The Cadbury Committee

The Cadbury Committee, Corporate Performance
and Top Management Turnover

Jay Dahyaa
Cardiff University
John J. McConnell
Purdue University
and
Nickolaos G. Travlos
ALBA (The Athens Laboratory of Business Administration) and Cardiff University
January 13, 2000
aCorresponding author. Cardiff Business School, Cardiff University, Aberconway Building,
Colum
Drive, Cardiff, CF1-3EU, United Kingdom. (Dahya@cf.ac.uk).
JEL Classification: G3; Keywords: Board Structure, Corporate Performance, Management
Turnover
Acknowledgement
This paper has benefited from the helpful comments and suggestions of David Denis, Diane
Denis,
Robert Parrino, Ronan Powell, Raghu Rau, Andrew Stark and seminar participants at Purdue
University, the EFMA (Paris) and the FMA (Orlando). McConnell acknowledges financial
support
from the Center for International Business Education and Research (CIBER) at Purdue
University.
Dahya acknowledges financial support received from the Leverhulme Trust.
The Cadbury Committee, Corporate Performance
and Top Management Turnover
In December 1992, the Cadbury Committee published the Code of Best Practice which
recommended that boards of publicly-traded UK corporations include at least three outside
directors and that the positions of the chairman of the board and chief executive officer not be
held
by a single individual. The underlying presumption was that these government-sponsored
recommendations would lead to enhanced board oversight. As a test of that presumption, we
analyze the relation between top management turnover and corporate performance. We find that
CEO turnover increased following publications of the Code, that the relationship between CEO
turnover and performance was strengthened following publication of the Code, and that the
increase
in the sensitivity of turnover to performance was concentrated among firms that adopted the
Cadbury
Committee’s recommendations.
The Cadbury Committee, Corporate Performance and Top Management Turnover
The Cadbury Committee was appointed by the Conservative Government of the United
Kingdom (UK) in May 1991 with a broad mandate to “…address the financial aspects of
corporate
governance.”1 In December 1992, the Committee issued its report which recommended, among
other things, that boards of directors of publicly traded companies include at least three
nonexecutive
(i.e., outside) directors as members and that the positions of Chairman of the Board
(Chairman) and Chief Executive Officer (CEO) of these companies be held by two different
individuals. The apparent reasoning underlying the Committee’s recommendations is that greater
independence of a corporate board will improve the quality of board oversight.
To appreciate the potential significance of the Cadbury Committee and its recommendations,
it is important to appreciate the environment surrounding the establishment of the Committee.
First,
the Committee was appointed in the aftermath of the “scandalous” collapse of several prominent
UK
companies during the later 1980s and early 1990s, including Ferranti International PLC, Colorol
Group, Pollypeck International PLC, Bank of Credit and Commerce International (BCCI) and
Maxwell Communication Corporation. The broadsheet press popularly attributed these failures
and
others to weak governance systems, lax board oversight, and the vesting of control in the hands
of a
single top executive.
The Cadbury Committee was set up in response to a number of corporate
scandals that cast doubt on the systems for controlling the ways companies are
1 Report of the Committee on the Financial Aspects of Corporate Governance (Section 1.8), December 1, 1992.
2
run. The downfall of powerful figures such as Asil Nadir or the late Robert
Maxwell, whose personal control over their companies was complete, raised
fears about the concentration of power.
Self-regulation Seen as the Way Forward, Financial Times,
May 28, 1992.
Second, historically, executive (i.e., inside) directors have heavily dominated UK boards.
For example, during 1988, of the Financial Times 500, for only 21 companies did non-executive
directors comprise a majority of the board and, when boards are ranked according to the fraction
of
non-executive board members, for the median board, non-executives comprised only 27 per cent
of
their membership. In comparison, during 1988, for 387 of the Fortune 500 U. S. companies,
outsiders comprised a majority of the board. Furthermore, for the Fortune 500 companies, for the
median board, outsiders comprised 81 per cent of the membership. With respect to the joint
position of Chairman and CEO, the UK and US historically are not dissimilar. For example,
during
1988, for 349 of the Fortune 500 companies and for 328 of the FTSE 500 companies, a single
individual jointly held the positions of Chairman and CEO.
At its issuance, the Cadbury Report was greeted with skepticism both by those who felt that
it went too far and by those who felt that it did not go far enough. The general unease of those
who
felt it went too far can best be summarized as a concern that the delicate balance between
shareholders and managers is best left to the forces of competition. A less generous interpretation
of
this perspective, which was most frequently espoused by corporate managers, was “leave us
alone -
There is danger in an over emphasis on monitoring, on non-executive directors
independence from the business of the corporation; on controls over decision
making activities of companies. When coupled with the clearly reduced status
of executives on the governing boards, such requirements must blunt the
3
competitive edge and deflect the entrepreneurial drive which characterises
participants, let alone success in a free market.
Sir Owen Green, Pall Mall Lecture on UK Corporate Governance,
February 24, 1994
The general concern of those who thought that the report did not go far enough centered on the
“voluntary” nature of the Report’s recommendations.
The committees’ recommendations are steps in the right direction. But, if the
government is to address the problems which led to the Maxwell, Polly Peck,
BCCI and other recent scandals, then new rules in a legal framework are
required…Shareholders, investors and creditors will have been disappointed
that just when the corporate failures of recent years cried out for bold and
imaginative legal return, the body from which so much had been expected
came up with a little, tinkering and a voluntary code.
Cadbury Committee Draft Orders Mixed News for Shareholders,
Financial Times, June 2, 1992
The purpose of this study is to cast light on what heretofore has been largely a vitriolic
dispute by investigating empirically the impact of the key Cadbury Committee recommendations
--
that boards include at least three non-executive members and that the positions of Chairman and
CEO be held by two different individuals - - on the quality of board oversight in UK firms over
the
period 1989 to 1995. We begin our investigation with the presumption that an important
oversight
role of boards of directors is the hiring and firing of top corporate management. We further
presume
that one indicator of effective board oversight is that the board will replace poorly performing
top
management. With those presumptions in place, we empirically investigate the relationship
between
top management turnover and corporate performance before and after the Cadbury Committee
issued its recommendations.
4
To conduct this investigation, we assemble a random sample of 460 UK companies from the
Official List of the London Stock Exchange (LSE) as of December 1988. For each company, we
collect information on top management turnover, board composition, and corporate performance
for
up to seven years before and four years after the issuance of the Cadbury Report. With these
data,
we determine that the relationship between top management turnover and corporate performance
was statistically significant both before and after adoption of the Cadbury Committee’s
recommendations - - poorer performance is associated with higher turnover. Importantly, for our
purposes, this relationship is significantly stronger following adoption of the Cadbury
Committee’s
recommendations. Upon further exploration, the increased sensitivity of turnover to performance
appears to be attributable to the increase in outside board members following Cadbury.
We view this study as making contributions in both the small and the large of corporate
governance. From a narrow perspective, this study thoroughly examines the effect of the
Cadbury
Committee’s recommendations on the relationship between top management turnover and
corporate
performance in the UK. From a broader perspective, this study contains implications for
corporate
governance and board composition generally, and augments studies by Agrawal and Knoeber
(1994), Bhagat and Black (1996; 1998), Byrd and Hickman (1992), Cotter, Shivdasani and
Zenner
(1997), Denis and Sarin (1999), Hermalin and Weisbach (1998), Kaplan and Reishaus (1990),
Kini, Kracaw and Mian (1995), Klein (1997), Kole and Lehn (1996), Rosenstein and Wyatt
(1990), Shivdasani (1993), Weisbach (1988), Yermack (1996) and You, Caves, Smith and Henry
(1986) among others. Our investigation also complements prior investigations of the relationship
between top management turnover and corporate performance by Coughlan and Schmidt (1985),
Denis and Denis (1995), Franks and Mayer (1997), Huson Parrino and Starks (1998), Jensen and
5
Murphy (1990), Kang and Shivdasani (1995), Kaplan (1994a, b), Martin and McConnell (1991),
Mikkelson and Partch (1997), Warner, Watts and Wruck (1988) and Weisbach (1988) among
others.
The next section briefly describes the Cadbury Committee Report on the “Financial Aspects
of Corporate Governance”. Section II describes our sample selection procedure. Section III
presents descriptive statistics for the sample. We reserve our review of related studies until after
we
present our empirical findings. In Section IV, we discuss our results in the context of prior
empirical
investigations and present our conclusions.
I. Cadbury Committee Report
The Cadbury Committee was chaired by a leading industrialist, Sir Adrian Cadbury, CEO of
the Cadbury confectionery empire, and included other senior industry executives, finance
specialists,
and academics. The Committee was charged with examining the “financial aspects of corporate
governance” in UK firms. The committee issued a draft report of its recommendations for public
comment on May 27, 1992. Between then and December 1, 1992, the committee accepted
comments and issued its final report on December 1, 1992.
The cornerstone of the Cadbury Report is “The Code of Best Practice” which presents the
committee’s recommendations on the structure and responsibilities of corporate boards of
directors.
The two key recommendations affecting the board structure were that boards of directors of
6
publicly-traded companies include at least three outside directors as members and that the
positions
of Chairman and CEO be held by two different individuals.2
As part of its report, the Committee “urged” that the boards of all companies registered on
the Official List of the London Stock Exchange (LSE) comply with the Code and further
“encouraged” that all other UK companies also aim to meet its guidelines.3 As such, compliance
with “The Code of Best Practice” is entirely voluntary. That is, the Code has not been enshrined
in
UK corporate law. This does not imply, however, that the Code is “without teeth”. First, the
Cadbury Committee, as part of its report, explicitly recognized that legislation would very likely
follow if companies did not comply with the guidelines of the Code.4 Second, the report has been
given further bite by the LSE which, since June 1993, has required a statement from each listed
company which spells out whether the firm is in compliance with the Code and, if not, further
requires that an explanation be given as to why the company is not in compliance. As it turns out,
this informal arm-twisting appears to have been effective: by 1998 all companies in the
Financial
Times 100 and over 90% of all firms on the Official List of the LSE were in compliance with the
key
provisions of the Code. The question that we investigate herein is whether adoption of the key
provisions of the Cadbury Committee’s recommendations has had a significant impact on the
relationship between corporate performance and top management turnover.
2 The report also recommended: (i) full disclosure of the pay of the chairman and the highest paid director; (ii)
shareholders’ approval on executive directors contracts exceeding three years; (iii) executive directors pay be set
by a board sub-committee (the remuneration committee) comprised primarily of outsiders and; (iv) directors
should establish a sub-committee of the main board, comprised mainly of outside directors, to report on the
effectiveness of the company’s system of internal control, including mechanisms for risk assessment and
management.
7
II. Sample Selection
Our empirical investigation focuses on top management turnover during the eight-year
interval surrounding the publication of the Cadbury Report in May 1992 (i.e., April 1988 through
May 1996). Our analysis employs data on top management turnover and composition of boards
of
directors along with various measures of corporate performance for a random sample of
publiclytraded
UK firms. Additionally, our analysis employs certain financial data for these firms along with
descriptive data for their boards and top management.
To begin construction of our sample, we randomly selected 650 industrial firms out of a total
of 1,828 industrial firms contained in the Official List of the LSE as of year-end 1988. For each
of
the 650 firms for which data are available in the Corporate Register for 1988, we determined the
names of board members, the number of outside directors, the age of the top executive, the
aggregate number of common shares held by the board, the number of shares held by
institutional
investors, and the number of block shareholders, where a block shareholder is defined as any
shareholder owning greater than 3 per cent of the company’s common stock. Such data are
available for 548 of the firms in the initial sample.5 Stock price data and accounting data
including
the book value of total assets, total sales, the book value of liabilities, and earnings before
depreciation, interest and taxes (EBDIT) are taken from Datastream for the years 1985 to 1988.
If
such data are not available for the three years 1985 through 1988, the firm is dropped from the
sample. Forty-seven of the 548 firms were dropped because of insufficient stock price data; an
additional 41 firms were dropped due to insufficient accounting data. The resulting sample
contains
5 Because of some apparent inconsistencies in share ownership data, we cross-checked these data with corporate
8
460 firms. These firms were then identified according to their Financial Times (FT) industry
classification. (The FT industry classification is roughly comparable to SIC classifications in the
US.)
The sample includes firms from 33 different industrial categories.
To capture the characteristics of firms naturally leaving and entering the LSE population,
when a firm in our sample ceases to be listed, we search chronologically among newly-listed
industrial firms until we identify the first firm with book value of assets within +/-20% of the
book
value of assets of the firm that ceased to be listed. For this firm to be eligible to enter our sample,
we
further require that data be available on management identity, board composition, share
ownership,
and financial performance. Finally, we require that if the existing firm was (was not) in
compliance
with the Code, the replacement firm must (must not) be in compliance. By following this
procedure,
a replacement firm was identified for each firm that ceased to be listed within at most four
months
following the delisting of that firm. We continue this procedure each year from 1988 onward,
replacing firms that are no longer listed on the LSE, through the end of 1996, so that the sample
always contains 460 firms each year through the end of 1996.
For firms that continue in the sample, for each year, we collected the names of board
members, the number of outside directors, the age of the top executive, the aggregate number of
common shares held by the board, the number of shares held by institutional investors, and the
number of block shareholders from the Corporate Register and take stock returns and accounting
data from Datastream. When a new firm enters the sample, we gather financial data from its year
of
entry onward from Datastream and descriptive data for the board and management from the
annual reports at Companies House, Cardiff, Wales.
9
Corporate Register. Accounting data for three years prior to the LSE listing year are taken from
filings with the LSE at the time of listing. The shares of some newly-listed firms had traded
elsewhere
prior to entering the LSE Official List. For these firms, stock price data are collected for up to
three
years preceding their listing date. For other firms, for which no prior stock price data are
available,
we use stock price data beginning with their entry date onto the Official List.
To determine top management turnover, we compare the names of top management from
year to year over the time period 1986 through 1996. For each company, we identify the top
executive as the individual with the title of CEO or Executive Chairman.6 In addition, we identify
other board members as members of the top management team if the board member is an
employee
of the firm and holds the title of chief of operations or managing director. If the name of the top
executive changes between successive years, we classify that as turnover in the top executive
position. For other members of the top management team, if their name disappears from the top
management list, that event is deemed to be a turnover in the top management team excluding
the top
executive. If the top executive leaves the list of top management and is replaced by another
member
of the top team, that event is considered turnover in the top executive position, but not turnover
in the
top management team (because that individual is still with the firm). We do not count as
turnover,
the event in which the position of Executive Chairman is split into the positions of Chairman of
the
board and CEO.
We classify turnover as “normal” or “forced” by examining news articles contained in the
Extel Weekly News Summaries, the Financial Times, and Macarthy’s News Information
6 In those firms in which a single individual holds the positions of Chairman and CEO; that individual carries the
10
Service. A turnover event is considered to be forced under any of the following three
circumstances:
(1) a news article states that the executive was “fired”; (2) a news article states that the executive
“resigned”, the executive was less than 60 years old, no other article indicates that the executive
had
taken a position elsewhere, and no other article cites health, family or death as the reason for the
executive’s departure; or (3) a news article indicates that the company was experiencing poor
performance, the executive was less than 60 years old, no other article indicates that the
executive
had taken a position elsewhere, and no other article cited health, family or death as the reason for
the
executive’s departure. All other turnover is considered “normal” turnover.
Neither of our turnover measures is a pristine characterization of the phenomenon that we
wish to capture. In particular, we would like to be able to identify instances in which an
executive
has departed his position involuntarily. Our first measure, i.e., all departures, undoubtedly
includes a
significant number of voluntary departures. Thus, this measure will be an overstatement of the
number we would like to have. However, if the rate of voluntary departures is constant before
and
after Cadbury, any differential in the rate of total turnover will represent a change in involuntary
turnover such that our total turnover measure will capture any change in the rate of forced
turnover.
Even then, of course, any effect will be estimated with noise and the significance level of the
effect
will be downwardly biased.
Our second measure of turnover, i.e., “forced” turnover, will embed a different type of
measurement error. Because our classification system is based on secondary sources, i.e., news
accounts, any modifications in the way in which top management changes are reported through
time
title of Executive Chairman.
11
could give rise to misclassifications. Of course, depending upon the way in which the practice of
reporting top management turnover changed, any modification may lead to either an over- or
understatement
of forced turnover. Our hope is that by using three sources to cross-reference turnover
events, we have minimized the instances in which we have misclassified turnover due to a
change in
reporting practices.
We are interested in the relationship between top management turnover and corporate
performance. In our tests, we employ both accounting earnings and stock returns data to measure
performance. Specifically, as our measure of accounting earnings, we use 3-year average
industryadjusted
return on assets (IAROA). For each year, for each firm in the sample, we calculate ROA
as earnings before depreciation, interest and taxes (EBDIT) divided by beginning of the year
total
assets. Then for each firm with the same Financial Times Industrial Classification as the firm in
our sample, we calculate ROA in the same way. Next, each year, for each Industrial
Classification group, we determine the median ROA. IAROA is calculated by subtracting the
industry median ROA from the sample firm’s ROA for each of the three years prior to a turnover
event. The simple average of these three IAROAs is in our measure of accounting performance.
As our measure of stock price performance, we calculate market model cumulative excess
returns (CERs) where market model parameters are estimated over a 280 trading-day period
beginning 30 days after the announcement of the change in management. The value-weighted
FTSE
All Share Index is used as the market return. CERs are computed using daily returns beginning
36
calendar months prior to, and ending 2 days prior to, the announcement of the change in top
management.
12
III. Characteristics of the Sample
To conduct our analysis, we split management turnover along two dimensions. First, for the
full sample, we split turnover events into pre- and post-Cadbury time periods. The pre-Cadbury
time period includes all top management turnover during 1989 through 1992. The post-Cadbury
time period includes all turnover during 1993 through 1996. Descriptive data for these two
samples
are presented in the first column of Table I.
Second, we classify the observations according to whether the firm that experienced the
turnover was (or was not) in compliance with the two key provisions of the Code. This second
classification scheme gives rise to three sets of firms. The first set includes those firms that were
in
compliance with the Code for each year that the firm is in our sample (hereafter, the “always-
incompliance”
set, 150 firms). The second set includes those firms that came into compliance with the
Code during a year in which the firm was in our sample (hereafter, the “adopted-Cadbury” set,
288
firms). The third set includes those firms that were never in compliance with the Code during
any
year in which the firm was in our sample (hereafter, the “never-in-compliance” set, 22 firms).
Descriptive data for the first and third sets are split into pre- and post-Cadbury time periods.
These
data are presented in columns two and four of Table I. Descriptive data for the second set of
firms
(i.e., the adopted-Cadbury set) are split into pre- and post-Cadbury adoption time periods (i.e., y-
4
to y-1 and y+1 to y+4, where y equals the year in which the firm came into compliance with the
Code). These data are presented in column three of Table I.
Panel A of Table I presents the market value of equity, total assets, and leverage for each set
of firms. If there is anything remarkable in these data, it is the similarity across the various sets
of
firms and time periods along these dimensions. For example, the pre-Cadbury mean book value
of
13
assets for the 3 sets of firms is £148.8m, £150.1m and £146.8m, respectively. These data
exemplify
the commonality of data across the sets of firms.
Panel B presents the fraction of shares owned by each of three ownership categories: the
top executive, the board of directors including the top executive, and institutional investors. The
table also gives the number of block shareholders. Regardless of the category of investor, the
fraction of shares held by that category is essentially unchanged from before to after Cadbury.
On
average, for the full sample, the top executive owns 1% of the stock, aggregate board ownership
is
approximately 2.25%, institutional owners hold approximately 11% of the shares, and the typical
firm has 2 or 3 blockholders. On these dimensions, the always-in-compliance set and the
adopted-
Cadbury set are similar to the full sample and to each other. However, the never-in-compliance
set
has significantly more ownership by the top executive (roughly 5% vs. 1%), significantly greater
board ownership (roughly 9% vs. 2.5%), significantly lower institutional ownership (roughly 6%
vs.
11%), and fewer blockholders than the other two sets. Apparently, firms with greater “inside”
ownership of shares are less likely to adopt the Cadbury Code.
Panel C presents data on the composition of the board. Not surprisingly, there is
considerable variation before and after Cadbury and across the various sets of firms. For the full
set
of firms, prior to Cadbury, the Chairman of the Board also held the position of top manager in
36.5% of the companies; after Cadbury, that fraction drops to 15.4%. Of course, most of this
change is due to the set of companies that came into compliance with the Code during the period
of
our study. For this set, prior to Cadbury, in 39% of the firms, a single individual held the position
of
Chairman and CEO; after adoption of Cadbury, of course, in none of these companies did a
single
individual hold both positions.
14
As regards, outside directors, for the full sample, prior to Cadbury, 35.3% of directors were
outsiders; after Cadbury, the figure increased to 46.0%. Almost all of this increase occurred
among
companies that came into compliance with the Code during the period of our study. For this set
of
firms, the fraction of outsiders increased from 26.1% before adoption of Cadbury to 46.6%,
afterward. For the always-in-compliance set, the percentage of outside directors prior to
Cadbury,
48.6% was nearly identical to the percentage afterward, 48.5%.
Finally, according to Panel C, most of the increase in outside directors came about by means
of increasing the board size as opposed to replacing inside directors with outsiders. The median
board increased by two members, from 5 to 7 directors, and most of this increase occurred
among
the adopted-Cadbury set of companies.
IV. Management Turnover
What is clear from our analysis thus far is that the Cadbury Committee’s recommendations
had considerable impact on the size and composition of boards of directors, and on the number
of
firms in which one individual holds the titles of Chairman and CEO. The question to which we
now
turn is - - what impact, if any, have these changes had on top management turnover?
A. Incidence and Rate of Top Management Turnover
Panel A of Table II presents the incidence and rates of turnover in the top executive for the
full sample, the always-in-compliance set, the adopted-Cadbury set, and the never-in-compliance
set. For the full sample, the always-in-compliance set, and the never-in-compliance set, the
turnover
statistics are split into two four-year periods: a pre-Cadbury period (1989 through 1992) and a
post-Cadbury period (1993 through 1996). For the adopted-Cadbury set, the turnover statistics
15
are split into two four-year periods surrounding the year in which the firm came into compliance
with
the key provisions of the Code. The incidence of turnover is the number of instances in which we
identified a change in the top executive. The rate of turnover is an annualized rate calculated as
the
incidence of turnover divided by the sample size divided by four years. The first two rows of
Panel
A present data on all turnover in the top executive and the second two rows present data on
forced
turnover in the top executive. Panel B parallels Panel A, except that Panel B contains the
incidence
and rates of turnover for the top management team excluding the top executive.
The incidence (and rate) of turnover in the top executive increased significantly from before
to after Cadbury. This increase in turnover is due to an increase in what we have classified as
forced
turnover. For example, for the full sample, the rate of top executive turnover increased by 1.23%
(i.e., from 6.48% to 7.71%), and the rate of forced turnover increased by 1.20% (i.e., from 3.10%
to 4.30%). Furthermore, the increase in turnover in the top executive is concentrated in the
adopted-Cadbury set of firms. For this set of firms, the rate of top executive turnover increased
by
1.57% (i.e., from 7.24% to 8.87%), and the rate of forced turnover increased by 2.27% (i.e.,
2.71% to 4.98%). For the always-in-compliance set, the rate of turnover and the rate of forced
turnover is essentially unchanged from before to after Cadbury. For the never-in-compliance set,
the
rate of turnover declined modestly from before to after Cadbury, however, given the small
sample
size, we are inclined not to place too much weight to this result. Thus, the increase in turnover of
the
top executive following Cadbury is primarily attributable to those firms that adopted the key
provisions of the Code of Best Practice.
From Panel B, for the full sample of firms, for the top management team excluding the top
executive, the rate and incidence of all turnover increased from before to after Cadbury, albeit
the
16
increase is not statistically significant according to conventional standards
(p-value = 0.15). However, for the adopted-Cadbury set, the incidence and rate of turnover is
statistically significant. For this set of firms, the rate of turnover in the top team excluding the
top
executive increased by 1.27% (i.e., from 4.34% to 5.61%). For the always-in-compliance and
never-in-compliance sets of firms, the rate of turnover in the top team is essentially unchanged.
The picture that emerges from forced turnover in the top management team excluding the top
executive is less clear-cut. For the full sample, the incidence and rate of forced turnover
increases by
statistically significant magnitudes from before to after Cadbury. Furthermore, the incidence and
rate
of forced turnover increased for the adopted-Cadbury set from before to after Cadbury and the
increase is close to significant at conventional levels (p-value = 0.12). The fly in the ointment
resides
in the always-in-compliance set. For this set of firms, which were already in compliance, the
incidence and rate of forced turnover does increase by a statistically significant margin.
Presumably
that increase cannot be attributed to the Cadbury Committee’s recommendations.
Turnover data for the top executive are consistent with an argument that the Cadbury
Committees’ recommendations have increased the quality of board oversight. That is, turnover,
especially forced turnover, in the top executive position has increased and that increase is
concentrated in the set of firms that adopted the key provisions of the Code of Best Practice. The
apparent clear-cut connection between top executive turnover and the Cadbury Committee’s
recommendations is less clear-cut for other members of the top executive team. The attenuation
of
that connection could be due to either of two phenomena: Either increased board oversight
following
Cadbury focused on the top executive or the reporting of turnover for second-tier managers is not
as
thorough as that for the top executive.
17
Of course, it could be that the increased management turnover that we have documented
following Cadbury is random across firms. The pertinent issue for our purposes is whether
turnover
is correlated with corporate performance. That is, are the “right” managers being replaced? That
is
the question to which we now turn.
B. Relationship between Top Management Turnover and Corporate Performance
Table III presents a first-pass look at the connection between turnover in the top executive
position and corporate performance. The presentation in Table III follows the classification
scheme
used in Table II in that firms are classified according to their Cadbury adoption status and
observations are classified according to whether they are pre- or post-Cadbury. The additional
dimension provided by Table III is the firms’ relative performance where performance is
measured
as three-year average IAROA or three-year CER as described in Section II. For example, to
construct Panel A, for each calendar year, firms are ranked from lowest to highest on the basis of
their prior three-year average IAROA. For each year, observations are then sorted into quartiles
with quartile 1 containing the 115 firms with the lowest IAROA and quartile 4 containing the
115
firms with highest IAROA. Panel B parallels Panel A except that Panel B includes only forced
turnover. Panels C and D parallel Panels A and B except that in Panels C and D performance is
based on three-year prior CER.
Regardless of whether we consider all turnover or forced turnover, regardless of the
performance measure used, and regardless of which set of firms we consider, the incidence and
rate
of turnover increases as we move from the best to the poorest performing firms both before and
after
Cadbury. That is, turnover of the top executive is concentrated in the poorest performing firms
both
18
before and after Cadbury. To the extent that there is any difference across the panels, it is that
forced turnover is especially concentrated in the poorest performing quartiles.
The data also hint that the increase in top executive turnover from before to after Cadbury
that we documented in Table II is due to an increase in turnover in the lowest two performance
quartiles in the adopted-Cadbury set of firms. For example, for this set of firms in Panel A, the
rate
of turnover in Quartiles 1 and 2 increased by 6.6% (i.e., from 9.0% to 15.6%) and 2.8% (i.e.,
from
7.6% to 10.4%) respectively from before to after adoption of Cadbury. Both of these increases
have p-values less than 0.05. In comparison, for the always-in-compliance set, in the same
bottom
two quartiles, the rate of turnover is essentially unchanged from before to after Cadbury.
The data for turnover in the top management team excluding the top executive (not shown in
a table) generally show any increase in the incidence and rate of turnover as we move from the
best
to the poorest performing firms, however, the relationship is not as linear as shown in Table III
for
top executives.7 For example, in the top two IAROA quartiles of the full sample of firms for
forced
turnover, the rate of turnover in the top team excluding the top executive is 1.0%. For the bottom
two quartiles, the rate of forced turnover is 5.1%. However, the rate of turnover increases slightly
from 4.25% to 6.1% as we move from the quartile 1 to quartile 2.
C. Multivariate Analysis of the Relationship between Top Management Turnover and
Corporate Performance
The final questions, to which we now turn, are whether the relationship between turnover and
performance is statistically significant and whether the sensitivity of turnover to performance is
greater
following Cadbury. To answer that question and to control for other factors that may influence
19
managerial turnover, we estimate logit regressions. Initially, we estimate regressions for the top
executive in which the dependent variable is 1 if a firm experiences turnover in the top executive
during a calendar year and zero otherwise. We estimate separate regressions for all turnover and
for
forced turnover. We estimate separate regressions using three-year prior IAROA and three-year
CER as our performance measures. We include four control variables in each regression: fraction
of
shares owned by directors, fraction of shares owned by institutional investors, number of block
shareholders, and log of total assets. (Subsequently, we estimate the same regressions for
turnover
in the top team excluding the top executive.)
The results of our regressions for the top executive are presented in Tables IV and V. In
Table IV, the performance variable is IAROA. In Table V, the performance variable is CER.
Panel
A of each table presents regressions with all top executive turnover as the dependent variable and
Panel B presents regressions with forced turnover as the dependent variable. Each panel contains
five regressions. Each regression includes either IAROA or CER as an independent variable. In
each regression, the coefficient of that variable is negative and, with one exception, each has a
pvalue
of less than 0.05. Thus, top executive turnover is significantly negatively correlated with
corporate performance: the poorer the firm’s performance, the greater the likelihood that the top
executive will depart his position.
Of the four control variables, only the fraction of shares owned by directors regularly has a
p-value less than 0.10. The coefficient of this variable is always negative which indicates that
after
7 These data in tabular form are available from the authors upon request.
20
controlling for performance, increased share ownership by the board reduces the likelihood that
the
top executive will depart his position.
We now turn to the effect of Cadbury on top executive turnover and the effect of Cadbury
on the relationship between top executive turnover and corporate performance. To begin, the first
regression in each panel is estimated for the full sample of firms and includes an indicator
variable
(Dum for 1993-96) which takes a value of 0 for all observations before January 1993 (the pre-
Cadbury period) and a value of 1 for all observations after that date (the post-Cadbury period). In
each regression, the coefficient of the indicator variable Dum for 1993-96 is positive with p-
values
ranging from 0.03 to 0.11. Thus, even after controlling for corporate performance, turnover is
higher
in the post-Cadbury period. However, as we noted in Table III, increased turnover appears to be
attributable to the set of firms that came into compliance with the Cadbury Committees’
recommendations (the adopted-Cadbury set) as opposed to those firms that were always in
compliance with Cadbury.
To determine whether the Cadbury/turnover relationship is due to a general phenomenon
affecting all firms or whether it is due specifically to a change in board structures traceable to the
Cadbury recommendations, we estimate the regression separately for the always-in-compliance
set
of firms and for the adopted-Cadbury set. The only difference in the regressions is that for the
adopted-Cadbury set, the indicator variable (Dum for Adopt) takes on a value of 0 in all years
prior
to the year in which the firm came into compliance with the Code of Best Practice and a value of
1
for all subsequent years. These are the second and third regressions in each panel.
For the always-in-compliance set, the coefficient of the Cadbury Dummy variable (Dum for
Adopt) is always positive, but the p-values range from 0.79 to 0.92. Thus, introduction of the
21
Cadbury Report had a trivial impact, if any, on the rate of turnover among top executives in
firms that
were already in compliance with the key provisions of the Code. For the adopted-Cadbury set,
the
coefficient of the indicator variable Dum for Adopt is always positive with p-values ranging
from
0.06 to 0.09. Additionally, the magnitude of the coefficient is 10 times the magnitude of the
coefficient of the Cadbury Dummy (Dum for 1993-96) for the always-in-compliance set. Thus,
the
publication of the Code of Best Practice did not have an impact, per se, on the rate of turnover
among top UK executives; rather the effect was concentrated among those firms that altered their
board structures to comply with the Code. This is not to say that the rate of turnover among top
executives in firms that were always-in-compliance was “too low” either before or after
Cadbury.
The data only show that the rate of turnover for these firms did not change between the pre- and
post-Cadbury periods. In comparison, the rate of turnover increased significantly among firms
that
came into compliance with the Cadbury recommendations during the period of this study.
To determine whether the increase in turnover is correlated with performance, we estimate a
regression with the adopted-Cadbury set of firms that includes the Adopted Cadbury Dummy
(Dum
for Adopt) and the Adopted Cadbury Dummy interacted with our measures of performance
(either
IAROA or CER) along with our measures of performance (Dum for Adopt x Perform) and our
four
control variables. These are the key regressions of our analysis and are reported as the fourth
regression in each panel.
The coefficient of the interaction variable will indicate whether the increase in turnover among
firms that adopted Cadbury is randomly distributed across those firms or is concentrated among
the
poorest performing firms. In each regression, the coefficient of the interaction variable is
negative
with p-values ranging from 0.02 to 0.08. Additionally, the coefficient of the Adopted Cadbury
22
Dummy (Dum-for-Adopt) is reduced by 75% and now has p-values ranging from 0.66 to 0.76.
These results indicate that the increase in top executive turnover is not random, rather it is
(inversely)
correlated with performance: After controlling for performance, the likelihood that the top
executive
will depart his position is greater once a poorly performing firm comes into compliance with the
key
provisions of the Code of Best Practice. The answer to the question of whether the “right”
managers are leaving the firms appears to be yes, assuming, of course, that our measures of
performance properly identify the right managers.
So far we have employed an indicator variable to capture the key provisions of the Code of
Best Practice. A further question is - - which of the key provisions is responsible for the
increased
sensitivity of turnover to corporate performance? To address that question, we estimate a final
regression with the adopted-Cadbury set of firms in which we include the fraction of outside
directors, an interaction between the fraction of outsiders and our measures of corporate
performance (either IAROA or CER), an indicator variable to identify observations in which the
positions of the Chairman and CEO are held by a single individual (1) or by two individuals (0),
and
an interaction between this indicator variable and our measures of corporate performance. These
variables are designed to capture the changes brought about by the Code of Best Practice.
Because, as we show in Table I, adoption of the Code led to a general increase in board size, we
also include the number of directors and an interaction between the number of directors and our
measure of performance. These regressions, which also include a performance measure, Dum-
for-
Adopt, and the four control variables, are shown as the fifth regression in each panel.
According to the regressions, when the board composition and Chairman/CEO variables are
included, the coefficients of the interaction of the Dum-for-Adopt and our measures of
performance
23
are not significant (p-values range from 0.59 to 0.96). Additionally, the coefficient of the fraction
of
outsiders on the board is positive, albeit not significant, in each regression (p-values range from
0.27
to 0.38). More interestingly, the coefficients of the interaction between the fraction of outsiders
and
our measures of performance are always negative with p-values that range from 0.07 to 0.10. In
contrast, in none of the regressions does the coefficients of the dummy for the CEO/chairman or
the
coefficient of the interaction of this variable with our measures of performance begin to approach
statistical significance (p-values range from 0.88 to 0.94).
Apparently, the increased sensitivity of turnover to corporate performance for the adopted-
Cadbury set (and the contemporaneous loss in significance of the interaction of Dum-for-Adopt
with
performance) is attributable to the increase in the fraction of outside directors. Splitting the
responsibilities of the Chairman and CEO between two individuals appears to have no effect on
the
rate of turnover in the top executive.
Two further observations are worth making. The coefficient of board size is always negative,
which indicates that turnover is less likely, the larger the board; however, with p-values that
range
from 0.20 to 0.37, this variable is not significant at traditionally accepted levels. The more
interesting
variable is the interaction of board size with our measures of performance. The coefficients of
this
variable are also always negative and have p-values that range from 0.07 to 0.10. Thus, the
sensitivity of turnover to performance is lower the larger the board. Or to put it slightly
differently,
firms with smaller boards show more sensitivity to performance (in terms of turnover in the top
executive) than do firms with larger boards.
The regressions reported in Tables IV and V for turnover in the top executive are also
estimated for turnover in the top management team excluding the top executive. The signs of the
24
coefficients for these regressions (not shown in a table) are identical to those of Tables IV and V,
however, the p-values of the variables are not significant at traditional levels. For example, the
sign
of the Cadbury 1993-96 dummy variable is positive with p-values that range from 0.16 to 0.20.
Similarly, the sign on the Dum-for-Adopt variable is also positive in each regression, but has p-
values
that range from 0.17 to 0.24. The coefficient for the interaction of Dum-for-Adopt and our
measures of performance in the same regression is always negative with p-values that range from
0.15 to 0.26.8 In short, the regressions for turnover in the top management team excluding the top
executive are consistent with those of turnover in the top executive, but the levels of statistical
significance are much weaker.
V. Commentary and Conclusions
As we noted at the outset, we view this study as making contributions in the small and the
large of corporate governance and of the connection between management turnover and
corporate
performance. From a narrow perspective, we have analyzed in detail the effect of the Cadbury
Committee’s key recommendations on the structure of UK boards of directors and on the impact
of
these recommendations on the connection between top management turnover and corporate
performance. We document a general increase in the size of corporate boards, an increase in the
fraction of outside directors, and an increase in the number of firms in which the positions of
CEO
and chairman are held by two different individuals following publication of the Cadbury
Committee’s
recommendations in December 1992. We also document an increase in the rate of top
management
8 The results of these regressions are available from the authors upon request.
25
turnover following publication of the Cadbury Report and that this increase is concentrated
among
firms that came into compliance with the key provisions of the Code of Best Practice during the
period of our study. We further document a significant (negative) correlation between top
management turnover and corporate performance both before and after the Cadbury Report: the
poorer the performance, the higher the rate of turnover. Among firms that came into compliance
with the Code during the period of our study, we find an increase in the correlation of turnover to
corporate performance following their adoption of the Code. Finally, this increase in the
sensitivity of
turnover to performance appears to be due to the increase in the fraction of outside directors,
rather
than splitting the responsibilities of the CEO and chairman between two individuals.
Thus, when we refer to our findings as contributing to the small of corporate governance, we
mean to say that our study examines the link between management turnover, corporate
performance,
and board structure in the specific context of the issuance and the implementation of the Cadbury
Report. We do not mean to minimize the importance of our findings to the firms and investors
involved nor to the global economy, after all the Code applies to all publicly-traded UK
companies
and the UK’s GNP ranks 7th among all nations.
From a broader perspective, we mean to say that our results are likely to have implications
beyond the confines of the Cadbury Report and add to the broader literature on management
turnover, corporate performance, corporate governance and board structure. Prior studies on the
relationship between top management turnover and corporate performance include Coughlan and
Schmidt (1985), Franks and Mayer (1995), Gilson (1989), Huson, Parrino and Starks (1998),
Jensen and Murphy (1990), Kang and Shivdasani (1995) and Kaplan (1994a, b), Martin and
McConnell (1991), Mikkelson and Partch (1997), Morck, Shleifer and Vishny (1989), Murphy
and
26
Zimmerman (1993), Warner, Watts and Wruck (1988) and Weisbach (1988). These studies cover
various time periods beginning in 1962 and encompass Japan, the US, and the UK. Each of these
studies reports a negative and significant correlation between top management turnover and at
least
one measure of corporate performance, either accounting profitability or stock returns. Our
results
complement those of earlier studies and add to them in that we document a negative and
significant
correlation between top management turnover and corporate performance and we document an
increase in the sensitivity of turnover to performance following publication of the Cadbury
Report
and the adoption of the Code of Best Practice by UK companies.
Our study also complements and adds to the literature on board composition and corporate
performance. Bhagat and Black (1998) dichotomize research on this topic into two categories:
(1)
studies of whether board composition determines the way in which boards accomplish discrete
tasks, such as hiring and firing top management, responding to hostile takeovers, setting CEO
compensation, and so forth and (2) studies of how board composition influences the firm’s
overall
profitability. Our study fits the former category.
Prior studies of board composition and management turnover provide mixed results.
Weisbach (1988) studies 367 publicly-traded non-financial US companies over the period 1974
through 1983. He determines that CEO turnover is more highly negatively correlated with
performance (measured with both accounting earnings and stock returns) in firms with outsider
dominated boards. Kang and Shivdasani (1995) examine 270 publicly-traded non-financial
27
Japanese companies over the period 1985 through 1990. Contrary to Weisbach, they find that the
sensitivity of turnover to performance is unrelated to the fraction of outside directors.9
Our results are consistent with Weisbach in that we determine that, among poorly performing
firms, top management turnover increases as the fraction of outside board members increases.
Like
Weisbach, our results are contrary to those of Kang and Shivdasani and that difference may very
well be attributable to cross-country differences in the role of boards and outside directors. If so,
the US and the UK apparently are more similar to each other on this dimension than is either one
to
Japan.
As we noted, our study fits into the first category of research identified by Bhagat and Black
(1998). Having examined the impact of the Cadbury Committee’s recommendations on one
specific
board task, in a subsequent study, we intend to turn our attention to the second category by
examining the effect of the Committee’s recommendations on overall corporate performance.
9Mikkelson and Partch (1997) examine 200 publicly-traded US companies over the period 1984 through 1993.
They find no relationship between the probability of management turnover and the fraction of outside directors
on the board. However, they do not examine the sensitivity of the relationship between turnover and
performance to the fraction of outside directors. Thus their study and ours are not directly comparable.
28
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Table I
Financial, Ownership, and Board Characteristics of UK Companies over 1989 through 1996
Descriptive statistics for a random sample of 460 publicly-traded non-financial UK firms over the period 1989-1996. The sample
firms are classified into 3 sets based on whether
they were (a) Always-in-Compliance, (b) Adopted-Cadbury recommendations and (c) Never-in-Compliance with the Cadbury
recommendations. Sample firms in (a) and (c) are
analyzed over two 4-year periods, pre- and post-publication of the Cadbury Report (1989-1992 and 1993 to 1996). Sample firms
in (b) are analyzed over two 4-year periods, preand
post-adoption of the Cadbury recommendations (y-4 to y-1 and y+1 to y+4). The sample consists of industrial companies
included in the Stock Exchange Yearbook and in
the Corporate Register and listed on the London Stock Exchange. Firms that leave the sample between 1989-96 are replaced by
firms entering the London Stock Exchange on
the date closest to departure. Management and board characteristics are from the Corporate Register and are cross-checked with
information at UK Companies House.
Accounting information and share prices are from Datastream.
Sample Firms Always-in-Compliance Adopted-Cadbury Never-in-Compliance
Years Mean (Median) Years Mean (Median) Years Mean (Median) Years Mean (Median)
Panel A: Financial Characteristics
N = 460 N = 150 N = 288 N = 22
Market Value of Equity 1989-92 523.4** (255.96)** 1989-92 539.2** (256.74)** y-4 to y-1 521.9** (255.61)** 1989-92
511.4 (254.11)
(£ million) 1993-96 717.2 (272.94) 1993-96 704.4 (269.32) y+1 to y+4 722.6 (273.91) 1993-96 579.3 (258.86)
Book Value of Assets 1989-92 149.2* (50.8) 1989-92 148.8* (48.8) y-4 to y-1 150.1* (50.7) 1989-92 146.8 (45.3)
(£ million) 1993-96 156.8 (56.7) 1993-96 155.6 (53.2) y+1 to y+4 158.6 (58.7) 1993-96 150.7 (49.2)
Liabilities/Assets 1989-92 0.501 (0.505) 1989-92 0.502 (0.493) y-4 to y-1 0.500 (0.509) 1989-92 0.579 (0.582)
1993-96 0.509 (0.562) 1993-96 0.519 (0.538) y+1 to y+4 0.503 (0.498) 1993-96 0.603 (0.597)
Panel B: Share Ownership
Top Executive 1989-92 1.08 (1.01) 1989-92 1.07 (0.98) y-4 to y-1 1.11 (1.05) 1989-92 5.37 (4.30)
Ownership of Shares (0%) 1993-96 1.04 (1.05) 1993-96 1.01 (0.99) y+1 to y+4 1.10 (1.08) 1993-96 3.89 (3.29)
Board Ownership 1989-92 2.23 (2.39) 1989-92 2.22 (2.23) y-4 to y-1 2.23 (2.44) 1989-92 9.93 (10.11)
of Shares (0%) 1993-96 2.24 (2.34) 1993-96 2.09 (1.96) y+1 to y+4 2.25 (2.43) 1993-96 8.34 (9.27)
Institutional 1989-92 10.70 (10.96) 1989-92 12.83 (12.60) y-4 to y-1 9.79 (9.99) 1989-92 6.45 (5.93)
Ownership (0%) 1993-96 11.35 (10.83) 1993-96 13.32 (13.01) y+1 to y+4 11.09 (10.44) 1993-96 6.09 (5.99)
Number of 1989-92 2 (2) 1989-92 3 (2.04) y-4 to y-1 2* (2)* 1989-92 1 (1)
Blockholders 1993-96 3 (3) 1993-96 3 (3.05) y+1 to y+4 3 (3) 1993-96 1 (1)
Table I - - continued
Panel C: Board Characteristics
Percent with 1989-92 36.49* 1989-92 0.00 y-4 to y-1 39.07** 1989-92 42.17
Single Individual as 1993-96 15.43 1993-96 0.00 y+1 to y+4 0.00 1993-96 35.21
Chairman & CEO
Board Size 1989-92 5.71 (5.00)* 1989-92 6.69 (6.00) y-4 to y-1 5.49* (5.00)* 1989-92 4.53 (4.00)
1993-96 7.29 (7.00) 1993-96 7.41 (7.00) y+1 to y+4 7.13 (7.00) 1993-96 5.02 (5.00)
Percentage of 1989-92 35.3** (36.9)** 1989-92 48.6 (43.4) y-4 to y-1 26.1** (25.7)** 1989-92 17.9 (15.4)
Outside Directors 1993-96 46.0 (43.1) 1993-96 48.5 (45.8) y+1 to y+4 46.6 (40.6) 1993-96 21.5 (20.9)
** and * denotes significance at the 0.01 and 0.05 levels respectively.
Table II
Incidence and Rates of Top Management Turnover in UK Companies, 1989 through 1996
Top management turnover for a random sample of 460 publicly-traded non-financial UK firms over the period 1989
through 1996. The sample firms are classified into 3 sets based
on whether they were (a) Always-in-Compliance, (b) Adopted-Cadbury recommendations, and (c) Never-in-
Compliance with the Cadbury recommendations. Sample firms in (a)
and (c) are analyzed over two 4-year periods, pre- and post-publication of the Cadbury Report (1989-1992 and 1993
to 1996). Sample firms in (b) are analyzed over two 4-year
periods, pre- and post-adoption of the Cadbury recommendations (y-4 to y-1 and y+1 to y+4). For each firm, top
management names in the Corporate Register are compared
from 1988 through 1996 to determine top management turnover. Turnover is classified as normal or routine by
examining news articles in the Extel Weekly News Summaries, the
Financial Times and Macarthy’s News Information Service.
Sample Firms Always-in-Compliance Adopted-Cadbury Never-in-Compliance
Panel A: Rates of Turnover in the Top Executive
Years Incidence Rate Years Incidence Rate Years Incidence Rate Years Incidence Rate
N = 460 N = 150 N = 288 N = 22
All Turnover 1989-92 119* 0.065* 1989-92 35 0.054 y-4 to y-1 80** 0.072** 1989-92 4 0.046
1993-96 138 0.071 1993-96 37 0.058 y+1 to y+4 98 0.089 1993-96 3 0.034
Forced Turnover 1989-92 57* 0.031* 1989-92 24 0.038 y-4 to y-1 30** 0.027** 1989-92 3 0.033
1993-96 79 0.043 1993-96 20 0.031 y+1 to y+4 58 0.050 1993-96 1 0.011
Panel B: Rates of Turnover in the Top Management Team excluding the Top Executive
All Turnover 1989-92 77 0.042 1989-92 21 0.033 y-4 to y-1 48* 0.043* 1989-92 8 0.091
1993-96 90 0.049 1993-96 22 0.034 y+1 to y+4 62 0.056 1993-96 6 0.068
Forced Turnover 1989-92 48* 0.026* 1989-92 6* 0.094* y-4 to y-1 37 0.033 1989-92 5 0.054
1993-96 66 0.036 1993-96 16 0.025 y+1 to y+4 47 0.043 1993-96 3 0.033
Table III
Top Executive Turnover in UK Firms Grouped by Quartiles of Performance over 1989 through 1996
Top management turnover for a random sample of 460 publicly-traded non-financial UK firms grouped into quartiles based on
performance measures in the two four-year periods
during the interval 1989 to 1996. IAROA is calculated as earnings before interest, tax and depreciation divided by the total book
value of assets less the median performance of
firms in the same Financial Times industrial grouping. Three years of IAROA are averaged. CERs are cumulative market model
excess returns computed using daily returns
beginning 36 calendar months prior to, and ending 2 days prior to the announcement of the top executive change. Top executive
turnover is any change in the CEO. Turnover is
classified as normal or routine by examining news articles in the Extel Weekly News Summaries, the Financial Times and
Macarthy’s News Information Service. The sample
firms are classified into 3 sets based on whether they were (a) Always-in-Compliance, (b) Adopted-Cadbury recommendations
and (c) Never-in-Compliance with the Cadbury
recommendations. Sample firms in (a) and (c) are analyzed over two 4-year periods, pre- and post-publication of the Cadbury
Report (1989-1992 and 1993 to 1996). Sample firms
in (b) are analyzed over two 4-year periods, pre- and post-adoption of the Cadbury recommendations (y-4 to y-1 and y+1 to y+4).
Interval Quartile 1 Quartile 2 Quartile 3 Quartile 4
(Lowest performance) (Highest performance)
Panel A: Top Executive Turnover by Quartiles of Industry- and Size-adjusted IAROA
Years Incidence Rate Incidence Rate Incidence Rate Incidence Rate
All sample firms 1989-1992 49 0.107** 33 0.072 24 0.052 13 0.028
1993-1996 66 0.143 41 0.089 21 0.046 10 0.022
(a) Always in compliance 1989-1992 21 0.140 10 0.067 3 0.020 1 0.007
1993-1996 20 0.133 10 0.067 6 0.040 1 0.007
(b) Adopted compliance y-4 to y-1 26 0.090** 22 0.076* 20 0.069 12 0.042
y+1 to y+4 45 0.156 30 0.104 14 0.049 9 0.031
(c) Never in compliance 1989-1992 2 0.091 1 0.045 1 0.045 0 0.000
1993-1996 1 0.045 1 0.045 1 0.045 0 0.000
Panel B: Forced Top Executive Turnover by Quartiles of Industry- and Size-adjusted IAROA
All sample firms 1989-1992 33 0.072* 15 0.033 9 0.020 0 0.000
1993-1996 47 0.102 25 0.054 7 0.015 0 0.000
1993-1996 15 0.100 5 0.033 0 0.000 0 0.000
(b) Adopted compliance y-4 to y-1 16 0.055** 8 0.023* 6 0.021 0 0.000
y+1 to y+4 31 0.108 20 0.069 7 0.028 0 0.000
1993-1996 1 0.045 0 0.000 0 0.000 0 0.000
Table III - - continued
Panel C: Top Executive Turnover by Quartiles of CERs
All sample firms 1989-1992 63 0.137* 34 0.074 11 0.024 11 0.024
1993-1996 72 0.157 42 0.091 12 0.026 12 0.026
1993-1996 25 0.167 5 0.033 4 0.027 3 0.021
(b) Adopted compliance y-4 to y-1 38 0.132 23 0.080* 10 0.035 9 0.031
y+1 to y+4 45 0.156 36 0.125 8 0.028 9 0.031
1993-1996 2 0.091 1 0.045 0 0.000 0 0.000
Panel D: Forced Top Executive Turnover by Quartiles of CERs
All sample firms 1989-1992 38 0.083* 17 0.037* 2 0.004 0 0.000
1993-1996 50 0.109 29 0.063 0 0.000 0 0.000
1993-1996 18 0.120 3 0.020 0 0.000 0 0.000
(b) Adopted compliance y-4 to y-1 18 0.063* 10 0.035* 2 0.007 0 0.000
y+1 to y+4 31 0.108 26 0.090 0 0.000 0 0.000
1993-1996 1 0.045 0 0.000 0 0.000 0 0.000
Table IV
Logit Regressions of Top Management Turnover on IAROA and Cadbury Report Compliance, 1989 through
1996
Results of logit regressions of top management turnover for a random sample of 460 publicly-traded non-financial UK firms in
two four-year periods during the interval 1989 to
1996. IAROA is calculated as earnings before interest, tax and depreciation divided by the total book value of assets less the
median performance of firms in the same Financial
Times industrial grouping. Three years of IAROA are averaged. Top executive turnover is any change in the CEO. Turnover is
classified as normal or routine by examining
news articles in the Extel Weekly News Summaries, the Financial Times and Macarthy’s News Information Service. The sample
firms are classified into 3 sets based on whether
they were (a) Always-in-Compliance, (b) Adopted-Cadbury recommendations and (c) Never-in-Compliance with the Cadbury
recommendations. Sample firms in (a) and (c) are
analyzed over two 4-year periods, pre- and post-publication of the Cadbury Report (1989-1992 and 1993 to 1996). Sample firms
in (b) are analyzed over two 4-year periods, preand
post-adoption of the Cadbury recommendations (y-4 to y-1 and y+1 to y+4). Accounting information and share prices are from
Datastream. Dependent variable equals one
when turnover occurs. Dum for 1993-96 variable equals one for the period 1993-1996. Dum-for-Adopt equals one for the period
following the adoption of the key
recommendations of the Cadbury Report. The interactive dummy is Dum-for-Adopt multiplied by IAROA. P-values are in
parentheses.
Panel A: Logit Regressions of All Top Executive Turnover on IAROA and Cadbury Compliance
Variable Total Sample Always-in-Compliance Adopted-Cadbury Adopted-Cadbury Adopted-Cadbury
(N=460) (N=150) (N=288) (N=288) (N=288)
Intercept -1.866 (0.08) -1.849 (0.09) -2.570 (0.00) -2.799 (0.00) -2.583 (0.00)
Performance Variable:
ROA -2.034 (0.02) -1.859 (0.10) -3.180 (0.00) -3.228 (0.00) -3.0194 (0.00)
Dum for 1993-96 0.457 (0.11) 0.055 (0.92)
Dum-for-Adopt 0.593 (0.06) 0.148 (0.66) 0.112 (0.72)
Dum-for-Adopt x Perform -0.739 (0.02) 0.038 (0.96)
Board variables:
Prop of non-execs 0.331 (0.30)
Prop non-execs x Perform -0.566 (0.08)
Dum Dual CEO -0.062 (0.86)
Dum Dual CEO x Perform -0.052 (0.89)
Board size -0.039 (0.20)
Board size x Perform -0.064 (0.08)
Control variables:
Directors Ownership -0.984 (0.04) -1.092 (0.05) -0.812 (0.08) -0.844 (0.09) -0.762 (0.12)
Institutional Shareholders 1.294 (0.08) 1.027 (0.21) 0.985 (0.28) 1.032 (0.21) 0.597 (0.65)
Blockholders 0.039 (0.60) 0.045 (0.48) 0.028 (0.72) 0.031 (0.68) 0.044 (0.46)
Assets (ln) -0.159 (0.02) -0.122 (0.06) -0.142 (0.05) -0.139 (0.05) -0.105 (0.12)
Observations 3680 1200 2304 2304 2304
Log-likelihood -572.89 -387.66 -454.11 -499.20 -501.58
Chi-square 86.45 (0.00) 37.10 (0.00) 60.84 (0.00) 70.36 (0.00) 70.93 (0.00)
Table IV - - continued
Panel B: Logit Regressions of Forced Top Executive Turnover on IAROA and Cadbury Compliance
(N=460) (N=150) (N=288) (N=288) (N=288)
Intercept -1.745 (0.16) -1.887 (0.10) -2.995 (0.00) -2.819 (0.00) -2.493 (0.00)
ROA -2.932 (0.00) -2.293 (0.00) -4.882 (0.00) -4.659 (0.00) -3.921 (0.00)
Dum for 1993-96 0.531 (0.08) 0.151 (0.79)
Dum-for-Adopt 0.631 (0.07) 0.164 (0.61) 0.132 (0.68)
Dum-for-Adopt x Perform -0.659 (0.06) 0.129 (0.68)
Board variables:
Dum Dual CEO -0.053 (0.87)
Board size -0.031 (0.25)
Control variables:
Blockholders 0.051 (0.48) 0.076 (0.38) 0.044 (0.46) 0.049 (0.45) 0.043 (0.46)
Assets (ln) -0.131 (0.05) -0.129 (0.06) -0.166 (0.04) -0.170 (0.04) -0.189 (0.03)
Observations 3680 1200 2304 2304 2304
Log-likelihood -621.87 -485.07 -569.29 -588.65 -603.03
Chi-square 89.35 (0.00) 53.58 (0.00) 88.66 (0.00) 87.69 (0.00) 88.21 (0.00)
Table V
Logit Regressions of Turnover on CER and Cadbury Report Compliance 1989 through 1996
Results of logit regressions of top management turnover for a random sample of 460 publicly-traded non-financial UK firms in
the two four-year periods during the interval 1989
to 1996. CERs are market model cumulative excess returns computed using daily returns beginning 36 calendar months prior to,
and ending 2 days prior to the announcement of
the top executive change. Top executive turnover is any change in the CEO. Turnover is classified as normal or routine by
examining news articles in the Extel Weekly News
Summaries, the Financial Times and Macarthy’s News Information Service. The sample firms are classified into 3 sets based on
whether they were (a) Always-in-Compliance,
(b) Adopted-Cadbury recommendations and (c) Never-in-Compliance with the Cadbury recommendations. Sample firms in (a)
and (c) are analyzed over two 4-year periods, preand
post-publication of the Cadbury Report (1989-1992 and 1993 to 1996). Sample firms in (b) are analyzed over two 4-year periods,
pre- and post-adoption of the Cadbury
recommendations (y-4 to y-1 and y+1 to y+4). Accounting information and share prices come from Datastream. Dependent
variable equals one when turnover occurs. Dum
1993-96 equals one for the period 1993-1996. Dum-for-Adopt equals one for the period following the adoption of the key
recommendations of the Cadbury Report. The
interactive dummy is Dum-for-Adopt multiplied by CER. P-values are in parentheses.
Panel A: Logit Regressions of Top Executive Turnover on CER and Cadbury Compliance
(N=460) (N=150) (N=288) (N=288) (N=288)
Intercept -3.857 (0.00) -2.629 (0.00) -2.739 (0.00) -2.695 (0.00) -2.458 (0.00)
Cumulative Excess Returns (CER) -0.021 (0.00) -0.010 (0.04) -0.025 (0.00) -0.025 (0.00) -0.023 (0.00)
Dum for 1993-96 0.512 (0.09) 0.069 (0.87)
Dum-for-Adopt 0.568 (0.08) 0.104 (0.76) 0.091 (0.85)
Dum-for-Adopt x Perform -0.684 (0.05) -0.147 (0.59)
Board variables:
Dum Dual CEO -0.062 (0.83)
Board size -0.037 (0.37)
Control variables:
Blockholders 0.059 (0.39) 0.071 (0.29) 0.039 (0.51) 0.031 (0.68) 0.039 (0.51)
Assets (ln) -0.088 (0.15) -0.128 (0.04) -0.076 (0.17) -0.085 (0.16) -0.088 (0.15)
Observations 3680 1200 2304 2304 2304
Log-likelihood -595.25 -494.65 -521.84 -584.28 -613.82
Chi-square 86.66 (0.00) 49.95 (0.00) 76.24 (0.00) 80.82 (0.00) 90.37 (0.00)
Table V - - continued
Panel B: Logit Regression of Forced Top Executive Turnover on CER and Cadbury Compliance
(N=460) (N=150) (N=288) (N=288) (N=288)
Intercept -4.184 (0.00) -2.938 (0.00) -5.029 (0.00) -5.012 (0.00) -4.667 (0.00)
Cumulative Excess Returns (CER) -0.038 (0.00) -0.017 (0.02) -0.057 (0.00) -0.061 (0.00) -0.052 (0.00)
Dum for 1993-96 0.592 (0.04) 0.052 (0.84)
Dum-for-Adopt 0.527 (0.09) 0.217 (0.63) 0.031 (0.92)
Dum-for-Adopt x Perform -0.574 (0.08) -0.129 (0.68)
Board variables:
Dum Dual CEO -0.061 (0.83)
Board size -0.039 (0.35)
Control variables:
Blockholders 0.079 (0.25) 0.103 (0.07) 0.045 (0.48) 0.044 (0.47) 0.044 (0.47)
Assets (ln) -0.108 (0.08) -0.140 (0.03) -0.041 (0.34) -0.049 (0.32) -0.041 (0.34)
Observations 3680 1200 2304 2304 2304
Log-likelihood -634.59 -548.51 -602.44 -589.02 -618.29
Chi-square 119.72 (0.00) 48.29 (0.00) 55.25 (0.00) 55.66 (0.00) 78.29 (0.00)
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Report of the Committee Appointed by the SEBI on Corporate Governance
under the Chairmanship of
Shri Kumar Mangalam Birla
Report of the Kumar Mangalam Birla Committee on Corporate Governance
Preface
1.1 It is almost a truism that the adequacy and the quality of corporate
governance shape the growth and the future of any capital market and economy.
The concept of corporate governance has been attracting public attention for quite
some time in India. The topic is no longer confined to the halls of academia and is
increasingly finding acceptance for its relevance and underlying importance in the
industry and capital markets. Progressive firms in India have voluntarily put in place
systems of good corporate governance. Internationally also, while this topic has
been accepted for a long time, the financial crisis in emerging markets has led to
renewed discussions and inevitably focussed them on the lack of corporate as well
as governmental oversight. The same applies to recent high-profile financial
reporting failures even among firms in the developed economies. Focus on
corporate governance and related issues is an inevitable outcome of a process,
which leads firms to increasingly shift to financial markets as the pre-eminent
source for capital. In the process, more and more people are recognizing that
corporate governance is indispensable to effective market discipline. This growing
consensus is both an enlightened and a realistic view. In an age where capital
flows worldwide, just as quickly as information, a company that does not promote a
culture of strong, independent oversight, risks its very stability and future health. As
a result, the link between a company's management, directors and its financial
reporting system has never been more crucial. As the boards provide stewardship
of companies, they play a significant role in their efficient functioning.
1.2. Studies of firms in India and abroad have shown that markets and investors
take notice of well-managed companies, respond positively to them, and reward
such companies, with higher valuations. A common feature of such companies is
that they have systems in place, which allow sufficient freedom to the boards and
management to take decisions towards the progress of their companies and to
innovate, while remaining within a framework of effective accountability. In other
words they have a system of good corporate governance.
1.3 Strong corporate governance is thus indispensable to resilient and vibrant

capital markets and is an important instrument of investor protection. It is the blood
that fills the veins of transparent corporate disclosure and high-quality accounting
practices. It is the muscle that moves a viable and accessible financial reporting
structure. Without financial reporting premised on sound, honest numbers, capital
markets will collapse upon themselves.
1.4 Another important aspect of corporate governance relates to issues of insider

trading. It is important that insiders do not use their position of knowledge and
access to inside information about the company, and take unfair advantage of the
resulting information asymmetry. To prevent this from happening, corporates are
expected to disseminate the material price sensitive information in a timely and
proper manner and also ensure that till such information is made public, insiders
abstain from transacting in the securities of the company. The principle should be
‘disclose or desist’. This therefore calls for companies to devise an internal
procedure for adequate and timely disclosures, reporting requirements,
confidentiality norms, code of conduct and specific rules for the conduct of its
directors and employees and other insiders. For example, in many countries, there
are rules for reporting of transactions by directors and other senior executives of
companies, as well as for a report on their holdings, activity in their own shares and
net year to year changes to these in the annual report. The rules also cover the
dealing in the securities of their companies by the insiders, especially directors and
other senior executives, during sensitive reporting seasons. However, the need for
such procedures, reporting requirements and rules also goes beyond corporates to
other entities in the financial markets such as Stock Exchanges, Intermediaries,
Financial institutions, Mutual Funds and concerned professionals who may have
access to inside information. This is being dealt with in a comprehensive manner,
by a separate group appointed by SEBI, under the Chairmanship of Shri Kumar
Mangalam Birla.
1.5 The issue of corporate governance involves besides shareholders, all other
stakeholders. The Committee's recommendations have looked at corporate
governance from the point of view of the stakeholders and in particular that of the
shareholders and investors, because they are the raison de etre for corporate
governance and also the prime constituency of SEBI. The control and reporting
functions of boards, the roles of the various committees of the board, the role of
management, all assume special significance when viewed from this perspective.
The other way of looking at corporate governance is from the contribution that good
corporate governance makes to the efficiency of a business enterprise, to the
creation of wealth and to the country’s economy. In a sense both these points of
view are related and during the discussions at the meetings of the Committee,
there was a clear convergence of both points of view.
1.6 At the heart of the Committee's report is the set of recommendations which
distinguishes the responsibilities and obligations of the boards and the
management in instituting the systems for good corporate governance and
emphasises the rights of shareholders in demanding corporate governance. Many
of the recommendations are mandatory. For reasons stated in the report, these
recommendations are expected to be enforced on the listed companies for initial
and continuing disclosures in a phased manner within specified dates, through the
listing agreement. The companies will also be required to disclose separately in
their annual reports, a report on corporate governance delineating the steps they
have taken to comply with the recommendations of the Committee. This will enable
shareholders to know, where the companies, in which they have invested, stand
with respect to specific initiatives taken to ensure robust corporate governance.
The implementation will be phased. Certain categories of companies will be
required to comply with the mandatory recommendations of the report during the
financial year 2000-2001, but not later than March31, 2001, and others during the
financial years 2001-2002 and 2002-2003. For the non-mandatory
recommendations, the Committee hopes that companies would voluntarily
implement these. It has been recommended that SEBI may write to the appropriate
regulatory bodies and governmental authorities to incorporate where necessary,
the recommendations in their respective regulatory or control framework.
1.7 The Committee recognised that India had in place a basic system of corporate
governance and that SEBI has already taken a number of initiatives towards raising
the existing standards. The Committee also recognised that the Confederation of
Indian Industries had published a code entitled "Desirable Code of Corporate
Governance" and was encouraged to note that some of the forward looking
companies have already reviewed or are in the process of reviewing their board
structures and have also reported in their 1998-99 annual reports the extent to
which they have complied with the Code. The Committee however felt that under
Indian conditions a statutory rather than a voluntary code would be far more
purposive and meaningful, at least in respect of essential features of corporate
governance.
1.8 The Committee however recognised that a system of control should not so
hamstring the companies so as to impede their ability to compete in the market
place. The Committee believes that the recommendations made in this report mark
an important step forward and if accepted and followed by the industry, they would
raise the standards in corporate governance, strengthen the unitary board system,
significantly increase its effectiveness and ultimately serve the objective of
maximising shareholder value.

The Constitution of the Committee and the Setting for the Report
2.1 There are some Indian companies, which have voluntarily established high
standards of corporate governance, but there are many more, whose practices are
a matter of concern. There is also an increasing concern about standards of
financial reporting and accountability, especially after losses suffered by investors
and lenders in the recent past, which could have been avoided, with better and
more transparent reporting practices. Investors have suffered on account of
unscrupulous management of the companies, which have raised capital from the
market at high valuations and have performed much worse than the past reported
figures, leave alone the future projections at the time of raising money. Another
example of bad governance has been the allotment of promoter’s shares, on
preferential basis at preferential prices, disproportionate to market valuation of
shares, leading to further dilution of wealth of minority shareholders. This practice
has however since been contained.
2.2 There are also many companies, which are not paying adequate attention to
the basic procedures for shareholders’ service; for example, many of these
companies do not pay adequate attention to redress investors’ grievances such as
delay in transfer of shares, delay in despatch of share certificates and dividend
warrants and non-receipt of dividend warrants; companies also do not pay
sufficient attention to timely dissemination of information to investors as also to the
quality of such information. SEBI has been regularly receiving large number of
investor complaints on these matters. While enough laws exist to take care of
many of these investor grievances, the implementation and inadequacy of penal
provisions have left a lot to be desired.
2.3 Corporate governance is considered an important instrument of investor

protection, and it is therefore a priority on SEBI’s agenda. To further improve the
level of corporate governance, need was felt for a comprehensive approach at this
stage of development of the capital market, to accelerate the adoption of globally
acceptable practices of corporate governance. This would ensure that the Indian
investors are in no way less informed and protected as compared to their
counterparts in the best-developed capital markets and economies of the world.
2.4 Securities market regulators in almost all developed and emerging markets
have for sometime been concerned about the importance of the subject and of the
need to raise the standards of corporate governance. The financial crisis in the
Asian markets in the recent past have highlighted the need for improved level of
corporate governance and the lack of it in certain countries have been mentioned
as one of the causes of the crisis. Indeed corporate governance has been a widely
discussed topic at the recent meetings of the International Organisation of
Securities Commissions (IOSCO). Besides in an environment in which emerging
markets increasingly compete for global capital, it is evident that global capital will
flow to markets which are better regulated and observe higher standards of
transparency, efficiency and integrity. Raising standards of corporate governance
is therefore also extremely relevant in this context.
2.5 In the above mentioned context, the Securities and Exchange Board of India
(SEBI) appointed the Committee on Corporate Governance on May 7, 1999 under
the Chairmanship of Shri Kumar Mangalam Birla, member SEBI Board, to promote
and raise the standards of Corporate Governance. The Committee’s membership
is given in Annexure 1 and the detailed terms of the reference are as follows:
a. to suggest suitable amendments to the listing agreement executed by

the stock exchanges with the companies and any other measures to
improve the standards of corporate governance in the listed
companies, in areas such as continuous disclosure of material
information, both financial and non-financial, manner and frequency of
such disclosures, responsibilities of independent and outside
directors;
b. to draft a code of corporate best practices; and
c. to suggest safeguards to be instituted within the companies to deal
with insider information and insider trading.
2.6 A number of reports and codes on the subject have already been published
internationally – notable among them are the Report of the Cadbury Committee,
the Report of the Greenbury Committee, the Combined Code of the London Stock
Exchange, the OECD Code on Corporate Governance and The Blue Ribbon
Committee on Corporate Governance in the US. In India, the CII has published a
Code of Corporate Governance. In preparing this report, while the Committee drew
upon these documents to the extent appropriate, the primary objective of the
Committee was to view corporate governance from the perspective of the investors
and shareholders and to prepare a Code to suit the Indian corporate environment,
as corporate governance frameworks are not exportable. The Committee also took
note of the various steps already taken by SEBI for strengthening corporate
governance, some of which are:
 strengthening of disclosure norms for Initial Public Offers following the

recommendations of the Committee set up by SEBI under the Chairmanship
of Shri Y H Malegam;
 providing information in directors’ reports for utilisation of funds and variation
between projected and actual use of funds according to the requirements of
the Companies Act; inclusion of cash flow and funds flow statement in
annual reports ;
 declaration of quarterly results;
 mandatory appointment of compliance officer for monitoring the share
transfer process and ensuring compliance with various rules and regulations;
 timely disclosure of material and price sensitive information including details
of all material events having a bearing on the performance of the company;
 despatch of one copy of complete balance sheet to every household and
abridged balance sheet to all shareholders;
 issue of guidelines for preferential allotment at market related prices; and
 issue of regulations providing for a fair and transparent framework for
takeovers and substantial acquisitions.
2.7 The Committee has identified the three key constituents of corporate
governance as the Shareholders, the Board of Directors and the Management and
has attempted to identify in respect of each of these constituents, their roles and
responsibilities as also their rights in the context of good corporate governance.
Fundamental to this examination and permeating throughout this exercise is the
recognition of the three key aspects of corporate governance, namely;
accountability, transparency and equality of treatment for all stakeholders.
2.8 The pivotal role in any system of corporate governance is performed by the
board of directors. It is accountable to the stakeholders and directs and controls the
Management. It stewards the company, sets its strategic aim and financial goals
and oversees their implementation, puts in place adequate internal controls and
periodically reports the activities and progress of the company in the company in a
transparent manner to the stakeholders. The shareholders’ role in corporate
governance is to appoint the directors and the auditors and to hold the board
accountable for the proper governance of the company by requiring the board to
provide them periodically with the requisite information ,in a transparent fashion, of
the activities and progress of the company. The responsibility of the management
is to undertake the management of the company in terms of the direction provided
by the board, to put in place adequate control systems and to ensure their
operation and to provide information to the board on a timely basis and in a
transparent manner to enable the board to monitor the accountability of
Management to it.
2.9 Crucial to good corporate governance are the existence and enforceability of
regulations relating to insider information and insider trading. These matters are
being currently examined separately by a Group appointed by SEBI under the
Chairmanship of Shri Kumar Mangalam Birla.
2.10 Adequate financial reporting and disclosure are the corner stones of good
corporate governance. These demand the existence and implementation of proper
accounting standards and disclosure requirements. A separate committee
appointed by SEBI under the Chairmanship of Shri Y. H. Malegam (who is also a
member of this Committee) is examining these issues on a continuing basis. This
Committee has advised that while in most areas, accounting standards in India are
comparable with International Accounting Standards both in terms of coverage and
content, there are a few areas where additional standards need to be introduced in
India on an urgent basis. These matters are discussed in greater detail in para 12.1
of this report.
2.11 The Committee’s draft report was made public through the media and also put
on the web site of SEBI for comments. The report was also sent to the Chambers
of Commerce, financial institutions, stock exchanges, investor associations, the
Association of Merchant Bankers of India, Association of Mutual funds of India, The
Institute of Chartered Accountants of India, Institute of Company Secretaries of
India, academicians, experts and eminent personalities in the Indian capital market,
foreign investors. A copy of the draft report was also sent to Sir Adrian Cadbury
who had chaired the Cadbury Committee on Corporate Governance set up by the
London Stock Exchange, the Financial Reporting Council and the Accountancy
Bodies in the U. K. in 1991.
2.12 The Committee has received comments from most of the above groups.
Besides, Sir Adrian Cadbury, and several eminent persons in the Indian capital
market, have sent detailed comments on the draft report. Separately, the
Committee held meetings with the representatives of the Chambers of Commerce,
Chairmen of the Financial Institutions, stock exchanges, investor associations.
Thus the Committee had the benefit of the views of almost all concerned entities
that have a role in corporate governance. The Committee has taken into account
the views and comments of these respondents in this final report.
2.13 The Committee puts on record its appreciation of the valuable inputs and
painstaking efforts of Shri Anup Srivastava, Vice-President Corporate Strategy and
Business Development of the Aditya Birla Group, Shri P K Bindlish, Division Chief,
SEBI, Shri Umesh Kumar, and other officers of the SMDRP department of SEBI, in
the preparation of this report.

The Recommendations of the Committee
3.1 This Report is the first formal and comprehensive attempt to evolve a Code of
Corporate Governance, in the context of prevailing conditions of governance in
Indian companies, as well as the state of capital markets. While making the
recommendations the Committee has been mindful that any code of Corporate
Governance must be dynamic, evolving and should change with changing context
and times. It would therefore be necessary that this code also is reviewed from
time to time, keeping pace with the changing expectations of the investors,
shareholders, and other stakeholders and with increasing sophistication achieved
in capital markets.

Corporate Governance –the Objective
4.1 Corporate governance has several claimants –shareholders and other

stakeholders - which include suppliers, customers, creditors, the bankers, the
employees of the company, the government and the society at large. This Report
on Corporate Governance has been prepared by the Committee for SEBI, keeping
in view primarily the interests of a particular class of stakeholders, namely, the
shareholders, who together with the investors form the principal constituency of
SEBI while not ignoring the needs of other stakeholders.
4.2 The Committee therefore agreed that the fundamental objective of corporate
governance is the "enhancement of shareholder value, keeping in view the
interests of other stakeholder". This definition harmonises the need for a company
to strike a balance at all times between the need to enhance shareholders’ wealth
whilst not in any way being detrimental to the interests of the other stakeholders in
the company.
4.3 In the opinion of the Committee, the imperative for corporate governance lies
not merely in drafting a code of corporate governance, but in practising it. Even
now, some companies are following exemplary practices, without the existence of
formal guidelines on this subject. Structures and rules are important because they
provide a framework, which will encourage and enforce good governance; but
alone, these cannot raise the standards of corporate governance. What counts is
the way in which these are put to use. The Committee is thus of the firm view, that
the best results would be achieved when the companies begin to treat the code not
as a mere structure, but as a way of life.
4.4 It follows that the real onus of achieving the desired level of corporate
governance, lies in the proactive initiatives taken by the companies themselves and
not in the external measures like breadth and depth of a code or stringency of
enforcement of norms. The extent of discipline, transparency and fairness, and the
willingness shown by the companies themselves in implementing the Code, will be
the crucial factor in achieving the desired confidence of shareholders and other
stakeholders and fulfilling the goals of the company.
Applicability of the Recommendations
Mandatory and non mandatory recommendations
5.1 The Committee debated the question of voluntary versus mandatory

compliance of its recommendations. The Committee was of the firm view that
mandatory compliance of the recommendations at least in respect of the essential
recommendations would be most appropriate in the Indian context for the present.
The Committee also noted that in most of the countries where standards of
corporate governance are high, the stock exchanges have enforced some form of
compliance through their listing agreements.
5.2 The Committee felt that some of the recommendations are absolutely essential
for the framework of corporate governance and virtually form its core, while others
could be considered as desirable. Besides, some of the recommendations may
also need change of statute, such as the Companies Act, for their enforcement. In
the case of others, enforcement would be possible by amending the Securities
Contracts (Regulation) Rules, 1957 and by amending the listing agreement of the
stock exchanges under the direction of SEBI. The latter, would be less time
consuming and would ensure speedier implementation of corporate governance.
The Committee therefore felt that the recommendations should be divided into
mandatory and non- mandatory categories and those recommendations which are
absolutely essential for corporate governance, can be defined with precision and
which can be enforced through the amendment of the listing agreement could be
classified as mandatory. Others, which are either desirable or which may require
change of laws, may, for the time being, be classified as non-mandatory.
Applicability
5.3 The Committee is of the opinion that the recommendations should be made
applicable to the listed companies, their directors, management, employees and
professionals associated with such companies, in accordance with the time table
proposed in the schedule given later in this section. Compliance with the code
should be both in letter and spirit and should always be in a manner that gives
precedence to substance over form. The ultimate responsibility for putting the
recommendations into practice lies directly with the board of directors and the
management of the company.
5.4 The recommendations will apply to all the listed private and public sector
companies, in accordance with the schedule of implementation. As for listed
entities, which are not companies, but body corporates (e.g. private and public
sector banks, financial institutions, insurance companies etc.) incorporated under
other statutes, the recommendations will apply to the extent that they do not violate
their respective statutes, and guidelines or directives issued by the relevant
regulatory authorities.

Schedule of implementation
5.5 The Committee recognises that compliance with the recommendations would
involve restructuring the existing boards of companies. It also recognises that some
companies, especially the smaller ones, may have difficulty in immediately
complying with these conditions.
5.6 The Committee recommends that while the recommendations should be

applicable to all the listed companies or entities, there is a need for phasing out the
implementation as follows:
 By all entities seeking listing for the first time, at the time of listing.
 Within financial year 2000-2001,but not later than March 31, 2001 by all
entities, which are included either in Group ‘A’of the BSE or in S&P CNX
Nifty index as on January 1, 2000. However to comply with the
recommendations, these companies may have to begin the process of
implementation as early as possible. These companies would cover more
than 80% of the market capitalisation.
 Within financial year 2001-2002,but not later than March 31, 2002 by all the
entities which are presently listed, with paid up share capital of Rs. 10 crore
and above, or networth of Rs 25 crore or more any time in the history of the
company.
 Within financial year 2002-2003,but not later than March 31, 2003 by all the
entities which are presently listed, with paid up share capital of Rs 3 crore
and above
This is a mandatory recommendation.

Board of Directors
6.1 The board of a company provides leadership and strategic guidance, objective
judgement independent of management to the company and exercises control over
the company, while remaining at all times accountable to the shareholders. The
measure of the board is not simply whether it fulfils its legal requirements but more
importantly, the board’s attitude and the manner it translates its awareness and
understanding of its responsibilities. An effective corporate governance system is
one, which allows the board to perform these dual functions efficiently. The board
of directors of a company, thus directs and controls the management of a company
and is accountable to the shareholders.
6.2 The board directs the company, by formulating and reviewing company’s
policies, strategies, major plans of action, risk policy, annual budgets and business
plans, setting performance objectives, monitoring implementation and corporate
performance, and overseeing major capital expenditures, acquisitions and
divestitures, change in financial control and compliance with applicable laws, taking
into account the interests of stakeholders. It controls the company and its
management by laying down the code of conduct, overseeing the process of
disclosure and communications, ensuring that appropriate systems for financial
control and reporting and monitoring risk are in place, evaluating the performance
of management, chief executive, executive directors and providing checks and
balances to reduce potential conflict between the specific interests of management
and the wider interests of the company and shareholders including misuse of
corporate assets and abuse in related party transactions. It is accountable to the
shareholders for creating, protecting and enhancing wealth and resources for the
company, and reporting to them on the performance in a timely and transparent
manner. However, it is not involved in day-to-day management of the company,
which is the responsibility of the management.
Composition of the Board of Directors

6.3 The Committee is of the view that the composition of the board of directors is
critical to the independent functioning of the board. There is a significant body of
literature on corporate governance, which has guided the composition, structure
and responsibilities of the board. The Committee took note of this while framing its
recommendations on the structure and composition of the board.
The composition of the board is important in as much as it determines the ability of
the board to collectively provide the leadership and ensures that no one individual
or a group is able to dominate the board. The executive directors (like director-
finance, director-personnel) are involved in the day to day management of the
companies; the non-executive directors bring external and wider perspective and
independence to the decision making. Till recently, it has been the practice of most
of the companies in India to fill the board with representatives of the promoters of
the company, and independent directors if chosen were also handpicked thereby
ceasing to be independent. This has undergone a change and increasingly the
boards comprise of following groups of directors - promoter director, (promoters
being defined by the erstwhile Malegam Committee), executive and non executive
directors, a part of whom are independent. A conscious distinction has been made
by the Committee between two classes of non-executive directors, namely, those
who are independent and those who are not.
Independent directors and the definition of independence

6.5 Among the non-executive directors are independent directors, who have a key
role in the entire mosaic of corporate governance.The Committee was of the view
that it was important that independence be suitably, correctly and pragmatically
defined, so that the definition itself does not become a constraint in the choice of
independent directors on the boards of companies. The definition should bring out
what in the view of the Committee is the touchstone of independence, and which
should be sufficiently broad and flexible. It was agreed that "material pecuniary
relationship which affects independence of a director" should be the litmus test of
independence and the board of the company would exercise sufficient degree of
maturity when left to itself, to determine whether a director is independent or not.
The Committee therefore agreed on the following definition of
"independence".Independent directors are directors who apart from receiving
director’s remuneration do not have any other material pecuniary relationship or
transactions with the company, its promoters, its management or its subsidiaries,
which in the judgement of the board may affect their independence of
judgement.Further, all pecuniary relationships or transactions of the non-executive
directors should be disclosed in the annual report.
6.6 The Blue Riband Committee of the USA and other Committee reports have
laid considerable stress on the role of independent directors. The law however
does not make any distinction between the different categories of directors and all
directors are equally and collectively responsible in law for the board’s actions and
decisions. The Committee is of the view that the non-executive directors, i.e. those
who are independent and those who are not, help bring an independent judgement
to bear on board’s deliberations especially on issues of strategy, performance,
management of conflicts and standards of conduct. The Committee therefore lays
emphasis on the calibre of the non-executive directors, especially of the
independent directors.
6.7 Good corporate governance dictates that the board be comprised of

individuals with certain personal characteristics and core competencies such as
recognition of the importance of the board’s tasks, integrity, a sense of
accountability, track record of achievements, and the ability to ask tough questions.
Besides, having financial literacy, experience, leadership qualities and the ability to
think strategically, the directors must show significant degree of commitment to the
company and devote adequate time for meeting, preparation and attendance. The
Committee is also of the view that it is important that adequate compensation
package be given to the non-executive independent directors so that these
positions become sufficiently financially attractive to attract talent and that the non
executive directors are sufficiently compensated for undertaking this work.
6.8 Independence of the board is critical to ensuring that the board fulfils its
oversight role objectively and holds the management accountable to the
shareholders. The Committee has, therefore, suggested the above definition of
independence, and the following structure and composition of the board and of the
committees of the board.
6.9 The Committee recommends that the board of a company have an optimum
combination of executive and non-executive directors with not less than fifty
percent of the board comprising the non-executive directors. The number of
independent directors (independence being as defined in the foregoing paragraph)
would depend on the nature of the chairman of the board. In case a company has
a non-executive chairman, at least one-third of board should comprise of
independent directors and in case a company has an executive chairman, at least
half of board should be independent.

6.10 The tenure of office of the directors will be as prescribed in the Companies
Act.
Nominee Directors
7.1 Besides the above categories of directors, there is another set of directors in
Indian companies who are the nominees of the financial or investment institutions
to safeguard their interest. The nominees of the institutions are often chosen from
among the present or retired employees of the institutions or from outside. In the
context of corporate governance, there could be arguments both for and against
the continuation of this practice.
7.2 There are arguments both for and against the institution of nominee directors.
Those who favour this practice argue that nominee directors are needed to protect
the interest of the institutions who are custodians of public funds and who have
high exposures in the projects of the companies both in the form of equity and
loans. On the other hand those who oppose this practice, while conceding that
financial institutions have played a significant role in the industrial development of
the country as a sole purveyor of long term credit, argue that there is an inherent
conflict when institutions through their nominees participate in board decisions and
in their role as shareholders demand accountability from the board. They also
argue that there is a further conflict because the institutions are often major players
in the stock market in respect of the shares of the companies on which they have
nominees.
7.3 The Committee recognises the merit in both points of view. Clearly when
companies are well managed and performing well, the need for protection of
institutional interest is much less than when companies are badly managed or
under-performing. The Committee would therefore recommend that institutions
should appoint nominees on the boards of companies only on a selective basis
where such appointment is pursuant to a right under loan agreements or where
such appointment is considered necessary to protect the interest of the institution.
7.4 The Committee also recommends that when a nominee of the institutions is
appointed as a director of the company, he should have the same responsibility, be
subject to the same discipline and be accountable to the shareholders in the same
manner as any other director of the company. In particular, if he reports to any
department of the institutions on the affairs of the company, the institution should
ensure that there exist chinese walls between such department and other
departments which may be dealing in the shares of the company in the stock
market.
Chairman of the Board
8.1 The Committee believes that the role of Chairman is to ensure that the board
meetings are conducted in a manner which secures the effective participation of all
directors, executive and non-executive alike, and encourages all to make an
effective contribution, maintain a balance of power in the board, make certain that
all directors receive adequate information, well in time and that the executive
directors look beyond their executive duties and accept full share of the
responsibilities of governance. The Committee is of the view that the Chairman’s
role should in principle be different from that of the chief executive, though the
same individual may perform both roles.
8.2 Given the importance of Chairman’s role, the Committee recommends that a
non-executive Chairman should be entitled to maintain a Chairman’s office at the
company’s expense and also allowed reimbursement of expenses incurred in
performance of his duties. This will enable him to discharge the responsibilities
effectively.
This is a non-mandatory recommendation.
Audit Committee
9.1 There are few words more reassuring to the investors and shareholders than
accountability. A system of good corporate governance promotes relationships of
accountability between the principal actors of sound financial reporting – the board,
the management and the auditor. It holds the management accountable to the
board and the board accountable to the shareholders. The audit committee’s role
flows directly from the board’s oversight function. It acts as a catalyst for effective
financial reporting.
9.2 The Committee is of the view that the need for having an audit committee
grows from the recognition of the audit committee’s position in the larger mosaic of
the governance process, as it relates to the oversight of financial reporting.
9.3 A proper and well functioning system exists therefore, when the three main
groups responsible for financial reporting – the board, the internal auditor and the
outside auditors – form the three-legged stool that supports responsible financial
disclosure and active and participatory oversight. The audit committee has an
important role to play in this process, since the audit committee is a sub-group of
the full board and hence the monitor of the process. Certainly, it is not the role of
the audit committee to prepare financial statements or engage in the myriad of
decisions relating to the preparation of those statements. The committee’s job is
clearly one of oversight and monitoring and in carrying out this job it relies on
senior financial management and the outside auditors. However it is important to
ensure that the boards function efficiently for if the boards are dysfunctional, the
audit committees will do no better. The Committee believes that the progressive
standards of governance applicable to the full board should also be applicable to
the audit committee.
9.4 The Committee therefore recommends that a qualified and independent audit
committee should be set up by the board of a company. This would go a long way
in enhancing the credibility of the financial disclosures of a company and promoting
transparency.
9.5 The following recommendations of the Committee, regarding the constitution,

functions and procedures of audit committee would have to be viewed in the above
context. But just as there is no "one size fits all" for the board when it comes to
corporate governance, same is true for audit committees. The Committee can thus
only lay down some broad parameters, within which each audit committee has to
evolve its own guidelines.
Composition
9.6 The composition of the audit committee is based on the fundamental premise
of independence and expertise.
The Committee therefore recommends that
 the audit committee should have minimum three members, all being non
executive directors, with the majority being independent, and with at least
one director having financial and accounting knowledge;
 the chairman of the committee should be an independent director;

 the chairman should be present at Annual General Meeting to answer
shareholder queries;
 the audit committee should invite such of the executives, as it considers
appropriate (and particularly the head of the finance function) to be present
at the meetings of the Committee but on occasions it may also meet without
the presence of any executives of the company. Finance director and head
of internal audit and when required, a representative of the external auditor
should be present as invitees for the meetings of the audit committee;
 the Company Secretary should act as the secretary to the committee.
These are mandatory recommendations.

Frequency of meetings and quorum
9.7 The Committee recommends that to begin with the audit committee should
meet at least thrice a year. One meeting must be held before finalisation of annual
accounts and one necessarily every six months.
This is a mandatory recommendation

9.8 The quorum should be either two members or one-third of the members of the
audit committee, whichever is higher and there should be a minimum of two
independent directors.
Powers of the audit committee

9.9 Being a committee of the board, the audit committee derives its powers from
the authorisation of the board. The Committee recommends that such powers
should include powers:
 To investigate any activity within its terms of reference.

 To seek information from any employee.
 To obtain outside legal or other professional advice.
 To secure attendance of outsiders with relevant expertise, if it considers
necessary.

Functions of the Audit Committee
9.10 As the audit committee acts as the bridge between the board, the statutory
auditors and internal auditors, the Committee recommends that its role should
include the following

 Oversight of the company’s financial reporting process and the disclosure of

its financial information to ensure that the financial statement is correct,
sufficient and credible.
 Recommending the appointment and removal of external auditor, fixation of
audit fee and also approval for payment for any other services.
 Reviewing with management the annual financial statements before
submission to the board, focussing primarily on:
o Any changes in accounting policies and practices.
o Major accounting entries based on exercise of judgement by
management.
o Qualifications in draft audit report.
o Significant adjustments arising out of audit.
o The going concern assumption.
o Compliance with accounting standards
o Compliance with stock exchange and legal requirements concerning
financial statements.
o Any related party transactions i.e. transactions of the company of
material nature, with promoters or the management, their subsidiaries
or relatives etc. that may have potential conflict with the interests of
company at large.
 Reviewing with the management, external and internal auditors, the
adequacy of internal control systems.
 Reviewing the adequacy of internal audit function, including the structure of
the internal audit department, staffing and seniority of the official heading the
department, reporting structure, coverage and frequency of internal audit.
 Discussion with internal auditors of any significant findings and follow-up
thereon.
 Reviewing the findings of any internal investigations by the internal auditors
into matters where there is suspected fraud or irregularity or a failure of
internal control systems of a material nature and reporting the matter to the
board.
 Discussion with external auditors before the audit commences, of the nature
and scope of audit. Also post-audit discussion to ascertain any area of
concern.
 Reviewing the company’s financial and risk management policies.
 Looking into the reasons for substantial defaults in the payments to the
depositors, debenture holders, share holders (in case of non-payment of
declared dividends) and creditors.

Remuneration Committee of the Board
10.1 The Committee was of the view that a company must have a credible and
transparent policy in determining and accounting for the remuneration of the
directors. The policy should avoid potential conflicts of interest between the
shareholders, the directors, and the management. The overriding principle in
respect of directors’ remuneration is that of openness and shareholders are entitled
to a full and clear statement of benefits available to the directors.
10.2 For this purpose the Committee recommends that the board should set up a
remuneration committee to determine on their behalf and on behalf of the
shareholders with agreed terms of reference, the company’s policy on specific
remuneration packages for executive directors including pension rights and any
compensation payment.
10.3 The Committee however recognised that the remuneration package should
be good enough to attract, retain and motivate the executive directors of the quality
required, but not more than necessary for the purpose. The remuneration
committee should be in a position to bring about objectivity in determining the
remuneration package while striking a balance between the interest of the
company and the shareholders.
Composition, Quorum etc. of the Remuneration Committee
10.4 The Committee recommends that to avoid conflicts of interest, the

remuneration committee, which would determine the remuneration packages of the
executive directors should comprise of at least three directors, all of whom should
be non-executive directors, the chairman of committee being an independent
director.
10.5 The Committee deliberated on the quorum for the meeting and was of the
view that remuneration is mostly fixed annually or after specified periods. It would
not be necessary for the committee to meet very often. The Committee was of the
view that it should not be difficult to arrange for a date to suit the convenience of all
the members of the committee. The Committee therefore recommends that all the
members of the remuneration committee should be present at the meeting.
10.6 The Committee also recommends that the Chairman of the remuneration
committee should be present at the Annual General Meeting, to answer the
shareholder queries. However, it would be up to the Chairman to decide who
should answer the queries.
All the above recommendations in paragraphs 10.4 to 10.6 are non-mandatory.
10.7 The Committee recommends that the board of directors should decide the
remuneration of non-executive directors.
Disclosures of Remuneration Package

10.8 It is important for the shareholders to be informed of the remuneration of the
directors of the company. The Committee therefore recommends that the following
disclosures should be made in the section on corporate governance of the annual
report:
 All elements of remuneration package of all the directors i.e. salary, benefits,
bonuses, stock options, pension etc.
 Details of fixed component and performance linked incentives, along with the
performance criteria.
 Service contracts, notice period, severance fees.
 Stock option details, if any – and whether issued at a discount as well as the
period over which accrued and over which exercisable.
Board Procedures
11.1 The measure of the board is buttressed by the structures and procedures of
the board. The various committees of the board recommended in this report would
enable the board to have an appropriate structure to assist it in the discharge of its
responsibilities. These need to be supplemented by certain basic procedural
requirements in terms of frequency of meetings, the availability of timely
information, sufficient period of notice for the board meeting as well as circulation
of agenda items well in advance, and more importantly, the commitment of the
members of the board.
11.2 The Committee therefore recommends that board meetings should be held at
least four times in a year, with a maximum time gap of four months between any
two meetings. The minimum information as given in Annexure 2 should be
available to the board.
The Committee further recommends that to ensure that the members of the board
give due importance and commitment to the meetings of the board and its
committees, there should be a ceiling on the maximum number of committees
across all companies in which a director could be a member or act as Chairman.
The Committee recommends that a director should not be a member in more than
10 committees or act as Chairman of more than five committees across all
companies in which he is a director. Furthermore it should be a mandatory annual
requirement for every director to inform the company about the committee
positions he occupies in other companies and notify changes as and when they
take place.
Accounting Standards and Financial Reporting

12.1 Over time the financial reporting and accounting standards in India have been
upgraded. This however is an ongoing process and we have to move speedily
towards the adoption of international standards. This is particularly important from
the angle of corporate governance. The Committee took note of the discussions of
the SEBI Committee on Accounting Standards referred to earlier and makes the
following recommendations:

 Consolidation of Accounts of subsidiaries

The companies should be required to give consolidated accounts in respect of all
its subsidiaries in which they hold 51 % or more of the share capital. The
Committee was informed that SEBI was already in dialogue with the Institute of
Chartered Accountants of India to bring about the changes in the Accounting
Standard on consolidated financial statements. The Institute of Chartered
Accountants of India should be requested to issue the Accounting Standards for
consolidation expeditiously.
 Segment reporting where a company has multiple lines of business.
Equally in cases of companies with several businesses, it is important that financial
reporting in respect of each product segment should be available to shareholders
and the market to obtain a complete financial picture of the company. The
Committee was informed that SEBI was already in dialogue with the Institute of
Chartered Accountants of India to introduce the Accounting Standard on segment
reporting. The Institute of Chartered Accountants of India has already issued an
Exposure Draft on the subject and should be requested to finalise this at an early
date.
 Disclosure and treatment of related party transactions.
This again is an important disclosure. The Committee was informed that the
Institute of Chartered Accountants of India had already issued an Exposure Draft
on the subject. The Committee recommends that the Institute of Chartered
Accountants of India should be requested to finalise this at the earliest. In the
interim, the Committee recommends the disclosures set out in Clause 7 of
Annexure-4
 Treatment of deferred taxation
The treatment of deferred taxation and its appropriate disclosure has an important
bearing on the true and fair view of the financial status of the company. The
Committee recommends that the Institute of Chartered Accountants of India be
requested to issue a standard on deferred tax liability at an early date.
Management
13.1 In the view of the Committee, the over-riding aim of management is to
maximize shareholder value without being detrimental to the interests of other
stakeholders. The management however, is subservient to the board of directors
and must operate within the boundaries and the policy framework laid down by the
board. While the board is responsible for ensuring that the principles of corporate
governance are adhered to and enforced, the real onus of implementation lies with
the management. It is responsible for translating into action, the policies and
strategies of the board and implementing its directives to achieve corporate
objectives of the company framed by the board. It is therefore essential that the
board should clearly define the role of the management.
Functions of the Management
13.2 The management comprises the Chief Executive, Executive-directors and the
key managers of the company, involved in day-to-day activities of the company.
13.3 The Committee believes that the management should carry out the following
functions:
 Assisting the board in its decision making process in respect of the

company’s strategy, policies, code of conduct and performance targets, by
providing necessary inputs.
 Implementing the policies and code of conduct of the board.
 Managing the day to day affairs of the company to best achieve the targets
and goals set by the board, to maximize the shareholder value.
 Providing timely, accurate, substantive and material information, including
financial matters and exceptions, to the board, board-committees and the
shareholders.
 Ensuring compliance of all regulations and laws.
 Ensuring timely and efficient service to the shareholders and to protect
shareholder’s rights and interests.
 Setting up and implementing an effective internal control systems,
commensurate with the business requirements.
 Implementing and comply with the Code of Conduct as laid down by the
board.
 Co-operating and facilitating efficient working of board committees.
13.4 As a part of the disclosure related to Management, the Committee

recommends that as part of the directors’ report or as an addition there to, a
Management Discussion and Analysis report should form part of the annual report
to the shareholders. This Management Discussion & Analysis should include
discussion on the following matters within the limits set by the company’s
competitive position:
 Industry structure and developments.

 Opportunities and Threats
 Segment-wise or product-wise performance.
 Outlook.
 Risks and concerns
 Internal control systems and their adequacy.
 Discussion on financial performance with respect to operational
performance.
 Material developments in Human Resources /Industrial Relations front,
including number of people employed.
13.5 Good corporate governance casts an obligation on the management in

respect of disclosures. The Committee therefore recommends that disclosures
must be made by the management to the board relating to all material financial and
commercial transactions, where they have personal interest, that may have a
potential conflict with the interest of the company at large (for e.g. dealing in
company shares, commercial dealings with bodies, which have shareholding of
management and their relatives etc.)
Shareholders
14.1 The shareholders are the owners of the company and as such they have
certain rights and responsibilities. But in reality companies cannot be managed by
shareholder referendum. The shareholders are not expected to assume
responsibility for the management of corporate affairs. A company’s management
must be able to take business decisions rapidly. The shareholders have therefore
to necessarily delegate many of their responsibilities as owners of the company to
the directors who then become responsible for corporate strategy and operations.
The implementation of this strategy is done by a management team. This
relationship therefore brings in the accountability of the boards and the
management to the shareholders of the company. A good corporate framework is
one that provides adequate avenues to the shareholders for effective contribution
in the governance of the company while insisting on a high standard of corporate
behaviour without getting involved in the day to day functioning of the company.
Responsibilities of shareholders
14.2 The Committee believes that the General Body Meetings provide an
opportunity to the shareholders to address their concerns to the board of directors
and comment on and demand any explanation on the annual report or on the
overall functioning of the company. It is important that the shareholders use the
forum of general body meetings for ensuring that the company is being properly
stewarded for maximising the interests of the shareholders. This is important
especially in the Indian context. It follows from the above, that for effective
participation shareholders must maintain decorum during the General Body
Meetings.
14.3 The effectiveness of the board is determined by the quality of the directors
and the quality of the financial information is dependent to an extent on the
efficiency with which the auditors carry on their duties. The shareholders must
therefore show a greater degree of interest and involvement in the appointment of
the directors and the auditors. Indeed, they should demand complete information
about the directors before approving their directorship.
14.4 The Committee recommends that in case of the appointment of a new

director or re-appointment of a director the shareholders must be provided with the
following information:
 A brief resume of the director;

 Nature of his expertise in specific functional areas; and
 Names of companies in which the person also holds the directorship and the
membership of Committees of the board.
Shareholders’ rights
14.5 The basic rights of the shareholders include right to transfer and registration
of shares, obtaining relevant information on the company on a timely and regular
basis, participating and voting in shareholder meetings, electing members of the
board and sharing in the residual profits of the corporation.
14.6 The Committee therefore recommends that as shareholders have a right to

participate in, and be sufficiently informed on decisions concerning fundamental
corporate changes, they should not only be provided information as under the
Companies Act, but also in respect of other decisions relating to material changes
such as takeovers, sale of assets or divisions of the company and changes in
capital structure which will lead to change in control or may result in certain
shareholders obtaining control disproportionate to the equity ownership.
14.7 The Committee recommends that information like quarterly results,

presentation made by companies to analysts may be put on company’s web-site or
may be sent in such a form so as to enable the stock exchange on which the
company is listed to put it on its own web-site.
14.8 The Committee recommends that the half-yearly declaration of financial

performance including summary of the significant events in last six-months, should
be sent to each household of shareholders.

14.9 A company must have appropriate systems in place which will enable the
shareholders to participate effectively and vote in the shareholders’ meetings. The
company should also keep the shareholders informed of the rules and voting
procedures, which govern the general shareholder meetings.
14.10 The annual general meetings of the company should not be deliberately
held at venues or the timing should not be such which makes it difficult for most of
the shareholders to attend. The company must also ensure that it is not
inconvenient or expensive for shareholders to cast their vote.
14.11 Currently, although the formality of holding the general meeting is gone
through, in actual practice only a small fraction of the shareholders of that company
do or can really participate therein. This virtually makes the concept of corporate
democracy illusory. It is imperative that this situation which has lasted too long
needs an early correction. In this context, for shareholders who are unable to
attend the meetings, there should be a requirement which will enable them to vote
by postal ballot for key decisions. A detailed list of the matters which should require
postal ballot is given in Annexure 3. This would require changes in the Companies
Act. The Committee was informed that SEBI has already made recommendations
in this regard to the Department of Company Affairs.
14.12 The Committee recommends that a board committee under the

chairmanship of a non-executive director should be formed to specifically look into
the redressing of shareholder complaints like transfer of shares, non-receipt of
balance sheet, non-receipt of declared dividends etc. The Committee believes that
the formation of such a committee will help focus the attention of the company on
shareholders’ grievances and sensitise the management to redressal of their
grievances.

14.13 The Committee further recommends that to expedite the process of share
transfers the board of the company should delegate the power of share transfer to
an officer, or a committee or to the registrar and share transfer agents. The
delegated authority should attend to share transfer formalities at least once in a
fortnight.
Institutional shareholders
14.14 Institutional shareholders have acquired large stakes in the equity share
capital of listed Indian companies. They have or are in the process of becoming
majority shareholders in many listed companies and own shares largely on behalf
of the retail investors. They thus have a special responsibility given the weightage
of their votes and have a bigger role to play in corporate governance as retail
investors look upon them for positive use of their voting rights.
14.15 Given the weight of their votes, the institutional shareholders can effectively
use their powers to influence the standards of corporate governance. Practices
elsewhere in the world have indicated that institutional shareholders can sufficiently
influence because of their collective stake, the policies of the company so as to
ensure that the company they have invested in, complies with the corporate
governance code in order to maximise shareholder value. What is important in the
view of the Committee is that, the institutional shareholders put to good use their
voting power
14.16 The Committee is of the view that the institutional shareholders
 Take active interest in the composition of the Board of Directors

 Be vigilant
 Maintain regular and systematic contact at senior level for exchange of views
on management, strategy, performance and the quality of management.
 Ensure that voting intentions are translated into practice
 Evaluate the corporate governance performance of the company
Manner of Implementation
15.1 The Committee recommends that SEBI writes to the Central Government to
amend the Securities Contracts (Regulation) Rules, 1957 for incorporating the
mandatory provisions of this Report.
15.2 The Committee further recommends to SEBI, that as in other countries, the
mandatory provisions of the recommendations may be implemented through the
listing agreement of the stock exchanges.
15.3 The Committee recognises that the listing agreement is not a very powerful
instrument and the penalties for violation are not sufficiently stringent to act as a
deterrent. The Committee therefore recommends to SEBI, that the listing
agreement of the stock exchanges be strengthened and the exchanges
themselves be vested with more powers, so that they can ensure proper
compliance of code of Corporate Governance. In this context the Committee
further recommends that the Securities Contract (Regulation) Act, 1956 should be
amended, so that in addition to the above, the concept of listing agreement be
replaced by listing conditions.
15.4 The Committee recommends that the Securities Contracts (Regulation) Act,
1956 be amended to empower SEBI and stock exchanges to take deterrent and
appropriate action in case of violation of the provisions of the listing agreement.
These could include power of levying monetary penalty both on the company and
the concerned officials of the company and filing of winding-up petition etc.
15.5 The Committee also recommends that SEBI write to the Department of
Company Affairs for suitable amendments to the Companies Act in respect of the
recommendations which fall within their jurisdiction.
15.6 The Committee recommends that there should be a separate section on

Corporate Governance in the annual reports of companies, with a detailed
compliance report on Corporate Governance. Non-compliance of any mandatory
recommendation with reasons thereof and the extent to which the non-mandatory
recommendations have been adopted should be specifically highlighted. This will
enable the shareholders and the securities market to assess for themselves the
standards of corporate governance followed by a company. A suggested list of
items to be included in the compliance report is enclosed. in Annexure 4.
15.7 The Committee also recommends that the company should arrange to obtain
a certificate from the auditors of the company regarding compliance of mandatory
recommendations and annexe the certificate with the directors’ report, which is
sent annually to all the shareholders of the company. The same certificate should
also be sent to the stock exchanges along with the annual returns filed by the
company.
End Note
There are several corporate governance structures available in the developed
world but there is no one structure, which can be singled out as being better than
the others. There is no "one size fits all" structure for corporate governance. The
Committee’s recommendations are not therefore based on any one model but are
designed for the Indian environment.
Corporate governance extends beyond corporate law. Its fundamental objective is

not mere fulfillment of the requirements of law but in ensuring commitment of the
board in managing the company in a transparent manner for maximising long term
shareholder value. The corporate governance has as many votaries as claimants.
Among the latter, the Committee has primarily focussed its recommendations on
investors and shareholders, as they are the prime constituencies of SEBI.
Effectiveness of corporate governance system cannot merely be legislated by law
neither can any system of corporate governance be static. As competition
increases, technology pronounces the death of distance and speeds up
communication, the environment in which firms operate in India also changes. In
this dynamic environment the systems of corporate governance also need to
evolve. The Committee believes that its recommendations will go a long way in
raising the standards of corporate governance in Indian firms and make them
attractive destinations for local and global capital. These recommendations will also
form the base for further evolution of the structure of corporate governance in
consonance with the rapidly changing economic and industrial environment of the
country in the new millenium.
Annexure 1
Names of the Members of the committee
Shri Kumar Mangalam Birla, Chairman, Aditya Birla group

Chairman of the Committee
1. Shri Rohit Bhagat, Country Head, Boston Consulting Group
2. Dr. J Bhagwati, Jt. Secretary, Ministry of Finance.
3. Shri Samir Biswas, Regional Director, Western Region, Department of Company
Affairs, Government of India
4. Shri S.P. Chhajed, President of Institute of Chartered Accountants of India
5. Shri Virender Ganda, Ex-President of Institute of Company Secretaries of India
6. Dr. Sumantra Ghoshal, Professor of Strategic Management, London Business
School
7. Shri Vijay Kalantri, President, All India Association of Industries
8. Shri Pratip Kar, Executive Director, SEBI — Member Secretary
9.Shri Y. H. Malegam, Managing Partner, S.B. Billimoria & Co
10.Shri N. R. Narayana Murthy, Chairman and Managing Director, Infosys
Technologies Ltd.
11.Shri A K Narayanan, President of Tamil Nadu Investor Association
12.Shri Kamal Parekh, Ex-President, Calcutta Stock Exchange (Shri J M
Chaudhary – President Calcutta Stock Exchange
13.Dr. R. H. Patil, Managing Director, National Stock Exchange Ltd.
14.Shri Anand Rathi, President of the Stock Exchange, Mumbai
15.Ms D.N. Raval, Executive Director, SEBI
16.Shri Rajesh Shah, Former President of Confederation of Indian Industries.
17.Shri L K Singhvi, Sr. Executive Director, SEBI
18.Shri S. S. Sodhi, Executive Director, Delhi Stock Exchange
Annexure 2
Information to be placed before board of directors
1. Annual operating plans and budgets and any updates.

2. Capital budgets and any updates.
3. Quarterly results for the company and its operating divisions or business
segments.
4. Minutes of meetings of audit committee and other committees of the board.
5. The information on recruitment and remuneration of senior officers just
below the board level, including appointment or removal of Chief Financial
Officer and the Company Secretary.
6. Show cause, demand and prosecution notices which are materially important
7. Fatal or serious accidents, dangerous occurrences, any material effluent or
pollution problems.
8. Any material default in financial obligations to and by the company, or
substantial non-payment for goods sold by the company.
9. Any issue, which involves possible public or product liability claims of
substantial nature, including any judgement or order which, may have
passed strictures on the conduct of the company or taken an adverse view
regarding another enterprise that can have negative implications on the
company.
10.Details of any joint venture or collaboration agreement.
11.Transactions that involve substantial payment towards goodwill, brand
equity, or intellectual property.
12.Significant labour problems and their proposed solutions. Any significant
development in Human Resources/ Industrial Relations front like signing of
wage agreement, implementation of Voluntary Retirement Scheme etc.
13.Sale of material nature, of investments, subsidiaries, assets, which is not in
normal course of business.
14.Quarterly details of foreign exchange exposures and the steps taken by
management to limit the risks of adverse exchange rate movement, if
material.
15.Non-compliance of any regulatory, statutory nature or listing requirements
and shareholders service such as non-payment of dividend, delay in share
transfer etc.
Annexure 3
POST BALLOT SYSTEM
Rationale
Voting at the general meetings of companies is the most valuable and fundamental
mechanism by which the shareholders accept or reject the proposals of the board
of directors as regards the structure, the strategy, the ownership and the
management of the corporation. Voting is the only mechanism available with the
shareholders for exercising an external check on the board and the management.
Under the present framework of the Companies Act, 1956, a company is required
to obtain the approval of its shareholders for various important decisions such as
increase in its authorised capital, shifting of registered office, change in the name,
amalgamation and reconstitution, buy-back of shares, further issue of shares, etc.
Since the shareholders of any large public listed company are scattered throughout
the length and breadth of the country, they are unable to physically attend the
general meetings of the company to exercise their right to vote on matters of vital
importance. The system of voting by proxy has also not proved very effective.
With a view to strengthening shareholder democracy, it is felt that all the

shareholders of a company should be given the right to vote on certain critical
matters through a postal ballot system, which has also been envisaged in the
Companies Bill, 1997.
Items requiring voting by postal ballot
Some of the critical matters which should be decided by this system are –

1. matters relating to alteration in the memorandum of association of the

company like changes in name, objects, address of registered office etc;
2. sale of whole or substantially the whole of the undertaking;
3. sale of investments in the companies, where the shareholding or the voting
rights of the company exceeds 25%;
4. Making a further issue of shares through preferential allotment or private
placement basis;
5. Corporate restructuring;
6. Entering a new business area not germane to the existing business of the
company;
7. Variation in the rights attached to class of securities.
Procedure for the postal ballot
Where a resolution is to be passed in relation to any of the aforesaid items through

postal ballot,
1. The board of directors shall appoint a Designated-Person to conduct,

supervise and control the exercise of postal ballot. This person may be the
Company Secretary, a retired judge or any person of repute who, in the
opinion of the board, can conduct the voting process in a fair & transparent
manner.
2. All communications in this regard shall be made by and addressed directly to
the said Designated-Person.
3. A notice containing a draft of the resolutions and the necessary explanatory
statement shall be sent to all members entitled to vote requesting them to
send their assent or dissent within a period of thirty days from the date of
posting of the letter.
4. The notice shall be sent under certificate of posting and shall include with the
notice, a pre-paid postage envelope for facilitating the communication of the
assent or the dissent of the shareholders to the resolutions within the said
period.
5. The envelope by post will be received directly by the Post Office through Box
No, which will be obtained by the Designated-Person in advance and will be
indicated on each pre-paid envelope to be used by the members for sending
the resolution.
6. The Designated-Person shall ascertain the will of the shareholders based on
the response received and the resolution shall be deemed to have been duly
passed if approved by members not less in number, than as prescribed by
law.
7. The Designated-Person shall thereafter give a report to the Chairman and on
the basis of such report the Chairman shall declare the results of the poll.
Annexure 4
Suggested List Of Items To Be Included In The Report On Corporate

Governance In The Annual Report Of Companies
1. A brief statement on company’s philosophy on code of governance.

2. Board of Directors:
 Composition and category of directors for example promoter, executive, non-

executive, independent non-executive, nominee director, which institution
represented as Lender or as equity investor.
 Attendance of each director at the BoD meetings and the last AGM.
 Number of BoD meetings held, dates on which held.
3. Audit Committee.
 Brief description of terms of reference

 Composition, name of members and Chairperson
 Meetings and attendance during the year
4. Remuneration Committee.
 Brief description of terms of reference

 Composition, name of members and Chairperson
 Attendance during the year
 Remuneration policy
 Details of remuneration to all the directors, as per format in main report.
5. Shareholders Committee.
 Name of non-executive director heading the committee

 Name and designation of compliance officer
 Number of shareholders complaints received so far
 Number not solved to the satisfaction of shareholders
 Number of pending share transfers
6. General Body meetings.
 Location and time, where last three AGMs held.

 Whether special resolutions
o Were put through postal ballot last year, details of voting pattern
o Person who conducted the postal ballot exercise
o Are proposed to be conducted through postal ballot
o Procedure for postal ballot
7. Disclosures.
 Disclosures on materially significant related party transactions i.e.

transactions of the company of material nature, with its promoters, the
directors or the management, their subsidiaries or relatives etc. that may
have potential conflict with the interests of company at large.
 Details of non-compliance by the company, penalties, strictures imposed on
the company by Stock Exchange or SEBI or any statutory authority, on any
matter related to capital markets, during the last three years.
8. Means of communication.
 Half-yearly report sent to each household of shareholders.

 Quarterly results
o Which newspapers normally published in.
o Any website, where displayed
o Whether it also displays official news releases; and
o The presentations made to institutional investors or to the analysts.
 Whether MD&A is a part of annual report or not.
9.General Shareholder information
 AGM : Date, time and venue

 Financial Calendar
 Date of Book closure
 Dividend Payment Date
 Listing on Stock Exchanges
 Stock Code
 Market Price Data : High., Low during each month in last financial year
 Performance in comparison to broad-based indices such as BSE Sensex,
CRISIL index etc.
 Registrar and Transfer Agents
 Share Transfer System
 Distribution of shareholding
 Dematerialization of shares and liquidity
 Outstanding GDRs/ADRs/Warrants or any Convertible instruments,
conversion date and likely impact on equity
 Plant Locations
 Address for correspondence
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The Cadbury Committee, Corporate Performance

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Shri Kumar Mangalam Birla

Report of the Kumar Mangalam Birla Committee on Corporate Governance

1.3 Strong corporate governance is thus indispensable to resilient and vibrant

1.4 Another important aspect of corporate governance relates to issues of insider

2.3 Corporate governance is considered an important instrument of investor

a. to suggest suitable amendments to the listing agreement executed by

 strengthening of disclosure norms for Initial Public Offers following the

The Recommendations of the Committee

Corporate Governance –the Objective

4.1 Corporate governance has several claimants –shareholders and other

Applicability of the Recommendations

Mandatory and non mandatory recommendations

5.1 The Committee debated the question of voluntary versus mandatory

5.6 The Committee recommends that while the recommendations should be

This is a mandatory recommendation.

Composition of the Board of Directors

Independent directors and the definition of independence

6.7 Good corporate governance dictates that the board be comprised of

This is a mandatory recommendation.

This is a non-mandatory recommendation.

This is a mandatory recommendation.

9.5 The following recommendations of the Committee, regarding the constitution,

The Committee therefore recommends that

 the chairman of the committee should be an independent director;

These are mandatory recommendations.

This is a mandatory recommendation

This is a mandatory recommendation.

Powers of the audit committee

 To investigate any activity within its terms of reference.

This is a mandatory recommendation.

 Oversight of the company’s financial reporting process and the disclosure of

This is a mandatory recommendation

This is a non-mandatory recommendation.

Composition, Quorum etc. of the Remuneration Committee

10.4 The Committee recommends that to avoid conflicts of interest, the

All the above recommendations in paragraphs 10.4 to 10.6 are non-mandatory.

This is a mandatory recommendation.