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.
Corporate governance is a multi-faceted subject. An important theme of corporate governance is
to ensure the accountability of certain individuals in an organization through mechanisms that try
to reduce or eliminate the principal-agent problem.
CORPORATE GOVERNANCE INITIATIVES IN INDIA / HISTORICAL
PERSPECTIVE/ CORPORATE GOVERNANCE OF INDIA HAS UNDERGONE A
PARADIGM SHIFT
There have been several major corporate governance initiatives launched in
India since the mid-1990s. The FIRST was by the Confederation of Indian
Industry (CII), Indias largest industry and business association, which came
up with the first voluntary code of corporate governance in 1998. The
SECOND was by the SEBI, now enshrined as Clause 49 of the listing
agreement. The THIRD was the Naresh Chandra Committee, which
submitted its report in 2002. The FOURTH was again by SEBI the
Narayana Murthy Committee, which also submitted its report in 2002. Based
on some of the recommendation of this committee, SEBI revised Clause 49 of
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More than a year before the onset of the Asian crisis, CII set up a committee to examine
corporate governance issues, and recommend a voluntary code of best practices. The committee
was driven by the conviction that good corporate governance was essential for Indian companies
to access domestic as well as global capital at competitive rates. The first draft of the code was
prepared by April 1997, and the final document (Desirable Corporate Governance: A Code), was
publicly released in April 1998. The code was voluntary, contained detailed provisions, and
focused on listed companies.
2. KUMAR MANGALAM BIRLA COMMITTEE REPORT AND CLAUSE 49-:
While the CII code was well-received and some progressive companies adopted it, it was Felt
that under Indian conditions a statutory rather than a voluntary code would be more Purposeful,
and meaningful. Consequently, the second major corporate governance initiative in the country
was undertaken by SEBI. In early 1999, it set up a committee under Kumar Mangalam Birla to
promote and raise the standards of good corporate governance. In early 2000, the SEBI board
had accepted and ratified key recommendations of this committee, and these were incorporated
into Clause 49 of the Listing Agreement of the Stock Exchanges.
3. THE NARESH CHANDRA COMMITTEE REPORT ON CORPORATE GOVERNANCE-:
The Naresh Chandra committee was appointed in August 2002 by the Department of Company
Affairs (DCA) under the Ministry of Finance and Company Affairs to examine various corporate
governance issues. The Committee submitted its report in December 2002. It made
recommendations in two key aspects of corporate governance: financial and non-financial
disclosures: and independent auditing and board oversight of management.
4. NARAYANA MURTHY COMMITTEE REPORT ON CORPORATE GOVERNANCE-:
The fourth initiative on corporate governance in India is in the form of the recommendations of
the Narayana Murthy committee. The committee was set up by SEBI, under the chairmanship of
Mr. N. R. Narayana Murthy, to review Clause 49, and suggest measures to improve corporate
governance standards. Some of the major recommendations of the committee primarily related to
audit committees, audit reports, independent directors, related party transactions, risk
management, directorships and director compensation, codes of conduct and financial
disclosures.
5. CII TASKFORCE ON CORPORATE GOVERNANCE 2009-:
Satyam is a one-off incident - especially considering the size of the malfeasance. The
overwhelming majority of corporate India is well run, well regulated and does business in a
sound and legal manner. However, the Satyam episode has prompted a relook at our corporate
governance norms and how industry can go a step further through some voluntary measures.
With this in mind, the CII set up a Task Force under Mr. Naresh Chandra in February 2009 to
recommend ways of further improving corporate governance standards and practices both in
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letter and spirit. The report enumerates a set of voluntary recommendations with an objective to
establish higher standards of probity and corporate governance in the country.
The recommendations in brief are as under:
1. Appointment of Independent
Director
a. Nomination Committee
2. Duties, liabilities and
remuneration of independent
directors
a. Letter of Appointment to
Directors
b. Fixed Contractual
Remuneration
c. Structure of Compensation to
NEDs
3. Remuneration Committee of
Board
4. Audit Committee of Board
5. Separation of the offices of the
Chairman and the Chief Executive
Officer
6. Attending Board and Committee
Meetings through Teleconferencing and
Video conferencing
7. Executive Sessions of
Independent Director
8. Role of board in shareholders
and related party transactions
Accountability
Clarifying governance roles & responsibilities, and supporting voluntary
efforts to ensure the alignment of managerial and shareholder interests and
monitoring by the board of directors capable of objectivity and sound
judgment.
Transparency
Requiring timely disclosure of adequate information concerning corporate
financial performance..
Responsibility-: Ensuring that corporations comply with relevant laws and
regulations that reflect the societys values
Fairness-: Ensuring the protection of shareholders rights and the
enforceability of contracts with service/resource providers.
Principles of corporate governance:
Key elements of good corporate governance principles include honesty, trust
and integrity, openness, performance orientation, responsibility and
accountability, mutual respect and commitment to the organization of
importance is how directors and management develop a model of
governance that aligns the values of the corporate participants and then
evaluate this model periodically for its effectiveness. In particular, senior
executives should conduct themselves honestly and ethically, especially
concerning actual or apparent conflicts of interest, and disclosure in
financial reports.
Commonly accepted principles of corporate governance include:
Given
choice
between
self-serving
behaviour
and
pro-
the society at large and draws all of them into corporate-mix. It is often
criticized as wooly minded liberalism because it is not applicable in
practice by companies. But the defense is that managers can act efficiently
only by drawing upon the resources of the stakeholders and as such there is
a contract between the company and the stakeholders
The primary feature of the stakeholder theory of corporate governance is
that those who have a stake in the functioning of the firm are made up of
large and diverse groups.
Simply put, stakeholders are those who seek some benefit from the optimum
running of the firm. Stakeholders have different goals and seek different
benefits from the firm. Workers seek job security, the IRS wants its tax
payments, investors want dividends, and the community wants a solid
economic base. The stakeholder theory holds that these different interests
do, in fact, control the firm in their own specific ways, and none has any
better right to have its voice heard than any other.
Function-: The stakeholder theory is both a descriptive and a normative
theory. It is descriptive in that it functions as a way of describing how
a company is constituted and controlled. In this case, one can see how
customers or investors all have their say in how the firm markets its
products, for example. It is a normative theory in that it suggests how
a firm should be run.
Benefits-: Stakeholder theory is a highly democratic and participatory
concept of corporate governance. Under this model, the firm is not
merely a profit-making machine for elite investors and major
executives. It is a profoundly social institution that is meant to serve
more than its shareholders. It is a communal institution that benefits
large segments of the local population. Thousands of lives are
potentially connected to and dependent upon the proper workings of
the firm.
D. SOCIOLOGICAL THEORY
The sociological approach has focused mostly on board composition and
implications for power and wealth distribution in the society. Under this
theory, board composition, financial reporting, and disclosure and auditing
are of utmost importance to realize the socio-economic objectives of
corporations.
MECHANISMS AND CONTROLS
Corporate governance mechanisms and controls are designed to reduce the
inefficiencies that arise from moral hazard and adverse selection. For
example, to monitor managers' behaviour, an independent third party (the
external auditor) attests the accuracy of information provided by
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competition
debt covenants
demand for and assessment of performance information (especially
financial statements)
government regulations
managerial labour market
media pressure
takeovers
CORPORATE GOVERNANCE SYSTEM:
The role of the management is to run the enterprise while the role of the
board is to see that it is being run well and in the right direction. Corporate
governance systems vary around the world. Scholars tend to suggest three
broad versions:
GERMAN MODEL
Corporate governance in the German model is exercised through two
boards, in which the upper board supervises the executive board on behalf of
stakeholders and is typically societal oriented. In this model, although
shareholders own the company, they do not entirely dictate the governance
mechanism. They elect 50 percent of members of supervisory board and the
other half is appointed by labour unions, ensuring that employees and
labourers also enjoy a share in governance. The supervisory board appoints
and monitors the management board.
THE JAPANESE MODEL
This is the business network model, which reflects the cultural relationships
seen in the Japanese keiretsu network, in which boards tend to be large,
predominantly executive and often ritualistic. The reality of power in the
enterprise lies in the relationships between top management in the
companies in the keiretsu network. In this model the financial institution has
accrual role in governance. The shareholders and the main bank together
appoint board of directors and the president.
The distinctive features of the Japanese corporate governance mechanisms
are as follows:
The president who consults both the supervisory board and the executive
management is included.
Importance of the lending bank is highlighted.
GERMAN
JAPANESE
Share holders
Shareholders
/unions
Elects
Elects
Elects
Board of Directors
Supervisory Board
Appoints
Appoints
Appoints
Officers/Executive
Management Board
Executive Board
and
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Manage
Manage
Manage
Company
Company
Company
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corporate should address this issue and relate it to more meaningful and
transparent accounting and reporting.
Transparency means that information is freely available and directly
accessible to those who will be affected by such decisions and their
enforcement. It also means that enough information is provided and that
it is provided in easily understandable forms and media.
Financial reporting and records: A company should prepare and
maintain accounts of its business affairs fairly and accurately in
accordance with the financial and accounting reporting standards, laws
and regulations of the country in which it conducts the business affairs.
Wilful material misrepresentation of and/or misinformation on the
financial accounts and reports shall be regarded as the violation of the
firms ethical conduct and also will invite appropriate civil or criminal
action under the relevant laws.
OBLIGATION TO EMPLOYEES
In the context of enhanced awareness of better governance practices,
managements should realize that they have their obligations towards their
workers too.
Fair employment practices: An ideal corporate should provide equal
access and fair treatment to all employees on the basis of merit; the
success of the company will be improved while enhancing the progress
of individuals and companies. The applicable labour and employment
laws should be followed wherever it operates.
Equal opportunities: A company should provide equal opportunity to
all its employees and all qualified applicants for employment without
regard to their race, caste, religion, colour, marital status, sex, age,
nationality and disability.
Humane treatment: Companies should treat employees as their first
customers and above all as human. They have to meet the basic needs of
all employees in the organization. There should be a friendly, healthy
and competitive environment for the workers to prove their ability.
Participation: Participation of both men and women is a key
cornerstone of corporate governance. Participation could be either direct
or through representatives. It needs to be informed and organized. This
means freedom of association and expression on one hand and an
organized civil society on the other.
Empowerment: Empowerment unleashes creativity and innovation
throughout the organization by truly vesting decision making powers at
the most appropriate levels in the organizational hierarchy.
Equity and inclusiveness: A corporation is a miniature of a society
whose well being depends on ensuring that all its employees feel that
they have a stake in it and do not feel excluded from the main stream.
This requires all groups, particularly the most vulnerable, have
opportunities to improve or maintain their well being.
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Unit- II
Land mark in the emergence of CG: CG Committees, World Bank on CG,
OECD Principle, Sarbanes, Oxley act-2002, Indian Committees and
guidelines, CII Initiatives.
Landmarks in the Emergence of Corporate Governance
Over a period of time, a change had come in the perception of people
about corporate governance from the exclusive benefits of shareholders
to the benefit of all stakeholders.
Developments in the US -: Corporate governance gained importance in
the US after the Watergate scandal that involved US corporate making
political contributions and offering bribes to government officials.
Developments in the UK -: In England, seeds of modern corporate
governance were sown in the aftermath of the Bank of Credit and
Commerce International (BCCI) scandal. BCCI, a global bank was
made up of holding companies, affiliates, subsidiaries, banks-with-inbanks. The BCCI entities flagrantly evaded legal restrictions in the
movement of capital and goods almost on a daily routine.
Another landmark that heightened peoples awareness and sensitivity on
the issue and resolve the rot of corporate misdeeds. Which leads to
failure of Barings Bank, Britains oldest merchant bank failed because of
unhealthy trades on behalf of its customers and lost $1.4 billion and
pulled its shutter down.
CG COMMITTEES
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Throughout the US, UK, and other countries a number of committees got
appointed to recommend reforms and regulations in corporate governance.
They are all known by the names of the individuals that had chaired the
committees.
The Cadbury Committee on Corporate Governance, 1992 - Sir Adrian
Cadbury
Stated Objective was to help raise the standards of corporate
governance and the level of confidence in financial reporting and
auditing by setting out clearly what it sees as the respective
responsibilities of those involved and what it believes is expected of
them.
The Cadbury committee investigated the accountability of the board of
directors to shareholders and to the society. The Cadbury Code of best
Practices had 19 recommendations in the nature of Guidelines to the
board of directors, nonexecutive directors, executive directors and such
other officials.
CORPORATE GOVERNANCE COMMITTEES
1. Cadbury committee Report
The report was mainly divided into three parts:A. Reviewing the structure and responsibilities of Boards of Directors
and recommending a Code of Best Practice
B. Considering the role of Auditors and addressing a number of
recommendations to the Accountancy Profession
C. Dealing with the Rights and Responsibilities of Shareholders
A. Reviewing the structure and responsibilities of Boards of Directors
and recommending a Code of Best Practice
1. Board of directors:
meet regularly, retain full and effective control over the company
and monitor the executive management
balance of power and authority
2. Non-Executive Directors
independent judgment
independent of management and free from any business
3. Executive Directors
full and clear disclosure of directors total emoluments
4. Financial Reporting and Controls
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Accountancy Profession should take the lead in:(i) Developing a set of criteria for assessing effectiveness;
(ii) Developing guidance for companies on the form in which directors
should report; and
(iii) Developing guidance for auditors on relevant audit procedures and the
form in which auditors should report.
C. Dealing with
Shareholders
the
Rights
and
Responsibilities
of
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The committee
Provided guidance to assist companies in implementing the
requirements of the Combined Code relating to internal control.
It recommended that where companies do not have an internal audit
function, the board should consider the need for carrying out an
internal audit annually.
The committee also recommended that board of directors confirm
the existence of procedures for evaluation and managing key risks.
Corporate Governance is constantly evolving to reflect the current corporate
economic and legal environment. To be effective, corporate governance
practices need to be tailor to particular needs, objectives and risk
management structure of an organization.
7. World Bank on Corporate Governance
The World Bank, involved in sustainable development was one of the
earliest economic organization o study the issue of corporate governance
and suggest certain guidelines. The World Bank report on corporate
governance recognizes the complexity of the concept and focuses on the
principles such as transparency, accountability, fairness and responsibility
that are universal in their applications.
Corporate governance is concerned with holding the balance between
economic and social goals and between individual and communal goals. The
governance framework is there to encourage the efficient use of resources
and equally to require accountability for the stewardship of those resources.
The aim is to align as nearly as possible, the interests of individuals,
organizations and society.
The foundation of any corporate governance is disclosure. Openness is the
basis of public confidence in the corporate system and funds will flow to
those centers of economic activity, which inspire trust. This report points the
way to establishment of trust and the encouragement of enterprise. It marks
an important milestone in the development of corporate governance.
OECD PRINCIPLES
Organization for Economic Co-operation and Development (OECD) was
one of the earliest non-governmental organizations to work on and spell out
principles and practices that should govern corporate in their goal to attain
long-term shareholder value.
The OECD were trend setters as the Code of Best practices are associated
with Cadbury report. The OECD principles in summary include the
following elements.
1. The rights of shareholders
2. Equitable treatment of shareholders
3. Role of stakeholders in corporate governance
4. Disclosure and Transparency
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FRAMEWORK
SHOULD
PROTECT
21
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C. The corporate governance framework should permit performanceenhancing mechanisms for stakeholder participation.
D. Where stakeholders participate in the corporate governance process, they
should have access to relevant information.
DISCLOSURE AND 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.
A. Disclosure should include, but not be limited to, material information on:
a) The financial and operating results of the company.
b) Company objectives.
c) Major share ownership and voting rights.
d) Members of the board and key executives, and their remuneration.
e) Material foreseeable risk factors.
f) Material issues regarding employees and other stakeholders.
g) Governance structures and policies.
B. Information should be prepared, audited, and disclosed in accordance
with high quality standards of accounting, financial and non-financial
disclosure, and audit.
C. An annual audit should be conducted by an independent auditor in order
to provide an external and objective assurance on the way in which
financial statements have been prepared and presented.
D. Channels for disseminating information should provide for fair, timely
and cost-efficient access to relevant information by users.
THE RESPONSIBILITIES OF THE BOARD
The corporate governance framework should ensure the strategic guidance
of the company, the effective monitoring of management by the board, and
the boards accountability to the company and the shareholders.
A. Board members should act on a fully informed basis, in good faith, with
due diligence and care, and in the best interest of the company and the
shareholders.
B. Where board decisions may affect different shareholder groups
differently, the board should treat all shareholders fairly.
C. The board should ensure compliance with applicable law and take into
account the interests of stakeholders.
D. The board should fulfill certain key functions, including:
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vii) CEOs and CFOs are required to affirm the financials: CEOs and
CFOs are required to certify the reports filed with the Securities and
Exchange Commission (SEC).
viii) Loans to Directors: The act prohibits US and foreign companies with
Securities traded within US from making or arranging from third parties any
type of personal loan to directors.
ix) Attorneys : The attorneys dealing with publicly traded companies are
required to report evidence of material violation of securities law or breach
of fiduciary duty or similar violations by the company or any agent of the
company to Chief Counsel or CEO and if CEO does not respond then to the
audit committee or the Board of Directors.
x) Securities Analysts: The SOX has provision under which brokers and
dealers of securities should not retaliate or threaten to retaliate an analyst
employed by broker or dealer for any adverse, negative or unfavorable
research report on a public company. The act further provides for disclosure
of conflict of interest by the securities analysts and brokers or dealers.
xi) Penalties: The penalties are also prescribed under SOX act for any
wrong doing. The penalties are very stiff. The Act also provides for studies
to be conducted by Securities and Exchange Commission or the
Government Accounting Office in the following area:
I.
II.
III.
IV.
Auditors Rotation
Off balance Sheet Transactions
Consolidation of Accounting firms & its impact on industry
Role of Credit Rating Industry
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whereby the directors might not act in the shareholders (or other
stakeholders) best interests. Agency theory considers this problem and what
could be done to prevent it.
What is agency theory?
Key concepts of agency theory
A number of key terms and concepts are essential to understanding agency
theory.
An agent is employed by a principal to carry out a task on their behalf.
Agency refers to the relationship between a principal and their agent.
Agency costs are incurred by principals in monitoring agency behavior
because of a lack of trust in the good faith of agents.
By accepting to undertake a task on their behalf, an agent becomes
accountable to the principal by whom they are employed. The agent
is accountable to that principal.
AGENCY THEORY AND CORPORATE GOVERNANCE
Agency theory can help to explain the actions of the various interest groups
in the corporate governance debate.
Examination of theories behind corporate governance provides a foundation for
understanding the issue in greater
depth and a link between an historical
perspective and its application in
modern governance standards.
Historically, companies were
owned and managed by the
same people. For economies
to grow it was necessary to
find a larger number of
investors to provide finance
to assist in corporate
expansion.
This led to the concept of limited
liability and the development of stock
markets to buy and sell shares.
Limited liability:
limited risk and so less
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RIGHTS OF SHAREHOLDERS
These rights are conferred on the shareholders either by the Indian
Companies Act of 1956 or by the Memorandum of Articles of Association of
the company or by the general law, especially those relating to contracts
under the Indian Contract Act of 1872. Following are some of the rights of
the shareholders based on the above acts of the country:
1. To obtain copies of the memorandum of association , Articles of
Association, and copies of certain resolutions and agreements on
request, on payment of prescribed fees
2. To get the share certificates within 3 months of the allotment
3. The right to transfer the shares or other interests in the company
subject to the provisions in the articles of the company
4. The right to appeal to the Company Law Board if the company
refuses/fails to register the transfer of shares
5. Has the preferential right to purchase the share on a pro-rata basis in
case of further issue of shares and holds the right to renounce all or a
part of the shares in favor of any other person
6. Holds the right to apply to the Company Law Board for the
rectification of the register of members
7. Is entitled to receive notices of general meetings and to attend such
meetings and vote either in person or by proxy
8.
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