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Effective Corporate Governance – A Reassessment

Dr. V.R. Narasimhan*, ACS, Executive Vice President, Kotak Mahindra Bank Ltd.,
Mumbai.

Shareholder value creation should be an outcome of a business effort of pursuing a

socially relevant objective. This effort requires business to continuously adapt itself
e-mail : to changing needs of the society. The power/management that governs the company
narasimhan.vr@kotak.com should have the vision, understanding and flexibility to steer the business to adapt to
changing needs of the society.

INTRODUCTION society in general and stakeholders in the company in particular.

Corporate governance is to be examined in the context of a
corporate being a part of the open society on the one hand and
separation between ownership of business and management
on the other. Any corporate is a part of society and can thrive
only so long as such corporate is relevant to the society
comprising a range of stakeholders viz., shareholders,
customers, employees, government, market in general,
environment, etc. John Kay, a British Economist, in his
interview to DNA published on June 19, 2010 gave the example
of ICI, a chemical giant with about 100 years history which
disappeared in 2007 as it altered its course from the objective
of “responsible application of chemistry to business” to
“shareholder value creation” objective.
It is now well established that the widespread ownership of
company entrusts the management/governance to professional
management/managers. It is expected that such managers will
govern the corporate to maintain the relevance. In order to
ensure that the managers work in the overall context of the
society, several laws and regulations are formulated. However,
it may not be possible for society/State to formulate laws/
regulations to structure managerial behaviour under every
perceivable exceptional condition and therefore it is necessary
that managers work not only within the realm of statutes/
regulations but also based on strong value systems and ethos
of ensuring that the company works for the satisfaction of the
* Views expressed in this article are the personal views of the author and do
not in any way reflect the views of his employer. The author acknowledges
that some quotations have been extracted from the book on Corporate
Governance by Dr. Sanjeev Agarwal.
N.R.Narayan Murthy explains ethical behaviour as “to me,
ethical behaviour is putting the interest of the company above
that of one’s own personal interest in all transactions. It is
about:
 Fairness to all stakeholders
 Transparency
 Rising trust and confidence of stakeholders in the way
the company is run
 Understanding and discharging societal
responsibilities
 Long term thinking
 Overcoming greed, insecurity and lack of self
confidence
 Following every law of the land even when the law
enforcers may not be able to detect your violation.”
(emphasis supplied)
WHAT IS GOVERNANCE
Every resource available in the society has multiple
applications whether it is human resource, raw materials,
electricity, etc. Corportes draw upon these resources to run
their business. Managers of the corporates have implied
responsibilities of efficient application of these resources.
“Corporate governance is concerned with holding the balance
between economic and social goals and between individual
and communal goals. The governance framework is there to
encourage the efficient use of resources and equally to require

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Effective Corporate Governance – A Reassessment
accountability for the stewardship of those resources. The
aim is aligning as nearly as possible the interests of
individuals, corporations and society. The incentives to
corporations and to those who own and manage them to adopt
internationally accepted standards is that these Standards will
help them to achieve their corporate aims and to attract
investments. The incentive for their adoption by States is
that these standards will strengthen the economy and
discourage fraud and mismanagement.” 1 It is also the
responsibility of managers in charge of the affairs to ensure
Corporate Excellence which establishes continued relevance
of the organisation to the society. “Corporate governance is
about creating an outperforming organisation, which leads
to increasing customer satisfaction and shareholder’s value.
…..If the corporation has to prosper in this changing context,
governance must transcend beyond the Boardroom and
permeate the organisation as a totality, through every
employee and function. Corporate governance therefore
hinges on creating an ethos around values shared by every
employee.”2 Thus it is very clear that both the corporate and
the State have adequate incentives to insist and ensure good
corporate governance.
The World Bank observed that “Corporate Governance is a
Blend of law, regulations and appropriate voluntary private
sector practices which enable corporations to attract financial
and human capital, perform efficiently and perpetuate itself
by generating long term economic value for its shareholders
while respecting the interests of stakeholders and society as a
whole.”3
HOW TO IMPROVE GOVERNANCE
Managers are expected to ensure corporate governance as
described above. When the managers disconnect themselves
from the rest of the society in which they live in, connect
themselves with the ownership on the resources at their
command attributable to their official position (though they
are not the owners of the resources) and fall into the illusion
that resources they command are subservient to their personal
needs and desires, they fall into temptation of benign or
malicious defrauding, embezzlement and such adverse actions.
Such adverse actions range from using the office stationary
for personal use, indulging in transactions with associates for
their personal financial benefit, to window dressing the accounts
in the lure of higher bonuses, etc. The premium placed by the
society on flaunting things indicative of financial success than
1. Sir Adrian Cadbury.
2. K.B.Dadisheth.
3. World Bank..
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on humility of character strength is one of the fundamental
reasons for the above stated misconnections. “In the financial
sector, Lehman would be an archetype of this. Organisations
that were not really organisations at all but were a collection
of individually greedy people. The objective of making profits
as an organisation is not one which is going to appeal to anyone
really. People who have a profit orientation would rather make
profits for themselves which is what people in these businesses
did. A corporate culture that extols greed is, in the end, unable
to protect itself against its own employees. Nor does the
business with such a culture attract public sympathy when
things go wrong.” 4 When personal character and inner
conscience submit to greed, there arises a need to impose
character conditioners externally. Thus, we find in this attempt
to improve corporate governance (read improve the character
and integrity of persons in power) and keep a check on
managerial behaviour. “Enough has been written and far more
has already been said about the various reports beginning with
those of Sir Adrian Cadbury and Kumar Mangalam Birla,
ending with the Securities and Exchange Board of India
Guidelines and the Listing Agreement.” 5 All these writing
focus on setting up certain procedures and some checks and
balances. However, “It is wiser to change the man and not
restrict him to playing around with the system that man himself
has created”.6
INDEPENDENT DIRECTORS
The regulatory stipulations relating to board composition,
independent directors, audit committee, etc are all external
conditioners to ensure better corporate governance.
The concept of “independent directors” being a part of the
Board is one of the methods of creating a pressure on the
persons in charge of governance of the company to behave
well within the statutory/regulatory/ethical framework.
Independent directors on the Boards play a critical role in
overseeing the business operations, check managerial greed
not taking over the interest of the company in situations of
conflict of interests between the individual interests of the
management and the interest of the stakeholders of the business.
“If one goes by corporate governance reports, codes and
governance principles, independent directors are one of the
independent tools for ensuring and effecting good corporate
governance. Different people talk of independence of directors
in their own diverse ways. Ideally, independent directors are
4. John Kay in his interview to DNA published on June 19th, 2010.
5. S. Jayashree.
6. S. Jayashree.
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non executive external directors independent of the
management and are free of any interest, monetary or
otherwise, and who can be easily perceived to be independent
by outsiders, insiders and stakeholders”.7
The question then is as independent directors also are human
beings potentially susceptible to greed, how can one ensure
that they can exercise the expected check on greed of other
managers. In order to ensure this, the theory on corporate
governance so far has taken a view that if these independent
directors do not have any pecuniary interests in the success of
the business on which they are directors and do not benefit in
any way from the transactions that the company enters into
but have the same fiduciary responsibility like the directors
who manage the business, they will be able to exercise
“independence” dispassionately and objectively. “The company
boards are a mix of executive directors, non executive directors
and independent directors. The difference between the later
two is that while both are non executive, the independent
directors have, or represent, no financial stake in the business.
The distinction between the executive directors and the
independent directors is two-fold; firstly the former are
employed, normally on a full time basis, to run the business,
whereas the independent directors are not. As far as the law is
concerned, even as far as the Stock Exchange is concerned,
they are all simply directors. They carry equal responsibility
for the business. They have the same fiduciary responsibility,
carry the same obligations, and face the same personal
liability.”8 However, there is a raging skepticism about the
effectiveness of the institution of independent directors as can
be seen from some reflections on the institution of independent
directors given below:
 “In large number of companies hardly any relevant
business information is passed on to the directors. In the
meetings of the Board they generally discuss only trivial
Recommendation of the Advisory group
1. Super majority of independent directors: Two thirds of
the directors of all investment companies be independent
directors.
7. P.L. Sanjeeva Reddy
8. “The corporate sector wants well-educated persons of high personal
integrity and a docile temperament. These are the people who would offer
good advice on neutral decisions, not trouble management on sticky ones
and lend appropriate professional weight to management sub-committees.
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Effective Corporate Governance – A Reassessment
and routine matters. Even where the Board is briefed
about the major developments or strategic changes, there
is hardly sufficient time or data made available in advance
for the outside directors for meaningful participation.”9
 “We can do a lot of back biting, but when we meet
formally we want a harmonious and clubby atmosphere”10
 “The Corporate sector wants well educated persons of
high personal integrity and a docile temperament. These
are people who could offer good advice on neutral
decisions, not trouble management on sticky ones and
lend appropriate professional weight to management sub-
committees”.11
The behaviour of independent directors can make a difference
to the standards of corporate governance. However, there are
no studies in India that have brought out the effectiveness of
the role of independent directors in policing and preventing
conflicts of interests. On the other hand, occasions of corporate
fraud and compromise of stake holders’ interest against the
interests of promoter groups/managerial persons were seen in
the recent past even in companies that are listed and having
independent directors.
Investment Company Institute, USA12 created an Advisory
Group on Best Practices for Fund Directors (Mutual Fund
companies). The objective of the Advisory group was to
identify best practices used by Fund Boards to enhance the
independence and effectiveness of investment company
directors and to recommend those practices that should be
considered for adoption by all fund boards. The
recommendations of the Advisory group to a great extent can
be extended not only to mutual fund companies but also all
other public limited companies. The following table shows
the extent to which the recommendations have been
implemented under the Corporate Governance Frame work in
India (i.e., Clause 49 of the Listing Agreement) :
Arrangement under the Listing Agreement
1. The Board should have at least half the number of
directors who are non-executive directors; if an executive
director is the Chairman of the Board and if a non-
executive director is the Chairman, not less than one
third should be non-executive directors. Rule of Super
majority of independent directors is not implemented
in India.
9. Dr.Madhav Mehra.
10. Prof KSR Murthy.
11. Sucheta Dalal.
12. ICI is industry body set up by mutual funds in the USA.
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2. Persons formerly associated with the adviser, principal
underwriter and certain underwriter. Former officers or
directors of a fund’s investment advisor, principal
underwriter or certain of their affiliates not to serve as
independent directors.
3. Control on the Nomination process by independent
directors: Independent directors be selected and
nominated by the incumbent independent directors.
4. Compensating independent directors: Independent
directors decide the appropriate compensation for
serving on fund boards.
5. Fund ownership policy: Fund directors invest in funds
on whose boards they serve.
6. Qualified independent counsel and other experts:
Independent directors may have investment company
counsel who is independent from the investment
advisor (AMC). The independent directors shall have
the express right and authority to consult independent
counsel, auditor or other experts, as appropriate, when
faced with issues which they believe require special
expertise.
7. Annual questionnaire on relations with the advisor and
other service providers: The independent directors
complete on an annual basis a qustionnaire on business,
financial and family relationships, if any with the advisor,
principal underwriter, other service providers and their
affiliates.
8. Organisation and operation of the Audit Committee:
The audit committee shall be constituted entirely by
independent directors; independent directors shall meet
with the independent auditors at least once a year outside
the presence of management representatives; shall secure
from the independent auditors a representation of
impendence from the management on annual basis and
audit committee shall have a written charter of its
duties and powers.
9. Separate Meetings of independent directors: Independent
directors shall meet separately from management in
connection with their consideration of the fund’s advisory
and underwriting contracts and otherwise as they deem
appropriate.
10. Lead independent director or directors: One or more
independent directors be designated as lead independent
director.
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2. The definition of independence is comprehensive enough
that a director to qualify as independent director does
not have pecuniary or family relationship with the
company/promoters or that director was not an executive
of the company in the last three years before
appointment.
3. There is no specific rule as to who should nominate
independent director. However, some companies have
constituted “nomination committee” to nominate
independent directors.
4. Remuneration of the independent directors is determined
by the Board and approved by the company in general
meeting.
5. The rule is specific to Mutual Funds. In listed companies,
independent directors are not expected to hold more
than 2% in the company to be able to establish their
independence.
6. There is no specific rule enabling or disabling
independent directors from seeking advise from experts.
However, in practice, if the independent directors seek
such advice, managements do not come in the way.
7. All directors, including independent directors, file
declarations under the provisions of the Companies Act
relating to their shareholding, other directorships, family
details, interest in contracts with the company, etc. It is
already implemented as a part of the legislation.
8. The Audit Committee shall be constituted by all non-
executive directors out of which at least two thirds should
be independent directors. However, there is no stipulation
or an observed practice that Audit Committee should
meet the Auditors outside the presence of management
representatives.
9. There is no such requirement under the law nor is it
observed as a corporate practice.
10. There is no such concept.
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11. Insurance coverage and indemnification: Fund board
shall obtain directors’ and officers errors and omissions
insurance coverage and/or indemnification from the
fund that is adequate to ensure the independence and
effectiveness of independent director.
12. Retirement policy: Board should adopt a retirement
policy.
13. Evaluation of Board Performance: The fund directors
should evaluate periodically the board’s effectiveness.
14. Orientation and education: New fund directors receive
appropriate orientation and that all fund directors keep
abreast of industry and regulatory developments.
15. Unitary or Cluster Boards: The company board of directors 15. The rule is fund specific. However, if we apply to holding
generally be organized either as a unitary board for all the and subsidiary company structure, under the Indian Law,
funds in complex rather than as separate board for each
individual fund.
As can be seen from the above, the Corporate Governance
Framework created under the Listing Agreement (Clause 49)
does not provide for all the best practices as perceived
elsewhere in the world. It is also pertinent to note the results
of examination conducted by The Office of Economic
Analysis (OEA) of Securities Exchange Commission, USA,
to assess the effectiveness or the potential benefits of
independence of mutual fund boards. The studies included
Literature Review and Power Study. The Literature Review
provides summary of recent academic research related to
mutual fund governance. The Power Study discusses the
strength of the statistical tests used in some of the academic
papers cited in the Literature Review. Taken together, the
OEA studies provide not compelling evidence that the board
independence requirements are necessary or that they would
provide any benefits that would justify their attendant costs.
More specifically:
 The Literature Review discusses several potential market
imperfections that could motivate regulatory intervention,
but it does no conclude that the board independence
requirements would enhance current regulations that seek
to address these same market imperfections.
 The Literature Review discusses market forces that help
align the interests of advisers and fund investors. The
market forces are much stronger than the independence
of directors in achieving the alignment.
 The OEA studies indicate that the arguments and evidence
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11. There is no such legal requirement. However, in practice,
most companies take D&O policy.
12. There is no requirement. Some companies voluntarily
enunciate retirement policy.
13. There is no such requirement or practice.
14. It is a voluntary effort.
each company has to have its own Board and therefore
it is unitary board structure.
that greater board independence is associated with better
governance are mixed. Indeed, the Literature Review
suggests that the optimal board structure may vary from
firm to firm.
 Neither OEA study finds any compelling evidence that
independent chairs enhance shareholder protection.
In the ultimate analysis, it appears that the character of the
persons in charge of the governance of the company matters
for whether the quality of governance will be of a specific
standard. Any regulatory Corporate Governance Framework
may help setting up symptoms of corporate governance in the
technical sense rather than ensuring corporate governance in
spirit. So long as the directors behave fairly (Fairness is not
an attitude. It’s a professional skill that must be developed
and exercised.) ‘without greed’(Greed is excessive desire to
possess wealth and property), ‘with courage’ (control the fear
of disapproval by colleagues on the Board, face the
disapproval, if it comes), ‘with confidence’ (being calm, cool
and composed and do/say what is necessary to be said in the
given context), ‘without fear’ (stating an honest thought
without being afraid of personal image and relationships) and
‘retaining individuality’(ability to stand by one’s own
convictions) and ethically (“In law a man is guilty when he
violates the rights of others. In ethics he is guilty if he only
thinks of doing so.”), a socially meaningful and successful
governance regime will get established whether the Board has
a super majority of independent directors or not. 
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