Corporate Governance 1. Satyam Vada Dharmam Chara” Taittariya Upanishad “Forever speak the truth and follow the dharma ” 2

Corporate Governance

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Satyam Vada Dharmam Chara”Taittariya Upanishad

• “Forever speak the truth and follow the

dharma”

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Concept of Corporate Dharmain ‘Ramayana’

To provide “the maximum happiness for the

maximum number of people for the maximum

period, based on the principles of Dharma –

righteousness and moral values.”

- Ayodhya Kand

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Concept of Danda - CG• Danda is systems , structures ,

institutional arrangements , laws , policies and rules and regulations which have to be created to ensure that dharma in a society prevails

• Dharma and Danda are conjoint principles of administration and leadership

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What is Governance?

“Corporate Governance is the application of best management practices, Compliance of law in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stakeholders”.

-The Institute of Company Secretaries of India

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Good government -Confucius

• You need three things-weapons, food and trust. In times of trouble you should give up weapon first, then food. But you should never give up trust . Without trust you cannot stand.

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Drivers of CG- Impact of Drivers of CG- Impact of GlobalizationGlobalization

– Integration with Foreign MarketIntegration with Foreign Market– Foreign Investors expectationsForeign Investors expectations– New Business Opportunities --- IT & New Business Opportunities --- IT &

ITES, BPO etc.,ITES, BPO etc.,– New Capital formation – FII, FDINew Capital formation – FII, FDI

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Impact of Privatization Impact of Privatization

New structure of OwnershipNew structure of Ownership

Multinational CompaniesMultinational Companies

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Recent Misconducts

• Computer Associates:– Artificially inflated revenue and improperly rewarded top

executives.

• CMS Energy

– Overstated revenues in 2000 and 2001 thru ‘round trip’ energy trades?

• Dynegy– Transactions to cut taxes and artificially increase cash flow ?

• Kmart– Suspected improper accounting for vendor allowances

• Lucent Technologies– Adjusted fiscal 2000 revenues by $679 million.

• Several more names, respected world-over– AOL Time Warner, Bristol-Myers, Elan,Halliburton, ImClone

Systems, Microstrategy, Mirant, Network Associates, Reliant Resources, Vivendi Universal, Xcel Energy, Xerox. 9

Corporate Mis-Governance

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Corporate Governance in India

The essence of CG lies in three basic corporate values :

• Accountability

• Probity

• Transparency

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IS CG a Cost?

• Management and boards feel that compliance costs money.

• Stockholders of Enron and World com alone suffered losses of more than $100 billion , even when the most aggressive estimates of Sarbanes-Oxley compliance costs for all the companies put together amount to less than $ 5 billon.

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History of CG regulation

• Until 1970-CG was the prerogative of company

• 1987-National Commission of the Fraudulent Financial Reporting in the US was instituted.

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• 1992-Cadbury’s Committee’s Report of the Committee on the Financial Aspects of Corporate Governance that established UK as the thought leader in developing CG best practices( they suggested segregation of Board chairman and CEO & institution of audit committee made up of independent directors )

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• 1995 saw the Greensbury Report addressing issues of directorial remuneration;

• simultaneously Dey Report-in Canada & King’s Commission report in South Africa came out with their proposals

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• Amendments made in company laws and listing agreements in Hong Kong, France, Australia & Singapore

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2002-Sarbanes –Oxley Act- USA

• Existence of an environment of conflict of interest with respect CG

• Lack of transparency & accuracy standards in financial reporting

• Lack of independence in key CG player –board, auditors and management

• Lack of adequate enforcement tools• Widespread conflict of interest in

securities market 17

• Unlike South-East and East Asia, the corporate governance initiative in India was not triggered by any serious nationwide financial, banking and economic collapse.The initiative in India was initially driven by an industry association, the Confederation of Indian Industry.

Corporate Governance in India-CII

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• In December 1995, CII set up a task force to design a voluntary code of corporate governance. The final draft of this code was widely circulated in 1997.

• In April 1998, the code was released. It was called Desirable Corporate Governance: A Code.

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• Following CII’s initiative, the Securities and Exchange Board of India (SEBI) set up a committee under Kumar Mangalam Birla to design a mandatory-cum-recommendatory code for listed companies

• The Birla Committee Report was approved by SEBI in December 2000

• Became mandatory for listed companies through the listing agreement, and implemented according to a rollout plan:

Corporate Governance in India-SEBI

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• Following CII and SEBI, the Department of Company Affairs (DCA) modified the Companies Act, 1956 to incorporate specific corporate governance provisions regarding independent directors and audit committees.

Corporate Governance in India-DCA

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• 2002- Following Sarbanes Oxley act the DCA instituted the Naresh Chandra committee to look into Companies` act that emphasized grounds for disqualifying auditors, compulsory rotation of audit partners,stricter definition of independent directors; need for more than 50% independent directors in the board ( not incorporated in Company law)

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• 2003-Narayan Murthy Committee suggested these amendments be in the listing agreement of the SEBI

• 2005 - JJ Irani Committee came out with more suggestions

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• Between 1998 and 2000, over 25 leading companies voluntarily followed the code:

• Bajaj Auto, Hindalco, Infosys, Dr. Reddy’s Laboratories, Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI and many others

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STRUCTURE OF CORPORATE GOVERNANCE IN INDIA

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Suppliers Customers

Stock ExchangeRegulator

Indu

stry

as

soci

atio

ns

Financial

Institutions

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External Regulators

• Stock Exchange

• Financial Institutions

• Industry Associates

• Suppliers

• Customers

• Regulators

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Role of Stock Exchanges

• As second tier regulatory agencies , market regulators and stock exchanges have unique power to amend listing rules . Presence of independent directors on Board and existence of Audit committee are the mandatory requirement laid down by these.

• SEBI has made the most important contributions in defining Clause 49- the latest revision of which was made in 2004.

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Clause 49 ( in line with international standards)

• CEO and CFO certification requirement related to truth and fairness of financial statement , adequacy of internal controls and legality of transactions .

• Establishment of Code of conduct for Board and senior executives

• Revision of the definition of independent directors

• Making financial literacy a pre requisite for the audit committee members with at least one member possessing accounting -financial management expertise

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Clause -49

• Corporate Governance section must be included in the Annual report of listed companies with respect to mandatory and non mandatory disclosures, aimed at bring greater accountability in the board members

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Role of Financial Institutions

• Reluctant activists of CG- Play a limited or virtually absent role.

• FI,s feel that monitoring cost does not justify the advantage gained by free riders ( other shareholders) . They are interested only when they become bloc shareholders – “ all or nothing approach “

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Role of Industry Associations

• 1998- Confederation of Indian Industries ( CII) produced “Desirable Corporate Governance – a code ( after Asian financial crises in mid 1997)

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Internal Regulators

• Board of Directors

• Audit Committee

• Auditors

• Management

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Role of Independent Directors

• The board is the guardian of the company .The onus of instilling a spirit of CG and executing it effectively rest with the board .

• The board is not only responsible for giving strategic direction to the company , but is the ultimate buck stop, to protect owners interest , fulfill their fiduciary duty through rigorous critical review, risk assessment and sound judgment . 34

Balance of power

• Power balance among executives, shareholders and Board is achieved by independent directors ( nations differ in the number of these).

• To get to the best from board members Directorial education , commitment, and information sharing is necessary.

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Role of Board Chairman

• In UK , Canada , & Australia CEO and board chairman are segregated . In US the CEO is the chairman ( ?). In India we have both permutations .

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Responsibilities of Board Chairperson

• Ensure an effective strategic planning process – manage vision,and executive defensiveness

• Build and develop a competent board • Communication of expectation to the directors.

( culture building)• Assessment and development of Boards

performance• Ensure CEO evaluation and succession planning

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Role of CEO

• Managing physical , financial and human resource of the corporation in a manner that it maximizes shareholder value by ensuring compliance to law and regulation.

• Culture building of good ethics , openness and transparency

• Certify and attest the corporation integrity in all matters

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Role of Audit Committee

They are the “Key Financial policemen “ involved in the review of :

• Financial reporting process• System of internal controls• Audit process

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Role of Audit Committee

• Process of monitoring compliance with laws, regulations and code of conduct

• Evaluating the Company’s risk management initiatives .

• The Audit Committee needs to develop an independent working relationship with the auditors and Board of directors .

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Audit Committee : Working with

management and internal auditors • Significant oversight includes asking difficult

questions, and obtaining reasonable answers .

• Senior management should share risk factors and issues as they come up with AC

• CFO and internal auditors should be in close contact with Audit committee

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Audit Committee : Working with management and external auditors

• Ensure independence of external auditors and monitoring non - audit services and fees.

• Understand and approve audit scope and fees• Understand audit findings and address issues• Be available for formal and informal meetings• Receive and review communication• Evaluate the performance of external auditors• Discus the companies financial practices with

auditors

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Role of Auditors: Internal & External

• While managers strives to achieve the right balance of growth and protection of value, auditors provide objective check that rules are being followed .Their role has transitioned from reporting to senior management to reporting to audit committee and board of directors .

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Internal auditors

• Internal auditors seek to understand and document business processes, identify risks and controls, and validate that controls are effective in mitigating risks.

• Through their review they confirm adherence to policies and ethical standards . They are the eyes and ears of management and board and its committees

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External Auditors

• As public accountants, external auditors express an opinion on the fairness with which a company presents its financial position, its results for operation, and its financial flows,

• To report if the reporting is in congruence with financial standards , and when it is not and under what circumstances.

• Clause 49 require external auditors to certify compliance

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ISSUES

• Regulators – Align CG with global standards , establish an environment for timely disclosure, equip enforcers with more power against non compliers

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ISSUES

• Stock exchanges- Establish a robust monitoring mechanism, promote transparency and safety , and actively investigate and prosecute erring companies`

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ISSUES

• Financial Institutions –Have strict standards for selection and continuation of investment to safe guard the final investor.

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ISSUES

• Industry associations –provide a forum to understand CG , share best practices, and uphold excellence in CG

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ISSUES

• Independent directors –Be committed and act as a conscience by providing independent third party view on issues and examine motives

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ISSUES

• Board Chairman –Establish a board that is in letter and spirit truly independent and distinct from management .

• CEO- Establish a control – self assessment in the company, and share information with stakeholders continuously

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Board of Directors: frequency of meetings and composition

• Board must meet at least four times a year, with a maximum time gap of four months between two successive meetings.

• If the chairman of the Company is a non-executive then one-third of the board should consist of independent directors, and 50% otherwise.

• ‘Independent’ defined as those directors who, apart from receiving director’s remuneration do not have any other monetary relationship or transactions with the company, its promoters, management or subsidiaries, which in the view of the board may affect independence of judgment.

Mandated CG guidelines and disclosures

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Board of Directors: frequency of meetings and composition

• The frequency of board meetings and board committee meetings, with their dates, must be fully disclosed to shareholders in the annual report of the company.

• The attendance record of all directors in board meetings and board committee meetings must be fully disclosed to shareholders in the annual report of the company.

• Full and detailed remuneration of each director (salary, sitting fees, commissions, stock options and perquisites) must be fully disclosed to shareholders in the annual report of the company.

• Loans given to executive directors are capped (no loans permitted to non-executives), and must be fully disclosed to shareholders in the annual report of the company.


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Board of Directors: information that must be supplied

• Annual, quarter, half year operating plans, budgets and updates.• Quarterly results of company and its business segments.• Minutes of the audit committee and other board committees.• Recruitment and remuneration of senior officers.• Materially important legal notices and claims, as well as any

accidents, hazards, pollution issues and labor problems.• Any actual or expected default in financial obligations.• Details of joint ventures and collaborations.• Transactions involving payment towards goodwill, brand equity

and intellectual property.• Any materially significant sale of business and investments.• Foreign currency and other risks and risk management.• Any regulatory non-compliance.


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Board of Directors: Audit Committee

• Audit Committee is mandatory.

• Must have minimum of three members, all non-executive directors, the majority of whom are independent.

• Chairman must be an independent director, and must be present at the annual shareholders’ meeting to answer audit or finance related questions.

• At least one member must be an expert in finance/accounts.

• Must have at least three meetings per year, including one before finalisation of annual accounts.

• Must meet with statutory auditors and internal auditors; have the powers to seek any financial, legal or operational information from the management; obtain outside legal or professional advice.


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Board of Directors: Audit Committee functions

• Oversight of the company’s financial reporting process to ensure that the financial statement is correct, sufficient and credible

• Appointment / removal of external auditor and fixing of audit fees• Reviewing with management the annual financial statements before

submission to the board, focusing on:– Changes in accounting policies and practices– Major accounting entries– Qualifications in draft audit report– Significant adjustments arising out of audit– The going concern assumption– Compliance with accounting standards, with stock exchange and

legal requirements– Any related party transactions


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Board of Directors: Audit Committee functions

• Adequacy of internal audit and internal control systems, through discussion with internal and statutory auditors as well as management.

• Significant findings, follow-up and action taken reports.

• Discussion with internal and statutory auditors about scope and design of audits.

• Reviewing financial and legal risks and company’s risk management policies.

• Examining reasons behind any materially significant default to creditors, bond-holders, suppliers and shareholders.


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Disclosures to shareholders in addition to balance sheet, P&Land cash flow statement

• Board composition (executive, non-exec, independent).

• Qualifications and experience of directors.

• Number of outside directorships held by each director (capped at director not being a member of more than 10 board-level committees, and Chairman of not more than 5).

• Attendance record of directors.

• Remuneration of directors.

• Relationship (familial or pecuniary) with other directors.

• Warning against insider trading, with procedures to prevent such acts.

• Details of grievances of shareholders, and how quickly these were addressed.

• Date, time and venue of annual general meeting of shareholders.


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Disclosures to shareholders in addition to balance sheet, P&L and cash flow statement

• Dates of book closure and dividend payment.

• Details of shareholding pattern.

• Name, address and contact details of registrars and/or share transfer agents.

• Details about the share transfer system.

• Stock price data over the reporting year, and how the company’s stock measured up to the index.

• Financial effects of stock options.

• Financial effects of any share buyback.

• Financial effects of any warrants that are to be exercised.

• Chapter reporting corporate governance practices


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Disclosures to shareholders in addition to balance sheet, P&L andcash flow statement

• Detailed chapter on Management Discussion and Analysis focusing on markets, operations, finances, accounts, risks, opportunities and threats, internal control systems.

• Consolidated financial statement, incorporating accounts of all subsidiaries (over 50% shares held by reporting company).

• Details of all significant related party transactions.

• Detailed segment reporting (revenues, costs, operating profits and capital employed).

• Deferred tax liabilities and assets and debit/credit in the P&L for the reporting year


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SATYAM

• Golden Peacock award for Corp. Gov. in 2008• Investor Relations Global Rankings (IRGR) rated

Satyam as the company with Best Corporate Governance Practices for 2006 and 2007.

• Golden Peacock Award for Excellence in Corporate Governance from the Institute of Directors in New Delhi in 2002.

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SCAM

• December 2008: Satyam Chairman Ramalinga Raju sends letter to board tendering his resignation and admitting to fraud in accounting books. Satyam Managing Director B Rama Raju also resigns.

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According to the letter

Balance Sheet on 30.11.08 saysNon existent cash and bank

balance of Rs 5,040 crore

Overstated debtors of Rs 490 crores against Rs 2651 reflected on the books

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The gap in the book has arisen purely because of the inflated profits over 7 years.

The marginal difference between actual operating profit and shown in the book continued to grow over years

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Every attempt to hide the gap failed.

Poor performance would lead to hostile take over-exposing the truth

Maytas was the last life line to fill the fictitious assets

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Consequences

• Jan 7Jan 7th2008 th2008

Ramalinga Ramu steps down as Chairman of Satyam Computer

Financial wrong-doings to the tune of 7000 crore of rupees

An illustrious corporate career to an undignified end

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Consequences

India's biggest corporate scandal in memory hammers Satyam's shares

Stock fells more than 80%.Company worth around $500 million, against nearer $7 billion six months ago.

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What went wrong with Satyam

Satyam’s independent directors met the standards set by the NYSE. BUT, they did not ask hard questions.

Directors in India may sit on as many as 15 boards, which leaves them little time to do their job properly

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Where Internal Stakeholders faulted

• In the case of Satyam, Chief Financial Officer and the Auditors have failed to show integrity towards their profession. They have failed to show assertiveness

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Where Internal Stakeholders faulted

• Satyam’s attempt to acquite Maytas Properties and Maytas Infra - for 1.6 billion dollars in order to compensate for the holes in books of account.The independent directors failed to perform their duties

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Market Forces at play

This fraud was the result of competitive pressures. Companies have targets that they need to reach every month, quarter and year.

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The Non-Market Forces at work

• Satyam, based in Hyderabad, was bound by India's lengthy corporate law, and by the rules of the Bombay Stock Exchange, the New York Stock Exchange and Euronext in Amsterdam, where the company was listed

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Loopholes exist

• Enforcement of regulations is weak

• Shareholder activism is lacklustre

• There is virtually no voting by poll at AGMs

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Documents

Corporate Governance 1. Satyam Vada Dharmam Chara” Taittariya Upanishad “Forever speak the truth and follow the dharma ” 2