CORPORATE GOVERNANCE

The Head, UG & PG Dept. of Commerce K. L. E. Societys Basavaprabhu Kore Arts, Science and Commerce College, Chikodi 591 201. Dist. Belagavi.

Dr. S. B. HAGARAGI

1 - INTRODUCTION
Meaning and origin of corporate governance. Top corporate and sources of corporate

power. Theories of corporate governance Agency theory sources and cost of agency conflict, Stack holders theory Corporate governance mechanisms internal and external, Corporate governance models US UK model. European model and Japanese Model. Linkage between corporate governance and economic development.

Governance Concept in Ramayana

To

provide

the

maximum

happiness

for

the

maximum number of people for the maximum period,

based on the principles of Dharma righteousness

and moral values.

- Ayodhya Kand

Corporate Governance
What is Governance? Corporate Governance is the application of best management practices, Compliance of law in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stakeholders. -The Institute of Company Secretaries of India
Purpose of corporate governance is to have a demonstrable IMPACT on a corporations FINANCIAL PERFORMANCE.

 'The primary purpose of corporate leadership is to create wealth legally and ethically...' The raison d'tre of every corporate body is to ensure predictability, sustainability and profitability.

 The primary purpose of corporate leadership is to create wealth legally and ethically. This translates to bringing a high level of satisfaction to five constituencies - customers, employees, investors, vendors and the society-atlarge. The raison d'tre of every corporate body is to ensure predictability, sustainability and profitability of revenues year after year.
- N. R. Narayana Murthy Chairman of the Board and Chief Mentor

Some Definitions
Corporate Governance is the system by which companies are directed and controlled
-- Cadbury Report (UK), 1992

to do with Power and Accountability: who exercise power, on behalf of whom, how the exercise of power is controlled.
. Sir Adrian Cadbury, in Reflectiobns on Corporate Governance, Ernest Sykes Memorial Lecture, 1993.

A Canadian Definition
the process and structure..to direct and manage the business and affairs of the corporation with the objective of enhancing shareholder value, which includes ensuring the financial viability of the business.
Where were the Directors? Guidelines for Improved Corporate Governance in Canada, TSE, 1994

An OECD Definition
Corporate governance involves a set of
relationships between a companys management, its board, its shareholders and other stakeholders ..also the structure through which objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.
Preamble to the OECD Principles of Corporate Governance, 2004 OECD = Organization of Economic Co-operation and Development ]

An Indian Definition
fundamental objective of corporate governance is the enhancement of the long-term shareholder value while at the same time protecting the interests of other stakeholders.
SEBI (Kumar Mangalam Birla) Report on Corporate Governance, January, 2000

A Gandhian Definition
Trusteeship obligations inherent in company operations, where assets and resources are pooled and entrusted to the managers for optimal utilisation in the stakeholders interests.

CG it is observed that,
Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment. How do the suppliers of finance get managers to return some of the profits to them? How do they make sure that managers do not steal the capital they supply or invest it in bad projects? How do suppliers of finance control managers?

From the above it tends to focus on simple model

Shareholders elect directors who represent them. Directors vote on key matters and adopt the majority decisions. Decisions are made in a transparent manner so that shareholders and others can hold directors accountable. The company adopts accounting standards to generate the information necessary for directors, investors and other stakeholders to make decisions. The companies policies and practices adhere to applicable national, state and local laws.

Mckinsey & Company Report 2001. Giving new life to the Corporate Governance Reforms Agenda for Emerging

Markets

provided models based on two versions of governance Model -1 The Market Model governance chain Model 2 . The Control Model governance chairn.

What is Corporate Governance?

The Manner in which a Corporation is Run
Achieving its Objectives Transparency of its Operations Accountability & Reporting Good Corporate Citizenship

The Processes & Operating Relationships that Best Achieve Organisational Goals

Driving Forces of CG in India

1)

Unethical Business Practices

Security Scams ---Harshad Mehtha Security Scam Equity allotments at discount rates to the controlling groups Disappearance of Companies (1993-94) - around 4,000 companies with 25,000 crores without starting business Misdeed of Companies Plantation, Sheep rearing, etc.

2)

Impact of Globalization
Integration with Foreign Market Foreign Investors expectations New Business Opportunities --- IT & ITES, BPO etc., New Capital formation FII, FDI

3)

Impact of Privatization
New structure of ownership Multinational Companies

Recent Misconducts: The List Goes On

Computer Associates:
Artificially inflated revenue and improperly rewarded top executives.

CMS Energy
Overstated revenues in 2000 and 2001 thru round trip energy trades?

Dynegy
Transactions to cut taxes and artificially increase cash flow ?

Kmart
Suspected improper accounting for vendor allowances

Lucent Technologies
Adjusted fiscal 2000 revenues by $679 million.

Several more names, respected world-over

AOL Time Warner, Bristol-Myers, Elan,Halliburton, ImClone Systems, Microstrategy, Mirant, Network Associates, Reliant Resources, Vivendi Universal, Xcel Energy, Xerox.

Corporate Mis-Governance

Brief history of corporate governance in India - CII

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

In December 1995, CII set up a task force to design a voluntary code of corporate governance.
The final draft of this code was widely circulated in 1997. In April 1998, the code was released. It was called Desirable Corporate Governance: A Code. Between 1998 and 2000, over 25 leading companies voluntarily followed the code: Bajaj Auto, Hindalco, Infosys, Dr. Reddys Laboratories, Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI

and many others

Brief history of corporate governance in India.. (SEBI)

Following CIIs initiative, the Securities and Exchange Board of India (SEBI) set up a committee under Kumar Mangalam Birla to design a mandatory-cum-recommendatory code for listed companies The Birla Committee Report was approved by SEBI in December 2000 Became mandatory for listed companies through the listing

agreement, and implemented according to a rollout plan:

2000-01: All Group A companies of the BSE or those in the S&P CNX Nifty index 80% of market cap. 2001-02: All companies with paid-up capital of Rs.100 million or more or net worth of Rs.250 million or more. 2002-03: All companies with paid-up capital of Rs.30 million or more

Brief history of corporate governance in India.. (DCA)

Following CII and SEBI, the Department of Company Affairs (DCA) modified the Companies Act, 1956 to incorporate specific corporate governance provisions regarding independent directors and audit committees. In 2001-02, certain accounting standards were modified to further improve financial disclosures. These were: Disclosure of related party transactions. Disclosure of segment income: revenues, profits and capital employed. Deferred tax liabilities or assets. Consolidation of accounts. Initiatives are being taken to (i) account for ESOPs, (ii) further increase disclosures, and (iii) put in place systems that can further strengthen auditors independence.

International scenario
Year
1992 1994 1995 1998 1999

Name of Committee/Body Areas/Aspects Covered

Sir Adrian Cadbury Committee, UK Mervyn E . Kings Committee , South Africa Greenbury Committee , UK Hampel Committee, UK Blue Ribbon Committee, US Financial Aspects of Corporate Governance Corporate Governance Directors Remuneration Combine Code of Best Practices Improving the Effectiveness of Corporate Audit Committees

1999
1999 2003 2003

OECD
CACG Derek Higgs Committee, UK ASX Corporate Governance Council, Australia

Principles of Corporate Governance

Principles for Corporate Governance in Commonwealth Review of role of effectiveness of Non-executive Directors Principles of Good Corporate Governance and Best Practice Recommendations
Rajkumar Adukia 22

Indian scenario
Year Name of Areas/Aspects Covered Committee/Body
Confederation of Indian Industry (CII) Desirable Corporate Governance A Code

1998

1999

Kumar Mangalam Birla Committee

Corporate Governance

2002

Naresh Chandra Committee N. R. Narayana Murthy Committee

Corporate Audit & Governance

2003

Corporate Governance

Rajkumar Adukia

23

Some Governance Models

Finance or the Principal-Agent Model
Markets for Capital, Managerial Talent and Corporate Control, Key determinant In general, profit- maximisation goal is cofunctional with social-welfare-maximisation Shareholders as Residual Claimants have superior control rights

&

Infosys Technologies: The Best among Indian Corporates

As per the Credit Lyonnais Securities Analysis (CLSA), the corporate governance ratings of the Software firms are higher than those of other Indian firms. Infosys, based in Bangalore, is a publicly held, ISO 9001 certified company offering information technology consulting & software services. The software offered include application development, Commerce & Internet Consulting, Software Maintenance. E-

Respected across the country, with very strong systems, high ethical values & a nurturing working atmosphere. Net income of US 1,155 million and revenue of US 4,176 million. At present having US 20.4 billion market capitalization.

Achievements

Voted as the Best Managed Company in Asia.

Biggest exporters of Software. First to follow the US Generally Accepted Accounting Principles before going for Nasdaq listing in 1991. Championed Corporate Governance in India.

Narayana Murthys Global Strategy

1)

Global Delivery Model

Producing where it is most cost effective to produce & selling where it is most profitable to sell.

2)

Moving up the Value Chain

Getting involved in a software development project at the earliest stage of its life cycle.

3)

PSPD Model

Predictability of Revenues, Sustainability of Revenues, Profitability, De-risking.

ICSI National Award for Excellence in Corporate Governance

Best Governed Companies

Concluding Observations
Code of CG should be redesigned to reflect international best practices Stringent enforcement of Law More effective coordination and cooperation between SEBI, DCA

CG mechanism should be flexible and suitable

Overall ethical values in all segments should be promoted for effective accounting, auditing, disclosure and transparent system.

WINNING EMPLOYEES

GROWING INVESTORS

DELIGHTED CUSTOMERS

HAPPY SOCIETY

GROUP-8 Debojit Roy H66 Sritanu Das Mahapatra H57 Abhisek Sahu H3 Krishnakant Pandey H25 Biswajit Ghosh H12

TRUSTED SUPPLIERS

SATISFIED GOVERNMENT AND REGULATORS

Issues in Corporate Governance

1. 2. 3. 4. 5. 6. 7. 8. Distinguishing the roles of board and management. Composition of the board and related issues. Separation of roles of CEO & Chairperson Should the board have committees. Appointment to the board and directors re-election Directors and executives remuneration. Disclosure and audit. Protection of shareholders rights and their expectations. 9. Dialogue with institutional investors. 10. Should investors have a say in making a company Socially responsible

Benefits of Good CG
1. Creation and enhancement of a corporations competitive advantage: 2. Enabling corporation perform efficiently by preventing fraud and malpractices. 3. Providing protection to shareholders Interest. 4. Enabling the valuation of an enterprise: 5. Ensuring compliance of laws and regulations.

Benefits of Good CG.

6. Preserve, protect and promote the interest of all stakeholders 7. Stability and growth to the company 8. Confidence building among all 9. Reduce risk and cost of capital 10. Acquire and promote intellectual property, specific skills, develops human capital.

Benefits of Good CG.

11. Competitive advantage in the financial market 12. Long term relation with stakeholders 13. Ethical icon, enjoys a position of pride /corporate culture 14. Aspiring, potential investors, financers, other business parties are attracted towards ideal corporate governed units. 15. Maximum benefits to all

What is Good Corporate Governance?

A good corporate governance is one which gives maximum satisfaction to maximum number of stakeholders for longer period Obligation to Society at Large: 1. National Interest 2. Political non-alignment 3. Legal compliance 4. Rule of Law 5. Honest and ethical conduct 6. Corporate citizenship 7. Ethical behaviour 8. Social concern 9. Corporate social responsibility

10. Environment friendliness

 Obligation to Society
11. Healthy and safe working conditions 12. Competition 13. Trusteeship

14. Accountability
15. Effectiveness and efficiency

16. Timely responsiveness

17. Corporations should uphold the fair name of the country.

Obligation to Investors:

1. Towards shareholders 2. Measures promoting transparency and informed shareholder participation 3. Transparency 4. Financial reporting and records

Obligation to Employees:

1. 2. 3. 4. 5. 6. 7. 8.

Fair employment practices Equal opportunities employer Encouraging whistle blowing Humane treatment Participation Empowerment Equity and inclusiveness Participative and collaborative environment

Obligation to Employees:

1. 2. 3. 4. 5. 6. 7. 8.

Fair employment practices Equal opportunities employer Encouraging whistle blowing Humane treatment Participation Empowerment Equity and inclusiveness Participative and collaborative environment

Obligation to Customers:

1. Quality of products and services 2. Products at affordable prices 3. Unwavering commitment to customer satisfaction.

Managerial Obligations
1. 2. 3. 4. 5. 6. Protecting companies assets Behavior towards government agencies Control Consensus oriented Gifts and donations Role and Responsibilities of corporate board and directors 7. Direction and management must be distinguished. 8. Managing and whole time directors.

Characteristics of Corporation 1. 2. 3. 4. 5. 6. Incorporated association Artificial legal existence Perpetual existence Common Seal Extensive membership Separation of management from ownership 7. Limited liability 8. Transferability of shares.

 The concept of Governance

The concept of governance implies the process of making quality decisions and their effective implementation in achievement of organizational goals. The concept of governance may be applied from micro units to macro level units. It may be a small business or it may be a MNC. It may be applied in governance from micro unit of Gram Panchayath to national and international level governance. It is the players role in making quality decisions and effective implementation.

Theories of CG.
Agency Theory Stewardship theory Stakeholders theory Sociological theory

Agency Theory
Adam Smith identified the problem of agency cost. Managerial negligence and profusion is the basic problem By virtue of ownership shareholders as principals predetermine their objectives. Select directors either directly or indirectly as their agent. The directors are expected to show their performance in achieving principals objectives. But in practice it does happen so. The Agent directors/ managers always found in variance from the predetermined objectives. Directors try to build their own image by diversifying funds which may increase the value of shares in long run. Individual shareholders, widely scattered shareholders are not able to counteract the performance of the directors. The mismatch of objectives is called the agency problem & the cost involved in such diversified objectives is called agency cost. The agency theory therefore, argues for minimizing the agency cost by effective monitoring, corrective system which consolidate the objectives of two players, shareholders and directors as well.

Agency Theory.
The main thrust of agency theory is that the wide spread share holders are the owner principals and directors are the agents. It focus on the consolidation of objectives of both shareholders should get maximum return on their investment and the directors should get appropriate compensation for their efforts. The agency theory suggest to devise a mechanism which avoids agency loss on one hand and gives rich returns to shareholders. The incentive schemes includes allocation of shares to directors at confessional rates, high rates of commission for the returns given to shareholders. A device protecting the two interest certainly brings expected return and value their holdings in the long run.

Problems with Agency Theory.

1. Two main problems: Degree of delegation: Shareholders are not in a position to pre determine what to delegate and what not. Simply under the notion that directors misuse their powers. The agency theory suggest to avoid this abuse. It is very difficult to practice. Investor board relationship: Lack of awareness and lack of information. In big corporation it is of great difficult task, shareholders are not in position to predetermine their targets.

2.

3. 4.

Equity shareholders have very poor control over board. The board should have self regulation for effective management of organization. 5. Two broad mechanisms to improve performance Fair and accurate financial disclosure Efficient and independent board of directors.

Stewardship Theory Trustworthiness of management The theory believes in, that the managers are not self centered rather they are trustworthy, reputed whose motives are based on their principles. Deserves high compensation. Stewardship is always aligned towards organizational goals. Controls may act counter productive. Great responsibility lies on board to shareholder to check and ensure the high order of corporate performance.

Stewardship Theory Trustworthiness of management Conflicts: Risk propensity of principles. It is very difficult to get support from all executives and investors. It is not new one. It was their even in our mythology. Mahatma Gandhi too propounded the theory of trusteeship.

Difference between Agency and Stewardship theory.

1.Status: The agency theory assumes that the management is agents of owners, whereas under stewardship theory they act as stewards. 2. Approach is materialistic and sociological and psychological 3. Behavioral approach: Under agency is individualistic, opportunistic and self servicing while it is collectivistic, proorganizational, and trustworthy 4. Interest: Diversified interest and principles among the managers under agency theory, where as convergence in the other theory. 5. Motivations own objectives organizational objectives. 6. Role of manager is to monitor and control facilitate and empower the people. 7. Owners attitude: Under agency theory it risk avoiding managing it in other. 8. Relationship: control based relation based.

Dif. betn. Agency and Stewardship theory based on psychological mechanisms. Agency Theory Stewardship theory

1. Motivation revolves around lower order and extrinsic needs. 2. Social comparison between compatriots 3. Little attachment to company 4.Powers rest with company

Motivation revolves higher order and intrinsic needs.

Social comparison between principals

3. Great attachment to company 4.Powers rest with personnel.

Shareholders Versus Stakeholder Approach Shareholders approach

1. It argues that corporates have limited responsibility limited to compliance to laws and maximizing shareholders wealth. Focusing on shareholders interest maximize societal interest. It is based on the assumption of perfect market. It holds good as long as the perfect market prevails and fails soon or after some time. The assumption that it maximize society

Stakeholders
It argues that those responsible for corporate governance have responsibilities not only to shareholders but also to others.

Stakeholder Theory
The theory dates back to 1930. It combines the economics, behavioral science, business ethics and stakeholders concept. The theory considers the firm as a input-output model by explicitly adding all interest groups employees, dealers, government and the society at large to the corporate mix. It is based on number of normative theories like ethics of care, fiduciary relationship, social contact theory, theory of stakeholders etc,. It argues on the responsibility to non-shareholders groups

Criticisms of Stakeholder Theory

Wooly minded liberalism it is not applicable in practice by corporations. No empirical evidences found in practice linking the stakeholders and corporate performance. There are number of theoretical arguments supporting stakeholders interest. Managers accomplish corporate performance drawing stakeholders as resource and are expected return their dues in turn. The major problem is Who are the genuine stakeholders? Any one negatively affected are stakeholders. employees, customers, suppliers, government, the community, pressure groups, shareholders the responsibility is on directors It is better to categories as primary and secondary stakeholders. It is quite possible that serving too many may result in ignoring the main stakeholders.

Criticism of Stakeholder Theory

Clive Smallman Relating to the range and diversity of stakeholders It is Superfluous that the intent of the theory can be achieved by depending on management to give social benefit where it is required. It gives scope for corruption and chaos. It gives agent to divert resource from one another.

Sociological Theory
The sociological theory focus on the compostion of board and the implications for power and wealth distribution in society. Interlocking of directorship and concentration of directorship in the hands of a privileged class are viewed as major challenges to equity and social progress. The theory argues for board composition, financial reporting, disclosure and auditing are necessary mechanisms to promote equity and fairness in society.

Corporate Governance Systems

1.The Anglo American Model

2.The German Model

3.The Japanese Model 4.Indian Model of Governance.

The Anglo- American Model

1.The Anglo American Model

The German Model

The German Model

The Japanese

1.The Japanese Model

Indian Model of Governance.

Good Corporate Governance.

Good corporate governance is the glue that holds together responsible business practices, which ensures

positive

workplace

management,

marketplace

responsibility, environmental stewardship, community engagement, and sustained financial performance. This is even more true now as we work worldwide to restore confidence and promote economic growth. Thierry buchs, head, private sector development division of switzerlands state secretariat for economic affairs (seco)