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Corporate Governance Codes in India

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

Corporate Governance Codes in India

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


he issue of corporate governance (CG) gained prominence with the publication of Jensen and Meckling’s article (1976) which triggered a body of theoretical and empirical work on the subject. During the 1970s and 1980s, theoretical and applied research work on CG was focused primarily on US corporations. By the early 1990s similar work had been done in other developed countries such as Japan, Germany, and the United Kingdom. This was quickly followed by research on CG in emerging markets.

The debate on corporate governance in India thus draws heavily on Anglo-American experience, literature and practice. Indian corporate sector regulators have been quick to assimilate and apply international CG practices based on the latest available knowledge. But these practices do not necessarily signal convergence in the values embedded in our national culture. Given the manner in which Indian firms have evolved since independence, and the role that FIs have played, corporate governance issues and problems in India are different to those typically encountered abroad. Adopting international CG practices without suitable modification does not, therefore, help to address or resolve specific governance issues plaguing the behaviour of Indian firms. Issues such as the effect of ownership concentration on shareholder rights, the role of relationship-based activity between banks and non-bank corporations, its impact on creditor participation in corporate governance, the prevalence of insiders and promoters, the effect of social and corporate culture on disclosure, transparency and enforcement, etc, cannot be resolved simply by transplanting international CG practices.

India’s equity markets and corporate governance structures are well developed compared to other emerging markets. Yet, they have been unable to bring about a desired change in the quality of corporate governance and firm-performance for the vast majority of listed companies. Large companies that are exposed to international markets have adopted international CG standards that are generally more rigorous than those applied in India; but these are exceptions to the norm.

The recent (2004-06) rally in the Indian stock markets – buoyed by an economic growth rate of 8 per cent and an increasing appreciation on the part of global investors of India’s vast potential

– drove overseas investors to buy a record $ 10.7 billion more stocks than they sold in 2005; more than three times the net purchases of local mutual funds of $2.85 billion. All this helped push share prices significantly higher for a select group of large and medium size companies. But the rest have remained impervious to international investment. In order to sustain international investors’ interest in Indian markets over the longterm, and to spread such interest across a broader spectrum of listed companies, a stronger focus on CG issues (specific to India) and how CG can be applied to all listed firms is, among other needed changes, an imperative.

Following this line of argument, this article emphasises the relevance and importance of CG for India. It considers how Indian CG standards compare with international standards in letter and spirit, pointing out areas where espousal of international practices has made little difference and why those areas remain a challenge for the inculcation of good CG in India. The first section of this article briefly describes what corporate governance is, the importance of CG in general, as well as more specifically in India. The second section deals with the structural features of the Indian economy which have contributed to sticky corporate practices detriment to the objective of good governance. The third section illustrates how Indian CG codes compare with international standards and codes. In concluding, the article deals with issues that pose challenges to good corporate governance in India.

What Is Corporate Governance?

Issues of CG arise because of the separation of ownership from management and control in modern corporations. In economic parlance, CG issues arise wherever contracts are incomplete and agency problems1 exist. Given this separation of ownership from control and the involvement of stakeholders, CG concerns the way in which other shareholders and stakeholders can legitimately exercise influence and exert effective control over the actions of corporate managers/promoters. The discipline of corporate governance has developed as a way of ensuring that:

  • (a) investors other than promoters receive a fair return on their investment by protecting them against management expropriation or use of the investment capital to finance poor projects2 and
  • (b) other stakeholders are assured that their interests are properly catered for. CG is a system by which firms are directed and monitored.
  • Definitions of corporate governance vary widely. They tend to fall into two categories. The first set of definitions concerns itself with a set of behavioural patterns: that is, the actual behaviour of corporations, in terms of such measures as performance, efficiency, growth, financial structure, and treatment of shareholders and other stakeholders. The second set concerns itself with the normative framework for governance: i e, the rules under which firms operate with such rules being influenced by external sources like the legal system, the judicial system, financial markets, and factor (labour) markets. A comprehensive definition of corporate governance suggests that it is “the complex set of constraints that shape ex post bargaining over the quasi rents generated by the firm”3 which focuses on the division of claims. Following from that logic, CG is the complex set of constraints that determine quasi-rents (profits) generated by the firm in the course of relationships and shape ex post bargaining over them. This definition refers to both the determination of value-addition by firms and the allocation or sharing of such value among stakeholders that have legitimate relationships with the firm.4

    Importance of CG

    Worldwide the “corporation” is considered to be the essential engine driving the private sector economically. CG is critical to its competitive performance. CG is of particular importance at a time when interactions between companies and their capital suppliers are undergoing fundamental changes. Due to global deregulation and technological change, entrepreneurs and companies are exposed to a wider and more complete range of capitalraising vehicles. For corporations, this means that they can support a variety of R&D activities, spin-offs, capacity expansion and new firm creation. Greater competition for capital results in greater pressure for corporate economic performance and significant pressures on long-standing relationships with employees. Failure to adapt to efficient governance practices may well lead to restricted access to capital markets.5 On the other hand, globalisation means capital suppliers are encountering new opportunities to improve their returns. They are willing to provide capital when they are confident that their growth rests on secure foundations.6 Research shows that in both OECD and emerging market countries, well-governed companies attract premium valuations.7 Better corporate governance standards make banks and rating agencies see companies in a better light. This means lower borrowing costs for well-governed firms.8

    CG plays a critical role at every stage of the investment process. At the first stage in the investment process, effective property protection and secure methods of ownership registration are basic corporate governance provisions that influence a firm’s ability to mobilise capital. At the second stage, reliable and transparent disclosure is essential if the market is to allocate available funds efficiently among various competing ends. At the third stage, the procedures for corporate decision-making, the distribution of authority among company organs, and the design of incentive schemes are examples of governance arrangements that have to be in place to effectively monitor the capital that is handed over to firms.9

    By demanding transparency in corporate transactions, in accounting and auditing procedures, and in all business transactions generally, CG attacks the supply side of the corruption relationship, especially in developing countries. Governance helps to provide legitimacy for governments undertaking unpopular reforms by indicating to the public that the government is not merely cutting back on welfare spending, but is developing an effective corporate structure which will generate conditions for further growth. CG is important in promoting greater efficiency among domestic firms to compete with MNCs in unprotected markets.10

    CG in India

    In spite of the fact that adoption of international CG practices has made little difference in India, CG still has the potential to play a very important role in India’s long-run and sustainable economic growth. India effectively began its move towards a more open and market friendly economy in 1991. Since liberalisation, India has seen a spectacular growth in the size of its stock markets, i e, number of firms listed and the value of the shares listed or the market capitalisation. The importance of CG is reflected in the growth that Indian stock markets have made in the last decade. During the capital market boom of 1993-95, many companies that tapped the capital market for funds defaulted in their commitments and simply vanished. Hundreds of obscure companies made public issues at large premia, with the help of obscure investment banks and misleading prospectuses. The managements of these companies siphoned off more than $ 2.2 billion, saddling around 11 million small investors with illiquid stocks of defunct companies. Moreover, the continued preponderance of firms with very low market capitalisation (around 80 per cent of the total listed companies) reflects a deeprooted structural flaw in Indian capital markets. Too many of these cases represent outright fraud and inefficiency; they call for effective external and internal CG mechanisms.

    Liberalisation and its associated developments, i e, deregulation, privatisation, internal and external liberalisation of product markets as well as extensive financial liberalisation, have made effective corporate governance more crucial. These developments have meant that the availability of long-term funds to firms from development finance institutions (mostly state-controlled) has declined markedly in the past decade when the need for extrafirm finance has increased substantially. The supply of extrafirm finance is now fulfilled mainly by capital markets and by syndicated loans from commercial banks. Cases of fraud, corruption (on the part of regulators), market manipulation (on the part of securities companies, brokers) and other malpractices (on the part of firms) in the equity market can render capital market reforms desultory and lead to low investor confidence. Fraudulent companies usually crowd out public investment from equity markets and the victims of general investor apathy are “genuine” companies. Firms with poor governance are forced to finance operations and growth internally to a much greater extent. This situation can become particularly detrimental for smaller firms and pose a serious development trap in which firms find it difficult to fund their investment projects as financial institutions have atrophied in importance and capital markets have become inefficient.11 Independent and effective corporate governance institutions thus become necessary in order to restore the credibility of capital markets to facilitate the flow of investment finance to firms. International creditors are also increasingly evaluating companies on the basis of these criteria – commitment to good CG, shareholders rights, BoD, transparency and disclosure.

    A good system of corporate governance in India has long being recognised as important for the domestic economy, in that it can raise efficiency and growth; particularly when stock markets are playing an increasingly significant role in financing investment. CG has implications for the functioning of the Indian financial system in terms of: better allocation of capital over time; the ability of Indian firms to raise funds overseas and compete internationally, reducing the likelihood of a domestic financial crisis as well as an external payments crisis; and laying a strong foundation for further opening of the capital account. As India embarks on a high growth trajectory, larger current account deficits will come about, an effective CG system will ensure that these larger current account deficits can be financed with longerterm and less speculative funds, reducing the chances of an external crisis in the future, even as capital inflows increase and remaining capital account restrictions are slowly phased out. The next section deals with some structural features related financial and legal systems of the economy which have contributed to poor CG practices in India.

    Structural Characteristics

    India withstood the Asian financial crisis of 1997-98 comparatively well, but the fallout from the crisis demonstrated that the corporate sector could play an important role in transmitting financial shocks and putting the financial sector at risk. Mismatches in the corporate sector’s balance sheet brought to light both domestic and external vulnerabilities. The Asian crisis showed that the deterioration in creditworthiness of large segments of the corporate sector sharply increases non-performing loans (NPLs), curtails new investment, and contributes to capital flight, all of which adversely affects economic activity as a whole. With a comparatively low level of foreign debt as a source of funds and India’s strong foreign exchange reserve position, the exposure of the Indian corporate sector to foreign exchange risk is low at this point of time. Other than this, only good CG practices can help an economy to withstand such systemic crises.

    India’s corporate sector has grown steadily over the past two decades in terms of number of registered companies and amount of paid up capital. The corporate sector consists of closely held (private limited) and publicly held (public limited) companies, with approximately 6,19,000 registered companies in 2004, about 40 per cent of which are in the manufacturing sector. Private limited companies comprise the majority of firms in the corporate sector, but account for less than one-third of the total paid-up capital. Government-owned enterprises (both public and private limited) are comparatively few in number but large in size, accounting for more than 25 per cent of the paid-up capital.

    The ownership of India’s corporate sector tends to be concentrated in the hands of firm promoters and, to a lesser extent, small investors. Focusing on the manufacturing sector, promoters’ share was 48 per cent of the paid-up capital for all companies in 2002 and as high as 71 per cent for government-owned enterprises. The prevalence of cross-holdings of ownership, together with heavy owner participation, makes India’s system of corporate control close to an “insider” one. The share of equity held by small (public) investors in India (32 per cent) is comparable to that of the US and UK (countries with a pronounced “outsider” system), inter-corporate holdings in India are much higher. In addition, financial institutions (FIs) in India hold a much smaller share of equity as compared to other countries and have been characterised as largely passive shareholders, mostly supportive of managements’ positions.12 In the Indian business groups, the concept of dominant shareholders is unstructured for two reasons. First, the promoters’ shareholding is spread across several friends and relatives as well as corporate entities. It is sometimes difficult to establish the total effective holding of this group. Second, the aggregate holding of all these entities taken together is typically well below a majority stake. In many cases, the promoter may not even be the largest single shareholder. What makes the promoters the dominant shareholders is that a large chunk of the shares is held by state owned financial institutions which have historically played a passive role.

    The major DFIs in India played a significant role in funding corporate growth, during a period when equity markets had not evolved to their current dominant status. However, FIs did very little to monitor13 their firms, until it was too late. Even in the presence of signs of financial distress in firms, FIs made available more funds to cover losses, thus further increasing their debtequity ratios. Until 1991, the objective of financial policy in India was to maximise loans for industrial development without adequate regard to recovery and monitoring. FIs were lax in their duty of corporate monitoring because the government did not desire that any of the existing managements be disturbed. As a result, nominee directors from banks and FIs colluded with managements ignoring their dual interests as debt and shareholders. FIs rarely divested their shareholding and legal institutions provided promoters with preferential rights (irrespective of corporate performance) helping them to hold on to their shareholding.14

    The legal framework governing Indian corporate sector is based on common law. Firms are governed by the Companies Act (CA), 1956 as amended. The CA is administered by the Department of Company Affairs (DCA) and enforced by the Company Law Board (CLB) and the company courts. Listed companies must comply with the rules and regulations prescribed by the Securities and Exchange Board of India (SEBI) Act, 1992; with the Securities Contract (Regulation) Act, 1956; the Depositories Act, 1996; the Sick Industrial Companies (Special Provisions) Act (SICA), 1985; and the listing rules. Changes in the legal and regulatory framework in the post-1991 period have been key to promoting greater competition, reducing the regulatory burden, and, of late, strengthening corporate governance, which will continue to be of crucial importance to India’s growth prospects.

    Other structural feature of the Indian economy is concerned with bankruptcy and liquidation laws and procedures. These are inadequate, time consuming and contribute to poor governance by management. Bankruptcy reorganisation of large industrial organisations is governed by the Sick Industrial Companies (Special Provisions) Act, 1985 and the process is supervised by the Board for Industrial and Financial Reconstruction (BIFR). The latter tends to support the rights of existing management and of old shareholders over fully secured creditors. Liquidation poses even more serious problems. This is because most liquidation cases take between one to two decades to complete in the Indian courts, resulting in a system that works against the interests of workers and secured creditors. Since management fears neither attachment nor bankruptcy, it leads to companies funding highly risky investments, which has several adverse consequences. It raises the cost of credit, it debases the disciplining role of debt and it increasingly risks the health of the financial sector. Probably the principal reason is that the major banks and mutual funds are under the control of the government. They are buffeted by contradictory pulls by the various ministries and therefore have difficulty in focusing on commercial accountability. The government involvement also raises the moral hazard problem with the financial institutions exposing themselves to risky lending and activities, because they know that they will be bailed out by the government, if they run into difficulties.15 These features are quintessential of an inability to cede control and of shirking from responsibility. The following two sections deal with the international codes of CG and how India measures up to these practices.

    International Standards and Codes of CG

    Good corporate governance systems are rooted in an appropriate combination of legal protection of investors and some form of concentrated ownership. The US and UK systems rely more heavily on stronger legal protection, while the German and Japanese systems are characterised by more concentrated equity ownership.16

    An observer of the international governance scene commented that if corporate governance codes appeared in trade figures, Britain would have a far healthier balance of payments. The comment reflected the fact that the first corporate governance code of the modern era – that was instituted in the UK by the Bank of England and London Stock Exchange in 1992, and chaired by Sir Adrian Cadbury – spawned many imitators. Some of those codes are the Bosch Report, Australia (1995), the Cardon Report, Belgium (1998), the Dey Report, Canada (1994), the Viénot Report, France (1999), the King Report, South Africa (1994), the Peters Committee, Netherlands (1997), the Corporate Governance Forum of Japan, (1998), the Governance of Spanish Companies, (1998), the Swedish Academy Report, (1994), the German Panel on Corporate Governance, (2000), the Sarbanes-Oxley Report, US (2002), etc. At the multilateral level, efforts to improve CG by establishing international standards were spearheaded by the WTO and its member countries to develop standards that sought to help firms expand across national boundaries. International accounting bodies and national associations of accountants have worked to develop an international set of accounting standards. In addition, the World Bank, the OECD, most of the regional development banks, the UN and other national development agencies have either launched or expanded CG programmes. There are now more than 60 governance codes in 30 markets, numerous international codes, a vast number of individual governance or voting guidelines produced by individual investment institutions as well as industry codes. The core content of most of these codes can be broadly classified into three areas: (i) the independence of the board, (ii) the responsibilities of institutional investors or shareholders, and (iii) the transparency of business structure and operation.17

    The Cadbury Committee was based on a formula for governance that has become the industry standard – it developed a list of “best practice” governance standards to which companies were encouraged to aspire. Companies were then required to disclose how they measured up to the code, giving explanations for any areas of non-compliance. Its formula eschewed burdensome regulation or inflexible legislation; allowed companies to be free to develop their own governance practices; and, via disclosure, put the responsibility for improvement on investors.

    Despite different starting points, a trend towards convergence of corporate governance regimes has been developing in recent years. This has happened due to firms adapting and adjusting as a result of the increasing globalisation and integration of capital markets, the increasing exposure of policy-makers to regional and global policy fora, and the impact of those on the minds of leaders to reform is more intense now. Developing countries are increasingly adopting the Anglo-American model because: (a) many of these countries had historical ties with the Anglo-American model (their company law is firmly rooted in British company law) and (b) the apparent lack of success of previous interventionist regimes which had some elements associated with other corporate governance models. International financial institutions have also encouraged developing countries to adopt the Anglo-American model.18

    Although capital market pressures are driving convergence on common governance principles, international agreement on a single model of corporate governance, or a single set of detailed governance rules, is both unlikely and unnecessary. Economists agree that there cannot be a “one size fits all” standard as unfamiliar practices cannot be transplanted or imposed, and because individual companies and markets are always subject to local cultures, pressures and practices. Furthermore, achieving good CG generally is more exigent in emerging markets than in advanced economies for a number of reasons: corporate ownership in emerging economies tends to be highly concentrated, often in a few families, with only limited ownership by minority shareholders, takeover markets are thin or non-existent, regulatory inefficiencies, lack of judicial enforcement, lack of property rights, contract violations, asset stripping and self-dealing, etc. In reality, the rules-on-books regarding CG appear to be converging in response to the pressures of global competition; but convergence of actual CG practices is much slower in materialising.

    Nevertheless a set of universal guiding principles are relevant especially to transnationals and multinationals. In terms of the functioning of transnationals the importance of regulatory convergence becomes critical, when countries have different company codes, capital market requirements and enforcement capabilities which transnationals can use to their advantage to arbitrage. The first effort to offer a global set of principles was done by the OECD19 by attempting to harmonise practices across its 29 country members, ranging from the US to South Korea.

    Indian vs International CG Standards

    In India the legal framework for regulating all corporate activities including governance and administration of companies, disclosures, and shareholders’ rights has been in place since the enactment of Companies Act in 1956. India can be considered to be in the “post-transition regime” with a well defined and stable corporate governance structure and where the management of enterprises is through due process defined by corporate law.20

    The Securities and Exchange Board of India (SEBI), an independent quasi-judicial, regulatory body, regulates the stock exchanges. Corporate governance requirements in India are largely based on recommendations of the Cadbury and Higgs Reports and the Sarbanes-Oxley Act. SEBI has been proactive in keeping India’s corporate governance rules and regulations in line with best practices around the world. In 1999, SEBI appointed the Kumar Mangalam Birla Committee to recommend improvements to the corporate governance framework. In 2002, SEBI updated its listing requirements with Clause 49.21 These listing requirements were again changed in 2004 to incorporate some best practices laid out in the Sarbanes-Oxley Act. SEBI has also issued regulations relating to the acquisition of significant shareholdings, takeovers, share buy-backs and insider trading. Bankruptcy and anti-competitive laws are also in place. There is currently a bill in Parliament to revamp the Companies Act of 1956, which was amended as recently as 2002.

    All listed companies were required to be in compliance with Clause 49 by December 31, 2005. Companies are required to provide information regarding their governance practices in a separate Corporate Governance section in the annual report to shareholders in which non-compliance with any mandatory requirements, and the extent to which non-mandatory requirements have been adopted, should be highlighted. Clause 49 also requires companies to file a quarterly compliance report with the stock exchange. The stock exchange in turn is required to file an annual compliance report with SEBI for each listed company.22

    The accompanying table highlights some of the differences between International CG codes and the existing Indian CG codes. All divergences from international best practices are associated to the unique structural characteristics of the Indian economy as highlighted in the table.

    Challenges to Promoting Good CG

    The challenges to promoting a good CG culture in India faces problems at two distinct levels i e, at the firm level and at the macro or extra-firm level. These follow from the non-conducive structural features of the Indian economy. At the firm level, the most striking and commonly agreed failures of CG practices in India have been the widely perceived (a) ownership structure in companies, (b) failure of boards, (c) accounting practices and transparency. Ownership structure in companies: In the private sector, most large Indian companies are a hybrid of family-owned conglomerates and publicly listed companies. Indian conglomerates have been successful in competing against multinational corporations by streamlining costs and rationalising businesses. However, the broader corporate governance structure in Indian companies generally remains poor. The endemic features of these conglomerates are: ownership and management are not segmented, there is informality of governance policies and inadequate controls, the ownership structure of individual companies within the conglomerates is usually opaque, often the controlling family retains control by creating complex crossholdings among subsidiaries, related-party transactions among subsidiaries and, in particular, related lending is opaque. Ownership of Indian familycontrolled companies is now moving into the second or third generation. It is therefore imperative that further reforms need to address the specific concerns facing the family-owned conglomerate structure. It is important that, among other things, family-owned companies focus on; voluntarily adopting mechanisms for governance of the family’s ownership stake; for example, creating family councils that deal with family disputes, reforming company boards by increasing overall board independence and reducing the number of family member-directors; limiting the role of family members in senior management and increasing transparency around the ownership structure and related-party transactions. Failure of boards: Boards in India do not exist as institutions of governance and truly independent directors are rare in Indian companies. There is a lack of clear understanding of what is expected from the directors in terms of their duties of care and loyalty to the company and its shareholders. In most cases therefore directors are simply for “rubber stamping” the decisions of management or promoters. Much needs to be done in terms of improvement in the constitution and functioning of the boards and their regard for minority shareholders’ rights. A key missing ingredient is a strong focus on director professionalism. In addition to the law or other regulations spelling out the responsibilities of directors, they themselves should engage in the formulation of their tasks and work procedures. The presence of FIs’ nominees is the most distinctive feature of Indian corporate governance system, and consequently the “failure” of corporate governance in India is often seen as a failure of the FIs to safeguard the general shareholder interest. The domestic financial institutions’ nominee system has been widely criticised and there has also been a strong campaign to remove nominees from boards, further reducing the accountability of boards. FIs’ nominees have been criticised on the grounds that their calibre is low, their contribution is minimal, and that they lack competence to understand the nature of the business. But the FIs’ nominees lack the right incentives to perform their duties with enthusiasm. There has been a constant pressure on FIs for reform of the governance culture of Indian businesses. Consequently, the FIs decided on radical ideas of a block sale of their equity holdings to effect a management change in the interests of a company. But this idea did not meet with much success because of a strong business lobby backlash that has chosen to make the issue of institutional nominees central to the debate on governance on the grounds that their access to price-sensitive information make institutions insiders.26 Accounting practices and transparency: Although, FIIs have been responsible for improvements in disclosure standards, levels of disclosure remain poor, accounting standards weak, and Indian corporate structures low in transparency. In India the level of disclosure is abysmal and creative accounting is extensive. The greatest drawback of financial disclosures in India is the absence of detailed reporting on related party transactions. At the level of the balance sheet, there is no requirement to report which investments and loans made by the corporation are to subsidiaries and associated companies. Auditor independence is another problem because of a large and segmented market in accounting services and the perceived powerlessness of auditors in the face of corporate pressure. Chartered accountants argue that despite the absence of consolidation, Indian financial statements give enough information for analysts to reconstruct the true picture of a group of companies. For most users of financial statements, however, the absence of consolidation27 leads to misrepresentation of the true picture of a business group as it does not disclose related party transactions or transactions with affiliated companies. There is also a further need for the harmonisation of Indian accounting system with an internationally accepted standard like the US GAAP.

    At the extra-firm level, CG problems relate to (a) surveillance and enforcement mechanisms and the court system, (b) insufficient powers of SEBI to police violations of regulations, (c) lack of shareholder activism in India. Surveillance and enforcement mechanisms and the court system: Although laws in India are generally comparable to those in the UK, the court system is seen as inadequate to handle the volume of cases being brought to trial. This results in delays in the delivery of justice. Verdicts are handed over 10 to 20 years after the incidences have occurred. Furthermore, corruption in the lower courts, delays the delivery of verdicts and increases the cost of litigation. Also, judges in lower courts who preside over murder trial are expected to be conversant with corporate law and preside over white-collar crimes like fraud. An amendment to the Companies Act of 2002 required the establishment of special courts to handle securities and finance-related crimes. Three years

    Table: Corporate Governance – Differences between International and Indian Codes

    Shareholders’ Rights

    Secure methods of ownership registration Yes Shares traded through a stock exchange are held in dematerialised form in the depositories. Companies must

    convey or transfer shares. maintain a register of shareholders or outsource this function to a share transfer agent. Shares are freely transferable. Guarantee funds largely eliminate settlement risk.

    Voting Rights Yes All shares are equal within one class. Indian companies to issue shares with multiple voting rights or dividends as long as such shares do not exceed 25 per cent of share capital and shareholders approve the issuance. Non voting preferred shares exist, but are not popular.

    Institutional investors and their voting rights No Pension funds do not play a corporate governance role. The Unit Trust of India (UTI), the Life Insurance Company (LIC) and the General Insurance Company (GIC) are the three largest institutional investors and are government owned. Together, they own 15-20 per cent of the listed sector. These institutions seldom exercise their voting rights but exert influence through directors nominated to the board of their portfolio companies.

    Proxy Voting Yes No notarisation required; registration 48 hours prior; no postal ballots.

    Cumulative Vote/Proportional Representation No

    Shareholder Meetings/Other Rights Yes The annual general meeting (AGM) be held every year, a notice convening the meeting be sent to all shareholders at least 21 days in advance of the meeting. Shareholders controlling 10 per cent of voting rights or paid-up capital to call a special or Extraordinary General Meeting (EGM), quorum at the AGM may not sufficiently protect minority shareholders. Shareholders may inspect the minutes of the AGM.

    Minority Shareholder Protection Yes The legal structure for corporate governance in India provides for strong minority shareholder protection compared with other emerging markets. Clause 49 stipulates that there must be a board-level shareholder grievance committee to address such disputes, and that a non-executive director must chair this committee. In theory India’s legal framework provides for strong minority shareholder protection, in practice minority shareholders cannot always garner the strength to exercise their voting rights together.

    Share in the profits of the corporation Yes The board of directors proposes the dividend, and the AGM approves it. Dividends must be paid within 30 days. As for complaints about transfer of shares and non-receipt of dividends while the redress rate has been an impressive 95 per cent, there were still over 1,35,000 complaints pending with the SEBI.

    Take-over Code Yes Increasing takeover activity.

    Insider Trading and Self-Dealing Prohibition Yes Criminal offence, but difficult to monitor due to multiple listings.

    Pre-emptive Rights Yes

    Changes in firm capital structure Yes Acquisition of more than 15 per cent of shares or voting rights requires the acquirer to make a public offering. To approve a merger, under SEBI’s regulations a shareholder vote of 75 per cent is required. New capital issues first be offered to existing shareholders in proportion to their shares of paid-up capital.

    Stakeholders rights Yes The corporate governance framework requires the board of directors to discuss material issues regarding employees and other stakeholders. Civil courts discourage creditors from litigating on issues relating to governance, citing “indoor management” policy. Promoters are not eligible for stock options. There is no ceiling on how many stock options can be issued. The options are tied to specific performance goals and vested over a time period – typically three to six years. The quality of the information varies markedly between the first two hundred listed companies and the rest of the market.

    Oversight of Management

    Board Structure

    Independent Directors No Mandatory for large companies as of March 2001 and for most small companies in 2003: If chairman is also CEO, ≥50 per cent; if not, ≥30 per cent. Despite the requirement for board independence, the availability of trained independent directors in India is limited.

    Board Meetings No The board should meet at least four times a year, board quorum only requires that 33 per cent of board members or two members, whichever is greater, be present. There is no provision that specifies whether non-executive or independent members need be present.

    Nomination and Election of Directors No Founder/promoters or controlling shareholders generally appoint directors. There is limited scope for minority shareholders to recommend director nominees.

    Committee Practices No Mandatory for large companies as of March 2001 and for most small companies in 2003.

    Disclosure and Transparency

    External Auditors Yes Annual statements audited. Auditors appointed/removed at AGM.

    Consolidated Statements No If ownership interest ≥50 per cent abridged data mandatory in annual report.

    Segment Reporting No Expected to be implemented soon.

    Disclosure of Price Sensitive Information Yes To the correspondent stock exchange and SEBI. SEBI’s Insider Trading Regulations, 2002, require every company to appoint a compliance officer who is responsible for setting policies, procedures, and monitoring adherence to the rules for the preservation of “price sensitive information” to prevent insider trading. There is no good legal definition of insider trading, which hampers surveillance efforts.

    Other Responsibilities No No provisions in the Indian governance framework for a investor relations programme and to provide a policy statement concerning environmental issues and social responsibility.

    Audit Committee Yes Minimum of three directors as members, with at least two-thirds of the members being independent. Clause 49 does not prohibit the contemporaneous provision of audit and non-audit services from the same entity.

    Accounting – Standards and Enforcement ICAI23 sets out standards monitored by SEBI and ICAI. Not in full compliance with IAS.24

    Company Officers related Disclosures Yes Aggregated remuneration info is required in annual report. In 2001, breakdown of remuneration by director must be provided.

    Related Party Transactions Yes Clause 49 requires listed companies to disclose materially significant related-party transactions in the Report on Corporate Governance in the annual report to shareholders, however, it does not define the term “materially significant”.

    Disclosure of Ownership Yes To SEBI and stock exchanges when ownership crosses 5 per cent.

    Risk Management and other Disclosures The law prescribes that companies have to be rated by approved credit rating agencies before issuing securities.

    Regulatory Environment25 Yes The weak enforcement mechanism in the country is a key concern.

    Sources: World Bank and IIF Report, 2006.

    after the amendment, the government is still in the process of identifying and appointing qualified judges. Insufficient powers of SEBI: Despite incorporating several positive features and raising the standards in the company law, and at the level of securities market and the regulatory authority, their implementation has proven to be challenging. This is partly because SEBI has insufficient powers to police violations of regulations. Although stock exchanges in India have responsibility for surveillance, they do not have the authority to take punitive action against errant companies. Indian regulatory structure is segmented where the authority and responsibility for surveillance and enforcement is divided among various entities, leading to a mismatch between the level of authority and responsibility. The same fate awaits a proposed bill in Parliament to revamp the Companies Act of 1956 to simplify procedures by moving to a rules-based system. When and if the bill passes, the voluminous provisions in the current act would be reduced by two-thirds from the present roughly 780 provisions. But it is unclear who will have the authority to set the rules. India’s corporate governance environment is characterised by a lack of an infrastructure relating to the surveillance and enforcement mechanisms and the court system.28 Shareholder activism: in India is practically non-existent. There are several explanations for the lack of shareholder activism in the Indian equity market. In India promoters typically retain control of companies by owning a small, yet significant, ownership stake in companies. Shares not owned or controlled by the promoter and his family and friends are widely dispersed, making it difficult for minority shareholders to voice their concerns. Although FII’s increasingly own a large number of shares in Indian companies, in general, no single minority shareholder owns enough shares to significantly influence change. Therefore, even though there are laws that empower shareholders controlling 10 per cent of equity, the dispersed nature of ownership of shares makes it difficult for minority shareholders to take a more active role in the management of the company. Pension and insurance companies in India are owned by the government and constitute a large part of the state-owned sector. The Indian government has only recently begun allowing private sector companies to engage in these activities. The government strictly regulates the instruments in which pension funds can invest. Some companies like LIC and UTI have significant stakes in Indian companies but are not activist shareholders. As a result in India there is no large institutional shareholder engaged in shareholder activism through its investment decisions like Calpers in the United States. Lastly, the time taken to deliver verdicts through the court system in India is inordinately long. This acts as a deterrent for minority shareholders to pursue legal action against companies.

    In addition, lack of trained staff at the stock exchanges and SEBI to effectively scrutinise compliance, the high transactions costs in both the primary and secondary equity markets making takeovers difficult, little competition among financial intermediaries and the state-run intermediaries and their significant amount of bad loans, which affect their ability to act as monitors29

    – have made the Indian corporate governance deficient.


    Despite a long corporate history, the phrase “corporate governance” remained unknown until the late 1990s in India. It came to the fore due to a spate of corporate scandals that occurred after the first phase of economic liberalisation. The above discussion has shown that ownership concentration, prevalence of insiders and principal promoters, lack of protection for minority shareholders, lack of strict enforcement rights of regulatory authorities, disregard for disclosure norms and transparency are some of the endemic features of Indian corporate governance regime. These features have restricted Indian corporate sector’s progress on the path of good governance principles. Hence, it can be concluded that despite India’s best efforts to adopt the best international CG practices, their implementation has remained inadequate due to reasons of path-dependency.

    CG practices the world over have evolved over time and are still evolving in response to various corporate failures and systemic crises. The focus to date has been on the structural and process elements of governance. But to achieve truly effective corporate governance, companies need to view this issue as a strategic challenge instead of simply responding to recurring imposition of new requirements. The task of adapting, refining and adjusting corporate governance practices is an ongoing process. Corporate governance should therefore be considered as “work in progress” and its practices should be reviewed systematically and periodically.




    1 The principal-agent theory is generally considered as the starting pointfor any discussion on corporate governance. It recognises property rightsinside the corporation and the different ways in which relations amongowners, managers, directors and other stakeholders are structured. Thistheory assumes that shareholders, managers, creditors and employees havedifferent preferences regarding the firm’s resources. This approach contrastswith the neoclassical financial theory, which looks at the corporation asa single entity dedicated to profit maximisation. Separation of ownershipand management control is a quintessential, endemic feature of the modernlimited liability corporation. In a firm owned entirely by an individual,all the net benefits and costs accrue to him or her. Conversely, in a diffuselyowned firm, the divergence between the accrual of benefit and costs ismuch larger for the typical fractional owner; he or she usually respondsby neglecting some tasks of ownership. Agency costs include the costsof structuring, monitoring and bonding a set of contracts among agentswith conflicting interests and asymmetric information.

    2 Shleifer and Vishny, ‘A Survey of Corporate Governance’, Journal of Finance, 52, June 1997, pp 737-84.3 Luigi Zingales, ‘Corporate Governance’, The New Palgrave Dictionaryof Economics and the Law, Macmillan, London, 1998. 4 Stijn Claessens, ‘Corporate Governance and Development’ World BankReport 2004.

    5 I Millstein, Michel Albert, Sir Adrian Cadbury, Robert Denham, DieterFeddersen and Nobuo Tateisi, ‘Corporate Governance: Improving Competitiveness and Access to Capital in Global Markets’, OECD Report 1998.

    6 Confidence is established by the practice of good CG and the presenceof basic building blocks like: an effective legal and regulatory systemthat minimises the prospects of their capital being squandered or stolen;a board of directors that genuinely guards shareholder interests and value;properly audited accounts that give a real view of the company’sperformance; a fair voting process that allows them to be consulted beforemajor corporate decisions are taken; transparent corporate reporting thatoffers a real-world view of the company’s future prospects; and thefreedom to sell their shares at any time to the highest bidder without anycomplications or restrictions.

    7 (i) Well-governed firms in Korea traded at a premium of 160 per centto poorly governed firms, a study by Korean and US researchers found.

    (ii) An ABN/AMRO study showed that Brazil-based firms with the bestcorporate governance ratings garnered P/E ratios that were 20 per centhigher than firms with the worst governance ratings. (iii) A study of S&P500 firms by Deutsche Bank showed that companies with strong orimproving corporate governance outperformed those with poor ordeteriorating governance practices by about 19 per cent over a two-yearperiod. (iv) A Harvard/Wharton study showed that if an investor purchasedshares in US firms with the strongest shareholder rights, and sold shares in the ones with the weakest shareholder rights, that investor would haveearned abnormal returns of 8.5 per cent per year. (v) In a 2002 McKinseysurvey, 6 institutional investors said they would pay premiums to ownwell-governed companies.

    8 A study by International Finance Corporation.9 Bill Witherell, ‘Corporate Governance and Responsibility: Foundationsof Market Integrity’, OECD, 2002.10 Daryl Reed, ‘Corporate Governance Reforms in Developing Countries’,Journal of Business Ethics, 3 (2002): 223-47.11 L Som, Stock Market Capitalisation and Corporate Governance, Oxford University Press, Delhi, 2006.

    12 Sarkar and Sarkar, 1999, ‘Large Shareholder Activism in CorporateGovernance in Developing Countries: Evidence from India’, IGIDR Working Paper.

    13 The nature of ineffective monitoring was evident in the project appraisal andevaluation, supervision of projects and mechanisms to anticipate problemsand take a proactive role in tackling them through managerial, technicaland/or financial assistance in time to projects/enterprises which did notperform as well as anticipated at the time of project appraisal. The primaryreason for the lack of adequate monitoring of enterprises has been thefailure of the lead development bank to evolve mechanisms of coordinationwith the commercial banks, which provided working capital finance(Cherian 1996).

    14 Omkar Goswami, ‘The Tide Rises Gradually Corporate Governance inIndia’, OECD Development Centre Seminars, 2001.

    15 Goswami, Omkar, ‘Legal and Institutional Impediments to CorporateGrowth’, Policy Reforms in India, OECD Development Centre Seminars, 1996.

    16 Shleifer and Vishny, ‘A Survey of Corporate Governance’, Journal of Finance, 52, June 1997, pp 737-84.

    17 L Som, Stock Market Capitalisation and Corporate Governance, Oxford University Press, Delhi, 2006.

    18 Daryl Reed, ‘Corporate Governance Reforms in Developing Countries’,Journal of Business Ethics, 3, 2002, pp 223-47.

    19 The OECD offered guidelines under five headings; the rights ofshareholders, the responsibilities of shareholders, the rights of stakeholders,disclosure and transparency, the role and structure of the board.

    20 Masahiko Aoki, 1995, ‘Controlling Insider Control: Issues of CorporateGovernance in Transition Economies’ in Masahiko Aoki and Hyung-KiKim (eds), Corporate Governance in Transitional Economies: InsiderControl and the Role of Banks, EDI, World Bank.

    21 In addition to mandatory requirements, Clause 49 provides a list of nonmandatory requirements, which promotes governance practices such ascreating a board level remuneration committee, training for board members,conducting board member evaluations and establishing whistle blowermechanisms.

    22 A Report by International Institute of Finance, Washington, 2006.

    23 The Institute of Chartered Accountants of India.

    24 International Accounting Standards.

    25 SEBI is an independent quasi-judicial body that plays an active regulatoryand development role in India’s security market. The central governmentappoints the chairman and may nominate a maximum of nine othermembers. The body is funded by contributions from public financial andinstitutional institutions, banks and the government of India. The Ministryof Company Affairs (MoCA), regulators like RBI and SEBI and stockexchanges have surveillance functions. MoCA has surveillanceresponsibility over unlisted. For listed companies, stock exchanges areconsidered to be the first line of defence followed by SEBI. RBI overseescompanies in the banking and financial sector.

    26 Jairus Banaji, 2000, ‘Investor Capitalism and the Reshaping of Businessin India’, Queen Elizabeth House (QEH) Working Paper, No 54. Jairus Banaji and Gautam Mody (2001), ‘Corporate Governance and theIndian Private Sector’,Queen Elizabeth House (QEH) Working Paper, No 73.

    27 The 1997 Bhave Committee report recommends consolidation of accounts,segment reporting, and deferred tax accounting. Consolidation wouldstrengthen transparency by helping to disclose the true extent of liabilitieswithin business groups, unearthing the complex maze of cross-holdingsthrough which promoter families have traditionally secured and fundedcontrol over corporate empires, and revealing the true economic strength ofindividual groups through the ‘netting out’ of transactions (Banaji, 2001).

    28 A report by International Institute of Finance, Washington, 2006.

    29 T Khanna and Krishna Palepu, ‘Corporate Governance: Evidence fromInfosys and the Indian Software Industry’ Harvard Business SchoolWorking Paper No 02-040, September 2001.


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