Corporate Governance

Module 1
Meaning
• Corporate Governance means a set of systems, procedures, policies,
practices, standards put in place by a corporate to ensure that
relationship with various stakeholders is maintained in transparent
and honest manner and business is conducted ethically.
• The phrase “corporate governance” describes “the framework of
rules, relationships, systems and processes within and by which
authority is exercised and controlled within corporations. It
encompasses the mechanisms by which companies, and those in
control, are held to account.”
Definition of Corporate Governance
• “Corporate Governance is the application of best management
practices, compliance of law in true letter and spirit and adherence to
ethical standards for effective management and distribution of wealth
and discharge of social responsibility for sustainable development of
all stakeholders.” - The Institute of Company Secretaries of India
• “Corporate Governance is about promoting corporate fairness,
transparency and accountability”. - James D. Wolfensohn (Ninth
President World Bank)
Principles of Corporate Governance
• Ethics
• Transparency
• Accountability
• Trusteeship
• Empowerment
• Fairness to all stakeholders
• Whistle blower policy
OECD Principles of Corporate
Governance
• Principles were originally developed by OECD in 1999 and further
updated in 2004
• On request by G20 Finance Ministers and Central Bank Governors a
draft of revised Principles was presented and discussed at the
G20/OECD Corporate Governance Forum in Istanbul on 10 April 2015
• The OECD Council adopted the Principles on 8 July 2015
• The Principles provide guidance through recommendations across six
chapters.
1. Ensuring the basis for an effective corporate governance
framework
2. The rights and equitable treatment of shareholders and
key ownership functions
3. Institutional investors, stock markets, and other
intermediaries
4. The role of stakeholders in corporate governance
5. Disclosure and transparency
6. The responsibilities of the board
 I. Ensuring the basis for an effective
corporate governance framework
• The corporate governance framework should be developed with a view that it
will impact on overall economic performance, market integrity and the incentives
it creates for market participants and the promotion of transparent and well-
functioning markets
• The division of responsibilities among different authorities should be clearly
articulated and designed to serve the public interest
• Supervisory, regulatory and enforcement authorities should have the authority,
integrity and resources to fulfil their duties in a professional and objective
manner. Moreover, their rulings should be timely, transparent and fully explained
• Cross-border co-operation should be enhanced, including through bilateral and
multilateral arrangements for exchange of information
 II. The rights and equitable treatment of
shareholders and key ownership functions

• Basic shareholder rights should include the right to

1. secure methods of ownership registration
2. convey or transfer shares
3. obtain relevant and material information on the corporation on a timely and
regular basis
4. participate and vote in general shareholder meetings
5. elect and remove members of the board
6. share in the profits of the corporation
• Shareholders should be sufficiently informed about, and have the
right to approve or participate in, decisions concerning fundamental
corporate changes such as
1. amendments to the statutes, or articles of incorporation or similar
governing documents of the company
2. the authorisation of additional shares
3. extraordinary transactions, including the transfer of all or substantially all
assets, that in effect result in the sale of the company
• Shareholders should have the opportunity to participate effectively
and vote in general shareholder meetings and should be informed of
the rules, including voting procedures, that govern general
shareholder meetings
1. Shareholders should be furnished with sufficient and timely information
concerning the date, location and agenda of general meetings
2. Equitable treatment of all shareholders. Company procedures should not
make it unduly difficult or expensive to cast votes.
3. Shareholders should have the opportunity to ask questions to the board
4. Impediments to cross border voting should be eliminated
5. Shareholders should be able to vote in person or in absentia, and equal
effect should be given to votes whether cast in person or in absentia
• All shareholders of the same series of a class should be treated
equally. Within any series of a class, all shares should carry the same
rights. All investors should be able to obtain information about the
rights attached to all series and classes of shares before they purchase
• Related-party transactions should be approved and conducted in a
manner that ensures proper management of conflict of interest and
protects the interest of the company and its shareholders
1. Members of the board and key executives should be required to disclose to
the board whether they, directly, indirectly or on behalf of third parties,
have a material interest in any transaction or matter directly affecting the
corporation
• Minority shareholders should be protected from abusive actions by,
or in the interest of, controlling shareholders
 III. Institutional investors, stock markets,
and other intermediaries
• For companies who are listed in a jurisdiction other than their
jurisdiction of incorporation, the applicable corporate governance laws
and regulations should be clearly disclosed. In the case of cross listings,
the criteria and procedure for recognising the listing requirements of
the primary listing should be transparent and documented.
• Votes should be cast by custodians or nominees in line with the
directions of the beneficial owner of the shares
• Insider trading and market manipulation should be prohibited and the
applicable rules enforced
• Stock markets should provide fair and efficient price discovery as a
means to help promote effective corporate governance
 IV. The role of stakeholders in corporate
governance
• The rights of stakeholders that are established by law or through
mutual agreements are to be respected
• Where stakeholder interests are protected by law, stakeholders
should have the opportunity to obtain effective redress for violation
of their rights
• Mechanisms for employee participation should be permitted to
develop
• Where stakeholders participate in the corporate governance process,
they should have access to relevant, sufficient and reliable
information on a timely and regular basis
 V. Disclosure and transparency
• Disclosure should include, but not be limited to, material information on :
1. The financial and operating results of the company.
2. Company objectives and non-financial information.
3. Major share ownership, including beneficial owners, and voting rights.
4. Remuneration of members of the board and key executives.
5. Information about board members, including their qualifications, the selection
process, other company directorships
6. Related party transactions.
7. Foreseeable risk factors.
8. Channels for disseminating information should provide for equal, timely and
cost-efficient access to relevant information by users
 VI. The responsibilities of the board
• Board members should act on a fully informed basis, in good faith, with
due diligence and care, and in the best interest of the company and the
shareholders
• Where board decisions may affect different shareholder groups differently,
the board should treat all shareholders fairly
• Boards should consider assigning a sufficient number of nonexecutive
board members capable of exercising independent judgement to tasks
where there is a potential for conflict of interest. Examples of such key
responsibilities are ensuring the integrity of financial and non-financial
reporting, the review of related party transactions, nomination of board
members and key executives, and board remuneration.
 Evolution of Corporate Governance
The following theories elucidate the basis of evolution of corporate
governance:
• Agency Theory
• Stewardship Theory
• Stakeholder Theory
• Shareholder Theory
 Agency Theory
• In agency theory, the owners are the ‘principals’ and managers act as
their ‘Agents’
• Principals(shareholders) are widely spread.
• This theory is mainly based on agency problem and agency cost

Mechanisms that help reduce agency costs and hence improve

corporate performance are as follows:
• Fair and accurate financial disclosures
• Efficient and independent board of directors
 Stewardship Theory
• The word ‘steward’ means a person who manages another’s property or
estate
• The theory defines situations in which managers are not motivated by
individual goals, but rather they are stewards whose motives are aligned
with the objectives of their principals
• Given a choice between self-serving behaviour, and pro-organizational
behaviour, a steward’s behaviour will not depart from the interests of
his/her organization
• Control can be potentially counterproductive, because it undermines the
pro-organisational behaviour of the steward, by lowering his/her motivation
 Comparison of Agency and Stewardship
Theory
Agency Theory Stewardship Theory
• Managers acts as agents • Managers act as stewards
• Behaviour pattern is individualistic • Behaviour pattern is collectivistic
and self-serving and trustworthy
• Managers are motivated by their • Managers are motivated by the
own objectives principal’s objectives
• There is a little attachment to the • There is great attachment to the
company company
• Principal-manager relationship is • Principal-manager relationship is
based on control based on trust
 Stakeholder Theory
• According to this theory, the company is seen as an input-output
model and all the interest groups which include creditors, employees,
customers, suppliers, local-community and the government are to be
considered
• The role of shareholders is reduced in the corporation
• Different stakeholders have different self-interest. The interests of these
different stakeholders are at times conflicting
• Some critics accuse stakeholder theory of being ‘superfluous’
• This theory also stands accused of opening up a path to corruption and
chaos
 Shareholder Theory
• According to this theory, it is the corporation which is considered as
the property of shareholders.
• The role of managers is to maximise the wealth of the shareholders
• The agents must be faithful to shareholders
• Mangers should ensure that the corporation is in compliance with
ethical and legal standards set by the government
 Corporate Governance Systems
Corporate Governance Systems may vary around the world. Scholars
tend to suggest three broad versions:
1. The Anglo-American Model
2. The German Model
3. The Japanese Model
 The Anglo-American Model
This is also known as Unitary Board Model and Anglo-Saxon Model

Board of Directors
Shareholders Stakeholders
(Supervisors)
Elect
Appoints and
supervises

Officers
(Managers)
Lien itors and
Creditors on Manage Mon ates Regulatory/Legal
regul Systems
Company
Own Stake in
 The German Model
It is also known as the ‘two tier model’ as corporate governance is
exercised through two boards, in which upper board supervises the
executive board on behalf of the shareholders. It is also called as
Continental European Approach.
Supervisory Board
Appoint-50% Appoint-50%
Appoints and
Supervises
Management Board
(including labour
Employees and Shareholders
relation officer)
Labour Unions
Manage
Own
Company
 The Japanese Model
This is the business network model, which reflects the cultural
relationships seen in the Japanese keiretsu network. In the Japanese
model, the financial institution plays a crucial role in governance.
Supervisory Board
(including President) Monitors
Appoint
Provides and act in
Ratifies the President’s
managers emergency
Decision

President
Shareholders Consults Main Bank
Executive Management
(primarily board of
directors)
Manages
Owns Provide loans
Company Owns
Indian Model of Corporate Governance
Government External Environment Corporate culture,
regulations, structure, characteristics,
policies, influences
Internal Environment
guidelines, etc.
Compant vision, mission and policies
Depositors, borrowers,
Companies Act Internal Auditors customers and other
SEBI Board of
stake- external stakeholders
Stock Exchange director
holders Corporate
Governance
System
Proper governance Shareholder value
Corporate Governance Outcomes/Benefits
to Society
Transparency
Investor protection Concern for customers
Healthy corporate sector development
Advantages of Corporate Governance
• Good corporate governance ensures corporate success and economic growth.
• Strong corporate governance maintains investors’ confidence, as a result of which,
company can raise capital efficiently and effectively.
• There is a positive impact on the share price.
• It provides proper inducement to the owners as well as managers to achieve
objectives that are in interests of the shareholders and the organization.
• Good corporate governance also minimizes wastages, corruption, risks and
mismanagement.
• It helps in brand formation and development.
• It ensures oranization is managed in a manner that fits the best interests of all.
• It reduces cost and aids in long term sustenance and growth of the Company.
Need for corporate governance
Corporate Better Access to
Enhanced
Performance Global Market
Investor Trust

Enhancing Easy Finance Combating

Enterprise from Institutions Corruption
Valuation

Reduced Risk of Accountability

Corporate Crisis
and Scandals