REPORT

ON Corporate Governance

SUBMITTED TO:
Mr. Mirza M. Waheed Baig

SUBMITTED BY:
Zaheer Abbas Doda Rasheed Namra Aziz Shahbaz Hussain 2nd Semester Session 2009-2012 MB-SI-09-113 MB-SI-09-115 MB-SI-09-051 MB-S1-09-021

BAHAUDDIN ZAKARIYA UNIVERSITY, MULTAN.

Institute of Management Sciences

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Acknowledgment
First of all, I would like to express my deepest sense of gratitude to my supervisor Mr Mirza M.Waheed Baig for his patient guidance, encouragement and excellent advice throughout this study. I would like to thank Mr Mirza M.Waheed Baig for his comments and suggestions for the editing of my report. I also thank my colleagues for sharing experiences and knowledge during the time of report making. Finally, I take this opportunity to express my profound gratitude to my beloved parent for their moral support and patience during my work.

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Executive Summary
Corporate governance mechanisms differ as between countries. The governance mechanism of each country is shaped by its political, economic and social history as also by its legal framework. Despite the differences in shareholder philosophies across countries, good governance mechanisms need to be encouraged among all corporate and non-corporate entities. While multilateral organisations like the World Bank and the Asian Development Bank have evinced keen interest in the subject of corporate governance an effective lead has been given by the OECD in evolving a set of cogent principles of corporate governance which are internationally recognised to serve as good benchmarks. There have also been some welcome initiatives by the stock exchanges in the UK and the US in prescribing good governance practices to their listed companies. These initiatives have been especially in the area of audit committee of the board and appointment of truly independent directors to tone up the quality of board deliberations and performance. The Advisory Group on Corporate Governance has attempted to compare the status of corporate governance in India vis--vis the internationally recognized best standards and has suggested a course of action to improve corporate governance standards in India. Globally, the process of convergence in corporate governance is gathering momentum due to growing international integration of financial and product markets. Foreign investors and creditors are more comfortable in dealing with economic entities that adopt transparent and globally acceptable accounting and governance standards. Companies that embrace high disclosure and governance standards invariably command better premium in the market and are thus able to raise capital at lower costs. The predominant form of corporate governance in India is much closer to the East Asian insider model where the promoters dominate governance in every possible way. Indian corporates, which reflect the pure outsider model with widely dispersed shareholdings and professional management control, are relatively small in number. A distinguishing feature of the Indian Diaspora is the implicit acceptance that corporate entities belong to the founding families though they are not necessarily considered to be their private properties. Even today, the concept of industrial house popularised some time ago by the Dutt Committee and the MRTP Act continues to be the commonly accepted reference points in most of the discussions on ownership patterns of industrial/business units. Strengthen Companies Act As is generally the case in most of the well governed economies, in India too a detailed statutory framework of corporate governance has been defined primarily by the Companies Act. Most of the important requirements set out by the OECD principles in regard to good corporate governance are very well defined in the Companies Act in India. These provisions have been further supplemented by SEBI recently which has directed all the stock exchanges to amend their listing agreement to incorporate new clauses to make it binding on the listed companies to improve their governance practices. However, the main instrumentality, viz. the listing agreement, through which SEBI seeks to ensure implementation of its measures is a weak instrument, as its penal provisions are not hurting enough. Secondly, several regional stock exchanges where a large number of companies are listed lack effective organisations and skills to monitor effective compliance with corporate governance requirements as stipulated by SEBI. Moreover, a vast majority of companies which are not listed on any of the stock exchanges will

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remain outside the purview of SEBIs measures. It is therefore desirable that the Companies Act needs to be amended suitably for enforcing good governance practices in India. Most of the important rights of shareholders like right to ownership and conveyance of transfer, obtaining relevant information regularly, elect members of the board, etc. are reasonably well covered by the Companies Act. However, the rights of shareholders of banks and public sector undertakings stand considerably abridged. The quality of disclosures by most of the Indian companies in regard to several key areas is rather poor. There is scanty disclosure regarding structures and arrangements that enable certain shareholders to obtain a degree of control disproportionate to their known equity ownership. Similarly, disclosures regarding intra-group company dealings, division-wise accounts, consolidated accounts, etc. are all rather very poor. Companies need to share their business goals and plans with the shareholders adequately. The risk factors and offbalance sheet items affecting companys future performance should all be disclosed to the shareholders. In short the quality of financial reporting adopted by the companies in India needs to be substantially improved. Role of Independent Directors India has adopted a unitary board structure. For unitary board structure to function efficiently there should be a strong representation of non-executive independent directors who are capable of taking independent stand and are not cowed down by the full time directors or the promoters of the company. The board should be able to perform its task of monitoring performance of the full time directors satisfactorily. It should ensure that returns to the shareholders on their investments are maximised while not making any compromises with the provisions of law and the rightful interests of all the stakeholders. Since most of the Indian companies belong to the insider model, the most important reform that should be quickly brought about is to make boards more professional and truly autonomous. They need to be restructured in such a way that majority of the directors are truly independent. An independent director is one who does not have any family relationship with any of the executive directors/promoters, does not have currently or during the last five years any material financial dealings with the company and is/was not, during the last five years, an employee of the company or other companies that have/had material financial dealings with the company. It should be made mandatory that 50% or more of the board members are really independent (not merely non-executive) and are under no obligations whatsoever either of the executive directors or the promoters. Unless there is a clear and unambiguous definition as to who really is an independent director, the term is likely to be misinterpreted conveniently by the promoter groups. The independent directors would be in a position to play their fiduciary role more effectively especially if they possess experience and expertise in the areas related to the activities of the company. In some ways, the independent directors may be considered as the trustees for protecting interests of the common shareholders and the stakeholders. In view of the complexity of the tasks of governance, the boards of companies should appoint at least four committees of independent directors for monitoring and direction of the affairs of the company, viz. audit committee, remuneration committee, appointment committee, and investment committee.

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While remuneration committee is expected to play a key role in the determination of compensation package of executive directors and senior employees, the appointment committee should be the focal point in the induction of new and independent directors in the place of retiring directors. The appointment committee has a crucial role to play in ensuring that the boards do not continue to be the cosy places towing the lines of promoters. Public Sectors Units & Banks Given the important place occupied by the public sector entities in the fields of industry and financial sector, any steps to improve corporate governance in the Indian economy would remain incomplete and half-hearted unless public sector units are also covered in this exercise. Multiple layering of 'principal-agent' chains in the case of government owned entities has important consequences for the corporate governance mechanisms that will be adopted in them. Often the accountability chain is very weak in public sector units. The first important step to improve governance mechanism in these units is to transfer the actual governance functions from the concerned administrative ministries to the boards and also strengthen them by streamlining the appointment process of directors. The process of selecting directors should be made highly credible by entrusting the task to a specially constituted body of eminent experts with an independent and high status like the Union Public Service Commission. The role and relationship of the administrative ministries should be limited to issuing of written guidelines/directives to units under their jurisdiction in so far as these instructions are expected to reflect the will of the ultimate owners viz. the voters as perceived by the concerned ministries. It is necessary that the rights of common shareholders should be recognised in the corporate governance mechanisms adopted by all the public sector entities. They should also adopt the system of setting up of the three important board committees viz. the audit committee, remuneration committee, appointment committee, and investment committee. While the body of the eminent experts prepares a panel of names, the appointment committees of the public sector entities should recommend to their boards the persons from such panels that could be considered for induction on their boards. Both government and RBI need to bring about significant changes in the corporate governance mechanism adopted by banks and other financial intermediaries. As a matter of principle, RBI should not appoint its nominees on the boards of banks to avoid conflict of interests. Although it is not feasible to have a free market for take-overs in respect banks there is a strong case for recognising the rights of the shareholders, especially of public sector banks and financial institutions. Today the common shareholders are denied such basic rights as adopting annual accounts or approving dividends. They cannot also influence composition of the boards in any way. As per the Bank Nationalisation Act, the general superintendence, direction, and management of the PSBs vest with their boards. At the same time, the Act also empowers government to issue directions/guidelines in matters of policy involving public interest. Over the years, however, the nature of government directions has often exceeded the matters involving public interest and includes the whole gamut of administrative and corporate activities of the PSBs. As a part of strengthening the functioning of their boards, banks should appoint a risk management committee of the board in addition to the three other board committees viz. audit, remuneration and appointment committees. Since banks and institutions are highly leveraged entities their failure would pose large risks to the entire economic system.

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Their corporate governance mechanisms should, therefore, be relatively much tighter. Current governance practices adopted by the PSBs have created an inequality among different types of directors. Special status amounting to veto powers given to government directors, is not in the interest good corporate governance. Banks should have clear strategies for guiding their operations and establishing accountability for executing them. Banks should maintain high degree of transparency in regard to disclosure of information.

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Corporate Governance

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Introduction
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.

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Corporate governance is the system by which companies are directed and controlled It covers topics such as: how power is divided between the board and the shareholders the accountability of the board to the members The rules and procedure for making decisions.

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. A related but separate thread of discussions focuses on the impact of a corporate governance system in economic efficiency, with a strong emphasis on shareholders' welfare. There are yet other aspects to the corporate governance subject, such as the stakeholder view and the corporate governance models around the world

The combined Code on the Corporate Governance History

The Combined Code on corporate Governance was first issued in 1998. It consisted of principles and provisions (best practice) A revised version, of the code was issued in 2003. This revised Code consisted of main principle, supporting principles and provisions (practical requirements) The most recent version, which applies to reporting year beginning on or after 1 November 2006, was issued by the financial reporting council in June 2006; none of the main principle has been changed. There were a few minor changes, which are outlined later.

Contents
The Code is divided into two sections: Section one is for companies Section two is for institutional shareholders.

There section for companies is subdivided into four areas Directors

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Directors remuneration Accountability and audit Relations with shareholders.

The Code has three appendices The turnbull Guidance on internal audit The Smith Guidance on audit committees The Higgs Guidance on best practice.

Main Principle Corporate Governance

The main principle of each section is outlined below.

Directors (1)
Every company should be headed by an effective beard, which is Collectively responsible for the success of the company

(2)

There should be a clear division of responsibilities at the if the Company between the running of the board and the executive Responsibility for the running of the company business. No one Individual should have unfettered powers of decision The board should include the balance of executive directors and NEDs (and in the particular independent NEDs) such that no Individual or small group of individuals can dominate the boards decisions taking. There should be a formal , rigorous and transparent procedure For the appointment of new directors to the board The board should be supplied in a timely manner with Information in a form and of a quality appropriate to enable it To discharge its duties. All directors should receive inductions On joining the board and should regularly update and refresh Their skills and knowledge. The Board should undertake a formal and rigorous annual

(3)

(4) (5)

(6)

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Evolution of its own performance and that of its committees And individual directors. (7) the board. All directors should be submitted for re-election at regular Intervals, subject to continued satisfactory performance. The board should ensure planned and progressive refreshing of

Directors remuneration (1)

Levels of remuneration should be sufficient t attract , retain and And motivate directors of the quality required to run the company successful, but a company should avoid playing more than is necessary for this purpose. A significant proportion of executive directors remuneration should be strutted so as to link reward to corporate and individual performance.

(2)

They should be a formal and transparent producer of developing policy on executive remuneration and for fixing the remuneration package of individual directors. No director should be involved in deciding his or her own remuneration. The Code provides that service contracts and notice periods Should not exceed on year

Accountability and audit (1)

The board should present a balanced and understandable Assessment of the companys position and prospects.

(2) (3)

The board should maintain a sound system of internal control to safeguard shareholders investments and the company asses. The board should established formal and transparent arrangements for considering how they should apply the financial reporting and internal control principles and for maintaining an appropriate relationship with the company auditors.

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The Code provides that the board should establish an audit committee of an least three (or in the case of smaller companies two) members, who should all be independent non-executive directors. The board should satisfy itself that at least one member of the audit committee has recent and relevant financial experience. The committee should meet at least three times during the year at times coinciding with key dates within the financial reporting and audit cycle.

Relation with shareholders (1)

There should be a dialogue with shareholder based on the mutual understanding of objectives. The board as a whole has responsibility for insuring that a satisfactory dialogue with shareholders takes place. The board should use the annual general meeting (AGM) to communicate with investor and to encourage their participation.

(2)

Institutional shareholders (1) (2)

Institutional shareholder should enter into a dialogue with companies based on the mutual understanding of objectives. When evaluating companies governance arrangements, particularly those relating to boards structure and composition, institutional shareholders should give due weight to all relevant factor drawn to their attention. Institutional shareholders have responsibilities to make considered use of their votes.

(3)

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The 2006 Combined Code

The (FRC) issued a new version of the Code on 27 June 2006. The new version contains a few charges, e.g.: The restriction on a company chairman serving on a remuneration committee has been relaxed. However it is still recommended that the chairman should not chair the committee. A vote withheld option should be included on proxy forms so that investors can indicate reservation about resolution that they do not wish to vote against. A recommendation that the companies publish on their website the details of proxy logged at a general meeting where votes are taken on show of hands.

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Rule-based versus principle-based approaches to governance

The Combined Code is a set of principles, rather than a set of rules. It requires directors to describe in their own words the way in which they have applied the general principle of corporate governance. A principle-based approach to governance has the following advantages and disadvantages. Advantages

Because the directors report on the actual circumstance of their own company, the report should be more meaningful than one based on specific detailed requirements. A Code of practice can be changed much more easily than statuary requirements. This means that the Combined Code can be updated to respond to changing conditions and changing expectations of share holder and others. A principle-based approach encourages the directors to follow the spirit if the Code; whereas a rule-based approach may result in a tick-boxes mentality. This means that the under rules, rather than the spirit.

Disadvantages A principle-based approach tends to result in general, meaningless statements. It may be difficult for the directors to see whether they have met the specific requirements of the Code.

The legal regulation of corporate governance

The legislation covering corporate governance has been covered in earlier chapters. The following table gives you an indication of where to

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Find the relevant provisions: Model articles CA 2206 Set out the internal constitution of the company, e.g. allowing the company and /or the board to negotiate directors service contacts. Provides the main framework for the legislation affecting companies. Specifies that the directors service contract cannot exceed two years unless first approved by the members. Specifies the duties that directors owe to their companies. IA 1986 Established liability for wrongful and fraudulent trading. Permits the liquidators to set aside transactions at an undervalue or where the company has given a performance. Allow the court of disqualify someone from being a director if they: Have persistently beached the companies legislation Are found to be unfit, or Are convicted of an indictable offence in connection with the promotion, formation, management or liquidation of a company. Contains the legislation on insider dealing.

CDDA 1986

CJA 1993

The Surbanes - Oxley Act 2002

The Surbanes-Oxley Act 2002 is a US law that applies to all companies (including foreign companies) that have a listing on the US Stock Exchange. It was introduced in the wake of corporate scandals such as the unexpected Collapse of Enron and WorldCom. The US approach to corporate governance is a statutory rules-based one. This differs from the UK where it is principle-based with an emphasis On voluntary compliance. The Surbanes-Oxley Act requires all companies with a listing in the US to include in their annual report certificate vouching for the accuracy of the financial statement. This certificate must be signed by the companys principle executive officer and principle financial officer.

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Parties to corporate governance

Parties involved in corporate governance include the regulatory body (e.g. the Chief Executive Officer, the board of directors, management, shareholders and Auditors).

Main parties of Corporate Governance

Other stakeholders

who take part include suppliers, employees, creditors, customers and the community at large.

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Shareholder

In corporations, the shareholder delegates decision rights to the manager to act in the principal's best interests. This separation of ownership from control implies a loss of effective control by shareholders over managerial decisions. Partly as a result of this separation between the two parties, a system of corporate governance controls is implemented to assist in aligning the incentives of managers with those of shareholders. With the significant increase in equity holdings of investors, there has been an opportunity for a reversal of the separation of ownership and control problems because ownership is not so diffuse.

Board of Directors

A board of directors often plays a key role in corporate governance. It is their responsibility to endorse the organisation's strategy, develop directional policy, appoint, supervise and remunerate senior executives and to ensure accountability of the organisation to its owners and authorities.

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 Corporate Secretary
The Company Secretary, known as a Corporate Secretary in the US and often referred to as a Chartered Secretary if qualified by the Institute of Chartered Secretaries and Administrators (ICSA), is a high ranking professional who is trained to uphold the highest standards of corporate governance, effective operations, compliance and administration. All parties to corporate governance have an interest, whether direct or indirect, in the effective performance of the organization. Directors, workers and management receive salaries, benefits and reputation, while shareholders receive capital return. Customers receive goods and services; suppliers receive compensation for their goods or services. In return these individuals provide value in the form of natural, human, social and other forms of capital.

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A key factor is an individual's decision to participate in an organization e.g. through providing financial capital and trust that they will receive a fair share of the organizational returns. If some parties are receiving more than their fair return then participants may choose to not continue participating leading to organizational collapse. Themselves honestly and ethically, especially concerning actual or apparent conflicts of interest, and disclosure in financial reports.

Principles of corporate governance

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 nonexecutive 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.

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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

internal controls and internal auditors the independence of the entity's external auditors and the quality of their audits

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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."[6] 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.

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 organizational goals. Examples include:

Monitoring by the board of directors:

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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. 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 decision-making 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:

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competition debt covenants demand for and assessment of performance information government regulations managerial labour market media pressure takeovers

Systemic problems of corporate governance

Demand for information: In order to influence the directors, the shareholders must combine with others to form a significant voting group which can pose a real threat of carrying resolutions or appointing directors at a general meeting. Monitoring costs: A 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 (EMH) asserts that financial markets are efficient), which suggests that the small shareholder will free ride on the judgments of larger professional investors. Supply of accounting information: Financial accounts form a crucial link in enabling providers of finance to monitor directors. Imperfections in the financial reporting process will cause imperfections in the effectiveness of corporate governance. This should, ideally, be corrected by the working of the external auditing process.

Role of the accountant and Auditors

Financial reporting is a crucial element necessary for the corporate governance system to function effectively Accountants and auditors are the primary providers of information to capital market participants. The directors of the company should be entitled to expect that management prepare the financial information in compliance with statutory and ethical obligations, and rely on auditors' competence. Current accounting practice allows a degree of choice of method in determining the method of measurement, criteria for recognition, and even the definition of the accounting entity. The exercise of this choice to improve apparent performance (popularly known as creative accounting) imposes extra information costs on users. In the extreme, it can involve nondisclosure of information.

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One area of concern is whether the auditing firm acts as both the independent auditor and management consultant to the firm they are auditing. This may result in a conflict of interest which places the integrity of financial reports in doubt due to client pressure to appease management. The power of the corporate client to initiate and terminate management consulting services and, more fundamentally, to select and dismiss accounting firms contradicts the concept of an independent auditor. Changes enacted in the United States in the form of the Sarbanes-Oxley Act (in response to the Enron situation as noted below) prohibit accounting firms from providing both auditing and management consulting services. Similar provisions are in place under clause 49 of SEBI Act in India. The Enron collapse is an example of misleading financial reporting. Enron concealed huge losses by creating illusions that a third party was contractually obliged to pay the amount of any losses. However, the third party was an entity in which Enron had a substantial economic stake. In discussions of accounting practices with Arthur Andersen, the partner in charge of auditing, views inevitably led to the client prevailing. However, good financial reporting is not a sufficient condition for the effectiveness of corporate governance if users don't process it, or if the informed user is unable to exercise a monitoring role due to high costs

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Process of Auditing

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Rules versus principles

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Rules are typically thought to be simpler to follow than principles, demarcating a clear line between acceptable and unacceptable behavior. Rules also reduce discretion on the part of individual managers or auditors. In practice rules can be more complex than principles. They may be illequipped to deal with new types of transactions not covered by the code. Moreover, even if clear rules are followed, one can still find a way to circumvent their underlying purpose - this is harder to achieve if one is bound by a broader principle. Principles on the other hand are a form of self regulation. It allows the sector to determine what standards are acceptable or unacceptable. It also preempts overzealous legislations that might not be practical.

Corporate governance models around the world

Although the US model of corporate governance is the most notorious, there is a considerable variation in corporate governance models around the world. The intricate shareholding structures of keiretsus in Japan, the heavy presence of banks in the equity of German firms, the chaebols in South Korea and many others are examples of arrangements which try to respond to the same corporate governance challenges as in the US. In the United States, the main problem is the conflict of interest between widely-dispersed shareholders and powerful managers. In Europe, the main problem is that the voting ownership is tightly-held by families through pyramidal ownership and dual shares (voting and nonvoting). This can lead to "self-dealing", where the controlling families favor subsidiaries for which they have higher cash flow rights.

Anglo-American Model
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 liberal model that is common in Anglo-American countries tends to give priority to the interests of shareholders. The coordinated model that one finds in Continental Europe and Japan also recognizes the interests of workers, managers, suppliers, customers, and the community. Each model has its own distinct competitive advantage. The liberal model of corporate governance encourages radical innovation and cost competition, whereas the coordinated model of corporate governance facilitates incremental innovation and quality competition. However, there are important differences between the U.S. recent approach to governance issues and what has happened in the UK. In the United States, a corporation is governed by a

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board of directors, which has the power to choose an executive officer, usually known as the chief executive officer. The CEO has broad power to manage the corporation on a daily basis, but needs to get board approval for certain major actions, such as hiring his/her immediate subordinates, raising money, acquiring another company, major capital expansions, or other expensive projects. Other duties of the board may include policy setting, decision making, monitoring management's performance, or corporate control. The board of directors is nominally selected by and responsible to the shareholders, but the bylaws of many companies make it difficult for all but the largest shareholders to have any influence over the makeup of the board; normally, individual shareholders are not offered a choice of board nominees among which to choose, but are merely asked to rubberstamp the nominees of the sitting board. Perverse incentives have pervaded many corporate boards in the developed world, with board members beholden to the chief executive whose actions they are intended to oversee. Frequently, members of the boards of directors are CEOs of other corporations, which some see as a conflict of interest.

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Codes and guidelines

Corporate governance principles and codes have been developed in different countries and issued from stock exchanges, corporations, institutional investors, or associations (institutes) of directors and managers with the support of governments and international organizations. As a rule, compliance with these governance recommendations is not mandated by law, although the codes linked to stock exchange listing requirements may have a coercive effect. For example, companies quoted on the London and Toronto Stock Exchanges formally need not follow the recommendations of their respective national codes. However, they must disclose whether they follow the recommendations in those documents and, where not, they should provide explanations concerning divergent practices. Such disclosure requirements exert a significant pressure on listed companies for compliance. In the United States, companies are primarily regulated by the state in which they incorporate though they are also regulated by the federal government and, if they are public, by their stock exchange. The highest numbers of companies are incorporated in Delaware, including more than half of the Fortune 500. This is due to Delaware's generally business-friendly corporate legal environment and the existence of a state court dedicated solely to business issues Most states' corporate law generally follow the American Bar Association's Model Business Corporation Act. While Delaware does not follow the Act, it still considers its provisions and several prominent Delaware justices, including former Delaware Supreme Court Chief Justice E. Norman Veasey, participate on ABA committees. One issue that has been raised since the Disney decision n 2005 is the degree to which companies manage their governance responsibilities; in other words, do they merely try to supersede the legal threshold, or should they create governance guidelines that ascend to the level of best practice. For example, the guidelines issued by associations of directors (see Section 3 above), corporate managers and individual companies tend to be wholly voluntary. For example, The GM Board Guidelines reflect the companys efforts to improve its own governance capacity. Such documents, however, may have a wider multiplying effect prompting other companies to adopt similar documents and standards of best practice. One of the most influential guidelines has been the 1999 OECD Principles of Corporate Governance. This was revised in 2004. The OECD remains a proponent of corporate governance principles throughout the world.

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Building on the work of the OECD, other international organizations, private sector associations and more than 20 national corporate governance codes, the United Nations Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR) has produced voluntary Guidance on Good Practices in Corporate Governance Disclosure. This internationally agreed benchmark consists of more than fifty distinct disclosure items across five broad categories auditing

Board and management structure and process Corporate responsibility and compliance Financial transparency and information disclosure Ownership structure and exercise of control rights

The World Business Council for Sustainable Development WBCSD has done work on corporate governance, particularly on accountability and reporting, and in 2004 created frameworks. This document aims to provide general information, a "snap-shot" of the landscape and a perspective from a thinktank/professional association on a few key codes, standards and frameworks relevant to the sustainability agenda.

Ownership structures
Ownership structures refer to the various patterns in which shareholders seem to set up with respect to a certain group of firms. It is a tool frequently employed by policy-makers and researchers in their analyses of corporate governance within a country or business group. And ownership can be changed by the stakeholders of the company. Generally, ownership structures are identified by using some observable measures of ownership concentration (i.e. concentration ratios) and then making a sketch showing its visual representation. The idea behind the concept of ownership structures is to be able to understand the way in which shareholders interact with firms and, whenever possible, to locate the ultimate owner of a particular group of firms. Some examples of ownership structures include pyramids, cross-share holdings, rings, and webs.

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Benefits of good corporate governance

Imperative for the establishment of a competitive market.

Good and proper corporate governance is considered imperative for the establishment of a competitive market. There is empirical evidence to suggest that countries that have implemented good corporate governance measures have generally experienced robust growth of corporate sector and higher ability to attract capital.

Sound corporate governance practices have become critical to worldwide efforts to stabiles and strengthen good capital markets and protect investors. Companies with better corporate governance have higher per book ratios ,demonstrating that investor do indeed reward good governance

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Corporate governance enables corporations to realize their corporate objectives, protect shareholder rights.

Corporate Governance in UK
History
The Cadbury Committee
Set up by
The Financial Reporting Council (FRC), The London Stock exchange and Accountability profession, To help raise the standards of corporate Governance and the level of confidence In financial reporting and auditing by setting Out clearly the respective responsibilities Of those involved and what was expected of them A Code of Best Practice (1992) was designed to Archive the necessary high slandered of corporate Behavior It is desirable to separate the role of chief executive and chairman The board should include sufficient nonexecutive directors (NEDs) fir their views to carry significant weight An audit committee should be appointed to review the financial statement before their submission to the full board A remuneration committee consisting wholly or meanly of Neds should set the remuneration of executive directors. The imposition of a three- year maximum term on executive directors services contracts. the stock Exchange required all listed To state whether or not they had complied With the code and to give reasons For any areas if non-compliance. it also required

Objective

Publication

Recommended

Outcome companies

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The companys statements of compliance to be Reviewed by the auditors before publication.

The Green bury Report

The CBI in 1995 To draw up guidelines on directors remuneration, which was perceived to be excessive and did not seem to be linked to the companys performance. A Code of best practice I determining and accounting fort directors, remuneration. All listed companies registered in the UK were required to comply with the code. Their annual reports had to include a statement about their directors remuneration. Any areas of non-compliance had to be explained and justified

Set up by? Objective

Publicatio n Outcome

The Hamepl Report

Issued Objective Summary

January 1998 To restrict the regulatory burden facing companies and substitute board principles (rather than detailed regulations) were practicable. A board must not approach the various corporate governance requirements in a compliance mentality: the so- called tick-box approach. Good corporate governance is not achieved by satisfying a checklist. Directors must comply with substance as well as the letter of all best practice pronouncements. After publishing its report, the Hampel committee drew up a single combined code if best practice , incorporating the Cadbury, greenbury and hampel recommendation

Outcome

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 The 1998 Combined Code

Objecti ve Outcom e

To combine the accepted principles and best practice guideline of Cadbury, greenbury and Hampel into a single code. The stock exchange listing Rules require a listed company in the UK to include the following in its annual report and accounts: A narrative statement of how it has applied the principles set out in the Combined Code, providing explanation which enables its shareholders to evaluate how the principles have been applied. A statement as to whether or not it has complied throughout the accounting period with the combined code provisions. If it has not complied , it must specify the provisions with which it has not complied , and give reasons for any non-compliance

This approach to compliance is known as comply or explain

The turnbull Report

Issued Objectiv e

In 1999 by the ICAEW To give additional guidance to listed companies on how to implement the provisions of the combined code dealing with the internal control.

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Summer y

The board should look forward and not just consider past performance. Companies should keep their shareholders informed about risks. Director should be aware that the company must continually adapt to its changing environment.

Outcom e

The turnbull guidance is appended to the 2003 combined code

The Higgs Report

Issued Objectiv e Outcom e

2003 To develop guidelines for making NEDs more effective. Most of the reports recommendations were either written into the 2003 combined code or include in the best practice guidelines that are appended to it.

The Smith Report

Issued Objectiv e Outcom e

2003 To give guidelines to company board in making suitable arrangements for their audit committees and to assist directors saving on audit committees in carrying out their role. The reports recommendations are appended to the 2003 combined code

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The role of the NEDs

At the time of the Cadbury Reports, there was a history in the UK if public companies being dominated by an all-powerful chiefExecutive/chairman. In additional, NEDs, where they existed at all, were often heavily outnumbered by executive directors. The Cadbury Reports recommended the separation of the roles of chief executive and chairman, although it did not state that the same person could never be both. The role of the chief executive is to take charge of the executive management and the companys business operations; the role of the chairman is to manage the board of directors. Cadbury recommendation that there should be sufficient independent NEDs for their view to carry sufficient weight. As their independence might be put at risk if they had to rely on the chairman or chief executive for their appointment , Cadbury recommendation that initial interviews should be conducted through a nomination committee. The role if the NEDs are to bring judgment and experience to the board that the executive directors might lack. In contrast to the executive directors, NEDs do not usually have a full-time relationship with the company. They are not employees and only receive directors, fees. They are expected to extra a measure of control over the executive directors to ensure that they run the company in the companys best interests (rather than their own). They should scrutinize the performance of management in the meeting agreed goals and the objectives and monitor the reporting of performance. They are also responsible for determining appropriate levels of remuneration of the executive directors. Note they as company law is concerned. There is no distinction between executive directors and NEDs. Both are subject to the same controls and liabilities.

The need for corporate governance

During the late 1980s a number of large UK public companies of them as a result of large-scale fraud by their directors. failed some

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These failures reduced public confidence in financial reporting and auditing. Many people believed that company directors regarded accounting standards as a set of rules to be circumvented and creative accounting was implicated in several company liquidations. Directors were pressuring auditors to accept the use of creative accounting schemes. As the auditors often received extra remuneration from the company fir con consultancy work, disagreement with the directors in the audit process could result in the loss of this additional income. This situation often compromised the auditors independence. There was no clear framework for ensuring that directors reviewed internal controls in their companies. There was perceived lake of accountability for excessive directors.

Main Principle of Corporate Governance of UK

Chairman and chief executive

There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the companys business. No one individual should have unfettered powers of decision. The chairman is responsible for leadership of the board, ensuring its effectiveness on all aspects of its role and setting its agenda. The chairman is also responsible for ensuring that the directors receive accurate, timely and clear information. The chairman should ensure effective communication with shareholders. The chairman should also facilitate the effective contribution of non-executive directors in particular and ensure constructive relations between executive and non-executive directors. The board should include a balance of executive and non-executive directors (and in particular independent non-executive directors) such that no individual or small group of individuals can dominate the boards decision taking. The board should not be so large as to be unwieldy. The board should be of sufficient size that the balance of skills and experience is appropriate for the requirements of the business and that changes to the boards

Board balance and independence

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composition can be managed without undue disruption. To ensure that power and information are not concentrated in one or two individuals, there should be a strong presence on the board of both executive and non-executive directors. The value of ensuring that committee membership is refreshed and that undue reliance is not placed on particular individuals should be taken into account in deciding chairmanship and membership of committees. No one other than the committee chairman and members is entitled to be present at a meeting of the nomination, audit or remuneration committee, but others may attend at the invitation of the committee. There should be a formal, rigorous and transparent procedure for the appointment of new directors to the board. Appointments to the board should be made on merit and against objective criteria. Care should be taken to ensure that appointees have enough time available to devote to the job. This is particularly important in the case of chairmanships. The board should satisfy itself that plans are in place for orderly succession for appointments to the board and to senior management, so as to maintain an appropriate balance of skills and experience within the company and on the board. The board should be supplied in a timely manner with information in a form and of a quality appropriate to enable it to discharge its duties. All directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge. The chairman is responsible for ensuring that the directors receive accurate, timely and clear information. Management has an obligation to provide such information but directors should seek clarification or amplification where necessary. The chairman should ensure that the directors continually update their skills and the knowledge and familiarity with the company required to fulfil their role both on the board and on board committees. The company should provide the necessary resources for developing and updating its directors knowledge and capabilities. Under the direction of the chairman, the company secretarys responsibilities include ensuring good information flows within the board and its committees and between senior management and non-executive directors, as well as facilitating induction and assisting with professional development as required. The company secretary should be responsible for advising the board through the chairman on all governance matters. The board should undertake a formal and rigorous annual evaluation

Appointments to the Board

Information and professional development

Performance evaluation

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of its own performance and that of its committees and individual directors. Individual evaluation should aim to show whether each director continues to contribute effectively and to demonstrate commitment to the role (including commitment of time for board and committee meetings and any other duties). The chairman should act on the results of the performance evaluation by recognising the strengths and addressing the weaknesses of the board and, where appropriate, proposing new members be appointed to the board or seeking the resignation of directors. All directors should be submitted for re-election at regular intervals, subject to continued satisfactory performance. The board should ensure planned and progressive refreshing of the board. All directors should be subject to election by shareholders at the first annual general meeting after their appointment, and to re-election thereafter at intervals of no more than three years. The names of directors submitted for election or re-election should be accompanied by sufficient biographical details and any other relevant information to enable shareholders to take an informed decision on their election.

Re-election

REMUNERATION
Levels of remuneration should be sufficient to attract, retain and motivate directors of the quality required to run the company successfully, but a company should avoid paying more than is necessary for this purpose. A significant proportion of executive directors remuneration should be structured so as to link rewards to corporate and individual performance. The remuneration committee should judge where to position their company relative to other companies. But they should use such comparisons with caution, in view of the risk of an upward ratchet of remuneration levels with no corresponding improvement in performance. They should also be sensitive to pay and employment conditions elsewhere in the group, especially when determining annual salary increases.

ACCOUNTABILITY AND AUDIT

The board should present a balanced and understandable assessment of the companys position and prospects. The boards responsibility to present a balanced and understandable assessment extends to interim and other price-sensitive public reports and reports to regulators as well as to information required to be presented by statutory requirements. The directors should explain in the annual report their responsibility for preparing the accounts and there should be a statement by the auditors about their reporting responsibilities.

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The directors should report that the business is a going concern, with supporting assumptions or qualifications as necessary. Internal Control The board should maintain a sound system of internal control to safeguard shareholders investment and the companys assets. The board should, at least annually, conduct a review of the effectiveness of the groups system of internal controls and should report to shareholders that they have done so. The review should cover all material controls, including financial, operational and compliance controls and risk management systems. The board should establish formal and transparent arrangements for considering how they should apply the financial reporting and internal control principles and for maintaining an appropriate relationship with the companys auditors. The board should establish an audit committee of at least three, or in the case of smaller companies18 two, members, who should all be independent non-executive directors. The board should satisfy itself that at least one member of the audit committee has recent and relevant financial experience. The main role and responsibilities of the audit committee should be set out in written terms of reference and should include: _ to monitor the integrity of the financial statements of the company, and any formal announcements relating to the companys financial performance, reviewing significant financial reporting judgements contained in them; _ to review the companys internal financial controls and, unless expressly addressed by a separate board risk committee composed of independent directors, or by the board itself, to review the companys internal control and risk management systems; _ to monitor and review the effectiveness of the companys internal audit function; _ to make recommendations to the board, for it to put to the shareholders for their approval in general meeting, in relation to the appointment, re-appointment and removal of the external auditor and to approve the remuneration and terms of engagement of the external auditor; _ to review and monitor the external auditors independence and objectivity and the effectiveness of the audit process, taking into consideration relevant UK professional and regulatory requirements; _ to develop and implement policy on the engagement of the external auditor to supply non-audit services, taking into account relevant ethical guidance regarding the provision of non-audit services by the external audit firm; and to report to the board, identifying any

Audit Committee and Auditors

RELATIONS WITH SHAREHOLDERS

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There should be a dialogue with shareholders based on the mutual understanding of objectives. The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place.20 Whilst recognising that most shareholder contact is with the chief executive and finance director, the chairman (and the senior independent director and other directors as appropriate) should maintain sufficient contact with major shareholders to understand their issues and concerns. The board should keep in touch with shareholder opinion in whatever ways are most practical and efficient. The board should use the AGM to communicate with investors and to encourage their participation. The company should count all proxy votes and, except where a poll is called, should indicate the level of proxies lodged on each resolution, and the balance for and against the resolution and the number of abstentions, after it has been dealt with on a show of hands. The company should ensure that votes cast are properly received and recorded. The company should propose a separate resolution at the AGM on each substantially separate issue and should in particular propose a resolution at the AGM relating to the report and accounts. The chairman should arrange for the chairmen of the audit, remuneration and nomination committees to be available to answer questions at the AGM and for all directors to attend. The company should arrange for the Notice of the AGM and related papers to be sent to shareholders at least 20 working days before the meeting.

Constructive Use of the AGM

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INSTITUTIONAL SHAREHOLDERS
Institutional shareholders should enter into a dialogue with companies based on the mutual understanding of objectives.

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Institutional shareholders should apply the principles set out in the Institutional Shareholders Committees The Responsibilities of Institutional Shareholders and Agents Statement of Principles22, which should be reflected in fund manager contracts. E.3 Shareholder Voting Institutional shareholders have a responsibility to make considered use of their votes. Institutional shareholders should take steps to ensure their voting intentions are being translated into practice. Institutional shareholders should, on request, make available to their clients information on the proportion of resolutions on which votes were cast and non-discretionary proxies lodged. Major shareholders should attend AGMs where appropriate and practicable. Companies and registrars should facilitate this.

Roles of Different Committees and Persons

AUDIT COMMITTEES

1.1. This guidance is designed to assist company boards in making suitable arrangements for their audit committees, and to assist directors serving on audit committees in carrying out their role. 1.2. The paragraphs in bold are taken from the Combined Code (Section C3). Listed companies that do not comply with those provisions should include an explanation as to why they have not complied in the statement required by the Listing Rules. 1.3. Best practice requires that every board should consider in detail what arrangements for its audit committee are best suited for its particular circumstances. Audit committee arrangements need to be proportionate to the task, and will vary according to the size, complexity and risk profile of the company. 1.4. While all directors have a duty to act in the interests of the company the audit committee has a particular role, acting independently from the executive, to ensure that the interests of shareholders are properly protected in relation to financial reporting and internal control. 1.5. Nothing in the guidance should be interpreted as a departure from the principle of the unitary board. All directors remain equally responsible for the companys affairs as a matter of law. The audit committee, like other committees to which particular responsibilities are delegated (such as the remuneration committee), remains a committee of the board. Any disagreement within the board, including disagreement between the audit committees members and the rest of the board, should be resolved at board level. 1.6. The Code provides that a separate section of the annual report should

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describe the work of the committee. This deliberately puts the spotlight on the audit committee and gives it an authority that it might otherwise lack. This is not incompatible with the principle of the unitary board. 1.7. The guidance contains recommendations about the conduct of the audit committees relationship with the board, with the executive management and with internal and external auditors. However, the most important features of this relationship cannot be drafted as guidance or put into a code of practice: a frank, open working relationship and a high level of mutual respect are essential, particularly between the audit committee chairman and the board chairman, the chief executive and the finance director. The audit committee must be prepared to take a robust stand, and all parties must be prepared to make information freely available to July 2003 The Smith Guidance
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the audit committee, to listen to their views and to talk through the issues openly. 1.8. In particular, the management is under an obligation to ensure the audit committee is kept properly informed, and should take the initiative in supplying information rather than waiting to be asked. The board should make it clear to all directors and staff that they must cooperate with the audit committee and provide it with any information it requires. In addition, executive board members will have regard to their common law duty to provide all directors, including those on the audit committee, with all the information they need to discharge their responsibilities as directors of the company. 1.9. Many of the core functions of audit committees set out in this guidance are expressed in terms of oversight, assessment and review of a particular function. It is not the duty of audit committees to carry out functions that properly belong to others, such as the companys management in the preparation of the financial statements or the auditors in the planning or conducting of audits. To do so could undermine the responsibility of management and auditors. Audit committees should, for example, satisfy themselves that there is a proper system and allocation of responsibilities for the day-to-day monitoring of financial controls but they should not seek to do the monitoring themselves. 1.10. However, the high-level oversight function may lead to detailed work. The audit committee must intervene if there are signs that something may be seriously amiss. For example, if the audit committee is uneasy about the explanations of management and auditors about a particular financial reporting policy decision, there may be no alternative but to grapple with the detail and perhaps to seek independent advice. 1.11. Under this guidance, audit committees have wide-ranging, timeconsuming and sometimes intensive work to do. Companies need to

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make the necessary resources available. This includes suitable payment for the members of audit committees themselves. They and particularly the audit committee chairman - bear a significant responsibility and they need to commit a significant extra amount of time to the job. Companies also need to make provision for induction and training for new audit committee members and continuing training as may be required. 1.12. This guidance applies to all companies to which the Code applies i.e. UK listed companies. For groups, it will usually be necessary for the audit committee of the parent company to review issues that relate to particular subsidiaries or activities carried on by the group. Consequently, the board of a UK-listed parent company should ensure that there is adequate cooperation within the group (and with internal and external auditors of individual companies within the group) to enable the parent company audit committee to discharge its responsibilities effectively.

The chairman is pivotal in creating the conditions for overall board and individual director effectiveness, both inside and outside the boardroom. Specifically, it is the responsibility of the chairman to: _ run the board and set its agenda. The agenda should take full account of the issues and the concerns of all board members. Agendas should be forward looking and concentrate on strategic matters rather than formulaic approvals of proposals which can be the subject of appropriate delegated powers to management; _ ensure that the members of the board receive accurate, timely and clear information, in particular about the company's performance, to enable the board to take sound decisions, monitor effectively and provide advice to promote the success of the company; _ ensure effective communication with shareholders and ensure that the members of the board develop an understanding of the views of the major investors; _ manage the board to ensure that sufficient time is allowed for discussion of complex or contentious issues, where appropriate arranging for informal meetings beforehand to enable thorough preparation for the board discussion. It is particularly important that non-executive directors have sufficient time to consider critical issues and are not faced with unrealistic deadlines for decisionmaking; _ take the lead in providing a properly constructed induction programme for new directors that is comprehensive, formal and tailored, facilitated by the company secretary; _ take the lead in identifying and meeting the development needs of individual directors, with the company secretary having a key role in facilitating provision. It is the responsibility of the chairman to address the development needs of the board as a whole with a view

ROLE OF THE CHAIRMAN

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to enhancing its overall effectiveness as a team; _ ensure that the performance of individuals and of the board as a whole and its committees is evaluated at least once a year; and _ encourage active engagement by all the members of the board.

As members of the unitary board, all directors are required to: _ Provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enable risk to be assessed and managed; _ Set the companys strategic aims, ensure that the necessary financial and human resources are in place for the company to meet its objectives, and review management performance; and _ Set the companys values and standards and ensure that its obligations to its shareholders and others are understood and met. In addition to these requirements for all directors, the role of the nonexecutive director has the following key elements: _ Strategy. Non-executive directors should constructively challenge and help develop proposals on strategy. _ Performance. Non-executive directors should scrutinise the performance of management in meeting agreed goals and objectives and monitor the reporting of performance. _ Risk. Non-executive directors should satisfy themselves on the integrity of financial information and that financial controls and systems of risk management are robust and defensible. _ People. Non-executive directors are responsible for determining appropriate levels of remuneration of executive directors, and have a prime role in appointing, and where necessary removing, executive directors and in succession planning. Non-executive directors should constantly seek to establish and maintain confidence in the conduct of the company. They should be independent in judgement and have an enquiring mind. To be effective, non-executive directors need to build a recognition by executives of their contribution in order to promote openness and trust. To be effective, non-executive directors need to be well-informed about the company and the external environment in which it operates, with a strong command of issues relevant to the business. A non-executive director should insist on a comprehensive, formal and tailored induction. An effective induction need not be restricted to the boardroom, so consideration should be given to visiting sites and meeting senior and middle management. Once in post, an effective non-executive director should seek continually to develop and refresh

ROLE OF THE NON-EXECUTIVE DIRECTOR

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their knowledge and skills to ensure that their contribution to the board remains informed and relevant. Best practice dictates that an effective non-executive director will ensure that information is provided sufficiently in advance of meetings to enable thorough consideration of the issues facing the board. The non-executive should insist that information is sufficient, accurate, clear and timely. An element of the role of the non-executive director is to understand the views of major investors both directly and through the chairman and the senior independent director.

The Code provides that the remuneration committee should consist exclusively of independent non-executive directors and should comprise at least three or, in the case of smaller companies1, two such directors. The committee should: _ determine and agree with the board the framework or broad policy for the remuneration of the chief executive, the chairman of the company and such other members of the executive management as it is designated to consider2. At a minimum, the committee should have delegated responsibility for setting remuneration for all executive directors, the chairman and, to maintain and assure their independence, the company secretary. The remuneration of nonexecutive directors shall be a matter for the chairman and executive members of the board. No director or manager should be involved in any decisions as to their own remuneration; _ determine targets for any performance-related pay schemes operated by the company; _ determine the policy for and scope of pension arrangements for each executive director; _ ensure that contractual terms on termination, and any payments made, are fair to the individual and the company, that failure is not rewarded and that the duty to mitigate loss is fully recognised3; _ within the terms of the agreed policy, determine the total individual remuneration package of each executive director including, where appropriate, bonuses, incentive payments and share options; _ in determining such packages and arrangements, give due regard to the contents of the Code as well as the UK Listing Authoritys Listing Rules and associated guidance; _ be aware of and advise on any major changes in employee benefit structures throughout the company or group;

REMUNERATION COMMITTEE

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agree the policy for authorising claims for expenses from the chief executive and chairman; _ ensure that provisions regarding disclosure of remuneration, including pensions, as set out in the Directors Remuneration Report Regulations 2002 and the Code, are fulfilled; _ be exclusively responsible for establishing the selection criteria, selecting, appointing and setting the terms of reference for any remuneration consultants who advise the committee; _ report the frequency of, and attendance by members at, remuneration committee meetings in the annual reports; and _ make available the committees terms of reference. These should set out the committees delegated responsibilities and be reviewed and, where necessary, updated annually. This guidance has been compiled with the assistance of ICSA who have kindly agreed to produce updated guidance on their website www.icsa.org.uk in the future.
_

There should be a nomination committee which should lead the process for board appointments and make recommendations to the board. A majority of members of the committee should be independent nonexecutive directors. The chairman or an independent non-executive director should chair the committee, but the chairman should not chair the nomination committee when it is dealing with the appointment of a successor to the chairmanship. The committee should: _ be responsible for identifying and nominating for the approval of the board, candidates to fill board vacancies as and when they arise; _ before making an appointment, evaluate the balance of skills, knowledge and experience on the board and, in the light of this evaluation, prepare a description of the role and capabilities required for a particular appointment; _ review annually the time required from a non-executive director. Performance evaluation should be used to assess whether the nonexecutive director is spending enough time to fulfil their duties; _ consider candidates from a wide range of backgrounds and look beyond the usual suspects; _ give full consideration to succession planning in the course of its work, taking into account the challenges and opportunities facing the company and what skills and expertise are therefore needed on the board in the future; _ regularly review the structure, size and composition (including the skills, knowledge and experience) of the board and make recommendations to the board with regard to any changes; _ keep under review the leadership needs of the organisation, both

NOMINATION COMMITTEE

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executive and non-executive, with a view to ensuring the continued ability of the organisation to compete effectively in the marketplace; _ make a statement in the annual report about its activities; the process used for appointments and explain if external advice or open advertising has not been used; the membership of the committee, number of committee meetings and attendance over the course of the year; _ make available its terms of reference explaining clearly its role and the authority delegated to it by the board; and _ ensure that on appointment to the board, non-executive directors receive a formal letter of appointment setting out clearly what is expected of them in terms of time commitment, committee service and involvement outside board meetings. The committee should make recommendations to the board: _ as regards plans for succession for both executive and nonexecutive directors; _ as regards the re-appointment of any non-executive director at the conclusion of their specified term of office; _ concerning the re-election by shareholders of any director under the retirement by rotation provisions in the companys articles of association; _ concerning any matters relating to the continuation in office of any director at any time; and _ concerning the appointment of any director to executive or other office other than to the positions of chairman and chief executive, the recommendation for which would be considered at a meeting of the board. This guidance has been compiled with the assistance of ICSA who have kindly agreed to produce updated guidance on their website www.icsa.org.uk in the future.

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Corporate governance in Pakistan

Background Pakistan is an Islamic Republic and its capital is Islamabad. Its assets include a rich cultural heritage, abundant natural and human resources, a large and potentially more productive agricultural sector, and a strategic location for trade. Although Pakistan has been burdened by internal political instability and costly regional conflicts in its first 53 years of independence, it has still managed to achieve substantial economic growth. While Pakistans social welfare indicators have improved over the past two decades, progress remains slow and the challenges daunting. Only 40 percent of the population is literate, compared to the average literacy rate of 49 percent in South Asia and 53 percent in low-income countries worldwide. The economy has been slowly recovering since the second half of 1999 because of improved agricultural performance. However, the balance of payments remains fragile and the long economic stagnation hampers the governments efforts to reduce rampant poverty. Mediumterm economic prospects depend on political stability, structural reforms, and capital inflows.2

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Developments Since Pakistan gained independence in 1947, the Republic has been under military rule for 50 percent of the time. The current government is headed by a military regime that came into power on 12 Oct 1999. The Constitution was promulgated in 1973 and includes articles covering the Annual Budget, Federal Consolidated Fund and the appointment and duties of the Auditor-General. In 1951 the Institute of Cost and Management Accountants was formed and legally established in 1966. In 1961 the Institute of Chartered Accountants of Pakistan was legally established. In 1984 the Pakistan Institute of Public Finance Accountants of Pakistan was legally established under the Companies Act. The accounting profession in Pakistan is strong and accounting and auditing standards are well established and based on International Accounting Standards (IAS).
2

Asian Development Bank. 2000. Asian Development Outlook 2000. p. 143.

Principles of Corporate Governance in Pakistan

A 2005 Report on the Observance of Standards and Codes (ROSC) on Corporate Governance by the World Bank states that there have been significant reforms improving corporate governance in line with international best practices in Pakistan. In 2002, the Securities and Exchange Commission (SECP) introduced a Code of Corporate Governance thereby establishing a framework for good corporate governance practices for listed companies. The Code is a result of joint efforts of the SECP and Institute of Chartered Accountants of Pakistan. A 2004 International Monetary Fund Financial System Stability Assessment report reiterated that Pakistan's corporate governance regulations are "extensive and comprehensive" and the Code of Corporate Governance is broadly in line with Organization for Economic Cooperation and Development (OECD) Principles. Nonetheless, weaknesses persist and the World Bank assessment recommended that compliance be improved in three main areas: disclosure of beneficial ownership, reporting of related party transactions, and rules on Annual General Meetings. Further, the report finds that ownership is concentrated, thereby limiting the influence of minority shareholders. The report also observes that the Code is weak with regards to the provisions for independent directors. A 2006 paper by Haroon H. Hamid and Valeria Kozhich further adds that the definition of "independent" covered in the Code does not address minority shareholder rights. Also, the World Bank finds that the fiduciary duties for board of directors are relatively under-developed in Pakistani law.

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Ensuring the Basis for an Effective Corporate Governance Framework

The 2005 World Bank assessment rates Pakistan's observance with the subprinciples of Principle I as follows: "Overall corporate governance framework" was rated as "observed" indicating that all essential criteria are met without significant deficiencies. "Legal framework enforceable, and transparent," "Regulatory authorities have sufficient authority, integrity and resources" and "Clear division of regulatory responsibilities" were rated "largely observed" indicating that only minor shortcomings are observed that do not raise questions about the authorities' ability and intent to achieve full observance in the short term. The IMF's Financial System Stability Assessment conducted in 2004 concluded that Pakistan's corporate governance regulations are extensive and comprehensive. In addition to the detailed corporate governance provisions in the Company Ordinance the report points out that the SECP "issued a detailed Code of Corporate Governance in March 2002 for all listed companies that is broadly in line with OECD Principles" (p. 23). The SECP ensures compliance with the law, the Code and the listing requirements for listed entities. However, the Hamid and Kozhich paper notes that the "comply or explain" regime does not allow an active monitoring role for the SECP. Listed companies only require a statement of compliance signed by a verified accountant and compliance may not always be achieved. The World Bank recommended that the SECP should work towards building its enforcement capability. The report added that "key steps include increasing the technical level of staff in key areas (particularly legal and accounting experts), continuing to define enforcement priorities, and refining enforcement procedures" (p. 5). The State Bank of Pakistan (SBP) is the central bank and is responsible for regulating the banking and financial sector. In addition to the Code, banks must comply with the Prudential Regulations of the SBP and the Banking Ordinance of 1962. The Hamid and Kozhich paper notes that "regulations for banks are more stringent and detailed than those for other listed companies" (p. 23).

The Rights of Shareholders and Key Ownership Function

The 2005 World Bank assessment rates Pakistan's observance with the subprinciples of Principle II as follows: "Basic Shareholder rights," "Shareholders should be allowed to consult with each other," "Shareholder's Annual General Meeting rights," and "Rights to participate in fundamental decisions," were rated "largely observed" indicating that only minor shortcomings are

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observed that do not raise questions about the authorities' ability and intent to achieve full observance in the short term. "Disproportionate Control Disclosure" and "The functioning of control arrangements" were rated as "Partially Observed," indicating that while the legal and regulatory framework complies with the Principle, practices and enforcement diverge. "The exercise of ownership rights by all shareholders" was rated "materially not observed" indicating that despite progress, deficiencies raise doubts on the authorities' ability to achieve observance. The 2006 paper by Hamid and Kozhich explains that the definition of "independent" covered in the Code does not address minority shareholder rights. The paper adds that the voluntary nature of this provision is indicative of the fact that "minority shareholder protection is not yet valued highly in Pakistani corporate sector" (p. 26). Moreover, the paper points out that there are no penal provisions in the Code to act as a deterrent. The World Bank noted that overall, the legal framework for basic shareholder rights is well established in Pakistan, and only relatively minor changes are needed in this area. However, other areas require improvements and the World Bank made recommendations including introduction of distance voting for the Annual General Meeting, by post or electronic means, prohibiting significant shareholders from voting when a conflict of interest is present and lowering the thresholds for shareholder action against companies and directors.

The Equitable Treatment of Shareholders

In its 2005 Corporate Governance Country Assessment, the World Bank rated Pakistan's observance with the sub-principles of Principle III as follows: "Prohibit insider trading" was rated as "partially observed," indicating that while the legal and regulatory framework complies with the Principle, practices and enforcement diverge. "Equitable treatment of shareholders," and "Board/management disclose interests" were rated as "largely observed," indicating that only minor shortcomings are observed which do not raise questions about the authorities' ability and intent to achieve full observance in the short term. The World Bank notes that the Securities and Exchange Ordinance of 1969 (SEO 1969) regulates insider trading, and the laws are enforced by the SECP, which has also issued Insider Trading Guidelines. Any "associated" person is prohibited from trading in his or her company's shares if he has information not "generally available", and which would affect the price of the securities, or related to any company transaction. "Associated" people include officers, employees, and any person with a "professional or business relationship which gives [them] access" (p. 18).

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Following the assessment a number of recommendations were made and the World Bank noted that although shareholders are required to disclose direct and indirect ownership, market participants cautioned that generally only direct ownership is reported. Also, many shareholders avoid this requirement by holding less than the 10 percent threshold. The World Bank recommended that the requirement for shareholders to disclose indirect ownership should be clarified in the law. Further, companies should be required to disclose a list of significant shareholders in their annual report and shareholders should disclose all shareholder agreements.

The Role of Stakeholders in Corporate Governance

In its 2005 Corporate Governance Country Assessment, the World Bank rated Pakistan's observance with the sub-principles of Principle IV as follows: "Performance-enhancing mechanisms" and "Stakeholder rights respected" were rated "observed" indicating that all essential criteria are met without significant deficiencies. "Redress for violation of rights" and "Stakeholders rights to communicate concerns about unethical and illegal practices to the board" were rated "partially observed" indicating that while the legal and regulatory framework complies with the Principle, practices and enforcement diverge. "Access to information" and "Effective insolvency framework and creditor's rights" were rated as "largely observed," indicating that only minor shortcomings are observed, which do not raise questions about the authorities' ability and intent to achieve full observance in the short term. The World Bank assessment explains that creditor protection used to be weak in Pakistan, however, significant reform has taken place since. For instance, the establishment of Banking Courts and legal changes to facilitate the collection and resale of collateral has improved the protection of creditors' rights. In addition, the report adds, "a variety of standard measures developed by the World Bank for 130 countries confirm that compared to its regional neighbors, Pakistan has relatively strong creditor rights" (p. 20). The report adds that while employees do not have a right to sit on boards, they are represented by works councils. Creditors can nominate directors to the board "by virtue of contractual agreement" and some companies have also started to adopt whistleblower policies. The World Bank explains that "labor/trade unions have a 'collective bargaining agent' who presents the grievances of employees on their behalf. However there is no specific whistleblower protection under the law" (p. 20).

Disclosure and Transparency

In its 2005 Corporate Governance Country Assessment, the World Bank rated Pakistan's observance with the sub-principles of Principle V as follows: "Disclosure standards," "Independent audit annually," "Standards of

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accounting and audit," "Fair and timely dissemination" and "Disclosure of conflicts of interests by analysts, brokers, rating agencies etc." were rated as "largely observed," indicating that only minor shortcomings are observed, which do not raise questions about the authorities' ability and intent to achieve full observance in the short term. "External auditors should be accountable to shareholders" was rated as "partially observed," indicating that while the legal and regulatory framework complies with the principle, practices and enforcement diverge. According to a 2003 publication by Cheema, Bari and Siddique, the Companies Ordinance provides a regime for detailed financial disclosure requirements and, more specifically, Section 233 of the Ordinance mandates the presentation by directors of a balance sheet and a profit and loss account at every annual general meeting. These reports are to be accompanied by an auditor's report and a director's report required to be made available to every member of the company, the SECP, the stock exchange and the Registrar. Nevertheless, the World Bank notes that although Pakistan has a Code of Corporate Governance in place since 2002, there are no disclosure requirements regarding employees and other stakeholders in the law or Code. With regards to financial reporting, according to the 2005 Accounting and Auditing Report on the Observance of Standards and Codes (ROSC) by the World Bank, Pakistan has "largely" adopted International Financial Reporting Standards (IFRS) as promulgated by the SECP in consultation with the Institute of Chartered Accountants of Pakistan (ICAP). Pakistan has also adopted International Standards on Auditing (ISA) without any modifications, however it is unclear whether all the latest revisions made by the International Auditing and Assurance Board have been incorporated. Further, members of ICAP must follow the Code of Ethics, revised in 2003 to comply with the IFAC Code.

The Responsibilities of the Board

In its 2005 Corporate Governance Country Assessment, the World Bank rated Pakistan's observance with the sub-principles of Principle VI as follows: "Board should act on a fully informed basis, in good faith, with due diligence and care," "Treat shareholders fairly," "The board should fulfill certain key functions" and "The board should be able to exercise objective judgment" were rated "partially observed" indicating that while the legal and regulatory framework complies with the Principle, practices and enforcement diverge. "Access to information" was rated as "observed," indicating that all essential criteria are met without significant deficiencies. "The board should apply high ethical standards" was rated "largely observed" indicating that only minor shortcomings are observed, which do not raise questions about the authorities' ability and intent to achieve full observance in the short term.

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The 2003 Cheema, Bari and Siddique report explains that the "major thrust" of the Code of Corporate Governance was to "restructure the board of directors in order to make it accountable to all shareholders; to strengthen internal control systems of corporations; to foster better disclosure and to strengthen internal and external audit requirements of listed companies" (pp. 182-183). The report also points out that "the Code makes a bold attempt at giving some definite shape and direction to the role of the Chairman of the BODs [Board of Directors] in Pakistan's Corporate Governance environment" (p. 184). However, according to the World Bank, fiduciary duties are relatively under-developed in Pakistani law. The assessment notes that "existing fiduciary duties are based primarily on a limited amount of case law, which is sparse and emphasizes loyalty to the company (not shareholders) and the provisions on conflict of interest in the Companies Ordinance (CO)" (p. 25). Pakistan has been taking a few initiatives in that direction and in 2004 the Pakistan Institute of Corporate Governance (PICG) was established to provide an enabling environment for effective implementation of the Code of Corporate Governance. The World Bank observed that the PICG can play a major role in the development of implementation guidelines for boards, and for audit committees. The assessment found the Code's provisions for independent directors relatively weak and recommended that independence provisions of the Code be clarified. In addition, it recommended that the Code should contain an explicit recommendation/requirement that companies should pay adequate compensation to all board members.

Framework of good corporate governance in Pakistan

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PAKISTAN'S INSTITUTE OF CORPORATE GOVERNANCE

The Securities and Exchange Commission of Pakistan (SECP) will be establishing an Institute of Corporate Governance. According to the press reports, the SECP Chairman, at a press conference on 2nd October 2002, explained the salient features of the project being launched in collaboration with the UNDP. The Resident Representative of UNDP was also present on the occasion. UNDP has reportedly committed $100,000 for the project that

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aims at developing a sound corporate governance framework in Pakistan. The SECP Chairman, appreciating the UNDP for its support for the project, said that the joint programme would lead to making Pakistan an attractive destination for domestic and foreign investors. The aims of the Institute, as gathered from the press reports, largely are: to train SECP's own staff and that of stock exchanges in managing the equities market in conformity with the best practices; to impart training to the directors; and to create awareness about principles of good corporate governance. Speaking on the occasion the Resident Representative said that the cooperation between UNDP and SECP is a modest example of what the UN Secretary General appealed for under the UN global pact inviting the business community to take more responsibility particularly the social responsibility. The code of corporate governance he hoped would help strengthen investors' confidence and investment environment. He assured to support the SECP's efforts to revive investors' confidence, alleviate poverty and enforce code of corporate governance. The SECP Chairman said that it had taken several steps to improve governance structure of the three stock exchanges and to infuse discipline in the capital market. While acknowledging the role of the brokers, he was of the view that only those markets had developed where exchanges were run independently of the brokers. According to him, the reforms were devised by the SECP carefully by reviewing the situation prevailing in the country and only those measures were to be enforced that could be absorbed by the market. He said that SECP plans to introduce long-term reforms in the corporate sector, with prime focus on corporate governance. He said that through this ICG initiative, the SECP would further its objective of enforcing the code of corporate governance and that it is looking for assistance in order to build up the capacity, train the staff, create awareness about what good norms of good corporate are and how they should be implemented in letter and spirit. The SECP reforms are building investors' confidence. More reforms are still needed in many areas and we should all be supporting the reform efforts. Encouraged by the SECP Chairman who is looking for assistance in order to build up the capacity, I thought of sharing my views on ICG with him and other stakeholders, through this article. JUSTIFICATION OF A NEW INSTITUTION: The SECP is embarking on training in an area for which there has presumably not been much activity in the past. The setting up of ICG will certainly help in many ways. ICG will be catering to the needs of diverse groups. One group is the Regulator while other groups are the Regulated. Close liaison is expected to help better appreciate the matters. However, the question that comes to mind is why but could we not get all such training done through the existing institutes

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such as ICAP, ICMAP, NIPA, IBA, LUMS or the SBP Institute at Islamabad, to name a few. These institutions have lot of experience in business and management areas and surely each one could contribute much if specialized courses were required to be developed for the benefit of SECP professionals / employees, stock exchange officers and the directors on the boards of different listed or other public / private companies in Pakistan. The CBR has very recently signed an MOU with the IBA to start an " MBA-tax management degree programme", the objective of which is to equip all grade-17 officers of the CBR (income tax and customs groups) with business and management education (daily DAWN - 6th October). This will reportedly be a two-year programme culminating in an MBA degree Tax Management). Each year approximately 40 to 50 officers of the CBR will undergo this mandatory programme. SPECIALIZED ACTIVITIES AND AFFILIATION: It has been said that the ICG activities aim at training SECP officials, the officials of the stock exchanges and the Board of Directors. It is felt that the SECP purpose will be served better if the list of ICG activities is expanded to also include more topics such as: (1) training of Corporate Secretaries, the CEOs and possibly the CFOs, (2) preparation of research reports on corporate issues and matters, (3) the ICG magazine to contain articles, guidelines and reviews on various corporate matters (4) ICG to develop expertise to mediate in conflicts resolution in corporate matters. The list can be further improved in consultation with the FPCCI and the business / corporate sector. Initially the institute can be affiliated with the Karachi University or other appropriate universities, and at a later stage the institute may seek approval for authority for awarding degrees. PUBLIC-PRIVATE PARTNERSHIP: ICG can be sponsored and nurtured by the SECP. However, with a view to make it an independent and credible institute, it is considered appropriate that it is sponsored, owned and implemented jointly with FPCCI, various CCIs, prominent business houses and industrialists. The SECP Chairman may consider taking up the matter with the FPCCI and the stock exchanges for collaboration. ICG should be formed as an educational trust. From government side SBP, MOF, CBR, SMEDA, BOI may join hands with the SECP. The board of governors may have the Chairman from the government but the Chief Executive should be from the private sector. Equal number of governors may be from private and public sectors. In addition there should be minimum two governors who are independent professionals or retired educationists of repute. ADB and IFC may perhaps agree to participate in various ways. The UNDP and other such agencies may be approached to provide technical know-how and material support to make the institute operational before the start of next financial year. The Government has been encouraging public-private partnership and it is felt that the ICG is a fit case for such cooperation.

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CAPITALIZATION AND ENDOWMENT FUND: ICG may be capitalized well and should start with large endow fund to meet future financial needs. The capital may be raised in phases over about three years time. Loans may not be considered as an option for meeting part of the cost. To start with the Endowment Fund as a minimum should be equal to the capital budget for the construction and implementation of the institute. A system may be introduced for future so that the Fund continues growing with the training of officers and the publication of the research studies. This way the institute will not be relying on continued government or private contributions and is expected to be able to maintain its independence. LOCATION OF THE MAIN CAMPUS: ICG may be located preferably at or around Karachi. Karachi has the largest stock exchange of the country and also has perhaps the headquarters of the largest number of listed companies. Most of the trainees might be from Karachi and so shall be the opportunities of writing research reports by the ICG faculty and other staff. Later zonal offices of ICG may be set up at other appropriate locations. Karachi may also be the best place to provide accommodation to the ICG if it is decided to make the institute operational before the start of next financial year. START OF ACTIVITIES: ICG initially can start in a make shift building taken on rent or acquired otherwise from the government until the purpose-built campus is developed and becomes functional. This approach will help maintain momentum in the corporate reforms and help develop a healthy corporate culture. For the training of directors initially topics such as preparation of mission statements and objectives; preparation of strategy and policies coupled with detailed procedures and processes; devising and implementing internal controls and avoidance of conflicts of interest; etc. may be given priority. THE TEACHING FACULTY: Good faculty and an experienced Executive Director are a pre-requisite for starting well any training institute. Initially work can be started with core faculty. However, more reliance shall be on visiting faculty drawn from the SECP, CBR, existing institutes providing specialized financial courses, retired government officers and experienced officers from stock exchanges, trade and industry. As more experienced is gained, the number of regular faculty and other staff can be increased later. LIBRARY FACILITIES: There is immense importance of a proper and wellstocked library for any training institute. For ICG it is more so, as it is an institution that has been sponsored by the regulator of corporate entities, NBFIs, insurance companies, etc. and there the library must be the repository of all the relevant material and reports.

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STUDIES ON CORPORATE ISSUES AND RESEARCH REPORTS: SECP may prepare tentative list of issues on which research reports need to be developed. The topics might appear far-fetched but as long as these relate to corporate matters, may be included in the probable list of the research reports. For setting the ball rolling, some of the topics for research reports or studies are: (1) a Director should not act as the Company Secretary as well; (2) Executive Directors not to have a vote when the Board is reviewing company performance; (3) should there be a list of authorities / powers that the Board can never delegate to the CEO or the Chairman, or ant other office; (4) policy for making public the minutes of the Board meetings, after two weeks; (5) separation of the position of the CEO and the Chairman; and (6) paying handsome salary or compensation to the independent directors. USE OF CONSULTANTS: It might not be possible for the ICG staff to carry out on timely basis all the desired or priority research reports. Possibly outside consultants may have to be associated. Rules and procedures for hiring such consultants and getting useful work out of them may be got developed. The international financial institutions use the consultants very often and so have developed requisite guidelines. These guidelines might be modified to suit ICG needs. TASK FORCE FOR IMPLEMENTATION: The Board of Governors of ICG might consider constituting a task force to take actions for implementation. This task force to have two sets of responsibilities. One set shall pertain to immediate start of training and research reports activities. The other shall pertain to the implementation of the ICG on proper lines, encompassing activities such as be the selection of the land for the permanent campus, development of the building plans, preparation of the cost estimates and the award of construction contract and the monitoring of quality of work and physical progress. The task force should submit monthly progress reports to the BOG. Two different task forces may not achieve the results as each team will be acting to prolong its existence and there may be in fighting as well.

Overview of recent corporate governance reforms

The need for enhanced corporate governance has been spearheaded by the Securities and Exchange Commission of Pakistan (SECP), the principal regulatory authority for corporate entities and non-banking financial institutions. The State Bank of Pakistan has also introduced certain codes of corporate governance for banks and development financial institutions operating in Pakistan. These require the adoption of certain governance structures and include provisions on board membership, management executives, compliance officers, dealings with shareholders and credit rating.

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The SECP Code of Corporate Governance, which contains both mandatory and voluntary provisions, was enforced in stages and is now effective in its entirety. However, many executive directors have criticised it for severely restricting the management of listed companies and requiring excessive and costly disclosures. In several cases majority shareholders have bought out minority shareholders to secure delisting, upon which the code ceases to apply. February 2004 saw the first major test to the codes implementation. The code requires a change in auditors every five years, or at the very least a change in the auditing firm partner responsible for the audit; but several auditing firms have challenged this provision before the courts and have obtained an interim order suspending its enforcement. The case may have serious implications, with the directors of a number of listed companies willing to defy the code on the basis that delisting is the worst punishment they can suffer. Despite this resistance, the SECP is determined that the code be implemented, and is reviewing its effectiveness and levels of compliance. It is expected that the SECP will continue to suggest revisions to the code and will issue further regulations applicable to listed companies.

Shareholders rights
Shareholders have the right to attend, speak and vote at all general shareholders meetings. The shareholder may also appoint a proxy to attend the meeting in his place. Unless the articles of association provide otherwise, the proxy must be a shareholder of the company Pakistan companies must hold at least one general shareholders meeting each year to approve the annual accounts. The shareholders may also be required to transact any special business at an annual general meeting. Alternatively, an extraordinary general meeting may be convened. Shareholders representing at least one-tenth of the total voting rights may propose a resolution for adoption at least 15 days before the date of the general meeting. The company must circulate a copy of the proposed resolution and all material information. Shareholders representing at least one-tenth of the voting rights may also request that a meeting be convened to discuss a particular issue. The request must state the object of the meeting and provide all material information. If the directors fail to convene the meeting within 21 days of receipt of this request, the shareholders may call the meeting themselves. All reasonable expenses incurred in convening the meeting must be

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reimbursed to the shareholders, and may be offset against payments due to the defaulting directors.

Quorum and voting requirements

A general shareholders meeting may only proceed to business if there is a quorum present. The articles of association usually specify the quorum required. However, in the case of a listed company, at least 10 shareholders must be present personally, and the shareholders present in person or by proxy must represent at least 25 per cent of the total voting power. Matters before the general meeting are usually decided by a show of hands, with the shareholders present in person voting. However, a poll may be demanded by the chairman of the meeting, by at least five shareholders or by one shareholder representing at least one-tenth of the total voting rights. On a poll, each shareholder present in person or by proxy has one vote. The demand for a poll may be withdrawn at any time. If a poll is required on a question of adjournment or appointment of the chairman of the meeting, it must be taken at that meeting; a poll on any other matter may be adjourned by the chairman for up to 14 days. The nominees of the chairman and, where a poll is demanded by the shareholders, a nominee of the shareholders, must be appointed as scrutineers. Most matters before the shareholders meeting are decided by simple majority vote of those present at the meeting. However, decisions on certain matters require a special resolution, passed by at least three-quarters of the shareholders present at the meeting. Right to question directors, officers and auditors All general shareholders meetings are chaired by the chairman of the board of directors, or if he is not present, by the chief executive or another director. Shareholders may question the directors about items on the agenda. Most questions are answered by the chairman or other executive directors present. With the permission of the chairman, shareholders may also ask questions of other officers, including the auditors. However, in practice this only occurs where the chairman seeks the assistance of an officer to respond to any issue raised by the shareholders.

Election of directors
The directors of a company must be elected by the general shareholders meeting. Directors are elected for a fixed term of three years, although retiring directors may stand for re-election unless otherwise ineligible for appointment.

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Right to inspect corporate records

Shareholders have the right to inspect the various corporate records and registers maintained by companies. Generally, these are open for inspection during business hours, subject to such reasonable restrictions as the company may impose. Shareholders may also take copies of or extracts from the shareholder register. Additionally, shareholders are entitled to request copies of the minutes of general meetings. However, they may not inspect the accounts or similar records unless specifically authorised to do so by the directors.

Disclosure of shareholdings
All directors, together with the chief executive, managing agent, secretary, chief accountant, auditor and legal adviser, must file a return of beneficial ownership to the registrar of companies and the SECP. This rule also applies to all shareholders directly or beneficially holding more than 10 per cent of the share capital of a listed company. Subsequent acquisitions and disposals must be reported within 15 days.

Protection of minority shareholders

Shareholders representing at least one-tenth of the share capital may challenge the proceedings conducted at a general meeting, or request the SECP or the court to appoint an inspector to investigate the companys affairs. Where such rights are exercised on the basis of allegations of mismanagement or oppression, the minimum threshold is 20 per cent. It is also possible to bring derivative actions in Pakistan, although these are only available against wrongdoers who are insiders of the company and in control of the companys affairs. Derivative actions are not available where the company is in liquidation.

The state as shareholder

The state continues to hold significant stakes in a number of listed companies. The law makes no special provision for the state as shareholder, except in regard to the appointment and removal of directors: the state may appoint and remove any person it chooses without having to follow the election procedure. However, any individual thus appointed must be eligible for election. The number of directors which the government may appoint is proportionate to its shareholding in the company.

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Institutional investors as shareholders

The government is trying to encourage investment in listed companies by institutional investors. Foreign exchange regulations have been liberalised to facilitate investment and repatriation by foreign institutional investors. Domestic provident, pension and gratuity funds for employees can no longer invest in the high-yield National Savings Scheme, and are thus looking to the stock market for improved returns. Insurance companies are also active investors. However, as yet institutional investors do not actively assert their shareholder rights. There are no groups of such shareholders contributing towards the formulation of standards for corporate governance. It was partly to remedy this situation that the SECP code was developed for incorporation into the stock exchange listing rules. The code also governs insurance companies, whether listed or unlisted.

Management structure and the role of directors

Structure Most listed companies have a single board of directors and manage the company through the chief executive, who is responsible for the companys day-to-day operations under the supervision of the board. Some listed companies, particularly those with foreign investment, also have a management committee to assist the chief executive, although such committees have no legal status under company law or the articles of association. A listed company must have at least seven directors, although no maximum is prescribed. The SECP code recommends that no more than 75 per cent of the directors of a listed company be executive directors, and that there be at least one independent director representing the equity interests of institutional investors. Under the SECP code, an independent director has no personal or financial connection to the listed company, or its promoters, directors or affiliates. The test of independence principally involves whether that person can be reasonably thought able to exercise independent business judgement without any interference.

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In practice, listed companies must have at least two non-executive directors, since they are obliged to establish an audit committee and these generally require two non-executive directors.

Election

The election procedure is an open process and allows for the possibility of minority representation on the board. However, the proposed candidate must be eligible for election, and must confirm that he is aware of the duties and obligations of a director and consent to serve as a director if elected. At the election, each shareholder has votes in proportion to his shareholding and the number of directors to be elected. A shareholder may cast all his votes in favour of one candidate or divide them between the candidates as he chooses. The candidates with the highest number of votes are elected as directors. There are no specific qualification requirements or age limits for appointment as a director of a listed company. However, certain persons are considered ineligible for such appointment. In addition, while no longer a legal requirement, most listed companies continue to include a shareholding requirement in their articles of association. The appointment of directors must be reported to the registrar of companies and to the stock exchanges. Moreover, the authorisation of the State Bank of Pakistan is required for any change in the directorship of banks, and certain additional eligibility criteria apply for the appointment of directors of banks. Term of office

The term of office of an elected director is three years. If a director is appointed to fill a casual vacancy, he will hold office for the remainder of the term for which his predecessor was elected. A companys first directors, who are designated as such at the time of its incorporation, hold office until the first annual general meeting, when the first election of directors must be held. Directors duties

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The companys business must be managed by the directors. In the event of winding up, the court may investigate the conduct of a director and compel him to restore assets and pay compensation where he is found guilty of any misfeasance or breach of trust or his duties in relation to the company. If it appears in the course of winding up that any business has been conducted with intent to defraud creditors or for any fraudulent purpose, the court may hold any knowing parties to such conduct personally responsible for the debts or other liabilities of the company. However, these powers have rarely been invoked against directors. In recent publications explaining the SECP code the SECP has drawn attention to actions abroad seeking to hold directors personally liable to the company, its shareholders and third parties. The code also seeks to emphasise the responsibilities of directors in a way that encourages shareholders and others to consider taking action against directors in appropriate cases. This approach has not yet resulted in the initiation of such actions, although it may well eventually set a trend requiring directors to defend their conduct in court. The currently accepted rule is that the directors owe a fiduciary duty to the company. There have been no reported instances of derivative actions, even though it is widely understood that shareholders may sue on behalf of a company in respect of a wrong done to the company where the company cannot do so in its own name. The courts may also develop the common law in a way which recognises that in certain circumstances, such as insolvency or near insolvency, the directors additionally owe a duty to creditors, although as yet they have not had the opportunity to make observations indicating a definite trend in this direction. A director can obtain indemnification for liability incurred by him in defending civil or criminal proceedings in which judgment is given in his favour or where he has been discharged from liability upon application to the court. Insurance coverage can also be made available. However, no indemnification is available where civil or criminal proceedings against the director are successful. Criminal prosecution against a director will generally follow from winding up where the court finds that the director defrauded creditors in any way. A prosecution may also follow for falsification of company books and papers. During winding up, the court also has the power to compel a director to repay any assets which he misapplied or unlawfully retained, or to compensate for any misfeasance. The SECP code does not insist on the separation of the offices of chairman and chief executive. There are no restrictions on the positions that individual

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board members may hold, except that an auditor cannot be a director of a company. A director may be removed from office by shareholders resolution. Operations of the board

Meetings of the board of directors may be convened at the request of the chairman or any director. Responsibility for managing board procedure rests with the chairman of the board. The agenda is prepared by the chairman together with the chief executive and the company secretary. Generally, management determines which papers and other materials must be presented to the board, although the directors may at any time demand additional information. The directors have unrestricted access to all company books, records, papers and properties, and this right of access is enforceable by the court. The SECP code recommends that the agenda of board meetings and complete details of agenda items, including working papers, be circulated along with notices of board meetings at least seven days before the meeting. The agenda commonly provides for the pursuit of any other business with the chairmans permission. The board must meet at least once each quarter. The company must keep an attendance register, and the SECP code now requires the annual directors report to specify the number of meetings held and the attendance record of each director. The chairman of the board presides at all board meetings. If the chairman is absent, the directors will decide on a chair generally another senior director. Each board has its own procedures in this regard. Decisions of the board are recorded in the minutes book. It is left to the board to determine how detailed these minutes must be. Generally, individual votes for a proposed resolution are not recorded, except in case of dissent. The minutes should also record abstentions and any conflicts of interest which prevented a director from voting. The minutes book is not open for inspection by the shareholders. The articles of association normally allow the directors to delegate certain powers to special committees. However, the board alone can deal with matters relating to: issuance of shares or debentures;

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 declaration of interim dividends; approval of accounts; payment of bonuses to employees; disposal and acquisition of assets beyond a specified value (PRs1 million for acquisitions and PRs100,000 for disposals); granting of loans; investment decisions; the borrowing of money; certain write-offs; and compromising claims and lawsuits. Board committees are legally recognised, although the only committee which listed companies are obliged to establish under the SECP code is the audit committee. This committee: approves the appointment and removal of external auditors for recommendation to the shareholders; reviews the companys financial statements prior to their approval by the board; reviews the scope and extent of the internal audit function, and ensures that this has adequate resources and is appropriately placed within the company; considers major findings of internal audit investigations and managements response thereto; and assesses the effectiveness of the internal control system, including financial and operational controls, the accounting system and the reporting structure. Pakistan companies do not usually have a nomination committee. Remuneration committees are commonly found in listed companies with foreign investment, although they are rare in other companies. Since the directors generally meet once a quarter, many well-organised companies also have an executive committee.

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Where board committees are established, the board resolution setting up the committee will normally specify its decision-making powers, and the responsibilities and procedures to be followed. The composition of each committee is also determined by the board and may be varied from time to time; however, the SECP stipulates that the audit committee must comprise a majority of non-executive directors and that the chairman also be a nonexecutive director. It is not usual to record the votes of individual committee members, although dissent will generally be recorded. The minutes of committee meetings are typically presented to the board for approval. Minutes of committee meetings are not open for inspection by shareholders. Executive officers

The positions of chief executive officer (CEO), chief financial officer (CFO), company secretary and internal auditor are all mandatory in listed companies. The CEO and CFO are generally elected directors. The general counsel or chief legal officer of a company is seldom a member of the board and plays no formal role in corporate governance. This officer often doubles as the company secretary. The company secretary is generally a full- time employee designated as such, although this does not preclude him from holding an additional executive position. The company secretary attends board meetings and general shareholders meetings and records the minutes. Other responsibilities include: the issue of notices by order of the board; maintenance of the shareholder register and share transfer register; and the issue of an annual secretarial compliance certificate, certifying that the secretarial and corporate requirements of company law have been duly observed. Remuneration Directors remuneration is usually determined by the board or, where the articles of association so provide, by the general shareholders meeting. Bonus schemes are common and are generally related to the companys performance, especially in companies with foreign investment. Incentives in the form of stock or stock options are also common in companies with

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foreign investment, where the incentives are typically provided by the parent company abroad. The remuneration and terms and conditions of the CEO are notified to the shareholders, and the annual reports and accounts must disclose the remuneration and benefits of the CEO and the directors. Conflicts of interest

A director of a listed company who has a direct or indirect interest in any contract or arrangement to which the company is or intends to be a party must disclose the nature of this interest at a meeting of the directors. Where a director or his relative has such an interest, he may not deliberate or vote on the matter, and his presence does not contribute to the formation of a quorum. Where a director represents a substantial shareholder, he should consider himself as having an interest and proceed on that basis. SECP guidelines on insider trading prohibit directors, senior executive officers and individual shareholders holding at least 10 per cent of the companys issued shares from dealing in the companys shares on the basis of unpublished price-sensitive information. Under the SECP code, listed companies must specify a closed period prior to the announcement of interim and final results, or any business decision which may materially affect the market price of their shares, during which no director or executive may deal in the companys shares. Where a director, CEO, managing agent, chief accountant, secretary, auditor or beneficial owner of 10 per cent or more of the issued shares of a listed company obtains a financial advantage through the sale and subsequent purchase or purchase and subsequent sale of the companys shares within a six-month period, this must be tendered to the company. Codes of conduct

The SECP code requires the boards of directors of listed companies to provide for a code of conduct which the company and its personnel must observe. Non-compliance constitutes a breach of the listing rules and could affect the listing of the companys securities. Subject to this requirement, compliance is left to each individual company Apart from issues relating to taxation, related-party transactions are governed by company law. All such transactions must be shown to have been concluded on an arms-length basis. The SECP code requires the approval of all such transactions by the audit committee and the board of directors. Disclosure

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In addition to reporting on the financial statements and accounting notes, the annual directors report must report on the state of the companys affairs, and disclose any material changes affecting its financial position or the nature of the business. Where a loss is incurred, this must be explained. The report must also provide a reasonable indication of future profit prospects. Debt defaults must also be fully disclosed and explained. The directors of a listed company are criminally liable for failure to comply with these statutory disclosure requirements. Accounts and audits

Pakistan companies must publish quarterly accounts which must be reviewed by the auditors, and annual account statements which must be audited. The directors are responsible for the accuracy of these accounts and for their conformity with applicable international accounting standards. The auditor is appointed for a single term of one year, although the shareholders may renew the appointment from year to year on the recommendations of the board and the audit committee. Only a chartered accountant may be appointed as an auditor. Chartered accountants must be members of a professional body whose disciplinary procedures are subject to SECP supervision. The SECP code restricts auditors from carrying out non-audit work for the company. The auditors liability for any inaccuracies depends on whether they were negligent in performing their duties. Primary responsibility in this respect rests with the directors. The SECP code aims to minimize accounting fraud in listed companies by making the CEO and CFO directly liable as signatories to the financial statements which are presented to the board for approval, and by requiring that an audit committee recommend whether such accounts should be approved. Audits in listed companies must be conducted in accordance with international accounting standards. The auditors must report to the board of directors on any irregularities of which they become aware. They need not report directly to the regulators. Enforcement

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The enforcement of corporate governance regulations set out in the Companies Ordinance is considered to be adequate and effective. The SECP code reinforces these regulations by requiring the stock exchanges to incorporate its provisions in their listing rules. Enforcement of the SECP code is thus effectively left to the stock exchanges, which can punish contraventions through delisting. However, the true value of the code lies in how it has increased shareholder and public awareness of managements accountability, and enabled them to question non-compliance. The system is designed to win eventual acceptance from stakeholders and other market players, and aims to establish standards by which the courts may judge the conduct of directors. However, certain provisions such as the requirement that the auditors be changed every five years are viewed as unnecessary bureaucratic interference in corporate management and there is thus some resistance to the code. It is of vital importance that shareholders enforce the code by asserting their rights through corporate procedure, and where necessary through the courts, as this will create a healthy environment for investment in and management of companies. As excessive regulation tends to inhibit investment, such regulation should be kept to the bare minimum necessary to protect stakeholders interests. While criminal prosecutions play an important part in safeguarding the public interest, it is neither necessary nor desirable that criminal enforcement be extended to all aspects of corporate governance. The current trend of encouraging whistle blowing by rewarding and protecting whistleblowers has not as yet manifested itself in Pakistan, although companies with US affiliations are bound by formal regulations in this regard. Ultimately, companies should formulate their own whistle blowing policies based on their individual circumstances. Outside lawyers and investment bankers and other professionals are liable under common law for any corporate irregularities occurring in transactions on which they have advised or acted for the company. This liability arises for negligence based on a duty of care owed to the company. Corporate social responsibility

There is a general acceptance of the need for transparency in corporate actions. This has prompted shareholders to demand information, and regulators to set standards for the provision of information in the reports and accounts. Corporate social responsibility is increasingly in evidence and there is a general expectation that a company will make the effort to represent itself as a good corporate citizen. Sarbanes-Oxley

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The US experience accelerated the development and publication of the SECP code, which was previously modeled on developments in England. The Sarbanes-Oxley requirements affect companies with affiliates operating in the United States and chartered accounting firms which are associated with public accounting firms reporting on listed companies.

Need of corporate governance in Pakistan

Is necessary to meet the increasing demand of investment capital. It enhance the performance of corporations by establishing and maintaining a corporate culture that motivate directors, managers, and entrepreneurs to maximize the companys operational efficiency and long term productivity growth. There has been a move away from traditional forms of financing and a collapse of many of the barriers to globalization. Companies are now competing against each other for new capital. Effective corporate governance allows the efficient use of recourses. it assists in attracting lower cost investment capital by improving nester confidence . It ensures the accountability of the management and board of directors and also ensures legal compliance. it also assist companies in responding to changes in the business environment ,crisis and the inevitable periods of decline. Transparency can be achieved through three key market elements of corporate governance: openness, accounting standers ,compliance reporting. Principles of corporate governance are more specifically framed to facilitate the so called Agency problems

Bibliography
wikipedia.org/wiki/Corporate_governance www.corpgov.net/ www.secp.gov.pk/dp/pdf/manual-CG.pdf www.interscience.wiley.com/jpages/0964-8410 www.frc.org.uk/corporate/ wikipedia.org/wiki/UK_Corporate_Governance
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www.itgovernance.co.uk/corpgov_uk.aspx

Table of Contents
Executive Summary....................................................................................................3 Corporate Governance............................................................................................... 7 Introduction................................................................................................................ 8 Corporate Governance .............................................................................................. 8 The combined Code on the Corporate Governance....................................................9 History.......................................................................................................................9 Main Principle Corporate Governance......................................................................10 The Surbanes - Oxley Act 2002................................................................................15 Principles of Corporate Governance in Pakistan....................................................52 Ensuring the Basis for an Effective Corporate Governance Framework.............53 The Rights of Shareholders and Key Ownership Function..................................53 The Equitable Treatment of Shareholders .........................................................54 The Role of Stakeholders in Corporate Governance...........................................55

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Disclosure and Transparency.............................................................................55 The Responsibilities of the Board.......................................................................56 Overview of recent corporate governance reforms..................................................62 Shareholders rights.................................................................................................63 Quorum and voting requirements.............................................................................64 Election of directors..................................................................................................64 Right to inspect corporate records...........................................................................65 Disclosure of shareholdings......................................................................................65 Protection of minority shareholders..........................................................................65 The state as shareholder..........................................................................................65 Institutional investors as shareholders.....................................................................66 Need of corporate governance in Pakistan...............................................................75 Bibliography.............................................................................................................75 Table of Contents..................................................................................................... 76

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