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Corporate Governance in the New Companies Act
The saying ‘old wine in a new bottle’ is often used despairingly, but this is not the case here. Corporate Governance practices like wine gets better with age, for here we are dealing with a five hundred year vintage product. The first joint stock company which had three distinctive features of joint ownership, limited liability and transfer ability of shares came into existence in 1553 AD in London. This company is more popularly known as the Russian Company or the Muscovy Company, as this company traded with Russia.
Muscovy Company prescribed three clear qualities for its directors ‘Sad, Discreet and Honest’. Sad is the word that puzzles us today. It is interesting to note that this word was used in its less popular meaning of denoting a satisfied person. Events unfolding over the last five centuries prove that the three groves set by the first company for corporate governance are still valid today.
Companies Act, 2013, the new legislation in India also follows the path set by the first company five centuries back and strengthens the three core elements of independence, transparency and honesty. In line with contemporary vocabulary, the act uses the words independent director, related party transactions and insider trading to give the required importance to corporate governance. The earlier act of 1956 did not use these words. These words were brought into practice by Accounting Standards and Listing Agreements with the Stock Exchange. By integrating these critical concepts, the new act has strengthened corporate governance in India significantly.
Clause 49 of the listing agreement limited the tenure of an independent director to nine years. Due to its non-mandatory nature, this provision was violated by many companies. Now with this clause mandated by section 149 (10) of the new Act, companies have no option but to comply. This change is a welcome move in strengthening the independence of the Board as it prevents cozy relationship between the management and independent directors. The concept of independence is not only strengthened in letter, it is also enhanced in spirit where a minimum of seven days notice is prescribed for calling any board meetings.
On the issue of honesty to protect the interest of passive shareholders and stakeholders, the new act makes it explicit what was implicitly understood all along. In the code of conduct, independent directors are now cast with the stated duty to ‘pay sufficient attention and ensure adequate discussion’ before approving related party transactions. Further the provisions relating to related party transactions have been substantially strengthened by disqualifying an individual who has been convicted of the offense of dealing with related party transaction from acting as a director.
Turning to insider trading the second facet of dishonesty, section 195 of the new act defines it with clarity. It goes further and makes it an offence by prescribing stringent punishment of a maximum term for imprisonment of five years or a fine with a cap of rupees twenty-five crores or three times the profit made on insider trading, whichever is higher.
Finally on the issue of transparency, the new act makes a welcome departure in reducing the information overload arising from disclosures related to financial statements. By cutting out computational details found in the schedules and notes to the financial statements, the act seek to separate the needle from the haystack and provide the reader a better chance to evaluate the management.
Overall the cynics could be prompted to say India never lacked good laws, but what it lacked was effective implementation. On the other hand optimists could take heart in harsh punishments prescribed by the act which will be an effective deterrent in creating good corporate governance in India.
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Author's Articles from earlier issues
Issue 5 - An IPL View of the Corporate Annual Report
Issue 4 - Corporate Reporting in India: Coming of Age
Issue 3 - Good Governance, Independent Directors and Fair Disclosure, Is there a Link?
Issue 2 - Annual report is dead, long live the Annual Report
Issue 1 - A Milestone or a Millstone