The Counsel

Corporate Governance


By Kshiti Bansal

National University of Law, Punjab, India

In India, the family owned business houses followed their particular way of governance, which suited them. The stakeholders considered them as acronyms of competence and trust. The meagre holding of the families in their company’s capital, non-transparency at various levels on various matters and superficial professionalism on the board with no public disclosure did not bring any reaction from the stakeholders, in a protected economy, till the seventies in India. Non-separation of ownership from the management generated corruption in business and resulted in the denial of its value to the stakeholders.1

In India, the fundamental concern of corporate governance is to ensure the means by which a company’s managers are held accountable to capital providers for the use of assets. The past five years have witnessed a proliferation of corporate governance guidelines, reports and codes designed to improve the ability of corporate directors to hold managements accountable. Although, the board of directors provide an important mechanism for holding management accountable, effective corporate governance is supported by and is dependent on market for corporate control, securities regulation, company law, accounting and auditing standards, bankruptcy laws, stock exchange listing rules and judicial enforcements.

In order to improve the corporate performance, a number of government and industry initiatives have been taken to lay down the necessary laws, bodies and guidelines for corporate governance. The most notable are the voluntary Code of Corporate Governance of the CII, the Kumar Mangalam Birla Committee Report, the Naresh Chandra Committee Report, and the Narayana Murthy Committee Report. The Kumar Mangalam Birla Committee Report led the introduction of clause 49 in the standard listing agreement for implementation by all stock exchanges for all listed companies, within a time frame of three years commencing from the financial year 2000-2001. The Committee’s recommendations pertained to the composition of the board, constitution of audit committee in certain sized companies, remuneration of directors, director’s report to include management discussion & analysis report and, better disclosure norms to the shareholders through annual report, etc.2

Based on these reports, the Companies Act was amended, first in 2000 and then in 2002. Following the recommendations of the Naresh Chandra Committee, the Companies (Amendment) Bill, 2003 was introduced in the Parliament to further amend the Companies Act. The Bill has since been withdrawn under the strong pressure of the industry.

Supervisory function and Management Function

The legislative and administrative efforts of the government and the industry have impacted the corporate governance tremendously. Due to these charges, now, in India, the board is a combination of executive and non-executive directors (the outsiders) under the chairman who accepts the duties and responsibilities which the post entails. The executive directors are involved in the day-to-day management of companies; the non-executive directors bring external and wider perspectives and independence to the decision-making, but bear only supervisory function.

With regard to the composition of the board, Clause 49 of the Listing Agreement provides that “the board of directors of the company shall have an optimum combination of executive and non-executive directors with not less than fifty percent of the board of directors comprising of non-executive directors. The number of independent directors would depend on whether the Chairman is executive or non-executive. In case of non-executive chairman, at least one-third of the board should comprise of independent directors, and in case of an executive chairman, at least half of the board should comprise of independent directors”.

The expression ‘independent director’ here means the non-executive director. Thus, the composition of board is one of the tools of corporate governance, and it should comprise of a mixture of directors, i.e., promoter directors, non-executive directors and independent directors and in no case should the number of promoters or executive directors exceed 50% total strength of the board.3

Independent director

As per clause 49 of the Listing Agreement, the independent director has been defined as a non-executive director who does not have any pecuniary relationship or transactions with the company, or its promoters, or its senior management and its holding or subsidiary company. As per clause 49-I (A) of the Listing Agreement, the board should be of seven members, out of which four should be independent directors. The independent directors should not be less than 50% of the board.

There are seven more negative covenants for independent director:

(i) he is not related to promoters or the management;

(ii) he has not been an executive of the company in the last three years;

(iii) he is neither a partner nor an executive of the audit, internal audit, legal firm or any consulting firm associated with the company for the last three years;

(iv) he is not a significant supplier, vendor or customer of the company;

(v) he is not a shareholder of the company, owning 2% or more voting shares;

(vi) he has not been any type of director of company for more than nine years; and

(vii) he is not a nominee director.

These requirements are applicable to all public companies that have capital and free reserves of Rs.100 million or a turnover of Rs. 500 million. However, it is not applicable to unlisted public companies, which do not have more than 50 shareholders and are without any debt from public, banks and financial institutions. According to current listing norms, institutional directors on the board of companies should be considered as independent directors whether the institution is an investing institution or a lending institution. [Explanation (ii) to clause 49-1(A)].4 The institutional directors have the same rights, duties, and responsibilities as other members of the board and as prescribed by the Companies Act and listing norms.

Sub-clause II-A of clause 49 stipulates that the Audit Committee should consist exclusively of independent directors. The role and function of audit committee should be clearly laid down in a charter. The chairperson of the audit committee must certify the date and frequency of meetings, the extent to which functions listed in the charter were discharged, tasks performed, committee’s views on adequacy of internal control systems, perceptions of risks, reasons for financial statements with qualifications being accepted and recommended, whether the committee met with the statutory and internal auditors without the presence of management and whether such meetings revealed materially significant issues or risks. Such directors should be exempted from criminal and civil liabilities relating to the company.5

In terms of section 309(1) of the Companies Act, 1956, the remuneration payable both to executive as well as non-executive directors is required to be determined by the board in accordance and subject to the provisions of the Act. Independent directors are required to attend one training course before assuming the responsibilities of their position. However, during their initial years they may undergo training within one year of becoming director. Untrained directors should be disqualified.

Protection of Minority Shareholder

Any serious attempt to reform corporate governance in Indian economy is to provide greater legal protection for minority shareholders from transactions involving potential conflicts of interest. In a recent judgment that will have a bearing on the rights of minority shareholders, the Bombay High Court has held that majority shareholders couldn’t ease out minority shareholders from the company merely by paying off the value of their shares. The minority shareholders should be offered a scheme by the company under sections 391 and 394 of the Companies Act that provides options to minority shareholders.

In order to protect the rights of the shareholders, clause 49-VII(F) provides that a board committee under the chairmanship of a non-executive director shall be formed to specifically look into the redressal of shareholder and investors complaints like transfer of shares, non-receipt of balance sheet, non-receipt of declared dividends etc. This committee shall be designated as ‘Shareholders/ Investors Grievance Committee’. Further, it provides that to expedite the process of share transfers, the board of the company shall delegate the power of share transfer to an officer or a committee or to the registrar and share transfer agents. The delegated authority shall attend to share transfer formalities at least once in a fortnight.6

Audit System

It is also required that a half-yearly declaration of financial performance including a summary of the significant events in the last six months should be sent to each household of shareholders. The company should disclose, in the Report on Corporate Governance, whether it has sent to each household of shareholders a half-yearly report on financial performance. Every public company having paid-up capital of rupees 5 crore or more shall constitute a Committee of the Board to be known as Audit Committee.

Audit Committee can be constituted both in terms of requirements of section 292A of the Companies Act, 1956 and in terms of requirements of sub-clause II of clause 49 of Listing Agreement. In case the Audit Committee has been constituted in accordance with the requirements of section 292A of the Companies Act, 1956, it would have to additionally meet the requirements of sub-clause II of Clause 49 of Listing Agreement.

Audit Committee has a critical role to play in ensuring the integrity of financial management of the company. This Committee adds assurance to the shareholders that the auditors, who act on their behalf, are in a position to safeguard their interests.

Sub–clause IIA of clause 49 stipulates that the Board shall set-up a qualified and independent Audit Committee. While the requirement of clause 49 applies to all listed companies, the provisions of section 292A of the Companies Act, 1956 apply to every public limited company having a paid-up share capital of rupees five crore or more.

The Audit Committee contemplated under Clause 49 of the Listing Agreement shall have at least three members. All members of the Committee should be non-executive directors. However, a majority of the directors should be Independent Directors. All members of Audit Committee shall be financially literate and at least one member should have accounting or related financial management expertise. It is worthwhile to note that since the Audit Committee is a committee of the Board, the provisions of the Companies Act, 1956 and the Articles of Association of the company regarding committees will be applicable to Audit Committee with regard to items such as Notice, Quorum, Minutes, etc.7

External Influences Upon Law Reform

The movement to articulate standards for corporate governance in India is greatly influenced by the international developments, particularly of the U.K. and the U.S. which have subsequently spread to other countries.

In UK over the past decade a trilogy of committees has reviewed the issue of corporate governance from a wide range of perspective. Cadbury Committee reviewed financial aspects of corporate governance; Greenbury Committee reviewed remuneration, while Hampel Committee reviewed broader aspects. In addition, three recent reports, the London Stock Exchange Combined Code, the Turnbull Report, and the Higgs Report have added a further dimension to the current corporate governance debate.

The Cadbury Committee was established in 1991 following a series of corporate scandals. The Cadbury report (1992) was acknowledged as a landmark development in corporate governance both in UK and internationally, and was effective in raising awareness of corporate governance. The committee was to consider the financial aspects of corporate governance only.8

The second report, the Greenbury Report (1995), focused solely on directors’ remuneration. During the 1990s, high salaries and share options for company directors appeared to be out of step with company performance and with the accompanying call for workforce cutbacks and employee pay restraints. The Greenbury Report did not answer for top directors’ pay restraint but instead stressed on accountability and full disclosure of directors’ remuneration.9

The third, the Hampel Committee (1998), spoke in terms of principles of good corporate governance rather than rules. Hampel emphasized on good internal control and risk management by the board and the effective communication of information through the company, in order to ensure the best informed decision-making. The Report recommended that companies and auditors should apply certain principles regarding Financial reporting, Internal control, Relationship with auditors and, External auditors. It also accepted the dual responsibility of auditors, i.e., the public report to shareholders on the statutory financial and on other matters and additional reporting to directors on operational matters.

The Higgs Report (2003) reviewed the role and effectiveness of non-executive directors. The London Stock exchange produced its own code, which acted as a consolidation of the trilogy with the added dimensions of the Turnbull Report (1999). The Report was focused upon the maximization of shareholder wealth through the management of risk. The basic aim is to ensure operational effectiveness and efficiency, and reliability of internal and external reporting and compliance.10

Blue Ribbon Committee on improving the effectiveness of Corporate Audit Committees (1999). recommended that the members of audit committee be independent; The audit committee consist of independent directors only; audit committee have a minimum of three directors and each one should be financially literate; audit committee to have formal written charter, approved by board, specifying responsibilities, structure, process and membership; a charter to specify outside auditors’ responsibility towards the board and the audit committee; companies to attach with Annual Report, a letter from audit committee as to whether or not the– management reviewed the audited financial statements with the audit committee; outsiders auditors discussed with the audit committee their judgments; the committee be of the believe that company’s financial statements are fairly presented in conformity with generally accepted accounting practices (GAAP).11

In USA, the Foreign Corrupt Practices Act, 1977 made specific provisions regarding establishment, maintenance and review of the system of internal control. In 1979, US Securities Exchange Commission prescribed mandatory reporting on internal financial controls. Due to high profile failures in the US, the Treadway Commission constituted in 1985 highlighted the need of putting in place a proper control environment and the , desirability of constituting independent boards and its committees.

As a consequence, the Committee of Sponsoring Organisations took birth. It produced and stipulated , in 1992, a control framework. After the Enron debacle of 2001, came other scandals involving large US Companies such as WorldCom, Qwest, Global Crossing and the auditing lacunae that eventually led to the collapse of Andersen. These developments triggered another phase of reforms in the area of corporate governance, accounting practices and disclosures – this time more comprehensive than ever before.

The Sarbanes- Oxley Act (SOX): The Act passed in July 2002 by the US Congress, is the most sweeping reform of corporate governance and corporate social responsibilities. It measures everything, from board composition to regulation of auditors. It emphasizes on the audit function and financial disclosures. It strengthens the power, importance and independence of audit committee. It provides for constitution of Public company Accounting Oversight Board to oversee the audit of public companies that are subject to securities laws, establish audit report standards and rules, and inspect, investigate and enforce compliance by auditors. It emphasizes on audit independence and prohibits an auditor from performing specified non-audit services along with the audit. It also requires pre-approval by the audit committee for those non-audit services that are not expressly forbidden. It confers responsibility upon audit committee for the appointment, compensation and oversight of any audit firm employed to perform audit services. It requires an audit committee member to be a member of the board and to be independent. Audit firms will be appointed by and will report directly to the audit committee and be subjected to rotation of partner and firm. In India, the Office of Comptroller and Auditor General (CAG) functions as oversight audit body for audit of public sector companies.12

The SEC (Securities and Exchange Commission) announced the details of the rules in January 2003. They are designed to make public companies transparent proactive in sharing material financial information with auditors, audit committees, analysts and investors. The Act provides a legislative template for financial reporting and compliance. The most relevant sections are 302 and 404 that govern rules of disclosure and financial reporting respectively.

Section 302 mandates that CEO and CFO shall personally certify corporate financial statements and filings. They shall also affirm that they are responsible for establishing and enforcing disclosure controls and procedures at all levels of their corporations. In addition, they must disclose to the audit committee all significant deficiencies, material weaknesses and acts of fraud.

Section 404 requires an annual evaluation of internal controls and procedures for financial reporting. Every corporation must document its existing controls that have a bearing on financial reporting, test them for efficacy and report on gaps and deficiencies. Furthermore, the company’s independent auditors must issue an annual report that attests to the management’s assertion regarding these controls. Thus, SOS-404 deals with internal control process, a matter of governance and qualitative process management. All the foreign companies listed on the US bourses have to comply with the Act. The compliance deadline for foreign issuers is the year 2006. SOA throws up opportunities for several professions – accountants, lawyers, software companies, EPR professionals, and consulting companies.

The major recommendations of the Naresh Chandra Committee and the Narayana Murthy are based on these committee reports and principally influenced by the SOX Act of the USA.13


Usually a debate is held before the enactment or amendment of any Act on an important issue. In this debate, the political parties, academics and business sector take part in the debates if the concerned Act is going to affect the sector. With the liberalization, international organizations have played a crucial role in the enactment of various Acts. In fact, for the last few years, most of the Acts or amendments have been made under the pressure of MNCs or international bodies.

There are, however, several corporate governance structures available in the developed world but there is no one structure, which can be singled out as being better than the others. There is no “one size fits all” structure for corporate governance. Each country has its own corporate culture, national personality and priorities. Similarly, each company has its own history, culture, goals and business cycle maturity. All these factors must be taken into consideration in crafting corporate governance structure and practices for any country or any company. However, the influence of international capital markets definitely has the effect of some convergence on governance practices. Corporate governance extends beyond corporate law. Its fundamental objective is not mere fulfilment of the requirements of law but in ensuring commitment of the board in managing the company in a transparent manner for maximizing long-term shareholder value.

India, even before the Asian financial crisis of 1998, took steps for corporate governance. The CII evolved a code of best practice in 1998, which was a self-regulatory effort by business leaders, followed by the second code of SEBI in 1999, which was tougher than CII code and aimed to make compliance a part of listing agreement. Simultaneously amendments were introduced in the company law in 2002 and a bill was introduced in 2003 based on the recommendations of various high power committees. It is hoped that enforcement of these measures in letter and spirit will help boost Indian and foreign investors’ confidence in the Indian corporate sector.

The author is specialising in Business Laws and Intellectual Property Rights at Rajiv Gandhi National University of Law, Punjab, India.

1 Balasubramaniam, N. (1997) “Towards Excellence in Board Performance”, The IIMB Management Review, January-March, 67-84.

2 Details are available in Company Law Journal cited as (2000) 2 Comp LJ; see also the reports at

3 The clause 49 has been amended by SEBI vide Notification No. SEBI/MRD/SE/2003/26/08, dated August 26, 2003. According to this, the schedule of implementation of corporate governance norms provided under Clause 49 is as follows:-
(i) by all entities seeking listing for the first time, at the time of listing,
(ii) by all listed entities having a paid-up share capital of Rs. 3 crores and above or net worth of Rs. 25 crores or more at any time in the history of entity on or before March 31, 2004.
The non-mandatory requirement may be implemented as per the discretion of the adoption or non-adoption of the non-mandatory requirements is required to be made in the section on Corporate Governance of the Annual Report. The Report shall provide details of compliance with every mandatory item of corporate governance guidelines. The non-compliance of any mandatory requirement with reasons must be stated in the Annual Report. Similarly, the extent to which the non-mandatory requirements have been adopted should also be specifically highlighted.

4 Id.

5Vittal, N. (1997), “Boards and Directors in Public Sector Enterprises”, The IIMB Management Review, January-March, 48-56.

6Supra note 1.

7The requirement to file a “Report on Corporate Governance” in its Annual Report is compulsory for every company. Under the Listing Agreement, the company shall obtain a compliance certificate with corporate governance guidelines either from the company secretaries or auditors and attached with the Director’s report. On the other hand, the Companies (Amendment) Act, 2000 provides that every company having paid-up capital of Rs. 10 lakh or more and not required to employ a whole-time secretary is required to file with the Registrar of Companies a compliance certificate from a secretary in whole-time practice and also to attach a copy of that certificate with Board’s report. (Proviso to section 383 A).

8Cadbury, A., Chairman, (1992), Report on the Financial Aspects of Corporate Governance, cited in Pound J. (1993) in “The fight for good governance”, Harvard Business Review, January- February, 76-83.

9Smith, A. (1776) An Inquiry into the Nature and Causes of the Wealth of Nations, Modern Library Edition, New York, Random House, 1937, 1965.


11Bajaj, R., Chairman, (1997) Draft code on corporate governance, Confederation of Indian Industry.


13Supra note 9.