Module: 6 - Report of Narayana Murthy Committee on Corporate Governance
- Genesis & Rationale
Report of Narayana Murthy Committee on Corporate Governance
1. Genesis & Rationale of the Report Other Modules under "Corporate Governance
2. Corporate Governance - Its Paramount Need &
Benefits
1. Module: 1 - Corporate Governance - General (7
3. Key Issues Discussed by Narayanamurthy articles)
Committee and Recommendations
2. Module: 2 - Corporate Governance in Banks (6
4. Key Issues Discussed by Narayanamurthy articles)
Committee and Recommendations (Contd)
3. Module: 3 - The Report of the Consultative Group
5. Relevant Recommendations of Nareshchandra of Directors of Banks/Financial Institutions
Committee on Corporate Governance included in (Chairman Dr A S Ganguly) - (10 articles)
the Report of Narayanamurthui Committee
4. Module: 4 - Mohan Kumar Mangalam Committee
6. Recommendations of Narayanamurthy Report (14 articles)
Committee Issues under clause 49 and proposed
amendments
5. Module: 5 - Initiatives by Department of Company
Affairs to formulate guidelines onCorporate
7. Recommendations of Narayanamurthy Governance (7 articles)
Committee Issues under clause 49 and proposed
amendments (Contd)
SEBI had constituted a Committee on May 7, 1999 under the chairmanship of
Shri Kumarmangalam Birla, then Member of the SEBI Board "to promote and
raise the standards of corporate governance". Based on the recommendations
of this Committee, a new clause 49 was incorporated in the Stock Exchange
Listing Agreements ("Listing Agreements").
Financial reporting and disclosures
Financial disclosure is a critical component of effective corporate governance.
SEBI set up an Accounting Standards Committee, as a Standing Committee,
under the chairmanship of Shri Y. H. Malegam with the following objectives:
To review the continuous disclosure requirements under the listing
agreement for listed companies;
To provide input to the Institute of Chartered Accountants of India
("ICAI")for introducing new accounting standards in India; and
To review existing Indian accounting standards, where required and to
harmonise these accounting standards and financial disclosures on par
with international practices.
SEBI has interacted with the ICAI on a continuous basis in the issuance of
recent Indian accounting standards on areas including segment reporting,
related party disclosures, consolidated financial statements, earnings per
share, accounting for taxes on income, accounting for investments in
associates in consolidated financial statements, discontinuing operations,
interim financial reporting, intangible assets, financial reporting of interests in
joint ventures and impairment of assets.
With the introduction of these recent Indian accounting standards, financial
reporting practices in India are almost on par with International Accounting
Standards.
Implementation of corporate governance requirements
The Recommendations were implemented through Clause 49 of the Listing
Agreements, in a phased manner by SEBI. They were made applicable to all
companies in the BSE 200 and S&P C&X Nifty indices, and all newly listed
companies, as of March 31, 2001. The applicability of the Recommendations
was extended to companies with a paid up capital of Rs. 100 million or with a
net worth of Rs. 250 million at any time in the past five years, as of March 31,
2002. In respect of other listed companies with a paid up capital of over Rs.
30 million, the requirements were made applicable as of March 31, 2003.
The accounting standards issued by the ICAI, which are applicable to all
companies under sub-section 3A of Section 211 of the Companies Act, 1956,
were specifically made applicable to all listed companies for the financial year
ended March 31, 2002, under the Listing Agreements.
Compliance with the Code and SEBI's experience
In terms of SEBI's Circular No. SMD/Policy/CIR-03/2001 dated January 22,
2001 All companies are required to submit a quarterly compliance report to
the stock exchanges within 15 days from the end of a financial reporting
quarter. The companies have to submit compliance status on eight sub-
clauses namely:
1. Board of Directors;
2. Audit Committee;
3. Shareholders / Investors Grievance Committee;
4. Remuneration of directors;
5. Board procedures;
6. Management;
7. Shareholders; and
8. Report on Corporate Governance.
Stock exchanges are required to set up a separate monitoring cell with
identified personnel, to monitor compliance with the provisions of the
Recommendations. Stock exchanges are also required to submit a quarterly
compliance report from the companies as per the Schedule of
Implementation. The stock exchanges are required to submit a consolidated
compliance report within 30 days of the end of the quarter to SEBI.
Both the Mumbai and National Stock Exchanges have submitted a
consolidated quarterly compliance report for the quarter ended September 30,
2002. SEBI observed that the compliance with the requirements in clause 49
of the Listing Agreement is, by and large, satisfactory; however, an analysis of
the financial statements of companies and the report on corporate governance
discloses that their quality is not uniform. This is observed on parameters
such as the nature of qualifications in audit reports, the quality of the
corporate governance report itself (which is often perfunctory in nature), and
the business transacted and the duration of audit committee meetings.
Variations in the quality of annual reports, including disclosures, raises the
question whether compliance is in form or in substance; and emphasise the
need to ensure that the laws, rules and regulations do not reduce corporate
governance to a mere ritual. This question has come under close scrutiny in
recent times.
Deficiencies Observed from the Analysis of the Reports
SEBI has analysed a few recently published annual reports of companies to
assess the quality of corporate governance. The directors' reports could be
classified into the following categories:
1. Reports where there is no mention about the compliance with
corporategovernance requirements;
2. Reports that state that the company is fully compliant with clause 49 of
the Listing Agreement, but where independent auditors have made
qualifications in their audit reports;
3. Reports that mention areas of non-compliance with clause 49 of the
Listing Agreement and provide explanation for non-compliance; and
4. Reports that mention areas of non-compliance with clause 49 of the
Listing Agreement but provide no explanation for auditor's qualification
or for reasons for non-compliance.
SEBI also observed that there is a considerable variance in the extent and
quality of disclosures made by companies in their annual reports
Rationale for a review of the Code
SEBI believes that efforts to improve corporate governance standards in India
must continue. This is because these standards are themselves evolving, in
keeping with market dynamics. Recent events worldwide, primarily in the
United States, have renewed the emphasis on corporate governance. These
events have highlighted the need for ethical governance and management,
and for the need to look beyond mere systems and procedures. This will
ensure compliance with corporate governance codes, in substance and not
merely in form.
Again, one of the goals of good corporate governance is investor protection.
The individual investor is at the end of a chain of financial information,
stretching from corporate accountants and management, through Boards of
Directors and audit committees, to independent auditors and stock market
analysts, to the investing public. Many of the links in this chain need to be
strengthened or replaced to preserve its integrity.
SEBI, therefore, believed that a need to review the existing code on corporate
governance arose from two perspectives,-
a. to evaluate the adequacy of the existing practices, and
b. to further improve the existing practices.
In the context of the rationale set out above, SEBI believed it necessary to
form a committee on corporate governance, comprising representatives from
the stock exchanges, chambers of commerce, investor associations and
professional bodies. The SEBI Committee on Corporate Governance (the
"Committee") was constituted under the Chairmanship of Shri N. R. Narayana
Murthy, Chairman and Chief Mentor of Infosys Technologies Limited.
The terms of reference of the Committee are set out as under.
To review the performance of corporate governance; and
To determine the role of companies in responding to rumour and other
price sensitive information circulating in the market, in order to enhance
the transparency and integrity of the market.
The Committee met thrice on December 7, 2002, January 7, 2003 and
February 8, 2003, to deliberate the issues related to corporate governance
and finalize its recommendations to SEBI.
The issues discussed by the Committee primarily related to audit committees,
audit reports, independent directors, related parties, risk management,
directorships and director compensation, codes of conduct and financial
disclosures. The Committee's recommendations in the final report were
selected based on parameters including their relative importance, fairness,
accountability, transparency, ease of implementation, verifiability and
enforceability.
It submitted its report to SEBI on 08.02.2001. Detailed recommendations as
set out in the Committee's report are discussed in subsequent articles.
The key mandatory recommendations focus on strengthening the
responsibilities of audit committees; improving the quality of financial
disclosures, including those related to related party transactions and proceeds
from initial public offerings; requiring corporate executive boards to assess
and disclose business risks in the annual reports of companies; introducing
responsibilities on boards to adopt formal codes of conduct; the position of
nominee directors; and stock holder approval and improved disclosures
relating to compensation paid to non-executive directors. Non-mandatory
recommendations include moving to a regime where corporate financial
statements are not qualified; instituting a system of training of board
members; and the evaluation of performance of board members.
Certain recommendations that were already contained in the Report of the
Naresh Chandra Committee on Corporate Audit and Governance (the "Naresh
Chandra Committee") were also discussed briefly. The members of the
Committee agreed in principle with the recommendations set out by the
Naresh Chandra Committee that are directly related to corporate governance.
It was therefore decided by the Committee, that in making the final
recommendations to SEBI, the Committee would also recommend that the
mandatory recommendations in the report of the Naresh Chandra Committee,
insofar as they related to corporate governance, be mandatorily implemented
by SEBI through an amendment to clause 49 of the Listing Agreement. These
recommendations are contained in Section 4 of this Report.
The Committee believes that these recommendations codify certain standards
of "good' governance into specific requirements, since certain corporate
responsibilities are too important to be left to loose concepts of fiduciary
responsibility. When implemented through SEBI's regulatory framework, they
will strengthen existing governance practices and also provide a strong
incentive to avoid corporate failures.
To the query whether the costs of governance reforms are too high, the
Committee in its report points out that "in this context, it should be noted that
the failure to implement good governance procedures has a cost beyond mere
regulatory problems. Companies that do not employ meaningful governance
procedures will have to pay a significant risk premium when competing for
scarce capital in today's public markets.
Implementation and Way Forward
The Committee noted that the recommendations contained in this Report can
be implemented by means of an amendment to the Listing Agreement, with
changes made to the existing clause 49.
A primary issue that arises with implementation is whether the
recommendations should be made applicable to all companies immediately or
in a phased manner since the costs of compliance may be large for certain
companies. Another issue is whether to extend the applicability of these
recommendations to companies that are registered with BIFR. In the case of
such companies, there is likely to be almost little or no trading in their shares
on the stock exchanges.
The Committee believes that the recommendations should be implemented
for all companies to which clause 49 apply. This would also continue to apply
to companies that have been registered with BIFR, subject to any directions
that BIFR may provide in this regard.
[Source: Report of the SEBI Committee on Corporate Governance (Narayana
Murthy Committee) dated 08.02.2003
