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Jargon Management Corporate governance

An article appeared in the Economic Times on 17th July.


Student Speak
A small co-operative bank in Maharashtra purchases a
Damagement lessons luxury car priced at Rs. Eight lakhs for its MD. So far so
good. Problem. The bank has a profit running into a few
thousands only. When asked about the need to purchase
Cyber Trek the same, the MD justified: "IF HDFC / ICICI can, we too
can move into MOBILE banking." So much for
CORPORATE GOVERNANCE.
General Management
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What does this psyche represent? What constitutes
Operations Management CORPORATE GOVERNANCE? It is this issue that this Post a message
article would like to address.
Financial Management
How do you define CORPORATE GOVERNANCE? Quick Search
Essentially it covers the gamut of activities having a Enter IIL company code
HR Management direct or indirect effect on the health of the entity. Nobel
Laureate MILTON FRIEDMAN stated; " Corporate
Governance is to conduct business in accordance with
Marketing Management Shareholders’ desire while confirming to local laws and Look up code
customs". More recently the President, World Bank –
J.Wolfensohn made a more contemporary definition of
Systems Management the same. "Corporate Governance is all about promoting Subscribe to IIL
Corporate Fairness, Transparency and Accountability". Newsletters
Entrance Guide How much of this is pertinent and really followed today
remains to be seen.

Career Guide Historical Perspective

Placement Guide The concept of CORPORATE GOVERNANCE in its


present form is rather new. The seeds of CORPORATE Drop us a line
GOVERNANCE were laid during the Watergate scandal Drop us your queries &
Case Studies Quiz that shook the Presidential house in the United States. suggestions
Also, 1980’s were characterised by a string of high profile
business failures. An investigation into these pinpointed
Entrepreneur MBA the fault to;

About us l Lack of proper internal controls


l Absence of independent audits (internal as well as
Disclaimer external)

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Corporate governance Page 2 of 6

It was to prevent the reoccurrence of the same that the


CADBURY Committee was set up. The report submitted
by Sir Cadbury proved to be a landmark in the field of
CORPORATE GOVERNANCE. Concurrently, India could
not stand isolated in this fast changing scenario. A
number of financial scams back home prompted the
government to set up a committee under the
chairmanship of Kumarmangalam Birla.

Kumarmangalam Report

The objective of the committee was "enhancement of the


long-term shareholders’ value

While at the same time protecting the interests of other


stakeholders."

The key recommendations of the report were;

i. Board of Directors

It provides leadership, strategic guidance and objective


judgement independent of management to the company
and exercises control over the company, while remaining
at all times accountable to the shareholders.

The Board Has 5 Basic Responsibilities:

l Overseeing Strategic Development and Planning.


l Management Selection, Supervision and
Upgrading.
l Maintenance of Good Member Relations
l Protecting and optimising the Organizations’
Assets.
l Fulfilling Legal Requirements.

ii. Composition of the Board of Directors

Lays emphasis on the calibre of the non-executive


directors

Independent directors have a key role.

- This is an important issue in the Indian context. A


major chunk of shares was held by financial
institutions like UTI, IFCI, etc. which could be termed
as quassi – government institutions. They would
appoint a director, who would generally not have any
sector specific knowledge. In the process however it
is the company that suffers.

iii. Audit Committee

Key components

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– The board, the internal auditor and the outside auditors


iv. Disclosures of Remuneration Package

v. Board meetings

Should be held at least four times in a year

l The report stressed the importance of the proxy


voting / ballot system.

Why? A few years back, companies would hold their


AGM in the most remote location possible. It would be
guaranteed to be the most inaccessible place.

Reasons? Avoid facing shareholder’s wrath or get some


crucial bill passed.

vi. Functions of the Management

-Chief Executive, Executive-directors and the key


managers

l Assisting the board in its decision making process


l Implementing the policies and code of conduct of
the board
l Ensuring compliance of all regulations and laws
l Providing timely, accurate, substantive and
material information

Vii Shareholders

l Have certain rights and responsibilities


l Effectively participate in General Body Meetings
l Should demand complete information

(Board Meetings in obscure places)

However the report ended with a note of Caution

It stated that no "one size fits all" structure possible

Ethics should play an important role.

It is a Continuously evolving system.

Reasons for Failure inspite of these norms

l Ineffective leadership
l Incompetence of the Board Members
l Lack of mutual trust

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l Time deficit
l Constant change –
l Less predictability in decision making;
l Need for quicker decisions.
l Superficial commitment to vision, mission and
values

Who’s to be blamed?

Are the above stated factors comprehensive to explain


the state of affairs we are in? Or is there a deeper
malaise that runs in the system?

Since monetary stakes are quite high, the first tendency


would be to put the blame on corruption. Analyse the
recent corruption index released by the World Audit.

Country Corruption index


Finland 1 (most clean)
Denmark 2
New Zealand 3
Canada 5
United Kingdom 10
United States 14
China 63
India 69
Nigeria 90 (Most corrupt)

Considering the spate of failures in the US, corruption as


a major factor can be ruled out. A more in-depth analysis
of the situation shows three key players.

Analysing each role separately.

CEO

Key facts:

Initially a CEO would be looked upon as "tough, decisive,


and goal-oriented." Today they are scorned upon.

On an average a CEO earned about 475 times the salary


of a worker in 2002

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In the past ten years, average wages increased 36%. For


CEOs, it was 340%. (Business Week May 6, 2002)

The average compensation for chief executives is $15.5


million

In fact a major contributor to the present mess has been


the introduction of the "Stock Options". Any book on
human behaviour would term it as an excellent motivating
tool. But the reality is far too different. Often the top
management gets caught in a web of short-term capital
appreciation. Given the fact that they are privy to insider
information, often they look for capital gains at the
expense of the common shareholder. CEO like Kenneth
Lay of Enron, Webbers of WorldCom were till recently
looked upon as demi-Gods. Webbers as a matter of fact
was voted as the CEO of the year for two successive
years ( in 2000 and 2001). Today however they stand
disgraced.

Shareholders

But are the shareholders also responsible for this mess?

Unfortunately, the answer is Yes. A recent survey found


that the average time a common shareholder holds on to
his stock has reduced from a few years to some weeks.
The latest trend being day-trading. What are its
implications?

It clearly shows that the shareholders are no longer


interested in the long-term growth of the company. They
would be interested in the short-term capital appreciation.
This puts an additional burden on the management of the
company to show continuously increasing profits/sales.
(Sometimes by resorting to unscrupulous means).

External Factors

India has always had a long history of too many laws.


However what ails the system is the poor implementation
of the same. A classic case of Shri Kumarmangalam
himself was when he appointed his mother as a Director
after the death of Shri Aditya Birla. There was a big
furore, but rules are probably meant to be broken. We
just analysed the role of insider information. Often a

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nexus is formed between the management and the


broker. The Big Bull scam of the early 90’s and more
recently the Ketan Parekh scam are prime indicators of
the same. CBI Findings revealed that money was
borrowed from banks with shares as collateral. The
broker would then buy the same shares with that money.
In its analysis the report said

-Madhavpura bank and others lacked proper internal


control mechanisms

-CSE has virtually no surveillance systems to monitor


any unfair trade practices

A clear reiteration of the importance of internal / external


audit.

Trends in Corporate Governance

l Demands for greater transparency and


accountability.
l Clear demarcation of roles and responsibilities
l Performance Appraisal of Board Members
l Succession planning.
l Concept of Social Welfare
l More recently with the spate of high profile failures
in the US, leaving the common investor at the
mercy of the management, there has been a
renewed call for more ethics in the way business
is carried out. There is also a concept gaining
ground that the firm has certain social
responsibilities to fulfil and existence of the firm
without doing so would be difficult.

The recent spate of high profile failures in the US have


further emphasised the fact that the firm is a part of the
system and should thus follow certain ethical standards
to maintain continued growth. Though President Bush did
stress upon ethics, how much of it would be really seep
down the corporate world, only time can tell.

Ashish Gupta,
IIM Indore

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