– AarzooThareja

Student V year, Faculty of Law, Mody University, Rajasthan.

– Shafaque Raza

Student V year, Faculty of Law, Mody University, Rajasthan.


There has been great ambiguity in the definitions of all the key words like ‘control’, ‘regulate’, ‘manage’ ‘govern’ and ‘governance’. Tannenbaum (1962) defined control as ‘any process in which a person or group of persons or organization of persons determines, i.e., intentionally affects, what another person or group or organization will do’. This definition provides a word to describe a situation where no standard of performance is required1. Other writers use the word control in the sense of meeting some standard of performance2. In these situations, the word ‘regulate’ will be used whether or not the ‘regulator’ is a manager of the organization concerned or an external bureaucrat. This facilitates the use of information theory in corporate governance analysis.

In the light of all these definitions Self-regulation in its broad sense may be understood as- the standards of performance are established by those being regulated. Self-governance means that the system of control or regulation includes the appointment of the controllers by the governed. By this means, self-regulation can be introduced through self-governance. Self- governance involves a political process within institutions to appoint the controllers responsible for regulation. Self-governance in a political context means ‘government of the people, by the people for the people’. This describes democracy. The introduction of elements of self- governance into institutions involved in productive activities would enrich democracy. There are arguments and evidence that this produces operating advantages3.


The historical background of self-regulation though not very old can be traced through the development of certain international codes of conduct established for the corporate world.

The postwar international economic order originally intended to establish three major international organizations: the World Bank, the International Monetary Fund (IMF), and the International Trade Organization (ITO). The failure of the United States to ratify the Havana Charter, which established the last of these, meant that the ITO never got off the ground and international trade rules were governed for four decades (prior to the creation of the World Trade Organization-WTO-in January 1995) by a much more ad hoc arrangement, the General Agreement on Tariffs and Trade (GATT). The ITO included provisions for the protection of investment and the control of restrictive business practices but, as these did not come within the purview of the GATT, the postwar system left the activities of international business unregulated.

While regulation at the international level was lacking, individual nation states were, of course, able to impose controls on foreign corporations that operated in their territory, but no comprehensive framework of international regulation for such activities existed. From the Declaration of Philadelphia in 1944 onwards, an international framework of labour standards with the various conventions of the International Labour Organization did develop. However, these conventions were essentially addressed to the member states as the principal actors in a public international law regime4 (Hepple, 1999). The conventions placed certain obligations on governments-for instance to permit freedom of association and collective bargaining-but did not directly address the behaviour of international business. It was not until the 1970s, with the emergence of a more critical attitude towards TNCs-in developing countries in particular5 – that there was a major effort to develop international standards for corporate behaviour. Although the first proposal of this kind, the International Chamber of Commerce’s Guidelines for International Investment of 1972, came from the corporate sector itself, most of the efforts emanated from international organizations, particularlyUnited Nations agencies. The demand for a New InternationalEconomic Order was part of a general climate of change, which saw southerngovernments become more assertive in internationaleconomic negotiations in the aftermath of the Organization of Petroleum Exporting Countries (OPEC) oil price increases.

In 1974 the United Nations set up its Centre on Transnational Corporations (UNCTC), following the Report of the Group of Eminent Persons set up by the UN Economic and Social Council. This led to the development of a Draft Code of Conduct on TNCs, which set out a framework for regulation. Several specialized UN agencies also developed codes covering particular aspects of TNC behaviour. These included the ILO’s Tripartite Declaration of Principles Concerning Multinational Enterprises and Social Policy (1977) and the United Nations Conference on Trade and Development’s (UNCTAD) proposed codes on Restrictive Business Practices and on the Transfer of Technology.

In the same period, the Organisation for Economic Co-operation and Development (OECD) adopted its Declaration on International Investment and MultinationalEnterprise (1976). This was an attempt by the governments of the North to respond to the growing criticism of TNCs from the South, while at the same time making it clear that they were not prepared to see excessive controls imposed on TNC activity. It was described by one commentator as a “pre-emptive Western strike emphasizing business responsibility” (Robinson, 1983) and was voluntary and not legally binding.6

International efforts to regulate TNCs were paralleled in the 1970s by a more restrictive climate at the national level in many countries in the South. Some 22 developing countries passed legislation controlling TNC activities in the late 1960s and 1970s7 (Hepple, 1999). Nationalization of foreign corporations reached a peak in the first half of the 1970s8 (Jenkins, 1999). Regional agreements such as theAndean Pact imposed controls on incoming investors. A common perception that underpinned these regulation efforts was that the interests of TNCs and those of host countries in the South did not coincide. Although what was good for General Motors might have been good for the United States, it was not necessarily good for Brazil or Mexico. Economic development could best be promoted, not by a policy of total openness to foreign capital, but by regulation, which would ensure that foreign investment was channeled into the areas where it could make a particular contribution. Foreign investors were also required to promote local development through joint ventures, local purchasing and indigenization policies. The role of the international codes of conduct proposed during this period was largely to improve the bargaining power of southern states in their efforts to obtain a greater share of the benefits from the activities of TNCs.9

The 1980s, as already noted, saw a major shift in the attitude towards TNCs, which reflected a more general shift towards market-based policies and away from state intervention in both developed and developing countries. Sectors which had been closed to foreign capital began to open up once more in the 1980s. This began with manufacturing and, in the late 1980s and early 1990s, partly as a result of privatization, it was extended to public utilities and natural resources. Access to certain service sectors, which were traditionally closed to foreign capital, also started to be liberalized (UNCTAD, 1994:294). At the same time most of the countries that had imposed across-the-board restrictions on foreign ownership abandoned them by the 1990s. The trend towards less strict ownership requirements began in the late 1970s or early 1980s, and has resulted in a reduction in the use of 50-50 joint ventures and minority-owned subsidiaries by US TNCs in developing countries10 (Contractor, 1990). Similarly, restrictions on profit repatriation and the terms permitted in technology transfer agreements have been relaxed, as have performance requirements regarding local content and exports. In contrast to the 1970s, the attitude of southern governments has shifted emphasis dramatically towards attracting, rather than regulating, TNCs and foreign investment. UNCTAD’s Division of Transnational Corporations and Investment noted in 1995:11

“The mid-1990s are characterized by a general movement towards the liberalization and facilitation of FDI. Today, inward FDI policy regimes of quite different countries around the world are broadly liberal in character….They (governments) are fine-tuning their policies to attract capital, technology and skills, and to facilitate access to markets with the help of FDI” (UNCTAD, 1995:272).From the early 1990s the vast majority of changes in investment regimes in developing countries have involved either the removal of existing restrictions or new promotional measures (see table 1).12

Given the change in attitudes among southern governments, it is hardly surprising that efforts at international regulation of TNCs did not prosper during the 1980s. The UNCTC Code was never agreed upon, despite being watered down considerably. In a 1993 restructuring of the UN’s economic and social agencies, UNCTC was dissolved and certain activities were transferred to UNCTAD’s Division of Transnational Corporations and Investment.

Only two major international codes, those of the OECD and the ILO, survived from the 1970s. As already noted, the OECD Guidelines did not represent a genuine attempt to control transnationals, but were designed to deflect criticism of their activities. Theywere voluntary in nature and had no enforcement mechanisms. Although cases have been taken to the Committee on International Investment and Multinational Enterprises, which processes matters arising from the OECD Guidelines, these are usuallydealt with through “clarifications” of the Guidelines. Trade unionists have expressed disappointment with the Committee’s handling of complaints, and even when it has been found that companies have engaged in anti-union activities, the Committee has merely reaffirmed the view that management should take a positive approach towards union activities.13

The ILO Declaration is narrower in scope, focusing on the social aspects of TNC activities. Like the OECD Guidelines, the Declaration is not binding and compliance is on a voluntary basis. Disputes are referred to the Committee on Multinational Enterprises for “interpretation” of the Declaration. It is not a procedure for dispute settlement over compliance with the Declaration. During its first decade in operation, the Committee only issued two such interpretations (ILO, 1989). Therefore, like the OECD Guidelines, the impact of the Declaration has been relatively limited.

While the trend in terms of both national and international policies from the late 1970s was towards liberalization and deregulation, the same period saw a new trend towards voluntary corporate codes of conduct. These began to be adopted in the late 1970s, particularly by US corporations, in response to the bad publicity received by TNCs, not only as a result of the ITT scandal, but also from revelations about bribery and questionable payments by many leading US companies14. The first wave of corporate codes was predominantly concerned with issues of questionable payments. Astudy of 174 codes in 1978 found that more than half of them covered questionable payments.15 Ninety per cent of the codes studied by Kline were formulated after the Securities and Exchange Commission began to investigate questionable payments. Further impetus to this movement came when the US Congress passed the Foreign Corrupt Practices Act of 1977.16

By the mid-1980s however, Kline17 noted that public pressure for adoption of codes had decreased. However, the 1990s saw a renewal of interest in corporate codes of conduct. The main areas that are now addressed in these codes are environmental and labour issues, which contrast with the emphasis found in the first wave of corporate codes. The OECD inventory of 246 codes found that 60% referred to labour standards and 59% to environmental stewardship (OECD, 2000: figure 3).18 In contrast, only 23% of codes in the 1990s addressed the issue of bribery.

The second wave of corporate codes began to emerge in the early 1990s. Levi Strauss, with its Business Partner Terms of Engagement adopted in 1992, was one of the first companies to establish this type of code, and it was followed in the United States by a number of other clothing manufacturers and retailers.19 By the mid-1990s, the growing trend for codes had spread to Europe and a number of companies in the United Kingdom and on the continent began to take them up. Again clothing manufacturers and retailers were among the first to adopt codes covering labour conditions.20 These included C&A, Otto Versand in Germany and the Pentland Group in the United Kingdom. Although comprehensive codes are relatively limited in number, they are being introduced by a growing number of companies, and there is a tendency for the scope of codes to expand as company experience with them increases.21 Their significance, if any, lies in the fact that they are being adopted by leading corporations in their fields, such as Levi Strauss and Gap in clothing, Nike and Reebok in sports goods, and the major British supermarkets in retailing.Although sharing a commonnomenclature, corporate codes of conduct are very different from the international codes that were proposed in the 1970s, particularly the UNCTC Draft Code. The latter were seen as a means of regulation by international bodies of TNCs, which would support or supplement national state regulation. Corporate codes are voluntary initiatives, which have been adopted by the business sector itself. These codes range from vague declarations of business principles applicable to international operations, to more substantive efforts at self-regulation.

The international codes were seen in the main as an attempt to redress the balance between the growing power of TNCs and the nation states, particularly in the South, where they invested. They emerged from a perception that the growth of giant international companies posed a threat to the sovereignty of small, poor states. Acommon perception at the time was that of “sovereignty at bay.”22 International regulation was seen as necessary in order to ensure that developing countries shared in the gains from the growth of international corporate activity.

The recent wave of corporate codes has tended to focus on the impact of TNCs in two main areas-social conditions and the environment. They are part of a much wider debate concerning the impact of globalization on labour and the environment, which is also reflected in the call for social and environmental clauses in trade agreements and within the WTO. Whereas support for codes in the 1970s came mainly from the South, and particularly from southern governments,23 in the 1990s support came mainly from the developed world. Here international trade union organizations, development and environmental NGOs and the corporate sector itself have all contributed to the demand for some form of code of conduct for international business. Although the range of issues covered by the corporate codes of the 1990s tends to be more focused than the comprehensive efforts of the 1970s, the scope of these more recent codes is broader. Whereas the 1970 codes emphasized the activities of TNCs and their subsidiaries, the 1990 codes were expanded to include responsibility for the labour and environmental practices of the suppliers as well as their direct activities. Indeed for many companies, the major impetus behind their code of conduct is to ensure acceptable behaviour on the part of their subcontractors.


Corporate governance is a broad and somewhat vague term for a range of corporate controls and accountability mechanisms designed to meet the aims of corporate stakeholders. The board is the legally defined corporate governance mechanism with other board mechanisms including, its independent non-executive directors, AGMs, separate holders of CEO and Chairman officers, and independent audit, remuneration, and appointments sub committees (of the board). Company board corporate governance mechanisms are underpinned by a legal model of investor property rights arising from share ownership. This incorporates, a clear chain of accountability from the management to the board and then onto the investors. The CompaniesActs also define minimum disclosure requirements and require companies to conduct their affairs in accordance withArticles ofAssociation as approved by shareholders from time to time. More specifically investors have the right to use a simple majority vote to remove any or all of the directors at any time and for any reason. The Stock Exchange imposes extensive listing requirements on applicant or currently quoted companies. The Takeover Panel has an extensive set of rules for takeovers and the purchase of large shareholdings.24 Ganz25 refers to the exponential growth of “”quasi regulation” or “”a wide spectrum of rules whose only common factor is that they are not directly enforceable through criminal or civilproceedings”. This has taken many forms including codes of practice, guidance, guidelines, codes ofconduct and many other guises in the society. Puxty26 argues that the form of domestic regulation is an expression of the dominant models of social order adopted in each sovereign state and they consider the community is principally “Associationist” in terms of regulatory organisation. “Associationism” is a strategy of (self) regulation where “”there is some dependence on principles of community. However, such principles are routinely subordinated to those of the Market. Membership is founded principally upon calculative rationality rather than a desire to share in common values”. The Cadbury Report corporate governance guidelines and the professional body codes of conduct both fall under Ganz27 and the Puxty28 definitions. They constitute a form of regulation with more public interest authority than pure self-regulation exercised by a community of professionals but weaker than the full force of law. Birkinshaw29 refers to this as a form of “Regulated autonomy” which is backed up by Company law and other legislation. This involves market and corporate based participants as rule developers and rule implementers operating within generalprinciples outlined in law, the SIB, and by the Cadbury Committee.The Cadbury Report identified board level mechanisms as essentialfor ensuring high qualitymonitoring of the financialaspects of Corporate Governance, especially for financial reporting and auditing issues. Given the recent corporate scandals the CadburyReport sought to clarifythis chain ofaccountabilityand to build monitoring and accountability into boardroom and managerial decision processes.


Company-Financial Institution relations are one of the central links between shareholders and senior management and the board. They involve complex networks between companies and shareholders. The fund managers are normally located in large investing financial institutions (F.I.) such as Pension funds, Insurance companies, Unit and Investment trusts as well as major banks. The case fund directors and managers who operate in F.I.s all supply some form of saving service for their clients. They all have a fiduciary duty to supply their clients with their preferred mix of return, diversification and liquidity30. This requirement dominates the

F.I. s view of their interactions with their investee companies and underpin the primary economic exchange between the parties. However, this primary exchange occurs in the context of a close, co-operative F.I.-Co relationship and this involves many other supporting exchanges, state changes and interactions. More specifically, a close, co-operative F.I. – Co relationship is characterized by:

a voluntary (primary) exchange of (new) capital for a proportional share of the company’s future residual cash flows in the form of dividends and growth, and an exchange of stable F.I. stake holding for access to high qualitymanagerial talent and continued good corporate financial performance.

A voluntary exchange of supporting elements such as information, opportunity to learn, and influence–generally two way flows. — Desirable changes in state for both parties such as enhanced knowledge, reputation and confidence both in the F.I. and company.

Repeated interactions through which the secondary exchanges can take place and changes in states occur. These include one on one meeting, phone calls, conferences and other direct contacts.

Thus the case F.I.-Co relations involve information flows, influencing and interaction processes, as well as the formal structures of the links. F.I.-Co links revolves around co-operative stable relationships, with regular meetings and other channels for two way flows of information, and feedback mechanisms after meetings. Aclose working relationship based on honesty, integrity, stable stakeholding and regular contact is considered to be one of the most effective means by which their influence can be exercised. They seek to understand corporate strategy, to assess the quality of management and the coherence of the top management team, succession policy, and to collect information on the competition and the industry. They judge the quality of this information in two ways. First by comparing management actions with their statements, and secondly by comparing company information with the sell side analysts, media, and their own research sources. Thus keeping in view the increasing number and gravity of corporate frauds it has become quintessential to analyze the role of self-regulation in company affairs and measures should be taken to strengthen the role of these Financial Institutions and they should play the role of watchdogs as well.


In a corporate entity ensuring self-regulatory mechanism is not one-man’s job. Various components of this entity have to work with minimum possible fiction in order to ensure desirable self-regulation. Some of the players and activities that ensure such efficient self- regulation are summarized as under:

1. The role of the Board of Directors

The Board of Directors plays a fundamental role in the management of the Company and the Group by performing strategic functions and coordinating the organization.31 The Board of Directors should act and resolve with full knowledge of the facts and autonomy, acting in the interests of the Shareholders as a whole so as to maximize the shareholder value, which is an indispensable pre-requisite for a profitable relationship with the financial market. The Board of Directors should be vested with fullpowers for the ordinaryand extraordinary administration and management of the Company and has the power to carry out all such acts that might be deemed necessary and useful to fulfill the corporate purpose, with the exception of those powers which, in compliance with the Articles of Association, pertain to the General Shareholder’s Meeting. In particular, the Board should:

Examine and approve the strategic, industrial and financial plans of the Company and the Groupcorporate structure of which it is in charge;

Grant and revoke powers to the Managing Directors and therein define the limitations, the operating means and the frequency with which the delegated bodies shall report to the Board in relation to the activities performed during the exercise of the powers granted;

Determine, having examined the proposals made by the Remuneration Committee and having heard the Board of Auditors, the remuneration of the Managing Directors and of those who hold particular positions in addition to, unless the General Shareholder’s Meeting has already made the required provisions, the apportionment of the all-inclusive fee to be paid to each individual member of the Board ;

Monitor the general management performance, with special reference to conflict of interests, with reference to the information received fromthe Managing Directors and the InternalAudit Committee, and periodically compare the results obtained with the predicted results;

Examine and approve the transactions which have special economic and financial relevance, with special reference to related party transactions;

Assess the adequacy of the general organization and administrative structure of the Company and Group set up by the Managing Directors;

Report to the General Shareholder’s Meeting.

2. Independent Directors

It seems that one of the important pre-requisites for enhancing the standard of self-regulation and of corporate governance as well, is the role of Independent Directors.32 They should have no dealings of economic or other nature with the Company or with the Company Shareholders that might influence their independent judgment in the execution of their functions. Some key points related to the role of directors in self-regulation are:

These independent directors should be elected in such a manner that ensures that they are not merely professionals but watchdogs as well. For example if an independent director is merely a business professional or market strategy expert then he has a mere professional value and there are no signs of self-regulation. But if he is a consumer right activist as well then he is a watchdog as well.

The time given by these directors in company affairs should be ample enough so that there appointment itselfnot becomes a mockery. Their participation should be regular and attendance in meetings should be commendable.

Quality ofservice, term, remuneration etc should be such that theyencourage these independent directors to devote more and more time to the company.

It should be seen and ensured that these directors should not hold the directorships of too many companies as it hampers their efficiency level as well.

The selection procedure of these independent directors should be very transparent.

The level of information supplied to these directors should be adequate and nothing, which would affect their advice and opinion, should be kept away from them.

3. Appointment of Directors33

The proposals for appointment to the office of Director, which must include exhaustive information concerning the professional and personal profile of candidates so as to ensure that the people who look into the management of the company and who guide the activities of the company are sufficiently competitive to do so.

4. Internal Auditing34

The Board of Directors and on behalf of the Board, the Chairman and the Managing Directors, by availing themselves of support of the InternalAudit Committee set up by the Board to this end, should assure the functionality and the suitability of the corporate system. Such process of self-regulation can be defined as being “the sum of processes established to monitor the efficiency of company transactions, the reliability of financial information, the compliancy with the Law and regulations, and the safeguard of Company assets.35” The Committee provides consulting and advisory functions to the Board of Directors and on its behalf to the Chairman and the Managing Directors. The Committee should perform the following functions:

• To assist the Board in assessing the adequacy and efficiency of the company’s internal control system. The InternalAudit Committee should examine and approve the proposals put forward by the Management; the InternalAuditing Service and theAuditing Company should identify the most suitable economic and financial communication structure necessary to monitor and represent the Company appropriately.

• To evaluate the business agenda prepared by the persons in charge of internal auditing and receive periodical reports form the same;

• To evaluate the findings included in the periodical reports prepared by the persons in charge of internal auditing, from the information received from Board ofAuditors and from the individual members of the Board;

• To report to the Board of Directors the financial statements for the year and the half-year report should be approved regarding the activities carried out and the adequacy of the company’s internal control system;

• To evaluate the adequacy of the accounting principals and their congruency for drawing up the consolidated financial statements;

• To assess the work carried out by the auditing company with reference to the independence of opinion and to the agenda implemented for the audits of the results included in the report on operations and in the advisory letter;

• To assess the proposals put forward by the auditing company in order to obtain the appointment;

• To carry out the other tasks assigned by the Board of Directors with special reference to the relations with the Auditing Company.

4. Relations with institutional investors and other stakeholders36

There should be an open and transparent channel of information with institutional investors, shareholders and the market, in order to ensure the efficient spreading of comprehensive and timely information concerning its activities, the only restrictions concerned the confidential nature of certain information. Accordingly, the information to investors, the market and the press is made available by means of press releases, periodical meetings with institutional investors and the financial community, and comprehensive documentation released.

5. Committee functions

There are certain committees, which take an active part in self-regulation thereby leading to good governance. These committees’ chiefly are- audit committee, remuneration committee, finance committee, recruitment committee and accounts committee. There are certain factors associated with the functioning of these committees, which are indicators of self-regulation. Some of these are:

• Qualification and capability of the leader of the committee.

• Time devoted by the committee.

• Rules and policy regarding accounting practice.

• Procedure of internal audit and control and periodic check

• Response to audit system

• Feedback mechanism for effective check

6. Ethical Code

In order to assure self-regulation a business ethics code should be developed by the members for the functioning of the entire corporate entity.37 Such an ethical code would include all the major business factors such as Price (no monopoly should be created), Quality (proper disclosure, regulation and standardization should be there) and Conditionality or fair trade practice (no foul play).


The debate about the merits or demerits of self-regulation was given renewed impetus by the appearance of the Cadbury Report in 1992, although a similar controversy had already surrounded the self-regulatory Code on Takeovers and Mergers.38 Much of the early public reception given to the Cadbury Report and the idea of self-regulation in corporate governance was sceptical.39 Self-regulation has its disadvantages, chiefly in relation to enforceability, and there is an obvious theoretical objection to allowing those who are likely to benefit most from a weakly regulated regime to be responsible for regulating it. And yet, by 1995, evidence was beginning to emerge of significant levels of compliance with the Cadbury Code, albeit with lower levels among smaller companies.40 It can be strongly argued that self- regulation is superior in some respects to regulation by statute: its potential for cultural change is likely to be greater because, deriving from public debate and perceived consensus within the sector to be regulated, it commands greater respect within that sector than rules imposed by an external lawgiver. It is also more flexible and can respond more quickly to change. Enforcement mechanisms, while not as final and crushing as legal enforcement, can nevertheless be very varied and create a supportive environment for a self- regulatory code. There is also the point that if it is seen not to be working in some particular respect, then legislation is an option; after all, that would hardly be new in the company law field. The use of self-regulatory codes is widespread, and while it could be a grand exercise in self-deception, it is more likely that the current public enthusiasm for them is based on a shared intuitive perception that they have a contribution to make. As a caveat to this it is worth observing that there maybe some matters, which are not amenable to self-regulation and where legislation may be needed, particularly where there is no consensus on the matter within the sector being regulated. The position on the question ofemployee participation in board decision-making was that it was “best promoted voluntarily”, but it is likely that this is an area where meaningful progress would only be made if it was kick-started by legislation. Possibly the advent of works councils41 will provide some impetus. These days the industrial democracy debate tends to be subsumed under the political theory usually referred to as “stakeholders”42. The Hampel Committee confined itself to observations encouraging directors to decide how to build relationships with stakeholders, which were relevant to the company’s success, and voiced their concern about the idea that the directors might become accountable to anyone other than the shareholders.43


Basel Committee44 norms relate only to commercial banks and financial institutions. Banking and financial institutions stand to benefit only if Corporate Governance is accepted universally by industry and business, with whom banks and financial institutions have to interact and deal. SEBI report only partially attends to this need. SEBI is a functional statutory body and it can prescribe regulations only within its functions. Kumar Mangalam Committee45 confined itself to submitting recommendations for good Corporate Governance and left it to SEBI to decide on the penalty provisions for non-compliance. In the absence of suitable penalty provisions, it would be difficult to establish good Corporate Governance. Some of the penalty provisions are not sufficient enough to discipline the Corporates. For example, the penalty for non- compliance of the stipulated minimum of 50% in respect of the number of directors in the Board that should be non-executive directors is delisting of shares of the company. This would hardlyserve the purpose. In fact, this would be detrimental to the interest of the investors and to the effective functioning of the capital market. Similarly, anAudit Committee, which is subservient to the Board, may serve no purpose at all; and one, which is in perpetual conflict with the Board, may result in stalemates to the detriment of the company. If a company is to function smoothly, it should be made clear that the findings and recommendations of the Audit Committee need not necessarily have to be accepted by the Board which is accountable to the shareholders for its performance and which, under Section 29146 of the Companies Act, is entitled to “exercise all such powers, and do all such things as the company is authorized to exercise and do”. However, some functional specialists are of the considered view that whenever there is a difference of opinion and the Audit Committee’s advice is ignored or over-ruled, the Board should be required to place the facts before the General Body of shareholders at their next meeting.

Need for Accounting Standards Providing for Transparency of Financial Reporting47 Apart from these issues, there is another area, which needs to be attended to for bringing about further improvements in Corporate Governance in India. One such area is theAccounting Standards. There are some gaps inAccounting Standards, which need to be closed or narrowed down for better transparency. One of the first and foremost demands of good corporate governance is to let investors know how their money has been used to further the interests of the companytheyhave invested in. The question that assumes importance here is how effectively the resources ofthe company are utilized for strengthening the organization. The only available source of information regarding the affairs of a company appears to be its Balance Sheet. Yet, for obvious reasons, the Balance Sheet remains the most abused statement of several companies. The common methods by which companies hide their wrongful practices, which are all too well known, are to use legal and accounting jargon, non-disclosure and selective adoption of only those policies that are mandatory in nature. It is only a handful of qualified persons, primarily the accountants and the other knowledgeable people, who can get to the picture behind the scenes and unmask the actual from the portrayed picture. It is in this context that the adoption of US-GAAP, which provides for rigorous Accounting Standards and disclosures, assumes relevance.

There are manyareas such as consolidation of accounts, treatment offixed assets, depreciation, R&D costs etc where Indian Accounting Standards (IAS) is at variance with US-GAAP. However, it is heartening to note that things appear to be changing for the better on the Indian turf; thanks to the impetus towards a more transparent accounting system shown by market leaders. Recently, the Institute of CharteredAccountants of India (ICAI) issued theAccounting Standard 21 (AS-21) for consolidation of accounts whereby accounts of companies will be presented along with those of their subsidiaries. This would meet the long pending demand of investors on greater transparency and disclosure.

Transparency in Private Sector48

The need for transparency, so far, appears to have been felt in the context of Public Sector alone. Consequently, we have on the anvil the Right to InformationAct and a modification of the Official Secrets Act. While, there is no doubt the government has to be completely transparent in its dealings, since it is dealing with public money, privately managed companies also have a wide shareholder base. They are also dealing with large volumes of public money. The need for transparency in private sector is, therefore, in no way less important than in the Public Sector.

However, private companies use “competitive advantage/company interests49” as a pretext to hide essential information. Awarding of contracts, recruitments, transfer pricing (for instance through under/over invoicing of goods in intra company transfers) are the areas, which require greater transparency. Environmental conservation, redressal of customer complaints and use of company resources for personal purposes are some of the other crucial areas, which call for greater disclosure. Relevant details about these must be available for public scrutiny. Fear of public scrutiny, as you will agree, will ensure corporate governance on sound principles both in the Public as well as Private Sectors.

Ethics and Values in Corporate Governance50

No discussion on public affairs will be complete without a reference to Ethics and Values. The quality of corporate governance is also determined by the manner in which top management, particularly the Board of Directors, allocates the financial resources of the company as between themselves and other interest groups such as employees, customers, government etc. The basic qualities invariably expected in this regard are trust, honesty, integrity, transparency and compliance with the laws of the land. There is an increasing body of public opinion that would expect a business enterprise not only to be a mere economic unit but also to be a good corporate citizen. For this, its corporate governance must be based on a genuine respect for Business Ethics and Values. An illustration regarding these ethics and values is the recognition of fiduciary relation of directors with the corporation. In this context, reference may be had to the decisions of the Indian Supreme Court in Nanalal Zhaver v. Bombay Life Assurance51, and Needle Industries India Ltd. v. Needle Industries (Newey) India Holding.52

Self-Regulation through an Audit Committee of the Board of Directors53

The self-regulatory approach is seen as being supportive of innovation and enterprise, unlike external regulation. This formed the basis of the recommendations of the Cadbury Committee and would appear to the basis of the recommendations of the Birla Committee. The Indian legal system is rapidly moving towards the establishment of independent regulators and a greater emphasis on self-regulatory structures. In keeping with this movement, the Listing Agreement Amendments have made an audit committee a mandatory requirement for all publicly traded companies:

The audit committee appointed by the board of directors needs to be independent and qualified. The audit committee is to have a minimum of three members, all being non- executive directors with the majority being independent directors (including the Chairman). At least one of these directors should have financial and accounting knowledge. Meetings to be held at least thrice a year with one meeting before finalization of annual accounts.?

Quorum for meetings of the audit committee needs to be one-third or two, whichever is higher. However, a minimum of two independent directors is essential to constitute a quorum.?

The functions of the audit committee include oversight of the company’s financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient, and credible; recommending the appointment and removal of the statutory auditor of the company; reviewing with management the financial statements of the company prior to submission to the board of directors; reviewing the internal audit function; review of the findings of the statutory auditor; pre-audit and post-audit discussions with the statutory auditor; review of the company’s financial and risk management policies etc. The Amendment Act has proposed to make audit committees mandatory for public companies (whether listed or unlisted) have a paid up capital in excess of Rupees Five Crores. The proposed amendment sets out the powers and functions of the audit committee.

Self-Regulation through a Remuneration Committee of the Board of Directors54 The Listing Agreement Amendments have included a “non-mandatory” recommendation that companies establish a remuneration committee of the board of directors, comprising of at least three directors. All of these directors should be non- executive with the Chairperson being independent. The terms of reference of this committee would include determination of the company’s policy on remuneration packages for executive directors. While companies are not required to establish a remuneration committee, the Listing Agreement Amendments make it mandatory for the board to decide on the remuneration packages of non-executive directors. In addition, as highlighted earlier, it is mandatory that all elements of remuneration of all the directors be disclosed in the Report on Corporate Governance.


The Department of CompanyAffairs55, in May 2000, invited a group of leading industrialists, professionals and academics to study and recommend measures to enhance corporate excellence in India. The Study Group in turn set up a Task Force, which examined the subject of Corporate Excellence through sound corporate governance and submitted its report in Nov 200056. The task force in its recommendations identified two classifications namely essential and desirable with former to be introduced immediately by legislation and latter to be left to the discretion of companies and their shareholders. Some of the recommendations of the task force include57:

• Greater role and influence for non-executive independent directors

• Stringent punishment for executive directors for failing to comply with listing and other requirements

• Limitation on the nature and number of directorship of Managing and Whole-Time directors

• Proper disclosure to the shareholders and investing community

• Interested shareholders to abstain from voting on specified matters.

• More meaningful and transparent accounting and reporting

• Tougher listing and compliance regimen through a Centralized National ListingAuthority

• Highest and toughest standards of Corporate Governance for Listed Companies.

• A code of public behaviour for Public Sector Units

• Setting Up of a Center for Corporate Excellence.

Apart from these the Indian efforts range from SEBI’s 58 initiatives for raising corporate standards via the Kumar Mangalam’s59 mandatory and recommendatory compliances to the coming up of the Naresh Chandra committee report.60


In order to bring about real change and improvement in corporate governance practices, it becomes necessary, firstly to stop deterioration of good practices, then to cognize new responsibilities of those at the helm of affairs, reform them and strengthen the skills, adopting sound governance principles. Negligence with regard to these principles and practice would adversely affect corporate heads and the professionals as well. As regards self-regulation it is towards becoming an indispensable part of the international code of corporate conduct and business ethics.All those responsible for company management should recognize the challenges that lie ahead in as much as companies will be subjected to more scrutiny, will be made more accountable for public losses. Professionals like company secretaries, accountants, auditors and independent directors shall have to work together more closely in the years to come not forgetting to restrict themselves to the framework set by self-regulation. As speaking of the world order, due to repeated losses suffered by investors, the ethics, code of conduct and principles of corporate governance have drawn the attention of professionals. The latest talk and discussion is regarding the Values and Principles. Great responsibility is fastened on the shoulders of professionals by binding them morally in some cases and compelling them to play the role of watchdogs in some others. In view of such paradigm shifts in favour of ethics and morality the need of the hour is to set up standards of self-regulation by creating frameworks with a set of questions for every player in a corporation and for every activity that goes on in order to assure the complete and all round effect of corporate governance and to have a concrete defense against its futile failure.