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Governing the corporates

The Satyam fraud has shattered the dreams of various investors, shocked the government and regulators alike and led to questioning the accounting practices of statutory auditors. Coming close on the heels of the Bernie Madoff scandal one can’t help but note the similarities in the confessional statements of these fraudsters.

Both Madoff and Raju state that no one besides them individually was involved or had knowledge of their fraud. If this were really true, it forces one to wonder how these scams can go on for so long without anybody discovering them.

Even though the Satyam incident is bound to influence public opinion of corporate India, the reality is that India does have strong corporate governance standards. In fact, these standards have continuously been changed/ tightened to address India’s economic growth. One cannot let this one-off incident erode the credibility of the various listed companies that have good and honest management and governance standards which are comparable to international best practices.

The source of most corporate governance regulations in India can be found in the Listing Agreement which all publicly listed companies execute with the stock exchange where their shares are traded. Clause 49 of the Agreement sets out the corporate governance requirements that the issuer company must fulfil. The company is required to fulfil these requirements before it files the draft Red Herring Prospectus with the Sebi and almost simultaneous with its filing to seek in-principle approval from the SE where it proposes to list its shares.

Sound corporate governance begins at the board level of a company and hence the composition of the board of directors is paramount. Clause 49 stipulates that the board of directors of a listed company is required to have a combination of executive and non-executive directors with not less than 50% of the board comprising of non-executive directors.

It further stipulates that if the chairman of the board is a non-executive director, then at least one-third of the board should consist of independent directors and where the chairman is an executive director, at least half of the board should consist of independent directors. Furthermore, where a non-executive chairman is also the promoter or is related to any promoter or a person occupying a management position, it is stipulated that at least one half of the board of directors should be independent.

Independent director, as used in the Listing Agreement, means a non-executive director of the company who amongst other requirements is not a substantial shareholder of the company (owning less than 2%), is not related to the promoter or person occupying management positions at the board level or one level below the board, has not been an executive of the company in the immediately preceding three financial years and apart from receiving director’s remuneration does not have any material pecuniary relationships or transactions with the company or its promoters or senior management (which included senior management and functional heads).

Corporate governance regulations in India also provide that the board of all publicly listed companies should lay down the code of conduct for all board members and senior management and requires that these members affirm compliance with the code on an annual basis.

The board of directors is also required to constitute a qualified and independent audit committee, a shareholders grievance committee and a remuneration committee. In companies like Satyam, it is the role of the audit committee to oversee the company’s financial reporting process, review the financial statement prepared and also review the adequacy of the internal control systems.

Aside from the requirements under the Listing Agreement, the [Indian] Companies Act, also sets out principles for corporate governance which amongst various others includes a duty on the board of directors to adopt the accounting standards as stipulated by the ICAI, a duty to maintain proper books of accounts and prepare financial statements which are in accordance with applicable standards, to exercise due care in the maintenance of records to prevent irregularities and to sign the directors report presented with the annual report.

The Satyam fraud, like the Madoff ‘Ponzi Scheme’, is evidence that despite sound governance norms unscrupulous businessmen will find ways to circumvent the law. Market regulators should, therefore, consider stipulating stricter compliance standards by companies and should also consider imposing greater personal responsibility on directors of listed companies.

Companies, on their part, need to realise that as India advances to secure greater economic significance self-regulation, through stricter financial controls is essential. In conclusion, while over regulation may hurt corporates and a knee jerk response should be avoided, it is without doubt that if Raju feared getting eaten by the tiger he thought to be riding, it is perhaps time for the government and regulators to tame all similar tigers that others may be afraid to dismount.

First Published in the Economic Times on January 12, 2009



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