22 Aug 2017 16:06 IST

All you wanted to know about corporate governance

The term governance refers to the act of managing an entity

In the slugfest between its founders and the management at Infosys the past week, corporate governance has been a much-bandied word. The founder has warned that the serious ‘governance deficits’ he was noticing at the tech major would lead to its downfall. The Board has retorted that it continues to adhere to ‘the highest international standards’ of corporate governance. Both camps have arguments to support their view.

What is it?

The term governance refers to the act of managing an entity. What makes the governance of a company so special, as opposed to the governance of a mom-and-pop business, is the separation of ownership from management in the corporate structure. Public limited companies pool capital from thousands of shareholders to build and run a business. But these owners effectively play no active role in the day to day running of company, delegating all the ‘governance’ to a management team. Ensuring that the management team runs the company in the interests of its owners, instead of lining its own pockets, is what good corporate governance is all about.

Governance norms for Indian listed companies are set out in the Companies Act, a detailed clause (Clause 49) in the listing agreement that companies sign with the exchanges and in SEBI’s new Listing Obligations and Disclosure Requirement Regulations of 2015.

Why is it important?

Most listed companies and large corporate groups in India were born as family-owned businesses, with family members occupying managerial positions and making all the key business decisions. This also meant very little distinction between the company’s finances and that of the family owners. With the evolution of the equity markets though, many of these family-owned businesses listed themselves on the exchanges. However, the traditional (mis) governance practices continued. Promoters, though no longer the sole owners, continued to wield disproportionate influence over decisions. Companies freely extended loans to group entities, folks from the family secured berths on the Board with generous pay packets and companies entered into cosy business deals with family and friends. The rights of public shareholders were freely trampled upon.

This was sought to be fixed in the Companies Act 1956, by requiring company Boards to seek Central Government permission for certain decisions (managerial remuneration beyond a certain limit, loans to directors) and shareholder approvals for others (appointment of relatives, for instance).

As these checks proved inadequate, SEBI constituted a series of committees — Kumar Mangalam Birla Committee in 2000, Narayana Murthy Committee in 2003 and Adi Godrej Committee in 2012 — to come up with more elaborate governance norms for India Inc. The present corporate governance norms, enshrined in the Companies Act, SEBI listing regulations and Clause 49 of the listing agreement are the result of deliberations by these committees. Yet another committee — the Uday Kotak committee — has recently been tasked with a further review.

Today, India’s corporate governance framework requires listed companies to have independent directors manning one-third of their Board, disclose all related party deals, disclose comparative metrics on managerial pay, appoint audit and nomination committees, and require the CEO and CFO to sign off on the governance norms being met in the financial statements. Minority shareholders with 10 per cent voting rights also have the right to drag companies to Court for ‘oppression and mismanagement’.

Why should I care?

Shareholders obviously have the most to lose if a company is prone to bad governance. Creative accounting, related party deals, exorbitant managerial remuneration, freebies to friends and family and risky mergers and acquisitions, directly deprive shareholders of profits that are rightfully theirs. But this apart, bad governance practices can have a bearing on all the stakeholders a company deals with – lenders/banks who extend finance, suppliers who sell it goods or services, employees who invest their career in it and customers who put faith in its brand, product or service quality. The ongoing fracas at Infosys has not just decimated the stock price by over 15 per cent, it may also lead to uncertainty for clients and employees. It is therefore in interests of all these stakeholders that corporate governance is treated with the seriousness it deserves.

The bottomline

You may have no choice in politics. But with companies, you don’t have to wait for five years to speak up on bad governance.

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