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Recipe for good corporate governance

As the corporate affairs ministry celebrates India Corporate Week, one’s attention is again drawn to corporate governance. Broadly defined, this is the standard adopted by corporations to regulate and manage internal processes. Although not a new function of society, corporate governance, as a measure of corporate functioning, has gained significant importance over the past decade. Corporations have become complex beings as have their systems of governance.

Simultaneously, academics and lawmakers have undertaken substantial research to develop ways to quantify and devise objective criterion for evaluating corporate governance. The objective of all research has been to identify ways of achieving a system of ‘better’ governance.

Historically, two models of corporate governance exist: the shareholders model and the stakeholders model. The first caters only to shareholders’ needs and individual interests. This is often critiqued when there exists a shareholder that directs decision-making in its own favour. By contrast, the stakeholder model is broader. It’s structured to protect interests of employees, creditors, customers and all other persons that have a stake in a corporation, aside from just the shareholders.

Based on these models, various tools to measure corporate governance have been developed. But questions have also emerged about whether there can really be one model to measure corporate governance across all companies. Can there really be an ideal level of governance? Corporations vary and are too diverse for one rule to be universally applicable. A report, generated by Wharton University, which evaluated 500 companies, concluded that “the recipe book is big and there’s a different recipe for each company.” Scholars believe that culture plays a large role in governance and simply adopting a system that works in another country leads to companies with fractured systems of governance.

For governance to be effective, it must check greed and corruption, and address the lack of foresight. This needs to be achieved within a framework of financial discipline, law, ethics and values. It is difficult to accomplish any of these with a precise tool or under any model. Instead, it may be productive to rest the system of governance on four fundamental pillars: state regulations, internal regulations, duty of loyalty and moral intelligence, all of which appear to be universally applicable.

The first pillar is the structure of rules and regulations set by the sovereign. Systems and procedures must be devised to objectively monitor the functioning of corporates, taking into account public interest. In India, these are reflected in the Companies Act and for public companies in the Listing Agreement. Equally important are internal regulations, which must ensure smooth functioning and transparency. Further, proper internal structures reduce the risk of the external regulator hauling up a company for fraudulent dealings. These are usually in the form of internal reporting mechanisms, disclosures, internal audits and codes of conduct.

Duty of loyalty forms the next pillar and is broader than the commonly used legal concept of duty of good faith and duty of care. The duty of loyalty precludes acting for unlawful purposes and requires officers of a company to make good faith efforts to monitor its affairs. As fiduciaries, these officers cannot be driven by personal objectives and must only act in the best interests of the corporation.

The last pillar, moral intelligence, unlike economic factors, cannot be reduced to numbers and thus is difficult to measure. Moral intelligence stems from personal and organisational success, integrity, and responsibility. It originates from the duty of care towards the organisation to which one belongs and is so personal that it is based on an individual’s conscience and ethics and is difficult to imbibe. In other words, moral intelligence is manifested by the manner in which an individual exercises his powers, conducts business and interacts with others in his organisation.

While structures and regulations can be put in place, if the people driving the process are tempted by riches and power and are devoid of any sense of morality, greed will take over and the system will fail. While regulations are essential as they prescribe the boundaries within which to act, it is the duty of loyalty and moral intelligence that prevents the corporate system from being faulty. In comparing a corporate to a house with four walls, while each wall is essential, not all four can be load-bearing. Moral intelligence is the differentiating load-bearing wall that separates corporate governance from good corporate governance.

Co-authored with Ms. Komal Kalha

First Published in the Financial Express on December 21, 2009



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