Corporate governance has been defined by the Securities and Exchange Board of India (SEBI) Committee on Corporate Governance as the approval by executive of the indisputable privileges of shareholders as the exact owners of the business and their individual responsibility as trustees on behalf of the stakeholders. Efficient and successful corporate governance is based on a commitment to values, ethical business conduct and clear distinction between private and company resources. In the management of a company, corporate governance emphasizes on the interests of the shareholders and investors over that of the management. In India, there have been numerous allegations of corruption and mismanagement in companies and one such case was in the Satyam Corporation (Gray & Manson 2011; Hanne 2003). For instance, over many years the Satyam Corporation, a company specializing in computer services, had been inflating its reported cash and bank balances, overstating its revenues and profits and understating its liabilities. This, although not being the first incident, brought to light the need for external control and monitoring measures on behalf of investors and shareholders. In the Satyam Corporation saga, the amount of the discrepancy was reported to exceed $1 billion and it shows how much there is to lose in case of a poor corporate governance. The Satyam Corporation case also highlighted the relevance of external auditors in verifying financial statements provided by a company’s management. This report seeks to explore corporate governance in India, to establish its relevance, efficiency, and effectiveness, and the impacts it has had on the business community so far.
Corporate Governance in India
In India, the mechanisms of corporate governance are borrowed from the Gandhian code of trusteeship and the command ideologies of the Indian supreme law. It highly emphasizes on the rights of the shareholders and charges the management of a given company with the responsibility of safeguarding the interests of these shareholders (Kaplan & Norton 1996). The corporate governance mechanism in India depends on a one-tiered board of directors that mostly constitutes of persons who are not executives in the company. They are usually elected by the shareholders under the unitary system. The executives serve as ex-officio members of the board, and the non-executive members take key positions in the auditing and compensation committees to provide a reliable system of checks and balances. The aim of combining executives and non-executives in the board is to create a body that caters for the interests of all the parties involved in the running of the company (Graham 2009). The executives represent the management while the non-executives represent the investors, shareholders and creditors of the company. Porter et al. (2008) confirms that the main responsibilities of the board include endorsing of the company’s business strategy, developing a working directional policy, appointment, supervision and remuneration of the company’s senior executives and ensuring that the company is accountable to its investors, creditors and tax authorities.
This system of checks and balances in corporate governance means to ensure that there are no cases of fraud and that the management does not waste the resources of investors, shareholders and creditors due to its selfish interests (Spencer, 2005). By representing of shareholders in the board of administrators, such mechanism protects their interests and prevents losses of their investments. The Indian system has therefore created a framework that protects the resources of shareholders and investors from fraudulent managements. The mechanism for corporate governance provides a network of both internal and external monitoring and control systems that create a well-balanced environment.
Internally, the non-executive members of the board are the committees on auditing and compensation. The compensation committee decides on the mechanisms of compensation for positive output. This can be in cash, shares or shares options as per the committee’s agreement. Since they are not liable to receiving these compensations, it is generally assumed that there will not be a conflict of interest (Moore & Brooks 2012). The auditing committee on the other hand decides on whether or not an audit is necessary and whether it will be internal or external. This means that the shareholders’ and investors’ elected representatives wield a lot of power as on how the company is being run. Under internal monitoring and control systems, the board of directors has the legal right to recruit, dismiss and compensate the senior executives of the company. In order to do this, they are required to review the performance of the disputed individual beyond the financial level. They monitor the decisions made by the individual in the company and the way they affect the company’s short and long-term objectives. When reviewing a manager’s capabilities in running the company, the board should look at more than just how much the company has earned during the manager’s tenure.
The board also should create policies for frequent internal auditing and control procedures that would assure interested parties of consistent economic reporting, operating competence and conformity with the corporate laws and regulations. The board of directors comprises of various committees with specific responsibilities, which should provide checks and balances within the system to prevent domination of a few individuals and create a well-balanced system of power distribution.
One of the board responsibilities is to control the way company executives award themselves unnecessary bonuses and salary increments to the detriment of the shareholders’ resources. Thereafter, the board should plan the remuneration of the employers of the company in order to ensure that the resources of the shareholders are spent efficiently. Remuneration is usually based on performance and is given in cash, shares or share options depending on the company policies and decided by the board. The board also authorizes the large shareholders and creditors to monitor the company in order to safeguard their own interests. This however means that the smaller shareholders do not get the chance to do the same as auditing services can be quite expensive. They therefore rely on the audit reports from their larger counterparts or those from the company itself. The external monitoring and control measures include services of an independent auditing firm and reporting to government regulatory bodies. The main regulatory body in this case is the Securities and Exchange Board of India (SEBI) and specifically the SEBI Committee on Corporate Governance. This is the government’s authority for ensuring that the rights and interests of shareholders and investors are protected (Whittington & Pany 2007). An audit is a scrutinizing search for evidence that, beyond doubt, the information provided by the management of an organization is accurate and reliable and that it provides extensive disclosure of all expected relevant information. The information is also assessed for its usefulness to other interested parties, as companies are required to give any information for all stakeholders and not just its shareholders, investors and creditors. After an audit, the report issued by the auditor is intended to increase the credibility of the financial statement provided by the company and therefore increase its usefulness to all stakeholders (Grove, Mock & Ehrenreich 1997). These financial statements are credible and useful if they do not mislead or misinform the reader, have a certain degree of accuracy and clarity in the explanatory notes, give a reasonable and impartial breakdown of the financial affairs and results, and based on the evidence provided in the audit report.
External auditing is used in order to verify the information provided by the management and bases on these three justifications:
(a) The Information Hypothesis
This hypothesis assumes that the intervention of an auditor improve the value of the information provided in the financial statements. It also suggests that auditors are necessary in a company because the information after auditing becomes more reliable and hence more useful to interested parties like shareholders, investors, creditors and tax authorities.
(b) The Agency Theory
This justification is based on a number of practical assumptions on the business management environment. First, according to this theory the owners and the managers (referred to as agents) of the business are both interested in increasing their own wealth through that business. The theory also assumes that the owners who are not involved in the day to day running of the business need a monitoring system in the form of a financial report from their agents (managers of the business). Another assumption of this theory is that informed individuals will benefit at the expense of the uninformed ones. In this case, the agents have more information than the owners do. For owners to believe information provided by the agents, the theory assumes that there must be an independent third party to verify this information. The theory also supposes the cost-effectiveness of external audits.
(c) The Insurance Hypothesis
This hypothesis states that auditors can provide a certain degree of insurance for people relying upon the audited information. Losses incurred because of relying on the audit results may be recovered as damages from auditors, based on the assumption of negligence on their part. This however does not mean that if a company fails due to mismanagement, it can blame the auditors. On the other hand, a successful damages claim against the auditor is mainly the same as a successful claim against a one’s insurer.
The fact that auditing improves the value of information provided by the management of a company in a financial statement highlights the importance of auditing to investors, shareholders and creditors, as they are the main recipients of the financial statements. Audits are useful to the executives in the company as they enable them to know how efficient their management strategies are (Brigham & Ehrhardt 2011). The use of external auditors is a common practice in the Indian corporate circles as this is not only effective but also reliable. Price Waterhouse Coopers is one of the most used auditing firms. Eternal auditors are more reliable in India because of a number of factors.
The first issue is Accountability. External auditors are not in any way connected to the management and therefore act in the best interests of primary stakeholders, also with regard to the wider interests of the general public (Fridson & Alvarez 2011). The stakeholders are identified by reference to the statute requiring an audit: and this is usually the company’s shareholders in general. In considering the ‘stakeholders’ instead of just ‘shareholders’ the auditors work in the interests of all interested parties thus ensure a relevance and accuracy that is non-partisan.
Parisse & Richman (2006) maintain that there is also the question of Integrity. Auditors are professionally bound by ethics that require them to act with integrity. This means that they are obliged to fulfill their responsibilities honestly, fairly, courageously and to respect confidentiality (Nicolai 2009). Confidential information obtained during an audit can only be disclosed when required in the public interest, or by an operation of law. This provides an ethical dimension to auditing that is the backbone of effective regulatory policies in regulatory bodies.
As Sampson (2001) confirms, there is the question of Objectivity and Independence. Auditors are usually objective since they are not interested parties in the company and thus they are able to provide impartial opinions without any bias, prejudice, compromise or conflicts of interest. Their independence means that they are free from situations and relationships, which would either impair their objectivity or cause a suspicion of even a slight possibility of bias (Anandaraian & Wen 1999).
Competence is another factor. Auditors are skilled professionals with excellent qualifications, training, and practical experiences. The profession demands a thorough understanding of financial reporting and business affairs, together with expertise in analyzing and compiling the evidence needed to form and support a particular opinion. Rigor is a factor too. Auditors should approach their work with special thoroughness and an attitude of professional skepticism (Angell & Smithson 1991). They always scrutinize critically the information and explanations they come across in their work and spend time in search of any available additional evidence that they may consider useful for the audit purposes. This simply means that they adopt a questioning attitude at all times during the audit to ensure that their findings answer all the clients’ questions. Auditors always apply professional judgment consciously taking account of the importance attached to their report and its possible effects on the relevant stakeholders (Garrison & Noreen 2003).
In addition, there is the question of clear, complete and effective communication. An auditor’s report contains a vivid expression of opinions and explanations of vital information that is necessary for a better and easier understanding of the given opinions. Auditors are known for their effectiveness in communicating their findings and giving reports that are clear and concise thus understandable to all interested parties (Guell 2011).
The other factor is Association. Auditors are specific when it comes to associating additional information with their reports. They only allow an inclusion of their reports in documents containing other information if they are sure that the additional information does not contradict or conflict with the matters brought up by their report and that the information is not in any way misleading. This is because most companies include into their reports the elements that the audit report does not specifically mean. The auditor has an ethical obligation to ensure that there is no conflict between the information contained in these reports and in the financial statements (Kemmerer 2006).
Furthermore, there is the principle of value provision. As stated before, auditors improve the perceived quality of financial reports and make them more reliable. After carrying out an audit, they present constructive observations that may come up from the audit process and thereby contribute to the effective operation of businesses. This stamps their relevance by translating the impact of their findings to the capital markets and the public sector. Auditing enables various interested groups to place greater reliance on the financial statements. Moreover, auditors are in the best position to advise to the board of directors on workable strategies and thus increase the management’s effectiveness (Lefley 1994).
Finally, there is the question of provision of assurance. Auditing financial statements is an assurance service, since a professional opinion regarding the truth and fairness is itself an assurance of the quality of the statements. The auditor provides an assurance for the benefit of the numerous interested parties, and it may not necessarily be expressed in terms of truth and fairness. In the case of auditing assurance means improving of the information quality, verifying that the given data is totally reliable and stating if it is not. The services that auditors provide for companies include business risk assessments, rating the performance of a business against predetermined criteria, and assessing the reliability of information provided by the management. They also evaluate the viability of new ventures such as e-commerce and the particular risks facing companies that are engaging in these new activities. The auditor is in a particularly good position to provide such services.
Despite the framework that is supposedly efficient for corporate governance, Indian businesses are still are at great risk of mismanagement due to the high levels of corruption both in the government and the private sector. This has been evidenced by the ranking of India as 94th out of 176 countries in the Transparency International’s Corruption’s Perception Index reported in 2012. The Indian authorities through the regulatory body, SEBI, have made quick and effective steps to curb the rampant corporate frauds by increasing the quality and extent of disclosures required. These steps enhance transparency and hence reduce cases of companies’ mismanagement and stakeholders’ misinformation (Lucey 2003).
According to Grove et al. (1997) andFridson & Alvarez (2011) a well-functioning capital market creates appropriate linkages of governance and information incentives between managers and investors. While the best agents to act as linkages are auditors because of their reliability, it can be compromised in a highly corrupted economy. An auditing firm may tailor its opinion to favor the respective company’s management based on how much consulting fees they have on a regular basis. This means that while auditing is a good way of checking the performance of the management systems used in a corporate, it is not the only method that should be used. Incorporating both internal and external monitoring and evaluation systems is much more effective for efficiently corporate governance to avoid cases of fraud and investor misinformation.
A good system of corporate governance has various principles that enforce its basic requirement of extensive and accurate accountability. The rights of shareholders should be respected, and this is possible if they are well informed. This means that a company with good governance mechanisms provides efficient information and encourages its shareholders to attend and actively participate in general meetings. It should also recognize that it has an obligation to provide accurate information to all the stakeholders, including those who are not shareholders, creditors or investors (Farbey, Land & Targett 1992). It should have a board that is sufficiently skilled and that can scrutinize and challenge the management systems where necessary. It should also have a code of conduct that promotes ethical conduct and responsible decision making amongst both the company executives and board members. It should ensure that all the provided information is factual and free from manipulations, and ensure that the management systems are clear enough for all interested parties to understand. Indian companies, despite the stringent regulatory measures implemented by SEBI, cannot be perfect examples of good corporate governance. Such situation exists because of the rampant corruption that undermines the rule of law and compliance to industry regulations by the big players. Indian boards of directors are expected to represent both the stakeholders (shareholders, creditors and investors) and the company’s employees in collectively drawing up company strategies that should be for the benefit of all the involved parties (Sherer & Turley 1997).