The Hindu Business Line : Revised Clause 49: A global benchmark

MARKET behaviour of listed companies requires constant and effective vigilance of the regulator in order to protect and further the interests of investors. When capital markets systematically open up to both domestic and foreign financial flows, corporate governance requires dynamic supervision.

The standards of good governance call for global benchmarking and professional surveillance. By introducing the revised Clause 49, SEBI has upgraded the information supply by companies to the capital market. It has also indirectly improved governance processes in the company through stricter role of audit committee, independent directors, transparency in compensation and disclosures, related party transactions, accounting, utilisation of public issue proceeds, risk management systems, etc.

In the overall corporate paradigm, what we are witnessing today is expanded reach of globalisation and global ambitions. To achieve global dimensions, corporations pool capital from a large investor base both in the domestic and international markets.

The growing investment expects the Board and the management of companies to act as trustees and not only ensure the safety of the capital but also returns higher than the cost of capital. All this could be possible when companies are fair to their stakeholders and transparent in all transactions.

Gone are the days when business and ethics were treated as adversaries and whose co-existence was impossible. Although the trade-off between good governance and the lure for higher profits has always been the dilemma of businessmen, the deep-rooted belief that as long as the performance is good, corporate governance is not an issue of great significance has outlived its relevance in view of the periodic crises experienced the world over in recent times.

It has now been widely recognised that outstanding performance, higher profits and expanded reach, nothing act as safeguards for a company when good governance and ethics are at back burner.

There is ample evidence to establish that a single wrongdoing is enough to ruin the reputation of a company, it took ages to build, while the culture of strict adherence to good governance practices keeps them ahead on sustainable basis.

While the goal of achieving monetary gains is laudable, the means to achieve that are as meaningful as the end itself. This makes it imperative for companies to ensure that their means do not trespass the moral and ethical boundaries, besides legal limitations.

The revised Clause 49 introduces checks and balances in various forms to ensure that corporate business is carried on with transparent ethics that help investors make informed decisions.

Global standards

Recent corporate failures of once mighty corporates have proved to be a huge wake up call for all constituents of corporate governance process including the governments and the regulators. They were the result of trespassing ethical and legal limitations by businesses. Their impact reverberates around the globe, creating shock waves that threaten the stability of global economic system. The circumstances might have been different for different countries and companies, but one thing all had in common was distorted governance structures that led to inefficient economic decision-making.

As a result, the discussions in the boardrooms today focus on issues of governance, accountability and disclosure; the voice of shareholder activism has never been so loud and of course, media scrutiny has never been sharper. The response of government and regulators, which has also been commendably swift to the challenges of corporate delinquency, should not be seen as reactionary phenomenon emanating from negative occurrences of the recent past.

The US Securities and Exchange Commission was the first to swiftly and severely respond to these challenges and enacted the Sarbanes Oxley Act with a reach even to the corporations incorporated beyond the borders. This response indicates the urgency for capital market regulators to put in place systems to avoid the recurrence of distasteful incidences of questionable corporate events, which not only leave the investors high and dry and erode their trust in the institution of business, but also affect the national economies and public at large.

The Securities and Exchange Board of India, which has been actively engaged in evolving, setting and enforcing the standards of good corporate governance, has taken steps towards benchmarking governance norms with those of international standards. The introduction of Clause 49 in the Listing Agreement in the year 2000 and now the implementation of the revised Clause 49, based on the report of the committee under the chairmanship of an acclaimed corporate captain itself, highlight the urgency for adoption of good governance practices by corporate India.

The revised Clause 49 of the Listing Agreement sets out a number of measures to raise the standards of corporate governance in listed companies. The revised clause provides for further disclosure requirements, new definition of independent director, periodical review of legal compliances by independent director, etc.

This clause also requires companies to submit a compliance report, inter-alia, by practicing company secretaries to stock exchanges every quarter providing details from the composition of board to audit committee and its functioning and disclosures on related party transactions, subsidiaries, remuneration of directors, management, shareholders, etc.

However, the major issue intensely debated during these days is the lack of sufficient number of independent directors.

Board independence

Independent directors bring an element of objectivity to board processes in the general interest of the company and to the benefit of all stakeholders including minority and small shareholders. They bring an independent judgement on the issues of strategy, performance and resources including key appointments and standards of conduct. They also ensure that proper, efficient and effective monitoring system exists in the company.

In fact, defining independence is necessary but not sufficient to ensure independence of judgment.

That has much to do with the choice of directors and the skills that they bring to the board; the conduct of board meetings; the quality and quantity of financial, operational and strategic information supplied by the management to the board; management's appetite for independent evaluation and criticism of strategies and performance; the extent to which promoters and management truly want healthy debate and independent oversight; the de facto role of the various committees of the board; and, of course, how much a company is willing to pay for the experience and skill sets of professional independent directors.

Therefore, the issue of independence and objectivity depends largely on willingness of companies and incumbent independent directors, as well.

The institution of independent directors to be successful requires corporates to ensure that the independent directors are allowed to act independently.

Similarly, independent directors should have will and courage to say no when things are not moving in the interest of the company and its stakeholders. Although maintaining objectivity and stand firm, are undoubtedly a very difficult task, but not the impossible one for a man of integrity and characters.

In the ultimate analysis the crux of corporate governance relates to the manner in which the top management is entrusted with the fiduciary responsibility of administering the resources. The basic qualities expected in this regard are invariably trust, honesty, transparency etc.

There is a growing expert opinion expecting the business enterprise to be much more than a mere economic unit, and be a good corporate citizen vigorously contributing to social issues and charity.

No doubt the need for compliance with statutory norms of corporate governance is far too obvious, but the ethical dimension of a legal issue arises when compliance involves meeting the letter of the law and not necessarily the spirit.

In fact being ethical in this sense adds to greater legal certainty in an era of multitude of complexities uncertainties and risks.

Therefore, a well-structured organisation needs a broad reference point of values in order to find sustained nourishment for its creative and innovative urges.

It provides the organisation not only the motivation to change, but also the ability to sense when change is due.

Despite the diversity of corporate governance system, the globalisation of markets is producing a degree of convergence in actual operations and governance practices.

The global market pressures are providing the impetus for private investors to harmonise corporate governance practice - to reduce risks to investors and hold down the cost of capital to corporations. It is well recognised that the fundamental objective of corporate governance is not mere fulfilment of the requirements of law but in ensuring commitment of the board in managing the company in transparent manner for maximising long-term shareholder value. It is about establishing a climate of trust and confidence.

As globalisation takes place and corporate governance becomes increasingly important in determining the perception of international investor, managerial structures and credibility of business, there is a need for corporates in India to heed this tide of change. They must proactively design their culture-specific codes and effectively implement, instead of sit and wait for rules to be imposed from the Government and regulatory agencies. Independent professional certification required under Clause 49 has enabled SEBI to inculcate new culture of good governance in Indian companies.