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Business Ethics and Corporate Governance

Meaning & Definition of Ethics and Business Ethics: Many philosophers have expressed different views about ethics. But they all agree that, in essence ethics deals with what is right or wrong. Business ethics is nothing but an application of ethical judgments to business activities. There was an argument whether ethics should form a part of business or not. This resulted in three different views: Unitarian view, Separatist view and Integration view. Unitarian view argues that morality and ethics are related to business. The Separatist view expressed that, business should concentrate on profits, and ethics and morality do not form a part of business. The Integration view defined a new area called business ethics, where ethical behavior and business are integrated. The external forces like government, market system, law and services will guide the ethical behavior of the business. Finally, the chapter discusses about the need or necessity for business ethics - business in order to survive in the long run should concentrate on the welfare of the society. Nature of Ethics: The followings are characterized as the nature of ethics. 1. Ethics deals with human beings 2. Ethics belongs to the field of social science. It deals with moral behavior and conduct of human being. 3. The science of ethics is a normative science. It deals with value judgment. It decides what ought to be rather than factual judgments. 4. It deals with human conduct which is voluntary and not forced by other person or circumstances. Sources of Ethics: Five primary sources of ethics have been identified in the American business area by ethics scholars George and John Stever as under: 1. Genetic Inheritance: A lots of evidence and arguments suggests that the evolutionary forces of natural selection influence the development of traits such as cooperation and alteration that lie at the core of our ethical system. 2. Religion: Many business people believe that their religion provides them with ethical principles and standards which are applied in business. Hinduism, Christianity, Islam, Judaism are the great world religions that guides people to behave ethically. The Christians believe the ten commandments as the will of god and so preached in their day to day life. The ethical commands are: You shall not kill You shall not commit adultery You shall not steal You shall not bear false witness against your neighbors You shall not covert your neighbors house. 3. Philosophical system: There are two basic philosophical systems who teach differently to pleasure and pain. The Epicureanism believe that pleasure is the chief good. Whereas the stoics are indifferent to pleasure and pain. Similarly different philosophies guide people differently towards good and bad.

4. Legal System: The law educates us about the ethical course in life. The legal system of a nation guides the businessmen how to deal with employees, shareholders, customers, suppliers and with the society at large. 5. Code of Conduct: The followings are the three primary codes of conduct to shape our ethical judgement. These are as follows: Company Codes Company operating policies Code of Ethics. Definition of Business Ethics: Business ethics is a form of applied ethics that scrutinizes ethical principles and moral or ethical problems that occur in a business environment. In the more conscientious marketplaces of the 21st century, the demand for more ethical business processes and actions (referred to as ethicism) is mounting. Also, pressures for the application of business ethics are being exerted through enactment of new public initiatives and laws

What is Business Ethics?


Business ethics demand that a company examines its behavior towards the outside world. It takes into consideration morality, ethical reasoning and ethics application. For instance, the business manager's moral philosophy of situations do affect the manager's ethical beliefs. Moral philosophy pertains to the overall guiding belief system behind the individual's perception of right or wrong. It is important to be acquainted with moral philosophy, ethical reasoning, and especially the application of ethics to business and management. Ethical theories and concepts are important to resolving moral problems confronting business. Employees and managers must integrate moral concerns into their decision-making process. What is ethical business performance? Ethical business performance always adheres to societys basic rules that define right and wrong behavior. One of the major challenges faced by business is to balance ethics and economics. Society wants business to be ethical and economically profitable at the same time. Therefore the ethical decision should be right, proper and just. Ethical Objectives: The followings are the basic objectives of ethics. 1. It studies human behavior. It makes evaluative assessment of what is moram and what is immoral. 2. It establishes moral standard/norms of behavior. 3. Makes judgment of human behavior based on these standards and norms. 4. It prescribes moral behavior. It makes recommendation how to or how not to behave. 5. Expresses opinion about human attitude or conduct in general.

Importance of Ethics in Business Ethics is important not only in business but in all aspects of life because it is the vital part and the foundation on which the society is build. A business/society that lacks ethical principles is bound to fail sooner or later. According to International Ethical Business Registry, "there has been a dramatic increase in the ethical expectation of businesses and professionals over the past 10 years. Increasingly, customers, clients and employees are deliberately seeking out those who define the basic ground, rules of their operations on a day today...." Ethics refers to a code of conduct that guides an individual in dealing with others. Business Ethics is a form of the art of applied ethics that examines ethical principles and moral or ethical problems that can arise in business environment. It deals with issues regarding the moral and ethical rights, duties and corporate governance between a company and its shareholders, employees, customers, media, government, suppliers and dealers. Henry Ford said, "Business that makes noting but money is a poor kind of business". Ethics is related to all disciplines of management like accounting information, human resource management, sales and marketing, production, intellectual property knowledge and skill, international business and economic system. As said by Joe Paterno once that success without honor is an unseasoned dish. It will satisfy your hunger, but won't taste good. In business world the organization's culture sets standards for determining the difference between good or bad, right or wrong, fair or unfair. "It is perfectly possible to make a decent living without compromising the integrity of the company or the individual, wrote business executive R. Holland, "Quite apart from the issues of rightness and wrongness, the fact is that ethical behavior in business serves the individual and the enterprise much better in long run.", he added. Some management guru stressed that ethical companies have an advantage over their competitors. Said Cohen and Greenfield, "Consumers are used to buying products despite how they feel about the company that sells them. But a valued company earned a kind of customer loyalty most corporations only dream of because it appeals to its customers more than a product". The ethical issues in business have become more complicated because of the global and diversified nature of many large corporation and because of the complexity of economic, social, global, natural, political, legal and government regulations and environment, hence the company must decide whether to adhere to constant ethical principles or to adjust to domestic standards and culture. Managers have to remember that leading by example is the first step in fostering a culture of ethical behavior in the companies as rightly said by Robert Noyce, "If ethics are poor at the top, that behavior is copied down through the organization", however the other methods can be creating a common interest by favorable corporate culture, setting high standards, norms, framing attitudes for acceptable behavior, making written code of ethics implicable

at all levels from top to bottom, deciding the policies for recruiting, selecting, training, induction, promotion, monetary / non-monetary motivation, remuneration and retention of employees. "Price is what you pay. Value is what you get" - Warren Buffet Thus, a manager should treat his employees, customers, shareholders, government, media and society in an honest and fair way by knowing the difference between right or wrong and choosing what is right, this is the foundation of ethical decision making. REMEMBER: GOOD ETHICS IS GOOD BUSINESS. "Non-corporation with the evil is as much a duty as is co-operation with good" - Mahatma Gandhi. Objectives of Business Ethics Statement To establish a framework for professional behavior and uphold values such as trust, transparency, honesty and integrity in all dealings; To increase the awareness to management and employees of the companys ethical stand in carrying out the daily activities and the discharge of responsibilities; To comply and maintain high ethical standards, obeying all applicable laws and regulations locally and internationally. 1.3 Scope and Application The scope and application should extend throughout the company and to all levels of employees and shall apply to all types of activities in the organization. The Code of Ethics statement is applied to all levels of management and employees, including our dealings with customers, suppliers, contractors, government authorities, and associated bodies or organizations. Factors influencing Business Ethics Business may be defined as a set of standards or principles governing the moral conduct of businessman. There are many factors influencing business ethics. Some of them are social values, legislation, industry norms, personal values and professionalisation. The main determinants of business ethics are as follows: Social forces and pressure exercise considerable influence on business ethics. Often, different groups in society compel businessman to discontinue unethical issues. Laws are generally passed to keep a check on unethical practices. They are the result of social pressures. When society considers a practice unethical, it may exercise its influence to get that practice declared illegal. In some industries and trades, specific codes of conduct have been laid down. In addition, many organizations have laid down guidelines for regulating their behavior of their employees. Most industries have ethical climate which governs the code of conduct of the employees. The personal beliefs of the individuals working in an organization also influence business ethics. However sometimes there is conflict between personal moral values and company goals. Generally employees look at their superiors and tend to adopt their values and actions. The behavior of competitors and associates also influences business ethics Professional managers normally tend to have higher ethical standards than family managers. Therefore growing professionalisation of management has exercised a healthy influence on ethics in business.

Ethical Aspects in Marketing

Frameworks of analysis for marketing ethics


Possible frameworks:

Value-oriented framework, analyzing ethical problems on the basis of the values which they infringe (e.g. honesty, autonomy, privacy, transparency). An example of such an approach is the AMA Statement of Ethics. Stakeholder-oriented framework, analysing ethical problems on the basis of whom they affect (e.g. consumers, competitors, society as a whole). Process-oriented framework, analysing ethical problems in terms of the categories used by marketing specialists (e.g. research, price, promotion, placement).

Specific issues in marketing ethics


Market research
Ethical danger points in market research include:

Invasion of privacy. Stereotyping.

Stereotyping occurs because any analysis of real populations needs to make approximations and place individuals into groups. However if conducted irresponsibly, stereotyping can lead to a variety of ethical undesirable results. In the AMA Statement of Ethics, stereotyping is countered by the obligation to show respect ("acknowledge the basic human dignity of all stakeholders").

Market audience
Ethical danger points include:

Targeting the vulnerable (e.g. children, the elderly). Excluding potential customers from the market: selective marketing is used to discourage demand from undesirable market sectors or disenfranchise them altogether.

Examples of unethical market exclusion or selective marketing are past industry attitudes to the gay, ethnic minority and obese ("plus-size") markets. Contrary to the popular myth that ethics and profits do not mix, the tapping of these markets has proved highly profitable. For example, 20% of US clothing sales are now plus-size.Another example is the selective marketing of health care, so that unprofitable sectors (i.e. the elderly) will not attempt to take benefits to which they are entitled.A further example of market exclusion is the pharmaceutical industry's exclusion of developing countries from AIDS drugs.

Examples of marketing which unethically targets the elderly include: living trusts, time share fraud, mass marketing fraud and other.The elderly hold a disproportionate amount of the world's wealth and are therefore the target of financial exploitation.[12] In the case of children, the main products are unhealthy food, fashionware and entertainment goods. Children are a lucrative market: "...children 12 and under spend more than $11 billion of their own money and influence family spending decisions worth another $165 billion", but are not capable of resisting or understanding marketing tactics at younger ages ("children don't understand persuasive intent until they are eight or nine years old"). At older ages competitive feelings towards other children are stronger than financial sense. The practice of extending children's marketing from television to the schoolground is also controversial (see marketing in schools). The following is a select list of online articles:

Sharon Beder, Marketing to Children (University of Wollongong, 1998). Miriam H. Zoll, Psychologists Challenge Ethics Of Marketing To Children (American News Service, 2000) Donnell Alexander and Aliza Dichter, Ads And Kids: How Young Is Too Young? Rebecca Clay, Advertising to children: Is it ethical? (Monitor on Psychology, Volume 31, No. 8 Sept. 2000) Media Awareness Network, How marketers target kids

Other vulnerable audiences include emerging markets in developing countries, where the public may not be sufficiently aware of skilled marketing ploys transferred from developed countries, and where, conversely, marketers may not be aware how excessively powerful their tactics may be. See Nestle infant milk formula scandal. Another vulnerable group are mentally unstable consumers. The definition of vulnerability is also problematic: for example, when should endebtedness be seen as a vulnerability and when should "cheap" loan providers be seen as loan sharks, unethically exploiting the economically disadvantaged? Pricing ethics: List of unethical pricing practices.

price fixing price skimming price discrimination variable pricing predatory pricing supra competitive pricing price war bid rigging dumping (pricing policy)

Ethics in advertising and promotion

Content
Ethical pitfalls in advertising and promotional content include:

Issues over truth and honesty. In the 1940s and 1950's, tobacco used to be advertised as promoting health. Today an advertiser who fails to tell the truth not only offends against morality but also against the law. However the law permits "puffery" (a legal term).The difference between mere puffery and fraud is a slippery slope: "The problem... is the slippery slope by which variations on puffery can descend fairly quickly to lies." See main article: false advertising. Issues with violence, sex and profanity. Sexual innuendo is a mainstay of advertising content (see sex in advertising), and yet is also regarded as a form of sexual harassment. Violence is an issue especially for children's advertising and advertising likely to be seen by children. Taste and controversy. The advertising of certain products may strongly offend some people while being in the interests of others. Examples include: feminine hygiene products, hemorrhoid and constipation medication. The advertising of condoms has become acceptable in the interests of AIDS-prevention, but are nevertheless seen by some as promoting promiscuity. Some companies have actually marketed themselves on the basis of controversial advertising - see Benetton. Sony has also frequently attracted criticism for unethical content (portrayals of Jesus which enfuriated religious groups; racial innuendo in marketing black and white versions of its PSP product; graffiti adverts in major US cities). Negative advertising techniques, such as attack ads. In negative advertising, the advertiser highlights the disadvantages of competitor products rather than the advantages of their own. The methods are most familiar from the political sphere: see negative campaigning.

Delivery channels

Direct marketing is the most controversial of advertising channels, particularly when approaches are unsolicited. TV commercials and direct mail are common examples. Electronic spam and telemarketing push the borders of ethics and legality more strongly. Shills and astroturfers are examples of ways for delivering a marketing message under the guise of independent product reviews and endorsements, or creating supposedly independent watchdog or review organisations. For example, fake reviews can be published on Amazon.[21] Shills are primarily for message-delivery, but they can also be used to drive up prices in auctions, such as Ebay auctions.

The use of ethics as a marketing tactic


Business ethics has been an increasing concern among larger companies, at least since the 1990s. Major corporations increasingly fear the damage to their image associated with press revelations of unethical practices. Marketers have been among the fastest to perceive the market's preference for ethical companies, often moving faster to take advantage of this

shift in consumer taste. This results in the expropriation of ethics itself as a selling point or a component of a corporate image.

The Body Shop is an example of a company which marketed itself and its entire product range solely on an ethical message, although its products were deceptively characterized and its history was marked by misrepresentations. "The Body Shop's only real product is honesty..." (Jon Entine in an ethics audit of the company). However the story of the Body Shop ended with increasing criticism of a gap between its morals and its practices. Greenwash is an example of a strategy used to make a company appear ethical when its unethical practices continue. Liberation marketing is another strategy whereby a product can masquerade behind an image that appeals to a range of values, including ethical values related to lifestyle and anti-consumerism.

"Liberation marketing takes the old mass culture critique consumerism as conformity fully into account, acknowledges it, addresses it, and solves it. Liberation marketing imagines consumers breaking free from the old enforcers of order, tearing loose from the shackles with which capitalism has bound us, escaping the routine of bureaucracy and hierarchy, getting in touch with our true selves, and finally, finding authenticity, that holiest of consumer grails." (Thomas Frank)

APPROACHES TO ETHICAL DECISION MAKING: Business owners often face difficult ethical dilemmas, such as whether to cut corners on quality to meet a deadline or whether to lay off workers to enhance profits. A current ethical debate concerns the use of extremely low-wage foreign workers, especially in the garment industry. The intense pressures of business may not always allow you the luxury of much time for reflection, and the high stakes may tempt you to compromise your ideals. How will you respond? No doubt, you already have a well-developed ethical outlook. Nevertheless, by considering various approaches to ethical decision making, you may be better able to make the right choice when the need arises. The subject of business ethics is complex. Fair-minded people sometimes have significant differences of opinion regarding what constitutes ethical behavior and how ethical decisions should be made. This article discusses four approaches that business owners can use to consider ethical questions. The method you prefer may not suit everyone. Hopefully, by considering the alternatives, you will be able to make decisions that are right for you. Utilitarian The utilitarian approach to ethical decision making focuses on taking the action that will result in the greatest good for the greatest number of people. Considering our example of employing low-wage workers, under the utilitarian approach you would try to determine whether using low-wage foreign workers would result in the greatest good.

For example, if you use low-wage foreign workers in response to price competition, you might retain your market share, enabling you to avoid laying off your U.S. employees, and perhaps even allowing you to pay your U.S. employees higher wages. If you refuse to use low-wage foreign workers regardless of the competition, you may be unable to compete. This could result in layoffs of your U.S. workers and even your foreign workers, for whom the relatively low wages may be essential income. On the other hand, using low-wage workers may tend to depress the wages of most workers, thus reducing almost everyones standard of living and depressing their ability to purchase the very goods you and others are trying to sell. Moral Rights The moral rights approach concerns itself with moral principles, regardless of the consequences. Under this view, some actions are simply considered to be right or wrong. From this standpoint, if paying extremely low wages is immoral, your desire to meet the competition and keep your business afloat is not a sufficient justification. Under this view, you should close down your business if you cannot operate it by paying your workers a "living wage," regardless of the actions of your competitors. Universalism The universalist approach to ethical decision making is similar to the Golden Rule. This approach has two steps. First, you determine whether a particular action should apply to all people under all circumstances. Next, you determine whether you would be willing to have someone else apply the rule to you. Under this approach, for example, you would ask yourself whether paying extremely low wages in response to competition would be right for you and everyone else. If so, you then would ask yourself whether someone would be justified in paying you those low wages if you, as a worker, had no alternative except starvation. Cost-Benefit Under the cost-benefit approach, you balance the costs and benefits of taking versus not taking a particular action. For example, one of the costs of paying extremely low wages might include negative publicity. You would weigh that cost against the competitive advantage that you might gain by paying those wages. Conclusion In our complex global business climate, ethical decision making is rarely easy. However, as a business owner, you have several models available for analyzing your ethical dilemmas. Sometimes one approach will be more appropriate than another. If you take time to consider the various possibilities, you are more likely to make a decision you believe is ethically correct.

Module-2:

Corporate Governance: Corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a corporation (or company) is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, management, and the board of directors. Other stakeholders include employees, customers, creditors, suppliers, regulators, and the community at large. Corporate governance is a multi-faceted subject. An important theme of corporate governance is to ensure the accountability of certain individuals in an organization through mechanisms that try to reduce or eliminate the principal-agent problem. Principles: Key elements of good corporate governance principles include honesty, trust and integrity, openness, performance orientation, responsibility and accountability, mutual respect, and commitment to the organization. Of importance is how directors and management develop a model of governance that aligns the values of the corporate participants and then evaluate this model periodically for its effectiveness. In particular, senior executives should conduct themselves honestly and ethically, especially concerning actual or apparent conflicts of interest, and disclosure in financial reports. Commonly accepted principles of corporate governance include:

Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by effectively communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings. Interests of other stakeholders: Organizations should recognize that they have legal and other obligations to all legitimate stakeholders. Role and responsibilities of the board: The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors. Integrity and ethical behaviour: Ethical and responsible decision making is not only important for public relations, but it is also a necessary element in risk management and avoiding lawsuits. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. It is important to understand, though, that reliance by a company on the integrity and ethics of individuals is bound to eventual failure. Because of

this, many organizations establish Compliance and Ethics Programs to minimize the risk that the firm steps outside of ethical and legal boundaries. Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information.

Issues involving corporate governance principles include:


internal controls and internal auditors the independence of the entity's external auditors and the quality of their audits oversight and management of risk oversight of the preparation of the entity's financial statements review of the compensation arrangements for the chief executive officer and other senior executives the resources made available to directors in carrying out their duties the way in which individuals are nominated for positions on the board dividend policy

Nevertheless "corporate governance," despite some feeble attempts from various quarters, remains an ambiguous and often misunderstood phrase. For quite some time it was confined only to corporate management. That is not so. It is something much broader, for it must include a fair, efficient and transparent administration and strive to meet certain well defined, written objectives. Corporate governance must go well beyond law. The quantity, quality and frequency of financial and managerial disclosure, the degree and extent to which the board of Director (BOD) exercise their trustee responsibilities (largely an ethical commitment), and the commitment to run a transparent organization- these should be constantly evolving due to interplay of many factors and the roles played by the more progressive/responsible elements within the corporate sector. John G. Smale, a former member of the General Motors board of directors, wrote: "The Board is responsible for the successful perpetuation of the corporation. That responsibility cannot be relegated to management."However it should be noted that a corporation should cease to exist if that is in the best interests of its stakeholders. Perpetuation for its own sake may be counterproductive. In India, a strident demand for evolving a code of good practices by the corporation, written by each corporation management, is emerging.

Mechanisms and controls Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral hazard and adverse selection. For example, to monitor managers' behaviour, an independent third party (the external auditor) attests the accuracy of information provided by management to investors. An ideal control system should regulate both motivation and ability. Internal corporate governance controls Internal corporate governance controls monitor activities and then take corrective action to accomplish organisational goals. Examples include:

Monitoring by the board of directors: The board of directors, with its legal authority to hire, fire and compensate top management, safeguards invested capital. Regular board meetings allow potential problems to be identified, discussed and avoided. Whilst non-executive directors are thought to be more independent, they may not always result in more effective corporate governance and may not increase performance.[6] Different board structures are optimal for different firms. Moreover, the ability of the board to monitor the firm's executives is a function of its access to information. Executive directors possess superior knowledge of the decisionmaking process and therefore evaluate top management on the basis of the quality of its decisions that lead to financial performance outcomes, ex ante. It could be argued, therefore, that executive directors look beyond the financial criteria. Internal control procedures and internal auditors: Internal control procedures are policies implemented by an entity's board of directors, audit committee, management, and other personnel to provide reasonable assurance of the entity achieving its objectives related to reliable financial reporting, operating efficiency, and compliance with laws and regulations. Internal auditors are personnel within an organization who test the design and implementation of the entity's internal control procedures and the reliability of its financial reporting Balance of power: The simplest balance of power is very common; require that the President be a different person from the Treasurer. This application of separation of power is further developed in companies where separate divisions check and balance each other's actions. One group may propose company-wide administrative changes, another group review and can veto the changes, and a third group check that the interests of people (customers, shareholders, employees) outside the three groups are being met. Remuneration: Performance-based remuneration is designed to relate some proportion of salary to individual performance. It may be in the form of cash or non-cash payments such as shares and share options, superannuation or other benefits. Such incentive schemes, however, are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behaviour, and can elicit myopic behaviour.

External corporate governance controls

External corporate governance controls encompass the controls external stakeholders exercise over the organisation. Examples include:

competition debt covenants demand for and assessment of performance information (especially financial statements) government regulations managerial labour market media pressure takeovers

What is good corporate governance? Good corporate governance is characterized by a firm commitment and adoption of ethical practices by an organization across its entire value chain and in all of its dealings with a wide group of stakeholders encompassing employees, customers, vendors, regulators and shareholders (including the minority shareholders), in both good and bad times. To achieve this, certain checks and practices need to be whole-heartedly embraced. Some considerations in this respect are outlined below: Codes of conduct and whistle blower policies are important, but more important is how they are communicated and practiced. It is vital for board members and senior management to lead by example The concept of having independent directors is a good one in theory but more important is the process underlying selection of independent directors is this process rigorous, transparent and objective and is it aligned to the companys needs? It is important to focus on not just earnings but on the sustainability of business models. Focus on not just How much? but on How?, At what cost? and At whose expense? Rating agencies need to develop criteria that focus on substance rather than the form of governance Compensation of executive directors should flow from an objective performance evaluation process conducted by the board Greater transparency and disclosure of executive performance criteria are required which should include financial and non-financial measures Regulators should send clear signals that they shall be proactive in imposing substantial penalties for non-compliance, so that compliance is strictly adhered to. Market Model of Governance Chain: The market model of governance chain is adopted in an efficient well developed equity market and where there is dispersed ownership. It is very common in the developed nations such as USA, Canada, Australia and UK. In these countries , the corporate governance policies basically deals with how companies deal fairly with problems that arise from separation of ownership and effective control.

Control Model of Governance Chain: The controlled model of corporate governance chain is represented by underdeveloped equity markets, concentrated ownership and less share holders transparency and inadequate protection to minority and foreign shareholders. This model is more familiar in Asia, Latin America and some East European nations. In such economies there is a need to build, nurture and grow supporting institutions through a strong and efficient capital market regulator and judiciary to enforce contracts or protects property rights. Narrow versus Broad Perception of Corporate Governance. Corporate governance can be viewed from a narrow to broad perspectives. In narrow sense it aims at establishing relationship of a company to its share holders. In broad sense it establishes relationship with the society. The narrow definition is propagated by Milton Friedman. According to him corporate governance is to conduct business according to the owners or share holders desires which basically aims at maximizing profit by confirming the basic rules of the society. This is purely viewed as internal to the corporations. The broader perspectives of corporate governance as defined by the world bank emphasis the relationship between owners, management, board and other stake holders. Here the role of governance to minimize the difference between private and social interests. Why Corporate Governance?
Investors primarily consider two variables before making investment decisions--the rate of return on invested capital and the risk associated with the investment. (13) In recent years, the "attractiveness of developing nations" as a destination for foreign capital has increased, partly because of the high likelihood of obtaining robust returns and partly because of the decreasing "attractiveness of developed nations." (14) The lure of achieving a high rate of return, however, does not, by itself, guarantee foreign investment; the attendant risk (15) weighs equally in an investor's decision-making calculus. (16) Good corporate-governance practices reduce this risk by ensuring transparency, accountability, and enforceability in the marketplace. (17) While strong corporate-governance systems help ensure a country's long-term success, weak systems often lead to serious problems. For example, weak institutions caused, at least in part, the debilitating 1997 East Asian economic crisis. (18) The crisis was characterized by plummeting stock and real-estate prices, as well as a severe erosion of investor confidence. (19) The total indebtedness of the countries (20) affected by the crisis exceeded one-hundred billion dollars. (21) While the presence of a good corporate-governance framework ensures neither stability nor success, (22) it is widely believed that corporate governance can "raise efficiency and growth," especially for countries that rely heavily on stock markets to raise capital. (23) In fact, some contend that the "Asian financial crisis gave developing countries ... a lesson on the importance of a sound corporate governance system." (24) In an open market, investors choose from a variety of investment vehicles. (25) The existence of a corporate-governance system is likely a part of this decision-making process. In such a scenario, firms that are "more open and transparent," (26) and thus well governed, are more likely to raise capital successfully because investors will have "the information and confidence necessary for them to lend funds directly" to such firms. (27) Moreover, well-governed firms likely will obtain capital more cheaply than firms that have poor corporate-governance practices because investors will require a smaller "risk premium" for investing in well-governed firms. (28)

Also, sound corporate-governance practices enable management to allocate resources more efficiently, which increases the likelihood that investors will obtain a higher rate of return on their investment. (29) Finally, leading indices show that developing countries that have good governance structures consistently outperform developing countries with poor corporate-governance structures. (30) Thus, in an efficient capital market, (31) investors will invest in firms with better corporate-governance frameworks (32) because of the lower risks and the likelihood of higher returns. (33) At a macro level, if firms in developing countries attract investment, they will stimulate growth in the local economy. (34) If they "cannot attract equity capital, they are doomed to remain on a small, inefficient scale," and they will be unable to stimulate growth in their host country. (35) Good corporate governance benefits developing countries in a number of ways. According to at least one scholar, good corporate-governance practices can decrease the "likelihood of a domestic financial crisis" (36) and the severity if such a crisis does occur. (37) Additionally, scholars have found strong "evidence linking corporate governance to corporate efficiency" (38) and have shown that "corporate governance creates more efficient corporate management." (39) Finally, research shows that wellgoverned firms are valued significantly higher than firms with imperfect corporategovernance practices. (40) It has been estimated that, by the end of this century, "funds seeking trustworthy, productive companies in today's developing countries are likely to top $500,000 billion." (41) The policy challenge that exists for governments in developing countries is to provide a hospitable environment for such funds; a sound corporate-governance framework can play a decisive role in creating this hospitable environment. (42)

Strong corporate governance has beneficial consequences even for countries that choose to follow a development strategy that does not focus on attracting foreign investment. (43) Many developing countries are home to strong distribution cartels that waste scarce resources. (44) Good corporate governance can reduce this wasteful behavior and, thus, "overcome the obstacles to productivity growth." (45) Moreover, corporate governance can play a role in reducing corruption, (46) and decreased corruption significantly enhances a country's developmental prospects. (47) Ultimately, corporate governance "is not just one of those imported western luxuries; it is a vital imperative." (48) Importance of Corporate Governance:
Corporate governance is a set of rules that define the relationship between stakeholders, management, and board of directors of a company and influence how that company is operating. At its most basic level, corporate governance deals with issues that result from the separation of ownership and control. But corporate governance goes beyond simply establishing a clear relationship between shareholders and managers. The presence of strong governance standards provides better access to capital and aids economic growth. Corporate governance also has broader social and institutional dimensions. Properly designed rules of governance should focus on implementing the values of fairness, transparency, accountability, and responsibility to both shareholders and stakeholders. In order to be effectively and ethically governed, businesses need not only good internal governance, but also must operate in a sound institutional environment. Therefore, elements such as secure private property rights, functioning judiciary, and free press are necessary to translate corporate governance laws and regulations into on-the-ground practice. Good corporate governance ensures that the business environment is fair and transparent and that companies can be held accountable for their actions. Conversely, weak corporate governance leads to waste, mismanagement, and corruption. It is also important to remember that although corporate governance has emerged as a way to manage modern joint stock corporations it is equally significant in

state-owned enterprises, cooperatives, and family businesses. Regardless of the type of venture, only good governance can deliver sustainable good business performance.

OECD Principle:
ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT
Pursuant to Article 1 of the Convention signed in Paris on 14th December 1960, and which came into force on 30th September 1961, the Organisation for Economic Co-operation and Development (OECD) shall promote policies designed: to achieve the highest sustainable economic growth and employment and a rising standard of living in Member countries, while maintaining financial stability, and thus to contribute to the development of the world economy; to contribute to sound economic expansion in Member as well as nonmember countries in the process of economic development; and to contribute to the expansion of world trade on a multilateral, nondiscriminatory basis in accordance with international obligations. The original Member countries of the OECD are Austria, Belgium, Canada, Denmark, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The following countries became Members subsequently through accession at the dates indicated hereafter: Japan (28th April 1964), Finland (28th January 1969), Australia (7th June 1971), New Zealand (29th May 1973), Mexico (18th May 1994), the Czech Republic (21st December 1995), Hungary(7th May 1996), Poland (22nd November 1996) and Korea (12th December 1996). The Commission of the European Communities takes part in the work of the OECD

THE RIGHTS OF SHAREHOLDERS


The corporate governance framework should protect shareholders rights.
A. Basic shareholder rights include the right to: 1) secure methods of ownership registration; 2) convey or transfer shares; 3) obtain relevant information on the corporation on a timely and regular basis; 4) participate and vote in general shareholder meetings; 5) elect members of the board; and 6) share in the profits of the corporation. B. Shareholders have the right to participate in, and to be sufficiently informed on, decisions concerning fundamental corporate changes such as: 1) amendments to the statutes, or articles of incorporation or similar governing documents of the company; 2) the authorisation of additional shares; and 3) extraordinary transactions that in effect result in the sale of the company. C. Shareholders should have the opportunity to participate effectively and vote in general shareholder meetings and should be informed of the rules, including voting procedures, that govern general shareholder meetings: 1. Shareholders should be furnished with sufficient and timely information concerning the date, location and agenda of general meetings, as well as full and timely information regarding the issues to be decided at the meeting. 2. Opportunity should be provided for shareholders to ask questions of the board and to place items on the agenda at general meetings, subject to reasonable limitations. 3. Shareholders should be able to vote in person or in absentia, and equal effect should be given to votes whether cast in person or in absentia. D. Capital structures and arrangements that enable certain shareholders to obtain a degree of control disproportionate to their equity ownership should be disclosed. E. Markets for corporate control should be allowed to function in an efficient and transparent manner. F. Shareholders, including institutional investors, should consider the costs and benefits of exercising their voting rights.
OECD Principles of Corporate Governance

1. The rules and procedures governing the acquisition of corporate control in the capital markets, and extraordinary transactions such as mergers, and sales of substantial portions of corporate assets, should be clearly articulated and disclosed so that investors understand their rights and recourse. Transactions should occur at transparent prices and under fair conditions that protect the rights of all shareholders according to their class. 2. Anti-take-over devices should not be used to shield management from accountability.

II. THE EQUITABLE TREATMENT OF SHAREHOLDERS


The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.
A. All shareholders of the same class should be treated equally. 1. Within any class, all shareholders should have the same voting rights. All investors should be able to obtain information about the voting rights attached to all classes of shares before they purchase. Any changes in voting rights should be subject to shareholder vote. 2. Votes should be cast by custodians or nominees in a manner agreed upon with the beneficial owner of the shares. 3. Processes and procedures for general shareholder meetings should allow for equitable treatment of all shareholders. Company procedures should not make it unduly difficult or expensive to cast votes. B. Insider trading and abusive self-dealing should be prohibited. C. Members of the board and managers should be required to disclose any material interests in transactions or matters affecting the corporation.

III. THE ROLE OF STAKEHOLDERS IN CORPORATE GOVERNANCE


The corporate governance framework should recognise the rights of stakeholders as established by law and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.
A. The corporate governance framework should assure that the rights of stakeholders that are protected by law are respected. B. Where stakeholder interests are protected by law, stakeholders should have the opportunity to obtain effective redress for violation of their rights. C. The corporate governance framework should permit performance-enhancing mechanisms for stakeholder participation. D. Where stakeholders participate in the corporate governance process, they should have access to relevant information.

IV. DISCLOSURE AND TRANSPARENCY


The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company.
A. Disclosure should include, but not be limited to, material information on: 1. The financial and operating results of the company. 2. Company objectives. 3. Major share ownership and voting rights. 4. Members of the board and key executives, and their remuneration. 5. Material foreseeable risk factors. 6. Material issues regarding employees and other stakeholders. 7. Governance structures and policies. B. Information should be prepared, audited, and disclosed in accordance with high quality standards of accounting, financial and non-financial disclosure, and audit.

C. An annual audit should be conducted by an independent auditor in order to provide an external and objective assurance on the way in which financial statements have been prepared and presented. D. Channels for disseminating information should provide for fair, timely and cost-efficient access to relevant information by users.

V. THE RESPONSIBILITIES OF THE BOARD


The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the boards accountability to the company and the shareholders.
A. Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the shareholders. B. Where board decisions may affect different shareholder groups differently, the board should treat all shareholders fairly. C. The board should ensure compliance with applicable law and take into account the interests of stakeholders. D. The board should fulfil certain key functions, including: 1. Reviewing and guiding corporate strategy, major plans of action, risk policy, annual budgets and business plans; setting performance objectives; monitoring implementation and corporate performance; and overseeing major capital expenditures, acquisitions and divestitures. 2. Selecting, compensating, monitoring and, when necessary, replacing key executives and overseeing succession planning. 3. Reviewing key executive and board remuneration, and ensuring a formal and transparent board nomination process. 4. Monitoring and managing potential conflicts of interest of management, board members and shareholders, including misuse of corporate assets and abuse in related party transactions. 5. Ensuring the integrity of the corporations accounting and financial reporting systems, including the independent audit, and that appropriate systems of control are in place, in particular, systems for monitoring risk, financial control, and compliance with the law. 6. Monitoring the effectiveness of the governance practices under which it operates and making changes as needed. 7. Overseeing the process of disclosure and communications.
OECD Principles of Corporate Governance

E. The board should be able to exercise objective judgement on corporate affairs independent, in particular, from management. 1. Boards should consider assigning a sufficient number of non-executive board members capable of exercising independent judgement to tasks where there is a potential for conflict of interest. Examples of such key responsibilities are financial reporting, nomination and executive and board remuneration. 2. Board members should devote sufficient time to their responsibilities. F. In order to fulfil their responsibilities, board members should have access to accurate, relevant and timely information.

Part Two

ANNOTATIONS TO THE OECD PRINCIPLES OF CORPORATE GOVERNANCE


27

I. THE RIGHTS OF SHAREHOLDERS


The corporate governance framework should protect shareholders rights.
Equity investors have certain property rights. For example, an equity share can be bought, sold, or transferred. An equity share also entitles the investor to participate in the profits of the corporation, with liability limited to the amount of the investment. In addition, ownership of an equity share provides a right to information about the corporation and a right to influence the corporation, primarily by participation in general shareholder meetings and by voting. As a practical matter, however, the corporation cannot be managed by shareholder

referendum. The shareholding body is made up of individuals and institutions whose interests, goals, investment horizons and capabilities vary. Moreover, the corporation's management must be able to take business decisions rapidly. In light of these realities and the complexity of managing the corporation's affairs in fast moving and ever changing markets, shareholders are not expected to assume responsibility for managing corporate activities. The responsibility for corporate strategy and operations is typically placed in the hands of the board and a management team that is selected, motivated and, when necessary, replaced by the board. Shareholders rights to influence the corporation centre on certain fundamental issues, such as the election of board members, or other means of influencing the composition of the board, amendments to the company's organic documents, approval of extraordinary transactions, and other basic issues as specified in company law and internal company statutes. This Section can be seen as a statement of the most basic rights of shareholders, which are recognised by law in virtually all OECD countries. Additional rights such as the approval or election of auditors, direct nomination of board members, the ability to pledge shares, the approval of distributions of profits, etc., can be found in various jurisdictions. A. Basic shareholder rights include the right to: 1) secure methods of ownership registration; 2) convey or transfer shares; 3) obtain relevant information on the corporation on a timely and regular basis; 4) participate and vote in general shareholder meetings; 5) elect members of the board; and 6) share in the profits of the corporation.
OECD Principles of Corporate Governance 28

B. Shareholders have the right to participate in, and to be sufficiently informed on, decisions concerning fundamental corporate changes such as: 1) amendments to the statutes, or articles of incorporation or similar governing documents of the company; 2) the authorisation of additional shares; and 3) extraordinary transactions that in effect result in the sale of the company. C. Shareholders should have the opportunity to participate effectively and vote in general shareholder meetings and should be informed of the rules, including voting procedures, that govern general shareholder meetings: 1. Shareholders should be furnished with sufficient and timely information concerning the date, location and agenda of general meetings, as well as full and timely information regarding the issues to be decided at the meeting. 2. Opportunity should be provided for shareholders to ask questions of the board and to place items on the agenda at general meetings, subject to reasonable limitations. In order to enlarge the ability of investors to participate in general meetings, some companies have increased the ability of shareholders to place items on the agenda by simplifying the process of filing amendments and resolutions. The ability of shareholders to submit questions in advance and to obtain replies from management and board members has also been increased. Companies are justified in assuring that frivolous or disruptive attempts to place items on the agenda do not occur. It is reasonable, for example, to require that in order for shareholderproposed resolutions to be placed on the agenda, they need to be supported by those holding a specified number of shares. 3. Shareholders should be able to vote in person or in absentia, and equal effect should be given to votes whether cast in person or in absentia. The Principles recommend that voting by proxy be generally accepted. Moreover, the objective of broadening shareholder participation suggests

that companies consider favourably the enlarged use of technology in voting, including telephone and electronic voting. The increased importance of foreign shareholders suggests that on balance companies ought to make every effort to enable shareholders to participate through means which make use of modern technology. Effective participation of shareholders in general meetings can be enhanced by developing secure electronic means of communication and allowing shareholders to communicate with each other without having to comply with the formaliOECD
Principles of Corporate Governance 29

ties of proxy solicitation. As a matter of transparency, meeting procedures should ensure that votes are properly counted and recorded, and that a timely announcement of the outcome be made. D. Capital structures and arrangements that enable certain shareholders to obtain a degree of control disproportionate to their equity ownership should be disclosed. Some capital structures allow a shareholder to exercise a degree of control over the corporation disproportionate to the shareholders equity ownership in the company. Pyramid structures and cross shareholdings can be used to diminish the capability of non-controlling shareholders to influence corporate policy. In addition to ownership relations, other devices can affect control over the corporation. Shareholder agreements are a common means for groups of shareholders, who individually may hold relatively small shares of total equity, to act in concert so as to constitute an effective majority, or at least the largest single block of shareholders. Shareholder agreements usually give those participating in the agreements preferential rights to purchase shares if other parties to the agreement wish to sell. These agreements can also contain provisions that require those accepting the agreement not to sell their shares for a specified time. Shareholder agreements can cover issues such as how the board or the Chairman will be selected. The agreements can also oblige those in the agreement to vote as a block. Voting caps limit the number of votes that a shareholder may cast, regardless of the number of shares the shareholder may actually possess. Voting caps therefore redistribute control and may affect the incentives for shareholder participation in shareholder meetings. Given the capacity of these mechanisms to redistribute the influence of shareholders on company policy, shareholders can reasonably expect that all such capital structures and arrangements be disclosed. E. Markets for corporate control should be allowed to function in an efficient and transparent manner. 1. The rules and procedures governing the acquisition of corporate control in the capital markets, and extraordinary transactions such as mergers, and sales of substantial portions of corporate assets, should be clearly articulated and disclosed so that investors understand their rights and recourse. Transactions should occur at transparent prices and under fair conditions that protect the rights of all shareholders according to their class.
OECD Principles of Corporate Governance 30

2. Anti-take-over devices should not be used to shield management from accountability. In some countries, companies employ anti-take-over devices. However, both investors and stock exchanges have expressed concern over the possibility that widespread use of anti-take-over devices may be a serious impediment to the functioning of the market for corporate control. In

some instances, take-over defences can simply be devices to shield the management from shareholder monitoring. F. Shareholders, including institutional investors, should consider the costs and benefits of exercising their voting rights. The Principles do not advocate any particular investment strategy for investors and do not seek to prescribe the optimal degree of investor activism. Nevertheless, many investors have concluded that positive financial returns can be obtained by undertaking a reasonable amount of analysis and by exercising their voting rights. Some institutional investors also disclose their own policies with respect to the companies in which they invest.
31

II. THE EQUITABLE TREATMENT OF SHAREHOLDERS


The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.
Investors confidence that the capital they provide will be protected from misuse or misappropriation by corporate managers, board members or controlling shareholders is an important factor in the capital markets. Corporate boards, managers and controlling shareholders may have the opportunity to engage in activities that may advance their own interests at the expense of non-controlling shareholders. The Principles support equal treatment for foreign and domestic shareholders in corporate governance. They do not address government policies to regulate foreign direct investment. One of the ways in which shareholders can enforce their rights is to be able to initiate legal and administrative proceedings against management and board members. Experience has shown that an important determinant of the degree to which shareholder rights are protected is whether effective methods exist to obtain redress for grievances at a reasonable cost and without excessive delay. The confidence of minority investors is enhanced when the legal system provides mechanisms for minority shareholders to bring lawsuits when they have reasonable grounds to believe that their rights have been violated. There is some risk that a legal system, which enables any investor to challenge corporate activity in the courts, can become prone to excessive litigation. Thus, many legal systems have introduced provisions to protect management and board members against litigation abuse in the form of tests for the sufficiency of shareholder complaints, so-called safe harbours for management and board member actions (such as the business judgement rule) as well as safe harbours for the disclosure of information. In the end, a balance must be struck between allowing investors to seek remedies for infringement of ownership rights and avoiding excessive litigation. Many countries have found that alternative adjudication procedures, such as administrative hearings or arbitration procedures organised by the securiOECD
Principles of Corporate Governance 32

ties regulators or other regulatory bodies, are an efficient method for dispute settlement, at least at the first instance level. A. All shareholders of the same class should be treated equally. 1. Within any class, all shareholders should have the same voting rights. All investors should be able to obtain information about the voting rights attached to all classes of shares before they purchase. Any changes in voting rights should be subject to shareholder vote. The optimal capital structure of the firm is best decided by the management and the board, subject to the approval of the shareholders. Some companies issue preferred (or preference) shares which have a preference in respect of receipt of the profits of the firm but which normally

have no voting rights. Companies may also issue participation certificates or shares without voting rights, which would presumably trade at different prices than shares with voting rights. All of these structures may be effective in distributing risk and reward in ways that are thought to be in the best interest of the company and to cost-efficient financing. The Principles do not take a position on the concept of one share one vote. However, many institutional investors and shareholder associations support this concept. Investors can expect to be informed regarding their voting rights before they invest. Once they have invested, their rights should not be changed unless those holding voting shares have had the opportunity to participate in the decision. Proposals to change the voting rights of different classes of shares are normally submitted for approval at general shareholders meetings by a specified majority of voting shares in the affected categories. 2. Votes should be cast by custodians or nominees in a manner agreed upon with the beneficial owner of the shares. In some OECD countries it was customary for financial institutions which held shares in custody for investors to cast the votes of those shares. Custodians such as banks and brokerage firms holding securities as nominees for customers were sometimes required to vote in support of management unless specifically instructed by the shareholder to do otherwise. The trend in OECD countries is to remove provisions that automatically enable custodian institutions to cast the votes of shareholders. Rules in some countries have recently been revised to require custodian institutions to provide shareholders with information concerning their options in the use of their voting rights. Shareholders may elect to delegate all
OECD Principles of Corporate Governance 33

voting rights to custodians. Alternatively, shareholders may choose to be informed of all upcoming shareholder votes and may decide to cast some votes while delegating some voting rights to the custodian. It is necessary to draw a reasonable balance between assuring that shareholder votes are not cast by custodians without regard for the wishes of shareholders and not imposing excessive burdens on custodians to secure shareholder approval before casting votes. It is sufficient to disclose to the shareholders that, if no instruction to the contrary is received, the custodian will vote the shares in the way he deems consistent with shareholder interest. It should be noted that this item does not apply to the exercise of voting rights by trustees or other persons acting under a special legal mandate (such as, for example, bankruptcy receivers and estate executors). 3. Processes and procedures for general shareholder meetings should allow for equitable treatment of all shareholders. Company procedures should not make it unduly difficult or expensive to cast votes. In Section I of the Principles, the right to participate in general shareholder meetings was identified as a shareholder right. Management and controlling investors have at times sought to discourage non-controlling or foreign investors from trying to influence the direction of the company. Some companies charged fees for voting. Other impediments included prohibitions on proxy voting and the requirement of personal attendance at general shareholder meetings to vote. Still other procedures may make it practically impossible to exercise ownership rights. Proxy materials may be sent too close to the time of general shareholder meetings to allow investors adequate time for reflection and consultation. Many companies in OECD countries are seeking to develop better channels

of communication and decision-making with shareholders. Efforts by companies to remove artificial barriers to participation in general meetings are encouraged. B. Insider trading and abusive self-dealing should be prohibited. Abusive self-dealing occurs when persons having close relationships to the company exploit those relationships to the detriment of the company and investors. Since insider trading entails manipulation of the capital markets, it is prohibited by securities regulations, company law and/or criminal law in most OECD countries. However, not all jurisdictions prohibit such practices, and in some cases enforcement is not vigorous. These practices can be seen as constituting a breach of good corporate governance inasmuch as they violate the principle of equitable treatment of shareholders.
OECD Principles of Corporate Governance 34

The Principles reaffirm that it is reasonable for investors to expect that the abuse of insider power be prohibited. In cases where such abuses are not specifically forbidden by legislation or where enforcement is not effective, it will be important for governments to take measures to remove any such gaps. C. Members of the board and managers should be required to disclose any material interests in transactions or matters affecting the corporation. This item refers to situations where members of the board and managers have a business, family or other special relationship to the company that could affect their judgement with respect to a transaction.
35

III. THE ROLE OF STAKEHOLDERS IN CORPORATE GOVERNANCE


The corporate governance framework should recognise the rights of stakeholders as established by law and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.
A key aspect of corporate governance is concerned with ensuring the flow of external capital to firms. Corporate governance is also concerned with finding ways to encourage the various stakeholders in the firm to undertake socially efficient levels of investment in firm-specific human and physical capital. The competitiveness and ultimate success of a corporation is the result of teamwork that embodies contributions from a range of different resource providers including investors, employees, creditors, and suppliers. Corporations should recognise that the contributions of stakeholders constitute a valuable resource for building competitive and profitable companies. It is, therefore, in the long-term interest of corporations to foster wealth-creating co-operation among stakeholders. The governance framework should recognise that the interests of the corporation are served by recognising the interests of stakeholders and their contribution to the long-term success of the corporation. A. The corporate governance framework should assure that the rights of stakeholders that are protected by law are respected. In all OECD countries stakeholder rights are established by law, such as labour law, business law, contract law, and insolvency law. Even in areas where stakeholder interests are not legislated, many firms make additional commitments to stakeholders, and concern over corporate reputation and corporate performance often require the recognition of broader interests. B. Where stakeholder interests are protected by law, stakeholders should have the opportunity to obtain effective redress for violation of their rights. The legal framework and process should be transparent and not impede the ability of stakeholders to communicate and to obtain redress for the violation of rights.

OECD Principles of Corporate Governance 36

C. The corporate governance framework should permit performance-enhancing mechanisms for stakeholder participation. Corporate governance frameworks will provide for different roles for stakeholders. The degree to which stakeholders participate in corporate governance depends on national laws and practices, and may vary from company to company as well. Examples of mechanisms for stakeholder participation include: employee representation on boards; employee stock ownership plans or other profit sharing mechanisms or governance processes that consider stakeholder viewpoints in certain key decisions. They may, in addition, include creditor involvement in governance in the context of insolvency proceedings. D. Where stakeholders participate in the corporate governance process, they should have access to relevant information. Where laws and practice of corporate governance systems provide for participation by stakeholders, it is important that stakeholders have access to information necessary to fulfil their responsibilities.
37

IV. DISCLOSURE AND TRANSPARENCY


The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company.
In most OECD countries a large amount of information, both mandatory and voluntary, is compiled on publicly traded and large unlisted enterprises, and subsequently disseminated to a broad range of users. Public disclosure is typically required, at a minimum, on an annual basis though some countries require periodic disclosure on a semi-annual or quarterly basis, or even more frequently in the case of material developments affecting the company. Companies often make voluntary disclosure that goes beyond minimum disclosure requirements in response to market demand. A strong disclosure regime is a pivotal feature of market-based monitoring of companies and is central to shareholders ability to exercise their voting rights. Experience in countries with large and active equity markets shows that disclosure can also be a powerful tool for influencing the behaviour of companies and for protecting investors. A strong disclosure regime can help to attract capital and maintain confidence in the capital markets. Shareholders and potential investors require access to regular, reliable and comparable information in sufficient detail for them to assess the stewardship of management, and make informed decisions about the valuation, ownership and voting of shares. Insufficient or unclear information may hamper the ability of the markets to function, may increase the cost of capital and result in a poor allocation of resources. Disclosure also helps improve public understanding of the structure and activities of enterprises, corporate policies and performance with respect to environmental and ethical standards, and companies relationships with the communities in which they operate. The OECD Guidelines for Multinational Enterprises are relevant in this context. Disclosure requirements are not expected to place unreasonable administrative or cost burdens on enterprises. Nor are companies expected to disclose
OECD Principles of Corporate Governance 38

information that may endanger their competitive position unless disclosure is necessary to fully inform the investment decision and to avoid misleading the investor. In order to determine what information should be disclosed at a minimum, many

countries apply the concept of materiality. Material information can be defined as information whose omission or misstatement could influence the economic decisions taken by users of information. The Principles support timely disclosure of all material developments that arise between regular reports. They also support simultaneous reporting of information to all shareholders in order to ensure their equitable treatment. A. Disclosure should include, but not be limited to, material information on: 1. The financial and operating results of the company. Audited financial statements showing the financial performance and the financial situation of the company (most typically including the balance sheet, the profit and loss statement, the cash flow statement and notes to the financial statements) are the most widely used source of information on companies. In their current form, the two principal goals of financial statements are to enable appropriate monitoring to take place and to provide the basis to value securities. Managements discussion and analysis of operations is typically included in annual reports. This discussion is most useful when read in conjunction with the accompanying financial statements. Investors are particularly interested in information that may shed light on the future performance of the enterprise. It is important that transactions relating to an entire group be disclosed. Arguably, failures of governance can often be linked to the failure to disclose the whole picture, particularly where off-balance sheet items are used to provide guarantees or similar commitments between related companies. 2. Company objectives. In addition to their commercial objectives, companies are encouraged to disclose policies relating to business ethics, the environment and other public policy commitments. Such information may be important for investors and other users of information to better evaluate the relationship between companies and the communities in which they operate and the steps that companies have taken to implement their objectives. 3. Major share ownership and voting rights. One of the basic rights of investors is to be informed about the ownership structure of the enterprise and their rights vis--vis the rights of other owners. Countries often require disclosure of ownership data once certain
OECD Principles of Corporate Governance 39

thresholds of ownership are passed. Such disclosure might include data on major shareholders and others that control or may control the company, including information on special voting rights, shareholder agreements, the ownership of controlling or large blocks of shares, significant cross shareholding relationships and cross guarantees. (See Section I.D.) Companies are also expected to provide information on related party transactions. 4. Members of the board and key executives, and their remuneration. Investors require information on individual board members and key executives in order to evaluate their experience and qualifications and assess any potential conflicts of interest that might affect their judgement. Board and executive remuneration are also of concern to shareholders. Companies are generally expected to disclose sufficient information on the remuneration of board members and key executives (either individually or in the aggregate) for investors to properly assess the costs and benefits of remuneration plans and the contribution of incentive schemes, such as stock option schemes, to performance. 5. Material foreseeable risk factors. Users of financial information and market participants need information

on reasonably foreseeable material risks that may include: risks that are specific to the industry or geographical areas; dependence on commodities; financial market risk including interest rate or currency risk; risk related to derivatives and off-balance sheet transactions; and risks related to environmental liabilities. The Principles do not envision the disclosure of information in greater detail than is necessary to fully inform investors of the material and foreseeable risks of the enterprise. Disclosure of risk is most effective when it is tailored to the particular industry in question. Disclosure of whether or not companies have put systems for monitoring risk in place is also useful. 6. Material issues regarding employees and other stakeholders. Companies are encouraged to provide information on key issues relevant to employees and other stakeholders that may materially affect the performance of the company. Disclosure may include management/ employee relations, and relations with other stakeholders such as creditors, suppliers, and local communities. Some countries require extensive disclosure of information on human resources. Human resource policies, such as programmes for human
OECD Principles of Corporate Governance 40

resource development or employee share ownership plans, can communicate important information on the competitive strengths of companies to market participants. 7. Governance structures and policies. Companies are encouraged to report on how they apply relevant corporate governance principles in practice. Disclosure of the governance structures and policies of the company, in particular the division of authority between shareholders, management and board members is important for the assessment of a companys governance B. Information should be prepared, audited, and disclosed in accordance with high quality standards of accounting, financial and non-financial disclosure, and audit. The application of high quality standards is expected to significantly improve the ability of investors to monitor the company by providing increased reliability and comparability of reporting, and improved insight into company performance. The quality of information depends on the standards under which it is compiled and disclosed. The Principles support the development of high quality internationally recognised standards, which can serve to improve the comparability of information between countries. C. An annual audit should be conducted by an independent auditor in order to provide an external and objective assurance on the way in which financial statements have been prepared and presented. Many countries have considered measures to improve the independence of auditors and their accountability to shareholders. It is widely felt that the application of high quality audit standards and codes of ethics is one of the best methods for increasing independence and strengthening the standing of the profession. Further measures include strengthening of board audit committees and increasing the boards responsibility in the auditor selection process. Other proposals have been considered by OECD countries. Some countries apply limitations on the percentage of non-audit income that the auditor can receive from a particular client. Other countries require companies to disclose the level of fees paid to auditors for non-audit services. In addition there may be limitations on the total percentage of auditor income that can come from one client. Examples of other proposals include quality reviews

of auditors by another auditor, prohibitions on the provision of non-audit services, mandatory rotation of auditors and the direct appointment of auditors by shareholders.
OECD Principles of Corporate Governance 41

D. Channels for disseminating information should provide for fair, timely and cost-efficient access to relevant information by users. Channels for the dissemination of information can be as important as the content of the information itself. While the disclosure of information is often provided for by legislation, filing and access to information can be cumbersome and costly. Filing of statutory reports has been greatly enhanced in some countries by electronic filing and data retrieval systems. The Internet and other information technologies also provide the opportunity for improving information dissemination.
42

V. THE RESPONSIBILITIES OF THE BOARD


The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the boards accountability to the company and the shareholders.
Board structures and procedures vary both within and among OECD countries. Some countries have two-tier boards that separate the supervisory function and the management function into different bodies. Such systems typically have a supervisory board composed of non-executive board members and a management board composed entirely of executives. Other countries have unitary boards, which bring together executive and non-executive board members. The Principles are intended to be sufficiently general to apply to whatever board structure is charged with the functions of governing the enterprise and monitoring management. Together with guiding corporate strategy, the board is chiefly responsible for monitoring managerial performance and achieving an adequate return for shareholders, while preventing conflicts of interest and balancing competing demands on the corporation. In order for boards to effectively fulfil their responsibilities they must have some degree of independence from management. Another important board responsibility is to implement systems designed to ensure that the corporation obeys applicable laws, including tax, competition, labour, environmental, equal opportunity, health and safety laws. In addition, boards are expected to take due regard of, and deal fairly with, other stakeholder interests including those of employees, creditors, customers, suppliers and local communities. Observance of environmental and social standards is relevant in this context. A. Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the shareholders. In some countries, the board is legally required to act in the interest of the company, taking into account the interests of shareholders, employees, and the public good. Acting in the best interest of the company should not permit management to become entrenched.
OECD Principles of Corporate Governance 43

B. Where board decisions may affect different shareholder groups differently, the board should treat all shareholders fairly. C. The board should ensure compliance with applicable law and take into account the interests of stakeholders. D. The board should fulfil certain key functions, including: 1. Reviewing and guiding corporate strategy, major plans of action, risk policy, annual budgets and business plans; setting performance objectives; monitoring implementation and corporate performance; and overseeing major capital expenditures, acquisitions and divestitures.

2. Selecting, compensating, monitoring and, when necessary, replacing key executives and overseeing succession planning. 3. Reviewing key executive and board remuneration, and ensuring a formal and transparent board nomination process. 4. Monitoring and managing potential conflicts of interest of management, board members and shareholders, including misuse of corporate assets and abuse in related party transactions. 5. Ensuring the integrity of the corporations accounting and financial reporting systems, including the independent audit, and that appropriate systems of control are in place, in particular, systems for monitoring risk, financial control, and compliance with the law. 6. Monitoring the effectiveness of the governance practices under which it operates and making changes as needed. 7. Overseeing the process of disclosure and communications. The specific functions of board members may differ according to the articles of company law in each jurisdiction and according to the statutes of each company. The above-noted elements are, however, considered essential for purposes of corporate governance. E. The board should be able to exercise objective judgement on corporate affairs independent, in particular, from management. The variety of board structures and practices in different countries will require different approaches to the issue of independent board members. Board independence usually requires that a sufficient number of board members not be employed by the company and not be closely related to the company or its management through significant economic, family or other ties. This does not prevent shareholders from being board members. Independent board members can contribute significantly to the decisionmaking of the board. They can bring an objective view to the evaluation of the performance of the board and management. In addition, they can play
OECD Principles of Corporate Governance 44

an important role in areas where the interests of management, the company and shareholders may diverge such as executive remuneration, succession planning, changes of corporate control, take-over defences, large acquisitions and the audit function. The Chairman as the head of the board can play a central role in ensuring the effective governance of the enterprise and is responsible for the boards effective function. The Chairman may in some countries, be supported by the company secretary. In unitary board systems, the separation of the roles of the Chief Executive and Chairman is often proposed as a method of ensuring an appropriate balance of power, increasing accountability and increasing the capacity of the board for independent decision making. 1. Boards should consider assigning a sufficient number of non-executive board members capable of exercising independent judgement to tasks where there is a potential for conflict of interest. Examples of such key responsibilities are financial reporting, nomination and executive and board remuneration. While the responsibility for financial reporting, remuneration and nomination are those of the board as a whole, independent non-executive board members can provide additional assurance to market participants that their interests are defended. Boards may also consider establishing specific committees to consider questions where there is a potential for conflict of interest. These committees may require a minimum number or be composed entirely of non-executive members. 2. Board members should devote sufficient time to their responsibilities.

It is widely held that service on too many boards can interfere with the performance of board members. Companies may wish to consider whether excessive board service interferes with board performance. Some countries have limited the number of board positions that can be held. Specific limitations may be less important than ensuring that members of the board enjoy legitimacy and confidence in the eyes of shareholders. In order to improve board practices and the performance of its members, some companies have found it useful to engage in training and voluntary self-evaluation that meets the needs of the individual company. This might include that board members acquire appropriate skills upon appointment, and thereafter remain abreast of relevant new laws, regulations, and changing commercial risks.
OECD Principles of Corporate Governance 45

F. In order to fulfil their responsibilities, board members should have access to accurate, relevant and timely information. Board members require relevant information on a timely basis in order to support their decision-making. Non-executive board members do not typically have the same access to information as key managers within the company. The contributions of non-executive board members to the company can be enhanced by providing access to certain key managers within the company such as, for example, the company secretary and the internal auditor, and recourse to independent external advice at the expense of the company. In order to fulfil their responsibilities, board members should ensure that they obtain accurate, relevant and timely information.

Corporate Governance Mechanism: Anglo-American Model


The Anglo-US model is characterized by share ownership of individual, and increasingly institutional, investors not affiliated with the corporation (known as outside shareholders or outsiders); a well-developed legal framework defining the rights and responsibilities of three key players, namely management, directors and shareholders; and a comparatively uncomplicated procedure for interaction between shareholder and corporation as well as among shareholders during or outside the AGM. Equity financing is a common method of raising capital for corporations in the United Kingdom (UK) and the US. It is not surprising, therefore, that the US is the largest capital market in the world, and that the London Stock Exchange is the third largest stock exchange in the world (in terms of market capitalization) after the New York Stock Exchange (NYSE) and Tokyo. There is a causal relationship between the importance of equity financing, the size of the capital market and the development of a corporate governance system. The US is both the worlds

largest capital market and the home of the worlds most-developed system of proxy voting and shareholder activism by institutional investors. Institutional investors also play an important role in both the capital market and corporate governance in the UK.

Key Players in the Anglo-US Model

Players in the Anglo-US model include management, directors, shareholders (especially institutional investors), government agencies, stock exchanges, self-regulatory organizations and consulting firms which advise corporations and/or shareholders on corporate governance and proxy voting. Of these, the three major players are management, directors and shareholders. They form what is commonly referred to as the "corporate governance triangle." The interests and interaction of these players may be diagrammed as follows:

Management

Shareholders

Board of Directors

The Anglo-US model, developed within the context of the free market economy, assumes the separation of ownership and control in most publicly-held corporations. This important legal distinction serves a valuable business and social purpose: investors contribute capital and maintain ownership in the enterprise, while generally avoiding legal liability for the acts of the corporation. Investors avoid legal liability by ceding to management control of the corporation, and paying management for acting as their agent by undertaking the affairs of the corporation. The cost of this separation of ownership and control is defined as agency costs. The interests of shareholders and management may not always coincide. Laws governing corporations in countries using the Anglo-US model attempt to reconcile this conflict in several ways. Most importantly, they prescribe the election of a board of directors by shareholders and require that boards act as fiduciaries for shareholders interests by overseeing management on behalf of shareholders.

Composition of the Board of Directors in the Anglo-US Model

The board of directors of most corporations that follow the Anglo-US model includes both

insiders and outsiders. An insider is as a person who is either employed by the corporation (an executive, manager or employee) or who has significant personal or business relationships with corporate management. An outsider is a person or institution which has no direct relationship with the corporation or corporate management. A synonym for insider is executive director; a synonym for outsider is non-executive director or independent director. Traditionally, the same person has served as both chairman of the board of directors and chief executive officer (CEO) of the corporation. In many instances, this practice led to abuses, including: concentration of power in the hands of one person (for example, a board of directors firmly controlled by one person serving both as chairman of the board of directors and CEO); concentration of power in a small group of persons (for example, a board of directors composed solely of insiders; management and/or the board of directors attempts to retain power over a long period of time, without regard for the interests of other players (entrenchment); and the board of directors flagrant disregard for the interests of outside shareholders. As recently as 1990, one individual served as both CEO and chairman of the board in over 75 percent of the 500 largest corporations in the US. In contrast to the US, a majority of boards in the UK have a non-executive director. However, many boards of UK companies have a majority of inside directors: in 1992, only 42 percent of all directors were outsiders and nine percent of the largest UK companies had no outside director at all. Currently there is, however, a discernible trend towards greater inclusion of outsiders in both US and UK corporations. Beginning in the mid-1980s, several factors contributed to an increased interest in corporate governance in the UK and US. These included: the increase in institutional investment in both countries; greater governmental regulation in the US, including regulation requiring some institutional investors to vote at AGMs; the takeover activity of the mid- to late-1980s; excessive executive compensation at many US companies and a growing sense of loss of competitiveness vis--vis German and Japanese competitors. In response, individual and institutional investors began to inform themselves about trends,

conduct research and organize themselves in order to represent their interests as shareholders. Their findings were interesting. For example, research conducted by diverse organizations indicated that in many cases a relationship exists between lack of effective oversight by the board of directors and poor corporate financial performance. In addition, corporate governance analysts noted that outside directors often suffered an informational disadvantage vis--vis inside directors and were therefore limited in their ability to provide effective oversight. Several factors influenced the trend towards an increasing percentage of outsiders on boards of directors of UK and US corporations. These include: the pattern of stock ownership, specifically the above-mentioned increase in institutional investment the growing importance of institutional investors and their voting behavior at AGMs; and recommendations of self-regulatory organizations such as the Committee on the Financial Aspects of Corporate Governance in the UK and shareholder organizations in the US.

The German Model:


The German model governs German and Austrian corporations. Some elements of the model also apply in the Netherlands and Scandinavia. Furthermore, some corporations in France and Belgium have recently introduced some elements of the German model.
The German corporate governance model differs significantly from both the Anglo-US and the Japanese model, although some of its elements resemble the Japanese model. Banks hold long-term stakes in German corporations6, and, as in Japan, bank representatives are elected to German boards. However, this representation is constant, unlike the situation in Japan where bank representatives were elected to a corporate board only in times of financial distress. Germanys three largest universal banks (banks that provide a multiplicity of services) play a major role; in some parts of the country, public-sector banks are also key shareholders. There are three unique elements of the German model that distinguish it from the other models outlined in this article. Two of these elements pertain to board composition and one concerns shareholders rights: First, the German model prescribes two boards with separate members. German corporations have a two-tiered board structure consisting of a management board (composed entirely of insiders, that is, executives of the corporation) and a supervisory board (composed of labor/employee representatives and shareholder representatives). The two boards are completely distinct; no one may serve simultaneously on a corporations management board and supervisory board. Second, the size of the supervisory board is set by law and cannot be changed by shareholders. Third, in Germany and other countries following this model, voting right restrictions are legal; these limit a shareholder to voting a certain percentage of the corporations total share capital, regardless of share ownership position.7 Most German corporations have traditionally preferred bank financing over equity financing. As a result, German stock market capitalization is small in relation to the size of the German economy. Furthermore, the level of individual stock ownership in Germany is low, reflecting

Germans conservative investment strategy. It is not surprising therefore, that the corporate governance structure is geared towards preserving relationships between the key players, notably banks and corporations. The system is somewhat ambivalent towards minority shareholders, allowing them scope for interaction by permitting shareholder proposals, but also permitting companies to impose voting rights restrictions. The percentage of foreign ownership of German equity is significant; in 1990, it was 19 percent. This factor is slowly beginning to affect the German model, as foreign investors from inside and outside the European Union begin to advocate for their interests. The globalization of capital markets is also forcing German corporations to change their ways. When Daimler-Benz AG decided to list its shares on the NYSE in 1993, it was forced to adopt US GAAP. These accounting principles provide much greater financial transparency than German accounting standards. Specifically, Daimler-Benz AG was forced to account for huge losses that it could have hidden under German accounting rules.

Key Players in the German Model

German banks, and to a lesser extent, corporate shareholders, are the key players in the German corporate governance system. Similar to the Japanese system described above, banks usually play a multi-faceted role as shareholder, lender, issuer of both equity and debt, depository (custodian Dresdner Bank AG and Commerzbank AG) held seats on the supervisory boards of 85 of the 100 largest German corporations. In Germany, corporations are also shareholders, sometimes holding long-term stakes in other corporations, even where there is no industrial or commercial affiliation between the two. This is somewhat similar, but not parallel, to the Japanese model, yet very different from the Anglo-US model where neither banks nor corporations are key institutional investors. The mandatory inclusion of labor/employee representatives on larger German supervisory boards further distinguishes the German model from both the Anglo-US and Japanese models.

The Japanese Model


The Japanese model is characterized by a high level of stock ownership by affiliated banks

and companies; a banking system characterized by strong, long-term links between bank and corporation; a legal, public policy and industrial policy framework designed to support and promote keiretsu (industrial groups linked by trading relationships as well as crossshareholdings of debt and equity); boards of directors composed almost solely of insiders; and a comparatively low (in some corporations, non-existent) level of input of outside shareholders, caused and exacerbated by complicated procedures for exercising shareholders votes. Equity financing is important for Japanese corporations. However, insiders and their affiliates are the major shareholders in most Japanese corporations. Consequently, they play a major role in individual corporations and in the system as a whole. Conversely, the interests of outside shareholders are marginal. The percentage of foreign ownership of Japanese stocks is small, but it may become an important factor in making the model more responsive to outside shareholders.

Key Players in the Japanese Model

The Japanese system of corporate governance is many-sided, centering around a main bank and a financial/industrial network or keiretsu. The main bank system and the keiretsu are two different, yet overlapping and complementary, elements of the Japanese model.4 Almost all Japanese corporations have a close relationship with a main bank. The bank provides its corporate client with loans as well as services related to bond issues, equity issues, settlement accounts, and related consulting services. The main bank is generally a major shareholder in the corporation. In the US, anti-monopoly legislation prohibits one bank from providing this multiplicity of services. Instead, these services are usually handled by different institutions: commercial bank loans; investment bank - equity issues; specialized consulting firms - proxy voting and other services. Many Japanese corporations also have strong financial relationships with a network of affiliated companies. These networks, characterized by crossholdings of debt and equity, trading of goods and services, and informal business contacts, are known as keiretsu. Government-directed industrial policy also plays a key role in Japanese governance. Since the 1930s, the Japanese government has pursued an active industrial policy designed to assist

Japanese corporations. This policy includes official and unofficial representation on corporate boards, when a corporation faces financial difficulty. In the Japanese model, the four key players are: main bank (a major inside shareholder), affiliated company or keiretsu (a major inside shareholder), management and the government. Note that the interaction among these players serves to link relationships rather than balance powers, as in the case in the Anglo-US model. In contrast with the Anglo-US model, non-affiliated shareholders have little or no voice in Japanese governance. As a result, there are few truly independent directors, that is, directors representing outside shareholders. The Japanese model may be diagrammed as an open-ended hexagon: The base of the figure, with four connecting lines, represents the linked interests of the four key players: government, management, bank and keiretsu. The open lines at the top represent the nonlinked interests of non-affiliated shareholders and outside directors, because these play an insignificant role.

Indian Model:
When investments take place in emerging markets, the investors want to be sure that not only are the capital markets or enterprises with which they are investing, run competently but they also have good corporate governance. Corporate governance represents the value framework, the ethical framework and the moral framework under which business decisions are taken. In other words, when investments take place across national borders, the investors want to be sure that not only is their capital handled effectively and adds to the creation of wealth, but the business decisions are also taken in a manner which is not illegal or involving moral hazard.

Corporate governance therefore calls for three factors: a) Transparency in decision-making b) Accountability which follows from transparency because responsibilities could be fixed easily for actions taken or not taken, and c) The accountability is for the safeguarding the interests of the stakeholders and the investors in the organization.

Implementation of corporate governance has depended upon laying down explicit codes, which enterprises and the organisations are supposed to observe. The Cadburys code in United Kingdom was the starting point, which led to a number of other codes. In India itself we have the Kumaramangalam Birla code as a result of the committee headed by him at the behest of the SEBI. Earlier we had the CII coming up with the code for corporate governance recommended by the committee headed by Shri Rahul Bajaj. The codes, however, can only be a guideline. Ultimately effective corporate governance depends upon the commitment of the people in the organisation. The very first issue of corporate governance in India is, do the India managements really believe in corporate governance? Corporate governance depends upon two factors. The first is the commitment of the management for the principle of integrity and transparency in business operations. The second is the legal and the administrative framework created by the government. If public governance is weak, we cannot have good corporate governance. The dramatic Enron case has highlighted how companies, which were the darlings of the stock market and held up as models for vigorous and innovative growth can ultimately collapse like a house of cards as they were based on fraud and dishonesty. The association of the accounting firm Anderson has also raised a doubt about the credibility of even well regarded global players. In the Indian context, the need for corporate governance has been highlighted because of the scams we have been having almost as an annual feature ever since we had liberalisation from 1991. We had the Harshad Mehta Scam, Ketan Parikh Scam, UTI Scam, Vanishing Company Scam, Bhansali Scam and so on. I have been suggesting that we should learn from especially the United States to see whether we can replicate similar conditions in our capital market. It is not that the United States is free of scams. Right now the Enron issue is examined by a number of committees at different levels in the United States. At the end of all these examinations, they are likely to come with a better model. In the Indian corporate scene we must be able to induct global standards so that at least while the scope for scams may still exist, we can reduce the scope to the minimum. I. BRIEF HISTORY The revolution started in the early 1990s with the Cadbury Report on the financial aspects of corporate governance, to which was attached a code of best practice. Aimed at listed companies and looking especially at standards of corporate behaviour and ethics, the Cadbury Code was gradually adopted by the City and the Stock Exchange as a benchmark of good boardroom practice. In 1995, the Greenbury Report added a set of principles on the remuneration of executive directors (in response to some particular fat cat scandals, notably that involving British Gas chief Cedric Brown, whose 75 per cent rise incensed both unions and small shareholders), and in 1998 the Hampel Report brought the two together and produced the first Combined Code. A year later, the Turnbull Report concentrated on risk management and internal controls.

In each case, the reports were prompted either by shareholder disquiet over perceived shortcomings in corporate structures and their ability to respond to poor performance, or to government threats of legislation if the corporate sector failed to put its house in order. In 2002 Derek Higgs, an investment banker was given the brief to look again at corporate governance and build on the previous reports to produce a single, comprehensive code. Shortly afterwards, the full consequences of the Enron and WorldCom scandals were realised, leading to new unease. The Higgs Report came out in early 2003, but was greeted with horror by some leading companies, with claims that it placed an unrealistic burden on non-executives and marginalised the role of the chairman. The task of taking Higgss draft forward was passed to the Financial Reporting Council (FRC), a body established by government and comprising members from industry, commerce and the professions. The FRC consulted further and produced a revised Code that followed most of Higgss recommendations but softened a few of the more contentious points, and so gained general acceptance. With rather less fuss, at the same time Sir Robert Smith, chairman of the Weir Group, was leading a review of the role of audit committees and his recommendations were incorporated into the new Code. The 2003 Code was updated with minor amendments in June 2006, with the new version applying to financial years beginning on or after November 1, 2006. Report of SEBI committee (India) on Corporate Governance defines corporate governance as 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 & corporate funds in the management of a company. The definition is drawn from the Gandhian principle of trusteeship and the Directive Principles of the Indian Constitution. Corporate Governance is viewed as ethics and a moral duty. On January 1, 2006, India entered a new era of corporate governance as the reforms popularly known as Clause 49 took full effect.1 A decade in the makingand complicated by Enron and the other corporate scandals of this time periodClause 49 has brought broad new requirements related to board composition, audit committee activity, information disclosure, and top management certification. The similarities with Sarbanes Oxley and other governance reforms around the globe should be obvious. A BRIEF HISTORY OF CORPORATE GOVERNANCE REFORM IN INDIA Corporate governance and financial regulation in India was generally considered quite poor until the economic reforms of the early 1990s. The Securities and Exchange Board of India (SEBI) was established in 1992 by an act of Parliament, and SEBI was given the job of regulating stock exchanges, brokers, fraudulent trade practices, and other areas of corporate activity.5 As its power grew over the decade, SEBI started to play a much more active role in setting minimum standards for corporate behavior. In addition, a voluntary code of corporate governance was developed by the Confederation of Indian Industry (CII), a group of well-regarded Indian firms.

Near the turn of the century, SEBI commissioned a series of projects to improve Indian corporate governance by building on CIIs code (and by converting the voluntary code into a mandatory one). This work would eventually lead to the Clause 49 reforms. The first SEBI committee, comprised of 17 prominent business leaders and chaired by Kumar Mangalam Birla, advocated a variety of new governance requirements including a minimum number of independent directors, the creation of audit committees and shareholders grievance committees, and additional management disclosures on firm performance. These recommendations were soon adopted, but, importantly, they were not imposed on every public company through legislation (in contrast with Sarbanes Oxley in the United States). Instead, SEBI implemented the Birla Committee reforms by modifying the listing requirements for firms seeking to go public on an Indian stock exchange. Thus was born Clause 49, a new collection of corporate governance obligations that individual firms would agree to when they signed listing contracts with any stock exchange in the country. As part of a gradual roll-out process, the Birla Committee reforms were not imposed immediately on all public firms. Instead, they were made mandatory in 2001 for the largest Indian companies (and for newly listing firms), and then expanded to smaller public companies over the next few years. All of this seemed fine until 2002, when fallout from Enron, WorldCom, and other corporate governance catastrophes caused Indian regulators to wonder whether Clause 49 went far enough. SEBI decided to sponsor a second corporate governance committee chaired by Narayana Murthy, the renowned leader of Infosys Technologies. The Murthy Committee went to work and released its additional recommendations in 2003. SEBI quickly adopted these suggestions and issued a revised Clause 49 in 2004. The Murthy Committee reforms expanded on the Birla Committees work in several areas. One main focus related to the qualifications for independent director status: a number of specific requirements were added to disqualify material suppliers and customers, recently departed executives, relatives, and other closely-related parties. A second set of changes affected the audit committee: it was now required to meet more frequently (four times per year), and members had to satisfy new financial literacy requirements. A third important change mandated CEO and CFO certification of financial reports and internal controls. And a number of additional shareholder disclosures, including expanded discussion of financial results, were added to the Clause 49 requirements. As before, these reforms were phased in gradually; all public firms were not required to comply with the Murthy Committee rules until January 1, 2006. The fruits of this labor were generally well-received, and Clause 49 seems to have improved the overall state of Indian corporate governance. For example, a recent study by Bernard Black and Vikramaditya Khanna argues that stock prices of imminently affected firms jumped almost four percent when SEBI announced its decision to pursue the initial Clause 49 reforms. Similarly, the World Bank as part of its 2005 standards and codes initiative benchmarked Indias regulatory framework to the OECD principles of corporate governance. It announced that India has indeed come a long way over the past decade,

reporting that a series of legal and regulatory reforms have transformed the Indian corporate governance framework and improved the level of responsibility/accountability of insiders, fairness in the treatment of minority shareholders and stakeholders, board practices, and transparency. But in this same study, the World Bank also flags four areas of concern. First, many sanctions seem inadequate, and there is a need for stricter enforcement of governance violations in order to increase compliance with Clause 49. Second, the division of regulatory responsibility between SEBI, the Department of Company Affairs (DCA), and the individual stock exchanges needs to be clarified to prevent oversight from slipping between jurisdictional flagstones. Third, board practices need to be strengthened to avoid director rubber stamping, especially by establishing credible institutions for training board members on their fiduciary responsibilities.21 And finally, according to the World Bank, institutional investors and large independent shareholders still need to become important forces to monitor insiders and play a disciplining role in the governance of corporations.

Corporate Governance at Infosys:


The case, 'Corporate Governance at Infosys'talks about the corporate governance practices at Infosys, one of India's largest software companies. Till late 1990s, corporate governance did not have much significance in India. In 1999, two committees (Confederation of Indian Industries, CII and the Kumar Mangalam Birla Committee) were set up to recommend good governance norms. These committees came out with several recommendations, which were made mandatory for the companies to adhere to by 2001. Infosys was one of the first companies in India which had complied with the recommendations made by the committees. The case discusses in detail, the corporate governance practices at Infosys, which complied with most of the recommendations made by the committees By the late 1990s, Infosys Technologies Limited (Infosys)1 had clearly emerged one of the best managed companies in India. Its corporate governance practices seemed to be better than those of many other companies in India. Because of its good governance practices, Infosys was the recipient of many awards. In 2001, Infosys was rated India's most respected company by Business World. Infosys was also ranked second in corporate governance among 495 emerging companies in a survey conducted by Credit Lyonnais Securities Asia (CLSA) Emerging Markets. It was voted India's best managed company five years in a row (1996-2000) by the Asiamoney poll. In 2000, Infosys had been awarded the National Award for Excellence in Corporate Governance by the Government of India. In 1999, Infosys had been selected as one of Asia's leading companies in the Far Eastern Economic Review's REVIEW 2000 Survey and voted India's most admired company by The Economic Times. Infosys had also provided all the information required by the Cadbury committee.Infosys had benchmarked its corporate governance practices against those of the best managed companies in the world (Refer Exhibit I for broad structures and processes for good governance).

It was one of the first companies in India to publish a compliance report on corporate governance, based on the recommendations of a committee constituted by the Confederation of Indian Industries (CII).Infosys maintained a high degree of transparency while disclosing information to stakeholders. In the late 1990s, the Confederation of Indian Industries (CII) published a code of corporate governance . In 1999, the Securities and Exchange Board of India (SEBI) appointed a committee under the Chairmanship of Kumar Mangalam Birla to recommend a code of corporate governance.
Corporate Governance Practices by Infosys Infosys is the high priest of corporate governance. Infosys had accepted the recommendations of both the CII and Kumar Mangalam Birla committee. This part of the paper provides an overview of corporate governance practices followed by Infosys. Infosys has an executive chairman and chief executive officer (CEO) and a managing director, president and chief operating officer (COO). The COO is responsible for all day to day operational issues and achievements of annual targets in client satisfaction, sales, profits, quality, productivity, employees' empowerment and employee retention. The CEO, COO, executive directors and the senior management made periodic presentations to the board on their targets, responsibilities and performance. Infosys adopted the tough US Generally Accepted Accounting Practices (GAAP) many years before other companies in India did. To maintain transparency, Infosys provided details on high or low monthly averages of share prices in all the stock exchanges on which the companies share were listed. Narayan Murthy believed in commitment to values, ethical conducts of business. He said, "Investors, Customers, Employees and Vendors have all become sharp, and are demanding greater transparency and fairness in all dealings." He also made a clear distinction between personal and corporate funds. Founding members took only salaries and dividend and did not have other benefits from the company. Achievements of Infosys for Its best CG practices By the late 1990s, Infosys Technology Ltd had clearly emerged one of the best managed companies in India. Its corporate governance practices seemed to be better than those of many other companies in India. Because of good corporate governance practices, Infosys was the recipient of many awards. In 2001, Infosys was rated India's most respected company by Business World. Infosys was also ranked second in corporate governance among 495 emerging companies in a survey conducted by Credit Lyonnais Securities Asia (CLSA) Emerging Markets. It was voted India's best managed company five years in a row (1996-2000) by the Asia money poll.

In 2000, Infosys had been awarded the "National Award for Excellence in Corporate Governance" by the Government of India. In 1999, Infosys had been selected as one of Asia's leading companies in the Far Eastern Economic Review's REVIEW 2000 survey and voted India's most admired company by The Economics Times.

TATA STEEL: Corporate Governance Policy

The Companys Corporate Governance Philosophy The Company believes in adopting the best practices in the areas of Corporate Governance. Even in a fiercely competitive business environment, the Management and Employees of the Company are committed to uphold the core values of transparency, integrity, honesty and accountability which are fundamental to the Tata Group. During the year, the Company has fine-tuned its corporate practices so as to bring them in line with the revised Clause 49 of the listing agreements. The Company adopted the Tata Code of Conduct for NonExecutive Directors and the Whistle Blower Policy as prescribed in the revised Clause. The Company will continue to focus its resources, strengths and strategies for creation and safeguarding of shareholders wealth and at the same time protect the interests of all its shareholders. Board of Directors The Company has a Non-Executive Chairman and the number of Independent Directors is more than one-third of the total number of Directors. The number of Non-Executive Directors (NEDs) is more than 50% of the total number of Directors. None of the Directors on the Board is a Member on more than 10 Committees and Chairman of more than 5 Committees (as specified in Clause 49), across all the companies in which he is a Director. The necessary disclosures regarding Committee positions have been made by the Directors. Seven Board Meetings were held during the year 2005-06 and the gap between two meetings did not exceed four months. The dates on which the Board Meetings were held were as follows : 19th May 2005, 27th July 2005, 23rd August 2005, 26th October 2005, 24th November 2005, 23rd January 2006 and 23rd March 2006. Dates for the Board Meetings in the ensuing year are decided well in advance and communicated to the Directors. Board Meetings are held at the Registered Office of the Company. The Agenda along with the explanatory notes are sent in advance to the Directors. Additional meetings of the Board are held when deemed necessary by the Board.

The Company has adopted the Tata Code of Conduct for Executive Directors, Senior Management Personnel and other Executives of the Company. The Company has received confirmations from the Executive Directors as well as Senior Management Personnel regarding compliance of the Code during the year under review. It has also adopted the Tata Code of Conduct for Non-Executive Directors of the Company. The Company has received confirmations from the Non-Executive Directors regarding compliance of the Code for the period ended 31st March, 2006. Both the Codes are posted on the website of the Company. Audit Committee The Company had constituted an Audit Committee in the year 1986. The scope of the activities of the Audit Committee is as set out in Clause 49 of the Listing Agreements with the Stock Exchanges read with Section 292A of the Companies Act, 1956. The terms of reference of the Audit Committee are broadly as follows : a) To review compliance with internal control systems; b) To review the findings of the Internal Auditor relating to various functions of the Company; c) To hold periodic discussions with the Statutory Auditors and Internal Auditors of the Company concerning the accounts of the Company, internal control systems, scope of audit and observations of the Auditors/ Internal Auditors; d) To review the quarterly, half-yearly and annual financial results of the Company before submission to the Board; e) To make recommendations to the Board on any matter relating to the financial management of the Company, including Statutory & Internal Audit Reports; f) Recommending the appointment of statutory auditors and branch auditors and fixation of their remuneration. Whistle Blower Policy The Audit Committee at its meeting held on 25th October, 2005, approved framing of a Whistle Blower Policy that provides a formal mechanism for all employees of the Company to approach the Ethics Counsellor/ Chairman of the Audit Committee of the Company and make protective disclosures about the unethical behaviour, actual or suspected fraud or violation of the Companys Code of Conduct. The Whistle Blower Policy is an extension of the Tata Code of Conduct, which requires every employee to promptly report to the Management any actual or possible violation of the Code or an event he becomes aware of that could affect the business or

reputation of the Company. The disclosures reported are addressed in the manner and within the time frames prescribed in the Policy. Under the Policy, each employee of the Company has an assured access to the Ethics Counsellor/Chairman of the Audit Committee. Remuneration Committee The Company had constituted a Remuneration Committee in the year 1993. The broad terms of reference of the Remuneration Committee are as follows : a) Review the performance of the Managing Director and the Whole-time Directors, after considering the Companys performance. b) Recommend to the Board remuneration including salary, perquisites and commission to be paid to the Companys Managing Director and Whole-time Directors. c) Finalise the perquisites package of the Managing Director and Whole-time Directors within the overall ceiling fixed by the Board. d) Recommend to the Board, retirement benefits to be paid to the Managing Director and Whole-time Directors under the Retirement Benefit Guidelines adopted by the Board. The Remuneration Committee also functions as the Compensation Committee as per SEBI guidelines on the Employees Stock Option Scheme. The Company, however, has not yet introduced the Employees Stock Option Scheme. Remuneration Policy The Company while deciding the remuneration package of the senior management members takes into consideration the following items : a) employment scenario b) remuneration package of the industry and c) remuneration package of the managerial talent of other industries. The annual variable pay of senior managers is linked to the performance of the Company in general and their individual performance for the relevant year measured against specific Key Result Areas, which are aligned to the Companys objectives. The Non-Executive Directors (NEDs) are paid remuneration by way of Commission and Sitting Fees. In terms of the shareholders approval obtained at the AGM held on 19th July, 2001, the Commission is paid at a rate not exceeding 1% per annum of the profits of the Company (computed in accordance with Section 309(5) of the Companies Act, 1956). The distribution of Commission amongst the NEDs is placed before the Board. The

Commission is distributed on the basis of their attendance and contribution at the Board and certain Committee Meetings as well as time spent on operational matters other than at the meetings. Shareholders' Committee An Investors Grievance Committee was constituted on 23rd March, 2000 to specifically look into the redressal of Investors complaints like transfer of shares, non-receipt of balance sheet and non-receipt of declared dividend, etc. Committees In addition to the above Committees, the Board has constituted 3 more Committees, viz. Committee of the Board, Committee of Directors and the Ethics and Compliance Committee. The terms of reference of the Committee of the Board (COB) are to approve capital expenditure schemes and donations within the stipulated limits and to recommend to the Board, capital budgets and other major capital schemes, to consider new businesses, acquisitions, divestments, changes in organisational structure and also to periodically review the Companys business plans and future strategies. The Committee of Directors has been constituted to approve of certain routine matters such as Opening and Closing of Bank Accounts of the Company, to grant limited Powers of Attorney to the Officers of the Company, to appoint proxies to attend general meetings on behalf of the Company etc. The Members of this Committee are Mr. R.N. Tata (Chairman), Mr. Ishaat Hussain and Dr. J.J. Irani. The business of the Committee is transacted by passing Circular Resolutions which are placed before the Board at its next meeting. Ethics and Compliance Committee In accordance with the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992, as amended (the Regulations), the Board of Directors of the Company adopted the Tata Code of Conduct for Prevention of Insider Trading and Code of Corporate Disclosure Practices (the Code) to be followed by Directors, Officers and other Employees. The Code is based on the principle that Directors, Officers and Employees of a Tata Company owe a fiduciary duty to, among others, the shareholders of the Company to place the interest of the shareholders above their own and conduct their personal securities transactions in a manner that does not create any conflict of interest situation. The Code also seeks to ensure timely and adequate disclosure of Price Sensitive Information to the investor community by the Company to enable them

to take informed investment decisions with regard to the Companys securities. Disclosures i) The Board has received disclosures from key managerial personnel relating to material, financial and commercial transactions where they and/or their relatives have personal interest. There are no materially significant related party transactions which have potential conflict with the interest of the Company at large. ii) The Company has complied with the requirements of the Stock Exchanges, SEBI and other statutory authorities on all matters relating to capital markets during the last three years. No penalties or strictures have been imposed on the Company by the Stock Exchange, SEBI or other statutory authorities relating to the above. iii) The Company has adopted a Whistle Blower Policy and has established the necessary mechanism in line with clause 7 of the Annexure I D to Clause 49 of the Listing Agreement with the Stock Exchanges, for employees to report concerns about unethical behaviour. No personnel has been denied access to the Ethics Counsellor/Chairman of the Audit Committee. iv) The Company has fulfilled the following non-mandatory requirements as prescribed in Annexure I D to Clause 49 of the Listing Agreement with the Stock Exchanges : a) The Company has set up a Remuneration Committee. Please see para 4 for details. b) A half-yearly declaration of financial performance including a summary of the significant events in the six-months period was sent to every shareholder. c) The Company has moved towards a regime of unqualified financial statements.

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Secretarial Audit A qualified practicing Company Secretary carried out a secretarial audit to reconcile the total admitted capital with National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL) and the total issued and listed capital. The audit confirms that the total issued/paid up capital is in agreement with the total number of shares in physical form and the total number of dematerialized shares held with NSDL and CDSL. 8. Means of Communication Half-yearly report sent to each household of shareholders In addition to the results of the Company being published in the newspapers and posted on the website of the Company, half-yearly reports are sent to each household of the shareholders. Results The quarterly and annual results along with the Segmental Report are generally published in Indian Express, Nava Shakti, Free Press Journal and also displayed on the website of the Company www.tatasteel.com shortly

after its submission to the Stock Exchanges.

Module-3
Role Players:Stemming from my earlier write up on corporate governance, this article is the second part of the series which looks at the factors and qualities that create good corporate governance and its best practices. For this article, we shall address the area of Board of Directors, since they are the driving force of every organization. Therefore, a strong governance framework needs to be established, and should serve the following objectives:1. Clarify the roles, responsibilities and accountabilities of the board members and management team; 2. Enable the board to provide strategic guidance and effective oversight of the management; and 3. Ensure that no one single individual has too much power or influence on the organization. Further to the above, the boards main role is to protect the interests of the shareholders and other relevant stakeholders. At the same time, they have to ensure that the company is able to compete in the market. The directors are also expected to be able to have a firm grip on the companys internal controls processes, to ensure operational and financial risks are identified, addressed and managed. In a general context, the effectiveness of a board within an organization depends on a few factors, namely, size and composition, competencies, activeness and leadership qualities. These factors are non-exhaustive and non-conclusive whereby every organization should include relevant gauge wherever necessary.

Size and Composition


There is no such thing as the optimal size for the board, but the Companies Act 1965 determines the minimum number of directors and the Articles of Association normally specifies the maximum. However, instead of arriving at the absolute number, an organization should look into certain factors to gauge the optimum size of the board. Some of these factors include:

Size of the organization, scope of business and geographical diversity; There should be a balance between executive and non-executive directors as well as the independent elements of those non-executive directors. This is mainly to

achieve the check and balance whereby no single individual has the ultimate control over the board; Whether the board has representation diversity in terms of professional experience, race, gender and technical know-how of the industry.

Competency
There should be a mixture of core competencies among the directors in the board to cover most aspects of the organization. Certain directors need to have relevant industry specific knowledge and experience whereas others are professionals having focused expertise in areas such as finance, accounting, risk management etc.

Activeness
The board is required to play an active role in directing the organization. Although they may not be playing an active role in the daily operational issues, the board is expected to be vigilant in ensuring the management is implementing the direction of the board. In addition to playing the strategic role within the organization, the board is also expected to monitor the managements decisions and actions, and if there are inconsistencies found, they should question the management based on factual knowledge. Furthermore, the board is also expected to ensure that the management conducts their tasks ethically and comply to all financial reporting and regulatory requirements.

Leadership Qualities
Being the driver of the organization, the board must should leadership qualities such as having ability to inspire talents and provide strategic direction and vision of the organization. They have to be able to evaluate strategic decisions, conceptualizing ideas and innovation to continually pressing for growth and address future challenges. Whilst the board of directors plays a very big part in corporate governance, certain other factors like risk management, internal and external audits too affect the framework of corporate governance. Role of Board of Directors: A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. The body sometimes has a different name, such as board of trustees, board of governors, board of managers, or executive board. It is often simply referred to as "the board." A board's activities are determined by the powers, duties, and responsibilities delegated to it or conferred on it by an authority outside itself. These matters are typically detailed in the

organization's bylaws. The bylaws commonly also specify the number of members of the board, how they are to be chosen, and when they are to meet. In an organization with voting members, e.g., a professional society, the board acts on behalf of, and is subordinate to, the organization's full assembly, which usually chooses the members of the board. In a stock corporation, the board is elected by the stockholders and is the highest authority in the management of the corporation. In a nonstock corporation with no general voting membership, e.g., a university, the board is the supreme governing body of the institution.[1] Typical duties of boards of directors include

governing the organization by establishing broad policies and objectives; selecting, appointing, supporting and reviewing the performance of the chief executive; ensuring the availability of adequate financial resources; approving annual budgets; accounting to the stakeholders for the organization's performance.

The legal responsibilities of boards and board members vary with the nature of the organization, and with the jurisdiction within which it operates. For public corporations, these responsibilities are typically much more rigorous and complex than for those of other types. Typically the board chooses one of its members to be the chairman.
AUDITING ROLE OF AUDITORS IN GOOD GOVERNANCE: Auditing is defined as obtaining and evaluating evidences regarding assertions about economic actions and events to ascertain the extent to which they correspond with the established criteria, and to communicating the result to the interested users. Thus, it encompasses investigation process, attestation process, and the reporting process, pertaining to economic actions and events. International Audit Standards maintain that an auditor's mandate may require him to take cognizance and report matters that come to his knowledge in performing his audit duties which relate to: >Compliance with legislative or regulatory requirements; >Adequacy of accounting and control systems; >Viability of economic activities, programmes, and projects. Two variant situations emerge when the functions of auditors and the requirements of good governance are placed face to face. The former is confined to 'econonuc actions and events, while the later is the outcome of a wide range of managerial functions. The question then arises whether the auditors should cross their operational limits in order to bring about the desired level of improvement in the quality of governance, or, alternatively, while restricting themselves to their term of reference, they should operate more effectively so as to help improve the quality of governance. Lately, a view has emerged that auditors should play a more vital and direct role in establishing good governance. Should this mean to expect them to cross the established borders of genuine audit functions, it would be stretching the string too far, without gaining any thing positive and

substantial. The only alternative then is to make the auditors feel more conscientious, more dutiful, and therefore to be more effective, while restricting themselves to their term of reference. International Auditing Standards (IAS) also recognize that the matters that may be relevant to the governance of any business entity may be broader than those that form the subject matter of IAS, which are directly related to the audit of financial statements. IAS 260 categorically requires the auditors to communicate with the officials charged with the governance of an entity the matters arising from the audit of financial statements. They will not be required, the IAS continues, "to design procedure for the specific purpose of identifying matters of governance interest". Even the Code of Good Corporate Governance envisaged by the SECP subscribes to this phenomenon. Rather, it prohibits in explicit terms any such excesses on the part of the auditors. Paragraph xl under the heading 'External Auditors' reads: "No listed company shall appoint its auditors to provide services in addition to audit except in accordance with the regulations and shall require the auditors to observe applicable IFAC (International Federation of Accountants) guidelines in this regard and shall ensure that the auditors do not perform management functions or make management decisions, responsibility for which remains with the Board of directors and management of the listed company. " Thus, it is established that auditors are not required to traverse their area of operation. Whatever they are expected to contribute towards good governance shall, therefore, be from within their range or sphere of activity. In other words, it is the quality of their performance that will make all the difference, which, therefore, needs to be ameliorated to match the requisites of good governance. Once it is settled that it is the quality of audit that is aimed at, the question arises what is the desirable quality, and how can it be measured? The question has gained great momentum in recent years when considerable attention has been focused on the auditor's responsibility for negligence. This is largely the result of wide publicity being given world over to considerable sums sought by plaintiffs in compensation for losses they have suffered, losses which, they believe, could have been prevented had the auditors been more vigilant. To quote a lively example, m/s Pricewater House, auditors of BCCI, remained in the news for quite some time during the last decade of the preceding century for their reportedly inapt behaviour leading to the collapse of the Bank. An answer to this very pertinent question can be traced back in what Denning LJ observed in Candler v. Crane Christmas & Co. (1951), whose opinion was later upheld in famous Hedley Byrne case [Hedley Byrne & Co. v. Heller and Partners Ltd. (1963)], and which reads. " Their [the auditors'] duty is not merely a duty to use care in their reports. They have also duty to use care in their work which results in their reports". The 'care' again is a relative term. The degree of care required may also vary from situation to situation. However, the overriding requirement is to have a "true and fair view". Interestingly enough, what is 'true and fair' is not necessarily the 'truth'. The famous Elephant Story will help explain this riddle. Three blind men were led to an elephant and asked to state by touching it what it was. The first who touched the animal from the side and felt hard and broad span of the skin said it was a wall. The other who groped around the tail announced that it was a rope. The third gentleman who came in contact with the trunk claimed that it was a hose-pipe. All the three, to the best of their knowledge, were 'true and fair' but none of them was right. This leads to the conclusion that the perception and belief a person may have, and the opinion that he forms, about a set of circumstances depend upon: (i) his view point, and (ii) the information made available to him.

This becomes all the more important in view of the fact that the law has not defined the expression 'true and fair'. Moreover, the whole process of auditing requires much imagination and careful thought from beginning to end. It is highly demanding and is often described as a very onerous responsibility. No doubt the vast majority of the profession do behave with integrity but auditors can and do some times fail to exercise their duty to as high a standard as is expected of them.

Birla Committee Report on Audit Committee:


Functions of the Audit Committee 9.10 As the audit committee acts as the bridge between the board, the statutory auditors and internal auditors, the Committee recommends that its role should include the following

Oversight of the companys financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible. Recommending the appointment and removal of external auditor, fixation of audit fee and also approval for payment for any other services. Reviewing with management the annual financial statements before submission to the board, focussing primarily on: o Any changes in accounting policies and practices. o Major accounting entries based on exercise of judgement by management. o Qualifications in draft audit report. o Significant adjustments arising out of audit. o The going concern assumption. o Compliance with accounting standards o Compliance with stock exchange and legal requirements concerning financial statements. o Any related party transactions i.e. transactions of the company of material nature, with promoters or the management, their subsidiaries or relatives etc. that may have potential conflict with the interests of company at large. Reviewing with the management, external and internal auditors, the adequacy of internal control systems. Reviewing the adequacy of internal audit function, including the structure of the internal audit department, staffing and seniority of the official heading the department, reporting structure, coverage and frequency of internal audit. Discussion with internal auditors of any significant findings and follow-up thereon. Reviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the matter to the board. Discussion with external auditors before the audit commences, of the nature and scope of audit. Also post-audit discussion to ascertain any area of concern. Reviewing the companys financial and risk management policies. Looking into the reasons for substantial defaults in the payments to the depositors, debenture holders, share holders (in case of non-payment of declared dividends) and creditors.

SEBI and Governance:

Good Governance in capital market has always been high on the agenda of SEBI. Corporate Governance is looked upon as a distinctive brand and benchmark in the profile of Corporate Excellence. This is evident from the continuous updation of guidelines, rules and regulations by SEBI for ensuring transparency and accountability. In the process, SEBI had constituted a Committee on Corporate Governance under the Chairmanship of Shri Kumar Mangalam Birla. The Committee in its report observed that the 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. Based on the recommendations of the Committee, the SEBI had specified principles of Corporate Governance and introduced a new clause 49 in the Listing agreement of the Stock Exchanges in the year 2000. These principles of Corporate Governance were made applicable in a phased manner and all the listed companies with the paid up capital of Rs 3 crores and above or net worth of Rs 25 crores or more at any time in the history of the company, were covered as of March 31, 2003. SEBI, as part of its endeavour to improve the standards of corporate governance in line with the needs of a dynamic market, constituted another Committee on Corporate Governance under the Chairmanship of Shri N. R. Narayana Murthy to review the performance of Corporate Governance and to determine the role of companies in responding to rumour and other price sensitive information circulating in the market in order to enhance the transparency and integrity of the market. The Committee in its Report observed that the effectiveness of a system of Corporate Governance cannot be legislated by law, nor can any system of Corporate Governance be static. In a dynamic environment, system of Corporate Governance need to be continually evolved. With a view to promote and raise the standards of Corporate Governance, SEBI on the basis of recommendations of the Committee and public comments received on the report and in exercise of powers conferred by Section 11(1) of the Securities and Exchange Board of India Act, 1992 read with section 10 of the Securities Contracts (Regulation) Act 1956, revised the existing clause 49 of the Listing agreement vide its circular SEBI/MRD/SE/31/2003/26/08 dated August 26, 2003. It clarified that some of the sub-clauses of the revised clause 49 shall be suitably modified or new clauses shall be added following the amendments to the Companies Act 1956 by the Companies (Amendment) Bill/Act 2003, so that the relevant provisions of the clauses on Corporate Governance in the Listing Agreement and the Companies Act remain harmonious with one another.

Schedule of Implementation
: The circular specifies following schedule of implementation of the revised clause 49 (i) All entities seeking listing for the first time, at the time of listing, (ii) All listed entities having a paid up share capital of Rs 3 crores and above or net worth of Rs 25 crores or more at any time in the history of the company.
* Secretary, The ICSI, Views expressed are personal views of the author and do not reflect those of the Institute.

The companies are required to comply with the requirements of the clause on or before March 31, 2004. The companies which are required to comply with the requirements of the revised clause 49 have been put under an obligation to submit a quarterly compliance report to the stock exchanges as per sub clause (IX) (ii), of the revised clause 49, within 15 days from the quarter ending 31st March, 2004. The report is required to be submitted either by the Compliance Officer or the Chief Executive Officer of the company after obtaining due approvals.

Application of Revised Clause 49 The revised clause 49 is applicable to the listed companies, in accordance with the schedule of implementation given above. However, for other listed entities, which are not companies, but body corporates (e.g. private and public sector banks, financial institutions, insurance companies etc.) incorporated under other statutes, the revised clause will apply to the extent that it does not violate their respective statutes, and guidelines or directives issued by the relevant regulatory authorities. The revised clause is not applicable to the Mutual Fund Schemes. Obligations on Stock Exchanges The Stock Exchanges are put under obligation to ensure that all the provisions of Corporate Governance have been complied with by the company seeking listing for the first time, before granting any new listing. For this purpose, it would be satisfactory compliance if these companies set up the Boards and constitute committees such as Audit Committee, shareholders/ investors grievances committee, etc. before seeking listing. The stock exchanges have been empowered to grant a reasonable time to comply with these conditions if they are satisfied that genuine legal issues exists which will delay such compliance. In such cases while granting listing, the stock exchanges are required to obtain a suitable undertaking from the company. In case of the company failing to comply with this requirement without any genuine reason, the application money shall be kept in an escrow account till the conditions are complied with. The Stock Exchanges have also been required to set

up a separate monitoring cell with identified personnel to monitor the compliance with the provisions of the Corporate Governance, and to obtain the quarterly compliance report from the companies which are required to comply with the requirements of Corporate Governance. The stock exchanges are required to submit a consolidated compliance report to SEBI within 30 days of the end of each quarter. HIGHLIGHTS OF THE NEW AMENDMENTS 1. Widening the Definition of Independent Director Under the revised clause 49, the definition of the expression independent director has been expanded. The expression independent director mean non-executive director of the company who (a) 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;
(b) is not related to promoters or management at the board level or at one level below the board; (c) has not been an executive of the company in the immediately preceding three financial years; (d) is not a partner or an executive of the statutory audit firm or the internal audit firm that is associated with the company, and 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. (e) is not a supplier, service provider or customer of the company. This should include lessor-lessee type relationships also; and (f) is not a substantial shareholder of the company, i.e. owning two percent or more of the block of voting shares.

It has been clarified that the Institutional Directors on the boards of companies are independent directors whether the institution is an investing institution or a lending institution. 2. Compensation to Non Executive Directors and Disclosure thereof As per earlier clause 49, the compensation to be paid to nonexecutive directors was fixed by the Board of Directors, whereas the revised clause requires all compensation paid to non-executive directors to be fixed by the Board of Directors and to be approved by shareholders in general meeting. There is also provision for setting up of limits for the maximum number of stock options that can be granted to non-executive directors in any financial year and in aggregate. The stock options granted to the non-executive directors to be vested after a period of at least one year from the date of retirement of such non-executive directors.

Placing the independent directors and non-executive directors on equal footing, the revised clause provides that the considerations as regards compensation paid to an independent director shall be the same as those applied to a non-executive director. The companies have been put under an obligation to publish their compensation philosophy and statement of entitled compensation in respect of nonexecutive directors in its annual report. Alternatively, this may be put up on the companys website and a reference thereto in the annual report. The company is also required to disclose on an annual basis, details of shares held by non-executive directors, including on an ifconverted basis. The revised clause also requires non-executive directors to disclose prior to their appointment their stock holding (both own or held by / for other persons on a beneficial basis) in the listed company in which they are proposed to be appointed as directors,. These details are required to be accompanied with their notice of appointment. 3. Periodical Review by Independent Director The revised clause 49 requires the Independent Director to periodically review legal compliance reports prepared by the company and any steps taken by the company to cure any taint. The revised clause specifies that no defence shall be permitted that the independent director was unaware of this responsibility in case of any proceedings against him in connection with the affairs of the company. 4. Code of Conduct The revised clause 49 requires the Board of a company to lay down the code of conduct for all Board members and senior management of a company and the same to be posted on the website of the company. Accordingly, all Board members and senior management personnel have been put under an obligation to affirm compliance with the code on an annual basis and a declaration to this effect signed by the CEO and COO is to be given in the Annual Report of the Company. It has been clarified that the term senior management will include personnel of the company who are members of its management / operating council (i.e. core management team excluding Board of Directors). Normally, this would comprise all members of management one level below the executive directors. 5. NonExecutive Directors Not to hold office for more than Nine Years Revised clause 49 limits the term of the office of the non-executive director and provides that a person shall be eligible for the office of non-executive director so long as the term of office does not exceed nine years in three terms of three years each, running continuously.

6. Audit Committee Two explanations have been added in the revised clause 49. The first explanation defines the term financially literate to mean the ability to read and understand basic financial statements i.e. balance sheet, profit and loss account, and statement of cash flows. It has also been clarified that a member is considered to have accounting or related financial management expertise if he or she possesses experience in finance or accounting, or requisite professional certification in accounting, or any other comparable experience or background which results in the individuals financial sophistication, including being or having been a Chief Executive Officer(CEO), Chief Financial Officer(CFO), or other senior officer with financial oversight responsibilities. 7. Review of information by Audit Committee The Audit Committee is required to mandatorily review financial statements and draft audit report, including quarterly / half-yearly financial information, management discussion and analysis of financial condition and results of operations, reports relating to compliance with laws and to risk management, management letters/ letters of internal control weaknesses issued by statutory / internal auditors, and records of related party transactions. The appointment, removal and terms of remuneration of the Chief Internal Auditor shall be subject to review by the Audit Committee. 8. Disclosure of Accounting Treatment The revised clause 49 requires that in case a company has followed a treatment different from that prescribed in an Accounting Standards, the management of such company shall justify why they believe such alternative treatment is more representative of the underlined business transactions. Management is also required to clearly explain the alternative accounting treatment in the footnote of financial statements. 9. Whistle Blower Policy Companies have been required to formulate an Internal Policy on access to Audit Committees. Personnel who observe any unethical or improper practice (not necessarily a violation of law) can approach the Audit Committee without necessarily informing their supervisors. Companies are also required to take measures to ensure that this right of access is communicated to all employees through means of internal circulars, etc. The employment and other personnel policies of the company should also contain provisions protecting whistle blowers from unfair termination and other unfair or prejudicial employment practices. Companies have also been required to affirm that it has not denied any personnel access to the Audit Committee

of the company (in respect of matters involving alleged misconduct) and that it has provided protection to whistle blowers from unfair termination and other unfair or prejudicial employment practices. Such affirmation should form part of the Boards report on Corporate Governance that is required to be prepared and submitted together with the annual report. 10. Subsidiary Companies The revised clause 49 provides that the provisions relating to the composition of the Board of Directors of the holding company are also applicable to the composition of the Board of Directors of subsidiary companies. The clause further requires that at least one independent director on the Board of Directors of the holding company should be a director on the Board of Directors of the subsidiary company. The Audit Committee of the holding company has been empowered to review the financial statements, in particular the investments made by the subsidiary company and the minutes of the Board meetings of the subsidiary company to be placed for review at the Board meeting of the holding company. It is further required that the Boards report of the holding company should state that they have reviewed the affairs of the subsidiary company also. 11. Disclosure of contingent liabilities The revised clause 49 requires the management to provide a clear description in plain English of each material contingent liability and its risks, which shall be accompanied by the auditors clearly worded comments on the managements view. This section is required to be highlighted in the significant accounting policies and notes on accounts, as well as, in the auditors report, where necessary. 12. Additional Disclosures The revised Clause 49 of the Listing Agreement requires the following additional disclosures: (A) Basis of related party transactions A statement of all transactions with related parties shall be placed before the Audit Committee for formal approval/ratification. If any transaction is not on an arms length basis, management is required to justify the same to the Audit Committee. (B) Board Disclosures Risk management The Board members should be informed about the risk assessment and minimization procedures. These procedures shall be periodically reviewed to ensure that executive management controls risk through means of a properly defined framework. Management shall place a quarterly report certified by the compliance officer of the company, before the entire Board of

Directors documenting the business risks faced by the company, measures to address and minimize such risks, and any limitations to the risk taking capacity of the corporation. This document shall be formally approved by the Board. (C) Proceeds from Initial Public Offerings (IPOs) When money is raised through an Initial Public Offering (IPO), it shall disclose to the Audit Committee, the uses / applications of funds by major category (capital expenditure, sales and marketing, working capital, etc), on a quarterly basis as a part of their quarterly declaration of financial results. Further, on an annual basis, the company shall prepare a statement of funds utilized for purposes other than those stated in the offer document/prospectus. This statement shall be certified by the independent auditors of the company. The Audit Committee shall make appropriate recommendations to the Board to take up steps in this matter. 13. Certification by CEO/CFO CEO (either the Executive Chairman or the Managing Director) and the CFO (Whole-Time Finance Director or other person discharging this function) of the company has been put under an obligation to certify that, to the best of their knowledge and belief, they have reviewed the balance sheet and profit and loss account and all its schedules and notes on accounts, the cash flow statements as well as the Directors Report and these statements do not contain any materially untrue statement, omits any material fact or do they contain statements that might be misleading. Further they are required to certify that these statements together present a true and fair view of the company, and are in compliance with the existing accounting standards and/or applicable laws/regulations. The revised clause requires them to be responsible for establishing and maintaining internal controls, to evaluate the effectiveness of internal control systems of the company, and to disclose to the auditors and the Audit Committee, deficiencies in the design or operation of internal controls, if any. They are also required to disclose to the auditors as well as the Audit Committee, instances of significant fraud, if any, that involves management or employees having a significant role in the companys internal control systems, whether or not there were significant changes in internal control and / or of accounting policies during the year. 14. Report on Corporate Governance The companies have been required to submit a quarterly compliance report in the prescribed format to the stock exchanges within 15 days from the close of the quarter. The report has to be submitted

either by the Compliance Officer or the Chief Executive Officer of the company after obtaining due approvals. 15. Company Secretary in Practice to Issue Certificate of Compliance This is a landmark amendment authorizing Company Secretaries in Practice among other professionals to issue certificate of compliance of clause 49. The revised clause requires the company to obtain a certificate from either the auditors or practicing company secretaries regarding compliance of conditions of corporate governance and annex the certificate with the directors report, which is sent annually to all the shareholders of the company. The same certificate is also required to be sent to the Stock Exchanges along with the annual returns filed by the company. 16. Additional disclosure in the Report on Corporate Governance The following additional items are required to be disclosed in the suggested list of Items to be included In the Report on Corporate Governance in the Annual Report of Companies. (i) Disclosure of accounting treatment, if different, from that prescribed in Accounting Standards with explanation.
(ii) Whistle Blower policy and affirmation that no personnel has been denied access to the audit committee.

17. Additional Disclosures under Non-Mandatory Requirements The following additional disclosures are required to be made under the non-mandatory requirements : (i) Audit qualifications
Company may move towards a regime of unqualified financial statements.

(ii) Training of Board Members Company shall train its Board members in the business model of the company as well as the risk profile of the business parameters of the company, their responsibilities as directors, and the best ways to discharge them. (iii) Mechanism for evaluating Non-Executive Board Members The performance evaluation of non-executive directors should be done by a peer group comprising the entire Board of Directors, excluding the director being evaluated; and Peer Group evaluation should be the mechanism to determine whether to extend / continue the terms of appointment of non-executive directors. Conclusion
The recent events worldwide, particularly in the United States have renewed the emphasis on Corporate Governance the worldover. These events have highlighted the need for ethical governance and require management to look beyond their systems and procedures. Reacting swiftly and spontaneously, the United States enacted

Sarbans Oxley Act, 2002 bringing out fundamental changes in every dimension of Corporate Governance. Back home in India, the need for strengthened norms for Corporate Governance is also felt. The revised clause 49 of the Listing Agreement is, therefore, most timely and provides much needed disclosure requirements, widened definition of independent director, periodical review by independent director, whistle blower policy, quarterly compliance report in the prescribed format and issue of certificate of compliance. It is hoped that the revised clause 49 would go a long way in providing corporates good governance framework

Module-4
Business Ethics & Corporate Governance
Good ethics lead us to believe in not doing things that are not right and not saying if they are not true. Ethics is a system of moral principles governing the appropriate conduct of a person or a group. It is a way of being human and having a feeling of compassion, sympathy or regard for others the way we have for ourselves. Good ethics is important to all occupations or social or economic class. Thus, maintaining good ethics is being consistent with the principles of correct moral conduct constantly. Business ethics is similar to our normal every day ethics. Good ethics leads to good business. It is a fundamental requirement of any profession. It is integral to the success of the business as well. Good ethics makes us aware of what we are doing including the consequences of our actions. An organization strives continually to be in pursuit of its goals while benefiting the employees in building up their high competencies. In this pursuit, the adherence to high ethical standards of the employees can be very much contributory to the impressive achievements of business goals being turned out as planned and intended. Ethics refers to human conduct as to make judgments between what is right and what is wrong. It could be that there are several factors that may encourage one to adopt unethical behavior, but the right person is he who, despite facing ethical dilemmas, assesses the situations and makes differentiation between what is morally good and bad in order to follow the rules and code of professional conduct. Good ethics causes to gain confidence of superiors while promoting integrity, which means to continue doing right things even when we are not being watched. Business also has responsibilities, such as, designing proper jobs. After the jobs are created and the employees are appointed, fair reward and promotion systems are necessary for an organization to implement. Employees develop positive feelings, the feeling of pleasure when a need or desired is fulfilled. If an organization does not recognize the talent and hard work of the employees, the consequences may lead the employees toward unethical behavior. Employees must be treated fairly. If they are treated respectfully and in an appropriate way, they are in favor of management else they may get back to adopt unethical behavior. Moreover, it is the responsibility of management to intervene if managers take improper decisions in terms of hiring and firing the employees because the managers of business may sometimes lose their ethics when they take certain decisions that affect the employees career and growth. If the decisions of managers are unethical,

both employees and the organization suffer the consequences. It must be seen whether employee morale is enhanced. The policy guidelines related to compensations is a factor affecting employee morale. The difference between the aspects that what compensation the employees expect to get and what is being offered to them is in general prevailing and so it is a reason of dissatisfaction. What in such situation a management needs to do is it should come out with the schemes that can enhance the morale with reasonable compensations. Furthermore, business managers or supervisors need to develop perceptual abilities that on the basis of accurate perceptions, an unbiased outlook may be maintained. Every employee should be treated fairly by inculcating the sense of positive feelings about the organization. Professionalism should be preferred to favoritism as the practice of giving special treatment or unfair advantages to a person or group creates lots of problems that result in hurting the feelings, causing emotional pain or suffering of another person or group. The importance of ethics in professional life can be evidenced by a number of instances showing failure of businesses and several scandals. It may be rightly said that the situations would not have been so worsened had there been observance of ethical standards. Therefore, maintaining ethical standards is must for the prosperity of an organization as well as the development of ones personality. Good ethics will lead us to maintain our honest image. It will enable us to refrain from such activities that may discredit to our profession. Thus, adhesion to good ethics is to let our conscience be our guide at all times. Albert Schweitzer says, Ethics is the activity of man directed to secure the inner perfection of his own personality.

Unethical Behavior: Roots & Causes Business literature is replete with stories of unethical behavior in executive suites and board rooms, yet everyone is potentially capable of falling into the same traps. With a little insight into the psychological traps that increase the probability that individuals will behave unethically, perhaps such behavior can be curbed. To date, the authors have delineated a total of 45 traps, including "Obedience to Authority," "Need for Closure," "The False Consensus Effect," "Lost in the Group," and "Self-Enhancement," and they fully expect more to be discovered.. Psychological traps are the root causes of unethical behavior. Psychological traps are similar to fish traps. A fish trap is comprised of a wire cage with an entrance shaped like a large funnel that narrows toward the inside of the cage; the design of the funnel directs the fish to swim into the trap. In the same way, an individual or organization is encouraged to move in a certain (unethical) direction once a psychological trap is present. Later, the action turns out to be disastrous and there are usually no simple means of reversing course.[1] Because they are psychological in nature, some of these traps distort perceptions of right and wrong so that one actually believes his or her unethical behavior is right. If people are not aware of these traps, they can act as illusions or webs of deception. Once the traps are identified, however, they lose much of their power to ensnare, and people can more easily

circumvent themjust as voyagers who know the location of quicksand can navigate around it. When danger is clearly identified, one can prepare for it and avoid it. Depending on their context, traps may be benign and can even exert a positive influence on our lives. For example, empathy is often considered the cornerstone of good ethics but in some circumstances, this personality trait can actually overpower our sense of fairness. This is because traps can incite tunnel vision; the pull to act on them is so strong that people can become blinded to other behavioral options. Individuals that we respect and admireeven whole companiescan descend rapidly down the path of corruption. Traps exist because at any given moment in time people experience impulses that motivate them to act. These impulses are reactions to internal or external stimuli. Sometimes, a stimulus is so powerful or triggers such automatic behavior that the individual acts without recognizing that other options exist. At other times, he or she is aware of other choices, but the stimulus' impact overrides these potential actions. The essential question the authors posed was: What prompts the individual or organization to begin to move in an ill-fated direction? The diverse traps presented in this article provide descriptions of different internal or external stimuli that compel people to begin this movement toward disaster. In addition, the article introduces three main categories of traps: Primary, Personality, and Defensive.

Primary Traps
Primary traps are predominantly comprised of external stimuli. They are the main traps that impel people to move in a certain direction without regard for ethical principles. "Obedience to Authority" is a clear example of a primary trap. Children are primed to obey their parentstheir survival depends upon itand in school, this conditioning continues. Students automatically know that they must show deference to their teachers. Consequently, later in life, when the boss orders an employee to do something, many people quickly obey without thinking. If a person of authority orders a subordinate to do something unethical, the compelling need to obey authority serves as such a powerful external stimulus that the individual will likely obey the order without being aware of its opposition to his or her own ethical principles. At other times, the subordinate might be aware that the order is unethical; nonetheless, the impulse to obey is so strong that it overrides his or her judgment.

Personality Traps
Personality traps consist exclusively of internal stimuli in the form of various personality traits that can make people more vulnerable to wrongdoing. An example of a personality trap is the "Need for Closure," that is, "the desire for a definite answer on some topic, any answer, as opposed to confusion and ambiguity." [2] It is the tendency to jump on the first opinion that comes to mind, rather than tolerating a state of uncertainty and taking the time to consider a problem or judgment from many different angles.

The need for closure is augmented under work conditions that make processing information more difficult, namely time pressure, fatigue, and excessive background noise. When such conditions exist, it is more difficult to tolerate a state of confusion and ambiguity. While the need for closure is influenced by situational factors, it is also a personality trait some people are more able to tolerate states of ambiguity than others. Arie Kruglanski has developed a "Need for Closure Scale" to measure this personality dimensionthose with a high tendency towards the trait are more apt to endorse items on the scale, such as "I usually make important decisions quickly and confidently," "I do not usually consult many different opinions before forming my own view," "When I'm confused about an important issue, I feel very upset," or "It's annoying to listen to someone who cannot seem to make up his or her mind."[3] Kruglanski and his colleagues have established that those who score high on the scale are more prone to stay with established impressions in the face of contradictory evidence.[4] So, what does this mean in the real world? Let us say that a CEO has a high need for closure. Based on the CEO's previous encounters with the CFO, he respects and likes him; however, the CFO has not been with his company long. One day over lunch, the CEO learns from a colleague that the CFO has accepted a bribe. "Impossible," says the CEO. "He is not like that. He would not do such a thing!" Because of the CEO's high need for closure, he stays with his established impressions and does not even consider the possibility that the CFO has acted illegally. Within an organization, if coworkers ignore, justify, or condone unethical behavior, this supports the view of the transgressor that he or she did not do anything wrong or, if they did, that it is not that big a deal. Coworkers with a high need for closure can potentially cling to established impressions and, in so doing, discount unethical behavior.

Defensive Traps
Defensive traps are a very different category. Although some of them can, at times, be counted as primary traps, defensive traps are basically attempts to find easy ways to reverse course after a transgression has been committed. For the most part, defensive traps are maneuvers that are reactions to two internal stimuli: guilt and shame. Guilt and especially shame are very painful emotions because they call into question the positive view that people have of themselves. Defensive traps are insidious because they are often very successful at annihilating or at least minimizing guilt and shame. They help people deny their transgressions, thus setting them up for repeated unethical behavior. An example of a defensive trap is the "False Consensus Effect." Consider this example: Thomas Gabor, professor of criminology at the University of Ottawa, interviewed employees that had illegally stolen equipment and materials from their jobs. A common rationalization was exemplified by the following employee's statement:

"We are as good as management. They commit employee theft. Everybody does it. If I don't take it, someone else will."[5] Psychologists call this type of rationalization the "False Consensus Effect." When people do something unethical, they appease their guilt by falsely assuming that it is something everyone does, and thereby minimize their transgressions"It's not that bad; it's something that happens all the time!" The insidious thing about the false consensus effect (as with most other traps) is that the person actually believes his or her own self-deception. Gina Agostinelli conducted an interesting experiment at the University of New Mexico that validated the false consensus effect.[6] Two-hundred-and-thirty-five subjects participated in her study, and these subjects were randomly assigned to either two conditions: a failure condition or a neutral condition. Agostinelli administered a test that was described as a "decision-making problem that many career centers use to help companies hire employeesa valid indicator of future job success that measured general problem-solving abilities under time pressure." Following the test, subjects relegated to the failure condition were given false feedback: "Your score is poor and indicates that you are not good at solving problems under time pressure and cannot make important decisions efficiently." Subjects in the neutral condition were given no feedback. All subjects were then given a questionnaire that asked them to estimate how well the general public would do on the problem-solving test. The magnitude of the false consensus effect was impressive. In the neutral condition, 40 percent of subjects estimated that the public would be successful with the problem-solving test. In the failure condition, subjects estimated that only 15 percent of the public would be successful! Subjects who "failed" the test estimated that a large number of people would also fail the test, as in "If I fail, most people would."

Executive Tactics
How can a company create a corporate culture in which psychological traps are less likely to nudge managers and employees toward unethical behavior? Let us focus on the three traps that were used as examples: "Obedience to Authority," "Need for Closure," and the "False Consensus Effect."

Photo: Cat Obedience to Authority

When trying to keep the trap of obedience to authority at bay, the most important thing an executive can do is to hire a psychologist to be part of his or her ethics and compliance team. Psychology can explain the nature of traps and often help structure the proper approach to avoiding or remediating them. Joseph Badaracco, an ethics professor at Harvard Business School, conducted 30 extensive interviews with recent MBA graduates who had faced ethical dilemmas in the business world.[7] Many of the Harvard managers interviewed in Badaracco's study confronted the trap of obedience to authoritythey had been overtly told to act unethically by their bosses. One manager was instructed "to make up data to support a new product introduction." When he objected, his boss cut him off and said, "Just do it." When ordered to act unethically, these entry-level managers experienced intense anxiety. If they did not obey, they worried that they would lose their boss' support, which was crucial to being perceived as "a candidate for the fast track and a team player." Ultimately, employees worried about destroying their careers and losing their jobs.[8] The crucial problem these managers faced was the intense anxiety that resulted from the obedience to authority trap. Emotions can bring people to their knees, and many of the traps incite powerful emotions that pull a person toward wrongdoing. The managers were able to cope with their anxiety by reassuring themselves that they were still young and their careers were just beginning. They told themselves that they could always find work in another company if being ethical resulted in the loss of their jobs. For the most part, the managers were able to resolve their dilemmas because of this flexibility. The managers acknowledged, however, that had they been older, with families and invested status in the company, finding new employment would have been a much less likely option. So, what about middle managers who do not have this flexibility, who have spent years climbing the corporate ladder and have a family to support. What do they do when intense anxiety hits? If middle managers are in a company that has a psychologist as part of its ethics team, the psychologist can help them cope with their anxiety when confronted with the trap of obedience to authority, as psychologists are well trained to mitigate intense anxiety. Need for Closure Psychological traps are insidious because they are often invisible. Managers with a high need for closure, for instance, are usually neither aware of having such a trait nor that it might lead them to disregard the unethical behavior of their coworkers. If managers know that they have a high need for closure and are aware of its implications, they are more likely to avoid being trapped. To contend with the need for closure, the most important thing an executive can do is to have a psychologist administer the "Need for Closure Scale" so that managers and

employees are aware of whether they have a personality trait that might incline them to act unethically. False Consensus Effect This trap is easily identifiableit basically sounds like: "What I (or we) did is not bad; it's something that everybody does." Once the company is aware of the false consensus effect, it is a signal that a transgression has already been committed. In such cases, established reporting and disciplinary procedures that are usually part of the companys code of business conduct and ethics should come into play.

Conclusion
Because there are more traps than the three outlined in this article, there will likely be more than three tactics developed to deal with these traps. Nonetheless, the authors have identified the following tactics as universally important: 1. Employ a psychologist to help coworkers contend with the strong emotions incited by traps; 2. Ensure that the psychologist tests coworkers to make them aware of potential personality traps; and 3. Recognize defensive traps as signs that transgressions have already been committed. It should also be noted that one's behavior can be affected by more than one trap simultaneously. Developing tactics to manage traps is an ongoing challenge, especially as more traps are discovered. But the fact that traps accurately define the root causes of unethical behavior will make this task easier and the solutions more effective and efficient. Corporate social responsibility: Corporate social responsibility (CSR), also known as corporate responsibility, corporate citizenship, responsible business, sustainable responsible business (SRB), or corporate social performance,[1] is a form of corporate self-regulation integrated into a business model. Ideally, CSR policy would function as a built-in, self-regulating mechanism whereby business would monitor and ensure its adherence to law, ethical standards, and international norms. Business would embrace responsibility for the impact of their activities on the environment, consumers, employees, communities, stakeholders and all other members of the public sphere. Furthermore, business would proactively promote the public interest by encouraging community growth and development, and voluntarily eliminating practices that harm the public sphere, regardless of legality. Essentially, CSR is the deliberate inclusion of public interest into corporate decisionmaking, and the honoring of a triple bottom line: People, Planet, Profit. The practice of CSR is subject to much debate and criticism. Proponents argue that there is a strong business case for CSR, in that corporations benefit in multiple ways by operating

with a perspective broader and longer than their own immediate, short-term profits. Critics argue that CSR distracts from the fundamental economic role of businesses; others argue that it is nothing more than superficial window-dressing; others yet argue that it is an attempt to pre-empt the role of governments as a watchdog over powerful multinational corporations. Corporate Social Responsibility has been redefined throughout the years. However, it essentially is titled to aid to an organization's mission as well as a guide to what the company stands for and will uphold to its consumers. Development Business ethics is one of the forms of applied ethics that examines ethical principles and moral or ethical problems that can arise in a business environment. In the increasingly conscience-focused marketplaces of the 21st century, the demand for more ethical business processes and actions (known as ethicism) is increasing. Simultaneously, pressure is applied on industry to improve business ethics through new public initiatives and laws (e.g. higher UK road tax for higher-emission vehicles). Business ethics can be both a normative and a descriptive discipline. As a corporate practice and a career specialization, the field is primarily normative. In academia, descriptive approaches are also taken. The range and quantity of business ethical issues reflects the degree to which business is perceived to be at odds with non-economic social values. Historically, interest in business ethics accelerated dramatically during the 1980s and 1990s, both within major corporations and within academia. For example, today most major corporate websites lay emphasis on commitment to promoting non-economic social values under a variety of headings (e.g. ethics codes, social responsibility charters). In some cases, corporations have re-branded their core values in the light of business ethical considerations (e.g. BP's "beyond petroleum" environmental tilt). The term CSR came in to common use in the early 1970s, after many multinational corporations formed, although it was seldom abbreviated. The term stakeholder, meaning those on whom an organization's activities have an impact, was used to describe corporate owners beyond shareholders as a result of an influential book by R Freeman in 1984. Potential business benefits: The scale and nature of the benefits of CSR for an organization can vary depending on the nature of the enterprise, and are difficult to quantify, though there is a large body of literature exhorting business to adopt measures beyond financial ones (e.g., Deming's Fourteen Points, balanced scorecards). Orlitzky, Schmidt, and Rynes[7] found a correlation between social/environmental performance and financial performance. However, businesses may not be looking at short-run financial returns when developing their CSR strategy. The definition of CSR used within an organization can vary from the strict "stakeholder impacts" definition used by many CSR advocates and will often include charitable efforts and volunteering. CSR may be based within the human resources, business development or public relations departments of an organisation,[8] or may be given a separate unit reporting

to the CEO or in some cases directly to the board. Some companies may implement CSRtype values without a clearly defined team or programme. The business case for CSR within a company will likely rest on one or more of these arguments:

Human resources
A CSR programme can be an aid to recruitment and retention,[9] particularly within the competitive graduate student market. Potential recruits often ask about a firm's CSR policy during an interview, and having a comprehensive policy can give an advantage. CSR can also help improve the perception of a company among its staff, particularly when staff can become involved through payroll giving, fundraising activities or community volunteering.

Risk management
Managing risk is a central part of many corporate strategies. Reputations that take decades to build up can be ruined in hours through incidents such as corruption scandals or environmental accidents. These can also draw unwanted attention from regulators, courts, governments and media. Building a genuine culture of 'doing the right thing' within a corporation can offset these risks.[10]

Brand differentiation
In crowded marketplaces, companies strive for a unique selling proposition that can separate them from the competition in the minds of consumers. CSR can play a role in building customer loyalty based on distinctive ethical values.[11] Several major brands, such as The Co-operative Group, The Body Shop and American Apparel[12] are built on ethical values. Business service organizations can benefit too from building a reputation for integrity and best practice.

License to operate
Corporations are keen to avoid interference in their business through taxation or regulations. By taking substantive voluntary steps, they can persuade governments and the wider public that they are taking issues such as health and safety, diversity, or the environment seriously as good corporate citizens with respect to labour standards and impacts on the environment. Criticisms and concerns:

CSR and the nature of business


Milton Friedman and others have argued that a corporation's purpose is to maximize returns to its shareholders, and that since (in their view), only people can have social responsibilities, corporations are only responsible to their shareholders and not to society as

a whole. Although they accept that corporations should obey the laws of the countries within which they work, they assert that corporations have no other obligation to society. Some people perceive CSR as incongruent with the very nature and purpose of business, and indeed a hindrance to free trade. Those who assert that CSR is incongruent with capitalism and are in favor of neoliberalism argue that improvements in health, longevity and/or infant mortality have been created by economic growth attributed to free enterprise.
[13]

Critics of this argument perceive neoliberalism as opposed to the well-being of society and a hindrance to human freedom. They claim that the type of capitalism practiced in many developing countries is a form of economic and cultural imperialism, noting that these countries usually have fewer labor protections, and thus their citizens are at a higher risk of exploitation by multinational corporations.[14] A wide variety of individuals and organizations operate in between these poles. For example, the REALeadership Alliance asserts that the business of leadership (be it corporate or otherwise) is to change the world for the better.[15] Many religious and cultural traditions hold that the economy exists to serve human beings, so all economic entities have an obligation to society (e.g., cf. Economic Justice for All). Moreover, as discussed above, many CSR proponents point out that CSR can significantly improve long-term corporate profitability because it reduces risks and inefficiencies while offering a host of potential benefits such as enhanced brand reputation and employee engagement.