CORPORATE GOVERNANCE – PART 1

CORPORATE GOVERNANCE IN INDIA 

  • Corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a corporation is directed, administered or controlled.
  • Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, management, and the board of directors. Other stakeholders include labor (employees), customers, creditors (e.g., banks, bond holders), suppliers, regulators, and the community at large.

An important theme of corporate governance is to ensure the accountability of certain individuals in an organization through mechanisms that try to reduce or eliminate the principal-agent problem. A related but separate thread of discussions focuses on the impact of a corporate governance system in economic efficiency, with a strong emphasis shareholders’ welfare. There are yet other aspects to the corporate governance subject, such as the stakeholder view and the corporate governance models around the world.

WHY CORPORATE GOVERNANCE

AT NATIONAL LEVEL :-

  • As barriers to free flow of capital fall, it becomes imperative to recognize that the quality of corporate governance is relevant to capital formation and that sound corporate governance principles is the foundation upon which the trust of investors is built.
  • Corporate governance represents the ethical the moral framework under which business decisions are taken. Thus, any investor, when making investments across the borders or even otherwise, wants to be sure that not only are the capital markets or enterprises with which they are investing are being run competently but they also have good corporate governance.
  • Consequently, lack of sound corporate governance practices in any country can badly affect the confidence of foreign investors, in turn causing damage to the amount of foreign investments flowing in.

At the company and individual level:-

  • It is self evident that sound corporate governance is essential to the well being of an individual company and its stakeholders, particularly its shareholders and creditors.
  • We need to only remind ourselves of the many companies, across the world, whose financial difficulties and, ultimate demise have been substantially attributable to weak corporate governance.

On the other hand, there are several areas of self-interest that should drive companies to embrace more effective governance. These areas are:

  1. Effective governance helps to minimize reputational risks and thus, protecting the brand;
  2. It helps to instill trust in customers and vendors;
  3. It also helps to assure effectiveness and integrity of a company’s business processes.

Factors influencing corporate governance

  1. The ownership structure 

    The structure of ownership of a company determines, to a considerable extent, how a Corporation is managed and controlled. The ownership structure can be dispersed among individual and institutional shareholders as in the US and UK or can be concentrated in the hands of a few large shareholders as in Germany and Japan. But the pattern of shareholding is not as simple as the above statement seeks to convey. The pattern varies the across the globe.Our corporate sector is characterized by the co-existence of state owned, private and multinational Enterprises. The shares of these enterprises (except those belonging to a public sector) are held by institutional as well as small investors. Specifically, the shares are held by

    (1) The term-lending institutions
    (2) Institutional investors, comprising government-owned mutual funds, Unit Trust of India and the government owned insurance corporations
    (3) Corporate bodies
    (4) Directors and their relatives and
    (5) Foreign investors. Apart from these block holdings, there is a sizable equity holding by small investors.

  2. The structure of company boards 

    Along with the structure of ownership, the structure of company boards has considerable influence on the way the companies are managed and controlled. The board of directors is responsible for establishing corporate objectives, developing broad policies and selecting top-level executives to carry out those objectives and policies. The board also requires management’s performance to ensure that the company is run well and shareholder’s interests are protected.

Company boards are permitted to vary in size, composition and structure to best serve the interests of the corporation and the shareholders. Boards can be single-tiered/two-tiered. With regard to the size of the board, opinions and practices vary. Some argue that the adequate size is to range from 9 to15. Some put the figure at 10. Yet others recommend a minimum of 5 and a maximum of 10.

  1. The financial structure 

    Along with the notion that the structure of ownership matters in corporate governance is the notion that the financial structure of the company, that is proportion between debt and equity, has implications for the quality of governance.

Recent research has shown contrary to the Modigliani-Miller hypothesis that the financial structure of the firm has no relationship to the value of a firm that the financial structure does matter; it is no secret that the lenders exercise significant influence on the way a company is managed and controlled. Banks can perform the important function of screening and monitoring companies as the (banks) are better informed than other investors. Further, banks can diminish short-term biases in managerial decision-making by favoring investments that would generate higher benefits in the long run. Banks play a more favorable role than other investors in reducing the costs of financial distress.

  1. The institutional environment 

    The legal, regulatory, and political environment within which a company operates determines in large measure the quality of corporate governance. In fact, corporate governance mechanisms are economic and legal institutions and often the outcome of political decisions. For example, the extent to which shareholders can control the management depends on their voting right as defined in the Company Law, the extent to which creditors will be able to exercise financial claims on a bankrupt unit will depend on bankruptcy laws and procedures etc.

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