Corp. Gov - Unit3

Business Ethics & Corporate Social Responsibility TY-BMS (Sem – 5)
UNIT – III
CORPORATE GOVERNANCE
• Corporate Governance: Meaning scope & Reporting
• The Agency Theory : Principal – Agent Relationship
• Role of CEO, Board and Senior Executives
• Right of Investors and Shareholders
• Financial Regulations and their scope in CG
• Corporate governance from Cadbury committee to
Narayan Murthy
Committee
Corporate governance is a process or a set of systems and

processes to ensure that a company is managed to suit the
best interests of all. The systems that can ensure this may
include structural and organizational matters. The stake
holders may be internal stake holders (promoters, members,
workmen and executives) and external stake-holders
(promoters, members, customers, lenders, vendors, bankers,
community, government and regulators).
Corporate governance is concerned with the establishing of a system

whereby the directors are entrusted with responsibilities and duties in
relation to the direction of corporate affairs. It is concerned with
accountability of persons who are managing it towards stakeholders. It
is concerned with the morals, ethics, values, parameters of conduct
and behaviour of the company and its management. Corporate
governance is nothing but a voluntary ethical code of business of
companies. This is based on the core values of the top management
and the guiding principles that emanate from it.
According to the Cadbury committee on financial aspects of CG,

corporate governance is the system by which companies are directed
and controlled. The board of directors is responsible for the
governance of the company. The directors and the auditors are to
satisfy themselves that an appropriate governance structure is in
place.
The concept of corporate governance hinges on total

transparency, integrity and accountability of the management.
Prof. Abdul Kadir Khan 1

There has been renewed interest in the corporate governance

practices of modern corporations since 2001, particularly due to the
high-profile collapses of a number of large U.S. firms such as Enron
Corporation and MCI Inc. (formerly WorldCom). In 2002, the U.S.
federal government passed the Sarbanes-Oxley Act, intending to
restore public confidence in corporate governance.
It is a system of structuring, operating and controlling a company with

a view to achieve long term strategic goals to satisfy shareholders,
creditors, employees, customers and suppliers, and complying with the
legal and regulatory requirements, apart from meeting environmental
and local community needs.
Report of SEBI committee (India) on Corporate Governance defines

corporate governance as the acceptance by management of the
inalienable rights of shareholders as the true owners of the corporation
and of their own role as trustees on behalf of the shareholders. It is
about commitment to values, about ethical business conduct and
about making a distinction between personal & corporate funds in the
management of a company.” The definition is drawn from the
Gandhian principle of trusteeship and the Directive Principles of the
Indian Constitution. Corporate Governance is viewed as business ethics
and a moral duty.
Corporate governance is a way of life and not a set of rules. It is more

of a way of life that necessitates taking interests in every business
decision. a key element of good corporate governance is transparency
projects through a code of good governance which incorporates a
system of checks and balances between key players- board of
management, auditors and shareholders.
Corporate governance is in essence determination of how companies

are governed, how executive actions are supervised and how a
company is accountable to regulations imposed on it by law or other
commitments to shareholders.
IMPACT OF CORPORATE GOVERNANCE
The positive effect of corporate governance on different stakeholders

ultimately is a strengthened economy, and hence good corporate
governance is a tool for socio-economic development.

A key factor is an individual's decision to participate in an organisation

e.g. through providing financial capital and trust that they will receive
a fair share of the organisational returns. If some parties are receiving
more than their fair return then participants may choose to not
continue participating leading to organizational collapse.
The Corporate Governance Framework:
The governance framework is based on principles of public sector

governance including:
• accountability—being answerable for decisions and having
meaningful mechanisms in place to ensure the agency adheres
to all applicable standards
• transparency/openness—having clear roles and
responsibilities and clear procedures for making decisions and
exercising power
• integrity—acting impartially, ethically and in the interests of the
agency, and not misusing information acquired through a
position of trust
• stewardship—using every opportunity to enhance the value of
the public assets and institutions that have been entrusted to
care
• efficiency—ensuring the best use of resources to further the
aims of the organisation, with a commitment to evidence-based
strategies for improvement
• leadership—achieving an agency-wide commitment to good
governance through leadership from the top.
Agencies need to have an approach to governance that enables them

to deliver their outcomes effectively and achieve high levels of
performance, in a manner consistent with applicable legal and policy
obligations.
EXCELLENCE THROUGH GOOD CORPORATE GOVERNANCE

Adherence to good governance practices enhances the

efficiency of corporate sector in the following manner
:
1. Good governance provides stability and growth to the companies.
2. Good governance system, demonstrated by adoption of good
corporate practices, builds confidence
3. Effective governance reduces perceived risks, consequently
reducing cost of capital.
4. In the knowledge driven economy, excellence ion skills like
management will be the ultimate tool for corporate houses to
leverage competitive advantage in the financial market.
5. Adoption of good corporate practices promotes stability and long-
term sustenance of stakeholders' relationship
6. A good corporate citizen becomes an icon and enjoys a position of
pride.
7. Potential stakeholders aspire to enter into a relationship with
enterprises whose governance credentials are exemplary.
A good corporate governance recognizes the diverse interests of

shareholders, lenders, employees, government, etc. The new concept
of governance to bring about quality corporate governance is not only
a necessity to serve the divergent corporate interests, but also is a key
requirement in the best interests of the corporates themselves and the
economy.
The Agency Theory : Principal – Agent Relationship
Main (dependent) Factors: Efficiency, alignment of interests, risk

sharing,
Successful contracting
Main (independent) Factors: Information asymmetry, contract, moral hazard, trust
In economics, the principal-agent problem treats the difficulties that

arise under conditions of incomplete and asymmetric information when
a principal hires an agent. Various mechanisms may be used to try to
align the interests of the agent with those of the principal, such as
piece rates/commissions, profit sharing, efficiency wages, the agent
posting a bond, or fear of firing. The principal-agent problem is found
in most employer/employee relationships, for example, when
stockholders hire top executives of corporations.
Agency Theory Overview

Key idea Principal-agent relationships should reflect

efficient organization of information and risk-
bearing costs
Unit of analysis Contract between principal and agent
Human Self interest
assumptions Bounded rationality
Risk aversion
Organizational Partial goal conflict among participants
assumptions
Efficiency as the effectiveness criterion
Information asymmetry between principal and

agent
Information Information as a purchasable commodity
Assumption
Contracting Agency (moral hazard and adverse selection)
problem
Risk sharing
Problem domain Relationships in which the principal and agent
have partly differing goals and risk preferences
(e.g. compensation, regulation, leadership,
impression management, whistle blowing,
vertical integration, transfer pricing)

The
An agency theory exists whe
Diagrammatic Representation of the Agency theory

Agency theory focuses on the relationship and goal incongruence between
managers and shareholders. Agency relationships occur when one partner in
a transaction (the principal) delegates authority to another (the agency) and
Shareholders
the welfare of the principal is affected by the choices of the agent.
Agency theory is directed at the ubiquitous agency relationship, in which one
party (the principal) delegates work to another (the agent), who performs
(Principal)
that work. Agency theory is concerned with resolving two problems that can
occur in agency relationships. The first is the agency problem that arises
when
--------------------------
(a) the desires or goals of the principal and agent conflict and
(b) it is difficult or expensive for the principle to verify what the
agent is actually doing.
Firm Owners
The problem here is that the principal cannot verify that the agent has
behaved appropriately. The second is the problem of risk sharing that arises
when the principal and agent have different attitudes towards risk. The
problem here is that the principle and the agent may prefer different actions
because of the different risk preferences.
Managers can be encouraged to act in the stockholders' best interests
through incentives, constraints, and punishments. These methods, however,
are effective only if shareholders can observe all of the actions taken by
managers. A moral hazard problem, whereby agents take unobserved actions
in their own self-interests, originates because it is infeasible for shareholders

to monitor all managerial actions. To reduce the moral hazard problem,

stockholders must incur agency costs.
Role and powers of the CEO, Board and Senior Management:

The foremost requirement of good corporate governance is the clear
identification of powers, roles, responsibilities and accountability of the
Board, CEO and the senior management.
Role of a CEO:
CEO means Managing Director of a company or Manager appointed in
terms of the Companies Act, 1956.
 Equitable Treatment of Share-holders

:
The CEO should respect the rights of share-holders and help share-
holders to exercise those rights. He can help share-holders exercise
their rights by effectively communicating information that is
understandable and accessible, and encouraging share-holders to
participate in general meetings.
 Interests of Other Stake-
holders :
The CEO should recognize that they have legal and other
obligations to all legitimate stake-holders.
 Role & Responsibilities of the Board
:
The board needs a range of skills and understanding - to be able to
deal with various business issues and have the ability to review and
challenge management performance. It needs to be of sufficient size
and have an appropriate level of commitment to fulfill its
responsibilities and duties. There are issues about the appropriate mix
of executive and non-executive directors. The key roles of Chairperson
and CEO should not be shared.
 Integrity & Ethical Behaviour :
The CEO should develop a code of conduct for their directors and
executives that promotes’ ethical and responsible decision-making. It
is important to understand, though, that systemic reliance on integrity
and ethics is bound to eventual failure.
 Disclosure & Transparency
:
The CEO should be ready to clarify the company's position to the
share-holders and the board and management to provide share-
holders with a level of accountability. They should also implement
procedures to independently verify and safe-guard the integrity of the

company's financial reporting. Disclosure of material matters

concerning the organization should be timely and balanced to ensure
that all investors have access to clear, factual information.
 Constant Improvement :
The CEO must have the oath "If you can't do it better, why do it?" It
under-scores our drive to become an ever better and bigger company.
 Issues involving Corporate Governance Principles include

:-
• Oversight of the preparation of the entity's financial statements.
• Internal controls and the independence of the entity's auditors.
• Review of the compensation arrangements for the chief executive
officer and other senior executives.
• The way in which individuals are nominated for positions on the board.
• The resources made available to directors in carrying out their duties.
• Oversight and management of risk.
 Foster a corporate culture that promotes ethical

practices, encourages individual integrity, and fulfils social and
environmental responsibility.
 Maintain a positive and ethical work climate that is
conducive to attracting, retaining and motivating top-quality
employees.
 Develop and recommend to the Board a long-term
strategy and vision for the Group.
 Ensure that the day-to-day business affairs of the
Group are appropriately managed by the MDs, and that proper
systems and controls are in place for effective risk management of
the Group.
 Ensure, in co-operation with the Board, that there is
an effective succession plan for the CEO in place.
Role of the Board:
Given the economic, operational and potential cultural implications of

unplanned departures and the risks associated with having to bring in
external talent, corporate boards need to make succession
management one of their most critical duties. While a large percentage

of directors believe in the importance of having a succession plan,

most organizations have nothing more than an emergency interim
plan, which can be extremely disruptive. Good governance dictates
that leadership succession is a priority, year in and year out.
The board—or its nomination, compensation or selection committee—

must be active stewards of CEO and C-suite succession management,
involved in all aspects of the process. This includes assessing potential
talent, mitigating risk, making the CEO accountable for executing
succession management and planning the development of critical
successors. The board’s fingerprints should be all over the
organization’s leadership development efforts so directors have
personal experience with high-potential candidates. In most
organizations, this will require a major increase in the level of time and
attention the board pays to the process as it shifts from a “checklist”
to a “hands-on” methodology.
A 2006 study by the National Association of Corporate Directors

(NACD) found that many boards rated their ability to plan for a CEO
change as “ineffective.” Few board members had the knowledge and
experience needed to run a succession management process. Although
some progress has been made since this study, the recession has
caused most boards to put succession management on the back
burner while they concentrate on urgent operational imperatives. As
the economic crisis subsides and organizations begin to refocus on
long-term business success and continuity, it is time for boards to
reenergize their succession management efforts.
Boards those are successful in completing their role in the succession

process exhibit two key characteristics:
 They have learned how to make decisions objectively. The nature of

interpersonal relationships and the proclivity of board members to
view leadership behaviors through a personal lens can create strong
interpersonal dynamics within the board. As a result, some boards
make succession decisions based on personal perceptions of an
individual’s leadership behavior and results.
 They have a transparent and well-defined succession process. In

many organizations, succession management is poorly defined in
terms of process steps, ownership and decision rights. A succession
management process that is not objective, transparent and robust
can be derailed easily, which will result in a poor outcome.
Rigorous succession management processes

Role of Board of Directors:
Corporate governance is basically a system of making directors

accountable to shareholders for effective management of the company
along with concern for ethics and values. It is the management of
companies by the board of directors. it hinges on complete
transparency, integrity and accountability of management that
includes executive and non-executive directors.
The key to good corporate governance is a well functioning, informed

board of directors. The board should have a core group of excellent,
professionally acclaimed non-executive directors who understand their
dual role: of appreciating the issues put forward by management, and
of honestly discharging their fiduciary responsibilities towards the
company’s shareholders as well as creditors.
The role of boards in corporate governance, and how to improve their

oversight capability, has been examined carefully in recent years, and
new legislation in a number of jurisdictions, and an increased focus on
the topic by boards themselves, has seen changes implemented to try
and improve their performance.
1) Directors have important and powerful positions in a company.

The stockholders entrust them with the running of the company,
and this is why the law requires directors to comply with certain
duties.
2) Directors have a duty to act within their powers for a proper

purpose, which is underlined in the bylaws of the company. They
also have a duty to promote the success of the company and, in
doing this, must balance the interests of the stockholders,
employees, suppliers, and customers of the company. The law
does not define success, but in general this is agreed to mean
increasing the value of the company and its business.
3) The directors are required to exercise independent judgment

when making their decisions. They also have a duty to exercise
reasonable care, skill, and diligence in the performance of their
duties. An experienced director will be expected to exercise a
higher degree of care, skill, and diligence in the performance of
his or her activities.

4) Directors have a duty to avoid conflicts of interest. What

constitutes a conflict of interest is a complex issue, but in
general it refers to transactions between a director and third
parties, rather than between a director and the company.
Directors have a duty not to accept benefits from third parties if
they give rise to a conflict of interest. Benefits in this sense
include money and benefits in kind, such as corporate
hospitality. It is advisable to obtain specific legal advice in
respect of conflicts of interest, as this subject can be quite
controversial and difficult to assess.
5) Directors have a duty to declare any interest in proposed

transactions or arrangements with the company. They must
disclose any such interest to the board of directors and, in
certain circumstances, obtain the approval of the stockholders.
This includes transactions involving the director or any person
connected with the director, such as a spouse or children, and
the company.
Role of Chairman:
The responsibilities of the Chairman expressly include:

Running the Board and ensuring its effectiveness in all aspects
of its role
1) Chairing the Board and general meetings and relevant

Board committees
a. Setting the Board agenda
b. Ensuring there is an appropriate delegation of authority from the Board
to executive management

c. Ensuring the Board receives timely and accurate information to enable

the Board to take sound decisions and monitor effectively and provide
advice to promote the success of the Group
d. Managing the Board to allow time for discussion of complex or
contentious issues
2) Ensuring the effective contribution and performance of all

members of the Board
a. Facilitating the effective contribution of Non-Executive Directors

b. Ensuring constructive relations between the Executive and Non-
Executive Directors
c. Identifying the development needs of the Board to enhance its overall
effectiveness as a team
d. Ensuring the performance of the Board, its Committees and individual
Directors is evaluated regularly and acting on the results of such
evaluation
3) Maintaining sufficient and effective communication with

shareholders
a. Ensuring effective communications with shareholders including at
general meetings
b. Maintaining sufficient contact with major shareholders to understand
their issues and concerns
c. Ensuring that the views of shareholders are communicated to the
Board
4) Upholding standards of integrity and probity

a. Setting the tone of Board discussions to promote effective decision
making and constructive debate
b. Ensuring the Board is fully informed on all issues of relevance
c. Ensuring effective implementation of Board decisions
d. Building an effective Board
e. Providing coherent leadership of the Group
Rights of Investor / Shareholder:

A shareholder is who owns shares of a corporation. For

corporations, along with the ownership comes a right to
declared dividends and the right to vote on certain company
matters, including the board of directors.
Shareholder is also called a stockholder. He / She owns the
company to the extent of his / her investment in the said
company.
A shareholder in a Company enjoys certain rights, which are as follows:

 to receive the share certificates, on allotment or transfer as the
case may be, in due time.
 to receive copies of the abridged Annual Report, the Balance
Sheet and the Profit & Loss Account.
 to participate and vote in General Meetings either personally or
through proxies.
 to receive Dividends in due time once approved in General
Meetings.
 to receive corporate benefits like rights, bonus, etc. once
approved.
 to apply to Company Law Board (CLB) to call or direct the Annual
General Meeting.
 to inspect the minute books of the General Meetings and to
receive copies thereof.
 to proceed against the Company by way of civil or criminal
proceedings.
 to apply for the winding-up of the Company.
 to receive the residual proceeds.
 other rights are as specified in the Memorandum and Articles of
Association.
Besides the above rights, an individual shareholder also enjoys

the following rights as a group :
 to requisition an Extraordinary General Meeting
 to demand a poll on any resolution.
 to apply to CLB to investigate the affairs of the Company.
 to apply to CLB for relief in cases of oppression and / or
mismanagement.
Rights of a shareholder include:

1) Voting Power on Major Issues :

This includes electing directors and proposals for fundamental
changes affecting the company such as mergers or liquidation.
Voting takes place at the company's annual meeting. If you can't
attend, you can do so by proxy and mail in your vote.
2) Ownership in a Portion of the Company

:
Previously we discussed the event of a corporate liquidation
where bondholders and preferred shareholders are paid first.
However, when business thrives, common shareholders own a
piece of something that has value. Said another way, they have
a claim on a portion of the assets owned by the company. As
these assets generate profits, and as the profits are reinvested in
additional assets, shareholders see a return in the form of
increased share value as stock prices rise
.
3) The Right to Transfer Ownership

:
Right to transfer ownership means shareholders are allowed to
trade their stock on an exchange. The right to transfer ownership
might seem mundane, but the liquidity provided by stock
exchanges is extremely important. Liquidity is one of the key
factors that differentiates stocks from an investment like real
estate. If you own property, it can take months to convert your
investment into cash. Because stocks are so liquid, you can
move your money into other places almost instantaneously.
4) An Entitlement to Dividends
:
Along with a claim on assets, you also receive a claim on any
profits a company pays out in the form of a dividend.
Management of a company essentially has two options with
profits: they can be reinvested back into the firm (hopefully
increasing the company's overall value) or paid out in the form of
a dividend. You don't have a say in what percentage of
profits should be paid out - this is decided by the board of
directors. However, whenever dividends are declared, common
shareholders are entitled to receive their share
.
5) Opportunity to Inspect Corporate Books and Records

:
This opportunity is provided through a company's public filings,

including its annual report. Nowadays, this isn't such a big deal
as public companies are required to make their financials public.
It can be more important for private companies.
6) The Right to Sue for Wrongful

Acts :
Suing a company usually takes the form of a shareholder class-
action lawsuit. A good example of this type of suit occurred in
the wake of the accounting scandal that rocked WorldCom in
2002, after it was discovered that the company had grossly
overstated earnings, giving shareholders and investors an
erroneous view of its financial health. The telecom giant faced a
firestorm of shareholder class-action suits as a result.
In addition to the six basic rights of common shareholders, it is vital

that you thoroughly research the corporate governance policies of a
company. These policies are often crucial in determining how a
company treats and informs its shareholders.
Shareholder rights vary from state to state, and country to country,

so it is important to check with your local authorities and public
watchdog groups.
These rights are crucial for the protection of shareholders against poor
management.
Buying a stock means ownership in a company and ownership gives

you certain rights. While common shareholders might be at the bottom
of the ladder when it comes to liquidation, this is balanced by other
opportunities like share price appreciation. As a shareholder, knowing
your rights is an essential part of being an informed investor -
ignorance is not a defense. Although the Securities and Exchange
Commission and other regulatory bodies attempt to enforce a certain
degree of shareholder rights, a well-informed investor who fully
understands his or her rights is much less susceptible to additional
risks .
Protection of Investors Interest
Many years ago, worldwide, buyers and sellers of corporation stocks

were individual investors, such as wealthy businessmen or families,
who often had a vested, personal and emotional interest in the
corporations whose shares they owned. Over time, markets have
become largely institutionalized: buyers and sellers are largely
institutions.

(e.g., pension funds, mutual funds, hedge funds, exchange-traded

funds, other investor groups; insurance companies, banks, brokers,
and other financial institutions).
The rise of the institutional investor has brought with it some increase
of professional diligence which has tended to improve regulation of the
stock market (but not necessarily in the interest of the small investor
or even of the naïve institutions, of which there are many). Note that
this process occurred simultaneously with the direct growth of
individuals investing indirectly in the market (for example individuals
have twice as much money in mutual funds as they do in bank
accounts). However this growth occurred primarily by way of
individuals turning over their funds to 'professionals' to manage, such
as in mutual funds. In this way, the majority of investment now is
described as "institutional investment" even though the vast majority
of the funds are for the benefit of individual investors.
Various Committees on Corporate Governance
Corporate Governance when used in the context of business

organizations is a system of making directors accountable to
share holders for effective management of the companies, in
the best interest of the company and shareholders along with
concern for ethics and values. It is a management of
companies by the board of directors.
It hinges on complete transparency, integrity and

accountability of management that includes executive and
non-executive directors. Its genesis can be traced to the
internal audit function and its importance was enhanced after
the Stock Market Crash of 1987.
With the CG reports of Adrian Cadbury in the United Kingdom,

Mervyn King in South Africa and Kumarmangalam Birla in India
the subject was reduced to controlling shareholder operations
and ensure ethical practices in the financial sector. From
there, it has moved into other areas of the organization but

unfortunately restricts itself to the management and control of

funds. The ambit of significance of CG lies far beyond this.
Cadbury Committee Report (1992)

The 'Cadbury Committee' was set up in May 1991 with a view to
overcome the huge problems of scams and failures occurring in the
corporate sector worldwide in the late 1980s and the early 1990s. It
was formed by the Financial Reporting Council, the London Stock of
Exchange and the accountancy profession, with the main aim of
addressing the financial aspects of Corporate Governance. Other
objectives include: (i) uplift the low level of confidence both in financial
reporting and in the ability of auditors to provide the safeguards which
the users of company's reports sought and expected; (ii) review the
structure, rights and roles of board of directors, shareholders and
auditors by making them more effective and accountable; (iii) address
various aspects of accountancy profession and make appropriate
recommendations, wherever necessary; (iv) raise the standard of
corporate governance; etc. Keeping this in view, the Committee
published its final report on 1st December 1992. The report was mainly
divided into three parts:-
Reviewing the structure and responsibilities of Boards of

Directors and recommending a Code of Best Practice The boards
of all listed companies should comply with the Code of Best Practice.
All listed companies should make a statement about their compliance
with the Code in their report and accounts as well as give reasons for
any areas of non-compliance. The Code of Best Practice is segregated
into four sections and their respective recommendations are:-
1. Board of Directors - The board should meet regularly, retain full

and effective control over the company and monitor the executive
management. There should be a clearly accepted division of
responsibilities at the head of a company, which will ensure a
balance of power and authority, such that no one individual has
unfettered powers of decision. Where the chairman is also the chief
executive, it is essential that there should be a strong and
independent element on the board, with a recognised senior
member. Besides, all directors should have access to the advice and
services of the company secretary, who is responsible to the Board
for ensuring that board procedures are followed and that applicable
rules and regulations are complied with.
2. Non-Executive Directors - The non-executive directors should

bring an independent judgement to bear on issues of strategy,

performance, resources, including key appointments, and standards

of conduct. The majority of non-executive directors should be
independent of management and free from any business or other
relationship which could materially interfere with the exercise of
their independent judgment, apart from their fees and shareholding.
3. Executive Directors - There should be full and clear disclosure of

directors’ total emoluments and those of the chairman and highest-
paid directors, including pension contributions and stock options, in
the company's annual report, including separate figures for salary
and performance-related pay.
4. Financial Reporting and Controls - It is the duty of the board to

present a balanced and understandable assessment of their
company’s position, in reporting of financial statements, for
providing true and fair picture of financial reporting. The directors
should report that the business is a going concern, with supporting
assumptions or qualifications as necessary. The board should
ensure that an objective and professional relationship is maintained
with the auditors.
Considering the role of Auditors and addressing a number of

recommendations to the Accountancy Profession
The annual audit is one of the cornerstones of corporate governance. It

provides an external and objective check on the way in which the
financial statements have been prepared and presented by the
directors of the company. The Cadbury Committee recommended that
a professional and objective relationship between the board of
directors and auditors should be maintained, so as to provide to all a
true and fair view of company's financial statements. Auditors' role is
to design audit in such a manner so that it provide a reasonable
assurance that the financial statements are free of material
misstatements. Further, there is a need to develop more effective
accounting standards, which provide important reference points
against which auditors exercise their professional judgement.
Secondly, every listed company should form an audit committee which
gives the auditors direct access to the non-executive members of the
board. The Committee further recommended for a regular rotation of
audit partners to prevent unhealthy relationship between auditors and
the management. It also recommended for disclosure of payments to
the auditors for non-audit services to the company. The Accountancy
Profession, in conjunction with representatives of preparers of
accounts, should take the lead in:- (i) developing a set of criteria for
assessing effectiveness; (ii) developing guidance for companies on the
form in which directors should report; and (iii) developing guidance for

auditors on relevant audit procedures and the form in which auditors

should report. However, it should continue to improve its standards
and procedures.
Dealing with the Rights and Responsibilities of Shareholders
The shareholders, as owners of the company, elect the directors to run

the business on their behalf and hold them accountable for its
progress. They appoint the auditors to provide an external check on
the directors’ financial statements. The Committee's report places
particular emphasis on the need for fair and accurate reporting of a
company's progress to its shareholders, which is the responsibility of
the board. It is encouraged that the institutional investors/shareholders
to make greater use of their voting rights and take positive interest in
the board functioning. Both shareholders and boards of directors
should consider how the effectiveness of general meetings could be
increased as well as how to strengthen the accountability of boards of
directors to shareholders.
The Kumar Mangalam Committee Report: (1998)
In early 1999, Securities and Exchange Board of India (SEBI)

had set up a committee under Shri Kumar Mangalam Birla,
member SEBI Board, to promote and raise the standards of
good corporate governance. The report submitted by the
committee is the first formal and comprehensive attempt to
evolve a ‘Code of Corporate Governance', in the context of
prevailing conditions of governance in Indian companies, as
well as the state of capital markets.
The Committee's terms of the reference were to:
1. suggest suitable amendments to the listing agreement executed
by the stock exchanges with the companies and any other
measures to improve the standards of corporate governance in
the listed companies, in areas such as continuous disclosure of
material information, both financial and non-financial, manner
and frequency of such disclosures, responsibilities of
independent and outside directors;
2. draft a code of corporate best practices; and
3. suggest safeguards to be instituted within the companies to deal

with insider information and insider trading.

The primary objective of the committee was to view corporate

governance from the perspective of the investors and
shareholders and to prepare a ‘Code' to suit the Indian
corporate environment.
The committee had identified the Shareholders, the Board of

Directors and the Management as the three key constituents
of corporate governance and attempted to identify in respect
of each of these constituents, their roles and responsibilities
as also their rights in the context of good corporate
governance.
Corporate governance has several claimants –shareholders and

other stakeholders - which include suppliers, customers,
creditors, and the bankers, the employees of the company, the
government and the society at large. The Report had been
prepared by the committee, keeping in view primarily the
interests of a particular class of stakeholders, namely, the
shareholders, who together with the investors form the
principal constituency of SEBI while not ignoring the needs of
other stakeholders.
Mandatory and non-mandatory recommendations
The committee divided the recommendations into two

categories, namely, mandatory and non- mandatory. The
recommendations which are absolutely essential for corporate
governance can be defined with precision and which can be
enforced through the amendment of the listing agreement
could be classified as mandatory. Others, which are either
desirable or which may require change of laws, may, for the
time being, be classified as non-mandatory.
Mandatory Recommendations:
 Applies To Listed Companies With Paid Up Capital Of Rs.3

Crore And Above
 Composition Of Board Of Directors – Optimum
Combination Of Executive & Non-Executive Directors
 Audit Committee – With 3 Independent Directors with One
Having Financial and Accounting Knowledge.
 Remuneration Committee
 Board Procedures – At least 4 Meetings Of The Board In A
Year With Maximum Gap Of 4 Months Between 2
Meetings. To Review Operational Plans, Capital Budgets,
Quarterly Results, Minutes Of Committee's Meeting.

Director Shall Not Be A Member Of More Than 10

Committee And Shall Not Act As Chairman Of More Than 5
Committees Across All Companies
 Management Discussion And Analysis Report Covering
Industry Structure, Opportunities, Threats, Risks,
Outlook, Internal Control System
 Information Sharing With Shareholders
Non-Mandatory Recommendations:
 Role Of Chairman
 Remuneration Committee Of Board
 Shareholders' Right For Receiving Half Yearly Financial
Performance Postal Ballot Covering Critical Matters Like
Alteration In Memorandum Etc
 Sale Of Whole Or Substantial Part Of The Undertaking
 Corporate Restructuring
 Further Issue Of Capital
 Venturing Into New Businesses
As per the committee, the recommendations should be made

applicable to the listed companies, their directors,
management, employees and professionals associated with
such companies, in accordance with the time table proposed in
the schedule given later in this section. Compliance with the
code should be both in letter and spirit and should always be
in a manner that gives precedence to substance over form. The
ultimate responsibility for putting the recommendations into
practice lies directly with the board of directors and the
management of the company.
The recommendations will apply to all the listed private and

public sector companies, in accordance with the schedule of
implementation. As for listed entities, which are not
companies, but body corporates (e.g. private and public sector
banks, financial institutions, insurance companies etc.)
incorporated under other statutes, the recommendations will
apply to the extent that they do not violate their respective
statutes, and guidelines or directives issued by the relevant
regulatory authorities .
The Committee recognizes that compliance with the

recommendations would involve restructuring the existing
boards of companies. It also recognizes that some companies,
especially the smaller ones, may have difficulty in immediately
complying with these conditions.

The recommendations were implemented through Clause 49 of

the Listing Agreements, in a phased manner by SEBI.
The Narayana Murthy Committee: (2003)
The Narayana Murthy Committee report on corporate

governance has made a number of recommendations in its
draft report to Securities and Exchange Board of India.
The committee met thrice on December 7, 2002, January 7,

2003 and February 2003, to deliberate the issues related to
corporate governance and finalise its recommendations to
Sebi.
The committee has recommended that the audit committees of

publicly listed companies should be required to review the
following information mandatorily - financial statements,
management discussion and analysis of financial condition and
results of operations, reports relating to compliance with laws
and risk management among others.
The committee has also said that all audit committee members
should be "financially literate" and at least one member should
have accounting or related financial management expertise.
In case a company has followed a treatment different from

that prescribed in an accounting standard, management
should justify why they believe such alternative treatment is
more representative of the underlying business transaction.
management should also clearly explain the alternative
accounting treatment in the footnotes to the financial
statements.

The auditor may draw reference to this footnote without

necessarily making it the subject matter of an audit
qualification. Companies should be encouraged to move
towards a regime of unqualified financial statements. This
recommendation should be reviewed at an appropriate
juncture to determine whether the financial reporting climate
is conducive towards a system of filing unqualified financial
statements.
A statement of all transactions with related parties including

their bases should be placed before the independent audit
committee at each board meeting for formal approval.
This statement should include transactions of a non arm's-

length nature also. Management should be required to explain
to the audit committee the reasons for the non-arm's length
nature of the transaction.
The committee believes that it is important for corporate

boards to be fully aware of the risks facing the business and
that it is important for shareholders to know about the process
by which companies manage their business risks. In light of
this, it was suggested that procedures should be in place to
inform board members about the risk assessment and
minimisation procedures.
These procedures should be periodically reviewed to ensure

that executive management controls risk through means of a
properly defined framework.
It was also suggested that management should place a report

before the board every quarter documenting any limitations to
the risk taking capacity of the corporation. This document
should be formally approved by the board.
Procedures should be in place to inform board members about

the risk assessment and minimization procedures. These
procedures should be periodically reviewed to ensure that

executive management controls risk through means of a

properly defined framework.
Management should place a report before the entire board of

directors every quarter documenting the business risks faced
by the company, measures to address and minimize such risks
and any limitations to the risk taking capacity of the
corporation. This document should be formally approved by
the board.
Companies should be encouraged to train their board members

in the business model of the company as well as the risk
profile of the business parameters of the company.
Companies raising money through an IPO should disclose the

uses and application of funds by major category on a quarterly
basis as part of their quarterly declaration of un-audited
financial results. This disclosure should distinguish between
specified and unspecified uses of IPO proceeds and should be
approved by the audit committee.
On an annual basis, the company shall prepare a statement of

funds utilised for purposes other than those stated in the offer
document/prospectus.
This statement should be certified by the independent auditors

of the company and formally approved by the audit committee.
The terms of reference of the committee are to review the

performance of corporate governance and To determine the
role of companies in responding to rumour and other price
sensitive information circulating in the market, to enhance the
transparency and integrity of the market.
Points to ponder
• All audit committee members should be "financially

literate" and at least one member should have
accounting or related financial management expertise.
• It is important for corporate boards to be fully
aware of the risks facing the business and that it is

important for shareholders to know about the process by

which companies manage their business risks.
• Companies should train their board members in the
business model of the company as well as the risk profile
of the business parameters of the company.
Case Study on Corporate Governance:
The Satyam Scam: Failure of corporate governance

Satyam fraud is unfolding and so are the inherent weaknesses of
Corporate Governance in India. Ramalinga Raju, once a posture boy of
India’s growing software sector who could find a seat beside Bill
Clinton on the dais, has become a villain in the corporate world for
valid reasons.
The company is listed in BSE, NSE and NYSE. On BSE, the Satyam’s
stock crashed down by 70 percent to Rs 52 from a high of Rs 188.70.
It had a client list that boasted of Fortune 500 companies.
His emotionally charged four and half page letter of startling
revelations shook the entire corporate world when he admitted of
cooking the account and inflating the figure by Rupees 5040 crores.
He committed this fraud and tried to hush up it by an abortive bid to

purchase Maytas infra, a company created by him and run by his son
Teja Raju.
This scam is being equated with Enron of USA because here also the
scam was orchestrated by its Auditor, Arthur Anderson, in Satyam,
Price Waterhouse cooper.
IS CORPORATE GOVERNENCE IN INDIA NOT WORLD CLASS???
Interestingly Satyam has bagged Golden Peacock award for best

corporate governance by World Council for Corporate Governance only
a few years ago. The scam has raised many doubts about the class of
corporate governance in India. While speaking at a seminar on
corporate governance organised by CII, Ministry of Company affairs
and National foundation of corporate governance, C.B.Bhave, the
chairman of SEBI said on 6th February, 2009 that the corporate
governance is an ongoing process. There is a retrospection everywhere
that some concrete steps with respect to it should be done.

There are few importance elements of corporate governance

namely Auditing, Independent Directors, Regulators and
Finally the Board including CEO itself. If we examine these
constituents one by one, it would be crystal clear that all the
constituents either failed or did not act as was required.
1. The PricewaterhouseCoopers was auditor of the company. A big

question is posed over the credibility of auditors. The role of Price
waterhouse Coopers(PwC), the Auditing firm of Satyam has been
dealt. Institute of Chartered Accountants of India (ICAI) constituted
under Charter Accountants Act, 1949 is the regulatory body of all
the accounting and auditing firms across the countries.
2. Secondly, the independent directors have also failed to discharge

their duties properly. Section 49 of SEBI Act and section 229 A of
Company Act, 1956 provides for appointment of Independent
Directors in the Companies for protecting the rights of public at
large in general and shareholders in particular. There are only two
possibilities in Satyam with respect to Independent directors. Either
they connive with Raju and knew everything that was going on, or
they did not know. In both the cases they failed miserably to
discharge their duties.
3. Thirdly, the SEBI and Ministry of Company Affairs too have failed
in their assigned jobs. SEBI is the highest regulator and keeps eagle
eye on the activities of the capital markets. When the profits of this
company were registering abnormal growth, thereby the prices of
the shares were soaring, what were these guys doing? There has
been a lot of hue and cry with respect to insider trading; a howl
SEBI failed to listen to and it inflicted heavily on Satyam. Raju had
pledged almost all his shares so did many of the promoters.
=========================End of Unit
3=======================

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Business Ethics & Corporate Social Responsibility TY-BMS (Sem – 5)

Corporate governance is a process or a set of systems and

Corporate governance is concerned with the establishing of a system

According to the Cadbury committee on financial aspects of CG,

The concept of corporate governance hinges on total

Prof. Abdul Kadir Khan 1

There has been renewed interest in the corporate governance

It is a system of structuring, operating and controlling a company with

Report of SEBI committee (India) on Corporate Governance defines

Corporate governance is a way of life and not a set of rules. It is more

Corporate governance is in essence determination of how companies

IMPACT OF CORPORATE GOVERNANCE

The positive effect of corporate governance on different stakeholders

Prof. Abdul Kadir Khan 2

A key factor is an individual's decision to participate in an organisation

The Corporate Governance Framework:

The governance framework is based on principles of public sector

Agencies need to have an approach to governance that enables them

EXCELLENCE THROUGH GOOD CORPORATE GOVERNANCE

Prof. Abdul Kadir Khan 3

Adherence to good governance practices enhances the

A good corporate governance recognizes the diverse interests of

The Agency Theory : Principal – Agent Relationship

Main (dependent) Factors: Efficiency, alignment of interests, risk

In economics, the principal-agent problem treats the difficulties that

Agency Theory Overview

Prof. Abdul Kadir Khan 4

Key idea Principal-agent relationships should reflect

Information asymmetry between principal and

Prof. Abdul Kadir Khan 5

An agency theory exists whe

Diagrammatic Representation of the Agency theory

Prof. Abdul Kadir Khan 6

to monitor all managerial actions. To reduce the moral hazard problem,

Role and powers of the CEO, Board and Senior Management:

 Equitable Treatment of Share-holders

Prof. Abdul Kadir Khan 7

company's financial reporting. Disclosure of material matters

 Issues involving Corporate Governance Principles include

 Foster a corporate culture that promotes ethical

Role of the Board:

Given the economic, operational and potential cultural implications of

Prof. Abdul Kadir Khan 8

of directors believe in the importance of having a succession plan,

The board—or its nomination, compensation or selection committee—

A 2006 study by the National Association of Corporate Directors

Boards those are successful in completing their role in the succession

 They have learned how to make decisions objectively. The nature of

 They have a transparent and well-defined succession process. In

Prof. Abdul Kadir Khan 9

Role of Board of Directors:

Corporate governance is basically a system of making directors

The key to good corporate governance is a well functioning, informed

The role of boards in corporate governance, and how to improve their

1) Directors have important and powerful positions in a company.

2) Directors have a duty to act within their powers for a proper

3) The directors are required to exercise independent judgment

Prof. Abdul Kadir Khan 10

4) Directors have a duty to avoid conflicts of interest. What

5) Directors have a duty to declare any interest in proposed