XAVIER INSTITUTE OF MANAGEMENT AND           ENTREPRENEURSHIP             Corporate Governance                 Case Study-...
INDEX  I.   Introduction II.   Corporate Governance in U.SIII.   Corporate Governance in U.K.IV.    Corporate Governance i...
IntroductionThe last few years have seen some major scams and corporate collapse across the globe. In India, themajor exam...
the corporate sector. In such cases where private action fails to resolve widespread externalitiesinvolving many parties t...
Corporate Governance in UKA detailed analysis of several UK corporate governance reports are given below-CADBURY REPORT (1...
Exchange. It was substantially influenced by the views taken by the EU Commission. One importantpoint was that an auditor ...
Corporate Governance in USPost Enron and WorldCom failures, the US Government had been heavily criticized, which in turn,s...
Supporters of SOX contend the legislation was necessary and has played a useful role in restoringpublic confidence in the ...
Corporate Governance in IndiaThe 1956 Companies Act as well as other laws governing the functioning of joint-stock compani...
have sometimes been defrauded by the management undertaking clandestine side deals with theacquirers in the relatively sca...
interact with statutory auditors and internal auditors and assist the board in corporate      accounting and reporting.   ...
Weaknesses of Corporate Governance In IndiaThe Satyam debacle has exposed the chinks in Indian corporate governance mechan...
defended on the principle of shareholder democracy since they have been sanctioned by resolutions ofthe general body of sh...
Recommendations to Implement Corporate GovernanceAfter a slew of scandals, politicians and regulators, executives and shar...
executives, the strategic direction of the company and worries about areas where they feelinadequately briefed.Explaining ...
Upcoming SlideShare
Loading in …5

Corporategovernance 100404044122-phpapp01


Published on

Published in: Business, Economy & Finance
  • Be the first to comment

  • Be the first to like this

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Corporategovernance 100404044122-phpapp01

  1. 1. XAVIER INSTITUTE OF MANAGEMENT AND ENTREPRENEURSHIP Corporate Governance Case Study-AnalysisBatch 15, Section B9/7/2009
  2. 2. INDEX I. Introduction II. Corporate Governance in U.SIII. Corporate Governance in U.K.IV. Corporate Governance in India V. Weakness in C.G. in IndiaVI. RecommendationsCorporate Governance Page 2
  3. 3. IntroductionThe last few years have seen some major scams and corporate collapse across the globe. In India, themajor example is Satyam which is one of the largest IT companies in India. All these events havecaused the pendulum of public faith to shift away from free market to a more closely regulated one.However "corporate governance," in spite of being the new object of interest and inquisitivenessfrom various quarters, remains an ambiguous and often misunderstood phrase. So before delvingfurther on the subject it is important to define the concept of corporate governance.To get a fair view, it would be prudent to give a narrow as well as broad definition of corporategovernance. In a narrow sense, it involves a set of relationships amongst the company’s management,its board of directors, its share holders, auditors and other stakeholders. These relationships whichinvolve various rules and incentives provide the structure through which the objectives of a companyare set and the means of attaining and monitoring performance are determined. In a broader sense,corporate governance is important for overall market confidence, the efficiency of capital allocation,the growth and development of countries’ industrial basis and ultimately the nations’ overall wealthand welfare. In both narrow as well as in the broad definitions, the following concepts occupy a centrestage: Rights and equitable treatment of shareholders Interests of other stakeholders Role and responsibilities of the board Integrity and ethical behaviour Disclosure and transparencyEver since the first writings on the subject appeared there have been many debates as to whom shouldcorporate governance really represent: the interest of the shareholders or that of all stakeholders. Theshareholder primacy is embodied in the finance view of corporate governance, i.e., the primaryjustification for the existence of the corporation is to maximise shareholders’ wealth. Sinceownership and control are separate the issue here is to align the objectives of management with theobjective of shareholder wealth maximisation.The issue raised in the stakeholder theories is whether the recognition of a wider set of claims thanthose of shareholders alone is the legitimate concern of corporate governance. It is argued that thenew technology world has reduced the opportunity, ability and the motivation of consumers to engagein rational decision making. So the development of inclusive stakeholder relationships rather thanproduction at a lower price will be the most important determinant of viability and success. It impliessearching for a balance among the distinct company interest groups – i.e., shareholders, workers,banks etc. - and also looks for their participation.A natural question to ask is why we need to impose particular governance regulations. There are atleast three reasons for regulatory intervention:1) If the founder of the company was allowed to design and implement a corporate charter he likes.He may not clearly address the issues faced by other shareholders and thus conjure inefficient rules.E.g. in the absence of regulations founders could employ anti-takeover defences excessively butshareholders may favour takeovers that increase the value of their shares even if they involve greaterlosses for unprotected creditors or employees. So the collective bargaining process may not yieldsocially acceptable solutions and may be at the mercy of few stakeholders.2) Another argument comes from the externality argument. An externality may be defined as a goodgenerated as the result of an economic activity, whose benefits or costs do not accrue directly to theparties involved in the activity. E.g. one corporate scandal can erode shareholder trust in the whole ofCorporate Governance Page 3
  4. 4. the corporate sector. In such cases where private action fails to resolve widespread externalitiesinvolving many parties the state has the responsibility to intervene and prevent market failure.3)Regulation is also needed to avoid a situation where efficient rules are designed initially but due tolack of active tracking by dispersed shareholders, are altered or broken later.While regulations are necessary, there are however, a few issues that need to be considered. The firstrelates to policing and punishment. The SEBI envisages that all these corporate governance normswill be enforced through listing agreements between companies and the stock exchanges but forcompanies with little floating stock deregulation because of non compliance is hardly a crediblethreat. The second issue has to do with form vs. Substance. There is a fear that by legally mandatingseveral aspects of corporate governance the regulators encourage the practise of companies followingthe letter of the law instead of focussing on the spirit of good governance. The third concern relates toapprehension about excessive interference that unwittingly leads to micro-management of companies.Considering these apprehensions, what we need is a small corpus of legally mandated rules,buttressed by much larger body of self-regulation and voluntary compliance.So after careful weighing of all pros and cons it is not tough to conclude that good CorporateGovernance makes for good business sense. It increases confidence of shareholders in the companyleading to better stock prices. Research has shown that the good Corporate Governance brings downthe cost of capital for the company. Good disclosure practices lead to a more liquid market for thecompany. This lowers cost of debt. Thus for the CEOs of today, there is a clear business case forcomplying with principles of good Corporate Governance.Corporate Governance Page 4
  5. 5. Corporate Governance in UKA detailed analysis of several UK corporate governance reports are given below-CADBURY REPORT (1992) - The Cadbury Report, titled ‗Financial Aspects of CorporateGovernance‘ is a report of a committee chaired by Adrian Cadbury that sets out recommendations onthe arrangement of company boards and accounting systems to mitigate corporate governance risksand failures. The report was published in 1992. The reports recommendations have been adopted invarying degree by the European Union, the United States, the World Bank, and others.Ethics and corporate governance: The issues raised by the Cadbury report in the United Kingdom:In the late 1980s there was a series of sensational business scandals in the United Kingdom. The Cityof London responded by creating a special committee to examine the financial aspects of corporategovernance. To reduce the power of executive directors in the boardroom the committeerecommended a greater role for non-executive directors, changes in board operations, and a moreactive role for auditors.GREENBURY REPORT (1995) - The Greenbury Report released in 1995 was the product of acommittee established by the United Kingdom Confederation of Business and Industry on corporategovernance. It followed in the tradition of the Cadbury Report and addressed a growing concern aboutthe level of director remuneration.HAMPEL REPORT (1998) - The Hampel Report (Committee on Corporate Governance) in 1998was designed to be a revision of the corporate governance system in the UK. The remit of thecommittee was to review the Code laid down by the Cadbury Report. It asked whether the codesoriginal purpose was being achieved. Hampel found that there was no need for a revolution in the UKcorporate governance system. The Report aimed to combine, harmonise and clarify the Cadbury andGreenbury recommendations.TURNBULL REPORT (1999) - The Turnbull Report - "Internal Control: Guidance for Directors onthe Combined Code", published by the Internal Control Working Party of the Institute of CharteredAccountants in England and Wales - sets out how directors of listed companies should comply withthe UKs Combined Code requirements in respect of internal controls, including financial, operational,compliance and risk management. Organisations that wish to be good corporate citizens, whetherpublicly quoted, privately owned or in the public sector, look to the Combined Code - and therefore tothe Turnbull Report - for guidance on how to do this.THE HIGGS REVIEW (2003) - In April 2002 the Secretary of State, Patricia Hewitt, and theChancellor, Gordon Brown, appointed Derek Higgs to lead a short independent review of the role andeffectiveness of non-executive directors and of the audit committee, aiming at improving andstrengthening the existing Combined Code. Derek Higgs published his report Review of the Role andEffectiveness of Non-Executive Directors on 20th January 2003. Higgs strongly backed the existingnon-prescriptive approach to corporate governance: "comply or explain". Yet he advocated moreprovisions with more stringent criteria for the board composition and evaluation of independentdirectors.SMITH REPORT (2003) - The Smith Report was a report on corporate governance submitted to theUK government in 2003. It was concerned with the independence of auditors in the wake of thecollapse of Arthur Andersen and the Enron scandal in the US in 2002. Its recommendations now formpart of the Combined Code on corporate governance, applicable through the Listing Rules for theCorporate Governance Page 5
  6. 6. Exchange. It was substantially influenced by the views taken by the EU Commission. One importantpoint was that an auditor himself should look at whether a companys corporate governance structureprovides safeguards to preserve his own independence.UK COMBINED CODE ON CORPORATE GOVERNANCE – UK incorporated companieslisted on the UK Stock Exchange are subject to the Combined Code on Corporate Governance. Themost recent (2003) version of the Code combines the Cadbury and Greenbury reports on corporategovernance, the Turnbull Report on Internal Control (revised and republished as the TurnbullGuidance in 2005), the Smith Guidance on Audit Committees and elements of the Higgs Report. TheCombined Code is, in 2006, subject to a review.The Financial Reporting Council (FRC) is the independent UK regulator and is also responsible forthe statutory oversight and regulation of auditors and of the professional accountancy and actuarialbodies. The UK Combined Code works on what is known as a ‗Comply or Explain‘ basis; in otherwords, companies may choose not to comply with specific provisions but, in that case, will have toprovide a proper public explanation of their decision.AIM Companies - Companies listed on AIM in the UK are not formally required to comply with theCombined Code. Some choose to do so. The QCA (Quoted Companies Alliance) published, in July2005, the Corporate Governance Guidelines for AIM companies, which are based on the CombinedCode and are voluntary.UK COMPANIES ACT 2004 - The UK‘s Companies (Audit, Investigations and CommunityEnterprise) Act of 2004 placed a statutory duty on officers and employees (including ex-employees)to provide auditors with information (other than legally privileged information) and explanations inrespect of any issue related to their audit of the company‘s accounts. The directors are required tomake a statement that they have disclosed (having taken appropriate steps to ascertain it) all relevantinformation to the auditors and making a false statement is a criminal offence.The UK‘s Financial Reporting Review Panel (the FRRP), which was originally set up in 1990 to lookinto instances of corporate accounting non-compliance with UK GAAP, gained new powers to requirecompanies, directors and auditors to provide documents, information and explanations if there mightbe an accounts non-compliance with relevant reporting requirements. With the exception of small andmedium enterprises, UK companies will be required to make detailed disclosure of non-audit servicessupplied by their auditors.UK COMPANIES ACT 2006 - The Companies Act 2006, which received royal assent at the end of2006, is coming into law in stages and will be fully in effect by October 2008. This Act replacesvirtually all the previous UK company legislation. The first commencement order containedrequirements on disclosure of company information and made provisions for the use of e-communications.Corporate Governance Page 6
  7. 7. Corporate Governance in USPost Enron and WorldCom failures, the US Government had been heavily criticized, which in turn,served as catalysts for legislative change (Sarbanes-Oxley Act of 2002) and regulatory change (newgovernance guidelines from the NYSE and NASDAQ). SEC Federal Law Firms and State Courts Auditor The s Company Management Shareholders Security Institutional Analysts Investors’ Organizations Stock MarketsFigure 1: US CORPORATE GOVERNMENT SYSTEMSSarbanes-Oxley Act: The Sarbanes-Oxley Act of 2002 (enacted July 30, 2002), also known asthe Public Company Accounting Reform and Investor Protection Act of 2002 and commonlycalled Sarbanes-Oxley, Sarbox or SOX, is a United States federal law enacted on July 30, 2002, as areaction to a number of major corporate and accounting scandals like Tyco International, Enron,Adelphia, Peregrine Systems and WorldCom. These scandals, which cost investors billions of dollarswhen the share prices of affected companies collapsed, shook public confidence in thenations securities markets. The legislation set new or enhanced standards for all U.S. publiccompany boards, management and public accounting firms. It does not apply to privately heldcompanies. The act contains 11 titles, or sections, ranging from additional corporate boardresponsibilities to criminal penalties, and requires the Securities and Exchange Commission (SEC) toimplement rulings on requirements to comply with the new law. No legislation is ever flawless butonce pressed into force is especially likely to contain imperfections. Although there have beencomplaints about this law from managers and directors, on the whole, it has worked better than mighthave been expected.The provisions of the law target top managers, board members, and the auditing profession, especiallyfirms that oversee the accounting and financial reporting of companies. The chief executive officer(CEO) and the chief financial officer (CFO) of such companies are required to certify that theirfinancial reports accurately depict the company‘s financial status. False statements are treated as acriminal act. The law also prevents executives from receiving loans from their companies. Despite thereal and perceived issues, the act seems to have contributed to improved financial reporting and goodcorporate governance. It has focused attention on transparent reporting and improved accountingcontrols.Corporate Governance Page 7
  8. 8. Supporters of SOX contend the legislation was necessary and has played a useful role in restoringpublic confidence in the nations capital markets by, among other things, strengthening corporateaccounting controls. Opponents of the bill claim it has reduced Americas international competitiveedge against foreign financial service providers, saying SOX has introduced an overly complexregulatory environment into U.S. financial markets. However the debate continues over the perceivedbenefits and costs.Current state of corporate governance in United States:Sporadic attempts have been made to give shareholders more influence in the governance process.The reality is that U.S. shareholders participate in governance as they always have: by following the―Wall Street rule.‖ They sell stock when they are unhappy with a company‘s performance and theybuy when a company‘s future seems promising.In spite of the scandals of the early years of the 21st century, there is much that is positive to reportabout corporate governance in the United States. Many boards of directors are improving theiroversight and guidance of their companies. The relationship between the directors and their auditorshas been clarified and strengthened by the Sarbanes-Oxley Act.Of course, more progress is needed. The process of board improvement is ongoing and needs to reacheven more board rooms. The greatest challenge of all will be for the business community andpolicymakers to find a path forward which enhances the role of shareholders in the governanceprocess, even though the majority of them seem more like short-term renters of shares than long-termowners.Corporate Governance Page 8
  9. 9. Corporate Governance in IndiaThe 1956 Companies Act as well as other laws governing the functioning of joint-stock companiesand protecting the investors‘ rights built on this foundation. The beginning of corporate developmentsin India were marked by the managing agency system that contributed to the birth of dispersed equityownership but also gave rise to the practice of management enjoying control rights disproportionatelygreater than their stock ownership. The turn towards socialism in the decades after independencemarked by the 1951 Industries (Development and Regulation) Act as well as the 1956 IndustrialPolicy Resolution put in place a regime and culture of licensing, protection and widespread red-tapethat bred corruption and stilted the growth of the corporate sector.The situation grew from bad to worse in the following decades and corruption, nepotism andinefficiency became the hallmarks of the Indian corporate sector. Exorbitant tax rates encouragedcreative accounting practices and complicated emolument structures to beat the system. In the absenceof a developed stock market, the three all-India development finance institutions (DFIs) – theIndustrial Finance Corporation of India, the Industrial Development Bank of India and the IndustrialCredit and Investment Corporation of India – together with the state financial corporations became themain providers of long-term credit to companies. Along with the government owned mutual fund, theUnit Trust of India, they also held large blocks of shares in the companies they lent to and invariablyhad representations in their boards.In this respect, the corporate governance system resembled the bank-based German model wherethese institutions could have played a big role in keeping their clients on the right track.Unfortunately, they were themselves evaluated on the quantity rather than quality of their lending andthus had little incentive for either proper credit appraisal or effective follow-up and monitoring.Borrowers therefore routinely recouped their investment in a short period and then had little incentiveto either repay the loans or run the business. Frequently they bled the company with impunity,siphoning off funds with the DFI nominee directors mute spectators in their boards.This sordid but increasingly familiar process usually continued till the company‘s net worth wascompletely eroded. This stage would come after the company has defaulted on its loan obligations fora while, but this would be the stage where India‘s bankruptcy reorganization system driven by the1985 Sick Industrial Companies Act (SICA) would consider it ―sick‖ and refer it to the Board forIndustrial and Financial Reconstruction (BIFR). As soon as a company is registered with the BIFR itwins immediate protection from the creditors‘ claims for at least four years. Between 1987 and 1992BIFR took well over two years on an average to reach a decision, after which period the delay hasroughly doubled. Very few companies have emerged successfully from the BIFR and even for thosethat needed to be liquidated, the legal process takes over 10 years on average, by which time theassets of the company are practically worthless. Protection of creditors‘ rights has therefore existedonly on paper in India. Given this situation, it is hardly surprising that banks, flush with depositors‘funds routinely decide to lend only to blue chip companies and park their funds in governmentsecurities.Financial disclosure norms in India have traditionally been superior to most Asian countries thoughfell short of those in the USA and other advanced countries. Noncompliance with disclosure normsand even the failure of auditor‘s reports to conform to the law attract nominal fines with hardly anypunitive action. The Institute of Chartered Accountants in India has not been known to take actionagainst erring auditors.While the Companies Act provides clear instructions for maintaining and updating share registers, inreality minority shareholders have often suffered from irregularities in share transfers andregistrations – deliberate or unintentional. Sometimes non-voting preferential shares have been usedby promoters to channel funds and deprive minority shareholders of their dues. Minority shareholdersCorporate Governance Page 9
  10. 10. have sometimes been defrauded by the management undertaking clandestine side deals with theacquirers in the relatively scarce event of corporate takeovers and mergers.Boards of directors have been largely ineffective in India in monitoring the actions of management.They are routinely packed with friends and allies of the promoters and managers, in flagrant violationof the spirit of corporate law. The nominee directors from the DFIs, who could and should haveplayed a particularly important role, have usually been incompetent or unwilling to step up to the act.Consequently, the boards of directors have largely functioned as rubber stamps of the management.For most of the post-Independence era the Indian equity markets were not liquid or sophisticatedenough to exert effective control over the companies. Listing requirements of exchanges enforcedsome transparency, but non-compliance was neither rare nor acted upon. All in all therefore, minorityshareholders and creditors in India remained effectively unprotected in spite of a plethora of laws inthe books.The years since liberalization have witnessed wide-ranging changes in both laws and regulationsdriving corporate governance as well as general consciousness about it. Perhaps the single mostimportant development in the field of corporate governance and investor protection in India has beenthe establishment of the Securities and Exchange Board of India (SEBI) in 1992 and its gradualempowerment since then. Established primarily to regulate and monitor stock trading, it has played acrucial role in establishing the basic minimum ground rules of corporate conduct in the country.Concerns about corporate governance in India were, however, largely triggered by a spate of crises inthe early 90‘s – the Harshad Mehta stock market scam of 1992 followed by incidents of companiesallotting preferential shares to their promoters at deeply discounted prices as well as those ofcompanies simply disappearing with investors‘ money. These concerns about corporate governancestemming from the corporate scandals as well as opening up to the forces of competition andglobalization gave rise to several investigations into the ways to fix the corporate governance situationin India. One of the first among such endeavours was the CII Code for Desirable CorporateGovernance developed by a committee chaired by Rahul Bajaj. The committee was formed in 1996and submitted its code in April 1998. Later SEBI constituted two committees to look into the issue ofcorporate governance – the first chaired by Kumar Mangalam Birla that submitted its report in early2000 and the second by Narayana Murthy three years later. The SEBI committee recommendationshave had the maximum impact on changing the corporate governance situation in India. The AdvisoryGroup on Corporate Governance of RBI‘s Standing Committee on International Financial Standardsand Codes also submitted its own recommendations in 2001.Recommendations of various committees on Corporate Governance in IndiaCII Code recommendations (1997) 1. No need for German style two-tiered board. 2. For a listed company with turnover exceeding Rs 100 crores, if the chairman is also the MD, at least half of the board should be independent directors, else at least 30%. 3. No single person should hold directorships in more than 10 listed companies. 4. Non-executive directors should be competent and active and have clearly defined responsibilities like in the Audit committee. 5. Directors should be paid a commission not exceeding 1% (3%) of net profits for a company with (out) an MD over and above sitting fees. Stock options may be considered too. 6. Attendance record of directors should be made explicit at the time of re-appointment. Those with less than 50% attendance shouldn‘t be re-appointed. 7. Key information that must be presented to the board is listed in the code. 8. Audit Committee: Listed companies with turnover over Rs. 100 crores or paid-up capital of Rs. 20 crores should have an audit committee of at least three members, all non-executive, competent and willing to work more than other non-executive directors, with clear terms of reference and access to all financial information in the company and should periodicallyCorporate Governance Page 10
  11. 11. interact with statutory auditors and internal auditors and assist the board in corporate accounting and reporting. 9. Reduction in number of nominee directors. FIs should withdraw nominee directors from companies with individual FI shareholding below 5% or total FI holding below 10%.Birla Committee (SEBI) recommendations (2000) 1. At least 50% non-executive members. 2. For a company with an executive Chairman, at least half of the board should be independent directors, else at least one-third. 3. Non-executive Chairman should have an office and be paid for job related expenses. 4. Maximum of 10 directorships and 5 chairmanships per person. 5. Audit Committee: A board must have a qualified and independent audit committee, of minimum 3 members, all non-executive, majority and chair independent with at least one having financial and accounting knowledge. Its chairman should attend AGM to answer shareholder queries. The committee should confer with key executives as necessary and the company secretary should be he secretary of the committee. The committee should meet at least thrice a year -- one before finalization of annual accounts and one necessarily every six months with the quorum being the higher of two members or one-third of members with at least two independent directors. It should have access to information from any employee and can investigate any matter within its TOR, can seek outside legal/professional service as well as secure attendance of outside experts in meetings. It should act as the bridge between the board, statutory auditors and internal auditors with arranging powers and responsibilities. 6. Remuneration Committee: The remuneration committee should decide remuneration packages for executive directors. It should have at least 3 directors, all Nonexecutive and be chaired by an independent director. 7. The board should decide on the remuneration of non-executive directors and all remuneration information should be disclosed in annual report. 8. At least 4 board meetings a year with a maximum gap of 4 months between any 2 meetings. Minimum information available to boards stipulated.Narayana Murthy committee (SEBI) recommendations (2003) 1. Training of board members suggested. 2. There shall be no nominee directors. All directors to be elected by shareholders with same responsibilities and accountabilities. 3. Non-executive director compensation to be fixed by board and ratified by shareholders and reported. Stock options should be vested at least a year after their retirement. Independent directors should be treated the same way as non-executive directors. 4. The board should be informed every quarter of business risk and risk management strategies. 5. Boards of subsidiaries should follow similar composition rules as that of parent and should have at least one independent directors of the parent company. 6. The Board report of a parent company should have access to minutes of board meeting in subsidiaries and should affirm reviewing its affairs. 7. Performance evaluation of non-executive directors by all his fellow Board members should inform a re-appointment decision. 8. While independent and non-executive directors should enjoy some protection from civil and criminal litigation, they may be held responsible of the legal compliance in the company‘s affairs. 9. Code of conduct for Board members and senior management and annual affirmation of compliance to it.Corporate Governance Page 11
  12. 12. Weaknesses of Corporate Governance In IndiaThe Satyam debacle has exposed the chinks in Indian corporate governance mechanism and themonitoring authorities. It has raised many questions about corporate governance in India—the role ofboards, of independent directors, of the auditors, of investors and of analysts. Unanimously it has beena gross failure of corporate governance standards in India and protection of rights of minorityinvestors.The board of directors is central to good governance, and the role of the board has featuredprominently in discussions about Satyam. The board is the body charged with having oversight of theoperations of the firm and setting its strategy. It should ensure that the company is upholding highstandards of probity and conduct, and provide a probing analysis of the activities of management. Inparticular, non-executive directors are supposed to give an independent assessment of the quality ofmanagement. But time and time again, failures of corporate governance suggest that they do not. Theinfractions of law have arisen despite independent directors which were stopped by external forces.There are several reasons pointing to these anomalies-First, it is difficult to appoint truly independent directors. This is particularly hard to achieve incountries such as India where family ownership is widespread and there is a close-knit group ofcorporate leaders. It is difficult for non-executive directors to perform a scrutiny objective at the bestof times, but it is particularly difficult to do so when faced with a dominant CEO who expects supportnot criticism from the company‘s board. Many countries have sought to separate the roles of chairmanand CEO. However, it can inhibit firms from implementing effective strategies, especially incompanies operating with new technologies, such as Indian IT/ITES firms, requiring visionarystrategies.Next, the very idea of independent directors is to ensure commitment to values, ethical businessconduct and about making a distinction between personal and corporate funds in the management of acompany. Yet, most independent directors have become sidekicks for the management, eying theircommission and fees, forgetting their very purpose of appointment. In the process, they implicitlytransform into dependent directors.To add to that the present corporate governance modelled on the Western Anglo-Saxon model whichdoes not address many of the current crises faced by India Inc. Professor Jayant Rama Verma of IIMBangalore had extensively commented on the unsuitability of the Western Code of CorporateGovernance in his well researched paper on the subject titled Corporate Governance in India -Disciplining the dominant shareholder (1997):According to him, the governance issue in the Anglo-Saxon world aims essentially at disciplining themanagement which is unaccountable to the owners. In contrast, the problem in the Indian corporatesector, he pointed out, is disciplining the dominant shareholder and protecting the minorityshareholders, vindicated in the recent Satyam case. To understand the issues that driving corporategovernance in the West, a brief idea about it is inevitable. After successfully working over thedecades separating ownership and management, owners, (especially, institutional owners) realisedthat they have lost control over the management or the board. Professor Verma points out succinctly,"The management becomes self-perpetuating and the composition of the board itself is largelyinfluenced by the whims of the CEO. Corporate governance reforms in the US and the UK havefocussed on making the board independent of the CEO.In contrast, the issues in India are entirely distinct - primarily due to our overall social-economicconditions. Therefore the issue in Indian corporate governance is not a conflict between managementand owners as elsewhere, but a conflict between the dominant shareholders and the minorityshareholders. And Professor Verma rightly concludes, "The board cannot even in theory resolve thisconflict" and that "some of the most glaring abuses of corporate governance in India have beenCorporate Governance Page 12
  13. 13. defended on the principle of shareholder democracy since they have been sanctioned by resolutions ofthe general body of shareholders."By now it is increasingly obvious that the very concept of corporate governance modelled on theWestern system is un-workable in a country like India. These efforts are akin to taking a hair of anelephant, transplanting it on the head of a bald man and making him look like a bear. In the West thefocus is on ownerless, CEO-driven paradigm. In India, it is still family-controlled, owner-drivenparadigm. CEOs do not matter much in the management of the company. Yet, the general discussioncentres on a standard, global prescription to manage diverse situations. Needless to emphasise, thesolution to these problems in India lies not within the company, but outside. This is precisely whathappened in the Satyam case where outsiders of the company took the lid off the fraud.In spite of numerous suggestions by the Securities and Exchange Board of India (SEBI), for peerreviews of audits among the companies listed in the Nifty and Sensex indices they have fallen flat onthe industry fraternity. Presumably, SEBI will allocate the audits to firms that are part of a panel ofreputed auditors. The simple solution would be for the regulator to make this course of actionmandatory—auditors could be allotted audits by the regulator. To avoid the allegations ofoverregulation, companies can submit a list of their preferred auditors, from which the regulator willhave to choose. Audits could also be rotated annually, keeping them on their toes. And these samerules could also be applied to rating agencies, internal auditors, independent directors etc. From timeto time these mechanisms can be fine-tuned and made more practical.The moot question is why these reformative suggestions have not been implemented? The answer isthat it depends on who‘s got more lobbying power. In the US, the large pension funds that have beeninstrumental in getting more transparency from company managements. India, on the other hand, hasno tradition of shareholder activism, despite organisations such as the Life Insurance Corporation ofIndia having substantial stakes in companies. The dependence of political parties on business intereststo fund elections also doesn‘t help. The failure of governments and regulators to pass what seems likevery basic safeguards preventing conflicts of interest, not only in India, but across the world, clearlyestablishes the clout that corporate interests have. Corporate governance is thus a charade, a cosmeticexercise rather than an attempt to get to the root of the problem.Of course, too rigid a focus on the stock market also has its own set of problems. As SatyamComputer Services Ltd‘s founder B. Ramalinga Raju said in his confession, the apparent reason whyhe inflated earnings was because he feared that bad results would lead to a fall in the stock and atakeover attempt. We needn‘t take Raju‘s word for it, but the fact remains that too much of a focus onquarterly earnings and the linking of executive compensation with the stock market via stock optionscould act as powerful incentives for inflating earnings.Corporate Governance Page 13
  14. 14. Recommendations to Implement Corporate GovernanceAfter a slew of scandals, politicians and regulators, executives and shareholders are all preaching thegovernance gospel. Corporate governance has come to dominate the political and business agenda.There is a growing concern among executives that hasty regulation and overly strict internalprocedures may impair their ability to run their business effectively. CEOs have to bear in mind thepotential trade-off between polishing the corporate reputation and delivering growth—for all theheadlines on corporate responsibility, are investors prepared consistently to sacrifice earnings for thesake of ethics?Regulations are only one part of the answer to improved governance. Corporate governance is abouthow companies are directed and controlled. The balance sheet is an output of manifold structural andstrategic decisions across the entire company, from stock options to risk management structures, fromthe composition of the board of directors to the decentralisation of decision-making powers. As aresult, the prime responsibility for good governance must lie within the company rather than outsideit.A key lesson from the Enron experience, where the board was an exemplar of best practice on paper,is that governance structures count for little if the culture isn‘t right. Designing and implementingcorporate governance structures are important, but instilling the right culture is essential. Seniormanagers need to set the agenda in this area, not least in ensuring that board members feel free toengage in open and meaningful debate. Not all board members need to be finance or risk experts,however. The primary task for the board is to understand and approve both the risk appetite of aparticular company at any particular stage in its evolution and the processes that are in place tomonitor risk.Culture is necessary but not sufficient to ensure good corporate governance. The right structures,policies and processes must also be in place. Transparency about a company‘s governance policies iscritical. As long as investors and shareholders are given clear and accessible information about thesepolicies, the market can be allowed to do the rest, assigning an appropriate risk premium to companiesthat have too few independent directors or an overly aggressive compensation policy, or cutting thecosts of capital for companies that adhere to conservative accounting policies. Too few companies aregenuinely transparent, however, and this is an area where most organisations can and should do muchmore.If any institution, inside or outside the company, deserves scrutiny, it is the board of directors.Executives have a clear responsibility consciously to define and implement corporate governancepolicies that offer a decent level of reassurance to employees and investors. Thereafter, disclosure isthe most effective way for companies to resolve the thorny tensions that do exist between vision andprudence, innovation and accountability.There is an inherent tension between innovation and conservatism, governance and growth. Asked toevaluate the impact of strict corporate governance policies on their business, executives thought thatM&A deals would be negatively affected because of the lengthening of due-diligence procedures, andthat the ability to take swift and effective decisions would be compromised. State-of-the-art corporategovernance can bring benefits to companies, to be sure, but also introduces impediments to growth.Some procedures and processes that companies can implement to enhance corporate governance aredetailed as follows.Scheduling regular meetings of the non-executive board members from which other executives areexcluded. Non-executives are there to exercise ―constructive dissatisfaction‖ with the managementteam. They need to discuss collectively and frankly their views about the performance of theCorporate Governance Page 14
  15. 15. executives, the strategic direction of the company and worries about areas where they feelinadequately briefed.Explaining fully how discretion has been exercised in compiling the earnings and profit figures. Theseare not as cut and dried as many would imagine. Assets such as brands are intangible and withfinancial practices such as leasing common, a lot of subtle judgments must be made about what goeson or off the balance sheet. Use disclosure to win trust.Initiating a risk-appetite review among non-executives. At the root of most company failures are ill-judged management decisions on risk. Non-executives need not be risk experts. But it is paramountthat they understand what the company‘s appetite for risk is—and accept, or reject, any radical shifts.Checking that non-executive directors are independent. Weed out members of the controlling familyor former employees who still have links to people in the company. Also raise awareness of ―soft‖conflicts. Are there payments or privileges such as consultancy contracts, payments to favouritecharities or sponsorship of arts events that impair non-executives‘ ability to rock the boat?Auditing non-executives‘ performance and that of the board. The attendance record of nonexecutivesneeds to be discussed and an appraisal made of the range of specialist skills. The board should discussannually how well it has performed.Broadening and deepening disclosure on corporate websites and in annual reports. Websites shouldhave a corporate governance section containing information such as procedures for getting a motioninto a proxy ballot. The level of detail should ideally include the attendance record of non-executivesat board meetings.Leading by example, reining in a company culture that excuses cheating. If the company culture hasbeen compromised, or if one is in an industry where loose practices on booking revenues andexpenditure are sometimes tolerated, take a few high-profile decisions that signal change.Finding a place for the grey and cautious employee alongside the youthful and visionary one. Hiringthrusting graduates will skew the culture towards an aggressive, individualist outlook. Balance thiswith some wiser, if duller heads—people who have seen booms and busts before, value probity andare not in so much of a hurry. Making compensation committees independent. Corporate bossesshould be prevented from selling shares in their firms while they head them. Share options should beexpensed in established companies—cash-starved start-ups may need to be more flexible.Corporate governance is not just a box ticking exercise, companies need an exchange of practicalguidance in order to conceive and implement successful governance mechanism. Instead of a menu ofcorporate governance options it would be more appropriate to present best practice guidelinesapplicable to businesses. These will serve as a benchmark for appropriate customization in differentcompanies. Corporate governance should be considered as an obligation not a luxury. Its spirit isgoing to expand further and deeper in the future.Corporate Governance Page 15