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Corporate Governance

What is Governance?
Corporate Governance
is the application
of best
management practices, Compliance of law in true letter
and spirit and adherence to ethical standards for effective
management and distribution of wealth and discharge of
social responsibility for sustainable development of all
stakeholders.
-The Institute of Company Secretaries of India

Purpose of corporate governance is to have a demonstrable


IMPACT on a corporations FINANCIAL PERFORMANCE.

What is corporate governance?


Corporate Governance is concerned with holding the
balance between economic and social goals and
between individual and communal goals.
The corporate governance framework is there to
encourage the efficient use of resources and
equally
to
require
accountability
for
the
stewardship of those resources.
The aim is to align as nearly as possible the
interests of individuals, corporations and society
- Sir Adrian Cadbury

Brief history of corporate governance in


India

Unlike South-East and East Asia, the corporate governance


initiative in India was not triggered by any serious nationwide
financial, banking and economic collapse
The initiative in India was initially driven by an industry
association, the Confederation of Indian Industry
In December 1995, CII set up a task force to design a
voluntary code of corporate governance. The final draft of
this code was widely circulated in 1997.
In April 1998, the code was released. It was called Desirable
Corporate Governance: A Code.
Between 1998 and 2000, over 25 leading companies
voluntarily followed the code: Bajaj Auto, Hindalco, Infosys,
Dr. Reddys Laboratories, Nicholas Piramal, Bharat Forge,
BSES, HDFC, ICICI, etc.

Brief history of corporate


governance in India

Following CII and SEBI, the Department of Company


Affairs (DCA) modified the Companies Act, 1956 to
incorporate specific corporate governance provisions
regarding independent directors and audit committees.
In 2001-02, certain accounting standards were modified
to further improve financial disclosures. These were:
Disclosure of related party transactions.
Disclosure of segment income: revenues, profits and
capital employed.
Deferred tax liabilities or assets.
Consolidation of accounts.
Initiatives are being taken to (i) account for ESOPs
(employee share ownership plan), (ii) further increase
disclosures, and (iii) put in place systems that can
further strengthen auditors independence.

Driving Forces of CG in India


1) Unethical Business Practices
Security Scams ---Harshad Mehtha Security Scam
Misdeed of Companies
2) Impact of Globalization
Integration with Foreign Market
Foreign Investors expectations
New Business Opportunities --- IT & ITES, BPO
etc.,
New Capital formation FII, FDI
3) Impact of Privatisation
New structure of ownership
Multinational Companies

Fundamental Objective of Corporate


Governance

Enhancement of Shareholder Value, keeping in view


the Interests of other Stakeholders

Corporate Governance a Way of Life rather than a


Code

Good corporate governance involves a commitment


of a company to run its businesses in a legal, ethical
and transparent manner a dedication that must
come from the very top and permeate throughout
the organization.

Clause 49 of Listing Agreement on


Corporate Governance
Deals with corporate governance norms that a listed entity
should follow
First introduced in the financial year 2000-01 based on the
recommendations of Kumar Mangalam Birla committee
In order to evaluate the existing practices and to further
improve the existing practices, SEBI set up a committee under
the Chairmanship of Mr Narayana Murthy during 2002-03
Organisational framework for corporate governance initiatives
in India consists of the Ministry of Corporate Affairs(MCA) and
the Securities and Exchange Board of India(SEBI)
Most of the CII code was subsequently incorporated in Clause 49

CII Task Force Report

Task force of CII under the Chairmanship of Shri


Naresh Chandra published code of corporate
governance for voluntary adoption by all listed
companies and its wholly owned subsidiaries.

Major aspects of the guidelines are:


1. Board of Directors
2. Responsibilities of the Board
3. Audit Committee of the Board
4. Auditors
5. Secretarial Audit
6. Institution of Mechanism for Whistle Blowing

Board of Directors - Appointment of


Directors
Appointments to the Board
companies should issue formal letters of appointment to
the
Non-Executive
Directors(ED)
and
Independent
Directors(ID)
which
shall
specify
their
terms
of
appointment, duties, remuneration, etc.
Such formal letter should form part of disclosure to the
shareholders at the time of ratification of his/her
appointment and/or re-appointment.
Separation of offices of Chairman and Chief Executive
Officer
To prevent unfettered decision making power with a single
individual, there should be a clear demarcation of the roles
and responsibilities of the Chairman of the Board and that
of the Managing Director(MD)/ Chief Executive Officer(CEO).

Board of Directors - Appointment of


Directors
Nomination Committee
Companies may have a nomination committee comprising of
majority of Independent Directors, including its Chairman
for considering proposals for searching, evaluating and
recommending appropriate ID, ED and NEDs.
Nomination committee should ensure that the Board
comprises of a balanced combination of ED and NED.
Annual Report should disclose the guidelines being followed
by the Nomination Committee and the role and work done
during the year under consideration.
Number of companies in which an individual may become a
Director
Maximum number of companies where a MD of a company
can serve as NED or ID should be restricted to seven.

Board of Directors - Independent


Directors

ID to have the option and freedom to meet Company Management


periodically

Attributes for Independent Directors


Board should put in place a policy for attributes of such as integrity,
expertise, foresight, ability to understand financial statements.
All ID should provide a certificate of independence at the time of
their appointment, and thereafter annually.
This certificate should be displayed on the website of the company
and in case of listed company, also on the website of the stock
exchange where the securities of the company are listed.

Tenure for Independent Director


Is not more than six years.
A gap of three years between two successive appointments.
Only three such tenures for one company.

Board of Directors Remuneration to


Directors
Remuneration
Guiding principles linking corporate and
individual performance
Companies should have an option of giving a fixed
contractual remuneration to NEDs, not linked with
profits, which should be uniform for all NEDs.
Companies may structure the remuneration to
NEDs into fixed, variable and additional variable
component.
Adequate sitting fees to be paid to ID which may
depend upon twin criteria of net worth and
turnover of companies.

Board of Directors Remuneration to


Directors
Remuneration committee
Should comprise of at least 3 members, majority of
whom should be NEDs with at least one being an ID.
Responsibility to determine the remuneration for all
EDs and the Executive Chairman.
Should also determine principles, criteria and the
basis of remuneration policy of the company which
should be disclosed to shareholders.
Should also recommend and monitor the level and
structure of pay for senior management.
Terms of reference, role, authority delegated to the
Committee by the Board, and work of Committee for
the year under review shall be disclosed in the
Annual Report.

Responsibilities of the Board


Training of Directors
Enabling quality decision making
Risk Management
Evaluation of performance of Board of Directors,
Committees thereof and of Individual Directors
Board to place Systems to ensure compliance with
laws

Audit Committee of the Board


Constitution
Three-member Audit Committee, with IDs constituting
the majority.
Chairman of such a Committee should be an ID.
Enabling powers
Independent back office support and other resources
from the company.
Access to information contained in the records of the
company.
Obtain professional advice from external sources.
Facility of separate discussions with both internal and
external auditors as well as management.

Audit Committee of the Board


Role and responsibilities
Monitor the integrity of the financial statements of
the company
Review the companys internal financial controls,
internal audit function and risk management
systems.
Make
recommendations
in
relation
to
the
appointment, reappointment and removal of the
external auditor and to approve the remuneration
and terms of engagement of the external auditor.
Monitor and approve all related party transactions.

Auditors
Appointment of auditors
Audit Committee of the Board should be the first point of reference
regarding the appointment of auditors.
Audit Committee should consider the profile of the audit firm,
qualifications and experience of audit partners, strengths and
weaknesses, if any, of the audit firm and other related aspects.
Audit Committee should discuss the audit plan to be undertaken by
the auditor, with the auditor; examine and review the certificate of
proof of independence of the audit firm, and recommend to the
Board, with reasons, either the appointment/re-appointment or
removal of the statutory auditor, along with annual audit
remuneration.
Certificate of Independence
Every company should obtain a certificate from the auditor
certifying his/its independence and arms length relationship with
the client company.

Auditors
Rotation of Audit partners and firms
To maintain independence of auditors, the company must
adopt a policy of rotation of auditors in the following manner:
audit partner to be rotated once every three years
Audit firm to be rotated once every five years
A cooling period between two audit assignment.
Need for clarity on information to be sought by auditor and/or
provided by the company to him/it
Appointment of internal auditor
Board may appoint an internal auditor and such auditor,
where appointed, should not be an employee of the company.

Secretarial Audit

To ensure that the Board processes and compliance


mechanisms of the company are robust, the
companies may get the Secretarial Audit conducted
by a competent professional.
Board should give its comments on the Secretarial
Audit in its report to the shareholders.

Institution of Mechanism for Whistle


Blowing
Companies
should
ensure
the
institution
of
mechanism for employees to report concerns about
unethical behavior, actual or suspected fraud, or
violation of the companys code of conduct or ethics
policy.
Companies should also provide for adequate
safeguards against victimization of employees who
avail of the mechanism

Mandated CG guidelines and disclosures


Board of Directors:
composition

frequency

of

meetings

and

Board must meet at least four times a year, with a


maximum time gap of four months between two
successive meetings.
If the chairman of the Company is a non-executive
then one-third of the board should consist of
independent directors, and 50% otherwise.
Independent defined as those directors who, apart
from receiving directors remuneration do not have
any other monetary relationship or transactions with
the
company,
its
promoters,
management
or
subsidiaries, which in the view of the board may affect
independence of judgment.

Mandated CG guidelines and disclosures


Board of Directors: frequency of meetings and composition
The frequency of board meetings and board committee
meetings, with their dates, must be fully disclosed to
shareholders in the annual report of the company.
The attendance record of all directors in board meetings
and board committee meetings must be fully disclosed to
shareholders in the annual report of the company.
Full and detailed remuneration of each director (salary,
sitting fees, commissions, stock options and perquisites)
must be fully disclosed to shareholders in the annual report
of the company.
Loans given to executive directors are capped (no loans
permitted to non-executives), and must be fully disclosed to
shareholders in the annual report of the company.

Mandated CG guidelines and disclosures


Board of Directors: information that must be supplied

Annual, quarter, half year operating plans, budgets and


updates.
Quarterly results of company and its business segments.
Minutes of the audit committee and other board committees.
Recruitment and remuneration of senior officers.
Materially important legal notices and claims, as well as any
accidents, hazards, pollution issues and labor problems.
Any actual or expected default in financial obligations.
Details of joint ventures and collaborations.
Transactions involving payment towards goodwill, brand
equity and intellectual property.
Any materially significant sale of business and investments.
Foreign currency and other risks and risk management.
Any regulatory non-compliance.

Mandated CG guidelines and disclosures


Board of Directors: Audit Committee
Audit Committee is mandatory. Must have minimum of three
members, all non-executive directors, the majority of whom are
independent.
Chairman must be an independent director, and must be present
at the annual shareholders meeting to answer audit or finance
related questions.
At least one member must be an expert in finance/accounts.
Must have at least three meetings per year, including one before
finalisation of annual accounts.
Must meet with statutory auditors and internal auditors; have
the powers to seek any financial, legal or operational information
from the management; obtain outside legal or professional
advice.

Mandated CG guidelines and disclosures


Board of Directors: Audit Committee functions
Adequacy of internal audit and internal control systems,
through discussion with internal and statutory auditors
as well as management.
Significant findings, follow-up and action taken reports.
Discussion with internal and statutory auditors about
scope and design of audits.
Reviewing financial and legal risks and companys risk
management policies.
Examining reasons behind any materially significant
default to creditors, bond-holders, suppliers and
shareholders.

Mandated CG guidelines and disclosures


Disclosures to shareholders in addition to balance sheet, P&L
and cash flow statement
Board composition (executive, non-exec, independent).
Qualifications and experience of directors.
Number of outside directorships held by each director (capped at
director not being a member of more than 10 board-level committees,
and Chairman of not more than 5).
Attendance record of directors.
Remuneration of directors.
Relationship (familial or pecuniary) with other directors.
Warning against insider trading, with procedures to prevent such
acts.
Details of grievances of shareholders, and how quickly these were
addressed.
Date, time and venue of annual general meeting of shareholders.

Mandated CG guidelines and disclosures


Disclosures to shareholders in addition to balance sheet, P&L
and cash flow statement
Dates of book closure and dividend payment.
Details of shareholding pattern.
Name, address and contact details of registrars and/or
share transfer agents.
Details about the share transfer system.
Stock price data over the reporting year, and how the
companys stock measured up to the index.
Financial effects of stock options.
Financial effects of any share buyback.
Financial effects of any warrants that are to be exercised.
Chapter reporting corporate governance practices

Mandated CG guidelines and


disclosures
Disclosures to shareholders in addition to balance sheet, P&L and
cash flow statement
Detailed chapter on Management Discussion and Analysis
focusing on markets, operations, finances, accounts, risks,
opportunities and threats, internal control systems.
Consolidated financial statement, incorporating accounts of all
subsidiaries (over 50% shares held by reporting company).
Details of all significant related party transactions.
Detailed segment reporting (revenues, costs, operating profits
and capital employed).
Deferred tax liabilities and assets and debit/credit in the P&L
for the reporting year

Summary
Indian corporate governance system has both supported
and held back Indias ascent to the top ranks of the worlds
economies.
While on paper the countrys legal system provides some of
the best investor protection in the world, enforcement is a
major problem with slow, over-burdened courts and
significant corruption.
Ownership remains concentrated and family business
groups continue to be the dominant business model.
Securities and Exchanges Board of India has a rigorous
regulatory regime to ensure fairness, transparency and
good practice.