CORPORATE GOVERNANCE

In market economies, the primary purpose of companies is to maximise shareholder value

(e.g. economic profit, share price and dividends) bound by legal/regulatory obligations
which address specific social and environmental issues. For this, companies pursue
competitive strategies which rely upon and develop relationships between the corporation
and its stakeholders.
CSR and corporate sustainability represent the way companies achieve enhanced ethical
standards and a balance of economic, environmental and social imperatives addressing
the concerns and expectations of their stakeholders. Corporate governance reflects the
way companies address legal responsibilities and therefore provides the foundations upon
which CSR and corporate sustainability practices can be built to enhance responsible
business operations.
Early roots of corporate social responsibility can be found in the actual business practices
of successful companies and early theoretical views in the 1950s and 60s linked corporate
social obligation to the power that business holds in society. Theoretical developments
are currently broadly subdivided into the ethical and accountability issues and the
stakeholder approaches to strategic management.
Ironically, it was US which brought in legislation called Foreign and Corrupt Practices
Act of 1977 followed by Securities and Exchange Commissions tightening of mandatory
reporting of internal financial controls in 1979. The Treadway commission was formed
in 1987 after the collapse of several Savings and Loan institutions in US. The Treadway
report highlighted the need for a proper control environment, Independent Audit
committees and an objective internal audit function. It also requested the sponsoring
organizations to write for themselves and develop an integrated set of control criteria for
betterment of the companies. Despite of this in 1990s, companies like Polly Peck, BCCI
and Robert Maxwell group of companies in UK became victims of spectacular failures,
primarily out of poorly managed business practices often times, standards set by the
respective Boards. In the Annexure I to my speech, I am summarizing the Cadbury Code
of Best Practices and I feel the 19 points there are of great relevance even today. The
Combined code was subsequently derived from the Ron Hampel report and the
Greenbury Report all of which were appended to the listing rules of London Stock
Exchange. Compliance is mandatory for all listed companies in the UK.

Since the early 1990’s, corporate responsibility issues including the social obligations of
corporations have attained prominence in political and business debate. This is mainly in
response to corporate scandals but also due to the realisation that development centred
only on economic growth paradigms is unsustainable and therefore there is a need for a
more pro-active role by states, companies and communities in a development process
aimed at balancing economic growth with environmental sustainability and social
cohesion.

Recent Developments in USA:

History continues to tick and Sarbanes-Oxley Act of the US was a serious wakeup call. It
has been much debated and there are very mild protests in some quarters. Nevertheless,
it is a call to get back to fundamentals and it identifies 58 separate provisions that affect
internal auditing and the question of Directors of Boards looking the other way is
unacceptable and must change. This message is applicable to the public and private
companies alike. I am tempted to quote some of the important extracts from the BIS
review 2003.

• The message for boards of directors is: Uphold your responsibility for
ensuring the effectiveness of the company’s overall governance process.
• The message for audit committees is: Uphold your responsibility for
ensuring that the company’s internal and external audit processes are rigorous
and effective.
• The message for CEOs, CFOs, and the senior management is : Uphold
your responsibility to maintain effective financial reporting and disclosure
controls and adhere to high ethical standards. This requires meaningful
certifications, codes of ethics, and conduct of insiders that, if violated, will
result in fines and criminal penalties, including imprisonment.
 • The message for external auditors is: Focus your efforts solely on auditing
financial statements and leave the add-on services to other consultants
• The message for internal auditors is: You are uniquely positioned within
the company to ensure that its corporate governance, financial reporting and
disclosure controls, and risk management practices are functioning
effectively. Although internal auditors are not specifically mentioned in the
Sarbanes-Oxley Act, they have within their purview of internal control the
responsibility to examine and evaluate all of an entity’s systems, processes,
operations, functions and activities.
Thus, the role of the internal auditor has substantially got escalated and the external
auditor perhaps took a back seat. However, a specific section of Sarbanes-Oxley Act
requires senior management to assess and report on the effectiveness of disclosure
controls and procedures as well as on internal controls for financial reporting. All of
these have to be in the public disclosure domain of the reports but outside the financial
statements. There is one risk to merely lean heavily on the certification, which after a
while become ritualistic. It would be good to be associated with the framing of the robust
audit programme and the company’s disclosure control framework. Further an internal
auditor must have the highest ethics and be willing to sacrifice everything (consultation
assignments) to maintain their independence within the auditing company. If there are
different sections of companies, which offer turn-key management consultation, at least
those who are involved in the audit exercise should disassociate themselves from being a
part of consulting side of the company’s work. Some of the provisions in the Act are
quite draconian particularly one would be the internal auditor of publicly traded financial
services company, as there are threats of fines and imprisonment, the internal auditor’s
voice is heard loud and clear by the Board and as such all those Boards who choose to
ignore this valuable advice would in my opinion be consigned to the dust bin of history.
Complex collapses, misfeasance and malfeasance of staggering proportions, Auditors
failing in their duties, call for tough Regulatory responses like the above Act and related
rules introduced and interpreted by Securities and Exchange Commission in USA.

Indian Situation:
Next I would like to turn to Indian situation. By and large we have followed the Cadbury
model. It is true that Audit Committees, Managing Committees and Remuneration
Committees have all come into existence. In most Indian companies and the CIIs studies
of 1999 chaired by Mr. Kumara Mangalam Birla was a landmark document with 25
recommendations 19 of them which are ‘mandatory’. The roles of a company with a
combination of Executive and Non-Executive Directors with atleast 50% comprising
non-executive directors is important. Likewise, the audit committee is chaired by
qualified independent Director preferably a Chartered Accountant and the members of
the Audit Committee are invariably non-executive independent Directors. We all know
that the independent Directors apart from receiving Director’s remuneration, do not have
any pecuniary relationship or transactions with the company. The Audit Committee has
wide powers and also looks into the compliance with Accounting Standards and all of the
other regular compliances like the stock exchange, legal requirements and it also looks
into several internal control systems. There is sub-committee of the Board, which also
looks at the shareholders’ grievances and files its compliances to the stock
exchange. Publication of quarterly or half yearly results of the companies after being
vetted by the Audit Committee is now a well established practice. What perhaps is
missing in the Indian situation at the present moment is the equivalent legislation, inline
with the Sarbanes-Oxley Act although, the dust has not settled down on the subject. The
Institute of Chartered Accountants of India have set up quite rigid Accounting Standards
to be followed which have progressively tightened compliances. This assumes
importance as many mid-sized and small companies are family controlled and at times
pyramidical structures are developed so that layered investments and crossholdings go
unnoticed. There is urgency to ensure against controlling of companies in the group by a
group of people who are not direct investors.

Corporate Governance for Banking Organizations:

Particularly, you may divide them into following:

 Term-Lending Institutions, governed by the Companies Act or Special Act

  Banks [public sector, private sector (old and new generation banks,
Cooperative Banks)] governed by Special Act or BR Act.
 Finance companies also known as non-banking financial companies
governed by Companies Act and guidelines issued by RBI and FCS.

The Basel Committee in the year 1999, had brought out certain important principles on
corporate governance for banking organizations which, more or less have been adopted in
India.

Basel committee underscores the need for banks to set strategies for their operations. The
committee also insists banks to establish accountability for executing these
strategies. Unless there is transparency of information related to decisions and actions it
would be difficult for stakeholders to make managements accountable. The underlying
theme is accountability at all levels including the Boards.

From the perspective of banking industry, corporate governance also includes in its ambit
the manner in which their boards of directors govern the business and affairs of
individual institutions and their functional relationship with senior management. This is
determined by how banks:

• set corporate objectives (including generating economic returns to

owners);
• run the day-to-day operations of the business and;
• consider the interests of recognized stakeholders i.e., employees,
customers, suppliers, supervisors, governments and the community and
• align corporate activities and behaviours with the expectation that banks
will operate in a safe and sound manner, and in compliance with applicable
laws and regulations; and ofcourse protect the interests of depositors, which is
supreme.
You may be aware that the Committee has issued several papers on specific topics, where
the importance of corporate governance is emphasized. These include Principles for the
management of interest rate risk (September 1997), Framework for internal control
systems in banking organizations (September 1998), Enhancing bank transparency
(September 1998), and Principles for the management of credit risk (issued as a
consultative document in July 1999). These papers have highlighted the fact that sound
corporate governance should have, as its basis, the following strategies and techniques:

• the corporate values, codes of conduct and other standards of appropriate

behaviour and the system used to ensure compliance with them;
• a well-articulated corporate strategy against which the success of the
overall enterprise and the contribution of individuals can be measured;
• the clear assignment of responsibilities and decision-making authorities,
incorporating an hierarchy of required approvals from individuals to the board
of directors;
• establishment of a mechanism for the interaction and cooperation among
the board of directors, senior management and the auditors;
• strong internal control systems, including internal and external audit
functions, risk management functions independent of business lines, and other
checks and balances;
• special monitoring of risk exposures where conflicts of interest are likely
to be particularly great, including business relationships with borrowers
affiliated with the bank, large shareholders, senior management, or key
decision-makers within the firm (e.g. traders);
• the financial and managerial incentives to act in an appropriate manner
offered to senior management, business line management and employees in the
form of compensation, promotion and other recognition; and
• appropriate information flows internally and to the public
For ensuring good corporate governance, the importance of overseeing the various
aspects of the corporate functioning needs to be properly understood, appreciated and
implemented.

There are four important aspects of oversight that should be included in the
organizational structure of any bank in order to ensure the appropriate checks and
balances:

(1) Oversight by the board of directors or supervisory board;

(2) Oversight by individuals not involved in the day-to-day running of the

various business areas;

(3) Direct line supervision of different business areas; and

(4) Independent risk management and audit functions.

The supervisory experience of Regulators in general, in banks consider the following as

critical elements in the governance process:

• Establishing strategic objectives and a set of corporate values that are

communicated throughout the banking organization.
• Setting and enforcing clear lines of responsibility and accountability
throughout the organization.
• Ensuring that board members are qualified for their positions, have a clear
understanding of their role in corporate governance and are not subject to
undue influence from management or outside concerns.
• Ensuring that there is appropriate oversight by senior management
• Effectively utilizing the work conducted by internal and external auditors,
in recognition of the important control functions they provide
 • Ensuring that compensation approaches are consistent with the bank’s
ethical values, objectives, strategy and control environment.
• Conducting corporate governance in a transparent manner
• Ensuring an environment supportive of sound corporate governance.

It is found that in a number of countries, bank boards have found it beneficial to establish
certain specialized committees. Let us look at a few of them:

• Risk management committee: It provides oversight of the senior

management’s activities in managing credit, market, liquidity, operational, legal
and other risks of the bank. (This role should include receiving from senior
management periodic information on risk exposures and risk management
activities)
• Audit Committee: It provides oversight of the bank’s internal and external
auditors, approving their appointment and dismissal, reviewing and approving
audit scope and frequency, receiving the reports and ensuring that management
is taking appropriate corrective actions in a timely manner to address control
weaknesses, non-compliance with policies, laws and regulations, and other
problems identified by auditors. The independence of this committee can be
enhanced when it is comprised of external board members that have banking or
financial expertise.
• Compensation committee: It provides oversight of remuneration of senior
management and other key personnel and ensuring that compensation is
consistent with the bank’s culture, objectives, strategy and control environment
• Nominations committee: It provides important assessment of board
effectiveness and directing the process of renewing and replacing board
members.

Companies worldwide are increasingly worried about the impact of their business
activities on society. Many have created so-called corporate social responsibility (CSR)
programmes that aim to balance their operations with the concerns of external
stakeholders such as customers, unions, local communities, NGOs and governments.
Social and environmental consequences are weighed against economic gains.
“Corporate governance and corporate social responsibility are both extremely important
to a company. But it is not a natural thing to separate them. If you have a well formed
corporate governance programme in place, which would probably take care of most CSR
issues.
According to OECD the Corporate Governance structure specifies the distribution of
rights and responsibilities among different participants in the corporation, such as, the
Board, managers, shareholders and other stakeholders spells out the rules and procedures
for making decisions on corporate affairs.
I would like to mention the structure of CG (corporate governance)

Structure of Corporate Governance

The current theory of corporate social responsibility (CSR) is developing along three
interwoven lines moral, social, and environmental. Although everybody recognizes that
although CSR is of growing concern in a globalised economy, it being at the top of the
board of director's agenda and also good for business, there is no sign of consensus on its
rules, structures, or procedures. Now, this collection of essays by leading jurists,
businesspeople, and academics takes a giant step toward a more cohesive and durable set
of principles that can contribute to a cleaner environment and a better society while
respecting and protecting the interests of all stakeholders.
The authors approach this complex but critical subject from a variety of perspectives,
including the following:
• the role of CSR in corporate governance;
• the legal enforceability of CSR rules;
• the impact of international human rights standards; CSR as part of
corporate DNA;
• choice of CSR strategy defensive or offensive;
• the need for fair competition between developing country exporters;
• the prospects for international social protection for workers;
• enforcement of minimal standards in remote locations;
• the active search for eco-efficient solutions;
• corporate assumption of human rights responsibilities; and
• the legal weight of codes of conduct
• the role of the lawyer in CSR.
In a world where the annual income of the five largest business corporations is more than
double the combined GNPs of the 50 poorest countries, the need for meaningful
standards of corporate social responsibility should be obvious. The well-informed and
considered analyses in this remarkable volume provide an excellent starting point for
those anxious to move the agenda forward in this area that, despite the efforts of many
companies, often seems so intractable. The book will be of immeasurable value to all
professionals and academics in relevant fields of law, policy, and business.

The 4CR multi-dimensional corporate responsibility perspective

The 4CR multi-dimensional corporate responsibility perspective is aimed at
establishing a coherent approach to addressing the various concepts of corporate
responsibility and their integration with strategic management.
The 4CR taxonomy described in the following table highlights four corporate
responsibility areas:
Corporate Competitiveness (CC)
Corporate Governance (CG)
CSR
Corporate Sustainability (CS)

At the centre of the 4CR Corporate Responsibilities Map is stakeholder management

which provides the common link between corporate competitiveness and corporate
responsibility and sustainability. The key issues in each of the Four Corporate
Responsibilities are as follows:

C o r porate Competitiveness addressed by strategic management is a subject

rarely discussed in the context of corporate responsibility. However, unless all
strands of corporate responsibility are brought together under a common management
 framework, CSR and sustainability will remain peripheral activities and their impact
is likely to remain well below required levels to achieve the Millennium and related
goals.
Corporate Governance sets the legal framework to protect a
company’s shareholders and stakeholders; the relative emphasis being dependent on
national approaches.
CSR is aimed at extending the legal requirements promoting ethics,
philanthropy and social reporting to satisfy stakeholder concerns.
Corporate sustainability focuses on long term economic and social
stakeholder expectations both by optimising their sustainability performance and by
participating in networks with governments, NGOs and other stakeholders that can
provide the capacity for the world’s sustainable development.
The 4CR strategic approach to corporate responsibility
Working Papers

The 4CR framework has been designed to:

i. integrate the various strands of corporate responsibility (CSR,

corporate sustainability and corporate governance);
ii.provide a strategic management framework incorporating corporate
responsibility;
iii.support the staged development of strategic capabilities enabling
companies to reach optimised performance.
Thus, it is the collective wisdom of eminent professionals serving on the Boards of the
financial institutions, which can further enhance corporate governance. I am afraid this
search for improvement is not limited by time. It would continue forever and it is only
hoped that scamsters are brought to justice sooner than later. There is an entire subject
called ‘whistle blowing’ and there is enormous literature on this subject These are the
questions for which one need to find the answers between spate of anonymous letters to
which any one working in public sectors is used to and often honest officials harassed on
one side, to which thanks to CVC are now ignored, and damaging investigative audit
reports and doctored Balance sheets on the other side. Somewhere in between lies the
governance and ethics and standards set up by virtuous men heading institutions. In such
institutions the reputation of the organization and the leader go hand in hand. In such
organizations the shareholders and other stakeholders truly derive their value. It is
myopic to look for astronomical return by the shareholders to allow the Boards to indulge
in unethical practices like market rigging, insider trading, speculation and host of other
irregular practices for making huge profits. One cannot argue that the shareholders value
is enhanced and higher profits and dividends are distributed, the Board acting as agent of
the shareholder being the principal. Here lies the real test of governance of the Boards
walking the well defined, honest and straight path in conducting the affairs in the
required atmosphere of transparency, seen and perceived by all the stakeholders and the
markets and regulators. Then only can one confidently state that corporate governance
has taken firm roots in the countries.