Module 3

Corporate Governance:
Meaning of Corporate Governance:
• Difference between Governance and Management.
•Purpose of Good Governance
• Potential Consequence of poor CG.
• Governance risk and Financial Stability
- The balancing of conflicting objectives.

Indian and Global Scenario:

•Sarbanes Oxley Act of 2002
• Overview of Anglo-American, Japanese, German models of CG
• Reports and recommendations of Narayan Murthy & Ganguly
Committees
• The subject of corporate governance has attracted
worldwide attention with a series of collapse of
high profile companies like Enron, WorldCom,
Satyam Computers, HIH Insurance etc.
• These failures have shattered the trust of investors
worldwide. Some of the scandals which made
headlines all around the world were somewhere
related to poor corporate governance. These
include the $18 billion meltdown of Parmalat
Finanziaria, in 2003.
• Parmalat was among the largest food-based
companies in the world. The Parmalat case
was one of the biggest scandals to hit Europe
and many analysts called this fraud as
'Europe's Enron'.
• The company’s corporate governance
structure could not keep up to some of the
key existing Italian corporate governance
standards of best practice.
• Another classic example of a corporate house
collapsing due to poor decision making and
weak corporate governance was the HIH
insurance group of Australia. This collapse
resulted in a deficiency up to $5.3 billion,
“making it the largest corporate failure” in
Australia.
• The collapse of the China Aviation Oil (CAO)
also created certain doubts regarding the
standard of corporate governance in China.
• This collapse came at a time when many
companies were trying to get internationally
listed and foreign investors were becoming
more and more eager to buy them out.
• Poor corporate governance in banks is not a
new subject. This inefficiency has been around
for a very long time. Since the beginning of
banking in 7 Nigeria in 1914, almost 75 banks
were lost primarily because of factors related
to poor corporate governance. The banks did
not fail due to lack of customers but due to
how they were managed and governed.
• Scholars and researchers from finance fields have
actively investigated the importance and efficacy of
corporate governance for at least a quarter of
century (Jenson and Meckling, 1976).
• There have been intense brainstorming and
debates over the practices of corporate
governance practices particularly in the developed
nations. However, the effectiveness of corporate
governance practices in the developed nations tells
an ironical story from the CG(corporate
governance) practices point of view.
• The volume of scandals and lack of
transparency in governance in the developed
nations nullifies its true commitment to
governance practices compared to the
developing world.
• Therefore, much prior to the recent wave of
corporate frauds in developed economies,
corporate governance has been a
fundamental subject in emerging economies.
 Concept of Corporate governance
• Corporate Governance may be defined as a set of
systems, processes and principles which ensure
that a company is governed in the best interest of
all stakeholders.
• It is the system by which companies are directed
and controlled. It is about promoting corporate
fairness, transparency and accountability. In
other words, 'good corporate governance' is
simply 'good business'. It ensures:
• Adequate disclosures and effective decision
making to achieve corporate objectives;
• Transparency in business transactions;
• Statutory and legal compliances;
• Protection of shareholder interests
• Commitment to values and ethical conduct of
business
• Corporate governance refers to the accountability of
the Board of Directors to all stakeholders of the
corporation i.e. shareholders, employees, suppliers,
customers and society in general; towards giving the
corporation a fair, efficient and transparent
administration.
• Corporate governance is typically perceived by
academic literature as dealing with ‘problems
that result from the separation of ownership
and control’.
• From this perspective, corporate governance
would focus on: the internal structure and rules
of the board of directors; the creation of
independent audit committees; rules for
disclosure of information to shareholders and
creditors; and control of the management.
 Corporate means legally united into a body so as to
act as an individual.
 Governance is control or direction.
 The two put together it gives a meaning that it brings
together many different groups for the purpose of
conducting business.
 Contd…

Managers
Employees

Brings Suppliers For

Different Business
Corporation Together Customers
Groups
Conducting

Investors
 DEFINITIONS OF CORPORATE GOVERNANCE

• “Corporate governance means that company

manage its business in a manner that is
accountable and responsible to the
shareholders. In a wider interpretation,
corporate governance includes company’s
accountability to shareholders and other
stakeholders such as employees, suppliers,
customers and local community.” –
Catherwood.
• “Corporate governance is the system by which
companies are directed and controlled.” – The
Cadbury Committee (U.K.)
(i) Corporate governance is more than company
administration. It refers to a fair, efficient and
transparent functioning of the corporate
management system.
(ii)Corporate governance refers to a code of conduct;
the Board of Directors must abide by; while
running the corporate enterprise.
(iii)Corporate governance refers to a set of systems,
procedures and practices which ensure that the
company is managed in the best interest of all
corporate stakeholders.
• The concept of corporate governance sounds
simple and unambiguous, but when one
attempts to define it and scan available
literature to look for precedence, one comes
across a bewildering variety of perceptions
behind available definitions.
• The definition varies according to the
sensitivity of the analyst, the context of varying
degrees of development and from the
standpoint of academics versus corporate
managements.
• However, there is an underlying uniformity in
the thinking of all analysts that there is a
definite need to eradicate corporate
misgovernance and promote corporate
governance at all costs.
• It is not only the stakeholders who are keenly
interested in ensuring adoption of best
governance practices by corporates, but all
societies and countries worldwide.
Difference between Governance and
Management
 Difference between Governance and
Management

• Governance can be said to be representing the

owners, or the interest group of people, who
represent a firm, company or any institution.
Governance represents the will of these interest
groups who manage the company.
• Governance consists of a governing body, which
directs the management on all aspects of a
company. It is the governing body that oversees
the overall function of an organization.
• The governing body, on the other hand,
appoints management personnel, whom are
given the power to administer the
organization. Management comes only second
to the governing body, and they are bound to
strive as per the wishes of the governing body.
• Governance can be said to set the right policy and
procedures for ensuring that things are done in a
proper way. On the contrary, management is all
about doing things in the proper way.

• The responsibilities between governance and

management also differ. The responsibilities of
governance include choosing top executives,
evaluating their performance, authorizing
plans/commitments and evaluating the
organization’s performance.
• On the other hand, management has the
responsibility for managing and enhancing the
overall performance of the organization.
Management has the responsibility to
implement the systems of governance.
• While governance pertains to the vision of an
organization, and translation of the vision into
policy, management is all about making
decisions for implementing the policies.

• While board of directors form the core of

governance, managers and executives form
part of the management.
• Governance relates to providing the right
direction and leadership. Governance relates
to managing the operations of an
organisation. The governing body has only the
role to oversee the functioning of the
management, and it has no role in
management.
Summary:

1. Governance can be said to be representing the owners, or

the interest group of people, who represent a firm, company
or any institution. The governing body, on the other hand,
appoints management personnel.

2. While governance pertains to the vision of an organization,

and translation of the vision into policy, management is all
about making decisions for implementing the policies.

3. Management comes only second to the governing body, and

they are bound to strive as per the wishes of the governing
body.
 Purpose of Good Corporate
Governance
• Corporate Governance is the art of directing and
controlling the organization by balancing the
needs of the various stakeholders.
• This often involves resolving conflicts of interest
between the various stakeholders and ensuring
that the organization is managed well meaning
that the processes, procedures and policies are
implemented according to the principles of
transparency and accountability.
• Whenever one speaks about corporate
governance, it has to be borne in mind that
the organizations have duties and
responsibilities towards their shareholders
and stakeholders and hence they need to be
governed in accordance with the law and
keeping in mind the interests of the
stakeholders and shareholders.
• The next aspect of corporate governance is
that the notion of economic efficiency must
be followed when directing, managing and
controlling organizations.
• For instance, it is truism that corporations
exist to make profits and hence the
profitability and revenue generation ought to
be the aim for which the corporates must
strive for.
• Of course, this does not mean that corporates can
cut corners in their pursuit of profit and power and
hence taken together with the principles in the
previous paragraph, corporate governance means
that a corporation must strive to generate
revenues and make profits in a transparent and
accountable manner.
• What this means is that the way in which
corporations are managed and directed have to be
done in accordance with standard norms and
procedures that apply to ethical and normative
conduct.
• Corporate Governance has been in the news for
the last decade or so following a spate of
scandals that engulfed companies like Enron
which led to their collapse because of
mismanagement.
• This prompted regulators all over the world to
implement various acts and rules to rein in
irresponsible corporate behavior that would mar
the prospects of the corporations and cause harm
to their shareholders and stakeholders.
• Acts like the Sarbanes Oxley were passed to
enforce greater oversight over corporations and
ensure that they did not overreach themselves in
their relentless pursuit of profits.
• Indeed, it can be said that the Enron debacle was
a wakeup call for corporate America to set its
house in order. It is unfortunate that some of the
lessons learnt during the early years of the last
decade were forgotten leading to gross abuse of
corporate power in the run up to the global
financial crisis.
• Broadly speaking, corporate governance can
be said to encompass the tenets of rights and
equitable treatment of the shareholders and
following ethical business behavior along with
practice of integrity.
• Good corporate governance means that the
processes of disclosure and transparency are
followed so as to provide regulators and
shareholders as well as the general public with
precise and accurate information about the
financial, operational and other aspects of the
company.
• The bottom line for good corporate governance
is the dual aim of pursuing profits and doing so
in a transparent and accountable manner.
 Potential Consequence of poor CG

• Whilst it is not implied that poor corporate

governance accounts for all corporate failures,
the general implication of poor corporate
governance of a company is an inability to
achieve the intended purpose of the
Company, and its reason for being is defeated.
On a macro level, this is amplified.
• A study on Corporate Governance and Bank Failure in
Nigeria was carried out to investigate issues, challenges
and opportunities associated with corporate
governance and Bank failure in Nigeria, and to
ascertain if a significant relationship exists between
corporate governance and Banks failure.
• The result of the study not only revealed that the new
code of corporate governance for Banks is adequate to
curtail Bank distress but that improper risk
management, corruption of Bank officials and over
expansion of Banks are the key reasons Banks fail.
• According to the former Governor, Central
Bank of Nigeria (CBN), Lamido Sanusi, the
inability of key personnel in some banks to live
up to expectations negatively impacted on the
institutions and reiterated that the failure of
corporate governance in most financial
institutions led to the recent crisis in the
banking sector.
• Eight chief executives and executive directors
of some Nigerian banks were summarily
dismissed between August and October, 2009
due to issues related to poor
corporate governance practices. This was
sequel to the conclusion of audit
investigations embarked upon by CBN to
determine the soundness of Nigerian banks.
• The release of these reports led CBN to
conclude that the affected banks acted in
manners detrimental to the interest of
depositors and creditors.
Potential Risks

• One stakeholder group may benefit unfairly at the

expense of other stakeholder groups due to
weaknesses in a company’s control systems.
• Managers could make poor investment decisions which
benefit them but are detrimental to the company’s
shareholders.
• A company’s exposure to legal, regulatory and
reputational risks could become heightened. For
example, a company may be subject to an
investigation by a regulatory authority due to a
violation of laws and regulations. The company
could also receive lawsuits from one of its
stakeholders due to some form of impropriety.
These could potentially damage the reputation of
the company and lead to significant legal costs.
• A company’s ability to honor its debt obligations
may become hindered. This exposes it to bankruptcy
risk if its creditors decide to take legal action against
it.
• Corporate governance failures
• It doesn’t happen overnight and there are
several warning signs which a firm must take
note of in order to avoid such failures. Some
of the governance issues faced by the firms
which eventually lead to corporate
governance failures are –
• Ineffective governance mechanisms, for example,
lack of board committees or committees consisting
of few or a single member.
• Non-independent board and audit committee
members, for example where a CEO fulfilled
multiple roles in various committees
• Management, who deliberately undermines the
role of the various governance structures by
circumventing the internal controls and making
misrepresentations to auditors and the Board.
• Inadequately qualified members, for example
audit committee members not having
appropriate accounting and financial
qualifications or experience to analyse key
business transactions, family members
holding board positions without appropriate
knowledge or qualifications.
• Ignorance by regulators, auditors, analysts etc
of the financial results and red flags.
• Corporate governance failures have resulted in
massive problems faced by the companies
over the years. A couple of examples of
corporate governance failures which forced
businesses and government authorities to
rethink their stance on corporate governance
are :
• The Enron scandal, which broke out in October 2001,
eventually led to the bankruptcy of the Enron Corporation, an
American energy company based in Houston, Texas. It was the
largest bankruptcy reorganization in American history at that
time.
• The primary reason for the failure of Enron was attributed to
an audit failure. The problem faced by Enron was despite
having structures and mechanisms in place for good corporate
governance. Nobody flaunted and flouted these rules and
regulations! The board of directors turned a blind eye to open
violation of the code.
• Particularly, when it allowed the CFO to serve in special
purpose entities(SPEs). The auditors failed to prevent suspect
and questionable accounting. The auditors did not even
examine the SPE transactions.
• Enron shareholders filed a $40 billion lawsuit
after the company’s stock price fell. It achieved a
high of US$90.75 per share in mid-2000,
plummeted to less than $1 by the end of
November 2001.
• On December 2, 2001, Enron filed for
bankruptcy under Chapter 11 of the United
States Bankruptcy Code.
As a result of the scandal, the US government
introduced new regulations and legislation to
expand the accuracy of financial reporting for
public companies.
• The Sarbanes-Oxley Act was introduced as a
result of the Enron scandal. It increased
penalties for destroying, altering, or
fabricating records in federal investigations or
for attempting to defraud shareholders.
• It also increased the accountability of audit
firms to remain unbiased and independent of
their clients.
• Satyam began facing problems from December the 16th,
2008. Its chairman Mr Ramalinga Raju, in a surprise
move announced a $1.6 billion bid for two Maytas
companies. He wanted to deploy the cash available for
the benefit of investors. Raju’s family promoted and
controlled the two companies.
• The share prices plunged 55% voicing concern towards
Satyam’s poor corporate governance. They overturned
the decision in 12 hours. This resulted in the resignation
of several independent directors of the firm. Thus,
this resulted in a further fall in the share prices of
Satyam.
• On 7th January 2009 B Ramalinga Raju, the
founder of Satyam Computer Services,
confessed to a Rs 7,000-crore balance sheet
fraud . He had hidden it from the IT company’s
board, employees and auditors for several
years. He revealed in his confession that his
attempt to buy Maytas companies was his last
attempt to “fill fictitious assets with real ones”.
• The government reacted to the fraud by
overhauling the regulatory framework. It
introduced the new Companies Act 2013,
which fixed liabilities of auditor and
independent directors, among other changes.
In 2014, market regulator SEBI amended
Clause 49 of listing guidelines to improve
corporate governance.
• Conclusion
• Corporate governance is critical issue faced by all
companies. The above cases highlight the fact that
poor corporate governance can lead to a downfall of
the largest companies.
• Regulatory bodies have increased their scrutiny on the
firms are under increased scrutiny by regulatory bodies
which increases the importance of good governance.
Digital solutions can help firms implement a robust
governance mechanism to help significantly reduce risk
of governance failure.
 Poor corporate governance leads to
higher risk and lower returns: Study
• https://www.business-
standard.com/article/markets/poor-
corporate-governance-leads-to-higher-risk-
and-lower-returns-study-
111052700092_1.html
Indian and Global Scenario:
Sarbanes-Oxley
Act of 2002
 SARBANES—OXLEY ACT, 2002

• ‘Corporate America has been blotted with many

scandals in the recent times. Despite the fact that
there have been differences between the recent
scandals and the earlier ones, there is a common
thread running in between them. The common
thread is that governance matters, that is, good
governance promotes good corporate decision-
making.
• The recent Sarbanes—Oxley Act is a step in this
direction, which codifies certain standards of good
governance as specific requirements.
• The Act calls for protection to those who have the
courage to bring frauds to the attention of those who
have to handle frauds. But it ensures that such things
are not left to the individuals who may or may not
choose to reveal them, it is better for the corporations
to appoint an officer with the responsibility to oversee
compliance and ethical issues.
• Unless corporate governance is integrated with
strategic planning and shareholders are really willing to
bear the additional expenses that may be required,
effective corporate governance cannot be achieved.’
• The Sarbanes—Oxley Act (SOX Act), 2002 is a sincere
attempt to address all the issues associated with
corporate failures to achieve quality governance and to
restore investor’s confidence. The Act was formulated
to protect investors by improving the accuracy and
reliability of corporate disclosures, made precious to
the securities laws and for other purposes.
• The Act contains a number of provisions that
dramatically change the reporting and corporate
director’s governance obligations of public companies,
the directors and officers.
 Contents

• Brief History
• Objectives of Sarbanes-Oxley
• Key Points
 Brief History
• Created by US Senator Paul Sarbanes (D-
Maryland) and US Congressman Michael
Oxley (R-Ohio)
• Signed into law July 30, 2002
• Most dynamic securities legislation since
the New Deal
 Objectives

• In response to the Arthur Anderson, Enron and

WorldCom debacle, the Sarbanes-Oxley Act
seeks to:
– Restore the public confidence in both public accounting and publicly
traded securities
– Assure ethical business practices through heightened levels of executive
awareness and accountability
 TITLE I – PUBLIC COMPANY
ACCOUNTING OVERSIGHT BOARD
• Creation of the Public Company Oversight Board (the
Board)
– Created as a non-profit organization, the Board will oversee
audits of public companies; it is under the authority of the
SEC but above other professional accounting organizations
such as the AICPA
– The Board is comprised of 5 members (appointees), with a
maximum of two CPA’s
– Among its duties are registering existing public accounting
firms which prepare audits for publicly traded companies
(issuers), reviewing registered public accounting firms
(auditing the auditors), establishing and amending rules and
standards (in cooperation with other standard setters), and
in the event of non-compliance by registered public
accounting firms, to try such firms (and/or any related
associate(s)) and penalize
 TITLE II – AUDITOR INDEPENDENCE
• Prohibits registered public accounting firms (RPAFs) who audit an
issuer from performing specific non-audit services for that issuer,
including but not limited to: bookkeeping, financial information
systems design, appraisal services, actuarial services, internal audit
outsourcing services, management/human resource functions,
broker/dealer, legal/expert services outside the scope of the audit
• In addition to these limitations, audit functions and all other non-
audit functions provided to the audit client must be pre-approved by
the Board (such as tax services)
• Audit Partner rotation – Lead partner on 5 years, off 5 years; other
partners on 7 years, off 2
• RPAFs performing audits to issuers must report to issuer’s audit
committees about: (1) critical accounting policies to be used in the
audit, (2) any written communication with management, and (3) any
deviations from GAAP in financial reporting
 TITLE II (cont.)
• A conflict of interest arises and an RPAF may
not perform audit services for any issuer
employing – in the capacity of CEO, controller,
CFO or any other equivalent title – a former
audit engagement team member – there is a
“cooling-off period” for one year
– i.e., an employee of an RPAF who works on an audit of an issuer may not
turn around and directly go to work for that issuer – they must wait one
year
• Currently under investigation is the possibility
of mandatory rotations of audit clients among
registered public accounting firms
 TITLE III – CORPORATE
RESPONSIBILITY
• Audit Committee (committees est. by the board of a
company for the purpose of overseeing financial
reporting) Independence
– Establishes minimum independence standards for audit
committees
• Independence of the audit committee crucial in that it must (1)
oversee and compensate RPAF to perform audit, and (2) establish
procedures for addressing complaints by the issuer regarding
accounting, internal control, etc. (this lays the foundation for
anonymous whistleblowing)
• CEOs and CFOs must certify in any periodic report the
truthfulness and accurateness of that report – creates
liability
• Under certain conditions of re-statement of financials
due to material non-compliance, CEOs and CFOs will be
required to forfeit certain bonuses and profits paid to
them as a result of material mis-information.
 TITLE IV – ENHANCED FINANCIAL
DISCLOSURES
• Issuers must disclose “off-balance sheet transactions”
in periodic reports
• No issuer shall make, extend, modify or renew any
personal loan to CEOs, CFOs (limited exceptions
include company credit cards)
• Annual reports will contain internal control reports
which state the responsibility of management for
establishing such controls and their assessment of the
effectiveness of such controls – which must be
attested to by the auditor
• In periodic reports filed, the issuer must disclose its
code of ethics for senior financial officers, and if the
issuer has not adopted such a policy, must disclose
why not.
• Issuer must disclose whether or not its audit
committee is comprised of at least one financial
expert, and if not, why
– Member considered financial expert if they have an
understanding of GAAP, experience in preparing/auditing
financials, experience with internal controls, and an
understanding of audit committee functions
• SEC must review disclosures (in financials) made by
any issuer at least once every three years (similar to
Board review of registered public accounting firms)
• Issuers must disclose in real time any additional
information concerning material changes in the
financial condition or operations of the issuer
 TITLE V – ANALYST CONFLICTS OF
INTEREST
• National Securities Exchanges and
registered securities associations must
adopt rules designed to address conflicts
of interest that can arise when securities
analysts recommend securities in
research reports
– To improve objectivity of research and
provide investors with useful and reliable
information
 TITLE VI – COMMISSION
RESOURCES AND AUTHORITY
• Increase 2003 appropriations for the SEC to
$780 million, $98 million to be used to hire an
additional 200 employees for enhanced
oversight of auditors and audit services
• SEC will establish rules setting minimum
standards for profession conduct for attorneys
practicing before it
• SEC to conduct investigations of any security
professional who has violated a security law
– May censure, temporarily bar or deny right to practice
 TITLE VII – STUDIES AND REPORTS
• The Comptroller General of the US shall conduct a study
regarding the consolidation of public accounting firms (e.g.
Coopers & Lybrand/Price Waterhouse combine to become
PriceWaterhouseCoopers; ToucheRoss/DeloitteHaskins merge to
become Deloitte & Touche) since 1989, analyze the past, present
and future impact of the consolidations, and create solutions to
problems discovered caused by such consolidations
• The Comptroller General and/or SEC will also explore such issues
as (1) the role and function of credit rating agencies in the
operation of the securities market, (2) the number of securities
professionals (public accountants, investment bankers,
attorneys) who have been found to have aided and abetted a
violation of securities law and who have not been disciplined, (3)
all enforcement actions by the SEC regarding re-statements,
violations of reporting requirements, etc., for the five year
period prior to the date the Act is passed, and (4) whether
investment banks and financial advisers assisted public
companies in manipulating their earnings (specifically Enron and
WorldCom)
 TITLE VIII – CORPORATE AND
CRIMINAL FRAUD ACCOUNTABILITY
• To knowingly destroy, create, manipulate
documents and/or impede or obstruct federal
investigations is considered felony, and violators
will be subject to fines or up to 20 years
imprisonment, or both
• All audit report or related workpapers must be
kept by the auditor for at least 5 years
• Whistleblower protection – employees of either
public companies or public accounting firms are
protected from employers taking actions against
them, and are granted certain fees and awards
(such as Attorney fees)
 TITLE IX – WHITE-COLLAR CRIME
PENALTY ENHANCEMENTS
• Financial statements filed with the SEC by any
public company must be certified by CEOs and
CFOs; all financials must fairly present the true
condition of the issuer and comply with SEC
regulations
– Violations will result in fines less than or equal to $5 million and /or a
maximum of 20 years imprisonment
• Mail fraud/wire fraud convictions carry 20 year
sentences (previously 5 year sentences)
• Anyone convicted of securities fraud may be
banned by SEC from holding officer/director
positions in public companies
TITLE X – CORPORATE TAX RETURNS

• Federal income tax returns must be signed

by the CEO of an issuer
 TITLE XI – CORPORATE FRAUD
ACCOUNTABILITY
• Destroying or altering a document or record with
the intent to impair the object’s integrity for the
intended use in a securities violation proceeding,
or otherwise obstructing that proceeding, will be
subject to a fine and/or up to 20 years
imprisonment
• The SEC has the authority to freeze payments to
any individual involved in an investigation of a
possible security violation
• Any retaliatory act against whistleblowers or
other informants is subject to fine and/or 10 year
imprisonment
 Overview of Anglo-American,
Japanese, German models of CG
Models of Corporate Governance
1. Anglo American Model
2. German Model
3. Japanese Model
 1. The Anglo-American Model

Elect
Shareholders Board of Directors
(Supervisors)

Appoints &
Creditors Supervises
Own
Officers
Lien on (Managers)

Stakeholders
Stake in Manage

Legal/Regulatory Monitors & Company

System Regulates
 1. Anglo American Model
 The board appoints & supervises the managers who
manage the day to day affairs of the corporation
 Creditors exercise their lien over the assets of the
company. (lien- Legal claim or charges)
 The policies are framed by the BOD & implemented by
the management.
 The legal system provides the structural framework
 The stakeholder will be supplier, employees & creditors
  Features of Anglo American Model

 Clear separation of ownership & management, which

minimizes conflicts of interest.(Investors avoid legal
liability)
 Equity financing is a common method of raising capital
for corporations in the UK and the US. So the capital
markets are quite active
 There exists a fairly active market for corporate takeover
& control.
 If company is poorly managed it is exposed to hostile
takeover threats.
 The Anglo-US model governs corporations in the UK, the US,
Australia, Canada, New Zealand and several other countries.
 The board of directors of most corporations that follow the
Anglo-US model includes both “insiders” and “outsiders”.
 An “insider” is as a person who is either employed by the
corporation (an executive, manager or employee) or who has
significant personal or business relationships with corporate
management.
 An “outsider” is a person or institution which has no direct
relationship with the corporation or corporate management.
2. The German Model

Shareholders Appoint – Supervisory Board

50%
Appoints and
Supervises
Management Board
Appoint – (Including Labour
50% Relations Officer)

Employees Manage
and Labour
Unions
Company
 The German Model
The German model governs German and
Austrian corporations.
In this model the shareholders own the
company but entirely governance is not there.
The shareholder elects 50% of members of
supervisory board & other 50% by Employee
& labour Unions.
The Supervisory Board appoints & monitors
the management board.
 It approves major management decisions; and advises the
management board. The supervisory board usually meets
once a month.
 The management board is composed solely of “insiders”, or
executives.
 The supervisory board contains no “insiders”, it is composed
of labor/employee representatives and shareholder
representatives.
 Features of German Model

Labour relations officer is represented in

management board. Worker’s participation in
management is essential.
Both shareholders & employees have equal
right in selecting members of the supervisory
board.
 3. The Japanese Model
elect Supervisory Board
Shareholders

Provides Loans Ratifies the

President’s
Decisions

President
Provides Managers
Monitors & Acts in Consults
Emergencies

Executive Management
(Primarily Board of Directors)

Manages

Own
Main Company
Bank
Provides Loans
 The Japanese Model
 The shareholders & the banks together appoints
the BOD & the president
 Inclusion of President who consults both the
supervisory board & the executive management.
 BOD carries out management functions.
 Sometimes the financial institutions monitor the
management functions by nominating the
managerial personnel.
 Importance of the lending bank is highlighted.
Reports and recommendations of
Narayan Murthy & Ganguly
Committees
• SEBI Committee on Corporate Governance was
constituted under the Chairmanship of N. R.
Narayana Murthy, to look into: governance
issues / review Clause 49, suggest measures to
improve corporate governance standards.
• The committee laid down some mandatory and
non- mandatory recommendations.
 Recommendation- Mandatory
• Audit committee
• Related party transactions
• Proceeds from initial public offerings
• Risk Management
• Code of conduct
• Nominee directors
• Compensation to non executive directors
• Whistle blower policy
 Recommendations- Non Mandatory
• Moving to a regime where corporate financial
statements are not qualified
• Instituting a system of training of board
members
• The evaluation of performance of board
members
Mandatory Recommendations
1 Audit Committee
• Review of information by audit committees regarding
› Financial statements and draft audit reports, including
quarterly/half yearly information.
› Management discussion and analysis of financial
condition and the results of operations.
› Report relating to compliance with laws and risk
management.
› Management letter/s of internal control weaknesses
issued by statutory/internal auditors and › Records of
related party transactions.
• Financial literacy of members of the audit committee
› All audit committee members should be “financially
literate” and at least one member should have
accounting or related financial management expertise.
2 Related Party Transaction
• A statement of all transactions with related
parties including their bases (methodology)
should be placed before the independent audit
committee for formal approval / ratification. If any
transaction is not on an arm’s length basis,
management should provide an explanation to
the audit committee justifying the same.
› The ‘arm's length’ is the condition or the fact that
the parties to a transaction are independent and
on an equal footing.
• The term “related party” shall have the same
meaning as contained in Accounting Standard
18, Related Party Transactions, issued by the
Institute of Chartered Accountants of India.
• Under AS 18, related party includes:
› Enterprises, directly or indirectly, controlled by
one or more other enterprises;
› Associates or Joint Ventures of an enterprise;
› Individuals who own interest in the voting
power of an enterprise and are in a position to
significantly influence the enterprise;
› Key Management Personnel and their relatives;
› Enterprises which share common directors.
3 Risk Management
• Procedures should be in place to inform Board
members about the risk assessment and
minimization procedures.
• These procedures should be periodically
reviewed to ensure that executive
management controls risk through means of a
properly defined framework.
• Management should place a report before the
entire Board of Directors every quarter
documenting the business risks faced by the
company, measures to address and minimize
such risks, and any limitations to the risk
taking capacity of the corporation.
• This document should be formally approved
by the Board.
4 Proceeds from initial public offerings
• Companies raising money through an Initial Public
Offering (“IPO”) should disclose to the Audit
Committee, the uses / applications of funds by major
category (capital expenditure, sales and marketing,
working capital, etc), on a quarterly basis.
• On an annual basis, the company shall prepare a
statement of funds utilised for purposes other than
those stated in the offer document/prospectus. This
statement should be certified by the independent
auditors of the company.
• The audit committee should make appropriate
recommendations to the Board to take up steps in this
matter.
5 Code of Conduct
• Lay down a code of conduct for all board members
and senior management of the company
• Posted on the company’s website
• Affirm compliance with the code on an annual
basis.
• Annual report- declaration to this effect- signed off
by the CEO
• Best practices
6 Nominee Directors
• Appointment should be made by the
shareholders
• Nominee of the Government shall be similarly
elected and shall be subject to the same
responsibilities and liabilities as other
directors
7 Compensation
• Compensation to non executive directors to
be approved by the shareholders in general
meeting;
• Restrictions placed on grant of stock option
• Requirement of proper disclosures of details
of compensation.
8 Whistle blower policy
• Whistle blower policy to be in practiced in a
company
• The directors of the holding company are to
be in the picture; audit committee of the
holding company to review financial
statements of subsidiaries etc.
Non-Mandatory Recommendations
• Moving to a regime where corporate financial
statements are not qualified
• Instituting a system of training of board
members
• The evaluation of performance of board
members
 Pros
• Strengthening of corporate governance
framework.
• Higher transparency in the functioning of the
company.
• Protection for whistle blower against
termination or unjust treatment.
 Cons
• Unclear Whistle Blower policy
› Instrumental in breeding indiscipline as most
likely the audit committee would be flooded
with frivolous complaints and minor issues.
› Many complainants might go by their personal
likes and dislikes and thus the possibility of
the right of access to the audit committee
being misused would always be there.
Reports and Recommendations of
Ganguly Committees
• To introduce corporate governance practices
in the banking sector the recommendations of
the working group of directors of Banks
Financial Institutions, known as the Ganguly
Group, will be of interest.
• Taking this move towards corporate
governance further, the Reserve Bank
constituted a consultative group of directors
of banks and financial institutions under the
chairmanship of Dr. A.S. Ganguly, to review
the supervisory role of boards of banks and
financial institutions.
• The Ganguly consultative group looked into
the functioning of the boards vis-à-vis
compliance, transparency, disclosures, audit
committees and suggested measures for
making the role of the board of directors more
effective.
• The Group has produced a list of
recommendations after a comprehensive review
of the existing legal framework governing
constitution of the Boards of banks and financial
institutions" interaction with various interested
groups" organisations" etc. and benchmarked its
recommendations with international best
practices as enunciated by the Basel Committee
on Banking & supervision" as well as of other
committees and advisory bodies" to the extent
applicable in the indian environment.
• In June 2002, the report of the Ganguly Group
was transmitted to all the banks for their
consideration while simultaneously
transmitting it to the Government of India for
appropriate consideration.
• The major recommendations of the group are
the following:
• The government while nominating directors on
the boards of PSBs should be guided by certain
broad “fit and proper” norms for the directors,
based on the lines suggested by BIS (Bank for
International Settlements).
• The appointment / nomination of independent /
non-executive directors to the board of banks
(both public sector and private sector) should be
from a pool of professional and talented people
to be prepared and maintained by RBI.
• It would be desirable to take an undertaking
from every director to the effect that they
have gone through the guidelines defining the
role and responsibilities of directors, and
understood what is expected of them.
• In order to ensure strategic focus it would be
desirable to separate the office of Chairman
and Managing Director in respect of large-
sized PSBs.
• The information furnished to the board should be
wholesome, complete and adequate to take
meaningful decisions. The board’s focus should
be devoted more on strategy issues, risk profile,
internal control systems, overall performance,
etc.
• It would be desirable if the exposures of a bank to
stockbrokers and marketmakers as a group, as
also exposures to other sensitive sectors, viz., real
estate etc. are reported to the board regularly.
• The disclosures of progress made towards
establishing progressive risk management
system, the risk management policy, strategy,
exposures to related entities, the asset
classification of such lending / investments
etc. should be in conformity with corporate
governance standards, etc.
• The Ganguly Committee recommendations have
been benchmarked with international best
practices as enunciated in the Basel Paper as
well as of other committees and advisory bodies
to the extent applicable to the Indian
environment. RBI has also implemented most of
the recommendations.
• In general these regulations have created an
enabling framework for improving corporate
governance in financial institutions.