Governance
Recap
In modern corporate Whenever responsibility for
systems, principal and agent activities and assets is
are not permanent entities delegated by those in
but positions. There is a principal position to those in
principal position and there agent position, the agency
is an agency position. dilemma will occur.
Corporate governance seeks
to resolve this dilemma by a
At the root of this dilemma
system of monitoring,
is information asymmetry.
controls and disclosures,
which has a cost.
This cost should be The study of governance
commensurate with the includes: identifying,
reduction in potential explaining and combating all
losses. (Transaction cost types of risky contracts-
theories) Williamson
Stewardship
Theory Directors can be trusted, historically and legally.
Directors have a fiduciary duty to act as a steward of shareholders’ interests.
Their legal duty is to their shareholders, not to themselves, not to any other
interest group.
They are faithful, responsive and effective people, good administrators of the
resources entrusted.
If the underpinning discipline of Agency theory is transactional economics, the
underlying discipline of stewardship theory are legal and organizational studies.
Maslov and McGregor: Theories of motivation
Theory Y- Managers are rational beings, there is not any need to excessively
monitor their behavior (as the agency theory assumes)
Implications?
Legal Responsibilities of the board
Is towards the company (The Competitive pressure in free Customers- monopoly and
Shareholders) markets competition law
Conflict of interest between
Employees- employee law, health
various stakeholder groups and Legislation and safety law
the company are to be met by:
Consumers- product safety law,
Legal Controls consumer protection law
Suppliers- contract law, credit
payment law
Society- environment law, health
and safety law, taxation laws
Flip Side of Stewardship Theory
Corporations are complex creatures
Diversified vs consolidated shareholding
Universal ownership
Normative, not predictive
Resource Dependency Theories
Pfeffer and Salancik (1978)
Organizational behaviour (and structure) is affected by external resources they are
connected to.
firms change, as well as negotiate with, their external environment in order to
secure access to the resources.
This means that a firm’s competitiveness is determined by the way they deal with
their external resources.
These resources may be more important than internal resources.
The directors are ‘boundary spanning’ nodes of networks able to connect the
business to its strategic environment.
Directors, chairman, CEO are not just
Resource company’s internal members, they are
Dependency also nodes in social networks.
Theories, social
networks and Such social networks can both enhance or
corporate adversely interfere with the independent
power game and objective governance activities.
Identifying such networks and monitoring
their activities can be insightful for
governance processes and powers.
Enlightened Shareholder
CORPORATE RESPONSIBILITY “DIRECTORS ARE RESPONSIBLE FOR RELATIONS GROUNDED IN THE STEWARDSHIP DUTY, THE
WITH STAKEHOLDERS, BUT ARE ACCOUNTABLE BOARD HAS TO TAKE STAKEHOLDERS INTEREST
TO THE SHAREHOLDERS.” INTO ACCOUNT, EXPLAINING THEIR ACTIONS TO
ALL STAKEHOLDERS
These are not scientific
theories. Each is true from
a perspective.
The Governance Model
The Original Context
Directors were
appointed by and were
No so any longer, the
usually in direct contact
distance has increased.
with their shareholders-
shareholder democracy.
Management
and
governance
Management runs (operates) the
business
Board insures that the business is
being well run and,
Run in the right
direction
Managemen Management is hierarchical, has operational
t and objectives, has a current and short-term outlook
Governance Board is, ideally, egalitarian, has strategic and
directional objectives and has long term outlook
Board consists of directors:
Directors
• Executive directors (EDs)
• Non-Executive (outside) directors
• Connected NEDs (Affiliated with the firm)
• Independent NEDs (no affiliation with the firm’s business)
What Board Does
Overall, direct the company.
Accountability- to Shareholders, resource networks, society and state
Outward/past and present focussed
Strategy formulation
Outward/future focussed
Supervising managerial activities
Inward/past and present focussed
Policy making
Inward/future focussed
Overall, direct the company.
What Accountability- to Shareholders, resource networks, society and state
Board Outward/past and present focussed
Does Strategy formulation
Outward/future focussed
Supervising managerial activities
Inward/past and present focussed
Policy making
Inward/future focussed
Approve and work with and through the CEO
Board, CEO and Independence
PERFORMANCE AND DILEMMA: MARKING THEIR TWO TIER BOARDS:
CONFORMANCE ROLES OWN EXAMINATION PAPERS EXECUTIVE AND SUPERVISORY
Four possible scenarios
Family firms, start-ups,
subsidiary companies
Back to All ED
Company is a legal convenience-
board
taxation benefits, limited
personal liability
Majority EDs
structure
s Majority NEDs
All NEDs
Majority EDs
NEDs in a minority
Need for backing up experience with expertise on
markets, technologies, complex financial issues
Price for accepting significant growth capital from
outside
Family members not involved in the direct running of
business
Retired executives with a treasure of experience
Power, however, remains with the EDs
Business has become complex, ownership not
Complex ownership begins with listing
Majority NEDs (some may
be independent)
• Professional boards
• A typical listed company in the
US, UK or similar advanced
economies will have a majority of
nonexecutive directors.
• CEO still commands powers for
performance role of the board.
All NEDs
Seldom in listed companies
Not for profit entities, subsidiary
companies
Stakeholder boards
Executives typically attend the board
meetings but not vote
Two tier boards
Supervisory and management
Germany- co-determination by labour
and capital
Dutch- Labour capital and society
Advisory boards
Board Diversity
Diversity for business effectiveness
Stakeholder diversity
Societal Diversity
How diverse should a board be?
Historical Perspective: Evolution
20th Century was an era of management theories.
In 21st corporate governance becomes the primary focus.
Growing interest in the way power is exercised over corporate
entities.
Not just profit oriented companies
Activities of the board and its relationship with members
(shareholders), management, external auditors, regulators and
other stakeholders.
Drivers:
Agency dilemma
Corporate collapses, frauds and widespread implications
Corporate giants and their powers
17th Century (Chartered Companies)
The need for big capital and shared risks-
emergence of joint stock companies
East India Company
Greed, ambitions and collapse: South Sea
Bubble
The Bubble Act
19th Century (Companies Legislation)
Industrial Revolution of 18th and 19th
Century
société en commandite par actions-
France, 1807
British Companies Act 1855 and 1862
The birth of limited liability, joint
stock companies
Public companies, private businesses
and family firms
20th Century (Securities and exchange
controls)
Separation and distancing of
ownership from operational
controls
Numerous, diverse, geographically
separated, differing in time
horizons, complex shareholding
Financial institutional investors
The Great Depression, 1929, Wall
Street Crash, 1929, and Creation of
US Securities and Exchange
Commission, 1933
For the next 40 years the work of
directors and boards remained the
province of jurisprudence.
1970s (audit committees, two
tier boards, corporate
responsibility)
1972- Audit Committees (a SEC,
US, requirement)- independent
outside directors
What does Audit Committee
do?
Europe: Two tier boards-
independent directors
Debate on board's duties
towards stakeholders- public
disclosures
Era of Reagan and
Thatcher- free markets and
growth
Also, an era of corruption,
1980s (corporate collapse) frauds and hostile
takeovers
Need for good practices
1990s: Corporate Governance Codes
Cadbury Report, 1992, UK:
• Wider use of independent directors, with independence defined
• Audit committee to consist fully of independent directors
• Division of chairman and CEO
• Remuneration committee
• Nomination committee
• Public Reporting of CG compliance, and explanation of non-compliance
Other reports world over to prevent abuse of corporate
power
OECD report
Securities and Exchange Regulations, regulators
21st Century
Globalization- more complex,
more powerful corporations
The Century began with hopes
for good governance
More collapses: Enron,
Worldcom, Tyco and Arthur
Anderson
GAAP could be manipulated!
Sarbanes Oxley Act, 2002
2007: Global Financial Crisis
Present Time Issues Growing Corporate complexity
Changes in ownership patterns
Board responsibility for enterprise
risk management and business
continuity
Governance by rules or by
Principles
Boards marking their own papers
Independent Directors who do not
know enough about the business
Board diversity
Growing shareholders’ expectations
Society’s expectations
Cultural considerations
Trump
Regulatory Framework
Company Law:
Incorporation
Appointment of directors
Compliances, disclosures and
filings
Accounting Standards: GAAP and IFRS
Stock exchange rules
Legislation: Securities and Exchange Regulations
Industry Regulators- RBI, IRDAI,
RERA, TRAI
Taxation Laws
Other laws: Environmental, safety,
consumer, anti corruption
Worldwide: OECD
Country Specific
Company Codes
Codes: Codes from institutional investors
Status of compliance
Governance Best
Practices
In the next class
