Report of the Kumar Mangalam Birla Committee on Corporate Governance
Preface
1.1 It is almost a truism that the adequacy and the quality of corporate governance shape the growth and the future of any capital market and economy. The concept of corporate governance has been attracting public attention for quite some time in India. The topic is no longer confined to the halls of academia and is increasingly finding acceptance for its relevance and underlying importance in the industry and capital markets. Progressive firms in India have voluntarily put in place systems of good corporate governance. Internationally also, while this topic has been accepted for a long time, the financial crisis in emerging markets has led to renewed discussions and inevitably focussed them on the lack of corporate as well as governmental oversight. The same applies to recent high-profile financial reporting failures even among firms in the developed economies. Focus on corporate governance and related issues is an inevitable outcome of a process, which leads firms to increasingly shift to financial markets as the pre-eminent source for capital. In the process, more and more people are recognizing that corporate governance is indispensable to effective market discipline. This growing consensus is both an enlightened and a realistic view. In an age where capital flows worldwide, just as quickly as information, a company that does not promote a culture of strong, independent oversight, risks its very stability and future health. As a result, the link between a company's management, directors and its financial reporting system has never been more crucial. As the boards provide stewardship of companies, they play a significant role in their efficient functioning.
1.2. Studies of firms in India and abroad have shown that markets and investors take notice of well-managed companies, respond positively to them, and reward such companies, with higher valuations. A common feature of such companies is that they have systems in place, which allow sufficient freedom to the boards and management to take decisions towards the progress of their companies and to innovate, while remaining within a framework of effective accountability. In other words they have a system of good corporate governance.
1.3 Strong corporate governance is thus indispensable to resilient and vibrant capital markets and is an important instrument of investor protection. It is the blood that fills the veins of transparent corporate disclosure and high-quality accounting practices. It is the muscle that moves a viable and accessible financial reporting structure. Without financial reporting premised on sound, honest numbers, capital markets will collapse upon themselves.
1.4 Another important aspect of corporate governance relates to issues of insider trading. It is important that insiders do not use their position of knowledge and access to inside information about the company, and take unfair advantage of the resulting information asymmetry. To prevent this from happening, corporates are expected to disseminate the material price sensitive information in a timely and proper manner and also ensure that till such information is made public, insiders abstain from transacting in the securities of the company. The principle should be ''disclose or desist''. This therefore calls for companies to devise an internal procedure for adequate and timely disclosures, reporting requirements, confidentiality norms, code of conduct and specific rules for the conduct of its directors and employees and other insiders. For example, in many countries, there are rules for reporting of transactions by directors and other senior executives of companies, as well as for a report on their holdings, activity in their own shares and net year to year changes to these in the annual report. The rules also cover the dealing in the securities of their companies by the insiders, especially directors and other senior executives, during sensitive reporting seasons. However, the need for such procedures, reporting requirements and rules also goes beyond corporates to other entities in the financial markets such as Stock Exchanges, Intermediaries, Financial institutions, Mutual Funds and concerned professionals who may have access to inside information. This is being dealt with in a comprehensive manner, by a separate group appointed by SEBI, under the Chairmanship of Shri Kumar Mangalam Birla.
1.5 The issue of corporate governance involves besides shareholders, all other stakeholders. The Committee's recommendations have looked at corporate governance from the point of view of the stakeholders and in particular that of the shareholders and investors, because they are the raison de etre for corporate governance and also the prime constituency of SEBI. The control and reporting functions of boards, the roles of the various committees of the board, the role of management, all assume special significance when viewed from this perspective. The other way of looking at corporate governance is from the contribution that good corporate governance makes to the efficiency of a business enterprise, to the creation of wealth and to the country''s economy. In a sense both these points of view are related and during the discussions at the meetings of the Committee, there was a clear convergence of both points of view.
1.6 At the heart of the Committee's report is the set of recommendations which distinguishes the responsibilities and obligations of the boards and the management in instituting the systems for good corporate governance and emphasises the rights of shareholders in demanding corporate governance. Many of the recommendations are mandatory. For reasons stated in the report, these recommendations are expected to be enforced on the listed companies for initial and continuing disclosures in a phased manner within specified dates, through the listing agreement. The companies will also be required to disclose separately in their annual reports, a report on corporate governance delineating the steps they have taken to comply with the recommendations of the Committee. This will enable shareholders to know, where the companies, in which they have invested, stand with respect to specific initiatives taken to ensure robust corporate governance. The implementation will be phased. Certain categories of companies will be required to comply with the mandatory recommendations of the report during the financial year 2000-2001, but not later than March31, 2001, and others during the financial years 2001-2002 and 2002-2003. For the non-mandatory recommendations, the Committee hopes that companies would voluntarily implement these. It has been recommended that SEBI may write to the appropriate regulatory bodies and governmental authorities to incorporate where necessary, the recommendations in their respective regulatory or control framework.
1.7 The Committee recognised that India had in place a basic system of corporate governance and that SEBI has already taken a number of initiatives towards raising the existing standards. The Committee also recognised that the Confederation of Indian Industries had publishedacode entitled "Desirable Code of Corporate Governance" and was encouraged to note that some of the forward looking companies have already reviewed or are in the process of reviewing their board structures and have also reported in their 1998-99 annual reports the extent to which they have complied with the Code. The Committee however felt that under Indian conditions a statutory rather than a voluntary code would be far more purposive and meaningful, at least in respect of essential features of corporate governance.
1.8 The Committee however recognised that a system of control should not so hamstring the companies so as to impede their ability to compete in the market place. The Committee believes that the recommendations made in this report mark an important step forward and if accepted and followed by the industry, they would raise the standards in corporate governance, strengthen the unitary board system, significantly increase its effectiveness and ultimately serve the objective of maximising shareholder value.
The Constitution of the Committee and the Setting for the Report
2.1 There are some Indian companies, which have voluntarily established high standards of corporate governance, but there are many more, whose practices are a matter of concern. There is also an increasing concern about standards of financial reporting and accountability, especially after losses suffered by investors and lenders in the recent past, which could have been avoided, with better and more transparent reporting practices. Investors have suffered on account of unscrupulous management of the companies, which have raised capital from the market at high valuations and have performed much worse than the past reported figures, leave alone the future projections at the time of raising money. Another example of bad governance has been the allotment of promoter''s shares, on preferential basis at preferential prices, disproportionate to market valuation of shares, leading to further dilution of wealth of minority shareholders. This practice has however since been contained.
2.2 There are also many companies, which are not paying adequate attention to the basic procedures for shareholders'' service; for example, many of these companies do not pay adequate attention to redress investors'' grievances such as delay in transfer of shares, delay in despatch of share certificates and dividend warrants and non-receipt of dividend warrants; companies also do not pay sufficient attention to timely dissemination of information to investors as also to the quality of such information. SEBI has been regularly receiving large number of investor complaints on these matters. While enough laws exist to take care of many of these investor grievances, the...
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