DECLARATION

Date: 19/02/2014

We Prof. Shirufi Purohit and Prof.Dipak Gaywala of Authors certifythat, the Research Paper on Impact ofCompanies’ Act 2013 and Rules framedthere under on Corporate Governanceof Micro, Small and Medium sizeenterprises.

Is properly referenced and will besolely responsible for responding toany claims of plagiarism of thepaper.

Name of the Authors :-

1. Prof. Dipak Gaywala2. Prof. Shirufi Purohit

Date :- 19/02/2014

Place :- Vadodara

Title of the Research Paper:

Impact of Companies’ Act 2013 and Rules framed there under on

Corporate Governance of Micro, Small and Medium size

enterprises.

CGS-2014 with Code no.: "ICGS2014_089". 

Authors:

1. Dipak S Gaywala

Associate Professor

Parul Institute of Management & Research(PIMR)

P.O. Limda, Tal.Waghodia,

Dist. Vadodara

Phone: 0265 2334368

Mobile; 9428429809

E-mail; dipak_gaywala@yahoo.co.in

2. Shirufi Purohit

Assistant Professor

Parul Institute of Management & Research(PIMR)

P.O. Limda, Tal.Waghodia,

Dist. Vadodara

Mobile; 9998568745

E-mail: shirufi@gmail.com

Title of the Research Paper:

Impact of Companies’ Act 2013 and Rules framed there under on

Corporate Governance of Micro, Small and Medium size

enterprises.

Abstract:

This study examines the impact of New Companies Act 2013 on

corporate governance of Micro, Small and Medium size

enterprises in India. The findings may be useful for small

business management.

The Companies Act 2013 enacted on 29 August 2013 was much

awaited legislation to meet present day challenges in the

corporate governance arising from stakeholders’ expectations

from the corporate enterprises that their interest is not

overlooked in the process of running the businesses under the

umbrella of corporate structure where there exists agency

conflict between owners (shareholders) and governing board of

such enterprises. The corporate failures in the recent past

liked Satyam in India also brought out that Companies Act

evolved in 1956 was found inadequate to safeguard the interest

of the stakeholders of the companies. The rules under the

Companies Act 2013 are framed or being framed. It is

imperative to note that Companies Act 2013 defined small

company also. In this background, following Research

Objectives are set out.

Objectives of the Research Paper:

1. To evaluate the impact of this legislation on corporate

governance of micro, small and medium scale enterprises

in the context of changes made in the provisions of

capital, governance and allied matters

2. To evaluate challenges and opportunities for the micro,

small and medium scale enterprises in the new regulatory

framework of corporate governance.

3. To evaluate experiences of the countries having similar

regulatory code for the corporate governance to provide

inputs to micro, small and medium enterprises for the

good corporate governance.

Keywords: corporate governance, old companies Act, 1956, New

Companies Act, 2013, Small Scale Enterprise, The Anglo Saxon

model, The Continental-European model, Japanese Model.

Article’s Theme Classification: Theme 7: Contemporary Issues

in Governance (Impact of New Companies Bill, 2013 on Corporate

Governance.

1. Introduction

1.1. Companies Act, 2013 impact on Corporate Governance

This paper draws research into the impact of new Companies Act

2013 on Corporate Governance in India, focusing on small and

medium enterprise. The companies Act 1956, which existed over

a period of 50 years, appeared to be somewhat ineffective at

handling some of the present day challenge of a growing

industry and interest of an increasing class of sophisticated

stakeholders.

The foundation of comprehensive revision in the Companies Act

1956, was laid in 2004 by Irani Committee. The Companies Act,

2013, ( enacted on 29 August 2013, has the potential to be a

historic milestone, as it aims on increased reporting

framework, Higher auditor accountability, Easier

Restructuring, Wider Director and Management Responsibility,

Inclusive CSR Agenda, Emphasis on Investor Protection.

Corporate governance refers to the set of systems, principles

and processes by which a company is governed.

Corporate Governance are currently being consolidated into an

amendment to the Companies Act, 1956 When the New Act is fully

implemented, it will have a direct bearing on the way

companies are governed in India – improving corporate

governance in a manner that, it is hoped, will reduce

misconduct at and by Indian companies. The New Act holds out

the possibility of reducing the risk of corrupt practices,

although in some ways it also potentially increases such risks

in certain respects. The principal risk in this regard arises

out of newly mandated Corporate Social Responsibility (“CSR”)

programs.

The New Act is seen as an important step in bringing Indian

company law closer to global standards and in improving the

ease and efficiency of doing business in India. It touches on

areas such as corporate governance, corporate social

responsibility, auditor rotation and investor protection, all

in an attempt to strengthen internal controls.

The Anglo Saxon model of governance on which the Corporate

Governance framework introduced in India is primarily based

on, has certain limitations in terms of its applicability in

the Indian environment. For instance, the central governance

issues in the US or UK is essentially that of disciplining

management that has ceased to be effectively accountable to

the owners who are dispersed shareholders.

The issues and the complexity arising from the application of

alien corporate governance model in the Indian Corporate and

business environment is further compounded by the weak

enforcement of corporate governance regulations through the

Indian legal system.

Learning from these experiences, the 2013 Act promises to

substantively ‘raise the bar on governance’. When the New Act

is fully implemented, it will have a direct bearing on the way

companies are governed in India – improving corporate

governance in a manner that, it is hoped, will reduce

misconduct at and by Indian companies

The aim of the research is to explore not only SME Corporate

Governance structures and processes but how SMEs had chosen to

implement the Principles and the reasons for their choice.

1.1 What are the principles underlying corporate governance?

In the current context of globalization, we can no longer talk

about increasing organizational value ignoring the interests

of shareholders, employees, business partners, etc. Such

interests may come into conflict, leading to internal

conflicts, with negative influence on the entity’s

performance. To avoid such discrepancies, a responsible

behavior from managers is increasingly necessary, which means,

in fact, adopting a corporate governance model.

Corporate governance is based on principles such as

conducting the business with all integrity and fairness, being

transparent with regard to all transactions, making all the

necessary disclosures and decisions, complying with all the

laws of the land, accountability and responsibility towards

the stakeholders and commitment to conducting business in an

ethical manner.

Major amendments in Companies Act 2013 in contrast to old

Companies Act, 1956

1. The companies Bill, 2013, primarily aimed at improving

the board oversight process. The concept of an

Independent Director and all listed Companies are

required to appoint Independent Directors with at least

one third of the Board of such companies comprising of

Independent Directors.

2. The definition of Independent Director has been

considerably tightened and the definition now requires

every Independent Director to declare that he or she

meets the criteria of Independence.

3. In order to ensure that Independent Director do not

become too familiar with the management, minimum tenure

is prescribed before tenure was of 5 years but now its

not allowed to exceed two consecutive term.

4. New companies Bill, expressly disallow Independent

Director from obtaining stock options in companies to

protect their independence.

5. Now their appointment, resignation, and evaluation

introduce a greater clarity in new companies Act, 2013.

6. In Independent Director in new companies Act seeks to

limit their liability to matters directly relatable to

them and limits their liability to only in respect of

acts of omission or commission or where he had not acted

diligently. Before in Companies Act, it does not provide

any clear limitation of liability and have left it to be

interpreted by courts.

7. The new Bill also requires that all resolutions in a

meeting convened with a shorter notice should be ratified

by at least one independent director which gives them an

element of veto power.

8. The Companies Act 2013 provides an opportunity to catch

up and make our corporate regulations more contemporary.

2013 Act enhances significantly the role and

responsibilities of the Board of Directors by making them

more accountable for their actions while protecting

shareholder interest.

9. Also, by mandating a women director on the board, the

intent of the 2013 Act is to improve gender diversity and

increase transparency.

10. A new provision has been made called class action

suits; here number of members may file an application

before the Tribunal on behalf of members if they feel

that the management is being prejudicial to the interest

of the company or its members. The order passed by the

Tribunal would be binding on the company and all its

members.

11. A major proposal in the new Bill is that any undue

gain made by a director by a busing his position will be

disgorged and returned to the company together with

monetary fines.

12. CSR will be mandatory for a company with a net worth

of INR 500 crores (approximately US$ 90 million) or more,

a turnover of INR 1,000 crores (approximately US$ 180

million) or more, or net profits of INR 5 crores

(approximately US$ 0.9 million) or more during any

financial year. Any company meeting these thresholds will

be required to spend annually at least 2% of its average

net profits of the preceding three financial years on

social and charitable causes.

13. The New Act provides for mandatory auditor rotation

for listed and other prescribed companies every five

years depending on whether the auditor is an individual

or a firm. In addition, there will be a cooling-off

period of five years after completion of such a term

during which the auditor cannot be re-appointed. Further,

the auditor will be required immediately to report to the

central government upon reasonable suspicion of any

offence involving fraud that is being or has been

committed against the company by its officers or

employees. Auditors can audit maximum 20 Companies.

14. The new law grants additional statutory powers to

the government’s investigative arm, the Serious Fraud

Investigation Office (“SFIO”), to tackle

corporate fraud.10 It also proposes the establishment of

special courts for speedy trials.11These measures are an

attempt to create an agency similar to the Serious Fraud

Office in the United Kingdom, to provide teeth to the

Indian government’s efforts to tackle serious fraud and

corrupt practices. However, what remains to be seen is if

true independence and the necessary infrastructure and

resources are given to this body.

15. Introduction of National Financial Reporting

Authority. This authority shall be responsible for

accounting and auditing standards in India. This

authority shall be responsible for monitoring and enforce

compliance of these standards and for that purpose

oversee the quality of professions associated with

ensuring compliances. The authority shall investigate

professional and other misconducts committed by members

and firms of chartered accountants.

16. Committees of the Board of Directors (Sections 177,

178) every listed companies and some other class of

companies shall constitute an audit committee. Audit

committee shall be constituted with minimum three

independent directors with majority of financially

literate persons.

17. The companies Act 2013 made the provisions of

mergers/acquisitions less cumbersome for small companies.

18. Related Party Transactions (Section 188) No company

shall enter into any contract or arrangement with a

related party without consent of board of directors given

by a resolution passed in a meeting with respect to

certain matters

19. Key Managerial Personnel - No company can have both

Managing Director and Manager at the same time.

20. All Listed companies have to annex secretarial audit

report obtained from a Practicing Company Secretary to

the Board's report.

21. Annual Return to be signed by a director and the

company secretary, or where there is no company

secretary, by a company secretary in practice. Stating

that the annual return discloses the facts correctly and

adequately and that the company has complied with all the

provisions of this Act.[21]

1.2. Corporate Governance and Small Business Firms in India

Small business firms play an important role in the Indian

economy. Small business sector comprises 95% of the total

industrial units in India, accounting for 40% of the total

industrial production, 34% of the national exports, and about

25 million persons of industrial employment (Malepati, 2011,

p. 1). In India, the majority of small business services [2]

Firms are operated by family members. The issues of corporate

governance have usually been associated with large and listed

firms. Less attention has been paid to the relationship

between corporate governance and small business firms. To fill

the gap, the present study focuses on the link between

Companies act and its impact on corporate governance and of

small business service firms in India.  The Companies Act,

2013 defined for the first time definition of small company

under the Act itself. Corporate governance, in the context of

this study, is defined as the structures, processes, and

systems that lead to successful operation of the small

business service firm. The majority of the small business

firms in India are not listed and boards of the directors

consist of family members. In many cases, the CEO is also from

the same family. Thus, family has full control on small

business firms in India (Gollakota & Gupta, 2006).

SMEs are characterized by their innate entrepreneurial culture

and by the active involvement of the promoter and dominate

shareholder in day to day management offering, key management

position are held by relatives or close confidants of the

promoter-CEO and a high degree of trust exist between the

officers of the company.

This obviates the need to implement stringent internal

controls systems of checks and balances. Both large companies

and SMEs are exposed to the same market forces, which unleash

uncertainties and new challenges on an ongoing basis. Both are

affected by new product introduction, competition from foreign

companies, and the war for talent, technology innovations,

currency and interest rate fluctuations, so on and so forth.

One could argue that, given lower resources, SMEs generally

have higher risk profiles than larger companies. Therefore,

the logic goes that SMEs has at least an equal, if not

greater, need for corporate governance processes compared to

large companies.

Recently, the SEC too, took a view to this effect. In the

aftermath of al- legations that the costs associated with SOX

compliance were very high and almost paralyzing for smaller

companies the SEC constituted an Advisory committee on smaller

Public companies. Its mandate was to evaluate whether there

existed a valid case to relax the Sarbanes Oxley provisions

for SMEs. The Committees report issued in April, 2006, after

almost a year of deliberations, emphasized the importance of

good governance and transparency even for SMEs. SEC rejected

the recommendation stating that governance of large and small

companies should be different- SMEs needs are not dissimilar

to those of large companies, third party capital is essential

as are talent, investments in technologies, processes and

capital assets. Finally SME often find themselves in

situations where internal processes lay the requirements of a

high growths company. In such a dynamic environment, SMEs do

not have a choice but to adopt all the components of corporate

governance. SME apart from the size, has strong internal

controls, the extent of monitoring by senior management in

SMEs is far more expansive.

It would be fair to say that the benefits accruing to an

enterprise from good corporate governance practices are

immense irrespective of its size.(Ameet Parikh ) [1]

1.3. Institutional Environment of Small Business and Corporate

Governance Structure in India

Although the Indian legal system provides strong creditor

protection, the environment is perceived to be contaminated by

corruption, red tape, and regulatory impediments to growth

(Gill, Biger, & Tibrewala, 2010).

Since 1991, India has introduced a wide range of changes in

laws and regulations in an effort to improve corporate

governance and investor protection. The changes in laws and

regulations also aimed at minimizing corporate scandals. For

example, Indian government implemented Clause 49 regulations.

The key mandatory features of Clause 49 regulations deal with

the followings: i) composition of the board of directors, ii)

the composition and functioning of the audit committee, iii)

governance and disclosures regarding subsidiary companies, iv)

disclosures by the company, v) CEO/CFO certification of

financial results, vi) reporting on corporate governance as

part of the annual report, and vii) certification of

compliance of a company with the provisions of Clause 49

(Chakrabarti, Megginson, & Yadav, 2007, p. 14). These changes

have forced all firms (small and large) to improve their

corporate governance.

1.4. The state of International corporate governance (Mihaela

Ungureanu, 2007-2013)

If in the traditional governance model, the company was run by

the owner family, economic, managerial and technological have

determined the need of a leadership realized by professional

managers. In this way new relationships and economic processes

between business owners and executives have occurred. Their

modeling and exercise makes the subject of corporate

governance, but its basic objectives have remained unchanged.

There are three main models of leadership on which the

corporate governance theory is based: the Anglo-Saxon, the

Continental and the Japanese model.[20]

1. THE ANGLO-SAXON MODEL – BASED ON ENTERPRENEURSHIP AND PRIVATE

PROPERTY

Anglo-Saxon model is characterized by the dominance in the

company of independent persons and individual shareholders.

The manager is responsible to the Board of Directors and

shareholders, Enterprises are required to disclose more

information compared to those Japanese or German. The

governance model takes place in organizations at three levels:

shareholders-directors-managers, since managers authority

derives from the administrators.

Legislation limits the rights of shareholders to intervene on

the current activities of the entity, for example they can

only decide the elected members of the Board. However, they

can influence changes in the managers’ attitude and manner of

leading; they may decide to liquidate holdings or refuse to

increase its capital contribution of the entity, thus stopping

the funding. Financial support of shareholders is the most

important weapon they have in front of managers. The Anglo-

Saxon countries are characterized by the emergence of

financial markets and strong banking restrictions

In the UK, but also in other Anglo-Saxon countries, where

market economy has significantly developed through sustained

economic growth, there is a high degree of dispersion of

capital and shareholder structure. Population can directly

intervene to the economic development through holding shares,

making of its own availabilities investment on capital

market. .[20]

2. THE CONTINENTAL-EUROPEAN MODEL – CHARACTERIZED BY MAJOR

SHAREHOLDERS’ INTERESTS

The Continental European model is characterized by a high

concentration of capital. Shareholders have common interests

with the organization and participate in its management and

control. Managers are responsible to a wider group of

stakeholders, besides shareholders, such as unions, business

partners, etc.

In the German system of governance, the enterprise is seen as

the combination of various interest groups aimed to coordinate

the national interest objectives. From a historical point of

view, German banks have played an important role in corporate

decisions. Only one of four companies in Germany is entitled

to public transactions, thus most companies seek financial

assistance from banks.

In Germany, the corporate governance system is a dual one,

aiming at the same time a national policy to provide employees

access to information and participation in various activities

of the enterprise and industrial democracy.

Within companies we can find an executive board and a

supervisory council. Such a governance structure is a

mechanism for management monitoring and control. .[20]

3. THE JAPANESE MODEL – SPECIFIC TO AN ORIENTED CONTROL

GOVERNANCE SYSTEM

The Japanese model brings, as a new, the holding concept,

which designates industrial groups consisting of companies

with common interests and similar strategies. The managers’

responsibility manifests itself in relations with shareholders

and keiretsu (a network of loyal suppliers and customers).

The characteristic pattern of governance is dominated by two

types of legal relationships: one of co-determination between

shareholders and unions, customers, suppliers, creditors,

government and another ratio between administrators and those

stakeholders, including managers.

The necessity of the model results from the fact that the

activity of a company should not be upset by the relations

between all these people, relationships that generate risks.

Therefore, the Japanese model (similar to the German one) is

based on internal control, As in Germany, major shareholders

are actively involved in the management process, to stimulate

economic efficiency and to penalize its absence. It is also

aims to harmonize the interests of social partners and

employees of the entity.

Corporate governance oriented to control is easily achieved in

Japan due to a concentrated shareholder structures, unlike the

United States. Many voices say that Japan has to go the

longest road to improve standards of governance, a significant

gap being now, as in the past, corporate transparency. The

existing situation is seen as a consequence of the market

dominated by companies founded and ran by families. Banks and

other institutional investors have usually a minor role in

terms of corporate governance discipline.

At present, Japan’s system is focused on transactional

networks and not enough on individuals. There are two

favorable factors: the first refers to passivity of

shareholders and second is the predominance of internal

directors. .[20]

Table 1 – The main features of corporate governance models

Anglo-Saxon Continental

Europe

Japanese

Oriented

towards

stock market banking market banking market

Considers shareholders’

property right

shareholders’

property right

and company’s

relationships

with its

stakeholders’

interests

(keiretsu)

employees Shareholding

structure

dispersed concentrated concentrated

(cross

possession of

shares) Management executive

directors non-

executive

directors

Supervisor

Board Board of

Directors

Board of

Directors

Revision

commission Control system external internal internal Accounting

system

GAAP IFRS GAAP and IFRS

Anglo-Saxon Continental

European

Japanese

Strengths continuous

discipline

multiple risk

carriers

decreased

optimism transparenc

y

mutual

benefit

direct

influence of

owners Weaknesses failure slow reaction resistance to

change Table 2 – Strengths and weaknesses of governance models

Table 3 – The degree of influence of the participants

according to the legal system

Legal system U.S.A. Germany Japan

Issues covered

by governance

capital market transactions corporations

network

Evaluating the

governance

efficiency

financial

performance

return on

social capital

return on human

capital

Findings

It turned out that no model of governance is perfect and even

better, their existence over time showing that each one is

effective in its own way, and corporate governance structure

specific to a country is difficult to transfer to another

country

For better corporate governance there should be closer

regulation and monitoring of related party transactions,

consolidation of the accounts of all companies within the

group, self declaration of interests by directors.

The impact that corporate governance has on business

profitability

Good corporate governance has been shown to help underpin

companies’ long term profitability. An effective and diverse

board is better able to identify and address key business

risks and the possible implications of board decisions. This

ultimately leads to better decision making which is critical

to business success and profitability. Good corporate

governance also improves a company’s invest ability; investors

need to know that proper systems and controls are in place

before investing, so good corporate governance facilitates

investment and growth. For public companies, failure to

conform to the UK corporate governance requirements can

drastically limit their potential pool of investors.

Good corporate governance around recruitment and remuneration

will help to recruit, reward, incentivize and retain the right

people for the right roles – and, ultimately, good management

teams build good businesses

Challenges faced Small Scale Enterprise by Corporate

Governance in India

1. Power of dominant shareholders

2. Lack of incentives for companies to implement corporate

governance reform measures( no direct correlation between

putting expensive governance systems and corresponding

returns)

3. Underdeveloped external monitoring systems

4. Shortage of real independent directors

5. Weak regulatory oversight including multiplicity of

regulators.

Action steps should be taken to improve corporate governance

of SME in India.

1. Companies must put in place a mechanism to assess and

periodically monitor foreign travel of its directors so as

to ensure that at least one director meets the hundred and

eighty two days criterion for being considered as a resident

in India.

2. Companies should actively start looking for a woman director

considering they have only a short period to comply with

these requirements of the 2013 Act.

3. Private companies to review the director's disqualification

and ensure compliance for their existing directors.

4. Private companies to consider including disqualification of

directors as a part of its articles of association.

5. Unlisted public companies to revisit the need to continue

with an audit committee

Requirement.

6. Audit committees would need to devise a mechanism to: form a

policy for recommendation and appointment of auditors of the

company; review and monitor the auditor’s independence

related matters; approval and/ or modification of the

related party transactions valuation of undertakings or

assets of the company; evaluation of internal financial

controls and risk management systems.

7. All the companies will need to determine the applicability

of the CSR criteria and also the activities that may

constitute CSR activities under the 2013 Act, to ensure

compliance.

8. A non-listed company with more than 1000 share/debenture or

security holders to form stakeholder’s relationship

committee and include one non-executive director.

9. Companies to obtain information from IDs pertaining to them

and their relatives to conclude that the independence

criteria are met annually. Listed companies will need to

assess how they would apply the stricter policy of

independence as per the 2013 and the requirements of the

Listing Agreement. Determine the course of action for

directors that may not qualify as independent under the 2013

Act – such as nominee directors. 2013 Companies will need to

identify outstanding stock options previously granted to IDs

and determine the 2013 appropriate course of action.

10. Companies and their directors will be required to

identify their directorships and transition out over the

year if they exceed the limit. Companies will also need to

identify replacement directors – including IDs. The

companies need to consider updating their charter documents

for incorporating the provisions with respect to duties and

resignation of the directors.

11. The companies need to prepare a strong mechanism to

ensure adherence to the rules and regulations as per the

2013 Act so as to avoid the rigorous penalties laid down

under the 2013 Act.[16]

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