CORPORATE

GOVERNANCE
2015-2016
Lecture 12 &13

WHAT IS
CG?

CONCEPTUAL BASIS
Characteristics
Origin: Agency
Theory

A theory concerning
the relationship
between a principal
(shareholder) and an
agent of the principal
(company's
managers)

Concept
originated with
separation of
ownership &
management

Agency costs
inherent in
separation of
ownership and
control
Professional
managers have
enormous powers
Governance :
1. What control do
the owners have on
the management ?
2. How do you
ensure that the
powers are not
misused?

FUNDAMENTAL
PRINCIPLES OF CG

CG is systems and procedures adopted and followed that ensure

all stakeholders share equally in the success (or failure) of a
firm.

OBJECTIVE OF CG

EFFECTIVE GOVERNANCE CAN

HAPPEN WHEN ----An effective and independent Board
Committees in Place
A sound internal control framework
A relevant code of ethical behaviour
Clear enforced policies and procedures
Transparent disclosure, effective communication, and
systems that ensure effective measurement and
accountability
An effective well resourced internal audit function and
independent effective external audit

TYPE OF DIRECTORS

Executive directors
Have day-to-day
management
responsibilities

Non Executive
Directors/ Independent
Directors
take no part in the
day-to-day running of
the business, but
have the same
responsibilities as
executive directors
They use their
experience and
expertise to provide
independent advice
and objectivity, and
they usually have a
role in monitoring
executive
management

Nominee directors
The interests of
substantial
shareholders or the
companys bankers
may be represented
by a nominee director

WHO IS AN INDEPENDENT DIRECTORS? : CLAUSE

49 REQUIREMENTS
As per Clause 49 of the Listing Agreements an
independent director shall mean non-executive
director of the company who

apart from receiving directors remuneration,

does not have any material pecuniary
relationships or transactions with the
company, its promoters, its senior
management or its holding company, its
subsidiaries and associated companies
is not related to promoters or management at
the board level or at one level below the board
has not been an executive of the company in the
immediately preceding three financial years

WHO IS AN INDEPENDENT
DIRECTORS? : CLAUSE 49
REQUIREMENTS (CONTD)
is not a partner or an executive of the statutory
audit firm or the internal audit firm that is
associated with the company,
has not been a partner or an executive of any such
firm for the last three years. This will also apply to
legal firm(s) and consulting firm(s) that have a
material association with the entity.
is not a supplier, service provider or customer of the company.
This should include lessor-lessee type relationships
is not a substantial shareholder of the company, i.e.
owning two percent or more of the block of voting
shares
Institutional directors on the boards of companies shall be
considered as independent directors whether the institution is
an investing institution or a lending institution.

DUTIES OF DIRECTOR
CHAPTER XI (SECTION 166)
Subject to the provisions of this Act, a director of a company shall
act in accordance with the articles of the company.

A director of a company shall act in good faith in order to promote the

objects of the company for the benefit of its members as a whole, and in
the best interests of the company, its employees, the shareholders, the
community and for the protection of environment.

A director of a company shall exercise his duties with due and reasonable
care, skill and diligence and shall exercise independent judgment.

A director of a company shall not involve in a situation in which he may

have a direct or indirect interest that conflicts, or possibly may conflict,
with the interest of the company.

DUTIES, ROLE & RESPONSIBILITIES OF

INDEPENDENT DIRECTORS (SCHEDULE IV)
Uphold ethical standards of integrity and probity; Mainly to assist
the company in implementing the best corporate governance
practices.
Bringing an independent judgment to bear on the Boards
deliberations especially on issues of strategy, performance, risk
management, resources, key appointments and standards of
conduct;
Satisfy themselves on the integrity of financial information and that
financial controls and the systems of risk management are robust
and defensible
Safeguard the interests of all stakeholders, particularly the minority
shareholders; balance the conflicting interest of the stakeholders

Moderate and arbitrate in the interest of the company as a whole, in

situations of conflict between management and shareholders
interest

DUTIES, ROLE & RESPONSIBILITIES OF

INDEPENDENT DIRECTORS (SCHEDULE IV)
Concerns about the running of the company or a proposed action,
ensure that these are addressed by the Board and, to the extent that
they are not resolved, insist that their concerns are recorded in the
minutes of the Board meeting;
Ensure adequate deliberations before approving related party
transactions (RPTs)and assure themselves that the same are in the
interest of the company;

Report concerns about unethical behaviour, actual or suspected fraud

or violation, of the companys code of conduct or ethics policy;
Not disclose confidential information, including commercial secrets,
technologies, advertising and sales promotion plans, unpublished
price sensitive information, unless such disclosure is expressly
approved by the Board or required by law.

DUTIES OF DIRECTOR : CHAPTER XI (SECTION 166)

A director of a company shall not achieve or attempt to achieve
any undue gain or advantage either to himself or to his relatives,
partners, or associates and if such director is found guilty of
making any undue gain, he shall be liable to pay an amount
equal to that gain to the company.
A director of a company shall not assign his office and any
assignment so made shall be void.
If a director of the company contravenes the provisions of this
section such director shall be punishable with fine which shall
not be less than one lakh rupees but which may extend to five
lakh rupees.

# good faith # care

# skill

# diligence

ROLE OF BOARD OF
DIRECTORS
The law imposes three clear duties on board
members, the duties of care, good faith, and loyalty.

The duty of care involves the exercise of reasonable

care by a board member to ensure that the corporate
executives with whom she or he works carry out their
management responsibilities and comply with the law
in the best interests of the corporation.

ROLE OF BOARD OF
DIRECTORS
The duty of good faith is one of obedience, which
requires board members to be faithful to the
organizations mission.
In other words, they are not permitted to act in a
way that is inconsistent with the central goals of the
organization.
Their decisions must always be in line with
organizational purposes and direction, strive
towards corporate objectives, and avoid taking the
organization in any other direction.

ROLE OF BOARD OF
DIRECTORS
The duty of loyalty requires faithfulnessa board
member must give undivided allegiance when
making decisions affecting the organization.
This means that conflicts of interest are always to
be resolved in favor of the corporation.
A board member may never use information
obtained through because of the position as a
board member for personal gain, but instead must
act in the best interests of the organization.

ROLE OF THE BOARD : DUTY

OF SKILL

Skill practiced ability

Strategic decisions
Evaluation of information
Application of mind
Application of experience and expertise.

ROLE OF INDEPENDENT
DIRECTOR
Shareholders
Shareholders especially minority shareholders look at
independent directors providing transparency in respect of the
disclosures in the working of the company and balance in
resolving conflict areas.

Other Stakeholders
Evaluating the boards or management decisions in respect of
employees, creditors etc. and in protecting stakeholders
interest.

WHY DO INVESTORS CARE

ABOUT CORPORATE
GOVERNANCE ?
Financial reports and other disclosures can be
trusted
Well governed companies mitigate non-business
risks
Believe that corporate performance in the long run is
correlated with CG

20

DOES BETTER CORPORATE

GOVERNANCE DELIVER HIGHER
SHAREHOLDER RETURNS ?

To ascertain this, McKinsey & Co. in

cooperation with the world bank conducted
a series of surveys
The survey gathered response from over 200 institutional
investors managing approx. US$2.5 trillion in assets. 40% of
the respondents were based in the U.S., balance in Europe,
Asia and Latin America

21

MOST INVESTORS WOULD BE WILLING TO PAY MORE

FOR THE SHARES OF A WELL-GOVERNED COMPANY
Q: Would you be willing to pay more for a company with good board
governance practices?
100%

Yes
83

89

81

No
17

11

Latin America

Asia

0%

Source: McKinsey Investor Opinion Study

19
Europe/US

CG WILL LEAD TO CORPORATE

EXCELLENCE
Profitability
Satisfied stakeholders such as shareholders, customers,
employees
Revenue and profit growth
Growth in market share
Growth in market value (Market capitalization)

PURPOSE OF SECTION
135 & CSR RULES
The general purpose of the CSR legal provision is
to encourage mindful, catalytic participation of
corporate India in the countrys development
centric agenda

The enactment of Section 135 on CSR ,

Companies Act 2013 has thrown open new
opportunities for nation building

SECTION 135 AND ITS

CHARACTERISTICS
Clause 135 of the Companies
Act requires that qualifying
companies spend a prescribed
formula-based amount on CSR,
report on those activities, or
explain why they failed to do so

The CSR clause is a type of

regulatory law commonly
referred to as a comply or
explain law

SECTION 135 (1)

Every company having
Net worth of Rs. 500 cr or more
OR
Turnover of Rs. 1000 cr or more
OR
Net profit of Rs. 5 cr or more
---- during any financial year shall constitute a Corporate Social
Responsibility (CSR) Committee of the Board consisting of 3 or more
directors, out of which at least one director shall be an independent
director

SECTION 135 (2)

The Board's report under sub-section (3) of
section 134 shall disclose the composition of the
CSR Committee

(As per Section 134(3)(o) also the details about the policy
developed and implemented by the company on CSR
initiatives taken during the year

SECTION 135 (3)

The CSR Committee shall
(a)formulate and recommend to the Board, a CSR Policy which shall
indicate the activities to be undertaken by the company as specified in
Schedule VII;
(b)recommend the amount of expenditure to be incurred on the
activities referred to in clause (a); and
(c)monitor the CSR Policy of the company from time to time.

SECTION 135(4)
The Board shall
(a) after taking into account the recommendations made by
the CSR Committee, approve the CSR Policy for the
company and disclose contents of such Policy in its report
and also place it on the company's website, if any, in such
manner as may be prescribed; and

(b) ensure that the activities as are included in CSR Policy

of the company are undertaken by the company.

SECTION 135(5)
The Board of every company shall ensure that the
company spends, in every financial year, at least 2
per cent of the average net profits of the company
made during the 3 immediately preceding financial
years, in pursuance of its CSR Policy:
Provided that the company shall give preference to
the local area and areas around it where it
operates, for spending the amount earmarked for
CSR activities:
Provided further that if the company fails to spend
such amount, the Board shall, in its report made
under clause (o) of sub-section (3) of section 134,
specify the reasons for not spending the amount.

SPECIFIED ACTIVITIES UNDER SCHEDULE VII

Promoting Education
Promoting health care including preventive
health care
Vocational skills
Eradicating hunger, poverty and malnutrition
Ecological balance
Conservation
Conservation of natural resource
See the List of Specified Activities dated June 18, 2014
http://forbesindia.com/blog/wpcontent/uploads/2014/06/General_Circular_21_2014.pdf

STEPS TO EXECUTE CSR MANDATE

Through
Through CSR,
CSR, aa conscientious
conscientious corporate
corporate would
would first
first assess
assess the
the needs
needs of
of the
the community
community
and
and the
the environment
environment through
through aa consultative
consultative mode
mode

The
The company
company would
would formulate
formulate aa CSR
CSR Policy
Policy based
based on
on its
its response
response strategy
strategy

ItIt will
will have
have to
to initiate
initiate activities/projects
activities/projects through
through measurable
measurable budgets
budgets and
and timelines
timelines leading
leading
to
to impactful
impactful sustainable
sustainable development.
development.

An
An alert
alert CSR
CSR Committee
Committee of
of the
the Board
Board of
of Company
Company must
must closely
closely monitor
monitor its
its CSR
CSR Policy
Policy to
to
ensure
ensure that
that itit is
is effective.
effective.

The
The Policy
Policy may
may be
be periodically
periodically reviewed
reviewed to
to be
be in
in harmony
harmony with
with changing
changing societal
societal and
and
environmental
environmental needs.
needs.

BOARD: ROLE & RESPONSIBILITY ( SEC 134 &

135)
A) Appoint Committee through Board Resolution
B) Approve the CSR Policy of the Company
C) Disclose names of CSR Committee members, CSR Policy
and Annual Report on the website
D) Ensure CSR spend: Procure Utilization Certificates
E) Ensure CSR Monitoring Mechanism

APPOINT CSR COMMITTEE

Setup
Setup the
the CSR
CSR
Committee
Committee of
of the
the
Board;
Board; decide
decide on
on
its
its composition
composition
based
based on
on
responsibilities
responsibilities and
and
operational
operational
involvement
involvement

IfIf Independent
Independent
Director
Director is
is required
required
the
the same
same should
should be
be
appointed
appointed

Pass
Pass aa resolution
resolution in
in
the
the Board
Board
approving
approving the
the
composition
composition of
of the
the
CSR
CSR Committee
Committee

In
In case
case of
of
Companies
Companies that
that are
are
part
part of
of larger
larger
corporate
corporate groups
groups //
conglomerates,
conglomerates,
they
they may
may also
also need
need
to
to look
look at
at
composition
composition of
of
individual
individual company
company
CSR
CSR Committees
Committees
in
in the
the context
context of
of
larger
larger group
group effort
effort
on
on CSR
CSR and
and overall
overall
co-ordination
co-ordination

The tenure and functioning of the CSR Committee shall depend upon the
extant governance rules of the Company as defined by its Board

COMPOSITION: CSR COMMITTEE

Rule 5 of the CSR Rules notified on 27th February 2014:
CSR Committee Formation
As per Section 135 (1), the CSR Committee of the Board
shall comprise of three or more Directors, out of which at
least one shall be an Independent Director
The choice of the Independent Director is an important
one, and should be done keeping in mind the CSR
requirements of the company
The Independent Director needs to be nominated only if
the company is required to have one as per provisions of
the Companies Act 2013. In case this position is not
required, only two Directors can form the CSR Committee

CSR COMMITTEE:
RESPONSIBILITIES
1. Formulate CSR Policy and identify activities to be undertaken
(preference to be given to local areas around its operations) as
specified in Schedule VII of the Companies Act 2013. This
should be done in a consultative manner, after due
deliberations with the CSR team, local officials of the company
and beneficiary communities
2. The detailed list of activities with allocated expenditure in the
format given in the Act should be appended to the Policy
3. Report back to the Board of Directors for approval of the CSR
Policy
4. Regularly monitor the implementation of the CSR Policy
5. Change/modify the CSR Policy as per feedback from the
implementation of the existing Policy. CSR activities with
allocated budget and monitoring mechanism can/will also be
revised accordingly. Any change in Policy must be duly ratified
by the Board