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Lal Bahadur Shastri Institute of Management, Delhi

LBSIM Working Paper Series

LBSIM/WP/2020/02

A Conceptual Analysis of

Development of Corporate

Governance Paradigms in

Indian Context

Vikas Mehra

August,2020

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LBSIM Working Papers indicate research in progress by the author(s) and are brought out to elicit

ideas, comments, insights and to encourage debate. The views expressed in LBSIM Working Papers

are those of the author(s) and do not necessarily represent the views of the LBSIM nor its Board of

Governors.

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WP/August2020/02

LBSIM Working Paper

Research Cell

A Conceptual Analysis of Development of Corporate Governance

Paradigms in Indian Context

Vikas Mehra

Professor, Department of General Management,

Lal Bahadur Shastri Institute of Management, New Delhi, India

E-Mail :vikas@lbsim.ac.in

ABSTRACT

This paper seeks to examine Corporate Governance prevalent in the Indian context and its

relevance in today’s scenario impacted by technological and regulatory changes. It looks at

evolving mechanisms and codes on Corporate Governance. Recent Public as well as Private

Banking Sector woes have exposed the vulnerabilities with respect to conflicts related to

ownership, management and regulation. It examines possible changes in scope to regulate

India’s Corporate sector as recommended by various committees.

KEYWORDS

Corporate Governance, Board of Directors, Public Sector, Private Sector,Banks, Corporate

Governance Committees in India, SEBI (Securities and Exchange Board of India),

Stakeholders, Productivity

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A Conceptual Analysis of Development of Corporate Governance

Paradigms in Indian Context

1. Introduction

The processes involved in managing organizations vary. The Principals (Shareholders and

Promoters) appoint Agents (Managers)to manage on their behalf. To prevent Agents from

making decisions that benefit themselves, but that are detrimental to others, a system of

checks and balances is put in place – which is codified as “corporate governance.” There are

no fixed norms or number of players inclusive in any governance system. However, the

following generally constitute the basic skeleton in any Corporate Governance;

i. Board of directors (to hire, fire, and compensate management).

ii. External Auditor (to make sure financial statements are accurate).

iii. Chief Executive Officer (CEO or Managing Director)

iv. Shareholders

The other actors who influence governance in corporations or firms are the employees,

suppliers, customers, creditors and the community i.e. all the stake holders for the

organization. A corporation can be defined as an instrument or a body by means of which

capital is acquired, used for investing in assets producing goods and services, and their

distribution (Prasad, Kesho, 2006) [1]. Both (Hitt et. al., 2012) [2] and Fernando (2012) [3]

elucidate concept of effective Corporate Governance Inadequate and diluted governance in

organizations is being recognized now as one of the root causes of corrupt practices in India’s

huge scams. An effective code of conductresponsible behavior towardssociety, Nation’s well-

being, Regulatory compliances, Corporate Social Responsibility, Environment sensitivity,

Employees Accountability, Effectiveness and Efficiency.This paper tries to trace the

developments in Indian corporate governance and critically assesses its strengths and

shortcomings.

1.1 Relevance of Corporate Governance

Corporate Governance reform has gained traction in 2018& 2019, as several banking and

corporate scandals have emerged in India because of non-application of good principles of

corporate governance. Hence the necessity to understand relevance of Corporate Governance.

Corporate governance refers to the values and guidelines followed by an organization for its

effective functioning. The concept of corporate governance has gained global prominence over

the years, primarily with the focus to monitor, control and guide decision-making of the top

leadership of a company. Misangyi & Acharya (2014) [4] in their studies highlight that

organizations profit when CEO incentive alignment and monitoring mechanisms are in sync

with each other. They further argue that organizations stand to gain when they have in place

both external and internal monitoring mechanisms.

Their findings show that while the need for the boards to be independent cannot be

underestimated, the CEO’s ability to effectively govern and resolve issues would depend on a

number of mechanisms that are present in the governance bundle and how they sync together

to provide a sense of direction.

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Corporate governance, or the governance bundle, therefore, refers to a set of guidelines and

practices for the board of directors to improve their performance. The Punjab National Bank’s

fraudulent issuance of LOUs (Letters of Undertaking) has exposed the systemic chinks in

Indian banking sector (The Indian Express, February 27, 2018) [5] and the dual need for

technology and strong corporate governance to check frauds. Andrea Georgescherer and

Guiclo Palazzo (2011) [6] in their paper “The New Political Role of Business in Globalized

World: A Review of New Perspective on CSR and its implications for the Firm, Government

and Democracy”, contend that in the absence of adequate functioning Corporate Governance

mechanism, organizations should share the responsibilities not covered under statutory

requirements.

Hence, the overriding usefulness of an effective Corporate Governance system is to create

value for all shareholders and other stakeholders through transparent, honest and effective

corporate governance practices.

1.2 The Stakeholders

The stakeholders of a business are the people who are integral to its inception, survival, and

growth. They are the human capital of a business entity and include all shareholders,

employees (full-time or contract), vendors, government agencies, regulators, banks, and

investors. Human resources create wealth and opportunities not only for its stakeholders but

also for the communities in which they operate. While manpower, machinery and technology

may change, or move from one place to another, people remain the foundation on which a

strong business is created.

The performance expectations of stakeholders as per Parthasarthy (2007) [7] are given below

in (Table-1)

Table.1. Stakeholders and Performance Expectation

Table.1. Stakeholders and Performance Expectation(Source: Parthasarthy (2007) [7])

Donaldson & Preston (1995) [8] in “The Stakeholder Theory of the Corporation: Concepts,

Evidence & Implications” concluded that normative stakeholder theory is dominant amongst

Sl. No. Stakeholder Performance Expectations

1. Investor Expects high dividend and capital appreciation in the

organization.

2. Lender Expects timely repayment of loan and interest

3. Supplier Expects fair terms and timely payments

4. Employee Expects good working environment, fair remuneration and

security

5. Customer Expects Quality product & services at fair price (value for

money)

6. Government Expects the company to partner in nation building by paying

taxes or directly spending on social projects

7. Society Expects the company to use resources judiciously so as to

maintain ecological balance and sustainable development and

also partner in nation building.

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all stakeholder theories, including descriptive and instrumental theories. The implication is

that each group of stakeholders’ merits consideration for its own sake (normative) and not

merely because of the ability to further the interests of some other group, such as the

shareowners (descriptive) and measurable (instrumental).Figure 1 depicts the 3 theories of

stakeholders that form part of any business.

Fig.1. Three Aspects of Stakeholder Theory

(Source: Donaldson & Preston, 1995) [8]

2. Ethical Corporate Governance - Desideratum

Research testifies to the fact that well-governed companies, or companies following

sustainable corporate governance stand to benefit from increased share price performance.

Increasing evidence supports the need for organizations to implement an ethical, transparent,

inclusive work culture based on the foundation of trust and confidence. Further, studies have

also shown that investors are more likely to invest in companies that have incorporated good

corporate governance. The following have been identified as good corporate governance

policies.

• Equal respect and treatment to all stakeholders

• The rights and obligation of shareholders

• Clearly defined roles of all the stakeholders, transparent disclosure of audit

information

• Clearly defined roles of the members of the board

• Clearly defined roles of the non-executive members of the board

• Clearly defined parameters for executive performance, management and

compensation

2.1 Ideal Corporate Governance Framework

Good corporate governance practices must have provisions to address issues of ethical

diversions that may arise because of any inefficiency, moral trespassing or an adverse

selection procedure. The mechanism to monitor, govern and control any such diversions can

include:

a. Procedures to monitor the role and performance of the board of directors.

b. Policies to measure the remuneration of the board and all other employees.

c. Clearly defined role and responsibilities of the Audit Committees. These can include

defining and incorporating and monitoring accounting policies and principles,

financial reporting, internal control procedures, recruitment policies and external

audits.

d. Monitoring of all regulatory compliance.

e. Effectively managing labor issues.

f. Defining ethical practices to address competition

2.2 Evolutionary Impact of Corporate Governance on Indian Organizations

Post-independence Indian corporate sector was dominantly controlled via state regulations.

Between 1956 and 1974, India's GDP grew between 3 -4 % per annum, when it was a closed

economy. It marginally reached between 4-5 % between 1975 and 1990 when India's private

sector was given more freedom. Due to IMF induced liberalization, GDP grew over 6 %

between 1991 and 2004, and touched 8.5 % thereafter.

Narayanaswamy, R. et al (2012) [9] highlight the major milestones in the evolving journey of

corporate governance in the country, post economic liberalization in 1991. The authors also

define scope for future research on issues associated with Indian governance, accounting and

auditing practices.

Fig.2. India’s GDP Story

(Source: The World Bank, 2007)

During the era of globalization, Indiancorporations were pushed out of their comfort zones.

To survive and prosper internationally, they had to adapt their claustrophobic Indian

Corporate Governance models,so as to better attract global talent and customers. Further, the

changing technologies modified the rules of the game.Technologies provide transparent

insights not relationships amongst organizations, customers, employees, suppliers &

regulatory authorities.

Bhattacharya, CB. et al McKinsey Report (2011) [10] have deliberated on corporate

responsibility to improve financials.Research has proved that stakeholders prefer to invest in

companies that provide both tangible results and psychological benefits – both of which are

only possible through effective corporate governance that is proactively implemented by top

leadership and cascades down to employees at all levels of the hierarchy.

A milestone in corporate governance was achieved when SEBI (Securities and exchange

Board of India) was established and given statutory powers in 1992 by the Indian

government.In the Indian context, certain public sector and private sector organizations have

established effective corporate governance mechanisms.The list is non-exhaustive and

includes 21st century titans likeMaruti-Suzuki, Infosys Technologies, Tata Group, Wipro

Technologies, Mahindra & Mahindra Group, Oil and Natural Gas Corporation (ONGC) and

Engineers India Limited (EIL).

3. Progression of Corporate Governance in India

As is clear from the above, corporate governance is finding increasing acceptance both

internationally and at the domestic front. The 2008 financial crisis in the global economies

has propelled greater interest on the subject. Over the period, various reports have been

prepared to draft efficient corporate governance practices in India and major ones are listed

below:

• Report of the Committee on Corporate Governance (October 5, 2017, headed by Uday

Kotak)

• Report of the Committee on Corporate Governance in Listed Entities – amendments

to Clauses 35B and 49 of the Equity Listing Agreement(SEBI, Aug 30, 2013)

• Report of the committee on Company Law May 31, 2004, headed by Dr J.J. Irani)

• Report of the committee on regulation of private companies and partnership (July,

2003, headed by Naresh Chandra - II)

• The report of the SEBI Committee on Corporate Governance (SEBI, Feb 8, 2003,

headed by N.R. Narayana Murthy)

• Report of the Committee on Corporate Audit and Governance (SEBI, Dec 23, 2002,

headed by Naresh Chandra - I)

• Report of the Consultative group of Directors of Banks/financial institutions (RBI,

April 2002)

• Report of the Advisory Group on Corporate Governance: Standing Committee on

International Financial Standards and codes (RBI, March 24, 2001)

• Report of the task force on Corporate Excellence through Governance (Dept. of

Company affairs, Nov. 20, 2000)

• Report of the Committee on Corporate Governance (SEBI, May 7, 1999, headed by

Kumar Mangalam Birla)

• Desirable Corporate Governance: A Code (Confederation of Indian Industry (CII),

April 1998)

3.1 Recent Development on the Code for Corporate Governance in Indian context

The most recent development was the constitution of 21-memberCommittee under the

Chairmanship of Shri Uday Kotak in June 2017 by SEBI. The following are key

recommendations of the Committee;

• Panel suggested that it was the right time to split Chairman, MD-CEO role of listed

companies

• Panel suggested it should be mandatory for top 500 companies by market

capitalization to undertake D&O insurance for its independent directors. D&O

Insurance stands for Directors and Officers insurance.

• Panel suggests minimum of 6 directors to be on board of listed entities; every listed

entity to have at least 1 independent woman director.

• Panel suggested more transparency on appointment of independent directors; wants

them to play a more active role on the boards.

• Panel suggested maximum number of listed entity directorship to be reduced to 8. At

least half of every listed entities board to have independent directors.

• Panel suggested Audit Committee must review use of loans/investment by holding co

in arm over Rs 100 crore.

• Panel suggested application to fill a casual vacancy of office of any Independent

Director must be okayed by holders; minimum number of Audit Committee meetings

be increased to five every year.

• Panel suggested no person to be appointed as alternate director for an independent

director of a listed company.

• Panel suggested a formal induction should be mandatory for every new Independent

Director appointed to the board.

• Panel suggested Board of Directors to be updated on regulatory & compliance

changes at least once a year.

Previously Companies Act 2013 (CA 2013) [14], which had replaced the Companies Act

1956 (CA 1956), has brought in some significant changes in Corporate Governance

standards, including:

CA 2013 requires companies to have following classes of Directors as shown in Fig – 3.

Fig.3. CA 2013 Classes of Directors [11]

Resident Director is a person who has stayed in India not less than 182 days in the previous

calendar year. CA 1956 did not require appointment of Independent directors; CA 2013

makes it mandatory in line with Clause 49 of Listing Agreement with Stock Exchange, along

with making it mandatory to have at least 1 Woman board director.

Company Act 2013 (CA 2013) [11] obligates the board to constitute the following 4

committees as shown in Fig-4.

Fig.4. CA 2013 Committees [11]

CA 2013 has introduced key changes w.r.t. board meetings and processes. It permits directors

to participate via audio visual means such as video conferencing, which recognizes the

technological advances in communication globally.

3.2 Recent research on Corporate Governance in Indian context

Prasad (2014) [12] opines that though corporate governance took roots in India in the 1980s,

at the time when the country opened up its economy, the concept still remains fragile, with

loopholes emerging every now and then during the last three decades, a case point being the

high-profile Satyam Computer failure. Any such failures tend to put off both domestic and

foreign direct investments, something which an emerging economy like India can ill afford.

Prasad (2014) further finds that the government of India is trying to put in place an effective

corporate governance mechanism, however, the problem lies not so much in policy as it does

in its implementation.

Bhalla (2012) [13] has tried to examine the attitude of various senior-level executives across

private and public companies towards corporate governance to identify a relationship

between performance of companies, satisfaction of investors and corporate governance

practices in India.

Arevalo et.al (2011) [14] focused on the Corporate Governance activities, specifically related

to Corporate Social Responsibility (CSR) of leading Indian firms participating in the UN

Global Compact (GC). The findings indicated that the most significant obstacles to CSR

implementation are those related to lack of resources, followed by those related to the

complexity and difficulty of implementing CSR in Indian Corporate Governance framework.

Estrin and Prevezer (2010) [15] in India, “substitutive” informal institutions, whereby

informal institutions substitute for and replace ineffective formal institutions, are critical in

creating corporate governance leading to enhanced domestic and foreign investment. India

has marked differences between regions. Although national legal structures and policies

apply in all states, there are marked variations in the implementation of the legal system at

the state level. Thus high-performing states such as Gujarat or Maharashtra have 8% per

annum growth rates in state GDP compared with 4% per annum and lower rates in Bihar or

Orissa. In poorly performing states, security of property, ownership rights, and enforcement

of the rule of law are poor and formal legal codes are ineffective.

Black and Khanna (2007) [16]reported evidence on investor reaction to the May 1999

announcement of India's plans to adoptthe Clause 49 governance reforms, considered a

watershed event in the evolution of Indian corporate governance. They found that large firms

gained 4.5% on average, relative to small firms, over a 3-trading-day event window

beginning on the announcement date. This suggested that properly designed mandatory

corporate governance reforms can increase share prices in an emerging market such as India.

A number of provisions of Clause 49 are similar to provisions of SOX. Thus, the positive

reaction of Indian investors to Clause 49 contrasts to the apparently negative investor reaction

to SOX. One explanation for the differing reactions is that the same reforms could have net

benefits in a poor governance country, such as India prior to Clause 49, yet net costs for

already well-governed companies. Just as governance is probably not one-size-fits-all at the

company level, so too, governance rules are likely not one-size-fits-all at the country level.

Tuteja (2006) [17] analyzed the corporate management structure of 100 companies in India

and found that irrespective of the year of incorporation or their investment capital, companies

favored a shift towards a system with a chief executive officer or full-time directors at the

helm, working under the guidance of the Board of Directors. In fact, most Indian companies

have opted for this system, also driven by the fact that as per law, it is mandatory for

companies with a paid-up capital of more than Rs. 5 crores to have a chief executive officer.

Liberalization in India seems to have an influence over the appointment of executive or

whole-time directors. Company boards, however, are still dominated by non-executive

directors especially due to the new rules relating to audit committees, and also due to

requirements of appointment of independent directors by companies. Tuteja (2006) [17]

argues that corporate directorships in India are undergoing a see change both quantitative and

qualitative terms, due to ongoing liberalization process.

Liberalization, it seems, has influenced the appointment of CEOs and full-time directors,

however, they are still dominated by non-executive directors, primarily due to the new

regulations related to audit committees and the appointment of independent directors. Tuteja

(2006) [17] opines that India is witnessing a dramatic change in the business environment due

to the ongoing liberalization.

Dwivedi and Jain (2005) [18] have studied 340 listed companies across various industries and

from 1997 to 2001 on parameters such as board size, director’s shareholders, and institutional

and foreign shareholding to understand their corporate governance practices.

Reed (2002) [19] examines efficacy of Corporate Governance and concludes if governance

reforms are to occur, then they have to take place in a larger context of political and legal

reform that can enable society to exercise effective control over corporations.

Desai (2000) [20] feels that the Companies (Second Amendment) Bill 1999 laid the

foundation of a new beginning of corporate governance for India. The bill specified the role

of the company secretaries to ensure regulatory compliance by small companies; the role of

directors in the Board of large companies; and the role of SEBI in the jurisdiction and control

over companies. It also laid down the guidelines for minimum capital and Amendments

regarding the auditors

4. Corporate Governance in Public and Private Sector Enterprises

India has a mixed economy since independence in 1947. Prior to 1991 economic crisis in

India Public sector was dominant, since welfare purposes took priority over profits.But

increasingly since than Private sector has expanded its share of the economy. Both sectors

have tried to balance welfare motives with profit generation.

Stakeholders prefer to deal with firms with good Corporate Governance. There is no perfect

model of Corporate Governance – every organization has to balance the interests of various

stakeholders.Indian private sector conglomerates such as Mahindra Group, Tatas, Infosys

Technologies, amongst others, have implemented good corporate governance practices in

order to compete internationally, where remaining competitive has moved beyond marketing

on cost basis to projecting positive image related to internal governance processes and

structure.

Mishra& Mohanty (2014) [21]in their study established the predictability of the new measure

of corporate governance on firm performance as a tool to boost investors' confidence and

financial health of firms. Bhalla (2012) [13], found the corporate governance practices of

both public sector and private sector companies to be quite similar, however, with a major

difference, in that the public sector companies were faced with greater political and

bureaucratic influences than the private sector. Gupta & Sharma (2013) [22] found that both

Private sector & Public sector banks are conforming to the guidelines on Corporate

Governance of SEBI and Reserve bank of India (RBI). However, considering the latest

Corporate Governance issues in both Public Sector and Private Sector banks (including,

Punjab National Bank, ICICI Bank), it raises questions on efficacy and if these measures are

being followed in right spirit.

It has been observed that on the whole, both the Public Sector Enterprises (PSEs) and the

Private sector companies in India have by and large understood the benefits to be reaped from

good governance and have implemented ethics, transparency, code of conduct of the Board

Members, the Audit Committee, and other related mechanisms of control to augment profits

and ensure sustainable development.

Some of the PSEs now figure in Fortune 500 Companies. Several PSEs, more notably Indian

Oil Corporation Limited (IOCL), National Thermal Power Corporation (NTPC), Oil and

Natural Gas Corporation (ONGC), Bharat Heavy Electrical (BHEL), Steel Authority of India

Ltd (SAIL), Gas Authority of India Ltd. (GAIL), Gujarat Alkalies and Chemicals Ltd., Bharat

Electronics Ltd (BEL), Power Grid Corporation, Fertilizer Corporation of India Ltd., have

taken initiatives to adopt good corporate governance practices with the aim to improve their

bottom line, and fulfill their social responsibilities, while moving towards sustainable

development.

The Standing Conference of Public Enterprises (SCOPE), based in New Delhi is a Central

Government owned Public Enterprise[23] representing the central/state public enterprises,

banks and other institutions in India. Its mission is to ensure high performance in

organizations which are funded by public investments. It, therefore, falls in its purview to

effectively implement good corporate governance practices in the public sector undertakings

in the country.Every year SCOPE gives Meritorious awards for Corporate Governance.

(Table 2 provides a list of companies who have received the SCOPE Awards for Corporate

Governance up to 2015) [24].For 2014-15, Meritorious awards for Good Corporate

Governance were given to Power Finance Corporation, Hindustan Aeronautics Limited,

WAPCOS by the President of India.

Table.2. SCOPE Corporate Governance Awards Winners (2010-15)

YEAR

PUBLIC SECTOR ENTERPRISE

(PSE)

2014-15 Power Finance Corporation, Hindustan Aeronautics Limited,

WAPCOS 2013-14 NSPCL (NTPC-SAIL Power Company Limited - Joint venture of

NTPC & SAIL) 2012-13 BPCL (Bharat Petroleum Corporation Limited)

2011-12 IOC (Indian Oil Corporation)

2010-11 SAIL (Steel Authority of India Limited)

4.1 Role of Board in Performance and Corporate Governance

Traditional role of Board of Directors in the Indian contextwas limited to monitoring

Executive decisions. However, with growing influence of stakeholders in organizations, this

passivity has increasingly given way to more active role. There is gradual evolution into four

critical board roles, namely: monitoring; service; strategy and resource provision (Daily et al.,

2003) [25]. As elucidated by Finegold, Benson and Hecht in2007 [26], the following figure

illustrates linkage between Corporate Boards and Company Performance.

Fig.5Corporate Boards and Company Performance: Framework for Future

Research

(Source: Finegold, Benson and Hecht, 2007)

5. Conclusion

To sum up, the ultimate role of good corporate governance is to implement best procedures

and practices to ensure conspicuousness. This automatically leads to ethical conduct which

maximizes value for the stakeholders and promote sustainability in organizations. It goes

without saying that it is to the benefit of the organizations to implement effective corporate

governance practices to stay relevant and maintain a competitive edge.

This paper has tried to light the issues and concerns faced by both public sector enterprises

and private organizations in implementing good corporate governance. It advocates for the

implementation of effective governance practices in organizations to remain competitive in

the global arena. It also highlights how it has become mandatory for Indian companies to

adopt corporate governance post-liberalization in 1991 and how the landscape is continuously

being redefined in sync with the continuously evolving business environment, driven by

advances in technology. The government’s role finds acknowledgement in the paper, via its

interventions in the enactment of Clause 49 &updated Company Act 2013 to improve

corporate governance practices.

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PLOT No. 11/7, SECTOR-11, DWARKA, NEW DELHI – 110075

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