PROJECT REPORT

On

CORPORATE GOVERNESS

Submitted in partial fulfillment of requirements for

the award of the degree of Bachelor of Commerce

Session : 2017-2018

Under Supervision of: Submitted by:

Mrs. Shuchi Goel Shivani
Lecturer Roll No. : 5400
Exam Roll No. :
VMM

Vaish Mahila Mahavidhyalya, Rohtak

MAHARSHI DAYANAND UNIVERSITY, ROHTAK
 DECLARATION

I, Shivani Roll No. 5400 of B.Com of VMM (MDU) Rohtak, hereby declare that the project entitled
Training & Effectiveness an original work and the same has not been submitted to any other institute for
award of any other degree. The interim report was presented to the supervisor on .and the
pre-submission presentation was made on.. The feasible suggestions have been duly
incorporated in consultation with the supervisor.

Signature of the Candidate

 ACKNOWLEDGEMENT

Gratitude is not a thing of expression; it is more a matter of feeling.

There is always a sense of gratitude which one express for others for their help and supervision
in achieving the goals. We too express my deep gratitude to each and everyone who has been
helpful to us in completing the project report successfully.

We would like to thank almighty God for blessing showered on us during the completion of
Dissertation Report.

We give our regards and sincere thanks to Mrs. Shuchi Goel (VMM) who has devoted her
precious time in guiding us & helping us complete it within time.

We feel self-short of words to thanks our parents and friends who had directly or indirectly
instrumental in the completion of the project. We are indebted to all respondents for their time
passion during the long conversations.

Shivani
 Corporate governance
Corporate governance is the mechanisms, processes and relations by which corporations are
controlled and directed.[1] Governance structures and principles identify 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
includes the rules and procedures for making decisions in corporate affairs.[2] Corporate
governance includes the processes through which corporations' objectives are set and pursued in
the context of the social, regulatory and market environment. Governance mechanisms include
monitoring the actions, policies, practices, and decisions of corporations, their agents, and
affected stakeholders. Corporate governance practices are affected by attempts to align the
interests of stakeholders.[3][4] Interest in the corporate governance practices of modern
corporations, particularly in relation to accountability, increased following the high-profile
collapses of a number of large corporations during 20012002, most of which involved
accounting fraud; and then again after the recent financial crisis in 2008.

Corporate scandals of various forms have maintained public and political interest in the
regulation of corporate governance. In the U.S., these include Enron and MCI Inc. (formerly
WorldCom). Their demise led to the enactment of the Sarbanes-Oxley Act in 2002, a U.S.
federal law intended to restore public confidence in corporate governance. Comparable failures
in Australia (HIH, One.Tel) are associated with the eventual passage of the CLERP 9 reforms.[5]
Similar corporate failures in other countries stimulated increased regulatory interest (e.g.,
Parmalat in Italy).
Corporate Governance In India

What is corporate governance? It is a process set up for the firms based on certain systems and
principles by which a company is governed. The guidelines provided ensure that the company is
directed and controlled in a way so as to achieve the goals and objectives to add value to the
company and also benefit the stakeholders in the long term.

The high profile corporate governance failure scams like the stock market scam, the UTI scam,
Ketan Parikh scam, Satyam scam, which was severely criticized by the shareholders, called for a
need to make corporate governance in India transparent as it greatly affects the development of
the country.
To understand the scope of the legal framework and study the amendments, proxy advisory firms
analyze the role of directors and how they are impacted by changes in the amendments. Proxy
firms offer analytical data for the shareholders and corporate advisory services to companies.

The Objectives Of Corporate Governance

Transparency in corporate governance is essential for the growth, profitability and stability of
any business. The need for good corporate governance has intensified due to growing
competition amongst businesses in all economic sectors at the national, as well as international
level.

The Indian Companies Act of 2013 introduced some progressive and transparent processes
which benefit stakeholders, directors as well as the management of companies. Investment
advisory services and proxy firms provide concise information to the shareholders about these
newly introduced processes and regulations, which aim to improve the corporate governance in
India.

Corporate advisory services are offered by advisory firms to efficiently manage the activities of
companies to ensure stability and growth of the business, maintain the reputation and reliability
for customers and clients. The top management that consists of the board of directors is
responsible for governance. They must have effective control over affairs of the company in the
interest of the company and minority shareholders. Corporate governance ensures strict and
efficient application of management practices along with legal compliance in the continually
changing business scenario in India.

Corporate governance was guided by Clause 49 of the Listing Agreement before introduction of
the Companies Act of 2013. As per the new provision, SEBI has also approved certain
amendments in the Listing Agreement so as to improve the transparency in transactions of listed
companies and giving a bigger say to minority stakeholders in influencing the decisions of
management. These amendments have become effective from 1st October 2014.

A Few New Provision for Directors and Shareholders

 One or more women directors are recommended for certain classes of companies
Every company in India must have a resident directory
The maximum permissible directors cannot exceed 15 in a public limited company. If
more directors have to be appointed, it can be done only with approval of the
shareholders after passing a Special Resolution
The Independent Directors are a newly introduced concept under the Act. A code of
conduct is prescribed and so are other functions and duties
The Independent directors must attend at least one meeting a year
Every company must appoint an individual or firm as an auditor. The responsibility of the
Audit committee has increased
Filing and disclosures with the Registrar of Companies has increased
Top management recognizes the rights of the shareholders and ensures strong co-
operation between the company and the stakeholders
 Every company has to make accurate disclosure of financial situations, performance,
material matter, ownership and governance

Additional Provisions

Related Party Transactions A Related Party Transaction (RPT) is the transfer of

resources or facilities between a company and another specific party. The company
devises policies which must be disclosed on the website and in the annual report. All
these transactions must be approved by the shareholders by passing a Special Resolution
as the Companies Act of 2013. Promotors of the company cannot vote on a resolution for
a related party transaction.
Changes in Clause 35B The e-voting facility has to be provided to the shareholder for
any resolution is a legal binding for the company.
Corporate Social Responsibility The company has the responsibility to promote social
development in order to return something that is beneficial for the society.
Whistle Blower Policy This is a mandatory provision by SEBI which is a vigil
mechanism to report the wrong or unethical conduct of any director of the company.

Why is Corporate Governance in India Important?

A company that has good corporate governance has a much higher level of confidence amongst
the shareholders associated with that company. Active and independent directors contribute
towards a positive outlook of the company in the financial market, positively influencing share
prices. Corporate Governance is one of the important criteria for foreign institutional investors to
decide on which company to invest in.

The corporate practices in India emphasize the functions of audit and finances that have legal,
moral and ethical implications for the business and its impact on the shareholders. The Indian
Companies Act of 2013 introduced innovative measures to appropriately balance legislative and
regulatory reforms for the growth of the enterprise and to increase foreign investment, keeping in
mind international practices. The rules and regulations are measures that increase the
involvement of the shareholders in decision making and introduce transparency in corporate
governance, which ultimately safeguards the interest of the society and shareholders.

Corporate governance safeguards not only the management but the interests of the stakeholders
as well and fosters the economic progress of India in the roaring economies of the world.

Concept of Corporate Governance Defined:

Corporate governance may be defined as follows:

Corporate governance refers to the accountability of the Board of Directors to all stakeholders of
the corporation i.e. shareholders, employees, suppliers, customers and society in general; towards
giving the corporation a fair, efficient and transparent administration.

Following are cited a few popular definitions of corporate governance:

(1) Corporate governance means that company managers its business in a manner that is
accountable and responsible to the shareholders. In a wider interpretation, corporate governance
includes companys accountability to shareholders and other stakeholders such as employees,
suppliers, customers and local community. Catherwood.

(2) Corporate governance is the system by which companies are directed and controlled. The
Cadbury Committee (U.K.)

Points of comment:

Certain useful comments on the concept of corporate governance are given below:

(i) Corporate governance is more than company administration. It refers to a fair, efficient and
transparent functioning of the corporate management system.

(ii)Corporate governance refers to a code of conduct; the Board of Directors must abide by;
while running the corporate enterprise.
(iii)Corporate governance refers to a set of systems, procedures and practices which ensure that
the company is managed in the best interest of all corporate stakeholders.

Need for Corporate Governance:

The need for corporate governance is highlighted by the following factors:

(i) Wide Spread of Shareholders:

Today a company has a very large number of shareholders spread all over the nation and even
the world; and a majority of shareholders being unorganised and having an indifferent attitude
towards corporate affairs. The idea of shareholders democracy remains confined only to the law
and the Articles of Association; which requires a practical implementation through a code of
conduct of corporate governance.

(ii) Changing Ownership Structure:

The pattern of corporate ownership has changed considerably, in the present-day-times; with
institutional investors (foreign as well Indian) and mutual funds becoming largest shareholders in
large corporate private sector. These investors have become the greatest challenge to corporate
managements, forcing the latter to abide by some established code of corporate governance to
build up its image in society.

(iii) Corporate Scams or Scandals:

Corporate scams (or frauds) in the recent years of the past have shaken public confidence in
corporate management. The event of Harshad Mehta scandal, which is perhaps, one biggest
scandal, is in the heart and mind of all, connected with corporate shareholding or otherwise being
educated and socially conscious.

The need for corporate governance is, then, imperative for reviving investors confidence in the
corporate sector towards the economic development of society.

(iv) Greater Expectations of Society of the Corporate Sector:

Society of today holds greater expectations of the corporate sector in terms of reasonable price,
better quality, pollution control, best utilisation of resources etc. To meet social expectations,
there is a need for a code of corporate governance, for the best management of company in
economic and social terms.

(v) Hostile Take-Overs:

Hostile take-overs of corporations witnessed in several countries, put a question mark on the
efficiency of managements of take-over companies. This factors also points out to the need for
corporate governance, in the form of an efficient code of conduct for corporate managements.

(vi) Huge Increase in Top Management Compensation:

It has been observed in both developing and developed economies that there has been a great
increase in the monetary payments (compensation) packages of top level corporate executives.
There is no justification for exorbitant payments to top ranking managers, out of corporate funds,
which are a property of shareholders and society.

This factor necessitates corporate governance to contain the ill-practices of top managements of
companies.

(vii) Globalisation:

Desire of more and more Indian companies to get listed on international stock exchanges also
focuses on a need for corporate governance. In fact, corporate governance has become a
buzzword in the corporate sector. There is no doubt that international capital market recognises
only companies well-managed according to standard codes of corporate governance.
Principles of Corporate Governance:

(or major issues involved in corporate governance)

The fundamental or key principles of corporate governance are described below:

(i) Transparency:

Transparency means the quality of something which enables one to understand the truth easily.
In the context of corporate governance, it implies an accurate, adequate and timely disclosure of
relevant information about the operating results etc. of the corporate enterprise to the
stakeholders.

In fact, transparency is the foundation of corporate governance; which helps to develop a high
level of public confidence in the corporate sector. For ensuring transparency in corporate
administration, a company should publish relevant information about corporate affairs in leading
newspapers, e.g., on a quarterly or half yearly or annual basis.

(ii) Accountability:

Accountability is a liability to explain the results of ones decisions taken in the interest of
others. In the context of corporate governance, accountability implies the responsibility of the
Chairman, the Board of Directors and the chief executive for the use of companys resources
(over which they have authority) in the best interest of company and its stakeholders.

(iii) Independence:

Good corporate governance requires independence on the part of the top management of the
corporation i.e. the Board of Directors must be strong non-partisan body; so that it can take all
corporate decisions based on business prudence. Without the top management of the company
being independent; good corporate governance is only a mere dream.

SEBI Code of Corporate Governance:

To promote good corporate governance, SEBI (Securities and Exchange Board of India)
constituted a committee on corporate governance under the chairmanship of Kumar Mangalam
Birla. On the basis of the recommendations of this committee, SEBI issued certain guidelines on
corporate governance; which are required to be incorporated in the listing agreement between the
company and the stock exchange.

An overview of SEBI guidelines on corporate governance is given below, under appropriate

heads:

(a) Board of Directors:

Some points in this regard are as follows:

(i) The Board of Directors of the company shall have an optimum combination of executive and
non-executive directors.

(ii) The number of independent directors would depend on whether the chairman is executive or
non-executive.

In case of non-executive chairman, at least, one third of the Board should comprise of
independent directors; and in case of executive chairman, at least, half of the Board should
comprise of independent directors.
The expression independent directors means directors, who apart from receiving directors
remuneration, do not have any other material pecuniary relationship with the company.

(b) Audit Committee:

Some points in this regard are as follows:

(1) The company shall form an independent audit committee whose constitution would be
as follows:

(i) It shall have minimum three members, all being non-executive directors, with the majority of
them being independent, and at least one director having financial and accounting knowledge.

(ii)The Chairman of the committee will be an independent director.

(iii)The Chairman shall be present at the Annual General Meeting to answer shareholders
queries.

(2) The audit committee shall have powers which should include the following:

1.To investigate any activity within its terms of reference

2.To seek information from any employee

3. To obtain outside legal or other professional advice

4. To secure attendance of outsiders with relevant expertise, if considered necessary.

(3) The role of audit committee should include the following:

(i) Overseeing of the companys financial reporting process and the disclosure of its financial
information to ensure that the financial statement is correct, sufficient and credible.

(ii) Recommending the appointment and removal of external auditor.

(iii) Reviewing the adequacy of internal audit function

(iv) Discussing with external auditors, before the audit commences, the nature and scope of
audit; as well as to have post-audit discussion to ascertain any area of concern.

(v) Reviewing the companys financial and risk management policies.

(c) Remuneration of Directors:

The following disclosures on the remuneration of directors shall be made in the section on
the corporate governance of the Annual Report:

(i) All elements of remuneration package of all the directors i.e. salary, benefits, bonus, stock
options, pension etc.

(ii) Details of fixed component and performance linked incentives, along with performance
criteria.

(d) Board Procedure Some Points in this Regards are:

(i) Board meetings shall be held at least, four times a year, with a maximum gap of 4 months
between any two meetings.

(ii) A director shall not be a member of more than 10 committees or act as chairman of more
than five committees, across all companies, in which he is a director.

(e) Management:

A Management Discussion and Analysis Report should form part of the annual report to the
shareholders; containing discussion on the following matters (within the limits set by the
companys competitive position).

(i) Opportunities and threats

(ii) Segment-wise or product-wise performance

(iii) Risks and concerns

(iv) Discussion on financial performance with respect to operational performance

(v) Material development in human resource/industrial relations front.

(f) Shareholders:

Some points in this regard are:

(i) In case of appointment of a new director or reappointment of a director, shareholders

must be provided with the following information:

1.A brief resume (summary) of the director

2.Nature of his expertise

3. Number of companies in which he holds the directorship and membership of committees of

the Board.

(ii) A Board Committee under the chairmanship of non-executive director shall be formed to
specifically look into the redressing of shareholders and investors complaints like transfer of
shares, non-receipt of Balance Sheet or declared dividends etc. This committee shall be
designated as Shareholders / Investors Grievance Committee.

(g) Report on Corporate Governance:

There shall be a separate section on corporate governance in the Annual Report of the company,
with a detailed report on corporate governance.

(h) Compliance:

The company shall obtain a certificate from the auditors of the company regarding the
compliance of conditions of corporate governance. This certificate shall be annexed with the
Directors Report sent to shareholders and also sent to the stock exchange.
We all are aware of Satyam scam which is the Indias Biggest corporate scam. The scam is all
about corporate governance and it is regarded as the Debacle of the Indian Financial System.
Ever since this scam the concern for good corporate governance has increased phenomenally.
The Cadbury Committee defined Corporate Governance as the system by which companies are
directed and controlled in its report called Financial Aspect of Corporate Governance published
in the year 1992. In general words Corporate Governance means set of rules and regulations by
which an organization is governed, controlled and directed. It is conducted by the Board of
Directors or the concerned committee for the benefit of the companys stakeholders.

In order to ensure good corporate governance in India many Regulatory frameworks are
introduced.

The Companies Act, 2013

The new Companies Law contains many provisions related to good corporate governance like
Composition of Board of Directors, Admitting Woman Director, Admitting Independent
Director, Directors Training and Evaluation, Constitution of Audit Committee, Internal Audit,
Risk Management Committee, SFIO Purview, Subsidiaries Companies Management,
Compliance center etc. All such provisions of new Company Law are instrumental in providing a
good Corporate Governance structure.

Few provisions are:-

1. Section 134, which mandates to attach a report to every Financial statement by Board of
Directors containing all the details of the matter including the statement containing
directors responsibility.
2. Section 177, which requires Board of Directors of every listed company or any other
class of committee to constitute an Audit Committee. It also provide the manner to
constitute the committee.
3. Section 184, which mandates the Director disclose his interest in any company or
companies, body corporate, firms, or other association of Individuals. The director is
 required to disclose any such interest at the first meeting of the board and if there is any
change in the interest then the first meeting held after such change.

Securities and Exchange Board of India (SEBI) guidelines

SEBI is a regulatory authority established on April 12, 1992. SEBI was established with the main
purpose of curbing the malpractices and protecting the interest of its investors. Its main objective
is to regulate the activities of Stock Exchange and at the same time ensuring the healthy
development in the financial market. In order to ensure good corporate governance SEBI came
up with detailed Corporate Governance Norms.

1. As per the new rules the companies are required to get shareholders approval for RPT
(Related Party Transactions), it established whistle blower mechanism, clear mandate to
have at least one woman director in the Board and moreover it elaborated disclosures on
pay packages.
2. Clause 35B of the Listing Agreement is being amended by the regulatory authority. Now
as per the amended clause, Listed companies are required to provide the option of e-
voting to its shareholders on all proposed or passed at general meetings. Those who do
not have access to e-voting facility, they should be provided to cast their votes in writing
on Postal Ballot. There was the need to amend the provision so that the provisions of the
listing agreement can be aligned with the provisions of Companies Act, 2013. By doing
so an additional requirement can be provided to strengthen the Corporate Governance
norms in India with respect to Listed companies.
3. Clause 49 of the Listing Agreement was also amended by SEBI in order to strengthen the
Corporate Governance framework for Listed companies in India. The revised clause
 forbids the independent directors from being eligible for any kind of stock option.
Whistle blower policy is also added in the revised clause whereby the directors and
employees can report any unethical behavior, any fraud or if there is violation of Code of
Conduct of the company. By the amendment Audit Committee is also enhanced, now it
will include evaluation of risk management system and internal financial control, will
keep a check on inter-corporate loans and investments. The amendment now requires all
the companies to form a policy for the purpose of determination of material subsidiaries
and that will be published online.

SEBI also implemented various Regulations for effective working of the companies, few of these
Regulations are as follows-

1. SEBI (Issue of Capital and Disclosure Requirements) regulation, 2009. This Regulation
contains provisions for public issue wherein the issuer shall satisfy the conditions
mentioned under the regulation, it also contains provisions regarding restriction on right
issue. It also contains provisions regarding listing of Securities on stock exchange
wherein in-principle is to be obtained by the issuer from recognised stock exchange.Part
A of schedule XI of this regulations talks about disclosure in Red Herring prospectus,
Shelf prospectus, and Prospectus wherein it is the duty of issuer to ensure that all material
information and reports were submitted prior to the issue.It also makes it very clear that
underwriting obligations would not be restricted to any kind of minimum subscription
level but it would be applicable to the whole issue. All such rules are instrumental in
ensuring good corporate governance.
2. SEBI (Listing obligations and Disclosure Requirements), 2015. The LODR Regulations
were notified with the aim of simplifying the existing provisions of listing agreements for
different segment of capital markets like convertible and non-convertible debt securities,
equity shares etc. it requires all listed entities to make disclosure and abide by the
provisions of these regulations. Listed entities shall ensure that directors, KMP or any
other person related to the company shall adhere to the responsibilities assigned to them
under this regulation. The intent here is to ensure that once the shares of a company is
listed on a Stock Exchange they are easily accessible to the normal public. The company
secretary who will be the Compliance Officer of the company shall ensure compliances
 and should also provide the Compliance certificate to Stock Exchanges. Listed
companies shall have a policy for Preservation of Documents approved by Board.
3. SEBI (Prohibition of Insider Trading) Regulations,2015. Insider trading per se is not a
violation of Law but what is prohibited is trading by an insider on the basis of Non-public
information. To prevent such trading SEBI came up with this regulation. Under this, the
restriction is corporate insiders who arrive at trading decisions by using the price
sensitive information directly or indirectly. Under this the disclosure mandated at two
different levels, one is the immediate disclosure of material facts while the other is
regarding disclosure of transactions undertaken. While the former prevents insider
trading, the latter reveals the insider trading. Under this Insiders may be restricted from
dealing in securities for a specific time period in order to prevent them taking advantage
of any material information before the shareholders or public. A condition can be
imposed upon the insiders to obtain a prior approval before dealing in securities of a
company.
4. SEBI came up with many other regulations like Regulation on Fraudulent and Unfair
Trade Practices, Regulations on Substantial Acquisition of Shares and Takeovers, Issue
of Sweat Equity etc. The main aim behind coming up with such Regulation, rules etc is to
ensure good corporate governance in a company.

Standard Listing Agreement of Stock Exchanges

It is for all those companies whose shares are listed on Stock Exchange. All companies are
required to file the listing agreement of the Stock exchange where its shares are listed.

Accounting standards issued by the ICAI (Institute of Chartered Accountants of

India)

ICAI is a statutory body established by Chartered Accountants Act, 1949. It issues accounting
standards for disclosure of financial information. Section 129 of the Companies Act, 2013 states
that financial statements of a company shall comply with the accounting standards notified under
section 133 of the Act. it also states that the financial statement shall give true and fair view of
the state of affairs of the company. Section 133 states that Central government may prescribe the
accounting standards as recommended by ICAI. accounting standards are provided so that good
corporate governance can be ensured in a company. Some accounting standards issued by ICAI
are: Disclosure of Accounting policies followed in preparation of Financial statement,
Determination of values at which the inventories are carried in a financial statement, cash flow
statements for assessing the ability of an enterprise in generating cash, standard to ensure that
appropriate measurement bases are applied to provisions and contingent liability, standard
prescribing accounting treatment of cost and revenue associated with construction contracts.

Secretarial standards issued by ICSI (Institute of Company Secretaries of India)

It is an autonomous body constituted by the Company Secretaries Act, 1980. It is a body to

regulate and develop the profession of Company Secretaries in India. It issues secretarial
standards as per the provision of the Companies Act,2013. Section 118(10) of the Companies
Act states that every company shall observe secretarial standards specified by Institute of
Company Secretaries of India with respect to General and Board meetings.

1. Secretarial standard-1 on Meeting of the Board seeks to prescribe a set of principles for
conducting meetings of Board of Directors. These principles are equally applicable to the
meetings of committees as well.SS-1 principles are applicable to the Meeting of Board of
Directors of all companies except one person company.
2. Secretarial standard-2 prescribes a set of principles for conducting and convening general
meetings. This standard also deals with the procedure for conducting e-voting and postal
ballot. SS-2 is applicable to all types of General meetings of all companies except one
person company incorporated under the act. The principles in SS-2 are applicable
mutatis-mutandis to meetings of creditors and debenture holders moreover it also
prescribes that any meeting of members or creditors or debenture-holders of a company
under the direction of CLB (Company Law Board), NCLT (National Company Law
Tribunal) or any other authority shall be governed by the provisions of this standard.

Apart from some initiatives for Corporate Governance as discussed above, few other initiatives
were also taken like-
 Setting up IEPF (Investor Education and protection Fund) for protection of the interest of
the investors and promoting investors awareness.
Empowering investors with the help of VOs, NGOs, Investor Association etc by
educating them and providing relevant information.
Launching websites like www.investorhelpline.in and www.watchoutinvestors.com .
Setting up NFCG (National Foundation for Corporate Governance) in partnership with
ICAI, ICSI, CII with the vision to foster the culture of good governance and to set a
framework related to best practices, ethics and processes. Under NFCG a core group on
Corporate Governance norms is constituted for Institutional Investors and IDs. Core
group on Corporate Social responsibility is also constituted under NFCG.

As per the SEBI committee the objective of Corporate Governance is maximization of

shareholders wealth and at the same time protecting the interest of other shareholders. As per the
Report on Corporate Governance initiative in India by OECD (Organization for economic Co-
operation and Development) the Government has renamed the Ministry to Corporate Affairs
from Company Affairs. The vision behind renaming the Ministry is to become a part for
initiating Corporate Reforms in the country by ensuring Good Governance and Enlightened
regulation and to facilitate effective investor protection and Corporate functioning.

Development of rules and norms is an important step but only the first step to ensure good
corporate governance. Journey is long but serious efforts from Indian government and SEBI will
always remain instrumental in dealing with the problem of Corporate Governance. Amendment
brought in the Companies Act, various initiatives taken up by the government, standards issued
by ICAI and ICSI provides a regulatory framework for curbing the malpractices and ensuring the
rights of the investors.

Stakeholder interests
In contemporary business corporations, the main external stakeholder groups are shareholders,
debtholders, trade creditors and suppliers, customers, and communities affected by the
corporation's activities. Internal stakeholders are the board of directors, executives, and other
employees.

Much of the contemporary interest in corporate governance is concerned with mitigation of the
conflicts of interests between stakeholders.[6] In large firms where there is a separation of
ownership and management and no controlling shareholder, the principalagent issue arises
between upper-management (the "agent") which may have very different interests, and by
definition considerably more information, than shareholders (the "principals"). The danger arises
that, rather than overseeing management on behalf of shareholders, the board of directors may
become insulated from shareholders and beholden to management.[7] This aspect is particularly
present in contemporary public debates and developments in regulatory policy.[3]

Ways of mitigating or preventing these conflicts of interests include the processes, customs,
policies, laws, and institutions which affect the way a company is controlled.[8][9] An important
theme of governance is the nature and extent of corporate accountability. A related discussion at
the macro level focuses on the effect of a corporate governance system on economic efficiency,
with a strong emphasis on shareholders' welfare.[10] This has resulted in a literature focussed on
economic analysis.[11][12][13]

Other definitions

Corporate governance has also been more narrowly defined as "a system of law and sound
approaches by which corporations are directed and controlled focusing on the internal and
external corporate structures with the intention of monitoring the actions of management and
directors and thereby, mitigating agency risks which may stem from the misdeeds of corporate
officers."[14]

Corporate governance has also been defined as "Is the act of externally directing, controlling and
evaluating a corporation"[15] and related to the definition of Governance as "The act of externally
directing, controlling and evaluating an entity, process or resource".[16] In this sense, Governance
and Corporate Governance are different from management because governance must be
EXTERNAL to the object being governed. Governing agents do not have personal control over,
and are not part of the object that they govern. For example, it is not possible for a CIO to govern
the IT function. They are personally accountable for the strategy and management of the
function. As such, they manage the IT function; they do not govern it. At the same time,
there may be a number of policies, authorized by the board, that the CIO follows. When the CIO
is following these policies, they are performing governance activities because the primary
intention of the policy is to serve a governance purpose. The board is ultimately governing the
IT function because they stand outside of the function and are only able to externally direct,
control and evaluate the IT function by virtue of established policies, procedures and indicators.
Without these policies, procedures and indicators, the board has no way of governing, let alone
affecting the IT function in any way.

One source defines corporate governance as "the set of conditions that shapes the ex post
bargaining over the quasi-rents generated by a firm."[17] The firm itself is modelled as a
governance structure acting through the mechanisms of contract.[18][10] Here corporate
governance may include its relation to corporate finance.[19]

Principles

Contemporary discussions of corporate governance tend to refer to principles raised in three

documents released since 1990: The Cadbury Report (UK, 1992), the Principles of Corporate
Governance (OECD, 1999, 2004 and 2015), the Sarbanes-Oxley Act of 2002 (US, 2002). The
Cadbury and Organisation for Economic Co-operation and Development (OECD) reports present
general principles around which businesses are expected to operate to assure proper governance.
The Sarbanes-Oxley Act, informally referred to as Sarbox or Sox, is an attempt by the federal
government in the United States to legislate several of the principles recommended in the
Cadbury and OECD reports.

Rights and equitable treatment of shareholders:[20][21][22] Organizations should respect

the rights of shareholders and help shareholders to exercise those rights. They can help
shareholders exercise their rights by openly and effectively communicating information
and by encouraging shareholders to participate in general meetings.
Interests of other stakeholders:[23] Organizations should recognize that they have legal,
contractual, social, and market driven obligations to non-shareholder stakeholders,
including employees, investors, creditors, suppliers, local communities, customers, and
policy makers.
Role and responsibilities of the board:[24][25] The board needs sufficient relevant skills
and understanding to review and challenge management performance. It also needs
adequate size and appropriate levels of independence and commitment.
Integrity and ethical behavior:[26][27] Integrity should be a fundamental requirement in
choosing corporate officers and board members. Organizations should develop a code of
 conduct for their directors and executives that promotes ethical and responsible decision
making.
Disclosure and transparency:[28][29] Organizations should clarify and make publicly
known the roles and responsibilities of board and management to provide stakeholders
with a level of accountability. They should also implement procedures to independently
verify and safeguard the integrity of the company's financial reporting. Disclosure of
material matters concerning the organization should be timely and balanced to ensure that
all investors have access to clear, factual information.

Models

Different models of corporate governance differ according to the variety of capitalism in which
they are embedded. The Anglo-American "model" tends to emphasize the interests of
shareholders. The coordinated or [Multistakeholder Model] associated with Continental Europe
and Japan also recognizes the interests of workers, managers, suppliers, customers, and the
community. A related distinction is between market-orientated and network-orientated models of
corporate governance.[30]

Continental Europe (Two-tier board system)

Main article: Aktiengesellschaft

Some continental European countries, including Germany, Austria, and the Netherlands, require
a two-tiered Board of Directors as a means of improving corporate governance.[31] In the two-
tiered board, the Executive Board, made up of company executives, generally runs day-to-day
operations while the supervisory board, made up entirely of non-executive directors who
represent shareholders and employees, hires and fires the members of the executive board,
determines their compensation, and reviews major business decisions.[32]

India

The Securities and Exchange Board of India Committee on Corporate Governance defines
corporate governance as the "acceptance by management of the inalienable rights of shareholders
as the true owners of the corporation and of their own role as trustees on behalf of the
shareholders. It is about commitment to values, about ethical business conduct and about making
a distinction between personal & corporate funds in the management of a company."[33][34]

United States, United Kingdom

The so-called "Anglo-American model" of corporate governance emphasizes the interests of

shareholders. It relies on a single-tiered Board of Directors that is normally dominated by non-
executive directors elected by shareholders. Because of this, it is also known as "the unitary
system".[35][36] Within this system, many boards include some executives from the company (who
are ex officio members of the board). Non-executive directors are expected to outnumber
executive directors and hold key posts, including audit and compensation committees. In the
United Kingdom, the CEO generally does not also serve as Chairman of the Board, whereas in
the US having the dual role has been the norm, despite major misgivings regarding the effect on
corporate governance.[37] The number of US firms combining both roles is declining,
however.[38]

In the United States, corporations are directly governed by state laws, while the exchange
(offering and trading) of securities in corporations (including shares) is governed by federal
legislation. Many US states have adopted the Model Business Corporation Act, but the dominant
state law for publicly traded corporations is Delaware, which continues to be the place of
incorporation for the majority of publicly traded corporations.[39] Individual rules for
corporations are based upon the corporate charter and, less authoritatively, the corporate
bylaws.[39] Shareholders cannot initiate changes in the corporate charter although they can
initiate changes to the corporate bylaws.[39]

It is sometimes colloquially stated that in the USA and the UK 'the shareholders own the
company'. This is, however, a misconception as argued by Eccles & Youmans (2015) and Kay
(2015).[40]
Regulation

Corporations are created as legal persons by the laws and regulations of a particular jurisdiction.
These may vary in many respects between countries, but a corporation's legal person status is
fundamental to all jurisdictions and is conferred by statute. This allows the entity to hold
property in its own right without reference to any particular real person. It also results in the
perpetual existence that characterizes the modern corporation. The statutory granting of
corporate existence may arise from general purpose legislation (which is the general case) or
from a statute to create a specific corporation, which was the only method prior to the 19th
century.[citation needed]

In addition to the statutory laws of the relevant jurisdiction, corporations are subject to common
law in some countries, and various laws and regulations affecting business practices. In most
jurisdictions, corporations also have a constitution that provides individual rules that govern the
corporation and authorize or constrain its decision-makers. This constitution is identified by a
variety of terms; in English-speaking jurisdictions, it is usually known as the Corporate Charter
or the [Memorandum] and Articles of Association. The capacity of shareholders to modify the
constitution of their corporation can vary substantially.[citation needed]

The U.S. passed the Foreign Corrupt Practices Act (FCPA) in 1977, with subsequent
modifications. This law made it illegal to bribe government officials and required corporations to
maintain adequate accounting controls. It is enforced by the U.S. Department of Justice and the
Securities and Exchange Commission (SEC). Substantial civil and criminal penalties have been
levied on corporations and executives convicted of bribery.[41]
The UK passed the Bribery Act in 2010. This law made it illegal to bribe either government or
private citizens or make facilitating payments (i.e., payment to a government official to perform
their routine duties more quickly). It also required corporations to establish controls to prevent
bribery.

Sarbanes-Oxley Act

The Sarbanes-Oxley Act of 2002 was enacted in the wake of a series of high-profile corporate
scandals. It established a series of requirements that affect corporate governance in the U.S. and
influenced similar laws in many other countries. The law required, along with many other
elements, that:

The Public Company Accounting Oversight Board (PCAOB) be established to regulate

the auditing profession, which had been self-regulated prior to the law. Auditors are
responsible for reviewing the financial statements of corporations and issuing an opinion
as to their reliability.
The Chief Executive Officer (CEO) and Chief Financial Officer (CFO) attest to the
financial statements. Prior to the law, CEO's had claimed in court they hadn't reviewed
the information as part of their defense.
Board audit committees have members that are independent and disclose whether or not
at least one is a financial expert, or reasons why no such expert is on the audit committee.
External audit firms cannot provide certain types of consulting services and must rotate
their lead partner every 5 years. Further, an audit firm cannot audit a company if those in
specified senior management roles worked for the auditor in the past year. Prior to the
law, there was the real or perceived conflict of interest between providing an independent
opinion on the accuracy and reliability of financial statements when the same firm was
also providing lucrative consulting services.[42]

Codes and guidelines

Corporate governance principles and codes have been developed in different countries and issued
from stock exchanges, corporations, institutional investors, or associations (institutes) of
directors and managers with the support of governments and international organizations. As a
rule, compliance with these governance recommendations is not mandated by law, although the
codes linked to stock exchange listing requirements may have a coercive effect.

Organisation for Economic Co-operation and Development principles

One of the most influential guidelines on corporate governance are the G20/OECD Principles of
Corporate Governance, first published as the OECD Principles in 1999, revised in 2004 and
revised again and endorsed by the G20 in 2015.[3] The Principles often referenced by countries
developing local codes or guidelines. Building on the work of the OECD, other international
organizations, private sector associations and more than 20 national corporate governance codes
formed the United Nations Intergovernmental Working Group of Experts on International
Standards of Accounting and Reporting (ISAR) to produce their Guidance on Good Practices in
Corporate Governance Disclosure.[43] This internationally agreed[44] benchmark consists of more
than fifty distinct disclosure items across five broad categories:[45]

Auditing
Board and management structure and process
Corporate responsibility and compliance in organization
Financial transparency and information disclosure
Ownership structure and exercise of control rights

The OECD Guidelines on Corporate Governance of State-Owned Enterprises are complementary

to the G20/OECD Principles of Corporate Governance, providing guidance tailored to the
corporate governance challenges unique to state-owned enterprises.

Stock exchange listing standards

Companies listed on the New York Stock Exchange (NYSE) and other stock exchanges are
required to meet certain governance standards. For example, the NYSE Listed Company Manual
requires, among many other elements:
 Independent directors: "Listed companies must have a majority of independent
directors...Effective boards of directors exercise independent judgment in carrying out
their responsibilities. Requiring a majority of independent directors will increase the
quality of board oversight and lessen the possibility of damaging conflicts of interest."
(Section 303A.01) An independent director is not part of management and has no
"material financial relationship" with the company.
Board meetings that exclude management: "To empower non-management directors to
serve as a more effective check on management, the non-management directors of each
listed company must meet at regularly scheduled executive sessions without
management." (Section 303A.03)
Boards organize their members into committees with specific responsibilities per defined
charters. "Listed companies must have a nominating/corporate governance committee
composed entirely of independent directors." This committee is responsible for
nominating new members for the board of directors. Compensation and Audit
Committees are also specified, with the latter subject to a variety of listing standards as
well as outside regulations.

Other guidelines

The investor-led organisation International Corporate Governance Network (ICGN) was set up
by individuals centered around the ten largest pension funds in the world 1995. The aim is to
promote global corporate governance standards. The network is led by investors that manage 18
trillion dollars and members are located in fifty different countries. ICGN has developed a suite
of global guidelines ranging from shareholder rights to business ethics.[citation needed]

The World Business Council for Sustainable Development (WBCSD) has done work on
corporate governance, particularly on Accounting and Reporting, and in 2004 released Issue
Management Tool: Strategic challenges for business in the use of corporate responsibility codes,
standards, and frameworks. This document offers general information and a perspective from a
business association/think-tank on a few key codes, standards and frameworks relevant to the
sustainability agenda.
In 2009, the International Finance Corporation and the UN Global Compact released a report,
Corporate Governance - the Foundation for Corporate Citizenship and Sustainable Business,
linking the environmental, social and governance responsibilities of a company to its financial
performance and long-term sustainability.

Most codes are largely voluntary. An issue raised in the U.S. since the 2005 Disney decision [46]
is the degree to which companies manage their governance responsibilities; in other words, do
they merely try to supersede the legal threshold, or should they create governance guidelines that
ascend to the level of best practice. For example, the guidelines issued by associations of
directors, corporate managers and individual companies tend to be wholly voluntary but such
documents may have a wider effect by prompting other companies to adopt similar
practices.[citation needed]

History

Early history

Further information: Economic history of the Dutch Republic, Financial history of the Dutch
Republic, and Dutch East India Company

The modern practice of corporate governance has its roots in the 17th-century Dutch
Republic.[47][48][49][50] The first recorded corporate governance dispute in history,[51] took place in
1609 between the shareholders/investors (most notably Isaac Le Maire) and directors of the
Dutch East India Company (VOC), the world's first formally listed public company.[52]

United States of America

Robert E. Wright argues in Corporation Nation (2014) that the governance of early U.S.
corporations, of which over 20,000 existed by the Civil War of 1861-1865, was superior to that
of corporations in the late 19th and early 20th centuries because early corporations governed
themselves like "republics", replete with numerous "checks and balances" against fraud and
against usurpation of power by managers or by large shareholders.[53] (The term "robber baron"
became particularly associated with US corporate figures in the Gilded Age - the late 19th
century.)

In the immediate aftermath of the Wall Street Crash of 1929 legal scholars such as Adolf
Augustus Berle, Edwin Dodd, and Gardiner C. Means pondered on the changing role of the
modern corporation in society.[54] From the Chicago school of economics, Ronald Coase[55]
introduced the notion of transaction costs into the understanding of why firms are founded and
how they continue to behave.[56]

US economic expansion through the emergence of multinational corporations after World War II
(1939-1945) saw the establishment of the managerial class. Several Harvard Business School
management professors studied and wrote about the new class: Myles Mace (entrepreneurship),
Alfred D. Chandler, Jr. (business history), Jay Lorsch (organizational behavior) and Elizabeth
MacIver (organizational behavior). According to Lorsch and MacIver "many large corporations
have dominant control over business affairs without sufficient accountability or monitoring by
their board of directors".[citation needed]

In the 1980s, Eugene Fama and Michael Jensen[57] established the principalagent problem as a
way of understanding corporate governance: the firm is seen as a series of contracts.[58]

In the period from 1977 to 1997, corporate directors' duties in the U.S. expanded beyond their
traditional legal responsibility of duty of loyalty to the corporation and to its
shareholders.[59][vague]

In the first half of the 1990s, the issue of corporate governance in the U.S. received considerable
press attention due to a spate of CEO dismissals (for example, at IBM, Kodak, and Honeywell)
by their boards. The California Public Employees' Retirement System (CalPERS) led a wave of
institutional shareholder activism (something only very rarely seen before), as a way of ensuring
that corporate value would not be destroyed by the now traditionally cozy relationships between
the CEO and the board of directors (for example, by the unrestrained issuance of stock options,
not infrequently back-dated).
In the early 2000s, the massive bankruptcies (and criminal malfeasance) of Enron and
Worldcom, as well as lesser corporate scandals (such as those involving Adelphia
Communications, AOL, Arthur Andersen, Global Crossing, and Tyco) led to increased political
interest in corporate governance. This was reflected in the passage of the Sarbanes-Oxley Act of
2002. Other triggers for continued interest in the corporate governance of organizations included
the financial crisis of 2008/9 and the level of CEO pay[60]

East Asia

In 1997 the East Asian Financial Crisis severely affected the economies of Thailand, Indonesia,
South Korea, Malaysia, and the Philippines through the exit of foreign capital after property
assets collapsed. The lack of corporate governance mechanisms in these countries highlighted
the weaknesses of the institutions in their economies.[citation needed]

Iran

The Tehran Stock Exchange introduced a corporate governance code in 2007 that reformed
"board compensation polices[sic], improved internal and external audits, ownership
concentration and risk management. However, the code limits the directors' independence and
provides no guidance on external control, shareholder rights protection, and the role of
stakeholder rights."[61] A 2013 study found that most Iranian companies "are not in an
appropriate situation regarding accounting standards" and that managers in most companies
conceal their real performance, implying little transparency and trustworthiness regarding
operational information published by them. Examination of 110 companies' performance found
that companies with better corporate governance had better performance.[61]

Saudi Arabia

In November 2006 the Capital Market Authority (Saudi Arabia) (CMA) issued a corporate
governance code in the Arabic language.[62] The Kingdom of Saudi Arabia has made
considerable progress with respect to the implementation of viable and culturally appropriate
governance mechanisms (Al-Hussain & Johnson, 2009).[63][need quotation to verify]
Al-Hussain, A. and Johnson, R. (2009) found a strong relationship between the efficiency of
corporate governance structure and Saudi bank performance when using return on assets as a
performance measure with one exception - that government and local ownership groups were not
significant. However, using stock return as a performance measure revealed a weak positive
relationship between the efficiency of corporate governance structure and bank performance.[64]

Stakeholders

Key parties involved in corporate governance include stakeholders such as the board of directors,
management and shareholders. External stakeholders such as creditors, auditors, customers,
suppliers, government agencies, and the community at large also exert influence. The agency
view of the corporation posits that the shareholder forgoes decision rights (control) and entrusts
the manager to act in the shareholders' best (joint) interests. Partly as a result of this separation
between the two investors and managers, corporate governance mechanisms include a system of
controls intended to help align managers' incentives with those of shareholders. Agency concerns
(risk) are necessarily lower for a controlling shareholder.[citation needed]

In private for-profit corporations, shareholders elect the board of directors to represent their
interests. In the case of nonprofits, stakeholders may have some role in recommending or
selecting board members, but typically the board itself decides who will serve on the board as a
'self-perpetuating' board.[65] The degree of leadership that the board has over the organization
varies; in practice at large organizations, the executive management, principally the CEO, drives
major initiatives with the oversight and approval of the board.[66]

Responsibilities of the board of directors

Former Chairman of the Board of General Motors John G. Smale wrote in 1995: "The board is
responsible for the successful perpetuation of the corporation. That responsibility cannot be
relegated to management."[67] A board of directors is expected to play a key role in corporate
governance. The board has responsibility for: CEO selection and succession; providing feedback
to management on the organization's strategy; compensating senior executives; monitoring
financial health, performance and risk; and ensuring accountability of the organization to its
investors and authorities. Boards typically have several committees (e.g., Compensation,
Nominating and Audit) to perform their work.[68]

The OECD Principles of Corporate Governance (2004) describe the responsibilities of the board;
some of these are summarized below:[3]

Board members should be informed and act ethically and in good faith, with due
diligence and care, in the best interest of the company and the shareholders.
Review and guide corporate strategy, objective setting, major plans of action, risk policy,
capital plans, and annual budgets.
Oversee major acquisitions and divestitures.
Select, compensate, monitor and replace key executives and oversee succession planning.
Align key executive and board remuneration (pay) with the longer-term interests of the
company and its shareholders.
Ensure a formal and transparent board member nomination and election process.
Ensure the integrity of the corporations accounting and financial reporting systems,
including their independent audit.
Ensure appropriate systems of internal control are established.
Oversee the process of disclosure and communications.
Where committees of the board are established, their mandate, composition and working
procedures should be well-defined and disclosed.

Stakeholder interests

All parties to corporate governance have an interest, whether direct or indirect, in the financial
performance of the corporation. Directors, workers and management receive salaries, benefits
and reputation, while investors expect to receive financial returns. For lenders, it is specified
interest payments, while returns to equity investors arise from dividend distributions or capital
gains on their stock. Customers are concerned with the certainty of the provision of goods and
services of an appropriate quality; suppliers are concerned with compensation for their goods or
services, and possible continued trading relationships. These parties provide value to the
corporation in the form of financial, physical, human and other forms of capital. Many parties
may also be concerned with corporate social performance.[citation needed]

A key factor in a party's decision to participate in or engage with a corporation is their

confidence that the corporation will deliver the party's expected outcomes. When categories of
parties (stakeholders) do not have sufficient confidence that a corporation is being controlled and
directed in a manner consistent with their desired outcomes, they are less likely to engage with
the corporation. When this becomes an endemic system feature, the loss of confidence and
participation in markets may affect many other stakeholders, and increases the likelihood of
political action. There is substantial interest in how external systems and institutions, including
markets, influence corporate governance.[34]

Absentee landlords vs. capital stewards

World Pensions Council (WPC) experts insist that institutional asset owners now seem more
eager to take to task [the] negligent CEOs of the companies whose shares they own.[69]

This development is part of a broader trend towards more fully exercised asset ownership
notably from the part of the boards of directors (trustees) of large UK, Dutch, Scandinavian and
Canadian pension investors:

No longer absentee landlords, [ pension fund ] trustees have started to exercise more
forcefully their governance prerogatives across the boardrooms of Britain, Benelux and
America: coming together through the establishment of engaged pressure groups [] to
shift the [whole economic] system towards sustainable investment.[69]

United Kingdom

In Britain, The widespread social disenchantment that followed the [2008-2012] great recession
had an impact on all stakeholders, including pension fund board members and investment
managers.[70]

Many of the UKs largest pension funds are thus already active stewards of their assets, engaging
with corporate boards and speaking up when they think it is necessary.[70]
Control and ownership structures

Control and ownership structure refers to the types and composition of shareholders in a
corporation. In some countries such as most of Continental Europe, ownership is not necessarily
equivalent to control due to the existence of e.g. dual-class shares, ownership pyramids,
voting coalitions, proxy votes and clauses in the articles of association that confer additional
voting rights to long-term shareholders.[71] Ownership is typically defined as the ownership of
cash flow rights whereas control refers to ownership of control or voting rights.[71] Researchers
often "measure" control and ownership structures by using some observable measures of control
and ownership concentration or the extent of inside control and ownership. Some features or
types of control and ownership structure involving corporate groups include pyramids, cross-
shareholdings, rings, and webs. German "concerns" (Konzern) are legally recognized corporate

groups with complex structures. Japanese keiretsu () and South Korean chaebol (which tend

to be family-controlled) are corporate groups which consist of complex interlocking business

relationships and shareholdings. Cross-shareholding are an essential feature of keiretsu and
chaebol groups [4]. Corporate engagement with shareholders and other stakeholders can differ
substantially across different control and ownership structures.

Family control

Family interests dominate ownership and control structures of some corporations, and it has been
suggested the oversight of family controlled corporation is superior to that of corporations
"controlled" by institutional investors (or with such diverse share ownership that they are
controlled by management). A recent study by Credit Suisse found that companies in which
"founding families retain a stake of more than 10% of the company's capital enjoyed a superior
performance over their respective sectorial peers." Since 1996, this superior performance
amounts to 8% per year.[72] Forget the celebrity CEO. "Look beyond Six Sigma and the latest
technology fad. One of the biggest strategic advantages a company can have is blood ties,"
according to a Business Week study[73][74]

Diffuse shareholders
The significance of institutional investors varies substantially across countries. In developed
Anglo-American countries (Australia, Canada, New Zealand, U.K., U.S.), institutional investors
dominate the market for stocks in larger corporations. While the majority of the shares in the
Japanese market are held by financial companies and industrial corporations, these are not
institutional investors if their holdings are largely with-on group.[citation needed]

The largest pools of invested money (such as the mutual fund 'Vanguard 500', or the largest
investment management firm for corporations, State Street Corp.) are designed to maximize the
benefits of diversified investment by investing in a very large number of different corporations
with sufficient liquidity. The idea is this strategy will largely eliminate individual firm financial
or other risk. A consequence of this approach is that these investors have relatively little interest
in the governance of a particular corporation. It is often assumed that, if institutional investors
pressing for changes decide they will likely be costly because of "golden handshakes" or the
effort required, they will simply sell out their investment.[citation needed]

Mechanisms and controls

Corporate governance mechanisms and controls are designed to reduce the inefficiencies that
arise from moral hazard and adverse selection. There are both internal monitoring systems and
external monitoring systems.[75] Internal monitoring can be done, for example, by one (or a few)
large shareholder(s) in the case of privately held companies or a firm belonging to a business
group. Furthermore, the various board mechanisms provide for internal monitoring. External
monitoring of managers' behavior, occurs when an independent third party (e.g. the external
auditor) attests the accuracy of information provided by management to investors. Stock analysts
and debt holders may also conduct such external monitoring. An ideal monitoring and control
system should regulate both motivation and ability, while providing incentive alignment toward
corporate goals and objectives. Care should be taken that incentives are not so strong that some
individuals are tempted to cross lines of ethical behavior, for example by manipulating revenue
and profit figures to drive the share price of the company up.[56]

Internal corporate governance controls

Internal corporate governance controls monitor activities and then take corrective actions to
accomplish organisational goals. Examples include:

Monitoring by the board of directors: The board of directors, with its legal authority to
hire, fire and compensate top management, safeguards invested capital. Regular board
meetings allow potential problems to be identified, discussed and avoided. Whilst non-
executive directors are thought to be more independent, they may not always result in
more effective corporate governance and may not increase performance.[76] Different
board structures are optimal for different firms. Moreover, the ability of the board to
monitor the firm's executives is a function of its access to information. Executive
directors possess superior knowledge of the decision-making process and therefore
evaluate top management on the basis of the quality of its decisions that lead to financial
performance outcomes, ex ante. It could be argued, therefore, that executive directors
look beyond the financial criteria.[citation needed]
Internal control procedures and internal auditors: Internal control procedures are
policies implemented by an entity's board of directors, audit committee, management,
and other personnel to provide reasonable assurance of the entity achieving its objectives
related to reliable financial reporting, operating efficiency, and compliance with laws and
regulations. Internal auditors are personnel within an organization who test the design
and implementation of the entity's internal control procedures and the reliability of its
financial reporting[citation needed]
Balance of power: The simplest balance of power is very common; require that the
President be a different person from the Treasurer. This application of separation of
power is further developed in companies where separate divisions check and balance
each other's actions. One group may propose company-wide administrative changes,
another group review and can veto the changes, and a third group check that the interests
of people (customers, shareholders, employees) outside the three groups are being
met.[citation needed]
Remuneration: Performance-based remuneration is designed to relate some proportion
of salary to individual performance. It may be in the form of cash or non-cash payments
such as shares and share options, superannuation or other benefits. Such incentive
 schemes, however, are reactive in the sense that they provide no mechanism for
preventing mistakes or opportunistic behavior, and can elicit myopic behavior.[citation needed]
Monitoring by large shareholders and/or monitoring by banks and other large
creditors: Given their large investment in the firm, these stakeholders have the
incentives, combined with the right degree of control and power, to monitor the
management.[77]

In publicly traded U.S. corporations, boards of directors are largely chosen by the President/CEO
and the President/CEO often takes the Chair of the Board position for him/herself (which makes
it much more difficult for the institutional owners to "fire" him/her). The practice of the CEO
also being the Chair of the Board is fairly common in large American corporations.[78]

While this practice is common in the U.S., it is relatively rare elsewhere. In the U.K., successive
codes of best practice have recommended against duality.[citation needed]

External corporate governance controls

External corporate governance controls encompass the controls external stakeholders exercise
over the organization. Examples include:

competition
debt covenants
demand for and assessment of performance information (especially financial statements)
government regulations
managerial labour market
media pressure
takeovers
proxy firms

Financial reporting and the independent auditor

The board of directors has primary responsibility for the corporation's internal and external
financial reporting functions. The Chief Executive Officer and Chief Financial Officer are
crucial participants and boards usually have a high degree of reliance on them for the integrity
and supply of accounting information. They oversee the internal accounting systems, and are
dependent on the corporation's accountants and internal auditors.

Current accounting rules under International Accounting Standards and U.S. GAAP allow
managers some choice in determining the methods of measurement and criteria for recognition
of various financial reporting elements. The potential exercise of this choice to improve apparent
performance increases the information risk for users. Financial reporting fraud, including non-
disclosure and deliberate falsification of values also contributes to users' information risk. To
reduce this risk and to enhance the perceived integrity of financial reports, corporation financial
reports must be audited by an independent external auditor who issues a report that accompanies
the financial statements.

One area of concern is whether the auditing firm acts as both the independent auditor and
management consultant to the firm they are auditing. This may result in a conflict of interest
which places the integrity of financial reports in doubt due to client pressure to appease
management. The power of the corporate client to initiate and terminate management consulting
services and, more fundamentally, to select and dismiss accounting firms contradicts the concept
of an independent auditor. Changes enacted in the United States in the form of the Sarbanes-
Oxley Act (following numerous corporate scandals, culminating with the Enron scandal) prohibit
accounting firms from providing both auditing and management consulting services. Similar
provisions are in place under clause 49 of Standard Listing Agreement in India.

Systemic problems

Demand for information: In order to influence the directors, the shareholders must
combine with others to form a voting group which can pose a real threat of carrying
resolutions or appointing directors at a general meeting.[79]
Monitoring costs: A barrier to shareholders using good information is the cost of
processing it, especially to a small shareholder. The traditional answer to this problem is
the efficient-market hypothesis (in finance, the efficient market hypothesis (EMH) asserts
 that financial markets are efficient), which suggests that the small shareholder will free
ride on the judgments of larger professional investors.[79]
Supply of accounting information: Financial accounts form a crucial link in enabling
providers of finance to monitor directors. Imperfections in the financial reporting process
will cause imperfections in the effectiveness of corporate governance. This should,
ideally, be corrected by the working of the external auditing process.[79]

Issues

Executive pay

Main article: Say on pay

Increasing attention and regulation (as under the Swiss referendum "against corporate Rip-offs"
of 2013) has been brought to executive pay levels since the financial crisis of 20072008.
Research on the relationship between firm performance and executive compensation does not
identify consistent and significant relationships between executives' remuneration and firm
performance. Not all firms experience the same levels of agency conflict, and external and
internal monitoring devices may be more effective for some than for others.[60][80] Some
researchers have found that the largest CEO performance incentives came from ownership of the
firm's shares, while other researchers found that the relationship between share ownership and
firm performance was dependent on the level of ownership. The results suggest that increases in
ownership above 20% cause management to become more entrenched, and less interested in the
welfare of their shareholders.[80]

Some argue that firm performance is positively associated with share option plans and that these
plans direct managers' energies and extend their decision horizons toward the long-term, rather
than the short-term, performance of the company. However, that point of view came under
substantial criticism circa in the wake of various security scandals including mutual fund timing
episodes and, in particular, the backdating of option grants as documented by University of Iowa
academic Erik Lie[81] and reported by James Blander and Charles Forelle of the Wall Street
Journal.[80][82]
Even before the negative influence on public opinion caused by the 2006 backdating scandal, use
of options faced various criticisms. A particularly forceful and long running argument concerned
the interaction of executive options with corporate stock repurchase programs. Numerous
authorities (including U.S. Federal Reserve Board economist Weisbenner) determined options
may be employed in concert with stock buybacks in a manner contrary to shareholder interests.
These authors argued that, in part, corporate stock buybacks for U.S. Standard & Poors 500
companies surged to a $500 billion annual rate in late 2006 because of the effect of options. A
compendium of academic works on the option/buyback issue is included in the study Scandal by
author M. Gumport issued in 2006.

A combination of accounting changes and governance issues led options to become a less
popular means of remuneration as 2006 progressed, and various alternative implementations of
buybacks surfaced to challenge the dominance of "open market" cash buybacks as the preferred
means of implementing a share repurchase plan.

Separation of Chief Executive Officer and Chairman of the Board roles

Shareholders elect a board of directors, who in turn hire a Chief Executive Officer (CEO) to lead
management. The primary responsibility of the board relates to the selection and retention of the
CEO. However, in many U.S. corporations the CEO and Chairman of the Board roles are held by
the same person. This creates an inherent conflict of interest between management and the board.

Critics of combined roles argue the two roles should be separated to avoid the conflict of interest
and more easily enable a poorly performing CEO to be replaced. Warren Buffett wrote in 2014:
"In my service on the boards of nineteen public companies, however, Ive seen how hard it is to
replace a mediocre CEO if that person is also Chairman. (The deed usually gets done, but almost
always very late.)"[83]

Advocates argue that empirical studies do not indicate that separation of the roles improves stock
market performance and that it should be up to shareholders to determine what corporate
governance model is appropriate for the firm.[84]
In 2004, 73.4% of U.S. companies had combined roles; this fell to 57.2% by May 2012. Many
U.S. companies with combined roles have appointed a "Lead Director" to improve independence
of the board from management. German and UK companies have generally split the roles in
nearly 100% of listed companies. Empirical evidence does not indicate one model is superior to
the other in terms of performance. However, one study indicated that poorly performing firms
tend to remove separate CEO's more frequently than when the CEO/Chair roles are combined.[85]