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CORPORATE

GOVERNANCE

CONTENTS
1. Meaning 2. Corporate Governance models around the World i. Continental Europe ii. India iii. The United States ad UK 3. Corporate Governance in India-a background 4. Principles of Corporate Governance 5. Organizational framework 6. A case study of Corporate Governance-SATYAM i. Role of Board of Directors ii. Directors remuneration iii. Audit committee iv. Shareholders committee v. Conclusion 7. Future prospects 8. Bibliography 1 2

4 6 7 8 10 11 12 13 14 16

Meaning
Corporate governance is "the system by which companies are directed and controlled". It involves a set of relationships between a companys management, its board, its shareholders and other stakeholders; it deals with prevention or mitigation of the conflict of interests of stakeholders. Ways of mitigating or preventing these conflicts of interests include the processes, customs, policies, laws, and institutions which have impact on the way a company is controlled. An important theme of corporate governance is the nature and extent of accountability of people in the business, and mechanisms that try to decrease the principalagent problem. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. In contemporary business corporations, the main external stakeholder groups are shareholders, debt holders, trade creditors, suppliers, customers and communities affected by the corporation's activities. Internal stakeholders are the board of directors, executives, and other employees. It guarantees that an enterprise is directed and controlled in a responsible, professional, and transparent manner with the purpose of safeguarding its long-term success. It is intended to increase the confidence of shareholders and capital-market investors. There has been renewed interest in the corporate governance practices of modern corporations since 2001, particularly due to the high-profile collapses of a number of large corporations, most of which involved accounting fraud. Corporate scandals of various forms have maintained public and political interest in the regulation of corporate governance. In the U.S., these include Enron Corporation and MCI Inc. (formerly WorldCom). Their demise is associated with the U.S. federal government passing the Sarbanes-Oxley Act in 2002, intending to restore public confidence in corporate governance. Comparable failures in Australia (HIH, One.Tel) are associated with the eventual passage of the CLERP 9 reforms. Similar corporate failures in other countries stimulated increased regulatory interest (e.g., Parmalat in Italy).

Corporate Governance models around the World


There are many different models of corporate governance around the world. These differ according to the variety of capitalism in which they are embedded. The Anglo-American "model" tends to emphasize the interests of shareholders. The coordinated or multi-stakeholder model associated with Continental Europe and Japan also recognizes the interests of workers, managers, suppliers, customers, and the community.

Continental Europe
Some continental European countries, including Germany and the Netherlands, require a two-tiered Board of Directors as a means of improving corporate governance. In the two-tiered board, the Executive Board, made up of company executives, generally runs day-to-day operations while the supervisory board, made up entirely of non-executive directors who represent shareholders and employees, hires and fires the members of the executive board, determines their compensation, and reviews major business decisions.

India
India's SEBI Committee 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." It has been suggested that the Indian approach is drawn from the Gandhian principle of trusteeship and the Directive Principles of the Indian Constitution, but this conceptualization of corporate objectives is also prevalent in Anglo-American and most other jurisdictions.

The United States and the UK


The so-called "Anglo-American model" (also known as "the unitary system") emphasizes a single-tiered Board of Directors composed of a mixture of executives from the company and non-executive directors, all of whom are elected by

shareholders. Non-executive directors are expected to outnumber executive directors and hold key posts, including audit and compensation committees. The United States and the United Kingdom differ in one critical respect with regard to corporate governance: In the United Kingdom, the CEO generally does not also serve as Chairman of the Board, whereas in the US having the dual role is the norm, despite major misgivings regarding the impact on corporate governance. In the United States, corporations are directly governed by state laws, while the exchange (offering and trading) of securities in corporations (including shares) is governed by federal legislation. Many U.S. states have adopted the Model Business Corporation Act, but the dominant state law for publicly-traded corporations is Delaware, which continues to be the place of incorporation for the majority of publicly-traded corporations. Individual rules for corporations are based upon the corporate charter and, less authoritatively, the corporate bylaws. Shareholders cannot initiate changes in the corporate charter although they can initiate changes to the corporate bylaws.

Corporate Governance in India a background


The history of the development of Indian corporate laws has been marked by interesting contrasts. At independence, India inherited one of the worlds poorest economies but one which had a factory sector accounting for a tenth of the national product; four functioning stock markets (predating the Tokyo Stock Exchange) with clearly defined rules governing listing, trading and settlements; a welldeveloped equity culture if only among the urban rich; and a banking system replete with well-developed lending norms and recovery procedures. In terms of corporate laws and financial system, therefore, India emerged far better endowed than most other colonies. The 1956 Companies Act as well as other laws governing the functioning of joint-stock companies and protecting the investors rights built on this foundation. The beginning of corporate developments in India were marked by the managing agency system that contributed to the birth of dispersed equity ownership but also gave rise to the practice of management enjoying control rights disproportionately greater than their stock ownership. The turn towards socialism in the decades after independence marked by the 1951 Industries (Development and Regulation) Act as well as the 1956 Industrial Policy Resolution put in place a regime and culture of licensing, protection and widespread red-tape that bred corruption and stilted the growth of the corporate sector. The situation grew from bad to worse in the following decades and corruption, nepotism and inefficiency became the hallmarks of the Indian corporate sector. Exorbitant tax rates encouraged creative accounting practices and complicated emolument structures to beat the system. In the absence of a developed stock market, the three all-India development finance institutions (DFIs) the Industrial Finance Corporation of India, the Industrial Development Bank of India and the Industrial Credit and Investment Corporation of India together with the state financial corporations became the main providers of long-term credit to companies. Along with the government owned mutual fund, the Unit Trust of India, they also held large blocks of shares in the companies they lent to and invariably had representations in their boards. In this respect, the corporate governance system resembled the bank-based German model where these institutions could have played a big role in keeping their clients on the right track. Unfortunately, they were themselves evaluated on the quantity

rather than quality of their lending and thus had little incentive for either proper credit appraisal or effective follow-up and monitoring. Their nominee directors routinely served as rubber-stamps of the management of the day. With their support, promoters of businesses in India could actually enjoy managerial control with very little equity investment of their own. Borrowers therefore routinely recouped their investment in a short period and then had little incentive to either repay the loans or run the business. Frequently they bled the company with impunity, siphoning off funds with the DFI nominee directors mute spectators in their boards. This sordid but increasingly familiar process usually continued till the companys net worth was completely eroded. This stage would come after the company has defaulted on its loan obligations for a while, but this would be the stage where Indias bankruptcy reorganization system driven by the 1985 Sick Industrial Companies Act (SICA) would consider it sick and refer it to the Board for Industrial and Financial Reconstruction (BIFR). As soon as a company is registered with the BIFR it wins immediate protection from the creditors claims for at least four years. Between 1987 and 1992 BIFR took well over two years on an average to reach a decision, after which period the delay has roughly doubled. Very few companies have emerged successfully from the BIFR and even for those that needed to be liquidated, the legal process takes over 10 years on average, by which time the assets of the company are practically worthless. Protection of creditors rights has therefore existed only on paper in India. Given this situation, it is hardly surprising that banks, flush with depositors funds routinely decide to lend only to blue chip companies and park their funds in government securities. Boards of directors have been largely ineffective in India in monitoring the actions of management. They are routinely packed with friends and allies of the promoters and managers, in flagrant violation of the spirit of corporate law. The nominee directors from the DFIs, who could and should have played a particularly important role, have usually been incompetent or unwilling to step up to the act. Consequently, the boards of directors have largely functioned as rubber stamps of the management. For most of the post-Independence era the Indian equity markets were not liquid or sophisticated enough to exert effective control over the companies. Listing requirements of exchanges enforced some transparency, but non-compliance was neither rare nor acted upon. All in all therefore, minority shareholders and creditors in India remained effectively unprotected in spite of a plethora of laws in the books.

Principles of Corporate Governance


Contemporary discussions of corporate governance tend to refer to principles raised in three documents released since 1990: The Cadbury Report (UK, 1992), the Principles of Corporate Governance (OECD, 1998 and 2004), the SarbanesOxley Act of 2002 (US, 2002). The Cadbury and OECD reports present general principals around which businesses are expected to operate to assure proper governance. The Sarbanes-Oxley Act, informally referred to as Sarbox or Sox, is an attempt by the federal government in the United States to legislate several of the principles recommended in the Cadbury and OECD reports. 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 openly and effectively communicating information and by encouraging shareholders to participate in general meetings. Interests of other stakeholders: Organizations should recognize that they have legal, contractual, social, and market driven obligations to nonshareholder stakeholders, including employees, investors, creditors, suppliers, local communities, customers, and policy makers. Role and responsibilities of the board: The board needs sufficient relevant skills and understanding to review and challenge management performance. It also needs adequate size and appropriate levels of independence and commitment Integrity and ethical behavior: Integrity should be a fundamental requirement in choosing corporate officers and board members. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide stakeholders 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.

Organizational Framework
The organizational framework for corporate governance initiatives in India consists of the Ministry of Corporate Affairs (MCA) and the Securities and Exchange Board of India (SEBI). The first formal regulatory framework for listed companies specifically for corporate governance was established by the SEBI in February 2000, following the recommendations of Kumarmangalam Birla Committee Report. It was enshrined as Clause 49 of the Listing Agreement. Thereafter SEBI had set up another committee under the chairmanship of Mr. N. R. Narayana Murthy, to review Clause 49, and suggest measures to improve corporate governance standards. Some of the major recommendations of the committee primarily related to audit committees, audit reports, independent directors, related party transactions, risk management, directorships and director compensation, codes of conduct and financial disclosures. The Ministry of Corporate Affairs had also appointed a Naresh Chandra Committee on Corporate Audit and Governance in 2002 in order to examine various corporate governance issues. It made recommendations in two key aspects of corporate governance: financial and non-financial disclosures: and independent auditing and board oversight of management. It had also set up a National Foundation for Corporate Governance (NFCG) in association with the CII, ICAI and ICSI as a not-for-profit trust to provide a platform to deliberate on issues relating to good corporate governance, to sensitize corporate leaders on the importance of good corporate governance practices as well as to facilitate exchange of experiences and ideas amongst corporate leaders, policy makers, regulators, law enforcing agencies and non- government organization

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A Case Study of Corporate Governance- SATYAM


Corporate governance has most recently been debated after the corporate fraud by Satyam founder and Chairman Ramalinga Raju. In fact, trouble started brewing at Satyam around December 16 when Satyam announced its decision to buy stakes in Maytas Properties and Infrastructure for $1.3 billion. The deal was soon called off owing to major discontentment on the part of shareholders and plummeting shareprice. However, in what has been seen as one of the largest corporate frauds in India, Raju confessed that the profits in the Satyam books had been inflated and that the cash reserve with the company was minimal. Ironically, Satyam had received the Golden Peacock Global Award for Excellence in Corporate Governance in September 2008 but was stripped of it soon after Raju's confession.

ROLE OF BOARD OF DIRECTORS


An independent and effective board is entrusted with the responsibility of guiding and monitoring the activities of Management to ensure safeguarding of interests of all the stakeholders. Since Satyam had an Executive Director as its Chairman. At least half its board should have comprised of Independent Directors. Of the total of 10 Directors Satyam had 6 Independent Directors.

Ideally Non-Executive Directors exercise independent judgment in matters of


corporate practices and performance.

In reality Satyam was very much a promoter-controlled, owner driven paradigm.


In a country largely indifferent to Corporate Governance practices Independent Directors are appointed at the whims of CEO.

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DIRECTORS AT SATYAM
Director Ramalinga Raju Rama Raju Category Executive Executive Designation
Chairman Managing Director President & Whole-Time Director

Meetings Held
4

Meetings Attended 4 4

Member In Other Boards 2 3

Ram Whole Time Mynampati Employment VP Rama Rao Mangalam Srinivasan Krishna G Palepu Vinod Dham Rammohan Rao Ts Prasad Vs Raju Independent Non Exec Independent Non Exec Non Exec Independent Non Exec Independent Non Exec Ditto Ditto

4 4 4 4 4 4 -

2 3 3 3 3 4 -

3 3 1 3 7 5 -

Director Director

Director Director

Director

Director

Director

INFERENCE
From the table above its quite self evident that none of the Independent Directors barring one had attended all the meetings. Moreover, all the Independent Directors form part of Board of another company also. This makes it almost impossible for them to exercise due diligence while monitoring the work of management. Despite the concept of having Independent Non Executive Directors being a well thought out step in the right direction by SEBI. It did not work out practically.

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Directors Remuneration
IDEALLY According to the SEBI Code on Corporate Governance, the
remuneration of Non-Executive Directors shall be decided by the board of directors. The code also specifies that full disclosure should be made regarding the elements of remuneration package, incentives, service contracts and Stock Options.

SATYAM
Particulars Commission Sitting Fee Prof. Fee TOTAL(Rs.) VP Rama Rao 12,00,000 1,30,000 13,30,000 Ram Mynampati 12,00,000 80,000 12,80,000 Krishna G Palepu 12,00,000 30,000 87,18,000 99,48,000 Vinod K Dham 12,00,000 40,000 12,40,000 Rammohan Rao 12,00,000 1,50,000 13,50,000

INFERENCE
It is often argued that the meager remuneration of Independent directors doesnt impel them enough to reasonably dedicate themselves to the cause of stakeholders of the company. But even a cursory look at the table above is enough to make it clear that a person drawing Rs. One Crore a year would not turn a blind eye towards the matters of concern. Although, the manner in which Raju framed his confession giving clean chit to the Independent directors has made it impossible to nail any one of them.

BUT STILL
Says Andrew Holland, CEO, equities, Ambit Capital,

"Independent directors should also (in addition to the management) be


held accountable for board decisions and audit-related compliance practices."

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Audit Committee
DRAFT BILL COMPANIES ACT 1997
Audit committee can improve the quality of financial reporting by reviewingthe financial statements, creating a climate of discipline and control andreducing the opportunity for fraud. It provides communication link with external auditor and strengthens theInternal Audit Function.

SATYAM
Composition and other details 1. Mr. V P Rama Rao, Chairman 2. Dr. (Mrs.) Mangalam Srinivasan, Member 3. Prof. M Rammohan Rao, Member During the year, the Audit committee met 8 times. Mr. V P Rama Rao attended seven meetings, Dr. (Mrs.) Mangalam Srinivasan attended four meetings and Prof. M Rammohan Rao attended all the meetings. The meetings of the Audit committee were attended by the Head of Finance,Head of Internal Audit and Statutory Auditors as invitees. The quarterly and annual audited financial statements of the Company were reviewed by the Audit committee before consideration and approval by the Board of directors. The Audit committee reviewed the adequacy of internal control systems and internal audit reports and their compliance thereof. INFERENCE Raju confessed that Satyam's balance sheet as of the September 30, 2008,carried inflated figures for cash and bank balances of INR 5,040 crore (as against INR5,361 crore reflected in the books). It carried an accrued interest of INR 376 crore which was non-existent. An understated liability of INR 1,230 crore on account of funds was arranged by himself. An overstated debtors' position of INR 490 crore (as against INR 2,651 crore in the books).He claimed that none of the board members had any knowledge of the situation in which the company was placed. While all this seems highly unlikely in the wake of a functioning Audit Committee. This throws open question marks not only on diligence but on the very purpose of Audit Committee. The extent of negligence on their part was such that they failed to verify the existence of cash balance. Such a scenario begs for greater transparency and accountability in the dealings.

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Share Holders Committee


SEBIs CODE
SEBIs Code for Corporate Governance provides for constitution of shareholders committee under the chairmanship of a non-executive director to ensure that the grievances of shareholders are properly received and solved.

SATYAM
In 2008, Satyam attempted to acquire two infrastructure companies founded by family members of company founder Ramalinga Raju (Maytas Infrastructure and Maytas Properties ) - for $1.6 billion, despite concerns raised by independent board directors. Both companies are owned by Raju's sons. All this was done without consent of shareholders. Satyam's investors lost about INR 3,400 crore in the related panic selling. The USD $1.6 billion (INR 8,000 crore) acquisition was met with skepticism as Satyam's shares fell 55% on the New York Stock Exchange. Three members of the board of directors resigned on Monday 29th Dec 2008.

RAMIFICATIONS
Institutional investors have the tools, bandwidth and clout to extract information and play an activist role (as had happened in Satyam's case) in ensuring that managements don't go off-track. But the retail shareholders whose consent wasnt even sought before Raju went ahead with the Maytas deal are the ones who are the real sufferers but are still indifferent about corporate governance; the Satyam episode will probably highlight the need to weigh this aspect. In such a scenario establishing minority shareholders' groups can also be a positive step. Individual shareholders through these groups can communicate with institutional shareholders for taking up their concerns with the company's management.

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Conclusion
Raju Riding a Tiger
While the corporate governance framework in the country is seen at par with other developed markets, the same has to be implemented in 'letter as well as spirit. The fact that white collar crime continues to occur, and seemingly at an increasing rate, suggests that the expected costs do not outweigh the expected benefits from cheating. Stronger penalties are needed. At the end of the day, the actions at Satyam were perpetrated by one or two individuals who simply may not have realized that the small distortions they created in the past would lead to massive problems today. Hopefully, creating an awareness of the large consequences of small lies may help some to avoid this trap. After all this is what Raju had to Say in his Confession: -

"What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years . . .. . . . . It was like riding a tiger, not knowing how to get off without being eaten.

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Future Prospects
The issues of governance, accountability and transparency in the affairs of the company, as well as about the rights of shareholders and role of Board of Directors have never been as prominent as it is today. The corporate governance has come to assume a centre stage in the Board room discussions. India has become one of the fastest emerging nations to have aligned itself with the international trends in Corporate Governance. As a result, Indian companies have increasingly been able to access to newer and larger markets around the world; as well as able to acquire more businesses. The response of the Government and regulators has also been admirably quick to meet the challenges of corporate delinquency. But, as the global environment changing continuously, there is a greater need of adopting and sustaining good corporate governance practices for value creation and building corporations of the future. It is true that the 'corporate governance' has no unique structure or design and is largely considered ambiguous. There is still lack of awareness about its various issues, like, quality and frequency of financial and managerial disclosure, compliance with the code of best practice, roles and responsibilities of Board of Directories, shareholders rights, etc. There have been many instances of failure and scams in the corporate sector, like collusion between companies and their accounting firms, presence of weak or ineffective internal audits, lack of required skills by managers, lack of proper disclosures, non-compliance with standards, etc. As a result, both management and auditors have come under greater scrutiny. But, with the integration of Indian economy with global markets, industrialists and corporates in the country are being increasingly asked to adopt better and transparent corporate practices. The degree to which corporations observe basic principles of good corporate governance is an increasingly important factor for taking key investment decisions. If companies are to reap the full benefits of the global capital market, capture efficiency gains, benefit by economies of scale and attract long term capital, adoption of corporate governance standards must be credible, consistent, coherent and inspiring. Quality of corporate governance primarily depends on following factors, namely:integrity of the management; ability of the Board; adequacy of the processes; commitment level of individual Board members; quality of corporate reporting; participation of stakeholders in the management; etc. Since this is an important element affecting the long-term financial health of companies, good governance

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framework also calls for effective legal and institutional environment, business ethics and awareness of the environmental and societal interests. Hence, in the years to come, corporate governance will become more relevant and a more acceptable practice worldwide. This is easily evident from the various activities undertaken by many companies in framing and enforcing codes of conduct and honest business practices; following more stringent norms for financial and non-financial disclosures, as mandated by law; accepting higher and appropriate accounting standards; enforcing tax reforms coupled with deregulation and competition; etc. However, inapt application of corporate governance requirements can adversely affect the relationship amongst participants of the governance system. As owners of equity, institutional investors are increasingly demanding a decisive role in corporate governance. Individual shareholders, who usually do not exercise governance rights, are highly concerned about getting fair treatment from controlling shareholders and management. Creditors, especially banks, play a key role in governance systems, and serve as external monitors over corporate performance. Employees and other stakeholders also play an important role in contributing to the long term success and performance of the corporation. Thus, it is necessary to apply governance practices in a right manner for better growth of a company.

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Bibliography
1. 2. 3. 4. 5. 6. http://www.scribd.com http://business.gov.in http://corpgov.proxyexchange.org http://en.wikipedia.org http://articles.economictimes.indiatimes.com http://www.slideworld.com