CORPORATE FINANCE

UNIT V

Corporate Governance
Corporate Governance refers to the way a corporation is governed. It is the technique by which companies are
directed and managed. It means carrying the business as per the stakeholders’ desires. It is actually conducted by
the board of Directors and the concerned committees for the company’s stakeholder’s benefit. It is all about
balancing individual and societal goals, as well as, economic and social goals.

Corporate Governance is the interaction between various participants (shareholders, board of directors, and
company’s management) in shaping corporation’s performance and the way it is proceeding towards.

Corporate Governance deals with the manner the providers of finance guarantee themselves of getting a fair return
on their investment. Corporate Governance clearly distinguishes between the owners and the managers. The
managers are the deciding authority. In modern corporations, the functions/ tasks of owners and managers should
be clearly defined, rather, harmonizing.

Corporate Governance deals with determining ways to take effective strategic decisions. It gives ultimate authority
and complete responsibility to the Board of Directors. In today’s market- oriented economy, the need for corporate
governance arises. Also, efficiency as well as globalization are significant factors urging corporate governance.
Corporate Governance is essential to develop added value to the stakeholders.

Corporate Governance ensures transparency which ensures strong and balanced economic development. This also
ensures that the interests of all shareholders (majority as well as minority shareholders) are safeguarded. It ensures
that all shareholders fully exercise their rights and that the organization fully recognizes their rights.

Benefits of Corporate Governance

1. Good corporate governance ensures corporate success and economic growth.

2. Strong corporate governance maintains investors’ confidence, as a result of which, company can raise
capital efficiently and effectively.
3. It lowers the capital cost.
4. There is a positive impact on the share price.
5. It provides proper inducement to the owners as well as managers to achieve objectives that are in interests
of the shareholders and the organization.
6. Good corporate governance also minimizes wastages, corruption, risks and mismanagement.
7. It helps in brand formation and development.
8. It ensures organization in managed in a manner that fits the best interests of all.

Guiding Principles of Corporate Governance

Business Roundtable supports the following core guiding principles:

1. The board approves corporate strategies that are intended to build sustainable long-term value; selects a chief
executive officer (CEO); oversees the CEO and senior management in operating the company’s business,
including allocating capital for long-term growth and assessing and managing risks; and sets the “tone at the top”
for ethical conduct.
 2. Management develops and implements corporate strategy and operates the company’s business under the
board’s oversight, with the goal of producing sustainable long-term value creation.

3. Management, under the oversight of the board and its audit committee, produces financial statements that fairly
present the company’s financial condition and results of operations and makes the timely disclosures investors
need to assess the financial and business soundness and risks of the company.

4. The audit committee of the board retains and manages the relationship with the outside auditor, oversees the
company’s annual financial statement audit and internal controls over financial reporting, and oversees the
company’s risk management and compliance programs.

5. The nominating/corporate governance committee of the board plays a leadership role in shaping the corporate
governance of the company, strives to build an engaged and diverse board whose composition is appropriate in
light of the company’s needs and strategy, and actively conducts succession planning for the board.

6. The compensation committee of the board develops an executive compensation philosophy, adopts and oversees
the implementation of compensation policies that fit within its philosophy, designs compensation packages for the
CEO and senior management to incentivize the creation of long-term value, and develops meaningful goals for
performance-based compensation that support the company’s long-term value creation strategy.

7. The board and management should engage with long-term shareholders on issues and concerns that are of
widespread interest to them and that affect the company’s long-term value creation. Shareholders that engage
with the board and management in a manner that may affect corporate decisionmaking or strategies are
encouraged to disclose appropriate identifying information and to assume some accountability for the long-term
interests of the company and its shareholders as a whole. As part of this responsibility, shareholders should
recognize that the board must continually weigh both short-term and long-term uses of capital when determining
how to allocate it in a way that is most beneficial to shareholders and to building long-term value.

8. In making decisions, the board may consider the interests of all of the company’s constituencies, including
stakeholders such as employees, customers, suppliers and the community in which the company does business,
when doing so contributes in a direct and meaningful way to building long-term value creation.

Introduction to SEBI:

The Government issued an ordinance on January 30, 1992 for giving statutory powers to SEBI. This Act was passed by
the Parliament as Act No. 15 of 1992 which received the assent of the Parliament on 4th April, 1992.

Further, on May 29, 1992 the Government issued an ordinance abolishing the Capital Issues Control Act, 1947. The
ordinance also supersedes the various guidelines issued by the CCI from time to time. Accordingly, SEBI has been set up
under the SEBI Act, 1992.

Purpose of the SEBI:

The purpose of the SEBI Act is to provide for the establishment of a Board called Securities and Exchange Board of India.

The purpose of the Board as laid down in its preamble is as below:

  To protect the interests of investors in securities;
 To promote the development of the securities market;
 To regulate the securities market; and
 For matters connected therewith or incidental thereto.

SEBI’s Board of Management:

i. Formation of the Board:

As per section 4 of the SEBI Act, 1992 as amended by the Securities and Exchange Board of India (Amendment) Act,
2002, the Board shall consist of the following members, namely:

 A chairman;
 Two members from amongst the officials of the Ministry of the Central Government dealing with Finance and
administration of the Companies Act, 1956;
 One member from amongst the officials of the Reserve Bank;
 five other members of whom at least three shall be the whole time members to be appointed by the Central
Government.

The Chairman and members referred to clauses (a) and (d) above shall be appointed by the Central Government and the
members referred to in clause (b) and (c) shall be nominated by the Central Government and the Reserve Bank
respectively.

The Chairman and other members shall be persons of ability, integrity and standing who have shown capacity in dealing
with problems relating to securities market or have special knowledge or experience of law, finance, economics,
accountancy, administration or in any other discipline which, in the opinion of the Central Government, shall be useful
to the Board.

The general superintendence, direction and management of the affairs of the Board is vested in the Board which may
exercise all powers and do all acts and things which may be exercised or done by the Board. The Chairman of the Board
can exercise all powers of the Board, except those specified in the regulations.

ii. The Term of Office and Conditions of Service:

The term of office and other conditions of service of the Chairman and the members appointed by the Central
Government shall be such as may be prescribed. However, the appointment can be terminated at any time before the
expiry of the prescribed period by giving not less than three months’ notice in writing or three months’ salary and
allowances in lieu thereof (Section 5).

iii. Removal of Member from Office:

The Central Government shall remove a member from office if he (a) is, or at any time has been, adjudicated as
insolvent; (b) is of unsound mind as declared by a competent court; (c) has been convicted of an offence involving moral
turpitude; (d) has so abused his position as to lender his continuation in office detrimental to the public interest (section
6).
iv. Meetings (Operation of the Board):

The Board shall meet at such times and places, and shall observe such rules of procedure in regard to the transaction of
business at its meetings as may be prescribed by regulations. Decisions at the meeting are to be made by a majority vote
of the members present and voting, and in the event of any equality of votes, the Chairman or the presiding member
has a second or casting vote (Section 7 of SEBI Act).

Any member who is a director of a company and who as such director has any direct or indirect pecuniary interest in any
matter coming up for consideration at a meeting of the Board shall, as soon as possible after relevant circumstances
have come to his knowledge, disclose the nature of his interest at such meeting and such disclosure shall be recorded in
the proceedings of the Board, and the member shall not take any part in any deliberation or decision of the board with
respect to that matter.

Acts or proceedings of the Board are valid even if there is a vacancy or any defect in the constitution of the Board
(section 8). The Board may appoint such other officers and employees as it considers necessary for the efficient
discharge of its functions.

Function of SEBI:

Section 11 of the SEBI Act specifies that basic duty of SEBI is to:

 Protect the interests of investors in securities, and

 To promote the development of, and to regulate the securities market.

The following measures may be taken by SEBI to fulfill its duties:

 Regulating the business in stock exchanges and any other securities markets;
 Registering and regulating the working of stock brokers, sub-brokers, share transfer agents, bankers to an issue,
trustees of trust deeds, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment
advisers and such other intermediaries who may be associated with securities markets in any manner;
 Registering and regulating the working of venture capital funds and collective investment schemes, including
mutual funds;
 Promoting and regulating self-regulatory organisations;
 Prohibiting fraudulent and unfair trade practices relating to securities markets;
 Promoting investors’ education and training of intermediaries of securities markets;
 Prohibiting insider trading in securities;
 Regulating substantial acquisition of shares and take-over of companies;

SEBI Guidelines for Issue of Securities:

SEBI has issued detailed guidelines in respect of issue of securities to public. The guidelines were first issued on 11th
June, 1992 and were amended subsequently from time to time. SEBI issued consolidated guidelines as SEBI (Disclosure
and Investor Protection) Guidelines, 2000 vide its circular No. 1 dated 19-1-2000.
These guidelines were applicable to all public issues by listed and unlisted companies, all offers for sale and rights issues
by listed companies whose equity share capital is listed, except in case of rights issues where the aggregate value of
securities offered does not exceed Rs. 50 lacs.

Broadly, there are three methods for issuing securities to the public:

 Conventional mode of receiving applications through bankers,

 Book building, and
 On line system of stock exchange (e-IPO).

Other Measures Taken By SEBI:

The Securities and Exchange Board of India, in addition to the above mentioned guidelines ‘for disclosure and investor
protection’, has taken a number of other measures for healthy development and regulation of the capital market.

 Guidelines for Merchant Bankers.

 Guidelines for EURO Issues.
 Guidelines for Mutual Funds and Asset Management Companies.
 Guidelines for Foreign Institutional Investors.
 Guidelines to Development Financial Institutions for Disclosure and Investor Protection.
 Guidelines for Book Building, Employees Stock Option Scheme (ESOS) and Employee Stock Purchase Scheme
(ESPS).
 Guidelines for Preferential Issues.
 Guidelines for OTCEI Issues.
 Guidelines on External Commercial Borrowings.
 Regulatory measures for Stock Brokers and Sub-brokers, Underwriters, Portfolio Managers, Registrars to an
Issue and Share Transfer Agents, Insider Trading, Bankers to an Issue, Depositories and Participants, Venture
Capital Funds, etc.

Limitations of SEBI:

Though SEBI has started as a watchdog in protecting investors’ interests, regulating the working of Stock Exchanges and
promoting capital market, still it faces a number of problems in its working.

Some of these limitations are as follows:

 The Central Government has authorised SEBI to frame its rules and regulations for actively monitoring capital
markets. These rules and regulations will have to be approved by the government first. This will cause
unnecessary delays and interference by the Finance Ministry.
 The bureaucratic delays in clearing the rules will hamper the working of SEBI. The government should direct SEBI
to frame or change the rules as per the demand of the situation so that it is able to achieve professional
efficiency.
 SEBI will have to seek prior approval for filing criminal complaints for violations of the regulations. This will again
cause delays at government level.
  SEBI has not been given autonomy. Its Board of Directors is dominated by government nominees. The Chairman
of the Board has no fixed tenure and can be sacked with three months’ notice. These appointments should be
for a fixed tenure to regulate the SEBI’s working in the long run.

CORPORATE SOCIAL RESPONSIBILITY

Corporate Social Responsibility is the continuing commitment by business to behave ethically and contribute to
economic development while improving the quality of life of the workforce and their families as well as of the local
community and society at large.

Corporate social responsibility includes six types of corporate social initiatives:

 Corporate philanthropy: company donations to charity, including cash, goods, and services, sometimes via a
corporate foundation
 Community volunteering: company-organized volunteer activities, sometimes while an employee receives pay
for pro-bono work on behalf of a non-profit organization
 Socially-responsible business practices: ethically produced products which appeal to a customer segment
 Cause promotions and activism: company-funded advocacy campaigns
  Cause-related marketing: donations to charity based on product sales
 Corporate social marketing: company-funded behavior-change campaigns

STAKEHOLDERS AND ETHICS

Stakeholder theory looks at the relationships between an organization and others in its internal and external
environments. It also looks at how these connections influence how the business conducts its activities. Think of a
stakeholder as a person or group that can affect or be affected by an organization. Stakeholders can come from inside or
outside of the business. Examples include customers, employees, stockholders, suppliers, non-profit groups,
government, and the local community, among many others.

One of the most important contributors to stakeholder theory is R. Edward Freeman and his book Strategic
Management: A Stakeholder Approach (1984). The core idea of stakeholder theory is that organizations that manage
their stakeholder relationships effectively will survive longer and perform better than organizations that don't. Freeman
suggests that organizations should develop certain stakeholder competencies.

These include:

 Making a commitment to monitor stakeholder interests

 Developing strategies to effectively deal with stakeholders and their concerns
 Dividing and categorizing interests into manageable segments
 Ensuring that organizational functions address the needs of stakeholders

PROFESSIONAL ETHICS

Meaning of Professional Ethics:

Professional ethics are ethics that refer to the moral rules and regulations governing the professional world. In other
words, they are the moral values that guide the way corporations or other business makes decisions. Professional ethics
are standards or codes of conduct set.by people in a specific profession.

Ethics related to a professional e.g., a manager of a factory are known as–professional ethics. Ethics may be internal or
external. As regards internal ethics, a manager must be honest with oneself, since one’s greatest asset is one’s
character. And one should be honest and straightforward with others also, treating them in the same manner in which
one wishes to be treated (external ethics).

Fairness in dealings with compeers and subordinates is mandatory; one should never discriminate by dispensing special
favours or privileges, whether for remuneration or not. Information coming to a professional confidentially should
neither be revealed nor used to the disadvantage of any subordinate or worker. One should ensure one’s employment
right to privacy. With reference to external ethics, the same suggestions as stated above can be followed.

A code of ethics is a part of the expectations of those involved in many different types of professions. People in a
profession don’t want to condone bad, dishonest or responsible behaviour if it does occur by someone in their field. By
setting out expected behaviours in the form of professional ethics, professionals work together to try to uphold a good
reputation. Professional ethics are commonly known as ethical business practices.

Respect and honesty are the two main Components of professional ethics. All employees are expected to represent a
business ethically as they are a part of it. This is why business people traditionally speak of ‘we’ or ‘us’ rather than the
more personal ‘I’ for the most part.

For instance, if an employee must mention company policy to a customer, he or she may say “I’m sorry, but this is our
company policy in these situations.” Policies are another type of preferred standards in how business is done, and
everyone in a company is expected to represent them.

Professional ethics training is often included in career education programs. For instance, medical assistants are trained
on the many ethics issues regarding patient confidentiality. It is both unethical and unlawful to discuss a patient’s health
records with others who are not involved in the medical care of the individual.

Engineering, journalism, religious organizations and many other professions have professional ethics. These ethical
codes or rules must never go against laws, but rather often coordinate with them as in the case of medical record
confidentiality. In general, professional ethics always include upholding honesty and respect in the profession over
personal needs, conflicts or biases. A bias is a personal belief such as prejudice towards a certain group of people.

Need of Professional Ethics:

Every company or business needs their own set of ethics and standards for several reasons.

Some of the important reasons are:

1. Success.
2. Checking Tool.
3. Integrity.
4. Mutual Respect.

1. Success:

Success is the most important reason for need of professional ethics. A company should give their employees in writing
the list of moral and ethics codes that they have to follow. In the world, every singles person’s individual set of morals
and ethics differ.

In the workplace, all these individuals come together and work under the same roof. If one person’s ethics is totally
against another person’s set of ethics, then this will lead to confusion and politics. No professional organization can
afford to have warring factions within their office if they have to conduct business successfully.

2. Checking Tool:

Work place ethics act as a moral police and check the employees when they are wrong. An employee, who knows what
the work ethics are, will not go wrong and live up to the business standards. This is the biggest advantage that an
organization gets by defining a set code of ethics.
3. Integrity:

Integrity is one thing that every business should have. When employees follow work ethics, they show integrity to the
outside world. Customers believe in the company and also business prospects increase. Every industry has its own
ethical guidelines, and a business should make sure that they follow these standards.

4. Mutual Respect:

Mutual respect also should be one of the strongest ethical points for a company. When employees respect each other,
then everyone else, including the customers, respect the business.

Importance of Professional Ethics:

Professional ethics are important for several reasons as explained below:

(a) Ethics corresponds to basic human needs:

It is a human trait that the man desires to be ethical, not only in his private life but also in his profession/business affairs
where, being a manager, he knows his decisions will affect the lives of thousands of employees.
Also, most people want to be a part of an organisation which they can respect and be publically proud of, because they
perceive its purpose and activities to be honest and beneficial to society.
These basic ethical needs compel the organisations/business enterprises to be ethically oriented.

(b) Ethics create credibility with the public:

A company ethically and socially responsive is honoured in the society, people favour its products and its public issues
attract an immediate response.

(c) Ethics give management credibility with employees:

The management automatically gets credibility with its employees when it has credit with the public. The leadership and
the people (employees) come and work together.

(d) Ethics help better decision making:

An ethical attitude of management helps making decisions in the interest of public, their employees and the company.

(e) Ethics and profit:

Ethics and profit go together. Value driven companies are always successful in the long run.

(f) Ethics can protect society:

What ethics can do, probably government, and law cannot, to protect society. For example, an ethical oriented
management can prevent pollution and protect the health of their workers, and people in general, much before being
mandated by law.