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CORPORATE GOVERNANCE
ACKNOWLEDGEMENT
At the outset, I am thankful to my college SANPADA COLLEGE OF COMMERCE AND TECHNOLOGY, and the authorities, for providing me an opportunity to undertake my Bachelor Degree in Banking And Insurance (BBI), and also for sponsoring me to undertake project. I am thankful to the management for giving me an opportunity to undertake my project ( A Study on) under the guidance of Prof. SHREKESH POOJARI as my mentor.
I would like to thank our Faculty guide, Prof. SHREKESH POOJARI for providing valuable suggestions and guidance during the project. His perspective has encouraged me to incorporate a different dimension to the project.
I am grateful to my colleagues for being a wonderful support a through at the same time I am thankful to all my friends of Sanpada College of Commerce & Technology for being with me at different junctures of need. I thank
I also acknowledge great sense of gratitude to all those who have enriched and improved my thinking, through their conversations, thoughts, experience and guided me to complete this report.
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CERTIFICATE
This is to certify that the project work titled ‘’CORPORATE GOVERNANCE” has been completed by ‘’S.VENKATESH” OF T.Y.B.B.I under the guidance of ‘’Prof. SHREKESH POOJARI ” during the academic year 20011-12” This report is submitted towards the partial fulfillment of Bachelor of Banking And Insurance, Oriental Education Society, Mumbai University.
The information in the project report is unique, true and fair to the best of my knowledge.
PROF. SHREKESH.POOJARI
(PROJECT GUIDE)
PLACE:
DATE:
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DECLARATION
I hereby declare that the project work entitled ‘’CORPORATE GOVERNANCE ” to the ‘’UNIVERSITY OF MUMBAI’’ is a record of an
original work done by me under the guidance of PROF. SHREKESH.POOJARI and this project work has not performed the basis for the award of any Degree or Diploma/associate ship/fellowship and similar project if any.
S.VENKATESH (T.Y.B.B.I)
PLACE:
DATE:
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UNIVERSITY OF MUMBAI.
PROJECT REPORT ON
“CORPORATE GOVERNANCE”
A PROJECT REPORT SUMITTED IN PARTIAL FULFILLMENT
OF THE REQUIREMENT FOR
BACHELOR OF BANKING AND INSURANCE
SUBMITTED BY: S.VENKATESH
UNDER GUIDANCE OF:
PROF. SHREKESH.POOJARI
SANPADA COLLEGE OF COMMERCE & TECHNOLOGY
Sector No . 2, Plot No. 3-5, Adj. Sanpada station
Navi Mumbai.
2011-2012
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Chapter -1
INTRODUCTION
Understand the meaning and genesis of corporate governance
Definition of corporate governance
Risk and concept of corporate governance
Importance of corporate governance
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Meaning:
Corporate governance while not a new concept, has in the 1990’s become an issue
of global importance. Corporate governance is a set of process, customs, policies,
laws and institutions affecting the way a also includes the relationships among the
many players involved (stakeholders) and the goal for which the corporation is
governed. The principal players are the stakeholder, management and board of
directors. Other stakeholders include employees, suppliers, customer, banks and
other lenders, regulators, the environment and the community at large. According
to sir Adrian Cadbury:
“Corporate governance is concerned with the holding the balance between
economic and social goal and between individual and communal goals. The
corporate governance framework is there to encourage the efficient use of
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resources and equally to require accountability for the stewardship of those
resources. The main aim is it align as nearly as possible the interest of individual,
corporation and society.”
Definition of corporate governance:
Corporate governance refers to the relationship that exists between the different
participants, and defining the direction and performance of corporate firm. The
following are the main actors in corporate governance:
the CEO, i.e., the management
the board of directors
the shareholders
The other actors who influence governance in corporation/firms are the staff,
suppliers, customers, creditors and the community. Before discussing the role of
different bodies, the understanding of corporation is must, what a corporation
stands for and who should define the direction of the firm.
The definition of corporation refers to an instrument or a body by means of which
capital is acquired, used for investing in assets producing goods and services, and
their distribution. As per the corporation law, the purpose of business corporation
should be engage in such activities which contribute the raising the profits of the
firm and enhance the value/gain of the shareholders. It has a legal entity and
originates from the authority of the land. A corporation differs from the people
who constitute it. Thus it follows from above that, once the individual forms the
corporation, they together constitute the corporation in the eyes of the Laws.
Definitions of corporate governance vary widely. They tend to fall into two
categories. The first set of definitions concerns itself with a set of behavioral
patterns: that is, the actual behavior of corporations, in terms of such measures as
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performance, efficiency, growth, financial structure, and treatment of shareholders
and other stakeholders. The second set concerns itself with the normative
framework: that is, the rules under which firms are operating—with the rules
coming from such sources as the legal system, the judicial system, financial
markets, and factor (labor) markets. For studies of single countries or firms within
a country, the first type of definition is the most logical choice. It considers such
matters as how boards of directors operate the role of executive compensation in
determining firm performance, the relationship between labor policies and firm
performance, and the role of multiple shareholders. For comparative studies, the
second type of definition is the more logical one. It investigates how differences in
the normative framework affect the behavioral patterns of firms, investors, and
others. In a comparative review, the question arises how broadly to define the
framework for corporate governance. Under a narrow definition, the focus would
be only on the rules in capital markets governing equity investments in publicly
listed firms. This would include listing requirements, insider dealing arrangements,
disclosure and accounting rules, and protections of minority shareholder rights.
Under a definition more specific to the provision of finance, the focus would be on
how outside investors protect themselves against expropriation by the insiders.
This would include minority right protections and the strength of creditor rights, as
reflected in collateral and bankruptcy laws. It could also include such issues as the
composition and the rights of the executive directors and the ability to pursue
class-action suits.
One can define corporate governance as the range of institutions and policies that
are involved in these functions as they relate to corporations. Both markets and
institutions will, for example, affect the way the corporate governance function of
generating and providing high-quality and transparent information is performed.
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Rise of the concept of corporate governance:
The word corporate governance is relatively a new addition to the vocabulary of
management science in Japan, said of Mitsubishi Corporation. The economic
recession of the late nineties and the early years of new millennium which gripped
Japan is being described as a “governance recession”. Downturn in trading and low
returns on investment are the most significant phenomena of the Japanese economy
during this period. These downturn are described to inappropriate structure of
corporate governance, which failed to respond to the changing business
environment.
It is the pertinent to quote the example of Daimler Benz, ‘the crown jewel’ of
the German industry, which learnt through hard experience to bring a change in the
classical accounting system and practices on the disclosure, so as to attract the
foreign capital. It is implied that emerging markets reflected the changes needed in
the structure of governance. The fact that governance considerations are vital in the
competition for acquisition of capital is also shown when Australian stock
Exchange denied Rupert Murdoch, an internationally known tycoon, his proposed
listing. Rupert Murdoch was to dispose his non-voting share.
The governments round the world have been concerned about developing
international code on governance. With the reduction in the trade barrier by the
countries, the investors are willing to invest across the world. Now they are able to
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access detailed information on investment opportunities in corporates easily on the
internet. Global companies are looking for first class regulatory and legal system,
among other conditions. The successive efforts of the shareholders of the firms like
Westing House, American Express, Sears, ITT, etc., have displayed that the well
informed equity owners of the firms have the potential to influence the governance
of the firm.
The word corporate governance started in the UK during the late eighties. In
1992, the UK developed a code on governance under the chairmanship of Adrian
Cadbury, governor, Bank of England.
Corporate governance occupies a significant place in the international
business. Today the subject is being taught in many B’ schools as a part of their
curriculum. In order to be able to appreciate the issue related to governance, one
needs to understand the underlying concept and the related assumptions in these
subjects, besides their inter-linkages to understand the business scenario.
Importance:
The scandals and crises are just manifestations of a number of structural reasons
why corporate governance has become more important for economic development
and a more important policy issue in many countries. The reasons are as follows:
(a) The private, market-based investment process underpinned by good corporate
governance is now much more important for most economies than it used to be.
Privatization has raised corporate governance issues in sectors that were previously
in the hands of the state. Firms have gone to public markets to seek capital, and
mutual societies and partnerships have converted themselves into listed
corporations.
(b) Due to technological progress, liberalization and opening up of financial
markets, trade liberalization, and other structural reforms—notably, price
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deregulation and the removal of restrictions on products and ownership—the
allocation within and across countries of capital among competing purposes has
become more complex, as has monitoring of the use of capital.
(c) The mobilization of capital is increasingly one step removed from the principal-
owner, given the increasing size of firms and the growing role of financial
intermediaries. The role of institutional investors is growing in many countries,
with many economies moving away from “pay as you go” retirement systems.
(d) Programs of deregulation and reform have reshaped the local and global
financial landscape. Long-standing institutional corporate governance
arrangements are being replaced with new institutional arrangements, but in the
meantime, inconsistencies and gaps have emerged.
Chapter-2
Corporate Governance & Development
To know the corporate governance & its Development in the
economy
Concepts and the objectives
The link between the corporate governance and other foundations
of development
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Corporate governance matters for growth and development
Introduction:
There is an investigation of the relationship between corporate governance and
economic development and well-being. It finds that better corporate frameworks
benefit firms through greater access to financing, lower cost of capital, better firm
performance, and more favorable treatment of all stakeholders. There is also
evidence that when a country’s overall corporate governance and property rights
system are weak, voluntary and market corporate governance mechanisms have
limited effectiveness. Less evidence is available on the direct links between
corporate governance and poverty. Two events are responsible for the heightened
interest in corporate governance. During the wave of financial crises in 1998 in
Russia, Asia, and Brazil, the behavior of the corporate sector affected entire
economies, and deficiencies in corporate governance endangered the stability of
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the global financial system. Just three years later confidence in the corporate sector
was sapped by corporate governance scandals in the United States and Europe that
triggered some of the largest insolvencies in history. In the aftermath, not only has
the phrase corporate governance become nearly a household term, but economists,
the corporate world, and policymakers everywhere began to recognize the potential
macroeconomic consequences of weak corporate governance systems. The
scandals and crises, however, are just manifestations of a number of structural
reasons why corporate governance has become more important for economic
development and well-being. The private, market based investment process is now
much more important for most economies than it used to be, and that process is
underpinned by better corporate governance. With the size of firms increasing and
the role of financial intermediaries and institutional investors growing, the
mobilization of capital has increasingly become one-step removed from the
principal-owner. At the same time, the allocation of capital has become more
complex as investment choices have widened with the opening up and
liberalization of financial and real markets, and as structural reforms including
price deregulation and increased competition, have increased companies ‘exposure
to market forces risks. These developments have made the monitoring of the use of
capital more complex in certain ways, enhancing the need for good corporate
governance. It aims to trace the many dimensions through which corporate
governance works in firms and countries. A well-established body of research has
for some time acknowledged the increased importance of legal foundations,
including the quality of the corporate governance framework, for economic
development and well-being. Research has started to address the links between law
and economics, highlighting the role of legal foundations and well defined
property rights for the functioning of market economies. It also provides some
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background on the ownership patterns around the world that determine and affect
the scope and nature of corporate governance problems.
Concept and Objectives:
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;
In other words, corporate governance is the acceptance by management of the
inalienable rights of shareholders as the true owners of the corporation and of their
own role as trustees on behalf of the shareholders. It deals with conducting the
affairs of a company such that there is fairness to all stakeholders and that its
actions benefit the greatest number of stakeholders. In this regard, the management
needs to prevent asymmetry of benefits between various sections of shareholders,
especially between the owner-managers and the rest of the shareholders.
The aim of "Good Corporate Governance" is to ensure commitment of the board in
managing the company in a transparent manner for maximizing long-term value of
the company for its shareholders and all other partners. It integrates all the
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participants involved in a process, which is economic, and at the same time social.
The fundamental objective of corporate governance is to enhance shareholders'
value and protect the interests of other stakeholders by improving the corporate
performance and accountability. Hence it harmonizes the need for a company to
strike a balance at all times between the need to enhance shareholders' wealth
whilst not in any way being detrimental to the interests of the other stakeholders in
the company. Further, its objective is to generate an environment of trust and
confidence amongst those having competing and conflicting interests.
It is integral to the very existence of a company and strengthens investor's
confidence by ensuring company's commitment to higher growth and profits.
Broadly, it seeks to achieve the following objectives:
A properly structured board capable of taking independent and objective
decisions is in place at the helm of affairs;
The board is balance as regards the representation of adequate number of
non-executive and independent directors who will take care of their interests
and well-being of all the stakeholders;
The board adopts transparent procedures and practices and arrives at
decisions on the strength of adequate information;
The board has an effective machinery to sub serve the concerns of
stakeholders;
The board keeps the shareholders informed of relevant developments
impacting the company;
The board effectively and regularly monitors the functioning of the
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management team.
THE LINK BETWEEN CORPORATE GOVERNANCEAND
OTHER FOUNDATIONS OF DEVELOPMENT.
The research on the role of corporate governance for economic development and
well-being is best understood from the broader perspective of other foundations for
development, notably the importance of finance, the elements of a financial
system, property rights, and competition. Three elements of this are worth
highlighting.
The link between finance and growth:
First, over the past decade, the importance of the financial system for growth and
poverty reduction has been clearly established. One demonstration is the link
between finance and growth. Almost regardless of how financial development is
measured, there is a cross-country association between it and the level of GDP per
capita growth. Numerous pieces of evidence have been assembled over the past
few years to indicate the relation is a causal one: that is, it is not only the result of
better countries having both larger financial systems and growing faster. The
relationship has been established at the level of countries, industrial sectors, and
firms and has consistently survived a rigorous series of econometric probes.
The link between the development of banking systems and market
finance and growth:
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Second, and importantly for the analysis of corporate governance, the development
both of banking systems and of market finance helps economic growth. Banks and
securities markets are complementary in their functions, although markets will
naturally play a greater role for listed firms. More generally, the findings provide
support for the functional view of finance. That is, it is not financial institutions or
financial markets that matter; it is the functions that they perform that matter. In
particular, for any regression model of growth that is selected and adapted by
adding various measures of stock market development relative to banking system
development, the results are consistent. None of these measures of financial sector
structure has any statistically significant impact on growth. To function well,
financial institutions and financial markets, in turn, require certain foundations,
including good governance.
The link between legal foundations and growth:
Third, the role of legal foundations is now better understood and documented.
Legal foundations matter crucially for a variety of factors that lead to higher
growth, including financial market development, external financing, and the
quality of investment. Legal foundations include property rights that are clearly
defined
and enforced and other key regulations. Comparative corporate governance
research took off following the works of economists Rafael La Porte, Florencio
Lopez-de-Silanes, Andrei Shleifer, andRobert Vishny.
CORPORATE GOVERNANCE IMPORTANT FOR GROWTH
AND DEVELOPMENT
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The literature has identified several channels through which corporate governance
affects growth and development:
The first is the increased access to external financing by firms. This in turn
can lead to larger investment, higher growth, and greater employment
creation.
The second channel is a lowering of the cost of capital and associated higher
firm valuation.
The third channel is better operational performance through better allocation
of resources and better management. This creates wealth more generally.
Fourth, good corporate governance can be associated with a reduced risk of
financial crises. This is particularly important, as financial crises can have
large economic and social costs.
Fifth, good corporate governance can mean generally better relationships
with all stakeholders.
All these channels matter for growth, employment, poverty, and well-being
more generally.
Better operational performance:
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In the end, the way better corporate governance can add value is by improving the
performance of firms, whether through more efficient management, better asset
allocation, better labor policies, and similar efficiency improvements. Evidence for
the United States, and elsewhere strongly suggests that at the firm level, better
corporate governance leads not only to improved rates of return on equity and
higher valuation, but also to higher profits and sales growth. This evidence is
maintained when controlling for the fact that “better” firms may adopt better
corporate governance and perform better due to other reasons. Across countries,
there is also evidence that operational performance is higher in better corporate
governance countries, although the evidence is less strong.
The role of entrenched owners and managers:
Evidence shows that firms adapt to weaker environments by adopting voluntary
corporate governance measures. A firm may adjust its ownership structure, for
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example, by having more secondary, large block holders, which can serve as
effective monitors of the primary controlling shareholders. This may convince
minority shareholders of the firm’s willingness to respect their rights. Or a firm
may adjust its dividend behavior if it has difficulty convincing shareholders that it
will reinvest properly and for their benefit. These voluntary mechanisms can
include hiring more reputable auditors. Since auditors have some reputation at
stake as well, they may agree to conduct an audit only if the firm itself is making
sufficient efforts to enhance its own corporate governance. The more reputable the
auditor, the more the firm needs to adjust its own corporate governance. A firm can
also issue capital abroad or list abroad, thereby subjecting itself to higher level of
corporate governance and disclosure. There is also evidence that the voluntary
corporate governance adopted by firms matter more in weak corporate governance
environments. Markets can adapt as well, partly in response to competition, as
listing and trading migrate to competing exchanges, for example. While there can
be races to the bottom, with firms and markets seeking lower standards, markets
can and will set their own, higher corporate governance standards. One example is
the Novo Mercado in Brazil, which has different levels of corporate governance
standards, all higher than the main stock exchange. Firms can choose the level they
want, and the system is backed by private arbitration measures to settle corporate
governance disputes. Efforts like these can help corporations improve corporate
governance at low cost as they can list locally.
Higher firm valuation:
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The quality of the corporate governance framework affects not only the access to
and amount of external financing, but also the cost of capital and firm valuation.
Outsiders are less willing to provide financing and are more likely to charge higher
rates if they are less assured that they will get an adequate rate of return. Conflicts
between small and large controlling shareholders are greater in weaker corporate
governance settings, implying that smaller investors are receiving lower rates of
return. There is clear empirical evidence for these effects. The cost of capital has
been shown to be higher and valuation lower in weaker property rights countries.
Investors also seem to apply a discount in their valuation for firms and countries
with relatively worse corporate governance. Furthermore, in countries with weaker
property rights, controlling shareholders also obtain a fraction of the value of the
firm that exceeds their direct ownership stake, at the expense of minority
shareholders.
CHAPTER-3
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NATURE AND SYSTEMS OF CORPORATE
GOVERANANCE
Definition & scope
Benefits of good governance
Corporate governance and economic performance
OECD principles
Models of corporate governance
Corporate Governance in India
Factors influencing corporate governance
Definition and Scope:
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Corporate governance comprises the systems and processes which ensure the
functioning of the firm in a transparent manner for the benefit of all the
stakeholders and accountable to them. The focus is on relationship between owners
and board in directing and controlling companies as legal entities in perpetuity. A
company’s ability to create wealth for its owners however, depends on the role and
freedom given to it by society.
Sir Adrian Cadbury in his preface to the World Bank publication,
Corporate Governance: A Framework for Implementation; states that “Corporate
governance is holding the balance between economic and social goods and
between individual and community goals. The governance framework is there to
encourage the efficient use of resources and equally to require accountability for
the stewardship of those resources. The aim is to align as nearly as possible the
interests of individuals, corporations and society .The incentive to corporate aims
and to attract investment. The incentive for states is to strengthen their economies
and discourage fraud and mismanagement”.
The focus on corporate governance arises out of the large dependence of
companies on financial markets as the preeminent sources of capital. The quality of
corporate governance shapes the future and the growth of capital market. But
capital markets and financial markets in general can function properly if
individuals have access to accurate basic information about the companies they
invest the link between a company’s management, board and its financial reporting
system is crucial. In the context of globalization, capital is likely to flow to markets
which are well regulated and practices high standards of transparency, efficiency
and integrity.
Benefits of Good Governance :
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Good governance leads to congruence of interests of board, management
including owner managers and shareholders.
Good governance provides stability and growth to the company.
Good governance system builds confidence among investors.
Good governance reduces perceived risk, consequently reducing coat of
capital.
Well governed companies enthuse employees to acquire and develop
company specific skills.
In the knowledge driven economy excellence in soft skills like management
will be the ultimate tool for corporates to leverage a competitive advantage
in the financial markets.
Adoption of good corporate practices promotes stability and long term
sustenance relationship.
A good corporate citizen becomes an ethical icon and enjoys a position of
pride in corporate culture.
Potential stakeholders aspire to enter into relationship with enterprises
whose governance credentials are exemplary.
Corporate Governance and Economic Performance:
Tradeoff between compliance with normative obligations such as the increasing
opportunities for stakeholder’s participation, access to information and economic
performance of the firm can be decided in the political realm.
Finally the existence of condition for fair choice of basic practices of
corporate governance may not be met since the system of rights and constitutional
state envisaged in a democratic system may not obtain in all countries. This may
result in bias in the selection of practices and structure favoring those able to
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mobilize wealth and other sources of social power. While a corporation has
universal obligations, there cannot be any one set of correct practices and structure
of corporate governance. Specific obligations are assumed by a corporation
through their decision and practices. Among the various attempts to evolve best
global standards, the principles evolved by organization for economic cooperation
and development (OECD) released in 1999 have been accepted as an international
benchmark. OECD principles recognize that different legal systems, institutional
frameworks across countries have led to the development of range of different
approaches to corporate governance. The OECD principles like other good
corporate governance regimes protect the interest of not only the shareholders but
all stakeholders like employees, creditors, suppliers, customers and environment.
OECD Principles:
The OECD principles of corporate governance cover five major areas.
The rights of shareholders.
The equitable treatment of shareholders.
The role of transparency.
Disclosure and transparency.
The responsibilities of the board.
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Rights of shareholders : Rights of shareholder mentioned in the OECD
report cover the registration of the right to ownership with the company,
conveyance or transfer of shares, obtain relevant information from the
company on a timely and regular basis, participate and vote in general
shareholders meetings, elect members of the board and share in the profits of
the company. The OECD principles emphasize that information on
shareholders who exercise control disproportionate to their equity ownership
should be disclosed.
Equitable Treatment of Shareholders : All shareholders should be treated
equitably and the law should not make any distinction among different
shareholders holding a given class or type of shares. Any changes in voting rights
of common shareholders can be done only with the consent of those shareholders.
Role of stakeholders : The rights if the stakeholders as established by law should
be recognized and active cooperation between corporations and stakeholders in
creating wealth, jobs and sustainability of financially sound enterprises should be
encouraged. While the shareholders are the true owners, the functioning of a
company affects several other economic players in the society. Employees are
directly as they develop and adopt company specific skills. There is a significant
synergetic relationship between the company and its employees. Corporate entities
have also an impact on the environment of the community in which they are
located. Polluting units may generate profits for shareholders but impose costs on
society. Representation of employees and community on the board are mooted.
Role of Board : The main task of a board is to monitor the performance of the
executives and to ensure that returns to shareholders are maximized. True
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independence of the board can be ensured by having a majority of outside directors
who do not have any financial of pecuniary involvement with the company.
Disclosures and Transparency : Timely disclosures relating to financial position,
ownership pattern and shareholding helps in infusing a sense of discipline and
accountability among managers. Increased transparency and information help to
reduce information symmetry between management and shareholders. Adoption of
internationally accepted best practices improves the understanding and comfort of
foreign investors about the operations of the companies and lowers their risk
perception.
Models of Corporate Governance:
Outsider Model:
Outsider model obtaining in UK and USA in which control and ownership are
distinct and separate. Since equity ownership is widely dispersed among a large
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number of institutional holders and small investors, control vests with professional
managers. The model is also referred to as principal-agent model where the
shareholders, the principals entrust the management of the firm to managers, the
agents. In actual practice with the growth of the firm the gulf between shareholders
and managers has widened and became distant giving rise to the agency problem,
ensuring that managers function in the interests of the shareholders. The dichotomy
between ownership and control has necessitated the adoption of regulatory and
legal frameworks to ensure that corporate practices protect the interests of
shareholders as well as other stakeholders.
Features of Companies in Outsider Model in UK and USA :
The US and UK have similar foundations in common law and the features of
corporate governance are alike. Both American and British Companies combine
managers with outside directors into a unitary board, Boards comprise a large
number of non-executive directors, markets in both countries have companies with
widely dispersed share ownership, high levels of public disclosure, relatively low
levels of outside regulation and clearly defined legal duties of care and loyalty to
shareholders. There are however subtle differences. While both countries have
boards relatively small, boards with between 7 and 12 directors. British boards are
slightly larger with more executive on their boards. Non-executive directors on
British boards work with executive directors as a collective body. In US the non-
executive directors tend to monitor management and do not get involved in
operational matters. The British boards also combine chairman of board and CEO.
While 95% of FTSE 100 companies have separated the two positions, the number
of S&P 500 companies in 2003 which have combined the two positions is only
21%. In Britain the chairman leads the board and CEO leads the company.America
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has chosen a system of checks and balances for its government but not for its
business because of its mistrust of the former and desire not to slow down
competitiveness of latter. There are of course checks and balances like ethics to
install an understanding of how one should behave in terms of fiduciary duty,
internal compliance and company governance as well as industry self-regulation.
The recent scandals however reveal a critical violation of fiduciary duty because of
conflicts of interest or greed. n the US the higher proportion of outside directors on
the boards may reduce the need for independent chairman while in the UK the split
roles at the heads of companies may allow for strong board independence.
Centralization of Regulation in US:
While the British have consolidated almost all public company oversight into a
super regulatory body, the Financial services Authority, the US has decentralized
and checked power is reflected in the balanced roles of Securities and Exchange
Commission (SEC), exchange listing rules and state statutes.
Shareholders :
Shareholders in Britain enjoy numerous and specific ownership rights than their
counter parts in US. Shareholders in Britain vote on dividends, buy backs, financial
statements, preemptive rights and small acquisitions and spin offs. In US
shareholders vote for directors and auditors.
Market for Corporate Control:
The approach to take over defenses and the market for corporate control are quite
different. The prevalence of defenses such as poison pills, green mail, dual class
voting stock in US is owed to the factor that law and regulation have entrusted to
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directors to take immediate decision on offers for the company. The US approach
emphasizes director’s fiduciary duty to adopt maximum defense where volatile
prices and ready cash make them attractive targets. The directors in British boards
have little altitude and have to follow the rules of the City Code on takeovers and
Mergers. The code set up specific time table for voting on bids, ensures equal
treatment of shareholders and in its preference for auctions regulates the statements
both sides may make to the market after an approach. Structural defenses like
poison pills freeze out provisions and green mail ate not allowed. The British
governance system assumes a conflict of interest when boards decide on mergers.
Disclosures:
The corporations in US are required to report on director backgrounds in AGM
notices and make public filling to SEC which provides free access to an online
database of corporations. In UK companies report twice a year and investors have
to depend only on annual reports.
Insider model :
The insider has two variants, the European and East Asian. In the European model
a relatively small compact group of shareholders exercise control over corporation.
On the other hand, the East Asian model of corporate governance, the founding
family generally holds the controlling share either directly or through holding
companies. In all Asian countries control is enhanced through pyramid structures
and cross holding among firms. In Japanese form of insider system, several
companies are linked together through interlocking directorships, which are backed
by cross holdings of one another’s shares. With these intertwined groups of firms,
called keiretsu, there is also a main bank and several another financial institutions,
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which holds share in the companies in the group and sit on the company’s
supervisory boards. Within a Japanese keiretsu control is multidirectional with
each company able to exercise some control over the companies that control it. The
Korean Chaebol is a hybrid between the German corporate pyramid and the
Japanese Keiretus. In 1995 the top 30 chaebol accounted for 40.2% of the value
added in Korea’s manufacturing sector, ownership stakes in the chaebol are
relatively small, 10% for 70 largest chaebolaffiliater companies. Founding families
however can maintain control through cross shareholdings among member
companies. Banks and other financial institutions, unlike japan do not play a
monitoring role. Claessens, Djankov and lang examined the separation of
ownership and control for 2,980 corporations in nine East Asian countries found
that separation of management from ownership control is rare and the top
management of about 60% of firms that are not widely held is related to the family
of the controlling shareholders. The separation of ownership and control is most
pronounced among family controlled as are small firms. It is a observed that
concentration of control generally diminishes with the level of a country’s
economic development. In the European insider model the controlling
shareholders are backed by complex shareholders agreements. The controlling
group maintains longer term and stable relationship among themselves. In the
European countries where this insider model is extant corporate sector depends on
banks as a source of finance and the corporate entities have quite levels of debt
equity ratios.
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Market Versus Bank Oriented Systems of Governance:
Side by side comparison of bank and market
It may distinguish between market oriented and bank oriented or relations-based
systems of corporate governance. A major difference between the two systems was
the degree to which creditors monitored the firms. In the bank oriented system
bank enter into long term relationships; and in market system, an arms length
relationship is maintained. In England creditors preferred hands off approach. In
the German economy banks play a dominant role in financial intermediation as
well as in the monitoring of corporations. One form of monitoring was to place
bank officers on the supervisory boards of industrial companies or to purchase
large block of shares. It was not hands-on relationship banking. However, in the
light of recent development we may note that the crucial difference between
American and German systems of governance may be traced to the different
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ownership structures and not to the role of banks per se. The US while nurturing
the corporate form of organization has established elaborate legal framework to
preserve competition and prevent dominance. Oversight is provided by
independent audit, stock exchanges and SEC. In the US economy both corporate
finance and control are market based. Large companies in US and UK are listed in
the stock markets and their ownership concentration is modest. In the UK as well
as USA there is a market for corporate control in which hostile takeover is
important and banks play a limited role. Outside the Anglo Saxon world most
companies are private, the ownership of listed companies is highly concentrated,
family ownership is very important and hostile takeovers are rare and pyramidal
control schemes are common in some countries bank ownership of equity is
important. The German economy may be typically characterized as bank system.
While banks shareholding is small, they enjoy significant voting rights on the
bearer form shares deposited with them by shareholders. They have representatives
on the top two tier boards. Banks are required to consult shareholders give their
advice and take their instructions on voting.
Corporate Governance in India:
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While the predominant form of corporate governance is much closer to the Asian
insider model, there are a number of firms that resemble the European version
where the control is maintained through pyramidal form of ownership and
control. The concept of industrial house which controls several companies is quite
commonly accepted although the funding family does not own the company.
There are quite a few companies whose practices of corporate governance are a
matter of concern. Dilution of accounting and reporting standards have allowed
corporations from manipulating resources for their own vested interest sideling
the stakeholders of the company. Investors have suffered on account of
unscrupulous management of the companies, which have raised capital from the
market at high valuations and performed much worse than the past reported
figures; leave alone the future projections at the time of raising money. Another
example of bad governance has been the allotment of promoters shares, on
preferential basis at preferential prices, disproportionate to market valuation of
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shares, leading to further dilution of wealth of minority shareholders. There are
also many companies, which are not paying adequate attention to the basic
procedures for shareholders service; for example, many of these companies do
not pay adequate attention to redress investors grievances such as delay in
transfer of shares, delay in dispatch of share certificates and dividend warrants
and non-receipt of dividend warrants; companies also do not pay sufficient
attention to timely dissemination of information to investors as also to the quality
of such information. Although the securities law and companies Act address
several of these investor grievances, the implementation and inadequacy of penal
provisions have left a lot to be desired.
Factors Influencing Corporate Governance :
a) Integrity of the management: A Board of directors with a low level
of integrity is tempted to misuse the trust, reposed by shareholders and
other stakeholders, to take decisions that benefit a few at the cost of
others.
b) Ability of the board: The collective ability, in terms of knowledge
and skill, of the board of directors to effectively supervise the
executive management determines the effectiveness of the board.
c) Adequacy of the process: Board of directors cannot effectively
supervise the executive management if the process fails to provide
sufficient and timely information to the board, necessary for
reviewing plans and the performance of the enterprise.
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d) Commitment level of individual board members: The quality of a
board depends on the commitment of individual members to tasks,
which thy are expected to perform as board members.
e) Quality of corporate reporting: The quality of corporate reporting
depends on the transparency and timeliness of corporate commination
with shareholders in making economic decisions and in correctly
evaluating the management in its stewardship function.
f) Participation of stakeholders in the management: The level of
participation of stakeholders determines the number of new ideas
being generated in optimum utilization of resources and for improving
the administrative structure and the process. Therefore an enterprise
should encourage and facilitate stakeholder’s participation.
Chapter-4
THE THREE ANCHORS OF CORPORATE
GOVERNANCE
Know Accountability and Responsibilities
Approaches to Balance Board and CEO Functions
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Board and Shareholders
Election of Directors
Introduction:
The three anchors of corporate governance are board of directors, management and
shareholders. While each of them has important responsibilities of its own, it is
their interaction with each other’s that is the key to effective governance. In
tandem they constitute an effective set of checks and balances. The system can
become unbalance if any one of them is not functioning well.
Accountability and Responsibilities:
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Mr. Obama Signs Credit Card accountability / The girl is showing her responsibility
The relationship in the governance triangle consisting of boards of directors
management, management-board of directors and boards of directors-shareholders
depend on mutual accountabilities and responsibilities. The board lays down policy
and monitors performance and counsels and management. The board hires and
fires and through the Remuneration Committee sets the compensation for the CEO.
It may be noted that in USA the jobs of CEO and Chairman are usually combined
while in India the practice varies. In some they are held by different individuals
while in others they are combined. Sir Adrian Cadbury believes that the jobs of
Chairman and Chief executive demand different abilities and perhaps
temperaments. In it is very much in shareholders interests to ensure they are
performed by different people.
Separation of Board from Management:
The new governance rules that have been adopted are designed to distance the
board from management and thereby prevent conflicts of interest that can
compromise the relationship. The changes call for an increase in the number of
independent directors and the committees on Audit and compensation be
composed entirely of independent directors. The New York stock exchange
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proposals also put forth the idea of director independence. They should have no
material relationship with the company.
Board and Management:
The changes introduced by focusing on board and Audit Committee composition
have not succeeded in establishing a healthy distance between the management and
board. The board should be free to monitor and the management tree to manage. If
the two functions are combined as under a system of Chief executive officer
Chairman, there is no separation of powers and functions. The policy making,
strategy formulation and monitoring is done by the same person who is supposed
to execute them. The efficiency of all these measures to distance Board from
management would be lost if we let a person wear two hats at the same time that of
Chairman of the board and Chief executive officer of management. At the outset it
should be noted that letting management personnel be members of the board
howsoever senior they may be by calling them full time directors/executive
directors has confounded the concepts of transparency and accountability. Good
corporate governance demands the separation of the board and management. Even
in the case of promoters whose personal wealth is tied to the company they have to
make a choice to be satisfied by being a member of the board or management
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team. This of course goes against the grain of Indian corporate governance, the
founding family as “owners” being the board as well as management. Management
accountability will be non-existent to the shareholders in such circumstances.
Family Dominated Companies:
Infosys like a family dominated business.
Family dominated company’s own substantial stakes in a large number of quoted
companies here as well as in U.S. In the U.S. the founding family is an influential
investor in more than one-third of standard and poor’s 500 companies. On average
while the family owns 18% of the equity its control of the board tends to be
disproportionately large. However, family dominated companies are both more
profitable and better marker performers than non-family especially when a
dynamic family member with a profound sense of stewardship is managing
Director/CEO. The key difference between the family firms and others is the
independence of the board packed with friends and relatives do badly, while those
with strong directors do better. It is good governance that makes the difference.
Approaches to Balance Board and CEO Functions :
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The (US) Conference Board Commission on public Trust and
private Enterprise (CPTPE) 2003 noted three principal approaches to
provide the appropriate balance between board and CEO functions.
Separation of the offices of Chairman and CEO with those two roles
being performed by separate individuals. The chairman would be one
of the independent directors.
Separation of offices but not a member of management and would not
report to CEO. Chairman who is a non-independent director may be
designated as lead independent director without any relationship with
CEO or management that compromises his or her ability to act
independently.
Where there is no separation of chairman and CEO position a
presiding director position could be established.
Duties of non-CEO chairman whether he is an independent director or
not, the lead independent director and presiding director should be
articulated.
Non CEO Chairman:
The duties of non- CEO Chairman according to CPTPE should include
i. Presiding at board meeting and at meetings of non management
directors,
ii. Approval over information sent to the board,
iii. Deciding board meeting agenda,
iv. Serving as principal liaison to the independent directors and
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v. Setting meeting schedules.
Duties of Lead Independent Director ( CPTPE):
i. Chairing meeting of the non-management directors,
ii. Serving as principal liaison to the independent directors,
iii. Working with the non CEO Chairman to finalize flow to the board
meeting agenda and meeting schedules.
Duties of presiding Director (CPTPE):
i. Preside at board meetings in the absence of chairman,
ii. Presiding at executive sessions of the non management directors,
iii. Serving as the principal liaison to the independent directors,
iv. Approve information to be sent to the board,
v. Approve agenda for board meeting,
vi. Set meeting schedules.
A non CEO Chairman who is not an independent director should not be
a member of the management team and should not report to the CEO. The non
management directors should have regular, frequent meetings without the CEO or
other directors who are members of management present.
Board and Shareholders :
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The regulatory efforts and operation of market forces have let out this relationship
in the third anchor of corporate governance. By and large shareholders do not
know what the directors are doing and directors do not know what the shareholders
want. Board members are elected by shareholders to serve as their agents but in
practice shareholders have not exerted much influence over directors. The
exchange of information between the two anchors is poor and directors are not
accountable to shareholders. There is no way for shareholders to know whether the
directors have acted in there is no efficient mechanism to nominate or even endorse
director candidates.
Shareholders on their part are quite apathetic and mute. Their
communication is limited to formal proxy votes which historically ratified board’s
wishes. Shareholders have access to no mechanism through which to effect
changes, except for calling an extraordinary general body meeting. The
relationship between the two anchors, board and shareholders is not linked together
in any manner or by any method except for the provision of annual general
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meeting. The absence of the link has created an imbalance in the governance
mechanism. It has also encouraged a closer relationship and stronger link between
board and management who fill the void. Directors can be effective in taking care
of shareholder interests of we set up a strong structure of board meetings and
enfranchisement of shareholders. Three steps mooted in this connection are record
of voting at Board meetings, letting shareholders put up as well as elect a director
on their behalf and make resolutions passed at shareholders meeting binding.
Transparency:
If the individual directors’ votes on corporate resolutions in key corporate proxy
statements are recorded, the directors become accountable to shareholders. When
people are held recount able for their actions as individuals rather than as a group
they tend to weigh their choices more carefully. Directors would have greater
incentive to air their views if individual votes are published. Such accumulated
information to create director score boards would supplement board self-
evaluation.
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Election of Directors:
While the shareholders in theory have the right to attend meetings and participate
in the election of directors of the Board, the cast majority of director elections are
uncontested. The only method is open to shareholders is to mount a proxy fight
which entails publishing and mailing their own list of proposed directors to
shareholders escalating the contest in effect into a fight for control of the firm. The
campaign has to be has to be financed by shareholders out of their out of their
pockets whereas the company’s own proxy materials sent to shareholders before
annual meetings company cost/or shareholders money. To enfranchise the
shareholders and democratize election of company directors shareholders may be
allowed to put their won candidates on the Company’s proxy material. This would
avoid the expense and stark choices of a proxy fight. In US has proposed the grant
of right to shareholders under special circumstances, such as opposition to
company’s proxy by withholding votes, and duration of share ownership for 3-5
years. The proposal has been opposed on the ground that it would create confusion
in elections when more than one candidate contests a board seat.
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Chapter – 5
Corporate Social Responsibilities
Stakeholders
Sustainable governance
Social contract between business and society
The Global Compact (2000)
An Overview
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Introduction:
The concept of corporate social responsibilities is not new. The history of
corporate activity shows that business have always encompassed the notion of
broader obligations to the communities in which they operate. Companies have
recognized the value of enlightened self interest responding to their own specific
circumstances. A project on corporate responsibilities was launched in 1969 by
Ralph Nadir and several other lawyers to change the purpose of corporation. In
Nader’s view the corporation is to be transformed from the means of maximizing
investor wealth to a vehicle for using a private wealth to redress social ills.
Stakeholders theory embodies many aspects of the theory of corporate social
responsibility. On the other hand, value based management holds that the social
mission of corporation is to make as much money as possible for its owners while
confirming the rules of society and let shareholders, employees and customers
undertake their own efforts. In practice corporations that wish to maximize
shareholder value generally find in their interest to devote corporate resources to
constituencies such as employees, customer, suppliers and local communities. CSR
concerns have shifted from local and particular to that of global and generic. This
results in a new focus on the environment, human and labor practices.
Stakeholders:
The issue of how responsible companies should be to those other than
their shareholders have come to the fore when entire communities are adversely
affected when companies fail. The approach of Anglo-Saxon shareholder
capitalism is that companies should exclusive pursue the interests of shareholders;
and the other, stakeholder capitalism which acknowledges that companies are also
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responsible to their workers and local communities often by having representatives
from both on their boards. The issue have further cofounded by anti-globalization
view which faults multinationals for exploiting third world workers, and pollute
the environment. It has to be noted that over half of the worlds 100 largest
economic entities are transnational corporations not nations. There is demand that
companies should be made to behave more responsibly and that government use
companies to implement their social policy: limit working hours, promote social
harmony and clean up environment.
In practice Anglo-Saxon companies have taken on social obligations
without the prompting of governments. Family dominated companies in India are
also involved in development of institutions of higher learning, healthcare and
places of worship. The robber-barons in USA have built much of the educational
and health infrastructure, company towns and introduced health care benefits. A
distinction should therefore be made between the demands of the capital market
and practices of the companies. Companies believe that taking care of their
workers and other in the society is in the long term interest of the company. Such a
policy builds trust which gives benefits of doubt when dealing with customers,
workers and even regulators. It also gives an edge in attracting employees and
customers. Companies are not in business of building fairer societies. That is the
job of government.
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Sustainable governance:
Superior corporate governance is rewarded by a premium in the market place.
investors are willing to pay more in emerging markets for the shares of companies
that had implemented high standards of corporate governance.
Companies have to build on understanding of challenges of sustainability
beginning with climate but including global income disparity, water usage,
biodiversity, labor practice and human rights into their long term strategies.
Otherwise they will be viewed as a poor or risk. Those who fail to act on concerns
embodied in sustainable governance will be plagued by doubts and questions from
NGOs, government, customer and major investors. Companies that fails to
understand sustainability, to pursue fair and equitable solutions to climate change
and to anticipate what lies ahead will be caught off guard by unexpected economic
risk, environmental hazards and social demands. Sustainable governance is not an
option. To restore confidence, to build the structure of trust, companies must
commit themselves to openness, transparency and fairness. They must do this
through innovations in listing exchanges, governance reforms and disclosure
through the Global Reporting Initiative (GRI). GRI released its sustainability
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reporting guidelines in August 2002 is expected to foster transparency and
accountability of corporate activities beyond financial matters.
Social contract between business and society:
The objective of shareholder value maximization has however to be as a part of the
social contract between business and society. This contract has obligations,
opportunity and mutual advantage for both sides according to Davis of McKinney
and company. Otherwise it could lead managers to focus exclusively in improving
the short term performance of their business neglecting important long term
opportunities and issues such as trust of customers, investment in innovation and
other growth prospects. Maximization of shareholder value also obscure questions
of ethics and legitimacy. Multinational enterprises need to tackle such issues for
reasons of integrity and enlightened self interest. The fundamental basis of social
contract between business and society is the efficient provision of goods and
services that society wants. Business has to restate and reinforce their own social
contracts to secure for the long term the shareholders investment.
The new approach calls for:
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Introduction of explicit processes to make sure that social issues
and emerging social forces are part of overall strategic
planning.
Establishment of ever higher standards of integrity and
transparency and active involvement in debates on social issues
that shape their business context.
The ultimate purpose of business is the efficient provision of goods and services
that society wants. It is the fundamental basis of the contract between business and
society. Such a noble purpose is not only more motivating but also beneficial
shareholder value over long term. Shareholder value creation or profits are
measure and reward of efficient provision of goods. Restating and reinforcing the
business own social contract will also secure for the long term the shareholders
investment
The Global Compact (2000):
The global compact, United Nations global compact programme launched by UN
in 2000 calls on companies to embrace nine principles in the areas of human rights,
labor standards and environment. The Global Compact is a value-based platform
designed to promote institutional learning. It is utilizes the power of transparency
designed to promote and dialogue to identify and disseminate good practices based
on universal principles. The nine principles are drawn from the Universal
Declaration of Human Rights, the International Labor Organization’s Fundamental
Principles on Rights at work and the Rio principles on Environment and
Development. According to these principles, business should:
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Support and respect the protection of internationally
proclaimed human rights : corporate leadership in human rights is good
for the community and for business. The benefits of responsible engagement
for business include a greater chance of a stable and harmonious atmosphere
in which to do business, and a better understanding of the opportunities and
problems of the social context. Further, the benefits impact from ill thought-
through business initiatives.
Uphold the freedom of association and the effective recognition
of the right to collective bargaining: Freedom of association and the
exercise of collective bargaining provide opportunities for constructive
rather than confrontational dialogue which harness energy to focus on
solutions that result in benefits to the enterprise, its stakeholders, and the
society at large.
Support the elimination of all forms of forced and compulsory
labor :
Forced labor robs societies of the opportunities to apply and develop human
resources for the labor markets of today and develop the skills in education
of children for the labor markets of tomorrow.
Support the effective abolition of child labor :
Child labor results in scores of under-skilled, unqualified workers and
jeopardizes future skills improvements in the workforce. Children who do
not complete their primary education are likely to remain illiterate and will
not acquire the skills needed to get a job and contribute to the development
of a modern economy.
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Eliminate discrimination in respect of employment and
occupation :
Discrimination in employment and occupation restricts the available pool of
workers and skills, and isolates an employer from the wider community.
Non-discriminatory practices help ensure that the best-qualified person fills
the job.
Support a precautionary approach to environmental
challenges :
It is more cost-effective to take early actions to ensure that irreversible
environmental damage does not occur. This requires developing a lifecycle
approach to business activities to manage the uncertainty and ensure
transparency
An Overview:
Concerning both public owned and private owned industrial/business both
have one thing in common: the capital is provided by one group, and business is
managed by another group of professionals. This means that the roles are divided
between two bodies. In case of public owned enterprise, equity is provided by the
state/government and management of the enterprise is in the hands of the managers
who are professionals. Managers are responsible for making the best use of
resources of enterprise in furtherance of its objectives. Effective management of
the enterprise is inevitable for two reasons: (a) to achieve the economic goals on
year to year basis and (b) to attract stable and low cost of capital for investment on
long term basis. The owners of the capital are interested in appreciation in the
value of equity provided. For this purpose, the owners of the capital depend upon
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the framework and the structure, i.e., the board of directors, of the enterprise to
monitor the performance of the managers so that managers are able to add value to
the capital invested.
There are some illustrations of PSUs like Steel Authority of India Ltd.
(SAIL), NTPC and others where the union government is the major equity
shareholder with private individual ownership of shares. Likewise, in Tata Steel
Company and Tata Motors (Telco), there are financial institutions, banks, staff etc.,
who jointly constitute the major shareholders along with Tata Sons. In these
enterprises, management is in the hands of the professional mangers who are
engaged to manage the company, in in furtherance of organizational goals.
Corporate governance has received utmost attention since the early nineties
in India and the western nations, including the US. The increase in the attention is
due to the multitude of factors but the main one is the anxiety of the enterprises
concerned to put up a clear image of the company in the society and to restore
confidence in the viability of the company in the society and to keep the enterprise
free from any legal implications. The board of directors of the enterprise or in the
case of two-tier system, the supervisory board are the vital organs of the corporate
structure. The board is designed to hold the management accountable to the
providers of the equity for harnessing the resources of the organization on the best
possible manner.
The beginning of new millennium has witnessed the global movement on the
good governance which resulted in a number of corporate guidelines/codes on the
best practices on governance. The global movement has underlined the
significance that the world attaches to the corporate governance and the role of
board of directors in monitoring governance of management activities.
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Effective governance is contingent upon security regulations, market trends,
company law of country, audit and account rules, legal atmosphere, etc. An
understanding of these rules in different countries is inevitable if one wants to
understand their practices on corporate governance. For example, in some
instances, the governance code with listing and / or has legally mandatory rules for
disclosure, as essential requirement.
The Cadbury Report of the UK, Dey report of Canada and guideline issued by the
board of directors of GE, US, have served as a reference and basis for development
of guideline on corporate governance. Guidelines on the subject have also been
issued by stock exchanges and other bodies like institutional investors, corporate
managers and association of directors, which are voluntary. Mostly these
guidelines are not Mandatory, e.g., the companies listed on the Toronto and
London stock exchanges are not obliged to observe the recommendations of the
Dey report or Cadbury report. But such companies have, of necessity, to follow the
disclosure requirements.
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Chapter -6
A STUDY OF CORPORATE GOVERNANCE INBANKS
Introduction
Main Indicator Of Corporate Governance
Unethical Business Practices
Sources
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Conference on Corporate Governance of Banks in Eurasia, London.
Introduction:
Globally, Corporate Governance guidelines and best practices have evolved over a
period of time. In the United States of America as well as India in the late 1800
and the early 1900s there were only closely held family owned corporate and the
concept of public limited companies was non-existent. The owners made strategic
decisions and bore the entire consequences-positive or negative.
However, by the 1930s increasing number of companies went public and
corporate ownership was dispersed across a large number of individuals and issues
of Accountability, Transparency and control were raised by these shareholders in
the Annual meeting of the shareholders. The years subsequently saw the
strengthening of the rights of the shareholders and the stakeholders which gained
momentum only in the early nineties.
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The Cadbury Committee report was a landmark effort from UK in 1992
followed by vienot report in France in 1995. The confederation of British Industry
in January 1995 set up theGreenbury committee to recommend a code of
governance for the UK Industries followed by the Hampel committee appointed by
the London Stock Exchange (LSE). The 30 member Organization for Economic
Cooperation and Development (OECD) in 1999 published the general principles of
corporate Governance. However, the Sarbanes Oxley Act 2002 of US brought in
sweeping changes in financial reporting.
In India, the confederation of Indian Industry (CII) tools the lead and
framed the code of Corporate Governance in 1998. The Securities and Exchange
Board of India (SEBI) appointed the Kumaramangalam Birla Committee and its
recommendations were accepted in 1999 and enshrined in the Clause 49 of the
Listing Agreement of the stock exchange. The Department of company affairs
appointed the Naresh Chandra committee in 2002, to repost on the relationship
between the auditors and their clients. Then the SEBI appointed Narayana Murthy
committee recommendation were also incorporated in to the revised Clause 49 in
2006. Further, the Corporate Governance Rating by agencies like CRISIL and
ICRA are now used to benchmark companies on Corporate Governance practices.
Main Indicator Of Corporate Governance:
Existence of good corporate governance : It is a primary and most
fundamental indicator of good corporate governance. The good governance
code should be based on widely accepted views of government, Business
Association, social organization or stakeholders. Moreover the existence of
the code should be used as a benchmark to measure the company’s actual
governance.
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The role, Responsibility and competence of the board: There has to be a
system that ensures that the board is empowered, informed, competent and
effective on a continuous basis. The board must provide the stewardship to
the company to take up the role and responsibility in running the company
efficiently and effectively.
Involvement of Non-Executive or independent directors : These directors
are appointed in the boards to provide independent, objective and
professional opinion in the board meetings on matters of importance and
concern to company. All the governance codes recommend a large
proportion of Independent Directors on the company boards and much
depends on how they are appointed, by whom they are influenced and what
financial interest they have in the company.
Dissemination of material Information: To avoid insider trading the
timely and adequate dissemination of material information to the public is
sign of good governance.
Distinction between the role of the Responsibilities of the Board and
Management: Governance standard of the company is basically judged
from the split between the role and responsibilities of the board and
management. The board is expected to steward the company, set the
strategic objectives, provide guidance and judgment independent of
management, and exercise control over the company, remaining all along
accountable to the shareholders in particular and the stakeholders in general.
Disclosure of Remuneration Package : Shareholders, as the owners of the
company have full right to know about the compensation policies and
packages of the directors as well as the executive. Extraordinarily high
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remuneration packages drain the company’s resources at the expense of
shareholders.
Specialized Board Committees : The quality of board increases if some key
decision requiring specialized expertise are entrusted to various committees
constituted by the board. Audit committee is very important to maintain
accountability in the corporate system through supervising and monitoring
of the system of the financial reporting. The specialized committee may
handle such important matters as nomination of directors, accounting
standards and procedures, audit system, reporting system, compensation of
the company executive and the like.
Unethical Business Practices:
The different unethical business practices include issues of Whistle Blowing,
bribes, accepting gifts, Insider trading, conflicts of interest, window dressing etc.
Globally these issue have been In the limelight under Sarbanes-Oxley Act 2002and
nationally SEBI under clause 49 of the listing agreement has taken policy
initiatives avoid the following:
Whistle Blower protection : allow an employee to report illegal activities by
those in position of authority in their company without any treat of backlash.
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Insider Trading : Using price sensitive information by a company
employees or individuals in violation of the fiduciary relationship that exist
with the company to make illegal profits in the transaction of the shares of
that company.
Prohibition of short selling of company shares: No employee or director
should directly or indirectly sell any equity shares including derivatives of
his company if he doesn’t own the share and indulge in short selling.
Bribes/ kickbacks : Corruption should be avoided strictly inside or outside
the company, so that later company should not suffer from any huge losses
which may turn in to scandal.
Conflicts of interest : Avoidance of any situation that would lead to or tend
to lead to any conflicts of interest between personal interest and the interest
of the company, resulting in impairing the exercise of independent
judgment.
Window dressing : The deceptive practice of using accounting tricks to
make company’s balance sheet and income statement appear better than the
reality and the deceptive practice of mutual funds to buy strong stocks
before the year ending to make their holding look impressive.
Funding of expense account/ Misappropriation of funds : Full, fair,
accurate, timely understandable records of the finances without presenting
false bills and incorrect accounts. KPMG’s fraud survey 2002 finds that
majority of cash losses occurs due to misappropriation, forged document,
expense accounts, diversion of funds, kickbacks , secret commission and
false and misleading information.
Misuse of company assets : Using company property, asset or resources for
the benefits of the employee, his/ her relatives or associates / friend is
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prohibited as the same can be used only for legitimate business purpose
only.
Antitrust/ Monopoly activity : Avoid all anti-competitive and unlawful
business practices and discourage corrupt and dishonest means. Avoid
enticing away key employees of competitors to lessen competition, price
fixing, hoarding and black marketing etc.
Hacking: A software designer who illegally enters encrypted sites and
accounts of others through modified software and hardware is highly
unethical.
Misuse of confidential information : Directors and employees must protect
the confidential information entrusted to them by the company, its customers
and all business associates.
Sources:
Market Initiative- CRISIL, a leading credit rating agency developed a yardstick
which help measure the Governance & Value Creation Rating (GVC) of
companies including the Banks.
The assessment is made on the basis of the following-
Governance Process : The Treatment of shareholders, transparency &
disclosures, composition and functioning of Board
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Wealth management : The levels of wealth creation and distribution
among stakeholders and the future wealth creation capacity, wealth being
utilized for the ultimate good of all stake holders in the medium to long
term. The wealth should be shared proportionately and equitably among the
shareholders without resorting to disproportionate sharing methods like
ESOP and Sweat equity.
Regulatory Initiative : All listed companies including banks have to adhere
to the listing agreement, which specifies:
Audit committee: Should include qualified and Independent Directors who
are finance literate and the chairman should be well versed in Management
and Accounts. The appointment and removal of the external auditors should
be decided by them to endure that accounting norms are strictly followed.
Composition of the board : If Non-executive chairman then 1/3rd Board of
Directors should be Independent otherwise ½ of the Board members should
be Non-Executive, Independent Directors. The shareholders should approve
the compensation paid to the Non-Executive Directors.
Code of conduct : the BOD and the senior management should follow this
code.
Legislature Initiative : the companies Act 1956 alone can provide the
statutory backing to the corporate governance standards, which require a
bill to be passed in the parliament. There are two areas that need the
necessary legal support to ensure compliance:
Audit process : A disciplinary mechanism is needed to check the
performance of auditors. Proper process to be laid down for appointment
and qualification of auditors
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Chapter -7
CORPORATE GOVERNANCE IN INDIAN BANKING
SECTOR
Introduction
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Measures taken by Banks and RBI for implementation of best
practices
Needs for corporate governance in banks
Introduction:
Corporate governance of banking institutions is an important issue in the financial
systems of developing economies and the widespread banking reforms. Given the
important financial intermediation role of banks in and economy, their high degree
of sensitivity to potential difficulties arising from ineffective corporate governance
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and the need to safeguard depositors’ funds, corporate governance for banking
organizations is of great importance to the international financial system and merits
targeted supervisory guidance. The Indian economy has seen wide ranging reforms
for over a decade now, covering industry, trade, taxation, external sector, banking
and financial markets. This has strengthened the fundamentals of the Indian
economy and transformed the operating environment for banks and financial
institutions in the country. Banking as a sector has been unique and the interests of
other stakeholders appear more important to it than in the case of non-banking and
non-finance organizations. The corporate governance of banks in developing
economies is important for several reasons. First, banks have an overwhelmingly
dominant position in developing-economy financial systems, and are extremely
important engines growth. Second, as financial markets are usually
underdeveloped, banks in developing economies are typically the most important
source of finance for the majority of firms. Third, as well as providing a generally
accepted means of payment, banks in developing countries are usually the main
depository for the economy’s saving. Fourth, many developing economies have
recently liberalized their banking systems through privatization and reducing the
role of economic regulation.
Measures taken by Banks and RBI for implementation of best
practices:
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Prudential norms in terms of income recognition, asset classification, and capital
adequacy have been well assimilated by Indian banking system. In keeping with
the international best practices, starting 31 march2004, banks have adopted 90 days
norm for classification of NPAs. Also, norms governing provisioning requirements
in respect of doubtful assets have been made more stringent in a phased manner.
Capital adequacy: All the Indian banks barring one today are well above the
stipulated benchmark of 9 percent and remaining in state of preparedness to
achieve the best standards of CRAR as soon as the new Basel 2 norms are made
operational. On the income recognition front, there is complete uniformity now in
the banking industry and the system therefore ensure responsibility and
accountability on the part of the management in proper accounting of income as
well as loan impairment.
ALM and Risk Management Practices- at the initiative of the regulators, banks
were quickly required to address the need for asset liability management followed
by risk management practices. Both these are critical areas for an effective
oversight by the board and the senior management which are implemented by the
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Indian banking system on tight frame and the implementation review by RBI.
These steps have enabled banks to understand, measure and anticipate the impact
of the interest rate risk and liquidity risk, which is deregulated environment is
gaining importance. RBI has taken various steps furthering corporate governance
in Indian banking system. These can be broadly classified in to the three
categories:
(a) transparency
(b) off-site surveillance
(c) Prompt corrective action.
Transparency and disclosure standards are also important constituents of a sound
corporate governance mechanism. Transparency and accounting standards in India
have been enhanced to align with international best practices. Prompt corrective
action has been adopted by RBI as a part of core principles for effective banking
supervision. As against a single trigger point based on capital adequacy normally
adopted by many countries, Reserve bank in keeping with Indian conditions have
set to more trigger points namely non performing asset(NPA) and Return on
asset(ROA) as proxies for asset quality and profitability. These trigger points will
enable the invention of regulator through a set mandatory action to stem further
deterioration in the health of banks showing signs of weakness. The coperate
governance of banks in developing economics is severally affected by political
consideration. Firstly, given the trend towards privatization of government owned
banks in developing economies, there is need for the managers of such banks to be
granted autonomy and be gradually introduced to the corporate governance
practices of the private sector in prior to divestment.
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Needs for corporate governance in banks:
If we examine the need for improving corporate governance in bank two reasons
stand out:
1. Banks exit because they are willing to take on and manage risk. Besides,
with the rapid pace of financial innovation and globalization, the face of
banking business is undergoing a sea-change. Banking business is becoming
more complex and diversified. Risk taking and management in a less
regulated competitive market will have to be done in such a way that
investor’s confidence is not eroded.
2. Even in a regulated set-up as it was in India prior to 1991, some big bank in
public sector and a few in the private sector had incurred substantial losses.
This along with massive failure of non-banking financial companies
(NBFFs), had adversely impacted investor’s confidence.
3. Moreover, protecting the interest of depositors became a matter of
paramount importance to banks. In other corporate, this is not and need not
be so for two reasons: The depositors collectively entrust a very large sum of
their hard-earned money to the care of the banks. It s found that in India, the
depositors contributions was well over 15.5 times the shareholders stake in
banks as early as in March 2001. This is bound to be much more now. The
depositors are very large in numbers and are scattered and have a little say in
the administration of banks. In other corporate, big lenders do exercise the
right to direct the management. In any case, the lenders stake in them might
not exceed 2 or 3 times the owner’s stake.
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4. Banks deal in people’s fund and should, therefore act as trustees of the
depositors. Regulators the world over as recognized the vulnerability of the
depositors to the whims of managerial misadventures in banks and, therefore
has been regulating more tightly than other corporate.
To sum up, the objective of governance in banks should first be protection of
depositor’s interest and then be to “optimize” the shareholders interests. All other
considerations would fall in place once this two are achieved.
Chapter -8
CASE STUDY ON SATYAM SCANDAL
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Satyam Computers services limited was a consulting and an Information
Technology (IT) services company founded by Mr. Ramalingam Raju in 1988. It
was India’s fourth largest company in India’s IT industry, offering a variety of IT
services to many types of businesses. Its’ networks spanned from 46 countries,
across 6 continents and employing over 20,000 IT professionals. On 7 th January
2009, Satyam scandal was publicly announced & Mr. Ramalingam confessed and
notified SEBI of having falsified the account.
Raju confessed that Satyam’s balance sheet of 30 September 2008 contained:
Inflated figures for cash and bank balances of Rs 5,040 crores.
An accrued interest of Rs. 376 crores which was non-existent.
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An understated liability of Rs.1,230 croreson account of funds which were
arranged by himself.
An overstated debtors’ position of Rs. 490 crores. The letter by B RamalingaRaju
where he confessed of inflating his company’s revenues contained the following
statements:
It has attained unmanageable proportions as the size of company operations grew
significantly in the September quarter of 2008 and official reserves of Rs. 8,392
crores. As the promoters held a small percentage of equity, the concern was that
poor performance would result in a takeover, thereby exposing the gap. The
aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with
real ones. It was like riding a tiger, not knowing how to get off without being
eaten.”
The Scandal:
The scandal all came to light with a successful effort on the part of investor’s to
prevent an attempt by the minority shareholding promoters to use the firm’s cash
reserves to buy two companies owned by them i.e. Maytas Properties and Maytas
Infra. As a result, this aborted an attempt of expansion on Satyam’s part, which in
turn led to a collapse in price of company’s stock following with a shocking
confession by Raju. The truth was its’ promoters had decided to inflate the revenue
and profit figures of Satyam thereby manipulating their balance sheet consisting
non-existent assets, cash reserves and liabilities.
The probable reasons:
Deriving high stock values would allow the promoters to enjoy benefits allowing
them to buy real wealth outside the company and thereby giving them opportunity
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to derive money to acquire large stakes in other firms on another hand. After the
scandal, on 10 January 2009, the Company Law Board decided to bar the current
board of Satyam from functioning and appoint 10 nominal directors. On 5th
February 2009, the six-member board appointed by the Government of India
named A. S. Murthy as the new CEO of the firm with immediate effect. The board
consisted of:
1) Banker Deepak Parekh.
2) IT expert KiranKarnik.
3) Former SEBI member C Achuthan S Balakrishnan of Life Insurance
Corporation.
4) Tarun Das, chief mentor of the Confederation of Indian Industry and
5) T N Manoharan, former President of the Institute of Chartered Accountants
of India.
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CONCLUSION
Finally I can conclude that compliance of corporate governance is
high among the Indian banks, however the composition of board should be
effective.
From my point of view the awards and the rewards for the corporate initiative
among Indian banks both public and private, can create the right momentum to
change the mind set of banks and ensure that the international norms like Basel are
followed in both letter and spirit, resulting in improved transparency,
accountability and competitive performance in the economy, that could help derive
fully the socio economic benefits of good corporate governance.
Banking is clearly a very special sub set of corporate
governance with much of its management obligations enshrined in law or
regulatory codes. The corporate governance of banks has an important role to play
in assisting supervisory institution to perform their task, allowing supervisors to
have a working relation with bank management, rather than adversarial one.
With the element of good corporate governance, appropriate
internal control system, better credit risk management, focus on newly emerging
business like micro finance, better customer service and proactive policies, banks
will definitely be able to grapple with these challenges and convert them in to
opportunities.
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So corporate governance is not only useful in banks but also useful in companies,
industries, firms, institutions etc. so as to have good relations with the customers
and to run their businesses in successive manner considering future prospect.
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RECOMMENDATIONS
It is also relevant to note that governance or lack of it has affected all agencies of
government. We have to set right all governance, not just corporate governance. In
today’s world a company cannot run to achieve results in a cost effective manner
and stay competitive unless we fix governance problem wherever they exist. What
is at stake not only the integrity of market mechanism but the survival of
democracy in India.
Corporate houses including banks are also taking measure to highlight the
importance of corporate governance and ethical business practices among the
future managers in reputed management institutes like Larsen and Turbo (L&T)
Ltd. has endowed a chair for business at the management center for human values
at IIMC.
The government bodies honor the select corporate for their exemplary
initiative in areas of corporate governance and ethical business practices and many
more awards and accolades should be given. Finally I suggest that scandals like
satyam case which became the major economic downturn and finally ended by
arresting mr. Raju for his fraud against the company, should not take place again
due to which corporate governance may suffer from negative effects.
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BIBLOGRAPHY
BOOKS:
Corporate governance-(Authors) H. R.
Machiraju,Keshoprasad,N Gopalsamy
WEBSITES:
www.corporate governance.com
SEARCH ENGINE
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