VOLUNTARY VS. MANDATORY CORPORATE GOVERNANCE: A PATH PAVED TOWARDS OPTIMAL REGULATORY FRAMEWORK: PRAKHAR HARI

 

INTRODUCTION

Two theorists were arguing among themselves about the nature of govt. role in. regulating the market. One of them was a proponent of the free market argued that a mandatory regime is unnecessary. He vowed for the voluntary nature of the legal regime under which firms competing for scarce capital would voluntarily implement enhanced corporate governance practices which would be beneficial and desirable by investors. In its response, another person, an investor advocated that voluntary regime is unnecessary as there is no guarantee that all the firms would voluntarily the reforms which are meant to provide adequate checks on management and board control so that it works in favor of protecting investors and build confidence in capital markets.

Both the point raised are true but they both are considering extreme positions which are not only undesirable but also a minimal mandatory regime is optimal.

Let us continue with the story. A third person overhearing the arguments comes to the rescue of both the parties. He suggests an optimal regime should be considered where one should take into account the benefits and costs to all stakeholders, like issuers and investors and a cost-benefit analysis should be done to weigh the benefits of a corporate governance regime (like) and the benefits of the free-market system. 

This discussion has several perspectives. One can study this with regards to disclosures pattern in capital markets[1] or from an environment literature perspective wherein firms' willingness to adopt more environmentally responsible practices through negotiated agreements with authorities.[2] Internationally, Corporate Governance has been interpreted through a mix of primary of secondary legislation. For ex., Contractual rules entered between the company and the exchange or shareholder, and the management must be mandated strictly whereas norms, codes, and ethical principles can be applied.

 

DEFINING CORPORATE GOVERNANCE:

Corporate Governance is a process that is meant to achieve an organization's objective but it's the perspective that changes for a promoter, a manager, or a customer. It addresses the principal-agent problem and strives to aligns the interests of the principal (shareholders) and agent (the board/management)[3]. However, the major problem in this alignment is the impossibility of writing an entire code that specifies desired management action for all contingencies. Though a principal-based regulation may limit the limitations of an incomplete contract for its effectiveness, a high level of competent regulator along with integrity among firms is required.

 

CORPORATE GOVERNANCE NORMS IN INDIA

For a much time after independence, Companies in India followed more of a Principal based approach. However, from a couple of decades back, India started following a rule-based approach. It was in December 1995, when Confederation of Indian Industry (CII) set up a voluntary task force for the first time for designing a voluntary code of Corporate Governance. Between 1998 and 2000, 25 leading Indian Companies followed that voluntary code.[4] Keeping note of the voluntary code, Securities Exchange Board of India (SEBI), Indian securities market regulator, designated Kumar Mangalam Birla Committee (Birla Committee)[5] for suggesting amendments to listing agreement executed by stock exchanges with the companies and to suggest safeguards for dealing in cases related to insider trading, by the companies. In its report, one of the recommendations was to provide timely, accurate, substantive, and material information that should be inclusive of financial matters to the board, board committees, and the shareholders. Committee separated this recommendation into two parts, mandatory and recommendary provisions for the governance of listed companies. This recommendation got approval from SEBI and was later included as Clause 49 of the stock exchange Listing Agreements[6]. In 2000, Govt. appointed Sanjeeva Reddy Committee issued its recommendations which were later enacted vide an amendment in the Companies Act, 1956.[7] Similarly, in Dec. 2006 Ministry of Corporate Affairs issued a set of voluntary guidelines with regards to corporate governance.[8]

Clause 49 and Corporate Governance

As previously discussed, Cl. 49 of Listing Agreements and some other requirement s under the companies act with regards to audit committees, remuneration of directors, board procedure, etc. acts as a benchmark for corporate governance in India. Cl. 49 requires the board of a listed company to have independent directors constituting at-least one-third of the board and should be headed by a non-executive chairman. In case, promoters or their relatives are appointed as the non-executive chairman, then the independent directors should constitute almost half the board strength. Furthermore, Annual reports should also have an additional section on corporate governance which shall show compliances with mandatory and non-mandatory requirements proposed by SEBI.

 

CONCLUSION:

Even though requirements under clause 49 and other provisions under the Companies Act opens a route for mandatory and recommendary disclosure, the basic challenge to Corporate Governance remains the same. It is quite difficult to measure human nature, motive, and behavior to create legislation that has proper and effective control and regulate them. In India, emphasis on Corporate Governance reforms has been made from the perspective of regulating the functioning of the board of directors and committees formed thereunder as well as prescribing eligibility conditions to be a director, ensuring the financial literacy of audit committee members, mandating regular attendance, etc. However, even after making boards more professional and independent, India has also seen corporate scams like that of Satyam Computer Services Limited which had highly reputed professionals into its board of directors.

While a wholly mandatory structure may yield slightly better compliance, its costs are likely to be much higher. Therefore, an optimal level of governance should take into account the benefits and costs of all the stakeholders and for this purpose, a cost-benefit analysis would be helpful if the level of expected compliance against the total costs of the regime is adopted by regulators are weighed properly.

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[1] See e.g. George J. Benston, “Required Disclosure and the Stock Market: An Evaluation of the Securities

Exchange Act of 1934” (1973) 63 AM. ECON. REV. 132; Robert E. Verrecchia, “Consensus Beliefs, Information

Acquisition and Market Information Efficiency” (1980) 70 Am. Econ. Rev. 874

[2] See e.g. Seema Arora & Timothy N. Cason, “An Experiment in Voluntary Environmental Regulation:

Participation in EPA’s 33/50 Program” (1995) 28 J. ENVTL. ECON. & MGMT. 271; Seema Arora & Shubhashis

Gangopadhyay, “Toward a Theoretical Model of Voluntary Overcompliance” (1995) 28 J. Econ. Behav. & Org. 289 (1995)

[3] Mukherjee, S. (2004). “Corporate governance and development in India”. In D. Reed & S. Mukherjee (Eds.), Corporate governance, economic reforms, and development: The Indian experience (pp 145–165). Oxford University Press.

[4] Naresh Chandra, Report of the CII Task Force on Corporate Governance 2 (November 2009) Available at

www.mca.gov.in/Ministry/latest news/Draft_Report_NareshChandra_CII.pdf

[5]Shri Kumar Mangalam Birla, Report of the Kumar Mangalam Birla Committee on Corporate Governance Available at http://www.nfcg.in/UserFiles/kumarmbirla1999.pdf

[6]Divesh Goyal, Clause 49 of Listing Agreement On Corporate Governance (October 2014) Available at https://taxguru.in/sebi/clause-49-listing-agreement-corporate-governance.html

[7] Department of Company Affairs (2000), Report of the Task Force on Corporate Excellence through Governance, (based on the report submitted by a committee chaired by Dr. P.L Sanjeeva Reddy) http://reports.mca.gov.in/Reports/7Sanjeeva%20Reddy%20committee%20Report%20on%20Corporate%20Excellence%20on%20sustained%20basis%20to%20sharpen%20India's%20global%20competitive%20edge%20and%20to%20future%20develop%20corporate%20culture%20in%20the%20country,%202000.pdf

[8] Ministry of Corporate Affairs,  Corporate Governance Voluntary Guidelines (2009) Available at https://www.mca.gov.in/Ministry/latestnews/CG_Voluntary_Guidelines_2009_24dec2009.pdf