Author: Anam Irfan Patel, ILS Law college
Corporate governance encompasses a company’s internal controls, policies, and procedures, creating a framework for its operations and interactions with stakeholders including customers, management, employees, government agencies, and industry groups. This framework should embody principles of transparency, integrity, ethics, and honesty. As the essence of an organization, adherence to corporate governance is essential in all business activities.
The term “governance” derives from the Latin word “gubanare,” meaning “to steer.” Governance refers to the way in which actions and affairs are directed and controlled. In the context of corporate governance, it involves the exercise of authority and decision-making to achieve an organization’s objectives. Corporate Governance is often described as an internal system that includes policies, processes, and personnel designed to serve the interests of shareholders and other stakeholders. This system ensures that management activities are directed and controlled with business acumen, objectivity, accountability, and integrity. Effective corporate governance depends on external market commitments, legislation, and a strong board culture that upholds policies and
In India, corporate governance guidelines have developed since 1998 through the efforts of various committees appointed by the Ministry of Corporate Affairs and the Securities and Exchange Board of India The primary sources of governance are the Companies Act, associated rules, and notifications issued by the MCA. LLPs are governed by the Limited Liability Partnership Act, 2008. Additionally, listed companies in India must adhere to the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, along with the listing agreement of the relevant stock exchange.
Principles of Corporate Governance:
Fairness: The principle of fairness requires that the board of directors ensures all stakeholders—including shareholders, employees, vendors, and communities—are treated equitably. This involves ensuring that all decisions and actions are impartial and free from favoritism or discrimination.
Transparency: Transparency demands that the board provides stakeholders with clear, accurate, and timely information about the company’s operations, financial status, and governance practices. This includes disclosing financial performance, potential conflicts of interest, and significant risks
Risk Management: Effective risk management is a vital duty shared by the board and management. This entails systematically identifying, assessing, and prioritizing potential risks. The board must ensure robust risk mitigation processes are in place and that management implements these measures effectively. Regular monitoring and communication about risk status are crucial to maintaining organizational stability and safeguarding assets.
Responsibility: The board of directors is crucial in overseeing the company’s operations and aligning management activities with the organization’s strategic goals and values.The board also plays a critical role in selecting, evaluating, and if necessary, removing the Chief Executive Officer (CEO), supporting the CEO in achieving company objectives, and making decisions that benefit the company and its investors.
Accountability: Accountability requires the board to take responsibility for the company’s performance and governance. This involves being transparent about the company’s activities and outcomes, including both successes and failures. The board must assess and report on the company’s capacity and performance, ensure adherence to values, and address any issues. This accountability fosters a culture of integrity and responsibility, enhancing stakeholder confidence and supporting long-term success.
Four Ps of Corporate Governance:
People: This aspect highlights the critical role of individuals in corporate governance, including the board of directors, senior executives, and employees. Key considerations include the board’s composition, their expertise, independence, and diversity, all of which are essential for effective governance.
Purpose: Purpose pertains to the company’s core mission and objectives. Corporate governance ensures that the company’s goals are aligned with ethical principles and aim to create long-term value for both shareholders and other stakeholders.
Processes: This component involves the systems and procedures set up to oversee and manage the organization. Governance processes include the methods for decision-making, risk assessment and management, and the maintenance of accountability.
Practices: This ‘P’ refers to the company’s performance in achieving its goals while adhering to ethical standards. The governance framework is responsible for monitoring and evaluating the company’s performance against predefined benchmarks.
Key Components of Corporate Governance:
Board of Directors:
Composition and Independence: The board of directors is essential for guiding and overseeing the company’s activities. The size of the board can vary based on the company’s type: public companies must have at least three directors, private companies need a minimum of two, and one-person companies must have at least one director. A maximum of fifteen directors can be appointed. Additionally, at least one director must be resident in India for at least 182 days in the previous year, as required by law. Public companies are mandated to have at least one woman director and must ensure that one-third of their board members are independent directors.
Board Committees: Boards often form sub-committees to handle specific responsibilities, especially in larger organizations. Common board committees include:
Audit Committees: Looks over the functions like financial reporting and disclosure.
Compensation Committees: Set executive pay and benefits.
Nominating Committees: Manage the process for appointing directors.
Shareholders and Stakeholders:
Rights and Responsibilities: Shareholders have several critical rights, including voting on key decisions such as electing directors, approving mergers and acquisitions, and altering the company’s articles of incorporation. They are also entitled to dividends and access to the company’s books and records.
Minority Shareholder Protection: Minority shareholders, owning less than 50% of the company’s shares, still possess voting rights and can hold directors and officers accountable. This helps ensure better governance and potentially increases financial returns by promoting fair practices.
Disclosure and Transparency:
Financial Reporting: Financial reporting involves providing stakeholders with detailed financial information through documents such as balance sheets, income statements, and cash flow statements. These reports must adhere to accounting standards like Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
Non-Financial Disclosure: Non-financial disclosure includes information not directly related to financial performance, such as the company’s Environmental, Social, and Governance (ESG) practices. This information helps stakeholders understand the company’s broader impact and sustainability efforts.
ESG Goals:
Environmental: Evaluates how a company manages its environmental responsibilities, including resource usage and pollution control.
Social: Examines how the company handles relationships with employees, suppliers, customers, and the communities where it operates. This involves assessing workplace practices, human rights, and community engagement.
Governance: Focuses on a company’s leadership, executive compensation, audit practices, internal controls, and shareholder rights. Good governance ensures that the company is led effectively and ethically.
The ESG framework represents an essential aspect of modern corporate governance, integrating ethical practices and sustainability into business operations. Unlike Corporate Social Responsibility (CSR), which focuses on tangible projects and philanthropy, ESG encompasses broader non-financial factors guiding investment decisions. Since the introduction of the United Nations Principles for Responsible Investing (UNPRI) in 2006, ESG has become a crucial component of business strategies, especially in developing economies like India, where CSR aligns with social development and good governance principles.
Corporate governance ensures effective management and ethical oversight through a well-structured board, clear processes, and transparency in financial and non-financial disclosures. Emphasizing ESG goals integrates sustainability and responsibility into business practices, fostering trust and long-term success. This framework is essential for aligning corporate actions with broader societal values.
FAQS
What is the role of the Board of Directors in corporate governance?
The Board of Directors is responsible for guiding and overseeing the company’s strategic direction and management. They make key decisions on major issues, ensure that the company adheres to legal and ethical standards, and monitor overall performance. Their roles include appointing and evaluating the CEO, setting company policies, and overseeing financial performance.
What are the key requirements for the composition of the Board of Directors?
For a public company, the board must consist of at least three directors, while a private company requires a minimum of two, and a one-person company must have at least one director. The maximum number of directors is fifteen. Additionally, at least one director must be a resident of India for a minimum of 182 days in the previous year, and public companies must include at least one woman director and ensure that one-third of their board members are independent directors.
What types of committees might a Board of Directors have?
Common committees include:
Audit Committee: Focuses on financial reporting, compliance, and internal controls.
Compensation Committee: Determines executive compensation and benefits.
Nominating Committee: Manages the process of selecting and appointing new directors.
