Corporate governance


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Corporate governance

  1. 1. UNIT – III CORPORATE GOVERNANCE • Corporate Governance: Meaning scope & Reporting • The Agency Theory : Principal – Agent Relationship • Role of CEO, Board and Senior Executives • Right of Investors and Shareholders • Financial Regulations and their scope in CG • Corporate governance from Cadbury committee to Narayan Murthy Committee Corporate governance is a process or a set of systems and processes to ensure that a company is managed to suit the best interests of all. The systems that can ensure this may include structural and organizational matters. The stake holders may be internal stake holders (promoters, members, workmen and executives) and external stake-holders (promoters, members, customers, lenders, vendors, bankers, community, government and regulators). Corporate governance is concerned with the establishing of a system whereby the directors are entrusted with responsibilities and duties in relation to the direction of corporate affairs. It is concerned with accountability of persons who are managing it towards stakeholders. It is concerned with the morals, ethics, values, parameters of conduct and behaviour of the company and its management. Corporate governance is nothing but a voluntary ethical code of business of companies. This is based on the core values of the top management and the guiding principles that emanate from it. According to the Cadbury committee on financial aspects of CG, corporate governance is the system by which companies are directed and controlled. The board of directors is responsible for the governance of the company. The directors and the auditors are to satisfy themselves that an appropriate governance structure is in place. The concept of corporate governance hinges on total transparency, integrity and accountability of the management. There has been renewed interest in the corporate governance practices of modern corporations since 2001, particularly due to the high-profile collapses of a number of large U.S. firms such as Enron Corporation and MCI Inc. (formerly WorldCom). In 2002, the U.S. federal government passed the Sarbanes-Oxley Act, intending to restore public confidence in corporate governance. 1
  2. 2. It is a system of structuring, operating and controlling a company with a view to achieve long term strategic goals to satisfy shareholders, creditors, employees, customers and suppliers, and complying with the legal and regulatory requirements, apart from meeting environmental and local community needs. Report of SEBI committee (India) on Corporate Governance defines corporate governance as the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company.” The definition is drawn from the Gandhian principle of trusteeship and the Directive Principles of the Indian Constitution. Corporate Governance is viewed as business ethics and a moral duty. Corporate governance is a way of life and not a set of rules. It is more of a way of life that necessitates taking interests in every business decision. a key element of good corporate governance is transparency projects through a code of good governance which incorporates a system of checks and balances between key players- board of management, auditors and shareholders. Corporate governance is in essence determination of how companies are governed, how executive actions are supervised and how a company is accountable to regulations imposed on it by law or other commitments to shareholders. IMPACT OF CORPORATE GOVERNANCE The positive effect of corporate governance on different stakeholders ultimately is a strengthened economy, and hence good corporate governance is a tool for socio- economic development. A key factor is an individual's decision to participate in an organisation e.g. through providing financial capital and trust that they will receive a fair share of the organisational returns. If some parties are receiving more than their fair return then participants may choose to not continue participating leading to organizational collapse. 2
  3. 3. The Corporate Governance Framework: The governance framework is based on principles of public sector governance including: • accountability—being answerable for decisions and having meaningful mechanisms in place to ensure the agency adheres to all applicable standards • transparency/openness—having clear roles and responsibilities and clear procedures for making decisions and exercising power • integrity—acting impartially, ethically and in the interests of the agency, and not misusing information acquired through a position of trust • stewardship—using every opportunity to enhance the value of the public assets and institutions that have been entrusted to care • efficiency—ensuring the best use of resources to further the aims of the organisation, with a commitment to evidence-based strategies for improvement • leadership—achieving an agency-wide commitment to good governance through leadership from the top. Agencies need to have an approach to governance that enables them to deliver their outcomes effectively and achieve high levels of performance, in a manner consistent with applicable legal and policy obligations. EXCELLENCE THROUGH GOOD CORPORATE GOVERNANCE Adherence to good governance practices enhances the efficiency of corporate sector in the following manner : 1. Good governance provides stability and growth to the companies. 2. Good governance system, demonstrated by adoption of good corporate practices, builds confidence 3. Effective governance reduces perceived risks, consequently reducing cost of capital. 4. In the knowledge driven economy, excellence ion skills like management will be the ultimate tool for corporate houses to leverage competitive advantage in the financial market. 5. Adoption of good corporate practices promotes stability and long-term sustenance of stakeholders' relationship 6. A good corporate citizen becomes an icon and enjoys a position of pride. 7. Potential stakeholders aspire to enter into a relationship with enterprises whose governance credentials are exemplary. A good corporate governance recognizes the diverse interests of shareholders, lenders, employees, government, etc. The new concept of governance to bring about quality corporate governance is not only a necessity to serve the divergent corporate interests, but also is a key requirement in the best interests of the corporates themselves and the economy. 3
  4. 4. The Agency Theory : Principal – Agent Relationship Main (dependent) Factors: Efficiency, alignment of interests, risk sharing, Successful contracting Main (independent) Factors: Information asymmetry, contract, moral hazard, trust In economics, the principal-agent problem treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent. Various mechanisms may be used to try to align the interests of the agent with those of the principal, such as piece rates/commissions, profit sharing, efficiency wages, the agent posting a bond, or fear of firing. The principal-agent problem is found in most employer/employee relationships, for example, when stockholders hire top executives of corporations. Agency Theory Overview Key idea Principal-agent relationships should reflect efficient organization of information and risk-bearing costs Unit of analysis Contract between principal and agent Human assumptions Self interest Bounded rationality Risk aversion Organizational assumptions Partial goal conflict among participants Efficiency as the effectiveness criterion Information asymmetry between principal and agent Information Assumption Information as a purchasable commodity Contracting problem Agency (moral hazard and adverse selection) Risk sharing Problem domain Relationships in which the principal and agent have partly differing goals and risk preferences (e.g. compensation, regulation, leadership, impression management, whistle blowing, vertical integration, transfer pricing) 4
  5. 5. The Agency Theory An agency theory exists when: Managers (Agents) ============== Decision Makers Which Creates Agency Relationship ================= Risk-Bearing Specialist (Principal) Managerial Decision-Making Specialist (Agent) HIRE Shareholders (Principal) -------------------------- Firm Owners Diagrammatic Representation of the Agency theory Agency theory focuses on the relationship and goal incongruence between managers and shareholders. Agency relationships occur when one partner in a transaction (the principal) delegates authority to another (the agency) and the welfare of the principal is affected by the choices of the agent. Agency theory is directed at the ubiquitous agency relationship, in which one party (the principal) delegates work to another (the agent), who performs that work. Agency theory is concerned with resolving two problems that can occur in agency relationships. The first is the agency problem that arises when (a) the desires or goals of the principal and agent conflict and (b) it is difficult or expensive for the principle to verify what the agent is actually doing. The problem here is that the principal cannot verify that the agent has behaved appropriately. The second is the problem of risk sharing that arises when the principal and agent have different attitudes towards risk. The problem here is that the principle and the agent may prefer different actions because of the different risk preferences. Managers can be encouraged to act in the stockholders' best interests through incentives, constraints, and punishments. These methods, however, are effective only if shareholders can observe all of the actions taken by managers. A moral hazard problem, whereby agents take unobserved actions in their own self-interests, originates because it is infeasible for shareholders to monitor all managerial actions. To reduce the moral hazard problem, stockholders must incur agency costs. 5
  6. 6. Role and powers of the CEO, Board and Senior Management: The foremost requirement of good corporate governance is the clear identification of powers, roles, responsibilities and accountability of the Board, CEO and the senior management. Role of a CEO: CEO means Managing Director of a company or Manager appointed in terms of the Companies Act, 1956.  Equitable Treatment of Share-holders : The CEO should respect the rights of share-holders and help share-holders to exercise those rights. He can help share-holders exercise their rights by effectively communicating information that is understandable and accessible, and encouraging share-holders to participate in general meetings.  Interests of Other Stake-holders : The CEO should recognize that they have legal and other obligations to all legitimate stake-holders.  Role & 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. The key roles of Chairperson and CEO should not be shared.  Integrity & Ethical Behaviour : The CEO 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 systemic reliance on integrity and ethics is bound to eventual failure.  Disclosure & Transparency : The CEO should be ready to clarify the company's position to the share-holders and the board and management to provide share-holders with a level of accountability. They should also implement procedures to independently verify and safe-guard 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.  Constant Improvement : The CEO must have the oath "If you can't do it better, why do it?" It under-scores our drive to become an ever better and bigger company. 6
  7. 7.  Issues involving Corporate Governance Principles include : - • Oversight of the preparation of the entity's financial statements. • Internal controls and the independence of the entity's auditors. • Review of the compensation arrangements for the chief executive officer and other senior executives. • The way in which individuals are nominated for positions on the board. • The resources made available to directors in carrying out their duties. • Oversight and management of risk.  Foster a corporate culture that promotes ethical practices, encourages individual integrity, and fulfils social and environmental responsibility.  Maintain a positive and ethical work climate that is conducive to attracting, retaining and motivating top-quality employees.  Develop and recommend to the Board a long-term strategy and vision for the Group.  Ensure that the day-to-day business affairs of the Group are appropriately managed by the MDs, and that proper systems and controls are in place for effective risk management of the Group.  Ensure, in co-operation with the Board, that there is an effective succession plan for the CEO in place. Role of the Board: Given the economic, operational and potential cultural implications of unplanned departures and the risks associated with having to bring in external talent, corporate boards need to make succession management one of their most critical duties. While a large percentage of directors believe in the importance of having a succession plan, most organizations have nothing more than an emergency interim plan, which can be extremely disruptive. Good governance dictates that leadership succession is a priority, year in and year out. The board—or its nomination, compensation or selection committee—must be active stewards of CEO and C-suite succession management, involved in all aspects of the process. This includes assessing potential talent, mitigating risk, making the CEO accountable for executing succession management and planning the development of critical successors. The board’s fingerprints should be all over the organization’s leadership development efforts so directors have personal experience with high- potential candidates. In most organizations, this will require a major increase in the level of time and attention the board pays to the process as it shifts from a “checklist” to a “hands-on” methodology. 7
  8. 8. A 2006 study by the National Association of Corporate Directors (NACD) found that many boards rated their ability to plan for a CEO change as “ineffective.” Few board members had the knowledge and experience needed to run a succession management process. Although some progress has been made since this study, the recession has caused most boards to put succession management on the back burner while they concentrate on urgent operational imperatives. As the economic crisis subsides and organizations begin to refocus on long-term business success and continuity, it is time for boards to reenergize their succession management efforts. Boards those are successful in completing their role in the succession process exhibit two key characteristics:  They have learned how to make decisions objectively. The nature of interpersonal relationships and the proclivity of board members to view leadership behaviors through a personal lens can create strong interpersonal dynamics within the board. As a result, some boards make succession decisions based on personal perceptions of an individual’s leadership behavior and results.  They have a transparent and well-defined succession process. In many organizations, succession management is poorly defined in terms of process steps, ownership and decision rights. A succession management process that is not objective, transparent and robust can be derailed easily, which will result in a poor outcome. Rigorous succession management processes Role of Board of Directors: Corporate governance is basically a system of making directors accountable to shareholders for effective management of the company along with concern for ethics and values. It is the management of companies by the board of directors. it hinges on complete transparency, integrity and accountability of management that includes executive and non-executive directors. The key to good corporate governance is a well functioning, informed board of directors. The board should have a core group of excellent, professionally acclaimed non-executive directors who understand their dual role: of appreciating the issues put forward by management, and of honestly discharging their fiduciary responsibilities towards the company’s shareholders as well as creditors. The role of boards in corporate governance, and how to improve their oversight capability, has been examined carefully in recent years, and new legislation in a number of jurisdictions, and an increased focus on the topic by boards themselves, has seen changes implemented to try and improve their performance. 8
  9. 9. 1) Directors have important and powerful positions in a company. The stockholders entrust them with the running of the company, and this is why the law requires directors to comply with certain duties. 2) Directors have a duty to act within their powers for a proper purpose, which is underlined in the bylaws of the company. They also have a duty to promote the success of the company and, in doing this, must balance the interests of the stockholders, employees, suppliers, and customers of the company. The law does not define success, but in general this is agreed to mean increasing the value of the company and its business. 3) The directors are required to exercise independent judgment when making their decisions. They also have a duty to exercise reasonable care, skill, and diligence in the performance of their duties. An experienced director will be expected to exercise a higher degree of care, skill, and diligence in the performance of his or her activities. 4) Directors have a duty to avoid conflicts of interest. What constitutes a conflict of interest is a complex issue, but in general it refers to transactions between a director and third parties, rather than between a director and the company. Directors have a duty not to accept benefits from third parties if they give rise to a conflict of interest. Benefits in this sense include money and benefits in kind, such as corporate hospitality. It is advisable to obtain specific legal advice in respect of conflicts of interest, as this subject can be quite controversial and difficult to assess. 5) Directors have a duty to declare any interest in proposed transactions or arrangements with the company. They must disclose any such interest to the board of directors and, in certain circumstances, obtain the approval of the stockholders. This includes transactions involving the director or any person connected with the director, such as a spouse or children, and the company. 9
  10. 10. Role of Chairman: The responsibilities of the Chairman expressly include: Running the Board and ensuring its effectiveness in all aspects of its role 1) Chairing the Board and general meetings and relevant Board committees a. Setting the Board agenda b. Ensuring there is an appropriate delegation of authority from the Board to executive management c. Ensuring the Board receives timely and accurate information to enable the Board to take sound decisions and monitor effectively and provide advice to promote the success of the Group d. Managing the Board to allow time for discussion of complex or contentious issues 2) Ensuring the effective contribution and performance of all members of the Board a. Facilitating the effective contribution of Non-Executive Directors b. Ensuring constructive relations between the Executive and Non-Executive Directors c. Identifying the development needs of the Board to enhance its overall effectiveness as a team d. Ensuring the performance of the Board, its Committees and individual Directors is evaluated regularly and acting on the results of such evaluation 3) Maintaining sufficient and effective communication with shareholders a. Ensuring effective communications with shareholders including at general meetings b. Maintaining sufficient contact with major shareholders to understand their issues and concerns c. Ensuring that the views of shareholders are communicated to the Board 4) Upholding standards of integrity and probity a. Setting the tone of Board discussions to promote effective decision making and constructive debate b. Ensuring the Board is fully informed on all issues of relevance c. Ensuring effective implementation of Board decisions d. Building an effective Board e. Providing coherent leadership of the Group 10
  11. 11. Rights of Investor / Shareholder: A shareholder is who owns shares of a corporation. For corporations, along with the ownership comes a right to declared dividends and the right to vote on certain company matters, including the board of directors. Shareholder is also called a stockholder. He / She owns the company to the extent of his / her investment in the said company. A shareholder in a Company enjoys certain rights, which are as follows:  to receive the share certificates, on allotment or transfer as the case may be, in due time.  to receive copies of the abridged Annual Report, the Balance Sheet and the Profit & Loss Account.  to participate and vote in General Meetings either personally or through proxies.  to receive Dividends in due time once approved in General Meetings.  to receive corporate benefits like rights, bonus, etc. once approved.  to apply to Company Law Board (CLB) to call or direct the Annual General Meeting.  to inspect the minute books of the General Meetings and to receive copies thereof.  to proceed against the Company by way of civil or criminal proceedings.  to apply for the winding-up of the Company.  to receive the residual proceeds.  other rights are as specified in the Memorandum and Articles of Association. Besides the above rights, an individual shareholder also enjoys the following rights as a group :  to requisition an Extraordinary General Meeting  to demand a poll on any resolution.  to apply to CLB to investigate the affairs of the Company.  to apply to CLB for relief in cases of oppression and / or mismanagement. Rights of a shareholder include: 1) Voting Power on Major Issues : This includes electing directors and proposals for fundamental changes affecting the company such as mergers or liquidation. Voting takes place at the company's annual meeting. If you can't attend, you can do so by proxy and mail in your 11
  12. 12. vote. 2) Ownership in a Portion of the Company : Previously we discussed the event of a corporate liquidation where bondholders and preferred shareholders are paid first. However, when business thrives, common shareholders own a piece of something that has value. Said another way, they have a claim on a portion of the assets owned by the company. As these assets generate profits, and as the profits are reinvested in additional assets, shareholders see a return in the form of increased share value as stock prices rise . 3) The Right to Transfer Ownership : Right to transfer ownership means shareholders are allowed to trade their stock on an exchange. The right to transfer ownership might seem mundane, but the liquidity provided by stock exchanges is extremely important. Liquidity is one of the key factors that differentiates stocks from an investment like real estate. If you own property, it can take months to convert your investment into cash. Because stocks are so liquid, you can move your money into other places almost instantaneously. 4) An Entitlement to Dividends : Along with a claim on assets, you also receive a claim on any profits a company pays out in the form of a dividend. Management of a company essentially has two options with profits: they can be reinvested back into the firm (hopefully increasing the company's overall value) or paid out in the form of a dividend. You don't have a say in what percentage of profits should be paid out - this is decided by the board of directors. However, whenever dividends are declared, common shareholders are entitled to receive their share . 5) Opportunity to Inspect Corporate Books and Records : This opportunity is provided through a company's public filings, including its annual report. Nowadays, this isn't such a big deal as public companies are required to make their financials public. It can be more important for private companies. 6) The Right to Sue for Wrongful Acts : Suing a company usually takes the form of a shareholder class-action lawsuit. A good example of this type of suit occurred in the wake of the accounting scandal that rocked WorldCom in 2002, after it was discovered that the company had grossly overstated earnings, giving shareholders and investors an erroneous view of its financial health. The telecom giant faced a firestorm of shareholder class- action suits as a result. 12
  13. 13. In addition to the six basic rights of common shareholders, it is vital that you thoroughly research the corporate governance policies of a company. These policies are often crucial in determining how a company treats and informs its shareholders. Shareholder rights vary from state to state, and country to country, so it is important to check with your local authorities and public watchdog groups. These rights are crucial for the protection of shareholders against poor management. Buying a stock means ownership in a company and ownership gives you certain rights. While common shareholders might be at the bottom of the ladder when it comes to liquidation, this is balanced by other opportunities like share price appreciation. As a shareholder, knowing your rights is an essential part of being an informed investor - ignorance is not a defense. Although the Securities and Exchange Commission and other regulatory bodies attempt to enforce a certain degree of shareholder rights, a well- informed investor who fully understands his or her rights is much less susceptible to additional risks . Protection of Investors Interest Many years ago, worldwide, buyers and sellers of corporation stocks were individual investors, such as wealthy businessmen or families, who often had a vested, personal and emotional interest in the corporations whose shares they owned. Over time, markets have become largely institutionalized: buyers and sellers are largely institutions. (e.g., pension funds, mutual funds, hedge funds, exchange-traded funds, other investor groups; insurance companies, banks, brokers, and other financial institutions). The rise of the institutional investor has brought with it some increase of professional diligence which has tended to improve regulation of the stock market (but not necessarily in the interest of the small investor or even of the naïve institutions, of which there are many). Note that this process occurred simultaneously with the direct growth of individuals investing indirectly in the market (for example individuals have twice as much money in mutual funds as they do in bank accounts). However this growth occurred primarily by way of individuals turning over their funds to 'professionals' to manage, such as in mutual funds. In this way, the majority of investment now is described as "institutional investment" even though the vast majority of the funds are for the benefit of individual investors. 13
  14. 14. Various Committees on Corporate Governance Corporate Governance when used in the context of business organizations is a system of making directors accountable to share holders for effective management of the companies, in the best interest of the company and shareholders along with concern for ethics and values. It is a management of companies by the board of directors. It hinges on complete transparency, integrity and accountability of management that includes executive and non-executive directors. Its genesis can be traced to the internal audit function and its importance was enhanced after the Stock Market Crash of 1987. With the CG reports of Adrian Cadbury in the United Kingdom, Mervyn King in South Africa and Kumarmangalam Birla in India the subject was reduced to controlling shareholder operations and ensure ethical practices in the financial sector. From there, it has moved into other areas of the organization but unfortunately restricts itself to the management and control of funds. The ambit of significance of CG lies far beyond this. Cadbury Committee Report (1992) The 'Cadbury Committee' was set up in May 1991 with a view to overcome the huge problems of scams and failures occurring in the corporate sector worldwide in the late 1980s and the early 1990s. It was formed by the Financial Reporting Council, the London Stock of Exchange and the accountancy profession, with the main aim of addressing the financial aspects of Corporate Governance. Other objectives include: (i) uplift the low level of confidence both in financial reporting and in the ability of auditors to provide the safeguards which the users of company's reports sought and expected; (ii) review the structure, rights and roles of board of directors, shareholders and auditors by making them more effective and accountable; (iii) address various aspects of accountancy profession and make appropriate recommendations, wherever necessary; (iv) raise the standard of corporate governance; etc. Keeping this in view, the Committee published its final report on 1st December 1992. The report was mainly divided into three parts:- Reviewing the structure and responsibilities of Boards of Directors and recommending a Code of Best Practice The boards of all listed companies should comply with the Code of Best Practice. All listed companies should make a statement about their compliance with the Code in their report and accounts as well as give reasons for any areas of non- compliance. The Code of Best Practice is segregated into four sections and their respective recommendations are:- 14
  15. 15. 1. Board of Directors - The board should meet regularly, retain full and effective control over the company and monitor the executive management. There should be a clearly accepted division of responsibilities at the head of a company, which will ensure a balance of power and authority, such that no one individual has unfettered powers of decision. Where the chairman is also the chief executive, it is essential that there should be a strong and independent element on the board, with a recognised senior member. Besides, all directors should have access to the advice and services of the company secretary, who is responsible to the Board for ensuring that board procedures are followed and that applicable rules and regulations are complied with. 2. Non-Executive Directors - The non-executive directors should bring an independent judgement to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct. The majority of non-executive directors should be independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgment, apart from their fees and shareholding. 3. Executive Directors - There should be full and clear disclosure of directors’ total emoluments and those of the chairman and highest-paid directors, including pension contributions and stock options, in the company's annual report, including separate figures for salary and performance-related pay. 4. Financial Reporting and Controls - It is the duty of the board to present a balanced and understandable assessment of their company’s position, in reporting of financial statements, for providing true and fair picture of financial reporting. The directors should report that the business is a going concern, with supporting assumptions or qualifications as necessary. The board should ensure that an objective and professional relationship is maintained with the auditors. Considering the role of Auditors and addressing a number of recommendations to the Accountancy Profession The annual audit is one of the cornerstones of corporate governance. It provides an external and objective check on the way in which the financial statements have been prepared and presented by the directors of the company. The Cadbury Committee recommended that a professional and objective relationship between the board of directors and auditors should be maintained, so as to provide to all a true and fair view of company's financial statements. Auditors' role is to design audit in such a manner so that it provide a reasonable assurance that the financial statements are free of material misstatements. Further, there is a need to develop more effective accounting standards, which provide important reference points against which auditors exercise their professional judgement. Secondly, every listed company should form an audit committee which gives the auditors direct access to the non-executive members of the 15
  16. 16. board. The Committee further recommended for a regular rotation of audit partners to prevent unhealthy relationship between auditors and the management. It also recommended for disclosure of payments to the auditors for non-audit services to the company. The Accountancy Profession, in conjunction with representatives of preparers of accounts, 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. However, it should continue to improve its standards and procedures. Dealing with the Rights and Responsibilities of Shareholders The shareholders, as owners of the company, elect the directors to run the business on their behalf and hold them accountable for its progress. They appoint the auditors to provide an external check on the directors’ financial statements. The Committee's report places particular emphasis on the need for fair and accurate reporting of a company's progress to its shareholders, which is the responsibility of the board. It is encouraged that the institutional investors/shareholders to make greater use of their voting rights and take positive interest in the board functioning. Both shareholders and boards of directors should consider how the effectiveness of general meetings could be increased as well as how to strengthen the accountability of boards of directors to shareholders. The Kumar Mangalam Committee Report: (1998) In early 1999, Securities and Exchange Board of India (SEBI) had set up a committee under Shri Kumar Mangalam Birla, member SEBI Board, to promote and raise the standards of good corporate governance. The report submitted by the committee is the first formal and comprehensive attempt to evolve a ‘Code of Corporate Governance', in the context of prevailing conditions of governance in Indian companies, as well as the state of capital markets. The Committee's terms of the reference were to: 1. suggest suitable amendments to the listing agreement executed by the stock exchanges with the companies and any other measures to improve the standards of corporate governance in the listed companies, in areas such as continuous disclosure of material information, both financial and non-financial, manner and frequency of such disclosures, responsibilities of independent and outside directors; 2. draft a code of corporate best practices; and 16
  17. 17. 3. suggest safeguards to be instituted within the companies to deal with insider information and insider trading. The primary objective of the committee was to view corporate governance from the perspective of the investors and shareholders and to prepare a ‘Code' to suit the Indian corporate environment. The committee had identified the Shareholders, the Board of Directors and the Management as the three key constituents of corporate governance and attempted to identify in respect of each of these constituents, their roles and responsibilities as also their rights in the context of good corporate governance. Corporate governance has several claimants –shareholders and other stakeholders - which include suppliers, customers, creditors, and the bankers, the employees of the company, the government and the society at large. The Report had been prepared by the committee, keeping in view primarily the interests of a particular class of stakeholders, namely, the shareholders, who together with the investors form the principal constituency of SEBI while not ignoring the needs of other stakeholders. Mandatory and non-mandatory recommendations The committee divided the recommendations into two categories, namely, mandatory and non- mandatory. The recommendations which are absolutely essential for corporate governance can be defined with precision and which can be enforced through the amendment of the listing agreement could be classified as mandatory. Others, which are either desirable or which may require change of laws, may, for the time being, be classified as non-mandatory. Mandatory Recommendations:  Applies To Listed Companies With Paid Up Capital Of Rs.3 Crore And Above  Composition Of Board Of Directors – Optimum Combination Of Executive & Non-Executive Directors  Audit Committee – With 3 Independent Directors with One Having Financial and Accounting Knowledge.  Remuneration Committee  Board Procedures – At least 4 Meetings Of The Board In A Year With Maximum Gap Of 4 Months Between 2 Meetings. To Review Operational Plans, Capital Budgets, Quarterly Results, Minutes Of Committee's Meeting. Director Shall Not Be A Member Of More Than 10 Committee And Shall Not Act As Chairman Of More Than 5 Committees Across All Companies  Management Discussion And Analysis Report Covering Industry Structure, Opportunities, Threats, Risks, Outlook, Internal Control System  Information Sharing With Shareholders 17
  18. 18. Non-Mandatory Recommendations:  Role Of Chairman  Remuneration Committee Of Board  Shareholders' Right For Receiving Half Yearly Financial Performance Postal Ballot Covering Critical Matters Like Alteration In Memorandum Etc  Sale Of Whole Or Substantial Part Of The Undertaking  Corporate Restructuring  Further Issue Of Capital  Venturing Into New Businesses As per the committee, the recommendations should be made applicable to the listed companies, their directors, management, employees and professionals associated with such companies, in accordance with the time table proposed in the schedule given later in this section. Compliance with the code should be both in letter and spirit and should always be in a manner that gives precedence to substance over form. The ultimate responsibility for putting the recommendations into practice lies directly with the board of directors and the management of the company. The recommendations will apply to all the listed private and public sector companies, in accordance with the schedule of implementation. As for listed entities, which are not companies, but body corporates (e.g. private and public sector banks, financial institutions, insurance companies etc.) incorporated under other statutes, the recommendations will apply to the extent that they do not violate their respective statutes, and guidelines or directives issued by the relevant regulatory authorities . The Committee recognizes that compliance with the recommendations would involve restructuring the existing boards of companies. It also recognizes that some companies, especially the smaller ones, may have difficulty in immediately complying with these conditions. The recommendations were implemented through Clause 49 of the Listing Agreements, in a phased manner by SEBI. 18
  19. 19. The Narayana Murthy Committee: (2003) The Narayana Murthy Committee report on corporate governance has made a number of recommendations in its draft report to Securities and Exchange Board of India. The committee met thrice on December 7, 2002, January 7, 2003 and February 2003, to deliberate the issues related to corporate governance and finalise its recommendations to Sebi. The committee has recommended that the audit committees of publicly listed companies should be required to review the following information mandatorily - financial statements, management discussion and analysis of financial condition and results of operations, reports relating to compliance with laws and risk management among others. The committee has also said that all audit committee members should be "financially literate" and at least one member should have accounting or related financial management expertise. In case a company has followed a treatment different from that prescribed in an accounting standard, management should justify why they believe such alternative treatment is more representative of the underlying business transaction. management should also clearly explain the alternative accounting treatment in the footnotes to the financial statements. The auditor may draw reference to this footnote without necessarily making it the subject matter of an audit qualification. Companies should be encouraged to move towards a regime of unqualified financial statements. This recommendation should be reviewed at an appropriate juncture to determine whether the financial reporting climate is conducive towards a system of filing unqualified financial statements. A statement of all transactions with related parties including their bases should be placed before the independent audit committee at each board meeting for formal approval. This statement should include transactions of a non arm's-length nature also. Management should be required to explain to the audit committee the reasons for the non-arm's length nature of the transaction. 19
  20. 20. The committee believes that it is important for corporate boards to be fully aware of the risks facing the business and that it is important for shareholders to know about the process by which companies manage their business risks. In light of this, it was suggested that procedures should be in place to inform board members about the risk assessment and minimisation procedures. These procedures should be periodically reviewed to ensure that executive management controls risk through means of a properly defined framework. It was also suggested that management should place a report before the board every quarter documenting any limitations to the risk taking capacity of the corporation. This document should be formally approved by the board. Procedures should be in place to inform board members about the risk assessment and minimization procedures. These procedures should be periodically reviewed to ensure that executive management controls risk through means of a properly defined framework. Management should place a report before the entire board of directors every quarter documenting the business risks faced by the company, measures to address and minimize such risks and any limitations to the risk taking capacity of the corporation. This document should be formally approved by the board. Companies should be encouraged to train their board members in the business model of the company as well as the risk profile of the business parameters of the company. Companies raising money through an IPO should disclose the uses and application of funds by major category on a quarterly basis as part of their quarterly declaration of un-audited financial results. This disclosure should distinguish between specified and unspecified uses of IPO proceeds and should be approved by the audit committee. On an annual basis, the company shall prepare a statement of funds utilised for purposes other than those stated in the offer document/prospectus. This statement should be certified by the independent auditors of the company and formally approved by the audit committee. The terms of reference of the committee are to review the performance of corporate governance and To determine the role of companies in responding to rumour and other price sensitive information circulating in the market, to enhance the transparency and integrity of the market. 20
  21. 21. Points to ponder • All audit committee members should be "financially literate" and at least one member should have accounting or related financial management expertise. • It is important for corporate boards to be fully aware of the risks facing the business and that it is important for shareholders to know about the process by which companies manage their business risks. • Companies should train their board members in the business model of the company as well as the risk profile of the business parameters of the company. Case Study on Corporate Governance: The Satyam Scam: Failure of corporate governance Satyam fraud is unfolding and so are the inherent weaknesses of Corporate Governance in India. Ramalinga Raju, once a posture boy of India’s growing software sector who could find a seat beside Bill Clinton on the dais, has become a villain in the corporate world for valid reasons. The company is listed in BSE, NSE and NYSE. On BSE, the Satyam’s stock crashed down by 70 percent to Rs 52 from a high of Rs 188.70. It had a client list that boasted of Fortune 500 companies. His emotionally charged four and half page letter of startling revelations shook the entire corporate world when he admitted of cooking the account and inflating the figure by Rupees 5040 crores. He committed this fraud and tried to hush up it by an abortive bid to purchase Maytas infra, a company created by him and run by his son Teja Raju. This scam is being equated with Enron of USA because here also the scam was orchestrated by its Auditor, Arthur Anderson, in Satyam, Price Waterhouse cooper. IS CORPORATE GOVERNENCE IN INDIA NOT WORLD CLASS??? Interestingly Satyam has bagged Golden Peacock award for best corporate governance by World Council for Corporate Governance only a few years ago. The scam has raised many doubts about the class of corporate governance in India. While speaking at a seminar on corporate governance organised by CII, Ministry of Company affairs and National foundation of corporate governance, C.B.Bhave, the chairman of SEBI said on 6th February, 2009 that the corporate governance is an ongoing process. There is a retrospection everywhere that some concrete steps with respect to it should be done. 21
  22. 22. There are few importance elements of corporate governance namely Auditing, Independent Directors, Regulators and Finally the Board including CEO itself. If we examine these constituents one by one, it would be crystal clear that all the constituents either failed or did not act as was required. 1. The PricewaterhouseCoopers was auditor of the company. A big question is posed over the credibility of auditors. The role of Price waterhouse Coopers(PwC), the Auditing firm of Satyam has been dealt. Institute of Chartered Accountants of India (ICAI) constituted under Charter Accountants Act, 1949 is the regulatory body of all the accounting and auditing firms across the countries. 2. Secondly, the independent directors have also failed to discharge their duties properly. Section 49 of SEBI Act and section 229 A of Company Act, 1956 provides for appointment of Independent Directors in the Companies for protecting the rights of public at large in general and shareholders in particular. There are only two possibilities in Satyam with respect to Independent directors. Either they connive with Raju and knew everything that was going on, or they did not know. In both the cases they failed miserably to discharge their duties. 3. Thirdly, the SEBI and Ministry of Company Affairs too have failed in their assigned jobs. SEBI is the highest regulator and keeps eagle eye on the activities of the capital markets. When the profits of this company were registering abnormal growth, thereby the prices of the shares were soaring, what were these guys doing? There has been a lot of hue and cry with respect to insider trading; a howl SEBI failed to listen to and it inflicted heavily on Satyam. Raju had pledged almost all his shares so did many of the promoters. =========================End of Unit 3======================= 22