CORPORATE GOVERNANCE

What is Corporation?
A corporation is a means whereby the wealth of innumerable individuals has been
concentrated into huge aggregates and whereby control over this wealth has been
surrendered to a unified direction.

Evolution of Indian corporate sector

The early history of joint stock companies in India is the history of managing agency
houses. They not only promoted the companies but also nurtured them for years
The economic activities during these period were largely communities based which led to
concentration of trade and banking in few communities like, Parsees, Gujarati and
Marwaris
 1850-1956
 Managing agents and joint stock companies grew rapidly
 It was not compulsory for the company to have board of directors
 Control over the company was retained through issue of disproportionate
voting shares
 The Companies Act 1913 imposed some minimum restrictions on powers
of managing agents
 1956-1970
 Enactment of the Companies Act, 1956 and subsequent amendments in
1969 made elaborate provisions for disclosure to Registrar of Companies
and shareholders and rights of shareholders
 Few more legislation were enacted and existing ones were amended to
strengthen the hold of the State over the business including FERA 1973,
MRTPA 1969
 1970-1980
 Dutt Committee in 1970s recommended active role of financial institution
in corporate boards and capital market
 Role of nominee director also came into sharp focus
 Sachar Committee and Patel Committee revisited The Companies Act
1956 and provided valuable recommendations for active interface between
stock market and Indian corporate sector
 1980-1990
 Legislations conferring dominance to State were diluted
 Company Law Board was vested with power to ratify or disapprove the
refusal of transfer of shares by the management
 Hectic takeover activities witnessed after the amendments in the
Companies Act 1956 in 1988
 1990 onwards
 With spurt in stock market activities and vibrant economic environment,
Indian industry felt the pinch of competitive pressures from invasion of
multinational companies
 SEBI was set up to regulate and develop Indian capital market
  Mergers, acquisitions and corporate restructuring exerted pressures on
Indian corporate boards to perform in new environment of larger
disclosures and activism of institutions and shareholders
 These factors lead to a renewed debate on CG

Governance : a broader view

 Governance means supervising and managing the company to the best interest of
everyone
 In India, governance has been extensively discussed in our popular epics like
Mahabharata and Ramayana. These epics have highlighted the relationship
between society, polity and business

Corporate Governance: A developmental perspective

 Corporate entity – corporate governance
 The seeds of modern corporate governance were probably sown by the Watergate
scandal in US.
 To highlight the control failures, US regulatory and legislative bodies led to the
development of FCPA 1977.
 The Foreign Corrupt Practices Act 1977 made specific provisions regarding
establishment, maintenance and review of systems of internal control
 In 1979, US Securities Exchange Commission prescribed mandatory reporting on
internal financial controls

 In 1999, OECD ministers endorsed the principles of corporate governance based

on the existing legal and regulatory arrangements as well as the best prevailing
practices followed by market participants in the OECD countries
 The OECD revised its principles in 2004 to reflect a global consensus on critical
importance of good corporate governance
 After the Enron debacle of 2001, came other scandals such as WorldCom, Qwest,
Global Crossing and Arthur Andersen
 In July 2002, the Sarbanes-Oxley Act was enacted
 In late 1980s, UK Government recognised insufficiency of implementable
governance practices
 As a result, In 1991 Cadbury Committee was set up by the London Stock
Exchange to help raise standards of corporate governance
 Subsequently Paul Ruthman Committee to some extent watered down the
Cadbury proposal
 In 1995, Greenbury Committee addressed the issue pertaining to director’s
remuneration
 In 1998, Rom Hampel Committee assessed the impact of Cadbury and Greenbury
recommendations and suggested one super code
 Combined Code was formulated and its compliance was made mandatory by all
listed companies
Developments in India
 In India, corporate governance began in 1998 with the desirable code of corporate
governance i.e. a voluntary code published by the CII
 Securities Exchange Board of India (SEBI) appointed the committee on corporate
governance under the chairmanship of Kumar Mangalam Birla (1999) to promote
and raise standards of corporate governance
 In 2000, DCA formed a study group under the chairmanship of Dr. P.L. Sanjeev
Reddy to operationalise the concept of corporate excellence on a sustained basis
 The enactment of Sarbanes Oxley Act led the Indian Government to set up Naresh
Chandra Committee (2002) to recommend amendments to the law involving the
auditor-client relationships and the role of independent directors
 In 2002 itself, to protect the interest of investors, SEBI constituted a Committee
under the Chairmanship of Shri N.R. Narayan Murthy
 In 2004, the Government constituted a committee under the Chairmanship of Dr.
J.J.Irani with the task of charting out the road map for a flexible, dynamic and
user-friendly new company law

The Ministry of Corporate Affairs, has set up National Foundation for Corporate
Governance (NFCG) in partnership with CII, ICSI and ICAI to make India the best in
corporate governance practices
 Corporate governance concern the enhancement of corporate performance via
supervision and monitoring of management performance and ensuring
management’s accountability to shareholders and other stakeholders

 Corporate governance is the social, legal and economic process in which

companies function and held accountable. It is a system by which companies are
run
 Hence, the model of corporate governance can not be universal as they need to be
adopted in context of socio-economic political and cultural context

Benefits of Good Governance:

 Good governance leads to congruence of interests of board, management
including owner managers and shareholders
 Good governance provides stability and growth to the company
 Good governance system builds confidence among investors
 Good governance reduces perceived risks, consequently reducing cost of capital

 Well governed companies enthuse employees to acquire and develop company

specific skills
 Adoption of good corporate practices promotes stability and long-term sustenance
of stakeholders’ relationship
 Potential stakeholders aspire to enter into relationships with enterprises whose
governance credentials are exemplary

Definition of corporate governance:

 No universal definition of corporate governance
  In the narrowest sense, Friedman defined corporate governance as “the conduct of
business in accordance with shareholder’s desires, which generally is to make as
much money as possible, while conforming to the basic rules of the society
embodied in law and local customs
 OECD has defined corporate governance to mean “A system by which business
corporations are directed and controlled”
 CII defined as “Corporate Governance deals with laws, procedures, practices and
implicit rules that determine a company’s ability to take informed managerial
decisions vis-à-vis its claimants – in particular, its shareholders, creditors,
customers, the state and employees. There is global consensus about the objective
of ‘good’ corporate governance: maximising long-term shareholders value”
 KMB Committee observe that: “Strong corporate governance is indispensable to
resilient and vibrant capital markets and is an important instrument of investor
protection. It is the blood that fills the veins of transparent corporate disclosure
and high quality accounting practices. It is the muscle that moves a viable and
accessible financial reporting structure.”
 Narayan Murthy Committee observed that: “Corporate governance is the
acceptance by management of the inalienable rights of shareholders as the true
owners of the corporation and of their own role as trustees on behalf of the
shareholders. It is about commitment to values, about ethical business conduct
and about making a distinction between personal and corporate funds in the
management of a company.”
 Derives from profit maximisation
 It ensures that the long term strategic objectives and plans are effectively and
efficiently achieved
 It ensures transparency in the corporate dealings and transactions
 It concerns the relationship which the shareholders and the directors share with
each other

Objectives of corporate governance?

 The theme of corporate governance is to establish a framework for how the Board
of Directors would oversee the company’s performance and perform it’s various
functions on behalf of the owners.
  It ensures that long term strategic objectives and plans are established and proper
management structure is in place to achieve these objectives.
 It inspires and strengthens investor’s confidence.
 It ensures transparency in the corporate world.
 It maintains the integrity and reputation of the organization.

Why India Needs to import this concept?

 Problems:
◦ Increasing misdeeds in the corporate world.
◦ Non executive directors do not perform their duties.
◦ Representatives of FI’s on the board do not take their jobs seriously.
◦ Investors at large are loosing interest in the management.
◦ IMF and World Bank has warned the Govts of the third world countries
that unless they clamp down heavily on corruption and mal practices, they
are not interested in providing assistance.

Essence of Corporate Governance:

 CG is all about the nitty gritties of how a company fulfills its obligations to
investors and other stake holders. It is about commitment to values and ethical
business conduct and a high degree of transparency. It is about creating
shareholder wealth while ensuring a fair play to all other stake holders and society
at large.

Elements of Good Corporate Governance:

 Purpose, Role and Powers of Board
◦ Board as a main functionary is primarily responsible to ensure value
creation for its stakeholders
◦ Absence of clearly designated role and powers of Board weakens
accountability mechanism and threatens the achievement of organizational
goals
◦ There should be clear identification of purpose, powers, roles and
responsibilities of the Board, CEO and the Chairman of Board
◦ The board’s purpose should be clearly documented in a Board Charter
 Legislation
◦ Clear and unambiguous legislations and regulations are fundamental to
effective corporate governance
 Management environment
◦ Setting-up of clear objectives and appropriate ethical framework
◦ Providing for transparency and clear enunciation of responsibility and
accountability
◦ Implementing sound business planning and assessment of business risk
◦ Having right people and right skill for the jobs
◦ Evaluating performance
 Board skills- A Board should have a mix of the following skills, knowledge and
experience:
 ◦ Operational or technical expertise
◦ Commitment to establish leadership
◦ Financial skills
◦ Legal skills and
◦ Knowledge of Government and regulatory environment
 Board appointments
◦ To ensure that the most competent people are appointed on the board
◦ Well defined and open procedure must be in place for reappointments as
well as for appointment of new directors
◦ High on the priority should be an understanding of skill requirements of
the Board
◦ All new directors should be provided with a letter of appointment setting
out in detail Board’s purpose, duties and responsibilities
 Board induction and training
◦ Directors must have a broad understanding of the area of operation of the
company’s business, corporate strategy and challenges being faced by the
board
 Board independence
◦ This can be achieved by associating sufficient number of independent
directors with the board
◦ The board needs to be capable of assessing the performance of managers
with an objective perspective
 Board meetings
◦ Directors must devote sufficient time and give due attention to meet their
obligations
◦ Effectiveness of board meetings is dependent on carefully planned
agendas and providing relevant papers and materials to directors
sufficiently prior to board meetings
 Code of conduct
◦ Organization should explicitly prescribe norms of ethical practices and
code of conduct are communicated to all stakeholders

 Strategy setting
◦ The objective of the company must be clearly documented in a long term
corporate strategy including an annual business plan together with
achievable and measurable performance targets and milestones
 Business and community obligations
◦ Commercial objectives and community service obligations should be
clearly documented after approval by the Board
◦ Stakeholders must be informed
 Financial and operational reporting
◦ The Board requires comprehensive, regular, reliable, timely, correct and
relevant information which is appropriate to discharge its functions of
monitoring corporate performance
 ◦The reports should be available to Board members well in advance to
allow informed decision-making
 Monitoring the Board performance
◦ Board must monitor and evaluate its performance collectively and also
that of individual directors at periodic intervals, using key performance
indicators besides peer review
 Audit Committee
◦ It is responsible for liaison with the management, internal and statutory
auditors, reviewing the adequacy of internal control and compliance with
significant policies and procedures, reporting to the Board on the key
issues
 Risk management
◦ There should be a clearly established process of identifying, analyzing and
treating risks, which could prevent the company from achieving its
objectives
◦ Appropriate control procedures in the form of a risk management plan
must be put in place to manage risk
◦ The Board has the ultimate responsibility for identifying major risks to the
organization and ensuring that senior management takes step to detect,
monitor and control these risks

Factors influencing quality of corporate governance:

 Quality of governance primarily depends on following factors:
◦ Integrity of the management
◦ Ability of the Board
◦ Adequacy of the processes
◦ Commitment level of individual Board members
◦ Quality of corporate reporting
◦ Participation of stakeholders in the management

The Spectrum of governance models:

 Corporate governance thinking is strongly influenced by geographical boundaries
 Each country is characterized by its rather ‘unique’ governance model
 Therefore, we refer to a corporate governance model as the specific corporate
governance structures and processes that are embodied in a country’s legal,
institutional and cultural context
 All characteristics of systems of corporate governance have legal, institutional
and cultural dimensions and are an useful analytical tool to cover a major part of
the spectrum of governance models:
 the role of capital markets in the national economy
 External market for corporate control and anti-take-over mechanisms
 Ownership and control (shareholders right and protection)
 The board system
 Disclosure rules and accounting standards
 The role of the firm and accountability
 The governance literature identifies two corporate governance systems i.e. Anglo-
American “market oriented” or “outsider system” and the Latin/Japanese system
“network oriented” or “insider system”
 The outsider system
◦ Control and ownership are distinct and separate
◦ Since equity ownership is widely dispersed among a large number of
institutional holders and small investors, control vests with professional
managers
◦ The model is also refereed to as principal-agent model
◦ Characterized by long-term financing through equity and corporate bond
markets
◦ Shares are widely dispersed among many (anonymous) shareholders
◦ This system is dominated by listed companies
◦ Managers and directors have the obligation to ensure that firms are run in
the interest of the shareholders

 The insider system

◦ The insider model has two variants:
 European – relatively small compact group of shareholders
exercise control over corporation.
 East Asian – the founding family generally holds the controlling
shares either directly or through holding companies.
◦ Equity and corporate bond markets play a less pronounced role
◦ Countries have by definition a relatively small stock market
◦ Companies have a concentrated ownership structure
◦ The insider system attaches more importance to the interests of all
stakeholders
◦ Directors serve as an instrument to create stakeholder wealth