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Corporate Governance - Is a Myth or Reality

Corporate Governance - Is a Myth or Reality

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Published by: mehta_vikram19868766 on May 06, 2010
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RT1802 B39 M.B.A. 4st-SEM



I take this opportunity to offer my deep gratitude to all those who have extended their valued support and advice to complete this term paper .I cannot in full measure, reciprocate the kindness showed and contribution made by various persons in this endeavor. I acknowledge my sincere thanks to Miss JaspreetKaur who stood by me as a pillar of strength throughout the course of work and under whose mature guidance the term paper arrives out successfully. I am grateful to his valuable suggestions.

Name of the Student Vikram Singh Mehta

In A Board Culture of Corporate Governance, business author Gabrielle O'Donovan defines corporate governance as 'an internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders, by directing and controlling management activities with good business savvy, objectivity, accountability and integrity. Sound corporate governance is reliant on external marketplace commitment and legislation, plus a healthy board culture which safeguards policies and processes'. O'Donovan goes on to say that 'the perceived quality of a company's corporate governance can influence its share price as well as the cost of raising capital. Quality is determined by the financial markets, legislation and other external market forces plus how policies and processes are implemented and how people are led. External forces are, to a large extent, outside the circle of control of any board. The internal environment is quite a different matter, and offers companies the opportunity to differentiate from competitors through their board culture. To date, too much of corporate governance debate has centered on legislative policy, to deter fraudulent activities and transparency policy which misleads executives to treat the symptoms and not the cause. It is a system of structuring, operating and controlling a company with a view to achieve long term strategic goals to satisfy shareholders, creditors, employees, customers and suppliers, and complying with the legal and regulatory requirements, apart from meeting environmental and local community needs. Report of SEBI committee (India) on Corporate Governance defines corporate governance as 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 is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company.´ The definition is drawn from the Gandhian principle of trusteeship and the Directive Principles of the Indian Constitution. Corporate Governance is viewed as business ethics and a moral duty. See also Corporate Social Entrepreneurship regarding employees who are driven by their sense of integrity (moral conscience) and duty to society. This notion stems from traditional philosophical ideas of virtue (or self governance) and represents a "bottom-up" approach to corporate governance (agency) which supports the more obvious "top-down" (systems and processes, i.e. structural) perspective.

Impact of Corporate Governance
The positive effect of corporate governance on different stakeholders ultimately is a strengthened economy, and hence good corporate governance is a tool for socio-economic development.

Parties to corporate governance
Parties involved in corporate governance include the regulatory body (e.g. the Chief Executive Officer, the board of directors, management, shareholders and Auditors). Other stakeholders who take part include suppliers, employees, creditors, customers and the community at large. In corporations, the shareholder delegates decision rights to the manager to act in the principal's best interests. This separation of ownership from control implies a loss of effective control by shareholders over managerial decisions. Partly as a result of this separation between the two parties, a system of corporate governance controls is implemented to assist in aligning the incentives of managers with those of shareholders. With the significant increase in equity holdings of investors, there has been an opportunity for a reversal of the separation of ownership and control problems because ownership is not so diffuse. A board of directors often plays a key role in corporate governance. It is their responsibility to endorse the organisation's strategy, develop directional policy, appoint, supervise and remunerate senior executives and to ensure accountability of the organisation to its owners and authorities. The Company Secretary, known as a Corporate Secretary in the US and often referred to as a Chartered Secretary if qualified by the Institute of Chartered Secretaries and Administrators (ICSA), is a high ranking professional who is trained to uphold the highest standards of corporate governance, effective operations, compliance and administration. All parties to corporate governance have an interest, whether direct or indirect, in the effective performance of the organization. Directors, workers and management receive salaries, benefits and reputation, while shareholders receive capital return. Customers receive goods and services; suppliers receive compensation for their goods or services. In return these individuals provide value in the form of natural, human, social and other forms of capital. A key factor is an individual's decision to participate in an organisation e.g. through providing financial capital and trust that they will receive a fair share of the organisational returns. If some parties are receiving more than their fair return then participants may choose to not continue participating leading to organizational collapse.

Key elements of good corporate governance principles include honesty, trust and integrity, openness, performance orientation, responsibility and accountability, mutual respect, and commitment to the organization. Of importance is how directors and management develop a model of governance that aligns the values of the corporate participants and then evaluate this model periodically for its effectiveness. In particular, senior executives should conduct themselves honestly and ethically, especially concerning actual or apparent conflicts of interest, and disclosure in financial reports. Commonly accepted principles of corporate governance include: 

Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by effectively communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings. Interests of other stakeholders:Organizations should recognize that they have legal and other obligations to all legitimate stakeholders. Role and responsibilities of the board:The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors. Integrity and ethical behaviour:Ethical and responsible decision making is not only important for public relations, but it is also a necessary element in risk management and avoiding lawsuits. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. It is important to understand, though, that reliance by a company on the integrity 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 steps outside of ethical and legal boundaries. Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters    

concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information. Issues involving corporate governance principles include: 

internal controls and internal auditors the independence of the entity's external auditors and the quality of their audits oversight and management of risk oversight of the preparation of the entity's financial statements review of the compensation arrangements for the chief executive officer and other senior executives the resources made available to directors in carrying out their duties the way in which individuals are nominated for positions on the board dividend policy 


Nevertheless "corporate governance," despite some feeble attempts from various quarters, remains an ambiguous and often misunderstood phrase. For quite some time it was confined only to corporate management. That is not so. It is something much broader, for it must include a fair, efficient and transparent administration and strive to meet certain well defined, written objectives. Corporate governance must go well beyond law. The quantity, quality and frequency of financial and managerial disclosure, the degree and extent to which the board of Director (BOD) exercise their trustee responsibilities (largely an ethical commitment), and the commitment to run a transparent organization- these should be constantly evolving due to interplay of many factors and the roles played by the more progressive/responsible elements within the corporate sector. John G. Smale, a former member of the General Motors board of directors, wrote: "The Board is responsible for the successful perpetuation of the corporation. That responsibility cannot be relegated to management."[6] However it should be noted that a corporation should cease to exist if that is in the best interests of its stakeholders. Perpetuation for its own sake may be counterproductive.

Internal corporate governance controls
Internal corporate governance controls monitor activities and then take corrective action to accomplish organizational goals. Examples include: 

Monitoring by the board of directors: The board of directors, with its legal authority to hire, fire and compensate top management, safeguards invested capital. Regular board

meetings allow potential problems to be identified, discussed and avoided. Whilst nonexecutive directors are thought to be more independent, they may not always result in more effective corporate governance and may not increase performance. Different board structures are optimal for different firms. Moreover, the ability of the board to monitor the firm's executives is a function of its access to information. Executive directors possess superior knowledge of the decision-making process and therefore evaluate top management on the basis of the quality of its decisions that lead to financial performance outcomes, ex ante. It could be argued, therefore, that executive directors look beyond the financial criteria. 

Internal control procedures and internal auditors: Internal control procedures are policies implemented by an entity's board of directors, audit committee, management, and other personnel to provide reasonable assurance of the entity achieving its objectives related to reliable financial reporting, operating efficiency, and compliance with laws and regulations. Internal auditors are personnel within an organization who test the design and implementation of the entity's internal control procedures and the reliability of its financial reporting Balance of power: The simplest balance of power is very common; require that the President be a different person from the Treasurer. This application of separation of power is further developed in companies where separate divisions check and balance each other's actions. One group may propose company-wide administrative changes, another group review and can veto the changes, and a third group check that the interests of people (customers, shareholders, employees) outside the three groups are being met. Remuneration: Performance-based remuneration is designed to relate some proportion of salary to individual performance. It may be in the form of cash or non-cash payments such as shares and share options, superannuation or other benefits. Such incentive schemes, however, are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behavior, and can elicit myopic behavior.  

External corporate governance controls
External corporate governance controls encompass the controls external stakeholders exercise over the organization. Examples include: 

competition debt covenants demand for and assessment of performance information (especially financial statements) government regulations 


managerial labor market media pressure takeovers

Systemic problems of corporate governance 

Demand for information: In order to influence the directors, the shareholders must combine with others to form a significant voting group which can pose a real threat of carrying resolutions or appointing directors at a general meeting. Monitoring costs: A barrier to shareholders using good information is the cost of processing it, especially to a small shareholder. The traditional answer to this problem is the efficient market hypothesis (in finance, the efficient market hypothesis (EMH) asserts that financial markets are efficient), which suggests that the small shareholder will free ride on the judgements of larger professional investors. Supply of accounting information: Financial accounts form a crucial link in enabling providers of finance to monitor directors. Imperfections in the financial reporting process will cause imperfections in the effectiveness of corporate governance. This should, ideally, be corrected by the working of the external auditing process.  

Corporate governance models around the world
Although the US model of corporate governance is the most notorious, there is a considerable variation in corporate governance models around the world. The intricated shareholding structures of keiretsus in Japan, the heavy presence of banks in the equity of German firms, the chaebols in South Korea and many others are examples of arrangements which try to respond to the same corporate governance challenges as in the US. In the United States, the main problem is the conflict of interest between widely-dispersed shareholders and powerful managers. In Europe, the main problem is that the voting ownership is tightly-held by families through pyramidal ownership and dual shares (voting and nonvoting). This can lead to "self-dealing", where the controlling families favor subsidiaries for which they have higher cash flow rights.

Anglo-American Model
There are many different models of corporate governance around the world. These differ according to the variety of capitalism in which they are embedded. The liberal model that is common in Anglo-American countries tends to give priority to the interests of shareholders. The coordinated model that one finds in Continental Europe and Japan also recognizes the interests of workers, managers, suppliers, customers, and the community. Each model has its own distinct competitive advantage. The liberal model of corporate governance encourages radical innovation and cost competition, whereas the coordinated model of corporate governance facilitates incremental innovation and quality competition. However, there are important differences between the U.S. recent approach to governance issues and what has happened in the UK. In the United States, a corporation is governed by a board of directors, which has the power to choose an executive officer, usually known as the chief executive officer. The CEO has broad power to manage the corporation on a daily basis, but needs to get board approval for certain major actions, such as hiring his/her immediate subordinates, raising money, acquiring another company, major capital expansions, or other expensive projects. Other duties of the board may include policy setting, decision making, monitoring management's performance, or corporate control. The board of directors is nominally selected by and responsible to the shareholders, but the bylaws of many companies make it difficult for all but the largest shareholders to have any influence over the makeup of the board; normally, individual shareholders are not offered a choice of board nominees among which to choose, but are merely asked to rubberstamp the nominees of the sitting board. Perverse incentives have pervaded many corporate boards in the developed world, with board members beholden to the chief executive whose actions they are intended to oversee. Frequently, members of the boards of directors are CEOs of other corporations, which some see as a conflict of interest.

Corporate governance and firm performance
In its 'Global Investor Opinion Survey' of over 200 institutional investors first undertaken in 2000 and updated in 2002, McKinsey found that 80% of the respondents would pay a premium for well-governed companies. They defined a well-governed company as one that had mostly out-side directors, who had no management ties, undertook formal evaluation of its directors, and was responsive to investors' requests for information on governance issues. The size of the premium varied by market, from 11% for Canadian companies to around 40% for companies where the regulatory backdrop was least certain (those in Morocco, Egypt and Russia).

Other studies have linked broad perceptions of the quality of companies to superior share price performance. In a study of five year cumulative returns of Fortune Magazine's survey of 'most admired firms', Antunovich et al. found that those "most admired" had an average return of 125%, whilst the 'least admired' firms returned 80%. In a separate study Business Week enlisted institutional investors and 'experts' to assist in differentiating between boards with good and bad governance and found that companies with the highest rankings had the highest financial returns. On the other hand, research into the relationship between specific corporate governance controls and some definitions of firm performance has been mixed and often weak. The following examples are illustrative.

1. Board composition 2. Remuneration/Compensation

Is Corporate Governance A Myth or Reality?
In a recent article on Train Wreck, Steve Tobak put forward the idea that corporate governance is a myth. He based that hypothesis on the assertion that there are no consistent and effective laws, methods and metrics governing public companies. From my years of experience with public company boards and directors, I would agree about the lack of consistently effective laws or methods for governance. But I would also give a bit more credit to those who serve on corporate boards. I have worked with quite a few in my day, and most have been peopled with ethical and hard-working directors and have managed good standards of governance, often under trying circumstances. Through my work in corporate governance, I have come to view governance as a social system that is very dependent on the qualities and characters of the people involved. I have also come to recognize the key elements of a successful board ± and a successful corporate governance program. While I have been fortunate to witness some real success stories, I do agree with Mr. Tobak that such stories are not nearly as common as they should be. For that reason, I¶ve outlined below what I believe are crucial factors for a successful board that truly serves its shareholders.

Straight Talking
The first requirement for a successful corporate board is a willingness to tell ± and hear ± hard truths. Good governance requires guts, and good boards are made up of brave and courageous people. I know about the sorts of boards that led Steve Tobak to write his article ± the very sorts who would never dare to hire a consultant (such as myself) who might tell them the truth.

Knowing the Goals
To discharge their responsibility to the shareholder requires a board to understand what type of shareholders they have and what type of performance the shareholders are looking for. For a large listed company, this is no mean feat. Responsible, successful boards invest time and effort on communicating with their shareholders to ensure that investors understand the company¶s direction, goals, and likely outcomes ± with a keen awareness of their responsibility to represent the interests of minority shareholders along with those of larger investors.

Planning Strategy and Execution
Once the board has worked out what is acceptable performance for their shareholders, they reach the real challenge: ensuring that the company has a strategy that will deliver that performance. It is imperative that the board should contain individuals with a deep understanding of both the company¶s business and the industries in which it operates, as well as any geographic regions and key customer needs. It is also imperative that the board should be independent of management and capable of thinking through an independent line of analysis.

Defining Success
Boards must take responsibility for developing key performance indicators (KPIs) and ensuring that management report these diligently and accurately. Reporting must be comprehensive and timely enough to ensure that the board is aware of performance without being so cumbersome that it hampers management¶s ability to deliver. Developing good KPIs is more of an art than a skill ² something that boards get better at with practice.

Building a Team
When the board has endorsed the corporate strategy, they then have a responsibility to ensure that there are sufficient skills within the boardroom for appropriate oversight of the strategy as management set about implementation. Sometimes the best person to add to a board is one who makes the other board members slightly nervous. It requires courage to recommend such appointments to shareholders, but a good chairman will seek out such directors, confident that they add value to the board, even if they do make his job more difficult.

Leadership on Compensation
both for the board and for executives. Many people consider ³independence´ in this sense to mean sufficient personal wealth that board directors need not rely on fees paid for board appointments. That is a sadly deficient definition. It is not uncommon for board members to become almost addicted to the status of his or her membership. There is a difference between loyalty to the board and a slavish desire to remain on the board. My personal preference is for a board fee that adequately compensates board members are the risks and liabilities of the position as well as the considerable time and expertise that it requires.

Like Mr. Tabek, I have found that stock and options provide incentives for board members to further their own interests over and above those of shareholders, although I know many ethical directors are paid in that manner and would never do any such thing. The board must also give thoughtful guidance as to executive compensation. Again the issue of options, whilst intended to align interests with those of the shareholders, can provide perverse incentives. Boards need to ensure that executives are paid sufficiently well to stay on board, without risking an unacceptable transfer of wealth from the shareholders to the CEO.

Effective Oversight
Having decided on the remuneration mechanism, the board must develop a close relationship with the CEO so that they can oversee performance and ensure that ethical behavior in the best interests of the company and the shareholder, rather than incentive-driven behavior in the best interests of the CEO¶s pay packet. As Steve Tobak points out, it is easy for a board to condone behavior that raises the share price in the short-term whilst undermining the long-term sustainability of the organization. Good boards do not take the easy route, instead understanding the key attributes of the strategy and linking compensation to achieving strategic milestones. These things can be consistently measured and compared across different companies ± but of course they don¶t tell you whether or not the board members are ethical, independent and fiercely committed to the success of the company. You cannot legislate for ethics or commitment. All you can do is hire the best available board members, support them in their endeavours, and hold them to account through appropriate disclosure. However, if you do that, my experience suggests that you will get good governance.

Corporate governance issues at Satyam
Mumbai: Just three months ago, Satyam Computer Services received a Golden Peacock award
from a group of Indian directors for excellence in corporate governance.

Double trouble for Satyam!
Now its board is in turmoil and its shares have plunged after a botched attempt to buy two infrastructure firms in which management held stakes, sparking concerns about conflicts of interest and a lack of transparency.

Slideshow of the day: Coloured gold!
Analysts say the saga exposes serious shortfalls in corporate India that must be addressed to ensure its credibility in an increasingly globalised and competitive world.

Check out our Yearender special
Four independent directors have resigned from the board of Satyam since the scandal erupted. But that does not fix the problem, said PremchandPalety, Director of the Centre for Forecasting and Research in Delhi.

AP government keeps eye on Satyam as its share value shrinks
"Independent directors are supposed to be the watchdogs, the ones responsible for safeguarding the interests of minority shareholders. They clearly failed in their duty," he said.

Satyam in spotlight for a possible takeover
Satyam says it adhered to corporate governance rules, appointing the requisite number of independent directors with excellent credentials, including the dean of a top business school in its hometown of Hyderabad and a professor at Harvard business school.

I'll not quit a ship in trouble: Satyam Director
But there are concerns that some directors may be too close to Satyam's chairman to be considered truly independent, and all of them failed to ask tough questions about the now controversial infrastructure deals, Palety said.

Raju turns to employees for support
"If Satyam's board was convinced about the merits of acquiring (the two firms), then good corporate governance demanded that it should have taken into confidence at least the major institutional shareholders," he said.

Satyam gains on talk of PE stake, management change
Even though the company aborted the plan, the damage was done: New York-listed Satyam's shares have plunged by a third since it first announced plans to acquire two sister firms for $1.6 billion and then abandoned the deal two weeks ago.

IL&FS Trust sells 44.1 lakh Satyam shares
Satyam's board will meet on January 10 to consider more options to improve shareholder value and corporate governance.

Deep introspection
Change has come slowly for Indian family-owned businesses that have long battled issues such as nepotism, mismanagement, weak boards and a lack of transparency and professionalism. About half the companies in the benchmark 30-share index are family-controlled.

Satyam directors¶ remuneration
With the opening of the economy in the early 1990s, bringing with it tighter regulations and greater foreign investor interest, Indian businesses have been forced to clean up their act. But problems remain, with long-drawn out leadership succession battles such as the months-long standoff between the wealthy Ambanibrotherrs highlighting the stranglehold by founders as well as the failure of regulatory authorities.

Do RamalingaRaju and family have any stake in Satyam?
Not all matters of corporate governance are big."In some cases, it could be as small a matter as keeping minutes of meetings, or spending too much time on routine matters," said Raman Uberoi, a senior director at ratings agency CRISIL, which also has a corporate governance ratings service. Some analysts say the market watchdog, the Securities and Exchange Board of India, lacks the teeth for ensuring compliance on governance, while others say the rules don't go far enough. In the case of independent directors, for example, the SEBI mandates they must make up onethird of a board where the chairman is a non-executive director, and half the board where the chairman is an executive director. With a limited pool of qualified and experienced managers from which to pick independent directors, company founders typically tap a network of associates, and it is not unusual to see the same familiar names on several boards. And even independent directors may be hamstrung by a cultural distaste for dissent, said Anjali Bansal, director of consultancy Spencer Stuart in India.

"The vast majority of independent directors are intimidated or unsure of how their criticism will be taken," Bansal said. It also boils down to the ethics of the top management and deep-rooted issues of education and corporate government awareness, Palety said. "If the basic culture is not ethical, then what good will rules do? It is time for deep introspection at our companies, at our business schools, and at our financial media," he said. The economic slowdown may be a trigger for better governance. When funding is tight, better corporate governance makes companies more attractive in the eyes of investors, Bansal said. "Also, with the bull run, companies were getting good valuations anyway. Now, perhaps they will pay closer attention to corporate governance for better valuations," said Uberoi.

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