Corporate Governance Mechanisms: An Overview

The article 'Corporate Governance Mechanisms: An Overview' explicitly covers various corporate governance mechanisms employed by companies to ensure effective decision-making, mitigate agency problems, and protect the interests of shareholders and stakeholders.

Cultivating a company that possesses high standards of integrity and sensitivity to its surroundings is becoming crucial in the ever-evolving corporate arena. This is bringing with itself, an ardent need for constant transformative practices in the corporate sector. However, all the diverse initiatives being introduced, such as the Green stock exchange, ESG mandates etc. point towards one common theme- the requirement for transparency and accountability. This takes us to the concept of ‘Corporate Governance’ that has its roots in all the good governance practices of a company. In this article, we shall be discussing the same at length.

Introduction

The Rules and Procedures that are established by a Company in order to maintain governance in adherence to relevant laws, along with fulfilling the interests of all the stakeholders involved is known as corporate governance. The term 'Corporate Governance' can be understood to be a set of policies that comprehensively describe the good governance practices to be undertaken by a company. The thrust of these policies is to promote transparency and accountability in the functioning of a company. This would further give confidence to the stakeholders.

The thematic governance under the aegis of corporate governance has witnessed a tremendous boost in the past few years. The introduction of the Companies Act, 2013 is responsible for bringing about a stern change in how the management and functioning of a company are to be carried out with the aid and assistance of corporate good governance practices. The Possible reason behind the same can be projected to be the growing consciousness and awareness of the public at large which further urges companies to get involved in good governance mechanisms. For instance, the ESG mandates that have been introduced and are now mandated by SEBI for certain classes of companies form a part of the larger picture of good governance or corporate governance itself as the idea is to make the company accountable towards all its stakeholders and to henceforth make it contribute to the society as well.

Governance Mechanisms

The Corporate Governance Mechanisms function on the base theme of ‘interest alignment’ and thus can be understood to be a coherent juxtaposition of the interests of all the stakeholders involved such as the shareholders, environment, public at large etc. Corporate governance mechanisms impact the decision-making process of a company which in turn reflects the ideals on which the company and its business are being carried on. While it is true that monetary benefits are not the ultimate objective of a company in today’s evolving times, it is however important for a company to make a certain extent of profits to continue. So, corporate governance mechanisms aim at creating this balance between the moral, social and financial obligations of a company.

Internal Corporate Governance Mechanisms:

Let us now discuss some of the internal corporate governance mechanisms:

1. Board of Directors

They are referred to as internal corporate governance mechanisms as they are the ones who are at the core of a company’s functional unit and thus they hold a large amount of responsibility in deciding what the principles for a company’s functioning shall be. The authorities and powers granted to them under the Companies Act, 2013 project the impact that they have on the output that the company produces, both socially and financially. They are even held accountable in case any red flags are cited by the auditors during the internal audit.

2. Financial Statements and Auditors

Financial statements of a company comprise its balance sheet, its Profit and Loss Account, and Cash flow statement for certain classes of companies. These documents are capable of projecting the position of the company at the end of each financial year and are also a mirror of the obligations and activities taken up by the company throughout the year. Further, auditors while conducting audits (internal and external) are responsible for evaluating whether the position of the company thus stated in these financial statements is actually true. Therefore, both financial statements and auditors portray whether a company is transparent in its functioning or not and whether it can be held accountable.

3. Ownership Structure

The Separation of ownership and management of a company is also a way to examine whether the managers of a company are able to continue the company with the expertise for which they are a part of the management of the company. This evaluation is handed over to the true owners of the company which in actuality are the shareholders. Thus corporate governance principle adherence is also checked internally through this ownership structure.

External Corporate Governance Mechanisms:

Let us now discuss some of the external corporate governance mechanisms:

1. Financial Market

It is well known that the market value of a firm regulates the efficiency of managers. Thus it can be understood how important the financial market is with regard to a company’s performance. With the evolving perspective of a company’s way of doing business, in today’s times performance is adjudged on the basis of several components that often comprise the holistic corporate governance practices that a company has. Thus this also impacts the value of its shares in the market as shareholders are now becoming actively informed about this aspect.

2. Market of goods and services

Apart from the financial market, the goods and services thus provided by a company and consumed by its customers, depend upon how well that company is performing comprehensively. Thus good corporate governance practices would certainly attract more number of loyal customers owing to the goodwill of the company thus garnered.

Independent Audit

Examination of the accounts of a company, financial documents, dealings during business activities etc. when done by an independent auditor, meaning an external auditor, is referred to as an independent audit. Here, it can be inferred that the use of the term ‘independent’ implies that the auditor is not an employee in any sense of the company (general or contractual). The auditor whether an individual or an audit firm is hired by the firm for the purpose of conducting the external audit.

This is different from the internal audit in the sense, that the auditor there is an employee of the company and functions in adherence to the requirements of the audit committee. He even flags any discrepancies found in the accounts of the company to it, in order to give it time to fix the same. Here is an external audit, the company is not informed and rather the discrepancies are directly reported to the government.

Principles of Corporate Governance

Although there is no exhaustive list of guiding principles concerning corporate governance, the five main principles are as follows:

1) Impartiality

The board is responsible solely, to garner an environment of impartiality in the company. This may be in relation to the decisions it takes or the class of members it favours or the owners as well. If the company is able to take independent decisions owing to its impartiality, it will be able to treat everyone in a fair and equitable manner which includes shareholders, employees, suppliers, and communities.

2) Transparency

Oftentimes, when big scams such as that of Sahara surface one common aspect binds all of them. This common feature is the lack of transparency in the functioning of a company. Thus corporate governance aims to eliminate this root cause. There should be no hidden functions or decisions taken by the company and this should be ensured by the board of directors themselves through a code of conduct established by them for this purpose.

3) Accountability

The aim of a company's operations and the outcomes of its conduct must be disclosed by the board. It is imperative for a company to be able to substantiate any of the decisions that it takes in the general course of business as well as long-term planning. This is referred to as accountability. If a company is accountable, it generates more trust and goodwill.

4) Management of Risk

The board and management must decide how to appropriately control and manage risks of all kinds by the company. In order to manage them, the board should duly consult the stakeholders and take calculative risks while taking any policy decisions. The risk committee must be duly formulated by the company which shall take care of this aspect by adhering to corporate good governance practices.

5) Responsibility

Since the board is in charge of regulating business affairs and managerial actions of the company, it must keep in mind the interests of the company and its ongoing performance in a responsible manner. The responsibility of the company includes making the right appointments, taking responsible decisions and taking due care of the interests of all the stakeholders.

Statutory Framework of Corporate Governance

Owing to the weightage that corporate governance principles have with respect to assisting the company to perform well in a holistic manner, due legislative initiatives have been taken in order to substantiate these principles and put them into regular as well as mandatory practices by a company.

The Indian government has established a comprehensive statutory mechanism for corporate governance by taking into account the world's best practices. The laws, rules and regulations that deal with the same are:

1) The Companies Act, 2013: The Companies Act, 2013 is the most detailed legislation that describes all the obligations that a company has to undertake. This Act requires adherence to all the laws as prescribed within that portray the manner in which a company has to operate. These include board meetings and conferences, audit committees, business dealings with third parties, disclosure of all financial statements, financial matters, and other similar factors which ensure proper accountability and transparency of the company management.

2) Accounting Norms and Standards: The Institute of Chartered Accountants of India (ICAI) has established certain accounting principles and standards which ensure that the accounts and financial policies of the company are open and transparent enough, in accordance with Section 129 of the Companies Act, 2013. Additionally, the ICAI also makes sure that the components of the company's financial statements adhere to the accepted accounting principles.

3) SEBI (Securities and Exchange Board of India) Regulations: SEBI is the regulatory body in charge of overseeing listed companies and issuing a number of guidelines, rules, and regulations to protect investors' interests. For instance, SEBI (LODR) 2018, lists all the obligations of a listed company. This further streamlines the detailed practices to be followed by the companies.

4) Secretarial Standards: The Institute of Company Secretaries of India (ICSI) has published secretarial standards, a regulatory setup which is a stand-alone entity with its own set of rules and regulations that fall under the Companies Act, 2013. The Institute of Company Secretaries of India has released two standards, SS-1, Meetings of the Board of Directors, and SS-2, Secretarial Standards on General Meetings. These clauses became effective on July 1, 2015.

5) Standard Listing Agreements of the Stock Exchanges: The stock exchanges have also introduced the standard listing agreements which are mandatorily required to be signed by the companies whose stocks are listed on stock exchanges.

In addition to the above, the Companies Act, 2013 has raised the bar for discussions during the Board Meetings. Some of the instances that project India’s attempt to bring corporate governance into the corporate realm include- the inclusion of gender diversity by the advancement of women directors in management, changes in disclosure norms and standards, the delegation of corporate social responsibility, the expansion of the role of independent directors, the preservation of minority shareholder interests, and the development of specific benchmarks for better corporate governance. A sound corporate governance framework must be established on a worldwide scale in order to enhance the environment of the company in terms of trust, transparency, and accountability since it supports the organization's long-term financial stability and sustainable growth.

Conclusion

After analyzing the crucial role of corporate governance in fostering the efficiency of the organization, boosting the trust of investors, and safeguarding the interests of shareholders, it will not be wrong to assume that ensuring corporate governance in its letter and spirit highly depends upon the morals and ethics of the management which is running the organization. The Indian government has made tremendous reforms in the last few decades by framing such a statutory framework which will not only obligate the management to follow the rules and procedures but will also help the Indian corporate environment in achieving the global standard of governance. However, in order to deal with the loopholes which still prevail within the governance mechanism, it is important that collaborative efforts shall be made by the government and the organizations to create such an impenetrable structure, which will lead India towards becoming a $6 trillion economy.

References

[1] Bhumesh Verma, Evolution of Corporate Governance in India, Available Here

[2] Arpit Srivastava, Regulatory Framework for Corporate Governance in India, Available Here

[3] Smita Sharma, Corporate Governance Mechanisms in India, Available Here

[4] Evolution of Corporate Governance in India, Available Here

[5] Role of Corporate Governance in India, Available Here

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