flowchart LR S[Shareholders<br/>Principals] -- delegate --> M[Managers<br/>Agents] M -- report --> B[Board of Directors] B -- monitor --> M B -- accountable --> S A[(Auditors / Regulators / Disclosures)] -. independent assurance .-> B A -. .-> S style S fill:#E3F2FD,stroke:#1565C0 style M fill:#FFF3E0,stroke:#EF6C00 style B fill:#FCE4EC,stroke:#AD1457 style A fill:#F1F8E9,stroke:#558B2F
13 Corporate Governance
13.1 What is Corporate Governance?
Corporate governance is the system by which companies are directed and controlled — the famous opening sentence of the Cadbury Report (UK, 1992) (cadbury1992?). It is the set of rules, practices and processes that guide how a company makes decisions, manages risk, and reports performance. Governance answers four questions in every firm: Who decides? Who is accountable to whom? How are conflicts of interest managed? How is performance measured and disclosed?
The OECD’s working definition: “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. It 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” (oecd2015?).
TipThree Working Definitions
| Source | Definition | What it foregrounds |
|---|---|---|
| Cadbury Committee (1992) | “The system by which companies are directed and controlled.” | Direction and control |
| OECD (2015) | “Relationships between management, board, shareholders, other stakeholders.” | Stakeholder structure |
| Sir Adrian Cadbury (later) | “Holding the balance between economic and social goals, and between individual and communal goals.” | Balance |
13.2 Why It Matters — Agency Theory
The economic foundation of corporate governance is agency theory (Jensen & Meckling, 1976) (jensenmeckling1976?). In a public company, ownership (shareholders, the principals) is separated from control (managers, the agents). Agents have private information about the firm and may pursue their own interests at the principal’s expense — empire-building, perks, risk-aversion, short-termism. The cost of this divergence is the agency cost.
Governance mechanisms — boards, audits, disclosures, incentives, takeover threats — exist to reduce agency costs by aligning the agent’s interest with the principal’s.
13.3 OECD Principles
The OECD/G20 Principles of Corporate Governance (latest revision 2023) are the global benchmark, used by IOSCO and incorporated into many national codes (oecd2015?). The six principles:
TipSix OECD/G20 Principles of Corporate Governance
| # | Principle | Core idea |
|---|---|---|
| 1 | Ensuring the basis for an effective corporate governance framework | Promote transparent, fair markets and the efficient allocation of resources |
| 2 | Rights and equitable treatment of shareholders | Protect shareholder rights; treat shareholders fairly |
| 3 | Institutional investors, stock markets, and other intermediaries | Their incentives and behaviour matter for governance |
| 4 | Role of stakeholders | Recognise stakeholder rights established by law or mutual agreement |
| 5 | Disclosure and transparency | Timely, accurate disclosure of all material matters |
| 6 | Responsibilities of the board | Strategic guidance, oversight of management, accountability |
13.4 Pillars of Good Governance
Most national codes condense the OECD into four practical pillars.
TipFour Pillars of Good Governance
| Pillar | What it asks |
|---|---|
| Transparency | Are decisions and disclosures clear and accessible? |
| Accountability | Is each person answerable for their actions and outcomes? |
| Fairness | Are all shareholders, including minority and foreign, treated equitably? |
| Responsibility | Does the firm act in the best long-term interest of all stakeholders? |
13.5 Major Committee Reports — A Tour
The architecture of modern corporate governance was built incrementally by a sequence of major committee reports.
13.5.1 Global
TipGlobal Milestones in Corporate Governance
| Year | Report / Law | Key contribution |
|---|---|---|
| 1992 | Cadbury Report (UK) | First definition; split CEO/Chairman; audit committee |
| 1995 | Greenbury Report (UK) | Director remuneration |
| 1998 | Hampel Report (UK) | Combined Code |
| 1999 | OECD Principles | First global benchmark; revised 2004, 2015, 2023 |
| 2002 | Sarbanes-Oxley Act (US) | Post-Enron / WorldCom; CEO/CFO certification, internal controls (Sec. 404) |
| 2003 | Higgs Report / Smith Report (UK) | Independent directors; audit committees |
| 2010 | UK Stewardship Code | Institutional investors’ responsibility |
13.5.2 India
TipIndian Milestones in Corporate Governance
| Year | Report / Law | Key contribution |
|---|---|---|
| 1998 | CII Code on Corporate Governance | First voluntary Indian code |
| 2000 | Kumar Mangalam Birla Committee | Listing requirement: Clause 49 introduced |
| 2003 | Naresh Chandra Committee | Auditor-client relations |
| 2003 | Narayana Murthy Committee | Strengthened Clause 49 — independent directors, audit committee |
| 2009 | Satyam scandal & MCA Voluntary Guidelines | Prompted statutory reform |
| 2013 | Companies Act, 2013 | Statutory framework — independent directors, audit committee, vigil mechanism, CSR |
| 2015 | SEBI LODR Regulations | Listing Obligations and Disclosure Requirements |
| 2017 | Uday Kotak Committee | Strengthened LODR — separation of CEO/Chairman, board diversity |
13.6 The Indian Statutory Framework Today
Three pillars hold up Indian corporate governance for listed companies.
13.6.1 Companies Act, 2013
The Act made governance statutory. The most-tested provisions:
TipKey Governance Provisions — Companies Act 2013
| Section | What it does |
|---|---|
| §149 | Independent directors — at least 1/3rd of board for listed companies; tenure 5+5 years |
| §177 | Audit committee — minimum 3 directors, majority independent; vigil mechanism in §177(9) |
| §178 | Nomination & Remuneration Committee; Stakeholders Relationship Committee |
| §134 | Board’s report — disclosure requirements |
| §135 | Corporate social responsibility (covered in topic 11) |
| §139 | Auditor appointment, mandatory rotation |
| §166 | Duties of directors — fiduciary duty, due care, no conflict of interest |
13.6.2 SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR)
LODR governs listed entities. The most-tested rules:
- Board composition — minimum number of directors, independent directors (at least one woman director).
- Separation of CEO and Chairman roles — for top 500 listed entities (Kotak Committee recommendation).
- Audit committee, NRC, SRC and Risk Management Committee mandates.
- Quarterly results disclosure, related-party transactions, material events.
- Annual report on corporate governance and certification by CEO/CFO.
13.6.3 SEBI (Prohibition of Insider Trading) Regulations, 2015
Covered in the previous topic — protects market integrity by criminalising trading on UPSI.
13.7 Board Structures and Roles
A modern board has three classes of directors and several mandatory committees.
TipThree Classes of Directors
| Class | Description |
|---|---|
| Executive | Full-time directors involved in day-to-day management — MD, CEO, CFO |
| Non-executive (non-independent) | Promoter or nominee directors not in management |
| Independent | No material pecuniary relationship with the company; provide objective oversight |
TipMandatory Board Committees (Listed Companies)
| Committee | Primary task |
|---|---|
| Audit Committee | Oversee financial reporting and audit |
| Nomination & Remuneration Committee | Director selection and pay |
| Stakeholders Relationship Committee | Investor grievances |
| Risk Management Committee | Identify and manage enterprise risk |
| CSR Committee | Recommend CSR policy and spend |
13.8 Models of Corporate Governance
Three broad models exist globally:
TipThree Global Models
| Model | Where | Distinctive feature |
|---|---|---|
| Anglo-American | US, UK | Single-tier board; shareholder-centric; dispersed ownership; market for corporate control |
| German / Continental European | Germany, Netherlands | Two-tier board (supervisory + management); co-determination with employees |
| Japanese | Japan | Keiretsu — interlocking ownership with banks and group firms; main-bank monitoring |
India broadly follows the Anglo-American model with significant promoter ownership — closer to family-owned conglomerates than to widely-held US firms.
13.9 Practice Questions
Q 01
Cadbury
Easy
"Corporate governance is the system by which companies are directed and controlled" — this definition is from:
View solution
Correct Option: B
The opening line of the Cadbury Report (UK, 1992) — the foundational text of modern corporate governance.
Q 02
Agency Theory
Medium
Agency theory in corporate governance is associated with:
View solution
Correct Option: B
Jensen & Meckling (1976) formalised the principal–agent problem in corporate governance. Berle & Means earlier (1932) flagged the separation of ownership from control.
Q 03
Pillars
Easy
Which of the following is not one of the four pillars of good corporate governance?
View solution
Correct Option: C
The four pillars are Transparency, Accountability, Fairness and Responsibility. Profit maximisation is a goal of the firm, not a pillar of governance.
Q 04
SOX
Medium
The Sarbanes-Oxley Act (2002) was enacted in the US in response to:
View solution
Correct Option: B
Enron (2001) and WorldCom (2002) prompted SOX — most famous for §404 internal-control requirements and CEO/CFO certification of accounts.
Q 05
India
Medium
Match the Indian committee with its principal contribution:
| (i) | Kumar Mangalam Birla | (a) | Strengthened Clause 49 — independent directors, audit committee |
| (ii) | Narayana Murthy | (b) | Auditor–client relations |
| (iii) | Naresh Chandra | (c) | Introduced Clause 49 of the Listing Agreement |
| (iv) | Uday Kotak | (d) | Separation of CEO and Chairman; board diversity |
View solution
Correct Option: A
Birla → Clause 49 introduced (2000); Murthy → Clause 49 strengthened (2003); Naresh Chandra → auditor–client (2003); Kotak → separation, diversity (2017).
Q 06
Companies Act
Medium
Under the Companies Act, 2013, the audit committee is provided for in:
View solution
Correct Option: C
Section 177 covers the audit committee (minimum 3 directors, majority independent) and the vigil mechanism in §177(9).
Q 07
Independent Director
Easy
An independent director is one who:
View solution
Correct Option: B
An independent director provides objective oversight — they have no material pecuniary relationship with the company, its promoters or its management.
Q 08
Models
Medium
A two-tier board structure (separate supervisory and management boards) is the hallmark of:
View solution
Correct Option: B
Germany and other Continental European systems use a two-tier board, often with employee co-determination on the supervisory board.
ImportantQuick recall
- Corporate governance = system by which companies are directed and controlled (Cadbury, 1992).
- Foundation: agency theory (Jensen & Meckling, 1976) — separating ownership from control creates principal–agent costs.
- Four pillars: Transparency · Accountability · Fairness · Responsibility.
- Global milestones: Cadbury 1992 → OECD 1999 → Sarbanes-Oxley 2002 → Higgs 2003 → UK Stewardship Code 2010.
- Indian milestones: CII 1998 → Birla 2000 (Clause 49) → Naresh Chandra 2003 → Murthy 2003 → Companies Act 2013 → SEBI LODR 2015 → Kotak 2017.
- Companies Act 2013 — §149 (independent directors), §177 (audit committee, vigil mechanism), §178 (NRC, SRC), §134, §135, §139, §166.
- Three global models: Anglo-American (single tier), German (two tier with co-determination), Japanese (keiretsu, main-bank).