Indian Ethos and Business Ethics Course Code:

22MBACC104
 Course Outline
No. of
Units Topics to be covered
Hours
Module 4: Corporate Governance

What is Corporate Governance? Principles and advantages of Corporate Governance; 4

Pillars of Corporate Governance; Board Structure and Functioning CSR-Legislation in
India in depth analysis: Scope for CSR Activities under Schedule VII, Appointment of
Independent Directors on the Board, Future of governance
4
4
Learning Outcome: To interpret conflicts and ethics in functional domains and hours
to understand the ethical dimensions of decision making.
 Module 4
Corporate Governance
 Meaning of Corporate Governance
▸ Business ethics - not a choice between profits
and ethics rather profits in an ethical manner
▸ Corporate governance – getting attention for
satisfying the divergent interest of the
stakeholders of a business enterprise
▸ Three main constituents of corporate governance
▹ Shareholders
▹ Board of Directors
▹ Management
 Stakeholders of Corporate
Governance Include:
▸ Stake Holders
▹ Internal Stake ▹ External Stake Holders
Holders ■ Suppliers
■ Promoters ■ Customers
■ Members ■ Lenders
■ Employees ■ Bankers
■ Management ■ Environment
■ Board of ■ Community
Directors
■ Government
■ Regulators
 Definition:
▸ The way a corporation is governed
▸ Technique by which companies are directed and
managed
▸ Carrying the business as per the stakeholders’
interest
▸ Conducted by the board of directors and
concerned committees
▸ Creating a balance between individual and
societal goals as well as economic and social
goals
▸ Gabreille O’Donovan

“An internal system encompassing the policies,

processes and people, which serves the
needs of shareholders and other stake
holders, by directing and controlling
management activities with good business
savvy, objectivity, accountability and integrity.”
 Objectives:
▸ To promote a healthy environment for long term
investment
▸ To create trust and confidence
▸ To promote business development
▸ To improve the efficiency of the capital markets
▸ To enhance the effectiveness in service of the
real economy
 Background: The Agency Theory
▸ 1983
▸ Eugene Fama &Michael Jensen
▸ Separation of ownership and control
▸ Relationship between principal-shareholders and
agents-managers
▸ Involves the cost of resolving conflicts between
▸ Shareholders & managers
▸ Shareholders & debenture/bond holders
 The Agency Theory
▸ Why companies make acquisitions that are bad
foe shareholders?
▸ Why convertible bonds are used and bonds are
sometimes sold warrants?
▸ Why capital structure matters?
 Forms of business and conflicts of
interest
▸ Proprietorship
▸ Partnership
▸ Corporation
 Forms of business and conflicts of
interest
▸ Proprietorship
▸ It is a business firm owned by an individual who possesses the
ownership right to the firm's profits and is personally liable for the
firm's debts.
▸ The proprietor often works directly for the firm, providing managerial
and other labor services.
▸ Proprietorship account for 73 percent of the businesses in the US, but
only 6 percent of all business revenues.
▸ Examples: neighborhood grocery stores, barbershops, farms.
▸ Corporate governance perspective: Since the manager and the owner
are the same, this form presents fewer risks than the corporation.
▸ The owner has the type and quality of information needed to evaluate
various risks of the firm.
▸ The owner can also easily monitor the condition and the risks of the
business, and control the business' risk exposure.
 Forms of business and conflicts of
interest
▸ Partnership
▸ It is a business firm owned by two or more individuals who possess
ownership rights to the firm's profits and are personally liable for the
debts of the firm.
▸ In terms of owner liability there is no difference between a
proprietorship and a partnership.
▸ Partnership account for 7 percent of the businesses in the US, and 5
percent of all business revenues.
▸ Examples: law, medical and accounting firms.
▸ Corporate governance perspective: Partners typically overcome
conflicts of interest internally by engaging in partnership contracts
specifying the rights and responsibilities of each partner.
 Forms of business and conflicts of
interest
▸ Corporation
▸ It is a business firm owned by shareholders who possess ownership
rights to the firm's profits, but whose liability is limited to the amount
of their investment in the firm.
▸ This is an attractive corporate structure since:
▸ Stockholders' liability is limited to the extent of their explicit
investment.
▸ Ownership can easily be transferred.
▸ Corporations accounts for 20 percent of businesses in the U.S. but 90
percent of total revenues.
▸ Corporate governance perspective: It's difficult for shareholders to
monitor management and the firm's operations.
 Advantages & Disadvantages of
Corporation
▸ Advantages:
▸ Can raise capital, grant ownership- issue stock or borrow- issue bonds
▸ Hires experts to manage the business – owners need not run the
business
▸ Ownership is transferable
▸ Disadvantages:
▸ More highly regulated than partnership or sole proprietorship
▸ Separation of owners and managers
▸ Agency relationship – agent acts on behalf of principal
▸ Principal-agent problem – potential conflict between the owners
and managers
▸ Principal- share holders
▸ Agents- management & members of board of directors
▸ Costs arising from conflicts
▸ https://www.youtube.com/
watch?v=w7mn0WHnTk
M
Essentials of
Corporate
Governance

17
Essentials of Corporate Governance
▸ Role and powers of Board
▸ Legislation
▸ Management Environment
▸ Board skills
▸ Board appointment
▸ Board instruction and training
▸ Board independence
▸ Board meetings
▸ Code of conduct
▸ Strategy setting
▸ Business and community obligation
▸ Financial and operational recording
▸ Monitoring the board performance
▸ Audit committees
▸ Risk management
 Characteristics of Corporate
Governance
▸ Fairness
▸ Openness/Transparency
▸ Independence
▸ Probity/Honesty
▸ Responsibility
▸ Accountability
▸ Reputation
▸ Judgment
▸ Integrity
 Benefits of Corporate Governance
▸ Benefits to the Companies
▸ Benefits to the Shareholders
▸ Benefits to the National Economy
 Benefits to the Companies
▸ Improving access to capital and financial markets
▸ Provide and exit policy and ensure the smooth inter-generation
transfer of wealth and disinvestment of family asset as well as
reducing the chance of conflict
▸ Leads to better system of internal control, greater accountability
and better profit margins
▸ Ability to attract equity investors within and from abroad
▸ Reduces the cost of loans/credit for corporations
▸ Investors and potential partners have more confidence in
investing and expanding company’s operations
▸ Lower the capital cost
▸ Helps in brand information development
▸ Ensures organisation is managed in a manner that suits the
interest of all
 Benefits to the Shareholders
▸ Maintains investors confidence and helps company raise
capital efficiently and effectively
▸ Greater security on investment
▸ Provides proper incentives for the board and management
to pursue objectives of the company
▸ Ensures that the shareholders are sufficiently informed on
decision concerning amendments of statutes or article or
law incorporation with sales of assets, etc.
 Benefits to the National Economy
▸ Ensures corporate success and economic growth
▸ Positive impact on share price
▸ Proper inducement to owners as well as managers to
achieve objectives in the interest of the shareholders and
the organisation
▸ Minimises wastages, corruption, risk and mismanagement
Drawbacks of Corporate Governance
▸ Separation of ownership and control
▸ Insider trading
▸ Misrepresentation of information
▸ Monitoring costs
▸ Corporations governed by statutes
▸ Fiduciary duty of board
▸ Increased costs
▸ Principal-agent conflict
 Importance of Corporate
Governance
▸ Changing ownership structure
▸ Importance of social responsibility
▸ Growing number of scams
▸ Indifference on the part of shareholders
▸ Globalisation
▸ Takeovers and mergers
▸ SEBI
 OECD Principles of Corporate
Governance
▸ The Organization of Economic Cooperation and Development released
its first set of corporate governance principles in 1999.
▸ A revised version was then released in 2004.
▸ The principles were developed and endorsed by the ministers of OECD
member countries in order to help OECD and Non-OECD governments in
their efforts to create legal and regulatory frameworks for corporate
governance in their countries.
 OECD Principles of Corporate
Governance
▸ The six OECD Principles are:
▹ Ensuring the basis of an effective corporate governance
framework
▹ The rights of shareholders and key ownership functions
▹ The equitable treatment of shareholders
▹ The role of stakeholders in corporate governance
▹ Disclosure and transparency
▹ The responsibilities of the board
Ensure the basis of an effective corporate governance
framework
▸ The corporate governance framework should:
▹ promote transparent and efficient markets,
▹ be consistent with the rule of law and
▹ clearly articulate the division of responsibilities among different
supervisory, regulatory and enforcement authorities.
 The rights of shareholders and key ownership
functions
▸ The corporate governance framework should protect and facilitate
the exercise of shareholders’ rights.
▸ Basic shareholder rights should include the right to:
▹ Secure methods of ownership registration;
▹ Convey or transfer shares;
▹ Obtain relevant and material information on the corporation on
a timely and regular basis;
▹ Participate and vote in general shareholder meetings;
▹ Elect and remove members of the board; and
▹ Share in the profits of the corporation.
 The equitable treatment of shareholders

▸ The corporate governance framework should ensure the equitable

treatment of all shareholders, including minority and foreign
shareholders.
▹ All shareholders should have the opportunity to obtain effective
redress for violation of their rights.
▸ The principles also state that:
▹ All shareholders of the same series of a class should be treated
equally
▹ Insider trading and abusive self-dealing should be prohibited
▹ Members of the board and key executives should be required to
disclose to the board whether they, directly, indirectly or on
behalf of third parties, have a material interest in any
transaction or matter directly affecting the corporation.
 The role of stakeholders in corporate governance

▸ The corporate governance framework should

▹ recognize the rights of stakeholders established by law or
through mutual agreements and
▹ encourage active co-operation between corporations and
stakeholders in creating wealth, jobs, and the sustainability of
financially sound enterprises.
 Disclosure and transparency

▸ The corporate governance framework should ensure that timely and

accurate disclosure is made on all material matters regarding the
corporation, including the financial situation, performance,
ownership, and governance of the company.
 The responsibilities of the board

▸ The corporate governance framework should ensure

▹ the strategic guidance of the company,
▹ the effective monitoring of management by the board, and
▹ the board’s accountability to the company and the shareholders
 Evolution of Corporate
Governance in India
Corporate Governance
Committees in India
Evolution of Corporate Governance in
India
• The concept of Corporate Governance evolved
in India by 1992
• Influenced by the recommendations of
Cadbury Committee and the efforts taken by
various countries to implement the system of
effective corporate governance
• Some committees were formed in India as
well
 Committees in India
 Narasimham Committee 1991
 Confederation of Indian Industry – Voluntary Code of
Corporate Governance for Listed Companies 1998
 Kumar Mangalam Birla Committee 1999
 Naresh Chandra Committee 2002
 Narayan Murthy Committee 2003
 Dr. J.J. Irani Committee Report 2005
 Narasimham Committee 1991
 Focused on Banking Reforms
 Recommendations regarding Corporate Governance were
based on the assumption that the resources of banks come
from general public and were held by the bank in trust that
they were to be deployed for maximum benefits of the
depositors
 Narasimham Committee
Recommendations Aimed At:
 Ensuring a degree of operational flexibility
 Internal autonomy of the public sector banks in their decision
making process
 A greater degree of professionalism in banking operations
 Confederation of Indian Industry – Voluntary Code of
Corporate Governance for Listed Companies 1998

 Recommendation 1
 There is no need to adopt the German system of two-tier boards to ensure
desirable corporate governance.
 A single board, if it performs well, can maximise long term shareholder value just
as well as a two- or multi-tiered board.
 Equally, there is nothing to suggest that a two-tier board, per se, is the panacea to
all corporate problems.
 Recommendation 2
 Any listed companies with a turnover of Rs.100 crores and above should have
professionally competent, independent, non- executive directors, who should
constitute at least 30 percent of the board if the Chairman of the company is a
non-executive director, or at least 50 percent of the board if the Chairman and
Managing Director is the same person.
 Confederation of Indian Industry – Voluntary Code of
Corporate Governance for Listed Companies 1998
 Recommendation 3
 No single person should hold directorships in more than 10 listed companies.
 Recommendation 4
 For non-executive directors to play a material role in corporate decision making and
maximising long term shareholder value, they need to become active participants in boards,
not passive advisors; have clearly defined responsibilities within the board such as the Audit
Committee; and know how to read a balance sheet, profit and loss account, cash flow
statements and financial ratios and have some knowledge of various company laws.
 Recommendation 5
 To secure better effort from non-executive directors, companies should:
 Pay a commission over and above the sitting fees for the use of the professional inputs.
 Consider offering stock options, so as to relate rewards to performance.
 Recommendation 6
 While re-appointing members of the board, companies should give the attendance record
of the concerned directors.
 If a director has not been present (absent with or without leave) for 50 percent or more
meetings, then this should be explicitly stated in the resolution that is put to vote.
 As a general practice, one should not re-appoint any director who has not had the time
attend even one half of the meetings.
 Confederation of Indian Industry – Voluntary Code of
Corporate Governance for Listed Companies 1998
 Recommendation 7
 Key information that must be reported to, and placed before, the board must contain:
 Annual operating plans and budgets
 Quarterly results for the company as a whole and its operating divisions or business segments.
 Internal audit reports
 Default in payment of interest or non-payment of the principal on any public deposit, creditor or FI’s.
 Any issue which involves possible public or product liability claims of a substantial nature
 Details of any joint venture or collaboration agreement.
 Transactions that involve substantial payment towards goodwill, brand equity, or intellectual property 10
 Recommendation 8
1. Listed companies with either a turnover of over Rs.100 crores or a paid-up capital of Rs.20
crores should set up Audit Committees within two years.
2. Audit Committees should consist of at least three members, all drawn from a company’s
non-executive directors
3. To be effective, the Audit Committees should have clearly defined Terms of Reference and
its members must be willing to spend more time on the company’s work
4. Audit Committees should assist the board in functions relating to financial statements and
proposals that accompany the public issue of any security
5. Audit Committees should periodically interact with the statutory auditors and the internal
auditors to ascertain the quality of the company’s accounts as well as the capability of the
auditors themselves.
Confederation of Indian Industry – Voluntary Code of
Corporate Governance for Listed Companies 1998
Recommendation 9
 Under “Additional Shareholder’s Information”, listed companies should
give data on:
1. High and low monthly averages of share prices
2. Greater detail on business segments
Recommendation 10
1. Consolidation of Group Accounts should be optional and subjective
2. If a company chooses to voluntarily consolidate, it should not be
necessary to represent the accounts of its subsidiary companies under
section 212 of the Companies Act.
Recommendation 11
 Major Indian stock exchanges should gradually insist upon a compliance
certificate, signed by the CEO and the CFO, which clearly states that:
 The management is responsible for the preparation, integrity and fair
presentation of the financial statements and other information in the Annual
Report
 Confederation of Indian Industry – Voluntary Code of
Corporate Governance for Listed Companies 1998
 Recommendation 12
 For all companies with paid-up capital of Rs. 20 crores or more, the quality and quantity
of disclosure that accompanies a GDR issue should be the norm for any domestic issue.
 Recommendation 13
 Government must allow far greater funding to the corporate sector against the security
of shares and other paper.
 Recommendation 14
1. If any company goes to more than one credit rating agency, then it must divulge in the
prospectus and issue document the rating of all the agencies that did such an exercise.
2. It is not enough to state the ratings. These must be given in a tabular format that
shows where the company stands relative to higher and lower ranking. It makes
considerable difference to an investor to know whether the rating agency or agencies
placed the company in the top slots, or in the middle, or in the bottom.
 Recommendation 15
 Companies that default on fixed deposits should not be permitted to
 accept further deposits and make inter-corporate loans or investments until the default is made
good; and
 declare dividends until the default is made good.
 Kumar Mangalam Birla Committee 1999
Securities and Exchange Board of India (SEBI) in 1999 set up a committee
under Shri Kumar Mangalam Birla, member SEBI Board, to promote and
raise the standards of good corporate governance.
The primary objective of the committee was to view corporate
governance from the perspective of the investors and shareholders and
to prepare a ‘Code’ to suit the Indian corporate environment.
The committee divided the recommendations into two categories,
namely, mandatory and non- mandatory.
The recommendations which are absolutely essential for corporate
governance can be defined with precision and which can be enforced
through the amendment of the listing agreement is classified as
mandatory.
Others, which are either desirable or which may require change of laws
be classified as non-mandatory.
 Kumar Mangalam Birla Committee 1999
 Mandatory Recommendations
 The mandatory recommendations apply to the listed companies with paid up share
capital of 3 crore and above.
 Composition of board of directors should be optimum combination of executive &
non-executive directors.
 Audit committee should contain 3 independent directors with one having financial
and accounting knowledge.
 Remuneration committee should be setup
 The Board should hold at least 4 meetings in a year with maximum gap of 4 months
between 2 meetings to review operational plans, capital budgets, quarterly results,
minutes of committee’s meeting.
 Director shall not be a member of more than 10 committee and shall not act as
chairman of more than 5 committees across all companies
 Management discussion and analysis report covering industry structure,
opportunities, threats, risks, outlook, internal control system should be ready for
external review
 Any Information should be shared with shareholders in regard to their investments.
 Kumar Mangalam Birla Committee 1999
 Non-Mandatory Recommendations
 The committee made several recommendations with reference to:
 Role of chairman
 Remuneration committee of board
 Shareholders’ right for receiving half yearly financial performance.
 Postal ballot covering critical matters like alteration in memorandum
 Sale of whole or substantial part of the undertaking
 Corporate restructuring
 Further issue of capital
 Venturing into new businesses
 These recommendations were to apply to all the listed private and public sector
companies, their directors, management, employees and professionals
associated with such companies. The Committee recognizes that compliance
with the recommendations would involve restructuring the existing boards of
companies. It also recognizes that smaller ones will have difficulty in
immediately complying with these conditions.
 Naresh Chandra Committee 2002

While SEBI was making efforts to introduce corporate governance

standards among Indian corporates, the Department of Company
Affairs took another initiative in this direction.
The Naresh Chandra Committee was appointed as a high level
committee to examine various corporate governance issues by the
Department of Company Affairs on 21 August, 2002.
 The committee’s recommendations mainly concerned issues such as
these:
1. the auditor-company relationship;
2. disqualifications for audit assignments;
3. list of prohibited non-audit services;
4. independence standards for consulting;
5. compulsory audit partner rotation;
6. auditor’s disclosure of contingent liabilities
 Narayan Murthy Committee 2003

The Committee on Corporate Governance, headed by Shri

Narayanmurthy was constituted by SEBI, to evaluate the
existing corporate governance practices and to improve these
practices as the standards themselves were evolving with
market dynamics.
The committee’s recommendations are based on the relative
importance, fairness, accountability, transparency, ease of
implementation, verifiability and enforceability related to audit
committees, audit reports, independent directors, related
parties, risk management, directorships and director
compensation, codes of conduct and financial disclosures.
 Narayan Murthy Committee 2003
 The key mandatory recommendations focus on
 Strengthening the responsibilities of audit committees
 At least one member should be ‘financially knowledgeable’ and at least one member should have accounting or
related financial management proficiency.
 Quality of financial disclosures
 Improving the quality of financial disclosures, including those related to related party transactions.
 Proceeds from initial public offerings
 Companies raising money through an IPO should disclose to the Audit Committee, the uses / applications of funds
by major category like capital expenditure, sales and marketing, working capital, etc.
 Other recommendations
 Requiring corporate executive boards to assess and disclose business risks in the annual reports of companies.
 Should be obligatory for the Board of a company to lay down the code of conduct for all Board members and
senior management of a company.
 The position of nominee directors: Nominee of the Government on public sector companies shall be similarly
elected and shall be subject to the same responsibilities and liabilities as other directors
 Improved disclosures relating to compensation paid to non-executive directors.

Non-mandatory recommendations include moving to a regime where

corporate financial statements are not qualified; instituting a system of
training of board members; and the evaluation of performance of board
members.
 Narayan Murthy Committee 2003

Whistle Blower Policy

Personnel who observe an unethical or improper practice should
be able to approach the audit committee without necessarily
informing their superiors.
Implementation issue
A primary issue that arises with implementation is whether the
recommendations should be made applicable to all companies
immediately or in a phased manner, since the costs of compliance
may be large for certain companies.
Another issue is whether to extend the applicability of these
recommendations to companies that are registered with BIFR. In
the case of such companies, there is likely to be almost little or no
trading in their shares on the stock exchanges.
 Dr. J.J. Irani Committee Report 2005

 DR J.J. IRANI COMMITTEE REPORT ON COMPANY LAW, 2005

 The Government of India constituted an expert committee on company
law on 2 December 2004 under the chairmanship of Dr J.J. Irani to make
recommendations on
 (i) responses received from various stakeholders on the concept paper;
 (ii) issues arising from the revision of the Companies Act, 1956;
 (iii) bringing about compactness by reducing the size of the Act and removing
redundant provisions;
 (iv) enabling easy and unambiguous interpretation by recasting the provisions of
the law;
 (v) providing greater flexibility in rule making to enable timely response to ever-
evolving business models; and
 (vi) protecting the interests of the stakeholders and investors, including small
investors
 Clause 49 in Listing Agreement on Corporate
Governance
 Clause 49 of “Listing agreement” deals with the complete guidelines for corporate
governance.
 Following are the provisions, a company, must comply to implement effective corporate
governance.
 In order to comply with clause 49(1) a company must adhere with some following principles.
 Right of Shareholder- As shareholders are the ultimate owner of the company, the company should seek to
protect and facilitate the exercise of right of shareholders. A company must always be transparent with its
shareholders and shareholders should have all the rights regarding General Meeting such as information
about meeting, participate, Vote and questioning in GM etc.
 Role of stakeholders- A company must take care of stakeholder’s right and encourage
cooperation between company & stakeholders. Their rights can be by Mutual agreement or by
Applicable law or statute.
 Disclosure & Transparency- It is the obligation on company to be transparent with its
stakeholders by giving disclosures of all material matters on timely basis. Disclosure can be
regarding financial position, Performance, ownership and Governance etc. Non disclosure of
Material Matter is Strictly Prohibited.
 Responsibility of Board- Members of the Board should disclose their interest in company and in
any individual transaction and contract. They should also maintain the rule of confidentiality.
They should also perform their key function such as preparation of major action plan, corporate
Strategy, execution of Board, and effective financial Performance.
Thank you