of corporate governance: the rights of shareholders, equitable treatment of shareholders, and role of stakeholders in corporate governance, disclosure and transparency, and responsibilities of the board.
  • The oft-quoted Cadbury Committee submitted its report along with the “Code of Best Practices” in December, 1992. In its globally well-received report, the committee elaborated the methods of governance needed to achieve a balance between the essential powers of the board of directors and their proper accountability. Against the different issues in corporate governance, the benefits of good corporate governance to a corporation were highlighted to be the following: creation and enhancement of a corporation's competitive advantage; enabling a corporation to perform efficiently by preventing fraud and malpractices; providing protection to shareholders' interest; enhancing the valuation of an enterprise and ensuring compliance of laws and regulations.
  • In India, the real history of corporate governance dates back to the year 1992, following the efforts made in many countries of the world to put in place a system suggested by the Cadbury Committee. In 2002, a high-level committee under the chairmanship of Naresh Chandra was appointed to examine and recommend drastic amendments to the law involving the auditor–client relationships and the role of independent directors by the DCA in the Ministry of Finance and Company Affairs. The Company Law Amendment Bill, 2003 envisaged many amendments on the basis of reports of the Naresh Chandra Committee and the subsequently appointed the N. R. Narayana Murthy Committee.
  • The Government of India constituted an Expert Committee on Company Law on 2 December, 2004 under the Chairmanship of J. J. Irani. It has come out with suggestions that will go far in laying a sound base for corporate growth in the coming years.
  • SEBI monitors and regulates corporate governance of listed companies in India through Clause 49. This clause is incorporated in the listing agreement of stock exchanges with companies and it is compulsory for them to comply with its provisions, which include composition of board, constitution of the audit committee, the audit committee, remuneration of directors, board procedures and shareholders information.
  • In early 2004, a corporate governance country assessment for India was carried out as part of the joint World Bank–IMF programme of Report on the Observance of Standards and Codes. Past experience on governance issues in the country has shown that none of the corporate governance principles can be cast in stone and laid to rest forever. There is an ongoing need for constant review and course corrections that would keep the country in the pink of health in terms of its corporate excellence.
  • By a judicious mix of legislation, regulation and suasion, this task needs to be constantly addressed. With growing maturity and competitive compulsions, it should be possible to gradually reduce legislative interventions and increase regulatory compliance with, and self-induced adherence to, the best practice in this field. Till then, however, legislation and regulation to ensure at least certain minimum standard is inevitable. To facilitate such a graduation into better governance practices, globalization has opened up an array of opportunities to corporate India. To emerge successful in its new tryst with destiny, there are no soft options available and the Indian corporate sector must necessarily turn to good governance in its pursuit of competitive excellence in a challenging international business environment.
KEY WORDS
board procedures clause corporate democracy
corporate misgovernance executive remuneration governance mechanisms
independent directors institutional investors market capitalization
public policy perspective responsible corporate whistle-blowing
DISCUSSION QUESTIONS

 

  1. Trace the evolution of corporate governance, both in the Western countries and in India. What are the factors that led to the increasing awareness of the need for corporate governance?
  2. What do you understand by corporate governance? Has the need for it arisen only because of the “problems that result from the separation of ownership and control?”
  3. What are the requirements of corporate governance as envisaged by the OECD?
  4. Discuss the various issues in corporate governance. Are these issues universal? To what extent are these issues viewed differently in the context of developing/emerging economies?
  5. What is the relevance of corporate governance? Do you think better governance practices boost corporate performance? Give illustrations.
  6. Explain what constitutes good corporate governance from the context of different stakeholders.
  7. What is Clause 49? Do you think that if Indian corporations comply with all the stipulations of Clause 49 we will have better corporate governance mechanism in India?
  8. Review corporate governance practices in India at present. Do you think that things are likely to improve on this front in future?
SUGGESTED READINGS

Cadbury, Sir Adrian, “The Code of Best Practice,” Report of the Committee on the Financial Aspects of Corporate Governance, Gee and Co Ltd., 1992.

Cadbury Committee Report, A Report by the Committee on the Financial Aspects of Corporate Governance. The committee was chaired by Sir Adrian Cadbury and issued for public comment on 27 May, 1992

Claessens, Stijn, Djankov, Simeon & Lang, Larry H. P. “The Separation of Ownership and Control in East Asian Corporations.” Journal of Financial Economics, 58 (2000): 81–112.

Clarke, Thomas. International Corporate Governance. London, UK and New York, NY: Routledge, 2007. ISBN 0415323096.

Clarke, Thomas and Jean-Francois Chanlat (Eds.). European Corporate Governance. London, UK and New York, NY: Routledge, 2009. ISBN 9780415405331.

Clarke, Thomas and Marie dela Rama (Eds.). Corporate Governance and Globalization (3 Volume Series). London, UK and Thousand Oaks, CA: SAGE, 2006. ISBN 9781412928991.

——— Fundamentals of Corporate Governance (4 Volume Series). London, UK and Thousand Oaks, CA: SAGE, 2008. ISBN 9781412935890.

Clarke, Thomas (Ed.). Theories of Corporate Governance: The Philosophical Foundations of Corporate Governance. London, UK and New York, NY: Routledge, 2004. ISBN 0415323088.

Colley, J., J. Doyle, G. Logan, and W. Stettinius. What is Corporate Governance? New York, NY: McGraw-Hill, December, 2004.

Denis, D. K. and J. J. McConnell (2003), “International Corporate Governance.” Journal of Financial and Quantitative Analysis, 38(1) (2003): 1–36.

Desirable Corporate Governance: A Code, Confederation of Indian Industry, March 1998.

Erturk, Ismail, Julie Froud, Sukhdev Johal, and Karel Williams. “Corporate Governance and Disappointment.” Review of International Political Economy, 11(4) (2004): 677–713.

Gupta, L. C. “Corporate Governance, Indian Style,” The Economic Times, 17 March, 2004.

Hovey, M. and T. Naughton. (2007), “A Survey of Enterprise Reforms in China: The Way Forward.” Economic Systems, 31(2) (2007): 138–56.

Investigating Board Members Remuneration and Responsibilities, Greenbury Committee Report, 1994.

La Porta, R., F. Lopez-De-Silanes, and A. Shleifer. “Corporate Ownership around the World.” The Journal of Finance, 54(2) (1999): 471–517.

Monks, Robert A. G. and Nell Minow. Corporate Governance. Oxford, UK: Blackwell, 2004.

Narayanamurthy, N. R. Committee on Corporate Governance, Report of SEBI, 2003.

New York Society of Securities Analysts. Corporate Governance Handbook. New York, NY: New York Society of Securities Analysts, 2003. OECD. Principles of Corporate Governance. Paris, France: OECD, 1999, 2004.

Oman, Charles P. “Corporate Governance and National Development: Working Paper No. 180,” OECD Development Centre, 2001, http://www.oecd.org/dataoecd/19/61/2432585.pdf.

Principles of Corporate Governance, A Report by OECD Task Force on Corporate Governance, 1999.

Sapovadia, Vrajlal K. “Critical Analysis of Accounting Standards Vis-À-Vis Corporate Governance Practice in India,” SSRN: http://ssrn.com/abstract=712461,January,2007.

Shleifer, A. and R. W. Vishny. “A Survey of Corporate Governance.” Journal of Finance, 52(2) (1997): 737–83.

The Combined Code of Best Practices in Corporate Governance, The Turnbull Committee Report, 1998.

The Committee on Corporate Governance, The Hampel Committee Report, 1998.

The Link Between Corporate Governance and Performance, Patterson Report, 2001.28

Case 28.1 Who is a Whistle-blower?

In common parlance, a whistle-blower is a “person who informs on another or makes public disclosure of corruption or wrongdoing”.1Literally, the word whistle-blower has been derived from “the practice of English bobbies who would blow their whistles when they noticed the commission of a crime. The blowing of the whistle would alert both law enforcement officers and the general public of danger.” Whistle-blowing is the process or an act of blowing the whistle. In the context of a business organization, it may be construed as an effort of an employee to bring to the knowledge of the top brass anything illegal or of grave impropriety, with a view of cleansing it of the evil. According to John R. Boatright, “Whistle-blowing can be defined as the release of information by a member or a former member of an organization that is evidence of illegal and/or immoral conduct in the organization that is not in the public interest”.2A more comprehensive definition of the concept would be: “A whistle-blower is an employee, a former employee, or a member of an organization, especially a business or government agency, who reports misconduct to people or entities who have the power and presumed willingness to take corrective action. Generally, the misconduct is a violation of law, rule, regulation and/or a direct threat to public interest—fraud, health, safety violations, and corruption are just a few examples”.3

It is also a direct threat to public interests, a violation of internal requirement such as policies, procedures and instructions, externally promoted policies and claims, government regulations, purchase order, service level agreements, technical specifications, and contracts, referenced documents, standards and codes. Fraud, health and safety violations, and corruption4 are also part of these violations.

Types of whistle-blowing

Basically there are three types of whistle-blowers. They are:

  1. Internal to internal whistle-blowers
  2. Internal to external whistle-blowers
  3. Extrinsic to external whistle-blowers

Internal to Internal: Internal people such as the staff who report misconduct or non-compliance to internal people such as supervisors, managers, service and supply, procurement and purchasing, human resources, executives and directors, CEOs, CFOs, Board of directors, shareholders, investors and business owners.

Internal to External: Internal people (staff) who report misconduct or non-compliance to external people such as the clients, the suppliers and sub-suppliers (includes companies contractors, consultants, lawyers), the competitors, government departments and agencies, and police.

Extrinsic to External: Extrinsic people (those who have intimate knowledge of the business) who report misconduct or non-compliance to external people such as the clients, the suppliers, the consultants, and government departments and agencies.5

Whistle-blowing is not accepted by all

Though whistle-blowing is increasingly being accepted by laymen over the years, there is still a great deal of mental reservation in several quarters to accept it as a virtuous or even desirable act. More often that not, whistle-blowing may bring harm to the career of the superiors who mentored the whistle-blower in the organization. While some see whistle-blowers as selfless mortals for a public cause and organizational accountability, others look at them as solely pursuing personal glory, fame and even using it as a means of vendetta. To a psychological egoist, “human beings are so made that they must behave selfishly, and all actions of men are motivated by self-interest and there is nothing like unselfish actions. To him, even the so-construed self-sacrificial act like whistle-blowing in an organization to bring to the notice of the top brass the unethical practices down the line, or by top executives, is an attempt by the whistle-blower to either take revenge or become a celebrity.”6“Even Peter Drucker, the famous management thinker is known to have been anti-whistle-blower and insisted more on loyalty towards the firm.”7It was, and in many cases still is, seen as an inconsiderate disloyal act where the employee has no concern for the hand that feeds him. The whistle-blower may be often looked down upon as a black sheep by his colleagues and shunned from professional and social circles. Many whistle-blowers have had to go through hardships, costly litigations and subject to being sued by their employers for the breach of contract or disclosure of confidential information. These people who jeopardize their lives, career and families should be hailed as heroes, but are often antagonized by the society for which they do so much. Their work and dedication is often construed to be a gimmick and are scandalized in media as attention seekers, even when they face tremendous hardships in a bid to uphold what they believe as the right way of governance.

However, in recent times in the context of attempts to cleanse public and corporate entities of unethical practices and in promoting corporate governance and social accountability, whistle-blowing is viewed as a matter of social duty, out of a spirit of public spiritedness, to serve a public or social purpose by exposing a misconduct which if not stopped forthwith, might work to the detriment of the whole organization. But it is an undeniable truth that whistle-blowers are often sacrificed for their brave acts and often undergo demotions, transfers, dismissals, etc. as retributions for their actions. Again, it should be stressed that whistle-blowing is not about sweeping things under the carpet, but bringing them to light. It is about accountability and responsibility, it is an act that reinforces the integrity of the individual, the corporation and the nation. An NGO called the National Whistleblower Center in Washington that helps, guides and supports whistle-blowers says that employees who decide to blow the whistle have one thing in common—a strong sense of right and wrong, guided by their moral philosophy. And having the courage of conviction, they follow that belief come what may, even if it means that they end up being dismissed, ostracized by friends and colleagues, accused of having a grievance against their employer, or even worse, of trying to gain some benefit out of their accusation.”8

Emerging trends in accepting whistle-blowing

Employees, of late, have started to voice their concerns, in spite of being conscious of the consequences that would follow and prefer to do their duty towards their fellowmen and the larger interests of the society over that of their employers or their firms. It is this increased and heightened awareness in society that has pushed to the forefront several whistle-blowers, both from the public sector and private enterprise; to feel their conscience pricked enough at the illegality or atrocities they see in their workplaces; to spill the beans publicly, notwithstanding the high cost they knew they would have to pay. It is the reflection of this emerging trend of public consciousness that the media has been highlighting this issue to make people aware of its importance and significance. For instance, the December, 2002 issue of Time magazine dedicated that year as a “year of corporate governance” and featured three women whistle-blowers—Cynthia Cooper of WorldCom, Sherron Watkins of Enron and Coleen Rowley of the Federal Bureau of Investigation (FBI). These three brave women were named “persons of the year” for their bravery in bringing to the public attention the manner in which American companies and the government agencies function to the detriment of people whom they are supposed to protect. These women, highly intelligent, imbued with a high sense of integrity and propriety, and conscious of the societal goals of their organizations, acted against them when their employers betrayed their trust and that of the society at large. “Related to this, a telephone poll among adult Americans taken for Time/CNN in December, 2002 showed 59% of the respondents considered the whistle-blowers as heroes and only 18% regarded them as traitors.”9Moreover, “Whistle-blowing has featured in films such as Serpico, Silkwood, Marie and, of course, The Insider”.10

Why only a few act as whistle-blowers?

Thousands of people come across unacceptable, unethical or even illegal business issues or governance practices, yet only a few take the courage to question such acts. There are two contrasting arguments which explain the rationale behind the fact that only certain employees act as whistle-blowers: (i) The first argument concerns the availability of information. Often times, only a few individuals are privy to highly sensitive information such as issues of fraud, bribery and malfeasance. Further, only a selected few may have the understanding of the ticklish issues in the information available; (ii) The second argument concerns the organizational dependence and culture as an issue of conformity. Employees generally feel that the particular unethical activity is essential for organizational functioning and tend to avoid making bold moves to correct them.11Under these circumstances, we can conclude that only those who have a high level of moral standards and responsibility, guts and concern for the organization and society at large can bring themselves to be whistle-blowers.

Why is whistle-blowing a significant tool to ensure corporate governance?

A company form of business organization, being a congregation of various stakeholders should be fair and transparent to all of them in all its transactions. This has become imperative in today's globalized business world where corporations need to access global pools of capital, attract and retain the best human resources from all parts of the world, partner with vendors in mega corporations and live in harmony with the community. Unless a corporation embraces and demonstrates ethical conduct, it will not be able to succeed12 in realizing the above objectives. However, the ground realities in real world tend to be different. Corporations, in their anxiety to produce best financial results for its stockholders and boost market capitalization, often resort to doing things that are illegal. There is also the possibility of grey areas, where an act is not illegal, but considered unethical, raising several moral issues.

Existence of an illegal activity in an organization may create a sense of guilt among employees and generate a perception that may prompt them to view that some actions need to be taken to curb it and it is well within the realm of the management to prevent it. This may lead to a process by which the individuals or groups try to expose the problems to the authorities, who can initiate corrective action.

Whistle-blowing may take different forms. Sometimes, the activities which employees feel are misdemeanours could be exposed in the form of rumours in an organization. This might be misconduct, wrongdoing of an individual, socially unacceptable practices, etc. The rumours at a certain stage can elicit an organizational response. Interestingly, trade unions, opposition parties and social activists are whistle-blowers in this context and their whistle-blowing is considered an essential part of their functioning. There may be different types of reactions when the whistle-blower may come across serious manipulations or illegal activity, due to proximity to first-hand information of the activity and goes through a variety of decision-making challenges, or his response is difficult to arrive as it may be against a set system.

A whistle-blower is generally confronted with a dilemma on how to react when he uncovers a malpractice in his organization. Whistle-blowing by someone working within the organization might bring shame to it as did Cynthia Cooper of WorldCom and Sherron Watkins of Enron, both of whom exposed corporate financial scandals, and Coleen Rowley of the FBI who pointed out the agency's slow action prior to the attacks of 11 September, 2001.

Whistle-blowers help recognize troubles growing in organizations. Reckless executives do not encourage whistle-blowing as it reveals their wrongdoings. This will only make the whistle-blower desist from calling a spade a spade. There are some whistle-blowers who have the inner courage and keep fighting persistently for the values their organization stands for. Senior management should open a direct communication channel for these loyal whistle-blowers at various levels of the organization structure which will help the management sense the heat before things burn down.13

Whistle-blowing promotes a firm's competitive advantage

Whistle-blowing promotes competitive advantage. Every organization makes earnest attempts to improve its environment, health and safety of employees. Organizations that offer a conducive working environment as part of its corporate governance process will be a preferred choice not only among its internal stakeholders such as shareholders, employees and investors, but also of outsiders who may include, inter alia, communities, joint venture partners, mutual funds and so on. When a company builds such preferred qualities, it is able to build its competitive advantage in terms of its creating goodwill among the members of the community. Organizations such as Johnson & Johnson, Infosys Technologies and Tata Steel have been able to reap immense benefits by projecting an image of ethical organizations. If whistle-blowing helps an organization to eliminate internal malpractices and helps it to project an image of an ethical organization, it will help it to build a reputation and establish credibility in the minds of the public.

Competitive advantage grows naturally when a corporation or its services facilitate the creation of value for its buyers. Creating competitive advantage requires both the vision to innovate and the strategy to manage the process of delivering value. An ethical corporation is able to draft strategies that fit the business environment and are flexible to accommodate opportunities and threats and to compete for the future. Corporations which develop their strategies by involving all levels of employees create widespread commitment to make them succeed. Such commitment will make employees associate themselves with the ethical side of the organization and shun the unethical aspects, leading to the emergence of one or two whistle-blowers.

Whistle-blowing enables a corporation to perform efficiently by preventing fraud and malpractices that destroy business from inside. It also provides protection to shareholders' interests, enhances the value of an enterprise and ensures compliance of laws and regulations. Moreover, when an organization has instilled in its employees a positive whistle-blowing culture, it would be able to perform better by identifying, detecting and deterring unethical practices; create an environment to feed authentic information to managers to make meaningful decisions and to control risk; helps to communicate to stakeholders and regulators that the organization means not only good business but also good governance; reduces opportunities for anonymous and malicious leaks that would create very poor impression about the organization; and reduces the chance of legal claims against the organization.

Whistle-blowing is not only moral, but also an obligation

Every whistle-blower may face an ethical dilemma inasmuch as he might debate in his mind whether he can bite the hand that feeds him. However, as a human being he has a moral responsibility to see that the society of which he is a member does not suffer from unethical practices in every field of human endeavour. By not bringing to the knowledge of authorities who can make amends or who can rectify unethical practices, one is committing a moral impropriety. Poet Dante in his Divine Comedy had observed: “The hottest place in hell is reserved for those who are silent during a moral crisis.” Albert Einstein, the redoubtable scientist, observed: “The world is a dangerous place not because of those who do evil, but because of those who look on and do nothing.” English litterateur Edmund Burke, commented: “All that is necessary for evil to triumph is for good men to do nothing.” Besides, loyalty to society and people at large and not to an individual or institution should be the guiding principle of ones life. One's loyalty should be to the kingdom and not to the king.

In most ethically run organizations, whistle-blowing is encouraged and a well-laid system is provided to protect the whistle-blowers. Whistle-blowing is a preview to corporate reform. It is encouraged to promote ethical behaviour among corporations because: (i) The concept that the corporations are for the sole purpose of profiteering is absurd; (ii) The society gives business the required infrastructure and other facilities such as trained labour expecting fulfilment of its needs in a just, fair and ethical manner; (iii) Corporations are permitted by society to exist only as long as there is a shared prosperity; (iv) There is a justification for the existence of a corporation only when public and social purposes are served by it and (v) The concept of “contractual analysis” of business implies that the corporation has to be ethical in its own interest, in the interest of the corporate community in general; it has entered into a tacit understanding with society to behave ethically; it is unfair on the part of a company to go back on its own agreement with others and expect them to keep theirs, it is inconsistent to agree to a moral behaviour and then violate it in secret and engage in breaking the rules assuming that they can get away with it; all these violations undermine the essential and conducive environment for business. Under such circumstances, where the society expects the business to be moral and ethical, whistle-blowing helps the corporation to be on the right side of law and ethics and helps it to correct itself when unethical practices exist in it, often without the knowledge of the top executives. Whistle-blowing is a method that exposes the unethical practices in corporations. It is justified because persons who are aware that grave errors or injustice is committed in the workplace and yet remain mute witnesses to protect their job or personal interest become confederate in such acts.

Guidelines for whistle-blowing

Though whistle-blowing in general promotes better governance it would not be productive all the time. It depends on the situation and circumstances in which it was brought to light. There are certain guidelines that would determine if a situation merits whistle-blowing in which case it would really help better governance. Lizabeth England lists the following guidelines for whistle-blowing.14

1. Magnitude of consequences

Before whistle-blowing, an employee should find answers to these two questions: “How much harm has been done or might be done to the victims?” Victim may indicate a person, a value or an ethical issue. Will the victim be really benefited by the whistle-blowing? Moreover, if only one person is going to be adversely affected by the situation, there is no justification for the whistle-blowing.

2. Probability of effect

The whistle-blower should consider the probability that the particular action about which he intends to blow the whistle would definitely take place causing harm to many people. He should be very positive that the action will really take place. If he does not know that the action is bound to happen and has proof to that effect that it would harm people (or the environment), the employee should reconsider his or her plan to blow the whistle.

3. Temporal immediacy

An employee must consider two things before he blows the whistle: (i) the length of time between the present and the time when the harmful event is likely to occur; and (ii) the urgency of the problem in question. He will have a strong case for whistle-blowing, if the problem is immediate, i.e., the consequences of the potentially unethical practices are likely to happen in the immediate future. For instance, if he comes to know that (i) a toxic waste is likely to be dumped by his organization within a week; and (ii) the company is going to discharge 100 employees by next year, then he should consider the former more urgent than the latter.

4. Proximity

The potential whistle-blower should evaluate the proximity of the potential victims. For instance, “A company that is depriving workers of medical benefits in a nearby town has a higher proximity than one thousands of miles away. The question arises about matters of emotional proximity or situations in which the ethical question relates to a victim with some emotional attachment to the whistle-blower.”15

5. Concentration of effect

The whistle-blower should determine the intensity of the unethical practice or behaviour. The question is how much the specific infraction carries. For example, a person is considered more unethical when he steals INR 10,000 from one person than stealing INR 10 from 1,000 people.

Thus, though whistle-blowing helps promote better governance, certain guidelines should be followed by the whistle-blowers. Besides, whistle-blowing should be used only as a last resort.

Some cases of whistle-blowing in India

  1. Satyendra Dubey, a brilliant engineer employed by the National Highways Authority of India (NHAI) as the Deputy General Manager, wrote to the then Prime Minister, Atal Bihari Vajpayee about the corruption in Golden Quadrilateral, a prestigious national infrastructure project. For doing this, Dubey had to pay the price with his life. Though Dubey knew he was targeted and his blowing the whistle would invite immediate retribution, he did not backtrack in his resolve to do what was best for the project he was involved in and for the country. His assassination revealed the enormous loopholes that exist in our system of governance, even at the level of the PMO which notwithstanding the request of Dubey not to let know the corrupt contractors of his complaint, acted as a conduit for the information. It also shows the lethargy, utter carelessness and callousness of our bureaucrats to protect whistle-blowers and the information they provide for the good of our society. The only silver lining in the whole episode of Dubey's murder was the exemplary manner in which the common man responded and how it stirred the collective conscience of the entire nation. It also resulted in several improvements in the system of execution of the prestigious Golden Quadrilateral Project. Dubey's martyrdom was certainly one more attempt, albeit painful, to cleanse India of corruption and mismanagement in public life. His supreme sacrifice defies description. After all, which sacrifice can be greater than the one in which a man lays down his precious life for the cause he so dearly espouses?

  2. In another tragic and soul-stirring incident, S. Manjunath, a former manager at Indian Oil Corporation Limited (IOCL) and a crusader against adulteration of petrol was shot dead at Sitapur, Uttar Pradesh on 19 November, 2005, allegedly by a petrol pump owner. He discovered that an oil mafia was adulterating both petrol and diesel to make money on the sly. Manjunath, a highly talented, educated and dedicated executive, threatened to revoke its license. He stubbornly went on to close down the pump, but ultimately paid for his honesty with his life.

  3. Sanjeev Chaturvedi, a young Indian Forest Service officer, is being hounded and is facing a disciplinary action of one kind or the other because he is a staunch believer in the rule of law and protection of wildlife. “He blew the whistle on a canal being dug without permission through Haryana's Saraswati Wildlife Sanctuary—home to the hog-deer, blackbuck and wild boar. When the officer found that trees were being felled and earth being dug, he did what he was supposed to do—he filed a report”16 to the competent authorities. Chaturvedi was warned by the State's Principal Secretary for doing something he was paid to do. He faced disciplinary action and was transferred. In the new posting, the whistle-blower-forest officer opposed a project for growing herbal plants with government funding on private land. For this he was suspended, a decision that was revoked by the Centre. After his suspension was revoked, Chaturvedi was posted with a demoted rank. However, the transfer was stayed at the intervention of the Central Administrative Tribunal. As of now, Sanjeev Chaturvedi continues to be without posting and disciplinary action against him remains pending.

Sources:

1 Webster's Encyclopedic Unabridged Dictionary of the English Language, New York, N.Y: Random House Value Publishing Inc, 1996.

2 Boatright, John, R., Ethics and Conduct of Business, New Delhi, India: Pearson Education, 2003, First Indian Reprint.

3 Wikipedia, “Whistle-blower,” http://en.wikipedia.org/wiki/whistle-blower, also http://www.uspsoig.gov/inv_sid.htm.

4 “Whistle-blowing,” http://www.mustor.com/whistle-blowerManagement.htm.

5 Leo J. Pravin, “Whistle-blowing as a means of promoting better governance,” unpublished essay, LIBA, 2008.

6 Fernando, A. C., Business Ethics, An Indian Perspective, New Delhi, India: Pearson Education, 2008.

7 Remya M. Nair, “Whistle-blowing as one of the means of promoting better governance,” Unpublished essay, LIBA, 2007.

8 Fernando, A. C., Business Ethics-An Indian Perspective, New Delhi, India: Pearson Education, 2009.

9 Siddharth G. Das and Regina Aldrin, “Whistle-blowing and Competitive Advantage,” SCML Journal of Management, 4(11) (April–June 2007), 70–76, Cochin, India: School of Communication and Management Studies.

10 Raghu Dayal, “Whistle-blowers Need To Be Protected,” The Economic Times, 26 December, 2006.

11 Sandeep Krishnan, “Whistle-blowing Gets Real,” http://stdwww.iimahd.ernet.in/~sandeepk/whistle.pdf.

12 Aparna Kutumbale, “Ethics Is the Foundation of Corporate Governance,” unpublished essay, LIBA, 2008.

13 Munish Bhalla, “Whistle-blowing as a Means to Improve Governance,” unpublished essay, LIBA, 2008.

14 http://draft.eca.state.gov/forum/journal/bus4background.htm.

15 Ibid.

16 Nitin Sethi, “Whistle-blower Forest Officer Falls to Jungle Law,” Times of India, 3 August, 2008.