Corporate Governance 1

Corporate Governance Session Coverage

Who are stake holders? What is Corporate Governance? Compelling need for Corporate Governance? Sir Adrian Cadburys Views and Definitions?

Corporate Governance 2 Perspectives

Who are stake holders? Individuals and groups who can effect and are effected by the strategic outcomes achieved by the company and who have claims or expectations from the Company. Wider / Comprehensive View Company as a Corporate Citizen. Wider focus to include interests / claims of all stake holders such as creditors, employees, customers, suppliers, governments, unions, competitors, local communities and the general public in addition to shareholders. Other View Issues emanating from Agency Relationship, due to separation of Ownership and Management Focus primarily on Shareholders interests / claims.

Corporate Governance

Wider / Comprehensive View Company as a Corporate Citizen

Corporate Governance Wider View

Company as a Corporate Citizen.
Need to act responsibly (like an ordinary citizen ) in society at large Follow rules and regulations, which govern a Company and its businesses and operations:
Company law Tax Laws Labor laws ( Minimum wages, safety, working hours and conditions) Quality Regulations e.g. (Prevention of Foods Adulteration Act)(PFA) Environmental laws and regulations (Pollution Control laws) Consumer Protection rules and regulations etc.

Fair dealings with stake holders Balancing claims of stakeholders (some time conflicting)

Stake holders & Nature of Claims

Stake Holder Stockholders Nature of Claims / expectations Participation in distribution of profits Additional stock offerings Disposal of assets on liquidation Voting rights Inspection of company books Transfer of stocks Election of board of directors Other specific rights as per contract with the company. Legal protection of interest payments Return of principal Security of pledged assets Relative priority in event of liquidation Specific rights and conditions as per agreement (such as in case of default) Economic, social and psychological satisfaction at work place Freedom from arbitrary behavior of employers Share in fringe benefits Freedom to join unions / collective bargaining Terms of employment contract Adequate working conditions

Creditors

Employees

Stake holders & Nature of Claims

Stake Holder Customers Nature of Claims / expectations Product and service quality Technical data provided with products Guarantees / Warranties Spares part support during life of product R&D and product improvements Facilitation of Credit Continuing source of business Timely payment (credit obligations) Professional relationship in contracting for purchasing and receiving of goods and services. Taxes (income, VAT, Service Tax etc) Fair and free competition Discharge of legal obligations Monopoly and Cartelization in pricing Hoarding & black marketing (in time of shortages) Recognition as negotiating agent for employees Role / participation of union in management

Suppliers

Governments

Unions

Stake holders & Nature of Claims

Stake Holder Competitors Local Communities Nature of Claims / expectations Observation of norms for competitive conduct Business statesmanship on the part of peers Place of productive and healthful employment in community Participation of company officials in community affairs Provision of regular employment Fair play Reasonable portion of purchases made from local community Interest in and support of local government Support of cultural and charitable projects Participation in and contribution to society as a whole Reciprocal understanding with Government & Society Assumption of fair share of burden of government and society Fair price of products and investment in R&D to improve products

The general Public

Corporate Governance Wider View

Company as a Corporate Citizen Related Issues
Corporate Social Responsibility (CSR) The concept that business has a duty to serve society in general as well as the financial interest of stock holders. Business Ethics and Values Conduct of business and activities with in accepted social norms and values and laws governing the business.

Corporate Governance Wider View

Challenges for Company and its Managers - CSR
Identifying Stakeholders Understanding their claims and expectations Reconciliation and prioritizing claims and expectations Coordination with Companys Vision, Mission and Business Objectives Evaluating costs & benefits of CSR

Ethics & Values Ethics & Values

Clearly defining right & wrong (Important Leadership role) Conviction to follow thorough and implement Economic Costs / Opportunities & business loss

Corporate Social Responsibility (CSR) Voluntary Moves

P&G
Shiksha is a part of P&Gs global cause credo P&G Live, Learn & Thrive to Support Children in need the world over. P&G supported Child education in India, by contributing Rs. 1 Cr to CRY. + Each purchase of a large pack of either Tide, Ariel, Pantene, Head & Shoulders, Rejoice, Vicks VapoRub or Pampers during April, - June, 2005. supported one days education of one child per pack purchased.

India Infoline (Financial Services & Broking)

Initiated FLAME ( Financial Literacy Agenda for Mass Empowerment. Includes publications, work shops for adults and school children, mass media advertising and help desk. Committed Rs. 25 Cr.

Corporate Social Responsibility (CSR) Voluntary Moves

ITC (paper Business)
With forestry, ITC has linked CSR to biz (The Financial Express 07 Sep 2011) ITC has created more than 1.15 lakh hectare of forest cover through social and farm-forestry initiatives in the last one decade. Sources all its wood requirements from these forests. How do you deal with farmers on growing Eucalyptus trees? ITC invested (estimated to be Rs. 2,000 crore) initially. After four years, started to buy back the wood pulp. Farmers kept aside a portion of their earnings in a separate community fund for development of village infrastructure like roads and schools. With the rest, the farmers try to buy more land. The key is that we have linked our Corporate Social Responsibility (CSR) to our business. It has become sustainable because, it is linked to business. Its a win-win for the business and farmers. As part of CSR, we are giving the saplings free to poor and tribal farmers. Out of 1.15-lakh hectare, about 20,000 hectare would be social forestry and rest would be farm forestry.

Business Ethics & Values Voluntary Moves

TATA Group Code of Conduct* (2008) Enunciates the values, which govern the conduct of activities of Companies and employees. 25 Clauses covering: 1. National Interest 2. Financial Reporting and records 3. Competition 4. Equal Opportunity employer 5. Gifts and donations 6. Government Agencies 7. Political Non alignment 8. Health, safety and environment 9. Quality Products & services 10. Corporate Citizenship 11. Cooperation among Tata Companies 12. Public representation of Company/Group 13. Third Party representation 14. Use of the Tata brand 15. Group Policies 16. Shareholders 17. Ethical conduct 18. Regulatory Compliance 19. Concurrent employment 20. Conflict of interest 21. Securities transactions and confidential information 22.Protecting Company assets 23. Citizenship 24. Integrity of data furnished 25. Reporting concerns

Business Ethics & Values Voluntary Moves

Founding Principles ( Long & Rich heritage of Tata Group) Since its formation by Jamsetji Tata in 1868, the Tata Group has consistently been run according to the principle that the wealth it creates should be returned to society. Jamsetji Tata believed that the health and welfare of the employees are the sure foundation of our prosperity. The Groups stated aim is to improve the quality of life of the communities we serve. This is demonstrated constantly by its businesses through their contributions to the communities of which they are part now in over 80 countries around the world. Two thirds of the equity of Tata Groups holding company, Tata Sons, is held by philanthropic trusts. Over the decades, these trusts have benefited a vast range of medical, academic, social and cultural projects and institutions. Tata Steel was one of the main foundations on which this pioneering industrial group has continued to grow around the world.

Business Ethics & Values Voluntary Moves

Our Values The Tata Group has always been driven by five core values: Integrity. We must conduct our business fairly, with honesty and transparency. Everything we do must stand the test of public scrutiny. Understanding. We must be caring, show respect, compassion and humanity for our colleagues and customers around the world, and always work for the benefit of the communities we serve. Excellence. We must constantly strive to achieve the highest possible standards in our day-to-day work and in the quality of the goods and services we provide. Unity. We must work cohesively with our colleagues across the group and with our customers and partners around the world, building strong relationships based on tolerance, understanding and mutual cooperation. Responsibility. We must be responsible and responsive to the countries, communities and environments in which we work, always ensuring that what comes from the people goes back to the people many times over.

Business Ethics & Values Voluntary Moves

Vision We will be a globally respected corporation. Mission To achieve our objectives in an environment of fairness, honesty, and courtesy towards our clients, employees, vendors and society at large.

Business Ethics & Values Voluntary Moves

Infosys Technologies Code of Conduct & Ethics Every employee has to read and sign this document. Excerpts:

This code of conduct is intended to establish and clarify the standards of for behavior in the organization. Infosys competes to win, but only within the framework of integrity, transparency and compliance with all applicable laws and regulations. and ensures compliance with legal requirements including with .. Sarbanes-Oxley Act of 2002 and US Securities and Exchange Commission Act (SEC) Clause 49 of the Listing Agreement with NSE and BSE and Rule 5610 of Nasdaq Global Select Market. Designed to deter wrong doinghandling of actual or apparent conflicts of interest between personal and professional relationships.compliance

Corporate Governance

Other View

Issues emanating from Agency Relationship

Agency Relationship Theory

Traditionally
Business managed by founder-owners and their descendents Ownership & control resided in the same persons

With businesses becoming larger and complex

Management and control shifted to professional mangers (Owner family could not supply all the management talent) Ownership dispersed among thousands of stock holders, with no involvement in day to day business. (Need to tap out side sources for capital)

Agency Relationship Theory

Agency Relationship An agency relationship exits, when one or more person (principal or principals) hire another person or persons( the agent or agents) as decision making specialists to perform a service. An agency relationship when one party delegates decision making responsibility to a second party for compensation. Thus, separation between owners and managers, and the working arrangement which emerges, creates an agency relationship.

Agency Relationship
Conflict of interests between PRINCIPAL(S) & AGENT(S) Principal and agent have different interests and goals. Shareholders lack direct control of large publicly traded companies. Chances for managerial (agent) opportunism. ( When agents pursue self interest, over the interest of the principal) Top Management may want to maximize their personal welfare and minimize personal risk.

Agency Relationship Theory

Conflict of interests between PRINCIPAL(S) & AGENT(S) Case in point 1 Agents may seek Product diversification:

To minimize risk of bad performance and job loss, lower compensation and managerial reputation. To make companys operation more complex, to increase their compensation To make companys operation larger to increase their compensation

Owners may prefer diversification only up to an optimal level to balance risk and reward. 2 Agents may seek to reinvest free cash flows back in to business Owners may prefer free cash flows, given out as dividend.

Agency Relationship Theory

Conflict of interests between PRINCIPAL(S) & AGENT(S) Hence, need to keep control & checks on the activities, actions and decisions of the agents. The mechanisms' and processes used to keep these controls and checks is called Corporate Governance.

Stewardship Theory
A contra view on Agency Theory Agency Theory Premise Assumes Managers to be self centered and irresponsible and interested in pursuing their interests only. Stewards theory a positive view on relationship. Assumes that Managers are responsible Stewards whose interests are aligned with that of owners. This theory recommends supporting and empowering managers rather than to check and control them.

Agency Relationship
Factors contributing to enhanced awareness and need for corporate governance. Frauds / Scams, misstatements of accounts Protection of Minority Shareholders Ownership Concentration The growing influence of Institutional Investors / Pension Funds Global Cross border Capital flows
Others 20%

Insurance 8%

Promotors 48%

DIIs 6%

FIIs 18%

Agency Relationship
Cases when agents failed to keep up to the faith reposed on them. Xerox
Said in June 28, 2002, that it would restate 5 years of financial results to reclassify more than $6 billion in revenues. In April, it settled SEC charges that it used accounting tricks to defraud investors, agreeing to pay a $ 10 mn fine.

Worldcom
The nations second largest telecom company filed for nations biggest bankruptsy on July 2, 2002. It admitted it hid $3.85 billion in expenses, allowing it to post a net income of US $ 1.38 billion. Its CEO was fired and began cutting 17000 jobs, more than 20% of its workforce.

Adelphia Communications
On July 24, 2002, John Rigas, the 77 year old founder of company was arrested along with his two sons and accused of looting the company. SEC charged them for concealment of billions of dollars in liabilities, falsifying statistics to meet wall street expectations.

Agency Relationship
Cases when agents failed to keep up to the faith reposed on them. Maxwell Communications, UK (Media Empire) June 2001
First came the startling revelation that the company was broke. Then came the discovery that Maxwell had pledged the same assets as collateral for various loans. The most explosive bombshell came when it was revealed that the media magnate had secretly -- and improperly -- "borrowed" $767 million from worker pension funds at the two public concerns under his control. The money is missing and unaccounted for. Company went under administration.

The Enron scandal

Revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company. and the dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world. In addition to being the largest bankruptcy in American history at that time, Enron was attributed as the biggest audit failure. Shareholders lost nearly $11 billion. Share fell from $ 90 to $1.

Agency Relationship
Cases when agents failed to keep up to the faith reposed on them. Satyam (2009)
Satyam's CEO, Ramalingam Raju, took responsibility for broad accounting improprieties that overstated the company's revenues and profits and reported a cash holding of approximately $1.04 billion that simply did not exist. Raju sent to Jail. Auditor PwC. Role of Auditors questioned. Company subsequently taken over by Mahindra.

The LIC HF (Nov 2010)

India's reputation as a place to do business took another hit after the scandal The scandal is one of the biggest to taint India, potentially harming the image of Asia's third-largest economy as destination for foreign investors

Sir Adrian Cadbury Committee Report United Kingdom

Sir Cadbury was a member of the Cadbury family, which founded chocolate conglomerate. Was Chairman of Cadbury Ltd from 1965 to 1989. His contributions in the field of Corporate Governance are globally recognized.

Sir Adrian Cadbury Committee Report

Committee set up in May 1991, by Financial Reporting Council, London Stock Exchange and Accountancy Profession , in the U.K. Committee was set up in the back ground of: Concerns over standards of financial reporting and accountability Declining confidence on Company reports Heightened by BCCI and Maxwell Cases Controversies over Directors pay and remuneration Report - The Financial aspects of Corporate Governance December,1 , 1992 Pioneering work. A landmark Foundation of Corporate Governance Code in OECD, IMF, World Banks and in countries across the globe.

Sir Adrian Cadbury Committee Report

Definition Corporate Governance (Cadbury Report) Corporate governance is the system by which companies are directed and controlled. Broad Framework Boards of directors are responsible for the Governance of their companies. The shareholders role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate corporate governance in place. T h e responsibilities of the board include setting the companys strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The boards actions are subject to laws, regulations and the shareholders in general meeting.

Sir Adrian Cadbury Committee Report - Setting

Economy depends on the drive and efficiency of its companies. The effectiveness with which their boards discharge their responsibilities, determines Britains competitive position. They must be free to drive their companies forward But exercise that freedom within a frame work of effective accountability. This is the essence of any system of good corporate governance

Sir Adrian Cadbury Committee Report - Setting

Focus of recommendations:
Control and reporting functions of Boards Role of Auditors

Code of Best Practices prescribed for Companies To reinforce trust in the corporate system and help gain confidence of investors Approach: Based on compliance with a voluntary code, coupled with disclosures. Areas of non compliance to be highlighted and reviewed by the auditors. Implementation through listing agreements between London Stock Exchange and the Company.

Sir Adrian Cadbury Committee Report

Focal Issues
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

Spirit of compliance Role & Responsibilities of Board of Directors / Chairman Role of shareholders Role of Independent Auditor Board Structure and Procedures Internal Audit Board Remuneration Financial Reporting Annual Audit Independence of Audit Firms Going Concern Frauds and illegal acts by Company

Sir Adrian Cadbury Committee Report

Spirit of Compliance
To be done in spirit and not just checking boxes. To be supported by effective accounting and reporting structures.

Sir Adrian Cadbury Committee Report

Company Boards
Each Public Company to be headed by an effective Board. Board acts as stewards of shareholders Board comprising of: Executive Directors with intimate knowledge of the business Out side, Non Executive Directors, who can bring a broader view Under a Chairman, who accepts the duties & responsibilities

Boards role in corporate governance is fundamental To provide leadership and checks and balances for effective governance Board to be collectively responsible to share holders. Share holders responsible for electing members of the Board

Sir Adrian Cadbury Committee Report

Company Boards Role of Independent Directors
Review performance of the board and executives To take lead where potential conflicts of interest arise : Between Whole time directors and the company Between Executives and the company Independent directors to be of high caliber Of special importance and high weight to corporate governance Independent judgment on issues of strategy, performance review, key appointments and standards of compliance No financial benefits except sitting fee and share holding No pension or stock options Appointment for specific period

Sir Adrian Cadbury Committee Report

Company Boards Role of Chairman
Responsible for effective working of the board Balance of membership, subject to approval of board and shareholders Ensure that executive and non executive directors play their roles Keep a distance from day to day running of business (objective view) Information sharing with non executive directors In principle, Chairman should be separate from Chief Executive. (Concentration of Power/ Operations bias)

Sir Adrian Cadbury Committee Report

Company Boards Structure and Procedures
Recognize importance of finance Designate one director to sign the accounts on behalf of the board Hold regular scheduled meetings. Strategic matters must be approved by the board:
Acquisition and disposal of assets of the company & its important subs. Investments, Capital Projects, Authority levels, treasury policies and risk management

To draw codes of ethics or standards of business practice and publish the same, both internally and externally Report also attempts to clarify directors responsibilities and draw boundaries between role of directors and independent auditor. Board to seek guidance and inputs from Company Secretary Board also responsible for frauds and illegal acts of the company. Boards to establish their legal duties and ensure compliance

Sir Adrian Cadbury Committee Report

Company Boards Remunerations / Nominations
Share holders have aright to know Disclosure of directors total emoluments, Chairmans and the highest paid directors remuneration Break up of salary and performance linked remuneration to be disclosed Criteria for performance evaluation to be disclosed Remuneration Committee, comprising of non executive directors to recommend directors remuneration Nomination committee to recommend appointment of directors.

Sir Adrian Cadbury Committee Report

Role of Independent Auditor
The role of the auditors is to provide the shareholders with an external and objective check on directors financial report. Audit program be able to confirm that report has been prepared in accordance with generally acceptable accounting policies and standards. To confirm that company has adequate system of internal controls. To comment on shortfalls / inadequacies in the system. To comment on non compliance To comment that company is a going concern To report suspected fraud to audit committee Limitations Reliance on management submissions and scope of audit, they may not be able to discover all frauds, particularly when management or board is a party to it. Audit firm does not prepare the accounts.

Sir Adrian Cadbury Committee Report

Role of Company Secretary
Qualified Company Secretary Ensures following of Board procedures Guides the board on their responsibilities and how these are to be discharged To administer, attend and prepare minutes of board proceedings.

Sir Adrian Cadbury Committee Report

Financial Report
Should represent true and fair picture To have highest level of disclosures Need to strength reporting standards To contain explanations on factors likely to influence business Need for more frequent reporting recognized. However, kept at half year and annual report.

Sir Adrian Cadbury Committee Report

Annual Audit
Corner stone of corporate governance Necessary to provide an external and objective view Need to ensure objectivity and effectiveness of audit Audit firm to retain a critical detachment Emphasis on development of effective accounting standards Auditor to have access to audit committee

Sir Adrian Cadbury Committee Report

Quarantining audit firms from other services
Recognized that audit firms should not provide other services, such as consultancy. E.g. financial restructuring, transaction services etc. However, not recommended in the report. Recommended that audit and any non audit fee paid to the auditor should be disclosed.

Change in audit firm Periodic change in audit firm was considered, but not recommended. Periodic rotation of change in partner in charge was recommended.

Sir Adrian Cadbury Committee Report

Role of Audit Committee
Formation of audit committee Comprising of minimum 3 non executive directors Majority of directors should be independent To recommend appointment of external auditors Review Accounts, before they are presented to Board. Internal Controls Regular monitoring of key controls and procedures Internal Auditor to have un restricted access to the Chairman and Audit Committee. Directors to make a statement in the report on the effectiveness of internal control systems External auditors to confirm that adequate controls are in place.