Becg- Mfc 4th Sem

Corporate Governance –MFC – 4th Sem.Mr. Rashmiranjan Panigrahi, Lecturer in Finance, ASMIT

Corporate Governance and Business Ethics

UNIT -1:Corporate Governance: Meaning, Historical Perspective, Issues in CG, Theoretical basis of CG, CG Mechanism, CG System, Good CG.

Corporate governance is…

A means whereby society can be sure that large corporations are well-run institutions to which investors and lenders can confidently commit their funds.

Corporate governance are the policies, procedures and rules governing the relationships between the shareholders, (stakeholders), directors and managers in a company, as defined by the applicable laws, the corporate charter, the company’s bylaws, and formal policies.

Primarily it is about managing top management, building in checks and balances to ensure that the senior executives pursue strategies that are in accordance with the corporate mission.

Corporate governance governs the relationship among the many players involved (the stakeholders) and the goals for which the corporation is governed.

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), India’s 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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the listing agreement in August 2003. Subsequently, SEBI withdrew the revised Clause 49 in December 2003, and currently, the original Clause 49. FIFTH was Recent Developments in India CII Taskforce on Corporate Governance – 2009 SIXTH was Corporate Governance Voluntary Guidelines –2009.

1. THE CII CODE- : 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 Directora. Nomination Committee2. Duties, liabilities and remuneration of independent directorsa. Letter of Appointment to Directorsb. Fixed Contractual Remunerationc. Structure of Compensation to NEDs3. Remuneration Committee of Board4. Audit Committee of Board5. Separation of the offices of the Chairman and the Chief Executive Officer6. Attending Board and Committee Meetings through Tele-conferencing andVideo conferencing7. Executive Sessions of Independent Director8. Role of board in shareholders and related party transactions

9. Auditor – Company Relationship

10. Independence to Auditors11. Certificate of Independence12. Auditor Partner Rotation13. Auditor Liability14. Appointment of Auditors15. Qualifications of Auditors Report16. Whistle Blowing Policy17. Risk Management Framework18. The legal and regulatory standards19. Capability of Regulatory Agencies - Ensuring Quality in Audit Process20. Effective and Credible Enforcement21. Confiscation of Shares22. Personal Liability23. Liability of Directors and Employees24. Institutional Activism25. Media as a stakeholder

According to the report, much of best-in-class corporate governance is voluntary – of companies taking conscious decisions of going beyond the mere letter of law.

6. CORPORATE GOVERNANCE VOLUNTARY GUIDELINES –2009More recently, in December 2009, the Ministry of Corporate Affairs (MCA) published a new set of “Corporate Governance Voluntary Guidelines 2009”, designed to encourage companies to adopt better practices in the running of boards and board committees, the appointment and rotation of external auditors, and creating a whistle blowing mechanism. The guidelines are divided into the following six parts:1. Board of Directors2. Responsibilities of the Board3. Audit Committee of the Board4. Auditors5. Secretarial Audit6. Institution of mechanism for Whistle BlowingThese guidelines provide for a set of good practices which may be voluntarily adopted by the Public companies. Private companies, particularly the bigger ones, may also like to adopt these guidelines. The guidelines are not intended to

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be a substitute for or additions to the existing laws but are recommendatory in nature.

AccountabilityClarifying 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.TransparencyRequiring timely disclosure of adequate information concerning corporate financial performance..Responsibility-: Ensuring that corporations comply with relevant laws and regulations that reflect the society’s 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:

Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by effectively

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communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings.

Interests of other stakeholders: Organizations should recognize that they have legal and other obligations to all legitimate stakeholders.

Role and responsibilities of the board: The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors.

Integrity and ethical behaviour: Ethical and responsible decision making is not only important for public relations, but it is also a necessary element in risk management and avoiding lawsuits. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. It is important to understand, though, that reliance by a company on the integrity and ethics of individuals is bound to eventual failure. Because of this, many organizations establish Compliance and Ethics Programs to minimize the risk that the firm steps outside of ethical and legal boundaries.

Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information.

THEORETICAL BASIS OF CORPORATE GOVERNANCE

There are four broad theories to explain and elucidate corporate governance. These are: (i) Agency Theory (ii) Stewardship Theory (iii) Stakeholder Theory and (iv) Sociological Theory.

A. AGENCY THEORY

The fundamental theoretical basis of corporate governance is agency costs. Adam Smith had identified the agency problem (managerial negligence and profusion). Shareholders are the owners and the principals too. The management, the board, chosen by the shareholders 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. There are many a way through which

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the management go counter to the objectives of the shareholders such maximizing shareholder returns. Ostentatious life styles of directors, empire building etc. are examples.

THE BASIS FOR THE AGENCY THEORY IS THE SEPARATION OF OWNERSHIP AND CONTROL.

PRINCIPAL (SHAREHOLDERS) OWN THE COMPANY BUT THE AGENTS (MANAGERS) CONTROL IT.

MANAGERS MUST MAXIMIZE THE SHAREHOLDERS WEALTH. THE MAIN CONCERN IS TO DEVELOP RULES AND INCENTIVES,

BASED ON IMPLICIT EXPLICIT CONTRACTS, TO ELIMINATE OR AT LEAST, MINIMIZE THE CONFLICT OF INTERESTS BETWEEN OWNERS AND MANAGERS.

The Agency problem occurs when:The desires or a goal of the principal and agent conflict and it is difficult or expensive for the principal to verify that the agent has behaved appropriately.Example: Over diversification because increased product diversification leads to lower employment risk for managers and greater compensation Solution: Principals engage in incentive-based performance contracts, monitoring mechanisms such as the board of directors and enforcement mechanisms such as the managerial labor market to mitigate the agency problemMechanisms that help reduce agency costs:1. Fair and accurate financial disclosures2. Efficient and independent board of directors

B. THE STEWARDSHIP THEORYThe theory defines situations in which managers are not motivated by individual goals, but rather they are stewards whose motives are aligned with the objectives of their principals. It assumes that managers are trustworthy and have high reputations. Therefore their behavior will not run counter to the interests of the company. There is 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.Steward is a person who manages other’s property and financial affairs and is entrusted with the responsibility of proper utilization and development of organization’s resources.

MANAGERS AS STEWARDS ASSUMED TO WORK EFFICIENTLY AND HONESTLY IN THE

INTERESTS OF COMPANY AND OWNERS. SELF DIRECTED AND MOTIVATED BY HIGH ACHIEVEMENTS AND

RESPONSIBILITY IN DISCHARGING THE DUTIES. MANAGERS ARE GOAL ORIENTED

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FEEL CONSTRAINED IF THEY ARE CONTROLLED BY OUTSIDE DIRECTORS

BASIC BEHAVIORAL DIFFERENCES BETWEEN AGENCY & STEWARDSHIP THEORIES

Stewardship theory can be reduced to the following basics:

The theory defines situation in which managers are not motivated by

individual goals, but rather they are stewards whose motives are

aligned with the objectives of their principles.

Given a choice between self-serving behaviour and pro-

organizational behavior, a steward’s behaviour will not depart from

the interests of his organization.

Control can be potentially counterproductive, because it undermines

the pro-organizational behaviour of the steward, by lowering his

motivation.

C. THE STAKEHOLDER THEORY

Managers are responsible to maximize the total wealth of all stakeholders of

the firm, rather than only the shareholders wealth. It deals with the common

interests of employees, customers, dealers, government, and 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

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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 THEORYThe 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 CONTROLSCorporate 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 management to investors. An ideal control system should regulate both motivation and ability. INTERNAL CORPORATE GOVERNANCE CONTROLSInternal corporate governance controls monitor activities and then take corrective action to accomplish organisational goals. Examples include:

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Monitoring by the board of directors: The board of directors, with its legal authority to hire, fire and compensate top management, safeguards invested capital. Regular board meetings allow potential problems to be identified, discussed and avoided. Whilst non-executive directors are thought to be more independent, they may not always result in more effective corporate governance and may not increase performance.[6]

Different board structures are optimal for different firms. Moreover, the ability of the board to monitor the firm's executives is a function of its access to information. Executive directors possess superior knowledge of the decision-making process and therefore evaluate top management on the basis of the quality of its decisions that lead to financial performance outcomes, ex ante. It could be argued, therefore, that executive directors look beyond the financial criteria.

Internal control procedures and internal auditors: Internal control procedures are policies implemented by an entity's board of directors, audit committee, management, and other personnel to provide reasonable assurance of the entity achieving its objectives related to reliable financial reporting, operating efficiency, and compliance with laws and regulations. Internal auditors are personnel within an organization who test the design and implementation of the entity's internal control procedures and the reliability of its financial reporting

Balance of power: The simplest balance of power is very common; require that the President be a different person from the Treasurer. This application of separation of power is further developed in companies where separate divisions check and balance each other's actions. One group may propose company-wide administrative changes, another group review and can veto the changes, and a third group check that the interests of people (customers, shareholders, employees) outside the three groups are being met.

Remuneration: Performance-based remuneration is designed to relate some proportion of salary to individual performance. It may be in the form of cash or non-cash payments such as shares and share options, superannuation or other benefits. Such incentive schemes, however, are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behaviour, and can elicit myopic behaviour.

EXTERNAL CORPORATE GOVERNANCE CONTROLS

External corporate governance controls encompass the controls external stakeholders exercise over the organisation. Examples include:

competition debt covenants demand for and assessment of performance information (especially

financial statements) government regulations

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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:

The Anglo-American model The German model The Japanese model

THE ANGLO-AMERICAN MODELThis is also known as unitary board model, in which all directors participate in a single board comprising both executive and non-executive directors in varying proportions. This approach to governance tends to be shareholder oriented. It is also called the ‘Anglo-Saxon’ approach to corporate governance being the basis of corporate governance in America, Britain, Canada, Australia and other Commonwealth law countries including India.

The major features of this model are as follows: The ownership of companies is more or less equally divided between

individual shareholders and institutional shareholders. Directors are rarely independent of management. Companies are typically run by professional managers who have

negligible ownership stake. There is a fairly clear separation of ownership and management.

Most institutional investors are reluctant activists. They view themselves as portfolio investors interested in investing in a broadly diversified portfolio of liquid securities. If they are not satisfied with a company’s performance, they simply sell the securities in the market and quit.

The disclosure norms are comprehensive, the rules against insider trading tight, and the penalties for price manipulations stiff, all of which provide adequate protection to the small investors and promote general market liquidity. They also discourage large investors from taking an active role in corporate governance.

GERMAN MODELCorporate 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

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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 MODELThis 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.

INDIAN MODEL OF GOVERNANCEIndian corporate is governed by the Company’s Act 1956 which follows more or less the UK model. The pattern of private companies is mostly that of closely held or dominated by a founder, his family and associates. India has adopted the key tenets of Anglo-American external and internal control mechanisms after economic liberalization.

ANGLO AMERICAN GERMAN JAPANESE

Share holders Shareholders and employees /unions

Shareholders and banks

Elects Elects Elects

Board of Directors Supervisory Board Supervisory Board appoints President And President

Appoints Appoints Appoints

Officers/Executive Management Board Executive Board

Manage Manage Manage

Company Company Company

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INDIAN MODEL = ANGLO AMERICAN MODEL +GERMAN MODELELEMENTS OF GOOD CORPORATE GOVERNANCEGood corporate governance is characterized by a firm commitment and adoption of ethical practices by an organization across its entire value chain and in all of its dealings with a wide group of stakeholders encompassing employees, customers, vendors, regulators and shareholders (including the minority shareholders), in both good and bad times. To achieve this, certain checks and practices need to be whole-heartedly embraced. Good governance deals with certain obligation to society at large, obligation to investors, obligation to employees, obligation to customers & Managerial obligations which are as follow -:OBLIGATION TO SOCIETY AT LARGEA corporation is a creation of law as an association of persons forming part of a society in which it operates. Its activities are bound to impact the society as the society’s value would have an impact on the corporation. Therefore, they have mutual rights and obligations to discharge for the benefit of each other. National interest: A company (and its management) should ne

committed in all its actions to benefit the economic development of the countries in which it operates and should not engage in any activity that would militate against such an objective.

Political non-alignment: A company should be committed to and support a functioning democratic constitution and system with a transparent and fair electoral system and should not support directly or indirectly any specific political party or candidate for political office.

Legal compliances: The management of a company should comply with all applicable government laws, rules and regulations. Legal compliance will also mean that corporations should abide by the tax laws of the nations in which they operate and these should be paid on time and as per the required amount.

Rule of law: Good governance requires fair, legal frameworks that are enforced impartially. It also requires full protection of rights, particularly those of minority shareholders. Impartial enforcement of laws requires an independent judiciary and regulatory authorities.

Honest and ethical conduct: Every officer of the company including its directors, executives and non executive directors, managing director, CEO, CFO and CCO should deal on behalf of the company with professionalism, honesty, commitment and sincerity as well as high moral and ethical standards.

Corporate citizenship: A corporate should be committed to be a good corporate citizen not only in compliance with all relevant laws and regulations but also by actively assisting in the improvement of the quality of life of the people in the communities in which it operates with the objective of making them self reliant and enjoy a better quality of life.

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Ethical behaviour: Corporations have a responsibility to set exemplary standards of ethical behaviour, both internally within the organizations, as well as in their external relationships.

Social concern: The Company should have concerns towards the society. It can help the needy people & show its concern by not polluting the water, air & land. The waste disposal should not affect any human or other living creatures.

Healthy and safe working environment: A company should be able to provide a safe and healthy working environment and comply with the conduct of its business affairs with all regulations regarding the preservations of environment of the territory it operates in.

Competition: A company should market its products & services on its own merits & should not resort to unethical advertisements or include unfair & misleading pronouncements on competitors’ products & services.

Timely responsiveness: Good governance requires that institutions & processes try to serve all stakeholders within a reasonable time frame.

Corporations should uphold the fair name of the country.OBLIGATION TO INVESTORSThe investors as shareholders and providers of capital are of paramount importance to a corporation. A company has following obligations to investors: Towards shareholders: A company should be committed to enhance

shareholder value and comply with all regulations and laws that govern shareholders rights. The boa5rd of directors of the company shall and fairly inform its shareholders about all relevant aspects of the company’s business and disclose such information in accordance with the respective regulations and agreements. Every employee shall strive for the implementation of and compliance with this in his professional environment. Failure to adhere to the code could attract the most severe consequences including termination of employment or directorship as the case may be.

Measures promoting transparency and informed shareholder participation: A related issue of equal importance is the need to bring about greater levels of informed attendance and meaningful participation by shareholders in matters relating to their companies without such freedom being abused to interfere with management decision. An ideal 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

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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 firm’s ethical conduct and also will invite appropriate civil or criminal action under the relevant laws.

OBLIGATION TO EMPLOYEESIn 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.

Participative and collaborative environment: There should not be any form of human exploitation in the company. There should be equal opportunities for all levels of management in any decision-making. The management should cultivate the culture where employees should feel they are secure and are being well taken care of. Collaborative environment would bring peace and harmony between the working community and the management, which in turn, brings higher productivity, higher profits and higher market share.

OBLIGATION TO CUSTOMERS

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A company’s existence cannot be justified without its catering to the needs of its customers. The companies have an obligation to its employees, without whose assistance they cannot realize their objectives. Quality of products and services: The Company should be committed

to supply goods and services of the highest quality standards, backed by efficient after sales service consistent with the requirements of the customers to ensure their total satisfaction. The quality standards of company’s goods and services should meet not only the required national standards but also should endeavour to achieve international standards.

Products at affordable prices: Companies should ensure that they make available to their customers quality goods at affordable prices while making normal profit is justifiable, profiteering and fattening on the miseries of the poor consumers is unacceptable. Companies must constantly endeavour to update their expertise, technology and skills of manpower to cut down costs and pass on such benefits to customers. They should not create a scare in the midst of scarcity or by themselves create an artificial scarcity to make undue profits.

Unwavering commitment to customer satisfaction: Companies should be fully committed to satisfy their customers and earn their goodwill to stay long in the business. They should encourage the warranties and guarantees given on their products and in case of harmful or sub-standard products should replace them with good ones.

MANAGERIAL OBLIGATIONS Protecting company’s assets: The assets of the company should not be

dissipated or misused but invested for the purpose of conducting the business for which they are duly authorized. These include tangible as well as intangible assets.

Behaviour toward government agencies: A company’s employees should not offer or give any of the firm’s funds or property as donation to any government agencies or their representatives directly or through intermediaries in order to obtain any favourable performance of official duties.

Control: control is a necessary principal of governance that the freedom of management should be exercised within a framework of appropriate checks and balances. Control should prevent misuse of power, facilitate timely management response to change and ensure that business risks are pre-emptively and effectively managed.

Consensus oriented: Good governance requires mediation of the different interests in society to reach a broad consensus on what is in the best interest of the whole community and how this can be achieved.

Gifts and donations: The Company’s employees should neither receive nor make directly or indirectly any illegal payments, remuneration, gifts,

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donations or comparable benefits which are intended to or perceived to obtain business or uncompetitive favours for the conduct of its business.

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-in-banks. The BCCI entities flagrantly evaded legal restrictions in the movement of capital and goods almost on a daily routine.

Another landmark that heightened people’s awareness and sensitivity on the issue and resolve the rot of corporate misdeeds. Which leads to failure of Barings Bank, Britain’s oldest merchant bank failed because of unhealthy trades on behalf of its customers and lost $1.4 billion and pulled its shutter down.

CG COMMITTEESThroughout 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

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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 PracticeB. 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 emoluments4. Financial Reporting and Controls a balanced and understandable assessment of their company’s position

should report that the business should ensure that an objective and professional relationship is maintained

with the auditors.B. Considering the role of Auditors and addressing a number

of recommendations to the Accountancy Profession o external and objective check

o professional and objective relationship between the board of directors and

auditors should be maintained

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o to design audit

o regular rotation of audit partners to prevent unhealthy relationship.

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 the Rights and Responsibilities of Shareholders

• Elect the directors to run the business on their behalf• Appoint the auditors to provide an external check• Committee's report places particular emphasis on the need for fair and

accurate reporting of a company's progress to its shareholders• TO make greater use of their voting rights and take positive interest in the

board functioning• Effectiveness of general meetings could be increased.

2. The Paul Ruthman CommitteeThe committee was constituted later to deal with the said controversial point of Cadbury Report. It watered down the proposal on the grounds of practicality. It restricted the reporting requirement to internal financial controls only as against “the effectiveness of the company’s system of internal control” as stipulated by the Code of Best Practices contained in the Cadbury Report.The final report submitted by the Committee chaired by Ron Hampel had some important and progressive elements, notably the extension of directors’ responsibilities to “all relevant control objectives including business risk assessment and minimizing the risk of fraud….”

3. The Greenbury Committee 1995 This committee was setup in January 1995 to identify good practices by the Confederation of British Industry (CBI), in determining directors’ remuneration and to prepare a code of such practices for use by public limited companies of United Kingdom.

The committee aimed to provide an answer to the general concerns about the accountability by the proper allocation of responsibility for determining directors’ remuneration, the proper reporting to shareholders and greater transparency in the process.The committee produced the Greenbury Code of Best Practice which was divided into the four sections : Remmuneration Committee, Disclosures, Remuneration Policy and Service Contracts and Compensation.

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The Greenbury committee recommended that UK companies should implement the code as set out to the fullest extent practicable, that they should make annual compliance statements, and that investor institutions should use their power to ensure that the best practice is followed.

4. The Hampel Committee 1995 The Hampel committee was setup in November 1995 to promote high standards on Corporate Governance both to protect investors and preserve and enhance the standing of companies listed on the London Stock Exchange. The committee developed further the Cadbury report. And it made the following recommendations.i) The auditors should report on internal control privately to the directors.ii) The directors maintain and review all controls.iii) Companies should time to time review their need for internal audit function and control.It also introduced the combined code that consolidated the recommendation of earlier corporate governance reports (Cadbury Committee and Greenbury Committee).

5. The Combined Code 1998 The combined code was subsequently derived from Ron Hampel Committee’s Final Report, Cadbury Report and the Greenbury Report. The combined code is appended to the listing rules of the London Stock Exchange. As such, compliance of the code is mandatory for all listed companies in UK. The stipulations contained in the Combined Code require, among other things, that the boards should maintain a sound system of internal control to safeguard shareholder’s investments and the company’s assets. The directors should, at least annually, conduct a review of the effectiveness of the group’s system of internal control covering all controls, including financial, operational and compliance and risk management, and report to shareholders that they have done so.

6. The Turnbull Committee The Turnbull Committee was set up by the Institute of Chartered Accountants in England and Wales (ICAEW) in 1999 to provide guidance to assist companies in implementing the requirements of the Combined Code relating to internal control.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

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practices need to be tailor to particular needs, objectives and risk management structure of an organization.

7. World Bank on Corporate GovernanceThe 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

5. Responsibilities of the board

THE RIGHTS OF SHAREHOLDERS

THE CORPORATE GOVERNANCE FRAMEWORK SHOULD PROTECT SHAREHOLDERS’ RIGHTS.

A. Basic shareholder rights include the right to: 1. Secure methods of ownership registration;

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2. Convey or transfer shares; 3. Obtain relevant information on the corporation on a timely and regular

basis; 4. Participate and vote in general shareholder meetings; 5. Elect members of the board; and 6. Share in the profits of the corporation.

B. Shareholders have the right to participate in, and to be sufficiently informed on, decisions concerning fundamental corporate changes such as:1. Amendments to the statutes, or articles of incorporation or similar

governing documents of the company; 2. The authorization of additional shares; and3. Extraordinary transactions that in effect result in the sale of the company.

C. Shareholders should have the opportunity to participate effectively and vote in general shareholder meetings and should be informed of the rules, including voting procedures that govern general shareholder meetings:

1. Shareholders should be furnished with sufficient and timely information concerning the date, location and agenda of general meetings, as well as full and timely information regarding the issues to be decided at the meeting.

2. Opportunity should be provided for shareholders to ask questions of the board and to place items on the agenda at general meetings, subject to reasonable limitations.

3. Shareholders should be able to vote in person or in absentia, and equal effect should be given to votes whether cast in person or in absentia.

D. Capital structures and arrangements that enable certain shareholders to obtain a degree of control disproportionate to their equity ownership should be disclosed.

E. Markets for corporate control should be allowed to function in an efficient and transparent manner.

F. Shareholders, including institutional investors, should consider the costs and benefits of exercising their voting rights.

THE EQUITABLE TREATMENT OF SHAREHOLDERS

The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.

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A. All shareholders of the same class should be treated equally.

1. Within any class, all shareholders should have the same voting rights. All investors should be able to obtain information about the voting rights attached to all classes of shares before they purchase. Any changes in voting rights should be subject to shareholder vote.

2. Votes should be cast by custodians or nominees in a manner agreed upon with the beneficial owner of the shares.

3. Processes and procedures for general shareholder meetings should allow for equitable treatment of all shareholders. Company procedures should not make it unduly difficult or expensive to cast votes.

B. Insider trading and abusive self-dealing should be prohibited.

C. Members of the board and managers should be required to disclose any material interests in transactions or matters affecting the corporation.

THE ROLE OF STAKEHOLDERS IN CORPORATE GOVERNANCE

The corporate governance framework should recognize the rights of stakeholders as established by law and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.

A. The corporate governance framework should assure that the rights of stakeholders that are protected by law are respected.

B. Where stakeholder interests are protected by law, stakeholders should have the opportunity to obtain effective redress for violation of their rights.

C. The corporate governance framework should permit performance-enhancing mechanisms for stakeholder participation.

D. Where stakeholders participate in the corporate governance process, they should have access to relevant information.

DISCLOSURE AND TRANSPARENCYThe 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.

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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 BOARDThe corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board’s 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:

1. Reviewing and guiding corporate strategy, major plans of action, risk policy, annual budgets and business plans; setting performance objectives; monitoring implementation and corporate performance; and overseeing major capital expenditures, acquisitions and divestitures.

2. Selecting, compensating, monitoring and, when necessary, replacing key executives and overseeing succession planning.

3. Reviewing key executive and board remuneration, and ensuring a formal and transparent board nomination process.

4. Monitoring and managing potential conflicts of interest of management, board members and shareholders, including misuse of corporate assets and abuse in related party transactions.

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5. Ensuring the integrity of the corporation’s accounting and financial reporting systems, including the independent audit, and that appropriate systems of control are in place, in particular, systems for monitoring risk, financial control, and compliance with the law.

6. Monitoring the effectiveness of the governance practices under which it operates and making changes as needed.

7. Overseeing the process of disclosure and communications.

The OECD guidelines are somewhat general and both the Anglo-American system and Continental European (or German) system would be quite consistent with it.

SARBANES- OXLEY ACT, 2002

The Sarbanes-Oxley Act (SOX) is a sincere attempt to address all the issues associated with corporate failure to achieve quality governance and to restore investor’s confidence. The Act was formulated to protect investors by improving the accuracy and reliability of corporate disclosures, made precious to the securities laws and for other purposes. The act contains a number of provisions that dramatically change the reporting and corporate director’s governance obligations of public companies, the directors and officers. The important provisions in the SOX Act are briefly given below.

i) Establishment of Public Company Accounting Oversight Board (PCAOB): SOX creates a new board consisting of five members of whom two will be certified public accountants. All accounting firms have to get registered with the board. The board will make regular inspection of firms. The board will report to SEC. The report will be ultimately forwarded to Congress.

ii) Audit Committee: The SOX provides for new improved audit committee. The committee is responsible for appointment, fixing fees and oversight of the work of independent auditors. The registered public accounting firms should report directly to audit committee on all critical accounting policies.

iii) Conflict of Interest: The public accounting firms should not perform any audit services for a publically traded company.

iv) Audit Partner Rotation: The act provides for mandatory rotation of lead audit or co-ordinating partner and the partner reviewing audit once every 5 years.

v) Improper influence on conduct of Audits : According to act, it is unlawful for any executive or director of the firm to take any action to fraudulently influence, coerce or manipulate an audit.

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vi) Prohibition of non-audit services : Under SOX act, auditors are prohibited from providing non-audit services concurrently with audit financial review services.

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. Auditor’s RotationII. Off balance Sheet Transactions

III. Consolidation of Accounting firms & its impact on industryIV. Role of Credit Rating IndustryV. Role of Investment Bank and Financial Advisers.

CONFEDERATION OF INDIAN INDUSTRY (CII) Initiatives

The Confederation of Indian Industry (CII) is an association of Indian businesses which works to create an environment conducive to the growth of industry in the country.

CII is a non-government, not-for-profit, industry-led and industry-managed organization, playing a proactive role in India's development process. Founded in 1895, CII has over 7200 members, from the private as well as public sectors, including SMEs and MNCs, and an indirect membership of

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over 1,00,000 enterprises from around 242 national and regional sectoral industry bodies

CII works closely with Government on policy issues, interfacing with thought leaders, and enhancing efficiency, competitiveness and business opportunities for industry through a range of specialized services and strategic global linkages.

Confederation of Indian Industry 'has 57 offices in India, 1 each in Australia, Austria, China, France, Singapore, UK, USA.

It has also forged partnerships with 240 organizations in 101 countries.

The ' Confederation of Indian Industry ' maxim of "Competitiveness for Sustainable and Inclusive Growth" reflects its commitment towards balanced development that includes all sections of society and industry.

The contribution of ' Confederation of Indian Industry ' in the booming MNC sector is worth mentioning. Mr Kamal Nath, Union Minister for Commerce and Industry, praised CII's initiatives and contribution in nurturing Indian MNCs. Mr D.S. Brar, Chairman, CII National Committee on Indian MNCs and Chairman, GVK Biosciences Private Limited, said "there was tremendous growth potential for Indian MNCs".

In short, the body of ' Indian Industry Confederation 'popularly known as ' Confederation of Indian Industry ' or CII pioneers and champions growth of Indian industry.

UNIT IIIAgents & Institutions in CG, Rights & Privileges of Shareholders, Investors Problems & Protection, CG & other Stakeholders, Role of Regulators & Government

AGENCY THEORY It involves the problem of directors controlling a company whilst shareholders own the company. In the past, a problem was identified 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.

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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 interest in the firm.

Stock market: wide and limited individual ownership and the ability to simply sell without the need to take any interest in the firm.

Delegation of running the firm to the agent or managers. Separation of goals between wealth maximization of shareholders and the personal

objectives of managers. This separation is a key assumption of agency theory. Possible short-term perspective of managers rather than protecting long-term

shareholder wealth. Divorce between ownership and control linked with differing objectives creates

agency problems.

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

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http://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/Risk.aspx


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. Is entitled to receive a copy of the statutory report

9. Entitled to receive copies of the annual report of directors, annual

accounts, and auditor’s report

10. Has the right to participate in the appointment of auditors and the

election of directors at the AGMs of the company

11. Has the right to request the Company law board for calling AGM in

case the company does not convene the meeting

12. Can request the directors to convene extra-ordinary AGMs

13. Is entitled to inspect and obtain copies of the minutes of the AGMs

14. Has the right to participate in declaration of dividends and receive

dividends duly

15. And many more

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Documents

Becg- Mfc 4th Sem