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Corporate Governance

And Etihcs
Corporate
misgovernance
• In new millenium several
comanies in USA and else
where faced collapse.
• Existing framework seems
inadequate with the gigantic
business conglomerates.
Corporate
misgovernance in INDIA
• Increasing corruption in the
government and its various
services had kept the
management of country’s
industrial and business
organizations above
accountability for their
misdeeds, encouraging
them to indulged in more
unethical practices.
Corporate
misgovernance in INDIA
• First realize during BIG BULL, harshad mehta
case.
• Involving lagre no’s of banks and resulting in
the stock market nosediving for the first
time.
• Preferential allotment scam where investors
loose Rs 5000 Crore.
• Disappearance of companies during 1993-
1994, when stock market shot up to 120 %,
companies raised Rs25000 crore vanished
and did not step back to their projects.
• Plantation companies scam Rs 50,000 crore
• Non banking finance companies scam. etc
Corporate
misgovernance in USA
• Worldcom improperly booked 3.8b
in expenses, thus inflating profits.
• Bernie ebbers borrows $408 million
from phone company to cover
personal debts.
• Enron created outside partnerships
that helped hide poor financial
condition. Executive earned
millions by selling company stock.
Reasons for
misgovernance
• A closed economy.
• Sheltered market.
• Limited need and access to
global business.
• Lack of competitive spirit.
• Inefficient regulatory
authority framework.
Corporate Governance
• Problems that results from the
separation of leadership.
• Focus upon: internal structure,
rules of the board of directors,
audit committees, discloser of
information rules to shareholders
and creditors, control of
management.
Corporate Governance
• Definition by corporate and
academic point.
• Academic point.
Shareholders

Board

Management

Employees
Corporate Governance
• Corporate point of view
• Corporate governance deals with
ways in which suppliers of finance
to corporation assure themselves of
getting a return on their
investment. How do the suppliers of
finance get management to return
some of the profits to them?
• How do they make sure that
managers do not steal the capital
they supply or invest it in bad
projects?
• How do suppliers of finance control
managers?
Corporate Governance
MODEL
• Mc kinsey model.
• The Market model.
• Efficient, well developed
equity markets and
dispersed ownership.
• Developed nations.
• US, UK, CANADA and
AUSTRALIA.
SHAREHOLDERS INVIRONMENT INDEPENDENCE AND PERFORMANCE

Non-executive
Dispersed Majority

CORPORATE CONTEXT
INSTITUTIONAL CONTEXT

ownership boards

Sophisticated
Aligned
Institutional
incentives
ownership

Active High
Equity discloser
market Active
Takeover Shareholder
market equity

CAPITAL MARKET LIQUIDITY TRANSPARENCY AND ACCOUNTABILITY


Corporate Governance
MODEL
• Second version of Mc Kinsey model.
• The control model
• Underdeveloped equity markets,
concentrated (family) ownership,
less share holder transparency and
inadequate protection of minority
and foreign shareholders
• ASIA, LATIN AMERICA, EAST
EROPEAN NATIONS
SHAREHOLDERS INVIRONMENT INDEPENDENCE AND PERFORMANCE

Concentrated Insider
boards

CORPORATE CONTEXT
INSTITUTIONAL CONTEXT

ownership

Reliance on
Incentive
family,
Aligned with
bank,
Core
public
shareholders
finance

Underdeveloped Limited
New issue Discloser
market Limited
takeover Inadequate
market minority
protection

CAPITAL MARKET LIQUIDITY TRANSPARENCY AND ACCOUNTABILITY


Corporate
Governance
• Sir adrian cadbury, chairman of
cadbury committee.
• Experts at the organisation of
economic co-operation and
development OECD.
• All these definitions which are
shareholder centric captures some
of the most important concerns of
government for society in general.
Corporate
Governance
• Management accountability.
• Providing adequate investment to
management.
• Disciplining and replacement of bad
management.
• Enhancing corporate performance.
• Transparency.
• Shareholder activism.
• Investor protection.
• Improving access to capital markets.
• Promoting long terms investments.
• Encouraging innovations.
Governance Is More Than
Just Board Processes And
Procedures
• It involves full set of relationship between
company’s management, its board, its
shareholders and its other stakeholders,
such as its employees and the community
in which it is located.
• Poor governance ripples Russia and Asian
markets.
• Cadbury code and CII code.
• World bank, OECD, APEC-Asia pacific
economic co-operation.
OECD emphasis
• Rights of shareholders.
• Equitable treatment of
shareholders.
• Role of stakeholders in
corporate governance.
• Discloser and transparency.
• Responsibility of board.
HOME WORK -1
RESPONSIBILITY:
KARANBIR
CG In Banking Sector
• Bank failure in west.
• Weakness in banking sector
leads to financial instability.
• Lyon G-7 summit in june
1996.
• IMF and world bank.
• Basel committee on banking
supervision.
Issues in corporate
governance
1.Distinguishing the roles of
board and management
• By or under the direction of board.
• Board occupies key position
between shareholders (owners)
and company’s management ( day
2 day managers)
Issues in corporate
governance
• Select, decide the remuneration and evaluate
on a regular basis, when necessary the CEO.
• Oversee the conduct of company business.
• Review and where necessary, approve the
company financial objectives and major
corporate plan and objectives.
• Render advice and counsel.
• Identify and recommend candidates for board
of directors.
• Comply with laws and regulations.
• All other functions required by law to be
performed.
Issues in corporate
governance
2.Composition of the
board and related issues
No. of directors of diff
kinds.
BORAD OF DIRECTORS

EXECUTIVE DIRECTORS NON EXECUTIVE DIRECTOS

AFFILATED DIRECTORS
INDEPENDENT DIRECTORS
NOMINEE
Issues in corporate
governance
3. Separation of the roles of the
CEO and chairperson
4. Should the board of directors
have committees.
Appointment of special committees
Nomination
Remuneration
auditing
Issues in corporate
governance
5. Appointment of the board and
director’s re-election.
6. Directors and executive’s
remuneration.
7. Discloser and audit.
8. Protection of shareholder rights
and their expectation.
9. Dialog with institutional
shareholders.
10.Should investor have a say in
making a company “socially
responsible corporate citizen”?.
Benefits Of Good
Corporate Governance To

A Corporation
Creation and enhancement of a
corporation’s competitive
advantage
• Enabling a corporation perform
efficiently by preventing fraud
and malpractices.
• Providing protection to
shareholders interest.
• Enhancing the valuation of an
enterprise.
• Ensuring compliance with laws
and regulations.
Theory In Corporate
Governance
AGENCY THEORY
• Adam smith who identified an agency
problem(managerial negligence and profusion).
• Shareholders (owners)- principals-they define objective
of the company.
• Agents-management who pursue such objectives.
• Chief executive desire and shareholders long term
investment.
• Mismatch objective leads to agency problem.
• Cost inflicted by such dissonance is the agency cost.
Theory In Corporate
Governance

AGENCY THEORY
Two broad mechanism that reduce
agency cost and improve
performance are:
• Fair and accurate financial
disclosures
• Efficient and independent board of
directors
Theory In Corporate
Governance
Stewardship theory:
• Managers are trustworthy and attach significant
value to their personal reputation
• Managers are steward whose motives are
aligned with the objectives of principles.
• Steward behavior will not depart from the
interests of his/her organization.
• Control can be counterproductive, because it
undermines the pro-organisational behavior of
the steward by lowering his/her motivation.
Theory In Corporate
Governance
Behavioral difference between agency and
stewardship theories
• Agent and steward
• Agency- sociological and psychological
• Steward- individualistic, opportunistic and self serving
With regard to psychological mechanisms
Agency theory states that motivation resolves around
lower order and extrinsic needs
Steward theory states it resolves around higher order
and intrinsic needs
Theory In Corporate
Governance
Stakeholder theory:
• Interest of all groups- employees,
customers, dealers, government and
society.
• Ethics of cares
• Ethics of fiduciary relationship
• Theory of property rights
• Criticised mainly because not applicable in
practice by corporations
Theory In Corporate
Governance
Sociological theory
• Focus on board composition
• Implication of power and wealth distribution
• Financial reporting
• Problems of interlocking dictatorship and
concentration in privilege class to equity
and social progress
• Socio-economic objective of corporations
Corporate Governance

The role of the management is to run


the enterprise while the role of the
board is to see that it is being run
well and in the right direction.
Corporate governance system vary
around the world. Scholars suggest 3
broad versions.
Anglo American Model
Unitary board model/ Anglo-Saxon
Corporate governance in America,
Britain, Canada, Australia
Board of directors stakeholders
Shareholder
supervisors
elect Appoints and supervise

Officers(managers) Regulation/legal
Monitor system
manage &
Lien on
Creditors Stake in
regulates
company
Anglo American Model
• Ownership is equally divided between
individual and institutional shareholders.
• Directors are rarely independent of
management.
• Run by professional managers who have
negligible ownership stake.
• Most institution investors are reluctant
activists.
• Discloser norms.
German Model

• Two tier boar model


• Upper boards supervises the executive
board on behalf of stakeholders and it is
typically social oriented.
• Shareholders do not dictate the
governance mechanism.
• Shareholder elects 50% of members of
supervisory board and rest is by labor
unions, ensuring they enjoy share in
governance.
• Supervisory board appoints and monitors
the management board
German Model
Appoint 50%
Supervisory board
Appoint 50%
Appoint 50%
Appoint
& supervise

Management board
Employees and
(including shareholder
Labor unions
labor relation officer)

manage

Own
Company
Japanese Model

• Business network model


• Boards tends to be large
• Predominantly executive and often ritualistic.
• President who consult both supervisory board and
the executive management.
• Importance of lending bank.
• Shareholders and lending bank together appoints
the board of directors and president.
Japanese Model
Appoint Provides managers,
Supervisory board monitor, act in emergencies

Ratifies president Provides


decisions managers
President

Consult
Main bank
Shareholders
Executive management
Primarily board of directors

Manages
Provides loans
Own Company
Own
Indian Model

• Governed by the company’s Act of 1965


• Which follow UK model
• Private companies is mostly held or
dominated by a founder, his family and
associates.
• India has adopted the key tenets of the
Anglo American external and internal
control mechanism after economic
liberlisation.
Indian Model

HOMEWORK:
Draw Indian model on your notebooks
in next class.
Obligation To Society

• National interest • Competition


• Political non-alignment • Trusteeship
• Legal compliance • Accountability
• Rule of law • Effectiveness and efficiency
• Honest and ethical • Timely responsiveness
• Corporate citizen • Corporation should uphold
• Ethical behavior the fair name of the country
• Social concerns
• CSR
• Environment- friendliness
• Healthy and safe working
environment
Obligation To Investors

• Towards shareholders
• Measures promoting transparency
and informed shareholder
participation
• Transparency
• Financial reporting and records
Obligation To Employees

• Fair employment practices


• Equal opportunities employer
• Encouraging whistle blowing
• Humane treatment
• Participation
• Empowerment
• Equity and inclusiveness
• Participative and collaborative
environment
Obligation To Customers

• Quality of products and services


• Products at affordable prices
• Unwavering commitment to
customer satisfaction
Managerial Obligation

• Protecting company’s assets


• Behavior towards government agencies
• Control
• Consensus oriented
• Gifts and donations
• Role and responsibility of corporate board and
directors
• Direction and management must be
distinguished
• Managing and whole time directions
Cadbury Committee
On Corporate
Governance
• Objective “to help raise the
standards of corporate
governance and level of
confidence in financial
reporting and auditing by
setting out clearly what it
sees as the perspective
responsibilities of those
involved and what it believes
is expected of them”.
Cadbury Committee
On Corporate
Governance
• Code of best practices
• Listed on London stock exchange
• 19 recommendations
• Relating to board of directors,
non executive directors,
executive directors, reporting
and controlling
Cadbury Committee
On Corporate
Governance
Relating to board of directors
• Board should meet regularly, retain full
control and monitor
• Division of responsibility, balance of power.
• Non executive directors should have skill
and knowledge and in right numbers
• Formal schedule of matters
• Take independent professional advice at
the company’s expense
• All directors should have access to the
advice and services of the company
secretary, removal also.
Cadbury Committee
On Corporate
Governance
Relating to non executive directors
• Non executive members should bring an
independent judgment to bear on issues of
strategy, performance, resources, key
appointments and standard of conduct.
• Independent of the management and any other
business and relationship, fee reflect the time
they commit to the work they are assigned.
• Appointment and reappointment.
• Selection through formal procedure.
Cadbury Committee
On Corporate
Governance
Relating to executive directors
• Directors service should not exceeds
3 years without shareholders
approval.
• Clear and full discloser of their salary
and other incomes.
• Pay should be according to
remuneration committee inclusive of
non executive directors.
Cadbury Committee
On Corporate
Governance
Reporting and controls
• Boards duty to present a balanced and
understandable assessment of the company.
• Board should insure that an objective and
professional relationship is maintained with the
auditors.
• Board should established an audit committee with
at least 3 non executive directors.
• Directors should explain their responsibilities.
• Should report on the effectiveness of the
company’s system to internal control
• Should report that the business is going concern
Paul Ruthman
Committee
• Controversial point of
cadbury committee.
• Practicality
• The effectiveness of
company’s system of
internal control
• Extensions of directors
responsibility
THE GRRENBURY
COMMITTEE 1995
• Established to identify good practices of
confederation of British industry CBI
• Directors remuneration and prepare code of
such practices used in public limited company
• Accountability and level of directors pay
• Proper allocations of responsibility, directors
remuneration, proper reporting to
shareholders, greater transparency
4 sections
• Remuneration committee
• Disclosures
• Remuneration policy
• Service contracts and compensation
The Hampel
Committee 1995
• To promote high standards of CG both
to protect investors and Enhance the
standing of companies in LSE
• Developed further cadbury committee
report
• Auditors should report privately to
directors
• Directors maintain and review all
controls
• Internal audit function importance
• Introduced combined code of cadbury
and greenbury
The Turnbull Committee
1999
• Established by the institute of
chartered accountants in
England and Wales ICAEW
• Stress put on combined code on
internal control
• Provide guidance to implement
combined codes
• Annual internal audit importance
• Board of directors confirm the
existence of procedures for
evaluating and managing key
risk function
World Bank on CG
• Earliest international organization to
study and suggest the guidelines for
CG
• Their report on CG recognize the
complexity of the concept
Focuses on
• Transparency
• Accountability
• Fairness
• Responsibility
That are universal in application
OECD Principles
• One of the earliest non government
organization to work on and spell out
principle and practices of CG and their
goal to attain long term shareholder
Value.
Major elements
• The right of shareholders
• Equitable treatment to shareholders
• The role of stakeholder in CG
• Discloser and transparency
• The responsibility of board
Mc Kinsey Survey On CG
• International management
consultant organization.
• Conducted a survey with a
sample size of 188 companies
from 6 countries.
• INDIA , MALAYSIA, MEXICO,
SOUTH KOREA , TAIWAN AND
TURKEY
• To determine the correlation
between good CG and valuation
of the company
Mc Kinsey Survey On
CG
• Increase financial performance
• Transparency of dealing
• Increasing investors confidence
Parameters for CG
• Accountability: transparent
ownership, board size, board
accountability
• Discloser and transparency
• Shareholders equity: one share on
vote
Sarbanes Oxley act
2002
• Scandals
• The Act calls for protection to those who
have the courage to bring frauds to the
attention of those who have to handle
frauds.
• It ensures that such things are not left
to the individuals who may or may not
choose to reveal them.
• The SOX Act is a sincere attempt to
address all the issues associated with
corporate failure to achieve quality
governance and to restore investors
confidence
Sarbanes Oxley act
2002
Provisions :
• Establishment of public company accounting oversight
board PCAOB
• Audit committee
• Conflict of interest- 1 year after preceding
• Audit partner rotation- once after 5 years
• Improve influence on conduct of audits
• Prohibition of non audit services
• CEOs and CFOs required to affirm financials
• Loans to directors
• Attorneys
• Securities analysis
• penalities
Indian Committees And
Guidelines
• Developments all over the
world
• Influence from UK
• After Cadbury Committee
report it was studied by CII,
Associated chambers of
commerce, SEBI
Working Group On the
Companies Act, 1996
• Review the Act in light of
modern requirements
• Aspiration of investors
• Globalization of economy
• Liberalisation
• Bill was introduced in rajya
sabha on 14th august 1997
Working Group On the
Companies Act, 1996
Financial disclosers recommended by the
group
• Directors remuneration and commission should be a part of
directors report
• Cost incurred in using the services of other group companies
• Listed co. must give report
A review on operation yearly
Share in total turnover
Market condition
Future aspects
• Use of each funds generated from shares and debentures
• Debt exposure disclosure
• Foreign exchange outflow
• Financial statements pertaining fixed and current assets and
long term liabilities
• Leased assets
• Any inappropriate treatment in balance sheet in directors report
Working Group On the
Companies Act, 1996
Non Financial disclosers recommended by
the group
• Comprehensive report on directors relatives-
either employee or directors
• Register maintenance for directors interest
• AGM members inspection at any time
• Loans to directors details
• Secretarial compliance certificate in concern
to returns file
• According to companies Act
Narayana Murthy
Committee Report ,2003
• Disclosure of contingent
liabilities
• Certifications by CEOs and
CFOs
• Definition of independent
directors
• Independence of audit
committees
homework
Rights To Share
Holders
• Right to obtain Copies of MOA & AOA
• Right to have certificate of shares held by him within 3 years
of allotment
• Right to transfer his share or interests in the company(AOA)
• Right to appeal company law board if refuses
• He has the preferential right to purchase shares on pro rata
basis
• Right to apply to the company law board
• For the rectification of register of members
• He has the right to apply to the court to have variation or
abrogation to his right set aside by the court
• Right to inspect the registers, index of members, annual
returns, etc.
• He is entitled to receive notice of general meeting and to
attend and vote in the meeting either in person or by proxy
• He is entitled to receive a copy of the statutory report
• He is entitled to receive a copy of the annual report of
directors, annual accounts and auditors reports.
Rights To Share
Holders
• He has the right to participate in the appointment of auditors and
elections of directors at the AGM.
• He has the right to AGM by writing letter to company law board
• He can make application to company law board to convene an
extraordinary general meeting of the company where it is
impractical to call such meeting
• He is entitled to have copies of minutes of general meetings.
• He has the right to participate in declaration of dividend and
receive on duly date.
• He has the right to demand poll
• He has the right to apply to the company law board for
investigation of affairs of the company.
• He has the right to remove a director even before the expiry of
the terms of director office
• He has the right to make an application to company law board
for any oppression and mismanagement.
• He can make a petition to the high court for winding up of
factory.
• He has the right towards any surplus assets of the company
Investors Problems
And Protection
• Investor protection is associated with
effective corporate governance.
• He invested hard earn money and have
expectation
• Capital growth
• Mismatch occurs with expectation and
final outcome of company
• Reasons of such outcome of company
Relationship Between
Investor Protection
And Cg
• CG lies in designing and putting
in place mechanisms such as
Disclosures
Monitoring
Oversight
Corrective system
To align the objective of two as
closely as possible and
minimise agency problems
CG Through Legal
Protection Of
Investors
• Impact of investors protection
on ownership and control of
firms
• Impact of investors protection
on the development of financial
markets
• Banks and corporate
governance
Investor Protection
In India
• Scandals of 1990’s
• Ketan parekh scam 2001
• UTI crisis 1998 and 2001
• Computer technology
House holds investors survey of society for
capital market research and development
SCMRD,
• Report unsatisfactory experience with
equity markets
• 80% say no confidence on companies
management
• 55% shows little or no confidence on the
market regulator or SEBI
• Most preferred savings are….

NK mittal committees
on investor protection
• Specific demand for an Act to
protect investors.
• Establishment of judicial forum
• Investor education and protection
fund in under companies Act Should
shift to SEBI.
• SEBI should be the only regulator
• SEBI should require all IPO’s to be
insured under third party
• SEBI Act 1992 should be amended
• The securities contracts Act 1956
should be amended.
Problems Of Investors
In India
• Against member broker of
stock exchange
• Against companies listed
for trading on stock
exchange
• Complaints against
financial intermediaries
Law Enforcement For
Investors Protection
• Company’s level
• Stock broker level
• Stock exchanges
• Regulatory agencies
Investor grievances and guidance
division ESBI
Department of company affairs
Department of economic affairs
RBI
Consumer courts and court of Law
Nature of complaints
• Complaints regarding delay in refund
• Complaints regarding delay in transfer of shares
• Complaints regarding refusal of transfer of shares
• Complaints regarding problems of odd lots
• Complaints regarding take over bid
• Complaints regarding insider trading, rigging, and other
malpractices
• Complaints regarding delay and non payments of
interest/ fixed deposits of companies
• Complaints regarding delay and non payment of dues or
non delivery of shares by brokers
• Complaints regarding non supply of debenture trust
deed, Refusal to inspection
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