Doing Things Right: Corporate Governance in India

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Doing Things RightCorporate Governance in India

• Omkar Goswami
• Chief Economist
• Confederation of Indian Industry
• 11-13 November, Mumbai, India

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Contents
Brief history of corporate governance in India
What are the mandated CG guidelines and
disclosures
How does India measure up with Sarbanes-Oxley
New corporate governance moves that are expected
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Brief history of corporate governance in India

• Unlike South-East and East Asia, the corporate
  governance initiative in India was not triggered
  by any serious nationwide financial, banking and
  economic collapse
• Also, unlike most OECD countries, the initiative
  in India was initially driven by an industry
  association, the Confederation of Indian Industry
• In December 1995, CII set up a task force to
  design a voluntary code of corporate governance
• The final draft of this code was widely
  circulated in 1997
• In April 1998, the code was released. It was
  called Desirable Corporate Governance A Code
• Between 1998 and 2000, over 25 leading companies
  voluntarily followed the code Bajaj Auto,
  Hindalco, Infosys, Dr. Reddys Laboratories,
  Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI
  and many others

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Brief history of corporate governance in India

• Following CIIs initiative, the Securities and
  Exchange Board of India (SEBI) set up a committee
  under Kumar Mangalam Birla to design a
  mandatory-cum-recommendatory code for listed
  companies
• The Birla Committee Report was approved by SEBI
  in December 2000
• Became mandatory for listed companies through the
  listing agreement, and implemented according to a
  rollout plan
• 2000-01 All Group A companies of the BSE or
  those in the SP CNX Nifty index 80 of market
  cap
• 2001-02 All companies with paid-up capital of
  Rs.100 million or more or net worth of Rs.250
  million or more
• 2002-03 All companies with paid-up capital of
  Rs.30 million or more

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Brief history of corporate governance in India

• Following CII and SEBI, the Department of Company
  Affairs (DCA) modified the Companies Act, 1956 to
  incorporate specific corporate governance
  provisions regarding independent directors and
  audit committees
• In 2001-02, certain accounting standards were
  modified to further improve financial
  disclosures. These were
• Disclosure of related party transactions
• Disclosure of segment income revenues, profits
  and capital employed
• Deferred tax liabilities or assets
• Consolidation of accounts
• Initiatives are being taken to (i) account for
  ESOPs, (ii) further increase disclosures, and
  (iii) put in place systems that can further
  strengthen auditors independence

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Brief history of corporate governance in India
What are the mandated CG guidelines and
disclosures
How does India measure up with Sarbanes-Oxley
New corporate governance moves that are expected
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What are the mandated CG guidelines and
disclosures

• Board of Directors frequency of meetings and
  composition
• Board must meet at least at least four times a
  year, with a maximum time gap of four months
  between two successive meetings
• If the chairman of the Company is a non-executive
  then one-third of the board should consist of
  independent directors, and 50 otherwise
• Independent defined as those directors who,
  apart from receiving directors remuneration do
  not have any other material pecuniary
  relationship or transactions with the company,
  its promoters, management or subsidiaries, which
  in the view of the board may affect independence
  of judgement
• This definition may be soon strengthened

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What are the mandated CG guidelines and
disclosures

• Board of Directors frequency of meetings and
  composition
• The frequency of board meetings and board
  committee meetings, with their dates, must be
  fully disclosed to shareholders in the annual
  report of the company
• The attendance record of all directors in board
  meetings and board committee meetings must be
  fully disclosed to shareholders in the annual
  report of the company
• Full and detailed remuneration of each director
  (salary, sitting fees, commissions, stock options
  and perquisites) must be fully disclosed to
  shareholders in the annual report of the company
• Loans given to executive directors are capped (no
  loans permitted to non-executives), and must be
  fully disclosed to shareholders in the annual
  report of the company

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What are the mandated CG guidelines and
disclosures

• Board of Directors information that must be
  supplied
• Annual, quarter, half year operating plans,
  budgets and updates
• Quarterly results of company and its business
  segments
• Minutes of the audit committee and other board
  committees
• Recruitment and remuneration of senior officers
• Materially important legal notices and claims, as
  well as any accidents, hazards, pollution issues
  and labor problems
• Any actual or expected default in financial
  obligations
• Details of joint ventures and collaborations
• Transactions involving payment towards goodwill,
  brand equity and intellectual property
• Any materially significant sale of business and
  investments
• Foreign currency and other risks and risk
  management
• Any regulatory non-compliance

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What are the mandated CG guidelines and
disclosures

• Board of Directors Audit Committee
• Audit Committee is mandatory
• Must have minimum of three members, all
  non-executive directors, the majority of whom are
  independent
• Chairman must be an independent director, and
  must be present at the annual shareholders
  meeting to answer audit or finance related
  questions
• At least one member must be an expert in
  finance/accounts
• Must have at least three meetings per year,
  including one before finalisation of annual
  accounts
• Must meet with statutory auditors and internal
  auditors have the powers to seek any financial,
  legal or operational information from the
  management obtain outside legal or professional
  advice

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What are the mandated CG guidelines and
disclosures

• Board of Directors Audit Committee functions
• Oversight of the companys financial reporting
  process to ensure that the financial statement is
  correct, sufficient and credible
• Appointment / removal of external auditor and
  fixing of audit fees
• Reviewing with management the annual financial
  statements before submission to the board,
  focusing on
• Changes in accounting policies and practices
• Major accounting entries
• Qualifications in draft audit report
• Significant adjustments arising out of audit
• The going concern assumption
• Compliance with accounting standards, with stock
  exchange and legal requirements
• Any related party transactions

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What are the mandated CG guidelines and
disclosures

• Board of Directors Audit Committee functions
• Adequacy of internal audit and internal control
  systems, through discussion with internal and
  statutory auditors as well as management
• Significant findings, follow-up and action taken
  reports
• Discussion with internal and statutory auditors
  about scope and design of audits
• Reviewing financial and legal risks and companys
  risk management policies
• Examining reasons behind any materially
  significant default to creditors, bond-holders,
  suppliers and shareholders

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What are the mandated CG guidelines and
disclosures

• Disclosures to shareholders in addition to
  balance sheet, PL and cash flow statement
• Board composition (executive, non-exec,
  independent)
• Qualifications and experience of directors
• Number of outside directorships held by each
  director (capped at director not being a member
  of more than 10 board-level committees, and
  Chairman of not more than 5)
• Attendance record of directors
• Remuneration of directors
• Relationship (familial or pecuniary) with other
  directors
• Warning against insider trading, with procedures
  to prevent such acts
• Details of grievances of shareholders, and how
  quickly these were addressed
• Date, time and venue of annual general meeting of
  shareholders

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What are the mandated CG guidelines and
disclosures

• Disclosures to shareholders in addition to
  balance sheet, PL and cash flow statement
• Dates of book closure and dividend payment
• Details of shareholding pattern
• Name, address and contact details of registrars
  and/or share transfer agents
• Details about the share transfer system
• Stock price data over the reporting year, and how
  the companys stock measured up to the index
• Financial effects of stock options
• Financial effects of any share buyback
• Financial effects of any warrants that are to be
  exercised
• Chapter reporting corporate governance practices

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What are the mandated CG guidelines and
disclosures

• Disclosures to shareholders in addition to
  balance sheet, PL and cash flow statement
• Detailed chapter on Management Discussion and
  Analysis focusing on markets, operations,
  finances, accounts, risks, opportunities and
  threats, internal control systems
• Consolidated financial statement, incorporating
  accounts of all subsidiaries (over 50 shares
  held by reporting company)
• Details of all significant related party
  transactions
• Detailed segment reporting (revenues, costs,
  operating profits and capital employed)
• Deferred tax liabilities and assets and
  debit/credit in the PL for the reporting year

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Brief history of corporate governance in India
What are the mandated CG guidelines and
disclosures
How does India measure up with Sarbanes-Oxley
New corporate governance moves that are expected
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How does India measure up with Sarbanes-Oxley
Sarbanes-Oxley Indian situation What might be needed
Certification of annual accounts by CEO, CFO At least two directors must sign, of whom one must be the Managing Director Need to change to have MD/CEO plus Finance Director/CFO to sign
Fully independent audit committees Fully non-executive, majority independent audit committees Need to consider (i) fully independent (ii) tighter definition of independence
Disgorgement of CEO/CFO compensation in event of restatement Accounts and profits once published cannot be re-stated Need to see if ESOP payments need to be disgorged if there is a restatement
Prohibition of insider trading Prohibits insider trading Nothing is needed
Prohibition of insider loans to directors Strict cap on insider loans to directors requires prior government approval Caps are stringent enough to prevent insider abuse
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How does India measure up with Sarbanes-Oxley
Sarbanes-Oxley Indian situation What might be needed
Real time disclosure concerning changes in financials and operations Listing agreement mandates companies to report quarterly results and material changes Nothing is needed
Mandatory periodic review of companys filings once every three years No such provision Need to consider how this can be done without creating administrative hassles
Auditors prohibited from nine types of non-audit services to audit clients These services are already prohibited in India Nothing is needed
Auditors to report to Audit Committee on critical accounting policies Mandated by the listing agreement and the Companies Act amendments Nothing is needed
Rotation of audit partners every five years No such provision exists A committee is considering such a change
Up to 20 years in prison for fraud and destruction of records No such provision Need to consider tougher penalties, including longer imprisonment
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Contents
Brief history of corporate governance in India
What are the mandated CG guidelines and
disclosures
How does India measure up with Sarbanes-Oxley
New corporate governance moves that are expected
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New corporate governance moves that are expected

• There are five reasons why one doesnt expect the
  corporate sector in India to exhibit the excesses
  that occurred in the US
• The amount of stock options to be granted to
  employees is strictly limited. Expensing options
  (if adopted) will create a further natural limit
• In general, companies are controlled by a
  sizeable shareholder, typically owning over 35
  of stocks. This tends to limit agency costs of
  dispersed ownership
• The variable compensation package is much more
  linked to profits and/or EVA, than stock prices
  or P/E
• Much greater importance is given to accumulating
  cash. Profit is an opinion cash is fact
• For better or for worse, most Indian companies
  still dont have to give forward looking earnings
  estimates

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New corporate governance moves that are expected

• After the US crises, there have been some
  initiatives
• A committee has been set up to examine stock
  options, including expensing them
• Another committee has been set up to recommend
  tighter enforcement by DCA and stiffer penalties,
  including longer prison terms
• A third committee has been set up to examine
  auditor-company relationships and the role of
  independent audit committees
• A fourth committee is examining what additional
  disclosures and accounting standards are needed
  to have even better corporate governance

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Concluding remarks

• By and large, Indian listed companies have been
  legally mandated to follow fairly strict
  standards of corporate governance and disclosure
• Comparisons will show that the standards are far
  stronger than all Asian countries, and in general
  stronger than most OECD countries
• Indian corporate sector regulators and companies
  have been quick to incorporate some of the best
  international corporate governance and disclosure
  practices
• The need of the day is more training of
  directors, audit committee members and senior
  executives of companies
• The challenge is to design and sustain a system
  that imbibes the spirit of corporate governance
  and not merely the letter of the law