Corp. Gov - Unit3

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Business Ethics & Corporate Social Responsibility TY-BMS (Sem 5)

UNIT III

CORPORATE GOVERNANCE

Corporate Governance: Meaning scope & Reporting

The Agency Theory : Principal Agent Relationship

Role of CEO, Board and Senior Executives

Right of Investors and Shareholders

Financial Regulations and their scope in CG

Corporate governance from Cadbury committee toNarayan Murthy

Committee

Corporate governance is a process or a set of systems andprocesses to ensure that a company is managed to suit thebest interests of all. The systems that can ensure this mayinclude structural and organizational matters. The stakeholders may be internal stake holders (promoters, members,workmen and executives) and external stake-holders(promoters, members, customers, lenders, vendors, bankers,community, government and regulators).

Corporate governance is concerned with the establishing of a systemwhereby the directors are entrusted with responsibilities and duties in

relation to the direction of corporate affairs. It is concerned withaccountability of persons who are managing it towards stakeholders. Itis concerned with the morals, ethics, values, parameters of conductand behaviour of the company and its management. Corporategovernance is nothing but a voluntary ethical code of business ofcompanies. This is based on the core values of the top managementand the guiding principles that emanate from it.

According to the Cadbury committee on financial aspects of CG,corporate governance is the system by which companies are directedand controlled. The board of directors is responsible for the

governance of the company. The directors and the auditors are tosatisfy themselves that an appropriate governance structure is inplace.

The concept of corporate governance hinges on totaltransparency, integrity and accountability of the management.

Prof. Abdul Kadir Khan 1


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There has been renewed interest in the corporate governancepractices of modern corporations since 2001, particularly due to thehigh-profile collapses of a number of large U.S. firms such as EnronCorporation and MCI Inc. (formerly WorldCom). In 2002, the U.S.federal government passed the Sarbanes-Oxley Act, intending to

restore public confidence in corporate governance.

It is a system of structuring, operating and controlling a company witha view to achieve long term strategic goals to satisfy shareholders,creditors, employees, customers and suppliers, and complying with thelegal and regulatory requirements, apart from meeting environmentaland local community needs.

Report of SEBI committee (India) on Corporate Governance definescorporate governance as the acceptance by management of the

inalienable rights of shareholders as the true owners of the corporationand of their own role as trustees on behalf of the shareholders. It isabout commitment to values, about ethical business conduct andabout making a distinction between personal & corporate funds in themanagement of a company. The definition is drawn from theGandhian principle of trusteeship and the Directive Principles of theIndian Constitution. Corporate Governance is viewed as business ethicsand a moral duty.

Corporate governance is a way of life and not a set of rules. It is moreof a way of life that necessitates taking interests in every business

decision. a key element of good corporate governance is transparencyprojects through a code of good governance which incorporates asystem of checks and balances between key players- board ofmanagement, auditors and shareholders.

Corporate governance is in essence determination of how companiesare governed, how executive actions are supervised and how acompany is accountable to regulations imposed on it by law or othercommitments to shareholders.

IMPACT OF CORPORATE GOVERNANCE

The positive effect of corporate governance on different stakeholdersultimately is a strengthened economy, and hence good corporategovernance is a tool for socio-economic development.

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A key factor is an individual's decision to participate in an organisatione.g. through providing financial capital and trust that they will receivea fair share of the organisational returns. If some parties are receivingmore than their fair return then participants may choose to notcontinue participating leading to organizational collapse.

The Corporate Governance Framework:

The governance framework is based on principles of public sectorgovernance including:

accountabilitybeing answerable for decisions and havingmeaningful mechanisms in place to ensure the agency adheresto all applicable standards

transparency/opennesshaving clear roles andresponsibilities and clear procedures for making decisions andexercising power

integrityacting impartially, ethically and in the interests of theagency, and not misusing information acquired through a

position of trust stewardshipusing every opportunity to enhance the value ofthe public assets and institutions that have been entrusted tocare

efficiencyensuring the best use of resources to further theaims of the organisation, with a commitment to evidence-basedstrategies for improvement

leadershipachieving an agency-wide commitment to goodgovernance through leadership from the top.

Agencies need to have an approach to governance that enables them

to deliver their outcomes effectively and achieve high levels ofperformance, in a manner consistent with applicable legal and policyobligations.

EXCELLENCE THROUGH GOOD CORPORATE GOVERNANCE



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Adherence to good governance practices enhances theefficiency of corporate sector in the following manner:

1. Good governance provides stability and growth to the companies.2. Good governance system, demonstrated by adoption of good

corporate practices, builds confidence3. Effective governance reduces perceived risks, consequently

reducing cost of capital.4. In the knowledge driven economy, excellence ion skills like

management will be the ultimate tool for corporate houses toleverage competitive advantage in the financial market.

5. Adoption of good corporate practices promotes stability and long-term sustenance of stakeholders' relationship

6. A good corporate citizen becomes an icon and enjoys a position ofpride.

7. Potential stakeholders aspire to enter into a relationship withenterprises whose governance credentials are exemplary.

A good corporate governance recognizes the diverse interests ofshareholders, lenders, employees, government, etc. The new conceptof governance to bring about quality corporate governance is not onlya necessity to serve the divergent corporate interests, but also is a keyrequirement in the best interests of the corporates themselves and theeconomy.

The Agency Theory : Principal Agent Relationship

Main (dependent) Factors: Efficiency, alignment of interests, risksharing,

Successful contracting

Main (independent) Factors: Information asymmetry, contract, moral hazard, trust

In economics, the principal-agent problem treats the difficulties thatarise under conditions of incomplete and asymmetric information whena principal hires an agent. Various mechanisms may be used to try toalign the interests of the agent with those of the principal, such as

piece rates/commissions, profit sharing, efficiency wages, the agentposting a bond, or fear of firing. The principal-agent problem is foundin most employer/employee relationships, for example, whenstockholders hire top executives of corporations.

Agency Theory Overview



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Key idea Principal-agent relationships should reflectefficient organization of information and risk-bearing costs

Unit of analysis Contract between principal and agent

Human

assumptions

Self interest

Bounded rationalityRisk aversion

Organizationalassumptions

Partial goal conflict among participants

Efficiency as the effectiveness criterion

Information asymmetry between principal andagent

InformationAssumption

Information as a purchasable commodity

Contractingproblem

Agency (moral hazard and adverse selection)

Risk sharing

Problem domain Relationships in which the principal and agenthave partly differing goals and risk preferences(e.g. compensation, regulation, leadership,impression management, whistle blowing,vertical integration, transfer pricing)



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An agency theory exis

Diagrammatic Representation of the Agency theory

Agency theory focuses on the relationship and goal incongruence betweenmanagers and shareholders. Agency relationships occur when one partner ina transaction (the principal) delegates authority to another (the agency) and

the welfare of the principal is affected by the choices of the agent.

Agency theory is directed at the ubiquitous agency relationship, in which oneparty (the principal) delegates work to another (the agent), who performsthat work. Agency theory is concerned with resolving two problems that canoccur in agency relationships. The first is the agency problem that ariseswhen

(a) the desires or goals of the principal and agent conflict and(b) it is difficult or expensive for the principle to verify what theagent is actually doing.

The problem here is that the principal cannot verify that the agent has

behaved appropriately. The second is the problem of risk sharing that ariseswhen the principal and agent have different attitudes towards risk. Theproblem here is that the principle and the agent may prefer different actionsbecause of the different risk preferences.

Managers can be encouraged to act in the stockholders' best intereststhrough incentives, constraints, and punishments. These methods, however,are effective only if shareholders can observe all of the actions taken bymanagers. A moral hazard problem, whereby agents take unobserved actionsin their own self-interests, originates because it is infeasible for shareholders



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to monitor all managerial actions. To reduce the moral hazard problem,stockholders must incur agency costs.

Role and powers of the CEO, Board and Senior Management:

The foremost requirement of good corporate governance is the clearidentification of powers, roles, responsibilities and accountability of theBoard, CEO and the senior management.

Role of a CEO:

CEO means Managing Director of a company or Manager appointed interms of the Companies Act, 1956.

Equitable Treatment of Share-holders:The CEO should respect the rights of share-holders and help share-

holders to exercise those rights. He can help share-holders exercisetheir rights by effectively communicating information that isunderstandable and accessible, and encouraging share-holders toparticipate in general meetings.

Interests of Other Stake-holders : The CEO should recognize that they have legal and otherobligations to all legitimate stake-holders.

Role & Responsibilities of the Board:

The board needs a range of skills and understanding - to be able todeal with various business issues and have the ability to review andchallenge management performance. It needs to be of sufficient sizeand have an appropriate level of commitment to fulfill itsresponsibilities and duties. There are issues about the appropriate mixof executive and non-executive directors. The key roles of Chairpersonand CEO should not be shared.

Integrity & Ethical Behaviour : The CEO should develop a code of conduct for their directors andexecutives that promotes ethical and responsible decision-making. Itis important to understand, though, that systemic reliance on integrity

and ethics is bound to eventual failure.

Disclosure & Transparency: The CEO should be ready to clarify the company's position to theshare-holders and the board and management to provide share-holders with a level of accountability. They should also implementprocedures to independently verify and safe-guard the integrity of the



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company's financial reporting. Disclosure of material mattersconcerning the organization should be timely and balanced to ensurethat all investors have access to clear, factual information.

Constant Improvement :

The CEO must have the oath "If you can't do it better, why do it?" Itunder-scores our drive to become an ever better and bigger company.

Issues involving Corporate Governance Principles include: -

Oversight of the preparation of the entity's financial statements.

Internal controls and the independence of the entity's auditors.

Review of the compensation arrangements for the chief executiveofficer and other senior executives.

The way in which individuals are nominated for positions on the board.

The resources made available to directors in carrying out their duties.

Oversight and management of risk.

Foster a corporate culture that promotes ethicalpractices, encourages individual integrity, and fulfils social andenvironmental responsibility.

Maintain a positive and ethical work climate that isconducive to attracting, retaining and motivating top-qualityemployees.

Develop and recommend to the Board a long-termstrategy and vision for the Group.

Ensure that the day-to-day business affairs of theGroup are appropriately managed by the MDs, and that propersystems and controls are in place for effective risk management ofthe Group.

Ensure, in co-operation with the Board, that there isan effective succession plan for the CEO in place.

Role of the Board:

Given the economic, operational and potential cultural implications ofunplanned departures and the risks associated with having to bring inexternal talent, corporate boards need to make successionmanagement one of their most critical duties. While a large percentage



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of directors believe in the importance of having a succession plan,most organizations have nothing more than an emergency interimplan, which can be extremely disruptive. Good governance dictatesthat leadership succession is a priority, year in and year out.

The boardor its nomination, compensation or selection committeemust be active stewards of CEO and C-suite succession management,involved in all aspects of the process. This includes assessing potentialtalent, mitigating risk, making the CEO accountable for executingsuccession management and planning the development of criticalsuccessors. The boards fingerprints should be all over theorganizations leadership development efforts so directors havepersonal experience with high-potential candidates. In mostorganizations, this will require a major increase in the level of time andattention the board pays to the process as it shifts from a checklistto a hands-on methodology.

A 2006 study by the National Association of Corporate Directors(NACD) found that many boards rated their ability to plan for a CEOchange as ineffective. Few board members had the knowledge andexperience needed to run a succession management process. Althoughsome progress has been made since this study, the recession hascaused most boards to put succession management on the backburner while they concentrate on urgent operational imperatives. Asthe economic crisis subsides and organizations begin to refocus onlong-term business success and continuity, it is time for boards toreenergize their succession management efforts.

Boards those are successful in completing their role in the successionprocess exhibit two key characteristics:

They have learned how to make decisions objectively. The nature ofinterpersonal relationships and the proclivity of board members toview leadership behaviors through a personal lens can create stronginterpersonal dynamics within the board. As a result, some boardsmake succession decisions based on personal perceptions of anindividuals leadership behavior and results.

They have a transparent and well-defined succession process. Inmany organizations, succession management is poorly defined interms of process steps, ownership and decision rights. A successionmanagement process that is not objective, transparent and robustcan be derailed easily, which will result in a poor outcome.Rigorous succession management processes



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Role of Board of Directors:

Corporate governance is basically a system of making directorsaccountable to shareholders for effective management of the companyalong with concern for ethics and values. It is the management of

companies by the board of directors. it hinges on completetransparency, integrity and accountability of management thatincludes executive and non-executive directors.

The key to good corporate governance is a well functioning, informedboard of directors. The board should have a core group of excellent,professionally acclaimed non-executive directors who understand theirdual role: of appreciating the issues put forward by management, andof honestly discharging their fiduciary responsibilities towards thecompanys shareholders as well as creditors.

The role of boards in corporate governance, and how to improve theiroversight capability, has been examined carefully in recent years, andnew legislation in a number of jurisdictions, and an increased focus onthe topic by boards themselves, has seen changes implemented to tryand improve their performance.

1) Directors have important and powerful positions in a company.

The stockholders entrust them with the running of the company,

and this is why the law requires directors to comply with certain

duties.

2) Directors have a duty to act within their powers for a proper

purpose, which is underlined in the bylaws of the company. They

also have a duty to promote the success of the company and, in

doing this, must balance the interests of the stockholders,

employees, suppliers, and customers of the company. The law

does not define success, but in general this is agreed to mean

increasing the value of the company and its business.

3) The directors are required to exercise independent judgment

when making their decisions. They also have a duty to exercisereasonable care, skill, and diligence in the performance of their

duties. An experienced director will be expected to exercise a

higher degree of care, skill, and diligence in the performance of

his or her activities.

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4) Directors have a duty to avoid conflicts of interest. What

constitutes a conflict of interest is a complex issue, but in

general it refers to transactions between a director and third

parties, rather than between a director and the company.

Directors have a duty not to accept benefits from third parties ifthey give rise to a conflict of interest. Benefits in this sense

include money and benefits in kind, such as corporate

hospitality. It is advisable to obtain specific legal advice in

respect of conflicts of interest, as this subject can be quite

controversial and difficult to assess.

5) Directors have a duty to declare any interest in proposed

transactions or arrangements with the company. They must

disclose any such interest to the board of directors and, in

certain circumstances, obtain the approval of the stockholders.

This includes transactions involving the director or any person

connected with the director, such as a spouse or children, and

the company.

Role of Chairman:

The responsibilities of the Chairman expressly include:

Running the Board and ensuring its effectiveness in all aspectsof its role

1) Chairing the Board and general meetings and relevantBoard committees

a. Setting the Board agendab. Ensuring there is an appropriate delegation of authority from the Board

to executive management

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c. Ensuring the Board receives timely and accurate information to enablethe Board to take sound decisions and monitor effectively and provideadvice to promote the success of the Group

d. Managing the Board to allow time for discussion of complex orcontentious issues

2) Ensuring the effective contribution and performance of allmembers of the Board

a. Facilitating the effective contribution of Non-Executive Directorsb. Ensuring constructive relations between the Executive and Non-

Executive Directorsc. Identifying the development needs of the Board to enhance its overall

effectiveness as a teamd. Ensuring the performance of the Board, its Committees and individual

Directors is evaluated regularly and acting on the results of suchevaluation

3) Maintaining sufficient and effective communication withshareholders

a. Ensuring effective communications with shareholders including atgeneral meetings

b. Maintaining sufficient contact with major shareholders to understandtheir issues and concerns

c. Ensuring that the views of shareholders are communicated to theBoard

4) Upholding standards of integrity and probity

a. Setting the tone of Board discussions to promote effective decisionmaking and constructive debate

b. Ensuring the Board is fully informed on all issues of relevancec. Ensuring effective implementation of Board decisionsd. Building an effective Boarde. Providing coherent leadership of the Group

Rights of Investor / Shareholder:



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A shareholder is who owns shares of a corporation. For

corporations, along with the ownership comes a right to

declared dividends and the right to vote on certain company

matters, including the board of directors.

Shareholder is also called a stockholder. He / She owns thecompany to the extent of his / her investment in the said

company.

A shareholder in a Company enjoys certain rights, which are as follows:

to receive the share certificates, on allotment or transfer as thecase may be, in due time.

to receive copies of the abridged Annual Report, the BalanceSheet and the Profit & Loss Account.

to participate and vote in General Meetings either personally or

through proxies. to receive Dividends in due time once approved in General

Meetings.

to receive corporate benefits like rights, bonus, etc. onceapproved.

to apply to Company Law Board (CLB) to call or direct the AnnualGeneral Meeting.

to inspect the minute books of the General Meetings and toreceive copies thereof.

to proceed against the Company by way of civil or criminalproceedings.

to apply for the winding-up of the Company. to receive the residual proceeds.

other rights are as specified in the Memorandum and Articles ofAssociation.

Besides the above rights, an individual shareholder also enjoysthe following rights as a group :

to requisition an Extraordinary General Meeting

to demand a poll on any resolution.

to apply to CLB to investigate the affairs of the Company.

to apply to CLB for relief in cases of oppression and / ormismanagement.

Rights of a shareholder include:

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1) Voting Power on Major Issues :This includes electing directors and proposals for fundamentalchanges affecting the company such as mergers or liquidation.Voting takes place at the company's annual meeting. If you can'tattend, you can do so by proxy and mail in your vote.

2) Ownership in a Portion of the Company :Previously we discussed the event of a corporate liquidationwhere bondholders and preferred shareholders are paid first.However, when business thrives, common shareholders own apiece of something that has value. Said another way, they havea claim on a portion of the assets owned by the company. Asthese assets generate profits, and as the profits are reinvested inadditional assets, shareholders see a return in the form ofincreased share value as stock prices rise

.

3) The Right to Transfer Ownership:Right to transfer ownership means shareholders are allowed totrade their stock on an exchange. The right to transfer ownershipmight seem mundane, but the liquidity provided by stockexchanges is extremely important. Liquidity is one of the keyfactors that differentiates stocks from an investment like realestate. If you own property, it can take months to convert yourinvestment into cash. Because stocks are so liquid, you can

move your money into other places almost instantaneously.

4) An Entitlement to Dividends:Along with a claim on assets, you also receive a claim on anyprofits a company pays out in the form of a dividend.Management of a company essentially has two options withprofits: they can be reinvested back into the firm (hopefullyincreasing the company's overall value) or paid out in the form ofa dividend. You don't have a say in what percentage ofprofits should be paid out - this is decided by the board of

directors. However, whenever dividends are declared, commonshareholders are entitled to receive their share.

5) Opportunity to Inspect Corporate Books and Records:This opportunity is provided through a company's public filings,

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including its annual report. Nowadays, this isn't such a big dealas public companies are required to make their financials public.It can be more important for private companies.

6) The Right to Sue for Wrongful

Acts :Suing a company usually takes the form of a shareholder class-action lawsuit. A good example of this type of suit occurred inthe wake of the accounting scandal that rocked WorldCom in2002, after it was discovered that the company had grosslyoverstated earnings, giving shareholders and investors anerroneous view of its financial health. The telecom giant faced afirestorm of shareholder class-action suits as a result.

In addition to the six basic rights of common shareholders, it is vitalthat you thoroughly research the corporate governance policies of a

company. These policies are often crucial in determining how acompany treats and informs its shareholders.

Shareholder rights vary from state to state, and country to country,so it is important to check with your local authorities and publicwatchdog groups.These rights are crucial for the protection of shareholders against poormanagement.

Buying a stock means ownership in a company and ownership givesyou certain rights. While common shareholders might be at the bottom

of the ladder when it comes to liquidation, this is balanced by otheropportunities like share price appreciation. As a shareholder, knowingyour rights is an essential part of being an informed investor -ignorance is not a defense. Although the Securities and ExchangeCommission and other regulatory bodies attempt to enforce a certaindegree of shareholder rights, a well-informed investor who fullyunderstands his or her rights is much less susceptible to additionalrisks .

Protection of Investors Interest

Many years ago, worldwide, buyers and sellers of corporation stockswere individual investors, such as wealthy businessmen or families,who often had a vested, personal and emotional interest in thecorporations whose shares they owned. Over time, markets havebecome largely institutionalized: buyers and sellers are largelyinstitutions.

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(e.g., pension funds, mutual funds, hedge funds, exchange-tradedfunds, other investor groups; insurance companies, banks, brokers,and other financial institutions).

The rise of the institutional investor has brought with it some increase

of professional diligence which has tended to improve regulation of thestock market (but not necessarily in the interest of the small investoror even of the nave institutions, of which there are many). Note thatthis process occurred simultaneously with the direct growth ofindividuals investing indirectly in the market (for example individualshave twice as much money in mutual funds as they do in bankaccounts). However this growth occurred primarily by way ofindividuals turning over their funds to 'professionals' to manage, suchas in mutual funds. In this way, the majority of investment now isdescribed as "institutional investment" even though the vast majorityof the funds are for the benefit of individual investors.

Various Committees on Corporate Governance

Corporate Governance when used in the context of businessorganizations is a system of making directors accountable toshare holders for effective management of the companies, inthe best interest of the company and shareholders along withconcern for ethics and values. It is a management ofcompanies by the board of directors.

It hinges on complete transparency, integrity andaccountability of management that includes executive andnon-executive directors. Its genesis can be traced to theinternal audit function and its importance was enhanced after

the Stock Market Crash of 1987.

With the CG reports of Adrian Cadbury in the United Kingdom,Mervyn King in South Africa and Kumarmangalam Birla in Indiathe subject was reduced to controlling shareholder operationsand ensure ethical practices in the financial sector. Fromthere, it has moved into other areas of the organization but

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unfortunately restricts itself to the management and control offunds. The ambit of significance of CG lies far beyond this.

Cadbury Committee Report (1992)

The 'Cadbury Committee' was set up in May 1991 with a view toovercome the huge problems of scams and failures occurring in thecorporate sector worldwide in the late 1980s and the early 1990s. Itwas formed by the Financial Reporting Council, the London Stock ofExchange and the accountancy profession, with the main aim ofaddressing the financial aspects of Corporate Governance. Otherobjectives include: (i) uplift the low level of confidence both in financialreporting and in the ability of auditors to provide the safeguards whichthe users of company's reports sought and expected; (ii) review thestructure, rights and roles of board of directors, shareholders andauditors by making them more effective and accountable; (iii) addressvarious aspects of accountancy profession and make appropriaterecommendations, wherever necessary; (iv) raise the standard ofcorporate governance; etc. Keeping this in view, the Committeepublished its final report on 1st December 1992. The report was mainlydivided into three parts:-

Reviewing the structure and responsibilities of Boards ofDirectors and recommending a Code of Best Practice The boardsof all listed companies should comply with the Code of Best Practice.All listed companies should make a statement about their compliance

with the Code in their report and accounts as well as give reasons forany areas of non-compliance. The Code of Best Practice is segregatedinto four sections and their respective recommendations are:-

1. Board of Directors - The board should meet regularly, retain fulland effective control over the company and monitor the executivemanagement. There should be a clearly accepted division ofresponsibilities at the head of a company, which will ensure abalance of power and authority, such that no one individual hasunfettered powers of decision. Where the chairman is also the chiefexecutive, it is essential that there should be a strong and

independent element on the board, with a recognised seniormember. Besides, all directors should have access to the advice andservices of the company secretary, who is responsible to the Boardfor ensuring that board procedures are followed and that applicablerules and regulations are complied with.

2. Non-Executive Directors - The non-executive directors shouldbring an independent judgement to bear on issues of strategy,



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performance, resources, including key appointments, and standardsof conduct. The majority of non-executive directors should beindependent of management and free from any business or otherrelationship which could materially interfere with the exercise oftheir independent judgment, apart from their fees and shareholding.

3. Executive Directors - There should be full and clear disclosure ofdirectors total emoluments and those of the chairman and highest-paid directors, including pension contributions and stock options, inthe company's annual report, including separate figures for salaryand performance-related pay.

4. Financial Reporting and Controls - It is the duty of the board topresent a balanced and understandable assessment of theircompanys position, in reporting of financial statements, forproviding true and fair picture of financial reporting. The directorsshould report that the business is a going concern, with supportingassumptions or qualifications as necessary. The board shouldensure that an objective and professional relationship is maintainedwith the auditors.

Considering the role of Auditors and addressing a number ofrecommendations to the Accountancy Profession

The annual audit is one of the cornerstones of corporate governance. Itprovides an external and objective check on the way in which thefinancial statements have been prepared and presented by thedirectors of the company. The Cadbury Committee recommended thata professional and objective relationship between the board ofdirectors and auditors should be maintained, so as to provide to all atrue and fair view of company's financial statements. Auditors' role isto design audit in such a manner so that it provide a reasonableassurance that the financial statements are free of materialmisstatements. Further, there is a need to develop more effectiveaccounting standards, which provide important reference pointsagainst which auditors exercise their professional judgement.Secondly, every listed company should form an audit committee whichgives the auditors direct access to the non-executive members of theboard. The Committee further recommended for a regular rotation ofaudit partners to prevent unhealthy relationship between auditors andthe management. It also recommended for disclosure of payments tothe auditors for non-audit services to the company. The AccountancyProfession, in conjunction with representatives of preparers ofaccounts, should take the lead in:- (i) developing a set of criteria forassessing effectiveness; (ii) developing guidance for companies on theform in which directors should report; and (iii) developing guidance for



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auditors on relevant audit procedures and the form in which auditorsshould report. However, it should continue to improve its standardsand procedures.

Dealing with the Rights and Responsibilities of Shareholders

The shareholders, as owners of the company, elect the directors to runthe business on their behalf and hold them accountable for itsprogress. They appoint the auditors to provide an external check onthe directors financial statements. The Committee's report placesparticular emphasis on the need for fair and accurate reporting of acompany's progress to its shareholders, which is the responsibility ofthe board. It is encouraged that the institutional investors/shareholdersto make greater use of their voting rights and take positive interest inthe board functioning. Both shareholders and boards of directorsshould consider how the effectiveness of general meetings could be

increased as well as how to strengthen the accountability of boards ofdirectors to shareholders.

The Kumar Mangalam Committee Report: (1998)

In early 1999, Securities and Exchange Board of India (SEBI)had set up a committee under Shri Kumar Mangalam Birla,member SEBI Board, to promote and raise the standards ofgood corporate governance. The report submitted by thecommittee is the first formal and comprehensive attempt to

evolve a Code of Corporate Governance', in the context ofprevailing conditions of governance in Indian companies, aswell as the state of capital markets.

The Committee's terms of the reference were to:

1. suggest suitable amendments to the listing agreement executedby the stock exchanges with the companies and any othermeasures to improve the standards of corporate governance inthe listed companies, in areas such as continuous disclosure ofmaterial information, both financial and non-financial, mannerand frequency of such disclosures, responsibilities of

independent and outside directors;2. draft a code of corporate best practices; and

3. suggest safeguards to be instituted within the companies to dealwith insider information and insider trading.



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The primary objective of the committee was to view corporategovernance from the perspective of the investors andshareholders and to prepare a Code' to suit the Indiancorporate environment.

The committee had identified the Shareholders, the Board ofDirectors and the Management as the three key constituentsof corporate governance and attempted to identify in respectof each of these constituents, their roles and responsibilitiesas also their rights in the context of good corporategovernance.

Corporate governance has several claimants shareholders andother stakeholders - which include suppliers, customers,creditors, and the bankers, the employees of the company, thegovernment and the society at large. The Report had been

prepared by the committee, keeping in view primarily theinterests of a particular class of stakeholders, namely, theshareholders, who together with the investors form theprincipal constituency of SEBI while not ignoring the needs ofother stakeholders.

Mandatory and non-mandatory recommendations

The committee divided the recommendations into twocategories, namely, mandatory and non- mandatory. Therecommendations which are absolutely essential for corporate

governance can be defined with precision and which can beenforced through the amendment of the listing agreementcould be classified as mandatory. Others, which are eitherdesirable or which may require change of laws, may, for thetime being, be classified as non-mandatory.

Mandatory Recommendations:

Applies To Listed Companies With Paid Up Capital Of Rs.3Crore And Above

Composition Of Board Of Directors Optimum

Combination Of Executive & Non-Executive Directors Audit Committee With 3 Independent Directors with One

Having Financial and Accounting Knowledge. Remuneration Committee Board Procedures At least 4 Meetings Of The Board In A

Year With Maximum Gap Of 4 Months Between 2Meetings. To Review Operational Plans, Capital Budgets,Quarterly Results, Minutes Of Committee's Meeting.



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Director Shall Not Be A Member Of More Than 10Committee And Shall Not Act As Chairman Of More Than 5Committees Across All Companies

Management Discussion And Analysis Report CoveringIndustry Structure, Opportunities, Threats, Risks,

Outlook, Internal Control System Information Sharing With Shareholders

Non-Mandatory Recommendations:

Role Of Chairman Remuneration Committee Of Board Shareholders' Right For Receiving Half Yearly Financial

Performance Postal Ballot Covering Critical Matters LikeAlteration In Memorandum Etc

Sale Of Whole Or Substantial Part Of The Undertaking

Corporate Restructuring Further Issue Of Capital Venturing Into New Businesses

As per the committee, the recommendations should be madeapplicable to the listed companies, their directors,management, employees and professionals associated withsuch companies, in accordance with the time table proposed inthe schedule given later in this section. Compliance with thecode should be both in letter and spirit and should always bein a manner that gives precedence to substance over form. The

ultimate responsibility for putting the recommendations intopractice lies directly with the board of directors and themanagement of the company.

The recommendations will apply to all the listed private andpublic sector companies, in accordance with the schedule ofimplementation. As for listed entities, which are notcompanies, but body corporates (e.g. private and public sectorbanks, financial institutions, insurance companies etc.)incorporated under other statutes, the recommendations willapply to the extent that they do not violate their respective

statutes, and guidelines or directives issued by the relevantregulatory authorities .

The Committee recognizes that compliance with therecommendations would involve restructuring the existingboards of companies. It also recognizes that some companies,especially the smaller ones, may have difficulty in immediatelycomplying with these conditions.



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The recommendations were implemented through Clause 49 ofthe Listing Agreements, in a phased manner by SEBI.

The Narayana Murthy Committee: (2003)

The Narayana Murthy Committee report on corporate

governance has made a number of recommendations in its

draft report to Securities and Exchange Board of India.

The committee met thrice on December 7, 2002, January 7,

2003 and February 2003, to deliberate the issues related to

corporate governance and finalise its recommendations to

Sebi.

The committee has recommended that the audit committees of

publicly listed companies should be required to review the

following information mandatorily - financial statements,

management discussion and analysis of financial condition and

results of operations, reports relating to compliance with laws

and risk management among others.

The committee has also said that all audit committee members

should be "financially literate" and at least one member should

have accounting or related financial management expertise.

In case a company has followed a treatment different fromthat prescribed in an accounting standard, management

should justify why they believe such alternative treatment is

more representative of the underlying business transaction.

management should also clearly explain the alternative

accounting treatment in the footnotes to the financial

statements.



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The auditor may draw reference to this footnote without

necessarily making it the subject matter of an audit

qualification. Companies should be encouraged to move

towards a regime of unqualified financial statements. This

recommendation should be reviewed at an appropriatejuncture to determine whether the financial reporting climate

is conducive towards a system of filing unqualified financial

statements.

A statement of all transactions with related parties including

their bases should be placed before the independent audit

committee at each board meeting for formal approval.

This statement should include transactions of a non arm's-

length nature also. Management should be required to explain

to the audit committee the reasons for the non-arm's length

nature of the transaction.

The committee believes that it is important for corporate

boards to be fully aware of the risks facing the business and

that it is important for shareholders to know about the process

by which companies manage their business risks. In light ofthis, it was suggested that procedures should be in place to

inform board members about the risk assessment and

minimisation procedures.

These procedures should be periodically reviewed to ensure

that executive management controls risk through means of a

properly defined framework.

It was also suggested that management should place a report

before the board every quarter documenting any limitations tothe risk taking capacity of the corporation. This document

should be formally approved by the board.

Procedures should be in place to inform board members about

the risk assessment and minimization procedures. These

procedures should be periodically reviewed to ensure that



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executive management controls risk through means of a

properly defined framework.

Management should place a report before the entire board of

directors every quarter documenting the business risks faced

by the company, measures to address and minimize such risks

and any limitations to the risk taking capacity of the

corporation. This document should be formally approved by

the board.

Companies should be encouraged to train their board members

in the business model of the company as well as the risk

profile of the business parameters of the company.

Companies raising money through an IPO should disclose the

uses and application of funds by major category on a quarterlybasis as part of their quarterly declaration of un-audited

financial results. This disclosure should distinguish between

specified and unspecified uses of IPO proceeds and should be

approved by the audit committee.

On an annual basis, the company shall prepare a statement of

funds utilised for purposes other than those stated in the offer

document/prospectus.

This statement should be certified by the independent auditorsof the company and formally approved by the audit committee.

The terms of reference of the committee are to review the

performance of corporate governance and To determine the

role of companies in responding to rumour and other price

sensitive information circulating in the market, to enhance the

transparency and integrity of the market.

Points to ponder

All audit committee members should be "financiallyliterate" and at least one member should haveaccounting or related financial management expertise. It is important for corporate boards to be fullyaware of the risks facing the business and that it is



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important for shareholders to know about the process bywhich companies manage their business risks. Companies should train their board members in thebusiness model of the company as well as the risk profileof the business parameters of the company.

Case Study on Corporate Governance:

The Satyam Scam: Failure of corporate governance

Satyam fraud is unfolding and so are the inherent weaknesses ofCorporate Governance in India. Ramalinga Raju, once a posture boy ofIndias growing software sector who could find a seat beside BillClinton on the dais, has become a villain in the corporate world for

valid reasons.

The company is listed in BSE, NSE and NYSE. On BSE, the Satyamsstock crashed down by 70 percent to Rs 52 from a high of Rs 188.70.It had a client list that boasted of Fortune 500 companies.

His emotionally charged four and half page letter of startlingrevelations shook the entire corporate world when he admitted ofcooking the account and inflating the figure by Rupees 5040 crores.

He committed this fraud and tried to hush up it by an abortive bid topurchase Maytas infra, a company created by him and run by his son

Teja Raju.

This scam is being equated with Enron of USA because here also thescam was orchestrated by its Auditor, Arthur Anderson, in Satyam,Price Waterhouse cooper.

IS CORPORATE GOVERNENCE IN INDIA NOT WORLD CLASS???

Interestingly Satyam has bagged Golden Peacock award for bestcorporate governance by World Council for Corporate Governance only

a few years ago. The scam has raised many doubts about the class ofcorporate governance in India. While speaking at a seminar oncorporate governance organised by CII, Ministry of Company affairsand National foundation of corporate governance, C.B.Bhave, thechairman of SEBI said on 6th February, 2009 that the corporategovernance is an ongoing process. There is a retrospection everywherethat some concrete steps with respect to it should be done.



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There are few importance elements of corporate governance

namely Auditing, Independent Directors, Regulators and

Finally the Board including CEO itself. If we examine these

constituents one by one, it would be crystal clear that all the

constituents either failed or did not act as was required.

1. The PricewaterhouseCoopers was auditor of the company. A bigquestion is posed over the credibility of auditors. The role of Pricewaterhouse Coopers(PwC), the Auditing firm of Satyam has beendealt. Institute of Chartered Accountants of India (ICAI) constitutedunder Charter Accountants Act, 1949 is the regulatory body of allthe accounting and auditing firms across the countries.

2. Secondly, the independent directors have also failed to dischargetheir duties properly. Section 49 of SEBI Act and section 229 A of

Company Act, 1956 provides for appointment of IndependentDirectors in the Companies for protecting the rights of public atlarge in general and shareholders in particular. There are only twopossibilities in Satyam with respect to Independent directors. Eitherthey connive with Raju and knew everything that was going on, orthey did not know. In both the cases they failed miserably todischarge their duties.

3. Thirdly, the SEBI and Ministry of Company Affairs too have failedin their assigned jobs. SEBI is the highest regulator and keeps eagleeye on the activities of the capital markets. When the profits of thiscompany were registering abnormal growth, thereby the prices ofthe shares were soaring, what were these guys doing? There hasbeen a lot of hue and cry with respect to insider trading; a howlSEBI failed to listen to and it inflicted heavily on Satyam. Raju hadpledged almost all his shares so did many of the promoters.

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Corp. Gov - Unit3

Documents

Transcript of Corp. Gov - Unit3