[FAQs] Conceptual Framework of Corporate Governance – Meaning | Elements | Theories

The Institute of Company Secretaries of India provides that

“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.”

1. When law is compiled in true letter and spirit it helps in bringing transparency, disclosure, accountability and integrity leading to Sustainable development of all the stakeholders.
2. When corporates comply with the laws, they actually discharge there social responsibility towards the society.
3. Main objective of corporate governance is that capital is adequately and correctly allocated amongst the organization hence proper allocation takes place leading to effective management and distribution of wealth’.

Conclusion: Therefore, this is how corporate governance helps in sustainable development, discharge of responsibility and effective management and proper distribution of wealth.

By Corporate Governance we mean application of best management practices, and compliance of law in true letter and spirit and complying with the ethical standards taking the decision in the interest of the stakeholders.

Advantages of Corporate Governance

1. Good corporate governance helps in corporate success and economic growth.
2. Helps in maintaining investors’ confidence.
3. Helps in can raise capital efficiently and effectively.
4. Minimizes wastages, corruption, risks and mismanagement.
5. It helps in brand formation and development.
6. Aids in long term sustenance and growth of the Company.

Need of Corporate Governance

1. It helps to improve the corporate performance by encouraging decision making and succession planning.
2. It helps the corporates to increase the interest of investors.
3. Good governance helps to provide better reach towards global markets.
4. It helps to combat corruption.
5. Companies that are following good governance also get access to Easy Finance from institutions.
6. There is more improvement in the enterprise valuation.
7. Well governed organisations cannot ignore the concept of accountability towards stakeholders.

The Characteristics of the effective Board of Directors are as follows:

1. The Board must possess the necessary blend of qualities, skills, knowledge and experience.
2. The directors should make quality contribution to the organizations policies, operations and management.
3. A Board should have a mix of the skills, knowledge and experience like Operational or technical expertise, financial skills, Legal skills, Knowledge of Government and regulatory requirement.
4. Board Diversity: Diverse boards exhibit a wider range of competencies, differing risk/reward orientations, all of which make for better identification of opportunities and innovative solutions in the boardroom.
5. Strong Chairperson: Chairperson must recognize that they are not commanders but facilitators. Their role is to create the conditions under which the directors can have productive group discussions. Good Chairpersons recognize that they are not first among equals. They are just the people responsible for making everyone on their boards a good director.
6. Induction and Education: Induction enables them to get an appropriate understanding of the business and the environment it operates and Continuing education will help them to be aware about the industry, legal, operational changes that will impact their roles and responsibilities.
7. Board Appointment: There must be a well-defined and open procedure for the appointment of the new directors, Orientation program for new directors should also be provided to apprise them about the company.
8. Board Independence: Independent Board is essential for sound corporate governance. There must be sufficient number of independent directors with the Board which shall ensures that the Board is effective in supervising and, where necessary, challenging the activities of management.
9. Board Meetings: Attending Board meetings regularly and preparing thoroughly before entering the Boardroom increases the quality of interaction at Board meetings, hence directors must devote sufficient time and give due attention to meet their obligations.

Conclusion: Hence an effective board is an outcome of thoughtful onboarding and evaluation, strong and committed leadership, good boardroom culture and dynamics.

Independent Board is very essential for the sound corporate governance due to following reasons:

• Independent directors are known to bring an objective view in board deliberations.
• They also ensure that there is no dominance of one individual or special interest group or the stifling of healthy debate.
• They act as the guardians of the interest of all shareholders and stakeholders.
• They bring a valuable outside perspective to the deliberations.
• Balance the often-conflicting interests of the stakeholders.
• Facilitate withstanding and countering pressures from owners.
• Fulfil a useful role in succession planning.
• Provide independent judgment and wider perspectives.
• Helps to judge the performance of executive directors.

The stanza that shareholders and stakeholders both are associated with the corporation equally however their interest in the organisation differs is true due to following.

Stakeholder theory is a concept suggests that organizations should consider the interests and concerns of all individuals or groups (stakeholders) who can affect or be affected by the organization’s actions.

Stakeholder Theory

• A company’s stakeholders are “those groups without whose support the organization would cease to exist.”
• This group include shareholders, but goes beyond shareholders to also include creditors, customers, employees, investors, suppliers, the local community, government agencies and many others who have a ‘stake’ or claim in some aspect of the company’s products, operations, markets, industry and outcomes.
• Therefore, shareholders are the subset of stakeholders.
• The stakeholder theory suggests that the purpose of a business is to create as much value as possible for stakeholders.
• In order to succeed and be sustainable over time, executives must keep the interests of customers, suppliers, employees, communities and shareholders aligned and going in the same direction.
• Different stakeholders have different self-interests. The interests of these different stakeholders are at times conflicting.
• The managers and the corporation are responsible to mediate between these different stakeholder’s interest.
• This theory assumes that stakeholders are capable and willing to negotiate and bargain with one another, this is good for long term self-interest.

Conclusion: Therefore, the interest of shareholders and stakeholders differ however both of them have equal interest in the organization.

Corporate governance is shaped by various theories and frameworks that guide its principles and practices.

Some of the key theories that form the basis of corporate governance include:

• Agency Theory: This theory focuses on the relationship between principals (such as shareholders) and agents (like managers or executives) and addresses potential conflicts of interest that may arise when agents make decisions on behalf of principals. It emphasizes aligning the interests of both parties to ensure that agents act in the best interest of the principals.
• Stakeholder Theory: This theory asserts that companies should consider the interests of all stakeholders, including shareholders, employees, customers, suppliers, the community, and the environment. It emphasizes the importance of balancing the needs of various stakeholders to achieve sustainable and ethical business practices.
• Stewardship Theory: In contrast to agency theory, stewardship theory focuses on the idea that managers and executives are motivated to act in the best interest of the company rather than in their own self-interest. It assumes that managers are inherently responsible and will work to maximize the value of the company. Companies often draw from these theories to design governance.

(a) Vidur Niti: The meaning of the word “Vidur” in Sanskrit is “skilled, intelligent and wise”. Vidura-niti, or Vidura’s Statecraft, which are narrated in the form of a dialogue between Vidura and King Dhritrashtra were stated to have taken place before the commencement of the Kurukshetra war. While most of the qualities and principles seem to be grounded in politics, these required qualities and principles can equally be well applied to daily life as well as to governance.

(b) Shantiparva: Shantiparva, meaning the book of peace, comprises of 18 parvas (books). It is believed to be the set of instructions given by Shri Bhishma (eldest among the Kuru Family, also called “Pitamah”) to King Yudhisthira. The book comprises of 365 chapters and 13,716 Shlokas, which is further divided into three sub-parvas namely:

• Raja Dharma Parva (Chapters 1 to 130 & 4716 Shlokas): Duties of king and his governance.
• Apad Dharma Parva (Chapters 131 to 173 & 1649 Shlokas): Rules of conduct when one faces adversity.
• Moksha Dharma Parva (Chapters 174 to 365 & 7351 Shlokas): Behaviour and rules to achieve moksha (emancipation, release, freedom).

These theories help guide individuals and organizations in making ethical decisions and navigating moral dilemmas, they are as follows:

• Teleological Theories: The term ‘teleological’ is derived from the Greek word ‘telos’ which means an end. According to teleological theories the Tightness of an action is determined solely by its consequences rather than by any feature of the action itself. Thus, teleological theories are based on the concept of goodness.
• Doctrine of Utilitarianism: The doctrine of utilitarianism is based on the principle of utility, which holds that the right action is the one that maximizes overall happiness or pleasure and minimizes pain or suffering.
• The Principle of Utility: Jeremy Bentham provides the theory principle of utility is the principle which approves or disapproves of every action, according to the tendency which it appears to have to augment or diminish the happiness of the party whose interest is in question or augment or diminish the unhappiness.
• The Principle of Utilitarianism: Utilitarianism is modified version of the principle of utility. Utilitarianism evaluates the morality of individual actions based on the principle of utility. It assesses the morality of actions by examining the general rules or principles that, if followed, would lead to the greatest overall happiness. Rule Utilitarianism under which an action is right if and only if it confirms to generally accepted rules and produces the greatest balance of pleasure over pain.

The principle of utilitarianism consists of the following elements:

1. Consequentialism – The Tightness of any action depends solely on its consequences.
2. Hedonism – Pleasure alone is good.
3. Maximization – A right action is one that creates greatest amount of net pleasure.
4. Universalism – Everyone’s consequences are alike.

• Deontological Theories: The term ‘deontological’ is derived from the Greek word ‘deon’ which means duty. According to deontological theories certain actions are right not due to some benefit to self or others but due to their basic nature or the rules underlying them. For example, bribery by its very nature is wrong irrespective of its consequences.

Philosopher has given the following moral rules:

• Duties of Fidelity — to keep promises, both explicit and implicit, and to tell the truth.
• Duties of Reparation — to compensate people for injury that we have wrongfully inflicted on them.
• Duties of Gratitude — to return favours that others do for us.
• Duties of Justice — to ensure that goods are distributed according to people’s merits.
• Duties of Beneficence — to do whatever we can to improve the condition of others.
• Duties of Self-improvement — to improve our own condition with respect to virtue and intelligence.
• Duties of Non-maleficence — to avoid injury to other.

The Companies follows the principle of separation of ownership and management. That means that owners don’t need to be managers and managers don’t need to be owners.

• In most small corporations, the owners manage the company but it is not necessary that owners run the company or are even involved in the day-to-day operations of the company.
• Shareholders own the company and hence the company ought to work according to the shareholders and in the best interest of the shareholders.
• Shareholders cannot manage the full details of the business organization hence they elect the board of directors to manage the board and to make policies.
• It is the duty of the board of directors to act in good faith and to take a well-informed decision keeping in mind the best interest of the stakeholders.
• Therefore, the shareholders are known as the OWNERS OF THE COMPANY and the directors are known as the MANAGERS OF THE COMPANY.

Conclusion: The shareholders are the ostensible owners and the Directors and officers are the ostensible fiduciary of the shareholders, therefore the ostensible owners authorize the ostensible fiduciary to act as agent i.e. in good faith and to protect the interest of the principle and to remain faithful to the goals.

In the case of Foss v. Harbottle [1843], it was held that the Courts would not generally interfere with the decisions of the company which it was empowered to take in so far, they had been approved of by the majority and made exceptions to breaches of charter documents, fiduciary duties and frauds or oppression and inadequate notice to the shareholders. The principle is still relevant as the court was right in ruling that every shareholder is bound by the terms and conditions of incorporation of the company, which operated as a set of mutually binding obligations.

However, in the process of implementing the objectives of the company, one should not override the legitimate expectations of minority shareholders. The following are the various sections which deal with minority shareholders under the Companies Act, 2013.

• Oppression & Mismanagement [Sections 241-246]
• Class Action Suits [Section 245]
• Appointment of director by small shareholders [Section 151]
• Promoting the confidence of minority shareholders [Schedule IV – Code for Independent Directors]

The corporate governance framework protects facilitates and ensure equitable treatment of all the shareholders, also provides opportunity to obtain effective redressal for the violation of their rights, Companies Act, 2013 provides for some measures to protect the interest of minority shareholders which are discussed as under: –

1. Oppression and Mismanagement: As per the sections from 241 to 246 of Companies Act, 2013 deals with prevention of Oppression and Mismanagement. When a shareholder’s rights are violated, it can be termed as oppression. The majority shareholders misuse their powers and earn profit at stake of minority.
2. Class Action Suit: A class action suit is a legal proceeding in which shareholders bring suit as a group against the company or its directors or officers and the judgment or settlement received from the suit covers all the shareholders equally.
3. Special Rights: The Companies Act. 2013 provides some special powers to small shareholders to prevent exploitation of their rights, as the will of the majority prevails majority exercise their rights without considering the interests of minority.
4. Representation on Board: Section 151 provides that a listed company may have one director elected by such small shareholders as prescribed under Rule 7 of the Companies (Appointment and Qualification of Directors) Rules. 2014.
5. E-Voting: Voting by electronic means is a facility given to the members of a company with more than 1000 shareholders to cast their votes on the resolutions through electronic mode. It provides an opportunity to shareholders residing in far-flung area to take part in the decision-making process of the company. Shareholder scan therefore exercise their voting rights even when they cannot be physically present for meetings and without spending too much time or money.
6. Related Party Transactions: Section 188(1) provides that a company shall not enter into any contract or arrangement with a related party that has been provided in the section of except with the consent of the Board of Director given by a resolution at meeting of the Board.

• 1998 Desirable Corporate Governance: A Code: CII took a special initiative on Corporate Governance, The objective was to develop and promote a code for Corporate Governance to be adopted and followed by Indian companies, whether in the Private Sector, the Public Sector, Banks or Financial Institutions
• 1999 Kumar Mangalam Birla Committee: The Securities and Exchange Board of India (SEBI) had set up a Committee on May 7, 1999 under the Chairmanship of Kumar Mangalam Birla to promote and raise standards of corporate governance.
• 2000 Task Force on Corporate Excellence through Governance: Department of Company Affairs [now Ministry of Corporate Affairs (MCA)] formed a broad-based study group under the chairmanship of Dr. P.L. Sanjeev Reddy, Secretary, DCA. Objective: for raising governance standards among all companies in India.
• 2017 Uday Kotak Committee: The SEBI Committee on Corporate Governance was formed in June 2017 under the Chairmanship of Mr. Uday Kotak. Some of the major changes accepted relate to:

1. 1. Increasing Transparency -Enhanced Disclosure Requirements.
   2. Disclosure of Utilization of Funds from Qualified Institutional Placement (QIP)/Preferential Issues
   3. Disclosures of Auditor Credentials, Audit Fee, Reasons for Resignation of Auditors
   4. Disclosure of Expertise/Skills of Directors
   5. Enhanced Disclosure of Related Party Transactions (RPT)-A
   6. Mandatory Disclosure of Consolidated Quarterly Results with effect from Financial Year 2019-2020-
   7. Reshaping the Institution of the Board of Directors and Enhancing the Role of Committees of the Board
   8. Separation of the office of the chairperson (i.e. the leader of the board) and CEO/ MD (i.e. the leader of the management)
   9. Augmenting board strength and diversity
   10. Enhanced Quorum etc.

2019 National Guidelines on Responsible Business Conduct (NGRBC): Ministry of Corporate Affairs propounded the National Guidelines on Responsible Business Conduct (NGBRC). The principles of NGRBC are

1. Businesses should conduct and govern themselves with integrity in a manner that is Ethical, Transparent and Accountable.
2. Businesses should provide goods and services in a manner that is sustainable and safe.
3. Businesses should respect and promote the well-being of all employees, including those in their value chains.
4. Businesses should respect the interests of and be responsive to all their stakeholders.
5. Businesses should respect and promote human rights.
6. Businesses should respect and make efforts to protect and restore the environment.
7. Businesses, when engaging in influencing public and regulatory policy, should do so in a manner that is responsible and transparent.
8. Businesses should promote inclusive growth and equitable development.
9. Businesses should engage with and provide value to their consumers in a responsible manner

The UK Stewardship Code sets out the principles of effective stewardship by investors. Stewardship responsibilities of institutional investors may include monitoring and engaging with companies on matters such as strategy, performance, risk, capital structure and corporate governance, including culture and remuneration.

The Stewardship Code also states that institutional shareholders should:

• Publicly disclose their policy on how they will discharge their stewardship responsibilities.
• Have a robust policy on managing conflicts of interest in relation to stewardship which should be publicly disclosed.
• Monitor their investee companies.
• Establish clear guidelines on when and how they will escalate their stewardship activities.
• Be willing to act collectively with other investors where appropriate.
• Have a clear policy on voting and disclosure of voting activity.
• Report periodically on their stewardship and voting activities.

CONCLUSION: Institutional investors should have clear guidelines about the
circumstances when they will intervene actively. Compliance with the code does not
constitute an invitation to manage the affairs of a company. If the company’s board does
not respond constructively, the institutional investor should have guidelines for
deciding whether and how to escalate their action.

(1) Audit, Risk, and Internal Control Principles

a) The board should establish formal and transparent policies and procedures to
ensure the independence and effectiveness of internal and external audit functions
and satisfy itself on the integrity of financial and narrative statements.

b) The board should present a fair, balanced, and understandable assessment of the
company’s position and prospects.

c) The board should establish procedures to manage risk, oversee the internal control
framework and determine the nature and extent of the principal risks the company
is willing to take in order to achieve its long-term strategic objectives.

(2) Remuneration Principles

a) Remuneration policies and practices should be designed to support strategy and
promote long term sustainable success.

b) Executive remuneration should be aligned to company purpose and values and be
clearly linked to the successful delivery of the company’s long-term strategy.

c) A formal and transparent procedure for developing policy on executive
remuneration and determining director and senior management remuneration
should be established. No director should be involved in deciding their own
remuneration outcome.

d) Directors should exercise independent judgement and discretion when authorizing
remuneration outcomes, taking account of company and individual performance,
and wider circumstances.

Introduction

• The Sarbanes Oxley Act was passed in the year 2002 by United States Congress.
• The Sarbanes-Oxley Act (SOX) to protect shareholders and the general public
  from accounting errors and fraudulent practices in enterprises, and to improve the
  accuracy of corporate disclosures.
• The act sets deadlines for compliance and publishes rules on requirements.
• The Act became effective since 2006 for all publicly traded companies which are
  required to implement and report to the SEC for compliance.
• Certain provisions of Sarbanes-Oxley also apply to privately-held companies.

Major Highlights: