Doing Things Right: Corporate Governance in India

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

Confederation of Indian Industry

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

Confederation of Indian Industry

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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Confederation of Indian Industry

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-cumrecommendatory 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 S&P 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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Confederation of Indian Industry

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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Confederation of Indian Industry

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

Confederation of Indian Industry

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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Confederation of Indian Industry

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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Confederation of Indian Industry

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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Confederation of Indian Industry

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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Confederation of Indian Industry

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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Confederation of Indian Industry

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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Confederation of Indian Industry

What are the mandated CG guidelines and disclosures

Disclosures to shareholders in addition to balance sheet, P&L 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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Confederation of Indian Industry

What are the mandated CG guidelines and disclosures

Disclosures to shareholders in addition to balance sheet, P&L 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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Confederation of Indian Industry

What are the mandated CG guidelines and disclosures

Disclosures to shareholders in addition to balance sheet, P&L 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 P&L for the reporting year
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Confederation of Indian Industry

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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Confederation of Indian Industry

How does India measure up with Sarbanes-Oxley

Sarbanes-Oxley Certification of annual accounts by CEO, CFO Fully independent audit committees Disgorgement of CEO/CFO compensation in event of restatement Prohibition of insider trading Prohibition of insider loans to directors Indian situation At least two directors must sign, of whom one must be the Managing Director Fully non-executive, majority independent audit committees Accounts and profits once published cannot be re-stated Prohibits insider trading What might be needed Need to change to have MD/CEO plus Finance Director/CFO to sign Need to consider (i) fully independent (ii) tighter definition of independence Need to see if ESOP payments need to be disgorged if there is a restatement Nothing is needed

Strict cap on insider loans to directors; requires prior government approval

Caps are stringent enough to prevent insider abuse

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Confederation of Indian Industry

How does India measure up with Sarbanes-Oxley

Sarbanes-Oxley Real time disclosure concerning changes in financials and operations Mandatory periodic review of companys filings once every three years Auditors prohibited from nine types of non-audit services to audit clients Auditors to report to Audit Committee on critical accounting policies Rotation of audit partners every five years Up to 20 years in prison for fraud and destruction of records 18 Indian situation Listing agreement mandates companies to report quarterly results and material changes No such provision What might be needed Nothing is needed

Need to consider how this can be done without creating administrative hassles Nothing is needed

These services are already prohibited in India Mandated by the listing agreement and the Companies Act amendments No such provision exists

Nothing is needed

A committee is considering such a change Need to consider tougher penalties, including longer imprisonment

No such provision

Confederation of Indian Industry

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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Confederation of Indian Industry

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 1. The amount of stock options to be granted to employees is strictly limited. Expensing options (if adopted) will create a further natural limit 2. In general, companies are controlled by a sizeable shareholder, typically owning over 35% of stocks. This tends to limit agency costs of dispersed ownership 3. The variable compensation package is much more linked to profits and/or EVA, than stock prices or P/E 4. Much greater importance is given to accumulating cash. Profit is an opinion; cash is fact 5. For better or for worse, most Indian companies still dont have to give forward looking earnings estimates
Confederation of Indian Industry

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New corporate governance moves that are expected

After the US crises, there have been some initiatives: 1. A committee has been set up to examine stock options, including expensing them 2. Another committee has been set up to recommend tighter enforcement by DCA and stiffer penalties, including longer prison terms 3. A third committee has been set up to examine auditorcompany relationships and the role of independent audit committees 4. A fourth committee is examining what additional disclosures and accounting standards are needed to have even better corporate governance
Confederation of Indian Industry

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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
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Confederation of Indian Industry