Corporate Governance Summary

8/3/2019 Corporate Governance Summary

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Corporate Governance



What is corporate governance?

• Corporate governance is the set ofprocesses, customs, policies, laws, andinstitutions affecting the way a corporation

(or company) is directed, administered orcontrolled. Corporate governance alsoincludes the relationships among the many

stake holders involved and the goals forwhich the corporation is governed.



Stakeholders



Corporate governance – an academic

point of view

It can be seen as one that

addresses “the problemsthat result from the

separation of ownership

and control”.

Shareholders

Board

Employees

Management

Separation of ownership &control



A simple model for corporategovernance1. Shareholders elect directors as their representatives

2. Directors vote on key issues and adopt majoritydecision

3. Directors make transparent decisions for which

shareholders and others can make them accountable4. Companies adopt accounting standards that generate

information required by directors, investors, otherstakeholders for decision-making

5. Companies adopt policies and practices compatiblewith relevant national, state, and local laws



McKinsey & Company Report -2001

• McKinsey and company report titled “Giving New

Life to the Corporate Governance Reform Agenda for Emerging Markets” suggests a two-

version governance chain model.• The “market model” governance chain (model 1)

described below is applicable to efficient, well-developed equity markets and dispersed

ownership prevalent in the developed industrialnations like US, UK, Canada, and Australia



The “market model” governance chain – Model 1

Shareholder environment Independence & performance

Capital market liquidity Transparency & accountability

I n s t i t u t i o n a l c o n t e

x t C

or p or a t e c on t ex t

Sophisticatedinstitutionalownership

Activeequity

markets

Activetakeovermarket

Non-executivemajorityboards

AlignedIncentives

Highdisclosure

Shareholderequality

Dispersedownership



The “control model” governance chain – Model 2

Shareholder environment Independence & performance

Capital market liquidity Transparency &

accountability

I n s t i t u t i o n a l c o n t e

x t C

or p or a t e c on t ex t

Concentratedownership

Reliance onfamily, bank,public finance

Underdeveloped Newissue market

Limitedtakeovermarket

Insider boards

Incentivesaligned with coreshareholders

Limiteddisclosures

Inadequateminorityprotection



Corporate Misgovernance

• Misgovernance in the US

• Misgovernance in India

• Scams in India



Winds of change

Prior to reforms in 1991, Indian companies wereinsulated by closed economy, a sheltered market, limitedaccess to global business, lack of competitive spirit andregulatory framework – all these changed on account of:

• Market-driven performs• Economic liberalization

• Dismantling of control and quota regime

• Delicensing and deregulation of industries

• Changes in import/export policies• Globalization of the economy within and outside the

ambit of the WTO



Corporate governance movementin IndiaThe movement took of:• The Confederation of Indian Industry (CII)

framed a code in 1997 and 30 large listedcompanies voluntarily adopted this code

• In 1999, the Securities and exchange Board ofIndia (SEBI, set up in 1988 and was made astatutory body in 1992) appointed a committeeheaded by Kumar Mangalam Birla to mandate

international standards of corporate governancefor listed companies• By 2003 every listed company joined the SEBI

code



Historical perspective of corporate

governance: from a narrow to broader vision

• Traditionally, the problem of the separation ofownership by shareholders and the control bymanagement

• Historical developments of corporatemisdemeanor and growing visions of societyfollowed

• Governance should stand up to the expectations

of all stakeholders namely employees,consumers, large institutional investors,government, and the society as a whole



All these had gonefar beyond the originalprescription of Milton

Friedman that thecompanies shouldconduct the businesspurely in accordance

with the desires of theshareholders



Growth of modern ideas ofcorporate governance

Watergate scandal which brought aboutthe end of Nixon Presidency led to thedisclosure that many companies made

illegal political contributions by bribinggovernmental officials – out came thelegislation of the Foreign and CorruptPractices Act of 1977. In the same year

Securities Exchange Commission (SEC)proposed mandatory reporting on financialcontrols.



The Cadbury Committee

• UK was rocked by aseries of scams andbusiness collapsesduring the 1980s early 1990s.In 1991, London Stock Exchange

appointed Sir Adrian Cadburycommittee to draft acode of practicesin English corporations todefine and apply internal

controls to limit their exposureto financial losses. The committeesubmitted the “Code of BestPractices” in 1992. It includedguidelines to board of directors,non-executive directors, and those

on reporting and control.



The Sarbanes –Oxley Act (SOA)2002• In the US, stock market began

declining in early 2000. Well-known companies like Enron,WorldCom Adelphia, GlobalCrossing, Dynegy and a few

others steeped in corruption,fraud, deception collapseddamaging investor confidence.Stock prices plummeted andinvestors lost billions of dollars.Investigations by the US

Congress and the Securitiesand Exchange Commission(SEC) brought about acomprehensive Act, theSarbanes-Oxley Act was enactedinto law on July 30, 2002.



Sen. Paul Sarbanes Michael Oxley

The Sarbanes – Oxley Act was formulated toprotect investors by improving the accuracy andreliability of corporate disclosures. The actcontained a number of provisions that

dramatically change the reporting and corporatedirector’s governance obligations of publiccompanies, the directors, and officers.

http://images.google.co.in/imgres?imgurl=http://www.rit.edu/news/pics/Sarbanes_Paul.jpg&imgrefurl=http://www.rit.edu/news/%3Fr%3D45610&usg=__GX0mQXqzkImGJXoAgYbCTNn8rDE=&h=1886&w=1496&sz=921&hl=en&start=2&um=1&tbnid=vWommgFWUD_LmM:&tbnh=150&tbnw=119&prev=/images%3Fq%3Dpaul%2Bsarbanes%26gbv%3D2%26ndsp%3D20%26hl%3Den%26safe%3Doff%26sa%3DN%26um%3D1



Issues in Corporate Governance

• Corporate governance means differentthings to different people. But to all,corporate governance is a means to an

end, the end being long term shareholder ,and importantly, stakeholder value. Goodcorporate governance practices involve

some critical and crucial issues. Theseare:



Distinguishing the roles of boardand management

• Business is to be managed “by or under

the direction’” of the board. The

responsibility of managing the business is

delegated to the CEO, who in turndelegates to other senior managers. Theboard is positioned between the

shareholders (owners) and the company’smanagement. The board holds importantfunctions:



1. Appoint and remove CEO

2. Indirectly oversee the conduct of the business

3. Review and approve company’s financial

objectives, corporate plans and objectives

4. Advice and counsel top management

5. Identify and recommend candidates to

shareholders for electing directors6. Review systems to comply with laws and

regulations



Composition of board and otherrelated issues• Committee elected by the shareholders of a limited company for the

policies of the company – sometimes full-time functional directorsare also appointed.

• The SEBI appointed Kumar Mangalam Birla’s report defined thecomposition of the board as:

“The board of directors of a company shall have an optimumcombination of executive and non-executive directors with not lessthan 50 per cent of the board of directors to be non-executivedirectors. The number of independent directors would dependwhether the chairman is executive or non-executive. In case of anon-executive chairman, at least one –third of the board shouldcomprise independent directors and in case of executive chairman,at least half of the board should be independent directors.”



Board of Directors

Executive Directors Non-Executive Directors

Independent Directors Affiliated Directors(Nominee Directors)

Types of Directors



• Executive director – an executive of thecompany and also a member of the board

• Non-Executive director – no employmentrelationship

• Independent non-executive directors – free fromany business or other relationship which mayinterfere with the exercise of independent

judgment

• Affiliated director – who has some kind ofindependence, yet may have links withsuppliers, customers, etc.



Roles of CEO and Chairperson

• The composition of the board is a major issue

• Professionalizing of family companies should start withthe composition of the board.

• Combining the roles of CEO and Chairperson prevalent

in US and India result in conflicting interests anddecision making. In UK and Australia the CEO can notbe the chairperson of the board.

• CEO is to lead the senior management and thechairperson is to lead the board and more over it may betoo heavy to handle both jobs by one person.



Disclosure and Audit

• The Cadbury Report termed audit as “one of the corner stones of corporate governance”.Audit provides a basis for reassurance to theshare holders and everyone else who has a

financial stake in the company. Audits raise ahost of issues:1. Should boards establish audit committees?

How should it be composed?

2. How to ensure the independence of theauditor?3. What about the non-audit services rendered by

the auditors?



Recent corporate scandalsinvolving auditors

Arthur AndersenAccountancy firm ArthurAndersen was declaredguilty of obstructing

justice by shredding

documents relating to thefailed energy giant Enron.The verdict could be thedeath knell for the 89-yearold company, once one ofthe world's top fiveaccountants.



• Andersen has already lost much of itsbusiness, and two-thirds of its once 28,000strong US workforce. Following the

conviction, multi-million dollar lawsuitsbrought by Enron investors andshareholders demanding compensation

are likely to follow, and could bankrupt thefirm.



Satyam

• Price Waterhouse resigned as statutory auditor ofSatyam Computer Services Ltd with effect from February12, 2009, while stating that it would co-operate with theongoing investigations into the Rs 7,800 crore fraud at

the IT major.

Documents

Corporate Governance Summary