--By Sujit Mundul

 

Corporate Governance (CG) is a set of manners through which organizations are directed and controlled. It provides structure through which a company’s objectives are set, and outlines the means for attaining and monitoring the performance of those objectives. CG includes laws that govern the formation of firms, bylaws established by the firm itself, and structure of the firm. It sets forth the broad parameters of the relationships and responsibilities between the board, management, shareholder and other relevant stakeholders within a legal and regulatory framework.

 

The fundamental concern of CG is to ensure the conditions whereby a firm’s directors and management act in the interests of the firm and its shareholders, and to ensure the means by which managers are held responsible and accountable to capital providers for the use of assets. Good governance aims to protect shareholders’ rights, enhance disclosure and transparency, facilitate effective co-ordination and functioning of the board and provide an efficient legal and regulatory enforcement framework. Let us now briefly deal with RATF (Responsibilities, Accountability, Transparency and Fairness), the four main pillars of CG.

 

Responsibility: of directors who approve the strategic direction of an organization within the framework of prudent controls and who employ, monitor and reward management. Accountability: of the board of the shareholders who have the right to receive information on the financial stewardship of the investment and exercise power to reward or remove the directors entrusted to run the company. Transparency: of clearinformation with which meaningful analysis of a company and its actions can be made. The disclosure of financial/ operational information oversight and control enables outsiders to understand the organization in greater depth.

 

Fairness: that all shareholders are treated equally and have the opportunity for redress of violation of their rights. It goes without saying that long-term survival and success of an institution depends greatly on the skills, experience and knowledge of its directors and the top management. The “Working board” requires individuals who are informed, competent and independent toensure enterprise and integrity, which can promote sound and sustainable growth. Increased competition resulting from the entries of international players now significantly contributes towards the improvement of CG in various sectors of many developing economies; South Asia has also witnessed the same positive influence.

 

As discussed earlier, CG achieves its objective through a set of codes in the form of board composition, approval processes on items of importance, and oversight of committees of the board. Statutory auditors of the companies are required to certify ex-post that the actions taken by the boards are as per the code. Notwithstanding such elaborate mechanisms, corporate governance in most Indian corporates leaves much to the desired; other countries in South Asia are virtually no exception in this regard.

 

It has been noted that many family run businesses in India, which are listed on exchanges, continue to think that the business is primarily andsubstantially controlled by themand listing is incidental to that business. The company management and the controlling shareholders are not obliged to the minority shareholders. It is pertinent to identify the key ingredient of corporate governance that needs to be fixed. In a report of the World Bank and the IMF, “Doing Business 2012”,one of the most important parameters against which India (I have chosen India as it is the largest economy in South Asia) was assessed as “protecting investors”. While India was rated 46th amongst 183 countries, in the overall assessmentit slipped to 132nd amongst 183 countries rated in the report.

 

P.S. Reddy, MD of CDSL, in his article, has very rightly said that one single important dimension considered to test the efficiency of protecting investors was RPT (i.e. Related Party Transactions). This comprises of three major indicators viz, extent of disclosure, extent of director’s liability and ease of shareholders’ suits. One can easily find that the disclosures are not immediate; the approval processes do not require the consent of minority shareholders; the liability of directors is not specifically provided under the provisions of company act, and finally it is not an easy task for the shareholders to sue the company or its directors or management. Regrettably, information required to file a suit is not adequately available.

 

It is clear that abusive RPT are the bane of effective Corporate Governance. There should be no doubt about why Corporate Governance cannot be fully attainedif thismalady is rectified. I am of the opinion that no RPT isjustified if it causes damages to the interest of the common shareholders regardless of the quantum of damage. If it is abusive in nature, which benefits only some shareholders, especially the controlling shareholders or the management, it must be declared void ab initio, regardless of the approval process enshrined in the corporate governance code or under company law. Among RPTs, the compensation to the management is a contentious issue, as no guidelines are prescribed in law, (except limits) nor are any objective, principles followed by the Board of Directors. Therefore, in many cases, the management, especially those, which are also controlling shareholders, liberally grant to themselves a hefty reward devoid of justification. It would also be not out of place to mention about the role of independent Directors. The institution of independent directors, which was created to check mate or to re-balance the governance in listed companies, must ensure that the information on RPTs put out in public domain is adequate for the committee to take a decision.

 

Now, considering the pitfalls of the corporate governance framework, mainly in the developing economics (e.g. the South Asia Countries) time has come for improving the CG framework. A complete overhaul of the companies act in 2013 in India is a laudable effort in the right direction. This act adopts a stakeholders’ approach to corporate governance. The governance safeguards introduced in the act are in line with global standards, including board diversity, effectiveness of independent directors, director appointment and their remuneration, director responsibilities, corporate fraud detection and investigation, and protection of minority shareholders interest. It would be really helpful should the other countries in South Asia Region initiate measures for plugging the loopholes in the CG framework as this would help clearing the systems and improve the stock exchange operations and restore confidence to ensure a more realistic approach for the investors to adopt.

 

 

(Sujit Mundul is former CEO of Standard Chartered Bank Nepal where he currently serves as a member of the Board of Directors.)