Section A

Introduction to corporate governance

Meaning and definition: Corporate Governance is a set of processes, customs ,policies ,laws
& instructions affecting the way a corporations is directed ,administrated or controlled.

Definition: Sir Adrian Cadbury ; “Corporate Governance is concerned with holding the
balance between economic & social goals and between individual and communal goals. The
CG framework is there to encourage the efficient use of resources and equally to require
stewardship of those resources. The aim is to align as nearly as possible the interest of
individuals, corporations and society.”

In other words ; CG may be defined as a set of systems, processes and principles which
ensures that a company is governed in the best interest of all the stakeholders. It is the system
by which the companies are directed and controlled. It is about promoting corporate fairness,
transparency and accountability.

Good corporate governance’ is simply ‘good business’. It ensures:

• Adequate disclosures and effective decision making to

achieve corporate objectives.

• Transparency in business transaction.

• Statutory and Legal Compliances

• Protection of shareholder interests

• Commitment of values and ethical conduct of business

OBJECTIVES OF CORPORATE GOVERNANCE:

 To eliminate or mitigate conflicts of interest.

 To maintain transparency in the operation of business.
 To maintain fairness in dealings of business.
 To protect the interest of shareholders.
 To develop an efficient organizational culture.
 To aid in achieving social and economic goals.
 To mitigate wastages, corruption, Red tapism etc.
 To ensure that the assets of the company are used efficiently and productively and in the best
interest of its investors and other stakeholders.

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 Significance of corporate governance

1. It ensures transparency
2. Ensures accountability
3. Fairness
4. Facilitate easy financing
5. Improve reputation and good image
6. Social responsibilities
7. Higher firm valuation and share performance
8. Eliminate corruption
9. Sound and clear administrative policies
10. Reduce conflict of interest
11. Facilitate dispute resolution
12. Good corporate governance ensures corporate success and economic growth.
13. Lowers the cost of capital: companies who are applying good corporate governance, can
borrow at low interest rates.
14. Good corporate governance also minimizes wastages, corruption, risks and
mismanagement.

Pillars of Corporate Governance

 Accountability: accountability of management to BOD and accountability of BOD to
shareholders
 Fairness: treating each party equally and fairly, Protect Shareholders rights, treat all
shareholders including minorities, equitably, Provide effective redress for violations etc.
 Transparency: ensuring transparency in operations, disclosing financial statements and Ensure
timely, accurate disclosure on all material matters, including the financial situation,
performance, ownership and corporate governance.
 Independence: Independent Directors and Advisers i.e. free from the influence of others.

Conceptual framework of Corporate Governance

More recently, corporate governance has been defined as the framework of rules and procedures
by which the decisions in an enterprise are made, and how the controllers and held accountable
for them.  The term, ‘enterprise’ refers to all types of associations, companies, trusts and other
hybrid entities that provide a product or service (Enterprise). An example of a corporate
governance framework can be seen in a basic proprietary limited company.  In this situation, the
Enterprise has a board of directors, who have responsibilities to their stakeholders, their
customers and the government, both state and federal. A basic framework of corporate
governance can be explained in following fig.

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 Regulatory framework on corporate governance

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There is no specific act or law regarding corporate governance in India but the Indian
framework on Corporate Governance has been vastly in sync with the international standards.
Broadly, it can be described in the following:

The Companies Acts 2013 has provisions concerning Independent Directors, Board

Constitution, General meetings, Board meetings, Board processes, Related Party Transactions,
Audit Committees, etc.

SEBI (Securities and Exchange Board of India) Guidelines ensure the protection of investors
and have mandated the companies to adhere to the best practices mentioned in the guidelines.

Accounting Standards issued by the ICAI (Institute of Chartered Accountants of India)

wherein the ICAI is an autonomous body and issues accounting standards. The disclosure of
financial statements is also made mandatory by the ICAI backed by the Companies Act 2013,
Sec. 129.

Standard Listing Agreement of Stock Exchanges applies to the companies whose shares are
listed on various stock exchanges.

Secretarial Standards Issued by the ICSI (Institute of Company Secretaries of India) issues

standards on ‘Meetings of the board of Directors’, General Meetings’, etc.. The companies Act
2013 empowers this autonomous body to provide standards which each and every company is
required to adhere to so that they are not punished under the Companies Act itself.

Principles of Corporate governance

Principle Number 1: Ensuring the basis for an effective corporate governance framework:
The corporate governance framework should be developed with a view to its impact on overall
economic performance, market integrity and the incentives it creates for market participants and
the promotion of transparent and well functioning markets.

 The legal and regulatory requirements that affect corporate governance practices should be
consistent with the rule of law, transparent and enforceable.
• The division of responsibilities among different authorities should be clearly
articulated and designed to serve the public interest.

• Stock market regulation should support effective corporate governance.

• Cross-border co-operation should be enhanced, including through bilateral and

multilateral arrangements for exchange of information.

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Principle Number 2: The rights and equitable treatment of shareholders and key
ownership functions. Basic shareholder rights should include

• secure methods of ownership registration

• convey or transfer shares

• obtain relevant and material information on

• the corporation on a timely and regular basis

• participate and vote in general shareholder meetings

• elect and remove members of the board

• share in the profits of the corporation.

Shareholders should be sufficiently informed about:

• Amendments to the statutes, or articles of incorporation or similar governing documents of

the company.

• The authorization of additional shares.

• Extraordinary transactions, including the transfer of all or substantially all assets, that in
effect result in the sale of the company.

Rights of shareholders:

• Shareholders should have the opportunity to participate effectively and vote in general
shareholder meetings

• Shareholders should have the opportunity to ask questions to the board, including questions
relating to the annual external audit, to place items on the agenda of general meetings, and to
propose resolutions, subject to reasonable limitations.

• Effective shareholder participation in key corporate governance decisions, such as the

nomination and election of board members

Principle Number 3: Institutional investors, stock markets, and other intermediaries.

• An institutional investor is an entity which pools money to purchase securities, real

property, and other investment assets or originate loans. They should disclose their corporate
governance with respect to their investments, including the procedures.

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• The corporate governance framework should require that advisors, analysts, brokers, rating
agencies and others that provide analysis or advice relevant to decisions by investors,
disclose and minimize conflicts of interest.

• Stock markets should provide fair and efficient price discovery as a means to help promote
effective corporate governance.

Principle Number 4: The role of stakeholders in corporate governance

• The rights of stakeholders that are established by law or through mutual agreements are to be
respected.

• Where stakeholder interests are protected by law, stakeholders should have the opportunity to
obtain effective redress for violation of their rights.

• Where stakeholders participate in the corporate governance process, they should have access
to relevant, sufficient and reliable information on a timely and regular basis.

• Stakeholders, including individual employees and their representative bodies, should be able
to freely communicate their concerns about illegal or unethical practices to the board and to
the competent public authorities and their rights should not be compromised for doing this.

Principle Number 5: Disclosure and transparency: Disclosure and transparency includes

1. The financial and operating results of the company.

2. Company objectives and non financial information.

3. Major share ownership, including beneficial owners, and voting rights.

4. Remuneration of members of the board and key executives.

5. Related party transactions.

Principle Number 6: The responsibilities of the board

• Board members should act on a fully informed basis, in good faith, with due diligence and
care, and in the best interest of the company and the shareholders.

• The board should treat all shareholders fairly.

• The board should apply high ethical standards.

• It should take into account the interests of stakeholders.

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 • Monitoring the effectiveness of the company’s governance practices and making changes as
needed.

• Selecting, compensating, monitoring and, when necessary, replacing key executives and
overseeing succession planning.

• Ensuring a formal and transparent board nomination and election process.

Theories of corporate governance

A key feature of modern day corporations is separation of ownership and control. Such a
separation gives rise to some corporate governance issues. Beginning from 1980’s, many
theories have been proposed by to explain and address corporate governance problems that arise
due to such separation. Some of the important theories are:

Agency/Shareholder theory

Stewardship theory

Stakeholders’ theory

Agency/Shareholder theory

(i) Concept - Jensen and Meckling (1986) defined the Agency/Shareholder relationship “as a
contract under which one or more person (the principals) engage another person (the agents)
to perform some service on their behalf which involves delegating some decision-making
authority to the agent”
(ii) Who is the principal - In the context of corporates, shareholders (principals) define the
objectives of the company.
(iii) Who is the agent - Board of Directors (BODs) and managers are considered as agents.
Shareholders delegate their power to BODs and who in turn delegates it to managers. BODs
is accountable to shareholders.

Assumptions

 Divergence of interest of shareholders and Board of Directors - Agency theory assumes that
the interests of principles and agents diverge and both of them seek to promote their own
interest.
 Information asymmetry - BODs have a better access to information about entity’s position vis-
a-vis shareholders.
 BODs have a fiduciary relationship with the shareholders.
Shareholders are interested in maximizing wealth while managers would be interested in
protecting and enhancing his pay and perks. This conflict of interest leads to Agency problem
where the important issue is how to ensure that agent acts in the best interests of the principal.

 Agency problem results in Agency costs, for example, monitoring costs etc.

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 Some ways to reduce agency cost - The shareholders (principal) need to ensure that agents act
in the best interest of shareholders and not abuse their power. Some of the ways to reduce agency
cost are:

 Fair and adequate financial disclosures

 Appointment of independent directors.
 Appointment of credible independent auditors.
 Board Committees to check issues like excessive remuneration, appointment of knowledgeable
directors, etc.
 Formation of Audit Committees

Stewardship theory

Concept - There is no conflict of interest between the shareholders and BoD and managers.

Who is a steward - According to stewardship theory top management acts as stewards for the
organization. According to this theory “a steward protects and maximizes shareholders’ wealth
through firm performance, because by so doing, the steward’s utility functions are maximized”.

Assumptions –

 Managers are trustworthy individuals and so are good stewards of the resources entrusted by
them by the shareholders.
 Senior managers have superior access to important information and are, thus, able to make
informed decisions.
 Managers attach significant value to their own personal reputations
 Manager is steward of principal
 Steward will do good for organization
 Controls will demotivate stewards

Role of shareholders and stewards

 The shareholders trust the stewards and give them autonomy.

 Employees or executives act to ensure the shareholders’ returns are maximized
 Stewardship theory sates that in order to protect their reputation and retain trust of the
shareholders, executives and directors will work to maximize financial performance of the
entity as well as shareholders’ profits.
 The theory suggests unifying the role of CEO and the chairman.

Benefits –

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 Trust is high and stewards are motivated to work in the interest of the organization.
 New ideas can be implemented leading to growth of the firm.
 Agency costs get automatically reduced.

Stakeholder Theory

Concept - Stakeholder theorists suggest that corporate strategies should be designed to take care
of interest of all the stakeholders.

Who is a stakeholder –

A stakeholder is defined as any person/group which can affect/be affected by the actions of a
business. It includes shareholders, employees, customers, suppliers, creditors, competitors and
even the wider community. These all are stakeholders.

The stakeholders are, generally, split into two groups- primary stakeholders and secondary
stakeholders. The existence and survival of organization depends on relationship of business
with primary stakeholders. primary stakeholders are those who have a direct interest in a
company, secondary stakeholders are those who have an indirect interest. Examples of primary
stakeholders include shareholders, employees, customers, suppliers, vendors and business
partners. Business competitors, trade unions, media groups, pressure groups and state or local
government organizations are some examples of secondary stakeholders.

Diversified Board structure - The stakeholders can have their representatives appointed on the
Board of Directors who will look after their interest.

Stakeholders and CSR - Stakeholder theory implies that it can be beneficial for the firm to
engage in certain corporate social responsibility activities that stakeholders other than
shareholders perceive to be important. Without such activities these stakeholders might withdraw
their support from the firm.

Emergence of Corporate Governance in India

Corporate governance has existed since past but it was in different form. During Vedic times
kings used to have their ministers and used to have ethics, values, principles and laws to run their
state but today it is in the form corporate governance having same rules, laws, ethics, values, and
morals etc which helps in running corporate bodies in the more effective ways so that they in the
age of globalization become global giants.

Corporate governance concept emerged in India after the second half of 1996 due to economic
liberalization and deregulation of industry and business. With the changing times, there was also
need for greater accountability of companies to their shareholders and customers. The report of
Cadbury Committee on the financial aspects of corporate Governance in the U.K. has given rise
to the debate of Corporate Governance in India.

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Need for corporate governance arises due to separation of management from the ownership. For
a firm success, it needs to concentrate on both economical and social aspect. It needs to be fair
with producers, shareholders, customers etc. It has various responsibilities towards employees,
customers, communities and at last towards governance and it needs to serve its responsibilities
at the best at all aspects.

Several Indian Companies like PepsiCo, Infuses, Tata, Wipro, TCS, and Reliance are some of
the global giants which have their flag of success flying high in the sky due to good corporate
governance.

Toady, even law has a great role to play in successful and growing economy. Government and
judiciary have enacted several laws and regulations like SEBI, FEMA, Cyber laws, Competition
laws etc and have brought several amendments and repeal the laws in order that they don’t act as
barrier for these corporate bodies and developing India. Judiciary has also helped in great way by
solving the corporate disputes in speedy way.

A few companies have also shown awareness of environment protection, social responsibilities
and the cause of upliftment and social development and they have deeply committed themselves
to it. The big example of such a company can be of Deepak Fertilizers and Petrochemicals
Corporation Limited which also bagged 2nd runner up award for the corporate social
responsibility by business world in 2005.

Under the present scenario, stakeholders are given more importance as to shareholders, they even
get chance to attend, vote at general meetings, make observations and comments on the
performance of the company.

Good Corporate Governance

Obligation to society at large :

 National Interest
 Legal Compliances
 Rule of Law
 Honest and Ethical Conduct
 Corporate Citizenship
 Ethical Behaviour
 Social Concerns
 Corporate Social Responsibility

Environment- friendliness:: Health, Safety and Working Environment

 Obligation to investors :
 Towards Shareholders
 Measures Promoting Transparency and Informed Shareholder Participation
 Transparency

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 Financial Reporting and Records

Obligation to customers:

 Quality of Products and Services

 Products at Affordable Prices
 Unwavering Commitment to Customer Satisfaction

Obligation to employees

 Fair Employment Practices

 Equal- opportunities Employer
 Encouraging Whistle Blowing
 Humane Treatment

Managerial obligation:

 Protecting Company’s Assets

 Behaviour Towards Government Agencies Control
 Consensus Oriented Gifts and Donations

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