Transplant of Corporate Governance in India

TABLE OF CONTENT

CHAPTER 1 INTRODUCTION
1.1 Objectives of corporate governance
1.2 Developments in India
1.3 Review literature
1.4 Research Methodology:
1.4.1 Research Problem
1.5 Objectives:
1.6 Type of Data:
1.6.1 Sources:
CHAPTER-2 CORPORATE GOVERNANCE & DEVELOPMENT
2.1 Introduction:
2.2 Concept and Objectives:
2.3 The link between corporate governance and other foundations of development.
2.3.1 The link between finance and growth:
2.3.2 The link between the development of banking systems and market finance and
growth:
2.3.3 The link between legal foundations and growth:
2.4 Corporate Governance Important For Growth and Development
2.4.2 The role of entrenched owners and managers:
CHAPTER-3 NATURE AND SYSTEMS OF CORPORATE GOVERANANCE
3.1 Definition and Scope:
3.1.1 Benefits of Good Governance:
3.1.2 Corporate Governance and Economic Performance:
3.1.3 OECD Principles:
3.2 Models of Corporate Governance:
3.3 Features of Companies in Outsider Model in UK and USA :
3.3.1 Centralization of Regulation in US:
3.4 Disclosures:
3.5 Corporate Governance in India:
CHAPTER 4 MAJOR DEVELOPMENTS AT INTERNATIONAL LEVELS
4.1 Introduction
4.2- Corporate Governance – Developments in India
CHAPTER-5 THE THREE ANCHORS OF CORPORATE GOVERNANCE
5.1 Introduction:
5.2 Accountability and Responsibilities:
5.3 Separation of Board from Management:
5.4 Approaches to Balance Board and CEO Functions:
CHAPTER 5: CONCEPTUAL FRAMEWORK
5.1 Introduction
5.2- Clause 49 of the Listing Agreement
5.3- Steps Implemented By Companies Act With Regard To Corporate Governance
CHAPTER -6 A STUDY OF CORPORATE GOVERNANCE INBANKS
6.1 Introduction:
6.2 Main Indicator Of Corporate Governance:
6.3 Unethical Business Practices:
6.4 Sources:
CHAPTER -7 PRESENTATIONS OF DATA, ANALYSIS AND FINDINGS
7.1- CLAUSE 49 – MANDATORY REQUIREMENTS
7.2- CLAUSE 49 – NON-MANDATORY REQUIREMENTS
CHAPTER -8 CASE STUDIES
8.1 Introduction
8.2 CASE STUDIES
CHAPTER 9 CONCLUSION & RECOMMENDATIONS
REFERENCES
 CHAPTER 1

INTRODUCTION:

“Corporate Governance in essentially about leadership; leadership for efficiency in order for
companies to compete effectively in the global economy, and thereby create jobs; leadership for
probity because investors require confidence and assurance that the management of a company
will behave honestly and with integrity in regard to their shareholders and others; leadership with
responsibility as companies are increasingly called upon to address legitimate social concerns
relating to their activities; and , leadership that is both transparent and accountable because
otherwise business leaders cannot be trusted and this will lead to the decline of companies and
the ultimate demise of a country’s economy.”1

“Corporate governance is concerned with ways of bringing the interests of investors and
manager into line and ensuring that firms are run for the benefit of investors”.2 “Corporate
governance includes ‘the structures, processes, cultures and systems that engender the successful
operation of organizations”.3

The corporate governance ensures the accountability of certain individuals in an organisation

through mechanisms that try to reduce or eliminate the principle-agent problem. It focuses on the
economic efficiency, with a strong emphasis on shareholders’ welfare. The history of the
development of India Corporate Laws has been marked by interesting contrast (Goswami, 2002).
In terms of Corporate Laws and financial system, therefore, India emerged far better endowed
than most other colonies. The 1956 Companies Act as well as other Laws governing the
functioning of joint-stock companies and protecting the investors’ right built on this foundation.

The beginning of corporate developments in India were marked by the managing agency system
that contributed to the birth of dispersed equity ownership but also gave rise to the practice of
1
Mervyn King, King Report on Corporate Governance for South Africa [King II Report] [Parktown, South Africa:
Institute of Directors in Southern Africa, 2002] p.18
2
F. Mayer (1997), ‘Corporate governance, competition, and performance’, In Enterprise and Community: New
Directions in Corporate Governance, S. Deakin and A. Hughes (Eds), Blackwell Publishers: Oxford.
3
K. Keasey, S. Thompson and M. Wright (1997), ‘Introduction: The corporate governance problem - competing
diagnoses and solutions,’ In K. Keasey, S. Thompson and M. Wright, Corporate Governance: Economic,
Management, and Financial Issues. Oxford University Press: Oxford.
management enjoying control rights disproportionately greater than their stock ownership. The
turn towards socialism in the decades after independence marked by the 1951 Industries
(Development and Regulation) Act as well as the 1956 Industrial Policy Resolution put in place
a regime and culture of licensing, protection and widespread red-tape that bred corruption and
stilted the growth of the corporate sector.4

While the Companies Act provides clear instructions for maintaining and updating share
registers, in reality minority shareholders have often suffered from irregularities in share
transfers and registrations – deliberate or unintentional. Sometimes non-voting preferential
shares have been used by promoters to channel funds and deprive minority shareholders of their
dues. Minority shareholders have sometimes been defrauded by the management undertaking
clandestine side deals with the acquirers in the relatively scarce event of corporate takeovers and
mergers. Boards of directors have been largely ineffective in India in monitoring the actions of
management. They are routinely packed with friends and allies of the promoters and managers,
in flagrant violation of the spirit of corporate law. The nominee directors from the DFIs, who
could and should have played a particularly important role, have usually been incompetent or
unwilling to step up to the act. Consequently, the boards of directors have largely functioned as
rubber stamps of the management. For most of the post-Independence era the Indian equity
markets were not liquid or sophisticated enough to exert effective control over the companies.
Listing requirements of exchanges enforced some transparency, but non-compliance was neither
rare nor acted upon. All in all therefore, minority shareholders and creditors in India remained
effectively unprotected in spite of a plethora of laws in the books.

1.1 OBJECTIVES OF CORPORATE GOVERNANCE:

The development of corporate governance concept is naturally and essentially related to the
“objectives of corporate governance”.5 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:

4
Chakrabarti, Rajesh. Corporate Governance in India – Evolution and Challenges available at http://
5
Corporate Governance Reporting (Model formats) by ICSI 2003.
 i. That a properly structured Board capable of taking independent and objective
decisions is in place at the helm of affairs;
ii. That 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 wellbeing
of all the stakeholders;
iii. That the Board adopts transparent procedures and practices and arrives at decisions
on the strength of adequate information;
iv. That the Board has an effective machinery to sub-serve the concerns of stakeholders;
v. That the Board keeps the shareholders informed of relevant developments impacting
the company;
vi. That the Board effectively and regularly monitors the functioning of the management
team; and
vii. That 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 organisation forward, to maximise
long-term value and shareholders’ wealth.”

1.2 DEVELOPMENTS IN INDIA:

On account of the interest generated by Cadbury Committee Report and also in the wake of
Government initiatives to respond to corporate developments world over, the following major
developments have taken place:

i. The Confederation of Indian Industries (CII), the Associated Chambers of Commerce

and Industry and the Securities and Exchange Board of India constituted committees
to recommend initiatives in corporate governance. The CII, in 1996, took a special
initiative on corporate governance. It was the first institutional initiative in Indian
industry. The objective being to develop a code for corporate governance to be
adopted by the Indian companies (private sector, the public sector, banks and
financial institutions which are corporate entities), a code by CII carrying the title
“Desirable Corporate Governance” was released.
ii. The SEBI appointed committee, known as the Kumar Mangalam Birla Committee’s
recommendations led to the addition of Clause 49 in the Listing Agreement.
 Compliance of provisions of Clause 49 was largely made mandatory by listed
companies. The committee recommended that there should be a separate section on
corporate governance in the Annual Report of companies. This section was required
to detail the steps taken to comply with the recommendations of the committee and
thus inform the shareholders of specific initiatives taken to ensure corporate
governance. The committee accorded recognition to the three vital aspects of
corporate governance, namely accountability, transparency and equality of treatment
for all stakeholders.
iii. The Department of Company Affairs (DCA) appointed a study group on 15.5.2000
under the Chairmanship of the then Secretary DCA to suggest ways and means of
achieving corporate governance. The study group appointed a task force. The study
group recommended the setting up of an independent, autonomous centre for
corporate excellence with a view to accord accredition and promote policy research
and studies, training and education and awards etc., in the field of corporate
excellence through improved corporate governance. It favoured greater shareholders’
participation, formal recognition of corporate social responsibility, non-executive
directors being charged with strategic and oversight responsibilities, minimisation of
interest–conflict potential, and also suggested application of corporate governance
principles to public sector.
iv. The Department of Company Affairs also constituted on August 21, 2002 a high level
committee, popularly known as Naresh Chandra Committee, to examine various
corporate governance issues and to recommend changes in the diverse areas such as
the statutory auditor-company relationship, rotation of statutory auditors, procedure
for appointment and determination of audit fees, restrictions if necessary on non-audit
fees, independence of auditing functions, ensuring presentation of ‘true and fair’
statement of the financial affairs of companies, certification of financial statements
and accounts, regulation of oversight functionaries, setting up an independent
regulator and the role of independent directors. The committee has made very
significant recommendations for changes inter alia, in the Companies Act.
v. Yet another major development includes the constitution of a committee by SEBI
under the Chairmanship of Shri N.R. Narayana Murthy, for reviewing the
 implementation of corporate governance code by listed companies. The mandatory
recommendations of the committee on various matters are detailed in the Annexure.
vi. The Department of Company Affairs also has set up a proactive standing company
law advisory committee to advise on issues like inspection of corporates for wrong
doings, role of independent directors and auditors and their liability, suggesting steps
to enhance imposition of penalties. A High powered Central Coordination and
Monitoring Committee (CCMC) co-chaired by Secretary DCA and Chairman SEBI
was also set up to monitor action against vanishing companies and unscrupulous
promoters, who misused funds raised from public.

SEBI has also undertaken a project for development of a comprehensive instrument by a reputed
rating agency for rating the good corporate governance practices of listed companies.

1.3 Review literature

Sir Adrian Cadbury in his preface to the World Bank publication, Corporate Governance: A
framework for Implementation; states that “Corporate Governance is … holding the balance
between economic and social goals and between individuals and community goals. The
governance framework is there to encourage the efficient use of resources and equally to require
accountability for the stewardship of those resources. The aim is to align as nearly as possible the
interest of individuals, corporations and society. The incentive to corporations is to achieve their
corporate aims and to attract investment. The incentive for states is to strengthen their economies
and discourage fraud and mismanagement.

The Economist Intelligence Unit has carried out a research on Corporate governance - The new
strategic imperative. In this study they have concluded that regulations are only one part of the
answer to improved governance. Corporate governance is about how companies are directed and
controlled. Designing and implementing corporate governance structures are important, but
instilling the right culture is essential. Senior managers need to set the agenda in this area. There
is an inherent tension between innovation and conservatism, governance and growth.
Transparency about a company’s governance policies is critical. As long as investors and
shareholders are given clear and accessible information about these policies, the market can be
allowed to do the rest, assigning an appropriate risk premium to companies that have too few
independent directors or an overly aggressive compensation policy, or cutting the costs of capital
for companies that adhere to conservative accounting policies. Too few companies are genuinely
transparent, however, and this is an area where most organizations can and should do much
more.

According to Raja J Chelliah, “the official economic doctrine in India has not been modified to
take account of the serious problems of governance that have arisen over the years in our
country. It is felt that the deplorable weaknesses in the system of governance in our country can
only be remedied through a movement of moral regeneration backed by sufficient pressure by an
enlightened public. Institutional and structural changes are called for in addition to moral
exhortation”.

1.4 Research Methodology:

1.4.1 Research Problem:
Corporate Governance needs to be studied separately for two main reasons. The first
reason is that in the past there have been many scams, scandals and flagrant violations under the
veil of corporate impenetrability. Question of what is ‘right’, ‘proper’ and ‘just’ in the decision
and actions have been raised in the governance of organizations.
The second reason is that with more awakened shareholders, and almost predatory
journalistic fervor the demands for adhering to good and ethical Corporate Governance practices
are likely to increase exponentially.
1.5 Objectives:
1) To compare corporate governance guidelines given by the OECD with those of other
international organizations.
2) To compare Indian corporate governance practices with the practices followed by other
nations.
3) To compare Infosys and Satyam on the basis of corporate governance.
1.6 Type of Data:
The research is based on secondary data.
1.6.1 Sources:
Sources of secondary data include –
1) Reference books
2) Internet
 Chapter-2
Corporate Governance & Development

2.1 Introduction:
There is an investigation of the relationship between corporate governance and
economic development and well-being. It finds that better corporate frameworks
benefit firms through greater access to financing, lower cost of capital, better firm
performance, and more favorable treatment of all stakeholders. There is also
evidence that when a country’s overall corporate governance and property rights
system are weak, voluntary and market corporate governance mechanisms have
limited effectiveness. Less evidence is available on the direct links between
corporate governance and poverty. Two events are responsible for the heightened
interest in corporate governance. During the wave of financial crises in 1998 in
Russia, Asia, and Brazil, the behavior of the corporate sector affected entire
economies, and deficiencies in corporate governance endangered the stability of
the global financial system. Just three years later confidence in the corporate sector
was sapped by corporate governance scandals in the United States and Europe that
triggered some of the largest insolvencies in history. In the aftermath, not only has
the phrase corporate governance become nearly a household term, but economists,
the corporate world, and policymakers everywhere began to recognize the potential
macroeconomic consequences of weak corporate governance systems. The
scandals and crises, however, are just manifestations of a number of structural
reasons why corporate governance has become more important for economic
development and well-being. The private, market based investment process is now
much more important for most economies than it used to be, and that process is
underpinned by better corporate governance. With the size of firms increasing and
the role of financial intermediaries and institutional investors growing, the
mobilization of capital has increasingly become one-step removed from the
principal-owner. At the same time, the allocation of capital has become more
complex as investment choices have widened with the opening up and
liberalization of financial and real markets, and as structural reforms including
price deregulation and increased competition, have increased companies ‘exposure
to market forces risks. These developments have made the monitoring of the use of
capital more complex in certain ways, enhancing the need for good corporate
governance. It aims to trace the many dimensions through which corporate
governance works in firms and countries. A well-established body of research has
for some time acknowledged the increased importance of legal foundations,
including the quality of the corporate governance framework, for economic
development and well-being. Research has started to address the links between law
and economics, highlighting the role of legal foundations and well defined
property rights for the functioning of market economies. It also provides some
background on the ownership patterns around the world that determine and affect
the scope and nature of corporate governance problems.

2.2 Concept and Objectives:

Corporate Governance may be defined as a set of systems, processes and principles
which ensure that a company is governed in the best interest of all stakeholders. It
is the system by which companies are directed and controlled. It is about
promoting corporate fairness, transparency and accountability. In other words,
'good corporate governance' is simply 'good business'. It ensures:

 Adequate disclosures and effective decision making to achieve corporate

objectives;
  Transparency in business transactions;
 Statutory and legal compliances;
 Protection of shareholder interests;

In other words, corporate governance is 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 deals with conducting the
affairs of a company such that there is fairness to all stakeholders and that its
actions benefit the greatest number of stakeholders. In this regard, the management
needs to prevent asymmetry of benefits between various sections of shareholders,
especially between the owner-managers and the rest of the shareholders.
The aim of "Good Corporate Governance" is to ensure commitment of the board in
managing the company in a transparent manner for maximizing long-term value of
the company for its shareholders and all other partners. It integrates all the
participants involved in a process, which is economic, and at the same time social.

The fundamental objective of corporate governance is to enhance shareholders'

value and protect the interests of other stakeholders by improving the corporate
performance and accountability. Hence it harmonizes the need for a company to
strike a balance at all times between the need to enhance shareholders' wealth
whilst not in any way being detrimental to the interests of the other stakeholders in
the company. Further, its objective is to generate an environment of trust and
confidence amongst those having competing and conflicting interests.

It is integral to the very existence of a company and strengthens investor's

confidence by ensuring company's commitment to higher growth and profits.
Broadly, it seeks to achieve the following objectives:
  A properly structured board capable of taking independent and objective
decisions is in place at the helm of affairs;
 The board is balance as regards the representation of adequate number of
non-executive and independent directors who will take care of their interests
and well-being of all the stakeholders;
 The board adopts transparent procedures and practices and arrives at
decisions on the strength of adequate information;
 The board has an effective machinery to sub serve the concerns of
stakeholders;
 The board keeps the shareholders informed of relevant developments
impacting the company;
 The board effectively and regularly monitors the functioning of the
management team.

2.3 THE LINK BETWEEN CORPORATE GOVERNANCEAND

OTHER FOUNDATIONS OF DEVELOPMENT.
The research on the role of corporate governance for economic development and
well-being is best understood from the broader perspective of other foundations for
development, notably the importance of finance, the elements of a financial
system, property rights, and competition. Three elements of this are worth
highlighting.

2.3.1 The link between finance and growth:

First, over the past decade, the importance of the financial system for growth and
poverty reduction has been clearly established. One demonstration is the link
between finance and growth. Almost regardless of how financial development is
measured, there is a cross-country association between it and the level of GDP per
capita growth. Numerous pieces of evidence have been assembled over the past
few years to indicate the relation is a causal one: that is, it is not only the result of
better countries having both larger financial systems and growing faster. The
relationship has been established at the level of countries, industrial sectors, and
firms and has consistently survived a rigorous series of econometric probes.

2.3.2 The link between the development of banking systems and

market finance and growth:
Second, and importantly for the analysis of corporate governance, the development
both of banking systems and of market finance helps economic growth. Banks and
securities markets are complementary in their functions, although markets will
naturally play a greater role for listed firms. More generally, the findings provide
support for the functional view of finance. That is, it is not financial institutions or
financial markets that matter; it is the functions that they perform that matter. In
particular, for any regression model of growth that is selected and adapted by
adding various measures of stock market development relative to banking system
development, the results are consistent. None of these measures of financial sector
structure has any statistically significant impact on growth. To function well,
financial institutions and financial markets, in turn, require certain foundations,
including good governance.

2.3.3 The link between legal foundations and growth:

Third, the role of legal foundations is now better understood and documented.
Legal foundations matter crucially for a variety of factors that lead to higher
growth, including financial market development, external financing, and the
quality of investment. Legal foundations include property rights that are clearly
defined
and enforced and other key regulations. Comparative corporate governance
research took off following the works of economists Rafael La Porte, Florencio
Lopez-de-Silanes, Andrei Shleifer, andRobert Vishny.

2.4 CORPORATE GOVERNANCE IMPORTANT FOR GROWTH

AND DEVELOPMENT
The literature has identified several channels through which corporate governance
affects growth and development:

 The first is the increased access to external financing by firms. This in turn
can lead to larger investment, higher growth, and greater employment
creation.
 The second channel is a lowering of the cost of capital and associated higher
firm valuation.
 The third channel is better operational performance through better allocation
of resources and better management. This creates wealth more generally.
 Fourth, good corporate governance can be associated with a reduced risk of
financial crises. This is particularly important, as financial crises can have
large economic and social costs.
 Fifth, good corporate governance can mean generally better relationships
with all stakeholders.
All these channels matter for growth, employment, poverty, and well-being
more generally.
2.4.1 Better operational performance:

In the end, the way better corporate governance can add value is by improving the
performance of firms, whether through more efficient management, better asset
allocation, better labor policies, and similar efficiency improvements. Evidence for
the United States, and elsewhere strongly suggests that at the firm level, better
corporate governance leads not only to improved rates of return on equity and
higher valuation, but also to higher profits and sales growth. This evidence is
maintained when controlling for the fact that “better” firms may adopt better
corporate governance and perform better due to other reasons. Across countries,
there is also evidence that operational performance is higher in better corporate
governance countries, although the evidence is less strong.

2.4.2 The role of entrenched owners and managers:

Evidence shows that firms adapt to weaker environments by adopting voluntary
corporate governance measures. A firm may adjust its ownership structure, for
example, by having more secondary, large block holders, which can serve as
effective monitors of the primary controlling shareholders. This may convince
minority shareholders of the firm’s willingness to respect their rights. Or a firm
may adjust its dividend behavior if it has difficulty convincing shareholders that it
will reinvest properly and for their benefit. These voluntary mechanisms can
include hiring more reputable auditors. Since auditors have some reputation at
stake as well, they may agree to conduct an audit only if the firm itself is making
sufficient efforts to enhance its own corporate governance. The more reputable the
auditor, the more the firm needs to adjust its own corporate governance. A firm can
also issue capital abroad or list abroad, thereby subjecting itself to higher level of
corporate governance and disclosure. There is also evidence that the voluntary
corporate governance adopted by firms matter more in weak corporate governance
environments. Markets can adapt as well, partly in response to competition, as
listing and trading migrate to competing exchanges, for example. While there can
be races to the bottom, with firms and markets seeking lower standards, markets
can and will set their own, higher corporate governance standards. One example is
the Novo Mercado in Brazil, which has different levels of corporate governance
standards, all higher than the main stock exchange. Firms can choose the level they
want, and the system is backed by private arbitration measures to settle corporate
governance disputes. Efforts like these can help corporations improve corporate
governance at low cost as they can list locally.
 CHAPTER-3
NATURE AND SYSTEMS OF CORPORATE
GOVERANANCE

3.1 Definition and Scope:

Corporate governance comprises the systems and processes which ensure the
functioning of the firm in a transparent manner for the benefit of all the
stakeholders and accountable to them. The focus is on relationship between owners
and board in directing and controlling companies as legal entities in perpetuity. A
company’s ability to create wealth for its owners however, depends on the role and
freedom given to it by society.

Sir Adrian Cadbury in his preface to the World Bank publication,

Corporate Governance: A Framework for Implementation; states that “Corporate
governance is holding the balance between economic and social goods and
between individual and community goals. The governance framework is there to
encourage the efficient use of resources and equally to require accountability for
the stewardship of those resources. The aim is to align as nearly as possible the
interests of individuals, corporations and society .The incentive to corporate aims
and to attract investment. The incentive for states is to strengthen their economies
and discourage fraud and mismanagement”.

The focus on corporate governance arises out of the large dependence of

companies on financial markets as the preeminent sources of capital. The quality of
corporate governance shapes the future and the growth of capital market. But
capital markets and financial markets in general can function properly if
individuals have access to accurate basic information about the companies they
invest the link between a company’s management, board and its financial reporting
system is crucial. In the context of globalization, capital is likely to flow to markets
which are well regulated and practices high standards of transparency, efficiency
and integrity.

3.1.1 Benefits of Good Governance:

 Good governance leads to congruence of interests of board, management

including owner managers and shareholders.
 Good governance provides stability and growth to the company.
 Good governance system builds confidence among investors.
 Good governance reduces perceived risk, consequently reducing coat of
capital.
 Well governed companies enthuse employees to acquire and develop
company specific skills.
 In the knowledge driven economy excellence in soft skills like management
will be the ultimate tool for corporates to leverage a competitive advantage
in the financial markets.
 Adoption of good corporate practices promotes stability and long term
sustenance relationship.
 A good corporate citizen becomes an ethical icon and enjoys a position of
pride in corporate culture.
 Potential stakeholders aspire to enter into relationship with enterprises
whose governance credentials are exemplary.

3.1.2 Corporate Governance and Economic Performance:

Tradeoff between compliance with normative obligations such as the increasing
opportunities for stakeholder’s participation, access to information and economic
performance of the firm can be decided in the political realm.

Finally the existence of condition for fair choice of basic practices of

corporate governance may not be met since the system of rights and constitutional
state envisaged in a democratic system may not obtain in all countries. This may
result in bias in the selection of practices and structure favoring those able to
mobilize wealth and other sources of social power. While a corporation has
universal obligations, there cannot be any one set of correct practices and structure
of corporate governance. Specific obligations are assumed by a corporation
through their decision and practices. Among the various attempts to evolve best
global standards, the principles evolved by organization for economic cooperation
and development (OECD) released in 1999 have been accepted as an international
benchmark. OECD principles recognize that different legal systems, institutional
frameworks across countries have led to the development of range of different
approaches to corporate governance. The OECD principles like other good
corporate governance regimes protect the interest of not only the shareholders but
all stakeholders like employees, creditors, suppliers, customers and environment.

3.1.3 OECD Principles:

The OECD principles of corporate governance cover five major areas.

 The rights of shareholders.

 The equitable treatment of shareholders.
 The role of transparency.
 Disclosure and transparency.
 The responsibilities of the board.
  Rights of shareholders: Rights of shareholder mentioned in the OECD
report cover the registration of the right to ownership with the company,
conveyance or transfer of shares, obtain relevant information from the
company on a timely and regular basis, participate and vote in general
shareholders meetings, elect members of the board and share in the profits of
the company. The OECD principles emphasize that information on
shareholders who exercise control disproportionate to their equity ownership
should be disclosed.

Equitable Treatment of Shareholders: All shareholders should be treated

equitably and the law should not make any distinction among different
shareholders holding a given class or type of shares. Any changes in voting rights
of common shareholders can be done only with the consent of those shareholders.

Role of stakeholders: The rights if the stakeholders as established by law should

be recognized and active cooperation between corporations and stakeholders in
creating wealth, jobs and sustainability of financially sound enterprises should be
encouraged. While the shareholders are the true owners, the functioning of a
company affects several other economic players in the society. Employees are
directly as they develop and adopt company specific skills. There is a significant
synergetic relationship between the company and its employees. Corporate entities
have also an impact on the environment of the community in which they are
located. Polluting units may generate profits for shareholders but impose costs on
society. Representation of employees and community on the board are mooted.

Role of Board: The main task of a board is to monitor the performance of the
executives and to ensure that returns to shareholders are maximized. True
independence of the board can be ensured by having a majority of outside directors
who do not have any financial of pecuniary involvement with the company.

Disclosures and Transparency: Timely disclosures relating to financial position,

ownership pattern and shareholding helps in infusing a sense of discipline and
accountability among managers. Increased transparency and information help to
reduce information symmetry between management and shareholders. Adoption of
internationally accepted best practices improves the understanding and comfort of
foreign investors about the operations of the companies and lowers their risk
perception.

3.2 Models of Corporate Governance:

 Outsider Model:

Outsider model obtaining in UK and USA in which control and ownership are
distinct and separate. Since equity ownership is widely dispersed among a large
number of institutional holders and small investors, control vests with professional
managers. The model is also referred to as principal-agent model where the
shareholders, the principals entrust the management of the firm to managers, the
agents. In actual practice with the growth of the firm the gulf between shareholders
and managers has widened and became distant giving rise to the agency problem,
ensuring that managers function in the interests of the shareholders. The dichotomy
between ownership and control has necessitated the adoption of regulatory and
legal frameworks to ensure that corporate practices protect the interests of
shareholders as well as other stakeholders.

3.3 Features of Companies in Outsider Model in UK and USA :

The US and UK have similar foundations in common law and the features of
corporate governance are alike. Both American and British Companies combine
managers with outside directors into a unitary board, Boards comprise a large
number of non-executive directors, markets in both countries have companies with
widely dispersed share ownership, high levels of public disclosure, relatively low
levels of outside regulation and clearly defined legal duties of care and loyalty to
shareholders. There are however subtle differences. While both countries have
boards relatively small, boards with between 7 and 12 directors. British boards are
slightly larger with more executive on their boards. Non-executive directors on
British boards work with executive directors as a collective body. In US the non-
executive directors tend to monitor management and do not get involved in
operational matters. The British boards also combine chairman of board and CEO.
While 95% of FTSE 100 companies have separated the two positions, the number
of S&P 500 companies in 2003 which have combined the two positions is only
21%. In Britain the chairman leads the board and CEO leads the company.America
has chosen a system of checks and balances for its government but not for its
business because of its mistrust of the former and desire not to slow down
competitiveness of latter. There are of course checks and balances like ethics to
install an understanding of how one should behave in terms of fiduciary duty,
internal compliance and company governance as well as industry self-regulation.
The recent scandals however reveal a critical violation of fiduciary duty because of
conflicts of interest or greed. n the US the higher proportion of outside directors on
the boards may reduce the need for independent chairman while in the UK the split
roles at the heads of companies may allow for strong board independence.
3.3.1 Centralization of Regulation in US:

While the British have consolidated almost all public company oversight into a
super regulatory body, the Financial services Authority, the US has decentralized
and checked power is reflected in the balanced roles of Securities and Exchange
Commission (SEC), exchange listing rules and state statutes.

Shareholders :

Shareholders in Britain enjoy numerous and specific ownership rights than their
counter parts in US. Shareholders in Britain vote on dividends, buy backs, financial
statements, preemptive rights and small acquisitions and spin offs. In US
shareholders vote for directors and auditors.

Market for Corporate Control:

The approach to take over defenses and the market for corporate control are quite
different. The prevalence of defenses such as poison pills, green mail, dual class
voting stock in US is owed to the factor that law and regulation have entrusted to
directors to take immediate decision on offers for the company. The US approach
emphasizes director’s fiduciary duty to adopt maximum defense where volatile
prices and ready cash make them attractive targets. The directors in British boards
have little altitude and have to follow the rules of the City Code on takeovers and
Mergers. The code set up specific time table for voting on bids, ensures equal
treatment of shareholders and in its preference for auctions regulates the statements
both sides may make to the market after an approach. Structural defenses like
poison pills freeze out provisions and green mail ate not allowed. The British
governance system assumes a conflict of interest when boards decide on mergers.
3.4 Disclosures:

The corporations in US are required to report on director backgrounds in AGM

notices and make public filling to SEC which provides free access to an online
database of corporations. In UK companies report twice a year and investors have
to depend only on annual reports.

 Insider model :

The insider has two variants, the European and East Asian. In the European model
a relatively small compact group of shareholders exercise control over corporation.
On the other hand, the East Asian model of corporate governance, the founding
family generally holds the controlling share either directly or through holding
companies. In all Asian countries control is enhanced through pyramid structures
and cross holding among firms. In Japanese form of insider system, several
companies are linked together through interlocking directorships, which are backed
by cross holdings of one another’s shares. With these intertwined groups of firms,
called keiretsu, there is also a main bank and several another financial institutions,
which holds share in the companies in the group and sit on the company’s
supervisory boards. Within a Japanese keiretsu control is multidirectional with
each company able to exercise some control over the companies that control it. The
Korean Chaebol is a hybrid between the German corporate pyramid and the
Japanese Keiretus. In 1995 the top 30 chaebol accounted for 40.2% of the value
added in Korea’s manufacturing sector, ownership stakes in the chaebol are
relatively small, 10% for 70 largest chaebolaffiliater companies. Founding families
however can maintain control through cross shareholdings among member
companies. Banks and other financial institutions, unlike japan do not play a
monitoring role. Claessens, Djankov and lang examined the separation of
ownership and control for 2,980 corporations in nine East Asian countries found
that separation of management from ownership control is rare and the top
management of about 60% of firms that are not widely held is related to the family
of the controlling shareholders. The separation of ownership and control is most
pronounced among family controlled as are small firms. It is a observed that
concentration of control generally diminishes with the level of a country’s
economic development. In the European insider model the controlling
shareholders are backed by complex shareholders agreements. The controlling
group maintains longer term and stable relationship among themselves. In the
European countries where this insider model is extant corporate sector depends on
banks as a source of finance and the corporate entities have quite levels of debt
equity ratios.

Market Versus Bank Oriented Systems of Governance:

Side by side comparison of bank and market

It may distinguish between market oriented and bank oriented or relations-based

systems of corporate governance. A major difference between the two systems was
the degree to which creditors monitored the firms. In the bank oriented system
bank enter into long term relationships; and in market system, an arms length
relationship is maintained. In England creditors preferred hands off approach. In
the German economy banks play a dominant role in financial intermediation as
well as in the monitoring of corporations. One form of monitoring was to place
bank officers on the supervisory boards of industrial companies or to purchase
large block of shares. It was not hands-on relationship banking. However, in the
light of recent development we may note that the crucial difference between
American and German systems of governance may be traced to the different
ownership structures and not to the role of banks per se. The US while nurturing
the corporate form of organization has established elaborate legal framework to
preserve competition and prevent dominance. Oversight is provided by
independent audit, stock exchanges and SEC. In the US economy both corporate
finance and control are market based. Large companies in US and UK are listed in
the stock markets and their ownership concentration is modest. In the UK as well
as USA there is a market for corporate control in which hostile takeover is
important and banks play a limited role. Outside the Anglo Saxon world most
companies are private, the ownership of listed companies is highly concentrated,
family ownership is very important and hostile takeovers are rare and pyramidal
control schemes are common in some countries bank ownership of equity is
important. The German economy may be typically characterized as bank system.
While banks shareholding is small, they enjoy significant voting rights on the
bearer form shares deposited with them by shareholders. They have representatives
on the top two tier boards. Banks are required to consult shareholders give their
advice and take their instructions on voting.

3.5 Corporate Governance in India:

While the predominant form of corporate governance is much closer to the Asian
insider model, there are a number of firms that resemble the European version
where the control is maintained through pyramidal form of ownership and control.
The concept of industrial house which controls several companies is quite
commonly accepted although the funding family does not own the company. There
are quite a few companies whose practices of corporate governance are a matter of
concern. Dilution of accounting and reporting standards have allowed corporations
from manipulating resources for their own vested interest sideling the stakeholders
of the company. Investors have suffered on account of unscrupulous management
of the companies, which have raised capital from the market at high valuations and
performed much worse than the past reported figures; leave alone the future
projections at the time of raising money. Another example of bad governance has
been the allotment of promoters shares, on preferential basis at preferential prices,
disproportionate to market valuation of shares, leading to further dilution of wealth
of minority shareholders. There are also many companies, which are not paying
adequate attention to the basic procedures for shareholders service; for example,
many of these companies do not pay adequate attention to redress investors
grievances such as delay in transfer of shares, delay in dispatch of share certificates
and dividend warrants and non-receipt of dividend warrants; companies also do not
pay sufficient attention to timely dissemination of information to investors as also
to the quality of such information. Although the securities law and companies Act
address several of these investor grievances, the implementation and inadequacy of
penal provisions have left a lot to be desired.

Factors Influencing Corporate Governance :

a) Integrity of the management: A Board of directors with a low level

of integrity is tempted to misuse the trust, reposed by shareholders and
other stakeholders, to take decisions that benefit a few at the cost of
others.
b) Ability of the board: The collective ability, in terms of knowledge
and skill, of the board of directors to effectively supervise the
executive management determines the effectiveness of the board.
c) Adequacy of the process: Board of directors cannot effectively
supervise the executive management if the process fails to provide
 sufficient and timely information to the board, necessary for
reviewing plans and the performance of the enterprise.
d) Commitment level of individual board members: The quality of a
board depends on the commitment of individual members to tasks,
which thy are expected to perform as board members.
e) Quality of corporate reporting: The quality of corporate reporting
depends on the transparency and timeliness of corporate commination
with shareholders in making economic decisions and in correctly
evaluating the management in its stewardship function.
f) Participation of stakeholders in the management: The level of
participation of stakeholders determines the number of new ideas
being generated in optimum utilization of resources and for improving
the administrative structure and the process. Therefore an enterprise
should encourage and facilitate stakeholder’s participation.
 CHAPTER 4

MAJOR DEVELOPMENTS AT INTERNATIONAL LEVELS

Since the mid-1990s, at international level, various corporate governance reports, guidelines and
regulations have come into existence.

In this project the emphasis has been made on the following major international developments in
corporate governance:

— Cadbury Committee Report

— OECD Principles

— The Sarbanes-Oxley Act 2002

Cadbury Committee Report on Corporate Governance

In an attempt to prevent the recurrence of business failures in countries like UK and to raise the
standards of corporate governance, the Cadbury Committee, under the chairmanship of Sir
Adrian Cadbury, was set up by the London Stock Exchange in May 1991.
The Committee investigated accountability of the Board of Directors to shareholders and to the
society. The resulting report, and associated “Code of Best Practices,” published in December
1992, was generally well received. The Cadbury Code of Best Practices had 19
recommendations. The recommendations are in the nature of guidelines relating to the Board of
Directors, Non-executive Directors, Executive Directors and those on Reporting & Control.

2: Organization for Economic Co-operation and Development (OECD) –Principles

Organization for Economic Co-operation and Development (OECD) – Principles OECD is a

unique forum where the governments of 30 market democracies work together to address the
economic, social and governance challenges of globalization as well as to exploit its
opportunities. The organization provides a setting where governments can compare policy
experiences, seek answers to common problems, identify good practices and co-ordinate
domestic and international policies.

The OECD Council, meeting at Ministerial level on 27-28 April 1998, called upon the OECD to
develop, in conjunction with national governments, other relevant international organizations and
the private sector, a set of corporate governance standards and guidelines. In order to fulfill this
objective, the OECD established the ad-hoc Task Force on Corporate Governance to develop a
set of non-binding principles that embody the views of Member countries on this issue.

The OECD revised its principles of corporate governance in the year 2004, which reflects a
global consensus regarding the importance of good governance practices in contributing to
economic viability and stability in economics.

3: The Sarbanes-Oxley Act

Sarbanes-Oxley Act is a US law passed in 2002 to strengthen corporate governance and restore
investor confidence. The Act was sponsored by US Senator Paul Sarbanes and US
Representative Michael Oxley.

Sarbanes-Oxley law passed in response to a number of major corporate and accounting scandals
involving prominent companies in the US. These scandals resulted in a loss of public trust in
accounting and reporting practices. In July 2002, the Sarbanes- Oxley Act popularly called
‘SOX’ was enacted. The Act made fundamental changes in virtually every aspect of corporate
governance and particularly in the matters of auditor independence, conflict of interest, corporate
responsibility and enhanced financial disclosures.

SOX is wide ranging and establishes new or enhanced standards for all US public company
Boards, Management, and public accounting firms. SOX contains 11 titles, or sections, ranging
from additional corporate board responsibilities to criminal penalties. It requires Security and
Exchange Commission (SEC) to implement rulings on requirements to comply with the new law.

SOX consists of new standards for Corporate Boards and Audit Committee, new accountability
standards and criminal penalties for Corporate Management, new independence standards for
External Auditors, a Public Company Accounting Oversight Board (PCAOB) under the Security
and Exchange Commission (SEC) to oversee public accounting firms and issue accounting
standards.

2.2- CORPORATE GOVERNANCE – DEVELOPMENTS IN INDIA

In India, a small beginning was made by the Confederation of Indian Industry (Cll) in the field of
good corporate governance which is explained below.

Thereafter, various committees have been constituted to give recommendations in this regard
viz.. Kumar Manglam Birla Committee, Naresh Chandra Committee, Narayana Murthy
Committee etc.

1: Confederation of Indian Industry (CII)

In 1996, CII took a special initiative on Corporate Governance, the theme of such initiative was
to develop and promote a code for Corporate Governance to be adopted and followed by Indian
Companies, be it in the Private Sector or Public Sector, Banks or Financial Institutions, all of
which are corporate entities. A National Task Force was set up with Mr. Rahul Bajaj, as the
Chairman and including members from industry, the legal profession, media and academia. This
Task Force presented the draft guidelines and Code for Corporate Governance in April 1997 at
the National Conference and Annual session of CII. After reviewing the various suggestions and
the developments which have taken place in India and abroad, the Task Force finalized the
Desirable Corporate Governance Code.

2: Kumar Manglam Birla Committee

The SEBI appointed a Committee on Corporate Governance on May 7, 1999 under the
chairmanship of Shri Kumar Manglam Birla, to promote and raise the standards of corporate
governance mainly from the perspective of the investors and shareholders and to prepare a code
to suit the Indian corporate environment.

Such committee submitted its interim & final report in 1999/2000. The Committee made a
number of recommendations towards corporate governance which include constitution of audit
committee, composition of Board of Directors, role of independent directors, & remuneration
standard and financial reporting etc. On the basis of such recommendations clause 49 (pre-
amended) of the listing agreement was issued by the SEBI.

3: Naresh Chandra Committee

The next development is constitution of a committee by ‘Department of Company Affairs’

(DCA), headed by Shri Naresh Chandra, called ‘Naresh Chandra Committee’ on August 21,
2002, to examine various issues of corporate governance relating to statutory auditor - company
relationship, rotation of statutory audit firm or partners, appointment of auditors and
determination of audit fees, independence of auditing functions, certification of accounts and
financial statements by management and directors role of independent directors etc. Many
recommendations of the report were incorporated in the Companies (Amendment) Bill 2003,
which is currently being reviewed.

4: Narayana Murthy Committee

Thereafter, ‘SEBI’ constituted another committee called ‘Narayana Murthy Committee’ under
the Chairmanship of N.R. Narayana Murthy comprising 23 persons, which included
representatives from the stock exchanges, Chamber of Commerce, industry, investor associations
and Professional bodies, for reviewing implementation of the corporate governance code by
listed companies.

Many of the recommendations made by such committee has been included in the revised Clause
49 of the Listing Agreement. The Narayana Murthy Committee attempted to promulgate an
effective approach for successful corporate governance. The Committee submitted its final report
on February 8, 2003.

5: The Securities and Exchange Board of India

SEBI vide its circular no. SEBI/CFD/DIL/CG/1/2004/ 12/10, Dated October 28, 2004 has
revised the existing clause 49, related to corporate governance. The above circular has also
amended many of the exiting provisions of Clause 49 of the listing agreement and has introduced
a number of new requirements.
The major changes in the new clause 49 include amendments/additions to provisions relating to
definition of independent directors, strengthening the responsibilities of audit committees,
improving quality of financial disclosures, including those related to related party transactions
and proceeds from public/rights/preferential issues, requiring Boards to adopt formal code of
conduct and requiring CEO/CFO certification of financial statements, etc. Such a step, if
properly implemented, will go a long way towards ensuring good governance practices in Indian
Corporate Sector.
 Chapter-5

THE THREE ANCHORS OF CORPORATE

GOVERNANCE

5.1 Introduction:

The three anchors of corporate governance are board of directors, management and
shareholders. While each of them has important responsibilities of its own, it is
their interaction with each other’s that is the key to effective governance. In
tandem they constitute an effective set of checks and balances. The system can
become unbalance if any one of them is not functioning well.

5.2 Accountability and Responsibilities:

Mr. Obama Signs Credit Card accountability / The girl is showing her responsibility

The relationship in the governance triangle consisting of boards of directors

management, management-board of directors and boards of directors-shareholders
depend on mutual accountabilities and responsibilities. The board lays down policy
and monitors performance and counsels and management. The board hires and
fires and through the Remuneration Committee sets the compensation for the CEO.
It may be noted that in USA the jobs of CEO and Chairman are usually combined
while in India the practice varies. In some they are held by different individuals
while in others they are combined. Sir Adrian Cadbury believes that the jobs of
Chairman and Chief executive demand different abilities and perhaps
temperaments. In it is very much in shareholders interests to ensure they are
performed by different people.
5.3 Separation of Board from Management:

The new governance rules that have been adopted are designed to distance the
board from management and thereby prevent conflicts of interest that can
compromise the relationship. The changes call for an increase in the number of
independent directors and the committees on Audit and compensation be
composed entirely of independent directors. The New York stock exchange
proposals also put forth the idea of director independence. They should have no
material relationship with the company.

Board and Management:

The changes introduced by focusing on board and Audit Committee composition

have not succeeded in establishing a healthy distance between the management and
board. The board should be free to monitor and the management tree to manage. If
the two functions are combined as under a system of Chief executive officer
Chairman, there is no separation of powers and functions. The policy making,
strategy formulation and monitoring is done by the same person who is supposed
to execute them. The efficiency of all these measures to distance Board from
management would be lost if we let a person wear two hats at the same time that of
Chairman of the board and Chief executive officer of management. At the outset it
should be noted that letting management personnel be members of the board
howsoever senior they may be by calling them full time directors/executive
directors has confounded the concepts of transparency and accountability. Good
corporate governance demands the separation of the board and management. Even
in the case of promoters whose personal wealth is tied to the company they have to
make a choice to be satisfied by being a member of the board or management
team. This of course goes against the grain of Indian corporate governance, the
founding family as “owners” being the board as well as management. Management
accountability will be non-existent to the shareholders in such circumstances.

Family Dominated Companies:

Family dominated company’s own substantial stakes in a large number of quoted

companies here as well as in U.S. In the U.S. the founding family is an influential
investor in more than one-third of standard and poor’s 500 companies. On average
while the family owns 18% of the equity its control of the board tends to be
disproportionately large. However, family dominated companies are both more
profitable and better marker performers than non-family especially when a
dynamic family member with a profound sense of stewardship is managing
Director/CEO. The key difference between the family firms and others is the
independence of the board packed with friends and relatives do badly, while those
with strong directors do better. It is good governance that makes the difference.

5.4 Approaches to Balance Board and CEO Functions:

The (US) Conference Board Commission on public Trust and

private Enterprise (CPTPE) 2003 noted three principal approaches to
provide the appropriate balance between board and CEO functions.
 Separation of the offices of Chairman and CEO with those two roles
being performed by separate individuals. The chairman would be one
of the independent directors.
 Separation of offices but not a member of management and would not
report to CEO. Chairman who is a non-independent director may be
designated as lead independent director without any relationship with
CEO or management that compromises his or her ability to act
independently.
  Where there is no separation of chairman and CEO position a
presiding director position could be established.
 Duties of non-CEO chairman whether he is an independent director or
not, the lead independent director and presiding director should be
articulated.

Non CEO Chairman:

The duties of non- CEO Chairman according to CPTPE should include

i. Presiding at board meeting and at meetings of non management
directors,
ii. Approval over information sent to the board,
iii. Deciding board meeting agenda,
iv. Serving as principal liaison to the independent directors and
v. Setting meeting schedules.

Duties of Lead Independent Director (CPTPE):

i. Chairing meeting of the non-management directors,

ii. Serving as principal liaison to the independent directors,
iii. Working with the non CEO Chairman to finalize flow to the board
meeting agenda and meeting schedules.

Duties of presiding Director (CPTPE):

i. Preside at board meetings in the absence of chairman,

ii. Presiding at executive sessions of the non management directors,
iii. Serving as the principal liaison to the independent directors,
iv. Approve information to be sent to the board,
v. Approve agenda for board meeting,
 vi. Set meeting schedules.

A non CEO Chairman who is not an independent director should not be

a member of the management team and should not report to the CEO. The non
management directors should have regular, frequent meetings without the CEO or
other directors who are members of management present.

Board and Shareholders:

The regulatory efforts and operation of market forces have let out this relationship
in the third anchor of corporate governance. By and large shareholders do not
know what the directors are doing and directors do not know what the shareholders
want. Board members are elected by shareholders to serve as their agents but in
practice shareholders have not exerted much influence over directors. The
exchange of information between the two anchors is poor and directors are not
accountable to shareholders. There is no way for shareholders to know whether the
directors have acted in there is no efficient mechanism to nominate or even endorse
director candidates.

Shareholders on their part are quite apathetic and mute. Their

communication is limited to formal proxy votes which historically ratified board’s
wishes. Shareholders have access to no mechanism through which to effect
changes, except for calling an extraordinary general body meeting. The
relationship between the two anchors, board and shareholders is not linked together
in any manner or by any method except for the provision of annual general
meeting. The absence of the link has created an imbalance in the governance
mechanism. It has also encouraged a closer relationship and stronger link between
board and management who fill the void. Directors can be effective in taking care
of shareholder interests of we set up a strong structure of board meetings and
enfranchisement of shareholders. Three steps mooted in this connection are record
of voting at Board meetings, letting shareholders put up as well as elect a director
on their behalf and make resolutions passed at shareholders meeting binding.

Transparency:

If the individual directors’ votes on corporate resolutions in key corporate proxy

statements are recorded, the directors become accountable to shareholders. When
people are held recount able for their actions as individuals rather than as a group
they tend to weigh their choices more carefully. Directors would have greater
incentive to air their views if individual votes are published. Such accumulated
information to create director score boards would supplement board self-
evaluation.

Election of Directors:

While the shareholders in theory have the right to attend meetings and participate
in the election of directors of the Board, the cast majority of director elections are
uncontested. The only method is open to shareholders is to mount a proxy fight
which entails publishing and mailing their own list of proposed directors to
shareholders escalating the contest in effect into a fight for control of the firm. The
campaign has to be has to be financed by shareholders out of their out of their
pockets whereas the company’s own proxy materials sent to shareholders before
annual meetings company cost/or shareholders money. To enfranchise the
shareholders and democratize election of company directors shareholders may be
allowed to put their won candidates on the Company’s proxy material. This would
avoid the expense and stark choices of a proxy fight. In US has proposed the grant
of right to shareholders under special circumstances, such as opposition to
company’s proxy by withholding votes, and duration of share ownership for 3-5
years. The proposal has been opposed on the ground that it would create confusion
in elections when more than one candidate contests a board seat.
 CHAPTER 5:

CONCEPTUAL FRAMEWORK

5.1- Clause 49 of The Listing Agreement

Clause 49 of the listing agreement: SEBI revise Clause 49 of the Listing Agreement pertaining to
corporate governance vide circular date October 29th, 2004, which superseded all other earlier
circulars issued by SEBI on this subject. All existing listed companies were required to comply
with the provisions of the new clause by 31st December 2005.

The major provisions included in the new Clause 49 are:

• The board will lay down a code of conduct for all board members and
senior management of the company to compulsorily follow.
• The CEO an CFO will certify the financial statements and cash flow
statements of the company.
• If while preparing financial statements, the company follows a treatment
that is different from that prescribed in the accounting standards, it must
disclose this in the financial statements, and the management should also
provide an explanation for doing so in the corporate governance report of
the annual report.
• The company will have to lay down procedures for informing the board
members about the risk management and minimization procedures.
• Where money is raised through public issues etc., the company will have
to disclose the uses/ applications of funds according to major categories
( capital expenditure, working capital, marketing costs etc) as part of
quarterly disclosure of financial statements.

Further, on an annual basis, the company will prepare a statement of funds utilized for purposes
other than those specified in the offer document/ prospectus and place it before the audit
committee.
The company will have to publish its criteria for making its payments to non-executive directors
in its annual report. Clause 49 contains both mandatory and non-mandatory requirements.

5.2- Steps Implemented By Companies Act With Regard To Corporate Governance

The Ministry of Company Affairs appointed various committees on the subject of corporate
governance which lead to the amendment of the companies Act in 2000. These amendments
aimed at increasing transparency and accountabilities of the Board of Directors in the
management of the company, thereby ensuring good corporate governance. The dealt with the
following:

1. COMPLIANCE WITH ACCOUNTING STANDARDS – SECTION 210A

As per this subsection inserted by the Companies Act, 1999 every profit and loss account and
balance sheet of the company shall comply with the accounting standards. The compliance of
Indian Accounting standards was made mandatory and the provisions for setting up of National
Committee on accounting standards were incorporated in the Act.

2. INVESTORS EDUCATION AND PROTECTION FUND – SECTION 205C

This section was inserted by the Companies Act 1999which provides that the central government
shall establish a fund called the Investor Education and protection Fund and amount credited to
the fund relate to unpaid dividend, unpaid matured deposits, unpaid matured Debenture, unpaid
application money received by the companies for allotment of securities and due for refund and
interest accrued on above amounts.

3. DIRECTOR’S RESPONSIBILITY STATEMENT- SECTION 217(2AA)

Subsection (2AA)added by the Companies Act, 2000 provides that the Boards report shall also
include a Director’s Responsibility statement with respect to the following matters:

a. Whether accounting standards had been followed in the preparation of annual

accounts and reasons for material departures, if any;
b. Whether appropriate accounting policies have been applied and on consistent basis;
 c. Whether directors had made judgments and estimate that are reasonable prudent so as
to give a true and fair view of the state of affair and profit and loss of the company;
d. Whether the directors had prepared the annual accounts on a going concern basis.
e. Whether directors had taken proper and sufficient care for the maintenance of
adequate accounting records for safeguarding the assets of the company.

4. NUMBER OF DIRECTORSHIPA- SECTION 275

As per this section of Companies Act, 2000 a person cannot hold office at same time as director
in more than fifteen companies.

5. AUDIT COMMITTEES – SECTION 292A

This section of the companies Act, 2000 provides for the constitution of audit committees by
every public company having a paid- up capital of Rs.5 crores or more. Audit Committee is to
consist of at least 3 directors. Two of the members of the Audit Committee shall be directors
other than managing or whole time director. Recommendation of the Audit Committee on any
matter related to financial management including audit report shall be binding on the Board.

6. PROHIBITION ON INVITIN OR ACCEPTING PUBLIC DPOSIT

The Companies Act, 2000 has prohibited companies to invite/accept deposit from public.

7. SMALL DEPOSITOR- SECTIONS 58AA AND 58AAA

The Companies Act, 2000 had added two new sections, viz, section a 58AA and 58AAA, for the
protection of small depositors. These provisions are designed to protect depositors who have
invested upto Rs. 20, 000 in a financial year in a company.

8. CORPORATE IDENTITY NUMBER

Registrar of Companies is to allot a Corporate Identity Number to each company registered on or

after November 1, 2000 (Valid circular No.)12/2000 dated 25-10-2000)
9. POWERS TO SEBI – SECTION 22A

This section added Companies Act, 2000 empowers SEBI to administer the provisions contained
in section 44 to 48, 59 to 84, 10, 109, 110, 112, 113, 116, 117, 118, 119, 120, 121, 122, 206,
206A and 207 so far as they relate to issue and transfer of securities and non- payment of
dividend. However, SEBI’S power in this regard is limited to listed companies.
 Chapter -6

A STUDY OF CORPORATE GOVERNANCE INBANKS

6.1 Introduction:

Globally, Corporate Governance guidelines and best practices have evolved over a
period of time. In the United States of America as well as India in the late 1800
and the early 1900s there were only closely held family owned corporate and the
concept of public limited companies was non-existent. The owners made strategic
decisions and bore the entire consequences-positive or negative.

However, by the 1930s increasing number of companies went public and

corporate ownership was dispersed across a large number of individuals and issues
of Accountability, Transparency and control were raised by these shareholders in
the Annual meeting of the shareholders. The years subsequently saw the
strengthening of the rights of the shareholders and the stakeholders which gained
momentum only in the early nineties.

The Cadbury Committee report was a landmark effort from UK in 1992

followed by vienot report in France in 1995. The confederation of British Industry
in January 1995 set up theGreenbury committee to recommend a code of
governance for the UK Industries followed by the Hampel committee appointed by
the London Stock Exchange (LSE). The 30 member Organization for Economic
Cooperation and Development (OECD) in 1999 published the general principles of
corporate Governance. However, the Sarbanes Oxley Act 2002 of US brought in
sweeping changes in financial reporting.
 In India, the confederation of Indian Industry (CII) tools the lead and
framed the code of Corporate Governance in 1998. The Securities and Exchange
Board of India (SEBI) appointed the Kumaramangalam Birla Committee and its
recommendations were accepted in 1999 and enshrined in the Clause 49 of the
Listing Agreement of the stock exchange. The Department of company affairs
appointed the Naresh Chandra committee in 2002, to repost on the relationship
between the auditors and their clients. Then the SEBI appointed Narayana Murthy
committee recommendation were also incorporated in to the revised Clause 49 in
2006. Further, the Corporate Governance Rating by agencies like CRISIL and
ICRA are now used to benchmark companies on Corporate Governance practices.

6.2 Main Indicator Of Corporate Governance:

 Existence of good corporate governance: It is a primary and most

fundamental indicator of good corporate governance. The good governance
code should be based on widely accepted views of government, Business
Association, social organization or stakeholders. Moreover the existence of
the code should be used as a benchmark to measure the company’s actual
governance.
 The role, Responsibility and competence of the board: There has to be a
system that ensures that the board is empowered, informed, competent and
effective on a continuous basis. The board must provide the stewardship to
the company to take up the role and responsibility in running the company
efficiently and effectively.
 Involvement of Non-Executive or independent directors: These directors
are appointed in the boards to provide independent, objective and
professional opinion in the board meetings on matters of importance and
concern to company. All the governance codes recommend a large
 proportion of Independent Directors on the company boards and much
depends on how they are appointed, by whom they are influenced and what
financial interest they have in the company.
 Dissemination of material Information:To avoid insider trading the
timely and adequate dissemination of material information to the public is
sign of good governance.
 Distinction between the role of the Responsibilities of the Board and
Management: Governance standard of the company is basically judged
from the split between the role and responsibilities of the board and
management. The board is expected to steward the company, set the
strategic objectives, provide guidance and judgment independent of
management, and exercise control over the company, remaining all along
accountable to the shareholders in particular and the stakeholders in general.
 Disclosure of Remuneration Package: Shareholders, as the owners of the
company have full right to know about the compensation policies and
packages of the directors as well as the executive. Extraordinarily high
remuneration packages drain the company’s resources at the expense of
shareholders.
 Specialized Board Committees: The quality of board increases if some key
decision requiring specialized expertise are entrusted to various committees
constituted by the board. Audit committee is very important to maintain
accountability in the corporate system through supervising and monitoring
of the system of the financial reporting. The specialized committee may
handle such important matters as nomination of directors, accounting
standards and procedures, audit system, reporting system, compensation of
the company executive and the like.
6.3 Unethical Business Practices:

The different unethical business practices include issues of Whistle Blowing,

bribes, accepting gifts, Insider trading, conflicts of interest, window dressing etc.
Globally these issue have been In the limelight under Sarbanes-Oxley Act 2002and
nationally SEBI under clause 49 of the listing agreement has taken policy
initiatives avoid the following:

 Whistle Blower protection: allow an employee to report illegal activities by

those in position of authority in their company without any treat of backlash.
 Insider Trading: Using price sensitive information by a company
employees or individuals in violation of the fiduciary relationship that exist
with the company to make illegal profits in the transaction of the shares of
that company.
 Prohibition of short selling of company shares:No employee or director
should directly or indirectly sell any equity shares including derivatives of
his company if he doesn’t own the share and indulge in short selling.
 Bribes/ kickbacks: Corruption should be avoided strictly inside or outside
the company, so that later company should not suffer from any huge losses
which may turn in to scandal.
 Conflicts of interest: Avoidance of any situation that would lead to or tend
to lead to any conflicts of interest between personal interest and the interest
of the company, resulting in impairing the exercise of independent
judgment.
 Window dressing: The deceptive practice of using accounting tricks to
make company’s balance sheet and income statement appear better than the
 reality and the deceptive practice of mutual funds to buy strong stocks
before the year ending to make their holding look impressive.
 Funding of expense account/ Misappropriation of funds :Full, fair,
accurate, timely understandable records of the finances without presenting
false bills and incorrect accounts. KPMG’s fraud survey 2002 finds that
majority of cash losses occurs due to misappropriation, forged document,
expense accounts, diversion of funds, kickbacks , secret commission and
false and misleading information.
 Misuse of company assets: Using company property, asset or resources for
the benefits of the employee, his/ her relatives or associates / friend is
prohibited as the same can be used only for legitimate business purpose
only.
 Antitrust/ Monopoly activity: Avoid all anti-competitive and unlawful
business practices and discourage corrupt and dishonest means. Avoid
enticing away key employees of competitors to lessen competition, price
fixing, hoarding and black marketing etc.
 Hacking: A software designer who illegally enters encrypted sites and
accounts of others through modified software and hardware is highly
unethical.
 Misuse of confidential information: Directors and employees must protect
the confidential information entrusted to them by the company, its customers
and all business associates.
6.4 Sources:

Market Initiative- CRISIL, a leading credit rating agency developed a yardstick

which help measure the Governance & Value Creation Rating (GVC) of
companies including the Banks.

The assessment is made on the basis of the following-

 Governance Process: The Treatment of shareholders, transparency &

disclosures, composition and functioning of Board
 Wealth management: The levels of wealth creation and distribution
among stakeholders and the future wealth creation capacity, wealth being
utilized for the ultimate good of all stake holders in the medium to long
term. The wealth should be shared proportionately and equitably among the
shareholders without resorting to disproportionate sharing methods like
ESOP and Sweat equity.
 Regulatory Initiative: All listed companies including banks have to adhere
to the listing agreement, which specifies:
 Audit committee: Should include qualified and Independent Directors who
are finance literate and the chairman should be well versed in Management
and Accounts. The appointment and removal of the external auditors should
be decided by them to endure that accounting norms are strictly followed.
 Composition of the board: If Non-executive chairman then 1/3rd Board of
Directors should be Independent otherwise ½ of the Board members should
be Non-Executive, Independent Directors. The shareholders should approve
the compensation paid to the Non-Executive Directors.
 Code of conduct: the BOD and the senior management should follow this
code.
 Legislature Initiative: the companies Act 1956 alone can provide the
statutory backing to the corporate governance standards, which require a
bill to be passed in the parliament. There are two areas that need the
necessary legal support to ensure compliance:
 Audit process: A disciplinary mechanism is needed to check the
performance of auditors. Proper process to be laid down for appointment
and qualification of auditors
 Chapter -7

PRESENTATION OF DATA, ANALYSIS AND FINDINGS

7.1- CLAUSE 49 – MANDATORY REQUIREMENTS

I. BOARD OF DIRECTORS

A. Composition of Board:
1. The Board of directors of the company shall have an optimum combination of
executive and non-executive directors with not less than fifty percent of the board of
directors comprising of non- executive directors .
2. Where the Chairman of the Board is non- executive directors, at least one third of the
Board should comprise of independent directors and in case he is an executive
directors, at least half of the Board should comprise of independent directors.
3. For the purpose of sub – clause (ii) the expression ‘independent director’ shall mean a
non executive director of the company who:
a) Apart from receiving director’s remuneration , does not have any material pecuniary
relationships or transactions with the company, its promoters, its directors its senior
management or its holding company, its subsidiaries and associated which many affects
independence of the director.
b) Is not related to promoters or persons occupying managements positions at the board
level or at one level below the board;
c) It not been executive or was not partner or an executive during the preceding three
years, of any of the following:
d) Is not a partner or an executive or was not partner or an executive during the preceding
three years, of any of the following:
I. The statutory audit firm or the internal audit firm that is associated with the company, and
II. The legal firm(s) and consulting firm(s) that have a material association with the
company
f. Is not a material supplier, service provider or customer or a lessor or lessee of the
company, which may affect independence of the directors; and
 g. is not a substantial shareholder of the company i.e owning two percent or more of the
block of voting shares.
4. Nominee directors appointed by an institution which has invested in or lent to the
company shall be deemed to be independent directors. However if the Dr. J.J. irani
Committee recommendations on the proposed new company law are accepted, then
directors, nominated by financial institutions and the government will not be
considered independent.
B. Non executive directors compensation and disclosures: all fees/ compensation and
disclosures: all fees/ compensation , if any paid to non executive directors, including
independent directors, shall be fixed by the Board of Directors and shall require
previous approval of shareholders in general meeting. The shareholders’ resolution
shall specify the limits for the maximum number of stock options that can be granted
to non- executive directors, including independent directors, in any financial year and
aggregate. However as per SEBI amendment made vide circular SEBI/ CFD/DIL/CG
dated 12/1/06 sitting fees paid to non-executive directors as authorized by the
Companies Act 1956, would not require the previous approval of shareholders.
C. Other provisions as to Board and Committees:
1. The board shall meet at least four times a year, with a maximum time gap of three
months between any two meetings. However SEBI has amended the clause 40 of the
listing agreement vide circular SEBI/CFD/DIL/CG dated 12-1-06 as per which the
maximum gap between two board meetings has been increased again to 4 months.
2. A director shall not be a member in more than 10 Audit and / or Shareholders
grievance Committee or act as chairman of more than five Audit Shareholders
Grievance committee across all companies in which he is a director. Furthermore it
should e mandatory annual requirement for every director to inform the company
about the committee positions he occupies in other companies and notify changes as
and when they take place.

D. Code of conduct:
 1. The Board shall lay down a code of conduct for all Board members and senior
management of the company. The code of conduct shall be posted the website of the
company,
2. All Board members and senior management personnel shall affirm compliance with
the code on an annual basis. The Annual report of the company shall contain
declaration to this effect signed by CEO.

II. AUDIT COMMITTEE.

A. Qualified and Independent Audit Committee: A qualified and independent audit

committee shall be set up, giving the terms of reference subject to the following:
1. The audit committee shall have minimum three directors as members. Two thirds of
the members fo audit committee shall be independent directors.
2. All members of audit committee shall be financially literate an at least one member
shall have accounting or related financial management expertise.
3. The chairman of the Audit Committee shall be an independent director.
4. The chairman of the Audit Committee shall be present at annual General Meeting to
answer shareholder queries;
5. The audit committee may invite such of the executives, as it considers appropriate
(and particularly the head of the finance function) to the present at the meetings of the
committee. The finance director, head of internal audit and representative of the
statutory auditor may be present as invitees for the meeting of the audit committee;
6. The Company Secretary shall act as the secretary to the committee.
A. Meeting of Audit Committee: the audit committee should meet at least four times in a
year and not more than four months shall elapse between two meetings. The quorum
shall be either tow members or one third of the members of the audit committee
whichever is greater, but there should be minimum of two independent members present.
B. Powers of Audit Committee: the audit committee shall have powers:
1. To investigate any activity within the terms of reference;
2. To seek information from any employee;
3. To obtain outside legal or other professional advice;
4. To secure attendance of outsiders with relevant experts, if any.
D. Role of audit committee: the role for the audit committee shall include the following:

1. Oversight of the company’s financial reporting process and the disclosure of

its financial information to ensure that the financial statement is correct,
sufficient and credible.
2. Recommending to the Board, the appointment re- appointment and if required
the replacement or removal of the statutory auditor and the fixation of audit
fees.
3. Approval of payment too statutory auditors for any other services rendered by
the statutory auditors.
4. Reviewing, with the management the quarterly and annual financial
statements before submission to the board for approval with reference to
Director’s Responsibility statement under section 217 (2AA)k, significant
adjustments made in financial statements, compliance with listing
requirements, disclosure of any related pending transaction etc.
5. Reviewing with the management performance of statutory and internal auditor
and adequacy of the internal control systems.
6. Discussion with internal auditors regarding any significant findings including
suspected frauds or irregularities and follow up thereon.
7. Reviewing the findings of any internal investigation by the internal auditors
into matters where there is suspected fraud or irregularity or a failure of
internal control system of a material nature and reporting the matter to the
board.
8. Discussion with statutory auditors before the audit commence, about the
nature and scope of audit as well as post- audit discussion to ascertain any
area of concern.
9. To look into the reason fo substantial defaults in the payments to the
depositors, debenture holders, shareholders (in case of nonpayment of
declared dividends) and creditors.
10. To review the functioning of the Whistle Blower mechanism, in case the same
is existing.
 11. Carrying out any other function as it mentioned in the terms of reference of
the Audit Committee.

III. SUBSIDARY COMPANIES

1. At least one independent director on the Board of Director of the holding

company shal be a director on the Board of Directors of a material non listed
Indian subsidiary company.
2. The audit committee of the listed holding company shall also review the
financial statements, in particular, the investment made by the unlisted
subsidiary company.
3. The minutes of the Board meeting of the unlisted subsidiary company shall be
placed at the Board meeting of the listed holding company, the management
should periodically bring to the attention of the Board of Directors of the
listed holding company, a statement of all significant transaction and
arrangements entered into by the unlisted subsidiary company.

IV. DISCLOSURES

A. Basis of related party transactions:

1. A statement in summary form of transactions with related parties shall be placed
periodically before the audit committee.
2. Details of material individual transactions with related parties which are not in the
normal course of business shall be placed before the audit committee.
B. Disclosure of Accounting Treatment: where in the preparation of financial
statements, a treatment different from that prescribed in an Accounting Standard has
been followed, the fact shall be disclosed in the financial statements, together with the
management’s explanation as to why it believes such alternative treatment is more
representative of the true and fair view of the underlying business transaction in the
Corporate Governance Report.
C. Board Disclosure- Risk Management: the company shall lay down procedures to
inform Board members about the risk assessment and minimization procedures.
3. D. Proceeds from public issues, rights issues , preferential issues etc. : When money
is raised through an issue (public issues rights issues, preferential issues etc.), it shall
disclose to the Audit committee, the uses/ applications of funds by major category
(capital expenditure,, sales and marketing, working capital, etc.), on a quarterly and
annual basis.
D. Remuneration of Directors :
1. All pecuniary relationship or transactions of the non- executive directors vis-
à-vis the company shall be disclosed in the Annual Report.
2. Further, certain prescribed disclosures on the remuneration of directors shall
be made in the section on the corporation governance of the Annual Report;
3. The company shall disclose the number of shares and convertible instruments
held by non-executive directors in the annual report.
4. Non executive directors shall be required to disclose their shareholding (both
own or held by/ for other persons on a (beneficial basis) in the listed company
in which they proposed to be appointed as directors, prior to their
appointment. These details should be disclosed in the notice to the general
meeting called for appointment of such directors.
E. Management: As part of the directors’ report or as an addition there to a
Management Discussion and Analysis report, the following should form part of the
Annual Report to the shareholders. This includes discussion on:
1. ;industry structure and developments.
2. Opportunities and threats.
3. Segment wise or product wise performance
4. Outlook
5. Risks and concerns.
6. Internal control systems and their adequacy
7. Discussion on financial performance with respect to operational performance.
8. Material developments in Human resources/ industrial Relations front
including number of people employed.
G. Shareholders:

1) In case of the appointment of a new directors or reappointment of a director the

shareholders must be provided with the following information:
a. A brief resume of the director
b. Nature of his expertise in specific functional areas;
c. Names of companies in which the persons also holds directorship and the
membership Committees of the Board; and
d. Shareholding of non – executive directors.
3. A board committee under the chairmanship of a non- executive director shall be
formed to specifically look into the redressal of shareholder and investor complaints
like transfer of shares, non receipt of declared dividends etc. this committee shall be
designated as ‘Shareholders/Investors Grievance Committee’.
4. To expedite the process of share transfer, Board of the company shall delegate the
power of share transfer to an officer or a committee or to the registrar and share
transfer agents. There delegated authority shall attend to share transfer formalities
and least once in a fortnight.

V. CEO/CFO CERTIFICATION

Through the amendment made by SEBI vide circular SEBI /CFD/DIL CG DATED 12-1-06, in
Clause 49 of the Listing Agreement, certification of intedrnal controls and internalcontrol system

CFO/CEO would be for the purpose of financial reporting. Thus the CEO, i.e. the Managing
Direcctor or Manager appointed in terms of the Companies Act, 1956 and the CFO i.e. the whole
– time Finance Director or any other Person heading the finance function discharging that
function shall certify to the Board that:

1. They have reviewed financial statements and the cash flow statement for the year and
that to the best of their knowledge and belief:
a. These statements do not contain any materially untrue statement or omit any material
fact or contain statements that might be misleading;
III. These statements together present a true and fair view of the company’s affairs and are in
compliance within existing accounting standards, applicable laws and regulations.
2. There are, to the best of their knowledge and belief, no transactions entered into by
the company during the year which fraudulent, illegal or violative of the company’s
code of conduct.
3. They accept responsibility for establishing and maintaining internal controls and they
have evaluated the effectiveness of the internal control system of the company
pertaining to financial reporting and they have disclosed to the auditors and the Audit
Committee, deficiencies in the design or operation of internal controls, if an, of which
they are aware and the steps they have taken or propose to take to rectify these
deficiencies
4. They have indicated to the auditors and the Audit Committee significant changes in
internal control over financial reporting during the year, significant fraud of which
they have become aware and the involvement there in if any, of the management or
an employee having a significant role in the company’s internal control system over
financial reporting.

VI. REPORT ON CORPORATE GOVERNANACE

1. There shall be separate section on Corporate Governance in Annual Reports of

Company with a detailed compliance report on Corporate Governance. Non
compliance of any mandatory requirement of this clause with reason there of and the
extent to which the non- mandatory requirements have been adopted should be
specifically highlighted.
2. The companies shall submit a quarterly compliance report to the stock exchange
within 15 days from the close of quarter as per the format given in
3. Annexure IB. the report shall be signed either by the Compliance Officer or the Chief
Executive Officer of the company.

VII. COMPLIANCE

1. The company shall obtain a certificate from either the auditor or practicing
company secretaries regarding compliance of conditions of corporate
 governance as stipulated in this clause and annex the certificate with the
directors’ report, which is sent annually to all the shareholders of the
company. The same certificate shall also be sent to the Stock Exchanges
along with the annual report filed by the company.
2. The non- mandatory requirements may be implemented as per the discretion
of the company. However, the disclosures of the compliance with mandatory
requirements and adoption / non- adoption of the non-mandatory requirements
shall be made in the section on corporate governance of the Annual Report.

4.2- CLAUSE 49 – NON-MANDATORY REQUIREMENTS

(1) THE BOARD

A non-executive Chairman may be entitled to maintain a Chairman’s office at the

company’s expense and also allowed reimbursement of expenses incurred in
performance of his duties.

Independent Directors may have a tenure not exceeding, in the aggregate, a period of nine years,
on the Board of a company.

(2) REMUNERATION COMMITTEE

I. The board may set up a remuneration committee to determine on their behalf and on
behalf of the shareholders with agreed terms of reference, the company’s policy on
specific remuneration packages for executive directors including pension rights and any
compensation payment.
II. ii. To avoid conflicts of interest, the remuneration committee, which would determine the
remuneration packages of the executive directors may comprise of at least three
directors, all of whom should be non-executive directors, the Chairman of committee
being an independent director.
III. iii. All the members of the remuneration committee could be present at the meeting.
IV. iv. The Chairman of the remuneration committee could be present at the Annual
General Meeting, to answer the shareholder queries. However, it would be up to the
Chairman to decide who should answer the queries.
(3) SHAREHOLDER RIGHTS

A half-yearly declaration of financial performance including summary of the significant events

in last six-months, may be sent to each household of shareholders.

(4) AUDIT QUALIFICATIONS

Company may move towards a regime of unqualified financial statements.

(5) TRAINING OF BOARD MEMBERS

A company may train its Board members in the business model of the company as well as the
risk profile of the business parameters of the company, their responsibilities as directors, and the
best ways to discharge them.

(6) MECHANISM FOR EVALUATING NON-EXECUTIVE BOARD MEMBERS

The performance evaluation of non-executive directors could be done by a peer group

comprising the entire Board of Directors, excluding the director being evaluated; and Peer
Group evaluation could be the mechanism to determine whether to extend / continue the
terms of appointment of non-executive directors.

(7) WHISTLE BLOWER POLICY

The company may establish a mechanism for employees to report to the management
concerns about unethical behavior, actual or suspected fraud or violation of the company’s
code of conduct or ethics policy. This mechanism could also provide for adequate safeguards
against victimization of employees who avail of the mechanism and also provide for direct
access to the Chairman of the Audit committee in exceptional cases. Once established,
the existence of the mechanism may be appropriately communicated within the organization.
 Chapter -8
CASE STUDY ON SATYAM SCANDAL

8.1 Introduction
Satyam Computers services limited was a consulting and an Information
Technology (IT) services company founded by Mr. Ramalingam Raju in 1988. It
was India’s fourth largest company in India’s IT industry, offering a variety of IT
services to many types of businesses. Its’ networks spanned from 46 countries,
across 6 continents and employing over 20,000 IT professionals. On 7 th January
2009, Satyam scandal was publicly announced & Mr. Ramalingam confessed and
notified SEBI of having falsified the account.
Raju confessed that Satyam’s balance sheet of 30 September 2008 contained:
 Inflated figures for cash and bank balances of Rs 5,040 crores.
 An accrued interest of Rs. 376 crores which was non-existent.
 An understated liability of Rs.1,230 croreson account of funds which were
arranged by himself.
 An overstated debtors’ position of Rs. 490 crores. The letter by B RamalingaRaju
where he confessed of inflating his company’s revenues contained the following
statements:
It has attained unmanageable proportions as the size of company operations grew
significantly in the September quarter of 2008 and official reserves of Rs. 8,392
crores. As the promoters held a small percentage of equity, the concern was that
poor performance would result in a takeover, thereby exposing the gap. The
aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with
real ones. It was like riding a tiger, not knowing how to get off without being
eaten.”
The Scandal:
The scandal all came to light with a successful effort on the part of investor’s to
prevent an attempt by the minority shareholding promoters to use the firm’s cash
reserves to buy two companies owned by them i.e. Maytas Properties and Maytas
Infra. As a result, this aborted an attempt of expansion on Satyam’s part, which in
turn led to a collapse in price of company’s stock following with a shocking
confession by Raju. The truth was its’ promoters had decided to inflate the revenue
and profit figures of Satyam thereby manipulating their balance sheet consisting
non-existent assets, cash reserves and liabilities.

The probable reasons:

Deriving high stock values would allow the promoters to enjoy benefits allowing
them to buy real wealth outside the company and thereby giving them opportunity
to derive money to acquire large stakes in other firms on another hand. After the
scandal, on 10 January 2009, the Company Law Board decided to bar the current
board of Satyam from functioning and appoint 10 nominal directors.  On 5th
February 2009, the six-member board appointed by the Government of India
named A. S. Murthy as the new CEO of the firm with immediate effect. The board
consisted of:
1)      Banker Deepak Parekh.
2)      IT expert KiranKarnik.
3)      Former SEBI member C Achuthan S Balakrishnan of Life Insurance
Corporation.
4)      Tarun Das, chief mentor of the Confederation of Indian Industry and
5)      T N Manoharan, former President of the Institute of Chartered Accountants
of India.
8.2 CASE STUDIES

1- Satyam Computers – ‘The Golden Peacock’ Winner Committing The Biggest Fraud In
Indian History.

The name of the company in Sanskrit is word for truth. Outsourcing I.T. has been the hottest
business in this hottest emerging market. Indian companies have been climbing the ranks of
world leadership ever since the spread of high-speed telecommunications lines to Bangalore,
Chennai and Mumbai made the country the favored destination.

Satyam was not the first in the business, and it certainly was not the biggest. But it was a fast
challenger, winning business that its bigger rivals would have embraced. Its shares traded in
Mumbai, but it had grander ambitions.

In the year ending 31st March, 2008 it had acquired four companies, in Belgium, the US and the
UK. Its revenues had pushed past $2 billion, and more than 20 per cent of that fell through to
pretax profits.

Its motto “A Commitment To Value Creation”. It seemed like a fairy tale, too good to be true.

Golden Peacock Winner

Satyam was, if not a paragon of good corporate governance, a pretty good example for listed
companies with a dominant shareholder.

It had just won Golden Peacock, an annual prize awarded by the World Council On Corporate
Governance for quality in risk management and compliance.

The Deal

On 16th December B. Ramalinga Raju, the major shareholder, founder and chairman, tried to
push through two more acquisitions-this time of companies controlled by his family, where his
sons led the management. It was a swaggering move: $ 1.6 billion- almost all the current assets
on Satyam’s books- for 51% (per cent) of Maytas Infrastructure and all of Maytas Properties.
The latter was an unlisted company for which the only public information available was the size
of its property holding. Maytas, of course, is Satyam, spelled backwards.

The World Bank

Just before taking its Christmas break, the World Bank Group in Washington struck Satyam off
its register of suppliers for eight years.

Satyam urged the World Bank to withdraw its comments about the decisions.

The Resignations

On 25th December, 2008, Dr. Mangalam Srinivasan, who had chaired the compensation
committee, resigned from the board, ending a 17- year relationship.On 29th December three
more independent directors resigned. M. Rammohan Rao, who had chaired the controversial
16th December board meetings where the Maytas acquisition was announced, joined Krishne
Palepu and Vinod K. Dham in leaving the company.

The Sell-Offs

Outside the investors were getting a bit nervous, as expected. The share price was even weaker
than the prevailing poor market sentiments present at that time.

But one day, the selling pressure became intense as a very large block of shares hit the market.
Perhaps some of the founder’s stake had changed hands as collateral for loans.

The lender may have put it up for sale to cover the loans. The game was up.

Another, Bigger Resignation

On 7th January, B. Ramalinga Raju, chairman and ‘promoter’ of the company, as Indian usage
has it, announced that he was stepping down. It seemed there was a hole of $ 1 billion in the
accounts. The reported 20+ per cent return on sales had really been only 3 per cent. Was the
failed deal to buy the other Raju-controlled companies a last-ditch effort to plug the whole? Or
was it instead to drain the remaining cash out of Satyam and into the family’s bank accounts?
And Where Was The Corporate Governance???

The dust was still settling. The board had been reconstituted and urgent meetings had been
underway to keep it afloat. A global recession did not help, of course, but Satyam would have
been in trouble under any circumstances. This company had followed all the codes, indeed it
exceeded governance standards as mandated in India, even sought to emulate standards in the
UK and to meet the New York Stock Exchange guidelines. The “Shareholder Grievance
Committee” – designed to anticipate concerns over related party dealings had by then seemed a
bad joke.

Postscript

PWC’s global CEO Samuel DiPiazza skipped the World Economic Forum’s shinding in Davos,
Switzerland, at the end of January 2009. He was in India, dealing with the arrest of two PwC
partners involved in the Satyam audit. KPMG and Deloitte had taken over the audit duties.

A majority shareholding in Satyam was acquired by another Indian technology and consulting
firm, Tech Mahindra. The rebranded Mahindra Satyam retained a listing on the New York Stock
Exchange.

The World Council on Corporate Governance stripped Satyam of its Golden Peacock.

The Conclusion Of The Satyam Scam

Satyam Computers services limited was a consulting and an Information Technology (IT)
services company founded by Mr. Ramalingam Raju in 1988. It was India’s fourth largest
company in India’s IT industry, offering a variety of IT services to many types of businesses. Its’
networks spanned from 46 countries, across 6 continents and employing over 20,000 IT
professionals. On 7th January 2009, Satyam scandal was publicly announced & Mr. Ramalingam
confessed and notified SEBI of having falsified the account.

Raju confessed that Satyam’s balance sheet of 30 September 2008 contained:

 • Inflated figures for cash and bank balances of Rs 5,040 crores (US$ 1.04
billion) [as against Rs 5,361 crores (US$ 1.1 billion) reflected in the
books].
• An accrued interest of Rs. 376 crores (US$ 77.46 million) which was non-
existent.
• An understated liability of Rs. 1,230 crores (US$ 253.38 million) on
account of funds which were arranged by himself.
• An overstated debtors’ position of Rs. 490 crores (US$ 100.94 million) [as
against Rs. 2,651 crores (US$ 546.11 million) in the books].

The letter by B Ramalinga Raju where he confessed of inflating his company’s revenues
contained the following statements:

“What started as a marginal gap between actual operating profit and the one reflected in the
books of accounts continued to grow over the years. It has attained unmanageable proportions as
the size of company operations grew significantly [annualised revenue run rate of Rs 11,276
crores (US$ 2.32 billion) in the September quarter of 2008 and official reserves of Rs 8,392
crores (US$ 1.73 billion)]. As the promoters held a small percentage of equity, the concern was
that poor performance would result in a takeover, thereby exposing the gap. The aborted Maytas
acquisition deal was the last attempt to fill the fictitious assets with real ones. It was like riding a
tiger, not knowing how to get off without being eaten.”
 CHAPTER 9

CONCLUSION

Finally I can conclude that compliance of corporate governance is high among the
Indian banks, however the composition of board should be effective.
From my point of view the awards and the rewards for the corporate initiative
among Indian banks both public and private, can create the right momentum to
change the mind set of banks and ensure that the international norms like Basel are
followed in both letter and spirit, resulting in improved transparency,
accountability and competitive performance in the economy, that could help derive
fully the socio economic benefits of good corporate governance.
Banking is clearly a very special sub set of corporate
governance with much of its management obligations enshrined in law or
regulatory codes. The corporate governance of banks has an important role to play
in assisting supervisory institution to perform their task, allowing supervisors to
have a working relation with bank management, rather than adversarial one.
With the element of good corporate governance, appropriate internal control
system, better credit risk management, focus on newly emerging business like
micro finance, better customer service and proactive policies, banks will definitely
be able to grapple with these challenges and convert them in to opportunities.
So corporate governance is not only useful in banks but also useful in companies,
industries, firms, institutions etc. so as to have good relations with the customers
and to run their businesses in successive manner considering future prospect.
 RECOMMENDATIONS

It is also relevant to note that governance or lack of it has affected all agencies of
government. We have to set right all governance, not just corporate governance. In
today’s world a company cannot run to achieve results in a cost effective manner
and stay competitive unless we fix governance problem wherever they exist. What
is at stake not only the integrity of market mechanism but the survival of
democracy in India.
Corporate houses including banks are also taking measure to highlight the
importance of corporate governance and ethical business practices among the
future managers in reputed management institutes like Larsen and Turbo (L&T)
Ltd. has endowed a chair for business at the management center for human values
at IIMC.
The government bodies honor the select corporate for their exemplary
initiative in areas of corporate governance and ethical business practices and many
more awards and accolades should be given. Finally I suggest that scandals like
satyam case which became the major economic downturn and finally ended by
arresting mr. Raju for his fraud against the company, should not take place again
due to which corporate governance may suffer from negative effects.
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