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CORPORATE LAW

SUBMITTED BY:

SHWETA RAUT
(PG-07)

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CORPORATE GOVERNANCE

The last few years have seen some major scams and corporate collapse across
the globe. In India, the major example is Satyam which is one of the largest IT
companies in India. All these events have caused the pendulum of public faith to shift
away from free market to a more closely regulated one. However "corporate
governance," in spite of being the new object of interest and inquisitiveness from
various quarters, remains an ambiguous and often misunderstood phrase. So before
delving further on the subject it is important to define the concept of corporate
governance.

To get a fair view, it would be prudent to give a narrow as well as broad


definition of corporate governance

In a narrow sense, it involves a set of relationships amongst the companys


management, its board of directors, its share holders, auditors and other stakeholders.
These relationships which involve various rules and incentives provide the structure
through which the objectives of a company are set and the means of attaining and
monitoring performance are determined. In a broader sense, corporate governance is
important for overall market confidence, the efficiency of capital allocation, the
growth and development of countries industrial basis and ultimately the nations
overall wealth and welfare. In both narrow as well as in the broad definitions, the
following concepts occupy a centre stage:
1. Rights and equitable treatment of shareholders
2. Interests of other stakeholders
3. Role and responsibilities of the board
4. Integrity and ethical behaviour
5. Disclosure and transparency

Ever since the first writings on the subject appeared there have been many
debates as to whom should corporate governance really represent: the interest of the
shareholders or that of all stakeholders. The shareholder primacy is embodied in the
finance view of corporate governance, i.e., the primary justification for the existence
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of the corporation is to maximise shareholders wealth. Since ownership and control


are separate the issue here is to align the objectives of management with the objective
of shareholder wealth maximisation

The issue raised in the stakeholder theories is whether the recognition of a


wider set of claims than those of shareholders alone is the legitimate concern of
corporate governance. It is argued that the new technology world has reduced the
opportunity, ability and the motivation of consumers to engage in rational decision
making. So the development of inclusive stakeholder relationships rather than
production at a lower price will be the most important determinant of viability and
success. It implies searching for a balance among the distinct company interest groups
i.e., shareholders, workers, banks etc. - and also looks for their participation

A natural question to ask is why we need to impose particular governance


regulations. There are at least three reasons for regulatory intervention:
1) If the founder of the company was allowed to design and implement a corporate
charter he likes. He may not clearly address the issues faced by other shareholders and
thus conjure inefficient rules. E.g. in the absence of regulations founders could
employ anti-takeover defences excessively but shareholders may favour takeovers that
increase the value of their shares even if they involve greater losses for unprotected
creditors or employees. So the collective bargaining process may not yield socially
acceptable solutions and may be at the mercy of few stakeholders.
2) Another argument comes from the externality argument. An externality may be
defined as a good generated as the result of an economic activity, whose benefits or
costs do not accrue directly to the parties involved in the activity. E.g. one corporate
scandal can erode shareholder trust in the whole of the corporate sector. In such cases
where private action fails to resolve widespread externalities involving many parties
the state has the responsibility to intervene and prevent market failure.
3) Regulation is also needed to avoid a situation where efficient rules are designed
initially but due to lack of active tracking by dispersed shareholders, are altered or
broken later.

While regulations are necessary, there are however, a few issues that need to be
considered. The first relates to policing and punishment. The SEBI envisages that all
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these corporate governance norms will be enforced through listing agreements


between companies and the stock exchanges but for companies with little floating
stock deregulation because of non compliance is hardly a credible threat. The second
issue has to do with form vs. Substance. There is a fear that by legally mandating
several aspects of corporate governance the regulators encourage the practise of
companies following the letter of the law instead of focussing on the spirit of good
governance. The third concern relates to apprehension about excessive interference
that unwittingly leads to micro-management of companies.

Considering these apprehensions, what we need is a small corpus of legally


mandated rules, buttressed by much larger body of self-regulation and voluntary
compliance.

So after careful weighing of all pros and cons it is not tough to conclude that
good Corporate Governance makes for good business sense. It increases confidence of
shareholders in the company leading to better stock prices. Research has shown that
the good Corporate Governance brings down the cost of capital for the company.
Good disclosure practices lead to a more liquid market for the company. This lowers
cost of debt. Thus for the CEOs of today, there is a clear business case for complying
with principles of good Corporate Governance.
Corporate Governance in India

The 1956 Companies Act as well as other laws governing the functioning of
joint-stock companies and protecting the investors rights built on this foundation. The
beginning of corporate developments in India were marked by the managing agency
system that contributed to the birth of dispersed equity ownership but also gave rise to
the practice of management enjoying control rights disproportionately greater than
their stock ownership. The turn towards socialism in the decades after independence
marked by the 1951 Industries (Development and Regulation) Act as well as the 1956
Industrial Policy Resolution put in place a regime and culture of licensing, protection
and widespread red-tape that bred corruption and stilted the growth of the corporate
sector.

The situation grew from bad to worse in the following decades and corruption,
nepotism and inefficiency became the hallmarks of the Indian corporate sector.
Exorbitant tax rates encouraged creative accounting practices and complicated
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emolument structures to beat the system. In the absence of a developed stock market,
the three all-India development finance institutions (DFIs) the Industrial Finance
Corporation of India, the Industrial Development Bank of India and the Industrial
Credit and Investment Corporation of India together with the state financial
corporations became the main providers of long-term credit to companies. Along with
the government owned mutual fund, the Unit Trust of India, they also held large
blocks of shares in the companies they lent to and invariably had representations in
their boards

The situation grew from bad to worse in the following decades and corruption,
nepotism and inefficiency became the hallmarks of the Indian corporate sector.
Exorbitant tax rates encouraged creative accounting practices and complicated
emolument structures to beat the system. In the absence of a developed stock market,
the three all-India development finance institutions (DFIs) the Industrial Finance
Corporation of India, the Industrial Development Bank of India and the Industrial
Credit and Investment Corporation of India together with the state financial
corporations became the main providers of long-term credit to companies. Along with
the government owned mutual fund, the Unit Trust of India, they also held large
blocks of shares in the companies they lent to and invariably had representations in
their boards

In this respect, the corporate governance system resembled the bank-based


German model where these institutions could have played a big role in keeping their
clients on the right track. Unfortunately, they were themselves evaluated on the
quantity rather than quality of their lending and thus had little incentive for either
proper credit appraisal or effective follow-up and monitoring. Borrowers therefore
routinely recouped their investment in a short period and then had little incentive to
either repay the loans or run the business. Frequently they bled the company with
impunity, siphoning off funds with the DFI nominee directors mute spectators in their
boards.

This sordid but increasingly familiar process usually continued till the
companys net worth was completely eroded. This stage would come after the
company has defaulted on its loan obligations for a while, but this would be the stage
where Indias bankruptcy reorganization system driven by the 1985 Sick Industrial
Companies Act (SICA) would consider it sick and refer it to the Board for Industrial
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and Financial Reconstruction (BIFR). As soon as a company is registered with the


BIFR it wins immediate protection from the creditors claims for at least four years.
Between 1987 and 1992 BIFR took well over two years on an average to reach a
decision, after which period the delay has roughly doubled. Very few companies have
emerged successfully from the BIFR and even for those that needed to be liquidated,
the legal process takes over 10 years on average, by which time the assets of the
company are practically worthless. Protection of creditors rights has therefore existed
only on paper in India. Given this situation, it is hardly surprising that banks, flush
with depositors funds routinely decide to lend only to blue chip companies and park
their funds in government securities.

Financial disclosure norms in India have traditionally been superior to most


Asian countries though fell short of those in the USA and other advanced countries.
Noncompliance with disclosure norms and even the failure of auditors reports to
conform to the law attract nominal fines with hardly any punitive action. The Institute
of Chartered Accountants in India has not been known to take action against erring
auditors.

While the Companies Act provides clear instructions for maintaining and
updating share registers, in reality minority shareholders have often suffered from
irregularities in share transfers and registrations deliberate or unintentional.
Sometimes non-voting preferential shares have been used by promoters to channel
funds and deprive minority shareholders of their dues have sometimes been defrauded
by the management undertaking clandestine side deals with the acquirers in the
relatively scarce event of corporate takeovers and mergers.

Boards of directors have been largely ineffective in India in monitoring the


actions of management. They are routinely packed with friends and allies of the
promoters and managers, in flagrant violation of the spirit of corporate law. The
nominee directors from the DFIs, who could and should have played a particularly
important role, have usually been incompetent or unwilling to step up to the act.
Consequently, the boards of directors have largely functioned as rubber stamps of the
management. For most of the post-Independence era the Indian equity markets were
not liquid or sophisticated enough to exert effective control over the companies.
Listing requirements of exchanges enforced some transparency, but non-compliance
was neither rare nor acted upon. All in all therefore, minority shareholders and
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creditors in India remained effectively unprotected in spite of a plethora of laws in the


books.

The years since liberalization have witnessed wide-ranging changes in both


laws and regulations driving corporate governance as well as general consciousness
about it. Perhaps the single most important development in the field of corporate
governance and investor protection in India has been the establishment of the
Securities and Exchange Board of India (SEBI) in 1992 and its gradual empowerment
since then. Established primarily to regulate and monitor stock trading, it has played a
crucial role in establishing the basic minimum ground rules of corporate conduct in
the country. Concerns about corporate governance in India were, however, largely
triggered by a spate of crises in the early 90s the Harshad Mehta stock market scam
of 1992 followed by incidents of companies allotting preferential shares to their
promoters at deeply discounted prices as well as those of companies simply
disappearing with investors money. These concerns about corporate governance
stemming from the corporate scandals as well as opening up to the forces of
competition and globalization gave rise to several investigations into the ways to fix
the corporate governance situation in India. One of the first among such endeavours
was the CII Code for Desirable Corporate Governance developed by a committee
chaired by Rahul Bajaj. The committee was formed in 1996 and submitted its code in
April 1998. Later SEBI constituted two committees to look into the issue of corporate
governance the first chaired by Kumar Mangalam Birla that submitted its report in
early 2000 and the second by Narayana Murthy three years later. The SEBI committee
recommendations have had the maximum impact on changing the corporate
governance situation in India. The Advisory Group on Corporate Governance of RBIs
Standing Committee on International Financial Standards and Codes also submitted
its own recommendations in 2001
Recommendations of various committees on Corporate Governance in India
CII Code recommendations (1997)
No need for German style two-tiered board.
For a listed company with turnover exceeding Rs 100 crores, if the chairman is
also the MD, at least half of the board should be independent directors, else at
least 30%.
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No single person should hold directorships in more than 10 listed companies.


Non-executive directors should be competent and active and have clearly
defined responsibilities like in the Audit committee.
Directors should be paid a commission not exceeding 1% (3%) of net profits
for a company with (out) an MD over and above sitting fees. Stock options
may be considered too.

Attendance record of directors should be made explicit at the time of reappointment. Those with less than 50% attendance shouldnt be re-appointed.

Key information that must be presented to the board is listed in the code.
Audit Committee: Listed companies with turnover over Rs. 100 crores or paid-up
capital of Rs. 20 crores should have an audit committee of at least three members, all
non-executive, competent and willing to work more than other non-executive
directors, with clear terms of reference and access to all financial information in the
company and should periodically
interact with statutory auditors and internal auditors and assist the board in
corporate accounting and reporting.
Reduction in number of nominee directors. FIs should withdraw nominee
directors from companies with individual FI shareholding below 5% or total FI
holding below 10%.
Birla Committee (SEBI) recommendations (2000)
At least 50% non-executive members.
For a company with an executive Chairman, at least half of the board should be
independent directors, else at least one-third.
Non-executive Chairman should have an office and be paid for job related
expenses.
Maximum of 10 directorships and 5 chairmanships per person.
Audit Committee: A board must have a qualified and independent audit committee,
of minimum 3 members, all non-executive, majority and chair independent with at
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least one having financial and accounting knowledge. Its chairman should attend
AGM to answer shareholder queries. The committee should confer with key
executives as necessary and the company secretary should be he secretary of the
committee. The committee should meet at least thrice a year -- one before
finalization of annual accounts and one necessarily every six months with the quorum
being the higher of two members or one-third of members with at least two
independent directors. It should have access to information from any employee and
can investigate any matter within its TOR, can seek outside legal/professional service
as well as secure attendance of outside experts in meetings. It should act as the bridge
between the board, statutory auditors and internal auditors with arranging powers and
responsibilities.
Remuneration Committee: The remuneration committee should decide
remuneration packages for executive directors. It should have at least 3 directors, all
Nonexecutive and be chaired by an independent director.
The board should decide on the remuneration of non-executive directors and
all remuneration information should be disclosed in annual report.
At least 4 board meetings a year with a maximum gap of 4 months between
any 2 meetings. Minimum information available to boards stipulated.
Narayana Murthy committee (SEBI) recommendations (2003)
Training of board members suggested.
There shall be no nominee directors. All directors to be elected by shareholders
with same responsibilities and accountabilities.
Non-executive director compensation to be fixed by board and ratified by
shareholders and reported. Stock options should be vested at least a year after
their retirement. Independent directors should be treated the same way as nonexecutive directors.
The board should be informed every quarter of business risk and risk
management strategies.
Boards of subsidiaries should follow similar composition rules as that of parent
and should have at least one independent directors of the parent company.
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The Board report of a parent company should have access to minutes of board
meeting in subsidiaries and should affirm reviewing its affairs.
Performance evaluation of non-executive directors by all his fellow Board
members should inform a re-appointment decision.
While independent and non-executive directors should enjoy some protection
from civil and criminal litigation, they may be held responsible of the legal
compliance in the companys affairs.
Code of conduct for Board members and senior management and annual
affirmation of compliance to
Weaknesses of Corporate Governance In India
The Satyam debacle has exposed the chinks in Indian corporate governance
mechanism and the monitoring authorities. It has raised many questions about
corporate governance in Indiathe role of boards, of independent directors, of
the auditors, of investors and of analysts. Unanimously it has been a gross
failure of corporate governance standards in India and protection of rights of
minority investors.
The board of directors is central to good governance, and the role of the board
has featured prominently in discussions about Satyam. The board is the body
charged with having oversight of the operations of the firm and setting its
strategy. It should ensure that the company is upholding high standards of
probity and conduct, and provide a probing analysis of the activities of
management. In particular, non-executive directors are supposed to give an
independent assessment of the quality of management. But time and time
again, failures of corporate governance suggest that they do not. The
infractions of law have arisen despite independent directors which were
stopped by external forces. There are several reasons pointing to these
anomalies First, it is difficult to appoint truly independent directors. This is particularly
hard to achieve in countries such as India where family ownership is
widespread and there is a close-knit group of corporate leaders. It is difficult
for non-executive directors to perform a scrutiny objective at the best of times,
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but it is particularly difficult to do so when faced with a dominant CEO who


expects support not criticism from the companys board. Many countries have
sought to separate the roles of chairman and CEO. However, it can inhibit
firms from implementing effective strategies, especially in companies
operating with new technologies, such as Indian IT/ITES firms, requiring
visionary strategies.
Next, the very idea of independent directors is to ensure commitment to values,
ethical business conduct and about making a distinction between personal and
corporate funds in the management of a company. Yet, most independent
directors have become sidekicks for the management, eying their commission
and fees, forgetting their very purpose of appointment. In the process, they
implicitly transform into dependent directors.
To add to that the present corporate governance modelled on the Western
Anglo-Saxon model which does not address many of the current crises faced
by India Inc. Professor Jayant Rama Verma of IIM Bangalore had extensively
commented on the unsuitability of the Western Code of Corporate Governance
in his well researched paper on the subject titled 'Corporate Governance in
India - Disciplining the dominant shareholder'
According to him, the governance issue in the Anglo-Saxon world aims
essentially at disciplining the management which is unaccountable to the
owners. In contrast, the problem in the Indian corporate sector, he pointed out,
is disciplining the dominant shareholder and protecting the minority
shareholders, vindicated in the recent Satyam case. To understand the issues
that driving corporate governance in the West, a brief idea about it is
inevitable. After successfully working over the decades separating ownership
and management, owners, (especially, institutional owners) realised that they
have lost control over the management or the board. Professor Verma points
out succinctly," The management becomes self-perpetuating and the
composition of the board itself is largely influenced by the whims of the CEO.
Corporate governance reforms in the US and the UK have focussed on making
the board independent of the CEO

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In contrast, the issues in India are entirely distinct - primarily due to our overall
social-economic conditions. Therefore the issue in Indian corporate
governance is not a 'conflict between management and owners' as elsewhere,
but 'a conflict between the dominant shareholders and the minority
shareholders'. And Professor Verma rightly concludes, "The board cannot even
in theory resolve this conflict" and that "some of the most glaring abuses of
corporate governance in India have been defended on the principle of
shareholder democracy since they have been sanctioned by resolutions of the
general body of shareholders."
By now it is increasingly obvious that the very concept of corporate
governance modelled on the Western system is un-workable in a country like
India. These efforts are akin to taking a hair of an elephant, transplanting it on
the head of a bald man and making him look like a bear. In the West the focus
is on ownerless, CEO-driven paradigm. In India, it is still family-controlled,
owner-driven paradigm. CEOs do not matter much in the management of the
company. Yet, the general discussion centres on a standard, global prescription
to manage diverse situations. Needless to emphasise, the solution to these
problems in India lies not within the company, but outside. This is precisely
what happened in the Satyam case where outsiders of the company took the lid
off the fraud.
In spite of numerous suggestions by the Securities and Exchange Board of
India (SEBI), for peer reviews of audits among the companies listed in the
Nifty and Sensex indices they have fallen flat on the industry fraternity.
Presumably, SEBI will allocate the audits to firms that are part of a panel of
reputed auditors. The simple solution would be for the regulator to make this
course of action mandatoryauditors could be allotted audits by the regulator.
To avoid the allegations of overregulation, companies can submit a list of their
preferred auditors, from which the regulator will have to choose. Audits could
also be rotated annually, keeping them on their toes. And these same rules
could also be applied to rating agencies, internal auditors, independent
directors etc. From time to time these mechanisms can be fine-tuned and made
more practical.

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The moot question is why these reformative suggestions have not been
implemented? The answer is that it depends on whos got more lobbying
power. In the US, the large pension funds that have been instrumental in
getting more transparency from company managements. India, on the other
hand, has no tradition of shareholder activism, despite organisations such as
the Life Insurance Corporation of India having substantial stakes in companies.
The dependence of political parties on business interests to fund elections also
doesnt help. The failure of governments and regulators to pass what seems
like very basic safeguards preventing conflicts of interest, not only in India, but
across the world, clearly establishes the clout that corporate interests have.
Corporate governance is thus a charade, a cosmetic exercise rather than an
attempt to get to the root of the problem.
Of course, too rigid a focus on the stock market also has its own set of
problems. As Satyam Computer Services Ltds founder B. Ramalinga Raju
said in his confession, the apparent reason why he inflated earnings was
because he feared that bad results would lead to a fall in the stock and a
takeover attempt. We neednt take Rajus word for it, but the fact remains that
too much of a focus on quarterly earnings and the linking of executive
compensation with the stock market via stock options could act as powerful
incentives for inflating earnings.
Recommendations to Implement Corporate Governance
After a slew of scandals, politicians and regulators, executives and
shareholders are all preaching the governance gospel. Corporate governance
has come to dominate the political and business agenda.
There is a growing concern among executives that hasty regulation and overly
strict internal procedures may impair their ability to run their business
effectively. CEOs have to bear in mind the potential trade-off between
polishing the corporate reputation and delivering growthfor all the headlines
on corporate responsibility, are investors prepared consistently to sacrifice
earnings for the sake of ethics?
Regulations are only one part of the answer to improved governance.
Corporate governance is about how companies are directed and controlled. The
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balance sheet is an output of manifold structural and strategic decisions across


the entire company, from stock options to risk management structures, from the
composition of the board of directors to the decentralisation of decisionmaking powers. As a result, the prime responsibility for good governance must
lie within the company rather than outside it.
A key lesson from the Enron experience, where the board was an exemplar of
best practice on paper, is that governance structures count for little if the
culture isnt right. Designing and implementing corporate governance
structures are important, but instilling the right culture is essential. Senior
managers need to set the agenda in this area, not least in ensuring that board
members feel free to engage in open and meaningful debate. Not all board
members need to be finance or risk experts, however. The primary task for the
board is to understand and approve both the risk appetite of a particular
company at any particular stage in its evolution and the processes that are in
place to monitor risk.
Culture is necessary but not sufficient to ensure good corporate governance.
The right structures, policies and processes must also be in place. Transparency
about a companys governance policies is critical. As long as investors and
shareholders are given clear and accessible information about these policies,
the market can be allowed to do the rest, assigning an appropriate risk
premium to companies that have too few independent directors or an overly
aggressive compensation policy, or cutting the costs of capital for companies
that adhere to conservative accounting policies. Too few companies are
genuinely transparent, however, and this is an area where most organisations
can and should do much more.
If any institution, inside or outside the company, deserves scrutiny, it is the
board of directors. Executives have a clear responsibility consciously to define
and implement corporate governance policies that offer a decent level of
reassurance to employees and investors. Thereafter, disclosure is the most
effective way for companies to resolve the thorny tensions that do exist
between vision and prudence, innovation and accountability.

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There is an inherent tension between innovation and conservatism, governance


and growth. Asked to evaluate the impact of strict corporate governance
policies on their business, executives thought that M&A deals would be
negatively affected because of the lengthening of due-diligence procedures,
and that the ability to take swift and effective decisions would be
compromised. State-of-the-art corporate governance can bring benefits to
companies, to be sure, but also introduces impediments to growth. Some
procedures and processes that companies can implement to enhance corporate
governance are detailed as follows.
Scheduling regular meetings of the non-executive board members from which
other executives are excluded. Non-executives are there to exercise
constructive dissatisfaction with the management team. ]
They need to discuss collectively and frankly their views about the
performance of the executives, the strategic direction of the company and
worries about areas where they feel inadequately briefed.
Explaining fully how discretion has been exercised in compiling the earnings
and profit figures. These are not as cut and dried as many would imagine.
Assets such as brands are intangible and with financial practices such as
leasing common, a lot of subtle judgments must be made about what goes on
or off the balance sheet. Use disclosure to win trust.
Initiating a risk-appetite review among non-executives. At the root of most
company failures are ill-judged management decisions on risk. Non-executives
need not be risk experts. But it is paramount that they understand what the
companys appetite for risk isand accept, or reject, any radical shifts.
Checking that non-executive directors are independent. Weed out members of
the controlling family or former employees who still have links to people in the
company. Also raise awareness of soft conflicts. Are there payments or
privileges such as consultancy contracts, payments to favourite charities or
sponsorship of arts events that impair non-executives ability to rock the boat?
Auditing non-executives performance and that of the board. The attendance
record of nonexecutives needs to be discussed and an appraisal made of the
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range of specialist skills. The board should discuss annually how well it has
performed.
Broadening and deepening disclosure on corporate websites and in annual
reports. Websites should have a corporate governance section containing
information such as procedures for getting a motion into a proxy ballot. The
level of detail should ideally include the attendance record of non-executives at
board meetings.
Leading by example, reining in a company culture that excuses cheating. If the
company culture has been compromised, or if one is in an industry where loose
practices on booking revenues and expenditure are sometimes tolerated, take a
few high-profile decisions that signal change
Finding a place for the grey and cautious employee alongside the youthful and
visionary one. Hiring thrusting graduates will skew the culture towards an
aggressive, individualist outlook. Balance this with some wiser, if duller heads
people who have seen booms and busts before, value probity and are not in
so much of a hurry. Making compensation committees independent. Corporate
bosses should be prevented from selling shares in their firms while they head
them. Share options should be expensed in established companiescashstarved start-ups may need to be more flexible.
Corporate governance is not just a box ticking exercise, companies need an
exchange of practical guidance in order to conceive and implement successful
governance mechanism. Instead of a menu of corporate governance options it
would be more appropriate to present best practice guidelines applicable to
businesses. These will serve as a benchmark for appropriate customization in
different companies. Corporate governance should be considered as an
obligation not a luxury. Its spirit is going to expand further and deeper in the
future.
KINGFISHER CRISIS
The current crisis going inside the kingfisher Airlines which can be realized by
the press statement from KFA, on 12 March 2012, highlights the challenges:
The flight loads have reduced because of our limited distribution ability
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caused by IATA suspension. We are therefore combining some of our flights.


Also, some of the flights are being cancelled as a result of employee agitation
on account of delayed salaries. This situation has arisen as a consequence of
our bank accounts having been frozen by the tax authorities. We are making all
possible efforts to remedy this temporary situation.
They need to discuss collectively and frankly their views about the
performance of the executives, the strategic direction of the company and
worries about areas where they feel inadequately briefed.
Explaining fully how discretion has been exercised in compiling the earnings
and profit figures. These are not as cut and dried as many would imagine.
Assets such as brands are intangible and with financial practices such as
leasing common, a lot of subtle judgments must be made about what goes on
or off the balance sheet. Use disclosure to win trust.
LET US INVESTIGATE
Investigate the reasons behind the failure of the Kingfisher airline in the year
2012. To investigate the government policies and the various steps taken to fix
the current crisis. To investigate the reasons due to which the whole Aviation
Industry is suffering from higher operating losses. What went so terribly wrong
with Kingfisher when rival Jet Airways has comparatively much higher
INTRODUCTION: Global aviation industry is passing through challenging times
due to unprecedented fuel price hike during the last 4 years, turbulent financial
markets and economic recession. Vijay Malayas dream bird, Kingfisher Airlines popularly known as The King of Good Times - is witnessing its worst phase. Indian
domestic aviation is suffering from a serious market failure, caused by misguided
government policy and ministers need to step in quickly to fix it. In India, most of the
upcoming airlines added a large number of aircraft since 2006 and deployed them
mostly on metro sectors resulting into suicidal price war among all the airlines. Every
airline in India is currently suffering from operating losses.
FINDINGS: While doing the research, we find that there are four main reasons why
Indian Aviation Industry is in so much pain, which can be reviewed as given below:
REASON BEHIND THE FAILURE:
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APART FROM AGGRESSIVE PRICE CUTTING FROM AIRINDIA


R

I S

I G

I N

I N

I C

I N

I C

Kingfishers net worth has been completely eroded, while its auditors had
raised several questions about its accounting practices in its annual report.
Kingfisher Airlines Ltds loan funds stand at Rs7, 543 crore (debt-to-equity
ratio of about 3.2) & that of Jet Airways (India) Ltds is Rs14, 123 crore (debtto-equity about 4.2). Spice jet Ltd, on the other hand, has lowest debt at
Rs712 crore (debt-to-equity about 0.7). Kingfishers fixed assets stand at Rs2,
286 crore, but it has a negative net working capital (excluding cash and bank
balance) of Rs1, 970 crore. Jet Airways has a much stronger asset base with the
value of its fixed assets at Rs14,417 crore; its negative net working capital
(excluding cash and bank balances) is relatively much lower at Rs560 crore.
Spice Jet has a total fixed asset base of Rs1, 115 crore.
Kingfisher could not deliver on profitability even last year when the going was
considered to be good. According to analysts, the sector experienced its best
returns in the quarter ended December 2010. Even during such times,
Kingfishers net loss for fiscal 2011 stood at Rs1, 027 crore. Thats when Jet
had managed a net profit of Rs9.69 croreon a stand-alone basisand Spice
Jet posted a net profit of Rs101 crore. Spice Jets net profitability, of course,
was also supported by relatively lower interest expenses.

18 | P a g e

SHARE PRICES WENT STEEPER DOWN


For the September quarter, Kingfishers operating losses are higher than the
other two, with Jets operating loss being far lower. Kingfishers fuel and
interest expense (Kingfishers debt is also probably costlier than that of Jet
Airways) as a percentage of revenue is higher than that of Jet. A higher
interest cost, coupled with higher operating losses, has led to pressure on
Kingfishers ability to service its interest and debt obligations. Further,
Kingfishers current liabilities have increased by 23% in September from
March (an indication that it may be Stretching payments to suppliers).
Naturally, Kingfisher seems to be the worst affected of all the three. Revenue
growth for Kingfisher domestically was very weak, falling 3% to Rs. 1,184
Crore from Rs. 1,227 Crore
International Revenue growth was even worse, falling 9% to Rs. 363 Crore
from Rs. 398 Crore Passengers carried fell 15% to 2.63 million; antithetical to
general market trends. Domestic Passenger Yield fell 3% to Rs. 3,804 despite
capacity discipline. International Passenger Yield rose 5% to Rs. 10, 864.
EBTIDAR Profit (which measures operating results before taxes, interest,
depreciation , loan amortization, and rents) of Rs. 125 Crore (Rs. 284 Crore in
Q3 10-11), EBITDAR profit of Rs. 161 Crore on Domestic (Profit of Rs. 225
Crore in Q3 10-11), and EBITDAR loss of Rs. 36 Crore on International (Rs.
59 Crore profit in Q3 10-11) Kingfisher deferred almost 213.4 Crores worth
of losses into future taxes under Deferred Tax Asset There was a onetime
special item of almost Rs. 79.25 crore that contributed to the loss.
RISK MANAGEMENT FAILURES
S T RATAG IC R IS K
M AR KE T A N A LY SIS

O P RAT IO N A L
R ISK C O S T
A N A LY SIS

S T RATAG IC R IS K
M E R G E R W IT H A IR
DECC AN

FIN A N C IA L R ISK
E XC ES S IV E D E B T

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S T RATAG IC R ISK
IN V E S TM E N T IN
P L AN ES

STRATAGIC RISK MARKET ANALYSIS


KFA Was launched as a premium Business class aircraft
A lack of understanding of customer requirements and basing a decision that
LUXURY SELLS IN AIRLINES
MR MALLYA highly successful in Liquour business did not comprehend the
difference in customer preference in both the INDUSTRIES
STRATAGIC RISK MERGER WITH AIR DECCAN
KFA ACQURIED THE DECCAN AIRLINES and entered the airdecans
international flying rights and thus simultaneously entered the cheaper market
segment.
It became the LARGEST AIRLINE IN INDIA WITH 27.5% MARKET
SHARE and increase in 30% domestic travel increase.HOWEVER DIDNT
MAKE ANY PROFITS..COMPARITIVELY JET AIRWAYS had shown
CONTINUOSLY PROFITABLE QUARTERS,
STRATEGIC RISK MERGER WITH AIRDECCAN
WITH THE MERGER OF AIRDECCAN IT LOST ITS BRAND IMAGE AS A
LUXURY AIRLINE
K
J
A
I
S
E
N
P
I
T
R
D
I
N
I
C
G
A
N
G
E
F
D
O
I
R
I
J
S
W
A
1
E
H
A
6
T
E
Y
1
.
R
S
5
7
1
%
3
1
1
.
8
5
4
.
%
2
%

20 | P a g e

STRATEGIC RISK INVESTMENT IN PLANES


366
DOMESTIC
FLIGHTS
AND
28 INTERNATIONAL FLIGHTS( AS PER REPORT ENDING 2011)
AIRCRAFT ENGINE /LEASE RENTALS STOOD AT 984 CRORES(US
DOLLAR 197 MILLION)
12 MONTH PERIOD APRIL 2010 TO 2011MARCH.
FINANCIAL RISK EXCESSIVE DEBT
KINGFISHER AIRLINES POSTED 1027.39 CRORES LOSSES(US 205.95
MILLION DOLLARS)DEC 2011 QUARTER

NET WORTH NEGATIVE 3633.08 CRORE as of 31st march 2011.(US D


728.29 million dollars)

AT PRESENT TOTAL DEBT ESTIMATED


7057.08 CRORES ( USD 1414 MILLION DOLLARS) AND TOTAL
ACCUMLATED LOSSES OF 6000 CRORES (1202 MILLION USD)
OPERATIONAL RISK COST ANALYSIS

2DE 2XU 7PE 4E TN C O D R ICOT UUR MRE SEU LDO A UN T RI AV I NE R G CI M R1 PA2 A F MCT TO F NOU TEF HL C : UP : ES RT IO O M D S 2 D 0 U1 0T Y - 1 1 M A R C H
SAO ACN LC AEO SC U C TN OA T XU I N N GB T U FO R O F D R SE 2HN 8A %R P O I FN CT RO ET AA SL E L OI N S SI N E TS E R N A T I O N A L F U E L P R I C E S
IOS N AN D L IAE A CS N C T CAOA VUUX ISNA TBT OIU OO MR NF DS SHE HNI T A MR PO RI N E C AR DE AV ES ER S I NE L IY N T E R N A T I O N A L F U E L P R I C E S
EI2 N X2 D 7P IE4 A N NC D R AC I OTVU URISA RE T SEOI MDO N UNS HR A I NTI R G MC RO1 A2R F EMT AO F DNU VET EHL R: P:S E E R L YI O D 2 0 1 0 - 1 1 M A R C H
21 | P a g e

MESSED UP MERGERS
All the full-service boys messed up their mergers. Coincidentally, all three
Jet, Kingfisher and Air India went in for acquisitions and mergers in 200708. While Jet bought Sahara, Kingfisher bought Air Deccan and Air India
merged with Indian Airlines. The traditional logic of mergers is cost savings
and synergy, where two and two equals five. The management ignored the
warning signs of stormy weather and failed to navigate the company into
safety.
THE CBI ON TRACK NOW:
CONCLUSION: Running an airline in India is a mugs game. Once defined as the
simple business of getting bums on seats more bums means better bottom line
the way the Indian industry is being run, one wonders if the bums are paying
enough for the seats they sit on. Almost paradoxically despite their continual
shrinkage in the domestic market, Kingfisher has continued to post solid, if
unspectacular operating figures in the domestic market. Kingfisher plans to increase
revenues through more efficient operations, while simultaneously controlling costs by
shedding some realty assets (including its Mumbai corporate office), entering sale
and leasebacks for some Airbus aircraft, and switching some high-cost rupee loans
into low-cost foreign currency loans. There has also been speculation the carrier will
permanently reduce its fleet of 66 aircraft (the same level as Jun-2010) to 35 aircraft.
Kingfisher Airlines is also working aggressively with a consortium of banks, which
hold a 23% stake in the company, to further reduce interest costs and raise working
capital
The Central Bureau of Investigation (CBI) is investigating a loan made by
state-run
IDBI
Bank
Ltd(IDBI.NS)
to
debt-laden
Kingfisher
Airlines(KING.NS) worth 9.5 billion rupees ($155.38 million), a police
spokeswoman said on Saturday.
The crime fighting agency is looking into why the loan was approved when the
airline has a negative net worth and a negative credit rating
The CBI has registered a preliminary inquiry to inquire into the role of IDBI
and Kingfisher Airlines .
22 | P a g e

"There was no need for the bank to take the exposure outside the consortium
when already other banks' loans were getting stressed."
A preliminary inquiry is usually the first step before a formal case is filed.
Kingfisher Airlines, controlled by liquor baron Vijay Mallya, has not flown in
almost two years and owes about $1 billion to a consortium of mostly state-run
banks, and hundreds of millions of dollars more to airports, tax authorities and
others.
CORPORATE FRAUDS AND CBI
According to more than three-fourths of the respondents, the incidence of fraud
has increased in the country in this last one year. But the fact that around twothirds of the respondents said that scams and corporate frauds were unearthed
because of legislations such as the Right to Information Act (RTI) and Public
Interest Litigation (PIL) speaks volumes about public awareness in India.
Two-thirds of India's bank assets are controlled by state-run banks, which in
turn account for three-quarters of the sector's bad loans.
Last week, CBI arrested Sudhir Kumar Jain, the chairman of state-run
Syndicate Bank Ltd (SBNK.NS) over allegations that he was seeking bribes to
favour debtors.
(1 US dollar = 61.1400 Indian rupee)
GUIDELINES FOR REPORTING FRAUDS TO POLICE/CBI
6.1 Private sector banks (including foreign banks operating in India) should
follow the following guidelines for reporting of frauds such as unauthorised
credit facilities extended by the bank for illegal gratification, negligence and
cash shortages, cheating, forgery, etc. to the State Police authorities:
In dealing with cases of fraud/embezzlement, banks should not merely be
actuated by the necessity of recovering expeditiously the amount involved, but
should also be motivated by public interest and the need for ensuring that the
guilty persons do not go unpunished.

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Therefore, as a general rule, the following cases should invariably be referred


to the State Police:
a. Cases of fraud involving an amount of `1 lakh and above, committed by
outsiders on their own and/or with the connivance of bank staff/officers.
b. Cases of fraud committed by bank employees, when it involves bank
funds exceeding `10,000/-.
Cases to be referred to Local Police
Cases below ` 300 lakh Local Police.
Cases of financial frauds of the value of `1 lakh and above, which involve
outsiders and bank staff, should be reported by the Regional Head of the bank
concerned to a senior officer of the State CID/Economic Offences Wing of the
State concerned.
Cases of frauds above `10,000/- but below ` 1 lakh should be reported to the
local police station by the bank branch concerned.
All fraud cases of value below `10,000/- involving bank officials, should be
referred to the Regional Head of the bank, who would scrutinize each case and
direct the bank branch concerned on whether it should be reported to the local
police station for further legal action.
6.3 Filing of Police complaint in case of fraudulent encashment of
DDs/TTs/Pay Orders/Cheques/ Dividend Warrants, etc.
6.3.1 In case of frauds involving forged instruments including those cleared
under CTS, the paying banker has to file the police complaint and not the
collecting banker.
REPORTING CASES OF THEFT, BURGLARY, DACOITY AND BANK
ROBBERIES
7.1 Banks should arrange to report by fax / e-mail instances of bank robberies,
dacoities, thefts and burglaries to the following authorities immediately on
their occurrence.
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The General Manager, Reserve Bank of India, Central Fraud Monitoring Cell,
Department of Banking Supervision, 10/3/8, Nruputhunga Road, P.B. No. 5467
Bengaluru 560001.
Regional Office of the Department of Banking Supervision, Reserve Bank of
India under whose jurisdiction the Head Office of the bank falls.
Financial Conglomerate Monitoring Division (FCMD) in respect of 12 large
banks in the country under whose jurisdiction the Head Office of the bank
falls. The names of which are given in Annex.
Regional Office of Reserve Bank of India, Department of Banking
Supervision, Reserve Bank of India, under whose jurisdiction the affected bank
branch is located to enable the Regional Office to take up the issues regarding
security arrangements in affected branch/es during the State Level Security
Meetings with the concerned authorities (endorsements).
The Security Adviser, Central Security Cell, Reserve Bank of India, Central
Office Building, Mumbai 400001.
Ministry of Finance, Department of Financial Services Government of India,
Jeevan Deep, Parliament Street, New Delhi.-110001.
The report should include details of modus operandi and other information as
at columns 1 to 11 of FMR 4.
7.2 Banks should also submit to the Reserve Bank, Department of Banking
Supervision, Central Fraud Monitoring Cell at Bengaluru as well as the
concerned Regional Office of the Reserve Bank/FCMD under whose
jurisdiction the banks Head Office is situated a quarterly consolidated
statement in the format given in FMR 4 (soft copy) covering all cases
pertaining to the quarter. This may be submitted within 15 days of the end of
the quarter to which it relates.
7.3 Banks which do not have any instances of theft, burglary, dacoity and / or
robbery to report during the quarter, may submit a nil report.

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