Business Ethics & Corporate Governance

CORPORATE GOVERNANCE
Definition
Corporate governance is the set of processes, customs, policies, laws &
institutions affecting the way a corporation is directed, administered or
controlled. Corporate governance also includes the relationships among the
many stakeholders involved and the goals for which the corporation is
governed.
The report of India's SEBI Committee 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." It has been suggested that
the Indian approach is drawn from the Gandhian principle of trusteeship and the
Directive Principles of the Indian Constitution, but this conceptualization of
corporate objectives is also prevalent in Anglo-American and most other
jurisdictions.
The concept of shareholders as owners of a publicly-traded corporation is
complex. Ownership applies to property rights, which leads to some ambiguity
in relation to a corporation where shareholders unambiguously own shares but
do not normally exercise ownership rights of the assets of corporation. This
distinction is fundamental to the legal person concept that defines the existence
of corporations.

PRINCIPLES OF CORPORATE GOVERNANCE

 Rights and equitable treatment of shareholders: Organizations should

respect the rights of shareholders and help shareholders to exercise those
rights. They can help shareholders exercise their rights by effectively
communicating information that is understandable and accessible and
encouraging shareholders to participate in general meetings.
 Interests of other stakeholders: Organizations should recognize that they
have legal and other obligations to all legitimate stakeholders.
 Role and 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.
 Integrity and ethical behaviour: Ethical and responsible decision making is
not only important for public relations, but it is also a necessary element in
risk management and avoiding lawsuits. Organizations should develop a
code of conduct for their directors and executives that promotes ethical and
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responsible decision making. It is important to understand, though, that

reliance by a company on the integrity and ethics of individuals is bound to
eventual failure. Because of this, many organizations establish Compliance
and Ethics Programs to minimize the risk that the firm steps outside of
ethical and legal boundaries.
 Disclosure and transparency: Organizations should clarify and make
publicly known the roles and responsibilities of board and management to
provide shareholders with a level of accountability. They should also
implement procedures to independently verify and safeguard 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.

ISSUES OF CORPORATE GOVERNANCE

1)Distinguishing the roles of board and Management.
2)Composition of board and related issues.
3)Separation of the role of CEO and Chairperson.
4)Should The board has committees.
5)Appointment to the Board and Directors' and Re-election.
6)Disclosure & audit 
OBJECTIVES OF CORPORATE GOVERNANCE
Good governance is integral to the very existence of a company. It inspires and
strengthens investor's confidence by ensuring company's commitment to higher
growth and profits. It seeks to achieve following objectives:
(i) A properly structured Board capable of taking independent and objective
decisions is in place at the helm of affairs;
(ii) The Board is balanced as regards the representation of adequate number of
non-executive and independent directors who will take care of the interests and
well-being of all the stakeholders;
(iil) The Board adopts transparent procedures and practices and arrives at
decisions on the strength of adequate information;
(iv) The Board has an effective machinery to subserve the concerns of
stakeholders;
(v) The Board keeps the shareholders informed of relevant developments
impacting the company;
(VI) The Board effectively and regularly monitors the functioning of the
management
team; and
vil) The Board remains in effective control of the affairs of the company at all
times.
The overall endeavour of the Board should be to take the organization forward,
maximize long-term values and shareholders' wealth.

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CORPORATE GOVERNANCE MODELS AROUND THE WORLD

There are many different models of corporate governance around the world.
These differ according to the variety of capitalism in which they are embedded.
The Anglo-American model tends to emphasize the interests of shareholders.
This model encompasses that the purpose of the modern corporation is to
maximize shareholder value, along with typical capital market and ownership
features. This contrasts the German (and Japanese) conception of the company
as a social institution. The coordinated or multi-stakeholder model associated
with Continental Europe and Japan recognizes the interests of workers,
managers, suppliers, customers, and the community. In making this distinction,
commentators have mostly focused on the extent and nature of the separation of
ownership and control.
The Anglo-Saxon model is said to be characterized by a clear separation
between management control and shareholder ownership, and hence is
described as an ‘outsider’ system of corporate governance. It is contrasted with
the ‘insider’ system, thought to be more descriptive of continental European and
Japanese corporate forms.  
Legal environment - General
Corporations are created as legal persons by the laws and regulations of a
particular jurisdiction. These may vary in many respects between countries, but
a corporation's legal person status is fundamental to all jurisdictions and is
conferred by statute. This allows the entity to hold property in its own right
without reference to any particular real person. It also results in the perpetual
existence that characterizes the modern corporation. The statutory granting of
corporate existence may arise from general purpose legislation (which is the
general case) or from a statute to create a specific corporation, which was the
only method prior to the 19th century.
In addition to the statutory laws of the relevant jurisdiction, corporations are
subject to common law in some countries, and various laws and regulations
affecting business practices. In most jurisdiction, corporations also have a
constitution that provides individual rules that govern the corporation and
authorize or constrain its decision-makers. This constitution is identified by a
variety of terms; in English-speaking jurisdictions, it is usually known as the
Corporate Charter or the [Memorandum and] Articles of Association. The
capacity of shareholders to modify the constitution of their corporation can vary
substantially.
 Codes and guidelines
Corporate governance principles and codes have been developed in different
countries and issued from stock exchanges, corporations, institutional investors,
or associations (institutes) of directors and managers with the support of
governments and international organizations. As a rule, compliance with these
governance recommendations is not mandated by law, although the codes
linked to stock exchange listing requirements may have a coercive effect. For
example, companies quoted on the London, Toronto and Australian Stock

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Exchanges formally need not follow the recommendations of their respective

codes. However, they must disclose whether they follow the recommendations
in those documents and, where not, they should provide explanations
concerning divergent practices. Such disclosure requirements exert a significant
pressure on listed companies for compliance.

MAJOR CORPORATE GOVERNANCE INITIATIVES

The Cadbury Code:
Produced by a committee chaired by Sir Adrian Cadbury, the Report was a
response to major corporate scandals associated with governance failures in the
UK. The committee was formed in 1991 after Polly Peck, a major UK company,
went insolvent after years of falsifying financial reports. Initially limited to
preventing financial fraud, when BCCI and Robert Maxwell scandals took
place, Cadbury's remit was expanded to corporate governance generally. So the
final report covered financial, auditing and corporate governance matters, and
made the following three basic recommendations:
 the CEO and Chairman of companies should be separated.

 Boards should have at least three non-executive directors, two of whom

should have no financial or personal ties to executives.

 Each board should have an audit committee composed of non-executive

directors.
These recommendations were initially highly controversial, although they did
no more than reflect the contemporary "best practice", and urged that these
practices be spread across listed companies. At the same time it was emphasised
by Cadbury that there was no such thing as "one size fits all". In 1994, the
principles were appended to the Listing Rules of the London Stock Exchange,
and it was stipulated that companies need not comply with the principles, but
had to explain to the stock market why not if they did not.
OECD Framework of Corporate Governance :
One of the most influential guidelines has been the 1999 Organisation for
Economic Co-operation and Development (OECD) Principles of Corporate
Governance. This was revised in 2004. The OECD guidelines are often
referenced by countries developing local codes or guidelines. Building on the
work of the OECD, other international organizations, private sector associations
and more than 20 national corporate governance codes, the United
Nations Intergovernmental Working Group of Experts on International
Standards of Accounting and Reporting (ISAR) has produced their Guidance on
Good Practices in Corporate Governance Disclosure. This internationally
agreed benchmark consists of more than fifty distinct disclosure items across
five broad categories:

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 
 Auditing
 
 Board and management structure and process
 
 Corporate responsibility and compliance
 
 Financial transparency and information disclosure
 
 Ownership structure and exercise of control rights

EVOLUTION OF CORPORATE GOVERNANCE & INITIATIVES IN

INDIA
The concept of good governance is very old in India dating back to third century
B.C. where Chanakya (Vazir of Parliputra) elaborated fourfold duties of a king
viz. Raksha, Vriddhi, Palana and Yogakshema. Substituting the King of the
State with the Company CEO or Board of Directors, the principles of Corporate
Governance refers to protecting shareholders wealth (Raksha), enhancing the
wealth by proper utilization of assets (Vriddhi), maintenance of wealth through
profitable ventures (Palana) and above all safeguarding the interests of the
shareholders (Yogakshema or safeguard).
Corporate Governance was not in agenda of Indian Companies until early
1990s. In India, weakness in the system such as undesirable stock market
practices, boards of directors without adequate fiduciary responsibilities, poor
disclosure practices, lack of transparency and chronic capitalism were all crying
for reforms and improved governance. The fiscal crisis of 1991 and resulting
need to approach the IMF induced the Government to adopt reformative actions
for economic stabilization through liberalization. The momentum gathered
slowly once the economy was pushed open and the liberalization process got
initiated in early 1990s. As a part of liberalization process, in 1999, the
Government amended the Companies Act, 1956. Further amendments have
followed subsequently in the year 2000, 2002 and 2003. A variety of measures
have been adopted including:
 strengthening of certain shareholder rights (e.g. postal balloting on key
issues),
 empowering of SEBI (e.g. to prosecute the defaulting companies,
increased sanctions for directors who do not fulfill their responsibilities,
 limits on the number of directorships,
 changes in reporting and
 requirement that a ‘small shareholders nominee’ be appointed on the
Board of companies with a paid up capital of Rs. 5 crore or more).
The major corporate governance initiatives launched in India since the mid
1990s include various committees for reforms such as:
 CII Code of desired corporate governance.
 Kumar Mangalam Birla Committee(2000)
 RBI Report of the Advisory Group on corporate governance (2001)
 Naresh Chandra Committee(2002)
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 N.R.Narayana Murthy Committee (2003)

 J.J.Irani Committee (2005)
The CII Code:
On account of the interest generated by Cadbury Committee Report of UK, the
Confederation of Indian Industry (CII) took special initiative with the objective
to develop and promote a code of Corporate Governance to be adopted and
followed by Indian Companies both in private & public sector, Banks and
Financial Institutions. The final draft of the code was circulated in 1997 and the
final code called ‘Desirable Corporate Governance Code’ was released in April
1998. The Committee was driven by the conviction that good corporate
governance was essential for Indian Companies to access domestic as well as
global capital at competitive rates. The code was voluntary, contained detailed
provisions with focus on listed companies.
Between 1998 & 2000, over 25 leading companies voluntarily followed the
code: Bajaj Auto, Hindalco, Infosys, Dr. Reddy's Laboratories, Nicholas
Piramal, Bharat Forge, BSES, HDFC, ICICI & many others.

Kumar Mangalam Birla Committee Report

While the CII code was well received by corporate sector and some progressive
companies also adopted it, it was felt that under Indian conditions a statutory
rather than a voluntary code would be more meaningful. Consequently the
second major initiative was undertaken by the Securities and Exchange Board
of India (SEBI) which set up a committee under the chairmanship of Kumar
Mangalam Birla in 1999, to design a mandatory-cum-recommendatory code for
listed companies, with the objective of promoting and raising of standards of
good corporate governance. The Committee in its Report observed “the strong
Corporate Governance is indispensable to resilient and vibrant capital market
and is an important instrument of investor protection. It is the blood that fills the
veins of transparent corporate disclosure and high quality accounting practices.
It is the muscle that moves a viable and accessible financial reporting structure”.
In early 2000 the SEBI Board accepted and ratified the key recommendations
of this committee and these were incorporated into Clause – 49 of the Listing
Agreement of the Stock Exchanges. These recommendations aimed at providing
the standards of corporate governance, are divided into mandatory and non-
mandatory recommendations. The recommendations have been made applicable
to all listed companies with the paid-up capital of Rs. 3 crore and above or net
worth of Rs.25 crore or more at any time in the history of the company. The
ultimate responsibility of putting the recommendations into practice rests
directly with the Board of Directors and the management of the company.

Report of Task Force

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In May 2000, the Department of Corporate Affairs (DCA) formed a broad based
study group under the chairmanship of Dr. P.L. Sanjeev Reddy, Secretary of
DCA. The group was given the ambitious task of examining ways to
“Operationalize the concept of corporate excellence on a sustained basis” so as
to “sharpen India’s global competitive edge and to further develop corporate
culture in the country”. In November 2000 the Task Force on Corporate
Excellence set up by the group produced a report containing a range of
recommendations for raising governance standards among all companies in
India. It also recommended setting up of a Centre for Corporate Excellence.

Naresh Chandra Committee Report

The Enron debacle of 2001 involving the hand-in-glove relationship between
the auditor and the corporate client, the scams involving the fall of the corporate
giants in the U.S. like the WorldCom, Owest, Global Crossing, Xerox and the
consequent enactment of the stringent Sarbanes Oxley Act in the U.S. led the
Indian Government to wake up. A committee was appointed by Ministry of
Finance and Company Affairs in August 2002 under the chairmanship of
Naresh Chandra to examine and recommend inter alia amendments to the law
involving the auditor-client relationships and the role of independent directors.
The committee made recommendations in two key aspects of corporate
governance:
 Financial and non-financial disclosures; &
 Independent auditing and board oversight of management.
Narayana Murthy Committee Report
The SEBI also analysed the statistics of compliance with the clause 49 by listed
companies and felt that there was a need to look beyond the mere systems and
procedures if corporate governance was to be made effective in protecting the
interest of investors. The SEBI therefore constituted a committee under the
chairmanship of Narayana Murthy for reviewing implementation of the
corporate governance code by listed companies and issue of revised clause 49.
Some of the major recommendations of the committee primarily related to audit
committees, audit reports, independent directors, related party transactions, risk
management, directorships and director compensation, codes of conduct and
financial disclosures.

J.J. Irani Committee Report

The Companies Act 1956 was enacted on the recommendations of the Bhaba
Committee set up in 1950 with the object to consolidate the existing corporate
laws and to provide a new basis for corporate operation in independent India.
With enactment of this legislation in 1956, the Companies Act 1913 was
repealed. The need for streamlining this Act was felt from time to time as the
corporate sector grew in pace with the Indian economy and as many as 24

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amendments have taken place since 1956. The major amendments to the Act
were made through Companies (Amendment) Act 1998 after considering the
recommendations of Sachar Committee followed by further amendments in
1999, 2000, 2002 and finally in 2003 through the Companies (Amendment) Bill
2003 pursuant to the report of R.D. Joshi Committee.
After a hesitant beginning in 1980, India took up its economic reforms
programme in 1990s and a need was felt for a comprehensive review of the
Companies Act 1956. Unsuccessful attempts were made in 1993 and 1997 to
replace the present Act with a new law. In the current national and international
context the need for simplifying corporate laws has long been felt by the
government and corporate sector so as to make it amenable to clear
interpretation and provide a framework that would facilitate faster economic
growth. The Government therefore took a fresh initiative in this regard and
constituted a committee in December 2004 under the chairmanship of Dr. J.J.
Irani with the task of advising the government on the proposed revisions to the
Companies Act 1956.The recommendations of the Committee submitted in May
2005 mainly relate to management and board governance, related party
transactions, minority interest, investors education and protection, access to
capital, accounts and audit, mergers and amalgamations, offences and penalties,
restructuring and liquidation, etc.

Central Coordination and Monitoring

A high powered Central Coordination and Monitoring Committee (CCMC) co-
chaired by Secretary, Department of Corporate Affairs’ and Chairman, SEBI
was set up by the Department of Corporate Affairs to monitor the action taken
against the vanishing companies and unscrupulous promoters who misused the
funds raised from the public. It was decided by this committee that seven Task
Forces be set up at Mumbai, Delhi, Chennai, Kolkata, Ahmedabad, Bangalore
and Hyderabad with Regional Directors/Registrar of Companies of respective
regions as convener, and Regional Offices of SEBI and Stock Exchanges as
Members. The main task of these Task Forces was to identify the companies,
which have disappeared, or which have misutilised the funds mobilized from
the investors and suggest appropriate action in terms of Companies Act or SEBI
Act.

National Foundation of Corporate Governance

Recently the Ministry of Company Affairs has set up National Foundation for
Corporate Governance (NFCG) in association with Confederation of Indian
Industry (CII), Institute of Company Secretaries of India (ICSI) and Institute of
Chartered Accountants of India (ICAI).
The NFCG would focus on the following areas:

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 Creating awareness on the importance of implementing good corporate

governance practices both at the level of individual corporations and for
the economy as a whole. The foundation would provide a platform for
quality discussions and debates amongst academicians, policy makers,
professionals and corporate leaders through workshops, conferences,
meetings and seminars.
 Encouraging research capability in the area of corporate governance in
the country and providing key inputs for developing laws and regulations,
which meet the twin objectives of maximizing wealth creation and fair
distribution of this wealth.
 Working with the regulatory authorities at multiple levels to improve
implementation and enforcement of various laws related to corporate
governance.
 Working in close co-ordination with the private sector, work to instill a
commitment to corporate governance reforms and facilitate the
development of a corporate governance culture.
 Cultivating international linkages and maintaining the evolution towards
convergence with international standards and practices for accounting,
audit and non-financial disclosure.
 Setting up of 'National Centers for Corporate Governance' across the
country, which would provide quality training to Directors as well as
produce quality research and aim to receive global recognition.
The recommendations put forward by various committees can be summarized as
follows:
Mandatory Non-
Mandatory
Board of Remuneration
Directors Committee
Audit Shareholder
Committee rights
Subsidiary Audit
Companies qualification
Disclosures Whistle
Blower policy

Driving Force for Corporate Governance in India

 Unethical business practices- Security Scams

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 Impact of Globalization- Foreign investors' expectation, integration with

foreign market.
 Impact of Privatization- new structure of ownership, MNCs

PARTIES TO CORPORATE GOVERNANCE

The most influential parties involved in corporate governance include
government agencies and authorities, stock exchanges, management(including
the board of directors and its chair, the Chief Executive Officer or the
equivalent, other executives and line management, shareholders and auditors).
Other influential stakeholders may include lenders, suppliers, employees,
creditors, customers and the community at large.
The agency view of the corporation posits that the shareholder forgoes decision
rights (control) and entrusts the manager to act in the shareholders' best (joint)
interests. Partly as a result of this separation between the two investors and
managers, corporate governance mechanisms include a system of controls
intended to help align managers' incentives with those of shareholders. Agency
concerns (risk) are necessarily lower for a controlling shareholder.
 Board of Directors:
A board of directors is expected to play a key role in corporate
governance. The board has the responsibility of endorsing the
organization's strategy, developing directional policy, appointing,
supervising and remunerating senior executives, and ensuring
accountability of the organization to its investors and authorities.
All parties to corporate governance have an interest, whether direct or
indirect, in the financial performance of the corporation. Directors,
workers and management receive salaries, benefits and reputation, while
investors expect to receive financial returns. For lenders, it is specified
interest payments , while returns to equity investors arise from dividend
distributions or capital gains on their stock. Customers are concerned
with the certainty of the provision of goods and services of an appropriate
quality; suppliers are concerned with compensation for their goods or
services, and possible continued trading relationships. These parties
provide value to the corporation in the form of financial, physical, human
and other forms of capital. Many parties may also be concerned
with corporate social performance.
A key factor in a party's decision to participate in or engage with a
corporation is their confidence that the corporation will deliver the party's
expected outcomes. When categories of parties (stakeholders) do not have
sufficient confidence that a corporation is being controlled and directed in
a manner consistent with their desired outcomes, they are less likely to
engage with the corporation. When this becomes an endemic system

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feature, the loss of confidence and participation in markets may affect

many other stakeholders, and increases the likelihood of political action.
 Ownership structures and elements
Ownership structure refers to the types and composition of shareholders
in a corporation. Researchers often "measure" ownership structures by
using some observable measures of ownership concentration or the extent
of inside ownership. Some features or types of ownership structure
involving corporate groups include pyramids, cross-shareholdings, rings,
and webs. German "concerns" (Konzern) are legally recognized corporate
groups with complex structures. Japanese keiretsu () and South
Korean chaebol (which tend to be family-controlled) are corporate groups
which consist of complex interlocking business relationships and
shareholdings. Cross-shareholding are an essential feature
of keiretsu and chaebol groups) [2]. Corporate engagement with
shareholders and other stakeholders can differ substantially across
different ownership structures.
 Family ownership
In many jurisdictions, family interests dominate ownership structures. It
is sometimes suggested that corporations controlled by family interests
are subject to superior oversight compared to corporations "controlled"
by institutional investors (or with such diverse share ownership that they
are controlled by management). A recent study by Credit Suisse found
that companies in which "founding families retain a stake of more than
10% of the company's capital enjoyed a superior performance over their
respective sectorial peers." Since 1996, this superior performance
amounts to 8% per year.[3] Forget the celebrity CEO. "Look beyond Six
Sigma and the latest technology fad. A study by Business Week [4] claims
that "BW identified five key ingredients that contribute to superior
performance. Not all are qualities are unique to enterprises with retained
family interests.
 Institutional investors
Many years ago, worldwide, investors were typically individuals or
families, irrespective of whether or not they acted through a controlled
entity. Over time, markets have become largely institutionalized:
investors are largely institutions that invest the pooled funds of their
intended beneficiaries. These institutional investors include pension
funds (also known as superannuation funds), mutual funds, hedge
funds,exchange-traded funds, and financial institutions such as insurance
companies and banks. 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.
The significance of institutional investors varies substantially across
countries. In developed Anglo-American countries (Australia, Canada,
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New Zealand, U.K., U.S.), institutional investors dominate the market for
stocks in larger corporations. While the majority of the shares in the
Japanese market are held by financial companies and industrial
corporations, these are not institutional investors if their holdings are
largely with-on group.
The largest pools of invested money (such as the mutual fund 'Vanguard
500', or the largest investment management firm for corporations, State
Street Corp.) are designed to maximize the benefits of diversified
investment by investing in a very large number of different corporations
with sufficient liquidity. The idea is this strategy will largely eliminate
individual firm financial or other risk and. A consequence of this
approach is that these investors have relatively little interest in the
governance of a particular corporation. It is often assumed that, if
institutional investors pressing for will likely be costly because of
"golden handshakes") or the effort required, they will simply sell out their
interest.
 Financial reporting and the independent auditor
The board of directors has primary responsibility for the corporation's
external financial reporting functions. The Chief Executive Officer and
Chief Financial Officer are crucial participants and boards usually have a
high degree of reliance on them for the integrity and supply of
accounting information. They oversee the internal accounting systems,
and are dependent on the corporation's accountants and internal auditors.

Current accounting rules under both U.S. GAAP and International

Accounting Standards allow managers some choice in determining the
methods of measurement and criteria for recognition of various financial
reporting elements. The potential exercise of this choice to improve
apparent performance increases the information risk for users. Financial
reporting fraud, including non-disclosure and deliberate falsification of
values also contributes to users' information risk. To reduce these risk and
to enhance the perceived integrity of financial reports, corporation
financial reports must be audited by an independent external auditor who
issues a report that accompanies the financial statements.
One area of concern is whether the auditing firm acts as both the
independent auditor and management consultant to the firm they are
auditing. This may result in a conflict of interest which places the
integrity of financial reports in doubt due to client pressure to appease
management. The power of the corporate client to initiate and terminate
management consulting services and, more fundamentally, to select and
dismiss accounting firms contradicts the concept of an independent
auditor.

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Changes enacted in the United States in the form of the Sarbanes-Oxley

Act (in response to the Enron situation as noted below) prohibit
accounting firms from providing both auditing and management
consulting services. Similar provisions are in place under clause 49
of SEBI Act in India.
The Enron collapse is an example of misleading financial reporting.
Enron concealed huge losses by creating illusions that a third party was
contractually obliged to pay the amount of any losses. However, the third
party was an entity in which Enron had a substantial economic stake. In
discussions of accounting practices with Arthur Andersen, the partner in
charge of auditing, views inevitably led to the client prevailing.
 Executive Remuneration/Compensation
Research on the relationship between firm performance and executive
compensation does not identify consistent and significant relationships
between executives' remuneration and firm performance. Not all firms
experience the same levels of agency conflict, and external and internal
monitoring devices may be more effective for some than for others.
Some researchers have found that the largest CEO performance
incentives came from ownership of the firm's shares, while other
researchers found that the relationship between share ownership and firm
performance was dependent on the level of ownership. The results
suggest that increases in ownership above 20% cause management to
become more entrenched, and less interested in the welfare of their
shareholders.
Some argue that firm performance is positively associated with
share option plans and that these plans direct managers' energies and
extend their decision horizons toward the long-term, rather than the short-
term, performance of the company. However, that point of view came
under substantial criticism circa in the wake of various security scandals
including mutual fund timing episodes and, in particular, the backdating
of option grants as documented by University of Iowa academic Erik Lie
and reported by James Blander and Charles Forelle of the Wall Street
Journal.
Even before the negative influence on public opinion caused by the 2006
backdating scandal, use of options faced various criticisms. A particularly
forceful and long running argument concerned the interaction of
executive options with corporate stock repurchase programs. Numerous
authorities determined options may be employed in concert with stock
buybacks in a manner contrary to shareholder interests. These authors
argued that, in part, corporate stock buybacks for U.S. Standard & Poors
500 companies surged to a $500 billion annual rate in late 2006 because
of the impact of options.

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A combination of accounting changes and governance issues led options

to become a less popular means of remuneration as 2006 progressed, and
various alternative implementations of buybacks surfaced to challenge the
dominance of "open market" cash buybacks as the preferred means of
implementing a share repurchase plan.

 MECHANISMS AND CONTROLS

Corporate governance mechanisms and controls are designed to reduce the
inefficiencies that arise from moral hazard and adverse selection. For example,
to monitor managers' behavior, an independent third party (the external auditor)
attests the accuracy of information provided by management to investors. An
ideal control system should regulate both motivation and ability.
1. Internal corporate governance controls
Internal corporate governance controls monitor activities and then take
corrective action to accomplish organisational goals. Examples include:
  Monitoring by the board of directors: The board of directors, with its
legal authority to hire, fire and compensate top management, safeguards
invested capital. Regular board meetings allow potential problems to be
identified, discussed and avoided. Whilst non-executive directors are thought
to be more independent, they may not always result in more effective
corporate governance and may not increase performance.[7] Different board
structures are optimal for different firms. Moreover, the ability of the board
to monitor the firm's executives is a function of its access to information.
Executive directors possess superior knowledge of the decision-making
process and therefore evaluate top management on the basis of the quality of
its decisions that lead to financial performance outcomes, ex ante. It could be
argued, therefore, that executive directors look beyond the financial criteria.
  Internal control procedures and internal auditors: Internal control
procedures are policies implemented by an entity's board of directors, audit
committee, management, and other personnel to provide reasonable
assurance of the entity achieving its objectives related to reliable financial
reporting, operating efficiency, and compliance with laws and regulations.
Internal auditors are personnel within an organization who test the design
and implementation of the entity's internal control procedures and the
reliability of its financial reporting
  Balance of power: The simplest balance of power is very common;
require that the President be a different person from the Treasurer. This
application of separation of power is further developed in companies where
separate divisions check and balance each other's actions. One group may
propose company-wide administrative changes, another group review and
can veto the changes, and a third group check that the interests of people
(customers, shareholders, employees) outside the three groups are being met.

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 Business Ethics & Corporate Governance

  Remuneration: Performance-based remuneration is designed to relate

some proportion of salary to individual performance. It may be in the form
of cash or non-cash payments such as shares and share
options, superannuation or other benefits. Such incentive schemes, however,
are reactive in the sense that they provide no mechanism for preventing
mistakes or opportunistic behavior, and can elicit myopic behavior.
In publicly-traded U.S. corporations, boards of directors are largely chosen by
the President/CEO and the President/CEO often takes the Chair of the Board
position for his/herself (which makes it much more difficult for the institutional
owners to "fire" him/her). The practice of the CEO also being the Chair of the
Board is known as "duality". While this practice is common in the U.S., it is
relatively rare elsewhere. It is illegal in the U.K.
2.External corporate governance controls
External corporate governance controls encompass the controls external
stakeholders exercise over the organization. Examples include:

 Competition
 Debt covenants
 Demand for and assessment of performance information
(especially financial statements)
 Government regulations
 Managerial labour market
 Media pressure
 Takeovers

 SYSTEMIC PROBLEMS OF CORPORATE GOVERNANCE

  Demand for information: In order to influence the directors, the
shareholders must combine with others to form a voting group which can
pose a real threat of carrying resolutions or appointing directors at a general
meeting.
  Monitoring costs: A barrier to shareholders using good information is
the cost of processing it, especially to a small shareholder. The traditional
answer to this problem is the efficient market hypothesis (in finance, the
efficient market hypothesis (EMH) asserts that financial markets are
efficient), which suggests that the small shareholder will free ride on the
judgments of larger professional investors.
  Supply of accounting information: Financial accounts form a crucial
link in enabling providers of finance to monitor directors. Imperfections in
the financial reporting process will cause imperfections in the effectiveness
of corporate governance. This should, ideally, be corrected by the working of
the external auditing process.
 
FACTORS INFLUENCING CORPORATE GOVERNANCE
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 Business Ethics & Corporate Governance

1. The ownership structure

The structure of ownership of a company determines, to a considerable extent,
how a Corporation is managed and controlled. The ownership structure can be
dispersed among individual and institutional shareholders as in the US and UK
or can be concentrated in the hands of a few large shareholders as in Germany
and Japan. But the pattern of shareholding is not as simple as the above
statement seeks to convey. The pattern varies the across the globe. 
Our corporate sector is characterized by the co-existence of state owned, private
and multinational Enterprises. The shares of these enterprises (except those
belonging to a public sector) are held by institutional as well as small investors.
Specifically, the shares are held by 
(1) The term-lending institutions 
(2) Institutional investors, comprising government-owned mutual funds, Unit
Trust of India and the government owned insurance corporations 
(3) Corporate bodies 
(4) Directors and their relatives and 
(5) Foreign investors. Apart from these block holdings, there is a sizable equity
holding by small investors.
2. The structure of company boards 
Along with the structure of ownership, the structure of company boards has
considerable influence on the way the companies are managed and controlled.
The board of directors is responsible for establishing corporate objectives,
developing broad policies and selecting top-level executives to carry out those
objectives and policies.
3. The financial structure 
Along with the notion that the structure of ownership matters in corporate
governance is the notion that the financial structure of the company, that is
proportion between debt and equity, has implications for the quality of
governance.
4. The institutional environment 
The legal, regulatory, and political environment within which a company
operates determines in large measure the quality of corporate governance. In
fact, corporate governance mechanisms are economic and legal institutions and
often the outcome of political decisions. For example, the extent to which
shareholders can control the management depends on their voting right as
defined in the Company Law, the extent to which creditors will be able to
exercise financial claims on a bankrupt unit will depend on bankruptcy laws and
procedures etc.

REGULATORY MECHANISMS OF CORPORATE GOVERNANCE

In our country, there are six mechanisms to ensure corporate governance:
(1) Companies Act 
Companies in our country are regulated by the companies Act, 1956, as

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 Business Ethics & Corporate Governance

amended up to date. The companies Act is one of the biggest legislations with
658 sections and 14 schedules. The arms of the Act are quite long and touch
every aspect of a company's insistence. But to ensure corporate governance, the
Act confers legal rights to shareholders to:

a) Vote on every resolution placed before an annual general meeting;

b) To elect directors who are responsible for specifying objectives and
laying down policies;
c) Determine remuneration of directors and the CEO;
d) Removal of directors and 
e) Take active part in the annual general meetings.

(2) Securities law 

The primary securities law in our country is the SEBI Act. Since its setting up in
1992, the board has taken a number of initiatives towards investor protection.
One such initiative is to mandate information disclosure both in prospectus and
in annual accounts. While the companies Act itself mandates certain standards
of information disclosure, SEBI Act has added substantially to these
requirements in an attempt to make these documents more meaningful.

(3) Discipline of the capital market 

Capital market itself has considerable impact on corporate governance. Here in
lies the role the minority shareholders can play effectively. They can refuse to
subscribe to the capital of a company in the primary market and in the
secondary market; they can sell their shares, thus depressing the share prices. A
depressed share price makes the company an attractive takeover target. 

(4) Nominees on company boards Development banks hold large blocks of

shares in companies. These are equally big debt holders too. Being equity
holders, these investors have their nominees in the boards of companies. These
nominees can effectively block resolutions, which may be detrimental to their
interests. Unfortunately, the role of nominee directors has been passive, as has
been pointed out by several committees including the Bhagwati Committee on
takeovers and the Omkar Goswami committee on corporate governance.

(5) Statutory audit 

Statutory audit is yet another mechanism directed to ensure good corporate
governance. Auditors are the conscious-keepers of shareholders, lenders and
others who have financial stakes in companies. 
Auditing enhances the credibility of financial reports prepared by any
enterprise. The auditing process ensures that financial statements are accurate
and complete, thereby enhancing their reliability and usefulness for making
investment decisions.

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(6) Codes of conduct

The mechanisms discussed till now are regulatory in approach. They are
mandated by law and violation of any provision invite penal action. But legal
rules alone cannot ensure good corporate governance. What is needed is self-
regulation on the part of directors, besides of course, the mandatory provisions.

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RECENT CORPORATE GOVERNANCE FAILURES

The creation of corporate regulation is often linked to perceived failures of
corporations and their management to behave in the way society expect them to.
Corporate governance is not an exception to this trend, and, as with accounting,
different countries may experience difficulties at different times.
The International Federation of Accountants (IFAC) claims that while there has
been a lot of strategic guidance for business, there has been too little said about
the need for good corporate governance. These authors emphasize the fact that
successful companies were visionary companies, with a long track record of
making a positive impact on the world. They did more than focus on profits;
they focused on continuous improvement. They took a long-term view and
realised that they were members of society with rights and responsibilities.
However, the long-term view is something of a rarity in many companies. A
critical factor in many corporate failures was:
 Poorly designed rewards package
 Including excessive use of share options (that distorted executive
behaviour towards the short term)
 The use of stock options, or rewards linked to short-term share price
performance (led to Aggressive earnings management to achieve target
share prices)
 Trading did not deliver the earnings targets, aggressive or even fraudulent
accounting tended to occur. This was very apparent in the cases of Ahold,
Enron, WorldCom and Xerox (IFAC, 2003).
Adelphia manipulated its earnings figures for every quarter between 1996 and
2002 to make it appear to meet analysts' expectations. Some of the better known
cases of financial irregularities are summarised in following table:

Company Country Causes of

Failure

Enron USA Inflated

earning

Worldcom USA Expenses

booked as
capital
expenditure

Tyco USA Looting of

CEO,
improper
share deals

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 Business Ethics & Corporate Governance

Global USA Inflated

Crossing corporate
profits to
defraud
investors

Royal Netherlands Earnings

Ahold overstated

Parmalat Italy False

transaction
recorded

Wal-Mart USA Weaknesses

in internal
controls have
led to
Government
investigations
& class
actions law
suits by
employees

Xerox USA Accelerated

revenue
recognition

In terms of corporate governance issues, Ahold, Enron and WorldCom all

suffered from
 Questionable ethics
 Behaviour at the top
 Aggressive earnings management
 Weak internal control
 Risk management
 Shortcomings in accounting and reporting

ENRON
Enron is an excellent example where those at the top allowed a culture to
flourish in which secrecy, rule-breaking and fraudulent behaviour were
acceptable. It appears that performance incentives created a climate where
employees sought to generate profit at the expense of the company's stated
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 Business Ethics & Corporate Governance

standards of ethics and strategic goals (IFAC, 2003). Enron had all the
structures and mechanisms for good corporate governance. In addition, it had a
corporate social responsibility task force and a code of conduct on security,
human rights, social investment and public engagement. Yet no one followed
the code. The board of directors allowed the management openly to violate the
code, particularly when it allowed the CFO to serve in the special purpose
entities (SPEs); the audit committee allowed suspect accounting practices and
made no attempt to examine the SPE transactions; the auditors failed to prevent
questionable accounting.
The use of questionable accounting and disclosure practices, their approval by
the board and their verification by the auditors arose from a variety of forces,
including:
 Pressure to meet quarterly earnings projections and maintain stock prices
after the expansion of the 1990s
 Executive compensation practices
 Outdated and rules-based accounting standards, complex corporate
financial arrangements designed to minimise taxes and hide the true state
of the companies, and the compromised independence of public
accounting firms.
WAL-MART
It has co-filed a shareholder proposal over concerns that Wal-Mart Stores Inc,
the US supermarket group, is failing to comply with its own governance
standards. Karina Litvack, head of governance and sustainable investment-
 Despite strong policies on paper, Wal-Mart has struggled to implement its
standards across its US business.
 Weaknesses in internal controls have eroded the company's reputation as
an attractive employer and are adding fuel to the fires of Wal-Mart's
critics.
 Its failure to deliver on these policy commitments is inhibiting Wal-
Mart's ability to expand into new domestic markets.
 Over the past several years, it has become increasingly concerned by
signs of failure in internal controls that have led to government
investigations and class action lawsuits by employees.
 Allegations include requiring employees to 'work off the clock' - during
breaks and after shifts - systematic discrimination against women, and
alleged questionable tactics to prevent workers from voting for union
representation.
 It got off to a promising start in 2005 with expectations of a dialogue with
the independent directors on the audit committee. But when this simply
withered on the vine, Wal-mart had little choice but to bring concerns
about internal controls, labour violations and the erosion of the company's
reputation to fellow shareholders.

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 Company was not interested in engaging in a productive discussion about

how it builds and supports a compliance culture and, as a result, they
have joined an international group of large filers led by the New York
City Employees' Retirement System to file a shareholder proposal.

SATYAM
Satyam is another case of a resounding failure in corporate governance, this
time in India. It is a failure that occurred with the fourth largest software
company from the country. This is not the first time that companies promoted
by family groups defraud the investors. But Satyam has a different face because
the Chairman himself admitted the fraud and wrote to the Board of Directors
and the Capital Market Regulator about the manipulations, which have made all
regulatory frameworks a mockery.
Accounting manipulations to which they appeal, consisted of understatement of
liabilities and inflated cash balance. Satyam reported a net profit of Rs. 649
cores whereas the real profit was only Rs.61 cores. Although financial
statements were prepared in accordance with Indian GAAP, IFRS and U.S.
GAP, in 2008, the year that we reference, have been audited by the PWC only
those drawn in concordance with Indian GAP. Another important fact to note is
that in the Board of Satyam were present two teachers from two major schools
of business, Mr. Rammohan Rao was from the Hyderabad Indian Business
School, which is the leading business school in India, Mr. Krishna Paleppu was
from the famous Harvard Business School, that with all their skill and
competence, allowed the commit of such errors. The company’s corporate
governance statement for 2007 shows that an audit committee was functioning
overseeing the financial reporting and disclosure process as also the ensuring
the sufficiency, correctness and credibility of the financial statements. But more
seriously, like in Enron and Lehman Brothers cases, PWC has slowed to hide
the fraud, not all the audit tests that were required in those cases were applied,
or had been partially applied. Satyam episode pulled down the stock market
indices heavily.

Satyam lost over 70 per cent in the market. The fate of over 50,000 employees
of Satyam is in doldrums. The investors who had great faith in Satyam lost
heavily in this game. The clients have already expressed their reactions by
blacklisting the company and Ramalinga Raju resigned from the Board.

It is one of Corporate India's worst unfolding chapters. The top level

management failed to estimate the intensity of the gangrene in the organization.
Questions also arise on the role of the auditors, and how such a magnitude of
financial fraud could have gone unnoticed. Corporate governance is a field
which constantly investigates how to secure and motivate efficient management

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of corporations. It has began as a corporate governance issue back in December

has now turned into a major financial scandal for the ages in India.
A business will always have two sides, it is not necessary to gain profits every
time, but to sustain in the market the integrity is vital. Every day in some or the
other place there is a merger or an acquisition happening, but due to the
projected image the co-players in the market are dropping out their plans of
taking over Satyam.
Undoubtedly there will be intense focus directed at the other Indian IT Services
companies as well. The Satyam corporate governance failure may also make its
competitors bolder in terms of acquiring market share created by its fallout,
provided the industry can regain the trust of the same investors that Satyam has
deceived.
CONCLUSION
It is important to recognise, however, the evidence base for firm
recommendations on corporate governance in financial institutions is thinner
than one would like, and certainly not robust enough to offer a standardised set
of recommendations valid at all times and in all places.
Principal conclusions are:
 People are more important than processes. Many of the failed firms, or
near failed firms which we have encountered, had Boards with the
prescribed mix of executives and non-executives, with socially acceptable
levels of diversity, with directors appointed through impeccably
independent processes, yet where the individuals concerned were either
not skilled enough for, or not temperamentally suited to, the challenge
role that came to be required when the business ran into difficulty.
 There are some good practice processes worth having. Properly
constituted audit committees, and Board risk committees can play an
important role, as long as they are prepared to listen carefully to sources
of advice from outside the firm.
 A regulatory regime built on senior management responsibilities is
absolutely essential. In some of the cases we have wrestled with, senior
management did not consider themselves to be responsible for the control
environment and indeed, in the old pre FSA regime, were able
successfully to claim that they were not responsible even if the business
failed. So our regulation is built on a carefully articulated set of
responsibilities up and down the business. It is important that they are not
unrealistic. We do not expect the CEO to check in the bottom drawers of
each of his traders for unbooked deal tickets. But we do expect the CEO
to ensure that there is a risk management structure and a control
framework throughout the business which ought to identify aberrant
behaviour, or at least prevent it going on unchecked for any length of
time.

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 One consequence of this senior management regime is that regulators

must focus attention on the top level of management in the firm. For the
major firms we regulate we insist that our supervisors have direct access
to the Board, and that they present to the Board their own unvarnished
view of the risks the firm is running, and of how good the control systems
are by comparison with the best of breed in their sector. Unfortunately,
we find some resistance to this approach. The management of some of
our firms want to negotiate the regulators assessment, so that when it
reaches the Board it is an agreed paper and sufficiently bland to cause no
debate. Well-structured Board, and a confident management, should
welcome an independent view, even expressed at the Board level, which
they may challenge and contest if they wish. And non-executive directors
should find it helpful to see a knowledgeable view of the institution
which does not come from or through its own senior management.
 Boards should take more interest in the nature of the incentive structure
within the organisation. It is not solely about the pay of the CEO,
important though that is to get right - as some firms in Britain have
recently discovered. Talking about ensuring that the incentives within the
firm, and pay is a very powerful one, are aligned with its risk appetite. A
number of our most problematic cases have their roots in a misalignment
of incentives.
 No corporate governance system will work well unless there is some
engagement on the part of shareholders. Boards are responsible to
shareholders. That is the received wisdom in Anglo-American capitalism,
at least. But if those shareholders are not prepared to vote their shares,
and show little interest in business strategy, then that accountability is
somewhat notional, and unlikely to be effective. Certainly regulators
cannot hope to substitute for concerned and challenging shareholders,
though in some senses they may complement them.

CADBURY
Adrian Cadbury, successor to and chairman of the Cadbury Schweppes
confectionary group- Mr. Cadbury's visit and interactions with Indian industry
triggered the first serious discussions on the subject of corporate governance.
All in all, it seemed like a promising new way of looking at the evil that was
single promoter-run firms in India then, who, among other things, ran their
companies like fiefdoms and were loath to give up control even if their
shareholdings were low.
Recognise that it was a not so competitive environment, the grip of the license
raj was still fairly firm and companies and their promoter/founders could pretty
much do what they wanted, with public money. The real pain of liberalisation
was yet to set in and the Infosys way of boardroom discipline was some way
from making its presence felt.

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History it seems is repeating itself. Indian companies have exposed themselves

to billions of dollars worth of forex derivative contracts over the last few years.
Precise numbers are hard to come by and will perhaps never will. What is clear
is that companies have taken financial risks they could or should have avoided.
What is clearer is that there was no compelling reason to take these risks. And
to that extent, it's a failure of corporate governance and must be treated and then
addressed as such. There is of course the other issue of how the Institute of
Chartered Accountants or the accounting regulator figuring out how to treat
derivative losses as they stand on scores of balance sheets today.
How did it happen? Companies have been steadily stepping up their exposure to
currency swaps and the like for at least four years now. Over time, as the stock
markets (which bolster sentiment) have held their own and the prospect of any
downside risk appeared more and more distant with every passing day, chief
financial officers (CFOs) of companies have got braver.
If a company entered into, let's say, a transaction to convert a local currency
borrowing into the Japanese yen or Swiss franc borrowing through the swap
route, then the company is inducing a risk into the system where there is not. 
No two ways about that.
Managements ought to have, in the interests of corporate governance, clearly
informed their boards of all foreign exchange exposures, the risks arising out of
that and the measures to mitigate them were something to go wrong.
Moreover, under the relevant Securities & Exchange Board of India regulations,
in the absence of an applicable standard in India for derivatives, the companies'
Audit Committees should have examined international standards and disclosed
the losses in the Governance report and indicated that these would have been
provided for had the country adopted international standards as applicable.
It is possible many companies did keep their boards informed and made the
appropriate references in their balance sheets. Though this does seem unlikely,
even if they did, no one was watching. It's also possible that some companies
are in violation of law. Either way, shareholders must perhaps shoulder some
part of the blame.
To conclude is another Enron waiting in the wings? Not quite, but it does raise
some fundamental questions on what companies do with their shareholders'
funds. It's also about how when the good times roll, everyone forgets to look at
the figures closely. There is something in the original Cadbury committee
definition of corporate governance. "Corporate governance is the system by
which companies are directed and controlled."

ISSUES IN CORPORATE GOVERNANCE

Chairman and CEO: It is considered good practice to separate the roles of the
Chairman of the Board and that of the CEO. The Chairman is head of the Board
and the CEO heads the management. If the same individual occupies both the

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positions, there is too much concentration of power, and the possibility of the
board supervising the management gets diluted.
Audit Committee: Boards work through sub-committees and the audit
committee is one of the most important. It not only oversees the work of the
auditors but is also expected to independently inquire into the workings of the
organisation and bring lapse to the attention of the full board.
Independence and conflicts of interest: Good governance requires that outside
directors maintain their independence and do not benefit from their board
membership other than remuneration. Otherwise, it can create conflicts of
interest. By having a majority of outside directors on its Board.
Flow of information: A board needs to be provided with important information
in a timely manner to enable it to perform its roles. A governance guideline of
General Motors, for instance, specifically allows directors to contact individuals
in the management if they feel the need to know more about operations than
what they are being told.
Too many directorships: Being a director of a company takes time and effort.
Although a board might meet only four or five times a year, the director needs
to have the time to read and reflect over all the material provided and make
informed decisions. Good governance, therefore, suggests that an individual
sitting on too many boards looks upon it only as a sinecure for he or she will not
have the time to do a good job. 

RECENT CORPORATE GOVERNANCE FAILURES IN INDIA

  Reebok India Case
 Vodafone wins $2.2 Billion Tax Bill Battle
 Diageo’s $2.1 billion deal for Mallya’s United Spirits
 Emkay Global’s bad orders trigger brief halt on NSE
 Kingfisher Airlines Loses License to fly
 Axis Bank Partners with Tata General Insurance
 INR 1,800 crore wiped off Adani Enterprise Ltd stocks after rumour
fuelled by blogger
 Hero Motors finally drops Honda
 Sahara told to repay small investors

REEBOK INDIA SUFFERS A MAJOR SCAM

This is probably the biggest corporate scam after Satyam, at least of whatever
has come to light. Reebok India, owned by Adidas AG, alleged a
Rs.870 crore fraud by its former managing director (MD) Subhinder Singh
Prem and former Chief Operating Officer (COO) Vishnu Bhagat, in a criminal
complaint filed at the Gurgaon police’s Economic Offence Wing in May, 2012.
In March 2013, Adidas, the parent company, announced a 153 million Euros
loss on account of the Reebok India episode.

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The two were accused of criminal conspiracy and

fraudulent practices including stealing products by setting up “secret
warehouses”. There has been a grave failure of corporate governance as well
since the company has also alleged that the former officials fudged accounts and
indulged in fictitious sales causing a multi-crore dent to the company. In its
FIR, Reebok has said that it carried out an internal investigation after certain
fraudulent activities were noticed – which again points to the importance of
internal checks for malpractices and corruption.
Gurgaon police had arrested Singh and Bhagat along with three others —
Sanjay Mishra, Prashant Bhatnagar and Surakshit Bhat. Allegedly, these
individuals have been siphoning off funds by creating ghost distributors across
the country and generating forged bills over the last five years.
Agencies probing the alleged Rs 870 crore corporate fraud in the operation
of Reebok India have detected a systemic “mismanagement” in the business
planning and running of the company.
The Income Tax department has alleged tax evasion of Rs 140 crore in the case.
The IT department’s first goal is to ensure that the company later does not claim
any “bad debt”. A bad debt is that amount that is owed to a business or
individual and has to be written off by the creditor as a loss because the debt
cannot be collected because of a host of reasons.
As soon as the scam came to light, affairs of the company came under close
government scrutiny. While the IT department documents investigated the
accounts and imports of the firm, the Serious Fraud Investigation Office is
probing the entire governance affairs of the company under Section 235 of the
Companies Act. A forensic audit was conducted by the German arm of Ernest &
Young – which revealed many falsification of documents and books.
 It is interesting to note that accounting officials of the firm and the auditors
were not held liable for their “deliberate” or “mistaken oversight” in identifying
the irregularities in the account books which led to the alleged financial
irregularities.

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 VODAFONE WINS $2.2-BILLION TAX BILL BATTLE

Vodafone Group PLC won a $2.2 billion legal battle against the tax department
in a Supreme Court ruling that analysts said would encourage foreign
investment and clear the way for the company’s planned initial public offering
(IPO) in India. Capitalists and Laissez Faire enthusiasts applauded the judgment
as a significant progressive judicial step.
The tax demand was over Vodafone’s $11 billion deal to buy Hutchison’s
Indian mobile business in 2007. The UK-based company had appealed to the
Supreme Court after losing the case in the Bombay High Court in 2010. The
verdict sent Vodafone shares up as much as 2.5 percent in London.
Vodafone, the world’s largest mobile operator by revenue, had taken the
position that Indian tax authorities had no right to tax the transaction which had
taken place between two foreign entities in the Caymans Island and had no
sufficient connection with India for attracting capital gains tax. The government
on the other hand argued that the foreign entities are merely shell companies
without any assets or operations except for the Indian company. The transaction
between foreign entities was nothing but a sham to avoid taxes, and that there is
sufficient connection with India to tax the transaction.
Even if tax was due, the company had argued, it should be paid by the seller not
the buyer.

Vodafone finally managed the avoid the capital gains tax slapped by the IT
department. Indian authorities had said the deal was liable for tax because most
of the assets were in India and because under local tax law, buyers have to
withhold capital gains tax liabilities and pay them to the government.

The court ordered the tax office to refund to Vodafone with 4 percent interest
the 25 billion rupees it had been asked to deposit pending a ruling.
For a brief period there was a government proposal to introduce a retrospective
law to tax all transactions such as Vodafone’s from the past after the judgment
was issued – but it was scrapped in the face of severe criticism and current
President of India Pranab Mukherjee leaving the finance ministry.

 DIAGEO AND UNITED SPIRITS: MASSIVE $2.1 BILLION M&A

Deal

Sweet deal-  Diageo PLC, the flagship of the world's largest spirits group,
bought a majority stake in United Spirits Ltd, controlled by Vijay Mallya, for
$2.1 billion.

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Diageo, which first tried to buy United Spirits in 2008, will buy 53.4 percent of
India’s largest spirits company in a two-part deal. This was the biggest inbound
Indian M&A deal since British oil firm Cairn Energy PLC sold a majority stake
in its Indian business to Vedanta Resources PLC.
Diageo said that India would be their second big market after USA and may
become the biggest in the future.

 EMKAY GLOBAL’S BAD ORDERS TRIGGER BRIEF HALT ON

NSE

 A series of technically erroneous orders placed by Emkay Global Financial

Services sent the NSE’s index Nifty tumbling, raising serious concerns about
the stability of trading systems after a series of global market glitches.
Trading on the National Stock Exchange (NSE) was briefly halted after the 59
trades worth more than $125 million were placed, triggering a sudden drop of
more than 900 points on the Nifty index. The orders, for an institutional client,
were sent from a single dealer terminal at Emkay Global.
 Emkay’s actions marked the another incident in a glitch-filled year for India’s
share markets, and raised the ghost of a sudden collapse like the Wall Street
flash-crash of May 2010.

 KINGFISHER AIRLINES LOSES LICENSE TO FLY

The financially troubled Kingfisher Airlines lost its flying permit after a

deadline to renew its suspended license expired. The Directorate General of
Civil Aviation (DGCA) has suspended Kingfisher Airlines license to fly till
further orders’ pursuant to Clause 15 (2) of Schedule XI of the Aircraft Rules,
1937, after the airline failed to deliver a viable financial and organizational
revival plan. The debt-ridden carrier was grounded since October 2012 after
repeated strikes by workers over unpaid wages.
Kingfisher owes various public sector banks $1.4bn (£870m) in debts and has
been frantically trying to raise funds after lenders refused to give fresh loans.
The airline now owes money to staff, airports, tax authorities and its lenders and
may have to be liquidated.

 AXIS BANK PARTNERS WITH TATA AIG GENERAL

INSURANCE

Axis Bank partnered with Tata AIG General Insurance to become its agent for
distributing insurance products to Axis Bank customers.
Under the partnership, Tata AIG will offer a range of general insurance
solutions to Axis Bank customers through the Bank’s extensive distribution
network across India. The Axis Bank-Tata AIG synergy will offer products for

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a range of insurance needs such as motor, health, travel, home for retail
customers and marine, liability, property etc. for corporate customers.
Banking companies are not allowed to engage in offering insurance services –
although banks with their wide network of branches create a unique
opportunity to distribute financial products. The tie up between Axis Bank and
Tata AIG is very significant in this light.

 1,800 CRORE WIPED OFF ADANI ENTERPRISE LTD STOCKS

AFTER ONLINE RUMOUR

This shocking event goes on to show the strength of online informal media such
as blogs and its real life impact. Stock prices of many companies under the
Adani Group took a tumble after a blogger posted incorrect rumors about
Gautam Adani’s arrest in connection with an arrest of a political leader.
 The blog, run by a Vadodara based blogger mentioned “Believe it or not: Our
Ahmedabad Bookie says: Mr. GAUTAM ADANI is been arrested? What will
happen to ADANI STOCKS? Something related to Kidnapping of Congress
Leader…We are Hearing (Rumours or Facts??) Let’s see…” The stock dipped
8.4% and closed at Rs. 195.

 HERO MOTORS FINALLY DROPS HONDA

Hero MotoCorp dropped Honda’s badge from all its models at the end of
September 2012. The 26 year old joint venture was ended in 2010 through a
separation agreement under which Hero Group bought out Honda’s stake in the
JV. Hero MotoCorp continues to pay royalty to Honda for its technology
despite the separation. It is believed that the new company has now more
potential for expansion as old restrictions such as no-export policy and bar on
new technology development under the JV agreement is now lifted.
After splitting from Honda and unveiling its new identity, Hero MotoCorp has
finally dropped the Honda mark from all its products in 2012.

 SAHARA TOLD TO REPAY $3 BILLION TO SMALL

INVESTORS

Unlisted conglomerate Sahara, one of India’s biggest business groups was

ordered by the Supreme Court of India after a prolonged legal battle with capital
markets regulator SEBI to refund 174 billion rupees raised by “dubious” means
from 22 million small investors. From 2008-11, they received 174 billion rupees
through what is known as an optionally fully convertible debentures. The
Sahara was also asked to pay 15 percent interest to the investors of the fund
which has been illegally raised from the public without resorting to proper legal
procedure.

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The Supreme Court, whose order reaffirmed an earlier ruling that the
fundraising did not meet the rules, ordered two unlisted Sahara group firms to
refund money they had raised with the interest within three months.
The judgment closed a much exploited loophole of the corporate fundraising
laws in India and underscored an increasing assertiveness by India’s judiciary
and regulators as businesses and financial markets expand at a fast pace in
Asia’s third-largest economy.

 Ranbaxy
Ranbaxy's criminal guilty plea and $500 million in fines and penalties has
brought back the spotlight on corporate governance. The criminal case focused
on sales in the US market. However, Ranbaxy committed systemic fraud in its
worldwide regulatory filings. The US case dates back to the year 2004. This is
the initial year when the Corporate Governance Code, which was issued
by SEBI in the year 2000, was made mandatory. Therefore, it is quite likely that
many independent directors had no clear idea about their responsibilities and
accountability. But that cannot be said about independent directors on the
Ranbaxy Board.
In the year 2004, Ranbaxy Board had Tejendra Khanna, Gurucharan Das, P S
Joshi, Vivek Bharat Ram, Nimesh Kampani, Vivek Mehra, Surendra-Daulet
Singh and J W Balani as independent directors. All of them are enlightened
leaders in their own field. SEBI Code was drawn from Anglo-Saxon corporate
governance model. It is unlikely that those who were on the Ranbaxy Board had
no exposure to corporate governance models.
Ranbaxy's shareholding data as on March 31, 2004, shows that promoters'
shareholding was 32.04 per cent, while foreign shareholding and Indian
institutions' shareholding were 32.98 per cent (including FII's shareholding of
22.68 per cent) and 15.16 per cent respectively. One would expect corporate
governance of highest order with the illustrious Board and significant foreign
and institutional shareholding, however, the reality was different. Ranbaxy
systematically perpetrated fraud on shareholders by exposing their investment
to huge reputation and compliance risks by fuzzing data submitted to regulators.
By selling adulterated drugs, it perpetrated fraud on consumers, hospitals, value
chain partners and common Indians who took pride that Ranbaxy had emerged
as the first Indian multinational in the pharmaceutical sector. The corporate
governance failures manifested in the Board's failure to check fraud, absence of
adequate risk management system, and unethical culture. Should we hold
independent directors accountable for the same?
It is unlikely that independent directors on Ranbaxy Board had no
exposure to corporate governance models
There is a similarity in the fraud at Satyam and the same at Ranbaxy. In both
cases, the top management overrode the internal control system. On January 2,

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2013, southern district of New York judge Barbara Jones gave a landmark
judgment. The judge did not see a case of the former independent directors of
Satyam acting recklessly.

The claim was not sustainable because "intricate and well-concealed fraud
perpetrated by a very small group of insiders and only reinforce the inference
that the [independent directors] were themselves victims of the fraud." It may be
argued that the Ranbaxy fraud was perpetrated with the support of employees at
different levels and not by a small group at the top level. But the fact remains
that it was well concealed. Therefore, it would be harsh on independent
directors if they were held accountable for the fraud.
Clause 149 (11) of the Companies Bill, 2012, provides that an independent
director shall be liable "only in respect of such acts of omission or commission
by a company which had occurred with his knowledge, attributable through
board processes, and with his consent or connivance or where he had not acted
diligently". We have to wait for Court rulings to understand Court's
interpretation of 'diligence' in the context of independent directors.
The dictionary meaning of the word diligent is 'Having or showing care and
conscientiousness in one's work or duties'. Did independent directors fail to act
diligently? Did independent directors fail to catch signals from the exit of
Devinder Singh Brar (then CEO), Rashmi Barbhaiya (then president, R&D),
Rajinder Kumar (successor to Rashmi) and Dinesh Thakur (whistle blower in
this case and subordinate to Kumar), who were celebrated leaders of the
company, in quick succession. Their exit signaled that something was wrong.
Assume that independent directors had taken notice of that and arranged exit-
interview and interacted with the employees at random to know the cause of
their exit. I guess that process would have been futile, as none would have
blown the whistle in the absence of protection to whistle-blowers. Thakur had
blown the whistle in USA and not in India.
It may be inappropriate to conclude that independent directors did not act
diligently. It has been reported in media (BS story on June 5, 2013) that
Tejendra Khanna and P S Joshi were present in the science committee meeting
held on December 21, 2004, in which detailed presentation was made on wide
spread lapses and fudging of data. If it is true, they cannot claim innocence.
Independent director's responsibility is limited to ensuring that he/she
understands the business model, best corporate governances practices (e.g.
board process, risk management system, internal audit and statutory audit,
whistle-blower policy, and transparency within and outside the Board) are in
place and operating effectively, analysing information available through the
Board processes or otherwise and acting proactively based on that analysis for
the benefit of the company as a whole. If independent directors are held
responsible for frauds perpetrated by or with the support of the top
management, which has the ability to override internal controls, it will be

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difficult to induce professionals to join Boards of companies as independent

directors.

ORGANIZATION'S OBLIGATIONS TOWARDS STAKEHOLDERS

An organization does not operate in a vacuum. To be successful, any business
needs to appeal to a variety of different stakeholders. Stakeholders are generally
defined as groups of people who have a relationship with the business.
For example, the stakeholders of a small business include:
 Employees
 Vendors
 Customers
 Owners
 Residents of the community in which it operates.
The basis of each relationship varies & can range from statutes & contracts to
informal undertakings. Each group requires the business to meet a certain set of
ethical standards. Failure to meet these ethical standards can lead to anything
from decline in sales to legal penalties.
1) Good Faith & Fair Dealing: The practice of ethical CSR is in the best
interest of the shareholder as well as other stakeholders. The corporation
has an ethical obligation to shareholders to uphold a corporate image of
which shareholders can be proud.
Much of what a business does is defined by the contracts it has with
vendors, employees & its own customers. The implied covenant of good
faith & fair dealing obliges all contracting parties not to do anything that
would make fulfilling of the terms of the contract impossible.
2) Employment Law: The employee is an important stakeholder. There are
8 rights provided by employment law to employees:
 Safe working environments
 Family & medical leave
 Ability to organize.
 Non-discriminatory hiring
 Minimum Pay
 Unemployment benefits
 Equal compensation regardless of gender
 Ability to voice concerns without retaliation from employer.
3) Social Responsibility: An organization owes a duty not only to the
people with whom it has a direct interaction, but to anyone who may be
affected by the business's activities. An organization has a responsibility
to support the public interest when it can, or at the very least, minimize
any negative impact it has on its surrounding community. The different

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ways in which an organization does that are by promoting charitable

events by its employees, minimizing pollution during the production of
its processes etc. By being socially responsible, the organization can not
only meet its ethical obligations, but promote its public image.

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