Theory and Practice of Corporate Governance

Definition
• By a company is meant an association of many persons, who contribute money to a common stock & invest in some trade or business, and who share the profit & loss arising. there from

Incorporated or registered under the Companies Act of a country Artificial legal existence. 7.Characteristics of a corporation 1. 3. 5. individual ownerships) Transferability of shares 4. 2. .equal to that of a natural person with its own legal entity Perpetual existence – Law creates a company and only law can dissolve it Common seal – an artificial person can not sign documents Extensive membership – no limitation on the number of members Limited liability (owners risk is limited unlike in the case of partnerships. 6.

• Principals may want to carry out the objectives of the company but the agents may not quite exactly match the requirements. chosen by the shareholders are the agents.Theoretical basis for corporate governance A. • Adam Smith had identified the agency problem (managerial negligence and profusion). the board. . • Shareholders are the owners and the principals too • The management. Agency Theory • The fundamental theoretical basis of corporate governance is agency costs.

are examples. • There are many a way through which the management go counter to the objectives of the shareholders.Conti… • The mismatch of objectives between principal & agents is called “agency problem” & the cost of the “dissonance” caused by the agency problem is the agency cost. empire building etc. • Ostentatious life styles of directors. .

Mechanisms that help reduce agency costs: Fair and accurate financial disclosures Efficient and independent board of directors . monitoring. 2. oversight & corrective systems that can align the objectives of 2 set players as closely as possible & minimize agency costs • 1.Conti… • The core of CG is designing & putting in place disclosures.

• There is a significant emphasis on the responsibility of the board to the shareholders in a corporate governance model that is emboldened by stewardship and trusteeship. .Conti… B. • It assumes that managers are trustworthy and have high reputations. Stewardship Theory • The theory defines situations in which managers are not motivated by individual goals. There fore their behavior will not run counter to the interests of the company. but rather they are stewards whose motives are aligned with the objectives of their principals.

and trustworthy Managers are motivated by the principals’ objectives Interests of the managers and principals converge The role of the management is to facilitate and empower Owners’ attitude is to take risks Principal-manager relationship is based on trust . proorganizational.Basic behavioral differences between Agency & Stewardship Theories Agency Managers act as agents Governance approach is materialistic Behavior pattern is individualistic. opportunistic. and self serving Managers are motivated by their own objectives Interests of the managers and principals differ The role of the management is to monitor and control Owners’ attitude is to avoid risks Principal-manager relationship is based on control Stewardship Managers act as stewards Governance is sociological and psychological Behavior pattern is collectivistic.

That is to say. In other words responsibilities of the companies in terms of maximizing profits toward the shareholders should be subject to obligations toward others. .Issues in Shareholder Versus Stakeholder • Shareholder approaches fundamentally mean that corporations have limited responsibilities namely that of obeying laws and maximizing shareholder wealth. shareholder interests will automatically maximize societal utility. • Stakeholder approaches dwell upon the theme that corporate managements have responsibilities toward other stakeholders.

dealers. customers. and stakeholder concept. • But then who are all genuine stakeholders? .C. and the society at large and draws all of them into corporatemix.Stakeholder theory • Dating back to 1930s. government. behavioral science. It is often criticized as “wooly minded liberalism” because it is not applicable in practice by companies. this theory represents a synthesis of a fair bit of economics. But the defense is that managers can act efficiently only by drawing upon the resources of the stakeholders and as such there is a “contract” between the company and the stakeholders. business ethics. It deals with the common interests of employees.

disclosure & auditing are necessary mechanisms to promote equity & fairness in society . board composition.D. Sociological theory • It has focused mostly on board composition & implications for power & wealth distribution in society • Under this theory. financial reporting.

Theoretical basis of CG • • • • Agency Cost Stewardship Theory Stakeholder Theory Sociological Theory .

Corporate governance systems • The role of the management (which mostly appears in the organizational chart and not the board) is to run the business while the board oversees that it is run well and in the right direction. Each director bears the same duties and responsibilities. authority. the board members need to work together as equals reaching agreement by consensus or if necessary by voting. There is an ordering of responsibility. delegation downwards through the firm and accountability upwards to the top brass. • . Management operates as a hierarchy. By contrast.

The Japanese Models .Conti… • Corporate governance systems vary around the world: 1.The German Model 3.The Anglo-American Model 2.

• While the CEO has the power delegated by the board to manage the company on a daily basis. UK. which is prevalent in the US. • This model calls for governance by the board of directors. facilitating CEO to function under set policy & guidelines . monitoring. management performance.The Anglo-American Model • This is a typical liberal model of governance. decision making. he or she needs board approval for certain major decisions. • Duties of the board includes policy making. control. and many English speaking countries of the former British Empire. which has the power to choose the CEO.

Cont… • In this model. the board of directors is responsible towards the shareholders. individual shareholders are not given the opportunity to choose their nominees to the board. • Contrary to the spirit of good corporate governance. • They were merely asked to put in their approval for the board nominee .

The Anglo-American Model Board of directors (Supervisors) Shareholders Elect Stakeholders Appoints & supervises Officers (Managers) Manage Creditors Own Lien on Company Monitors & regulates Regulatory Legal System Stake in .

they just sell shares and pack off Disclosure norms are comprehensive – rules against insider trading. Ownership equally divided among individual and institutional shareholders Directors are rarely independent of management Companies run by professional managers with negligible ownership stakes – clear separation of ownership and management Institutional investors are reluctant activists – if not satisfied with the company. penalties for price manipulation. protection for small investors. discourage large investors from taking active role in corporate governance 4. . 5. 2. 3.Features of Anglo-American Model 1.

The shareholders own the company but do not entirely dictate governance mechanism – shareholders and labor unions on a 50-50 basis appoint the supervisory board 3. Supervisory board appoints and monitors the management board .Features of German Model 1. Governance is exercised through two-tier board – upper board supervises the executive board on behalf of shareholders 2.

labor relations officer) Manage Own Shareholders Appoint 50% Company .The German Model Appoint 50% Supervisory Board Appoints & Supervises Employees & Labor Unions Management Board (incl.

Importance of the lending bank is highlighted . The President who consults the supervisory board and the executive management is included 3. The financial institution has accrual role in governance – shareholders and main bank together appoint the Board of Directors and the President 2.Features of Japanese Model 1.

acts in emergencies Supervisory Board (including the President) Ratifies the President’s decisions President Shareholders Consults Executive Management (Primarily Board of Directors) Manages Provides managers Main Bank Provides loans Own Company Owns .The Japanese Model Appoint Provides managers . monitors.

Features of Indian Model 1. Indian companies are governed by the Company’s Act of 1956 2. and associates 4. In the wake of economic liberalization. India has adopted the key tenets of the AngloAmerican external and internal control mechanism . Private companies are closely held or dominated by a founder. his family. Follows more or less the UK model 3.

customers and other external stakeholders Proper governance Corporate Governance System Shareholder value Corporate governance outcomes/Benefits to society Transparency Concern for customer Healthy corporate sector development Investor protection . Stock Exchange Company vision. characteristics. guidelines . structure. etc External Environment Corporate culture. policies. Influences Internal Environment Company Act SEBI. mission.Indian Corporate Governance Model Government regulations. norms Internal stakeholders Auditors Board of Directors Depositors. borrowers. policies.

We must consistently strive to reduce costs in order to maintain reasonable prices. and patients. In meeting their needs everything we do must be of high quality. Customers’ orders must be serviced promptly and accurately. . Our suppliers and distributors must have an opportunity to make a fair profit.Our Credo We believe that our first responsibility is to the doctors . nurses. to mothers and fathers and all others who use our products and services.

We must respect their dignity and recognize their merit. They must have a sense of security on their jobs. Compensation must be fair and adequate. Employees must feel free to make suggestions and complaints. and their actions must be just and ethical. and safe. and working conditions clean.We are responsible to our employees. the men and women who work with us throughout the world. We must be mindful of ways to help our employees fulfill their family responsibilities. . We must provide competent management. There must be equal opportunity for employment. development and advancement for those qualified. Everyone must be considered as an individual. orderly.

. We must maintain in good order the property we are privileged to use.We are responsible to the communities in which we live and work and to the world community as well. protecting the environment and natural resources. We must encourage civic improvements and better health and education. We must be good citizens – support good works and charities and bear out fair share of taxes.

new facilities provided. Research must be carried on. and new products launched. We must experiment with new ideas. Reserves must be created to provide for adverse times. the stockholders should realize a fair return.Our final responsibility is to our stockholders. . Business must make a sound profit. innovative program developed and mistakes paid for. New equipment must be purchased. When we operate according to these principles.

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