Business Law

Corporate governance


The term “corporate governance” derives from an analogy between the government of cities, nations or states and the governance of corporations.

As per the 1999 definition from the OECD:

Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those.


To Build up an environment of trust and confidence amongst those having competing and conflicting interests.

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To Enhance Shareholder’s value and protect the interest of other Stakeholders by enhancing the corporate performance and accountability.

The OECD Principles of Corporate Governance

I. Ensuring the Basis for an Effective Corporate Governance Framework

II. The Rights of Shareholders and Key Ownership Functions III. The Equitable Treatment of Shareholders IV. The Role of Stakeholders in Corporate Governance V. Disclosure and Transparency VI. The Responsibilities of the Board

S o u rce : O E C D p ri ci l s o f co rp o ra te g o v e rn a n ce , 2 0 0 4 , O E C D Pu b l ca ti n S e rv i , 75775 n p e i o ce

Paris Cedex 16 , France .

Global Perspective
v Sir adrian cadburycommittee

The Cadbury Report titled’Financial Aspects of Corporate Governance’ published in1992. sets out recommendations on the arrangement of company boards and accounting systems to mitigate corporate governance risks and failures. The report's recommendations have been adopted in varying degree by the European Union, the United States, the World Bank, and others.

v Corporate governance report of singapore government

v Sarbanes-Oxley act, 2002 by the american congress
v The Sarbanes-Oxley Act of 2002 also known as the Public Company Accounting Reform and Investor Protection Act of 2002 and commonly called Sarbanes-Oxley is a United States federal law enacted on July

Indian :Perspective

Shri Kumar MangalamCommittee
v Constituted in may 1999 to promote and raise the standard of corporate governance in india

Mandatory Recommendations of Birla Committee:
v APPLIES TO LISTED COMPANIES WITH PAID UP CAPITAL OF rs.3 crore and above v Composition of board of directors – optimum combination of executive & nonexecutive directors v Audit committee – with 3 independent directors with one having financial and accounting knowledge.

Mandatory Recommendations - Birla Committee
v Remuneration committee v Board procedures – Atleast 4 meetings of the board in a year with maximum gap of 4 months between 2 meetings. To review operational plans, capital budgets, quarterly results, minutes of committee’s meeting. v Director shall not be a member of more than 10 committee and shall not act as chairman of more than 5 committees across all companies v Management discussion and analysis report covering industry structure, opportunities, threats, risks, outlook, internal control system v Information sharing with shareholders

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Role of chairman Remuneration committee of board Shareholders’ right for receiving half yearly financial performance Postal ballot covering critical matters like alteration in memorandum etc Sale of whole or substantial part of the undertaking Corporate restructuring Further issue of capital Venturing into new businesses


By introduction of clause 49 in the listing agreement with stock exchanges Provisions of clause 49

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Composition of board - in case of full time chairman, 50% nonexecutive directors and 50% executive directors Constitution of audit committee – with 3 independent directors with chairman having sound financial background. Finance director and internal audit head to be special invitees and minimum 3 meetings to be convened. Responsible for review of financial performance 0n half yearly/annually basis; appointment/ removal/remuneration of auditors; review of internal control systems and its adequacy

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Remuneration of directors

Remuneration of non-executive directors to be decided by the board. Details of remuneration package, stock options, performance incentives of directors to be disclosed

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Board procedures

Atleast 4 meetings in a year. Director not to be member of more than 10 committees and chairman of more than 5 committees across all companies

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Management discussion & analysis report – should include:
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Industry structure & developments Opportunities & threats Segment wise or product wise performance

v Management discussion & analysis report– to include:
q q q q q Outlook Risks & concerns Internal control systems & its adequacy Discussion on financial performance Disclosure by directors on material transactions with the company




v Shareholders information - brief resume of new/re-appointed directors,
quarterly results to be submitted to stock exchanges and to be placed on web-site, presentation to analysts v Shareholders’/investors grievance committee under the chairmanship of independent director. Minimum 2 meetings in a year

v Report on corporate governance and certificate from auditors on compliance of provisions of corporate governance as per clause 49 in the listing agreement


v Committee headed by Shri Naresh Chandra constituted in August 2002 to examine corporate audit, role of auditors, relationship of company & auditor v v Recommendation of Naresh Chandra committee: q Recommended a list of disqualifications for audit assignments like direct relationship with company, any business relationship with client, personal relationship with director q Audit firms not to provide services such as accounting, internal audit assignments etc. To audit clients q Auditor to disclose contingent liabilities & highlight significant accounting policies q

v Recommendation of Naresh Chandra committee: v q q q Audit committee to be first point of reference for appointment of auditors\ CEO & CFO of listed company to certify on fairness, correctness of annual audited accounts Redefinition of independent directors – does not have any material, pecuniary relationship or transaction with the company Composition of board of directors Statutory limit on the sitting fee to non-executive directors to be reviewed Companies

q q q

v Recommendations have formed part of (amendment) bill, 2003 (yet to be passed))

v SEBI Constituted A Committee Headed By Shri N. R. Narayana Murthy To Review Existing Code Of Corporate Governance v v Recommendations: q q q q q q q q Strenghtening The Responsibilities Of Audit Committee Improving Quality Of Financial Disclosures Utilisation Of Proceeds From Ipo To Assess & Disclose Business Risks Formal Code Of Conduct For Board Whistle Blower Policy To Be Palce In A Company Providing Freedom To Approach The Audit Committee Subsidiaries To Be Reviewed By Audit Committee Of Holding Company

Problems:Corporate Governance

As of 1-4-2007, only, 1928 out of 4782 BSE listed companies have filed information about their compliance with Clause 49 of Listing Agreement Corporate governance often becomes the centre of discussion only after the exposure of a large scam. Recent upheavals in the financial sector have conclusively proved that increased regulation has not improved the quality of corporate governance. The World Bank's annual World Governance Indicators rate U.S. regulatory quality at 90.8 out of 100. India is rated 46.1 -- below South Korea (78.6), Malaysia (67.0) and Thailand (56.3) but above China (45.6), Indonesia (43.7) and Vietnam (35.9).

Assessing the integrity of accounting practices, the Economist Intelligence Unit gives India a rating of 2 on a scale of 0 to 4, where 0 is the best.
Corporate fraud scandals can detonate That puts it above China, the Philippines and Vietnam, rated 3, and 2 anywhere The Economic Times Jan 2009 Reference:

Indonesia, rated 4.


Problems Contd..

Problems Contd..

India: Loopholes in Clause 49

Allows the promoters to gain/retain control over companies.
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Full freedom to the promoters. Hardly any threat to incumbent managements of vast majority of companies.

In most companies institutional investors, have either no presence or are only marginal players.

Lack of genuine independent Directors getting elected to corporate boards .

In many companies the promoter redesignated themselves as the non-executive Chairmen

Some companies are designating the promoter’s father in-law, mother’s brother or wife’s brother as non-executive Chairman as -Refrence
Corporate Governance at crossroads –Vedant Shukla Practical Lawyer


2 January 2009:  Hiranandani in the midst of a corporate governance controversy.Several shareholders are likely to oppose Hirco’s proposal to acquire two estate projects owned by the group. 13 January 2009 :  Reporting & disclosure issues in Siemens: Brokerages

Reference: The Economic Times

Case I:South Sea Bubble & The bubble act
 The South Sea Company was a British joint stock company that traded in South America during the 18th century. Founded in 1711, the company was granted a monopoly to trade in Spain's South American colonies as part of a treaty during the War of Spanish Succession. In return, the company assumed the national debt England had incurred during the war. Speculation in the company's stock led to a great economic bubble known as the South Sea Bubble in 1720, which caused financial ruin for many. In spite of this it was restructured and continued to operate for more than a century after the Bubble. The government and the company convinced the holders of around £10 million of short-term government debt to exchange it with a new issue of stock in the company. In exchange, the government granted the company a perpetual annuity from the government paying £576,534 annually on the company's books, or a perpetual loan of £10 million paying 6 percent. This guaranteed the new equity owners a steady stream of earnings to this new venture. The government thought it was in a win-win situation because it would fund the interest payment by placing a tariff on the goods brought from South America

 The company did not undertake a trading voyage to South America until 1717 and made little actual profit. Furthermore, when ties between Spain and Britain deteriorated in 1718 the short-term prospects of the company were very poor. Nonetheless, the company continued to argue that its longer-term future would be extremely profitable.  A number of other joint-stock companies then joined the market, making usually fraudulent claims about other foreign ventures or bizarre schemes, and were nicknamed "bubbles".  In June, 1720, the Royal Exchange and London Assurance Corporation Act 1719 (repealed in 1825) required all joint-stock companies to have a Royal Charter. This became known as the "Bubble Act" later, after the speculative bubble had burst.

Case II : Satyam
 Just three months ago, Satyam Computer Services received the Golden Peacock Award from a group of Indian directors for excellence in corporate governance. The fact is that until Ramalinga Raju, the erstwhile chairman of Satyam Computer Services, disclosed the big hole of over Rs. 7,000 crore in the company’s balance sheet, everything seemed hunky dory.  True, its image was dented after the abortive takeover bid of the two Maytas infrastructure companies owned and controlled by the family members of Ramalinga Raju.  Actually, as Mr. Raju were to explain later, if Satyam had bought over the two infrastructure companies, it might have been able to show ‘real assets’ in its balance sheet.  Now, its board is in turmoil and its shares have plunged and its employees are looking at an uncertain future.

Case III :Enron
 After a series of revelations involving irregular accounting procedures bordering on fraud perpetrated throughout the 1990s involving Enron and its accounting firm Arthur Andersen, Enron stood on the verge of undergoing the largest bankruptcy in history by mid-November 2001 (the largest Chapter 11 Bankruptcy until that of Lehman Brothers on September 15 2008).  A white knight rescue attempt by a similar, smaller energy company, Dynegy, was not viable.  In addition, the scandal caused the dissolution of Arthur Andersen, which at the time was one of the world's top accounting firms.  The firm was found guilty of obstruction of justice in 2002 for destroying documents related to the Enron audit and was forced to stop auditing public companies.  Although the conviction was thrown out in 2005 by the Supreme Court, the damage to the Andersen name has prevented it from returning as a viable business.

Accounting practices at Enron
 Enron had created offshore entities, units which may be used for planning and avoidance of taxes, raising the profitability of a business. This provided ownership and management with full freedom of currency movement and the anonymity that allowed the company to hide losses. These entities made Enron look more profitable than it actually was, and created a dangerous spiral in which each quarter. This practice drove up their stock price to new levels, at which point the executives began to work on insider information and trade millions of dollars worth of Enron stock. The executives and insiders at Enron knew about the offshore accounts that were hiding of losses for the company; however the investors knew nothing of this Enron adopted mark to market accounting, in which anticipated future profits from any deal were tabulated as if real today. Thus, Enron could record gains from what over time might turn out losses Enron was the only company that could not release a balance sheet along with its earnings statements.

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Case IV: Worldcom
 Beginning in 1999 and continuing through May 2002, the company (under the direction of Scott Sullivan(CFO), David Myers (Controller)and Buford “Buddy” Yates (Director of General Accounting) used fraudulent accounting methods to mask its declining earnings by painting a false picture of financial growth and profitability to prop up the price of WorldCom’s stock. The fraud was accomplished primarily in two ways: i)Underreporting ‘line costs’ (interconnection expenses with other telecommunication companies) by capitalizing these costs on the balance sheet rather than properly expensing them. ii)Inflating revenues with bogus accounting entries from ‘corporate unallocated revenue accounts’. In 2002 a small team of internal auditors at WorldCom worked together, often at night and in secret, to investigate and unearth $3.8 billion in fraud. Shortly thereafter, the company’s audit committee and board of directors were notified of the fraud and acted swiftly: Sullivan was fired, Myers resigned, Arthur Andersen withdrew its audit opinion for 2001, and the U.S. Securities and Exchange Commission (SEC) launched an investigation into these matters on June 26, 2002 (see accounting scandals). By the end of 2003, it was estimated that the company's total assets had been inflated by around $11 billion.

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Case V:Tyco International
 In 2002, three former top Tyco International executives were indicted on fraud charges. Former CEO L. Dennis Kozlowski, former CFO Mark Schwartz, and former legal counsel Mark Belnick allegedly issued themselves low or no interest loans, which they then forgave through an unauthorized bonus program. They were accused of concealing their illegal actions by keeping them out of the accounting books and away from the eyes of shareholders and Board members. Tyco later on replaced its CEO and most of its Board in an attempt to purge the company of fraud and restore its reputation. It agreed to pay almost $3 billion to settle class-action suits brought by investors. It had also earlier paid $50 million to settle a suit brought by the SEC.

Case VI:Cendant Fraud
 Walter Forbes, the former chairman of Cendant, masterminded an accounting fraud that was considered at the time it was discovered 1998 - to be the largest on record. Investors lost $19 billion when Cendant’s stock fell after the disclosure. This fraud was later eclipsed by the scandals at Enron and WorldCom. The Cendant case also resulted in a record payment for settling a lawsuit brought by shareholders who had lost money in a fraud. Cendant paid $2.85 billion to settle, and its auditor, Ernst & Young, paid $335 million.

Case VII: Daewoo
 Kim Woo-chong, the founder and former chairman of defunct conglomerate Daewoo Group, was in May 2006 sentenced to 10 years in prison on charges of embezzlement and accounting fraud. The Seoul Central District Court also ordered Kim, 69, to pay back more 21 trillion Korean won ($22 billion), according to press reports. Kim was charged about a year ago with accounting fraud, illegal financing and diverting funds out of the country. The court found Kim guilty of 20 trillion won of accounting fraud, 9.8 trillion won of illegal financing and sending 19 trillion won out of the country illegally. He was also convicted of embezzling $100 million. At the time of its downfall, Daewoo Motor was the biggest corporate failure in South Korean history.


Due to lack of proper structure and control mechanism, the trust of India Inc. is at stake in the World Markets. This is bound to have a cascading effect on the ongoing economic and financial turmoil globally

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The focus of corporate governance in India should primarily be of Controlling, considering the fact that most businesses in India are family run. SEBI should keep this in mind when moving towards implementing international standards. Transparency, objectivity and rigour in the processes to select independent directors.Current limits on independent directors are unrealistic and it is likely that many independent directors may fail to do justice to their commitments.  The conduct of board meetings needs introspection in terms of frequency and duration, information needs, balance between presentation and discussion, interaction outside the boardroom and consultation when in doubt.  The CEO and board chair roles should be segregated. Board chairs should actively monitor how individual directors are pro-actively identifying and fulfilling their knowledge and competency needs.  Code of conduct norms should be communicated to the wider stakeholder group. All whistle blowing should be linked directly to the Audit Committees.  Auditors should be asked to prove their / New Delhi January 14, 2009, 0:58 IST///NEVILLE M DUMASIA understanding and evaluation Business Standard ED & Head, Governance, Risk and Compliance Services, KPMG, India of risks. 


The twin objectives of corporate governance should be to take decisions in the best interests of a wide group of stakeholders together with seeking to achieve consistency in exemplary corporate behaviour that does justice to the substance behind the rules. Corporate boards and specifically the independent directors on the board have a major role to play in achieving these objectives through the principles they adopt and the practices they follow.

Business Standard / New Delhi January 14, 2009, 0:58 IST///NEVILLE M DUMASIA ED & Head, Governance, Risk and Compliance Services, KPMG, India


Corporate governance is beyond the realm of law. It is about openness, integrity and accountability.

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The legislation should lay down standards and systems for ethical business practices in the interest of the various stakeholders of the corporation

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