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CORPORATE GOVERNANCE

IN INDIA

Recent Developments in
Governance Practice in Indian Corporates

By
Dr. Bandi Ram Prasad1
Consultant, Economics & Financial Markets
+91 98201 59618
bandi.ramprasad@gmail.com

Introduction

Stock markets in the emerging markets and in particular India, experienced


exceptional growth in the recent years. In terms of market capitalization
India has already crossed $one trillion mark which it will soon catch up to
that level in regard to value of share trading as well. Indian companies are
showing robust growth in earnings and expansion enabling them to pursue
global acquisitions. Foreign institutional investment in Indian markets is on a
continuous surge, with the portfolio investment flows showing a dramatic rise
from about $1 bn in the early 1990s to $18 bn in 2007. India now accounts for
a major chunk of such flows to emerging markets.

The sustained growth of investor interest in Indian markets could be


attributed mainly to aspects such as prospects for higher domestic economic
growth, surge in corporate profits and performance, rigour and quality of
regulation in the financial markets and an extensive and effective
intermediation process.

Better practices in governance standards have been a major incentive for the
corporates to expand the scope of their operations and enhance the quality of

1
The paper draws inputs from a report on the subject prepared by the author for a national
institution. The author, a consultant in banking and securities markets was formerly with Bombay
Stock Exchange as Chief Knowledge Officer and Indian Banks’ Association as Chief Economist and is
currently a senor consultant with the Economic Analysis Group of the Dun and Bradstreet Information
Services India Pvt. Ltd.

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performance that equipped them to engage intensely with the global and
domestic financial markets in pursuit of further growth, diversification and
value realization.

Rapid growth of financial markets set a strong background for good


governance. As financial markets expanded on the back of growing domestic
and global investment, governance standards became a key determinant for
investing in corporates. Well governed companies found it easier and cost
effective to access public equity markets for resource mobilization that
helped them expand the scope and significance of the business.

Global IPO issuance was $246 bn in 2006 and $255bn in 2007. 14 of the top 20
issues in 2007 belonged to the BRIC (Brazil, Russia, India and China) markets
that raised over $106bn compared to $90bn in 2006. China alone raised $57
bn in 2006 and $55 bn in 2007. In India, companies raised about $8 bn in each
of the last two years from the public equity markets.

It is not only issuance of fresh capital that received a big boost, but equally
remarkable was the growth of secondary markets for securities leading to
record levels of market capitalization. During the ten year period 1996-2006,
market capitalization in the North America rose from $8.9 trillion to $23
trillion, in Europe/Middle East/Africa from $5.1trillion to $16.2 trillion and in
the Asia Pacific $ 5 trillion to $11.8 trillion. Huge levels of capital flows to
the equity markets in several emerging markets led to rapid rise in
investments made in companies from emerging markets. The flow of net
foreign direct investment (FDI) into developing countries increased from
$170bn in 1998 to $325 bn in 2006 and net portfolio equity flows increased
from $6bn to $94 bn during the same period. Net portfolio equity flows to
China between the year 2000 and 2006 rose from $6.9 bn to $32 bn and in
India from $2.3 bn to $8.7 bn. In the first ten months of 2007 alone, foreign
institutional investment flows into India peaked to about $18bn making it one
of the most favored destination for global portfolio flows.

Global capital flows speeded up on the back of growing institutional


investment. Institutional investors have been the major source of capital
markets growth in the recent period. During the period 1995 and 2005, the

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assets under management of the institutional investors doubled from $21trn
to $53 trn. The shift of home bias of the institutional investors into emerging
markets stepped up the resource flows to the developing countries. For
instance in the United States, in 1994, pension funds invested 41 percent of
their portfolio in domestic equity and 7 percent in international equities,
where as by 2005 that share rose to 48 percent in domestic equities and 15
percent in international equities. The portfolio allocation to bond markets
during the same period reduced from 42 percent to 32 percent. Emerging
markets received sizeable portion of the investments. In the US the dedicated
Emerging Market mutual funds rose from about $27 bn in 2000 to $ 230 bn in
2006.

In India too, the merger and acquisition activity increased substantially.


Where as, the foreign acquisitions in India rose from $2.9 bn in 2005 to $28 bn
in 2007, Indian acquisitions abroad rose from $1.5 bn to $18.1bn during this
period. In addition to technology companies such as Infosys, Wipro and TCS,
major Indian corporates who conducted sizeable cross border mergers by
acquiring foreign target companies included; Tata, Suzlon, Bharat Forge,
Ranbaxy, Hindalco, United Breweries etc. In the first three quarters of the
year 2007, Indian companies announced 150 foreign acquisitions with a total
value of $18.1 bn, a four fold increase of the total value in 2005. A survey of
340 of the world’s largest manufacturers, by the Paris based Capgemini
Consulting revealed that India could challenge China as the leading
manufacturing center of the world in the next three to five years.

This paper presents a short outline of the progress made in India in regard to
corporate governance in terms of policy and direction, processes and
practices. The paper is organized in the following manner

1. Global View
2. Definitions of Corporate Governance
3. Evolution of Corporate Governance
4. Review of Literature
5. Assessment on Corporate Governance in India
6. Concepts and Principles in Corporate Governance in India
7. Corporate Governance Practice in India

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8. Recent Trends in Corporate Governance in India
9. Emerging Challenges
10. Looking Ahead

1. Global View

A recent assessment (September 2007) 2 on the implementation standards of


corporate governance on a sample of about 1600 companies worldwide,
Ethical Investment Research Services (EIRIS), a UK based leading global
provider of independent research into the social, environmental and
governance (ESG) performance of companies that tracks performance of
about 3000 companies across the world, has brought out some interesting
insights. These include;

• 62% of the companies studied have boards containing more than a


third of independent directors. However the proportion of
independent directors varies greatly between countries. Over 90% of
companies in North America, UK, Switzerland, the Netherlands,
Norway, Finland and Australia have more than a third of
independent directors, compared with less than 10% in Germany,
Austria and Japan

• Disclosure of directors’ remuneration is consistently high, with 96%


of all companies disclosing this information.

• In half of the countries studied, over 90% of companies separate


the roles of chair and chief executive. However rates of separation
are lower in the US (30%), Japan (54%) and France (56%).

• These differences are driven by the fact that companies largely


adhere to their relevant national Corporate Governance guidelines

• However corporate governance practices are converging.


Governance codes are being revised to improve the levels of

2
The EIRIS Foundation is a UK based charity that supports ethical investment

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transparency and independence, and the proportion of companies
adopting western models of board structure is increasing.

• Significant improvements was evident in respect of gender


empowerment and representation in the boards as also corporate
social responsibility and environment.

• Increasingly, companies view equal opportunities less as a way to


avoid criticism or lawsuits, but more as a means to build reputation
and gain competitive advantage by accessing a broader skill set.

• Around 90% of companies in North America (94%), Europe (88%) and


Australia/New Zealand (87%) have basic or advanced equal
opportunities policies. Conversely, just over 50% of Japanese and
less than 25% of companies in Asia ex-Japan meet these standards.
The pattern is slightly different for equal opportunities management
systems. The criterion includes disclosure of staff demographics in
relation to women and ethnic minorities as well as the presence of
flexible working policies. Europe and Australia/New Zealand both
perform well, with around 80% and 70% respectively, demonstrating
at least basic systems. Performance amongst Japanese companies is
also strong at 60%, whereas it is weaker amongst US companies
at 25%. In the US, companies are less inclined to disclose this
information, possibly due to fear of litigation.

• Worldwide, only 8.1% of board members are women.


Representation of women on the board continues to be lowest in
Japan at less than 1% and remains generally low in Mediterranean
countries. These low levels are driven by a mixture of cultural
factors including a history of fewer women in formal employment
combined with weak legislative encouragement.

• The highest rate of 33% is seen in Norway where the government


has enforced a quota for a minimum of 40% board members to be
women by the end of 2007. The number of women on the board is

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set to increase Spain as the Spanish government has recently
established a quota similar to that imposed in Norway.

 The developments as discussed above lead to and envisage greater


thrust on the quality of governance.
 Corporate governance is catching up fast as a major instrument of
corporate reform in several countries
 Good governance emerged as a major incentive for corporate growth
and in pursuing global business aspirations
 Good companies are going beyond the mandatory requirements in
adopting best practices in governance
 Greater interaction and sharing of knowledge is gaining ground
across countries in setting effective governance frameworks
 Disclosure and transparency are emerging as the key determinants of
good governance
 As the financial markets grow and the developing countries
corporations increasingly explore global financial markets for
resources and business, harmonization of the corporate governance
increases and intensified

2. Definition and Recent Evidence

Corporate governance has been defined by scholars and market practioners as per
the perspective with which they were analyzing the subject. The practioner’s
point of view that was powerfully conveyed was that of N.R. Narayana Murthy,
Chairman, Committee on Corporate Governance, Securities and Exchange Board of
India, 2003 and he himself a highly successful and globally acclaimed entrepreneur
who built Infosys on the premise and foundations of a strong corporate governance
“The term “corporate governance”, is susceptible both to broad and narrow
definitions. In fact, many of the codes do not even attempt to articulate what is
encompassed by the term. The important point is that corporate governance is a
concept, rather than an individual instrument. It includes debate on the
appropriate management and control structures of a company. Further, it includes
the rules relating to the power relations between owners, the Board of Directors,

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management and, last but not least, the stakeholders such as employees,
suppliers, customers and the public at large:”.

From a policy perspective and from who chaired the first ever influential and
widely discussed report on the subject, Adrian Cadbury, the author of the Cadbury
Report, said “In its broadest sense, corporate governance is concerned with holding
the balance between the 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 interest of the individuals,
of corporations and of society. The incentives to corporations and those who own
and manage them to adopt internationally accepted governance standards is that
these standards will assist them to achieve their aims and to attract investment.
The incentive for their adoption by states is that these standards will strengthen
their economies and encourage business probity”.

From a regulatory point of view Arthur Levitt, former chairman of the Securities
and Exchange Commission, United States emphasized the importance of the
corporate governance as “If a country does not have a reputation for strong
corporate governance practices, capital will flow elsewhere. If investors are not
confident with the level of disclosure, capital will flow elsewhere. If a country opts
for a lax accounting and reporting standards, capital will flow elsewhere. All
enterprises in that country- regardless of how steadfast a particular company’s
practices may be-suffer the consequences. Markets exist by the grace of investors.
And it is today’s more empowered investors that will determine which companies
and markets will stand the test of time and endure the weight of greater
competition. It serves us well to remember that no market has a divine right to
investors’ capital”.

Organization of Economic Cooperation and Development (OECD) which spearheaded


the design and development of corporate governance principles and guidelines,
from a global perspective defined it as” Corporate governance involves a set of
relationships between a company’s management, its board, its shareholders, and
other stakeholders. Corporate governance also provides the structure through
which the objectives of the company are set and the means of attaining those
objectives and monitoring performance are determined”

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An institutional point of view presented by Ira Millstein, who worked on drafting
the OECD corporate governance guidelines as also the co-chairman of the NYSE-
NASDAQ constituted Blue Ribbon Committee3 (1998) that looked into important
aspects of the audit committees, defined “ Corporate governance refers to that
blend of law, regulation and appropriate voluntary private sector practices which
enables the corporation to attract financial and human capital, perform efficiently
and thereby perpetuate itself by generating long term economic value for its
stakeholders, while respecting the interests of stakeholders and society as a
whole”.

From an academic perspective based on extensive surveys and studies on the


subject, Shleifer and Vishny (1997) define corporate governance as the ways in
which suppliers of finance to corporations assure themselves of getting a return on
their investments; Zingales (1998) views governance systems as the complex set of
constraints that shape the ex post bargaining over the quasi-rents generated by the
firm; Gillan and Stakes (1998) define corporate governance as the system of laws,
rules, and factors that control operations at a company.

To sum up, the important message of the need for a good corporate governance is
well articulated by M. Damodaran, Chairman, Securities and Exchange Board of
India, who spearheaded introduction of most significant reforms in the Indian stock
markets, including the October 2007 guidelines on the Participatory Notes (PNs)
observed “There are those who will tell you that business and ethics cannot stand
together. In the short run, it might appear that company pay a price for adhering
to values while their competitors get ahead in a shorter time frame, but in the long
run people would learn to distinguish, stakeholders learn to ask the right questions
and distinguish between the grain and chaff. Those that don’t subscribe to values
will fall by the way side; those that subscribe to values will last the course and will
set benchmarks”.

3. Evolution of Corporate Governance


3
Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of the
Corporate Audit Committees. NYSE and NASDAQ, 1998.

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The roots of the recent developments in the corporate governance could be traced
to Treadway Commission (1985), United States which found that inadequate
internal controls lead to financial failures, which later led to the Commission
defining objectives of the internal controls which are; (a) effectiveness and
efficiency of operations (b) reliability of financial reporting and (c) compliance
with laws and regulations and (d) safeguarding of assets.

The evolution of the corporate governance guidelines in the global context and
from the perspective of progress made in India is given in the chart below.

Table 1: Recent Evolution of the Corporate Governance

Cadbury Report, United The objective of the Cadbury committee was to investigate
Kingdom 1995 how large public companies should adopt corporate
governance guidelines with a focus on the procedures of
financial report production and the role of the accounting
profession. Issues included the role of the board of
directors, standards of financial reporting, accountability of
the auditors and directors pay.

Greenbury Report, United The report dealt with the remuneration of executives and
Kingdom, 1995 non-executives board members and recommended the
setting up of a remuneration committee in each public
company to determine remuneration packages for the
board members. It also provided suggestions on the
disclosure of remuneration and the setting up of
remuneration policy and service contracts and
compensation.
Hampel Report, United Four major issues were discussed with practical guidelines
Kingdom, 1998 offered; (a) the role of directors (b) directors compensation
(c) the role of shareholders (d) accountability and audit.
CII Voluntary Code of The first of the voluntarily evolved codes in India.
Corporate
Governance,1998
Kumara Mangalam Birla The mandatory recommendations of the Kumar Mangalam
Committee, India, 1999 committee include the constitution of Audit Committee and
Remuneration Committee in all listed companies,
appointment of one or more independent directors in them,
recognition of the leadership role of the Chairman of a
company, enforcement of Accounting Standards, the
obligation to make more disclosures in annual financial
reports, effective use of the power and influence of
institutional shareholders, and so on. The Committee also
recommended a few provisions, which are non- mandatory.
Sarbanes-Oxley Act, 2002 A major initiative of corporate compliance, the Sarbanes-

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Oxley Act of 2002, is also known as the Public Company
Accounting Reform and Investor Protection Act of 2002 is a
US federal law that has main features such as ;
establishment of the Public Company Accounting Oversight
Board (PCAOB), auditors independence, corporate
responsibility, enhanced financial disclosures, analyst
conflict of interest, commission resources and authority,
corporate and criminal fraud accountability, while collar
crime penalty enhancement, corporate tax returns and
corporate fraud accountability.
Higgs Report, 2003 On non-executive directors.
Smith Report, 2003 On Audit Committees.
Narayana Murthy The key mandatory recommendations focus on
Committee, 2002 strengthening the responsibilities of audit committees;
improving the quality of financial disclosures, including
those pertaining to related party transactions and proceeds
from initial public offerings; requiring corporate executive
boards to assess and disclose business risks in the annual
reports of companies; introducing responsibilities on boards
to adopt formal codes of conduct; the position of nominee
directors; and stock holder approval and improved
disclosures relating to compensation paid to non-executive
directors. Non-mandatory recommendations include moving
to a regime where corporate financial statements are not
qualified; instituting a system of training of board
members; and the evaluation of performance of board
members.
Naresh Chandra The auditor-company relationship, Auditing the auditors
Committee,2003 Independent directors: Role, remuneration and training.
OECD Principles,2004 The OECD Principles cover five aspects of governance (a)
the rights of shareholders (b) the equitable treatment of
shareholders (c) the role of stakeholders (d) disclosure and
transparency (e) the responsibilities of the board.
Clause 49 of the Listing
Agreement, 2005 A major compliance directive that came into force from the
quarter ended June 2005, it has major aspects of
compliance by listed companies that include; definition of
independent directors; Non-Executive Director’s
compensation and disclosures, other provisions as to Board
and Committees, Code of Conduct, Composition of Audit
Committee, Meeting of Audit Committee, Subsidiary
Companies, Disclosures pertaining to (a) basis of related
transactions (b) accounting treatment (c) risk management
(d) proceeds from public/rights/preferential issues
(e) remuneration of directors and management discussion
and analysis, CEO/CFO Certification, report on corporate
governance, auditors certificate on compliance etc.

The current structure of the corporate governance in India as evolved in the recent
years is as below.

Table 2 : Major features of the Corporate Governance in India


Legal Framework Companies Act, 1956 and Clause 49 of the Listing
Agreement of Stock Exchanges
Voting Rights All shareholders have the right to vote. Proxy voting

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allowed. Companies allowed to issue shares with
multiple voting rights or dividends
Firm Capital Structure Requires board/shareholder approval to change
capital structure. A merger needs 75% of the
shareholder vote
Shareholder Meetings It is required to hold AGM every year. Allows
shareholders controlling 10% of voting rights or paid
up capital to call a special or Extra Ordinary
General Meeting
Board Structure One third of the board should be non executive and
a majority of these independent. In case where the
Chairman of the board is an executive, 50 % of the
board be comprised of independent directors
Board Meetings The Board should meet at least four times a year.
33% of the board members or two members,
whichever is greater, be present. All fees and
compensation paid to the non-executive directors
require prior approval of the shareholders in the
AGM
Election of Directors The directors of the Board be approved and
appointed by the company in the Annual General
Meeting.
Board Committees Every board is required to have a shareholder
grievance committee and an audit committee.
Remuneration committee is non-mandatory
Disclosure Every company to have a compliance officer
responsible for setting policies, procedures and
monitoring adherence. SEBI has established an
insider trading committee to monitor the same.
Companies required to disclose information through
annual reports/websites etc.,Management
Discussion Analysis, a part of the Annual Report
Accounting Shareholders to appoint an independent auditor,
certified by Institute of Chartered Accountants of
India. Accounting standards comply with
International Accounting Standards (IAS) and
International Financial Reporting Standards (IFRS).
Companies conduct comprehensive audits annually.
Audit Committees Audit Committee to have a minimum of three
members, of which two-thirds be independent
directors and at least one members should have
accounting/finance background. Audit Committee
also reviewed internal control systems
Related Party Transactions Clause 49 required listed companies to disclose
material significant related party transactions to
shareholders.
Whistle Blower Policy Right of access to all employees. Direct access to
audit committee without informing the superiors.
Submissions Quarterly Compliance Report within 15 days from
the end of the quarter. (Format revised)
Annual Compliance by the separate section in the
Annual report. Compliance Certificate from the
auditors of the company.

Sources: Stock Exchanges, Institute of International Finance.

4. Review of Literature

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Early discussion on the governance rose from an analysis by Berle and Means 4 (1932)
following the Great Crash in the US in 1929, which traced the problem of
governance due to the separation of ownership and control. The authors
recommended stake holder value over the share holder value as essential for good
governance, a premise on which formal securities regulation began in the US with
the setting up of the Securities and Exchange Commission (1933). This debate led
the governance being associated with the agency problem {Coase, 1937) 5, (Jensen
and Meckling6, 1976), (Fama and Jensen7,1983) in which the essence is the
separation of ownership and control. Agency problem refers to the difficulties
financiers have in assuring that their funds are not expropriated or wasted on
unattractive projects(Shliefer and Vishny 8,1997) Early work in the corporate law
development in the 18th and 19th centuries in Britain, Continental Europe and Russia
had focused more on addressing to the problems of managerial theft rather than
that of shirking or even empire building. Shleifer and Vishny cite studies on vast
mangerialist literature that explains how managers use their effective control
rights to pursue projects that benefit them rather than investors which are
described as private benefits of control {Grossman and Hart 9,1982)} Managers can
expropriate shareholders by entrenching themselves and staying in the job even if
they are no longer competent or qualified to run the firm. Poor managers who
resist being replaced might be the costliest manifestation of the agency problem
(Jensen and Ruback10, 1983) Agency theory considered the firm as a nexus of
contracts; associating the firm and the entire group of resource contributors (the
team of productive inputs) and analyzing the relationship between the principle
(shareholders) and the agent (managers), the conceptual framework which is found
relevant even today. This perspective led to a wide range of studies relating to the
board of directors, share holders meetings, remuneration system for managers, the
legal and accounting regulations and takeover etc.

4
Berle A.A. and Means G.C.., The Modern Corporation and the Private Property, New York: MacMillan,
1932
5
Coase, Ronald (1937), The Nature of the Firm, Economica, 4, 386-405
6
Jensen, Micheal and William Meckling (1976), Theory of the Firm, Managerial Behaviour, Agency
Costs, and Ownership Structure, Journal of Financial Economics, 3, 305-60
7
Fama, Eugene and Micheal Jensen (1983b), Separation of Ownership and Control, Journal of Law and
Economcs, XXVI, 301-25
8
Shleifer, A.,and R.Vishny, 1997, A Survey of Corporate Governance, Journal of Finance, 52, 737-775
9
Grossman, Sanford., and Oliver D. Hart, 1982, Corporate Financial Structure and Managerial
Incentives, in John J. McCall, ed.: The Economics of Information and Uncertainty (University of
Chicago Press, Chicago, IL
10
Jensen, Michael and Richard Ruback,1983; The Market for Corporate Control: The Scientific
Evidence, Journal of Financial Economics, 11, 5-50

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With the enormous growth of financial markets, the interest on corporate
governance flows beyond the finance and extends to law, economic, politics,
sociology and management science.

Historical developments that impact the overall scope of the corporate governance
in different countries is discussed by Randall K. Morck, Lloyd Steir11 (2005) who
observed that financial disasters tainted French confidence in financial securities
early on, and set corporate governance in that country on a different parity from
that of Britain, where a similar trauma was overcome and forgotten. Similarly
historical trends such as imperial monopoly in China that was evident in the late
19th century, large scale trading networks belonging to particular communities and
ethnic and sectarian groups in India, family and bank controlled pyramidal groups
in Germany, Zeibatsu and Keiratsu in Japan and Chaebols in Korea etc., have
influenced the process of growth of corporate governance in the respective
countries. Certain features that are common to all countries that contributed to
the varying types and pace of the corporate governance norms include; Accidents
of history, ideas, families,business groups, trust, law, origins, evolution,
transplants, large outside shareholders, financial development, politics and
entrenchment, etc.

Ownership is a key driver that determines the quality of governance. The first of
the studies on the ownership of the global companies by Rafeal La Porta 12 shows
higher incidence of family ownership in global corporations that runs contrary to
the earlier observation of widely held corporations analysed by Berley and Means.
The study presents data on ownership structures of large corporations in 27
wealthy economies, making an effort to identify the ultimate controlling
shareholders of these firms. The study found that except in economies with very
good shareholder protection, relatively few of these firms are widely held. Rather,
these firms are typically controlled by families or the State. Equity control by
financial institutions or other widely held corporations is far less common. The
controlling shareholders typically have power over firms significantly in excess of
their cash flow rights, primarily through the use of pyramids and participation in
management ownership issues; particularly the predominance of family owned

11
Morck, Randall K, Steier, Llyod, 2005, the Global History of Corporate Governance, an Introduction,
NBER Working Paper No 11062, January 2005.
12
La Porta, Rafael, Florencia Lopez-de-Silanes, Andrei Shleifer and Robert Vishny, 1999, Corporate
Ownership Around the World, Journal of Finance (54(2), 445-70

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companies remains an important issue in several emerging economies and forms an
important aspect of the corporate governance reforms.

Franklin Yale and Dougles Gale13 (2002) discuss the term corporate governance that
is used in two distinct ways. In Anglo-Saxon countries like the US and UK good
corporate governance involves firms pursuing the interests of shareholders. In other
countries like Japan, Germany and France it involves pursuing the interests of all
stakeholders including employees and customers as well as shareholders. Anglo-
Saxon capitalism has been widely analyzed but stakeholder capitalism has not. The
authors argue that stakeholder capitalism can often be superior when markets are
not perfect and complete.

Paolo Fulghieri and Matti Suominen14 (2005) find that the quality of the corporate
governance system may have a significant impact on the economy’s level of
competition and its degree of industry concentration. Poor corporate governance
and low investor protection may in fact lead to high industry concentration.

Craig Doidge, G. Andrew Karolyi, and René M. Stulz 15 (2006) showed that the
incentives to adopt better governance mechanisms at the firm level increase with a
country’s financial and economic development. Further, these incentives increase
or decrease with a country’s investor protection depending on whether firm-level
governance mechanisms and country-level investor protection are substitutes or
complements. The study observes that when economic and financial development
is poor, the incentives to improve firm-level governance are low because outside
finance is expensive and the adoption of better governance mechanisms is
expensive.

A cross country study by Vidhi Chhaochharia and Luc Laeven 16 (2007) shows that
governance provisions adopted by firms beyond those imposed by regulations and
common practices among firms in the country have a strong, positive effect on firm
valuation. The study showed that, despite the costs associated with improving
13
Allen, Franklin, Gale, Douglas, 2002, A Comparative Theory of Corporate Governance, Financial
Institutions Center, Wharton University, 2002
14
Fulghieri, Paolo, Suominen, Matti, 2005, Does Bad Corporate Governance Lead to Too Little
Competition?, Finance Working Paper No. 74/2005, March 2005, European Corporate Governance
Institute.
15
Dodge, Craig, Karolyi, George Andrew, Stulz, Rene M, 2004, Finance Working Paper Ho. 50/2004,
European Corporate Governance Institute, Charles A. Dice Center Working Paper No.2004-16 and
Fisher College of Business Working Paper No.2006—03-008
16
Chhaochharia, Vidhi, Laeven, Luc, 2007, The Invisible Hand in Corporate Governance, Finance
Working Paper No. 165/2007, April 2007

14
corporate governance at the firm level, many firms choose to adopt governance
provisions beyond what can be considered the norm in the country, and these
improvements in corporate governance have a positive effect on firm valuation.

An Empirical analysis by Leora F. Klapper and Inessa Love 17 (2002) of the World
Bank showed that better corporate governance is highly correlated with better
operating performance and market valuation. They provide the evidence that firm
level corporate governance provisions matter more in countries with weak legal
environments. The results suggest that firms can partially compensate for
ineffective laws and enforcement by establishing good corporate governance and
providing credible and investor protection.

Good corporate governance commands high premium 18. A CLSA April 2003 study
showed that over the past five years, high CG stocks (ranked in the 1st quartile)
outperformed the Sensex by 169%. The out-performance was at over 40% even if
one excluded the software stocks. A study by Wolfganag Dorbetz, University of
Basel showed that an investment strategy that bought high-CGR firms and shorted
low CGR firms would have earned excess returns of 12% compared to the DAX 100
during 1998-2000. A Lipper-GMI Mutual Fund Report showed that Mutual funds that
invest in companies with higher CG ratings have been rewarded with superior
returns

According to a Harvard Law School study 19, the disregard for shareholder rights
caused lower firm valuations to the extent of 7 percent per annum and large
negative abnormal returns during the 1990-2003 period; A Deutsche Bank research
showed that European companies with improving governing standards outperformed
a portfolio of deteriorating companies by 4.4 per annum. A joint study of the
European Corporate Governance Institute and London Business School showed that
the governance focused Hermes UK Focus Fund outperformed its benchmark by an
average 4.8% each year from 1999 through 2004. The CLSA/ACGA Governance Score
for 27 countries confirms that firms with better governance outperform
significantly even in bull markets when governance usually has a lower priority with
investors. All these show positive effects of the good governance A 2002 McKinsey

17
Klapper, Leora F, Love, Inessa, 2002, Corporate Governance, Investor Protection and Performance
in Emerging Markets, Policy Research Working Paper 2818, Development Research Group, The World
Bank.
18
Corporate Governance Ratings and Audit, a presentation by ICRA, October, 2004
19
Bebchuk, Lucian, Cohen Alma, Ferrell, Alma, 2005, What Matters in Corporate Governance,
Discussion Paper No. 491., revised 03/2005, Hardvard Law School, Cambridge, MA

15
Survey revealed that investors then were willing to pay a premium of 23% for well
governed companies in India which in the recent time came down to 5 to 10
percent due to overall improvement in the governance standards.

Christian Leuz, Karl V. Lins, Francis E. Warnock 20 (2006), in their study using a set
of foreign holdings by U.S. investors as a proxy for foreign investment that
analysed a sample of 4,411 firms from 29 emerging market and developed
economies found that, foreigners invest significantly less in firms that are poorly
governed, i.e., firms that have ownership structures that are more conducive to
outside investor expropriation Interestingly, this finding is not simply a matter of a
country’s economic development but appears to be directly related to a country’s
information rules and legal institutions. The authors argue that information
problems faced by foreign investors play an important role in this result.
Supporting this explanation, they argue that foreign investment is lower in firms
that appear to engage in more earnings management.

An event study by Bernard Black & Vikramaditya Khanna 21 (2007) showed that good
corporate governance benefits faster growing firms (esp. mid sized ones) than
others and cross-listed firms get the benefit more than others.

Alexander Dyck, Adair Morse, Luigi Zingales 22(2007)examine how external control
mechanisms are most effective in detecting corporate fraud. The authors study in
depth all reported cases of corporate fraud in companies with more than 750
million dollars in assets between 1996 and 2004 and found that fraud detection
does not rely on one single mechanism, but on a wide range of, often improbable,
actors. Only 6% of the frauds are revealed by the SEC and 14% by the auditors.
More important monitors are media (14%), industry regulators (16%), and
employees (19%). Before SOX, only 35% of the cases were discovered by actors with
an explicit mandate. After SOX, the performance of mandated actors improved,
but still account for slightly more than 50% of the cases.

20
Leuz, Christian, Lins, Karl V, Warnock, Francis E., 2006, Do Foreigners Invest Less in Poorly
Governed Firms, Finance Working Paper No. 43/2004, Revised version: April 2006, European
Corporate Governance Institute
21
Black, Bernand S, Khanna, Vikramaditya S., Can Corporate Governance Reforms Increase Firms’
Market Values? Event Study Evidence from India, Havard Law School
22
Dyck, Alexander, Morse, Adair, Zingales, Luigi, 2007, Who Blows the Whistle on Corporate Fraud,

16
The Board and its committees are the key instruments in driving the scope,
significance, quality of the governance in the companies. A board is defined as a
group of individuals that are elected as, or elected to act as, representatives of the
stockholders to establish corporate management related policies and to make
decisions on major company issues. Such issues include; the hiring/firing of
executives, dividend policies, options policies and executive compensation. Every
public company must have a Board of Directors. The Board of Directors should be a
fair representation of both management and shareholder's interests, because too
many insiders serving as directors would mean that the board will make decisions
more beneficial to management. On the other hand, too many independent
directors may discourage management of decision-making process that may
demotivate good managers.

The board structure can be in the form of unitary board, dual board and mixed
board. US has the unitary board structure so as in India. Other countries where
unitary board structures are prevalent included, Australia, Brazil, Canada, Egypt,
India, Italy, Japan, Malaysia, Norway, Philippines, Singapore, South Africa, South
Korea, Sweden, Thailand, Turkey,U.S., Ukraine, United Kingdom, Zimbabwe. Dual
board structure where share holders elect a supervisory board that in turn appoints
and supervises a management board, are more prevalent in European countries
such as Germany, Austria, Belgium, China, Croatia, Czech Republic, Denmark,
Estonia, Georgia, Germany, Holland, Indonesia, Latvia, Mauritius, Poland, Spain,
Taiwan, where as mixed board structures are more evident in countries like
Bulgaria, Finland, France, Switzerland.

In the aftermath of several codes of corporate governance coming into force in


several countries, the Board and its various committees, in particular the role and
functions of the Audit Committee have been extensively implemented and
analysed. This chapter discusses major aspects in regard to the board in various
aspects of composition, structure, independence, as also one of the most
importance committees of the board, namely the Audit Committee.

Recent academic and analytical exercises on the various aspects of the board of
directors, shows that (a) board size and independence have increased since SOX
(Chhaochharia and Grinstein23, (2005)} (b) Busy boards donot harm shareholder

23
Chhaochharia, Vidhi, Yaniv Grinstein, 2005, Corporate Governance and Firm Value: The Impact of
2002 Governance Rules, Working Paper, Cornell University.

17
wealth (Ferris, Jagannathan and Pritchard 24, (2003) (c) Board’s ability to monitor is
compromised at firms with several busy directors (Fich and Shivdasani 25,2004)
(d) cozy board relationships limit effective monitoring (Larcker, Richardson, Tuna
and Seary26, 2005) (d) financial expertise on boards limits the likelihood of
accounting restatements (Agrawal and Chadha 27, 2005) (e) market attaches more
credibility to earnings announcement when boards and audit committees are both
independent and active (Booth, Deli, 28 1999) (f) presence of commercial bankers on
boards is associated with the size of loans, whereas on the presence of investment
bankers is associated with more frequent outside financings and larger public debt
issues (Guner, Melmendier and Tate29 (2005) (g) presence of financial experts does
not necessarily improve shareholder value (h) Excess compensation paid to
directors is associated with excess CEO compensation (Brick, Palmon and Wald 30)
(i) Excess compensation is associated with poor future performance (j) excess
compensation for directors compromise their independence and leads to
overpayment of CEOs (k) proportion of outside directors, the number of board
meetings and the tenure of the board chair are associated with the incidence of
fraud (Chen, Firth, Gao, and Rui31).

The board structure indicates risk elements on the evident of the following trends.

 Chairman not independent upon appointment


 Less than half of the board are non-executives
 Board turnover has been greater than 25% over the previous year or more
than three new people (excluding internal promotions) have joined the
board in the same period
 Fewer than three executive directors
 No senior independent director on the board

24
Ferris, Stephen P., Murali Jagannathan and A.C. Pritchard, 2003, Too Busy to Mind the Business?
Monitoring by Directors with Multiple Board Appointments, Journal of Finance, 58, 3, 1087-1112.
25
Fich, Eliezer and Shivdasani Anil,, 2004, Are Busy Boards Effective Monitors? Finance Working Paper
No. 55/2004, European Corporate Governance Institute
26
Larcker, David F., Scott A. Richardson, Andrew Seary and A. Irem Tuna, 2005, Back Door Links
Between Executives and Executive Compensation, Working Paper, The University of Pennsylvania.
27
Agrawal, Anup and Chedda, Shaiba, 2005, Corporate Governance and Accounting Scandals, Journal
of Law and Economics.
28
Booth, James, Deli, Daniel N, 1999, On Executives of Financial Institutions as Outside Directors,
Journal of Corporate Finance 5, 227-250.
29
Guner, A. Burak, Ulrike Malmendier,m Geoffrey Tate, 2005, The Impact of Board with Financial
Expertise on Corporate Policies, Working Paper, Stanford University.
30
Brick, Ivan E., Oded Palmon and John Wald, CEO Compensation, Director Compensation and Firm
Performance, Evidence of Cronyism.
31
Chen, Firth, Gongmeng Gao and Rui, Ownership Structure, Corporate Governance and Fraud:
Evidence from China.

18
 Chairman of the company chairs audit committee
 Executives on the audit committee.
 Remuneration risk indicators:
 Any Insight votes against or abstentions on the company’s remuneration
report in the past three years
 Any Insight votes against or abstentions on the company’s share schemes in
the past three years.

Board evaluation forms an important aspect of assessing the performance as also


sharing important aspects that will lead to better functioning of the board. Board
performance review is emerging as an important aspect of strengthening the board
structure and performance.

Another aspect assuming importance in regard to the board structures in particular


its composition, is the representation of women. Gender equality in boards is
assuming significance, though women representation in the boards remains at very
low levels in many countries. Norway made a major breakthrough in this regard by
introducing from January 2003, that enterprises that are subject to statutory audit
to prepare an annual report are required to be specific in that report the state of
the gender equality in that enterprise and what measures have been or planned to
be implemented to promote gender equality. The percentage of women on the
boards increased from 6 percent in 2004 to 25 percent by January 2007. and thirty
eight percent of the 500 odd public limited companies in the private sector were
able to fulfill the gender requirements in the board. Special databases have been
created to find companies find competent women as board directors and several
activities to promote women participation in the boards such as arranging training
courses to develop women directors are being carried out. Stringent action is
provided for companies not complying with women representation in the board.
The Public Limited Companies Act, the Norwegian law provides for the liquidation
and dissolution of the company found failing to meet the statutory requirements
regarding women representation in the board.

5. Assessments on Corporate Governance in India

19
From the year 2003 onwards CLSA and Asia Corporate Governance Network 32
together collaborated in bringing performance scores of countries in the Asian
region in regard to corporate governance. The first of the report, CG Watch 2003,
had an interesting title, “Faking It : Board Games in Asia “ perhaps most
appropriate at that time in the background of global meltdown of stock markets
brought about by severe inadequacies and abuses in corporate conduct and
disclosure standards. The 2004 report had a more promising title “Spreading the
Word. Changing Rules in Asia “reflecting changing landscape of the corporate
governance brought out in the backdrop of Sarbanes-Oxley and a host of regulatory
reforms that came into being in a number of countries. The CG Watch 2005 had the
title “Holy Grail: Quality at Reasonable Price (QARP) showing growing commitment
towards, better corporate governance. The 2007 report had a much more
encouraging theme “On a Wing and a Prayer: Greening of the Governance” that
brought out the significant changes in the corporate governance practice in the
Asia region. The 2007 survey assessed the quality of corporate governance in Asian
markets that included Japan for the first time, and provided aggregate data from
582 companies in the region.

Corporate governance scores improved sizeably in many countries of Asia. India


now ranks third after Singapore and Hong Kong in regard to performance in
corporate governance. The slight decline in the 2007 score is not due to lowering of
standards but due to inclusion of a larger number of parameters for evaluation,
that was common to all the countries. The 2007 study has also included Japan in
among the countries assessed. The “CG Watch 2007” has this to say on the quality
of governance standards in India “A large population (hence low GNI per-capita);
economic reform started much later than China (1991) vs 1978); yet corporate
governance reform started early by regional standards (1998) and the country
has some pockets of world-class corporate governance”.

32
Allen, Jamie, 2007,.The Benefits of Corporate Governance to Emerging Economies, Asian Corporate
Governance Network.

20
Table3 : India ranks high among Asia governance league tables

Country33 2000 2001 2002 200334 200435 200536 2007


Singapore 75 74 74 77 75 70 65
Hong Kong 71 68 72 73 67 69 67
India 56 54 59 66 62 61 56
Malaysia 32 37 47 55 60 56 49
Taiwan 57 53 58 58 55 52 54
Korea 52 38 47 55 58 50 49
Thailand 28 37 38 46 53 50 47
Philippines 29 33 36 37 50 48 41
China 36 34 39 43 48 44 45
Indonesia 29 32 29 32 40 37 37

Source: “CG Watch”, a joint report by CLSA Asia- Pacific Markets and ACGA.

Table 4: Matching Rules and Regulations


Question China HK India Indo SKorea Mala Phil Sing Tai Thai
nesia ysia
Is quarterly Yes No Yes Yes Yes Yes Yes Yes Yes Yes
reporting
mandatory
Are Auidt Yes Yes Yes Yes Some Yes Yes Yes No Yes
committees
mandatory?
Must Yes Yes Yes Some Yes Yes Yes Yes Som Yes
ownership e
stakes above
5% be
disclosed?
Detailed Some Yes Yes Some Yes Yes Yes Yes Yes Yes
disclosure of
material
transactions?
Is the Yes Yes Yes Some Yes Yes Yes Yes Yes Yes
national code
of CG based
largely on
International
standards?

Is there n Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
national
policy to
converge with

33
Ranked in descending order according to 2005 score
34
First year in which ACGA collaborated with CLSA
35
Introduced more rigorous scoring methodology in 2004
36
Enhanced methodology further in 2005

21
IAS/IFRS?

Source: CLSA/ ACGA “CG Watch 2005: The Holy Grail”.

An assessment by the Institute of International Finance37 (Corporate Governance


in India, An Investor Perspective, February 2006) brings out the following features
of governance practice in India.

 Corporate governance-related requirements in India are largely based on


the recommendations of the Cadbury and Higgs Reports and the Sarbanes-
Oxley Act. SEBI has been proactive in keeping India’s corporate governance
rules and regulations in line with the best practices in the world.

 The state of corporate governance in India has improved over the last four
years particularly among the large cap Indian companies.

 In many large Indian companies, globalization- and not regulatory


requirements- has served as an impetus for adoption of corporate
governance best practices.

 High market premiums that the stock of these (good corporate governance)
companies command has reinforced the belief among Indian investors and,
more importantly, other Indian companies that better corporate governance
contributes to a high stock price and provides access to cheaper capital.

 Improvements in corporate governance in Indian companies seem largely to


be voluntary and driven by globalization

 Companies that wish to access markets for capital or that wish to become
leading global suppliers to corporations in developed markets are becoming
increasingly transparent and more willing to adopt higher corporate
governance standards. These governance changes are having a trickle-down
effect on smaller Indian companies.

37
Institute of International Finance, Inc, Corporate Governance in India, An Investor Perspective, IIF
Equity Advisory Group, Task Force Report, February 2006

22
 Stock exchanges are viewed as being at the front line of the surveillance
function for compliance with all listing requirements, including those that
pertain to corporate governance.

An assessment by the World Bank on the corporate governance standards in India,


along with specific recommendation in cases where it is required is given below.
India is found to be observing/largely observing 16 of the 22 standards with
continuous improvements in these as well as other remaining standards in the last
three years.
Table 5: Corporate Governance Assessment and Policy Recommendations for India
World Bank, 2004
I The Rights of Shareholders
Basic Shareholder rights OBSERVED
Rights to participate in fundamental decisions: OBSERVED
Shareholders’ AGM rights: OBSERVED
Disproportionate control disclosure: LARGELY OBSERVED
Markets for corporate control should be allowed to OBSERVED
function
Cost/benefit to voting* MATERIALLY NOT OBSERVED
II. Equitable Treatment of Shareholders
All shareholders should be treated equally$ PARTIALLY OBSERVED
Prohibit insider trading # PARTIALLY OBSERVED
Board/Mgrs. disclose interests** PARTIALLY OBSERVED
III. Role of Stake holders in Corporate Governance
Stakeholder rights respected OBSERVED
Redress for violation of rights PARTIALLY OBSERVED
Performance enhancement OBSERVED
Access to information OBSERVED
IV. Disclosure and Transparency
Disclosure standards: LARGELY OBSERVED
Standards of accounting & audit LARGELY OBSERVED
Independent audit annually PARTIALLY OBSERVED
Fair & timely dissemination: OBSERVED
V. Responsibilities of the Board
Acts with due diligence, care: LARGELY OBSERVED
Treat all shareholders fairly: LARGELY OBSERVED
Ensure compliance w/ law: OBSERVED
The board should fulfill certain key functions LARGELY OBSERVED
The board should be able to exercise objective PARTIALLY OBSERVED
judgment
Access to information OBSERVED
*Regulators should consider introducing an obligation that institutional investors acting in a
fiduciary capacity adopt and disclose their corporate governance and voting policy.- Regulators
should also disclose to the public how they manage material conflicts of interest that may
affect the exercise of their corporate governance rights.- Shareholder activism among retail
investors should be encouraged.

$ Depository receipt contracts should provide owners with same rights to vote as are accorded
to holders of underlying shares.- Consider strengthening regulators’ enforcement power to
offset backlog and delays of court procedures.

#Implement SEBI’s initiative of a unique client code for each investor.- There should be greater
cooperation between NSE and BSE on surveillance. - Publish share trading by directors and

23
senior management in the newspaper.- Successfully prosecute one insider trading case to
enhance perception of market integrity.

**While audit committees should pre-vet related party transactions, ultimate responsibility of
judging whether a related party transaction is in the best interest of the company should
remain with the board.
Source : World Bank.

6. Concepts and Principles in Corporate Governance in India

India has advanced significantly in adopting better governance standards and its
standing in the world is quite high in regard to designing effective policies and
procedures. Several companies go beyond the mandatory requirements in fulfilling
the corporate governance objectives. Companies have developed philosophies
governing the governance practices that were introduced in their respective
companies and the outcome that is being expected from these initiatives. Some of
the modern governance practices such as separation of the Chair and the CEO,
constitution of boards, representation of independent directors, meetings of the
board and audit committees, discussion on the corporate governance practices in
the annual reports, disclosure through a wide range of media and company sources
etc., have greatly enhanced the image of the quality of corporate governance in
India. India currently is ranked third in Asia for the overall quality of corporate
governance.

Practice of corporate governance has progressed in a big way in Indian companies.


There are several companies which made proactive initiatives in introducing good
governance norms and standards even before these became mandatory. For
instance, in its corporate governance report, Wipro, mentions about some of the
pioneering efforts made by it in setting good governance standards such as;
instituting stock ownership in 1984, constitution of sub-committees of the Board
of Directors for Audit, compensation and benefits in 1986 and preparation of
consolidated financial statements in 1983, the first year in which it established a
subsidiary company. Similarly, good governance in Tata Power is governed by
“Leadership with Trust” a principle that has been in practice since long; where as
Tata Motors began Tata Business Excellence Model and the Tata Code of Conduct
long back. Ranbaxy voluntarily adopted several best practices in good governance
in 1999 that included; majority independent directors in the composition of the
board, constitution of board committees for oversight and guidance concerning
key decisions and soundness of decision making processes connected with the

24
functioning of the company, timely dissemination of information to shareholders
and a code of conduct. Infosys not only complies with Indian governance standards
but also Euro shareholders Corporate Governance Guidelines 2000 and the
recommendations of the Conference Board Commission on Public Trusts and
Private Enterprises in the United States. It also adheres to the UN Global Compact
Programme. ACC has instituted a Chair for Business Ethics at the Management
Center for Human Values at the Indian Institute of Management, Kolkata. The
objectives of the corporate governance of the companies included in this paper are
given along with the corporate governance practice profiles of the respective
companies.

The governance practices set out by the Reliance Energy beyond the regulatory
requirements include; Values and Commitments, Code of Ethics, Business Policies,
prohibition of insider trading, prevention of sexual harassment, whistle blower
policy, environment policy, risk management, SA 8000 (standard for social
accountability), six sigma, OHSAS 18001 (for establishment of occupational and
safety management system) etc., Some of the innovations in the boardroom
practices that were detailed in the corporate governance report included; Board
charter, tenure of independent director, Interaction of non-executive,
including independent directors with the chairman, lead independent directors,
independent director’s interaction with shareholders, meeting of independent
directors without the management, independent director on the risk
management committee, commitment of directors, evaluation of the board etc.

The next round of reforms in the corporate governance would be in the realm of
strengthening evaluation processes of the functioning of the board and its
subcommittees, in particular the audit committee, as also greater discussion on the
executive compensation policies, ombudsman for reviewing whistle blower
policies etc. As Indian companies assume greater responsibilities in expanding
business in domestic and global markets, compensation issues will become
pertinent.

7. Corporate Governance Practice in India

India has been ranked high on several aspects of corporate governance such as
shareholder rights, creditor rights, disclosure requirements, liability standards and

25
quality of regulation; whereas it displays limitations on aspects such as
enforcement, corruption, red tape, ease of doing business, hiring and firing staff,
quality of credit information, contract enforcement. India’s position in regard to
key indicators of standards in governance and securities law is given in annexure.

The above trends could be better explained by Indian companies winning global
accolades for the corporate governance on one hand and the securities market
regulator show causing some companies, including the public sector, to tone up the
governance parameters on the other. In September 2007. World Council for
Corporate Governance, a UK based organisation, announced global awards in the
emerging markets category for ONGC, NTPC, Jubilant Technologies and GTL.
Several others awarded in the national category included; LIC India (Insurance);
Punjab National Bank (Banking); Hindustan Construction Company (Construction);
India Travel House (Hospitality); KPIT Ltd (IT); Power Finance Corporation (Power);
Hindustan Construction Company Ltd (Petroleum); Hindustan Zinc, Ltd (Metal) and
Shree Cement (Manufacturing). In a related development, Infosys Technologies,
Kotak Mahindra Bank, Satyam Computer Services and Grasim Industries were
figured in the IR Global Rankings: 2007 announced by the IR Global Rankings, a
global investor relations web company. Around the same time, Securities and
Exchange Board of India, has initiated proceedings against 20 companies for non
compliance of corporate governance, among which five were reported to be the
public sector undertakings.

This paper discusses the results of a review on the corporate governance practices
in 42 companies taken from 12 major sectors with these companies together
accounting for over 80 percent of the stock market capitalization (October 2007).
These companies represent 77 percent of the Sensex and 64 percent of the Nifty
(50) constituents. Data collected from the annual reports of these companies is
analysed in certain aspects of practice of corporate governance, a summary of
which is given below.

26
Table 6: A Snapshot of Corporate Governance

Con Petro Cem Tel Diver


Particulars Metals FMCG Dur Mine Banks Energy IT Pharma ent com sified Auto

Average No of Directors 12.33 9.7 9 12.6 12.33 11 11 10.4 14 12 14.5 14.33


%companies where the
chairman is non executive 83 66 50 na 66.6 33.3 50 80 100 33.3 na 33
Proportion of Non Executive
Directors in the above Cos 73 74 50 na 50 67 74 60 67 80 na 81
Proportion of Independent
Directors in the above Cos. 42 43 33.3 na 61.5 33.3 48 42 33.3 40 na 45
% of companies where the
chairman is executive 17 33 50 100 33.3 33.3 50 20 na 67 100 67
proportion of non executive
directors in the above Cos. 59 83 67 57 36.4 47.6 76 75 na 89 62 72
Proportion of Independent
Directors in the above Cos. 50 50 33.3 41 36.4 38.1 71 75 na 50 55 50
% companies in which the
chairman is Independent
Director 100 na na na
No of Board Meetings held in
FY07 7.5 5.33 12 11.4 8.33 8.67 6.5 5.4 7.33 7.67 8 6.33
No of Audit Committee
Meetings held in FY07 5.33 5 4.5 7.8 8.33 7 6 4.6 6.33 5.33 7.5 8
Number of Investor Grievances
Comm Meetings hled in FY07 1 1.33 2 1.2 8.33 1.33 3 2 8 4.66 18 8
Promoter Shareholding % 61.46 54.75 76.34 62.58 27.1 58.63 38.87 40.21 39.14 59.28 34.38 39.39
FII Share holding % 12.67 12.2 2.03 13.29 32.02 14.06 23.94 15.79 21.93 13.76 15.58 22.34
Individual share holding % 13.57 17.8 9.28 7.52 8.25 9.57 10.95 19.73 19.91 1.99 20.12 14.45
Space devoted to Corporate
Governance in Annual Report 7.93 16 11.58 13.37 9.55 11.16 10.63 14.77 16.71 11.26 10.15 11.08
Sectors : Metals; Fast Moving Consumer Goods, Consumer Durables, Petroleum and Mining, Banks,
Energy, Information Technology, Pharmaceuticals, Cement, Telecommunications, Diversified and
Automobiles

The average number of directors range from 9 in the Consumer Durables to 14.5 in
the Diversified industry sector.

27
Average No of Directors
16

12

0
Metals

Diversified
Cement
Consumer Durables

Pharmaceuticals
FMCG

Energy
Petroleum & Mining

Financial Services

Information
Automobile

Technology
Telecommunications
Sectors

In companies where the chairman is non executive, it was found that 69.53 are non
executive directors and 44.28 percent are independent directors. There are 3
companies all belonging to the Pharmaceuticals in which the chairman is non
executive as also independent director.

Composition of the board when the Chairman is Non executive

140

120

100

80

60

40

20

0
Consume Petroleu Telecom Informati
Financial Automob Pharmace Diversifie
M etals FMCG r m& Energy municati on Cement
Services ile uticals d
Durables M ining ons Technolo

Proportion of Independent Directors 42 43 33.3 0 61.5 33.3 45 40 42 48 33.3 0

Proportion of Non Executive Directors 73 74 50 0 50 67 81 80 60 74 67 0

In companies where the Chairman is executive, it is found that 63.42 percent are
non executive and 46.7 percent are independent. The proportion of independent
directors when the chairman is executive is short of the mandatory requirements in
sectors like energy, financial services and petroleum in mining. In all these sectors,
the company specific data indicates that public sector undertakings face
constraints in filling up the positions of the non independent directors in the board
since they are appointed by the Government.

28
Composition of Board when the Chairman is executive
160

140

120

100

%
80

60

40

20

0
Consu Petrole Financi Teleco Pharma Inform
Autom Cemen Diversif
Metals FMCG mer um & al Energy mmuni ceutica ation
obile t ied
Durabl Mining Service cations ls Techno

Proportion of Independent Directors 50 50 33.3 41 36.4 38.1 50 50 75 71 0 55


Proportion of Non Executive Directors 59 83 67 57 36.4 47.6 72 89 75 76 0 62
Sectors

The average meetings of Board and the Audit Committee works out to 7.76 and
6.24 per company, which is higher than the stipulated number of meetings required
to be held as per the Clause 49 Listing Agreement.

Table7: Average number of meetings held


Sector Average Number Average Average Number
of Board Number of of Investor
Meetings held Audit Grievances
Committee Committee
Meetings Meetings
Automobile 6.33 8 8
Cement 7.33 6.33 8
Consumer Durables 12 4.5 2
Diversified 8 7.5 18
Energy 8.67 7 1.33
Banks 8.33 8.33 8.33
FMCG 5.33 5 1.33
Information Technology 6.5 6 3
Metals 7.5 5.33 2.33
Petroleum and Mining 11.4 7.8 1.2
Pharma 5.4 4.6 2
Telecom 7.67 12.33 4.66

Indian companies are relatively closely held as could be evident from the high
percent of promoter holdings in most of the sectors. Higher levels of promoter
holdings is a feature widely prevalent in the Asian corporates as brought out by
several studies in this regard.

29
Shareholding Pattern
90

80

70

60
Percentage

50

40

30

20

10

0
Consume Petroleu Informati
Financial Automob Pharmac Diversifi
Metals FMCG r m&Minin Energy Telecom on Cement
Services ile euticals ed
Durables g Technolo

FII Holding (%) 12.67 12.2 0.01 13.29 32.02 14.06 22.34 13.76 15.79 23.94 21.93 15.58
Promoter Group Holding (%) 61.46 54.75 76.34 62.58 27.1 58.63 39.39 59.28 40.21 38.87 39.14 34.38

Sectors

Cement, FMCG and Pharma companies devoted greater amount of space for
corporate governance (in terms of no pages on governance discussions in the total
annual report) discussion as proportion to all aspects included in the annual report.

Space devoted to Corporate Governance in Annual


Reports
18
16
14
12
10
%

8
6
4
2
0
Telecommunications

Information
Automobile

Technology

Diversified
Petroleum & Mining
Consumer Durables

Pharmaceuticals
Banks

Energy

Cement
Metals

FMCG

Sectors

30
8. Recent Trends in Corporate Governance in India

A few of the major trends evident in the realm of corporate governance practice
are discussed below.

a. Separation of Chairman and CEO

Separation of Chairman and CEO are increasingly recognized as a best practice that
the companies should absorb. Several companies now have separate Chairman and
the CEOs. In the sample of 42 companies that this study has analysed in regard to
corporate governance practices, more than half of them have chairman separate
from the chief executive officer and this trend is rising in several companies.

b. An Independent Board

Given the importance of independence of the board, the scope of non executive
directors and independent directors assume great significance. This study revealed
that about 65 percent of the directors are non executive and about 46 percent are
independent directors. There are three companies in which the chairman is non
executive as also independent. There is a growing trend of making the board
structure more independent. Companies with foreign shareholding in the
pharmaceutical industry have non executive and independent directors as
chairmen.

c. Lead Independent Directors

Big corporations are now designating lead independent directors who will
coordinate the work of the independent directors as also review the progress of the
company and set its business agenda. The role of the Lead Independent Director in
one of the top Indian companies is defined as below:

 To preside over the meetings of Independent Directors


 To ensure that there is adequate and timely flow of information to
Independent Directors

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 To liaise between the Chairman and Managing Director, the Management
and Independent Directors
 To preside over meetings of the Board and Shareholders when the Chairman
and Managing Director is not present or where he is an interested party
 To perform such other duties as may be delegated to the Lead Independent
Director by the Board/Independent Directors.

It can be seen that companies are beginning to give more weightage to the scope
and functions of the independent directors and in this process identifying a Lead
Independent Director, who could be a catalyst in deriving the best from this
process.

Some companies have more than one Lead Independent Directors with different
directors looking at different aspects of the governance and growth of the
companies. For instance, in one company, one Independent Director each is vested
with the responsibilities of the driving agenda for the Board, improving board
processes, corporate strategy, financial and internal controls, risk management and
compliance and one independent director identified as the Chief Ombudsman for
the Whistle Blower Policy of the company.

d. Independent Directors

Independent Directors are the major instrument of the corporate governance in the
modern corporates. Many companies, excepting a few public sector have complied
with the requirement in regard to proportion of the representation of the
independent directors in the boards. Though big corporates find good quality
independent directors with relative ease, the same is emerging as a major
challenge for the mid and small cap companies who appear to be facing sizeable
problem in finding right number of directors with right qualities and qualifications.
At present, nominee directors are treated as independent directors, but SEBI is
proposing not to consider nominee directors as independent directors, in which
case, the challenge becomes much tougher for a host of companies. In view of the
representation of independent directors becoming a prominent aspect of the
corporate governance, it is important that companies take this aspect with greater
focus and seriousness.

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In March 2007, the Union Cabinet of the central government gave its approval to
the guidelines on Corporate Governance for Central Public Sector Enterprises
(CPSEs) as per which, the board of directors of a company shall have an optimum
combination of executive and non executive directors with not less than 50 percent
comprising non executive directors. On implementation, it would improve the
compliance standards of the public sector enterprises.

e. Board Committees

Companies are taking keen interest in constituting various subcommittees of the


board in addition to the strengthening of the board. In addition to the mandated
ones such as the audit committee and investor grievances committee and
remuneration committee etc., companies are found to set up a wide range of sub
committees as per their specific requirements. Names of the few sub committees
in the corporate analysed in the study include; project appraisal committee, ethics
committee, human resources policy committee, investment committee, safety,
health and environment committee, planning and projects committee, contracts
committee, projects evaluation committee, establishment committee, financial
management committee, marketing strategy committee, technology committee,
rural sector business committee, risk management committee, directors
committee, asset-liability management committee, special committee for
monitoring large value frauds, board management committee, credit approval
committee, customer service committee, management controls committee,
science committee, banking and organization committee, intellectual property
rights committee,

f. Meetings

Companies have shown good progress in respect of the number of meetings of the
Board and the Audit Committee held in a year. The number of meetings held are
normally higher than the mandatory requirement in most of the companies.

g. Periodic Evaluation of the Performance

Good governance requires periodic evaluation of the performance of the Board and
Audit Committees by an internal process or an external agency. Though big

33
corporations take elaborate care and processes in identification and selection of
the members of the board, not all companies have a well defined process of
performance evaluation. Infosys has put in place, where in an annual performance
evaluation exercise; each non executive board member has to make a presentation
to the Board on the major contribution made by him leading to an assessment that
will determine the further scope of the members participation in the board. Such
structured processes are not evident in a large number of companies.

h. Related Party Transactions

OECD defines related party transactions as those that involve between a parent
company and subsidiary, employees, an enterprise and its principal owners,
management or members of their immediate families; and affiliates (OECD
Principles, IAS 24(9); FASB Statement No.57). Related party transactions can take
various forms including; transfer pricing, asset stripping, inter company loans and
guarantees; sale of receivables to special purpose vehicle; leasing or licensing
agreement between a parent and a subsidiary. In view of the extensive family
holding of Indian companies, concerns exist on the accuracy and authenticity of the
declarations and statements made to the board on the related party transactions.
Governance professionals express the scope for further refinement and reforms in
the information pertaining to related party transactions.

i. Annual Reports

Annual Reports are important documents for assessing and analyzing the company
performance in regard to corporate governance standards and compliance. There is
vast improvement in the quality of content in the Annual Reports, but scope exists
for presenting the data in a manner that is easy to locate and understand. Even in
respect of the corporate governance reports, though the number of aspects on
which information is required to be given is uniform, companies present
information in different formats making it rather cumbersome for the readers who
look at the documents of a number of companies.

j. Corporate Governance Reports

34
Corporate Governance Reports are important part of the Annual Reports. Many
companies in addition to giving the compliance on various parameters also some
times discuss the philosophy and objectives of the corporate governance thus
setting the background for the spirit and letter of governance that is reported.

k. Corporate Social Responsibility

It is also found that several leading Indian companies undertake corporate social
responsibility, which they report in the annual reports in a separate section. It is
interesting to note several companies taking interest in corporate social
responsibility.

l. Statement of the Policies

Most of the disclosures that are found in the companies annual reports are
mandatory in nature. Many companies tend to fulfill the regulatory or compliance
norms rather than taking a proactive initiative in discussing and disclosing
pertinent policies and procedures on a wide range of issues that the company deals
with.

For the purpose of an illustration, a global major corporate, in its corporate


governance report discussed and disclosed the following. Such disclosures and
discussions are however, evident only in major corporations in India.

a. Board Reserves one full day per year to discuss strategic questions
b. Average duration of the Board Meetings
c. Average attendance at the Board Meeting
d. Working of the Compensation Committee.
e. Information Policy
f. Specific guidelines/ policy in regard to 1. Dealing with the people, 2.
Relationships with suppliers and customers, 3. Legal compliance, 4. Gender
equality and empowerment, 5. Health and safety, 6. Environment and
public good, 7. Conflict of interest 8. Protection of confidential
information, 9. Use of company facilities, 10. Leading by example and 11.
Buying and selling of company stock.

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m. Promoter Holding

A recent report of the Moody’s quoted in the media showed that 17 of the 30
companies in the Sensex are family controlled. The report observed that family
controlled companies face corporate governance challenges in the future. Family
controlled companies came up for criticism during the economic and financial
crises in the South East Asia, wherein problems accentuated because of lesser
disclosure standards prevalent in family owned firms. Growth of stock markets may
induce reduction in the family holding and ownership in companies.

n. Directors Training

Companies are found to disclose the importance of training for their directors and
mention the same in the corporate governance reports. While some companies
explain the specific nature of training that is usually imparted to the directors,
some make a broad reference to it. There is however no mention of the specific
time spent by the directors on training.

o. Whistle Blower Policy

Being a non mandatory disclosure, companies mention about the Whistle Blower
policy in place, but no record of any specific activity or incidence in this regard.
Some companies put an independent director to look into the implementation of
the policy

p. Scope for improvement in Compliance

Though the design of the corporate governance framework in India is considered


matching that of the advanced countries, on aspects of enforcement and quality of
supervision, scope exists for significant improvement. According to the information
provided by the Ministry of Corporate Affairs, almost 30000 companies came under
its scanner default in filing of annual returns for the year ended March 2006. As
mentioned earlier in this report, Securities and Exchange Board of India has
initiated adjudication proceedings against 20 companies for non compliance with

36
the corporate governance of which five belong to the public sector. In a statement
to the Parliament, Finance Ministry informed that 13 of the Group A companies of
the Bombay Stock Exchange have not complied with the Clause 49 stipulations.
Seven of the Nifty 50 companies were found short of fulfilling corporate
governance norms. At the same time, it is important to note that things are
improving at a good pace and governance environment could see significant
improvements in the near future. It is also pertinent to note that India is not an
exception to these shortcomings as these are quite general to Asia as also several
other countries.

9. Emerging Challenges

While corporates have been quite successful in placing effective processes that will
ensure compliance with the listing norms, several challenges exist in the
governance landscape. Though the Chairman and CEO are separated in several
companies, in certain instances, it is found that a family member who is a non
executive director is chairman and another family member is the CEO. Such
arrangements meet the compliance requirements in letter but not in spirit.
Similarly, in some it was found that meetings of several committees are clubbed
together to save on time. Though time is an important element that needs to
conserved with great care, the focus of the discussion should not be lost in trying
to save time, which might lead to a situation where committees are called in a
routine manner to fulfil the regulatory requirement. Significant improvements are
required in respect to the reporting of subsidiary company operations as also
related party transactions, a general feeling that is commonly shared by most of
the practicing community on the corporate governance. Evaluation of the
performance of the Board and the sub committees in particular the Audit
Committee needs to be further strengthened and streamlined. In view of the
sizeable representation of the public sector enterprises in the stock market
capitalization, it becomes important to speed up the process of placing required
number of independent directors in these companies. These companies being big in
size and having significant growth, it is important that the short coming on the
proportion of independent directors should not place them in a disadvantageous
position in regard to compliance standards. Companies should endeavour to extend
the range of disclosures beyond the mandatory norms to areas such as management
processes, corporate social responsibility etc. The next round of reforms might

37
focus on the compensation and remuneration committees since they will assume
greater significance in the background of enormous growth of the companies and
their operations extending beyond the national boundaries entailing greater
challenges for management. Experts are of the view that the next round of major
discussion and disclosures will be centered on compensation disclosure analysis to
discuss the parameters governing the compensation for the executive directors as
also designing effective structures for executive compensation.

10 . Looking Ahead

Corporate governance both in respect of policy and practice made a quantum leap
in India. On the policy side, India has one of the best frameworks for corporate
governance. On the practice side, there is great improvement in the standards of
reporting, disclosure and compliance of companies. Given more than one hundred
thousand companies registered, of which about 5000 are listed, monitoring
corporate governance in Indian companies is an intensely challenging task.

Notwithstanding the size of numbers, improvements are evident in various aspects


of governance. Companies are found to be increasingly complying with the
governance standards and norms.

Sustained efforts to step up the quality of governance are in place. SEBI expressed
its unwillingness to allow any relaxation of the Clause 49 Listing norms for public
sector undertakings despite their limitations in finding required number of
independent directors, as defined by the norms. Similarly SEBI came up with
further curbs on insider trading by proposing surrender of profits made by insiders
of a company in any equity-based securities transaction of the company leading to
short term profits. To help companies to expand the scope of corporate governance
reports in the annual reports, SEBI has allowed company secretaries to certify the
report in addition to the statutory auditors.

Indian economy is experiencing unprecedented growth and receiving intense


interest of the international investing community. Indian companies can derive
huge benefits from this extremely conducive environment by strengthening the
company performance as also its governance standards. International investing is
increasingly governed by quality governance as evidenced from a number of studies

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and it becomes imperative for Indian companies to sustain the pace of reforms in
corporate governance. While Clause 49 deals with what is mandatory, good
companies can go an extra mile in devising effective ways of governance that could
lead to efficient markets.

Good governance is required for business growth, expansion and in pursuing global
aspirations. It is also important to bring in qualitative improvement in the
corporate environment in India that will induce others also to adopt best practices.
Good corporate governance in big companies will be a guiding force for mid and
small companies to devise effective governance frameworks that will result in
further strengthening of the governance environment. The society at large as well
as the stakeholders of the companies will the biggest beneficiaries of this outcome.

39
Annexure
Indices of Regulation of Securities Markets

This table shows the securities laws variables for each country covering the areas of (a) disclosure requirements (b) Liability standards (c)
Supervisor characteristics (d) Rule making power of the Supervisor (e) Investigative powers of the Supervisor (f) Orders to issuers,
distributors, and accountants (f) Criminal sanctions applicable to directors, distributors, and accountants and (g) Public enforcement

Company Symbol Disclosure Liability standard Supervisor Rule - Investigative Orders Criminal Public
requirements characteristics making powers Sections enforcement
power
English Legal Origin      
Australia AUS 0.75 0.66 0.67 1.00 1.00 1.00 0.83 0.90
Canada CAN 0.92 1.00 0.67 0.50 1.00 1.00 0.83 0.80
Hong Kong HKG 0.92 0.66 0.33 1.00 1.00 1.00 1.00 0.87
India IND 0.92 0.66 0.33 0.50 1.00 0.67 0.83 0.67
Ireland IRL 0.67 0.44 0.00 1.00 0.00 0.00 0.83 0.37
Israel ISR 0.67 0.66 0.67 0.00 1.00 1.00 0.50 0.63
Kenya KEN 0.50 0.44 0.33 1.00 0.50 1.00 0.67 0.70
Malaysia MYS 0.92 0.66 0.33 0.50 1.00 1.00 1.00 0.77
New Zealand NZL 0.67 0.44 0.33 0.00 1.00 0.00 0.33 0.33
Nigeria NGA 0.67 0.39 0.67 0.50 0.00 0.00 0.50 0.33
Pakistan PAK 0.58 0.39 0.67 1.00 1.00 0.17 0.08 0.58
Singapore SGP 1.00 0.66 0.33 1.00 1.00 1.00 1.00 0.87
South Africa ZAF 0.83 0.66 0.33 0.00 0.50 0.00 0.42 0.25
Sri Lanka LKA 0.75 0.39 0.33 1.00 0.50 0.00 0.33 0.43
Thailand THA 0.92 0.22 0.67 1.00 1.00 0.33 0.58 0.72
USA USA 1.00 1.00 1.00 1.00 1.00 1.00 0.30 0.90
United Kingdom GBR 0.83 0.66 0.00 1.00 1.00 1.00 0.42 0.68
Zimbabwe ZWE 0.50 0.44 1.00 0.00 0.00 0.08 1.00 0.42
Mean   0.78 0.58 0.48 0.67 0.75 0.57 0.65 0.62

Company Symbol Disclosure Liability standard Supervisor Rule - Investigative Orders Criminal Public

40
requirements characteristics making powers Sections enforcement
power
French Legal Origin      
Argentina ARG 0.50 0.22 0.67 1.00 1.00 0.08 0.17 0.58
Belgium BEL 0.42 0.44 0.00 0.00 0.25 0.00 0.50 0.15
Brazil BRA 0.25 0.33 0.33 1.00 0.50 0.75 0.33 0.58
Chile CHL 0.58 0.33 0.33 1.00 0.75 0.42 0.50 0.60
Colombia COL 0.42 0.11 0.33 1.00 0.75 0.33 0.50 0.58
Ecuador ECU 0.00 0.11 1.00 1.00 0.25 0.08 0.42 0.55
Egypt EGY 0.50 0.22 0.67 0.00 0.25 0.17 0.42 0.30
France FRA 0.75 0.22 1.00 0.50 1.00 1.00 0.33 0.77
Greece GRC 0.33 0.50 0.67 0.00 0.25 0.17 0.50 0.32
Indonesia IDN 0.50 0.66 0.33 1.00 1.00 0.25 0.50 0.62
Italy ITA 0.67 0.22 0.67 1.00 0.25 0.00 0.50 0.48
Jordan JOR 0.67 0.22 0.33 1.00 1.00 0.67 0.00 0.60
Mexico MEX 0.58 0.11 0.00 1.00 0.25 0.00 0.50 0.35
Netherlands NLD 0.50 0.89 0.33 1.00 0.50 0.00 0.50 0.47
Peru PER 0.33 0.66 0.67 1.00 0.75 1.00 0.50 0.78
Philippines PHL 0.83 1.00 0.67 1.00 1.00 1.00 0.50 0.83
Portugal PRT 0.42 0.66 0.67 1.00 1.00 0.25 0.00 0.58
Spain ESP 0.50 0.66 0.67 0.00 0.50 0.00 0.50 0.33
Turkey TUR 0.50 0.22 0.67 1.00 1.00 0.00 0.50 0.63
Uruguay URY 0.00 0.11 0.67 1.00 0.25 0.50 0.42 0.57
Venezuela VEN 0.17 0.22 0.33 1.00 1.00 0.08 0.33 0.55
Mean   0.45 0.39 0.52 0.79 0.64 0.32 0.40 0.53

Company Symbol Disclosure Liability standard Supervisor Rule - Investigative Orders Criminal Public
requirements characteristics making powers Sections enforcement

41
power
German Legal Origin      
Austria AUT 0.25 0.11 0.33 0.00 0.00 0.00 0.50 0.17
Germany DEU 0.42 0.00 0.33 0.00 0.00 0.00 0.50 0.22
Japan JPN 0.75 0.66 0.00 0.00 0.00 0.00 0.00 0.00
Korea KOR 0.75 0.66 0.33 0.00 0.00 0.08 0.33 0.25
Switzerland CHE 0.67 0.44 0.33 1.00 1.00 0.00 0.33 0.33
Taiwan TWN 0.75 0.66 0.33 1.00 1.00 0.17 0.83 0.52
  0.60 0.42 0.28 0.33 0.17 0.04 0.42 0.25
Scandinavian Legal Origin      
Denmark DNK 0.58 0.55 0.00 1.00 0.50 0.33 0.00 0.37
Finland FIN 0.50 0.66 0.67 0.00 0.25 0.17 0.50 0.32
Norway NOR 0.58 0.39 0.00 0.00 0.25 0.33 1.00 0.32
Sweden SWE 0.58 0.28 0.00 1.00 0.25 0.67 0.38 0.50
Mean   0.56 0.47 0.17 0.50 0.31 0.38 0.52 0.38
Mean all countries   0.60 0.47 0.45 0.66 0.60 0.38 0.50 0.52
Source: What Works in Securities Laws? Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer*, Dartmouth College, Yale University, and Harvard
University, June 11, 2004

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