Internal & External CG Mechanism (Lesson-12: BECG)

Prof. C. Anand Faculty IBS, Hyderabad

Contents
This deals with:1. Internal CG Mechanism

Board of Directors Functional Committees of Board Codes of Conduct Whistle Blowers

2.

External CG Mechanism
Regulators Gate Keepers Institutional Investors Corporate Raiders
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1. Internal CG Mechanism
(i)

Board of Directors: The primary function of the Board is to take responsibility for the performance of the company, to promote its interests on behalf of shareholders, to whom it is accountable. Board overseas the performance of the co., its CEO and top managers. It monitors corporate performance with reference to goals, objectives and targets. The Board provides strategic guidance to the co. It studies the future trends so that the co. has necessary funds for future growth and development. The Board has to maintain good relations with the stake-holders and run the company on ethical grounds. Its important roles include: Strategic role; Policy Making role; and monitoring and supervisory role. The designing and structure of the Board shall be suitable to the co. for its efficient functioning.

1. Internal CG Mechanism (..contd)

(ii) Functional Committees of Board: The main functional committees of the board are: (a) Audit Committee; (b) Remuneration Committee; and (c) Nomination Committee, which are very briefly explained below:(a) Audit Committee: It consists of independent directors and reports to the Board. It looks into the matters raised by external auditors relating to management system and tries to resolve objections raised by auditors relating to financial accounts. It tries to bring quality of financial reporting system, and makes recommendations regarding audit fees, selection and replacement of auditors.
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1. Internal CG Mechanism (..contd)

(b) Remuneration Committee: The Board sets up this committee to objectively review the remuneration packages of EDs and top-level managers. This committee, which is made up of independent directors, chalks out the remuneration policy, which checks the unreasonable increase of executive remuneration. The committee designs a transparent remuneration policy that can attract and retain directors and top management and motivate them to achieve the long term goals of the organization. (c) Nomination Committee: This committees is set up to select the new non-executive directors and is headed by the Chairman and it shortlists and interviews the final candidates.
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1. Internal CG Mechanism (..contd)

(iii). Codes of Conduct: A code is a set of rules, which are accepted as general principles, or a set of written rules, which state how people in a particular organization or country should behave. A regulation is an official rule that lays down how things should be done. Both codes and regulations are a set of rules or principles or standards that are intended to control, guide, or manage the behavior or conduct of individuals working in an organization. Various CG Committees like Cadbury Committee, Kumara Mangalam Birla Committee, CII and OECD have developed various codes which spell out various self-regulatory rules for guiding conduct or behavior.
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1. Internal CG Mechanism (..contd)

Self-Regulatory Codes: These are self-regulatory rules for guiding conduct or behavior and they do not direct or control behavior by some official authority. International Capital Market Group (ICMG) listed the following codes:a. In self-regulation, it is possible to impose ethical standards which go beyond statutory legislation. b. Self-regulators are directly accountable to members of their group and understand issues facing the group; and identify complex regulatory problems at an early stage and develop suitable solutions. c. Self-regulations operate in an atmosphere of willingness to accept them. They have built-in systems of checks & balances and are more comprehensive than official regulations.
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1. Internal CG Mechanism (..contd)

(iv) Whistle Blowers: The company may establish a mechanism for employees to report to the management concerns about unethical behavior, actual or suspected fraud or violation of the companys code of conduct or ethics policy. This mechanism could also provide for adequate safeguards against victimization of employees who avail of the mechanism and also provide for direct access to the Chairman of the Audit committee in exceptional cases. Once established, the existence of the mechanism may be appropriately communicated within the organization.

2. External CG Mechanism
(i)

(ii)

Regulators: The external CG mechanism shall ensure that the co. shall comply with all relevant laws, regulations and codes. It also includes that the Board and executive management shall comply with the rules and regulations of all Regulators such as SEBI, RBI, IRDA, and also strictly comply with the provisions of the Companies Act etc. Gate-Keepers: In the wake of a series of corporate governance disasters in the US and Europe viz. Enron, WorldCom, Tyco, Parmalat and Satyam Computers recently - one question has not yet been addressed. A number of gatekeeping professions - auditors, attorneys
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2. External CG Mechanism (..contd)

securities analysts, credit-rating agencies and independent directors - exist to guard against these governance failures. Yet clearly these watchdogs did not bark while corporations were looted and destroyed. This requires deeper examination in regard to the evolution, responsibilities, and standards of these professions. Obviously these gatekeeping professions had failed, and many reforms are needed to set them right. The institutional changes and pressures had caused gatekeepers to underperform or neglect their responsibilities, and certain feasible changes are required to restore gatekeepers as the loyal agents of investors.
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2. External CG Mechanism (..contd)

(iii) Institutional Investors (IIs):

IIs such as large Pension Funds, Insurance Cos., Mutual Funds, Unit Trusts and other FIs have become the largest shareholders in many countries, having significant shareholdings in the companies in which they invest. This has resulted in growing influence of IIs in their investee Cos. and they are now increasingly interested in CG, as good CG increases corporate efficiency leading to good returns to IIs and other shareholders. The tools of governance include one-to-one meetings, voting, focus lists, and rating systems. The evidence as to whether good corporate governance impacts on corporate performance is rather mixed but, looking at it another way, good governance can help to ensure that companies do not fail. Also, a company with good corporate governance is more likely to attract external capital flows than one without.
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2. External CG Mechanism (..contd)

(iv) Corporate

Raiders:

(i) Corporate Raider is a person or co. that is offering or executing a hostile takeover by buying shares directly from shareholders. If a firm makes an offer to shareholders to acquire a publicly-traded company after the board of directors refuses, or if it bypasses the board completely, one refers to the acquiring firm as a corporate raider. Often, the corporate raider does not actually intend to take over the target co., but is simply trying to force the board of directors to repurchase shares at a premium to their market value. A corporate raider that accumulates more than 5% of a company's outstanding shares must register with the SEBI. It is also known simply as a raider.
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2. External CG Mechanism (..contd)

(ii) Corporate Raider is a person or organization that acquires a substantial holding of the shares of a co. in order to take it over or to force its management to act in a desired way. Greenmail or greenmailing is a corporate acquisition strategy for generating large amounts of money from the attempted hostile takeovers of large, often undervalued or inefficient companies. Greenmailing is a variant of the corporate raid strategy of asset stripping. However, once having secured a large share of a target company, instead of completing the hostile takeover, the greenmailer offers to end the threat to the victim company by selling his share back to it, but at a substantial premium to the fair market stock price. Whilst benefitting the predator, the company and its shareholders are impoverished. 13

2. External CG Mechanism (..contd)

Asset Stripping refers to the sale of selected assets of an acquired company generally for the purpose of raising money to pay off some of the debt incurred in financing the acquisition. Hostile Takeover: An acquisition of a firm despite resistance by the target firm's management and board of directors. The takeover code, which governs takeover norms in India, is set for a major overhaul. SEBI Takeover Code Committee is likely to consider big ticket changes like hike in 15% trigger limit and a 100% open offer are being considered. (Details next page)

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2. External CG Mechanism (..contd)

Under the current Takeover Code, with the acquisition of 15% or more of the voting rights of the target company, open offer for additional 20% shares is mandatory. This restricts the acquirer to make large investments in the co., where controlling the company is not an objective, limiting the acquirer to below 15% so as to avoid an open offer. This is especially a big hindrance in private equity deals wherein private equity intends to acquire more than 15% without any intention of running the companies. An option may be considered wherein this limit could be raised to 25% which will ease fund raising for India Inc. Also, this limit of 15% does not converge with the limits followed globally by countries such as Hong Kong (35%), UK (30%), Malaysia (33%), and Singapore (30%). However, in India, there are many listed cos. where promoter shareholding is less than 40%. Hence, even if the limits are raised, adequate protection should be provided in the case of cos. with low promoter shareholdings. *End*