CORPORATE GOVERNANCE - A Needy Discussion

"Business is going to change more and more in the next 10 years than it has in the last 50 years. These changes will occur because of a disarmingly simple idea: the flow of digital information." - Bill Gates Introduction As the above statement goes true the corporate world needs clean & neat mechanisms and arrangements employed by financiers (shareholders & lenders) to induce managers, who tend to acquire considerable residual control rights in practice, to care for their interest. This is the essence of corporate governance. As Andrei Shleifer and Robert W Vishny say: "Much of the subject of corporate governance deals with constraints that managers put on themselves, or that investors put on managers, to reduce the ex post misallocation and thus to induce investors to provide more funds ex ante." It deals with questions like: How do financiers exercise control over managers? How do financiers ensure that managers do not steal the resources placed with them, or squander them on uneconomic projects? More specifically, corporate governance covers issues like: (a) The legal rights of financiers, the role of large investors, (b) The method of electing boards of directors, (c) The composition of the board, the ability of the board to maintain surveillance, (d) The system of checks and balances instituted over managerial behaviour, (e) The incentives offered to managers to protect financiers from dissipation of capital, (f) The standards of financial reporting and corporate disclosure, and so on. Corporate Governance - What does it mean? Corporate governance carries great depth of meaning. To most people, it means the way a company manages its business, in a manner that is accountable and responsible to someoneusually the shareholders. In a broad sense, responsibility and accountability are seen to be to broader audiences that also include the company's other stakeholders such as employees, suppliers, customers, and the local community. It suggests ethics and morals, as well as the best practices. Corporate governance is usually expressed in the form of a codesuch as the Cadbury code in the UK. The CII has established its committee on corporate governance. The challenge for corporate India will be to establish a set of principles or a code that is acceptable in international best practice terms. This set of codes will lead to change in the Companies Act and auditing and reporting requirements eventually.

Corporate governance practices in India are likely to be changed for the better in the coming years. Promoters are becoming more answerable and responsive to shareholders. Financial institutions are appreciating the interventionist role they need to play in ensuring sound corporate governance. Corporate governance refers to the relationship among the owners, directors and managers. Corporate Governance - in US In order to improve the quality of corporate governance in publicly held companies, the Sarbanes-Oxley Act, 2002 places a great deal of accountability squarely on the shoulders of CEOs and CFOs of these companies. The Act calls for the CEO and CFO of a listed company to certify that financial statements and other financial information provided in annual or quarterly reports of the company, filed with the concerned authority, fairly present in all material respects the financial condition and the results of operations of the company. Company executives found guilty of non-complying with the Act's provisions could face fines of up to $1 million and 10 year imprisonment or both. Executives who willfully fail to comply could be given monetary punishment of up to $5 million and 20 year-imprisonment or both. For mail and wire fraud, the guilty executives could be sentenced jail term up to a period of 20 years. The Act creates a new felony for securities fraud, punishable by up to 25 years in prison. To prevent shredding of documents or obstruction of justice, which was the case with the auditing firm Andersen related to its dealings with one of its client firms M/s Enron, the Act calls for fines and imprisonment of up to 20 years. Corporate Governance in India Corporate Governance in Public Sector in India The equity shares are owned wholly or substantially (meaning 51% or more) by the government. Technically, of course, the shares of the central public sector undertakings are held in the name of the president of India. The boards of public sector undertakings, appointed for all practical purposes by the controlling administrative ministry, comprise three categories of directors (1) functional directors (2) government directors and (3) outside directors. There is, in general, a good deal of political and bureaucratic influence over the management of public sector undertakings. As a result, the autonomy of the management of the public sector undertakings is often eroded. Of late, however, things have improved. These undertakings are constrained by various regulations and administrative guidelines. Further, they are subject to the CAG audit and are accountable, to parliament. This leads to an excessive emphasis on observing rules, regulations, and guidelines. Efficiency and performance are often sacrificed at the altar propriety. Chief executives of these undertakings have short-term tenures, as chairman and MD, often one to five years. It is rare to find a chief executive who has been at the helm of affairs for more than 5 years. Such a short tenure, coupled with limited freedom, leads to a myopic outlook. It is, therefore, rare to find a visionary leader guiding the destiny of a public sector undertaking with a long planning horizon. Most of the CEOs seem to be concerned with fulfilling short-term targets emanating from

the MOU's. Incidentally, the MOU does themselves appear to be the outcome of an elaborate budgetary game between the management and the government. In general, performance standards are soft, compensation levels low, incentives for performance poor, and 'real' accountability weak. In summary, the corporate governance system in the public sector may be characterized as the 'transient system' with the key players, viz., politicians, bureaucrats, and managers taking a myopic view of things.

Corporate Governance in Private Sector in India Here in the private sector there are 3 broad categories of shareholders: promoters, financial institutions and retail investors. On an average, the 3 categories are more or less equally important, though there are wide variations across companies. For electing the directors, the majority rule voting system is typically followed. The proportionate rule voting system is rarely followed. Company boards generally comprise 3 types of directors: promoter directors, professional directors and institutionally nominated directors. In general, institutional investors have been supportive of promoters. They seem to implicitly subscribe to what P.L. Tandon has referred as the "Management by Chromosomes" principle. They interfere only when a crisis develops or when there is clear evidence of malafide behaviour and performance of the management seriously. Of late, however, institutional investors have become more assertive. IDBI and ICICI, for example, have forced companies to undertake restructuring initiatives aimed at protecting the interest of institutional investors. Similarly UTI has started the practice of asking companies to make regular presentations and even give board position. Individual investors have, by and large, been benign, tolerant, and ignorant. Though there are some knowledgeable shareholders who raise sensible queries in the AGMs, they are not able to accomplish much because the management enjoys an informational advantage and knows how to retain the support of most the shareholders by offering sops here and there and portraying a glowing picture that enthuses them. Scattered and ill-organised, individual shareholders are not in a position to play a meaningful role in electing directors. Further, the majority rule voting system prevents even a well-organised substantial minority to have any say in the election of board of directors. Family managed companies, in general, seem to display greater entrepreneurial vigor, act more proactively, and exercise stricter control. However, the virtually unchallenged control of the family provides enormous scope for self-dealing and facilitates personal enrichment at the expense of the company. The degree to which these aberrations occur depends on the level of integrity of the controlling family. Professionally managed companies, in general, react somewhat slowly to new opportunities and challenges, put together greater emphasis on systems, favour the interest of incumbent management over that of shareholders, and set relatively easy performance targets. The corporate governance system in the private sector may therefore be characterized as the 'entrenched system', given the firm hold of the promoters over the companies managed by them and disinclination and / or inability of others to challenge them. Hence the principal conflict in India is not between the interests of shareholders on the one hand and the interest of managers on the other. Rather, it is between the interests of dominant shareholders (promoters) on the one hand and the interests of the remaining shareholders on the other. This seems to be true of companies controlled by families or multinationals parents or even the government.

_________________________________________________________________________ _______________ Sources/References/Bibliography Financial Management Dr. Prasanna Chandra Tata McGraw Hill Publications. 'Analyst' magazine from the ICFAI press - September 2002 issue.

About-the-Author M. Subramanian, Faculty in Finance, R.L. Institute of Management Studies, Madurai, Tamil Nadu-625022, Ph. No.0452-2690623/614 (office) 0452-2564660(res); email id: madurai_subbu @ yahoo.co.in. The author has 8 years of teaching experience in management subjects and 4 years of industrial experience. The author has published Course materials on 'Management Accounting' and 'Financial Management' as an in house publication (private circulation only) for benefits of students. Authors' Qualification: B.COM, BGL, MFC, MBM, PGDMM, DIRPM (MBA), (M.Phil-Mgt)