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Effective Corporate Governance :
Role of Board of Directors
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The primary goal of a corporation is to
maximise the shareholders wealth in a
legal and ethical manner.
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Players
The shareholders : invest the capital
The directors : answerable to shareholders
The management : runs the company and is
answerable to the directors.
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Role of Board of Directors
BoD = governs the Company
within
the limits oflaw
and
decency.
BoD directs but not manages the affairs of the Company.
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Corporate Governance = system of making
directors accountable to shareholders for
effective management of the company inthe best interest of the company and
shareholders along with concern for ethics
and values.
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I would like to speak to you briefly about corporate governance atAlcan. In the current environment, shareholders of publiccorporations must inform themselves about their company'sgovernance practices.
Alcan has always been committed to be and remain a leader in thisarea. The Board believes that this commitment is essential toAlcan's success and to its ability to enhance Shareholder value.Allow me to give you three examples of our leadership in this area:
(1) the roles of Chairman and CEO were separated in 1995
well before this practice became a fundamental precept ofcorporate governance;(2) also, since 1995, Alcan's Board has been composedentirely of unrelated Directors with the exception of the CEO,and(3) the involvement of the fully-independent Audit
Committee of the Board in the audit of the Company and inits financial reporting, became a practice long before itbecame best practice in the corporate world.
From an address by L. Yves Fortier, Chairman of theBoard, Alcan Inc. to the 101st Annual General Meeting of
Shareholders, Montreal, Canada
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Board of Directors : constituents
Executive Directors
Independent (Non executive) Directors
Nominees of Financial Institutions
Various committees : audit, compensation,
etc
Company Secretary
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BoDits role
Monitor: By acting thro its committees,
Board can keep abreast of developments
inside and outside the corporation, bringingto the managements attention
developments it might have overlooked.
A Board should atleast carry out this task.
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BoDits role
Evaluate and influence : A Board canexamine management proposals, decisions
and actions, agree or disagree with them,give advice and offer suggestions, outlinealternatives.
More active Boards perform this task inaddition to the monitoring one.
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BoDits role
Initiate and determine : A Board can dileate
a corporations mission and specify options
to its management.
Only the most active Boards take on this task
in addition to the two previous ones.
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BoD : its responsibilities
Setting corporate strategy, overall direction,
mission or vision.
Hiring and firing the CEO and top management. Controlling, monitoring or supervising top
management.
Reviewing and approving the use of resources. Caring for shareholders interests.
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What will BoD do to fulfill its
duties ? Ensuring prudent management of the assets
Selecting and appointing the chief executive
Delegating all duties of management notspecifically reserved to the boards
Reviewing and appraising the performance
of the chief executive and other executivedirectors
Reviewing its own performance
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What will BoD do to fulfill its
duties ? Reviewing strategies and policies
Discussing thoroughly any action that might
have a significance impact on the future ofthe company
Approving auditors and other advisors
Ensuring the company stays within law Reviewing the compensation paid to senior
officers in the company.
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What is never a problem, difference lies in
how part that makes the board effective.
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Todays forces in which the Boards operate :
Deregulation : competitive market
Disintermediation: financial sector reforms, depend
on market for capitalInstitutionalisation : Institutionalisation of capital
markets
Globalisation : higher standards of disclosure and
corporate governanceTax reforms: Tilted the balance away from black
market transactions
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What went wrong at Tata Finance Ltd
Please go through the case provided and think
on following lines of BoDs role:
Monitor :
Evaluate and influence :
Initiate and determine :
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Role of Board : industrial
economy vs developing economy Legal framework and information system is
transparent
Financial markets are developedvs
Oriental value system
Social hierarchy acting as a deterrent to
professionalism in Board Encourages passive or indifferent or reluctant
participation in guiding commercial destiny ofcompany.
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In a study conducted of 246 central public
sector Boards, it was found :
1. 40% had more than 50% slots vacant.
2. 49% had vacancy between 20-50% slots.
3. 40% of Boards did not appoint any sub
committees
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4. Instead of optimal size of 12, it was 7.
5. Instead of average 12 meetings a year, it
was 7.6. 40% boards did not have any sub
committees.
and so on
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A study conducted at select 30 large Indian public
corporations inferred that :
Profits have no relation with the kind of Corporategovernance model followed in the samplecompanies.
Directors in most of the companies are foundineffective in monitoring the managements
performance.
Better corporate governance is driven bycollective conscious and not by stakeholdersdemands or market forces.
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Changes expected in Boards of
India: Independence of Directors
Agenda setting
Quality of debate
Providing direction
Developing strategic thinking
Moderating companies growth path Communicating with shareholding and non
shareholding constituencies
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In India, more often than not, if the Board is
active, it is occupied with operating and not
strategic decision making.
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What went wrong at Tata Finance
LtdLet us now discuss the case based on these
three roles of BoD.
Monitor :
Evaluate and influence :
Initiate and determine :
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Important issues related to BoD
Structure of Board :
Process of review :
Culture :
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Legal requirements:
Indian Companys Act, 1956 provides for :
Legal rights to shareholders :
a. Vote on every resolution placed before AGM
b. Elect Directors
c. Determine remuneration of Directors and CEOd. Removal of Directors
e. Appoint auditors to provide an external check onfinancial statements.
f. Take active part in AGM
SEBI (1992) had made certain recommendationswhich has impacted directly corporate
governance.
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Category of Directors:
Promoter
Executive
Non executive
Independent non executive : directors with
no business relationship with the company.
Nominee
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Ideal board:
Optimum combination of executive and nonexecutive directors
Not less than 50% of the Board consisting of nonexecutive directors
If non-executive Chairman, atleast one third of theBoard be Independent directors
If executive Chairman, atleast 50% of the Boardbe Independent directors
from Kumarmangalam Birla (SEBI) Report
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Ideal board:
Directors should have:
Integrity
Sense of accountability
Track record of acheivements
Ability to ask tough questions
Financial literacy
Ability to think strategically
Commitment to the company
Can represent maximum 10 Boards instead of 20from Kumarmangalam Birla (SEBI) Report
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Ideal board:
Nominees of Financial Institutions
Appointment on selective basis where such
appointment is considered necessary to protectthe interests of the institution or where it is a
right under loan agreement.from Kumarmangalam Birla (SEBI) Report
Id l b d
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Ideal board: Role of Chairman
To ensure Board works both as governance and as a
contributor to policy and growth. Maintain relation with institutional shareholders,
government, media and business
Collaborates the overall design of policy, encouragesgrowth and development.
vs
Role of CEO Developing the bottomline
Maintain operational control Proposing and implementing policy
Leading the operational team
Can same person hold both the position ?
from Kumarmangalam Birla (SEBI) Report
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Creating the right structure by inductingprofessionally acclaimed people who can:
Evaluate and comment. (eg Orchid Chemicals)
Contribute in critical areas. (eg Marico)
Independent from the management (eg Hughes)
Give good counsel (eg HLL)
Build the brand equity (eg Goenka)
Build up overall expertise (eg Mahindra and Mahindra)
Complement the expertise of Board (eg Godrej)
Market the company (eg Infosys)
Provide right kind of diversity
Provide adequate time
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Creating the right structure by inductingprofessionally acclaimed people :
Supervisory or advisory boards
Independence vs knowledge
Past CEOs even on joining as independent directors
think and act like management !
From across spectrum of background to bring
in new perspective
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Examples
L&T : 3 insiders vs 7 outsiders
ITC : 4 insiders vs 9 outsiders
Hughes : 1 insider vs 10 outsiders
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Important issues related to BoD
Process makes perfect :
- Process of regularly reviewing, aligning and, if needed,adding and removing talent and expertise on its Board.
- Individual accountability
- Fluid portfolio of roles
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A survey of 200 CEOs in 2001 serving as outside
directors of public firms found :
1. 63% of the boards they serve have never been
subjected to performance evaluation.
2. 42% of their own companies, where they are CEOs,
have never done a board evaluation.
A Korn/Ferry study of board directors in 2001
found that :
1. 67% of the boards regularly evaluate the CEOs.
2. 42% assess the Board performance.
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Examples
Once every three years, every Director on theBritish Airways Board is expected to submit apeer group review to the Chairman.
Independent Director signs KRAs to be achieved.
Pepsico Board spends one full day of each Boardmeeting to look in depth at the strategic challengesof each business unit.
Home Depot Board members are expected to visit8 stores outside their home states between each
board meeting.
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Murugappa groupEach Director mentors
few managers out of the list of 100 fast
track managers. Annual reviewsInfosys and Dr Reddys
Lab
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Important issues related to BoD
Culture :
Culture of openness
Culture of open dissent
Culture of trust and candour
Intellectually stimulating
Training
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Some examples:
Groupthink ?????
In Enron, Rebecca Mark and Clifford Baxterresigned as they were not comfortable with the
paths the Company had taken.
Walter Hewlett was the lone dissenter in themerger of HP with Compaq.
At Tycono body questioned the millions oddollar lent to the CEO.
Medtronicpharma companylone dissenterconvinced the Co not to get out of angioplasty
business.
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ICICI BankMiddle level managers makepresentatiion to the Board
Some of the most exciting times that I have
had as an independent director have been onthe Board S Ganguly, one of the formerICICI Bank Directors.
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Independent Directors
Clarion call for independent Directors
Expected to participate actively in auditcommittees
Part of non statutory advisory or superevisoryBoard
Proposed amendments seek to expand the scope of
their responsibilities. Eg, they have to periodically review legal compliance
reports prepared by the Company and the steps taken tocure any taint.
For NASDAQ/NYSE listed companies, every director
of a audit committee is expected to be independent.
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Examples:
Supervisory Boards :
no restriction on payment (BoD members are
paid sitting fee of Rs 5000.00 per Boardmeeting and the Board shares upto 1% of the
profit).
Utilise their expertise better.
Eg, Orchid Chemicals has a scientific
advisory Board.
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Please go through the handout detailing Maricos
BoD.
Harsh Mariwala reconstituted his Board in mid2002. He put the structure ahead of Directors.
Marico identified four critical areas where
Directors could contribute and spent close to 7months in finalising the Board.
FMCG strategy
Entrepreneurial wisdom Technology
finance
Can you identi fy who fi ts in which slot ?
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BoDs role : from active to passive
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Corporate governance and public
enterprises
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Public Sector Enterprise:
Monopoly environment for 40 years.
Protected from vissitudes of market.
State is the biggest shareholder. Board is beset by :
Political interference
Political appointeesLow expectation of performance
General apathy
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Is there a lack of understanding of the role
that Board could play in public enterprises ?
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What are some progressive
Boards saying about their roles ?ONGC:
1. Visioning
2. Strategising3. Promote business
4. Ensure long-term growth
5. Add value in large investment decisions
6. Technology upgradation
7. Encourage creativity
8. Value-based business
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Question : Can you tell us Board composition
at ONGC ?
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Question : How Board has helped in guiding
ONGC in market driven economy.
Answer : Can you tell us ?
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Transformational vs
Transactional leadershipmotivate performance through empowerment
vs
Management through command & control.
Transformational Board : creating and
sustaining an environment that delivers.
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Please go through the BBC report on US 64
debacle.
Do you notice that this is a extremely apt case
of corporate misgovernance.
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Whistleblower
What should you (a Director) do if awhistle-blower comes to you with
allegations that the company, orone or more of its officers, iscooking the books or misbehaving
in some other way?
Whi tl bl
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Whistleblower
- Worldcom inflated its income figuressince 1999 by as much as $9bn
Dy Vice President of Internal Audit deptacted as the whistleblower
- At Enron, Sharron Watkins of InternalAudit had raised major questions aboutfinancial irregularities.
(check out whistleblower.org. The GovernmentAccountability Projects mission is to protect thepublic interest by promoting government andcorporate accountability through advancingoccupational free speech and ethical conduct,defending whistleblowers, and empowering citizenactivists.)
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We will now discuss 10 recommendationscategorized into three broad areas of
responsibility for improving theeffectiveness of corporate governancepractices in Public Enterprises:
1. stewardship of the corporation;
2. working with management;
3. and the functioning of the board.
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Stewardship of Corporation
1 B d R ibilit
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1. Board Responsibility
(i) approve the strategic direction and the
corporate plan for the corporation; (ii) ensure that the principal risks of the
corporations business have been identified andthat appropriate systems to manage these risks
have been implemented; (generally all PSUs have commercial andpublic policy objectives)
(iii) approve managements succession planincluding appointing, training and monitoring
senior management; and (iv) ensure that the corporations information
systems and management practices meet its needsand give the board confidence in the integrity of
information produced.
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2. Public Policy Objectives
(i) document the current public policy objectives of
the corporation;
(ii) appreciate the contemporary trade-offs betweenthe often competing public policy and commercial
objectives of the corporation; and
(iii) assess the relevance of the corporations
mandate, and, if appropriate, propose changes forthe consideration of the appropriate ministry
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3. Communications
The board of directors of every corporation
should ensure that the corporation
communicates effectively, with theGovernment, other stakeholders and the
public.
Communication responsibilities Reporting responsibilities
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Working with Management
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4 Board and Management Relations
Allocating responsibility
Building a Relationship
Establishing Accountability
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6. The Position of the CEO
Assessing the CEOs position
Evaluating the CEOs performance
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7. Renewal of the Board
Assessing the Board
Renewal of the Board
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8. Education of Directors
New Directors
Ongoing education
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Business Ethics
Imagine that you are the ruler of the world You have
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Imagine that you are the ruler of the world. You have
total power over everything on the planet. You are faced
with the following dilemma:
1. You can almost completely remove hunger from the face of the planet.
Unfortunately, to do so will involve you killing one million people. The reason for
this is not clearyou just have to andthere is no way out.
2. You can reduce hunger in the world by 20% from its current level. This is still
clearly a desirable outcome. Again though, there is a downside. In this case you have
to kill one hundred people
3. You can leave things as they are. There is no trade off whatsoever in this case.
What do you do ? There are some more rules to be noted :
1. Whichever decision you make, you will not kill yourself.
2. The people you kill will all be complete strangers to you.
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Two broad school of thoughts :
Teleological : Ends justify the means.
Deontological : Is bothered about the
means, and not just the end.
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Business ethics make business
sense: Ethical positioning could be your
differentiator in the market. (eg Bodyshop,
Shahnaz Hussain) Reduce the demand for consumerism. (eg
Mclibel case of Mcdonalds)
Cooperation with govt. agencies, non profitorganizations, consumer groups.
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Business ethics : the set/system of principles
and rules of conduct applied to business.
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The Electronics Company
Please read the case study.
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Its legal so it is OK
Morality is broader than legality.
The view that laws and not morals should
restrict business practice fails to recognize:It is illegal as it is immoral !!!
If morals are not policed by industry, then when
laws do come along they are much mortougher.
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Business ethics has come to represent a set of
fundamental beliefs about business such
as :
a. Employees do their best in a good work
place.
b. Companies do their best in healthy
communities with a good quality of life.
c. Companies achieve more if they respect
the environment and conserve resources.
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Remember :
1. The car did not break any law.2. By producing the car, Ford kept many people in
work. The death of a few people was a small
price to pay. Many other Americans lost their
lives in car accidents during this time. It is bestto benefit the majority.
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Analysis:
Why ?
Groupthink !!!!
(This concept argues that a group of peoplewill tend to focus on one objective and goalong with the rest of the group in search ofthis goal, even though the gol or the means
should have been questioned. Go with theflow)
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Financial aspects of Corporate
Governance
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Inaccurate stating of stock levels to increase
or reduce profits
Booking orders at quarter end/year end toboost revenue
Smooth out performance of the company
by holding back sales in certain periods. Manipulation of fixed assets
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Changing the depreciation method from
year to year.
Qualification for bad debts. Cash.
Stocks.
Treatment of extraordinary items
Off balance sheet accounting
Wh is creati e acco nting so
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Why is creative accounting so
common ? Pressure to produce results which look
good.
Market expectation. Short term outlook of investor.
Creative accounting is a short term approachto paste over the crack until long term andlegitimate solutions can be found.
Some examples of selective
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Some examples of selective
display : Tata Steel : Net profit is up 651%. This is not dueto operational efficiences but instead a rise in steel
prices from a 20 month low in Sept 2002.
Grasim : Net profit grew 55%. This is due to gainson exceptional items rather than an increase in netsales which were up by mere Rs 4 crore.
L&T : Operating income down by 14%; net profit
up 5%. This is due to a 41% fall in interestpayments from Rs 90.1 crore to Rs 53.4 crore.
Bajaj Auto : Gross profit is up 50% over the lastquarter but net profit is down by 8.21%
Some examples of selective
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Some examples of selective
display : BPCL : Net profit grew by 78.4 %. This is
due to a gain of Rs 9.2 crore on deferred
taxes against a tax outgo of Rs 31.8 crore inquarter ended sept 2002.
ONGC : A higher other income of of Rs
630 crore and lower interest payments of Rs7.20 crore account for almost half of net
profit increase in Sept 2002.
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Insider dealing :
This occurs when an individual with inside
information about a company uses theirparticular knowledge to gain on the stock
market.
Refer to Tata Finance case.
Insider trading : HLL vs Tata
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Insider trading : HLL vs Tata
Finance HLL : Hindustan Lever which when charged withinsider trading by the stock market regulator,could demonstrate adherence to elaborate
compliance rules by the directors TFL : Tatas have no reporting requirements
regarding individual trading operations. One of theDirectors was asked to step down due to charges
of insider trading, but the role of other Tatadirectors on the board of Tata Finance is also opento question.
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Rogue trader : Nick Leeson
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Analysis:
Star trader was given too much freedom.
Lack of segregation og Leesons duties, so
he could cover his tracks well. Lack of supervsision.
No body questioned the extraordinary profit
that he was making.
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We can similarly discuss many more aspects
of business ethics :
- marketing aspect
- environment aspect
- globalization aspect
Boeing sacked the CFO on Nov 24 2003 His
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Boeing sacked the CFO on Nov 24, 2003. His
alleged misdeed :
Negotiating to hire Air Force procurement officer
Darleen A Druyun while she was in a position to
influence the outcome of a defense dept contract to
buy Boeing 767 tankers.Druyun, hired in Jan 2003,
after leaving the Air Force job in Nov 2002, also
lost her job.
CEO Philip M Condit said Boeing must and will live
by the highest standards of ethical conduct.
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Enron
Please go through the writeup on Enron.
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Enron :
The deadly combination of :
- bad business strategy,
- bad investments and
- desperate attempts to use accountingtricks to hide bad decisions
led Enron to free fall into the largestbankruptcy in American history.
What can Directors learn from
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whats happened at Enron ?
Directors should understand the operations andeconomics of their company, its strategy, and thekey performance indicators that give them someidea of how the business is doing.
Excellence in corporate governance is critical tothe accountability and integrity of any company,and that requires knowledgeable, active, andindependent board members.
Outside board members need to be sure they donthave economic ties to the company or other
possible conflicts of interest that might seem tocompromise their independence.
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What red flags could Directors
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What red flags could Director s
have checked out ? Beware of all kinds of transactionsbetween members of management andoutside firms and affiliates, any one of
which might provide an opportunity forself-dealing. Directors should considerwhether there is a legitimate businessreason for the company to enter into
any such transaction. If necessary, getoutside legal advice.
(something similar happened at Tata Finance)
What red flags could Directors
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have checked out ?
Building off-balance-sheet financing, such assecuring debt with leases and special-purposeentities, or SPEs. Investment bankers,lenders, auditors, and other outsiders oftenhelp put these kinds of deals together as a
way to get around showing debt in thefinancial statements. It is often done in orderto hide just how leveraged a company is.
Directors have to request the CFO or treasurerto provide a quarterly summary of all debt,both on and off the balance sheet, along withinformation on where the cash will come fromto service the debt .
What red flags could Directors
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have checked out ?
Directors should make sure that (1) the company has up-to-date written risk-
management policies, procedures, and internalcontrols and that theyre in place;
(2) the internal controls include sufficientsafeguards, such as adequate segregation of duties,that prevent any one person in the company fromexecuting improper transactions or doing improperaccounting;
(3) the company has established well-reasoned andsupportable methodologies that consistently measure
the fair values of derivatives and financialinstruments. A board would be well advised to askindependent auditors or other experts to assess thecompanys policies and controls on this topic.
Learnings for the audit committee
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Ask tough questions
Insists on answers
Ensure that each committee member isfinancially literate enough to
understand the companys financialstatements and disclosures.
Provide training for all new inductees
Learnings for the audit committee
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Ensure from both the CFO and the
independent auditor if the accountingfor transactions, as reported anddisclosed in the financial statements,reflects the highest-quality accounting
standard that could be used, and if not,why not. (eg, debt could be on or offbalance sheet. Have any accountingpolicies changed ?)
Insist on an annual statement from theCEO and CFO that the company hasinternal controls and that they areoperating effectively.
Learnings for the audit committee
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the audit committee and independent
auditor have open lines ofcommunication and a clear delineationthat the auditor is working for the auditcommittee.
ask the auditor to identify the mostsensitive accounting and auditing issuesand to describe the steps he is taking totest whether those transactions are
properly accounted for and disclosed.
Role of Audit Firm
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non-audit fees have approximated tens
of millions of dollars, up to 20 times theamount paid for the actual audit. Thebig issue is whether any of these extraservices impair an auditors
independence.
(remember the TFL case as well)
Role of Audit Firm
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If the CEOs and CFOs play the numbers gameand cook the books, andifthe auditors dont stir the pot enough tofigure out whats being cooked,and whether it is edible by investors and the
markets, they will continue to repeat themistakes that they did at Enron