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Unit 2 & 3

Corporate governance is the new buzzword in corporate and academic circles today. This chapter gives an overview of the concept, defines it, discusses its evolution and explains its relevance and impact on the economy. Many of their top executives were committing fraud and irregularities.

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100% found this document useful (1 vote)

413 views

Unit 2 & 3

Uploaded by

Chirag Dugar

Available Formats

Download as PPT, PDF, TXT or read online on Scribd

You are on page 1/ 157

Corporate Governance:

An Overview

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Chapter 13

Corporate Governance An Overview:- Management of

corporate governance, duties, responsibilities,
attributes and liabilities of corporate board, models
of corporate governance, Key objectives of corporate
governance, recent development in corporate
governance, Development of corporate governance
internationally. The behaviour of directors in relation
to corporate governance and duty of care towards
their stakeholders. The role of the board in
establishing corporate governance standards.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Corporate Board:- Attributes, Duties,

Responsibilities, Liabilities. Shaping Directorial
Competence and Board Effectiveness. Financial
Institutions and Nominee Directors. Corporate
Board Committees-15 ch. Role of independent
directors, legal & regulatory setting of an
company. (Policies and procedures for best
practice companies. Rules and principles
based approaches to governance. The
regulatory governance framework.- ch 20)

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Corporate governance is the new buzzword in corporate

and academic circles today. It means several things to
several people, depending on the sensitivity of the analyst
and his vested interest in it. This chapter gives an overview
of the concept, defines it, discusses its evolution and
explains its relevance and impact on the economy.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Objectives

Capitalism at crossroads
Increasing awareness
Global concerns
What is corporate governance?
Governance is more than just board processes and
procedures
A historical perspective of corporate governance
Issues in corporate governance

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Chapter Outline

Many of their top executives were

committing fraud and irregularities.

Business Ethics and Corporate Governance, 2e

penalized

A. C. Fernando

for

Capitalism at crossroads
Americas hall of shame 2002
Giant corporations such as Enron Worldcom, Dynegy,
Waste Management, Adelphia Communications, Tyco,
Imclone Systems and Rite Aid failed and were being
investigated for fraud and malpractices.

Corporate misgovernance in India

Reasons for corporate misgovernance

Indian corporations were insulated. A closed economy,

a sheltered market, limited need and access to global
business/trade, lack of competition, lack of adequate
regulatory framework were all the causes. Besides,
promoter families ruled the roost. As a result, there were
a series of scams.
Increasing awareness
Global concerns
What is corporate governance?

Business Ethics and Corporate Governance, 2e

A. C. Fernando

From the Academic Point of View

Corporate governance addresses problems that result
from the separation of ownership and control.
From the Angle of Developed Versus Developing Countries
John D. Sullivan: In developing economies, one must
look to supporting institutions for example, shoring up
weak judicial and legal systems in order to better enforce
contracts and protect property rights.
Narrow Versus Broad Perceptions of Corporate Governance
Corporate Governance is defined narrowly as the
relationship of a company to its shareholders or, more
broadly, as a relationship to society.
(An article in Financial Times)
Business Ethics and Corporate Governance, 2e

A. C. Fernando

Definitions of Corporate Governance:

is a much broader concept and includes a fair, efficient and

transparent administration to meet certain well-defined
objectives.

It is a system of structuring, operating and

controlling a company with a view to achieving long-term

strategic goals to satisfy shareholders, creditors, employees,
customers and suppliers and complying with the legal and
regulatory requirements, apart from meeting environmental
and local community needs.

When it is practised under a

well-laid out system, it leads to the building of a legal,

commercial and institutional framework and demarcate the
boundaries within which these functions are performed.
(A. C. Fernando. Corporate Governance The Time for
a Metamorphosis, The Hindu Businessline, July 9, 1997.)

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Corporate governance is not just corporate management; it

Governance is more than just board processes and

procedures
The Rights of Shareholders
The Equitable Treatment of Shareholders
The Role of Stakeholders in Corporate Governance
Disclosure and Transparency
The Responsibilities of the Board

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Different Perceptions
in Definitions

A Historical Perspective of Corporate Governance

From a Narrow to a Broader Vision
(Shareholder to Stakeholder perspective)
The Growth of Modern Ideas of Corporate Governance from
the USA
England Catches Up With US
The Cadbury Committee
The Aftermath of Cadbury Report
Corporate Governance in the Banking Sector
Revival of Corporate Governance Issues in the New Millennium

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Issues in Corporate Governance

Distinguishing the roles of the board and the management

Composition of the board and related issues

Separation of the roles of the CEO and the chairperson

Should the board have committees

Appointments to the board and directors re-election

Directors and executives remuneration

Disclosure and audit

protection of shareholder rights and their expectations

Dialogue with institutional shareholders

Should investors have a say in making a company socially
responsible corporate citizen

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Corp- owners vs mgmt. ie shareholders vs managers/BoDThrs a conflict- loss of trust is concern

Mgmt to be trusted to run co in best interests of
shareholders & other stakeholders
Vital info abt co is more accessible to mgmt., creditors wd
worry abt their money bng wasted on useless projects etchence need for transparency & good governance.
CG means governing corp in a way that interests of
shareholders are protected whilst ensuring that other
stakeholders needs are fulfilled as far as possible.
High profile corporate frauds & scandals mandate good
governance practices.
Business Ethics and Corporate Governance, 2e

A. C. Fernando

Relevance/objectives of CG

Relevance of Corporate Governance

Managements usually have an information advantage over others.
Good corporate governance will ensure all stakeholders interests are
protected, while their requirements are fulfilled.

Need for and Importance of Corporate Governance

To maximize long-term shareholder value/customer satisfaction,
shareholder wealth

Governance and Corporate Performance

These are very closely inter-related. Most imp trait of CEO was Ethics

Investors Preference for Good Governance

Shareholders are prepared to pay a premium for a company with
good corporate governance practices.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

governance
Corporate values, codes, internal control systems etc. are
useful to ensure flow of capital for combating corruption,
stakeholder protection, ensuring industrialization and
economic development.
Benefits of good corporate governance to a corporation culture
within the organization and industry improves shareholder
confidence improves
Companies that are seen as well governed get a premium for
their stocks
Benefits to the society- transparency in dealing with investors
& creditors, combats corruption by fair disclosure of
accounting & auditing practices & improved management of
firm by professionals instead of being just family owned

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Strategies and techniques basic to sound corporate

Enabling a corporation perform efficiently by preventing

and malpractices code of best conduct

fraud

Providing protection to shareholders interest- imposes fiduciary duty

on management to be transparent & ensure accountability

Creates additional shareholder value over time

Enhancing the valuation of an enterprise

Ensuring compliance of laws and regulations

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Creation and enhancement of a corporations competitive advantage

Seperartion of ownership & control

Handles concers as- mgmt. accountability,
discipline & replacement of bad mgmt., enhanced
cororate performance, transparency investor
protection, shareholder wealth maximisation etc
Thus, a set of laws, regulation, contracts & norms
to create self-governing firms
Relationships bw cos mgmt., board, shareholders
& stakeholders
Cadbury committee report- code of best practices

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Contd

Management of corporate
governance,

Business Ethics and Corporate Governance, 2e

A. C. Fernando

IntroductionThe separation of ownership from active direction and management is

an essential feature of the company form of organization. To manage the
affairs of the company, shareholders elect their representatives called
the Directors of the company. A number of such directors constitutes
the Board of Directors.
The board generally has only part-time
directors.
The board may be expected to lay down policies, procedures and
programmes, but may not be able to secure their implementation under
their guidance and continuous supervision, or communicate their
decision to the rest of the staff.
The CEOs who include Managing Directors and managers receive
instructions from the board and disseminate them to executives in
charge of various departments.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Management of corporate governance

Shareholders
elect
forms

Board of
Directors

Executive
Committee

appoints

Chief Executives and Senior

Executives
Business Ethics and Corporate Governance, 2e

A. C. Fernando

Fig 1 : Corporate Management Structure

In the eyes of law, a company is an artificial person, who

however has no physical existence and has neither a body
nor soul.
In many countries, as in India, it is mandatory for a public
limited company to have directors and in practice the
identities of directors and those of their companies are
inseparable for good or bad.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Company Director and the Board

Section 2 (13) of the Companies Act defines a director as follows: A director includes any person occupying the
position of director by whatever name called. The important factor to determine whether a person is or is not a
director is to refer to the nature of the office and its duties. It does not matter by what name he is called. If he
performs the functions of a director, he is a director?
Section 2(6) of the Companies Act states that directors are collectively referred to Board of Directors or simply the
board.
Kinds of Directors
A director may be a full time working director, namely, managing or whole time director covered by a service contract.
A company may also have non-executive directors who do not have anything to do with the day-to-day management
of the company.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Who is a Director?

We can recognize another category of directors as per

certain provisions of the (Indian) Companies Act Shadow
Directors. These so-called deemed- directors acquire
their status by virtue of their giving instructions (other than
professional advices) according to which appointed
directors are accustomed to act.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Kinds of Directors (contd.)

A Nominee Director is generally appointed in a company to ensure

that the affairs of the company are conducted in a manner dictated
by the laws governing companies and to ensure good corporate
governance. A nominee director, as an affiliated director,
is
nominated to ensure that the interests of the institution which he
or she represents are duly or effectively safeguarded.
Kumar Mangalam Birla Committee on Corporate Governance
suggested that financial institutions should not have their
representatives on the boards of assisted companies

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Nominee Directors

The Articles of Association of a company usually name the first set of

directors by their respective names or prescribe the method of
appointing them.
Certain provisions of the Companies Act in India govern the appointment
or reappointment of directors by a company in general meeting.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Directors Appointment

They have been described variously as agents, trustees, or

managing partners of the company.
The legal position of the directors as agents and trustees
emanate from the fact that a company being an artificial
person cannot act in its own person.
It has become a well-settled fact now that directors are not
only agents but also act as trustees as a result of several
court decisions in India and England.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Legal Position of a Director

Business Ethics and Corporate Governance, 2e

A. C. Fernando

duties, responsibilities,
attributes and liabilities of
corporate board

The directors have certain duties to discharge. These are:

(i) Fiduciary dutiesA. exercise their powers honestly & bona fide for benefit of co
B. ensure no conflict of interest bw duties of co & personal interests. No secret profit out of their
position
(ii) Duties of care, skill and diligence;
(iii) Duties to attend board meetings;
(iv) and duties not to delegate their functions except to the extent authorized by the Act or the
constitution of the company and to disclose his interest.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Duties and Responsibilities of Directors

No body corporate, association or firm can be appointed directors of a company. A director

must: (a) be an individual; (b) be competent to enter into a contract; and (c) hold a share
qualification if so required by the Articles of Association.
The following persons are disqualified for appointment as directors
(i) A person of unsound mind; (ii) an undischarged insolvent or one whose petition for declaring
himself so is pending in a Court; (iii) a person who has been convicted by a Court for any
offence involving moral turpitude; (iv) a person whose calls in respect of shares of the
company held for more than six months have been in arrears; and

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Qualifications and Disqualifications

of Directors

(v) a person who is disqualified for appointment as director by

an order of the Court on grounds of fraud or misfeasance in
relation to the company and, of course, directors can be
removed from office by (i) the shareholders; (ii) the Central
(Federal) Government ;and (iii) the Company Law Board.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Qualifications and Disqualifications of

Directors (contd.)

The Board of Directors of a company which includes all the directors

elected by shareholders to represent their interests is vested with the
powers of management. The board has extensive powers to manage the
company, delegate its power and authority to executives and carry on all
activities to promote the interests of the company and its shareholders,
subject to certain restrictions imposed by public authorities.
The board of directors of a company is authorized to exercise such powers
and to perform all such acts and things as the company is entitled to.
Subject to two conditions: (1)The board shall not do any act which is to be
done by the company in general meeting of shareholders; and (2)The
board shall exercise its powers subject to the provisions contained in the
Articles or the Memorandum or in the Federal Acts concerned with
companies or any regulation made by the company in any general meeting.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Board of Directors (contd.)

Board of directors shall exercise the following powers

(a)
make calls on shareholders in respect of money unpaid
on their shares;
(b)
issue debentures;
(c)
borrow moneys otherwise (For example, through public
deposits);
(d)
invest the funds of the company; and
(e)
make loans.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Powers of the Board

The board of directors also can exercise certain other powers

as listed below with the consent of the company in
general meeting, as in the case of an amalgamation
scheme:
(a) to sell, lease or otherwise dispose of the whole or
substantially the whole, of the undertaking of the
company;
(b) to remit/cancel or give time for repayment of any debt
due to the company by a director except in the case of
renewal or continuance of an advance made by the
banking company to its director in the ordinary course of
business;

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Powers of the Board of Directors (contd.)

(c) to borrow in excess of capital;

(d) to contribute to charitable and other funds not relating to the business
of the company or the welfare of its employees beyond a specified
amount;
(e) to invest, compensation amounts received on compulsory acquisition of
any of company properties; and
(f)
to appoint a sole selling agent.
(g)
These powers are subject to certain conditions specified in articles of
association & agreements. In exercising these powers, cos interest
should be above self interest of directors.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Powers of the Board of Directors (contd.)

(1) Directors of a company may be liable to third parties in connection with the issue of a Prospectus,
which does not contain the particulars required under the Companies Act or which contains material
misrepresentations;
(2)

Directors may also incur personal liability under the Act

(a) on their failure to repay application money if minimum subscription has not been subscribed;
(b) on an irregular allotment of shares to an allottee (and likewise to the company) if loss or damage is
sustained;
(c) on their failure to repay application money if the application for the securities to be dealt in on a
recognized Stock Exchange is not made or refused; and

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Liabilities of Directors

(d)

(e)

on failure by the company to pay a bill of exchange,

promissory note, cheque or order for money or goods
wherein the name of the company is not mentioned in
legible characters.
Thus, directors responsible for fraudulent trading on part of
co, may be liable for debts or liabilities at the time of its
winding
Certain liabilities independent of the act in some
exceptional circumstances by signing a negotiable
instrument without a cos name & fact that signing on
behalf of co, he is personally liable to holder of such
instrument

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Liabilities of Directors (contd.)

(1) Ultra vires Acts:

Directors are personally liable to the company in matters of illegal acts. Eg-by
paying dividends out of capital or dissipating the funds of co illegally
(2) Negligence:
A director may be held liable for negligence in the exercise of his duties. Eg- missed
on due diligence & care which led to co damage. Neg w/o damage-non action
(3) Breach of Trust:
being trustees of cos money & property, they are liable to the company for any
material loss on account of the breach of trust. Liable for any wrongful profits made.
(4) Misfeasance:
Directors are liable to the company for misfeasance, i.e, wilful misconduct. May be
sued in court.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The Directors Liability to the Company

The Companies Act imposes penalty upon the directors for

not complying with or contravening the provisions of the
Act, which include sections on criminal liability for misstatements in Prospectus, penalty for fraudulently inducing
persons to invest money, purchase by a company of its own
shares, concealment of names of creditors entitled to object
to reduction of capital, penalty for default in filing with the
Registrar for registration of the particulars of any charge
created by the company.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Liability for Breach of Statutory Duties

A director is not liable for the acts of his co-directors provided he has no
knowledge and he is not a party.
When more than one director is alleged to have neglected his duties of
care, all the directors are jointly and severally liable.
Directors with Unlimited Liability
In a limited company ,the liability of all or any of the directors may ,if so
provided by the Memorandum is unlimited.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Liability for Acts of his Co-directors

In order to protect the interest of a company and its shareholders,

the Companies Act has placed the following disabilities on the
directors:
(1) Any provision in the Articles or an agreement which exempts a
director (including any officer of the company or an auditor) from
any liability on account of any negligence, default, misfeasance,
breach of duty or breach of trust by him shall be wholly void.
(2) An undischarged insolvent shall not be appointed to act as director
of any company or in any way to take part in the management of
any company.
(3) No person shall hold office at the same time as director in more
than 15 companies.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Disablities of Directors

(4)

A company shall not without obtaining the previous approval of the Central Government in that
behalf, directly or indirectly make any loan to-

(i) any director of the lending company or of a company which is its holding company or any partner
or relative of any such director;
(ii) any firm in which any such director or relative is a partner;
(iii) any private company of which any such director is a director or member;
(iv) any body corporate at a general meeting of which not less than 25 per cent of the total voting
power may be exercised or controlled by any such director; or
(v) any body corporate, the board of directors, managing director, or manager whereof is accustomed
to act in accordance with the directions or instructions of the Board, or of any director or directors
of the lending company.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Disabilities of Directors (contd.)

Except with the consent of the board of directors of a

company, a director of the company or his relative, a firm in
which such a director or relative is a partner, any other
partner, in such a firm, or a private company of which the
director is a member or director, shall not enter into any
contract with the company.
(a) for the sale, purchase or supply of any goods, materials or
services; or
(b)
for underwriting the subscription of any shares in, or
debentures of, the company.
(5)

(6)

A director shall not assign his office. If he does, the

assignment shall be void.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Disabilities of Directors (contd.)

An undischarged insolvent cannot

(1) act as, or discharge any of the function of, a director or
manager of any company, or
(2) directly or indirectly take part or be concerned in the
promotion, formation or management of any company.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Prevention of Management by
Undesirable Persons

(1) a person who is convicted of any offence in connection

with the promotion or management of a company; or
(2) a person who in the course of winding up of a company
(2)

(i) has been guilty of fraudulent conduct of business; or

(ii) has otherwise been guilty, while being an officer of the

company, of any fraud or misfeasance in relation to the
company or of any breach of his duty to the company.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Fraudulent Persons

Though the board is recognized legally as the top

layer of management with the responsibility of
governing the enterprise, yet, in actual practice,
the board of directors delegates most of its
managerial power to chief executives- say, the
managing director or manager. In many cases,
the board appoints many committees and confers
them with its power.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Effectiveness of the Board of Directors

The realistic functions of the board may, therefore, be enumerated as follows:

(a)
Confirming management decisions on major changes in objectives,
policies, and those
transactions which will have a substantial effect on
the success of the company;Eg- divestment strategies of Jack Welch of GE,
mergers & acquisitions (Ranbaxy), layoffs (Jet Airways)
(b) Providing
constructive advice to the executives through discussion on
important matters such as business outlook, new governmental legislation,
wage policy, etc., with a view to guiding the executives when
the
policies are still in the process of formation;
(c)
Selecting the chief executives and confirming the selection of the other
executives in the company made by chief executives; Eg Apple Ceo Steve
Jobs was fired by Board
(d)
Reviewing the results of current operations.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Effectiveness of the Board of Directors

Role
of
Board
Corporate Governance -

Ensuring

The quality of directors, their competence, commitment,

willingness and ability to assume a high degree of obligation to
the company and its shareholders as members of the board alone
drives the value of any board. A strategic board with broad
governing responsibilities rather than one that acts in response to
the demands of the CEO has become the need of an intensely
competitive world.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The role of the board in establishing corporate

governance standards.

of several boards of directors condenses her experiences and research in the

following summation:

1.
2.
3.

The smaller the board, the greater the directors involvement.

The essence of strategic boards is independence.
Diversity (of Board) means that a company has access to the
best. It also means that the company is not arbitrarily limited
to a single subset of its global constituency.
If the board is not informed appropriately, intelligently and
comprehensively, it cannot function. In simple words, the
output is only as good as the input.
The board has a broader responsibility to long-term
shareholder value than the CEO, who is necessarily focused
on day-to-day operations.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Susan F. Shultz, founder of SSA Executive Search

International, author of several best sellers on the subject & a member

Small Size of the Board

Independence of the Board
Diversity of the Board
A Wellinformed Board
The Board should have a Longer Vision and Broader
Responsibility

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(1)
(2)
(3)
(4)
(5)

Market Forces &

Shareholders

Competition

Accountability

Depositors, Borrowers
and Other Customers
Customer Service and
Satisfaction

Empowerment and
Pressure to perform
Regulatory Compliance

Organizations welfare
Supplies

Continuing Relationship

Board of Directors
Policy,
Directors
and

Compliance of Business Ethics

Compliance
and
Accountability

Providers of Services &

Top Management

Career Advancement
and Job satisfaction

Transparency and
fairness in dealings

Employees

All Other Stakeholders

Social Responsibility

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Fig 2: Dynamics of Corporate Governance and Board of Directors

The Role of Directors (in ensuring CG)

An efficient and independent board should be conscious of protecting the interests of all
stakeholders and not concerned too much with the current price of the stock.
(2)
Another important function of the director is to set priorities and to ensure that these are
acted upon.
(3)
A director is also expected to have the courage of conviction to disagree.
(4) Directors have great responsibility in the matter of employment and dismissal of the CEO.
(5) One of the toughest challenges confronted by boards arises while approving acquisitions.
(1)

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The Role of Directors (contd.)

(6) An efficient board should be able to anticipate business

events that would spell
success or lead to disaster
if proper measures are not adopted in time.
(7)
The directors have a duty to act bona fide for the benefit
of the company as a whole.
(8)
In recent times, those who advocate reform of laws
governing corporate practices stress the importance of
reformulation of the concepts behind these laws.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The board of directors, including chairmen and managing

directors, consisted of family members with a couple of
directors from funding financial institutions and perhaps a
couple of outside passive directors.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

IV. Family-owned Businesses and Corporate

Governance

(a) Family concerns will turn professional in order to face

successfully competition and market forces.
(a) Members of the board will be persons with technical and
managerial capabilities Who can guide and oversee
operating management in the discharge of their
functions.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Prof. N. Balasubramanian in his article

Economic Reforms, Corporate Boards, and
Governance provides a profile of the postreforms corporate board.

(d) Rubber stamp boards will be a relic of the past, prompted

and goaded by SEBI and its guidelines, board members
would be expected to devote more time and show
commitment.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(c) The practice of one person combining in himself both the

positions of Chairman and CEO will sooner rather than
later, come to an end.

(f)

Transparency in reporting and full disclosures will be norms.

(g) Guidelines on corporate governance all over the world insist

on independence of audit, and this will be observed by
boards in India too. Boards will have to ensure unattached
and professionally competent auditors audit the companys
accounts.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(e) Boards
delegating
specific
tasks
such
as
audit,
remuneration and appointments to committees with
members having professional expertise will be a normal
phenomenon.

(i)

Since boards will have to shoulder greater responsibility,

bear risk and manage uncertainty with a great deal of
pressure on them to perform, their members would have to
be compensated adequately and appropriately.

(j)

Corporate social responsibility would become part and

parcel of the duties of boards of directors.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(h) The highest priority of the boards would be to ensure longterm maximisation of shareholder value and wealth. Better
corporate performance through legitimate and transparent
policies will enrich shareholders. Accountability to
shareholders does not mean, that other stakeholders such
as customers and employees would have to be excluded,
as the respective objectives are not naturally exclusive.

(l)

Companies would in due course put in place an

appropriate whistle blower policy enabling both the
board and senior management take corrective measures
to stem the rot.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(k) Companies in India emulating the examples of Western

countries, would have their own corporate governance
rules that clearly describe their vision, value systems
and board responsibilities.

The foray of Infosys Technologies into consultancy and

Business Process Outsourcing (BPO) from its original
profile of just a services company was prompted by its
proactive board.
The Industrial Credit and Investment Corporation of India
(ICICI), has an active board. The board initiated and
helped actively the merger of the ICICI and its banking
arm. The ICICI Bank also insists that its middle level
managers make presentations to the board regularly.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Some Pioneering Indian Boards

The
board
of
the
fast-growing
Chennai-based
pharmaceutical
company,
Orchid
Chemicals
and
Pharmaceuticals Ltd, directed its Managing Director to
seek the advice of the international consultant, Mckinsey
and Co. on his growth strategy for the company.
The board of Chennai-based Polaris Software Lab. forced
its Chairman and Managing Director not to acquire any
new business at the peak of dotcom boom, but instead to
consolidate the companys business.
Godrej Consumer Products consulted the Confederation of
Indian Industry (CII) for forming its board. The CII
advised the company to choose independent professionals
and not industrialists.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Governance committees

The stated objective of the Cadbury Committee was "to

help raise the standards of corporate governance and the
level of confidence in financial reporting and auditing by
setting out clearly what it sees as the respective
responsibilities of those involved and what it believes is
expected of them".

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Cadbury Committee on
Corporate Governance, 1992

The Cadbury Code of Best Practices had 19 recommendations.

Relating to the board of directors, the recommendations are:
The Board should meet regularly, retain full and effective
control over the company and monitor the executive
management.
There should be a clearly accepted division of responsibilities
at the head of a company, which
will
ensure balance of
power and authority, such that no individual has unfettered
powers of decision.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Cadbury Committee on
Corporate Governance, 1992 (contd)

The board should include non-executive directors of

sufficient calibre and number for their views to carry
significant weight in the board's decisions.

All directors should have access to the advice and services of

the Company Secretary, who is responsible to the Board for
ensuring that board procedures are followed and that
applicable rules and regulations are complied with. Any
question of the removal of company secretary should be a
matter for the board as a whole.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Cadbury Committee on
Corporate Governance, 1992 (contd.)

Relating to the non-executive directors the recommendations

are:
Non-executive directors should bring an independent
judgment to bear on issues of strategy, performance,
resources, including key appointments, and standards of
conduct.
Non-executive Directors should be appointed for specified
terms and reappointment should not be automatic.
Non-executive Directors should be selected through a
formal process and both, this process and their
appointment, should be a matter for the Board as a
whole.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Cadbury Committee on
Corporate Governance, 1992 (contd)

It is the Boards duty to present a balanced and

understandable assessment of the companys position.
The Board should ensure that an objective and professional
relationship is maintained with the Auditors.
The Board should establish an audit committee of at least 3
non-executive directors with written terms of reference,
which deal clearly with its authority and duties.
The directors should explain their responsibility for
preparing the accounts next to a statement by the auditors
about their reporting responsibilities.
The directors should report on the effectiveness of the
companys system of internal control.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

On reporting and controls, the Cadbury Code of Best Practices

stipulate the following:

This committee was set up in January 1995 to identify good

practices by the Confederation of British Industry (CBI) in
determining directors' remuneration and to prepare a code of
such practices for use by public limited companies of the United
Kingdom.
The committee
aimed to provide an answer to the general concerns about
the accountability and level of directors' pay;
argued against statutory control and for strengthening
accountability by the proper allocation of responsibility for
determining directors' remuneration, the proper reporting to
shareholders, and greater transparency in the process.
Business Ethics and Corporate Governance, 2e

A. C. Fernando

The Greenbury Committee, 1995

Produced the Greenbury Code of Best Practice which was

divided into four sections thus:
Remuneration committee
Disclosure
Remuneration policy
Service contracts and compensation.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The Greenbury Committee, 1995 (contd.)

The World Bank, both as an international development bank

and as an institution interested and involved in equitable
and sustainable economic development worldwide, was one
of the earliest international organisations to study the issue
of corporate governance and suggest certain guidelines.
Corporate governance is concerned with holding the balance
between economic and social goals and between individual
and communal goals. The governance framework is there to
encourage the efficient use of resources and equally to
require accountability for the stewardship of those
resources.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

World Bank on
Corporate Governance

Openness is the basis of public confidence in the corporate

system and funds will flow to those centres of economic
activity, which inspire trust. This Report points the way to
the establishment of trust and the encouragement of
enterprise. It marks an important milestone in the
development of corporate governance.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

World Bank on
Corporate Governance (contd.)

The Organisation for Economic Cooperation and Development

(OECD) was one of the earliest non-governmental
organisations to work on and spell out the principles and
practices that should govern corporations in their goal to
attain long-term shareholder value.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

OECD Principles

The Rights of Shareholders

In summary, they include the following elements.

The rights of shareholders include a set of rights to secure

ownership of their shares, the right to full disclosure of
information, voting rights, participation in decisions on sale or
modification of corporate assets mergers and new share issues.

Equitable Treatment of Shareholders

The OECD is concerned with protecting minority shareholders
rights by setting up systems that keep insiders, including
managers and directors, from taking advantage of their roles.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The OECD recognizes that there are other stakeholders in

companies in addition to shareholders. Banks, bondholders
and workers, for example, are important stakeholders in
the way in which companies perform and make decisions.

Disclosure and Transparency

The OECD lays down a number of provisions for the
disclosure and communication of key facts about the
company ranging from financial details to governance
structures including the board of directors and their
remuneration.
Business Ethics and Corporate Governance, 2e

A. C. Fernando

The Role of Stakeholders in Corporate Governance

The OECD guidelines provide a great deal of details about the

functions of the board in protecting the company and its
shareholders. These include concerns about corporate
strategy, risk, executive compensation and performance as
well as accounting and reporting systems.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The Responsibilities of the Board

McKinsey, the international management consultant

organisation conducted a survey with a sample size of 188
companies from six emerging markets (India, Malaysia,
Mexico, South Korea, Taiwan and Turkey), to determine the
correlation between good corporate governance and the
market valuation of the company.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

McKinsey Survey on
Corporate Governance

In short, good corporate governance increases market

valuation by:
Increasing financial performance;
Transparency of dealing, thereby reducing the risk that
boards will serve their own self-interest;
Increasing investor confidence.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

McKinsey Survey on
Corporate Governance (contd.)

McKinsey rated the performance on corporate governance of

each company based on the following parameters:
Accountability: Transparent ownership, board size, board
accountability, ownership neutrality
Disclosure and transparency of the board, timely and
accurate disclosure, independent directors
Shareholder equality: One share, one vote

Business Ethics and Corporate Governance, 2e

A. C. Fernando

McKinsey Survey on
Corporate Governance (contd.)

Through the survey, McKinesy found that companies with

good corporate governance practices have high price-to-book
values indicating that investors are willing to pay a premium
for the shares of a well-managed and governed company.
Additionally, the survey revealed that investors are willing to
pay a premium of as much as 28 per cent for shares of such a
corporate governance based company.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

McKinsey Survey on
Corporate Governance (contd.)

Companies in emerging markets often claim that Western

corporate governance standards do not apply to them.
However, the survey revealed that studies of the six
emerging markets show that investors the world over look
for high standards of good governance. Additionally, they are
willing to pay a high premium for shares in companies that
meet their requirements of good corporate governance.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

McKinsey Survey on
Corporate Governance (contd.)

The SarbanesOxley Act (SOX Act), 2002 is a serious

attempt to address all the issues associated with corporate
failures to achieve quality governance and to restore
investor confidence. The Act contains a number of
provisions that dramatically change the reporting and
corporate directors governance obligations of public
companies, the directors and officers.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Sarbanes-Oxley Act, 2002

The behaviour of directors in relation

to corporate governance and duty of
care towards their stakeholders.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

External Environment
Government Regulations,
Policies, Guidelines etc.

Corporate Culture, Structure,

Characteristics, Influences

Company Acts

SEBI
Stock Exchanges

Depositors, Borrowers,

Internal Environment

Customers and other

External Stakeholders

Company vision; mission, policies, norms

Internal
Stakeholders
Directors

Auditors
Board of

CORPORATE
GOVERNANCE
SYSTEM

Proper governance
value

Shareholder

Corporate Governance Outcomes / Benefits to Society

Transparency
Investor protection
customer

Concern for
Healthy corporate sector development
Business Ethics and Corporate Governance, 2e

A. C. Fernando

Fig.14.4 : Indian Corporate Governance Model

Obligation to society at large

National interest
Political non-alignment
Legal compliances
Rule of law
Honest and ethical conduct
Corporate citizenship
Ethical behavior
Social concerns
Corporate social responsibility

Business Ethics and Corporate Governance, 2e

A. C. Fernando

What Is Good Corporate Governance?- Duty

towards various stakeholders

Environment-friendliness

Health, safety and working environment

Competition

Trusteeship

Accountability

Effectiveness and efficiency

Timely responsiveness

Corporations should uphold the fair name of the country

Obligation to Investors

Towards shareholders

Measures promoting transparency and informed

shareholder participation

Transparency

Financial reporting and records

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Obligation to Customers
o Quality of products and services
o Products at affordable prices
o Unwavering commitment to
o Customer satisfaction

Obligation to Employees
Fair employment practices
Equal-opportunities employer
Encouraging whistle blowing
Humane treatment
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A. C. Fernando

o Empowerment
o Equity and inclusiveness
o Participative and collaborative environment

Managerial Obligation

Protecting companys assets

Behaviour towards government agencies

Control

Consensus-oriented

Gifts and donations

Role and responsibilities of corporate board and directors

Direction and management must be distinguished

Managing and whole-time directors

Business Ethics and Corporate Governance, 2e

A. C. Fernando

o Participation

Our Credo
We believe our first responsibility is to the doctors, nurses and
patients, to mothers and fathers and all others who use our
products and services.
In meeting their needs everything we do must be of high quality.
We must constantly strive to reduce our costs in order to
maintain reasonable prices.
Customers' orders must be serviced promptly and accurately.
Our suppliers and distributors must have an opportunity to make
a fair profit.
Business Ethics and Corporate Governance, 2e

A. C. Fernando

Johnson & Johnsons excellent Credo exemplarily epitomizes

what an ideal corporate should aspire to be.

In the new era, the board of directors has to shoulder

larger responsibilities to meet the increasing demand of the
market place.
The Board of Directors expected to play a powerful role in
such a metamorphosis the world is waiting to see happen.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Conclusion

Business Ethics and Corporate Governance, 2e

A. C. Fernando

CHAPTER 20
Policies and procedures for best
practice companies. Rules and
principles based approaches to
governance. The regulatory
governance framework. models of
corporate governance

The countries with developed economies apply two different

systems of corporate governance: the group-based system
and the market-based one or, as they are often referred to,
the insider and outsider systems.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Corporate Governance Models

In concentrated ownership structures, ownership and/or

control is concentrated in the hands of a small number of
individuals, families, managers, directors, holding companies,
banks and/or other non-financial corporations. Most countries,
especially those governed by civil law, have concentrated
ownership structures. Insiders exercise control over companies
in several ways; own the majority of the company shares and
voting rights; own some shares, but enjoy the majority of the
voting rights.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Insider System

Insider System- Adv & Disadv

Insiders have the power and the incentive to monitor management closely thereby
minimizing the potential for mismanagement and fraud.
2. Insiders tend to keep their investment in a firm for long periods of time. As a result, insiders
tend to support decisions that will enhance a firm's long-term performance as opposed to
decisions designed to maximise short-term gains.
Disadv- However, insider systems predispose a company to certain corporate governance
failures. One is that dominant owners and/or vote holders can bully or collude with
management to expropriate the firms assets at the expense of minority shareholders. This is a
significant risk when minority shareholders do not enjoy legal rights.
Insiders who wield their power irresponsibly waste resources and drain company productivity
levels; they also foster investor reluctance and illiquid capital markets. Shallow capital markets,
in turn, deprive companies of capital and prevent investors from diversifying their risks.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Dispersed ownership is the other type of ownership structure.

In this scenario, a large number of owners hold a small number
of company shares. Small shareholders have little incentive to
closely monitor a company's activities and tend not to be
involved in management decisions or policies. Hence, they are
called outsiders, and dispersed ownership structures are
referred to as outsider systems.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Outsider System

Common Law countries such as the UK and the US tend to have

dispersed ownership structures. The outsider system or AngloAmerican, market-based model is characterised by the ideology
of corporate individualism and private ownership, a welldeveloped and liquid capital market, with a large number of
shareholders, and a small concentration of investors. The
corporate control is realised through the market and outside
investors.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Outsider System (contd.)

Adv- In contrast to insider systems, owners in outsider systems

rely on independent board members to monitor managerial
behaviour and keep it in check. As a result, outsider systems are
considered more accountable and less corrupt and they tend to
foster liquid capital markets.
Disadv-1. Dispersed ownership structures have certain
weaknesses. Dispersed owners tend to be interested in shortterm profit maximisation. They tend to approve policies and
strategies that will yield short-term gains, but that may not
necessarily promote long-term company performance.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Outsider System (contd.)

2. At times, this can lead to conflicts between directors and

owners, and to
frequent ownership changes because
shareholders may divest in the hopes of reaping higher profits
elsewhere, both of which weaken company stability.
3. Small-scale investors have less financial incentive to vigilantly
monitor boardroom decisions and to hold directors accountable.
Directors who support unsound decisions may remain on the
board when it is in the company's interest that they be removed.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Outsider System (contd.)

There are three different ways that owners maintain control over
the work of management:
1) the owners directly influence the corporate strategy and
selection of the top management team;
2) the owners delegate their rights to the board, but ensure that
compensation and other incentives are aligned with share price
maximization; and
3) the owners rely on the market mechanisms of corporate control.
In other words, the corporate governance mechanisms can be
both internal and external.

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A. C. Fernando

Developing a Corporate Governance Framework

INTERNAL MECHANISMS:
OWNERSHIP CONCENTRATION
A relative amount of shares owned by individual owners or
institutional investors
BOARD OF DIRECTORS
Individuals responsible for representing the owners' interests
by means of controlling strategic decisions made by the top
management
REWARDING MANAGERS
Using earnings, bonuses and long-term stimuli in order to
reconcile managers' and owners' interests
MULTIDIVISIONAE STRUCTURE
Business division movement in order to control managers
strategic decisions
EXTERNAL MECHANISMS:
MARKET FOR CORPORATE CONTROL
Take control of an underperforming firm in order to
improve the strategic competitiveness.
Business Ethics and Corporate Governance, 2e

A. C. Fernando

Table 1. Mechanisms of Corporate Governance

The framework for the implementation of corporate

governance in developed economies is explained as
under by the World Bank.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Table 1. Mechanisms of Corporate Governance

(contd.)

INTERNAL

EXTERNAL

Private

Regulatory

Shareholders

Stakeholders
(for example,
accounting and
auditing)

Standards

Board of Directors
Reputed agents Laws and regulations
* Accountants Financial sector
Reports Appoints
* Lawyers
to
* Credit rating
* Debt
and
* Investment bankers
Financial media * Equity
monitors
* Investment advisors
* Research
* Corporate governance Financial sector
Management
analysts
* Competitive factor
and product markets
Operates
* Corporate control
Core functions

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Modern Corporations Are Disciplined by Internal and External Factors

It can be observed from the illustration of the framework

that there are internal and external forces that interface
and interact with each other and have an impact on the
behaviour and activities of corporations.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Modern Corporations Are Disciplined by

Internal and External Factors (contd.)

(1) Property Rights

It is essential that property rights, laws and regulations
establish simple and straightforward standards to specify
clearly who owns what and how these rights can be
combined or exchanged for recording required information
in a timely and cost-efficient manner into an integrated,
publicly accessible data base.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The Institutional Framework for Effective

Corporate Governance

Very few business transactions will occur without

legislation and regulations that legally guarantee and
enforce the sanctity of contracts.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(2) Contract Law

The banking sector provides the necessary capital and

liquidity for corporate transactions and growth. Good
governance within the banking system is especially
important in developing countries where banks provide
most of the finance.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(3) A Well-regulated Banking Sector

The banking framework is based on three pillars:

minimum capital requirements; supervisory review of an
institution's internal assessment process and capital
adequacy; and effective use of disclosure to strengthen
market discipline as a complement to supervisory efforts.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(3) A Well-regulated Banking Sector (contd.)

Disclosing information about banks' ownership structures

and relationships with other firms or the public sector
fosters good governance of banks and corporations, and
helps prevent moral hazard and financial meltdowns.
Many developing countries experienced financial crises
that stemmed from undisclosed transactions that were
not conducted at arm's length.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(3) A Well-regulated Banking Sector (contd.)

Not all corporate endeavours succeed, legislation that

establishes orderly and equitable clearing and exit
mechanisms is essential so that investments can be
liquidated and reallocated into productive undertakings
before they are squandered completely.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(4) Exit Mechanisms: Bankruptcy and Foreclosure

Efficient securities markets discipline insiders by sending price

signals rapidly and allowing investors to liquidate their
investment quickly and inexpensively.

(6) Competitive Markets

The existence of competitive markets is an important external

control on companies forcing them to be efficient and
productive lest they lose market share or go under.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(5) Sound Securities Markets

To this end, governments can:

Remove barriers to entry

Enact competition and anti-trust laws
Eliminate protectionist barriers including the protection of
monopolies
Eliminate preferential treatment schemes such as subsidies,
quotas, tax exemptions etc.
Establish fair trade priorities
Remove restrictions on foreign direct investment and foreign
exchange
Reduce the cost of setting-up and running a formal business.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(6) Competitive Markets (contd.)

Having transparent, straightforward and fair rules and procedures stipulating how and when enterprises can be privatised is, therefore, essential.
(8) Transparent and Fair Taxation Regimes
Taxation systems should be reformed so that they are fair, simple and straightforward. In this regard, multi-step, complex procedures on fiscal reporting, that allow officials to exercise
considerable discretion and therefore engage in corruption, should be eliminated
(9) An Independent, Well-functioning Judicial System
One of the most important institutions of a democratic, market-based economy is an independent, well-functioning judicial system that enforces laws consistently, efficiently and fairly,
thereby maintaining the rule of law.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(7) Transparent and Fair Privatization Procedures

(11) Reform Government Agencies

Government agencies that are excessively bureaucratic and
inefficient need to be reformed.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(10) Anti-corruption Strategies

The State should implement effective anti-corruption
measures by specifying and streamlining legal and regulatory
codes and clarifying laws on conflict of interest.

Governments should strengthen and maintain their agencies' administrative

and enforcement capacity by cultivating a staff of well-qualified civil servants,
hiring and promoting staff based on verifiable professional standards, offering
civil servants vocational training based on the latest technology, paying
adequate salaries to attract well-qualified professionals and to deter bribetaking, and offering tenure based on performance.
(13) Establish Routine Mechanisms of Participation
To ensure that the new framework creates a level playing field, citizens need
to have ample opportunity to participate in grafting it.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(12)Strengthen Administrative and Enforcement Capacity of

Government Agencies

The

role of the Fourth Estate (Press) in ensuring corporate

democracy cannot be overstressed, and can be considered as
important as its role in ensuring that political democracy
functions as well as it is intended to be. Many a scam in the
corporate world would not have come to limelight but for the
bold and upright investigation of journalists.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(14) An Investigative and Well-informed Media

Reputed agents are individuals and/or groups that reduce the

information gap between insiders and outsiders by seeking
and providing information to outsiders about the performance
of insiders and enterprises and by setting high professional
standards and then applying peer pressure and, at times,
sanctions to uphold them. Reputed Agents can also refer to
private sector agents, self-regulating bodies, the media and
civic society that reduce information asymmetry, improve the
monitoring of firms, and shed light on opportunistic
behaviour.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

(15) Strengthening Reputed Agents

Examples include:

Self-regulation bodies such as accounting and auditing

professionals
Media
Investment bankers and corporate governance analysts,
Lawyers
Academicians, economists and corporate analysts
Credit rating agencies
Consumer activists
Environmentalists
Activist investors and shareholders such as institutional
investors and venture capitalists
Non-Government Organisations (NGOs)
Business Ethics and Corporate Governance, 2e

A. C. Fernando

(15) Strengthening Reputed Agents (contd.)

A common misconception is that achieving profits and

looking after stakeholders interests are diametrically
opposite goals.
Operating fairly, responsibly, transparently
and accountably towards both shareholders and other
stakeholders does more than improve a company's
reputation and attract investment; it gives the corporation a
competitive advantage. Firms rely on stakeholders to provide
a series of essential inputs such as labour, components,
spare parts, and other supplies on a predictable basis.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Sound Stakeholder Relationships are

Good for Business

A companys treatment of other stakeholders such as suppliers

is just as important to the companys long-term performance.
A firm that breaks a contract with a supplier or pays unfair
prices not only hurts the supplier, but damages its own
reputation as a reliable and honest business partner.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Sound Stakeholder Relationships are Good for

Business (contd.)

Establishing any one of institutions enumerated above is a

necessary and challenging undertaking without which
democratic markets and corporate governance can not take
root.

Some of the general challenges confronting developing,

emerging and transition economies include:

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Corporate Governance Challenges in Developing,

Emerging and Transition Economies

Establishing a rule-based (as opposed to a relationship-based)

system of governance;
Combating vested interests;
Dismantling pyramid ownership structures that allow insiders
to control and, at times, siphon off, assets from publicly
owned firms based on very little direct equity ownership and
thus few consequences;
Severing links such as cross shareholdings between banks and
corporations;
Establishing property rights systems that clearly and easily
identify true owners even if the state is the owner;

Business Ethics and Corporate Governance, 2e

A. C. Fernando

De-politicising decision-making and establishing firewalls

between the government and management in corporatized
companies where the state is a dominant or majority
shareholder;
Protecting and enforcing minority shareholders' rights;
Preventing asset stripping after mass privatization;
Finding active owners and skilled managers amid diffuse
ownership structures;

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Educating and enlightening investors of their rights and duties

Encouraging good corporate governance practices and creating
benchmarks through cooperation with trade associations.
Establishing regulatory bodies that help reduce fissures through
arbitrations and conciliations between competing and conflicting
parties.
Promoting
good
governance
within
family-owned
and
concentrated ownership structures; and
Cultivating technical and professional know-how.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

In many developing, emerging, and transition economies,

public sector companies contribute more to the nation's
gross national product, employment, income, and capital
use than private sector firms. Moreover, public sector
companies often shape public policies. Instituting sound
corporate governance practices within public sector
companies is essential to economic development, growth
and reform. To begin with, public companies need to be
corporatized before they can be privatized.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Corporate Governance Is Not Only a

Private Sector Affair

This can be enhanced through granting of financial and

managerial
autonomy
which
will
reduce
political
interference, nepotism, corruption and other such evils.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Corporate Governance Is Not Only a

Private Sector Affair (contd.)

Many international organizations are funding corporate

governance initiatives that aim to put in place developed
country models of corporate governance.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Successful Strategies:
One Size Does Not Fit All

Critics complain that these Western-based organizations try

to transplant systems and procedures that are workable in
the West, but are unsuitable in the developing economies
that have different cultures, work ethics, employeremployee relations and so on.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Successful Strategies:
One Size Does Not Fit All (contd.)

In emerging economies, the term "corporate governance" is

new, yet it has caught on rapidly. A set of formal legal
frameworks, often modeled after the Anglo-American system,
frequently exists. Nearly all firms have shareholders, boards,
and "professional" managers, which are the components of
modem corporate governance. However, the similarities in
governance between emerging and developed economies are
often more in form than in substance.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Current Corporate Governance Settings in

Transition Economies

The countries in transition are facing the problem of corporate

governance in a specific way. Their corporate sector consists of
instant corporations formed as the result of mass
privatisation, without the simultaneous development of legal
and institutional structures necessary to operate in a
competitive market economy.
Unstable macroeconomic conditions create a situation of great
uncertainty and shorten the time horizon in business. Under
unpredictable economic circumstances, managers see their
positions as temporary and uncertain which leads to maximizing
their own profit instead of maximizing the company profit.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The role of the state in the transition economies is ambiguous.

On the one hand, the role of the state in post-socialism should
be limited. On the other hand, strong state power is needed to
carry through the political programmes required by economic
transformation. Weak governments have proved to be
incapable of economic transformation.

Transactions between privatized enterprises become linked to

each other, to banks and to the state through complex
structures of cross-shareholding and corporate interlocks.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

In transition economies, the most important firms, such as

public sector companies that contribute more to the nation's
gross national product, employment, income, and capital use
than private sector firms, are controlled by the state as it was
in India, prior to 1991.

The missing element in the context of corporate governance

development in transition economies is the lack of institutions
associated with successful market economies.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The question is whether it is possible to reproduce all at once

the institutions from developed market economies in transition
economies. The standard institutional portfolio has evolved
gradually in different circumstances. Merely transplanting these
institutions is not possible because there are new conditions
and many cultural differences.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The transition economies cannot afford the luxury of searching

for new third way between socialism and capitalism. Instead,
they have to find a way to accept the existing institutional
portfolio and to make it work in the specific cultural, historical
and economic environment. Each region is in a different stage
of establishing a democratic, market-based economy and a
corporate governance system.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Corporate

Governance

Developing

and

Transition

Economies

Objectives
The developing, transitional or emerging economies of the world are at a
crossroads. Their development efforts cannot overlook the wide distribution of
wealth and incomes their corporates generate, nor can they close their eyes to
the problem of the insiders stealing the legitimate share of the outsiders. This
chapter elaborates on corporate governance challenges in emerging economies,
and also discusses successful strategies to ensure corporate governance.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Chapter 20

Introduction
Problems Faced by Developing and Transitional Economies
Defining Corporate Governance
Corporate Governance Models
The Institutional Framework for Effective Corporate
Governance
Corporate Governance Challenges in Developing, Emerging
and Transition Economies
Current Corporate Governance Settings in Transition
Economies

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Chapter Outline

Steps were mooted to root out the misdemeanours of the illbehaved corporations. However, there was a problem. While it
was easy to incorporate the required transformational changes in
the corporate sphere of advanced countries where the systems
and procedures and regulatory bodies to combat and arrest the
declining standards were in place, albeit in an immature degree,
it was difficult in the case of developing and transition economies
where everything had to be built from the scratch.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Introduction

Earlier, the common perspective of Corporate Governance was to

respect the individual system of each country. But in the context
of globalisation with its attendant enhanced transnational
movement of goods and services and for borderless capital
markets, a set of global standards for corporate governance is
being attempted in recent times.
In such a scenario, it is
imperative that developing and transition economies should try to
put in place required systems and institutions with a view to
benefiting from the world-wide application of the principles and
percepts of best corporate governance practices.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Introduction (contd.)

Many developing, emerging and transition economies lack,

or are now in the process, of developing the most basic
market institutions.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Problems Faced by Developing

and Transition Economies

The state and para-state institutions such as privatisation funds

remain the largest shareholders of companies. Internal owners
dominate in many companies, while the external owners do not
have enough voting power to control the companies and thereby
to ensure for themselves appropriate returns. The capital
markets are just developing and do not facilitate the inflow of
new capital as intended. Further, market transactions are often
based on the abuse of inside information.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Problems Faced by Developing

and Transition Economies (contd.)

The need for corporate governance in developing, emerging

and transition economies extends far beyond resolving
problems stemming from the separation of ownership and
control, which is the core and substance behind the need for
corporate governance. Developing and emerging economies
are constantly confronted with issues such as the lack of
property rights, the abuse of minority shareholders, contract
violations, asset stripping and self-dealing.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Problems Faced by Developing

and Transition Economies (contd.)

To make matters worse, these acts often go unpunished since

many developing, emerging and transition economies lack the
necessary political and economic institutions to enable
democracy and markets to function.
In the context of
developing, emerging and transition economies, instituting
corporate governance entails establishing democratic, marketbased institutions as well as sound guidelines for how
companies are run internally.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Problems Faced by Developing

and Transition Economies (contd.)

Even in countries like India which have the benefit of

democratic institutions and equity culture for well over five
decades, there have been a series of scams involving huge
sums of public funds. The judiciary is so lethargic and
bureaucratic that it takes more than a couple of decades to
bring the scamsters to book. Regulatory bodies are not alert,
government appointees in Boards are lax, due to partisan
politics and corruption in government, the bureaucracy hardly
play their roles in effectively stemming the damages caused
by corporate misgovernance.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Problems Faced by Developing

and Transition Economies (contd.)

Lower economic growth.

Dominant public sector: The general perception is that
corporate governance is meant for the private sector and the
public sector does not fall within its purview.
Lack of effectiveness of privatization.
Lack of awareness among shareholders.
Greater government influence, and less autonomy to
enterprises.
Largest shareholders in most of the companies are the
privatization funds.
Internal owners dominate more than a companys external
owners. Given their discretionary powers, company managers
use the company resources to their own advantage. Investors,
therefore, cannot get their returns from cash flow of the
company from the projects.
Business Ethics and Corporate Governance, 2e

A. C. Fernando

Summary of Problems Facing

These Economies

External owners do not have enough voting power.

Concentration of ownership in the hands of few individuals and
family-owned corporations.
Lack of strong legal protection for investors in developing
countries that leads to concentration of ownership which is
used as a means to overcome the power of the management.
This, leads to misappropriation of minority interests.
Capital markets are underdeveloped and do not facilitate the
inflow of new capital.
Market transactions are often based on abuse of internal
information.
Redrawing property rights and contract laws are slow in
coming.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Lack of well regulated banking sector.

Exit mechanisms, bankruptcy and foreclosure norms are absent.
Sound securities market do not exist.
Competitive markets have not developed.
Corruption and mismanagement.
Non-uniform guidelines: The government-formulated guidelines
to ensure better governance are not uniformly applied to all
companies.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Appendix

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Who is an Independent Director?

Desirability of having Independent Directors
Views of Promoters

Business Ethics and Corporate Governance, 2e

A. C. Fernando

II. Independent Directors

Business Ethics and Corporate Governance, 2e

A. C. Fernando

SEBI directions are meant only for listed companies

Recommendations of Irani committee apply both to the
listed & non-listed companies

Definition of Independent Director is now wider and includes

a Non-Executive Director (NED), who
Does not have any material pecuniary relationships or transactions
with the companys associates
Is not related to promoters or persons occupying management
positions at the Board level of a level below
Has not been a company executive in past 3 years
Is not/was not in last 3 years a partner or executive of the statutory
audit/internal audit/consulting firm
Is not a material suppliers, service provider, customer, lessor or lessee
of the company
Does not own 2 per cent or more of voting shares

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Independent Director Clause 49

At least one Independent Director to be present on the Boards

of all material subsidiaries
Minutes of the Board meeting of a subsidiary to be tabled at
board meeting of parent company
Significant transactions or arrangements entered into by each
subsidiary to be reported to the Board periodically
Audit Committee to have minimum of three directors as
members, of which two-thirds must be Independent Directors
Independent Director to be Chairman of Audit Committee and
be present at AGM to answer shareholders queries
A minimum of two Independent Directors to be present at AGM

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Role and Responsibilities

Prior approval of shareholders required in a general

meeting for all fees and compensation paid to NEDs
Maximum number of stock options for NEDs including
independent directors in a financial year to be specified in
shareholders resolution
Criteria of making payments to NEDs to be disclosed either
in the annual report or on the website
Number of shares and convertible instruments held by
NEDs to be disclosed in Annual Report
Shareholding of persons proposed to be appointed as NEDs
to be disclosed in the notice if the general meeting called
for appointment of the directors
Business Ethics and Corporate Governance, 2e

A. C. Fernando

Remuneration of Independent Directors

Formulation and execution of strategy

Audit and assurance process
Shareholder and stakeholder communications
Legal and regulatory compliance
Enterprise risk management
Organisational ethics, brand loyalty, and employee retention
An organization must manage a host of governance
related activities and expectations that affect its
ability to create and sustain value.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Challenges for Independent Directors

Executive Pay, an Unsettled Issue

Emphasis on Transparency and Disclosure
Pay as a Reward for Performance
Performance Hurdles
Remuneration Committee
Severance Payments
Other Remuneration Packages

Business Ethics and Corporate Governance, 2e

A. C. Fernando

III. Directors Remuneration

Remuneration shall include,

(a) any expenditure incurred by the company in providing any
rent free accommodation, or any other benefit or amenity in
respect of accommodation free of charge, to any director or
manager;
(b) any expenditure incurred by the company in providing any
other benefit or amenity free of charge or at a concessional
rate to any of the person aforesaid;

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Directors Remuneration in India

(c)

any expenditure incurred by the company in respect of any

obligation, or service, which but for such expenditure by the
company, would have been incurred by any of the persons
aforesaid; and

(d) any expenditure incurred by the company to effect any

insurance on the life of, or to provide any pension, annuity or
gratuity for, any of persons aforesaid or his spouse or child.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Directors Remuneration in India

According to Section 200 of the Companies Act:

(1) No company shall pay to any officer or employee thereof,
whether in his capacity as such or otherwise, remuneration
free of any tax, or otherwise calculated by reference to, or
varying with, any tax payable by him, or the rate or standard
rate of any such tax, or the amount thereof.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

Prohibition of Tax-free Payments

The Hampel Committee was set up in November 1995 to protect

investors and preserve and enhance the standing of companies
listed on the London Stock Exchange.
The committee
developed further the Cadbury Report
produced the Combined Code
recommended that
the auditors should report on internal control privately
to the directors
the directors maintain and review all (and not just
financial) controls

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The Hampel Committee, 1995

Companies that do not already have an internal audit

function should from time to time review their need
for one

Introduced the Combined Code that consolidated the

recommendations of earlier corporate governance reports
(Cadbury and Greenbury).

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The Hampel Committee, 1995 (contd.)

The Turnbull Committee was set up by the The Institute of

Chartered Accountants in England and Wales (ICAEW) in 1999.
The committee
provided guidance to assist companies in implementing the
requirements of the Combined Code relating to internal
control.
recommended that where companies do not have an internal
audit function, the board should consider the need for
carrying out an internal audit annually.
recommended that boards of directors confirm the existence
of procedures for evaluating and managing key risks.

Business Ethics and Corporate Governance, 2e

A. C. Fernando

The Turnbull Committee, 1999

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