Corporate Governance

What is 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 stake holders involved and the goals
for which the corporation is governed.
Stakeholders
Stakeholders
• The principal stakeholders are the
shareholders/members, management, and
the board of directors. Other stakeholders
include labor (employees), customers,
creditors (e.g., banks, bond holders),
suppliers, regulators, and the community
at large. For Not-Profit-For Corporations
or other membership Organizations the
“shareholders” means “members”.
Corporate governance – an academic
point of view
Separation of ownership &
control

It can be seen as one that Shareholders

addresses “the problems

that result from the Board

separation of ownership
and control”. Management

Employees
Corporate governance focuses on:

• Structures and mechanisms that ensure

internal structure and rules of the board of
directors
• Disclosure strictures in regard to
information for shareholders and creditors
• Transparency of operations and an
impeccable process of decision-making
• Control of management
A simple model for corporate
governance
1. Shareholders elect directors as their representatives
2. Directors vote on key issues and adopt majority
decision
3. Directors make transparent decisions for which
shareholders and others can make them accountable
4. Companies adopt accounting standards that generate
information required by directors, investors, other
stakeholders for decision-making
5. Companies adopt policies and practices compatible
with relevant national, state, and local laws
 McKinsey & Company Report -
2001
• McKinsey and company report titled “Giving New
Life to the Corporate Governance Reform
Agenda for Emerging Markets” suggests a two-
version governance chain model.
• The “market model” governance chain (model 1)
described below is applicable to efficient, well-
developed equity markets and dispersed
ownership prevalent in the developed industrial
nations like US, UK, Canada, and Australia
The “market model” governance chain –
Model 1
Shareholder environment Independence & performance

Dispersed Non-executive
ownership majority
boards
Institutional context

Corporate context
Sophisticated Aligned
institutional Incentives
ownership

Active High
equity disclosure
markets

Active Shareholder
takeover equality
market
Capital market liquidity Transparency & accountability
• The “control model” governance chain (model 2)
described below is represented by underdeveloped
equity markets, concentrated (family) ownership, less
shareholder transparency and inadequate protection of
minority and foreign shareholders familiar in Asia, Latin
America, and some East European countries. In such
transitional and developing capital economies, there is
need to build, nurture and grow supporting institutions
such as strong and efficient capital market regulator and
judiciary to enforce contracts or protect property rights
The “control model” governance chain –
Model 2
Shareholder environment Independence & performance

Concentrated Insider boards

ownership
Institutional context

Incentives

Corporate context
Reliance on aligned with core
family, bank, shareholders
public finance

Under
developed New Limited
issue market disclosures

Inadequate
Limited minority
takeover protection
Capital market liquidity market Transparency &
accountability
 Corporate Misgovernance
• From the early years of the new millennium, a few US
companies got mired in a grave crisis of credibility.
Business conglomerates like Xerox, WorldCom, and
Enron perpetuated frauds to artificially inflate turnovers
and profits. Such problems of corporate America and
developing economies like India were growing due to the
failure of auditing profession to safeguard the interests of
shareholders and other stakeholders. Corporate lootings
have destroyed the term “business ethics”. The
swashbuckling CEOs are suddenly being looked upon as
crooks who gamble the retirement savings of hapless
workers and unwary investors.
Misgovernance in the US - 2002
• WorldCom improperly booked $3.8 billion in expenses
leading to inflation of profits
• Enron created outside partnerships that hid its poor
financial position; company executives made millions
selling company stocks
• Accounting firm Anderson was accused of shredding
Enron documents and got convicted for obstructing
justice
• Mismanagement by Dynegy, Waste Management,
Adelphia Communications, Imclone Systems, Peregrine
Systems
 Misgovernance in India
• Only after 1947, industrial growth and corporate culture
had started in India. But the Indian scene was dominated
by:
• Feudalistic forces
• Political system bordering on pseudo-democracy
• Business firms practicing unethical methods on the
market place showing little respect to human and
organizational values in regard to employees,
shareholders, and customers
• Increasing corruption at all levels of government fanned
the desires of firms not held accountable for more and
more unethical practices
• Various public sector undertakings enjoying
monopoly passed on to the hapless customers
costs of corporate misgovernance
• Private firms fleeced their customers and denied
due to the government; they also resorted to
rampant corporate corruption
• Employees at all levels of government and at the
top levels of private sector firms indulged in or
contributed to corporate misgovernance
 Scams in India that rocked the
investor confidence

• “Big Bull” Harshad Mehta’s security scam uncovered in April,

1992
• During 1993-94, stock market index shot up by 120% -
during this boom 3911 companies that raked in
Rs. 25,000 crore had vanished or failed to set up projects
• 1995-96 witnessed the plantation companies
scam worth Rs. 50.000 crore raised from gullible
investors looking for huge returns
• 1995-1997 saw the scam worth Rs. 50,000 crore
in the so-called non-banking finance sector
when the firms performed the vanishing act
• 1995-98 also produced the mutual fund scam
worth Rs. 15,000 crore borne out of the huge
returns promised by public sector banks
• In 2001, Ketan Parek resorted to price rigging in
association with a bear cartel
Companies adopted different illegal
tactics
• Cornering of industrial licenses to pre-empt
competitors and put up entry barriers
• Using Import licenses
• Illegally holding money abroad
• Bribing officialdom to generate unaccounted
money to be used for “business” expenses and
political donations
• Tax evasions through compensation packages
to senior level managers and using funds and
facilities for personal uses such as travel,
furniture home improvements etc.
 Winds of change

Prior to reforms in 1991, Indian companies were insulated by

closed economy, a sheltered market, limited access to global
business, lack of competitive spirit and regulatory framework – all
these changed on account of:
• Market-driven performs
• Economic liberalization
• Dismantling of control and quota regime
• Delicensing and deregulation of industries
• Changes in import/export policies
• Globalization of the economy within and outside the ambit of the
WTO
Corporate governance movement
in India
The movement took of:
• The Confederation of Indian Industry (CII) framed a
code in 1997 and 30 large listed companies
voluntarily adopted this code
• In 1999, the Securities and exchange Board of India
(SEBI, set up in 1988 and was made a statutory body
in 1992) appointed a committee headed by Kumar
Mangalam Birla to mandate international standards of
corporate governance for listed companies
• By 2003 every listed company joined the SEBI code
Historical perspective of corporate
governance: from a narrow to broader vision
• Traditionally, the problem of the separation of
ownership by shareholders and the control by
management
• Historical developments of corporate
misdemeanor and growing visions of society
followed
• Governance should stand up to the expectations
of all stakeholders namely employees,
consumers, large institutional investors,
government, and the society as a whole
• More additions to the ambit of corporate
governance included business ethics,
social responsibility, management
discipline, corporate strategy, life-cycle
development, stakeholder participation in
decision making processes, and promotion
of sustainable economic development
All these had gone
far beyond the original
prescription of Milton
Friedman that the
companies should
conduct the business
purely in accordance
with the desires of the
shareholders
 Growth of modern ideas of
corporate governance
Watergate scandal which brought about
the end of Nixon Presidency led to the
disclosure that many companies made
illegal political contributions by bribing
governmental officials – out came the
legislation of the Foreign and Corrupt
Practices Act of 1977. In the same year
Securities Exchange Commission (SEC)
proposed mandatory reporting on financial
controls.
 The Cadbury Committee
• UK was rocked by a series of
scams and business collapses
during the 1980s early 1990s.
In 1991, London Stock Exchange
appointed Sir Adrian Cadbury
committee to draft a
code of practices in English
corporations to define and apply internal
controls to limit their exposure
to financial losses. The committee
submitted the “Code of Best
Practices” in 1992. It included guidelines to board of
directors, non-executive directors, and those
on reporting and control.
The Sarbanes –Oxley Act (SOA)
2002
• In the US, stock market began
declining in early 2000. Well-
known companies like Enron,
WorldCom Adelphia, Global Crossing,
Dynegy and a few others
steeped in corruption, fraud,
deception collapsed damaging
investor confidence. Stock prices
plummeted and investors lost billions of
dollars. Investigations by the US
Congress and the Securities
and Exchange Commission
(SEC) brought about a
comprehensive Act, the
Sarbanes-Oxley Act was enacted
into law on July 30, 2002.
 Sen. Paul Sarbanes Michael Oxley
The Sarbanes – Oxley Act was formulated to protect
investors by improving the accuracy and reliability of
corporate disclosures. The act contained a number
of provisions that dramatically change the reporting
and corporate director’s governance obligations of
public companies, the directors, and officers.
 Issues in Corporate Governance
• Corporate governance means different
things to different people. But to all,
corporate governance is a means to an
end, the end being long term shareholder ,
and importantly, stakeholder value. Good
corporate governance practices involve
some critical and crucial issues. These
are:
Distinguishing the roles of board
and management
• Business is to be managed “by or under
the direction’” of the board. The
responsibility of managing the business is
delegated to the CEO, who in turn
delegates to other senior managers. The
board is positioned between the
shareholders (owners) and the company’s
management. The board holds important
functions:
1. Appoint and remove CEO
2. Indirectly oversee the conduct of the business
3. Review and approve company’s financial
objectives, corporate plans and objectives
4. Advice and counsel top management
5. Identify and recommend candidates to
shareholders for electing directors
6. Review systems to comply with laws and
regulations
Composition of board and other
related issues
• Committee elected by the shareholders of a limited company for the
policies of the company – sometimes full-time functional directors
are also appointed.

• The SEBI appointed Kumar Mangalam Birla’s report defined the

composition of the board as:

“The board of directors of a company shall have an optimum

combination of executive and non-executive directors with not less
than 50 per cent of the board of directors to be non-executive
directors. The number of independent directors would depend
whether the chairman is executive or non-executive. In case of a
non-executive chairman, at least one –third of the board should
comprise independent directors and in case of executive chairman,
at least half of the board should be independent directors.”
 Board of Directors

Executive Directors Non-Executive Directors

Independent Directors Affiliated Directors

(Nominee Directors)

Types of Directors
• Executive director – an executive of the
company and also a member of the board
• Non-Executive director – no employment
relationship
• Independent non-executive directors – free from
any business or other relationship which may
interfere with the exercise of independent
judgment
• Affiliated director – who has some kind of
independence, yet may have links with
suppliers, customers, etc.
 Roles of CEO and Chairperson
• The composition of the board is a major issue
• Professionalizing of family companies should start with
the composition of the board.
• Combining the roles of CEO and Chairperson prevalent
in US and India result in conflicting interests and decision
making. In UK and Australia the CEO can not be the
chairperson of the board.

• CEO is to lead the senior management and the

chairperson is to lead the board and more over it may be
too heavy to handle both jobs by one person.
Should board have committees?
• Many committees on corporate governance have
recommended appointment of special committees for:
1. Nomination
2. Remuneration
3. Auditing
4. When the above committees are composed of
independent directors selected due to their
competence, professional expertise in their own fields,
and proven experience, they are likely to take objective
decisions and serve the long term interests of the
company.
 Appointments and reelection of
directors
• As per the Indian Company Law, shareholders
elect directors; but when there are so many
shareholders and they are scattered all over the
country, specially constituted committees go
into these issues and elect persons as directors
who will be confirmed in the ensuing General
Body meetings of the company. Same way re-
election of the directors too takes place.
 Directors’ and executives’
remuneration
• This is one of the mixed and vexed issues of
corporate governance. In recent years the
remuneration payable has become most visible
and politically sensitive issue. Essentially the
shareholders should get a full disclosure about
how much benefits the directors are entitled and
paid for. Committees (Cadbury) on corporate
governance have laid emphasis on issues such
as transparency, “pay-for-performance”,
severance payments, pension for non-executive
directors, and appointment of remuneration
committees.
 Disclosure and Audit
• The Cadbury Report termed audit as “one of the
corner stones of corporate governance”. Audit
provides a basis for reassurance to the share
holders and everyone else who has a financial
stake in the company. Audits raise a host of issues:
1. Should boards establish audit committees? How
should it be composed?
2. How to ensure the independence of the auditor?
3. What about the non-audit services rendered by the
auditors?
Recent corporate scandals
involving auditors

Arthur Andersen
Accountancy firm Arthur
Andersen was declared
guilty of obstructing
justice by shredding
documents relating to the
failed energy giant Enron.
The verdict could be the
death knell for the 89-year
old company, once one of
the world's top five
accountants.
• Andersen has already lost much of its
business, and two-thirds of its once 28,000
strong US workforce. Following the
conviction, multi-million dollar lawsuits
brought by Enron investors and
shareholders demanding compensation are
likely to follow, and could bankrupt the firm.
 Satyam
• Price Waterhouse resigned as statutory auditor of
Satyam Computer Services Ltd with effect from February
12, 2009, while stating that it would co-operate with the
ongoing investigations into the Rs 7,800 crore fraud at
the IT major.
• Protection of shareholder rights and their
expectations
• Dialogue with Institutional investors
• Should investors have a say in making
company “socially responsible corporate
citizen”?