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There has been renewed interest in the corporate governance practices of modern corporations, particularly in relation to accountability, since the high!profile collapses of a number of large corporations during "##$%"##", most of which involved accounting fraud. Corporate scandals of various forms have maintained public and political interest in the regulation of corporate governance. &n the '.(., these include )nron Corporation and *C& &nc. (formerly +orldCom). Their demise is associated with the '.(. federal government passing the (arbanes!, ley -ct in "##", intending to restore public confidence in corporate governance. Comparable failures in -ustralia (.&., ,ne.Tel) are associated with the eventual passage of the C/)01 2 reforms. (imilar corporate failures in other countries stimulated increased regulatory interest (e.g., 1armalat in &taly). Corporate governance has also been defined as 3a system of law and sound approaches by which corporations are directed and controlled focusing on the internal and e ternal corporate structures with the intention of monitoring the actions of management and directors and thereby mitigating agency risks which may stem from the misdeeds of corporate officers. &n contemporary business corporations, the main e ternal stakeholder groups are shareholders,
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Corporate Governance
debt holders, trade creditors, suppliers, customers and communities affected by the corporation4s activities. &nternal stakeholders are the board of directors, e ecutives, and other employees. *uch of the contemporary interest in corporate governance is concerned with mitigation of the conflicts of interests between stakeholders. +ays of mitigating or preventing these conflicts of interests include the processes, customs, policies, laws, and institutions which have an impact on the way a company is controlled. -n important theme of governance is the nature and e tent of corporate accountability. - related but separate thread of discussions focuses on the impact of a corporate governance system on economic efficiency, with a strong emphasis on shareholders4 welfare. &n large firms where there is a separation of ownership and management and no controlling shareholder, the principal%agent issue arises between upper!management (the 3agent3) which may have very different interests, and by definition considerably more information, than shareholders (the 3principals3). The danger arises that rather than overseeing management on behalf of shareholders, the board of directors may become insulated from shareholders and beholden to management. This aspect is particularly present in contemporary public debates and developments in regulatory policy. )conomic analysis has resulted in a literature on the subject. ,ne source defines corporate governance as 3the set of conditions that shapes the e post bargaining over the 5uasi! rents generated by a firm.3The firm itself is modeled as a governance structure acting through the mechanisms of contract. .ere corporate governance may include its relation to corporate finance.
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Corporate Governance
Rig t! an" e#$ita%&e treat'ent o( ! are o&"er!6 ,rgani;ations should respect the rights of shareholders and help shareholders to e ercise those rights. They can help shareholders e ercise their rights by openly and effectively communicating information and by encouraging shareholders to participate in general meetings.
Intere!t! o( ot er !ta)e o&"er!6 ,rgani;ations should recogni;e that they have legal, contractual, social, and market driven obligations to non!shareholder stakeholders, including employees, investors, creditors, suppliers, local communities, customers, and policy makers.
Ro&e an" re!pon!i%i&itie! o( t e %oar"6 The board needs sufficient relevant skills and understanding to review and challenge management performance. &t also needs ade5uate si;e and appropriate levels of independence and commitment.
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Corporate Governance
Integrit* an" et ica& %e avior6 &ntegrity should be a fundamental re5uirement in choosing corporate officers and board members. ,rgani;ations should develop a code of conduct for their directors and e ecutives that promotes ethical and responsible decision making. Di!c&o!$re an" tran!parenc*6 ,rgani;ations 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 company4s financial reporting. 8isclosure of material matters concerning the organi;ation should be timely and balanced to ensure that all investors have access to clear, factual information.
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Corporate Governance
&t lays down the framework for creating long!term trust between companies and the e ternal providers of capital. &t improves strategic thinking at the top by inducting independent directors who bring a wealth of e perience, and a host of new ideas
&t rationali;es the management and monitoring of risk that a firm faces globally &t limits the liability of top management and directors, by carefully articulating the decision making process
&t has long term reputational effects among key stakeholders, both internally (employees) and e ternally (clients, communities, political=regulatory agents)
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Good governance is integral to the very e istence of a company. &t inspires and strengthens investor?s confidence by ensuring company?s commitment to higher growth and profits. &t seeks to achieve following objectives6
That a properly structured @oard capable of taking independent and objective decisions is in place at the helm of affairsA That the @oard is balanced as regards the representation of ade5uate number of non! e ecutive who will take care of the interests and well!being of the independent directors and all the stakeholdersA
That the @oard adopts transparent procedures and practices and arrives at decisions on the strength of ade5uate informationA
That the @oard has an effective machinery to sub serve the concerns of stakeholdersA That the @oard keeps the shareholders informed of relevant developments impacting the companyA
That the @oard effectively and regularly monitors the functioning of the management team, and
That the @oard remains in effective control of the affairs of the company at all times, The overall endeavor of the @oard should be to take the organi;ation forward to ma imi;e long!term value and shareholders? wealth.
Corporate Governance
Corporate Governance
-oar" in"epen"ence1 &ndependent @oard is essential for sound corporate governance. This goal may be achieved by associating sufficient number of independent directors with the board. &ndependence of directors would ensure that there are no actual or perceived conflicts of interest. Co"e o( con"$ct6 &t is essential that the organi;ation?s e plicitly prescribed norms of ethical practices and code of conduct are communicated to all stakeholders and are clearly understood and followed by each member of the organi;ation. (ystems should be in place to periodically measure adherence to code of conduct and the adherence should be periodically evaluated and if possible recogni;ed. Strateg* !etting6 The objectives of the company must be clearly documented in a long!term corporate strategy and an annual business plan together with achievable and measurable performance targets and milestones. -$!ine!! an" co''$nit* con!$&tation6 Though basic activity of a business entity is inherently commercial yet it must also take care of community?s obligations. Commercial objectives and community service obligations should be clearly documented after approval by the @oard. The stakeholders must be informed about the proposed and ongoing initiatives taken to meet social responsibility obligations. Financia& an" operationa& reporting6
Corporate Governance
The @oard re5uires comprehensive, regular, reliable, timely, correct and relevant information in a form and of a 5uality that is appropriate to discharge its function of monitoring corporate performance. A$"it Co''ittee!6 The -udit Committee is inter alia responsible for liaison with the managementA internal and statutory auditors, reviewing the ade5uacy of internal control and compliance with significant policies and procedures, reporting to the @oard on the key issues. The 5uality of -udit Committee significantly contributes to the governance of the company. Ri!) 'anage'ent6 0isk is an important element of corporate functioning and governance. There should be a clearly established process of identifying, analy;ing and treating risks, which could prevent the company from effectively achieving its objectives. Dor this purpose the company should subject itself to periodic e ternal and internal risk reviews. The above improves public understanding of the structure, activities and policies of the organi;ation. Conse5uently the organi;ation is able to attract investors, and to enhance the trust and confidence of the stakeholders.
Corporate Governance
Corporate governance mechanisms and controls are designed to reduce the inefficiencies that arise from moral ha;ard and adverse selection. There are both internal monitoring systems and e ternal monitoring systems. &nternal monitoring can be done, for e ample, by one (or a few) large shareholder(s) in the case of privately held companies or a firm belonging to a business group. Durthermore, the various board mechanisms provide for internal monitoring. ) ternal monitoring of managers4 behavior occurs when an independent third party (e.g. the e ternal auditor) attests the accuracy of information provided by management to investors. (tock analysts and debt holders may also conduct such e ternal monitoring. -n ideal monitoring and control system should regulate both motivation and ability, while providing incentive alignment toward corporate goals and objectives. Care should be taken that incentives are not so strong that some individuals are tempted to cross lines of ethical behavior, for e ample by manipulating revenue and profit figures to drive the share price of the company up. &t can be further controlled with the help of two methods 6 $. &nternal corporate governance controls
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Corporate Governance
&nternal corporate governance controls monitor activities and then take corrective action to accomplish organi;ational goals. ) amples include6
$. *onitoring by the board of directors6 The board of directors, with its legal authority to hire, fire and compensate top management, safeguards invested capital. 0egular board meetings allow potential problems to be identified, discussed and avoided. +hilst non!e ecutive directors are thought to be more independent, they may not always result in more effective corporate governance and may not increase performance. 8ifferent board structures are optimal for different firms. *oreover, the ability of the board to monitor the firm4s e ecutives is a function of its access to information. ) ecutive directors possess superior knowledge of the decision!making process and therefore evaluate top management on the basis of the 5uality of its decisions that lead to financial performance outcomes, e ante. &t could be argued, therefore, that e ecutive directors look beyond the financial criteria. ". &nternal control procedures and internal auditors6 &nternal control procedures are policies implemented by an entity4s 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. &nternal auditors are personnel within an organi;ation who test the design and implementation of the entity4s internal control procedures and the reliability of its financial reporting.
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Corporate Governance
<. @alance of power6 The simplest balance of power is very commonA re5uire that the 1resident 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 other4s actions. ,ne 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. :. 0emuneration6 1erformance!based remuneration is designed to relate some proportion of salary to individual performance. &t may be in the form of cash or non!cash payments such as shares and share options, superannuation or other benefits. (uch incentive schemes, however, are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behavior, and can elicit myopic behavior. >. *onitoring by large shareholders and=or monitoring by banks and other large creditors6 Given their large investment in the firm, these stakeholders have the incentives, combined with the right degree of control and power, to monitor the management. &n publicly traded '.(. corporations, boards of directors are largely chosen by the 1resident=C), and the 1resident=C), often takes the Chair of the @oard position for his=herself (which makes it much more difficult for the institutional owners to 3fire3 him=her). The practice of the C), also being the Chair of the @oard is fairly common in large -merican corporations. +hile this practice is common in the '.(., it is relatively rare elsewhere. &n the '.7., successive codes of best practice have recommended against duality.
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E3TERNAL CORPORATE GOVERNANCE CONTROLS ) ternal corporate governance controls encompass the controls e ternal stakeholders e ercise over the organi;ation. ) amples include6 Competition 8ebt Covenants 8emand for and assessment of performance information (especially financial statements) Government 0egulations *anagerial /abour *arket *edia 1ressure Takeovers
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Corporate Governance
CHAPTER 4 REGULATIONS
/egal environment % Corporations are created as legal persons by the laws and regulations of a particular jurisdiction. These may vary in many respects between countries, but a corporation4s legal person status is fundamental to all jurisdictions and is conferred by statute. This allows the entity to hold property in its own right without reference to any particular real person. &t also results in the perpetual e istence that characteri;es the modern corporation. The statutory granting of corporate e istence may arise from general purpose legislation (which is the general case) or from a statute to create a specific corporation, which was the only method prior to the $2th century. &n addition to the statutory laws of the relevant jurisdiction, corporations are subject to common law in some countries, and various laws and regulations affecting business practices. &n most jurisdictions, corporations also have a constitution that provides individual rules that govern the corporation and authori;e or constrain its decision!makers. This constitution is identified by a variety of termsA in )nglish!speaking jurisdictions, it is usually known as the Corporate Charter or the E*emorandumF and -rticles of -ssociation. The capacity of shareholders to modify the constitution of their corporation can vary substantially. The '.(. passed the Doreign Corrupt 1ractices -ct (DC1-) in $2CC, with subse5uent modifications. This law made it illegal to bribe government officials and re5uired
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corporations to maintain ade5uate accounting controls. &t is enforced by the '.(. 8epartment of Gustice and the (ecurities and ) change Commission (()C). (ubstantial civil and criminal penalties have been levied on corporations and e ecutives convicted of bribery. The '7 passed the @ribery -ct in "#$#. This law made it illegal to bribe either government or private citi;ens or make facilitating payments (i.e., payment to a government official to perform their routine duties more 5uickly). &t also re5uired corporations to establish controls to prevent bribery.
(ome continental )uropean countries, including Germany and the Hetherlands, re5uire a two!tiered @oard of 8irectors as a means of improving corporate governance. &n the two!tiered board, the ) ecutive @oard, made up of company e ecutives, generally runs day!to!day operations while the supervisory board, made up entirely of non!e ecutive directors who represent shareholders and employees, hires and fires the members of the e ecutive board, determines their compensation, and reviews major business decisions. &ndia &ndia4s ()@& Committee on Corporate Governance defines corporate governance as the 3acceptance by management of the inalienable rights of shareholders as the true owners
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of the corporation and of their own role as trustees on behalf of the shareholders. &t is about commitment to values, about ethical business conduct and about making a distinction between personal I corporate funds in the management of a company.3 &t has been suggested that the &ndian approach is drawn from the Gandhian principle of trusteeship and the 8irective 1rinciples of the &ndian Constitution, but this conceptuali;ation of corporate objectives is also prevalent in -nglo!-merican and most other jurisdictions.
The so!called 3-nglo!-merican model3 of corporate governance emphasi;es the interests of shareholders. &t relies on a single!tiered @oard of 8irectors that is normally dominated by non!e ecutive directors elected by shareholders. @ecause of this, it is also known as 3the unitary system3. +ithin this system, many boards include some e ecutives from the company (who are e officio members of the board). Hon!e ecutive directors are e pected to outnumber e ecutive directors and hold key posts, including audit and compensation committees. The 'nited (tates and the 'nited 7ingdom differ in one critical respect with regard to corporate governance6 &n the 'nited 7ingdom, the C), generally does not also serve as Chairman of the @oard, whereas in the '( having the dual role is the norm, despite major misgivings regarding the impact on corporate governance. &n the 'nited (tates, corporations are directly governed by state laws, while the e change (offering and trading) of securities in corporations (including shares) is governed by federal legislation. *any '( states have adopted the *odel @usiness Corporation -ct, but the dominant state law for publicly traded corporations is 8elaware, which continues to be the place of incorporation for the majority of publicly traded corporations. &ndividual rules for corporations are based upon the corporate charter and, less authoritatively, the corporate bylaws. (hareholders cannot initiate changes in the corporate charter although they can initiate changes to the corporate bylaws.
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Corporate Governance
Corporate Governance
prohibit accounting firms from providing both auditing and management consulting services. (imilar provisions are in place under clause :2 of (tandard /isting -greement in &ndia. (ystemic problems of corporate governance 8emand for information6 &n order to influence the directors, the shareholders must combine with others to form a voting group which can pose a real threat of carrying resolutions or appointing directors at a general meeting. $. *onitoring costs6 - barrier to shareholders using good information is the cost of processing it, especially to a small shareholder. The traditional answer to this problem is the efficient market hypothesis (in finance, the efficient market hypothesis ()*.) asserts that financial markets are efficient), which suggests that the small shareholder will free ride on the judgments of larger professional investors. ". (upply of accounting information6 Dinancial accounts form a crucial link in enabling providers of finance to monitor directors. &mperfections in the financial reporting process will cause imperfections in the effectiveness of corporate governance. This should, ideally, be corrected by the working of the e ternal auditing process.
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Corporate Governance
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Corporate Governance
)ven before the negative influence on public opinion caused by the "##B backdating scandal, use of options faced various criticisms. - particularly forceful and long running argument concerned the interaction of e ecutive options with corporate stock repurchase programs. Humerous authorities (including '.(. Dederal 0eserve @oard economist +eisbenner) determined options may be employed in concert with stock buybacks in a manner contrary to shareholder interests. These authors argued that, in part, corporate stock buybacks for '.(. (tandard I 1oors >## companies surged to a K>## billion annual rate in late "##B because of the impact of options. - compendium of academic works on the option=buyback issue is included in the study (candal by author *. Gumport issued in "##B. - combination of accounting changes and governance issues led options to become a less popular means of remuneration as "##B progressed, and various alternative implementations of buybacks surfaced to challenge the dominance of 3open market3 cash buybacks as the preferred means of implementing a share repurchase plan. (eparation of Chief ) ecutive ,fficer and Chairman of the @oard roles (hareholders elect a board of directors, who in turn hire a Chief ) ecutive ,fficer (C),) to lead management. The primary responsibility of the board relates to the selection and retention of the C),. .owever, in many '.(. corporations the C), and Chairman of the @oard roles are held by the same person. This creates an inherent conflict of interest between management and the board. Critics of combined roles argue the two roles should be separated to avoid the conflict of interest. -dvocates argue that empirical studies do not indicate that separation of the roles improves stock market performance and that it should be up to shareholders to determine what corporate governance model is appropriate for the firm. &n "##:, C<.:J of '.(. companies had combined rolesA this fell to >C."J by *ay "#$". *any '.(. companies with combined roles have appointed a 3/ead 8irector3 to improve independence of the board from management. German and '7 companies have generally split the roles in nearly $##J of listed companies. )mpirical evidence does not indicate one model is superior to the other in terms of performance. .owever, one study
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Corporate Governance
indicated that poorly performing firms tend to remove separate C),4s more fre5uently than when the C),=Chair roles are combined.
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Corporate Governance
The best!governed companies, according to investor perceptions, include TC(, &nfosys, .'/, .8DC and .8DC @ank, *I*, and Hestle. 1rofessionally managed companies and *HCs feature more prominently in this list, as compared to promoter!managed firms or public sector units (1('s). -lthough &nfosys emerged as a favorite with investors, respondents were divided about H.0. Harayana *urthy4s return to &nfosys as e ecutive chairman with nearly :2 per cent seeing his move as a repudiation of corporate governance principles. &nterestingly, more foreign institutions disapproved of *urthy4s comeback than domestic institutions. (o, what are the biggest issues that investors look for when it comes to corporate governanceL The survey says clarity in business and accounting practices are considered the most important dimension in corporate governance. ,ther important aspects include fair dealing with clients and suppliers, strong representation from independent directors, compliance and remuneration. The survey shows two!thirds of respondents indicated they would initiate action against the company for their grievances. The Companies -ct "#$< provides for filing class action suits against companies.3+hen faced with a company proposal that they disagree with, nearly B# per cent of the respondents are willing to engage with the company ! either directly or indirectly. .owever, a si;eable share of the respondents ("9 per cent) said that they would e it the company,3 the survey adds. +hile >: per cent respondents said the Companies -ct was sufficient to address corporate governance concerns, :# per cent said it was not sufficient.
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Corporate Governance
Corporate Governance at 0eliance is based on the following main principles6 Constitution of a @oard of 8irectors of appropriate composition, si;e, varied e pertise and commitment to discharge its responsibilities and duties. )nsuring timely flow of information to the @oard and its Committees to enable them to discharge their functions effectively. &ndependent verification and safeguarding integrity of the Company?s financial reporting - sound system of risk management and internal control.
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Corporate Governance
Timely and balanced disclosure of all material information concerning the Company to all stakeholders.
Transparency and accountability. Compliance with all the applicable rules and regulations. Dair and e5uitable treatment of all its stakeholders including employees, customers, shareholders and investors.
CONCLUSION
Corporate Governance has become the latest bu;;word today. -lmost every country has institutionali;ed a set of Corporate Governance codes, spelt out best practices and has sought to impose appropriate board structures. 8espite the MCorporate Governance revolution? there e ists no universal benchmark for effective levels of disclosure and transparency. There are several corporate governance structures available in the developed world but there is no one structure, which can be singled out as being better than the others. There is no None si;e fits allO structure for corporate governance. Corporate governance e tends beyond corporate law. &ts fundamental objective is not the mere fulfillment of the re5uirements of law but in ensuring commitment of the board in managing the company in a transparent manner for ma imi;ing long term shareholder value. )ffectiveness of corporate governance system cannot merely be legislated by law. -s competition increases, technology pronounces the death of distance and speeds up communication. The environment in which companies operate in &ndia also changes. &n this dynamic environment the systems of corporate governance also need to evolve.
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Corporate Governance
The recommendations made by different e pert committees will go a long way in raising the standards of corporate governance in &ndian companies and make them attractive destinations for local and global capital. These recommendations will also form the base for further evolution of the structure of corporate governance in consonance with the rapidly changing economic and industrial environment of the country in the new millennium.
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