Corporate governance and employee compensation

CORPORATE GOVERNANCE AND EXECUTIVE COMPENSATION

Presented by:

Dheera C

Gouri R

Mamtha M

Neha Sethu

Nikhila C

Contents

• Introduction to Corporate Governance• Illegal tactics of Indian corporate• Corporate Governance in India• Corporate governance in Pvt and Public sector• Legal Provisions and SEBI code• Reforming Corporate Governance• Employee Compensation and • Employee Stock Option Plan (ESOP).

What is corporate governance?

• Problem that result from the separation of ownership an control.

• Divergence of interestSHARE HOLDERS

BOARD

MANAGEMENT

EMPLOYEES

Illegal tactics of Indian corporate• Cornering of industrial licenses mainly with a view to pre

empting competitors to enter into well entrenched industry

• Using import licenses to make a quick profit in the market

• Illegally holding money abroad to meet business expenses and investments for which government would not allow enough funds

• Trying to gain special advantage for the business through the bribery of concerned officials ,generating un accounted money in the business so as to compensate for penal levels of taxation other business expenses and political donations

Agency TheoryAgency Theory

An agency relationship exists when:


Shareholder(Principals)

Firm Owners



Shareholders (Principals)

Firm Owners

Managers (Agents)

DecisionMakers

Hire



Shareholders (Principals)

Firm Owners

Agency RelationshipRisk Bearing Specialist

(Principal)

Managers (Agents)

DecisionMakers

which creates

Managerial Decision-Making Specialist(Agent)

Hire


The Agency problem occurs when:- The desires or goals of the principal and agent conflict

and it is difficult or expensive for the principal to verify that the agent has behaved appropriately


The Agency problem occurs when:- The desires or goals of the principal and agent conflict

and it is difficult or expensive for the principal to verify that the agent has behaved appropriately

Agency cost: The cost inflicted by dissonance


DEVICES FOR CONTAININGAGENCY COST

• Internal Monitoring• Incentive compensation contracts

• Market for corporate control• Managerial labor market

EXTERNAL DEVICES:EXTERNAL DEVICES:

INTERNAL DEVICESINTERNAL DEVICES

Benefits of corporate governance to a corporation

• Creation and enhancement of 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 of laws and regulation

Corporations have a stake in preserving the environment and the ecology

This case is one of the best example to understand the same

BHOPAL GAS TRAGEDY: Mother of all industrial disasters

BHOPAL GAS TRAGEDY• 3 rd December 1984• Occurred in union carbide factory when 500

liters of water got into MIC storage tank• Leakage was detected by workers at 11.30 pm

they informed their supervisor• More than 3500 people were killed and 4,00,000

people remain injured • Tragedy of errors:

legal,technolgical,organizational and human errors

Corporate Governance in India

• Indian corporate scenario was more or less stagnant till 90s.

• The position and goal of Indian sector has changed a lot after liberalization.

• India’s reform program made a steady progress since 1994.

• Part mainly covers Corporate governance in private sector and public sector.

THE BIGGEST IT “SCAMSTER”.

The SCAM• The biggest corporate scam in India has come from one

of the most respected businessmen.

• Satyam founder Byrraju Ramalinga Raju resigned as its chairman after admitting to cooking up the account books.

• His efforts to fill the "fictitious assets with real ones" through Maytas acquisition failed, after which he decided to confess the crime.

• India's fourth largest IT company lost a staggering Rs 10,000 crore (Rs 100 billion) in market capitalisation as investors reacted sharply and dumped shares, pushing down the scrip by 78 per cent to Rs 39.95 on the Bombay Stock Exchange.

• The NYSE-listed firm also faced regulator action in the US.

Confession and Aftermath

• The CEO was convinced that the gap in the balance sheets reached an unmanageable heights and could not be filled in future by any means.

• I am now prepared to subject myself to the laws of the land and face consequences thereof," Raju said in a letter to SEBI and the Board of Directors

• Satyam Computer crashed by Rs 139.15 or 77.69 per cent to close at Rs 39.95, after the Chairman`s confession

• Bombay stock exchange fell 700 points

• The declining Sensex recorded the biggest single-day loss in the past two months, after Satyam Computers Services, the country's fourth-largest software developer, plunged around 80 per cent.

Corporate Governance in Private Sector

Features of Corporate governance

• 3 Categories of stakeholders:

• Unique system of promoters. Eg, Tata’s, Ambani, Birla, Mahindra etc

• List of non promoters companies are short. Eg, ITC, L&T, ICICI and HDFC.

• Crossholding- to maintain control over different group companies.

Promoters

Financial

Institutions

Individual

Investors

• Successful business group are able to perform like capital and labour markets , also create wealth for shareholders.

• Promoters take longer view and provide a more solid foundation.

• Company boards consists of 3 directors :

• Institutional investors have been supportive of promoters.

• Family managed companies display greater entrepreneurial vigour, strict control and act proactively.

Promoter

directors

Professional

directors

Institutionally

nominated

directors

• Characterised as “Entrenched system”.• Conflict not between interest of shareholders and

interest of managers.• Between interest of dominant

shareholders(managers) and interest of remaining shareholders.

• Tunnelling – dominant shareholder may exploit minority shareholders.

• Facilitated with cross-holding and use of private companies and non public trusts for owning shares.

Example : TCS

• TCS (Tata Consultancy Services),a leading global IT solutions and consulting firm with consolidated revenues of US $11.6 billion

• With over 276,000 consultants, TCS has become the largest private sector employers in India with the highest retention rate.

• Strong leadership and corporate governance have been TCS' hallmark.

• The Tatas have an elaborate Code of Conduct predicated on the concept of "Humata, Hukta, Huvarashta" from which flows the five Tata core values of integrity, understanding, excellence, unity and responsibility.

Another Example : Toyota

• Toyota; a good example for adopting corporate governance principles.

• Toyota is a global leader in automotive sales, technology and production, retaining one of the world’s most recognizable and highly valued brands.

• The incorporation of sound stakeholder management practices into their core business activities, making it the most valuable company.

• to enhance its corporate governance based on the belief that maintaining and improving management efficiency and the fairness and transparency of its corporate activities is of utmost importance.

• They treat employees as partners, as opposed to subordinates and also maintain relationship with the suppliers.

INTRODUCTION TO THE “BIG BULL OF THE TRADING FLOOR”.

HARSHAD MEHTA-CASE• He triggered a rise in the BSE in year 1992 by trading in

shares at a premium across many segments.

• Taking advantages of the loopholes in the banking system, Harshad and his associates triggered a securities scam diverting funds to the tune of Rs 4000 crore (Rs 40 billion) from the banks to stockbrokers between April 1991 to May 1992.

CASE

• Harshad Mehta worked with the New India Assurance Company before he moved ahead to try his luck in the stock markets.

• Mehta soon mastered the tricks of the trade and set out on dangerous game plan. Mehta has siphoned off huge sums of money from several banks and millions of investors were conned in the process.

• His scam was exposed, the markets crashed and he was arrested and banned for life from trading in the stock markets.

• He was later charged with 72 criminal offences. A Special Court also sentenced Sudhir Mehta, Harshad Mehta's brother, and six others, including four bank officials, to rigorous imprisonment (RI) ranging from 1 year to 10 years on the charge of duping State Bank of India to the tune of Rs 600 crore (Rs 6 billion) in connection with the securities scam that rocked the financial markets in 1992.

• He died in 2002 with many litigations still pending against him.

CORPORATE GOVERNANCE IN THE PUBLIC SECTOR

Features of Public sector governance

• Public sector companies contribute more to the nation’s gross national product, employment and capital than Private sector.

• They often shape public policies.• Instituting sound corporate governance

practices within public sector companies is essential to economic development growth and reforms.

• Some public economic entities may never be privatized as they are considered vital to national security or political sensitive.

Good

governance

Effective

utilization

of resources

Increase

productivi

ty and

value

• Corporate governance system in the public sector may be characterized as the ‘transient system’

• Equity shares are owned wholly or partially (more than 51%) by Government.

• The board, appointed comprises of 3 categories of directors:– Functional directors –Government directors–Outside directors

• PSEs are constrained by various rules and administrative guidelines.

• They are subject to CAG audit and are accountable to parliament.

• Chief executives of PSEs have short tenures i.e.: 1-5 years.

• PSEs enjoy greater operating autonomy.• Partial privatization has further heightened

their profit orientation.

STATE BANK OF INDIA

• Governed by act of Parliament(SBI Act 1955)• President of India is the Largest Shareholder (59.41%)• Non residents(FII,NRI,GDR) (12.33%)• Institutions (10.90%)• Resident Individuals(6.7%)• Board of Directors

– 3 Executive Directors and 7 non Executive Directors– Chairman, 2 MD (Executive Directors)– 4 directors- elected by Shareholders– 3 directors- nominated by GOI– Non EDs include Academicians, Journalists, Business

Professionals

STATE BANK OF INDIA - COMMITTEE

• 9 Committees– Executive Committee– Audit Committee– Shareholders’/Investors Grievance Committee,– Risk Management Committee– Special Committee for Monitoring of Large Value Frauds

(Rs.1crore and above)– Customer Service Committee– Technology Committee– Committee on Rural Sector Business– Remuneration Committee of the Board

Legal provisions and SEBI code

• Legal provisions under the companies Act strength – three directorsMeetings- at least once in a quarterComposition :

a) No fixed number of non –executive directors.

b) No person can be a director of more than twenty companiesPowers : B.O.D has powers to :

a) borrow, lend, & invest funds

b) recommend dividends

c ) appoint the managing directorremuneration : total remuneration – 11% of net profit

fee for board members - 20000 per meeting duties : present the annual report to the members liabilities : punishable for breach of trust , dishonesty, and fraud

Companies bill 2013• At least 1/3 of the board of directors of the listed company - independent directors.• Independent directors can serve 2 consecutive terms of five years each on the Board. Limited

liability • Mandatory internal and secretarial auditing provisions.• Mandatory rotation of auditors.• Limitation of number of companies which can be audited by an auditor.• Elaborate quorum requirements.• Prohibition on insider trading and forward dealing by directors and key management persons.• Uniform financial year from April to March for all companies.• Higher disclosure requirements.• Stringent accountability on directors, auditors and other professional associated with the

company.• Restriction on investment through more than two layers of investment companies.• Mandatory disclosure of interest by directors.• Streamlined procedure and disclosure in respect of related party transactions.• Introduction of voting though electronic participation, meeting through video conferencing.• Requirement that at least one director shall be stayed in India for a total period of not less than

182 days.

Provisions applicable to listed companies

• Clause 49Board of directors

1) Chairman (non executive director) - 1/3rd of the board – independent directors Chairman (executive director) - Half of the board – independent

2) Compensation /fees:• non- executive director (independent director)• fixed by board• prior approval of share holders in a general meeting

3) Meeting• 4 times a year• Maximum time gap – 4 months b/w 2 meetings

4) Information• Operating plans, budgets, minutes etc

Cont.

5) Director shall not:• Member in more than 10 committees • Act as chairman of more than 5 committees

6) Code of conduct

AUDIT COMMITTEE

1) Qualified , independent audit committee

2) Directors• Minimum -3 • 2/3rd members- independent directors3) Chairman• independent director • present at AGM4) Company secretary

5) Meeting• 4 times in a year•Maximum time gap – 4 months b/w 2 meetings

cont:

6) Role of audit committees

DISCLOSURES

1) Deviation from prescribed Accounting Standards

2) Management discussion & analysis report – part of annual report

3) pecuniary relationship – non-executive director shall be disclosed in the annual report

4) Separate section for corporate governance – annual report

CEO/CFO Certification

1) Financial statement- True & fair view of the company ‘s affairs

The provisions of clause 49 is closely parallel to SOX (sarbanes-Oxley Act of US)

Reforming corporate governanceStrengthen the hands of institutional investors

Separate management from control

Expand the role of non- executive director

Limit the size of the board

Ensure that the board is informationally well-equipped

Link managerial compensation to performance

Enhance contestability

Improve corporate accounting & reporting practices

THE FOLLOWER OF THE “BIG BULL”

• Ketan Parekh followed Harshad Mehta's footsteps to swindle crores of rupees from banks. A chartered accountant he used to run a family business, NH Securities.

• He targeted smaller exchanges like the Allahabad Stock Exchange and the Calcutta Stock Exchange, and had contacts with the brokers over there & bought shares in fictitious names.

• His dealings revolved around shares of ten companies like Himachal Futuristic, Global Tele-Systems, SSI Ltd, DSQ Software, Zee Telefilms, Silverline, Pentamedia Graphics and Satyam Computer (K-10 scrips).

• He got around 650 Cr from zee & HFCL whose shares were ramping up

• Ketan borrowed Rs 250 crore from Global Trust Bank to fuel his ambitions. Ketan alongwith his associates also managed to get Rs 1,000 crore from the Madhavpura Mercantile Co-operative Bank.(MMCB)

• Banks issued pay orders • According to RBI regulations, a broker is allowed

a loan of only Rs 15 crore (Rs 150 million). • The Crime Branch of India arrested Ketan Parekh

on the charge of defrauding BOI.

EXECUTIVE COMPENSATION

EXECUTIVE COMPENSATION

SALARY BENEFITS INCENTIVE COMPENSATION

• The main objectives of a firm’s compensation policy are:

Alignment

Shareholder cost

Retention

Leverage

Designing an Incentive Compensation Plan • There are certain guidelines in aligning the interests of managers

and shareholders for a well conceived incentive compensation plan.

Use objective criteria: the plan must be easily observable by all parties and manipulation should not take place.

Select the Right set of Performance Measures: the plan must be linked to the performance measures that is consistent with the responsibilities of the executives.

Reward Relative Performance: the plan should be based on the performance of the peer group.

Discourage Parochial Behavior: the plan undergoes a joint incentive.

Lengthen the Decision Making Horizon of the Executive: the plan enable the managers to implement “long term performance plans”.

Employ Stock Options Judiciously

EMPLOYEE STOCK OPTION PLAN (ESOP)

• Employee stock options is a label that refers to compensation contracts between an employer and an employee that carries some characteristics of financial options.

• Companies like Infosys, TCS, HDFC Bank, Axis Bank have implemented ESOPs to drive talents of their executives.

• Many companies use employee stock options plans to retain and attract employees, the objective being to give employees an incentive to behave in ways that will boost the company's stock price.

• By doing so has gathered the momentum as stock options align closely to the interest of managers with those of shareholders.

SEBI Guidelines on ESOS

• Eligibility: an employee should be eligible to participate i.e. he should not be a promoter or a director who holds more than 10% of outstanding equity shares.

• Compensation Committee: ESOS should be offered to company that has a compensation committee of independent directors.

• Shareholder Approval: No ESOS can be offered to employees of a company that is not approved by shareholders.

• Pricing: A company granting ESOS to its employees has the freedom to determine the exercise price in account to the guidelines.

“The Biggest Risk In Life Is Not Taking One.”

References

• Books: corporate governance principal policies and practices by A.C. Fernando

• Financial management theory and practice• Financial management: MY khan PK Jain