corporate governance

1. CORPORATE GOVERNANCE
AND
BUSINESS ETHICS

2. Corporate Governance
Module 1

3. We will study ………
• Its Importance
• Principles of CG
• The Organization for Economic Cooperation
and Development (OECD) Principles of CG
• Theories of CG:- Agency and Stewardship
Theory
• Models of CG around the world
• Need for good CG
• Present Scenario

4. Ramalinga Raju

5. Subruto Roy
SAHARA

6. Vijay Malya

7. Corporate means
• relating to a large company or group.
•The action or manner of governing a state,
organization, etc.
•Rule; control
Governance means

8. CORPORATE GOVERNANCE means
• Corporate governance is the system of rules,
practices and processes by which a company is
directed and controlled.
• Corporate governance essentially involves
balancing the interests of a company's many
stakeholders, such as shareholders,
management, customers, suppliers, financiers,
government and the community.

9. Why Corporate Governance?
• Better access to external finance
• Lower costs of capital – interest rates on
loans
• Improved company performance –
sustainability
• Higher firm valuation and share
performance
• Reduced risk of corporate crisis and
scandals

10. 10
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 exercises power,
on behalf of whom, how the exercise
of power is controlled.”
• Sir Adrian Cadbury, in Reflections on
Corporate Governance, Ernest Sykes
Memorial Lecture, 1993

11. OECD
• The Organization for Economic Cooperation
and Development (OECD) is a group of 34
member countries that discuss and develop
economic and social policy.
• OECD members are democratic countries that
support free market economies.

12. 12
An OECD Definition
• “Corporate governance involves a set of
relationships between a company’s
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

13. 13
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

14. Importance of CG
• The increasing scale, complexity and international
activities of major corporate groups
• Greater power and activities of institutional investors,
• Hostile (unsympathetic) activities of predator (looter)
companies
• Renewed responsibilities and powers of the regulatory
authorities due to company law amendment
(modification) and new securities trading regulations in
various parts of the world
• Recent disclosures and rethinking on insider trading
(the illegal practice of trading on the stock
exchange to one's own advantage through
having access to confidential information.)

15. Importance of CG
• Demand for more checks and balances at board level
and demand for separation of CEO’s function from
that of the chairman of the board
• Calls for greater accountability (responsibility) by
companies and their boards
• Changes in the world of international audit
profession
• Developments in accounting standards and
corporate regulation
• Emergence of newly corporatized and privatized
corporate entities
• An increasingly litigious (ready to take legal action to
settle disputes) environment.

16. Principles of Corporate Governance
• Sustainable development of all stake holders- to
ensure growth of all individuals associated with or
effected by the enterprise on sustainable basis
• Effective management and distribution of wealth –
to ensue that enterprise creates maximum wealth and
judiciously uses the wealth so created for providing
maximum benefits to all stake holders and enhancing
its wealth creation capabilities to maintain
sustainability

17. • Discharge of social responsibility- to ensure that
enterprise is acceptable to the society in which it is
functioning
• Application of best management practices- to ensure
excellence in functioning of enterprise and optimum
creation of wealth on sustainable basis
• Compliance of law in letter & spirit- to ensure value
enhancement for all stakeholders guaranteed by the law
for maintaining socio-economic balance
• Adherence to ethical standards- to ensure integrity,
transparency, independence and accountability in dealings
with all stakeholders

18. Four Pillars of Corporate
Governance
• Accountability
• Fairness
• Transparency
• Independence

19. Accountability
• Ensure that management is accountable to
the Board
• Ensure that the Board is accountable to
shareholders

20. Fairness
• Protect Shareholders rights
• Treat all shareholders including minorities, equitably
• Provide effective redress for violations

21. Transparency
Ensure timely, accurate disclosure on all material
matters, including the financial situation,
performance, ownership and corporate governance

22. Independence
• Procedures and structures are in place so as to
minimise, or avoid completely conflicts of interest
• Independent Directors and Advisers i.e. free from the
influence of others

23. 23
Theories of Corporate Governance
• Agency theory
• Stewardship theory

24. Theories of Corporate Governance
24
• Agency theory
• The economic relationship that arises between two
individuals
• Principal
• Agent
• Three conditions to operate relationship
• The agent has the freedom to choose between
various course of actions
• Actions of agent influence their own growth as
well as the principals
• Difficult for the principal to observe the actions
of the agent as information is not enough

25. Corporate Governance
25

26. 26
Theories of Corporate Governance
• Agency theory
• The supplier of finance need return on their investment
• Principal needs assurance that agent does not steal the
investment
• Principal needs to control the agent
• Control is dispersed and less effective
• Problems with agency theory
• Utility maximizer (agent will not act in the best interest of
the principal
• Unequal sharing of information
• Element of risk (judge performance based on annual
reports )
Corporate Governance

27. 27
Theories of Corporate Governance (contd)
• Agency theory
• Agency loss
• How to reduce it
• Focuses on quantitative and not qualitative aspect
• To overcome the problems mentioned above:
• Transparent accounting practices and disclosure
• Non executive independent directors
Corporate Governance

28. Theories of Corporate Governance
28
Stewardship Theory
• Built on premise that directors will fulfill their duties towards the
shareholders
• Assumes that human are good and directors are trustworthy
• Directors are stewards whose motives are aligned with the
objectives of the principles
• Directors take in to account the stake holders but after the
shareholders
• Strengths
• Trust is high and stewards are motivated
• New ideas and growth
• More liberal and believes in empowerment
• Weaknesses
• Causal relationship between governance and performance
cannot be assessed using this theory

29. Criteria for a good Director
– Willing to challenge management
– Has special expertise
– Available outside of meetings
– Expertise on global business issues
– Understands key firm’s technologies
– Brings valuable external contacts
– Knowledge of firm’s industry
– High visibility in their field
– Accomplished in representing the firm to
stakeholders

30. MODELS OF CORPORATE GOVERNANCE
• Corporate governance systems vary around the world. This because
in some cases, corporate governance focuses on link between a
shareholder and company, some on formal board structures and board
practices and yet others on social responsibilities of corporations.
• However, basically, corporate governance is seen as the process by
which organizations are run.
• There is no one model of corporate governance which is universally
acceptable as each model has its own advantages and disadvantages.
• Following are some of the models of corporate governance:

31. Anglo-American Model
• This model is also called an ‘Anglo-Saxon model’ and is used
as basis of corporate governance in U.S.A, U.K, Canada,
Australia, and some common wealth countries.
•The shareholders appoint directors who in turn appoint the
managers to manage the business. Thus there is separation of
ownership and control.

32. Anglo-American Model
• The board usually consist of executive directors and few
independent directors. The board often has limited
ownership stakes in the company. Moreover, a single
individual holds both the position of CEO and chairman of the
board.
• This system (model) relies on effective communication
between shareholders, board and management with all
important decisions taken after getting approval of
shareholders (by voting).

33. The-Anglo American Model
Shareholders
Board of Directors
(Supervisor) Stakeholders
Officers
(Manager)
Company
Regulatory/Leg
al system
Creditors
Elect
Appoints and
supervises
Manage
Monitors
&
regulates

34. German Model
• This is also called as 2 tier board model as there are 2 boards viz.
The supervisory board and the management board. It is used in
countries like Germany, Holland, France, etc.
• Usually a large majority of shareholders are banks and financial
institutions. The shareholder can appoint only 50% of members to
constitute the supervisory board. The rest is appointed by employees
and labour unions.

35. The German Model
Supervisory Board
Management Board
(including Labour
Relation Board)
Company
Shareholder
Employees and
Labour unions
Appoint 50%
Appoint -50%
Appoint and
supervises
Manage
Own

36. Japanese Model
• This model is also called as the business network model, usually
shareholders are banks/financial institutions, large family
shareholders, corporate with cross-shareholding.
• There is supervisory board which is made up of board of directors
and a president, who are jointly appointed by shareholder and
banks/financial institutions. This is rejection of the Japanese
‘keiretsu’- a form of cultural relationship among family controlled
corporate and groups of complex interlocking business relationship,
where cross shareholding is common most of the directors are heads
of different divisions of the company. Outside director or
independent directors are rarely found of the board.

37. The Japanese Model
Executive Management
(Primarily Board of
Directors)
President
Supervisory Board
(including President)
Company
Main bank
Shareholders
Appoint
Provides managers, monitors
and acts in emergencies
Provides
managers
Ratifies the President’s decision
Consults
Managers
Provides Loan
Owns
Own

38. Indian model
• The model of corporate governances found in India is a mix of the
Anglo-American and German models. This is because in India, there
are three types of Corporation viz. private companies, public
companies and public sectors undertakings (which includes statutory
companies, government companies, banks and other kinds of
financial institutions).
• Each of these corporation have a distinct pattern of shareholding.
For e.g. In case of companies, the promoter and his family have
almost complete control over the company. They depend less on
outside equity capital. Hence in private companies the German
model of corporate governance is followed.

39. Anglo-American model
• This model is also called an ‘Anglo-Saxon model’ and is used as
basis of corporate governance in U.S.A, U.K, Canada, Australia, and
some common wealth countries.
• The shareholders appoint directors who in turn appoint the
managers to manage the business. Thus there is separation of
ownership and control.
• Board - Executive directors and few independent directors.

40. • This model relies on effective communication
between shareholders, board and management
with all important decisions taken after getting
approval of shareholders (by voting).
• There is only less control on foreign ownership and
portfolio investment.
• The firms are allowed to buyback their own shares
in open market operations.

41. German model
• This is also called as 2 TIER BOARD MODEL as there are 2 boards viz.
The SUPERVISORY BOARD and the MANAGEMENT BOARD.
• It is used in countries like Germany, Holland, France, etc.
• Usually a large majority of shareholders are banks and financial
institutions.
• The shareholder can appoint only 50% of members to constitute the
supervisory board. The rest is appointed by employees and labour
unions.

42. Japanese model
• This model is also called as the business network model.
• usually shareholders are banks/financial institutions, large family
shareholders, corporate with cross-shareholding.
• There is supervisory board which is made up of board of directors
and a president, who are jointly appointed by shareholder and
banks/financial institutions.
• most of the directors are heads of different divisions of the company
• Outside director or independent directors are rarely found of the
board.

43. Indian model
• Indian model =Anglo-American + German models.
• This is because in India, there are three types of Corporation viz.
private companies, public companies and public sectors
undertakings.
• Each of these corporation have a distinct pattern of shareholding.
• e.g. In case of private companies, the promoter and his family have
almost complete control over the company. They depend less on
outside equity capital. Hence in private companies the German
model of corporate governance is followed.
• Diluted principal-agent relationship
• Need for more additional protective measures by market regulator,
ie. SEBI

44. • In December 1995, CII set up a task force to design
a voluntary Code of Corporate Governance focused
on listed companies.
• Following CII’s initiative, 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.

45. • SEBI’s Board, in its meeting held on January 25,
2000, considered the recommendations of the
Committee and decided to make the
amendments to the listing agreement on
February 21, 2000 for incorporating the
recommendations of the committee by inserting
a new clause in the Equity Listing Agreement –
i.e. Clause 49.

46. • Clause 49
Clause 49 of the Equity Listing Agreement consists of mandatory as well
as nonmandatory provisions.
• Mandatory provisions comprises of the following:
o Composition of Board and its procedure - frequency of meeting, number
independent directors, code of conduct for Board of directors and senior
management;
o Audit Committee, its composition, and role
o Provision relating to Subsidiary Companies
o Disclosure to Audit committee, Board and the Shareholders
o CEO/CFO certification
o Quarterly report on corporate governance

47. • Non-mandatory provisions consist of the following:
o Constitution of Remuneration Committee
o Dispatch of Half-yearly results
o Training of Board members
o Peer evaluation of Board members
o Whistle Blower policy
• As per Clause 49 of the Listing Agreement, there should be a
separate section on Corporate Governance in the Annual Reports of
listed companies, with detailed compliance report on Corporate
Governance.
• The companies should also submit a quarterly compliance report to
the stock exchanges within 15 days from the close of quarter as per
the prescribed format. The report shall be signed either by the
Compliance Officer or the Chief Executive Officer of the company.

48. • Apart from Clause 49 of the Equity Listing Agreement, there are
certain other clauses in the listing agreement, which are protecting
the minority share holders and ensuring proper disclosures
o Disclosure of Shareholding Pattern
o Maintenance of minimum public shareholding (25%)
o Disclosure and publication of periodical results
o Disclosure of Price Sensitive Information
o Disclosure and open offer requirements under SAST

49. • In August 2002, DCA appointed Naresh Chandra
Committee to examine various corporate
governance issues.
• The Committee was entrusted to analyze and
recommend changes, to the issues related to the
statutory auditor-company relationship,
certification of accounts and financial statements
by the management and directors; and role of
independent directors.

50. Recommandations of the commitee
• Disqualifications for audit assignments in which includes -
Prohibition of receiving any loans and/or guarantees from
or on behalf of the audit client by the audit firm,
Prohibition of any business relationship with the audit
client, Prohibition of personal relationships etc..
• List of prohibited non-audit services which includes -
Accounting and bookkeeping services, related to the
accounting records or financial statements of the audit
client, Internal audit services, Broker, dealer, investment
adviser or investment banking services etc…

51. • Independence Standards for Consulting and Other Entities
that are Affiliated to Audit Firms.
• Compulsory Audit Partner Rotation
• Auditor’s disclosure of contingent liabilities.
• Section 225 of the Companies Act needs to be amended to
require a special resolution of shareholders, in case an
auditor, while being eligible to re-appointment, is sought to
be replaced.
• The Audit Committee of the board of directors shall be the
first point of reference regarding the appointment of
auditors.
• For all listed companies as well as public limited companies
whose paid-up capital and free reserves exceeds Rs.10
crore, or turnover exceeds Rs.50 crore, there should be a
certification by the CEO

52. • Setting up of independent Quality Review Board.
• Proposed disciplinary mechanism for auditors.
• The minimum board size of all listed companies, as well as
unlisted public limited companies with a paid paidup share
capital and free reserves of Rs.10 crore and above, or
turnover of Rs.50 crore and above should be seven — of
which at least four should be independent directors.
• Audit Committees of all listed companies, as well as
unlisted public limited companies with a paid- up share
capital and free reserves of Rs.10 crore and above, or
turnover of Rs.50 crore and above, should consist
exclusively of independent directors,

53. Narayana Murthy Committee
Report [2003]

54. • SEBI Committee on Corporate Governance was
constituted under the Chairmanship of N. R.
Narayana Murthy, in 2003.
• It deals with governance issues / review of Clause
49 and suggest measures to improve corporate
governance standards.
• SEBI issued a circular on August 26, 2003 revising
Clause 49 of the Listing Agreement.

55. • The revised clause 49 superseded all the earlier
circulars on the subject and became effective for
listed companies from January 01, 2006.
• It is applicable to the entities seeking listing for the
first time and for existing listed entities having a
paid up share capital of Rs. 3 crores and above or
net worth of Rs. 25 crores or more at any time in
the history of the company.

56. • In December 1995, CII set up a task force to design
a voluntary Code of Corporate Governance focused
on listed companies.
• Following CII’s initiative, 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.

57. • SEBI’s Board, in its meeting held on January 25,
2000, considered the recommendations of the
Committee and decided to make the
amendments to the listing agreement on
February 21, 2000 for incorporating the
recommendations of the committee by inserting
a new clause in the Equity Listing Agreement –
i.e. Clause 49.

58. • Clause 49
Clause 49 of the Equity Listing Agreement consists of mandatory as well
as nonmandatory provisions.
• Mandatory provisions comprises of the following:
o Composition of Board and its procedure - frequency of meeting, number
independent directors, code of conduct for Board of directors and senior
management;
o Audit Committee, its composition, and role
o Provision relating to Subsidiary Companies
o Disclosure to Audit committee, Board and the Shareholders
o CEO/CFO certification
o Quarterly report on corporate governance

59. • Non-mandatory provisions consist of the following:
o Constitution of Remuneration Committee
o Dispatch of Half-yearly results
o Training of Board members
o Peer evaluation of Board members
o Whistle Blower policy
• As per Clause 49 of the Listing Agreement, there should be a
separate section on Corporate Governance in the Annual Reports of
listed companies, with detailed compliance report on Corporate
Governance.
• The companies should also submit a quarterly compliance report to
the stock exchanges within 15 days from the close of quarter as per
the prescribed format. The report shall be signed either by the
Compliance Officer or the Chief Executive Officer of the company.

60. • Apart from Clause 49 of the Equity Listing Agreement, there are
certain other clauses in the listing agreement, which are protecting
the minority share holders and ensuring proper disclosures
o Disclosure of Shareholding Pattern
o Maintenance of minimum public shareholding (25%)
o Disclosure and publication of periodical results
o Disclosure of Price Sensitive Information
o Disclosure and open offer requirements under SAST

61. • In August 2002, DCA appointed Naresh Chandra
Committee to examine various corporate
governance issues.
• The Committee was entrusted to analyze and
recommend changes, to the issues related to the
statutory auditor-company relationship,
certification of accounts and financial statements
by the management and directors; and role of
independent directors.

62. Recommandations of the commitee
• Disqualifications for audit assignments in which includes -
Prohibition of receiving any loans and/or guarantees from
or on behalf of the audit client by the audit firm,
Prohibition of any business relationship with the audit
client, Prohibition of personal relationships etc..
• List of prohibited non-audit services which includes -
Accounting and bookkeeping services, related to the
accounting records or financial statements of the audit
client, Internal audit services, Broker, dealer, investment
adviser or investment banking services etc…

63. • Independence Standards for Consulting and Other Entities
that are Affiliated to Audit Firms.
• Compulsory Audit Partner Rotation
• Auditor’s disclosure of contingent liabilities.
• Section 225 of the Companies Act needs to be amended to
require a special resolution of shareholders, in case an
auditor, while being eligible to re-appointment, is sought to
be replaced.
• The Audit Committee of the board of directors shall be the
first point of reference regarding the appointment of
auditors.
• For all listed companies as well as public limited companies
whose paid-up capital and free reserves exceeds Rs.10
crore, or turnover exceeds Rs.50 crore, there should be a
certification by the CEO

64. • Setting up of independent Quality Review Board.
• Proposed disciplinary mechanism for auditors.
• The minimum board size of all listed companies, as well as
unlisted public limited companies with a paid paidup share
capital and free reserves of Rs.10 crore and above, or
turnover of Rs.50 crore and above should be seven — of
which at least four should be independent directors.
• Audit Committees of all listed companies, as well as
unlisted public limited companies with a paid- up share
capital and free reserves of Rs.10 crore and above, or
turnover of Rs.50 crore and above, should consist
exclusively of independent directors,

65. Narayana Murthy Committee
Report [2003]

66. • SEBI Committee on Corporate Governance was
constituted under the Chairmanship of N. R.
Narayana Murthy, in 2003.
• It deals with governance issues / review of Clause
49 and suggest measures to improve corporate
governance standards.
• SEBI issued a circular on August 26, 2003 revising
Clause 49 of the Listing Agreement.

67. • The revised clause 49 superseded all the earlier
circulars on the subject and became effective for
listed companies from January 01, 2006.
• It is applicable to the entities seeking listing for the
first time and for existing listed entities having a
paid up share capital of Rs. 3 crores and above or
net worth of Rs. 25 crores or more at any time in
the history of the company.

68. • Setting up of independent Quality Review Board.
• Proposed disciplinary mechanism for auditors.
• The minimum board size of all listed companies, as well as
unlisted public limited companies with a paid paidup share
capital and free reserves of Rs.10 crore and above, or
turnover of Rs.50 crore and above should be seven — of
which at least four should be independent directors.
• Audit Committees of all listed companies, as well as
unlisted public limited companies with a paid- up share
capital and free reserves of Rs.10 crore and above, or
turnover of Rs.50 crore and above, should consist
exclusively of independent directors,