Shareholder Democracy

A company’s shareholders are like an electorate in a democracy. Their views and voice must count. This is important because the shareholders are the owners of the company. Recognising this, the Companies Act, 2013 and SEBI’s LODR Regulations, 2015 have given a number of rights to the shareholders, including the right to vote on some important matters such as appointment of directors and auditors, managerial remuneration, approval of financial statements etc. Shareholders exercise these rights through general meetings.

Sometimes, two or more sets of shareholders enter into an agreement known as the Shareholders’ Agreement (SHA). This is important and useful to secure the rights and interests of the parties to the agreement. Parties to an SHA often have more information, better information or faster information. This creates information asymmetry and other shareholders suffer in comparison. This asymmetry of information are often in nature of Related Party Transactions (RPTs). Such RPTs are sometimes not at arms length and not in the ordinary course of business. Shareholders who are parties to the SHA often act in concert and this is frowned upon by regulators. However, SHAs cannot be avoided since they are based on which big ticket investments come into a company.   

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Aspects of Corporate Governance

Corporate governance is driven by the value system that a company follows. It is a set of principles, system and processes that acts as a guideline as to how a company can be governed, directed and managed. Corporate governance is often mistaken for compliance. Good Corporate Governance is based on values whereas compliance is in response to law and regulations. Corporate governance flows from the culture of the organisation. The right tone has to be set at the top.

Research has shown that markets attach a governance premium to the share prices of well-governed entities.  At the same time, there is a governance discount for companies where there could be murmurs that things are not okay.

The Comply or Explain (CorEx) principle in corporate governance is relatively new in India. It is based on the principle that if a company does not comply with a provision of law, it should explain the reason for the same to the shareholders, usually in the general meeting. However, CorEx will work only if shareholders ask the right questions to the management, and demand satisfactory answers. In the Companies Act, 2013, Corporate Social Responsibility (CSR) is the only provision which follows the principle of CorEx.

Another important contributor to corporate governance is Board diversity because varying and diverse backgrounds of the board members will ensure better attention to the interests of all stakeholders. Board diversity should be understood as much broader than only gender diversity. It should consider diversity of experience, expertise, background, geographies, age etc.

Constructive tension between the Board and the management is vital for corporate governance.  Peaceful coexistence between them yields sub-optimal results since there it could result in the Board agreeing to the management without constructively challenging it. The management too could get into a comfort zone of not providing enough alternatives etc for a constructive discussion.

Importance of Good Corporate Governance

It is said that the (good) governance is the soul of any growing society. It is true to all the successful businesses as well; to achieve its goal it is essential for the organization to follow certain guidelines. This is possible only under good governance, or the 'Corporate Governance', what we call it, generally. Good corporate governance in india is referred to as the method of leading a firm; through this governance, a company is carried and managed, as per the stakeholders’ requirements. Corporate Governance deals with formative ways to take operational and tactical decisions. It offers complete authority and thorough responsibility to the Board of Directors (BODs).

But, sometimes governance can turn into muddles as it is the fusion of process and arrangement constructed to aid the firm to accomplish its target. Hence, there are risks involved, some estimated and a few unforeseen. This is when the 'Internal Audit' plays a significant role. Through Internal Audit, the BOD avails the objective certainty of the efficiency of risk management, governance procedure, and internal control.

Internal Audit

Internal audit plays a crucial role in an organization’s corporate governance mechanisms and manoeuvres. It verifies that the firm meets the terms with the laws and all the parameters. It also supervises the operational results and validates the authenticity of the company’s bookkeeping. It provides the fortification against the wastage, exploitation and, on top of all, against the probable fraud. Not only this, but it also strives to detect the internal collapse. In case the management and the Board of Directors are not performing their duties as envisioned, then additional advice and recommendations are provided by the internal auditors, in order to improve the situation. Let's take the example of the recent collapse of IL&FS, India's one of the largest infrastructure and financial development companies. Had there been a provision of internal audit, the situation could have been different. The case of Satyam is also no different.

In a nutshell, internal audit provides an even-handed observation and delivers independent assurance that the risk management, internal control and governance of a firm are functioning efficiently. Internal audit is the unsung protagonist of corporate governance.

Internal Audit Procedures

The first and foremost step is to detect the area where auditing is essential, such as the operational departments where the company’s policies are used. Then define how frequent it needs to be practiced, as the internal audit can be executed on an annual, monthly or even on a daily basis. It differs from department to department, for instance, the manufacturing department might be audited every day due to the quality assurance, and on the other hand, the sales department may be audited monthly or annually. Scheduling audits are always preferred, as to provide managers with time to prepare. And at the end comes the documentation of the results, as the objective is to find gaps in obedience and to brainstorm the techniques to bridge the gap.
An organization only maintains the effectiveness and efficiency by following the policies and guidelines, which also helps them to deliver quality products and services to the clients. If we are looking for an effective corporate governance then the internal audit is one such tool that needs to be diligently practiced, which assures the constant quality of work. For more information visit us at http://www.excellenceenablers.com