A STUDY ON DISPARITIES BETWEEN THE THEORIES AND REALITIES OF CORPORATE GOVERNANCE: SALONI SHARMA

 

Introduction

Every business is operated, controlled and regulated by its own machinery consisting of rules and regulations. ‘Corporate governance’ refers to such a combination of procedures and laws observed by an entity to run its business. It may consist of mode of conduct and procedures for varied spheres of management, from internal administerial controls to corporate disclosures. The objective of having such a mechanism is to strike a balance between the interests of the various stakeholders of the company. A company having a well-functioning and transparent governance system has a better chance at gaining trust of an investor and is more likely to gain global market access, and ultimately leads to more stable sources of finance. The Board of Directors of a company are generally responsible for the framework of these rules in order to best meet the objectives of the business, keeping in mind the interests of all the participants.

 

History

The financial liberalization of 1991 and various scams in the country were one of the major reasons for development of the concept of Corporate Governance in India. In 1998, the Confederation of Indian Industry (CII), took the first initiative to develop and promote a code for Corporate Governance for Indian companies, called ‘Desirable Corporate Governance: A Code’. The Kumar Mangalam Birla committee report 1999 was the first formal attempt to summarize the prevailing conditions of governance in Indian companies. The recommendations of the Report, led to inclusion of Clause 49 in the Listing Agreement. In the year 2002, Naresh Chandra Committee recommended amendments to the auditor-client relationship laws and the role of independent directors. In the year 2003 SEBI constituted N. R. Narayana Murthy  Committee  for reviewing implementation of the corporate governance code by listed companies and for issue of revised clause 49 based on its recommendations.

Dr. J. J. Irani Committee on Company Law was constituted in the year 2004 which recommended that effective measures be initiated for protecting the interests of stakeholders and investors and recommended the constitution of a “Stakeholders’ Relationship Committee”. Finally the Companies Act, 2013 and amendment of 2017 introduced many changes and included the concepts of disclosure, and compliance requirements. The Uday Kotak Committee 2017 recommended about the Composition and Role of the Board of Directors, The Institution of Independent Directors, Board Committees, Disclosures and Transparency, Accounting and Audit related Issues, Investors participation in Meetings of Listed Entities etc.

 

Theories of Corporate Governance

There may be various instances where the interests of a number of stakeholders like the shareholders, managers, investors etc, may be in conflict. Hence, in such a situation it is best to have a structure of regulation to best manage their interests. The main objective of having a strong structure for Corporate governance is to enhance Investor Trust, improve performance, increase access to the global market, ensure accountability, prevent corruption etc. The better governance the company has, greater is the possibility to attract investors which leads to growth and ultimately profit generation. 

There are various theories developed by thinkers that interpret the interest of various stakeholders in a company/firm. Some of these are listed below-

 

1. Agency Theory-

Agency theory was first proposed by Alchian and Demsetz.^[1]  According to it, the managers act as ‘Agents’ of the corporation and are delegated work by the principal.  The owners set the central objectives of the corporation and the managers are responsible for carrying out the day-to-day work of the company. It is expected that under the contract of such agency, the agent should act in good faith and protect the interest of the principal. Separation of ownership and control is considered as the key feature of the theory.

 

However in reality, the goal may be a little distant as it is often observed that agents tend to misuse their powers for monetary and other benefits.

The theory relies on Agent-Principal relationship, which may work the best in case there is only one Principal involved.^[2] However in the Corporate world today, there may be an amorphous number of shareholders acting as principals who are unknown to the managers of the business. Thus it may not be possible to establish a relationship between shareholders and the managers, which in turn may lead to conflict between the principal’s desires and agent’s desire.

 

2. Stakeholder Theory

A company consists of various kinds of stakeholders, and may be classified into different interest groups which include creditors, employees, customers, suppliers, local-community and the government. The corporation is deemed to function for all stakeholders and not just shareholders. There may be instances where the interests of the stakeholder may vary in a given situation. Hence, it is the managers and the corporation who are responsible to mediate between them and play an important role to work for the interest of all the stakeholders equally. The theory works on an assumption that stakeholders are capable and willing to negotiate and bargain with one another. This results in long term self interest. The role of shareholders is reduced in the corporation.

 

It is often observed that sometimes principal shareholders monopolise organisational resources to attend their own needs why infringes the rights of other stakeholders. In India, board of directors are not much empowered and are subordinate to the shareholders. Therefore, conflicts between majority and minority shareholders becomes a threat for corporate governance in India.^[3]

 

3. Stewardship Theory

Stewardship theory is an alternate theory to agency theory in terms of managerial motivation. The managers and employees who are responsible to safeguard the resources of the corporation, its property and interest, in absence of the owner should manage the same as their own. It is generally considered that the managers are motivated by the principal’s objective. The theory assumes that the managers do not think of themselves as outsiders, rather they treat themselves as a part of the business. Hence, the organizational structure should give and support acceptable authority, worth and power to the management.

 

However, it also to be noted that the directors are humans and flawed, but not predicated on one of the primary underlying principles behind agency theory that humans will act selfishly as a matter of course. In a business corporation there needs to be some accountability, to ensure smooth functioning and transparency.^[4]

 

Conclusion

Forign investors have increasingly started to depend more and more on the efficiency  of Corporate governance of the company for their investments. A good governance structure of an enables the investor to trust the company and its other stakeholders. The presence of independent directors on the board also ensures confidence in the market. The MNCs in India have acquired better corporate governance compliance in accordance with global standards for transparency and accountability.^[5] Indian corporate governance framework provides one of the highest. However, enforcement of these corporate governance norms is a vital hindrance towards movement of good corporate governance in India. The Public Enterprises and MNCs have witnessed advancement in terms of corporate governance standards.

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^[1] Alchian, A. and Demsetz, H., Production information costs, and economic organization, 62 A. E. Rev., 777, 795 (1972).

^[2]  David Crowther,  Renu Jatana, Critiquing Agency Theory, Agency Theory: A Cause of Failure in Corporate Governance, (Aug 28, 2020, 15:40 PM), https://pdfs.semanticscholar.org/9998/2e30599c4ec2f268fda15b35bfeedb85dad2.pdf

^[3] Key Issues in Corporate Governance, Corporate Governance: An Indian Perspective-Disparities in Theory and Reality,( Aug. 28, 2020, 17:20 PM), https://repository.uel.ac.uk/download/f21ab12d3e6a1e36d3d97056a885609539a7928294a03c0e1f20cb97ecaff75f/5813671/2013_MBA_Jakkal.pdf

^[4] Keay, A, Stewardship Theory : Is Board Accountability Necessary?, 59 IJL & M, 1292, 1314 (2017), http://eprints.whiterose.ac.uk/109675/3/BOARD%20ACCOUNTABILITY%20AND%20THE%20STEWARDSHIP%20THEORY%20J%20Law%20and%20manrevised.pdf

^[5] Supra note 3