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Corporate Governance in India

Submitted in partial fulfillment of the requirements for (FM)

(Year2011-14)

PROJECT GUIDE

(Prof. GaziaSayed)

SUBMITTED BY

Name: (Mahendra Shantaram Patil)

(MFM) Roll No. (MF-11-30.)

Batch: (2011 - 2014)

IESManagementCollege and Research Centre

University of Mumbai

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Mahendra S. Patil Corporate Governance In India Page 2 of 84

DECLARATION

I hereby declare that this report submitted in partial fulfillment of the requirement of the

award for the marks of master of finance management (MFM / MIM /MMM) to IES

Management College is my original work and not submitted for award for award of any

degree or diploma, fellowship or for similar titles or prizes.

I further certify that I have no objection and grant the rights to IES Management college

to publish any chapter / project if they deem fit the journals/Magazine and newspapers

etc without my permission.

Place : Mumbai

Date :

Name :Mahendra Shantaram Patil Signature:

Class : Master of Finance Management (MFM)

Roll No :MF11 - 30

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CERTIFICATE*

This is to certify that project titled: Corporate Governance in India

has been submitted by Mr. Mahendra Shantaram Patil towards partial fulfillment of the

requirements of the MFM degree course 2011 - 20014 and has been carried out by him

under the guidance of Ms. Gazia Sayed at the IES Management College and Research

Centre affiliated to the University of Mumbai.

The matter presented in this report has not been submitted for any other purpose in this

Institute.

_______________________ ___________________________

Guide : Director: Dr.Dinesh D. Harsolekar

Place : Place :

Date : Date :

* on IES Letterhead

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Table of Contents

Certificate

Declaration

Acknowledgement (i)

Preface (ii)

1. Introduction 1

a) Meaning of Corporate Governance 2

b) IndiaThe Birth Place of Corporate Governance 2

c) Fundamental objective of corporate governance 3

2. Evolution of Frame work 4

a) Global scene 4

b) Indian Scene 10

3. Comparison Of Corporate Governance Guidelines & Codes Of Best

Practice In Developed & Developing / Emerging Markets 27

4. Four Pillars of Corporate Governance 34

5. Indian Stock Exchange requirements on compliance 36

6. Triple Effect of Corporate Governance 47

7. Adherence to Corporate Governance - A critical analysis 49

a) On HDFC 49

b) On Infosys 52

8. Flouting of corporate governance norms and its consequencesA critical

analysis 56

a) On Enron 56

b) On WorldCom 58

9. Conclusion 62

Bibliography 63

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1. Introduction

Although India has been rather slow in establishing corporate governance principles over

the last two decades, 2012 was a positive year for progression in the Indian corporate governance

arena. The Companies Bill 2012, passed by LokSabha (the lower house) on 18 December 2012,

includes a number of new provisions aimed at improving the governance of public companies.

Many countries have now started recognizing the synergy between macroeconomic and

structural policies. One key element in improving economic efficiency is corporate governance,

which involves a set of relationships between a company's management, its board, its

shareholders and other stakeholders. Corporate governance also provides the structure through

which the objectives of the company are set, and the means of attaining those objectives and

monitoring performance are determined. Good corporate governance should provide proper

incentives for the board and the management to pursue objectives that are in the interests of the

company and shareholders and should facilitate effective monitoring, thereby encouraging firms

to use resources more efficiently.

There has been renewed interest in the corporate governance practices of modern

corporations, particularly in relation to accountability, since the high-profile collapses of a

number of large corporations during 20012002, most of which involved accounting fraud.

Corporate scandals of various forms have maintained public and political interest in the

regulation of corporate governance.

Definitions of Corporate Governance

Cadbury Report (UK), 1992

Corporate Governance is the system by which companies are directed and controlled.

SEBI (Kumar Mangalam Birla) Report on Corporate Governance, January, 2000

Fundamental objective of corporate governance is the enhancement of the long-term

shareholder value while at the same time protecting the interests of other stakeholders.
http://en.wikipedia.org/wiki/Corporate_scandalshttp://en.wikipedia.org/wiki/Corporate_scandals

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a) Meaning of Corporate Governance

Corporate governancerefers to the system by which corporations are directed and

controlled. The governance structure specifies the distribution of rights and responsibilities

among different participants in the corporation such as the board of directors, managers,

shareholders, creditors, auditors, regulators, and other stakeholders and specifies the rules and

procedures for making decisions in corporate affairs. Governance provides the structure through

which corporations set and pursue their objectives, while reflecting the context of the social,

regulatory and market environment. Governance is a mechanism for monitoring the actions,

policies and decisions of corporations. Governance involves the alignment of interests among the

stakeholders.

Corporate governance refers toan economic, legal and institutional environmentthat

allows companies diversify, grow, restructure and exit, and do everything necessary to maximize

long term shareholder value.

Corporate Governance harmonizes the need for a company to strike a balance at all times

between the need to enhance shareholders wealth whilst not in any way being detrimental to the

interests of the other stakeholders in the company.

b) IndiaThe Birth Place of Corporate Governance

We as a country have been practicing Corporate Governance since Nanda and Maurya

Dynasties i.e. 198 BC - 320BC. Kautilya's concept of Corporate Governance tallies with the

global consensus on the objective of Good Corporate Governance.

Kautilya (Chanakya) Says:

"Prajasukhesukhamragyam,

Prajanancahitehitam,

Naatmanpriyamhitamragyam

Parajanantupriyamhitam"

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Means : In the happiness and well-being of the subjects, lies the well-being of the king, in the

welfare of the subjects, is the welfare of the king, what is desirable and beneficial to the subjects

and not his personal desires and ambition, is desirable and beneficial for the king.

Chanakya further elaborated on the "four-fold" duties of the king as "Raksha -protection",

"Vriddhi- enhancement", "Palana- maintenance", "Yogakshema- safeguarding". It is the duty of

the king to protect the wealth of the state and its subjects, to enhance the wealth, to maintain it

and safeguard it and the interest of the subjects. The substitution of the STATEby the

CORPORATION, theKINGby the CEO or theBOARD OF A CORPORATION and the

SUBJECTSby the SHAREHOLDERSbrings out the quintessence of Corporate Governance,

because central to the concept of Corporate Governance is the belief that public good should be

ahead of private good; and that the corporations resources cannot be used for personal benefits.

The fourfold duties of the king can be interpreted to imply for the corporation, as shareholder's

wealth, its enhancement of the wealth through proper utilization of assets, maintenance of that

wealth taking care not to fritter it away in unconnected and non-profitable ventures or through

expropriation, and above all safeguard of the interest of the shareholders.

c) Fundamental objective of corporate governance

From the beginning and until today, the corporate objective has been The conduct of

business activities with a view toward enhancing corporate profit and shareholder gain, keeping

in view the interests of other stakeholder".

The three key constituents of Corporate Governance:

Management Board of Directors Share Holders

Corporate governance aims at identifying roles and responsibilities of these constituents as also

their rights to achieve the higher standards of transparency, efficiency and integrity.

The three key aspects of Corporate Governance:

Accountability Transparency

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Equality of treatment for all stakeholders2. Evolution of framework

a) Global scene

Corporate governance guidelines and codes of best practices began in the early 1990s in

the United Kingdom and the United States in response to problems in the performance of leading

companies and the perceived lack of effective board oversight that contributed to those problems.

The Cadbury Report of the UK, the General Motors Board of Directors Guidelines in the US and

the Dey Report in Canada proved to be influential sources for other guidelines and codes. Over

the past decade, several guidelines and codes have been issued by various countries. Compliance

with these recommendations is generally not mandated by law, although codes that are linked to

stock exchanges sometimes have a mandatory content.

There is a diversity of opinion regarding beneficiaries of corporate governance. The Anglo-

American system tends to focus on shareholders and various classes of creditors. Continental

Europe, Japan and South Korea believe that companies should also discharge their obligations

towards employees, local communities, suppliers, ancillary units, and so on

Irrespective of differences between various forms of corporate governance, all recognize that

good corporate practices mustat the very leastsatisfy two sets of claimants: creditors and

shareholders. In the developed world, company managers must perform to satisfy creditors dues

because of the disciplining device of debt.

OECD Pri nciples of Corporate Governance

In April 1998, the Business Sector Advisory Group on Corporate Governance, chaired by Ira M.

Millstein, issued a report to the Organization for Economic Cooperation and Development

(OECD) titled Corporate Governance: Improving Competitiveness and Access to Capital in

Global Markets which urged the OECD to formulate a set of core governance principles.

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Subsequently, the OECD organized an Ad Hoc Task Force for this purpose, and the Principles of

Corporate Governance were issued in April 1999.

The OECD Principles address:

I. The Rights of Shareholders;

II. Equitable Treatment of Shareholders;

III. The Role of Stakeholders;

IV. Disclosure and Transparency; and

V. The Responsibilities of the Board.

Intended to serve as non-binding reference points for local governments and private sectors to

adapt and build upon, the OECD Principles are grounded on two important propositions: 1) no

one country or existing system can serve as the model that dictates reform worldwide; and 2)

access to capital is the primary driver for the integration of core corporate governance practices

in the international arena. The G7 countries have endorsed the OECD Principles.

The Principles are intended to assist Member and non-Member governments in their efforts to

evaluate and improve the legal, institutional and regulatory framework for corporate governance

in their countries, and to provide guidance and suggestions for stock exchanges, investors,

corporations, and other parties that have a role in the process of developing good corporate

governance. The Principles focus on publicly traded companies. However, to the extent they are

deemed applicable, they might also be a useful tool to improve corporate governance in non-

traded companies, for example, privately held and state-owned enterprises. The Principles

represent a common basis that OECD Member countries consider essential for the development

of good governance practice. They are intended to be concise, understandable and accessible to

the international community. They are not intended to substitute for private sector initiatives to

develop more detailed "best practice" in governance.

The Principles are non-binding and do not aim at detailed prescriptions for national legislation.

Their purpose is to serve as a reference point. They can be used by policy makers, as they

examine and develop their legal and regulatory frameworks for corporate governance that reflect

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their own economic, social, legal and cultural circumstances, and by market participants as they

develop their own practices.

The Principles are evolutionary in nature and should be reviewed in light of significant changes

in circumstances. To remain competitive in a changing world, corporations must innovate and

adapt their corporate governance practices so that they can meet new demands and grasp new

opportunities. Similarly, governments have an important responsibility for shaping an effective

regulatory framework that provides for sufficient flexibility to allow markets to function

effectively and to respond to expectations of shareholders and other stakeholders. It is up to

governments and market participants to decide how to apply these Principles in developing their

own frameworks for corporate governance, taking into account the costs and benefits of

regulation.

Following are the principles laid down:

I. The rights of shareholders

The corporate governance framework should protect shareholders rights.

A. Basic shareholder rights include the right to:1) Secure methods of ownership registration;

2) Convey or transfer shares;

3) Obtain relevant information on the corporation on a timely andRegular basis;

4) Participate and vote in general shareholder meetings;

5) Elect members of the board; and

6) Share in the profits of the corporation.

B. Shareholders have the right to participate in, and to be sufficiently informed on, decisionsconcerning fundamental corporate changes such as:

1) Amendments to the statutes, or articles of incorporation or similar Governing documents

of the company;

2) The authorization of additional shares; and

3) Extraordinary transactions that in effect result in the sale of theCompany.

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C. Shareholders should have the opportunity to participate effectively and vote in generalshareholder meetings and should be informed of the rules, including voting procedures, that

govern general shareholder meetings:

Shareholders should be furnished with sufficient and timely information concerning the date,

location and agenda of general meetings, as well as full and timely information regarding the

issues to be decided at the meeting. Opportunity should be provided for shareholders to ask

questions of the board and to place items on the agenda at general meetings, subject to

reasonable limitations. 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.

D. Capital structures and arrangements that enable certain shareholders to obtain a degree of controldisproportionate to their equity ownership should be disclosed.

E. Markets for corporate control should be allowed to function in an efficient and transparentmanner. The rules and procedures governing the acquisition of corporate control in the capital

markets, and extraordinary transactions such as mergers, and sales of substantial portions of

corporate assets, should be clearly articulated and disclosed so that investors understand their

rights and recourse. Transactions should occur at transparent prices and under fair conditions that

protect the rights of all shareholders according to their class. Anti-take-over devices should not

be used to shield management from accountability.

F. Shareholders, including institutional investors, should consider the costs and benefits ofExercisingtheir voting rights.

II. The equitable treatment of shareholders

The corporate governance framework should ensure the equitable treatment of all shareholders,

including minority and foreign shareholders. All shareholders should have the opportunity to

obtain effective redress for violation of their rights.

A. All shareholders of the same class should be treated equally. Within any class, all shareholdersshould have the same voting rights. All investors should be able to obtain information about the

voting rights attached to all classes of shares before they purchase. Any changes in voting rights

should be subject to shareholder vote. Votes should be cast by custodians or nominees in a

manner agreed upon with the beneficial owner of the shares. Processes and procedures for

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general shareholder meetings should allow for equitable treatment of all shareholders. Company

procedures should not make it unduly difficult or expensive to cast votes.

B. Insider trading and abusive self-dealing should be prohibited.C. Members of the board and managers should be required to disclose any material interests in

transactions or matters affecting the corporation.

III. The role of stakeholders in corporate governance

The corporate governance framework should recognize the rights of stakeholders as established

by law and encourage active co-operation between corporations and stakeholders in creating

wealth, jobs, and the sustainability of financially sound enterprises.

A. The corporate governance framework should assure that the rights of stakeholders that areprotected by law are respected.

B. Where stakeholder interests are protected by law, stakeholders should have the opportunity toobtain effective redress for violation of their rights.

C. The corporate governance framework should permit performance-enhancing mechanisms forstakeholder participation.

D. Where stakeholders participate in the corporate governance process, they should have access torelevant information.

IV. Disclosure and transparency

The corporate governance framework should ensure that timely and accurate disclosure is made

on all material matters regarding the corporation, including the financial situation, performance,

ownership, and governance of the company.

A. Disclosure should include, but not be limited to, material information on:The financial and operating results of the company.

Company objectives.

Major share ownership and voting rights.

Members of the board and key executives, and their remuneration.

Material foreseeable risk factors.

Material issues regarding employees and other stakeholders.

Governance structures and policies.

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B. Information should be prepared, audited, and disclosed in accordance with high quality standardsof accounting, financial and non-financial disclosure, and audit.

C. An annual audit should be conducted by an independent auditor in order to provide an externaland objective assurance on the way in which financial statements have been prepared and

presented.

V. The responsibilities of the board

The corporate governance framework should ensure the strategic guidance of the company, the

effective monitoring of management by the board, and the boardsaccountability to the company

and the shareholders.

A. 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.

B. Where board decisions may affect different shareholder groups differently, the board should treatall shareholders fairly.

C. The board should ensure compliance with applicable law and take into account the interests ofstakeholders.

D. The board should fulfill certain key functions, including:Reviewing and guiding corporate strategy, major plans of action, risk policy, annual

budgets and business plans; setting performance objectives; monitoring implementation and

corporate performance; and overseeing major capital expenditures, acquisitions and divestitures.

Selecting, compensating, monitoring and, when necessary, replacing key executives and

overseeing succession planning.

Reviewing key executive and board remuneration, and ensuring a formal and transparent

board nomination process.

Monitoring and managing potential conflicts of interest of management, board members

and shareholders, including misuse of corporate assets and abuse in related party transactions.

Ensuring the integrity of the corporations accounting and financial reporting systems, including

the independent audit, and that appropriate systems of control are in place, in particular, systems

for monitoring risk, financial control, and compliance with the law.

Monitoring the effectiveness of the governance practices under which it operates and

making changes as needed.

Overseeing the process of disclosure and communications.

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E. The board should be able to exercise objective judgment on corporate affairs independent, inparticular, from management.

Boards should consider assigning a sufficient number of non-executive board members

capable of exercising independent judgment to tasks where there is a potential for conflict of

interest. Examples of such key responsibilities are financial reporting, nomination and executive

and board remuneration.

Board members should devote sufficient time to their responsibilities.

F. In order to fulfill their responsibilities, board members should have access to accurate, relevantand timely information.

b) Indian Scene

There is no unique structure of "corporate governance" in the developed world; nor is one

particular type unambiguously better than others. Thus, one cannot design a code of corporate

governance for Indian companies by mechanically importing one form or another.

Second, Indian companies, banks and financial institutions (FIs) can no longer afford to ignore

better corporate practices. As India gets integrated in the world market, Indian as well as

international investors will demand greater disclosure, more transparent explanation for major

decisions and better corporate value.

Hence in India, the Confederation of the Indian Industry (CII) took the lead in framing a

desirable code of corporate governance in April 1998. This was followed by the

recommendations of the Kumar Mangalam Birla Committee on Corporate Governance appointed

by the Securities and Exchange Board of India (SEBI)the recommendations were accepted by

SEBI in December 1999, and are now enshrined in Clause 49 of the Listing Agreement of every

Indian stock exchange

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Desirable Corporate GovernanceA CII Code (April 1998).

The CII code on Corporate governance finds it useful to limit the claimants to shareholders and

various types of creditors. There are two reasons for this preference.

1. The corpus of Indian labour laws is strong enough to protect the interest of workers in theorganized sector, and both employees as well as trade unions are well aware of their legal rights.

In contrast, there is very little in terms of the implementation of law and of corporate practices

that protects the rights of creditors and shareholders

2. There is much to recommend in law, procedures and practices to make companies more attunedto the needs of properly servicing debt and equity. If most companies in India appreciate the

importance of creditors and shareholders, then we will have come a long way.

Recommendations made on various aspects of corporate governance are as follows:

Board of Directors:

Obviously not all well governed companies do well in the market place. Nor do the badly

governed ones always sink. But even the best performers risk stumbling some day if they lack

strong and independent boards of directors. The key to good corporate governance is a well

functioning board of directors. The board should have a core group of excellent, professionally

acclaimed non-executive directors who understand their dual role: of appreciating the issues put

forward by management, and of honestly discharging their fiduciary responsibilities towards the

companys shareholders as well as creditors.

Recommendati on 1

There is no need to adopt the German system of two-ti er boards to ensure desirable corporate

governance. A single board, i f it perf orms well , can maximi ze long term shareholder value just

as well as a two- or mult i -tiered board. Conversely, there is nothi ng to suggest that a two-tier

board, per se, is the panacea to all corporate problems. However, the fu l l board should meet a

min imum of six times a year, preferably at an in terval of two months, and each meeting

should have agenda items that require at least half a days discussion.

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Securing the services of good, professionally competent, independent non-executive

directors does not necessarily require the institutionalizing of nomination committees or search

committees. However, it does require a code that specifies a minimal thumb-rule. This leads to

the second recommendation.

Recommendati on 2

Any listed companies with a turnover of Rs.100 cror es and above should have prof essionall y

competent and acclaimed non-executi ve dir ectors, who should constitute

at least 30 percent of the board if the Chairman of the company is a non-executive director, or at least 50 percent of the board if the Chairman and M anaging Di rector is the same person.

Getting the right type of professionals on the board is only one way of ensuring diligence. It has

to be buttressed by the concept of limitation: one cannot hold non-executive directorships in a

plethora of companies, and yet be expected to discharge ones obligations and duties. This yields

the third recommendation.

Recommendati on 3

No single person should hold dir ectorships in more than 10 companies. This ceil ing excludesdir ectorshi ps in subsidiar ies (where the group has over 50% equi ty stake) or associate

companies (where the group has over 25% but no mor e than 50% equi ty stake).

As of now, section 275 of the Companies Act allows a person to hold up to 20

directorships. TheReport of the Working Group on the Companies Act(February 1997) has kept

the number unchanged. It is extremely difficultalmost inconceivablefor someone to hold 20

directorships and yet discharge his fiduciary responsibilities towards all. In this context, it is

useful to give the trend in the USA. According to a recent survey of over 1,000 directors and

chairmen of US corporations, the directors themselves felt that no one should serve on more than

an average of 2.6 Boards. On 12 November 1996, a special panel of 30 corporate governance

experts co-opted by the National Association of Corporate Directors of the USA recommended

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that Senior executives should sit on no more than 3 boards, including their own. Retired

executives and professional non-executive directors should serve on no more than 6.

Recommendati on 4

For non-executive dir ectors to play an important role in maximizing long term shareholder

value, they need to

become active participants in boards, not passive advisors; have clearl y defi ned responsibi li ties with in the board; and Know how to read a balance sheet, prof i t and loss account, cash f low statements and f inancial

ratios and have some knowledge of various company laws. This, of course, excludes those who

are invi ted to join boards as experts in other f ields such as science and technology.

Remuneration:

This brings one to remuneration of non-executive directors. At present, most non-

executive directors receive a sitting fee which cannot exceed Rs.2,000 per meeting. The Working

Group on the Companies Act has recommended that this limit should be raised to Rs.5,000.

Although this is better than Rs.2,000, it is hardly sufficient to induce serious effort by the non-

executive directors.

Recommendati on 5

To secure better eff ort from non-executive directors, companies shoul d:

Pay a commission over and above the sit ting fees for the use of the prof essional inputs. Thepresent commission of 1% of net profi ts (if the company has a managing director), or 3% (i f

there is no managing director) i s suf fi cient.

Consider offer ing stock options, so as to relate rewards to performance. Commissions arerewards on cur rent profi ts. Stock options are rewards contingent upon future appreciation of

corporate value. An appropriate mix of the two can al ign a non-executive dir ector towards

keeping an eye on short term profi ts as well as longer term shareholder value.

The above recommendation can be easily achieved without the necessity of any

formalized remuneration committee of the board. To ensure that non-executive directors properly

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discharge their fiduciary obligations, it is, however, necessary to give a record of their attendance

to the shareholders.

Recommendati on 6

While re-appoin ting members of the board, companies should give the attendance record of

the concerned dir ectors. I f a dir ector has not been present (absent with or wi thout leave) for

50 percent or more meetings, then th is shoul d be expli citl y stated in the resolution that i s put

to vote. As a general practice, one should not re-appoin t any non-executi ve dir ector who has

not had the time attend even one hal f of the meetings

It is important to recognize that, under usual circumstances, non-executive directors

suffer from informational asymmetry. Simply put, the extent to which non-executive directors

can play their role is determined by the quality of disclosures that are made by the management

to the board. In the interest of good governance, certain key information must be placed before

the board, and must form part of the agenda papers.

Recommendati on 7

Key inf ormation that must be reported to, and placed before, the board must contain :

Annual operating plans and budgets, together wi th up-dated long term plans.

Capital budgets, manpower and overhead budgets. Quar terly resul ts for the company as a whole and i ts operating divisions or business segments. I nternal audi t reports, including cases of theft and dishonesty of a materi al nature. Show cause, demand and prosecution notices received from revenue authorit ies which are

considered to be materiall y important. (Material nature is any exposure that exceeds 1 percent

of the companys net worth).

Fatal or seri ous accidents, dangerous occurrences, and any eff luent or polluti on problems. Defaul t in payment of i nterest or non-payment of the pri ncipal on any public deposit, and/or

to any secured creditor or f inancial instituti on.

Defau lts such as non-payment of in ter-corporate deposits by or to the company, or material lysubstantial non-payment for goods sold by the company.

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Any issue which i nvolves possible publi c or product li abil ity claims of a substantial nature,including any judgment or order whi ch may have either passed str ictures on the conduct of

the company, or taken an adverse view regarding another enterpri se that can have negative

implications for the company.

Details of any joint venture or collaboration agreement. Transactions that involve substantial payment towards goodwill , brand equi ty, or intellectual

property.

Recruitment and remuneration of senior of f icers just below the board l evel, includingappoin tment or removal of the Chief F inancial Off icer and the Company Secretary.

Labour problems and their proposed solutions. Quar terly detai ls of foreign exchange exposure and the steps taken by management to limit the

r isks of adverse exchange rate movement

The Report of the Working Group on the Companies Actwas in favor of Audit Committees, but

recommended that these be set up voluntarily "with the industry associations playing a catalytic

role" [p.23]. The Group felt that legislating in favor of Audit Committees would be counter-

productive, and could lead to a situation where such committees would be often constituted to

meet the letterand not the spiritof the law. Nevertheless, there is a clear need for Audit

Committees, which yields the next recommendation.

Recommendati on 8

L isted companies with either a turnover of over Rs.100 cores or a paid-up capital of Rs.20

coreswhi chever is lessshould set up Audi t Committees withi n two years.

Audit Committees should consist of at least three members, all drawn from a companys non-executive dir ectors, who should have adequate knowledge of f inance, accounts and basic

elements of company law.

To be effective, members of Audit Committees must be will ing to spend more time on thecompanys work vis--vis other non-executi ve directors.

Audit Committees should assist the board in ful fi ll ing its functions relating to corporateaccount ing and reporti ng practices, f inancial and accounting contr ols, and financial

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statements and proposals that accompany the publ ic issue of any secur ityand thus provide

effective supervision of the f inancial reporting process.

Audit Committees should peri odically interact with the statutory auditors and the internalauditors to ascertain the quality and veracity of the companys accounts as well as the

capabil i ty of the audi tors themselves.

For Audi t Committees to discharge their fi duciary responsibi li ties with due dil igence, it mustbe incumbent upon management to ensur e that members of the committee have ful l access to

f inancial data of the company, its subsidiary and associated companies, including data on

contingent li abil iti es, debt exposure, current li abili ties, loans and investments.

By the fiscal year 1998-99, li sted companies satisfying cri terion (1) should have in place astrong internal audit department, or an external auditor to do internal audits; without this,

any Audi t Committee will be toothless.

Desirable Disclosure:

The last two years have seen domestic investors escape from equity in favor of debt, particularly

bonds issued by public financial institutions. If the corporate sector wants to create a comeback

for equity, it can only do so through greater transparency. Audit Committees ensure long term

goodwill through such transparency

Our corporate disclosure norms are inadequate. With the growth of the financial press and equity

researchers, the days of having opaque accounting standards and disclosures are rapidly coming

to an end. As a country which wishes to be a global player, we cannot hope to tap the GDR

market with inadequate financial disclosures; it will not be credible to present one set of accounts

to investors in New York and Washington DC, and a completely different one to the

shareholders in Mumbai and Chennai. So, what is the minimum level of disclosure that Indian

companies ought to be aiming for?

The Working Group on the Companies Acthave recommended many financial as well as non-

financial disclosures. It is worth recapitulating the more important ones.

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Non-Financial disclosures recommended by the Working Group on the Companies Act1. Comprehensive report on the relatives of directorseither as employees or Board membersto

be an integral part of the Directors Report of all public limited companies.

2. Companies have to maintain a register which discloses interests of directors in any contract orarrangement of the company. The existence of such a register and the fact that it open for

inspection by any shareholder of the company should be explicitly stated in the notice of the

AGM of all public limited companies.

3. Similarly, the existence of the directors shareholding register and the fact that it can beinspected by members in any AGM should be explicitly stated in the notice of the AGM of all

public limited companies.

4. Details of loans to directors should be disclosed as an annex to the Directors Report in additionto being a part of the schedules of the financial statements. Moreover, such loans should be

limited to only three categorieshousing, medical assistance, and education for family

membersand be available only to full time directors. The loans should not exceed five times

the annual remuneration of the whole time director, and would need shareholders approval in a

general meeting.

5. Appointment of sole selling agents for India will require prior approval of a special resolution ina general meeting of shareholders. The board may approve the appointment of sole selling agents

in foreign markets, but the information must be divulged to shareholders as a part of the

Directors Report accompanying the annual audited accounts. In either case, if the sole selling

agent is related to any director or director having interest, this fact has to not only be stated in the

special resolution but also divulged as a separate item in the Directors Report.

6. Subject to certain exceptions, there should be a Secretarial Compliance Certificate forming a partof the Annual Returns that is filed with the Registrar of Companies which would certify, in

prescribed format that the secretarial requirements under the Companies Act have been adhered

to.

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Financial disclosures recommended by the Working Group on the Companies Act1. A tabular form containing details of each directors remuneration and commission should form a

part of the Directors Report, in addition to the usual practice of having it is a note to the profit

and loss account.

2. Costs incurred, if any, in using the services of a Group Resource Company must be clearly andseparately disclosed in the financial statement of the user company.

3. A listed public limited company must give certain key information on its divisions or businesssegments as a part of the Directors Report in the Annual Report. This should encompass (i) the

share in total turnover, (ii) review of operations during the year in question, (iii) market

conditions, and (iv) future prospects. For the present, the cut-off may be 10% of total turnover.

4. Where a company has raised funds from the public by issuing shares, debentures or othersecurities, it would have to give a separate statement showing the end-use of such funds, namely:

how much was raised versus the stated and actual project cost; how much has been utilized in the

project up to the end of the financial year; and where are the residual funds, if any, invested and

in what form. This disclosure would be in the balance sheet of the company as a separate note

forming a part of accounts.

5. The disclosure on debt exposure of the company should be strengthened.6. In addition to the present level of disclosure on foreign exchange earnings and outflow, there

should also be a note containing separate data on of foreign currency transactions that are

germane in todays context: (i) foreign holding in the share capital of the company, and (ii)

loans, debentures, or other securities raised by the company in foreign exchange.

7. There are often differences in assets and liabilities between the end of the financial year and thedate on which the board approves the balance sheet and profit and loss account. These

disclosures appear in the Directors Report. In addition, such differences should be clearly stated

under the relevant sub-heads, and presented as a note forming a part of the accounts.

8. If any fixed asset acquired through or given out on lease is not reported under appropriate sub-heads, then full disclosure would need to be made as a note to the balance sheet. This should give

details of the type of asset, its total value, and the future obligations of the company under the

lease agreement.

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9. Any inappropriate treatment of an item in the balance sheet or profit and loss account should notbe allowed to be explained away either through disclosure of accounting policies or via notes

forming a part of accounts.

10.The threshold remuneration of those employees whose details have to divulged under section217(2A) should be raised to Rs.5 lakhs per year, and this disclosure should only be submitted to

the Registrar of Companies and not form a part of the Directors Report. The statement should be

made available for inspection of shareholders at the AGM. However, if there are any directors

relatives who receive remuneration, full details of such cases should be given.

While the disclosures recommended by the Working Group in its report as well as in the

modified Schedule VI that would accompany the Draft Bill go far beyond existing levels, much

more needs to be done outside the framework of law., particularly (i) a model of voluntary

disclosure in the current context, and (ii) consolidation of accounts.

All other things being equal, greater the quality of disclosure, the more loyal are a companys

shareholders. Besides, there is something very inequitable about of present disclosure standards:

we have one norm for the foreigners when we go in for GDRs or private placement with foreign

portfolio investors, and a very different one for our more loyal Indian shareholders. This should

not continue. The suggestions given below partly rectify this imbalance.

Recommendati on 9

Under "Additional Shareholders Information", listed public companies should give data on:

High and low monthl y averages of share prices in all the Stock Exchanges where the companyis li sted for the report ing year.

Statement on value added, which is total income minus the cost of all in termediate inputs andadmin istrative expenses.

Greater detai l on business segments or divisions, up to 5% of tur nover, giving share in salesrevenue, share in contri bution, review of operati ons, analysis of markets and f uture prospects

The Working Group on the Companies Acthas recommended that consolidation should be

optional, not mandatory. There were two reasons: (i) first, that the Income Tax Department does

not accept the concept of group accounts for tax purposesand theReport of the Working Group

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on the Income Tax Actdoes not suggest any difference, and (ii) the public sector term lending

institutions do not allow leveraging on the basis of group assets. Thus:

Recommendati on 10

Consolidation of Group Accounts should be optional and subject to the FI s allowingcompanies to leverage on the basis of the groups assets, and the Income Tax Department

using the group concept in assessing corporate income tax.

I f a company chooses to voluntari ly consolidate, it should not be necessary to annex theaccounts of i ts subsidiary companies under section 212 of the Companies Act.

However, i f a company consolidates, then the minimal defi ni tion of " group" should includethe parent company and i ts subsidiaries (in which the reporting company owns over 50% of

the voting stake).

One of the most appealing features of the Cadbury Committee Report(Committee on the

Financial Aspects of Corporate Governance) is the Compliance Certificate that has to

accompany the annual reports of all companies listed in the London Stock Exchange. This alone

has created a far more healthy milieu for corporate governance despite the cosy, club-like

atmosphere of British boardrooms. It is essential that a variant of this be adopted in India.

Recommendati on 11

Major I ndian stock exchanges should gradually insist upon a compliance cert if icate, signed by

the CEO and the CFO, which clearl y states that:

The management i s responsible for the preparation, integrity and fai r presentation of thef inancial statements and other information in the Annual Report, and which also suggest that

the company wil l continue in business in the course of the fol lowing year.

The accounti ng poli cies and pri nciples conform to standard practice, and where they do not,ful l disclosure has been made of any material departures.

The board has overseen the companys system of internal accounting and administrativecontrol s systems either through its Audit Committee (for companies with a turnover of Rs.100

crores or paid-up capital of Rs.20 crores, whichever i s less) or dir ectly.

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As mentioned earlier, there is something inequitable about a company declaring disclosing

substantially more for its GDR issue compared to its domestic issue. This treats Indian

shareholders as if they are children of a lesser God.

Recommendati on 12

For al l companies with paid-up capital of Rs.20 crores or more, the qual ity and quant ity of

disclosure that accompanies a GDR i ssue should be the norm for any domestic issue.

Capital Market Issues :

Since "take-over" is immediately associated with "raider", it is considered an unethical act of

corporate hostility. The bulk of historical evidence shows otherwise. Growth of industry and

business in most developed economies have been aided and accompanied by take-overs, mergers

and strategic acquisitions.

International data shows that take-overs usually serve three purposes: (i) creates economies of

scale and scope, (ii) imposes a credible threat on management to perform for the shareholders,

and (iii) enhances shareholder value in the short- and in the medium-term. Because the targets

are typically under-performing companies, take-overs typically enhance short- as well as longer

term shareholder value. The short term value rises because the bidder has to offer shareholders a

price that is significantly higher than the market. Longer term gains tend to occur because the

buyer has not only bet on generating higher value through cost cutting, eliminating unproductive

lines and strengthening productive ones but also put in his money to own the controlling block of

equity.

The new Take-over Code has been introduced in India. Although the code has its problems

especially after a 50 percent acquisitionit is a step in the right direction. However, the code is,

at best, necessary for facilitating take-overs; it is hardly sufficient. There lies the basic problem

with take-overs in India. One cannot have a dynamic market and a level playing fi eld for take-

overs when there are mul tiple restr ictions on f inancing such acquisitions.

Banks do not lend for such activities. Until the slack season credit policy announced on 15 April1997, banks had imposed a credit limit is Rs.10 lakhs against share collateralhardly the kind

of money that can fund domestically financed take-overs.

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There is no securitisation. This prevents the value of underlying assets to be used inrefinancingsomething which could not only reduce cost of funds but also facilitate take-overs

by dynamic but not necessarily cash rich entrepreneurs.

FIs do not finance take-overs. There are not enough corporate debt instruments which a company could use to finance a take-

overand even these attract very high rates of Stamp Duty.

In such an environment, it is not surprising that one ends up with a severely limited take-over

code where an acquirer can go into take-over mode and, yet need not increase its equity exposure

to more than 30 percent. Moreover, it queers the pitch in favour of those who have access to off-

shore funds, which do not operate under these artificial constraints. As things stand, there will be

only two types of raiders: (i) entrepreneurs from cash rich industries, and (ii) foreign investors

who can garner substantial cheap funds from abroad. From a perspective of industrial growth

where take-overs become vehicles for synergy, scale, new technological and managerial inputs,

corporate dynamism, and long term enhancement of shareholder valueit is essential that

dynamic Indian firms and entrepreneurial groups attempting take-overs be treated the same way

by Indian banks and FIs as their buyout counterparts are in the west. This leads to an important

recommendation.

Recommendati on 13Government must allow far greater funding to the corporate sector against the secur ity of

shares and other paper. Th is has been outl ined in the slack season credit pol icy announced on

15 Apr il 1997, but i t remains to be seen how banks and F I s wil l react.

When this is in place, the take-over code should be modified to reflect international norms. Once

take-over finance is easily available to Indian entrepreneurs, the trigger should increase to 20%,

and the minimum bid should reflect at leasta 51% take-over.

Creditors Rights :

It is a universal axiom that creditors have a prior and pre-committed claim on the income

of the company, and that this claim has to be satisfied irrespective of the state of affairs of the

company. Important creditors can, and do, demand periodic operational information to monitor

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the state of health of their debtor firms; but, so long as their dues are being repaid (and expected

to be repaid) on schedule, pure creditors have no legal say in the running of a company.

Therefore, insofar as creditors are not shareholders, and so long as their dues are being paid in

time, they should desist from demanding a seat on the board of directors.

This is an important point in the Indian context. Almost all term loans from FIs carry a covenant

that it will represented on the board of the debtor company via a nominee director. This yields

the next recommendation.

Recommendati on 14

I t would be desir able for F I s as pure creditors to re-write their covenants to eliminate having

nominee dir ectors except:

in the event of serious and systematic debt defaul t; and in case of the debtor company not providing six-monthly or quarter ly operational data to the

concerned FI (s).

Today, credit-rating is compulsory for any corporate debt issue. But, as in the case of primary

equity issues, the quality of information given to the Indian investing public is still well below

what is disclosed in many other developed countries. Given below are some suggestions.

Recommendati on 15

I f any company goes to more than one credit rating agency, then i t must divulge in theprospectus and issue document the rating of all the agencies that did such an exercise.

I t is not enough to blandly state the ratings. These must be given in a tabular f ormat thatshows where the company stands relati ve to higher and lower r anking. I t makes considerable

dif ference to an investor to know whether the rating agency or agencies placed the company in

the top slots, or in the middle, or in the bottom.

I t is essential that we look at the quanti ty and quali ty of disclosures that accompany the issueof company bonds, debentur es, and fi xed deposits in the USA and Br itainif only to learn

what more can be done to inspir e conf idence and create an envir onment of transparency.\

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F inal ly, companies which are making foreign debt issues cannot have a two sets of disclosurenorms: an exhaustive one for the foreigners, and a relatively minuscule one for I ndian

investors.

There is another area of concern regarding creditors rights. This has to do with holders of

company deposits. In the last three years, there have been too many instances where

manufacturing as well as investment and finance companies have reneged on payment of interest

on company deposits or repayment of the principal. Since these deposits are generally unsecured

loans, the deposit holders are prime targets of default.

Recommendati on 16

Companies that defaul t on f ixed deposits should not be permitted to

accept fur ther deposits and make inter-corporate loans or investments unt il the default ismade good; and

declare dividends unti l the defaul t is made good.Both have been suggested by the Working Gr oup on the Companies Act, and are endorsed by

CI I .

On FIs and Nominee Directors :

Consider two facts: (i) the largest debt-holders of private sector corporate India are public sector

term lending institutions such as IDBI, IFCI, and ICICI; and (ii) these institutions are also

substantial shareholders and, like in Germany, Japan and Korea, sit on the boards as nominee

directors. So, in effect they have combined inside debt-cum-equity positions so common to

German, Japanese and Korean forms of corporate governance. But these informed insiders in

India do no seem to behave like their German counterparts; corporate governance and careful

monitoring do not happen as they are supposed to when a stake-holder is both creditor and owner

of equity, as in Germany.

The apparent failure of government controlled FIs to monitor companies in their dual capacity as

major creditors and shareholders has much to do with a pervasive anti-incentive structure. There

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are several dimensions of this structure. First, major decisions by public sector financial

institutions are eventually decided by the Ministry of Finance, and not by their board of

directors. De jure, this cannot be cause for complaintafter all the Government of India is the

major shareholder and, hence, has the right to call the shots. However, at issue is the manner in

which the government calls the shots, and whether its decisions enhance shareholder value for

the FIs. Second, nominee directors of FIs have no personal incentive to monitor their companies.

They are neither rewarded for good monitoring nor punished for non-performance. Third, there

is a tradition of FIs to supporting existing management except in the direst of circumstances.

Stability of existing management is not necessarily a virtue by itself, unless it translates to

greater transparency and higher shareholder value. Fourth, compared to the number of companies

where they are represented on the board, the FIs simply do not have enough senior-level

personnel who can properly discharge their obligations as good corporate governors. In a

nutshell, therefore, while nominee directors of FIs ought to be far more powerful than the

disinterested non-executive directors, they are in fact at par. Consequently, the institutions which

could have played the most proactive role in corporate governanceIndias largest concentrated

shareholders-cum-debt-holdershave not done so.

The long term solution requires questioning the very basis of majority government ownership of

the FIs, and whether it augurs for better governance and higher shareholder value for Indias

companies as well as the FIs themselves. As a rule, government institutions are not sufficiently

concerned about adverse income and wealth consequences arising out of wrong decisions and

inaction; their incentive structures do not reward performance and punish non-performance; and,

most of all, they remain highly susceptible to pulls and pressures from various ministries which

have little to do with commercial accountability, and which often destroy the bottom-line.

Therefore, it is necessary to debate whether the government should gradually become a minority

shareholder in all its financial sector institutions. This debate needs to be thrown open to

taxpayers and the investing public. But, for the present, there is a short term solution that must be

considered as quickly as possible.

Recommendati on 17

Reduction in the number of companies where there are nomi nee dir ectors. I t has been argued

by FI s that there are too many companies where they are on the board, and too few competent

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off icers to do the task properl y. So, in the fi rst instance, F I s should take a policy decision to

withdraw f rom boards of companies where they have lit tle or no debt exposure and where their

individual shareholding is 5 percent or l ess, or total F I holding is under 10 percent.

HIGHLIGHTS OF REPORT OF THE COMMITTEE APPOINTED BY THE SEBI ONCORPORATE GOVERNANCE UNDER THE CHAIRMANSHIP OF SHRI KUMAR

MANGALAM BIRLA

This Report is the first formal and comprehensive attempt to evolve a Code of Corporate

Governance, in the context of prevailing conditions of governance in Indian companies, as well

as the state of capital markets.

The Securities and Exchange Board of India (SEBI) appointed the committee on Corporate

Governance on May 7, 1999 under the Chairmanship of Shri Kumar Mangalam Birla, member

SEBI Board, to promote and raise the standards of Corporate Governance. The terms of the

reference are as follows:

To suggest suitable amendments to the listing agreement executed by the stock exchanges withthe companies and any other measures to improve the standards of corporate governance in the

listed companies, in areas such as continuous disclosure of material information, both financial

and non-financial, manner and frequency of such disclosures, responsibilities of independent andoutside directors;

To draft a code of corporate best practices; and To suggest safeguards to be instituted within the companies to deal with insider information and

insider trading. The recommendations made in this report mark an important step forward and if

accepted and followed by the industry, they would raise the standards in corporate governance,

strengthen the unitary board system, significantly increase its effectiveness and ultimately serve

the objective of maximising shareholder value. These recommendations will go a long way in

raising the standards of corporate governance in Indian firms and make them attractive

destinations for local and global capital. These recommendations will also form the base for

further evolution of the structure of corporate governance in consonance with the rapidly

changing economic and industrial environment of the country in the new millennium.

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3. Comparison Of Corporate Governance Guidelines & Codes Of Best Practice In Developed

& Developing / Emerging Markets

Corporate governance guidelines and codes of best practice arise in the context of, and

are affected by, differing national frameworks of law, regulation and stock exchange listing

rules, and differing societal values. Although boards of directors provide an important internal

mechanism for holding management accountable, effective corporate governance is supported by

and dependent on the market for corporate control, securities regulation, company law,

accounting and auditing standards, bankruptcy laws, and judicial enforcement. Therefore, to

understand one nations corporate governance practices in relation to anothers, one must

understand not only the best practice documents but also the underlying legal andenforcement

framework.

The brief review of the primary principles addressed by various guidelines and codes

framed/adopted in Developed & Developing / Emerging Markets indicates that there is no single

agreed upon system of good governance. Each country has its own corporate culture, national

personality and priorities. Likewise, each company has its own history, culture, goals and

business cycle maturity. All of these factors need to be taken into consideration in crafting the

optimal governance structure and practices for any country or any company.

However, the influence of international capital markets will likely lead to some

convergence of governance practices, as regulatory barriers between national economies fall and

global competition for capital increases, investment capital will follow the path to those

corporations that have adopted efficient governance standards, which include acceptable

accounting and disclosure standards, satisfactory investor protections and board practices

designed to provide independent, accountable oversight of managers.

This convergence is evident in the growing consensus in both developed and developing

nations that board structure and practice is key to providing corporate accountability -- of the

management to the board and the board to the shareholdersin the governance paradigm.

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The responsibilities and functions of the corporate board in both developed and

developing nations are receiving greater attention as a result of the increasing recognition that a

firms corporate governance affects both its economic performance and its ability to access

patient, low-cost capital. After all, the board of directors -- or, in two-tier systems, the

supervisory board -- is the corporate organ designed to hold managers accountable to capital

providers for the use of firm assets. The past five years has witnessed a proliferation of corporate

governance guidelines and codes of best practice designed to improve the ability of corporate

directors to hold managements accountable. This global movement to emphasize that boards

have responsibilities separate and apart from management, and to describe the practices that best

enable directors to carry out these responsibilities, is a manifestation of the importance now

attributed to corporate governance generally and, more particularly, to the role of the board.

Some of the key elements of governance guidelines and codes of best practice,

particularly as issued in developing nations, are summarized below:

The Corporate Objective :

Variations in societal values lead different nations to view the corporate objective or mission

distinctly. Expectations of how the corporation should prioritize the interests of shareholders and

stakeholders such as employees, creditors and other constituents take two primary forms. In the

Anglo-Saxon nations -- Australia, Canada, the U.K., and the U.S. -- maximizing the value of the

owners investment is considered the primary corporate objective. This objective is reflected in

governance guidelines and codes that emphasize the duty of the board to represent shareholders

interests and maximize shareholder value. Among developing nations, the Brazilian Institute of

Corporate Governance Code, the Confederation of Indian Industry Code, the Kyrgyz Republic

Charter of a Shareholding Society, the Malaysian Report on Corporate Governance, and the

Korean Stock Exchange Code of Best Practice all expressly recognize that the boards mission is

to protect and enhance the shareholders investment

in the corporation.

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In other countries, more emphasis is placed on a broader range of stakeholders. However, this

view is not strongly advocated in the governance guidelines and codes emanating from

developing nations, There is a growing recognition that shareholder expectations need to be met

in order to attract patient, low-cost capital. Likewise, there is growing sensitivity to the need to

address stakeholder interests in order to maximize shareholder value over the long term. As the

General Motors Board of Directors Mission Statement recognizes, the boards responsibilities

to shareholders as well as customers, employees, suppliers and the communities in which the

corporation operates are all founded upon the successful perpetuation of the business. Simply

put, shareholder and stakeholder interests in the success of the corporation are compatible in the

long run.

Board Responsibilities & Job DescriptionMost governance guidelines and codes of best practice assert that the board assumes

responsibility for the stewardship of the corporation and emphasize that board responsibilities are

distinct from management responsibilities. However, the guidelines and codes differ in the level

of specificity with which they explain the boards role. For example, Canadas Dey Report,

Frances Vienot Report, Malaysias Report on Corporate Governance, Mexicos Code of

Corporate Governance, South Africas King Report and the Korean Stock Exchange Code all

specify board functions such as strategic planning; risk identification and management; selection,

oversight and compensation of senior management; succession planning; communication with

shareholders; integrity of financial controls; and general legal compliance, as distinct board

functions. The Kyrgyz Republic Charter sets out a detailed list of matters requiring board

approval. Other governance guidelines and codes of best practice are far less specific. For

example, the Hong Kong Stock Exchange Code simply refers to directors obligations to ensure

compliance with listing rules as well as with the declaration and undertaking that directors are

required to execute and lodge with the Exchange. The different approaches among codes on this

point likely reflect variations in the degree to which company law or listing standards specify

board responsibilities, rather than any significant substantive differences.

Board Composition

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Most governance guidelines and codes of best practice address topics related to board

composition including director qualifications and membership criteria, the director nomination

process, and board independence and leadership.

Criteria. The quality, experience and independence of a boards membership directly affect

board performance. Board membership criteria are described by various guidelines and codes

with different levels of specificity, but tend to highlight issues such as experience, personal

characteristics (including independence), core competencies and availability.

Di rector Nomination. The process by which directors are nominated has gained attention in

many guidelines and codes, which tend to emphasize a formal and transparent process for

appointing new directors. The use of nominating committees is favored in the U.S. and U.K. as a

means of reducing the CEOs influence in choosing the board that is charged with monitoring his

or her performance. (See, in the U.S., the Report of the National Association of Corporate

Directors Commission on Director Professionalism (1996), and the General Motors Board of

Directors Guidelines (1994); in the U.K., the Hampel Committee Report (1998)). The Malaysian

Corporate Governance Report expresses a similar view: [T]he adoption of a formal procedure

for appointments to the board, with a nomination committee making recommendations to the full

board, should be recognized as good practice. (Explanatory Note 4. See also Korean Stock

Exchange Code of Best Practice II.3.) At the same time, however -- and as advocated by the

King Report (South Africa) -- it is generally agreed that the board as a whole has the ultimate

responsibility for nominating directors.

Mix of Inside and Outside or Independent Directors.

Most governance guidelines and codes of best practice agree that some degree of director

independence -- or the ability to exercise objective judgment of managementsperformance -- is

important to a boards ability to exercise objective judgment concerning management

performance. In the U.S., U.K., Canada and Australia, although not required by law or listing

requirements, best practice recommendations generally agree that boards of publicly-traded

corporations should include at least some independent directors. This viewpoint is the furthest

developed in the U.S. and Canada, where best practice documents call for a substantial

majority of the board to be comprised of independent directors. Elsewhere best practice

recommendations are somewhat less stringent and seek to have a balance of executives and non-

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executives, with the non executives including some truly independent directors. (Although non-

management or non-executive directors may be more likely to be objective than members of

management, many code documents recognize that a non-management director may still not be

truly independent if he or she has significant financial or personal ties to management.)

Nonetheless, a general consensus is developing throughout a number of countries that public

company boards should include at least some non-executive members who lack significant

family and business relationships with management.

Definitions of independence vary. For example, according to the Brazilian Institute of

Corporate Governance, a director is independent if he or she: has

no link to the company besides board membership and share ownership and receives no

compensation from the company other than director remuneration or shareholder dividends; has

never been an employee of the company (or of an affiliate or subsidiary); provides no services or

products to the company (and is not employed by a firm providing major services or products);

and is not a close relative of any officer, manager or controlling shareholder.

In comparison, the Cadbury Code simply refers to directors whoapart from their fees and

shareholdings -- are independent from management and free from any business or other

relationship which could materially interfere with the exercise of independent judgment. And

many of the best practice documents -- such as the Cadbury Report and the National Association

of Corporate Directors Report on Director Professionalism (U.S.) -- view the ultimate

determination of just what constitutes independence to be an issue for the board itself to

determine.

I ndependent Board Leadership. Independent board leadership is thought by some to encourage

the non-executive directors ability to work together toprovide true oversight of management.

As explained by the National Association of Corporate Directors (U.S.): the purpose of creating

[an independent] leader is not to add another layer of power but to ensure organization of, and

accountability for, the thoughtful execution of certain critical independent functions such as

evaluating the CEO; chairing sessions of the non-executive directors; setting the board agenda;

and leading the board in responding to crisis. Many guidelines and codes seek to institute

independent leadership by recommending a clear division of responsibilities between Chairman

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and CEO. In this way, while the CEO can have a significant presence on the board, the non-

executive directors will also have a formal independent leader to look to for authority on the

board. Documents that place less emphasis on the need for a majority of independent directors

seem to place more emphasis on the need for separating the role of Chairman and CEO. For

example, the Indian Confederation Report expressly relates the two concepts recommending that

if the Chairman and CEO (or managing director) are the same person, a greater percentage of

non-executive directors is necessary. (Recommendation 2) The Malaysian Report on Corporate

Governance similarly emphasizes that [w]here the roles are combined there should be a strong

independent element on the board. (Best Practice AA.II) This is in accord with the Cadbury

Report, which states that, where the Chairman is also the CEO it is essential that there shouldbe

a strong and independent element on the board. (Section 1.2)

Board CommitteesIn developed nations, it is fairly well accepted that many board functions are carried out by board

committees. For example, a nominating committee, an audit committee and a remuneration

committee are recommended in Australia, Belgium, France, Japan, the Netherlands, Sweden,

United Kingdom and the United States. While composition of these committees varies, it is

generally recognized that non-executive directors have a special role. The functioning and

composition of the audit committee receives significant attention in most guideline and code

documents because of the key role it plays in protecting shareholder interests and promoting

investor confidence. Certain countries specifically recommend the size of an audit committee. In

India, the minimum size recommended is three members, as it is in Malaysia and the United

Kingdom. Also, South Africa and India both emphasize the extra time requirements demanded of

audit committee members, and the importance of written terms of reference for this committee.

Malaysia also refers to the need for written terms of reference for audit and other board

committees.

Disclosure IssuesDisclosure is an issue that is highly regulated under securities laws of many nations. However,

there is room for voluntary disclosure by companies beyond what is mandated by law. Most

countries generally agree on the need for directors to disclose their own relevant interests and to

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disclose financial performance in an annual report to shareholders. Generally this is required by

law, but some guidelines and best practice documents address it as well. Similarly, even though

directors are usually subject to legal requirements concerning the accuracy of disclosed

information, a number of codes from both developed and developing nations describe the boards

responsibility to disclose accurate information about the financial performance of the company,

as well as information about agenda items, prior to the annual general meeting of shareholders.

Many codes also itemize the issues reserved for shareholder decision at the AGM. Generally,

guidelines and codes of best practice place heavy emphasis on the financial reporting obligations

of the board, as well as board oversight of the audit function. Again, this is because these are key

to investor confidence and the integrity of markets. South Africa lays out the key points that the

directors must comment on, whereas other countries do not go to this level of detail, but the

distinction is not necessarily substantive since disclosure tends to be heavily regulated in many

nations through securities laws.

This brief review of the primary principles addressed by various guidelines and codes indicates

that there is no single agreed upon system of good governance. Each country has its own

corporate culture, national personality and priorities. Likewise, each company has its own

history, culture, goals and business cycle maturity. All of these factors need to be taken into

consideration in crafting the optimal governance structure and practices for any country or any

company. However, the influence of international capital markets will likely lead to some

convergence of governance practices. This convergence is evident in the growing consensus in

both developed and developing nations that board structure and practice is key to providing

corporate accountability -- of the management to the board and the board to the shareholdersin

the governance paradigm.

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4 Four Pillars of Corporate Governance

Never before has corporate governance received as much attention as it does now. Recent

corporate scandals and questionable business ethics have forced companies and their leadership

under the microscope. To deal with the problemslegislation, codes of conduct and guidelines

for corporate governance practices have proliferated.

Directors are under pressure. In the early 20th century, Lord Boothby described his board

meetings as resembling a series of pleasant hot baths followed by food and money. The water

temperature has risen a lot since then!

Most of the prescriptions for improving corporate governance (including the infamous Sarbanes-

Oxley Act) have focused on the structure of boards including their size, composition,

independence of directors and so on. But what is the role of the board and is there a relationship

between board structure and corporate performance? I will consider the answers to these

questions.

I will start by looking at the definition of corporate governance and what better place to look for

a definition than a web encyclopaedia.

The definition I found is:

Corporate governance is the set of processes, customs, policies, laws and institutions affecting

the way a corporation is directed, administered or controlled.

It includes the relationships among the many players or stakeholders involved. Of course there

are numerous players and stakeholders in any business but in the context of governance there are

three key ones: shareholders, management and the board of directors.

In an organisation with multiple shareholders (for example a listed company) the concept of the

separation of ownership and control is important in understanding how corporate governance

works.

Shareholders invest but usually do not want to run or are incapable of running the company; they

provide the capital and the risk appetite, but they want people with specialised knowledge to

manage the business, so they appoint an agentthe board of directorsto oversee their

investment on their behalf. The board is the agent for all shareholders and stakeholders.

The board of directors is the interface between the shareholders and the company and the board

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is ultimately accountable to the shareholders who appoint the directors. But in law the directors

must act in what they consider to be the best interests of the company. This is not necessarily the

same thing as acting in the best interests of shareholders. This is a critical point which I find is

often not that well understood and once it is understood then other aspects of corporate

governance and how the board works fall into place.

So, the board oversees and directs, management manages day to day and implements, and, the

board is accountable to the shareholders, management is accountable to the board.

Having set out the different roles of board and management I will briefly outline some of the

fundamental functions of the board. Then I will talk about the link between board structure and

corporate performance.

There are many ways to explain the functions of a board and many models have been used. I

have chosen to use The Four Pillars of Effective Corporate Governance originally formulated

in the Institutes best practice statement entitled The Role of the Board in Adding Value.

These pillars are:

1.Accountability

It ensure that management is accountable to the Board & board is accountable to

shareholders.The board must have ultimate accountability and ownership of the company

purpose and strategy. Management will provide analysis, operational and business knowledge,

research and thinking. Probably they will make recommendations to the board, but it is the board

that must approve the company purpose, philosophy and strategy.

2.Fairness

It protect the shareholders rights, & treat all shareholders including minorities, equitably .

Also, provide effective redress for violations.An effective board must ensure that it holds

management to account. Few companies fail overnight. More frequently failure is the result of

ongoing under-performance that accumulates over time. An example here is the recent spate of

finance company collapsesyou have to wonder if the boards of these companies really

challenged management and understood the risks their companies were taking.

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3.Transparency

It ensure timely, accurate disclosure on all material matters, including the financial

situation, performance, ownership.Culture is critical in the performance of the board and the

organization as a whole. Trust is important around the board table but obviously it needs to be

earned. Challenge is also important. Discussion and debate need to be robust. Above all there can

be no compromise on ethics and integrity. This sounds like a simple aspiration, but it should be

shared by both the board and management.

Boards should assess their own performance regularly and should consider issues such as the

balance of skills around the table, succession planning, professional development and, crucially,

whether they add value to the company. I am pleased to say that director evaluation is becoming

much more commonplace and most boards undertake regular assessments. Although it may seem

a somewhat self-serving process, we find that self-evaluation by directors is highly effective. In

reality, good boards have very low tolerance for underperformance amongst their members.

4.Independence

The procedures and structures are in place so as to minimize, or avoid completely conflicts of

interest. Independent Directors and Advisers i.e. free from the influence of others.Boards of

directors need to ensure that a companys financial position is solvent and that other financial

matters including audit, both internal and external are properly and effectively undertaken. As

part of this process the board must also ensure that risk is managed and that a formal process is

put in place for assessing, managing and reporting on risk.

Directors must also be aware of other compliance issues such as regulations, delegated

authorities, confidentiality, safety guidelines and many others. Some of these are common to all

organizations and others will depend on the operating environment of the company.

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5 Indian Stock Exchange requirements on compliance

SEBI GUIDELINES ON CORPORATE GOVERNANCE

I BOARD OF DIRECTORS :

1. The Non-executive Directors on board should not be less than fifty percent of

the Board of Directors.

Or

2. In case of a non-executive chairman, at least one-third of board should

comprise of independent directors.

3. A director shall not be a member in more than 10 committees or act