Project on Corporate Governance

8/6/2019 Project on Corporate Governance

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CORPORATE GOVERNANCE

Good business practice is no longer just about ensuring the absence

of any red ink in the annual report. It isnt just about keeping theultimate owners of the enterprise, the shareholders, happy.

Today, if an organization has to survive and thrive in acommercial environment that is becoming increasinglyglobal in its outlook, it has got to factor in the interests andconcerns of every stakeholder in the business. And thatincludes not just the shareholder, but also the domestic andglobal customer, the vendor, the creditor, the lawmaker, the

community in which the enterprise operates, andenvironmental groups.

It is in this context that corporate governance has assumedgreater significance, particularly with companies that areseeking to establish a global footprint.

The deep-rooted belief that as long as the performance isgood, corporate governance is not an issue of greatsignificance has outlived its relevance in view of the periodic

crises experienced the world over in recent times.

It has now been widely recognised that outstandingperformance, higher profits and expanded reach, nothing actas safeguards for a company when good governance andethics are at back burner.

There is ample evidence to establish that a singlewrongdoing is enough to ruin the reputation of a company, ittook ages to build, while the culture of strict adherence to

good governance practices keeps them ahead onsustainable basis.


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Definitions of Corporate Governance

Corporate governance is the set of processes, customs,

policies, laws, and institutions affecting the way acorporation (or company) is directed, administered orcontrolled. Corporate governance also includes therelationships among the many stakeholders involved and thegoals for which the corporation is governed. The principalstakeholders are the shareholders, management, and theboard of directors. Other stakeholders include employees,customers, creditors, suppliers, regulators, and thecommunity at large.

Corporate Governance is concerned with holding the balancebetween economic and social goals and between individualand communal goals. The corporate governance frameworkis there to encourage the efficient use of resources andequally to require accountability for the stewardship of thoseresources. The aim is to align as nearly as possible theinterests of individuals, corporations and society. ( Definitionby Sir Adrian Cadbury in 'Global Corporate Governance

Forum', World Bank, 2000 )

Corporate governance is about the whole set of legal,cultural, and institutional arrangements that determine whatpublic corporations can do, who controls them, how thatcontrol is exercised, and how the risks and return from theactivities they undertake are allocated. ( As said byMargaret Blair , Professor of Law, Vanderbilt University Law

School )

Good corporate governance is characterized by a firm commitmentand adoption of ethical practices by an organization across its entirevalue chain and in all of its dealings with a wide group ofstakeholders encompassing employees, customers, vendors,
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regulators and shareholders (including the minority shareholders),in both good and bad times

C ommonly Accepted Principles of Corporate

Governance

1. Rights and equitable treatment of shareholders:Organizations should respect the rights of shareholders andhelp shareholders to exercise those rights. They can helpshareholders exercise their rights by effectivelycommunicating information that is understandable andaccessible and encouraging shareholders to participate ingeneral meetings.

2. Interests of other stakeholders: Organizations shouldrecognize that they have legal and other obligations to alllegitimate stakeholders.

3. Role and responsibilities of the board: The board needsa range of skills and understanding to be able to deal withvarious business issues and have the ability to review andchallenge management performance. It needs to be ofsufficient size and have an appropriate level of commitmentto fulfill its responsibilities and duties. There are issues aboutthe appropriate mix of executive and non-executive directors.

4. Integrity and ethical behaviour: Ethical and responsibledecision making is not only important for public relations, butit is also a necessary element in risk management andavoiding lawsuits. Organizations should develop a code ofconduct for their directors and executives that promotesethical and responsible decision making. It is important tounderstand, though, that reliance by a company on theintegrity and ethics of individuals is bound to eventual failure.Because of this, many organizations establish Compliance

and Ethics Programs to minimize the risk that the firm stepsoutside of ethical and legal boundaries.5. Disclosure and transparency: Organizations should clarify

and make publicly known the roles and responsibilities ofboard and management to provide shareholders with a levelof accountability. They should also implement procedures toindependently verify and safeguard the integrity of the
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company's financial reporting. Disclosure of material mattersconcerning the organization should be timely and balanced toensure that all investors have access to clear, factualinformation.

CORPORATE GOVERNANCE CONCERNS IN INDIA

1. Independent directors need significant empowerment :Many Indian companies operate in a family-ownedculture. There has been an implicit assumptionamongst boards that senior managers know their joband have the best interests of companies they manageat heart. This has sometimes resulted inboardsrefraining from asking the difficult questions to

senior managers when the company has beenperforming well or until there is a crisis.

Solution:Adoption of a formal and transparent process for directorappointments. The conflict of interest involved inmanagements appointing independent directors should betackled through nomination committees (comprisingindependent directors) for identification of directorial

candidates.

2. Principle of trusteeship - appropriate protection forminority shareholders : As minority shareholders do not havea complete understanding of their rights or the avenuesthrough which these rights could be exercised, increasedactivism from institutional shareholders and reinforcing therole of independent directors on the board is likely to takeshape in the near future.

In the context of meeting expectations of stakeholdersbeyond the minority shareholders (eg. employees,customers, vendorsetc.) a number of initiatives need to be embraced such as:


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Informative Management Discussions and Analysisdisclosures that focus on improving level of detail aroundoperations and key risks Openness and transparency in dialogue with shareholders

Objective and transparent whistle blower policies that areavailable to key stakeholders (employees, customers andvendors)and provide adequate safeguards against victimisation ofwhistle blowers Have minority shareholders representatives on boards asindependent directors.

3 Committees of boards may not have high effectiveness: In present times, companies have numerous

committees of the board such as ESOP Committee,Audit Committee, Remuneration Committee, RiskManagement Committee etc. There is a need forestablishing a framework around the functioning ofcommittees of boards so that their effectiveness isdemonstrated.

4. Quality of Management Discussion and Analysis in

annual reports : Quality of Management Discussion andAnalysis (MD&A) , which highlights the structure,developments, opportunities, threats, concerns, etc, ofthe company is moderate

5. Audit committee skill-sets may need to beenhanced :Audit committees, largely comprisingindependent directors, are entrusted with theresponsibility of ensuring the integrity of the companysfinancial statements, managing risks through internalcontrol system and functioning of its internal auditfunction and regulatory compliance. While it is the dutyof all directors to act in the interests of the company,the audit committee, which acts independently ofexecutive management, has a specific responsibility ofacting in the interests of stakeholders through effective


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oversight of the companys financial reporting and itsrisk management and internal control systems.

Companies should address the challenges that their audit

committees face and focus on enhancing skills in some ofthe most important areas listed below: Better understanding of risk, strategy and business models Understanding implications of the external environment onfinancial forecasts and performance Comprehend complex accounting policies and practices how their application impacts results Monitoring fraud risk especially relating to seniormanagement override of internal controls Effective oversight of internal and external auditors

Ensuring that the boards strategic direction is in the bestinterest of all including minority shareholders Evaluation of audit committee and its members based onan established framework for its functioning.

All these informations regarding Corporate Governance concerns inIndia are according to a poll The State of Corporate

Governance in India: 2008, conducted by KPMG in IndiasAudit Committee Institute.The poll, conducted between lateNovember 2008 to early January 2009, involved over 90respondents comprising CEOs, CFOs, independent directorsand similar leaders, who were asked about the journey,experience and the outlook for corporate governance inIndia. The respondents are predominantly from privateequity firms, financial services and the manufacturing sector.


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SATYAM SCANDAL AND CLAUSE 49 REVIEW

Satyam Computers, the fourth largest IT industry of India, Themember of Nifty 50, BSE Sensex, winner of golden peacock awardfor best corporate governance, and many more laurels that it has in

its kitty did not stop it from drowning like a rock in its dirty waters.

The Satyam Computer Services scandal was publiclyannounced on 7 January 2009, when Chairman RamalingaRaju confessed that Satyam's accounts had been falsified.Ramalinga Raju of Satyam computers, confessed in a fourpage letter, stating that the accounting books of Satyam hadbeen hugely inflated and that the company did not have thatmuch of money as it was showing.

About $1 billion, or 94 per cent of the cash, on the company's bookswas fictitious and manipulation of the cash flow may be a reasonwhy the fraud was undetected (as said by Ramalinga Raju )

Auditors generally assume if there is cash, things are OK. But thereare plenty of accounting and governance loopholes.

It was after a rare revolt by minority shareholders whoobjected to Raju's plan to drain Satyam's cash reserves to buy two

property companies run by his sons that brought Satyam down

New York-listed Satyam did everything by the rulebook, with aninternational firm auditing its books, declaration of accounts inaccordance with Indian and U.S. standards, and the requisitenumber of independent directors with excellent credentials,including a Harvard business school professor and a former federal
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cabinet secretary.

Regulators were blindsided, and analysts and experts said there are"systemic flaws" in accounting and audit practices.

Considering the role of independent directors in the light of theSatyam scam, Mr. Madhav Mehra (President of London based WorldCouncil for Corporate Governance) said that there is need fordirectors with independent minds. There is a need for independentboards. The independent directors are not bothered about anythingas long as they get salaries. That is why the Satyam fraudhappened.

He further said: "There are people who are directors of 15companies. How can you be an independent director of 15companies? People have not been able to understand therole of corporate governance."

All these deficiencies and loopholes forced SEBI to tightenrules for accounting and corporate governance, includingappointment of independent directors by selectioncommittees, and greater oversight from regulatory andgovernment authorities.

Clause 49 of the Listing Agreement

Every company wishing to list its securities on a stockexchange has to sign an agreement with the latter, calledthe Listing Agreement. It has 51 clauses. These deal with

various guidelines on listing and responsibilities of thecompany management. Clause 49, one of the longest, dealswith corporate governance. It lists mandatory and non-mandatory norms for companies to comply with.

With a view to promote and raise the standards of CorporateGovernance, SEBI on the basis of recommendations of the


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Committee for Corporate Governance under the Chairmanship ofShri N.R. Narayan Murthy and public comments received on thereport submitted by the Committee and in exercise of powersconferred by Section 11(1) of the Securities and Exchange Board of

India Act, 1992, revised the existing clause 49 of the Listingagreement vide its circular SEBI/MRD/SE/31/2003/26/08 datedAugust 26, 2003.

Important Highlights Of Revised Clause 49

Schedule of Implementation

The circular specifies following schedule of implementation of therevised clause 49 :

(i) All entities seeking listing for the first time, at the time oflisting,

(ii) All listed entities having a paid up share capital of Rs 3 croresand above or net worth of Rs 25 crores or more at any time inthe history of the company.

1. Widening the Definition of IndependentDirector

Under the revised clause 49, the definition of the

expression independent director has been expanded. The expression independent director mean non-executive director of the company who

(a) apart from receiving directors remuneration, doesnot have any material pecuniary relationships ortransactions with the company, its promoters, its seniormanagement or its holding company, its subsidiariesand associated companies;

(b) has not been an executive of the company in theimmediately preceding three financial years;

(c)is not a partner or an executive of the statutory audit firm orthe internal audit firm that is associated with the company,and has not been a partner or an executive of any such firmfor the last three years. This will also apply to legal firm(s) and


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consulting firm(s) that have a material association with theentity.

2. Compensation to Non Executive Directors and Disclosurethereof

As per earlier clause 49, the compensation to be paid to non-executive directors was fixed by the Board of Directors, whereasthe revised clause requires all compensation paid to non-executivedirectors to be fixed by the Board of Directors and to be approvedby shareholders in general meeting. Placing the independentdirectors and non-executive directors on equal footing, the revisedclause provides that the considerations as regards compensationpaid to an independent director shall be the same as those appliedto a non-executive director. The companies have been put under

an obligation to publish their compensation philosophy andstatement of entitled compensation in respect of non-executivedirectors in its annual report.

3. Periodical Review by Independent Director The revised clause 49 requires the Independent Director toperiodically review legal compliance reports prepared by thecompany and any steps taken by the company to cure any taint.

4.NonExecutive Directors Not to hold office formore than Nine Years

Revised clause 49 limits the term of the office of the non-executive director and provides that a person shall beeligible for the office of non-executive director so long asthe term of office does not exceed nine years in threeterms of three years each, running continuously.

5. Audit Committee

Two explanations have been added in the revised clause49. The first explanation defines the term financiallyliterate to mean the ability to read and understand basicfinancial statements i.e. balance sheet, profit and lossaccount, and statement of cash flows. It has also beenclarified that a member is considered to have accountingor related financial management expertise if he or she


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possesses experience in finance or accounting, orrequisite professional certification in accounting.

6. Disclosure of Accounting Treatment

The revised clause 49 requires that in case a company hasfollowed a treatment different from that prescribed in anAccounting Standards, the management of such companyis required to clearly explain the alternative accountingtreatment in the footnote of financial statements.

7. Whistle Blower Policy

Companies have been required to formulate an InternalPolicy on access to Audit Committees. Personnel whoobserve any unethical or improper practice (not

necessarily a violation of law) can approach the AuditCommittee without necessarily informing theirsupervisors.Companies have also been required to affirm that it hasprovided protection to whistle blowers from unfair terminationand other unfair or prejudicial employment practices.

8. Report on Corporate Governance

The companies have been required to submit a quarterlycompliance report in the prescribed format to the stockexchanges within 15 days from the close of the quarter.

The report has to be submitted either by the ComplianceOfficer or the Chief Executive Officer of the company afterobtaining due approvals.

9. Company Secretary in Practice to Issue Certificateof Compliance

This is a landmark amendment authorizing CompanySecretaries in Practice among other professionals to issuecertificate of compliance of clause 49. The revised clauserequires the company to obtain a certificate from eitherthe auditors or practicing company secretaries regardingcompliance of conditions of corporate governance and


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annex the certificate with the directors report, which issent annually to all the shareholders of the company.

The revised clause 49 of the Listing Agreement providesmuch needed disclosure requirements, widened definitionof independent director, periodical review by independentdirector, whistle blower policy, quarterly compliance reportin the prescribed format and issue of certificate ofcompliance. Hence it can be said that the revised clause49 would go a long way in providing corporates goodgovernance framework.


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ACGA White Paper on Corporate Governance

The Asian Corporate Governance Association (ACGA), basedin Hong Kong, had released a 55-page white paper on Indiancorporate governance , which suggests that many of theconditions that helped facilitate Raju's $2.5 billion fraud stillexist, despite efforts to reform.

According to ACGA critical areas of corporate governance weresidestepped in spite of the reforms enacted in recent years.

The report draws on the views of more than a dozen foreigninstitutional investors, like the California Public Employees'

Retirement System, auditors, like KPMG, and law firms, likeWhite&Case.

The White Paper is of importance for two reasons. First, it seeks tosupplement the existing reform process in India that is alreadyunderway and one that has culminated, at least for the moment,with the issue of the Corporate Governance Voluntary Guidelines2009 by the Ministry of Corporate Affairs. Second, and moreimportantly, it side-steps most of the conventional issues that have

inundated the corporate governance discourse in India recently andoffers some different perspectives, like a whiff of fresh air.

The goal of the effort is set out as follows:

The aim of the India White Paper is to provide officials,financial regulators, listed companies, investors and otherswith constructive and detailed suggestions for thebroadening and deepening of sound corporate governance inIndia. While India has undertaken numerous reforms in

corporate governance over the past decade, especially in thearea of company boards, independent directors anddisclosure and accounting standards, certain critical areasremain to be addressedparticularly relating to theaccountability of promoters (controlling shareholders), theregulation of related party transactions, and the governanceof the audit profession.
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The White Paper states that despite wide-ranging developments inregulation and policy, what becomes apparent in India is that thereform process has not addressed, or effectively addressed, a key

challenge at the heart of the governance problem, namely theaccountability of promoters to other shareholders. In other words,this is recognition of the fact that a large number of governanceproblems in Indian companies are related to the position ofcontrolling shareholders or promoters relative to that of minorityshareholders. The White Paper finds that the overwhelming focuson board reforms is misplaced and is not adequate to deal withthese problems.

In this context, relying largely on independent directors

(appointed by controlling shareholders), independent boardcommittees and greater corporate disclosure as the primarymechanisms to check abuses of power by promoters and tosafeguard the interests of minority shareholders is likely toprove weak and insufficient (as indeed it did in the Satyamcase). Board reform is fundamentally important, and is amajor issue of concern to institutional investors, but it needsto be complemented by other regulations that directlyaddress the relationship between controlling and minority

shareholdersin other words, a proper regime for theregulation of related-party transactions.

According to ACGA some of the issues which needs to beurgently addressed are as follows :-

1. Controlling shareholders have too much power, asituation which roots in Indian culture and the nation'scorporate regulations. Many Indian businesses arerooted in old family empires run by men who are happy

to take money from public shareholders but loathe tocede control. As a result, minority shareholders andindependent directors often have little real power. That,plus inadequate regulation and lax oversight, meanscontrolling shareholders can often manipulate a publiccompany for their personal profit, What is required is a


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balance of power between the promoters and othershareholders .

ACGA argues that one good way to fix the problem is toempower institutional investors. It was, after all, a rarerevolt by minority shareholders who objected to Raju'splan to drain Satyam's cash reserves to buy two propertycompanies run by his sons that brought Satyam down.

2. Selective disclosure of information by management,poor quality financial reporting and the absence ofmeaningful punishment for flouting the law remain seriousproblems.

Poor disclosure rules mean investors don't necessarilyknow what a company's holdings are and give controllingshareholders scope to abuse corporate linkages by, forexample, overpaying for the assets of a private companythey also own.

The Indian regulators have implemented some reforms,like requiring greater disclosure of the holdings ofcontrolling shareholders and any pledging of those shares.

3. Voting by show of hands, the norm in India, gives everyinvestor one vote, irrespective of the number of shares heor she owns. Proxies for foreign investors aren't allowed tovote by hand count or speak at shareholder meetingsunder Indian law.

4. ACGA calls for changes to shareholder meetings.Investors want earlier notification of meetings and to be ableto instruct their proxies to speak at the gatherings.

5. Annual meetings are often held in out of the way places( for instance, ICICI Bank, India's largest private sector bank,holds its meetings in Baroda, a small city in Gujarat ) andweak representation at shareholder meetings meansminority investors "did not have a voice".


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6. Audits require closer scrutiny by both accountants andcompany management and the audit profession is highlyfragmented and hamstrung by regulations that protect thesmall firm at the expense of the market .

In order to tackle the issues recommended by ACGA, theMinistry of Corporate Affairs released a set of voluntaryguidelines on Corporate Governance.


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CORPORATE GOVERNANCE VOLUNTARY GUIDELINES 2009

The Ministry of Corporate Affairs in India had released aset of voluntary guidelines on Corporate Governance .It

was released at the conclusion of the first-ever IndiaCorporate Week ( 14 21 December ). The guidelinesincorporate all Ten Principles of the United Nations GlobalCompact.

The Ministry of Corporate Affairs after examining thecommittee reports as well as suggestions received fromvarious stakeholders on issues related to corporategovernance released the guidelines. Keeping in mind that

the subject of corporate governance may go well beyond theLaw and that there are inherent limitations in enforcingmany aspects of corporate governance through legislative orregulatory means, it has been considered necessary that aset of voluntary guidelines called Corporate Governance-Voluntary Guidelines 2009 which are relevant in thepresent context, are prepared and disseminated forconsideration and adoption by corporates.

These guidelines provide for a set of good practices whichmay be voluntarily adopted by the Public companies. Privatecompanies, particularly the bigger ones, may also like toadopt these guidelines. The guidelines are not intended tobe a substitute for or addition to the existing laws but arerecommendatory in nature.

After taking into account the experience of voluntary

adoption of these guidelines by the corporates andconsideration of relevant feedback, the Governmentwould initiate the exercise for review of these guidelinesfor further improvement after one year.


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The CGV Guidelines suggest guidelines with reference to thebelow:

I Board of Directors A. Appointment of Directors

B. Independent Directors

C. Remuneration of Directors

II Responsibilities of Board A. Training of Directors

B. Quality Decision Making

C. Risk Management

D. Evaluation of Performance ofDirectors

E. Board to ensure complianceof law

III Audit Committee A. Constitution

B. Powers

C. Roles and Responsibilities

IV Auditors A. Appointment

B. Certificate of Independence

C. Rotation of Auditors

D. Clarity of Information

E. Internal AuditorV Secretarial Audit

VI Whistle BlowingMechanism


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Some of the guidelines are as follows:

I. BOARD OF DIRECTORSA. APPOINTMENT OF DIRECTORSA.1 Appointments to the Board(i) Companies should issue formal letters of appointment to Non-Executive Directors (NEDs) and Independent Directors - as is doneby them while appointing employees and Executive Directors. Theletter should specify:

The term of the appointment; The fiduciary duties that come with such an appointment

alongwith accompanying liabilities; The list of actions that a director should not do while

functioning as such in the company; and The remuneration, including sitting fees and stock options

etc., if any.(ii) Such formal letter should form a part of the disclosure toshareholders at the time of the ratification of his/her appointment

or re-appointment to the Board.A.2 Separation of Offices of Chairman & Chief Executive Officer To prevent unfettered decision making power with a singleindividual, the roles and offices of Chairman of the Board and thatof the Managing Director/Chief Executive Officer(CEO) should beseparated, as far as possible, to promote balance of power.A.3 Nomination Committee(i) The companies may have a Nomination Committee comprisingof majo-rity of Independent Directors, including its Chairman. ThisCommittee should consider:

proposals for searching, evaluating, and recommendingappropriate Independent Directors and Non-ExecutiveDirectors [NEDs], based on an objective and transparent setof guidelines.

determining processes for evaluating the skill, knowledge,experience and effectiveness of individual directors as well asthe Board as a whole.

(ii) With a view to enable Board to take proper and reasoneddecisions, Nomination Committee should ensure that the Board

comprises of a balanced combination of Executive Directors andNon-Executive Directors.(iii) The Nomination Committee should also evaluate andrecommend the appointment of Executive Directors.A.4 Number of Companies in which an Individual may become aDirector(i) For reckoning the maximum limit of directorships, the followingcategories of companies should be included:

public limited companies,

private companies that are either holding or subsidiarycompanies of public companies.-


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Conclusion

Good corporate governance helps an organization achieveseveral objectives and some of the more important onesinclude:

Developing appropriate strategies that result in theachievement of stakeholder objectives

Attracting, motivating and retaining talent

Creating a secure and prosperous operating environmentand improving operational performance

Managing and mitigating risk and protecting andenhancing the companys reputation.

Good corporate governance practices are a sine qua non forsustainable business that aims at generating long term valueto all its shareholders and other stakeholders. It is strong

fundamentals and ethical behavior in a company that canhelp it overcome huge crisis. Compliance with goodgovernance practices should not be regarded as regulatoryrequirement but rather as an opportunity and valueproposition for organisations. Investors all around the worldnotice companies with clean governance, and thisappreciation leads to higher valuation of such organisation.

Some positive steps towards improving CorporateGovernance:

Codes of conduct and whistle blower policies areimportant, but more important is how they arecommunicated and practiced. It is vital for board membersand senior management to lead by example.


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Documents

Project on Corporate Governance