CORPORATE GOVERNANCE UNDER THE COMPANIES ACT, 2013

1. Introduction

Corporate governance issues have attracted considerable attention worldwide in recent

decades. This is mainly due to some financial scams or corporate failures that
highlighted the need for tighter surveillance over corporate behaviour. Corporate law
in India too has undergone changes in relevant rules and regulations due to corporate
frauds and failures. Regulators expected the more stringent corporate governance laws
to improve the governance climate, resulting in better financial performance of
companies, thereby winning stakeholders’ confidence as well.1

Corporate governance implies managing the business responsibly, commitment to

ethics and adequate and timely disclosure on all material matters so as to increase
overall stakeholder confidence which will in turn lead to efficient allocation of capital
and sustained economic growth. Governance is about running the company, but good
governance is about ensuring that is run fairly and openly. The Companies Act, 2013
was passed by the Rajya Sabha on 8th August 2013 paving way for a new company
law and received the assent of the president on 29thAugust, 2013. The Act, 2013
replaces the existing Companies Act, 1956 which was enacted 57 years ago. The new
Act seeks to usher in more transparency and governance in the corporate bodies
besides creating the necessary environment for growth in the present global structure.
It has the potential to be a historic milestone, as it aims to improve corporate
governance, simplify regulations, enhances the interests of minority investors and for
the first time states the role of whistle-blowers. The Act encourages good governance
practices by placing the onus on independent directors to bring oversight in the
functioning of the Board and protect the interest of minority shareholders.2

1
Dr. KVSN Jawahar Babu, Role of Corporate Governance in Strategic Management, available at:
<http://ssrn.com/abstract=2184235> last visited on 11-11-2017 at 6:56 pm
2
A.C. Fernando, Corporate Governance: Principles, Polices and Practices, (Dorling Kindersley Pvt.Ltd,
New Delhi, 2012) p. 17

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2. Corporate Governance

Corporate governance is essentially concerned with the process by which companies

are governed and managed. It is a set of standards which aims to improve the
Company’s image, efficiency, effectiveness, and social responsibility. It is a specially
designed framework of legal, institutional, and cultural factors shaping the patterns of
influence that shareholders (or stakeholders) exert on managerial thinking and
decision-making process. The concept primarily hinges on complete transparency,
integrity, and accountability of the management with an increasingly greater focus on
stakeholders protection. A key element of good governance is transparency projected
through a code of good governance which incorporates a system of checks and
balances between all stakeholders. Out of the two models of corporate governance the
stakeholder model is gaining momentum in recent times than the shareholders model,
though the implementation of the former is difficult, if not impossible. It is more-or-
less a country-specific system. Corporate governance mechanisms are the methods
employed to solve governance problems at the firm level.3

A basic definition of corporate governance, which has been widely recognized, was
given in a report by the committee under the chairmanship of Sir Adrian Cadbury tiled
(the Cadbury Report): "Corporate governance is the system by which companies are
directed and controlled. The boards of directors are responsible for the governance of
their companies. The shareholder’s role in governance is to appoint the directors and
the auditors to satisfy themselves that an appropriate governance structure is in place.
The responsibilities of the board include setting the company’s strategic aims,
providing the leadership to put them into effect, supervising the management of the
business and reporting to shareholders on their stewardship. The board’s actions are
subject to laws, regulations and the shareholders in general meeting." “Corporate
Governance is the acceptance by management of the inalienable rights of shareholders
as the true owners of the corporation and of their own role as trustees on behalf of the
shareholders. It is about commitment to values, about ethical business conduct and
about making a distinction between personal and corporate funds in the management
3
<https://www.caclubindia.com/articles/importance-of-corporate-governance-and-companies-act-2013-
24923.asp> last visited on 10-11-2017 at 11:06 pm

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of a company.” “Corporate Governance is the application of best Management
practices, Compliance of law in true letter and spirit and adherence to ethical standards
for Effective Management and distribution of wealth and discharge of social
Responsibility for sustainable development of all stakeholders.”4

3. What Constitutes Good Governance?

Corporate Governance may be defined as a set of systems, processes and principles

which ensure that a company is governed in the best interest of all stakeholders. It is
the system by which companies are directed and controlled. It is about promoting
corporate fairness, transparency and accountability. In other words, 'good corporate
governance' is simply 'good business'. It ensures:

 Adequate disclosures and effective decision making to achieve corporate

objectives;
 Transparency in business transactions;
 Statutory and legal compliances;
 Protection of both shareholder and stakeholder interests;
 Commitment to values and ethical conduct of business

The fundamental objective of corporate governance is to enhance shareholders' value

and protect the interests of other stakeholders by improving the corporate performance
and accountability. Hence it harmonizes the need for a company to strike a balance at
all times between the need to enhance shareholders' wealth whilst not in any way
being detrimental to the interests of the other stakeholders in the company. Further, its
objective is to generate an environment of trust and confidence amongst those having
competing and conflicting interests. It is about commitment to values, about ethical
business conduct and about making a distinction between personal and corporate funds
in the management of a company. Ethical dilemmas arise from conflicting interests of
the parties involved. In this regard, managers make decisions based on a set of
principles influenced by the values, context and culture of the organization. Ethical

4
CS Nitin Kumar, ‘A study of corporate governance under the companies act, 2013’Available online at
<www.ajms.co.in> last visited on 11-11-2017 at 9:31 am

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leadership is good for business as the organization is seen to conduct its business in
line with the expectations of all stakeholders.5

4. Corporate Governance under the Companies Act, 2013

The Companies Act, 2013 focuses on good corporate governance practices by

increasing the roles and responsibilities of the Board, protecting shareholders’ interest,
bringing in a disclosure based regime and built in deterrence through self regulation.
The 2013 Act significantly changes the way companies are governed. The Act
provides for the following provisions:

4.1. Board functioning

4.1.1. Appointment of Board

The Companies Act, 2013 provides that a public as well as a private company can
have a maximum of fifteen directors on the Board and appointing more than fifteen
directors would require approval of shareholders through a special resolution in the
General Meeting. It also provides for appointment of at least one woman director on
the Board for such class or classes of companies as may be prescribed. The Act makes
it mandatory for a company to have minimum one director who has stayed in the
country for a period of 182 days in the previous calendar year.6

4.1.2. Disqualification of directors

The Companies Act, 2013 makes directors’ disqualification more stringent, includes
more scrutiny around related party transactions. The 2013 Act includes the following
additional grounds of disqualification: (i) A person who has been convicted of an
offence dealing with related party transactions at any time during the past five years.
(ii) The directorship in private companies has also been brought under the ambit of
disqualification on ground for non-filing of annual financial statements or annual

5
Rajanikanta Khuntia, Companies Act, 2013 – A new wave of Effective Regulation and Corporate
Governance in India,( International Journal of Advancements in Research & Technology, Volume 3) p.149
6
CA. Raj Garg, Corporate Governance under the Companies Act, 2013, Available at
<http://www.iosrjournals.org/iosr-jbm/papers/Vol18-issue5/Version-1/I1805016769> last visited on 13-11-
2017 at 6:34 pm

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returns for any continuous period of three years, or failure to repay deposits for more
than a year.7

4.1.3. Number of Directorships

As per the provisions of the Companies Act, 2013, a person cannot become a director
in more than 20 companies instead of 15 as provided in the Companies Act 1956 and
out of this 20, he cannot be director of more than 10 public companies.8

4.1.4. Independent Directors

The meaning of the term independent director given in the Companies Act, 2013
contains most of the attributes of the listing agreement. An independent director should
be a person of integrity and possess relevant expertise and experience. The Act states
that independent directors should not have any material pecuniary relationship with the
company, its promoters, directors and subsidiaries which can affect the independence
of the director either in the current financial year or immediately preceding two years.
The Act provides for the following provisions with respect to Independent directors:

1. The Companies Act, 2013 states that every listed company will have at least
one-third of total number of directors as independent directors, with any
fraction to be rounded off as one.
2. The central government will have the power to prescribe minimum number of
independent directors in other class of public companies.
3. The Act, 2013 requires that every independent director should at the first
meeting of the Board in which he participates as a director and thereafter at the
first meeting of the Board in every financial year or whenever there is any
change in the circumstances which may affect his status as an independent
director, give a declaration that he meets the criteria of independence.
4. The Act provides for the selection of independent director from a data bank
maintained by an association, body or institute or as per the specification of the
Central government.
5. The independent director is not entitled to any stock options in the company.
6. No independent director should hold office for more than two consecutive
terms of five years each.9

7
Ibid.
8
Nitin Kumar, Companies Act, 2013: An analysis of the key Rules, Available online on
<www.saiompublications.com> last visited on 12-11-2017 at 3:56 pm
9
Supra Note, 5

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4.1.5. Code of conduct for independent directors

Schedule IV of the Act provides for a Code for Independent Directors which an
independent director needs to follow. “Code for independent directors” contains
detailed guidelines for professional conduct, roles and responsibilities. It covers the
following aspects:

 Professional Conduct;
 Seek clarification of information;
 Safeguard the interests of all stakeholders;
 Exercise duties and responsibilities in a bona fide manner; and
 Evaluation of the performance of board and management etc10

4.1.6. Liabilities of independent director

Under the Companies Act, 2013, an independent director and a non-executive director
not being promoter or KMP, will be held liable, only in respect of such acts of
omission or commission by a company, which had occurred with his knowledge,
attributable through board processes, and with his consent or where he had not acted
diligently.11

4.1.7. Board’s report

Section 134 of the Act seeks to make the board's report more comprehensive by
inserting disclosures to bring transparency in the functioning of the Board. Important
disclosures include:

 Extract of the Annual Return;

 A statement on declaration by the independent directors;
 Development and implementation of risk management policy for the company;
 Particulars of loans, guarantees or investments;
 CSR Policy and initiatives taken during the year;
 Policy on director’s appointment and remuneration; and

10
<http://indiamicrofinance.com/impact-new-companies-act-2013-corporate-governance.html> last visited
on 14-11-2017 at 9:46pm
11
Section 149(12) The companies Act 2013

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  Related party transactions not in the ordinary course of business and not at
arm’s length basis12

4.2. Audit and Auditors

4.2.1. Internal Audit

The Act, 2013 provides companies of certain class as may be prescribed to appoint an
internal auditor for internal auditing on the functions and activities of the company.
The board should either appoint chartered accountant or cost accountant or any other
professional for carrying internal audit. The Central government has the authority to
prescribe the manner and the time period in which the audit will be conducted and the
structure of reporting the same to the board.13

4.2.2. Appointment of auditors

Under the Companies Act, 2013, a company will appoint auditor at its first Annual
General meeting and the auditor appointed will hold its office till the conclusion of the
sixth Annual General meeting. Though the auditor will be appointed for five years the
matter relating to such appointment will be placed for ratification at each Annual
General meeting. Auditors have to report to central government any offence involving
fraud being committed against the company by its officer or employee.14

4.2.3. Rotation of auditors

Section 139 of the Companies Act of 2013 provides for compulsory rotation of
individual auditors and of audit firm. No listed company or a company belonging to
such class or classes of companies as may be prescribed, should appoint or reappoint
an individual as auditor for more than one term of five consecutive years; and an audit
firm as auditor for more than two terms of five consecutive years.15

4.2.4. Responsibilities of an auditor

12
Supra Note, 4
13
Nishant Sharma, Ruchita Dang, Analyzing Companies Act: A move towards better Governance, Available
online on <http://iosrjournals.org> last visited on 12-11-2017 at 10:32 am
14
Ibid.
15
Section 139, The Companies Act 2013

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The statutory responsibilities of the auditor fundamentally require the following:

 To make certain inquiries;

 To make a report to the company on the accounts examined;
 To make a proclamation in terms of the provisions set;
 Detection and Prevention of Fraud;
 Duty to report fraud; and
 Duty as to substantial precision.16

4.3. Committees of Board

4.3.1. Audit committee

Section 177 of the Companies Act, 2013 makes audit committees mandatory for listed
companies and other prescribed classes of companies. The Act provides that audit
committee should consist of minimum of three directors with independent directors
forming majority. The 1956 Act did not prescribe any academic or professional
qualifications for directors. The 2013 Act provides that majority of members of Audit
Committee including its Chairperson shall be persons with ability to read and
understand the financial statements.

 The role of the audit committee includes the following activities as per the
2013 Act:
 The recommendation for appointment, remuneration and terms of appointment
of auditors of the company;
 Review and monitor the auditor’s independence and performance, and
effectiveness of audit process;
 Examination of the financial statement and the auditors’ report thereon;
 approval or any subsequent modification of transactions of the company with
related parties;
 Scrutiny of inter-corporate loans and investments;
 Valuation of undertakings or assets of the company, wherever necessary;
 Evaluation of internal financial controls and risk management systems;
 Monitoring the end use of funds raised through public offers and related
matters; and

16
<https://blog.ipleaders.in/role-of-auditor-under-new-companies-act-2013/> last visited on 13-11-2017 at
5:21 pm

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  Authority to investigate into any matter in relation to the items specified above
or any such matter referred to it by the Board.17

4.3.2. Nomination and Remuneration Committee

Section 178 of The Act, 2013 requires all listed companies and other prescribed classes
of companies to constitute Nomination and Remuneration Committee that formulates
the criteria for selection of the directors, a policy relating to the remuneration for the
directors, Key Managerial Personnel and other employees. Such committee should
consist of three or more non executive directors and at least one-half of the members
should be independent directors.18

4.3.3. The Corporate Social Responsibility (CSR) Committee

The Act provides that a company meeting certain conditions should constitute a
Corporate Social Responsibility Committee of the Board, consisting of minimum of
three directors. The CSR Committee should consist of a minimum of one independent
director. The CSR committee should formulate and monitor CSR policies and discuss
the same in the Board’s report. Board has to approve CSR policy and disclose the
contents in the board report and place it on the company website. 19

4.3.4. Stakeholders Relationship Committee

The Act protects all security holders in addition to equity investors. It requires that a
company with more than 1000 shareholders, debenture holders, deposit holders and
other security holders at any time during the financial year shall constitute a
Stakeholders Relationship Committee. It will be chaired by a non-executive director
and consist of such other members as may be decided by the board. The committee
will consider and resolve the grievances of security holders of the company.20

5. Conclusion

17
<https://aishmghrana.me/2013/05/17/board-committee-in-companies-act-2013/> last visited on 14-11-
2017 at 4:54 pm
18
Ibid.
19
Supra note, 13
20
https://blog.ipleaders.in/overview-stakeholder-relationship-committee/> last visited on 14-11-2017 at
01:23 pm

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The concept of corporate governance has been attracting public attention for quite
some time in India. Corporate governance has become an issue of worldwide
importance. The corporation has a vital role to play in economic development and
social progress. It is the engine of growth internationally increasingly responsible for
providing employment, public and private services, goods and infrastructure. The
efficiency and accountability of the corporation is now a matter of both private and
public interest and governance has thereby come to the head of international agenda.

Therefore we can say the recently enacted Companies Act, 2013 is landmark
legislation by the government. Many provisions pertaining to independence of
directors, auditors, strict disclosure norms and protection of investors will have wide
implications and bring in greater transparency and accountability in the working of the
company and at the same time, minimise the incidents of corporate frauds. Companies
and stakeholders should start evaluating their position vis-à-vis that required under the
new regime and make strategies accordingly. The Act is forward looking in nature and
is at par with international best practices. However, the effectiveness of this
legislation, like all other, will depend on its implementation. The Ministry of
Corporate Affairs should issue circulars and clarifications to ensure smooth
implementation of the provisions. Corporate should ensure that they follow the law not
just in letter but in spirit also as the true value of Corporate Governance lies beyond
compliance.

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