Corporate Governance Practices in India

A Synthesis of Theories, Practices, and Cases

Kenneth A. Loparo, Priyanka Kaushik Sharma

• Publisher: Palgrave Macmillan
• Year: 2015
• Print ISBN: 9781349704675, 9781137519351
• eBook ISBN: 9781137519368
• Topic: Business
• Subtopic: Business Ethics
• Index: Business

Corporate Governance Practices in India examines corporate governance practice in Indian industry. This book critically analyses the governance practice and evaluates the needs of corporate governance in the two major industries in India: Auto Industry and Heavy Engineering Industry.

1

Introduction

Corporate governance is the current buzzword in business jargon. It has become a subject of discussion in corporate boardrooms, academic circles, and governments around the globe. High profile corporate collapses in India (for example, Harsad Mehta’s securities scam, the Ketan Parikh scam, the C. R. Bansal scam, and, most recent of all, the Satyam fraud), and overseas (for example, the Junk Bond scam, Qwest, Global Crossing, Andersen, Enron, and WorldCom), have shattered the dreams of various investors, shocked governments and regulators alike and led to a questioning of the accounting practices of statutory auditors, and of corporate governance norms. Unethical business conduct and behavior, failure of boards of directors, flaws in external audits, failure in corporate strategies, unfettered power in the hands of the chairman/chief executive officer (CEO), lack of transparency, inadequate disclosures, fraud, lack of proper internal audits, weak internal control, the dubious role of rating agencies, and inadequate regulatory mechanisms are the most common governance problems or flaws noticed in all such corporate failures in India, the US, the UK, and other parts of the world.

What is Corporate Governance?

According to Patnaik, corporate governance ‘potentially covers the entire gamut of activities having direct or indirect influence on the financial health of the corporation.’¹ It covers a broad range of fields, from economics and management to law and accounting, and thus varies depending on the particular focus. Corporate governance is an instrument for satisfying all stakeholders of a corporate entity.

The origin of the word governance can be found in Latin, where ‘gubernare’ means to rule or to steer. According to J. Wolfenshon, ‘Corporate governance is about promoting fairness, transparency and accountability.’² In the proceedings of the Silver Jubilee National Convention of The Institute of Company Secretaries of India (ICSI), we see that:

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.³

The Kumar Mangalam Birla Committee report on corporate governance states in the endnote: ‘Corporate governance extends beyond corporate laws. Its fundamental objective is not mere fulfillment of the requirement of law but ensuring the board’s commitment to managing the company in a transparent manner for maximizing long-term shareholder value.’⁴

The debate on corporate governance transcends the realm of socio-economic-political and cultural environments. Hence, the model of corporate governance cannot be universal. Sir Adrian Cadbury advises Indian business leaders ‘not to import systems of corporate governance but to adapt internationally recognized principles to suit the country’s requirements because governance systems are not exportable.’⁵ They evolve in different parts of the world in different contexts. Hence, they need to be adopted in the context of their specific socio-economic-political and cultural environment.

Need for Industries to Explain Variations in Corporate Governance Compliance

No literature on corporate governance would be complete without giving the reader an insight into the actual realities of what happens in the corridors of power within the corporation. It is imperative to study the applicability of corporate governance norms in all industrial sectors of India. However, due to constraints imposed by non-availability of sufficient funds, as well as owing to the time required for a study of such massive magnitude, it was decided to confine this study of corporate governance to two major Indian industries – the automobile industry and the heavy engineering industry – in the hope that it may at least provide indications, general directions, and practices followed in respect of corporate governance in Indian industry as a whole. The present study seeks to examine critically governance practice and to evaluate the needs of corporate governance in these two major industries. The study will evaluate the state of compliance of the key governance parameters in both industries, in line with the statutory and non-mandatory requirements stipulated by the revised Clause 49 of the Securities and Exchange Board of India (SEBI) Listing Agreement, as well as the provisions required by the Companies Act of 1956.

Automobile Industry

The automobile industry is one of the largest industries. Due to its deep forward and backward linkages with several key segments of the economy, the automobile industry is having a strong multiplier effect on the growth of a country and hence is capable of being the driver of economic growth. It plays a major catalytic role in developing the transport sector on the one hand, and on the other hand helping the industrial sector to grow faster and thereby generating significant employment opportunities. Also, as many countries are opening their land borders for trade and developing international road links, the contribution of an automobile sector in increasing exports and imports will be significantly high.⁶ Among the forward linkages, the key generators of employment are the oil industry, distribution, after-sales service network, and supply of spares and replacements by the auto component industry. It is estimated that over 3 million persons are employed in the distribution and after-sales industry. Other critical forward linkages include the auto finance and leasing industry (estimated at Rs. 70 billion) and insurance (estimated at Rs. 35 billion). The biggest impact is on the auto component industry, which today has become a key sector in the Indian economy, its turnover being around US$ 15,000 million with exports of US$ 2873 million.⁷ As for the backward linkages, the automobile industry is the largest consumer of raw materials such as cold rolled and hot rolled steel, aluminum and zinc alloys, and also of high value rubber and plastics. Moreover, the automobile industry is the most important driver of the machine tool industry – the bedrock of industrial growth.⁸ It is due to these multiplier effects on the manufacturing and service industries that the auto industry is viewed as the engine of growth by developed economies. This multiplier effect is most pronounced in developed economies. For example, one out of every six persons employed in Germany is in the automobile or related industry, as compared to India’s one in 40 persons. This industry has registered an aggregate increase of over 200 per cent in the production of vehicles during the period 1995–96 to 2004–05.

The automobile industry in India is headed for interesting and challenging times and has reached significant milestones, from producing around 69,000 vehicles in 1960 to 10.8 million vehicles in 2007–08, including two-, three-, and four-wheelers. This industry accounts for 22 per cent of the country’s manufacturing gross domestic product (GDP).⁹ The automobile industry has a relatively low share (5–6 per cent) of industrial output in India compared to the 8–10 per cent share in developing countries such as Mexico and Brazil, and a much higher share of around 15–17 per cent in developed countries such as the US and Germany. The automotive industry has a 6 per cent share in the country’s industrial output and gross value added 5.5 per cent share in industrial employment, and more than 17 per cent share in the indirect tax of the government. In 2007–08, India manufactured about 8 million two-wheelers, 1.76 million passenger cars, 0.54 million commercial vehicles, and 0.5 million three-wheelers.¹⁰ India ranks second in the world (after China) in the production of two-wheelers, fifth in the production of commercial vehicles, and eleventh in the production of passenger cars. India is the largest tractor and three-wheeler manufacturer in the world and holds the fourth largest position in the world truck manufacturing sector.¹¹ The Indian passenger vehicles market is dominated by cars (79 per cent). Apart from this, motorcycles contribute 80 per cent of the two-wheeler segment. Tata Motors dominates over 60 per cent of the commercial vehicle market.

The automotive industry encompasses commercial vehicles, multi-utility vehicles, passenger cars, two-wheelers, three-wheelers, tractors, and auto components. There are 15 manufacturers of passenger cars and multi-utility vehicles, nine manufacturers of commercial vehicles, 16 of two- and three-wheelers, and 14 of tractors, as well as five of engines. The industry had investment of about Rs. 800,000 million in 2007 and has already attained a turnover of Rs. 1,650,000 million (US$ 34 billion).¹² According to the Automotive Mission Plan 2006–16, the automotive sector will be contributing 10 per cent of India’s GDP by the year 2016. In addition to this, after achieving this much growth the automotive industry will be able to provide employment for around 25 million people in the country.

Domestic sales figures for the automobile industry more than doubled over the ten-year period 1995–96 to 2004–05. The export performance of the Indian automobile sector has also exhibited a steady growth, registering a growth rate of 55.98 per cent. Automobile exports crossed the US$ 1 billion mark in 2003–04 and increased to US$ 2.76 billion in 2006–07.¹³ The industry is now on its way to becoming a major foreign exchange earner for the country.

The government has decided to implement the Rs. 17,180 million National Automobile Testing and R&D Infrastructure Project (NATRIP) to improve the global competitiveness of the Indian automotive sector. The project should help usher in better safety, emission, and performance standards, which will improve its export potential. World-class testing centers will be set up at Manesar and Chennai, and the existing facilities at ARAI in Pune and VRDE in Ahmednagar will be upgraded. Going forward, the organization plans to open three more centers in Silchar, Rai Bareilly, and Indore. All this is likely to boost the current exports of 100,000 million by a ten-fold increase within the next five to seven years.

The Indian automobile industry offers significant growth potential, given its existing low penetration levels and a fast growing economy with a burgeoning middle- and high-income group of consumers. In terms of manufacturing base, India offers some significant advantages: namely, a large pool of well-qualified manpower, which can also be utilized in fostering local research and development; availability of enough land and other natural resources, such as iron ore, coal, and bauxite; decreasing costs of funds and a well-defined legal environment. These factors of competitive advantage assume special significance in the light of changes in the business practices of automobiles majors with respect to increased Business Process Outsourcing (BPO) of key activities within the ambit of automobile companies. On the flip side, volumes are low, firms spend very little on R&D, the industry is fragmented, design capabilities are limited, and labor productivity is low. The future challenge for the Indian automobile industry would be to develop a supply base with emphasis on lower costs and economies of scale, develop technical and human capabilities, overcome infrastructural bottlenecks, stimulate domestic demand, and exploit export and international business opportunities. The key to success is to achieve the critical mass that would make India competitive and profitable for sustained investment.¹⁴

Heavy Engineering Industry

The engineering sector is the largest segment of the overall Indian industrial sector and its role has been accentuated with growing emphasis on infrastructure development. The engineering sector can be primarily categorized into heavy engineering and light engineering. The share of heavy engineering is about 80 per cent of the value, while the rest was contributed by the light engineering sector.¹⁵ The heavy engineering industry comprises capital goods/machinery and equipment and is broadly classified into electrical machinery and equipment and non-electrical machinery and equipment. The heavy engineering segment forms the majority of the engineering sector in India. The Indian engineering industry, including transport equipment, was estimated to be worth around Rs. 1.2 trillion in 2006. The engineering sector employed over 4 million skilled and semi-skilled workers (directly and indirectly).¹⁶ As per the annual survey of the Central Statistics Office (CSO), the engineering industry employs 27 per cent of total workers. In 2006–07, engineering exports accounted for 8 per cent of total employment that was generated by all export activities in the country.¹⁷

The performance of the heavy engineering sector is directly linked to the industry, which in turn depends on the performance of the overall economy. The heavy engineering industry is an intermediate industry and its demand depends on a variety of end-user industries, such as power, mining, oil and gas, consumer goods, automotive, and the general manufacturing sector.¹⁸ Companies in the light engineering sector act as major suppliers to the heavy engineering industry. The demand for heavy engineering goods is driven by investment in infrastructure. Sanket Rege, Research Analyst at IndiaInfoline, says, ‘The demand in the engineering sector is expected to be maintained primarily on account of the government focus on infrastructure development in the country, which is expected to continue in the long term. The profitability of the sector will continue to improve over the coming years. The margins are expected to remain strong due to increased demand.’

This industry comprises multinational companies, joint ventures, large domestic players, and regional players, in the organized sector. The majority of players in the heavy engineering industry have a well-defined market catering to spec...

Table of contents

• Cover
• Title Page
• Copyright
• Dedication
• Contents
• List of Tables
• Preface and Acknowledgments
• 1. Introduction
• 2. Conceptual Framework of Corporate Governance
• 3. Codes and Standards of Corporate Governance
• 4. Evaluation of Corporate Governance Compliance
• 5. Summary, Conclusions, and Suggestions
• Appendix 1: List of Sample Companies
• Appendix 2: Corporate Governance Parameter Scores
• Notes
• Bibliography
• Further Reading
• Index