VISHWAKARMA SAHJEEVAN INSTITUTE OF MANAGEMENT, KHED

Behavioral Finance In Corporate Governance

Soni Singh (8655244014), email: singh.soni021@gmail.com, Prajakta Mahadik(9665950980) email: prajaktamahadik27@gmail.com

1. INTRODUCTION Behavioural Finance denotes cognitive factors of investors and authorities which affects on their decision making. Behavioural Finance is a new stream of finance which studies relationship among human psychology, perceptions and power of decision making. Human being is unpredictable but some cognitive factors definitely help us to analyze the behaviour and his thinking process. Here, behavioural finance in context to decision making behaviour of board of directors and behaviour of auditors is under study. Board of Directors are the decision makers, while taking decisions they think about company policies, guidelines and interest of the company instead of shareholders, creditors and other stakeholders. In the same way external auditors interest in future contracts, employment and to derive other benefits from the company insist him to ignore irregularities in the business. Hence the regulating authority has introduced the mechanism to reduce arbitratory behaviour of Board of directors and auditors. In this research paper, we have pinpointed the behaviour of Board of Directors and Auditors in maintaining corporate governance and the mechanism which regulates their behaviour.

2. KEY CONCEPTS 2.1 Stakeholders: A corporate stakeholder is a party that can affect or be affected by the actions of the business as a whole. The stakeholder concept was first used in a 1963 internal memorandum at the Stanford Research Institute. It defined stakeholders as "those groups without whose support the organization would cease to exist. 2.2 Code of Conduct: A code of conduct is a set of rules outlining the responsibilities of or proper practices for an individual, party or organization. Related concepts include ethical codes and honour codes. Every code of conduct should go into the business ethics of an organization. These are usually targeted to explain the non-economic values of an organization, or those not directly related to working towards profit. Business ethics explain the philosophy of an organization and include the rights and duties of employees and the corporation as a whole, as well as the relationship between the corporation and its stakeholders.

2.3 Corporate Governance: Corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a corporation (or company) is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, management, and the board of directors. Other stakeholders include employees, customers, creditors, suppliers, regulators, and the community at large. According to Zingales (1998), Corporate Governance is defined as The complex set of constraints that shape the ex-post bargaining over the quasi rent generated by firm. According to Shleifer and Vishny (1997), Corporate Governance is defined as the mechanism is legal and economic that can be altered through political process.

2.4 Corporate Legislation:

Corporate legislation is the study of how shareholders, directors, employees, creditors, and other stakeholders such as consumers, the community and the environment interact with one another. Corporate legislation is a part of a broader companys law (or law of business associations). 2.5 Behavioural finance: An important subfield of finance is Behavioural Finance. Behavioural finances use insights from the field of psychology and apply them to the actions of individuals in trading and other financial applications. A theory of finance that attempts to explain the decisions of investors by viewing them as rational actors looking out for their selfinterest, given the sometimes inefficient nature of the market. Tracing its origins to Adam Smith's The Theory of Moral Sentiments, one of its primary observations holds that investors (and people in general) make decisions on imprecise impressions and beliefs rather than rational analysis. A second observation states that the way a question or problem is framed to an investor will influence the decision he/she ultimately makes. These two observations largely explain market inefficiencies; that is, behaviour finance holds that markets are sometimes inefficient because people are not mathematical equations. Behavioural finance stands in stark contrast to the efficient markets theory.

3. OBJECTIVES OF THE RESEARCH To study the concept of Behavioural Finance and Corporate Governance. To study relationship between Behavioural Finance and Corporate Governance. To study the role of auditor and Board of Directors in Corporate Governance. To study internal governance mechanism of the company.

4. RESEARCH METHODOLOGY
In this paper, we have done the detailed study of corporate governance. We have elaborated the behavioural aspects of corporate governance in todays current scenario. We have derived information from various websites, journals, magazines and books. We have incorporated this information and our own views on this subject.

5. BEHAVIOURAL FINANCE IN CONTEXT TO CORPORATE GOVERNANCE

According to James Moniter If you put good people into bad situations they usually turn bad. From a Corporate Governance point of view, the importance of situational factors should lead us to be on our guard for situation and incentives that could give rise to bad behaviour. According to Randall Morck Many corporate governance disasters could often be averted if directors asked hard questions, demanded clear answers and blew whistles. Milligram (1974) states The most far-reaching consequence of the agented shift is that a man feels responsibility to the authority directing him, but feels no responsibility for the content of the actions that the authority prescribes. Good corporate governance by boards of directors is recognised to influence the quality of financial reporting, which in turn has an important impact on investor confidence (Levitt, 1998 and 2000). Watts and Zimmerman (1986) noted that the auditor serves a central role in reducing agency conflicts. Transparency in accounting is one of the essential element of corporate governance. Even today many Boards, are in dark about actual financial condition of the company. Auditor should give true information about financial condition of the company on the basis of which Board takes important decisions. Most of the time top management considers company policies, guidelines and financial data provided by the auditors while taking decision. They do not think whether the decision is ethical or unethical, even do not consider the interest of the body to which they are representing. Sometimes there may be conflicts in the interest of the body to whom they are representing and company interest or their personal interest and company interest. For instance Board of directors and external auditors should protect the interest of the shareholders. But Board of Directors and Auditors are, no less than other individuals subject to the common human preference for immediate gratification, like gratification from a bonus, re-election to a board of directors, renewal of an auditing contract, or the prospects of employment in a clients firm, is certain and experienced in the present or the immediate future.

In our research we have tried how the mechanism regulates the behaviour of the Board of Directors and Auditors regarding corporate governance.

6. ROLE OF BOARD OF DIRECTORS IN CORPORATE GOVERNANCE.

A company in the eyes of law is an artificial person. It has no physical existence. It has neither soul nor body of its own. As such, it cannot act in its own person. It can do so only through some human agency i.e. Directors (F.V Wilson 1866). The directors are a body to whom is delegated the duty of managing the general affairs of the company. A Corporate body can only act by agents, and it is of course the duty of those agents so to act as best to promote the interest of the corporation whose affairs they are conducting. (Lord Cranworth, 1854). Every director is bound by common law by separate and distinct and fiduciary duty to the company. In this fiduciary capacity, a director assumes two roles, as an agent acting on behalf of the company, and as a trustee who controls company asset. These roles give rise to the following directors duties: To act in good faith towards the company. To act only within their powers and use their powers only for the best interest of the company. Not to use for personal gains any information acquire as their capacity as a director. To act in the best interest of the company and to avoid a conflict between personal and company interests. To exercise independent judgement in decision making. For ex a director who is appointed to represent an interest of employees, is nevertheless obliged to act in the best interests of the company as the whole. The principle role of the board of director as representatives of the shareholders is to oversee the function of the organisation and ensure that it continuous to operate in the best interests of all stakeholders. Here stakeholders might be non-shareholders. According to stakeholder theory, company should design their corporate strategy considering the interest of their stakeholders-groups and individuals who can effect or are affected by the organisations purpose (Freeman 1984).In this sense, Stakeholders of a firm can defined as Individuals and constituencies that contribute

either voluntarily and involuntarily to its wealth-creating capacity and activities, and who are therefore its potential beneficiary and/or risk bearers.(Post et al ..,2002) . The board may delegate certain powers to managers and at the same time impose some restrictions and conditions which can be varied at any time thus directors have a duty to monitor managements performance and insure good governance. The literature review suggest that directors role in corporate governance in different capacity such as advice and counsel (Mace),setting the strategic direction of the company (Yet Demb and Neubauer), watchdog for shareholders, dividend (Yet Demb and Neubauer), managerial rubber stamps to active and independent monitors (MacAvoy and Millsteil-1999). In the new era Chief Executive Officer (CEO) is becoming a powerful authority in the company. Many independent directors are appointed by the CEOs and they are loyal to their masters i.e. CEOs. The boards explicit purpose is to hire, monitor, and if necessary fire the CEO but Mace (1986) shows that directors remain steadfastly loyal to misguided CEOs. The huge scandal like Enron and WorldCom are the examples of it.

CASE STUDY OF MARUTI SUZUKIMaruti Suzuki resolved the issue of labour unrest in very unethical manner and institutional investors raised question mark on it. The story is like this, ex-president of the Maruti-Suzuki Employees Union Sonu Gujjar had left the company after receiving hefty severance packages. Institutional investors are disgruntled at lack of communication from the company on the severance packages, which is of Rs. 40 Lakhs. No doubt this issue will do long term damage to Marutis Corporate Governance Practices. Chief Investment Officer of foreign fund house has also blamed the company for non-disclosure regarding deal with workers. A proper disclosure regarding the deal with workers was all the more necessary as prolonged labour unrest had seen the companys shares struggle. The Maruti stock has not only underperformed the benchmark indices but also failed to put a good show against the auto index. Since June, Maruti Suzukis stocks have plunged a little more than 10 per cent against a rise of 3.5 per cent in the auto index. During this period, the BSE benchmark Sensex lost less than six per cent. Last week, Marutis shares closed weak at Rs 1,123.35 on the BSE. Gujjar and his 2,000-strong band of workers have stopped work thrice since June at the Manesar unit. The labour unrest has been the worst over a decade in the company, resulting in a production loss of 74,500 units. That amounted to revenue losses of Rs 2,200 crore. Some institutional investors feel better by this decision and majority irritated and said that it was not the ideal way to resolve worker unrest. Institutional investors also feel cheated by Gujjar, who had become the poster boy for worker unions in the Manesar belt and now disappeared after taking money. While investors acknowledged that there is no legal obligation for Maruti Suzuki to inform shareholders of its actions, they believe it should done so for the sake of good corporate governance. In this case we can clearly experience that how the behaviour of board of directors adversely affects on the corporate governance. Board has taken decision in the best

interest of the company but it had a great impact on employee morale as well as on investors trust over company.

7. ROLE OF AN AUDITOR IN CORPORATE GOVERNANCE

Auditing is defined as an independent examination of financial information of any entity whether profit oriented or not, irrespective of its size or legal form, when such an examination is conducted with a view to expressing an opinion thereon (kashma kaushik and Rewa Kamboj). Audit is a systematic process of examination and verification of firms accounting records by a professional to make an opinion on reliability and validity of information reported by that firm (Fan & Wong 2005). Auditing profession is governed by the Institute of Chartered Accountants of India (ICAI), only a member of ICAI, holding certificate of practice can be named as an auditor of a company. As per the company Act, auditor is personally responsible for conducting an audit and he must be an independent person.( Act specifies persons who may not be appointed as an auditor such as a body corporate, an employee of the entity, a debtor etc. ) When auditor signs the accounting statements of business enterprise, he certifies that according to his belief and understanding the statements are true and fair, which give correct information. Auditor has enormous power to ask explanations from directors and company authorities if any transaction looks suspicious. It is moral responsibility of the auditor to find out such incorrect information provided by the people inside the organization and correct them before he certifies in order to protect the interest of the stakeholders associated with the organization. There are several rights of the Auditor that are protected by the Companies Act in order to ensure that s/he conducts the audit fearlessly, independently and have access to all information necessary. 1. Right to collect information 2. Right of access to books of accounts and vouchers 3. Right to obtain information and explanations from directors/company officials 4. Right to signature of authentication 5. Right to attend general meeting and Auditors report to be read at the Annual General Meeting

However, auditor is held liable for fraud: 1. The statement signed by him was untrue in fact 2. That the auditor knew that it was untrue or was recklessly ignorant whether it was true or not; 3. That the statement was made with the intent that the other party should act on it; and 4. That the other party did in fact rely on it and consequently suffered damage An auditor is liable to make good the loss of investors of a company who has suffered due to negligence of auditor. Traditionally, the external auditor has also played an important role in improving the credibility of financial information (Mautz and Sharaf, 1961; Wallace, 1980)., Cohen and Hanno (2000) examine how auditors consider CG structure when they are planning an audit program. The various changes in accounting, financial reporting and auditing were all designed to provide protection to investors. This is being achieved by imposing a duty of accountability upon the managers of a company (Crowther and Jatana, 2005). Auditor can play an important role to reduce information asymmetry (Al-Ajmi 2009, Further, Krishnan (2001) finds a relationship between the quality of the CG structure and the incidence of internal control problems. Literature review also suggest the role of audit committee in corporate governance as audit committees are effective in reducing the occurrence of earnings management that may result in misleading financial statements (Defond and Jiambalvo, 1991; Dechow, et al., 1996; Peasnell, et al., 2000). Literature also linked audit quality with the boards of directors, and the audit committees of boards of directors. This shows that audit quality is positively related to boards and audit committees when they are more independent (that is, higher number of outside directors).

8. BASIC PRINCIPLES AND MECHANISM FOR GOOD GOVERNANCE

Good Governance:Principles
Strategic Vision & Consensus Orientation Participatory Rule of Law Effective & Efficient Equitable & Inclusive Accountable Transparent

Good Governance

Responsive

Basic principles of Corporate Governance

Strategic vision and consensus orientation- This principle suggest that corporate

vision and corporate culture creates trust in the mind of stakeholders. Ethical approach , culture, society; organizational paradigm , balanced objectives , congruence of goals of all interested parties are the starting point of smooth running of business organization. Accountability- In this each party plays his part. In the corporate owners, directors and managers are the key players. Everyone should comply the responsibilities entrusted upon them. Transparency-The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company. Responsive- Companies should be ready, where practicable, to enter into a dialogue with institutional shareholders based on the mutual understanding of objectives. Boards

should use the AGM to communicate with private investors and encourage their participation.

Equitable and inclusive--The corporate governance framework should ensure the equitable treatment of all stakeholders. There should be due weight to all stakeholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights. There should be grievance redressal system for employees. The corporate governance framework should recognize the rights of stakeholders established by law or through mutual agreements and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.

Effective and Efficient- The principal objective of business enterprises is to enhance economic value for all shareholders by making the most efficient use of resources. A company that meets this shareholder value creation objective will have greater internally generated resources, improving its prospects for meeting its environmental, community, and social obligations; pay taxes; reward, train, and retain key staff; and enhance employee satisfaction. A key focus area is a companys human capital strategy, which is a lead indicator of corporate success.

Rule of Law- Company should not construct the rules and regulations contradictory to the fundamental laws. Rules and regulations of the company should be compatible to natural laws.

Participatory- This principle suggest that the company management should be participative while taking any decision. Voice of shareholders, employees, creditors and any other person whose interest is involved in it should be heard before taking any decision.

Mechanism for Good Governance

In our country, there are six mechanisms to ensure corporate governance: 7.1 Companies Act

Companies in our country are regulated by the companies Act, 1956, as amended up to date. The companies Act is one of the biggest legislation each and every aspect of a company's insistence comes under the purview of this act. But to ensure corporate governance, the Act confers legal rights to shareholders to

(1) Voting right at AGM (2) To elect directors who are responsible for specifying objectives and laying down policies; (3) Determine remuneration of directors and the CEO; (4) Removal of directors and (5) Take active part in the annual general meetings. 7.2 Securities law The primary securities law in our country is the SEBI Act. Since its setting up in 1992, the board has taken a number of initiatives towards investor protection. SEBI has made mandatory to disclose accounting information in both prospectus and in Annual Report. To preserve transparency and accountability SEBI has established certain standards of information disclosure. 7.3 Discipline of the capital market Capital market itself has considerable impact on corporate governance. Here in lies the role the minority shareholders can play effectively. They can refuse to subscribe to the capital of a company in the primary market and in the secondary market; they can sell their shares, thus depressing the share prices. A depressed share price makes the company an attractive takeover target. 7.4 Nominees on company boards Development banks hold large blocks of shares in companies. Nominee directors appointed by the creditors, employees and by government can effectively block resolutions which may be detrimental to their interest. 7.5 Statutory Audit Statutory audit is yet another mechanism directed to ensure good corporate governance. Auditors are the conscious-keepers of shareholders, lenders and others who have financial stake in companies. Auditing enhances the credibility of financial reports prepared by any enterprise. The auditing process ensures that financial statements are accurate and complete, thereby enhancing their reliability and usefulness for making investment decisions.

7.6 Codes The mechanisms discussed till now are regulatory in approach. They are mandated by law and violations of any provision invite penal action. But legal rules alone cannot ensure good corporate governance. What is needed is self-regulation on the part of directors, besides of course, the mandatory provisions.

9. CONCLUSIONS AND FINDINGS

To prevent the cognitive factors effect on decision making and to regulate the behaviour of Board of Directors and Auditors mechanism introduced by the government is less effective. The real problem is lack of transparency and disclosure of information. To access the information investors have to pay processing cost. To achieve greater transparency and accountability in the organization some good practices have to be followed. 1. Separation of role of Chairman of the Board and CEO. 2. Board works through Audit committees and it is expected that audit committee should work diligently in financial matters. 3. For good governance appointment of independent directors is beneficial. He will avoid conspiracy. 4. A Board needs to be provided adequate information from officials of the company to take right decision. 5. There should be restriction of many directorships. Because person working on too many boards will not give justice to anyone.

9. REFERANCES
1. The role of auditors in the context of corporate governance. Asst. Prof. Loganathan Krishnan 2. Report of the SEBI Committee on Corporate Governance (February 8, 2003) 3. Corporate Governance In India, By Dr. B. S. Hothi, Dr. S. L. Gupta, Mr. Abhishek Gupta (Singhania University of Rajasthan) 4. Corporate governance duty and roles and responsibilities of directors by R balakrishnan. 5. Status of Corporate Governance Research on India: An Exploratory Study. By Padmini Srinivasan Assistant Professor, Finance & Control Indian Institute of Management Bangalore. 6. Business law written by N.D.Kapoor.