Corporate governance

DEPARTMENT OF MANAGEMENT STUDIES PONDICHERRY UNIVERSITY Assignment ON Corporate Governance Submitted To:-Dr.B.Charumathi Submitted by:- Amresh Kumar Pandey (1st yr.)MBA ‘A’, DMS Pondicherry University CORPORATE GOVERNANCE History of Corporate Governance : History of Corporate Governance Kautilya’s governance, the concept of governance cannot be completed without acknowledging the contribution of the most celebrated scholar of ancient India, Kautilya. One of the world’s most complete manuscripts on the science of governance was penned by Kautilya in the third century BC. Kautilya’s discussions on administration and management are strikingly modern and scientific covering almost all facets of governance. In the 19th century, state corporation laws enhanced the rights of corporate boards to govern without unanimous consent of shareholders in exchange for statutory benefits like appraisal rights, to make corporate governance more efficient. INTRODUCTION :- Corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a corporation (or company) is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. A Professional body is a group of people in a learned occupation who are entrusted with maintaining control or oversight of the legitimate practice of the occupation. Professional involved in corporate governance includes the regulatory body (e.g. the Chief Executive Officer, the board of directors, management, shareholders and Auditors). Other stakeholders include employees, customers, creditors, suppliers, regulators, and the community at large. The term corporate governance has come to mean 2 things : The processes by which all companies are directed and controlled. a field in economics, which studies the many issues arising from the separation of ownership and control. Corporate governance is a field in economics that investigates how to secure/motivate efficient management of corporations by the use of incentive mechanisms, such as contracts, organizational designs and legislation. This is often limited to the question of improving financial performance, for example , how the corporate owners can secure/motivate that the corporate managers will deliver a competitive rate of return. Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as , the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance. FACTORS INFLUENCING The ownership structure of a corporation Its financial structure. The structure and funtioning of the company boards The legal, political and regulatory environment within which the company operates 6 MECHANISMS : WHY DO WE NEED MECHANISMS AND CONTROLS : Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection . For example , to monitor managers' behaviour, an independent third party (the auditor ) attests the accuracy of information provided by management to investors . An ideal control system should regulate both motivation and ability. INTERNAL GOVERNANCE : Internal corporate governance controls monitor activities and then take corrective action to accomplish organisational goals. Monitoring by the board of directors : The board of directors, with its legal authority to hire, fire and compensate top management, safeguards invested capital. Regular board meetings allow potential problems to be identified, discussed and avoided. Non-executive directors are thought to be more independent , they may not always result in more effective corporate governance and may not increase performance. Remuneration : Performance - based remuneration is designed to relate some proportion of salary to Individual performance. It may be in the form of cash or non - cash payments such as shares and share options , super annuation or other benefits. Such as incentive schemes, however, are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behaviour, and can elicit myopic behaviour. EXTERNAL GOVERNANCE : External corporate governance controls encompass the controls external stakeholders exercise over the organisation. debt covenants Government regulations Media pressure takeovers competition managerial labour market Telephone tapping CORPORATE GOVERNANCE ENVIRONMENT AND OUTCOMES : PRINCIPLES : Commonly accepted principles of corporate governance include: Rights and equitable treatment of shareholders : Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by effectively communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings. Interests of other stakeholders : Organizations should recognize that they have legal and other obligations to all legitimate stakeholders. Role and responsibilities of the board : The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors. The key roles of chairperson and CEO should not be held by the same person. Integrity and ethical behaviour : Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. It is important to understand, though, that systemic reliance on integrity and ethics is bound to eventual failure. Because of this, many organizations establish Compliance and Ethics Programs to minimize the risk that the firm steps outside of ethical and legal boundaries. Disclosure and transparency : Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information. ISSUES INVOLVING CORPORATE GOVERNANCE INCLUDES : 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 Dividend policy SYSTEMIC PROBLEMS OF CORPORATE GOVERNANCE : Supply of accounting information: Financial accounts form a crucial link in enabling providers of finance to monitor directors. Imperfections in the financial reporting process will cause imperfections in the effectiveness of corporate governance. This should, ideally, be corrected by the working of the external auditing process. Monitoring costs: In order to influence the directors, the shareholders must combine with others to form a significant voting group which can pose a real threat of carrying resolutions or appointing directors at a general meeting. Demand for information: A barrier to shareholders using good information is the cost of processing it, especially to a small shareholder. The traditional answer to this problem is the efficient market hypothesis (in finance, the efficient market hypothesis (EMH) asserts that financial markets are efficient), which suggests that the shareholder will free ride on the judgements of larger professional investors. Recommendations of the birla committee : The birla committee report is 1 st formal and comprehensive attempt to evolve a code of conduct of corporate governance. The committee felt that recommendations should be divided into mandatory and non – mandatory categories . PRE – REQUISITES OF A GOOD CORPORATE GOVERNANCE : A proper system consisting of clearly defined and adequate structure of roles, authority and responsibility. Vision, principles and norms which indicate development path, normative considerations and guidelines and norms of performance. A proper system for guiding, monitoring, reporting and control. Corporate governance - Performance and Measurement : Corporate Governance : Corporate Governance A system of checks and balances between the board, management and investors to produce an efficiently functioning corporation, ideally geared to produce long-term value Issues in Corporate Governance : Issues in Corporate Governance Asymmetry of power Asymmetry of information Interests of shareholders as residual owners Role of owner management Theory of separation of powers Division of corporate pie among stakeholders Current status on corporate governance : Current status on corporate governance Insistence on forms and structures Overarching regulations Regulatory overkill Lack of adequate number of strong, independent directors Large liabilities for companies and officers Has the pendulum swung too far? For the first time in the decade-long history of the Index of Economic Freedom, the U.S. is no longer among the top ten “most free” countries Wall Street Journal and the Heritage Foundation “Index of Economic Freedom” Governance and performance : Governance and performance Good governance leads to good performance It creates an open and transparent system It improves communication and breaks down systematic barriers to flow of information Good governance allows decision making based on data. It reduces risk Good governance helps in creating a brand and creates comfort for all stakeholders and society Does performance depend on governance : Short term performance does not necessarily depend on governance Market asymmetries are responsible for this. However, this increases risk. This also creates barrier to long term growth We all know what happened to Enron? Medium to long term performance requires governance Most companies which have grown in the last 25 years have outstanding performance and have good governance structure A good governance structure treats all stakeholders fairly Governance alone cannot ensure performance Governance and Performance - issues : Governance and Performance - issues Is governance a luxury that can be afforded only by the performing companies? Do strategies and tactics need to change to accommodate governance with performance? Is there a time-lag between governance and performance? Are stakeholders concerned about “performance” or “promised performance” ? Governance and Performance measurement - issues : Governance and Performance measurement - issues Is governance behavior motivated by legislation? Do standards vary with jurisdictions or do you adopt the best option? Do you choose the right thing to do irrespective of whether it’s mandatory or not? Is performance evaluation limited to valuation metrics? Is it only ROE, Net margin, growth, shareholder wealth creation? Do performance measures need to be holistic? We need to encompass all stakeholders Governance is an enabler for holistic performance How do managers better understand governance requirements? Do we need market research for governance requirements? Investing in Corporate Governance : Investing in Corporate Governance Companies need to invest in good governance Corporate governance has a direct bearing on business performance and thereby ROI Leverage the power of IT On average, businesses with superior governance practices generate 20 percent greater profits than other companies A study based on 256 companies conducted at the MIT Sloan School of Management Efficiency, effectiveness and is sustainable in performance at large Accountability Integrity, probity and transparency Recognition and protection of stakeholder rights An inclusive approach based on democratic ideals, legitimate representation and participation Normal and ethical corporate social behaviour The crux of the good corporate governance seeks to promote Impact & Principles of Corporate Governance : Impact & Principles 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. Key elements of good corporate governance principles include Honesty, Trust And Integrity, Openness, Performance Orientation, Responsibility And Accountability, Mutual Respect, And Commitment to the organization. Commonly accepted principles of corporate governance include; Rights and equitable treatment of shareholders Interests of other stakeholders Role and responsibilities of the board Integrity and ethical behaviour Mechanisms and Controls : Mechanisms and Controls Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection. For example, to monitor managers' behaviour, an independent third party (the external auditor) attests the accuracy of information provided by management to investors. An ideal control system should regulate both motivation and ability. Internal Corporate Governance controls : Internal Corporate Governance controls Monitoring by the board of directors Internal control procedures and internal auditors Balance of power Remuneration External Corporate Governance Controls : External Corporate Governance Controls Competition Debt covenants Government regulations Managerial labour market Media pressure Takeovers Role of professionals : Role of professionals A company secretary is often call the conscience of the company so professional bodies must be the conscience of the regulators and to a certain extent society in their areas of expertise – whether these are financial, construction, environmental fields or other areas. Only professional bodies acting with their greatest asset “integrity” as their foundation stone can perform such a role. In Corporate Governance, Role of professionals is as follows, Normally, Role of professionals can be two types; (1) Direct involvement in corporate governance as a member of the board of directors / various committees of the board / Holding the position of a CFO / CEO / Compliance Officer of the company. (2) As a reviewer of the functioning of the company, its board and committees as a part of the certification relating to corporate governance. R O L E O F P R O F E S S I O N A L EXAMPLE : Satyam scandal: Showed corporate governance can be Skin-deep It was dubbed “India’s Enron.” The Rs7,000 crore fraud (it is now over Rs10000crore and rising), the biggest in India’s history, wiped off $2 billion worth shareholders wealth in the week that followed Ramaling Raju’s “riding a tiger not knowing how to get off without being eaten”. It exposed glaring shortcomings of corporate governance, threatening India’s appeal to foreign investors. “This is a lesson for corporate houses. In the new companies Act, we propose to give more powers to independent directors. BOARD OF DIRECTORS : BOARD OF DIRECTORS The members on the board should posses adequate experience, expertise and skills necessary to manage the affairs of the company in a efficient manner. The decisions taken by the board of directors should be transparent to the Government, Shareholder, Creditor, etc. PARTIES IN CG : PARTIES IN CG Parties involved in corporate governance include the regulatory body (e.g. the Chief Executive Officer, the board of directors, management, shareholders and Auditors). Other stakeholders who take part include suppliers, employees, creditors, customers and the community at large. EVOLUTION OF CG IN INDIA : EVOLUTION OF CG IN INDIA Corporate governance in India has evolved over last 10 years. During this period, the Indian economy opened up, mergers and acquisitions took place and foreign investors started evincing interest in Indian companies. The first formal corporate governance in India came in 1998, when CII came out with a “Desirable Code of Corporate Governance” SEBI appointed a committee under the Chairmanship of Kumar Mangalam Birla, noted industrialist, to study international practices and recommend appropriate CG regulations for Indian companies. Based on this committee the SEBI framed the corporate governance provisions SEBI COMMITTEE : SEBI COMMITTEE 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. CG 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. CHANGES IN GOVERNANCE REFIME DISCERNIBLE : CHANGES IN GOVERNANCE REFIME DISCERNIBLE Good CG practices results in Improved brand image and reputation Better social acceptance Better impact on customers Government support Ability to attract more investors Better valuation KEY ELEMENTS OF CG : KEY ELEMENTS OF CG Key elements of good corporate governance principles include Honesty Trust Integrity Openness Performance orientation Responsibility Accountability Mutual respect Commitment to the organization. Corporate Governance in India Introduction:- One of the major economic developments of this decade has been the recent take-off of India,with growth rates averaging in excess of 8% for the past four years, a stock market that has risen over three-fold in as many years and a steady inflow of foreign investment. In 2006, total equity issuance reached $19.2 billion in India, up 22%, while merger and acquisition volume was a record $27.8 billion,up 38%, driven by a 371% increase in outbound acquisition--exceeding for the first time inbound deal volumes. Debt issuance reached an all-time high of $13.7 billion, up 28% from a year earlier. Indian companies were also among the world's most active issuers of depositary receipts in the first half of 2006, accounting for one in three new issues globally, according to the Bank of New York. And, in each of the years 2005 and 2006, the number of trades on the National Stock Exchange of India, one of the two major Indian Stock Exchanges, was third highest in the world, just behind NASDAQ and the New York Stock Exchange, and several times greater than the number of trades on the London Stock Exchange or Euronext. Corporate Governance in India – A Historical Background The historical development of Indian corporate laws has been marked by many interesting contrasts. At independence, India inherited one of the world’s poorest economies but one which had a factory sector accounting for a tenth of the national product. The country also inherited four functioning stock markets (predating the Tokyo Stock Exchange) with clearly defined rules governing listing, trading and settlements, a well-developed equity culture (if only among the urban rich), and a banking system replete with well-developed lending norms and recovery procedures. In terms of corporate laws and financial system, therefore, India emerged far better endowed than most other colonies. The 1956 Companies Act built on this foundation, as did other laws governing the functioning of joint-stock companies and protection of investors’ rights. Early corporate developments in India were marked by the managing agency system. This contributed to the birth of dispersed equity ownership but also gave rise to the practice of management enjoying control rights disproportionately greater than their stock ownership. The turn towards socialism in the decades after independence, marked by the 1951 Industries (Development and Regulation) Act and the 1956 Industrial Policy Resolution, put in place a regime and a culture of licensing, protection, and widespread red-tape that bred corruption and stilted the growth of the corporate sector. The situation worsened in subsequent decades and corruption, nepotism, and inefficiency became the hallmarks of the Indian corporate sector. Exorbitant tax rates encouraged creative accounting practices and gave firms incentives to develop complicated emolument structures with large “under-the-table” compensation at senior levels. In the absence of a stock market capable of raising equity capital efficiently, three central (federal) government development finance institutions (the Industrial Finance Corporation of India, the Industrial Development Bank of India and the Industrial Credit and Investment Corporation of India),together with about thirty other state-government owned development finance institutions, became the main providers of long-term credit to companies. Along with the central government owned and managed mutual fund, the Unit Trust of India, these institutions also held (and still hold) large blocks of shares in the companies to which they lent, and invariably had representations on their boards in the form of nominee directors, though they traditionally played very passive roles in the boardroom. Recent Developments in Corporate Governance in India Liberalization of the Indian economy began in 1991. Since then, we have witnessed wide-ranging changes in both laws and regulations, and a major positive transformation of the corporate sector and the corporate governance landscape. Perhaps the single most important development in the field of corporate governance and investor protection in India has been the establishment of the Securities and Exchange Board of India in 1992 and its gradual and growing empowerment since then. Established primarily to regulate and monitor stock trading, it has played a crucial 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 in the early 1990’s—particularly the Harshad Mehta stock market scam of 1992--followed by incidents of companies allotting preferential shares to their promoters at deeply discounted prices, as well as those of companies simply disappearing with investors’ money. These concerns about corporate governance stemming from the corporate scandals, coupled with a perceived need of opening up the corporate sector to the forces of competition and globalization, gave rise to several investigations into ways to fix the corporate governance situation in India. One of the first such endeavors was the Confederation of Indian Industry Code for Desirable Corporate Governance, developed by a committee chaired by Rahul Bajaj, a leading industrial magnate. The committee was formed in 1996 and submitted its code in April 1998. Later the SEBI constituted two committees to look into the issue of corporate governance--the first chaired by Kumar Mangalam Birla, another leading industrial magnate, and the second by Narayana Murthy, one of the major architects of the Indian IT outsourcing success story. The first Committee submitted its report in early 2000, and the second three years later. These two committees have been instrumental in bringing about far reaching changes in corporate governance in India through the formulation of Clause 49 of Listing Agreements . Concurrent with these initiatives by the SEBI, the Department of Company Affairs and the Ministry of Finance of the Government of India also began contemplating improvements in corporate governance. These efforts included the establishment of a study group to operationalize the Birla Committee recommendations in 2000, the Naresh Chandra Committee on Corporate Audit and Governance in 2002, and the Expert Committee on Corporate Law (J.J. Irani Committee) in late 2004. All of these efforts were aimed at reforming the existing Companies Act of 1956 that still forms the backbone of corporate law in India. Corporate Governance of Banks The reforms adopted since 1991 have marked a shift from hands-on government control to market forces as the dominant instrument of corporate governance in Indian banks.19 Competition has been encouraged with the issuance of licenses to new private banks and by giving more power and flexibility to bank managers, both in directing credit and in setting prices. The Reserve Bank of India (RBI), India’s central bank, has moved to a model of governance by “prudential norms” rather from that of direct interference, even allowing debate about the appropriateness of specific regulations among banks. Along with these changes, market institutions have been strengthened by government actions attempting to infuse greater transparency and liquidity into markets for government securities and other asset markets. This market orientation of governance in banking has been accompanied by stronger disclosure norms and greater stress on periodic RBI surveillance. From 1994, the Board for Financial Supervision (BFS) inspects and monitors banks using the “CAMELS” (Capital adequacy, Asset quality, Management, Earnings, Liquidity and Systems and controls) approach. Audit committees in banks have been stipulated since 1995. Greater independence of public sector banks has also been a key feature of the reforms. Nominee directors from government and the RBI are being gradually phased out, with a stress on boards being elected rather than “appointed from above.” There is increasing emphasis on greater professional representation on bank boards, with the expectation that the boards will have the authority and competence to properly manage the banks within broad prudential norms set by the RBI. Rules like nonlending to companies that have one or more of a bank’s directors on their boards are being softened or removed altogether, thus allowing for “related party” transactions for banks. The need for professional advice in the election of executive directors is increasingly being realized. As for the old private banks, concentrated ownership remains a widespread characteristic, limiting the possibilities for professional excellence and opening the possibility of misdirecting credit. Corporate governance in co-operative banks and non-bank financial companies perhaps needs the greatest attention from regulators. Rural co operative banks are frequently run by politically powerful families as their personal fiefdoms, with little professional involvement and considerable channeling of credit to family businesses. It is generally believed that the “new” private banks (those established after the reforms process started in the 90’s) have better and more professional corporate governance systems in place.20 In recent years, the collapse of the private Global Trust Bank and its subsequent acquisition by a public sector bank has, however, strengthened beliefs that the government will ultimately bail out failing banks. It is noteworthy that India has one of the best banking sectors in Asia in terms of the ratio of nonperforming assets. The India NPL ratios of around 4% of total banking assets are far below those of China (or Japan) and most other Asian and emerging markets. Public Sector Governance in India Public sector Enterprises (PSEs) have played a major role in India’s mixed economy and industrialization program. The Industrial Policy Resolution of 1956 reserved the “commanding heights” of the economy for the public sector, and during the second half of the twentieth century the number of central (federal) PSEs in India climbed steadily, from 5 to 242. In addition, there are also many more smaller PSEs promoted and owned by different state governments. Between 1996-97 and 2005-06 PSEs registered a 70% increase in investments to over US$87 billion. Over the same period their return on investment improved from barely 13% to over 18%. The public sector still accounts for over 11% of India’s GDP, over 27% of industrial output and over a third of central government receipts. They account for over 20% of the market capitalization of firms listed on the Bombay Stock Exchange, and five of the six Indian Fortune 500 firms are Central PSEs. Though the cumulative profits of the PSEs have risen over time their performance has always been a concern, with close of half of the PSEs incurring losses. As these enterprises came under the purview of the government, they have often been subjected to political interference and governance by rigid bureaucratic norms rather than on the basis of performance and profitability. A break with this tradition happened in 1987 with the adoption of a Memorandum of Understanding (MoU) between the enterprises and the government that gave greater functional autonomy to the PSEs, with a stipulation of targets against which the government would hold its performance. MoUs specified various targets with different weights, with the most important being gross profit margin and net profit as a proportion of capital employed (30% each). By the end of 2000, 107 PSEs had signed MoUs with the government. With the adoption of MoUs, PSEs have increasingly gained operational autonomy and moved to a “board managed corporation” model rather than reporting to government ministry officials directly. In 1997, nine large and profitable central PSEs, now referred to as the “Navratnas” (Nine jewels), were granted even greater autonomy than others, including the right to form joint ventures and engage in mergers and acquisitions. Recent findings about corporate governance in India:- Jayati Sarkar and Subrata Sarkar show that corporate boards of large companies in India in 2003 were slightly smaller than those in the United States (in 1991), with 9.46 members on average in India compared to 11.45 in America.21 While the percentage of inside directors was roughly comparable (25.38% compared to 26% in the U.S.), Indian boards had relatively fewer independent directors, (justover 54% compared to 60% in the U.S.) and relatively more affiliated outside directors (over 20% versus14% in the U.S.). 41% of Indian companies had a promoter on the board, and in over 30% of cases a promoter served as an Executive Director. There is evidence that larger boards lead to poorer performance (market-based as well as in accounting terms), both in India and in the United States

Corporate governance

More Related Content

What's hot

Viewers also liked

Similar to Corporate governance

Recently uploaded

Corporate governance