Corporate governance
The rules, processes and procedures followed in running a company, judged by an analyst against a checklist of board, audit and related-party tests rather than by reputation.
In plain language
Corporate governance is the machinery that is supposed to stop the people running a company from running it for themselves. The workbook defines it as the rules, processes and procedures followed in the management and operations of a firm, with the objective of ensuring the company is run well for all its stakeholders — shareholders, lenders, employees, suppliers and customers.
For a research analyst it is not an abstraction. A company with strong governance either prevents agency risk or detects and rectifies it in time. One without it can report perfectly good numbers for years and then lose them.
How it works
The workbook turns governance into nine things an analyst can actually check, and gives the SEBI minimum for each:
- Board composition — independent directors should be at least 50% of the board if the chairman is an executive director, and one-third in all other cases.
- Separation of chairman from MD/CEO — mandated for the top 1,000 listed companies, where the CEO must also not be from the promoter group.
- Nomination committee — ideally composed exclusively of independent directors.
- Auditor independence — the auditor's remuneration for all services to the group should be less than 10% of the auditor's overall income.
- Auditor rotation — auditors rotated once in five years.
- Audit committee — at least two-thirds independent; ideally all.
- Related party transactions — ideally pre-approved by the audit committee; SEBI as described requires placement before it, with justification where a transaction is not at arm's length.
- Remuneration committee — all members non-executive, chairman independent.
- Remuneration of independent directors — fully disclosed, so shareholders can judge the true degree of independence.
The framing matters as much as the list: regulatory standards are the minimum a company must follow, and the workbook says it would be preferable for companies to go beyond them.
A worked example
A listed company with a 12-member board chaired by the executive promoter, revenue Rs 2,000 crore.
| Check | Requirement | This company | Result |
|---|---|---|---|
| Independent directors | 50% (executive chairman) = 6 | 4 | Fails, short by 2 |
| Chairman / MD separation | Top 1,000 companies | Chairman is the promoter-CEO | Fails |
| Audit committee | 2/3 of 6 = 4 independent | 3 | Fails, short by 1 |
| Auditor independence | Fees < 10% of auditor's income | See below | Fails |
| Auditor rotation | Every 5 years | Same firm since FY2016 | Fails |
The auditor test in rupees:
Statutory audit fee Rs 1.10 crore
Tax and advisory work Rs 2.10 crore
Total billed to the group Rs 3.20 crore
Auditor firm total income Rs 24.00 crore
3.20 ÷ 24.00 = 13.3% against a 10% threshold
And the related party transaction: the promoter's private trading company bills Rs 96 crore a year to the listed entity — 4.8% of revenue — placed before the audit committee after the fact, which is the SEBI minimum the workbook describes rather than the pre-approval it calls ideal.
Five of nine checks fail. The analyst's conclusion is not that the accounts are wrong; it is that agency risk is not being controlled, and the usual expression of that conclusion is a discount to the valuation multiple.
Why NISM asks about it
Chapter 7 (Company Analysis – Business and Governance, section 7.6.2) sets out the nine checks with their SEBI thresholds, immediately after agency risk and immediately before promoter holdings. Expect questions on specific numbers — the 50% versus one-third board test, the two-thirds audit committee, the 10% auditor fee test, the five-year rotation — and on the principle that regulation is a floor.
Common exam traps
- Regulatory standards are the minimum, not the target (Chapter 7.6.2). A company meeting every SEBI requirement is compliant, which is not the same as well governed.
- The independent director threshold is conditional. At least 50% if the chairman is an executive director; one-third otherwise. Quoting a single figure loses the mark.
- Chairman/CEO separation applies to the top 1,000 listed companies, along with the rule that the CEO not be from the promoter group — not to every listed company.
- The 10% auditor test is on the auditor's total income from all services to the group, not on the statutory audit fee alone.
- The audit committee rule is at least two-thirds independent. "Entirely independent" is the workbook's ideal for the audit, nomination and remuneration committees, not the regulatory requirement.
- The workbook cites Clause 49 of the listing agreement. Clause 49 was superseded by the SEBI (LODR) Regulations, 2015, where Regulations 16 to 27 now carry these standards — and under Regulation 23 related party transactions require the audit committee's prior approval, not merely placement before it. Answer Chapter 7 as printed; know the current rule.
Check yourself
1.The three criteria used to evaluate companies under the ESG framework are:
- a)Earnings, Solvency and Growth
- b)Efficiency, Scale and Governance
- c)Environment, Social and Corporate Governance
- d)Equity, Sustainability and Growth
Show the answer
Answer: (c) Environment, Social and Corporate Governance
ESG stands for Environment, Social and Corporate Governance. Under environment, companies with low carbon emission and low contribution to pollution rank better. Under social, activities around human rights, gender equality and similar factors. The third criterion is the corporate governance standard followed by the company.
The other three options are plausible-sounding financial expansions of the same letters, which is exactly why they are offered. ESG is not a financial acronym at all — it started with a handful of "impact" investors before gaining wider traction.
2.According to the workbook, pledging of shares by promoters:
- a)Is always a signal of poor corporate governance
- b)Is always a signal that the business fundamentals have deteriorated
- c)May be a normal way of raising funds and does not necessarily signal a governance or fundamentals concern; what matters is whether the pledged amount is high or low
- d)Is prohibited for the promoters of listed companies in India
Show the answer
Answer: (c) May be a normal way of raising funds and does not necessarily signal a governance or fundamentals concern; what matters is whether the pledged amount is high or low
This is where the workbook contradicts the common market reflex. Its exact position: "Pledging of shares may be done by promoters as a way of raising funds in their normal course and thus does not necessarily signal any concern related to corporate governance or business fundamentals. However, analysts should look at whether amount of such pledged shares is high or low."
So options A and B overstate it — the word always is the giveaway. Option D is plainly false; pledging is permitted and disclosed.
The genuine concern with a high pledge is mechanical, not moral: a price fall reduces or eliminates the lender’s margin, the lender may be forced to liquidate, and that sudden sale creates further downward pressure on the share price.
3.For an analyst, which is the authentic source to check facts on a company?
- a)Research reports and opinions of other research analysts
- b)Annual reports
- c)Media reports
- d)Business portals
Show the answer
Answer: (b) Annual reports
Annual reports. The workbook names them, together with quarterly reports and the analyst's own calculations, as the source for every fact-based section of a report: peer group analysis, shareholding pattern, company fundamentals, key financial indicators and financials.
The other three options are secondary at best. Another analyst's report is that analyst's interpretation; media reports and business portals are summaries of a source rather than the source. The annual report is the company's own audited statement of record.
Where the other kind of information comes from: the view-based sections — Company Business, Key Strengths, Key concerns, Industry Overview — draw on communication with management, personal understanding of the business and industry.
And several checklist items point straight back at the annual report: any important/notable auditors' qualification · any important observation from notes to accounts (intangibles, MTMs on outstanding derivatives and guarantees etc.). Any change in the accounting policy with impact on P/L and B/S · any major observation from corporate governance report · present shareholding pattern. Changes in SH pattern over last 5 yrs.
None of those can be checked from a business portal.
Where this is taught
- Series XV · Chapter 7: Company Analysis – Business and Governanceintroduced here
- Series X-A · Chapter 8: Investing in Stocksintroduced here
Related terms
- Agency riskThe risk that a company's management, who control day-to-day decisions, pursue their own interests rather than those of the shareholders who actually own the business.
- Audit committeeThe board sub-committee responsible for reviewing a company's financial statements and nominating its auditors, which SEBI requires to be at least two-thirds independent directors.
- Auditor rotationThe corporate-governance rule that a company's statutory auditor must be changed at least once every five years, so a long-standing relationship cannot let facts stay hidden.
- Conflict of interestAny interest of the analyst's own — a shareholding, a fee, a relationship — that could bias the research, and which the regulations require to be disclosed rather than merely avoided.
- Independent directorA director who is neither part of management nor otherwise connected to the company — at least half the board where the chairman is executive, and one-third otherwise.
- PromoterUnder the ICDR Regulations, a person named as promoter in the offer document or annual return, or who controls the issuer's affairs, or on whose advice the board is accustomed to act.
- Contingent liabilityAn obligation that may or may not arise, depending on the outcome of an uncertain future event — a lawsuit, a tax dispute, a guarantee — disclosed in the notes rather than booked in the accounts.
- Related party transactionA deal between a company and a party connected to its controllers — promoters, their relatives, group firms. Watched because it can enrich the promoter group at minority shareholders' cost.
- Interim resolution professionalThe professional the adjudicating authority appoints when an insolvency application against a company is admitted under the IBC, who takes over management and forms the committee of creditors.
- Auditor independence testThe corporate-governance check that an auditor's total fees from a company or group stay below 10% of the auditor's overall income, so it is not financially dependent on that one client.
- Non-executive directorA board director who is not part of day-to-day management, but who is also not classed as independent — a third category sitting between executive and independent directors.
- Remuneration committeeThe board committee that decides the pay of directors and senior management, which SEBI requires to be made up entirely of non-executive directors with an independent director as chairman.
- Pledging of sharesPromoters using their shareholding as collateral to raise a loan instead of selling it — legitimate on its own, but a governance risk analysts must size up when the pledged amount is high.
- ESG frameworkA framework in which investors assess a company on environmental, social and corporate governance criteria, used as a screening filter before the usual financial analysis is done.
- Nomination committeeThe board committee that appoints independent directors, which the workbook says should ideally consist exclusively of independent directors so that company executives have no role in the appointment.
- Keyman riskThe risk that a company depends so heavily on one or a few individuals that a change at the top can derail its decision making.
- Proxy adviserA person who advises institutional investors or shareholders on exercising their rights in a company, including voting recommendations on agenda items and recommendations on public offers.