Chapter 19. Role of the Government in Ensuring Corporate Governance – Business Ethics and Corporate Governance

CHAPTER 19

Role of the Government in Ensuring Corporate Governance

INTRODUCTION

Taking the cue from the classical economists, die-hard admirers of capitalism often aver that ‘the government should get out of the way and let the market function’. Of course, that idea is a myth. Government is absolutely essential in setting up of a market economy. Without rules and structures of a binding nature, anarchy will be the outcome. ‘Under such conditions business becomes nothing but “casino capitalism” where investments are simply bets: bets that people will keep their word, bets that the firms are telling the truth, bets that employees will be paid, and bets that debts will be honoured. What corporate governance is all about in larger terms is how a structure can be set up that allows for a considerable amount of freedom within the rule of law. Ultimately these arrangements provide for the establishment of trust, one of the most important ingredients in business.’1

State participation in the orderly functioning of the economy is no more a matter of disagreement among social scientists. The free play of economic forces has often resulted in anarchy of production, unemployment, and economic instability. Laissez-faire has now been considerably diluted. State intervention is now considered necessary to ensure economic stability and full employment of the productive resources. The transformation of ‘free enterprise’ economies from ones with a non-interfering state to one that intervenes too often and sometimes far too much in economic affairs has been due to the following historical developments: (i) The facile assumption of the classical economists that capitalism does not require any state intervention and has enough self-correcting mechanism within itself, has been proved wrong by the regular occurrance of trade cycles, causing untold miseries to people in times of recession and depression due to unemployment and falling incomes. State intervention becomes absolutely necessary to restore the economy back to its recovery—prosperity path; (ii) The necessity of the state to concentrate on defence production and the co-ordination it has to bring about in transporting men and materials to the theatres of war so as to execute its war efforts successfully call for and justify state interference; (iii) The emergence of socialism as an alternative economic system to capitalism and its vehicle of delivery, namely, central planning, has provided another justification; (iv) The emergence of labour power and the imperative of the state to protect its interests calls for state intervention; (v) The concept of welfare state and the need to direct development efforts to have a human face and be covered by a social safety net could not be achieved without the active role of the state; and (vi) In recent times successive corporate frauds and scams have necessitated state intervention to protect the unwary investors and regulate corporates so as to make them accountable to their internal and external stakeholders that include the society at large.

GOVERNMENT INTERFERENCE IN MARKET ECONOMIES

The modern capitalist or market economies are characterized by government interference in varying degrees. A variety of reasons explain why this is the case, but the following are the most important ones:

  1. The contractual arrangements and exchanges needed for free market operations cannot exist without the protection and enforcement of a governmentally provided legal structure.
  2. The claim that the market mechanism leads to efficient use of resources (i.e. produces what consumers want most and does so in the cheapest possible way) is based on the assumption of competition in factor and product markets. This means that there are no obstacles to free entry and free exit and that consumers and producers have full knowledge of market conditions. However, government regulations or other administrative measures are needed to secure these conditions.
  3. Even if all barriers to competition are removed, production or consumption characteristics of certain goods are such that these goods cannot be provided for through markets.
  4. The market system, especially in a highly development-oriented economy, does not necessarily bring high employment, price stability and the socially desired rate of economic growth. Public policy is needed to secure these objectives.
  5. Social values may require adjustments in the distribution of income and wealth which result from the market system and from the transmission of property rights through inheritance.
  6. Today, government participation is considered an essential ingredient of high and rising levels of economic activities for both developing and developed countries.
  7. In developed market economies, budgets of governments exercise a very significant influence over the economy. In a number of these countries, government revenue as well as expenditure exceed one-third of the Gross Domestic Product (GDP).
  8. In many countries, there has been a growing participation by the state in national production and a vast expansion of its laws, regulations and executive fiats governing economic affairs.
  9. Even in free market economies, state ownership of enterprises and even of the whole of certain industries is quite common. There has also been a tendency in some of these countries to nationalize certain critical industries as well as to own enterprises in important industries.

In short, there is hardly any country in the world, the economy of which is not in one way or way the other influenced by its government.

DIFFERENT ROLES OF GOVERNMENT IN THE ECONOMY

There are four important roles played by the government in an economy, namely:

  1. The regulatory role;
  2. The promotional role;
  3. The entrepreneurial role; and
  4. The planning role.

The first three roles of the state are elucidated in the following pages.

REGULATORY ROLE

A large part of the economy of even most of non-centrally planned countries is regulated by the government, as discussed below:

  1. Government may determine the conditions under which persons or corporations may enter certain lines of business as in the granting of a charter, a franchise, a licence, or permitting any ‘person’ to use public facilities or resources.
  2. Government may regulate or assist the conduct of economic ventures of various types once they are under way.
  3. Public control may extend to the results of business operations as in the limitation of public utility profits, ceiling on dividends and imposition of excess-profit taxes on business, etc.
  4. Government may control the relationship between various segments of the economy, the purpose being to settle conflicts of interests or of legal rights and to prevent concentration of economic power in the hands of few monopolies or in a few localities that may cause regional imbalances.
  5. Government may put in place legally constituted regulatory bodies to protect investors, consumers and the general public by ensuring best corporate practices.

    Government regulation of an economy may be broadly divided into: (i) Direct controls and (ii) Indirect controls.

Direct controls: Direct administrative or physical controls are more drastic in their overall effect and impact. For instance, many developing countries have instituted a variety of direct controls over their economies including industrial licensing and price and distribution controls. The use of industrial licensing is, therefore, justified as the mechanism by which the state can control industrial investment and allocate resources to conform to pre-determined priorities and plan targets.

Indirect controls: Indirect controls are usually exercised through various fiscal and monetary incentives and disincentives or penalties. For instance, a high import duty may discourage imports and fiscal and monetary incentives may encourage development of export oriented industries.

PROMOTIONAL ROLE

The promotional role played by government is very important in developed as well as developing countries. Thus, considering the whole of its activities, a government does more to assist and to help develop industrial, labour, agricultural and consumer interests than it does to regulate them.

In developing countries, where the infrastructural facilities for development are inadequate and entrepreneurial activities scarce, the promotional role of the government assumes special significance. The state will have to assume direct responsibility to build up and strengthen the necessary development of infrastructure such as power, transport, finance, marketing, institutions—for training and guidance and other promotional activities.

The promotional role of the state also encompasses the provision of various fiscal, monetary and other incentives, including measures to cover certain risks for the development of certain priority sectors and activities.

ENTREPRENEURIAL ROLE

The growing importance of the entrepreneurial or participative role of the state has been evident from the fast expansion of the public sector in most developing countries. However in post-1990s there has been a significant reversal in this policy as governments having experienced inefficient functioning of public sector industries and the huge losses incurred by them which are made good by budgetary allocations affecting tax-payers, have given up their policy of promoting them.

Public ownership in free societies and their growth in recent times are justified for the following reasons:

  1. In a democracy, the national emergency of war inevitably causes an expansion of state activities, including public ownership, because modern requirements of total war cause people to forsake their convictions concerning private responsibilities and to concentrate on massed power in the state apparatus.
  2. Major economic dislocations, such as the great depression of the 1930s, also tend to stimulate state activities, again leaving a residue of public ownership that takes time and efforts to dissipate, if it is ever finally accomplished.
  3. In economic dislocations, as in the early history of the United States and in the economic development of developing nations today, government is called on to act as banker, helper or owner of infant industries and generally to expand its central concern for the economy, thus creating considerable degree of public ownership at the outset.
  4. When private undertakings become unprofitable but the need for their services continues, government may be prevailed upon to acquire and manage such non-profitable business concerns even at a loss.
  5. Governments are also required to extend the owner-manager relationship when there is a pronounced wastage of national resources, or when the threat to them is great, thus diminishing the nation’s ability to defend itself or to preserve the bases of a sound economy.
  6. Government ownership may also be extended by the failure of private management to consider itself a trustee of the public good and abuse its power, especially in cases where monopoly or semi-monopoly, is the condition.

For these reasons, and also due to compulsions of development, there has been a tendency in many developing countries to assign a dominant place to the government-owned public sector, as was evident in India.

STATE INTERVENTION IN A DEVELOPING ECONOMY

State intervention is inevitable in developing countries to break the (i) vicious circle of poverty—a circular constellation of forces that keep the poor country in a stationary state of underdevelopment and (ii) to usher in economic growth through comprehensive government planning. The economic rationale for state intervention in the process of economic development of poor countries is briefly discussed further:

  1. Simple market forces cannot ensure high rate of investment and growth in output. Economic rigidities and structural disequilibrium hinder free operation or even the normal process of growth. Since economic development is not an automatic or spontaneous process, government should interfere with the market forces to break the vicious circle of poverty.
  2. In the initial phase, development is hindered for want of basic social and economic overheads. These create external economies, but require huge investments. For development of industry and agriculture, these are essential but private enterprise will not enter into these areas.
  3. Poor countries also suffer from deficiency of resources and skills. This calls for wise and efficient allocation of limited resources. Only the state is best equipped to do this through centralized planning. Besides, a government can mobilize large resources through taxation, borrowing and deficit financing. Large enterprises that require huge investment can be started only by the state.
  4. Besides, monopolies should be curbed, investments in schemes of collective values made, long-term problems of economy tackled, immediate prospects of profit not being the sole criterion, economic decisions properly co-ordinated, integration of various sectors of economy ensured only by a decisive role of the state.
  5. The latest addition to these functions of the state is that it should help promotion of investments in industries by safeguarding investors’ interest and instilling confidence in them. The state has a moral responsibility to ensure that corporates are run ethically and do not in any manner offend the interests of its stakeholders, both internal and external. To achieve this objective, they have to put in place laws, legal and institutional structures, regulatory bodies and help trade associations develop codes of best practices to be observed by their members.
PUBLIC GOVERNANCE AND CORPORATE GOVERNANCE

Governance is the exercise of authority, which involves not solely the right to direct but also to lead and to control within an organization. Two problems exist regardless of whether the organization operates within political society or within civil society:

  1. How to accumulate the power and authority required to achieve the purposes of the association?
  2. How to limit the power and authority to specified areas rather than to allow it to overflow into areas that are not its concern?

Although the same problems need to be addressed, governance within enterprise associations such as corporations is not at all like governance within a governmental body. Commercial activity conducted by corporations and by other forms of business is fundamentally different from the types of activity conducted by coercive government.

Good governance is supposed to exist if the following three objectives are achieved:

  • First, there should be equality of law and effective implementation of laws.
  • Second, there should be opportunity for every individual to realize his full human potential.
  • Third, there should be effective productivity and no waste in any sector.
POLITICAL GOVERNANCE REQUIRES RESTRAINTS OF POWER

Constitutional governments are characterized by specific restraints established by law and imposed on power-holders to ensure that citizens’ rights are not being transgressed. Constitutionalism embodies the principles that the government is organized by, and operated on behalf of the people, but subject to a series of restraints, a system of checks and balances and to keep power from being abused. By dividing power, constitutionalism provides a system of restraints upon coercive state action.

The basic idea underpinning restraints rests on the notion of a law higher than positive man-made law, and thus limiting the operation of the state. Natural law provides a criterion by which positive laws are judged. Another basic principle underlying the idea of limited government is that legitimate governments always rest on the consent of the governed. The working democracies that have developed from these ideas are given below.

  1. A political system with a central-local distribution of power.
  2. Subordinate distributions of power among agencies with functionally-defined realms of authority.
  3. A chronological distribution of power through periodic and regular elections.
  4. A written constitution enforceable by the courts limiting the exercise of political power.
FORMS OF GOVERNMENT REGULATION

The object of government regulation, as has been pointed out earlier, is to steer the wheel of the economy in the direction of maximum social good without replacing it. This can be achieved through regulatory action at all-important points in the economic system. However, the regulatory system and the context of regulation may vary from country to country, the degree of maturity of political governance and the degree of economic growth. The more important forms of regulation of private enterprises by the government especially in developing countries like India are as follows:

  • General direction and regulation of investment activity in private enterprise. This is achieved through economic planning and industrial licensing policy.
  • Regulation of investment, location, size and expansion of individual enterprises and specific industries through a well-defined policy of industrialization.
  • Regulation of prices of commodities and industrial products through legislative authority and systematic investigations into cost structures and mark-ups.
  • Regulation of monopolies and unfair trade practices or restrictive practices through legislation.
  • Regulation of wages and bonus for employees in private sector to minimize exploitation, ensure reasonable standards of living and maintain peace and harmony in industry.
  • Regulation of corporate management.
  • Regulation of specific norms of business activity such as speculation in shares and commodities or imports/exports, etc.
ROLE OF GOVERNMENTS IN LIMITING CORPORATE POWER

Modern corporations have grown so huge in size and so powerful in influence that these mega corporations, if unrestrained by political authority, might over-reach all the segments of the society with their mercenary and baneful influence. Unrestricted and unregulated corporations could overwhelm governments if proper checks and balances are not worked out and put in place, as Enron and WorldCom tried to do. Ralph Nader, the consumer advocate, and Mark Green, Director of Public Citizens’ Congress Watch, were almost prophetic as early as in 1979, when they articulated this view as follows: ‘We must redesign the law to keep up with economic and political evolution of giant corporations, which are tantamount to private governments.’ One definition of ‘government’ would be ‘an entity that can tax, coerce or even take life…. They (giant corporations) can spend decisive amounts in elections, determine which town thrives and which gathers cobwebs, corrupt or help overthrow foreign governments, develop technology that takes lives or saves lives…’.

The economic government (giant corporations) is largely unaccountable to its constituencies—shareholders, workers, consumers, local communities, tax payers, small businesses, future generations, etc.2

This view, which would have sounded extreme, strident and partisan when it was expressed with the major scams of mega corporations still to emerge from the womb of time, did reflect the most fundamental public concerns with large corporations. ‘However expressed, there appears to be a widespread fear that corporate managers have significant unrestrained discretion to make critical choices regarding a myriad of economic, social and political issues touching the lives of every citizen—including to name a few: what products and services to offer; what prices to charge; whether to invest in existing lines of business, to build new lines or buy out existing companies; where to locate corporate headquarters and new facilities; what plants to open and close; whether to adopt measures to protect the environment and conserve energy; whether to adopt worker benefit, safety and health programmes; which philanthropic endeavours to favour and so on.’3

THE LIMITS OF CORPORATE POWER

Millstein and Katsh assert that there are definite restraints for corporates exercising unbridled power as opined by Ralph Nader. They expostulate five basic theories that guide the state for exercising control over the behaviour of corporations. First, states have the inherent and inalienable political right to charter laws and regulations, limiting de jure what the corporation does and how it is done. Second, corporates face de facto limitations in the laws of supply and demand operating through the market mechanism and the profit motive. The free play of market forces and the competitive markets for goods and services, of course, are ensured through the state putting in place anti-trust and securities’ regulation. Third, the state offers incentives as well as deterrents to corporations through the system of taxation. In every decision-making and economic behaviour, corporations will have to reckon these. ‘Tax legislation clearly demonstrates the dangers of tinkering with powerful economic forces without considering the entire matrix of incentives and constraints which determine economic behaviour.’4 Fourth, state and federal (central) governments’ administrative codes and regulatory statutes impose on corporations certain direct, command-type controls. These may have considerable impact on various socio-economic situations that influence the corporations, and the economy itself, in many unintended ways. These may include labour relations; equal employment opportunities; community-wise quotas and reservations; occupational safety and health; environment; social security measures and social safety net to safeguard the poor and under-privileged; consumer protection and energy consumption, etc. Fifth, there is the impact of social forces on corporate behaviour, with specific attention to public opinion in general and to activate special interest groups in particular. All these groups exercise the checks and balances that keep the corporates under control so that they do not become social monsters, and fatten themselves on the miseries of the stakeholders.

However, there are anamolies, inconsistencies and incompatibilities which have crept into the system over time, as well as the growing divergence between the intentions of the government and empirical results of its actions. Moreover, with increasing changes coming into the functioning of the free enterprise system and the growing needs of a fast-growing consumerist society, when being catered to by the mammoth size mega corporations, the dynamics of the situation brings in a lot of confrontation and conflicts. For instance, the regulatory systems that were put in place after the Great Depression to regulate the corporations served the purpose admirably well until the business organizations such as Enron and WorldCom grew far beyond the most sanguine expectations of their promoters. With such stupendous growth of corporations and the required regulations lacking behind to keep them under check, they discovered several grey areas to play ducks and drakes with the investors’ hard-earned funds by circumventing government regulations and hoodwinking the regulators. If free societies rely more and more on private ownership of economic resources, on the one hand, and develop, due to historical reasons based on past experience, a discomfort with the discretionary powers of the managers, on the other, they should work out a system to strike a judicious balance between the two, so that neither their growth imperatives, nor equity as their driving force, is jeopardized.

DEMAND FOR CORPORATE CONSTITUTIONALISM IS A KNEE-JERK REACTION

Reformers who desire greater corporate democracy have mistakenly called for constitutionalism, a principle of public government, to be applied to the operation of the private corporations. Freedom, without the existence of constitutional restraints, according to them, may lead to corporate absolutism in the economic sphere. According to these critics, the concentration of the control of property in the hands of a few managers, no matter how dispersed the actual stock ownership may be, threatens the idea of pluralism. What has resulted has been a call for the development of means by which the powers of these private governments can be moderated regarding those both inside and outside of the firm.

There has been a recent demand for due process in corporations. Critics argue that when a corporation has the power to affect a great many lives, it should be subject to the same constraints under the constitution that apply to the government. Some have advocated the control of corporations by external agencies such as central or federal governments. Others have recommended control through internal, institutional devices such as: (i) stakeholder directors on the Board; (ii) social audits; (iii) the preparation of community impact analyses; (iv) the implementation of plant closing restrictions; (v) full-time, outside, professional directors; (vi) ethics committees; and (vii) separating the Board chair (external) from the president (internal).

Some critics maintain that large corporations, because of their size, special legal status, and economic, political, and social impacts, have as much public power as do states, and therefore, they as private governments should be federally chartered, constitutionally limited, and held to higher levels of social responsibility than non-corporate firms. They argue that modern corporations represent large concentration of power and have the potential to effect great changes in society. Instances are galore to prove this contention. From matured to nascent democracies, money power of corporates and the considerable political clout they exercise as a result have influenced elections and elected officials, including presidents and prime ministers. In other words, social responsibility arises from social power. Because corporations can affect the interests of others, they must be concerned with social responsibility. Advocates of corporate democracy theory even go so far as to call for restraints on the control of shareholders and managers so that the corporation can be run as a democracy in the interests of all of its constituents. Reformers have failed to recognize that commerce is essentially different from government and that methods appropriate to government are not germane to commercial enterprises. Unlike coercive governments, commerce is based on ideas such as trade, voluntary agreements, honesty, trust, confidence in strangers, openness to strangers, competition, inventiveness, efficiency, initiative and enterprise, thriftiness, dissent for the sake of the job, etc. Thus, there are some special features that corporates exhibit which make them very different from political institutions. These are as follows.

CORPORATIONS ARE VOLUNTARY ASSOCIATIONS

A corporation, is created through the exercise of individual rights (i.e. freedom of association and freedom of contract). People have an inherent right to form a corporation by contract for their own benefit and in their mutual self-interest. Based upon a consciousness of common interests, the corporation is an association of individuals who engage in a particular type of contractual relationship with one another in order to pursue common business objectives, and is governed by rules of the individuals’ own making, and is said to be able to assert rights and assume obligations. When rights and obligations are imputed to a corporation, what is really being referred to are the rights and obligations of its members who create and sustain it.

Corporations are properly viewed as voluntary associations and as private property. Arising from individual contracts, corporations are not the creation of the state—the state simply recognizes and records their creation in a similar fashion as it does with births, marriages, sales of real estates, etc. The corporate charter is merely the articles of incorporation which are not related to state authority and do not obligate the corporation to serve the public interest. Since corporations are not created by the state, the government has no authority to tell them what to do or what not to do, as long as they operate within the four corners of the law.

The state grants a charter as a legal technicality and neither creates nor changes the essence of these voluntary associations whose success depends upon the social bonds that unite their members and upon the human need for group membership. The state may choose to recognize these units but in so doing it simply acknowledges that, which already exists. The corporation is an association of human beings bound together in order to achieve a purpose. Positive law alone cannot provide the community of purpose necessary for a corporation to exist. In fact, the equivalent of a corporation frequently exists in the absence of legal action.

CORPORATE GOVERNANCE REQUIRES THE FREEDOM TO CREATE AND TO ExECUTE

In government, executive power is feared and thus checked—in the corporation it is desired and, therefore, fostered. Since a corporation is not a political community, checks and balances are not appropriate to it. In a corporation, the whole idea is to accomplish certain goals and to create something new. In government, the point is to keep leaders from doing anything beyond their stated powers. In corporations, we value swift action. Contrariwise, in government we desire judiciousness and deliberation.

Investors who have an idea, combine their resources, and attempt to create new wealth, create corporations. The corporation can only survive and prosper if it meets the needs of its customers and the purposes of its investors including the provision of goods or services at a profit along with fiduciary care for resources invested in it. A corporation is created to attain specific purposes. It follows that the problem of corporate governance is not to check power—it is to summon up and channel power toward the accomplishment of organizational objectives. No one should desire a ‘separation of powers’ within a corporation, executives must be permitted to execute.

With respect to corporate governance, owners are in sufficient control via the buying and selling of shares and other actions. Discontented shareholders may theoretically bring a suit against the directors and managers when they spend the shareholders’ money on unauthorized projects that are not in the owners’ interest or engage in other ultra vires acts. It is more likely that they will vote against such directors, remove the managers, or simply sell their shares. In a publicly owned corporation, the owners may be located all over the world. However, it is more probable that a large percentage of the shares of any major firm will be owned by particular mutual funds and pension plans, who act as proxies for a large number of individuals. The relationships between shareholders and corporate managers, and shareholders and money managers are principal-agent relationships. The growth of mutual funds and pension plans means broader stock ownership and stronger pressure on behalf of stockholders to keep managers in line. Since directors of mutual funds and pension plans want to invest in highly profitable firms, there is a powerful motivation for corporate directors and managers to continue to work hard and creatively. Money managers, as agents of the absentee-owner shareholders, can vote a CEO out of office by taking control of the board of directors or can sell the stock of companies from which they no longer expect competitive returns.

We are in an era of ‘fiduciary capitalism’ in which there is a concentration of ownership in the hands of a relatively small number of decision makers. However, in fact, legal ownership is still widely dispensed and the fiduciary duty of the money managers of mutual funds and pension plans gives them the responsibility to exercise the powers of ownership. The fiduciary standards require that the fiduciary takes only those actions that a prudent person would take regarding the management of the resources entrusted to the fiduciary. In discharging their fiduciary duty, money managers purchase securities and vote proxies. In essence, they exercise ownership rights, although on behalf of their beneficiaries. The idea of the morality of the principal-agent relationship is certainly not new. For example, the Biblical Parable of the Talents clearly illustrates the idea that separating control from ownership does not strip the owner of his rights.5 Today, we have simply added the idea of the fiduciary responsibility of the mutual fund or pension plan manager as a middleman, between the owners and the managers of a corporation.

CORPORATIONS DO NOT POSSESS THE POWER OF COERCION

Ethically, a corporation’s ‘power’ is irrelevant. Unlike governments, a corporation does not enjoy the power of coercion. The idea of a private government is oxymoronic. Only the State can force people to do things through its political, military, and police power. When a business offers a quid pro quo to its potential customers, employees, and others, it simply adds to their existing set of options—this in no way constitutes an exercise of power. Therefore, only governments should be constitutionally limited by legal restraints imposed on power holders to keep power from being abused.

What about the possibility of the abuse of power by individual managers over employees within a corporation? Certainly, corporations need to give authority to command others and provide the means necessary to gain obedience to these commands. Authority, the right to be obeyed by others, requires power. In a corporation, authority and power should be restricted to assigned legitimate areas. Power exercised without authority is illegitimate. Surely, any well-run corporation will have internal due process policies and procedures to provide some assurance of non-arbitrariness by requiring those who exercise authority to justify their actions. In a free society, if management’s order is not agreeable to a worker who believes it to be arbitrary or not within the manager’s legitimate sphere of authority, the worker can choose to: (i) initiate the firm’s due process procedures; (ii) ignore the manager’s overstepping of his authority; or (iii) terminate his relationship with the company.

PUBLIC VERSUS CORPORATE GOVERNANCE—A STUDY OF COMPARISON

Link Between the Two Systems

Corporate governance depends upon two factors, namely, the attitude and the values cherished by the management of the business enterprise and the external environment in which the business operates. The external environment in which the business operates would include the legislation relating to the functioning of business enterprises, covering the entire spectrum from registration of companies, their structure, and settlement of disputes, to laws relating to the capital market and punishment for unethical practices such as insider trading.

Public governance, on the other hand, is broadly connected with the running of the government of a country and ensuring that the rule of law prevails. There has to be fairness and transparency in the system of justice. If the public governance is not conducted on healthy lines and there is corruption, then there is no fairness. Corruption, as the World Bank defines, ‘is the use of public office for private gain’. If the public servants are going to exploit their position for private gain, then the quality of public governance suffers. If the quality of public governance suffers, corporate governance then is more difficult to practise. It can definitely be said that the management of an enterprise can still be ethical and try to maintain its internal corporate governance. If the environment in which it operates is not clean, then it may not be successful or even if successful, it will find it very difficult to operate.

CORPORATE GOVERNANCE CAN BE AN END BY ITSELF

The issue of corporate governance has its own dynamism and justification. This will be obvious from the fact that, thanks to globalization there are many multinational companies that have their own internal sense of values. In India, there are excellent business leaders like Narayana Murthy of Infosys and Azim Premji of Wipro who have built world-class enterprises. Both these business leaders are also placing a very high value on the principles of business ethics. What Narayana Murthy said in a talk to the students at Wharton School of Business is worth recalling: ‘The Infosys value system can be captured in one line—the softest pillow is a clear conscience. A company’s value system is the guiding light in its hours of darkness. It builds confidence, peace of mind, and enhances enthusiasm during tough times. The importance you attach to your value system is reflected in the cost you are willing to incur for your beliefs and convictions. At Infosys, we have stood firm whenever our value system was tested. We know that taking short cuts that compromise our values would be detrimental. One of my strongest beliefs is that corporations have an important duty to contribute to society. No corporation can sustain its progress unless it makes a difference to its context.’

It is, therefore, obvious that even if public governance is not up to the mark in a country, managements of business enterprises can try to maintain the best corporate governance and stick to certain values in their own system. In fact, companies that observe good corporate governance or maintain values seem to be doing better in the business areas also.

BETTER PUBLIC GOVERNANCE CAN ACCELERATE CORPORATE GOVERNANCE

Public governance can also bring in greater discipline for better corporate governance by nurturing the appropriate external environment in which an enterprise operates. Presently in India we have the Securities and Exchange Board of India (SEBI), to regulate stock exchanges. We also have the Companies’ Act for governing the operations of business enterprises. Based on the experience gained, the rules and regulations relating to business are being constantly revised.

Based on the past experience, corrections have to be made in public governance and regulation of business. In the stock exchanges of the United States in the 1980s and 1990s, there were a series of scams such as insider trading, junk bond schemes and savings and loan scandals. Corrective measures were taken to build systems to ensure that malpractices do not flourish in the capital market and the business world. The role of public governance, therefore, as the watchdog of corporate governance and as the agency primarily responsible for laying down the rules of the game is therefore important and obvious.

ROLE OF GLOBALizATION AND INFORMATION TECHNOLOGY

The increasing globalization and removal of trade barriers, thanks to institutions such as the WTO, is also adding one more dimension to better corporate governance through introduction of uniform standards. For instance, India has been examining the issue of adopting GAAP—Globally Accepted Accounting Practices. Perhaps acceptance of such standards will bring in, in due course of time, a uniform set of practices for corporate governance. The thrust for greater uniform standards has got a boost thanks to the increasing use of information technology. The Internet and the increasing use of information technology are opening new horizons for business. Simultaneously, the potential for cyber crimes which can be committed internationally is also being realized and corrective measures are contemplated along with research to arrest such crimes. To tackle cyber crimes, it becomes necessary to have international standards and international cooperation. This is also going to contribute significantly to evolution of systems and procedures, principles and regulation to ensure healthy corporate governance practices prevail. One can hope that this, in turn, will have an impact on the public governance in different countries and this may bring out a healthy impact on society.

Development of organizations like the WTO is also another step that would introduce in good time a set of uniform standards and approaches so far as treatment of the behaviour of business enterprises is concerned. To the extent common standards evolve, either due to the operational needs dictating adoption of uniform standards or the necessity for fighting common evils such as cyber crime promoting cooperation or the legal commitment entered into internationally by members of the WTO, all point to a state where the public governance and the corporate governance become increasingly inter-related. To the extent a country is more and closely linked with the global economy, this inter-connection also becomes stronger.

ROLE OF THE JUDICIARY

The judicial system has an important role to play in ensuring better public governance and corporate governance. There may be so many regulations, rules and procedures; but ultimately when disputes arise, they have to be settled in a court of law. There could be, of course, alternative dispute resolution mechanism such as conciliation or arbitration, but in countries like India, it is the judiciary that has to step in and ensure that healthy practices prevail.

The basic framework of the Constitution in India depends on the three main pillars, namely, judiciary, executive and the legislature. It is axiomatic that the basic structure of the Constitution is not to be tampered with. One of the areas in which the judiciary has been very active is in pointing out whether in terms of any legislation that is passed or practised, principles and laws are enacted to test whether they are in tune with the basic structure of the Constitution. This is an important provision and to that extent the judiciary is found to be clean and effective. It can be a guarantee not only for better public governance but also for better corporate governance.

GOVERNANCE IS A MATTER OF CONTINUOUS LEARNING

Ultimately, both better public governance and corporate governance are an exercise in continuous learning. We learn from experience and try to avoid the mistakes committed in the past. But when it comes to new types of crimes or new types of frauds, it is better to remember what Oscar Wilde said: ‘The thief is an artist and the policeman is only a critic.’ It does not mean that we should stop devising systems, which will be as effective as possible in ensuring that better governance prevails. Ultimately, there are two elements for better governance. First is the individual values of the people who are running the enterprise and the second is the external framework of rules, regulations, organizations and systems. Perhaps a continuous effort at sensitizing the people about the need for good corporate governance is required because, however good are the operational systems and procedures, we will not succeed if the people who are operating the systems do not have the right values.

OF GOVERNANCE AND GOVERNMENT

The present concerns of governance present a point of view that seems to suggest a singular concern for the shareholder, whether minority or otherwise. A change in this narrow perspective is essential. The discussions and practices of corporate governance have to include a stakeholder perspective. Governance has to be understood as a construct, which includes the accountability of the entity to all its stakeholders. Managing the interests of all the stakeholders is the essence of governance. Governance is as much a political process as it is economic, unlike management, which is only economic. Governance is about managing interests.

Corporate governance is as much about the organization and goals of companies as it is about the institutional environment and markets in which companies operate. Hence, it deals with the constitutions, competence and character of the board as much as it deals with internal government of the company and its rule-making processes. Corporate governance is concerned with the rule of law in the company and the respect the company has for rule of law. And for good corporate governance, the leadership of the entity has to manifest statesmen-like behaviour. Therefore, invoking the tenets of governance in every context may dilute the concept beyond recognition.

While the need to move towards desirable governance practices by Indian companies is essential, it may be useful to define these practices in wider terms within a broader perspective. Measuring such a rich and broad concept in terms of simple instrumentalities such as audit committees or accounting compliance may lead to trivializing the concept. As a consequence, companies may just present their accounts better and continue to ignore more critical and substantial governance practices. The entities at the level of the state and corporate have to recognize that governance is not merely about being compliant but about understanding the importance of compliance and accountability to stakeholders. Corporate India and the Government of India have to work hard towards this understanding.

THE SCOPE OF GOVERNMENT’s RELATIONS WITH BUSINESS

The scope of government relations with business in the context of developing countries is indeed wide and deep. The role of government in few areas are mentioned below:

  • It prescribes the rules of the game.
  • It is the major purchaser of the output of business.
  • It uses its contracting power to get business do things it wants.
  • It promotes and subsidizes business.
  • It is an architect of economic growth.
  • It protects interests of society against business exploitation.
  • It directly manages large areas of private business.
  • It is a national security protector.
GOVERNMENTS HAVE TO BE PROACTIVE IN THE FOLLOWING AREAS
  • Government should ensure that stakeholders’ interests are protected by continuous monitoring of companies, to see that they do not cheat their stakeholders.
  • Government should make laws to govern companies, to undertake all the activities within the rules of the game. It should also make sure that all companies adhere to rules, as for example—MRTP (Monopolies and Restrictive Trade Practices) Act. This Act enables the government to regulate industries wherein none of the private companies becomes a monopoly by indulging in practices that would adversely affect consumer interests.
  • If companies do not adhere to rules and regulations the government should penalize such companies and make sure that they do not repeat it again.
  • Government has appointed regulators to regulate several sectors, to monitor the activities of companies, to allow them to a have fair competition in the market and also to save them from disputes when problems arise. For example, we have the Reserve Bank of India (RBI), the Securities and Exchange Board of India (SEBI), Telecom Regulatory Authority of India (TRAI), and Insurance Regulatory and Development Authority (IRDA). These regulatory authorities have some important functions to perform to ensure better governance practices in their respective areas. They should ensure accountability, which follows from transparency. Responsibilities could be fixed easily for actions taken or not taken. Each activity in the company should be made known to all the stakeholders. A company has to be very fair to its stakeholders and inform them as to how the funds are being utilized. Regulators can also avoid insider trading through preventive measures. Regulators allow fair competion in the market. They also prevent emergence of monopolies in their sector.
ENACTMENT OF LAWS

Different laws have been enacted by the government to fulfill the needs of different people in society like employees, employers, customers and the society at large. To protect employees, government has brought in legislations such as Factory Acts, Minimum Wages Act, Labour Laws and Trade Union Act to make sure that they are well protected and their problems are solved. Through these Acts, employees are able to negotiate or bargain with their employers. Employees’ grievances are addressed by these Acts so that employees’ welfare can be taken care of by the government.

There are laws for employer protection also to save them from illegal strikes and lock-outs that cause production losses and the like.

Human Rights are protected by ensuring good quality products at reasonable prices. Pollution standards are maintained by making all companies adhere to some ecological standards. Government makes investments in capital goods industries in which most private companies can not invest because of some constraints such as huge investments and long gestation period as in the power sector, oil sector, telecom and airlines industries and so on. In the above mentioned industries, Indian government had invested huge sums of money and developed them over a long period of time. Government can also play a major role in developing and building corporate culture by taking measures to diversify investments, protect investors and boosting their confidence in times of financial crises.

AS A ROLE MODEL

Government should portray itself corrupt-free so that companies can follow its worthy example. Removal of the license system for several industries, greater transparency in administration, granting of autonomy to public sector enterprises, reducing the role of the Inspector Raj in the economy, allowing greater degree of competition in industries which were hitherto protected, will all go a long way to reduce corruption.

AREAS THAT NEED SPECIAL ATTENTION

The government should ensure that the quality of audit, which is required for effective corporate governance, should be considerably improved. Government should ensure with assistance from industry, the accountability of the CEOs and CFOs. It should try to maintain the quality and effectiveness of the legal regulatory framework as well as the administrative framework.

In the ultimate analysis, government should set an example by transparently blameless conduct of its own affairs. It should legislate, regulate, and ensure proper conduct of organizations, and enable them to adopt effective voluntary codes of conduct without the heavy hand of legislation, and, wherever possible, stimulate national debate on moral aspects of governance and help create awareness among all sections of society on the importance of ensuring better governance practices both among corporates and in civil society. In this context, it will be worthwhile to quote the view the of the Indian government in the matter of corporate governance. The government has indicated that while it believes in regulation of corporate governance standards in the country, it would not transgress to policing. Speaking at a CII conference on corporate governance trends, the Minister of Company Affairs, Prem Chand Gupta, said that the government was committed to transparency and simplification, and was opposed to any kind of policing of the corporate sector. On the long-standing debate on whether corporate governance should be regulated or flexibility should be accorded to companies vis-à-vis, their corporate governance practices, the minister counted two reasons in support of the stand for regulation. ‘One corporate failure or scandal can potentially erode shareholders, trust in the whole of the corporate sector and thus negatively affect the business of honest firms as well,’ he said, citing the examples of Enron and WorldCom, which had dented the faith of investors in the corporate sector and hurt the larger interest of the economy. ‘It is thus the responsibility of the government to prevent such occurrences.’6 Gupta further argued that the employment of a large number of public and substantial public money rides on the corporate sector.

KEY WORDS
  • Different roles of government
  • Comparative study
  • Corporate constitutionalism
  • Developing economy
  • Enactment of laws
  • Entrepreneurial role
  • Globalization
  • Government regulation
  • Government relations with business
  • Information technology
  • Limiting corporate power
  • Political governance
  • Power of coercion
  • Promotional role
  • Public governance
  • Regulatory role
  • Restraints of power
  • Role model
  • Role of judiciary
  • State intervention
  • Voluntary associations
DISCUSSION QUESTIONS
  1. Discuss the rationale for government intervention in free market economies. What are its limitations in its exercise of power in regulating business?
  2. Explain with suitable examples the different roles of governments in free market economies.
  3. Why is it necessary for the state to intervene in the development process of a developing economy? Explain this in the context of India’s economic growth.
  4. What are the limits of corporate power? In this context, discuss the role of the state in limiting corporate power.
  5. Do you think better public governance can play a decisive role in improving corporate governance? Discuss it in the context of developing countries like India.
  6. Discuss the scope of governments’ relation with business. When do you think this relationship will lead to a win-win situation?