CORPORATE GOVERNANCE

AOL

In January 2000, AOL merged Time-Warner with itself. The combined entitys shares were trading at around US $ 70 during the initial months AOL Chairman Steve Case and Time Warner CEO Gerald Levin were instrumental in taking the lead for merger.. Steve Case became the Chairman and Gerald Levin become CEO of the AOL Time Warner, the largest media firm in the world, reaching each and every American Citizen in one form or other 2000 employees were fired to achieve synergy.. 20 % of the global workforce

After 3 years, for the financial year 2002, the company announced a loss of US $ 98.7 billion. The share prices touched US $ 8 Another 2000 employees were laid off During the 3 year period 2.3 million customers moved out of the company

What was the mistake of the shareholders and employees? The decision was taken by Levin and His team.. He and his team grossly overestimated the benefits They need to be punished but why the employees and shareholders?

Refco

Refco brokerage firm for commodities, futures contracts and securities. - the largest broker on the Chicago Mercantile Exchange It was founded in 1969 as "Ray E. Friedman and Co. Went public in August 11, 2005 with the sale of 26.5 million shares to the public at $22. It closed the day over 25% higher than that, valuing the entire company at about $3.5 billion.

Refco

In October 2005, some accounting malpractices were found about related party transactions The CEO Phillip R. Bennett US$430 million The firms stock fell to US 0.80 from $ 28 The company filed bankruptcy under chapter 11. Almost 50 % of the employees were sacked

Asea Brown Boveri (Sweden/Switzerland)

A deeply flawed expansion strategy created by the CEO and sanctioned by the Board put the industrial engineering company in financial jeopardy; problems were compounded by the granting of US $170 million of pension benefits to the CEO and his successor without full and proper board approval

Akai (China)

The diversified conglomerate became Hong Kongs largest corporate failure when it collapsed in 2000; executive management looted the company by redirecting assets and defrauding investors and creditors.

Arthur Anderson (USA)

The accounting firm filed for bankruptcy under the weight of many flawed auditing/consulting assignments

Citibank (USA)

The bank was implicated in several scandals, and was forced to pay regulators hundreds of millions of dollars in fines

Daewoo (Korea)

The conglomerate collapsed under the weight of debts accumulated for an expensive and misguided diversification strategy.

Kmart (USA)

The firm filed for bankruptcy in 2002. Investigations revealed abuse of corporate resources by top executives, conflicts of interest, falsification of internal documents and failure of duties to adequately supervise.

Merck (USA)

The pharmaceutical company falsely recorded billions in consumer-to-pharmacy co-payments that it never collected. It was forced to restate earnings, pay fines and postpone a public offering for a subsidiary.

Xerox (USA)

The Company misstated its revenues by US$6.4 billion and its pre-tax earnings by US$1.3 billion over five years and was forced to settle charges with regulators.

Indiabulls

On August 8th 2012, shares of Indiabulls Financial Services fell by 11%, Indiabulls Real Estate by 12%, Indiabulls power by 11.8%, and Indiabulls Securities by about 5% during intra-day trade, after a Veritas report questioned its governance practices. The Canadian Research firm reported that the financial disclosures of IBREL and IBP are unreliable, and the sole purpose of IBREL is to bilk institutional and retail investors for the benefit of select insiders. Veritas advised its clients to Sell Indiabulls group stocks as corporate governance has been sacrificed to enrich the controlling stakeholders.

Issues in Corporate governance

ETHICAL ISSUES frauds illegal activities cartels-lobbying EFFICIENCY Performance of management Time Warner and AOL ACCOUNTABILITY ISSUES Stakeholders need for transparency of management-Refco

Other issues to be addressed..

Growth of private companies Magnitude and complexity of corporate groups Importance of institutional investors Rise in hostile activities of predators i.e. takeover Insider trading Litigations against Directors Need for restructuring of Boards Changes in Auditing practices

Corporate Governance

Managers (or controlling shareholders) have the control Other stakeholders are affected by their actions This creates problems for the stakeholders when the managers act on their own selfish objectives

Corporate Governance

Aims at guiding corporations to protect the interests of stakeholders It is a system by which business corporations are directed and controlled System of structuring, operating, and controlling a company with a view to achieve long-term strategic goals to satisfy primary stakeholders with the legal and regulatory requirements, apart from meeting environmental and local community needs. It leads to the building of a legal, commercial and institutional framework. It also demarcates the boundaries within which these functions are to be performed.

Theories of Corporate Governance

STEWARDSHIP THEORY monitoring required to curtail rare misconduct of humans managing corporations (managers)-Berle and Means AGENCY THEORY managers need to be monitored as their motives differ from that of shareholders

CORPORATE GOVERNANCE MECHANISMS

Internal mechanism

Board of Directors Top Management Code of Conduct & Whistleblower policy

External mechanism

Regulatory Oversight (Financial market regulator) Legal System (Company law, Bankruptcy law) Corporate Control activity Institutional investors (CalPERS, FIIs) Capital market access Rating Agencies External Auditors

CORPORATE BOARDS

Board, Top Management and Shareholders

CEO &Management

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AGMs, Director Elections

Investors
Grievance redressing mechanism

Board

Types of Directors

Executive Directors Non- Executive directors (Independent Directors and family members) Nominee Directors Representative Directors for employees, suppliers Alternative directors Shadow directors/Associate directors

Types of Board structure

All executive board (Most of the unlisted firms) Majority Executive board (family business firms) Majority outsider board - (Software companies- Satyam, Wipro) Two Tier structure Advisory board Murugappa Corporate Board

Issues in designing the board

The board size The role of chairman and CEO Duality of board membership in a subsidiary boards

Board Styles
Based on concern for relationship among directors and Concern for effective communication

Rubber stamp board (fully owned subsidiaries) Country club board Representative board Professional board

Role of directors

PERFORMANCE ROLE (i.e. activities to improve overall performance)

specialized knowledge specialists Lawyers, Auditors, Academics (Infosys, RIL) Caters the needs of corporation for networking, representing and adding status
Provides

Role of directors

CONFORMANCE ROLE
Ensure

top management follows policies and procedures laid down by the board Monitoring and evaluating

Responsibilities

Responsibilities to the shareholders Obligation to maintain honesty and integrity Proper presentation of documents and annual accounts

Duties of Directors

Exercise care in the discharge of functions as Directors Attend Board meetings and devote sufficient time and attention to the affairs of the company Not to be negligent and not to commit or let others commit tort-liable acts (Tort -wrongful act that causes injury to a person or property and for which the law allows a claim by the injured party to recover damages money)

Duties of Directors

Not to misuse power Protect the interests of creditors and employees Maintain confidentiality Not to exercise power for a collateral purpose Not to waste company assets

Role of Chairman

Manage the board and conduct of meetings Good business and financial knowledge Maintain good relations with the Executive directors Independent directors and CEO

Role of CEO with respect to board

Good relationship with directors and Chairman (ABB) Assist the executive directors in presenting the strategic proposals To present the company to the investors To act as a representative of executive directors while interacting with independent directors

Functions of the Board

Strategic role
Systemic

Level Strategy Structural and portfolio Strategy Implementation Strategy

Policy making role - ex. code of conduct Monitoring and supervisory role

Committees of the board

Audit committee Remuneration Committee Nomination committee

Corporate Code

Corporate Codes are the policy statements which guides the behavior of employees based on the value systems of the company. The top management and board has the responsibility prepare the Corporate Code

Types of corporate codes

Compliance Code : Directive Statements which provide guidance and prohibit certain kind conduct Corporate Credos: The broad general statements of corporate commitments relating to constituencies, values and Objectives Management Philosophy Statements : The formal statements of companys value system

Types of Compliance code

Special documents Code of conduct Circulated letters about company policies for employees while dealing business partners

Code of Conduct

Companies' policy statements that define ethical standards for the employee conduct Code varies from company to company Can take a number of formats and address any issue - like workers' rights, behavior with customers . Codes of conduct create a proper environment to help identify and reinforce within the firm those critical success factors which improve its capacity to compete in a rapidly changing environment.

Process of corporate code

Identification of key behavior developing the code Review Communicate the code Implement Update

Code of Conduct an example

Code of conduct @ Grasim Industries Ltd

Whistle Blowing

Whistle blowing - the deed of making exposures about the corporate fraud and corruption to the public in anticipation of implementing appropriate measures of correction. Whistleblower - an employee, former employee, or member of an organization, especially a business or government agency, who reports misconduct to people or entities that have the power and presumed willingness to take corrective action. The misconduct which are reported, by and large, include an infringement of law, rule, regulation and/or a constant menace to public interest, such as health/safety violations, fraud and corruption.

EXTERNAL GOVERNANCE MECHANISM

Market Regulators

Government Bureaucrats and Politicians May not have sufficient knowledge about the market Regulators Experts to regulate markets Banks were the entities to be regulated first with central banks gradual development

Securities Regulator
SEC was formed in 1934 after the Great Crash of Wall street Stock ion October 1929 SEC is very active and the regulatory system was well advanced Managements Discussion and Analysis since 1960s Regulatory norms were revised regularly by SEC

SEBI

Securities and Exchange Board of India (SEBI) - created in 1988 and given statutory form in 1992 with the SEBI Act 1992

Financial Regulators

Independent professional bodies that regulate the financial markets through regulations Ex Prevent insider trading etc

Regulatory Bodies in India and USA

Market Securities Market Banks Regulator - India SEBI RBI Regulator USA Securities Exchange Commission Federal Deposit Insurance Corporation, Federal Reserve System, Office of the Comptroller of the Currency, Office of Thrift Supervision. Commodities Futures Trading Commission State level regulators National Association of Insurance Commissioners Pension Benefit Guaranty Corporation Securities Exchange Commission Employee Benefits Security Administration

Commodities Market Insurance Pension Funds

Forward Markets Commission IRDA PFRDA

Corporate Laws

Corporate Laws- that govern the structure of the companies Bankruptcy laws tells what need to be done when a company is not in a financial position to continue its operations liquidation Regulatory Law- define powers to the regulators

Institutional Investors

Institutional Investors have significant stake in almost all major firms CalPERS - California Public Employees' Retirement System- Active in CG April 2004- Entry into India with US $ 100 million

Gatekeepers

Auditors Credit Rating Agencies Analysts

Auditors

Only certified people can audit the accounts The audit firms need to be changed every three years in India Audit firms appointment need to be approved by shareholders

Security Analysts

A financial professional who studies various industries and companies, providing research and valuation reports, and making buy, sell, and hold recommendations.

Credit Rating

Credit rating is for the creditors To access the credit worthiness and financial soundness of the firm Might not fully capture the corporate governance practices of the firms The companies might ignore the investors while maintaining good financial performance Ex- Walt Disney, Citi Corp

Credit Rating Agencies

A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings

Indian CRAs

Credit Rating Information Services of India Limited (CRISIL) Subsidiary of S&P Investment Information and Credit Rating Agency of India (ICRA)- Moodys Credit Analysis & Research Limited (CARE) IDBI Bank (26.75%), Canara Bank (23.6%) and State Bank (10 %)of India. The other share holders Federal Bank, IL&FS, ING Vyasa Bank etc.

CG Rating

To overcome the problem for the sake of equity investors rate the companies based their corporate governance practices

CG Rating

Governance Metrics International (GMI) the first agency to rate the corporate governance practices of the firms in 2000 The Corporate Library TCL Rating since 2001 Standard and Poors CG Scores Started in 2001 -Discontinued in 2005 Deminor Rating European Agency Since 2002- Acquired by ISS in 2005 Institutional Shareholder Services (ISS) since 2002 - Risk Metrics Group acquired ISS in 2007

The GMI research process

Collect pertinent public data, including regulatory filings, company websites, news services and other specialized websites. Enter all data collected into a relational database to fit into a template for analysis. (GMI research template is divided into six broad categories of analysis. These categories are further divided into sub-sections. Each individual metric has a numerical value and each subsection and research category is weighted according to investor interest) Compile the research template answers Send the profile to each company for a final accuracy

The GMI research process

After any company adjustments are made the data are locked and GMI runs a scoring model that calculates and assigns ratings to each company. Companies are scored on a scale of 1.0 (lowest) to 10.0 (highest) and are always scored relative to the other companies in our research universe Companies are assigned 14 ratings in all. The first seven GMI global ratings. Global ratings are designed to demonstrate how each company's governance profile compares to all others in the GMI universe. Global ratings include an overall GMI score and separate scores for each of GMI's six research categories. Then comes "home market" ratings which reflect how well its governance policies and practices compare to others in its home country or region. Home market ratings also include an overall GMI score and separate scores for each of GMI's six categories of analysis.

The Corporate Library Ratings

Known as TCL ratings Comprised of four main component ratings 1. Board composition and succession planning 2. CEO compensation practices 3. Takeover defenses 4. Board level accounting concerns

Rating Scale of TCL Rating

Ratings use a traditional AF scale A and B-Rated Companies Relatively LOW governance risk with no major concerns in the 4 categories C-Rated Companies This rating represents a MODERATE degree of governance risk with concerns in one of the four categories D and F-Rated Companies Both ratings represent a HIGH degree of governance risk with concerns in two or more categories, with F-rated firms presenting extreme circumstances

RiskMetrics Groups Corporate Governance Quotient -CGQ

RiskMetrics Group rates over 7,400 companies in more than 30 markets, Rated companies include US companies in the S&P 500, S&P 400, S&P 600 and Russell 3000 indices, Canadian companies in the S&P/TSX Canadian Composite Index; UK companies in FTSE All Share Index; and additional companies tracked by the MSCI/EAFE Index and FTSE All World Developed Index.

RiskMetrics Groups CGQ

Data is derived from public disclosure documents, press releases and corporate websites Collected data goes through a verification process by the RMG team Companys may also review and verify the information we have collected on them through a free Data Verification tool. Once the data are collected, specific rating factors are applied resulting in a raw score. This raw score is then used to determine a companys relative score with respect to index and industry group, as well as subscores in four key areas: Board Structure, Anti-Takeover Defenses, Audit and Compensation and Ownership.

Who will buy CG ratings

Institutional Investors Banks Foreign institutional Investors

Rating - mostly based on secondary data and SEC filings

CR Rating in India

ICRA launched CG ratings for Indian firms in 2001 Not for sales to be initiated by the companies themselves ITC was the first company to be rated scored CG2

ICRA Ratings

ICRAs Corporate Governance Rating for shareholder protection Ratings from CGR 1(High) to CGR 6 (Low) ICRAs Stakeholder Value and Governance (SVG) Rating for stakeholder protection Ratings from SVG 1 (High) to SVG 6 (Low)

ICRA Rating Methodology

Ownership structure Governance Structure and Management Processes Board Structure and Processes -Audit Committee and Risk Management Stakeholder Relations Transparency & Disclosures Financial discipline

GVC rating by CRISIL

Known as Governance and Value Creation (GVC) Ratings From 2004 Best CG practices GVC level 1 Worst CG practices GVC level 8

GVC rating Criteria

Equitable treatment of shareholders Ownership rights of shareholders Transparency & disclosure Composition of Board Functioning of Board Management assessment Value creation for various stakeholders

GVC Rating list

CRISIL GVC Level 1 companies Bharti Airtel, HDFC Bank, Hero Honda Motors, HDFC, Infosys and Mahindra & Mahindra CRISIL GVC Level 2 companies Dabur India, Foseco India and IIFFCo CRISIL GVC Level 3 companies Kanoria Chemicals & Industries