Corporate Governance Reforms in India PDF

CHAPTER-IV
CORPORATE GOVERNANCE REFORMS

IN INDIA
CHAPTER-IV
CORPORATE GOVERNANCE REFORMS IN INDIA
In India the Corporate Governance is not a new concept it is as old as
‘Kautilya’s Arthashastra. From the point of king he laid down four principles of
Governance: -
a) Raksha - means protection;
b) Vridhi - means enhancement;
c) Palana - means maintenance; and
d) Yogakshema - means safeguard.1 2
According to Kautilya ideal king is one for whom “Praja Sukhe, Sukham ragyam”.
Which means in the happiness and well-being of the subjects, lies the well-being of
the king, the welfare of the subjects, is the welfare of the king, what is desirable and
beneficial to the subjects and not his personal desires and ambitions, is desirable and
beneficial to the king. And “it is the duty of the king to protect the wealth of the state
and its subjects, to enhance the wealth, to maintain it and safeguard it and the interest
of the subjects”. This concept of duties of a king is quite relevant in the regulation of
corporate sector.
The corporate sector in India is at cross roads in respect of legal structure and
internal management, control and administration. Numerous issues are before it, for
instance, tax evasion, mismanagement scandals, misappropriation etc. The
1 Sanjeev Agarwal., Corporate Governance Concept and Dimension, Snow-white Publications, Part -
II, p.18.
2 Ibid.
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government, as the ruler i.e. like king, need to have an urgent look at the whole
scenario prevailing in the country to ensure good Corporate Governance.
In the context of globalization the profile of corporate ownership is changing
with the increasing flow of foreign investment, preferential allotment of shares to the
promoters of companies and the new role being given to the institutional investors, the
qualitative improvement in the Corporate Governance is the need of the time.
Improvement in the Corporate Governance based on a code of good governance
practices and meaningful disclosure of information to shareholders hold the key to
corporate success. To reach the benefit of good Corporate Governance to the
investors, customers, lenders of finance and to the society at large, there must be
better governance and management of corporate bodies, prompt compliance of legal
and financial obligations and adherence to ecological and environmental standards.
4.1 Corporate Governance: Regulatory Framework
Corporate Governance deals with the laws, procedures, rules etc relating to
corporate functioning in the country. The present system comprises-
a) Companies Act, 1956 - board of directors,3 meetings,4 management,5 conduct
of meetings,6 appointment or removal of auditors7 or directors,8 director’s
3 Section 252, The Companies Act, 1956.

4 Section 285.
5 Section 291 to 293.
5 Section 285 to 290.
7 Sections 224 (5) 224 A and 225.
8 Sections 263&284.
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responsibility,9 corporate restructuring mergers,10 inter corporate activities,
audit committee,*11 accounting standards,12 shareholder’s directors,13 postal
ballots14 etc.
b) Monopolies and Restrictive Trade Practices Act, 1969- for control of
monopolistic acts, restrictive and unfair trade practices and control consumer
interest.15
c) Foreign Exchange Management Act, 2000- for control and monitoring of
activities of foreign flow of funds, investments and investors.
d) Sick Industrial Companies (Special Provision) Act 1985 and Board of
Industrial and Financial Reconstruction (BIFR).16
e) Securities and Exchange Board of India Act, 1992 - In this Act Rules and
Regulations are made to deal with unfair Trade Practices, insider trading,
takeover and mergers, raising money from the market and regulation of
secondary market.
f) Securities Contract Regulation Act 1956.
g) Listing Agreement of Stock Exchanges.
h) The Depositories Act, 1996.17
9 Director is an officer under section 5. He is liable in any cases for non-compliance of the statutory
provision.
10 Section 391.
11 Section 292A.
12 Section 210A.
13 Section 252.
14 Section 192A.
15 Competition Law.
16 Replaced by insolvency law and National Company Law Tribunal.
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i) Consumer Forums.
j) Arbitration and Consultation Act, 1996.
k) Codes prescribed by Chambers/Self Regulatory Organizations.
l) SEBI code on Corporate Governance.
The Companies Act 1956 is the principal legislation providing formal structure
for the Corporate Governance. Also MRTP Act (Now Competition Act 2000),
FEMA, IDR Act and other economic legislation also have bearing on the governing
the corporate activities. Now SEBI has assumed greater role, especially after New
Economic policy of 1991.
4.2 Corporate Governance: Reforms
Improvement of Corporate Governance acquired global attention; India cannot
be a silent spectator. To cope with the global demand, to attract foreign investment as
well as to protect domestic investors, it has taken in right spirit and adopted good
corporate practices of other countries. This is evident from the various legislative
changes being brought in, in the last couple of years in corporate legislations and law
relating to capital market. All these changes were made on the recommendations of
various committees, such as.
1) CI.I. Committee on Code of desirable Corporate Governance, 1998;
2) UTI Committee on Code of Governance 1999;
17 The companies (amendment) Act 2000 added S.60-B, which requires that every public company,
making initial offer of securities of Rs.10 corer or more, should issue the securities in dematerialized
form hence the depositors act 1996 made certain regulations. A depository is an organization, which
holds securities in the form of electronic accounts in the same way as a bank holds money. National
Securities Depository Ltd (NSDL) and Central Depository Services (India) Ltd (CDSL) are the two
depositories in India.
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3) Kumar Mangalama Birla Committees on Corporate Governance, 2000.
4) Naresh Chandra Committee on Corporate Audit and Governance, 2002 and
5) N.R.Narayan Murthy Committee (SEBI) 2003.
Following is the analysis of some of the recommendations of the committees reefed
to above.
4.2.1 Confederation of Indian Industry (C.I.I.) Desirable Corporate

Governance in India, 1998
C.I.I.s Corporate Governance, a Code is based on the recommended of Rahul
Bajaj, past president of the Confederation of Indian Industry (CII). About this code
Mr.Shekhar Datt, in the foreword to the draft, said that,
“Corporate Governance is a phrase which implies transparency of management
systems in business and industry, be it private sector, public sector or the financial
institutions all of which are corporate entities. Just as industry seeks transparency in
Government policies and procedures, so also, the debate on Corporate Governance
seeks transparency in the corporate sector”.18
By looking to the importance of Corporate Governance in the Indian economy,
the CII, National Council considered it essential to set up a National Task Force on
Corporate Governance in mid 1996 under the leadership of Mr .Rahul Bajaj.19
After careful study of Corporate Governance prevailing in various countries,
the Task Force made the following recommendations for India. They are -
18 Business Today, 7th May 1997, p.10,
19 Other Members of the Tasks Force are, Mr.Subodh Bhargava, Mr.Jamshyd N.Godrej, Dr.Jamshed
J.Irani, Mr.Tapan Mitra, Mr.Dhruv M.Sawhney, Mr.R.C.Bhargava, Mr.C.K.Birla, Dr.Omkar
Goswami, M.R Rajive Kaul, Mr.K.N.Shenoy and Mr.Shailendra Swarup.
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Board of Directors: The key to good Corporate Governance is a well functioning
board of directors. The board should have a core group of excellent, professionally
acclaimed non-executive directors who understand their dual role of appreciating
the issues put forward by management, and of honestly discharging their fiduciary
responsibilities towards the company’s shareholders as well as creditors.
4.2.2 Recommendations of the Task Force
1) There is no need to adopt the German system of two-tier boards to ensure
desirable Corporate Governance. A Single Board, if it performing well, can
maximize long-term shareholders value just as well as a two or multi-tired board.
Conversely there is nothing to suggest that a two-tier board, per se, is the panacea
for all the corporate problems.
2) Any listed company with a turnover of Rs. 100 crore, and above should have
professionally competent and acclaimed non-executive directors, who should
constitute- (a) at least 30 percent of the board, if the chairman of the company is a
non-executive director, or (b) at least 50 percent of the board, if the chairman and
managing directors is the same person.
3) No single person should hold directorship in more than 10 companies. This
ceiling excludes directorship in subsidiaries (where the group has over 50 percent
equity stake) or associate companies where the group has over 25 percent but no
more than 50 percent equity stake.
4) For non-executive directors to play an important role in maximizing long-term
shareholders value, they need to (a) become active participants in boards, not
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passive advisors; (b) have clearly defined responsibilities within the board; and (c)
know how to read a balance sheet, profit and loss account, cash flow statement and
financial ratios and have some knowledge of various company laws. This, of
course, excludes those who are invited to join boards experts as other fields such
as science and technology.
5) To secure better effort from non-executive directors, companies should- (a) pay a
commission over and above the sitting fees for the use of the professional inputs.
The present commission of 1 percent of the net profits (if the company has a
managing directors) or 3 percent (if thee is no managing director) is sufficient, (b)
Consider offering stock option, so as to relate rewards to performance.
Commission are rewards on current profits... stock options are rewards contingent
upon future appreciation of corporate value. An appropriate mix of the two can
align a non-executive director towards keeping an eye on short-term profits as well
as long-term shareholder value.
6) While re-appointing members of the board, companies should give the attendance
record of the concerned directors. If a director was not present (absent with or
without leave) for 50 percent or more meetings, then this should be explicitly
stated in the resolution that is put to vote. As a general practice, one should not re
appoint any non-executive director who has not had the time to attend even one-
half of the meetings.
7) Key information that must be reported to, and place before, the board must
contain.
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a) Annual operating plans and budgets, together with updated long-term plans.
b) Capital budgets, manpower and overhead charges.
c) Quarterly results for the company as a whole and its operating divisions or
business segments.
d) Internal audit reports, including case of theft and dishonestly of a material
nature.
e) Show cause, demand and prosecution notices received from revenue
authorities, which are considered to be materially important (material
nature is any exposure that exceeds 1 percent of the company’s net worth).
f) Fatal or serious accidents, dangerous occurrences and any effluent or
pollution problems.
g) Default in payment of interest or non-payment of the principal on any
public deposit, and or to any secured creditor or financial institutions.
h) Defaults such as non-payment of inter-corporate deposits by or to the
company, or materially substantial non-payment of goods sold by the
company.
i) Any issue which involves possible public or product liability claims of a
substantial nature, including any judgment or order which may have either
passed strictures on the conduct of the company, or taken an adverse view
regarding another enterprise that can have negative implications of the
company.
j) Details of any joint venture or collaboration agreement.

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k) Transactions that involve substantial payment towards good will brand
equity, or intellectual property.
l) Recruitment and remuneration of senior officers just below the board level,
including appointment and reappointment or removal of the chief financial
officer and the company secretary.
m) Labour problems and their proposed solutions.
n) Quarterly details of foreign exchange exposure and the steps taken by
management to limit the risks of adverse rate movement, if material.
8) (a) Listed companies with either a turnover of Rs.100 crore or a paid up capital
of Rs.20 crore whichever in less should set up audit committees within two years.
(b) Audit committees should consist of at least three members all drawn from a
company’s non-executive directors who should have adequate knowledge of
finance, accounts and basic elements of company law.
(c) To be effective, members of audit committees must be willing to spend
more time on the company’s work vis-a-vis other non-executive directors.
(d) Audit committees should assist the board in fulfilling its functions relating
to corporate accounting and reporting practices, financial and accounting controls
and financial statements and proposal that accompany the public issue of any
security and thus provide effective supervision of the financial reporting process.
(e) Audit committees should periodically interact with the statutory auditors
and the internal auditors to ascertain the quality and veracity of the company’s
accounts as well as the capability of the auditors themselves.

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(f) For audit committees to discharge their fiduciary responsibilities with due
diligence, it must be incumbent upon management to ensure that members of the
committee have full access to financial data of the company, its subsidiary and
associated companies, including data on contingent liabilities, debt exposure,
current liabilities, loans and investments.
(g) By the fiscal year 1998-99, listed companies satisfying criterion (l) should
have in place a strong internal audit department, or an external auditor to do
internal audit; without this, any audit committee will be toothless.
9) Under ‘Additional shareholders’ Information’ listed public companies should give
data on;
(a) High and low monthly averages of shares prices in all the stock
exchanges where the company is listed for the reporting year.
(b) Statement on value added, which is total income minus the cost of all
inputs and administrative expenses.
(c) Greater detail on business segments or divisions, up to 5% of turnover,
giving share in sales revenue, share in contribution, review of
operations, analysis of markets and future prospectus.
10) (a) Consolidation of groups account should be optional and subject to (I) the
FIS20 allowing companies to leverage on the basis of the groups assets, and (ii) the
Income-Tax Department using the group concept in assessing corporate income
tax. (b) If a company chooses to voluntarily consolidate, it should not be necessary
20
Financial Institutions.
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to annex the accounts of its subsidiary companies under section 212 of the
Companies Act. (c) However, if a company consolidates, than the minimal
definition of ‘group’ should include the parent company and its subsidiaries
(where the reporting company owns over 50% of voting stake).
11) Major Indian stock exchanges should gradually insist upon a compliance
certificate, signed by the CEO and the CFO, which clearly states that; (a) The
managements responsible for the preparation, integrity and fair presentation of the
financial statements and other information in the annual report, and which also
suggest that the company will continue in business in the course of the following
year, (b) The accounting policies and principles conform to standard practice, and
where they do not, full disclosure has been made of any material departures, (c)
The board has overseen the company’s system of internal accounting and
administrative controls system, either through its audit committee (for companies
with a turnover of Rs.100 crores or paid up capital of Rs.200 crores (whichever is
less) or directly.
12) For all companies with paid up capital of Rs.20 crore or more, the quality and
quantity of disclosure that accompanies a GDR issue should be the norm for any
domestic issue.
13) The Government must allow for greater funding to the corporate sector against the
security of shares and other paper.
14) It would be desirable for F I s as pure creditors to rewrite their covenants to
eliminate having nominee directors except: - (a) in the event of serious and
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systematic debt default; and (b). incase of the debtor company not providing six
monthly or quarterly operational data to the concerned FIs.
15) (1) If any company goes to more than one credit rating agency, it must divulge in
the prospectus and issue document the rating of all the agencies that did such an
exercise. (2) It is not enough to blandly state the ratings. These must be given in a
tabular format that shows where the company stand relative to higher and lower
ranking. It makes considerable difference to an investor to know whether the
rating agency or agencies placed the company in the top slots, or in the middle or
at the bottom. (3) It is essential that we look at the quantity and quality of
disclosures that accompany the issue of company bonds, debentures and fixed
deposits in the US and Britain- if only to earn what more can be done to inspire
confidence and create an environment to transparency. (4) Finally, companies
making foreign debt issues cannot have two sets of disclosure norms; an
exhaustive one for the foreigners and a relatively minuscule one for Indian
investors
16) Companies that default on fixed deposits should not be permitted to (a) accept
further deposits and make inter-corporate loans or investments until the default is
made good; and (b) declare dividends until the default is made good.
17) Reduction in the number of companies where there are nominee directors. It has
been argued by F I s that, there are too many companies where they are on the
board and too few competent officers to do the task properly. So in the first
instance, F I s should take a policy decision to withdraw from boards of companies

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where they have little or no debt exposure and where their individual shareholding
is 5 percent or less or total FI holding under 10 percent.21
The gist of the recommendation and desirable Corporate Governance code,
1997 is-
(1) For India single tired board is enough, the German system of two-tier board is
not suitable to India. The full board should meet at least twice a year. This
change is against the present requirement of four meetings in a year.
(2) The non-executive directors should comprise at least 30 percent of the board if
one of them is the Chairman. Under company law there is no reference to non
executive director. But we come across nominee director,23 additional
directors24 and alternative directors.25 But the Act does not make any distinction
between them. All of them are simply directors.
(3) The non-executive directors should comprise at least 50 percent of the board if
the chairman and the managing director is the same person. Though the
committee is in favour of single tier board yet it made classification of directors
into executive and non-executive directors. It means within the single tier
system, one may see two-tier system. The only difference between Indian and
German system is, in Germany employees are playing major role but that is not
21 (1997) 3 Comp L.J. p.3.

22 Cf. section 285.
23 Section 255 (2).
24 Section 260.
25 Section 314.
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so in India. Because of structural differences in Indian and German Corporation,
suggestion of the committee in this regard is well founded.
(4) Code has curtailed the number of directorship. A person can become director in
10 companies.26
(5) Code is in favour of defining the responsibility of the non-executive directors. It
also speaks that executive director should be active. But it has not given any
guidelines in defining the responsibilities of non-executive directors. If that
responsibility is given to the promoters and directors i.e. board of directors, the
investigator is of the opinion that, the fate of Indian companies will not be
different from the existing one.
(6) Provision is made for payment of commission for the professional services
rendered by non-executive directors in addition to the sitting fees and additional
payment is justiceable. It increases the responsibly of non-executive directors.
(7) The most important recommendation is the provision for the audit Committee.
To regulate through out the years, audit committee is must. In other parts of the
world many countries have made provision for an audit committee, so in India
also to meet global standards of Corporate Governance it is required.
(8) Disclosure of share prices, maximum and minimum in financial statements, and
financial performance is very useful to long term investors. Because, generally,
he will not go for speculation. But in case of need of money i.e. sale of shares in
26
Sections 275 and 276- have fixed number of directorship to 15 companies.
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the open market it is a useful guidance for him. Indian investors requires training
and knowledge of share market.
(9) Code gives caution to directors, and shareholders, while reappointment of
retiring directors. It requires that if a director is absent for more the 50% of
meetings in a year, at the reappoint, that should be specifically informed to the
members. Here provision for information about absenteeism is to be given but
no reference for legislative intervention.
(10) Code is critical about the creditor’s rights. At present the major creditors are
financial institutions. Because of their financial strength they have secured a
place in the board of directors. S.25 (2) provides for the appointment of
nominee directors. But this has been criticized in the code. Because they have a
prior and pre-committed claim on the income of the company and that this claim
is satisfied irrespective of the state of affairs of the company. Financial
institution is enjoying this privilege irrespective of whether their debt is timely
paid or not. But that is not so with regard to other creditors and shareholders.
Apart form this lack of sufficient number of qualified and trained directors
financial institutions are unable to nominate active directors. Hence the
committee properly recommended against the appointment of nominee directors.
Committee in its concluding remarks aptly stated that ‘A code of
Corporate Governance cannot be static; Corporate Governance is a changing
concept. It changes with the time. Time means growth along with the growth of
the nation the corporate governance also grows. Hence it should be reviewed
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timely. But one has to remember that, Corporate Governance is an inter-play
between companies, shareholders, creditors, capital markets, financial
institutions and company law. Hence, a code of Corporate Governance must
attempt to address all these issues.
4.3 Kumar Mangalam Birla Committee Report on Corporate Governance

2000:
Background of Constitution of the Committees
After publication of ‘desirable code of Corporate Governance some of the
forward looking companies have already revived or are in the process of reviewing
their board structures and have also reported in their 1998-99 annual reports the extent
to which they have complied with the code. The SEBI, however, felt that under
Indian condition a statutory rather than a voluntary code would be far more purposive
and meaningful, at least in respect of essential features of Corporate Governance.
But there were many companies, whose practices are a matter of concern.
There is also increasing concern about standards of financial reporting and
accountability especially, after losses27 suffered by investors and lenders in the recent
past, which could have been avoided with better and more transparent reporting
practices.
Another reason was there were also companies, which were not paying
adequate attention to the basic procedures for shareholders services, such as delay in
27 Investors have suffered on account of unscrupulous management of the companies, which have
raised capital from the market at high valuations and have performed much worse than the part
reported figures; leave alone the future protections at the time of raising money.
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transfer of shares, delay in dispatch of share certificates and dividend warrants and
non-receipt of dividend warrants; companies also did not pay sufficient attention to
timely dissemination of information to investors, these investors grievance did not
receive adequate attention.
Corporate Governance is considered as an important instrument of investor
protection, and it is therefore a priority of SEBFs agenda. To further improve the
level of Corporate Governance, need was felt for a comprehensive approach. Hence
SEBI, constituted a committee under the chairmanship of Shri Kumaramangalam
Birla on 7 may 1999.28
4.3.1 Terms of Reference to the Committee
“(a) To suggest suitable amendments to the listing agreements executed by the
stock exchanges with the companies and any other measures to improve the
standards of Corporate Governance in the listed companies in areas such as
28 Other members of the committee

(1) Shri.Kumar Mangalam Birla - Chairman, Aditya Birla Group
(2) Shri. Rohit Bhagat - Country head, Boston Consulting Group
(3) Dr.J.Bhagwath - Jt. Secretary, Ministry of Finance.
(4) Shri.Samir Biswas Raj Director, Western Region, DCA GOI.
(5) Shri S.P.Chhayed - President of Institute of Chartered Accountants of India.
(6) Shrill Virender Ganda- President of Institute of Company Secrecy India.
(7) Dr.Sumnatra Ghoshal- Prof, of Strategic Management, London Business School
(8) Shri.Vijaya Kalantri -President, all India Association of Industries.
(9) Shri Pratip Kar- Executive Director SEBI Member Secretary.
(10) Shri. Y.H. Malegam -Managing Partner, S.B. Billimona and Co.
(11) Shri.Narayanan Murthy - Chairman and managing Director, Infosys Technologies Ltd.
(12) Shri A.K. Narayana - President of Tamil Nadu Investors Association
(13) Shri Kamal Prakash - Ex-President Calcutta stock Exchange.
(14) Dr. R.H. Patil- Managing Director, National Stock Exchange Ltd.
(15) Shri Anand Rathi- President of the Mumbai stock Exchange
(16) M.S. D.N.Raval - Executive Director, SEBI
(17) Shri Rajesh Shab- Former President of the Confederation of India Industries.
(18) Shri L.K. Singhvi- Sr-Executive Director, SEBI
(19) Shri. S.S. Sodhi- Executive Director, Delhi Stock Exchange.
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continuous disclosure of material information both financial and non-financial,
manner and frequency of such disclosures, responsibilities of independent and
outside directors; (b) to draft a code of corporate best practices and (c) to
suggest safeguards to be instituted within the companies to deal with insider
information and insider trading”.
The committee, before submitting its report took note of the recommendations of
various committees abroad and C 11* s ‘desirable Code of Corporate Governance in
India. Some of them are as following;
(1) Strengthening of disclosure norms for initial public offers following the
recommendations of the committee set up by SEBI under the chairmanship of Shri
Y.H. Malagam
(2) Providing information in director’s reports for utilization of funds and variation
between projected and actual use of funds according to the requirements of the
Companies Act;
(3) Inclusion of cash flow and funds flow statement in annual report;
(4) Declaration of quarterly results;
(5) Mandatory appointment of compliance officer for monitoring share transfer
process and ensuring compliance with various rules and regulations;
(6) Timely discloser of material and price sensitive information etc .
The Committee has identified the three key factors of Corporate Governance,
namely,
29
(2002) 2 Comp L.J.
108
a) Accountability;
b) Transparency and
c) Equality of treatment for all stakeholders.
The Board of directors performs the pivotal role in any system of Corporate
Governance. It is accountable to the stakeholders and directs and controls the
management. The shareholders role in Corporate Governance is to appoint the
directors and auditors and to hold the Board accountable for the proper governance of
the company by requiring the board to provide them periodically with the requisite
information in a transparent fashion of the activities and progress of the company.
4.3.2 The Recommendations of the Committee
In the Report the Committee made it clear that, its recommendations are made
keeping in view primarily the interest of the shareholders but at the same time it has
not ignored the needs of the other stakeholders.30 According to the committee the
fundamental objective of Corporate Governance is the enhancement of shareholders
value keeping in view the interest of other stakeholder. In the opinion of the
Committee, the imperative for Corporate Governance lies not merely in drafting a
code of Corporate Governance, but in practicing it.
4.3.3 Mandatory and Non-Mandatory Recommendations
i) The Mandatory recommendations
ii) Non-mandatory or optional recommendations
30 Other stakeholders are suppliers, customers, creditors, the bankers, and the employees of the
company.
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1) Applicability: it should be made applicable to listed, public or private
companies.31
2) Board of Directors: The board of a company provides leadership and strategic
guidance, objective judgment independent of management to the company and
exercises control over the company, while remaining at all times accountable to
the shareholders. The measure of the board is not simply whether it fulfils its legal
requirements but more importantly, the board’s attitude and the manner it
translates its awareness and understanding of its responsibilities. An effective
Corporate Governance system is one, which allows the board to perform these
dual functions efficiently. The board of directors of a company is accountable to
the shareholders.32
The board directs the company, by formulating and reviewing company’s
policies, strategies, major plans of action, risk policy annual budgets and business
plans, setting performance objectives, monitoring implementation and corporate
performance, and overseeing major capital expenditures, acquisitions and divestitures,
change in financial control and compliance with applicable laws taking into account
the interest of stakeholders. It controls the company and its management by laying
down the code of conduct, overseeing the process of discloser and communications
ensuring the appropriate systems for financial control and reporting and monitoring
risk are in place, evaluating the performance of management, chief executive,
3! From year 2002-03, it is applicable to all listed companies with paid up share capital of Rs.3 crore
and above
32 Recommendation 6.1. Kumarmangalam Birla Committee.
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executive directors and providing checks and balances to reduce potential conflict
between the specific interests of management and the wider interests of the company
and shareholders including misuse of corporate assets and abuse in related party
transaction. It is accountable to the shareholders for creating, protecting and
enhancing wealth and resources for the company, and reporting to them on the
performance in a timely and transparent manner. However, it is not involved in day-
to-day management of the company, which is the responsibility of the management.33
4.3.4 Composition of the Board of Directors
The committee is of the view that the composition of the board of directors is
critical to the independent functioning of the board. There is a significant body of
literature on Corporate Governance, which has guided the composition, structure and
responsibilities of the board. The committee took note of this while framing its
recommendations on the structure and compositions of the board. The composition
of the board is important in as much as it determines the ability of the board to
collectively provide the leadership and ensures that no one individual or a group is
able to dominate the board. The executive directors are involved in the day-to-day
management of the companies; the non-executive directors bring external and wider
perspective and independence to the decision-making. Till recently, it has been the
practice of the most of the companies in India to fill the board with representatives of
the promoters of the company, and independent directors it chosen were also
handpicked thereby ceasing to be independent. This has undergone a change and
33
Recommendation 6.2.
Ill
increasingly the boards comprise of the following groups of directors, promoters,
directors executive and non-executive directors, a part of who are independent.34
4.3.5 Independent Directors and the Definition of Independence
Among the non-executive directors, independent directors, play a key role in
the entire mosaic of Corporate Governance. The committee was of the view that it
was important that independence be suitably, correctly and pragmatically defined so
that the definition itself does not became a constraint in the choice of independent
directors on the boards of companies. The definition should bring out what in the
view of the committee is the touchstone of independence, and which should be
sufficiently broad and flexible. It was agreed that “material pecuniary relationship
which affects independence of a director ” should be litmus test of independent and
the board of the company would exercise sufficient degree of maturity when left to
itself, to determine whether a director, is independent or not. The committee therefore
agreed on the following definition of “independence”. Independent directors are
“directors who apart from receiving directors remuneration do not have any other
material pecuniary relationship or transactions with the company, its promoters, its
management or its subsidiaries, which in the judgment of the board may affect their
independence of judgment”. Further all pecuniary relationships or transactions of the
non-executive directors should be disclosed in the annual report.35
34 Recommendation 6.4.
112
The committees view on independent director is that “the non-executive
directors i.e. those who are independent and those who are not, help bring an
independent judgment to bear on boards deliberations, especially on issues of
strategy, performance, management of conflicts and standard of conduct. The
committee therefore lays emphasis on the caliber of the non-executive directors,
especially of the independent directors.36 For the good Corporate Governance the
board is comprised of individuals with certain personal characteristics, competency,
integrity, a sense of accountability, and track record of achievements. They must
posses’ leadership quality and ability to think strategically and must commitment to
the company and devote adequate time for meeting. The committee is also of the
view that the adequate compensation package is given to the non-executive
independent directors.37
The board must be independent to fulfill its oversight role objectively and to
hold the management accountable to the shareholders.38
The committee recommended that the board of a company have an optimum
combination of executive and non-executive directors with not less than 50% of the
board comprising the non-executive directors. In case a company has a non-executive
chairman, than at least 33% of board should comprise of independent directors. This
is a mandatory recommendation.39
36 Recommendation 6.6
f'
\ *£•
113
4.3.6 Nominee Directors
The Companies Act 1956 provides for the appointment of nominee director.
But there are arguments for and against the appointment of nominee directors. The
committee recognized the merit of both points of view and, therefore recommended
that institutions should appoint nominees on the boards of companies only on a
selective basis where such appointment is pursuant to a right under loan agreement or
where such appointment considered necessary to protect the interest of the
• • • 40
institution.
The committee clearly laid down the responsibilities of nominee director; he is
subject to the same discipline and is accountable to the shareholder in the same
manner as any other director.41
4.3.7 Chairman of the Board
The role of the chairman is to ensure proper conduct of the board meetings,
secure the effective participation of all directors, executive and non-executive, and to
encourage all to make an effective contribution, maintain balance of power and see
that adequate information is received by all the directors. The committee is of the
view that the chairman’s role should in principle be different from that of the
executive, though the same individual may perform both roles. Hence the committee
recommended that a non-executive chairman should be entitled to maintain a
40 Supra note 23.

41 Recommendation 7.1 to 7.3.
114
chairman’s office at the company’s expense. This will enable him to discharge the
responsibilities effectively. This is a non-mandatory recommendation.42
4.3.8 Audit Committee
Good Corporate Governance holds the management accountable to the board
and the board accountable to the shareholders. The audit committee’s role flows
directly from the board’s oversight function. It acts as a catalyst for effective
financial reporting. Hence the committee is of the view that the need for having an
audit committee grows from the recognition of its position in the governance
process.43 A proper and well functioning system exists when the three main groups
responsible for financial reporting the board, the internal auditor and the out side
auditor form the three legged stool that supports responsible financial disclosure and
active and participatory oversight.44 The committee is in favour of extending the
progressive standards of governance applicable to the full board to the audit
committee. Hence the committee recommended that the board of a company should
set up a qualified and independent audit committee. This is a mandatory
recommendation.45
4.3.9 Composition
The composition of the audit committee is based on the fundamental premise
of independence and expertise. The committee therefore recommends that: -
42 Recommendation 8.1 & 82.

43 Recommendation 8.1 & 8.2.
115
a) ‘The audit committee should have minimum three members, all being non
executive directors, with the majority being independent, and with at least one
director having financial and accounting knowledge;
b) The chairman of the committee should be an independent director;
c) The chairman should be present at Annual General meeting to answer
shareholders queries;
d) The audit committee should invite such of the executives as it considers
appropriate to be present at the meetings of the committee but on occasions it
may also meet with out the presence of any executives of the company. Finance
director and head of internal audit and when required, a representative of the
external audit should be present as invitees for the meetings of the audit
committee;
e) The company secretary should act as the secretary to the committee. These are
mandatory recommendations.46
The audit committee shall meet at least thrice a year. One meeting must be
before finalization of annual account and are necessarily every six months. It is a
mandatory recommendation.47 The quorum should be two members or one-third of
the members of the audit committee; which ever in higher and there should be a
JO
minimum of two independent directors.
116
4.3.10 Powers of the Audit Committee
The powers of the audit committee are as follows:
a) To investigate any activity within its terms of reference.
b) To seek information from any employee;
c) To obtain outside legal or other professional advice;
d) To secure attendance of outsiders with relevant expertise, if it considers
necessary. It is a mandatory recommendation.49
4.3.11 Functions of the Audit Committee
The audit committee acts as the bridge between the board the statutory auditors
and internal auditors, hence the committees recommended, among other functions, the
following are also: -
a) Overseeing of the company’s financial reporting process, disclosure of
financial information, to ensure the correctness, sufficient and credible
information.
b) The appointment, removal of external auditor, and their fees.
c) Review of the annual financial statement before submission to the board;
focusing on changes in accounting policies and practices, accounting crises,
compliances with accounting standards and stock exchange and legal
requirements.
d) Reviewing the adequacy of internal control systems.
49
Recommendation 9.9.
117
e) Reviewing the adequacy of internal audit function, structure of internal audit
department and coverage and frequency of internal audit.
f) Discussion with internal auditors of any significant findings and follow-up
thereon.
g) Reviving the findings of any internal investigations by he internal auditors
when there is suspected fraud or regulating or a failure of internal control
systems.
h) Reviewing the company’s financial and risk management policies.
i) Looking into the reasons for substantial defaults in the payments to the
depositors, debenture-holders, shareholders (in case of non-payment at
declared dividends) and creditors- this is a mandatory recommendation.50
4.3.12 Remuneration Committee of the Board
To avoid potential conflict of interest between the shareholders, the directors
and the management and to enable the shareholders to know full and clear benefits
available to their directors, the committee recommended the constitution of
remuneration committee. But this is a non-mandatory recommendation.51
4.3.13 Composition, Quorum etc. of the Remuneration Committee
A committee comprising of at least three directors shall determine the
remuneration of the executive directors, all of whom should be non-executive
118
directors and the chairman of the committee must be an independent director. On
the quorum of the remuneration committee, the committee recommended that the
entire member should be present at the meeting.53
The Board of directors shall decide remuneration of the non-executive
directors. This is mandatory recommendation.54
Investigator is of the opinion that this recommendation is not proper. Because
remuneration of the executive directors is fixed by the non-executive directors, and
non-executive directors remuneration by the Board of Directors i.e. reciprocity is
applied. Hence the shareholders will not get the expected protection. So, the
remuneration of the non-executive directors has to be fixed by the shareholders in the
General Body meeting.
4.3.14 Board Procedures
The Board to discharge its responsibilities properly its structure must be
appropriate. This is to be supplemented by certain basic procedural requirements
such as frequency of meetings, availability of timely information, sufficient notice
period and the commitment of the members of the board.55 Hence the committee
recommended that board meetings should be held at least four times in a year with a
maximum time gap of four months between two meetings.56 Further to ensure the
commitment of member of the board the committee recommended that a director
119
should not be a member in more than 10 committees or act as chairman of more than
5 committees across all companies in which he is a director. This is a mandatory
requirement.
4.3.15 Accounting Standards and Finance Reporting
As an accounting standard is an ongoing process and to move speedily towards
the adoption of international standards the committee took note of the discussions of
the SEBI Committee on accounting standards and recommended for the consolidation
of account of subsidiaries.58
4.3.16 Management
The aim of management is to maximize shareholders value without affecting
the interest of other stakeholders. The management is subservient to the board of
directors and must operate within the boundaries and the policy framework laid down
by the board and those are to be implemented by the management. Hence the board
should clearly define the role of management.59
4.3.17 Functions of the Management
The management comprises the chief executive, executive -directors and the
key managers of the company.60 The committee believes that the management
should carryout the following functions:
120
a) “Assisting the board in its decision making process in respect of the company’s
strategy, polices, code of conduct and performance targets, by providing
necessary inputs.
b) Implementing the policies and code of conduct of the board.
c) Managing the day-to-day affairs of the company.
d) Providing timely, accurate, substantive and material information to the board,
board-committees and the shareholders.
e) Ensuring compliance of all regulation and laws.
f) Ensuring timely and efficient service to the shareholders and to protect
shareholders rights and interest.
g) Setting up and implementing an effective internal control systems,
commensurate with the business requirements.
h) Implementing and comply with the code of conduct as laid down by the board.
i) Co-operating and facilitating efficient working of board committees”.61
Good Corporate Governance costs an obligation on the management in respect of
disclosures. The committee therefore recommended that the management must
make the disclosure to the board relating to all material, financial and commercial
transactions. Where they have personal interest, which may have potential conflict
62
with the interest of the company at large. This is a mandatory recommendation.
121
4.4 Shareholders
The shareholders are the owners of the company and as such they have certain
rights and responsibilities. But in reality companies cannot be managed by
shareholder referendum. They have to delegate many of their responsibilities to the
directors, who then become responsible for corporate strategy and operations. The
management team implements strategy. Hence this relationship brings in the
accountability of the boards and the management to the shareholders of the company.
A good corporate framework is one that provides adequate avenues to the
shareholders for effective contribution in the governance of the company.
4.4.1 Responsibilities of Shareholders
The General Body meetings provide an opportunity to the shareholders to
address their concerns to the board of directors and comment on and demand any
explanation on the annual report. For this an effective participation of shareholders is
required. The effectiveness of the board is determined by the quality of the directors
and the quality of the financial information is dependent upon the efficient discharge
of duties by the auditors. Hence the shareholders must show a greater degree of
interest and involvement in the appointment of the directors and the auditors.64
Hence the committee recommended that in case of appointment of a new
director or re-appointment of a director, the shareholders must be provided with the
following information:
122
a) A brief resume of the director;
b) Nature of his expertise in specific functional areas; and
c) Names of companies in which the person also holds the directorship and the
membership of committees of the board. This is mandatory recombination. 65
4.4.2 Shareholders Rights
The basic rights of the shareholders are right to transfer and registration of
shares, information about the company, participating and voting in shareholders
meetings, electing members of the board and sharing in the residual profits of the
corporation. Hence the committee recommended that all these rights are protected
and in addition to this they are to be informed about the material changes such as
takeovers, sale of assets or division of the company and changes in capital structure
which will lead to change in control or may result in certain shareholders obtaining
control disproportionate to the equity ownership.66 Further the committee
recommended for quarterly information has to be put on company’s web site or sent
to stock exchange, wherein company’s securities are listed. This is a mandatory
recommendation.67 Regarding half-yearly declaration of financial performance,
committee made a non-mandatory recommendation that it may be sent to each
household shareholder.
The committee recommended for the constitution of a board committee under
the chairmanship of a non-executive director to look into the redressing of
123
shareholders complaints like transfer of shares, non-receipt of declared dividends etc.
This is a mandatory one. 69
For the quick and smooth transfer of shares the committee recommended for
the delegation of power of transfer of share to an officer or a committee or to the
registrar and share transfer agents. This is a mandatory recommendation.70
4.4.3 Institutional Shareholders
They are in the process of becoming majority shareholders in many listed
companies and holding large stakes. So the special responsibilities have been given
and have to play a bigger role in Corporate Governance. Their responsibility is to use
their voting power effectively and influence the standards of Corporate Governance.71
Hence the committee is of the view that the institutional shareholders: -
a) Take active interest in the composition of the board of directors;
b) Be vigilant;
c) Maintain regular and systematic contact at senior level for exchange of views
on management, strategy, performance and the quality management.
d) Ensure that voting intentions are translated into practice.
e) Evaluate the Corporate Governance performance of the company. 72
4.5 Manner of Implementation
The committee recommended for the amendment of the Securities Contract
73
(Regulation) Rules 1957 for incorporating the mandatory provisions.
Recommendation 14.16.
124
Further, the committee recommended the implementations of mandatory
provisions are to implement through the listing agreement of the stock exchange.74
As the penalties for violation of listing agreements are not adequate to deter the
wrongdoer, the committee recommended the SEBI that vesting more powers so that
they can ensure proper compliance of code of Corporate Governance strengthen the
listing agreement of the stock exchange.75
The committee further recommended the SEBI, to write to the department of
company affairs for suitable amendments to the Companies Act.76
The committee provided for the separate section on Corporate Governance in
the annual reports of companies, with a detailed compliance report. This is a
mandatory one.77
Finally the committee also recommended that the company should arrange to
obtain a certificate from the company’s auditor’s regarding compliance of mandatory
recommendations and annexes the certificate with the director’s report which is sent
annually to all the shareholders of the company. The same certificate should also be
sent to the stock exchanges along with the annual return filed by the company. This is
a mandatory recommendation.78
76 On these recommendation the Companies Act 1956 was amended in 2000.
125
4.6 Naresh Chandra Committee on Corporate Audit and Governance- 2002
On August 21, 2002, the Department of Company Affairs (DCA) under the
Ministry of Financial and company affairs appointed a high level committee to
examine various Corporate Governance issues under the chairmanship of Mr. Naresh
Chandra.79 Among others, important issues before the committee are: -
1) The statutory auditor- company relationship so as to further strengthen the
professional nature of this interface;
2) The need, if any, for rotation of statutory audit firms or partners;
3) The procedure for appointment of auditors and determination of audit fees;
4) Restrictions, if necessary, on non-audit fees;
5) Independence of auditing functions;
6) Measures required ensuring that the management and Companies Actually
present ‘true and fair’ statement of the financial affairs of companies.
7) The need to consider measures such as certification of accounts and financial
statements by the management and directors;
8) The necessity of having a transparent system of random scrutiny of audited
accounts;
79 The members of the committee are

(l) MrNaresh Chandra Chairman
(ii) Mr.Ashok Chandak Member
(iii) Mr.Aditya Vikram Lodha
(iv) Mr.R.Krishna
(v) Mr.M.K. Sharma
(vi) Ms.Kaipana Morparia
(vii) Mr. Mahesh Vyas
(viii) Dr.Omkar Goswami
(ix) Mr. Rajiv Mehrishi
(x) S.B. Mathur.
126
9) Adequacy of regulations of chartered accountants, company secretaries and other
similar statutory oversight functionaries;
10) Advantages, if any, of setting up of an independent regulator similar to the
public company accounting oversight board as in the S.O.Act and if so, its
constitution; and
11) The role of independent directors, and how their independence and effectiveness
can be ensured.80
By looking to the terms reference, the committee is entrusted to look into the two key
aspects of Corporate Governances: -
a) Financial and non-fmancial disclosers, and
b) By independent auditing and board oversight management. Related aspects
are, the need for independent oversight of auditors, and efficacious disciplinary
procedure for professionals.
On these various aspects of Corporate Governance the committee made its
recommendation in chapters 2 to5 of the report submitted to the SEBI.
Chapter 2 deals with the entire range of the statutory auditor-company
relationship. The object of this chapter is to suggest ways and means of ensuring and
enhancing the independent and professional nature of Corporate Governance. Things
examined in this chapter are the rotation of audit firms versus that of auditing
80 Report of the Committee (Naresh Chandra) on Corporate Audit and Governance SEBI, Dec 23,
2002.
127
partners, restrictions on non-audit work and fees from such works, the procedure for
appointment of audits, determination of audit fees, and allied subjects.81
Chapter 3 focuses on the issues of who audits the performance of auditors- and
examines whether the present system of regulation of chartered accountants, company
secretaries and cost and works accounts is sufficient and has adequately served the
interests of corporate shareholders and stakeholders. Also the chapter analyzed the
need for setting up of an independent regulatory body to oversee the quality of audit
of public limited companies as has been done in the case of the public company
accounting oversight board prescribed by the Sox Act.82
Chapter 4 deals with the independence of the board of directors. It examined
the definition of independence, and reviewed whether there is a need to tighten such
definitions. Then next it discussed the composition and size of corporate boards, and
steps that can be taken to ensure and enhance independence of judgment. It examined
in detail the role and functions of the audit committee of the board, and suggested
things that can be done to strengthen the committee. Remuneration and liabilities of
non-executive and independent directors are also looked into and finally suggested for
the nation wide training programme for directors.83
The Report concludes with chapter 5, which discussed some related or allied
matters, and recommendations of a consequential nature. It covers some of the
concerns that emanated during discussions on the terms of reference, such as
81 See Appendix A, pp.296-304.

82 See appendix B, pp. 305-312.
83 see appendix C, pp. 313-319.
128
improving the conditions and functions of Register of Company offices, strengthening
the inspection wing of the DCA, harmonization of action between SEBI and DCA, the
need to set up a corporate serious frauds office, random scrutiny of accounts and the
like.84
Naresh Chandra Committee, as the terms of reference confined it to the
accounting audit of the companies, committee in clear terms recommended for the
two types of auditors, internal auditors and external auditors. The functions and
purposes of these auditors are, though different, but aimed at protecting the interest of
the investors by ensuring proper Corporate Governance. But the major role has to be
played by the institutional investors. In these financial institutions, there are
shareholders or investor either as shareholders or fixed depositors or unit holders.
These investors directly do not have any control on these financial institutions. If at
all something goes wrong with the invested company, it is not the financial
institutions but ultimately suffer are investors in financial institutions. From this
view, the investigator is of the opinion that the responsibility imposed on the financial
investor is not adequate. They must be made more stringent to cover every lapse on
the part of these institutions. Hence it seems proper for these financial institutions to
discharge the role of internal auditors.
Although the committee is not in favour of two tier board, as practiced in
German, but it recommended for executive directors and non-executive directors.
This recommendation is timely one and by this proper governance may be ensured.
$4
see Appendix D.
129
The committee recommendations are on par with the practice prevailing in other parts
of the world. Disclosure provisions and provisions relating to certification are navel
one. The responsibility of the executive directors is enhanced beyond the scope of
Companies Act.
4.7 N.R.Narayan Murthy Committee Report on Corporate Governance 2003
The reason for the constitution of the new Committee by the SEBI, is that it
believes that efforts to improve Corporate Governance standards must continue as the
market dynamics goes on changing. To review the existing Code on Corporate
Governance from two perspectives, (a) to evaluate (b) to further improve the existing
practices.
Hence the SEBI committee on Corporate Governance was constituted under
the chairmanship of Shri N.R.Narayan Murthy, Chairman infosys Technologies Ltd.
The terms of reference are as follows:
a) To review the performance of Corporate Governance; and
b) To determine the role of companies in responding to rumor and other price
sensitive information circulating in the market in order to enhance the
transparency and integrity of the market.
The Committee mainly discussed the issues relating to audit committees, audit report,
independent directors, related parties, risk management directorship and director
compensation, codes of conduct and financial disclosures.

130
Apart from discussing the main issues, the Committee also discussed some of
the recommendations already made by the Naresh Chandra Committee on corporate
Audit and Governances, and the Committee accepted them.
Like Naresh Chandra Committee, this Committee also made mandatory and non
mandatory recommendations.
The following is the gist of the recommendation on key issues:
Audit Committee: Audit committees of publicly listed companies should review the
following information
a) Financial statements;
b) Management discussion and analysis of financial condition and results of
operations;
c) Reports relating to compliance with laws and to risk management;
d) Management letter/letters of internal control weakness issued by
statutory/intemal auditors; and

Of
e) Records of related party transactions.
The above recommendation was already contained in the Kumar Mangalam Birla
Committee’s Report on Corporate Governance. But in addition to the K.M. Birla
Committee’s Report, it imposed additional responsibility on the Audit Committee vis-
a-vis their duties and role.
Financial literacy of members of the audit committee: It is common practice in
India that usually audit committee, apart from other professional, it consisted
85 Recommendation 3.2.1. N.R.Narayan Murthy Committee.

131
representatives or nominees of promoters or controlling director. Some of them are
financially illiterate. Hence they were not in a position to protect the investor and
ensure good Corporate Governance. Hence the committee made the following
mandatory recommendation “All audit committee members should be financially
literate” and at least one member should have accounting or related financial
management expertise.
Explanation-1: The term “financial literate means the ability to read and understand
basic financial statements i.e. balance sheet, profit and loss account and statements of
cash flows.
Explanation-2: A member will be considered to have accounting or related financial
management expertise if he or she possesses experience in finance or accounting, or
requisite professional certification in accounting, or any other comparable experience
or background, which results in the individuals financial sophistication, including
being or having been a chief executive officer, chief financial officer, or other senior
officer with financial oversight responsibilities.86
In this recommendation the Committee insisted for at least one member should
be financial literate. The investigator has strong reservation against this
recommendation. As the audit committee plays vital role in ensuring proper
Corporate Governance in financial matters, if majority of the members of audit
committee are financial illiterates, how one can expect proper auditing of financial
86
Recommendation 3.2.2.
132
matter and ensure investor protection? Hence, the investigator is of the opinion that if
not all at least majority of them should be financial literates.
4.7.1 Audit Report and Audit Qualifications
This recommendation87 deals with a case where the company has followed
different form of accounting standards. Then independent/statutory auditors should
justify why they are supporting differential form of accounting standards. The
committee made the following mandatory recommendation. “In case of a company
has followed a treatment different from the prescribed in an accounting standard,
management should justify why they believe such alternative treatment is more
representative of the underlying business transaction. Management should also
clearly explain the alternative accounting treatment in the footnotes to the financial
statements.”88
In this recommendation the committee provided for different form of
accounting standards in lieu of standardized form of accounting. If the company has
adopted differential form then it only required justifying its stand. But this option to
the company may dilute investor’s protection and efficacy of effective Corporate
Governance. Hence the investigator is of the opinion that there shall be only one that
to international standard of accounting this may attract foreign investors.
133
4.7.2 Audit Qualifications
On this aspect the committee made a non-mandatory recommendation as
follows:
“Companies should be encouraged to move towards a regime of unqualified
financial statements. This recommendation should be reviewed at an appropriate
juncture to determine whether the financial reporting climate is conducive towards a
statement of filing only unqualified financial statements”.89
For making non-mandatory recommendation reasons put forward by the
committee is that already there are adequate safeguards90 and to avoid undue hardship
to some of the companies.91 The stand taken by the committee seems to be not
appropriate. The very purpose of constituting the committee is to improve Corporate
Governance and investor’s protection. Even before the recommendation of this
committee there were and there are number of provisions, regulations to protect
investors and regulate Corporate Governance. But the SEBI, in the light of
developments that have taken in and around the country, it felt the exiting safeguards
are not adequate hence constituted this committee but the committee has not made
any recommendation on this issue.
4.7.3 Related Party Transactions
Insider transactions are very detrimental to the investor’s protection and also
transaction with the relatives of the directors and mangers. Generally these
89 Recommendation 3.3.2.
90 Recommendation 3.3.2.3.
134
transactions are called ‘interested transaction’. To ensure proper governance the
committee made the following mandatory recommendations. “A statement of all
transactions with related parties including their basis should be placed before the
independent audit committee for formal approval /ratification. If any transaction is
not on an arm’s length basis, management should provide an explanation to the audit
committee justifying the same.92 Further the committee defined ‘related party’ as
follows;
“The term related party shall have the same meaning as contained in
Accounting Standard 18, related party transactions, and issued by the Institute of
chartered accounts of India.93
4.7.4 Risk Management
Business risks management is one of the important issues from the point of
investors. In every business there is a certain kind of risk. Proper assessment of risk
in advance may minimize the loss. Hence there is need to review risk management
periodically. Here the risk would include global risks, general, economic and political
risks; industry risks; and company specific risk. Placing of the report on risk before
the board is essential. Hence the committee made the following mandatory
recommendation.
“Procedures should be in place to inform board members about the risk
assessment and minimization procedures. These procedures should be periodically
135
reviewed to ensure that executive management controls risk through means of a
properly defined framework.
Management should place a report before the entire board of directors every
quarter documenting the business risks faced by the company, measures to address
and minimize such risks, and any limitations to the risk taking capacity of the
corporation. The board should formally approve this document.94
In addition to this the Committee felt the need of training of Board members,95
hence the committee is after training in the business model as well as the risk profile
of the business of the company. However the committee made a non-mandatory
recommendation on this issue.
“Companies should be encouraged to train their board members in the business
model of the company as well as the risk profile of the business parameters of the
company, their responsibilities as directors, and the best ways to discharge them.96
With regard to training of Board members, the investigator is of the view that
the committee would have made mandatory recommendation instead of non
mandatory one. As the proper Corporate Governance and enhancing the investor
value depends upon the risk assessment and forecast and now trained and qualified
executives manage many companies in other parts of the world. Hence in India there
is a greater need for training not only from the point of protecting investors but also to
attract outside investors. Hence mandatory recommendation is justice able.
94 Recommendation3.5.1.
95 Naresh Chandra Committee also recommends.
136
4.7.5 Proceeds from Initial Public Offerings
Capital of the company comes from the public. It is raised through prospectus.
But once the money is collected, although at the time of issuing certain disclosure is
made regarding the object of raising funds, but thereafter what happens to the fund
collected from public, only directors know it. Hence there is need to disclose the use
of proceeds hence the committee has made the following mandatory recommendation.
“Companies raising money through an initial public offering (IPO) should
disclose to the audit committee, the uses/applications of funds by major category
(capital expenditure, sales and marketing, working capital, etc) on a quarterly basis.
On an annual basis, the company shall prepare a statement of funds utilized
for purposes other than those stated in the offer document/ prospectus. The
independent auditors of the company should certify this statement. The audit
committee should make appropriate recommendations to the board to take up steps in
this matter.97
Among all other recommendation, the investigator feels that this is the best
way to protect the investor’s interest. Timely receipt of information will make the
investor to decide whether their agents i.e. fund managers are using their money
properly or not. The committee has made most welcoming recommendations.
4.7.6 Code of Conduct
Directors of the companies are enjoying vast powers and subjected to various
duties and liabilities. Apart from this onerous obligation the Indian Companies Act
97
Recommendation 3.6.
137
also imposes the fiduciary obligation on them. Though the Companies Act made
provision for directors’ power but no provision is made in respect of code of conduct
i.e. statutory provision regarding their liabilities. Hence the committee felt the need
of written code of conduct for board members i.e. all categories of directors’
executive directors, independent directors, nominee directors and promoter directors
and also for senior financial personnel including Chief Financial Officer, Treasurer
and Financial Controller. While making recommendation the committee noted the
recommendation made by the Kumarmangalam Biria Committee on the board roles
and responsibilities of management. By considering the need of written code of
conduct, the committee made the following mandatory recommendation;
“It should be obligatory for the Board of a company to lay down the code of
conduct for all board members and senior management of a company. This code of
conduct shall be posted on the website of the company.
All board members and senior management personnel shall affirm compliance
with the code on an annual basis. The annual report of the company shall contain a
declaration to this effect signed off by the CEO and COO.
Explanation- for this purpose, the term senior management shall mean personnel of
the company who are member of its management /operating council (i.e. core
management team excluding board of directors). Normally, this would comprise all
98
members of management one level below the executive directors.
98
Recommendation 3.7.
138
On this recommendation, the investigator is of the opinion that the Indian
Companies Act 1956 has to be amended on par with the Nigerian Companies Act,"
which deals with the duties of directors.
The Act made statutory provision, which is not found in the Indian Companies
Act. Hence this recommendation is a step forward in protecting the interest of
investors as well good Corporate Governance.
4.7.7 Nominee Directors
S.255 (2) provides for appointment of nominee directors by the financial
institutions100 to guard its interest. But the issue is whether nominee director is to be
included in the list of independent director or not, some of the companies included
nominee director within the number of independent directors.101 As nominee director
is representing a particular group of investors’ i.e. financial institution, hence strictly
speaking he cannot be considered as an independent director. Hence the committee
aptly recommended that the nominee director should be excluded from the definition
of independent director. The mandatory recommendation made by the committee is
as follows.
“There shall be no nominee directors where an institution wishes to appoint a
director on the board, such appointment should be made by the shareholders. An
institutional director, so appointed, shall have the same responsibilities and shall be
subject to the same liabilities as any other director. Nominee of the Government on
99 Singh Avatar, Company Law, 13th ed.264.

100 But there is criticism for this.
101 Naresh Chandra Committee recommend for % of Independent directors
139
public sector companies shall be similarly elected and shall be subject to the same
responsibilities and liabilities as other directors.102
In this recommendation, the committee enlarged the scope of liability and
responsibilities of a nominee director. Earlier he was liable only to the financial
institution, of which he represented, without incurring any liability to the other
investor. But the present recommendation holds him liable to other investor. This is
also a good sign in process of investor’s protection.
4.7.8 Non-Executive Director Compensation
Non-Executive Director or Independent Director plays a significant role in
Corporate Governance. Heavy responsibility is imposed on him to protect the interest
of the investor. Naresh Chandra Committee makes heavy reliance on non-executive
director as well this committee. Like executive directors non-executive directors are
also be remunerated. The Companies Act 1956 made express provision relating to the
maximum limit of remuneration payable to executive directors. The Companies Act
in fact prescribed 1% of net profit on the maximum limit of remuneration payable to
other than executive Directors .By looking to the nature of duties discharged by the
independent director non-executive director is getting a very meager sum. Hence
there is need to re-look into this aspect. So the committee made the following
mandatory recommendation on this issue.

103 Section 198 lays down that the over all remuneration payable to executive director shall not
exceed 5% if more than on 10% of the total net profits of the company in that financial year and for
all directors 11% of the net profit.
140
“All compensation paid to non-executive directors may be fixed by the board
of directors and should be approved by shareholders in general meeting. Limits
should be set for the maximum of stock options that can be granted to non-executive
directors in any financial year and in aggregate. The stock options granted to the non
executive directors shall vest after a period of at least one year from the date such
non-executive directors have relived from the board of the company”.
Companies should publish their compensation philosophy and statement of
entitled compensation in respect of non-executive directors in their annual report.
Alternatively, this may be put up on the company’s website and reference drawn
thereto in the annual report.
Companies should disclose on an annual basis, details of shares held by non
executive directors, including the as ‘if-converted’ basis.
Non-executive directors should be required to disclose their stock holding
(both own or held by /for other persons on a beneficial basis) in the listed company in
which there is proposal to them as director, prior to their appointment. These details
should accompany their notice of appointment.104
In this recommendation the committee rightly provided for payment of
remuneration of non-executive directors by stock options. By this method, the
investigator feels that the investors are properly protected. Because, if the
independent non-executive directors do not properly discharge their duties, the share
price i.e. stock holding will come down and results in loss of remuneration to
104
Recommendation 3.9.
141
independent directors. If price goes up means more remuneration to them. So while
laying down the policies and supervision, because it acts like a supervisory board on
behalf of shareholders, of the executive directors they will take appropriate care. But
only threat to the interest of other shareholder is over a time the shareholding of
independent director may increase and it may result in the concentration of controlling
powers in the independent directors. By looking to the mode of fixing the
remuneration of non-executive directors, [i.e. it is fixed by the board of directors and
approved by the general body,] the investigator feels that, independent directors will
not be independent in stricto senso. Because of their remuneration they have to look
to the board of director. Hence, the suggestion of the investigator is that the
remuneration is to be fixed directly in the Annual General Body meeting and it need
not either be recommended or approved by the board of directors.
4.7.9 Independent Directors
Regarding the definition of the ‘independent director’ the committee noted the
recommendation of the Naresh Chandra Committee.105 It also looked into the
definition given in the code of the International Corporate Governance Network. The
definition on independent director become material from several points viz for the
payments of benefits like sitting fees, remuneration, travel and stay arrangements;
stock options and performance bonus that executive directors may be entitled.
The committee defined the term ‘independent directors’ as follows:
105
See Appendix ‘C’ Recommendation 4.1.
142
“[The Independent Director is one] who apart from receiving director remuneration,
does not have any material pecuniary relationships or transactions with the company,
its promoters its senior management or its holding company, its subsidiaries and
associated companies;
Is not related to promoters or management at the board level or at one level below the
board;
• Has not been an executive of the company in the immediately preceding three
financial years;
• Is not a partner or an executive of the statutory audit firm or the internal audit
firm that is associated with the company, and has not been a partner or an
executive of any such firm for the last three years. This will also apply to the
legal firms (and consulting firms) that have a material association with the
entity;
• Is not a supplier, service provider or customer of the company. This should
include lessor-lessee type relationship also;
• And is not substantial shareholder of the company i.e. owning 2% or more of
the block of voting shares”.106
4.8 Whistle Blower Policy
The navel and significant suggestion made by the committee is that personnel
who observe an unethical or improper practice should be able to approach the
independent body without first approaching the Board. And also there must be
106
143
mechanism to inform this privilege to the employees. It is a sort of warning signal,
which is aptly required for the proper governance of the company. By considering
this committee made the following mandatory recommendation.
Personnel who observe an unethical or improver practice [not necessarily a
violation of law] should be able to approach the audit committee without necessarily
informing their supervisors.
Companies shall take measures to ensure that this right of access is
communicated to all employees through the means of internal circulars, etc. The
employment and other personnel of the company shall contain provisions protecting
‘whistle blower’ from unfair termination and other unfair prejudicial employment
practices.107
This recommendation is useful in controlling the insiders trading. Further the
committee-imposed responsibility on SEBI to maintain this. 108 The committee is in
favor of enhancing the independence of the audit committee and full protection must
be provided to it.109 In this regard the mandatory recommendation of the committee is
as follows.
“Companies shall annually affirm that they have not denied any personnel
access to the audit committee of the company (in respect of matters involving alleged
misconduct) and that they have provided protection to ‘whistle blowers’ from unfair
termination and other unfair or prejudicial employment practices.
107 Recommendation 3.11.1

109 Recommendation 3.11.2.3.
144
The appointment, removal and terms of remuneration of the chief internal
auditor must be subject to review by the audit committee.
Such affirmation shall form a part of the Board report on Corporate
Governance that is required to be prepared and submitted together with the annual
report”.1,0
4.9 Subsidiary Companies
Forming a subsidiary company is a way-out to overcome the legal regulations,
as the subsidiary company is also an independent entity. But virtually it is under the
control of the board of directors of the holding company. Though many provisions are
made in the Companies Act to protect the interest of investors of holding company.
Yet there is need to bring subsidiary companies within the purview of audit
committees of holding company. If two separate audit committees are created for
holdings and subsidiary company, investors will not get a clear picture. So to enlarge
protection the committee made mandatory recommendation as follows.
“The provisions relating to the composition of the board of directors of the
holding company should be made applicable to the composition of the board of
directors of subsidiary companies.
At last one independent director on the board of directors of the parent
company shall be a director on the board of directors of the subsidiary company.
The audit committee of the parent company shall also review the financial
statements, in particular the investments made by the subsidiary company.
110 Ibid.
145
The minutes of the Board meetings of the subsidiary company shall be placed
for review at the board meeting of the parent company.
The Board report of the parent company should state that they have reviewed
the affairs of the subsidiary company also”. 111
4.10 Real Time Disclosures
The committee suggested that SEBI should issue rules relating to real time
disclosers of certain transactions, which are important for investors within 3-5
business days. Important events are
(a) Change in the control of the company
(b) A company’s acquisition/ disposal of a significant amounts of assets;
(c) Bankruptcy or receivership
(d) A change in the company’s independent auditors, and
(e) The resignation of a director.112
Above information is a price sensitive. Timely disclosure will protect.
Investor’s because price in stock market will fluctuate. By giving real time disclosure
will put a break on market rumors.
4.11 Evaluation of Board Performance
The business of the company is in the hands of board of directors. Proper
disclosure of duties and responsibility will bring profit to the investors. Under the
company law there are numbers of provisions, which deal with the power of the

146
directors and some are dealing with their duties. But, as long as a big fraud will not
occur the investors are in dark. So there is need to have a Board performance
evaluation. Hence the committee made the following non-mandatory
recommendation.
‘The performance evolution of non-executive directors and be by a peer group
comprising the entire board of directors, excluding the director being evaluated; and
peer group evaluation should be the mechanism to determine whether to extend /
continuance the terms of appointment of non-executive directors’.113
In this recommendation, the committee says it is non-mandatory. By looking to
the situation prevailing in India and state of investors, the investigator, feels it should
be made mandatory. The peer group must contain at least one members nominated by
SEBI and one by the Reserve Bank of India.
4.12 Analyst Reports
To avoid conflict of interests between stock analysts and their employing
brokerage /investment banking firms on the one hand and listed companies on the
other hand, that the stock analysts must submit proper and accurate report. It depends
upon the integrity and creditability of the reporters. Hence the committee made the
following mandatory recommendation.
“ SEBI should make rules for the following;
Disclosure in the report issued by security analyst whether the company that is
being written about is a client of the analysts employer or an associate of the
113
147
analysts employer, and the nature of services rendered to such company. It any;
and
Disclosure in the report issued by a security analyst whether the analyst or the
analysts employer or an associate of the analysts employer hold or held (in the
12 months immediately preceding the date of the reporter) or intend to hold
any debt of equity instrument in the issuer company that is the subject matter
of the report of the analysts.”114
4.13 Recommendation of the Naresh Chandra Committee
Apart from making independent recommendation, the committee endorsed the,
recommendations of Naresh Chandra Committee and made the following mandatory
recommendations.
1) Disclosure of contingent liabilities: “Management should provide a clear
description in plain English of each material and contingent liability and its risks,
which should be accompanied by the auditors clearly worded comments on the
managements view. This section should be highlighted in the significant
accounting policies and notes on accounts, as well as in the auditors report, where
necessary. This is important because investors and shareholders should obtain a
clear view of a company’s contingent liability as there may be significant risks
factors that could adversely affect the company’s future financial condition and
results operations”.115

148
2) The committee, CEO/CFO certification of Naresh Chandra Committee116 made
the following mandatory recommendations.
• For all listed companies, there should be a certification by the CEO (either the
Executive Chairman or the Management Directors) and the CFO (whole time
Finance Director or other person discharging this function), which should state
that to the best of their knowledge and belief.
• They have reviewed the balance sheet and profit and loss account and all its
schedules and notes and accounts, as well as the cash flow statements and
the director’s reports.
• These statements do not contain any material untrue statement or omit any
material fact nor do they contain statements that might be misleading;
• These statements together present a true and fair view of the company, and
are in compliance with the existing accounting standards and /or applicable
laws regulations;
• They are responsible for establishing and maintaining internal controls and
have evaluated the effectiveness and internal control system of the
company; and they have also disclosed to the auditors and the audit
committee, deficiencies in the designer operation of internal controls, if
any, and what they have done or propose to do to rectify these;
• They have also disclosed to the auditors as well as the audit committee,
instances of significant fraud, if any, that involves management or

116
Section 2.10 of Naresh Chandra Committee Report.
149
employees having a significant role in the company internal control
systems; and
• They have indicated to the auditors, the audit committee and in the notes on
accounts, whether or not there were significant changes in internal control
and or of accounting policies during the year”.117
3) On definition of independent director118 the committee incorporates in the report
without making or suggesting any changes.119
4) On independence of audit committee120, the committee has made the following
mandatory recommendation: “All audit committee members shall be non
executive members.121
Naresh Chandra Committee has made provisions for exemption of independent
directors.122 But this committee made, in addition to that, the following
recommendation:
“Legal provisions must specifically exempt non-executive and independent
directors from criminal and civil liabilities.under certain circumstances. SEBI should
recommend that such exemptions are need to specifically spell out for the relevant
laws by the relevant departments of the Government and independent regufators, as
the case may be.

1,8 Section 4.1 of Naresh Chandra Committee Report.
120 Section 4.7 of Naresh Chandra Committee Report.
122 Section 4.107. supra note, 116.
150
However, independent directors should periodically review legal compliance
reports prepared by the company as well as steps taken by the company to cure any
fault. In the event of any proceedings against independent director in connection with
the affairs of the company, defense should not be permitted on the ground that the
independent director was unaware of this responsibility. 123
4.14 Other Suggestions
The committee received certain other suggestions relating to the Corporate
Governance. They are:
Harmonization: On these aspects the committee suggested SEBI should work
harmonizing the provisions of clause 49124 of the listing agreement and those of
Companies Act, 1956. Because there are some difference between the listing
agreement clause 49 and the Companies Act. This should be identified by the SEBI
and should make appropriation provision.125
On the suggestion of removal of independent director and informing the SEBI/
Stock Exchange within 5 business days, the committee disapproved this suggestion on
the ground that there are enough safeguards to protect investors.126 But on the
recommendation, the investor feels that the committee has taken liberal approach.
When it has made crucial recommendation to protect investors and to ensure proper
Corporate Governance, why the committee has taken a liberal view. The committee
would have accepted the suggestions.

124 See Appendix E, pp. 326-334.
151
Term of office of non-executive directors: It was suggested that there must be a cap
on the term of office of a non-executive director. On this issue the committee
recommended that as long as the term of office did not exceed nine years (in three
terms of three years each, running continuously) that shall be a cap on the term of
office.127 Further the committee opined that it would be a good practice for directors
to retire after a particular age and recommended the companies to fix it at either 65 or
70 years.128
4.15 Corporate Governance Ratings
Regarding the rating of Corporate Governance of companies, that the criteria
recommended, parameters of wealth generation, maintenance and sharing as well as
Corporate Governance. But at the same time the committee left it to the company
whether it is to be rated or not. But the investigator feels that whether company
likes it or not the SEBI shall give its own rating based on the parameters suggested by
the committee.
4.16 Implementation of Recommendation
The committee has made several recommendations to protect investor, internal
as well external, and to ensure proper governance of the company. At the same time
it has suggested means and ways of implementation of these recommendation. The
committee believes that the recommendations should be implemented for all
companies to which clause 49 apply. This would also continue to apply to companies
177
Recommendation 5.5.
152
that have been registered with BIFR, subject to any direction that BIFR may provide
in this regard. 130
The committee in concluding remarks aptly opined that there are several
Corporate Governance structures in the developed world. But there is no one ‘the
structure'. There is no “one size fits air structure for Corporate Governance.
Different conditions prevailing in different parts of the world require different models.
Important factors which influence Corporate Governance are stock market literacy
and financial literary of the shareholders (investors). Other categories of stakeholders
are creditors, employees and public who are influencing the structure of Corporate
Governance. Hence the committee recommendations are not based on any one model,
but are designed for the Indian Environment. “Corporate Governance extends beyond
corporate Law”, The fundamental objective is not mere fulfillment of the requirement
of law, but in insuring commitment of the board in managing the company in a
transparent manner for maximizing long-term shareholder value.
Effectiveness of a system of Corporate Governance cannot be legislated by
law, nor can any system of Corporate Governance be static. In a dynamic
environment the systems of Corporate Governance need to continually evolve.
130
Recommendation 6.

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CHAPTER-IV

CORPORATE GOVERNANCE REFORMS

In India the Corporate Governance is not a new concept it is as old as

a) Raksha - means protection;

b) Vridhi - means enhancement;

c) Palana - means maintenance; and

d) Yogakshema - means safeguard.1 2

instance, tax evasion, mismanagement scandals, misappropriation etc. The

scenario prevailing in the country to ensure good Corporate Governance.

In the context of globalization the profile of corporate ownership is changing

qualitative improvement in the Corporate Governance is the need of the time.

Improvement in the Corporate Governance based on a code of good governance

practices and meaningful disclosure of information to shareholders hold the key to

corporate success. To reach the benefit of good Corporate Governance to the

better governance and management of corporate bodies, prompt compliance of legal

and financial obligations and adherence to ecological and environmental standards.

4.1 Corporate Governance: Regulatory Framework

corporate functioning in the country. The present system comprises-

a) Companies Act, 1956 - board of directors,3 meetings,4 management,5 conduct

of meetings,6 appointment or removal of auditors7 or directors,8 director’s

3 Section 252, The Companies Act, 1956.

responsibility,9 corporate restructuring mergers,10 inter corporate activities,

audit committee,*11 accounting standards,12 shareholder’s directors,13 postal

b) Monopolies and Restrictive Trade Practices Act, 1969- for control of

c) Foreign Exchange Management Act, 2000- for control and monitoring of

activities of foreign flow of funds, investments and investors.

d) Sick Industrial Companies (Special Provision) Act 1985 and Board of

Industrial and Financial Reconstruction (BIFR).16

f) Securities Contract Regulation Act 1956.

g) Listing Agreement of Stock Exchanges.

h) The Depositories Act, 1996.17

j) Arbitration and Consultation Act, 1996.

k) Codes prescribed by Chambers/Self Regulatory Organizations.

l) SEBI code on Corporate Governance.

Economic policy of 1991.

4.2 Corporate Governance: Reforms

Improvement of Corporate Governance acquired global attention; India cannot

various committees, such as.

1) CI.I. Committee on Code of desirable Corporate Governance, 1998;

2) UTI Committee on Code of Governance 1999;

3) Kumar Mangalama Birla Committees on Corporate Governance, 2000.

4) Naresh Chandra Committee on Corporate Audit and Governance, 2002 and

5) N.R.Narayan Murthy Committee (SEBI) 2003.

Following is the analysis of some of the recommendations of the committees reefed

4.2.1 Confederation of Indian Industry (C.I.I.) Desirable Corporate

C.I.I.s Corporate Governance, a Code is based on the recommended of Rahul

Mr.Shekhar Datt, in the foreword to the draft, said that,

“Corporate Governance is a phrase which implies transparency of management

Government policies and procedures, so also, the debate on Corporate Governance

seeks transparency in the corporate sector”.18

By looking to the importance of Corporate Governance in the Indian economy,

Corporate Governance in mid 1996 under the leadership of Mr .Rahul Bajaj.19

After careful study of Corporate Governance prevailing in various countries,

Board of Directors: The key to good Corporate Governance is a well functioning

acclaimed non-executive directors who understand their dual role of appreciating

responsibilities towards the company’s shareholders as well as creditors.

4.2.2 Recommendations of the Task Force

1) There is no need to adopt the German system of two-tier boards to ensure

desirable Corporate Governance. A Single Board, if it performing well, can