Report of Narayana Murthy Committee on Corporate Governance Genesis & Rationale

Corporations pool capital from a large investor base both in the domestic and in the international
capital markets. In this context, investment is ultimately an act of faith in the ability of a corporations
management. When an investor invests money in a corporation, he expects the board and the
management to act as trustees and ensure the safety of the capital and also earn a rate of return that
is higher than the cost of capital. In this regard, investors expect management to act in their best
interests at all times and adopt good corporate governance practices.
Corporate governance is the acceptance by management of the inalienable rights of shareholders as
the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is
about commitment to values, about ethical business conduct and about making a distinction between
personal and corporate funds in the management of a company.
It was the belief of the Securities and Exchange Board of India (SEBI) that efforts to improve
corporate governance standards in India must continue. This is because these standards themselves
were evolving in keeping with market dynamics. Accordingly, the Committee on Corporate
Governance (the Committee) was constituted by SEBI, to evaluate the adequacy of existing
corporate governance practices and further improve these practices. The Committee comprised
members from various walks of public and professional life. This includes captains of industry,
academicians, public accountants and people from financial press and from industry forums.
The issues discussed by the Committee primarily related to audit committees, audit reports,
independent directors, related parties, risk management, directorships and director compensation,
codes of conduct and financial disclosures. The Committees recommendations in the final report
were selected based on parameters including their relative importance, fairness, accountability,
transparency, ease of implementation, verifiability and enforceability.
The key mandatory recommendations focus on strengthening the responsibilities of audit committees;
improving the quality of financial disclosures, including those related to related party transactions and
proceeds from initial public offerings; requiring corporate executive boards to assess and disclose
business risks in the annual reports of companies; introducing responsibilities on boards to adopt
formal codes of conduct; the position of nominee directors; and stock holder approval and improved
disclosures relating to compensation paid to non-executive directors. Non-mandatory
recommendations include moving to a regime where corporate financial statements are not qualified;
instituting a system of training of board members; and the evaluation of performance of board
members.
The Committee believes that these recommendations codify certain standards of good governance
into specific requirements, since certain corporate responsibilities are too important to be left to loose
concepts of fiduciary responsibility. When implemented through SEBIs regulatory framework, they will
strengthen existing governance practices and also provide a strong incentive to avoid corporate
failures. Some people have legitimately asked whether the costs of governance reforms are too high.
In this context, it should be noted that the failure to implement good governance procedures has a
cost beyond mere regulatory problems. Companies that do not employ meaningful governance
procedures will have to pay a significant risk premium when competing for scarce capital in todays
public markets.
[source: Preamble to Report dated 08.02.2003 on Corporate GHovernance by Narayana Murthi, Chairman, Committee on
Corporate Governance, SEBI]

This clause 49 was inserted in late 2000 consequent to the recommendations of the Kumarmangalam Birla
Committee on Corporate Governance constituted by the Securities Exchange Board of India (SEBI) in 1999.

Clause 49 specified the

1)minimum number of independent directors required on the board of a company,

2)setting up of an Audit committee, and a

3) Shareholders Grievance committee etc were made mandatory,
4) report on Corporate Governance in the Annual Report, and 5)disclosures of fees paid to non-executive directors,
6)limit was placed on the number of committees that a director could serve on.

Composition of committee:

Committee was constituted under the Chairmanship of Shri N. R. Narayana Murthy, Chairman and Chief Mentor of Infosys
Technologies Limited.
Members included from various walks of public and professional life which included captains of industry, academicians,
public accountants and people from financial press and industry forums were included.

The terms of reference of the committee were to:

-> Review the performance of corporate governance; and

-> Determine the role of companies in responding to rumour and other price sensitive information circulating in the market to
enhance the transparency and integrity of the market.

The issues discussed by the committee primarily related to

1)

audit committees,

2)

audit reports,

3)

independent directors,

4)

related parties,

5)

risk management,

6)

directorships and director compensation,

7)

codes of conduct and

8)

financial disclosures.

The key mandatory recommendations focused on:

1)

strengthening the responsibilities of audit committees;

2)

improving the quality of financial disclosures, including those related to related party transactions and proceeds
from initial public offerings;

3)

requiring corporate executive boards to assess and disclose business risks in the annual reports of companies;

4)

introducing responsibilities on boards to adopt formal codes of conduct; the position of nominee directors; and

5)

stock holder approval and improved disclosures relating to compensation paid to non-executive directors.

Non-mandatory recommendations included:

1)

moving to a regime where corporate financial statements are not qualified;

2)

instituting a system of training of board members; and

3)

evaluation of performance of board members.

As per the committee, these recommendations codify certain standards of 'good governance' into specific
requirements

Their implementation through SEBI's regulatory framework will strengthen existing governance practices and also
provide a strong incentive to avoid corporate failures.

Based on the recommendations of this committee, SEBI issued a modified Clause 49 on 29 October 2004 which
came into operation on 1 January 2006.

The revised Clause 49 has suitably pushed forward the original intent of protecting the interests of investors
through enhanced governance practices and disclosures.

Five major modifications were

1) The independence criteria for directors have been clarified.

2) The roles and responsibilities of the board have been enhanced.
3)The quality and quantity of disclosures have improved.
4)The roles and responsibilities of the audit committee in all matters relating to internal controls and financial reporting have
been consolidated
5)The accountability of top managementspecifically the CEO and CFOhas been enhanced.

The Kumarmangalam Birla Committee on Corporate Governance

SEBI had constituted a Committee on May 7, 1999 under the chairmanship of Shri Kumarmangalam
Birla, then Member of the SEBI Board to promote and raise the standards of corporate governance.
Based on the recommendations of this Committee, a new clause 49 was incorporated in the Stock
Exchange Listing Agreements (Listing Agreements)
Financial reporting and disclosures
Financial disclosure is a critical component of effective corporate governance. SEBI set up an
Accounting Standards Committee, as a Standing Committee, under the chairmanship of Shri Y. H.
Malegam with the following objectives:

To review the continuous disclosure requirements under the listing agreement for listed
companies;

To provide input to the Institute of Chartered Accountants of India (ICAI) for introducing new
accounting standards in India; and

To review existing Indian accounting standards, where required and to harmonise these
accounting standards and financial disclosures on par with international practices.

SEBI has interacted with the ICAI on a continuous basis in the issuance of recent Indian accounting
standards on areas including segment reporting, related party disclosures, consolidated financial
statements, earnings per share, accounting for taxes on income, accounting for investments in

associates in consolidated financial statements, discontinuing operations, interim financial reporting,

intangible assets, financial reporting of interests in joint ventures and impairment of assets.
With the introduction of these recent Indian accounting standards, financial reporting practices in India
are almost on par with International Accounting Standards.
Implementation of corporate governance Requirements
The Recommendations were implemented through Clause 49 of the Listing Agreements, in a phased
manner by SEBI.They were made applicable to all companies in the BSE 200 and S&P C&X Nifty
indices, and all newly listed companies, as of March 31, 2001.The applicability of the
Recommendations was extended to companies with a paid up capital of Rs. 100 million or with a net
worth of Rs. 250 million at any time in the past five years, as of March 31, 2002. In respect of other
listed companies with a paid up capital of over Rs. 30 million, the requirements were made applicable
as of March 31, 2003. The accounting standards issued by the ICAI, which are applicable to all
companies under sub-section 3A of Section 211 of the Companies Act, 1956, were specifically made
applicable to all listed companies for the financial year ended March 31, 2002, under the Listing
Agreements.
Compliance with the Code and SEBIs experience
In terms of SEBIs Circular No. SMD/Policy/CIR-03/2001 dated January 22, 2001:

All companies are required to submit a quarterly compliance report to the stock exchanges
within 15 days from the end of a financial reporting quarter. The report has to be submitted
either by the Compliance Officer or by the Chief Executive Officer of the company after
obtaining due approvals. SEBI has prescribed a format in which the information shall be
obtained by the Stock Exchanges from the companies. The companies have to submit
compliance status on eight sub-clauses namely:
i.

Board of Directors;

ii.

Audit Committee;

iii.

Shareholders / Investors Grievance Committee;

iv.

Remuneration of directors;

v.

Board procedures;

vi.

Management;

vii.

Shareholders; and

viii.

Report on Corporate Governance.

Stock exchanges are required to set up a separate monitoring cell with identified personnel, to
monitor compliance with the provisions of the Recommendations. Stock exchanges are also
required to submit a quarterly compliance report from the companies as per the Schedule of
Implementation. The stock exchanges are required to submit a consolidated compliance
report within 30 days of the end of the quarter to SEBI.

Both the Mumbai and National Stock Exchanges have submitted a consolidated quarterly compliance
report for the quarter ended September 30, 2002. It was observed that 1,848 and 741 companies
were required to comply with the requirements of the Code, for the Mumbai and National Stock

Exchanges, respectively. Of these, compliance reports were submitted in respect of 1,026 and 595
companies, for the Mumbai and National Stock Exchanges, respectively.
The status of compliance with respect to provisions of corporate governance analysed from data
submitted by the Mumbai Stock Exchange for the quarter ended September 30, 2002 is set out below.
The key observations contained in the consolidated compliance report sent by the Mumbai and
National Stock Exchanges are set out below.

The compliance level in respect of requirements relating to Board of Directors, Audit

Committee, Shareholders Grievance Committee and Shareholders is very high;

Many companies are yet to comply with the requirements relating to Remuneration
Committee (which is not mandatory), Board Procedures, Management and Report on
Corporate Governance; and

Few companies have submitted that the provisions relating to Management and Board
Procedures are not applicable.

SEBI observed that the compliance with the requirements in clause 49 of the Listing Agreement is, by
and large, satisfactory; however, an analysis of the financial statements of companies and the report
on corporate governance discloses that their quality is not uniform. This is observed on parameters
such as the nature of qualifications in audit reports, the quality of the corporate governance report
itself (which is often perfunctory in nature), and the business transacted and the duration of audit
committee meetings. Variations in the quality of annual reports, including disclosures, raises the
question whether compliance is in form or in substance; and emphasise the need to ensure that the
laws, rules and regulations do not reduce corporate governance to a mere ritual. This question has
come under close scrutiny in recent times.
SEBI has analysed a few recently published annual reports of companies to assess the quality of
corporate governance. The directors reports could be classified into the following categories:

Reports where there is no mention about the compliance with corporate governance
requirements;

Reports that state that the company is fully compliant with clause 49 of the Listing Agreement,
but where independent auditors have made qualifications in their audit reports;

Reports that mention areas of non-compliance with clause 49 of the Listing Agreement and
provide explanation for non-compliance; and

Reports that mention areas of non-compliance with clause 49 of the Listing Agreement but
provide no explanation for auditors qualification or for reasons for non-compliance.

SEBI also observed that there is a considerable variance in the extent and quality of disclosures made
by companies in their annual reports.
Rationale for a review of the Code
SEBI believes that efforts to improve corporate governance standards in India must continue. This is
because these standards are themselves evolving, in keeping with market dynamics. Recent events
worldwide, primarily in the United States, have renewed the emphasis on corporate governance.
These events have highlighted the need for ethical governance and management, and for the need to
look beyond mere systems and procedures. This will ensure compliance with corporate governance
codes, in substance and not merely in form.

Again, one of the goals of good corporate governance is investor protection. The individual investor is
at the end of a chain of financial information, stretching from corporate accountants and management,
through Boards of Directors and audit committees, to independent auditors and stock market analysts,
to the investing public. Many of the links in this chain need to be strengthened or replaced to preserve
its integrity.
SEBI, therefore, believed that a need to review the existing code on corporate governance arose from
two perspectives,
a. to evaluate the adequacy of the existing practices, and
b. to further improve the existing practices.
The Committee, Terms of Reference and Approach
Constitution of the Committee
In the context of the rationale set out in Section 1.6 of this Report, SEBI believed it necessary to form
a committee on corporate governance, comprising representatives from the stock exchanges,
chambers of commerce, investor associations and professional bodies.
The SEBI Committee on Corporate Governance (the Committee) was constituted under the
Chairmanship of Shri N. R. Narayana Murthy, Chairman and Chief Mentor of Infosys Technologies
Limited.
A list of names of the members of the Committee is set out in Enclosure II to this report.
The Committee met thrice on December 7, 2002, January 7, 2003 and February 8, 2003, to deliberate
the issues related to corporate governance and finalize its recommendations to SEBI.
Terms of Reference
The terms of reference of the Committee are set out below.

To review the performance of corporate governance; and

To determine the role of companies in responding to rumour and other price sensitive
information circulating in the market, in order to enhance the transparency and integrity of the
market.

The recommendations of the Committee are presented in this Report.

Approach
Members of the Committee met to deliberate the issues related to corporate governance, primarily
relating to audit committees, audit reports, independent directors, related parties, risk management,
directorships and director compensation, codes of conduct and financial disclosures.
The Committee felt that that the regulator should clearly define regulations and be able to effectively
enforce the recommendations. The regulations should be as few as possible and the role of the
regulator should primarily be that of a catalyst in enforcement.
The issues relating to corporate governance were discussed by the Committee. Based on the
responses / suggestions to the issues, draft recommendations were prepared. These
recommendations were circulated to the members. Members were asked to rate the
recommendations on a scale of 1 (Least) through 10 (Most) across the seven following parameters:

i.

Importance How important is the recommendation to the member?

ii.

Fairness Does the recommendation enhance fairness to all stakeholders, by minimizing

asymmetry of benefits?

iii.

Accountability Does the recommendation make corporate management more accountable?

iv.

Transparency Does the recommendation enhance transparency?

v.

Ease of implementation Is the recommendation easy to implement?

vi.

Verification Is the recommendation objectively verifiable?

vii.

Enforcement Can the recommendation be effectively enforced?

The ratings received from members were first aggregated across recommendations and tabulated.
Recommendations whose ratings were 7 and above were then aggregated, on each of the seven
parameters set out above. The rating score for each such recommendation was aggregated. The
recommendations were then sorted in descending order of importance. The top 20 recommendations
were presented to the Committee for their views. These recommendations were discussed in detail by
the members and will form the basis of the final recommendations of the Committee. Certain
recommendations that were not part of the top 20 recommendations were also presented to the
Committee. This was because of their important nature. Certain recommendations that were already
contained in the Report of the Naresh Chandra Committee on Corporate Audit and Governance (the
Naresh Chandra Committee) were also discussed briefly. The members of the Committee agreed in
principle with the recommendations set out by the Naresh Chandra Committee that are directly related
to corporate governance.
It was therefore decided by the Committee, that in making the final recommendations to SEBI, the
Committee would also recommend that the mandatory recommendations in the report of the Naresh
Chandra Committee, insofar as they related to corporate governance, be mandatorily implemented by
SEBI through an amendment to clause 49 of the Listing Agreement. These recommendations are
contained in Section 4 of this Report. The Committee accepted that ratings were not received from all
members. It was of the view that members who have not submitted their ratings should not raise
objections to the Committees recommendations at a later stage. The Committee also acknowledged
that the ratings methodology did not capture the qualitative comments of the members. Further, it was
also accepted that a few recommendations could not be rated since they were more of a qualitative
nature for which it was difficult to assign a numerical weight.
The Report is composed of six chapters with two enclosures as under
Table of Contents
i.

Introduction

ii.

The Committee, Terms of Reference and Approach

iii.

Key Issues Discussed and Recommendations

iv.

Recommendations of the Naresh Chandra Committee

v.

Other Suggestions and the Committees Response

vi.

Implementation and Way Forward

Enclosure 1 SMDRP/POLICY/CIR-10/2000 dated February 21, 2000 containing the recommendations

of
the
Kumar
Mangalam
Birla
Committee
on
Corporate
Governance
Enclosure 2 Members of the Committee to Review the Performance of Corporate Governance