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8/2/2019 Corporate Governance & Business Ethics
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Corporate governance &
business ethics
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UNIT-I
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Meaning of corporate governanceCorporate governance involves a set of relationships between
a companys 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 andmonitoring performance are determined
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Corporate governance is:
1. a relationship among stakeholders used to determine and
control the strategic direction and performance oforganisations.
2. Concerned with identifying ways to ensure that strategic
decisions are made effectively.
3. Used in corporations to establish order between firms ownersand its top level managers.
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An Indian Definition
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.
SEBI (Kumar Mangalam Birla) Report on CorporateGovernance, January, 2000
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Corporate governance involves a set of relationshipsbetween a companys management, its board, its
shareholders and other stakeholders ..also the
structure through which objectives of the companyare set, and the means of attaining those objectives
and monitoring performance are determined.
Preamble to the OECD Principles of Corporate Governance, 2004
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Corporate governance is the process whereby people in
power direct, monitor and lead corporations and thereby
create ,destroy the structures and systems under which they
operate. Corporate governors are both potential agents for
change and also guardians of existing ways of working. As
such they are therefore, a significant part of the fabric of oursociety. Corporate governance deals with the ways in which
suppliers of finance to corporations assure themselves of
getting a return on their investment.
- The journal of Finance.
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NATURE OF CORPORATE GOVERNANCE
The term corporate governance, although commonly used,
has no standard definition. It encompasses a wide range of
items and activities, and holds different meanings for different
user groups.
In the CGC Report, corporate governance refers to the
processes and structure by which the business and affairs of
the company are directed and managed, in order to enhance
long-term shareholder value through enhancing corporate
performance and accountability, whilst taking into accountthe interests of other stakeholders
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Board of Directors, management, owners
Business partners
Current and retired employees, and their families
Suppliers
Lenders Customers
Government
Communities where business operates and sells
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The growth of modern ideas of CG from the USA:
The seeds of CG were sown by the Watergate scandal
during the Nixon presidency in the U.S.
Legislation of Foreign & corrupt practices Act of 1977 inAmerica that reviews the internal control in anestablishment.
In the same year (SEC) proposed mandatory reporting oninternal financial controls.
In 1985 a series of high profile business failures rockedthe US which led the government to appoint the
Treadway Commission. It highlighted the need forproper control mechanisms, independent auditcommittees & an objective Internal Audit system.
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England catches up:
Famous corporations in the UK collapsed due to
poor mgmt & lack of control.The Cadbury committee:
Realizing the inefficacy of existing legislation & self-
regulation a committee under the chairmanship of
Sir Adrian Cadbury was appointed by the London
Stock Exchange in 1991.
It was assigned the task of drafting a code of
practices to assist corporations in England for limitingtheir exposure to financial loss.
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The aftermath of the Cadbury Report:
The committee submitted its report along with code
of best practices in December 1992. The most controversial of the Cadburys
recommendations was that the directors should
report on the effectiveness of a companys system of
internal control After 5 years of publication of the report peoples
confidence was again shaken by scandals. To deal
with the situation a committee on CG headed by Ron
Hampel was constituted to assess the Cadbury report
& develop further guidelines.
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The final report of the Hampel committee in 1998contained extension of directors responsibilities to
all control objectives including risk assessment &minimising the risk of fraud.
A amalgam of these codes known as the combinedcode was subsequently derived. It is appended in the
listing rules of London Stock Exchange. Scandals such as Enron, Tyco, and WorldCom shook
investor confidence in financial statements andrequired an overhaul of regulatory standards.
An act was passed by U.S. Congress in 2002,theSarbanes-Oxley Act (SOX) in response to theaccounting scandals in the early 2000s.
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Need for corporate governance
Separation of ownership from management.
Global capital.
Investor protection
Foreign investments Financial reporting and accountability
Banks and financial institutions
Globalisation of economy
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Importance of corporate governance
It shapes the growth and future of capital market in the economy.
It helps in raising funds from capital markets.
It links management with its financial reporting system
It helps management to take rational decisions within the legal
framework of accountability.
It makes corporate accounting practices transparent.
It avoids insider- trading
It is an instrument of economic growth
It improves international image and helps to raise global funds.
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Principles of corporate Governance
Rights and equitable treatment of shareholders:
Organizations should respect the rights of shareholders andhelp shareholders to exercise those rights. They can helpshareholders exercise their rights by openly and effectivelycommunicating information and by encouraging shareholdersto participate in general meetings.
Interests of other stakeholders: Organizations should
recognize that they have legal, contractual, social, and marketdriven obligations to non-shareholder stakeholders, includingemployees, investors, creditors, suppliers, local communities,customers, and policy makers.
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Role and responsibilities of the board: The board needs sufficientrelevant skills and understanding to review and challengemanagement performance. It also needs adequate size and
appropriate levels of independence and commitment
Integrity and ethical behavior: Integrity should be a fundamentalrequirement in choosing corporate officers and board members.Organizations should develop a code of conduct for their directorsand executives that promotes ethical and responsible decisionmaking.
Disclosure and transparency: Organizations should clarify and makepublicly known the roles and responsibilities of board and
management to provide stakeholders with a level of accountability.They should also implement procedures to independently verifyand safeguard the integrity of the company's financial reporting.Disclosure of material matters concerning the organization shouldbe timely and balanced to ensure that all investors have access toclear, factual information.
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Characteristics of corporate governance
DisciplineAll involved parties will have a commitment to adhere to procedures,processes, and authority structures established by the organization.
TransparencyAll actions implemented and their decision support will be available forinspection by authorized organization and provider parties.
IndependenceAll processes, decision-making, and mechanisms used will be establishedso as to minimize or avoid potential conflicts of interest.
Accountability
Identifiable groups within the organization - e.g., governance
boards who take actions or make decisions - are authorizedand accountable for their actions.
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ResponsibilityEach contracted party is required to act responsibly to the
organization and its stakeholders.
FairnessAll decisions taken, processes used, and their implementationwill not be allowed to create unfair advantage to any one
particular party. Social responsibility
A well-managed company will be aware of, and respond to,social issues, placing a high priority on ethical standards
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Corporate governance and organisational
success
The following measures help in ensuring success of anorganisation:
1. Maintain good relations with the stakeholders: stakeholderscan provide gidelines to directors regarding companysstrategic plans and policies. For this they have to know
companies operations in complete transparency.2. Motivate the employees: a committed workforce is
motivated to work for the cause of theorganisation.Following components promote a dedicated
workforce-vision
mission
goals
objectives
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3. Develop plans to achieve the objectives: plans are made toachieve the vision, mission, goals and objectives of the
organisation. Planners must conduct a thorough market
research before framing plans.
4. Define the authority and responsibility of managers: the
authority and responsibility of managers should be well
defined to avoid overlapping of tasks.
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Factor influencing the corporate
governance
1. The ownership structure
2. The structure of company boards
3. The financial structure 4. The institutional environment
problems of corporate governance
Demand for information
Monitoring costs
Supply of accounting information
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We lay structures over the corporate business, and fail to
organize the business
Corporate Performance Management reports against overlaid
structures
Accounting accounts for only part of the business cycle and
against the wrong entities
We govern the corporation by rules and regulations, because
we cannot manage the actual business
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Economic
An Enterprises Triple Effect on Society
BusinessImpact
Sustainable Development Equal Opportunities
Waste Control Education &CultureEmissions Community
RegenerationEnergy Use Human RightsProduct Employee
Life-cycle VolunteersProduct Wealth Productive EthicalValue Generation Employment Trading
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The Triple-Bottom line Impact
Business Impact
Environment Society
Economics
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Code of corporate practices
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Code of practice: ( given by Cadbury report)
The CEO and chairperson of the board of Directors
should be separate.
CEO is responsible for day to day operations of the
company and chairman should manage the affairs of theboard.
The chairman should set the goals of the CEO and
monitor his performance.
The organisation should have non- executive Directors.They should not prove to be mere rubber stamp to
enforce board decisions.
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Combined code of practice:(Ron Hampel
committees and Cadbury report)
It was added to the listing rules of LSE and its compliancewas mandatory for all listed companies in UK. Thecombined code are as follows:
Fool-proof system of internal control.
Directors hold fiduciary relationship with thestakeholders.
Directors should annually review the internal controlsystem of the firm like financial control, operationalcontrol, compliance control and risk management.
The review should be disclosed to the shareholders. It is the duty of the directors to protect investors money
by not indulging in insider trading, over- invoicing, under-invoicing.
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SEBI code on corporate governance
The SEBI board considered the recommendations of the Birla
committee and made amendments by incorporating a new
clause, namely clause 49 in the listing as under:
A. Board of directors:
Optimum combination of executive and non-executive
directors, with 50% of non-executive directors.( 1/3- non-ex
director), (1/2- ex. chairman)
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B. Audit committee:
powers
Functions
Composition
Frequency of meetings and quorum
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Composition of the committee
The audit committee should have minimum three members, allbeing non executive directors, with the majority being independent,and with at least one director having financial and accountingknowledge.
the chairman of the committee should be an independent director.
the chairman should be present at Annual General Meeting toanswer shareholder queries;
the audit committee should invite such of the executives, as itconsiders appropriate (and particularly the head of the financefunction) to be present at the meetings of the Committee but onoccasions it may also meet without the presence of any executives
of the company. Finance director and head of internal audit andwhen required, a representative of the external auditor should bepresent as invitees for the meetings of the audit committee;
the Company Secretary should act as the secretary to thecommittee.
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Frequency of meetings and quorum
The audit committee should meet at least thrice a year. One
meeting must be held before finalisation of annual accounts
and one necessarily every six months.
The quorum should be either two members or one-third of
the members of the audit committee, whichever is higher and
there should be a minimum of two independent directors.
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Functions of the Audit Committee
Oversight of the companys financial reporting process and the disclosure
of its financial information to ensure that the financial statement iscorrect, sufficient and credible.
Recommending the appointment and removal of external auditor, fixation
of audit fee and also approval for payment for any other services.
Reviewing with the management, external and internal auditors, the
adequacy of internal control systems.
Reviewing the adequacy of internal audit function, including the structure
of the internal audit department, staffing and seniority of the official
heading the department, reporting structure, coverage and frequency of
internal audit.
Discussion with internal auditors of any significant findings and follow-up
thereon.
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Reviewing with management the annual financial statements before
submission to the board, focussing primarily on:
Any changes in accounting policies and practices.
Major accounting entries based on exercise of judgement by
management.
Qualifications in draft audit report.
Significant adjustments arising out of audit.
The going concern assumption.
Compliance with accounting standards
Compliance with stock exchange and legal requirements concerning
financial statements.
Any related party transactions i.e. transactions of the company ofmaterial nature, with promoters or the management, their
subsidiaries or relatives etc. that may have potential conflict with the
interests of company at large.
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Reviewing the findings of any internal investigations bythe internal auditors into matters where there is
suspected fraud or irregularity or a failure of internalcontrol systems of a material nature and reporting thematter to the board.
Discussion with external auditors before the auditcommences, of the nature and scope of audit. Also post-
audit discussion to ascertain any area of concern. Reviewing the companys financial and risk management
policies.
Looking into the reasons for substantial defaults in the
payments to the depositors, debenture holders, shareholders (in case of non-payment of declared dividends)and Creditors.
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C. Remuneration of directors
The board should set up a remuneration committee to
determine specific remuneration packages for executive
directors including pension rights and any compensation
payment.
The Committee however recognised that the remuneration
package should be good enough to attract, retain and
motivate the executive directors of the quality required, butnot more than necessary.
C iti Q t f th R ti C itt
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Composition, Quorum etc. of the Remuneration Committee
The Committee recommends that to avoid conflicts of interest, the
remuneration committee, which would determine the remunerationpackages of the executive directors should comprise of at least threedirectors, all of whom should be non-executive directors, the chairman ofcommittee being an independent director.
The Committee deliberated on the quorum for the meeting and was of
the view that remuneration is mostly fixed annually or after specifiedperiods. It would not be necessary for the committee to meet veryoften. The Committee was of the view that it should not be difficult toarrange for a date to suit the convenience ofall the members of thecommittee.
The Committee therefore recommends that all the members of theremuneration committee should be present at the meeting.
The Committee recommends that the board of directors should decidethe remuneration of non-executive directors.
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Disclosures of Remuneration Package
All elements of remuneration package of all the directors i.e.salary, benefits, bonuses, stock options, pension etc.
Details of fixed component and performance linked
incentives, along with the performance criteria.
Service contracts, notice period, severance fees.
Stock optiondetails, if any and whether issued at a discount
as well as the period over which accrued and over which
exercisable.
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E. Functions of the Management
1. Managementdiscussion and Analysis report should form part of the
annual report to the shareholders. it should include discussion on thefollowing matters :
Industry structure and developments.
Opportunities and Threats
Segment-wise or product-wise performance.
Outlook.
Risks and concerns
Internal control systems and their adequacy.
Discussion on financial performance with respect to operationalperformance.
Material developments in Human Resources /Industrial Relations front,including number of people employed.
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2. Good corporate governance casts an obligation on the
management in respect of disclosures. The Committeetherefore recommends that disclosures must be made
by the management to the board relating to all
material financial and commercial transactions, where
they have personal interest, that may have a potentialconflict with the interest of the company at large (for
e.g. dealing in company shares, commercial dealings
with bodies, which have shareholding of management
and their relatives etc.)
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2. The Committee recommends that information like quarterly
results, presentation made by companies to analysts may be
put on companys web-site or may be sent in such a form soas to enable the stock exchange on which the company is
listed to put it on its own web-site.
3. The Committee further recommends that to expedite theprocess ofshare transfers the board of the company should
delegate the power of share transfer to an officer, or a
committee or to the registrar and share transfer agents. The
delegated authority should attend to share transferformalities at least once in a fortnight.
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4. The Committee recommends that a board committee underthe chairmanship of a non-executive director should be
formed to specifically look into the redressing of shareholder
complaints like transfer of shares, non-receipt of balance
sheet, non-receipt of declared dividends etc. The Committee
believes that the formation of such a committee will help
focus the attention of the company on shareholders
grievances and sensitise the management to redressal of
their grievances.
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G. Report on corporate governance
The Committee recommends that there should be a separate
section on Corporate Governance in the annual reports of
companies, with a detailed compliance report on Corporate
Governance. Non-compliance of any mandatory
recommendation with reasons thereof and the extent towhich the non-mandatory recommendations have been
adopted should be specifically highlighted. This will enable
the shareholders and the securities market to assess for
themselves the standards of corporate governance followed
by a company. A suggested list of items to be included in the
compliance report is enclosed.
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H. Compliance
The Committee also recommends that the company should
arrange to obtain a certificate from the auditors of the
company regarding compliance of mandatory
recommendations and annexe the certificate with the
directors report, which is sent annually to all theshareholders of the company. The same certificate should also
be sent to the stock exchanges along with the annual returns
filed by the company.
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I. Schedule of implementation
By all entities seeking listing for the first time, at the time of
listing. By March 31, 2001 by all entities, which are included either in
Group A of the BSE or in S&P CNX Nifty index as on January
1, 2000.
By March 31, 2002 by all the entities which are presentlylisted, with paid up share capital of Rs. 10 crore and above, or
networth of Rs 25 crore or more any time in the history of the
company.
By March 31, 2003 by all the entities which are presently
listed, with paid up share capital of Rs 3 crore and above.
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Features of CII code:
Well functioning, informed board of directors with a coregroup of professionally acclaimed non-executivedirectors who understand their role.
The board should meet a minimum 6 times a year.
No single person should hold directorship of more than20 listed companies.
Any listed company with a turnover of 100 crore andabove should have competent, independent, non-executive directors, who should constitute:
i) 30% of the board if the chairman is non-executivedirector
Ii) 50% if the chairman and managing director is same.
F ti di t t l t i l l th d t
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For non-executive directors to play material role, they need to:
i) be active participants
Ii) have clearly defined responsibilities.
Iii) knowledge about finance,company laws. Pay a commission over and above sitting fees for the use of
professional inputs.
While re-appointing members of the board, give the attendancerecord of the directories.
Set up audit committees within 2 years with atleast 3 membersfrom non-executive directors.
Major stock exchanges should insist on Compliance certificatesigned by CFO & CEO, stating that the mgmt will disclose properfinancial information and the accounting policies and principlesconform to standard practice.
.
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Government must allow greater funding to the corporate
sector.
Companies with paid-up capital of 20 crore or more, thequality and quantity of disclosure for domestic issues should
be the same as that for GDR issues.
Under additional shareholders information listed
companies should give data on high and low monthly
averages of share prices in a major stock exchange.
It is the prerogative of FIs to have nominee directors in case of
debt default and in case of the debtor company not providing
operational data to the concerned FIs.
Rating of the agency that rated the company.
Companies that default on fixed deposits should not accept
further deposits or declare dividends until the default is made
good.
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History of Corporate Governance in India
Unlike South-East and East Asia, the corporate governanceinitiative in India was not triggered by any serious nationwidefinancial, banking and economic collapse
Also, unlike most OECD countries, the initiative in India wasinitially driven by an industry association, the Confederation ofIndian Industry
In December 1995, CII set up a task force to design a voluntarycode 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 Between 1998 and 2000, over 25 leading companies
voluntarily followed the code: Bajaj Auto, Hindalco, Infosys, Dr.Reddys Laboratories, Nicholas Piramal, Bharat Forge, BSES,HDFC, ICICI and many others
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Cont.
Following CII and SEBI, the Department of Company Affairs(DCA) modified the Companies Act, 1956 to incorporatespecific corporate governance provisions regardingindependent directors and audit committees
In 2001-02, certain accounting standards were modified tofurther improve financial disclosures. These were:
Disclosure of related party transactions
Disclosure of segment income: revenues, profits and capitalemployed
Deferred tax liabilities or assets Consolidation of accounts
Initiatives are being taken to (i) account for ESOPs, (ii) furtherincrease disclosures, and (iii) put in place systems that canfurther strengthen auditors independence
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Cont.
Following CIIs 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
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Driving Forces of CG in India
1) Unethical Business Practices
Security Scams ---Harshad Mehtha Security Scam
Equity allotments at discount rates to the controlling
groups
Disappearance of Companies (1993-94) - around 4,000 companies with 25,000 crores without starting business
Misdeed of Companies
Plantation, Sheep rearing, etc.
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2) Impact of Globalization
Integration with Foreign Market
Foreign Investors expectations
New Business Opportunities --- IT & ITES, BPO etc.,
New Capital formation FII, FDI
3) Impact of Privatisation
New structure of ownership Multinational Companies
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BOARD OF DIRECTORS- ROLES & RESPONSIBILIIES
Roles:
Establish vision, mission and values
Set strategy an structure
Delegate to management
exercise accountability to shareholders & be
responsible to other stakeholders
Responsibilities:
To ensure that proper books of accounts are kept.
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In some cases directors may be required to pay
company debts. The directors must exercise their powers for a
proper purpose for which they are there.
They must act in good faith for the best interest ofthe company.
Must act with due skill and care.
Must consider the interest of employees of the
company.
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Powers of BOD
The roles of Chairman and Chief
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Executive- Chairman
Ensure effective operation of the Board and its
committees in conformity with the highest standards of
corporate governance.
Ensure effective communication with shareholders, host
governments and other relevant constituencies and that
the views of these groups are understood by the Board.
Chair the Nominations Committee and build an effective
and complementary Board, initiating change andplanning succession on Board and Group Executive
appointments.
Set the agenda style and tone of Board discussions to
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Set the agenda, style and tone of Board discussions to
promote constructive debate and effective decision-making.
Ensure that all Board committees are properly established,composed and operated.
Ensure comprehensive induction programmes for new
directors and updates for all directors as and when necessary.
Support the Chief Executive in the development of strategyand, more broadly, to support and advise the Chief Executive.
Maintain access to senior management as is necessary and
useful, but not intrude on the Chief Executive's
responsibilities.
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Promote effective relationships and communications between
non-executive directors and members of the Group Executive
Committee.
Ensure that the performance of the Board, its main
committees and individual directors is formally evaluated onan annual basis.
Establish a harmonious and open relationship with the Chief
Executive.
Chief Executive
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Chief Executive
Develop strategy proposals for recommendation to theBoard and ensure that agreed strategies are reflected in thebusiness.
Develop annual plans, consistent with agreed strategies, forpresentation to the Board for support.
Plan human resourcing to ensure that the Company has thecapabilities and resources required to achieve its plans.
Develop an organisational structure and establish processesand systems to ensure the efficient organisation ofresources.
Be responsible to the Board for the performance of thebusiness consistent with agreed plans, strategies andpolicies.
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Lead the executive team, including the development ofperformance contracts and appraisals.
Ensure that financial results, business strategies and, whereappropriate, targets and milestones are communicated to theinvestment community.
Develop and promote effective communication with shareholdersand other relevant constituencies.
Ensure that business performance is consistent with the BusinessPrinciples.
Ensure that robust management succession and managementdevelopment plans are in place and presented to the Board from
time to time. Develop processes and structures to ensure that capital investment
proposals are reviewed thoroughly, that associated risks areidentified and appropriate steps taken to manage the risks.
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Develop and maintain an effective framework of
internal controls over risk in relation to all business
activities including the Group's trading activities.
Ensure that the flow of information to the Board is
accurate, timely and clear.
Establish a close relationship of trust with theChairman, reporting key developments to him in a
timely manner and seeking advice and support as
appropriate.
The Chairman and Chief Executive will meet regularly
to review issues, opportunities and problems.
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UNIT-II
Corporate disclosure practices and investor
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Corporate disclosure practices and investor
protection
Meaning of disclosure-
Disclosure is a process through which business enterprises
communicate and report accounting and non- accounting
information to various direct and indirect users for the purpose of
their analysis and decision making. Disclosure should be full, fair
and adequate.
Full- refers to complete and comprehensive presentation of
information of financial activities in the financial reports.
Fair-implies that information should be unbiased and impartial.Adequate-implies that all material information needed by the users
should be included in financial statements.
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Factors affecting disclosure
Divorce between ownership and management.
Growing complexities of corporations.
Growing awareness of public.
Changing socio-political environment in the country.
Greater emphasis on rational decision-making.
Helps in assessing risk.
Scope for improvement in internal conduct of thecompany.
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Objectives of disclosure
Timely, consistent and appropriate disclosure of
information.
To protect and prevent disclosure of material
information and company information. To give material information according to legal and
regulatory requirements.
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Why is investor protection needed?
Investor protection is associated with effectivecorporate governance.
If there is no investor protection the insiders can
easily steal the firms profits. If the investors rights are effectively enforced, it
would enforce insiders to repay and distribute profits
to shareholders and thereby protect external
financing mechanism from breaking down.
Organisational framework for investor
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Organisational framework for investor
protection
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