Introduction to Corporate Governance

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Introduction to CORPORATE GOVERNANCE bY Dr. b. s. navi Associate Professor, RCU PGC Vijayapur

Corporate governance:

Corporate governance Protects the rights of shareholders to trade shares, to obtain timely and regular information about corporate well being, participate and vote in general shareholder meetings, elect and remove members of the board, and share in corporate profits. Recognises and protect the rights of stakeholders. Dr. B. S. Navi 2


Contd … The structure and conduct of corporate governance and the methods used in the measurement of company operations, accounting, principles, and practice vary dramatically across countries The relationship among stakeholders used to determine and control strategic direction and performance of an organization is termed corporate governance The way in which order and process is established to ensure that decisions are made and interests are represented properly for all stakeholders. Dr. B. S. Navi 3


Corporate Governance- Concept & Objectives “CORPORATE GOVERNANCE is a system by which companies are directed and controlled”. Protecting the long term interest and enhancing the values of shareholders and other stakeholders ( viz .,customers, employees, creditors, bankers, regulators and society at large) Harmonizing rights & interest of shareholders and stakeholders by continuous exercise of striking balance . 4 Dr. B. S. Navi

Ethical principles supported by law:

Ethical principles supported by law Honesty and Transparency Responsibility and Accountability Fairness and Justice Avoidance of conflicts of interest and related party dealings Application of the principles of good corporate governance Dr. B. S. Navi 5


Why is good corporate governance important? It can lower the cost of capital. It promotes investor confidence. It is important to respond to global best practice . Dr. B. S. Navi 6


How is good corporate governance achieved? There are various models of good corporate governance. Most recently, the OECD has set guidelines. The Cadbury Committee in the UK, benchmarked CG and then the General Motors Guidelines on Significant Corporate Governance Issues. The Canadians and the ASX Corporate Governance Council have espoused similar principles. Dr. B. S. Navi 7


Reducing the risks normally faced by the company/ organization. Responsibility to introduce and effectively implement Corporate Governance is exclusively of Board of Directors in a manner that it becomes way of organizational life and not merely written rules or regulations or code of ethics. Ethics & Transparency are cardinals of Corporate Governance . 8 Dr. B. S. Navi


Evolution and Implementation of the Concept at Global Level. 9 Corporate Governance evolved and introduced as remedial measures in corporate sector for forbidding the wrongs or unethical practices. Appointment of Various committees at global level to address the issue and give recommendations. Worldwide economic crisis and corporate debacles have proven the inadequacy of regulatory frame work to bring the best out of corporate management. Establishment of GATT and WTO regulations also emphasized the need of good corporate practices i.e. Corporate Governance . Dr. B. S. Navi


Challenges 19th C Entrepreneurship 20thC Management 21st C Governance Dr. B. S. Navi 10

Why Governance? Now:

Why Governance? Now International deregulation of financial markets Increasing scale and activity of corporations Growth of investment institutions Effective monitoring necessary for security of investments Recognition that governance matters for accountability, performance and attracting capital. A general trend in society towards openness, transparency and disclosure . Dr. B. S. Navi 11

Goal of Corporate Governance:

Goal of Corporate Governance The single overriding objective of corporate governance is the optimization over time of the return to shareholders The most widely accepted statement of good corporate governance practices are those established by OECD The rights of shareholders The equity treatment of shareholders The role of stakeholders in corporate governance Disclosure and transparency The responsibilities of the board Dr. B. S. Navi 12

Structure of Corporate Governance:

Structure of Corporate Governance The internal forces, the officers of the corporation and the Board of directors, are those directly responsible for determining the strategic direction and the execution of the company’s future The external forces include: The equity markets The analysts The creditors and credit agencies who lend them money The auditors The multitude of regulators Dr. B. S. Navi 13


Definitions “Corporate Governance is the system by which companies are directed and controlled…” Cadbury Report (UK), 1992 “…to do with Power and Accountability: who exercises power, on behalf of whom, how the exercise of power is controlled.” Sir Adrian Cadbury, in Reflections on Corporate Governance, Ernest Sykes Memorial Lecture, 1993 Dr. B. S. Navi 14

Canadian Definition:

Canadian Definition “…the process and structure… to direct and manage the business and affairs of the corporation with the objective of enhancing shareholder value, which includes ensuring the financial viability of the business….” Where were the Directors? Guidelines for Improved Corporate Governance in Canada, TSE, 1994 . Dr. B. S. Navi 15

OECD Definition:

OECD Definition “ Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders ..also the structure through which objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.” Preamble to the OECD Principles of Corporate Governance, 2004 Dr. B. S. Navi 16

OECD recommendations 2004:

OECD recommendations 2004 Disclosure of The financial and operating results of the company. Company objectives. Major share ownership and voting rights. Remuneration policy for members of the board and key executives, and information about board members, including whether they are independent. Related party transactions. Foreseeable risk factors. Issues regarding employees and other stakeholders. Governance structures and policies Dr. B. S. Navi 17

Indian Definition:

Indian Definition “…fundamental objective of corporate governance is the ‘enhancement of the long-term shareholder value while at the same time protecting the interests of other stakeholders.” SEBI (Kumar Mangalam Birla) Report on Corporate Governance, January, 2000 Dr. B. S. Navi 18

Gandhian Definition:

Gandhian Definition Trusteeship obligations inherent in company operations, where assets and resources are pooled and entrusted to the managers for optimal utilisation in the stakeholders’ interests. Dr. B. S. Navi 19

Others Definition:

Others Definition “Corporate governance is the system by which companies are directed and managed. It influences how the objectives of the company are set and achieved, how risk is monitored & assessed, & how performance is optimized. Good corporate governance structures encourage companies to create value (through entrepreneurialism, innovation, development & exploration) and provide accountability & control systems commensurate with the risks involved” Dr. B. S. Navi 20

Other Definitions:

Other Definitions Corporate governance is essentially about leadership: leadership for efficiency; leadership for probity; leadership with responsibility; and leadership which is transparent and which is accountable. - PRINCIPLES FOR CORPORATE GOVERNANCE IN THE COMMONWEALTH Dr. B. S. Navi 21

What is Corporate Governance:

What is Corporate Governance The Manner in which a Corporation is Run Achieving its Objectives Transparency of its Operations Accountability & Reporting Good Corporate Citizenship The Processes & Operating Relationships that Best Achieve Organisational Goals Dr. B. S. Navi 22


Purpose In its broadest sense, “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’. The aim is to align as nearly as possible the interests of individuals, of corporations, and of society. (Cadbury 2004 ) Dr. B. S. Navi 23

Good corporate governance and development:

Good corporate governance and development 1991 - following collapse of firms declared healthy in audited returns, the Financial Reporting Council, the London Stock Exchange and the UK accountancy profession established the Cadbury Committee to inquire into financial aspects of corporate governance. Dr. B. S. Navi 24

Cadbury Report Recommended:

Cadbury Report Recommended Conformity with its Code of Best Practice. This was voluntary. More clear and detailed financial reporting in order to: Inspire public confidence in corporations Enable directors to advance the best interests of the company and to avoid concentrations of power. The clear separation of the responsibilities of CEO and chair of the board. Dr. B. S. Navi 25

Non-executive directors should:

Non-executive directors should Have a stronger role on boards Should be selected according to formal processes Be clearly independent from the management of the company Not have business interests which could conflict with those of the company Dr. B. S. Navi 26

Cadbury also recommended:

Cadbury also recommended The establishment of an Audit Committee with at least 3 non-executive directors and access to independent audit advice Dr. B. S. Navi 27

Diversity in CG :

Diversity in CG National, regional and cultural differences Ownership structure and dispersion The industry and market environment of the corporation Firm size and structure Life cycle variations including origin & development, technology & periodic crises and new directions Dr. B. S. Navi 28

ASX principles:

ASX principles Derived substantially from the lead of Cadbury, but good practice in any setting. Dr. B. S. Navi 29


Formalise and disclose the functions reserved to the board and those delegated to management . Adopt a formal board charter that details the functions and responsibilities of the board or a formal statement of delegated authority to management. Principle 1: Lay solid foundations for management and oversight Dr. B. S. Navi 30


Principle 2: Structure the board to add value A majority of the board should be independent directors. An independent director is independent of management and free of any business or other relationship that could materially interfere with – or could reasonably be perceived to interfere materially with – the exercise of their unfettered and independent judgment. Dr. B. S. Navi 31


Principle 3: Promote ethical and responsible decision-making Clarify the standards of ethical behaviour required of company directors and key executives Establish a code of conduct Promote integrity Dr. B. S. Navi 32


Principle 4: Safeguard integrity in financial reporting Require written statements from the CEO and the CFO to the board that the company’s financial reports present a true and fair view of its financial condition in accordance with relevant accounting standards. Establish an audit committee of at least 3 non-executive directors, not chaired by chair of board. Dr. B. S. Navi 33


Principle 5: Make timely and balanced disclosure Develop continuous disclosure policies and procedures. Dr. B. S. Navi 34


Principle 6: Respect the rights of shareholders Design and disclose a communications strategy to promote effective communication with shareholders and encourage effective participation at general meetings. Dr. B. S. Navi 35


Principle 7: Recognise and manage risk Establish a system to identify , assess, monitor and manage risk inform investors of material changes to the company’s risk profile . The CEO and CFO should certify to the board that the company’s risk management and compliance systems are operating effectively. Dr. B. S. Navi 36


Principle 8: Encourage enhanced performance Disclosure of performance evaluation of the board. Induction program for new directors. All board members to have direct access to company secretary. Board members to have access to independent advice at company expense. Dr. B. S. Navi 37


Principle 9: Remunerate fairly and responsibly Disclose company’s remuneration policies including cash, fees and other benefits. The board should establish a remuneration committee Dr. B. S. Navi 38


Principle 10: Recognise the legitimate interests of stakeholders The board should set standards of public accountability for the company and oversee adherence to these. Establish a code of conduct to guide compliance with legal and other obligations. Dr. B. S. Navi 39

Why were not such measures already in place?:

Why were not such measures already in place? Why did it take the collapse of Enron, WorldCom, HIH Insurance and many other firms to move the industry, investors and governments to act? Was it because of the accepted dogma that high risk is good for business because it produces high returns? Dr. B. S. Navi 40

Such rules are a floor, not a ceiling:

Such rules are a floor, not a ceiling The GM Corporate Governance Guidelines by contrast, place a stronger emphasis on Directors’ skills and suitability for the Board, eg . Item 4, Director Orientation and Continuing Education The Board and Management will conduct a comprehensive orientation process for new Directors to become familiar with the Corporation's vision, strategic direction, core values including ethics, financial matters, corporate governance practices and other key policies and practices .... The Board also recognizes the importance of continuing education for its directors and is committed to provide such education in order to improve both Board and Committee performance. Dr. B. S. Navi 41


Classic Symptoms Preceding Collapse Overstatement of the value of assets, and understatement of liabilities in financial reports . Use of related party transactions to disguise the reality, e.g. to create a false impression about earnings. Delays in financial reporting. Dr. B. S. Navi 42


Continuing financial losses and cash flow deficiencies Weak management Inadequate management succession planning Looming debt payments & concealment of bad debts Inadequate capital expenditure programs Lack of adequate information systems Shareholder disputes Dr. B. S. Navi 43


Theories of Corporate Governance Agency theory Stewardship theory Shareholders Vs stakeholders theory Transaction cost theory Sociological theory


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


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


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


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


Transaction Theory Assumes that managers seek self interest Managers operate under bounded rationality Selfishly driven to undertake transaction that benefits them personally Make transaction without study as the money invested is not their own Strengths / weaknesses Quantification is easy Shareholders are residual receivers , concern about safety of investment .


The sociological theory Composition of the board, transparency of the financial reporting, disclosure and auditing are considered central to realizing the socio economic objectives Strengths / weaknesses Based on fair distribution of wealth in society The challenge is that the board should not have absolute powers Government control, interference may increase leading to constraints and red tape


Importance of CSR in corporate governance Stakeholders theory is integral to corporate governance in addition to shareholders value General acceptance that government cannot mange all needs of society and companies have to involve themselves for the welfare of stakeholders Corporations have the following responsibility Economic Legal Ethical Honor trust Be culture sensitive to provide the right services Discretionary Undertake voluntary activities and expenses, keeping the greater good of society in mind


Corporate Governance in Banking sector. 52 OECD principles 1999 also dwelt upon the issue of Corporate Governance. Guidelines of Basel Committee on Banking supervision issued to supervisory authorities in different countries. Dr. B. S. Navi


Corporate Governance in India The issue of Corporate Governance has come up mainly in the wake up economic reforms characterized by liberalization and deregulation. In April 1998, Confederation of Indian Industries (CII) took issue of Corporate Governance Practices and made certain recommendations. SEBI committee on Corporate Governance headed by Shri. Kumarmangalam Birla submitted its report in February 2000 . Clause 49 in Listing Agreement with stock exchanges was made mandatory by SEBI to include disclosures about Corporate Governance and its certification by Statutory Auditors in annual report of the company. 53 Dr. B. S. Navi


Thank You Dr. B. S. Navi 54

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