Business Ethics and Corporate Governance Prof. Abhay Singh Borivali February, 2010 No part of this document must be reproduced for distribution without

Business Ethics and Corporate GovernanceProf. Abhay Singh

Borivali

February, 2010

No part of this document must be reproduced for distribution without prior consent from Prof. Abhay Singh.

CONFIDENTIAL 1Prof. Abhay Singh

CONFIDENTIAL Prof. Abhay Singh 2

Unit 3: Corporate Governance

Corporate:

• A corporation is an organization created (incorporated) by a group of shareholders who have

ownership of the corporation.

• The elected Board of directors appoint and oversee management of the corporation.

Governance:

• The word has Latin origins that suggest the notion of 'steering'. It deals with the processes and

systems by which an organization or society operates.


Unit 3: contd...

Corporate Governance:

• It is a broad concept and has been defined and understood differently by different groups

and at different points of time.

• The Cadbury Committee report defines it as “the system by which companies are directed

and controlled”.

• It is generally understood as the framework of rules, relationships, systems and processes

within and by which authority is exercised and controlled in corporations.”


Unit 3: Contd...

Frame work of Corporate Governance:

1. Supervisory Board/ Committee/ Team

2. Audit Committee

3. Internal Audit

4. Statutory Audit

5. Disclosure of information

6. Risk management framework

7. Internal Control framework

8. Whistle blower policy


Unit 3: contd...

(A) Every management guru and leader in the organizational sciences has his/her own

typology of good governance principle. All these principles can be collapsed into nine

general principia. These are:

1. Knowing what governance is.

2. Achievements of strategic ends.

3. Board-CEO relationship.

4. Unity of direction.

5. Unity of command.

6. Unity of accountability/responsibility.

7. Ownership needs.

8. Self-improvement.

9. Understanding the cost of governance.


Unit 3: contd...

1) Knowing what governance is:

Governance is nothing but “responsibility and accountability for the overall operation” of an

organization. “Boards” of one type or another are almost always charged with this level of

responsibility and accountability. Today, the “managing” part is delegated by the board to

CEO. The board remains responsible for:

a) developing corporate policies and plans;

(b) monitoring and measuring organizational performance against those policies and plan; and

(c) acting as a voice of ownership of the company.

The CEO is responsible to the board for implementing its policies, plans and strategic

directions. However, three non-delegable governance responsibilities remain with the board:


Unit 3: Contd...

i. providing a linkage between the company and its moral ownership;

ii. monitoring the performance of the CEO and,

iii. developing an explicit statement of values for the company.

2) Achievements of strategic ends:

• The governance structure and organizational structure must be such that performance

objectives (or ends) can be set, measured and accomplished.

• Therefore, the organization and all of its members must be synchronized in terms of

values, goals and activities.

• Weber (1947)-the father of organizational science-suggested that a large organization

must have a structured way to deal with individuals so that they do not interfere with the

ability to accomplish its goals.


Unit 3: Contd...

• He prescribed that each person have a specific place within organization and specific

tasks to perform. This he called as bureaucracy.

• Bureaucracy took the form of a pyramid subdivided by layers and compartments within

layers.

• Inherent in Weber’s bureaucracy was a chain of command in which authority and

responsibility were delegated downward along singular routes.

• At the apex of the pyramid and the chain of command were the board of directors and

CEO.

• Another means by which governance can help assure accomplishment by an organization

of its ends is strategic planning.

• The better a board strategically plans, the better is it’s organization’s performance.


Unit 3: Contd...

• If governance is about overseeing an organization’s achievement of its strategic ends, then

the CEO must be held accountable to the BOD for achievement of those same ends.

• This only works if the board does its job by clearly stating what it wants, in measurable

terms, in a strategic plan.

• This strategic planning, however, has organization’s mission, vision, values and ownership

as well as the needs of the organization’s community.

3) Board-CEO relationship:

• Any organization will be effective and high performing if there is a high level of mutual

confidence and trust throughout the organization and especially between the BOD & CEO.

• Governance is not the responsibility of a board alone; and definitely is not the responsibility

of a CEO separate from his or her board. It is a solemn partnership; a leadership team.


Unit 3: Contd...

• Board members and the CEO are equal, colleagues. The board hires, evaluates and fires

the CEO.

• Should the CEO find it necessary to deviate from board policy then s/he should inform the

board, and the board can approve or disapprove if it so chooses.

• Any governing board has the right to expect from its CEO performance, honesty &

straightforwardness. On the other hand, every CEO has the right to expect his/her board to

speak in one voice.

4) Unity of direction:

• Fayol’s (1949) research found that the higher performing organization had only one board

of governance, one CEO and one strategic plan, mission or vision at any one time.


Unit 3: Contd...

• This Fayol called unit of direction; there was unity or cohesion within and across those

elements that comprised organizational governance.

• According to his research, anything more would be recipe for duality, confusion, disorder,

waste and ineffectiveness.

• Today the talk is about the strategic alignment. For any organization to be strategically

successful it is crucial that there be a high degree of strategic alignment, fit or congruence

among the organization’s mission, vision, values, goals, strategy, structure, culture,

leadership style, resource deployment and investment, incentive system, skills set, and

performance measures.

• This strategic alignment is the responsibility of the CEO under the stewardship of the BOD.


Unit 3: Contd...

5) Unity of command:

• The “second” unity of good governance is unity of command or the scalar principle.

• For any action whatsoever, an employee (including CEO) should receive orders from

one superior only.

• It is physically impossible for a person to obey two contradictory commands.

• Decision making authority (the chain of command) should flow in a straight line from top

to the bottom of an organization. The violation of this principle creates confusion.

• A CEO reporting to more than one governing master usually ends up being more

powerful than either master.


Unit 3: Contd...

6) Unity of accountability/responsibility:

• The responsibility principle in organizational theory clearly states that, first, subordinates

are responsible for their performance directly to their superiors/supervisors and second,

that supervisors are directly responsible for the performance of those they supervise.

• Authority within an organization should always be commensurate with responsibility.

• Where it is not, decisions are delayed or not made at all because of the affected

individual’s refusal to act beyond his/her authority limits.

• Dual accountability-or the lack of unity of accountability-signals the need for

communication and consensus.

• Anything less than direct, single-line accountability is not effective within today’s

dynamic environment, and is incompatible with the challenging demands.


Unit 3: contd...

• Unclear accountability almost guarantees total collapse in economic crunch.

• Unity of accountability is simply good, sound management. Dual/multiple accountability

breeds ambiguity, confusion, conflicts, with-drawl, alienation, and even anarchy.

7) Ownership needs:

• Of the governing board’s three main functions (formulating corporate policies, monitoring

operations according to plans, and acting as a voice of ownership) its role as a voice of

ownership is the least explicit.

• To find out what really matters requires a board and CEO to get to know their

organization’s key stakeholders.


Unit 3: contd...

• They need to understand what matters to the constituents they serve. Governors and

CEOs need to communicate in a strategic fashion with their owners and communities in

order to satisfy the new demands of governance.

• Generally, two things are key for boards of governance: due diligence and corporate

intangibles.

• Due diligence refers to the careful examination of current finances, long term debts,

contractual obligations, and pending litigations.

• Intangibles, however, refer to corporate culture, reputation, integrity, relationships and

above all, values.


Unit 3: Contd...

• As the board can be forgiving of a CEO with respect to performance but should never bend

on integrity, so can owners be forgiving in the realm of due diligence (although this is never

encouraged) but should never tolerate their mission or values being subverted.

8) Self-improvement:

• If organization truly embrace the principles of Total Quality Management then continuous

improvement, as an organizational philosophy, needs to permeate from top of the pyramid

to the bottom.


Unit 3: Contd...

9) Understanding the cost of governance:

Boards are not only “governance centres” but “cost centres” as well. There are five

basic costs of governance:

a) board member’s personal opportunity costs,

b) direct board meeting expenses,

c) the costs of staff supporting board activists,

d) the costs associated with errors made by boards; and

e) the costs of ineffectively structured governance-management-organization relationships.


Unit 3: Contd...

(B) Five benchmarks of excellence in governance:

There are five generic benchmarks of excellence in governance:

(1) Clearly articulated mission and vision:

• A well governed organization has a clearly articulated mission that drives the commitment and

work of the governance group and staff, and that serves as the benchmark against which the

organization evaluates its achievements and adjusts its behaviour over time.

(2) Achievement-oriented culture:

• A well governed institution is led by an individuals or individuals who create a culture that

enables and motivates the achievement of the mission.

• Mission of well governed organizations are crafted in such a way as to set high expectations


Unit 3: Contd...

for achievement.

• Key to this benchmark is a board’s selection and evaluation (using selected, quantifiable

performance indicators straight out of the mission or vision statement) of a highly

competent CEO who will lead by example.

(3) Leadership partnership:

• Organizations that demonstrates excellence in governance always have a committed and

involved BOD which vigorously interacts with the CEO and other top-level leaders in shared

governance.

• In doing so, these boards also act accountable to the ownership and/or larger community to

which they are ultimately accountable.


Unit 3: Contd...

(4) Focus on improvement:

• Such organizations are focused on continuous improvement.

• Not only do benchmark organizations continually assess and improve their work processes,

but the governing entities of these organizations drive it and even continually assess and

improve their own governing processes.

(5) Boards are a workable size:

• Boards function best in executing their responsibilities if they are workable size. Those

boards which excel in their governance duties usually have seven to 15 members.

Example: HDFC-Corporate Governance

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Unit 3: Contd...

(C) Adrian Cadbury Report:

• The stress in the Cadbury report is on the crucial role of the board and the need for it to

observe a Code of Best Practices.

• Its important recommendations include the setting up of an audit committee with

independent members, and disclosures by institutional shareholders of their policies on the

use of their voting rights.

• The Cadbury model is one of self-regulation. It was recognised that in the event British

companies fail to comply with the voluntary code, legislation and external regulation would

follow.

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Unit 3: Contd...

In India, the Cadbury Committee's report has generated a number of studies by, the

Confederation of Indian Industries (CII), the Associated Chamber of Commerce and the

Securities and Exchange Board of India (SEBI).

(D) Kumarmangalam Report:


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Business Ethics and Corporate Governance Prof. Abhay Singh Borivali February, 2010 No part of this document must be reproduced for distribution without