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CORPORATE GOVERNANCE
Definition of corporate governance:
"Corporate Governance is concerned with holding the balance between
economic and social goals and between individual and communal goals. The corporate
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."
"Corporate governance is about promoting corporate fairness, transparency and
accountability" J. Wolfensohn, president of the Word bank, as quoted by an article in
Financial Times, June 21, 1999.
Corporate governance comprises the systems and processes which ensure the
efficient 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 companys
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 goals 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 these 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 state is to strengthen their economies and discourage fraud
and mismanagement.
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OECD Principles
The OECD principles of corporate governance cover five major areas:
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.
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 of 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.
Corporate entities also have 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.
Role of Board: The main task of a board is to monitor the performance of executives and
to ensure that returns to shareholders are maximized. True independence of board can be
ensured by having a majority of outside directors who do not have any financial or
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 of managers. Increased transparency and information help to reduce
information a symmetry between management and shareholders.
OUTSIDER MODEL
Outsider model obtaining in USA and UK 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 the 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 the managers function in
the interests of the shareholders.
INSIDER MODEL
The insider model 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 shares either directly or through holding
companies. In all East Asian countries control is enhanced through pyramid structures
and cross holding firms.
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 on banks as a source of finance and the corporate entities have
quite high levels of debt equity ratio.
The majority should be independent of management and free from any business or
other relationship, which could materially interfere with the exercise of their
independent judgement, apart from their fees and shareholding. Their fees should
reflect the time, which they commit to the company.
Non executive Directors should be appointed for specific terms and
reappointment should not be automatic.
Non executive Directors should be selected through a formal process and both,
this process and their appointment, should be a matter for the Board as a whole.
Relating to the Executive Directors:
Directors service contracts should not exceed three years without shareholders
approval.
There should be full and clear disclosure of their total emoluments and those of
the Chairman and the highest paid UK directors, including pension contributions
and stock options. Separate figures should be given for salary and performance
related elements and the basis on which performance is measured should be
explained.
Executive Directors pay should be subject to the recommendations of a
Remuneration Committee made wholly or mainly of Non Executive Directors.
Cadbury Code of Best Principles on Reporting and Control:
It is the Boards duty to present a balanced and understandable assessment of the
companys position.
The Board should ensure that an objective and professional relationship is
maintained with the Auditors.
The Board should establish on Audit Committee of atleast three Non Executive
Directors with written terms of reference, which deal clearly with its authority and
duties.
The Directors should explain their responsibility for preparing the accounts next
to a statement by the Auditors about their reporting responsibilities.
The Directors should report on the effectiveness on the Companys system of
internal control.
The Directors should report that the business is a going concern, with supporting
assumptions or qualification as necessary.
executive directors and the board of directors so that the company is managed efficiently
and the rewards are equitably shared among shareholders and stakeholders.
in their interests. Although they have the right to elect board, there is no efficient
mechanism to nominate or even endorse director candidates.
Shareholders on their part are apathetic and mute. Their communication is limited
to formal proxy votes which historically ratified boards wishes. Shareholders have
access to no mechanism through which to effect changes, except for calling an extra
ordinary 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 shareholders interests if we set up a strong structure of board shareholder
relationship through ensuring transparent operation of the 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 recountable for their actions as individual 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 directors
score boards would supplement board self evaluation.
Separate the position of CEO and Chairman of the Board as is the practice in UK
and Canada.
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Corporate Governance when strictly followed / enforced would not allow the
payments to agencies with which a company has to deal with. While political
contributions are allowed extra legal payments are not allowed as payments. They can be
financed only by inflating expenditure or understanding receipts. But such practices
cannot be limited and the door would open wide for manipulation of accounts.
It is not just the integrity of the market that is at stake but the probity of the
nation. We rank high among corrupt nations. Let us reform corporate governance but by
doing so we have a much bigger job of limiting the insane greed that is eating away like
cancer the vitals of our nation.
Aspects of corporate governance that require attention are strengthening the
board, and reducing the sweeping powers of executive directors / fulltime directors
whose position undermines the balance of power between shareholders, directors and
managers, accountability of management and promoting shareholders participation.
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ROLE OF A DIRECTOR
Definition of Independent Director:
Report of the Committee on Audit and Corporate Governance (2003), has defined
Independent Director as a director:
Not receiving remuneration
Not related to promoters or management
Not an executive of the company in the last three years
Not a partner or executive in the Auditing firm
Not a significant supplier or vendor or customer
Not a shareholder owing 2% or more
Not been a director for more than three terms of three years each.
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Clause 49 of the listing agreement between the public limited company and the
stock exchange on which its shares are listed envisages a dominant role for Independent
Director by suggesting their inclusion in Audit committee, remuneration committee and
shareholders committee. In fact the committee on corporate governance (1999) had
recommended that atleast half of the board should be of independent members if the
Chairman is an executive and one third shall be independent directors, if the chairman is
a non executive member. Later the department of company affairs with effect from
16.01.2000 introduced an amendment in schedule XIII to the Companies Act wherein the
presence of Remuneration Committee has been made obligatory for a recommendation of
appointment and fixing of remuneration of managing and all time directors. Thus even
though the amendment act does not speak about the role of independent directors, clause
49 of the listing agreement and amendment of Schedule XIII has made it almost
obligatory to appoint independent directors for listed and public companies. Even under
section 292 A, it has been laid down that the composition of Audit committee shall
consist of Directors who shall not be managing or whole time directors. The inference is
inclusion of independent directors.
Prior to the Amendment Act, 2000 Independent directors were their only for the
purpose of quorum under section 207. This was the case in USA too.
Director or Independent Director: Non executive director is typically a powerful
business person in his own right whose wisdom is based on a clear understanding of
todays financial issues and a grasp of how to create shareholders value. Directors
experience and expertise influence for performance more than directors independence.
The modern non executive director frequently represents the larger shareholders within
the company. Outside directors signal their abilities through the effective monitoring of
management. They have greater incentives to make decisions that benefit shareholders
than do inside directors. Their decisions are signal to the labor market of their abilities as
decision control agents. Since they are major decision makers with other organizations
concerned for their reputation in the labor market provides them with incentives to act in
the interest of shareholders. Todays larger shareholders have shown that they wish to see
board decisions taken of which they fully approve. This is the global trend and has found
acceptance in India. SEBI also emphasis the importance of non executive, independent
directors by insisting upon committees of directors directly or indirectly to play a major
role in controlling the audit committee and remuneration committee, which consists of
only independent directors as Chairman and majority forming independent directors.
Given the requirement for greater risk management oversight by firms, empirical
evidence reveals a significant and positive relation between the quantity of interest rate,
derivatives used and the relative influence of outside directors. There is also evidence that
the corporate interest rate derivative use, on average, benefits shareholders. Independent
directors should be prepared to whistle blow or even resign where companies are not
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BIBLIOGRAPHY
en.wikipedia.org/wiki/Corporate_governance
www.cbr.cam.ac.uk/pdf/wp277.pdf
www.corpgov.net/
www.beyondgreypinstripes.org/pdf/CGReport.pdf
www.icmrindia.org/casestudies/Case_Studies.asp?cat=Corporate
%20Governance
searchfinancialsecurity.techtarget.com/sDefinition/0,,sid185_gci1174602,
00.html
news.mba4india.com/1762/definition-corporate-governance/
www.brainguide.in/corporate-governance-definition-aspekte-und-diefrage-nach-dem-nutzen-von-corporate-governance
www.scribd.com/doc/5034294/Corporate-Governancecadbury-report
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