Role of Ethics in Corporate Governance

What is corporate governance?

Corporate Governance is concerned with holding the balance between economic and social goals and between individual and communal goals.

The corporate 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, corporations and society

- Sir Adrian Cadbury

What is corporate governance? Contd…

• The primary purpose of corporate leadership is to create wealth legally and ethically.

• This translates to bringing a high level of satisfaction to five constituencies -- customers, employees, investors, vendors and the society-at-large.

• The raison d'être of every corporate body is to ensure predictability, sustainability and profitability of revenues year after year.

• - N R Narayana Murthy

History of Corp Gov in India

• Unlike South-East and East Asia, the corporate governance initiative in India was not triggered by any serious nationwide financial, banking and economic collapse

• Also, unlike most OECD countries, the initiative in India was initially driven by an industry association, the Confederation of Indian Industry– In December 1995, CII set up a task force to design a voluntary code of

corporate governance– The final draft of this code was widely circulated in 1997– In April 1998, the code was released. It was called Desirable Corporate

Governance: A Code– Between 1998 and 2000, over 25 leading companies voluntarily

followed the code: Bajaj Auto, Hindalco, Infosys, Dr. Reddy’s Laboratories, Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI and many others

History of Corp Gov in India

• Following CII’s initiative, the Securities and Exchange Board of India (SEBI) set up a committee under Kumar Mangalam Birla to design a mandatory-cum-recommendatory code for listed companies

• The Birla Committee Report was approved by SEBI in December 2000

• Became mandatory for listed companies through the listing agreement, and implemented according to a rollout plan

History of Corp Gov in India• Following CII and SEBI, the Department of Company

Affairs (DCA) modified the Companies Act, 1956 to incorporate specific corporate governance provisions regarding independent directors and audit committees

• In 2001-02, certain accounting standards were modified to further improve financial disclosures. These were:– Disclosure of related party transactions– Disclosure of segment income: revenues, profits

and capital employed – Deferred tax liabilities or assets – Consolidation of accounts

• Initiatives are being taken to (i) account for ESOPs, (ii) further increase disclosures, and (iii) put in place systems that can further strengthen auditors’ independence

Fundamental Objective of Corporate Governance

• Enhancement of Shareholder Value, keeping in view the Interests of other Stakeholders

• CG a Way of Life rather than a Code

Constituents of Corp Gov

• The Board of Directors • Pivotal role • Accountable to stakeholders • Directs management

• The Shareholders & Stakeholders• To participate in appointment of directors• To hold the BoD accountable for governance through

proper disclosures

• The Management• To act on the direction of the BoD• To provide requisite information to the BoD for

decision making• To implement and monitor control systems

Rationale` for Disclosures

An effective disclosure based regulation (DBR) implies greater responsibilities on the company directors, its management and advisers

An effective DBR promotes investor activism

Markets believe that perceived benefits outweigh perceived costs

Disclosure based Regulation – Components & types of disclosure

Disclosures Disclosuresby whom for whom

Public Listed Cos. ShareholdersIntermediaries InvestorsStock Exchanges MARKET IntermediariesMutual Funds RegulatorAnalysts & advisors Government

Other stake -holders

Disclosure Based Regulation

Components & types of disclosures Initial Disclosures – Disclosures for

raising capital by companies, mutual funds in offer documents

- Public Offers- Private Placement

Continuous disclosures – financial / non-financial

Frequency of disclosure Dissemination process – electronic,

physical, centralised, dispersed Accessibility of information

Disclosure Based Regulation

Initial Disclosures Continuous disclosures Corporate Governance Financial disclosures Risk based disclosures for

intermediaries Disclosures for stock exchanges

DisclosuresBoard of Directors: information that must be

supplied• Annual, quarter, half year operating plans, budgets and

updates• Quarterly results of company and its business segments• Minutes of the audit committee and other board committees• Recruitment and remuneration of senior officers• Materially important legal notices and claims, as well as any

accidents, hazards, pollution issues and labor problems• Any actual or expected default in financial obligations• Details of joint ventures and collaborations• Transactions involving payment towards goodwill, brand

equity and intellectual property• Any materially significant sale of business and investments• Foreign currency and other risks and risk management• Any regulatory non-compliance

DisclosuresDisclosures to shareholders in addition to

balance sheet, P&L and cash flow statement • Board composition (executive, non-exec, independent)• Qualifications and experience of directors• Number of outside directorships held by each director

(capped at director not being a member of more than 10 board-level committees, and Chairman of not more than 5)

• Attendance record of directors• Remuneration of directors• Relationship (familial or pecuniary) with other directors• Warning against insider trading, with procedures to

prevent such acts• Details of grievances of shareholders, and how quickly

these were addressed• Date, time and venue of annual general meeting of

shareholders

DisclosuresDisclosures to shareholders in addition to

balance sheet, P&L and cash flow statement • Dates of book closure and dividend payment• Details of shareholding pattern• Name, address and contact details of registrars

and/or share transfer agents• Details about the share transfer system• Stock price data over the reporting year, and how

the company’s stock measured up to the index• Financial effects of stock options• Financial effects of any share buyback• Financial effects of any warrants that are to be

exercised• Chapter reporting corporate governance practices

DisclosuresDisclosures to shareholders in addition to

balance sheet, P&L and cash flow statement

• Detailed chapter on Management Discussion and Analysis focusing on markets, operations, finances, accounts, risks, opportunities and threats, internal control systems

• Consolidated financial statement, incorporating accounts of all subsidiaries (over 50% shares held by reporting company)

• Details of all significant related party transactions

• Detailed segment reporting (revenues, costs, operating profits and capital employed)

• Deferred tax liabilities and assets and debit/credit in the P&L for the reporting year

Disclosures(A) Basis of related party transactions

I. A statement in summary form of transactions with related parties in the ordinary course of business shall be placed periodically before the audit committee.

II. Details of material individual transactions with related parties which are not in the normal course of business shall be placed before the audit committee.

III. Details of material individual transactions with related parties or others, which are not on an arm’s length basis should be placed before the audit committee, together with Management’s justification for the same

Disclosures(B) Disclosure of Accounting Treatment

To disclose in the financial statements, if an accounting treatment other than prescribed in Accounting Standard has been followed alongwith explanation.

(C) Board Disclosures – Risk management

– Internal and external business risks– Procedures to inform Board members about

the risk assessment and minimization.– Periodically reviewed

Disclosures (D) Proceeds from public issues, rights

issues, preferential issues etc. To disclose to the Audit Committee, on

use/application of funds as and when any issue is made

(E) Additional disclosures: In the Annual Report the criteria of making

payments to NEDs to be disclosed or a reference to be made that the same is available on the company’s website

number of shares and convertible instruments held by NEDs.

NEDs shall disclose their shareholding (both own or held by / for other persons on a beneficial basis) in the company in which they are proposed to be appointed as directors, prior to their appointment.

Disclosures

F) ManagementA Management Discussion and Analysis report to form part of the Annual Report.

G) ShareholdersDisclosures to shareholders in case of appointment /reappointment of directors, quarterly results and presentations made, shareholders’ grievance committee and share transfer committee, shareholding pattern-change

CEO/CFO certification

The CEO, i.e. Managing Director and the CFO i.e. whole-time Finance Director or head of the finance function to certify to the Board that:(a) They have reviewed financial statements and the cash flow statement for the year and these statements:

(i) do not contain any materially untrue statement or omit any material fact or contain statements that might be misleading;

(ii) together present a true and fair view of the company’s affairs and are in compliance with existing accounting standards, applicable laws and regulations.

(b) no transactions entered into by the company during the year which are fraudulent, illegal or violative of the company’s code of conduct.

CEO/CFO certification (contd)

(c)They accept responsibility for establishing and maintaining internal controls and that they have evaluated the effectiveness of the internal control systems of the company and they have disclosed to the auditors and the Audit Committee, deficiencies in the design or operation of internal controls, if any, of which they are aware and the steps they have taken or propose to take to rectify these deficiencies.

(d)They have indicated to the auditors and the Audit committee(i) Significant changes in internal control during the year;(ii) Significant changes in accounting policies

during the year and that the same have been disclosed in the notes to the financial statements; and

(iii)Instances of significant fraud of which they have become aware and the involvement therein, if any, of the management or an employee having a significant role in the company’s internal control system

ETHICS-definitions• The word ethics is derived from the Greek

word ethos meaning character and latin word mores meaning customs

• To better understand ethics let us understand and contrast the definition of ethics and law

• Law is a consistent set of universal rules that are widely published, generally accepted and usually enforced. These rules describe the ways in which people are required to act in society.

• Ethics defines what is good for the individual and for society and establishes the nature of duties that people owe to oneself and others in society

What are ethics

• The principle of conduct – professional ethics• A system or philosophy of conduct• A discipline dealing with what is good and bad-

moral duty and obligation• A set of moral principles or values.

Relation between ethics and law

ETHICS- Reflection in a company’s operations of the values

and moral principles used in the communities in which they operate

Successful markets and corporate performance are founded on a commitment to basic ethical principles aligned as much as possible to the interests of individuals, corporations and society.

Ethical standards may be expressed in a company’s formal conduct requirements, or contained in generally stated principles that guide a company’s preferred conduct or behavior.

Most companies have put in place a code of ethics for its employees to conduct themselves in a particular manner while doing business.

Purpose of Ethics • Ethics are the guiding principles. • Where the proposed business activity/

operation of the company borders on the unknown, the company needs to apply the ethics principle to decide on the project.

• Ethics help make relationships mutually pleasant and productive- imbibes a sense of community among members- a sense of belongingness to society.

Why have a code of ethics?

• To define acceptable behavior• To promote high standards of practice• To provide a benchmark for self-

evaluation• To establish a framework for professional

behavior and responsibilities• As a vehicle for occupational identity• As a mark of occupational maturity.

Code of ethics -transition

OriginalOriginal

Compliance

Enforcement

Punishment

Directive

Secretive

Compliance

Enforcement

Punishment

Directive

Secretive

Integrity

Inspiration

Motivation

Educational

Open

Integrity

Inspiration

Motivation

Educational

Open

RevisedRevised

Creating the Ethical Imperative

• Written code of ethics• Employee commitment• Employee training• Discipline process• Full disclosure• Building expectations• Resolution process – conflict

management

THE INFOSYS MODEL

• A formal code of business conduct and ethics.

• To be signed and adhered to by employees.

• Action against any employee for violation thereof.

THE INFOSYS MODEL -Contents

• General standards of conduct• Management of conflicts of interest• Prohibition of exploitation of corporate

opportunities• Protection of company’s confidential

information• Obligations under securities laws• Use of assets• An entire section on responsibilities to

customers and stakeholders.

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