In April 2004, the World Bank published a Report on the Observance of Standards and Codes (ROSC) on Corporate Governance in India, benchmarking the countries corporate governance framework against the Organization for Economic Cooperation and Development's (OECD) Principles of Corporate Governance. The assessment team noted that since the first Corporate Governance assessment in 2000, a series of legal and regulatory reforms have transformed the Indian corporate governance framework and improved the level of responsibility/accountability of insiders, fairness in the treatment of minority shareholders and stakeholders, board practices, and transparency. The first, voluntary Code of Corporate Governance was published by the Confederation of Indian Industries (CII) in 1998. The Securities and Exchange Board of India (SEBI) followed by setting up the Kumar Mangalam Birla Committee on Corporate Governance, whose recommendations in December 1999 formed the basis for Clause 49 of the Listing Agreement of the Bombay Stock Exchange. SEBI revised Clause 49 in late 2004 on the recommendations of the Narayana Murthy Committee on Corporate Governance, with the revisions coming into effect on January 1, 2006. However, despite these developments, enforcement and implementation of laws and regulations remain important challenges.

General Overview

In April 2004, the World Bank published a Report on the Observance of Standards and Codes (ROSC) on Corporate Governance in India, benchmarking the countries corporate governance framework against the Organization for Economic Cooperation and Development's (OECD) Principles of Corporate Governance. The assessment team noted that since the first Corporate Governance assessment in 2000, a series of legal and regulatory reforms have transformed the Indian corporate governance framework and improved the level of responsibility/accountability of insiders, fairness in the treatment of minority shareholders and stakeholders, board practices, and transparency. In particular, the securities regulator introduced a corporate governance clause (Clause 49) in the listing agreement that clarified many issues. Recent efforts to strengthen enforcement have enhanced investors' trust in the market. The financial press is increasingly reporting violations of shareholder rights. These are positive drivers of change. However, enforcement and implementation of laws and regulations remain important challenges. (WB 2004, p. 1)

The Asian Corporate Governance Association (ACGA) reports that India is the only country in the region where industry, rather than government, provided the initial impetus for corporate governance reform. Driven by a desire to make Indian business more competitive and respected on the world stage, the Confederation of Indian Industries (CII) published a voluntary Code of Corporate Governance in 1998--one of the first major codes in Asia. The Securities and Exchange Board of India (SEBI) followed by setting up the Kumar Mangalam Birla Committee on Corporate Governance, whose recommendations in December 1999 formed the basis for Clause 49 of the Listing Agreement. SEBI revised Clause 49 in late 2004 on the recommendations of the Narayana Murthy Committee on Corporate Governance, with the revisions coming into effect on January 1, 2006. (ACGA 2007)

ACGA goes on to note that unlike in other parts of Asia, shareholder activism emerged in India not as a response to the Asian crisis, but as a reaction to stock manipulation scandals in the early 1990s. These events gave rise to one of the country's more established organizations, the Investor Grievances Forum. While India has a surprisingly large number of SEBI-recognized investor associations--18--activism is less developed than in other markets. Most groups are poorly funded, low-profile and barely known around the country (partly because their activities are restricted to single cities or states). This situation is epitomized by the Bombay Shareholders Association (BSA), the oldest investor organization in India if not the region. Founded in 1928 to advocate for small shareholders who encountered abuses under the old paper-based trading system, BSA is struggling to find a new mandate, new members and funding. (ACGA 2007)

The above mentioned Mangalam committee 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 Stock Exchange, Mumbai (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. (SEBI 2003, p. 4)

In its 2006 Annual Report, SEBI reports that revised corporate governance standards were prescribed by SEBI as of October 2004 according to the recommendations of the Narayana Murthy Committee. Under Clause 49 of the Listing Agreement, corporates have been advised to comply with the revised guidelines on corporate governance. Initially, the compliance date was April 1, 2005 which was subsequently extended to December 31, 2005. Without further extension of the date of compliance, certain provisions of Clause 49 were clarified in January 2006. These were: a) maximum gap between two board meetings has been increased to four months; b) sitting fees paid to the non-executive directors would not require prior approval of the shareholders; and c) certification of internal controls and internal control systems by CEO /CFO would be for the purpose of financial reporting. (SEBI 2006, p. 13)

According to the 2004 Review of the Standing Committee on International Financial Standards and Codes that was set up by the Reserve Bank of India (RBI) in consultation with the Government of India in December 1999, notable progress has been made in regard to corporate governance in private corporate sector following the SEBI guidelines and in banks following the RBI issuing operational circulars in June 2002. RBI has also issued circular on consolidated accounting in February 2003. These circulars have created an enabling framework for improving corporate governance in financial institutions. However, there is a need for consultative process to harmonies the approaches suggested by the Ganguly Committee and the Narayana Murthy Committee with regards to banks. As proposed in the Mid-Term Review of Monetary and Credit Policy for the year 2003-04, SEBI and RBI are working jointly towards harmonization of the approach adopted by SEBI towards corporate governance with the corporate governance practices in banks. While on an overall basis there has been a marked progress in this area, governance in PSUs requires focused attention. Further progress in regard to corporate governance in all the three types of companies - private, public and banks (both private and public) could be facilitated by the Government and regulatory agencies by continuing the attention the subject has received in recent years. (RBI 2004, pp. 88-89)

The World Bank report identifies several areas for reform: (1) Sanctions and enforcement should be credible deterrents to help align business practices with the legal and regulatory framework, in particular with respect to related party transactions and insider trading; (2) The current institutional framework places the oversight of listed companies partly with the Department of Company Affairs (DCA), partly with the Securities and Exchange Bard of India (SEBI) and partly with the stock exchanges. This fragmented structure gives rise to regulatory arbitrage and weakens enforcement. (3) Board practices need to be strengthened; (4) Institutional investors acting in a fiduciary capacity should be encouraged to formulate a comprehensive corporate governance policy, including voting and board representation. Together with the detailed policy recommendations, these measures will help implement reforms and provide opportunities for issuers to signal good practices to investors and the market. (WB 2004, p. 1)

Regarding board practices, the assessment team urged that if boards are to move away from simply "rubber stamping" the decisions of management or promoters, they must have a clear understanding of what is expected. They should know their duties of care and loyalty to the company and all shareholders. The law or other regulations should spell out the responsibilities of directors and they themselves should engage in the formulation of their tasks and work procedures. A key missing ingredient is a strong focus on director professionalism. Director training institutes can play a key capacity building role and expand the pool of competent candidates. (WB 2004, p. 14)

In the same context, institutional investors could become important forces to monitor insiders and play a disciplining role in the governance of corporations. The behavior of institutional investors has traditionally been characterized by apathy with respect to voting - they prefer to use "exit" over "voice" to express dissatisfaction with a company. In addition, asset managers owned by financial institutions that maintain credit and advisory relationships with portfolio companies tend to feel uncomfortable when exercising their voting rights, especially against management. Policymakers could play a role in encouraging institutional investors who act as fiduciaries to attend shareholder meetings and vote. This might encourage shareholder activism across the board, which is an important engine of change in corporate governance reform. Increasingly, international good practice suggests that it is preferable for institutional investors to nominate independent directors to the boards of their portfolio companies, rather than awarding the position to current or retired employees who may offer little value added and are more likely to be subject to conflicts of interest in the exercise of their fiduciary duties. (WB 2004, pp. 14-15)

The Asian Corporate Governance Association (ACGA) identifies several weaknesses in the India corporate governance framework. There is a penchant for setting up official committees and enacting new regulations, but under-investing in enforcement and implementation. Neither SEBI nor the Ministry of Company Affairs (MCA) seem to have enough competent staff who truly understand the capital markets, although SEBI is on a recruitment drive this year and MCA has been training its officers in white-collar crime. However, it will be quite a while before serious changes are seen. (ACGA 2007)

To make matters worse, there is a lack of cooperation and coordination between key government departments, in particular MCA and SEBI. As noted in the Irani Report, on which the new Companies Act is being based: "Sometimes, various agencies pursue action in their respective domain without regard to the comprehensive picture. This results in overlap of jurisdiction or regulatory gaps. There is a need to bring about coordination in the role and action of various regulatory agencies to enable effective investor protection". (ACGA 2007)

According to the ACGA, as of March 2007, the following developments are under way in India in the area of corporate governance. A new Companies Act is being drafted that will reportedly allow class-action lawsuits and statutory derivative suits. "MCA-21", a program to streamline the Ministry of Company Affairs (MCA) and deter corrupt practices by its officers. The SEBI Act is being amended to give the regulator, among other things, more powers of investigation and prosecution. The Institute of Chartered Accountants (ICAI) has formed a committee to create a roadmap for the convergence of Indian accounting standards with International Financial Reporting Standards by 2008. SEBI formed a Committee on Disclosures and Accounting Standards in late 2006 to advise on disclosure requirements for listed companies and to facilitate the implementation of ICAI accounting standards as they relate to the capital markets. (ACGA 2007)

The 2004 World Bank assessment notes that traditionally, financing was debt driven, and Development Finance Institutions (DFIs) were an important source of finance. Equity financing is now growing, slowly modifying the ownership structure. Promoters tend to own at least 26% of a company, as this threshold gives them veto rights in special resolutions. Business groups are common. In 2003, there were over 9,500 listed companies and 23 registered stock exchanges in India. Since 1999, total market capitalization has hovered around 22 to 25 percent of GDP. The Stock Exchange, Mumbai (BSE) and the National Stock Exchange (NSE) are the two main exchanges competing with each other. In May 2003, there were 5,6504 companies listed on the BSE and 1,471 on the NSE,5 1,000 of which were actively traded. The top 100 BSE companies represented nearly 86 percent of BSE's market capitalization. NSE's trading volume accounted for 57 percent of its total. The average free float for the 1,034 BSE companies most frequently traded was 47 percent. 80 percent of trading volume is retail. (WB 2004, pp. 1, 2)

The U.S. Department of Commerce reports that the Indian capital market has grown in recent years, but remains relatively small compared to other emerging markets and developed economies. Spot prices for index stocks are usually market-driven and settlement mechanisms are close to international standards. India's debt and currency markets lag behind its equity markets. Although private placements of corporate debt have been increasing, the daily trading volume remains insignificant. The ratio of daily trading volume to total debt outstanding is less than one percent in India, compared to about 7 percent in U.S. The Indian stock markets lack broad liquidity, although high transaction costs and systemic risk have come down with recent regulatory and administrative improvements. Currently, about 50 Indian stocks, out of more than the 9,000 listed, make up over 75 percent of trading. The proportion of stock available for trading is limited. Institutional improvements have helped to reduce episodes of market manipulation, which have led to a lack of confidence by retail investors who invest primarily in public sector debt instruments. The GOI has yet to implement "second-generation" financial market reforms to promote liquidity and a broader domestic investor base. (U.S. DoC 2006, p. 114)

CLSA Asia-Pacific Markets and the Asian Corporate Governance Association (ACGA) jointly publish an annual survey ("CG Watch") of corporate governance in Asia. In September 2006, they published an inaugural report on Proxy Voting in Asia. CG Watch is a general survey, covering five broad categories of corporate governance: rules and regulations; enforcement; political and regulatory institutions; international accounting and auditing standards; and "corporate governance culture". In the 2005 CG Watch ranking, India ranks third out of ten Asian markets with a score of 61%, compared to leading Singapore with a score of 70%. In the Proxy Voting Index India ranks fourth with a score of 57% compared to leading Hong Kong with 67%. (Allen & Jones 2006, p. 25)

The Principles

Principle I: Ensuring the Basis for an Effective Corporate Governance Framework

II

According to the 2004 World Bank Report on the Observance of Standards and Codes (ROSC) on Corporate Governance in India, benchmarking the countries corporate governance framework against the Organization for Economic Cooperation and Development's (OECD) Principles of Corporate Governance, the Indian legal framework is based on common law. Firms are governed by the Companies Act (CA), 1956 as amended. The CA is administered by the Department of Company Affairs (DCA) and enforced by the Company Law Board (CLB) and the Company Courts. Listed companies must comply with the rules and regulations prescribed by the Securities and Exchange Board of India (SEBI) Act, 1992; with the Securities Contract (Regulation) Act, 1956; the Depositories Act, 1996; the Sick Industrial Companies (Special Provisions) Act (SICA), 1985; and the listing rules. (WB 2004, p. 2) However, the 2004 World Bank assessment does not explicitly address India's compliance with this principle.

The Securities and Exchange Board of India (SEBI) regulates the stock exchanges, stock brokers, share transfer agents, merchant banks, portfolio managers, and other market intermediaries, collective investment schemes and primary issues. It prohibits fraudulent and unfair trade practices, and regulates the substantial acquisition of shares and takeovers. It is an autonomous body established under an act of Parliament, to whom it submits annual reports. The Cabinet appoints SEBI's board. SEBI's budget comes from fees, levies and government grants. Its decisions are subject to independent judicial review. SEBI is operationally independent, but the government can issue directions in policy matters. (WB 2004, p. 2)

The Department of Company Affairs (DCA), Securities and Exchange Board of India (SEBI) and the stock exchanges share jurisdiction over listed companies. This creates a potential for regulatory arbitrage and weakens enforcement. An in-depth revision of the three-tiered regulatory system would reveal whether changes in the respective roles and responsibilities of the involved institutions and their supervisory functions are in order. Clarification of responsibilities could strengthen enforcement and reduce the danger that issuers treat compliance as a "box ticking" exercise. It is important to keep in mind the enormous size of the equity market and the implications of any changes in the respective organizational structures and capacities. (WB 2004, p. 14)

Over the last few years, a series of joint corporate governance committees were appointed by DCA and SEBI. Their recommendations are reflected in CA amendments, listing rules and SEBI regulations. "Clause 49" of the listing rules addresses corporate governance on a "comply or explain" basis. All listed companies with paid up capital of Rs 30 million (USD 660,000) or with a net worth of Rs 250 million (USD 5.5 million) must comply with Clause 49. There are mandatory and non-mandatory requirements. Two credit rating agencies rate the quality of corporate governance of issuers. (WB 2004, p. 2)

The U.S. Department of Commerce criticizes that even though India has made much progress on economic reform since 1991, the economy is still hobbled by excessive rules and a powerful bureaucracy with broad discretionary powers. Despite these shortcomings, central government efforts to establish independent and effective regulators in some sectors, such as telecommunications, securities, and insurance, have shown positive results. In December 2004, the GOI also created an independent pension regulator as part of its larger program to reform India's pension system. It also established a Competition Commission and has indicated its intention to strengthen the commodities futures markets. Lack of oversight on corporate governance and financial disclosure remain an obstacle to transparent and stable markets. (U.S. DoC 2006, p. 113)

The Asian Corporate Governance Association (ACGA) identifies several weaknesses in the India corporate governance framework. There is a penchant for setting up official committees and enacting new regulations, but under-investing in enforcement and implementation. Neither SEBI nor the Ministry of Company Affairs (MCA) seem to have enough competent staff who truly understand the capital markets, although SEBI is on a recruitment drive this year and MCA has been training its officers in white-collar crime. However, it will be quite a while before serious changes are seen. (ACGA 2007)

To make matters worse, there is a lack of cooperation and coordination between key government departments, in particular MCA and SEBI. As noted in the Irani Report, on which the new Companies Act is being based: "Sometimes, various agencies pursue action in their respective domain without regard to the comprehensive picture. This results in overlap of jurisdiction or regulatory gaps. There is a need to bring about coordination in the role and action of various regulatory agencies to enable effective investor protection". (ACGA 2007)

Principle II: The Rights of Shareholders and Key Ownership Function

CP

The 2004 World Bank Report on the Observance of Standards and Codes (ROSC) rates four of the sub-principles of this principle as observed, one as largely observed and one as materially not observed in India. Regarding secure methods of ownership registration, there are two electronic depositories: the National Securities Depository (NSDL) and the Central Depository Services (CDSL). Shares traded through a stock exchange are held in dematerialized form in the depositories. Registration in a depository is proof of ownership. Companies must maintain a register of shareholders or outsource this function to a share transfer agent. (WB 2004, p. 3)

Shares are freely transferable. Shares traded through stock exchanges are transferred through book entry at the depositories. Cash settlement occurs at the designated clearing banks of the stock exchanges' clearing houses. Guarantee funds largely eliminate settlement risk. (WB 2004, p. 3)

Annual and half yearly statements are mailed to shareholders; quarterly accounts are published in newspapers and posted on the websites of issuers and stock exchanges. Companies must file their memorandum, articles of association and financial information with a Registrar of Companies (ROC).16 Investors can access this information for a nominal fee of approximately 1 USD. Shareholders may inspect the minutes of the Annual General Meeting (AGM). (WB 2004, p. 3)

Shareholders have the right to participate and vote at general meetings. Elect members of the board. Usually, directors are proposed by the board and elected by shareholders. Shareholders can also propose a candidate up to fourteen days before the Annual General Meeting (AGM). The company must inform all shareholders about the candidature at least seven days before the meeting. In practice, shareholders seldom use this right. Share in the profits of the corporation. The board of directors proposes the dividend, and the AGM approves it. Dividends must be paid within thirty days. (WB 2004, p. 3)

Certain fundamental corporate decisions are the exclusive power of the shareholder meeting: changing registered office; authorizing capital increases; waiving pre-emptive rights; buying back shares; amending articles of association; delisting; acquisitions, disposals, mergers and takeovers; changes to company business or objectives; making loans and investments beyond limits prescribed under Companies Act (CA)Section 372A; authorizing the board to: (1) sell or lease major assets; (2) borrow money in excess of paid-up capital and free reserves, and (3) appoint sole selling agents and apply to the court for the winding up of the company. Such decisions require a 75 percent majority present and voting. (WB 2004, pp. 3-4)

Under the CA, a company must hold an AGM every year. The notice must be sent to all shareholders 21 days in advance. It must specify the meeting place and time and contain an agenda. In case of special business, the agenda must set out the material facts concerning each item, including the nature of the concern or interest of any director or manager. The AGM must be held at or near the company's registered office. Reportedly, some companies hold AGMs in remote locations, which discourage attendance. The standard quorum is five shareholders. If the quorum is not met after half an hour, the meeting is dissolved if called by shareholders, or postponed for one week if called by the board. Shareholders may vote in person or through proxies who have registered with the company up to 48 hours before the meeting. The CA allows postal voting for certain fundamental decisions. Any shareholder may apply to the Company Law Board (CLB) to call an AGM if the company has defaulted in conducting an AGM. The requisition for an EGM must be signed by shareholders holding at least 10 percent of the paid up voting capital. (WB 2004, p. 4)

The legal framework and stock exchange rules should provide for full disclosure of shareholder agreements that could have an impact on how the company is governed or how other shareholders may be treated. For example, agreements include understandings with respect to the exercise of voting rights, puts and calls, rights of first refusal, and powers of certain shareholders to nominate corporate officers. (WB 2004, p. 5)

As India integrates into the global economy, critical mass, process efficiency and productivity are becoming important issues for firms. Consolidation is driving the market for corporate control. Transparency has increased since Securities and Exchange Board of India (SEBI) issued a takeover code in 1997. The code requires any person or body corporate whose shareholding crosses the 5 percent threshold to disclose it to the stock exchange and to SEBI; an acquirer who crosses the 15 percent threshold must make an offer for at least an extra 20 percent of the shares and deposit 25 percent of the value of his bid in an escrow account. The minimum price for this public offer cannot be lower than the negotiated acquisition price or the highest price paid by the acquirer during the last 26 weeks. Within a 12 month period, a maximum of 5 percent may be acquired without it being considered a "creeping acquisition." Poison pills are banned by law. The SEBI Takeover Code has been successfully tested in over 25 hostile bids. (WB 2004, p. 5)

Foreign Institutional Investors (FIIs) must register with Securities and Exchange Board of India (SEBI) to participate in the market. FIIs issues synthetic instruments called "participatory notes" to investors who want indirect exposure to the Indian equity market. Investors crossing the 5% threshold must inform the stock exchange and SEBI. Issuers must disclose in their quarterly reports all investors who own 1% or more of their shares. However, the mandatory disclosure includes only the shareholder's name - not the address. This is often insufficient to identify an investor. While there is a trend towards more transparent share ownership, the classification still fails to give a fully transparent picture of control due to the prevalence of complex cross-holdings across family or business groups. (WB 2004, p. 5)

Pension funds do not play a corporate governance role. The Unit Trust of India (UTI), the Life Insurance Company (LIC) and the General Insurance Company (GIC) are the three largest institutional investors and are government owned. Together they own 15-20% of the listed sector. These institutions seldom exercise their voting rights but exert influence through directors nominated to the board of their portfolio companies. (WB 2004, p. 5)

The World Bank report recommended that regulators should consider introducing an obligation that institutional investors acting in a fiduciary capacity adopt and disclose their corporate governance and voting policy. They should also disclose to the public how they manage material conflicts of interest that may affect the exercise of their corporate governance rights. Shareholder activism among retail investors should be encouraged. (WB 2004, p. 5)

Principle III: The Equitable Treatment of Shareholders

EN

The 2004 Report on the Observance of Standards and Codes (ROSC) rates all three sub-principles on the equitable treatment of shareholders as partially observed, which implies that the legal and regulatory framework complies with Organization for Economic Cooperation and Development (OECD) principles, while practices and enforcement diverge. (WB 2004, p. 6)

The Companies Act (CA) confers rights to shareholders in matters of oppression by the majority or mismanagement. The lesser of 100 shareholders or those representing 10 percent of shareholders can apply to the Company Law Board (CLB) for redress. CLB can instruct management to buy out dissenting shareholders, terminate or modify agreements entered into by the company or remove/appoint directors to the board. CLB's decisions may be appealed to the high and supreme courts. Any shareholder may apply for the winding up of a company. Investors can also apply to Securities and Exchange Board of India (SEBI) for redress. SEBI can disbar company directors and de-list companies or pass a judicial order. Clause 49 requires issuers to set up a "Grievance Committee," chaired by a non-executive director, to look into the redress of shareholders rights and investor complaints. (WB 2004, p. 6)

Shareholders have the same voting rights within the same class. Information about the voting rights of each class is easy to obtain. Custodians do not usually have to consult beneficial owners on how to vote the underlying shares of ADRs. Most contracts give voting rights to management. Infosys is the exception - the ADR holders may instruct the custodian on how to vote. (WB 2004, p. 6)

Depository receipt contracts should provide owners with the same rights to vote as are accorded to holders of the underlying shares, in line with International Corporate Governance Network recommendations. Policymakers should consider whether to strengthen the enforcement powers or regulators to offset the backlog and delays of court procedures. (WB 2004, p. 6)

The courts authorize derivative actions in certain cases. Relief goes to the company. Class action suits have been initiated in mergers where shareholders were unsatisfied by the proposed share-swap ratio. However, prolonged delays are the norm in court proceedings. Market analysts report that it not unusual for the first hearing to take six years and the final decision up to 20 years. (WB 2004, p. 6)

Insider trading is regulated by the SEBI (Prohibition of Insider Trading) Regulation, 1992, which criminalizes insider trading and abusive self-dealing. Anybody in possession of price sensitive information is considered an insider. Price sensitive information must be disclosed to the exchange promptly. In 1995, SEBI directed the stock exchanges to set up surveillance departments. Investor perception of market integrity seems to have improved since. However, implementation of the Regulation is problematic. Despite Stock Exchange, Mumbai (BSE) and National Stock Exchange (NSE) electronic trading facilities and mutual exchange of information, it is difficult to flag a trade as a possible case of insider trading. A person with insider information can create fire-walls between himself and the regulators, given the number of intermediaries who operate in the market. Anecdotal evidence suggests that front running remains a problem. An additional factor making surveillance more difficult, are multiple listings. SEBI is in the process of setting up a unique client code (UCC) for each investor. (WB 2004, pp. 6-7)

SEBI's initiative to provide each investor with a unique client code should be implemented. A greater level of cooperation between National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) on surveillance could further enhance the integrity of the market. The perception of market integrity will be enhanced, once an insider trading case has been successfully prosecuted. (WB 2004, p. 7)

Management, board members and their close families are included in the definition of related parties. A related party must disclose the nature of his/her concern or interest to the board of directors. The audit committee reviews and approves all material related party transactions, materiality being defined by the committee. Listed companies must disclose the information to shareholders under guidelines of the Institute of Chartered Accountants of India (ICAI). Reportedly, some firms obey the letter, not the spirit, of the law. One example is to restrict ownership in a company to 49.9 percent to avoid having to call it a "subsidiary." Misuse of corporate assets and abuse in related party transactions remain problems. It is not always easy to identify "related parties" or assess the fairness of a transfer price. (WB 2004, p. 7)

The 2004 World Bank assessment recommended that depository receipt contracts should provide owners with same rights to vote as to vote as are accorded to holders of underlying shares. The authorities should further consider strengthening regulators' enforcement power to offset backlog and delays of court procedures and there should be greater cooperation between NSE and BSE on surveillance. Furthermore, the regulator should successfully prosecute one insider trading case to enhance perception of market integrity. While audit committees should pre-vet related party transactions, ultimate responsibility of judging whether a related party transaction is in the best interest of the company should remain with the board. (WB 2004, Annex B, p. 1)

Furthermore, the World Bank noted, the disclosure protocol for related party transactions is a necessary, but insufficient condition to protect minority shareholders from potential abuse. While the audit committee should pre-vet related party transactions, the ultimate responsibility should remain with the board as a whole. (WB 2004, p. 7)

Principle IV: The Role of Stakeholders in Corporate Governance

CP

The 2004 World Bank Report on the Observance of Standards and Codes (ROSC) rates three of the sub-principles of this principle as observed and one as partially observed in India. (WB 2004, p. 7)

The corporate governance framework requires the board of directors to discuss material issues regarding employees and other stakeholders. Secured creditors offering long term debt have the right to be represented on the board through "nominee directors." (WB 2004, p. 7)

Creditors can petition the Company Law Board (CLB), Board for Industrial and Financial Reconstruction (BIFR, the special bankruptcy court under SICA), civil and high courts, as well as the Debt Recovery Tribunals for violation of their rights. Employees and environmental groups can seek redress through civil and high courts. However, there are long delays and backlogs. Creditors seldom approach the courts when their rights have been violated, except by recalling their loans and initiating recovery procedures. Civil courts discourage creditors from litigating on issues relating to governance, citing "indoor management" policy. (WB 2004, pp. 7-8)

The Securities and Exchange Board of India (SEBI) has issued detailed guidelines on share options. Promoters are not eligible for stock options. Share option schemes are approved at the AGM. Stock options are not expensed in the income statement, but disclosed in the notes. There is no ceiling on how many stock options can be issued. The options are tied to specific performance goals and vested over a time period - typically three to six years. Large grants (exceeding 1 percent of capital) must be individually voted on by special resolution. (WB 2004, p. 8)

Information is posted on the company and stock exchange websites. According to market analysts, the quality of the information varies markedly between the first two hundred listed companies and the rest of the market. (WB 2004, p. 8)

Principle V: Disclosure and Transparency

CP

The 2004 World Bank Report on the Observance of Standards and Codes (ROSC) rates one of the sub-principles of this principle as observed, two as largely observed and one as partially observed. (WB 2004, p. 8)

A standing committee was set up by the Securities and Exchange Board of India (SEBI)under the chairmanship of Shri Y H Malegam, Managing Partner of S.B.Billimoria & Company in 2002, to review the prevailing disclosure requirements in the offer documents and recommend additions and modifications thereof in Prospectus/Letter of Offer for Public/Rights issue. SEBI modifies the Disclosure And Investor Protection (DIP) guidelines based on the recommendations of the committee. The committee has the following objectives: 1) To review the continuous disclosure requirements under the listing agreement for listed companies; 2) To provide input to the Institute of Chartered Accountants of India (ICAI) for introducing new accounting standards in India; and 3) To review existing Indian accounting standards, where required and to harmonize these accounting standards and financial disclosures on par with international practices. (Malegam Committee 2002)

According to the World Bank ROSC, companies must prepare and send an annual report to shareholders, the stock exchange, Department of Company Affairs (DCA), and the Registrar of Companies (ROC). Its content is regulated by statute. It includes a chairman's statement (non-mandatory), management discussion and analysis (MD&A), directors' report, balance sheet, profit and loss account, notes, discussion of significant accounting policies, auditor opinion, segment accounts, and a cash flow statement. Consolidation is mandatory for listed companies and financial institutions. However, commercial company objectives and policies related to business ethics are not disclosed in the MD&A. (WB 2004, p. 8)

Share ownership must be disclosed in the annual report by investor category (promoters, financial institutions, foreign investors, etc.) and by branches of ownership (up to 500 shares, 501 to 1000, etc.). Disclosure does not extend to the level of ultimate beneficiary and the structure of business groups. (WB 2004, pp. 8-9)

The annual report's corporate governance section includes summary information on directors, including qualifications, relationship with each other and management, attendance records, number of directorships held (and in which companies). Sitting fees and commissions (for non-executive directors), bonuses, salaries, stock options and loans (for executive directors) must be disclosed individually and in aggregate. Senior management salaries and bonuses are reported individually. Company policies on risk management and material risk factors are disclosed in the annual report. It includes a discussion on internal controls, accompanied by a director responsibility statement. (WB 2004, p. 9)

Section 217 of the Companies Act (CA) requires the board to report annually on employee and other stakeholder issues. The annual report contains a section on corporate governance, certified by the auditor. Market analysts confirm that the quality of disclosure has improved in recent years, as companies begin to understand the relationship between transparency and market valuation. However, the stock exchanges' human resources are insufficient to ensure compliance. Consequently, they heavily rely on the auditors. (WB 2004, p. 9)

The World Bank in 2004 recommended that SEBI and the exchanges need to cooperate more closely to effectively monitor and enforce compliance with the listing agreement. It is imperative that steps are taken to clarify the division of responsibilities among stock exchanges, SEBI, Department of Company Affairs (DCA) to avoid unintentional regulatory overlap and potential conflicts. (WB 2004, p. 9)

Market analysts confirm that the quality of disclosure has improved in recent years, as companies begin to understand the relationship between transparency and market valuation. However, the stock exchanges' human resources are insufficient to ensure compliance. Consequently, they rely heavily on the auditors. (WB 2004, p. 9)

The quality of financial disclosure for listed companies is determined by the DCA, SEBI, and ICAI. ICAI lays down the parameters of accounting and auditing standards. According to ICAI, India is materially in conformity with International Financial Reporting Standards (IFRS) and International Standards on Auditing (ISA). Under the CA, management must explain any deviations from the prescribed accounting standards in the financial statements. The sanctions for non-compliance with financial disclosures range from a maximum fine of Rs 2,000 (USD 44) to imprisonment of up to six months. In practice, there have been no instances of imprisonment. Usually, if a company does not comply with proper audit practices or does not make available the necessary financial documents, the penalty is a maximum fine of Rs 500 (USD 11). Qualified auditor opinions do not prompt automatic action from SEBI. However, companies must disclose the qualification in each quarterly report. If the auditor's signed reports do not conform with the law, the maximum penalty is Rs 10,000 (USD 220). Moreover, judicial delays diminish the deterrence-factor of such penalties. ICAI can take disciplinary actions against its members. (WB 2004, p. 9)

The CA requires annual accounts to be audited by a certified chartered accountant who is an ICAI member. Quarterly reports are subject to a limited audit review. Auditors must also issue an annual certification that Clause 49 has been complied with. Auditors are appointed at the annual general meeting (AGM). Auditor independence is defined under Section 226 of the CA. (WB 2004, p. 9)

The recommendations of the Naresh Chandra Committee on Corporate Audit and Governance regarding non-audit services to audit clients, rotation of auditors and qualified audit opinions are included in the current Companies (Amendment) Bill. It is important that this legislation go forward. In order to enhance the quality of auditing practice, policymakers should consider options to establish a monitoring and enforcement arrangement in line with recent international developments and the recommendations of the Naresh Chandra Committee. (WB 2004, p. 10)

Dissemination channels include direct mailing, company websites, the stock exchange, and press announcements. Price sensitive information must be disclosed to the exchange continuously. This is published online by the exchanges. The major cost for issuers is the printing and distribution of the annual report to each shareholder. For companies with many shareholders, the expense is significant. Moreover, although consolidation is now mandated for listed companies, Section 212 of the CA still requires publication of accounts of all subsidiaries. This makes the annual report bulky and adds to distribution costs. (WB 2004, p. 10)

The quality of financial disclosure for listed companies is determined by the Department of Company Affairs (DCA), Stock Exchange Board of India (SEBI), and Institute of Chartered Accountants of India (ICAI). ICAI lays down the parameters of accounting and auditing standards. According to ICAI, India is materially in conformity with International Financial Reporting Standards (IFRS) and International Standards on Auditing (ISA). Under the Companies Act (CA), management must explain any deviations from the prescribed accounting standards in the financial statements. The sanctions for non-compliance with financial disclosures range from a maximum fine of Rs 2,000 (USD 44) to imprisonment of up to six months. In practice, there have been no instances of imprisonment. Usually, if a company does not comply with proper audit practices or does not make available the necessary financial documents, the penalty is a maximum fine of Rs 500 (USD 11). Qualified auditor opinions do not prompt automatic action from SEBI. However, companies must disclose the qualification in each quarterly report. If the auditor's signed reports do not conform with the law, the maximum penalty is Rs 10,000 (USD 220). Moreover, judicial delays diminish the deterrence-factor of such penalties. ICAI can take disciplinary actions against its members. (WB 2004, p. 9)

Principle VI: The Responsibilities of the Board

CP

The 2004 World Bank Report on the Observance of Standards and Codes (ROSC) rates two of the sub-principles of this principle as observed, three as largely observed and one as partially observed. (WB 2004, p. 10)

Indian firms have a unitary board structure. The board is accountable to shareholders. It ensures the strategic guidance of the company and monitors management. The members of the board of directors are considered to hold the fiduciary position of a trustee for the company. The basic fiduciary duties are not spelled out in legislation, but are embedded in the jurisprudence, which remains sparse. It is not customary for directors to be covered by an insurance policy. Traditionally, companies have been dominated by their promoters, who act as managers, and not by their boards. While the board has the general power of stewardship, it can delegate certain powers to employees who are on the board, i.e. "whole time" or "executive directors." (WB 2004, p. 11)

The CA defines the concept of "officer in default" for contraventions committed by a company. These are: (1) the managing director(s); (2) executive or whole-time director(s); (3) manager(s); (4) the company secretary; (5) any person in accordance with whose instructions the board acts; and (6) any person who has been charged by the board to be an officer in default, subject to his/her consent. However, the "officer in default" concept has been interpreted by some to mean that there are different levels of fiduciary liability for different kinds of directors - the executive director being the first in line and the independent director being the least liable. The introduction of the audit committee added a new layer to the set: audit committee members are considered by some "more liable" than the rest of the board. (WB 2004, p. 11)

The World Bank recommended that the Companies Act (CA) should clearly spell out the fiduciary obligations of directors, including care, skill and diligence in the performance of their duties, as well as loyalty and avoidance of conflicts of interests. There should not different standards of care for executive and independent directors, except where executive directors act in a management function that has been clearly delegated by the board and that is separated from the board functions. Directors should have access to training in order to fully understand their rights, responsibilities, duties and liabilities. (WB 2004, p. 11)

Board members have a fiduciary obligation to treat all shareholders fairly. If shareholders feel treated unfairly, they have the right of appeal to SEBI, Court and the Company Law Board. At least two-thirds of the board of directors should be rotational. One-third consists of permanent directors, which include promoters, executive directors and nominee directors. Section IV, Clause 49, requires issuers to have at least one-third independent directors, if the functions of chairman of the board and CEO are decoupled, and 50 percent otherwise. An independent director is defined as a non-executive director who, inter alia, has no material pecuniary relationships or transactions with the company, its promoters, senior management or its holding company, its subsidiaries and associated companies, which in the judgment of the board may affect the independence of judgment of the director, and is not related to promoters or management at the board level, or at one level below the board. Reportedly, there are cases where so-called "independent" directors are, in reality, former employees, relatives, lawyers, consultants, employees of associated companies, etc. (WB 2004, pp. 11-12)

It has been argued that the institutional nominee directors representing Development Finance Institutions (DFIs) do not bring specialized knowledge and hence, contribute little to the deliberation of the boards. An alternative would be for DFIs to nominate expert independent directors on their behalf. This would make them more independent. Such directors would not face the same conflicts of interest in where the repayment of loans is discussed as do current and former DFI employees. The maximum term of independent directors should be capped. (WB 2004, p. 12)

Clearly defined board procedures are needed to allow the board to effectively exercise its oversight function on risk management. International good practice suggests that shareholders should be consulted with respect to general compensation policy for senior management, rather than each individual compensation package. The department in charge of corporate communication should have a direct reporting line to the board. (WB 2004, p. 13)

Given that multiple board memberships held by the same person can interfere with performance of directors, companies and shareholders should consider whether such a situation is desirable. Audit committee members have sufficient financial and accounting knowledge to understand financial information, ask informed questions to the internal and external auditors and conduct meaningful meetings. Special training courses should be developed, including possibly a certification program. Adequate across-the-board compensation for independent directors will help ensure that they devote sufficient time to their responsibilities and will increase the supply of high quality candidates. Compliance with the audit committee requirements should be monitored closely by regulators. (WB 2004, p. 13)

The company secretary ensures that the board complies with its statutory duties and obligations. The board reports annually on company activities, including company performance on environmental issues, labor issues, tax compliance and provisions of the Competition Act. (WB 2004, p. 12)