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CORPORATEGOVERNANCE

Meaning:
Corporate governance refers to the set of processes, customs, policies, laws and
institutions influencing the administration of a corporation.
Corporate governance includes the relationships among the many players and the goals of
the corporation.
The shareholders, management and the board of directors are the principal players. The
employees, suppliers, customers, banks, the environment and the community at large are
the other stakeholders.
Accountability of individuals and economic efficiency of the corporation are the
important aspects of corporate governance. The stakeholder view and the corporate
governance models are also the topics of concern of corporate governance. Thus
corporate governance is a multi-faceted subject.

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
and integrity. Sound corporate governance is reliant on external market place
commitment and legislation, plus a healthy broad culture which safeguards policies and
processes".

According to SEBI, corporate governance is the acceptance by the 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. Corporate governance is considered as
ethics and a valuable duty.

Principles of corporate governance


Honesty, trust, openness, performance orientation, responsibility, accountability, mutual
respect and commitment are the key elements of corporate governance.
The important principles of corporate governance can be stated as follows:
(1) Rights of shareholders:
Corporations should respect the rights of shareholders and help the shareholders to
exercise their rights.
(2) Equal treatment for shareholders:
Equal treatment should be given to all the shareholders. All the shareholders are to be
encouraged to participate in general meetings.
(3) Interests of stakeholders:
The interests of all the stakeholders have to be protected.
(4) Role ofthe Board of Directors:
The Board of Directors should be dynamic, efficient and capable of developing a range of
skills. It should be capable of meeting all the challenges. It should be sufficient in size
and a good level of commitment to fulfill its responsibilities and duties. There should be a
good mix of executive and non-executive directors. The key positions of chairman and
CEO should not be held by the same person.
(5) Ethical behaviour:
Corporations should develop a code of conduct for the directors and executives to
promote ethical and responsible decision making. Many corporations have established
Compliance and Ethics Programmes to minimize the risk that the firm steps outside of
ethical and legal boundaries.
(6) Disclosure and transparency:
There should be the timely and balanced disclosure of matters related to the organisation
so that all investors have accessto clear and factual information.

Issues involved in corporate governance principles:


Corporate governance involves in the following issues.
• Effective internal controls and independence of auditors.
• Correct preparation of financial statements.
• A good review of the compensation arrangements for CEO and other Directors.
• Nomination of members of the Board.
• Management of risk.
Rights of corporation:
A corporation is a legal entity with the following rights:
(i) The ability to sue and be sued.
(ii) The ability to hold assets in its own name.
(Hi) The ability to hire agents.
(iv) The ability to sign contracts.
(v) The ability to make by-laws to govern its internal affairs.

Need for corporate governance:


(1) It is reducing the risk of the investor.
(2) It increases the mobilization of capital.
(3) It enhances the value of the companies.

The companies have to be evaluated on the basis of commitment to good


corporate governance, shareholders' rights, nature of Board of Directors as well as
transparency and disclosure.

Most of the Indian companies are a hybrid of family owned


and publicly listed companies with the following problems:
(a) Ownership and management are not separated.
(b) Governance policies are informal.
(c) The controls are inadequate.
(d) Absence of professional management.
(e) The rights of shareholders are not fully protected.
(f) Absence of adequate transparency and disclosure.

Tata Group:
Corporate governance in Tata group is fair and civic minded, fulfilling its duties to the
stakeholders.
Integrity is an article of faith across all its operations. Jamsetji Tata gave importance to
the means and ends.

Tata wrote: "We do not claim to be more unselfish, more generous or more philanthropic
than other people, but we think we started on sound and straightforward business
principles, considering the interests of the shareholders our own, and the health and
welfare of the employees the sure foundation of our success.
The 'leadership with trust' is the philosophy of Tatas. Tata Business Excellence Model is
a framework which helps Tata companies to achieve their business objectives through
specific process.

Global Reporting Initiative (GRI) is an independent body affiliated to UNO. GRI has a
triple bottom approach, financial, social and environmental. Tata group has the
appreciation of GRI.

Theories of corporate governance


I. Agency theory:
This theory is based on the principal-agent framework. One party, namely, the principal
delegates work to another party, the agent. The agent has to work for the principal.
The managers are supposed to be the agents of a corporation's owners. At the same time,
the managers must be monitored and checks and balances have to be implemented. The
costs resulting from managers are called 'agency costs'.
Both the principal and manager should have a clear and correct understanding. Both
should have correct access to information.
There is the separation of ownership and control. All the shareholders, including minority
shareholders have to be protected. There is a drive for effective shareholders. The need
for improved transparency and disclosure are also emphasized.

II. Transaction cost economics:


This theory was developed by Williamson and is closely related to agency theory. The
firm is considered as a governance structure. The marketing costs have to be saved. The
ideas of economies of scale and scope have to be introduced. Good governance can
reduce the cost and increase the profit. A mere operation of incentives is not good in the
long run.
In terms of this theory, there is a justification for the growth of large firms and
conglomerates. it states that the costs may be reduced by judicious choice of governance.

III. Stakeholder theory:


Good governance should take care of the interests of all the stakeholders. There are many
stakeholders like shareholders, employees, suppliers, customers, local communities and
government. A good corporate governance should increase the long-term enhancement of
the various stakeholders. The corporate governance should recognize the rights of the
stakeholders established through mutual agreements and encourage active co-operation
between corporations and stakeholders. This will result in the good co-operation of all the
stakeholders.

IV. Stewarding theory:


There should be a unity of command in the corporate governance. The managers should
be empowered to take autonomous executive action. The share holders should facilitate
authority to exercise managerial opportunism by the board.

Role of independent directors:


There is an urgent need to minimise corporate frauds and scams. An effective tool is the
reinforcement of the institution of audit. Audit committees should play an important role
through the guidance of independent directors. It should be noted that independence
should be combined with competence.
The corporations should appoint competent independent directors to achieve higher
standards of governance.
The independent directors should be able to offer wise inputs for the companies.
Naturally, the remuneration for independent directors should be of decent standards.
Globalisation requires high standards of governance.
The non-executive or independent directors should have proper competences and enough
time.
They should meet appropriate independence criteria. They should be appointed for
specified terms subjected to re-election. They should have required diversity of
knowledge, judgement and experience to properly complete their tasks.
The independent director should be independent from any business, family or other
relationship with the company.

Independent directors are invited to join the board for their specialisation and expertise in
achieving a balance of knowledge, skills and attitudes of other directorial resources.
Neutrality of views and the quality of debate at the board level are necessary for good
governance.

Irani Committee (2005) has recommended the important advisory role of independent
directors. The independent directors should be independent in their thinking, approach
and actions.
An independent director should be independent of judgement with no pecuniary
relationship.
An independent director is required because of independent judgement, technical
expertise and to build investor confidence.

Duties of independent director:


(i) To reduce potential conflict between specific interests of the management and wider
interests of the company and shareholders.
(ii) To demand financial transparency.
(Hi) To safeguard the interests of minority shareholders.
(iv) To protect the interests and welfare of the employees.
(v) To make independent assessment of evaluating business plans.
(vi) To make the use of technical and financial expertise and experience for the
development of the corporation.
(vii) To make useful communication between management and shareholders.

Power of independent directors:


(i) Power to demand the necessary information.
(ii) Power to exercise the vote.
(Hi) Power to govern.

Independent directors are the cornerstones of good corporate governance. Their duty is to
provide an independent unbiased and experienced perspective to the Board of Directors.
One third of company's directors are required to be independent. The independent
directors should be really independent. The independent directors are the only hope to
instill some discipline in the murky world of corporate finance.

The independent directors bring to the corporation a wide range of experience,


knowledge and judgement from their proficiencies in finance, housing, management, law,
accounting and corporate strategy. The corporations should be immensely benefited from
their inputs. In fact, the audit committee and compensation committee should be
consisting of independent directors
The independent directors should safeguard the interests of the company during difficult
times.

Board structure:
An ideal board structure is necessary for good corporate governance. Recent research has
shown that effective boards must be legitimate and credible. It should be legitimate in the
sense that stakeholders perceive the board to represent all significant interests and
perspectives. It should also be creditable in the sense the board is viewed as
knowledgeable and fair and that the board process is considered rational.
The combined code of best practices was given by Cadbury code.
The board is the link between managers and shareholders. The board is essential to good
corporate governance and excellent investor relations.

High performance boards should achieve the following core objectives:


(a) Strategic guidance for the growth and prosperity of the company.
(b) Accountability to all the stakeholders.
(c) Provision of a highly qualified team to manage the company.

Role. duties and responsibilities:


The board's role is to provide entrepreneurial leadership of the company within a
framework of effective controls. The risks have to be assessed and managed. Decisions
have to be taken in an objective way and the interests of the company have to be
protected.
The boards should have regular meetings with an agenda. There should be appropriate
reporting procedures. The roles of chair and CEOshould preferably be split to ensure that
no one individual is too powerful. There should be a balance between executive and non-
executive directors.
All the directors should have access to the company secretary. They can also take
independent professional advice.

The following are the duties of directors:


(a) To act in accordance with the company's constitution.
(b) To promote the success ofthe company.
(c) To exercise independent judgement.
(d) To exercise reasonable care, skill and diligence.
(e) To avoid conflicts of interest.
(f) Not to accept benefits from third parties.
(g) To declare an interest on proposed transactions or arrangements.

It is not possible for the directors to please all shareholders at all times. Directors should
have access to reliable information regularly. The board should be accountable to
shareholders and provide them the relevant information.

Chief Executive Officer:


The CEOhas the executive responsibility of running the business. The CEO should not
become the chairman of the company.

Chairman:
The chairman is responsible for the effective running of the board. The board should
meet frequently and the directors should have access to all information and all the
directors should have an opportunity to give their views at board meetings.

Senior Independent Director:


There should be an appointment of a Senior Independent Director (SID) who should be
one of the independent non-executive directors. The SID should be available to the
shareholders if they have concerns to be resolved.
The non-executive directors should meet without the chairman present at least annually in
order to appraise the performance of the chairman. The SIDwill lead these meetings.

Company secretary:
The company secretary should facilitate the work of the board by providing the necessary
information to all the directors. The company secretary can advice the board, via the
chairman, on all governance matters. The company secretary will assist the professional
development needs of directors and induction requirements for new directors. The
company secretary must act in good faith and avoid conflicts of interest. The dismissal of
the company secretary should be a decision of the board as a whole and not the CEOor
chairman.

Audit committee:
It is a most important subcommittee. It should review the scope and outcome of the audit.
It should ensure that the objectivity of the auditors is maintained. It provides a bridge
between both internal and external auditors and the board. The board should be fully
aware of all relevant issues related to the audit. It should be able to assessthe financial
and non-financial risks of the company.

Remuneration committee:
This committee should make recommendations to the board on the company's framework
of executive remuneration and its cost. It should determine remuneration packages for
each of the executive directors, including pension rights and any compensation payments.
The establishment of a remuneration committee has prevented the executive directors
from setting their own remunerations. The remuneration of non-executive directors
should be decided by the chairman and the executive members of the board.

Nomination committee:
Directors were appointed on the basis of personal contacts in the past. At present there is
a formal, rigorous and transparent procedure for the appointments and recommendations
to the board. A majority of members of the nomination committee should be independent
non-executive directors.
This committee should evaluate the existing balance of skills, knowledge and experience
on the board. It should throw its net as wide as possible for the search of suitable
candidates.

Risk committee:
Business operations involve risks and this committee should comprehend the risks
involved in the business. The competitive advantages have to be analysed. This
committee should be consisting of more of non-executive directors.

Non-executive directors:
Non-executive directors are essential for good governance. They cannot be under the
pressure of the Board of Directors as executive directors. The non-executive directors can
add to the overall leadership and development of the company.
The non-executive directors should be independent in the presentation of their views.
They should scrutinize the performance of the management in meeting agreed goals and
objectives. The added value of a non-executive director may be experience, knowledge,
public life and reputation. The non-executive directors should bring an independent
judgement to bear on issues of strategy,
performance, resources and standards of conduct.

Director's remuneration:
The following are the six elements in director's remuneration:
(1) Basic salary
(2) Bonus
(3) Stock options
(4) Restricted share plans
(5) Pension
(6) Benefits like car and health care

The basic salary is in accordance with terms of contract. It is neither related to the
performance of the company nor the performance of an individual. The size of the
company and the experience of the individual are the major deciding factors.
The bonus is linked to the accounting performance of the firm. The stock options give the
directors to purchase shares at a specified exercise price over a specified time period.

Performance measures:
The following are the important performance measures:
• Shareholder return
• Share price
• Profit related measures
• Return on capital
• Earnings for share
• Performance of individual director

Training and development of Directors:


The directors who are elevated from managerial roles find it difficult to understand their
roles.
It is more than a change of responsibility. The newly inducted directors should know
the answers for the following questions:
(a) What are the challenges of the new role?
(b) What are the expectations of the company, customers, and investors?
(c) How to handle the change of status and relationships?

The directors should be given training in the following areas:


(1) Diversity managing training.
(2) Understanding the basics of economy and industry.
(3) Orientation to the company.
(4) Finance for non-financial directors.
(5) Marketing strategies.
(6) Negotiation skills.
(7) Management of HR issues.
(8) Leadership.
(9) Mergers and acquisitions.
(10)Effectiveness of the Board.

Accounting standards:
Accounting standards regulate accounting policy so as to use the suitable accounting
principles and methods. Accounting standards also ensure adequate disclosures in
financial statements. The use of uniform accounting policy improves comparability.
Hence the quality of financial report is determined by the quality of accounting standards
and the level of compliance.
In 1977, the Institute of Chartered Accountants of India (ICAI) constituted the
Accounting Standards Board (ASB). ASB organised a workshop in 1983 to hold a
dialogue with the industry on the implementation of the accounting standards.

The following methods were approved for implementation of standards:


• Approaching banks and financial institutions to point out that the adoption of
accounting standards by their borrowers would be of great use to them.
• Approaching authorities for making compliance with the standards as a necessary
condition for listing companies at the various stock exchanges in the country.
• Making request to apex bodies of trade and industry like FICCIand ASSOCHAM to
issue directives to their associates to follow the accounting standards.

At present nearly fifty items of disclosure are available. The nature of business, size of
the company, accounting standards, profit data, strategies and investment pattern are
important.
The value of brand equity, the economic value added (EVA) and the value of human
assets are themost popular disclosures.

Reserve Bank of India has suggested the following disclosures:


• Characteristics of underlying assets.
• Procedure for administration and servicing.
• Purpose and contents of legal documents.

Summary
(1) Meaning of corporate government - It refers to the set of processes, customs, policies,
laws and institutions influencing the administration of a corporation.
(2) Principles of corporate governance.
(3) Issues involved in corporate governance principles.
(4) Rights of corporation.
(5) Need for corporate governance.
(6) Theories of corporate governance - Agency theory - Transaction cost economies -
Stakeholder theory - Stewardship theory.
(7) Role of independent directors.
(8) Board structure.
(9) Training and development of Directors.
(10)Accounting standards.

Questions
Section 'A'
(1) Define corporate governance.
(2) What is agency theory?
(3) Define stakeholder theory.
(4) Define stewardship theory.
Section 'B'
(1) What are the principles of corporate governance?
(2) What is the need for corporate governance?
(3) What is transaction cost economics?
(4) What is the role of independent directors?
(5) Explain the various committees in corporate governance.
(6) Explain the importance of training to the directors.
(7) What are accounting standards?
Section 'e'
(1) Examine the need, features and challenges of corporate governance in the corporate
world.