CORPORATE GOVERNANCE AND FINANCIAL CRISIS

The ongoing financial crisis has proved that Corporate America and the Corporates in other
countries around the world have exhibited behavior that can be described as mismanagement and
not keeping in tenets of good corporate governance. In this respect, some of the criticism that has
been directed at corporate leaders and the bankers in particular appears to be justified given the
excesses that have been on display from them. For instance, excessive CEO compensation is a hot
topic in the aftermath of the global financial crisis.

Studies have shown that the CEO of some companies like Wal-Mart and GM along with Wall Street
Banks take home pay that is 100 to 150 times the average pay of the working class. This is indeed
a fact that speaks volumes about the blatant disregard for fair compensation and reflects the
skewed priorities of the corporate leaders. After all, what can possibly justify this huge imbalance
even after taking into consideration the fact that CEO’s and Bankers are engaged in activities that
are cerebral and visionary in nature?

The answer from corporate chieftains is that while these levels of gap between the CEO pay and
the average pay are indeed troubling, there is no need to panic since the trickle-down economics
that they rely on means that the wealth eventually finds its way to the bottom. It is another fact
that this has not happened so far in practice and what we have instead is a rising inequality gap.
The reason for pointing this aspect is to highlight the kind of corporate governance practices that
have seeped into corporates around the world. The point here is that one reason why the global
financial crisis happened was because of the failure of the very vision and direction as well as
misplaced faith in markets for which these CEO’s and Bankers were being paid such humungous
amounts. Hence, the notion that this aspect reflects good corporate governance has fallen flat on
the face.

Another aspect of corporate governance that underlines the ongoing financial crisis is that there
were serious issues of transparency and accountability concerning the behavior of the corporate
leaders. When they overwhelmingly make the rules that benefit them at the expense of the
shareholders and the stakeholders, then there is something wrong with the kind of corporate
governance being performed. The fact that the employees in these companies and banks along
with the shareholders had to pay the price for the mismanagement of the corporate leaders
indicates that there is an urgent need to clean up the stables of corporate governance before it is
too late.

Finally, the issues related to pursuit of profits at the expense of social and environmental concerns
points to another malaise of the current systems of corporate governance. Hence, taken together
these aspects reflect the fact that the current models of corporate governance need a rethink
especially when one considers the fact that the global financial crisis was brought about due to
excessive greed and reckless risk taking. The bottom line is that corporate leaders must be
answerable to the regulators and the shareholders along with the stakeholders and only when
there are effective checks and balances to keep the corporate governance on track can we avoid
crises like the ongoing global financial crisis.

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CORPORATE GOVERNANCE after the FINANCIAL CRISIS and the EMERGING BEST PRACTICES

In previous articles, we have discussed how the global financial crisis forced a rethink of corporate
governance practices. To start with, the global financial crisis brought into focus the unfettered
greed and uncontrolled risk taking that characterized the global financial crisis. These were
symptoms of the crisis that happened because of poor corporate governance. Added to that was
the inability of regulators to provide oversight over the actions of the banks and corporates and
the humungous amounts spent by banks to lobby for less oversight and control over their actions.
Hence, it can be said that the underlying reasons for the crisis were poor banking practices and
lack of transparency and accountability by the corporates.

In the wake of the crisis, several proposals aimed at introducing greater transparency and
accountability from the corporates have been set in motion. These include the Dodd-Frank Act or
the legislation that has been passed in the US to monitor the accounting and business practices of
the banks and corporates.

Further, the Consumer Protection Agency under Elizabeth Warren has taken a series of steps to
restore consumer confidence and to bring back the trust that suffered as a result of the crisis. The
bottom-line requirement for good corporate governance is that the shareholders and the
consumers must have implicit and explicit trust in the actions and reporting of corporates. Hence,
any move towards increasing transparency and accountability has to be done in a manner that
makes the stakeholders trust the actions. The point here is that credibility and integrity is the key
to successful corporate governance.

The emerging best practices include stricter regulatory requirements, reporting done in a
transparent and ethical manner and fair business practices aimed at servicing the small consumer
as well as the large institutional shareholders. The legislation mentioned above along with the slew
of measures that have been collectively called Wall Street Reform are aimed at reining in the
rapacious and reckless behavior of the banks and financial institutions. Further, since the crisis was
thought of as an assault on capitalism itself, it became necessary for the reformers to focus on the
aspect of investigating the ideas and theories underpinning capitalism.

Finally, there has been some movement towards instituting best practices though the pace has
been slow because banks have been resisting these reforms. It needs to be mentioned that human
ingenuity knows no limits and hence, unless there is voluntary compliance, we would always find
ways and means to circumvent the rules and regulations. Hence, more than anything else, a
mindset change is needed from the corporates to set in process patterns of corporate behavior
that are sustainable and socially and environmentally conscious. Only when there is a desire to
change from within can the best practices work.

In conclusion, the global financial crisis shook the very foundations of capitalism and laid bare the
tenets and the wrong assumptions under which the market-based system was working. Hence, after
the crisis, the attempt at reform though slow has still been noteworthy because the size of the
task at hand is ambitious and fraught with dangers. It is hoped that the crisis would serve as a

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valuable learning experience for the corporates to mend their ways and to avoid a repeat of such
occurrences.

BROADENING the CORPORATE GOVERNANCE AGENDA: The Corporate Social Responsibility

In recent years, there has been an increasing emphasis on governing corporations according to
social and environmental norms and ensuring that the negative externalities associated with them
are minimized. When we talk about negative externalities, what we mean are the social and
environmental costs that corporations impose on society and which are not factored into the costs
incurred by them. Since these affect society without the corporations paying for them, there is a
need for the corporations to be socially and environmentally conscious and responsible so as to
minimize inconveniencing society at large. This is the paradigm of corporate social responsibility
or CSR which indicates the need for corporations to follow sustainable business practices.

In the context of corporate governance, CSR means that corporations have to take into account
society and the environment as stakeholders and cater to their needs instead of just pursuing profits
at the expense of everything else.

The point here is that corporate governance must include aspects of social and environmental
responsibility and this is where CSR comes into the picture. By including CSR within the ambit of
corporate governance, it is hoped that corporates would govern themselves and be accountable
for their social and environmental costs. Thus, by broadening the ambit of corporate governance
by embracing CSR, it is hoped that corporates would be responsible towards society and the
environment.

To take examples of how corporate governance has been impacted by CSR, there are many cases
of corporates like Samsung, Hyundai, Unilever and P&G (to name a few) that are publishing their
CSR reports along with their annual reports. This is a direct consequence of the push to broaden
the corporate governance agenda by including CSR within its ambit. Further, many corporates now
routinely report how much cost they are imposing on society (the negative externalities) and their
efforts towards minimizing them. Moreover, corporate governance is no longer just about
transparency and accountability within the business framework. Instead, it has been broadened
to include the whole gamut of social and environmental concerns that make up the corporate
governance agenda.

In recent years, multilateral bodies like the United Nations and WTO have established normative
rules of conduct under classifications like the UN Global Compact that bind organizations to social
and environmental responsibility and formulate a set of guidelines that these corporations can
follow. There are many corporates who are signatories to the UN Global Compact and it is
expected that the guidelines, though voluntary, would be followed by the corporates as part of
their sustainability drives.

Finally, it is indeed the case that there needs to be a combination of voluntary and enforced rules
of conduct and behavior that corporates are expected to follow as part of their social responsibility

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related to corporate governance. Hence, we have reached a stage where if the voluntary
guidelines do not work, multilateral bodies like the UN have a duty to enforce them so that society
as a whole is better off. Including social and environmental concerns as part of a corporate
governance agenda is a good thing. However, there needs to be a mechanism that tracks
compliance with these principles as well.

In conclusion, corporate governance is no longer just about ethical practices pertaining to business
processes alone. Instead, the corporate governance agenda has been broadened to include social
and environmental norms as well.

The ROLE of INSTITUTIONAL INVESTORS in PROMOTING GOOD CORPORATE GOVERNANCE

We have discussed how corporate governance and the practice of ethical and normative business
practices are essential for companies to stay the course and reap longer term benefits. In this
article, we look at how institutional investors or the investors who are not individuals but large fund
managers and investment houses play a major role in promoting good corporate governance.

At the heart of the issue about institutional investors and corporate governance is the fact that
there is something called an agency problem that creeps up with professionally managed
organizations. What this agency problem indicates is that managers have conflicting
responsibilities to themselves and the organization and in most cases; they seek to promote their
interests at the expense of the organization’s interest. The point here is that managers by nature
seek to maximize their benefits in relation to the profits and hence there is a need for
counterbalancing this with other forces.

These forces or the countervailing balance is brought about by the institutional investors who have
an interest in promoting the longer-term health of the company. By actively pursuing the boards
of organizations to follow effective corporate governance, institutional investors would ensure
that the corporates put the longer-term interests of the organization as well as ensure that
organizations put shareholder interest over the interests of the managers. The point here is that
institutional investors often represent large chunks of shareholders and hence they can be an
effective check to the tendency of the managerial class to put their own interests first. The other
aspect relates to the way in which they can monitor the health of the organization because they
have the necessary expertise and knowledge in running organizations since they sit on the boards
of other companies as well.

The third aspect of institutional investors is that they are more effective than minority
shareholders or small shareholders. In most annual general meetings, we can see small investors
raise questions related to corporate governance. In some cases, these concerns are addressed
whereas in most cases, the small shareholders despite voicing objections are overruled because
they do not have the numbers. This is where institutional investors come into the picture since
they represent humungous numbers of shareholders and hence have the bargaining power
needed to make a difference. Of course, the flipside to this is that institutional investors do not

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usually pursue radical changes and instead focus on maintaining the financial and operational
efficiencies of the organization and promoting good corporate governance.

Finally, institutional investors can be a rock of stability in turbulent times as was evident during
the recent crisis over Coal India. This case where the PSU was trying to override many objections
of the shareholders was thwarted in its attempts because of the activism of the institutional
investors. Further, in the case of Vedanta, institutional investors made sure that the company
followed social and environmental norms and did not ride roughshod over its obligations to society
and the government.

NEED for a UNIFORM INTERNATIONAL CORPORATE GOVERNANCE CODE

With the globalization of the world economy starting in the 1970s, continuing through the 1980s
and accelerating since the 1990s reaching its zenith in the first decade of the new millennium,
there has been a concomitant trend of global corporations expanding their international footprint
and operating in multiple countries around the world.

This meant that they had to deal with a maze of regulations and laws and procedures, which were
different in each country, as well as being unique to each country.

Further, with the codes of corporate governance in the West (especially the United States and
Europe) being deep, structured, and comprehensive, compared to those elsewhere, which were
still in the process of evolving, the situation was such that global corporations had to do with
dealing with different yardsticks in regional and country specific terms.

If this were the only imperative, then investors, activists, and regulators would not have bothered
since this was the domain of the global corporations and something, which they could handle.

However, given the fact that bribery and corruption are rampant in the Third World meant that
global corporations could truthfully assert that they were not breaking any laws as far as their home
countries and their rules were concerned. Instead, could resort to underhand dealing in the rest of
either the world where corporate governance was yet to be evolved or the regulation lax.

This situation was compounded by the fact that there were many corporate scandals in the last
two decades arising out of corporate mis-governance and malfeasance from companies such as
Enron, Parmalat, WorldCom, and the recent instances of dubious practices that were revealed in
the aftermath of the Great Recession of 2008.

These placed the spotlight squarely on the activities of the global corporations around the world,
which led to calls from regulators and activists of the need for global corporations to be brought
under the ambit of a uniform and consistent corporate governance standard around the world.

For instance, it is the practice in Germany to have representatives from the labor unions on the
boards of corporations. Moreover, in many Asian countries, it is the practice for family members
and relatives of the owners of the firms that are family owned to find places in the boards. Apart

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from that, in China, it is the law that officials from the Communist Party be made members of the
boards. Therefore, taken together these examples point to the difficulty of having a uniform code
of corporate governance that is applicable internationally.

Having said that, it must also be noted that unless global corporations are regulated by an
international code of corporate governance, they are more likely to succumb to the temptation to
cut corners in those areas of the globe where regulation is weak. In addition, they would have to
comply with purely local rules and regulations that might impede their smooth operation.

Apart from this, the increasing incidence of corporate scandals means that the shareholders stand
to lose the most in addition to the broader societal stakeholders and hence, there is indeed a need
to make the global corporations adhere and conform to the same standards that they follow back
home. Therefore, as mentioned earlier, this article argues that there is indeed a case to make for
an international code of corporate governance despite the difficulties of actualizing it in practice.

This means that global corporations while thinking globally have to act locally which when taken
together means that they must be Glocal in their approach, which is another theme that runs
concurrent to the main themes in this article.

This can be applied to the international code of corporate governance wherein global corporations
are made to observe those rules and regulations that are global in nature, adapt, and adjust to the
local rules and regulations in a Glocal manner thereby increasing the viability of an international
code (Wharton.edu, 2014).

To take the example of Fidelity International or Vanguard investments that are increasingly
diversifying out of the US stocks into international companies, they must be reassured that the
companies that they are investing in are reasonably and relatively well governed when compared
to the corporations in the United States and Europe.

This means that their equity investment strategies must focus on the accounting standards in
various countries in which they are investing. These must be complaint with the provisions of
corporate governance codes such as Sarbanes-Oxley, Cadbury rules, OECD (Organization of
Economic Cooperation and Development) guidelines, the ICGN (International Corporate
Governance Network) which are some of the global regulatory codes that would be discussed in
this article.

The central focus of corporate governance in any country is on the board of directors and the
structure of the corporate board. Therefore, when international investors invest in say, a company
in Italy or Lithuania, they must be convinced that the respective boards are in conformance with
global corporate governance codes. This makes the case for an international code of governance
that much stronger.

However, as mentioned earlier, the specific rules in place in many countries around the world
makes it more difficult for uniform application of corporate governance that follows the Sarbanes-
Oxley guidelines of reporting and disclosure which means that the move towards an international
code of governance would run into difficulties.

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In other words, just as globalization ensures a creative dialogue between East and West and arrives
at a meeting point, similarly, corporates around the world can make strides towards actualization
of global norms adapted to local conditions that can result in a win-win situation for both.

Ultimately, the driving force for any international code has to come from the borderless attributes
of global capital that seeks the maximum returns for the lowest costs and emphasizes efficiency and
productivity. In other words what this means is that by ensuring that markets do their best when
confronted with a problem, capitalism can find a path forward that would solve the problem of
differing standards of corporate governance around the world.

Further, in recent years, global investors too have veered around to the view that they might have
to abide by different rules in different countries. Of course, the implicit assumption here is that as
long as the rules do not change suddenly, they are fine with separate reporting, board structures,
and laws related to shareholding and equity control.

The discussion so far has debated both sides of the issue as to whether an international code of
corporate governance is viable. The key themes and the insights that have animated the discussion
point to the fact that as long as there are different cultures, there tends to be diversity and hence,
it is indeed the case that celebrating differences and actualizing homogeneity must go hand in
hand.

Therefore, wherever possible there can be convergence in the adoption of uniform codes of
governance and the differences can coexist with the agreements. This has been the case with
other multilateral bodies such as the WTO (World Trade Organization) and the United Nations,
which have been somewhat successful in respecting national sovereignty in the midst of global
cooperation and coordination.

In concluding this article, it would be pertinent to note that the final argument being made in this
article is that as long as the demands of global capital towards transparency and accountability
being more profitable are concerned, individual differences related to local conditions can be co-
opted and embraced within the ambit of an international code of corporate governance.

Therefore, without either ruling out the viability of such a code or insisting upon the adoption of
the same, this article makes the point that letting the winds of the world breeze into the rooms
without being swept off one’s feet by them would be a good metaphor to describe how an
international code of corporate governance would work in practice.

The ROLE of the INDEPENDENT DIRECTORS

With the explosion of scandals pertaining to corporates due to mismanagement and fraud in
recent years, the regulators all over the world have been implementing a series of policies aimed
at improving corporate governance and ensuring that companies follow ethical and normative
rules of business. A part of this initiative has been to goad the companies to nominate a certain
percentage of their board to persons who are not affiliated to the company. These are the so-

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called independent directors who sit on the boards of companies in a purely professional manner
without having a hand in the day to day running or other activities of the company.

The point about the independent directors is that they are drawn from a pool of professional who
have had wide industry experience and are qualified to sit on the boards of the companies. What
makes this process appealing to the regulators is that these independent directors can bring the
needed perspective that is objective and balanced since they are not connected to the company
nor its management and hence do not have hidden agendas.

In India, SEBI and the Corporate Affairs Ministry have decreed that between 10-15 percent of the
composition of the board must be made up of independent directors. This move is aimed to bring
in more objectivity to the art of corporate governance and introduce transparency and
accountability from the directors who are drawn from the ranks of the management. This rule has
been enforced given the spate of corporate scandals like Satyam where the top management itself
indulged in fraud and dubious business practices. So, the line of thinking goes that bringing in
independent directors would usher in greater oversight over the functioning of these companies.
Since the Satyam Scandal was because of the board looking the other way when its founder was
indulging in defrauding the company, the Ministry of Corporate Affairs is implementing this rule
to introduce greater oversight.

In the US, independent directors have been known to bring in a fresh perspective as well as check
the runaway business behavior dictated by profits and personal benefit. In many companies in the
US, the independent directors are the ones who often thwart the management from taking
decisions that are based on personal benefit as opposed to the interests of the shareholders.
Further, independent directors are tasked with investigating cases of corporate malfeasance and
unethical behavior because of their supposed objectivity. However, there have been instances
where the independent directors themselves acquiesced in the wrongdoings of the companies
and their boards. The solution to this has been the initiative to make the independent directors
responsible for the actions of the board so that they have a stake in ensuring that the board does
not tread on the wrong side.

Finally, independent directors also bring in the needed professional expertise since they are
individuals with wide experience in running companies as well as the fact that they sit on the
boards of other companies which means that they are abreast of the latest happenings. There has
been a move by the regulators in many countries to ensure that independent directors do not
have conflicts of interest and these have been codified into rules governing how many companies
they can associate themselves with and the sectors and industries that they represent.

Introduction to the CONCEPT of BOARD of DIRECTORS

Any public limited or private company needs to have a board of directors constituted for the
purpose of oversight and accountability to the company. The concept of the board of directors is
that it provides an umbrella for the company to operate in and ensures that the decisions and
actions taken by its management are reviewed and held to the mirror. The reason for the existence

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of the board of directors is that there needs to be a body that is above the management and which
can be accountable to the regulators and shareholders for the decisions taken by the management
of the company. Hence, it is common to find many members of the management sitting on the
board as executive directors. Again, it is for this very purpose that the regulators deem the
company to have a certain percentage of directors in the non-executive capacity and those who
are independent.

In recent years, the concept of the board has become crucial for corporate governance because of
the incidence of several corporate scandals involving unethical conduct by the management.

In some of these cases like the Enron scandal and the Satyam scandal in India, the board was found
to have played a major role in facilitating the scandal. This has led to the regulators asking for
greater oversight from the board and to make the board accountable to its shareholders. Of
course, there are many instances that prove the contrary where the board has stepped in to stem
the rot that the management has through its actions engendered. Prominent among these are the
actions of Reebok in recent months where the board asked the top leadership to resign in the
wake of corporate scandals involving them.

The concept of the board has been introduced explicitly to ensure that ethical and normative rules
of conduct of corporate governance are followed. The point here is that since the buck stops with
the board of directors, shareholders and regulators know who to turn to in case they have queries
or doubts about the decisions taken by the company. In many cases, the board of directors acts
as the ombudsman as well for shareholder complaints and grievance redressal. Further, the board
of directors is comprised of individuals with exemplary records of managing companies and hence
it is expected that the board of directors would provide technical and managerial guidance to the
way in which the company is run.

Finally, the concept of the board of directors is also important for the way in which it is deemed
to play a pivotal role in providing good corporate governance. In most cases, the way in which the
company is governed depends on the way in which the board directs the management in its
operation of the company. This is relevant to the contemporary times where the managerial class
has been found to enrich itself at the expense of the company and its shareholders. It is for this
reason that the board of directors is expected to steer the company away from agency problems,
conflicts of interest and asymmetries of information in the way shareholders are briefed about the
decisions taken by the company.

The ROLE and DUTIES of the BOARD of DIRECTORS

Any public limited or a private company needs to have a board of directors which would ratify the
management decisions taken by the leadership. These decisions can be financial or operational
that affects the day to day running of the company. Further, the board of directors is expected to
give a direction to the company in terms of strategic and visionary terms as to how the company
expects to grow without having to abandon the ethical and normative rules of conduct. Note the
emphasis on the term ethical and normative rules as the board of directors is the final arbiter of

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decisions taken by the company and hence, they must only approve a certain decision only when
they are convinced that it would be in the best interests of the company and its shareholders.

The board of directors is often held responsible for the decisions taken by the company and hence,
it is answerable to the shareholders as well as the regulators. In this context, it becomes necessary
for the board of directors to be composed of individuals of exceptional abilities and leadership
traits as well as being visionary.

The role of the board of directors can be summed up in one single sentence: the buck stops with
them and hence they are the final authority as far as the company is concerned. The duties of the
board of directors are similarly to be the ones who would take the decisions that have the stamp
of authority and hence become the yardstick by which the company is judged.

Apart from these roles and duties, the board of directors is also answerable to the shareholders
and the regulators. So, this means that the board of directors must take decisions that are in the
larger interests of the shareholders and they must protect the interests of the shareholders at all
costs. Further, whenever there is a scandal in the company, the regulators write to the board of
directors so as to elicit information on what happened. For instance, when the Satyam scandal
broke, the regulators and the press turned to the board of directors for guidance and information.
It is another matter that in this particular case, the board was compromised as well.

This brings us to the final aspect that the board of directors has to have a coherent approach
towards managing the company and hence, must be consensual in its decision making. Unless the
board of directors agrees on decisions either unanimously or through a majority vote, there cannot
be movement for the company. Hence, it is clear that boardroom battles and directors with hidden
agendas be avoided to the extent possible in the larger interests of good corporate governance.
Since the board has the final say in matters concerning the company, the CEO and the leadership
have to present the information truthfully and accurately. In the case of Satyam, there were
allegations that the CEO and some of the compromised members of the board kept the other
directors in the dark about some key decisions. This should not be allowed to happen.

The RELATIONSHIP between the BOARD of DIRECTORS and the MANAGEMENT

The relationship between the board of directors and the management cannot be described as just
being that of a relationship between an employee and his or her manager. Though the board
oversees the decisions taken by the management and ratifies them along with acting as the final
arbiters of the strategic direction and focus that the company is heading into, the relationship goes
beyond that. For instance, the board of directors is responsible for the actions of the management
and hence not only does the board need to monitor the management, the management needs to
take the board into confidence about its decisions. Hence, the relationship can be described as
being symbiotic with each with each serving in an ecosystem called the organization. The point
here is that neither the management nor the board can exist without each other and hence both
need each other to survive and flourish.

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Another aspect to the relationship between the board and the management is that more often
than not, there is a significant representation of the management in the board. This means that
the other board members have to study the decisions taken by these members carefully so that
there are no agency problems, conflicts of interest and asymmetries of information.

Only when the board and the management coexist together in a harmonious manner can there
be true progress for the organization. For this to happen, there must be a provision for having
independent directors and those directors that are not affiliated to the management. The point
here is that unless there is objectivity and separation of the directors belonging to the
management and those from outside can there is a semblance of avoidance of conflict of interest.

The third aspect of the relationship between the board and the management is the role played by
institutional investors or directors from large equity houses and mutual fund companies. These
directors bring to the table rich and varied expertise and experience in running companies and
hence their input is crucial to the working of the company. It is for this reason that many regulators
insist on having a certain percentage of the board as independent directors and another
percentage from institutional shareholders. The reason for this is the fact that unless there is a
process of due diligence and oversight over the actions of the management, the management can
take unilateral decisions that are not always in the best interests of the company.

Finally, the relationship between the board and management is somewhat strained whenever the
company is not doing well. This happens because the board has a top view of the organization and
the management has a deeper insight. Hence, to be fair to the management, they are the ones
who have to run the organization and so they cannot be constrained by what the board dictates
sitting on its perch. This is the classic problem that many companies face especially when they are
not doing well and the remedy for this is to take the board into confidence about the complexities
of the day-to-day operations and apprise them of the nuances and subtleties of running the
organization.

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