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PROBLEMS WITH CORPORATE GOVERNANCE IN INDIA AND THEIR SOLUTIONS

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 PROBLEMS WITH CORPORATE GOVERNANCE IN INDIA AND THEIR SOLUTIONS

Akshay Pandya

INTRODUCTION

Corporate governance issues have been ever present in India and can be traced back to
the British East India Company.2 Scams in the preceding two decades, have made the
Indian corporate sector and the Government realize the immense significance of
effective implementation of corporate governance standards. India adopted the policies
of liberalisation, privatization and globalisation in 1991. Despite opening up the economy
there have been several concerns with the way corporations conduct their business. As
the problems and the solutions to corporate governance issues are evolving concurrently
due to the changing dynamics of business around the globe, it becomes difficult to
ascertain conclusively as to what a long lasting solution should look like. This essay will
try to identify the major problems with corporate governance in India and discuss the
relevant solutions along with their current level of implementation. Rather than
presenting problems first and solutions later, both will be discussed simultaneously,
considering their interwoven structure.

THE INDIAN MODEL OF CORPORATE GOVERNANCE & PROMOTER

PREDICAMENT

The reform process in India has been largely based on the Anglo Saxon model of
corporate governance. It can be argued that this model has limited relevance in the
Indian context. The structure and pattern of shareholding in India is different than the
dispersed shareholder base of USA and UK. The central theme of corporate governance

1
Abhinay Bajpai, ’Impact of Corporate Governance in Modern Workplace’, Abhinay Bajpai’s Blog (Blog Post)
<http://bajpaiabhinay.blogspot.com/2014/04/impact-of-corporate-governance-in.html>.
2
Vijay Seth, ‘The East India Company - A Case Study in Corporate Governance’ (2012) 13(2) Global Business Review
221,238.
 in these countries runs along the lines of disciplining the management which is not
accountable to the owners, i.e. the dispersed base of shareholders. The central issue in
Indian corporate scenario must be to discipline the principal block holder or dominant
holder of shares and also on the protection of the interest of the minority shareholders.3
The concern in US or UK is that the directors must see to it that the management acts
on behalf of the shareholders, and that there is no conflict of interests or incongruence of
goals between them. In India also there is a conflict of interest, but rather between the
dominant shareholder and the minority shareholders.4 This problem cannot be solved by
the board which derives its powers from these very dominant shareholders. Some of the
most flagrant abuses of corporate governance were conducted in the garb of
“shareholder democracy” because these decisions were undertaken after the majority of
shareholders ratified it through resolution.5 While in the PSUs (Public Sector
Undertakings), it is the government which is the dominant shareholder, it is the foreign
parent in multi-national corporations. In Indian business groups however, it is the
promoter and his friends and relatives who possess the dominant shareholding.6 It
becomes rather difficult to ascertain the actual holding of the promoter because of the
amorphous nature of his holding spread across various friends and relatives. In India the
dominant form of business is the family owned business or firm. As per the report of
Prowess,7 the holding of promoters in Indian publicly traded firms was 55.6% (2015-
2016).8 But even where these shareholdings are less, the promoters still play the role of
the dominant shareholders because a large chunk of the shares is owned by financial
institutions owned by the State, which are known to play a rather dormant role in
governance.

THE CONTROL CONUNDRUM

Perhaps the reason for this behaviour of promoters is that they do not want the outsiders
to control their business which they have painstakingly built. This is evident from the fact
that Indian firms rely heavily on debt financing in contrast to equity. This heavy reliance
on debt was not a concern for these promoters because defaulting on it did not result in
loss of their control over the business as they could stretch the insolvency process to a

3
Santosh Pande, ‘An Overview of Corporate Governance Reforms in India’ (2011) SSRN Electronic Journal: 1-53.
4
Nandini Rajagopalan, ‘Corporate Governance Reforms in China and India: Challenges and Opportunities’ (2008)
51(1) Business Horizons 55, 64.
5
Jayanth Rama Varma, ‘Corporate Governance in India: Disciplining the Dominant Shareholder’ (1997) 9(4) The
Journal of the Indian Institute of Management, Bangalore 5, 18.
6
Ibid.
7
Prowess is a database of financial performance of companies maintained by CMIE (Center for Monitoring Indian
Economy Pvt. Ltd.) since 1990.
8
Radhakrishnan Gopalan, ‘Implications of Higher Promoter Holdings’, Livemint (Web Page, 29 August 2018)
<https://www.livemint.com/Opinion/cYD0KdtaC9xcofEdYw5iaL/Opinion--Implications-of-higher-promoter-
holdings.html>.
 very long time. But this is fast changing with the introduction of new insolvency laws.9
Such heavy reliance on debt can affect the entire economy and interestingly India is
witnessing a banking crisis at the moment.

A possible solution for young Indian entrepreneurs to retain control over their business is
to allow them to issue dual-class shares.10 It is argued that this can have negative
consequences on corporate governance because the outside shareholders are already
battered. But this would in fact allow the investors to exercise better due diligence as the
dual class shareholding will make insider control more transparent by making it easier to
identify the firms where there is excessive insider control.

PLEASE REMAIN AT ARM’S LENGTH

11

Another corporate governance issue connected with the previous issue is the problem of
related party transactions and possible tunnelling of funds associated with it. Ever since
the Satyam scam (2009) and moreover because of the latest ICICI Videocon Scam,
regulators have considered serious reforms in the field of related party transactions.
Section 188 of the new Companies Act, 2013, states that related party transactions can
be undertaken only by the board‟s consent and by the express approval of the Audit
Committee. Furthermore, transactions beyond the threshold will require special
resolution. What is interesting and reformative, is the definition of related party as
specified in Section 2(76) of the new Companies Act, wherein the investor, its venturer
and also corporations incorporated outside India are included. But still India witnessed a

9
The Insolvency and Bankruptcy Code, 2016, is a massive reform in the financial sector of India, enacted for speedy
recovery of debts from corporates.
10
Ibid.
11
Will Kenton, ‘Related Party Transaction’, Investopedia (Web Page, 3 May 2019)
<https://www.investopedia.com/terms/r/related-partytransaction.asp>.
 fraud related to transactions with related party after this enactment.12 Thus, the
Securities and Exchange Board of India (Listing Obligations and Disclosure
Requirements) (Amendment) Regulations, 2018, were made effective from April 2019.
These new regulations further expand the scope of „related party‟ by including any
person or entity related to the promoter group and holding more than 20% of shares in
the listed entity. Furthermore, transactions with any person or entity belonging to the
promoter group and holding more than 10% shares in the listed entity are mandatorily
required to be disclosed. Thus the persons, who could escape the definition of related
party in The Companies Act, 2013 and the accounting standards, will not be spared now.

ACCOUNTABLE ACCOUNTING

13

12
The ICICI Videocon scam was an unearthing of a series of deceitful and skillful transactions with related parties
over more than a decade.
13
Nabeel Ahmed, ‘Will India align with IFRS?’, Business Line (Web Page, 27 October 2013)
<https://www.thehindubusinessline.com/news/education/Will-India-align-with-IFRS/article20681909.ece>.
 Speaking of accounting standards, although India had declared to adopt IFRS
(International Financial Reporting Standards) by 2011, as of 2019, this goal has still not
been achieved. India relies on Ind AS (Indian Accounting Standards) issued by ICAI
(Institute of Chartered Accountants of India). IFRS is particularly more relevant in the
present context of „Make in India‟ programme of Prime Minister Narendra Modi which
aims at attracting maximum foreign direct investment in India. The good news is that as
per the IASB (International Accounting Standards Board) India is set to converge fully
with IFRS till 2021.14 The Chairman of IASB, Hans Hoogervorst believes that “the glass
is much more than half full” in the context of Indian convergence with IFRS.15 The
adoption of Ind AS is a major reformative deviation from the earlier IGAAP (Indian
Generally Accepted Accounting Principles) and presently there are only seven IFRS
from which Ind AS do not converge.16

BLOW WHISTLES; NOT HORNS

India unfortunately, has not been able to protect its whistleblowers. This would be an
understatement rather. Whistleblowers in India have simply been killed in the most brutal
and inhumane manners. Their torture begins by suspending them or implicating them in
false charges, followed by a brutal murder or suicide.17 The situation has improved a lot
in recent years as is evident from the unearthing of the ICICI Videocon Scam by the
whistle blower Arvind Gupta, who patiently analysed the publicly available records of the
company for years and traced surprising patterns of related party transactions. There is
a drastic improvement in whistleblower protection since the adoption of The
Whistleblower Act, 2011 and several amendments to the Company Law. As per section
177(9) of The Companies Act, 2013, all listed companies are mandated to have a vigil
mechanism which must safeguard whistleblowers and the details of which must be
published in the board report and on the website of the company. Whistleblowers in
India can have a direct access to the Chairman of the Audit Committee. But this does
not suffice because the foremost importance is of protection of the identity of the whistle
blower. Mechanism of protecting whistle blowers in India is managed internally by
companies. Here, India can definitely learn from the USA wherein anonymous
complaints can be filed with the SEC (Securities and Exchange Commission).18 The
Securities and Exchange Board of India (SEBI) has no such facility. Whistle blowing
mechanisms alone cannot be effective unless coupled with stringent anti-corruption

14
K.R.Srivats, ‘India will achieve full convergence with IFRS in 5 years’, Business Line (Web Page, 16 October 2016)
<https://www.thehindubusinessline.com/news/india-will-achieve-full-convergence-with-ifrs-in-5-
years/article9226918.ece>.
15
Ibid.
16
Ibid.
17
Several whistleblowers have been killed in India in fighting against corruption; Satyendra Dubey, Shanmugam
Manjunath, Narendra Kumar, Lalit Mehta etc.
18
It is noteworthy that on October 21 certain anonymous shareholders wrote a letter to the SEC alleging corporate
misconduct on the part of the CEO and CFO of Infosys (an Indian IT company listed in USA as well).
 legislation.19 The SEBI should handle whistleblower complaints directly. A model
disclosure format or model whistle blowing policies by SEBI should also be considered.
An interesting development is the new announcement by SEBI that it will reward an
informer of insider trading with 1 crore (10 million) rupees, under „Informant Mechanism‟
rules of „Prohibition of Insider Trading‟ regulations of SEBI.20

SUNDRY ISSUES & CERTAIN WELCOME STEPS

21

19
It is noteworthy that the Prevention of Corruption Act, 1988 does not encompass foreign public officers.
20
Press Trust of India, ‘Sebi Plans Rs 1 Crore Reward for Informers of Insider Trading’, ET Markets (Web Page, 6
August 2019) <https://economictimes.indiatimes.com/markets/stocks/news/sebi-plans-rs-1-crore-reward-for-
informers-of-insider-trading/articleshow/70558577.cms?from=mdr>.
21
Jayshree P.Upadhyay, ‘Why Independent Directors are Rushing for the Exit Door’, livemint (Web Page, 19
December 2018) <https://www.livemint.com/Companies/bntAau6XcAhPfTZ5yCVx7O/Why-independent-directors-
arerushingfortheexit-door.html>.
 Independent directors in India, rather than asserting their independence, prefer the easy
option of resigning from the board prematurely in the event of a conflict. More than 2000
independent directors quit in 2018.22 A possible reason is that if they voice an opinion,
they can risk getting unpopular with other directors which in turn can affect their future
employment. There need to be greater safeguards for independent directors. Another
reason could be the lack of independence because the law holds independent directors
personally liable in the case of an illegal act that happened within their awareness.23 To
ensure the independence of independent directors there is now a cap on the number of
independent directorships. A person can hold the position of an independent director in a
maximum of seven listed entities and merely three listed companies in case he is also
holding a whole time directorship.24 It is interesting to note that no similar cap is placed
on the remuneration of such directors. Independent directors earning a salary between 1
crores to 5 crores (10-50 million) rupees has risen to 86 in 2017-18.25 But it is a subject
of further study whether higher remuneration impacts the effectiveness of the
independent directors.

Furthering the cause of the independence of independent directors, the law mandates
every listed public company to have one third of its total number of directors, as
independent directors.26 Furthermore, in case the Chairman is executive, the minimum
number of independent directors should be half of the total strength of the board. „Board
interlocks‟, nominee directors and persons who fall within the definition of „promoter
group‟ are now specifically excluded from being an independent director. Appointment of
an alternate director for an independent director is also prohibited.

Board diversity has also been an issue which has been aimed by The Companies Act,
2013, which now mandates three classes of directors for every listed entity, namely,
resident director, woman director and independent director.

Corporate jurisprudence is undergoing a metamorphosis in India currently as is evident

from the following:-

 India is the first country to mandate Corporate Social Responsibility.27

 XBRL, the international reporting standard is mandatory for all listed companies
while making disclosures to stock exchange.

22
Indo-Asian News Service, ‘2000 Independent Directors Quit Last Year, Here’s Why They are Losing Their Hearts’
sifyfinance (Web Page, 24 July 2019) <https://www.sify.com/finance/2-000-independent-directors-quit-last-year-
here-s-why-they-are-losing-their-hearts-news-business-thylWscebhhie.html>.
23
The Companies Act, 2013 (India) s 149 (12).
24
‘Press Release’ Prime Database (Web Page, 25 November 2014)
<http://www.primedatabasegroup.com/newsroom/PR-298.pdf>.
25
Rica Bhattacharyya, ‘In Short supply, More Independent Directors Earn Rs 1 Crore a Year’ The Economic Times
(Web Page, 21 November 2018) <https://economictimes.indiatimes.com/news/company/corporate-trends/in-
short-supply-more-independent-directors-earn-rs-1-crore-a-year/articleshow/66722540.cms?from=mdr>.
26
The Companies Act, 2013 (India) s 149.
27
The Companies Act, 2013 (India) s 135.
  Mandatory disclosure of credit ratings obtained for all outstanding instruments of
the company, on the official website of the company.
 Top 500 listed companies on the Bombay Stock Exchange are mandated to
adopt BRR (Business Responsibility Reporting) wherein a report of the
environmental, social and governance initiatives adopted by the company has to
be attached with the annual report of the company. These reports shall be based
on nine principles of responsible business and corporate governance
enumerated in the National Voluntary Guidelines of the Ministry of Corporate
Affairs.28

CONCLUDING OBSERVATIONS

India is definitely progressing on the road to better corporate governance. It has become the
number one country in terms of ease of doing business, in the South Asian region.29 But, in the
World Corporate Governance Index Rankings, India features in Group 2 (grade 60-80), and lags
behind 22 Group 1 (grade above 80) countries like Australia, USA, UK etc.30 This is because
there are various issues which still need to be addressed. For example the role of institutional
investors and proxy firms in ensuring better corporate governance; the evolving issues of data
protection in the age of e-commerce, artificial intelligence and computerised business;
separation of the role of CEO and Chairman, which is suggested by various committees on
corporate governance, but not mandated upon; investor awareness and responsible investment
based on corporate governance factors and ESG (environmental, social and governance)
parameters, etc. Yet despite all this, the glass is more than half full. It is a positive development
to note that the infamous duo of corruption and bribery are nowhere to be seen in the top
causes of corporate frauds.31 There is a visible transition in the patterns of market fluctuations
as well. A marked absence is of the earlier callous attitudes of the managers towards effective
implementation of corporate governance standards due to its lack of direct nexus with the
market value of the stocks. Good product stories overshadowed poor corporate governance.32
Boards have become vigilant in recent years out of the awareness that any negative information
on corporate governance can manifest a sharp nosedive in the value of the shares and can be
detrimental to the firm, as is evident from the dramatic stock devaluations of Infibeam, Yes
bank, P C Jewellers, etc, to name a few. Furthermore, India is in a need of a central regulator of
corporate governance issues. Currently the framework of corporate governance is a mixture of

28
Balbir Singh Aulakh, ‘Things You Should Know About Business Responsibility Reporting in India’ The CSR Journal
(Web Page, 14 September, 2017) <https://thecsrjournal.in/business-responsibility-reporting/>.
29
‘The World Bank’, Doing Business (Web Page, 2018)
<https://www.doingbusiness.org/en/rankings?region=south-asia>.
30
‘World Corporate Governance Index’, SAHA (Web Page, 8 October 2019)
<http://www.saharating.com/~saharati/en/world-corporate-governance-index/>.
31
Deloitte, 'India Corporate Fraud Perception Survey 2018 Edition III’, Deloitte (Web Page)
<https://www2.deloitte.com/in/en/pages/finance/articles/india-corporate-fraud-perception-survey2018.html>.
32
India Infoline News Service, ‘Corporate Governance in India: Key Challenges and What Needs to Change’ IIFL
(Blog Post, 30 November 2018) <https://www.indiainfoline.com/article/general-blog/corporate-governance-in-
india-key-challenges-and-what-needs-to-change-118113000309_1.html>.
 guidelines issued by SEBI, The Companies Act, Listing Agreement, Accounting Standards of
ICAI, Secretarial Standards of ICSI etc.

On a non legislative note, the fundamental cause of corporate governance issues springs forth
from the very nature of a corporation. The fact that a complex web of contracts create an
invisible entity, „the Corporation‟ and that real human beings motivated by basic laws of
psychology, i.e., reward and punishment, act as agents for the corporation and avow to fulfil the
objectives of the corporation over and above their own personal gains, poses the fundamental
challenge to observance of corporate governance standards through „self motivation‟,
„understanding‟ or „ethics‟. A more human narrative in corporate functioning is required for any
kind of success in the implementation of business ethics. Perhaps the distance between the
corporation, its owners, their representatives and the management, is also responsible for
fading corporate governance standards around the globe. Legislation as a source of corporate
governance can only go so far as any external motivation can go. It cannot radically alter the
intrinsic quality of its subjects. For all one knows, a sense of intrinsic responsibility and
remembering the fundamental values of the culture and tradition of what constitutes „India‟ is
absolutely necessary to realise the ultimate objectives of corporate governance and ethical
conduct of business.33

33
It is a fundamental duty of every Indian to uphold the culture and integrity of India and to protect the noble
ideas that led to the formation of this great country as per Article 51a of The Constitution of India.

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