Audit Snd Corporate Governance Kind 1

B.Com. (Hons.
) Semester-VI Commerce
Core Course - XIII

Auditing and Corporate Governance
Study Material-1 : Unit (I-II)
SCHOOL OF OPEN LEARNING

University of Delhi
Department of Commerce
CONTENT
UNIT-I
Chapter-1 : Basic Principles and Techniques of Auditing & Classification of Audit
Chapter-2 : Audit Planning and Internal Control
Chapter-3 : Role of Auditors in Corporate Governance
Chapter-4 : Peer Review of Audit
Chapter-5 : Public Company Accounting Oversight Board (PCAOB)
Chapter-6 : The National Financial Reporting Authority (NFRA)
UNIT-II
Chapter-7 : Meaning Theories and Models of Corporate Governance
Chapter-8 : Corporate Governance
Chapter-9 : Shareholder Activism
Chapter-10 : Insider Trading
Chapter-11 : Board Committees and Functions
Chapter-12 : Credit Rating Agencies and Proxy Advisory Firms
Edited by: Written by:

Sh. K. B. Gupta Neha Singhal
SCHOOL OF OPEN LEARNING

University of Delhi
5, Cavalry Lane, Delhi-110007
UNIT-I
AUDITING
1. BASIC PRINCIPLES AND TECHNIQUES OF AUDITING & CLASSIFICATION

OF AUDIT
2. AUDIT PLANNING AND INTERNAL CONTROL
3. ROLE OF AUDITORS IN CORPORATE GOVERNANCE
4. PEER REVIEW OF AUDIT
5. PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD (PCAOB)
6. NATIONAL FINANCIAL REPORTING AUTHORITY (NFRA)
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CHAPTER-1
BASIC PRINCIPLES AND TECHNIQUES OF AUDITING &
CLASSIFICATION OF AUDIT
1.1 Meaning of Auditing
1.2 Origin and Evolution
1.3 Features of Auditing
1.4 Objectives of Auditing
1.5 Advantages of Auditing
1.6 Limitations of Auditing
1.7 Expression of Opinion
1.8 Detection of Errors and Frauds
1.9 Qualities of an Auditor
1.10 Principles of Auditing
1.11 Techniques of Auditing
1.12 Classification According to Organization of Business
1.12.1 According to Organization of Business
1.12.2 According to Ownership of Business
1.12.3 According to Time of Audit
1.12.4 According to Objectives of Audit
Case: Kingston Cotton Mill
1.1 MEANING OF AUDITING

The term audit is derived from a Latin word “audire” which means to hear authenticity of
accounts is assured with the help of the independent review. Audit is performed to ascertain
the validity and reliability of information. Examination of books and accounts with
supporting vouchers and documents to detect and prevent error, fraud is the primary function
of auditing.
According to Spicer and Pegler, ‘An auditing may be said to be such an examination of books of
accounts, voucher as will enable the auditor that the balance sheet is properly drawn so as to give
paper, true and fair view of the financial a period according to the best of the information and
explanation given to him as shown by the books and if not to what respect he is not satisfied’.
According to the Institute of Chartered Accountants of India, “Auditing.... is a systematic and
independent examination of data, statements, records, operations and performance (financial
or otherwise) of an enterprise for a stated purpose”.
Thus, an audit implies an investigation and a report. The process of checking and vouching
continues until the study is completed and the auditor enables himself to report under the
terms of his appointment.
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1.2 ORIGIN AND EVOLUTION
Auditing is as old as accounting. It was in use in all ancient countries such as Mesopotamia,
Greece, Egypt. Rome, U.K. and India. The Vedas contain reference to accounts and auditing.
Arthasashthra by Kautilya detailed rules for accounting and auditing of public finances.
The original objective of auditing was to detect and prevent errors and frauds. Auditing
evolved and grew rapidly after the industrial revolution in the 18th century. With the growth
of the joint stock companies the ownership and management became separate. The
shareholders who were the owners needed a report from an independent expert on the
accounts of the company managed by the board of directors who were the employees. The
objective of audit shifted and audit was expected to ascertain whether the accounts were true
and fair rather than detection of errors and frauds.
In India the companies Act 1913 made audit of company accounts compulsory With the
increase in the size of the companies and the volume of transactions the main objective of
audit shifted to ascertaining whether the accounts were true and fair rather than true and
correct.
Hence the emphasis was not on arithmetical accuracy but on a fair representation of the
financial efforts. The companies Act,1913 also prescribed for the first time the qualification
of auditors The International Accounting Standards Committee and the Accounting Standard
board of the Institute of Chartered Accountants of India have developed standard accounting
and auditing practices to guide the. accountants and auditors in the day to day work The later
developments in auditing pertain to the use of computers in accounting and auditing. In
conclusion it can be said that auditing has come a long way from hearing of accounts to
taking the help of computers to examine computerised accounts
1.3 FEATURES OF AUDITING
The audit is structured into activities that follow a logical sequence. The audit will focus on
the management and delivery of the electronic device, which supposes fluxes of electronic
devices and procedures of treatment specific associated. There are six essential features or
characteristics of auditing:
1. Systematic process: Auditing is a systematic and scientific process that follows a
sequence of activities, which are logical, structured, and organized.
2. Three-party relationship: The audit process involves three parties, that is,
shareholders, managers, and auditors.
3. Subject matter: Auditors give assurance on a specific subject matter. However, the
subject matter may differ considerably, such as – data, systems or processes and
behaviour.
4. Evidence: The auditing process requires collecting the evidence, that is, financial and
non-financial data, and examining thereof.
5. Established criteria: The evidence must be evaluated regarding established criteria,
which include International Accounting Standards, International Financial Reporting
Standards, Generally Accepted Accounting Principles, industry practices, etc.
6. Opinion: The auditor has to express an opinion as to the reasonable assurance on the
financial statements of the entity.
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Audit Features influences the objectives of the audit to refer to the security of the information
and systems, the protection of the personal data, access to some databases with an
informational sensitive character.
1.4 OBJECTIVES OF AUDITING
The objective of an audit is to express an opinion on financial statements. The auditor has to
verify the financial statements and books of accounts to certify the truth and fairness of the
financial position and operating results of the business. Therefore, the objectives of audit are
categorized as primary or main objectives and secondary objectives.
1. Primary Objectives of Audit: The main objectives of the audit are known as the
primary objectives of the audit. They are as follows:
a. Examining the system of internal check.
b. Checking arithmetical accuracy of books of accounts, verifying posting, casting,
balancing, etc.
c. Verifying the authenticity and validity of transactions.
d. Checking the proper distinction between capital and revenue nature of transactions.
e. Confirming the existence and value of assets and liabilities.
2. Secondary Objectives:These are such objectives that are set up to help in attaining
primary objectives. They are as follows:
a. Detection and prevention of errors:Errors are those mistakes that are committed
due to carelessness or negligence or lack of knowledge or without having vested
interest.Errors may be committed without or with any vested interest.
So, they are to be checked carefully. Errors are of various types. Some of them are:
 Errors of principle.
 Errors of omission.
 Errors of commission.
 Compensating errors.
b. Detection and prevention of frauds: Frauds are those mistakes that are committed
knowingly with some vested interest in the direction of top-level management.
Management commits frauds to deceive tax, to show the effectiveness of
management, to get more commission, to sell a share in the market or to maintain the
market price of share, etc.
Detection of fraud is the main job of an auditor.
Such frauds are as follows:
 Misappropriation of cash.
 Misappropriation of goods.
 Manipulation of accounts or falsification of accounts without any misappropriation.
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1.5 ADVANTAGES OF AUDITING
1] Assurance to the Owners/Investors
One of the biggest advantages of auditing is that it offers assurances to the owners, investors,
shareholders etc. The owners of the business will be assured about the accuracy of their books of
accounts. They will be satisfied with the workings of their various departments and the overall
efficiency and profitability of their business operations. It is the same case with investors, who
will find assurance in the books of accounts after auditing.
2] Errors and Frauds
An error is something that is done without the intention to fraud the company, it is an innocent
mistake. Fraud, on the other hand, is deliberate. During the process of auditing, both errors and
frauds are discovered. Auditing also helps prevent such errors and frauds. It creates a fear of
being detected.
So auditing helps us minimize the risks of errors and frauds in our books of accounts but does
not eliminate the risk entirely. There is always the chance that the error may go unnoticed, and
the fraud is very cleverly hidden so may go undetected.
3] Independent Viewpoint
If the auditor is an external auditor, the business can get a second opinion on their financial
statements and their financial standing as well. An external auditor will closely inspect the books
and be completely true and fair in his opinion as he has no hidden agenda. If he says the
accounts are true and fair, it has a lot of weightage with the company and the investors.
4] Moral Check
One of the other advantages of auditing is that the staff and the workers of the company do not
try to steal or defraud the company. They are under constant scrutiny since they know that the
accounts will be audited. Any irregularities can be identified during such an audit, and they will
be caught eventually. This helps the staff in being honest and responsible at all times.
5] Stakeholders Confidence
After auditing stakeholders like creditors, investors, banks, debenture holders etc. can rely on the
books of accounts with more confidence. And so after auditing by an independent authority, the
financial statements have more credibility.
1.6 LIMITATIONS OF AUDITING
1] Cost Factor
A very thorough and detailed audit would be a costly affair. It is not cost effective. So the
auditor has to limit the scope of his audit and use techniques like sampling and test checking.
2] Time Factor
Auditors generally work on a very specific timeline. Sometimes this is due to statutory
requirements. This means he has to audit a whole year’s accounts in a few weeks. Hence
insufficient time is one of the main limitations of auditing.
3] Inconclusive Evidence
Generally, the audit evidence the auditor collects is persuasive in nature, not conclusive in
nature. So there is never cent percent conclusive evidence in most cases while auditing.
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This is one of the major limitations of auditing. There also a lot of use of estimates in
accounting. The auditor cannot measure or comment on the exact accuracy of these estimates.
He has to rely on his knowledge.
Q: Auditing helps in securing loans from banks. True or False?
Ans: This statement is in fact, true. Audited statements are a necessity when availing loan or
credit facilities from banks. The banks are more assured about the financial position of the
company and can sanction loans accordingly.
1.7 EXPRESSION OF OPINION
When we speak of the objective, we rationalize the thinking process to formulate a set of
attainable goals, with reference to the circumstances, feasibility and constraints. In money
matters, frauds and errors are common place of occurrence. Apart from this, the statements of
account have their own purpose and use of portraying the financial state of affairs. The
objective of audit, naturally, should be to see that what the statements of account convey is
true and not misleading and that such errors and frauds do not exists as to distort what the
accounts should really convey. Till recently, the principal emphasis was on arithmetical
accuracy; adequate attention was not paid to appropriate application of accounting principles
and disclosure, for ensuring preparation of accounting statement in such a way as to enable
the reader of the accounting statement to form a correct view of the slate of affairs. Quite a
few managements took advantage of the situation and manipulated profit or loss and assets
and liabilities to highlight or conceal affairs according to their own design. This state of
affairs came up for consideration in the Royal Mail Steam Packet Company’s Case as a result
of which the Companies Acts of England and India were amended in 1948 and 1956
respectively to require the auditor to state inter alia whether the statements of account are true
and fair. This is what we can take as the present day audit objective. The implication of the
substitution of “true and fair” need to be understood. There has been a shift of emphasis from
arithmetical accuracy to the question of reliability to the financial statements. A statement
may be reliable even though there are some errors or even frauds, provided they are not so
big as to vitiate the picture. The word “correct” was somewhat misplaced as the accounting
largely consists of estimates. However, you should not infer that the detection of errors and
frauds is no longer an audit objective; it is indeed an audit objective because statements of
account drawn up from books containing serious mistakes and fraudulent entries cannot be
considered as a true and fair statement. To establish whether the financial statement show a
true and fair state of affairs, the auditors must carry out a process of examination and
verification and, if errors and frauds exist they would come to his notice in the ordinary
course of checking. But detection of errors of frauds is not the primary aim of audit; the
primary aim is the establishment of a degree of reliability of the annual statements of account.
If there remains a deep laid fraud in the accounts, which in the normal course of examination
of accounts may not come to light, it will not be construed as failure of audit, provided the
auditor was not negligent in the carrying out his normal work. This principle was established
as early as in 1896 in the leading case in Re-Kingston 8 Cotton Mills Co.
1.8 DETECTION OF FRAUD & ERRORS
The term fraud means the wilful misrepresentation made with an intention of deceiving
others. It is a deliberate mistake committed in the accounts with a view to get personal gain.
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In accounting, fraud means two things. a. Defalcation involving misappropriation of either
cash or goods; and b. Fraudulent manipulation of accounts not involving defalcation.
1.9 QUALITIES OF AN AUDITOR
So far we have discussed the question of formal qualifications of an auditor. But it is not
enough to realise what an auditor should be. He is concerned with the reporting on financial
matters of business and other institutions. Financial matters inherently are to be set with the
problems of human fallibility; errors and frauds are frequent. The qualities required,
according to Dicksee, are tact, caution, firmness, good temper, integrity, discretion, industry,
judgment, patience, clear headedness and reliability. In short, all those personal qualities that
goes to make a good businessman contribute to the making of a good auditor. In addition, he
must have the shine of culture for attaining a great height. He must have the highest degree of
integrity backed by adequate independence. In fact, AAS-1 mentions integrity, objectivity
and independence as one of the basic principles. He must have a thorough knowledge of the
general principles of law which govern matters with which he is likely to be in intimate
contact. The Companies Act, 1956 and the Partnership Act, 1932 need special mention but
mercantile law, especially the law relating to contracts, is no less important. Needless to say,
where undertakings are governed by a special statute, its knowledge will be imperative; in
addition, a sound knowledge of the law and practice of taxation is unavoidable. 24 He must
pursue an intensive programme of theoretical education in subjects like financial and
management accounting, general management, business and corporate laws, computers and
information systems, taxation, economics, etc. Both practical training and theoretical
education are equally necessary for the development of professional competence of an auditor
for undertaking any kind of audit assignment. The auditor should be equipped not only with a
sufficient knowledge of the way in which business generally is conducted but also with an
understanding of the special features peculiar to a particular business whose accounts are
under audit. AAS-8 on ‘Audit Planning’ emphasises that an auditor should have adequate
knowledge of the client’s business. The auditor, who holds a position of trust, must have the
basic human qualities apart from the technical requirement of professional training and
education. He is called upon constantly to critically review financial statements and it is
obviously useless for him to attempt that task unless his own knowledge is that of an expert.
An exhaustive knowledge of accounting in all its branches is the sine qua non of the practice
of auditing. He must know thoroughly all accounting principles and techniques. Auditing is a
profession calling for wide variety of knowledge to which no one has yet set a limit; the most
useful part of the knowledge is probably that which cannot be learnt from books because its
acquisition depends on the alertness of the mind in applying to ever varying circumstances,
the fruits of his own observation and reflection; only he who is endowed with common sense
in adequate measure can achieve it. Lord Justice Lindley in the course of the judgment in the
famous London & General Bank case had succinctly summed up the overall view of what an
auditor should be as regards the personal qualities. He said, “an auditor must be honest that
is, he must not certify what he does not believe to be true and must take reasonable care and
skill before he believes that what he certifies is true
Thus, Auditing is a systematic and scientific examination of the books of accounts and
records of business to enable the auditor to satisfy himself that the profit and loss account and
the balance sheet are properly drawn up so as to exhibit a true and fair view of the financial
state of affairs of the business and profit or loss for the financial period.
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The term auditing has been distinguished from accounting and investigation. The main point
of distinction is that accountancy is concerned with the preparation of financial statements
whereas auditing is concerned with checking of these financial statements and reporting on
the financial position and result of operation of the organisation. Investigation is undertaken
for some special purpose i.e. to determine the extent of fraud or to determine the purchase
price of the organisation and the like. Objectives of audit are broadly classified into a)
primary objective and b) secondary objective. Primary objective of audit is to substantiate the
accuracy of the financial statements prepared by the accountant while the secondary objective
is to detect and prevent errors and frauds. A number of advantages can be derived from
getting the accounts audited by a qualified auditor, such as early detection of errors and
frauds, reliability of accounts, statements of various types of claims, securing loans from
banks and other financial institutions, etc. Audit is classified into various types, viz., audit
under statute, audit of accounts of private firm, audit of accounts of private individuals, audit
of trust accounts. An auditor can adopt any one of the modes to conduct his audit of an
organisation, viz. continuous audit or periodical audit or interim audit. Besides being a
Chartered Accountant, an auditor should possess certain other qualities, such as knowledge of
relevant laws, intelligence, tactfulness, vigilance, honesty and integrity courage, impartiality,
broadmindedness, patience, perseverance, maintaining secrecy of his client, commonsense
etc.
1.10 PRINCIPLES OF AUDITING
Audits depend on a set of principles to make them effective and reliable tools in supporting
management controls and policies. Audit principles provide information for organisations to
act and improve their performance in business.
According to the ISO, auditing must be based on these six basic principles:
1. Integrity:
o Audits are performed with diligence, honesty, and responsibility
o Observation and compliance with applicable legal requirements
o Demonstrating competence when performing an audit
o Audits are conducted in an impartial manner
o Auditors remain unbiased or fair in all their dealings
o Being sensitive to influences exerted on the judgment during an audit.
2. Fair Presentation
o Makes sure that reports, findings and conclusions are truthfully and accurately
reflective of the audit activities
o Reporting of significant obstacles encountered during the audit
o Reporting of unresolved or the diverging opinions between the business being
audited and the audit team
o Makes sure that communications are objective, truthful, accurate, timely, clear
and complete.
3. Due Professional Care
o Apply due care based on the importance of tasks and on the confidence given
to you by a client
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o Make reasonable judgments in all audit situations.
4. Confidentiality
o Practice discretion and protection of information when auditing
o Never use audit information for personal gain or in harmful way to legitimise
the interests of an auditee
o Handle sensitive and confidential information properly.
5. Independence
o Remain independent from the business or activity being audited
o Always be free of conflict or bias
o Be objective all throughout the audit process
o Make sure that findings and conclusions are based on verifiable evidence
o Internal auditors should be independent of what is being audited.
6. Evidence-Based Approach
o Collate and collect verifiable evidence
o Evidence should be based on samples of ready information
o Use samples because audits are to be conducted in a limited amount of time
and with limited resources
o Properly or appropriately use samples to add confidence on audit conclusion.
1.11 TECHNIQUS OF AUDITING
Auditing technique is defined as “any technique used by auditors to determine deviations
from actual accounting and controls established by a business or organization as well as
uncovering problems in established process and controls”.
Following are the important techniques of audit.
1. Examination of books of accounts: The basic technique of an auditor is to examine
the books of accounts. The examination is conducted to verify the accuracy of data.
2. Vouching: It refers to the examination of the original documentary evidence supporting
the transaction. Examples for vouchers are invoices, bills, receipts, debit and credit
notes, etc.
3. Inquiry: The auditor makes inquires and collects information from persons inside and
outside the organization to check the correctness of the recorded data.
4. Sampling: Sampling refers to selecting and checking a few items from the whole
accounting information.
5. Confirmation: The auditor contacts debtors, creditors, officials, etc and collects
information which helps him to confirm the transactions.
6. Compliance test: These tests are employed by the auditor to check the effectiveness of
the internal control system prevailing in the organization.
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7. Financial system analysis: Financial statements such as profit and loss account and
balance sheet re analyzed to establish relationship between two accounting figures.
Auditors generally use ratio analysis to test liquidity, solvency and the profitability of
concerns.
8. Computer techniques: The auditor may use techniques such as audit software, test
packing, mapping, etc to test the accuracy of accounting data.
9. Observation: The auditor relies on personal observation and witnesses the physical
stock taking conducted at the end of the year.
10. Expert opinion: the auditor contacts experts like engineers, lawyers, etc to gather their
opinion about the business. He also depends on the internal auditors for completing his
work.
1.12 CLASSIFICATION OF AUDIT

1.12.1 According to the Organization of Business
1. Statutory Audit: A statutory audit is a legally required review of the accuracy of a
company’s or government’s financial statements and records. The purpose of a statutory
audit is to determine whether an organization provides a fair and accurate representation
of its financial position by examining information such as bank balances, bookkeeping
records, and financial transactions.
2. Private Audit: Private companies, ranging from family businesses to global, publicly
trading corporations, are not part of the government. Their profits are designated at the
operators’ prerogative, often for good old capitalist gain, and companies’ objectives can
differ vastly.
1.12.2 According to the Ownership of Business
1. Audit of Companies: Under companies Act, audit of accounts of companies in India is
compulsory. Chartered accountant who is professionally qualified is required for the
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audit of accounts of companies. Companies Act 1913 for the first time made it
compulsory for joint stock companies to get their accounts audited from a qualified
accountant. A number of amendments have been made in companies Act, 1956 and
2013 regarding appointment, duties, qualification, power and liabilities of a qualified
auditor.
2. Audit of Trusts: The beneficiaries of the trusts may not have access and knowledge of
accounts of the trust. The trustees are appointed to manage and look after the property
and business of the trust. Accounts of the trust are maintained as per the conditions and
terms of the trust deed. The income of the trust is distributed to the beneficiaries. There
are more chances of frauds and mis-appropriation of incomes. In the trust deed as well
as in the Public Trust Act which provide for compulsory audit of the accounts of the
trust by a qualified auditor. The audited accounts of the trust ensure true and fair view
of accounts of the trust.
3. Audit of Accounts of Co-operative Societies: Co-Operative societies are established
under the Co-Operative Societies Act, 1912. It contains various provisions for the
regulations and the working of these societies. Some of the states have adopted it
without any change, while others have brought certain changes to it. The auditor of the
Co-operative Society should have an expert knowledge of the particular act under
which Co-operative society under audit is functioning. He should also study by-laws of
the society and make sure that the amendments made from time to time in the by-laws
have been duly registered in the Registrar’s Office. Companies Act is not applicable to
the co-operative Societies. The Registrar of co-operative societies shall audit or cause to
be audited by some person authorized by him, the accounts of the society once in every
financial year.
4. Audit of Government Offices: Audit of government offices and departments is
covered under this heading. A separate department is maintained by government of
India known as Accounts and Audit Department. This department is headed by the
Comptroller and Auditor General of India. This department works only for the
government offices and departments. This department cannot undertake audit of non-
government concerns. Its working is strictly according to government rules and
regulations.
5. Audit of Proprietorship: In case of proprietary concerns, the owner himself takes the
decision to get the accounts audited. Sole trader will decide about the scope of audit and
appointment of auditor. The auditing work will depend upon the agreement with auditor
and the specific instructions given by the proprietor.
6. Audit of Partnership: To avoid any misunderstanding and doubt, partnership audits
their accounts. Partnership deed on mutual agreement between the partners may provide
for audit of financial statements. Auditor is appointed by the mutual consent of all the
partners. Rights, duties and liabilities of auditor are defined in the mutual agreement
and can be modified by the partners.
7. Audit of Individuals: An Individual such as estate managers, rent collectors, investors,
etc. who engaged in business/ or profession is required to maintain books of account
and to get them audited and obtain and furnish Tax Audit Report of the Income Tax Act
(1961) from a Chartered Accountant if the sale, gross receipts or turnover etc. exceeds
prescribed limit.
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1.12.3 According to the Time of Audit
1. Interim Audit: When an audit is conducted between two annual audits, such audit is
known as Interim audit. It may involve complete checking of accounts for a part of the
year. Sometimes it is conducted to enable the board of directors to declare an Interim
dividend. It may also be for the purpose of dealing with interim figures of sales.
2. Continuous Audit: The Continuous Audit is conducted throughout the year or at the
regular short intervals of time. A continuous audit involves a detailed examination of all
the transactions by the auditor attending at regular intervals for example weekly,
fortnightly or monthly, during the whole period of trading.
3. Final Audit: Final Audit means when the audit work is conducted after the close of
financial year. A final audit is commonly understood to be an audit which is not
commenced until after end of the financial period and is then carried on until
completed.
4. Balance Sheet Audit: Balance Sheet Audit relates to the verification of various items
of balance sheets such as assets, liabilities, reserves and surplus, provisions and profit
and loss balance. The procedure under this audit is to follow a backward process. First
the item is located in balance sheet, and then it is located in original record for the
purpose of verification.
1.12.4 According to the Objectives of Audit
1. Management Audit: Management audit is a systematic examination of decisions and
actions of the management to analyse the performance. Management audit involves the
review of managerial aspects like organizational objective, policies, procedures,
structure, control and system in order to check the efficiency or performance of the
management over the activities of the Company. Management Audit is an assessment of
methods and policies of an organization’s management in the administration and the use
of resources, tactical and strategic planning, and employee and organizational
improvement.
2. Internal Audit: It implies the audit of accounts by the staff of the business. Internal
audit is an appraisal activity within an organization for the review of the accounting,
financial and other operations as basis for protective and constructive service to the
management. It is a type of control which functions by measuring and evaluating the
effectiveness of other types of control. It deals primarily with accounting and financial
matters but it may also properly deal with matters of operating nature.
3. Cost Audit: Cost Audit is the verification of the correctness of cost accounts and
adherence to the cost accounting plans. Cost Audit is the detailed checking of costing
system, techniques and accounts to verifying correctness and to ensure adherence to the
objectives of cost accounting.
4. Secretarial Audit: Secretarial Audit is concerned with verification compliance by the
company of various provisions of Companies Act and other relevant laws. Secretarial
audit report includes:
a) Whether the books are maintained as per companies act, 2013.
b) Whether necessary approvals as required from central Government, Company law
board or other authorities were obtained.
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5. Independent Audit: Is conducted by the independent qualified auditor. The purpose of
independent audit is to see whether financial statements give true and fair view of
financial position and profits. Mainly it is for safeguarding the interest of owners,
shareholders and other parties who do not have knowledge of day-to-day operations of
organization.
6. Tax Audit: Now-a-days tax audit has become very important to ascertain the accuracy
of tax related documents. Tax audit mostly covers income returns, invoices, debit and
credit notes and various current and fixed assets. Tax audit is an innovation of 21st
century. It has added one more chapter to the practice of auditing. Tax audit ensures the
validity and credibility of tax related documents.
SUMMARY
1. Auditing is a systematic and independent examination of data, statements, records,
operations and performance (financial or otherwise) of an enterprise for a stated
purpose. The original objective of auditing was to detect and prevent errors and frauds.
2. There are six essential features or characteristics of auditing: Systematic process, Three-
party relationship, Subject matter, Evidence, Established criteria & opinion.
3. The objectives of audit are categorized as primary or main objectives and secondary
objectives.
4. Auditing provide many advantages like Assurance to the Owners/Investors, Errors and
Frauds detection, Independent Viewpoint, Moral Check, Stakeholders Confidence.
5. The term fraud means the wilful misrepresentation made with an intention of deceiving
others. In accounting, fraud means two things-Defalcation involving misappropriation of either
cash or goods &Fraudulent manipulation of accounts not involving defalcation.
6. AAS-8 on ‘Audit Planning’ emphasises that an auditor should have adequate
knowledge of the client’s business. The auditor, who holds a position of trust, must
have the basic human qualities apart from the technical requirement of professional
training and education.
7. Auditing must be based on these six basic principles: Integrity, Fair presentation, Due
Professional Care, Confidentiality, Independencs, Evidence-based approach.
8. Auditing are classified according to Organization of Business, Ownership of Business,
Time of Audit, Objectives of Audit.
FILL IN THE BLANKS
1. …………………. and ……….. With supporting vouchers and documents to detect and
prevent error, fraud is the primary function of auditing.
2. The objective of an audit is to express an opinion on ……………….
3. One of the biggest advantages of auditing is that it offers assurances to the
…………………
4. The primary aim is the establishment of a …………….of the annual statements of
account.
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5. ………… is a systematic and scientific examination of the books of accounts and
records of business to enable the auditor to satisfy himself that the all financial account
drawn up so is true and fair.
MULTIPLE CHOICE QUESTIONS
1. Audit principles provide information for organisations to act and improve their
performance in business. Which of the following is not a principle of auditing.
(i) Fair Presentation
(ii) Confidentiality
(iii) Vouching
(iv) Evidence-Based Approach
2. Which of the followings comes under audit according to the Ownership of Business.
(i) Statutory Audit
(ii) Audit of Accounts of Co-operative Societies
(iii) Continuous Audit
(iv) None of above
3. The audit is structured into activities that follow a logical sequence. Which of the
following is not a feature of audit.
(i) Three-party relationship
(ii) Subject matter
(iii) Inconclusive Evidence
(iv) Systematic process
4. Detection of fraud is the main job of an auditor. Which type of fraud is detected by
auditor.
(i) Manipulation of accounts
(ii) Misappropriation of cash or goods.
(iii) Falsification of accounts without any misappropriation.
(iv) All of the above.
5. Which of the following is not a part of error checked by auditor.
(i) Errors of principle.
(ii) Falsification of accounts
(iii) Errors of commission.
(iv) Compensating errors.
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SHORT ANSWER TYPE QUESTIONS
1. Define the term auditing. Explain its features.
2. What is the quality of good auditor?
3. Explain the principles of auditing.
4. How we can classify according to different bases?
5. Explain the different techniques of auditing.
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CHAPTER-2
AUDIT PLANNING AND INTERNAL CONTROL
2.1 Audit Process

2.1.1 Objectives of Audit Process
2.1.2 Stages of Audit Process
2.2 Audit Programme
2.2.1 Features of Audit Programme
2.2.2 Objectives of Audit Programme
2.2.3 Advantages of Audit Programme
2.2.4 Disadvantages of Audit Programme
2.3 Audit Notebook
2.3.1 Contents of Audit Notebook
2.3.2 Advantages of Audit Notebook
2.3.3 Disadvantages of Audit Notebook
2.4 Audit working papers/ audit documentation (SA 230)
2.4.1 Advantages of Audit Working Papers
2.5 Internal Control
2.5.1 Purpose of Internal Control
2.5.2 Characteristics of Internal Control
2.5.3 Limitations of Internal Control
2.5.4 Scope of Internal Control
2.5.5 Internal Control and Audit
2.5.6 Review of Internal Control System
2.6 Internal Check
2.6.1 Characteristics of Internal Check
2.6.2 Objectives of Internal Check
2.6.3 Principles of Internal Check
2.6.4 Advantages of Internal Check
2.6.5 Disadvantages of Internal Check
2.7 Distinction between Internal Control and Internal Check
2.8 Distinction between Internal Control, Internal Check and Internal Audit
2.9 Distinction between Internal Audit and Statutory Audit
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2.1 AUDIT PROCESS
Audit process is a set of actions and procedures to control an organization. They aim to
test and prove that processes are being conducted effectively and follow due control
mechanisms. They also aim to detect opportunities for improvement in the audit process.
2.1.1 OBJECTIVES OFAUDIT PROCESS
Every organization has strategic objectives to achieve. One of the objectives of the audit
process is to verify that all company processes are aligned with this strategic vision and
that they deliver the value that internal customers need and external ones want.
 Evaluate the operational efficiency of processes
 Verify that the process chain provides protection for company assets
 Find out if your company information and data is secure and reliable
 Evaluate processes to determine if they’re reliable
 Check for incorrect procedures during processes
 Report detected failures and non-conformities
 Provide recommendations for appropriate corrections
2.1.2 STAGES OF AUDIT PROCESS
Audit process is the well-defined methodology for organizing. Its phases are:
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1. Planning: During the planning phase, contact with audit clients is initiated and relevant
background information is gathered to gain an understanding of the audited area’s size,
responsibilities, and procedures in place. Also in this phase, audit objectives are defined
and audit methodology is determined through the creation of an audit program, which is
the blueprint for conducting the audit and accomplishing the audit objectives. In most
cases, a risk assessment of the department and/or function will be performed to help
ensure appropriate areas are included.
a. Notification Letter – With few exceptions, audit clients are notified in writing when
their area is selected for an audit; however, due to the nature of some audit work, little
or no advance notice may be given.
b. Entrance Meeting – Depending on the type of audit and the amount of audit work
planned, an entrance meeting may be scheduled with the head of the unit and any
administrative staff that may be involved in the audit. In-person meetings are
preferred, but this may be accomplished via telephone or other ways if necessary.
2. Fieldwork: The evaluation phase of the audit is referred to as fieldwork. This phase
includes assessing the adequacy of internal controls and compliance, testing of
transactions, records, and resources, and performing other procedures necessary to
accomplish the objectives of the audit.
It may be necessary for the audit team to conduct interviews with departmental personnel and
to review departmental records and practices; however, efforts will be made to minimize
disruptions and cooperate with audit clients to make the audit process as smooth as possible.
The duration of an audit varies depending upon its scope; limited scope audits may take only
a week or two while broad scope audits may take several months. In addition, access to
personnel and records and the timeliness of responses to audit requests may also affect the
duration of the audit.
3. Reporting: The final result of every audit is a written report that details the audit scope
and objectives, results, recommendations for improvement, and the audit client’s
responses and corrective action plans.
a. Draft Report – Audit reports are typically prepared in draft form and distribution is
initially limited to the immediate manager of the area so it can be reviewed prior to
further distribution of the audit report.
If recommendations are made, written responses detailing the following are requested of the
audit client:
 A corrective action plan to resolve the problem and its root cause,
 The person responsible for implementing the corrective action, and
 An expected implementation dates.
b. Exit Meeting – If necessary, an exit meeting will be held to provide an opportunity to
resolve any questions or concerns the audit client may have about the audit results and to
resolve any other issues before the final audit report is released. Those attending usually
include the audit team, management of the audited entity such as the Dean, Chairperson,
and Director, as well as others that the audit client wishes to invite.
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c. Final Audit Report – The final audit report is addressed to the University President and
copies are provided to appropriate levels of management, the Board of Regents, the UT
System Audit Office, and required state agencies.
4. Follow-up: There will be occasions when corrective actions to resolve an audit issue will
not be accomplished until after the audit report has been finalized. In these cases, follow-
up will be performed on the previously reported recommendations to determine whether
corrective action plans have been effectively implemented and that expected results are
being achieved. Depending on the severity of the audit issue, follow-up activities could
include interviewing staff, reviewing updated procedures or documentation, or re-auditing
the processes that originally led to the audit issue.
The audit is considered a very important step that helps develop a much-needed trust in the
market. It helps to establish that there are no material misstatements in the company’s
financial statements, and the company is free and fair from all types of fraud.
In this regard, it is highly important to ensure that auditors are able to carry out their tasks in
a responsible manner so that users of financial statements can actually rely on the audit
statements that these auditors present.
In order to achieve the desired level of accuracy while conducting the audit, auditors are
supposed to design their audit procedures that reflect professional skepticism and present a
trajectory regarding the key indicators that need to be addressed during the course of the audit
2.2 AUDIT PROGRAMME
An audit programme is a detailed, written statement designed by the auditor indicating the
work to be performed by the audit assistants, specifying the time limit for completion of
work, instructions and guidance to the audit staff. In short, it is a tool for planning, directing
and controlling the audit work.
Prof. Meigs defines an audit programme as, “an audit programme is a detailed plan of the
auditing work to be performed, specifying the procedures to be followed in verification of
each item and the financial statements and giving the estimated time required.”
2.2.1 FEATURES OF AN AUDIT PROGRAMME
The features of an audit programme may be of the following:
1. It is a set of procedures to be adopted to conduct the audit more efficiently.
2. It is a written scheme designed by the auditor.
3. It is a blue print of the audit work.
4. It facilitates delegation of work, based on the capabilities of audit staff.
5. It acts as evidence in future for the audit work being performed.
6. It specifies the work to be done by the audit staff, the manner and time limit for
completion of the work.
2.2.2 OBJECTIVES OF AUDIT PROGRAMME
The following are the objectives of audit programme:
1. To provide clear instructions to the audit assistants specifying the nature of work to be
performed and fixing the time span for completion of each work.
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2. To facilitate coordination among various parts of audit work.
3. To ensure uniformity in the performance of audit work and to avoid duplication and
repetition of work.
4. To attain a fair allocation of work among audit team.
5. To fix responsibility and accountability of each audit assistant.
6. To serve as a guide for planning the audit work in future.
7. To serve as evidence in future showing the date of completion of audit work, methods
or procedures undertaken, persons involved in completion of audit work etc.
2.2.3 ADVANTAGES OF THE AUDIT PROGRAMME
1. An audit program helps in ensuring that all-important areas are considered while
conducting the audit.
2. An audit program helps an auditor in the allocation of work among its team members
according to their skills and competency.
3. It enhances the accountability of audit team members towards work performed by them
4. An audit program also reduces the scope for misunderstanding among team members
regarding the performance of audit work.
5. It helps the auditor in checking the status of audit work, its progress, how much it is left
for performance while conducting the audit.
6. Auditor prepares audit working papers which contains a record of various audit
procedure applied which serves as evidence against the charge of negligence.
7. Audit program enables the auditor to keep a record of useful information specifically for
future audit and references.
2.2.4 DISADVANTAGES OF AUDIT PROGRAMME
1. Rigidity: There is no set standard audit program that can be applied in the case of every
entity. However, programs differ for different types of entities. Every entity has its own
problems. Therefore, we cannot apply for a single audit program in the case of all
business entities.
2. Reduces the Initiative of Efficient Staff: – A program reduces the initiatives of
efficient and competent staff. Thus, staff members cannot make changes in the audit plan
and cannot make suggestions to it.
3. Audit Work becomes Mechanical: The program becomes mechanical when it ignores
other aspects like internal control.
4. Overlooking New Areas: A program may overlook the new areas. With the change in
time and technology, new problems may arise which an audit program may not consider.
Question: Write a program for the audit of cash.
Ans. A program for cash involves the following:–
 Checking of the opening balance
 The checking of petty cash
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 The checking cash book
 Checking cash receipt and payment voucher
 Authorization for cash payments
 Comparison with the bank statement
 Surprise check of cash balance
 Cash summary
 Examination of direct deposits by the third parties
2.3 AUDIT NOTEBOOK
Audit Note Book is a register maintained by the audit staff to record important points
observed, errors, doubtful queries, explanations and clarifications to be received from the
clients. It also contains definite information regarding the day-to-day work performed by the
audit clerks. In short, audit note book is usually a bound note book in which a large variety of
matters observed during the course of audit are recorded. The note book should be
maintained clearly, completely and systematically. It serves as authentic evidence in support
of work done to protect the auditor against any legal charge initiated against him for
negligence. It is of immense help to the auditor in preparing audit report. It also acts as a
valuable guide for conducting audit for future years.
2.3.1 Contents of Audit Note Book
The following matters should have been incorporated in an Audit Note Book:
1. A list of the account books normally used and maintained.
2. Names of the principal officers, their duties and responsibilities.
3. Nature of business carried on and important documents relating to the constitution of
business like Memorandum of Association, Articles of Association, Partnership deed
etc.,
4. Extracts of minutes and contracts affecting the accounts.
5. Extracts of correspondence with statutory authorities.
6. Copy of audit programme.
7. Accounting methods, internal control and internal check system in operation.
8. Routine queries like missing receipts and vouchers etc.
9. Details of errors and frauds discovered during the course of audit.
10. Points to be included in audit report.
11. Details of all important information to be used as reference for future audits.
12. Date of commencement and completion of audit.
2.3.2 Advantages of Audit Note Book
1. Facilitates Audit Work: It facilitates the work of an auditor as all important details
about the audit are recorded in the note book which the audit clerk cannot remember
everything at all the time. It helps in remembering and recalling the important matters
relating to the audit work.
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2. Preparation of Audit Report: Audit note book helps in providing required data for
preparing the audit report. An auditor examines the audit note book before preparing
and finalizing the audit report.
3. Serves as Documentary Evidence: Audit note book serves as a documentary evidence
in the court of law when a suit is filed against the auditor for his negligence.
4. Serves as a Guide: When a audit assistant is changed before the completion of audit
work, audit note book serves as a guide in completion of balance work. It also acts as a
guide for carrying on subsequent audits.
5. Evaluating Work of Audit Staff: It helps to assess the work performed by the audit
staff and helps in evaluating their level of efficiency.
6. Fixation of Responsibility: Audit note book helps in fixing responsibility on concerned
clerk who is responsible for any undetected errors and frauds in the course of audit.
7. No Dislocation of Audit Work: An audit note book contains all important details about
audit hence any change in the audit staff will not disturb or dislocate the audit work.
2.3.3 Disadvantages of Audit Note Book
1. Fault-finding Attitude: It leads to development of a fault-finding attitude in the minds
of the staff.
2. Misunderstanding: Very often maintenance of audit note book creates
misunderstanding between the client’s staff and the audit staff.
3. Improper Preparation: Since it serves as evidence in the court of law, it needs to be
prepared with great caution. When the note book is prepared without due care it cannot
be used as evidence against the auditor for negligence.
4. Adverse Effects on Subsequent Audits: Since audit note book is used in performing
subsequent audits, any mistakes in the note book may have adverse impacts on the next
audit.
2.4 AUDIT WORKING PAPERS
Audit working papers are the outcome of the documentation process. Working papers are the
record of various audit procedures performed, audit evidence obtained, allocation of work
between audit team members etc. Audit working papers are the documents and evidence that an
auditor collects and retains with himself during the audit.
Audit working papers support the work that the auditor performs for providing assurance that he
conducts the audit in accordance with all the applicable standards on auditing (SA’s). They
constitute all the audit evidence that an auditor obtains. Also, it contains various procedures that
he applies to indicate that the audit is performed by him.
They help auditor in audit planning and collecting evidence of the audit work performed on
which his opinion is based.
Working papers provide information on the following matters
 Information about audit team members and work allocated to them. Information
regarding unallocated work
 Whether he follows all the applicable standards on auditing (SA’s) or not
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 He properly plans the audit or not
 Whether there was proper supervision over the work performed. Enabling the audit
team members to be responsible for the work performed by them
 An auditor undertakes an appropriate review or not
 Whether the evidence is relevant, sufficient and appropriate to support the opinion of
the auditor
We can divide the working papers into two parts:
1. Permanent audit file
2. Current audit file
A permanent audit file contains information which is of continuous interest and is relevant in
future audits. Information like articles of association, loan agreements, leases, documents related
to internal control of the entity, record of accounting policies followed by the entity on a
continuous basis, significant observations of previous audits etc.
A current audit file contains information regarding audit conducted for the current period. It
includes information like financial statements and audit report of the entity, trial balance and
worksheets, records regarding internal control risk of an entity, external confirmations received,
queries of auditor and reply received from the management etc.
Question: State whether the working papers are the property of the client or auditor.
Whether the client can demand custody of such working papers?
Answer: – Working papers are the record of various audit procedures performed, audit evidence
obtained, allocation of work between audit team members etc. Audit working papers are the
documents and evidence that an auditor collects and retains with himself during the audit. Thus,
the audit working papers are the property of auditor and not of the client. No, client cannot
demand custody of such working papers. The auditor may on his discretion make portions of or
extracts of working papers available to his client. But the client cannot ask the auditor for the
custody of working papers.
2.4.1 Advantages of Audit Working Papers
The important advantages of the working papers may be stated as below:
1. Support for auditor’s opinion:
SAP-3 states, “Sufficient competent evidential matter is to be obtained through inspection,
observation, inquiries and confirmation to afford a reasonable basis for an opinion regarding
the financial statements under examination.” From this statement, it can be easily concluded
that audit working papers provide the auditor sufficient background for giving his opinion
about the financial state of affairs of the enterprise.
2. Helpful in the preparation and certification of audit report:
Working papers serve as the notes for the auditor for preparing his audit report of the
enterprise. Schedules analysis etc., prepared by the auditor in the course of his audit work,
serve as the basis and also certificate for this audit report.
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3. Help in the performance of the audit work:
Working papers help the auditor in coordinating the work of the audit staff as well as
directing them in the conduct of the audit. These papers help in the evaluation of the
progress of the audit work also.
4. Work can be easily divided among the audit staff:
These papers help in the division and distribution of work among the audit staff.
These working papers divide the work in the senior and junior staff and the senior staff may
easily monitor the work of the junior staff. These papers are very much useful where the audit
work is being conducted at various branches, or at various offices of the enterprise.
5. Can be used as a permanent record:
Working papers serve as a permanent record as the audit procedures adopted and examination
of various books of accounts done are recorded in writing. This written record becomes a
permanent record and can be used for many purposes by the auditor in the present as well as
in future also.
6. Create a bridge between original transactions and financial statements:
Working papers can be prepared by the auditor himself or by his staff also. The analysis of
transactions provide an important link between the original transactions and the financial
statements. The reason of this is that the work done by the auditor or his staff is in the nature
of tracing the origin of the business transactions of the enterprise. This is based upon the
books of the original entries. Further, rectification and adjustment entries are also based upon
these papers, as the errors located are to be rectified through the journal entries.
7. Act as a basis for review and revision of internal control system:
Questionnaires relating to Internal Control System adopted by the enterprise are part and
parcel of working papers. Where the auditor finds weaknesses in the internal control system
of the enterprise, he suggests his client for a review and revision of it. Thus, these papers help
in the depth review of the internal control system.
8. Help in evaluation and training of audit staff:
Working papers serve as a means of examination of the audit staff. These papers help the
auditor to know whether the work done by the audit staff is upto the prescribed standard.
These papers reflect the auditor’s capability and capacity to audit, since at every step he has
to take proper decisions regarding the audit work to be done by his staff.
9. Good evidence for the work done:
Working papers serve as evidence of the nature and extent of work being done by the auditor
and his staff. The audit tests done, procedures followed by him and conclusions arrived by
him are all recorded and form part of these working papers. These serve as good evidence for
the auditor. In case he is charged for negligence, he can use these papers as a defence for
himself.
2.5 INTERNAL CONTROL
Internal Control comprises of the plan of the organization and all the co-ordinate methods
and measures adopted within a business to safeguard its assets, check the accuracy and
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reliability of its accounting data to promote operational efficiency and to encourage
adherence to prescribed managerial policies.
2.5.1 Purpose of Internal Control
1. From Auditor’s Point of View: It is very important from the Auditor’s point of view
to study and evaluate the system of internal control. To obtain an adequate
understanding of the internal control system, that must be tested. The Auditor has to
determine whether audit is possible, if yes, then he should determine the scope of
audit.
2. From Client’s Point of View:
 Internal control system provides reliable and accurate data that is necessary for
decision making and to run business activity efficiently.
 Adequate internal control system safeguard business assets, in absence of it, assets of
the company may be stolen, misused or accidentally destroyed.
 Internal control system within organization is necessary to discourage and stop non
performing business activities and to protect business from wastage is all aspects of
the business.
 Internal control system insures that rules and procedures are to be followed by
business personnel.
2.5.2 Characteristics of Internal Control
Following are the main characteristics of Internal Control usually abbreviated as
CROSSASIA−
 Competent and trustworthy personnel
 Records, Financial and other Organization plan
 Organizational plans
 Segregation of duties
 Supervision
 Authorization
 Sound practice
 Internal Audit
 Arithmetic and accounting controls
2.5.3 Limitations of Internal Control
Following are the inherent limitations of Internal Control−
 Management decision to choose cost effective control system may reduce the
effectiveness of internal control system.
 There are chances of misuse by a person of authority who is operating on internal
control system.
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 Objectives of internal control systems may be defeated by manipulation of
management.
 Since internal control system is involved in routine transactions, irregular transactions
may be overlooked.
 Changes in conditions may affect the effectiveness of internal control system.
2.5.4 Scope of Internal Control
Following are the main areas which are generally covered by a good internal control
system−
 Cash − Here, internal control is applied over payments and receipts of an
organization. This is to safeguard from misappropriation of cash.
 Control over Sale and Purchase − With proper and efficient control system for
transactions regarding purchase and sale of material, handling of material and
accounting for the same is must.
 Financial Control − It deals with the efficient system of accounting, recording and
supervision.
 Employee’s Remuneration − Internal control system is applied to preparation and
maintenance of records of employees and the payment methods also. It is also
necessary to safeguard against misappropriation of cash.
 Capital Expenditure − Internal control system ensures the proper sanction of capital
expenditure and also the use of it for the purpose intended.
 Inventory Control − It covers the proper handling of inventory, minimization of
slow moving items or dead stock, proper valuation of stock, recording of it, etc.
 Control over Investments − internal control system is applied to the proper
recording of transactions be it purchases, additions, sale or redemption, income on
investments, profit or loss on investment.
2.5.5 Internal Control and Auditor
An Auditor should ensure that certain rules and procedures are followed by the business unit
he is working on, in spite of the fact that a sound system of internal control is as sole
responsibility of the management. The Auditor can simply guide or help the management if
he is asked to do so, because he has no authority to prescribe such rules and procedures. The
degree of reliance on the system depends upon the effectiveness of internal control system;
therefore, the Auditor should review and evaluate the internal control system of an
organization to prepare his audit Program.
2.5.6 Review of Internal Control System
Internal control system should be reviewed by the Auditor before star audit as described
below −
 Reviewing the system of accounting entries, whether recorded as per accounting
standard or not.
 To frame audit program according to present circumstances.
 Frauds, errors and mistakes are likely to be located or not.
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 To review existence of internal audit program and to check the efficiency of internal
control system.
 To review the reliability of reports, records and certificates as presented by the
management.
 To check if there is any possibility of improvement in existing internal control
system.
2.6 INTERNAL CHECK
In the opinion of Spicer and Pegler, “A system of internal check is an arrangement of staff
duties, whereby no one person is allowed to carry through and to record every aspect of a
transaction so that without collusion between two or more persons, fraud is activated and at
the same time the possibilities of errors are reduced to the minimum.”
L.R. Dicksee defines an internal check as “such an arrangement of book-keeping routine that
errors and frauds are likely to be prevented or discovered by the very operation of the book-
keeping itself.”
Internal check means practically a continuous internal audit carried on by the staff itself,
using which other members of the staff independently check the work of each individual.
2.6.1 Essential Characteristics of Internal Check System
Certain qualities are needed to make an internal check system more effective and efficient.
Such qualities are known as features of internal check system, which are as follows:
1. Division of Work: No one should be allowed to have the right to perform the work
from origin to end.
2. Provision of Check: An organization should set up such provisions so that work can
be checked by another staff. An officer can check the work of one staff by transferring
to the staff and again.
3. Use of Devices: In this modem world, various devices can be used to do various
functions like the use of time record machines, wage determination machines, etc. An
organization should use machines that help to make work of internal check easier.
4. Self-balancing System: An organization can use self-balancing ledger accounts,
which help to make the work of internal check easier. Its effectiveness depends on its
management.
5. Control: There is more chance of frauds where there is direct contact between
consumers or the public. So, a manager can keep eyes in those works so that the
internal check system can be made more effective.
2.6.2 Objectives of Internal Check
There are several objectives of the internal check. They are given below:
1. To minimize the possibility of error, fraud, and irregularity.
2. To prevent the misappropriation of cash and goods.
3. To allocate duties and responsibilities to every clerk in the organization.
4. To ensure an accurate recording of all business transactions.
5. To enhance the efficiency of the clerk in the organization.
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6. To exercise moral influence over the staff member.
7. To prepare a final account with ease and efficiency.
2.6.3 Principles of Internal Check
An internal check is based on some specific principles. Without which, an internal check is of
no use. These principles are given below:
a. The process should be allocated among the staff of the business according to the
duties, responsibility, and rights in such a. There is no room for interference.
b. No single person should have independent control over the all-important aspects of
the business.
c. The duties among the staff of the business should be changed from time to time so
that no staff should be engaged in a particular job for a long time.
d. Every member of the staff should be encouraged to go on leave at least once in a year
.this will help in detecting concealed fraud.
e. An efficient system of internal check should provide for automatic checking of the
work of an assistant by others.
f. The division of work should not be much expensive.
g. The self-balancing system should be invariably used.
h. The financial and administrative power should be assigned very judiciously to
different officers.
i. A person having physical custody of assets must not be permitted to have access to
the books of account.
2.6.4 ADVANTAGES OF INTERNALCHECK
The main advantages of internal check system are as follows:
1. Proper Division of Work: Total work is divided as per each employee’s ability and
training. Such specialization helps to
3.12 Auditing and Corporate Governance
increase overall efficiency and effectiveness. The object of staff development is also
achieved through appropriate and timely change of work.
2. Fixation of Responsibility: Clear cut definition of tasks helps in fixing responsibility
on individual employees. Every employee knows what is expected from him. He alone
will be held responsible for any error or fraud.
3. Early Detection of Errors and Fraud: Each employee’s work is independently
checked by another. Therefore, any error or fraud committed by an employee can be
discovered in time.
4. Minimisation of Errors and Fraud: The work done by one individual or department is
automatically checked by another employee or department in the daily routine. This helps to
reduce carelessness and dishonesty and errors and fraud are minimised.
5. Timely Preparation of Final Accounts: An effective internal check system helps in
preparing the final accounts in time.
6. Reliability of Books of Account: When an enterprise has an effective system of
internal check, interested parties rely or its books of accounts. The statutory auditor
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does selective test checking. It avoids the need for a detailed checking of each and
every transaction.
2.6.5 Disadvantages of Internal Check
1. Expensive: Establishment of an effective system of internal check involves additional
costs which a small enterprise may not be able to afford.
2. Complacency among Officials: Managers in-charge of the control function may become lax
thinking that nothing can go wrong.
3. Risky for the Auditor: The auditor is likely to avoid detailed checking. However, he
remains liable for negligence in case he does not use proper compliance and substantive
procedures.
2.7 DISTINCTION BETWEEN INTERNAL CONTROL AND INTERNAL CHECK
2.8 DISTINCTION BETWEEN INTERNAL CONTROL, INTERNAL

CHECKAND INTERNAL AUDIT
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2.9 DIFFERENCE BETWEEN INTERNALAUDITAND STATUTORY AUDIT
Basis of Distinction Internal Audit Statutory Audit
1. Objective It is to state accuracy of information The objective is to express an
and compliance with plans and policies. opinion on true and fair view
of the concern.
2. Scope Scope of audit is determined by the Scope of audit is determined
management. by the law.
3. Nature Internal audit is not a legal re- Statutory audit is not a legal
quirement. requirement.
4. Qualification Auditor need not possess the An auditor must be a prac-
qualifications mentioned under law. ticing CA.
5. Appointment and Appointment and removal of an auditor Appointment and removal of
Removal is done by the management. an auditor is done by the
shareholders.
6. Remuneration Remuneration of an auditor is decided Remuneration of an auditor
by the management. is decided by the sharehold-
ers.
7. Report Report is submitted to the management Report is submitted to the
shareholders.
Can a statutory auditor be an internal auditor and vice versa?

Internal auditor is appointed by management who, generally the employee of the
organisation.
Nature and scope of an internal audit is decided by management whereas statutory auditor is
an internal auditor who is appointed by shareholders, whose duties and qualification are
prescribed by law. Internal auditor cannot be appointed as statutory auditor because he may
not have qualification prescribed by law and may not be able to give independent opinion.
SUMMARY
1. Audit process is a set of actions and procedures to control an organization.One of the
objectives of the audit process is to verify that all company processes are aligned with
this strategic vision and that they deliver the value that internal customers need and
external ones want.
2. Audit process is the well-defined methodology for organizing. Its phases are: Planning,
Entrance meeting, Fieldwork, Reporting, Follow-up.
3. An audit programme is a detailed plan of the auditing work to be performed, specifying
the procedures to be followed in verification of each item and the financial statements
and giving the estimated time required.
4. Audit Note Book is a register maintained by the audit staff to record important points
observed, errors, doubtful queries, explanations and clarifications to be received from
the clients.
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5. Audit working papers are the documents and evidence that an auditor collects and
retains with himself during the audit.They help auditor in audit planning and collecting
evidence of the audit work performed on which his opinion is based.
6. Internal Control comprises of the plan of the organization and all the co-ordinate
methods and measures adopted within a business to safeguard its assets, check the
accuracy and reliability of its accounting data to promote operational efficiency and to
encourage adherence to prescribed managerial policies.
7. Internal check means practically a continuous internal audit carried on by the staff
itself, using which other members of the staff independently check the work of each
individual.
8. Internal auditor is appointed by management who, generally the employee of the
organisation.Internal auditor cannotbe appointed as statutory auditor because he may
not have qualification prescribed by law and may not be able to give independent
opinion.
FILL IN THE BLANKS
1. Audit process is a set of ………. and …………… to control an organization.
2. In planning phase, audit objectives are defined and audit methodology is determined
through the ……………….
3. The audit is considered a very important step that helps develop a
………………………………………..
4. Audit Note Book is a register maintained by the ………….. to record
………………….. to be received from the clients.
5. Statutory auditor is ………….. Who is appointed by ……………. whose duties and
qualification are prescribed by law.
1. Which of the following is an objective of audit process.
(i) Data security and reliability
(ii) Operational efficiency
(iii) Report detected failures
(iv) All of the above
2. Audit process is the well-defined methodology for organizing. Its phases are:
(i) Planning
(ii) Fieldwork
(iii) Reporting &Follow up
3. Which of the following matters not incorporated in an Audit Note Book:
(i) Names of the principal officers
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(ii) Cash summary
(iii) Copy of audit programme.
(iv) Date of commencement and completion of audit.
4. Audit Working papers provide information on the following matters. Which of the
information is not provided by working paper.
(i) Information about audit team members
(ii) Evidence is relevant to support the opinion
(iii) Interest in future audit.
(iv) Detail of proper supervision over the work performed.
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CHAPTER-3
ROLE OF AUDITORS IN CORPORATE GOVERNANCE
CHAPTER OUTLINE
3.1 Meaning of Corporate Governance
3.2 Scope of Corporate Governance
3.3 Importance of Corporate Governance
3.4 Need of Corporate Governance
3.5 Characteristics of Corporate Governance
3.6 Corporate Governance-Role of Auditor
3.6.1 Auditor’s responsibilities within the organization
3.6.2 Auditor’s Role in Corporate Governance
3.7 Lesson from Scandals
3.7.1 The Enron Conundrum
3.7.2 The Satyam Scandal
3.8 Auditing in India-Role of Auditor
3.1 MEANING OF CORPORATE GOVERNANCE

Corporate governance is the system or structure of rules, practices, and laws by which a
firm is directed and controlled. The Board of directors manages the corporate
governance and they are responsible for every situation of the company.
Basically, Corporate Governance balances the interests of a company’s stakeholders.
Stakeholders refer to those people who have an interest in the company and get affected
by the business. Stakeholders include company shareholders, employees, customers,
suppliers, financiers, the government, and the community. The Board of directors
manages the corporate governance and they are responsible for every situation of the
company.
3.2 SCOPE OF CORPORATE GOVERNANCE
The scope of having corporate governance are:
1. Accountability
2. Fairness
3. Transparency
4. Independence
5. Compliance with rules
1. Accountability – Accountability means a situation in which any person is
responsible and needs to give a satisfactory reason for anything wrong in work.
Corporate governance makes accountability.
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(a) Accountability ensures that working management i.e. Managers, Employees is
responsible to the Board Of Directors ( BOD ).
(b) Further, Accountability Ensure that the BOD is accountable to shareholders if
anything bad happens.
2. Fairness
(a) Corporate governance ( CG ) protects the rights of Shareholders.
(b) CG treat all shareholders equally including minorities i.e. who has small part
of company’s ownership.
(c) Provides effective redressal for any violations i.e Customer care
3. Transparency
(a) CG makes ensure timely, accurate disclosure on all material matters of the
company including the financial situation, performance, ownership.
4. Independence
(a) CG makes procedures, rules, and structures in place to minimize or avoid
conflicts of interest
(b) CG appoints Independent Directors and Advisers i.e. to take the free decision
from the influence of others
(a) CG ensures compliance with all the laws and code of spirit.
(b) Corporate governance is necessary to meet the requirement of SEBI for listed
companies
3.3 IMPORTANCE OF CORPORATE GOVERNANCE
1. Brings Honesty & Transparency
2. Access Foreign Capital
3. Protection of Investor
4. Fairness In Financial Reporting and Accountability
5. Improves Shareholder Communication
6. Increases Goodwill and market reputation
7. Enhancing Company Valuation
Corporate governance is important to promote the honest and transparent
monitoring of each and every activity of the company. It helps the company to
maintain the rules and standards of the company. Corporate governance also assists
the training and development of directors so that they can perform well in the
decision-making process.
Foreign capital means getting capital investment from foreign countries. Foreign
capital markets want high standards for efficiency & transparency of the
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company. Good corporate governance is important to bring efficiency &
transparency to the company which helps the global market players to gains
credibility and trust.
The next importance of corporate governance is to protect the rights of investors.
Every investor wants their rights to be protected by companies. Bringing corporate
governance in a company can protect investors’ interests by improving the
efficiency of corporate enterprises.
4. Fairness In Financial Reporting & Accountability
Financial reporting is the financial results of a company in which company
provides the results to its stakeholders and the public. Corporate governance
ensures sound, transparent, and credible financial reporting. Corporate governance
also makes accountability (Responsibility) of employees & managers for their work
to increase their effectiveness.
Shareholder communication refers to the right to vote in the decision-making
process. It is the another way in which investors can communicate with the
companies. Corporate governance is important to set up the right for shareholder
communication. Nowadays more importance is giving to corporate governance.
Example– In 2003, New provisions are added in corporate governance in order to
improve shareholder’s involvement in decision making.
Corporate governance is important to increase goodwill and market reputation. As
corporate governance ensures the protection of rights, the efficiency of a company,
right decisions, etc.
Improved management, accountability, good market reputation, and transparency
fulfill the investor’s need and confidence in the company. This increases the value
of the company in the market.
3.4 NEED OF CORPORATE GOVERNANCE
1. Growing Number of Scams
2. Takeovers and Mergers
3. Comply with SEBI Requirement
4. Need of Social Responsibility
1. Growing Number of Scams: Misuse and misappropriation of public money are
happening everywhere i.e stock market, banks, financial institutions, companies,
and government offices. In order to avoid these financial irregularities, companies
need to start using corporate governance.
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2. Takeovers and Mergers: There are many takeovers and mergers are going on in
the business world. The need of corporate governance is to protect the interest of all
the parties during takeovers and mergers.
3. Comply with SEBI Requirement: SEBI has made corporate governance
compulsory for certain companies i.e for listed companies to comply with its
provisions. This SEBI requirement protects the interest of the investors and other
stakeholders. If any company doesn’t comply with SEBI rules, it can bring a high
penalty.
4. Need of Social Responsibility: Today, social responsibility is given a lot of
importance. The Board of Directors (BOD) has to protect the rights of the
customers, employees, shareholders, suppliers, local communities, government, etc.
This is possible only if they use corporate governance.
3.5 CHARACTERISTICS OF CORPORATE GOVERNANCE
To be effective, company’s leaders must take responsibility for their decisions and the
performance of the organization as a whole. For example, the leaders of a company should
design and adhere to a code of ethics that helps management promote each of the important
characteristics of good corporate governance.
1. Clear Organizational Strategy: Good corporate governance starts with a clear
strategy for the organization. For example, a furniture company’s management team
might research the market to identify a profitable niche, create a product line to meet
the needs of that target market and then advertise its wares with a marketing campaign
that reaches those consumers directly. At each stage, knowing the overall strategy
helps the company’s workforce stay focused on the organizational mission: meeting
the needs of the consumers in that target market.
2. Effective Risk Management: Even if your company implements smart policies,
competitors might steal your customers, unexpected disasters might cripple your
operations and economy fluctuations might erode the buying capabilities of your
target market. You can’t avoid risk, so it’s vital to implement effective strategic risk
management. For example, a company’s management might decide to diversify
operations so the business can count on revenue from several different markets, rather
than depend on just one.
3. Discipline and Commitment: Corporate policies are only as effective as their
implementation. A company’s management can spend years developing a strategy to
push into new markets, but if it can’t mobilize its workforce to implement the
strategy, the initiative will fail. Good corporate governance requires having the
discipline and commitment to implement policies, resolutions and strategies.
4. Fairness to Employees and Customers: Fairness must always be a high priority for
management. For example, managers must push their employees to be their best, but
they should also recognize that a heavy workload can have negative long-term effects,
such as low morale and high turnover. Companies also must be fair to their customers,
both for ethical and public-relations reasons. Treating customers unfairly, whatever
the short-term benefits, always hurts a company’s long-term prospects.
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5. Transparency and Information Sharing: Managers sometimes keep their own
counsel, limiting the information that filters down to employees. But corporate
transparency helps unify an organization: When employees understand management’s
strategies and are allowed to monitor the company’s financial performance, they
understand their roles within the company. Transparency is also important to the
public, who tend not to trust secretive corporations.
6. Corporate Social Responsibility: Social responsibility at the corporate level is
increasingly a topic of concern. Consumers expect companies to be good community
members, for example, by initiating recycling efforts and reducing waste and
pollution. Good corporate governance identifies ways to improve company practices
and also promotes social good by reinvesting in the local community.
7. Regular Self-Evaluation: Mistakes will be made, no matter how well you manage
your company. The key is to perform regular self-evaluations to identify and mitigate
brewing problems. Employee and customer surveys, for example, can supply vital
feedback about the effectiveness of your current policies. Hiring outside consultants
to analyse your operations also can help identify ways to improve your company’s
efficiency and performance.
3.6 CORPORATE GOVERNANCE – ROLE OF AUDITORS
Corporate Governance is usually looked upon as a process or system related to management

of an entity. Similarly overlooked is the contribution of auditors to the corporate governance.
Corporate Governance is normally defined to include the different processes and procedures
which the corporations follow to direct and control their organizations. Xie, Davidson III and
DaDalt provide that majorly the corporate governance is in the hands of board. (Xie,
Davidson III and DaDalt, 2003) It is because corporate governance is the manner in which an
organization operates. And since Board of directors is the highest authority in the whole
entity, usually they decide alone or with the consult of top level management the manner in
which entity would operate. This decision needs to be made on the basis of interests of
several stakeholders. These stakeholders not only include internal stakeholders like
management, employees, etc., but also the external stakeholders like shareholders,
bondholders and others. Once they have considered all of them, they decide about the
operations. On the basis of their decision, they direct the top management to further direct
and control whole organization. Daily, Dalton and Cannella Jr. pronounce that one issue
which is highly relevant to corporate governance is consideration of different stakeholders
with intersecting and contradicting interests in one policy. (Daily, Dalton and CannellaJr,
2003) Since many times, this contradictions are high the board or top management decides a
middle policy. At other times they have to prefer one stakeholder on the other based on their
personal bias and then on that basis define the organizational policy.
3.6.1 AUDITORS RESPONSIBILITY WITHIN THE ORGANIZATION
There are two types of auditors; internal auditors and external auditors. While internal
auditors are included in the employee list of the organization, external auditors are
independent. Arens present that the operations of the entity are carried out with the oversight
of these auditors. (Arens, 1999) However this is not their main responsibility within the
organization. They are required to carry out an examination of financial statements and
accounts to identify whether there is any misstatement in them. This initiates with them
37
identifying the factors which can predict or indicate the existence of any misstatement.
Follow up on those factors led them to carry out different processes like substantive audit
procedures, analytical audit procedures and others to identify the actual existence or not of
the misstatement. Bedard, Chi, Graham and Shanteau highlight that the efficiency of an
auditor is related to whether he is able to identify the misstatements existing in the financials
or not. (Bedard, Chi, Graham and Shanteau, 1993) This level of efficiency increases as the
auditor gains experience is specified industry or field. This efficiency is required equally by
both the kinds of auditors. Internal auditors require this efficiency to determine misstatement
and bringing the same to management action so that the issue can be resolved at the earliest.
Against them, the external auditors have to use this efficiency to determine misstatements to
report in their audit report. Therefore though there goals are different the major responsibility
of both types of auditors is same. Beside this major responsibility auditors have some
additional duties which can change as per organizational policies and legal requirements. The
Internal auditors may have to support the management in terms of issues as to how they can
govern the organization to achieve organizational goals. The same work can also be extended
to external auditor however this duty is at lower part for external auditors to not let this
assistance impact their independence. Thus these together aggregate the auditor’s
responsibility within the organization.
3.6.2 AUDITOR IN CORPORATE GOVERNANCE ROLE
Though the auditor is not engaged in the work of management, but still he has the oversight
of management. Also at times he is the one who supports management on different tasks.
These roles together also lend the auditor a corporate governance role. Among the major
corporate governance roles that an auditor may presume are included the following –
 Incorporation in the audit plan – Rossiter highlights that one method by which the
auditor can presume corporate governance role is by incorporating the same into their
audit plan. (Rossiter, 2011) Auditors get an insight of several acts being carried out in
the organization this exposes them to several direction and control issues being handled
by entity. This allows flow of information from auditors side to the entities in relation to
different stakeholders whose interests might have been overlooked by management.
This information sharing can led to better level of corporate governance by
management. Ernst and Young in their publication give example of impact of
incorporation of corporate governance in audit plan on the entity’s corporate
governance achievement. (Ernst and Young) They state that it results in achievement of
corporate governance at the ultimate possible level.
 Accountability – The auditors while identifying material misstatements may encourage
the management to determine accountability of issues. Keith writes that it may result in
the management recognizing the importance of accountability and on same lines
including it in their controlling process. (Keith, 2002) It can be reasonably considered to
be substantially acceptable, because the board of directors at their own level for
management also need to identify people behind every activity being carried out. An
example of it is Volkswagen where due to lack of accountability establishment,
corporate governance was defeated through a scam which negatively impacted several
entities. Therefore the inclusion would not only benefit the other stakeholders but also
allow the main authority, board of director to get benefitted in their task of
management.
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 Check on corporate governance aspects – Broadley presents that in any case the
auditor doesn’t owns a responsibility to ensure existence of efficient corporate
governance. (Broadley, 2006) However, he can put a check on different aspects on
corporate governance. The reason that the author presents is that the auditor hold a
social responsibility. An audit is carried out to ensure that the public, who is stakeholder
in different names in the entity, gets a true and fair view about the operations of the
organization through financial statements. Until the organization is considerate towards
its stakeholders, it would be indifferent towards their interest and the employees or
management would value their interests more. This can lead to inefficient corporate
governance as well as chances of misstatements. Though the auditor merely has the
responsibility to keep a check on misstatement, since non effective corporate
governance can also lead to misstatement, they can keep a check of the same. However
to be successful it is needed that there be a free open dialogue between management and
auditor on the same.
 Internal Auditors contribution – Though external auditors can help the entities in
ensuring effective corporate governance, the support that the internal auditors can
provide is highly effective. Ojo presents that internal auditors have a grip over several
issues within management. (Ojo, 2009) This earns them a respectful position which
they can utilize in relation to corporate governance. They can identify the different
interests of different stakeholders. Once they have recognized the same, they can help
the management identify the same and also determine the possible steps in relation to
corporate governance which can be effective when the interests contradict.
 Risk management – Risk management is one of the necessities to ensure effective
corporate governance. The auditors can include a risk assessment procedure within their
audit procedure. Such a procedure would require the management to keep a check on
issues which can result in increase in risk assessment made by auditor. Cohen highlights
that the fear of being caught with any risk factor kept open due to the check kept by
auditor can encourage the management to ensure risk management. (Cohen, 2002) And
this fear to keep the risk under check can result in management taking up risk
management procedures in their governance procedures. Therewith it would result in
management being able to carry out one necessary corporate governance process.
If an analysis be made of the role of auditor in terms of corporate governance, it presents that
the major role is related to the management fear in relation to audit reports. However in case
the same is effective, it can lead to considerable achievement of entity in terms of effective
corporate governance while giving the auditor a credit for the same.
Corporate governance is the responsibility of management. It includes directing and
controlling the organization in such a manner that organizational objectives can be achieved.
Since it is the board which directs the top management for effective operation, corporate
governance is also managed by them. Besides, the auditors have the responsibility of
examination of accounts for identifying any potential misstatements. The auditors this
responsibility which allows them to list any unusual transaction or account in the audit report
gives them the major role in relation to corporate governance. They can incorporate corporate
governance in their audit plan and keep a check on corporate governance aspects in their
audit. Also they can encourage the management to ensure accountability and manage risks.
Finally the internal auditor can provide management support in their being able to manage
39
effective corporate governance. In the above manner the auditors take on corporate
governance role in the organization.
3.7 LESSONS FROM FINANCIAL SCANDALS
Financial scandals have always been one of the major reasons for change in the company law.
The financial scandals prove to show that the auditors have fallen below the expected
standards. Thus, the most common question asked whenever there has been a financial
scandal is, whether the auditors carried out their duties and obligations properly.
On the other hand, distinction should be made between audit failures and business failures. In
the former case, the blame should be attached on the auditors. In the latter case, there are
external factors attached. This is because not all business failures are due to audit failures.
Enron, the Texas-based energy trading company is the first scandal which shook up the
auditing profession although there were many cases involving auditors since the 18th century.
Enron has caused a crisis to the confidence in auditors and the reliability of financial
reporting. The audit quality and the independence of the auditors were questionable. This is
because the auditors, who were Arthur Andersen, were not only receiving fees for auditing
but for non-audit services too i.e., for consultancy services.
Nonetheless, in 2002, WorldCom which is one of the biggest telecommunications companies
in US collapsed. The company faced US$28 billion in loans and yet Bernie Ebbers who ran
the company was given a loan of US$366 million. The auditors were Arthur Andersen. It was
found that the auditors did not take proper steps in detecting accounting irregularities (Wong,
2004). Although it is the duty of the auditors to detect accounting irregularities, they failed to
do so. Since they failed to do so rightfully, they should be liable. In Australia, the collapse of
HIH Insurance Ltd was seen as the beginning of the reflection into auditors’ role, duties and
obligations. The auditors were Arthur Andersen. The auditors were providing audit and non-
audit services.
In Megan Media Holdings Bhd, it was found that there was fraudulent trading. There has
been a default of RM900 million of bank loan. It has incurred a net loss of RM1.27 billion in
the financial year ended in April 2007. However, the auditors failed to report the matter. In
matter involving Bumiputra Commerce-Holdings Bhd (BCHB), BCHB is planning to bring a
legal action against Deloitte Kassim Chan over audit work on the then Southern Bank Bhd
(SBB). This is because there has been inappropriate accounting treatment on the 2005
accounts. This was found by Price-water house Coopers (PWC). They were inappropriately
valuing certain derivative financial instruments, not writing down in full the collateral value
and wrongly writing back specific provisions made on certain foreclosed properties relating
to nonperforming loans aged seven years and above and non-expensing of certain costs
incurred.
This can be seen not only in the international arena but also in the domestic front. There is a
lacuna in the current legal framework as the duties and obligations reposed on auditors are
inadequate in countering financial scandals.
The auditors play a very important role in overseeing the company’s financial matters. As per
S. 141 of the Companies Act, 2013 (’Act’) only chartered accountants can be auditors. S.
143 provides that the auditor of a company shall have access to the books of accounts of the
company at all times. S. 139 (2) read with Rule 3 of the Companies (Audit and Auditors)
40
Rules, 2014 (’Rules’) provide for a very detailed regulation regarding the appointment of
auditors in aspects of qualification and duration of holing office as an auditor.
This seems to indicate that the legislation has devoted a great deal of thought with regards to
auditors. However, these sections and rules did not exist in the current format in the 1956 Act
and were later incorporated after a series of scams that shook the economy of the country, the
most important of them being the Satyam case in India and the ENRON case of the USA.
3.7.1 The ENRON Conundrum
A look at the ENRON case from the lens of analyzing the role of auditors suggests that
investors including financial institutions could have been misled by the projection of the
company’s net income by the Audit firm- Arthur Anderson. Its losses and liabilities were far
larger than that were reported.[9] The lack of independence of the audit firm played a big role
in carrying forward the manipulation of financial statements. There were personal relations
between the Company and the Auditors in so much so that they were paid a huge fee with
regards to their non-audit services. An interesting point is that this scandal happened despite
there being accounting and auditing standards in place in the States.
This case proves that mere presence of legal framework of accounting and auditing standards
is not enough if the auditors are not completely independent of the company being evaluated.
3.7.2 The Satyam Scandal
Satyam Computer Services founded by B. Ramalinga Raju and it caused a great deal of hue
and cry after the chairman Mr. Raju in a letter confessed to manipulating the Company’s
accounts by an amount close to $1.47 billion. The auditor firm- Price water house Coopers
(PwC) and the BoD allegedly knew nothing of the scam. This points to the glaring fact that
the PwC intentionally did not abide by the accounting standard and failed to properly fulfil its
duties as auditor. However, CBI investigations in 2018 found PwC guilty of conspiracy with
the accused as they were not only paid more than any auditing firm during that time but also
portrayed discrepancies in the treatment of Satyam; where it relied on the documents
provided by the accused himself rather than doing any independent investigation and other
companies it was auditing at that time.
This case lays down the need of strict protocols that need to be followed by the Auditors
while discharging their duties.
3.8 AUDITING IN INDIA-ROLE OF AUDITORS
Going by the Investopedia definition, “Corporate governance essentially involves balancing
the interests of a company’s stakeholders which includes shareholders, management,
customers, suppliers, financiers, government and the community.” To do so the main
prerequisite is to have a transparent, clear, concise and real picture of the company’s financial
affairs.
The roles of various gatekeepers of corporate governance, such as auditors, independent
directors and credit rating agencies, has increasingly come under scrutiny as a response to the
various financial scandals that shook corporate India – from Satyam to IL&FS, and more
recently, in the case of the auditor resigning from Reliance Capital. While the company’s
management is ultimately responsible for ensuring that the accounts give a true and fair view
of its state of affairs, its auditors also play a key role in assessing the accuracy and reliability
of such accounts.
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The auditor-company relationship has potential for conflicts of interest, where the former is
providing more lucrative non-audit services (NAS) to a company that it audits, which could
compromise its independence, and by extension, the quality of its audit. The Companies Act,
2013, has addressed these issues to some extent by prohibiting auditors from providing
services such as internal audit, accounting, investment advisory and investment banking to an
audit client (including its holding and subsidiary companies). Firms are, however, free to
offer NAS such as tax and unspecified advisory services with the approval of the company’s
board of directors or the audit committee of the board, as applicable.
Even before the very famous Satyam scam shook the Indian corporate sector, the world had
its share of a breakdown of corporate governance in the form of Parmalat, Enron, Qwest,
Global Crossing, etc. all from auditing spaces that shook the very fundamentals of corporate
governance. These scams made Auditing in India an essential part in the hierarchy of ideal
corporate governance structure.
That is, doing the right things and doing them in the right way is the essence of corporate
governance. But why we’re telling all this? If you are planning to pursue Auditing in India,
definitely this should matter to you. Perhaps not given due importance in the academics, a
good corporate governance practice will help you and your client earn due respect from all
the stakeholders.
Auditing in India: How it Affects Corporate Governance?
1. Promote Accountability: The researchers have found out that extent evaluating
controls and operations as a role of auditors enhances corporate governance. Measures
and policies introduced by external auditors are designed to compel accountability in
the workplace.
For example, if the financial statements are manipulated by inflating figures or cooking
accounting numbers, auditors could recommend penalties. For such acts, penalties could
include stripping the manager of his position or his compensation, reducing annual
bonuses or pensions. So, if the auditor has the slightest bit of suspicion of the legality
and integrity of a record or transaction, it his/her the duty to investigate and report it,
before he certifies it to be true.
2. Represent Interest Of Shareholders: One of the many important roles of a
professional Auditing in India in corporate governance is to protect the interests of
shareholder and stakeholders of a company. It is made possible by conducting
independent reports by the auditors and not being influenced by the company.
External auditors are required to state the finances of the company and attest to the
validity of financial reports that may have been released. It is their job to ensure that the
board receives accurate and reliable information. The board may also question the
views expressed and an assessment made by the auditor on the appropriateness of the
principles used by the company.
3. Crisis Management: By developing efficient crisis management plans to be used in the
event of allegations of corruption or fraud, an auditor helps in ensuring good corporate
governance. Typically, the idea is to assign responsibilities to different officials of the
administration. This provides that if the company becomes involved in a financial crisis,
those officials have an action plan that can be used in making sure that confidence
42
among investors is sustained. Controls measures that are to be used with the media and
law-enforcement officials are part of the crisis management plans.
4. Risk Assessment and Mitigation Planning: Auditors help in promoting corporate
governance by conducting a period risk assessment. External auditors reassess the
security measures that a company has in place against corruption or corporate fraud.
Additionally, they also analyse the on the whole risk tolerance of the company and the
efforts that the company has made towards lessening the risks. For example, if a
government agency or a company has a system with an under-performing
whistleblower, then the efforts may be made to improve the system in question.
5. Maintain Strong Relationship with Regulators: The efforts put in by an external
auditor helps in fostering a good relationship with regulators. Mostly if the companies
and agencies have transparent operations, the regulators are supportive of them.
External auditors evaluate the compliance with the regulations of a company’s
organisation. Once an auditor attests the company’s disclosures, it is more likely that
the regulators also show their trust towards them.
Apart from examining the company’s accounts and reports, these days auditors are also asked
to comment on internal control being practised in the company.
Alll in all, the role of an audit committee and auditors has become very crucial in the current
scenario. Stakeholders expect loyalty and trust from auditor while resolving financial facts
and exposing the fault in an organisation.
An auditor’s experience, qualification background, relevant exposures and in-depth
knowledge need to be highlighted. As, when directors are experts, qualified, experienced and
financial wizards, they can have vision and foresightedness to protect stakeholders. The role
of an auditor, in general, is no walk in the park. Having been regarded as a certified
professional, the auditor has placed himself, responsibilities to various parties and the duties
that go with it.
The auditor’s opinion basically makes or breaks the reliability of the financial statements and
the information they provide. Audited financial statements have an extremely high degree of
reliability and validity in comparison with unaudited statements.
In the case where the company is under the scope of an investigation, it is the duty of the
auditor to provide assistance to the officers as required for the same. Hence, it can be seen
that the duties of the auditor are pretty diverse, it has an all-round and far-reaching impact.
The level of assurance provided by a set of audited financial statements is comparatively far
higher as compared to regular unaudited financial statements.
SUMMARY
1. Corporate governance is the system or structure of rules, practices, and laws by which
a firm is directed and controlled. The scope of having corporate governance are:
Accountability, Fairness, Transparency, Independence, Compliance with rules.
2. Need Of Corporate Governance- Growing Number of Scams, Takeovers and Mergers,
Comply with SEBI Requirement, Need of Social Responsibility.
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3. Corporate Governance is usually looked upon as a process or system related to
management of an entity. Similarly overlooked is the contribution of auditors to the
corporate governance.
4. There are two types of auditors; internal auditors and external auditors. While internal
auditors are included in the employee list of the organization, external auditors are
independent.
5. The major corporate governance roles that an auditor may presume are: Incorporation
in the audit plan, Accountability, Check on corporate governance aspects, Internal
Auditors contribution, Risk management.
6. Financial scandals have always been one of the major reasons for change in the
company law. The financial scandals prove to show that the auditors have fallen
below the expected standards.
7. Auditing in India affect corporate governance in many ways like Promote
Accountability, Represent Interest Of Shareholders, Crisis Management, Risk
Assessment and Mitigation Planning, Maintain Strong Relationship with Regulators.
FILL IN THE BLANKS
1. The ……………….. manages the corporate governance and they are responsible
for every situation of the company.
2. ……………… is the financial results of a company in which company provides
the results to its stakeholders and the public.
3. There are two types of auditors-……………… auditors are included in the employee
list of the organization, ………………auditors are independent.
4. ……………… help in promoting corporate governance by conducting a period risk
assessment.
5. ……………….. have an extremely high degree of reliability and validity in
comparison with ……………….. statements.
1. Which of the following is comes under the scope of corporate governance.
(i) Compliance with rules
(ii) Accountability
(iii) Transparency
2. Which of the following is not a need of corporate governance.
(i) Need of Social Responsibility
(ii) Takeovers and Mergers
(iii) Separation of ownership and management
(iv) Comply with SEBI Requirement
3. The framework for establishing good corporate governance and accountability was
originally set up by the
(i) Nestle committee
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(ii) Cadbury committee
(iii) Thornton committee
(iv) Rowntree committee
4. Corporate governance is a form of
(i) External regulation
(ii) Charitable action
(iii) Self-regulation
(iv) Government control
5. Under the ………….,both internal and external corporate governance mechanism
intended to induce managerial actions that maximize profit and shareholder value
(i) Shareholder theory
(ii) Corporate governance theory
(iii) Agency theory
(iv) Stakeholder theory
1. What is corporate governance? Explain the need & scope of corporate governance.
2. What is auditor responsibility in an organisation in corporate governance?
3. What is financial scandals? Discuss some major financial scandal of India.
4. Discuss the role of auditor and how auditing affects corporate governance?
5. Discuss the importance of corporate governance. Give some example.
6. Internal Control comprises of the plan of the organization. Which of the following is a
purpose of internal control.
(i) Provides reliable and accurate data that is necessary for decision making.
(ii) Protect business from wastage is all aspects of the business.
(iii) Deals with the efficient system of accounting.
(iv) Avoiding detailed checking.
1. Define audit process and its stages.
2. Explain the content of audit notebook & its advantages and disadvantages.
3. What is internal control? Explain its purpose and scope.
4. What is internal check? And how it is different from internal control.
5. Differentiate between internal audit and statutory audit. Can a statutory auditor be an
internal auditor and vice versa?
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Chapter-4
PEER REVIEW OF AUDIT
CHAPTER OUTLINE
4.1 Meaning
4.2 Scope of Peer Review
4.3 Objectives of Peer Review
4.4 Qualifications of a Reviewer
4.5 Collection of evidence by Peer Reviewer
4.6 Limitations of Peer Review
4.7 Reasons to Conduct Peer Review
4.8 Benefits of Peer Review
4.9 Peer Review Board
4.10 Peer Review Process
4.11 Difference between Peer Review and Quality Review
4.12 Audit Review Mechanism in India
4.13 Peer Review- A Value Addition
Conclusion
4.1 MEANING
The term “peer” means a person of similar standing. The term “review” means conduct of re-
examination or retrospective evaluation of the subject matter. In generality, for a
professional, the term “peer review” would mean review of work done by a professional by
another professional of similar standing.
As per the statement on peer review, peer review - means an examination and review of the
systems and procedures to determine whether they have been put in place by the practice unit
for ensuring the quality of attestation services as envisaged and implied/mandated by the
technical standards and whether these were effective or not during the period under review.
Peer review is the evaluation of work by one or more people of similar competence to the
producers of work. A peer review means an examination and review of the systems and
procedures to determine whether they have been put in place by the practice unit for ensuring
the quality of attestation services envisaged and implied/mandated by the technical standards
and whether these were effective or not during the period under review.
The purpose of the peer review can be defined as a review of accountants, by their fellow
accountants, in order to promote quality in the accounting and auditing services, which are
provided by cpa firms.
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It is mainly carried out in order to ensure that firms are performing at a high standard, which
can ensure that they are able to offer opportunities to the firms when it comes to ensuring
quality protocols. It further provides areas for improvement, which can be worked upon by
the employees in order to ensure that they are able to improve their service protocol.
4.2 SCOPE OF PEER REVIEW
The statement on peer review lays down the scope of review to be conducted as under:
1. Once a practice unit is selected for review, its attestation engagement records
pertaining to the immediately preceding three completed financial years shall be
subjected to review. Provided that the records of audit reports/attestation services
relating to years prior to the accounting year beginning 1.04.2002 shall not be
subjected to review.
2. The review shall focus on:

i. Compliance with technical standards.
ii. Quality of reporting.
iii. Office systems and procedures with regard to compliance of attestation
services systems and procedures.
iv. Training programs for staff (including articled and audit clerks) concerned
with attestation functions, including appropriate infrastructure.”
As is clear from the above, the first part of paragraph (7) of the statement aims to confine the
scope of review to preceding three years since this would establish the consistency or
deviations, if any, in respect of procedures followed by the practice unit. The tenure of
immediately three financial years, perhaps, has been envisaged since all practice units would
not be subjected to mandatory annual review. However in the first year of its implementation,
it provides clearly that records of attestation services relating to the accounting year
beginning on or after April 1, 2002 only shall be subjected to review.
The second part of paragraph (7) of the statement indeed defines the scope of peer review
which revolves around compliance with technical standards; quality of reporting; office
systems and procedures with regard to compliance of attestation engagements; and, training
programmes for staff including articled and audit clerks involved in attestation engagements.
The reviewers may note that the entire peer review process is directed at the attestation
services which may be used interchangeably as audit services, attestation function or audit
functions of a practice unit. The attestation services which shall be subjected to peer review
include auditing or verification of financial transactions, books, accounts or records and
verification or certification of financial accounting and related statements as defined under
section 2(2)(ii) of the chartered accountants act, 1949. Specifically, the services which have
been excluded from the scope of attestation services are all management consulting
engagements, representation services, taxation matters, compilation/preparation of financial
statements, compilation of any other information, testifying as expert witness and providing
expert opinion on points of principle. It may be noted that while reviewing office systems and
procedures and training programmes for the staff, the reviewer shall focus on such areas with
reference to attestation engagements only.
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It is also quite important for a reviewer to understand the scope of review with reference to
compliance with technical standards because the said term has been defined in an inclusive
manner in the statement on peer review. As per the statement, the term “technical standards”
include accounting standards; auditing standards; framework in respect of accounting and
auditing; statements; guidance notes; self-regulatory measures; and, relevant legislation in the
context of specific engagement. Therefore, the reviewer shall have to concentrate on
compliance with all standards, statements, guidance notes, notifications and relevant
legislative requirements in respect of services rendered by the practice unit while performing
a particular attestation engagement.
4.3 OBJECTIVES OF PEER REVIEW
The statement on peer review lays down the objective of review as under:
‘2.1 the main objective of peer review is to ensure that in carrying out their professional
attestation services assignments, the members of the institute (a) comply with the technical
standards laid down by the institute and (b) have in place proper systems (including
documentation systems) for maintaining the quality of the attestation services work they
perform.’
In view of the above, the reviewer may note that the primary objective of peer review is not
to find out deficiencies but to improve the quality of services rendered by members of the
profession. In the same vein, the statement also makes it clear that peer review, “does not
seek to redefine the scope and authority of the technical standards specified by the council
but seeks to enforce them within the parameters prescribed by the technical standards”.
The peer review is directed towards maintenance as well as enhancement of quality of
attestation services and to provide guidance to members to improve their performance and
adherence to various statutory and other regulatory requirements. Such an objective of the
peer review process makes it amply clear that the reviewer is not going to sit on the
judgement of the practice unit while rendering attestation services but to evaluate the
procedure followed by the practice unit in rendering such a service.
Accordingly, where a practice unit is not following technical standards, the reviewers are
expected to recommend measures to improve the procedures. Therefore, the objective is to
maintain and enhance the quality of attestation services by providing appropriate guidelines
rather than simply pointing out deficiencies and penalising the practice unit.
To elaborate further, a key objective of peer review exercise is not to identify isolated cases
of engagement failure, but to identify weaknesses that are pervasive and chronic in nature.
For instance, absence of formal planning on an audit represents a serious deficiency that
needs to be remedied by the practice unit. An instance of the auditor not carrying out physical
verification of furniture and fixture may not attract the same comment. However, certain
items of assets are best verified through the physical verification process and not adopting the
same may rightly be viewed as a systemic failure.
The conclusion, therefore, is that the peer review seeks to identify and address patterns of
non-compliance with quality control standards
4.4 QUALIFICATIONS OF THE REVIEWER
In order to conduct a peer review audit, mostly licensed CPAs, who have completed their
training, are eligible to audit. Additionally, they are also supposed to meet a few other
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requirements, which mainly include being an active member of the association, as well as
being currently active in public practice at a supervisory level.
In the same manner, the auditor should also have a minimum experience of at least five years
of recent experience in public accounting. These eligibility requirements ensure that the
auditor has sufficient integrity and experience so that the review is credible and worthwhile.
Requirements include:
 Be a member of the AICPA in good standing, licensed to practice as a CPA.
 Be currently active in public practice at a supervisory level in the accounting or
auditing function of a firm enrolled in the program, as a partner of the firm, or as a
manager or person with equivalent supervisory responsibilities.
 Be associated with a firm that has received a report with the peer review rating of pass
for its most recent system or engagement review that was accepted timely, ordinarily
within the last three years and six months.
 Possess current knowledge of professional standards applicable to the kind of practice
to be reviewed, including quality control and peer review standards.
 Have at least five years of recent experience in the practice of public accounting in the
accounting or auditing function.
 Have provided the administering entity with information that accurately reflects the
qualification of the reviewer including recent industry experience, which is updated
on a timely basis.
 Obtain at least 40% of the aicpa required cpe in subjects relating to accounting,
auditing, and quality control. Peer reviewers should obtain at least 8 hours in any 1
year and 48 hours every 3 years.
4.5 COLLECTION OF EVIDENCE BY PEER REVIEWER
A peer reviewer collects evidence by applying the following methods:
(a) inspection: it includes scrutiny of documentation and other records of the practicing
unit.
(b) observation: he observes the procedures/processes followed in the production unit.
(c) enquiries: he enquires and collects required information from the responsible person of
practice unit, even by the use of questionnaire.
4.6 LIMITATIONS OF PEER REVIEW
 the reviewer conducts the review in accordance with the statement on peer review.
 the review would not necessarily disclose all weaknesses in compliance of technical
standards and maintenance of quality of assurance services since it would be based on
selective tests.
 as there are inherent limitations in the effectiveness of any system of quality control
which happens to be subject-matter of review, departure from the system may occur and
may not be detected.
4.7 REASONS TO CONDUCT A PEER REVIEW AUDIT
There are a number of reasons, because of which a peer review audit is conducted. These
reasons are based on the rationale that includes the following:
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1. Ensuring high quality services provision to clientele: this is created as a scrutiny based
tool, in order to ensure that best services are provided to the clientele. If accountants, or
the accounting firm knows about the peer review, they know they would be held
accountable, and this reasonably increases their accountability to provide top notch
audit and assurance services.
2. Review of optimization of internal services: the review helps organizations to optimize
their services, and ensure that they are able to identify subsequent areas of
improvement. This mainly includes an insight about the existing weaknesses of the
firm, which needs to be worked upon, in order to ensure that they are able to work on
them in the coming years, for a better service delivery protocol.
3. Provides firms with insights, as well as recommendations for efficiency improvements:
in addition to optimization, it also provides the company with valuable resources, which
can help users to opt for efficiency when it comes to service delivery and protocols.
Hence, it ensures better utilization of services, which directly results in increased
efficiency within the service delivery.
4.8 BENEFITS OF PEER REVIEWS
There are many benefits of peer reviews for both clients of CPA firms and the reviewed CPA
firms, including:
 Ensure high quality services are provided to clients
 Review and optimize internal processes
 Provides firms with insights and recommendations for efficiency improvements
4.9 PEER REVIEW BOARD
Constitution The PRB shall be constituted by the council of ICAI.
Composition  The board shall consist of a maximum of 12 members to be
appointed by the council, of whom not lessthan50% shall be
from amongst the members of the council.
 The council may nominate members to the board from outside
bodies and from amongst prominent individuals of high integrity
and reputation, including but not limited to regulatory
authorities, bankers, academicians, economists, legal
professionals and business executives.
 The council shall appoint the chairman and the vice-chairman
from amongst its elected council members appointed on the
board.
Tenureofmembers  The term of 2/3rdmembers shall be for 3 years or end of the term
of the member in the council whichever is earlier, or such other
period as may be prescribed by the council from time to time.
 The chairman and the vice-chairman of the board may be rotated
every year by the council of the institute.
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 Casual vacancies on the board shall be filled by the council.
Personsdisqualified Membersofthedisciplinarycommitteeorthedisciplinaryboardoftheicais
hallnotbeamember of the board.
Meetingsoftheboard  No business shall be transacted at any meeting of the board
unless there are present atleast 1/3rdmembers of the board but
not less than 3 members, including the chairman or, inhis
absence, the vice-chairman.
 If there is no quorum within half an hour of the time fixed for the
meeting, the meeting shall stand adjourned to a date, time and
place fixed by the chairman or, in this absence, the vice-
chairman.
 The board shall meet as and when required for transaction of the
business before it. However, atleast one meeting shall be held in
every 3 months.
Reporting The board shall submit are port to the council prior to the date of
every meeting of the council.
Eligibilitytobeare  Apeerre viewer:
viewer
a) Shall be a member in practice with at least 10 years of
experience for level i entitiesand7yearsofexperience for level
iientities.
b) In case a member has moved from industry to practice and is
currently in practice he should have at least 15 years of
experience in industry and at least 5 years experience in
practice for level i entities and an experience of at least 10
years in industry and atleast3yearsexperiencein practice, for
level iientities.
c) Should have undergone the requisite training and cleared the
requisite test for peer review as prescribed by the board.
d) Should have conducted audit of level i entities for at least 7
years or got his entity audited for at least 7 years which
should be alevelientity to be eligible for conducting peer
review of level ientities.
 A member on being appointed as are viewer shall be required
to:
a) Furnish a declaration as prescribed by the board, at the time
of acceptance of peer review appointment.
b) Sign a declaration of confidentiality.
 A member shall not be eligible for being appointed as are

51
viewer, if–
a) Any disciplinary action/proceeding is pending against him
b) He has been found guilty of professional or other misconduct
by the council or the board of discipline or the disciplinary
committee at anytime
c) He has been convicted by a competent court whether within
or outside India, of an offence involving moral turpitude and
punishable with imprisonment
d) Heorhispartnersorpersonnelhasanyobligationorconflictofinter
estinthepracticeunit.
 A reviewer shall not accept any professional assignment from
the practice unit for a period of two years from the date of
appointment. Further, he should not have accepted any
professional assignment from the practice unit for a period of
two years before the date of appointment as reviewer of that
practice unit.
4.10 PEER REVIEW PROCESS

STAGE–I: PLANNING –
1. Peer review board selects the practice unit (PU) for peer review or PU voluntary
applies for undergoing peer review.
2. PU will be notified by the board and will be sent a questionnaire for completion along
with the panel of at least three reviewers.
3. PU selects & informs the name of reviewer to board within 7 days. A completed
questionnaire enclosing a complete list of assurance services clients sent to selected
reviewer within 15 days.
4. PU to provide any other information which the reviewer may seek. An initial sample
is selected by the reviewer, representative of PU’s client portfolio.
PU will be notified of the selection of initial sample two weeks in advance of
commencement of review fixation of date of initial meeting initial meeting between
PU and reviewer.
1. Compliance review of general controls five key controls- independence, maintenance
of professional skills & standards outside consultation, staff supervision &
development and office administration final selection of assurance services
engagements & client files to be reviewed on random selection basis
2. A review of records which approach to adopt substantive approach compliance
approach consider effectiveness and efficacy of control procedures perform
substantive procedures - less extensive perform substantive procedures - more
extensive determine nature timing and extent of substantive procedures – more
extensive .
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STAGE -II: EXECUTION
The execution stage in volves the actual conduct of review and, thus, begins within it ial
meeting and ends with review of records by the reviewer.
1. Peer Review Visit:
o Peer Review visits will be conducted at the Practice Unit’ she ad office or/and
branch (es) or any other locations.
o This on-site review should not extend beyond 7 to 15 working days based on the size
of the Practice Unit.
2. Compliance Review:
To begin with, there viewers expected to carry out the compliance review of the key
controls,
 Independence,
 Maintenance of professional skills and standards,
 Outside consultation,
 Staff selection & supervision and
 Office administration
For evaluating the degree of reliance to be placed upon them for effective Review.
3. Selection of Assurance Service Engagements:
The number of assurance service engagements to be reviewed shall depend upon:
 Standard of quality controls generally prevailing;
 The size and nature of assurance service engagement sunder taken by the PU.
 The methodology generally adopted by the PU in providing assurance services.
 The number of partners/members involved in assurance service engagement sin the PU;
 The number of locations/branch offices of the practice Unit;
The Fees charged/received/GST paid by the Practice unit.
From the initial sample selected at the planning stage, the Reviewer, in consultation
with the Peer Review Board, may reduce or enlarge the initial sample size of assurance
service engagements for Review.
4. Review of Records -Compliance and Substantive Approach:
a. COMPLIANCE APPROACH
The compliance approach is to assess whether proper control procedures have been
established/followed by the Practice Unit to ensure that assurance services are being
performed in accordance with Technical, Professional and Ethical Standards.
The following are as shall be considered:
(i) Assurance services records for Administration
(ii) Review and Evaluation of System of Internal controls
53
(iii) Substantive Tests
(iv) Financial Statements Presentation and Disclosures
(v) Assurance Services Conclusions
Assurance Services Reporting
b. SUBSTANTIVE APPROACH: This approach requires a Review of the assurance
working papers in order to establish the extent of compliance, whether the assurance
work has been carried out as per the Technical, Professional, and Ethical Standards.
STAGE– III: REPORTING
Reviewer sends a preliminary report to PU. The PU submit its representation on deficiencies/
non – compliance, if any, to reviewer within 15 days of receipt of preliminary report if
reviewer is satisfied with systems and procedures of pu, then he submits final report to board.
Otherwise reviewer submits final report to board incorporating reasons for dis - satisfaction
along with preliminary report and PU’s submissions (remember the 2014 amendment for
disciplinary proceedings in the revised statement by peer review board)
COMPLIANCE REVIEW PROCEDURES
It is the first stage of applying review procedures to ascertain whether the practice unit has
been observing the systems as contemplated by it in the questionnaire. The statement requires
the reviewer to consider the ‘general controls’ which comprise of five controls, viz.,
independence maintenance of professional skills and standards outside consultation staff
supervision and developments office administration
The statement makes it imperative that all practice units are expected to address each of the
five key control areas. However, the reviewer shall have regard to the size of the practice unit
while evaluating such controls.
It also envisages that the reviewer may have certain supplementary questions to consider and
evaluate whether such controls are in place and are operational within the practice unit.
Independence: PU is expected to have policy for does the practice unit have a policy to
ensure independence, objectivity and integrity, on the part of partners and staff and indicate
as to who is responsible for this policy? Pu should communicate these policies and the
expected standards of professional behaviour to all staff.
PU should monitor compliance with policies and procedures relating to independence and
periodically review the PU’s association with clients to ensure objectivity and independence.
Professional skills and standards: PU should have an established plan for personnel needs
at all levels, based on current and anticipated clientele, business growth, impending
retirements, etc. PU should have an established recruitment policy and all applicants and new
personnel be informed of the personnel policies and procedures relevant to them.
PU should have continuing education programmes for partners and staff and allow easy
access to current and relevant professional literature, including accounting and auditing
standards and pronouncements by professional bodies.
54
PU should conduct programmes for developing expertise in specialised areas and industries
outside consultation. Pu should have a policy for consulting experts (both internal and
external) and should have built up a network of other accountants, solicitors and advocates
and technical consultants in industries in which its clients operate. This will ensure easy
access to expertise in other fields and ensure high standards in service.
Staff supervision and development - PU should have written guidelines on the
responsibility at each level, and on the expected performance and qualifications necessary for
advancement to the next level. PU should also have a system for gathering and evaluating
information on the performance of personnel, have a system of periodically counselling
personnel on performance and career opportunities. PU should have a system of assigning an
audit to the most appropriate personnel with requirements of specialized expertise and
personnel skills given due consideration in appropriate casers. PU should have written
guidelines for maintaining working papers (form and content) standardised forms, checklists,
and questionnaires to assist in the conduct of audit.
Office administration – PU should have established procedures for record retention,
including security aspects. Pu should maintain a record containing particulars such as client
name, nature of engagement, engagement, particulars regarding date of commencement of
audit, date of audit report, billing, etc. Pu should maintain staff register, should have a proper
library containing relevant books and all publications of institute of chartered accountants of
india as well as other relevant publications on professional subjects.
4.11 DIFFERENCE BETWEEN PEER REVIEW AND QUALITY REVIEW
 peer review is a review of the systems and procedures of an audit firm. Although sample
audit files are inspected by the peer reviewer, it is done for the purpose of testing the
effectiveness of the systems and procedures. The intention is to not to find faults but to
help the firm develop effective systems. It is a kind of mentoring process. Peer review is
a part of the activities of icai aimed at improving the quality of service.
 a quality review normally pertains to one particular audit conducted by an audit firm. The
main objective quality review is to find errors or inadequacies, if any, committed by the
auditor while conducting the audit. Serious errors detected in quality review lead to
disciplinary action against the member.
4.12 AUDIT REVIEW MECHANISM IN INDIA
For nearly 16 years, auditors in India are only self-regulated under peer review. The
professional body of accountants in India – institute of chartered accountants of India (ICAI)
has established peer review board and quality review board to conduct limited reviews of
audit services. Peer review board was established in year 2002 by ICAI to ensure that in
carrying out the assurance service assignments applicable technical, professional and ethical
standards are followed.
The objective being educative to enhance quality of professional work and transparency in
audit standards, peer review has no connection with any disciplinary or any other regulatory
mechanism. While peer review programme in the us by the sec practice section (SECPS)of
AICPA had been quite effective as during the period of 20 years from 1977 to 1997, SECPS
conducted 4,021 peer reviews and 769 corrective actions were imposed by the peer review
committee (Alam et al., 2000), the peer review board in India has a limited significance only.
55
Its domain being limited to organising training programmes imparting training to the
reviewers and issuing peer review certificates to firms reviewed. Quality review board (QRB)
seemingly is more powerful peer-review body in India as it consists of half of the members
nominated by the government and others by the ICAI.
The first quality review board was constituted in 2007 and then in 2011, 2012, 2014, 2015
and 2016. International journal of accounting and financial during the period 2012-15, the
board could only review 216 statutory audit assignments and in 74 cases advisories were
issued to the audit firms for improvement in their services. QRB, however has never been an
effective body as it does not have disciplinary or investigation power over the auditors. In the
midst of intense debate in India to regulate the public accountants in the aftermath of the
Punjab national bank heist of more than $ 2 billion, the government of India established
National Financial Reporting Authority (NFRA), an independent review body over the
auditors and auditing firms with a view to improve the audit quality while retaining self-
regulation mechanism by the professional body of auditors. As per section 132(2) of the
Indian Companies Act, 2013, the national financial reporting authority (NFRA) shall make
recommendations to the government on formulation of accounting and auditing policies and
standards. Most importantly NFRA will oversee the quality of service of the professions
associated with ensuring compliance with accounting and auditing standards, and suggest
measures for improvement in quality of service. NFRA has the twin powers of investigation
and judicial powers of a civil court of summoning including imposing penalty and debarring
the public accountant or the firm from engaging in practice as chartered accountant. NFRA is
to consist of government appointee chairperson, three full-time, and nine part-time members
with a term of three-years each. To make NFRA a wide participating body, it will have
representation from different bodies and regulators in the field of accountancy, auditing, law
and capital market through their nominees as part time members.
The functions of NFRA include the standard setting; monitoring, compliance, review and
overseeing quality of service; and enforcement. NFRA is given a mandate to undertake
investigation or conduct quality review of audit of following class of companies:
 listed companies
 unlisted companies with net worth equal or more than indian rupees (inr) 500 crores or
paid up capital equal or more than inr 500 crores or annual turnover equal or more than
inr 1 000 crores as on 31st march of immediately preceding financial year; or
 companies having securities listed outside India the inherent regulatory role of ICAI shall
continue in respect of its members in general and specifically with respect to audits of
private companies and public unlisted companies below the threshold limit. Quality
review board (QRB) will also continue to review the audits of private limited companies
and public unlisted companies below prescribed threshold.
The peer review helps to monitor these firms, accounting, and auditing services, which can
facilitate higher practice monitoring, as well as the program itself.
Furthermore, it is directed towards improving the overall quality of accounting and finance-
related services that are provided by the members, and their respective firms. In this regard,
the primitive goal is to serve the larger public interest, as well as enhance the overall
credibility and integrity of the membership of the accounting body.
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4.13 PEER REVIEW – A VALUE ADDITION
Many PUs find the peer review as mere burden of compliance apart from unnecessary evil of
expenditure of resources. Few PUs opine that peer review is mere documentary compliance
necessitating the increased documentation for file and record purpose. PUs also find an
excuse to avoid the peer review under the pretext of either office renovation, shifting or
absence of concerned partner etc. Or seek compliance expecting active participation from
reviewer. But all the previous excuses are ill founded and found illogical. Many PUs have
expressed satisfaction after completion of peer review. There is an improvement in
documentation after peer review. Establishment of evidence for having conducted and
completed various assurance services is necessary since there is growing awareness amongst
stakeholders making professional accountants vulnerable for penal action. Increased expertise
of staff and associates results in overall improvement in standard service to client.
Standardisation of various forms and documentation procedures has eased compliance and
saved time and resources for many pus. Preparation of audit programme, audit plans and
checklists has eased burden of supervision and identification of responsibilities of relevant
staff member. Partners could focus on development of clients as well as professional
commitments. This has further benefitted their clients with improved service.
One window service has been realised for clients with expertise in other fields being available
through the pu. Staff members have expressed satisfaction since transparency has helped
them in improving their personal capabilities. Improved office administration has helped
better communication with staff, partners as well as clients. Increased involvement of staff
has helped access various developments in areas of specific interests speedily and
dissemination of knowledge easier.
Since peer review does not seek to redefine the scope and authority of any of the technical,
professional and ethical standards but only seeks to ensure that they are implemented both in
letter and spirit. The level of friendly approach helps many practising units in identifying and
establishing their house in order. Apart from cost saving, increased standard of service and
improved satisfaction has helped practice unit better overall turnover thus proving win-win
situation for them.
Improved documentation has raised confidence while facing various enquiries, litigations etc.
Better environment and availing advanced technological facilities has helped face
competition for practice units. These and many such invisible benefits have been possible
only after undergoing peer review.
CONCLUSION
Therefore, it can be seen that the peer review audit can be seen as a highly important part that
works for the benefit of both, the public stakeholders, as well as the accountants.
It is a highly important qualitative tool, which can help users to identify top areas for quality
improvement, which can help them to learn and grow as a team, so that they can provide
better services to their clients, to say the least.
Furthermore, it can also be seen that there is a need to conduct a peer review audit, so that
there is an audit of the auditor himself. This increases the overall level of accountability in
the field of accountancy, and gives public a reason to trust the audit reports.
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SUMMARY
1. Peer review mean review of work done by a professional by another professional of
similar standing. The purpose of the peer review can be defined as a review of
accountants, by their fellow accountants, in order to promote quality in the accounting
and auditing services, which are provided by cpa firms.
2. A peer reviewer collects evidence by applying the following methods: Inspection,
Observation, Enquiries.
3. The Peer review board shall be constituted by the council of ICAI &consist of a
maximum of 12 members to be appointed by the council, of whom not less than 50%
shall be from amongst the members of the council.
4. Peer review process involve: Planning, Execution &Reporting.
5. NFRA will oversee the quality of service of the professions associated with ensuring
compliance with accounting and auditing standards, and suggest measures for
improvement in quality of service.
FILL IN THE BLANKS
1. …………… is the evaluation of work by one or more people of similar competence to
the producers of work.
2. ……………..include accounting standards; auditing standards; framework in respect
of accounting and auditing; statements; guidance notes; self-regulatory measures; and,
relevant legislation in the context of specific engagement.
3. A key objective of peer review exercise is not to identify isolated cases of engagement
failure, but to identify …………………………
4. The auditor should also have a minimum experience of …………….. of recent
experience in public accounting.
5. ………………. was established in year 2002 by ICAI to ensure that in carrying out
the assurance service assignments applicable technical, professional and ethical
standards are followed.
1. Which of the following method used by peer reviewer for collection of evidence.
(i) Enquiries
(ii) Observation
(iii) Inspection
2. There are a number of reasons, because of which a peer review audit is conducted.
These reasons are based on the rationale, which of the following is not included in
reason :
(i) Ensuring high quality services provision to clientele.
(ii) The review would not necessarily disclose all weaknesses of technical
standards.
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(iii) Review of optimization of internal services
(iv) Provides firms with insights, as well as recommendations for efficiency
improvements.
3. Which of the following included in execution in peer review process:
(i) Compliance Review
(ii) Selection of Assurance Service Engagements
(iii) Peer Review Visit
4. Which of the following area should not be considered in compliance approach of
review record.
(i) Financial statement presentation and disclosure
(ii) Substantive test
(iii) Assurance Services Conclusions
(iv) Review according to statement of peer review.
5. Which of the following is compulsory terms for composition of peer review.
(i) Maximum of 12 members
(ii) Chairman and the vice-chairman from amongst its elected council members
appointed on the board.
(iii) The council may nominate members to the board from outside bodies
(iv) All of above.
1. Explain peer review and its scope & objectives.
2. What is the main reason to conduct a peer review audit?
3. Explain the Eligibilitytobea reviewer in peer review board.
4. Explain the peer review process in detail.
5. Differentiate between peer review and quality review with help of an example.
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CHAPTER-5
PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD (PCAOB)
CHAPTER OUTLINE
5.1 Meaning
5.2 History of PCAOB
5.3 Key Activities of PCAOB
5.4 Advisory Groups
5.5 Role of PCAOB
5.6 Powers of PCAOB
5.7 Steps for Ensuring Compliance with the Sarbanes-Oxley Act
5.8 PCAOB vs. AICPA
5.9 Process for reviewing Firm’s audit work
5.1 MEANING
The PCAOB is an acronym for the Public Company Accounting Oversight Board. The
PCAOB is a regulatory board that oversees the audits of public companies.
The PCAOB is board comprised of five members appointed by the SEC. Each board member
serves full-time for five-year terms. While members of the PCAOB may have a variety of
backgrounds, two members must be Certified Public Accountants.
Board members are supported by over 800 staffers in a number of departments including
Economic and Risk Analysis, Registration and Inspections, and Enforcement and
Investigations.
5.2 HISTORY OF PCAOB
The PCAOB was created by Congress in 2002 as part of the Sarbanes-Oxley Act (SOX) that
was passed in response to a series of accounting scandals (e.g., Enron, Worldcom, etc.) to
provide better oversight of the auditing industry. The auditing industry self-policed itself
before the formation of the PCAOB. However, this approach seemed to be failing the public
in the early 2000s.
The auditors of Satyam did not detect several accounting irregularities, such as artificial
inflation of profits and cash account, despite such practice continuing over several years.
Although Satyam’s statutory auditor was registered with the PCAOB, the regulator also
failed to detect any significant audit lapses despite an audit inspection in 2008.
The PCAOB makes certain parts of audit inspection reports public to expose negligent audit
firms. The non-public parts of inspection reports, which contain quality control criticisms, are
also made public if the firm fails to address such criticisms within 12 months. This can have a
significant impact on audit quality, auditors’ reputation, and client retention. The PCAOB has
also adopted a new standard (effective 2019), requiring auditors to report critical audit
matters in which the auditors had to confront the management.
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The PCAOB reports to the Securities and Exchange Commission (SEC) which is charged
with the responsibility of protecting investors and maintaining the US securities markets. The
PCAOB’s mission and vision statements highlight the aims of their organization:
Mission: “The PCAOB is a non-profit corporation established by Congress to protect
investors and the public interest by promoting informative, accurate, and independent audit
reports and to oversee the audits of public companies and broker-dealers.”
Vision: “The PCAOB seeks to be a model regulatory organization. Using innovative and
cost-effective tools, the PCAOB aims to improve audit quality, reduce the risks of auditing
failures in the U.S. public securities market and promote public trust in both the financial
reporting process and auditing profession.”
5.3 KEY ACTIVITIES OF PCAOB
1) PCAOB Registration: The PCAOB registers public accounting firms. In order to
monitor, the PCAOB needs to know who the firms are. All firms performing financial
audits of publicly registered companies must register with the PCAOB. Currently, there
are 1,793 firms registered.
2) PCAOB Auditing Standards: The PCAOB board dictates the professional auditing
standards that registered auditing firms must use. These standards are utilized to
monitor accounting firms. Prior to the PCAOB, standards were set by the AICPA. The
PCAOB has largely adopted the AICPA’s auditing standards, added its own, and
reorganized the standards to bring them together in a single, integrated numbering
system. Please refer to the PCAOB’s website for a full listing of all the standards.
The PCAOB Independence Rules and the Professional Code of Conduct are PCAOB rules
that are worth highlighting. The PCAOB adopted the AICPA Professional Code of Conduct
(Code). The Code is often referred to as their Independence standards. The Code’s
requirements include the integrity, objectivity, and ethical standards that CPA practitioners
should adhere to in order to best serve the public.
A CPA or CPA firm’s first duty is to serve the public–not the client. The Code establishes
guidelines to help CPAs’ from losing their independence. It provides guidance and examples
of relationships and activities that would threaten one’s actual or perceived independence. An
example is an auditor who has financial interests in an audit client or close relationships with
personnel in key positions within the client’s organization. The Code explains the actions that
a firm or individuals may take to eliminate or reduce threats to independence. Efforts taken to
ensure independence should be documented so firms can demonstrate their efforts to remain
independent.
3) PCAOB Inspection Reports: The PCAOB performs inspections to evaluate firms’
compliance with the standards mentioned earlier. The PCAOB’s inspections focus on
firms that audit 100 or more public companies each year. The PCAOB inspects firms
that audit fewer than 100 public companies at least once every three years. The PCAOB
stated that the inspections will focus on areas of considered higher risk. These areas
include internal control over financial reporting, assessing and responding to risks of
material misstatement, and accounting estimates.
A risk-based approach is employed by the PCAOB to selects audit engagements to review.
The goal of these inspections is to determine if there are errors in how an accounting firm
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performed its audit procedures and documentation and if there are adequate quality controls
in place within the audit firm. If the PCAOB determines that there was not sufficient
evidence to support the auditor’s opinion, audit deficiencies are reported in the inspection
report that is published on the PCAOB website.
4) Enforcement: Finally, as a result of the inspections, if the board determines a serious
violation has occurred, an enforcement hearing could be conducted. The PCAOB can
impose sanctions and fines to firms or individual auditors. A recent example is the
SEC/PCAOB issuing a $50 million to KPMG for misconduct including the revision of
work papers to reduce the likelihood of receiving findings from a PCAOB inspection.
Thus, the main goals of the PCAOB are to monitor the audit firms, in order to restore and
maintain investors and the public’s trust in the field, which took a big hit with the
aforementioned accounting scandals. The PCAOB also focuses on promoting and enforcing
high professional standards to improve the quality of the audit services offered by the
registered firms.
Therefore, the focus of a PCAOB audit has a distinct bent towards a company’s stakeholders
and providing the investing public with clarity, accuracy, and accountability. As such, a
PCAOB audit will have two opinions, one for financial statements and the other, ICFR,
regarding your control environment and effectiveness. The auditor will typically have a lower
materiality threshold due to the public nature of the company and the involved risk. This
corresponds with a lower scoping materiality as well.
5.4 PCAOB ADVISORY GROUPS
The PCAOB has two advisory groups: the Standing Advisory Group and the Investor
Advisory Group. The role of these two groups is to provide advice and insight to the Board.
The Standing Advisory Group meets semi-annually to discuss data and technology,
cybersecurity, corporate culture, communications on PCAOB standards, the governance and
leadership of quality control systems, current or emerging issues affecting audits or auditors,
and implementation of the new auditor’s report.
The Investor Advisory Group meets once a year to discuss the group’s strategic plan,
quality control standards, implementation of the new auditor’s report, and implementation of
Form AP. The PCAOB Board has developed a five-step strategic plan, which is laid out in
its annual report. The five-step plan is composed of the following:
 Drive improvement in the quality of audit services through a combination of
prevention, detection, deterrence, and remediation.
 Anticipate and respond to the changing environment, including emerging
technologies and related risks and opportunities.
 Enhance transparency and accessibility through proactive stakeholder engagement.
 Pursue operational excellence through efficient and effective use of our resources,
information, and technology.
 Develop, empower, and reward our people to achieve our shared goals.
5.5 ROLE OF THE PCAOB
The Sarbanes-Oxley Act established the PCAOB as the independent auditor oversight body
in the United States. The PCAOB’s mission is to oversee the auditors of public companies,
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protect the interests of investors, and further the public interest in the preparation of
informative, accurate, and independent audit reports. The PCAOB does this through its
standards setting, inspections, enforcement, and outreach programs.
Since the PCAOB opened its doors in January 2003, it has registered more than 1,750
accounting firms that audit, or wish to audit, U.S. public companies. Once registered, these
firms become subject to the PCAOB’s supervisory oversight and must use PCAOB standards
when they audit public companies.
In carrying out its mandates, the PCAOB cooperates closely with the Securities and
Exchange Commission, not only because the SEC oversees the PCAOB’s activities, but
because the PCAOB and the SEC share the mutual objective of investor protection.
The PCAOB continues to explore ways to improve its audit requirements and their
implementation by audit firms, while preserving the intended benefits. For example, at the
moment, the SEC and the PCAOB are closely coordinating work on implementing Section
404 of the Act, which covers internal control over financial reporting.
1. Inspections: In order to discuss global coordination, it is worth going into a bit more
detail on the PCAOB’s inspection role, which is a key component of the PCAOB
auditor oversight program. Public accounting firms that are required to register with
the PCAOB are subject to the Board’s inspection program. PCAOB inspections
replaced the audit profession’s previous peer reviews, which focused on compliance
with applicable standards but did not address the overall audit environment. PCAOB
inspections are risk-based and designed to identify auditing problems at an early stage
and focus firms on correcting them. This approach is designed to provide a
constructive exchange between firms and the PCAOB, and we have observed that
concerns identified during inspections are often promptly addressed by the firm being
inspected.
2. Home-Host Supervision: Coordinating the Supervisory Objective: Twenty years
ago, and particularly prior to the Bank of Credit and Commerce International (BCCI)
scandal, banking supervisors had a less-developed approach to cross-border
supervision. Coordination was more episodic, unlike today’s more continuous
coordination model. Importantly, at that time, banking organizations themselves often
conducted operations in a relatively decentralized manner and local activities were not
heavily dependent on either services or risk management infrastructure that resided in
other locations. Banking organizations and supervisors were primarily focused on
understanding and managing the individual pieces of the organization as opposed to
looking at the consolidated organization.
It is important to observe that the risk management challenges faced by global banking
organizations -- with their ability to book and manage highly correlated risks in numerous
physical locations, and their ability to transmit risk directly into the financial system -- are
different from those faced by global audit firms. However, as I mentioned earlier, today’s
global banking organizations and audit firms are both often critically dependent on the
activities occurring in multiple geographic locations.
In the wake of BCCI, global banking organizations and their supervisors moved toward
enterprise-wide risk management models, where risk exposures and interdependencies can be
appropriately assessed and managed on a consolidated basis. For the largest and most
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globally-active banking organizations this often involves ongoing coordination by the
responsible parties.
In the banking supervisory model, each supervisory authority - whether home or host – must
maintain a robust oversight system, which includes not only the ability to coordinate with
other supervisors on a routine basis, but also to respond quickly and effectively to any
supervisory concerns. This can become more challenging when an entity is subject to
oversight in multiple jurisdictions, due to the potential for different statutory objectives
between home and host authorities.
3. The Importance of Regulatory Coordination to the PCAOB: The PCAOB faces
an interesting challenge with respect to the inspection of registered firms located
outside of the United States. Congress mandated that public accounting firms,
whether located in the United States or elsewhere, would be subject to PCAOB
oversight with respect to that part of their practice that relates to preparing audit
reports for issuers whose securities trade in U.S. markets and who must file audited
financial statements with the SEC.
When the Act was passed, representatives of foreign regulators, governmental bodies, and
firms expressed concern about the prospect of PCAOB oversight of non-U.S. firms.
Due to these concerns and the practicalities involved in developing an effective oversight
program, the PCAOB has made it a priority to reach out to its non-U.S. counterparts. The
early fruits of these relationships already are evident. In the short time that the PCAOB has
been in operation, it has developed a registration and inspection program that takes into
consideration the factors unique to non-U.S. firms.
While auditor oversight bodies around the world may be taking a variety of approaches in
implementing auditor oversight models, we all share the objective of improving public
confidence in the credibility of audits of financial statements. If closely coordinated, this will
help to limit regulatory arbitrage and promote a global confidence in financial reporting, and
more specifically audited financial statements. This is good for all markets.
Due to the increasingly global footprint of large audit firms and the increasing inter-
relationships between capital markets, auditor oversight bodies must continue to find ways to
enhance coordination of work and exchange experiences.
To illustrate the importance of regulatory coordination to the PCAOB, more than 750 of the
over 1750 firms registered with the PCAOB are in countries outside the United States,
although they may be affiliated with large, U.S. based audit firms. As required by the
Sarbanes-Oxley Act, many of these firms are registered with the PCAOB because they audit
non-U.S. companies whose securities trade in U.S. markets and are required to file audited
financial statements with the SEC. In addition, as also provided for in the Act and the Board’s
rules, a number of other non-U.S. firms are registered because they audit or wish to audit
significant non-U.S. subsidiaries of multinational U.S. companies. With respect to both
categories of firms, the PCAOB continues to work closely with its foreign counterparts to
minimize unnecessary overlap and achieve our shared objectives in the oversight of these
non-US firms.
4. Reliance: Under the PCAOB’s rules, in appropriate cases, the PCAOB may rely on
the inspections and other work of those oversight bodies in achieving its own
oversight mandate. Specifically, the PCAOB rules enable it to rely on the work of the
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home-country regulator and to assist non-U.S. authorities in their oversight of U.S.
audit firms that are within the regulatory jurisdiction of the non-U.S. authorities.
The PCAOB’s degree of reliance on home-country inspections is framed by our rules to be
based on the independence and rigor of the home-country system of oversight and agreement
between the PCAOB and the home-country regulator on the inspection work program for
individual firms. The more independent and rigorous the home-country system, the more the
PCAOB rules indicate the PCAOB can rely on its counterpart to conduct an inspection of a
PCAOB-registered firm. The PCAOB’s approach with its counterparts continues to evolve,
as we continue to reach out to them in order to appropriately coordinate our inspections
outside of the United States.
PCAOB is keenly aware of the potential for unnecessary, duplicative regulatory costs, and
the sensitivity surrounding issues such as data protection and having PCAOB personnel
inspect the files of non-U.S. firms. The establishment of new, independent auditor oversight
systems in other countries will enable more efficient and effective regulation of global audit
firms. This is important for investors who are also global.
5. The Cost and Benefit of Financial Reforms: Policy makers are involved in the
debate over U.S. competitiveness, and on the ever-important need to strike the right
balance with financial regulation. In the areas of financial regulation and standard
setting, this balance must not only weigh costs, but also bear in mind the importance
of ensuring our investors is provided ample transparency and protection. Regulators
should continuously monitor the impact and value gained from their regulations.
In this regard, Sarbanes-Oxley has been the focus of intense discussion. It has now been over
four years since the corporate scandals rocked investor confidence and led to the passage of
Sarbanes-Oxley.
With regard to Sarbanes-Oxley, particularly Section 404 which addresses internal control
over financial reporting, the PCAOB understands that these milestones have not been reached
without cost. For example, we continue to hear concern that the costs associated with Section
404 have weakened U.S. markets, pointing to recent growth in non-U.S. markets. The
PCAOB monitored the implementation of its standard issued under Section 404 closely. The
proposal package seeks to achieve a better alignment of the costs of these audits with their
benefits.
6. The Impact of Regulations on U.S. Markets: Recent reports have criticized U.S.
financial regulations as moving companies away from U.S. markets. To be sure, the
position of the U.S. in relation to other financial markets has changed since the early
1990s.
For one, many markets outside of the United States have grown to become global players,
due to a number of factors, including ease of information exchange and the reduction of
certain barriers to cross-border transactions. As a result, companies today are presented with
more options when they are determining where to raise capital.
Regulatory regimes as well as local political and cultural influences are often factored into
this decision.
Thus, the PCAOB works hard to achieve its objectives, but part of this hard work is looking
carefully at programs and requirements, and their impact. I am encouraged that the PCAOB
oversight program is contributing to a reduction in the risk of financial reporting failures and
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a renewed confidence in financial reports of publicly traded companies and ultimately in the
U.S. securities markets.
The Board continues to assess its oversight program, however, and will make appropriate
adjustments to assure that it achieves the objectives of the Act in the most effective and
efficient manner possible. The PCAOB model clearly resonates in countries that are seeking
to strengthen the integrity of their own capital markets, and we are pleased that other nations
are implementing similar models to auditor oversight.
It is important to eliminate unnecessary regulatory costs, vigilance in that regard should not
detract from the fundamental reasons for the long-standing strength of U.S. markets. That
strength has been due in large part to the high-quality standards and investor protections that
have been the trademark of U.S. markets for decades. For the PCAOB, it is their job to
identify efficiencies so that the implementation of our requirements can achieve intended
results without unintended costs.
5.6 POWERS OF PCAOB
The Public Company Accounting Oversight Board provide informative, independent, and
accurate public accounting audits and oversee audits of broker-dealers. The Sarbanes-Oxley
Act was passed in large part as a reaction to a number of corporate accounting scandals,
including Enron and Global Crossing. The various sections of the act include responsibilities
for a public company’s board of directors, specify criminal penalties for specific types of
misconduct, and require the Securities and Exchange Commission (SEC) to come up with
new regulations that define exactly how public companies must comply with the law.
The Powers of the PCAOB
 Require registration for public accounting firms preparing audits of issuers and
broker-dealers
 Create quality control, auditing, independence, and additional standards that relate to
the preparation of audits
 Inspect PCAOB-registered public accounting firms
 Investigate and create disciplinary proceedings against public accounting firms (and
those associated with them)
 Fine individual auditors up to $100,000
 Fine audit firms up to $2 million
 Promote professional standards among registered public accounting firms
 Improve the quality of audit services provided by public accounting firms
 Sue, complain, be sued, and defend with the approval of any court (Federal, State, and
other) or the SEC
 Create and maintain offices and operations in any part of the US
 Exercise all rights and powers anywhere in the US without regard to typical
qualifying, licensing, or other provisions of state or local laws
 Hire lawyers, staff, accountants, and other agents
 Collect, assess, and allocate accounting fees that fund the PCAOB
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 Execute instruments, enter contracts, incur liabilities, and do whatever else is required
to conduct its operations
The Sarbanes-Oxley Act also makes it illegal for companies who offer public accounting
audits to provide non-audit services (like consulting) to the clients they’re auditing. Note that
there are exceptions (such as tax services) but these exceptions are overseen by the PCAOB.
The Most Important Part of Sarbanes-Oxley for Accounting Firms
The PCAOB has many investigative powers, including the ability to require that public
accounting firms—and anyone associated with them—offer testimony and hand over any and
all documents in their possession.
In the event a person or firm refuses to provide this, the PCAOB has the power to suspend
that person or entity from the public audit industry—either temporarily or indefinitely.
5.7 STEPS FOR ENSURING COMPLIANCE WITH THE SARBANES-OXLEY ACT
Sarbanes-Oxley requires all applicable companies (which includes every publicly traded
company in the US, all publicly traded non-US-based companies who do business in the US,
and all private companies preparing for an initial public offering) to establish an accounting
framework that includes generating financial reports that can be verified with source data that
can be traced.
The source data must remain intact and cannot be revised without those revisions being
documented.
In fact, any and all revisions to any financial or accounting software have to be documented.
That documentation must include what was changed, why it was changed, who changed it,
and when it was changed.
 Create safeguards that prevent data tampering
 Create safeguards that establish and confirm timelines
 Create verifiable controls that track who access data
 Make sure said safeguards are verifiable
 Regularly test and report the effectiveness of your safeguards
 Immediately respond to direct security breaches
 Disclose all security safeguards—and breaches of safeguards—to those in a PCAOB
auditing role
 Notify independent auditors of security breaches
 Disclose failures in your accounting system
 Develop a list of controls that ensure the accuracy of all financial reports and
disclosures
The good news is that companies don’t have to start from scratch when looking for the right
safeguards. E File Cabinet does most of the heavy lifting for you.
With it, companies can track each and every piece of accounting data. All revisions are
tracked, noting when it was changed, what was changed, and who changed it. Users can also
leave notes with the required information about why the data was changed.
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Auditors can review the data in e File Cabinet and have a single place to go to get all the
information they need.
The process is simplified for both sides, and companies and auditors can feel confident that
the information in review is secure, accurate, and up-to-date.
5.8 PCAOB vs. AICPA (American Institute of Certified Public Accountants)
It is important to understand the similarities and differences between AICPA and PCAOB.
The first difference between the two is their type of organizational structure. The PCAOB is a
non profit corporation and the AICPA is a professional member association.
Both the AICPA and PCAOB are related to the accounting/audit industry. However, their
roles are very different. The AICPA is a professional association of accounts and the PCAOB
is responsible for monitoring accountants and accounting firms. Both entities are responsible
for guidance to the audit and account field. The AICPA created standards that guide
accounting professionals. The PCAOB has adopted some of the AICPA’s standards and
applied them to public accounting firms.
Another contrast between the two is the scope or each entity. The PCAOB deals specifically
with the limited scope of public accounting firms and the audits of public companies. The
AICPA provides guidance across a spectrum of accounting services that it members perform
for a variety of companies.
AICPA Audits: By far the older of the two, AICPA was founded in the 1940s to help auditors
better perform their tasks, the more modern set of their self-regulatory audit standards taking
root in the 1970s. The group has a diverse set of responsibilities that range in everything from
preparing and grading the CPA examination and public financial education programs to
setting audit standards for every size of company along with non-profits and government
entities.
Simply put, it’s an audit opinion that concentrates on providing assurances to stakeholders
that an organization’s financial statements are accurate, reliable, and free of material
misstatements. Therefore, while the concurring partner is still meant to bolster the integrity of
the process, their review is much lighter and non-evasive. An AICPA audit has a
comparatively longer timeline and substantially lower in risk, where the PCAOB has
absolutely no jurisdiction over the process.
PCAOB Audits: If an AICPA audit is the kinder, gentler side of the audit coin, then a
PCAOB audit is the more intense and scrutinizing one. In fact, its very name and founding
speak volumes -- the Public Company Accounting Oversight Board, founded in 2002 as a
part of Sarbanes-Oxley. PCAOB was formed in direct response to the many accounting
scandals from that era that, collectively, shook investor confidence and broke the public’s
trust in many publicly traded companies. Given the dynamic nature of industry, PCAOB
adopts a forward-looking perspective to keep pace with changes in the financial environment,
helping to ensure ongoing investor protection.
5.9 PROCESS FOR REVIEWING SELECTED FIRMS’ AUDIT WORK
PCAOB inspection teams review work performed on audits by making selections of
completed audits through the following process:
1. Select audits for review: The inspection team selects the audits and the audit areas
that it will review. The inspected firm has no opportunity to limit or influence the
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PCAOB’s selections. In selecting issuer audits for review, we generally use both risk-
based and random methods of selection, and we generally focus our attention on audit
areas we believe to be of greater complexity, areas of greater significance or with a
heightened risk of material misstatement to the issuer’s financial statements, and areas
of recurring deficiencies. The inspection team generally selects the audits most
recently completed by the firm but may also select audits completed in prior years if,
for example, there are no recently completed audits.
2. Review work papers and interview engagement team: For each audit area that we
select, the inspection team reviews the engagement team’s work papers and
interviews engagement personnel regarding those audit areas.
3. Provide comment forms: If the inspection team identifies a potential deficiency, it
discusses the matter with the firm and may review additional audit documentation. If
the inspection team still believes that a potential deficiency exists after its discussion
with the firm and review of any additional audit documentation, it will provide the
firm with a written comment form on the matter. The firm is allowed the opportunity
to provide a written response to the comment form.
4. Evaluate deficiencies: After the firm’s response to the comment form, the PCAOB
evaluates the matter for inclusion in the inspection report. If a deficiency is included
in Part I.A of the report, it does not necessarily mean that the firm has not addressed
the deficiency. In many cases, the firm may take remedial actions, including
performing additional audit procedures after the issue is identified, and may have
completed those actions by the time the PCAOB publishes the inspection report.
Depending on the circumstances, the firm may inform management of the issuer of
the need for changes to the financial statements or reporting on ICFR, and may take
steps to prevent reliance on prior audit reports. An inspection may include a review,
on a sample basis, of the adequacy of a firm’s remedial actions, either with respect to
previously identified deficiencies or deficiencies identified during that inspection.
5. Prepare an inspection report: The report includes deficiencies in reviewed issuer
audits that were of such significance that the Board believes that the firm, at the time
it issued its audit report, had not obtained sufficient appropriate audit evidence to
support its opinion on the issuer’s financial statements and/or ICFR. These are
included in Part I.A of the inspection report. Within Part I.A, we identify each issuer
by a letter (e.g., Issuer A) and industry sector. In instances where classifying an issuer
using its industry sector could make an issuer identifiable, we have not included the
industry sector in Part I.A.
The report may also include certain deficiencies that do not relate directly to the
sufficiency or appropriateness of evidence the auditor obtained to support its audit
opinion(s) but nevertheless relate to instances of non-compliance with PCAOB
standards or rules. These are included in Part I.B of the inspection report.
Consistent with the Sarbanes-Oxley Act, it is the Board’s assessment that nothing in
Part I of an inspection report deals with a criticism of, or potential defect in, the firm’s
quality control system. Any such criticisms or potential defects are discussed in Part II
of a report. Further, readers should not infer from any Part I deficiency, or
combination of deficiencies, that a quality control finding is identified in Part II.
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6. What an audit deficiency in an inspection report does and does not mean: The
inclusion of a deficiency in an inspection report reflects information communicated to
the Board by the inspection team and is not a determination by the Board as to
whether the firm has engaged in conduct for which it could be sanctioned through the
Board’s disciplinary process. In addition, any references in a report to violations or
potential violations of law, rules, or professional standards are not a result of an
adjudicative process and do not constitute conclusive findings for purposes of
imposing legal liability. Inclusion of a deficiency in an inspection report—other than
those deficiencies for audits with incorrect opinions on the financial statements and/or
ICFR—does not necessarily mean that the issuer’s financial statements are materially
misstated or that undisclosed material weaknesses in ICFR exist. It is often not
possible for the Board to reach a conclusion on those points based on inspection
procedures and related deficiencies because, for example, the inspection team has
access only to the information that the auditor retained and the issuer’s public
disclosures. The inspection team does not have direct access to the issuer’s
management, underlying books and records, and other information that may be
relevant.
7. Enforcement and other referrals: The inspection team may refer matters, where
appropriate, to the PCAOB’s Division of Enforcement and Investigations, and/or—
consistent with requirements of the Sarbanes-Oxley Act and PCAOB Rule 4004—to
the Securities and Exchange Commission or other appropriate regulatory or law
enforcement authorities (federal, state, or foreign).
Thus, the PCAOB enforces the professional standards and other related laws and rules
governing the audits of public companies and broker-dealers. PCAOB staff investigates
potential violations by public accounting firms and individuals of these standards, laws, and
rules in order to protect investors and further the public interest in the preparation of
informative, accurate, and independent audit reports.
SUMMARY
1. The Public Company Accounting Oversight Board (PCAOB) is a regulatory board
that oversees the audits of public companies.
2. The PCAOB has two advisory groups: the Standing Advisory Group and the Investor
Advisory Group. The role of these two groups is to provide advice and insight to the
Board.
3. The Public Company Accounting Oversight Board provide informative, independent,
and accurate public accounting audits and oversee audits of broker-dealers. The power
of PCAOB includes: Create quality control, Inspect PCAOB-registered public
accounting firms, etc.
4. Sarbanes-Oxley requires all applicable companies to establish an accounting
framework that includes generating financial reports that can be verified with source
data that can be traced.
5. PCAOB inspection teams review work performed on audits by making selections of
completed audits through the following process: Select audits for review, Review
work papers and interview engagement team, Provide comment forms, Evaluate
deficiencies, Prepare an inspection report, Audit deficiency in an inspection report,7.
Enforcement and other referrals.
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FILL IN THE BLANKS
1. PCAOB stands for ……………………………..
2. The PCAOB has two advisory groups: ……………….. and ………………………
3. The PCAOB Board has developed a …………………plan, which is laid out in its
annual report
4. PCAOB inspections replaced the audit profession’s previous …………………, which
focused on compliance with applicable standards but did not address the overall audit
environment.
5. The PCAOB has many investigative powers, including………………………………
………………………………
1. Which accounting firm are subject to PCAOB annual inspection?
(i) With audit of more than 10 public companies.
(ii) With audits totalling to 50 or more
(iii) With at least one audit of public company
(iv) With audits of more than 100 public companies
2. Who can be a chairperson of PCAOB?
(i) Any Auditor of Public Company
(ii) A former SEC Counsel General
(iii) A CPA with at least 5 years’ experience in Auditing
(iv) A CPA who has not been a practicing for at least five years prior to being
appointed to the board.
3. Which of the following including in key activities of PCAOB.
(i) PCAOB Auditing Standards
(ii) PCAOB Inspection Reports
(iii) Enforcement
4. Which of the following will not include in powers of the PCAOB.
(i) Inspect PCAOB-registered public accounting firms
(ii) Promote professional standards
(iii) Improve the quality of audit services
5. The Sarbanes-Oxley Act Applies to which non US companies?
(i) Registered equity or debt securities with the NASDAQ stock exchange and the
accounting firms that provide auditing services to them.
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(ii) Registered equity or debt securities with the CFTC and the accounting firms
that provide auditing services to them.
(iii) Registered equity or debt securities with the NY stock exchange and the
accounting firms that provide auditing services to them.
(iv) Registered equity or debt securities with the SEC and the accounting firms that
provide auditing services to them.
(1) Explain the term PCAOB & its key activities.
(2) Explain the role of PCAOB.
(3) Explain the steps for ensuring compliance with the sarbanes-oxley act.
(4) Explain the process for reviewing selected firms’ audit work.
(5) Differentiate between PCAOB & AICPA.
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CHAPTER-6
THE NATIONAL FINANCIAL REPORTING AUTHORITY (NFRA)
CHAPTER OUTLINE
6.1 Introduction
6.2 Sec-132, The Companies Act, 2013
6.3 NFRA Background
6.4 Auditing and Assurance Standards Boards
6.5 Composition of NFRA
6.6 Scope of NFRA
6.7 Role of NFRA
6.8 Power of NFRA
6.9 Appeal Provision
6.10 Recommending Accounting Standards and Auditing Standards
6.11 Advisory Committees, Study Groups, and Task Forces
6.12 Financial Reporting Advocacy and Education
6.13 Confidentiality and Security of Information
6.14 NFRA vs. ICAI
Conclusion
6.1 INTRODUCTION
The importance of Audit of an organization is perhaps as same as what is oxygen for human
being. It is a 360-degree review of all the organization working and to speculate whether the
organization can expand or if there is some cost cutting to do. Auditing should be viewed not
only as a statutory requirement but as a value addition for any entity. An auditor has
professional skepticism and an overall understanding of the business process and is therefore
capable of identifying deficiencies and improving the same thereby creating value for the
services rendered. The correct accounts can only show the correct position and profitability of
a company, assessment of which is essential for survival and growth of any entity irrespective
of its size and complexities and audit by an independent CA can meet this end. Besides
Auditor’s knowledge and skepticism helps in detection of Fraud and misfeasance, detection
of non-compliances with financial laws of the land, ensuring timely filing of statutory returns
and forms and reporting departure if any. This protects the client from monitory losses,
penalties and prosecutions. Hence, the scope of Audit function can only but increase and has
a bright future, it is just onto us professionals to project it in a proper way.
The National Financial Reporting Authority which is an independent authority was proposed
by section 132 of the Companies Act, 2013 for the establishment and enforcement of
accounting and auditing standards and oversight of the work of auditors. Pursuant to it, the
Government of India constituted the National Financial Reporting Authority (NFRA) on 01st
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October, 2018 vide MCA Gazette Notification No. 5099(E), with its head office at New
Delhi. On 13th November, 2018, vide Gazette Notification No. G.S.R. 1111(E), Ministry of
Corporate Affairs issued National Financial Reporting Authority Rules, 2018 (NFRA Rules,
2018). On 29th September 2021, NFRA has issued a Consultation Paper and has raised some
very interesting questions. These questions have created sensation among the Audit
community, especially the one which raises questions on audit of MSMCs that is Micro,
Small and Medium Companies.
6.2 SECTION 132 OF THE COMPANIES ACT, 2013
Section 132 consists of 15 sub-sections pertaining to Constitution of National Financial
Reporting Authority, its functions, its constitution, its powers and other regulatory matters.
Of these Sections 6,7,8,& 9 which proposed constitution of an Appellate Authority were
removed by the Companies (Amendment) Act,2017 effective from 9th February 2018.
Initially, Sub Section (3) and (11), which deals with composition of NFRA were notified on
21st March 2018. Thereafter, while sub-sections (1) and (12) were notified on 1st October
2018, the sub-sections (2), (4), (5), (10), (13), (14) and (15) of section 132 of the Companies
Act, 2018 were notified on 24th October 2018. The NFRA Rules, 2018 The NFRA Rule,
2018 consists of 19 Rules and 2 forms.
These rules are:
1. Short Title and Commencement
2. Definitions
3. Classes of companies and bodies corporate governed by the Authority
4. Functions and duties of the Authority
5. Annual return
6. Recommending accounting standards and auditing standards
7. Monitoring and enforcing compliance with accounting standards
8. Monitoring and enforcing compliance with auditing standards
9. Overseeing the quality of service and suggesting measures for improvement
10. Power to investigate
11. Disciplinary proceedings
12. Manner of enforcement of orders passed in disciplinary proceedings
13. Punishment in case of non-compliance
14. Role of chairperson and full-time members
15. Advisory committees, study groups and task force
16. Financial reporting advocacy and education
17. Confidentiality and security of information
18. Avoidance of conflict of interest
19. International associations and international assistance
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Form 1 Form NFRA-1 speaks of information of Auditor of Body Corporate & Foreign Body
Corporate only. It is to be filed by:
Initial or one-time disclosure on the commencement of the Rules: Body corporate, excluding
companies falling under the scope of NFRA Rules, 2018, within 30 days from the date of
deployment of the form on the website;
Regular Disclosures on the appointment of the Auditors: Every corporate body governed by
NFRA, other than companies, within 15 days of the appointment of an auditor. The
requirement to file NFRA 1 confused many, so NFRA released a FAQ to clarify the
requirement.
Form-2 is to be filed by the Auditors of companies governed by NFRA Rules, 2018 by 30th
November every year
6.3 NFRA BACKGROUND
Prior to constitution of NFRA, there was a similar body under section 210(A) of the
Companies Act, 1956 called National Advisory Committee on Accounting Standards
(NACASA) which came into existence from 1998. Its main objective was to advise the
Central Government on the formulation and laying down of accounting policy and accounting
standards for adoption by companies. in consultation of Institute of Chartered Accountants of
India. However, prior to NFRA coming into existence, Institute of Chartered Accountants of
India (ICAI), was the sole regulator of auditors and auditing firms in India.
Role of ICAI in regulating Accounting and Auditing Profession:
As a statutory body regulating the profession of Chartered Accountancy in India, the ICAI
has had a long and glorious history in its 71 years of existence as the second largest Institute
in the world. As the premier accounting body, the ICAI has delivered to the world high class
CA professionals apart from setting benchmarks in the quality of financial reporting not
only in India but across the Globe. ICAI regulates its members and hence ensures the quality
of audit profession in number of ways as discussed below:
6.4 AUDITING & ASSURANCE STANDARDS BOARD
The Institute had, in the year 1977, constituted the Accounting Standards Board (ASB) to
formulate the accounting standards to be used in the preparation and presentation of general-
purpose financial statements. The Institute also constituted, in 1982, the Auditing Practices
Committee {now known as the Auditing and Assurance Standards Board (AASB)}. To
review the existing and emerging auditing practices worldwide and identify areas in which
Standards on Quality Control, Engagement Standards and Statements on Auditing need to be
developed. So far AASB has issued 45 standards which include: 1 Standards of Quality
Control (SQC), 37 Standards on Auditing (SAs), 2 Standards on Review Engagements
(SREs), 3 Standards on Assurance Engagements (SAEs) and 2 Standards on Related Services
(SRSs). SQC1 extensively deals with Quality Control for Firms that Perform Audit and
Reviews of Historical Financial Information, and other Assurance and Related Services
Engagements thereby ensuring the quality in audit profession in India.
1. Ethical Standards Board: ICAI has established the Ethical Standards Board to function
as standard setting body. The Ethical Standards Board develops and issues ethical
standards and other pronouncements for chartered accountants. It works towards
evolving a dynamic and contemporary Code of Ethics and ethical behavior for members
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while retaining the long cherished ideals of `excellence, independence, integrity’ as also
to protect the dignity and interests of the members.
2. Financial Reporting Review Board: ICAI in July 2002, constituted the Financial
Reporting Review Board (FRRB) to review the general purpose financial statements of
certain enterprises and auditor’s report thereon with a view to determine, to the extent
possible: Compliance with the generally accepted accounting principles in the
preparation and presentation of financial statements; Compliance with the disclosure
requirements prescribed by regulatory bodies, statutes and rules and regulations relevant
to the enterprise; and Compliance with the reporting obligations of the auditor. Such
review is done either suo motto or on a reference made to it by any regulatory body like,
Reserve Bank of India, Securities and Exchange Board of India, Insurance Regulatory
and Development Authority, Ministry of Corporate Affairs, Election Commission of
India etc. In cases where FRRB observes non-compliance which are not material non-
compliances it would appropriately bring the non-compliance to the attention of the
auditor. However, if non compliance is material it would refer the case to the Director
(Discipline) of the ICAIfor initiating action against the auditor under the Chartered
Accountants Act, 1949.
3. Peer Review Board: It is a board established by the Council of the ICAI in 2002, with
main objective to ensure that in carrying out the assurance service assignments, the
members of the Institute comply with Technical, Professional and Ethical Standards as
applicable including other regulatory requirements thereto and have in place proper
systems including documentation thereof, to amply demonstrate the quality of the
assurance services.
4. Quality Review Board: Government of India has on 28th June, 2007, constituted a
Quality Review Board (QRB) to:
 To make recommendations to the Council with regard to the quality of services
provided by the members of Institute;
 To review the quality of services provided by the members of the Institute including
audit services; and
 To guide the members of the Institute to improve the quality of services and
adherence to the various statutory and other regulatory requirements.
However, with NFRA coming into existence, the role of QRB has been curtailed, in respect
to companies covered under NFRA, and the issue of QRB reviewing will only arise in case a
reference is so made to QRB by NFRA, and not otherwise. Accordingly, QRB would now be
able to initiate reviews of quality of audit services provided by members of the Institute only
in respect of entities other than those specified under Rule 3(1) of NFRA Rules, 2018,
namely, private limited companies, unlisted public companies below the thresholds specified
under Rule 3(1) of NFRA Rules, 2018 and other entities not specified under Rule 3(1) of
NFRA Rules, 2018; and those referred to QRB by NFRA under Rule 9(4) of NFRA Rules,
2018.
5. Disciplinary Mechanism Of ICAI: ICAI not only performs its statutory duties as a
regulator of the profession of Chartered Accountancy in India by formulating
Accounting Standards in keeping pace with changing economic-scenario but also has
enforced the ethical values as enshrined in Code of Ethics and proactively taken action
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against its erring members, found guilty of professional misconduct through its well-
defined disciplinary mechanism. Under the disciplinary mechanism, a mandatory duty
has been cast upon the Disciplinary Directorate of the ICAI to look into any alleged
lapses/irregularities committed by its members across the country so as to lay down a
strong foundation of credibility to the future members joining the profession, which it
does through Director (Discipline), Board of Discipline and Disciplinary Committee
Taxation Audits Quality Review Board: To review any report prescribed under the
Income-tax Act, 1961 and Rules framed there under and any report prescribed under the
Indirect Tax Laws including Goods and Services Tax Law which are certified by a
Chartered Accountant (tax auditor) in respect of certain enterprises with a view to
determine, to the extent possible, compliance with the reporting requirements prescribed
under the Income-tax Act, 1961 and Rules framed there under; compliance with the
reporting requirements prescribed under the Indirect Tax Laws including Goods and
Services Tax Law and compliance with the respective pronouncements, guidance notes
of ICAI.
Then Why NFRA?
As stated above ICAI already has robust system in place to regulate audit profession in India.
This is the reason people have debated the requirement to constitute another body to regulate
audit of a class of company. This can well be apprehended by the fact that while most
sections of the Companies Act, 2014 became operational in 2014, section 132 of the
Companies Act became functional in October 2018 and that too partially. The argument went
in favour of creation of NFRA as most of the major economies of the world have independent
audit regulators. Besides, unearthing of huge financial scams like Satyam, not only in India
but across the globe, has highlighted the need to tighten the corporate governance and
reporting requirements for the corporate entities. One of the most disastrous outcomes of
scams has been the non-performing assets (NPA) situation in Indian Banks. Besides,
inadequate and improper financial reporting has been facilitating the tax evasion. Citing
above reasons NFRA was finally created by the Central Government.
6.5 COMPOSITION OF THE NFRA
The Companies Act requires the NFRA to have a chairperson who will be appointed by the
Central Government and a maximum of 15 members. The appointment of such chairperson
and members are subject to the following qualifications:
1. They should be having an expertise in accountancy, auditing, finance or law.
2. They are required to make a declaration to the Central Government that there is no
conflict of interest or lack of independence in their appointment.
3. All the members including the chairperson who are in full-time employment should not
be associated with any audit firm (including related consultancy firms) during their term
of office and 2 years after their term.
The terms and conditions relating to the appointment of the chairperson and members have
not yet been prescribed. However, the draft NFRA rules outline the following composition of
the authority:
1. Chairperson is a Chartered Accountant and a person of eminence having expertise in
accountancy, auditing, finance or law;
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2. Member – Accounting;
3. Member – Auditing;
4. Member – Enforcement;
5. One representative of the MCA not below the rank of Joint Secretary or equivalent (ex-
officio)
6. One representative of RBI, being a member of the RBI Board is to be nominated by the
RBI;
7. One representative of SEBI, being the Chairman of SEBI or whole-time member of
SEBI is to be nominated by SEBI;
8. A retired chief justice of high court or a person who has been the judge of a high court
for more than 5 years is to be nominated by the Central Government,
9. President of the Institute of Chartered Accountants of India (ex-officio)
The Chairman may also invite any other person to the meeting to give their expert opinion.
6.6 SCOPE OF NFRA
The rules and regulation of NFRA does not cover every corporate entity. The classes of
companies and bodies corporate and their auditors governed by NFRA have been specified in
the Rule 3 of the NFRA Rule, 2018. These are:
1. companies whose securities are listed on any stock exchange in India or outside India;
2. unlisted public companies having paid-up capital of Rs. 500 crores or more
3. unlisted public companies having annual turnover of Rs. 1000 crores or more
4. unlisted public companies having, in aggregate, outstanding loans, debentures and
deposits of Rs. 500 crores as on the last date of immediately preceding financial year;
5. insurance companies, banking companies, companies engaged in the generation or
supply of electricity, companies governed by any special Act being in force
6. anybody corporate or company or person, or any class of bodies corporate or companies
or persons, on a reference made to the Authority by the Central Government in public
interest; or
7. a body corporate incorporated or registered outside India, which is a subsidiary or
associate company of any company or body corporate incorporated or registered in
India as referred to above, if the income or net worth of such subsidiary or associate
company exceeds 20% of the consolidated income or consolidated net worth of such
company or the body corporate.
It is pertinent to note that an entity stated above shall continue to be governed by NFRA for a
period of three years after it ceases to meet the criteria mentioned above. All entities under
the purview of NFRA are required to inform it, within 15 days of appointment of Auditor in
Form 1. Besides, Rule 3(2) required every existing body corporate other than a company
covered above to inform the NFRA within thirty days of the commencement of the NFRA
Rules, in Form NFRA-1, the particulars of the auditor as on the date of commencement of the
rules.
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It is interesting to note that though the Rule 5 of the NFRA Rules, 2018 requires every
auditor covered under NFRA rules to file a return in Form -2 with the NFRA on or before
30th April every year. However, by an amendment dated 5th September, 2019, the last date
for filing NFRA- by auditors was changed to 30th November every year.
6.7 ROLE OF NFRA
Section 132(2) prescribes the broad role the NFRA is expected to play which are as follows:
1. make recommendations to the Central Government on the formulation and laying down
of accounting and auditing policies and standards for adoption by companies or class of
companies or their auditors, as the case may be;
2. monitor and enforce the compliance with accounting standards and auditing standards;
3. oversee the quality of service of the professions associated with ensuring compliance
with such standards, and suggest measures required for improvement in quality of
service and such other related matters as may be prescribed; and
4. perform such other functions relating to above.
The Rule 4 of NFRA Rules 2018, details the functions NFRA is expected to perform.
Accordingly, it shall protect the public interest and the interests of investors, creditors and
others associated with the companies or bodies corporate governed by it by establishing high
quality standards of accounting and auditing and exercising effective oversight of accounting
functions performed by the companies and bodies corporate and auditing functions performed
by auditor. In a more specific way NFRA performs following functions:
1. maintain details of particulars of auditors appointed in the companies and bodies
corporate covered by it
2. recommend accounting standards and auditing standards for approval by the Central
Government;
3. monitor and enforce compliance with accounting standards and auditing standards;
4. oversee the quality of service of the professions associated with ensuring compliance
with such standards and suggest measures for improvement in the quality of service;
5. promote awareness in relation to the compliance of accounting standards and auditing
standards;
6. co-operate with national and international organizations of independent audit regulators
in establishing and overseeing adherence to accounting standards and auditing
standards; and
7. perform such other functions and duties as may be necessary or incidental to the
aforesaid functions and duties.
6.8 POWERS OF NFRA
The NFRA shall have the following powers as per the section 132(4) of the Companies Act,
2013:
1. To investigate the matters of professional or other misconduct committed by a
prescribed class of CA firms or CAs. No other authority can initiate or continue
proceedings where the NFRA has initiated an investigation. Such an investigation can
be initiated either suo moto (by itself) or on a reference made by the Central
Government.
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2. The same powers as a Civil Court in respect of a suit involving:
 Discovery and production of books of account and other documents
 Summoning and enforcing the attendance of persons and examining under Oath
 Inspection of any books, registers, and other documents of any person at any place
 Issuing commissions for the examination of witnesses or documents
3. Where professional or other misconduct is proved, it shall have the power to impose the
penalty which may be as follows:
 For individuals a fine between Rs. 1,00,000 to 5 times the fees received
 For firms a fine Between Rs. 5,00,000 to 10 times the fees received
4. Where professional or other misconduct is proved, it shall have the power to debar the
member/firm from being appointed as an auditor or internal auditor or undertaking any
audit in respect of financial statements or internal audit of the functions and activities of
any company or performing any valuation services for a period which may be from 6
months to 10 years.
Thus, we see NFRA has extensive powers in relation to auditors of the Companies covered
under the NFRA Rule 3.
6.9 APPEAL PROVISION
The section 132(5) off the Companies Act, 2013 provides that any person who is not satisfied
with the order of the NFRA can then make an appeal to the Appellate Authority.
NFRA Consultation Paper
NFRA has issued a Consultation Paper on 29th September 2021 to review the requirement of
compulsory statutory audit and compliance with auditing standards for all companies
irrespective of their size and/ or public interest, specially the ‘Micro, Small and Medium
Companies (MSMCs)’ with net worth of less than Rupees 250 Crores. Stakeholders have
been invited to submit their comments by 10/11/2021. After conducting a preliminary
analysis on the key financial parameters of the companies registered in India, the NFRA has
provided following observations:
1. Dominance of private limited companies: As per NFRA’s report around 95% of
companies incorporated in India are one-person or private company.
2. High Non- Compliances among Companies: NFRA has pointed out that only 52.48%
of the companies have done their annual filings with MCA and for FY 2018-19, even
after two years which they attribute to lack of adequate accounting professionals with
many of these companies.
3. Dominance of MSMCs: Out of the total companies which have made filings, 99.41%
have reported Net Worth below ₹ 250 Crores which are to be treated as MSMCs for the
purpose of the consultation paper.
4. Low Turnover Companies: Around 34.88% of companies have reported nil turnover
and of rest nearly 61.22% have very low turnover i.e., below ₹ 50 Crores.
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5. Indebtedness: Nearly 45% of MMCs are debt free. Of the remaining companies around
5.68% have debt below Rs.25 crores.
6. Ease of doing business: The regulations relating to financial reporting and auditing
should not impose undue burdens and costs on the regulated entities, and the overall
regulatory framework should be proportional to the size and type of the entities that are
subject to such regulations.
7. Low Audit Fees: The fees paid to auditors by a large majority of Micro, Small and
Medium Companies (MSMCs) are way below what an audit, when performed in
compliance with the letter and spirit of the Standards of Auditing, would require.
Around 41% of the companies have reported Audit Fee below Rs. 25000 and over
40000 companies have reported audit fees below Rs. 5000. NFRA with a hypothetical
example has worked out that a reasonably good quality audit, for an MSMC, with
Turnover below 50 Crores would cost in the range of 1.50 lakhs to Rs. 8.43 lakhs.
8. Limited Users of Financial Statements of MSMCs: As per NFRA a large majority of
Companies have very low or NIL Indebtedness, which indicates low risk to the larger
public interest and therefore very limited users of financial statements. Here it is
important to note Rs.25 crores cannot be regarded a small in a country like India, and
secondly, lenders are not the only users of financial statements.
9. Auditing Threshold set by Tax authorities: As per NFRA Tax audit has been
dispensed for businesses with a turnover of up to Rs 10 crores, provided not more than
5 % of the total transactions are in cash. GST Audit has also been completely done
away with. It is to be noted these thresholds are there probably because Tax Department
relies on statutory audit for corporate entities and in the case of other entities to, they
have already set a minimum presumptive tax limit to avail these exemptions.
10. Global Precedence: NFRA has at length discussed how various countries either never
required or has done away with audit for smaller companies. It covered the study of the
European Union, UK, Singapore, Australia, USA, and Japan. Most countries give
exemption from Audit to small companies where the public is not substantially
interested based on meeting of the three criteria viz. Turnover, Net worth & Number of
Employees. USA accepts financial statements that are certified by the management in
the case of small companies, in case they are not certified by a CPA. Japan has audit
requirements only for specified large companies.
6.10 RECOMMENDING ACCOUNTING STANDARDS AND AUDITING
STANDARDS
Rule 6 of the NFRA Rules, 2018 deals with recommending accounting standards and auditing
standards. Rule 6(1) provides that for the purpose of recommending accounting standards or
auditing standards for approval by the Central Government, the NFRA—
(a) shall receive recommendations from the Institute of Chartered Accountants of India on
proposals for new accounting stan¬dards or auditing standards or for amendments to
existing accounting standards or auditing standards;
(b) may seek additional information from the Institute of Char¬tered Accountants of India
on the recommendations received under (a) above, if required.
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The NFRA shall consider the recommendations and additional information in such manner as
it deems fit before making recommendations to the Central Government.
6.11 ADVISORY COMMITTEES, STUDY GROUPS, AND TASK FORCES
Rule 15 of the NFRA Rules, 2018 provides that for the effective performance of its functions
under the Act, the NFRA may constitute advisory committees, study groups and task forces.
6.12 FINANCIAL REPORTING ADVOCACY AND EDUCATION
Rule 16 of the NFRA Rules, 2018 provides that the NFRA shall take suitable measures for
the promotion of awareness and significance of accounting standards, auditing standards,
auditors’ responsibilities, audit quality and such other matters through education, training,
seminars, workshops, conferences and publicity.
6.13 CONFIDENTIALITY AND SECURITY OF INFORMATION
Rule 17 of the NFRA Rules, 2018 provides as under:
a. The NFRA and all persons and organizations associated with it shall maintain complete
confidentiality and security of the information provided to them for the purpose of the
work of the Authority.
b. The NFRA may enter into such contractual arrangements as may be necessary in order to
maintain complete confidentiality and security of the information.
6.14 NFRA v/s ICAI
Prima facie, there appears to be a conflict in the roles and responsibilities of NFRA and ICAI;
since the Institute of Chartered Accountants (ICAI) is also working with the said objectives.
Hence, one can argue that there are two parallel organizations operating with the same
objective. With the establishment of NFRA which will act as a watchdog for companies
including auditors, gets an upper hand and as clarified in the rules published recently, NFRA
gets the ultimate authority to impose a monetary penalty as well as debar an auditor or audit
firm in case of misconduct.
The key differences between the roles and responsibilities of NFRA and ICAI are in the
following areas:
 Scope: As per the rules notified recently, the establishments that will be controlled
by NFRA include the following: all listed companies; (securities can be listed in
India or outside India)unlisted companies with a paid up capital of Rs 500 crore or
more; or an annual turnover of Rs 1,000 crore or more; or outstanding loans,
debentures and deposits of Rs 500 crore or more insurance companies, banking
companies and companies engaged in the generation or supply of electricity large
offshore subsidiaries and associates of the above companies provided their income
or net worth exceeds 20 % of the income or net worth of the parent.
 Authority: NFRA rules, gives authority to NFRA to protect the public interest and
the interests of investors, creditors and others associated with companies. As
specified in the Companies Act, the rules provide that the NFRA may direct auditors
in improving audit quality. This was so far a sole responsibility of ICAI. With NFRA
rules, there is a clear dilution of power rested with ICAI.
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 Penal Action against misconduct: NFRA has also been given wide powers of
investigation including into professional misconduct of an auditor. The law states
that once the action or investigation is initiated by NFRA; no other body corporate
shall initiate or continue any proceedings against the same matter. This restricts
ICAI’s power to act against the misconduct of its members/auditors.
 Advisory role: NFRA advises the Central Government whereas ICAI will advise
NFRA in creating high-quality accounting standards, etc.
Who is the ultimate authority?
Considering the wide scope and powers vested with NFRA, the powers entrusted with ICAI
are diluted. From a listed or large companies’ perspective NFRA is an important body and
they are required to comply with the norms laid by NFRA. However, ICAI will help in
creating these rules and will govern small and unlisted companies as usual.
Finally, this kind of “Oversight-board” is in place in many countries and was also
recommended in the Sarbanes Oxley Act; post “Enron scam”.
The government has said that the National Financial Reporting Authority (NFRA) and
Institute of Chartered Accountants of India (ICAI) must resolve their differences pertaining to
statutory audit of small firms and accounting standards applicable to them through dialogue.
According to an official from Ministry of Corporate Affairs (MCA), the audit regulator and
the institute both are defined clearly and distinctly, hence the two bodies must sort out things
between themselves as Centre does not make any clarification on perceptions. However, if
the government has to articulate anything it will be in form of Acts and rules,” added the
official.
CONCLUSION
Thus, it can be concluded that the ICAI will continue to retain its regulatory powers in
respect of private companies and unlisted public companies below the above-prescribed
threshold. The Quality Review Board will also continue conducting quality audits in respect
of private limited companies, unlisted public companies and such other audit of companies
that are delegated by the NFRA.
As an independent audit regulator, it will be expected that the NFRA enhances an investor’s
confidence and bring more transparency and accountability in the auditing profession. As we
see more complex and multi-layered structures and increased corporate governance, it will be
interesting to see whether the NFRA will be able to act as the watchdog to protect the public
interest and the interests of investors, creditors and others associated with the companies or
bodies corporate falling within its purview.
SUMMARY
1. NFRA objective was to advise the Central Government on the formulation and laying
down of accounting policy and accounting standards for adoption by companies.
2. Auditing and Assurance Standards Board has issued 45 standards which include:
1 Standards of Quality Control (SQC), 37 Standards on Auditing (SAs), 2 Standards
on Review Engagements (SREs), 3 Standards on Assurance Engagements (SAEs) and
2 Standards on Related Services (SRSs).
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3. The Companies Act requires the NFRA to have a chairperson who will be appointed
by the Central Government and a maximum of 15 members.
4. The broad role the NFRA is expected to play is make recommendations to the Central
Government on the formulation and laying down of accounting and auditing policies,
Monitor and enforce the compliance with accounting standards and auditing
standards, Oversee the quality of service of the professions associated.
5. The NFRA shall consider the recommendations and additional information in such
manner as it deems fit before making recommendations to the Central Government.
6. With the establishment of NFRA which will act as a watchdog for companies
including auditors, gets an upper hand and as clarified in the rules published recently,
NFRA gets the ultimate authority to impose a monetary penalty as well as debar an
auditor or audit firm in case of misconduct.
7. NFRA rules, gives authority to NFRA to protect the public interest and the interests of
investors, creditors and others associated with companies. NFRA has also been given
wide powers of investigation including into professional misconduct of an auditor.
FILL IN THE BLANKS
(1) Auditing should be viewed not only as a statutory requirement but as a
……………………………
(2) The NFRA which is an independent authority was proposed by section 132 of the
Companies Act, 2013 for the establishment and enforcement of accounting and auditing
standards and oversight of the work of auditors.
(3) The Companies Act requires the NFRA to have a ……………… who will be appointed
by the Central Government and a maximum of ……….. members.
(4) As per NFRA a large majority of Companies have very low or NIL Indebtedness, which
indicates ……………………………………
(5) Rule 16 of the NFRA Rules, 2018 provides that the NFRA shall take suitable measures
for……………………………………
(1) NFRA stands for
(i) National financial reporting authority
(ii) National financial regulatory authority
(iii) National financial restructure authority
(iv) None of the above
(2) Consider the following statements:
(1) NFRA was constituted under the companies act, 2013
(2) NFRA account is monitored by the Comptroller and Auditor General of India
(3) NFRA cannot undertake investigation of companies which are listed on any stock
exchange.
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Which of the statements given above is/are correct?
(i) 2 & 3 only
(ii) 1 & 2 only
(iii) 1 & 3 only
(iv) 1, 2 & 3
(3) With reference to Comptroller and auditor General of India (CAG), which of the
following statement is correct.
(i) He act as the balancing wheel of fiscal federalism in India.
(ii) The Public Accounts Committee examines the reports submitted by CAG to the
President.
(iii) Public corporation like Life insurance Corporation of India and Reserve Bank of
India are audited by CAG.
(4) Which of the following statement is true regarding National Financial Reporting
Authority.
(i) It is headed by Union Finance Minister
(ii) It can make recommendations on the foundation and laying down of accounting
and auditing policies and standards.
(iii) It also enjoy the power of a civil court in some matter.
(5) Which of the following will be included in 45 Standard issued by AASB.
(i) 2 Standards on Review Engagements (SREs)
(ii) 37 Standards on Auditing (SAs)
(iii) 1 Standards of Quality Control (SQC)
(1) Explain national financial reporting authority & its scope.
(2) Explain section 132 of the companies act, 2013 and its rules.
(3) Explain the powers and functions of NFRA.
(4) Differentiate between NFRA & ICAI.
(5) “In the wake of accounting scams, a need was felt to establish an independent regulator
for enforcement of auditing standards and ensuring the quality of audits so as to
enhance investor and public confidence in financial disclosures of companies”. Explain
the role of NFRA in the light of above statement.
(6) Discuss scope of NFRA.
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UNIT-II
CHAPTER-7
MEANING THEORIES AND MODELS OF
CORPORATE GOVERNANCE
7.1 Meaning of Corporate Governance

7.2 Features of Corporate Governance
7.3 Scope of Corporate Governance
7.4 Importance of Corporate Governance
7.5 Need of Corporate Governance
7.6 Good Governance
7.7 Objectives of Good Governance
7.8 Factors influencing quality of Corporate Governance
7.9 Corporate Governance & Excellence
7.10 Principles of Corporate Governance
7.11 4 Ps of Corporate Governance
7.12 Benefits of Corporate Governance
7.13 Theories of Corporate Governance
7.14 Models of Corporate Governance
7.1 MEANING OF CG
Corporate governance is the system or structure of rules, practices, and laws by which a
firm is directed and controlled. The Board of directors manages the corporate
governance and they are responsible for every situation of the company. Thus, it refers to
the way a corporation is governed. It is the technique by which companies are directed and
managed. It means carrying the business as per the stakeholders’ desires. It is actually
conducted by the board of Directors and the concerned committees for the company’s
stakeholder’s benefit. It is all about balancing individual and societal goals, as well as,
economic and social goals.
7.2 FEATURES OF CG
1. Corporate Governance is the interaction between various participants (shareholders,
board of directors, and company’s management) in shaping corporation’s performance
and the way it is proceeding towards. The relationship between the owners and the
managers in an organization must be healthy and there should be no conflict between the
two. The owners must see that individual’s actual performance is according to the
standard performance. These dimensions of corporate governance should not be
overlooked.
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2. Corporate Governance deals with the manner the providers of finance guarantee
themselves of getting a fair return on their investment. Corporate Governance clearly
distinguishes between the owners and the managers. The managers are the deciding
authority. In modern corporations, the functions/ tasks of owners and managers should
be clearly defined, rather, harmonizing.
3. Corporate Governance deals with determining ways to take effective strategic decisions.
It gives ultimate authority and complete responsibility to the Board of Directors. In
today’s market- oriented economy, the need for corporate governance arises. Also,
efficiency as well as globalization are significant factors urging corporate governance.
Corporate Governance is essential to develop added value to the stakeholders.
4. Corporate Governance ensures transparency which ensures strong and balanced
economic development. This also ensures that the interests of all shareholders (majority
as well as minority shareholders) are safeguarded. It ensures that all shareholders fully
exercise their rights and that the organization fully recognizes their rights.
5. It includes both social and institutional aspects. Corporate Governance encourages a
trustworthy, moral, as well as ethical environment.
7.3 SCOPE OF CORPORATE GOVERNANCE
The scope of having corporate governance is:
1. Accountability – Accountability means a situation in which any person is responsible and
needs to give a satisfactory reason for anything wrong in work. Corporate governance makes
accountability.
(a) Accountability ensures that working management i.e. Managers, Employees is
responsible to the Board Of Directors (BOD ).
(b) Further, Accountability Ensure that the BOD is accountable to shareholders if anything
bad happens.
2. Fairness
(a) Corporate governance ( CG ) protects the rights of Shareholders.
(b) CG treat all shareholders equally including minorities i.e. who has small part of
company’s ownership.
(c) Provides effective redressal for any violations i.e Customer care
3. Transparency
(a) CG makes ensure timely, accurate disclosure on all material matters of the
company including the financial situation, performance, ownership.
4.Independence
(a) CG makes procedures, rules, and structures in place to minimize or avoid conflicts of
interest
(b) CG appoints Independent Directors and Advisers i.e. to take the free decision from the
influence of others
(a) CG ensures compliance with all the laws and code of spirit.
(b) Corporate governance is necessary to meet the requirement of SEBI for listed
companies
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7.4 IMPORTANCE OF CORPORATE GOVERNANCE
Corporate governance is important to promote the honest and transparent monitoring of each
and every activity of the company. It helps the company to maintain the rules and standards
of the company. Corporate governance also assists the training and development of directors
so that they can perform well in the decision-making process.
Foreign capital means getting capital investment from foreign countries. Foreign capital
markets want high standards for efficiency & transparency of the company. Good corporate
governance is important to bring efficiency & transparency to the company which helps the
global market players to gains credibility and trust.
The next importance of corporate governance is to protect the rights of investors. Every
investor wants their rights to be protected by companies. Bringing corporate governance in a
company can protect investors’ interests by improving the efficiency of corporate enterprises.
4. Fairness In Financial Reporting & Accountability
Financial reporting is the financial results of a company in which company provides the
results to its stakeholders and the public. Corporate governance ensures sound, transparent,
and credible financial reporting. Corporate governance also makes accountability
(Responsibility) of employees & managers for their work to increase their effectiveness.
Shareholder communication refers to the right to vote in the decision-making process. It is
the another way in which investors can communicate with the companies. Corporate
governance is important to set up the right for shareholder communication. Nowadays more
importance is giving to corporate governance.
Example- In 2003, New provisions are added in corporate governance in order to improve
shareholder’s involvement in decision making.
Corporate governance is important to increase goodwill and market reputation. As corporate
governance ensures the protection of rights, the efficiency of a company, right decisions, etc.
Improved management, accountability, good market reputation, and transparency fulfill the
investor’s need and confidence in the company. This increases the value of the company in
the market.
7.5 NEED OF CORPORATE GOVERNANCE
1. Growing Number of Scams
Misuse and misappropriation of public money are happening everywhere i.e stock market,
banks, financial institutions, companies, and government offices. In order to avoid these
financial irregularities, companies need to start using corporate governance.
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2. Takeovers and Mergers
There are many takeovers and mergers are going on in the business world. The need of
corporate governance is to protect the interest of all the parties during takeovers and mergers.
3. Comply with SEBI Requirement
SEBI has made corporate governance compulsory for certain companies i.e for listed
companies to comply with its provisions. This SEBI requirement protects the interest of the
investors and other stakeholders. If any company doesn’t comply with SEBI rules, it can
bring a high penalty.
4. Need of Social Responsibility
Today, social responsibility is given a lot of importance. The Board of Directors (BOD) has
to protect the rights of the customers, employees, shareholders, suppliers, local communities,
government, etc. This is possible only if they use corporate governance.
7.6 GOOD CORPORATE GOVERNANCE
Corporate Governance is intended to increase the accountability of your company and avoid
massive disasters before they occur. Failed energy giant Enron, and its bankrupt employees
and shareholders, is a prime argument for the importance of solid Corporate Governance.
Well- executed Corporate Governance should be similar to a police department’s internal
affairs unit, weeding out and eliminating problems with extreme prejudice. The Need,
Significance or Importance of Corporate Governance is listed below.
1. Changing Ownership Structure:-In recent years, the ownership structure of
companies has changed a lot. Public financial institutions, mutual funds, etc. are the
single largest shareholder in most of the large companies. So, they have effective
control on the management of the companies. They force the management to use
corporate governance. That is, they put pressure on the management to become more
efficient, transparent, accountable, etc. They also ask the management to make
consumer-friendly policies, to protect all social groups and to protect the
environment. So, the changing ownership structure has resulted in corporate
governance.
2. Importance of Social Responsibility: 3Today, 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, etc. This is possible only if
they use corporate governance
3. Growing Number of Scams: In recent years, many scams, frauds and corrupt
practices have taken place. Misuse and misappropriation of public money are
happening everyday in India and worldwide. It is happening in the stock market,
banks, financial institutions, companies and government offices. In order to avoid
these scams and financial irregularities, many companies have started corporate
governance.
4. Indifference on the part of Shareholders: In general, shareholders are inactive in
the management of their companies. They only attend the Annual general meeting.
Postal ballot is still absent in India. Proxies are not allowed to speak in the meetings.
Shareholders associations are not strong. Therefore, directors misuse their power for
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their own benefits. So, there is a need for corporate governance to protect all the
stakeholders of the company.
5. Globalization: Today most big companies are selling their goods in the global
market. So, they have to attract foreign investor and foreign customers. They also
have to follow foreign rules and regulations. All this requires corporate governance.
Without Corporate governance, it is impossible to enter, survive and succeed the
global market.
6. Takeovers and Mergers: Today, there are many takeovers and mergers in the
business world. Corporate governance is required to protect the interest of all the
parties during takeovers and mergers.
7. SEBI: SEBI has made corporate governance compulsory for certain companies. This
is done to protect the interest of the investors and other stakeholders
7.7 OBJECTIVE OF GOOD GOVERNANCE
It is felt that objective of corporate governance, i.e. the overall objective of wealth
generation and competitiveness for the benefit of all can best be achieved through the twin
components of:
 An “ inclusive” approach to director’s duties which requires directors to have regard to
all the relationship on which the company depends and to the long, as well as the short-
term implications of their actions, with a view achieving company success for the benefit
of shareholders as a whorl; and  Wilder public accountability is to be achieved
principally through improved company reporting, which for public and very large private
companies will require the publication of board operating and financial review which
explains the company’s performance, strategy and relationships (eg. With employees,
customers and suppliers as well as the wider community).
7.8 FACTORS INFLUENCING QUALITY OF GOVERNANCE
Quality of governance is influenced by integrity of the management, ability of the board,
adequacy of the processes, commitment level of individual board members, quality of
corporate reporting and participation of stakeholders in the management.
i. Integrity of management: A Board of Directors with a low level of integrity is
tempted to misuse the trust reposed by shareholders and other stakeholders to take
decisions that benefit a few at the cost of others.
ii. Ability of the board: The collective ability, in terms of knowledge and skill,
determines the effectiveness of the Board.
iii. Adequacy of the process: Board of Directors cannot effectively supervise the
executive management if the process fails to provide sufficient and timely information
to the Board, necessary for reviewing plans and the performance of the enterprise.
iv. Commitment level of individual board members: The quality of a board depends on
the commitment of individual members to tasks which they are expected to perform as
board members.
v. Financial reporting: Accuracy and transparency in financial statements and disclosure,
internal controls and independence of auditors.
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vi. Participation of stakeholders in the management: The level of participation of
stakeholders determines the number of new ideas being generated in optimum
utilization of resources and for improving the administrative structure and the process.
vii. Quality of corporate reporting: The quality of corporate reporting depends on the
transparency and timeliness of corporate communication with shareholders. This helps
the shareholders in making economic decisions and in correctly evaluating the
management in its stewardship function. Best practices of corporate governance will
broadly include – a definition of practices that defines good governance; a code of best
practices covering the constitution of the Board, its various committees, defining their
goals and responsibilities, exploring preferred internal systems and disclosure
requirements.
7.9 CORPORATE GOVERNANCE & EXCELLENCE
Achieving corporate and professional excellence is what we all aim at in our life. This is what
will make us different from other and this is what we can achieve as ultimate. Business must
be lead by example. That example is set by good governance practices. “Corporate
Governance” is not just another fashionable word but it is a more important concept of lasting
value. It is an important concept and a means to an end-that of achieving corporate
excellence. Corporate Governance is the most appropriate tool for achieving Corporate
Excellence. Companies should identify, assess and establish core values, core capability and
core purpose to achieve Corporate Excellence. Since today’s technology is yesterday’s
magic, It is Imperative that all corporates be innovative, creative and responsible citizens to
bring excellence in their vision, mission and action. Good Corporate Governance is a source
of competitive advantage and a critical input for achieving excellence in all productive,
economic and social pursuits. Tomorrow does not belong to mere machinery, computers,
software or internet. At best they are mere tools. If there is one single element that has the
power to harness these, it is the prudent principles of good governance. We must focus on
end result, own it and be accountable for our actions and their results. A company’s most
valuable asset is goodwill it enjoys with its stakeholders, which can only be earned by
actions, not demanded. Good governance is a necessary condition for achieving excellence,
not a sufficient one. Good governance is a source of competitive advantage and critical to
economic progress. The essence of Corporate Governance is transparency, accountability,
investor protections, better compliance with statutory laws and regulations, value creation for
shareholders (as also for other stakeholders) and societal value. Corporate governance is the
one and only route to achieve corporate excellence. Every corporate has become alive to the
reality of having to stay lean and fit in order to deliver its best strictly in consonance with the
principles of corporate governance. Any attempt on the part of corporates to circumvent this
reality and resort to shortcuts to achieve excellence will only result in short-circuiting their
ill-conceived efforts. What does corporate excellence or success really mean would depend
on one’s vision. Excellence has been defined in many different ways. Some commonly
accepted measures of excellence in the modern economic model of the firm include: 
Profitability  Satisfied stakeholders, such as customers, employees and shareholders. 
Revenue and profit growth Growth in market share  Growth in market value (Stock
Market Capitalization) One can see importance being given to “Corporate Governance”
issues, as we understand them today. Look at the importance being given to satisfied
stakeholders, closeness to customers, productivity through people and value . Corporate
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Excellence and Governance are closely connected concepts and it is felt that in the long run,
it is difficult to achieve excellence without good governance.
Conclusion As rightly observed by Martin Luther King Jr. “We shall have to repent in
this generation, not so much for the evil deeds of the wicked people but for the
appalling silence of the good people”. The message is loud and crystal clear. The
corporates of ill afford have to proactively formulate a code and stick to it to survive
as well as to excel. Professionals have challenging period ahead keeping track of
legislative reforms and technological developments, understanding their impact on his
duties and responsibilities.
7.10 PRINCIPLES OF CORPORATE GOVERNANCE

There are 4 main principles of corporate governance which include
1. Fairness: Fairness refers to equal treatment, for example, shareholders should receive
equal consideration in proportion to their respective shareholdings.
Moreover, all stakeholders including employees, communities and public officials
should be treated fairly.
2. Responsibility: The Board of Directors have authority to act on the company’s behalf.
Hence, they should assume complete responsibility and exercise the authority
accordingly.
The Board of Directors is responsible for overseeing management of the business,
company affairs, appointing the chief executive and monitoring the company’s
performance.
3. Transparency: Transparency refers to a company’s openness and willingness to
disclose clear information to shareholders and other stakeholders. Material matters
concerning company performance and activities should be disclosed in a timely and
accurate manner to make sure that all investors are given clear, factual information that
precisely reflects the financial, social and environmental position of the organisation.
Transparency helps ensure that stakeholders have confidence in the decision-making
and management processes of a company.
4. Accountability: Corporate accountability refers to the obligation and responsibility to
explain the company’s actions and conduct. The board should present a balanced and
comprehensible assessment of the company’s position and prospects, and it should
employ prudent risk management and internal control systems.
It should communicate with stakeholders at regular intervals a fair, balanced and
comprehensible assessment of the company’ sections toward achieving its business
objectives.
7.11 4 PS OF CORPORATE GOVERNANCE

1. People: People associated with the organisation including investors, shareholders,
employees, society, government, etc. can help clarify the people orientation of an
organisation’s corporate governance scheme.
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2. Purpose: The organisation’s purpose should be measurable, actionable and
communicated well to the organisation’s stakeholders. This includes mission and
vision, which should be based on shared organisational values, leading to organisational
commitment, ensuring good corporate governance in turn.
3. Process: This includes process management, process compliance and process
innovation. To ensure good corporate governance, the organisation must comply with
all rules and regulations prescribed by the government and other relevant authorities
and have a proper mechanism for avoiding violations of norms.
4. Performance: Performance should be measured, analysed and communicated to
achieve growth through efficiency. development and promotes good corporate
governance.
7.12 BENEFITS OF GOOD CORPORATE GOVERNANCE
TO BUSINESS
1. Takes into account the needs of all stakeholders
2. Creates transparency in all activities
3. Creates a good corporate image
4. Creates and sustains corporate social responsibility within the organisation
5. Ensures business activities are ethical
TO ORGANIZATION
1. Employees show commitment to work and deliver better results
2. Government extends exemptions and privileges
3. Company’s reputation in society improves
4. Repeat business from customers increases
5. Conflicts and fraud decrease
TO VARIOUS PARTIES INVOLVED
1. Shareholders are better informed about all important management decisions.
2. The company follows fair employment policies and procedures
3. Customers get high-quality products at fair prices
4. Investors’ return on investment is maximised
5. Society benefits owing to the social and environmental activities of the organisation
7.13 THEORIES OF CORPORATE GOVERNANCE
There are many theories of corporate governance which addressed the challenges of
governance of firms and companies from time to time. The 1 is the process of decision
making and the process by which decisions are implemented in large businesses is known as
Corporate Governance. There are various theories which describe the relationship between
various stakeholders of the business while carrying out the activity of the business.
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1. Agency Theory
Agency theory defines the relationship between the principals (such as shareholders of
company) and agents (such as directors of company). According to this theory, the principals
of the company hire the agents to perform work. The principals delegate the work of running
the business to the directors or managers, who are agents of shareholders. The shareholders
expect the agents to act and make decisions in the best interest of principal. On the contrary,
it is not necessary that agent make decisions in the best interests of the principals. The agent
may be succumbed to self-interest, opportunistic behavior and fall short of expectations of the
principal. The key feature of agency theory is separation of ownership and control. The
theory prescribes that people or employees are held accountable in their tasks and
responsibilities. Rewards and Punishments can be used to correct the priorities of agents.
2. Stewardship Theory
The steward theory states that a steward protects and maximises shareholders wealth through
firm Performance. Stewards are company executives and managers working for the
shareholders, protects and make profits for the shareholders. The stewards are satisfied and
motivated when organizational success is attained. It stresses on the position of employees or
executives to act more autonomously so that the shareholders’ returns are maximized. The
employees take ownership of their jobs and work at them diligently.
3. Stakeholder Theory
Stakeholder theory incorporated the accountability of management to a broad range of
stakeholders. It states that managers in organizations have a network of relationships to
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serve– this includes the suppliers, employees and business partners. The theory focuses on
managerial decision making and interests of all stakeholders have intrinsic value, and no sets
of interests is assumed to dominate the others
4. Resource Dependency Theory

The Resource Dependency Theory focuses on the role of board directors in providing access
to resources needed by the firm. It states that directors play an important role in providing or
securing essential resources to an organization through their linkages to the external
environment. The provision of resources enhances organizational functioning, firm’s
performance and its survival. The directors bring resources to the firm, such as information,
skills, access to key constituents such as suppliers, buyers, public policy makers, social
groups as well as legitimacy. Directors can be classified into four categories of insiders,
business experts, support specialists and community influentials.
5. Transaction Cost Theory
Transaction cost theory states that a company has number of contracts within the company
itself or with market through which it creates value for the company. There is cost associated
with each contract with external party; such cost is called transaction cost. If transaction cost
of using the market is higher, the company would undertake that transaction itself.
6. Political Theory
Political theory brings the approach of developing voting support from shareholders, rather
by purchasing voting power. It highlights the allocation of corporate power, profits and
privileges are determined via the governments’ favor.
Corporate form of business is generally managed by the Board of Directors and the board
members are elected by shareholders. The board in turn appoints the professional managers to
manage the business. Different countries have different regulations and corporate governance
models differ based on these differences.
7.14 MODELS OF CORPORATE GOVERNANCE
The corporate governance structure has certain basic elements. These elements are the pattern of
share ownership, key players in the corporate sector, composition of the board of directors,
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interaction among the key players, the regulatory framework, disclosure requirements for listed
companies, and corporate decisions that require approval of shareholders. These elements differ
between countries. As a result, there are different corporate governance models. These models are
explained below:
1. The Anglo-Saxon Model (The Outsider Model): The corporate governance model of the
United States and commonwealth countries such as UK, Australia, Canada, India (to a large
extent), etc., is known as the outsider model. This model is characterized by:
(i) A well-developed Stock Market with Considerable Depth and Liquidity: In the
USA and the UK a vast majority of public companies are listed at stock exchanges.
The capital market in these countries serves as a disciplinary mechanism. There is
convergence between the interests of shareholders and managers due to the threat of
takeover.
(ii) The ownership structure of companies is widely Dispersed: For example, the
median size of the largest voting block is 5 per cent in the USA and 10 per cent in the
UK. The influence of shareholders on management is weak due to widely dispersed
share ownership. The company is owned by individual as well as well institutional
shareholders.
(iii) Unitary or single tier board of directors to give primacy to the interests of
shareholders: Both executive and non-executive directors are elected by shareholders
who have voting rights in proportion to their shareholding.
(iv) The board of directors consists inside and outside directors: Inside directors are
either employed in the company (called executive directors) or have significant
relationship with the promoters. Outside or independent directors are neither
employed in the company nor are related to the promoters.
Shareholders
Elect
Board of Directors Control Stock Market
Legal System
Regulatory
Managers Control Authorities
Manager
Company
Fig. 9.4 : Anglo-Saxon Model of Corporate Governance
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The Anglo-Saxon model is market oriented. It is characterized by a large number of listed
companies, widespread shareholding and a well-functioning capital market. The stock market
exercises control over the functioning of companies. In addition, the legal framework and
regulatory agencies are assumed to ensure protection of shareholders who elect directors. The
board of directors performs the functions of direction, control and representation. Managers
appointed by the board of directors implement policies and manage day-to-day affairs of the
company. Institutional investors (pension funds, mutual funds, insurance firms, etc.) are
exercising increasing control over companies.
2. The Insider Model: This model of corporate governance is prevalent in Germany,
Japan, etc.
German Model: This model exists in Germany, Switzerland, Australia and
Netherlands. Therefore, this is also known as ‘Continental Europe Model. The main
features of the German Model are as follows:
(i) Weak Stock Market : Debt is the major source of finance due to restrictions on
listing of companies. It is a bank-oriented rather than market oriented system.
Universal banks supply both loans and equity capital.
The concentrated bank holdings and cross holdings are not traded on the stock
market. Therefore the stock market is less developed and illiquid. The Stock
market exercises insignificant control over companies.
(ii) Concentrated and Cross Shareholdings : In most German companies there are
large controlling block holders of shares. According to Franks and Mayer, a
single owner holds more than 50 percent of the equity in more than half of the
listed companies. The widely used mechanism of cross holding creates ownership
pyramids. A few big shareholders maintain control through substantial voting
power. Block holders also form voting pacts such as multiple or capped voting
systems. Bank may even exercise veto power.
(iii) Dual Class Shares: One class of shares has more voting rights than the other
class. Therefore, the principle of one share one vote is not applicable.
(iv) Dual Board or Two Tier Board: All public limited companies (AG) and private
limited companies (GmbH) with more than 500 employees have an executive
board (vorstand) and a supervisory board (Aufsichts crat). The executive board
consists of full time managers who are appointed by the supervisory broad. The
supervisory board elected by the shareholders and employees approves the
decisions and oversees the activities of the executive board. Banks are offered
membership on the supervisory board.
(v) Employee Participation: In German companies, employees elect one third to one
half (depending on the total member of employees) directors on the supervisory
board. The rest of the directors are nonexecutives such as representatives of banks
and firms having business relationship, and professional advisers.
Thus, concentrated ownership, cross shareholding, bank finance, two tier board structure,
weak capital market, little legal protection for investors and weak public disclosures are the
key features of the German model.
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The German model reduces institutional pressures for short term decisions and allows long
range strategic planning. It is relationship oriented. It provides representation to employees.
But this model overlooks the interests of small shareholders. The model is not suitable for
global capital market as it is too secretive.
3. Japanese Model
The Japanese corporate governance model is characterized by the following features:
(i) Small Dominant Groups (Keiretsu): There is a small number of dominant groups.
These groups (e.g. Mitsubishi and Mitsui) are linked by cross-shareholdings and
trading relationships. Most of these groups are diversified and vertically integrated by
cross holdings.
(ii) Consortium Financing: Banks and other financial institutions are the main source of
funds for Japanese companies. They provide both debt and equity capital. They are
led by a major bank known as main bank. Banks hold majority of shares on a long
term basis and build strong relationship with the client companies.
(iii) Government – Industry Linkage The industrial groups employ retired civil servants
and work together on government sponsored committees. Retired Government
officers are appointed as directors to seek preferential treatment from the government.
These bureaucrats also ensure effective implementation of government policies. The
government plays a dominant role of supervision and control over corporate activities.
(iv) Employee Participation Long serving and committed employees are offered
membership on the board of directors. Senior managers and former employees
account for 90 per cent of the company directors.
(v) Unitary Board Structure :Boards of major corporations represent the company as an
integrated social unit. The entire board takes all major decisions of the company. In
theory, the ultimate power to oversee the company’s functioning lies with the board of
directors. But in practice the board of directors has by tradition surrendered most of
its authority to the president of the company. The president along with an operating
committee of top executives select new members of the board of directors and
evaluate the company’s performance.
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Appoint
Supervisory Board Appoint
(Including President)
Employees
Ratifies President’s consults
decisions
President
Main Bank
consults
Executive Committee
Appoints
Provides
Managers
Provides Loan and Equity
Company Owns
Shareholders
Fig. 9.6 : Japanese Model of Corporate Governance

Thus, long-term company bank relationship high, level of stock ownership by banks cross
holdings, board of directors controlled by insiders, employee representation, retired
government officers board members, and intervention by the main bank in emergency are the
main characteristics of the Japanese model. This model is many sided and represents trust and
relationship oriented approach to corporate governance.
The Japanese Model involves participation of employees in corporate governance which ensures
their long term commitment to the company. The model seeks to balance the interests of all
stakeholders unlike the Anglo—Saxon model which gives primacy to the interest of
shareholders.
4. THE FAMILY BASED MODEL
Family based model of corporate governance exists in several underdeveloped and emerging
countries of East Asia (India, Korea, Malaysia, Middle East, Brazil, Mexico, Chile, Turkey,
Egypt, Kuwait, Saudi Arabia, UAE, etc). The main characteristics of this model are as
follows:
1. Closely Held Companies: In most of the listed companies, the promoter’s family is a
dominant shareholder accounting for more than 50 per cent of the issued share capital.
The founder, his relatives and associates dominate. In case of public enterprises,
central or State Government is the major shareholder. Family owns the company for
long term and ownership is inherited by succeeding generations.
2. Family Control :The family exercises full control due to ownership, cross holding,
inter-locking directorships. Business families are held in high esteem, the regulatory
framework is weak and outside shareholders have apathy. Banks and financial
institutions provide considerable finance to family owned and managed companies.
But they do not exercise much control. Their nominees on the board of directors of
the borrowing company generally support the family control.
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Meaning, Theories and Models 9.23
Fig.9.7 : Family-based Model of Corporate Governance

3. Family Interest: The company is run primarily for the benefit of the family. Owners
extract private gain by transfer of wealth through sale of assets at lower than market
prices. Funds are sometimes diverted for family’s interest. In some cases there have
been conflict of interest between the controlling family and minority shareholders.
Managers act primarily for the controlling family. Family based model fills the
monitoring gap of market mechanism because the family exercises an effective control.
It is driven by long term interest of creating wealth for the family. But the model
expropriates the minority interest. Tensions within the controlling family may hamper
the functioning and performance of companies. Corporate governance practices are not
very sound and effective.
The family-based model of corporate governance is changing due to globalization and
liberalization. Internationalisation of capital markets, global competition, increasing role of
financial institutions, tightening of regulatory framework are the major forces due to which
companies in developing countries are improving their corporate governance practices. For
example, Indian companies which want to raise capital abroad and get listed on foreign stock
exchanges are adopting international standards concerning accounting and public disclosure.
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This will prevent influencing of independent directors to push promoters’ interests. It will aid
self-regulation with greater disclosure levels as opposed to the existing “government-
approach-based regime,” which is seen as restrictive limiting entrepreneurial growth. New
forms of organisation such as ‘one person-company’ and ‘small company’ concepts would
get appropriate legal recognition making India’s business law environment more
contemporary. The Act also contains rules for inter-corporate loans. The Act states that
atleast third of a company’s board should consist of independent directors.
SUMMARY
1. Corporate governance is the system or structure of rules, practices, and laws by which
a firm is directed and controlled. Thus, it refers to the way a corporation is governed.
It is the technique by which companies are directed and managed.
2. The scope of having corporate governance is: Accountability, Fairness, Transparency,
Independence, Compliance with rules.
3. Corporate Governance is intended to increase the accountability of your company and
avoid massive disasters before they occur. It is felt that objective of corporate
governance, i.e. the overall objective of wealth generation and competitiveness for the
benefit of all can best be achieved.
4. Quality of governance is influenced by integrity of the management, ability of the
board, adequacy of the processes, commitment level of individual board members,
quality of corporate reporting and participation of stakeholders in the management.
5. There are 4 main principles of corporate governance which include: Fairness,
Responsibility, Transparency, Accountability.
6. 4P’s of Corporate governance are : People, Purpose, Process & Performance.
7. Good corporate governance provide many benefits to business, shareholders, invertors
etc.
8. There are many theories of corporate governance which addressed the challenges of
governance of firms and companies from time to time. Theories are: Agency Theory,
Stewardship Theory, Stakeholders theory, Resource Dependency Theory, Transaction
Cost Theory, Political Theory.
There are different corporate governance models: The Anglo-Saxon Model (The Outsider
Model), The Insider Model, German Model, Japanese Model, The Family Based Model.
FILL IN THE BLANKS
1. Corporate Governance clearly distinguishes between the ………….. and the
………………..
2. Quality of governance is influenced by………………………
3. Good Corporate Governance is a source of …………………… and ………………for
achieving excellence in all productive, economic and social pursuits.
4. ………………………….is responsible for overseeing management of the business,
company affairs, appointing the chief executive and monitoring the company’s
performance.
5. ………………….. theory focuses on managerial decision making and interests of all
stakeholders have intrinsic value, and no sets of interests is assumed to dominate the
others.
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1. Corporate governance is a system of rules, policies, and practices that dictate how-
(i) Company’s Board of director manage
(ii) Oversee the Operations
(iii) to carrying the business as per the stakeholders’ desires.
2. Bad corporate governance can cast doubt on a company’s-
(i) Reliability
(ii) Integrity
(iii) Transparency which can impact its financial health.
3. The purpose of corporate governance is to help build-
(i) An environment of trust and transparency
(ii) Financial stability and business integrity
(iii) Support for stronger growth and more inclusive societies.
4. Which of the following not comes under 4P’s of corporate governance.
(i) People
(ii) Performance
(iii) Place
(iv) Process
5. In India ,Which of the following corporate governance model is followed-
(i) The Anglo-Saxon Model
(ii) The Insider Model
(iii) Japanese Model
(iv) German Model
1. Explain the term corporate governance & its scope & need.
2. Explain the factors that influence the quality of governance in organisation.
3. Briefly explain the principles & 4P’s of corporate governance.
4. Explain the different theories of corporate governance.
5. What are different models of corporate governance? Which model of governance
followed in India?
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CHAPTER-8
CORPORATE GOVERNANCE
8.1 E Governance
8.1.1 Meaning
8.1.2 Importance of E Governance
8.1.3 Advantages of E Governance
8.1.4 Types of E Governance
8.1.5 Disadvantages of E Governance
8.2 Green Governance
8.2.1 Meaning
8.2.2 Seven Steps for Transition
8.2.3 Legal Provisions relating to Green Governance in India
8.3 Class Action Suit
8.3.1 Introduction
8.3.2 Class Action Suit under Various Laws
8.3.2a Companies Act, 2013
8.3.2b Code of Civil Procedure
8.3.2c Competition Act
8.3.3 Advantages of Class Action Suit
8.3.4 Eligible Entities according to Companies Act, 2013
8.3.5 Reliefs under Class Action Suit
8.3.6 Consideration by Tribunal
8.3.7 Punishment for Non Compliance of Tribunal’s Orders
8.3.8 Required Members for Applying Class Action Suit
8.3.9 Procedure after the admission of application u/s 245(5)
8.1 E-GOVERNANCE
8.1.1 MEANING
E-governance, expands to electronic governance, is the integration of Information and
Communication Technology (ICT) in all the processes, with the aim of enhancing
government ability to address the needs of the general public. The basic purpose of e-
governance is to simplify processes for all, i.e. government, citizens, businesses, etc. at
National, State and local levels.
In short, it is the use of electronic means, to promote good governance. It connotes the
implementation of information technology in the government processes and functions so as to
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cause simple, moral, accountable and transparent governance. It entails the access and
delivery of government services, dissemination of information, communication in a quick and
efficient manner.
8.1.2 IMPORTANCE OF E GOVERNANCE
1. Information delivery is greatly simplified for citizens and businesses.
2. It gives varied departments’ information to the public and helps in decision making.
3. It ensures citizen participation at all levels of governance.
4. It leads to automated services so that all works of public welfare is available to all
citizens.
5. It revolutionizes the functions of the government and ensures transparency.
6. Each department and its actions is closely monitored.
7. Public can get their work smartly done and save their time.
8. It provides better services to citizens and brings government close to public. Public
can be in touch with the government agency.
9. It cuts middlemen and bribery if any from the picture.
8.1.3 ADVANTAGES OF E-GOVERNANCE
1. Speed: Technology makes communication swifter. Internet, smartphones have enables
instant transmission of high volumes of data all over the world.
2. Saving Costs: A lot the Government expenditure goes towards the cost of buying
stationery for official purposes. Letters and written records consume a lot of stationery.
However, replacing them with smartphones and the internet can save crores of money in
expenses every year.
3. Transparency: The use of e-governance helps make all functions of the business
transparent. All Governmental information can be uploaded onto the internet. The
citizens access specifically access whichever information they want, whenever they want
it, at the click of a mouse, or the touch of a finger.
However, for this to work the Government has to ensure that all data as to be made
public and uploaded to the Government information forums on the internet.
4. Accountability: Transparency directly links to accountability. Once the functions of the
government are available, we can hold them accountable for their actions.
Through e-governance, the government plans to raise the coverage and quality of information
and services provided to the general public, by the use of ICT in an easy, economical and
effective manner. The process is extremely complicated which requires, the proper
arrangement of hardware, software, networking and indeed re-engineering of all the
processes to facilitate better delivery of services.
8.1.4 TYPES OF INTERACTIONS IN E-GOVERNANCE
1. G2G (Government to Government): When the exchange of information and
services is within the periphery of the government, is termed as G2G interaction. This
can be both horizontal, i.e., among various government entities and vertical, i.e.
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between national, state and local government entities and within different levels of the
entity.
2. G2C (Government to Citizen): The interaction amidst the government and general
public is G2C interaction. Here an interface is set up between government and
citizens, which enables citizens to get access to wide variety of public services. The
citizens has the freedom to share their views and grievances on government policies
anytime, anywhere.
3. G2B (Government to Business): In this case, the e-governance helps the business
class to interact with the government seamlessly. It aims at eliminating red-tapism,
saving time, cost and establish transparency in the business environment, while
interacting with government.
4. G2E (Government to Employees): The government of any country is the biggest
employer and so it also deals with employees on a regular basis, as other employers
do. ICT helps in making the interaction between government and employees fast and
efficient, along with raising their level of satisfaction by providing perquisites and
add-on benefits.
Thus, E-governance can only be possible if the government is ready for it. It is not a one day
task, and so the government has to make plans and implement them before switching to it.
Some of the measures include Investment in telecommunication infrastructure, budget
resources, ensure security, monitor assessment, internet connectivity speed, promote
awareness among public regarding the importance, support from all government departments
and so forth. It has a great role to play, that improves and supports all tasks performed by the
government department and agencies, because it simplifies the task on the one hand and
increases the quality of work on the other.
8.1.5 DISADVANTAGES OF E-GOVERNANCE
1. Loss of Interpersonal Communication: The main disadvantage of e-governance is the
loss of interpersonal communication. Interpersonal communication is an aspect of
communication that many people consider vital.
2. High Setup Cost and Technical Difficulties: Technology has its disadvantages as
well. Specifically, the setup cost is very high and the machines have to be regularly
maintained. Often, computers and internet can also break down and put a dent in
governmental work and services.
3. Illiteracy: A large number of people in India are illiterate and do not know how to
operate computers and smartphones. E-governance is very difficult for them to access
and understand.
4. Cybercrime/Leakage of Personal Information: There is always the risk of private
data of citizens stored in government serves being stolen. Cybercrime is a serious issue;
a breach of data can make the public lose confidence in the Government’s ability to
govern the people.
5. Speed: Technology makes communication swifter. Moreover, internet, smartphones
have enables instant transmission of high volumes of data all over the world.
6. Saving Costs: A lot the Government expenditure goes towards the cost of buying
stationary specifically for official purposes. Letters and written records consume a lot of
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stationaries. However, replacing them with smartphones and internet can saves crores of
money in expenses every year.
7. Transparency: In addition to saving cost, use of e-governance helps make all functions
of the business transparent. All Governmental information will be uploaded onto the
internet. The citizens access whichever information they want, whenever they want it, at
the click of a mouse, or the touch of a finger. However, for this to work the Government
has to ensure that all data as to be made public and uploaded to the Government
information forums on the internet. Thus, it is not possible to withhold uploaded
information.
8. Accountability: Transparency thus directly links to accountability. Once we have
visibility over functions of the government are available, we can hold them accountable
for their actions.
9. Technical: There are technical problems in implementing e-governance
transformation. Information and Communication Technology infrastructure is the
main challenge for Electronic governance transformation. Architecture should be in
place to provide a uniform set of guiding principles models and standards.
Governments must build an effective telecommunication infrastructure.
10. Privacy: Privacy and security of confidential reports is the main problem. There are
concerns about hacking defence information and other data, tracking the website,
mismanagement of private information are big challenges.
11. Security: Security of information and systems against disclosure or destruction of data
is one of the main concerns. It includes the security of documents and network security.
Maintenance and E-infrastructure should be protected in the form of firewalls and data
accessibility should be limited. The security technology like encryption and digital
signatures should be used to protect user IDs, credit card numbers, passwords, and other
data.
12. Lack of Training and Qualified Personnel: Lack of digital skills is one of the main
challenges in developing countries. Appointing and training the personnel to acquire
appropriate technical and functional skills is very much essential for governance to be
successful.
13. Digital Availability: Accessing the internet might be a challenge. Since there is a lack of
internet skills and internet availability, all citizens cannot access the internet. Lack of
computer literacy is one of the main challenges.
Digital Transformation of e-governance has the potential to administrate systematically. It is
an instrument to run a government for its citizens. The services can be provided to citizens on
time and on demand. The criminal cases register1ed in police stations cannot be manipulated
if the files are digital. Digital transformation in the public sector will be a boon to the
country if it is successful.
8.2 GREEN GOVERNANCE
8.2.1 MEANING
Environmental problems caused by human behaviour have become increasingly serious in
recent decades, thereby driving global green governance issue to become an important
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research agenda. The proper governance structure design and governance mechanism
arrangement can effectively coordinate the relationship between human and nature. Open
innovation activities can effectively deal with the externalities of resources and environment
and then relatively balance the economic value and green value of organizations, which is an
effective green governance mode, reflecting the characteristics of the main subject
composition and mechanism operation of green governance.
Green governance is a systematic approach to help organisations work in environment
friendly manner and to strive towards sustainable development. Environmental regulation is
increasing rapidly around the world. Therefore, business and other organisations have to
efficiently track and manage their green efforts. They want to improve the bottom line
through more efficient use of energy and other natural resources.
9.28 Auditing and Corporate Governance
Green governance requires organisations to:
(i) Clearly articulate a strategy with well defined goals concerning green economy.
(ii) Understand the risks involved in meeting the goals and objectives.
(iii) Comply with both prescribed regulations and the internal policies.
(iv) Solicit ideas from key stakeholders on what can be done to meet the defined
objectives and goals.
(v) Evaluate comprehensively the portfolio of possible initiatives.
(vi) Focus on effective and efficient implementation of chosen initiatives.
8.2.2 SEVEN STEPS FOR TRANSITION
Rula Qalyoub (June 2012) has suggested seven practical steps for transition to green
economy, these are:
1. Political Commitment: Political commitment to the green growth path presupposes
that fiscal and monetary tools are used to steer economies away from business-as-
usual. This would include investing in research and development (R&D),
demonstration, deployment and the commercialisation of different renewable
technologies in production and consumption activities. For example, in the wake of
the 1990s financial crises both Finland and Korea made stategic moves to increase R
&D funding for renewables while scaling back on other public expenditures coupled
with phasing out fuel subsidies. Currently, Finland and Korea have the competitive
advantage in innovative technologies in renewable energies. Korea’s New Green Deal
established 17 new growth ventures and supported funds to research potential
alternative energies.
2. Legal and Regulatory Framework: If decisions and policies are not anchored in a
binding and enforceable framework, they become merely olrnamental in nature. While
we do not need to green all regulatory systems concurrently in order to respond to
climate change challenges, legal standards must be assessed in a systematic approach.
Legal reform require revisiting existing laws and tuning their jurisdictions through
amendments and directives. In some areas, this may require energizing the legal stand
by conducting gap analysis, which entails comparing current environmental laws and
procedures with international best practices in order to assess the current incentive
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system. The model of Kalundborg in Denmark demonstrates that wise planning can
generate income and economic growth without adding environmental pressures. This
distinctive example of using wastes from certain manufacturing operations as raw
materials for industry was the result of coordinated efforts and a sustainability mindset
in action.
3. Financial Instruments: Policy makers backed by a regulatory body have the power to
initiate a paradigm shift using three simultaneous measures. Firstly, putting proper
mechanisms in place to prevent natural resource use and abuse. This entails
reevaluation of the two types of resource usage, one being resource-use intensity and
the other the depletion of natural stock. Secondly, government bodies need to
reevaluate subsidy provisions and redirect funds towards ventures that provide
permanent solutions to energy security issues. Finally, to reduce the financial risks
associated with provate green investment the government should boost their R & D
support, providing stimulus packages aimed at increasing the efficiencies of existing
systems and supporting the development and demonstration stages of the renewable
energy agenda.
4. Technology Viability: Even with financial instruments in place, the choice of
renewable technologies may prove to be a significant chalenge. There are three steps
by which choices in technology can be tested, the first of which is to use public funds
to support working groups to debate the type of renewable technology most suited to
current geopolitical and climatic conditions. The criterion of technology debates must
be in line with technology suitability in order to meet the designated goal and to avoid
duplications of efforts. Secondly, government funding for frequent sensitivity analysis
will enable a clear vision of all options regarding renewable technologies. Thirdly,
governments should champion resource-gap assessments. Such dialogues promote
stakeholders to participate in finding solutions by acknowledging resource gap
difficulties. This gap analysis should be sponsored by different government bodies in
coordination with practitioners, research groups and venture capitalists at the national
and local levels.
5. Human Capital Formation: Investments into human capital is a crucial expenditure
that should not be compromised and as part of public funding ought to enhance the
know-what, know-how and the know-why. Education, vocational training and
research are extremely vulnerable areas during economic downtuirns. During
recessions, governmental bodies (at both local and national levels) exercise greater
budgetary discretion and often downsize publicly funded activities such as education
and training. Stripping educational budgets reduces the value of human capital that
could otherwise help to stimulate the economy out of recession. It is during economic
downturns that education and other human capital building vehicles need extra support
to fund training and facilitate the formation of a cadre that fits the new green ideal.
Lessons can be learned from Finland where during the economic crisis in the early
1990s, the government made a commitment to avoid cuts on essential services
favoring R & D and educational institutions. Finland experienced a quick recovery
from recession with a world-class educational system and highly skilled workforce.
6. Institutional setup: Institutional adjustments are required which will adopt and adapt
ot innovative solutions, otherwise institutions will face “creative destruction” through
inaction. The Village Council of Wild poldsried in Bavaria, Germany, passes a local
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green initiative in 1997 with modest goals to attract new industries and to bring in new
revenue. The council equipped new installations with solar panels, built biogas
digesters and installed seven windmills. Today the villages sell power back to the
national grid generating 321 percent more energy than it requires. This far, returns on
this investment have amounted to US$5.7 million for 2,600 villages (though the
proportion of initial public investment is hard to tell).
7. Common language: Common language entails the standardizations of targets,
benchmarks, indicators and measurement units and methods. Moreover, common
language is about a unified code of practices, streamlined green accreditation of
products and services, and consistent decision making processes on green issues
across government. This is an important criterion as it eliminates the ambiguities and
doubts associated with an emerging breed of buzz words which quickly become
redundant and which government officials frequently need to relearn. Choice of target
thresholds and indices may be important in order to establish a benchmark comparison
but ought to be used with caution. By and large, instruments ought to be modified by
region and reflect local environmental circumstances. This may require some trial and
error but more importantly requires having the necessary human capital base to
provide knowledge both of local conditions and on the availability and viability of
tools.
8.2.3 LEGAL PROVISIONS RELATING TO GREEN GOVERNANCE IN INDIA
The Department of Commercial Affairs (MCA) provides the legal framework for companies
to support sustainable development and, through the amendment of the Indian Companies
Act of 1956 in 2013, has made arrangements for initiatives respectful of the environment.
Now the law is known as the Indian Companies Act, 2013
Legal provisions related to green initiatives The Corporate Affairs department is important to
all its stakeholders, including:
 More than a million companies are incorporated under the Companies Act of 1956 or
2013.
 28,000 companies are covered by LLP (Limited Liability Partnership).
 CA (auditor)
 CS (company secretariat)
From 2008, MCA will become the electronic administrative portal of the Ministry of
Enterprise.
(A) Electronic submission Under Annual electronic filing, companies registered under the
Companies Act of 1956 must file electronically the following documents to the ROC :
 P&L A/C FROM XXIII ACA Income Tax Return Report to be Filed by All Businesses
 Annually 20B Form to submit declaration form by capital companies
 Annually the declaration form 21A must be submitted by companies without share capital
Certificate must be submitted [from companies selling Rs. Have deposited 10 lakh capital
at Rs. 5 crore
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(B) Registration of companies Companies can register via the MCA portal. It is also set up
for, Registration of companies under Section 8 of Companies Act and foreign
companies.
(C) Digital signature ,certificate Services The Information Technology (IT) Act 2000
contains certain mandatory provisions for the application of digital signatures to
documents submitted in electronic form to confirm the security and accuracy of the
documents submitted electronically. This is a safe and accurate way to^submit a
document electronically. Just as such Business LLP advice under the MCA21
Electronic Governance program submitted by the person authorized to sign the
documents with digital signatures.
(D) Corporate Sewa Kendra For any problem related to Companies can contact Corporate
Sewa Kendras to consult business creations, electronic filing and public documents. A
single DIN cell for questions about the DIN also arise.
(E) Business data to be managed electronically Form Any publicly traded company or
company with no less than 1000 shareholders, obligation Holders and other holders of
securities manage their administration electronically (form.16)
(F) Postal voting A company makes decisions by correspondence only for matters
announced by central government. In a postal vote, voting takes place within 30 days
after sending by post or electronically.
(G) Dividend payment Section 123 of the new law states that a cash dividend can be paid
by: check or money order or. electronically to the shareholder who is authorized to pay
the dividend.
(H) Transfer of decisions in circulation: Section 175 of the 2013 Law provides that “it is to
be assumed that a decision by the Board of Directors has only been taken in a circular
procedure if it is included in the project, through the accompanying documents, by
manual delivery or by post or by post or electronically can contain email or fax.”
(I) Electronic voting Every listed company or a company with no less than 1,000
shareholders offers him convenience Members must grant GM their voting rights
electronically. A member is authorized grants each CEO the right to vote electronically
and the company can confirm any decision (regular / special) regarding an electronic
voting system.
(J) Meeting notification “A report of every rejection, messages and subsequent returns are
made by or on behalf of Company as proof of delivery. The company is not responsible
for defects in communication beyond their control. If the member does not provide an
updated email, address, the company is not in default. Meeting announcement: A
company can bet Summons via electronic mode. A message can be sent by e-mail text
or attached to an email or as an electronic link or URL statement to access this
notification when posted on the company website. Can be electronic mode any
communication from a company through her secure computer program that is
authorized to store the acceptance and document of such communication with the
copyright holder communication to the last email address provided by the member. The
meeting is convened through distribution report at least 7 days, this can be done
electronically. General meeting; can be electronically stored in the prescribed manner
for at least 21 days.”35
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(K) Document delivery: A document can be delivered on an electronic company.
(L) Inspection and copies of documents in electronic form: The company examines
documents in electronic form or provides copies of these documents
Indian law provisions on CSR are scattered across legislations in different areas and need to
be collated under a single umbrella for corporates to be able to develop a systemic or
institutional approach to CSR and their responsibilities to stakeholders. With some additional
policy input and legislative changes, the existing corporate governance legal system can
provide the enabling environment for improved Green Governance integration by corporates
within their business. Within the field of board responsibilities towards stakeholders, the
scattered provisions on board responsibility towards certain stakeholders, as well as the
liability of directors for a company’s non-compliance with environmental and labour laws
make it clear that Indian law intended for the board to be responsible, at least to certain
stakeholders. However, what is missing is legal or regulatory guidance regarding a
comprehensive approach towards stakeholders, which includes philanthropic initiatives.
8.3 CLASS ACTION SUITS UNDER THE COMPANIES ACT 2013
8.3.1 INTRODUCTION
In a class action suit, a large group of people, having same or similar injuries caused by the
same person, collectively bring a claim to court, represented by one or more persons. This
form of lawsuit is also called a Representative Action. One set of persons representing a
larger group approach the court for redressal of their grievances.
The rationale behind such suits are – firstly to protect the interest of members of a class who
are geographically dispersed and secondly to reduce the duplication of the litigation as it
combines the various proceedings initiated in different parts/jurisdiction bearing same cause
of action(s).
Further it also makes adjudication possible; otherwise as per the rule of necessary party all
the members of a class are required to be made plaintiff, which otherwise would have made
the adjudication impossible.
In January 2009, India witnessed one of its biggest corporate scandals – the ‘Satyam scandal’
also referred to as ‘India’s Enron’. Satyam Computers Services Limited (”SCSL”) was under
the microscope for fraudulent activity and misrepresentation of its accounts to its board, stock
exchanges, regulators, investors and all other stakeholders. Thereafter, shareholders of SCSL,
approximately 300,000 were unsuccessful in claiming damages worth millions due to the
absence of the provision for filing a class action suit under the Companies Act, 1956.
American investors on the other hand were able to claim their part of damages in the US
Courts through a class action suit against SCSL.
The concept of class action was first introduced in the US in the year 1938. ‘Class Action’,
which is also known as ‘Representative Action’, is actually a form of lawsuit where a large
group of people collectively brings a claim to the court through a representative. A class
action suit is filed generally when a number of people have suffered the same or similar
injuries. Often many of the individuals’ injuries are relatively minor, such that they might not
pursue legal redress on their own. Together, however, the value of the claims of the class add
up, and claiming as a class helps consolidate the attorneys, evidence, witnesses, and most
other aspects of the litigation.
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8.3.2. CLASS ACTION SUITS UNDER VARIOUS LAWS
8.3.2a Class Action suits under Companies Act, 2013:
1. A suit can be filed or any other action may be taken by any person, group of persons or
any association of persons affected by any misleading statement or the inclusion or
omission of any matter in the prospectus under the following provisions of the Act.
(Section 37)
Section 34 – Criminal Liability for misstatements in prospectus
Section 35 – Civil Liability for misstatements in a prospectus
Section 36 – Punishment for fraudulently inducing persons to invest money.
2. A class action suit can be filed by members or depositors of the company or any class of
them if they are of the opinion that the affairs of the company are being conducted in a
manner prejudicial to the interest of the company or members or depositors. (Section
245)
8.3.2b Class Action suits under Code of Civil Procedure:
There are no limits on the subject matter except for actions that cannot be filed in the civil
courts at all, such as mismanagement suits. All persons having same interest in the suit can
make an application for the class action suit.
8.3.2c Class Action suits under Competition Act:
A class may dispute an agreement which causes an appreciable adverse effect on competition
within India or abuse of dominant position by an enterprise. Any person, consumer or their
association can bring the action. E.g. Price Fixing Class Action suits under Consumer
Protection Act: The suit under this Act is restricted to disputes relating to goods and services
sold/provided or delivered or agreed to be sold/provided or delivered. Consumers of the
goods or services aggrieved can bring the action under this Act.
8.3.3. ADVANTAGES OF CLASS ACTION SUITS
1. Clubbing of similar applications and bar on futile litigations: When the facts are
similar in suits filed in different dominions by the members of the same class, standing
against the same or similar defendants, it makes sense to combine them all and
adjudicate it under one roof. Clubbing of similar claims/suits would also result in
efficiency of judiciary, as the same would save precious time of judiciary from
adjudicating the similar dispute numerous times. Hence Class Action Suits against
similar defendants/respondents seeking similar relief may be consolidated into one.
Further the legislature also intends to bar the future class action on same subject matter.
2. Reduction of Cost: The cost of bringing a claim to the settlement under the present
mechanism at times is very expensive as well as time consuming particularly while filing
of suits under Civil Procedure Code, 1908. Further the territorial jurisdiction of the civil
court also leads to duplicity of litigation leading to multiplicity of cost for same cause of
action. It therefore makes far greater sense for people to share the costs of litigation by
teaming up with others in a similar position. If as a group, only one set of counsels are
instructed and the factual cases of each member are identical the legal cost will be far
less than that would have been if instituted individually.
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3. Class action suits would allow individuals to hold some of the world’s most powerful
companies and organizations accountable for their actions. These lawsuits will cover a
wide range of issues including the mismanagement of monies invested with a company,
securities law related fraud, malfunctioning of accounts, restraining company to act ultra
vires or in breach of the articles of association of the Company, etc.
4. Class action suits will provide a window to the small shareholders to redress their
grievances irrespective of their jurisdictional limitation.
8.3.4 ELIGIBLE ENTITIES ACCORDING TO THE COMPANY’S ACT, 2013
A class action suit can be filed against following persons to claim damages or compensation
or demand any other suitable action from or against:
 the company or its directors for any fraudulent, unlawful or wrongful act or omission.
 the auditor/audit firm for any improper or misleading statement made in audit report
or for any fraudulent, unlawful or wrongful act or conduct.
 any expert or advisor or consultant or any other person for any incorrect or misleading
statement made to the company or for any fraudulent, unlawful or wrongful act or
conduct or any likely act or conduct on his part.
8.3.5 RELIEFS UNDER CLASS ACTION SUITS
Following orders can be sought from Tribunal by Members/Depositors:
(A) To restrain the Company from:
 committing an act which is ultra vires to Memorandum of Association (MOA)
or Articles of Association (AOA)
 committing breach of any provision of MOA or AOA
 acting on resolution which is void (due to suppression of facts/misstatements)
 doing an act which is contrary to the provisions of this Act or any other Act
 taking action contrary to any resolution passed by the members.
(B) To claim damages or compensation or demand any other suitable action from or
against:
 the company or its directors
 the auditor/audit firm for any improper or misleading statement made in audit
report or for any fraudulent, unlawful or wrongful act or conduct
 any expert or advisor or consultant or any other person for any incorrect or
misleading statement made to the company or for any fraudulent, unlawful or
wrongful act or conduct or any likely act or conduct on his part;
(C) To declare a resolution altering the memorandum or articles of the company as void if the
resolution was passed by suppression of material facts or obtained by mis-statement to the
members or depositors
(D) To seek any other remedy as the Tribunal may deem fit.
8.3.6. CONSIDERATION BY TRIBUNAL
Section 245(4) provides that in considering an application under sub-section (1), the Tribunal
shall take into account, in particular—
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(a) whether the member or depositor is acting in good faith in making the application for
seeking an order;
(b) any evidence before it as to the involvement of any person other than directors or
officers of the company on any of the matters provided in this section;
(c) whether the cause of action is one which the member or depositor could pursue in his
own right rather than through an order under this section;
(d) any evidence before it as to the views of the members or depositors of the company
who have no personal interest, direct or indirect, in the matter being proceeded under
this section;
(e) where the cause of action is an act or omission that is yet to occur, whether the act or
omission could be, and in the circumstances would be likely to be – authorised by the
company before it occurs or ratified by the company after it occurs;
(f) where the cause of action is an act or omission that has already occurred, whether the
act or omission could be, and in the circumstances would be likely to be, ratified by the
company.
8.3.7. PUNISHMENT FOR NON-COMPLIANCE OF TRIBUNAL’S ORDERS
Any Order passed by the Tribunal shall be binding on the Company, Members, Depositors,
Directors, Auditors, Experts, Consultant, Advisors or any other person. [Section 245(6)]. In
case the company or any officer who is in default does a non-compliance of any order passed
by the Tribunal under section 245, then the fine/punishment is as follows [Section 245(7)]:
 Company: Fine ` 5,00,000 to ` 25,00,000
 Officer in Default: Imprisonment up to 3 years and fine ` 25,000 to ` 1,00,000
8.3.8. REQUIRED MEMBERS FOR APPLYING ACTION CLASS SUITS
(A) Members:
 Company having Share Capital: at least 5% of total number of members or 100
members whichever is less. (Listed or Unlisted)
 Unlisted Company: member or members holding not less than five per cent (5%) of
the issued share capital.
 Listed Company: member or members holding not less than two per cent (2%) of the
issued share capital.
 Company having not Share Capital: at least 1/5th of total number of members.
(B) Depositors:
At least five per cent (5%) of the total number of depositors of the company or one hundred
(100) depositors of the company.
Depositor or depositors to whom the company owes five per cent of total deposits of the
company.
8.3.9. PROCEDURE AFTER THE ADMISSION OF APPLICATION U/S 245(5)
In case of admission of Application [Section 245(5)]
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 public notice shall be served on admission of the application to all the
members or depositors
 all similar applications prevalent in any jurisdiction should be consolidated
into a single application
 the class members or depositors should be allowed to choose the lead
applicant
 the Tribunal shall have the power to appoint a lead applicant, who shall be in
charge of the proceedings (If members/depositors can’t decide)
 two class action applications for the same cause of action shall not be allowed
 the cost or expenses connected with the application for class action shall be
defrayed by the company or any other person responsible for any oppressive
act.
SUMMARY
1. E-governance, expands to electronic governance, is the integration of Information and
Communication Technology (ICT) in all the processes, with the aim of enhancing
government ability to address the needs of the general public.
2. Types of interactions in e-governance are G2G (Government to Government), G2C
(Government to Citizen), G2B (Government to Business), G2E (Government to
Employees).
3. Green governance is a systematic approach to help organisations work in environment
friendly manner and to strive towards sustainable development.
4. Rula Qalyoub (June 2012) has suggested seven practical steps for transition to green
economy, these are: Political Commitment, Legal and Regulatory Framework,
Financial instrument, Technology Viability, Human capital formation, Institutional
setup, Common language.
5. In a class action suit, a large group of people, having same or similar injuries caused
by the same person, collectively bring a claim to court, represented by one or more
persons. A class may dispute an agreement which causes an appreciable adverse
effect on competition within India or abuse of dominant position by an enterprise.
FILL IN THE BLANKS
1. When the exchange of information and services is within the periphery of the
government, is termed as …………………
2. ………………………… is the main challenge for Electronic
governance transformation.
3. ………………………. is a systematic approach to help organisations work in
environment friendly manner and to strive towards sustainable development.
4. The rationale behind representative Action suits are …………………………………..
5. In January 2009, India witnessed one of its biggest corporate scandals – the ‘Satyam
scandal’ also referred to as…………….
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1. In keeping with the good governance initiative, which ministry has launched its e-
office on 28th December 2015?
(i) Women & child Development
(ii) Information and technology
(iii)Environment
(iv) Home affairs
2. E-governance is technology that improves?
(i) Accountability
(ii) Transparency
(iii)Efficiency of government processes
3. Which of the following is not comes under types of interactions in e-governance.
(i) Government to Government
(ii) Government to Citizen
(iii)Government to Business
(iv) Business to Citizen
4. Which of the following practical steps for transition to green economy suggested by
RulaQalyoub (June 2012).
(i) Legal and Regulatory Framework
(ii) Technology Viability
(iii)Institutional setup
5. In case the company who is in default does a non-compliance of any order passed by
the Tribunal under section 245, then the fine/punishment is-
(i) Fine ` 5,00,000 to ` 25,00,000
(ii) Fine ` 50,000 to ` 2,50,000
(iii)Fine ` 1,00,000 to ` 5,00,000
(iv) None of above
1. Explain the term e-governance and its advantages & disadvantages.
2. What is green governance? Explain the seven steps for transition.
3. Explain “Legal Provisions Relating to Green Governance in India”.
4. What is class action suits? Explain its advantages.
5. What reliefs available under class action suits?
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CHAPTER-9
SHAREHOLDER ACTIVISM
9.1 Meaning
9.2 Use of Shareholder Activism
9.3 Regulation of Shareholder Activism
9.4 Remedies to the Shareholder
9.5 Goal of Shareholder Activism
9.6 Strategies used by Activist Shareholders
9.7 Shareholder Disclosures
9.8 Tools available to Activist Shareholder
9.9 Prevention of Shareholder Activism
9.10 Steps to take when faced with Shareholder Activism
9.11 Current Trends in Shareholder Activism
9.12 Recent Campaign
9.1 MEANING
“Activism” represents a range of activities by one or more of a publicly traded corporation’s
shareholders that are intended to result in some change in the corporation. The activities fall
along a spectrum based on the significance of the desired change and the assertiveness of the
investors’ activities. On the more aggressive end of the spectrum is hedge fund activism that
seeks a significant change to the company’s strategy, financial structure, management, or
board.
9.2 USE OF SHAREHOLDER ACTIVISM
Shareholder activism involves the efforts of the shareholders to bring about a desired change
in the operations of the company or to influence the management in governing the company
to protect the interest of the shareholders.
1. In India, the Companies Act 2013 is the main source of law relating to shareholder
activism. In addition to the Act, regulations framed by the Securities and Exchange
Board of India (SEBI) also provide rights and remedies to the shareholders of listed
companies. With the enactment of the Companies Act and subsequent developments, the
law has been updated to further facilitate shareholder activism.
2. Under the Companies Act 2013, shareholders’ approval is required for dealing in certain
matters. Shareholders can bring a class action suit against the company, its directors and
third-party advisers. They can sue against oppression and mismanagement, and to exit in
certain specified circumstances.
3. The regulations framed by SEBI provide many additional rights and remedies to
shareholders of listed companies to make their views known and to protect their interests
more actively. Listed companies must constitute a stakeholders’ relationship committee
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to provide a mechanism for redressal of shareholder grievances and to provide electronic
voting facilities.
4. Proxy Advisory Firms (PAFs) regulated by Securities and Exchange Board of India
(Research Analysts) Regulations 2014 have massively contributed to shareholder
activism. A proxy advisor is any person who provides advice through any means to an
institutional investor or shareholder of a company on how to exercise their rights in the
company (including recommendations on a public offer or voting recommendations on
agenda items). Recommendations by PAFs have proved to be influential in determining
the voting pattern of shareholders.
5. The recent developments in Indian law have led to (among other things) increased
corporate governance standards, creation of new shareholder remedies and improvement
in shareholders’ rights. Due to the ease of exercising, and enforcement of shareholders’
rights, shareholders are now more willing to voice their opinion, resulting in increased
shareholder activism.
9.3 REGULATION OF SHAREHOLDER ACTIVISM
The following rights (among others) are relevant to shareholder activism under the laws of
India:
1. Right to receive information. Shareholders are entitled to receive information and
documents such as:
 annual return extracts;
 audited financial statements along with an auditor’s report; and
 statutory registers maintained by the company (such as the register of members,
debenture-holders, directors and key managerial personnel).
2. Right to give approval. A company is managed by the board, but the Companies Act
2013 restricts the powers of the board to an extent and certain important matters require
the consent of the shareholders. Their approval can be obtained either by a simple
majority or special majority, as prescribed under the Companies Act 2013. These include
amending the company’s memorandum of association or articles of association,
appointing and removing directors, and obtaining loans and sale of undertakings above
certain thresholds. Shareholders have used this voting right as a tool to defeat resolutions
they want to oppose.
The requirement of shareholder approval ensures active shareholder involvement in matters
that are critical to the company. In public companies, shareholder approval is required by a
special majority for matters or transactions, including:
 sale or lease of a company’s whole or substantially whole undertakings;
 investment of compensation received as a result of any merger or amalgamation;
and
 entering into related party transactions (RPT) over a certain threshold.
In some situations, the minority shareholders are strongly placed. In 2018, a public listed
company proposed three RPT for shareholder consideration at its annual general meeting. All
resolutions were defeated with a minor percentage of total shareholding opposing it, as
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interested shareholders of a public company are not permitted to vote on RPT resolutions.
Material RPT’s require shareholder approval and a related party cannot vote to approve these
resolutions whether the entity is a related party to the particular transaction or not (Securities
and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations
2015).
3. Right to appoint and remove directors. The directors of a company are appointed by
its shareholders. Independent directors appointed by listed companies and specific
public companies are required to be approved by shareholders in a general meeting
before they are appointed. In addition, small shareholders holding shares of not more
than INR20,000 in value can propose the appointment of a director on the board of a
listed company subject to certain terms and conditions. This way small shareholders can
seek board representation.
In August 2017, a long standing pharmaceutical company received a proposal from over
1,000 small shareholders under a portfolio manager. They sought the appointment of a
small shareholder director. However, the board successfully resisted the appointment of
the director due to a conflict of interest.
Shareholders can remove a director before his/her term has expired by a simple majority
in the manner prescribed under the Companies Act 2013. However, such a right will not
be available in cases where the director has been appointed by the National Company
Law Tribunal (Tribunal) or the company has opted for appointment of director basis
proportional representation. Further, an independent director re-appointed for a second
term can be removed by the company only by passing a special resolution and after
giving him or her a reasonable opportunity of being heard.
In May 2018, the shareholders of a leading healthcare company voted by a majority to
oust the director of that company.
4. Right to appoint auditor. The auditor is appointed by the shareholders in an annual
general meeting at the recommendation of the board or the audit committee. This
appointment is for a five-year period.
5. Right to requisition a meeting. Shareholders can requisition the directors to convene
an extraordinary general meeting for consideration of company matters and for voicing
their opinion. If the directors fail to convene an extraordinary general meeting, the
requisitions shareholders can call a meeting on their own. The minimum threshold for
calling such a meeting is 10% of the shareholders with voting rights in the company.
6. Right to electronic voting. Shareholders can benefit from the electronic voting facility
as every listed company or a company having at least 1,000 members must have an
electronic voting facility at general meetings. Electronic voting has increased
shareholder participation and eased the process of voting.
9.4 REMEDIES TO THE SHAREHOLDERS
Shareholders that have been wronged can use the following when seeking a remedy:
1. Grievance redressal mechanisms. A listed company or a company with more than
1,000 shareholders, debenture holders, deposit holders and any other security holders at
any time during a financial year must have a Stakeholders Relationship Committee to
resolve security holder grievances. Listed companies must also be registered on the
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SCORES platform (operated by the Securities and Exchange Board of India). SCORES
enables investors to file complaints and track the status or redressal of these complaints.
This is an example of the shareholders’ right to have their grievances and concerns
heard.
2. Oppression and mismanagement proceedings. A minimum of 100 or 10% of the total
number of members (whichever is less), or any member or members holding at least
10% of the issued share capital of the company, can approach the Tribunal to initiate
proceedings for oppression and/or mismanagement on the ground that the company’s
affairs are being conducted in a manner prejudicial to the interest of the company or its
members.
3. Class action suits. If the rights of any of the members are infringed or the conduct of
the management is prejudicial to the interest of the company or its shareholders, the
following can bring a class action suit against the company, its directors and third-party
advisers:
 a minimum of 100 members or at least 5% of the total number of members
(whichever is less); or
 any member or members holding at least 5% of the issued share capital in an
unlisted company or at least 2% of the issued share capital in a listed company.
4. Derivative actions. A single shareholder, irrespective of his/her shareholding in the
company, can also bring a derivative suit on behalf of the company challenging a
board resolution if it was detrimental to the interest of the company. However, the
shareholder must approach the court with “clean hands”. The derivative action
procedure is set out in the Code of Civil Procedure 1908.
5. Application to the Serious Fraud Investigation Office (SFIO). The shareholders by
passing a special resolution can intimate to the Central Government that the affairs of
the company are required to be investigated. The Central Government, on receiving
such a request, can order the SFIO to investigate the affairs of the company.
9.5 GOALS OF SHAREHOLDER ACTIVISM
1. Financial reasons
a. Activist shareholders exercise their rights to improve and increase shareholder value.
Through such activism, shareholders’ activists aim to create value by acting as a positive
catalyst in the growth of the company.
b. Such creation of value by shareholder activists was seen when a listed arm of a global
conglomerate proposed to sell one business unit to another subsidiary of its parent. Since
it was a related party transaction, the proposal required special majority of the
shareholders of the parent and the subsidiaries. However, the proposal was rejected due
to a low valuation. The revised proposal increased the valuation, to the benefit of the
shareholders.
c. A shareholder can hold shares in the company for several years to ensure long term
return from the investment made in the company. This can be achieved by ensuring that
the focus of the management is to balance and maximise long term returns on the
investment made by such shareholders. Activist shareholders aim to improve the
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performance of the company to maximise the return on their investment. This also
encourages proper and efficient management to increase the company’s value in the long
term.
d. Activist shareholders encourage cost cutting to maximise profits by ensuring the
resources of the company are being utilised in a just and prudent manner.
e. Shareholder’s voice their opinions and concerns more often. For example, nearly, a
quarter of the shareholders of a financial conglomerate voted against the continuance of
its chairman. A proxy advisory firm advised investors to vote against the resolution to
reappoint the non-executive chairman of the company, as that person was on the boards
of eight other companies (which could prevent him from discharging his duties
effectively).
f. Shareholder activism occurred in a large automobile company in India where some
shareholders raised concerns about the purchase of automobiles by the company from a
related party. Strong opposition by the activist shareholders forced the company to
modify the terms of the contract to secure approval.
Also, in 2014, a proposal for payment of extraordinary remuneration to top executives of a
listed Indian automobile manufacturer did not get majority approval of shareholders, forcing
the company to continue its earlier remuneration structure and reduce costs.
2. Non-financial reasons
Activist shareholder ensures a high level of shareholder participation in the decision-making
of the company and direct engagement of the shareholders with the management. This has a
positive impact on the outcome of corporate decisions of the company and therefore
improves corporate governance.
Activist shareholders aim to enhance strategic and operational decisions of the company to
improve business operations and to align the policies of the company with policies prevalent
in the market.
9.6 STRATEGIES USED BY ACTIVIST SHAREHOLDERS
The strategies used by activist shareholders include the following:
1. Shareholders purchase shares with voting rights in the company to influence the
decisions taken by the management and to ensure active participation in the affairs of the
company to the extent permitted under the Companies Act 2013.
2. The shareholders adopt the strategy of interacting with the board on a regular basis and
providing strategic advice to the board which is for the benefit of the company and its
members. Consistent interaction with the board creates awareness of shareholder
concerns and helps the board to take well informed decisions board.
3. In companies which are required to have a Stakeholders Relationship Committee, the
shareholders actively participate in such committee to voice their concerns and
grievances.
4. If companies are not proactively addressing shareholder concerns, the shareholders make
public announcements to voice their opinions.
5. Shareholders can requisition the directors to convene a meeting to consider company
matters and to effect a particular change.
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6. Approaching the National Company Law Tribunal to initiate proceedings for oppression
and/or mismanagement on the ground that the company’s affairs are being conducted in
a manner prejudicial to the interest of the company or its members.
7. Class action suits.
8. Application to the Serious Fraud Investigation Office (SFIO).
9. The Securities and Exchange Board of India (SEBI) can initiate action suo moto or after
a complaint by an aggrieved shareholder if governance norms for listed entities
(prescribed by the SEBI) are breached.
9.7 SHAREHOLDER DISCLOSURES
Disclosure requirements
The Companies Act 2013 provides that if a person’s name is entered in the register of
members of a company as the shareholder in that company, but that individual does not hold
the beneficial interest in those shares, that individual is required to declare certain
information to the company specifying (among other things) the name and particulars of the
person who holds the beneficial interest in those shares. Further, every person who holds or
acquires a beneficial interest in share of a company is also required to make a declaration to
the company specifying (among other things) the nature of his/her interest and the particulars
of the person in whose name the shares stand registered in the books of the company. In the
event of a change in the beneficial interest in such shares, the persons mentioned above are
required to make certain declarations to the company within a period of 30 days.
Following such declarations, the company is required to take note in its register and file a
return with the Registrar of Companies (ROC). The Companies Act 2013 and the rules made
under that Act provide for reporting by significant beneficial owners to the Registrar of
Companies (ROC). This is in addition to the aforementioned requirements. The shareholding
of the company filed with the ROC is available on the website of the Ministry of Corporate
Affairs.
Penalties for non-compliance
If any person fails to make the declarations required as outlined above, without any
reasonable cause, he/she can be subject to a fine which may extend to INR50,000. Where the
failure is a continuing one, that person can also be subject to a further fine which may extend
to INR200 for every day after the first day during which the failure continues, subject to a
maximum of INR50,000.
9.8 TOOLS AVAILABLE TO ACTIVIST SHAREHOLDERS
Shareholder activists have the following legal and regulatory tools available to them. In
outline, these are the:
1. Right to receive information.
2. Right to give approval.
3. Right to appoint and remove directors.
4. Right to appoint an auditor.
5. Right to requisition a meeting.
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6. Right to electronic voting. This is available only in listed companies or companies with
more than 1,000 shareholders.
7. Grievance redressal mechanisms. Listed companies or companies with more than 1,000
shareholders debenture holders, deposit holders and any other security holders at any
time during a financial year must have a Stakeholders Relationship Committee. Further,
listed companies must be registered on SCORES platform (operated by the Securities
and Exchange Board of India). Both of these provide mechanisms to resolve shareholder
grievances.
8. Oppression and mismanagement proceedings. If at least 100 members or 10% of the
total number of the members (whichever is less), or members holding at least 10% of the
issued share capital of the company can approach the National Company Law Tribunal
to initiate oppression or mismanagement proceedings.
9. Class action suits.
10. Derivative actions.
11. Application to the Serious Fraud Investigation Office.
9.9 PREVENTION OF SHAREHOLDER ACTIVISM

The red flags that may indicate that a company is (or is about to be) targeted by shareholder
activists include the following:
 Substantial increase in the shareholding of a few shareholders, leading to control of the
company by them.
 A director failing to fulfil their duties under the Companies Act 2013.
 Controversy regarding the financial transactions or ethically questionable behaviour of
one or more board members.
 Frequent changes in management leading to issues in addressing the concerns of the
shareholders and formulating the strategies to be adopted by the company.
 Lack of communication with shareholders.
 Disregarding shareholder concerns regarding major dealings of the company.
 Inability or unwillingness of the management to resolve the concerns of its shareholders.
 Poor financial performance together with low market performance compared to its peers
in the industry.
Certain declarations concerning the beneficial ownership of the shares of a company are
required to be disclosed by the relevant shareholder and the beneficial owner to the company.
9.10 STEPS TO TAKE WHEN FACED WITH SHAREHOLDER ACTIVISM
1. Responding before a general meeting
The steps that a company can take when faced with shareholder activism before responding
to concerns at a general meeting include:
 Proactively and directly dealing with the concerns of the shareholder activist.
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 Assuring the shareholder activist that the issues raised will be considered seriously by the
management.
 Objectively considering the ideas of the shareholder activist.
 Evaluating and communicating the risk factors relating to the proposal of the shareholder
activist.
 Formulating an arrangement that is aligned to the interest of the shareholders and
concerns of the company.
2. Responding at a general meeting
At a general meeting, the company can take the following steps (among others):
 Elaborating on the proposed strategy to be implemented.
 Convincing the shareholder activists because the proposed strategy is in the best long-
term interests of the company and its members.
3. Responding after a general meeting
After a general meeting, the company can take the following steps:
 Continuous review of the governance policies of the company and the strategy
implemented.
 Engaging in interactive dialogues with the shareholders concerned.
Risks and benefits of company responses
Promptly responding to the concerns of activist shareholders offers the directors an
opportunity to embrace stakeholder interests and support the company’s governance profile
and long-term strategic plan. In addition to focusing on the financial performance of the
company, focusing on a strategic plan will help the board of directors to ensure that it has
adequate policy space to implement that plan and garner the support of shareholders.
Although there is a substantial risk that the company may fail to satisfy all of the concerns
raised by activists despite its best efforts, demonstrating a proactive approach to the problem
helps the management and the board of directors gain the confidence of a greater number of
shareholders. Conversely, ineffective communication can create a multitude of activist
shareholders’ concerns.
9.11 CURRENT TRENDS AND DEVELOPMENTS
With the rise of shareholder activism in India, companies are required to maintain good
corporate governance standards and ensure a high level of shareholder engagement. Greater
participation of shareholders in companies and implementation of best practices adopted by
companies will assist in maintaining shareholder credibility.
The legal and regulatory dynamics have enhanced protection of shareholders’ interests. The
Companies Act 2013 and the rules and regulations by Securities and Exchange Board of India
(SEBI) have protected the rights of shareholders, especially minority shareholders.
From the recent developments in India, it appears that proxy advisory firms have played a
significant role in the Indian market. The recommendations provided by proxy advisory firms
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to shareholders include appointment of directors (especially independent directors) of
companies, corporate transactions, appointment auditors and so on.
Regulators other than SEBI are also encouraging increased shareholder participation. This
can be observed from the guidelines issued by the Insurance Regulatory and Development
Authority of India on stewardship code for insurers. The code includes requirements for
insurers to have a policy regarding their conduct in general meetings of companies they have
invested in and related disclosures. This is to ensure more engagement of insurers with
management, therefore improving governance and informed decisions by parties, and to
improve the return on investments of insurers.
SEBI formed a committee on corporate governance to further consider corporate governance
issues. A number of the Kotak Committee recommendations on corporate governance have
been implemented.
The recommendations include (among others) the following:
 Board of directors:
 no person can hold directorship in more seven listed companies from 1 April
2020;
 the corporate governance report must include the expertise/skill-sets matrix of
the board of directors;
 there must be a minimum of six directors in the top 2,000 listed entities by 1
April 2020; and
 there must be at least one female independent director in the top 1,000 listed
entities 1 by April 2020.
 Improving safeguards and disclosures in relation to:
 related party transactions;
 utilisation of funds from QIP/preferential issue in the relevant financial year
until those funds are fully utilised; and
 consolidated quarterly results.
 Addressing issues faced by investors on voting and participation in general meetings.
Top 100 listed entities by market capitalisation must provide a one-way live webcast
of the proceedings of the annual general meetings.
 Quorum for every meeting of the directors of the top 2,000 listed entities with effect
from 1 April 2020 must be one-third of its total strength or three directors, whichever
is higher, including at least one independent director.
 With the recent developments in the space of corporate governance, entities in India
need to adapt to the changing policies and get involve in more shareholder
engagement.
Key trends in shareholder activism
These are still very early days for shareholder activism in India but some initial trends are
summarised below.
1. Fissures in corporate India: The rise of shareholder activism in India has coincided with
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succession issues, over-leveraged balance sheets and other issues that have made
promoters and professional management of listed companies vulnerable. These have even
affected companies with a better governance history.
For instance, in late 2016 and 2017, Infosys, a US and Indian listed IT company with a good
governance reputation, faced a period of sustained pressure from its original founder
shareholders, which ultimately contributed to the resignation of its CEO. The founders
criticised the level of severance payments paid to certain departing executives and the
US$200 million Panaya acquisition, which led to an investigation by an international law
firm (which reportedly exonerated the management team). Following this, in July 2017, the
board of Infosys indicated its willingness to work with its founders. However, on 18 August
2017, Vishal Sikka, the incumbent CEO, resigned. Without naming the founders, he indicated
that the criticism he faced made his role untenable.
The Tata conglomerate was also subject to a battle for control in late 2016 and early 2017.
Following differences between Cyrus Mistry, then chair of Tata Sons, and Ratan Tata, the
former chair, on 24 October 2016, Cyrus Mistry was removed from his position as chair
through a board resolution. This was followed by allegations and counter-allegations between
the two individuals. Cyrus Mistry was removed as director from the various Tata Group
companies between November and December 2016 and, ultimately, was removed as a
director of Tata Sons pursuant to an EGM held on 6 February 2017, although this removal is
still being litigated.
2. Litigation v. other strategies: Historically, litigation strategies have proved to be less
effective. For instance, the litigation strategy employed by the Children’s Investment
Fund (TCI) against the directors of Coal India for breach of fiduciary duties between
2012 and 2014 did not meet with success. In 2014, TCI withdrew its court claims and
sold its Indian holdings. Equally, recent attempts by Cyrus Mistry, the deposed chair of
Tata Sons, to seek relief under Sections 241 and 244 of CA 2013 (for oppression and
mismanagement) were dismissed by the NCLT, and the Bombay High Court refused to
entertain a separate representative suit against Ratan Tata (Cyrus Mistry’s predecessor)
for damages. Similarly, litigation by minority shareholders of Cadbury in relation to the
valuation in a minority squeeze-out scheme failed as the court ruled against the minority
shareholder group. A more effective technique that certain shareholders have used is to
register complaints with regulatory authorities. For instance, in July 2019, the
shareholders of Bharat Nidhi Limited objected to a share buy-back scheme and asked
SEBI to investigate.
Given that promoters still remain powerful, the more effective strategies are likely to be those
that involve investors working with the promoters or seeking to curb obvious abuses, for
which there is likely to be greater institutional investor and regulatory support (see Section
IV).
3. Proxy firms: Several proxy advisory firms are now active in India and are regulated by
SEBI under the SEBI (Research Analysts) Regulation 2014.
Proxy advisory firms recommended that shareholders vote against the Tata Motors executive
remuneration resolutions in 2014 and claimed credit for the outcome. They have also been
vocal on governance matters; for instance, in commenting on the leave of absence taken by
the CEO of ICICI Bank (while allegations of impropriety are investigated). More recently, in
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2019, proxy firms challenged the management of Sterling Wilson over the failure to repay
debt out of its IPO proceeds.
They do not have the same level of influence as in the United States but proxy firms are
emerging as important market participants.
However, these firms have also faced criticism around perceptions of their own conflicts of
interest and, in 2019, SEBI recommended safeguards in this regard.
4. Role of the media: Although public campaigns by shareholders seeking strategic changes
are uncommon, the media has emerged as a key player, for instance, in the engagement
that Narayana Murthy, a founder of Infosys, had with its board in 2016 and 2017
5. Greater investor participation:In the past, collective action issues held back
shareholder activism, with investors preferring to simply exit their investments. However,
mutual funds and other long-term investors in the Indian market now more actively
engage with promoters (see Section IV). Part of this has been driven by regulation. Indian
regulated mutual funds are now required by SEBI to vote on resolutions involving their
portfolio companies and provide voting reports on a quarterly and annual basis. Efforts by
India’s insurance regulator to encourage market engagement by insurance companies are
likely to continue this trend.
In addition to long-only investors, certain funds have sought to take activist positions in
various listed companies, seeking board appointments (albeit unsuccessfully) and
successfully removing a director (in the case of Fortis Healthcare). In 2019, the asset sale of
the Leela Hotels to Brookfield was challenged by ITC, a non-financial investor, and Life
Insurance Corporation, a state owned insurer, on the grounds that certain deal participants
were related parties and hence could not vote in favour of the sale. This challenge and its
subsequent appeal were dismissed, but it does illustrate that the extent of shareholders
asserting their rights has now expanded.
9.12 RECENT SHAREHOLDER ACTIVISM CAMPAIGNS
1. Blocking transactions: There have been a number of instances where shareholders have
been able to block transactions adverse to the shareholders’ interests.
Since shareholders with an interest in related party transactions cannot vote to approve them,
minority shareholders can sometimes be strongly placed. For instance, in 2018, shareholders
of Tata Sponge Iron Limited, holding just 3.77 per cent of the votes, were able to defeat the
related party approval resolutions for this reason. Also, in July 2017, the shareholders
opposed a related party transaction between Raymond Limited and its promoters (involving
the sale of an asset at a significant undervalue). More than 97 per cent of the votes cast were
against the transaction.
Similarly, in November 2015, after pressure from its shareholders, Sun Pharma withdrew
from a potential US$225 million investment in the United States.
Finally, in 2016, HDFC Standard Life Insurance Company Limited and Max Life Insurance
Company Limited announced a merger to create a new insurer and the deal terms included
the payment of a 8.5 billion rupee non-compete fee to one of the promoters. Ultimately, the
deal did not complete owing to regulatory concerns, but various proxy firms had strongly
opposed the payment of this fee.
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2. Forcing renegotiation of terms: In certain cases, shareholders have been able to force a
renegotiation of terms in large transactions.
In 2014, Maruti Suzuki’s proposed manufacturing contract with a shareholder, Suzuki, was
criticised for failing to seek shareholder approval for the transaction. Some of the largest
funds in India wrote a letter to Maruti Suzuki challenging the proposed transaction. Even Life
Insurance Corporation of India, a state-owned insurer, not known for activism, reportedly
engaged with the company. The transaction terms were modified, and the company ultimately
did obtain shareholder approval as a related party transaction matter, in 2015.
In the public M&A context, minority shareholders threatened to challenge a mandatory share
swap scheme (announced in December 2019) between Reliance Industries Limited (RIL) and
Reliance Retail Limited, on the basis that they had not been provided an exit option. In
January 2020, as a result of this shareholder opposition, RIL made this scheme optional.
3. Changes to board composition: Investors have had one notable success in removing a
director of Fortis Healthcare in May 2018. This was in the context of investor concerns as to
the board assessment of certain bids for the company, so this is a significant shareholder
activism landmark in India. Also, in 2019, the board of CG Power and Industrial Solutions
removed its promoter from his role as chairman (although this was not the removal of a
directorship) in the wake of allegations of certain irregularities.
However, the question is whether attempts to change the composition of the board outside the
particular circumstances set out above will work. In the past, this has not proved easy in
practice. For instance, the attempt of a 20 per cent investor to seek board representation in
relation to MRO-TEK and the attempt by Florintree Advisors to seek a seat on the board of
PTC India did not succeed. Some investors have persisted in unusual ways, such as the
provisions for a ‘small shareholder’ director by Unifi Capital s
In certain cases, shareholders have opposed the reappointment of senior incumbent
management as directors. For instance, in July 2018, 22.64 per cent of the shareholders of
HDFC Limited voted against the reappointment of Deepak Parekh, the group chair, as a
director. Similarly, in September 2018, a significant number of investors opposed the re-
election of Kumar Mangalam Birla (head of Aditya Birla Group) to the board of UltraTech
Cement. Although both reappointments were ultimately approved, this scale of opposition in
relation to such senior figures in corporate India is noteworthy.
Litigation has also occasionally been attempted as a strategy to force a change in board
composition, although these are harder to achieve.
SUMMARY
1. Activism represents a range of activities by one or more of a publicly traded
corporation’s shareholders that are intended to result in some change in the corporation.
2. Shareholder activism involves the efforts of the shareholders to bring about a desired
change in the operations of the company or to influence the management in governing
the company to protect the interest of the shareholders.
3. The following rights (among others) are relevant to shareholder activism under the laws
of India: Right to receive information, Right to give approval, Right to appoint and
remove directors, Right to appoint auditor, Right to requisition a meeting, Right to
electronic voting.
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4. Shareholders that have been wronged can use the following when seeking a
remedy:Grievance redressal mechanisms, Oppression and mismanagement proceedings,
Class action suits, Derivative actions, Application to the Serious Fraud Investigation
Office (SFIO).
5. Promptly responding to the concerns of activist shareholders offers the directors an
opportunity to embrace stakeholder interests and support the company’s governance
profile and long-term strategic plan.
6. With the rise of shareholder activism in India, companies are required to maintain good
corporate governance standards and ensure a high level of shareholder engagement.
7. Key trends in shareholder activism in india are: Fissures in corporate India, Litigation v.
other strategies, Proxy firms, Role of the media, Greater investor participation.
8. Recent shareholder activism campaigns are: Blocking Transaction, Forcing
renegotiation of terms, Changes to board composition.
FILL IN THE BLANKS
1. ………………… involves the efforts of the shareholders to bring about a desired
change in the operations of the company.
2. The auditor is appointed by the shareholders in an annual general meeting is for a
……..... years.
3. ………………………. enables investors to file complaints and track the status or
redressal of these complaints. This is an example of the shareholders’ right to have their
grievances and concerns heard.
4. Listed companies or companies with more than 1,000 shareholders debenture holders,
deposit holders and any other security holders at any time during a financial year must
have a …………………….. Committee.
5. The Companies Act 2013 and the rules and regulations by Securities and Exchange
Board of India (SEBI) have protect the …………………………………..
1. Decision passed by shareholders are known as :
(i) Resolution
(ii) Provision
(iii) Articles
(iv) Memorandums
2. Which of the following meetings are all shareholders invited to?
a) Annual General Meeting
b) General meeting
c) Class Meeting
d) Board Meeting
(i) 1 Only
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(ii) 1 &2 Only
(iii) 1, 2 & 3 Only
3. What percentage of shareholders is needed to pass special resolution?
(i) It must be unanimous
(ii) Not less than 90%
(iii) Not less than 75%
(iv) More than 50%
4. Which of the following rights (among others) are relevant to shareholder activism under
the laws of India-
(i) Right to receive information
(ii) Right to appoint and remove directors
(iii) Right to requisition a meeting
5. Which of following are recent Key trends in shareholder activism-
(i) Proxy firms
(ii) Greater investor participation
(iii) Fissures in corporate India
1. What is Shareholder Activism? Explain the regulation of shareholder activism.
2. What remedies available for shareholders?
3. What steps to take when faced with shareholder activism?
4. Explain the key trends in shareholder activism with the help of an example.
5. Briefly discuss some recent shareholder activism campaigns.
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CHAPTER-10
INSIDER TRADING
10.1 Insider Trading

10.1.1 Meaning
10.1.2 Reasons to control Insider Trading
10.1.3 Rationale for Insider Trading Regulations
10.1.4 Significant Penalties in case of Insider Trading
10.1.5 Methods of Prevention of Insider Trading
10.1.6 Salient Features of Regulation
10.2 Whistle Blowing
10.2.1 Meaning
10.2.2 Employer’s Responsibilities in regards to Whistle blowing
10.2.3 Communicating Policies and Procedures
10.2.4 Standard Whistle Blowing Policy
10.2.5 Whistle blowing Disclosures
10.2.6 Confidentiality
10.2.7 Whistle blowing Code of Practice
10.1 INTRODUCTION
InsiderTradingasatermissubjecttomanydefinitionsanditincludesbothlegalandprohibitedactivi
ties. Insider Trading happens on a daily basis, legally, when corporate management and
Board of Directors buy or sell or deal with stocks of their own companies within confines
of the company policies and regulations governing the trading. Insider Trading is buying,
selling or dealing with a security while breaching the company policies or regulations, thus
breaching the trust and confidence of a company while possessing material or non-public
information about the securities.
The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations
1992, does not directly define the term Insider Trading. But it defines the term “Insider”,
“Connected Person” and “Price Sensitive Information”. Insider Trading is the trading of
securities of a company by an Insider using company’s non-public, price sensitive
information while causing losses to the company or profit to oneself.
10.1.1 MEANING
 Insider: a “connected person” or a person possessing or having access to
unpublished price sensitive information;
 Connected person: one who has been associated with the company in any capacity
such as a director, officer or employee or in a contractual or fiduciary relationship
with the company; and includes a list of “deemed connected persons”;
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 Unpublished price sensitive information (UPSI): any information relating to
securities of a company that is not generally available and, upon being available, is
likely tomaterially affect the price of the company’s securities. It includes matters
such as financial results, dividends, changes in capital structure, significant
corporate transactions and changes in key managerial personal. (Source: SEBI
(Prohibition of Insider Trading) Regulations, 2015).
Following are some examples of Price Sensitive Information:
1. Financial results of the company.
2. Intended declaration of Dividends.
3. Issue of shares by way of public rights, bonus, etc.
4. Any major expansion plans or execution of new projects
5. Amalgamation, mergers and take overs.
6. Disposal of the whole/substantial of the undertaking.
Real-life Examples of Insider Trading
1. Martha Stewart: Shares of ImClone took a sharp dive when it was found out that the
FDA rejected its new cancer drug. Even after such a fall in the share price, the family of
CEO Samuel Waskal seemed to be unaffected. After receiving advance notice of the
rejection, Martha Stewart sold her holdings in the company’s stock when the shares
were trading in the $50 range, and the stock subsequently fell to $10 in the following
months. She was forced to resign as CEO of her company and Waskal was sentenced to
more than seven years in prison and fined $4.3 million in 2003.
2. Reliance Industries: The Securities and Exchange Board of India banned RIL from the
derivatives sector for a year and levied a fine on the company. The exchange regulator
charged the company with the intention of making profits by skirting regulations on its
legally permissible trading limits and lowering the price of its stock in the cash market.
3. Joseph Nacchio: Joseph Nacchio made $50 million by dumping his stock on the
market while giving positive financial projections to shareholders as chief of Qwest
Communications at a time when he knew of severe problems facing the company. He
was convicted in 2007.
4. Yoshiaki Murakami: In 2006, Yoshiaki Murakami made $25.5 million by using non-
public material information about Live door, a financial services company that was
planning to acquire a 5% stake in Nippon Broadcasting. His fund acted upon this
information and bought two million shares.
5. Raj Rajaratnam: Raj Rajaratnam made about $60 million as a billionaire hedge fund
manager by swapping tips with other traders, hedge fund managers, and key employees
of IBM, Intel Corp, and McKinsey & Co. He was found guilty of 14 counts of
conspiracy and fraud in 2009 and fined $92.8 million.
10.1.2 REASONSTOCONTROL INSIDERTRADING
1. To protect general investors. The manipulation of market by using Insider trading
generally causes great losses to a company, thus leading to loss for investors or great
profit only for the Insiders. It steals away the possibility of earning profit from an
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investor.
2. To protect the interest and reputation of the company. Once a company faces a
problem of Insider Trading, investors tend to lose confidence in the company and
stop investing in the company and also selling all the stocks of the company.
3. To maintain confidence in the stock exchange operations. With SEBI also regulating
all the trading, if any Insider gets a chance to get past the laws, it decreases the
investors’ confidence in the stock exchange operations itself.
4. To maintain public confidence in the financial system as a whole. Indian Financial
Market is still very low in the domestic investment rate. To have a healthy economy,
a proper financial system is a must and for that, confidence in the market is of
utmost importance.
10.1.3 RATIONALEFORINSIDERTRADINGREGULATIONS
It is well known that high standards of corporate governance and transparency are essential to
the development of capital markets. The disclosure of information regarding a company
enables investors to take decisions regarding investments in securities of such a company. For
prices of securities to accurately reflect relevant information about a company - an essential
precondition for efficient functioning of capital markets - such information should be equally
available to all market participants at the same time. Naturally, distortions occur in the market
if company insiders possess superior information that they use to trade in the securities of
their company, which is unavailable to the counterparties with whom they trade or to the
market generally. Hence, countries generally tend to enact laws that prohibit insider trading.
A side from preserving capital market efficiency, there are other justifications too for
regulating insider trading. Insider trading causes unfairness to investors who possess inferior
information, it under mines investor confidence and integrity of the securities markets, and it
is also regarded as the ftorm is appropriation of information. Yet, opponents of regulating
insider trading wax eloquent about its virtues, including the fact that it may result in greater
market efficiency and operate as a form of compensating employees, thereby motivating
them to generate greater corporate performance that benefit all share holders. Despite some
voices continuing to support insider trading, most countries prohibit insider trading in some
form or the other. The fairness objective eseems to have trumped any perceived arguments in
favour of insider trading. Infact, empirical evidence suggests that “more stringent insider
trading laws are generally associated with more dispersed equity ownership, greater stock
price accuracy and greater stock market liquidity”. These would in turn facilitate better
corporate governance.
10.1.4 SIGNIFICANTPENALTIES IN CASEOF INSIDERTRADING
 SEBI may impose a penalty of not more than Rs. 25 Crores or three times the amount of
profit made out of Insider Trading; which ever is higher.
 SEBI may initiate criminal prosecution; or
 SEBI may issue order declaring transactions in Securities based on unpublished price
sensitive information; or
 SEBI may issue orders prohibiting an insider or refraining an insider from dealing in the
securities of the company.
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10.1.5 METHODSOF PREVENTIONOF INSIDERTRADING
1. Disclosure of Interest by corporate insiders.
a. Listed companies:–
If change exceeds 2 per cent of the total voting right of persons holding more than 5
per cent of the shares/voting rights. -If change exceeds Rs.5,00,000/25000 shares/ 1
per cent of capital by Directors and officers.
b. Other entities:–
Initial statement of holdings. -Periodic statement of holdings. This can show any
suspicious time based and trading based activities by Insiders.
2. Disclosure of Price Sensitive Information:
a. Limited access to price sensitive information, forex.: Need to know basis.
b. Dissemination of information by the Stock Exchange.
c. Transmitting information to news agency.
3. Chinese Wall:
a. Separate inside area from public areas.
b. Bringing over the wall.
4. Trading Window Facility:
a. Decided by the company.
b. Closed during the time price-sensitive information is not published.
c. Opened 24 hours after the information is made public.
d. Allowing the exercise of ESOP.
5. Minimum holding period:
a. Securities to be held for minimum period of 30 days to be considered investment.
b. 30 days holding from the date of IPO allotment.
c. Only personal emergency cases be excluded.
6. Pre-clearance of trades prevents Front Running:
India has put great efforts in the enactment of Insider Trading. SEBI- to be at par within
ternational standards of Insider Trading Laws has modified the laws on Insider Trading
under the chairmanship of Justice N. K. Sodhi and drafted the “Prohibition of Insider
Trading Regulations, 2015.” The new Insider Trading Regulations has brought about
several changes by amending definitions of various concepts. It comprises of Five
Chapters, Two schedules and 12 sections. First Chapter deals with the definitions, second
deals with the Restriction on Communications and Trading by Insiders. Chapter 3 talks
about the disclosures made by the company and fourth prescribes a Code of Disclosure and
Conduct. Chapter 5 consists of Power and Sanctions.
10.1.6 SALIENTFEATURESOFTHEREGULATIONSARE
1. Every connected person is an Insider. The term includes relatives and public servants
also who have expected to have access to UPSI.
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2. Definition of UPSI has changed. Any information not generally available to public,
which when available may materially affect the price of the securities are included in
UPSI. For eg.: Financial results, Dividends, Change in Capital structure, Mergers,
demergers, acquisitions, delisting, disposals and expansion of business, changes in key
managerial personnel, etc.
3. Trading Plans are novel concepts introduced in the regulations wherein Insiders who are
liable to possess UPSI all-round the year are permitted to formulate trading plans with
appropriate safe guards.
4. Every listen company must formulate and publish a code of practices to be followed for
safe and fair disclosures UPSI in accordance to principles set out in Schedule A to the
Regulations.
5. Notional trading windows are set to 48 hours after the UPSI information becomes public.
6. Due diligence may be conducted when the Board is of the opinion that the merger or
transaction is in the best interest of the company.
The substantive law relating to insider trading has been considerably strengthened over the
years. SEBI has also acquired greater enforcement powers, which it is likely to exercise
given that insider trading can potentially cause a serious dent on market integrity.
Regulations issued by SEBI, their enforcement by SEBI as well as rulings by SAT and
various courts have highlighted the need for companies to take serious note of insider
trading concerns.
10.2 WHISTLEBLOWING
10.2.1 MEANING
Whistle blowing is the term used when a worker passes on information concerning
wrongdoing. In this guidance, we call that “making a disclosure” or “blowing the whistle”.
The wrongdoing will typically (although not necessarily) be something they have witnessed
at work.
To be covered by whistle blowing law, a worker who makes a disclosure must reasonably
believe two things. The first is that they are acting in the public interest. This means in
particular that personal grievances and complaints are not usually covered by whistle blowing
law.
The second thing that a worker must reasonably believe is that the disclosure tends to show
past, present or likely future wrongdoing falling into one or more of the following categories:
 criminal offences (this may include, for example, types of financial impropriety such as
fraud)
 failure to comply with an obligation set out in law
 miscarriages of justice
 endangering of someone’s health and safety
 damage to the environment
 covering up wrong doing in the above categories
Whistle blowing law is located in the Employment Rights Act 1996 (as amended by the
Public Interest Disclosure Act 1998). It provides the right for a worker to take a case to an
employment tribunal if they have been victimised at work or they have lost their job because
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they have ‘blown the whistle’.
10.2.2 EMPLOYER’S RESPONSIBILITIES IN REGARDS TO WHISTLEBLOWING
As an employer it is good practice to create an open, transparent and safe working
environment where workers feel able to speak up. Although the law does not require
employers to have a whistle blowing policy in place, the existence of a whistle blowing
policy shows an employer’s commitment to listen to the concerns of workers. By having
clear policies and procedures for dealing with whistle blowing, an organization demonstrates
that it welcomes information being brought to the attention of management. This is also
demonstrated by the following:
1. Recognising workers are valuable ears and eyes: Workers are often the first people to
witness any type of wrongdoing within an organisation. The information that workers
may uncover could prevent wrongdoing, which may damage an organisation’s reputation
and/or performance, and could even save peoplee from harm or death.
2. Getting the right culture: If an organisation hasn’t created an open and supportive
culture, the worker may not feel comfortable making a disclosure, for fear of the
consequences. The two main barriers whistleblowers face are a fear of reprisal as a
resultofmakingadisclosureandthatnoactionwillbetakeniftheydomakethedecisionto’blow
the whistle’. There have been a number of high profile cases, including evidence collated
by the Mid-Staffordshire NHS Foundation Trust Public Inquiry1, the Freedom to Speak
Up Independent Review into creating an open and honest culture in the NHS2; and the
Parliamentary Commission on Banking Standards3 that confirm many workers are scared
of speaking up about poor practice. Making sure your staff can approach management
with important concerns is the most important step in creating an open culture.
Employers should demonstrate, through visible leadership at all levels of the
organisation, that they welcome and encourage workers to make disclosures.
3. Training and support: An organisation should implement training, mentoring, advice and
other support systems to ensure workers can easily approach a range of people in the
organisation.
4. Being able to respond: It is in the organisation’s best interests to deal with a whistle
blowing disclosure when it is first raised by a worker. This allows the organisation to
investigate promptly, ask further questions of a worker and where applicable provide
feedback. A policy should help explain the benefits of making a disclosure.
5. Better control: Organisations that embrace whistle blowing as an important source of
information find that managers have better information to make decisions and control
risk. Whistle blowers respond more positively when they feel that they are listened to.
6. Resolving the wrongdoing quickly: There are benefits for the organisation if a worker
can make a disclosure internally rather than going to a third party. This way there is an
opportunity to act promptly on the information and put right whatever wrongdoing
isfound.
10.2.3 COMMUNICATEPOLICYANDPROCEDURE
Having a policy is a good first step to encourage workers to blow the whistle but each
organisation needs to let its workers know about the policy and make sure they know how to
make a disclosure. Some organisations choose to publicise their policy via their intranet or
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through a staff newsletter. If an organization recognises a trade union it might develop
apolicy in consultation with them. It is a good idea for organisations to share the information
with all staff regularly to make sure they are all reminded of the policy and procedures and to
inform any newcomers. Providing training at all levels of an organisation on the effective
implementation of whistle blowing arrangements will help to develop a supportive and open
culture.
When someone blows the whistle an organisation should explain its procedures
formakingadisclosureandwhetherthewhistleblowercanexpecttoreceiveanyfeedback.
Often a whistleblower expects to influence the action the organisation might take, or expects
to make a judgement on whether an issue has been resolved – such expectations need to be
managed.
It is for the organisation to be satisfied that the disclosure has been acted upon appropriately
and that the issue has been resolved. There should be clear and prompt communications
between the whistleblower and the organisation. It is best practice for organisations to
provide feedback to whistle blowers, within the confines of their internal policies and
procedures. Feedback is vital so that whistleblowers understand how their disclosure has been
handled and dealt with. If a whistleblower is unhappy with the process or the outcome it will
make them more likely to approach other individuals and organisations to ‘blow the whistle’,
such as a “prescribed person”.
Disclosure or grievance
Sometimes an employee believes they are blowing the whistle when, in fact, their complaint
is a personal grievance. Workers who make a disclosure under an organisation’s whistle
blowing policy should believe that they are acting in the public interest. This means in
particular that personal grievances and complaints are not usually covered by whistle blowing
law. It is important that any policy, procedures and other communications make this clear.
An organisation may want to direct workers to the Government’s guidance for whistle
blowers to verify the position that a personal grievance is not generally regarded as a
protected disclosure. Workers can also contact the Advisory, Conciliation and Arbitration
Service (Acas) for guidance on whistle blowing and grievances.
10.2.4 STANDARD WHISTLEBLOWING POLICY
There is no one-size-fits-all whistle blowing policy as policies will vary depending on the
size and nature of the organisation. Some organisations may choose to have a standalone
policy whereas others may look to implement their policy into a code of ethics or may have
‘local’ whistle blowing procedures relevant to their specific business units.
A large organisation may have a policy where employees can contact their immediate
manager or a specific team of individuals who are trained to handle whistle blowing
disclosures. Smaller organizations may not have sufficient resources to do this.
Any whistle blowing policies or procedures should be clear, simple and easily understood.
Here are some tips about what a policy should include:
 An explanation of what whistle blowing is, particularly in relation to the organisation
 A clear explanation of the organisation’s procedures for handling whistle blowing, which
can be communicated through training
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 A commitment to training workers at all levels of the organisation in relation to whistle
blowing law and the organisation’s policy
 A commitment to treat all disclosures consistently and fairly
 A commitment to take all reasonable steps to maintain the confidentiality of the
whistleblower where it is requested (unless required by law to break that confidentiality)
 Clarification that any so-called ‘gagging clauses’ in settlement agreements do not prevent
workers from making disclosures in the public interest
 An idea about what feedback a whistleblower might receive
 An explanation that anonymous whistleblowers will not ordinarily be able to receive
feedback and that any action taken to look into a disclosure could be limited –anonymous
whistleblowers may seek feedback through a telephone appointment or by using an anony
missed email address
 A commitment to emphasise in a whistle blowing policy that victimisation of a
whistleblower is not acceptable. Any instances of victimisation will be taken seriously
and managed appropriately
 An idea of the time frame for handling any disclosures raised
 An idea of the time frame for handling any disclosures raised
 Clarification that the whistleblower does not need to provide evidence for the employer to
look into the concerns raised
 Signpost to information and advice to those thinking of blowing the whistle, for example
the guidance from the Government, Acas, Public Concern at Work or Trade Unions
 Information about blowing the whistle to the relevant prescribed person(s)
Promoting a policy and making sure it is easily accessible
It’s no good having a policy in place if no one knows about it. Actively promoting a policy
shows the organisation is genuinely open to hearing concerns from its staff. Managers and
leaders in the organisation can also promote a policy in the way they behave at work.
Conduct and written policies will help to create an open culture, which will increase the
likely hood of a workers peaking up about any wrong doing they come across.
Written policies are not enough.
Training should be provided to all staff on the key arrangements of the policy. Additional
training should be provided to those with whistle blowing responsibilities, such as managers
or designated contacts, so they are able to provide guidance confidently to workers. Managers
should also lead by example and ensure they are committed to creating an open culture where
disclosures are welcome. It is also a good idea to include handling whistle blowing
disclosures as part of discipline and grievance training for managers and staff. Training
should be offered at regular points to make sure it stays fresh in managers’ minds and to
capture any newcomers to the organisation.
Here are some ideas about how to promote a policy:
 Hold a staff session or in larger organisations require managers to hold smaller, consistent
team meetings
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 Make the policy accessible on the staff intranet
 Appoint a whistleblowers’ champion to drive the commitment to valuing whistle blowing
and protecting whistleblowers within the organisation
 Use promotional posters around the building
 Include the policy within induction packs for newcomers
 Set the policy out in staff handbooks and contracts
10.2.5 DISCLOSURE OF WHISTLEBLOWING
Where a worker feels able to do so they may make a disclosure to their immediate manager
who will be able to decide whether they can take forward the disclosure or whether it will
require escalation. An organisation will need to equip managers with the knowledge and
confidence to make these judgements. A whistle blowing policy and training can help with
this.
Larger organisations may have a designated team who can be approached when workers
make a disclosure. Although this may not be possible for smaller organisations, it is
considered best practice that there is at least one senior member of staff as a point of contact
for individuals who wish to blow the whistle. This is particularly helpful in cases where the
immediate line management relationship is damaged or where the disclosure involves the
manager. Alternatively, there are commercial providers who will manage a whistle blowing
process on the employer’s behalf.
Dealing with disclosures
Once a disclosure has been made it is good practice to hold a meeting with the whistleblower
to gather all the information needed to understand the situation. In some cases a suitable
conclusion may be reached through an initial conversation with a manager. In more serious
cases there may be a need for a formal investigation. It is for the organization to decide what
the most appropriate action to take is.
It is important to note that if an investigation concludes that the disclosure was untrue it does
not automatically mean that it was raised maliciously by a worker.
When dealing with disclosures, it is good practice for managers to:
 Have a facility for anonymous reporting
 Treat all disclosures made seriously and consistently
 Provide support to the worker during what can be a difficult or anxious time with access
to mentoring, advice and counselling
 Reassure the whistleblower that their disclosure will not affect their position at work
 Document whether the whistleblower has requested confidentiality
 Manage the expectations of the whistleblower in terms of what action and/or feedback
they can expect as well clear time scales for providing updates
 Produce a summary of the meeting for record keeping purposes and provide a copy to
the whistleblower
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 Allow the worker to be accompanied by a trade union representative or colleague at any
meeting about the disclosure, if they wish to do so
 Provide support services after a disclosure has been made such as mediation and dispute
resolution, to help rebuild trust and relationships in the work place
It will be useful to document any decisions or action taken following the making of a
disclosure by a worker.
It is also good practice for organizations to:
 Record the number of whistle blowing disclosures they receive and their nature
 Maintain records of the date and content of feedback provided to whistleblowers
 Conduct regular surveys to ascertain the satisfaction of whistleblowers.
Worker blows the whistle to someone other than their employer
Ideally workers will feel able to make a disclosure to their organisation. Good policies and
procedures for handling whistle blowing will help encourage this. However, there may be
circumstances where they feel unable to. There are other ways, some of which are set out in
law, that a worker may make a disclosure without losing their rights under whistle blowing
law. One option for external disclosures of this type is prescribed persons. Prescribed persons
are mainly regulators and professional bodies but include other persons and bodies such as
MPs. The relevant prescribed person depends on the subject matter of the disclosure, for
example a disclosure about wrongdoing in a care home could be made to the Care Quality
Commission.
Prescribed persons have individual policies and procedures for handling concerns and
complaints. Generally these will be accessible on their websites.
Alternatively, a worker might choose to approach the media with their concerns. If a worker
goes to the media, they can expect in most cases to lose their whistle blowing law rights. It is
only in exceptional circumstances that a worker can go to the media without losing their
rights. They must reasonably believe that the information they disclose and any allegation
contained in it are substantially true. They cannot be acting for personal gain. Unless the
wrongdoing is exceptionally serious, if they have not already gone to their employer or a
prescribed person, they must reasonably believe that their employer will subject them to
“detriment” or conceal or destroy evidence if they do so. And even then, their choice to make
the disclosure must be reasonable.
When Whistleblower believes they have been unfairly treated
If a whistleblower believes that they have been unfairly treated because they have blown the
whistle they may decide to take their case to an employment tribunal. The process for this
would involve attempted resolution through the Advisory, Conciliation and Arbitration
Service (Acas) early conciliation service.
10.2.6 CONFIDENTIALITY
There may be good reasons why a worker wishes their identity to remain confidential. The
law does not compel an organization to protect the confidentiality of a whistleblower.
However, it is considered best practice to maintain that confidentiality, unless required by
law to disclose it. Managers dealing with whistle blowing concerns should be briefed to
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ensure they understand how to handle the disclosure and protect personal information.
It will help to manage the expectations of whistleblowers if the risk that some colleagues may
still speculate about who has raised the concern is explained to them.
Anonymous information will be just as important for organisations to act upon. Workers
should be made aware that the ability of an organisation to ask follow up questions or provide
feedback will be limited if the whistleblower cannot be contacted. It may be possible to
overcome these challenges by using telephone appointments or through an anonymised email
address.
Workers should be made aware that making a disclosure anonymously means it can be more
difficult for them to qualify for protections as a whistleblower. This is because there would be
no documentary evidence linking the worker to the disclosure for the employment tribunal to
consider.
10.2.7 WHISTLEBLOWINGCODEOFPRACTICE
It is important that employers encourage whistle blowing as a way to report wrong doing and
manage risks to the organisation. Employers also need to be well equipped for handling any
such concerns raised by workers. It is considered best practice for an employer to:
 Have a whistle blowing policy or appropriate written procedures in place
 Ensure the whistle blowing policy or procedures are easily accessible to all workers
 Raise awareness of the policy or procedures through all available means such as staff
engagement, intranet sites, and other marketing communications
 Provide training to all workers on how disclosures should be raised and how they will be
acted upon
 Provide training to managers on how to deal with disclosures
 Create an understanding that all staff at all levels of the organisation should demonstrate
that they support and encourage whistle blowing
 Confirm that any clauses in settlement agreements do not prevent workers from making
disclosures in the public interest
 Ensure the organisation’s whistle blowing policy or procedures clearly identify who can
be approached by workers that want to raise a disclosure. Organisations should ensure a
range of alternative persons who a whistleblower can approach in the event a worker feels
unable to approach their manager. If your organisation works with a recognised union, a
representative from that union could be an appropriate contact for a worker to approach
 Create an organisational culture where workers feel safe to raise a disclosure in the
knowledge that they will not face any detriment from the organisation as a result of
speaking up.
 Undertake that any detriment towards an individual who raises a disclosure is not
acceptable
 Make a commitment that all disclosures raised will be dealt with appropriately,
consistently, fairly and professionally
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 Undertake to protect the identity of the worker raising a disclosure, unless required by
law to reveal it and to offer support throughout with access to mentoring, advice and
counselling
 Provide feedback to the worker who raised the disclosure where possible and appropriate
subject to other legal requirements. Feedback should include an indication of timings for
any actions or next steps.
Whistle blowing often causes significant disruption within an organization. In one way or
another, the organization is likely to lose control of its affairs as it is subjected to external
inquiries and constraints. Indeed, it may find itself crippled, and many within it who are little
more than innocent bystanders may also suffer. Whistle blowing, therefore, can be more
easily condoned if several conditions are satisfied. First, the disruption likely to be caused by
blowing the whistle can be justified only if other avenues of protest have proved ineffective.
Sometimes, of course, the risks confronting whistleblowers may make less-extreme forms of
reporting impracticable or dangerous. Although whistleblowers may be expected to
demonstrate good faith, their martyrdom cannot be demanded. Second, whistleblowers must
have good reasons for believing that their organizations are perpetrating the wrongs of which
they are accused. Whistleblowers need evidence that will withstand public scrutiny. Third,
the potential whistleblower needs to consider the seriousness of the detrimental behaviour.
Finally, whistle blowing should accomplish some public good; otherwise, the damage it
causes will likely outweigh any other value it may have.
Because whistleblowers are possible victims of retaliatory behaviour, many jurisdictions have
enacted whistleblower-protection acts. Such acts, however, have generally provided
inadequate protection, because retaliatory behaviour may be successfully disguised as
something else, and even justifiable criticism of the employee may be seen as retaliatory. For
many whistleblowers, the law has proved an inappropriate vehicle for protection. In some
jurisdictions, therefore, whistleblower-protection programs have been developed, designed to
offer the same personalized protection that witness-protection programs offer witnesses at
risk of retaliation.
SUMMARY
1. Insider Trading is buying, selling or dealing with a security while breaching the
company policies or regulations, thus breaching the trust and confidence of a company
while possessing material or non-public information about the securities.
2. SEBI may impose a penalty of not more than Rs. 25 Crores or three times the amount of
profit made out of Insider Trading; whichever is higher.
3. Methods of prevention of insider trading are: Disclosure of Interest by corporate insiders,
Disclosure of Price Sensitive Information, Chinese Wall, Trading Window Facility,
Minimum holding period, Pre-clearance of trades prevents Front Running.
4. Whistle blowing is the term used when a worker passes on information concerning
wrongdoing. Employees Rights Act provides the right for a worker to take a case to an
employment tribunal if they have been victimised at work or they have lost their job
because they have ‘blown the whistle’.
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5. It is important that employers encourage whistle blowing as a way to report wrongdoing
and manage risks to the organisation. Employers also need to be well equipped for
handling any such concerns raised by workers.
FILL IN THE BLANKS
1. ………….is the trading of securities of accompany by an Insider using company’s non-
public, price sensitive information while causing losses to the company or profit to
oneself.
2. ………………………banned RIL from the derivatives sector for a year and levied a
fine on the company.
3. ………………. is the term used when a worker passes on information concerning
wrong doing.
4. Provide support services after a disclosure has been made such as ……………………..
………………., to help ………………………………
5. If a whistleblower believes that they have been unfairly treated because they have
blown the whistle they may decide to take their case to …………………………
1. Which of the following is insider trading?
(i) You sell your company’s stock because you know it is about to announce poor
earnings.
(ii) Your company starts supplying parts for a customer’s secret major product, so
you buy the client’s stock.
(iii) You dump a company’s share after your broken confidentially tells you the CEO
at that company just sold stock, but the sale has not yet been publicly reported
2. To whom is the term “insider trading” related?
(i) Hawala
(ii) Public
(iii) Share Market
(iv) Tax
3. Which of the following employer’s responsibility in regard to whistle blowing-
(i) Getting the right culture
(ii) Resolving the wrongdoing quickly
(iii) Recognising workers are valuable ears and eyes
4. What arrangement can you make to provide an affirmative defence against charges of
insider trading?
(i) A Section 83(b) election
(ii) A Section 16 election
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(iii) A Rule 10b5-1 trading plan
(iv) A Rule 144 Trading Plan
5. What could be wrongdoing in a workplace subject to whistle blowing?
(i) Corruption
(ii) Unsafe Workplace
(iii) Violated Laws
1. What is insider trading? Give some example.
2. Explain the methods of prevention of insider trading.
3. What is whistle blowing?
4. What is employee’s responsibilities in regards to whistle blowing?
5. Briefly explain whistle blowing code of practice?
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CHAPTER-11
BOARD COMMITTEES AND FUNCTIONS
11.1 Introduction
11.2 Significance of Board Committees
11.3 Functions of Board Committees
11.4 Need of Board Committees
11.5 Committee Management
11.6 Role of Individual Member
11.7 Board Committees
11.8 Characteristics of Board Committees
11.1 INTRODUCTION
A board committee is a small working group identified by the board, consisting of board
members, for the purpose of supporting the board’s work. Committees are generally formed
to perform some expertise work. Members of the committee are expected to have expertise in
the specified field.
Committees are usually formed as a means of improving board effectiveness and
efficiency, in areas where more focused, specialized and technical discussions are required.
These committees prepare the groundwork for decision-making and report at the
subsequent board meeting. Committees enable better management of full board’s time and
allow in-depth scrutiny and focused attention.
However, the Board of Directors are ultimately responsible for the acts of the committee.
Board is responsible for defining the committee role and structure.
The structure of aboard and the planning of the board’s work are key elements to effective
governance. Establishing committees is one way of managing the work of the board, there
by strengthening the board’s governance role. Boards should regularly review its own
structure and performance and whether it has the right committee structure and an
appropriate scheme of delegation from the board.
11.2 SIGNIFICANCE OF BOARD COMMITTEES
Committees allow the board to–
 handle a greater number of issues with greater efficiency by having experts focus on
specific areas
 develop subject specific expertise on areas such as compliance management, risk
management, financial reporting
 enhance the objectivity and independence of the board’s judgment
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Greater specialization and intricacies of modern board work is one of the reasons for
increased use of board committees. The reasons include:
 responsibilities are shared
 more members become involved
 specialized skills of members can be used to best advantage
 inexperienced members gain confidence while serving on matters may be examined in
more detail by a committee
The committees focus accountability to known groups. While the board as a legal unit always
retains responsibility for the work of its committees, the committees because of its focus on
the mandate, the size of the committee being relatively smaller than the board tend to be more
effective. However, committees may dilute governance integrity to the extent that they may
obscure the direct board to CEO accountability and fragment the board’s wholeness.
Therefore, it is important that there is clarity of delegation and it should be ensured that
committees are not put between the board and the CEO, either by giving committees official
instructional authority or by allowing them to evaluate performance using their own criteria.
11.3 FUNCTIONS OF BOARD COMMITTEES
Committees of ten serve several different functions:
1. Governance: In large organizations participation of each and every director is not
possible in decisions making of the organization as a whole, a committee is given the
power to make decisions, spend money, or take actions. Some or all such powers may
be limited or effectively unlimited. Members of the committee take decisions, keeping
in view the interest of all stake holders.
2. Coordination: Where there is a large board, it is common to have committee swith
more specialized functions for better coordination-for example, audit committee,
finance committee, compensation committee, etc. wherein members meet
regularly to discuss developments in their areas, review projects that cut
across organizational boundaries, talk about future options, etc.
3. Research and recommendations: Committees are often formed to do research and
make recommendations on a potential or planned projector change. For example, an
organization considering a major capital investment might create at emporary working
committee of several people to review options and make recommendations to the
Board of Directors. Such committees are typically dissolved after giving
recommendations.
With the increasing business complexities and time commitment of Board members,
constituting committees has become inevitable for organization of any significant size.
Committees keep the number of participants manageable; in larger groups, either many
people do not get to speak or discussion gets quite lengthy.
11.4 NEEDFORCOMMITTEES
A Board can set up committees with particular terms of reference when it needs assistance
(for example a new project sub-committee) or when an issue requires more resources and
attention (review of effect of legislative changes on organizational programs). They can be
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set up for a specific purpose or to deal with general issues such as ‘development’. They can
be established on a short-term or temporary basis, or they can be formed as a permanent
body for ongoing work.
A Board can either delegate some of its powers to the committee, enabling it to act
directly, or can require the recommendations of the committee to be approved by the
Board. The Board will normally depend heavily on the finding sand recommendations of its
committees, although final decisions to accept or reject these recommendations will be
made by the Board. Committees thus have an important role to play in company
governance.
Committees may be formed for arrange of purposes, including:
• Board development or Governance Committee
– To look after/ administer/ support Board members and committee members and
other executive positions
• Selection Committee/ Nomination Committee
– To select Board members, to select a CEO, to select key managerial and senior
management personnel
• Investment Committee
• Risk Management Committee
• Safety, Health & Environment Committee
• Committee of Inquiry
– To inquire into particular questions (disciplinary, technical, etc.)
– to manage the business of the organization between Board meetings.
• Finance or Budget Committees
– to be responsible for financial reporting, organising audits, etc.
• Marketing and Public Relations Committees
– to identify new markets, build relationship with media and public, etc.
Committees need clear goals, objectives, and terms of reference in order to function
efficiently, and Boards should ensure that these are developed before establishing the
committee. Many committees have been known to work outside their intended purpose
due to a lack of precise objectives.
11.5 COMMITTEE MANAGEMENT
• Committees function in accordance with the terms of reference established by the
board.
• Board Committees may be standing committees; oradhoc committees that cease when
the activities are completed. Standing committees should be included in the articles or
by-laws.
• Committees recommend policy for approval by the entire board.
• Committees make full use of board members’ expertise, time and commitment, and
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ensure diversity of opinions on the board.
• They do not supplant responsibility of each board member; they operate at the board
level and not the staff level.
• Minutes should be recorded for all Committee meetings and final minutes are
required to be placed before the Board.
A. Important points for consideration while constituting Committees
• Ensure the committee has a specific charge or set of tasks to address, and ensure
board members understand the committee’s charge, the same has been enunciated in
terms of reference.
• Have at least two board members on each committee, preferably three
• The memberships on the board committees should be planned in such a way so
that the time devoted by the each member is justified. The committee minutes and
action taken reports should be placed before the subsequent board meeting. The
committee may be permitted to take expert guidance.
• Committee members may be briefed up on by the senior management personnel
on certain agenda items. Committee chairs should promote full and fair
discussions on the various issues placed before the committees. The company
secretary of the company should be the secretary of the committee.
B. How to constitute a Committee
1. Selection of committee chairman
The Board may appoint the committee chairman or the committee members can
choose/elect the chairman. The committee chairman is the key to an effective committee,
he sets the tone, pace and strategies of the committees’ functioning, hence chairman selected
should have motivational and leadership skills and time commitment expected of him.
In seeking an effective chairman, most important things are knowledge and experience
relevant to the work of the committee, proven leadership and behavioral skills that will be
essential if the committee is to work effectively. The role of committee chairman requires
extra work, time for communication with committee members and senior management so
that here mains informed about the developments and a willingness to resolve conflicts
among members.
The committee chairman co-ordinates work and establishes an environment of thoughtful
deliberation. The chairman is expected to stimulate the members and help the group use all
the abilities and experiences its members possess and new skills that they develop as they
work together. The committee’s goal must be aligned to achieve the objectives of the
organization as a whole. The committee chairman will be responsible for preparing agendas
for the meetings, assigning responsibilities to committee members and doing some of the
follow-upto make sure that the assigned work is being done by members.
According to “Articles of Association” under Table F of Schedule I of the Companies
Act, 2013, committee may elect a Chairperson of its meetings. Where no such
Chairpersoni selected, or if at any meeting the Chair person is not present within five
minutes after the time
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Appointed for holding the meeting, the members present may choose one of their
members to be Chairperson of the meeting.
The Exposure Draft on Secretarial Standards (SS-1) provides that a member of the
Committee appointed by the Board or elected by the Committee as Chairman of the
Committee, in accordance with the Actor any other law or the Articles, shall conduct the
Meetings of the Committee. If no Chairman has been so elected or if the elected
Chairmanis unable to attend the Meeting, the Committee shall elect one of its members
present to chair and conduct the Meeting of the Committee, unless so the rwise provided
in the Articles.
2. Selection of committee members
Specific committee members may be appointed by either the Board or the committee
Chairman. Area of knowledge and expert is edomain and time commitment of the Board
member should be considered as the criteria for the selection on any specific committee. The
committee members should be selected with following questions in mind: What tasks are the
committee responsible for and who among the members possess the skills and experience
needed to complete those tasks. Every effort should be made to match the needs and
requirements of the committee and the skills, knowledge and interests of prospective
committee members.
It is very important that members have a clear view of the committee’s goals and the
chairman should have flair to utilize the committee member’s knowledge exponentially
well to achieve those goals.
C. Committee Functioning
The committee has to function in accordance with the terms of reference assigned by the
Board.
As a good practice, an annual committee calendar should be prepared and finalized for all
the major activities during the year. The committee calendar should be in line with the
overall annual board calendar so that efforts are unified and coordinated for maximum
benefit. In addition to this, scheduling regular meetings of the committee in advance also
helps members plan far enough in advance to assure good attendance.
11.6 ROLEOFINDIVIDUALCOMMITTEEMEMBER
How the role of committee members is described may vary according to the size and
nature of the organization. However, all committee members need to individually
commit to:
• upholding the values and objectives of the organization;
• giving ad equate time and energy to the duties assigned; and
• acting within tegrity and avoiding or declaring personal conflicts of interest.
As committee members, they will make decisions as a collective group and hold joint
responsibility for decisions and actions taken by the committee, even in their absence. They
are responsible for ensuring that all decisions are taken in the best interests of the
organization and that their role is carried out effectively. Individual members should
demonstrate selflessness, integrity, objectivity, accountability, openness, honesty and
leadership.
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Committee members should have access to relevant information to support them in carrying
out their responsibilities. This clarity should commence during the committee formation
process, with provision of:
• a written role description; and
• confirmation of the commitment required.
There should be a proper/formalized induction process, ensuring that the new members are
well-equipped to carry out their role effectively. It should be ensured that the terms of
reference are well understood by the committee members. It is also important to have a
training and development strategy in place for the committee members, ensuring that they
remain sufficiently well-informed and skilled.
Committee members need to ensure that there is clarity in relation to the task being delegated.
Committees cannot delegate responsibility for decisions taken.
Table F of Schedule I of the Companies Act, 2013 in this context expressly provides the
following:
• The Board may delegate any of its powers to committees consisting of such
member or members of its body as it thinks fit. Any committee so formed shall, in the
exercise of the powers so delegated, conform to any regulations that may be imposed
on it by the Board.
• A committee may meet and adjourn a sit thinks fit.
• Questions arising at any meeting of a committee shall be determined by a majority of
votes of the members present, and in case of an equality of votes, the Chairperson shall
have a second or casting vote.
• All acts done in any meeting of the committee or by any person acting as a director,
shall, not withstanding that it may be after wards discovered that there was some
defect in the appointment of any one or more of such directors or of any person
acting as aforesaid, or that they or any of them were disqualified, be as valid as if
every such director or such person had been duly appointed and was qualified to be
a director.
• Save as otherwise expressly provided in the Act, are solution in writing, signed by
all the members of the Board or of a committee there of, for the time being entitled to
receive notice of a meeting of the Board or committee, shall be valid and effective as
if it had been passed at a meeting of the Board or committee, duly convened and
held.
11.7 BOARD COMMITTEES
Committees appointed by the Board focus on specific areas and take informed decisions
within the framework of delegated authority, and make specific recommendations to the
Board on matters in their areas or purview. All decisions and recommendations of the
committees are placed before the Board for information or for approval.
To enable better and more focused attention on the affairs of the Corporation, the board
delegates particular matters to the committees of the board set up for the purpose.
Committees review items in great detail before it is placed before the Board for its
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consideration. These committees prepare the groundwork for decision making and report at
the subsequent board meeting.
VARIOUS COMMITTEES OF THE BOARD
The following are some of the important committees of the Board-
1. AUDIT COMMITTEE
The Audit Committee shall assist the Board of Directors in the oversight of
(1) The integrity of the financial statements of the Company,
(2) The effectiveness of the internal control over financial reporting,
(3) The independent registered public accounting firm’s qualifications and independence,
(4) The performance of the Company’s internal audit function and independent registered
public accounting firms,
(5) The Company’s compliance with legal and regulatory requirements,
(6) The performance of the Company’s compliance function.
Organization and Membership: The Committee shall be appointed by the Board and consist
of at least three Directors, each of whom are independent of management and the Company
as defined by the Bylaws of the Company, the SEC and the New York Stock Exchange as
well as Clause 49 of the Listing Agreement. Two thirds of the members shall be independent
directors.
All Committee members shall be financially literate, or shall become financially literate
within a reasonable period of time after appointment to the Committee. The Committee shall
aspire to have at least one member who is an “audit committee financial expert” as such term
is defined by the SEC.
The Chairman of the Committee shall be an independent director. No Director may serve as a
member of the Committee if such Director serves on the audit committees of more than two
other public companies unless the Board determines that such simultaneous service would not
impair such Director’s ability to serve effectively on the Committee. The Board shall
designate one member of the Committee as its Chairman. Directors will serve the Committee
at the pleasure of the Board and for such terms as the Board may determine. The Committee
shall meet at least quarterly and otherwise as the members of the Committee deem
appropriate. Minutes shall be kept of each meeting of the Committee.
Meeting of Audit Committee: The audit committee shall meet at least thrice a year. One
meeting shall be held before finalization of annual accounts and one every six months. The
quorum shall be either two members or one third of the members of the audit committee,
whichever is higher and minimum of two independent directors
Powers of Audit Committee: The audit committee shall have powers which should include
the following:
 To investigate any activity within its terms of reference.
 To seek information from any employee.
 To obtain outside legal or other professional advice.
 To secure attendance of outsiders with relevant expertise, if it considers necessary.
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Role of Audit Committee: The role of the audit committee shall include the following:
 Oversight of the company’s financial reporting process and the disclosure of its
financial information to ensure that the financial statement is correct, sufficient and
credible.
 Recommending the appointment and removal of external auditor, fixation of audit fee
and also approval for payment for any other services.
 Reviewing with management the annual financial statements before submission to the
board, focusing primarily on;
 Any changes in accounting policies and practices.
 Major accounting entries based on exercise of judgment by management.
 Qualifications in draft audit report.
 Significant adjustments arising out of audit.
 The going concern assumption.
 Compliance with accounting standards.
 Compliance with stock exchange and legal requirements concerning financial
statements
 Any related party transactions
 Reviewing with the management, external and internal auditors, the adequacy of
internal control systems.
 Reviewing the adequacy of internal audit function, including the structure of the
internal audit department, staffing and seniority of the official heading the
department, reporting structure coverage and frequency of internal audit.
 Discussion with internal auditors any significant findings and follow up there on.
 Reviewing the findings of any internal investigations by the internal auditors into
matters where there is suspected fraud or irregularity or a failure of internal control
systems of a material nature and reporting the matter to the board.
 Discussion with external auditors before the audit commences about nature and scope
of audit as well as post-audit discussion to ascertain any area of concern.
 Reviewing the company’s financial and risk management policies.
 To look into the reasons for substantial defaults in the payment to the depositors,
debenture holders, shareholders (in case of non payment of declared dividends) and
creditors.
Review of information by Audit Committee: The Audit Committee shall mandatorily review
the following information:
 Financial statements and draft audit report, including quarterly / half-yearly financial
information;
 Management discussion and analysis of financial condition and results of operations;
 Reports relating to compliance with laws and to risk management;
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 Management letters/ letters of internal control weaknesses issued by statutory/ internal
auditors; and
 Records of related party transactions
 The appointment, removal and terms of remuneration of the Chief internal auditor
shall be subject to review by the Audit Committee.
2. SHARE HOLDERS GRIEVANCE COMMITTEE
In terms of Clause 49-IV(G)(iii) of the Listing Agreement, a board committee under the
chairmanship of a non-executive director shall be formed to specifically look into the
redressal of shareholder and investors complaints like transfer of shares, non-receipt of
balance sheet, non-receipt of declared dividends etc. This committee shall be designated as
“Shareholders/ Investors Grievance Committee”.[ix]
The terms of reference of our Shareholders’/ Investors Grievance Committee are given
below:
“To allot the Equity Shares of the Company, and to supervise and ensure:
 Efficient transfer of shares; including review of cases for refusal of transfer
transmission of shares and debentures;
 Redressal of shareholder and investor complaints like transfer of shares, non-receipt
of balance sheet, non-receipt of declared dividends etc;
 Issue of duplicate / split / consolidated share certificates;
 Allotment and listing of shares;
 Review of cases for refusal of transfer / transmission of shares and debentures;
 Reference to statutory and regulatory authorities regarding investor grievances; and to
otherwise ensure proper and timely attendance and redressal of investor queries and
grievances.”[x]
The Shareholders/ Investor Grievances Committee looks into redressal of shareholder and
investor complaints, issue of Duplicate/ Consolidated Share Certificates, Allotment and
Listing of shares and review of cases for refusal of Transfer/ Transmission of shares and
debentures and reference to Statutory and Regulatory Authorities. The scope and functions of
the Shareholders/Investor Grievances Committee are as per Clause 49 of the Listing
Agreement.
3. REMUNERATION COMMITTEE
The role of a Remuneration Committee is:
 To decide and approve the terms and conditions for appointment of executive
directors and/ or whole time Directors and Remuneration payable to other Directors
and matters related thereto.
 To recommend to the Board, the remuneration packages of the Company’s
Managing/Joint Managing/ Deputy Managing/Whole time / Executive Directors,
including all elements of remuneration package (i.e. salary, benefits, bonuses,
perquisites, commission, incentives, stock options, pension, retirement benefits,
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details of fixed component and performance linked incentives along with the
performance criteria, service contracts, notice period, severance fees etc.);
 To be authorized at its duly constituted meeting to determine on behalf of the Board
of Directors and on behalf of the shareholders with agreed terms of reference, the
Company’s policy on specific remuneration packages for Company’s Managing/Joint
Managing/ Deputy Managing/ Whole-time/ Executive Directors, including pension
rights and any compensation payment;
 To implement, supervise and administer any share or stock option scheme of the
Company.[xii]
 to review the overall compensation policy, service agreements and other employment
conditions to Executive Directors and senior executives just below the Board of
Directors and make appropriate recommendations to the Board of Directors;
 to review the overall compensation policy for Non-Executive Directors and
Independent Directors and make appropriate recommendations to the Board of
Directors;
 to make recommendations to the Board of Directors on the increments in the
remuneration of the Directors;
 to assist the Board in developing and evaluating potential candidates for senior
executive positions and to oversee the development of executive succession plans;
 to review and approve on annual basis the corporate goals and objectives with respect
to compensation for the senior executives and make appropriate recommendations to
the Board of Directors;
 to review and make appropriate recommendations to the Board of Directors on an
annual basis the evaluation process and compensation structure for our Company’s
officers just below the level of the Board of Directors;
 to provide oversight of the management’s decisions concerning the performance and
compensation of other officers of our Company;
4. RISK COMMITTEE
The committee comprises a minimum of three independent non-executive directors, as well
as the chief executive and financial director. The chair of the board may not serve as chair of
this committee. Members of the committee are individuals with risk management skills and
experience. The committee’s responsibilities include:
 Review and approve for recommendation to the board a risk management policy and
plan developed by management. The risk policy and plan are reviewed annually.
 Monitor implementation of the risk policy and plan, ensuring an appropriate
enterprise- wide risk management system is in place with adequate and effective
processes that include strategy, ethics, operations, reporting, compliance, IT and
sustainability.
 Make recommendations to the board on risk indicators, levels of risk tolerance and
appetite.
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 Monitor that risks are reviewed by management, and that management’s responses to
identified risks are within board-approved levels of risk tolerance.
 Ensure risk management assessments are performed regularly by management.
 Issue a formal opinion to the board on the effectiveness of the system and process of
risk management.
 Review reporting on risk management that is to be included in the integrated annual
report.
 Review annually the charters of the group’s significant subsidiary companies’ risk
committees, and their annual assessment of compliance with these charters to
establish if the Naspers committee can rely on the work of these risk committees.
 Perform an annual self-assessment of the effectiveness of the committee, reporting
these findings to the board.[xiv]
5. NOMINATION COMMITTEE
The primary role of the Nomination Committee of the board is to assist the board by
identifying prospective directors and make recommendations on appointments to the board
and the senior most level of executive management below the board. The committee also
clears succession plans for these levels.[xv] The Nomination Committee is responsible for
making recommendations on board appointments and on maintaining a balance of skills and
experience on the board and its committees.
Succession planning for the board is a matter which is devolved primarily to the Nomination
Committee, although the committee’s deliberations are reported to and debated by the full
board. The board itself also regularly reviews more general succession planning for the senior
management of the group.[xvi]
6. CORPORATE GOVERNANCE COMMITTEE
Together with the audit and compensation committees, the nominating/corporate governance
committee rounds out the three standing committees of a public company’s board of
directors. It plays a critical role in overseeing matters of corporate governance for the board,
including formulating and recommending governance principles and policies. As its name
implies, this committee is charged with enhancing the quality of nominees to the board and
ensuring the integrity of the nominating process. Given the recent focus on board
composition and diversity, director elections, and proxy access, the role of
nominating/corporate governance committee is in the spotlight.[xvii]
7. CORPORATE COMPLIANCE COMMITTEE
The primary Objective of the Compliance Committee is to review, oversee and monitor:
 The company’s compliance with applicable legal and regulatory requirements.
 The company’s policies, programs, and procedures to ensure compliance with
relevant laws, the company’s code of conduct, and other relevant standards
 The company’s efforts to implement legal obligations arising from settlement
agreements and other similar documents
 Perform any other duties as are directed by the board of directors of the company.
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The committee’s specific responsibilities in this area include:
 Overseeing the corporate compliance program, including policies and practices
designed to ensure the organization’s compliance with all applicable legal, regulatory,
and ethical requirements.
 Recommending approval of the annual corporate compliance plan and reviewing
processes and procedures for reporting concerns by employees, physicians, vendors,
and others.
 Recommending organizational integrity guidelines and a Code of Conduct.
 Reviewing and reassessing the guidelines and Code of Conduct at least
annually[xviii]
8. ETHICS COMMITTEE
The possible roles for an Ethics Committee are:
 Contribute to the continuing definition of the organization’s ethics and compliance
standards and procedures.
 Assume responsibility for overall compliance with those standards and procedures.
 Oversee the use of due care in delegating discretionary responsibility.
 Communicate the organization’s ethics and compliance standards and procedures,
ensuring the effectiveness of that communication.
 Monitor and audit compliance.
 Oversee enforcement, including the assurance that discipline is uniformly applied.
 Take the steps necessary to ensure that the organization learns from its experiences.
But an ethics committee can do much more. The committee can be charged to meet all seven
requirements for an effective ethics management process. For each of the above arenas of
responsibility there may be several specific roles.[xix]
11.8 CHARACTERISTICS OF AN EFFECTIVE BOARD
a. Well-functioning Boards are teams led by the Chairman
b. The Board of a public Company must be carefully selected and managed, taking into
account group dynamics and the needs of the business.
c. Succession planning is very important and a clear policy needs to be documented.
d. A well refined Corporate strategy is most likely to be developed by a Board and
delivered by an executive team, and encouraged by the Chairman, to work together
for the benefit of all stakeholders.
CHAIRMAN ROLE
a. The role of the Chairman has become much higher in profile and the expectations
have increased as quite rightly, shareholders now expect an engaged, energetic,
charismatic and involved Chairman who does more than simply manage the
Corporate Governance process.
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b. The success of a Chairmanship undoubtedly hinges on the relationship the Chairman
has with the CEO, a relationship which should be centred on honesty, trust and
transparency. The success of the relationship is based on mutual understanding, by
both parties of the distinction between their two roles.
c. Effective Chairmen must have a good knowledge of the business to provide a
constructive level of challenge to the CEO.
d. Chairmen need to comprehend that they are not there to run the business. Their role is
to support and guide. To ensure that the Business is well run but not to run the
business.
e. What ultimately defines a good Chairman is the ability to run an effective Board and
to manage relationships with both shareholders and stakeholders.
CEO ROLE
a. The role of the CEO is to run the day-to-day business of the Company
b. To communicate with the Chairman and Board
c. To gain the confidence of the Board
d. To be responsible for ensuring that the Business Plan and Vision for the Company is
achieved and that the business is well managed
ARTICULATING STRATEGY OF THE COMPANY
a. Each Director should be capable of articulating internally
b. The Company strategy and the manner in which it will be delivered
c. How the Corporate Governance structure facilitates decision making
d. Why the structure is appropriate for the Company
BOARD EVALUATIONS
a. The Chairman should work to maximise the effectiveness of each Board member for
the benefit of the Company as a whole
b. Open and honest Board evaluation is an opportunity for the Board to improve its
performance
AN EFFECTIVE BOARD INFORMS AND ENGAGES WITH SHAREHOLDERS
a. The Chairman must ensure that the Company has in place, effective lines of
communications with all shareholders, institutional and individual.
b. Communication must be dynamic, encouraging both discussion and feed back
EFFECTIVE BOARDS HAS A BALANCE OF SKILLS
The composition of the Board should demonstrate to its shareholders that it has the right mix
of skills and experiences to deliver the strategy of the Company, for the benefit of the
shareholders as a whole
DIRECTORS INDEPENDENCE
a. It may not be possible for SMEs to meet all the independence criteria
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b. A Company should have at least two independent Non-Executive Directors and in a
small Company, the Chairman may count as one of the independent Directors,
provided he/she was independent at the time of his/her appointment
INDEPENDENT AND MAJOR SHAREHOLDERS
Directors who are or connected with a major shareholder is an issue of significant concern.
Therefore, Boards including Directors associated with major shareholders should clearly
explain to shareholders the reasons for them sitting on the Board
COMPOSITION OF THE BOARD
a. A balanced Board of a listed Company would consist of:
i) A Non-Executive Chairman
ii) Non-executive Directors – usually two (one of whom may be the Chairman)
iii) Executive Directors
b. Independent NEDs are important as they provide the appropriate oversight to deliver
the strategy of the Company for the benefit of shareholders as a whole.
Independence can be defined as independence of character and judgement, and being able to
demonstrate this to shareholders in an objective manner.
c. The qualities required in my opinion
i) Good interpersonal skills
ii) Sound Judgement
iii) Ability to influence
iv) Integrity
v) The independence and conviction to say things that need saying when necessary
d. The NEDs usually chair and sit on the following committees
i) Audit Committee
ii) Risk Committee
iii) Remuneration committee
iv) Nominations Committee
CULTURE
The FRC recently came out with a report which looked at the increasing importance which
Corporate culture plays in delivering long term business and economic success. The FRC
believes that Company Boards
i) Should be connecting their purpose and strategy to culture
ii) Aligning values and incentives which support and encourage positive behaviours
consistent with the Company’s purpose, values, strategy and business model
iii) Assessing, measuring and reporting on Company culture in annual financial
statements.
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SUMMARY
1. Committees are usually formed as a means of improving board effectiveness and
efficiency, in areas where more focused, specialized and technical discussions are
required.A board committee is a small working group identified by the board,
consisting of board members, for the purpose of supporting the board’s work.
2. Committees often serve several different functions: Governance, Coordination,
Research and recommendation.
3. Board Committees may be standing committees; or ad hoc committees that cease
when the activities are completed. Standing committees should be included in the
articles or by- laws.
4. The Board may appoint the committee chairman or the committee members can
choose/elect the chairman.The role of committee chairman requires extra work, time
for communication with committee members and senior management so that he
remains informed about the developments and a willingness to resolve conflicts
among members.
The following are some of the important committees of the Board- Audit Committee,
Shareholder Grievance Committee, Remuneration Committee, Risk Committee, Nomination
Committee, Corporate Governance Committee, Corporate Compliance Committee, Ethics
Committee
FILL IN THE BLANKS
1. ……………………. is one way of managing the work of the board, there by
strengthening the board’s governance role.
2. Committees are often formed to do research and make ………………………
………………..
3. The committee chairmanis the key to an effective committee, he sets the
………………………..............
4. The Board may delegate any of its powers to committees consisting
……………………..
5. The risk committee comprises a minimum …………………………………………….
1. Which of the following is a reason of an increase use of board committees.
(i) Specialized skills of members can be used to best advantage
(ii) Responsibilities are shared
(iii) Inexperienced members gain confidence
2. Which of the following is a function of board committees
(i) Research and recommendations
(ii) Coordination
(iii)Governance
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3. Which of the following is a role of individual committee member-
(i) Upholding the values of organisation
(ii) Giving ad equate time
(iii) Avoiding personal conflicts of interest
(iv) All of above
4. To look after/administer/support Board members and committee members and other
executive positions, which type of committee formed-
(i) Board development or Governance Committee
(ii) Safety, Health & Environment Committee
(iii) Committee of Inquiry
(iv) Risk Management Committee
5. Which of the following committees is related to the investor protection?
(i) Bhagwati Committee
(ii) N. k. Mitra Committee
(iii) J. R Verma Committee
(iv) L. C Gupta Committee
1. Explain board committee and its significance.
2. Briefly explain committee management.
3. Explain the various committees of the board.
4. Explain the characteristics of an effective board.
5. Differentiate between corporate compliance committee &corporate governance
committee.
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CHAPTER-12
CREDIT RATING AGENCIES AND PROXY ADVISORY FIRMS
12.1 Credit Rating Agencies

12.1.1 Meaning
12.1.2 Characteristics of CRA
12.1.3 Functions of CRA
12.1.4 Advantages of CRA
12.1.5 Compulsory Credit Rating
12.1.6 Factors considered in Credit Rating
12.1.7 Credit Rating Process
12.1.8 Types of Credit Rating
12.1.9 CRA in India
12.2 Proxy Advisory Firms
12.2.1 Meaning
12.2.2 Evolution of Proxy Advisory Firms
12.2.3 Functions of Proxy Advisory Firms
12.2.4 Driving Force for Corporate Governance
12.2.5 SEBI Rules related to Proxy Advisory Firms
12.2.6 New Procedural Guidelines for Proxy Advisory Firms
12.2.7 Grievances regarding mechanism for Listed Companies
12.2.8 Challenges faced by Proxy Advisory Industry
12.1 CREDIT RATING AGENCIES

12.1.1 MEANING
A credit rating is a quantified assessment of the creditworthiness of a borrower in general
terms or with respect to a particular debt or financial obligation. A credit rating can be
assigned to any entity that seeks to borrow money—an individual, corporation, state or
provincial authority, or sovereign government.
Individual credit is scored from by credit bureaussuc has Experian and Trans Union on a 3-
digit numerical scale using a form of Fair Isaac (FICO) credit scoring. Credit assessment and
evaluation for companies and governments is generally done by a credit rating agency such as
Standard & Poor’s (S & P), Moody’s, or Fitch. These rating agencies are paid by the entity
that is seeking a credit rating for itself or for one of its debt issues.
Thus, Credit rating is an analysis of the credit risks associated with a financial instrument or
a financial entity. It is a rating given to a particular entity based on the credentials and the
extent to which the financial statements of the entity are sound, interms of borrowing and
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lending that has been done in the past.
How Credit Rating Works
A loan is a debt—essentially a promise, often contractual, and a credit rating determines the
likelihood that the borrower will be able and willing to pay back a loan within the confines of
the loan agreement, without defaulting. A high credit rating indicates a high possibility of
paying back the loan in its entirety without any issues; a poor credit rating suggests that the
borrower has had trouble paying back loans in the past and might follow the same pattern in
the future. The credit rating affects the entity’s chances of being approved for a given loan or
receiving favorable terms for said loan.
Credit ratings apply to businesses and government, while credit scores apply only to
individuals. Credit scores are derived from the credit history maintained by credit-reporting
agencies such as Equifax, Experian, and Trans Union. An individual’s credit score is reported
as a number, generally ranging from 300 to 850. Similarly, sovereign credit ratings apply to
national governments, while corporate credit ratings apply solely to corporations. (For related
reading, see “Credit Rating vs. Credit Score: What’s the Difference?”)
A short-term credit rating reflects the likelihood of the borrower defaulting within the year.
This type of credit rating has become the norm in recent years, where as in the past, long-
term credit ratings were more heavily considered. Long-term credit ratings predict the
borrower’s likelihood of defaulting at any given time in the extended future.
Credit rating agencies typically assign letter grades to indicate ratings. Standard & Poor’s, for
instance, has a credit rating scale ranging from AAA (excellent) to C and D. A debt
instrument with a rating below BB is considered to be a speculative grade or a junk bond,
which means it is more likely to default on loans.
12.1.2 CHARACTERISTICSOFCREDITRATING
1. Assessment of issuer’s capacity to repay. It assesses issuer’s capacity to meet its
financial obligations i.e., its capacity to pay interest and repay the principal amount
borrowed.
2. Based on data. A credit rating agency assesses financial strength of the borrower on
the financial data.
3. Expressed in symbols. Ratings are expressed in symbol se. g. AAA, BBB which can
be understood by a layman too.
4. Done by expert. Credit rating is done by expert of reputed, accredited institutions.
5. Guidance about investment-not recommendation. Credit rating is only a guidance
to investors and not recommendation to invest in any particular instrument.
12.1.3 1FUNCTIONS/IMPORTANCEOFCREDITRATING
1. It provides unbiased opinion to investors. Opinion of good credit rating agency is
unbiased because it has no vested interest in the rated company.
2. Provide quality and dependable information. Credit rating agencies employ highly
qualified, trained and experienced staff to assess risks and they have access to vital
and important information and therefore can provide accurate information about credit
worthiness of the borrowing company.
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3. Provide information in easy to understand language. Credit rating agencies gather
information, analyse and interpret it and present their findings in easy to understand
language that is in symbols like AAA, BB, C and not in technical language or in the
form of lengthy reports.
4. Provide information free of cost or at nominal cost. Credit ratings of instruments
are published in financial newspapers and advertisements of the rated companies. The
public has not to pay for them. Even otherwise, anybody can get them from credit
rating agency on payment of nominal fee. It is beyond the capacity of individual
investors together such information at their own cost.
5. Helps investors in taking investment decisions. Credit ratings help investors in
assessing risks and taking investment decision.
6. Disciplines corporate borrowers. When a borrower gets higher credit rating, it
increases its good will and other companies also do not want to lag behind in ratings
and inculcate financial discipline in their working and follow ethical practice to
become eligible for good ratings, this tendency promotes healthy discipline among
companies.
7. Formation of public policy on investment. When the debt instruments have been
rated by credit rating agencies, policies can be laid down by regulatory authorities
(SEBI, RBI) about eligibility of securities in which funds can be invested by various
institutions like mutual funds, provident funds trust etc.
12.1.4 ADVANTAGES OF CREDIT RATING AGENCIES
BENEFITSTOINVESTORS
1. Assessment of risk. The investor through credit rating can assess risk involved in an
investment. A small individual investor does not have the skills, time and resources to
undertake detailed risk evaluation himself. Credit rating agencies who have expert
knowledge, skills and manpower to study these matters can do this job for him.
Moreover, the ratings which are expressed in symbols like AAA, BB etc. can be
understood easily by investors.
2. Information at low cost. Credit ratings are published in financial newspapers and are
available from rating agencies at nominal fees. This way the investors get credit
information about borrowers at no or little cost.
3. Advantage of continuous monitoring. Credit rating agencies do not normally
undertake rating of securities only once. They continuously monitor them and upgrade
and down grade the ratings depending upon changed circumstances.
4. Provides the investors a choice of Investment. Credit ratings agencies helps the
investors to gather information about creditworthiness of different companies. So,
investors have a choice to invest in one company or the other.
5. Ratings by credit rating agencies is dependable. A rating agency has no vested
interest in a security to be rated and has no business links with the management of the
issuer company. Hence ratings by them are unbiased and credible.
BENEFITSTOTHERATEDCOMPANY
1. Ease in borrowings. If a company gets high credit rating for it ssecurities, it can raise
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funds with more ease in the capital market.
2. Borrowing at cheaper rates. A favorably rated company enjoys the confidence of
investors and therefore, could borrow at lower rate of interest.
3. Facilitates growth. Encouraged by favorable rating, promoters are motivated to go in
for plans of expansion, diversification and growth. Moreover, highly rated companies
find it easy to raise funds from public through issue of ownership or credit securities
in future. They find it easy to borrow from banks.
4. Recognition of lesser-known companies. Favorable credit rating of instruments of
lesser known or unknown companies provides them credibility and recognition in the
eyes of the investing public.
5. Adds to the goodwill of the rated company. If a company is rated high by rating
agencies it will automatically increase its good will in the market.
BENEFITSTOINTERMEDIARIES
1. Merchant bankers’ and brokers’ job made easy. In the absence of credit rating,
merchant bankers or brokers have to convince the investors about financial position of
the borrowing company. If a borrowing company’s credit rating is done by a reputed
credit agency, the task of merchant bankers and brokers becomes much easy.
BENEFITSTOTHEBUSINESSWORLD
1. Increase in investor population. If investors get good guidance about investing the
money in debt instruments through credit ratings, more and more people are encouraged
to invest their savings in corporate debts.
2. Guidance to foreign investors. Foreign collaborators or foreign financial institutions
will invest in those companies only whose credit rating is high. Credit rating will enable
them to instantly identify the position of the company.
12.1.5 COMPULSORY CREDIT RATING
Obtaining credit rating is compulsory in the following cases:
1. For debt securities. The Reserve Bank of India and SEBI have made credit rating
compulsory in respect of all non-government debt securities where the maturities
exceed 18 months.
2. Public deposits. Rating of deposits in companies has also been made compulsory.
3. For commercial papers (CPs). Credit rating has also been made compulsory for
commercial papers. As per Reserve Bank of India guidelines rating of P2 by CRISIL or
A2 by ICRA or PP2 by CARE is necessary for commercial papers.
4. For fixed deposits with non-banking financial institutions (NBFCs). Under the
Companies Act, credit rating has been made compulsory for fixed deposits with NBFs.
12.1.6 FACTORSCONSIDEREDINCREDITRATING
1. Issuer’s ability to service its debt. For this credit rating agencies calculate
a) Issuer Company’s past and future cash flows.
b) Assess how much money the company will have to pay as interest on borrowed
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funds and how much will be its earnings.
c) How much are the outstanding debts?
d) Company’s short term solvency through calculation of current ratio.
e) Value of assets pledged as collateral security by the company.
f) Availability and quality of raw material used, favorable location, cost advantage.
g) Track record of promoters, directors and expertise of the staff.
2. Market position of the company. What is the market share of various products of the
company, whether it will be stable, does the company possess competitive advantage
due to distribution network, customer base research and development facilities etc.
3. Quality of management. Credit rating agency will also take into consideration track
record, strategies, competency and philosophy of senior management.
4. Legal position of the instrument. It means whether the issued instrument is legally
valid, what are the terms and conditions of issue and redemption; how much the
instrument is protected from frauds, what are the terms of debenture trust deed etc.
5. Industry risks. Industry risks are studied in relation to position of demand and supply
for the products of that industry (e.g. cars or electronics) how much is the international
competition, what are the future prospects of that industry, is it going to dieorexpand?
6. Regulatory environment. Whether that industry is being regulated by government
(likelyqu or industry), whether there is a price control on it, whether there is
government support for it, can it take advantage of tax concessions etc.
7. Other factors. In addition to the above, the other factors to be noted for credit rating
of a company are its cost structure, insurance cover undertaken, accounting quality,
market reputation, working capital management, human resource quality, funding
policy, leverage, flexibility, exchange rate risks etc.
12.1.7 CREDIT RATING PROCESS
In India credit rating is done mostly at the request of the borrowers or issuer companies. The
borrower or issuer company requests the credit rating agency for assigning a ranking to the
proposed instrument. The process followed by most of the credit rating agencies is as
follows:
1. Agreement. An agreement is entered into between the rating agency and the issuer
company. It covers details about terms and conditions for doing the rating.
2. Appointment of analytical team. The rating agency assigns the job to a team of
experts. The team usually comprises of two analysts who have expert knowledge in the
relevant business area and is responsible for carrying out rating.
3. Obtaining information. The analytical team obtains the required information from
the client company and studies company’s financial position, cash flows, nature and
basis of competition, market share, operating efficiency arrangements, managements
track cost structure, selling and distribution record, power (electricity) and labour
situation etc.
4. Meeting the officials. To obtain clarifications and understanding the client’s business
165
the analytical team visits and interacts with the executives of the client.
5. Discussion about findings. After completion of study of facts and their analysis by
the analytical team the matter is placed before the internal committee (which
comprises of senior analysts) an opinion about the rating is taken.
6. Meeting of the rating committee. The findings of internal committee are referred to
the “rating committee” which generally comprises of a few directors and is the final
authority for assigning ratings.
7. Communication of decision. The rating decided by the rating committee is
communicated to the requesting company.
8. Information to the public. The rating company publishes the rating through reports
and the press.
9. Revision of the rating. Once the issuer company has accepted the rating, the rating
agency is under an obligation to monitor the assigned rating. The rating agency
monitors all ratings during the life of the instrument.
12.1.8 TYPESOFCREDITRATING
1. Rating of bonds and debentures. Rating is popular in certain cases for bonds and
debentures. Practically, all credit rating agencies are doing rating for debentures and
bonds.
2. Rating of equity shares. Rating of equity shares is not mandatory in India but credit
rating agency ICRA has formulated a system for equity rating. Even SEBI has no
immediate plans for compulsory credit rating of initial public offerings (IPOs).
3. Rating of preference shares. In India preference shares are not being rated, however
Moody’s Investor Service has been rating preference shares since 1973 and ICRA has
provision for it.
4. Rating of medium term loans (Public deposits, CDs etc.). Fixed deposits taken by
companies are rated on regular scale in India.
5. Rating of short-term instruments [Commercial Papers (CPs). Credit rating of short
term instruments like commercial papers has been started from 1990. Credit rating for
CPs is mandatory which is being done by CRISIL, ICRA and CARE.
6. Rating of borrowers. Rating of borrowers, may be an individual or a company is
known as borrower’s rating.
7. Rating of real estate builders and developers. A lot of private colonisers and flat
builders are operating in big cities. Rating about them is done to ensure that they will
properly develop a colony or build flats. CRISIL has started rating of builders and
developers.
8. Rating of chit funds. Chit funds collect monthly contributions from savers and give
loans to those participants who offer highest rate of interest. Chit funds are rated on
the basis of their ability to make timely payment of prize money to subscribers.
CRISIL does credit rating of chit funds.
9. Ratings of insurance companies. With the entry of private sector insurance
companies, credit rating of insurance companies is also gaining ground. Insurance
166
companies are rated on the basis of their claim paying ability (whether it has high,
adequate, mode rate or weak claim-paying capacity). ICRA is doing the work of rating
insurance companies.
10. Rating of collective investment schemes. When funds of a large number of investors
are collectively invested in schemes, these are called collective investment schemes.
Credit rating about them means (assessing) whether the scheme will be successful or
not. ICRA is doing credit rating of such schemes.
11. Rating of banks. Private and cooperative banks have been failing quite regularly in
India. People like to deposit money in banks which are financially sound and capable
of repaying back the deposits. CRISIL and ICRA are now doing rating of banks.
12. Rating of states. States in India are now being also rated whether they are fit for
investment or not. States with good credit ratings are able to attract investors from
within the country and from abroad.
13. Rating of countries. Foreign investors and lenders are interested in knowing there
paying capacity and willingness of the country to repay loans taken by it. They want
to make sure that investment in that country is profitable or not. While rating a
country the factors considered are its industrial and agricultural production, gross
domestic product, government policies, rate of inflation, extent of deficit financing
etc. Moody’s, and Morgan Stanley are doing rating of countries.
12.1.9 CREDIT RATING AGENCIES IN INDIA
There are 6 credit rating agencies which are registered with SEBI. These are CRISIL, ICRA,
CARE, Fitch India, Brick work Ratings, and SMERA.
12.2 PROXY ADVISORY FIRMS
12.1.1. MEANING
Proxy advisory firms provide analysis and voting recommendations to shareholders of
publicly traded companies. Their main clients are institutional investors, who either don’t
have enough information with respect to a voting matter or don’t want to spend time and
resources in analysing issues related to companies in their portfolio.
The appointment of proxy advisors also prevents duplication of efforts across multiple
investor firms and makes economic sense as it centralizes the costs associated with analysing
each voting proposition. An important aspect of proxy advisory firms is their relationship
with activist investors, who seek to make company management more responsive towards the
needs of shareholders or towards environmental, social or governance concerns.
Since institutional investors mostly vote in the manner the proxy advisory firms recommend,
these firms could induce a change in the management, company policies or the entire
structure of the company. Hence, proxy advisors act as a check on the decision-making by the
management of a company. However, a number of criticisms have become associated with
the functioning of a proxy advisor. For instance, they are not held to a fiduciary standard that
would require them to show their actions are in the interests of the shareholders as well as the
company.
Proxy advisory firms are relatively new institutions in the corporate landscape but they play
an imperative role and have gained popularity among the shareholders of the company.
167
According to Regulation 2(1)(p) of the SEBI (Research Analysts) Regulations, 2014, ‘proxy
advisor’ refers to any individual or any organization that prepares recommendations and
gives advice for the institutional investors or shareholders so as to aid them in the casting of
their vote in respect of any policy issues or a public offer.
These are independent research outfits that weigh all the pros and cons of any decision and
thus provide research and voting recommendations for their clients. Generally, only the
directors decide upon the everyday issues of the company but as shareholders are the real
owners of the company, they also vote on the crucial matters of the company. Some
shareholders are mainly concerned about the profits (dividends, interests, etc) and thus are
not well-acquainted about the issues, policies, and notices of the company and thus need an
independent analyst to evaluate the decision taken by the company and here the proxy
advisory firms act as a helping hand and provide recommendations to shareholders according
to which they can cast their vote on issues such as executive compensation, corporate
governance, etc.
Also, if proxy advisors are providing other consulting services to the company, then there
may be conflicts of interest with regards to their voting recommendations. Another criticism
is that not all advisors have the necessary resources to accurately investigate each matter that
is up for consideration. Lastly, proxy advisory firms are prone to over-interfere in the matters
of the company to push their own agendas and thereby derail the functioning of the company
concerned.
12.2.2 EVOLUTION OF PROXY ADVISORY FIRMS
At first, when the companies were formed, the best possible way to have a unanimous
decision was voting and for this purpose the physical presence of all the members was
necessary. This is not a practical situation to have every member in the meeting every time
because people buy shares through the share market and do not have any personal access to
the firm. Moreover, because of the global market, even foreigners invest in the companies,
and thus it is not feasible for everyone to cast their votes physically and it is a cumbersome
and expensive process even for the firms to follow. These reasons lead to the evolution of the
concept of ‘proxy’ in which one person was appointed to represent the other and the proxy
has the power to vote on the behalf of the shareholder if the shareholder authorized the proxy
for the same and this emerged as a more convenient way of voting.
This mechanism of voting evolved according to the needs of society and the proxy advisory
firms came into the picture that acted as third-party consultants and provided expert advice
and recommendations on whether to vote ‘for’ or against’ the motion decided in the
company. Basically, these firms are products of shareholders’ activism that have boomed
because of unscrupulous corporate governance in the organizations. Their main aim is to
provide counseling to the shareholders but they can also be given the right to vote if they are
expressly authorized by the stockholders.
This system was prevalent in the USA’s financial market from the 1980s but in India, the
proxy advisory industry was even invisible during the 2000s. In 2009, when the Satyam
scam took place, the entire financial market shivered. SEBI incorporated several steps to
prevent these scandals and one such measure was the passing of the Securities and Exchange
Board of India (Mutual Funds) (Amendment) Regulations, 2010 in July 2010. This regulation
demanded more transparency in the voting and disclosure of the norms followed to determine
the voting right of the shareholders. This regulation by SEBI and as already there was a rise
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in shareholder’s activism and indulgence, investment climate was becoming more common
day by day, leading to the beginning of the proxy advisory industries in India. The ‘InGovern
Research Services’ was the first proxy advisory firm of India started by Mr. Shriram
Subramanian in June 2010. Since then, several firms like the Institutional Investors Advisory
Services (IIAS), Stakeholders Empowerment Services (SES), etc have been incepted and
enormous growth of these firms has been recorded.
12.2.3 FUNCTIONS OF ADVISORY FIRMS
 The major task is proxy advisory i.e. advising on the intricate matters of the company.
 They aid shareholders in exercising their voting rights in the company in significant
decisions like the appointment of the directors, changes in the policies of the
company, etc.
 To provide a report that is basically a scorecard or rating on the corporate governance
of the entity.
 To provide the Environmental, Social, and Governance (ESG) analysis. ESG analysis
is done to study all the factors (environmental, social, and governance) of the
company to calculate all the prospective growth opportunities and threats. It helps the
company and shareholders to prepare accordingly.
 To monitor risks and protect the interests of the investors.
12.2.4 DRIVING FORCE FOR CORPORATE GOVERNANCE
The proxy firms act as the shaping tool that helps in complying with the stringent corporate
governance norms. Investors are drivers of corporate governance and they are assisted by
these proxy firms to understand the agendas of the company, to provide them with analysis of
different proposals and voting decisions of the company. Basically, they can guide them in
every decision that is to be taken by the investors regarding the company. Corporate bodies
also need to adhere to these recommendations otherwise it could negatively impact their
reputation and adversely affect the confidence of the investors which may lead to a decline in
share price, fewer funds, etc. There are several examples where the proxy advisors’
recommendations helped in the administration of better governance policies in the
companies. For instance, the Global Funds advised against the appointment of Deepak Parekh
as the non-executive chairman of HDFC as he was already on board of eight companies as
they were of the view that he would not be able to handle all positions judiciously at the same
time. Another situation where the InGovern advised against the appointment of B.C.
Prabhakar as independent Director in Wipro, against Shardul Shroff in IDFC, and against
S.H. Khan as ID of IDBI stating that they are in the same position for several years and
remarked that their relationship is like, ‘if they are married to the company’. Another reason
for such negative recommendations was the introduction of clause 49 in the Equity Listing
Agreement between SEBI and listed companies. Thus, proxy advisors through their
recommendations ensure the efficient functioning of the company.
Recommendations drive companies to follow good governance policies
Their reports help the companies to build their reputation and trust among the shareholders. If
the report showcases a positive report of the company regarding their decisions and legal
compliance, then this would attract investor’s confidence in the company. This helps in more
investments in the company. Thus, companies tend to follow good governance policies so
169
that the recommendations drafted by the proxy advisors favor them. Generally, it is seen that
shareholders like to invest in the companies that fall under the jurisdiction of these advisory
firms because they could access insider information and the status of the company which
would otherwise not have been available for the investors.
Watchdogs for the companies
They act as the watchdog for the corporate bodies. They keep a check on companies whether
they are adhering to the rules and regulations and working in the interest of shareholders.
Earlier investors only acted as passive members in the firm and because of this they were not
able to analyze the pros and cons of the changes made in the organization and this affected
them adversely. But this whole situation has been transformed by these advisors as now any
matter that is against the interests of the shareholders can be called out by them and the same
has to be considered by the company. Like in the case of Lavasa, where AjitGulabchand was
receiving the salary five times than what was allowed by the Central government without any
express sanction of the shareholders, which is necessary in this case. This scenario was
analyzed by the proxy advisory firms and finally, he was ordered to refund all the excessive
amounts that had been received by him over the years. Thus, the corporate bodies need to
work according to the recommendations of the advisory firms.
12.2.5 SEBI RULES RELATED TO PROXY ADVISORY FIRMS
Proxy firms play a significant role while voting in the company. Any biased recommendation
can be disastrous for the firm, as the major decisions to be voted upon by the shareholders in
the company are influenced by their advice. Thus, to avoid such conflict of interest and any
faulty report, the SEBI Guidelines, 2014 have been issued. These guidelines were developed
for regularizing the powers of proxy firms on August 3, 2020, which came into force on
January 01, 2021 (September 01, 2020, was earlier decided as the date of enforcement but
was extended because of the COVID-19 pandemic). These were the first guidelines that
brought proxy advisors under the umbrella of law where they could be monitored. Although
these regulations were nascent but following parameters were mandatory to be followed: -
1. First of all, all the proxy advisory firms have to get themselves registered with SEBI.
2. They have to disclose all the recommendations that are made by proxy advisors
3. A proper framework is to be established to look after the internal functioning and
discipline of the firm
4. Proper records are to be maintained regarding the recommendations that are being given
by the advisory firms.
5. It also gave a roadmap regarding the code of conduct that is to be followed which
encompassed eight principles like honesty, good faith, confidentiality, etc
These guidelines were governing Indian proxy industries till 2018. In August 2018, there was
a vote on the reappointment of three directors of a private sector bank in India. The domestic
and international proxy advisors voted against this decision and as a result, two of them
backed out and the third one was reappointed with a small margin as the director of the bank.
This incident was criticized by several experts in the market. The main reason behind such
criticism was that these pieces of advice are being framed by the international advisories and
are not apt for the Indian scenario. As these international firms are formulating
recommendations on the basis of practices as followed in their home country, the
170
recommendations thus are not apt for the Indian scenario. So they feel that they are not
competent enough to draft the advice for the Indian situation. Moreover, some baseless and
hasty advice could lead to egregious results. The demand for stringent policy to regulate
functions of the proxy advisory firms was made. Due to this incident, SEBI constituted a
committee in November 2018 to look into this matter and to suggest any changes that can be
made in the guidelines of 2014 that were guiding proxy advisories earlier. The committee
issued its report in May 2019 to SEBI and newly formulated guidelines were enacted. These
included procedural guidelines for proxy advisors, as well as the mechanism of grievance
resolution between listed entities and proxy advisors.
12.2.6 NEW PROCEDURAL GUIDELINES FOR PROXY ADVISORS
1. They have to disclose policies on the recommendation of voting and these are to be
reviewed every year.
2. The report should be shared simultaneously with the company and investors and if there
are any clarifications or comments that the company wants to suggest, the same could
be sent by the company to proxy advisors within the timeline decided beforehand and
the needful changes can be made in the report
3. If the opinion of the company varies from that of the proxy advisor’s report and it could
not be justified by minor amendments then the needful changes can be done by issuing
additional reports or adding an addendum depending on the issue.
4. If there are any discrepancies, false information, or material revisions are required to be
done, the same should be disclosed to clients within 24 hours of realizing such an error.
(Regulation 20)
5. The methodologies, procedures, and sources that were being referred to or followed, to
formulate the report should also be disclosed to the clients.
6. An explicit framework is to be set up to handle and resolve any conflict of interest that
arises during the ancillary course of service like if they provide consultancy service in
addition to the advisory which could lead to a biased point of view and the same should
be disclosed to the clients also. (Regulation 15(1))
7. Clarify the situations in which the firm will not provide voting recommendations in its
voting recommendation policy.
8. They also need to mention adequate reasons if they are suggesting any higher standard
in their recommendations than generally stipulated by law.
9. The stated communication process between clients and the listed company should be
developed so as to interact and inform the clients regarding recommendations and to get
reviews on the same (Regulation 23).
12.2.7 GRIEVANCE REDRESSAL MECHANISM FOR LISTED COMPANIES
Apart from these disclosure measures for the proxy advisors, a mechanism has been set up by
SEBI under these new guidelines which will redress the issues faced by listed companies and
provide relief for the same. Under this, the aggrieved company that has a contrary opinion
than that of the recommendations provided by proxy firms can report to SEBI about their
grievance. The SEBI will act as an arbiter between the two and after examination of the issue,
will discharge the case accordingly. This system is based on natural justice as this provides
171
the company with the right of being heard in case they are being exploited by the policies and
recommendations formed by the proxy advisors.
These guidelines will create additional safety for both the companies and the shareholders by
regularizing the proxy industry. This will ensure transparency and even build the credibility
of the advisors. Compliance with all these measures will however create additional liability
on the advisory firms.
12.2.8 CHALLENGES FACED BY THE PROXY ADVISORY INDUSTRY
No doubt, there is a huge potential in this industry to boom but there are still some hindrances
that should be paid heed to and incorporate necessary measures so as to overcome them. The
hurdles faced by the proxy industries are as follows: -
1. The passive attitude of shareholders: The shareholders, most of the time, are unaware
and indifferent about the norms of corporate governance of the organization unlike in
the foreign countries where investors work according to the recommendations by the
proxy industry. This is because they have had a passive attitude for many years. Thus,
the awareness is to be created so that shareholder’s activism can boost which will in
turn help in the rise of the proxy advisory industry. Many bodies like the Institute of
Chartered Accountants of India, the Institute of Company Secretaries of India, and even
SEBI have come forward to create awareness about them.
2. Unacceptance by the corporate bodies: They started facing resistance from the
corporate entities before they could even win the confidence of the investors. Many
allegations of having personal interest, not following proper research practices, lack of
concern towards companies, and misleading investors through unreliable
recommendations became very common. These allegations hampered their growth at
the embryonic stage. And now after the guidelines issued by SEBI, the proxy firms
have made them more credible but still, they need to put in more effort to prove
themselves.
3. Higher competition: The limited scope of the firms is another drawback and that is
why there is no room for multiple firms in this uncertain environment. In the USA also,
the advisory industry mostly remained as a monopoly or duopoly only for the practical
working of the market. Thus, where the space is limited and there are three firms in the
Indian market and even international advisors, there exists cut-throat competition in the
market to establish themselves.
4. Insufficient human resource availability: There was no specialized degree or
program that was curated for the employees so as to cater to the needs of this industry.
The companies were hiring engineers based on their logical reasoning and then training
them to induct them. Thus, it is a huge issue because there is a lack of desired human
resources with expertise in this field.
5. Hefty cost: The whole process of preparing reports on the inside matters is
cumbersome as well as expensive because it involves extensive research and analysis in
itself but now as they have to build up the system for communication and even more
detailed reports would require more funds to be incurred, thereby, putting a burden of
additional cost to be borne by the proxy industry.
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CONCLUSION
The stock market of India is growing day by day and investors have become more engrossed
in the intricacies of the matter than before. This surely has created an apt situation for the
growth of the proxy industry in India. The proxy advisory firms have revolutionized the
concept of corporate governance as they play a vital role in the working of the company.
Now the annual meetings are not dictated by a few people only, instead, the directors of the
company have to tune themselves and work according to the suggestions by proxy advisors
because they are the guiders of the institutional investors. The firms ensure the system of
transparency, check, and balances for the investors in the companies as the minute
happenings in the company are notified to them which in some cases could go unattended.
This could help in the better understanding of the situation and in turn aids in the formulation
of the decisions by the shareholders. No doubt still the role of the proxy industry in India is
very less as compared to the USA because India is the hub of family-owned businesses and
the shareholders are in minority because of which the authority cannot be challenged easily.
But this role of proxy advisors will likely change over the next decade because of an increase
in start-ups that would have diversified shareholding and the firms could benefit from that
and they will play a pivotal role in giving vent to investor concerns by engaging positively
with the companies.
SUMMARY
1. Credit rating is an analysis of the credit risks associated with a financial instrument or a
financial entity. It is a rating given to a particular entity based on the credentials and the
extent to which the financial statements of the entity are sound, in terms of borrowing
and lending that has been done in the past.
2. Credit rating agencies typically assign letter grades to indicate ratings. Standard &
Poor’s, for instance, has a credit rating scale ranging from AAA (excellent) to C and D.
FILL IN THE BLANKS
1. Credit assessment and evaluation for companies and governments is generally done
by………………………………………………..
2. Credit rating agencies gather information, analyse and interpret it and present their
findings in easy to understand language that is …………………………………
3. The borrower or issuer company requests the credit rating agency for
………………………………….
4. There are 6 credit rating agencies which are registered with SEBI. These are ………
…………................................................
5. The appointment of proxy advisors also prevents ..………………………..………….…
………………………
1. Which of the following is type of credit rating agencies–
(i) Rating of medium term loans
(ii) Rating of bonds and debentures
173
(iii) Rating of short-term instruments
2. Which of the following changes not faced by the proxy advisory industry-
(i) Unacceptance by the corporate bodies
(ii) Insufficient human resource availability
(iii) Economic demand for proxy advisory firm
(iv) Hefty cost
3. Which of the following is a first proxy advisory firm of India.
(i) Institutional Investors Advisory Services (IIAS)
(ii) Stakeholders Empowerment Services (SES)
(iii) InGovern Research Services
(iv) None of above
4. Which of following is not a part of credit rating process-
(i) Appointment of analytical team
(ii) Meetingoftheratingcommittee
(iii) Revision of the rating
(iv) Concealment of material information
5. Which of the following factor should considered in credit rating-
(i) Market positon of the company
(ii) Legal position of the various instrument
(iii) Regulatory environment
SHORT ANSWER TYPE QUESTIONs
1. Briefly explain credit rating agencies & how credit rating works.
2. Explain the advantages of credit rating agencies to investor, rated company &
intermediaries.
3. Explain the credit rating process.
4. What is mean by proxy advisory firms? And explain the function of it.
5. Explain the challenges faced by the proxy advisory industry.
174

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B.Com. (Hons.

Core Course - XIII

SCHOOL OF OPEN LEARNING

Edited by: Written by:

SCHOOL OF OPEN LEARNING

1. BASIC PRINCIPLES AND TECHNIQUES OF AUDITING & CLASSIFICATION

1.1 MEANING OF AUDITING

1.12 CLASSIFICATION OF AUDIT

2.1 Audit Process

2.8 DISTINCTION BETWEEN INTERNAL CONTROL, INTERNAL

Can a statutory auditor be an internal auditor and vice versa?

3.1 MEANING OF CORPORATE GOVERNANCE

Corporate Governance is usually looked upon as a process or system related to management

2. The review shall focus on:

 A member shall not be eligible for being appointed as are

4.10 PEER REVIEW PROCESS

7.1 Meaning of Corporate Governance

7.10 PRINCIPLES OF CORPORATE GOVERNANCE

7.11 4 PS OF CORPORATE GOVERNANCE

4. Resource Dependency Theory

Board of Directors Control Stock Market

Fig. 9.6 : Japanese Model of Corporate Governance

Fig.9.7 : Family-based Model of Corporate Governance

9.9 PREVENTION OF SHAREHOLDER ACTIVISM

10.1 Insider Trading

12.1 Credit Rating Agencies

12.1 CREDIT RATING AGENCIES

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