Corporate Governance & Ethics

Prof. Harisankar

1
Having a good governance structure, transparent policies and
internal controls mechanisms are critical to good governance

Equally important are the external entities that can influence

governance of corporations
Good governance depends on internal as well as
external mechanisms
External Entities
Auditors, Banks/Lenders
Rating Agencies, Investment Advisors
Internal Governance Regulators & Government Institutions
Mechanisms Min of Corp Affairs,
Registrar of Companies, SEBI, SEC
Board of Directors
Management
Legislations & Guidelines
Shareholders’ rights
SOX, Companies Act, OECD Guidelines
Audit Committee
Internal Audits
CG Policies Shareholder Activism
Controls on executive pay & Active role by institutional investors,
accountability Proxy Fights, Proxy Advisory Firms

Actions by other corporates

Setting Examples, Threat of take over
 Key Takeaways from Volkswagen Case
• Diesel gate scandal was not simply an issue of a group of engineers
finding an unethical way to cheat the testing system – Poor governance,
bad board practices and even flawed laws contributed to the issue
• German governance model (Two-tier structure)
• Pros and Cons of 2-tier structure of governance
• Role of workers and worker unions in governance
• Comparisons with other models (Anglo Saxon, Japanese, Chaebol)
• Influence of powerful promoter family, power struggles and the
importance of corporate culture
• Role of state (Lower Saxony) - Pros and Cons
• Competency of the regulator
• Issues with flawed policies and laxity in enforcement
• Issues of accountability of regulator
 Models of Corporate Governance

• Corporate governance systems/structures vary around the world.

•There is no model of corporate governance which is universally

acceptable as each model has its own advantages and disadvantages.

• Three Main Models are recognized as references by experts in

Corporate Governance:
•Anglo American Model
•German Model
•Japanese Model
The-Anglo American Model
Elect
Shareholders Board of Directors
(Supervisor)

Appoints and
supervises

Officers
Own (Manager)

Manage

Act as a
balancing Monitors &
force regulates
Creditors Regulatory/Legal
system
Company
 Anglo-American Model

• This model is also called an ‘Anglo-Saxon model’ and is used as basis of

corporate governance in U.S.A, U.K, Canada, Australia, and some common
wealth countries.

• The shareholders appoint directors who in turn appoint the managers to manage
the business. There is separation of ownership and control.

• The board usually consist of executive directors and a few independent

directors. The board often has limited ownership stakes in the company. A single
individual usually (not always) holds both the position of CEO and chairman of
the board.

•This system (model) relies on effective communication between shareholders,

board and management with all important decisions taken after getting approval
of shareholders (by voting).
The German Model
Appoint -50% Appoint 50%
Supervisory Board

Appoints and
supervises

Employees and Shareholders

Labour unions Management Board

Manages

Work for Company Own

 German Model

• This is also called as 2 tier board model as there are 2 boards viz. The supervisory
board and the management board. It is used in countries like Germany, Holland,
France, etc.

• Anglo Saxon model usually gives priority to shareholders, German model is

considered to have a stakeholder orientation

• A distinct characteristics is the employee representation on the supervisory board

through the principle of co-determination

• Usually a large majority of shareholders are banks and financial institutions. The
shareholders can appoint only 50% of members to constitute the supervisory board.
The rest is appointed by employees and labour unions.
 Japanese Model
• This model is also called as the business network model, usually
shareholders are banks/financial institutions, large family shareholders and
corporates with cross-shareholding.

• There is supervisory board which is made up of board of directors and a

president, who are jointly appointed by shareholder and banks/financial
institutions.

•This is reflection of the Japanese ‘keiretsu’- a form of cultural relationship

among corporate entities. It is characterized by an interconnected network of
companies, having strong interlocking alliances and cross-shareholding

•Most of the directors are heads of different divisions of the company. Outside
director or independent directors are rarely found on the board.
 Takeaways from Yahoo Case
• Executive Remuneration – A Key challenge in governance
• Various components used in executive remuneration (Pros and
Cons of these)
• Sign on bonus, Stocks options, Golden Parachutes
• Role of Remuneration committee (and BOD)
• Role of shareholders (Say on Pay)
• Role of regulators
• Guiding rules for Indian companies
• Need for good governance practices
• Benchmarking, seeking help from consultants, disclosures, linking pay to
individual performances, deferred pay-outs, claw back clauses
Role of Auditors
Source : statista.com
Enron: A landmark event
• What happened?
• Bankruptcy of one of the largest corporation of that time
• Result of Accounting Fraud
• Mark to market
• Use of SPVs to hide debt
• Why?
• Greed!
• Lack of regulatory control/oversight
• Usual mix of unethical corporate executives, political influence,
incompetent authorities
• Aftermath?
• Big 5 became Big 4
• Changes to regulations – Sarbanes Oxley
Role of Auditors in CG

• Auditors are one of the many stakeholders in a company; they are

authorized to review and verify the accuracy of financial records in
order to ensure that the company complies with the tax laws
• Auditors have many responsibilities
• Provide an audit report
• Reporting failures and indictable offences
• Exercising professional integrity
• Mitigate risk factors by carrying out periodic checks
• Protect stakeholder interests and promote accountability
Challenges faced
• Complex nature of financial transactions
• Regulatory changes
• Digitalisation and associated issues (cyber security, integrity of
digital records etc)
• Balancing the role as independent professionals and service
providers
Read more about Auditors’ role in CG
• https://corporatelawilnu.wordpress.com/2020/11/05/roles-and-
responsibilities-of-an-auditor-in-corporate-governance/

• https://proschoolonline.com/blog/auditing-in-
india#:~:text=In%20simple%20words%2C%20an%20auditor,interests
%20in%20the%20business%20landscape
 Along with good governance structure and
internal policies of individual companies, it is
important to have the right policy
framework/regulations/codes
Evolution of Corporate Governance
Guidelines/Codes
 Milestones in evolution of CG Codes
Year Name of Areas/Aspects Covered
Committee/Body
1992 Sir Adrian Cadbury Financial Aspects of Corporate Governance
Committee, UK
1994 Mervyn E . King’s Committee Corporate Governance
, South Africa
1995 Greenbury Committee , UK Directors’ Remuneration
1998 Hampel Committee, UK Combine Code of Best Practices
1999 Blue Ribbon Committee, US Improving the Effectiveness of Corporate Audit
Committees
1999 OECD Principles of Corporate Governance
1999 CACG Principles for Corporate Governance in
Commonwealth
2002 Derek Higgs Committee, UK Review of role of effectiveness of Non-executive
Directors
2002 Sarbanes Oxley Act, United Corporate Auditing Accountability and
States Responsibility
• International Corporate Governance Network (ICGN) guidelines
• 2009 – International Finance Corporation guidelines linking E-S-G
• 2010 – Dodd Frank Act (US)
• 2021 – ISO 37000 (guidelines on good governance)

26
 Sarbanes Oxley Act 2002

• Initiated and sponsored in US by congressmen Paul Sarbanes & Michael

Oxley

• Also known as Public Company Accounting Reform and Investor

Protection Act. (Often referred to as Sarbox or SOX)
• Enacted in the backdrop of a number of corporate collapses and frauds
in late 90s and early 2000 (Enron, Worldcom and others)
• Is a federal law that set new or expanded requirements for all U.S Public
company boards, management and public accounting firms
• Scandals like Enron raised concerns around many areas

• Need for better standards for auditing

• Need for better accountability and oversight for auditors
• How to prevent fraud using loopholes in accounting practices (like use of
SPVs)
• Lack of expertise in BODs to identify accounting frauds
• Raise accountability of BOD
• Prevent insider trading
 Some of the key
norms/recommendations in
Sarbanes Oxley Act
SARBANES-OXLEY
Major Objectives

• Improve corporate governance

• Reform public accounting (auditing)
• Reform Wall Street practices
• Attack insider trading and obstruction of justice (document
retention)

“Restore confidence in capital markets”

Creation of Public Company Accounting Oversight Board
U.S. Securities
& Exchange
Commission (SEC)

Public Company
Corporate Board
Accounting Oversight
Of Directors
Board (PCAOB)

Independent
Audit Committee CEO & CFO
Audit Firm

Internal Audit
Function

Internal Control
System
 Creation of Public Company Accounting
Oversight Board
• Established by Sarbanes-Oxley, ending self regulation
followed by auditing firms
• Broad powers to regulate audits and auditors of public
companies
• Appointed by the SEC
• Oversight authority expanded (in 2010) to audits of brokers
and dealers registered with SEC
 Role of PCAOB

• Register public accounting firms

• Establish auditing standards
• Inspect registered public accounting firms
• Conduct investigations and disciplinary
proceedings – with ability to sanction
auditors and audit firms
 In India

• India has an equivalent of PCAOB – National

Financial Reporting Authority (NFRA)
• Set up in 2018 (jurisdiction was carved out
of ICAI’s domain)
 Auditor Independence

• Prohibits certain non-audit services

• Consultancy, Bookkeeping, financial systems design, appraisal or valuation,
actuarial, internal auditing outsourcing, management or human resources,
broker-dealer or investment banking, others per PCAOB
• Audit partner rotation (recommended)
• Audit Committee is directly responsible for oversight of
external auditors
• Audit committee must pre-approve all auditing and non-
auditing services
Enhanced Executive and Board Responsibilities
• Requires executives and financial officers (CEO & CFO) to certify financial
reports are accurate, complete and fairly presented
• State of internal controls also to be certified
• Audit Committee to include independent directors
• At least one member of the audit committee to be an “Audit Committee
Financial Expert”
• Audit Committee has responsibility to appoint, compensate, and oversee
public accounting firm performing the audit
• Audit Committee has responsibility to resolve disagreements over financial
reporting between management and external auditors
• Audit Committee to establish “whistle-blower” procedures with clear
penalties for any retaliation against them
 Enhanced Financial Disclosures

• Off-balance sheet arrangements and obligations to be

disclosed
• Prohibits loans to executives and directors
• Insider trades to be disclosed
• Code of ethics for senior financial officers to be
adopted and status to be disclosed
 Takeaways from Tata Sons Case
• Excessive control by promoter families (or by influential personalities)
• Pros and Cons of holding company structures
• Need for succession planning and value alignment (especially for family
controlled businesses)
• Lack of powers for independent directors
• Ways to empower IDs (fixed tenures, higher thresholds of shareholder approval for
removal, veto powers etc.)
• Risk to good governance associated with manipulations of AoA
• Need for good governance practices
• Clear & proactive succession planning
• Options to empower independent directors (super voting, assured tenures)