Corporate Governance Voluntary guidelines 2009: A study


Citizens never support a weak company and birds do not build nests on a tree that does not bear fruits” Minister Salman Khurshid quoted Arthshastra while introducing Corporate Governance Voluntary Guidelines 2009 (CGV Guidelines). These guidelines being recommendatory in nature, focus on fairness, transparency, accountability and responsibility by Indian Incorps. CGV Guidelines are set of standard practices which may be voluntarily adopted by the public companies, and big private companies. In the present article we have tried to capture significant policies of the CGV Guidelines and their implications.

The CGV Guidelines suggest guidelines with reference to the below:

I Board of Directors A. Appointment of Directors

B. Independent Directors

C. Remuneration of Directors

II Responsibilities of Board A. Training of Directors

B. Quality Decision Making

C. Risk Management

D. Evaluation of Performance of Directors

E. Board to ensure compliance of law

III Audit Committee A. Constitution

B. Powers

C. Roles and Responsibilities

IV Auditors A. Appointment

B. Certificate of Independence

C. Rotation of Auditors

D. Clarity of Information

E. Internal Auditor

V Secretarial Audit
VI Whistle Blowing Mechanism

An incorporated company has perpetual succession and separate legal identity; but it needs people to run it. The key driver of a company is its management, which includes its Board of Directors (BoD) and key Managerial personnel. A company is run by its management but there are several stakeholders in a company, such stakeholders[1] whose interest is directly or indirectly affected by the performance of company. The stakeholders are dormant and the day to day functions of a company are discharged by its management. The immense powers in the hand of management come along with greater responsibilities, however regrettably constant lapses have been found on the part of management in discharge of their duties and functions. Though there are various statutes and guidelines which govern the management of the company and its functioning, but undoubtedly there are some gray areas yet. Besides advocating transparency and increased disclosures in Annual Report, company’s website, and stock exchange website if company is listed, the guidelines have brought in clarity into certain standard corporate practices such as tenure of Independent Director, remuneration etc. The suggestive guidelines are a further step to strengthen the Corporate Governance framework for Indian Incorps.

Board of Directors

The Board should consist of a balanced combination of Executive Directors and Non-Executive Directors, so as to take a proper and reasoned decision. The Directors are appointed in a company in a General meeting as per the provisions of the Act, however the policies and terms of appointment of a Director vary from company to company and from director to director. The guidelines suggest formal letters of appointment to Non-Executive Directors and Independent Directors, clearly stating the term of the appointment, fiduciary duties, liabilities and remuneration of the appointed Director. The Non-Executive Directors and Independent Directors should be recommended by nomination committee, comprising of majority of Independent Directors including its Chairman. The nomination committee should clearly set out the guidelines  for evaluating the skill, knowledge, experience and effectiveness of individual directors. The Independent Directors should provide a certificate of independence at the time of appointment and thereafter annually. Further to ensure independent approach of Independent Directors, the maximum tenure for Independent Director in a company should not be more than six years, and a period of three years should elapse before such an individual is inducted again in the same company in any capacity. No individual may be allowed to have more than three tenures as Independent Director in a company and the maximum number of pubic companies in which an individual may serve as an Non-Executive Directors/Independent Directors should be restricted to seven. Independent Directors should be allowed to have the option and freedom to meet company management periodically to enable them to study and analyze various information and data provided by the company management.

A Chairman of a company presides over the Board meetings, he has a casting vote in decisions of the Board, whereas Chief Executive Officer(CEO) is incharge of day to day functioning and the management of affairs of the company. Both the positions are senior and helps to provide a check within the top level management. However in a number of Indian companies, the position of Chairman and CEO is enjoyed by the same individual, resulting in unfettered decision making power with a single individual. Thus the guidelines suggest separation of offices of Chairman & CEO, and a clear demarcation of the roles and responsibilities of the Chairman of the Board and that of the Managing Director/CEO such as to promote balance of power .

Remuneration of Directors and senior managerial personnel is an arena which in most vulnerable to  conflict of interest between management and stakeholders. Though there are legal provisions set to govern managerial remuneration, there is a more discipline required through these guidelines which suggest to clearly lay down and disclose Remuneration Policy for the members of the Board and Key Executives. The companies should pay either a fixed contractual remuneration to its Non-Executive Directors, or an appropriate percent of the net profits of the company. The structure of compensation to Non-Executive Directors may have a fixed and variable component based on attendance in Board and Committee meetings. Whereas the Independent Directors should be paid adequate sitting fees(not stock options) which may depend upon the twin criteria of Net Worth and Turnover of companies. The company should form a Remuneration Committee for determining the remuneration of executive directors and executive chairman including compensation payments. The Remuneration committee should consist of at least three members, majority being non executive directors with at least one being an Independent Director. Further no director is to be involved in deciding his or her own remuneration. The committee should also determine principles, criteria and the basis of remuneration policy of the company and any deviation from such policy, should be brought to the notice of shareholders with justification/reasons.

Responsibilities of the Board

  1. Generally the Non-executive Directors and Independent Directors do not take active part in the day-day functioning of the company and may not be aware of the technical and operational details. The companies should have a proper induction program for Directors, also providing adequate training to familiarise them with the operational aspect of the company.
  2. The Board should ensure that there are systems, procedures and resources available to ensure that every Director is supplied, in a timely manner, with precise and concise information in a form and of a quality appropriate to effectively enable/discharge his duties. The Directors should be given substantial time to study the data and contribute effectively to Board discussions.
  3. The Board, its Audit Committee and its executive management should collectively identify the risks impacting the company’s business and document their process of risk identification, risk minimization, risk optimization as a part of a risk management policy; and should make disclosure in the Directors’ Report..
  4. A formal and rigorous annual evaluation of its own performance and that of its committees and individual directors.
  5. The Board should place systems to ensure Compliance with Laws, to safeguard shareholders’ investment and the company’s assets. It should review of the effectiveness of the company’s system of internal controls and should report to shareholders.

Audit Committee of Board

Section 292A requires every company with a paid up capital not less than five crores to have a Audit Committee to ensure compliance of internal control systems. Listing agreement has also provision for Audit Committee, which is applicable to listed companies. Now, the guidelines also suggest that the companies should have at least a three-member Audit Committee, with Independent Directors constituting the majority. The Chairman of such Committee should be an Independent Director. All the members of audit committee should have knowledge of financial management, audit or accounts. The Audit Committee should have the responsibility to –

  • monitor the integrity of the financial statements of the company;
  • review the company’s internal financial controls, internal audit function and risk management systems;
  • make recommendations in relation to the appointment, reappointment and removal of the external auditor and to approve the remuneration and terms of engagement of the external auditor;
  • review and monitor the external auditor’s independence and objectivity and the effectiveness of the audit process.
  • monitor and approve all Related Party Transactions including any modification/amendment in any such transaction.

Auditors

The Statutory Auditors of a company verifies and states that the financial statements of the company reflect a true and fair view of the state of affairs of the company. The Auditor acts as a watchdog and protect the interest of the stakeholders. The CGV Guidelines suggest appointment of Auditors should be referred by the Audit Committee. Every company should obtain a certificate of independence from the auditor certifying his/its independence and arm’s length relationship with the client company.

Since the havoc created by Satyam episode in December 2008, where the leading audit firm failed to check deep irregularities in the financial statements of a giant IT company leading to fraud of billions of rupees of a publicly listed company, there has been constant attempts to make and implement a rule for rotation of Auditors. The CGV Guidelines suggest that a policy of rotation of auditors should be adopted where a Audit partner should be rotated once every three years, whereas an Audit firm may be rotated once every five years. A cooling off period of three or five years should elapse before a partner or audit firm respectively, can resume the same audit assignment.

Further to strengthen the independence and credibility of the internal audit process, an internal auditor should be appointed, not being an employee of the Company.

Secretarial Audit

Good corporate governance practices enhance companies’ value and stakeholders’ trust; hence it is essential to ensure transparent, ethical and responsible governance of the company. A company can ensure standard corporate governance practices through Secretarial Audit by an Independent Professional.

Institution of mechanism for Whistle Blowing

The term whistleblower derives from the practice of English (policemen), who would blow their whistles when they noticed the commission of a crime. The whistle would alert other law enforcement officers and the general public of danger. In corporate parlance, whistle blowing is a mechanism for employees to raises a concern about wrongdoing occurring in an organization or body of people, such as suspected fraud or violation of the company’s code of conduct or ethics policy. The guidelines suggest to set up whistle blowing mechanism to track frauds or non-violation occurring in the company. However it is also essential to have adequate safeguards against victimization of employees who avail the mechanism.

Conclusion

“Good corporate governance practices are a sine qua non for sustainable business that aims at generating long term value to all its shareholders and other stakeholders”. It is strong fundamentals and ethical behavior in a company that can help it overcome huge crisis. Compliance with good governance practices should not be regarded as regulatory requirement but rather as an opportunity and value proposition for organisations. Investors all around the world notice companies with clean governance, and this appreciation leads to higher valuation of such organisation. The CGV Guidelines is a benchmark for the corporate governance practices in the Indian Incorps, and hopefully the corporate world will make the best use of it.

Author: Neha Singhi

Contact: +91-33-40083385

neha@nehasinghi.com

Date: January 8, 2010


[1] Stakeholders include shareholders, creditors, financiers, consumers, government, employees and public at large.

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