Home >Opinion >Online-views >Opinion | Corporate governance needs moral compass

Regulatory interventions have often been the antidote of choice after large scams. Yet both corporate governance scandals and regulatory interventions have been making headlines with alarming frequency. This begs the question: do we need something else to prevent this epidemic outbreak of corporate governance failures?

Regulation is the hardware to drive consistent corporate governance standards and, hence, an imperative. At the same time, excessive regulation can become a burden, disproportionately increasing the cost of compliance and changing the focus of a forward-looking, strategy-oriented board to a backward-looking, compliance-oriented board. Adequate regulation is the backbone without which corporate governance may flounder and, therefore, the recent spate of regulations has essentially plugged the basic gaps. But this remedy has largely lived its life and likely to provide marginal diminishing returns from now. If at all, the focus should be towards implementation “in spirit" and building a culture of compliance, enforcement and consequence management.

Beyond regulations, effective corporate governance needs a thorough ecosystem, with elements such as active institutional and private equity investors, proxy advisers, auditors and media. These external pressure elements are essential conscience-keepers in the corporate governance journey, and while India is seeing increasing relevance and activity from all of these lately, the focus needs to be more proactive, rather than reactive. Economies dominated by distributed corporate ownership provide a better natural habitat for this ecosystem to be effective and therefore the key challenge for India Inc will be to contextualise and empower each of these elements to gain more voice in boardroom decisions.

Ultimately, it is the board of directors that is charged with the primary responsibility for matters of governance and set the tone at the top for the organization. While both executive and independent directors share the blame for corporate governance failures, a lot of the flak for the recent debacles has been directed towards independent directors. Independent directors are expected to play a fiduciary role and protect the interests of all stakeholders; however, can this really happen when they are appointed by the very people they are expected to keep in check?

If one looks at this from an external stakeholder perspective, one would think independent directors are people with significant experience, with full access to the management and information, who add great value to the board and are expected to play the fiduciary role of ensuring corporate governance.

But looking at this from the perspective of independent directors themselves, it may seem that the responsibilities and expectations are far in excess of what is practically possible, given the time available, access, completeness and timeliness of information. The question one hears a lot these days is whether the rewards are commensurate with the risks, especially in times where the risk of damage to reputation seems more worrying that the financial/legal risks. Numerous recent cases have seen years of professional reputation taking a beating in media on allegations of corporate governance failures. There are also cases where personal assets have been attached, meaning genuine financial loss and hardship. The silver lining here is that sometimes fear can be a big motivator and dread of all of the above happening can be an important consideration in pushing independent directors to take the path that may not necessarily agree with promoters, especially dominant ones. Regulations often serve as a useful tool for independent directors to nudge and push companies and their promoters towards better corporate governance.

Just like fear is a motivator, so is incentive for success, and while there are enough studies that show better governance resulting in improved valuation, this doesn’t necessarily have a correlated impact on independent director compensation. The corollary implication is that being on well-governed boards can eventually result in many such lucrative opportunities.

Many situations are not black or white, and sometimes fear is not a big enough factor and nor is success. Therefore, the only hope for upholding and preserving the spirit of corporate governance has to come from individuals who have a strong sense of purpose and are driven by a strong moral compass. A compass that points to the right direction, whether it means standing up to a dominant shareholder/star CEO, a risk of losing a prestigious directorship, social ostracism for making an unpopular choice, going against consensus or giving the real reason for a resignation rather than masking that in the garb of “personal reasons".

While regulations, auditors, institutional/private equity investors, proxy advisers, media, etc., all have a role to play in strengthening the corporate governance ecosystem, the litmus test is what happens in the boardroom. Only individuals (executive/independent directors and key management) with a strong value system, a decisive moral compass and a strong “independence of mind and opinion" can help create an ethical boardroom culture, which will set the right tone at the top. Corporate governance can only be really effective when this invisible ingredient is the base of the recipe.

Pankaj Arora is partner—governance, risk & compliance practice, KPMG in India.

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