CH.

1 INTRODUCTION

The need for corporate governance has arisen because of the

increasing concern about the non-compliance of standards of
financial reporting and accountability by board of directors and
management of corporate inflicting heavy losses on investors.

The modern companies, due to their vast size, use vast societal
resources. It is therefore imperative that these resources are used
by Board of Directors for the best interest of not only the
shareholders but other stakeholders as well. The Board therefore
must have the freedom to take executive decisions but such
freedom must be exercised within the framework of
accountability.1

The collapse of international giants likes Enron, World Com of the

US and Xerox of Japan are said to be due to the absence of good
corporate governance and corrupt practices adopted by
management of these companies and their financial consulting
firms. The failures of these multinational giants bring out the
importance of good corporate governance structure making clear
the distinction of power between the Board of Directors and the
management which can lead to appropriate governance processes
and procedures under which management is free to manage and
board of directors is free to monitor and give policy directions.2

In India, SEBI realized the need for good corporate governance

and for this purpose appointed several committees such as Kumar
Manglam Birla Committee, Naresh Chandra Committee and
Narayana Murthy Committee.

1
Taxmann’s Company Law, Kapoor G.K., 20 th edn.
2
www.economicsdiscussion.net

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CH.2 CORPORATE GOVERNANCE

Corporate governance is the system of rules, practices and

processes by which a firm is directed and controlled. Corporate
governance essentially involves balancing the interests of a
company's many stakeholders, such as shareholders, management,
customers, suppliers, financiers, government and the community.
Since corporate governance also provides the framework for
attaining a company's objectives, it encompasses practically every
sphere of management, from action plans and internal controls to
performance measurement and corporate disclosure.3

The Organisation for Economic Co-operation and Development

(OPEC) states that ‘Corporate Governance involves a set of
relationship between a company’s management, its board, its
shareholders and other stakeholders. Corporate Governance also
provides the structure through which objectives of the company are
set, and the means of attaining those objectives and monitoring
performance are determined. Good corporate governance provides
proper incentives for the board and management to pursue
objectives that are in the interest of the company and its
shareholders and should facilitate effective monitoring. The
presence of an effective governance system, within an individual
company and across an economy as a whole helps to provide a
degree of confidence that is necessary for the proper functioning of
a market economy. As a result, the cost of capital is lower and
firms are encouraged to use resources more efficiently, thereby
underpinning growth.’

3
https://www.investopedia.com/terms/c/corporategovernance.asp

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DEFINITIONS OF CORPORATE GOVERNANCE

Corporate governance refers to the accountability of the Board of

Directors to all stakeholders of the corporation i.e. shareholders,
employees, suppliers, customers and society in general; towards
giving the corporation a fair, efficient and transparent
administration.4

According to Cadbury Committee Corporate Governance is the

system by which companies are directed and controlled.

Organization of Economic Cooperation and Development (OECO)

defined Corporate Governance as a system by which business
corporations are directed and controlled.

Institute of Company Secretaries of India (ICSI) – According to

ICSI, Corporate Governance is the application of best management
practices, compliance of law in true letter and spirit and adherence
to ethical standards for effective management and distribution of
wealth and discharge of social responsibility for sustainable
development of all stakeholders.

The Oxford University Press Business English Dictionary defines

corporate governance as the “way in which directors and managers
control a company and make decisions, especially decisions that
have an important effect on the shareholders.”

According to Catherwood “Corporate governance means that

company manages its business in a manner that is accountable and
responsible to the shareholders. In a wider interpretation, corporate
governance includes company’s accountability to shareholders and

4
http://www.yourarticlelibrary.com/business/corporate-governance-
business/corporate-governance-in-india-concept-needs-and-principles/69978

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other stakeholders such as employees, suppliers, customers and
local community.”

Corporate Governance is the system of rules, practices and

processes by which a firm is directed and controlled. Corporate
Governance essentially involves the balancing of interests between
company’s stakeholders.5

5
https://www.investopedia.com/terms/c/corporategovernance.asp

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CH.3 NEED FOR CORPORATE GOVERNANCE

The need for corporate governance is highlighted by the following

factors:

1. Wide Spread of Shareholders:

Today a company has a very large number of shareholders spread

all over the nation and even the world; and a majority of
shareholders being unorganised and having an indifferent attitude
towards corporate affairs. The idea of shareholders’ democracy
remains confined only to the law and the Articles of Association;
which requires a practical implementation through a code of
conduct of corporate governance.

2. Changing Ownership Structure:

The pattern of corporate ownership has changed considerably, in

the present-day-times; with institutional investors (foreign as well
Indian) and mutual funds becoming largest shareholders in large
corporate private sector. These investors have become the greatest
challenge to corporate managements, forcing the latter to abide by
some established code of corporate governance to build up its
image in society.

3. Corporate Scams or Scandals:

Corporate scams (or frauds) in the recent years of the past have
shaken public confidence in corporate management. The event of
Harshad Mehta scandal, which is perhaps, one biggest scandal, is
in the heart and mind of all, connected with corporate shareholding
or otherwise being educated and socially conscious.

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The need for corporate governance is, then, imperative for reviving
investors’ confidence in the corporate sector towards the economic
development of society.

4. Greater Expectations of Society of the Corporate

Sector:

Society of today holds greater expectations of the corporate sector

in terms of reasonable price, better quality, pollution control, best
utilisation of resources etc. To meet social expectations, there is a
need for a code of corporate governance, for the best management
of company in economic and social terms.

5. Hostile Take-Overs:

Hostile take-overs of corporations witnessed in several countries,

put a question mark on the efficiency of managements of take-over
companies. This factor also points out to the need for corporate
governance, in the form of an efficient code of conduct for
corporate managements.

6. Huge Increase in Top Management Compensation:

It has been observed in both developing and developed economies

that there has been a great increase in the monetary payments
(compensation) packages of top level corporate executives. There
is no justification for exorbitant payments to top ranking managers,
out of corporate funds, which are a property of shareholders and
society.

This factor necessitates corporate governance to contain the ill-

practices of top managements of companies.

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 7. Globalisation:

Desire of more and more Indian companies to get listed on

International stock exchanges also focuses on a need for corporate
governance. In fact, corporate governance has become a buzzword
in the corporate sector. There is no doubt that international capital
market recognises only companies well-managed according to
standard codes of corporate governance.

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CH.4 PRINCIPLES OF CORPORATE GOVERNACE

The fundamental or key principles of corporate governance are

described below:

 Transparency:

Transparency means the quality of something which enables one to

understand the truth easily. In the context of corporate governance,
it implies an accurate, adequate and timely disclosure of relevant
information about the operating results etc. of the corporate
enterprise to the stakeholders.

In fact, transparency is the foundation of corporate governance;

which helps to develop a high level of public confidence in the
corporate sector. For ensuring transparency in corporate
administration, a company should publish relevant information
about corporate affairs in leading newspapers, e.g., on a quarterly
or half yearly or annual basis.

 Accountability:

Accountability is a liability to explain the results of one’s decisions

taken in the interest of others. In the context of corporate
governance, accountability implies the responsibility of the
Chairman, the Board of Directors and the chief executive for the
use of company’s resources (over which they have authority) in the
best interest of company and its stakeholders.

 Independence:

Good corporate governance requires independence on the part of

the top management of the corporation i.e. the Board of Directors
must be strong non-partisan body; so that it can take all corporate
decisions based on business prudence. Without the top

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management of the company being independent; good corporate
governance is only a mere dream.

 SEBI Code of Corporate Governance:

To promote good corporate governance, SEBI (Securities and

Exchange Board of India) constituted a committee on corporate
governance under the chairmanship of Kumar Mangalam Birla. On
the basis of the recommendations of this committee, SEBI issued
certain guidelines on corporate governance; which are required to
be incorporated in the listing agreement between the company and
the stock exchange.

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CH.5 IMPORTANCE (CG)

A good system of corporate governance is important on account of

the following:

 Investors and shareholders of a corporate company

need protection for their investment due to lack of
adequate standards of financial reporting and
accountability.

It has been noticed in India that companies raised capital from the
market at high valuation of their shares by projecting wrong
picture of the company’s performance and profitability.

The investors suffered a lot due to unscrupulous management of

corporate that performed much less than reported at the time of
rais­ing capital. “Bad governance was also exemplified by
allotment of promoters’ share at preferential prices
disproportionate to market value affecting minority-holders
interest”.

There is increasing awareness and consensus among Indian

investors to invest in companies which have a record of observing
practices of good corporate governance. Therefore, for
encourag-ing Indian investors to make adequate investment in the
stock of corporate companies and thereby boosting up rate of
growth of the economy, the protection of their interests from
fraudulent practices of corporate of boards of directors and
management are urgently needed.

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  Corporate governance is considered as an important
means for paying heed to investor’s grievances.

Kumar Manglam Birla Committee on corporate governance found

that companies were not paying adequate attention to the timely
dissemination of required information to investors in by India.

Though some measures have been taken by SEBI and RBI but
much more required to be taken by the companies themselves to
pay heed to the investor grievances and protection of their
investment by adopting good standards of corporate governance.

 The importance of good corporate governance lies in

the fact that it will enable the corporate firms to (1)
attract capital and (2) perform efficiently.

This will help in winning investor confidence. Investors will be

willing to invest in the companies with a good record of corporate
governance.

New policy of liberalization and deregulation adopted in India

since 1991 has given greater freedom to management which should
be prudently used to promote investors’ interests. In India, there
are several instances of corporate failures due to lack of
transparency and disclosures and instances of falsification of
accounts. This discourages investors to make investment in the
companies with poor record of corporate governance.

 Global Perspective

The extent to which corporate enterprises observe the basic

principles of good corporate governance has now become an
important factor for attracting foreign investment. In this age of
globalisation when quantitative restrictions have been removed and
trade barriers dis-mantled, the relationship between corporate

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governance and flows of foreign investment has become
increasingly important.

Studies in India and abroad show that foreign investors take notice
of well- managed companies and respond positively to them,
capital flows from foreign institutional investors (FII) for
investment in the capital market and foreign direct investment
(FDI) in joint ventures with Indian corporate companies will be
coming if they are convinced about the implementation of basic
principles of good corporate governance.

Thus, “International flows of capital enable companies to access

financing from a large pool of investors. If countries are to reap the
full benefits of the global capital markets, and if they are to attract
long-term capital, corporate governance arrangements must be
credible and well understood across borders”. The large inflows of
foreign investment will contribute immensely to economic growth.

 Indispensable for healthy and vibrant stock market

An important advantage of strong corporate governance is that it is

indispensable for a vibrant stock market. A healthy stock market is
an important instrument for investor’s protection. A bane of stock
market is insider trading. Insider trading means trading of shares of
a company by insiders such directors, managers and other
employees of the company on the basis of information which is not
known to outsiders of the company.

It is through insider trading that the officials of a corporate

company take undue advantage at the expense of investors in
general. Insider trading is a kind of fraud committed by the
officials of the company. One way of dealing with the problem of
insider trading is enacting legislation prohibiting such trading and
enforcing criminal action against violators.

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In India, insider trading has been rampant and therefore it was
prohibited by SEBI. However, the experience shows prohibiting
insider trading by law is not the effective way of dealing with the
problem of insider trading because legal process of providing
punishment is a lengthy process and conviction rate is very low.

According to Securities and Financial Regulations Report, the

effective way of tackling the problem is by encouraging the
companies to practice self-regulation and taking prophylactic
action. This is inherently connected to the field of corporate
governance.

It is a means by which the company signals to the market that

effective self-regulation is in place and that investors are safe to
invest in their securities. In addition to prohibiting inappropriate
actions (which might not necessarily be prohibited) self-regulation
is also considered an effective means of creating shareholders
value. Companies can always regulate their directors/officers
beyond what is prohibited by the law.6

6
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CH.6 CONCLUSION

Corporate governance refers to the accountability of the Board of

Directors to all stakeholders of the corporation i.e. shareholders,
employees, suppliers, customers and society in general; towards
giving the corporation a fair, efficient and transparent
administration.

It is essential that good governance practices must be effectively

implemented and enforced preferably by self-regulation and
voluntary adoption of ethical code of business conduct and if
necessary through relevant regulatory laws and rules framed by
Govern-ment or its agencies such as SFBI, RBI.

The effective implementation of good governance practices would

ensure investor confidence in the corporate companies which will
lead to greater investment in them ensuring their sustained growth.
Thus good corporate governance would greatly benefit the
companies enabling them to thrive and prosper.

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CH.7 SUGGESTIONS

In the context of liberalization and globalisation there is growing

realization in the emerging economies including India that a
country’s business environment must be maintained and operated
in a manner that is conducive to investor’s confidence so that both
domestic and foreign investors are induced to make adequate
investment in corporate companies. This will be conducive to rapid
capital formation and sustained growth of the economy.

Further, it needs to be emphasized that practices and principles of

good corporate governance have been evolved which stimulate
business rather than stifle it. In fact in good corporate governance
structure what is ensured is that companies must preferably follow
voluntarily ethical code of busi-ness conduct which are conducive
to the expansion of investment in them and ensure good outcome
in terms of rates of return.

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BIBLIOGRAPHY

 Kapoor G.K., Taxmann’s Company Law, 20th edition

 Singh Avtar, Company Law, EBC (2016)
 https://www.jordanscorporatelaw.com/our-thinking/blog/-
/blogs/the-importance-of-good-corporate-governance
 https://www.thecsclubindia.com/what-is-corporate-
governance-principlebenefits-and-importance/
 https://www.investopedia.com/terms/c/corporategovernanc
e.asp
 http://www.economicsdiscussion.net/business-
environment/corporate-governance/corporate-governance-
in-india-need-importance-and-conclusion/10145
 Gulshan SS, Company Law, 3rd edition

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