Module 3

Corporate Governance
Definition
CG refers to the distribution of rights &
responsibilities among different participants in a
corporate entity such as shareholders,
management & other stakeholders & spells out
rules & procedures for making decisions on
corporate affairs
CG is generally perceived as a set of codes &
guidelines to be followed by the companies. But
governance is more than just board processes
& procedures. It involves relationship b/w
companys mgmt, its board, shareholders &
stakeholders
From this point of CG focus on a simple model:
1. Shareholders elect directors who represent
them
2. Directors- vote on key matters- majority
decision
3. Decisions- made in transparent manner- so
that directors can be held responsible
4. Company- adopts- accounting stds- generate
information necessary for directors, investors
& other stakeholders
5. Company policies & practices- adhere to
applicable national, state & local laws


Mckinsey suggested 2 version of Governance Model
Market model:
Efficient, well developed
equity markets &
dispersed ownership-
US,UK, Canada, Australia
Model depicts- CG- well
understood & highly
appreciated by global
investors

Control model:
Depicts governance
chain- underdeveloped
equity markets,
concentrated (family)
ownership, less
shareholder
transparency,
inadequate protection of
minority & foreign
stakeholders
In such developing
economies- need to
build & nurture
supporting institutions-
market regulator &
judiciary
Organisation of Economic Co-
operation & Development
Defines CG as the system by which business
corporations are directed & controlled
CG is a structure- specifies distribution of rights &
responsibilities among diff participants in the
corporation, such as the Board, managers,
shareholders & other stakeholders- spells out the
rules & procedures for making decisions on
corporate affairs
By CG- provides structure through which the
company objective is set, means to attain &
monitoring the performance

Most worldwide organizations- strongly
promote CG- means of enhancing economic
growth of a member nations such as world
bank, OECD, APEC (Asia Pacific Economic
Cooperation)- insist inalienable rights of
shareholders, equitable treatment, role of
stakeholders in realizing CG through
disclosure, transparency & boards
responsible in ensuring all these
OECD- emphasised following requirements
of corporate Governance:
1. Rights of shareholders: includes secure
ownership of their shares, voting rights, the
right to full disclosure of information,
participation in decision or sale of any
corporate assets including mergers,
acquisitions, right to know the capital
structure, transparent transactions, should
know the cost & benefits of exercising their
voting rights
2. Equitable treatment of shareholders:
i. All shareholders- including minority
foreign shareholders- equitable treatment-
all share
ii. Equal opportunity for redressal of their
grievances & violation of their rights
iii. Should not have any difficulties in
exercising their voting rights
iv. Should avoid situations- conflict of
interest- decision making

3. Role of stakeholders in CG:
i. CG framework- apart from recognizing-
rights of shareholders, allows employees
representation on BOD, profit sharing
ii. For active stakeholder- ensure that they
have access to relevant information
4. Disclosure & transparency:
i. OECD- no of provisions- laid for the
disclosure & dissemination- key info about
the company- to the entitled
ii. Ranges form companys objective to financial
details, operating results, governance structure
& policies, remuneration, foreseeable risk
factors etc
iii. OECD- spells out guidelines for annual audits-
to be performed
5. Responsibilities of the board:
i. Primary function- protecting the company, its
shareholders & stakeholders
ii. Functions include concerns about corporate
stgy, risk, executive compensation &
performance, accounting, monitoring
effectiveness
Historical Perspective of Corporate Governance
From narrow to broader vision:
CG has focused traditionally on the
problems of separation of ownership by
shareholders & control by management
It is now accepted that firms should respond
to the expectations of more categories of
stakeholders
Wide range of CG practices include business
ethics, social responsibility, mgmt discipline,
corporate strategy, stakeholder participation
in DM & promotion of sustainable dvlpment
Growth of Modern Ideas of CG from USA
The seeds of modern ideas of CG-
Watergate scandal- US- investigations-
revealed- regulators & legislative bodies
failure- control & stop several major
corporations- making illegal politics
contribution- bribing govt officials-paved
way for stiffer legislations
Cadbury Committee
In England, Sir Adrian Cadbury was entrusted
in 1991- by London Stock Exchange- drafting
a code of practices- to assist corporations-
defining & applying internal controls-limit
their exposure to financial loss
CC invested extensively- accountability of
BOD- to shareholders & to the society
Committee submitted report- Code Of Best
Practices- elaborated mtds of CG- to achieve
balance b/w essential powers of the board &
accountability
Corporate Governance in Banking Sector
Some bank failures- in west- underlined the
necessity of close monitoring- banking
system of a country- can threaten financial
stability- within country & globally
Central Bank Governors of the group of ten
countries, Bank for International
Settlements, International Monetary Funds
& world bank- ways & means- strengthen
financial stability
Issues in Corporate Governance
CG means- to an end- being long term
shareholder value. Some governance issues
being crucial & critical to achieve these
objectives are:
1. Distinguishing the roles of board &
management:
Constitutions of more & more stress &
underline- business to be managed by or
under the direction if the board
Such practice-responsibility for managing-
Business- delegated- by the board to CEO-
delegates responsibilities- senior executives
Board occupies- key position b/w companys
shareholders (owners) & the companys
management.
The following are the functions of the board:
1. Select, decide the remuneration- evaluate on
regular basis- whenever necessary- change the
CEO
2. Oversee indirectly the conduct of the
companys business- evaluate- companys
properly managed or not
3. Review & approve the financial objectives
(wherever necessary)-company- & major
corporate plans
4. Render advice & counsel- top management
5. Identify & recommend candidates- to
shareholders- for electing them to BOD
6. Review the adequacy of systems- to
comply with applicable laws & regulations


2. Composition of the board & related issues:
1. BOD- committee elected by the
shareholders- responsible for the policy of
the company
2. Full time functional directors- responsible
for each branch
3. Composition- no of directors- different
expertise
4. SEBI- appointed- Kumar Mangalam Birla
committee report- composition of board-
BOD- company- optimum combination of
Executives & non executives directors- with
not less than 50% of board directors to be
non executive directors.
5. The no of independent directors- depends
chairman- executive or non executive
6. Non executive chairman- one third of the
board- independent directors
7. Executive chairman- half of the board-
independent directors
Executive director-
executive of the
company- also member
of BOD
Non executive directors-
not employee of the
company- does not
engage in day to day
management- but
involved in policy
making & planning,
strategy formulation-
hold shares of the
company
BOD
Non- exec.
Directors
Exec.
Directors
Affiliated
directors
(Nominee)
Independent
directors
Independent non executive directors-
outsiders- process of DM- watchful monitors
of promoters & management-on behalf of
public shareholders
Affiliated or nominee directors- impairing
relationship- company- eg: director- links
major supplier or customer of company
3. Separation of roles of the CEO &
chairperson:
1. Composition of board- major issue- link b/w
shareholders & management

2. In India, US- combining CEO & chairman-
conflicts in DM- concentration of the
power
3. Role of CEO- lead senior management-
manage the enterprise; role of chairperson-
lead the board- board has to evaluate the
performance of the senior management
including CEO
4. Should the board have committees?:
recommends special committees:
nomination, remuneration, auditing-clear
procedures- reporting back to the board-
lessens the burden on board
5. Appointments to the board & directors re-
election: as per Indian Company Law- elect
directors- expensive, time consuming.
Actual practice-board- constitutes
committee-selects & appoints- prospective
director-formally elected- by shareholders-
annual general body meeting.

In India- endorse- rarest of Rare opposing
6. Directors & non executives compensation:
key issues are: pay for performance,
severance payments (compensation- laid
off, mutual agreement to leave the
company- employee may receive- month
pay for each year), transparency, pensions
7. Disclosure & audit: OECD- no of provisions
for disclosure- for auditing- questions are-
should board form committee? If so-
composition, how to ensure independence
of auditor, precautions etc
8. Protection of shareholders rights & their
expectations: vital factor for the company-
no of questions- company adhere to one to
one voting?, voting through poll or by
hand?, should shareholders approval for all
major transactions
9. Dialogue with institutional stakeholders:
CC- recommends- investors- regular &
systematic contact- companies- apart from
participation in meeting, voting, positive
interest in composition of the board, rather
than just buying & selling of shares
10. Should investors have say in making a
company socially responsible corporate
citizen?
One school of thought- socially responsible
company-enhance cost- reducing profits-
but another school of thoughts-
Environment friendliness & economic
gains- not contradictory- benefits
corporations for a long run

Relevance of Corporate Governance
Different economies have systems of CG-
differ in relative strength exercised by the
stakeholders & how they influence the
management
Good corporate governance means
governing the corporation in such a way-
interest of the shareholders are protected-
while ensuring the stakeholders
requirements are fulfilled
Need for & importance of Corporate
Governance
Corporate Governance- needed to create a
corporate culture of consciousness,
transparency & openness
Refers to combination of laws, rules,
regulations, procedures & voluntary
practices- enable companies to maximise
shareholders long term value
Should lead to increasing customer
satisfaction, shareholder value & wealth
Benefits of Good Corporate Governance
Good corporate governance secures-
effective & efficient operation of a company
in interest of all stakeholders
Provides assurance that management-
acting best interest of the corporation-
contributing to the business prosperity-
through openness in disclosures &
accountability
Key contributions of good corporate
governance include:
1. Creation & enhancement of corporations
competitive advantage:
Competitive advantage- grows naturally-
corporation or its service- creation of value
for its buyers.
Creating competitive advantage- vision to
innovate & strategy to manage process of
delivering value.
Strategies that creates value to corporations
are sales, marketing, customer base &
branding. Eg: Himalayas- Ayurveda, Sony-
Quality etc
2. Enabling a corporation perform efficiently by
preventing fraud & malpractices:
The Code of Best Conduct policies &
procedures- governing the behavior of
individuals of a corporation-form part of CG
Prevents fraud & malpractices- destroys
business from inside (internal trading)
3. Providing protection to shareholders
interest:
CG- set of rules- focuses on transparency
of info & management
Imposes fiduciary duty on management-
act in bets interest of all shareholders &
properly disclose the operations of the
corporations
Particularly important when ownership &
management enterprise of an enterprise
are in different hands
4. Enhancing value of an enterprise:
Improved management accountability &
operational transparency- fulfill investors
expectations & confidence on management &
corporations
In turn increases the value of the corporations
Companies- adopted CG stds- enhanced
market valuations
5. Ensuring compliance of laws & regulations:
Jurisdictions- protect investors- compliance-
key agenda in establishing good CG
Concept of Corporate
Term business corporation- instrument
through which capital is assembled for
activities of producing & distributing goods &
services & making investments
Company- an association of many persons,
who contributes money or moneys worth to
a common stock- invest in some trade or
business- share profit & loss arising. Persons
who contribute it, or whom it belongs are
Members. The proportion of capital-
entitled as his shares, shares are
transferable
Corporation- association of persons- perpetual
succession- corporations- distinct from its
members- has a common seal.
Characteristics of a corporate are:
1. Incorporated association: legally registered
under Companies Act
2. Artificial legal existence: Supreme court of
India defines legal status of the company as
The Corporation in law is equal to a natural
person- has its own entity- bears its own
name & seal, assets are separate distinct from
its members, it can sue & it can be sued, the
liability of the investors & shareholders is
limited to the capital invested by them

3. Perpetual existence: life of the corporation-
not like life of the members. Corporate life
does not end with exit, retirement,
insolvency or death of any or all directors. A
companys existence- depends on law & it
can only dissolve it
4. Common seal: company- legal entity-
documents- seal & signed by the CEO.
Under the Companies Act- any document-
seal of the company- witnessed by 2
directors of the company
5. Extensive membership: joint stock
company- public limited- min no is 7 no
limit in issuance of shares
6. Separation of management from ownership:
practical- shareholders- scattered- not
feasible- take part in administration. BOD-
oversees management- daily
administration- salaried managers-
misgovernance
7. Limited liability: Liability of the each
shareholder is limited to proportion of
shares he holds so joint stock company is
also called as limited company

If company is unable to repay the loan or
interest- creditors can claim only on the
assets of the company but not on the
personal belongings of the shareholder
This limitation of liability eliminates- risk of
investments- stimulated investments- large
industries
8. Transferability of shareholders: public
limited company- free transferring of
shares- without the consent of the
company- imparts liquidity

Concept of Governance
Governance- process of decision making &
the process by which it is implemented.
Analysis of governance focuses on the formal
& informal players involved in decision
making & implementing the decisions made
Government- one of the players in
governance- others involved are for
example rural areas- influential landlords,
NGOs, religious leaders, political parties etc
Urban areas small scale entrepreneurs,
media
National level- media, MNCs etc
Theoretical basis of Corporate Governance
Theoretical basis of Corporate
Governance
Agency
theory
Stewardship
theory
Stakeholder
theory
Sociological
theory
Agency theory
Conflicts of interest between owners & the
managers of a firm is the Agent Problem &
the cost inflicted- dissonance- Agency Cost
In organizational set up owners (principal) &
managers (agents), owners hire employees to
carry out specified activity
CG- designing- putting disclosure in places-
monitoring & oversight &corrective systems-
align both objectives- minimise agency costs
Problems with Agency Theory
1. Fair and accurate financial disclosure:
Financial & non financial disclosure- relate
to role of independent auditors- appointed
for the audit of the company- present a
true & fair view of the financial health of
the corporation
Responsibility of the auditors- raise queries
& objections, arrive at a true & fair view of
financial position
2. Efficient & independent board of directors:
Joint stock company- owned by
shareholders- appoints directors to
supervise management- ensure that it does
all ethical & legal means to make business
grow & maximise long term corporate value
Stewardship theory
The stewardship theory assumes- managers
are trustworthy- motives are aligned with
objectives,
Managers are stewards-behavior- will not
depart from organisation
Control undermines the org. behavior of the
steward- lowering his motivation
Stewardship- oversee day to day operations-
trusteeship- better understanding of the roles
& responsibilities of the employees

Behavioral difference between
Agency theory
1. Managers acts as
agents
2. Governance
approach-
materialistic
3. Behavior pattern is
individualistic,
opportunistic, self
serving
4. Mgrs- motivated by
their own objectives
Stewardship theory
1. Managers acts as
stewards
2. Governance
approach- non-
materialistic
3. Behavior pattern is
collectivistic, pro-
organisational,
trustworthy
4. Mgrs- motivated by
their principals
objectives



Agency theory
5. Interest of managers
& principals differ
6. Role of the
management is to
monitor & control
7. Owners attitude-
avoid risks
8. Principal manager
relationship- based on
control
Stewardship theory
5. Interest of managers
& principals converge
6. Role of the
management is to
facilitate & empower
7. Owners attitude- take
risks
8. Principal manager
relationship- based on
trust

Psychological Mechanisms
Agency Theory
1. Motivation revolves
around lower order
needs & extrinsic
needs
2. Social Comparison is
between Compatriot
(fellow citizen)
3. Little attachment to
the company
4. Power rests with the
institution
Stewardship Theory
1. Motivation revolves
around higher order
needs & intrinsic
needs
2. Social Comparison is
between principal
3. Great attachment to
the company
4. Power rests with the
personnel


Situational Mechanisms
Agency Theory
1. Management
philosophy- control
oriented
2. To deal with
increasing
uncertainty & risks-
theory suggests-
greater controls &
more supervisions
Stewardship Theory
1. Management
philosophy-
involvement oriented
2. To deal with
increasing
uncertainty & risks-
theory suggests-
training &
empowering ppl &
making jobs
challenging &
motivating

Agency Theory
3. Risk orientation-
system of control
4. Cultural differences
revolve around
individualism
5. Objective is cost
control
Stewardship Theory
3. Risk orientation-
trust
4. Cultural differences
revolve around
collectivism
5. Objective is
improving
performance

Stakeholder Theory
This theory- emphasis on ethics of care,
ethics of professional relationship, social
contract theory, theory of property rights
Criticism of stakeholder theory:
Definition of genuine stakeholders-
stakeholder model
Few opine- employees, customers, suppliers,
government, community etc
Sociological Theory
More focused on broad composition & wealth
distribution
Financial reporting, disclosure & auditing- to
realise socio economic objectives of the
corporations
Obligation to the Society
Corporation- association of persons- part of
the society. Activities- bound to impact
society as the societys values- impact on
corporation
Mutual rights & obligations: national interest,
legal compliance, honest & ethical conduct
1. National interest: company- committed in all
its actions- benefit the economic
development- not to involve- any activity-
mitigate against the objectives
2. Political non-alignment: company should
support democratic constitution- not to
sponsor for any political party for the
campaign or as donations
3. Legal compliances: company- should
comply with applicable government laws,
rules & regulations. All levels of
management- aware of these laws-
violating- criminal or civil liability or
disciplinary action
4. Rule of law: no favoritism- protection of
shareholders especially minority
shareholders
5. Honest & ethical conduct: every officer in
the company- CEO,CFO, MD etc- deal with
professionalism, honesty, commitment&
sincerity- with high moral & ethical
standards
6. Corporate citizenship: corporation- good
corporate citizenship- not only by abiding
laws- but also by assisting the improvement
of QWL
7. Ethical behavior: set examples- moral
responsibility of BOD
8. Social concerns: corporate exist beyond
time & space- equitable treatment of
shareholders
9. CSR: responsiveness towards the society
10.Environment friendliness: Environmental
sense- eco friendly products
11.Healthy & safe working environment:
company should provide- Healthy & safe
working environment- prevents wasteful use
of resource & avoids hazardous impact
12.Competition: open to competition- no
unethical advertisements- company- market
its products & services- own merit
13.Trusteeship: corporations- social & economic
purpose- coalition of interest- shareholders,
employees & others- enhance the value of the
shareholder
14.Accountability: answerable to public &
stakeholders- cannot be enforced through
law
15.Effectiveness & efficiency: context of good
governance- sustainable use of resources to
protect the environment
16.Timely responsiveness: towards
stakeholders & employees
17.Corporations should uphold fair name of the
country: companies- export their product/
service- quality

Obligation to the Investors
Company has to ideally follow obligations to the
investors by promoting transparency & informed
shareholders participation
In context of enhanced awareness of better
governance corporate should address these issues:
1. Towards shareholders: company- committed to
enhance shareholders value- comply by govt laws-
fair & transparency in all means to the
shareholders & stakeholders
2. Measures promoting transparency & informed
shareholder participation: addressing the issues of
the shareholders & provides meaningful
participation of shareholders- without the
interference of the management & accounting it

3. Transparency: decision taking &
enforcement- follows rules & regulations-
directly accessible- to those who are affected
by the decisions & enforcement
4. Financial reporting & records: prepare &
maintain accounts- biz affairs (transaction &
affairs)- according to the standards-
accessible to the auditors, non executive,
independent directors, government agencies.
Any misrepresentation & or/ misinformation
on financial accounts- violation of the firm

Obligation to Employees
1. Fair employment practices: performance & quality
based compensation, promotion, privacy,
punishment etc
2. Equal opportunities employer: no illegal
discrimination (race, caste, religion, gender,
colour, marital status, nationality, disability etc)
3. Encouraging whistle blowing: ideal corporate-
proactively deal with whistle blowers- comfortable
reporting channels- no unfair termination of the
whistle blowers
4. Humane treatment: companies- treat employees-
customers- cater basic needs
5. Participation: freedom of association & expression
6. Empowerment: it unleashes the creativity &
innovation in the organization- decision
making power- vested in the appropriate
levels in the hierarchy
7. Equity & inclusiveness: employees- should
not feel excluded from the mainstream,
equal opportunities
8. Participative & collaborative environment:
collaborative environment- brings peace &
harmony- improves productivity, higher
profits & market share
Obligations to Customers
Companys existence- cannot be justified-
without catering to the needs of the
customer.
1. Quality of products & services: Committed
to supply goods & services of high quality
set by the quality stds @ national level
2. Products @ affordable price: normal profits-
but not by exploiting the consumers
3. Unwavering commitment to customer
satisfaction: earn goodwill & should deliver
what they promise (quality, after sales
service, warranties & guarantees)
Managerial Obligation
1. Protecting companys assets: should not be
misused or dissipated for the purpose of
conducting business- includes tangible assets
like machineries, system, facilities, as well as
intangible assets
2. Behavior towards government agencies:
company employee- should not give any
firms fund or donation- govt agency or
intermediaries- favoring official duties
3. Control: principle of governance-
management- exercise- freedom &
appropriate checks- ensure biz risk- managed
pre-emptively & effectively
4. Consensus oriented: good governance-
mediation of different interest in society-
broad interest- whole community to be
achieved.
5. Gifts & donations: companys employees-
should not- receive any gifts, illegal
payments, remuneration, donations etc- to
obtain biz or uncompetitive favors for the
conduct of the biz
6. Roles & responsibilities of corporate board &
directors: role of corporate BOD as stewards-
stakeholders- gained importance, successive
scams & companys failure- demands more
transparency & accountability.
Good board more of non executive directors &
independent directors
7. Direction & management must be distinguished:
necessary to distinguish 2 main components- in
terms of policy making & oversight responsibilities.
Executives who are also on board- can be a part of
board & as well as part of management.
Directors derive authority- only when acting
collectively- managers sense the responsibilities-
execute the policies- under the supervision of the
board
8. Managing & whole time directors: whole time
directors- devote whole time- company affairs-
rather than serving non executive board