Corporate governance is to a corporation what moral values are to an individual — guiding principles for one’s conduct. Going largely by this belief, in India the Ministry of Corporate Affairs’s Corporate Governance Voluntary Guidelines served as recommendations rather than rules per se . There are corporates that have adopted the guidelines in the said spirit, but many others continue to treat corporate governance as another “tick-in-the box”.

The latter may have pushed regulators to revise their approach, and combine mandatory laws with voluntary self-regulation. This is reflected in Companies Bill 2012, which has mandated several corporate governance best practices. This covers issues such as professionalising the role of auditors; making financial statements more transparent; greater independence of the Board with focus on diversity; and encouraging whistleblowers.

Auditor independence

Many companies tend to employ the same auditors for prolonged periods of time. Such a long association may lead to friendly relations between the two, thereby undermining the quality and integrity of the audit. The Companies Bill’s move to mandate rotation of auditors is expected to improve audit independence and objectivity. It also restricts the number of clients and annual ratification of statutory auditors to break such long-term associations. However, the higher costs involved in auditor rotation may give rise to criticism.

Transparent statements

Many companies have complex structures involving numerous subsidiaries, joint ventures, and associate companies. As each subsidiary contributes to the income and liabilities of the parent, separate financial statements generally present a deceptive picture of the organisation’s overall health. Hence, the Bill mandates a consolidated financial statement, along with standalone statements. This covers associate companies and joint ventures too.

Independent Board

The Companies Bill builds on the governance norms outlined in Clause 49 of the Listing Agreement. To enhance Board independence, the Bill introduces stiffer eligibility criteria for independent directors, and restrictions on their tenure. It also, for the first time, spells out their responsibilities, accountabilities, and legal liabilities.

Diversity across the Board

Research suggests that companies with more women on the Board significantly, and consistently, outperform others. Board diversity in terms of gender, education, experience, technical skills, family background, age, and ethnicity can provide companies a wider perspective and help identify, assess and manage risks better, besides exploiting strategic opportunities more effectively. Diversity also boosts investor confidence, thereby reducing the cost of capital.

To encourage diversity on company Boards, the Bill mandates at least one woman director. To ensure quality involvement by Board members, it mandates at least one director who has stayed in India for 182 days or more during the previous calendar year.

recruitment committee

Indian corporates often complain about lack of competent talent for Board positions. Also, the compensation and bonuses paid to senior management are subjected to heightened scrutiny by regulators and the media. The Bill mandates a nomination and remuneration committee with the responsibility to identify candidates for directors, recommend appointments/ removals, evaluate performance, and recommend remuneration.

Mandatory CSR

Given the collective size of Indian business, even a small contribution towards social cause will help achieve inclusive growth. Hence, the Bill mandates companies above a certain level of turnover/ net worth/ profit to contribute at least 2 per cent of average net profit towards corporate social responsibility, or CSR, activities. It also recommends preference for local areas and focus on pressing issues such as eradicating hunger, promoting education and gender equality, and combating HIV and other diseases.

whistleblower

An effective whistleblower mechanism can greatly improve the corporate governance framework. According to the KPMG India Fraud Survey 2012, a whistleblower hotline is the most effective way to detect fraud. The Bill requires listed companies to establish a vigil mechanism for directors and employees. Ideally, the whistleblower hotline should be accessible to all employees, vendors and partners — across geographies, and round the clock. There should also be adequate safeguards against victimisation of whistleblowers.

Raajeev B. Batra is Partner, KPMG in India

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