1. XAVIER INSTITUTE OF MANAGEMENT AND
ENTREPRENEURSHIP
Corporate Governance
Case Study-Analysis
Batch 15, Section B
9/7/2009

2. INDEX
I. Introduction
II. Corporate Governance in U.S
III. Corporate Governance in U.K.
IV. Corporate Governance in India
V. Weakness in C.G. in India
VI. Recommendations
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3. Introduction
The last few years have seen some major scams and corporate collapse across the globe. In India, the
major example is Satyam which is one of the largest IT companies in India. All these events have
caused 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 inquisitiveness
from various quarters, remains an ambiguous and often misunderstood phrase. So before delving
further 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 corporate
governance. 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 which
involve various rules and incentives provide the structure through which the objectives of a company
are 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 wealth
and welfare. In both narrow as well as in the broad definitions, the following concepts occupy a centre
stage:
Rights and equitable treatment of shareholders
Interests of other stakeholders
Role and responsibilities of the board
Integrity and ethical behaviour
Disclosure and transparency
Ever since the first writings on the subject appeared there have been many debates as to whom should
corporate governance really represent: the interest of the shareholders or that of all stakeholders. The
shareholder primacy is embodied in the finance view of corporate governance, i.e., the primary
justification for the existence of the corporation is to maximise shareholders’ wealth. Since
ownership and control are separate the issue here is to align the objectives of management with the
objective of shareholder wealth maximisation.
The issue raised in the stakeholder theories is whether the recognition of a wider set of claims than
those of shareholders alone is the legitimate concern of corporate governance. It is argued that the
new technology world has reduced the opportunity, ability and the motivation of consumers to engage
in rational decision making. So the development of inclusive stakeholder relationships rather than
production at a lower price will be the most important determinant of viability and success. It implies
searching 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 at
least 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 but
shareholders may favour takeovers that increase the value of their shares even if they involve greater
losses for unprotected creditors or employees. So the collective bargaining process may not yield
socially 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 good
generated as the result of an economic activity, whose benefits or costs do not accrue directly to the
parties involved in the activity. E.g. one corporate scandal can erode shareholder trust in the whole of
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4. the corporate sector. In such cases where private action fails to resolve widespread externalities
involving 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 to
lack 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 first
relates to policing and punishment. The SEBI envisages that all these corporate governance norms
will be enforced through listing agreements between companies and the stock exchanges but for
companies with little floating stock deregulation because of non compliance is hardly a credible
threat. The second issue has to do with form vs. Substance. There is a fear that by legally mandating
several aspects of corporate governance the regulators encourage the practise of companies following
the letter of the law instead of focussing on the spirit of good governance. The third concern relates to
apprehension 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 Corporate
Governance makes for good business sense. It increases confidence of shareholders in the company
leading to better stock prices. Research has shown that the good Corporate Governance brings down
the cost of capital for the company. Good disclosure practices lead to a more liquid market for the
company. This lowers cost of debt. Thus for the CEOs of today, there is a clear business case for
complying with principles of good Corporate Governance.
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5. Corporate Governance in UK
A detailed analysis of several UK corporate governance reports are given below-
CADBURY REPORT (1992) - The Cadbury Report, titled ‗Financial Aspects of Corporate
Governance‘ is a report of a committee chaired by Adrian Cadbury that sets out recommendations on
the arrangement of company boards and accounting systems to mitigate corporate governance risks
and failures. The report was published in 1992. The report's recommendations have been adopted in
varying 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 City
of London responded by creating a special committee to examine the financial aspects of corporate
governance. To reduce the power of executive directors in the boardroom the committee
recommended a greater role for non-executive directors, changes in board operations, and a more
active role for auditors.
GREENBURY REPORT (1995) - The Greenbury Report released in 1995 was the product of a
committee established by the United Kingdom Confederation of Business and Industry on corporate
governance. It followed in the tradition of the Cadbury Report and addressed a growing concern about
the level of director remuneration.
HAMPEL REPORT (1998) - The Hampel Report (Committee on Corporate Governance) in 1998
was designed to be a revision of the corporate governance system in the UK. The remit of the
committee was to review the Code laid down by the Cadbury Report. It asked whether the code's
original purpose was being achieved. Hampel found that there was no need for a revolution in the UK
corporate governance system. The Report aimed to combine, harmonise and clarify the Cadbury and
Greenbury recommendations.
TURNBULL REPORT (1999) - The Turnbull Report - "Internal Control: Guidance for Directors on
the Combined Code", published by the Internal Control Working Party of the Institute of Chartered
Accountants in England and Wales - sets out how directors of listed companies should comply with
the UK's Combined Code requirements in respect of internal controls, including financial, operational,
compliance and risk management. Organisations that wish to be good corporate citizens, whether
publicly quoted, privately owned or in the public sector, look to the Combined Code - and therefore to
the Turnbull Report - for guidance on how to do this.
THE HIGGS REVIEW (2003) - In April 2002 the Secretary of State, Patricia Hewitt, and the
Chancellor, Gordon Brown, appointed Derek Higgs to lead a short independent review of the role and
effectiveness of non-executive directors and of the audit committee, aiming at improving and
strengthening the existing Combined Code. Derek Higgs published his report 'Review of the Role and
Effectiveness of Non-Executive Directors' on 20th January 2003. Higgs strongly backed the existing
non-prescriptive approach to corporate governance: "comply or explain". Yet he advocated more
provisions with more stringent criteria for the board composition and evaluation of independent
directors.
SMITH REPORT (2003) - The Smith Report was a report on corporate governance submitted to the
UK government in 2003. It was concerned with the independence of auditors in the wake of the
collapse of Arthur Andersen and the Enron scandal in the US in 2002. Its recommendations now form
part of the Combined Code on corporate governance, applicable through the Listing Rules for the
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6. Exchange. It was substantially influenced by the views taken by the EU Commission. One important
point was that an auditor himself should look at whether a company's corporate governance structure
provides safeguards to preserve his own independence.
UK COMBINED CODE ON CORPORATE GOVERNANCE – UK incorporated companies
listed on the UK Stock Exchange are subject to the Combined Code on Corporate Governance. The
most recent (2003) version of the Code combines the Cadbury and Greenbury reports on corporate
governance, the Turnbull Report on Internal Control (revised and republished as the Turnbull
Guidance in 2005), the Smith Guidance on Audit Committees and elements of the Higgs Report. The
Combined Code is, in 2006, subject to a review.
The Financial Reporting Council (FRC) is the independent UK regulator and is also responsible for
the statutory oversight and regulation of auditors and of the professional accountancy and actuarial
bodies. The UK Combined Code works on what is known as a ‗Comply or Explain‘ basis; in other
words, companies may choose not to comply with specific provisions but, in that case, will have to
provide a proper public explanation of their decision.
AIM Companies - Companies listed on AIM in the UK are not formally required to comply with the
Combined Code. Some choose to do so. The QCA (Quoted Companies Alliance) published, in July
2005, the Corporate Governance Guidelines for AIM companies, which are based on the Combined
Code and are voluntary.
UK COMPANIES ACT 2004 - The UK‘s Companies (Audit, Investigations and Community
Enterprise) 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 in
respect of any issue related to their audit of the company‘s accounts. The directors are required to
make a statement that they have disclosed (having taken appropriate steps to ascertain it) all relevant
information 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 look
into instances of corporate accounting non-compliance with UK GAAP, gained new powers to require
companies, directors and auditors to provide documents, information and explanations if there might
be an accounts non-compliance with relevant reporting requirements. With the exception of small and
medium enterprises, UK companies will be required to make detailed disclosure of non-audit services
supplied by their auditors.
UK COMPANIES ACT 2006 - The Companies Act 2006, which received royal assent at the end of
2006, is coming into law in stages and will be fully in effect by October 2008. This Act replaces
virtually all the previous UK company legislation. The first commencement order contained
requirements on disclosure of company information and made provisions for the use of e-
communications.
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7. Corporate Governance in US
Post 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 (new
governance 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 Markets
Figure 1: US CORPORATE GOVERNMENT SYSTEMS
Sarbanes-Oxley Act: The Sarbanes-Oxley Act of 2002 (enacted July 30, 2002), also known as
the Public Company Accounting Reform and Investor Protection Act of 2002 and commonly
called Sarbanes-Oxley, Sarbox or SOX, is a United States federal law enacted on July 30, 2002, as a
reaction 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 dollars
when the share prices of affected companies collapsed, shook public confidence in the
nation's securities markets. The legislation set new or enhanced standards for all U.S. public
company boards, management and public accounting firms. It does not apply to privately held
companies. The act contains 11 titles, or sections, ranging from additional corporate board
responsibilities to criminal penalties, and requires the Securities and Exchange Commission (SEC) to
implement rulings on requirements to comply with the new law. No legislation is ever flawless but
once pressed into force is especially likely to contain imperfections. Although there have been
complaints about this law from managers and directors, on the whole, it has worked better than might
have been expected.
The provisions of the law target top managers, board members, and the auditing profession, especially
firms 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 their
financial reports accurately depict the company‘s financial status. False statements are treated as a
criminal act. The law also prevents executives from receiving loans from their companies. Despite the
real and perceived issues, the act seems to have contributed to improved financial reporting and good
corporate governance. It has focused attention on transparent reporting and improved accounting
controls.
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8. Supporters of SOX contend the legislation was necessary and has played a useful role in restoring
public confidence in the nation's capital markets by, among other things, strengthening corporate
accounting controls. Opponents of the bill claim it has reduced America's international competitive
edge against foreign financial service providers, saying SOX has introduced an overly complex
regulatory environment into U.S. financial markets. However the debate continues over the perceived
benefits 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 they
buy 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 report
about corporate governance in the United States. Many boards of directors are improving their
oversight and guidance of their companies. The relationship between the directors and their auditors
has 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 reach
even more board rooms. The greatest challenge of all will be for the business community and
policymakers to find a path forward which enhances the role of shareholders in the governance
process, even though the majority of them seem more like short-term renters of shares than long-term
owners.
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9. Corporate Governance in India
The 1956 Companies Act as well as other laws governing the functioning of joint-stock companies
and protecting the investors‘ rights built on this foundation. The beginning of corporate developments
in India were marked by the managing agency system that 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 as well as the 1956 Industrial
Policy Resolution put in place a regime and culture of licensing, protection and widespread red-tape
that bred corruption and stilted the growth of the corporate sector.
The situation grew from bad to worse in the following decades and corruption, nepotism and
inefficiency became the hallmarks of the Indian corporate sector. Exorbitant tax rates encouraged
creative accounting practices and complicated emolument structures to beat the system. In the absence
of a developed stock market, the three all-India development finance institutions (DFIs) – the
Industrial Finance Corporation of India, the Industrial Development Bank of India and the Industrial
Credit and Investment Corporation of India – together with the state financial corporations became the
main providers of long-term credit to companies. Along with the government owned mutual fund, the
Unit Trust of India, they also held large blocks of shares in the companies they lent to and invariably
had representations in their boards.
In this respect, the corporate governance system resembled the bank-based German model where
these 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 and
thus 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 incentive
to 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 was
completely eroded. This stage would come after the company has defaulted on its loan obligations for
a while, but this would be the stage where India‘s bankruptcy reorganization system driven by the
1985 Sick Industrial Companies Act (SICA) would consider it ―sick‖ and refer it to the Board for
Industrial and Financial Reconstruction (BIFR). As soon as a company is registered with the BIFR it
wins immediate protection from the creditors‘ claims for at least four years. Between 1987 and 1992
BIFR took well over two years on an average to reach a decision, after which period the delay has
roughly doubled. Very few companies have emerged successfully from the BIFR and even for those
that needed to be liquidated, the legal process takes over 10 years on average, by which time the
assets of the company are practically worthless. Protection of creditors‘ rights has therefore existed
only 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 government
securities.
Financial disclosure norms in India have traditionally been superior to most Asian countries though
fell short of those in the USA and other advanced countries. Noncompliance with disclosure norms
and even the failure of auditor‘s reports to conform to the law attract nominal fines with hardly any
punitive action. The Institute of Chartered Accountants in India has not been known to take action
against erring auditors.
While the Companies Act provides clear instructions for maintaining and updating share registers, in
reality minority shareholders have often suffered from irregularities in share transfers and
registrations – deliberate or unintentional. Sometimes non-voting preferential shares have been used
by promoters to channel funds and deprive minority shareholders of their dues. Minority shareholders
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10. have sometimes been defrauded by the management undertaking clandestine side deals with the
acquirers 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 violation
of the spirit of corporate law. The nominee directors from the DFIs, who could and should have
played 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 sophisticated
enough to exert effective control over the companies. Listing requirements of exchanges enforced
some transparency, but non-compliance was neither rare nor acted upon. All in all therefore, minority
shareholders and creditors in India remained effectively unprotected in spite of a plethora of laws in
the books.
The years since liberalization have witnessed wide-ranging changes in both laws and regulations
driving corporate governance as well as general consciousness about it. 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 (SEBI) in 1992 and its gradual
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 90‘s – 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 as well as opening up to the forces of competition and
globalization gave rise to several investigations into the ways to fix the corporate governance situation
in India. One of the first among such endeavours was the CII Code for Desirable Corporate
Governance developed by a committee chaired by Rahul Bajaj. The committee was formed in 1996
and submitted its code in April 1998. Later SEBI constituted two committees to look into the issue of
corporate governance – the first chaired by Kumar Mangalam Birla that submitted its report in early
2000 and the second by Narayana Murthy three years later. The SEBI committee recommendations
have had the maximum impact on changing the corporate governance situation in India. The Advisory
Group on Corporate Governance of RBI‘s Standing Committee on International Financial Standards
and Codes also submitted its own recommendations in 2001.
Recommendations of various committees on Corporate Governance in India
CII 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 periodically
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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.
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12. Weaknesses of Corporate Governance In India
The Satyam debacle has exposed the chinks in Indian corporate governance mechanism and the
monitoring authorities. It has raised many questions about corporate governance in India—the role of
boards, of independent directors, of the auditors, of investors and of analysts. Unanimously it has been
a gross failure of corporate governance standards in India and protection of rights of minority
investors.
The board of directors is central to good governance, and the role of the board has featured
prominently in discussions about Satyam. The board is the body charged with having oversight of the
operations of the firm and setting its strategy. It should ensure that the company is upholding high
standards of probity and conduct, and provide a probing analysis of the activities of management. In
particular, non-executive directors are supposed to give an independent assessment of the quality of
management. But time and time again, failures of corporate governance suggest that they do not. The
infractions 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 in
countries such as India where family ownership is widespread and there is a close-knit group of
corporate leaders. It is difficult for non-executive directors to perform a scrutiny objective at the best
of times, but it is particularly difficult to do so when faced with a dominant CEO who expects support
not criticism from the company‘s board. Many countries have sought to separate the roles of chairman
and CEO. However, it can inhibit firms from implementing effective strategies, especially in
companies operating with new technologies, such as Indian IT/ITES firms, requiring visionary
strategies.
Next, the very idea of independent directors is to ensure commitment to values, ethical business
conduct and about making a distinction between personal and corporate funds in the management of a
company. Yet, most independent directors have become sidekicks for the management, eying their
commission and fees, forgetting their very purpose of appointment. In the process, they implicitly
transform into dependent directors.
To add to that the present corporate governance modelled on the Western Anglo-Saxon model which
does not address many of the current crises faced by India Inc. Professor Jayant Rama Verma of IIM
Bangalore had extensively commented on the unsuitability of the Western Code of Corporate
Governance 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 the
management which is unaccountable to the owners. In contrast, the problem in the Indian corporate
sector, he pointed out, is disciplining the dominant shareholder and protecting the minority
shareholders, vindicated in the recent Satyam case. To understand the issues that driving corporate
governance in the West, a brief idea about it is inevitable. After successfully working over the
decades separating ownership and management, owners, (especially, institutional owners) realised
that 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 largely
influenced by the whims of the CEO. Corporate governance reforms in the US and the UK have
focussed on making the board independent of the CEO.
In contrast, the issues in India are entirely distinct - primarily due to our overall social-economic
conditions. Therefore the issue in Indian corporate governance is not a 'conflict between management
and owners' as elsewhere, but 'a conflict between the dominant shareholders and the minority
shareholders'. And Professor Verma rightly concludes, "The board cannot even in theory resolve this
conflict" and that "some of the most glaring abuses of corporate governance in India have been
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13. defended on the principle of shareholder democracy since they have been sanctioned by resolutions of
the general body of shareholders."
By now it is increasingly obvious that the very concept of corporate governance modelled on the
Western system is un-workable in a country like India. These efforts are akin to taking a hair of an
elephant, transplanting it on the head of a bald man and making him look like a bear. In the West the
focus is on ownerless, CEO-driven paradigm. In India, it is still family-controlled, owner-driven
paradigm. CEOs do not matter much in the management of the company. Yet, the general discussion
centres on a standard, global prescription to manage diverse situations. Needless to emphasise, the
solution to these problems in India lies not within the company, but outside. This is precisely what
happened 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 peer
reviews of audits among the companies listed in the Nifty and Sensex indices they have fallen flat on
the industry fraternity. Presumably, SEBI will allocate the audits to firms that are part of a panel of
reputed auditors. The simple solution would be for the regulator to make this course of action
mandatory—auditors could be allotted audits by the regulator. To avoid the allegations of
overregulation, companies can submit a list of their preferred auditors, from which the regulator will
have to choose. Audits could also be rotated annually, keeping them on their toes. And these same
rules could also be applied to rating agencies, internal auditors, independent directors etc. From time
to 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 is
that it depends on who‘s got more lobbying power. In the US, the large pension funds that have been
instrumental in getting more transparency from company managements. India, on the other hand, has
no tradition of shareholder activism, despite organisations such as the Life Insurance Corporation of
India having substantial stakes in companies. The dependence of political parties on business interests
to fund elections also doesn‘t help. The failure of governments and regulators to pass what seems like
very basic safeguards preventing conflicts of interest, not only in India, but across the world, clearly
establishes the clout that corporate interests have. Corporate governance is thus a charade, a cosmetic
exercise 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 Satyam
Computer Services Ltd‘s founder B. Ramalinga Raju said in his confession, the apparent reason why
he inflated earnings was because he feared that bad results would lead to a fall in the stock and a
takeover attempt. We needn‘t take Raju‘s word for it, but the fact remains that too much of a focus on
quarterly earnings and the linking of executive compensation with the stock market via stock options
could act as powerful incentives for inflating earnings.
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14. Recommendations to Implement Corporate Governance
After a slew of scandals, politicians and regulators, executives and shareholders are all preaching the
governance 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 internal
procedures may impair their ability to run their business effectively. CEOs have to bear in mind the
potential trade-off between polishing the corporate reputation and delivering growth—for all the
headlines on corporate responsibility, are investors prepared consistently to sacrifice earnings for the
sake of ethics?
Regulations are only one part of the answer to improved governance. Corporate governance is about
how companies are directed and controlled. The balance sheet is an output of manifold structural and
strategic decisions across the entire company, from stock options to risk management structures, from
the composition of the board of directors to the decentralisation of decision-making powers. As a
result, the prime responsibility for good governance must lie within the company rather than outside
it.
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 implementing
corporate governance structures are important, but instilling the right culture is essential. Senior
managers need to set the agenda in this area, not least in ensuring that board members feel free to
engage 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 a
particular company at any particular stage in its evolution and the processes that are in place to
monitor 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 is
critical. As long as investors and shareholders are given clear and accessible information about these
policies, the market can be allowed to do the rest, assigning an appropriate risk premium to companies
that have too few independent directors or an overly aggressive compensation policy, or cutting the
costs of capital for companies that adhere to conservative accounting policies. Too few companies are
genuinely transparent, however, and this is an area where most organisations can and should do much
more.
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 governance
policies that offer a decent level of reassurance to employees and investors. Thereafter, disclosure is
the most effective way for companies to resolve the thorny tensions that do exist between vision and
prudence, innovation and accountability.
There is an inherent tension between innovation and conservatism, governance and growth. Asked to
evaluate the impact of strict corporate governance policies on their business, executives thought that
M&A deals would be negatively affected because of the lengthening of due-diligence procedures, and
that the ability to take swift and effective decisions would be compromised. State-of-the-art corporate
governance 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 are
detailed as follows.
Scheduling regular meetings of the non-executive board members from which other executives are
excluded. Non-executives are there to exercise ―constructive dissatisfaction‖ with the management
team. They need to discuss collectively and frankly their views about the performance of the
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15. executives, the strategic direction of the company and worries about areas where they feel
inadequately briefed.
Explaining fully how discretion has been exercised in compiling the earnings and profit figures. These
are not as cut and dried as many would imagine. Assets such as brands are intangible and with
financial practices such as leasing common, a lot of subtle judgments must be made about what goes
on 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 paramount
that 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 family
or 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 favourite
charities 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 nonexecutives
needs to be discussed and an appraisal made of the range of specialist skills. The board should discuss
annually how well it has performed.
Broadening and deepening disclosure on corporate websites and in annual reports. Websites should
have a corporate governance section containing information such as procedures for getting a motion
into a proxy ballot. The level of detail should ideally include the attendance record of non-executives
at board meetings.
Leading by example, reining in a company culture that excuses cheating. If the company culture has
been compromised, or if one is in an industry where loose practices on booking revenues and
expenditure 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. Hiring
thrusting graduates will skew the culture towards an aggressive, individualist outlook. Balance this
with some wiser, if duller heads—people who have seen booms and busts before, value probity and
are not in so much of a hurry. Making compensation committees independent. Corporate bosses
should be prevented from selling shares in their firms while they head them. Share options should be
expensed 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 practical
guidance in order to conceive and implement successful governance mechanism. Instead of a menu of
corporate governance options it would be more appropriate to present best practice guidelines
applicable to businesses. These will serve as a benchmark for appropriate customization in different
companies. Corporate governance should be considered as an obligation not a luxury. Its spirit is
going to expand further and deeper in the future.
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