Q: Key Recommendations of Kumar Mangalam Birla committee Report

Securities and Exchange Board of India (SEBI) in 1999 set up a committee under Shri
Kumar Mangalam Birla, member SEBI Board, to promote and raise the standards of good
corporate governance.

The primary objective of the committee was to view corporate governance from the perspective
of the investors and shareholders and to prepare a ‘Code’ to suit the Indian corporate
environment.

The committee divided the recommendations into two categories, namely, mandatory and
non- mandatory.

The recommendations which are absolutely essential for corporate governance can be defined
with precision and which can be enforced through the amendment of the listing agreement is
classified as mandatory.

Others, which are either desirable or which may require change of laws be classified as non-
mandatory.

Mandatory Recommendations

 The mandatory recommendations apply to the listed companies with paid up share
capital of 3 crore and above.
 Composition of board of directors should be optimum combination of executive & non-
executive directors.
 Audit committee should contain 3 independent directors with one having financial and
accounting knowledge.
 Remuneration committee should be setup
 The Board should hold at least 4 meetings in a year with maximum gap of 4 months
between 2 meetings to review operational plans, capital budgets, quarterly results,
minutes of committee’s meeting.
 Director shall not be a member of more than 10 committee and shall not act as chairman
of more than 5 committees across all companies
 Management discussion and analysis report covering industry structure, opportunities,
threats, risks, outlook, internal control system should be ready for external review
 Any Information should be shared with shareholders in regard to their investments.
Non-Mandatory Recommendations

The committee made several recommendations with reference to:

 Role of chairman
 Remuneration committee of board
 Shareholders’ right for receiving half yearly financial performance.
 Postal ballot covering critical matters like alteration in memorandum
 Sale of whole or substantial part of the undertaking
 Corporate restructuring
 Further issue of capital
 Venturing into new businesses

These recommendations were to apply to all the listed private and public sector companies,
their directors, management, employees and professionals associated with such companies.
The Committee recognizes that compliance with the recommendations would involve
restructuring the existing boards of companies. It also recognizes that smaller ones will have
difficulty in immediately complying with these conditions.

BUSINESS ETHICS- SIGNIFICANCE

The word ethics is derived from the Greek word ‘ethos’, which means character.

Ethics means the set of rules or principles that the organization should follow. While in
business ethics refers to a code of conduct that businesses are expected to follow while doing
business...

Business ethics compromises of all these values and principles and helps in guiding the
behavior in the organizations.

In Practice:

The Ford Motor Company decided to produce the first lowest-priced car in the USA. The
Company President Mr. Lee Lacocca wanted to rush the development of a car costing less than
$2,000, as he promised the public that his company will bring out a car at that price (as low as
$2,000) and also fight the growing popularity of Volkswagen’s Beetle. Preliminary tests
showed that it involved an additional cost of $11 to enhance the safety of the car.
He organised a meeting of company executives to decide how to reduce the cost below $2,000.
Many executives suggested that the company should sell the car at $2,011 but include the safety
feature. Some executives thought that the company should sell the car at $2,000 as promised
but exclude the safety feature. The company decided to go ahead without the safety feature.

The car was released and sold at $2,000. After six months of release, one of the cars was
involved in an accident killing all the passengers. Competitors influenced newspapers to
publish this accident and the newspapers in the U.S.A. highlighted the absence of the safety
feature. This incident resulted not only in the loss of sales, but also in the closure of the unit
resulting in a loss of $250 million to the company.

Business Ethics Practiced by Indian Companies are:

1. Principle of ‘sacrifice’ – A person, who is able to sacrifice a part of his asset or effort,
commands a superior place in the organisation.
2. Principle of ‘harmony’- harmony helps in avoiding conflicts in the organization.
3. Principle of ‘non-violence’- It protects an organisation from strikes and lockouts.
4. Principle of ‘reward’- The one who performs well is encouraged in form of rewards.
5. Principle of ‘justice’ – The one who works hard is awarded and the one who fails is
punished.
6. Principle of ‘taxation’- The one who is taxed more is encouraged to stay fit for a longer
period by proper appreciation. This principle applies to people who are hardworking and
productive.
7. Principle of ‘integrity’ – Integrity emphasis unity which helps to reap the benefits of
division of labour.
8. Principle of ‘polygamy’ – It emphasized on combining of two different cultures by
absorption or takeover.
Clause 49 of “Listing agreement ” deals with the complete guidelines for corporate
governance. Following are the provisions, a company, must comply to implement effective
corporate governance.

Clause 49 of the Listing Agreement to the Indian stock exchange that came into effect from 31
December 2005. It has been formulated for the improvement of corporate governance in all
listed companies.

Corporate Governance-:

In order to comply with clause 49(1) a company must adhere with some following principles.

1. Right of Shareholder- As shareholders are the ultimate owner of the company, the
company should seek to protect and facilitate the exercise of right of shareholders. A
company must always be transparent with its shareholders and shareholders should
have all the rights regarding General Meeting such as information about meeting,
participate, Vote and questioning in GM etc.
2. Role of stakeholders- A company must take care of stakeholder’s right and encourage
cooperation between company & stakeholders. Their rights can be by Mutual
agreement or by Applicable law or statute.
3. Disclosure & Transparency- It is the obligation on company to be transparent with its
stakeholders by giving disclosures of all material matters on timely basis. Disclosure
can be regarding financial position, Performance, ownership and Governance etc. Non
disclosure of Material Matter is Strictly Prohibited.
4. Responsibility of Board- Members of the Board should disclose their interest in
company and in any individual transaction and contract. They should also maintain the
rule of confidentiality. They should also perform their key function such as preparation
of major action plan, corporate Strategy, execution of Board, and effective financial
Performance.

Clause 49 of the Listing Agreement is applicable to companies which wish to get themselves
listed in the stock exchanges. This clause has both mandatory and non-mandatory provisions.
Key Mandatory provisions are as follows:

 Composition of Board and its procedure – frequency of meeting, number of

independent directors, code of conduct for Board of directors and senior management;
 Audit Committee, its composition, and role
 Provision relating to Subsidiary Companies
 Disclosure to Audit committee, Board and the Shareholders
 CEO/CFO certification
 Quarterly report on corporate governance
 Annual compliance certificate
Key Non-mandatory provisions include the following:
 Constitution of Remuneration Committee
 Training of Board members
 Peer evaluation of Board members
 Whistle Blower policy

CORPORATE SOCIAL RESPONSIBILITY

“the responsibility of enterprises for their impacts on society”

India is the first country in the world to make corporate social responsibility (CSR) mandatory,
following an amendment to the Companies Act, 2013 in April 2014. Businesses can invest their
profits in areas such as education, poverty, gender equality, and hunger as part of any CSR
compliance.

The amendment notified in the Companies Act, 2013 requires companies with a net worth of
INR 5 billion (US$70 million) or more, or an annual turnover of INR 10 billion (US$140
million) or more, or net profit of INR 50 million (US$699,125) or more, to spend 2 percent of
their average net profits of three years on CSR.

What is Corporate Social Responsibility?

The CSR has been defined in CA13 as projects or programs relating to activities specified in
Schedule VII of CA13; or projects or programs relating to activities undertaken by the board
of directors of a company in pursuance of recommendations of the CSR Committee of the
Board as per declared CSR policy of the company subject to the condition that such policy will
cover subjects enumerated in Schedule VII of CA13.1

Activities which may be included by companies in their Corporate Social Responsibility

Policies Activities relating to:—

[(i) Eradicating hunger, poverty and malnutrition, ‘‘promoting health care including
preventinve health care’’] and sanitation 4[including contribution to the Swach Bharat Kosh
set-up by the Central Government for the promotion of sanitation] and making available safe
drinking water.

(ii) promoting education, including special education and employment enhancing vocation
skills especially among children, women, elderly and the differently abled and livelihood
enhancement projects.

(iii) promoting gender equality, empowering women, setting up homes and hostels for women
and orphans; setting up old age homes, day care centres and such other facilities for senior
citizens and measures for reducing inequalities faced by socially and economically backward
groups.

(iv) ensuring environmental sustainability, ecological balance, protection of flora and fauna,
animal welfare, agroforestry, conservation of natural resources and maintaining quality of soil,
air and water 4[including contribution to the Clean Ganga Fund set-up by the Central
Government for rejuvenation of river Ganga].

(v) protection of national heritage, art and culture including restoration of buildings and sites
of historical importance and works of art; setting up public libraries; promotion and
development of traditional art and handicrafts;

(vi) measures for the benefit of armed forces veterans, war widows and their dependents, 9[
Central Armed Police Forces (CAPF) and Central Para Military Forces (CPMF) veterans, and
their dependents including widows];
(vii) training to promote rural sports, nationally recognised sports, paralympic sports and
olympic sports

(viii) contribution to the prime minister's national relief fund [or Prime Minister’s Citizen
Assistance and Relief in Emergency Situations Fund (PM CARES Fund)] or any other fund set
up by the central govt. for socio economic development and relief and welfare of the schedule
caste, tribes, other backward classes, minorities and women;

CORPORATE GOVERNANCE FAILURES

It doesn’t happen overnight and there are several warning signs which a firm must take note of
in order to avoid such failures.Some of the governance issues faced by the firms which
eventually lead to corporate governance failures are –

 Ineffective governance mechanisms, for example, lack of board committees or

committees consisting of few or a single member.
 Non-independent board and audit committee members, for example where a CEO
fulfilled multiple roles in various committees
 Management, who deliberately undermines the role of the various governance
structures by circumventing the internal controls and making misrepresentations to
auditors and the Board.
 Inadequately qualified members, for example,audit committee members not having
appropriate accounting and financial qualifications or experience to analyse key
business transactions, family members holding board positions without appropriate
knowledge or qualifications.
 Ignorance by regulators,auditors, analysts etc of the financial results and red flags.
Corporate governance is critical issue faced by all companies. The above cases highlight the
fact that poor corporate governance can lead to a downfall of the largest companies. Regulatory
bodies have increased their scrutiny on the firms are under increased scrutiny by regulatory
bodies which increases the importance of good governance. Digital solutions can help firms
implement a robust governance mechanism to help significantly reduce risk of governance
failure.

CORPORATE GOVERNANCE initiatives in India

National Committees on Corporate Governance

1. Committee # 1. CII Code of Desirable Corporate Governance (1998):

2. Committee # 2. Kumar Mangalam Birla Committee (2000):
3. Committee # 3. Reserve Bank of India (RBI) Report of the Advisory Group on
Corporate Governance (2001):
4. Committee # 4. Naresh Chandra Committee (2002):
5. Committee # 5. N.R. Narayana Murthy Committee (2003):
6. Committee # 6. J.J. Irani Committee (2005)

Others :

 The Government has renamed the Ministry from “Company Affairs” to “Corporate
Affairs” – with a new vision
 Introduction of LLPs; transformation in the service delivery mechanism for
transparency
 and certainty – low-cost, easy compliance;
 Setting up of Investor Education and Protection Fund

• Empowering investors through the medium of education education and information

information with the help of investor associations, VOs, NGOs, etc.;

• Launching of websites – www.investorhelpline.in and www.watchoutinvestors.com ;

• Setting up of NFCG as National Foundation for Corporate Governance in partnership with

stakeholders – CII, ICAI & ICSI;
The organizational framework for corporate governance initiatives in India consists of the
Ministry of Corporate Affairs (MCA) and the Securities and Exchange Board of India (SEBI).
SEBI monitors and regulates corporate governance of listed companies in India through Clause
49. This clause is incorporated in the listing agreement of stock exchanges with companies and
it is compulsory for listed companies to comply with its provisions. MCA through its various
appointed committees and forums such as National Foundation for Corporate Governance
(NFCG), a not-for-profit trust, facilitates exchange of experiences and ideas amongst corporate
leaders, policy makers, regulators, law enforcing agencies and non- government organizations.
Regulation

The Companies Act, 2013 got assent of the President of India on 29th August, 2013 and it was
enacted on 12th September, 2013 repealing the old Companies Act, 1956. The Companies Act,
2013 provides a formal structure for corporate governance by enhancing disclosures, reporting
and transparency through enhanced as well as new compliance norms.

Apart from this, the Monopolies and Restrictive Trade Practices Act, 1969 (which is replaced
by the Competition Act 2002), the Foreign Exchange Regulation Act,1973 (which has now
been replaced by Foreign Exchange Management Act,1999), the Industries (Development and
Regulation) Act, 1951 and other legislations also have a bearing on the corporate governance
principles.

In addition to various acts and guidelines by various regulators, non-regulatory bodies have
also published codes and guidelines on Corporate Governance from time to time.

For example, Desirable Corporate Governance Code by the Confederation of Indian Industries
(CII) in 2009.

The issue of corporate governance for listed companies came into prominence with the report
of the Kumar Mangalam Birla Committee (2000) set up by SEBI in the to suggest inclusion of
a new clause, Clause 49 in the Listing Agreement to promote good corporate governance.

On 21 August 2002, the Ministry of Finance appointed the Naresh Chandra Committee to
examine various corporate governance issues primarily around auditor – company relationship,
rotation of auditors and defining Independent directors.

This was followed by constitution of the Narayana Murthy Committee (2003) by SEBI, which
provided recommendations on issues such as audit committee’s responsibilities, audit reports,
independent directors, related parties, risk management, independent directors, director
compensation, codes of conduct and financial disclosures. Many of these recommendations
were then incorporated in the Revised Clause 49 that is seen as an important statutory
requirement.

Further, after enactment of the Companies Act, 2013, SEBI has amended Clause 49 in 2013
to bring it in line with the new Act.

Board of Directors

The Desirable Corporate Governance Code by CII (1998) for the first time introduced the
concept of independent directors for listed companies and compensation paid to them. The
Kumar Mangalam Birla Committee (2000) then suggested that for a company with an executive
Chairman, at least half of the board should be independent directors, else at least one-third. The
updated Clause 49 based on the report by the Narayana Murthy Committee further elaborates
the definition of Independent Directors; and also requires listed companies to have an optimum
combination of executive and non-executive directors, with non-executive directors
comprising of at least 50% of the Board. The 2013 Act introduces the requirement of appointing
a resident director and a woman director. The term ‘Key Managerial Personnel’ has been
defined in the 2013 Act, comprising of Chief Executive Officer, Managing director, Manager,
Company Secretary, Whole-time director, Chief Financial Officer; and any such other officer
as may be prescribed. The 2013 Act has also introduced new concepts such as performance
evaluation of the board, committee and individual directors. The revised Clause 49 (in 2013)
now also states that all compensation paid to non –executive directors, including independent
directors shall be fixed by the Board and shall require prior approval of shareholders in the
General meeting and that limit shall be placed on stock options granted to non executive
directors. Such remuneration and stock option is required to be disclosed in the annual report
of the company. The independent directors are also required to adhere to a ‘Code of Conduct’
and affirm compliance to the same annually.

Audit Committee

The audit committee’s role flows directly from the board’s oversight function and delegation
to various committees. It acts as an oversight body for transparent, effective anti-fraud and risk
management mechanisms, and efficient Internal Audit and External Audit functions financial
reporting. As per section 177 of the Companies Act, 2013 read with Rule 6 of Companies
(Meetings of Board and its powers) Rules, 2014, every listed company and all other public
companies with paid up capital of Rs. 10 crore or more; or having turnover of 100 crore or
more; or having in aggregate, outstanding loans or borrowings or debentures or deposits
exceeding Rs.50 Crores or more, to have an Audit Committee which shall consist of not less
than three directors and such number of other directors as the Board may determine of which
two thirds of the total number of members shall be directors, other than managing or whole-
time directors.

The Kumar Mangalam Birla Committee, Naresh Chandra Committee and the Narayana Murthy
Committee recommended constitution, composition for audit committee to include
independent directors and also formulated the responsibilities, powers and functions of the
Audit Committee. The Audit Committee and its Chairman are also entrusted with the ethics
and compliance mechanisms of an organization, including review of functioning of the
whistleblower mechanism. The revised Clause 49 expands the role of the Audit Committee
with enhancing its responsibilities in providing transparency and accuracy of financial
reporting and disclosures, robustness of the systems of internal audit and internal controls,
oversight of the company’s risk management policies and programs, effectiveness of anti-fraud
and vigil mechanisms and review and administration of related party transactions of the
organization.

Subsidiary Companies

The rationale behind having separate provisions with respect to subsidiary companies in the
Revised Clause 49 was the need for the board of the holding company to have some
independent link with the board of the subsidiary and provide necessary oversight. Hence, the
recommendation of Narayana Murthy Committee to make provisions relating to the
composition of the Board of Directors of the holding company to be made applicable to the
composition of the Board of Directors of subsidiary companies and to have at least one
independent director on the Board of Directors of the holding company on the Board of
Directors of the subsidiary company, were incorporated in the Revised Clause 49 of the Listing
Agreement. Besides the Audit Committee of the holding Company is to review the financial
statements, in particular investments made by the subsidiary and disclosures about materially
significant transactions ensures that potential conflicts of interests with those of the company
may be taken care of. The definition of ‘subsidiary’ is also widened by the Companies Act,
2013 to include joint venture companies and associate companies.

Role of Institutional Investors

Fast growing countries like India have attracted large shareholding by international investors
and large Indian financial institutions with global ambitions. This has resulted in a significant
progress in the standards of corporate governance in the investee companies. Many research
reports published in recent years show that companies with good governance system have
generated high risk-adjusted returns for their shareholders. So, if a company wants institutional
investor participation, it will have to convincingly raise the quality of corporate governance
practices. Indian companies thus need to adopt the best practices such as the OECD Corporate
Governance Principles (revised in 2004) that serve as a global benchmark. In countries like
India where corporate ownership still continues to be highly concentrated, it is important that
all shareholders including domestic and foreign institutional investors are treated equitably.

Institutional investors are expected to actively participate in the AGM voting on the shares held
by them in their portfolio companies along with public disclosure of their voting records and
reasons for non-disclosures. Their reason for assenting or dissenting to any Board Resolution
of their portfolio companies shall be disclosed on their website.

Stakeholders Relationship Committee

As one of its mandatory recommendations, the Kumar Mangalam Birla Committee propounded
the need to form a board committee under the chairmanship of a non-executive director to
specifically look into the redressing of shareholder complaints like transfer of shares, non-
receipt of balance sheet, non-receipt of declared dividends etc. The Committee believed that
the formation of shareholders’ grievance committee would help focus the attention of the
company on shareholders’ grievances and sensitise the management to redress their grievances.
The 2013 Act as well as the revised Clause 49 now mandate the formation of such a committee
with broader remit to cover issues and concerns of all stakeholders and not just shareholders.

The 2013 Act now mandates companies with more than one thousand shareholders, debenture-
holders, deposit-holders and any other security holders at any time during a financial year are
required to constitute a Stakeholders Relationship Committee consisting of a chairperson who
shall be a non-executive director and such other members as may be decided by the Board to
resolve the grievances of security holders of the company.
Risk Management

The Kumar Mangalam Birla Committee report included mandatory Management Discussion
& Analysis segment of annual report that includes discussion of industry structure and
development, opportunities, threats, outlook, risks etc. as well as financial and operational
performance and managerial developments in Human Resource /Industrial Relations front.
Clause 49 included this recommendation as a part of management disclosures. Risk
Management was however propounded for the first time by the Narayana Murthy Committee
(2003) in its report by which it required that the company shall lay down procedures to inform
Board members about the risk assessment and minimization procedures. These procedures
shall be periodically reviewed to ensure that executive management controls risk through
means of a properly defined framework and overlooked by a Risk Management Committee.
This is incorporated in Clause 49 as a part of internal disclosures to the Board.

The 2013 Act and Revised Clause 49 specify requirements related to risk management. Audit
Committee and the independent directors of the company are entrusted with the responsibility
of evaluating the robustness of the risk management systems and policy laid down by the
Board.

Ethics

A code of conduct creates a set of rules that become a standard for all those who participate in
the group and exists for the express purpose of demonstrating professional behaviour by the
members of the organization.The Naresh Chandra Committee for the first time recommended
that companies should have an internal code of conduct. The Report by Narayana Murthy
Committee further recommended that a company should have a mechanism (whistle blower)
to report on any unethical or improper practice or violation of code of conduct observed and
that Audit Committee would be entrusted with the role of reviewing functioning of the
mechanism.

Clause 49 incorporated these recommendations further mandating directors of every listed

company to lay down a Code of Conduct and post the code on their company’s website. The
Board members and all senior management personnel are required to affirm compliance with
the code annually and include a declaration to this effect by the CEO in the Annual Report.
The recommendation of Narayana Murthy Committee to make Audit Committee responsible
for reviewing the functioning of the whistle blower mechanism, where it exists, is incorporated
in the Clause 49. The 2013 Act and revised Clause 49 mandate establishing Whistleblower
mechanism to let employees and directors blow whistles on financial and non-financial wrong
doings and also that such mechanism should provide protection to the whistle blower from
victimization and provide direct access to the Chairman of the Audit Committee in exceptional
cases.

Executive Remuneration

The overriding principle in respect of directors’ remuneration is that of openness and

shareholders are entitled to a full and clear statement of benefits available to the directors. The
2013 Act and Revised Clause 49 mandate the formation of a Nomination & Remuneration
Committee comprising of at least three directors, all of whom shall be non-executive directors
and at least half shall be independent. The Nomination and Remuneration Committee is to
ensure that the level and composition of remuneration is reasonable and sufficient; the
relationship of remuneration to performance is clear and meets appropriate performance
benchmarks; and the remuneration to directors, key managerial personnel and senior
management involves a balance between fixed and incentive pay reflecting short and long-term
performance objectives appropriate to the working of the company and its goals. There are also
compulsory disclosures to be made in the section on corporate governance of the annual report
- All elements of remuneration package of all the directors i.e. salary, benefits, bonuses, stock
options, pension etc.; Details of fixed component and performance linked incentives, along
with the performance criteria; Service contracts, notice period, severance fees; Stock option
details, if any – and whether issued at a discount as well as the period over which accrued and
over which exercisable.

Directors’ Responsibility Statement

To promote better disclosures and transparency, the 2013 Act, requires the company’s Annual
Report to include a Director’s Responsibility Statement stating the following:

(a) Applicable accounting standards had been followed in the preparation of the annual
accounts

(b) The directors have selected such accounting policies and applied them consistently and
made judgments and estimates that are reasonable and prudent so as to give a true and fair view
of the state of affairs of the company
(c) Proper and sufficient care for the maintenance of adequate accounting records in accordance
with the provisions of this Act for safeguarding the assets of the company and for preventing
and detecting fraud and other irregularities

(d) The annual accounts of the company are prepared on a going concern basis

(e) The directors have laid down internal financial controls to be followed by the company and
that such internal financial controls are adequate and were operating effectively

(f) The directors had devised proper systems to ensure compliance with the provisions of all
applicable laws and that such systems were adequate and operating effectively.

CEO/CFO Certification

Internal control is a process, effected by an entity’s board of directors, management and other
personnel, designed to provide reasonable assurance regarding the achievement of objectives
in the following categories:
− Effectiveness and efficiency of operations,
− Reliability of financial reporting, and
− Compliance with applicable laws and regulations.

The Naresh Chandra Committee for the first time required the signing officers, to declare that
they are responsible for establishing and maintaining internal controls which have been
designed to ensure that all material information is periodically made known to them; and have
evaluated the effectiveness of internal control systems of the company. Also, that they have
disclosed to the auditors as well as the Audit Committee deficiencies in the design or operation
of internal controls, if any, and what they have done or propose to do to rectify these
deficiencies. Clause 49 requires the CEO and CFO to certify to the board the annual financial
statements in the prescribed format and establishing internal control systems and processes in
the company. CEOs and CFOs are, thus, accountable for putting in place robust risk
management and internal control systems for their organization’s business processes. The 2013
Act and revised Clause 49 have also brought much rigour into internal controls certification by
making it as one of the parts of Directors’ Responsibility Statement.