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CORPORATE GOVERNANCE

ARYA SCHOOL OF MANAGEMRENT & IT (ASMIT) , BBSR


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MR. RASHMIRANJAN PANIGRAHI, LECTURER IN FINANCE, ASMIT
CONCEPTUAL OVERVIEW OF CORPORATE
GOVERNANCE
Rashmi Ranjan Panigrahi- Lecturer, Department of MBA/ MFC (Master of Finance and
Control), Education- Arya School of Management & IT, Bhubaneswar, India: E mail-:
rashmipanigrahi090@gmail.com, Mob No-: 9778789570
ABSTRACT
Corporate governance is a process that aims to allocate corporate resources in a manner that
maximizes value for all stakeholders shareholders, investors, employees, customers, suppliers,
environment and the community at large and holds those at the helms to account by evaluating
their decisions on transparency, inclusivity, equity and responsibility. The World Bank defines
governance as the exercise of political authority and the use of institutional resources to manage
society's problems and affairs. Corporate governance is the set of processes, customs, policies,
laws, and institutions affecting the way acorporation (or company) is directed, administered or
controlled. Corporate governance also includes the relationships among the many stakeholders
involved and the goals for which the corporation is governed. In contemporary business
corporations, the main external stakeholder groups are shareholders, debt holders, trade creditors,
suppliers, customers and communities affected by the corporation's activities. Internal stakeholders are
the board of directors, executives, and other employees. This paper highlighted the points on corporate
governance: meaning, historical perspective, issues in cg, theoretical basis of cg, cg mechanism,
cg system, goodcg , Land mark in the emergence of CG: CG Committees, World Bank on CG,
OECD Principle, Sarbanes, Oxley act-2002, Indian Committees and guidelines, CII Initiatives.
Corporate Governance: Meaning, Historical Perspective, Issues in CG, Theoretical basis of
CG, CG Mechanism, CG System, Good CG. CG Committees, World Bank on CG, OECD
Principle, Sarbanes, Oxley act-2002, Indian Committees and guidelines, Agent and
Institution in CG: Rights and privileges of shareholder, investor Problems & Protection,
CG & other stakeholders
Governance is -----------------------------------
A means whereby society can be sure that large corporations are well-run institutions to
which investors and lenders can confidently commit their funds.
Corporate governance are the policies, procedures and rules governing the relationships
between the shareholders, (stakeholders), directors and managers in a company, as defined
by the applicable laws, the corporate charter, the companys bylaws, and formal policies.
Primarily it is about managing top management, building in checks and balances to ensure
that the senior executives pursue strategies that are in accordance with the corporate mission.
Corporate governance governs the relationship among the many players involved (the
stakeholders) and the goals for which the corporation is governed.
Corporate governanceis the set of processes, customs, policies, laws, and institutions affecting
the way a corporation (or company) is directed, administered or controlled. Corporate
governancealso includes the relationships among the many stakeholders involved and the goals
for which the corporation is governed. The principal stakeholders are the shareholders,
CORPORATE GOVERNANCE
ARYA SCHOOL OF MANAGEMRENT & IT (ASMIT) , BBSR
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MR. RASHMIRANJAN PANIGRAHI, LECTURER IN FINANCE, ASMIT
management, and the board of directors. Other stakeholders include employees, customers,
creditors, suppliers, regulators, and the community at large.
Corporate governance is a multi-faceted subject. An important theme of corporate governance is
to ensure the accountabilityof certain individuals in an organization through mechanisms that try
to reduce or eliminate the principal-agent problem.
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Accountability
Clarifying governance roles & responsibilities, and supporting voluntary efforts to ensure the
alignment of managerial and shareholder interests and monitoring by the board of directors
capable of objectivity and sound judgment.
Transparency
Requiring timely disclosure of adequate information concerning corporate financial
performance..
Responsibility-: Ensuring that corporations comply with relevant laws and regulations that
reflect the societys values
Fairness-: Ensuring the protection of shareholders rights and the enforceability of contracts
with service/resource providers.
Principles of corporate governance:
Key elements of good corporate governance principles include honesty, trust and integrity,
openness, performance orientation, responsibility and accountability, mutual respect and
commitment to the organization of importance is how directors and management develop a
model of governance that aligns the values of the corporate participants and then evaluate this
model periodically for its effectiveness. In particular, senior executives should conduct
themselves honestly and ethically, especially concerning actual or apparent conflicts of interest,
and disclosure in financial reports.
Commonly accepted principles of corporate governance include:
Rights and equitable treatment of shareholders: Organizations should respect the rights of
shareholders and help shareholders to exercise those rights. They can help shareholders
exercise their rights by effectively communicating information that is understandable and
accessible and encouraging shareholders to participate in general meetings.
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MR. RASHMIRANJAN PANIGRAHI, LECTURER IN FINANCE, ASMIT
Interests of other stakeholders: Organizations should recognize that they have legal and
other obligations to all legitimate stakeholders.
Role and responsibilities of the board: The board needs a range of skills and understanding
to be able to deal with various business issues and have the ability to review and challenge
management performance. It needs to be of sufficient size and have an appropriate level of
commitment to fulfill its responsibilities and duties. There are issues about the appropriate
mix of executive and non-executive directors.
Integrity and ethical behaviour: Ethical and responsible decision making is not only
important for public relations, but it is also a necessary element in risk management and
avoiding lawsuits. Organizations should develop a code of conduct for their directors and
executives that promotes ethical and responsible decision making. It is important to
understand, though, that reliance by a company on the integrity and ethics of individuals is
bound to eventual failure. Because of this, many organizations establish Compliance and
Ethics Programs to minimize the risk that the firm steps outside of ethical and legal
boundaries.
Disclosure and transparency: Organizations should clarify and make publicly known the
roles and responsibilities of board and management to provide shareholders with a level of
accountability. They should also implement procedures to independently verify and
safeguard the integrity of the company's financial reporting. Disclosure of material matters
concerning the organization should be timely and balanced to ensure that all investors have
access to clear, factual information.
THEORETICAL BASIS OF CORPORATE GOVERNANCE
There are four broad theories to explain and elucidate corporate governance. These are: (i)
Agency Theory (ii) Stewardship Theory (iii) Stakeholder Theory and (iv) Sociological Theory.
A. AGENCY THEORY
The fundamental theoretical basis of corporate governance is agency costs. Adam Smith had
identified the agency problem (managerial negligence and profusion). Shareholders are the
owners and the principals too. The management, the board, chosen by the shareholders arethe
agents. Principals may want to carry out the objectives of the company but the agents may not
quite exactly match the requirements. The cost of the dissonance caused by the agency
problem is the agency cost. There are many a way through which the management go counter to
the objectives of the shareholders such maximizing shareholder returns. Ostentatious life styles
of directors, empire building etc. are examples.
THE BASIS FOR THE AGENCY THEORY IS THE SEPARATION OF OWNERSHIP AND
CONTROL.
PRINCIPAL (SHAREHOLDERS) OWN THE COMPANY BUT THE AGENTS (MANAGERS)
CONTROL IT.
MANAGERS MUST MAXIMIZE THE SHAREHOLDERS WEALTH.
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MR. RASHMIRANJAN PANIGRAHI, LECTURER IN FINANCE, ASMIT
THE MAIN CONCERN IS TO DEVELOP RULES AND INCENTIVES, BASED ON IMPLICIT
EXPLICIT CONTRACTS, TO ELIMINATE OR AT LEAST, MINIMIZE THE CONFLICT OF
INTERESTS BETWEEN OWNERS AND MANAGERS.
The Agency problem occurs when:
The desires or a goal of the principal and agent conflict and it is difficult or expensive for the
principal to verifythat the agent has behaved appropriately.
Example: Over diversification because increased product diversification leads to lower
employment risk for managers and greater compensation
Solution: Principals engage in incentive-based performance contracts, monitoring mechanisms
such as the board of directors and enforcement mechanisms such as the managerial labor market
to mitigate the agency problem
Mechanisms that help reduce agency costs:
1. Fair and accurate financial disclosures
2. Efficient and independent board of directors
B. THE STEWARDSHIP THEORY
The theory defines situations in which managers are not motivated by individual goals, but rather
they are stewards whose motives are aligned with the objectives of their principals. It assumes
that managers are trustworthy and have high reputations. Therefore their behavior will not run
counter to the interests of the company. There is a significant emphasis on the responsibility of
the board to the shareholders in a corporate governance model that is emboldened by
stewardship and trusteeship. These concepts of stewardship and trusteeship are traceable in the
scriptures of India and Christendom.
Steward is a person who manages others property and financial affairs and is entrusted
with the responsibility of proper utilization and development of organizations resources.
MANAGERS AS STEWARDS
ASSUMED TO WORK EFFICIENTLY AND HONESTLY IN THE INTERESTS OF COMPANY
AND OWNERS.
SELF DIRECTED AND MOTIVATED BY HIGH ACHIEVEMENTS AND RESPONSIBILITY IN
DISCHARGING THE DUTIES.
MANAGERS ARE GOAL ORIENTED
FEEL CONSTRAINED IF THEY ARE CONTROLLED BY OUTSIDE DIRECTORS
BASIC BEHAVIORAL DIFFERENCES BETWEEN AGENCY & STEWARDSHIP
THEORIES
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MR. RASHMIRANJAN PANIGRAHI, LECTURER IN FINANCE, ASMIT
Stewardship theory can be reduced to the following basics:
The theory defines situation in which managers are not motivated by individual goals, but
rather they are stewards whose motives are aligned with the objectives of their principles.
Given a choice between self-serving behaviour and pro-organizational behavior, a
stewards behaviour will not depart from the interests of his organization.
Control can be potentially counterproductive, because it undermines the pro-
organizational behaviour of the steward, by lowering his motivation.
C. THE STAKEHOLDER THEORY
Managers are responsible to maximize the total wealth of all stakeholders of the firm, rather than
only the shareholders wealth. It deals with the common interests of employees, customers,
dealers, government, and the society at large and draws all of them into corporate-mix. It is
often criticized as wooly minded liberalism because it is not applicable in practice by
companies. But the defense is that managers can act efficiently only by drawing upon the
resources of the stakeholders and as such there is a contract between the company and the
stakeholders
The primary feature of the stakeholder theory of corporate governance is that those who have a
stake in the functioning of the firm are made up of large and diverse groups.
Simply put, stakeholders are those who seek some benefit from theoptimum running of the firm.
Stakeholders have different goals and seek different benefits from the firm. Workers seek job
security, the IRS wants its tax payments, investors want dividends, and the community wants a
solid economic base. The stakeholder theory holds that these different interests do, in fact,
control the firm in their own specific ways, and none has any better right to have its voice heard
than any other.
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MR. RASHMIRANJAN PANIGRAHI, LECTURER IN FINANCE, ASMIT
Function-: The stakeholder theory is both a descriptive and a normative theory. It is descriptive
in that it functions as a way of describing how a company is constituted and controlled. In this
case, one can see how customers or investors all have their say in how the firm markets its
products, for example. It is a normative theory in that it suggests how a firm should be run.
Benefits-: Stakeholder theory is a highly democratic and participatory concept of corporate
governance. Under this model, the firm is not merely a profit-making machine for elite investors
and major executives. It is a profoundly social institution that is meant to serve more than its
shareholders. It is a communal institution that benefits large segments of the local population.
Thousands of lives are potentially connected to and dependent upon the proper workings of the
firm.
D. SOCIOLOGICAL THEORY
The sociological approach has focused mostly on board composition and implications for power
and wealth distribution in the society. Under this theory, board composition, financial reporting,
and disclosure and auditingare of utmost importance to realize the socio-economic objectives of
corporations.
MECHANISMS AND CONTROLS
Corporate governance mechanisms and controls are designed to reduce the inefficiencies that
arise from moral hazardand adverse selection. For example, to monitor managers' behaviour, an
independent third party (the external auditor) attests the accuracy of information provided by
management to investors. An ideal control system should regulate both motivation and ability.
INTERNAL CORPORATE GOVERNANCE CONTROLS
Internal corporate governance controls monitor activities and then take corrective action to
accomplish organisational goals. Examples include:
Monitoring by the board of directors: The board of directors, with its legal authority to
hire, fire and compensate top management, safeguards invested capital. Regular board
meetings allow potential problems to be identified, discussed and avoided. Whilst non-
executive directors are thought to be more independent, they may not always result in more
effective corporate governance and may not increase performance.
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Different board
structures are optimal for different firms. Moreover, the ability of the board to monitor the
firm's executives is a function of its access to information. Executive directors possess
superior knowledge of the decision-making process and therefore evaluate top management
on the basis of the quality of its decisions that lead to financial performance outcomes, ex
ante. It could be argued, therefore, that executive directors look beyond the financial criteria.
Internal control procedures and internal auditors: Internal control procedures are policies
implemented by an entity's board of directors, audit committee, management, and other
personnel to provide reasonable assurance of the entity achieving its objectives related to
reliable financial reporting, operating efficiency, and compliance with laws and regulations.
Internal auditors are personnel within an organization who test the design and
implementation of the entity's internal control procedures and the reliability of its financial
reporting
Balance of power: The simplest balance of power is very common; require that the President
be a different person from the Treasurer. This application of separation of power is further
developed in companies where separate divisions check and balance each other's actions.
One group may propose company-wide administrative changes, another group review and
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can veto the changes, and a third group check that the interests of people (customers,
shareholders, employees) outside the three groups are being met.
Remuneration: Performance-based remuneration is designed to relate some proportion of
salary to individual performance. It may be in the form of cash or non-cash payments such as
sharesand share options, superannuationor other benefits. Such incentive schemes, however,
are reactive in the sense that they provide no mechanism for preventing mistakes or
opportunistic behaviour, and can elicit myopic behaviour.
EXTERNAL CORPORATE GOVERNANCE CONTROLS
External corporate governance controls encompass the controls external stakeholders exercise
over the organisation. Examples include:
competition
debt covenants
demand for and assessment of performance information (especially financial statements)
government regulations
managerial labour market
media pressure
takeovers
CORPORATE GOVERNANCE SYSTEM:
The role of the management is to run the enterprise while the role of the board is to see that it is
being run well and in the right direction. Corporate governance systems vary around the world.
Scholars tend to suggest three broad versions:
The Anglo-American model
The German model
The J apanese model
THE ANGLO-AMERICAN MODEL
This is also known as unitary board model, in which all directors participate in a single board
comprising both executive and non-executive directors in varying proportions. This approach to
governance tends to be shareholder oriented. It is also called the Anglo-Saxon approach to
corporate governance being the basis of corporate governance in America, Britain, Canada,
Australia and other Commonwealth law countries including India.
The major features of this model are as follows:
The ownership of companies is more or less equally divided between individual
shareholders and institutional shareholders.
Directors are rarely independent of management.
Companies are typically run by professional managers who have negligible ownership
stake. There is a fairly clear separation of ownership and management.
Most institutional investors are reluctant activists. They view themselves as portfolio
investors interested in investing in a broadly diversified portfolio of liquid securities. If
they are not satisfied with a companys performance, they simply sell the securities in the
market and quit.
The disclosure norms are comprehensive, the rules against insider trading tight, and the
penalties for price manipulations stiff, all of which provide adequate protection to the
small investors and promote general market liquidity. They also discourage large
investors from taking an active role in corporate governance.
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MR. RASHMIRANJAN PANIGRAHI, LECTURER IN FINANCE, ASMIT
GERMAN MODEL
Corporate governance in the German model is exercised through two boards, in which the upper
board supervises the executive board on behalf of stakeholders and is typically societal oriented.
In this model, although shareholders own the company, they do not entirely dictate the
governance mechanism. They elect 50 percent of members of supervisory board and the other
half is appointed by labour unions, ensuring that employees and labourers also enjoy a share in
governance. The supervisory board appoints and monitors the management board.
THE JAPANESE MODEL
This is the business network model, which reflects the cultural relationships seen in the J apanese
keiretsu network, in which boards tend to be large, predominantly executive and often ritualistic.
The reality of power in the enterprise lies in the relationships between top management in the
companies in the keiretsu network. In this model the financial institution has accrual role in
governance. The shareholders and the main bank together appoint board of directors and the
president.
The distinctive features of the J apanese corporate governance mechanisms are as follows:
The president who consults both the supervisory board and the executive management is
included.
Importance of the lending bank is highlighted.
INDIAN MODEL OF GOVERNANCE
Indian corporate is governed by the Companys Act 1956 which follows more or less the UK
model. The pattern of private companies is mostly that of closely held or dominated by a
founder, his family and associates. India has adopted the key tenets of Anglo-American external
and internal control mechanisms after economic liberalization.
ANGLO AMERICAN GERMAN JAPANESE
Share holders Shareholders and employees
/unions
Shareholders and banks
Elects Elects Elects
Board of Directors Supervisory Board Supervisory Board appoints
President And President
Appoints Appoints Appoints
Officers/Executive Management Board Executive Board
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Manage Manage Manage
Company Company Company
INDIAN MODEL = ANGLO AMERICAN MODEL +GERMAN MODEL
ELEMENTS OF GOOD CORPORATE GOVERNANCE
Good corporate governance is characterized by a firm commitment and adoption of ethical
practices by an organization across its entire value chain and in all of its dealings with a wide
group of stakeholders encompassing employees, customers, vendors, regulators and shareholders
(including the minority shareholders), in both good and bad times. To achieve this, certain
checks and practices need to be whole-heartedly embraced. Good governance deals with certain
obligation to society at large, obligation to investors, obligation to employees, obligation to
customers& Managerial obligationswhich are as follow -:
OBLIGATION TO SOCIETY AT LARGE
A corporation is a creation of law as an association of persons forming part of a society in which
it operates. Its activities are bound to impact the society as the societys value would have an
impact on the corporation. Therefore, they have mutual rights and obligations to discharge for
the benefit of each other.
National interest: A company (and its management) should ne committed in all its actions to
benefit the economic development of the countries in which it operates and should not
engage in any activity that would militate against such an objective.
Political non-alignment: A company should be committed to and support a functioning
democratic constitution and system with a transparent and fair electoral system and should
not support directly or indirectly any specific political party or candidate for political office.
Legal compliances: The management of a company should comply with all applicable
government laws, rules and regulations. Legal compliance will also mean that corporations
should abide by the tax laws of the nations in which they operate and these should be paid on
time and as per the required amount.
Rule of law: Good governance requires fair, legal frameworks that are enforced impartially.
It also requires full protection of rights, particularly those of minority shareholders. Impartial
enforcement of laws requires an independent judiciary and regulatory authorities.
Honest and ethical conduct: Every officer of the company including its directors,
executives and non executive directors, managing director, CEO, CFO and CCO should deal
on behalf of the company with professionalism, honesty, commitment and sincerity as well
as high moral and ethical standards.
Corporate citizenship: A corporate should be committed to be a good corporate citizen not
only in compliance with all relevant laws and regulations but also by actively assisting in the
improvement of the quality of life of the people in the communities in which it operates with
the objective of making them self reliant and enjoy a better quality of life.
Ethical behaviour: Corporations have a responsibility to set exemplary standards of ethical
behaviour, both internally within the organizations, as well as in their external relationships.
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MR. RASHMIRANJAN PANIGRAHI, LECTURER IN FINANCE, ASMIT
Social concern: The Company should have concerns towards the society. It can help the
needy people & show its concern by not polluting the water, air & land. The waste disposal
should not affect any human or other living creatures.
Healthy and safe working environment: A company should be able to provide a safe and
healthy working environment and comply with the conduct of its business affairs with all
regulations regarding the preservations of environment of the territory it operates in.
Competition: A company should market its products & services on its own merits & should
not resort to unethical advertisements or include unfair & misleading pronouncements on
competitors products & services.
Timely responsiveness: Good governance requires that institutions & processes try to serve
all stakeholders within a reasonable time frame.
Corporations should uphold the fair name of the country.
OBLIGATION TO INVESTORS
The investors as shareholders and providers of capital are of paramount importance to a
corporation. A company has following obligations to investors:
Towards shareholders: A company should be committed to enhance shareholder value and
comply with all regulations and laws that govern shareholders rights. The boa5rd of directors
of the company shall and fairly inform its shareholders about all relevant aspects of the
companys business and disclose such information in accordance with the respective
regulations and agreements. Every employee shall strive for the implementation of and
compliance with this in his professional environment. Failure to adhere to the code could
attract the most severe consequences including termination of employment or directorship as
the case may be.
Measures promoting transparency and informed shareholder participation: A related
issue of equal importance is the need to bring about greater levels of informed attendance and
meaningful participation by shareholders in matters relating to their companies without such
freedom being abused to interfere with management decision. An ideal corporate should
address this issue and relate it to more meaningful and transparent accounting and reporting.
Transparency means that information is freely available and directly accessible to those who
will be affected by such decisions and their enforcement. It also means that enough
information is provided and that it is provided in easily understandable forms and media.
Financial reporting and records: A company should prepare and maintain accounts of its
business affairs fairly and accurately in accordance with the financial and accounting
reporting standards, laws and regulations of the country in which it conducts the business
affairs.
Wilful material misrepresentation of and/or misinformation on the financial accounts and
reports shall be regarded as the violation of the firms ethical conduct and also will invite
appropriate civil or criminal action under the relevant laws.
OBLIGATION TO EMPLOYEES
In the context of enhanced awareness of better governance practices, managements should
realize that they have their obligations towards their workers too.
Fair employment practices: An ideal corporate should provide equal access and fair
treatment to all employees on the basis of merit; the success of the company will be
improved while enhancing the progress of individuals and companies. The applicable labour
and employment laws should be followed wherever it operates.
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Equal opportunities: A company should provide equal opportunity to all its employees and
all qualified applicants for employment without regard to their race, caste, religion, colour,
marital status, sex, age, nationality and disability.
Humane treatment: Companies should treat employees as their first customers and above
all as human. They have to meet the basic needs of all employees in the organization. There
should be a friendly, healthy and competitive environment for the workers to prove their
ability.
Participation: Participation of both men and women is a key cornerstone of corporate
governance. Participation could be either direct or through representatives. It needs to be
informed and organized. This means freedom of association and expression on one hand and
an organized civil society on the other.
Empowerment: Empowerment unleashes creativity and innovation throughout the
organization by truly vesting decision making powers at the most appropriate levels in the
organizational hierarchy.
Equity and inclusiveness: A corporation is a miniature of a society whose well being
depends on ensuring that all its employees feel that they have a stake in it and do not feel
excluded from the main stream. This requires all groups, particularly the most vulnerable,
have opportunities to improve or maintain their well being.
Participative and collaborative environment: There should not be any form of human
exploitation in the company. There should be equal opportunities for all levels of
management in any decision-making. The management should cultivate the culture where
employees should feel they are secure and are being well taken care of. Collaborative
environment would bring peace and harmony between the working community and the
management, which in turn, brings higher productivity, higher profits and higher market
share.
OBLIGATION TO CUSTOMERS
A companys existence cannot be justified without its catering to the needs of its customers. The
companies have an obligation to its employees, without whose assistance they cannot realize
their objectives.
Quality of products and services: The Company should be committed to supply goods and
services of the highest quality standards, backed by efficient after sales service consistent
with the requirements of the customers to ensure their total satisfaction. The quality standards
of companys goods and services should meet not only the required national standards but
also should endeavour to achieve international standards.
Products at affordable prices: Companies should ensure that they make available to their
customers quality goods at affordable prices while making normal profit is justifiable,
profiteering and fattening on the miseries of the poor consumers is unacceptable. Companies
must constantly endeavour to update their expertise, technology and skills of manpower to
cut down costs and pass on such benefits to customers. They should not create a scare in the
midst of scarcity or by themselves create an artificial scarcity to make undue profits.
Unwavering commitment to customer satisfaction: Companies should be fully committed
to satisfy their customers and earn their goodwill to stay long in the business. They should
encourage the warranties and guarantees given on their products and in case of harmful or
sub-standard products should replace them with good ones.
MANAGERIAL OBLIGATIONS
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Protecting companys assets: The assets of the company should not be dissipated or
misused but invested for the purpose of conducting the business for which they are duly
authorized. These include tangible as well as intangible assets.
Behaviour toward government agencies: A companys employees should not offer or give
any of the firms funds or property as donation to any government agencies or their
representatives directly or through intermediaries in order to obtain any favourable
performance of official duties.
Control: control is a necessary principal of governance that the freedom of management
should be exercised within a framework of appropriate checks and balances. Control should
prevent misuse of power, facilitate timely management response to change and ensure that
business risks are pre-emptively and effectively managed.
Consensus oriented: Good governance requires mediation of the different interests in
society to reach a broad consensus on what is in the best interest of the whole community and
how this can be achieved.
Gifts and donations: The Companys employees should neither receive nor make directly or
indirectly any illegal payments, remuneration, gifts, donations or comparablebenefits which
are intended to or perceived to obtain business or uncompetitive favours for the conduct of its
business.
Unit- II-: Landmark in the emergence of CG: CG Committees, World Bank on CG, OECD
Principle, Sarbanes, Oxley act-2002, Indian Committees and guidelines, CII Initiatives.
Landmarks in the Emergence of Corporate Governance
Over a period of time, a change had come in the perception of people about corporate
governancefrom the exclusive benefits of shareholders to the benefit of all stakeholders.
Developments in the US -: Corporate governance gained importance in the US after the
Watergate scandal that involved US corporate making political contributions and offering
bribes to government officials.
Developments in the UK -: In England, seeds of modern corporate governance were sown in
the aftermath of the Bank of Credit and Commerce International (BCCI) scandal. BCCI, a
global bank was made up of holding companies, affiliates, subsidiaries, banks-with-in-banks.
The BCCI entities flagrantly evaded legal restrictions in the movement of capital and goods
almost on a daily routine.
Another landmark that heightened peoples awareness and sensitivity on the issue and
resolve the rot of corporate misdeeds. Which leads to failure of Barings Bank, Britains
oldest merchant bank failed because of unhealthy trades on behalf of its customers and lost
$1.4 billion and pulled its shutter down.
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CG COMMITTEES
Throughout the US, UK, and other countries a number of committees got appointed to
recommend reforms and regulations in corporate governance. They are all known by the names
of the individuals that had chaired the committees.
The Cadbury Committee on Corporate Governance, 1992 - Sir Adrian Cadbury
Stated Objective was to help raise the standards of corporate governance and the level of
confidence in financial reporting and auditing by setting out clearly what it sees as the
respective responsibilities of those involved and what it believes is expected of them.
The Cadbury committee investigated the accountability of the board of directors to
shareholders and to the society. The Cadbury Code of best Practices had 19
recommendations in the nature of Guidelines to the board of directors, nonexecutive
directors, executive directorsand such other officials.
CORPORATE GOVERNANCE COMMITTEES
1. Cadbury committee Report
The report was mainly divided into three parts:-
A. Reviewing the structure and responsibilities of Boards of Directors and recommending a
Code of Best Practice
B. Considering the role of Auditors and addressing a number of recommendations to the
Accountancy Profession
C. Dealing with the Rights and Responsibilities of Shareholders
A. Reviewing the structure and responsibilities of Boards of Directors and recommending
a Code of Best Practice
1. Board of directors:
meet regularly, retain full and effective control over the company and monitor the
executive management
balance of power and authority
2. Non-Executive Directors
independent judgment
independent of management and free from any business
3. Executive Directors
full and clear disclosure of directors total emoluments
4. Financial Reporting and Controls
a balanced and understandable assessment of their companys position should report that the
business
should ensure that an objective and professional relationship is maintained with the auditors.
B. Considering the role of Auditors and addressing a number of
recommendations to the Accountancy Profession
o external and objective check
o professional and objective relationship between the board of directors and auditors should be
maintained
o to design audit
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o regular rotation of audit partners to prevent unhealthy relationship.
Accountancy Profession should take the lead in:-
(i) Developing a set of criteria for assessing effectiveness;
(ii) Developing guidance for companies on the form in which directors should report; and
(iii) Developing guidance for auditors on relevant audit procedures and the form in which
auditors should report.
C. Dealing with the Rights and Responsibilities of Shareholders
Elect the directors to run the business on their behalf
Appoint the auditors to provide an external check
Committee's report places particular emphasis on the need for fair and accurate reporting of a
company's progress to its shareholders
TOmake greater use of their voting rights and take positive interest in the board functioning
Effectiveness of general meetings could be increased.
2. The Paul Ruthman Committee
The committee was constituted later to deal with the said controversial point of Cadbury Report.
It watered down the proposal on the grounds of practicality. It restricted the reporting
requirement to internal financial controls only as against the effectiveness of the companys
system of internal control as stipulated by the Code of Best Practices contained in the Cadbury
Report.
The final report submitted by the Committee chaired by Ron Hampel had some important and
progressive elements, notably the extension of directors responsibilities to all relevant control
objectives including business risk assessment and minimizing the risk of fraud.
3. The Greenbury Committee 1995
This committee was setup in J anuary 1995 to identify good practices by the Confederation of
British Industry (CBI), in determining directors remuneration and to prepare a code of such
practices for use by public limited companies of United Kingdom.
The committee aimed to provide an answer to the general concerns about the accountability by
the proper allocation of responsibility for determining directors remuneration, the proper
reporting to shareholders and greater transparency in the process.
The committee produced the Greenbury Code of Best Practice which was divided into the four
sections: Remmuneration Committee, Disclosures, Remuneration Policy and Service
Contracts and Compensation.
The Greenbury committee recommended that UK companies should implement the code as set
out to the fullest extent practicable, that they should make annual compliance statements, and
that investor institutions should use their power to ensure that the best practice is followed.
4. The Hampel Committee 1995
The Hampel committee was setup in November 1995 to promote high standards on Corporate
Governance both to protect investors and preserve and enhance the standing of companies listed on
the London Stock Exchange. The committee developed further the Cadbury report. And it made
the following recommendations.
i) The auditors should report on internal control privately to the directors.
ii) The directors maintain and review all controls.
iii) Companies should time to time review their need for internal audit function and control.
It also introduced the combined code that consolidated the recommendation of earlier corporate
governance reports (Cadbury Committee and Greenbury Committee).
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5. The Combined Code 1998
The combined code was subsequently derived from Ron Hampel Committees Final Report,
Cadbury Report and the Greenbury Report. The combined code is appended to the listing rules of
the London Stock Exchange. As such, compliance of the code is mandatory for all listed
companies in UK. The stipulations contained in the Combined Code require, among other things,
that the boards should maintain a sound system of internal control to safeguard shareholders
investments and the companys assets. The directors should, at least annually, conduct a review
of the effectiveness of the groups system of internal control covering all controls, including
financial, operational and compliance and risk management, and report to shareholders that they
have done so.
6. The Turnbull Committee
The Turnbull Committee was set up by the Institute of Chartered Accountantsin England and Wales
(ICAEW) in 1999 to provide guidance to assistcompanies in implementing the requirements of the
Combined Code relatingto internal control.
The committee
Provided guidance to assist companies in implementing the requirements of the Combined
Code relating to internal control.
It recommended that where companies do not have an internal audit function, the board
should consider the need for carrying out an internal audit annually.
The committee also recommended that board of directors confirm the existence of procedures
for evaluation and managing key risks.
Corporate Governance is constantly evolving to reflect the current corporate economic and legal
environment. To be effective, corporate governance practices need to be tailor to particular
needs, objectives and risk management structure of an organization.
WORLD BANK ON CORPORATE GOVERNANCE
The World Bank, involved in sustainable development was one of the earliest economic
organization o study the issue of corporate governance and suggest certain guidelines. The World
Bank report on corporate governance recognizes the complexity of the concept and focuses on
the principles such as transparency, accountability, fairness and responsibility that are universal
in their applications.
Corporate governance is concerned with holding the balance between economic and social goals
and between individual and communal goals. The governance framework is there to encourage
the efficient use of resources and equally to require accountability for the stewardship of those
resources. The aim is to align as nearly as possible, the interests of individuals, organizations and
society.
The foundation of any corporate governance is disclosure. Openness is the basis of public
confidence in the corporate system and funds will flow to those centers of economic activity,
which inspire trust. This report points the way to establishment of trust and the encouragement of
enterprise. It marks an important milestone in the development of corporate governance.
OECD PRINCIPLES
Organization for Economic Co-operation and Development (OECD) was one of the earliest non-
governmental organizations to work on and spell out principles and practices that should govern
corporate in their goal to attain long-term shareholder value.
The OECD were trend setters as the Code of Best practices are associated with Cadbury report.
The OECD principles in summary include the following elements.
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i) The rights of shareholders
ii) Equitable treatment of shareholders
iii) Role of stakeholders in corporate governance
iv) Disclosure and Transparency
v) Responsibilities of the board
i) THE RIGHTS OF SHAREHOLDERS
The corporate governance framework should protect shareholders rights.
A. Basic shareholder rights include the right to: 1) secure methods of ownership registration; 2)
convey or transfer shares; 3) obtain relevant information on the corporation on a timely and
regular basis; 4) participate and vote in general shareholder meetings; 5) elect members of the
board; and 6) share
in the profits of the corporation.
B. Shareholders have the right to participate in, and to be sufficiently informed on, decisions
concerning fundamental corporate changes such as:
1) amendments to the statutes, or articles of incorporation or similar governing documents of the
company; 2) the authorisation of additional shares; and 3) extraordinary transactions that in
effect result in the sale of the company.
C. Shareholders should have the opportunity to participate effectively and vote in general
shareholder meetings and should be informed of the rules, including voting procedures, that
govern general shareholder meetings:
1. Shareholders should be furnished with sufficient and timely information concerning the date,
location and agenda of general meetings, as well as full and timely information regarding the
issues to be decided at the meeting.
2. Opportunity should be provided for shareholders to ask questions of the board and to place
itemson the agenda at general meetings, subject to reasonable limitations.
3. Shareholders should be able to vote in person or in absentia, and equal effect should be given
to votes whether cast in person or in absentia.
D. Capital structures and arrangements that enable certain shareholders to obtain a degree of
control disproportionate to their equity ownership should be disclosed.
E. Markets for corporate control should be allowed to function in an efficient and transparent
manner.
F. Shareholders, including institutional investors, should consider the costs and benefits of
exercising their voting rights.
ii) THE EQUITABLE TREATMENT OF SHAREHOLDERS
The corporate governance framework should ensure the equitable treatment of all
shareholders, including minority and foreign shareholders. All shareholders should have
the opportunity to obtain effective redress for violation of their rights.
A. All shareholders of the same class should be treated equally.
1. Within any class, all shareholders should have the same voting rights. All investors should be
able to obtain information about the voting rights attached to all classes of shares before they
purchase. Any changes in voting rights should be subject to shareholder vote.
2. Votes should be cast by custodians or nominees in a manner agreed upon with the beneficial
owner of the shares.
3. Processes and procedures for general shareholder meetings should allow for equitable
treatment of all shareholders. Company procedures should not make it unduly difficult or
expensive to cast votes.
B. Insider trading and abusive self-dealing should be prohibited.
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C. Members of the board and managers should be required to disclose any material interests in
transactions or matters affecting the corporation.
iii) THE ROLE OF STAKEHOLDERS IN CORPORATE GOVERNANCE
The corporate governance framework should recognise the rights of stakeholders as
established by law and encourage active co-operation between corporations and stakeholders
in creating wealth, jobs, and the sustainability of financially sound enterprises.
A. The corporate governance framework should assure that the rights of stakeholders that are
protected by law are respected.
B. Where stakeholder interests are protected by law, stakeholders should have the opportunity to
obtain effective redress for violation of their rights.
C. The corporate governance framework should permit performance-enhancing mechanisms for
stakeholder participation.
D. Where stakeholders participate in the corporate governance process, they should have access
to relevant information.
iv) DISCLOSURE AND TRANSPARENCY
The corporate governance framework should ensure that timely and accurate disclosure is made
on all material matters regarding the corporation, including the financial situation, performance,
ownership, and governance of the company.
A. Disclosure should include, but not be limited to, material information on:
1. The financial and operating results of the company.
2. Company objectives.
3. Major share ownership and voting rights.
4. Members of the board andkey executives, and their remuneration.
5. Material foreseeable risk factors.
6. Material issues regarding employees and other stakeholders.
7. Governance structures and policies.
B. Information should be prepared, audited, and disclosed in accordance with high quality
standards of accounting, financial and non-financial disclosure, and audit.
C. An annual audit should be conducted by an independent auditor in order to provide an
external and objective assurance on the way in which financial statements have been prepared
and presented.
D. Channels for disseminating information should provide for fair, timely and cost-efficient
access to relevant information by users.
v) THE RESPONSIBILITIES OF THE BOARD
The corporate governance framework should ensure the strategic guidance of the company, the
effective monitoring of management by the board, and the boards accountability to the company
and the shareholders.
A. Board members should act on a fully informed basis, in good faith, with due diligence and
care, and in the best interest of the company and the shareholders.
B. Where board decisions may affect different shareholder groups differently, the board should
treat all shareholders fairly.
C. The board should ensure compliance with applicable law and take into account the interests of
stakeholders.
D. The board should fulfil certain key functions, including:
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1. Reviewing and guiding corporate strategy, major plans of action, risk policy, annual budgets
and business plans; setting performance objectives; monitoring implementation and corporate
performance; and overseeing major capital expenditures, acquisitions and divestitures.
2. Selecting, compensating, monitoring and, when necessary, replacing key executives and
overseeing succession planning.
3. Reviewing key executive and board remuneration, and ensuring a formal and transparent
board nomination process.
4. Monitoring and managing potential conflicts of interest of management, board members and
shareholders, including misuse of corporate assets and abuse in related party transactions.
5. Ensuring the integrity of the corporations accounting and financial reporting systems,
including the independent audit, and that appropriate systems of control are in place, in
particular, systems for monitoring risk, financial control, and compliance with the law.
6. Monitoring the effectiveness of the governance practices under which it operates and making
changes as needed.
7. Overseeing the process of disclosure and communications.
The OECD guidelines are somewhat general and both the Anglo-American system and
Continental European (or German) system would be quite consistent with it.
SARBANES- OXLEY ACT, 2002
The Sarbanes-Oxley Act (SOX) is a sincere attempt to address all the issues associated with
corporate failure to achieve quality governance and to restore investors confidence. The Act was
formulated to protect investors by improving the accuracy and reliability of corporate
disclosures, made precious to the securities laws and for other purposes. The act contains a
number of provisions that dramatically change the reporting and corporate directors governance
obligations of public companies, the directors and officers. The important provisions in the SOX
Act are briefly given below.
i) Establishment of Public Company Accounting Oversight Board (PCAOB): SOX creates a
new board consisting of five members of whom two will be certified public accountants. All
accounting firms have to get registered with the board. The board will make regular inspection of
firms. The board will report to SEC. The report will be ultimately forwarded to Congress.
ii) Audit Committee: The SOX provides for new improved audit committee. The committee is
responsible for appointment, fixing fees and oversight of the work of independent auditors. The
registered public accounting firms should report directly to audit committee on all critical
accounting policies.
iii) Conflict of Interest: The public accounting firms should not perform any audit services for a
publically traded company.
iv) Audit Partner Rotation: The act provides for mandatory rotation of lead audit or co-ordinating
partner and the partner reviewing audit once every 5 years.
v) Improper influence on conduct of Audits : According to act, it is unlawful for any executive or
director of the firm to take any action to fraudulently influence, coerce or manipulate an audit.
vi) Prohibition of non-audit services : Under SOX act, auditors are prohibited from providing non-
audit services concurrently with audit financial review services.
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vii) CEOs and CFOs are required to affirm the financials : CEOs and CFOs are required to
certify the reports filed with the Securities and Exchange Commission (SEC).
viii) Loans to Directors: The act prohibits US and foreign companies with Securities traded
within US from making or arranging from third parties any type of personal loan to directors.
ix) Attorneys : The attorneys dealing with publicly traded companies are required to report
evidence of material violation of securities law or breach of fiduciary duty or similar violations
by the company or any agent of the company to Chief Counsel or CEO and if CEO does not
respond then to the audit committee or the Board of Directors.
x) Securities Analysts: The SOX has provision under which brokers and dealers of securities
should not retaliate or threaten to retaliate an analyst employed by broker or dealer for any
adverse, negative or unfavorable research report on a public company. The act further provides
for disclosure of conflict of interest by thesecurities analysts and brokers or dealers.
xi) Penalties: The penalties are also prescribed under SOX act for any wrong doing. The
penalties are very stiff. The Act also provides for studies to be conducted by Securities and
Exchange
Commission or the Government Accounting Office in the following area:
i) Auditors Rotation
ii) Off balance Sheet Transactions
iii) Consolidation of Accounting firms & its impact on industry
iv) Role of Credit Rating Industry
v) Role of Investment Bank and Financial Advisers.
INDIAN COMMITTEES AND GUIDELINES & CII INITIATIVES
Corporate Governance Initiatives in India / Historical Perspective/ Corporate Governance
of India Has Undergone A Paradigm Shift
There have been several major corporate governance initiatives launched in India since the mid-
1990s. The FIRST was by the Confederation of Indian Industry (CII), Indias largest industry
and business association, which came up with the first voluntary code of corporate governance in
1998. The SECOND was by the SEBI, now enshrined as Clause 49 of the listing agreement. The
THIRD was the Naresh Chandra Committee, which submitted its report in 2002. The FOURTH
was again by SEBI the Narayana Murthy Committee, which also submitted its report in 2002.
Based on some of the recommendation of this committee, SEBI revised Clause 49 of the listing
agreement in August 2003. Subsequently, SEBI withdrew the revised Clause 49 in December
2003, and currently, the original Clause 49. FIFTH was Recent Developments in India CII
Taskforce on Corporate Governance 2009 SIXTH was Corporate Governance Voluntary
Guidelines 2009.
1.THE CII CODE- :
More than a year before the onset of the Asian crisis, CII set up a committee to examine
corporate governance issues, and recommend a voluntary code of best practices. The committee
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was driven by the conviction that good corporate governance was essential for Indian companies
to access domestic as well as global capital at competitive rates. The first draft of the code was
prepared by April 1997, and the final document (Desirable Corporate Governance: A Code), was
publicly released in April 1998. The code was voluntary, contained detailed provisions, and
focused on listed companies.
2. KUMAR MANGALAM BIRLA COMMITTEE REPORT AND CLAUSE 49-:
While the CII code was well-received and some progressive companies adopted it, it was Felt
that under Indian conditions a statutory rather than a voluntary code would be more Purposeful,
and meaningful. Consequently, the second major corporate governance initiative in the country
was undertaken by SEBI. In early 1999, it set up a committee under Kumar Mangalam Birla to
promote and raise the standards of good corporate governance. In early 2000, the SEBI board
had accepted and ratified key recommendations of this committee, and these were incorporated
into Clause 49 of the Listing Agreement of the Stock Exchanges.
3. THE NARESH CHANDRA COMMITTEE REPORT ON CORPORATE GOVERNANCE-:
The Naresh Chandra committee was appointed in August 2002 by the Department of Company
Affairs (DCA) under the Ministry of Finance and Company Affairs to examinevarious corporate
governance issues. The Committee submitted its report in December 2002. It made
recommendations in two key aspects of corporate governance: financial and non-financial
disclosures: and independent auditing and board oversight of management.
4. NARAYANA MURTHY COMMITTEE REPORT ON CORPORATE GOVERNANCE-:
The fourth initiative on corporate governance in India is in the form of the recommendations of
the Narayana Murthy committee. The committee was set up by SEBI, under the chairmanship of
Mr. N. R. Narayana Murthy, to review Clause 49, and suggest measures to improve corporate
governance standards. Some of the major recommendations of the committee primarily related to
audit committees, audit reports, independent directors, related party transactions, risk
management, directorships and director compensation, codes of conduct and financial
disclosures.
5. CII TASKFORCE ON CORPORATE GOVERNANCE 2009-:
Satyam is a one-off incident - especially considering the size of the malfeasance. The
overwhelming majority of corporate India is well run, well regulated and does business in a
sound and legal manner. However, the Satyam episode has prompted a relook at our corporate
governance norms and how industry can go a step further through some voluntary measures.
With this in mind, the CII set up a Task Force under Mr. Naresh Chandra in February 2009 to
recommend ways of further improving corporate governance standards and practices both in
letter and spirit. The report enumerates a set of voluntary recommendations with an objective to
establish higher standards of probity and corporate governance in the country.
The recommendations in brief are as under:
1. Appointment of Independent Director
a. Nomination Committee
2. Duties, liabilities and remuneration of
independent directors
a. Letter of Appointment to Directors
b. Fixed Contractual Remuneration
c. Structure of Compensation to NEDs
3. Remuneration Committee of Board
4. Audit Committee of Board
5. Separation of the offices of the Chairman
and the Chief Executive Officer
6. Attending Board and Committee Meetings
through Tele-conferencing and
Video conferencing
7. Executive Sessions of Independent Director
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8. Role of board in shareholders and related
party transactions
9. Auditor Company Relationship
10. Independence to Auditors
11. Certificate of Independence
12. Auditor Partner Rotation
13. Auditor Liability
14. Appointment of Auditors
15. Qualifications of Auditors Report
16. Whistle Blowing Policy
17. Risk Management Framework
18. The legal and regulatory standards
19. Capability of Regulatory Agencies -
Ensuring Quality in Audit Process
20. Effective and Credible Enforcement
21. Confiscation of Shares
22. Personal Liability
23. Liability of Directors and Employees
24. Institutional Activism
25. Media as a stakeholder
According to the report, much of best-in-class corporate governance is voluntary of companies
taking conscious decisions of going beyond the mere letter of law.
6. CORPORATE GOVERNANCE VOLUNTARY GUIDELINES 2009
More recently, in December 2009, the Ministry of Corporate Affairs (MCA) published a new set of
Corporate Governance Voluntary Guidelines 2009, designed to encourage companies to adopt
better practices in the running of boards and board committees, the appointment and rotation of
external auditors, and creating a whistle blowing mechanism. The guidelines are divided into the
following six parts:
1. Board of Directors
2. Responsibilities of the Board
3. Audit Committee of the Board
4. Auditors
5. Secretarial Audit
6. Institution of mechanism for Whistle Blowing
These guidelines provide for a set of good practices which may be voluntarily adopted by the Public
companies. Private companies, particularly the bigger ones, may also like to adopt these guidelines.
The guidelines are not intended to be a substitute for or additions to the existing laws but are
recommendatory in nature.
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Unit- III -: Agent and Institution in CG: Rights and privileges of shareholder, investor Problems
& Protection, CG & other stakeholders, Role of Regulators & Government.
Corporate Governances is needed to create a corporate culture of consciousness, transparency
and openness. it refers to a combination of laws, rules, regulations, procedure and voluntary
practices to enable companies to maximize the shareholders long term value.
It leads to increase customer satisfaction, shareholder value and wealth.
THEORETICAL BASIS -
AGENCY COSTS
Fundamental theoretical basis of corporate governance is agency costs
Shareholders are the owners of the joint-stock, Limited Liability Company and are the
principals
The management directly or indirectly selected by the shareholders pursues the objectives of
the company defined by the principals
Though it is presumed that the management may carry out this responsibility, it often may
not be the case as the objectives of the management in real practice could differ from those of
the shareholders which may lead to agency costs.
Instruments that may reduce the agency costs
Financial and non-financial disclosures
Independent oversight of management consisting of two aspects:
1. The role of the independent statutory auditors
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2. Independent oversight by the board of directors of a company
LONG-TERM SHAREHOLDER VALUE
Universally, it is accepted that the objective of good corporate governance is to maximize the
long-term shareholder value. There have been various committees and boards that havebeen set
up both internationally and in India to improve the quality of corporate governance.
We need to at this stage understand the rights of the shareholders laid down by the Indian
Companies Act of 1956.
RIGHTS AND PRIVILEGES OF SHAREHOLDERS
Rights of shareholders
The members of the company enjoy various rights in relation to the company. These rights are
conferred on the members of the company either by the Indian Companies Act 1956 or by the
Memorandum and articles of Association of the company or by the general law, especially those
relating to contracts under the Indian Contract Act, 1872.
Some of the more important rights of the shareholders as stressed by these acts are the following:
He has the right to obtain copies of the Memorandum of Association, Article of Association
and certain resolutions and agreements on request, on payment of prescribed fees.
He has the right to have the certificate of shares held by him within 3 months of the
allotment.
He has the right to transfer his share or other interests in the company subject to the manner
provided by the articles of the company.
He has a right to appeal to the Company Law Board if the company refuses or fails to register
the transfer of shares.
He has the right to apply to the Company Law Board for the rectification of the register of
members.
He has the right to apply to the court to have any variation or abrogation to his rights set
aside by the court.
He has a right to inspect the register and the index of members, annual returns, register of
charges and register of investments not held by the company in its own name without any
charge.
He is entitled to receive notices of general meetings and to attend such meetings and vote
either in person or by proxy.
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He is entitled to receive a copy of the statutory report.
He is entitled to receive copies of the annual report of directors, annual accounts and
auditors report.
He has the right to participate in the appointment of auditors and the election of directors at
the annual general meeting of the company.
He has the rights to make an application to Company Law board for calling annual general
meeting, if the company fails to call such a meeting within the prescribed time limits.
He is entitledto obtain and inspect the copies of minutes of proceedings of general meetings.
He has the right to participate in the declaration of dividends and receive his dividends duly.
He has a right to demand poll.
He has a right to apply for investigation of theaffairs of the company.
He has a right to remove the director before the expiry of the term of his office.
He has a right to make an application to company Law Board for relief in case of oppression
and mismanagement.
He can make a petition to the High Court for the winding up of the company under certain
circumstances.
INVESTOR PROTECTION
Investor protection focuses on making sure that investors are fully informed about their
purchases, transactions, affairs of the company that they have invested in and the like. Investor
protection is one of the most important elements of a thriving securities market or other financial
investment institution. Simply put, investor protection is the effort to make sure that those who
invest their money in regulated financial products are not defrauded by brokers or other parties.
SEBI & INVESTOR PROTECTION
The Securities and Exchange Board of India Act, 1992 (the SEBI Act) was amended in the years
1995, 1999 and 2002, the primary function of which is the protection of the investors interest
and the healthy development of Indian financial markets.
OBJECTIVES OF SEBI
1. Investor protection, so that there is a steady flow of savings into the Capital Market.
2. Ensuring the fair practices by the issuers of securities, namely, companies so that they can
raise resources at least cost.
3. Promotion of efficient services by brokers, merchant bankers and other intermediaries so that
they become competitive and professional.
4. regulating substantial acquisition of shares and takeover of companies
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5. promoting investors education and training of intermediaries of securities markets
6. Carry out inspection/ audits of the SEs / intermediaries etc.
7. Call for information from any bank / any authority / corporation / agencies in respect of any
transaction in securities which is under investigation or inquiry by SEBI
8. performing such functions and exercising such powers under the Securities Contracts
(Regulation) Act, 1956 (SCRA)
9. conducting research
INVESTOR PROTECTION MEASURES BY SEBI
Section 11(2) of the SEBI Act contains measures available with SEBI to implement the
legislated desire of investor protection. The measures available with SEBI include the following:
1. regulating the business in Stock Exchanges (SEs) and any other securities markets
2. registering and regulating the working of intermediaries like stock brokers, sub-brokers,
3. registering and regulating the working of venture capital funds and collective investment
schemes, including mutual funds
4. prohibiting fraudulent and unfair trade practices relating to securities markets
5. prohibiting insider trading in securities.
IMPACT OF INVESTOR PROTECTION ON OWNERSHIP AND CONTROL OF
FIRMS
In many countries, firms are owned and controlled by promoter families and in such closely
held firms; insiders may use every opportunity to abuse rights of other shareholders and steal
their profits through devious means.
Investor protection also provides an impetus for the growth of capital markets. When
investors are protected from the insider expropriation, they tend to pay more for securities which
makes it attractive for the entrepreneurs to issue securities.
Through investor protection, financial markets can develop with ease and perfection. This
promotes economic growth through:
I.Enhancing savings and capital formation
II.Channelising these into real investments
III.Improving the efficiency of capital allocation since capital flows into more productive uses
CORPORATE GOVERNANCE PROVISIONS IN THE COMPANIES ACT, 2013
The enactment of the companies Act 2013 was major development in corporate governance in
2013. The new Act replaces the Companies Act, 1956 and aims to improve corporate governance
standards, simplify regulations and enhance the interests of minority shareholders. The new Act
is a major milestone in the corporate governance sphere in India and is likely to have significant
Corporate Governance MFC 4th Sem.
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impact on the governance of companies in the country. Following are the main provisions related
to corporate governance that have been incorporated in the Companies Act, 2013.
1. THE COMPANIES ACT, 2013 introduces new definitions relating to accounting standards,
auditing standards, financial statement, independent director, interested director, key
managerial personnel, voting right etc. For example, the legislation introduces a new class of
companies called one person company (OPC) to the existing classes of companies, namely
public and private. OPC is a new vehicle for individuals for carrying on a business with
limited liability.
2. BOARD OF DIRECTORS (CLAUSE 166): The new Act provides that the company can
have a maximum of 15 directors on the Board; appointing more than 15 directors, however,
will require shareholder approval. Further, the new Act prescribes both academic and
professional qualifications for directors. It states that the majority of members of Audit
Committee including its Chairperson should have the ability to read and understand the
financial statements. In addition, for the first time, duties of directors have been defined in
the Act. The Act considerably enhances the roles and responsibilities of the Board of
Directors and makes them more accountable. Infringement of these provisions has been made
punishable with fine.
3. INDEPENDENT DIRECTOR (CLAUSE 149): The concept of independent directors (IDs)
has been introduced for the first time in the Company Law in India. It prescribes that all
listed companies must have at least one-third of the Board as IDs. IDs may be appointed for a
term of up to five consecutive years. While the introduction of the concept of IDs in the new
Act is a welcome move, it does not appear to sufficiently address the enduring challenges
related to the effectiveness of IDs in the context of concentrated shareholding pattern in most
of the listed companies in India.
4. RELATED PARTY TRANSACTIONS (RPT) (CLAUSE 188): The new Act requires that
no company should enter into RPT contracts pertaining to (a) sale, purchase or supply of
any goods or materials; (b) sale or dispose of or buying, property of any kind; (c) leasing of
property of any kind; (d) availing or rendering of any services; (e) appointment of any agent
for purchase or sale of goods, materials, services or property; (f) such related party's
appointment to any office or place of profit in the company, its subsidiary company or
associate company. In case such a contract or arrangement is entered into with a related
party, it must be referred to in the Boards Report along with the justification for entering
into such contract or arrangement. Further, any RPT between a company and its Directors
shall require prior approval by a resolution in general meeting. Violations of these provisions
would be punishable with fine or imprisonment or both.
5. CORPORATE SOCIAL RESPONSIBILITY (CSR) (CLAUSE 135): The new Act has
mandated the profit making companies to spend on CSR related activities. Every company
having net worth of Rs 500 crore or more or turnover of Rs 1000 crore or more or net profit
of Rs 5 crore or more during any financial year shall constitute a CSR Committee of the
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Board. In pursuance of its CSR policy, the Board of every such companythrough these
committees--shall ensure that the company spends (in every financial year) at least 2 percent
of the average net profits of the company made during the three immediately preceding
financial years.
6. AUDITORS (CLAUSE 139): A listed company cannot appoint or reappoint (a) an
individual as auditor for more than one term of five consecutive years, or (b) an audit firm as
auditor for more than two terms of five consecutive years. To avoid any conflict of interest,
the Act has mentioned the services that an auditor cannot render, directly or indirectly, to the
company, which include: accounting and book-keeping services, internal audit, investment
banking services, investment advisory services, management services etc.
7. DISCLOSURE AND REPORTING (CLAUSE 92): In the new Act, there is significant
transformation in non-financial annual disclosures and reporting by companies as compared
to the earlier format in the Companies Act, 1956.
8. SERIOUS FRAUD INVESTIGATION OFFICE (SFIO) (CLAUSE 211): The Act has
proposed statutory status to SFIO. Investigation report of SFIO filed with the Court for
framing of charges shall be treated as a report filed by a Police Officer. SFIO shall have
power to arrest in respect of certain offences of the Act which attract the punishment for
fraud. Further, the new Act has a provision for stringent penalty for fraud related offences.
9. CLASS ACTION SUITS (CLAUSE 245): For the first time, a provision has been made for
class action under which it is provided that specified number of member(s), depositor(s) or
any class of them, may file an application before the Tribunal seeking any damage or
compensation or demand any other suitable action against an audit firm. The order passed by
the Tribunal shall be binding on all the stakeholders including the company and all its
members, depositors and auditors.
(Source- www.nseindia.com)
GUIDELINES FOR INVESTORS/SHAREHOLDERS
The Securities and Exchange Board of India (SEBI), the Indian capital market regulator in its
guidelines to investors/shareholders, titled Quick reference Guide for Investors published
recently makes it known that a shareholder of a company enjoys the following rights:
Rights of shareholder, as an individual:
To receive the share certificates on allotment or transfer, as the case may be, in due time.
To receive copies of abridged annual report, the balance sheet and the Profit & Loss account
and the auditors report.
To participate and vote in general meetings either personally or through proxies.
To receive dividends in due time once approved in general meeting.
Corporate Governance MFC 4th Sem.
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To receive corporate benefits such as rights, bonus etc. once approved.
To apply to Company Law board (CLB) to call or direct the convening the annual general
meeting.
To inspect the minute books of the general meetings and to receive copies thereof.
To proceed against the company by way of civil or criminal proceedings.
To apply for the winding up of the company.
To demand a poll on any resolution.
To requisition and extraordinary general meeting.
Rights of a Debenture holder:
To receive interest/redemption in due time.
To receive a copy of the trust deed on request.
To apply for winding up of the company if the company fails to pay its debts.
To approach the debenture trustee with the debenture holders grievance.
Shareholders responsibilities:
While a shareholder may be happy to note that one has so many rights as a stakeholder in the
company, it should not lead one to complacency because one also has certain responsibilities to
discharge, such as
To remain informed
To be vigilant
To participate and vote in general meetings
To exercise ones rights on ones own or as a group
CORPORATE GOVERNANCE AND OTHER STAKEHOLDERS
A. CORPORATE GOVERNANCE AND EMPLOYEES
An organization needs capital and labour to create wealth. Earlier, the most important need for
an organization to be a success was capital. But today the growing recognition that human capital
is a source of competitive advantage has led to the understanding that labour is more important
than capital. The interest of the employees can be protected through the following:
Trade unions: Trade unions alone can represent the collective interests of employees and
fight for what is rightly due to them from the organization. They could use this as a platform
to negotiate agreements between the organization and labour.
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Co-determination: It a situation where there is employee representation on the board of
directors of the organization.
Profit sharing: Profit sharing motivates the individual worker to put in his best as his efforts
are directly related to the profits of the organization, in which he gets a share. Profit sharing
could be done in many ways, such as
- cash based sharing of annual profits where the annual cash profits of the organization are
shared among the employees,
- Deferred profit sharing where the deferred profits of the organization are shared among the
employees.
The objective of such profit sharing is to encourage employee involvement in the
organization and improve their motivation and distribution of wealth among all the
factors of production.
Equity sharing: Under equity sharing, employees are given an option to buy the
companies shares, identify themselves with, and thus become the owners of the organization.
There are various way sin which equity sharing could be done: employees share
1) Ownership plans, 2) stock bonus plans, 3) stock option plans, 4) employee buyout, and 5)
worker cooperatives.
Team production solution: Team production solution is a situation where the boards of
directors must balance competing interests of various stakeholders and then arrive at
decisions that are in the best interest of the organization.
B. CORPORATE GOVERNANCE AND CUSTOMERS
On 15
th
March 1962, President J ohn F. Kennedy declared four rights of consumers- the right to
satisfaction of basic needs, the right to safety, the right to be informed, and the right to choose. In
1983, the United Nations recommended that world governments develop, strengthen and
implement a coherent consumer protection policy. In India, the Consumer Protection Act 1986
was passed and the country embarked on strengthening the consumer protection regime.
The explosion of interest in consumer matters is a very recent phenomenon. The reason is
twofold- a combination of new business methods and changing attitudes. The all pervasive
exaggerated and often false claims, made for services and goods, emphasize the imperative need
Corporate Governance MFC 4th Sem.
Mr. Rashmiranjan Panigrahi, Lecturer in Finance, ASMIT
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for Consumer Protection Legislation and creation of awareness about it among the general
public.
The rights of the consumer are as follows:
The right to safety: The rights to be protected against the marketing of goods and services
which are hazardous to life and property.
The right to be informed: The consumer has the right to be informed about the quality,
quantity, potency, purity, standard and price of goods or services so as to protect them
against unfair trade practices.
The right to choose: The right to be assured, wherever possible, access to variety of goods
and services at competitive prices.
The right to be heard: The right to be assured that consumers interests will receive due
consideration at appropriate forums.
The right to seek redressed: the right against unfair trade practices or restrictive trade
practices or unscrupulous exploitation of consumers.
C. CORPORATE GOVERNANCE AND INSTITUTIONAL INVESTORS
Most of the reports on corporate governance have emphasized the role which institutional
investors play in corporate governance. In India, there are broadly four types of institutional
investors:
The financial institutions, such as IFCI, ICICI, IDBI, the State Financial Corporation, etc.
Insurance companies such as LIC, GIC, and their subsidiaries.
All banks
All Mutual funds (MF) including UTI.
While an investor decision is under consideration, the key factors to be taken into consideration
are
Financial results and solvency: This is the most important factor among the factors such as
an upward trend in earnings per share and profits, a healthy cash flow and a reasonable level
of dividend payment. All these are considered major indicators of a companys financial
health and are indicated in the financial results. However, a consistent dividend policy is less
significant.
Financial statements and annual reports: There are two important aspects under this head.
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o Extent of disclosure: The quality of the financial statements is the next most influential factor
when it comes to investment decisions. Institutional investors consider the level of disclosure
of the companys strategies, initiatives and quality of managements discussion and analysis
of the years results. Financial position in the annual report is equally important. This is a
strong indication of the investing publics emphasis and preference for clear disclosures in a
companys annual report, in excess of regulatory requirements.
o Comparability with international GAAP: a significant5 proportion of institutional investors
do not invest in a company if the financial statements are non-comparable to International
Generally Accepted Accounting Principles. Implicitly, this could mean that comparability of
financial statements of companies with International GAAP is important in the eyes of the
investor.
Investor communications: Institutional investors value the willingness of companies to
provide additional information to investors, analysts and other commentators, their prompt
release of information about transactions affecting minority shareholders and the existence of
other transparency mechanisms that help ensure fair treatment to all shareholders.
Composition and quality of the board: The most important aspect within this factor is the
quality and experience of the executive directors on the board. In contrast, investors would
consider investing even though they are dissatisfied with the quality, qualification and
experience of independent non-executive directors and their role in board meetings. In
addition, many investors are not too concerned if there are insufficient independent non-
executive directors on the board.
Corporate governance practices: Investors consider corporate governance practices when
they make investment decisions. The company should follow the principles for corporate
governance being- auditing and compliance, disclosure and transparency and board
processes.
Corporate image: The image of the company in the community is also considered when an
institutional investor is called on to take an investment decision. The image of the
organization should not be bad.
Share price: This is the last factor that is considered by an institutional investor when an
investment decision is made. If the shares of the company enjoy continuously rising prices in
the bourses, investors could be encouraged to invest in them.
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D. CORPORATE GOVERNANCE AND CREDITORS
Banks and other creditors have an extremely important role to play in fostering efficiency in
medium and large private firms. Creditors, in turn, rely for their survival on debt repayment by
their borrowers. Without dependable debt collection, no amount of supervision or competition
can make banks run efficiently. Strong creditors are as critical to the efficient functioning of
enterprises as are strong owners.
Creditor monitoring and control
There are three crucial elements in creditor monitoring and control in market economies:
Adequate information: Lenders need information on the creditworthiness or otherwise of
potential borrowers, and depositors and bank supervisors need information on bank
portfolios.
Creditor incentives: The second requirement for debt to serve a control function is the
existence of appropriate market based incentives for creditors, be they banks, trade creditors
or government. These incentives may be in the form of higher margin of profit, high interest
charges from customers and sometimes even reduction in the quantum of Non-Performing
Assets.
Debt collection: without an effective system of debt collection, debtors lose repayment
discipline, the flow of credit is constrained, and creditors may be forced to come to the state
to cover their losses if they are to survive. Well designed and implemented rules facilitate
rapid and low cost debt recovery in cases of default, thereby lowering the risk of lending and
increasing the availability of credit to potential borrowers. Poorly designed and implemented
rules make lending more costly and stifle the flow of credit.
E. CORPORATE GOVERNANCE AND THE GOVERNMENT
The government plays the key role in corporate governance by defining the legal environment
and sometimes by directly influencing managerial decisions. Beyond defining the rules of the
game, the government may directly influence corporate governance. At one extreme, the
government owns the firm, so that the government is charged with monitoring managerial
decisions and limiting the ability of managers to maximizeprivate benefits at the cost of society.
Corporate Governance MFC 4th Sem.
Mr. Rashmiranjan Panigrahi, Lecturer in Finance, ASMIT
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References
1. In its broadest sense the constituents may be thought of as those stakeholders who have a
moral interest or stake in the existence and activities of a corporation. In a more narrow
sense it embraces, at the core, shareholders and employees, but also extends to certain
customers, suppliers and lenders. It is this loose definition of stakeholders which we adopt
here.
2. National Foundation for Corporate Governance , Discussion Paper : CorporateGovernance
in India : Theory and Practice.
3. A.C.Fernando (2006), Corporate Governance, Principles, Policies and Practices. pp 76,
Pearson
4. A.C.Fernando (2006), Corporate Governance, Principles, Policies and Practices. pp 77,
Pearson
5. Cadbury Committee Report : A report by the committee on the financial aspects of corporate
governance. The committee was chaired by Sir Adrian Cadbury and issued for comment on
(27 may 1992)
6. Greenbury Committee Report (1994) investigating board members remuneration and
responsibilities
7. The committee report on corporate governance, The Hampel committee report (1998)
8. The combined code of Best practices in Corporate Governance , The Turnbull Committee
Report, (1998)
9. Principles of Corporate Governance : A report by OECD Task Force on Corporate
Governance. (1999)
10. Patterson Report : The link between Corporate Governance and Performance (2001)
11. Sarbanes Oxley Act of 2002 passed by the congress of the United States of America on 23rd
J anuary, 2002.
12. Confederation of Indian Industry, (March 1998) Desirable corporate Governance : A Code
(Based on recommendations of the national task forceon corporate governance , chaired by
Shri Rahul Bajaj).