8/12/2019 Corporate Governance in Private Limited

1/3

Corporate Governance in Private

Limited CompaniesTransparency is often just as effective as a rigidly applied rule book and is usually more

flexible and less expensive to administer.

By Gary HamelCorporate governance in private limited companies is an often-ignored topic as it is notmandatory by law. The Companies Act and SEBI Listing Agreement focus on corporate

governance aspects of public listed companies. The reason for excluding private limited

companies is that they do not have numerous shareholders hence the risk is minimal. I beg todiffer. Corporate governance encompasses much more than shareholder rights. Corporate

governance includes rights of investors, financial institutions, customers, suppliers, employees

and society.

Let us first cover the backdrop of the problem briefly. In India,90% of the companies are either

unlisted public companies or private limited companies Private limited companies fall under

three groups 1) private companies belonging to business families; 2) private companies assubsidiaries of listed Indian public companies; and 3) private companies as subsidiaries of

foreign companies.

The corporate governance is limited in 1stand 3

rdcategories as in the 2

ndcategory the provisions

of listed companies apply to quite an extent. In the second category, it is dependent on the

owners to take the initiative. The biggest challenge is for 3rd

category as holding companiesprovisions may not be applicable in India. However, they are applicable in the country of the

holding company. If the holding company is listed then corporate governance aspects apply of

the relevant country. Though, quite frequently the focus in the subsidiary company is not thesame as holding company. These companies sometimes have turnover and employees more than

the listed organizations. Still these are not covered in the regulatory ambit.

The Institute of Companies Secretary of India has issued recommendatory guidelines for it. The

Companies Bill, presently awaiting parliamentary approval does cover the same. This definitely

is a step in the right direction. Organizations must take first mover advantage to incorporate theprovisions in their governance, risk management and compliance programs. I am giving below

five areas that they can focus on:

1. Corporate Social ResponsibilityIn 2009, Ministry of Corporate Affairs (MCA) issued voluntary guidelines for Corporate Social

Responsibility (CSR). The guidelines discuss key aspects of governance practices that business

organizations need to focus on. The policy covers six aspects- 1) Care of all stakeholders; 2)Ethical functioning; 3) Respect for workers rights and welfare; 4) Respect for human rights ; 5)Respect for environment; and 6) Activities of social and inclusive development. The policy

requires that business entities should provide an implementation strategy covering projects,

timelines, resource allocation etc.Organizations to communicate their commitment to CSR can put the policy on their website with

each locations implementation strategy. This will help communicate organizations ethical stance

to all third parties wishing to do business with it.

http://soniajaspal.wordpress.com/2011/02/17/reflections-on-definition-of-corporate-governance-in-india/http://soniajaspal.wordpress.com/2010/12/17/prime-minister-finance-minister-speak-on-corporate-governance/http://soniajaspal.wordpress.com/2011/01/15/fraud-symptom-3-board%e2%80%99s-failure-to-exercise-judgment/http://soniajaspal.wordpress.com/2011/01/15/fraud-symptom-3-board%e2%80%99s-failure-to-exercise-judgment/http://soniajaspal.wordpress.com/2010/12/17/prime-minister-finance-minister-speak-on-corporate-governance/http://soniajaspal.wordpress.com/2011/02/17/reflections-on-definition-of-corporate-governance-in-india/

8/12/2019 Corporate Governance in Private Limited

2/3

2. Appointment of Board of Directors

In public listed companies, independent board of directors is appointed to ensure better

governance. Family owned listed companies and private limited companies are remarkably cageyabout appointment of external independent directors as they consider it as interference and

sharing of power. The private companies owned by foreign companies generally appointdirectors from within the subsidiary organization. Friends and colleagues are appointed and theyform a coterie. Although, this is legal it does influence governance as Chairman/ CEO lose the

benefit of independent viewpoints and unbiased opinions. Boards have two purposes1) Act as

trustees for the organization 2) Provide strategic insight to CEO. However, CEOs of privatelimited companies are disadvantageous position in comparison to listed companies CEOs. In

such cases, it is a good practice to appoint directors from other group organizations. Secondly, if

the holding company management permits, appoint exceptionally qualified independent

directors. Here, management gurus, ethics leaders, financial experts and other professionals canbe appointed. A right balance must be maintained to have an effective board.

3.Rules and Performance of Board of Directors

Unfortunately, the board meetings in private limited companies are sometimes held for

namesake. It is more to complete the paperwork to meet the regulatory requirements can have an

engaged discussion and chart out business strategies.To ensure the board members areengaged the first step is to formulate and implement rules for the directors and define their area

of responsibility. Roles and responsibilities should be given according the qualifications and

skill sets of the member. If the board skills are not sufficiently diversified, additional membersmust be appointed. Board members should commit sufficient time to the company. On a periodic

basis, their performance against the targets should be evaluated by other board members. The

mandate must be to add business value to the organization. It is a good practice to early audit the

participation of board members in meetings and their respective performance.

4. Risk Management & Internal Controls

Indian Company Law mandates all companies private and public limited, over specified

turnovers and capital to have proper internal control systems. The external auditors are required

to report on the status ofinternal controls.

However, it does not mandate audit committees or risk committees for private limited companies

at board level. It is a good practice to formulate one and ensure it provides relevant information

to the audit. Financial and risk management experts can be appointed from within the

organization or outside to give an independent view.

5. Appointment of Auditors

Auditors in family owned companies are sometimes appointed based on old business

relationships. This practice in India, significantly affects the independence of the auditors. Inrespect to subsidiary companies, Indian and foreign companies, auditors are chosen by

the holding companys management. In most cases, the holding companys auditors are

http://soniajaspal.wordpress.com/2011/01/15/fraud-symptom-3-board%e2%80%99s-failure-to-exercise-judgment/http://soniajaspal.wordpress.com/2010/06/28/independence-of-internal-auditors-an-oxymoron/http://soniajaspal.wordpress.com/2010/07/14/auditor-a-listener/http://soniajaspal.wordpress.com/2010/07/14/auditor-a-listener/http://soniajaspal.wordpress.com/2010/07/14/auditor-a-listener/http://soniajaspal.wordpress.com/2010/06/28/independence-of-internal-auditors-an-oxymoron/http://soniajaspal.wordpress.com/2011/01/15/fraud-symptom-3-board%e2%80%99s-failure-to-exercise-judgment/

8/12/2019 Corporate Governance in Private Limited

3/3

appointed for confidence in consolidation of financial statements. Although this is a good

practice, in Indian context there is a small snag. Local relationships with the auditors might

circumvent the independence. Hence, if local management is involved in frauds, the auditorsmay compromise in ethical reporting. It is a good practice to frequently call on the holding

companies audit partner and advise him/her on the issues. Direct relationships with international

partners put a check on local auditors.

Closing thoughts

In India, corporate governancepractices are just a little over a decade old and mostly focused onlisted public companies. In private limited companies, it is still in nascent stage. Organizations

however can voluntarily take the initiative to adopt best practices. This improves confidence of

third parties and brand reputation. It also benefits if the organization in a few years is planning to

turn public limited or plans to sell the company.

References:

Ministry of Corporate Affairs (MCA)Corporate Social Responsibility (CSR) Voluntary

Guidelines.

http://soniajaspal.wordpress.com/2010/11/09/has-corporate-governance-improved-in-india/http://soniajaspal.wordpress.com/2010/11/09/has-corporate-governance-improved-in-india/