Corporate Governance

Lecture 9 & 10

Important Websites
Securities & Exchange Board of India, www.sebi.org Academy of Corporate Governance www.academyofcg.org CII www.ciionline.org Organization for Economic Cooperation and Development (OECD) www.oecd.org European Corporate Governance Institute www.ecgi.org

What is Corporate Governance?

Genesis & Importance of CG

Concept originated with separation of ownership & management Origin can be traced back to Agency Theory-- A theory concerning the relationship between a principal (shareholder) and an agent of the principal (company's managers) Corporatisation of business and increasing scales of production Opening of Economy Compliance Requirements Capital Markets are getting Institutionalized

Corporate Governance Tripod

Board of Directors Environment
Customers

Employees Suppliers

Shareholders

Management

Society

Government

Corporate Governance (CG)

Designing and implementing systems, procedures & institutions that ensure that management acts in the best interest of the owners or shareholders. The fundamental objective of good CG is to strike a balance at all times between shareholders & other stakeholders.

Stakeholder Perception of Governance?

Value creation Thru Governance: Stakeholder perception

Shareholders Return on invested capital. Debt Holders High debt protection measures credit rating Customers Market Share; Assessment of Customer satisfaction; Cost savings passed on to customers etc.

Value creation Thru Governance: Stakeholder perception

Employees Absolute Salary levels, adjusted growth in average annual salaries; Intangibles etc. Suppliers Relative change in credit terms; Support/Intangibles to suppliers, etc. Society Total direct taxes paid; Employment generated; Expenditure on social infrastructure; Environmental/Social impact cost; Fair practices followed etc.

Historical Developments

International Developments
Organization for Economic Cooperation and Development (OECD) has set a cogent principles of corporate governance A) The Right of shareholders B The equitable treatment of shareholders C) Role of Stakeholders D) Disclosure and Transparency

Developments in UK
Cadbury Committee Report- 1992 focused on accountability & transparency aspects Greenbury Committee Report-1995 highlighted the executive and Directors role & compensation aspects Myner Committee Report-1995 focussed on productive relationship between owners and managers

Development in USA
CG came into forefront through shareholder activism California Public Employees Retirement Systems ( CalPERS) is in the forefront of shareholder activism and internationally credited as a torch bearer of CG Global Governance Principles- Accountability, Transparency, Equity, Voting Method improvements, Long term vision

CG. International Developments

Surbanes Oxley Act, 2002
Post ENRON development Most comprehensive piece of legislation in last 70 years Quality Review Board ( Auditors Independence) Independent Directors Whistle Blower Policy

Indian Scenario
The standard of corporate governance was poor during the earlier decades dominated by family business houses. They operated in a virtually closed economy and could manipulate the rules governing the licence-permit raj by generous donations to political parties, and other corrupt practices. Years ago, the Textile Enquiry Committee had vividly brought out how the managements of the once prospering cotton and jute textile mills turned them into sick units by siphoning out funds to other family-owned subsidiaries.

SEBI Malpractices took on significant proportions and the grievances of retail investors increased alarmingly. GOI was rather helpless in solving the retail investors' grievances in such large volumes because of the lack of proper penal provisions. SEBI was constituted as a supervisory body to regulate and promote security markets.

Developments in India
1997 : Release of CIIs Voluntary Code of Corporate Governance for listed companies 2000 : Kumar Mangalam Birla committee by SEBI Specific clause (Clause 49) in the Listing Agreement as prescribed by SEBI. 2002 : Naresh Chandra Committee 2003: Narayana Murthy Committee
Both dealt with issues of transparency & accountability dimensions of the board process. The Naresh Chandra Committee also dealt with the role of the Audit function & the Audit Committee of the board.

2005: The Naresh Chandra Committee proposed salient changes in the Partnership Act.

Narayana Murthy Committee Recommendations

Enhanced role of the Audit Committee Written code of conduct for Executive Management Non-Executive Directors Whistle Blower Policy Subsidiary companies Liability of CEO / CFO

Clause 49
At least 33% (in case of a non-executive chairman) and at least 50% (in case of executive chairman) of the directors of the board of a company to be independent. Board Meetings to be held at least four times a year, with a maximum gap of four months between any two meetings. No director to be a member of more than 10 boards / committees or chairman of more than 5 committees and inform the respective companies about these memberships. Attendance of the directors at board meetings to be disclosed to shareholders. All material, financial and commercial transactions where there is personal interest of directors or potential conflict of interestrelated party transactions to be fully disclosed.

What are the various types of Directors on Board

Type of Directors
Executive directors responsibilities have day-to-day management

Non Executive Directors- take no part in the day-to-day running of the business, but have the same responsibilities as executive directors. They use their experience and expertise to provide independent advice and objectivity, and they usually have a role in monitoring executive management. Nominee directors- The interests of substantial shareholders or the companys bankers may be represented by a nominee director.

Independent Director - Definition

As per Clause 49 of Listing Agreement Should not be related to promoters or management at the Board level or at one level below the Board Should not have been a partner or an executive of the statutory audit firm or an internal audit firm or legal and consultancy firm, during last 3 years Should not have been a supplier, service provider or customer of the company Should not hold 2% or more shares of the company Should not have been an executive of the Company in the immediately proceeding 3 financial years S Appointment of Non Executive Director beyond continuous hperiod of 9 years not permissible o u

Independent Directors Clause 49 ( 2005)

If the chairman of the board is a nonexecutive director, at least one-third of the company's board should comprise independent directors. If the chairman is an executive director, at least one-half (or 50 per cent) should be independent directors.

Role of Independent Director

Shareholders
Shareholders especially minority shareholders look at independent directors providing transparency in respect of the disclosures in the working of the company and balance in resolving conflict areas.

Other Stakeholders
Evaluating the boards or management decisions in respect of employees, creditors etc. and in protecting stakeholders interest.

Independent Directors in the Board

Counterbalance management weaknesses in a company. Ensure legal & ethical behaviour at the company, while strengthening accounting controls. Extend the reach of a company through expertise, skills and knowledge and access to debt & equity capital. Help a company survive, grow, and prosper over time thru improved succession planning, thru membership in the nomination committee.

Committees of the Board

Audit Committee Shareholders / Investors Grievance Committee, Remuneration Committee (Non mandatory)

Principles of Effective Governance

An effective and independent Board A proactive audit committee A compensation committee A nominating committee A sound internal control framework A relevant code of ethical behaviour Clear enforced policies and procedures Effective management of risks An effective well resourced internal audit function Independent effective external audit Transparent disclosure, effective communication, and systems that ensure effective measurement and accountability

An Effective and Independent Board

Appropriate balance of independent and executive directors Effective mechanism, appropriate competence, adequate experience, and sufficient information Validating and approving the strategy and the operation of business, providing advice, counsel and feedback to the Chief Executive Ensure that the personal skills of the Directors are well aligned with the needs of the company and evolving regulations and standards

Vodafone No. of Board Members 18

Barclays 18-20 9 9 11 Yes Yes Yes

HSBC 22-25 14 11 7 Yes Yes Yes

GE 13-17 One third Two third 13 Yes Yes Yes

Singapore Airlines 11-14 5 6 4 Yes Yes Yes

Non- Exec Directors8 Independent Directors 8

Frequency of Board 8 Meetings Nomtn Commt Yes

Compentn Commt Yes Audit Commt Yes

An Effective and Independent Board

Non-Executive Directors are expected to make two visits to GE businesses, without management being present Management briefing for new directors and independent advice available as required- Singapore Airlines Annual Review of director independence- Barclays Annual Review of Chairmans performance- Vodafone

Some essential Qualities of effective Boa of Directors

Individual directors should have Highest standards of personal integrity Excellent judgment and an ability to make informed decisions

within time constraints Professional credibility Capacity to think strategically Demonstrate sound communication skills Sound interpersonal skills Team orientation The board, as a whole should ideally have Strategic thinking Analytical skills, appropriate professional experience Effective communication skills Knowledge of the organization and the industry

Some essential Qualities of effective BOD

contd
Board should have a mix of Directors with skills in Law Finance, including accounting expertise Marketing Operations relevant to the Companys activities including other

key industries in which the company operates Corporate Governance Human Resources Risk Management Merger and Acquisitions Other specific matters relevant to the company

Role of Board In CG
Guiding Corporate Strategy, Major Plans of Action, Risk Policy, Annual Business Plans, overseeing major capital expenditures, acquisitions and disposals. Monitoring managerial performance, conflicts of interests of management, board members and shareholders. Monitoring misuse of corporate assets and abuse in related party transactions. Achieving adequate returns for shareholders.

Role of Board In CG
Compliance with Laws and regulations, including
Maintaining integrity of accounting and financial reporting systems Internal & operational controls Systems for evaluating risk management

Interests of Stakeholders, such as employees Corporate Social Responsibility

Best CG
L &T Godrej Consumer Products Infosys Wipro Tata Motors HDFC Dabur

CG will lead to Corporate Excellence

Profitability Satisfied stakeholders such as shareholders, customers, employees Revenue and profit growth Growth in market share Growth in market value (Market capitalization)

Corporate Governance
Good corporate governance aims at increasing transparency, accountability, investor protection, compliance with statutory laws and regulations and value-creation for shareholders and other stakeholders. A companys most valuable asset is goodwill it enjoys with its stakeholders and institutional investors are willing to pay 20% more on average for companies with a good governance record.