The concept of Corporate Governance The joint stock company known as the corporation is the nucleus of all business activities in modern economies. All corporations do not however enjoy equal share of power; they also do not have the same size and degree of operations.
The business corporation is an instrument through which capital is assembled for activities of producing and distributing goods and services and making investments. Business corporation - its objective Enhancing the corporations profit and gains of the corporations owners
Important property immortality Allowed, individually A perpetual succession of many persons are considered the same and may act as a single individual
What is Corporate?
In the capitalist economy, capital accumulation takes place through development and growth The corporation of today has replaced the sole proprietor of old days and tries to maximize profits and generate wealth. Differs on two counts: 1. More rational in decision making as it is run by a board of directors 2. Take decisions based on cost accounting, budget analysis, data collection and processing, and managerial consulting
Characteristics of a corporation
1. 2. 3. 4. 5. 6. 7. 8. Incorporated or registered under the Companies Act of a country Artificial legal existence- equal to that of a natural person with its own legal entity Perpetual existence Law creates a company and only law can dissolve it Common seal an artificial person can not sign documents Extensive membership no limitation on the number of members Separation of management from ownership Limited liability (owners risk is limited unlike in the case of partnerships, individual ownerships) Transferability of shares
Concept of governance
As old as human civilization. Governance stands for decision making and implementing it. Corporate governance, international governance, national governance, local governance. Companies, Associations, NGOs, Cooperatives, political, parties, police and so on are governed All except government and the armed forces are part of the civil society.
The fundamental theoretical basis of corporate governance is agency costs. Adam Smith identified the agency problem (managerial negligence and profusion). Shareholders are the owners and the principals too. The management, the board, are the agents. Principals may want to carry out the objectives of the company but the agents may not quite exactly match the requirements. The cost of the dissonance caused by the agency problem is the agency cost. Management may go counter to the objectives of the shareholders such maximizing shareholder returns. Ostentatious life styles of directors, empire building etc. are examples.
Mechanisms that help reduce agency costs: 1. Fair and accurate financial disclosures 2. Efficient and independent board of directors
B.
Stewardship Theory Managers not motivated by individual goals As stewards whose motives aligned with the objectives of their principals Managers are trustworthy and have high reputations. Their behavior will not run counter to the interests of the company. A significant emphasis on the responsibility of the board to the shareholders in a corporate governance model that is emboldened by stewardship and trusteeship. These concepts of stewardship and trusteeship are traceable in the scriptures of India and Christendom.
Stewardship
Managers act as stewards Governance is sociological and psychological Behavior pattern is collectivistic, proorganizational, and trustworthy Managers are motivated by the principals objectives Interests of the managers and principals converge The role of the management is to facilitate and empower Owners attitude is to take risks Principal-manager relationship is based on trust
Stakeholder theory
Dating back to 1930s, this theory represents a synthesis of a fair bit of economics, behavioral science, business ethics, and stakeholder concept. Deals with the common interests of employees, customers, dealers, government, and the society Often criticized as wooly minded liberalism because it is not applicable in practice by companies. The defense is that managers can act efficiently only by drawing upon the resources of the stakeholders A contract between the company and the stakeholders. But then who are all genuine stakeholders? Bizarre choices like terrorists, dogs, trees and to the least questionable like employees and customers!
Shareholders liability for debts is limited to the amount of capital they have agreed to subscribe for. The company as a legal person has the rights to sell, buy, to own assets, to incur debts, to employ, to contract, and to sue and be sued upon. Company has a long life span different from those of its innumerable shareholders.
Companies need to be governed as well as managed. The board of directors is central and its structure and processes are fundamental The boards relationships with its shareholders, regulators, auditors, top management, and other legitimate stakeholders.
Companies shareholders are of diverse nature private individuals, institutional investors such as banks and pension funds, insurance companies, and other companies who might have business relationship with the company. This make it a very complex situation.
There has been a growing awareness of corporate governance around the world. A number of studies and official reports have followed as a result of the growing awareness and societal responses. These provided a code of best practices for the governance.
Many a major company today operate through group structures of wholly-owned subsidiary companies, partly owned subsidiaries in which other external parties have a minority equity interest and associated companies in which the holding company has a significant but not dominant holding. In an era of globalization, major companies are getting engaged in a variety of joint ventures and strategic alliances.
Shareholders
Elect
Stakeholders
Officers (Managers)
Manage Creditors Own Lien on Company Monitors & regulates Regulatory Legal System Stake in
Company
Supervisory Board
(including the President)
Ratifies the Presidents decisions President Shareholders Consults Executive Management (Primarily Board of Directors) Manages
Provides managers
Main Bank
Provides loans
Own
Company
Owns
External Environment
Internal Environment
Company Act SEBI, Stock Exchange Company vision, mission, policies, norms Internal stakeholders Auditors Board of Directors Depositors, borrowers, customers and other external stakeholders
Proper governance
Shareholder value
Investor protection
Our Credo
We believe that our first responsibility is to the doctors , nurses, and patients, to mothers and fathers and all others who use our products and services. In meeting their needs everything we do must be of high quality. We must consistently strive to reduce costs in order to maintain reasonable prices. Customers orders must be serviced promptly and accurately. Our suppliers and distributors must have an opportunity to make a fair profit.
We are responsible to our employees, the men and women who work with us throughout the world. Everyone must be considered as an individual. We must respect their dignity and recognize their merit. They must have a sense of security on their jobs. Compensation must be fair and adequate, and working conditions clean, orderly, and safe. We must be mindful of ways to help our employees fulfill their family responsibilities. Employees must feel free to make suggestions and complaints. There must be equal opportunity for employment, development and advancement for those qualified. We must provide competent management, and their actions must be just and ethical.
We are responsible to the communities in which we live and work and to the world community as well. We must be good citizens support good works and charities and bear out fair share of taxes. We must encourage civic improvements and better health and education. We must maintain in good order the property we are privileged to use, protecting the environment and natural resources.
Our final responsibility is to our stockholders. Business must make a sound profit. We must experiment with new ideas. Research must be carried on, innovative program developed and mistakes paid for. New equipment must be purchased, new facilities provided, and new products launched. Reserves must be created to provide for adverse times. When we operate according to these principles, the stockholders should realize a fair return.