Understanding Corporate Governance and the Role of the Board of Directors

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  • Last Updated on 30 August, 2023

Corporate Governance

Table of contents

  1. Corporate Social Reporting
  2. Objectives of Corporate Social Reporting
  3. Role of the Government and Legislation in Enforcing Ethical Business Practices
  4. Corporate Governance and Role of Board of Directors
  5. Levels of Governance Structure
  6. Governance at the level of Board of Directors
  7. Governance by the Corporate Management Committee (CMC)
  8. Governance by Divisional Management Committee (DMC)
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1. Corporate Social Reporting

“Code of Best Practices for Corporate governance” was advocated by Sir Adrian Cadbury in 1992 when corporate governance committee was set up by the London Stock Exchange in 1991. The issues about corporate governance arose in India because, prior to 2000, the lopsided distribution of wealth created by Indian industries created inequalities, which if not checked, would have lead to political, economic and financial problems. The Kumar Mangalam Birla Report on corporate governance was submitted to improve transparency and corporate governance practices of Indian companies. It said that companies with good governance practices have high market standing. The Boards of management should become independent. It should have independent Directors (of public and social standing) who will increase the growth rate of Indian industries.

Though the economy is facing recession in the light of global recessionary phase, the Indian Economy has witnessed a growth rate of 8.5% in the past, high rate of savings and investment and attractive inflow of foreign direct investment across the globe. Indian companies have also acquired financial stakes in overseas business. In this growing business environment, there is shift in the expectations of stakeholders who demand (i) high returns from companies, and (ii) high transparency, accountability and respon-siveness from corporate management. To meet these expectations, good corporate environment is required which is a combination of compliance to legal practices and development of corporate culture that depicts values, morals and ethics. In the light of recent Satyam Computers Scam, good corporate governance has become the need of corporate business houses which provides cheap and easy access to capital by business houses and maximises wealth of the shareholders.

Corporate governance is a powerful system which guides and controls the corporate entities. It strengthens relationship amongst owners, directors and managers of the companies. The central authority is held by the Board of Directors who look after interests of the company and the society at large.

Various issues covered under corporate governance are :

(i) Issues related to investors.

(ii) Issues related to election of Board of Directors.

(iii) Issues related to composition of Board and its committees.

(iv) Issues related to ethics, values and maximisation of owner’s wealth.

(v) Issues related to surveillance maintained by the Board.

Social reporting in corporate governance has emerged out of pressure from society, mandatory social disclosure practices and desire of management to improve the company’s image.

(i) Mandatory social disclosure practices advocate that firms would disclose social information only if it becomes the requirement of law.

(ii) If law does not make social reporting mandatory, firms would disclose this information if stakeholders demand it from company’s management and the management also feels that it will be in the interest of the society.

Social responsibility, thus, has two dimensions :

(i) Socio-economic dimension: Business firms realise that since they are the creation of society and manage an economic unit in the society, it is their responsibility to look after the interests of the society and public welfare by providing employment opportunities and maintain the level of competition in the economy.

(ii) Socio-human dimension: Business firms should promote and develop human values by providing ethical climate to work in the organisation. They should promote moral cooperation and self-reliance amongst workers at their work place.

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2. Objectives of Corporate Social Reporting

The objectives of corporate social reporting are :

    1. To measure contribution of firm to the society.
    2. To determine whether firm’s social activities are consistent with the wider social priorities persistent in the society.
    3. To provide information on firm’s goals, policies and contribution to social goals.
    4. To establish meaningful communication with the firm’s stakeholders which will demonstrate its performance and plans for future improvement.
    5. To improving firm’s reputation by demonstrating its concern about environmental and social issues and by fostering transparency and accountability.
    6. To improve firm’s environmental and social risk management by identifying its risks and their management.

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3. Role of the Government and Legislation in Enforcing Ethical Business Practices

As to how the government can enforce ethical business practices, the following points need to be considered:

    1. In a country already suffering from plethora of rules and regulations the solution lies not in more rules but in bringing more transparency and encouragement to adhere to the established norms.
    2. There should be a shift in emphasis for government to acting rather as a facilitator to stimulate and co-ordinate action.
    3. There is little need to pass new laws. Rather, there is need to reinforce the resources and structures that are already in place.
    4. It is evident from experience that great deal of work is being done by companies to address a wide range of social and environmental issues. In most cases, these activities are undertaken not because there is legal requirement to do so but because the company believes there is commercial rationale behind this. Many business leaders believe that responding to wider social and environmental challenges is simply the right thing to do. The market for organic agriculture, for example, emerged from the joint interests and actions of retailers, farmers, investors, consumers and civil society – all of whom have shaped the market into what it is today.
    5. This does not mean that market is perfect individually and collectively. Companies do have negative impacts. However, this does not negate relevance of the market. It simply means the market needs to be better tailored to produce the benefits that modern society requires. It is the responsibility of the government to step in where free markets produce undesirable and unsustainable social and environmental outcomes.
    6. “It is unsurprising that governments routinely fail, when elected, to do what they promised in their manifestos. Many of the things they promise are not delivered by government acting on its own simply through legislation. There is a strong need for collaborative problem-solving.”
    7. Government has to develop its role as a catalyst for debate and action on key issues of concern, bringing together different groups that can help to bring about change. This approach will empower not just companies but also other key groups in the society, like charities, cultural groups or consumers.
    8. Relevant government departments and agencies should participate in deciding corporate social responsibilities and create responsibility and collaborative deals that decide about creating a market environment where financial rewards should be given to companies that produce non-financial benefits to others. The focus should be to offer rewards for positive environmental and social behaviour and not punishment for anti-social behaviour.

However, there are practical difficulties in creating a forum for responsibility deals :

(a) Many companies find it difficult to “Join up” efforts to address the social and environmental aspects of their operations with the work of others. Responsibility deals place co-operation between companies and others at the centre of the process of government – be they NGOs, government agencies or voluntary groups.

(b) Participants in responsibility deals should set the standards by which their progress should be judged. They have to decide what sector or issues are appropriate for responsibility deals and should offer public comment on their performance. Companies would be encouraged to report on their participation in responsibility deals in their corporate responsibility reporting. Each collaborative and responsibility deal should have an annual review process, led by the chair with transparent reporting and an independent group of experts that provides information on corporate social reporting.

(c) The combined code on corporate governance, in its current form, does not contain obligation for boards to consider business values and ethical standards. The combined code is missing information on corporate responsibility strategy. There should be requirement for boards to consider their corporate values and ethical standards (corporate responsibility) into the combined code. This would encourage enlightened businesses such as profits, wages, dividends, taxes, etc. and perform business activities in a manner that support the objectives of all the stakeholders.

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4. Corporate Governance and Role of Board of Directors

“Corporate governance is a systematic process by which it is directed and controlled to enhance its wealth generating capacity”. Company gets its resources from the society and should use these resources effectively to meet the expectations of society and all its stakeholders.

The two basic principles that govern corporate governance are :

    1. Management should have the power to take decisions in the interest of the company, and
    2. Management should be accountable for its decisions.

Corporate policies, should empower the management to take decisions within the framework of effective accountability towards stakeholders and society as a whole. Unethical corporate behaviour defames the organisation culture and undermines the confidence of stakeholders in the company. Management’s efforts towards ensuring effective governance reinforces and actualises company’s effort to become an ethical corporate citizen.

5. Levels of Governance Structure

Corporate Governance is structured at three level in the company :

    1. Governance (strategic supervision) at the level of Board of Directors
    2. Governance (strategic management) by the Corporate Management Committee
    3. Governance (executive management) by the Divisional Head assisted by the Divisional Management Committee

Balance between freedom and accountability of management to shareholders is maintained by differentiating between strategic supervision, strategic management and executive management.

    • Board of Directors exercise strategic supervision through strategic management (planning and control). They seek accountability for strategic management from corporate management committee (CMC).
    • Strategic supervision is free from strategic management and, therefore, can be objectively conducted by the Board and the Board can assume accountability for the same.
    • The CMC focuses on strategic management of the company within the framework of approval given by the Board.
    • Strategic management remain free from day-to-day executive management tasks and focuses on company as a whole.
    • The Divisional head assisted by the divisional management committee focuses on executive management of the business of his division. The executive management is free from strategic responsibilities of the company as a whole and focuses on the quality and effectiveness of its divisional business only.

Governance at these three levels determines the roles and responsibilities of the entities (Board of Directors, Corporate Management Committee, Divisional Management Committee) at these levels. Necessary powers are delegated to these entities in order to discharge their responsibilities. The entire corporate governance structure, thus, revolves around the following :

(i) Roles of the entities;

(ii) Responsibilities of the entities; and

(iii) Powers of the entities.

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6. Governance at the level of Board of Directors

I. Roles of Board of Directors

    1. To represent shareholders and create shareholder value.
    2. To align the interests of management with those of the shareholders and also protect the interests of other stakeholders like creditors, customers, suppliers, etc.
    3. To define the company’s mission and goals.
    4. To establish or approve strategic plans and ways to achieve goals framed in the plans.
    5. To set pace for the company’s current operations and its future development.
    6. To determine the values to be promoted in the company.
    7. To appoint senior executives to manage the company according to established plans, policies, strategies and procedures.
    8. To review and evaluate the present and future environmental opportunities and threats in relation to company’s internal strengths and weaknesses.
    9. To determine strategic options, business strategies and plans and ensure that organisation structure is appropriate to implement these plans and strategies.
    10. To delegate authority to managers and determine the monitoring criteria to evaluate the implementation of plans, policies and strategies.
    11. To ensure effective communication with senior management, shareholders and other stakeholders and maintain effective internal control systems.
    12. To maintain and monitor relations with stakeholders by gathering relevant information.
    13. To develop and approve compensation, pension and post-retirement benefit plans and other long-term benefits like stock options for the executives.
    14. To approve the company’s major operating, investing and financial activities.
    15. To evaluate the performance of the Board, its committees and members of each committee.
    16. To hold the Board, its committees and Directors accountable for fulfilling the assigned fiduciary duties.
    17. To approve dividends, financing, capital changes and other extraordinary corporate matters.

II. Responsibilities of Board of Directors

The Board of Directors have the following responsibilities  :

    1. To maintain proper books of account.
    2. To pay company’s debts (though company is a separate legal entity) if he is found guilty of misconduct or wrongful trading.
    3. To act in the best interest of the company as they are in a position of trust and faith (fiduciary position). They should not make profits at the expense of the company or shareholders.
    4. In case of conflict between the company’s interest and their own, they should favour the company.
    5. To act in due care and skill.
    6. To determine the organisation’s mission and purpose.
    7. To select the Executive.
    8. To support the Executive and review his or her performance.
    9. To ensure effective organisational planning.
    10. To ensure availability of adequate resources.
    11. To manage resources effectively.
    12. To determine and monitor organisation’s programmes and services.
    13. To enhance the organisation’s public image.
    14. To serve as a court of appeal.
    15. To assess its own performance.
    16. To review financial reports, audited annual financial statements, quarterly reviewed financial statements and other important financial disclosures such as management discussion and analysis, earnings releases and reports filed with regulators or disseminated to the public.

III. Powers of the Board of Directors

Some of the issues that require prior approval of the Board are as follows :

    1. Entry or exit from any business or product line except those which are delegated to CMC.
    2. Making business plans, annual operating plans, budgets, long-term business plans including strategies, budgets, revenues and profits.
    3. Promoting or closing companies, joint ventures and partnership firms.
    4. Forming or closing divisions, subsidiaries and companies in India and abroad.
    5. Invest or disinvest in equity or preference capital of any company.
    6. Recommendations on the boards of subsidiary and associate companies of the chairman, managing director and other directors.
    7. Accept membership of other Boards by the executive directors.
    8. Appoint trustees to the trust created by the company.
    9. Make changes in rules relating to pension and superannuation funds of the company.
    10. Long-term and short-term borrowing except those which need the approval of CMC.
    11. Loans made by companies to individuals other than employees and corporates.
    12. Donations within the overall statutory limit but in excess of limits of CMC.
    13. Changes to be made in company’s logo, appointment or extension of individuals for fixed time periods as consultants or in any other capacity irrespective of the amount of remuneration to be paid to them.

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7. Governance by the Corporate Management Committee (CMC)

I. Roles of the CMC

The role of the CMC is to look after strategic management of the company within the directions approved by the Board. The CMC operates under the control of the Board who determines its composition based on the recommendation of the Nominations Committee. The composition of CMC consists of Executive Directors and three/four senior members of management subject to review by the Nominations Committee. Executive Chairman of the company convenes the meetings of the CMC and its secretary is the Company Secretary. The CMC meeting is held normally once a month and the agenda for meeting is usually circulated three days in advance.

The executive chairman of the company is the Chairman of the Board and CMC. He operates as chief executive of the CMC. His role is :

    • To provide leadership to the Board and CMC.
    • To work for company’s goal according to the charter approved by the Board.
    • To ensure that issues discussed in the meetings are on the agenda.
    • To ensure that all directors and CMC members are enabled to participate in activities of the Board and CMC.
    • To keep the Board and CMC informed on all matters of importance.
    • To preside over general meetings of shareholders.

Roles of Executive Directors, as members of the CMC include looking after strategic management of the company within the directions framed by the Board.

II. Responsibilities of the CMC

The responsibilities of the CMC, executive chairman and executive director are as follows:

Responsibilities of the CMC

    • To formulate business plans, objectives and strategies of the company.
    • To formulate policies and processes of the organisation.
    • To formulate risk management systems.
    • To formulate personnel policies regarding recruitment, selection, compensation and development of the human resource.
    • To review the implementation of plans and obtain feedback.
    • To review compliance to statutory requirements.
    • To keep the Board informed of developments in all the businesses.

Responsibilities of the Executive Chairman

    • To preside at the meeting of shareholders, Board and CMC.
    • To help the Board in formulating and achieving the company objectives.
    • To initiate the process of change for organisational growth.
    • To ensure healthy corporate communication.
    • To appraise the performance of executive directors and functional heads.
    • To maintain healthy relationships with shareholders, government, regulatory bodies and other sections of the society.
    • To sustain and enhance company’s image as a responsible corporate citizen by catering to socially responsible activities.

Responsibilities of the Executive Directors

    • To work for strategic goals of the company’s business and be responsible to the Board and CMC for the same.
    • To guide the divisional head in management of his business.
    • To focus on development of human resource through career planning processes.
    • To intermediate between the divisional business and CMC/Board.
    • To keep the CMC/Board informed on divisional business issues and development.
    • To ensure conformity to effective management processes at the divisional level.
    • To attend divisional management committee meetings when required.

III. Powers of the CMC

Powers of Corporate Management Committee

Some of the items that require prior approval of CMC are as follows :

    1. All key projects which require huge capital outlays and execution plans.
    2. Issue of bank guarantees for and on belief of the company.
    3. Opening and closing of bank accounts and changes in authorised signatories to company’s bank accounts.
    4. Appointment of DMC members which are based on the recommendations of the director.
    5. Write off and disposal of fixed assets.
    6. Write off advances, receivables, claims and other amounts due to the company.
    7. Forming any task force/committee for specific objectives/assignment.
    8. Recruitment of children and spouses of existing or former managers of the company.
    9. For recruitment and confirmation of managers from a particular grade to a different grade.
    10. For giving gratuities, awards or rewards.
    11. For all types of systems, policies, control manuals and other types of policy framework, aimed at exercising operational and risk management controls.
    12. If there are some approved plans and if there is any departure from the approved plans, it must be approved by CMC.
    13. For retrenchment, lockout and layoffs, prior approval of CMC is needed.

Powers of the Executive Chairman

Following are some of the powers of Executive Chairman :

    1. Executive Chairman of the company has the power to allocate business/management portfolios among executive directors in relation to macro structuring of business groups.
    2. He can supersede any decisions made by any other manager/executive director/DMC. In this case CMC is required to record everything in writing and getting it rectified at the next meeting of the CMC and they take the responsibility till it is ratified in the next meeting.
    3. He can take any decision listed under the powers of the CMC to meet the business exigencies.
    4. Appoint divisional heads in consultation with CMC.
    5. He can approve subscription to souvenirs/advertisement in brochures.
    6. He has the power to approve foreign travel of executive directors, heads of divisions and corporate functional heads of the company.
    7. He has the power to approve any event/people sponsorship.

Powers of Executive Directors

    1. Executive director has power to exercise all powers delegated below the level of the executive directors as long as they are recorded in writing and communicated to the manager who was originally empowered to take the major decisions.
    2. In case of meeting emergencies, he has the power to bypass any decision taken by the DMC by recording it in writing and getting it ratified at the next meeting of the CMC and taking the responsibility for such decision till such ratification.
    3. He can approve foreign travel of DMC members (other than divisional CEOs) and corporate managers (other than functional heads).
    4. He can recommend CMC appointments, increments and promotions in respect of DMC members.

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8. Governance by Divisional Management Committee (DMC)

I. Roles of the DMC

DMC is composed and determined by the line director with the approval of the CMC. Its objective and role is the executive management of the divisional business to realise tactical and strategic objectives of the company. DMC meetings are chaired by the divisional heads. If he is unable to convene the meeting, he shall in writing delegate the power to convene and chair the meeting to one of the DMC members who is identified by name. This delegation will hold good either for a stipulated time period or for a particular meeting. The whole process has to be in writing to convence and chair the meeting to one of the DMC members identified by name.

Delegation cannot be open-ended. The DMC shall generally meet at least once a month to review the divisional performance and related issues. Quorum of meeting is at least 50% of the members subject to a minimum of three members. In case of Divisional Management Committee (DMC), all the decisions are taken by simple majority. Minutes are prepared and tabled before CMC for its information. Comprehensive notes are also attached along with agenda and shall be circulated at least three days prior to the meeting.

Roles of the Divisional Head

Divisional head is responsible for day to day responsibility of the division business. He functions as a chief operating officer. He shows the leadership to the divisional management committee in its task of executive management of the divisional business.

II. Responsibilities of the DMC

    1. Helps in formulating and recommending divisional business plans including objectives and strategies to CMC.
    2. Monitors effective implementation of approved business plans.
    3. Determination and recommendation of business specific policies, systems and processes to CMC.
    4. Ensuring effective adherence and implementation to approved systems, policies and processes.
    5. Monitors business environment.
    6. Ensures implementation of approved plans of human resources and policies at empowered levels.
    7. Determines and ensures right implementation of industrial / employee relation policies.
    8. Ensures all statutory compliance in right functioning of the division.

Responsibilities of the Divisional Head

    1. The main responsibility of divisional head is effective executive management of the divisional business within CMC/Board approved plans.
    2. Presides over DMC meetings.
    3. Provides effective leadership to the DMC.
    4. Signs statutory compliance to confirm statutory compliance.
    5. Reports to the Board/CMC jointly with the divisional financial controller.

III. Powers of the DMC

Following issues must obtain prior approval of the DMCs :

    1. All business plans including business strategy, functional strategies, related action plans, revenues, cost, profits, investments for recommendation to CMC.
    2. Pricing of division’s products.
    3. Recommendation for CMC’s approval for policy and control system manuals relating to major areas of risk management.
    4. Policy guidelines relating to maintenance and management of inventories of raw materials, finished goods and spares.
    5. For any kind of rebates/allowances/discounts pertaining to policy of pricing, DMC may delegate the power to any designated managers up to the specified limits.
    6. Approve within CMC sanctioned, item-wise cost overwinds up to the value of each item, provided total specified budget is not exceeded.
    7. Policy framework in relation to credit sales including terms and conditions of sale. All these powers can be delegated to a designated manager also.
    8. For writing off fixed assets, raw material, spare parts, inventories, receivables, claims etc. for the approval of CMC.
    9. Appointment and transfers of experts.
    10. Execution of long-term agreements with employee unions.
    11. Matters relating to dismissal of non-management staff, workmen and secretaries.
    12. Issues relating to sale/disposal of assets to management staff.

Powers of the Divisional Head

He has the following powers :

    1. He takes day-to-day decisions except those which are entrusted to DMC.
    2. In case of emergencies, he can exercise all powers vested with the DMC provided these decisions are ratified by the DMC.
    3. He can supersede any decision taken by the DMC provided he states reasons to that effect in writing and gets the approval of the CMC.

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