Unit 2- Corporate Governance

1. Concept and Definition

Corporate governance refers to the broad range of policy and practices that stockholders, executive managers, and boards of directors use to manage the operations of corporate entities towards fulfilling their responsibilities to the investors and other stakeholders in the society. Over the past decade, corporate governance has become the subject of increasing concern to the stakeholders, which has prompted their close attention and scrutiny of the corporate activities. Hence, these concerns have given rise to a powerful shareholder movement with a view to extract compliance from the operators of corporate organisations.

The Good Governance Codes

The decision to issue a code of good governance can be assimilated to the adoption of new practices in an existing corporate governance system. Codes of good governance are, in fact, best practice recommendations regarding the characteristics of the board of directors and other governance mechanisms. They provide a voluntary means for innovation and improvement of governance practices. Such codes have been designed to address deficiencies in the corporate governance system, by recommending a set of norms aimed at improving transparency and accountability among top managers and directors In most legal systems, codes of good governance have no specific legal basis, and are not legally binding. Enforcement is generally left to the effectiveness of internal corporate bodies (i.e., the board of directors) and of external market forces. Only in a few countries

(e.g., Germany and the Netherlands in Europe), the law attaches explicit legal consequences to the code or even to its provisions.

In brief, codes of best practices exert major influence on the corporate governance of listed companies, or at least formally. The content of codes has been strongly influenced by corporate governance studies and practices. Codes touch fundamental governance issues such as fairness to all shareholders, clear accountability by directors and managers, transparency in financial and non-financial reporting, the composition and structure of boards, the responsibility for stakeholders' interests, and for complying with the law. The core of codes of good governance lies in the recommendations on the board of directors. Following the dominant agency theory, governance codes encourage the board of directors to play an active and independent role in controlling the behaviour of top management. In particular, scholars and practitioners recommend: the quest for an increasing number of non-executive and independent directors; the splitting of Chairman and CEO roles; the creation of board committees (nomination, remuneration and the audit committee), made up of non-executive independent directors; and the development of an evaluation procedure for the board. The introduction of these practices is considered a necessary factor in order to avoid governance problems, and to increase board and firm performance.

The Reasons behind the Diffusion of Good Governance Codes

The efficiency rationale. The main function of codes of good governance is to compensate for deficiencies in the legal system regarding investor protection. In countries with weak protection of investors' rights, the potential benefits for the economic system associated with the reinforcement of good governance practices are greater than in countries with strong protection of investors' rights.

The institutional (legitimation) rationale. The development of codes of good governance aims to increase not only the efficiency of governance rules, but also the legitimation of national companies in the global financial market. Competition among countries in the

global economy generates coercive or normative imitation (i.e., mimetic isomorphism) Countries more exposed to other national economic systems experience greater pressure to harmonize and legitimate their governance practices. Under the pressure of external forces, the national stock exchanges, the domestic associations, and the governments, may be forced to change governance practices in the country, not only to increase the efficiency of domestic companies, but also to harmonize the national corporate governance system with international best practices.

2. Need to Improve Corporate Governance Standards

The need to implement and improve corporate governance standards can be understood in three ways:

The historical development of the concept of Corporate Governance (factors which triggered the initiatives to develop corporate governance in India-Asked in end term exam 2009)
The need/ importance/significance/ requirement of Corporate Governance Benefits/ advantages of Corporate Governance to Corporates and Society

The following reasons have been identified for instituting and implementing corporate governance in corporate world: To reduce conflict of interests between Board and Management resulting in board squabbles. To address ineffective board oversight functions. To eliminate or reduce fraudulent and self-serving practices among members of the board, managements and staffs. To reduce over bearing influence of chairman or MD/CEO, especially in family controlled businesses. To ensure compliance with laid-down internal control and operation procedures. To remove the problem of sit tight directors even where such directors fail to make meaning full contributions to the growth and development of the firm. To prevent succumbing to pressure from other stakeholders e.g. shareholders appetite for high dividend. To forestall inability to plan and respond to changing business circumstances. To bring about an effective management information system. To put an end to insider trading. To ensure better accountability towards stakeholders Maintaining transparency and clarity in all the dealings To promote stability of global financial systems For monitoring effective utilization of capital For maintaining better investors relationships

Benefits of Good Corporate Governance to Society

Reduced Corruption Healthy competition in product and factor markets Protection of stakeholders from fraudulent activities Maximization of wealth for shareholders Growth of society, and economy etc.

3. Features OF Good Governance

Good governance has 8 major characteristics. It is participatory, consensus oriented, accountable, transparent, responsive, effective and efficient, equitable and inclusive and follows the rule of law. It assures that corruption is minimized, the views of minorities are taken into account and that the voices of the most vulnerable in society are heard in decision-making. It is also responsive to the present and future needs of society.

Figure 2: Characteristics of good governance

Participation Participation by both men and women is a key cornerstone of good governance. Participation could be either direct or through legitimate intermediate institutions or representatives. It is important to point out that representative democracy does not necessarily mean that the concerns of the most vulnerable in society would be taken into consideration in decision making. Participation needs to be informed and organized. This means freedom of association and expression on the one hand and an organized civil society on the other hand. Rule of law Good governance requires fair legal frameworks that are enforced impartially. It also requires full protection of human rights, particularly those of minorities. Impartial enforcement of laws requires an independent judiciary and an impartial and incorruptible police force. Transparency Transparency means that decisions taken and their enforcement are done in a manner that follows rules and regulations. It also means that information is freely available and directly accessible to those who will be affected by such decisions and their enforcement. It also means that enough information is provided and that it is provided in easily understandable forms and media. Responsiveness Good governance requires that institutions and processes try to serve all stakeholders within a reasonable timeframe. Consensus oriented There are several actors and as many view points in a given society. Good governance requires mediation of the different interests in society to reach a broad consensus in society on what is in the best interest of the whole community and how this can be achieved. It also requires a broad and long-term perspective on what is needed for sustainable human development and how to achieve the goals of such development. This can only result from an understanding of the historical, cultural and social contexts of a given society or community. Equity and inclusiveness A societys well- being depends on ensuring that all its members feel that they have a stake in it and do not feel excluded from the mainstream of society. This requires all groups, but particularly the most vulnerable, have opportunities to improve or maintain their well being. Effectiveness and efficiency

Good governance means that processes and institutions produce results that meet the needs of society while making the best use of resources at their disposal. The concept of efficiency in the context of good governance also covers the sustainable use of natural resources and the protection of the environment. Accountability Accountability is a key requirement of good governance. Not only governmental institutions but also the private sector and civil society organizations must be accountable to the public and to their institutional stakeholders. Who is accountable to whom varies depending on whether decisions or actions taken are internal or external to an organization or institution. In general an organization or an institution is accountable to those who will be affected by its decisions or actions. Accountability cannot be enforced without transparency and the rule of law. CONCLUSION From the above discussion it should be clear that good governance is an ideal which is difficult to achieve in its totality. Very few countries and societies have come close to achieving good governance in its totality. However, to ensure sustainable human development, actions must be taken to work towards this ideal with the aim of making it a reality.

4. Abuses/Lacunas/Weakness /Ills /Impediments of Corporate Governance (Asked in End Term Exam 2009, 2010)

Principles of Corporate Governance cant be casted in stone and laid to be rest for ever . Discuss the lacunas of Corporate Governance in Indian Context (Asked in End Term

Examination 2009)
Past experience of Corporate Governance enables one to make one prediction about Corporate Governance with certainty is: Corporate Governance has not reached a steady state so change will continue. New ways of governing, breakthrough in information technology, imagination, ideas, and findings from research could all stimulate change. But seemingly, 21st century will be the century of Corporate Governance. In the Indian context, the concept of Corporate Governance has some special reference. Although in India, the Corporate Governance is in its infancy, yet India has many lacunae in different aspects of Corporate Governance. India still has poor bankruptcy laws and procedures, Indian

accounting standards do not mandate consolidation, Indian stock markets are still inefficiently run and do not have adequate depth to give shareholders greater comfort and consolation.

WEAKNESSES OF CORPORATE GOVERNANCE IN INDIA

The Satyam debacle has exposed the chinks in Indian corporate governance mechanism and the monitoring authorities. It has raised many questions about corporate governance in Indiathe role of boards, of independent directors, of the auditors, of investors and of analysts. Unanimously it has been a gross failure of corporate governance standards in India and protection of rights of minority investors.

The board of directors is central to good governance, and the role of the board has featured prominently in discussions about Satyam. The board is the body charged with having oversight of the operations of the firm and setting its strategy. It should ensure that the company is upholding high standards of probity and conduct, and provide a probing analysis of the activities of management. In particular, non-executive directors are supposed to give an independent assessment of the quality of management. But time and time again, failures of corporate governance suggest that they do not. The infractions of law has arose despite independent directors which were stopped by external forces. There are several reasons pointing to these anomalies-

First, it is difficult to appoint truly independent directors. This is particularly hard to achieve in countries such as India where family ownership is widespread and there is a close-knit group of corporate leaders. It is difficult for non-executive directors to perform a scrutiny objective at the best of times, but it is particularly difficult to do so when faced with a dominant CEO who expects support not criticism from the companys board. Many countries have sought to separate the roles of chairman and CEO. However, it can inhibit firms from implementing effective strategies, especially in companies operating with new technologies, such as Indian IT/ITES firms, requiring visionary strategies.

Next, the very idea of independent directors is to ensure commitment to values, ethical business conduct and about making a distinction between personal and corporate funds in the management of a company. Yet, most independent directors have become sidekicks for

the management, eying their commission and fees, forgetting their very purpose of appointment. In the process, they implicitly transform into dependent directors. In contrast, the issues in India are entirely distinct - primarily due to our overall socialeconomic conditions. Therefore the issue in Indian corporate governance is not a 'conflict between management and owners' as elsewhere, but 'a conflict between the dominant shareholders and the minority shareholders'. Some of the most glaring abuses of corporate governance in India have been defended on the principle of shareholder democracy since they have been sanctioned by resolutions of the general body of shareholders .

Corporate Governance and India

The various impediments of corporate governance (In general and in Indian Context) can be identified as: The quality of governance system is directly dependent on the policy framework within a nation. The Indian judiciary and legal processes are very slow and lethargic No legal binding in terms of implementation of Corporate Governance codes Deficiencies in the legal system regarding investor protection Conceptual ambiguity in the definitions of some components Split of power and control between Ministry of Corporate Affairs and SEBI
The current institutional framework places the oversight of listed companies partly with the Ministry of Corporate Affairs (MCA), partly with the Securities and Exchange Board of India (SEBI) and partly with the stock exchanges. This fragmented structure gives rise to regulatory overlap and weakens enforcement. A streamlined regulatory structure would help improve accountability and market discipline.

Corporate Governance slows down the overall decision making process Corporate governance is a set of regulations, checks and balances that cant control the human nature

It leads to nil secrecy because of the clause of complete disclosure. Due to presence on non-executive directors on board, there is a subsequent loss in the overall decision making power It adds an unnecessary level of bureaucracy and redtapism. Makes running a company unnecessarily difficult Hinders with creativity and innovation by holding the hands of the decision maker ( in the name of formal compliance with regards to everything) A key missing ingredient in India today is a strong focus on director professionalism etc.

5. Role of Regulators in Corporate Governance (Asked in End Term Exam 2006, 2007)
The initiatives for improvement in corporate governance are coming mainly from three sources namely,

Market, Regulator (SEBI- capital market, RBI Banks, TRAI-Telecom, IRDA- Insurance, ICAI etc.) Legislature (Government-Ministry of Corporate Affairs)

While the legislative initiative is directed towards bringing about amendments to the basic law Indias Companies Act - to include certain fundamental provisions related to corporate governance, dynamic aspects of corporate governance such as disclosures, accounting standards, etc. are being pursued through the regulatory initiatives by bringing about amendments to the Listing Agreement. Such an approach is aimed at because a comparatively more complicated and protracted process is involved in the amendments to legislation in a truly democratic society like Indias. The most important initiative comes from market forces and mechanisms which encourage and insist on the managements improving the quality of corporate governance. Indian market has formalised such forces in the form of a rating called Corporate Governance and Value Creation Rating, which is quite unique in the World and is sought after voluntarily by the companies. Beyond courts, arbitration panels, stock exchanges and lending institutions, other institutions such as rating agencies, institutional investors and the media can also play an important role in improving corporate governance practices in developing countries Media can play a potentially important role in enforcement, both nationally and locally, although they may not use any legal tools The Media. Finally, the impact of the media cannot be underestimated. Consider the power of public scrutiny who would want to invest in a company which makes headlines because its majority shareholders sacrice the interests of the minority shareholders for their own private gain? By bringing these stories to light, the nancial media in developing countries can play an important role in facilitating the enforcement and recognition of investor rights.

The SEBI is managed by six members, i.e. by the chairman who is nominated by central government & two members, i.e. officers of central ministry, one member from the RBI & the remaining two are nominated by the central government. The office of SEBI is situated at Mumbai with its regional offices at Kolkata, Delhi & Chennai.

Role of SEBI (regulator) in Ensuring Effective corporate Governance for Listed Companies

Now, we explain role of SEBI in regulating Indian Capital Market more deeply with following points:

1. Power to make rules for controlling stock exchange : SEBI has power to make new rules for controlling stock exchange in India. For example, SEBI fixed the time of trading 9 AM and 5 PM in stock market. 2. To provide license to dealers and brokers : SEBI has power to provide license to dealers and brokers of capital market. If SEBI sees that any financial product is of capital nature, then SEBI can also control to that product and its dealers. One of main example is ULIPs case. SEBI said, " It is just like mutual funds and all banks and financial and insurance companies who want to issue it, must take permission from SEBI." 3. To Stop fraud in Capital Market : SEBI has many powers for stopping fraud in capital market. It can ban on the trading of those brokers who are involved in fraudulent and unfair trade practices relating to stock market. It can impose the penalties on capital market intermediaries if they involve in insider trading. 4. To Control the Merge, Acquisition and Takeover the companies : Many big companies in India want to create monopoly in capital market. So, these companies buy all other companies or deal of merging. SEBI sees whether this merge or acquisition is for development of business or to harm capital market. 5. To audit the performance of stock market : SEBI uses his powers to audit the performance of different Indian stock exchange for bringing transparency in the working of stock exchanges.

6. To make new rules on carry - forward transactions : Share trading transactions carry forward can not exceed 25% of broker's total transactions. 90 day limit for carry forward.

7. To create relationship with ICAI : ICAI is the authority for making new auditors of companies. SEBI creates good relationship with ICAI for bringing more transparency in the auditing work of company accounts because audited financial statements are mirror to see the real face of company and after this investors can decide to invest or not to invest. Moreover, investors of India can easily trust on audited financial reports. After Satyam Scam, SEBI is investigating with ICAI, whether CAs are doing their duty by ethical way or not. 8. Introduction of derivative contracts on Volatility Index : For reducing the risk of investors, SEBI has now been decided to permit Stock Exchanges to introduce derivative contracts on Volatility Index, subject to the condition that; a. The underlying Volatility Index has a track record of at least one year. b. The Exchange has in place the appropriate risk management framework for such derivative contracts.

9. To Require report of Portfolio Management Activities : SEBI has also power to require report of portfolio management to check the capital market performance. Recently, SEBI sent the letter to all Registered Portfolio Managers of India for demanding report. 10. To educate the investors: Time to time, SEBI arranges scheduled workshops to educate the investors. On 22 may 2010 SEBI imposed workshop.

SEBIs Role defined

As the regulator for the securities market, the Securities and Exchange Board of India (SEBI) has been focusing on the following areas to improve corporate governance: a. Ensuring timely disclosure of relevant information, b. Providing an efcient and effective market system, c. Demonstrating reliable and effective enforcement, and d. Enabling the highest standards of governance. A company is required to make specied disclosures at the time of issue and make continuous disclosures as long as its securities are listed on exchanges. The standards for these disclosures, including the content, medium and time of disclosure, have been specied in the Companies Act, Disclosure and Investor Protection Guidelines, Listing

Agreement, regulations relating to insider trading and takeovers, etc. These disclosures are made through various documents such as prospectuses, quarterly statements, annual reports, etc. and are disseminated through media, websites of the company and the exchanges, and through EDIFAR (Electronic Data Information Filing and Retrieval) System, which is maintained by the regulator Indian securities market has a large infrastructure to meet the demands of a sub continental market. There are 23 stock exchanges, and about 10,000 brokers, 15,000 sub-brokers, 10,000 listed companies, 500 foreign institutional investors, 400 depository participants, 150 merchant bankers, 40 mutual funds offering over 450 schemes, and 20 million investors. Yes, there is only one regulator- SEBI. In addition to creating an efficient trading platform and clearing and settlement mechanism, SEBIs focus is substantially directed towards: a. Provision of timely availability of high quality price sensitive information to the market participants to enable them to take informed decision and ensure efficient price discovery, b. Maintenance of high quality of services and fair conduct for market participants. The regulations specify high standards to become market intermediaries and require them to abide by a code of conduct. c. Ensuring that the market is fair, transparent and safe so that issuers and investors are at ease to carry out transactions. Reliable and Effective Enforcement The regulator aims to ensure that no misconduct goes unnoticed or unpunished. It keeps an eagle eye on the happenings in the market and identifies anything unusual or undesirable, which may adversely affect the efficacy of the market. Every market participant, irrespective of his size and influence in the market or in the polity, is held accountable for his misdeeds very expeditiously. The proactive and aggressive approach of the regulator in enforcement can be gauged from the fact that during the financial year 2002-2003, SEBI passed 561 orders, out of which over 350 were punitive Highest Standards of Governance If Indian securities market is a model for others, it is natural that it leads in the area of corporate governance also. The Kumar Mangalam Birla Committee of the Indian jurisdiction outlined a code of good Corporate Governance, which compared very well with the recommendations of the Cadbury Committee and the OECD codes. The code was operationalized by inserting a new clause (Clause 49) to the Listing Agreement, and has been made applicable to all the listed companies in India in a phased manner. Following the implementation of the Birla Committee recommendations, substantial developments took place in corporate world and securities market which required revisit of the issue. The Narayan Murthy Committee has refined the corporate governance norms which are proposed to be implemented through modification in the listing agreement. Government also appointed a few committees. Based on their recommendations, Government is trying to provide statutory back up to corporate governance standards.

Role of Government (Regulator) in Ensuring Effective corporate Governance For All Companies (Listed and Unlisted)
The Government of India established Department of Company Affairs (DCA) (under ministry of Finance and Company Affairs) now Ministry of Corporate Affairs, , whereby the role of MCA is to administer and control both the listed and unlisted companies throughout India by the way of enforcing regulations as mentioned in the Companys law. A formal structure has been set up to ensure that the MCA, which regulates all the companies, and SEBI, which regulates only listed companies, act in coordination and harmony. Company Law takes care of the basic requirement of the form of corporate governance structure, and SEBI is concerned with the corporate governance practices on on-going basis.

SEBI may refrain from exercising powers of subordinate legislation in areas where specific legislation exists as in the Companies Act, 1956. If any additional requirements are sought to be prescribed for listed companies, then, in areas where specific provision exists in the Companies Act, it would be appropriate for SEBI to have the requirement prescribed in the Companies Act itself through a suitable amendment. In recognition of the fact that SEBI regulates activities in dynamic market conditions, the Ministry of Corporate Affairs should respond to SEBIs requirements quickly. In case the changes proposed by SEBI necessitate a change in the Companies Act, the MCA should agree to the requirement being mandated in clause 49 of SEBI regulation until the Act is amended. It would be appropriate for SEBI to use its powers of subordinate legislation, in consultation with the MCA, and vice versa. All committees set up either by SEBI or MCA to consider changes in law, rules or regulations should have representatives of both SEBI and MCA.

Note: (For the initiative and role of MCA, refer to the hard copy notes.)

Role of Regulators (SEBI, RBI etc. in general) in ensuring effective Corporate Governance
Regulatory authorities like SEBI, RBI etc. lay down guidelines so that a certain degree of transparency is automatically ensured. Enhancing market integrity by enforcing rules and regulations in a professional, timely, transparent and consistent fashion Regulators ensure that sanctions and enforcement are credible deterrents to help align business practices with the legal and regulatory framework, in particular with respect to related party transactions and insider trading Regulators demonstrates their ability to book and punish powerful companies that break the laws Controlling and terminating fraudsters and market manipulators etc.

Clause 49 for Ensuring Effective Corporate Governance

6. Corporate/Organizational culture (Asked in End Term Exam-2012)

Organizational culture is the collective behaviour of humans who are part of an organization and the meanings that the people attach to their actions. Culture includes the organization values, visions, norms, working language, systems, symbols, beliefs and habits.[1] It is also the pattern of such collective behaviours and assumptions that are taught to new organizational members as a way of perceiving, and even thinking and feeling.[2] Organizational culture affects the way people and groups interact with each other, with clients, and with stakeholders. [3] Corporate culture is a set of shared mental assumptions that guide interpretation and action in organizations by defining appropriate behaviour for various situations. At the same time although a company may have "own unique culture", in larger organizations, there is a diverse and sometimes conflicting cultures that co-exist due to different characteristics of the management team.[4] The organizational culture may also have negative and positive aspects.[4] EX: Tata, Infosys, Wipro are known for their excellent corporate culture. Google is a company that is well-known for its employee-friendly corporate culture. It explicitly defines itself as unconventional and offers perks such as telecommuting, flex time, tuition reimbursement, free employee lunches, on-site doctors and, at its corporate headquarters in Mountain View, Calif., on-site services like oil changes, massages, fitness classes, car washes and a hair stylist. Google's corporate culture has helped it to consistently earn a high

ranking

on Fortune magazine's

list

of

"100

Best

Companies

to

Work

For."

Various dimensions of corporate culture precisely mean the various issues that are discussed commonly under the umbrella of corporate culture, like: Individual Autonomy: This refers to the individuals freedom to exercise his or her responsibility Position Structure: This refers to the extent of direct supervision, formalizations and centralization in an organization. Reward Orientation: This refers to the degree to which an organization rewards individuals for hard work or achievement. Consideration, Warmth and Support: This refers to the extent of stimulation and support received by an individual from other organization members. Conflict: This refers to the extent to conflict present between individuals and the willingness to be honest and open about interpersonal differences. Progressiveness and Development: This aspect refers to the degree to which organization conditions foster the development of the employees, allow scope for growth and application of new ideas methods. Risk Taking: The degree to which an individual feels free to try out new ideas and otherwise take risks without fears of reprisal, ridicule or other form of punishments, indicate the risktaking dimension of OC. Control: This dimension refers to the degree to which control over the behavior of organizational members is formalized. We can also categorize the dimensions as follows:

(Note: Kindly refer the hard copy notes also, for further details on the individual topics)

(End of Unit-2)