CORPORATE GOVERNANCE (UNIT-03) 3.1 Conceptual Framework of Corporate Governance "Corporate Governance is the application of best management practices, compliance of law in true letter ond spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stakeholders.” -The Institute of Company Secretaries of India (ICS!) “Corporate governance is a set of systems, processes which ensure that a company is managed to the best interests of all the stakeholders, set systems that help the task of corporate governance should include certain structural organisational will embrace how things are within such structure and organisational systems," - LV.V. lyer Corporate Governance is about promoting corporate fairness, transparency and accountability Good Corporate Governance is a formal system of accountability, decision making and control of ethical and socially responsible organisational decisions and use of resources. Itis getting a focused attention particularly after market and public confidence became fragile after a series of high profile corporate failures in which the absence of effective governance was a major factor. Good ‘governance is the need of the hour whether itis the public sector units, multinational companies or Indian/domestic business groups Good corporate are not born, but are made and developed and ethical foundations make base for good governance that is in the interest of all the stakeholders. Objectives of Good Corporate Governance Good corporate governance seeks to achieve the following objectives: * To ensure adequate disclosures and effective decision making to achieve corporate objectives © To ensure a higher degree of transparency in an organisation by encouraging full disclosure of transactions in the company accounts. * To encourage accountability of the management to the company directors and the accountability of the directors to the shareholders. © The board is balance as regards the representation of adequate number of non-executive and independent directors who will take care of their interests and well-being of all the stakeholders. * To create a secure and prosperous operating environment and improving operational performance. * To ensure that the board keeps the shareholders informed of relevant developments impacting the company. * To ensure that the board effectively and regularly monitors the functioning of the management team. * To ensure that the board remains in effective control of the affairs of the company at all times. 1|Page(CA AMAN AGRAWAL Principles of Good Corporate Governance Good corporate governance is based on some established principles Important among them are- 1ess with all integrity and fairness, being transparent, making disclosure complying with laws, accountability and responsibility towards the stakeholders and commitment to conducting business in an ethical manner. 1. Respecting the Rights of Shareholders: Organisations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by ‘openly and effectively communicating information and by encouraging shareholders to participate in general meetings. 2, Equitable Treatment of Shareholders: It is the responsibility of the companies to engage with long-term shareholders in a meaningful way on issues and concerns that are of widespread interest to long-term shareholders, with appropriate involvement from the board of directors and management. ‘3. Protecting the Interests of All Stakeholders: It is the responsibility of the companies to deal with its employees, customers, suppliers and other stakeholders in a fair and equitable manner and to ‘exemplify the highest standards of corporate citizenship. 4, Role and Powers of Board of Directors: Primary responsibility for ensuring effective governance rests with the board of directors. Directors must not only ensure that sound governance systems and processes are in place, they also carry the responsibility to ensure that such systems and processes work effectively through active monitoring and evaluation of performance. 5. Duties of the Board: he board should be responsible for the management of the company as a collective body; it should act in the corporate interest and serve the common interests of the shareholders ensuring the sustainable development of the company. 6. Composition of the Board and the Special Committees: The board must be composed of competent, honest and qualified persons. The board should also establish the special committees, such as, remuneration committee, nomination committee, audit committee, etc., for the proper performance of its task. 7. Board Appointments: Having a well functioning Nomination Committee will play a significant role in giving investors substantial comfort about the process of Board-level appointments. A well defined and open procedure must be in place for reappointments as well as for appointment of new directors. 8, Board Meetings: Meetings are the forums for board decision making. These meetings enable directors to discharge their responsibilities. The effectiveness of board meetings is dependent on carefully planned agendas and providing relevant papers and materials to directors sufficiently prior to board meetings. 9. Transparency: It refers to the degree of clarity and openness with which decisions are made and is built on the free flow of information. Transparency, achieved through the disclosure of information, is an essential ingredient of the Principles of Corporate Governance, allowing external control to function effectively. 21PaceCA AMAN AGRAWAL 10. Code of Conduct: it is essential that an organisation's explicitly prescribed codes of conduct are ‘communicated to all stakeholders and are clearly understood by them. There should the some systems in place to periodically measure and evaluate the adherence to such code of conduct by ‘each member of the organisation. tions are accountable to the pu ty differs dependit 11. Accountability: it implies that decision-makers in orgai well as to institutional stakeholders for what they say and do this accountabil ‘on the organisations and whether the decision is internal or external, 412, Conllets of interest: The directors should take decisions in the best interests of the company. They should warn the board of possible conflicts between their direct or indi and those of the company. They must refrain from taking part in any deliberation or decision involving such a conflict. Benefits/Importance of Good Corporate Governance 1. Creating Goodwill: Corporate governance helps in brand formation and development reputed brand image leads to greater loyalty which results in greater commitment and creativity of the ‘employees. In the current competitive environment, creativity is vital to get a competitive edge. 2. Accessing Capital and Finance: The credibility offered by good corporate governance procedures also helps maintain the confidence of investors-both foreign and domestic-to attract more long- term capital. This will ultimately induce more stable sources of financing Firms can raise funds from capital market leading to higher level of investment, growth and employment. 3. Higher Market Valuation: Corporate governance leads to higher market valuation. Buenaventura, a Peruvian company, managed to improve its corporate governance and the CEO estimates that these improvements resulted in an additional 20% increase in market valuation. 4, Stock Market Efficiency: CG has great impact on the efficiency of stock markets. For example, in the Asian crisis in 1997, poor corporate governance influenced the stock markets efficiency to the large extent. Stability is only possible with the help of corporate governance. 5. Reducing Risk: Effective governance reduces perceived risks, consequently reduces cost of capital and enables board of directors to take quick and better decisions which ultimately improves bottom line of the corporate. 6. Importance of Social Responsibility: Today, social responsibility is given a lot of importance. The Board of Directors has to protect the rights of the customers, employees, shareholders, suppliers, local communities, ete. This is possible only if they use good corporate governance practices. 7. Reducing Wastage: Good practices of corporate governance help companies become more efficient in the business. Employees that are trained to follow ethical business practices will avoid excess wastage of company sources will tend to utilise all resources optimally. 8. Increasing Operational Efficiency: Good Corporate Governance standards add considerable value to the operational performance of a company by improving strategic thinking at the top through Induction of independent directors who bring in experience and new ideas. 3[PageCA AMAN AGRAWAL 3.2 Corporate Governance Reforms ‘There are various committees formed with a view to reforming the Corporate Governance in india since 1990s, Some of the recommendations of these committees are highlighted below. 1. Confederation of Indian Industries (Cil) set up a task force in 1995 under Rahul Bajaj, a reputed industrialist. In 1998, the Cll released the code called "Desirable Corporate Governance”. It looked into various aspects of Corporate Governance and was first to criticize nominee directors and suggested dilution of government stake in companies. 2. Kumar Mangalam Birla Committee: In early 1999, Securities and Exchange Board of India (SEB!) had set up a committee under Shri Kumar Mangalam Birla, member SEB! Board, to promote and raise the standards of good corporate governance. The report submitted by the committee is the first formal and comprehensive attempt to evolve a Code of Corporate Governance’, in the context of prevailing conditions of governance in Indian companies, as well as the state of capital markets. Mandatory Recommendations of the Committee are as follows: ‘© Applies To Listed Companies With Paid Up Capital of 83 Crore and above ‘+ Composition of Board of Directors Optimum Combination of Executive & Non-Executive Directors ‘© Audit Committee with 3 Independent Directors with One Having Financial and Accounting Knowledge. ‘+ Remuneration Committee ‘© Board Procedures- At least 4 Meetings of The Board in a Year with Maximum Gap of 4 ‘Months between 2 Meetings. To Review Operational Plans, Capital Budgets, Quarterly Results, Minutes of Committee's Meeting. ‘Director shall not be A Member of More Than 10 Committees and Shall Not Act as Chairman of More Than 5 Committees Across All Companies ‘¢ Management Discussion and Analysis Report Covering Industry Structure, Opportunities, Threats, Risks, Outlook, internal Control System, ‘Non-Mandatory Recommendations of the Committee are as follows: ‘* Role of Chairman ¢ Remuneration Committee of Board ‘© Shareholders’ Right For Receiving Half Yearly Financial Performance Postal Ballot Covering Critical Matters Like Alteration In Memorandum, ete. ‘© Sale of Whole or Substantial Part of The Undertaking ‘© Corporate Restructuring, ‘© Further Issue of Capital 3, The Department of Companies Affairs (DCA) modified the Companies Act, 1956. It undertakes periodic review and brings about amendments in the Companies Act, 1956. In 1999, the Act introduced the provision relating to nomination facilities for shareholders and share buybacks and for formation of Investor education and protection fund. AlPageCA AMAN AGRAWAL 4, Naresh Chandra Committee: The Naresh Chandra committee was appointed in August 2002 by the Department of Company Affairs (DCA) under the Ministry of Finance and Company Affairs to examine various corporate governance issues. The Committee submitted its report in December 2002. It made recommendations in two key aspects of corporate governance: (i) financial and non- financial disclosures and (ii) independent auditing and board oversight of management. The Committee's recommendations relate to: + Disqualifications for audit assignments; + List of prohibited non-audit services; Independence Standards for Consulting and Other Entities that are Affiliated to Audit Firms; ‘+ Compulsory Audit Partner Rotation; ‘© Auditor's disclosure of contingent liabilities; * Auditor's disclosure of qualifications and consequent action; ‘+ Management's certification in the event of auditor's replacement; '* Auditor's annual certification of independence, ‘+ Appointment of auditors; Setting up of independent Quality Review Board; Proposed disciplinary mechanism for auditors; Defining an independent director: Minimum board size of listed companies; Disclosure on duration of board meetings/committee meetings: Additional disclosure to directors; Independent directors on Audit Committees of listed companies: ‘* Remuneration of non-executive directors; 5, Narayan Murthy Committee: SEB! appointed Narayan Murthy Committee in 2002. Its report mainly focuses on and makes mandatory recommendations regarding responsibilities of audit committee, quality of financial disclosure, requiring boards to assess and disclose business risks in the company's annual reports. ‘The key mandatory recommendations focused on: + strengthening the responsibilities of audit committees; Improving the quality of financial disclosures, including those related to related party transactions and proceeds from initial public offerings, * requiring corporate executive boards to assess and disclose business risks in the annual reports of companies; * introducing responsibilities on boards to adopt formal codes of conduct; and * Stock holder approval and improved disclosures relating to compensation paid to non- executive directors. Non-mandatory recommendations included: ‘+ moving to a regime where corporate financial statements are not qualified; ‘+ instituting a system of training of board members; and ‘+ Evaluation of performance of board members. SpaceCA AMAN AGRAWAL ‘The Committee noted that the recommendations contained in their report can be implemented by means of an amendment to the Listing Agreement, with changes made to the existing clause 49. I, Clause 49 of the Listing Agreement Clause 49 of Listing Agreements includes the following key requirements: 1, Board Independence: The Board of directors of the company shall have an optimum combination of executive and non-executive directors with not less than fifty percent of the board Of directors comprising of non-executive directors. Where the Chairman of the Board is a non- executive director, at least one-third of the Board should comprise independent directors and in case he is an executive director, at least half of the Board should comprise independent directors. 2. Code of Conduct: A code of conduct for Board members and senior management has to be laid down by the Board which should be posted on the website of the company. All Board members and senior management should affirm compliance with the code on annual basis and the annual report shall contain a declaration to this effect signed by the CEO. 3, Audit Committee: The Clause requires Audit Committee to have minimum three directors as members and two third of members shall be independent directors. The Audit Committee has been given a significant role regarding the appointment and monitoring of auditors, financial reporting of the Company, monitoring inter corporate loans, RPTs, reviewing the functioning of the whistle blower mechanism, etc. 4. Disclosure: Listed companies must periodically make various disclosures regarding financial and ‘other matters to ensure transparency. 5, Compulsory Whistle Blower Mechanism: The New Clause makes it mandatory for companies to establish a vigil mechanism to enable directors and employees to report unethical behaviour and frauds. The mechanism should also provide adequate safeguards to prevent victimisation of the whistle blower. In the light of the growing corporate scams and scandals, development of a legislative framework for adequate whistle blower mechanism is 2 move towards the right direction. 6. CEO/CFO certification: The CEO or the Managing Director or Manager and the CFO shall (a) certify that the financial statements are fair and (b) accept responsibility for internal controls, 7, Annual Reports: Annual reports of listed companies must carry status reports about compliance with corporate governance norms. 8, Nomination and Remuneration Committee: The New Clause makes it mandatory for companies to set up a Nomination and Remuneration Committee to formulate criteria for determining qualifications, positive attributes and independence of a director and recommend a policy relating to the remuneration of the directors, key managerial personnel and other employees. The Committee will be formulating criterion to evaluate independent directors and identifying people who are qualified to be appointed as directors and at the senior management levels. 9, Woman Director: In line of the Companies Act 2013, the Clause mandates representation of at least one woman director in the board. 6|PageCA AMAN AGRAWAL 3.3 Major Corporate Scandals in India & Abroad 1. Enron Corporation (2001) By 1992, Enron was the largest merchant of natural gas in North America, and the gas trading business became the second largest contributor to Enron's net income. By 2001, Enron had become a conglomerate that both owned and operated gas pipelines, pulp and paper plants, broadband assets, electricity plants, and water plants internationally. The corporation also traded in financial markets for the same types of products and services. Before its bankruptcy on December 2, 2001, Enron employed approximately 20,000 staff and was one of the world's major electricity, natural gas, communications, and pulp and paper companies, with claimed revenues of nearly $111 billion during 2000. Fortune named Enron “America's Most Innovative Company for six consecutive years. Enron shareholders filed a $40 billion lawsuit after the company's stock price, which achieved a high of US $90,75 per share in mid-2000, plummeted to less than $1 by the end of November 2001. ‘The USS. Securities and Exchange Commission (SEC) began an investigation. Enron's $63.4 bill assets made it the largest corporate bankruptcy in U.S. history. Dynegy, which had agreed on Nov. 9 to buy Enron but had second thoughts as Enron disclosed more financial problems and investors pummelled its stock, accused Enron of misrepresenting the health of its business, Causes of Enron's Failure ‘The particular causes of Enron's failure are complex. There are lots of issues that have to do with the Enron collapse. Important ones are as follows: 1. Fraudulent Accounting Practices: Enron's non-transparent financial statements did not clearly detail its operations and finances with shareholders and analysts. In addition, its complex business model stretched the limits of accounting, requiring that the company use accounting limitations to manage earnings and modify the balance sheet to portray a favourable depiction of its performance. 2. Failure of Corporate Governance: The Enron failure demonstrated a failure of corporate governance, in which internal control mechanisms were short-circuited by conflicts of interest that enriched certain managers at the expense of the shareholders. Although derivatives made appearances in the course of the governance failures, they played no essential role. 3. Preferential Treatment: The Company leveraged political connections in both the Clinton and Bush administrations, as well as on Wall Street, for preferential treatment and the air of legitimacy that allowed it to perpetrate its frauds. In this context, the accounting practices widely considered the cause of the Enron collapse can be seen as just a symptom of a larger management culture that exemplified the dark side of American capitalism. 4. Audit Failure: There was a conflict of interest between the two roles played by Arthur Andersen, as auditor but also as consultant to Enron. The audit committee allowed suspect accounting Practices and made no attempt to examine the special purpose entities (SPE) transactions. The auditors failed to prevent questionable accounting. 7|PageCA AMAN AGRAWAL 5. Ignorance of the Board of Directors: The board of directors was neither attentive to the nature Of the off-books entities created by Enron nor to their own obligations to monitor those entities once they were approved. The board did not pay attention to the employees because most directors in the United States do not consider this their responsibility, 6. Wrong Investments: The first and main cause of Enron's collapse was failed investments, Enron invested money in fibre-optic networks, a power plant in India and water distribution in the United Kingdom, to name a few. While a company the size of Enron could afford occasional losses, the ‘mounting, failed investments added up and created a plethora of debt. 2. WorldCom (2002) The first discovery of possible illegal activity was by World Com’s own internal audit department who uncovered approximately $3.8 billion of the fraud in June 2002. The company’s audit committee and board of directors were notified of the fraud and acted swiftly: Sullivan was fired, Myers resigned, and the Securities and Exchange Commission (SEC) launched an investigation. By ‘the end of 2003, it was estimated that the company's total assets had been inflated by around $11 billion. Causes of WorldCom Failure 1. Accounting Misstatements: WorldCom made major accounting misstatements that increasingly perilous financial condition of the company. As enormous as the fraud was, it was accomplished by more than $9 billion in false or unsupported accounting entries were made in WorldCom's financial systems in order to achieve desired reported financial results. 2. Mergers and Acquisitions Overload: WorldCom could obviously not afford this many mergers and acquisitions. Instead, the company used the cash from newly acquired companies to cover its expenses and did not properly service the debts of the new acquisitions. The company also failed to integrate the accounts into one uniform system, which meant it maintained them with multiple billing systems and different accounting practices. 3, Recession in Telecom Industry: Complicating Ebbers’ situation was an industry-wide downturn in telecommunications. During this time, Wall Street had continuing expectations of double-digit growth for World Com. 4, Mismanagement: WorldCom became known for questionable management. After going public in 1989, the company focused on meeting expectations of analysts and appeasing shareholders while overlooking misdeeds in the financial records, according to several former employees. A 2005 Business Week article says World Com's corporate culture operated like a tribe with the leaders insisting on loyalty with no questions asked. During bankruptcy proceedings, it was discovered the company loaned senior executives hundreds of millions of dollars. 10. Satyam Computer Services Ltd Satyam is case of a resounding failure in corporate governance in India. At nearly 8,000 crore, the Satyam scam was among the biggest in corporate India and tarred the image of the snow white IT industry. The perpetrator the soft-spoken founder and Chairman of Satyam Computer Services, B. Ramalinga Raju. In January 2009, when Raju confessed to cooking the books of then India's fourth- 8| PageCA AMAN AGRAWAL largest software services company, Investors in Satyam shares lost a whopping 13,600 crore within a month and the company faced an avalanche of lawsuits. The Scandal Problems in Satyam began when on December 16th, 2008; its Chairman Mr Ramalinga Raju, in a surprise move announced a $1.6 billion bid for two Maytas companies i.e. Maytas Infrastructure Ltd and Maytas Properties Lid saying he wanted to deploy the cash available for the benefit of investors. The two companies have been promoted and controlled by Raju’s family. The thumbs down given by investors and the market forced him to retreat within 12 hours. Share prices plunges by 55% on concerns about Satyam's corporate governance. That aborted attempt at expansion precipitated a collapse in the price of the company's stock and a shocking confession of financial manipulation and fraud from its chairman, 8. Ramalinga Raju. This was mainly done to hide the irregularities in the accounts of Satyam, What is known as of now is that over an extended period of time, the promoters decided to inflate the revenue and profit figures of Satyam, In the event, the company has a huge hole in its balance sheet, consisting of non- existent assets and cash reserves that have been recorded and liabilities that are unrecorded, According to the confessional statement of Mr. Raju, the balance sheet shortfall is more than 7000 crore. 1.4 Common Governance Problems Noticed in Various Corporate Failures A presentation of only a few cases shows an important number of similarities in the company’s actions, or negligence allowed by the persons responsible for management, which inevitably led to failure, which brings together a complex financial failures, image failures or ethical failures for the company, as individual cases, but certainly for the sector in which it operates, We will discuss some common problems of corporate governance noticed in various corporate failures. 1. Principal-Agent Problem The risk bearing function of ownership and the managerial function of control are separate functions performed by different parties. These parties often pose conflicting nature of interests. As the directors remain in charge of company's finances which make them the agents of the company and the company as principal of the agents, i, directors. The different interests of principals and agents may become a source of conflict. In some circumstances, agents may not perfectly act in the principal's best interests and work for their own interest. The resulting miscommunication and disagreement may result in various problems within companies. It is known as principal-agent problem or agency problem. 2, Lack of Transparency "Transparency can be defined as a principle that allows those affected by administrative decisions, business transactions or charitable work to know not only the basic facts and figures but also the mechanisms and processes. It is the duty of civil servants, managers and trustees to act visibly, predictably and understandably". Transparency is one of the essential requirements of good 91PageCA AMAN AGRAWAL corporate governance but sometimes companies lie about their accounts for various reasons Disclosure practices must keep pace with a firm's ever-changing business and risk management procedures. 3. Conflict of interest Conflict of interest is another factor commonly found in various corporate scandals. A conflict of interest is a situation in which a person or organisation is involved in multiple interests (financial, emotional, or otherwise), one of which could possibly corrupt the motivation of the individual or organisation. A widely used definition is: A conflict of interest is a set of circumstances that creates 2 risk that professional judgement or actions regarding a primary interest will be unduly influenced by a secondary interest. Conflicts of interest between controlling and minority shareholders may arise because the controlling shareholders become the controlling managers. They can divert part of the firm's resources for their own private benefit at the expense of non-controlling shareholders. 4, Chief Executive Officer's Influence on the Board Aboard of directors is a body of elected or appointed members who jointly oversee the activities of an organisation. The primary role of the Board is to govern, to control managerial opportunism and to ensure that Chief Executive Officer (CEO) carries out their managerial functions and duties in the best interests of Members. The CEO is the highest ranked manager of an organisation. CEO's main responsibility is of management and administration. He/she carries out the plans and policies envisioned by the Board. CEO's influence on the board can reduce the board's effectiveness in monitoring managers. The greater a CEO's influence on the board, the less likely the board is to suspect irregularities that a more Independent board may have caught. It is considered good practice to separate the roles of the Chairman of the Board and that of the CEO. 5. Lack of Independence of Auditors The auditor does not have direct corporate governance responsibility but rather provides a check on the information aspects of the governance system. The results of audit failures (for example Enron) are very serious. External auditors are qualified chartered accountants who are involved in public practice, their main responsibility is to verify and certify the quality of financial statements issued by the company. One of the main objectives of an audit is to express an expert opi financial statements present. By keeping objectivity, the external auditors can add value to shareholders by ensuring that the company’s internal controls are strong and effective. However, over the last several decades, a substantial and increasing portion of an accounting and auditing firm's total revenues have been derived from consulting services of various kinds. Provision of these non-audit services can potentially hurt the quality of an audit by impairing auditor independence because of the economic bond between the auditor and the client. Irresponsible auditing leads to a great loss of investors’ confidence. This is another cause of the failure of the corporate governance. 10 |PageCA AMAN AGRAWAL One of the examples of thi Company. id of failure of corporate governance is the failure of the Satyam 6. Extravagance and Top Executives' Remuneration In the UK, in 1995 the Greenbury committee was formed to look in to the directors remunerations. it recommended that remunerations must be linked to performance. In case of failed corporation MG Rover, one of the director received $40 million in terms of wages and pension during his time in the company while an inquiry held that the company was suffering from mismanagement but the directors pay was excessive. In this case four of the directors were banned to serve as directors of company in the future. Had there been effective and independent directors there might have been better supervision and the results might have been different. There are also many people in public listed companies who may not be able to flagrantly loot the company, so they try to ensure that they spend a lot of money that is part of the company's income for their own benefit. These people try to loot the money from the company as they use it to travel for their own needs and also use for various other needs of their own 7. Ineffective Independent Directors (IDs) The concept of the institution of independent directors (IDs) is simple. They are expected to be independent from the management and act as the trustees of shareholders. The present corporate governance structure hinges on the independent directors, who are supposed to bring objectivity to the oversight function of the board and improve its effectiveness. Stakeholders place high expectation on them. This implies that they are obligated to be fully aware of and question the conduct of organisations on relevant issues. Good governance requires that independent directors maintain their independence and do not benefit from their board membership other than remuneration, Otherwise, it can create conflicts of interest. 1.5 Codes & Standards on Corporate Governance ‘The term corporate codes refer to companies policy statements that define ethical standards for their conduct. It is a codified set of ethical standards to which a corporation aims to adhere; it is a set of best practice recommendations. A common code of conduct is written for employees of a company. Main objectives of corporate codes and standard can be summarised as follows: ‘© To give every employee an insight into the Mis: Company activities. A, Values and Principles underlying the * To serve as a tool to outline the structure and behaviour of the board, including how it interacts with management. * To contribute to improved corporate performance and accountability in creating long-term shareholder value, ‘+ To serve as a tool for preventing possible offences and conflict situations. ‘© To develop a sense of equality in dealing with internal stakeholders. ‘* To reach an equitable judgement in each ethical situation. ‘+ To help control executive directors of public companies. ‘+ To provide checks and alerts. 1|Page CA AMAN AGRAWALCA AMAN AGRAWAL As of 2012, there are almost 90 countries with codes of corporate governance, with many countries having multiple codes. A brief description of important codes and guidelines is given below. 1, Sir Cadbury Committee Report (1952), UK Financial Aspects of Corporate Governance Committee under the chairmanship of Sir Adrian Cadbury was established, it sets out recommendations on the arrangement of company boards and accounting systems to mitigate corporate governance risks and failures. Its recommendations were incorporated into the Listing Rules of the London Stock Exchanges. ‘The report was mainly divided into three parts. (i) Structure and Responsibilities of Boards of Directors ‘The boards of all listed companies should comply with the Code of Best Practice. The Code of Best Practice is segregated into four sections and their respective recommendations are as follows: {a) Board of Directors: Every public company should be headed by an effective board which can both lead and control the business. The board should meet regularly, control the company and ‘monitor management. There should be clearly accepted division of responsibilities. There should be strong and independent elements on the board, with a recognised senior member. Shareholders are responsible for electing board members and itis in their interests to see that the boards of their companies are properly constituted and not dominated by any one individual. {b) Non-Executive Directors: The majority of non-executive directors should be independent of management. They should be free from any business or other relationship which could materially interfere with the exercise of their independent judgment, apart from their fees and shareholding. Non-Executive Directors should be appointed for specified term and re-appointment should not be automatic. Besides, Non-Executive Directors should be selected through a formal process and both this process and their appointment should be a matter for the Board as a whole. {¢) Executive Directors: Executive directors should not be granted service contracts for more than three years without shareholders approval. There should be full and clear disclosure of directors’ total remuneration Executive Directors’ pay should be subject to the recommendations of the Remuneration Committee made up wholly or mainly of Non-Executive Directors {d) Reporting and Controls: It is the duty of the board to present a balanced and understandable assessment of their company's position. The board should ensure that an objective and professional relationship is maintained with the auditors. {i Role of Auditors and the Accountancy Profession ‘The annual audit is one of the comerstones of corporate governance. It provides an external and objective check on the way in which the financial statements have been prepared and presented by the directors of the company. The Cadbury Committee recommended that an audit committee, comprising mainly non-executive directors, should be established. Professional and objective relationship between the board of directors and auditors should be maintained. Auditors should provide a reasonable assurance that the financial statements are free of material misstatements. 12|Page‘CA AMAN AGRAWAL Another proposal was that some form of compulsory rotation of audit firms should be introduced, to prevent relationships between management and auditors becoming too comfortable. (iii) Rights and Responsibilities of Shareholders The shareholders, as owners of the company, elect the directors to run the business on their behalf and hold them accountable for its progress. They appoint the auditors to provide an external check on the director's financial statements. The Committee's report places particular emphasis on the need for fair and accurate reporting of a company’s progress to its shareholders, which is the responsibility of the board. It is encouraged that the institutional investors ‘shareholders to make greater use of their voting rights and take positive interest in the board functioning. 2. Greenbury Committee Report (1995), UK Cadbury Committee was followed by the Greenbury Committee In January 1995, the Confederation of British Industry (CBI) established the Study Group on Directors Remuneration under the chairmanship of Sir Richard Greenbury. The purpose was to set out best practice in determining and accounting for Directors remuneration. The committee published a report with a new Code of Best Practice related to the remuneration of directors on July 17, 1995. It was recognised that a very specific issue that the Cadbury Report had not dealt with in great detail was the level (and rate of increase) of executive pay Greenbury report's recommendations centred around accountability, responsibility, full disclosure, alignment of director and shareholder interests and improved company performance. The Code contains detailed provisions that supplement the requirements of the Companies Act on the disclosure of board remuneration elements in annual financial reports. Main points of Greenbury report's Code of Best Practice on Director's Remuneration are as follows: + Boards of Directors should set up remuneration committees for Non-Executive Directors. Only truly independent non-executive directors should sit on such remuneration committees. * Remuneration Committee chairmen should be directly accountable to shareholders (rather than just the board). * Companies Articles of Association should be amended to enable remuneration committees to discharge their functions on behalf of the Board. ‘Remuneration Committees were to give attention to incent by avoiding issuing share options at a discount. + Remuneration committees should consist exclusively of Non-Executive Directors. * Director's service contracts should be a year or less. A robust line should be taken if performance was poor. * The remuneration committee should report direct to the members each year and this would be their main means of accountability. + Annual reports were also to carry details of each individual director’s pay package rather than just those of the chairman and highest paid executive. ‘+ The report should include full details of each element of the directors’ remuneration. packages including pension. ing long-term performance 13|PageCA AMAN AGRAWAL 3. CalPERS Global Principles of Accountable Corporate Governance (US), (1996) The California Public Employees Retirement System (CalPERS, System) is the largest US public pension fund, with assets totalling approximately $300 billion spanning domestic and International markets as of June 30, 2014 Global Governance Programme has evolved since the mid-80. The late 1980s and early 1990s represented a period in which CalPERS learned a great deal about the “rules ‘of the game-how to influence corporate managers, what issues were likely to elicit fellow shareowner support, and where the traditional modes of shareowner/corporation communication were at odds with current reality. To date, the focus of CalPERS efforts on governance, and that of regulators and investors, has been ‘on wholly-owned business units, subsidiaries, and affiliates of public companies. Bycentering its attention and resources in this way, CalPERS demonstrated very specific and tangible results to those who questioned the value of corporate governance In 1997, CalPERS Board adopted a set of "Global Governance Principles.” 4, Hampel Committee Report on Corporate Governance (UK) (1998) ‘The Hampel Committee was established in 1996 to review and revise the entire recommendations of the Cadbury and Greenbury Committees. The Committee released a preliminary report in August 1997, followed by a final report in January 1998. The Report aimed to combine, harmonise and clarify the Cadbury and Greenbury recommendations. The Final report emphasised principles of good governance rather than explicit rules to reduce the regulatory burden on companies. Important principles suggested by the Hampel Committee are as follows: [A] Board and Directors (i) The Board: The Board should lead and control the company. (ii) Chairman and Chief Executive Officer: There are two distinct jobs that of the chairman of the board and that of the chief executive officer a decision to combine these roles in one Individual should be publicly explained. (ili) Board Balance: The board should include a balance of executive directors and non-executive directors (including independent directors) such that no individual or small group of individuals can dominate the board's decision making. (iv) Supply of Information: The board should be supplied in a timely fashion with information in a form and of quality appropriate to enable it to discharge its duties. (v) Appointments to the Board: There should be a formal and transparent procedure for the appointment of new directors to the board. [8] Directors’ Remuneration Director's remuneration should be sufficient to attract and retain the directors needed to run the company successfully. It should be based on corporate and individual performance. The procedure for fixing executive remuneration should be formal and transparent. Besides, the company's annual report should contain a statement of remuneration policy and details of the remuneration of each director. 14|PageCA AMAN AGRAWAL Ic] Shareholders Companies and institutional shareholders should engage themselves, whenever possible, to enter into a dialogue process on the mutual understanding of objectives, Institutional shareholders should use their volte responsibly Companies should use the AGM to communicate with shareholders and encourage their participation. [0] Accountability and Audit In order to safeguard shareholders investment and the company’s assets, the board should maintain a sound system of internal control The board should also establish formal and transparent arrangements for maintaining an appropriate relationship with the company's auditors. Auditors should independently report to shareholders in accordance with statutory and professional requirements. 5. Combined Code of Best Practices The combined code of best practices was derived from Ron Hampel Committee's Final Report, Cadbury Report and the Greenbury Report, Compliance of the combined cade is mandatory for all Listed companies in UK because it is appended to the listing rules of the London Stock Exchange. As per combined code, the boards should maintain a sound system of internal control to safeguard shareholder's Investments and the company's assets. Besides, the directors should conduct a review of the effectiveness of the internal control and report to shareholders that they have done so. 6. Blue ibbon Committee (USA), 1999) The Blue Ribbon Committee recommends that all listed companies over a certain size have audit committees composed entirely of independent directors. Independence is defined to exclude ‘current and former employees, relatives of management, persons receiving compensation from the company (except directors fees) or controlling for profit organisations receiving from or paying the corporation significant sums, and compensation committee interlocking directorships Other Important recommendations are as follows: '# Stock exchanges should adopt rules requiring public companies to have audit committees comprised of a minimum of three directors, each of whom is financially literate (i.e, able to read and understand basic financial statements), and that at least one member of the audit committee have accounting or related financial management expertise. ‘+ Each audit committee should adopt a written charter governing its operations, and the SEC should adopt rules requiring annual disclosure of the terms of and compliance with the charter. ‘+ Each listed company should adopt a formal written charter that is approved by the board of directors and that specifies the scope of the committee's responsibilities, and how it carries out those responsibilities, including structure, processes, and membership requirements. ‘+ Each listed company should review and reassess the charter’s adequacy on an annual basi ‘© Each reporting company should disclose annually in its prosy statement whether the audit committee has adopted a formal written charter 1s|Page CA AMAN AGRAWALCA AMAN AGRAWAL + To promote the efficacy of a company's internal audit function, audit committees muss establish a culture and procedures that encourage free and independent information Dow between the committee and the internal auditors. 7, Guidelines issued by Ministry of corporate Affairs, India (2008) In December 2009, the ministry of corporate Affairs issued voluntary Guidelines on corporate Governance for the Indian corporate sector. Important guidelines are summarised below. (1) Companies should issue formal letters of appointment to Non-executive Directors (NEDs) and independent Directors. The letter should specify terms of appointment, expectations of the Board from the new appointee, fiduciary duties and accompanying liabilities, etc. Roles and office of chairman and CEO should be separated to promote balance of power. (2) All independent Directors should provide a detailed certificate of independence at the time of their appointment, and thereafter annually. Independent Directors should be restricted to six-year terms. They must leave for three years before serving another term, and they may not serve more than three tenures for a company. {3) NEDs should be paid either a fixed fee or a percentage of profits whichever payment trend method is elected should apply to all NEDs, Independent Directors should not be paid with stock options or profit-based commission. (i) The Remuneration Committee should have at least three members with the majority of NEDs, and at least one Independent Director. {4) The Audit Committee should be composed of at least three members, with Independent Directors in the majority and an Independent Director as the chairperson. (i) The Audit Committee is responsible for reviewing the integrity of financial statements, the company’s internal financial controls, internal audit function and risk management systems. {5) The Audit Committee should be consulted on the selection of auditors. The committee must be supplied with relevant information about the auditing firm. Every auditor should provide a certificate stating his/her/its arm's length relationship with the client company. The audit partner should be rotated every three years; the firm should be rotated every five years. {6) The companies should ensure the institution of a mechanism for employees to report concerns about unethical behaviour, actual or suspected fraud, or violation of the company's code of conduct or ethical policy. The companies should also provide for adequate safeguards against victimization of employees who avail of the mechanism. 16|Page