Corporate Governance – Theory and Practice

Corporate Governance is much more than only compliance. Best practices in Corporate Governance set standards that are often higher than what is prescribed in laws and regulations. While the arithmetic of Board composition is prescribed in law, the quality of composition is very important for the functioning of the Board of Directors. Law prescribes independence for independent directors, but true independence is a state of mind. As a result, a number of Boards in India do not have truly independent directors. Another important aspect for proper functioning of a Board is its role clarity. The Board is accountable for its action to all stakeholders, and not only to shareholders.

Since the functioning of the Board of Directors is critical in ensuring Corporate Governance, periodic Board Evaluation and the performance evaluation of Directors becomes very important. Performance Evaluation of Directors can be done in-house or through an external agency. Performance evaluation of Directors by an external agency has been found to be more objective. If a Director’s performance evaluation yields an unsatisfactory conclusion, he or she should not remain on the Board. If persuasion does not succeed, the Board should remove the Independent Director, though, this should not lead to the removal of Independent Directors only because they do not toe the line of management.

It is imperative for good Corporate Governance that the Founders and the Board should put in place a process of succession planning so that at any given time, the company has a good leadership. Also, the Founders should not overstay on the Board. Their interests as owners can be protected by good professional leadership as a result of succession planning. Succession Planning is an excellent Corporate Governance Practice.

The basic precepts of good Corporate Governance are fundamental to all organisations. Every organisation, big or small, should have clarity of roles and responsibilities, a focus on strategic objectives and prudential risk management, appropriate financial management, and disciplined accountability and transparency to members, shareholders, and stakeholders. For more information: http://excellenceenablers.com/

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 

Role of Internal Audit in Corporate Governance

It has been widely recognized that the role of the Internal Audit has become increasingly more important in terms of creating good Corporate Governance structures. In today’s business environment, Internal Audit provides the management with a far broader range of information. This strengthens the management and helps it take prompt decisions concerning the organization’s financial, operational and compliance related issues to improve effectiveness, efficiency, and the economy.  Internal Audit is important because the Internal Audit function is the eyes and ears of the management. It is a significant part of a preventive vigilance mechanism.

Clearly, without a sound Internal Audit system, the Board and the management will not be able to identify process gaps, human errors, and even frauds. The sole purpose of the Internal Audit is to enhance Corporate Governance and support the Board of Directors in fast and accurate decision-making. Therefore, Internal Audit has the responsibility of getting into the details of representative transactions to study, and suggest remedies, for identified shortcomings. Based on its findings, the Internal Audit recommends changes to improve processes and follows up on their implementation.

An organization only maintains the effectiveness and efficiency by following the policies and guidelines, which also help it to deliver quality products and services to the clients. The Internal Audit is certainly one of the most dynamic yet important ingredients of a good corporate governance structure. It is best positioned to provide assurance when its resource level, competence, and structure are aligned with organizational strategies. An effective Internal Audit leads to a fair presentation of the financial statements and thus increases stakeholders’ confidence. Since every business has inherent risks, it is the function of Internal Audit, acting in concert with the risk management function, to identify risks, and put in place acceptable risk mitigation mechanisms. 

However, Internal Audit can function effectively only if it enjoys the complete trust and support of management and the Board. Without that support, Internal Audit will not be taken seriously by some functional heads in the company. By maintaining its independence, internal audit can perform its assessments objectively, providing management and the board an informed and unbiased critique of governance processes, risk management, and internal control.

Therefore, Internal Audit can add value by providing advisory and consulting services, intended to improve governance, risk management, and control processes, so long as it assumes no management responsibility. This is vital to maintaining Internal Audit’s objectivity and avoiding conflicts of interest. Selection of the type of audits or services to be performed should be based on the audit activity’s authority, maturity, and purpose, as well as the organization’s needs and issues. For more information: http://excellenceenablers.com/