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Corporate Governance in India: The Transition from Code to Statute

Chapter · April 2017

DOI: 10.1007/978-3-319-51868-8_5

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[The final version of this paper has been published as a chapter in Jean J. du Plessis &
Chee Keong Low (eds.), Corporate Governance Codes for the 21st Century:
International Perspectives and Critical Analyses (Switzerland: Springer International
Publishing, 2017)
https://www.springer.com/gp/book/9783319518671]

CORPORATE GOVERNANCE IN INDIA:

THE TRANSITION FROM CODE TO STATUTE

Umakanth Varottil*

Abstract

This paper explores the evolution and implementation of corporate

governance norms in India. While India initially jumped on the
bandwagon of countries adopting voluntary codes of corporate
governance following the Cadbury Report, the approach towards “soft
law” was rather quickly jettisoned in favour of a mandatory approach
towards corporate governance. As a result of more recent reforms,
corporate governance norms have now become well ensconced almost
in their entirety in the primary corporate legislation (a phenomenon
this paper refers to as the “ultra-mandatory” approach), arguably
more so than most jurisdictions. As this paper demonstrates, voluntary
codes are ill-equipped to serve their goals in dissimilar jurisdictions,
as their success is dependent upon a cocktail of factors that may not be
present in all legal systems. Considering an emerging economy like
India as an example, it is clear that in the absence of such factors
corporate codes merely perform lip service, and do not carry any
functional effectiveness. However, in India’s case, the pendulum has
swung far afield towards mandating corporate governance in that it
has resorted to legislative rulemaking that also attracts significant
costs. This paper advocates for a milder form of the mandatory
approach towards corporate governance that is consistent with the
corporate structures and legal system prevalent in India, but is rid of
the unnecessary rigours of the present approach.

*
This paper was presented at the 2016 ICGL Forum on "Reflections on Voluntary Corporate
Governance Codes: Is it now time to move on from a 'soft law' approach to a ‘hard law’ approach?"
on 25-26 April 2016 in Hong Kong. The author thanks participants at the Forum for their comments,
and Varnika Chawla for research assistance.
1 Introduction

Corporate governance codes have proliferated over the last 25 years in various
countries around the world. As already pointed out in this book, the genesis for this
phenomenon is attributed to the Cadbury Committee Report issued in the United
Kingdom (UK) in 1992.1 Although the nature of the codes varies considerably, they
are essentially ‘soft law’ as they are not accompanied by legal enforcement for non-
compliance. Enforcement is achieved through voluntary, market-oriented means. This
contrasts with mandatory rules which carry penalties for violations, principally as
deterrence against corporate misbehaviour.2

The use of codes to engender enhanced corporate governance was popularised in the
United Kingdom (UK). The UK has distinct features in terms of ownership structures
(mainly dispersed shareholding) and legal mechanisms in the corporate sector
(substantially voluntary). However, countries with radically different ownership
structures (mainly concentrated shareholding) and legal mechanisms (substantially
mandatory) have adopted similar codes.3 The global corporate governance movement
triggered by large-scale corporate scandals at the turn of the century led many countries
to adopt these UK-styled codes despite such dissimilarities.4 This book indeed pioneers
an emerging robust discussion around the acceptability and utility of codes in different
jurisdictions (and in the UK itself).

This paper focuses on the evolution and implementation of corporate governance

norms in India. India was among the initial countries that adopted corporate governance
codes. However, a voluntary initiative spearheaded by the Indian industry meant that a
‘soft law’ approach was rather quickly jettisoned in favour of a mandatory approach
towards corporate governance. As far as India is concerned, the question ‘Is it now time
to move on from a ‘soft law’ approach to a ‘hard law’ approach?’ has been answered
quite emphatically, because India has already completely transitioned to a ‘hard law’
approach.

Moreover, as a result of more recent reforms, corporate governance norms have

become well ensconced in the primary corporate legislation (a phenomenon this paper

1
Cheffins (1999), p 6; Hopt (2011), p 12.
2
The distinctions between voluntary codes (soft law) and mandatory rules (hard law) are discussed
in detail in Anand (2006) and du Plessis et al (2014), pp 194–205. See also, Keay (2014) and Cuomo
et al (2016).
3
Nestor and Thompson (2001).
4
Jordan (2005), pp 1010, 1014.

2
refers to as the ‘ultra-mandatory’ approach), arguably more so than most jurisdictions.5
Indeed, this is by design and not by default. While displaying sporadic affinity towards
codes of corporate governance on a voluntary basis, India has been unwavering in its
commitment to a mandatory approach to corporate governance.

This paper aims to demonstrate that voluntary codes are ill-equipped to serve their
purpose in dissimilar jurisdictions, as their success is dependent on an amalgam of
factors that may not be present in all legal systems. Considering an emerging economy
like India as an example, it is clear that in the absence of such factors corporate codes
merely perform ‘lip service’, and do not carry any functional effectiveness. Therefore,
India’s choice of a mandatory approach seems to be more appropriate.6 However, in
India’s case, the pendulum has swung so far towards mandating corporate governance
that it has resorted to legislative rule-making – at significant costs. This is arguably due
to the law being enacted in the wake of a massive corporate scandal. This paper
advocates for a milder form of the mandatory approach towards corporate governance
that is consistent with the corporate structures and legal system prevalent in India, but
without the unnecessary rigours of the present approach.

Firstly, I trace the evolution of corporate governance norms in India until the present
day – a story of oscillation between the voluntary and mandatory approaches. I then
discuss how the mandatory approach is more suitable than reliance on a market-
oriented voluntary code of conduct in India, and explore reasons for a rather strict
penalty-based legislative approach towards corporate governance that makes India
somewhat of an outlier among other jurisdictions. Finally, I offer some suggestions
regarding alternative methods of implementing the mandatory approach that generate
net benefits to corporate actors as well as to society.

2 Evolution of Corporate Governance Norms in India

In the years following India’s independence in 1947, aspects of corporate governance

were embedded in the basic corporate legislation, for instance the Companies Act 1956.

5
Generally, in most jurisdictions while principal companies’ legislation deals with some essential
elements of corporate law and governance, the detailed aspects of corporate governance such as
board composition, roles and responsibilities of directors, board committees, audit, disclosure and
transparency norms and the like are left to either corporate governance codes or to listing rules
issued by the stock exchanges. However, in the case of the ‘ultra-mandatory approach’ (an
expression coined for the purposes of this paper), the detailed elements of corporate governance are
contained in the primary corporate legislation itself rather than in subordinate legislation, corporate
governance codes or stock exchange rules.
6
See Black and Kraakman (1996), p 1932, in the context of Russia.

3
However, it was only after India’s economic liberalisation in 1991 that governance
issues gained ground in the corporate discourse. 7 Curiously enough, the first ever
formal adoption of corporate governance norms in India emanated from a code for
‘Desirable Corporate Governance’ in 1998 as recommended by the Confederation of
Indian Industry (CII). 8 This was a voluntary code adopted by certain leading
companies, and it undoubtedly drew inspiration from the Cadbury Code in the UK. The
motivating factors behind such a voluntary code-based corporate governance were first
the internationalisation of the Indian capital markets, with the need for Indian
companies to attract foreign investment on beneficial terms, and second cross-listings
by Indian companies on stock exchanges in developed markets, again to attract foreign
capital.9 Underlying both factors was the need for Indian companies to be bound by
corporate governance norms prevalent in countries from which they raise capital, as
investors were likely to be more familiar and comfortable with such norms.

India’s experimentation with a voluntary code was short-lived. Based on the report of
a committee chaired by Kumar Mangalam Birla in 2000,10 India’s securities regulator,
the Securities and Exchange Board of India (SEBI), incorporated specific corporate
governance norms into Clause 49 of the Listing Agreement applicable to listed
companies beyond a specified size.11 Although in substance Clause 49 was similar to
the recommendations of the Cadbury Committee report in the UK, there was one
material difference. Clause 49 was made largely mandatory for listed companies to
which it applied, and prescribed measures such as board independence, audit
committees, periodic financial disclosures, certification of financial statements and
issue of compliance reports.12 Although mandatory in character, in its early years any
violation of Clause 49 would amount to a breach of the listing agreement that only
resulted in potential delisting of the company. Stock exchanges are generally hesitant
to activate such an option as that would deprive minority shareholders of liquidity in
the shares.13 The Parliament consequently introduced reforms to securities legislation,
which effectively imposed large penalties of up to Rs 250 million (approximately USD

7
Chakrabarti et al (2008), p 63.
8
Confederation of Indian Industry (1998).
9
Varottil (2009), pp 9–12.
10
Securities and Exchange Board of India (2000a).
11
Securities and Exchange Board of India (2000b).
12
These corporate governance norms were progressively enhanced through amendments to Clause 49,
which also contained some non-mandatory aspects. Black and Khanna (2007) conducted an event
study and found that Clause 49 was received positively by the investors.
13
Afsharipour (2010), p 58.

4
3.75 million) for non-compliance with the listing agreement, including Clause 49.14
This reform had a significant positive effect on the Indian markets. 15 During this
period, not only were substantive corporate governance norms strengthened, but they
were supported by additional enforcement measures.

In parallel with SEBI’s constant efforts at strengthening corporate governance norms,

the Government of India had been considering modernising companies’ legislation by
replacing the Companies Act, 1956 with a new one. Based on the report of a committee
under the chairmanship of Mr. JJ Irani,16 the Government introduced the Companies
Bill 2008 in Parliament, which was intended to replace the Companies Act 1956. At
the time, corporate India was struck by a huge corporate governance scandal in Satyam
Computers Limited, a leading information technology company, to a magnitude
exceeding US $1 billion, arising primarily from misstatements in the company’s
financials. 17 This and other scandals at the time triggered an upheaval in India’s
corporate sector and securities markets, with calls being made for urgent reforms to the
corporate governance system. 18 Prominent among several recommendations were
those of the CII, which suggested additional measures, albeit for adoption by
companies on a voluntary basis.19 Based on these recommendations, the Government
of India through the Ministry of Corporate Affairs (MCA), promulgated certain
voluntary guidelines 20 that contained additional governance measures arising from
lessons obtained from the various scandals. After the initial adoption of mandatory
corporate governance norms came the resurgence of a voluntary approach towards
corporate governance. This was admittedly an effort to avoid a ‘knee-jerk’ reaction
towards governance reforms, and the prohibitive costs associated with emergency
legislation in the wake of a crisis.

However, again, the voluntary approach did not last long. The Companies Bill 2009
pending before Parliament was referred to a Standing Committee. After reviewing the
Bill and consulting various stakeholders, the Standing Committee issued its report,
which recommended the insertion of detailed corporate governance norms into the

14
This was achieved by introducing Section 23E to the Securities Contracts (Regulation) Act, 1956.
15
Dharmapala and Khanna (2012).
16
Irani (2005).
17
Varottil (2015), p 38. The Satyam scandal has often been referred as ‘India’s Enron’, although there
are significant differences in the modus operandi and impact of both scandals. See Khanna (2009)
pp 188–189.
18
Varottil (2010), p 3.
19
Ministry of Corporate Affairs (2009a).
20
Ministry of Corporate Affairs (2009b).

5
Companies Bill.21 These included measures such as enhancing board independence,
the independence of auditors and others such as regulating related party transactions
intended to rein in managements and controlling shareholders. Based on this report, the
Government introduced the Companies Bill 2011 in Parliament. This Bill was referred
back to the Standing Committee, which made further recommendations.22 Once they
were incorporated, the Companies Act 2013 was passed by both houses of Parliament
and received the assent of the President of India on 31 August 2013. It is currently
being brought into effect in stages, although a substantial portion of the legislation
dealing with corporate governance norms has already been in force since 1 April 2014.
In parallel, SEBI substituted Clause 49 with the SEBI (Listing Obligations and
Disclosure Requirements) Regulations 2015, which bring SEBI corporate governance
norms (applicable to listed companies) on par with the regime under the Companies
Act. These regulations are also mandatory in nature.

Corporate governance norms in India are currently an integral part of the basic
companies’ legislation, compulsory for all companies to which they apply and result in
penal consequences for non-compliance. If the Sarbanes-Oxley Act 2002 in the United
States (US) represented the move towards a more mandatory approach towards
corporate governance in that country, the Companies Act 2013 in India achieved the
same result, but arguably to a greater degree as the legislation itself set out the entire
gamut of corporate governance measures customarily set forth in subordinate
legislation or in codes of conduct in other jurisdictions.

Fig. 8.1 Timeline of corporate governance norms in India

1998 2009
CII Code Voluntary
Guidelines

Voluntary

Mandatory
2000 2004 2013 2015
Clause Penalties Companies SEBI
49 Clause Act Regulations
49

21
Ministry of Corporate Affairs (2010).
22
Ministry of Corporate Affairs (2012).

6
The trajectory of corporate governance norms in India is encapsulated in figure 8.1
above. In this background, I discuss the motivating factors behind why India adopted
the mandatory approach.

3 The Suitability of a Mandatory Approach for India

A voluntary code of corporate governance that follows the ‘comply or explain’

formulation tends to be considered desirable so long as it is accompanied by mandatory
disclosure requirements.23 This feature ensures that corporate governance mechanisms
are enabling in nature, and would allow for flexibility in compliance by different types
of companies (e.g. big or small) and would eschew a ‘one size fits all’ approach that
tends to be too rigid. These are some of the fundamental reasons why corporate
governance codes are so popular. However, as explored in this section, such codes
function in an optimal manner only in the presence of specific conditions and
circumstances. While these conditions are present in developed markets such as the
UK, justifying the use of corporate governance codes, it is not the case in countries
such as India. For this reason, lawmakers in India have been reluctant to use voluntary
codes (except intermittently and as a precursor to mandatory legislation). It is argued
that such an approach is understandable given the different circumstances in India.

3.1 Prerequisites for a Voluntary Code

A voluntary code will demonstrate success only in the presence of specific interrelated
conditions such as those prevalent in the UK, which explains the origin and continuance
of such a code on a ‘comply or explain’ basis. First, a voluntary or enabling approach
is not unfamiliar to English legal tradition. Apart from analogous situations such as its
reliance on parliamentary conventions in lieu of a written constitution, the UK has
displayed a pattern of reliance on voluntary codes in the corporate sphere. For example,
even prior to the Cadbury Code, a standing example of a self-regulatory code has been
the City Code on Takeovers and Mergers. This represented a deliberate attempt by City
of London investors to establish a flexible mechanism to deal with disputes relating to
takeovers with ‘soft’ powers of enforcement such as ‘cold-shouldering’ which can
profoundly affect the reputation of various players in the takeover market.24 Although
the City Code has subsequently obtained statutory recognition under the Companies

23
Anand (2006).
24
Reputation tends to be a powerful tool against misbehaviour, especially in the case of repeat players
in the market. Armour and Skeel (2007), pp. 1771–1772.

7
Act 2006, the practice of relying on voluntary compliance by various market players
largely continues. Given the track record of such a voluntary code, the transposition of
this mechanism from takeovers to the corporate governance arena in response to the
Cadbury Report has been arguably smooth.

Second, such a voluntary approach has been orchestrated in the UK by its large and
influential pool of institutional investors. 25 Apart from the fact that institutional
investors in the UK are repeat players who preferred a voluntary mechanism for
regulating their affairs as well as those of the companies in which they have invested,
the use of a voluntary code of conduct also operated as an effective way to forestall
more stringent mandatory rules.26

Third, institutional investors tend to play a more active role in monitoring their
investments and therefore the management of the companies in which they have
invested.27 Unlike retail investors who tend to be passive given they are afflicted with
the collective action problem, institutional investors are more likely to review
information disclosed by the company under a ‘comply or explain’ regime, and react
to that information either positively (hold or buy) or negatively (exit) thereby, in
efficient markets, driving the market price of the company in the appropriate
direction.28 Given the UK’s largely dispersed shareholding structure,29 the actions of
informed institutional investors tend to operate as a check on the actions of
management. A voluntary corporate governance code in this way fully realises the
utility of a market-oriented approach. Consistent with this hypothesis, empirical
evidence suggests that companies with dispersed shareholding are more likely to
comply with voluntary norms than companies with concentrated shareholding.30

Fourth, a market-oriented approach would function effectively only if supported by a

system of legal institutions and mechanisms with strong foundations.31 These include
a robust company law (such as fiduciary duties imposed on directors) and an efficient
enforcement mechanism through courts. The presence of sophisticated market players
and gatekeepers such as independent directors, auditors and compliance professionals

25
Black and Coffee (1998).
26
Armour and Skeel (2007), pp 1767–1768.
27
Burke (2002), p 357.
28
Steeno (2006), p 407.
29
Davies (2015), p 355.
30
See section 3.2 below.
31
Wymeersch (2005), p 19; Varottil (2010), p 23.

8
will ensure third-party monitoring as a means to ensure enhanced corporate
governance.

These four conditions enable the use of voluntary codes of corporate governance in
countries such as the UK that rely on the ‘comply or explain’ approach. While this has
worked in a mainly satisfactory manner, there are concerns regarding the utility of such
an approach, as explored in various studies. 32 . These concerns include the use of
standard explanations for non-compliance with the code, and also other monitoring
issues.33 When concerns relate to the implementation of such a voluntary code in a
country like the UK where the prerequisites for its success are largely present, there
could be grave doubts regarding the feasibility of such an approach in a jurisdiction
such as India where these prerequisites are either non-existent or present to a much
lesser extent.34

3.2 The Case for Mandatory Rules in India

The factors that enable an effective functioning of a voluntary code are not present in
India, at least not at the current stage of development of its securities markets.35 Hence,
it could be argued that transposing a voluntary approach that might work in other
jurisdictions would be imprudent for India. It is necessary to explore how the relevant
factors in India operate differently from other jurisdictions to understand the need for
a mandatory approach.

First, in terms of legal tradition, unlike the UK, there has been a continued dependence
on government regulation of the corporate sector. Although India’s company law
initially constituted a transplant of English company law and displayed a laissez faire
approach in its early years, several amendments to the Companies Act 1956 that were
introduced beginning in the 1960s instilled significant regulation and oversight of the
corporate sector by the state.36 The judiciary supported the legislative activity whereby
the actions of companies were judged against their impact on society.37 Although some
deviation from this approach is evident since India’s economic liberalisation in 1991

32
de Jong et al (2005).
33
Arcot et al (2010), p 193.
34
See Black and Kraakman (1996), p 1929, in the context of Russia.
35
Mirza and Mohanty (2014).
36
Chakrabarti et al (2008), pp 59, 62–63.
37
Varottil (2015), pp 29–31.

9
through voluntary codes introduced transitorily, the focus on mandatory rules has
remained unabated.38

Second, a voluntary approach is viable for a jurisdiction only if a large body of

institutional investors exerts sufficient influence to justify the implementation of
corporate governance norms through a code. Historically, institutional investors
(whether domestic or international) have not played an active role in oversight of the
companies in which they have invested. 39 Hence, they did not take a lead role in
developing voluntary codes of the kind witnessed in the UK. Even where codes have
come about in India, they have been advocated by industry (i.e. managers) and not the
investing community. Managers could have several incentives for promoting such
codes, including avoiding more stringent regulation.

Third, the ‘comply or explain’ approach works only if typically passive shareholders
take on a more active role in companies based on disclosures made by them regarding
compliance (or otherwise) with the corporate governance norms. While India has come
a long way in promoting shareholder activism (certainly in comparison with most other
Asian jurisdictions), such activism is yet to match that evident in developed markets.
Generally speaking, there is considerable evidence of shareholder activism in India
fuelled not only by additional shareholder rights and remedies granted through legal
reforms (particularly under the Companies Act, 2013), but also through market
reforms. Hitherto passive institutional investors have begun to take on a more activist
stance, especially on controversial matters that affect minority shareholder interest, and
they have been supported by a vibrant proxy advisory industry that has rapidly grown
in India in the last few years.40 Despite the giant strides taken in Indian markets, the
level of activism among shareholders of Indian companies does not warrant a move
towards a voluntary code of corporate governance. While there is anecdotal evidence
of activism, empirical evidence does not indicate a clear and positive impact of such
activism on minority shareholder protection. 41 Moreover, shareholder activism is
unlikely to have a significant impact on companies with concentrated shareholding—
something that typifies the Indian corporate landscape.42

38
In fact, over a period of time, rules governing companies and their managements were significantly
tightened, often at the cost of enterprise, innovation and the ease of doing business.
39
Goswami (2000), p 8.
40
Varottil (2012), pp 602–608.
41
Ibid, pp 622–627.
42
Ibid, pp 625–627.

10
Related to institutional investor participation and shareholder activism is the fact that
the shareholding pattern of companies has a bearing on the use of voluntary corporate
governance codes and associated compliance. Given the relative success of voluntary
codes in jurisdictions such as the UK, it is possible to hypothesise that such codes are
likely to work more optimally in jurisdictions with dispersed shareholding than those
with concentrated shareholding. Given this scenario, codes are unlikely to work in
India and hence the excessive reliance on mandatory rules for the governance of
companies.43 A growing body of empirical literature supports this assertion. One study
finds that companies with concentrated shareholding are less likely to promote
voluntary disclosure due to their ability to generate private information and benefits.44
Other studies probe further into the nature of the controlling shareholders, and find the
incidence of non-compliance with voluntary norms to be greater among firms owned
by business families, founders or heirs. 45 Such opacity without mandatory rules is
likely to adversely affect the interests of minority shareholders. Apart from disclosure
requirements, companies with concentrated shareholding are less likely to conform to
other governance requirements such as a monitoring board and other governance
practices. This is particularly so in the case of family firms.46 With these findings in
mind, it is clear why a mandatory regime on corporate governance would be more
appropriate in the context of India. Mandatory rules supported by public and private
enforcement mechanisms are necessary to ensure that controlling shareholders and the
management act in the interests of the shareholders (particularly the minority).47 Such
rules act as an incentive to do so in companies with concentrated shareholding.
Voluntary codes spawned by the Cadbury Report are unsuitable in such cases. Such
codes are premised on dispersed shareholding where there is a clear separation between
ownership and control. As observed by Banaji and Mody:

Cadbury is not tailor-made to a context where dominant shareholders, e.g.

promoters, control management and where the corporate governance problem
is chiefly one of the protection of minority shareholder rights. The assumption
of dispersed ownership explains why there is little emphasis in Cadbury on the
equitable treatment of different groups of shareholders.48

43
That Indian companies are characterised by concentrated shareholdings is beyond doubt, with the
average shareholding of controllers being in the range of 48–56% in the last decade under various
empirical studies. See for example Balasubramanian and Anand (2013). Controlling shareholders
tend to be business families, the state or multinational firms.
44
Ajinkya et al (2005), p 346.
45
Arcot et al (2010), p 198; Chen et al (2008), p 499; Anderson, et al (2009), p 205.
46
Arcot and Bruno (2011), p 2.
47
Dharmapala and Khanna (2012), p 1081.
48
Banaji and Mody (2001), p 8.

11
Given voluntary codes originated from a dispersed shareholding context where the
presence of institutional investors who instigated the effort have the necessary
incentives to ensure compliance, such codes are not adequately suited to concentrated
shareholding contexts. In the latter context, voluntary codes create problems between
the interests of controlling shareholders on the one hand and minority shareholders on
the other. This significant difference has received scant attention in the literature,
although compelling empirical evidence indicates less compliance with voluntary
codes in companies with concentrated shareholding, especially in family firms. Since
companies with concentrated shareholding constitute the majority of listed companies
in India, a mandatory approach to corporate governance could be deemed more
effective than a voluntary code-based approach.

Fourth, the prevalent legal institutions and mechanisms in India have not engendered a
culture of voluntary compliance, which makes codes susceptible to large-scale
deviances. 49 Although corporate governance standards have generally improved over
the years, the rate of compliance has been less than desirable. Moreover, there have
been significant instances of non-compliance, including by state-owned firms, which
have generated negative signaling implications to the markets.50 Apart from perceived
weaknesses in public enforcement, there are obvious shortcomings in private remedies
available to shareholders, including delays due to an overburdened judiciary and
significant costs in bringing civil claims before Indian courts. 51 Due to a lax
enforcement environment, it would be too much to expect compliance with voluntary
codes. At the same time, the Companies Act 2013 has introduced stringent corporate
governance measures coupled with strong enforcement mechanisms, both public and
private. It remains to be seen whether these measures will be fully utilised in the initial
years of implementation of the recent legislation.

While a mandatory regime is more suitable for India due to the factors and
circumstances discussed here, there is growing concern that recent developments in
India have swung the pendulum too far towards a rule-based approach, to the extent
that it creates an inflexible regime. This is particularly because corporate governance
norms have now been encompassed within basic companies’ legislation (i.e. the ‘ultra-
mandatory’ phenomenon), which is uncommon from a global perspective. It is
therefore necessary to trace these recent developments – to consider the rationale
behind their occurrence, and to question whether they are desirable

49
Varottil (2010), p 26.
50
Varottil (2009), pp 31–32.
51
Varottil (2012), pp 613–618.

12
4 Companies Act, 2013: A Statute in the Wake of a Crisis

Corporate governance norms are dynamic in nature, whether captured in a voluntary

code or mandatory rules.. They are evolutionary by nature because they must readily
adapt to constant changes in the business sphere. Efforts towards enhanced corporate
governance tend to be perpetual ‘works-in-progress’. In any given jurisdiction, these
efforts ought to be reviewed periodically, with necessary adjustments made to suit the
circumstances at the time. Arguably, corporate governance codes are better at keeping
up with the times due to their flexible nature.52 However, mandatory rules can also be
suitably moulded as long as they can be quickly amended as required. Stock exchange
listing rules or regulations issued by a securities regulator may be modified swiftly in
an uncomplicated manner.53 On the contrary, mandatory rules contained in legislation
carry too many costs in implementation. Apart from the fact that legislators lack the
expertise required in corporate matters, enacting or amending legislation is fraught with
delays and difficulties.54 Legislative activity in the corporate sphere is often a hasty
response to a corporate scandal. In such a scenario, corporate matters take on political
hues and attract the attention of the political establishment and its various
constituencies. Although it can be considered a widely representative process (directly
and indirectly), such a legislative endeavour could deliver unintended outcomes. The
story of the enactment of the Companies Act 2013 in India fits this paradigm, and
explains not only the adoption of mandatory rules towards corporate governance, but
also the form in which it was achieved—through detailed prescriptions in principal
corporate legislation. It is argued that while the need for mandatory rules is
understandable, the use of an ultra-mandatory approach for implementation is
attributable to hurried lawmaking in the wake of a crisis.

An analysis of developments that led to the Companies Act 2013 helps an examination
of this issue. After several failed efforts to replace the previous Companies Act 1956,
the Government of India appointed a committee under the chairmanship of Mr JJ Irani
to review that legislation and recommend a modern company law.55 In consultation
with the public, the Irani Committee recommended a new company law, which
contained enhanced corporate governance norms, but was also considered to be
business-friendly. Based on the report, the Government introduced a new Companies

52
Anand (2006), p 241; Hopt (2011), p 66.
53
Armour et al (2011), p 229.
54
Armour et al (2011), p 229.
55
Irani (2005).

13
Bill 2008 in Parliament. This Bill lapsed when elections were called in early 2009.56 It
was at this juncture that the Satyam corporate governance scandal broke. Apart from
the magnitude of the scandal, in excess of US$ 1 billion, investors bore significant
losses as the stock price of the company plummeted on announcement of the fraud.57
More importantly, the episode exposed vulnerabilities in the prevailing corporate
governance regime in India, which failed to prevent such a large-scale fraud and kept
it hidden from the public eye for a number of years. This caused consternation among
various stakeholders in Indian industry as it struck at the heart of the Indian information
technology (IT) and outsourcing industries, which constituted the fulcrum of India’s
exports at the time.58 The episode was seen as eroding the trust and confidence that
Indian IT companies had painstakingly built with their customers and other
constituencies around the world over a long period of time. Moreover, the closure and
collapse of a large company such as Satyam would have left thousands of employees
out of work, thereby prompting adverse societal outcomes.59 Given the extraordinary
nature of this episode, any regulatory response would not be a clinical one led by a
regulatory process. This unusual situation called for an uncharacteristic response – and
also incited the sensibilities of the political class who decided to take charge of the
legislative response to the crisis.

The initial response to the Satyam crisis was rather muted and relied entirely on ‘soft
law’. For example, when the Companies Bill 2009 was presented in Parliament, it
contained no changes whatsoever from its previous iteration in 2008, and failed to
address the intervening events pertaining to Satyam. The Government instead issued
the Corporate Governance Voluntary Guidelines in December 2009, which contained
a number of measures aimed at enhancing corporate governance norms in India. These
included ‘streamlining the process of appointment of independent directors, clarifying
their roles and responsibilities and fixing appropriate remuneration for them, reforming
the audit process by crystallising the roles of the audit committee and the auditors, and
certain incidental matters such as secretarial audit and the institution of a mechanism
for whistle blowing’.60 The choice of a voluntary approach was aimed at avoiding any
knee-jerk reaction and the potentially adverse consequences of a hastily assembled
mandatory package. However, even as these guidelines were promulgated, there was a

56
Varottil (2015), p 38.
57
Varottil (2009), pp 32–33.
58
Varottil (2015), p 40.
59
The company was finally acquired by Tech Mahindra, another Indian IT company. Afsharipour
(2010), p 48.
60
Varottil (2010), p 4.

14
sense that the effort was only temporary and that these requirements would soon find
their way into mandatory norms.61

Sure enough, the Companies Bill 2009 was referred to the Parliamentary Standing
Committee on Finance. 62 The Standing Committee, comprising members of
Parliament, began reviewing the Bill in the light of events such as the Satyam scandal.
After consulting various stakeholders, the Standing Committee recommended
significant changes to the Companies Bill, including the insertion of drastic corporate
governance measures. These included matters relating to independent directors, audit,
disclosures and transparency measures.63 These were mandatory in nature: during this
discourse and given the context, there was no indication, nor any penchant, for a
voluntary system of corporate governance. More so, the Standing Committee
recommended the ultra-mandatory form: ‘Different aspects of corporate governance to
be brought in the main statute rather than left to the guidelines; corporate governance
expected to become integral to corporate functioning and governance structures of
companies.’64 A Companies Bill 2011 was drafted pursuant to the recommendations of
the Standing Committee. It was referred back to the Standing Committee for further
review, after which the law was enacted in the form of the Companies Act 2013.

The peculiarities of corporate governance in India are manifold. The norms are most
elaborately manifested in the principal corporate statute, arguably more than generally
in other countries around the world. The Companies Act 2013 contains matters
customarily dealt with in voluntary codes, stock exchange listing rules or other
regulations issued by the securities regulators in most other countries. Advocates of
mandatory corporate governance rules coupled with public and private enforcement
with severe consequences (both penal and otherwise) may have cause to celebrate.

Merely as an example,65 the Companies Act 2013 contains detailed provisions relating
to independent directors. It carries a detailed definition of independent directors,
prescribes the number of independent directors each company must have, and then goes
on to painstakingly describe the roles, functions, responsibilities and liabilities of
independent directors. For instance, the Act has a four-page schedule containing a code
of conduct for independent directors. Not only are the mandatory rules in this regard

61
Ibid, pp 27–28.
62
The committee was chaired by Mr. Yashwant Sinha, who was a member of Parliament representing
the political party then in opposition.
63
Ministry of Corporate Affairs (2010), para. 14.
64
Ministry of Corporate Affairs (2010), para. 14.
65
The Companies Act, 2013 is replete with several such provisions. It would not be possible to deal
with all of those due to paucity of space.

15
extremely prescriptive, but they are also contained in the principal company statute,
which is difficult to periodically amend. This seems a rather overenthusiastic response
to a crisis that goes to the other extreme of making corporate governance norms rather
rigid.66 This is likely to attract significant costs for companies in implementing these
norms, and shares some of the critique that the Sarbanes-Oxley Act 2002 attracted in
the United States.67

Interestingly, the rigidity of such an approach was not lost on the legislators. In fact the
Standing Committee stressed that ‘simple procedural aspects which may require
flexibility and periodic revision depending on time-period or economic circumstances
should continue to remain in the domain of delegated legislation. It is not the intention
of the Committee that frequent amendments should be warranted to the governing
statute’.68 Despite this broad concern, the structure of the Companies Act (in so far as
it relates to corporate governance) inscribes the substantial details in the primary
legislation itself, with only some of the more minor aspects delegated to subsidiary
legislation to be made by the Government. Hence, most changes to the corporate
governance norms would require legislative amendments. This could substantially
delay any periodic (or even sporadic) reform efforts in this arena.

The rigidity of the Companies Act 2013 is evident in the efforts made following its
enactment to reduce the impact of the provisions as they have proven to be significant
impediments to business. Hence, in 2015 the Act was amended to ensure efficiency of
doing business by diluting some of the onerous conditions. 69 Thereafter, the
Government appointed a committee to examine the functioning of the legislation and
make recommendations. Following the committee’s report, 70 the Government has
presented the Companies (Amendment) Bill 2016 in Parliament. The legislative
amendment is ‘broadly aimed at addressing difficulties in implementation owing to
stringency of compliance requirements; facilitating ease of doing business in order to
promote growth with employment’. 71 Although efforts are underway to soften the
rigours of the legislation such that it addresses governance concerns without
significantly hindering business and entrepreneurship, the amendments of 2015 and
those proposed in 2016 complement the basic philosophy of the Act, which
incorporates the detailed governance provisions. While the amendments propose to

66
See Hopt (2011), p 17.
67
Romano (2005); Ribstein (2002); Hill (2005). See also, Anderson (2008).
68
Ministry of Corporate Affairs (2010), para. 20.
69
Companies (Amendment) Act, 2015.
70
Ministry of Corporate Affairs (2016).
71
Companies (Amendment) Bill, 2016, Statement of Objects and Reasons, para. 4.

16
chip away at the margins, the broad thrust of the 2013 reforms is likely to stay. There
does not appear to be any momentum or political will to significantly alter the direction
of the reforms.

As the discussion in this section indicates, the appropriateness of mandatory rules of

corporate governance for India is one thing, but the rather extreme ultra-mandatory
form they have taken through presence in the companies’ legislation is another. This
leads us to conclude with an examination of how this could be addressed in a manner
that does not compromise governance matters, but at the same time retains the required
flexibility and cost-effectiveness in implementing the regime.

5 Conclusion: The Way Forward

This paper explored the appropriateness of a ‘soft law’ approach through a code of
corporate governance for a jurisdiction like India. I find that voluntary codes are more
suitable for a country like the UK with its general reliance on ‘soft law’ in certain
business aspects, a dispersed shareholding structure with institutional shareholder
wielding considerable influence, and a strong regime of legal institutions that engender
compliance with such norms. Voluntary codes are unlikely to function in an optimal
way without these factors. In India’s case, I find that while voluntary codes have been
adopted as interim measures, mandatory rules by way of ‘hard law’ have been the
mainstay of the Indian corporate governance regime. This is understandable given the
different circumstances prevalent in that jurisdiction: a history and culture of
government regulation of business, concentrated shareholding with considerable power
wielded by controlling shareholders whose opportunistic attitude may adversely affect
the interests of minority shareholders, a growing (but limited) incidence of shareholder
activism, and the lack of a voluntary compliance culture. Recent reforms culminating
in the enactment of the Companies Act 2013 epitomise the mandatory nature of
corporate governance in India.

However, the Indian position is unique in that it has adopted an ultra-mandatory

approach towards corporate governance by incorporating all the detailed norms of
corporate conduct into the primary company legislation. In this paper I have argued
that while the mandatory approach towards corporate governance is appropriate, the
ultra-mandatory approach is questionable. Using company legislation to deal with
detailed corporate governance norms generates excessive costs without the
concomitant benefits. The rigidity of the regime generates difficulties not just for
companies and various actors, but also for the regulators. Hence, I conclude that the
ultra-mandatory approach in India should be discarded in favour of a mandatory

17
approach where the Companies Act 2013 contains the broad parameters for corporate
governance. But the detailed rules regarding corporate governance must be left to
subordinate legislation or regulations made by the securities regulator (i.e. SEBI). This
would ensure that the necessary stringency is maintained in the corporate governance
norms in an appropriate manner for the Indian situation, but at the same time the regime
should retain sufficient flexibility so that it is dynamic in nature. Legislative
amendments are not the answer to corporate governance problems. Legislators often
have other pressing issues to address, and corporate governance matters may not be
high on their agenda, unless of course there is a scandal. Scandal-driven progress is
hardly the means for better governance.

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