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The origin of the report

The Committee on the Financial Aspects of Corporate Governance, forever after known as the Cadbury Committee, was established in May 1991 by the Financial Reporting Council, the London Stock Exchange, and the accountancy profession. The spur for the Committee's creation was an increasing lack of investor confidence in the honesty and accountability of listed companies, occasioned in particular by the sudden financial collapses of two companies, wallpaper group Coloroll and Asil Nadir's Polly Peck consortium: neither of these sudden failures was at all foreshadowed in their apparently healthy published accounts. Even as the Committee was getting down to business, two further scandals shook the financial world: the collapse of the Bank of Credit and Commerce International and exposure of its widespread criminal practices, and the posthumous discovery of Robert Maxwell's appropriation of 440m from his companies' pension funds as the Maxwell Group filed for bankruptcy in 1992. The shockwaves from these two incidents only heightened the sense of urgency behind the Committee's work, and ensured that all eyes would be on its eventual report. The effect of these multiple blows to the perceived probity and integrity of UK financial institutions was such that many feared an overly heavy-handed response, perhaps even legislation mandating certain boardroom practices. This was not the strategy the Committee ultimately suggested, but even so the publication of their draft report in May 1992 met with a degree of criticism and hostility by institution which believed themselves to be under attack. Peter Morgan, Director General of the Institute of Directors, described their proposals as 'divisive', particularly language favouring a two-tier board structure, of executive directors on the one hand and of non-executives on the other.

Features of the report Sir Adrian Cadbury was a visionary chairman who energetically
promoted the committee recommendations The committee reflected the main shareholders The investigation produced the draft report followed by an extensive process of consultation A final report was produced whose recommendations was widely accepted and adopted

Objective of the report

Uplift the low level of confidence Review the structure, rights and role Address various aspects of accountancy profession Raise the standard of corporate governance

The contents of the Report

The suggestions which met with such disfavour were considerably toned down come the publication of the final Report in December 1992, as were proposals that shareholders have the right to directly question the Chairs of audit and remuneration committees at AGMs, and that there be a Senior Non-Executive Director to represent shareholders' interests in the event that the positions of CEO and Chairman are combined. Nevertheless the broad substance of the Report remained intact, principally its belief that an approach 'based on compliance with a voluntary code coupled with disclosure, will prove more effective than a statutory code'. The central components of this voluntary code, the Cadbury Code, are:

that there be a clear division of responsibilities at the top, primarily that the position of Chairman of the Board be separated from that of Chief Executive, or that there be a strong independent element on the board; that the majority of the Board be comprised of outside directors;

that remuneration committees for Board members be made up in the majority of non-executive directors; and that the Board should appoint an Audit Committee including at least three non-executive directors.

The recommendations in the Cadbury code of best practices are:

Directors service contracts should not exceed three years without shareholders approval. There should be full and clear disclosure of their total emoluments and those of the Chairman and the highest-paid Directors, including pension contributions and stock options. Separate figures should be given for salary and performance-related elements and the basis on which performance is measured should be explained. Executive Directors\ pay should be subject to the recommendations of a Remuneration Committee made up wholly or mainly of Non-Executive Directors. It is the Boards duty to present a balanced and understandable assessment of the companys position. The Board should establish an Audit Committee of at least three Non-Executive Directors with written terms of reference, which deal clearly with its authority and duties. The Directors should explain their responsibility for preparing the accounts next to a statement by the Auditors about their reporting responsibilities. The Directors should report on the effectiveness of the companys system of internal control. The Directors should report that the business is a going concern, with supporting assumptions or qualifications as necessary. The report created mixed feelings and with some more frauds emerging in UK, Governance came to mean the extension of Directors responsibility to all relevant control objectives including business risk assessment and minimizing the risk of fraud. The shareholders are surely entitled to ask, if all the significant risks had been reviewed and appropriate actions taken to mitigate them and why a wealth destroying event could not be anticipated and acted upon.

The one common denominator behind the corporate failures and frauds was the lack of effective risk management and the role of the Board of Directors. When it became clear that merely reviewing the internal processes of control were not enough and, therefore, risk management had to be embodied throughout the organization, an easy solution was found by passing on this responsibility to the internal audit.


Much of the initially adverse reaction to the draft of the Cadbury Report published in May 1992 was mollified by the mellowing of the language in the final report that December. The Reports fits firmly into the AngloAmerican corporate tradition of favouring checks and balances to the potentially heavy hand of regulation, and thus while its recommendations were widely welcomed, there was doubt as to how effective these provisions would prove when companies were under no obligation to enforce them. Sir Adrian Cadbury had two responses to these concerns. Firstly he declared that it was up to shareholders, as the owners of these companies, to exert the necessary pressure toward compliance. Added to this was the recommendation for a follow-up committee to evaluate implementation of the Report's findings, with the suggestion that if companies were not found to be complying, "it is probable that legislation and external regulation will be sought". This was not a strategy Sir Adrian relished, and he voiced worries that Adrian Higgs would be unable to resist pressures for legislative solutions in his 2003 report on the role and effectiveness of non-executive directors (worries that ultimately proved unfounded). The major legacy of the report is the widespread acceptance of the division of the roles of Chief Executive and Chairman: almost 90% of listed UK companies had separate individuals fulfilling these positions in 2007, while just over 50% of US companies did so according to a 2008 survey by the National Association of Corporate Directors. This has diminished the cult of personality surrounding such figures, and avoided the domination of boards and companies by individuals whose agendas all too easily went unchecked. Sir Stuart Rose at Marks and Spencers is one of the few prominent people to have recently combined the two, and despite his stellar performance M&S shareholders voted against him continuing in both jobs by margin of almost 38% at the 2009 AGM.


The origin of the report
It is almost a truism that the adequacy and the quality of corporate governance shape the growth and the future of any capital market and economy. The concept of corporate governance has been attracting public attention for quite some time in India. The topic is no longer confined to the halls of academia and is increasingly finding acceptance for its relevance and underlying importance in the industry and capital markets. Progressive firms in India have voluntarily put in place systems of good corporate governance. Studies of firms in India and abroad have shown that markets and investors take notice of well managed companies, respond positively to them, and reward such companies. Strong corporate governance is thus indispensable to resilient and vibrant capital markets and is an important instrument of investor protection. It is the blood that fills the veins of transparent corporate disclosure and highquality accounting practices. It is the muscle that moves a viable and accessible financial reporting structure. Without financial reporting premised on sound, honest numbers, capital markets will collapse upon themselves. Another important aspect of corporate governance relates to issues of insider trading. It is important that insiders, which include corporate insiders also, do not use their position of knowledge and access to inside information, to take unfair advantage over the uninformed stockholders and other investors transacting in the stock of the company. To achieve this, the corporate are expected to disseminate the material price sensitive information in a timely and proper manner and also ensure that till such information is made public, insiders abstain from transacting in the securities of the company.

The Committee's recommendations look at corporate governance from the point of view of the stakeholders and in particular that of the shareholders, because they are the raison for corporate governance and also the prime constituency of SEBI. The control and reporting functions of boards, the roles of the various committees of the board, the role of management, all assume special significance when viewed from this perspective. The other way of looking at corporate governance is from the contribution of corporate governance to the efficiency of a business enterprise, to the creation of wealth and to the countrys economy. The Committee agreed that India had in place a basic system of corporate governance and SEBI has already taken a number of initiatives towards raising the existing standards. The Committee also recognised that the Confederation of Indian Industries had published a Desirable Code of Corporate Governance and was encouraged to note that some of the forward looking companies have already reviewed or are in the process of reviewing their board structures and have also reported in their 199899 annual reports the extent to which they have complied with the Code. The Committee felt that under the Indian conditions a statutory rather than a voluntary code would be far more purposive and meaningful. At the heart of the Committee's report is the set of recommendations which distinguishes the responsibilities and obligations of the boards and the management in instituting the systems for good corporate governance and restates the rights of shareholders in demanding corporate governance. A large part of the recommendations are mandatory and are intended to be the listed companies for initial and continuing disclosures in a phased manner within specified dates. The companies will be required to disclose separately in their annual reports, a report on corporate governance, delineating the steps they have taken to comply with the recommendations of the Committee. This will enable shareholders to know where the companies in which they have invested stand with respect to specific initiatives taken to ensure robust corporate governance. Companies above a particular size will be required to comply with the mandatory recommendations of the report by April 2000 and the remaining companies in the next year. For the non-mandatory recommendations the Committee felt that it would be desirable for companies to voluntarily follow these.

Objectives of the report

To enhance the shareholders value and keeping in view the interest of other stakeholders To treat the code not as a mere structure but as the way of life Proactive initiatives taken by the companies themselves and not in the external measures

Relating to the director the recommendations are:

The Board should meet regularly, retain full and effective control over the company and monitor the executive management. There should be a clearly accepted division of responsibilities at the head of a company, which will ensure balance of power and authority, such that no individual has unfettered powers of decision. In companies where the Chairman is also the Chief Executive, it is essential that there should be a strong and independent element of the Board, with a recognized senior member. The Board should include nonexecutive Directors of sufficient caliber and number for their views to carry significant weight in the Boards decisions. The Board should have a formal schedule of matters specifically reserved to it for decisions to ensure that the direction and control of the company is firmly in its hands. There should be an agreed procedure for Directors in the furtherance of their duties to take independent professional advice if necessary, at the companys expense. All Directors should have access to the advice and services of the Company Secretary, who is responsible to the Board for ensuring that Board procedures are followed and that applicable rules and regulations are complied with. Any question of the removal of Company Secretary should be a matter for the board as a whole.

In India, the CII came out with its own views, but SEBI, as the custodian of millions of investors came out with its guidelines and Kumar Mangalam Committee recommendations became mandatory and, therefore, all the listed companies were obliged to comply in accordance with the listing agreement with these Stock Exchanges. The clean up of most companies has begun in a big way and the Section 49 of the SEBI Act has now almost become the hallmark of compliance in this country.

The mandatory recommendations of the Kumar Mangalam Committee include the constitution of Audit Committee and Remuneration Committee in all listed companies; appointment of one or more independent Directors; recognition of the leadership role of the Chairman of a company; enforcement of accounting standards; the obligation to make more disclosures in annual financial reports; effective use of the power and influence of institutional shareholders; and so on. The Committee also recommended a few provisions, which are non-mandatory. Some of the mandatory recommendations are;

The Board of a company should have an optimum combination of executive and non-executive Directors with not less than 50% of the Board comprising the nonexecutive Directors. The Board of a company should set up a qualified and an independent Audit Committee. The Audit Committee should have minimum three members, all being nonexecutive Directors, with the majority being independent, and with at least one Director having financial and accounting knowledge. The Chairman of the Audit Committee should be an independent Director. They are responsible for balance sheet compilation and clarificatory notes appearing thereto; and to ensure that sensitive information is not tucked away in small print.

Apart from these, the Kumar Mangalam Committee also made some recommendations that are nonmandatory in nature. Some of them are:

The Board should set up a Remuneration Committee to determine the companys policy on specific remuneration packages for Executive Directors. Half-yearly declaration of financial performance including summary of the significant events in the last six months should be sent to each shareholder. Non-executive chairman should be entitled to maintain a chairmans office at the companys expense. This will enable him to discharge the responsibilities effectively.

It will be interesting to note that Kumar Mangalam Committee while drafting its recommendations was faced with the dilemma of statutory v/s voluntary compliance. One may also be aware that the desirable code of Corporate Governance, which was drafted by CII was voluntary in nature and did not produce

the expected improvement in Corporate Governance. It is in this context that the Kumar Mangalam Committee felt that under the Indian conditions a statutory rather than a voluntary code would be far more purposive and meaningful. This led the Committee to decide between mandatory and non-mandatory provisions. The Committee felt that some of the recommendations are absolutely essential for the framework of Corporate Governance and virtually from its code, while others could be considered as desirable. Besides, some of the recommendations needed change of statute, such as the Companies Act for their enforcement. Faced with this difficulty, the Committee settled for two classes of recommendations. SEBI has given effect to the Kumar Managlam Committees recommendations by a direction to all the Stock Exchanges to amend their listing agreement with various companies in accordance with the mandatory\ part of the recommendations. For ensuring good corporate governance in a banking organization the importance of overseeing the various aspects of the corporate functioning needs to be properly understood, appreciated and implemented. There are four important forms of oversight that should be included in the organizational structure of any bank in order to ensure the appropriate checks and balances: oversight by the board of directors or supervisory board; oversight by individuals not involved in the day-today running of the various business areas; direct line supervision of different business areas; and independent risk management and audit functions. In addition to these, it is important that the key personnel are fit and proper for their jobs (this criterion also extends to selection of Directors).

Implementation of the recommendations of Birla committee

By introduction of clause 49 in the listing agreement with stock exchanges

Provisions of clause 49
composition of board - in case of full time chairman, 50% non-executive directors and 50% executive directors

constitution of audit committee with 3 independent directors with chairman having sound financial background. finance director and internal audit head to be special invitees and minimum 3 meetings to be convened. responsible for review of financial performance 0n half yearly/annually basis; appointment/ removal/remuneration of auditors; review of internal control systems and its adequacy

Requirements of clause 49

Remuneration of directors remuneration of non-executive directors to be decided by the board. details of remuneration package, stock options, performance incentives of directors to be disclosed

Board procedures atleast 4 meetings in a year. director not to be member of more than 10 committees and chairman of more than 5 committees across all companies

Management discussion & analysis report should include: industry structure & developments opportunities & threats segment wise or product wise performance

Outlook Risks & concerns Internal control systems & its adequacy Discussion on financial performance Disclosure by directors on material financial and commercial transactions with the company

shareholders/investors grievance committee under the chairmanship of independent director. minimum 2 meetings in a year

report on corporate governance and certificate from auditors on compliance of provisions of corporate governance as per clause 49 in the listing agreement