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Good Corporate Governance practices are important to encourage investment in a country. Companies in global economy, where access to capital markets is in the interest of economy, assume greater significance. While the report of Kumar Mangalam Birla committee on Corporate Governance opined that a strong Corporate Governance was a prerequisite for the growth of capital market and was an important instrument of investor protection, studies of various companies the world over revealed that markets and investors did take notice of well governed companies, responded positively to them and rewarded such companies with higher valuations as reflected in stock prices. Good Corporate Governance leads to the efficiency of a business enterprise, to the creation of wealth of stakeholders and to the countries economy. The need is for the entire corporate world to follow the principles of Corporate Governance. There is to need to monitor the functioning of Corporates for guarding the interest of investors and creditors. With increasing awareness and access to information, investors do not solely depend upon regulators to protect them. They are conscious of their rights and strive to maximize their wealth, so does a company. The key differences, with everything else being common, will be the ability to create self driven, selfaccessed, self-regulated organization with a conscience. This is ultimately all about Corporate Governance in India and elsewhere. Also the Satyam scandal has allowed us to look at the fundamental aspects of Corporate Governance—on whose behalf the company is governed, and how we can distribute power to ensure the longevity and effectiveness of the institution
What is Corporate Governance?
• • “Corporate Governance is the system by which companies are directed and controlled…” – Cadbury Report (UK), 1992 “…to do with Power and Accountability: who exercises power, on behalf of whom, how the exercise of power is controlled.” • Sir Adrian Cadbury, in Reflections on Corporate Governance, Ernest Sykes Memorial Lecture, 1993 A Canadian Definition • “…the process and structure to direct and manage the business and affairs of the corporation with the objective of enhancing shareholder value, which includes ensuring the financial viability of the business….” – Where were the Directors? Guidelines for Improved Corporate Governance in Canada, TSE, 1994 An OECD Definition • “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders also the structure
through which objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.” – Preamble to the OECD Principles of Corporate Governance, 2004
An Indian Definition • “…fundamental objective of corporate governance is the ‘enhancement of the long-term shareholder value while at the same time protecting the interests of other stakeholders.” – SEBI (Kumar Mangalam Birla) Report on Corporate Governance, January, 2000
A Gandhian Definition – Trusteeship obligations inherent in company operations, where assets and resources are pooled and entrusted to the managers for optimal utilization in the stakeholders’ interests. Some Further Definitions Corporate governance is essentially about leadership: – leadership for efficiency; – leadership for probity; – leadership with responsibility; and – leadership which is transparent and which is accountable. And according to me Corporate Governance is: System of laws, regulations and a practice, which promotes enterprise, accelerates performance and ensures accountability. OR It may also be defined as a system of structuring, operating and controlling a company.
Genesis of Governance
One may govern life in accordance with the revealed truth as one sees it or natural law or a simple percept of not treating others as just ends, or in the pursuit of the good life of contemplation prized by Aristotle. One may believe that morality lies in doing the best one can do for oneself and one’s children and giving something back to the society, when one can buy money or time. One may also think that morality is simply being responsible for one’s actions, not harming others, and when one can compensate people for their pain and when one cannot. One may think that morality is simply doing whatever produces the greatest good for the greatest number; others may believe that morality is nothing more than maximizing one’s wealth. One may believe any of these things has a moral compass to direct one’s daily life. One should come to the realization that sometimes the ends do not justify the means and sometimes the ends themselves are not pursuing. But a company/corporation has one end in mind. Corporations have nothing called systems or beliefs. The result is that corporations are able to act without morality or accountability, for they are formed for that one purpose: To maximize pecuniary shareholder’s value. Therefore, to maintain the sanctity of a corporate self, the corporations self, the corporations are required to follow a moral and ethical suit that has become more pronounced in the present scenario, and has indeed exceeded the axiom of wealth maximization.
What went wrong in the recent past? » Environment » Loss of moral fibre of corporations » Business environment characterized by need to compete with the new economy » Boards » Fundamental weaknesses in business models sought to be compensated by adoption of aggressive accounting practices » Ignored ethics and value systems when a much hyped business strategy failed to deliver as expected and articulated to Wall Street » Incompetence of board members and overriding of audit committees » Managements » Stock option heavy compensation structures » Bonus linked to short-term revenue growth, EPS and stock price » An inability to accept failure » Excessive focus on beating the street » Auditors » Aggressive interpretation of accounting standards » Independence compromised to obtain lucrative consulting assignments » Employees » Compensation linked to stock-price movement » Large disparity between the highest and lowest paid employee » Culture of greed promoted within the organization by management » Manipulative accounting practices » Analysts » Ever-greening of reports with an eye on investment banking assignments » Pressurized managements to beat quarterly estimates » Investors » Short term focus of investors
Concept of Corporate Governance
The concept of corporate governance cannot be completed without acknowledging the contribution of the most celebrated scholar of ancient India, Kautilya. One of the worlds most compete manuscript on the science of governance was penned by Kautilya in the third century BC. Kautilya’s discussions on administrations and management are strikingly modern and scientific covering almost all facets of governance. According to him, an ideal king is one for whom Praja sukhe, sukhamragyam, Prajanan ca hite hitam, Naatman priyam hitam ragyan Prajanan tu piyam hitam, i.e., in the happiness and wellbeing of the subjects lies the well-being of the king, in the welfare of the subjects is the welfare of the king, what is desirable and beneficial to the subjects and not his personal desires and ambitions is desirable and beneficial for the king. He further elaborates that a king has fourfold duty as Raksha or protection, vridhi or enhancement, palana or maintenance, yogakshema or safeguard. It is the duty of the king to protect the wealth of the state and its subjects. If we for a moment assume today’s business CEO or corporate board as king and the shareholders as the subject, it brings out the quintessence of corporate governance as public good should be ahead of private good and company’s resources should not be used for personal gains .The four duties in corporate parlance would imply protection of shareholders wealth enhancement of wealth by proper utilization of assets, maintaining the wealth (without appropriating it otherwise)and safeguarding the interests of all stakeholders.
Aims of Corporate Governance
• • • • • Fulfilling long-term strategic goals of owners Taking care of the interests oh employees A consideration of the environment and local community Maintaining excellent relations with customers and suppliers Proper compliance with all the applicable legal and regulatory requirements.
Following extracts fro Kumar Mangalam Birla’s report on corporate governance brings out the cardinal principle of corporate governance-“Strong corporate governance is indispensable to resilient and vibrant capital markets and is an important instrument of investor protection .It is the blood that flow within the veins of transparent corporate disclosure and high quality accounting practices. It is the muscle that moves a viable and accessible financial reporting structure.”
Results of Good Corporate Governance
Enhancing the value for stakeholders. A well-understood corporate vision/mission statement. A broad-based board, comprising of directors with professional and expert acumen with independent dispositions. • Establishment of relevant committees of the board, with their roles clearly defined, to oversee functions of the company in critical areas. Setting standards for good corporate practices to• • •
• • • •
1. Ensure a transparent and fair relationship between the stakeholders and the company, 2. Institute a comprehensive management evaluation system; 3. Proactively eliminate investor complaints and evolve for redressal of the grievances (of the customers, investors and borrowers),and, 4. Institute systems and processes to ensure compliance with the statuses and laws concerning the company. A clearly enunciated code of conduct for dealing with the stakeholders. Effective systems of internal control, monitoring and reporting mechanisms. Communication to the shareholder to ensure a high degree of transparency. The board to establish appropriate policies and monitor the performance at all levels organization including self-evaluation.
Components of Corporate Governance
Board of Directors Shareholders Management
The main constituents of Corporate Governance are the shareholders, the board of directors and the management. The Board of Directors is responsible for the governance of the company. The board members set the strategic objectives, frame financial as well as other policies and oversee the implementation thereof, control the financial aspects and present the director’s report on the activities and the progress of the company to the shareholders to whom they are accountable. The board’s actions are subject to applicable laws, rules and regulations. The shareholder’s role in enabling good governance is to identify and elect the directors as well as auditors of the company and satisfy themselves as well as the auditors of the company and satisfy themselves that an appropriate governance structure is in place. The responsibilities of the senior management include ensuring that control systems are in place to achieve the objectives laid down by the Board and help the board to discharge its responsibilities to the shareholders effectively.
Is Corporate Governance a Business Ethic?
Yes, Corporate governance is about ethical conduct in business. Business ethics are concerned with the core values and principles that enable a person to choose between right and wrong and, therefore, select from alternative courses of action. However, ethical dilemmas may arise from conflicting interests of the parties involved. Managers have to, thus, make decisions based on a set principles influenced by the values, context and culture of the organization. Ethical leadership is desirable for business as the organization is seen to conduct its business in line with the expectations of all concerned stakeholders. Independent directors of the company, i.e., board, are pivotal to the implementation of corporate governance code and achievement of its desired results. Independent directors are expected to take active interest in taking part in the company’s board functions including policy formulation and strategic business decisions. The board should function through committees, comprising of most of the directors, who are independent. These committees could be: • Audit committee • Remuneration committee • Nomination committee • Shareholders committee • Other committees specific to company’s needs. Audit committees exercise responsibility in three important areas: 1. Financial reporting 2. Corporate Governance 3. Corporate control In financial reporting ,the responsibility of audit committee should be to provide assurance to the board about financial disclosures made by the management to reasonably portray the company’s financial health, results of operations, true and fair view of state of affairs and profitability, and the company’s future plans and long-term commitments. The role of audit committees in corporate relevant laws and regulations, is conducting its affairs ethically, and is maintaining effective control against any conflict of interest and malafide practices .In corporate control, the audit committee’s responsibility should include an understanding of the company’s key financial reporting, areas and the system of internal control and fiscal management.
Legal and regulatory framework of corporate governance mainly covers the legal regime as stipulated in the Securities and Exchange Board of India (SEBI)guidelines and Companies Act (1956) covering various Indian Codes and Recommendations of committees. Corporate Governance extends its jurisdiction beyond corporate laws. Its fundamental objective is not only to merely fulfill the requirements of law but also to
ensure commitment of the board in managing the company in a transparent manner for maximizing long-term shareholder value. It should be noted that effectiveness of any corporate governance system cannot be legislated by law alone. While several laws exist to take care of most of the investor grievances, the implementation and inadequacy of penal provisions have left a lot to be desired and this is an area which requires significant improvement. The real onus of achieving the desired level of corporate governance, therefore, lies in the proactive initiatives taken by the companies and their board internally and not by way of external measures. In the Indian context, there is no single apex a regulatory body which can be said to be the regulation of corporate, but there exists a coordination mechanism among various functional regulators. For example, in India, we have different regulators for the following: • Corporates (MCA) • Capital Market and Stock Exchanges (SEBI) • Money Market and Banking (RBI) • Insurance—Life and Non-Life (IRDA) • Communication (TRAI) • Foreign business (FIBP) • Imports and Exports (FEMA, DGFT) • Professions (Professional Institutes such as ICAI, ICSI, ICWAI, etc.).
Corporate Gov Drivers: A C
CCG & C
REGULA Regulators (SEBI/RBI)
Behind any corporate success or corporate failure lies the reason to it in the form of corporate governance. Good governance in any corporate the world over is the interplay of legal requirements, the ethics, effectiveness, board relationships and group dynamics. Corporate Governance is common to one and all, be it India, China, Africa, or the other advanced countries such as the US or the UK. In the corporate sector, governance has been extrapolated to cover issues such as corporate sustainability, social and financial inclusion, social responsibilities or even social inclusion, etc .In fact, every such issue hinges on good governance, be it any part of the world. Since India and its economy are no longer isolated constitute an important part of the global economy, it is high time that Indian Companies also marched towards global best practices. While operations, capital and risk management, technological innovations and customer satisfaction shall be the drivers of growth, it is going to be corporate governance which shall lead Indian Corporate to match best business practices on the globe. Comparison of Board structure – Indian top 50 Vs U.S. top 50 – Key Findings Parameter Ownership pattern
India (Nifty Fifty companies) US (top 50 out of NYSE 100 index)
48% of Indian companies have Largest shareholder holds less largest shareholder holding than 10% in all cases over 50% • • Largest board size – 17. smallest – 5 44% of the top 50 companies have more than 12 directors • • Largest board size 18. smallest – 10 66% of the top 50 companies have more than 12 directors
All companies have a board of independent 58% of companies majority have a board majority directors of independent directors 12% have less than 1/3rd of their directors independent
In 35 companies 50% of the Boards of 49 companies out of directors – or more – are 50 have less than 25% executive directors executive directors 60% have separate Chairman Only 20% have Chairman and CEO and CEO separate
Chairman and CEO
Lead independent director Board committees
3 companies have independent directors •
lead 20 companies have independent directors
All companies have fully audit All companies have independent audit committees – remuneration and nomination 54% have fully committees independent Audit Committees 33 companies have remuneration committees – of these 14 fully independent and 16 have majority independent committees 9 companies have nomination committees – 6 are fully independent and 3 have majority independent committees
Source: Crisil Report on Corporate Governance
Management vs. Governance
Many people often mistakes the two terms to be synonymous. Even well-managed corporations could be badly governed and lead to corporate failure. While governance has to come fro the topmost layer-the-board-the management functions one layer beneath the board, the executive or top management. The well-governed model will come from more new ideas, more adaptable decision making and better accountability. Companies in India will have to shift from best managed companies to best governed companies where the board’s role will be to foster effective decisions and reverse failed policies.
Effective board empowerment is missing on Indian corporate boards. This emanates from the composition itself which in most public sector units is government controlled. In contrast, private sector company boards are more effective, efficient contributing, responsive and empowered. This gets reflected in quality qualification of director’, selection process, contributions made and even the sitting fees paid to them. While private sector boards could be said to be assets in many public sector cases in India, one
finds many boards devoid of good people. Each board is a mix of all variants which dilutes the quality. The mis-governance in the recent example of Punjab and Sindh Bank is a glaring case before us. towards global best practices, Indian companies are expected to move in the direction of board empowerment so that boards can be effective. One should not have any reservation about empowering outside directors, but this is the only way to take out the best from them ;of course with a defined code of conduct in place-which we behave. There have been several instances where independent directors participate more effectively in the board meetings and CEOs in such entities do not find their powers diminished. The practice of empowering the boards is followed in companies such as Dayton Hudson Corporation, Monsanto, and General Motors, etc. One need to be reminded that corporate governance, at its core, is not about power, but about ensuring that decisions are made effectively.
Recent trends in Corporate Governance include issues such as social corporate responsibilities, value rating for governance and concepts such as economic value added, market value added, total shareholder value and human resources. All these concepts tend to enhance the value of corporate governance practices and consider quality so far as financial performance is concerned.
W hat is the Current Status
G reater emphasis on leaders hip by exam ple
Boards are returning to basic value s ystem s
While Corporate governance is a necessary tool for managerial performance, it also leads to corporate growth and excellence. ‘Corporate’ is a path on which one can drive to reach the heights of excellence and from there, proceed towards another milestone only through good corporate governance practices. Corporate governance is the path on which success can be experienced and excellence reached. It is the vehicle that drives an institution to the stage of corporate excellence --a state of the highest satisfaction in terms of value creation not only for the owners or contributors of capital and labor but also for all the other stakeholders of an enterprise. Ideals of corporate governance primarily need transparency, full disclosure, fairness to all stakeholders and effective monitoring of the state of corporate affairs. The basic philosophy of corporate governance is to achieve business excellence and enhance stake holder’s value while keeping in view the need to balance the interests of all stakeholders.
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