I.

INTRODUCTION Former World Bank President James Wolfensohn "has equated the importance of the governance of corporations to that of the governance of countries." (1) According to the Organisation for Economic Co -operation and Development ("OECD"), (2) "Corporate governance deals with the rights and responsibilities of a company's management, its board, shareholders and various stakeholders." (3) The spectacular collapses of Enron (4) and WorldCom (5) in the United States, (6) where shareholders lost a combined $245 billion, (7) and the collapse of Italian dairy giant Parmalat (8) in Europe, have transformed corporate governance from an afterthought to the cornerstone of any firm's or country's long -term success. (9) Corporate governance in a developing-country setting takes on additional importance. Good corporate governance is vital because of its role in attracting foreign investment. (10) The extent of foreign investment, in turn, shapes the prospects fo r economic growth for many developing countries. This Note presents an in-depth inquiry into corporate governance in one such developing country, India. While India's corporate-governance framework is advanced for a developing country, it still can be significantly improved. Part II discusses the importance of corporate governance for developing countries. (11) Part III provides a brief history of corporate governance in India. Part IV examines the current standards of corporate governance in India. Finally, Part V recommends improvements to India's corporate-governance framework. (12) II. WHY CORPORATE GOVERNANCE? Investors primarily consider two variables before making investment decisions--the rate of return on invested capital and the risk associated with the investment. (13) In recent years, the "attractiveness of d eveloping nations" as a destination for foreign capital has increased, partly because of the high likelihood of obtaining robust returns and partly because of the decreasing "attractiveness of developed nations." (14) The lure of achieving a high rate of r eturn, however, does not, by itself, guarantee foreign investment; the attendant risk (15) weighs equally in an investor's decision-making calculus. (16) Good corporategovernance practices reduce this risk by ensuring transparency, accountability, and enf orceability in the marketplace. (17) While strong corporate-governance systems help ensure a country's long-term success, weak systems often lead to serious problems. For example, weak institutions caused, at least in part, the debilitating 1997 East Asia n economic crisis. (18) The crisis was characterized by plummeting stock and real -estate prices, as well as a severe erosion of investor confidence. (19) The total indebtedness of the countries (20) affected by the crisis exceeded one -hundred billion dollars. (21) While the presence of a good corporate-governance framework ensures neither stability nor success, (22) it is widely believed that corporate governance can "raise efficiency and growth," especially for countries that rely heavily on stock markets to raise capital. (23) In fact, some contend that the "Asian financial crisis gave developing countries ... a lesson on the importance of a sound corporate governance system." (24) In an open market, investors choose from a variety of investment vehicles. (25) The existence of a corporate-governance system is likely a part of this decision-making process. In such a scenario, firms that are "more open and transparent," (26) and thus well governed, are more likely to raise capital successfully because invest ors will have "the information and confidence necessary for them to lend funds directly" to such firms. (27) Moreover, well -governed firms likely will obtain capital more cheaply than firms that have poor corporate-governance practices because investors will require a smaller "risk premium" for investing in well-governed firms. (28) Also, sound corporate-governance practices enable management to allocate resources more efficiently, which increases the likelihood that investors will obtain a higher rate of return on their investment. (29) Finally, leading indices show that developing countries that have good governance structures consistently outperform developing countries with poor corporate -governance structures. (30) Thus, in an efficient capital market, (31) investors will invest in firms with better corporate-governance frameworks (32) because of the lower risks and the likelihood of higher returns. (33) At a macro level, if firms in developin g countries attract investment, they will stimulate growth in the local economy. (34) If they "cannot attract equity capital, they are doomed to remain on a small, inefficient scale," and they will be unable to stimulate growth in their host country. (35) Good corporate governance benefits developing countries in a number of ways. According to at least one scholar, good corporate-governance practices can decrease the "likelihood of a domestic financial crisis" (36) and the severity if such a crisis does occur. (37) Additionally, scholars have found strong "evidence linking corporate governance to corporate efficiency" (38) and have shown that "corporate governance creates more efficient corporate management." (39) Finally, research shows that well-governed firms are valued significantly higher than firms with imperfect corporate-governance practices. (40) It has been estimated that, by the end of this century, "funds seeking trustworthy, productive companies in today's developing countries are likely to top $500,000 billion." (41) The policy challenge that exists for governments in developing countries is to provide a hospitable environment for such funds; a sound corporate-governance framework can play a decisive role in creating this hospitable environment. (42) Strong corporate governance has beneficial consequences even for countries that choose to follow a development strategy that does not focus on attracting foreign investment. (43) Many developing countries are home to strong distribution cartels that waste scarce resources. (44) Good corporate governance can r educe this wasteful behavior and, thus, "overcome the obstacles to productivity growth." (45) Moreover, corporate governance can play a role in reducing corruption, (46) and decreased corruption significantly enhances a country's developmental prospects. (47) Ultimately, corporate governance "is not just one of those imported western luxuries; it is a vital imperative." (48) III. HISTORY OF CORPORATE GOVERNANCE IN INDIA A. PRE-LIBERALIZATION

When India attained independence from British rule in 1947, the country was poor, with an average per-capita annual income under thirty dollars. (49) However, it still possessed sophisticated laws regarding "listing, trading, and settlements." (50) It even had four fully operational stock exchanges. (51) Subsequent laws, such as the 1956 Companies Act, further solidified the rights of investors. (52) In the decades following India's independence from Great Britain, the country turned away from its capitalist past and embrac ed socialism. (53) The 1951 Industries Act (54) was a step in this direction, requiring "that all industrial units obtain licenses from the central government." (55) The 1956 Industrial Policy Resolution (56) "stipulated that the public sector would dominate th e economy." (57) To put this plan into effect, the Indian government created enormous state -owned enterprises, (58) and India steadily moved toward a culture of "corruption, nepotism and inefficiency." (59) As the government took over floundering priv ate enterprises and rejuvenated them, it essentially "convert[ed] private bankruptcy to high-cost public debt." (60) One scholar referred to India's economic history as "the institutionalization of inefficiency." (61) The absence of a corporate-governance framework exacerbated the situation. Governm ent accountability was minimal, and the few private companies that remained on India's business landscape enjoyed free reign with respect to most laws; the government rarely initiated punitive action, even for nonconformity with basic governance laws. (62) Boards of directors invariably were staffed by friends or relatives of management, and abuses by dominant shareholders and management were commonplace. (63) India's equity markets "were not liquid or sophisticated enough" to punish these abuses. (64) Scholars believe that "takeover threats act as [a] disciplining mechanism to poorly performing companies" (65) because as the stock price of poorly governed firms decreases (because disgruntled investors discard stock), the firms become susceptible to hostile-takeover attempts. (66) Thus, "the fear of a takeover ... is supposed to keep the management honest." (67) However, until recently, hostile takeovers were almost entirely non-existent in India, (68) and therefore, the poorly governed Indian firms had little to worry about in terms of following corporate laws once they had raised capital through their initial public offering. Thus, corporate governance in India was in a dismal condition by the early 1990s. B. POST-LIBERALIZATION In 1999, in a defining mom ent in India's corporate-governance history, the Indian Parliament created the Securities and Exchange Board of India ("SEBI") to "protect the interests of investors in securities and to promote the development of, and to regulate[,] the securities market. " (69) In the years leading up to 2000, as Indian enterprises turned to the stock market for capital, (70) it became important to ensure good corporate governance industry -wide. (71) Additionally, a plethora of scams rocked the Indian business scene, (72) and corporate governance emerged as a solution to the problem of unscrupulous corporate behavior. In 1998, the Confederation of Indian Industry ("CII"), "India's premier business association," (73) unveiled India's first co de of corporate governance. (74) However, since the Code's adoption was voluntary, few firms embraced it. (75) Soon after, SEBI appointed the Birla Committee (76) to fashion a code of corporate governance. (77) In 2000, SEBI accepted the recommendations of the Birla Committee and introduced Clause 49 into the Listing Agreement of Stock Exchanges. Clause 49 outlines requirements vis-a-vis corporate governance in exchange-traded companies. (78) In 2003, SEBI instituted the Murthy Committee (79) to scrutinize India's corporate-governance framework further and to make additional recommendations to enhance its effectiveness. (80) SEBI has since incorporated the recommendations of the Murthy Committee, and the latest revisions to Clause 49 became law on January 1, 2006. (81) IV. THE CURRENT STATE OF CORPORATE GOVERNANCE IN INDIA (82) Corporate governance reform in India has focused primarily on the "role and composition of the board of directors." (83) Each of the three sets of recommendations (the CII Code recommendations from 1997, the Kumar Mangalam Birla Committee recommendations from 2000, and the Murthy Committee recommendations from 2003) has advanced a more nuanced and sophisticated understanding of corporate governance in this respect. For example, while the CII Code was silent on the financial-literacy levels expected of directors, (84) the Murthy Committee recommended that companies train their "Board members ... in the business model of the company as well as the risk profile of the business parameters of the company." (85) Another notable recommendation of the Murthy Committee was that the Audit Committee be comprised entirely of "financially literate non-executive members with at least one member having accounting or related financial