Corporate Governance in India

Arindam Das

• Publisher: Routledge
• Year: 2019
• Print ISBN:
  9781138581128
• eBook ISBN:
  9780429015687
• Topic: Business
• Subtopic: Business History
• Index: Business

This book looks at how we can promote better governance practices in business organizations of developing economies. It presents a mix of conceptual perspectives and observations on corporate governance practices in a concise manner and illustrates through empirical evidence drawn from the Indian business environment. The secondary data analysis provides insights into Indian firms' corporate governance practices. This book is a useful reference for anyone who wishes to identify leading practices and develop broad recommendations applicable to corporate governance practices in developing economies in general.

Part I

Introduction

1 Business model, strategy, governance and performance of the firm

Purpose of the firm and its business model

Way back in 1937 Ronald Coase asked a fundamental question about the purpose and existence of firms in his paper, “The nature of the firm.” The essential idea behind his question was why certain economic activities take place within a firm and not as transactions in the market (Fontrodona and Sison, 2006). Of course, Coase came up with an explanation – a firm essentially is an instrument in the service of economic efficiency.

Taking Coase’s argument further, one would ask, how and why the firm reduces the cost of production and what makes it more cost-effective than market transactions, and can we take it for granted that the firm, by its very existence, minimizes transaction costs?

Further theory developments, especially the concept of the principal-agent relationship within the firm, resource based views, and the fact that a firm is essentially a complex web of players and interactions, explain how firms are able to reduce costs in certain situations, and how in certain instances they would not be able to achieve economic efficiency. This may also explain, albeit partially, why costs and value created are different for any given set of firms, even though they operate in similar environments with similar resources.

Thus, one of the primary challenges for management and business professionals is about creating superior value for the firm in a competitive marketplace and sustaining this superior value creation. The concept of the business model is useful in explaining how superior value could be created by a firm. The key functions of a business model are to articulate the firm’s value proposition by reflecting on management’s hypothesis in defining the ways the enterprise delivers and captures value: identify a market segment, and define the structure of the value network required by the firm to create and distribute the offering (Teece, 2010). A sustainable business model involves segmenting the market, specifying the revenue generation mechanisms for the firm, estimating the cost structure and profit potential of producing the offering, describing the position of the firm within the value network, linking suppliers and customers, identifying potential complementors and competitors, and finally it should formulate the competitive strategy by which the firm will gain and hold advantage over its rivals.

Firm performance and role of strategy

When we study business organizations, we observe significant variation in their performance. It varies for firms with similar resources and capabilities within the same industry sectors, having been subjected to similar external stimuli and constraints, and it varies with time as well. And, over time, some business organizations get wiped from the market, while others continue to create value, and they evolve as the business environment and opportunities change. For example, Japan’s Sumitomo group, which is a conglomerate today, traces its origins back to the copper mining business in the early 17th century. In essence, the most efficient and effective companies win.

Researchers argue that the strategies a company pursues have a major impact on its performance relative to its competitors. In addition, to create sustained superior value for its owners as well as other stakeholders, a firm must engage in business model innovation, coupled with strong strategy formulation and execution practices. A firm’s managers, under the guidance of the leadership team, carry out analysis of pertinent information to identify appropriate strategies for the firm, and implement them to achieve sustained competitive advantage.

A strategy formulation process primarily involves reviewing the firm’s existing business model, its mission, vision and goals, and subsequently carrying out analyses of the external business environment and internal environment. The external business environment analysis helps the managers identify threats and opportunities, and the internal business environment analysis helps the firm recognize its strengths and weaknesses, associated with its people, processes, capabilities and resources, both financial and non-financial. Such environment analysis helps the firm to make the right strategic choices. Next, the firm develops its corporate-level strategies which define the broad contours of its business activities and inter-relationship among business divisions, business-level strategies which deal with developing competitive advantage in the products and services it offers to the customers, and function-level strategies which help improve the functional capability of people and the organization.

In contrast to the strategy formulation process, which is primarily analytical and involves decision-making at the highest level, the strategy implementation process is essentially operational in nature, and involves almost the entire workforce who execute the strategic decisions taken at the formulation stage. It also involves designing organization structure, developing an organizational culture, and the processes and control systems to measure and evaluate performance.

The three jobs of management, according to Peter Drucker, are managing a business, managing managers, and managing workers and work (Drucker, 2012). Thus, successful companies transform key management processes to focus not only on strategy formulation and implementation, but also on organizational alignment and workforce alignment, strategy communication, and promoting best practices. In doing so, the company positions itself uniquely in the competitive landscape, and creates value in a sustainable manner.

Importance of governance

Having deliberated on the role of business models and strategy in capturing and delivering value for the organization, we need to explore the importance of governance in value creation.

The Cadbury Committee, UK defines governance as:

a system of rules, procedures and processes by which a company is directed and controlled. Specifically it is a framework by which various stakeholder interests are balanced and efficiently and professionally managed. (Cadbury, 1992)

In other words, governance is the process of determination of the broad uses to which organizational resources will be deployed and the resolution of conflicts among the multitude of participants in organizations (Daily, Dalton and Cannella, 2003). The context is critical due to the diversity of participants in a modern organization. A modern organization is run by a management team that is responsible for carrying out the management functions. However, while this management team runs the day-to-day operations and takes decisions on behalf of the company, it normally does not include the owners of the company. The owners and the management team are typically bound by a principal-agent contract whereby the management team is the agent of the principal, i.e., the owners, and it is the agent’s responsibility to act and make decisions that creates and captures maximum value for the owners.

The Organisation for Economic Cooperation and Development (OECD) defines corporate governance as:

Corporate Governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate Governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. (OECD, 2015)

The OECD acknowledges the multi-dimensionality of the relationship that exists between the interested parties in the organization. It is not merely a principal-agent relationship. A comprehensive definition of corporate governance is provided by the Institute of Company Secretaries of India (ICSI) as:

Corporate governance is not just corporate management; it is something much broader to include a fair, efficient and transparent administration to meet certain well-defined objectives. It is a system of structuring, operating and controlling a company with a view to achieve long term strategic goals to satisfy shareholders, creditors, employees, customers and suppliers and complying with the legal and regulatory requirements, apart from meeting environmental and local community needs. When it is practised under a well laid out system, it leads to the building of a legal, commercial and institutional framework and demarcates the boundaries within which these functions are performed. (Arya, Tandon and Vashisht, 2003)

As a multitude of players with differing objectives, some with executive powers and others without, tend to drive decisions and actions at the firm, it becomes necessary to align on the broad objectives of the firm, how they need to be achieved and measured. The modern business enterprise distinguishes between the providers of capital to the firm and the managers, who make and execute decisions. Thus, corporate governance deals with protecting the interests of the owners and others who bring in capital, monitoring the activities of the executive management, and setting broad directions to the executive management. It also becomes important to comply with applicable regulatory frameworks, and address the needs of the larger external stakeholders, who could be impacted by the business activities of the firm – the firm must realize that it is part of society and owes certain responsibilities to that society. The presence of strong governance standards provides better access to capital, which aids economic growth for the firm.

To summarize, the business model deals with the building blocks of a firm’s business, and strategic functions deal with the firm’s unique positioning, trajectory and supervision of implementation of strategic initiatives. In contrast, as Capasso and Dagnino (2014) suggest, the governance function deals with the congruence assessment between the firm’s chosen strategy and the interests of the owners and other relevant stakeholders represented in the board of directors, and the effective appraisal of managerial actions.

In the following chapters we explore the theoretical underpinnings of corporate governance, and evolution of practices, regulations, and frameworks.

References and further reading

Arya, P. P., Tandon, B. B., & Vashisht, A. K. (2003). Corporate Governance. New Delhi: Deep and Deep Publications Pvt. Ltd.

Cadbury, A. (1992). Report of the Committee on the Financial Aspects of Corporate Governance (Vol. 1). London: Gee & Co. Ltd.

Capasso, A., & Dagnino, G. B. (2014). Beyond the “silo view” of strategic management and corporate governance: Evidence from Fiat, Telecom Italia and Unicredit. Journal of Management & Governance, 18(4), 929–957.

Daily, C. M., Dalton, D. R., & Cannella Jr, A. A. (2003). Corporate governance: Decades of dialogue and data. Academy of Management Review, 28(3), 371–382.

Drucker, P. (2012). The Practice of Management. London: Routledge.

Fontrodona, J., & Sison, A. J. G. (2006). The nature of the firm, agency theory and shareholder theory: A critique from philosophical anthropology. Journal of Business Ethics, 66(1), 33–42.

Leblanc, R. (2016). The Handbook of Board Governance: A Comprehensive Guide for Public, Private, and Not-for-Profit Board Members. Hoboken, NJ: John Wiley.

OECD (2015). G20/OECD Principles of Corporate Governance. Paris: OECD Publishing. https://doi.org/10.1787/9789264236882-en. Last accessed 7 April 2019.

Teece, D. J. (2010). Business models, business strategy and innovation. Long Range Planning, 43(2–3), 172–194.

2 Theories and models of corporate governance

Essential elements of governance

In Chapter 1 we studied how corporate governance integrates with the functions of management and strategic planning to create and capture value.

The four key elements of corporate governance are transparency, responsibility, accountability, and fairness. Transparency deals with ensuring timely, adequate, and accurate disclosure of all material information. These disclosures must be over and above the statutory provisions given under rules and regulations. In fact, corporate governance’s fundamental objective is not only the fulfilment of the legal requirements, but also ensuring the board’s commitment to managing the company in a transparent manner for creating value.

Apart from ensuring transparency, the board has to take responsibility for its decisions: it has to balance its overall responsibility to shareholders with obligations to other stakeh...

Table of contents

• Cover
• Half Title
• Series Page
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• List of figures
• List of tables
• List of abbreviations
• PART I: Introduction
• PART II: Empirical evidence from India
• PART III: Summary: learning from the Indian experience
• Index