M.COM.

(FINAL) SEMESTER IV

PAPER 4401: Corporate Governance, Ethics and

Social Responsibilities of Business
Lessons: 1-12

SCHOOL OF OPEN LEARNING

(CAMPUS OF OPEN LEARNING)
UNIVERSITY OF DELHI

Department of Commerce
Editor: Dr. K.L. Dahiya
 Postgraduate Course
PAPER 4401: Corporate Governance, Ethics and
Social Responsibilities of Business
Lessons: 1-12

Contents:
Lesson 1: Corporate Governance and Business Ethics
Lesson 2: Conceptual Framework of Corporate Governance
Lesson 3: Insider Trading and Crony Capitalism
Lesson 4: Shareholder‘s Activism
Lesson 5: The Secretarial Audit and Shareholder Meeting
Lesson 6: Corporate Governance: An International Perspective
Lesson 7: Corporate Management
Lesson 8: Role and Functions of Board Committees
Lesson 9: Major Corporate Failures
Lesson 10: Corporate Governance in PSUs/ Banks and other Enterprises
Lesson 11: Whistleblowing and Corporate Governance
Lesson 12: Corporate Social Responsibility (CSR)

Edited by: Written by:

Dr. K. L. Dahiya Dr. Rinku Mahindru
(Asstt. Professor,
Dept. of Commerce, DU)

SCHOOL OF OPEN LEARNING

(Campus of Open Learning)
University of Delhi
5, Cavalry Lane, Delhi – 110007
 LESSON 1
CORPORATE GOVERNANCE AND BUSINESS ETHICS

1 STRUCTURE

1.1. The Concept of Ethics

1.2. How Do Law And Ethics Differ
1.3. Business Values And Ethics
1.4. Concept of Business Ethics
1.5. Approaches to Business Ethics
1.6. Major Ethical Theories
1.7. Ethical Governance
1.8. Corporate Social Responsibility
1.9. The Concept Of Business/Corporate Ethics;
1.10. Benefits Of Adopting Ethics In Business
1.11. Ethics Programme;
1.12. Code Of Ethics
1.13. Ethics Committee
1.14. Self-Assessment Questions

1.1 THE CONCEPT OF ETHICS (Crowther & Seifi, 2018)

Ethics is not new for people in business. The corporate world has always had some rules,
standards and norms for doing business. However these are generally changing with some social
and cultural basis which can be different country by country, even though we might expect
universal rules. When the company applies these standards or norms as a part of its
responsibility we can call them an ethical code of conduct of business. Moreover ethics is also
inevitably a part of business responsibility. Corporate behaviour should be ethical and
responsible; that is why corporate promises for their shareholders and stakeholders have to
behave fair, ethical and equitable. And of course ethics is inevitably related to governance.
Ethics shows a corporation how to behave properly in all its business and operations. However,
business ethics is characterized by conflicts of interests. Businesses attempt to maximize profits
as a primary goal on one hand while they face issues of social responsibility and social service
on the other. Ethics is the set of rules prescribing what is good or evil, or what is right or wrong
for people. In other words, ethics is the values that form the basis of human relations, and the
quality and essence of being morally good or evil, or right or wrong. Business Ethics means
honesty, confidence, respect and fair acting in all circumstances. However, such values as
honesty, respect and confidence are rather general concepts without definite boundaries. Ethics
can also be defined as overall fundamental principles and practices for improving the level of
wellbeing of humanity.

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Ethics is the natural and structural process of acting in line with moral judgments, standards and
rules. Being a concrete and subjective concept, “business ethics” can be discussed with differing
approaches and in varying degrees of importance in different fields. Indeed, it is highly difficult
to define ethics and identify its limits and criteria. Accordingly, there are difficulties in
discussing this concept in literature as it is ubiquitous in business life, at the business level, and
in human life. According to what, how, how much and for whom ethics is or should be are
important questions. It is not always easy to find answers to these questions (Aras & Crowther
2008a).

A business which does not respect ethical criteria and fails to improve them will disrupt its
integrity and unity, i.e., its capacity to achieve its goal, and will lead to internal or external
conflicts. Business ethics is the honest, respectful and fair conduct by a business and its
representatives in all of its relations. A predicate question to the role of ethics in business is the
question of why businesses engage in ethical practices. Some authors, notably Milton Friedman
(1962), would strongly deny that a business has a responsibility to any group but the firm’s
shareholders.

To initiate corporate giving, for example, would be a fiduciary breach of management in

Friedman’s opinion: an agent for a principal is neither legally nor morally permitted to give
away or “waste” the principal’s capital (Joyner & Payne, 2002). Milton Friedman also argued
that ‘there is only one social responsibility of business – use its resources and engage in
activities designed to increase its profits so long as it ... engages in open and free competition
without deception and fraud’ (Friedman, 1962). However, ethical behaviour and ethical
business has effects not only on stakeholders, and shareholders but also on the entire economy.
We believe that when we act ethically in business decision-making process this will ensure
more effective and productive utilization of economic resources.

1.2 HOW DO LAW AND ETHICS DIFFER (Mayer, 2012)

There is a difference between legal compliance and moral excellence. Few would choose a
professional service, health care or otherwise, because the provider had a record of perfect legal
compliance, or always following the letter of the law. There are many professional ethics codes,
primarily because people realize that law prescribes only a minimum of morality and does not
provide purpose or goals that can mean excellent service to customers, clients, or patients.
Business ethicists have talked for years about the intersection of law and ethics. Simply put,
what is legal is not necessarily ethical. Conversely, what is ethical is not necessarily legal. There
are lots of legal maneuvers that are not all that ethical; the well-used phrase “legal loophole”
suggests as much.
Here are two propositions about business and ethics. Consider whether they strike you as true or
whether you would need to know more in order to make a judgment.

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Individuals and organizations have reputations. (For an individual, moral reputation is most
often tied to others’ perceptions of his or her character: is the individual honest, diligent,
reliable, fair, and caring?

The reputation of an organization is built on the goodwill that suppliers, customers, the
community, and employees feel toward it. Although an organization is not a person in the usual
sense, the goodwill that people feel about the organization is based on their perception of its
better qualities by a variety of stakeholders: customers or clients, suppliers, investors,
employees, government officials).

The goodwill of an organization is to a great extent based on the actions it takes and on whether
the actions are favorably viewed. (This goodwill is usually specifically counted in the sale of a
business as an asset that the buyer pays for. While it is difficult to place a monetary value on
goodwill, a firm’s good reputation will generally call for a higher evaluation in the final
accounting before the sale. Legal troubles or a reputation for having legal troubles will only
lessen the price for a business and will even lessen the value of the company’s stock as bad
legal news comes to the public’s attention.)

Another reason to think about ethics in connection with law is that the laws themselves are
meant to express some moral view. If there are legal prohibitions against cheating the Medicare
program, it is because people (legislators or their agents) have collectively decided that cheating
Medicare is wrong. If there are legal prohibitions against assisting someone to commit suicide,
it is because there has been a group decision that doing so is immoral. Thus the law provides
some important cues as to what society regards as right or wrong.

Finally, important policy issues that face society are often resolved through law, but it is
important to understand the moral perspectives that underlie public debate—as, for example, in
the continuing controversies over stem-cell research, medical use of marijuana, and abortion.
Some ethical perspectives focus on rights, some on social utility, some on virtue or character,
and some on social justice.

People consciously (or, more often, unconsciously) adopt one or more of these perspectives, and
even if they completely agree on the facts with an opponent, they will not change their views.

Fundamentally, the difference comes down to incompatible moral perspectives, a clash of basic
values. These are hot-button issues because society is divided, not so much over facts, but over
basic values. Understanding the varied moral perspectives and values in public policy debates is
a clarifying benefit in following or participating in these important discussions.

1.3 BUSINESS VALUES AND ETHICS (Warren, 2014)

How is Ethics to be applied in the Business Context?

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We will now examine the use of practical reason in the business context, and consider what the
connection is between ethics and business, and how ethical problems in business can be
analyzed.

First, can a corporation be held to be ethically responsible? Some commentators argue that only
people are ethically responsible and that a corporation is not a person and so is not a responsible
moral agent. Others argue that corporations are organizations that are recognized under the law
as legal persons and so can be treated as moral agents for the purposes of making them
accountable for the deeds and misdeeds committed in their name. Second, the question of
whether there is a corporate social responsibility is also the subject of debate. One of the early
denouncers of this notion, Milton Friedman, the economist, argued that the social responsibility
of business began and ended with the duty to increase profits, that it was the shareholders who
should then decide what their personal ethical stance was, and that this right should not be
subverted by management, nor should managers try to second guess the ethical preferences of
the shareholders (Friedman, 1970: Friedman 1999). This view is challenged by those who stress
that the separation of ownership from control in the corporation is an undeniable fact, and that
the accountability of the modern firm is increasingly tenuous in terms of shareholders and
nation states (Hutton, 1995). The corporation is a structure of enormous power in society, and
has responsibilities to its various stakeholders, which are dependent upon and subject to the
actions of the corporation (Bakan, 2004). Therefore, to maintain a social mandate, the managers
of the corporation need to be mindful of these responsibilities and act accordingly.

Business ethics is the study of the conduct of people in the business context and this raises the
question of whether this behaviour should be judged by the same standards of ethical behaviour
we apply to the rest of life. Some commentators claim that personal ethics are unrelated to
business ethics. But we should be careful that business ethics does not allow people to use the
cloak of corporate legal personality to avoid moral responsibility when doing business. Indeed if
business ethics becomes, as Peter Drucker puts it, a form of discredited excuse making, then it
will not last long and “it will have become a tool of the business executive to justify what for
other people would be unethical behaviour rather than a tool to restrain the business executive
and to impose tight ethical limits on business” (Drucker, 1981). Ethical conduct should be
consistent in all contexts and there is no fundamental separation between personal and business
ethics.

Ethical problems are part of business life. They are as old as business itself (arguments about a
fair price, a just wage and usury are found in the Bible and Koran); but today, they are more
complex, as business has expanded and become truly global. The Bhopal disaster, the Enron
fraud, the collapse of Barings Bank, the Parmalat fraud, and the most recent 2008 credit crunch
and banking collapse are all the stuff of current public concern over the morals of business.
Ethical issues are also part of everyday business life and ordinary transactions could not be
performed if certain moral norms did not prevail. For example, the making of contracts, whilst
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legally enforceable, depends for its efficacy upon the ethical behaviour of truth telling, keeping
promises and acting in good faith. In fact, it is impossible to think of an employment contract
purely as a legal contract, for it would be meaningless and quite useless as a contract unless it is
built upon a whole raft of moral and social norms which both parties leave unacknowledged in
the contract.

Any business issue that relates to human values is of interest to business ethics. The analysis of
such issues requires the use of ethical theories to investigate in a systematic way specific
business practices. The language, concepts and arguments of those facing ethical dilemmas in
business have to be examined and the moral choices identified. Of course, not all moral
dilemmas are resolvable, nor can ethical analysis make us agree about what to do; but at least
we can be clear about what we are doing when we act, what the contending viewpoints are and
how they are being justified.

Today, globalization is one of the main reasons why business ethics has become an important
topic in the international business schools. The firm doing business on a global basis faces many
difficult decisions about what to do in different countries: whether to follow the company’s
home country rules and customs, or whether to follow host country rules and local customs.
Ethical dilemmas and value contradictions arise frequently and students of business and
corporate managers need to exercise ethical reasoning and imagination.

1.4 CONCEPT OF BUSINESS ETHICS (Douglas R McKay, 2015)

The field of business ethics is not recently new but is relatively new. It arose in the 1970s and
slowly gained acceptance as an academic discipline and practice through the decades that
followed. Business ethics is temporal, that is to say that the guiding principles that arise through
study may vary over time. While some principles remain concrete, social norms may vary over
time, forcing once-acceptable practices into obsolescence. The environmental movement and
the recognition that we are destroying our planet may have changed the public’s perception of
fossil fuel consumption. When the automobile industry first arose, burning more gas to glean
more power was embraced, now efficiency and minimizing emissions is the more acceptable
standard. While some might believe that it is intuitively obvious that a corporation should be
ethically constrained to act within the norms of society, the pure advocates of unadulterated
capitalism don’t necessarily agree.

There are those who argue ethical constraints are unnecessary and harmful. They believe that
the progress of a corporation is impeded through constraint and, as such, the advancement of the
corporation toward its goals are restricted. The argument follows that society as a whole suffers
as progress – medical, technical or otherwise – is stunted. While this view may seem extreme,
the business literature suggests that is not entirely the case. In fact, in an international study in
2011 (1), only 30% to 80% of high management believed that a corporation had an obligation to
do well by society in addition to making shareholder’s more money.
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The areas of an organization potentially subject to ethical analysis are practically unlimited.
Human resources, contract negotiations, new business development, accounting and finance,
can all be subject to ethical analysis and constraint. What arises over time is a corporate culture
that falls under the umbrella of the values of the corporation. The corporation begins to adhere
to organization ethics but also can self-define an operating culture in alignment with society.
Business ethics is the study of proper business policies and practices regarding potentially
controversial issues such as corporate governance, insider trading, bribery, discrimination,
corporate social responsibility and fiduciary responsibilities. Law often guides business ethics,
while other times business ethics provide a basic framework that businesses may follow to gain
public acceptance.

Business ethics ensure that a certain required level of trust exists between consumers and
various forms of market participants with businesses. For example, a portfolio manager must
give the same consideration to the portfolios of family members and small individual investors.
Such practices ensure the public receives fair treatment.

The concept of business ethics arose in the 1960s as companies became more aware of a rising
consumer-based society that showed concerns regarding the environment, social causes and
corporate responsibility. Business ethics goes beyond just a moral code of right and wrong; it
attempts to reconcile what companies must do legally versus maintaining a competitive
advantage over other businesses.

Salient Features of Business Ethics (Investopedia, 2018)

• It is the ethical standards which regulate business persons in performing business

activities.
• It is both science and art.
• It relies on theological principles like good behaviour, sincerity, welfare of society and
so on.
• It is universally applicable.
• It is based on social customs existing in the environment.
• It is dynamic in nature and constantly test the norms and moral principles.

Business ethics is concerned with the attitude of the businessperson in conducting business, by
inculcating morality in his business. It propagates welfare of society, increases profitability,
improves productivity and foster business relationship.

• Need for Business Ethics

• Stop business malpractices
• Safeguarding consumer’s rights
• Gain confidence of customers
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 • Survival and growth of business
• Creating goodwill
• Healthy competition
• Consumer satisfaction.
• Building strong relationship with customers and clients

These are the set of principles and practices; that determine acceptable behaviour in the business
organization. It guides the managers and other executives in taking everyday business decisions.
It stresses on the impact of the business decision on the stakeholders, such as employees,
consumers, government, society, investors, shareholders and so on.

Elements of Business Ethics (BusinessJargons, 2018)

1. Formal Code of Conduct: Those organizations which undertake to inculcate ethical

conduct in the business organization establish and implement the code of conduct, for
their employees and members. These codes are the statement of organizational values.
2. Ethics Committee: There are many organizations, which create the ethics committee,
which is especially dedicated to maintaining ethics in the organization. Such committees
raise ethical concerns, develop and update the code of conduct, settle down ethical
dilemmas, in the organizations.
3. Ethical Communication: Another major component is the development of an effective
ethical communication system, which has a great role to play in making the ethics
programme successful. It tends to educate employees regarding the ethical standards and
norms of the organization.
4. Ethics Office: The next step is the setting up an ethics office, to communicate and enact
policies among various members of the organization.
5. Disciplinary System: A disciplinary system should be formed, so as to handle the
ethical contravention quickly and severely.
6. Ethics Training Programme: Another important aspect is the ethics training
programme, in which the employees of the organization undergo training, and learn
ethical norms of the company.
7. Monitoring: An ethical programme is considered successful and fruitful only when an
effective monitoring committee, is created which looks after various processes and
controls deviations.

The life of the business greatly depends on the ethics established and followed by the
businessman and unethical practices pose a threat to the survival and growth of the business.
Being ethical in business creates a positive reputation that opens various opportunities for profit.
Further, the techniques adopted to pursue business goals should also be pure, i.e. lawful,
because the objective of business cannot be attained if it employs unfair means.

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1.5 APPROACHES TO BUSINESS ETHICS (Crowther & Seifi, 2018)

One component of the change to a concern with social responsibility and accountability has
been the recognition (or reinstatement) of the importance of ethics in organizational activity and
behaviour. In part this can be considered to be recognition of the changing societal environment
of the present time and in part recognition of the problems brought about through corporate
activity taken without any account of ethical implications. Among such activity can be seen the
many examples of pollution (for example Union Carbide at Bhopal. India or the Exxon Valdiz
oil spill or BP in the Mexican Gulf) and greed such as the Enron incident. These have caused a
rethinking of the role of ethics in organization theory.

Ethics is however a problematical area as there is no absolute agreement as to what constitutes

ethical (or unethical) behaviour. For each of us there is a need to consider our own ethical
position as a starting point because that will affect our own view of ethical behaviour. The
opposition provided by deontological ethics and teleological ethics (regarding the link between
actions and outcomes) (see below), and by ethical relativism and ethical objectivism (regarding
the universality of a given set of ethical principles) represent key areas of debate and contention
in the philosophy of ethics. This provides a starting point for our consideration of ethics.

1. Deontological Ethics: According to deontologists certain actions are right or wrong in

themselves and so there are absolute ethical standards which need to be upheld. The
problems with this position are concerned with how we know which acts are wrong and
how we distinguish between a wrong act and an omission. Philosophers such as Nagel
argue that there is an underlying notion of right which constrains our actions, although
this might be overridden in certain circumstances. Thus, there may be an absolute moral
constraint against killing someone, which in time of war can be overridden.
2. Teleological Ethics: Teleological theory distinguishes between ‘the right’ and ‘the
good’, with ‘the right’ encompassing those actions which maximize ‘the good’. Thus it
is outcomes which determine what is right, rather than the inputs (i.e. our actions), in
terms of ethical standards. This is the viewpoint which is promoted by Rawls in his ‘A
Theory of Justice’. Under this perspective, one’s duty is to promote certain ends, and the
principles of right and wrong organize and direct our efforts towards these ends.
3. Utilitarianism: Utilitarianism is based upon the premise that outcomes are all that
matter in determining what is good and that the way in which a society achieves its
ultimate good is through each person pursuing his / her own self-interest. The
philosophy states that the aggregation of all these self-interests will automatically lead to
the maximum good for society at large. Some Utilitarian’s have amended this theory to
suggest that there is a role for government in mediating between these individual actions
to allow for the fact that some needs could best be met communally.
4. Ethical Relativism: Relativism is the denial that there are certain universal truths. Thus,
ethical relativism posits that there are no universally valid moral principles. Ethical
relativism may be further subdivided into: ‘conventionalism’, which argues that a given
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 set of ethics or moral principles are only valid within a given culture at a particular time;
and ‘subjectivism’, that sees individual choice as the key determinant of the validity of
moral principles.

According to the ‘conventional’ ethical relativism it is the mores and standards of a society
which define what is moral behaviour and ethical standards are set, not absolutely, but
according to the dictates of a given society at a given time. Thus if we conform to the standards
of our society then we are behaving ethically. We can see however that ethical standards change
over time within one society and vary from one society to another; thus the attitudes and
practices of the 19th century are different to our own as are the standards of other countries. A
further problem with this view of ethics is that of how we decide upon the societal ethics which
we seek to conform to. Thus there are the standards of society at large, the standards of our
chosen profession and the standards of the peer group to which we belong. For example, the
standards of society at large tend to be enshrined within the laws of that society. But how many
of us rigorously abide by the speed limits and traffic laws of our country?

Different grouping within society tend to have different moral standards of acceptable
behaviour and we have a tendency to behave differently at different times and when we are with
different groups of people. Equally when we travel to a foreign country we tend to take with us
the ethical standards of our own country rather than changing to the different standards of the
country which we are visiting. Thus it becomes very difficult to hold to a position of ethical
relativism because of the difficulty of determining the grouping to which we are seeking to
conform.

Ethical Objectivism: This philosophical position is in direct opposition to ethical relativism; it

asserts that although moral principles may differ between cultures, some moral principles have
universal validity whether or not they are universally recognized. There are two key variants of
ethical objectivism: ‘strong’ and ‘weak’. Strong ethical objectivism or ‘absolutism’ argues that
there is one true moral system. Weak ethical objectivism holds that there is a ‘core morality’ of
universally valid moral principles, but also accepts an indeterminate area where relativism is
accepted.

One can see that each of these theories of ethics is problematical and that there is no
overarching principle which determines either what is ethical or what is not. Nevertheless a
concern with ethics has been introduced explicitly into organization theory and strategy in
recent years. This has led to an increased interest in Corporate Social Responsibility.

1.6 MAJOR ETHICAL THEORIES ( The Legal Environment and Business Law, 2018)

There are several well-respected ways of looking at ethical issues. Some of them have been
around for centuries. It is important to know that many who think a lot about business and ethics
have deeply held beliefs about which perspective is best. Others would recommend considering
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ethical problems from a variety of different perspectives. Here, we take a brief look at (1)
utilitarianism, (2) deontology, (3) social justice and social contract theory, and (4) virtue theory.
We are leaving out some important perspectives, such as general theories of justice and “rights”
and feminist thought about ethics and patriarchy.

1. Utilitarianism: Utilitarianism is a prominent perspective on ethics, one that is well

aligned with economics and the free-market outlook that has come to dominate much
current thinking about business, management, and economics. Jeremy Bentham is often
considered the founder of utilitarianism, though John Stuart Mill (who wrote On Liberty
and Utilitarianism) and others promoted it as a guide to what is good. Utilitarianism
emphasizes not rules but results. An action (or set of actions) is generally deemed good
or right if it maximizes happiness or pleasure throughout society. Originally intended as
a guide for legislators charged with seeking the greatest good for society, the utilitarian
outlook may also be practiced individually and by corporations.

Bentham believed that the most promising way to obtain agreement on the best policies
for a society would be to look at the various policies a legislature could pass and
compare the good and bad consequences of each. The right course of action from an
ethical point of view would be to choose the policy that would produce the greatest
amount of utility, or usefulness. In brief, the utilitarian principle holds that an action is
right if and only if the sum of utilities produced by that action is greater than the sum of
utilities from any other possible act. Further following are some frequent mistakes that
people make in applying what they think are utilitarian principles in justifying their
chosen course of action:

• Failing to come up with lots of options that seem reasonable and then choosing the one
that has the greatest benefit for the greatest number. Often, a decision maker seizes on
one or two alternatives without thinking carefully about other courses of action. If the
alternative does more good than harm, the decision maker assumes it’s ethically okay.
• Assuming that the greatest good for you or your company is in fact the greatest good for
all—that is, looking at situations subjectively or with your own interests primarily in
mind.
• Underestimating the costs of a certain decision to you or your company. The now-classic
Ford Pinto case demonstrates how Ford Motor Company executives drastically
underestimated the legal costs of not correcting a feature on their Pinto models that they
knew could cause death or injury. General Motors was often taken to task by juries that
came to understand that the company would not recall or repair known and dangerous
defects because it seemed more profitable not to. In 2010, Toyota learned the same
lesson.
• Underestimating the cost or harm of a certain decision to someone else or some other
group of people.
• Favoring short-term benefits, even though the long-term costs are greater.
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• Assuming that all values can be reduced to money. In comparing the risks to human
health or safety against, say, the risks of job or profit losses, cost-benefit analyses will
often try to compare apples to oranges and put arbitrary numerical values on human
health and safety.

2. Rules and Duty: Deontology: In contrast to the utilitarian perspective, the deontological
view presented in the writings of Immanuel Kant purports that having a moral intent and
following the right rules is a better path to ethical conduct than achieving the right
results. A deontologist like Kant is likely to believe that ethical action arises from doing
one’s duty and that duties are defined by rational thought. Duties, according to Kant, are
not specific to particular kinds of human beings but are owed universally to all human
beings. Kant therefore uses “universalizing“ as a form of rational thought that assumes
the inherent equality of all human beings. It considers all humans as equal, not in the
physical, social, or economic sense, but equal before God, whether they are male,
female, Pygmy, Eskimoan, Islamic, Christian, gay, straight, healthy, sick, young, or old.

3. Social Justice Theory and Social Contract Theory: Social justice theorists worry
about “distributive justice”—that is, what is the fair way to distribute goods among a
group of people? Marxist thought emphasizes that members of society should be given
goods to according to their needs. But this redistribution would require a governing
power to decide who gets what and when. Capitalist thought takes a different approach,
rejecting any giving that is not voluntary. Certain economists, such as the late Milton
Friedman (see the sidebar in Section 2.4 "Corporations and Corporate Governance") also
reject the notion that a corporation has a duty to give to unmet needs in society,
believing that the government should play that role. Even the most dedicated free-
market capitalist will often admit the need for some government and some forms of
welfare—Social Security, Medicare, assistance to flood-stricken areas, help for AIDs
patients—along with some public goods (such as defense, education, highways, parks,
and support of key industries affecting national security).

People who do not see the need for public goods (including laws, court systems, and the
government goods and services just cited) often question why there needs to be a
government at all. One response might be, “Without government, there would be no
corporations.” Thomas Hobbes believed that people in a “state of nature” would
rationally choose to have some form of government. He called this the social contract,
where people give up certain rights to government in exchange for security and common
benefits. In your own lives and in this course, you will see an ongoing balancing act
between human desires for freedom and human desires for order; it is an ancient tension.
Some commentators also see a kind of social contract between corporations and society;
in exchange for perpetual duration and limited liability, the corporation has some
corresponding duties toward society. Also, if a corporation is legally a “person,” as the

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Supreme Court reaffirmed in 2010, then some would argue that if this corporate person
commits three felonies, it should be locked up for life and its corporate charter revoked!

Modern social contract theorists, such as Thomas Donaldson and Thomas Dunfee (Ties
that Bind, 1999), observe that various communities, not just nations, make rules for the
common good. Your college or school is a community, and there are communities
within the school (fraternities, sororities, the folks behind the counter at the circulation
desk, the people who work together at the university radio station, the sports teams, the
faculty, the students generally, the gay and lesbian alliance) that have rules, norms, or
standards that people can buy into or not. If not, they can exit from that community, just
as we are free (though not without cost) to reject US citizenship and take up residence in
another country. Donaldson and Dunfee’s integrative social contracts theory stresses the
importance of studying the rules of smaller communities along with the larger social
contracts made in states (such as Colorado or California) and nation-states (such as the
United States or Germany). Our Constitution can be seen as a fundamental social
contract.

It is important to realize that a social contract can be changed by the participants in a

community, just as the US Constitution can be amended. Social contract theory is thus
dynamic—it allows for structural and organic changes. Ideally, the social contract struck
by citizens and the government allows for certain fundamental rights such as those we
enjoy in the United States, but it need not. People can give up freedom-oriented rights
(such as the right of free speech or the right to be free of unreasonable searches and
seizures) to secure order (freedom from fear, freedom from terrorism). For example,
many citizens in Russia now miss the days when the Kremlin was all powerful; there
was less crime and more equality and predictability to life in the Soviet Union, even if
there was less freedom.

Thus the rights that people have—in positive law—come from whatever social contract
exists in the society. This view differs from that of the deontologists and that of the
natural-law thinkers such as Gandhi, Jesus, or Martin Luther King Jr., who believed that
rights come from God or, in less religious terms, from some transcendent moral order.
Another important movement in ethics and society is the communitarian outlook.
Communitarians emphasize that rights carry with them corresponding duties; that is,
there cannot be a right without a duty. Interested students may wish to explore the work
of Amitai Etzioni. Etzioni was a founder of the Communitarian Network, which is a
group of individuals who have come together to bolster the moral, social, and political
environment. It claims to be nonsectarian, nonpartisan, and international in scope.

The relationship between rights and duties—in both law and ethics—calls for some
explanations:

12
 • If you have a right of free expression, the government has a duty to respect that right
but can put reasonable limits on it. For example, you can legally say whatever you
want about the US president, but you can’t get away with threatening the president’s
life. Even if your criticisms are strong and insistent, you have the right (and our
government has the duty to protect your right) to speak freely. In Singapore during
the 1990s, even indirect criticisms—mere hints—of the political leadership were
enough to land you in jail or at least silence you with a libel suit.
• Rights and duties exist not only between people and their governments but also
between individuals. Your right to be free from physical assault is protected by the
law in most states, and when someone walks up to you and punches you in the nose,
your rights—as set forth in the positive law of your state—have been violated. Thus
other people have a duty to respect your rights and to not punch you in the nose.
• Your right in legal terms is only as good as your society’s willingness to provide
legal remedies through the courts and political institutions of society.
A distinction between basic rights and non-basic rights may also be important. Basic
rights may include such fundamental elements as food, water, shelter, and physical
safety. Another distinction is between positive rights (the right to bear arms, the right to
vote, the right of privacy) and negative rights (the right to be free from unreasonable
searches and seizures, the right to be free of cruel or unusual punishments). Yet another
is between economic or social rights (adequate food, work, and environment) and
political or civic rights (the right to vote, the right to equal protection of the laws, the
right to due process).

4. Aristotle and Virtue Theory: Virtue theory, or virtue ethics, has received increasing
attention over the past twenty years, particularly in contrast to utilitarian and
deontological approaches to ethics. Virtue theory emphasizes the value of virtuous
qualities rather than formal rules or useful results. Aristotle is often recognized as the
first philosopher to advocate the ethical value of certain qualities, or virtues, in a
person’s character. As LaRue Hosmer has noted, Aristotle saw the goal of human
existence as the active, rational search for excellence, and excellence requires the
personal virtues of honesty, truthfulness, courage, temperance, generosity, and high-
mindedness. This pursuit is also termed “knowledge of the good” in Greek
philosophy.LaRue Tone Hosmer, Moral Leadership in Business (Chicago: Irwin
Professional Publishing, 1994), Aristotle believed that all activity was aimed at some
goal or perceived good and that there must be some ranking that we do among those
goals or goods. Happiness may be our ultimate goal, but what does that mean, exactly?
Aristotle rejected wealth, pleasure, and fame and embraced reason as the distinguishing
feature of humans, as opposed to other species. And since a human is a reasoning
animal, happiness must be associated with reason. Thus happiness is living according to
the active (rather than passive) use of reason. The use of reason leads to excellence, and
so happiness can be defined as the active, rational pursuit of personal excellence, or
virtue.
13
 Aristotle named fourteen virtues: (1) courage, particularly in battle; (2) temperance, or
moderation in eating and drinking; (3) liberality, or spending money well; (4)
magnificence, or living well; (5) pride, or taking pleasure in accomplishments and
stature; (6) high-mindedness, or concern with the noble rather than the petty; (7)
unnamed virtue, which is halfway between ambition and total lack of effort; (8)
gentleness, or concern for others; (9) truthfulness; (10) wit, or pleasure in group
discussions; (11) friendliness, or pleasure in personal conduct; (12) modesty, or pleasure
in personal conduct; (13) righteous indignation, or getting angry at the right things and
in the right amounts; and (14) justice.

From a modern perspective, some of these virtues seem old-fashioned or even odd.
Magnificence, for example, is not something we commonly speak of. Three issues
emerge: (1) How do we know what a virtue is these days? (2) How useful is a list of
agreed-upon virtues anyway? (3) What do virtues have to do with companies,
particularly large ones where various groups and individuals may have little or no
contact with other parts of the organization?

As to the third question, whether corporations can “have” virtues or values is a matter of
lively debate. A corporation is obviously not the same as an individual. But there seems
to be growing agreement that organizations do differ in their practices and that these
practices are value driven. If all a company cares about is the bottom line, other values
will diminish or disappear. Quite a few books have been written in the past twenty years
that emphasize the need for businesses to define their values in order to be competitive
in today’s global economy. James O’Toole and Don Mayer, eds., Good Business:
Exercising Effective and Ethical Leadership (London: Routledge, 2010).

1.7 ETHICAL GOVERNANCE (Civil Services India, 2018)

Ethics is vital part of corporate governance, and administration must reflect accountability for
their actions on a global community scale. Ethical governance in business is more than
'regulatory compliance'. It is not rule-based but value-based. Human values are ingrained in
virtues which, being difficult to measure, quantify and monitor. 'Principle-centred' corporate
guidelines are encouraged to replace 'rule-based' ones. Values are learnt from childhood, not
taught, from various contacts a person experiences, stories and situations. Morals are, many a
time not explicitly articulated, but implicitly conveyed. Ethics should govern 'corporate
governance' every action in business. A Research Report (2006) by CFO Asia prepared in
collaboration with ACCA titled "Corporate Governance, Business Ethics & the CEO states as
follows: "It is harder to establish a connection between codified ethics and practical actions than
to track compliance on governance or accounting systems. But ethics can be reasonably seen as
an intangible, yet powerful, catalyst and supporter of compliance. Put another way, it is not
possible to legislate for ethical behaviour."

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For factual 'ethical governance', the person in the business world involved in any action has to
absorb himself a commitment i.e. a strong conviction that 'social good' is more important than
'individual good'. It has to come from 'within'. Whether it is awareness or knowledge, it should
create true transformation 'within' for the 'ethical' behaviour to happen always on every occasion
as a natural instinct. Performance consequence reflecting true 'ethical governance' comes neither
from those who do it with 'I am sacrificing' attitude nor from those who do with 'I do sacrifice
for the world to know' attitude. This is major difference between 'ethical governance' and other
forms of 'governance' including activities of CSR and Charities. The regulatory mechanism can
only provide a favourable environment for this to happen. Punitive environment cannot create
'transformation' for ethical governance; it can only guarantee 'compliance' approach.

To ensure ethical governance, an organization has to develop effective system to address

featuring commercial realities, challenging administrative processes and difficult technical facts.
This would essentially require, among other things, a well-designed and structured training
mechanism which is different from all other types of corporate or industrial training.

Ethical Governance offers people array of great opportunity to differentiate from the
competition in the market to add value. A corporation which is known to be secure and run on
moral principles will be more trusted by customers, shareholders and investors, and it will be
more efficacious than those less ethical companies. Briefly, by operating with a social
conscience, the ethical leader does not just build confidence and loyalty with staff, but builds
goodwill in the market, community and society at large. Ethical Leadership is not without its
challenges. For instance, ethics are often highly personal. Nor can Ethical Management be
instilled in an organization or corporation overnight. Ethical Governance requires habit, and it
requires proper regulations. Education and communication must be further enhanced, Ethical
issues must find and gain support in the work place and also in the society, and finally there
must be proper motivation and recognitions given for those wishing to follow Morals. It is well
understood that accountability and ethics are strongly related. Effective accountability assists
the accomplishment of ethical standards in the governance system. Legislative or parliamentary
control through questions, debates and committees provide ample opportunity to the people’s
representatives to raise, among other things, issues of ethics and morality in the governance
system. More particularly, the Public Accounts Committee in India, which gives its comments
on the report of the Comptroller and Auditor General of India in its reports, raises matters that
directly or indirectly relate to ethics and good governance. Reports have indicated that a well-
functioning civil service aids to foster good policy making, effective service delivery,
accountability and responsibility in utilizing public resources which are the features of good
governance. “Good Governance” is being used as a comprehensive framework not only for
administrative and civil service reform but as a link between Civil Service Reform and an all-
embracing framework for making policy decisions effective within viable systems of
accountability and citizen participation.

15
It can be summarized that Ethics is the base of every business firm. Top managers are
undoubtedly the protectors of values of the firm. But individual and corporate values drive
behaviour. Collective human behaviour describes the organizational culture. Ethics should
oversee business. Ethical standards assist to make it happen. Management control systems
including various practices such as management audit, operational audit and cost audit can be
made more operative if such practices can widen scope beyond 'compliance oriented' approach.
Ethical governance is a continuing focus, starting with the Board and extending to all workers.
With transparency and unwavering ethics, people will seek to earn the trust of those they partner
with, forge lasting service relationships and strengthen business over the long term.

1.8 CORPORATE SOCIAL RESPONSIBILTY (CSR) (Investopedia, 2016)

Corporate social responsibility (CSR) is a self-regulating business model that helps a company
be socially accountable — to itself, its stakeholders, and the public. By practicing corporate
social responsibility, also called corporate citizenship, companies can be conscious of the kind
of impact they are having on all aspects of society including economic, social, and
environmental. To engage in CSR means that, in the normal course of business, a company is
operating in ways that enhances society and the environment, instead of contributing negatively
to it.

Corporate social responsibility is a broad concept that can take many forms depending on the
company and industry. Through CSR programs, philanthropy, and volunteer efforts, businesses
can benefit society while boosting their own brands. As important as CSR is for the community,
it is equally valuable for a company. CSR activities can help forge a stronger bond between
employee and corporation; they can boost morale and can help both employees and employers
feel more connected with the world around them.

In order for a company to be socially responsible, it first needs to be responsible to itself and its
shareholders. Often, companies that adopt CSR programs have grown their business to the point
where they can give back to society. Thus, CSR is primarily a strategy of large corporations.
Also, the more visible and successful a corporation is, the more responsibility it has to set
standards of ethical behavior for its peers, competition, and industry.

CSR Benefits to Organizations (Double the Donation, 2018)

1. Improve Public Image: Corporations can improve their public image by supporting
nonprofits through monetary donations, volunteerism, in-kind donations of products and
services, and strong partnerships.
2. Increases Media Coverage: Make sure you’re forming relationships with local media
outlets so they’ll be more likely to cover the stories you offer them. On the other hand, if
a corporation participates in production or activities that bring upon negative community

16
 impacts, the media will also pick this up. Unfortunately, bad news spreads quicker than
good news.
3. Boosts Employee Engagement: When companies show that they are dedicated to
improving their communities through corporate giving programs (like matching gifts
and volunteer grants!), they are more likely to attract and retain valuable, hardworking,
and engaged employees
4. Attracts & Retains Investors: When companies donate money to nonprofit
organizations and encourage their employees to volunteer their time, they demonstrate to
investors that they don’t just care about profits.

CSR Benefits to Non-Profit Organizations (Double the Donation, 2018)

1. Funding Via Matching Gift Programs: Corporations that offer matching gift programs
essentially double the donations that their employees are giving to eligible nonprofits
2. More Volunteer Participation: Employees of corporations are seen volunteering and
donating their time to important causes in the community, and nonprofits are receiving
free time and volunteer work, which are essential for the success of so many nonprofits.
3. Forging Corporate Partnerships: For a nonprofit organization, a partnership with a
local or national corporation puts its name on tons of marketing materials that otherwise
could not have been afforded on tight budgets. A key benefit is that the partnership
brings additional awareness to the nonprofit’s cause.
4. Varied Sources of Revenue: Companies with strong corporate social responsibility
programs are looking for nonprofits to be the recipient of grants, matching gift
programs, and volunteer grant programs.

CSR Benefits for Employees (Double the Donation, 2018)

1. Positive Workplace Environment: Business environments are more enjoyable when

companies engage in corporate social responsibility.
2. Increase in Creativity: Companies that maximize their social responsibility potential
foster innovative and creative employees.
3. Encourages Professional & Personal Growth: Employees are able to professionally
and personally develop as a result of corporate social responsibility.
4. Promotes Individual Philanthropy: Employees become more philanthropically aware
when they work for companies that are socially responsible.

Models of CSR (Petryni, 2017)

Corporate social responsibility is the commitment a company has to the community outside of
its shareholders and employees. The subject isn't without controversy, with some claiming
corporations have no role in social responsibility and others asserting that they can't escape it.
Business researcher Elizabeth Redman proposed the three models of corporate social
17
responsibility as a way of understanding this often contentious conversation. In her work on
corporate social responsibility, published in the Roosevelt Review, Redman contends that the
discussion often involves one of three conceptual models for CSR: a conflict model, an added
value model and a multiple goals model.

1. Traditional Conflict Model: In the traditional conflict model for corporate social
responsibility, social values and benefits are seen as in conflict with shareholder profits.
Under this model, corporations opting to practice forms of social responsibility are
likely to see added costs for doing so. Proponents of this conceptual model generally
argue that the nature of business is one of trade-offs between economic and moral
values, and corporate managers will inevitably be forced to decide between their social
and fiduciary responsibilities or their commitment to shareholder equity value.
2. Added Value Model: A second model for conceptualizing corporate social
responsibility is to see social and environmental commitments as a means to increase
profit. While proponents of this model tend to acknowledge that conflicts persist in
business decisions, they also believe that CSR investments are also capable of
generating new revenues. This model tends to focus on issues like the value of CSR in
attracting socially conscious consumers, finding socially conscious employees and
managing the risks of negative press.
3. Multiple Goals Model: Finally, a third model for corporate social responsibility posits a
role for social values in corporate decisions that are untethered to economic values.
Under this model, corporations have goals beyond shareholder value, including the
enhancement of their community without respect to monetary gain. According to
Redman, this model is thought to be relatively radical, though some corporate officers
have expressed support for it. Proponents of this model emphasize quality of life as the
basis of economic activity.

1.9 CONCEPT OF BUSINESS/CORPORATE ETHICS (Business Ethics, 2018)

‘Business Ethics’ also known as ‘Corporate Ethics’ is the study of proper business policies
and practices regarding potentially controversial issues such as corporate governance, insider
trading, bribery, discrimination, corporate social responsibility and fiduciary responsibilities.
Law often guides business ethics, while other times business ethics provide a basic framework
that businesses may follow to gain public acceptance.

Business ethics ensure that a certain required level of trust exists between consumers and
various forms of market participants with businesses. For example, a portfolio manager must
give the same consideration to the portfolios of family members and small individual investors.
Such practices ensure the public receives fair treatment.

The concept of business ethics arose in the 1960s as companies became more aware of a rising
consumer-based society that showed concerns regarding the environment, social causes and
18
corporate responsibility. Business ethics goes beyond just a moral code of right and wrong; it
attempts to reconcile what companies must do legally versus maintaining a competitive
advantage over other businesses. Firms display business ethics in several ways.

1.10 BENEFITS OF ADOPTING ETHICS IN BUSINESS

The importance of business ethics reaches far beyond employee loyalty and morale or the
strength of a management team bond. As with all business initiatives, the ethical operation of a
company is directly related to profitability in both the short and long term. The reputation of a
business in the surrounding community, other businesses and individual investors is paramount
in determining whether a company is a worthwhile investment. If a company is perceived to not
operate ethically, investors are less inclined to buy stock or otherwise support its operations.
Companies have more and more of an incentive to be ethical as the area of socially responsible
and ethical investing keeps growing. The increasing number of investors seeking out ethically
operating companies to invest in is driving more firms to take this issue more seriously. With
consistent ethical behavior comes an increasingly positive public image, and there are few other
considerations as important to potential investors and current shareholders. To retain a positive
image, businesses must be committed to operating on an ethical foundation as it relates to
treatment of employees, respecting the surrounding environment and fair market practices in
terms of price and consumer treatment. (Importance of Business Ethics, 2018)

Following are list of benefits and advantages of adopting ethics in Business: (Powers, 2015)

1. A Focus on Business Ethics Has Substantially Improved Society and Working

Conditions: If it wasn’t for ethical standards being set, children would still be working
in factories; 16-hour work days would be the norm; and discrimination, abuse, and
unfair labor practices would still be part of doing business. What’s important to
recognize is that change is happening and new standards are now being set. This is good
for all of us.
2. Having a Code of Ethics Provides a Morale Compass during Tough Times: By
having a code of ethics, it provides you a tool to make consistent decisions about what is
right and wrong. This is especially helpful when making decisions in times of conflict.
3. Ethics in the Workplace Support Employee Growth and Provide Meaning to the
Work They Do: By running an ethical operation, employees feel like they are
contributing to society in a positive way. This sense of accountability provides meaning
and context to what they do on a daily basis.
4. Ethics Programs Can Align with Personal Values and Improve Performance: If
clear ethics are consistently communicated in your organization and discussions take
place on how they align with personal values, it can develop motivation and
collaboration in your organization. Employees that feel strong alignment with their
personal values and the ethics of an organization react with strong commitment and
performance.
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 5. Clear Business Ethics Can Promote a Strong Public Image and Goodwill: Aligning
behaviors with values is important in developing a positive image for your business.
Today’s savvy consumer is doing more research and watching more closely how
businesses conduct themselves and if they truly “walk the talk.” Consistently applying
ethical values to everyday business decisions is the foundation to building a truly
successful and socially responsible business.

1.11 ETHICS PROGRAMME (The Business Ethics Program, 2018)

A business ethics program helps owners and managers improve their business performance,
make profits, and contribute to the economic progress of their communities by meeting the
reasonable expectations of their stakeholders. A business ethics program also aims to achieve
specific expected program outcomes, such as increasing awareness of ethics issues, improving
decision-making, and reducing misconduct.

To be effective over time, a business ethics program must be a formal plan, because it touches
on all aspects of the enterprise—operations, human resources, communications, and marketing
to name but a few. Formally planning a business ethics program ensures that owners and
managers give due consideration to the enterprise’s relevant context, organizational culture, and
reasonable stakeholder expectations.

Owners and managers should define and communicate the purpose of the business ethics
program as early as possible. Responsible management recognizes that an effective business
ethics program touches every decision and activity of the enterprise. It guides patterns of
thought, choice, and action that subtly shape the organizational culture of the enterprise. The
business ethics program should be based on the core beliefs of the enterprise and should reflect
an approach or orientation that will resonate with employees and other stakeholders.

A well-designed and implemented business ethics program provides enterprise employees and
agents with the guidance and information they need for effective, efficient, and responsible
choices and actions. An effective program contains the following nine structural components:

1. Standards and procedures to guide member behavior and foster reasonable stakeholder
expectations
2. Adequate structures and systems that provide for authority, responsibility,
accountability, and sustainability
3. Communication of standards, procedures, and expectations to the enterprise’s members
4. Programs that monitor and audit member conduct
5. Encouragement of members to seek advice and report concerns
6. Due diligence in hiring, especially for sensitive positions in, for example, management,
finance, and contracting
7. Encouragement of members to follow standards and procedures
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 8. Appropriate responses when standards and procedures are violated
9. Regular evaluations of program effectiveness

1.12 CODE OF ETHICS (Investopedia, 2018)

A code of ethics is a guide of principles designed to help professionals conduct business

honestly and with integrity. A code of ethics document may outline the mission and values of
the business or organization, how professionals are supposed to approach problems, the ethical
principles based on the organization's core values and the standards to which the professional is
held. A code of ethics, also referred to as an "ethical code," may encompass areas such as
business ethics, a code of professional practice and an employee code of conduct. Both
businesses and trade organizations typically have some sort of code of ethics that its employees
or members are supposed to follow. Breaking the code of ethics can result in termination or
dismissal from the organization. A code of ethics is important because it clearly lays out the
rules for behavior and provides the groundwork for a preemptive warning. Regardless of size,
businesses count on their management staff to set a standard of ethical conduct for other
employees to follow. When administrators adhere to the code of ethics, it sends a message that
universal compliance is expected of every employee. Following are the various types of Code of
Ethics:

1. Compliance-Based Code of Ethics: For all businesses, laws regulate issues such as
hiring and safety standards. Compliance-based codes of ethics not only set guidelines for
conduct, but also determine penalties for violations. In some industries, including
banking, specific laws govern business conduct. These industries formulate compliance-
based codes of ethics to enforce laws and regulations. Employees usually undergo
formal training to learn the rules of conduct. Because noncompliance can create legal
issues for the company as a whole, individual workers within a firm may face penalties
for failing to follow guidelines. To ensure that the aims and principles of the code of
ethics are followed, some companies appoint a compliance officer. This individual is
tasked with keeping up to date on changes in regulation codes and monitoring employee
conduct to encourage conformity. This type of code of ethics is based on clear-cut rules
and well defined consequences rather than individual monitoring of personal behavior.
Therefore, despite strict adherence to the law, some compliance-based codes of conduct
do not promote a climate of moral responsibility within the company.
2. Value-Based Code of Ethics: A value-based code of ethics addresses a company's core
value system. It may outline standards of responsible conduct as they relate to the larger
public good and the environment. Value-based ethical codes may require a greater
degree of self-regulation than compliance-based codes. Some codes of conduct contain
language that addresses both compliance and values. For example, a grocery store chain
might create a code of conduct that espouses the company's commitment to health and
safety regulations above financial gain. That grocery chain might also include a

21
 statement about refusing to contract with suppliers that feed hormones to livestock or
raise animals in inhumane living conditions.
3. Code of Ethics among Professionals: Financial advisers registered with the Securities
and Exchange Commission or a state regulator is bound by a code of ethics known as
fiduciary duty. This is a legal requirement and also a code of loyalty that requires them
to act in the best interest of their clients. Certified Public Accountants, who are not
typically considered to be a fiduciary to their clients, still are expected to follow similar
ethical standards, such as integrity, objectivity, truthfulness and avoidance of conflicts of
interest, according the American Institute of Certified Public Accountants (AICPA).

1.13 ETHICS COMMITTEE (Ray, 2017)

Board of Directors of companies is increasingly concerned with the need to ensure the ethical
behaviour of companies and its managers. A board sub-committee responsible for overseeing
the effectiveness of the business ethics and ethical code is one way that boards can monitor the
companies. The establishment of a high level ethical committee as sub-committee of the board
whether standing alone or with an existing board committee is good corporate governance
practice. Through regular deliberations on contentious issues, monitoring and reports, the ethics
committee raises board awareness of ethical values and issues, and indicates to the managers
that values and ethics are the top priority at the top. The committee addresses ethics matters and
is able to establish an ethical culture throughout the company. Companies have different names
for Ethics Committee: Corporate Responsibility Committee, Compliance Committee, CSR
Committee, Business Principles Committee etc.

Role of Ethics Committee: (Ray, 2017)

A variety of organizations create ethics committees to oversee compliance with the rules of
conduct, standards and policies that guide the company. Committees typically are made up of
executives from various departments and an outside third-party consultant who chairs the
committee. An ethics committee can serve a number of roles consisting of a range of
responsibilities, but most follow a basic premise.

1. Conflict Resolution All the Way Around: Members of an ethics committee often get
involved in setting up the initial guidelines and policies for behavior within an
organization. The impetus for new or revised rules may start with a conflict. The
problems may arise from conflicts between management and front-line staff or between
customers and the company. The ethics committee then creates guidelines for various
circumstances and may step in as the arbiter of conflicts and find solutions that then can
be integrated into company policies.
2. Oversee Compliance to Company Standards: Businesses thrive in an atmosphere of
accountability. When each department, manager and employee works with the best
interests of the company in mind, success is more likely. Standards for patient care in a
22
 hospital, for example, are set for customer service to increase referrals. The ethics
committee oversees the results of customer service efforts to ensure employees follow
the parameters of the process in how they treat patients. Manufacturers may rely on an
ethics committee to oversee government or trade compliance issues to ensure the
company’s profitability.
3. Conduct Reviews and Deliver Discipline: It’s often left to the ethics committee
members to dole out discipline when an employee violates company ethics rules. At the
very least, it’s the ethics committee that oversees disciplinary actions taken by managers
to ensure they are distributed equally and fairly. Ethics committee members review
disciplinary actions and make recommendations to managers about how to effectively
handle employee problems. They also ensure managers comply with all legal
requirements when enforcing company policies.
4. Review Company Ethics Policies and Recommend Changes: While the ethics
committee may create the initial set of rules and regulations to govern company ethics, it
also reviews those policies on a regular basis and refines them when necessary. The
committee may get input from employees through surveys, employee hotlines and
questionnaires. The member use situations and circumstances to create learning
experiences from which they can determine other appropriate actions. Finally, their role
is to effectively communicate company ethics policies to the entire company.

1.14 SELF ASSESSMENT QUESTIONS

True and false Questions:

Indicate whether the following statements are true or false:

a) Ethical decision making in business is limited to major corporate decisions with

dramatic social consequences
b) The direct costs of unethical business practice are more visible today than they have ever
been before.
c) A firm’s ethical reputation can provide a competitive advantage in the marketplace with
customers suppliers and employees.
d) Ethics refers to how human beings should properly live their lives.
e) Ethical business leadership is the skill to create circumstances in which bad people are
taught to do well.

Answers: a (F), b (T), c (T), d (T), e (F)

Long Answer Questions

Q1. Distinguish between Corporate Governance, Business Ethics and CSR?

Q2. What is meant by Business Ethics? Describe its nature. Is business ethics a necessity?
23
 LESSON 2
CONCEPTUAL FRAMEWORK OF CORPORATE
GOVERNANCE

1 STRUCTURE

2.1 Concept of Corporate Governance

2.2 Evolution of Corporate Governance in India
2.3 Regulatory framework of Corporate Governance in India
2.4 Clause 49 of SEBI Guidelines on Corporate Governance
2.5 SEBI Guidelines on Corporate Governance
2.6 Reforms in Companies Act, 2013
2.7 Role of Comptroller And Auditor General (CAG) Of India
2.8 National Company Law Tribunal (NCLT)
2.9 OECD Principles
2.10 Self-Assessment Questions

2.1 CONCEPT OF CORPORATE GOVERNANCE

The principles of good governance are as old as good behavior, which needs no formal
definition. However, in reference to corporate world, it has been defined by various persons,
some of whom is described below just in order to satisfy that the vital details and spirit of the
term are not missed. Sir Adrian Cadbury Committee, which looked into corporate governance
issues in U.K. defines Corporate Governance “as the system by which the companies are
directed and controlled. The basic objective of corporate governance is to enhance and
maximize shareholder value and protect the interest of other stake holders”. According to World
Bank, Corporate Governance is Blend of law, regulation and appropriate voluntary private
sector practices,

• Which enables the corporation to attract financial and human capital to perform efficiently,
and
• Prepare itself by generating long term economic value for its shareholders,
• While respecting the interests of stakeholders and society as a whole

The Kumar Mangalam Birla Committee constituted by SEBI has observed that "Strong
corporate governance is indispensable to resilient and vibrant capital markets and is an
important instrument of investor protection. It is the blood that fills the veins of transparent
corporate disclosure and high quality accounting practices. It is the muscle that moves a viable
and accessible financial reporting structure”

24
N.R. Narayana Murthy Committee on Corporate Governance constituted by SEBI has observed
"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 is about commitment to values, about ethical business conduct and about
making a distinction between personal and corporate funds in the management of a company."
The Institute of Company Secretaries of India has also defined the term Corporate Governance
as under:

"Corporate Governance is the application of best management practices, compliance or jaw in

true letter and spirit and adherence to ethical standards for effective management and
distribution of wealth and discharge of social responsibility for sustainable development of all
stakeholders."

Another comprehensive definition given in the report on corporate governance that was
accepted for implementation by the Singapore Government is that the term refers to the
“process and structure by which the business and affairs of the company are directed and
managed in order to enhance long term shareholder value through enhancing corporate
performance and accountability, whilst taking into account the interests of other stakeholders”.
Thus in order to get a fair view on the subject we may summarize the Corporate Governance in
a narrow and broad definition. In the narrow sense, corporate governance involves a set of
relationship amongst the company’s management, its board of directors, its shareholders, its
auditors and other stakeholders. These relationships, which involve various rules and incentives,
provide the structure through which the objectives of the company are set, and the means of
attaining these objectives as well as monitoring performance are determined. Thus, the key
aspects of good corporate governance include transparency of corporate structures and
operations; the accountability of managers and the boards to shareholders; and corporate
responsibility towards stakeholders. While corporate governance essentially lays down the
framework for creating long-term trust between companies and the external providers of capital,
it would be wrong to think that the importance of corporate governance lies solely in better
access of finance.

Companies around the world are realizing that better corporate governance adds considerable
value to their operational performance in the following ways:

• It improves strategic thinking at the top by inducting independent directors who bring a
wealth of experience, and a host of new ideas
• It rationalizes the management and monitoring of risk that a firm faces globally
• It limits the liability of top management and directors, by carefully articulating the decision
making process
• It assures the integrity of financial reports
• It has long term reputational effects among key stakeholders, both internally and externally

25
In a broader sense, however, good corporate governance- the extent to which companies are run
in an open and honest manner- is important for overall market confidence, the efficiency of
capital allocation, the growth and development of countries’ industrial bases, and ultimately the
nations’ overall wealth and welfare. It is important to note that in both the narrow as well as in
the broad definitions, the concepts of disclosure and transparency occupy center-stage. In the
first instance, they create trust at the firm level among the suppliers of finance. In the second
instance, they create overall confidence at the aggregate economy level. In both cases, they
result in efficient allocation of capital.

Elements of Good Corporate Governance (Regional Training Institute, Allahabad, 2018)

Good governance is decisively the manifestation of personal beliefs and values, which
configure the organizational values, beliefs and actions of its Board. The Board as a main
functionary is primary responsible to ensure value creation for its stakeholders. The absence of
clearly designated role and powers of Board weakens accountability mechanism and threatens
the achievement of organizational goals. Therefore, the foremost requirement of good
governance is the' clear identification of powers, roles, responsibilities and accountability of the
Board, CEO, and the Chairman of the Board. The role of the Board should be clearly
documented in a Board Charter. To sub-serve the above discussion, the following are the
essential elements of good corporate governance:

• Transparency in Board’s processes and independence in the functioning of Boards. The

Board should provide effective leadership to the company and management for achieving
sustained prosperity for all stakeholders. It should provide independent judgment for
achieving company's objectives.
• Accountability to stakeholders with a view to serve the stakeholders and account to them at
regular intervals for actions taken, through strong and sustained communication processes.
• Fairness to all stakeholders.
• Social, regulatory and environmental concerns
• Clear and unambiguous legislation and regulations are fundamentals to effective corporate
governance.
• A healthy management environment that includes setting up of clear objectives and
appropriate ethical framework, establishing due processes, clear enunciation of
responsibility and accountability, sound business planning, establishing clear boundaries for
acceptable behavior, establishing performance evaluation measures.
• Explicitly prescribed norms of ethical practices and code of conduct are communicated to all
the stakeholders, which should be clearly understood and followed by each member of the
organization.
• The objectives of the company must be clearly documented in a long-term corporate
strategy including an annual business plan together with achievable and measurable
performance targets and milestones.

26
• A well composed Audit Committee to work as liaison with the management, internal and
statutory auditors, reviewing the adequacy of internal control and compliance with
significant policies and procedures, reporting to the Board on the key issues.
• Risk is an important element of corporate functioning and governance, which should be
clearly identified, analyzed for taking appropriate remedial measures. For this purpose the
Board should formulate a mechanism for periodic reviews of internal and external risks.
• A clear Whistle Blower Policy whereby the employees may without fear report to the
management about unethical behaviour, actual or suspected frauds or violation of
company’s code of conduct. There should be some mechanism for adequate safeguard to
employees against victimization that serves as whistleblowers.

Need for Corporate Governance in India (Prathiksharavi, 2018)

In the last decade, corporate fraud and governance failure is occurring frequently which is why
we require good corporate governance in the country. India provides proper norms and laws
aligned with international requirements to govern a corporate. Some of the important reasons
are discussed below which raised the need for corporate governance in India.

1. A corporate has a lot of shareholders with different attitudes towards corporate affairs,
corporate governance protects the shareholder democracy by implementing it through its
code of conduct.
2. Large corporate investors are becoming a challenge to the management of the company
because they are influencing the decision of the company. Corporate governance set the
code to deal with such situations.
3. Corporate governance is necessary to build public confidence in the corporation which
was shaken due to numerous corporate fraud in recent years. It is important for reviving
the confidence of investors.
4. Society having greater expectations from corporate, they expect that corporates take care
of the environment, pollution, quality of goods and services, sustainable development
etc. code to conduct corporate is important to fulfil all these expectations. Takeovers of
the corporate entity created lots of problems in the past. It affects the right of various
stakeholders in the company. This factor also pushes the need of corporate governance
in the country.
5. Globalization made the communication and transport between countries easy and
frequent, so many Indian companies are listed with international stock exchange which
also triggers the need for corporate governance in India.
6. The huge flow of international capital in Indian companies are also affecting the
management of Indian Corporates which require a code of corporate conduct.

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2.2 EVOLUTION OF CORPORATE GOVERNANCE IN INDIA (Regional Training
Institute, Allahabad, 2018)

The concept of good governance is very old in India dating back to third century B.C. where
Chanakya (Vazir of Parliputra) elaborated fourfold duties of a king viz. Raksha, Vriddhi, Palana
and Yogakshema. Substituting the king of the State with the Company CEO or Board of
Directors the principles of Corporate Governance refers to protecting shareholders wealth
(Raksha), enhancing the wealth by proper utilization of assets (Vriddhi), maintenance of wealth
through profitable ventures (Palana) and above all safeguarding the interests of the shareholders
(Yogakshema or safeguard).

Corporate Governance was not in agenda of Indian Companies until early 1990s and no one
would find much reference to this subject in book of law till then. In India, weakness in the
system such as undesirable stock market practices, boards of directors without adequate
fiduciary responsibilities, poor disclosure practices, lack of transparency and chronic capitalism
were all crying for reforms and improved governance. The fiscal crisis of 1991 and resulting
need to approach the IMF induced the Government to adopt reformative actions for economic
stabilization through liberalization. The momentum gathered albeit slowly once the economy
was pushed open and the liberalization process got initiated in early 1990s. As a part of
liberalization process, in 1999 the Government amended the Companies Act, 1956. Further
amendments have followed subsequently in the year 2000, 2002 and 2003. A variety of
measures have been adopted including the strengthening of certain shareholder rights (e.g.
postal balloting on key issues), the empowering of SEBI (e.g. to prosecute the defaulting
companies, increased sanctions for directors who do not fulfill their responsibilities, limits on
the number of directorships, changes in reporting and the requirement that a ‘small shareholders
nominee’ be appointed on the Board of companies with a paid up capital of Rs. 5 crore or more)

The major corporate governance initiatives launched in India since the mid-1990s are
discussed below:

1. The CII Code: On account of the interest generated by Cadbury Committee Report of
UK, the Confederation of Indian Industry (CII) took special initiative with the objective
to develop and promote a code of Corporate Governance to be adopted and followed by
Indian Companies both in private & public sector, Banks and Financial Institutions. The
final draft of the code was circulated in 1997 and the final code called ‘Desirable
Corporate Governance Code’ was released in April 1998. The Committee was driven by
the conviction that good corporate governance was essential for Indian Companies to
access domestic as well as global capital at competitive rates. The code was voluntary,
contained detailed provisions with focus on listed companies.
2. Kumar Mangalam Birla Committee Report: While the CII code was well received by
corporate sector and some progressive companies also adopted it, it was felt that under
Indian conditions a statutory rather than a voluntary code would be more meaningful.
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 Consequently the second major initiative was undertaken by the Securities and
Exchange Board of India (SEBI) which set up a committee under the chairmanship of
Kumar Mangalam Birla in 1999 with the objective of promoting and raising of standards
of good corporate governance. The Committee in its Report observed “the strong
Corporate Governance is indispensable to resilient and vibrant capital market and is an
important instrument of investor protection. It is the blood that fills the veins of
transparent corporate disclosure and high quality accounting practices. It is the muscle
that moves a viable and accessible financial reporting structure”. In early 2000 the SEBI
Board accepted and ratified the key recommendations of this committee and these were
incorporated into Clause – 49 of the Listing Agreement of the Stock Exchanges.
(Discussed in detail in Session XI & XII) These recommendations, aimed at providing
the standards of corporate governance, are divided into mandatory and non-mandatory
recommendations. The recommendations have been made applicable to all listed
companies with the paid-up capital of Rs. 3 crore and above or net worth of Rs.25 crore
or more at any time in the history of the company. The ultimate responsibility of putting
the recommendations into practice rests directly with the Board of Directors and the
management of the company.
3. Report of Task Force: In May 2000, the Department of Corporate Affairs (DCA)
formed a broad based study group under the chairmanship of Dr. P.L. Sanjeev Reddy,
Secretary of DCA. The group was given the ambitious task of examining ways to
“operationalise the concept of corporate excellence on a sustained basis” so as to
“sharpen India’s global competitive edge and to further develop corporate culture in the
country”. In November 2000 the Task Force on Corporate Excellence set up by the
group produced a report containing a range of recommendations for raising governance
standards among all companies in India. It also recommended setting up of a Centre for
Corporate Excellence.
4. Naresh Chandra Committee Report: The Enron debacle of 2001 involving the hand-
in-glove relationship between the auditor and the corporate client, the scams involving
the fall of the corporate giants in the U.S. like the WorldCom, Owest, Global Crossing,
Xerox and the consequent enactment of the stringent Sarbanes Oxley Act in the U.S. led
the Indian Government to wake up. A committee was appointed by Ministry of Finance
and Company Affairs in August 2002 under the chairmanship of Naresh Chandra to
examine and recommend inter alia amendments to the law involving the auditor-client
relationships and the role of independent directors. The committee made
recommendations in two key aspects of corporate governance: financial and non-
financial disclosures: and independent auditing and board oversight of management. The
recommendations are discussed in detail in Session XIII & XIV.
5. Narayana Murthy Committee Report: The SEBI also analysed the statistics of
compliance with the clause-49 by listed companies and felt that there was a need to look
beyond the mere systems and procedures if corporate governance was to be made
effective in protecting the interest of investors. The SEBI therefore constituted a
committee under the chairmanship of Narayana Murthy for reviewing implementation of
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 the corporate governance code by listed companies and issue of revised clause 49. Some
of the major recommendations of the committee primarily related to audit committees,
audit reports, independent directors, related party transactions, risk management,
directorships and director compensation, codes of conduct and financial disclosures.
Details of the major recommendations are given in Session – XIII & XIV.
6. J.J. Irani Committee Report: The Companies Act 1956 was enacted on the
recommendations of the Bhaba Committee set up in 1950 with the object to consolidate
the existing corporate laws and to provide a new basis for corporate operation in
independent India. With enactment of this legislation in 1956 the Companies Act 1913
was repealed. The need for streamlining this Act was felt from time to time as the
corporate sector grew in pace with the Indian economy and as many as 24 amendments
have taken place since 1956. The major amendments to the Act were made through
Companies (Amendment) Act 1998 after considering the recommendations of Sachar
Committee followed by further amendments in 1999, 2000, 2002 and finally in 2003
through the Companies (Ammendment) Bill 2003 pursuant to the report of R.D. Joshi
Committee. After a hesitant beginning in 1980, India took up its economic reforms
programme in 1990s and a need was felt for a comprehensive review of the Companies
Act 1956. Unsuccessful attempts were made in 1993 and 1997 to replace the present Act
with a new law. In the current national and international context the need for simplifying
corporate laws has long been felt by the government and corporate sector so as to make
it amenable to clear interpretation and provide a framework that would facilitate faster
economic growth. The Government therefore took a fresh initiative in this regard and
constituted a committee in December 2004 under the chairmanship of Dr. J.J. Irani with
the task of advising the government on the proposed revisions to the Companies Act
1956.The recommendations of the Committee submitted in May 2005 mainly relate to
management and board governance, related party transactions, minority interest,
investors education and protection, access to capital, accounts and audit, mergers and
amalgamations, offences and penalties, restructuring and liquidation, etc. The summary
of recommendations are given in Session – XIII & XIV
7. Central Coordination and Monitoring Committee: A high powered Central
Coordination and Monitoring Committee (CCMC) co-chaired by Secretary, Department
of Corporate Affairs’ and Chairman, SEBI was set up by the Department of Corporate
Affairs to monitor the action taken against the vanishing companies and unscrupulous
promoters who misused the funds raised from the public. It was decided by this
committee that seven Task Forces be set up at Mumbai, Delhi, Chennai, Kolkata,
Ahmedabad, Bangalore and Hyderabad with Regional Directors/Registrar of Companies
of respective regions as convener, and Regional Offices of SEBI and Stock Exchanges
as Members. The main task of these Task Forces was to identify the companies, which
have disappeared, or which have mis-utilized the funds mobilized from the investors and
suggests appropriate action in terms of Companies Act or SEBI Act.
8. National Foundation of Corporate Governance: Recently the Ministry of Company
Affairs has set up National Foundation for Corporate Governance (NFCG) in association
30
 with Confederation of Indian Industry (CII), Institute of Company Secretaries of India
(ICSI) and Institute of Chartered Accountants of India (ICAI). The NFCG would focus
on the following areas:
• Creating awareness on the importance of implementing good corporate governance
practices both at the level of individual corporations and for the economy as a whole.
The foundation would provide a platform for quality discussions and debates
amongst academicians, policy makers, professionals and corporate leaders through
workshops, conferences, meetings and seminars.
• Encouraging research capability in the area of corporate governance in the country
and providing key inputs for developing laws and regulations, which meet the twin
objectives of maximizing wealth creation and fair distribution of this wealth.
• Working with the regulatory authorities at multiple levels to improve
implementation and enforcement of various laws related to corporate governance.
• Working in close co-ordination with the private sector, work to instill a commitment
to corporate governance reforms and facilitate the development of a corporate
governance culture.
• Cultivating international linkages and maintaining the evolution towards
convergence with international standards and practices for accounting, audit and
non-financial disclosure.
• Setting up of 'National Centers for Corporate Governance' across the country which
would provide quality training to Directors as well as produce quality research and
aim to receive global recognition.

2.3 REGULATORY FRAMEWORK OF CORPORATE GOVERNANCE IN INDIA

Regulatory Framework on Corporate Governance (Vaish & Mehta, 2015)

The Indian statutory framework has, by and large, been in consonance with the international
best practices of corporate governance. Broadly speaking, the corporate governance mechanism
for companies in India is enumerated in the following enactments/ regulations/ guidelines/
listing agreement:

1. The Companies Act, 2013 inter alia contains provisions relating to board constitution,
board meetings, board processes, independent directors, general meetings, audit
committees, related party transactions, disclosure requirements in financial statements,
etc.
2. Securities and Exchange Board of India (SEBI) Guidelines: SEBI is a regulatory
authority having jurisdiction over listed companies and which issues regulations, rules
and guidelines to companies to ensure protection of investors.
3. Standard Listing Agreement of Stock Exchanges: For companies whose shares are
listed on the stock exchanges.

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 4. Accounting Standards issued by the Institute of Chartered Accountants of India
(ICAI): ICAI is an autonomous body, which issues accounting standards providing
guidelines for disclosures of financial information. Section 129 of the New Companies
Act inter alia provides that the financial statements shall give a true and fair view of the
state of affairs of the company or companies, comply with the accounting standards
notified under s 133 of the New Companies Act. It is further provided that items
contained in such financial statements shall be in accordance with the accounting
standards.
5. Secretarial Standards issued by the Institute of Company Secretaries of India
(ICSI): ICSI is an autonomous body, which issues secretarial standards in terms of the
provisions of the New Companies Act. So far, the ICSI has issued Secretarial Standard
on “Meetings of the Board of Directors” (SS-1) and Secretarial Standards on “General
Meetings” (SS-2). These Secretarial Standards have come into force w.e.f. July 1, 2015.
Section 118(10) of the New Companies Act provide that every company (other than one
person company) shall observe Secretarial Standards specified as such by the ICSI with
respect to general and board meetings.

Key Legal Framework for Corporate Governance in India “The Companies Act, 2013”

The Government of India has recently notified Companies Act, 2013 (“New Companies Act”),
which replaces the erstwhile Companies Act, 1956. The New Act has greater emphasis on
corporate governance through the board and board processes. The New Act covers corporate
governance through its following provisions:

• New Companies Act introduces significant changes to the composition of the boards of
directors.
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 • Every company is required to appoint 1 (one) resident director on its board.
• Nominee directors shall no longer be treated as independent directors.
• Listed companies and specified classes of public companies are required to appoint
independent directors and women directors on their boards.
• New Companies Act for the first time codifies the duties of directors.
• Listed companies and certain other public companies shall be required to appoint at least
1 (one) woman director on its board.
• New Companies Act mandates following committees to be constituted by the board for
prescribed class of companies:
o Audit committee
o Nomination and remuneration committee
o Stakeholders relationship committee
o Corporate social responsibility committee

Listing agreement – Applicable to the listed companies

SEBI has amended the Listing Agreement with effect from October 1, 2014 to align it with New
Companies Act. Clause 49 of the Listing Agreement can be said to be a bold initiative towards
strengthening corporate governance amongst the listed companies. This Clause intends to put a
check over the activities of companies in order to save the interest of the shareholders. Broadly,
cl 49 provides for the following:

1. Board of Directors: The Board of Directors shall comprise of such number of minimum
independent directors, as prescribed. In case where the Chairman of the Board is a non-
executive director, at least one-third of the Board shall comprise of independent
directors and where the Chairman of the Board is an executive director, at least half of
the Board shall comprise of independent directors. A relative of a promoter or an
executive director shall not be regarded as an independent director.
2. Audit Committee: The Audit Committee to be set up shall comprise of minimum three
directors as members, two-thirds of which shall be independent.
3. Disclosure Requirements: Periodical disclosures relating to the financial and
commercial transactions, remuneration of directors, etc, to ensure transparency.
4. CEO/ CFO Certification: To certify to the Board that they have reviewed the financial
statements and the same are fair and in compliance with the laws/ regulations and accept
responsibility for internal control systems.
5. Report and Compliance: A separate section in the annual report on compliance with
Corporate Governance, quarterly compliance report to stock exchange signed by the
compliance officer or CEO, company to disclose compliance with non-mandatory
requirements in annual reports.

2.4 CLAUSE 49 OF THE SEBI GUIDELINES ON CORPORATE GOVERNANCE

(Indian Boards, 2018)
33
Under the Clause 49 of Corporate Governance the company agrees to comply with the
following provisions:

I. Board of Directors

(A) Composition of Board

i. 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.
ii. Where the Chairman of the Board is a non-executive director, at least one-third of the
Board should comprise of independent directors and in case he is an executive director,
at least half of the Board should comprise of independent directors. Provided that where
the non-executive Chairman is a promoter of the company or is related to any promoter
or person occupying management positions at the Board level or at one level below the
Board, at least one-half of the Board of the company shall consist of independent
directors.

(B) Non Executive Directors’ 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 in aggregate. Provided that the requirement of obtaining prior approval
of shareholders in general meeting shall not apply to payment of sitting fees to non-executive
directors, if made within the limits prescribed under the Companies Act, 1956 for payment of
sitting fees without approval of the Central Government.

(C) Other Provisions as to Board and Committees

i. The board shall meet at least four times a year, with a maximum time gap of four
months between any two meetings.
ii. A director shall not be a member in more than 10 committees or act as Chairman of
more than five committees across all companies in which he is a director. Furthermore it
should be a 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.
iii. The Board shall periodically review compliance reports of all laws applicable to the
company, prepared by the company as well as steps taken by the company to rectify
instances of non-compliances.
34
 iv. An independent director who resigns or is removed from the Board of the Company
shall be replaced by a new independent director within a period of not more than 180
days from the day of such resignation or removal, as the case may be: Provided that
where the company fulfills the requirement of independent directors in its Board even
without filling the vacancy created by such resignation or removal, as the case may be,
the requirement of replacement by a new independent director within the period of 180
days shall not apply

(D) Code of Conduct

i. 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 on the website of the
company.
ii. 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 a declaration
to this effect signed by the 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:

i. The audit committee shall have minimum three directors as members. Two-thirds of the
members of audit committee shall be independent directors.
ii. All members of audit committee shall be financially literate and at least one member
shall have accounting or related financial management expertise.
iii. The Chairman of the Audit Committee shall be an independent director;
iv. The Chairman of the Audit Committee shall be present at Annual General Meeting to
answer shareholder queries;
v. The audit committee may invite such of the executives, as it considers appropriate (and
particularly the head of the finance function) to be present at the meetings of the
committee, but on occasions it may also meet without the presence of any executives of
the company. The finance director, head of internal audit and a representative of the
statutory auditor may be present as invitees for the meetings of the audit committee;
vi. The Company Secretary shall act as the secretary to the committee.

(B) 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 two members or one third of the
35
members of the audit committee whichever is greater, but there should be a minimum of two
independent members present.

(C) Powers of Audit Committee

The audit committee shall have powers, which should include the following:
1. To investigate any activity within its 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 expertise, if it considers necessary.

(D) Role of Audit Committee

The role of 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 to statutory auditors for any other services rendered by the
statutory auditors.
4. Reviewing, with the management, the annual financial statements before submission to
the board for approval, with particular reference to:
a. Matters required to be included in the Director’s Responsibility Statement to be
included in the Board’s report in terms of clause (2AA) of section 217 of the
Companies Act, 1956
b. Changes, if any, in accounting policies and practices and reasons for the same
c. Major accounting entries involving estimates based on the exercise of judgment
by management
d. Significant adjustments made in the financial statements arising out of audit
findings
e. Compliance with listing and other legal requirements relating to financial
statements
f. Disclosure of any related party transactions
g. Qualifications in the draft audit report.
5. Reviewing, with the management, the quarterly financial statements before submission
to the board for approval
5A. Reviewing, with the management, the statement of uses / application of funds raised
through an issue (public issue, rights issue, preferential issue, etc.), the statement of
funds utilized for purposes other than those stated in the offer
document/prospectus/notice and the report submitted by the monitoring agency

36
 monitoring the utilization of proceeds of a public or rights issue, and making appropriate
recommendations to the Board to take up steps in this matter.
6. Reviewing, with the management, performance of statutory and internal auditors, and
adequacy of the internal control systems.
7. Reviewing the adequacy of internal audit function, if any, including the structure of the
internal audit department, staffing and seniority of the official heading the department,
reporting structure coverage and frequency of internal audit.
8. Discussion with internal auditors any significant findings and follow up there on.
9. Reviewing the findings of any internal investigations by the internal auditors into
matters where there is suspected fraud or irregularity or a failure of internal control
systems of a material nature and reporting the matter to the board.
10. Discussion with statutory auditors before the audit commences, about the nature and
scope of audit as well as post-audit discussion to ascertain any area of concern.
11. To look into the reasons for substantial defaults in the payment to the depositors,
debenture holders, shareholders (in case of nonpayment of declared dividends) and
creditors.
12. To review the functioning of the Whistle Blower mechanism, in case the same is
existing.
12A. Approval of appointment of CFO (i.e., the whole-time Finance Director or any
other person heading the finance function or discharging that function) after assessing
the qualifications, experience & background, etc. of the candidate.
13. Carrying out any other function as is mentioned in the terms of reference of the Audit
Committee.

(E) Review of information by Audit Committee

The Audit Committee shall mandatorily review the following information:

1. Management discussion and analysis of financial condition and results of operations;
2. Statement of significant related party transactions (as defined by the audit committee),
submitted by management;
3. Management letters / letters of internal control weaknesses issued by the statutory auditors;
4. Internal audit reports relating to internal control weaknesses; and
5. The appointment, removal and terms of remuneration of the Chief internal auditor shall be
subject to review by the Audit Committee.

III. Subsidiary Companies

i. At least one independent director on the Board of Directors of the holding company
shall be a director on the Board of Directors of a material non listed Indian subsidiary
company.
ii. The Audit Committee of the listed holding company shall also review the financial
statements, in particular, the investments made by the unlisted subsidiary company.
37
 iii. The minutes of the Board meetings 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 transactions and arrangements entered into by the unlisted
subsidiary company.

IV. Disclosures

(A) Basis of related party transactions

i. A statement in summary form of transactions with related parties in the ordinary course
of business shall be placed periodically before the audit committee.
ii. Details of material individual transactions with related parties which are not in the
normal course of business shall be placed before the audit committee.
iii. Details of material individual transactions with related parties or others, which are not
on an arm’s length basis should be placed before the audit committee, together with
Management’s justification for the same.

(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 Disclosures – Risk management

The company shall lay down procedures to inform Board members about the risk assessment
and minimization procedures. These procedures shall be periodically reviewed to ensure that
executive management controls risk through means of a properly defined framework.

(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 basis as a part of
their quarterly declaration of financial results. Further, on an annual basis, the company shall
prepare a statement of funds utilized for purposes other than those stated in the offer
document/prospectus/notice and place it before the audit committee. Such disclosure shall be
made only till such time that the full money raised through the issue has been fully spent. This
statement shall be certified by the statutory auditors of the company. Furthermore, where the
38
company has appointed a monitoring agency to monitor the utilization of proceeds of a public
or rights issue, it shall place before the Audit Committee the monitoring report of such agency,
upon receipt, without any delay. The audit committee shall make appropriate recommendations
to the Board to take up steps in this matter.

(E) Remuneration of Directors

i. All pecuniary relationship or transactions of the non-executive directors’ vis-à-vis the

company shall be disclosed in the Annual Report.
ii. Further the following disclosures on the remuneration of directors shall be made in the
section on the corporate governance of the Annual Report:
• All elements of remuneration package of individual directors summarized under major
groups, such as salary, benefits, bonuses, stock options, pension etc.
• Details of fixed component and performance linked incentives, along with the
performance criteria.
• Service contracts, notice period, severance fees.
• Stock option details, if any – and whether issued at a discount as well as the period over
which accrued and over which exercisable.
iii. The company shall publish its criteria of making payments to non-executive directors in
its annual report. Alternatively, this may be put up on the company’s website and
reference drawn thereto in the annual report.
iv. The company shall disclose the number of shares and convertible instruments held by
non-executive directors in the annual report.
v. 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 are
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 director.

(F) Management

i. As part of the directors’ report or as an addition thereto, a Management Discussion and

Analysis report should form part of the Annual Report to the shareholders. This
Management Discussion & Analysis should include discussion on the following matters
within the limits set by the company’s competitive position:
• Industry structure and developments.
• Opportunities and Threats.
• Segment–wise or product-wise performance.
• Outlook
• Risks and concerns.
• Internal control systems and their adequacy.
• Discussion on financial performance with respect to operational performance.

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 • Material developments in Human Resources / Industrial Relations front, including
number of people employed.
ii. Senior management shall make disclosures to the board relating to all material financial
and commercial transactions, where they have personal interest, that may have a
potential conflict with the interest of the company at large (for e.g. dealing in company
shares, commercial dealings with bodies, which have shareholding of management and
their relatives etc.)

(G) Shareholders

i. In case of the appointment of a new director or re-appointment of a director the

shareholders must be provided with the following information:
• A brief resume of the director;
• Nature of his expertise in specific functional areas;
• Names of companies in which the person also holds the directorship and the
membership of Committees of the Board; and
• Shareholding of non-executive directors as stated in Clause 49 (IV) (E) (v) above
i(a). Disclosure of relationships between directors inter-se shall be made in the Annual
Report, notice of appointment of a director, prospectus and letter of offer for issuances
and any related filings made to the stock exchanges where the company is listed.
ii. Quarterly results and presentations made by the company to analysts shall be put on
company’s web-site, or shall be sent in such a form so as to enable the stock exchange
on which the company is listed to put it on its own web-site.
iii. A board committee under the chairmanship of a non-executive director shall be formed
to specifically look into the redressal of shareholder and investors complaints like
transfer of shares, non-receipt of balance sheet, non-receipt of declared dividends etc.
This Committee shall be designated as ‘Shareholders/Investors Grievance Committee’.
iv. To expedite the process of share transfers, the 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. The delegated authority shall attend to share transfer formalities at least once in a
fortnight.

V. CEO/CFO Certification

The CEO, i.e. the Managing Director 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:
a. They have reviewed financial statements and the cash flow statement for the year and
that to the best of their knowledge and belief:
o these statements do not contain any materially untrue statement or omit any material
fact or contain statements that might be misleading;

40
 o These statements together present a true and fair view of the company’s affairs and
are in compliance with existing accounting standards, applicable laws and
regulations.
b. There are, to the best of their knowledge and belief, no transactions entered into by the
company during the year which are fraudulent, illegal or violation of the company’s
code of conduct.
c. They accept responsibility for establishing and maintaining internal controls for
financial reporting and that they have evaluated the effectiveness of internal control
systems 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 such
internal controls, if any, of which they are aware and the steps they have taken or
propose to take to rectify these deficiencies.
d. They have indicated to the auditors and the Audit committee
i. significant changes in internal control over financial reporting during the year;
ii. significant changes in accounting policies during the year and that the same have
been disclosed in the notes to the financial statements; and
iii. Instances of significant fraud of which they have become aware and the
involvement therein, 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 Governance

i. There shall be a separate section on Corporate Governance in the Annual Reports of

company, with a detailed compliance report on Corporate Governance. Noncompliance
of any mandatory requirement of this clause with reasons thereof and the extent to which
the non-mandatory requirements have been adopted should be specifically highlighted.
The suggested list of items to be included in this report is given in Annexure- I C and list
of non-mandatory requirements is given in Annexure – I D.
ii. The companies shall submit a quarterly compliance report to the stock exchanges within
15 days from the close of quarter as per the format given in Annexure I B. The report
shall be signed either by the Compliance Officer or the Chief Executive Officer of the
company.

VII. Compliance

i. The company shall obtain a certificate from either the auditors 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.
ii. The non-mandatory requirements given in Annexure – I D may be implemented as per
the discretion of the company. However, the disclosures of the compliance with
41
 mandatory requirements and adoption (and compliance) / non-adoption of the non-
mandatory requirements shall be made in the section on corporate governance of the
Annual Report.

2.5 SEBI GUIDELINES ON CORPORATE GOVERNANCE (Regional Training

Institute, Allahabad, 2018)

The SEBI was established under the Securities and Exchange Board of India (SRBI) Act, 1992
as an independent capital market regulatory authority with the objective to protect the interests
of investors in securities, promote and regulate the securities market in India. The scams
committed by Harshad Mehta in early nineties and subsequently rigging of share prices by
Ketan Parikh resulted in heavy losses to public and erosion of faith in the capital market. These
circumstances resulted in passing of an ordinance to empower the SEBI which inter-alia hiked
the monetary penalties for various offences to either three time the undue gains made by a
market player or a maximum of Rs. 25 crore whichever is higher (as against the monetary limit
of Rs. 5 lakh earlier). Besides, the SEBI has also been granted powers to search and seize books
of accounts and other documents of the stockbrokers and intermediaries after obtaining the
approval of a Magistrate. The strength of the Board has also been increased from six to nine of
which three are full time directors, excluding the Chairman. The ordinance was confirmed to
make the amendments part of the SEBI (Amendment) Act 2002. The SEBI is playing an
important role in promoting good corporate governance as would be evident from the following
discussions on the functions and powers of the Board:

Functions

1. Regulating the business in stock exchanges and any other securities markets;
2. Registering and regulating the working of stock brokers, sub-brokers, share transfer agents,
bankers to an issue, trustees of trust deeds, registrars to an issue, merchant bankers,
underwriters, portfolio managers, investment advisers and such other intermediaries who
may be associated with securities markets in any manner;
3. Registering and regulating the working of the depositories, participants, custodians of
securities, foreign in institutional investors, credit rating agencies and other intermediaries
as the Board may, by notification, specify in this behalf.
4. Registering and regulating the working of venture capital funds and collective investment
schemes including mutual funds;
5. Promoting and regulating self-regulatory organizations;
6. Prohibiting fraudulent and unfair trade practices relating to securities markets;
7. Promoting investors’ education and training of intermediaries of security markets;
8. Prohibiting insider trading in securities;
9. Regulating substantial acquisition of shares and take-over of companies;

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10. Calling for information from, undertaking inspection, conducting enquiries and audits of the
stock exchanges, mutual funds and other persons associated with the securities market and
intermediaries and self-regulatory organizations in the securities market;
11. Performing such functions and exercising such powers under the provisions of the Securities
Contracts (Regulation) Act 1956, as may be delegated to it by the Central Government;
12. Levying fee or other charges;
13. Conducting research;
14. Calling from or furnishing to any such agencies, as may be specified by the Board, such
information as may be considered necessary by it for the efficient discharge of its functions;
15. Performing such other functions as may be prescribed.

Powers

The Board is vested with same powers as are vested in a civil court in respect of following
matters, namely:
1. the discovery and production of books of account and other documents at such place and
at such time as may be specified by the Board;
2. Summoning and enforcing the attendance of persons and examining them on oath;
3. Inspection of any books, registers and other documents of stockbrokers, sub brokers,
share transfer agents etc.
4. For the protection of investors’ interests, the Board may issue regulations for (Section
11A): The matters relating to issue of capital, transfer of securities and other matters
incidental there to; and
• The manner, in which such matters, shall be disclosed by the companies.

5. The Board may issue directions under section 11B to:

• Stock-brokers, sub-brokers, share transfer agents, bankers to an issue, trustee of trust
deed, registrar to; an issue, merchant banker, underwriter, portfolio manager,
investment adviser and such other intermediary who may, be associated with
securities market.
• Depository, depository participant, custodian of securities, foreign institutional
investor, credit rating agency or any intermediary associated with the securities
market
• Sponsors of venture capital funds, or collective investment schemes including
mutual funds
• And to any company with regard to matters to be disclosed by the companies as
specified in section 11A:

o Different intermediaries mentioned above can commence functioning in their

respective activities only after registration with the SEBI and complying with
requirements as stated under specific regulations mentioned for each.

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 o Stock-brokers, sub-brokers, share transfer agents, bankers to an issue, trustee of
trust deed, registrar to; an issue, merchant banker, underwriter, portfolio
manager, investment adviser and such other intermediary who may, be
associated with securities market cannot buy, sell or deal in securities except
under, and in accordance with, the conditions of a certificate of registration
obtained from the Board in accordance with the regulations made under this Act.
o No Depository, depository participant, custodian of securities, foreign
institutional investor, credit rating agency or any intermediary associated with
the securities market, as the Board may notify by notification, shall buy or sell or
deal in securities except under and in accordance with the conditions of a
certificate of registration obtained from the Board in accordance with the
regulations made under this Act.
o No person shall sponsor or cause to be sponsored or carry on or cause to be
carried on any venture capital funds or collective investment schemes including
mutual funds, unless he obtains a certificate of registration from the Board in
accordance with the regulations.
o No civil court shall have jurisdiction to entertain any suit or proceeding in
respect of any matter which an adjudicating officer appointed under this Act or a
Securities Appellate Tribunal constituted under this Act is empowered by or
under this Act to determine and no injunction shall be granted by any court or
other authority in respect of any action taken or to be taken in pursuance of any
power conferred by or under this Act. However, appeals against the decision of
the Securities Appellate Tribunal can be preferred before a High Court.

Safeguard for Investors

The SEBI has taken several steps for ensuring the interests of investors and helping them to
exercise their choice and decisions in their financial dealings:
• The Electronic Data Filing and Retrieval System (EDIFAR) were commenced from July
2002. It is an automated web based system for filing, retrieval and dissemination of
information pertaining to corporate.
• Benchmarking has been made compulsory for debt oriented and balanced funds for
providing objective analysis of performance of the mutual fund schemes.
• A code of conduct for mutual fund intermediaries has been prescribed.
• Guidelines for risk management system issued and implemented for the mutual funds in
order to eliminate/minimize the risks in operations of mutual funds.
• Guidelines have been issued for valuation of unlisted equity shares by mutual funds with
a view to bringing about uniformity in the calculation of NAV.
• A provision of nominations for the unit holders has been made.
• Mutual funds have been advised to follow a uniform method to calculate the sale and
repurchase price. This would avoid creation of confusion in the minds of the investors.

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 • Rebating and discounting by the mutual funds has been prohibited for ensuring a fair
treatment to all the investors.
• Guidelines have been issued to mutual funds for exercising due diligence while making
investments in unlisted equity shares. The Mutual funds cannot buy unlisted equity
shares at high prices arbitrarily.
• With a view to improving corporate governance standards, the trustees who act as first
line regulators are now required to meet on bi-monthly basis instead of earlier
requirement of meeting on quarterly basis. They are required to review the performance
and compliance of regulations on bi-monthly basis.
• Quarterly secretarial audit has been made mandatory for listed entities to reconcile the
issued, capital and electronic shares.

Enforcement of Regulatory Obligations

The SEBI has initiated several measures for regulating the market players for better service to
the investors.
• The Prof. Verma Committee, which reviewed the SEBI (Employee Stock Option
Scheme and Employee Stock Purchase Scheme) Guidelines 1999, inter-alia
recommended for mandatory disclosure of the fair value of the ESOPs, the impact on
profits and on EPS of the company, had the company expensed the ESOPs on fair value
basis and also relaxations from lock-in requirement subject to certain disclosures in the
offer document in case the company is going for IPO after the grant of options.
• The Accounting Standards Committee has recommended additional disclosures for
investment in associates and subsidiaries. It also recommended introduction of half
yearly audited consolidated results and quarterly audit review.
• Credit Rating Agencies have been asked to develop model for rating corporate
governance on the principles of wealth creation, wealth management and wealth sharing.
• Code of conduct has been specified for listed entities and regulated firms under the
Insider Trading Regulations.
• SEBI has brought a scheme to enable individuals and companies to disclose the
irregularities in reporting of acquisition of shares under the SEBI (SAST) Regulations,
1997.

Insider Trading Regulations

The Insider Trading Regulations issued by SEBI in 1992 have been amended and the new
regulations were notified in February 2002 viz. the SEBI (Insider Trading) (Amendment)
(Regulations) 2002 to remove the shortcomings found in the earlier regulations and also to
make them mover effective. This will protect investors’ interest and ensure transparency in
dealings of securities of companies by employees, directors, officers and other market
intermediaries. SEBI has further amended these regulations in November 2002 with the
introduction of SEBI (Prohibition of Insider Trading) (Second Amendment) Regulations 2002.
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The Insider Trading Regulations are applicable to those persons who have temporary or
permanent relationship with the company including its directors, officers, designated
employees, professionals, businessmen and their dependent relatives, who may reasonably be
expected to have an access to unpublished price sensitive information in relation to that
company. The term ‘Designated Employees’ include all employees comprising of the top two
tiers of the company management and those specifically designated by the company and who
may be able to have access to any Price Sensitive Information as defined in the regulations. As
per the regulation 3, no insider shall:

• Either on his own behalf or on behalf of any other person, deal in securities of a company
listed on any stock exchange when in possession of any unpublished price sensitive
information; or
• Communicate, counsel or procure, directly or indirectly any unpublished price sensitive
information to any person, who, while in possession of such unpublished price sensitive
information, shall not deal in securities.
• Provided that nothing contained above, shall be applicable in any communication required
in the ordinary course of business or profession or employment or under any law.
• No company shall deal in the securities of another company or associate of that other
company while in possession of any unpublished price sensitive information. The regulation
3A shall not apply in certain cases discusses below:
o In a proceeding against a company in respect of regulation 3A, it shall be a defense
to prove that it entered into a transaction in the securities of a listed company when
the unpublished price sensitive information was in the possession of an officer or
employee of the company if.
o The decision to enter into the transaction or agreement was taken on its behalf by a
person or persons other than that officer or employee; and
o Such company has put in place such systems and procedures which demarcate the
activities of the company in such a way that the person who enters into transaction in
securities on behalf of the company cannot have access to information which is in
possession of another officer or employee of the company; and
o It had in operation at that time, arrangements that could reasonably be expected to
ensure that the information was not communicated to the persons or persons who
made the decision and that no advice with respect to the transactions or agreement
was given to that person or any of those persons by that officer or employee, and
o The information was not so communicated and no such advice was so given.
o In a proceeding against a company in respect of regulation 3A which is in possession
of unpublished price sensitive information, it shall be defense to prove that
acquisition of shares of a listed company was as per the SEBI (Substantial
Acquisition of Shares and Takeovers) Regulations, 1992.

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Price Sensitive Information

Any information, which relates directly or indirectly to a company and which if published is
likely to materially affect the price of securities of the company, is referred to as Price Sensitive
Information. The following shall be deemed to be price sensitive information:

• Periodical financial results of the company,

• Intended declaration of dividends (both interim and final).
• Issue of securities or buy-back of securities.
• Any major expansion plans or execution of new projects.
• Amalgamation or mergers or takeovers.
• Disposal of the whole or substantial part of the undertaking.
• Any significant changes in policies, plans or operations of the company

All directors/officer/designated employees are required to maintain the confidentiality of all

price sensitive information. They must not pass on such information directly or indirectly by
way of making the recommendation for the purchase or sale of any security of the
company/client company. Price sensitive information is to be handled on a “need to know”
basis. It should be disclosed only to those within the company who may need the same to
discharge their duty and whose possession of such information will not give rise to a conflict of
interest or appearance of misuse of the information. All directors / officers / designated
employees of the company shall be subject to following trading restrictions:

• They shall trade in the company’s securities only when the trading window is open.
Trading window means a trading period for trading in company’s securities as specified
by the company from time to time.
• When the trading window is closed, during that period, the employees and directors
shall not trade in the company’s securities.
• The trading window shall be, inter alia, closed at the time of:
a. Declaration of financial results (quarterly, half yearly and annual).
b. Issue of securities by way of public rights/bonus etc.
c. Declaration of dividends (interim and final).
d. Any major expansion plan or execution of new project.
e. Amalgamation, mergers, takeovers and buy-back.
f. Disposal of the whole or substantially whole of the undertaking.
g. Any changes in policies, plans or operations of the company.
• The time for commencement of closing of trading window shall be decided by the
company.
• All directors, officers and designated employees of the company shall conduct all their
dealings in the securities of the company only in a valid trading window and shall not
deal in any transactions involving the purchase or sale of the Company’s securities
during the period when trading window is closed.
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Threshold Limit to Transactions in Securities

Any transactions in securities of the company exceeding 25000 shares or Rs. 5 lakh in value or
1 percent of the total holding of the company whichever is lower shall be carried out by the
designated persons only after receiving pre-clearance of trades from the company and the
execution of the order will have to be completed within one week of approval of pre-clearance.
Further, the investment in securities will have to be held for a minimum period of 30 days from
the date of purchase/actual allotment.

Disclosure of interest or holding by directors and officers and substantial shareholder in a

listed company

Initial Disclosure

1. Any person who holds more than five percent of shares or voting rights, in any listed
company, shall disclose to the company, the number of shares or voting rights held by such
person, or becoming such holder, within four working days of
• The receipt of intimation of allotment of shares or
• The acquisition of shares or voting rights
2. Any person who is a director or officer of a listed company shall disclose to the company,
the number of shares or voting rights held by such person, within four working days of
becoming a director or officer of the company.

Continual Disclosure

1. Any person who holds more than five percent shares or voting rights in any listed company
shall disclose to the company the number of shares or voting rights held and change in
shareholding or voting rights, even if such change results in shareholding falling below five
percent, if there has been change in such holdings from the last disclosure made and such
change exceeds two percent of total shareholding or voting right in the company.
2. Any person who is a director or officer of a listed company, shall disclose to the company,
the total number of shares or voting rights held and change in shareholding or voting rights,
if an there has been a change in such holdings from the last disclosure made and the change
exceeds rupees five lakh in value or 25000 shares or one percent of total shareholding or
voting rights, whichever is lower.
3. The disclosure shall be made within four working days of
• The receipt of intimation of allotment of shares, or
• The acquisition or sale of shares or voting rights, as the case may be.

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Disclosure by Company to Stock Exchanges

Every listed company within five days of receipt shall disclose to all stock exchanges on which
the company is listed, the information received as above. All designated persons will have to
forward details of their securities transactions including the statement of their dependent family
members to the compliance officer in the following manner:

• All holdings of securities of that company by directors /officers/designated employees at

the time of joining of the company.
• Periodic statement of any transactions in securities (the periodicity of reporting may be
defined by the company). The company may also be free to decide whether reporting is
required for trades where pre-clearance is also required and
• Annual statement of all holdings in securities.
• The compliance officer shall maintain records of all the declarations in the appropriate
forms given by the designated persons for a minimum period of three years.
• The compliance officer shall place before the Managing Director/Chief Executive
Officer or a committee specified by the company, on a monthly basis, all the details of
the dealings in the securities by employees/director/officer of the company and the
accompanying documents that such persons had executed under the pre-dealing
procedure as envisaged in the Model Code.

2.6 REFORMS IN THE COMPANIES ACT, 2013

The Companies (Amendment) Act, 2017 – Key Changes for Corporate Governance in
India: (Boddupalli, 2018)

India’s upper house of parliament passed the Companies Act (Amendment) Bill, 2016 in
December 2017, after it was approved by the lower house last July. Upon securing the
President’s assent, the Act came into effect on January 4, this year. In India, the Companies Act
regulates the incorporation of a company, responsibilities of a company and its directors, and
the dissolution of a company. The 2017 Amendment Act consists of 93 amendments to the 2013
Companies Act, resulting in changes related to legal definitions, corporate governance, and
management compliance. It impacts different aspects of business management in India,
including key structuring, disclosure, and compliance requirements.

The new law is an important feature of the Modi government’s economic reforms agenda, and
aims to improve the ease of doing business in India. The Amendment Act also irons out existing
policy inconsistencies between financial regulatory mechanisms, such as the Securities and
Exchange Board of India (SEBI) and the Reserve Bank of India (RBI).

49
Below is the key Changes Highlighted in the 2017 Companies (Amendment) Act:

• Expansion of the Term ‘Related Party’: The Amendment Act expands the definition
of related party to include “an investing company or venture of the company”. This
means that any company which receives investments from the body corporate, will
become an associate of the body corporate. This is likely to cover investments in assets,
joint ventures, human resource, and technology, among other things.
• Definition of a Subsidiary Company: The subsidiary company will be determined on
the basis of total voting power and not total share capital. The holding company must
control the composition of the Board of Directors or control more than half of the total
voting power in the subsidiary. The Amendment Act also allows firms to offer loans to
subsidiary companies without approval from shareholders.
• Definition of Associate Company: The term associate company will be used in place of
the term “significant influence”. The 2013 Companies Act associates significant
influence with control of 20 percent of total share capital while the 2017 Amendment
Act provides for the associate company to hold 20 percent of the total voting power or
participation in business decisions as per an agreement. The same section also clarifies
the definition of joint ventures as: a joint arrangement whereby the parties that have joint
control of the arrangement, have rights to the net assets of the arrangement. This section
is crucial for the financial accounting of the parent company, especially in cases of
insolvency management.
• Simplification of the Private Placement Process: Private placement is redefined as
any offer or initiation to subscribe or issue securities to a select group of persons by a
company through private placement offer-cum-application. The private placement
process no longer requires companies to keep separate offer letter details. The number of
filings to be made to the Registrar of Companies have also been reduced. The reduced
documentation is expected to enable faster access to funds.
• Definition of Independent Directors: The 2013 law restricted a person with a
‘pecuniary interest’ in the firm from becoming an independent director. The term
pecuniary interest was open to interpretation, and often resulted in confusion. The
Amendment Act provides clarity by stipulating that a person can become an independent
director if the monetary benefit accruing to them, from the firm, is less than 10 percent
of their total income.
• Simplification of Company Incorporation: The Amendment Act relaxes several
procedures involved in company incorporation. The period of reservation for a company
name is now 20 days, which is counted from the date of approval for the new company.
The reservation period is increased to 60 days in case an existing company wants to
change its name. The proposed directors of the company can submit a self-attested
declaration instead of an affidavit. The time period for a company to establish its
registered office is now 30 days, counted from the date of its incorporation.
• Remuneration to Management: The Amendment Act does away with the need to
secure government approval for remuneration (exceeding 11 percent of profits) to top
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 management. Instead, this matter will now need to be cleared by the company’s
shareholders.
• Financial Statements and Annual Returns: Financial statements and annual returns of
a firm must be attested by its chief executive officer (CEO), whether she/he is appointed
as a director or not. The Form MGT-9, which served as a summary of the annual return
in the board of director’s report has now been removed. The Amendment Act also
authorizes the government to issue a separate annual return form for one person
companies (OPCs) and small companies. Further, companies with subsidiaries and
associates (including joint ventures) must prepare a consolidated financial statement,
apart from individual statements.
• Ratification of Auditors and Audit Committee: Auditors can be appointed for five
years, and their appointment will not need to be ratified in every annual general meeting
(AGM). Public listed companies must constitute an audit committee.
• Loans to Directors and Employees: The 2013 law provided that a firm can extend
credit to its directors and others that a director is interested in. The Amendment Act
clarifies that a firm can offer loans and security to a director or a company in which they
have stake. Such an offer can be made only after a special resolution is passed, that is,
75 percent of the company’s shareholders must approve it. Loans to family members of
the company’s director are still restricted.

2.7 ROLE OF COMPTROLLER AND AUDITOR GENERAL (CAG) OF INDIA

(Regional Training Institute, Allahabad, 2018)

The external audit in India like ours derives its mandate from (a) the Constitution of India and
(b) Comptroller and Auditor General’s (Duties, Power and Conditions of Service) Act 1971.
The system of government audit in India has a long history, starting from the days of the East
India Company. The Constitution of India has vested this function with the Comptroller and
Auditor General of India (CAG). The CAG is the head of the Supreme Audit Institution of India
(SAI) and he derives his duties and powers from Article 149 to 151 of the Constitution of India
and the Comptroller and Auditor General’s (Duties, Powers and Conditions of Service) Act
1971. Under provisions of the Constitution of India and the Act, the CAG is the sole auditor of
accounts of the Central Government and the State Governments. The external audit set up in our
democratic set up is a means through which the legislative accountability of the executive is
ensured in the matter of finance.

Under provisions of Section 19 (1) of the Act, the duties and powers of the CAG in relation to
the audit of the accounts of Government companies shall be performed and exercised by him in
accordance with the provisions of the Companies Act 1956. Under sub section (2) of Section 19
of the Act, the duties and powers of CAG in relation to the audit of the accounts of corporations
(not being companies) established by or under law made by Parliament shall be performed and
exercised by him in accordance with the provisions of the respective legislations. The sub
section (3) of Section 19 of the Act provides that the Governor of a State or the Administrator of
51
a Union Territory having a Legislative Assembly may, where he is of opinion that it is
necessary in the public interest so to do, request the CAG to audit the accounts of a corporation
established by law made by the Legislature of the State or of the union territory, as the case may
be, and where such request has been made, the CAG shall audit the accounts of such
corporation and shall have, for the purposes of such audit, right of access to the books and
accounts of such corporation:

Provided that no such request shall be made except after consultation with the CAG and except
after giving reasonable opportunity to the corporation to make representations with regard to the
proposal for such audit.

Further, under provisions of Section 19-A of the Act, the reports of the CAG in relation to audit
of accounts of a Government company or a corporation shall be submitted to the Government or
Governments concerned which shall lay it, as soon as may be after it is received, before each
House of Parliament or Legislature. The provisions of Section 619(2) of the Companies Act
provide that the auditor of a Government Company shall be appointed or reappointed by the
CAG. While appointing auditors of Government Company, CAG has taken steps for ensuring
the independence of auditors by adopting the system of rotation of auditors, prohibition of
certain services etc. A system of rotation of the auditors of Government companies every four
years has been adopted as a good practice. Sub Section 3 provides that the CAG shall have
power

a. to direct the manner in which the company’s accounts shall be audited by the auditor
appointed in pursuance of sub-section (2) and to give such auditor instructions in regard
to any matter relating to the performance of his functions as such;
b. to conduct a supplementary or test audit of the company’s accounts by such person or
persons as he may authorize in this behalf; and for the purpose of such audit, to require
information or additional information to be furnished to any person or persons so
authorized, on such matters, by such person or persons, and in such form, as the CAG
may, by general or special order, direct.

Sub section (4) provides that the auditor aforesaid shall submit a copy of his audit report to the
CAG who shall have the right to comment upon, or supplement, the audit report in such manner
as he may think fit. Any such comment upon or supplement to the audit report shall be place
before the Annual General Meeting of the Company in terms of sub section at the same time
and in the same manner as the audit report. Thus the provisions made in the statutes and rules
and orders there under are comprehensive and foolproof. Despite such elaborate and strong
control and checks, we find that the best results are not forthcoming. True that Finance,
Accounts and Audit cannot be held responsible wholly for the failures but at the same time, all
these players in the financial sector can play a very significant role in minimizing, if not
eliminating, the deficiencies in the system and practices and shortfall in performance. We are at
the threshold of a new age with newer challenges and newer opportunities as a result of
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increasing global interests of corporate world in our economy and in order to shoulder the
increased responsibilities we have to emerge stronger in the days to come.

2.8 NATIONAL COMPANY LAW TRIBUNAL (NCLT) (Archana, 2018)

What is National Company Law Tribunal?

The National Company Law Tribunal or NCLT is a quasi-judiciary body established in India
that makes a formal judgment on a disputed matter, relating to the companies issues in India. It
was set up to govern the companies registered in India. It is a successor to the Company Law
Board. The government has appointed 11 benches for NCLT. Selection of members is done by a
selection committee headed by the Secretary of the Corporate Affairs Ministry (MCA).
The National Company Law Tribunal was established by the Central Government in 2016 under
Section 408 of the Companies Act of 2013, and it was constituted on June 1, 2016.

Scope of National Company Law Tribunal

The National Company Law Tribunal consolidates the corporate jurisdiction of the Appellate
Authority for Industrial and Financial Reconstruction (AAIFR), the Company Law Board,
Board of Industrial and Financial Reconstruction (BIFR) and the powers relating to the winding
up of the company and other provisions vested in High Courts. The Company Law Board which
was set up under the Companies Act, 1956 stands dissolved with the establishment of National
Company Law Tribunal (NCLT) and National Company Law Appellate Tribunal (NCLAT).

Advantages of National Company Law Tribunal

The following are the advantages of National Company Law Tribunal:

• It reduces the multiplicity of litigation before different forums and courts.
• It is a specialized court, meant only for corporates - for the companies registered in India.
• It consists of both the judiciary members as well as technical members while deciding on
the matters.
• It has many branches spread across India.
• It will be able to provide justice at a close range.
• The time consumed for the winding up of a company is reduced.
• It disposes of cases speedily which will further help to reduce the total number of cases
• Both NCLT and NCLAT have exclusive jurisdiction.

Powers of National Company Law Tribunal

• To declare the liability of members unlimited.

• De-registration of companies
• To seek assistance of Chief Metropolitan Magistrate
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• Remedy for oppression and mismanagement
• To freeze assets of the company
• To investigate the ownership of the company
• To restrict any securities related to the company
• Conversion of Public Limited Company into Private Limited Company
• To alter the financial year of a company, registered in India
• To investigate or for initiating investigation proceedings

Procedure for Appeals

The Tribunal and Appellate Tribunal follows the rules laid down in the Code of Civil procedure,
and it is also guided by the principles of the natural justice, subject to the other provisions of the
Act and any different rules made by the Central Government. Both Tribunal and Appellate
Tribunal has the power to control its procedure. No other civil court has the jurisdiction to
consider any case concerning any matter which the Tribunal and Appellate Tribunal is
empowered to decide. Any appeal on the order of Tribunal can be raised at the National
Company Law Appellate Tribunal. Appeals can be made within 45 days from the date of the
decision of the Tribunal. Any person or party aggrieved by the Tribunal order can appeal to the
Appellate Tribunal. The Appellate Tribunal has to dispose the appeal within six months from
the date of the receipt of the appeal. Recently the National Company Law Tribunal (NCLT) has
allowed the Corporate Affairs Ministry (MCA) to freeze assets of 64 respondents relating to the
Nirav Modi case.

Major Functions of NCLT (National Company Law Tribunal, 2018)

National Company Law Tribunal is the outcome of the Eradi Committee. NCLT was intended
to be introduced in the Indian legal system in 2002 under the framework of Companies Act,
1956 however, due to the litigation with respect to the constitutional validity of NCLT which
went for over 10 years, therefore, it was notified under the Companies Act, 2013. It is a quasi-
judicial authority incorporated for dealing with corporate disputes that are of civil nature arising
under the Companies Act. However, a difference could be witnessed in the powers and
functions of NCLT under the previous Companies Act and the 2013 Act. The constitutional
validity of the NCLT and specified allied provisions contained in the Act were re-challenged.
Supreme Court had preserved the constitutional validity of the NCLT, however, specific
provisions were rendered as a violation of the constitutional principles.
NCLT works on the lines of a normal Court of law in the country and is obliged to fairly and
without any biases determine the facts of each case and decide with matters in accordance with
principles of natural justice and in the continuance of such decisions, offer conclusions from
decisions in the form of orders. The orders so formed by NCLT could assist in resolving a
situation, rectifying a wrong done by any corporate or levying penalties and costs and might
alter the rights, obligations, duties or privileges of the concerned parties. The Tribunal isn’t

54
required to adhere to the severe rules with respect to appreciation of any evidence or procedural
law. Following are major functions of NCLT discussed in detail:

1. Registration of Companies: The new Companies Act, 2013 has enabled questioning
the legitimacy of companies because of specific procedural errors during incorporation
and registration. NCLT has been empowered in taking several steps, from cancelling the
registration of a company to dissolving any company. The Tribunal could even render
the liability or charge of members to unlimited. With this approach, NCLT can de-
register any company in specific situations when the registration certificate has been
obtained by wrongful manner or illegal means under section 7(7) of the Companies Act,
2013.
2. Transfer of Shares: NCLT is also empowered to hear grievances of rejection of
companies in transferring shares and securities and under section 58- 59 of the Act
which were at the outset were under the purview of the Company Law Board. Going
back to Companies Act, 1956 the solution available for rejection of transmission or
transfer were limited only to the shares and debentures of a company but as of now the
prospect has been raised under the Companies Act, 2013 and the now covers all the
securities which are issued by any company.
3. Deposits: The Chapter V of the Act deals with deposits and was notified several times
in 2014 and Company Law Board was the prime authority for taking up the cases under
said chapter. Now, such powers under the chapter V of the Act have been vested with
NCLT. The provisions with respect to the deposits under the Companies Act, 2013 were
notified prior to the inception of the NCLT. Unhappy depositors now have a remedy of
class actions suits for seeking remedy for the omissions and acts on part of the company
that impacts their rights as depositors.
4. Power to Investigate: As per the provision of the Companies Act, 2013 investigation
about the affairs of the company could be ordered with the help of an application of 100
members whereas previously the application of 200 members was needed for the same.
Moreover, if a person who isn’t related to a company and is able to persuade NCLT
about the presence of conditions for ordering an investigation then NCLT has the power
for ordering an investigation. An investigation which is ordered by the NCLT could be
conducted within India or anywhere in the world. The provisions are drafted for offering
and seeking help from the courts and investigation agencies and of foreign countries.
5. Freezing Assets of a Company: The NCLT isn’t just empowered to freezing the assets
of a company for using them at a later stage when such company comes under
investigation or scrutiny, such investigation could also be ordered on the request of
others in specific conditions.
6. Converting a Public Limited Company into a Private Limited Company: Sections
13-18 of the Companies Act, 2013 read with rules control the conversion of a Public
limited company into the Private limited company, such conversion needs an erstwhile
confirmation from the NCLT. NCLT has the power under section 459 of the Act, for

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 imposing specific conditions or restrictions and might subject granting approvals to such
conditions.

2.9 OECD PRINCIPLES (Business.Gov.in, 2018)

The OECD Principles of Corporate Governance were developed with a view to assist OECD
and non-OECD governments in their efforts to evaluate and improve the legal, institutional and
regulatory framework for corporate governance in their countries, and to provide guidance and
suggestions for stock exchanges, investors, corporations, and other parties that have a role in the
process of developing good corporate governance. Although, these principles mainly focuses on
publicly traded companies (both financial and non-financial), they also act as a useful tool to
improve corporate governance in non-traded companies, for example, privately held and state
owned enterprises. These principles majorly include:-

1. An effective corporate governance framework should be developed with a view to its impact
on overall economic performance, market integrity and the incentives it creates for market
participants as well as for the promotion of transparent and efficient markets. The legal and
regulatory requirements that affect corporate governance practices in a jurisdiction should
be consistent with the rule of law, transparent and enforceable. They should clearly
articulate the division of responsibilities among different supervisory, regulatory and
enforcement authorities.
2. The corporate governance framework should protect and facilitate the exercise of basic
shareholders’ rights, which should include the right to: (i) secure methods of ownership
registration; (ii) convey or transfer shares; (iii) obtain relevant and material information on
the corporation on a timely and regular basis; (iv) participate and vote in general shareholder
meetings; (v) elect and remove members of the board; and (vi) share in the profits of the
corporation. Shareholders should have the right to participate in, and to be sufficiently
informed on, decisions concerning fundamental corporate changes, such as, amendments to
the statutes or articles of incorporation; authorisation of additional shares; etc.
3. Capital structures and arrangements that enable certain shareholders to obtain a degree of
control disproportionate to their equity ownership should be disclosed. The rules and
procedures governing the acquisition of corporate control in the capital markets, and
extraordinary transactions, such as mergers and sales of substantial portions of corporate
assets, should be clearly articulated and disclosed so that investors understand their rights
and recourse. Transactions should occur at transparent prices and under fair conditions that
protect the rights of all shareholders according to their class.
4. All shareholders of the same series of a class, including minority and foreign shareholders,
should be treated equally. Within any series of a class, all shares should carry the same
rights. All investors should be able to obtain information about the rights attached to all
series and classes of shares before they purchase. Besides, all shareholders should have the
opportunity to obtain effective redress for violation of their rights.
5. Insider trading and abusive self-dealing should be prohibited.
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6. The corporate governance framework should recognise the rights of stakeholders established
by law or through mutual agreements and encourage active co-operation between
corporations and stakeholders in creating wealth, jobs and the sustainability of financially
sound enterprises. Further, it should be complemented by an effective, efficient insolvency
framework and by effective enforcement of creditor rights.
7. Performance-enhancing mechanisms for employee participation should be permitted to
develop.
8. The corporate governance framework should ensure that timely and accurate disclosure is
made on all material matters regarding the corporation, including the financial situation,
operating results, objectives, performance, ownership, remuneration policy and governance
of the company. Information should be prepared and disclosed in accordance with high
quality standards of accounting and financial and non-financial disclosure.
9. An annual audit should be conducted by an independent, competent and qualified auditor in
order to provide an external and objective assurance to the board and shareholders, such that
the financial statements fairly represent the financial position and performance of the
company in all material respects. External auditors should be accountable to the
shareholders and owe a duty to the company to exercise due professional care in the conduct
of the audit.
10. The corporate governance framework should ensure the strategic guidance of the company,
the effective monitoring of management by the board, and the board's accountability to the
company and its shareholders. That is, the Board members should act on a fully informed
basis, in good faith, with due diligence and care, and in the best interest of the company and
the shareholders. It should review and guide corporate strategy, major plans of action, risk
policy, annual budgets, business plans, performance objectives, etc. as well as monitor the
effectiveness of company's governance practices and make changes, wherever needed.

2.10 SELF ASSESSMENT QUESTIONS

True and false Questions:

Indicate whether the following statements are true or false:

a) Satisfied stakeholders will tend to remain loyal to the organization.
b) Corporate governance is the influence of stakeholders and their exercising of power to
control the strategic direction of the company.
c) Non-executive directors have an operational role in one of the key functions of the
business along with their director's duties.
d) Good corporate governance allows different people to hold the roles of chairman and
managing director.
e) The role of chairman is to ensure the organization is run efficiently and effectively.

Answers: a (T), b (T), c (F), d (T), e (T)

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Long Answer Questions

Q1. Define various forces that shaped the Industrial Relations in India. Also what impact ILO
left on Indian Industrial Relations?

Q2. What are the characteristics of Industrial Relations in India and how Tripartism affected the
Indian Scenario of Industrial Relations?

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 LESSON 3
INSIDER TRADING AND CRONY CAPITALISM

3 STRUCTURE

3.1. Insider Trading

3.2. Development of Insider trading law in India
3.3. Insider Trading and Stock Exchange Board of India
3.4. Amendments to Insider Trading Regulations
3.5. Trading Plan Under SEBI (Prohibition Of Insider Trading) Regulations, 2015
3.6. Crony Capitalism in India
3.7. Corporate Funding of Political Parties
3.8. Credit Rating Agencies
3.9. Green/E-Governance in India
3.10. Self-Assessment Questions

3.1 INSIDER TRADING (Shodhganga, 2018)

Insider trading becomes a serious crime in the capital market because it trenches upon the faith
of fair dealing. Trading by an insider of a company in the shares of a company is not a violation
of law per se but what is prohibited is the trading by an insider in the breach of trust or
confidence in the stock of a company on the basis of nonpublic information to the exclusion of
others. The degree of the violation and penalties differ widely from country to country and is
considered one of the most serious crimes on the faith of fair dealing in a capital market. The
degree of the violation and penalties differ widely from country to country. Trading by an
insider of a company in the shares of a company is not per se a violation of law. In fact trading
by insiders, including directors, officers and employees of the company in the shares of their
own company is a positive feature which companies should encourage because it aligns its
interests with those of the insiders. What is prohibited is the trading by an insider in breach of a
duty of trust or confidence in the stock of a company on the basis of nonpublic information to
the exclusion of others.

Insider trading refers to transaction in securities of a public listed company, by any insider or
any person connected with the company, based on any material yet non-published information,
which have the ability to impact on said company's securities market price, for their personal
advantage. Corporate insiders such as employees, directors, managers, and other connected
persons get access to the critical price sensitive information easily. When these persons use this
price sensitive and non-public information for their own economic advantage, they not only
breach the fiduciary duty they have been imposed with, but also impair the interests of
shareholders. The act of insider trading is a result of asymmetric information. Insiders enjoy the
privilege of being in the company and close to the primary source of information while general
shareholders at large are dependent upon the secondary sources of information. In most
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countries, trading by corporate insiders such as officers, key employees, directors, and large
shareholders may be legal, if this trading is done in a way that does not take advantage of non-
public information. However, this theory does not hold much relevance today. The United
States of America took a big step and became the very first country to formally enact a
legislation to regulate insider trading. Taking inspirations from America, most of the
jurisdictions around the world also put legal restrictions to this effect. India was also not late in
recognizing the detrimental impact that insider trading can inflict upon the rights of the public
shareholders, corporate governance in India and the financial markets overall. The market
watchdog, Securities Exchange Board of India (SEBI) has laid down the SEBI (Prohibition of
Insider Trading) Regulations, 1992 to curb and prevent this malpractice.

Insider trading is a term subject to various interpretation, connotations and definitions. “Insider"
means any person who is a connected person or in possession of or having access to
unpublished price sensitive information. "Trading" means and includes subscribing, buying,
selling, dealing, or agreeing to subscribe, buy, sell, deal in any securities, and "trade" shall be
construed accordingly. In simple terms, it can be defined as dealing in the securities of a
company on the basis of certain confidential information relating to the company which is not
published or not in the public domain, i.e. unpublished price sensitive information. Such
unpublished price sensitive information, if had been published, would have affected the
securities price of the company in a significant manner, and includes information relating to the
major mergers and acquisitions, takeovers, any major project plan, contract, buy back of
securities, bonus issues and so on and so forth. This is the fundamental reason behind the
disclosure norms set up by the regulators. The disclosure requirements can reduce the investor's
uncertainty and search expenses. Moreover, making such price sensitive information public may
enable the company's current investors to sell their shares at a higher price in the market. The
insider trading involves three basic elements. Firstly, there must be material non-public
information. Secondly, this information must emanate from an inside source and must be in
possession of some persons. And lastly, these persons shall deal in the securities based on the
possessed material non- public information.

These persons who make the profits or avoid losses are known as Insiders. To put it differently,
an insider is a person who has received or had access to such information or is so connected
with the company that it is reasonable to expect that he would have had access to such
information. The person who trades or tips any information violates the law if he has a fiduciary
duty or other relationship of trust and confidence not to use the information. Trading is also
prohibited when a person who receives information through a confidential relationship uses the
information for his or her own trading or tips to others. People who receive information in
confidence can include a broad range of persons involved in the securities markets. In USA,
from time to time, the Security Exchange Commission (USA market regulator) has charged
investment bankers, arbitrageurs, attorneys, law firm employees, accountants, bank officers,
brokers, financial reporters and even a psychiatrist with misappropriating information and
violating insider-trading prohibitions.
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The rationale behind the prohibition of Insider Trading is the obvious need and understandable
concern about the damage to public confidence which insider dealing is likely to cause and the
clear intention to prevent, so far as possible, what amounts to cheating when those with inside
knowledge use that knowledge to make a profit in their dealings with others. Permitting few
people to take advantage of Unpublished Price Sensitive Information before it not only affects
the performance of the company but also integrity of the financial market. Any market that is
not fair in its dealings or cannot effectively control unfair dealings in companies will not be an
attractive investment destination for investors. Rampant market manipulation and fluctuations
will be frowned upon by the investors and will dry up the inflow of investment into such
markets. Since, absolute prohibition of share trading by the insiders is not feasible; insider
trading is restricted and monitored through a series of measures in different jurisdictions.

3.2 DEVELOPMENT OF INSIDER TRADING LAW IN INDIA (Shodhganga, 2018)

India’s Company Law was enacted in 1956. However, it did not include any provisions to
charge the directors and the managing agents of companies for making the unfair use of inside
information. Although the Thomas Committee had pointed out the lack of a special legislation
to deal with the “unfair use of inside information” in 1948 itself, it took a few decades to
actually formulate a legislation to curb insider training.

The provisions relating to Insider Trading were incorporated in the Companies Act, 1956 under
Sections 307 and 308, which required shareholding disclosures by the directors and managers of
a company. Due to inadequate provisions of enforcement in the companies Act, 1956, the
Sachar Committee in 1979, the Patel Committee in 1986 and the Abid Hussain Committee in
1989 proposed recommendations for a separate statute regulating Insider Trading. The concept
of Insider Trading in India started fermenting in the 80's and 90's and came to be known and
observed extensively in the Indian Securities market. The rapidly advancing Indian Securities
market needed a more comprehensive legislation to regulate the practice of Insider Trading,
thus resulting in the formulation of the SEBI (Insider Trading) Regulations in the year 1992,
which were amended in the year 2002 after the discrepancies, observed in the 1992 regulations.
The amendment in 2002 came to be known as the SEBI (Prohibition of Insider Trading)
Regulations, 1992. The regulations of 1992 seemed to be more punitive in nature while the
2002 amendment regulations on the other hand are preventive in nature. The amendment
required all the listed companies, market intermediaries and advisers to follow the regulations
and also take steps in advance to prevent the practice of insider trading. These preventive
measures ensured the reduction of the cases involving the practice of Insider Trading and also
informing the persons who indulge in such practices, of the laws relating to Insider Trading.
These regulations particularly emphasize on the delegation of powers on the entities themselves
to conduct internal investigations before they present their case before the Stock Exchange
Board of India in relation to insider trading. The guidelines provide for a definite set of
procedures and code of conduct for the entities whose employees, directors and owners are most
expected to be in a position to take an undue advantage of confidential inside information for
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their personal profits. Various committees were constituted in India from time to time to assess
the corporate regulation frame work in India. These committees had also examined the then
existing framework in the U.S., as the U.S. had elaborate laws on the subject. The provisions in
the U.S. law, under the Exchange Act were considered effective. For instance, the regulations
framed by the SEC under Section 14(d) of the Exchange Act, facilitated active participation by
security holders and the investors in the affairs of the companies. The following committees
were constituted in this regard:

Thomas Committee: This committee considered the issue of introducing regulation of short
swing profit in the line with section 16 (b) of Securities Exchange Act, 1934 of U.S.A. the
Committee gave recommendation for strengthening of disclosure mechanism under the
company law in the line with similar recommendation of Cohen Committee on company law
reform in U.K. Cohen approach reflected the old tradition that insider trading is wholly a matter
of company law. The rationale was disclosure of holding in public domain would reduce the
opportunity for engaging in insider trading. Based upon this and other recommendations of
disclosure regime were introduced under section 307 and 308 of Companies Act, 1956 by its
1965 amendment. Insider trading continued to be legal it was only in early 1980s it began to be
recognised as undesirable practice.

The Bhaba Committee: The Bhaba Committee was constituted in 1952 in order to revamp the
then existing Companies Act, 1913. In its report, the committee observed the trend of fraudulent
dealings in the shares by the directors of the companies. The report observed that there existed
evil of the directors dealing in the shares of their own companies, exists although on a limited
scale. However, it is interesting to note that the term „insider trading‟ does not find place in the
report prepared by the committee, especially when Thomas Committee has elaborately
discussed this issue way back in 1948.

Sachar Committee: In 1977, Sachar Committee14, a high powered committee was set up to
review the provisions of the Companies Act and the Monopolies and Restrictive Trade Practices
Act, 1969 (the current Competition Act, 2002). This Committee opined that Sections 307 and
308 of the Companies Act were insufficient to curb insider trading. The Committee‟s view was
that the statutory provisions which require disclosures to the shareholders regarding the
transactions in the sale and purchase of shares by the directors and other key managerial persons
are insufficient to solve the problem of certain class of people securing unfair profits by the use
of non-public confidential information.

The Sachar Committee had also identified certain category of persons who may be included in
the category of insiders, such as the company's directors, statutory auditors, cost auditors,
financial accountants or financial controller, cost accountants, tax management consultants or
advisers and the whole time legal advisers or solicitors who would generally have access to the
price sensitive information not available to the outsiders. Although the Thomas Committee had

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also earlier suggested a broader category of insiders to be identified within the regulatory
purview, no legislative actions were pursued in this regard.

Further, the Sachar Committee had identified that it is often difficult to prove whether or not the
material non-public information has been actually put to use in a transaction. The committee
was of the view that the law should provide that an insider including the categories mentioned
above, should be prohibited from purchasing or selling the shares of the company, either
directly or indirectly, for a period of two (2) months‟ prior to and after the closing of the
accounting year of the company. This period was specifically considered crucial as there was a
presupposition that an insider would possess confidential information during such time. The
proposal was that once it is proved that the deal by an insider has resulted in one party taking
advantage over the other by misusing the information relating to the company, then the insider
shall be liable at law to the other party: i.e., the person with whom the insider has then dealt, the
company in whose shares he has dealt or whose information he has used in so doing.

Another recommendation made by the Sachar Committee had also opined that the law should
confer a remedy on persons who can establish an identifiable loss by reason of the misuse of
materially significant information; and in addition, an insider should be held to be accountable
to the company for his unjustifiable profits. Despite the foregoing recommendations, until date,
the Indian securities laws do not provide for sufficient remedies to the persons suffering losses
due to misuse of information. In this regard in India, the Stock Exchange Board of India has
made efforts to disgorge the profits illegally made by market manipulators and insiders, by
exercising its powers, to issue directions in the interest of the investors and to protect the
integrity of the securities market. However, until 2009, the SAT had not upheld any such
enforcement order for disgorgement, as the Stock Exchange Board of India did not have any
specific statutory powers to order disgorgement. In Dhaval Mehta v SEBI the SAT, for the first
time, recognized Stock Exchange Board of India‟s power to direct disgorgement of illegal
profits made by market manipulators. More specifically, the Sachar Committee had
recommended additional requirements for the disclosures under the Companies Act and the
disclosures by other persons, who are temporary insiders or who become insider by virtue of
their possession of information.

Patel Committee: The Government of India had constituted a high power committee in May
1984 headed by G. S. Patel (the “Patel Committee”) to make a comprehensive review of the
functioning of the stock exchanges. The Patel Committee had highlighted that insider trading
was unethical as it involves misuse of confidential information and betrayal of fiduciary
position of trust and confidence. The Patel Committee had suggested that a malpractice such as
„insider trading‟ should be made a cognizable offence. The report submitted by the Patel
Committee defined „insider trading‟ as “trading in the shares of the company by the persons
who are in the management of the company or are close to them, on the basis of unpublished
price sensitive information, regarding the working of company, which others do not have.” This
was the first time that the term “insider trading” was defined and proposed as an area that
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required legislation, to the Indian Government. Further, it was for the first time in India that a
government committee had recommended a specific statutory prohibition of insider trading.
Although the Sachar Committee had recommended that transactions by directors and key
managerial persons of like nature should be prohibited, the activity by the name of „insider
trading‟ was sought to be prohibited for the first time by the Patel Committee. The Patel
Committee had recommended that a codified legislation similar to the Australian law should be
drafted in India also to counter the malpractice of „insider trading.‟ The committee had also
submitted draft legislation for prohibiting insider trading. As regards the legal mechanism, the
Patel Committee had recommended the introduction of provisions relating to insider trading as
an amendment to the SCRA, on the lines of the Australian legislation. Additionally, the
committee also recommended incorporating some of the important provisions of the U.K.
Company Securities (Insider Dealing) Act, 1985.

This committee dealt with the offence of insider trading in a thorough and comprehensive
manner. For example, the committee had suggested that insider trading should be fined heavily
for first offence, and imprisonment up to five (5) years should be given for second and
subsequent offences. The Patel Committee report also acknowledged that in the U.S., other than
the specific legislation, the Supreme Court and the Court of Appeals of various states have
issued guidelines on insider trading, to maintain proper „fiduciary standards‟, ensure justice and
equity in the securities market, and to protect the interests of the investing public. The
committee’s report also suggested certain remedial measures for tackling the menace of insider
trading. The Committee had identified that one of the reasons for excessive speculation in the
stock exchanges during 1980s, was the lack of prompt disclosure of corporate news by the
companies whose shares are listed with the stock exchanges.

Therefore, as remedial measure, the Patel Committee had recommended that all the listed
companies should publish their un-audited working results at least on a half -yearly basis, and
on a quarterly basis if the paid-up capital of the company is more than Rs.10 crores. The
committee further recommended that the stock exchanges should be immediately informed
about any significant financial or other news or developments affecting the price of the
company’s securities, as soon as such matters are placed on the agenda of the board meetings
and circulated to other directors.

The committee also proposed that if any company fails to comply with the provisions of the
listing agreement (entered between the companies and the stock exchanges) relating to material
disclosures by the company, the person in-charge of the management of the company should
also be penalized for non-compliance. The committee recommended that such statutory
responsibility for noncompliance of disclosure obligations should be introduced under the
Companies Act, 1956, and the Securities Contract (Regulation) Act. However, it was only after
20 years in 2002, that a provision imposing monetary penalty for noncompliance of listing
agreement was inserted in Securities Contract (Regulation) Act, 1956.

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Abid Hussain Committee on Capital Markets: In 1989, the Abid Hussain Committee was set
up to examine the adequacy of the existing institutions, instruments and the structures in the
Indian capital market and the rules governing its functioning. One of the first and foremost
problems identified by the committee was insufficiency of the basic rules of the capital market.
The basic rules were adjudged to be insufficient because of the fast changing needs capital
market especially in the area of investor protection and guidance. The committee also
acknowledged that despite the continuing efforts on the part of various authorities, many aspects
of trading practices still required improvement. Rules and standards emphasizing fairness in
securities dealings were perceived to be insufficient and amenable to misuse by the traders. The
committee also observed that the absence of effective checks and penalties was encouraging the
speculators and not the genuine investors.

In April 1988, the Government of India constituted the SEBI, with the primary mandate of
investor protection. During the deliberations of the Abid Hussain Committee, the SEBI had
initiated the process of incorporating the legal framework to regulate the conduct of all the
major players in the market, i.e., the issuers, intermediaries and the exchanges.

Although the Abid Hussain Committee had admitted its difficulty in prescribing remedies to
each one of the trading malpractices in the Indian stock market, it is observed that problems of
insider trading and secret takeover bids could be tackled to a large extent by appropriate
regulatory measures. The committee proposed that insider trading should be regarded as a major
offence, punishable with civil as well as criminal penalties. The committee recommended that
the SEBI should be asked to formulate the necessary legislation, empowering itself with the
authority to enforce the provisions.

Sodhi Committee: The High Level Committee was constituted to Review the SEBI
(Prohibition of Insider Trading) Regulations, 1992 under the Chairmanship of Justice N.K.
Sodhi, former chief justice of Karnataka and Kerala High Courts and former presiding officer of
the Securities Appellate Tribunal, submitted its report to SEBI Chairman, Shri U.K. Sinha, on
December 7, 2013 at Chandigarh. The Committee has made a range of recommendations to the
legal framework for prohibition of insider trading in India and has focused on making this area
of regulation more predictable, precise and clear by suggesting a combination of principles-
based regulations and rules that are backed by principles. Some of the salient features of the
proposed regulations are set out below:-

1. While enlarging the definition of "insider", the term “connected person” has been
defined more clearly and immediate relatives are presumed to be connected persons,
with a right to rebut the presumption. The term “immediate relative” would cover close
relatives who are either financially dependent or consult an insider in connection with
trading in securities.
2. Insiders would be prohibited from communicating, providing or allowing access to UPSI
unless required for discharge of duties or for compliance with law.
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 3. The regulations would bring greater clarity on what constitutes “unpublished price
sensitive information” (“UPSI”) by defining what constitutes “generally available
information” (essentially, information to which non-discriminatory public access would
be available). A list of types of information that may ordinarily be regarded as price
sensitive information has also been provided.
4. Trading in listed securities when in possession of UPSI would be prohibited except in
certain situations provided in the regulations.
5. Insiders who are liable to possess UPSI all-round the year would have the option to
formulate pre-scheduled trading plans. In such cases, the new UPSI that may come into
their possession without having been with them when formulating the plan would not
impede their ability to trade. Trading plans would, however, be required to be disclosed
to the stock exchanges and have to be strictly adhered to.
6. Conducting due diligence on listed companies would be permissible for purposes of
transactions entailing an obligation to make an open offer under the Takeover
Regulations. In all other cases, due diligence would be permissible subject to making the
diligence findings that constitute UPSI generally available prior to the proposed trading.
In all cases, the board of directors would need to opine that permitting the conduct of
due diligence is in the best interests of the company, and would also have to ensure
execution of non-disclosure and non-dealing agreements.
7. Trades by promoters, employees, directors and their immediate relatives would need to
be disclosed internally to the company. Trades within a calendar quarter of a value
beyond Rs. 10 lakhs or such other amount as SEBI may specify, would be required to be
disclosed to the stock exchanges.
8. Every entity that has issued securities which are listed on a stock exchange or which are
intended to be so listed would be required to formulate and publish a Code of Fair
Disclosure governing disclosure of events and circumstances that would impact price
discovery of its securities.
9. Every listed company and market intermediary is required to formulate a Code of
Conduct to regulate, monitor and report trading in securities by its employees and other
connected persons. All other persons such as auditors, law firms, accountancy firms,
analysts and consultants etc. who handle UPSI in the course of business operations may
formulate a code of conduct and the existence of such a code would evidence the
seriousness with which the organization treats compliance requirements.
10. Companies would be entitled to require third-party connected persons who are not
employees to disclose their trading and holdings in securities of the company.

3.3 INSIDER TRADING AND THE STOCK EXCHANGE BOARD OF INDIA

(Shodhganga, 2018)

The Controller of Capital Issue was the first authority to approve issue of securities, and the
amount, type and the price of securities, as well. The Controller of Capital Issue was set up in
1947, under the Capital Issues Act. However, with the repeal of Capital Issues (Control) Act,
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1947 the Controller of Capital Issue also was abolished and the SEBI was set up in April 1988,
for healthy growth of capital market and investor protection as its primary objective.
The SEBI Act had established SEBI as a regulatory body to protect the interests of the investors
in securities, promote the development of the securities market, and to regulate the securities
market. SEBI assumed the statutory status on 21 February, 1992, by way of an ordinance
promulgated on 30 January, 1992. This Ordinance was replaced by the SEBI Act on 4 April,
1992. The Preamble to the SEBI Act mandates SEBI to ensure investor protection and healthy
and orderly development of the securities market. In July 1988, before the Ordinance, the SEBI
had prepared an approach paper on a complete legislative framework for securities market
which included measures to curb fraudulent and unfair practices. Relying on the “high standard
of conduct” stressed by the Cohen Committee with respect to insider dealing, the SEBI had
issued a press release dated 19 August 199224 with a recommendation to formulate the
“internal code of conduct” for the companies to check the practice of insider trading.

SEBI (Prohibition of Insider Trading In the Securities Market), Regulations, 1992

Under the SEBI Act, Section 11(2) (g) 25 empowered the SEBI to take such measures, inter
alia, to prevent insider trading, to protect the interest of investors and to promote the
development of and regulate the securities market. The SEBI has been further empowered to
make regulations consistent with the SEBI Act under Section 30 of the SEBI Act. Pursuant to
such powers, the SEBI had framed the SEBI (Prohibition of Insider Trading in the Securities
Market), Regulations, 1992 on 19 November, 1992 for prohibiting the offence of „insider
trading.‟ Thus, the Insider Regulations were framed by SEBI seven (7) months after the Indian
Parliament enacted the SEBI Act. Regulation 4 deals with the offence of insider trading, it
provides that any insider who deals in securities27 in contravention of Regulation 3 (or 3A) 28
is guilty of „insider trading‟. Regulation 3 seeks to prohibit dealing, communication and
counselling on the basis of unpublished price sensitive information (“UPSI”). Therefore, the
ingredients for the offence of insider trading are identified in Regulation 3.

The Insider Regulation defines the term “insider” as any person who, is or was connected with
the company or is deemed to be connected with the company and who is reasonably expected to
have access, by virtue of such connection, to unpublished price sensitive information in respect
of securities of the company, or who has received or has had access to such unpublished price
sensitive information (Regulation 2(e) of the Insider Regulations). If a person is an “insider”
and if he is in possession of „unpublished price sensitive information‟, then he will be covered
within the prohibition contained in Regulation 3 of the Insider Regulations. However, prior to
the amendment of 2002, the prohibition applied to situations where the insider had actually used
the unpublished price sensitive information while dealing in securities. The reason attributed for
this shift from liability for use of the unpublished price sensitive information to mere possession
of the unpublished price sensitive information is because of the difficulty to prove that the
insider had actually used the unpublished price sensitive information while dealing in the

67
securities, whereas it is easier to prove that the insider dealt in securities while in possession of
unpublished price sensitive information.

In 1993, the SEBI once again advised the companies to prescribe certain internal norms relating
to the company’s information vis-à-vis the Insider Trading Regulations.30 The suggested
parameters under the press release were:

i. Identification of the types of information which could be considered as price sensitive

information in relation to the business of the company and its subsidiaries and associate
companies, for example:
a. Earnings forecast or material changes therein;
b. Proposals for mergers & acquisitions;
c. Significant changes in investment plans;
d. Acquisition or loss of a significant contract;
e. Significant disputes with major suppliers, consumers or subcontractors; and
f. Significant decision affecting the product pricing, profitability, etc.
ii. Identification of the employees or officers or sections of employees/officers of the
company who are likely to have access to such information and considered as insiders.
iii. Nomination of an officer or officers of a company who would give clarifications to the
employees of the company on their ability to deal in the company’s shares without
attracting the charges of insider trading.
iv. Controls on handling the price-sensitive information identified above and the publication
of such information, wherever possible, so as to eliminate the non-public character of
the information.
v. The norms to be followed by all officers and the employees of the companies, such as
not dealing in the shares of the company for a particular period (before and after the
declaration of periodical financial results), the time period for which the employees and
officers of the company have to wait before they deal in the shares of the company (after
any price-sensitive information has been made public), etc.
vi. Declaration of purchase and sale of the shares of the company to be obtained from
employees and officers including transactions done by the relatives of employees and
officers.
vii. The procedure to be laid down for handling information which may affect the price of
the securities of other companies in situation such as mergers, takeovers, etc.

In 2002, the above norms were further modified and the Model Code of Conduct framed under
the Insider Regulations came into force. Further, it was only in 2002 that a specific provision
regarding the prohibition on insider trading was inserted in the SEBI Act. The SEBI Act
prohibits manipulative trades, insider trading activities and substantial acquisition of securities.
It provides as below:-“No person shall directly or indirectly –

68
 i. use or employ, in connection with the issue, purchase or sale of any securities listed or
proposed to be listed on a recognized stock exchange, any manipulative or deceptive
device or contrivance in contravention of the provisions of this Act or the rules or the
regulations made there under;
ii. employ any device, scheme or artifice to defraud in connection with issue or dealing in
securities which are listed or proposed to be listed on a recognized stock exchange;
iii. engage in any act, practice, course of business which operates or would operate as fraud
or deceit upon any person, in connection with the issue, dealing in securities which are
listed or proposed to be listed on a recognized stock exchange, in contravention of the
provisions of this Act or the rules or the regulations made there under;
iv. engage in insider trading;
v. deal in securities while in possession of material or non-public information or
communicate such material or non-public information to any other person, in a manner
which is in contravention of the provisions of this Act or the rules or the regulations
made there under;
vi. acquire control of any company or securities more than the percentage of equity share
capital of a company whose securities are listed or proposed to be listed on a recognized
stock exchange in contravention of the regulations made under this Act.”

As regards sub-clauses (d) and (e) above, although the SEBI had incorporated the provisions
relating to insider trading in the SEBI Act, the SEBI Act did not define the term “insider
trading.” Although the Section 12A did not have any material impact on the analyses and
enforcement of the insider trading cases in India, the demand among the jurists for a specific
provision under the SEBI Act prohibiting insider trading was recognized. Subsequently, the
SEBI amended the Insider Regulations on several occasions. A close look at the timing of these
amendments even makes it possible to think that the experiences gained through the process of
testing various enforcement actions of the Indian regulator and the views of the courts and
tribunals/appellate authority on the subject, was the background of these amendments.

Kumar Mangalam Birla Committee: In early 1999, the SEBI had set up a committee headed
by Kumar Mangalam Birla, a member of the SEBI Board, to promote and raise the standards of
good corporate governance. The Kumar Mangalam Birla Report on Corporate Governance
elaborately discussed about the importance of prohibition of insider trading for good corporate
governance. Some of the relevant recommendations in the report are as follows:

i. suitable amendments to the listing agreement executed by the stock exchanges with the
companies and any other measures to improve the standards of corporate governance in
the listed companies, in areas such as continuous disclosure of material information,
both financial and non-financial, manner and frequency of such disclosures,
responsibilities of independent and outside directors;
ii. drafting a code of corporate best practices; and

69
 iii. safeguards to be instituted within the companies to deal with the inside information and
insider trading.

The report also observed that the existence and enforceability of regulations relating to insider
information and insider trading are crucial to good corporate governance. Further, the
provisions regarding existence and enforceability of insider trading regulations were examined
separately by a group appointed by SEBI under the Chairmanship of Kumar Mangalam Birla.
However, no separate report is publicly available prescribing safeguards for companies to deal
with insider trading or suggesting any changes in the Insider Regulations. Nevertheless, the
2002 amendment to the Insider Regulations is presumed to be an outcome of the deliberations
of this committee.

3.4 AMENDMENTS TO INSIDER TRADING REGULATIONS

1. Securities and Exchange Board of India (Insider Trading) (Amendment) Regulations,

2002

Insider Trading Amendment Regulations, 2002 brought about the much awaited amendments in
the Insider Regulations, which included the conceptual alterations. The below mentioned
significant amendments were introduced under different headings of the Insider Regulations:

Insider

i. The definition of “connected person” at Regulation 2 (c) that existed earlier was
substituted with a new definition of “connected person”. The amendment included the
persons having both temporary and permanent professional or business relationship with
the company under in the definition of “connected person.” Therefore, the scope of the
term “insider” was broadened by including temporary professionals as well. Further,
connection was given a periodical existence, i.e., a person connected within six (6)
months prior to the act of insider trading was regarded as connected person.
ii. The definition of “insider” was modified and the words “ by virtue of such connection”
were deleted from the definition. SEBI‟s argument in the Hindustan Lever Case that the
acquisition of UPSI by an insider could be independent of the insider’s connection with
the company was upheld by the appellate authority. On similar lines, by the amendment
in 2002, the SEBI had altered the law to avoid any contrary interpretations in future.
iii. A clause was included in the definition of “insider” whereby the intermediaries such as
the Investment Company, the Trustee Company, the Asset Management Company or an
employee or director of stock exchange or clearing house or clearing corporation were
also included in the scope of “deemed connected person”.39 This description of
“intermediary” was taken from Section 12 of the SEBI Act.
iv. The relatives of connected person were also included in the category of deemed
connected person.
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 v. Further categories were included in the definition of “deemed connected person”, such
as a person who is a concern, firm, trust, Hindu undivided family, company or
association of persons wherein, either the director or deemed director41 or any of the
persons mentioned at Regulation 2(h) (vi) to (viii), (i.e., relative of the persons
mentioned in the initial clauses of definition of “deemed connected person”), who have
more than 10% of the holding or interest.

Unpublished Price Sensitive Information

The definition of “unpublished price sensitive information” was bifurcated into “unpublished
information” and “price-sensitive information”. The new definition for “price-sensitive
information” was inserted at Regulation 2(ha) and the term “unpublished” was defined at
Regulation 2(k). The term “unpublished” was defined separately as “information which is not
published by the company or its agents and is not specific in nature.” The explanation to the
provision stated that “speculative reports in print or electronic media are not considered to be
published.” The term “price-sensitive information” was defined as “any information which
relates directly or indirectly to a company and which if published is likely to materially affect
the price of securities of company.” The definition also provided an inclusive list of kinds of
information which are deemed to be price-sensitive information. Thus, the new definition of
„price sensitive information‟ seems to have taken care of the ambiguity pointed out by the
appellate authority in the Hindustan Lever Case relating to the “unpublished price sensitive
information.”

Offence of Insider Trading

i. The definition of “dealing in securities” was amended to include the term “subscribe”, in
addition to the existing actions of buying and selling. Therefore, the offence of insider
trading was extended to the primary market by covering the cases of initial public offers.
ii. Earlier, the liability of insider trading could be imposed if the insider dealt in the
securities on the basis of the UPSI. However, the amendment altered this requirement
and provided that mere possession of the UPSI is sufficient to impose the liability for
insider trading. The words “on the basis of” in Regulation 3 was substituted with the
words “while in possession of”. This amendment was similar to the Rule 10 b-5-1 of the
U.S.‟ Exchange Act relating to possession v. use of UPSI. This amendment in the
Insider Regulation was very significant in the Indian scenario as well, as the amendment
eased SEBI’s difficulties in proving the liability of an insider who had traded on the
basis of UPSI. Consequently, this resulted in better enforcement of insider trading cases
in India.
iii. Tipping per se was made an offence under the amendment. Earlier, if the tippee did not
trade using the tipped UPSI, the tippee and the tipper could not be held liable. However,
after the amendment, the tippers‟ and the tippees‟ liability was made absolute and they
could be held liable even if the tippee himself did not trade on the tipped UPSI.
71
 Therefore, Regulation 3 (ii) was amended to prohibit tipping UPSI, irrespective of
whether the tipped trades using the tipped UPSI.
iv. Prior to the amendment, a company could not be held liable for insider trading. This
became an issue as many companies also involved in insider trading and made huge
profits. Therefore, the Regulation 3A was inserted to prohibit companies from dealing in
the securities of another company or associate of that other company while in possession
of UPSI. This amended was warranted as companies and not just persons were
stakeholders in other companies and during takeovers, the potential bidders (which were
companies) were in possession of UPSI.

Provisions on Investigation

i. The amendment conferred SEBI with additional powers to conduct inquiries and
inspection against an insider to establish the liability for violation of Insider Regulations.
ii. Prior to the amendment, SEBI could not proceed with an action for insider trading
violation, if the SEBI did not have written information about the violation. However,
now the requirement of “written information” to be in the possession of SEBI has been
dispensed with. Now, SEBI can initiate investigation by appointing an investigating
authority if SEBI is of the prima facie opinion that it is necessary to investigate.
iii. The scope of investigation has been extended to more categories such as stock
exchanges, mutual funds, other persons associated with the securities market,
intermediaries and self-regulatory organizations in the securities market.
iv. The timeframe of one (1) month to complete the investigation and submit the
investigation report has been substituted by “reasonable time”. Although this
amendment may cause delays in enforcement of insider trading cases, SEBI will get
adequate time to carry out detailed investigations as required and collect evidence,
before concluding the liability of insider trading on an insider.
v. Time limit of twenty-one (21) days was prescribed to a person who had to file a reply
upon receipt of the communication with the findings of the investigation.

Enforcement

The amendment gave additional powers to SEBI to issue appropriate directions to an insider for
insider trading violations, focusing on the investors’ interests. Under the amended provisions,
the SEBI had powers to declare a transaction underlying an insider trade null and void. SEBI
also procured additional power to issue directions to the person who acquired the securities to
deliver such securities back to the seller, and if he is not in a position to deliver, to pay the
market price of such securities (prevailing at the time of \issuing of directions or at the time of
the transactions) to the seller. Post 2002 amendment, SEBI could also direct a person who has
dealt in securities in violation of the regulations to transfer a fixed amount or proceeds
equivalent to the cost price or market price of securities, whichever is higher, to the investor
protection fund of a recognized stock exchange.
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Corporate Governance

The most important amendment introduced was the mandatory good governance provisions in
Chapter IV of the Insider Regulations and the Model Code of Conduct for the listed companies
and other entities, and relating to disclosures, for prevention of insider trading as Schedules I
and II respectively. Based on the foregoing, it can be concluded that the amendments of 2002
have significantly strengthened the regulatory regime of insider trading in India. Emphasis was
given to the inclusion of corporate governance norms as a method for prevention of insider
trading in companies and other entities associated with the capital market. The “possession”
requirement for deciding the liability in the cases of insider trading also resolved the problems
faced by the regulator in proving the cases. Substantial changes were made to the provision of
UPSI, all of which had enhanced the SEBI‟s enforcement capability, specifically with respect to
insider trading cases.

2. Amendment of 2002 for Chinese wall Defenses

It is interesting to note that another amendment was introduced in the same year 2002 in the
Insider Regulations. The amendment was introduced as Regulation 3B, which provided for
general defenses available to a company for defending the charge of insider trading. These
defenses are popularly referred to as Chinese Wall Defenses for the companies and are similar
to the provisions under the Australian Corporations Act. The defenses available in India are that
the UPSI was in the possession of an officer or employee, and:

i. that the decision to enter into the transaction or the agreement was taken on the
company’s behalf by person or persons other than that officer or employee;
ii. the company has put in place the system of demarcating the activities of the company in
such a way that the person who enters into a transaction on behalf of the company
cannot have access to information which is in the possession of other officer/employee
of the company;
iii. arrangements were made to ensure that information was not communicated to the person
or persons who made the decision and that no advice with respect to the transactions or
agreement was given to that person or any of those persons by that officer or employee;
iv. the information was not communicated or no such advice was given; and
v. the acquisition of shares of a listed company were as per the SEBI‟s Takeover
Regulations.

In view of the foregoing, the defenses for insider trading under the Insider Regulations are
available only to the companies and not to the individuals. It is surprising that no defenses have
been made available to the entities other than the companies. An intermediary or other entities
in the securities market who is alleged to have indulged in insider trading, while in possession
of UPSI, and if it was the intermediary’s/entities‟ employee who actually committed the insider
trading stealthily, cannot have a defence under Regulation 3B. But if it has the legal structure of
73
the company, the defences are available. It is unfair that the norms prescribed for prevention of
insider trading apply to all entities including the companies, whereas the defences are available
only to the companies. The specific inclusion of Regulation 3A and 3B (relating to offence of
insider trading by a company and the defences) was on the premise that a company is a juristic
person and not a natural person, and therefore, a company cannot indulge in insider trading.
However, this explanation is untenable from a legal and logical standpoint.

3. Amendments in Insider Regulations (2003)

Minor amendments were again introduced in the Insider Regulations in 2003 regarding the
formats in which the disclosures were to be made under the Insider Regulations. For instance,
the Form A under Regulation 13 (filing of disclosures) was part of this amendment. In Reliance
Industries Limited v Securities and Exchange Board of India this case, Based on the complaint
received the SEBI conducted an investigation into the alleged transactions. SEBI was of the
prima facie view that RIL and the Ambanis were insiders, the acquisition of RIL’s stake in L&T
by GIL was pricesensitive information, and that the acquisition of L&T shares by RIL, prior to
the sale to GIL was on the basis of UPSI. Based on the above, SEBI had issued a show-cause
notice to RIL. The Ambanis denied that they were insiders and also said that they did not have
access to the alleged price-sensitive information. Therefore, the primary issue before the SEBI
was the interpretation of the term “insider” whether Mukesh Ambani and Anil Ambani were
„insiders‟ within the meaning of Regulation 2(e) of the Insider Regulations and whether they
can be termed as „connected persons‟ or „deemed to be connected persons‟ in terms of
Regulation 2 (c) and (h) of the Insider Regulations. In its order dated 21 January 2004, the SEBI
ruled that as the Ambanis were the directors on the board of L&T and were reasonably expected
to have access to the L&T‟s UPSI; the Ambanis were „connected persons‟ within the meaning
of Regulation 2 (c) of the Insider Regulations. SEBI also observed that RIL and L&T may be
deemed to be bodies corporate under the same management as per Section 2 (g) of the MRTP
Act, 1969, and therefore, RIL would be “deemed to be a connected person” with L&T. Thus,
although the SEBI concluded that the Ambanis can be regarded as “insiders”, the finding
regarding insider trading violation was that as the UPSI was not received by RIL or Ambanis as
insiders of L&T, they cannot be held liable for violation of Regulation.

4. SEBI Insider Regulations 2008

In 2008, the SEBI made an attempt to introduce the concept of short swing profits in the Insider
Regulations. SEBI sought to prohibit certain category of insiders from making short swing
profits, i.e., profits made from the sale of securities followed by their repurchase within six (6)
months. However, the proposal as contemplated in SEBI’s concept paper did not materialize in
its entirety. Prior to this, the Thomas Committee of 1948, inter alia, had evaluated the U.S.
regulations on short swing profits under Section 16 of the Exchange Act. Section 16 of the
Exchange Act provides for a three-fold attack against the possible abuses of inside information
by corporate insiders, which, inter alia, include: (i) reporting by certain insiders of their stock
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holdings and transactions in the company’s securities; (ii) makes it unlawful for the same
insiders to engage in short sales of their company's equity securities; (iii) permits the company
or a security holder to initiate an action on behalf of the corporation to recover the benefits of
the short swing profits. Besides the short swing profit regulations, the other key features of the
2008 amendment are as follows:-

i. The term “insider “was amended once again, finally resolving a lot of issues relating to
the interpretation of the term “insider”. Thus, with the amendment in 200853, the
definition of “insider” has been simplified and is made applicable to any person who has
or has had access to the UPSI of the company. Therefore, any person, irrespective of
whether the person is within the company or outside, who chances upon UPSI can be
held liable for insider trading.
ii. Prior to the 2008 amendments, the Regulation 13 provided that certain category of
persons had to make certain disclosures within four (4) working days. The amendment
of 2008 has reduced this reporting time period from four (4) days to two (2) working
days.
iii. The provision at Regulation 13(4) has been substituted with the new clause that any
person who is a director or officer of a listed company, shall disclose to the company
and the stock exchange the total number of shares or voting rights held, and change in
shareholding or voting rights, if there has been a change in such holdings of such person
and his dependents (as defined by the company) from the last disclosure made under
sub-regulation (2) or under this sub-regulation, and the change exceeds Rs.5 lakh in
value or 25,000 shares or 1% of total shareholding or voting rights, whichever is lower.
These disclosures were to be made within two (2) working days from the receipt of the
intimation of allotment of shares, or the acquisition or sale of shares or voting rights, as
the case may be. Prior to the amendment, there was no disclosure requirement to the
stock exchanges. Further, the furnishing of information regarding the change in the
shareholding of the dependents did not exist earlier.
iv. The procedure of e-filing54 was introduced to simplify the disclosure procedure.
v. The amendment made it mandatory for all the shareholders to provide their Permanent
Account Number (PAN) in all the forms relating to the disclosures under the Insider
Regulations.

3.5 TRADING PLAN UNDER SEBI (PROHIBITION OF INSIDER TRADING)

REGULATIONS, 2015 (Sethi, 2015)

The concept of trading plan has been introduced in India by the SEBI (Prohibition of Insider
Trading) Regulations, 2015 (the PIT Regulations). In every company there are persons holding
key managerial positions or promoters who may be perpetually in possession of Unpublished
Price Sensitive Information (UPSI). For such persons it is impossible to trade in the securities of
the Company. These persons are always involved in decision making and thus have access to
UPSI. Trading plans provide such persons opportunity to trade in the securities of the company
75
without compromising the prohibitions imposed under the PIT Regulations. It is a mechanism
which facilitates monetizing of securities by insiders on a regular basis who may otherwise be
unable to trade in securities of the company.

When an insider formulates a trading plan, he may be in possession of certain UPSI which
would become generally available to the public by the time the cooling off period is over and
the insider trades on the basis of the trading plan. Under the circumstances, impact of such UPSI
gets factored in the price of the security at the time of trading. In another situation, at the time of
trading the insider may be in possession of certain UPSI which was not existent at the time of
formulation of the trading plan. Existence of such UPSI does not matter because it had not
influenced the insider’s decision to trade. The decision to trade had already been taken before
this UPSI came into existence. This is the basic principle on which the concept of trading plan
has been developed.

Trading plans enable compliant trading by insiders without compromising the prohibitions
imposed in the PIT Regulations. However, the possibility of abuse of the trading plans cannot
be ruled out. Though, the trades may be predetermined but the publishing of UPSI may be so
timed as to profit the insider from the predetermined trades. Such instances were reported in the
United States where the concept of trading plans was introduced way back in the year 2000.
Thus the trading plan does not provide absolute immunity from investigations into trading under
a pre-determined trading plan because there may be instances of manipulation of timing of
making UPSI generally available to suit the trading plans of insiders.

Trading plans enable compliant trading by insiders without compromising the prohibitions
imposed in the PIT Regulations. However, the possibility of abuse of the trading plans cannot
be ruled out. Though, the trades may be predetermined but the publishing of UPSI may be so
timed as to profit the insider from the predetermined trades. Such instances were reported in the
United States where the concept of trading plans was introduced way back in the year 2000.
Thus the trading plan does not provide absolute immunity from investigations into trading under
a pre-determined trading plan because there may be instances of manipulation of timing of
making UPSI generally available to suit the trading plans of insiders.

Trading plans provide an affirmative defense against accusations of insider trading. Where the
insider is aware of UPSI on the date of trading he can raise a defense that the trade was made as
per the terms of a trading plan drawn as per the requirements of the PIT Regulations.
Affirmative defense allows a defendant to raise a defense but does not guarantee a win on the
defense. The defendant who has done a wrongful act may prove that there exist circumstances
which under the law either justify or excuse his otherwise wrongful actions. Another illustration
of an affirmative defense in criminal cases is action taken in ‘self-defense’.

To curb the abuse of the Trading Plans, certain safeguards have been built in the provisions of
PIT Regulations, which are:
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 1. cooling off period of six months;
2. no trading during specified periods;
3. trading plan to cover a period of at least 12 months;
4. no overlapping of trading period in two trading plans;
5. approval of trading plan;
6. public dissemination of trading plan;
7. mandatory implementation of trading plan;
8. trading plan to be deferred in case UPSI at the time of formulation of the trading plan is
not generally available at the time of execution of trades.

Regulation 5 of PIT Regulations contains provisions relating to trading plans. These provisions
are discussed in the following paragraphs. Regulation 5(1) provides for formulation of a trading
plan by an insider and reads as under:

“An insider shall be entitled to formulate a trading plan and present it to the compliance officer
for approval and public disclosure pursuant to which trades may be carried out on his behalf in
accordance with such plan.”

As per the above provisions an insider is entitled to formulate a trading plan to trade in
securities of the company in a compliant manner. The plan is to be submitted to the compliance
officer for approval and its disclosure to the public. The public disclosure is done by disclosing
the trading plan to the stock exchanges where the securities of the company are listed.
Thereafter, after complying with other requirements of the PIT Regulations trades can be
carried out by or on behalf of the insider in accordance with the trading plan. Legislative note
appended to this sub-regulation explaining the legislative intent and purpose of this provision
states as under:

“This provision intends to give an option to persons who may be perpetually in possession of
unpublished price sensitive information and enabling them to trade in securities in a compliant
manner. This provision would enable the formulation of a trading plan by an insider to enable
him to plan for trades to be executed in future. By doing so, the possession of unpublished price
sensitive information when a trade under a trading plan is actually executed would not prohibit
the execution of such trades that he had pre-decided even before the unpublished price sensitive
information came into being.”

Regulation 5(2) of PIT Regulations lays down the requirements for a trading plan. It provides as
under:

“Such trading plan shall:

i. not entail commencement of trading on behalf of the insider earlier than six months from the
public disclosure of the plan;

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This provision requires a cool-off period of six months for executing trades from the date of
public disclosure of the trading plan. As per the legislative note appended to this provision the
six months cool-off period is considered reasonably long for UPSI that is in possession of the
insider when formulating the trading plan, to become generally available. However, this cool-
off period would not grant immunity from action if the insider were to be in possession of the
same unpublished price sensitive information both at the time of formulation of the plan and
implementation of the same. To cope with such circumstances, Proviso to regulation 5(4)
provides for deferment of trading plan.

ii. not entail trading for the period between the twentieth trading day prior to the last day of any
financial period for which results are required to be announced by the issuer of the securities
and the second trading day after the disclosure of such financial results;

Around the time of declaration of financial results a lot of unpublished price sensitive
information is generated. The process of preparation of financial results usually starts before the
close of the financial period and continues till the results are made public. The results are
required to be declared on a quarterly basis. To curb any misuse of the exception granted for
trading by the insiders pursuant to a trading plan, the regulations prohibit trading during the
specified periods. For each quarter, the trading plan formulated should not allow trading during
the period, starting from the twentieth trading day prior to the last day of the quarter and ending
on the second trading day after the disclosure of such financial results.

The term “trading day” has been defined in Regulation 2(m) of the PIT Regulations as “Trading
day means a day on which the recognized stock exchanges are open for trading.” In a calendar
month there are around 20 trading days. In view of the above, virtually the non-trading period
under a trading plan may extend upto two and a half months in each quarter. Two and half
months period comprise of one month before the close of the quarter and maximum one and
half month for declaration of results after close of the quarter (maximum two months in case of
last quarter). Thus, effective number of trading days in each quarter will be very few. These
may differ for each company depending on the date of declaration of financial results. In case,
the annual accounts closing of the company is on 31st March, there may be situations when no
trading day is available for trading during the period 1st March to 15 August. Therefore, while
formulating the trading plan this need to be kept in mind and non-trading periods should also be
specified in the trading plan.

iii. entail trading for a period of not less than twelve months;

This provision requires a trading plan to cover at least a period of twelve months. Legislative
note appended to this clause explaining the legislative intent and purpose of this provision states
as under:

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“It is intended that it would be undesirable to have frequent announcements of trading plans for
short periods of time rendering meaningless the defence of a reasonable time gap between the
decision to trade and the actual trade. Hence it is felt that a reasonable time would be twelve
months.”

iv. not entail overlap of any period for which another trading plan is already in existence;

To curb the abuse of timing of disclosure of UPSI to suit the trading requirements of the insider
or to have multiple trading plans to circumvent the provisions of PIT Regulations, it has been
provided that multiple trading plans covering the same period would not be allowed. In this
regard legislative note to this clause states as under:

“It is intended that it would be undesirable to have multiple trading plans operating during the
same time period. Since it would be possible for an insider to time the publication of the
unpublished price sensitive information to make it generally available instead of timing the
trade, it is important not to have the ability to initiate more than one plan covering the same
time period.”

v. set out either the value of trades to be effected or the number of securities to be traded along
with the nature of trade and the intervals at, or dates on which such trades shall be effected;
and

The trading plan should specify the nature of trade i.e., whether acquisition or disposal. It
should also specify the number of shares to be traded or the value of trades to be executed. The
date and time interval of undertaking trades may also be set out in the plan.

vi. not entail trading in securities for market abuse.

The trading under a trading plan does not provide absolute immunity against action for market
abuse. It provides only an affirmative defence. Legislative note to this clause states as under:
“Trading on the basis of such a trading plan would not grant absolute immunity from bringing
proceedings for market abuse. For instance, in the event of manipulative timings of the release
of unpublished price sensitive information to ensure that trading under a trading plan becomes
lucrative in circumstances of regulation 4 being detected, it would be open to initiate
proceedings for alleged breach of SEBI (Prohibition of Fraudulent and Unfair Trad Practices
Relating to Securities Markets) Regulations, 2003.”

Regulation 5(3) provides for review, approval and monitoring of trading plan by the compliance
officer. It states as under:

“The compliance officer shall review the trading plan to assess whether the plan would have
any potential for violation of these regulations and shall be entitled to seek such express
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undertakings as may be necessary to enable such assessment and to approve and monitor the
implementation of the plan.”

Review and approval of trading plan by the compliance officer is required with a view to assess
whether the proposed trading as per the plan has any potential for violation of these regulations.
The compliance officer may require the insider to furnish undertaking to the effect that he is not
in possession of UPSI or he would ensure that any UPSI in his possession becomes generally
available before he commences executing his trades.

Regulation 5(4) provides as under:

“The trading plan once approved shall be irrevocable and the insider shall mandatorily have to
implement the plan, without being entitled to either deviate from it or to execute any trade in the
securities outside the scope of the trading plan.
Provided that the implementation of the trading plan shall not be commenced if any
unpublished price sensitive information in possession of the insider at the time of formulation of
the plan has not become generally available at the time of the commencement of implementation
and in such event the compliance officer shall confirm that the commencement ought to be
deferred until such unpublished price sensitive information becomes generally available
information so as to avoid a violation of sub-regulation (1) of regulation 4.”

In terms of this provision, an approved trading plan cannot be cancelled or amended. It is

required to be executed without any exception or deviation. The rationale behind such
prohibition is that when a trading plan is approved and disclosed to the public the other
investors would factor the impact of the trading plan on their own trading decisions and in price
discovery. If deviations from approved and disclosed trading plans are permitted then it would
not be fair for those investors who have factored in the proposed trades by the insider while
taking their trading decisions for the scrip. Proviso to the sub-regulation has been inserted to
deal with a situation where on completion of the cooling period of six months, the UPSI which
was in possession of the insider, at the time of formulation of the trading plan, has not become
generally available and is still a UPSI. It has been provided that under such circumstances, the
commencement of the trading plan would be deferred, until such UPSI becomes generally
available information.

Regulation 5(5) provides as under:

“Upon approval of the trading plan, the compliance officer shall notify the plan to the stock
exchanges on which the securities are listed.”

Public dissemination of trading plan is mandatory. After approval the compliance officer is
required to disclose the trading plan to the stock exchanges where the securities of the company
are listed for dissemination to the public. Legislative note to this provision is reproduced below
to bring out the legislative intent:

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“It is intended that given the material exception to the prohibitory rule in regulation 4, a
trading plan is required to be publicly disseminated. Investors in the market at large would also
factor the potential pointers in the trading plan in their own assessment of the securities and
price discovery for them on the premise of how the insiders perceive the prospects or approach
the securities in their trading plan.”

3.6 CRONY CAPITALISM IN INDIA (Sen, 2017)

‘Crony capitalism’ refers to a business environment in which the competitive rules of the game
in a market economy are corroded, particularly in relation to the allocation of publicly-owned
resources. This happens because of the government’s favoritisms towards particular private
entities. It constitutes a major flaw in the government-business configuration in a country. This
phenomenon has emerged particularly in ‘emerging market economies’ and ‘transition
economies’ during the process of implementing market-oriented economic reforms. Market
reform policy experiments have been unfolding globally for over three decades. They are part of
a world-wide resurgence of capitalism.

In India, the process began in 1991 under P. V. Narasimha Rao. Inspired by “Washington
Consensus” policies, and supported by the World Bank and the International Monetary Fund
(IMF), the grand objective of these reforms was to introduce liberal market systems in
developing countries. This involved disrupting the pre-existing economic “developmental
state”, particularly the reversal of the government’s dominant role in the economy, and
retreating from strategic policy making. Economic controls and regulation would be reduced.
The role of the private sector would be significantly enhanced, public sector enterprises reined
in, and privatized where feasible. At the heart of the structural agenda of reforms has been the
redefinition of the relationship between government and private business. This transition has
not, however, always gone in the direction that market reforms had intended.

Prior to liberalization, the prevailing business environment in India was characterized by rigid
controls and licensing. Public sector enterprises were the main vehicles of industrialization
strategy. Private industrial enterprises in India played a minor role. However, even in this
environment, a small number of large Indian-owned enterprises managed to thrive. Most of
them were family-controlled conglomerates (“business houses”), who were able to benefit from
protection from competition despite the manifold constraints on economic activity. These
companies forged an understanding with government, which enabled them to negotiate business
conditions and obtain licenses.

Crony capitalism (though currently relatively narrowly based) poses a major future threat to the
Indian economy. The wide publicity received by scams projects a negative image of the
country’s business environment. This is likely to deter both domestic and foreign investment,
and lead to a slowdown of economic growth. Crony capitalism is a more deep rooted malaise
than corruption. Petty corruption and bribery serve to facilitate transactions and distort
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competition, but they do not normally threaten the functioning of the overall economic system.
However, under crony capitalism particular economic agents acquire the ability to directly
influence policies in their favour, and also the capacity to bend or bypass established
governmental decision making processes. This corrodes the competitive mechanism and robs
the market system of its singular allocated instrument.

3.7 CORPORATE FUNDING OF POLITICAL PARTIES (Furtado, 2017)

Corporate Funding corresponds to the funding of the political parties by corporate bodies in
India. It has been observed that most of the donations to political parties are made by
companies. In the year 2013-2014, 90% of the funds of political parties came from big
corporates in the countries. Donation by corporate bodies is governed by the Companies Act,
2013. Section 182 of the Act provides that:

• a company needs to be at least three years old since the date of its existence to be able to
donate to a political party,
• companies can donate a maximum of 7.5% of the average net profits they made during
three immediately preceding financial years,
• such contribution must be disclosed in the profits and loss accounts of the companies,
• no contribution shall be made without obtaining the approval of the board of directors by
passing a resolution,
• if a company contravenes the provisions of this section, it may be held liable to a pay
fine which may extend up to five times the amount contributed in default and every
officer guilty of such contravention may be imprisoned for a term which may extend to
six months and with fine which may extend up to five times the amount contributed in
default.

As evident, corporate funding is a major player in the election campaigns in India. It is a matter
of common sense that no company would fund a political party without any personal interest.
The more the funding, the more influence the company has over the party. It is for this,
corporate funding is criticized, and many-a-times have been debated over to be banned.
One of the biggest problems in corporate funding is the use of fake companies to flush the black
money as donations. It can be prevented if proper scrutiny of all the companies is done
regarding their incorporation documents and data available on the website of the registrar of the
companies regarding the company in question, verifying PAN details of the company, verifying
credit score of the company, etc.

Public Funding or State Funding

On the other hand, State funding or public funding is where the government provides funds to
the political parties for election-related purposes. The basic motive behind the state funding is to
allow a political party to gather funds without approaching companies or people holding money
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as it often leads to such contributors having influence over the political parties they fund. Also,
state funding helps save the high amount wasted in election campaigns and provides fair
opportunities to political parties having limited sources funding them. State Funding can be of
two types:

1. Direct Funding: giving direct funds to political parties.

2. Indirect Funding: other methods except direct funding, such as free access to media,
free access to public places for rallies, free or subsidised transport facilities, etc. fall
under the category of indirect funding.

Direct funding by the state is prohibited in India. However, indirect funding is allowed in a
regulated manner. Some examples of indirect funding in India to the political parties are
providing free access, for campaigning, of state-owned television and radio network, free
electoral rolls, income tax exemption under Section 13A of the Income Tax Act,
1961(hereinafter the IT ACT), etc.

3.8 CREDIT RATING AGENCIES

Since the early 1990s, the law prescribes that companies have to be rated by approved credit
rating agencies before issuing any commercial paper, bonds and debentures. At present there are
five rating agencies, of which four — CRISIL, CARE, ICRA and Duff and Phelps — are well
established. Each of these agencies have a set of ratings from very safe to poorer than junk bond
status. The rating has to be made public, and must be accompanied by the rating agencies’
perceptions of risk factors that can affect payment of interest and repayment of the principal.
Company management also exercises its right to comment on these risk factors.In the past there
has been a tendency to do ‘rating shopping’ — namely, to approach more than one rating
agency and then publish the one which is most beneficial to the company. Section 8 highlights
the code of best practices suggested by the Confederation of Indian Industry (CII). At this
juncture, it is important to note that the CII code has commented on this practice, and
recommended that:

“If any company goes to more than one credit rating agency, then it must divulge in the
prospectus and issue document the rating of all the agencies that did such an exercise. It is not
enough to blandly state the ratings. These must be given in a tabular format that shows where
the company stands relative to higher and lower ranking. It makes considerable difference to an
investor to know whether the rating agency or agencies placed the company in the top slots, or
in the middle, or in the bottom.”

Definition: (PaisaBazaar, 2018)

A credit rating agency (CRA) is a company that rates debtors on the basis of their ability to pay
back their interests and loan amount on time and the probability of them defaulting. These
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agencies may also analyse the creditworthiness of debt issuers and provide credit ratings to only
organizations and not individuals consumers. The assessed entities may be companies, special
purpose entities, state governments, local governmental bodies, non-profit organizations and
even countries. Individual customers are rated by specialised agencies known as credit bureaus
that provide a credit score to every customer based on his/her financial history. Credit rating
agencies in India do not have a distant past. They came into existence in the second half of the
1980s. As of now, there are six credit rating agencies registered under SEBI namely, CRISIL,
ICRA, CARE, SMERA, Fitch India and Brickwork Ratings. Ratings provided by these agencies
determine the nature and integrals of the loan. Higher the credit rating, lower is the rate of
interest offered to the organization. Let us discuss about some of the credit rating agencies in
India:

1. CRISIL: CRISIL stands for Credit Rating Information Services of India Limited and it
was the first credit rating agency set up in India in 1987. Today, CRISIL has become a
global analytical company that rates companies, researches the markets and provides
risk and policy advisory services to its clients. At the time of incorporation, the agency
was promoted by ICICI Limited, UTI and many such financial institutions. The agency
started operations in 1988. CRISIL is headquartered in Mumbai. CRISIL provides
independent opinion and efficient solutions by performing data analysis and research. It
has a strong track record of growth and innovation. CRISIL has expanded its business
operation to USA, UK, Poland, Argentina, Hong Kong, China and Singapore apart from
India. The majority shareholder of CRISIL is Standard & Poor’s, one of the biggest
credit rating agencies of the world. CRISIL works with various governments and policy-
makers in India and other developing nations to enhance and improve the infrastructure
and meet the demands of the region. The agency has rated around 5180 SMEs in India
and has issued in excess of 10,000 SME ratings overall. CRISIL commands revenue of
Rs 1,110 Crores with a net income of Rs 298 Crores and an operating income of Rs 320
Crores.
2. CARE: Credit Analysis and Research limited was established in 1993 and since then it
has gone on to become India’s second largest credit rating agency. It was promoted by
Industrial Development Bank of India (IDBI), Unit Trust of India (UTI) Bank, Canara
Bank and other financial institutions. CARE has its headquarters in Mumbai and
regional offices in New Delhi, Bangalore, Chennai, Hyderabad, Ahmedabad and
Kolkata. CARE has the primary function to perform rating of debt instruments, credit
analysis rating, loan rating, corporate governance rating, claims-paying ability of
insurance companies, etc. It also grades construction entities and courses undertaken by
maritime training institutions. Ratings provided by CARE include financial institutions,
state governments and municipal bodies, public utilities and special purpose vehicles.
The Information and Advisory Service Department of CARE prepares credit rating and
reports on requests from business partners, banks and other financial entities. It also
conducts sector-based studies and provides necessary advisories for valuation, financial
restructuring and credit appraisal systems. CARE conducts an extensive research and
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 rates SMEs based on their financial health. These ratings are provided under 8 levels
where CARE SME 1 signifies excellent financial health with negligible risks and CARE
SME 8 rank signifies lowest credit quality with highest credit risk.
3. ICRA: Originally named as Investment Information and Credit Rating Agency, the
organization was set up in 1991. It was a joint venture of Moody’s and Indian financial
and banking service organizations. It was renamed to ICRA Limited and was listed in
the Bombay Stock Exchange and National Stock Exchange in April 2007. ICRA, which
is an independent professional corporate investment information and credit rating and
advisory agency, is headquartered in Gurugram, Haryana. ICRA assigns corporate
governance rating, performance ratings, grading and provides ranking to mutual funds,
hospitals and construction and real estate companies. The agency generates revenue of
Rs 2.28 Billion. ICRA has a major focus on the MSME sector. To cater to its clients, the
dedicated team of professionals has developed a linear scale for the concerned sector. It
helps the agency to benchmark peers quite easily. ICRA ratings are used to analyse the
credit risk in India. It does not cater to the international companies and organizations.
4. SMERA: Small and Medium Enterprises Rating Agency of India is one such agency
that functions exclusively for the sector it was formed for, i.e. Micro, Small and Medium
Enterprises. This agency was founded in 2005 by Small Industries Development Bank of
India (SIDBI), Dun and Bradstreet Information Services India Private Limited (D&B)
and various public, private sector and other MNC banks of India. The agency has its
headquarters in Mumbai. SMERA has been registered with SEBI as a credit rating
agency and accredited by Reserve Bank of India in 2012. It is an external credit
assessment institution (ECAI). SMERA rates bank loans under Base II guidelines.
Grading of various instruments like IPO, bonds, commercial papers, NCDs, fixed
deposits, security receipts, etc. is done by SMERA which can be used by all banks for
capital adequacy requirements calculation as authorised by the RBI. SMERA pioneered
SME rating in India and till date it has rated more than 38,000 enterprises. Financial
institutions highly consider SMERA ratings before approving or lending funds.
5. ONICRA: ONICRA Credit Rating Agency is the private rating agency established by
Sonu Mirchandani under ONIDA Finance. It is headquartered in Gurugram, Haryana.
The agency provides credit ratings, conducts risk assessment and provides analytical
solutions to individuals, corporates and MSMEs. The solutions offered by the agency
helps organizations take informed decisions about lending funds to individuals, MSMEs
and other organizations. After its establishment in 1993, the agency has gained expertise
in assessing micro, small and medium enterprises. It is one of the seven agencies
licensed by the National Small Industries Corporation (NSIC) for the rating of SMEs.
Onicra provides grading services as well. Its grading services include education grading,
healthcare grading, solar energy grading and APMC grading. Onicra has signed MoUs
with 16 banks and NBFCs in India to provide interest rate concession to up to 1% to top
MSME units. It performs a wide range of tasks such as accounting, finance, analytics,
customer relations and back-end management. More than 2500 SMEs have been rated
by Onicra in the past two and a half decades.
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 6. FITCH India: India Ratings and Research (Ind-Ra) is a credit rating agency that
provides time-bound, accurate and prompt credit opinions. It is 100% owned subsidiary
of the Fitch Group. Ind-Ra covers corporate issuers, financial institutions, banks,
insurance companies, urban local bodies, structured finance and project finance. Fitch‘s
Ind-Ra is headquartered in Mumbai and has branch offices in Ahmedabad, Bengaluru,
Chennai, Delhi, Hyderabad and Kolkata. Ind-Ra is recognized by Securities and
Exchange Board of India, National Housing Bank and the Reserve Bank of India. Fitch
is a major financial information service provider and rating agency having its operations
in more than 30 countries across the globe. It checks credit capacity of global leaders in
all industries.

3.9 GREEN/E-GOVERNANCE IN INDIA

E-Governance (Electronic Governance) is associated with carrying out the functions and
achieving the results of governance through the utilization of ICT (Information and
Communications Technology). ICT facilitates efficient storing and retrieval of data,
instantaneous transmission of information, processing information and data faster than the
earlier manual systems, speeding up governmental processes, taking decisions expeditiously and
judiciously, increasing transparency and enforcing accountability. It also helps in increasing the
reach of government – both geographically and demographically.

Benefits of E-Governance (e-Governance in India, 2018)

i. Better access to information and quality services for citizens: ICT makes available
timely and reliable information on various aspects of governance.
ii. Simplicity, efficiency and accountability in the government: Application of ICT to
governance combined with detailed business process reengineering leads to
simplification of complicated processes, weeding out of redundant processes,
simplification in structures and changes in statutes and regulations. The end result is
simplification of the functioning of government, enhanced decision making abilities and
increased efficiency across government – all contributing to an overall environment of a
more accountable government machinery. This, in turn, would result in enhanced
productivity and efficiency in all sectors.
iii. Expanded reach of governance: Rapid growth of communications technology and its
adoption in governance helps in bringing government machinery to the doorsteps of the
citizens. Expansion of telephone network, rapid strides in mobile telephony, spread of
internet and strengthening of other communications infrastructure facilitates delivery of
a large number of services provided by the government.
2. National eGovernance Plan (NeGP) was approved by Cabinet in 2006 with a vision “To
make all Government services accessible to the common man in his locality, through
common service delivery outlets and to ensure efficiency, transparency & reliability of such
services at affordable costs to realise the basic needs of the common man”. The approach of
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 NeGP was based on: (i) Centralised Planning - Decentralised Implementation, (ii)BPR: Pre-
decided Service levels - Identified Services, and (iii) Services to Common Man at
‘doorstep’. While some progress in eGovernance was been made through launch of 31
Mission Mode Projects (MMPs) and establishment of core ICT infrastructure, various
infrastructure, technical and process barriers impacted up scaling of e-Governance.
3. To address the challenges concerned, the Government envisaged e-Kranti i.e. “NeGP 2.0”
based on the following objectives:
i. To redefine NeGP with transformational and impact making e-Governance
ii. initiatives
iii. To enhance the portfolio of citizen centric services
iv. To ensure optimum usage of core infrastructure
v. To promote rapid replication and integration of eGov applications
vi. To leverage emerging technologies
vii. To make use of more agile implementation models
4. Further the following principles were in-grained in e-Kranti:
i. Transformation and not Translation
ii. Integrated Services and not Individual Services
iii. GPR to be mandatory in every MMP
iv. Infrastructure on Demand
v. Cloud by Default
vi. Mobile First
vii. Fast Tracking Approvals
viii. Mandating Standards and Protocols
5. The vision of e-Kranti, approved in March-2015, is "Transforming eGovernance for
Transforming Governance". The Mission of e-Kranti is to ensure a Government wide
transformation by delivering all Government services electronically to citizens through
integrated and interoperable systems via multiple modes, while ensuring efficiency,
transparency and reliability of such services at affordable costs. Subsequently, 13 new
MMPs were added into e-Kranti portfolio in 2014.
6. The ambitious Digital India programme launched in July, 2015 is centered on three key
areas, namely Infrastructure as Utility to Every Citizen, Governance and Services on
Demand and Digital Empowerment of Citizens. The ‘Digital India’ programme is envisaged
to be coordinated by DeitY and implemented by the entire Government.
7. The nine components of Digital India are namely Broadband Highways, Universal Access
to Mobile Connectivity, Public Internet Access Programme, eGovernance: Reforming
Government through Technology, e-Kranti – Electronic Delivery of Services, Information
for All, Electronics Manufacturing, IT for Jobs and Early Harvest Programmes. Each of
these components is a complex programme in itself and cut across multiple Government
Ministries and Departments.
8. Some of the key initiatives taken under Digital India include:
i. Common Services Centres (CSC) 2.0: More than 2.06 lakh CSCs are operational.
CSCs given license by RBI under Bharat Bill Payment System in June, 2016.
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 ii. e-Districts: Launched in 621 Districts and providing more than 900 eServices.
iii. State Wide Area Network (SWAN): Operational in 34 States / UTs.
iv. Electronic Transaction Aggregation & Analysis Layer (e-TAAL): Integrated with
3051 eServices. More than 62.67 Cr eTransactions delivered per month.
v. BharatNet (NOFN): Optical fibre reached in more than 50,700 Gram Panchayats.
vi. Digital Literacy: 94 lakh people enrolled, out of which 68 lakh trained.
vii. Public Hotspots: 2504 wi-fi hotspots commissioned at 1227 locations.
viii. Digital Locker: More than 20 lakh users have uploaded more than 23lakh
documents.

E-Governance Provisions under the Companies Act, 2013 (Aswal, 2014)

1. Maintenance, Security, and Inspection of Books and Records in Electronic Form:

The Section 120 facilitates that a company must keep a safe account of all business and
management related documents, records, registers, minutes, etc., preferably in the
electronic forms, in such a manner that these could easily be inspected or reproduced
whenever necessary.
2. Service of Documents: Section 20 of the Companies Act provides that every
presentation, submission, or dispatch of company-related documents should preferably
be made through electronic means, to the concerned officials, shareholders, or the
Registrar.
3. Notice of Meetings: The notices of the Board Meetings and the General Meetings, are
also to be sent by electronic means and in the prescribed manner, as are described in the
Section 173(3), and Section 101, respectively. Also, the Rule 18 of the Indian
Companies Rules of 2014 recommends that a record of any failed transmissions of such
notices and subsequent re-sending of these, must be retained by the company as "Proof
of Sending". Notices to shareholders, directors, or auditors regarding electronic voting
on a resolution and participation in a general meeting, may also be published on the
website of the company.
4. Payment of Dividend: As per Section 123, any dividend payable in cash, can also be
remitted in any electronic mode to the entitled shareholders, besides being paid by
Cheques or Warrant.
5. Admissibility of Certain Documents as Evidence: Any document reproduced from
returns, or any document related with the administration, management, or business
activities of a company formally filed with the Registrar on paper or in electronic form
and duly authenticated by the Registrar, shall be admissible to any proceedings of the
company, without any further proof or production of the original documents as evidence.
6. E-Voting: Voting through electronic means at the general meetings of a company, is one
of the highly significant provisions introduced by the new Indian Companies Act of
2013, to support e-management and governance. Section 108, New Revised Clause 35B
of the Listing Agreement of SEBI, and the Rule 20 of the Companies (Management and
Administration) Rules of 2014, all emphasize that every listed company or a moderately
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 big company with at least 1000 shareholders, should utilize preferably the facility of
voting electronically by the shareholders and members at the general meetings of the
company, for passing any resolution (Ordinary/Special).

3.10 SELF ASSESSMENT QUESTIONS

True and false Questions:

Indicate whether the following statements are true or false:
a) The enforcement agency for the federal government is the Exchange and Security Law
Commission, whose authority encompasses both the sale of new securities and the
trading of existing securities.
b) A venture capitalist is the slang term used by the SEC to represent individuals who are
involved in insider trading.
c) The Sarbanes-Oxley (SOX) Act of 2002 was designed to regulate the signaling effects
of issuing new common stock in the primary market.
d) In the SEC revision creating categories or classifications of issuers, well-known
seasoned issuers (WKSIs) gained significant speed and flexibility in raising funds which
is expected to lower their cost of capital all else equal.
e) Awareness of the rights, duties and responsibilities by the citizens is a must for e-
governance.

Answers: a (F), b (F), c (F), d (T), e (T)

Long Answer Questions

Q1. Define e- governance. Explain some of the important initiatives taken by the Ministry of
Corporate Affairs in the area of e-governance?

Q2. Explain the concept of insider trading. Elaborate the various provisions along with the
amendments in insider trading?

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 LESSON 4
SHAREHOLDER’S ACTIVISM

4 STRUCTURE

4.1. Shareholders Activism

4.2. Shareholders Rights And Responsibilities
4.3. Differential Voting Rights
4.4. Class Action Suit
4.5. Voting Mechanism
4.6. Rights of Minority Shareholders
4.7. Shareholder Proposal
4.8. Institutional Activism
4.9. Stewardship Code
4.10. Foreign Institutional Investors (FII) In India
4.11. Proxy Advisory Firms
4.12. Self-Assessment Questions

4.1 SHAREHOLDERS ACTIVISM (Chadwick, 2014)

Shareholder activism is a way that shareholders can influence a corporation's behavior by

exercising their rights as partial owners. Classes of shares allow for distinct voting privileges, in
addition to dividend entitlements. While minority shareholders don't run day to day operations,
several ways exist for them to influence a company’s board of directors and executive
management actions. These methods can range from dialogue with managers to formal
proposals, which are voted on by all shareholders at a company's annual meeting. Over the past
20 years shareholder activism has evolved from an obscure, frequently vilified strategy to a
mainstream form of investing that is not only increasingly regarded for its high‐return potential,
but also as a necessary component of our public equity markets.

The term shareholder activism has become ubiquitous for what in reality is an extremely wide
spectrum of investor activity. The origins of shareholder activism lay in the 1980s during the
era of corporate raiders and hostile takeovers. The mass adoption of shareholder rights plans
(also known as the “poison pill”) brought an end to the hostile takeover era and ushered in the
first activist funds during the 1990s. By the mid‐2000s, the strategy became even more
mainstream. There are investors who label themselves “shareholder activists” that pursue a
diverse array of agendas, including:

• Share price underperformance / undervaluation

• Corporate governance – shareholder rights specific

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 • ESG ‐ environmental, social and corporate governance
• Executive compensation, among other causes

As the financial media typically refers it to, however, shareholder activism is an investment
strategy whereby minority shareholders (as opposed to controlling shareholders) exercise their
ownership rights with the objective of improving shareholder value. In the process, activist
investors proactively identify investment opportunities in which the utilization of activism can
unlock value by serving as the catalyst for change. Where other active investors identify value‐
appreciating catalyst events and then hope for that event to occur, activist investors replace hope
with action by exercising their rights as shareholders to effect change. There are numerous
change‐creating tools at the activist’s disposal, the most extreme being a proxy contest, which is
a shareholder vote for board representation/control.

In addition, activists often sponsor other shareholder resolutions and/or proposals, and utilize
public filings to broadcast communication to other investors despite the high profile media
attention certain activist investors receive, by and large, most shareholder activism occurs
behind closed doors and out of the press. In fact, research by McKinsey & Co. indicates the
highest return outcomes from activist campaigns come about from collaborative resolutions /
settlements. Although 75% of all activist campaigns start off collaboratively, 60% become
hostile before they are resolved, of which approximately half end in a public threat of
shareholder intervention, with the remainder resulting in either a proxy fight, litigation, or
takeover bids. For the most part, it is unusual for activists to attempt to outright acquire a public
company.

Shareholder activism also plays a role in well‐functioning public markets. For example, while
shareholder activists frequently do the heavy lifting, the benefits of activism generally accrue to
all shareholders. In addition, the fear of becoming the target of an activist contributes to the
overall efficiency of capital markets by holding management teams accountable for the diligent
stewardship of corporate assets. Increasingly, activists present well‐conceived capital allocation
and business plans to management ensuring that a wide variety of value creating strategies are
explored. Rarely do the more collaborative activists lead with a demand to sell the company.
However if management fails to pursue clear‐cut value creating strategies, activists can and will
push for a potential sale of the company if they believe it is in the best interest of shareholders.
Lastly, shareholder activism gives the value oriented investor additional levers to pull by
proactively pursuing identifiable company catalysts. This event driven optionality can be useful
to investors across a wide variety of market environments. It is believed that shareholder
activism plays a vital role in well‐functioning capital markets, by holding companies more
accountable to shareholders. It is the shareholders after all who own the company. Whether you
invest directly in a targeted activist strategy, own a mutual fund or own shares of common stock
in a publicly traded company, it is becoming increasingly likely that you will be touched by
some form of shareholder activism during your investing lifetime. So, when an activist rings the
doorbell, it is generally a good idea to answer it.
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4.2 SHAREHOLDERS RIGHTS AND RESPONSIBILITIES (STRUCTURE AND
MECHANISM OF CORPORATE GOVERNANCE IN INDIA, 2018)

In India, companies are mostly established and governed by Companies Act 2013. There are
basically two types of companies established in India, namely public limited company and
private limited company. In India, people prefer to open private limited firm because of fewer
restrictions and more benefits. Shareholders play an important role in a company. It is very
important for a company to look after them as they should also be safeguarded and time to time
proper bonus should be given to them.

A shareholder, commonly referred to as a stockholder, is any person, company, or institution

that owns at least one share of a company’s stock. Because shareholders are a company’s
owners, they reap the benefits of the company’s successes in the form of increased stock
valuation. Shareholders play an important role in the framing and profits of the company.
Shareholders are the owner of the company. They are the main stakeholders in the company.
There are two types of shareholders:

Equity Shareholders: Equity shareholders are the main stakeholders in a company and when
the time of dividend distribution comes the preference shareholders would get the first. Equity
investors have certain rights. An equity share entitles the investor to participate in the profits of
the corporation, with liability limited to the amount of the investment. In addition, ownership of
an equity share provides a right to information about the corporation and a right to influence the
corporation, primarily by participation in general shareholder meetings and by voting. The
shareholding body is made up of different types of shareholders like individuals and institutions
and the responsibility for corporate strategy and operations is typically placed in the hands of
the Board of Directors and its management team. Basic shareholder rights which should be
provided by every organization include the right to:

1. Secure methods of ownership registration;

2. Transfer ownership of shares;
3. Obtain relevant and material information about the corporation on a timely and regular
basis;
4. Participate and vote in general shareholder meetings;
5. Elect and remove members of the board; and
6. Share in the profits of the corporation.

Preference Shareholders: Preference shareholders generally have no voting rights because of

their preferred status. They receive fixed dividends, generally larger than those paid to common
stockholders, and their dividends are paid before common shareholders. Responsibilities of
Institutional Shareholders:- holding additional meetings with management specifically to
discuss the specific shareholders concerns; meeting with the Chairman, senior independent
director, or with all independent directors; making a public statement in advance of the AGM or
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an EGM; and submitting resolutions at shareholders meetings. The number of shareholders in a
company depends upon the type of company which they are opening.

• For a one-person company, one person is required.

• For a private limited company, two persons are needed.
• For a public limited company, a minimum of seven persons are required.

Shareholders’ Rights

There are various rights available to a shareholder. Different type of rights has been discussed
below:

1. Appointment of Directors: Shareholders play an important role in the appointment of

directors. An ordinary resolution is required to be passed by the shareholders for the
appointment. Apart from this, shareholders can also appoint various types of directors.
They are:

• An additional director who will hold the office until the next general body meeting;
• An alternate director who will act as an alternate director for a period of 3 months;
• A nominee director;
• Director appointed in the case of a casual vacancy in the office of any director
appointed in a general meeting in a public company.

Apart from this shareholder also can challenge any resolution passed for the
appointment of a director in the general body meeting.

2. Legal Action against Directors: Shareholders also can bring legal action against
director by the rules laid down in the Companies Act 2013. They are:

• Any act done by the director in any manner which is prejudicial against the affairs of
the company.
• Any act done which is beyond the law or against the constitution.
• Fraud.
• When the assets of the company are being transferred at an undervalued rate.
• When there is a diversion of funds of the company.
• Any act done in a mala fide manner.

3. Appointment of Company Auditors: Shareholders also have a right to appoint the

company auditors. Under Companies Act 2013, the first auditor of the company is to be
appointed by the board of directors. Further the shareholders at the annual general body
meeting at the recommendation of directors and audit committee. The appointment is

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 generally done for five years and further can be ratified by passing a resolution in the
annual general body meeting.

4. Voting Rights: Shareholders also have the right to attend and vote at the annual general
body meeting. Every company registered in India should comply with the provisions of
the Companies Act 2013. It is mandatory for every Indian company to hold an annual
general meeting once in every year. The meeting can be held anywhere at the head
office of the company or any other place as given by the company. At the meeting, there
are various mandatory agendas which are to be discussed. These include the adoption of
financial statements, appointment or ratification of directors and auditors etc. When a
resolution is brought by members of a company then according to companies act 2013 it
can be passed only by the means of voting by the shareholders. Companies Act 2013
recognizes following types of voting:

• Voting by the Showing of Hands – Every member present in the meeting has one
vote. So, in this type of voting shareholders vote just by showing of hands.
• Voting done by Polling – In this type of voting the chairman or the shareholders’
demand for a poll. However, in case of differential rights as to voting, a particular
class of equity shares may also have weighted voting rights.
• Voting done by Electronic Means– every company who has more than 1000
shareholders has to put up a facility of voting through online means. Every member
should be provided with the means of voting of online.
• Voting by means of Postal Ballot– any resolution in the meeting can also be passed
by means of a postal ballot.

A shareholder also has a right to appoint proxy on his behalf when he is unable to attend
the meeting. Though the proxy is not allowed to be included in the quorum of the
meeting in case of voting, it is allowed by following a procedure mentioned in the
Companies Act 2013.

5. Right to Call for General Meetings: Shareholders have the right to call a general
meeting. They have a right to direct the director of a company to can all extraordinary
general meeting. They also can approach the Company Law Board for the conduction
of general body meeting, if it is not done according to the statutory requirements.

6. Right to Inspect Registers and Books: As shareholders are the main stakeholders in a
company, they have the right to inspect the accounts register and also the books of the
firm and can ask questions about the same if they feel so.

7. Right to get Copies of Financial Statements: Shareholders have the right to get copies
of financial statements. It is the duty of the company to send the financial statements of
the company to all its shareholders either in a quarterly or annual statement.
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 8. Winding Up of the Company: Before the company is wound up, the company has to
inform all the shareholders about the same and also all the credit has to be given to all
the shareholders

Other Shareholders’ Rights

• When the sale of any material of any company is done then the shareholders should get
the amount which they are entitled to receive;
• When a company is converted into another company then it requires prior approval of
shareholders. Also, all the appointment has to be done according to all the procedures
and also auditors and directors have to be done;
• Right to approach the court in case of insolvency.

Shareholders’ Duties

There are also responsibilities and duties of shareholders which they should perform. Besides
several rights which they have, there exist several duties. They are:

1. Shareholders should participate in the general body meetings so that they can see and
also can advise on the matters which they feel is not going good.
2. Shareholders should consult on the matters of finance and other topics.
3. Shareholders should be in touch with other members of the company so that they can see
the work progress of the company.

4.3 DIFFERENTIAL VOTING RIGHTS (Lexis Nexis, 2018)

As per Section 43(a)(ii) of the Companies Act, 2013, a company incorporated under the laws of
India and limited by shares is permitted to have equity shares with differential voting rights as
part of its share capital. The differential rights appended to such equity shares may be with
respect to dividend, voting or otherwise. Such equity shares may be issued by a company as per
Rule 4 of the Companies (Share Capital & Debentures) Rules, 2014 prescribed under the
Companies Act, 2013. Private companies can issue shares with differential voting rights in the
manner prescribed under their Articles of Association, provided the Articles exempt the
applicability of the Companies Act, 2013, s 43 read with Companies (Share Capital &
Debentures) Rules 2014, r 4 on such private companies. The Companies Act, 2013, s 47
provides for every shareholder of a company to have a right to vote on every resolution
presented before the company. However, in the event that the memorandum and articles of
association of the company so provide, a private company may opt to not accord every member
with such right to vote.

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It is pertinent to note that equity shares with differential rights issued by a company under the
Companies Act, 1956 and the rules made thereunder shall continue to be regulated under such
provisions and rules.

Benefits of Differential Voting Rights

A company may choose to issue shares with differential voting rights for obtaining investments
without offering voting rights to the investor and thereby avoiding any attempts at a hostile
takeover. Similarly, an investor intending to invest into a public listed company, may avoid the
implications of the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011
(Takeover Code) on acquiring a substantial portion of the voting rights in a company. The
Takeover Code requires an acquirer to make an open offer to the public in the event that the
acquirer intends to acquire such number shares which amount to more than 25% of the total
voting rights in the company.

By subscribing to a large number of shares with differential voting rights, an investor may get
entitled to receiving higher returns on investment without having to undertake an open offer as
mandated under the Takeover Code. Shares with differential voting rights are favourable to
private companies which do not have abundance of dispensable funds or distributable profits
and are susceptible to a hostile takeover. Issuance of shares with differential voting rights
affords an opportunity to such private companies to broaden their capital base without having to
lose control over or management of the company.

Precautions

Shares with differential voting rights may carry voting rights subservient to those attached to
ordinary equity shares. Therefore such shares serve as instruments to keep the promoters in
control of the company. An investor seeking to invest substantial amount of funds into a
company would also want at least some control to ensure that the company utilizes the supplied
funds judiciously. Such control cannot be exercised by virtue of the diminished rights attached
to the shares issued to the investor. Therefore, the transaction documents contemplating the
issuance and subscription of the shares with differential rights must provide for ample
affirmative rights to the investor and detail the manner of exercise of the affirmative rights.

4.4 CLASS ACTION SUIT (Unadkat, 2017)

Class action suits against Indian companies in the context of corporate governance first made
headlines back in 2009 at the time of the Satyam scam. While investors in India were not in a
position to take legal action against the company and were constrained to wait for SEBI to act,
their counterparts in the United States filed class action suits and demanded compensation from
Satyam. It may surprise many to know that the Code of Civil Procedure, 1908, recognizes class
action in Order 1 Rule 8 and lays out a clear and simple procedure.
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Civil lawyers cynically remind us that in addition to Order 1 Rule 8 of the Code of Civil
Procedure, 1908, the common law right of “derivative action” by shareholders to protect the
company has been well recognized and civil courts in India have been actively dealing with this
for many decades now, despite this right not being specifically recognized in company law. The
idea behind class action is fairly simple and one that can prove to be beneficial for many
reasons – avoid multiplicity of proceedings by a large number of interested people. Class action
allows everyone interested in the issue to benefit from the resolution of the issue in one forum
thereby avoiding conflicting decisions that may arise from different courts hearing different
stakeholders on the same issue.

Who can File Class Action Suits?

The number of members or depositors who may file class action suits under section 245 of the
Companies Act differs, depending on whether or not the company has share capital. For a
company with share capital, 100 members of the company or 10 percent of the total number of
members of a company may file a class action suit, only if the members filing a class action suit
have paid all calls and dues on their shares. On the other hand, for a company without share
capital, this number increases to one fifth of the total number of members of the company. In
addition to shareholders, other stakeholders like depositors have also been granted this right.

Who can be sued?

In addition to the company itself, the directors of the company, its auditors, or even the advisors
of the company will now be targets before the National Company Law Tribunal (NCLT), in
case the management or affairs of the company are not being conducted with transparency or
are being conducted in a prejudicial manner. It is expected that suits can be filed for acts of
breaching, or activities beyond the scope of charter documents, misrepresentation or
suppression of material facts, fraudulent conduct and making incorrect statements.

Why is there a Need for a Separate Provision for Class Action Suits?

While the provisions for class action suits are contained in the chapter related to the prevention
of oppression and management in the Companies Act of 2013, one may wonder why there is the
need for a separate provision for class action suits and how this is different from similar
provisions in the Companies Act, 1956.

The outcomes sought from explicit class action suits and those from the general provisions of
oppression and management are very different from each other. With a class action lawsuit,
applicants (which may include a member or a depositor) are able to seek compensation for any
unlawful or fraudulent behaviour from directors as well as third party experts or obtain an
injunction against the company and directors from doing certain acts.

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Directors and Officers Beware

While the Indian company law is now recognizing class actions, judicial precedent
demonstrating the practical application of this are awaited. Directors and those in managerial
positions in companies throughout the country now need to be vigilant and should have updated
information about the process of class action lawsuits and what must be done to prevent a
lawsuit being filed against them. They must also understand that providing misleading
information and engaging in fraudulent activities can end up in legal action being taken not only
against the company, but the directors themselves. It will not be prudent to be complacent and
rely on lack of enforcement action by regulatory agencies. Activist stakeholders in India will
now be able to hold companies and management to account.

4.5 VOTING MECHANISM (CFA, 2014)

Voting is a legal mechanism for shareholders to express their opinions to board members and let
their voices is heard. Effective shareholder participation in key corporate governance decisions,
such as the nomination and election of board members, should be facilitated. Company
procedures should not make it unduly difficult or expensive to cast votes. The exercise of voting
rights by foreign shareholders should be facilitated. There are various ways shareholders can
vote in a general meeting:

1. Show of Hands: A resolution put to vote at any general meeting is generally decided by
a show of hands. This follows the principle of one vote per person (unlike in a poll,
where it is one vote per share). Shareholders interested in voting for the proposals raise
their hands to notify their approval or disapproval.

2. Poll: A poll is generally requested at a general meeting when there are contentious
issues or there is a close vote. The key features of a poll are as follows:

a. The chairperson can order a poll

b. on or before the declaration of results of voting by hand or
c. on demand from shareholders holding at least 10% of voting power or shares on which
not less than a sum of 500,000 Indian rupees is paid up.

d. The polling method follows the principle of one vote per share.
e. A proxy is permitted to vote only when a poll is requested.
f. Persons demanding the poll can withdraw their request any time before the poll.
g. The chairperson for the meeting will
h. appoint persons to scrutinize the poll process and
i. regulate the manner in which poll is taken
j. The result of the poll shall be the decision of the meeting on the resolution.

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 3. Voting by Electronic Means (E-Voting): The Companies Act, 2013, stipulates that
every listed company (or company having not fewer than 1,000 shareholders) shall
provide a facility to vote by electronic means to its shareholders for all types of
meetings, including AGMs, EGMs, postal ballots, and CCMs. As per Clause 35B of the
Listing Agreement, all companies shall provide an e-voting facility with respect to all
resolutions to be passed at general meetings or through postal ballots. But companies
that provide an e-voting facility also need to continue to provide a postal ballot option
for the benefit of those shareholders who do not have access to the e-voting facility. An
e-voting process generally remains open for a minimum period of one day and a
maximum of three days. Once a vote is cast, it cannot be changed. The board appoints a
scrutinizer(s), who must not be in the employment of the company, to oversee the entire
process.

4.6 RIGHTS OF MINORITY SHAREHOLDERS (Srivastava, 2016)

Minority shareholders are the persons in the company whose involvement in the company’s
democratic decisions are overshadowed by the majority rule and to overcome this problem
companies act 2013 has come up to tackle the problems faced by the minority in companies act,
1956. However minority shareholders are not defined under any law but still under section
235(power to acquire shares of dissenting shareholders) and section 244(right to apply for
oppression and mismanagement) of companies act, 2013 have been given 10% shares or
minimum hundred shareholders whichever is less in companies with share capital and 1/3rd of
the total number of its members in case of companies without share capital.

Rights of Minority Shareholders

Many provisions in companies act, 1956 deals with situations where minority shareholders are
affected and the same can be divided into various major heads:-

A. Oppression and Mismanagement of the Company

Oppression is a means of exercising authority or power in a burdensome, cruel or unjust

manner. Example of oppression could be: -not calling a general meeting, depriving the member
of right to dividend etc. It can be also filed in case there is any material change in the
management or control of the company such as:-
1. Alteration in the board of directors.
2. Manager.
3. In the ownership of company’s share.
4. If it has no share capital in its membership.
5. In any other manner whatsoever.

• Right to apply for application under section 241:- If a company having share capital:-
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 1. Not less than 100 members of the company.
2. Not less than one-tenth of the total number of its members.

Whichever is less shall have the right to apply under section 241.

However, any member or members holding not less than one-tenth of the issued share capital of
the company subject to the condition that the applicant has paid all calls, shall also have the
right to apply under section 241. In case a company is not having a share-capital not less than
one-fifth of the total number of its members shall have the right to apply under section 241.

• Power of the tribunal on receiving the application (section 242):- On an application made
under section 241, the tribunal shall frame its opinion on two points:-

1. That the company’s affairs are being conducted in a manner prejudicial or oppressive.
2. That to wind up the company would unfairly prejudice such member or members.

On the basis of above two points, the tribunal shall pass an order which includes:-

1. The regulation of the conduct of the affairs of the company in future.

2. The purchase of shares or interest of any member of the company by other members
thereof.
3. c.)Restriction on the transfer or allotment of the shares of the company.
4. Removal of the managing directors, manager or any of the directors of the company.
5. Imposition of costs as may be deemed fit by the tribunal etc.

Mismanagement means “conducting the affairs of the company in a manner prejudicial to

public interest or in a manner prejudicial to the interests of the company.” Instances which can
be considered as mismanagement in the company are:-

1. Secret profit being made out of the company’s accounts.

2. Company doomed to trade unprofitably but the directors continue to draw their salary.
3. Company affairs being given in the wrong person’s hand who misuses it.
4. Any resolution passed by the company which is violated of the company’s memorandum
or articles or contrary to any provisions of law for the time being in force.

B. Reconstruction and Amalgamation of the Company

In case of reconstruction and amalgamation, minority shareholders may be suppressed in taking

decisions of the company and therefore the Courts, while approving the scheme must follow
judicial approach by making the public aware about the proposed scheme in newspapers to seek
any objections, against the scheme from the shareholders. If any objections are found, then any
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interested person (including a minority shareholder) may appear before the court to initiate a
class action.

C. Rights of Shareholders to be informed through Correct Disclosures

The right of the company members to attain the timely information must be expressed clearly in
the statute. The financial information and disclosures need to be provided to shareholders in a
simple format. This leads to informed investment decision making by the shareholders and help
increasing the credibility of the company.

D. Right of Minority to be heard

An appropriate mechanism should be established for ensuring that provisions relating to

“Minority Interest” do not obstruct the Board or the management from performing their
functions genuinely in interests of the company so that the Board and the management should,
be protected from undue and unjustified interference from unscrupulous shareholders acting in
the guise of investors‟ rights.

E. Rights of Minority Shareholders during Meeting of the Company

Sometimes the minorities are deprived of an effective hearing because meeting of the company
are conducted in such a manner and therefore it must be ensured that they have the right to
attend the general meetings, right to direct the court for the appointment of a general meeting,
to appoint proxies so that they can attend and vote at general meeting, making proposal at
shareholder’s meeting.

F. Fair Valuation as a Means of Safeguarding Minority Interests

For evaluating the shares of the company there must be an independent valuation mechanism
for safeguarding minority interests. The appointment of the independent valuer is required to be
appointed by the audit committee where such a committee would ensure that shareholders must
have the right to approach the tribunal if the process appears to be unfair. These principles for
valuation of shares could also apply in case of companies that are delisted and have a
shareholder base of 1000 or more.

G. Right of Minority Shareholders to seek Information

Every individual shareholder has the right to know about all the information of the company.
The existing Act lays down the provision for fairness to all shareholders irrespective of each
individual’s shareholdings. They have the right to receive Notice of General Meetings (the
AGM or the EGM), annual report and audited accounts and quarterly and annual accounts etc.

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H. Class Action

A class action suit is a law suit where a group of persons approach the company law tribunal to
represent a common interest. It may be filed either by the members or depositors of the
company. Class action suits help minority shareholders as a redressal tool to approach the
company law tribunal having the common interest. The relief which the member or depositors
(including minority shareholders) may get through class action suits is to:-

1. Restrain the company from committing an act which is ultravires of the company.
2. Restrain the company from committing breach of any provisions of company including
memorandum or articles.
3. Restrain the company from acting contrary to the provisions of any law for the time
being in force.
4. Restrain the company from taking action contrary to any resolution passed by its
members, etc.

4.7 SHAREHOLDER PROPOSAL (McGuire, 2012)

A “Shareholder Proposal” is an essential component in the tool kit of any investor activist or
corporate gadfly.

Basically, a shareholder proposal is a document recommendation that a shareholder formally

submits to a publicly traded company advocating the company take a specific course of action.
The process requires having more than an opinion, but being able to articulate a specific course
of action for a policy change for the betterment of the company.

This is the essence of participatory, responsible shareholder activism. Your idea should be able
to withstand an opposing viewpoint and flourish based on its merits. It should be practical and
include a clearly defined path to implementation, and offer an innovation that can generate
support in the shareholder base, which will ultimately vote on the measure.

What Should the Shareholder Propose?

A shareholder proposal should not be an ambiguous rant, but a well-conceived recommendation

to take a specific course of action. Some typical uses of shareholder proposals are to address
issues with management compensation, change shareholder voting rights, focus on a policy
related to a social or environmental issue, or to advocate for corporate charitable contributions.
However, due to the say-on-pay voting mandate where shareholders can vote against CEO
compensation packages, the proposals related to corporate pay have since declined. Therefore,
the more successful proposals will address a specific company policy and provide a detailed
resolution for adopting a change to that policy or company by-law.

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General Processes and Guidelines for Shareholder’s Proposal in India (Shroff & Adani,
2011)

Under Indian law, a number of matters are reserved for the approval of shareholders. These
include:

• the amendment of the charter documents of a company;

• the appointment of directors of a company;
• related-party transactions;
• the sale of an undertaking of the company; and
• Borrowings and investments beyond specified thresholds.

In addition to matters reserved for their approval, shareholders can also make proposals at
shareholder meetings, subject to compliance with procedural requirements prescribed by law.
Proposals made by shareholders are required to be considered at meetings provided that they are
made by shareholders holding at least 10 per cent of the paid-up capital or voting power (as
applicable) in the company, and are submitted to the company in time for them to be included in
the notice calling the meeting. In the event that the company fails to include a shareholder
proposal in the materials for the meeting, or to call a meeting to consider the proposal,
shareholders are entitled to requisition a meeting of their own.

A shareholder proposal will be considered at a meeting in the same manner as any other
proposal - requiring a majority or three-quarters (depending on the subject matter of the
proposal) of voting shareholders to vote in favour of it for it to be approved.

However, it is not common for shareholder proposals to be made. Those that are made usually
deal with the appointment and removal of directors. It is expected that the spectrum of
shareholder proposals that are made will widen substantially as shareholders take advantage of
the new legal regime to become more active in the coming years.

The Companies Act 2013 permits granting of different rights for different types or classes of
shareholders, provided that the charter documents of the company provide for the same or if the
terms of issue of such shares do not prohibit such variation and any such variation can be
effected with the consent of no fewer than three-quarters of the shareholders to whom such class
of shares are issued or if a special resolution is passed at a separate shareholders’ meeting of
such class.

Therefore, the process may be similar for different class of shareholders to submit a proposal.
However, the eligibility condition applicable and rights vested in shareholders may vary.

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4.8 INSTITUTIONAL ACTIVISM (Pettinicchio, 2012)

The concept of institutional activist or activism is not a rigid one. Basically, institutional
activists are individuals who affect change (from changing organizational norms to policy
reform) from within organizations and institutions. However, the concept’s flexibility has also
lead to important variations of its use. Institutional activist and activism is similar to, and often
times (depending on the movement in question) interchangeable with, concepts like sympathetic
elites, institutional entrepreneurs; idea⁄issue ⁄meaning entrepreneurs, moral entrepreneurs, elite
mobilization, state movement coalitions, and inside agitators. These terms denote varying
degrees of elite claims-making because, as Banaszak (2005, 156) argues, different movements
have different degrees of outsider status. Constituents can be legally or normatively excluded
from the political process, they can be included but marginalized, or they can be included and
highly influential. For instance, where blacks in the United States were legally excluded from
the polity, the disabled were normatively excluded as it was believed that they could not
advocate on their own behalf. Thus, the role institutional activist’s play is highly dependent on
how much exclusion a movement or constituency experiences.

Both Tilly (1978) and Pierson (1994) characterize institutional activists as those with access to
institutional resources and the decision-making process who are working on movement issues.
In other words, institutional activists are insiders working on outsider causes (Santoro and
McGuire 1997). This implies that institutional activists take up an already existing cause
championed by outside challengers. That is, issues are defined and framed by social movements
before reaching insiders. For instance, Santoro and McGuire (1997) find that black elected
officials and feminist politicians actively promoted affirmative action policy. They also find that
feminist politicians were largely responsible for including comparable worth policies in the
political agenda. Institutional activists play an important role following protest cycles when
often times, elite responses push movements into the political arena (see Staggenborg 1991).
Ruzza’s (1997) study of the Italian peace movement shows that institutional activists are
important when protest cycles decline suggesting that they help outsiders when their influence
becomes less efficacious. On the other hand, Ruzza also claims that institutional activists are
more widespread when the cause is politically salient which implies that the main reason elites
take on issues is because they are either pressured or influenced by social movements and ⁄or
public opinion.

Institutional activists can be much more entrepreneurial than is suggested by the conventional
understanding described above. A growing literature in sociology and political science has
shown that elites do not always take on issues because they are pressured to do so by public
preferences or organized interests (Sulkin 2005). This means that institutional activists may act
as issue entrepreneurs because of personal histories and experiences with an issue or
constituency, biographical characteristics, ideology, and career ambitions (Costain and
Majstrovic 1994; Reichman and Canan 2003; Sulkin 2005). Framing the problem and its
remedies can be done on the inside (see Reichman and Canan 2003 on ‘‘ozone entrepreneurs’’
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and Skrentny 2002on ‘‘idea entrepreneurs’’ and Steensland’s 2008 ‘‘ideational diffusion’’). In
turn, the actions of elites, such as policy, programs, and the creation of government agencies,
can create new constituencies (see Meyer 2005) as well as new opportunities for mobilization
(see Baumgartner and Mahoney 2005; see also Baumgartner and Jones 2002 and the Public
Agendas Project). Banaszak (2005, 2010) emphasizes how policies create accompanying
regulatory agencies and staffs with whom movement actors can develop a relationship,
especially the ways in which these can come to incorporate movement activists into the
government. In addition, personnel within the legislature and the executive branch may actively
create new opportunities for movement actors while in some cases, governmental and
bureaucratic rules and norms may encourage activism within the government.

Scattered studies have provided a framework for understanding the dynamic interplay between
insiders and outsiders. Their work showcases the flexibility of the concept. Some scholars focus
on the ways in which opportunities for mobilization are initiated by institutional activists (e.g.,
Costain 1992; Katzmann 1986; Scotch 2001), some on how insiders take on a movement cause
(e.g., Santoro and McGuire 1997), and others on how outsiders become insiders while
remaining movement activists (e.g., Banaszak 2005, 2010). Drawing from these works, we can
make some general conclusions about the role of institutional activists. First, they are not just
reactionary, but rather, they proactively work on issues that overlap with social movements.
Second, institutional activists have access (or gain access) to institutional resources and have
some influence over the policymaking ⁄implementation process. Third, they not only believe in
the cause, but will promote that cause even after mobilization declines (especially if outsiders
are brought into the state). And finally, institutional activists may pursue favorable policy or
expand existing policy without any push from outsiders.

4.9 STEWARDSHIP CODE (Mohanty, 2017)

A ‘stewardship code’ is typically a principles-based framework which is designed to assist

institutional investors and their stewardship service providers (including proxy advisors) in
fulfilling their responsibilities to their clients to protect and enhance the value that accrues to
them, and account for how they have done so. The principles enshrined in the Code, which are
intended to allow flexibility in their application, are supported by best practice guidance. The
Code is typically enforced through a ‘comply or explain’ approach, which implies that the
(institutional) investors, at whom this Code is directed, either comply with the Code, or if they
do not comply, explain publicly why they do not.

In India, although considerable progress has been made in improving Indian corporate
governance in recent years, the progress towards the creation of ‘stewardship code’ has been
limited. It was the Insurance Regulatory and Development Authority (IRDA) that took a lead in
March 2017 and launched guidelines for a ‘stewardship code’ for Indian insurers, who are
important investors in India’s capital markets, building on Securities and Exchange Board in
India’s (SEBI) issuance of voting disclosure guidelines to mutual funds in 2010. There is
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however no ‘common stewardship code’ yet that is applicable to all institutional investors,
regardless of who they are regulated by (SEBI or IR-DA or pension fund regulator, PFRDA).

The first ‘stewardship code’ was published by the UK’s Financial Reporting Council (FRC) in
2010, in response to lessons learned from the financial crisis. It has been reviewed every two
years and now has approximately 300 signatories including many leading institutional investors
such as Aberdeen Asset Management, Black Rock and Capital International. The signatories are
committed to adopting and upholding the Code’s principles, which relate to:

1. Publicly disclosing their policy on how they will discharge their stewardship
responsibilities;
2. Having a robust policy on managing conflicts of interest, which should be publicly
disclosed;
3. Monitoring their investee companies, which is regarded by the frc as an ’essential
component of stewardship’;
4. Establishing clear guidelines on when and how they will escalate their stewardship
activities by, for example, attending and speaking at annual general meetings (agm);
5. Their willingness to act collectively with other investors;
6. Having a clear policy on voting and disclosure of voting activity; and
7. Reporting periodically on their stewardship and voting activities.

There are now at least 10 ‘stewardship codes’ globally which are mainly modeled on the UK
approach. In addition, a number of large and influential investors in US markets launched the
Investor Stewardship Group in January 2017. It published a Stewardship Framework, which has
rapidly gained momentum and traction among other major US investors and will be effective
from 1 January 2018.

It is particularly important that the Indian Stewardship Code be supported by best practice
guidance that will provide practical pointers to help ensure that the Code gets off to a flying
start. The primary purposes of a principles-based Indian Stewardship Code should be to:

1. Encourage all institutional investors to vote frequently, transparently and thoughtfully;

2. Provide a generally accepted framework for responsible shareholder engagement;
3. Better inform discussions in Indian boardrooms in respect of investor views on relevant
issues and improve the accountability of Indian boards to their shareholders;
4. Improve the quality of investment decisions by investors in Indian companies; and
5. Strengthen the confidence of Indian retail investors and foreign investors in the integrity
of Indian capital markets.

It is believed that an effective Indian Stewardship Code should improve transparency and
accountability throughout the stewardship chain to such an extent that it results in enhanced

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investor returns over the long-term, and lower cost of capital for Indian companies in general
and companies with high standards of corporate governance, in particular.

4.10 FOREIGN INSTITUTIONAL INVESTORS (FII) IN INDIA (FII, 2018)

A foreign institutional investor (FII) is an investor or investment fund registered in a country

outside of the one in which it is investing. Institutional investors most notably include hedge
funds, insurance companies, pension funds and mutual funds. The term is used most commonly
in India and refers to outside companies investing in the financial markets of India.

A foreign institutional investor (FII) is any type of large investor who does business in a country
other than the one in which the investment instrument is being purchased. In addition to the
types of investors above, others include banks, large corporate buyers or representatives of large
institutions. All FIIs take a position in a foreign financial market on behalf of the home country
in which they are registered.

Regulations for Investing in Indian Companies

All FIIs are allowed to invest in India's primary and secondary capital markets only through the
country's portfolio investment scheme (PIS). This scheme allows FIIs to purchase shares and
debentures of Indian companies on the normal public exchanges in India.

However, there are many regulations included in the scheme. There is a ceiling for all FIIs that
states the max investment amount can only be 24% of the paid-up capital of the Indian company
receiving the investment. The max investment can be increased above 24% through board
approval and the passing of a special resolution. The ceiling is reduced to 20% of the paid-up
capital for investments in public sector banks.

The Reserve Bank of India monitors daily compliance with these ceilings for all foreign
institutional investments. It checks compliance by implementing cutoff points 2% below the
max investment amounts. This gives it a chance to caution the Indian company receiving the
investment before allowing the final 2% to be invested.

4.11 PROXY ADVISORY FIRMS (Varottil, 2012)

Since 2010, the proxy advisory industry has blossomed in India as well. Within a span of two
years, three proxy advisory firms have been established in India, and they have already
published hundreds of recommendations regarding corporate proposals pertaining to various
listed companies in India. Their recommendations cover companies’ proposals relating to the
appointment of directors (especially independent directors), the appointment of auditors, and
major corporate transactions such as mergers and takeovers. Where there are governance

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concerns, the recommendations of proxy advisors have been against the management proposals.
For example, these firms have recommended against appointment of independent directors who
have served companies for a long period of time, although there is yet no maximum tenure
mandatorily prescribed for independent directors. They have raised similar concerns with
respect to auditor appointments. They have also registered opposition in the case of mergers and
corporate restructurings where there is a likelihood value to the public shareholders might be
eroded.

No longer can managements and controlling shareholders ignore the influence of minority
shareholders (both institutional and retail). The recommendations of the proxy advisory firms
have the effect of shedding greater light on corporate proposals, and of galvanizing minority
shareholders to overcome collective action problems and shareholder apathy and to participate
more effectively in corporate decision-making. The fledgling nature of the proxy advisory
industry in India and the absence of systematic empirical evidence might not yet indicate
whether there has been greater exercise of minority franchise in Indian listed companies, but the
fact that the recommendations are discussed in the public domain in a transparent manner (such
as through the financial press) is expected to operate as a set of checks and balances against
managements and controlling shareholders from initiating proposals that might not pass muster
from a governance standpoint.

Another positive effect of the proxy advisory industry is its ability to constantly enhance
governance standards. Although listed companies in India are required to comply with the
standards of corporate governance set out by law, the close monitoring by proxy advisory firms
will motivate companies to elevate their standards of governance. It is expected that the industry
will also help instill global best standards and practices among Indian companies.

Proxy advisory firms also benefit institutional investors in other ways. For example, it is no
longer necessary for institutional investors to spend efforts and costs on research, as they can
simply outsource these functions to external firms. The investors and their managements can
train their resources on investment analysis and decisions, and minimize their focus on
governance decisions in their investee companies. Moreover, managers of institutional
shareholders tend to discharge their responsibilities to their own investors by relying upon
external independent advice on voting and governance matters. While the emergence of the
proxy advisory industry represents a whole new chapter in Indian corporate governance as it
generates the much need activism among public shareholders, it is necessary to caution against
some possible concerns that have been witnessed in other jurisdictions. It is much too early to
determine their impact in India yet, but lessons from experiences in those jurisdictions would
play a role in better moderating the functioning of the industry in India so as to take full
advantage of its benefits by addressing any ill-effects along the way.

At a conceptual level, there are different lines of concerns raised regarding the operation of
proxy advisory firms. These concerns have emanated globally in the industry, and are not
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specific to India, where the experience with the industry is fairly new. First, proxy advisory
firms may suffer from conflicts of interest, either actual or potential, that may impinge upon the
independence and impartiality of their recommendations. Proxy advisory firms comprise both
for-profit entities that must raise revenues to carry on their business, and some non-profit
entities. While for-profit entities mainly charge their customers (being institutional investors) a
fee for the advisory services rendered, some firms also seek other income by offering
consultancy services. Often, such services, which are in the nature of governance consultancies,
are provided to listed companies. This raises conflict concerns, as the independence of
recommendations put out in respect of such companies is not beyond doubt. It is not known if
such conflicts have manifested in the Indian context yet, but it is useful to take cognizance of
international practices that have emanated.

Second, there are concerns regarding the policies followed by the proxy advisory firms while
conducting their research and issuing recommendations. One of the criticisms is that the
governance methodologies and metrics developed and utilized are too general and do not pay
sufficient attention to the specificities involved in each company. For example, there could be a
tendency to adopt a “check the-box” or “one-size-fits-all” approach, without delving into the
circumstances that operate in each company or with respect to different proposals. Excessive
standardization of recommendations will have the effect of substantially diluting their value,
and obliterating the contributions that proxy advisory firms can make towards better corporate
governance.

Third, the functioning of proxy advisory firms can be subjected to more optimal monitoring
with a robust legal regime that clearly delineates the legal responsibility and liability of proxy
advisory firms for the advice they provide. Currently, such a regime does not exist in India. At
most, firms may be responsible contractually for the advice they provide to institutional
investors with whom they have a contractual relationship. Responsibility for a wider audience in
the form of retail investors for public recommendations is even remote. The absence of such a
regime for responsibility could potentially threaten the full utilization of the proxy advisory
industry as an effective corporate governance intermediary.

At a broad level, some of the concerns raised may be addressed either by market forces or by
governmental regulation. A market-based approach would rely on a number of high quality
players in the industry to enhance standards through competitiveness. This would necessitate
the presence of a larger number of players in the industry as opposed to the current oligopoly
situation witnessed in the market, both in India and globally. The shortcoming of relying purely
on a market-based approach is evident from other sectors in the corporate governance field,
such as credit rating agencies and large accounting firms, where a limited number of large
players dominate the industry.

On the other hand, proxy advisory firms are subject to virtually no governmental regulation.
Since the lack of a legal regime governing the industry would exacerbate the issues such as
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conflicts of interest and the inadequacies in transparency standards, leading economies around
the world are actively considering reform efforts to rein in proxy advisors. Proposals for
regulating the proxy advisory industry are under active consideration in Europe, the United
States and Canada.

In India, proxy advisory firms do not fall within any specific regulatory oversight mechanism.
Given the industry’s nascence, SEBI, which may have the closest domain relationship with such
firms, has not yet taken any steps to regulate it. At the same time, there have been calls for SEBI
to initiate steps to regulate the industry and lay down standards of service to be provided by
proxy advisory firms. This would require the establishment of a registration mechanism for such
firms, which would ensure that only those firms with basic qualifications and competence levels
will be permitted to carry on the business, thereby instituting high entry-barriers. This would
help maintain high quality standards in the industry. Such a registration mechanism would also
help SEBI monitor the actions of the firms, and also to impose sanctions in the event of non-
compliance with services standards. This would be similar to the regulation of credit rating
agencies, whereby SEBI has been effective in maintaining standards within the Indian industry,
although the industry at the wider global level had come under some criticism due to its role in
the sub-prime crisis.

4.12 SELF-ASSESSMENT QUESTIONS

True and false Questions:

Indicate whether the following statements are true or false:

a) In India, proxy advisory firms do not fall within any specific regulatory oversight
mechanism.
b) A positive effect of the proxy advisory industry is its ability to constantly enhance
governance standards
c) The Reserve Bank of India monitors daily compliance with these ceilings for all foreign
institutional investments.
d) All FIIs take a position in a foreign financial market on behalf of the home country in
which they are registered.
e) A shareholder proposal should not be an ambiguous rant, but a well-conceived
recommendation to take a specific course of action.
Answers: a (T), b (T), c (T), d (T), e (T)

Long Answer Questions

Q1. Define the concept of ‘Shareholder Activism’. Explain various types of activists.

Q2. Trace out in brief the history of ‘shareholder activism’ and explain briefly the evolution of
‘shareholder activism’ globally.
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 LESSON 5
THE SECRETARIAL AUDIT AND SHAREHOLDER MEETING

5 STRUCTURE

5.1. Secretarial Audit

5.2. Shareholder Meeting: The Life Cycle
5.3. Types of Shareholder Meetings
5.4. Procedure for Convening a Meeting
5.5. Procedure of Conducting Annual General Meeting (AGM)
5.6. Electronic Meetings
5.7. Recording and Distribution of Minutes
5.8. Self-Assessment Questions

5.1 SECRETARIAL AUDIT (Gupta A. S., 2017)

Secretarial Audit is an audit to check compliance of various legislations including the

Companies Act and other corporate and economic laws applicable to the company. Secretarial
Audit helps to detect the instances of non-compliance and facilitates taking corrective measures.
It audits the adherence of good corporate practices by the company. It is therefore an
independent and objective assurance intended to add value and improve operations of the
Company. It helps to accomplish the organization’s objectives by bringing a systematic,
disciplined approach to evaluate and improve effectiveness of risk management, control, and
governance processes. Secretarial Audit thus provides necessary comfort to the management,
regulators and the stakeholders, as to the statutory compliance, good governance and the
existence of proper and adequate systems and processes.

It is a tool of risk mitigation and will allow companies to effectively address compliance risk
issues. It helps the companies to build their corporate image.

Companies that go the extra mile with their compliance programs lay the foundation for good
governance. Companies with an effective compliance management programme have lesser
chance of receiving penalties, both monetary and by way of imprisonment. Companies that
imbibe business and personal ethics and an effective compliance management programme
within their work culture often enjoy employee and customer loyalty and public respect for their
brand, which can translate into better market capitalization and shareholder returns. Recognition
for the company as a good corporate citizen. The Secretarial Audit provides an in-built
mechanism for enhancing corporate compliance generally and help restore the confidence of
investors in the capital market through greater transparency in corporate functioning.

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 Only a member of the Institute of Company Secretaries of India holding certificate of practice
(company secretary in practice) can conduct Secretarial Audit and furnish the Secretarial Audit
Report to the company. [Section 204(1) of Companies Act, 2013]

As per section 204(1) of Companies Act, 2013 read with rule 9 of the Companies (Appointment
and Remuneration of Managerial Personnel) Rules, 2014, the following companies are required
to obtain Secretarial Audit Report: –

• Every listed company

• Every public company having a paid-up share capital of fifty crore rupees or more
• Every public company having a turnover of two hundred fifty crore rupees or more.
• Every Private company which is a subsidiary of a Public Company

Companies which are not covered under section 204 may obtain Secretarial Audit Report
voluntarily as it provides an independent assurance of the compliances in the company.
Proactive Secretarial Audit on a continuous basis would help the company in initiating
corrective measures and strengthening its compliance mechanism and processes.

It is therefore, advisable that the Secretarial Audit is carried out periodically (quarterly/ half
year/ annually) and adverse finding if any, is reported on interim basis to the Board
immediately. The Secretarial Audit Report to be annexed with Board’s report is required to be
submitted before the preparation of Board’s Report.

Secretarial Audit Report is required to be provided in the format prescribed in Form MR-3.
(Rule 9 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules,
2014). In terms of Form MR-3, the Secretarial Auditor needs to examine and report on the
compliance of the following five specific laws:

i.The Companies Act, 2013 (the Act) and the rules made there under;
ii.The Securities Contracts (Regulation) Act, 1956 („SCRA‟) and the rules made there under;
iii.The Depositories Act, 1996 and the Regulations and Bye-laws framed there under
iv. Foreign Exchange Management Act, 1999 and the rules and regulations made there under to
the extent of Foreign Direct Investment, Overseas Direct Investment and External
Commercial Borrowings;
v. The following Regulations and Guidelines prescribed under the Securities and Exchange
Board of India Act, 1992 („SEBI Act‟):-
a. The Securities and Exchange Board of India (Substantial Acquisition of Shares and
Takeovers) Regulations, 2011;
b. The Securities and Exchange Board of India (Prohibition of Insider Trading)
Regulations, 1992;
c. The Securities and Exchange Board of India (Issue of Capital and Disclosure
Requirements) Regulations, 2009;
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 d. The Securities and Exchange Board of India (Employee Stock Option Scheme and
Employee Stock Purchase Scheme) Guidelines, 1999;
e. The Securities and Exchange Board of India (Issue and Listing of Debt Securities)
Regulations, 2008;
f. The Securities and Exchange Board of India (Registrars to an Issue and Share Transfer
Agents) Regulations, 1993 regarding the Companies Act and dealing with client;
g. The Securities and Exchange Board of India (Delisting of Equity Shares) Regulations,
2009; and
h. The Securities and Exchange Board of India (Buyback of Securities) Regulations,
1998;

In addition, the form MR-3, point (vi) also refers to „Other laws as may be applicable
specifically to the company.‟ Reporting on compliance of ‘Other laws as may be applicable
specifically to the company’· which shall include all the laws which are applicable to specific
industry, for example for Banks all laws applicable to Banking Industry; for insurance company
all laws applicable to insurance industry; Likewise for a company in petroleum sector all laws
applicable to petroleum industry; Similarly for companies in pharmaceutical sector, cement
industry etc.

Examining and reporting whether the adequate systems and processes are in place to· monitor
and ensure compliance with general laws like labour laws, competition law, environmental
laws.

Examining and reporting specific observations / qualification, reservation or adverse· remarks

in respect of the Board Structures/system and processes relating to the Audit period.
In case of financial laws like tax laws and Customs Act etc., Secretarial Auditor may rely on·
the Reports given by statutory auditors or other designated professionals. Secretarial Auditor
needs to examine and report on the compliance with the applicable clauses of the following:

i. Secretarial Standards issued by The Institute of Company Secretaries of India and

approved by the Central Government.
ii. The Listing Agreements entered into by the Company with Stock Exchange(s), if
applicable;

Section 448 of Companies Act, 2013 deals with penalty for false statements, and provides that if
in any return, report, certificate, financial statement, prospectus, statement or other document
required by, or for the purposes of any of the provisions of this Act or the rules made there
under, any person makes a statement,—

(a) Which is false in any material particulars, knowing it to be false; or

(b) Which omits any material fact, knowing it to be material; he shall be liable under section
447
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5.2 SHAREHOLDER MEETING: THE LIFE CYCLE (CFA, 2014)

Shareholders meetings help facilitate public shareholders’ engagement with company

management and the board of directors. Resolutions passed at all such meetings are binding on
the company and its stakeholders (see Annexure A for a list of common resolutions passed in
shareholder meetings). Every shareholder meeting has its own life cycle that can be segregated
into three distinct phases. The role of the company and the key rights and duties of shareholders
in each phase are shown in Table 1.

5.3 TYPES OF SHAREHOLDER MEETINGS

There are four primary types of shareholder meetings—that is, forums to facilitate interaction
between public shareholders and the company management—in India: (1) annual general
meetings, (2) extraordinary general meetings (EGMs), (3) postal ballots, and (4) court convened
meetings (CCMs). They differ in their periodicity and type of business agenda. Except for the
AGM, which must be held every year, the meetings are held to seek shareholder approval on
specific resolutions, ranging from electing a small shareholder director4 to altering the
memorandum of association (MoA, see the Glossary) and from issuing bonus shares to
increasing borrowing limits.
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1. Annual General Meeting

The AGM is a compulsory meeting to be held by every company every financial year. AGMs
serve three principal functions:

• to inform shareholders about the financial performance of the company and key
management decisions,
• to seek consent of the shareholders for decisions that are beyond the discretion of the
board of directors (see Annexure A), and
• to provide a forum for discussions between the management of the company and
shareholders to analyze past performances and evaluate future business policies.

The routine business items (also known as “ordinary business”) that are transacted at an AGM
are the consideration of financial statements and the reports of the board of directors and
auditors, declaration of dividend, (re)appointment of directors, and appointment of auditors,
including their remuneration. All other business items are considered “special business.”
As per the Companies Act, 2013, the first AGM for a newly established entity has to be held
within nine months from the date of closing of its first financial year. All subsequent AGMs
should be held within 15 months from the date of last AGM or 6 months from the close of the
financial year, whichever is earlier. In some cases, for special reasons, the Registrar of
Companies may extend the time for holding the meeting by a period not exceeding three months
(except in the case of the first AGM).

Every annual general meeting shall be called during business hours—that is, between 9 a.m. and
6 p.m. on any day that is not a national holiday and shall be held either at the registered office of
the company or at some other place within the city, town, or village in which the registered
office of the company is situated.

The documents to be included with an AGM notice are as follows:

• A hard copy of the annual report, which includes the financial statements,8 as well as
the consolidated financial statements, auditors’ report, directors’ report, proxy form, and
others, shall be sent to every shareholder at least 21 days before the date of the meeting.
Further, the company shall dispatch the soft copies of the complete financial statements
and annual reports, along with such statements as prescribed under the law, to all those
shareholders who have registered their e-mail addresses for the purpose.
• A statement setting out the material facts concerning each item of special business to be
transacted at the meeting.

All the documents mentioned have to be made available for inspection by shareholders at the
company’s registered office during business hours for a period of 21 days before the meeting.
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Listed companies shall also post all the prescribed documents on their website. Companies shall
post separate audited financial statements for each of their subsidiaries on their websites and
provide copies to any shareholder who requests them.

2. Extraordinary General Meeting

Any meeting of shareholders conducted between two annual general meetings is termed an
extraordinary general meeting. These meetings are held when an issue arises that is to be
considered and approved by the shareholders of the company and is too urgent to wait until the
next AGM. The board can call an EGM whenever it deems fit. Shareholders can also request
that the company convene an EGM.

3. Postal Ballot

Physically attending a meeting is often a constraint for shareholders in India. In order to

encourage wider participation from all investors, the central government has listed the following
business items that are to be mandatorily approved by postal ballot instead of at an in-person
meeting:

• alteration of object clause of MoA;

• alteration of articles of association (AoA) to change the type of company (public or
private);
• change in purpose for which the company has raised money from the public and still has
unutilized funds;
• buyback of shares;
• issue of shares with differential rights and variation in rights of existing shares;
• sale of undertaking or substantially the whole of an undertaking of the company;
• granting of loans or extension of a guarantee in excess of the prescribed limits;
• shifting of registered office outside the local limits of any city, town, or village; and
• Election/appointment of a small shareholder director.

In addition, other special business items may be conducted through a postal ballot (see
Annexure A). The resolutions through a postal ballot will be passed if assented to by the
requisite majority of shareholders. For this, shareholders will need to submit the postal ballot
form (see Annexure E) to the company before the scheduled deadline (which shall not be later
than 30 days from the date of dispatch of the notice). If the company has provided an e-voting
platform, shareholders can cast their votes online.

The votes are counted by the scrutinizer—the person who verifies and validates the votes
received and is not employed by the company. The scrutinizer(s) will have to submit the report
within seven days after the last date of receipt of postal ballots.

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4. Court Convened Meeting

Another type of meeting conducted for all schemes of arrangement (mergers, acquisitions,
amalgamations, or winding up proposals) is a court convened meeting. Such meetings are
conducted as per the directions given by the court, and the resolutions proposed in the meetings
need to be approved by a majority in a number representing three-fourths in value held by the
shareholders present in person or through proxies at the time of meeting. In the case of listed
entities, the schemes need an in-principle approval from the capital market regulator— the
Securities and Exchange Board of India—before being submitted to the court. Once the court
approves it, the scheme is binding on all shareholders, creditors, directors, and every other
person related to the company. The Companies Act, 2013, envisages setting up of a National
Company Law Tribunal (NCLT) to oversee such schemes in the future.

5.4 PROCEDURE FOR CONVENING A MEETING (CFA, 2014)

1. General Meeting Notice

Notice of the general meeting should be sent to all participants at least 21 days prior to the
meeting (excluding the date of the notice and the date of the meeting). Figure 2 provides an
overview of the timeline for the meeting, including notice dates.

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2. Shorter Notice

General meetings can also be conducted with shorter notice (i.e., fewer than 21 days) if consent
in writing or by electronic mode is obtained from 95% or more of the shareholders who are
entitled to vote at such meetings. Accidental omission or non-receipt of meeting notice by a
shareholder does not invalidate the proceedings of the meeting.

3. Modes of Notice Delivery

Notice of the meeting can be given either in writing or electronically (via e-mail). The notice
shall be simultaneously placed on the website of the company. In addition, under the Listing
Agreement, every listed company has to inform the stock exchanges about all shareholder
meetings. Such notices should also be advertised in at least one leading national daily English
language newspaper (as per the Companies Act, 2013) and one leading daily Mumbai
newspaper (as per the Listing Agreement).

4. Content of Notice

All general meeting notices shall state the following:

• place, date, day, and hour of the meeting;
• business agenda, which lists the various items to be transacted at a meeting;
• explanatory statement (for each special business item), which discloses material facts for
each item, any interest (financial or otherwise) of directors or key management
personnel and their relatives, and any other information necessary for the shareholders to
understand the scope and make an informed decision.

Any document referred to in the notice will be available for inspection at a specified time and
place.

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5. Special Notice

Shareholders have the authority to propose certain business items by giving a special notice to
the company. These business items include

• resolution for removal of an auditor before the expiry of the term,

• resolution to appoint another auditor in place of the removed/retiring auditor,
• resolution to remove a director before the expiry of the director’s period in office,
• resolution to appoint another director in place of the removed/retiring director, and
• any other resolution as required by the AoA of the company.

In order to give such a notice, the shareholder(s) must own at least 1% of the total voting power
or hold fully paid-up shares of an aggregate face value of 500,000 Indian rupees. Special notice
should be given not earlier than three months and at least 14 days before the date fixed for the
meeting.

6. Adjournment of Meeting

A meeting is adjourned until a later date if none of the business items in the agenda can be
discussed for want of quorum or other exigencies. If the quorum is not present within half an
hour of the appointed time for the meeting, the meeting will automatically be adjourned. The
quorum should be present throughout the meeting. Proxies are to be excluded for determining
the quorum. The meeting may also be adjourned because of such exigencies as power outages,
natural calamities, and external disruptions. The power of adjournment vests in the majority of
those present at the meeting. The chairperson cannot arbitrarily adjourn the meeting. In case of
an adjourned meeting, the company shall inform its shareholders about reconvening the
adjourned meeting at least three days in advance, either individually or by publishing an
advertisement in the newspapers (one in English and one in the vernacular language) that are in
circulation at the place where the registered office of the company is located. In the adjourned
meeting, if the quorum is not present within half an hour from the time appointed for the
meeting, the shareholders present will constitute the quorum and no further adjournment is
required. All the matters discussed at such a meeting are valid.

5.5 PROCEDURE OF CONDUCTING ANNUAL GENERAL MEETING (AGM)

(Actuaries India, 2013)

The Council shall decide the time and place of the meeting every year.

1. Chairperson of the Meeting - The President or in his absence the Vice President, or in
the absence of both the Honorary Secretary, or in the absence of all the three, a member
elected from amongst the members present shall preside over the meeting.

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 2. Notice for the time and place of a meeting shall be sent at least seven days in advance to
the members of the Institute either electronically or by post.
3. The notice shall contain a statement of business to be transacted at such meeting.
4. Twelve members of IAI shall form the quorum. If quorum is not present within half an
hour from the time appointed for the meeting, the meeting shall stand adjourned to such
time and place as the Chairperson may decide. No quorum is required for such
adjourned meeting. All members of the Institute shall be entitled to attend such
adjourned meeting.
5. No decision shall be made on any item taken up for discussion which is not in the
agenda approved by the Council for the AGM.
6. The Chairperson shall, with consent of majority of the members present, adjourn a
meeting to such time and place as agreed by the majority of members present. Such
adjourned meeting can consider only the unfinished business at such meeting. AGM that
gets adjourned, for whatever reason, can be attended by members even though they were
not present at the time the meeting was adjourned. There shall be no fresh notification
given on the timing of the adjourned meeting if the adjourned meeting is held on the
same day. Only discussion on unfinished agenda can be taken up in the adjourned
meetings. No quorum is required for such adjourned meeting.
7. Every decision at the AGM shall be decided by majority of votes and in the event of
equality of votes the Chairperson shall have the casting vote.
8. The minutes of a meeting shall be recorded by any member present as decided by the
Chairperson.
9. The minutes of the meeting, after having been approved by majority of members
present, shall be signed off (electronically or otherwise) by the Chairperson within thirty
days of such meeting and shall be taken on record in the next meeting.
10. Any action items stemming from the minutes of the meeting can be implemented once
the Chairperson signed off the minutes.

5.6 MEETINGS THROUGH ELECTRONIC MODE

Meetings are held to provide an opportunity to communicate information and opinions and to
make decisions. In Companies decisions are always taken in a meeting. On certain matters
Directors are authorized to decide, on certain other matters shareholders are empowered to
decide, and there are certain common grounds were both the parties are involved in the decision
making. For these reasons there are meetings of the directors and meeting of shareholder.
However, physical presence of all the members may not be possible in all the meetings called
by the management. Emphasizing the importance of this requirement, under the provisions of
Companies Act, 2013, the step has been initiated in order to ensure larger participation and for
curbing cost borne by company, directors, and shareholders in order to attend various meetings.
Nevertheless, conducting meetings through video conferencing still remains as optional for
companies. The participation in such meetings through video conferencing has been permitted
subject to certain compliances.
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Provisions of the Companies Act, 2013 in this regard are as follows:

1. Meetings of the board: the meeting of the top level management, particularly the board
of director’s can be conducted using the video conferencing facility. This would help the
management for greater participation of the Board members in taking decisions for the
organization. However, a number of checks have been introduced in the arrangement to
ensure authenticity and creditability of the proceedings.

2. Meetings of shareholders: The meetings of shareholders can also be conducted through

the video conferencing, similar to board meetings. However, the process should be
subject to in-built safeguards. The participation of the shareholders through the
electronic mode helps the company to:

• Take advantage of the emerging Technologies and be competitive in the industry.

• Give a fair chance of participation to all the shareholders for taking any major
decision for the company, irrespective of their location.
• Improve the participation of the shareholders in the meeting, through a process of E-
Voting.
• Achieve potential time and cost saving for both the shareholders and the companies.
• Reducing the carbon footprints of annual meetings by reducing travel by the various
participants and also abiding by the recommendations of the Quoto protocol on
carbon Emissions.

5.7 RECORDING AND DISTRIBUTION OF MINUTES (Process-calling-board-meeting-

companies-act-2013, 2018)

The process involves following steps:

• Calling a Board Meeting: A Board meeting is called by the directors of the committee. The
company directors exercise their powers collectively at a Board Meeting. As per the old
Companies Act, 1956, a board meeting had to be held once in three months with at least
four meetings in a year. Under Section 285 of the Companies Act, 2013, every company
must hold a board meeting at least once in every three months and at least four such
meetings should be held every year. If a meeting is called within the given period, then it
would not amount to a violation, though it could not be held due to want of a quorum. This
meeting should be held within 30 days from the date of incorporation with a 120 days’ gap
between two board meetings. The meeting can be held in person or through video
conferencing.
• Notice for the Board Meeting: Before the beginning of the Board Meeting, a notice for the
same should be given to every Director in the Company. A failure to give notice for the
meeting would invalidate the meeting and the matters debated or approved upon in the
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 meeting would be null and void. Section 286 of the Act states that there is a penalty imposed
on the concerned officer if the notice for the meeting is not given. The Act does not give any
period for the length of such a notice.
• Agenda for the Board Meeting: It is wise to send the agenda of the meeting before the
meeting so that the Directors’ can ponder and jot down their notes before the meeting. The
Act does not lay down any provision that the Agenda of the Meeting should be sent to the
Directors’ attending the meeting before the start of the meeting as mentioned above. Other
matters apart from the agenda items can also be discussed in the meeting. However, it would
be a matter of wisdom if the extra items to be discussed are also added to the agenda list.
• Quorum for the Board Meeting: The quorum for a Board Meeting is one-third of the total
number of the directors of the company or two directors, whichever is higher. If the quorum
is not present then, the meeting will be adjourned to the same time and place on the same
day in the following week.
• Conducting a Board Meeting: The Articles of Association of a Company provides for the
manner or procedure in which an item or business has to be conducted at a Board Meeting.
A majority of votes resolves all debates, questions, or resolutions and if a consensus is not
obtained than the Chairman of the Board of Directors has the casting vote in case of an
equality of votes.
• Recording of the Proceedings of the Meeting: The proceedings of the meeting are to be
recorded within thirty days from the conclusion of the meeting in a Minutes book. The
minutes of the meeting should contain the names of the Directors attending the meeting,
resolutions taken in the meeting, dissent on any issue, solution for the issue, etc. It should
provide a fair and accurate summary of the meeting and contain evidence of every issue
discussed at the meeting. It should contain the assent of the Chairman of the Board as well
as details of the next meeting.
• Resolution of the Meeting: Section 289[8] States that a resolution can be passed either at
the meeting of the Board of Directors or by Circulation. If a resolution has to be passed
through circulation, then a draft of the resolution along with the necessary papers should be
given to each and every director. The resolution by circulation should be approved by a
majority of the directors on the board.

Under Section 292, the following six powers can be exercised by the Board of Directors,
with regards to passing of resolutions in a Board Meeting and not by Circulation:

o Make calls on shareholders in respect to money which is unpaid on their shares.

o Authorize buy-back of the shares of the Company (the Buy-back should be less than
10% of the total paid-up equity capital and free reserves of the company.
o Issuance of debentures.
o Borrowing of Money other than on debentures.
o Investing funds of the company.
o Make loans.

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5.8 SELF ASSESSMENT QUESTIONS

True and false Questions:

Indicate whether the following statements are true or false:

a) Only a member of the Institute of Company Secretaries of India holding certificate of
practice (company secretary in practice) can conduct Secretarial Audit and furnish the
Secretarial Audit Report to the company.
b) There are three primary types of shareholder meetings—that is, forums to facilitate
interaction between public shareholders and the company management—in India
c) The AGM is a compulsory meeting to be held by every company every financial year.
d) As per the Companies Act, 2013, the first AGM for a newly established entity has to be
held within nine months from the date of closing of its first financial year.
e) General meetings can also be conducted with shorter notice (i.e., fewer than 21 days) if
consent in writing or by electronic mode is obtained from 95% or more of the
shareholders who are entitled to vote at such meetings.

Answers: a (T), b (F), c (T), d (T), e (T)

Long Answer Questions

Q1 .What do you understand by proxy? What are the statutory provisions regarding proxies?
When should a proxy be lodged with a company?

Q2.Explain the provisions of the Companies Act, 2013 with regard to the ‘resolutions requiring
special notice’. When such a notice is required?

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 LESSON 6

CORPORATE GOVERNANCE: AN INTERNATIONAL

PERSPECTIVE

6 STRUCTURE

6.1. Corporate Governance Framework: United Kingdom

6.2. Corporate Governance Framework: United States
6.3. Corporate Governance Framework: Australia
6.4. Corporate Governance Framework: China
6.5. Corporate Governance Framework: South Africa
6.6. Self-Assessment Questions

6.1 CORPORATE GOVERNANCE FRAMEWORK: UNITED KINGDOM (FRC, 2018)

The first version of the UK Corporate Governance Code (the Code) was published in 1992 by
the Cadbury Committee. It defined corporate governance as ‘the system by which companies
are directed and controlled.

Boards of directors are responsible for the governance of their companies. The shareholders’
role in governance is to appoint the directors and the auditors and to satisfy themselves that an
appropriate governance structure is in place.’ This remains true today, but the environment in
which companies, their shareholders and wider stakeholders operate continues to develop
rapidly.

Over the years the Code has been revised and expanded to take account of the increasing
demands on the UK’s corporate governance framework. The principle of collective
responsibility within a unitary board has been a success and – alongside the stewardship
activities of investors – played a vital role in delivering high standards of governance and
encouraging long-term investment.

Nevertheless, the debate about the nature and extent of the framework has intensified as a result
of financial crises and high-profile examples of inadequate governance and misconduct, which
have led to poor outcomes for a wide range of stakeholders.

At the heart of this Code is an updated set of Principles that emphasize the value of good
corporate governance to long-term sustainable success. By applying the Principles, following
the more detailed Provisions and using the associated guidance, companies can demonstrate
throughout their reporting how the governance of the company contributes to its long-term
sustainable success and achieves wider objectives.

The 2018 Code focuses on the application of the Principles and includes the following:
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A. Board Leadership and Company Purpose

Principles

1. A successful company is led by an effective and entrepreneurial board, whose role is to

promote the long-term sustainable success of the company, generating value for
shareholders and contributing to wider society.
2. The board should establish the company’s purpose, values and strategy, and satisfy itself
that these and its culture are aligned. All directors must act with integrity, led by example
and promote the desired culture.
3. The board should ensure that the necessary resources are in place for the company to meet
its objectives and measure performance against them. The board should also establish a
framework of prudent and effective controls, which enable risk to be assessed and managed.
4. In order for the company to meet its responsibilities to shareholders and stakeholders, the
board should ensure effective engagement with, and encourage participation from, these
parties.
5. The board should ensure that workforce policies and practices are consistent with the
company’s values and support its long-term sustainable success. The workforce should be
able to raise any matters of concern.

B. Division of Responsibilities

Principles

6. The chair leads the board and is responsible for its overall effectiveness in directing the
company. They should demonstrate objective judgment throughout their tenure and promote
a culture of openness and debate. In addition, the chair facilitates constructive board
relations and the effective contribution of all non-executive directors, and ensures that
directors receive accurate, timely and clear information.
7. The board should include an appropriate combination of executive and non-executive (and,
in particular, independent non-executive) directors, such that no one individual or small
group of individuals dominates the board’s decision-making. There should be a clear
division of responsibilities between the leadership of the board and the executive leadership
of the company’s business.
8. Non-executive directors should have sufficient time to meet their board responsibilities.
They should provide constructive challenge, strategic guidance, offer specialist advice and
hold management to account.
9. The board, supported by the company secretary, should ensure that it has the policies,
processes, information, time and resources it needs in order to function effectively and
efficiently.

C. Composition, Succession and Evaluation

Principles

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10. Appointments to the board should be subject to a formal, rigorous and transparent
procedure, and an effective succession plan should be maintained for board and senior
management. Both appointments and succession plans should be based on merit and
objective criteria and, within this context, should promote diversity of gender, social and
ethnic backgrounds, cognitive and personal strengths.
11. The board and its committees should have a combination of skills, experience and
knowledge. Consideration should be given to the length of service of the board as a whole
and membership regularly refreshed.
12. Annual evaluation of the board should consider its composition, diversity and how
effectively members work together to achieve objectives. Individual evaluation should
demonstrate whether each director continues to contribute effectively.

D. Audit, Risk and Internal Control

Principles

13. The board should establish formal and transparent policies and procedures to ensure the
independence and effectiveness of internal and external audit functions and satisfy itself on
the integrity of financial and narrative statements.
14. The board should present a fair, balanced and understandable assessment of the company’s
position and prospects.
15. The board should establish procedures to manage risk, oversee the internal control
framework, and determine the nature and extent of the principal risks the company is willing
to take in order to achieve its long-term strategic objectives.

E. Remuneration

Principles

16. Remuneration policies and practices should be designed to support strategy and promote
long-term sustainable success. Executive remuneration should be aligned to company
purpose and values, and be clearly linked to the successful delivery of the company’s long-
term strategy.
17. A formal and transparent procedure for developing policy on executive remuneration and
determining director and senior management remuneration should be established. No
director should be involved in deciding their own remuneration outcome.
18. Directors should exercise independent judgment and discretion when authorizing
remuneration outcomes, taking account of company and individual performance, and wider
circumstances.

6.2 CORPORATE GOVERNANCE FRAMEWORK: UNITED STATES (Sharma J. ,

Corporate Governance, Business ethics and CS, 2016)

The US approach to Corporate Governance can be characterized as a regulated system

predominantly enforced through SEC regulation, listing rules and state laws. The US doesn’t
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have a code of corporate Governance similar to that of the UK, given the federal nature of its
constitution. While the internal aspects of corporate Governance, such as directors’ duties and
shareholders rights, are a matter for state law, the SEC and stock exchanges also play a
significance role in the governance of listed companies. US public companies are subject to US
federal statutory laws, including the Securities Act of 1933, as amended, the Securities
Exchange Act of 1934, as amended, and the regulations, rules and other guidance promulgated
by the Securities and Exchange Commission (SEC). Most US public companies are listed either
through the NYSE EURONEXT or the NASDAQ OMX. US public companies must comply
with the listing standards published by the stock Exchange on which the company’s shares are
listed.

Regulatory Framework of Corporate Governance in US

According to the IOD publication (2005), the governance system in the US is based largely on
the law of corporation enacted in each of the 50 states. These state corporation laws resemble
each other closely as the Model Business Corporation Act (MBCA) is published and regularly
updated by the American Bar Association (ABA). State Laws and the influential MBCA set
forth the fundamentals of the corporation and the fiduciary duties of the corporations.

In the United States there are 2 primary sources of Law and Regulation related to Corporate
Governance:

• State Corporate Laws: State Corporate Laws both statutory and judicial which governs
the formation of privately held and publically traded corporation and the fiduciary duties
of the directors. Delaware is the most common state of incorporation. Shareholder suits
are the primary enforcement mechanism of state corporate laws.
• Federal Securities Law: On the Federal level, the securities laws regulate all offerings
and sales of Securities whether by public or private companies. The Exchange Act
addresses many issues, including the organization of the financial market place
generally, the activities of brokers, dealers and other financial market participants, and,
as to corporate governance, specific requirements related to the periodic disclosure of
information by publically held, or ‘reporting’ companies.

The following provide the general framework for U.S Corporate Governance and Securities
Laws:

• Company Boards: The U.S Companies follow a Unitary Board Structure i.e only one
Board. In case of holding companies, there is a central Board, with additional boards for
subsidiaries; in mutual funds- fund families may have a single board (overseeing all
funds) or multiple boards (one per fund or sub group). A gradual growth has been
observed in the presence of independent outside directors, most of these were CEO or
senior executive of corporations including women in large numbers or professionals
with specialized knowledge. In the U.S, the board of directors is responsible for
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 appointing the management or officers of the company. Individuals holding equivalent
positions in the U.S would normally be classed as “Officers” but not Directors of the
company. For Example, the functions of the Managing Director or Finance Director are
typically undertaken in a U.S company by the Chief Executive Officer and Chief
Financial Officer respectively (who in these roles are officers, and not Directors), who
are responsible for the day to day operations of the business under powers delegated by
the board. In the U.S, state laws govern the ability of the company to limit the liability of
and indemnify a Director. Most states allow a company to eliminate or limit director’s
personal liability to the company and its shareholder for breach of their fiduciary duty.
However, there are often restrictions on this limitation of Directors’ liability. Many
companies also provide contractual indemnities to their directors, in addition to the
indemnification provided by the state law.

While US state laws do not, subject to certain limitations, and govern director
independence requirements, US securities law generally requires a majority of the board
of a public company to be independent. US public companies must also identify there
independent directors and, under NYSE EURONEXT rules, disclose the basis for that
determination. This disclosure is usually contained in the company’s Annual Report or
Proxy Statements filed with the SEC.

US stock exchange listing rules include definitions for ‘independence’ that, at a

minimum, require that the director should not currently be (or within the past 3 years
have been) an employee of the company. Under NYSE EURONEXT rules, a director
also may not qualify as Independent unless the board affirmatively determines that the
director has no material relationship with the company. Both NYSE EURONEXT and
NASDAQ OMX require that there are regularly scheduled board meetings (referred to
as Executive sessions) at which only independent directors or Non-Executive directors
are present.

• Board Committees: The most common committees used by the US Boards are Audit,
Compensation and Nomination Committees. The Audit Committees of Public
companies must ensure that the companies comply with generally accepted Accounting
Principles as determined by the Financial Accounting Standards Boards (FASB), the
entity sets accounting standards for US companies.

Sarbanes-Oxley doesn’t cover the duties of the 2 key committees. However, the new
NYSE and NASDAQ listing rules include requirements for all 3 committees.

• Disclosure and Transparency: A primary goal of US Securities laws is Transparency

and Disclosure. Sarbanes-Oxley and the new stock listing rules include new
requirements to disclose procedural matters.

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Sarbanes-Oxley Act 2002

On July 2nd 2002, President George W. Bush signed into law the Public Accounting Reform and
Investor Protection Act of 2002, known as Sarbanes-Oxley Act after its sponsors Paul Sarbanes
and Michael Oxley. The law has been hailed as a landmark comparable to the Securities and
Securities Exchange Act that created the Securities and Exchange Commission (SEC). Under
Sarbanes-Oxley, auditors must give report to the audit committee on all critical accounting
policies and practices to be used as well as report on the auditor’s discussion with management
about accounting policies and any material matters.

Furthermore it requires that the Audit committee of the companies listed on Stock Exchanges
disclose the presence or absence of at least one member who is “an Audit Committee financial
expert”.

The Provisions and the requirements of the Sarbanes-Oxley Act include:

• Among other goals, the law has created the Public Company Accounting Oversight
Board, to monitor auditors, strength auditor’s independence, and give the SEC more
resources and authority to enforce securities laws.
• Measures intended to enhance the independence of External Auditors, including the
mandatory rotation of Audit partners, restrictions on the non-audit services that may be
provided by External Auditors and limitations regarding the employment of External
Auditor personnel by client companies.
• The law has strengthened the role of Audit Committee. Measures intended to enhance
the Independence of Members of Audit Committees of listed companies and the
effectiveness of Audit Committees.
• Measures intended to increase CEO accountability for financial statements, make CEO
and CFO’s sign off on financials, with significant criminal penalties for giving false
certifications.
• Enhancement to the ability of the SEC to prohibit persons from serving as directors and
officers.
• Establishment by the SEC of a compensation fund for investors.
• Rules requiring disclosure of off-balance sheet transactions, the use of performa
financial information, management reports on the effectiveness of internal controls and
the adoption (and waivers) of codes of ethics for senior financial officers.
• Prohibition on loans to directors and executive officers.
• Creation of new criminal offences regarding securities fraud and the destruction of
documents and the increase of criminal penalties.
• A prohibition on “insider’ trades during pension fund blackout periods.
• New protections for whistleblowers.

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6.3 CORPORATE GOVERNANCE FRAMEWORK: AUSTRALIA (R & A Associates,
2018)

The Australian Securities Exchange (ASX) Corporate Governance Council was formed in
August 2002 and has been chaired by the ASX Group (ASX) since its inception. ASX Group is
a market operator, clearing house and oversees compliance with its operating rules, promotes
standards of corporate governance among Australia's listed companies and helps to educate
retail investors. The Council is a remarkably diverse body, bringing together business, and
investment and shareholder groups. Its ongoing mission is to ensure that the principles-based
framework it developed for corporate governance continues to be a practical guide for listed
companies, their investors and the wider Australian community. The ASX Corporate
Governance Council’s Recommendations are not mandatory and cannot, in themselves, prevent
corporate failure or poor corporate decision-making. They are intended to provide a reference
point for companies about their corporate governance structures and practices. The
Recommendations are not prescriptions, they are guidelines, designed to produce an outcome
that is effective and of high quality and integrity. The Corporate Governance Principles and
Recommendations as laid down by the ASX Corporate Governance Council are:

Principle 1: lay solid foundations for management and oversight: Companies should
establish and disclose the respective roles and responsibilities of Board and Management.

Recommendation:

• Companies should establish the functions reserved to the board and those delegated to
senior executives and disclose those functions.
• Companies should disclose the process for evaluating the performance of senior
executives.
• Companies should provide the information indicated in the Guide to reporting on
Principle 1.

Principle 2 Structuring of Board: - Structure the board to add value Companies should have a
board of an effective composition, size and commitment to adequately discharge its
responsibilities and duties.

Recommendation:

• A majority of the board should be independent directors.

• The chair should be an independent director.
• The roles of chair and chief executive officer should not be exercised by the same
individual.
• The board should establish a nomination committee.
• Companies should disclose the process for evaluating the performance of the board, its
committees and individual directors.

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Principle 3 - Promote ethical and responsible decision-making Companies should actively
promote ethical and responsible decision-making.

Recommendation:

• Companies should establish a code of conduct and disclose the code or a summary of the
code as to
o the practices necessary to maintain confidence in the company’s integrity - the
practices necessary to take into account their legal obligations and the reasonable
expectations of their stakeholders - the responsibility and accountability of
individuals for reporting and investigating reports of unethical practices.
• Companies should establish a policy concerning diversity and disclose the policy or a
summary of that policy. The policy should include requirements for the board to
establish measurable objectives for achieving gender diversity for the board to assess
annually both the objectives and progress in achieving them.
• Companies should disclose in each annual report the measurable objectives for
achieving gender diversity set by the board in accordance with the diversity policy and
progress towards achieving them.
• Companies should disclose in each annual report the proportion of women employees in
the whole organization, women in senior executive positions and women on the board.

Principle 4 - Safeguard integrity in financial reporting Companies should have a structure to

independently verify and safeguard the integrity of their financial reporting.

Recommendation:

• The board should establish an audit committee.

• The audit committee should be structured so that it
o consists only of non-executive directors - consists of a majority of independent
directors - is chaired by an independent chair, who is not chair of the board - has
at least three members.
• The audit committee should have a formal charter.

Principle 5 - Make timely and balanced disclosure: Companies should promote timely and
balanced disclosure of all material matters concerning the company.

Recommendation:

• Companies should establish written policies designed to ensure compliance with ASX
Listing Rule disclosure requirements and to ensure accountability at a senior executive
level for that compliance and disclose those policies or a summary of those policies.

Principle 6 - Respect the rights of shareholders Companies should respect the rights of
shareholders and facilitate the effective exercise of those rights.

Recommendation:
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 • Companies should design a communications policy for promoting effective
communication with shareholders and encouraging their participation at general
meetings and disclose their policy or a summary of that policy.

Principle 7- Recognize and manage risk Companies should establish a sound system of risk
oversight and management and internal control.

Recommendation

• Companies should establish policies for the oversight and management of material
business risks and disclose a summary of those policies.
• The board should require management to design and implement the risk management
and internal control system to manage the company's material business risks and report
to it on whether those risks are being managed effectively. The board should disclose
that management has reported to it as to the effectiveness of the company's management
of its material business risks.
• The board should disclose whether it has received assurance from the chief executive
officer (or equivalent) and the chief financial officer (or equivalent) that the declaration
provided in accordance with section 295A of the Corporations Act 2001is founded on a
sound system of risk management and internal control and that the system is operating
effectively in all material respects in relation to financial reporting risks.

Principle 8- Remunerate fairly and responsibly Companies should ensure that the level and
composition of remuneration is sufficient and reasonable and that its relationship to
performance is clear.

Recommendation

• The remuneration committee should be structured so that it:

o consist of a majority of independent directors -is chaired by an independent chair has
at least three members.
• Companies should clearly distinguish the structure of non-executive directors’
remuneration from that of executive directors and senior executives.

The ASX Corporate Governance Council considers that a well-reasoned “if not, why not”
explanation from a company is a valid response to a particular Recommendation. Effective “if
not, why not” reporting practices involve:

• identifying the Recommendations the company has not followed

• explaining why the company has not followed the relevant Recommendation
• explaining how its practices accord with the ‘spirit’ of the relevant Principle, that the
company understands the relevant issues and has considered the impact of its alternative
approach.

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6.4 CORPORATE GOVERNANCE FRAMEWORK: CHINA (OECD, 2011)

The Legal Framework of Corporate Governance for Listed Companies in China

China’s legal framework for corporate governance comprises four levels: basic laws,
administrative regulations, regulatory provisions, and self-disciplinary rules. The first level
comprises some fundamental laws, formulated either by the National People’s Congress or its
Standing Committee. They include the Company Law, the Securities Law, the Criminal Law
Amendment Act (6), and the Law on the State-Owned Assets of Enterprises and the Accounting
Law.

The second level includes State Council administrative regulations, notably: Opinions on
Promoting the Reform, Opening and Steady Growth of Capital Markets, Circular of the State
Council on its Approval of the CSRC’s Opinion on Improving the Quality of Listed Companies.

The third level involves departmental provisions formulated by the Ministries, Commissions,
the People’s Bank of China, the Auditing Administration and other agencies with administrative
jurisdiction directly under the State Council. These include: the Code of Corporate Governance
of Listed Companies, Regulations on Information Disclosure of Listed Companies, Guidelines
on Articles of Association of Listed Companies, Rules on Shareholders’ Meetings of Listed
Companies, Guiding Opinions on the Establishment of the System of Independent Directors in
Listed Companies, Provisions on Strengthening the Protection of the Rights and Interests of
Public Shareholders, Regulations on the Takeover of Listed Companies, Regulations on Major
Asset Reorganization of Listed Companies, Regulations on Option Incentives of Listed
Companies (Trial), Regulations on the Registration and Settlement of Securities.

The fourth level of self-disciplinary rules refers to the Rules on Listing Stocks and Trading
Rules made by the stock exchanges, among others.

When the laws, regulations and rules at various levels are drafted, the legislature or competent
administrative departments generally carry out in-depth research and implement the relevant
legal procedures strictly to solicit a broad scope of opinions through round-table discussions,
argumentation, consultation and comments so that individual citizens and market entities are
able to express their views directly or through their representatives, thereby safeguarding their
legitimate rights and interests.

Perpetrators of irregularities and violations in corporate governance shall be held accountable

for the relevant administrative, civil and criminal responsibilities. The CSRC may deliver
administrative sanctions, such as warnings, fines, disqualification and banning the entry into the
securities market of the companies and individuals responsible for violations. Those suspected
of a criminal offence shall be transferred to the judicial departments to ascertain criminal
liability. The company registration department and other competent departments may also
punish violating companies, intermediaries and persons responsible by ordering them to return
company property, confiscating the illicit gains, imposing a fine, cancelling company

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registration and revoking a business license, ordering intermediaries to stop business operations
and revoking qualification certificates of those directly responsible. Furthermore, shareholders
may also, according to law, file lawsuits against those persons and institutions that have
undermined the legitimate rights and interests of the company and its shareholders and claim
civil damage. Companies in violation shall undertake the responsibility of civil compensation
and pay the fines. When assets are insufficient, civil damage compensation shall be paid out
first. Criminal responsibility shall be investigated when a criminal offence is involved.

A. Basic Laws

1. Company Law (2006): The Company Law (2006) is formulated to standardize the
organization and behaviour of companies, to protect the legitimate rights and interests of
companies, shareholders and creditors, safeguard socioeconomic order and promote the
development of a socialist market economy. It governs the incorporation and organizational
structure of limited liability companies, equity transfers of limited liability companies, the
incorporation, organizational structure, issuance and transfer of shares of companies limited
by shares, the qualifications and obligations of company directors, supervisors and senior
executives, corporate bonds, corporate finance and accounting, company mergers, splits,
capital increases and reductions, company dissolution and clearance, branches of foreign
companies and legal liabilities.
2. Securities Law (2006): The Securities Law (2006) was drawn up to standardize securities
issues and transactions, protect the legitimate rights and interests of investors, safeguard
socioeconomic order and public interests and promote the development of a socialist market
economy. It governs securities issues, securities transactions, general provisions, listing of
securities, disclosure of information, prohibited transactions, acquisition of a listed
company, stock exchanges, securities companies, securities registration and clearance
institutions, securities service organizations, securities industry associations, securities
regulatory institution and legal liabilities.
3. Criminal Law Amendment Act (6) (2006): Amendment VI to the Criminal Law (2006)
was designed to match the amended Securities Law and Company Law, to give a more
complete definition of legal liabilities in the securities field, improve the laws governing the
securities market and promote its healthy development. The Amendment governs the
following corporate governance related offences: disclosure breaches, non-disclosure of
major information, breach of trust and damage of listed company’s interests, insider trading
and leakage of insider information and manipulation of securities or futures market.
4. Law on the State-Owned Assets of Enterprises (2009): The Law on the State-Owned
Assets of Enterprises (2009) was promulgated to safeguard the country’s basic economic
system, to consolidate and develop the state owned sector, strengthen the protection of state-
owned assets, allow the state-owned sector to play a dominant role in the national economy,
and promote the development of a socialist market economy. The Law governs the
institution that performs the function of investor, enterprises with funds from the state, the
selection managers of enterprises funded by the state and the assessment of their

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 performance, significant matters bearing on the rights and interests of the investor of state-
owned assets, operational budgets of state-owned assets, supervision of state-owned assets
and legal liabilities.
5. Accounting Law (2000): The Accounting Law (2000) was introduced to standardise
accounting behaviour, ensure the truthfulness and completeness of accounting materials,
strengthen economic administration and financial management, improve economic
performance and safeguard the order of the socialist market economy. This law lays out
requirements regarding accounting practices, special provisions on companies’ accounting
practices, accounting supervision, accounting offices, accounting personnel, and legal
liability.

B. Administrative Regulations and Regulatory Documents

1. Regulations on the Administration of Company Registration (2005): These regulations

provide for the confirmation that a company qualifies as a legal personality, standardized
company registration and complete and standardized provisions concerning the
establishment, alteration and termination of companies in terms of registration, registered
items, registration of establishments, changes and cancellations, as well as registration
procedures.
2. Opinions on Promoting the Reform, Opening-up and Steady Growth of Capital
Markets (2004): These opinions focus on the need to fully appreciate the importance of
capital market development, the guiding ideology and tasks for promoting reform, and the
opening-up and steady growth of capital markets. Efforts need to be made to improve
relevant policies to promote the steady growth of capital markets. The structure of capital
markets needs to be optimized and the range of investment securities expanded. The quality
of listed companies needs to be improved and their operation should be standardized. Efforts
should be made to promote the standardization of intermediaries in the capital markets and
strengthen their professional skills. The development and integrity of the legal system need
to be promoted to raise the level of supervision over capital markets. Emphasis should be
put on co-ordinate efforts to fend off and monitor market risks. Past experiences and lessons
learned should be reviewed to steadily promote implementation of the opening-up policy.
3. Circular of the State Council on its Approval of the CSRC’s Opinion on Improving the
Quality of Listed Companies (2005): This document discusses how improving the quality
of listed companies must be viewed as a priority. Corporate governance must be improved
to enhance listed companies’ business performance and management and raise their level of
standardized operations. Efforts need to be made to address both the symptoms and root
causes of the quality issues pertaining to listed companies, especially related to outstanding
problems. Effective measures must be taken to help listed companies grow and excel. Their
supervision and management mechanisms must be improved and regulatory co-ordination
must be strengthened. Better leadership and guidance should be provided to create a
favorable environment for the healthy development of listed companies.

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C. Regulatory Provisions and Normative Documents

1. Code of Corporate Governance of Listed Companies (2002): The Code of Corporate

Governance for Listed Companies (2002) was drawn up in line with the basic principles
established by the original Company Law, Securities Law and other relevant laws and
regulations, and has made a positive contribution to promoting listed companies in China to
establish and improve a modern enterprise system, standardize their operations and promote
the healthy development of the securities market. The Code governs shareholders and
shareholders’ meetings, listed companies and controlling shareholders, directors and board
of directors, supervisors and the supervisory board, performance assessment and incentive
and disciplinary systems, stakeholders, and information disclosure and transparency. The
Code comprises the main measurement criteria used to judge whether a listed company has
a sound corporate governance structure. The securities regulatory institution has the power
to order the listed companies that have major problems in corporate governance to remedy
them according to the Code. The CSRC is making active preparations to amend the Code,
along with the amendments to the Company Law, Securities Law and other relevant laws
and regulations, in order to adapt to the changed market environment, enhance the
effectiveness of listed-company governance, encourage them to improve quality and
promote the healthy development of Chinese capital markets.
2. Regulations on Listed Companies’ Information Disclosure (2007): These regulations set
out the requirements and listing particulars for the issuance of an Initial Public Offering
(IPO) prospectus, offering circular, periodic reports, ad-hoc reports, information disclosure
management, supervision and legal liability.
3. Guidance on Listed Companies’ Articles of Association (2006): This document provides
guidance on business purposes and scope, shares, shareholders and shareholders’ meetings,
boards of directors, managers and other executives, supervisory boards, financial and
accounting systems, profit distribution and auditing, public announcements and notices,
mergers, divestments, capital increases and reductions, dissolution and liquidation, and
revision of the articles of association.
4. Rules on Listed Companies’ Shareholders’ Meetings (2006): These rules relate to the
convening of shareholders’ meetings, their resolutions and related notifications, and
supervisory measures.
5. Guiding Opinions on the Establishment of the System of Independent Directors in
Listed Companies (2001): These opinions provide guidance on independent directors, who
must truly be independent and have the necessary qualifications to perform their duties. The
nomination, election and appointment of independent directors must be conducted according
to the law and relevant regulations. Listed companies must accord the appropriate
importance to independent directors and the role they play. Independent directors must have
independent opinions on major issues affecting the listed company, which shall provide its
independent directors with the required conditions to fulfill their roles.
6. Provisions on Strengthening the Protection of the Rights and Interests of Public
Shareholders (2004): These provisions cover the introduction of a trial public shareholder
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 voting system on major issues pertaining to a company and the enhancement of the
independent directors system, giving more importance to the role played by independent
directors. They also seek to improve investor relations management and raise the quality of
information disclosure by listed companies, including those with active profit distribution
plans, and to reinforce the supervision of listed companies and their senior management.
7. Regulations on the Takeover of Listed Companies (2006): These regulations outline
listed companies’ requirements in relation to the disclosure of rights and interests, tender
offers, block purchases, indirect purchases, exemption applications, financial advisors,
ongoing supervision, supervisory measures and legal liability.
8. Regulations on Major Asset Reorganization of Listed Companies (2008): These
regulations outline listed companies’ requirements in relation to the principles and
standards, procedures and information management governing major asset reorganization.
They also include special provisions on issuing shares for asset purchase, applications for
issuing new shares or company bonds after a major asset reorganization, supervision
management and legal liability.
9. Regulations on Equity Incentives of Listed Companies (Trial) (2005): These regulations
outline listed companies’ requirements in relation to general provisions, restricted shares,
stock options, implementation procedures and information disclosure, supervision and
penalties for breaches of regulations.
10. Regulations on the Registration and Settlement of Securities (2006): These regulations
outline listed companies’ requirements regarding institutions in charge of registering and
settling securities, managing security accounts, trusteeship and depository of securities, the
clearance and delivery of securities and money, risk prevention and handling delivery
defaults.
11. Basic Standard for Enterprise Internal Control (2008): The Basic Standard covers the
objectives, principles and elements that enterprises should establish and implement
regarding internal controls, internal environments, risk assessment, control activities,
information and communication, and internal supervision.

D. Self-Disciplinary Rules

1. Rules Governing the Listing of Stocks on the Shanghai Stock Exchange (2008), Rules
Governing the Listing of Stocks on the Shenzhen Stock Exchange (2008): These rules
cover: the general principles and provisions on information disclosure, directors, supervisors
and senior management, appointed advisers/investment banks, listing of stocks and
convertible bonds, periodic reports, general provisions on ad-hoc reports, resolutions of
boards of directors, boards of supervisors and shareholders’ meetings, transactions requiring
disclosure, related-party transactions, other material matters, suspension and restoration of
trading, special treatment, suspension, resumption and termination of listing, applications
for review, co-ordination between domestic and overseas listings, day-to-day regulation and
dealing with breaches of these rules.

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2. Trading Rules of the Shanghai Stock Exchange (2006), Trading Rules of the Shenzhen
Stock Exchange (2006): These rules cover: the trading market, securities trading, other
trading-related matters, trading information, supervision of trading activities, handling
extraordinary circumstances during trading, trading disputes, trading fees, disciplinary
sanctions.

6.5 CORPORATE GOVERNANCE FRAMEWORK: SOUTH AFRICA (Institute of

Directors Southern Africa, 2016)

In South Africa, the following Principles embody the aspirations of the journey towards good
corporate governance:

1. The governing body should lead ethically and effectively

2. The governing body should govern the ethics of the organization in a way that supports
the establishment of an ethical culture.
3. The governing body should ensure that the organization is and is seen to be a
responsible corporate citizen.
4. The governing body should appreciate that the organization’s core purpose, its risks and
opportunities, strategy, business model, performance and sustainable development are
all inseparable elements of the value creation process.
5. The governing body should ensure that reports issued by the organization enable
stakeholders to make informed assessments of the organization’s performance and its
short, medium and long-term prospects.
6. The governing body should serve as the focal point and custodian of corporate
governance in the organization.
7. The governing body should comprise the appropriate balance of knowledge, skills,
experience, diversity and independence for it to discharge its governance role and
responsibilities objectively and effectively.
8. The governing body should ensure that its arrangements for delegation within its own
structures promote independent judgment, and assist with balance of power and the
effective discharge of its duties.
9. The governing body should ensure that the evaluation of its own performance and that of
its committees, its chair and its individual members, support continued improvement in
its performance and effectiveness.
10. The governing body should ensure that the appointment of, and delegation to,
management contribute to role clarity and the effective exercise of authority and
responsibilities.
11. The governing body should govern risk in a way that supports the organization in setting
and achieving its strategic objectives.
12. The governing body should govern technology and information in a way that supports
the organization setting and achieving its strategic objectives.

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 13. The governing body should govern compliance with applicable laws and adopted, non-
binding rules, codes and standards in a way that supports the organization being ethical
and a good corporate citizen.
14. The governing body should ensure that the organization remunerates fairly, responsibly
and transparently so as to promote the achievement of strategic objectives and positive
outcomes in the short, medium and long term
15. The governing body should ensure that assurance services and functions enable an
effective control environment, and that these support the integrity of information for
internal decision-making and of the organization’s external reports.
16. In the execution of its governance role and responsibilities, the governing body should
adopt a stakeholder-inclusive approach that balances the needs, interests and
expectations of material stakeholders in the best interests of the organization over time.
17. The governing body of an institutional investor organization should ensure that
responsible investment is practiced by the organization to promote the good governance
and the creation of value by the companies in which it invests.

6.6 SELF-ASSESSMENT QUESTIONS

True and false Questions:

Indicate whether the following statements are true or false:

a) The first version of the UK Corporate Governance Code (the Code) was published in
1992 by the Cadbury Committee.
b) Boards of directors are responsible for the governance of their companies.
c) The board should present a fair, balanced and understandable assessment of the
company’s position and prospects.
d) The US approach to Corporate Governance can be characterized as a regulated system
predominantly enforced through SEC regulation, listing rules and state laws.
e) On July 2nd 2002, President George W. Bush signed into law the Public Accounting
Reform and Investor Protection Act of 2002, known as Sarbanes-Oxley Act after its
sponsors Paul Sarbanes and Michael Oxley.

Answers: a (T), b (T), c (T), d (T), e (T)

Long Answer Questions

Q1. Differentiate between the UK shareholder-led corporate governance and US regulator led
corporate governance.

Q2. Distinguish the Australian model of corporate governance from the UK Model.

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 LESSON 7

CORPORATE MANAGEMENT

7 STRUCTURE

7.1. Management vs. Governance

7.2. Internal Constituents/Pillars of Corporate Governance
7.3. Key Managerial Personnel (KMP)
7.4. Chairman: Role and Responsibilities
7.5. CEO: Role and Responsibilities
7.6. Separation of Roles of Chairman and CEO
7.7. Role of CFO in Corporate Governance
7.8. Role of Company Secretary in Corporate Governance
7.9. Role of an Auditor in Corporate Governance
7.10. Board Diversity
7.11. Self-Assessment Questions

7.1 MANAGEMENT vs. GOVERNANCE (Ashe-Edmunds, 2018)

Corporate governance differs from corporate management in that governance is primarily about
protecting a business, while management is more about growing it. Governance refers to the
policies and procedures set in place to ensure a business operates within the law and for the
optimal benefit of all stakeholders. Management refers to the techniques executives use to help
the company operate and flourish.

• Governance: Governance comes from the word “govern,” which means to control the
actions of a group for the benefit of the whole. In the business world, this refers to policies
that specifically restrict or direct how people can act. For example, governance policies
might include prohibiting a board of directors from awarding contracts to board members’
companies or the companies of family members. A business might require its accounting
department to have two signatures on any check it writes to reduce the threat of fraud.

• Management: Management refers to the actions taken by a company to lead the business in
a positive direction. Examples of management include setting budgets, giving staff members
directions and making strategic plans about marketing or product development.
Corporations usually have management teams once the company becomes too big for the
founder or one individual to oversee the entire business. Management team members
include titles such as department head, director, vice president and manager, chief executive
officer, chief operating officer and chief financial officer.

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• Common Governance Activities: Businesses benefit from written policies and procedures
that allow leaders to avoid specific conflicts of interests and fraudulent activities before they
happen and to detect any fraud that might occur. Many governance policies pertain to
financial activities, setting procedures for soliciting and awarding contracts, accounting
practices and disbursing profits. Business set strict rules for human resources activities that
fall under state and federal guidelines. When a corporation becomes a public company,
corporate governance expands to include following SEC rules and providing transparency
for shareholders. Unlike company policies that govern the behavior of individual
employees, such as dress codes or grievance procedures, corporate governance policies
pertain mostly to the operations of the business.

• Common Management Activities: Management activities help a business operate, with

instruction from top leaders directing the activities of staff members. Companies create
plans for developing, pricing, promoting and distributing their products, put systems into
place to oversee their plans and review and assess their projections and performance.
Companies manage their employees by training workers to help them perform better.
Analyses of operations help management to determine if the company needs to change any
practices, such as bringing contracted work in-house or vice versa, setting new goals,
modifying the marketing mix and monitoring financial performance.

7.2 INTERNAL CONSTITUENTS/PILLARS OF CORPORATE GOVERNANCE

The three pillars of corporate governance are: transparency, accountability, and security. All
three are critical in successfully running a company and forming solid professional relationships
among its stakeholders which include board directors, managers, employees, and most
importantly, shareholders: (Roman, 2017)

• Transparency: In simplest terms, transparency means having nothing to hide. For a

company, this means it allows its processes and transactions observable to outsiders. It also
makes necessary disclosures, informs everyone affected about its decisions, and complies
with legal requirements. After the financial scandals in the early 2000s, transparency has
played a bigger role in preventing fraud from happening again, especially at such a large
scale. But aside from stopping the next illegal moneymaking scheme, transparency also
builds a good reputation of the company in question. When shareholders feel they can trust a
company, they are willing to invest more, and this greatly helps in lowering cost of capital.
Therefore, a company gets its ROI on the money it spent on improving transparency.
Transparency is a critical component of corporate governance because it ensures that all of a
company’s actions can be checked at any given time by an outside observer. This makes its
processes and transactions verifiable, so if a question does come up about a step, the
company can provide a clear answer. And after the Enron scandal in 2001, transparency is
no longer just an option, but a legal requirement that a company has to comply with.

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 But although transparency is a necessity for the whole company, its presence is even more
important at the top where strategies are planned and decisions are made. Shareholders
expect that the corporate board is open about their actions; otherwise, distrust will form.
And when trust breaks, shareholders tend to stay away and invest somewhere else.

• Accountability: It takes more than transparency to build integrity as a company. It also

takes accountability, which can also mean answerability or liability. Shareholders are deeply
interested in who will take the blame when something goes wrong in one of a company’s
many processes. And even when everything goes smoothly as expected, knowing that
someone will be held accountable for future mishaps increases shareholders’ confidence,
which in turn increases their desire to invest more. Again, this concern over accountability
goes back to the financial scandals in the early 2000s, in which there had been a lot of
money stolen, but not enough people to answer for the crime.

Accountability can have a negative connotation because many people associate it with
blame. “Who’s responsible for when something goes wrong?” is just one of the many
questions that accountability seeks to answer. But accountability is more than that. It’s about
having ownership over one’s actions whether the consequences of those actions are good or
bad. Thus, accountability covers not only failings, but also accomplishments. When the idea
of accountability is approached with this positive outlook, people will be more open to it as
a means to improve their performance. This applies from the staff all the way up to the
corporate board.

How can accountability improve performance? People who have no sense of ownership over
their tasks don’t feel the motivation to do more than what’s expected of them. There’s no
incentive to work hard and achieve something. But when they understand the weight of their
responsibilities, they’re more inclined to make sure that they carry out their tasks properly.
And when they’re successful in this regard, they’re likely to feel a sense of accomplishment,
and this further fuels their desire to do better.

• Security: A company is expected to make their processes transparent and their people
accountable while keeping their enterprise data secure from unauthorized access. There is
simply no compromise for this. Companies that experience security breaches involving the
exposure of their clients’ personal information quickly lose their credibility. To get back the
public’s trust, extensive damage control is called for — just look at what had to be done
after Neiman Marcus and Target suffered from data leakage Thus, even with accountability
and transparency, a company without inadequate security measures will have a hard time
attracting shareholders. After all, any scandal — even a breach caused by third-party
hackers — can have a negative effect on a company’s stock market performance.

The increasing threat of cybercrime in recent years puts security at a high priority for many
companies. Complying with security standards isn’t enough — a company needs to imbibe a
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 culture of security to ensure that trade secrets, corporate data, and client information are all
kept safe from unauthorized access from inside and out. Security is not just an IT concern
anymore, unlike in the past.

Nowadays, everyone in a company has a responsibility to adhere to strict security standards.

Even entry-level staff members usually have their own company email addresses. But are
they trained enough to conscientiously keep their accounts safe? And that’s just scratching
the surface. Think of how much confidential data there is at the hands of directors in the
corporate board, and suddenly, the stakes are much higher.

Thus, directors should be made aware of the seriousness of cybercrime and the gravity of its
consequences. A security breach — especially involving client information — can make the
public easily lose their trust. Trust is big factor would-be shareholders consider before
making an investment in a company.

7.3 KEY MANAGERIAL PERSONNEL (KMP)

The Companies Act, 2013 (Act) has brought with it many new concepts; one amongst them is
key managerial personnel (KMP), which had been a matter of imprecision and legal scrutiny
among the corporates since its inception. Be that as it may, the concept inarguably, does have to
its credit, several new ideas which are intended to raise the level of professionalism and
accountability in the corporate arena. The concept of KMP is nothing but bringing together a
group of persons under one title, some of which already exist under the Companies Act, 1956
(1956 Act). Through this article, we have endeavored to address some key issues related to
KMP.

As per section 2(51) of the Act, KMP means the following person(s), if appointed in a
company, whether under a legal obligation under the Act [i.e. under section 203(1) of the Act]
or otherwise:

• the Chief Executive Officer (CEO) or the Managing Director (MD) or the manager;
• the company secretary (CS);
• the whole-time director (WTD);
• the Chief Financial Officer (CFO); and
• such other officer as may be prescribed (none prescribed till date).

While there is no doubt about CS, CFO and WTD being KMP, the first category of persons who
are to be treated as KMP i.e. CEO or MD or manager, requires some analysis because of the use
of the word ‘or’. While section 196(1) of the Act provides that no company shall appoint or
employ at the same time a MD and a manager, nothing prohibits a company to have both a CEO
and a MD or a CEO and a manager. The question that arises in such a situation is whether both

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the CEO and MD/manager would be treated as KMP or the company has the option of naming
one of them as KMP.

On a perusal of the various provisions of the Act, it can be seen that onerous responsibilities,
obligations and liabilities have been casted on KMP and that they are also included in the
definition of ‘officers in default’ and ‘related party’ under the Act. Some of key provisions
related to KMP are outlined below:

Following are the main provisions concerning KMP, under the Act: (Corporate Professional,
2016)

1. KMP are included in the definition of ‘officer’ under section 2 (59) of the Act;
2. KMP are included in the definition of ‘officer who is in default’ under section 2 (60) of
the Act;
3. KMP and his relative are included in the definition of ‘related party’ under section 2
(76) of the Act;
4. The nature of concern or interest of KMP on the matters proposed to be transacted in a
meeting, are to be disclosed in the explanatory statement to the notice of such meeting,
in terms of section 102 of the Act;
5. A relative of KMP is not eligible to be appointed as auditor in terms of section 141 of
the Act;
6. A KMP or his relative cannot be appointed as an independent director under section 149
of the Act;
7. The details of securities held by each KMP in the company or its holding, subsidiary,
subsidiary of company’s holding company or associate companies is to be recorded in a
separate register, to be maintained in terms of section 170 of the Act and rules made
thereunder;
8. KMP shall have a right to be heard in the meetings of the Audit Committee when it
considers the auditor’s report but shall not have the right to vote in terms of section 177;
9. The Nomination and Remuneration Committee shall formulate and recommend to the
Board a policy, relating to the remuneration for the KMP in terms of section 178;
10. The appointment or removal of KMP shall be made in a board meeting in terms of
section 179 of the Act;
11. Every KMP shall, within a period of thirty days of his appointment, or relinquishment of
his office, disclose to the company his concern or interest in the other associations or
such other information relating to himself as may be prescribed in terms of section 189;
12. KMP are prohibited from forward dealings in securities of company under section 194;
13. KMP shall not enter into insider trading in terms of section 195;
14. For appointment of KMP, a return in form DIR-12 & MR-1 is required to be filed with
the Registrar of Companies within 60 days of appointment in terms of section 196 r/w
section 170 of the Act;

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 15. Appointment of whole-time KMP is mandatorily in certain prescribed class of
companies in terms of section 203;
16. Every whole-time KMP shall be appointed by means of a resolution of the Board
containing the terms and conditions of the appointment including the remuneration in
terms of section 203;
17. A whole-time KMP shall not hold office in more than one company except in its
subsidiary company at the same time in terms of section 203;
18. Whole-time KMP holding office in more than one company at the same time on the date
of commencement of this Act, shall, within a period of six months from such
commencement, choose one company in which he wishes to continue to hold the office
of KMP in terms of section 203;
19. If the office of any whole-time KMP is vacated, the resulting vacancy shall be filled-up
by the Board at a meeting within a period of six months from the date of such vacancy in
terms of section 203;
20. Notice of meeting ordered by tribunal pursuant to a proposed compromise and
arrangement shall be accompanied by a statement explaining its effect on KMP in terms
of section 230; and
21. A report adopted by the directors of the merging companies explaining effect of
compromise on each KMP shall be circulated by the Company for the meeting ordered
by the Tribunal pursuant to proposed merger or division of company in terms of section
232.

Keeping this in mind, the law cannot be read to permit exclusion of certain KMPs from their
prescribed obligations and liabilities by designating only one person as KMP. Thus, where a
company has appointed both a CEO and a MD and the company is given the option to name one
of them to be KMP, it would amount to excluding the other from the ambit of officer in default
or related party, which cannot be the intention of law and although the word used under section
2(51) (i) and section 203(1) (a) of the Act, is ‘or’ yet it must be read as ‘and’ so as to carry out
the intention of the legislature.

Thus, in case a company has appointed MD and CEO or CEO and manager, both will be treated
as KMP with no regard to the question as whether such company is mandatorily required to
appoint KMP in terms of section 203 of the Act or not and whether the appointment of MD and
CEO or CEO and manager, is made on whole time or part time basis.

7.4 CHAIRMAN: ROLE AND RESPONSIBILITIES

The term Chairman is not defined under the Companies Act, 2013 (Act). As per the relevant
regulations of Article of Association (AOA) of the Company and relevant Sections casts various
powers, obligation and functions for the chairman.

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Section 118 of the Act extensible refers to minutes of proceedings of general meetings and of
Board and other meetings, where the Chairman has to conduct the meeting of its Board of
Directors and the power of Chairman on inclusion of matters in minutes of meeting.
With reference to the above provisions and as those stated in AOA as a matter of convention,
the Chairman of a Company presides over the meetings of the board. Therefore, the Chairman
has the powers under the common law, such as:- (Rane, 2015)

• the power to preside over the meetings,

• bring the discussion on any question and
• the power to adjourn the meeting if necessary under the circumstances(Article 96).

Roles and Responsibilities (Petrotal, 2018)

The principal role of the Chairman of the Board is to manage and to provide leadership to the
Board of Directors of the Company. The Chairman is accountable to the Board and acts as a
direct liaison between the Board and the management of the Company, through the Chief
Executive Officer (“CEO”). The Chairman acts as the communicator for Board decisions where
appropriate. The concept of separation of the role of the Chairman from that of the CEO implies
that the Chairman should be independent from management and free from any interest and any
business or other relationship which could interfere with the Chairman’s independent judgment
other than interests resulting from Company shareholdings and remuneration. More specifically,
the duties and responsibilities of the Chairman are as follows:

1. to act as a liaison between management and the Board;

2. to provide independent advice and counsel to the CEO;
3. to keep abreast generally of the activities of the Company and its management;
4. to ensure that the Directors are properly informed and that sufficient information is
provided to enable the Directors to form appropriate judgments;
5. in concert with the CEO, to develop and set the agendas for meetings of the Board;
6. to act as Chair at meetings of the Board;
7. to recommend an annual schedule of the date, time and location of Board and
Committee meetings;
8. to review and sign minutes of Board meetings;
9. to sit on other Committees of the Board where appropriate as determined by the Board;
10. to call special meetings of the Board where appropriate;
11. in concert with the CEO, to determine the date, time and location of the annual meeting
of shareholders and to develop the agenda for the meeting;
12. to act as Chair at meetings of shareholders;
13. to recommend to the Board, after consultation with the Directors, management and the
Governance and Nominating Committee, the appointment of members of the
Committees of the Board;

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 14. to assess and make recommendations to the Board annually regarding the effectiveness
of the Board as a whole, the Committees of the Board and individual Directors; and
15. to ensure that regularly, upon completion of the ordinary business of a meeting of the
Board, the Directors hold discussions without management present.

Qualities of a Successful Chairman

The Chairman plays an important role in a Company. The Chairman’s main duties include
chairing meetings of the Board of Directors, setting meeting agendas in conjunction with the
Company Secretary, managing and providing leadership to the Board of Directors, and acting as
a direct liaison between the Board and the Company’s management, through the Chief
Executive Officer. What ultimately defines a good Chairman is the ability to run an effective
Board and to manage relationships with both shareholders and stakeholders. Below are some of
the key qualities that make an effective Chairman:

1. Ability to Chain Meetings: Must ensure that all the business is discussed in line with
the agenda, that everyone’s views are heard and discussed, that clear decisions are
reached and accepted and that they follow up to make sure agreed actions are carried out
in line with Board decisions.
2. Understanding the Business: An exceptional Chairman understands the business, its
culture, people and processes. They also understand the wider industry and prepare the
Company for all eventualities. Experienced Chairmen can quickly identity opportunities
and potential risks facing their organization. They can engage with their Boards at an
early stage to discuss potential courses of action.
3. Ability to Influence Others, without Dominating: A good Chairman is responsible
for ensuring that all Board members are using their own unique skills for the good of the
organization. They must ensure all Board members contribute to discussions and the
decision-making process and they must allow each Board member to express their
views, even if they conflict with the Chairman’s view. Developing effective
communication with Board members is key. An exceptional Chairman is careful not to
allow their own personalities to dominate. They are willing to be challenged on their
own views and enjoy open debate.
4. Strong Personality: The role of the Chairman is a difficult job. They have ultimate
responsibility for Board performance. A good Chairman gives strength and support to
others while being resilient themselves. This requires a strong personality. Even the
most experienced and effective Boards can face challenging times and the ability of the
Chair to deal with these situations and to bounce back is essential to a Company
recovering and moving on.
5. Good Communication: One of the exceptional Chairman’s secrets of success is
effective communication with all stakeholders. Through effective communication, the
Chairman gains the confidence of their Board of Directors and provides clarity in the
boardroom. The Chairman’s ability at communicating Company strategy to external
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 stakeholders and giving stakeholders confidence in the Company’s future direction will
help keep external pressures at bay. They will also stand up to shareholder pressure, if
necessary. An effective Chairman does not lose sight of his main priority of improving
the long-term performance of the business.

Inadequate leadership and governance contributed to the underperformance and failure of major
companies during the economic crisis. The role of the Chairman has become even more
important. The current environment places greater responsibility and a higher profile on the
Chairman. Recent events have shown how, when things go wrong, the Chairman can be first in
the firing line.

7.5 CHIEF EXECUTIVE OFFICER: ROLE AND RESPONSIBILITIES (HKEX group,

2017)

The Chief Executive Officer (“CEO”) is responsible for leading the development and execution
of the Company’s long term strategy with a view to creating shareholder value. The CEO’s
leadership role also entails being ultimately responsible for all day-to-day management
decisions and for implementing the Company’s long and short term plans. The CEO acts as a
direct liaison between the Board and management of the Company and communicates to the
Board on behalf of management. The CEO also communicates on behalf of the Company to
shareholders, employees, Government authorities, other stakeholders and the public. More
specifically, the duties and responsibilities of the CEO include the following:

1. Leads the management in the day-to-day running of the Group’s business in accordance
with the business plans and within the budgets approved by the Board
2. Leads the management to ensure effective working relationships with the Chairman and
the Board by meeting or communicating with the Chairman on a regular basis to review
key developments, issues, opportunities and concerns
3. Develops and proposes the Group’s strategies and policies for the Board’s consideration
4. Implements, with the support of the management, the strategies and policies as approved
by the Board and its committees in pursuit of the Group’s objectives
5. Maintains regular dialogue with the Chairman on important and strategic issues facing
the Group, and ensures bringing these issues to the Board’s attention
6. Ensures that the management gives appropriate priority to providing reports to the Board
which contain relevant, accurate, timely and clear information necessary for the Board to
fulfill its duties
7. Ensures that the Board, especially the Chairman, is alerted to forthcoming complex,
contentious or sensitive issues affecting the Group
8. Leads the communication programme with our stakeholders including shareholders
9. Conducts the affairs of the Group in accordance with the practices and procedures
adopted by the Board and promotes the highest standards of integrity, probity and
corporate governance within the Group.
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7.6 SEPARATION OF ROLES OF CHAIRMAN AND CEO (Matteo Tonello, 2011)

When, as after the recent financial crisis, public corporations come under fire from activist
shareholders, institutional investors, proxy advisory firms, and regulators, the issue of
separating the chair/CEOs roles is often front and center, with a view to achieving independent
leadership on the board. Both academic papers and practitioner-oriented literature routinely call
for separation of the chair and CEO roles, as do a variety of best practice codes and guidelines.
Some corporate leaders and associations, however, have responded to the debate about the pros
and cons of role separation, often resisting a mandated separation or a “one size fits all”
approach.

In the most common argument based on agency theory, the separation of the chair and CEO
roles increases the board’s independence from management and thus leads to better monitoring
and oversight. Because the CEO manages the company and the chair leads the board in
overseeing (hiring, compensating, and replacing as necessary) the CEO on behalf of
shareholders, holders of this view see a conflict of interest if one person occupies both the CEO
and chair roles.

In contrast, stewardship or administrative theory suggests that the benefits of separating the
chair and CEO roles are not so clear-cut. Stewardship theory is based on the principle of “unity
of command” and argues that having clear and unambiguous authority concentrated in one
person is essential to effective management. Unity of command creates clear lines of authority
to which management (and the board) can respond more effectively. In an environment where
strong, directive, stable, and unconfused leadership is seen as critical to organizational success,
this kind of legitimacy is an important signal to stakeholders about who is accountable.

There are good reasons to separate the two positions in order to strengthen the overall integrity
of the company. (Mohr, 2018)

1. Executive Compensation: An increase in executive pay generally gets the attention of

company shareholders. Increases come at the expense of shareholder profits, although
most understand that competitive pay helps to keep talent in the business. However, it is
the board of directors that votes to increase executive pay. When the CEO is also the
chairman, a conflict of interest arises, as the CEO is voting on his or her own
compensation. Although a board is required by legislation to have some members who
are independent of management, the chair can influence the activities of the board,
which allows for abuse of the chair position.
2. Corporate Governance: One of the board's main roles is to monitor the operations of
the company and to ensure that it is being run in conjunction with the mandate of the
company and the will of the shareholders. As the CEO is the management position
responsible for driving those operations, having a combined role results in monitoring
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 oneself, which opens the door for abuse of the position. A board led by an independent
chair is more likely to identify and monitor areas of the company that are drifting from
its mandate and to put into place corrective measures to get it back on track.
3. Audit Committee Independence: In 2002, the Sarbanes-Oxley Act, legislated as a
response to several high-profile corporate failures, set out stronger regulations for
corporate oversight, including a requirement that the audit committee consist of only
external board members. This means that no member of management can sit on the audit
committee. However, because the committee is a sub-group of the board of directors and
reports to the chair, having the CEO in the chair role limits the effectiveness of the
committee. This is especially true for the whistleblower clause. Sarbanes-Oxley requires
that the audit committee have a procedure where employees and other connected
individuals can report fraud and other abuse directly to the committee without reprisal.
When the board is led by management, employees may be less likely to report such
activities and the audit committee may be less likely to act on such reports.

7.7 ROLE OF CHIEF FINANCIAL OFFICER (CFO) IN CORPORATE GOVERNANCE

(THAPAR, 2018)

With Globalization, Stiff Competition, uncertain Capital Markets, Shareholders Activism,

Technological modernization and sharper focus on Corporate Governance, the role of Chief
Financial Officer (CFO) is changing radically. In past CFO role was of Finance Accountant
who make sure that strategy of the company fits the budget , annual accounts are ready in time,
Income tax returns are filed timely, internal controls are properly implemented in the company
but over past 5 years as companies have started developing their business globally by
establishing their business offices worldwide, making investments , incurring huge expenses in
R & D, deploying talent to do business globally, the role of CFO is becoming more complex
and important . He no longer regarded as Guardian of Accounts Books and Records, crunching
numbers, or focusing on their finance functions. Modern CFO deals with company-wide
concerns and needs to be value integrator.

Gradually, due to increasing statutory compliances and corporate governance codes and
practices, acceptance of globally harmonized reporting standards, there was a need to make
finance accountants answerable to Board of Directors and stakeholders by getting financial
statements of the company endorsed by them, which has turned Finance Accountants to Chief
Financial Officers (CFO) and made them key player in today’s C-Suite.
CFO is a valuable resource to the Board. Some of the top ten roles of Modern CFOs are:

1. He has to be steward, operator, catalyst and strategist as of CEO.

2. He should look beyond the balance sheet to understand and manage risks and opportunities
and communicate in clear terms to management of the company and its stakeholders. He
must serve as the financial authority in the company ensuring proper transparency,
accountability and integrity of financial, non-financial and external reporting.
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3. Besides, projecting and attending financial position of the company, he should support the
Board in making strategic decisions by timely placing following information before the
Board of Directors for consideration:
a. Annual Business plans
b. Monthly/Quarterly financial results
c. Cash Flow Statements and Cash Flow Projections
d. Annual Budgets
e. Details of foreign collaborations, Joint Ventures and other financial commitments
related to it.
f. Details of outstanding Secured and Unsecured Debts including principal and interest,
Statutory Dues, any defaults in payments thereto.
g. Details of Bad debts, debtors and creditors on monthly basis.
h. Details of Show cause Notices, pending litigations and contingent claims against the
company in future.
4. He must assure to Board of Directors for making disclosures in the Director’s Report that:
a. In the preparation of annual accounts for the financial year, the applicable standards and
the requirements set out under statutory laws have been followed and there are no
material departures from the same;
b. The accounting policies have been properly selected and applied consistently and made
judgments and estimates that are reasonable and prudent to give a true and fair view of
the state of affairs of the company;
c. Proper and sufficient care have been taken for the maintenance of adequate accounting
records in accordance with the provisions of applicable statutory acts for safeguarding
the assets of the company and for preventing and detecting fraud and other irregularities
and;
d. Annual accounts of the company are ready on a “Going Concern” basis.
e. There are no material departures from the codes of Corporate Governance, listing
regulations and any other company policies.
f. Internal Control systems are effectively implemented and maintained and in case of any
deficiencies in the design or operation of internal controls, if any it is well disclosed to
Auditors and Audit Committee of the Company.
5. He should be effective leader, own team building skills, negotiation to manage the finance
functions. He should be flexible, presentable, multi-lingual and global minded.
6. He should have skill and ability that have impact on Board processes and strategic
decisions.
7. He should give forecasts, manage risk and provide insight into the issues ranging from price
to production to sales, spot market opportunities, predict change in business, environment,
develop the process for sustainable business, do more business development and operations,
refocus on technical skills with implications on IFRS, ensure integration of regulatory
environmental outlook with business environmental outlook, make corporate governance
code and practices and internal controls.

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8. He must stay up to date on their companies, statutory provisions, sustainability policies and
initiatives and on ESG issues more broadly.
9. As an Advocate and Ambassador for the company, he should focus more on Investor
Relations by ensuring better and continuous communications with stakeholders.
10. He should help the Board in strategic development, operational planning and financial risk
management, fraud prevention, fraud detection and investigation.
In the present corporate scenario, CFO is considered as key influencer in the Board. He works
in close nexus with the Board and CEO. It is also noticed that mostly in big corporate scams,
CFO is connected with CEO closely. The mere existence of nexus is not bad and it does not
necessarily indicate detrimental boards or governance systems. It is important to focus on the
origin of such nexus. Thus, the key focus of regulators, policy makers, institutional investors
and shareholders is to watch and control the CEO, CFO-Board nexus in the companies in order
control corporate frauds and develop sustainable business. There has to be arm’s length
independence between boards, CEO’s and CFO then only the corporate governance codes can
be implemented in the company both in letter and spirit, which will reap rewards for them in the
form of sustainable business and profit maximization.

7.8 ROLE OF COMPANY SECRETARY IN CORPORATE GOVERNANCE (Price,

2017)
The role of the company secretary is now considered a senior position, equal to a managerial
position or above. Beyond their normal course of duties, company secretaries often provide
advice and counsel to the board chair, executive director and others, and serve as confidantes.
The board secretary signs legal documents as a representative for the corporation, and bears
custody of the corporate seal. Company secretaries share information with the board and
managers on best practices for corporate governance and work with them to uphold them.
Because of the increased duties and very important responsibilities that boards require in a
company secretary, the role of a corporate secretary is often filled by a senior board member.
Many of today’s corporations are finding that it’s helpful to appoint a lawyer to fill the role of
the company secretary. A corporate secretary with a law degree may perform dual duty for the
corporation as general counsel or by serving another legal role within the company.
At a minimum, the corporate secretary should belong to a body of professional accountants or a
recognized body of corporate chartered secretaries. Boards also expect their corporate
secretaries to have minimally achieved a master’s degree in business administration or
commerce.

Industry experts recognize that the many demands and multiple facets that the role of corporate
secretary requires make it a difficult position to fill. The Society of Corporate Secretaries came
to the rescue when they developed a guide called the “Core Competencies of Successful
Corporate Secretaries.” The list includes personal and professional attributes for successful
corporate secretaries. The list of core competencies includes:

1. Having a thorough understanding of the company’s business

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 2. Having basic knowledge of corporate and securities laws, at a minimum
3. Having solid communication skills and an “executive presence”
4. Being intuitive and sensitive to the thoughts and feelings of board directors and the CEO
5. Staying current with changes in corporate governance and giving the board and
managers a “heads up” about new developments
6. Being able to work and achieve a consensus within multidisciplinary settings
7. Being able to navigate bureaucratic thinking
8. Being flexible, creative and detailed
9. Remaining calm under pressure and not losing sight of perspective

Duties of the Corporate Secretary

In addition to some of the duties that are more familiar to the role of the corporate secretary, like
preparing for meetings, planning agendas, taking minutes and storing records, secretaries in
today’s corporate world have many legal duties.

The corporate secretary must make sure that the organization conducts business and manages its
affairs according to the bylaws. As mentioned earlier, they need to know and be able to
comprehend existing and new laws, and they need to be able to communicate that information
to the board directors and managers. It’s not uncommon for corporate secretaries to be an
integral part of discussions with the CEO, executive director, board chair and attorneys
regarding legal matters. This is one reason that many corporations look toward filling the role of
the corporate secretary with a lawyer.

Corporate secretaries also have many important responsibilities to the shareholders. They are
responsible for making sure dividends get paid, carrying out matters concerning share allotment,
issuing share certificates and managing share transfers. The corporate secretary is also the main
communicator to the shareholders upon the advice and recommendation of the CEO or
executive director and the board chair.

7.9 ROLE OF AN AUDITOR IN CORPORATE GOVERNANCE

International Audit Standards uphold that an auditor's mandate may require him to take
cognizance and report matters that come to his knowledge in performing his audit duties which
relate to:

• Compliance with legislative or regulatory requirements;

• Adequacy of accounting and control systems;
• Viability of economic activities, programmes and projects.

Two alternative situations emerge when the functions of auditors and the requirements of good
governance are placed face to face. The former is confined to 'economic actions and events,
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while the later is the outcome of a wide range of managerial functions. The question then arises
whether the auditors should cross their operational limits in order to bring about the desired
level of improvement in the quality of governance, or, alternatively, while restricting
themselves to their term of reference, they should operate more effectively so as to help
improve the quality of governance.

It is established that auditors are not required to traverse their area of operation. Whatever they
are expected to contribute towards good governance shall, therefore, be from within their range
or sphere of activity. In other words, it is the quality of their performance that will make all the
difference, which, therefore, needs to be ameliorated to match the requisites of good
governance.

The ‘auditors’ role in the achievement of corporate governance in India should be such which
facilitates efficient operations through: (Ray S. , 2012 )
1. audit of agency costs inherent in a division between the provision of capital and the
stewardship of the undertaking such capital is invested in;
2. seeking to ensure a proper standard of performance and accountability for the benefit of
all stakeholders.

It would also be obligatory for the auditors to understand the importance of transparency and
public accountability of the company as a means of ensuring that the stakeholders could hold
him also account for the external impact of non-disclosures in the statements or non-transparent
statements. This principle of disclosure is of fundamental nature, which arises out of freedom to
choose and disclose. Transparency can reinforce sound corporate governance.

Transparency should lead to the efficient operation of market forces and the exercise of
beneficial economic choices without the need for a legal or regulatory intervention with its
distorting and costly effects.

The role of the auditors would be to audit the historic financial information in annual report,
review for consistency of the surroundings to the annual accounts, reach a view whether
statements have been 'properly prepared' and are forward looking statements (not necessarily
forecasts) and policies. The auditors have a duty of ‘care’ to existing shareholders of the
company and also to any other person and purpose to whom and for which they have or are
deemed to have explicitly or implicitly agreed to owe such duty.

The Irani Committee has suggested a four point agenda to be adhered to in the company’s
preparation of its account which is as follows: (Das, 2018)

• Disclosure accuracy and adequacy

• Standardization
• Clarity
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 • Synchronization of law and Accounting Standards

Auditors of the Company play an important role in all the aforementioned aspects of
Governance primarily through its provisions from Section 224 to 233 of the Companies Act
which seek to regulate the audit of company’s accounts and its external auditors. As has been
discussed hereinbefore auditors act as eyes and ears of the shareholders and prospective
investors, thus to instil confidence in market and to provide a true and fair account of the
company the role of an unbiased objective auditor is an undeniable necessity. Before proceeding
to an analysis of the Indian provisions of law and the recommendation of various committees
and recommendations in this regard, we would like to provide an account of two major
corporate scandals which took advantage of poor accounting standards and disclosure
requirements i.e. ENRON from the USA and Parmalat from Europe.

7.10 BOARD DIVERSITY (Valsan, 2013)

The studies on the relation between board diversity and corporate performance have identified
several main benefits and costs of diversity. On the benefits side, the positive business effects of
board diversity include:

• Improved access to information, increased creativity and more effective problem-solving

• Better understanding of the marketplace, customers and suppliers
• Improved relations with employees, by signalling that the company values diversity and
offers mentoring and advancement opportunities for all groups of employees
• Improved public image, by conforming to societal expectations

On the costs side, the potential downsides of diversity include:

• Decreased cohesion in the board, resulting in distrust, lack of cooperation and
breakdown in communication
• A lengthier and more costly decision-making process
• Decrease of quality of decisions, due to insufficient business expertise of directors
chosen on diversity criteria
• Enhanced conflicts of interest by directors aiming to promote agendas or ideologies

From a corporate governance perspective, some of the most promising arguments in support of
diversity are those linking diversity with directors’ improved ability to discharge their main
duties. The first duty that comes to mind is the duty of care, skill and diligence. The improved
access to information, the diversity of viewpoints, and the greater scope for debates could
increase the quality of business judgment and the outcomes of board deliberations.

Another example is directors’ duty to take into account the interests of relevant stakeholders,
while promoting the success of the company as a whole. Board diversity may help directors
weigh more accurately the relevant considerations by helping to correct some of their prejudices
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and biases. The different traits or characteristics associated with a certain ethnicity or gender
create cognitive and behavioural diversity in the boardroom, which in turn may lead to a more
balanced weighting of relevant considerations for each decision. Another way in which
diversity could improve compliance with this duty is the difference between male and female
directors in terms of self- and other- orientation: it has been argued that women directors have a
greater “other-orientation”, and hence are more committed to the development of stakeholder
relationships and the long-term firm value.

Board diversity may also assist non-executive directors in discharging their oversight duty,
requiring them to scrutinise the executive directors’ performance and the company’s system of
financial controls and risk management. A diversified board increases non-executives’
independence by reducing the probability of “groupthink”. Groupthink is a feature of
homogenous groups, manifested in loss of individual creativity and independent thinking due to
loyalty to group norms and desire for harmony. Diverse boards undermine the homogeneity
required by groupthink and reduce the likelihood of uncritical rubber-stamping of
management’s decisions.

7.11 SELF-ASSESSMENT QUESTIONS

True and false Questions:

Indicate whether the following statements are true or false:

a) The three pillars of corporate governance are: transparency, accountability, and security.
b) KMP are prohibited from forward dealings in securities of company under section 194
c) CFO is considered as key influencer in the Board
d) Diverse boards undermine the homogeneity required by groupthink and reduce the
likelihood of uncritical rubber-stamping of management’s decisions.
e) Enhanced conflicts of interest by directors aiming to promote agendas or ideologies

Answers: a (T), b (T), c (T), d (T), e (T)

Long Answer Questions

Q1. Discuss duties and functions of company secretary under the Company Act 2013.

Q2. Explain the term ‘Key Managerial Personnel (KMP)’. Elaborate the different classes of
companies that are required to have KMP’s.

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 LESSON 8
ROLE AND FUNCTIONS OF BOARD COMMITTEES

8 STRUCTURE

8.1. Building Professional Boards

8.2. Powers of Board of Directors
8.3. Types of Committees
8.4. Advisory Committee/Board
8.5. Pros and Cons of Committees for Administration and Management
8.6. Role of Board Committees
8.7. Related Party Transaction
8.8. Self-Assessment Questions

8.1 BUILDING PROFESSIONAL BOARDS (Harvard Law School, 2018)

An effective system of corporate governance provides the framework within which the board
and management address their key responsibilities.

Board Structure

Public companies employ diverse approaches to board structure and operations within the
parameters of applicable legal requirements and stock market rules. Although no one structure
is right for every company, Business Roundtable believes that the practices set forth in the
following sections provide an effective approach for companies to follow.

Board Composition

• Size: In determining appropriate board size, directors should consider the nature, size and
complexity of the company as well as its stage of development. Larger boards often bring
the benefit of a broader mix of skills, backgrounds and experience, while smaller boards
may be more cohesive and may be able to address issues and challenges more quickly.
• Composition: The composition of a board should reflect a diversity of thought,
backgrounds, skills, experiences and expertise and a range of tenures that are appropriate
given the company’s current and anticipated circumstances and that collectively, enable the
board to perform its oversight function effectively.
o Diversity: Diverse backgrounds and experiences on corporate boards, including
those of directors who represent the broad range of society, strengthen board
performance and promote the creation of long-term shareholder value. Boards
should develop a framework for identifying appropriately diverse candidates that
allows the nominating/corporate governance committee to consider women,
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 minorities and others with diverse backgrounds as candidates for each open board
seat.
o Tenure: Directors with a range of tenures can contribute to the effectiveness of a
board. Recent additions to the board may provide new perspectives, while directors
who have served for a number of years bring experience, continuity, institutional
knowledge, and insight into the company’s business and industry.
• Characteristics: Every director should have integrity, strong character, sound judgment, an
objective mind and the ability to represent the interests of all shareholders rather than the
interests of particular constituencies.
• Experience: Directors with relevant business and leadership experience can provide the
board a useful perspective on business strategy and significant risks and an understanding of
the challenges facing the business.
• Independence: Director Independence is critical to effective corporate governance, and
providing objective independent judgment that represents the interests of all shareholders is
at the core of the board’s oversight function. Accordingly, a substantial majority of the
board’s directors should be independent, according to applicable rules and regulations and
as determined by the board.
o Definition of “independence:” An independent director should not have any
relationships that may impair, or appear to impair, the director’s ability to exercise
independent judgment. Many boards have developed their own standards for
assessing independence under stock market definitions, in addition to considering
the views of institutional investors and other relevant groups.
o Assessing independence: When evaluating a director’s independence, the board
should consider all relevant facts and circumstances, focusing on whether the
director has any relationships, either direct or indirect, with the company, senior
management or other directors that could affect actual or perceived independence.
This includes relationships with other companies that have significant business
relationships with the company or with not-for-profit organizations that receive
substantial support from the company. While it has been suggested that long-
standing board service may be perceived to affect director independence, long
tenure, by itself, should not disqualify a director from being considered independent.
• Election: Directors should be elected by a majority vote for terms that are consistent with
long- term value creation. Boards should adopt a resignation policy under which a director
who does not receive a majority vote tenders his or her resignation to the board for its
consideration. Although the ultimate decision whether to accept or reject the resignation will
rest with the board, the board and its nominating/corporate governance committee should
think critically about the reasons why the director did not receive a majority vote and
whether or not the director should continue to serve. Among other things, they should
consider whether the vote resulted from concerns about a policy issue affecting the board as
a whole or concerns specific to the individual director and the basis for those concerns.
• Time commitments: Serving as a director of a public company requires significant time
and attention. Certain roles, such as committee chair, board chair and lead director, carry an
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 additional time commitment beyond that of board and committee service. Directors must
spend the time needed and meet as frequently as necessary to discharge their responsibilities
properly. While there may not be a need for a set limit on the number of outside boards on
which a director or committee member may serve—or for any limits on other activities a
director may pursue outside of his or her board duties—each director should be committed
to the responsibilities of board service, and each board should monitor the time constraints
of its members in light of their particular circumstances.

Board of Directors

A corporation’s business is managed under the board’s oversight. The board also has direct
responsibility for certain key matters, including the relationship with the outside auditor and
executive compensation. The board’s oversight function encompasses a number of
responsibilities, including:

• Selecting the CEO: The board selects and oversees the performance of the company’s CEO
and oversees the CEO succession planning process.
• Setting the “Tone at the Top”: The board should set a “tone at the top” that demonstrates
the company’s commitment to integrity and legal compliance. This tone lays the
groundwork for a corporate culture that is communicated to personnel at all levels of the
organization.
• Approving Corporate Strategy and Monitoring the Implementation of Strategic Plans:
The board should have meaningful input into the company’s long-term strategy from
development through execution, should approve the company’s strategic plans and should
regularly evaluate implementation of the plans that are designed to create long-term value.
The board should understand the risks inherent in the company’s strategic plans and how
those risks are being managed.
• Setting the Company’s Risk Appetite, Reviewing and Understanding the Major Risks,
and Overseeing the Risk Management Processes: The board oversees the process for
identifying and managing the significant risks facing the company. The board and senior
management should agree on the company’s risk appetite, and the board should be
comfortable that the strategic plans are consistent with it. The board should establish a
structure for overseeing risk, delegating responsibility to committees and overseeing the
designation of senior management responsible for risk management.
• Focusing on the Integrity and Clarity of the Company’s Financial Reporting and other
Disclosures about Corporate Performance: The board should be satisfied that the
company’s financial statements accurately present its financial condition and results of
operations, that other disclosures about the company’s performance convey meaningful
information about past results as well as future plans, and that the company’s internal
controls and procedures have been designed to detect and deter fraudulent activity.

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• Allocating Capital: The board should have meaningful input and decision making authority
over the company’s capital allocation process and strategy to find the right balance between
short-term and long-term economic returns for its shareholders.
• Reviewing, Understanding and Overseeing Annual Operating Plans and Budgets: The
board oversees the annual operating plans and reviews annual budgets presented by
management. The board monitors implementation of the annual plans and assesses whether
they are responsive to changing conditions.
• Reviewing the Company’s Plans for Business Resiliency: As part of its risk oversight
function, the board periodically reviews management’s plans to address business resiliency,
including such items as business continuity, physical security, cyber security and crisis
management.
• Nominating Directors and Committee Members, and Overseeing effective Corporate
Governance: The board, under the leadership of its nominating/corporate governance
committee, nominates directors and committee members and oversees the structure,
composition (including independence and diversity), succession planning, practices and
evaluation of the board and its committees.
• Overseeing the Compliance Program: The board, under the leadership of appropriate
committees, oversees the company’s compliance program and remains informed about any
significant compliance issues that may arise.

8.2 POWERS OF BOARD OF DIRECTORS (Sangmi, 2016)

Under the Indian Companies Act 1956, BoDs has powers to make calls on shareholders in
respect of money unpaid on their share, power to authorize the buy-back, power to issue
debentures, power to borrow moneys otherwise than on debentures, power to invest the funds of
the company and power to take and make loans. There is no doubt that BoDs may, by a
resolution passed at a meeting, delegate to any committee of Directors, the Managing Director,
the Manager or any other principal officer of the company, the above powers. However the
principal power still vests in BoDs and the Manager or Managing Director acts only as an agent
of the BoDs. Apart from this, BoDs has power to form opinion about the solvency of the
company in respect of buy back shares (Section 77A), power to fill up casual vacancies in the
office of Directors (Section 262), power to constitute Audit Committee and specify terms of
reference thereof (Section 292A), power to make donation to political parties [Section
293A(2)], power to accord sanction for specified contracts in which one or more directors are
interested [Section 297(4)], power to receive notice of disclosure of director’s interest [Section
299(3)(c)], power to appoint or employ a person as Managing Director or Manager [Section
316(2)], power to invest in shares or debentures of any other body corporate (Section 372A),
power to appoint or employ a person as its Manager [Section 386(2)], power to make a
declaration of solvency, where it is proposed to wind up the company voluntarily [Section
488(1)], power to approve the text of advertising for inviting public deposits [Section 58A r/w
Rule 4(4)]. Some of the powers can only be exercised by resolution passed at the meeting with
consent of the Directors present at the meeting.
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8.3 TYPES OF COMMITTEES

It is necessary to remember that the Committees cannot replace the Board. They are
supplementary to the Board. There are many types of Committees that can be formed by the
Board. These Committees can be broadly classified into:

• Standing Committee for Generic purpose

• Ad-hoc Committee for Specific purpose
• Standing Committee for Specific purpose

1. Standing Committees for Generic Purpose: The term ‘standing committee’ refers to any
committee that is a permanent feature within the management structure of an organization.
In the context of corporate governance, it refers to committees made up of members of the
board with specified sets of duties. The four committees most often appointed by public
companies are the audit committee, the remuneration committee, the nominations committee
and the risk committee. (ACCA, 2012)
2. Ad-hoc Committees: In essence, an Ad-Hoc committee is a Crisis committee. The
difference between regular Crisis committees and an Ad-Hoc committee is that Ad-Hoc
topics are made available to delegates only a few days before the conference, or in some
cases, possibly even during your first committee session! As such, delegates have to adapt to
the situation at hand, anticipate upcoming crises, and find solutions all at a moment’s notice.
Needless to say, this committee is not for the faint hearted. Most of the time, Ad-Hoc
committees are considerably more challenging than regular committees. Since the
functioning of an Ad-Hoc is dependent on new crisis updates being formed and released,
there must be somebody creating these scenarios, right? That’s where the Crisis Director
and their staff steps in. Try to think of each Crisis committee as two separate rooms, the first
one is the actual committee room, of which each one of you will be debating; and then
there’s the crisis room – that’s where the Crisis staff work. Throughout the conference, the
crisis staff will visit your committee with updates on how the crisis is progressing.
Interestingly, these updates can be presented on multiple platforms, including videos,
newspaper articles, and briefings, to name a few. Sometimes, Crisis staffers will even act
out scenes in the committee room for dramatic purposes! During this time, your job is to
react to these updates, and take action as a body. You can even respond in the form of
personal directives. In Crisis committees, debate is usually conducted as a continuous
moderated caucus, with delegates moving to discuss specific topics for debate related to the
crisis. And also, the most important thing to know about Ad-Hoc committees is that there is
no resolution. Instead of a resolution, the committee decides upon “Directives” to take
action in the committee. (Sezgin, 2017)
3. Standing Committee for Specific purpose: It is formed for long term purposes and
comprises of a specialized group of people on continuous basis on a much focused area.

The Role and Responsibilities Enshrined upon the Executive Committee are: (CPA, 2013)
• General management of the organization

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 • To make necessary operational decisions on behalf of the Board and get them ratified in
the subsequent Board meetings
• Prepare annual plans, budgets and other reports; present the same to the Board; and
finally implement them once approved by the Board
• Handle issue related to recruitment, appraisals and capacity building
• Ensure operational implementation of policies and procedures
• Guide and direct the management in the implementation of various programs.
• Review of various risks and take necessary mitigation measures

8.4 ADVISORY COMMITTEE/BOARD (Odgersberndtson, 2018)

An increasing number of organizations are appointing advisory boards. There are many good
reasons for a company to do so. It could be to ensure it receives expert advice on emerging
technology or scientific advances, or to gain insight into doing business in diverse global
markets. An advisory board may also assist a company to sell its products and services to
government customers, or to provide counsel on public relations and reputation management.
Advisory boards are no substitute for statutory boards of directors. Indeed, properly constituted,
advisory boards should complement and strengthen the existing board. Equally, to be effective,
advisory boards need a clear remit. The board’s objectives and terms of reference, as well as the
expected time commitment, should be established from the start.

• What are the Differences between a Regular Board of Directors and an Advisory
Board?
An advisory board is more informal than a board of directors in that it generally does not
have regular meetings, has little or no delegated authority and is created primarily to
provide business advice and bring specialist skills or knowledge to the owner and
business. The selection and oversight of management, monitoring of performance,
approval of strategy and assessment of risks are all subjects properly reserved for the
main board. An advisory board can support the board by providing expert insight or
contacts, but it must be clear where ultimate decision-making authority and collective
responsibility lie.
• Why Create an Advisory Board?
Most businesses decide to create advisory boards when it is apparent that there is a
subject area where expert outsiders can augment the knowledge, understanding and
strategic thinking of the board and management team. Experienced advisory board
members can provide technical or specialist advice and extend the range of skills and
understanding of management and the board in areas beyond their day-today fields of
expertise. There is a critical balance to be struck, however. When considering the
composition of the advisory board, the company should give thought to what skills and
experience rightly belong on the main board. Advisory boards can be a useful way for
the main board to challenge its own assumptions, particularly on specialist or technical

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 matters. Advisory boards provide access to talent that boards would otherwise not be
able to tap.
• What is the Legal Position of Directors on Advisory Boards?
An advisory board is not legally constituted and has no decision-making power (unless
specifically delegated). Further, the owner is under no obligation to heed its advice.
• What are the Pros and Cons of an Advisory Board?
An advisory board is a good choice where the owner or company needs ongoing
professional advice and contacts, but may feel threatened by a formal board with the
power to direct the business or where the ‘legal’ board is made up of managers as is
sometimes the case with subsidiary companies. However, an advisory board’s
effectiveness will depend on whether the owner or management respects its advice
and/or takes advantage of the knowledge and skills it brings.
• When might a Company consider Setting up an Advisory Board?
An advisory board is a good choice where the owner or company needs ongoing
professional advice and contacts. An advisory board with the requisite professional skills
will serve as a sounding board, a source of ideas and expertise. In the case of succession
planning, an advisory board can be particularly useful in helping an owner get an
objective view on the potential successors and what they might require in terms of skills
building and to help facilitate transition in ownership and/or management.
• Do Advisory Boards have an Impact on Corporate Governance?
Demonstrating good governance practices will improve a company’s access to capital as
it provides confidence to investors, financial institutions and venture capitalists that the
company has instituted better systems of internal control. This is particularly the case for
companies seeking growth and expansion such as those in the technology sector.
Therefore, implementing good governance practices and procedures at the earliest
opportunity is advisable. Third, a well-structured advisory board, or formal board, can
contribute to the performance of the business through roles such as strategy, advising
and mentoring the owner or CEO and providing the business with vital contacts or
resources.
• How to make Advisory Board Work
Clearly setting and communicating the roles and expectations of individual advisors and
articulating the mandate and purpose of the board is essential. The advisory board must
have an unambiguous mission and definition. The structure, research background and
financial arrangements must be clear.” An important first step is to ensure that the main
board supports the concept of appointing an advisory board, and understands its purpose
and remit. The balance of responsibilities between the main board and the advisory
board should be clearly understood by all sides. On appointment, it is important that the
company and the advisory directors have a shared view of the time involved. Having
agreed the commitment, both sides must stick to it. At one extreme, it is easy for
‘mission creep’ to develop so that advisory directors are called upon far more often than
anticipated, or than the remuneration justifies. Equally, if there is too long between each
contact, the individual directors may become disconnected from the business and lose
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 interest and focus. It may be that most of the advisory board’s work will be informal,
carried out via phone and email contact or attendance at company events. Nevertheless,
it is a good discipline for the advisory board to meet in person perhaps quarterly or twice
yearly to bring together the participants in a boardroom setting and create a formal
structure for the board’s work. The organization and advisory board must establish how
they will work together. It should be clear who from the company’s side can make
contact with the advisory board, and on what issues. To ensure contact is kept focused
and at a high level, it may make sense to restrict informal contact with the advisory
board to the chair and chief executive.

8.5 PROS AND CONS OF COMMITTEES FOR ADMINISTRATION AND

MANAGEMENT

Now-a-days committees are widely used in all areas of administration and management on
account of the following reasons:

Advantages

1. Pooling of Knowledge and Experience: The personal skills and Hence of several
persons are pooled together. Group deliberations and combined judgment of all the
members can be brought to bear on important problems. There can be a more realistic
and objective appraisal of the problem from all angles. This helps to improve the quality
of decisions. Business problems are multifaceted and require breadth of decision.
Subjective and unbalanced decisions can be minimized. "When several people study and
deliberate on each critical problem, there is more assurance that every facet will be
thoroughly explored and weighed in terms of the interests of the company as a whole."
A group of people can bring to bear a wider range of experience and a more thorough
prob-ing of facts than a single person.
2. Improved Communication: Committees serve as important means of communication
between the members of an organization. Informa-tion and ideas can be easily
transmitted both upward and downward. Unwritten policies and objectives can be
explained effectively through deliberations of a committee. Creative ideas emerge from
interactions among the members. Doubts and ambiguity can be removed on the spot.
3. Facility of Coordination: Participation in committee meetings pro-motes mutual
understanding, team-work and cooperation among employees. Committees serve as an
important technique of coordination by bringing together managers from different
departments. Members of a committee come to appreciate each other's point of view and
they can pursue a common course of action. A committee is a useful means of
integrating and unifying various points of view.
4. Better Motivation: Committees help to improve the motivation and morale of
employees by providing them an opportunity to express them- selves. Participation in
the decision making process not only improves quality of decisions, it creates a sense of
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 belonging. Employees are keen on the execution of decisions in the making of which
they have taken an active part.
5. Executive Development: A committee is an useful device for educat-ing and training
subordinate managers. Participation in committee meetings provides opportunity for
learning through experience. A manager learns to take an integrative view of
organizational problems by serving on various committees. Executive development
ensures con-tinuity of management in the organization.
6. Democratic Management: As a plural executive, a committee helps to avoid the risk of
concentration of too much authority in the individual and the danger of abuse of power.
There is no fear of delegating too much authority to one individual. The tyranny of a
powerful head can be reduced. Group authority makes for diffusion of power and
demo-cratic leadership.
7. Representation of Interests: Various interest groups can be given representation on a
committee. Such representation may be necessary to secure the commitment and
cooperation of people. Members can be enlightened on policy matters and ideas beyond
the capacity of one individual can be generated.
8. Consolidation of Authority: The manager of every department or section may have a
portion of the total authority required to take a deci-sion. Such authority is known as
splintered authority. In such a case, a committee of different managers may be
constituted to consolidate the authority. In this way the decision can be taken without
reference to the higher level. However, frequent need for consolidation of splintered
authority is the sign of a poor organization structure.
9. Avoidance of Action: Sometimes, committees are constituted to postpone or avoid
action. In order to cool off agitation and temper on the part of employees, the matter
may be referred to a committee. Delaying of action through a committee is a strategy for
overcoming resistance, pressure or opposition from affected people.

Disadvantages

The committee form of organization suffers from the following weaknesses:

1. Indecisiveness: In general, it takes longer to get decision or action from a committee
than from an individual. Members of a committee tend to indulge in lengthy,
discussions. Every member has the right to speak and be heard. Matters are
unnecessarily dragged. Opinion is divided and decisions get delayed. Group decision
processes are not appropriate where prompt action is required. Due to conflicting
view-points, a committee fails to reach a decision in time.
2. High Costs: A lot of expenditure and time is incurred in convening meetings and giving
travelling or other allowance to members. There-fore, committees are an expensive form
of administration. As such a committee should be appointed only when the gains of
committee work justify the s costs. Committee work is very time-consuming.
3. Compromised Decisions: Committee decisions are often mediocre compromises
between conflicting viewpoints. The ultimate decisions may reflect the opinion of none
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 so that there is little enthusiasm for them. Individual thinking is expected to conform to
the average or group thinking. Such leveling effect or log-rolling reduces the quality of
deci-sion. The compromise is often arrived at the least common denominator. Therefore,
committee decisions are not necessarily the best decisions but merely acceptable ones.
4. Diffused Responsibility: No member can be individually held responsible for a wrong
decision taken by a committee. As no one feels accountable for results, members shirk
their responsibilities. The committee becomes an organized means of passing the buck.
According to committees do not necessarily increase the democratic process
administration.
5. Domination by Few: A few aggressive or vocal members often dominate committee's
deliberations. A minority group exercises an unwarranted tyranny ignoring the interest
of other members. Members frequently seek to protect their narrow sectional interests.
There is a tendency to cloud the real issues and bring in extraneous matters for
discus-sion often a committee becomes a battle-ground for warring camps to settle
personal scores.
6. Perpetuation: Committees have a tendency to perpetuate them- selves even after the
purpose is served. There exist too many committees even for routine problems.
Sometimes committees are appointed to just avoid actions. Such committees serve no
useful purpose and the aggrie-ved people remain aggrieved. It is often difficult to
dissolve a committee even when it has outlived its utility.
7. Lack of Secrecy: It is difficult to maintain secrecy regarding the decisions and actions
taken by a committee. A large number of persons participate in committee meetings.
Due to its weaknesses and misuse, a committee has been described as "a group of unfits
engaged by the unwilling to do the unnecessary." Some people remark that a committee
is a group of people who indi-vidually can do nothing but who can meet together and
decide that noth-ing can be done. Such remark reflects wide-spread frustration and
dis-illusionment with committees.

8.6 ROLE OF BOARD COMMITTEES

The Board of the Company has the following Committees: (EDC, 2018)

1. Audit Committee: - Section 292A of the Companies Act, 1956 requires that every public
limited company (whether listed or unlisted) having a paid-up capital of at least Rs.5 crore
should constitute a committee of the board to be known as Audit Committee. The meetings
of the Audit Committee shall at least be held four times a year and preferably on the day
preceding the date of each of Board meeting. Being mandatory under Section 292A of the
Companies Act, 1956 and Clause 49 of the listing agreement, the audit committee can be of
facilitator of Board to implement, monitor and continue good corporate governance
practices for the benefit of the company and its stakeholders. The main function of Audit
Committee is to oversee the company’s financial reporting process and the disclosure of its
financial information to ensure that the financial statement is correct, sufficient and credible.
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 The Audit Committee can recommend to the Board, the appointment, re-appointment and, if
required, the replacement or removal of the statutory auditor and the fixation of audit fees.
The members of Audit Committee should have formal knowledge of accounting and
financial management or experience of interpreting financial statements.
2. Remuneration Committee: - The remuneration Committee shall be held at least four times
a year on the day preceding the date of every Board meeting. The Committee’s principle
functions are to authorize the remuneration, business and other benefits of executive
directors, including the CEO, and to grant awards under the Courtaulds Long-Term
Incentive Scheme.
3. Nomination Committee: - The Nomination Committee shall be held at least twice in a
year. The Committee’s functions are to make recommendations to the Board about the
future appointments of non-executive directors and of the chairman and the chief executive,
and to consider recommendations from the chief executive to the Board about the future
appointments of executive directors.
4. Shareholders’/Investors’ Grievance and Administrative Committee: The
Shareholders’/Investors’ Grievance and Administrative Committee meetings shall be at least
held thrice in a month. The Chairman of this Committee shall be a Non-executive
Independent Director. This Committee shall approve transfer of shares, transmission of
shares, issue of duplicate share certificate, etc. This Committee shall also review the
queries/complaints received from the shareholders during the fortnight and responses given
to the shareholders.
5. Compliance Committee: The Compliance Committee is a standing subcommittee of the
Audit Committee of the Board of Directors that has general responsibility to oversee the
Company’s compliance and ethics programs, policies and procedures. The purpose of the
Committee is to: (i) oversee the Company’s implementation of compliance programs,
policies and procedures that are designed to respond to the various compliance and
regulatory risks facing the Company; (ii) assist the Audit Committee in fulfilling its
oversight responsibility for the Company’s compliance and ethics programs, policies and
procedures; and (iii) perform any other duties as directed by the Board or the Audit
Committee. The oversight responsibility of the Committee shall not extend to planning or
conducting audits, conducting investigations, or assuring compliance with relevant laws, the
Company’s Code of Business Conduct, or other relevant standards, including those imposed
by any settlement agreements.
6. Investors Relation Committee: This committee’s purpose is to engage the board of
directors and other investors in working with staff to ensure the organization has adequate
resources to fulfill its mission. It performs the following functions:
a. Develops and helps to implement an annual fundraising plan for the organization.
b. Involves and motivates board members in the cultivation and stewardship of investors.
c. Ensures that the case for investor support is strong and based on the organization’s
mission and goals.
d. Develops strategies for involvement and cultivation of investors
e. Helps to evaluate potential prospects for increased investor levels.
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 f. Participates actively in special events and provides leadership in investor relations.
7. Investment Committee: The Investment Committee establishes investment guidelines and
supervises the investment activity. The Investment Committee regularly monitors the
overall investment results, reviews compliance with the investment objectives and
guidelines, and ultimately reports the overall investment results to the board of directors.
These guidelines specify minimum criteria on the overall credit quality and liquidity
characteristics of the Company's portfolio. They include limitations on the size of certain
holdings as well as restrictions on purchasing certain types of securities or investing in
certain industries. The purposes of the Investment Committee of the Board of Directors shall
be to oversee the Company's investment transactions, management, policies and guidelines,
including review of investment manager selection, establishment of investment benchmarks,
review of investment performance and oversight of investment risk management exposure
policies and guidelines. (Endurance, 2018)
8. Risk Management Committee: The purpose of the Risk Assessment Committee is to early
diagnosis of the risks that would endanger the existence, development and continuity of the
company, implementing the measures and remedies required in this respect, and to manage
and report these risks in parallel with the company’s corporate risk -taking profile, to apply
necessary precautions relevant to recognized risks, to consider while making decision and to
make suggestions to the board about developing and integrating internal control systems.
The duties of the Risk Management Committee are as follows: (KOC, 2018)
• Identifying, evaluating, following the current and potential risk factors that can have
impact on reaching company targets, within the context of Enterprise Risk Management
(ERM) system, and determining the principles concerning risk management in parallel
with the company’s risk- taking profile, ensuring that these are used in decision making
mechanism,
• Ascertaining the risks that shall be kept in company and managed, shared or completely
removed according to possibility and impact calculations,
• Ensuring the integration of risk management and internal control systems into
company’s corporate structure,
• Reviewing the risk management systems and supervising the application of committee
decisions in the departments those are responsible for managing risks,
• Early recognizing the technical bankruptcy and warning board of directors’, developing
advices about the precautions,
• Performing other duties that will be required under Capital Markets Board regulations.

The Committee must submit its evaluation and recommendations on the abovementioned
subject matters to the Board of Directors verbally or in writing.

8.7 RELATED PARTY TRANSACTION (Investopedia, 2018)

A related-party transaction is a business deal or arrangement between two parties who are
joined by a preexisting special relationship. For example, a business transaction between a
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major shareholder and a corporation, such as a contract for the shareholder's company to
perform renovations to the corporation's offices, would be deemed a related-party transaction.
Related-party transactions are common in business. For example, companies often seek to
secure business deals with parties with whom they are familiar or have a common interest.
While these types of transactions are legal, the special relationship inherent between the
involved parties creates potential conflicts of interest. However, regulations exist to prevent an
unfair advantage granted to related parties.

Related parties and business services can take many different forms. Some of the most common
types of related parties include business affiliates, shareholder groups, subsidiaries, and
minority-owned companies. Related party transactions can include sales, leases, service
agreements, and loan agreements.

In large corporate situations, public companies are often minority or majority-owned by other
entities. These entities may have similar business interests due to business commonalities. In
these cases, related-party transactions may naturally occur, such as vendor or supplier
relationships for the mutual benefit of both companies.

Historical Context for Existence of Large Number of Related Party Transactions (OECD,
2010)

There are several factors which are relevant to any discussion on related party transactions in
India and also the reason for a large number of such transactions. The number of family owned
businesses is high in India. In a family owned and operated business, it is natural to expect that
there will necessarily be closer ties. The desire and opportunity to use a known party will be
greater. While there can be benefits to such arrangements, such as the level of trust involved
when dealing with familiar people, the chance for that closeness to also become a problem
grows, too. The line between using a familiar face and exploiting shareholders' resources for
personal gain becomes very wide and very gray in family owned businesses.

There are also a large number of listed companies in India that are also subsidiaries of
multinational corporations, consequential to the Foreign Exchange Regulations Act, 1977 which
required the 100% subsidiaries of international companies to dilute to 40% or less. Post-1991
policies discouraged 100% subsidiaries of foreign companies in certain industries. These often
necessitated a number of related party transactions between an overseas parent and its Indian
subsidiary. Wholly Indian “groups” also began to have such transactions intra-se their group
companies. Where a director happens to be a professional lawyer or accountant, the legal
provisions also covered purchases of professional services from him or his firm. There could
also be transactions with businesses belonging to directors or their relatives & partners. Some
related party transactions are for products or services whose prices have clear arm’s length
benchmarks in the form of sales to or purchases from independent third parties. Others, and

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there are quite a many such products or services, are not comparable to benchmarks in the
marketplace, these being provided only within a closed group.

Good Practices in Related Party Transactions followed by Companies in India:

Boards play an important role in determining the policy on related party transactions and in
monitoring the implementation of the policy –

1. Board sets the clear direction and culture on all related party transactions.
2. Board mandatory reviews related party transactions exceeding 1% of revenue.
3. The audit committee reviews all material related party transactions.
4. Systems, processes, procedures are in place to avoid related party transactions becoming
abusive.
5. The employees communicated a strong employee ethics policy that related party
transactions are strongly discouraged.
6. Directors/Commissioners/Controlling shareholders are made personally liable for
company loss if they exploit the company for personal interests.
7. Companies are required to develop and make public the policy and procedure for the
approval of the related party transactions.
8. The financials of all subsidiaries and related entities are published on the web so that the
shareholders can get a clear picture on the need and the related party transactions.
9. Every year, insiders who are responsible for decision in the company, are required to
make statements that they do not have any conflict of interest in all decisions they make
and they comply with the code of conduct of the company.

8.8 SELF-ASSESSMENT QUESTIONS

True and false Questions:
Indicate whether the following statements are true or false:
a) In determining appropriate board size, directors should not consider the nature, size and
complexity of the company as well as its stage of development.
b) Directors with a range of tenures can contribute to the effectiveness of a board.
c) An independent director should not have any relationships that may impair, or appear to
impair, the director’s ability to exercise independent judgment.
d) The board selects and oversees the performance of the company’s CEO and oversees the
CEO succession planning process.
e) The four committees most often appointed by public companies are the audit committee,
the remuneration committee, the nominations committee and the risk committee.
Answers: a (F), b (T), c (T), d (T), e (T)
Long Answer Questions
Q1. Define ‘grievance’ and state the causes of grievances. Also indicate the guidelines for
handling grievances?
Q2. What are the causes of indiscipline? Also mention the principles of effective Discipline?
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 LESSON 9
MAJOR CORPORATE FAILURES

9 STRUCTURE

9.1. Common Governance Problems in Corporate Failures

9.2. Major Codes and Standards on Corporate Governance
9.3. Top Ten Issues in Corporate Governance Practices in India
9.4. Top Corporate Failure Cases in United Kingdom
9.4.1. Poly Peck International, UK, 1991
9.4.2. Maxwell Corporation, UK, 1991
9.4.3. Bank of Credit and Commerce International, UK, 1991-92
9.4.4. Nick Leeson and Barings Bank, UK, 1991-93
9.5. Top Corporate Failure Cases in United States Of America
9.5.1. Corporate Governance Failure at Enron
9.5.2. World.com, US, 2001
9.5.3. Rajat Gupta, USA, 2010-12
9.6. Top Corporate Failure Cases in India
9.6.1. Satyam Computers, India, 2008
9.6.2. Sahara Airlines
9.6.3. Kingfisher Airlines (KFA), India, 2012
9.7. Self-Assessment Questions

9.1 COMMON GOVERNANCE PROBLEMS IN CORPORATE FAILURES

Internal and External corporate Governance mechanism serve the purpose of protecting the
interest of stakeholder of a company. Ineffectiveness of the board of directors, inadequate
internal controls or weak regulations may lead to a corporate problem. The corporate failure
may occur if these flaws are allowed to develop over a period of time. The Governance flaws of
collapsed companies may be classified into 5 broad categories:

1. Failure of the Board of Directors: Failure of Board of Directors is the most common
Governance failure noticed in various corporate failures for e.g. Satyam, World.Com and
Enron. Some of the reasons are:
• Lack of Independence/Conflicts of Interest
• Lack of Strength of the Board
• Unwillingness of the Board to challenge the Dominating CEO
• Combination of the Role of Board Chairman and CEO
• Insufficient Skills of the Directors
2. Dominating Dishonest CEO’s: Corporate Governance hinges on an appropriate balance of
accountability between the board of directors and the executives led by the CEO. When
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 there is imbalance with the CEO taking a dominating role and uses this position to pursue
his/her greediness, the result inevitably is Corporate failure as happened in the series of
collapses which took place one after the other since the turn of this century. The COSO
report 2010 states that CEO’s are involved in 72 per cent of the 347 alleged cases of
fraudulent financial reporting listed with SEC during 1998-2007 periods. The report
indicates that in most major cases of fraudulent reporting the CEO’s of the companies are
the main instigators and it is a planned initiative. The motivations of fraud ranges from the
desire to meet the financial expectations, to expropriating the funds, and include diversion
of funds for family concern, empire building ad to hide worsening business situation,
increase executive compensation and/or improved chances of gaining Debt and Equity
funding.
3. Failure of Corporate Strategies: The prime responsibility of the board is to formulate
corporate strategies in the best interest of the shareholders and also other stakeholders. The
boards of failed companies blundered in formulating strategies and policies in the interest of
the companies. In most cases the strategies were not clear being based on the whims and
fancies of the founders or over dominating CEOs in complete disregard to the rights of the
shareholders. The policies were excessively focused on short term profits and share prices.
The strategies were not in consonance with the resources and capacity of the company
giving rise to excessive risk taking which could not be controlled and ultimately lead to the
collapse.
4. Failure of Internal Controls: Internal control mechanism within an organization provides
checks and balances ensures adherence to the legal requirements to prevent frauds, and to
ensure governance in the interest of the stakeholders. Breakdown in the internal control
systems made the companies vulnerable to pressures and problems which eventually
collapsed.
5. Flaws in External Audit: The corporate failures appearing one after the other question the
utility and efficacy of the external audit process. In almost all such cases either the auditor
applied faulty audit techniques or was negligent in performing their duties or had the
conflict of interest.
6. Inadequate Regulatory Mechanisms: Regulatory framework is designed to strengthen
corporate governance by requiring compliance with the rules and regulations. Weakening of
the regulatory mechanism, which may arise from oversight of the regulators or poor
implementation of the rules or lax rules or conflict of interest can compound corporate
problems and speed up the collapses.

9.2 MAJOR CODES AND STANDARDS ON CORPORATE GOVERNANCE

Following are major codes and standards on Corporate Governance operated across major
economies:

1. Prominent codes in United Kingdom (UK) includes the following:

• The UK Corporate Governance Code (28 Sep 2012)
• The UK Stewardship Code (28 Sep 2012)
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• Corporate Governance in Central Government Departments; Code of Good Practice
2011 (19 July 2011)
• Corporate Governance Guidance and Principles for Unlisted companies in UK, (Nov
2010)
• The AIC Code of Corporate Governance (Oct 2010)
• The UK Stewardship Code (2 July 2010)
• The UK Corporate Governance Code(June 2010)
• A stewardship Code for institutional Investors (19 January 2010)
• The Audit Firm Governance Code (January 2010)
• 2009 Review of the Combined Code: Final Report (1 December 2009)
• A review of corporate governance in UK banks and other financial industry entities:
Final recommendations- the Walker Review (26 November 2009)
• The Combined Code of Corporate Governance (revised June 2008)
• Guidelines for Transparency and disclosure in Private Equity (20 November 2007)
• The Combined Code on Corporate Governance (June 2006)
• Good Practice suggestions from the Higgs Report (June 2006)
• Internal Control: Revised Guidance for Directors on the Combined Code(October 2005)
• Corporate Governance in Central Government Departments: Code of good Practice( July
2005)
• Pensions Scheme in Governance- fit for 21st Century: A Discussion paper from NAPF
(July 2005)
• Good Governance: A Practical Guide (24 August 2004)
• The Combined Code on Corporate Governance(23 July 2003)
• Audit Committee- Combined Code Guidance- The Smith Report (January 2003)
• The Higgs Report: Review of the role and effectiveness of non- executive
directors(January 2003)
• The Responsibilities of Institutional Shareholders and Agents Statement of Principles(21
October 2002)
• The Hermes Principles (21 October 2002)
• Review of the role and effectiveness of non-executive directors-consultation Paper (7
July 2002)
• Code of Good Practice (January 2001)
• The Combined Code: Principles of Good Governance and Code of Best Practices (May
2000)
• Hermes Statement on International Voting Principles (13 December 1999)
• The KPMG Review Internal Control : A Practical Guide (October 1999)
• Internal Control: Guidance for Directors on the combined Code (Turnbull
Report)(September 1999)
• Hampel Report-Final(January 1998)
• Greenbury Report- Study Group on Directors’ Remuneration (15 July 1995)
• Cadbury Report- The Financial Aspects of Corporate Governance (1 December 1992)

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2. Prominent codes in USA includes the following:
• Full CII Corporate Governance Policies (27 September 2013)
• Principles of Corporate Governance 2012(27 March 2012)
• Report of the New York Stock Exchange Commission on Corporate Governance (23
September 2010)
• Key Agreed Principles to Strengthen Corporate Governance for U.S. Publicly Traded
Companies (16 October 2008)
• TIAA-CREF Policy Statement on Corporate Governance2007 (13 March 2007)
• Asset Manager Code of Professional Conduct (November 2004)
• Final NYSE Corporate Governance Rules (3 November 2003)
• Restoring Trust- The Breeden Report on Corporate Governance for the future of MCI,
Inc.(August 2003)
• Commission on Public Trust and Private Enterprise Findings and Recommendations:
Part 2: Corporate governance (9 January 2003)
• Corporate Governance Rule Proposals ( 1 August 2002)
• Principles of Corporate Governance (May 2002)
• Core Policies, General Principles, Positions & Explanatory Notes( 25 March 2002)
• Principles of Corporate Governance: Analysis & Recommendations 2002
• Report of the NACD Blue Ribbon Commission on Director Professionalism 2001
• Global Corporate Governance Principles 1999
• Statement on Corporate Governance (September 1997)

3. Prominent codes in RUSSIA includes the following:

• Russian Code of Corporate Governance 2014(18 April 2014)
• Russian ‘Business Ethics Manual’ (2004)
• The Corporate Governance Code (2002)
• The Civil Code (1994)

4. Prominent codes in Germany includes the following:

• German Corporate Governance Code as amended 13 May 2013
• German Corporate Governance Code as amended on 15 May 2012
• German Corporate Governance Code as amended on 26 May 2010
• German Corporate Governance Code as amended on 18 June 2009
• German Corporate Governance Code as amended on 6 June 2008
• German Corporate Governance Code as amended on14 June 2007
• Amendment to the German Corporate Governance Code – The Cromme Code (June
2006) 12 June 2006
• Amendment to the German Corporate Governance Code – The Cromme Code (June
2006) 2 June 2005
• Corporate Governance Code for Asset Management Companies 27 April 2005
• Amendment to the German Corporate Governance Code – The Cromme Code (May
2003) 21 May 2003
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 • The German Corporate Governance Code (The Cromme Code) 26 Feb 2002
• Baums Commission Report (Bericht der Regierungskommission Corporate
Governance) 10 July 2001
• German Code of Corporate Governance (GCCG) 06 June 2000.
• Corporate Governance Rules for German Quoted Companies Jan 2000.
• DSW Guidelines June 1998.
• Gesetz zur Kontrolle und Transparenz im Unternehmensbereich (KonTraG) 5 March
1998

5. Prominent codes in China includes the following:

• Provisional Code of Corporate Governance for Securities Companies (15 Jan 2004)
• The Code of Corporate Governance for Listed Companies in China (07 Jan 2001)

9.3 TOP TEN ISSUES IN CORPORATE GOVERNANCE PRACTICES IN INDIA

(Unadkat, op Ten Issues in Corporate Governance Practices in India, 2017)

Set out below are top ten issues affecting corporate governance practices in India.

1. Getting the Board Right: Enough has been said on board and its role as the cornerstone for
good corporate governance. To this end, the law requires a healthy mix of executive and
non-executive directors and appointment of at least one woman director for diversity. There
is no doubt that a capable, diverse and active board would, to large extent, improve
governance standards of a company. The challenge lies in ingraining governance in
corporate cultures so that there is improving compliance "in spirit". Most companies' in
India tend to only comply on paper; board appointments are still by way of "word of mouth"
or fellow board member recommendations. It is common for friends and family of
promoters (a uniquely Indian term for founders and controlling shareholders) and
management to be appointed as board members. Innovative solutions are the need of the
hour – for instance, rating board diversity and governance practices and publishing such
results or using performance evaluation as a minimum benchmark for director appointment.
2. Performance Evaluation of Directors: Although performance evaluation of directors has
been part of the existing legal framework in India, it caught the regulator's attention
recently. In January 2017, SEBI, India's capital markets regulator, released a 'Guidance Note
on Board Evaluation'. This note elaborated on different aspects of performance evaluation
by laying down the means to identify objectives, different criteria and method of evaluation.
For performance evaluation to achieve the desired results on governance practices, there is
often a call for results of such evaluation are made public. Having said that, evaluation is
always a sensitive subject and public disclosures may run counter-productive. In a peer
review situation, to avoid public scrutiny, negative feedback may not be shared. To negate
this behaviour, the role of independent directors in performance evaluation is key.
3. True Independence of Directors: Independent directors' appointment was supposed to be
the biggest corporate governance reform. However, 15 years down the line, independent
directors have hardly been able to make the desired impact. The regulator on its part has,
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 time and again, made the norms tighter – introduced comprehensive definition of
independent directors, defined a role of the audit committee, etc. However, most Indian
promoters design a tick-the-box way out of the regulatory requirements. The independence
of such promoter appointed independent directors is questionable as it is unlikely that they
will stand-up for minority interests against the promoter. Despite all the governance
reforms, the regulator is still found wanting. Perhaps, the focus needs to shift to limiting
promoter's powers in matters relating to in independent directors.
4. Removal of Independent Directors: While independent directors have been generally
criticized for playing a passive role on the board, instances of independent directors not
siding with promoter decisions have not been taken well – they were removed from their
position by promoters. Under law, an independent director can be easily removed by
promoters or majority shareholders. This inherent conflict has a direct impact on
independence. In fact, earlier this year, even SEBI's International Advisory Board proposed
an increase in transparency with regard to appointment and removal of directors. To protect
independent directors from vendetta action and confer upon them greater freedom of action,
it is imperative to provide for additional checks in the process of their removal – for
instance, requiring approval of majority of public shareholders.
5. Accountability to Stakeholders: Empowerment of independent directors has to be
supplemented with greater duties for, and accountability of directors. In this regard, Indian
company law, revamped in 2013, mandates that directors owe duties not only towards the
company and shareholders but also towards the employees, community and for the
protection of environment. Although these general duties have been imposed on all
directors, directors including independent directors have been complacent due to lack of
enforcement action. To increase accountability, it may be a good idea to require the entire
board to be present at general meetings to give stakeholders an opportunity to interact with
the board and pose questions.
6. Executive Compensation: Executive compensation is a contentious issue especially when
subject to shareholder accountability. Companies have to offer competitive compensation to
attract talent. However, such executive compensation needs to stand the test of stakeholders'
scrutiny. Presently, under Indian law, the nomination and remuneration committee (a
committee of the board comprising of a majority of independent directors) is required to
frame a policy on remuneration of key employees. Also, the annual remuneration paid to
key executives is required to be made public. Is this enough? To retain and nurture a
trustworthy relationship between the shareholders and the executive, companies may
consider framing remuneration policies which are transparent and require shareholders'
approval.
7. Founders' Control and Succession Planning: In India, founders' ability to control the
affairs of the company has the potential of derailing the entire corporate governance system.
Unlike developed economies, in India, identity of the founder and the company is often
merged. The founders, irrespective of their legal position, continue to exercise significant
influence over the key business decisions of companies and fail to acknowledge the need for
succession planning. From a governance and business continuity perspective, it is best if
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 founders chalk out a succession plan and implement it. Family owned Indian companies
suffer an inherent inhibition to let go of control. The best way to tackle with this is widen
the shareholder base - as PE and other institutional investors pump in capital, founders are
forced to think about a succession plan and step away with dignity.
8. Risk Management: Today, large businesses are exposed to real-time monitoring by
business media and national media houses. Given that the board is only playing an oversight
role on the affairs of a company, framing and implementing a risk management policy is
necessary. In this context, Indian company law requires the board to include a statement in
its report to the shareholders indicating development and implementation of risk
management policy for the company. The independent directors are mandated to assess the
risk management systems of the company. For a governance model to be effective, a robust
risk management policy which spells out key guiding principles and practices for mitigating
risks in day-to-day activities is imperative.
9. Privacy and Data Protection: As a key aspect of risk management, privacy and data
protection is an important governance issue. In this era of digitalisation, a sound
understanding of the fundamentals of cyber security must be expected from every director.
Good governance will be only achieved if executives are able to engage and understand the
specialists in their firm. The board must assess the potential risk of handling data and take
steps to ensure such data is protected from potential misuse. The board must invest a
reasonable amount of time and money in order ensure the goal of data protection is
achieved.
10. Board's Approach to Corporate Social Responsibility (CSR): India is one of the few
countries which has legislated on CSR. Companies meeting specified thresholds are
required to constitute a CSR committee from within the board. This committee then frames
a CSR policy and recommends spending on CSR activities based on such policy. Companies
are required to spend at least 2% of the average net profits of last three financial years. For
companies who fail to meet the CSR spend, the boards of such companies are required to
disclose reasons for such failure in the board's report. During the last year, companies which
failed to comply received notices from the ministry of corporate affairs asking for reasons
why they did not incur CSR spend and in some cases questioning the reasons disclosed for
not spending. In these circumstances, increased effort and seriousness by the board towards
CSR is necessary. CSR projects should be managed by board with as much interest and
vigour as any other business project of the company.

9.4 TOP CORPORATE FAILURE CASES IN UNITED KINGDOM

9.4.1 Poly Peck International, UK, 1991

PPI was a small British textile company which expanded rapidly in the 1980’s and became a
constituent of the FTSE 100 Index before collapsing in 1990 with debts of £1.3 billion,
eventually leading to the flight of its CEO Asil Nadir to Northern Cyprus in 1993. Polly Peck
was one of several corporate scandals that led to the reform of UK company law, resulting in
the early versions of the UK Corporate Governance Code. On 26 August 2010 Nadir returned to
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the UK to try to clear his name. Prosecutors alleged that he stole more than £150m from Polly
Peck and he faced trial on 13 specimen charges totaling £34m. Nadir was found guilty on 10
counts of theft totaling £29m. On 23 August 2012 at the Old Bailey he was sentenced to 10
years in prison.

Collapse

In August 1990 Nadir came to the view that the company was undervalued and then announced
that he was taking it private. Almost as suddenly later that month he announced that he had
changed his mind. An independent investigation by the accountants' Joint Disciplinary Tribunal
found that during 1988 Polly Peck made 24 separate payments to its subsidiaries in Turkey and
northern Cyprus, totaling some £58m. The following year Polly Peck paid out £141m in 64
different deals. The report said that "Mr. Nadir was able to initiate transfers of funds out of
[Polly Peck's] London bank accounts without question or challenge. Further ... he was able to
conceal his actions until such time as the cumulative cash outflow became so great that the
group was unable to meet its obligations to its bankers."

In 1990, Polly Peck's board became so worried about the money transferred into Northern
Cyprus that it confronted Mr Nadir and asked him to return it. He refused.

The accounting regulators found that the Inland Revenue had been investigating transactions by
a Swiss nominee company, Fax Investments, in shares in Polly Peck and another company run
by Mr Nadir's son, Birol. It found a trail of transactions which indicated that money had come
from Polly Peck businesses in northern Cyprus to Fax.

When confronted about these deals, Mr. Nadir told Polly Peck's auditors, Stoy Hayward, that
one of the group's Northern Cyprus businesses "provided what were in effect personal banking
services for certain Turkish and [Northern Cypriot] residents". The auditors described this
arrangement as "extremely unwise transactions". On top of these massive money transfers and
"unwise transactions", the regulators found that some of Polly Peck's assets had been secretly
registered in Mr. Nadir's name. These were all in Northern Cyprus and had a net book value of
£25.5m in 1989. In addition the Didima Hotel development in Northern Cyprus, valued at
£15.5m, and £6.7m worth of other buildings, had no registered owner. Nadir said he was
holding the assets "on trust" for Polly Peck businesses.

On 20 September 1990, the Serious Fraud Office (SFO) raided South Audley Management, the
company that controlled the Nadir family interests. The raid triggered a run on Polly Peck
shares with the price practically in free fall.

Trading in the company’s shares was suspended on 20 September 1990. PPI's problems became
apparent from the structure of the group's debts. The company had over £100 million in short-
term revolving lines of credit. Even more debt consisted of long term loans for which Nadir had
offered Polly Peck's shares as collateral.

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At end of October 1990 an ex-parte application for provisional liquidation was granted at the
High Court in London to the London branch of the National Bank of Canada. The directors of
Polly Peck met at their London HQ and undertook a course of action leading to voluntary
administration.

A considerable number of antiques were located at the HQ offices of the company in Berkeley
Square, London. The book value attributed to these was around £6 million, but upon later
inspection and independent valuation the total sum was stated at approximately £2.5 to £3
million.

Ultimately the company collapsed, and charges were brought against Asil Nadir for 70 charges
of false accounting and the theft, which he denied.

In 1991, Polly Peck Group transferred all of its Vestel Electronics shares to one of its
subsidiaries, Collar Holding BV, which was based in the Netherlands. Following the collapse of
the Polly Peck Group, PPI was placed in administration. In November 1994, Ahmet Nazif Zorlu
acquired PPI from the administrator by buying the entire share capital of Collar Holding BV,
which at the time held 82% of the Polly Peck's issued share capital.

9.4.2 Maxwell Corporation, UK, 1991 (Jha, 2017)

In November 1991, chairman of the group companies Robert Maxwell, 68, was found drowned
floating beside his luxury yacht near the Canary Islands. In a matter of weeks of the mysterious
death of Maxwell, the global empire of publishing and other businesses collapsed amidst
scandal about shocking financial maneuvers. Investigations revealed that Maxwell’s group
companies owed £2.8 billion to its bankers. Maxwell’s untimely death triggered a flood of
instability with banks frantically calling in their massive loans. His two young sons Kevin and
Ian struggled to hold the empire together, but were unable to prevent its collapse. Furthermore,
the most famous UK pension scandal of all time came to light when £530 million hole in the
pension funds of 16,000 employees of Mirror Group Newspapers was discovered. The
thousands of employees of the Mirror Group had paid into pension funds totaling many millions
of pounds, which Maxwell had ‘borrowed’ in a desperate attempt to prop up the ailing Maxwell
Communication.

The Company went into administration following the death of Robert Maxwell. Its properties
were sold to various media companies. The London based Maxwell Communication
Corporation- parent of the giant U.S. book publisher Macmillan also filed the Chapter 11
bankruptcy petition in New York, in part, because bulk of its revenue and operating profit was
generated in the United States. The Maxwell case was one of the most important transnational
insolvencies of modern times. The empire of Maxwell was an unusual one with its true “seat” in
London, where it was administered and nearly all of its financial affairs (especially loans and
the grant of security) were managed, but its principal assets were in the United States in the
form of various large operating companies.

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Reasons of the Debacle

1. Acquisitions through Heavy Debts: Maxwell was in deep debts following large
acquisitions. The borrowings were personal as well on company accounts. The company
borrowed $3 billion in 1988 to buy the US publishers Macmillan and Official Airlines
Guide. In fact, Maxwell wanted to buy everything from American book publishers to British
soccer teams to Israeli and German newspapers. He piled debt upon debt by pledging the
assets of the companies under his control. It was discovered later that Maxwell had pledged
the same assets as collateral for various loans.
2. Financial Difficulties and Diversion of Funds: By the end of the 1980s the Maxwell
empire, comprising more than 400 companies, was experiencing acute financial difficulties
and was only kept afloat by shifting funds around his maze of inter-locking private
companies, misappropriating pensioners’ funds, and relentless deal-making. Months before
Maxwell vanished from his yacht, there was a growing fear that he was having trouble
meeting his repayment schedule. With the American and European economies starting to
sour, Maxwell was faced with declining cash flow and debilitating debt payments. Despite
his eroding financial condition, however, he was able to pass annual audits by leading
European accountants Coopers & Lybrand Deloitte. That enabled Maxwell to add on more
debt in March 1991 when he purchased the Daily News from the Tribune Co. by assuming
as much as $35 million in obligations. In 1991, desperate for money, Maxwell sold
Pergamon and floated Mirror Group Newspapers as a public company. But it was too late.
3. Uncertainties following the Death of Maxwell: The stock of Maxwell Communication
plunged to $2.18 on 5 November 1991, (the day Maxwell disappeared) from a high of $4.28
a share in April 1991, and further dropped to $0.63. The decline in stock value was of
special concern to Maxwell’s creditors, since most of the family’s 68 per cent stake in the
company was pledged as collateral for loans. The untimely death of Maxwell triggered a
wave of uncertainty amongst the lenders and creditors which ultimately led to the collapse
of the empire of Robert Maxwell based around Maxwell Communications Corporation.

Aftermath

1. It emerged that, without adequate prior authorization, Maxwell had used hundreds of
millions of pounds from his companies’ pension funds to shore up the shares of his Group
and to save his companies from bankruptcy.
2. The scandal sent shockwaves through the occupational pension market as employees
confidence crashed. Eventually, the pension funds were replenished with money from
investment banks Shearson Lehman and Goldman Sachs, as well as the British government.
This replenishment was limited. The rest of the £100 million was waived. Maxwell’s theft
of pension funds was, therefore, partly repaid from public funds. The result was that, in
general, pensioners received about 50 per cent of their company pension entitlement.
3. The son of Maxwell, Kevin was declared bankrupt with debts of £400 million. In 1995
Maxwell’s sons Kevin and Ian and two other former directors went on trial for conspiracy to
defraud, but were unanimously acquitted by the jury.
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Flaws in Corporate Governance

1. Domineering CEO - Maxwell was a physically imposing and domineering individual who
ran his companies as his personal fiefdom, acting as both chairman and chief executive. He
had a complete control over the companies of his empire. Maxwell personally controlled
movement of funds around his empire consisting of web of hundreds of companies. Ethical
and professional standards be it governance of company or governance of pension funds
were relegated to the background for commercial advantages and empire building.
2. Ineffective Board - The non-executive directors on the Maxwell Communication board, all
reputed persons, did little in discharging their responsibilities. Unrestricted movement of
funds across group companies, pledging shares of a company to raise funds for another
company, excessive borrowings took place under the nose of the board. It appeared that the
board was helpless in the face of larger than life personality of Robert Maxwell.
3. Lack of Transparency - Assets of the company and pension assets which belong to the
employees were mixed. There was hardly any transparency of the financial activities of
Maxwell. The shareholders as well as the creditors were unaware of the corporate structure
and web of hundreds of interlocking companies woven together by the tycoon. Maxwell had
incorporated family trusts in Liechtenstein, where tax laws and disclosure rules are virtually
non-existent. It was later learnt that even Maxwell family members were not aware of the
companies and trusts managed single-handedly by Robert Maxwell.
4. Flaws in the Audit - To make the matters worse the auditors of the company failed to pick
up the transfers Maxwell was making from the Mirror Group pension scheme, even though
they were in a position to do so. The Institute of Chartered Accountants in England & Wales
(ICAEW) asked the Joint Disciplinary Scheme (JDS) to investigate 35 complaints against
the Maxwell auditors, Coopers & Lybrand (now part of PricewaterhouseCoopers), and 24
complaints against four individual partners, in relation to Mirror Group of Newspapers and
other Maxwell companies for the period 1988 to 1991. The panel found lack of objectivity
in dealing with Mr. Maxwell and his companies. The audit firm also admitted 59 errors of
judgment.

9.4.3 Bank of Credit and Commerce International, UK, 1991-92 (Dutton, 2018)

Bank of Credit and Commerce international (BCCI) was a major international bank founded in
1972 by agha Hassan Abedi, a Pakistani financier. The BCCI was incorporated in Luxembourg
with head offices in Karachi and London. The bank primarily focused on serving Muslim and
third-world clients. The quadrupling of oil prices in 1973-74 led to huge deposits by Arab oil
producers. As a result BCCI expanded rapidly in the 1970s. BCCI also acquired parallel banks
through acquisitions. BCCI entered the African markets in 1979, and Asia in the early 1980s.
BCCI was among the first foreign banks awarded a license to operate in the Chinese special
economic Zone of Shenzhen. By 1980, BCCI was reported to have assets of over $4 billion with
over 150 branches in 46 countries. BCCI expanded rapidly and by 1991 it had 420 offices
around the world and a presence in 70 countries.

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Forced Closure of the Bank

Although BCCI’s published results showed ever-rising profits, by the late 1970s the bank was
suffering an alarming level of bad debts due to reckless lending. BCCI came under the scrutiny
of numerous financial regulators and intelligence agencies in the 1980s due to concerns that it
was poorly regulated. Reality was not reflected in BCCI’s accounts because the losses were
concealed in a Cayman Islands subsidiary, a bank within a bank known internally as ‘the
dustbin’, safe from regulatory scrutiny. As the losses mounted Abedi resorted to more and more
desperate ways of keeping the bank afloat. He tried ‘proprietary trading’, but the results were
further huge losses. The bank only kept going by fraudulent accounting and massive
misappropriations of depositors’ funds. Desperately in need of new sources of deposits and
revenue, from the early 1980s BCCI’s Panama branch acted as money-launderer for Latin
America’s drug barons. Subsequent investigations and the inquiry report in June 1991 for BCCI
by Price Waterhouse at the behest of Bank of England code named ‘Sandstorm Report’ revealed
that BCCI was involved in massive money laundering and other financial crimes, and illegally
gained controlling interest in a major American bank. The report indicated massive
manipulation of non-performing loans, fictitious transactions and charges, unrecorded deposit
liabilities, fictitious profits and concealment of losses.

Uncovering of BCCI’s fraud and illegal operations in the 1991 probe led to a massive
regulatory battle in 1991. Eventually on July 5, 1991 customs and bank regulators in seven
countries moved quickly to seize and take over the bank’s branches in the UK, US, France,
Spain, Switzerland, Luxembourg and the Cayman Islands. BCCIs assets were ultimately
liquidated, and a pool was established to reimburse depositors who had lost their funds when the
bank shut down.

The BCCI scandal was the biggest bank fraud in history. Its closure left 150,000 depositors
around the world scrambling to recover lost money. The biggest loser of all was Abedi’s backer,
the Sheikh of Abu Dhabi. Eventually small depositors recovered 75 per cent of their claims,
leaving a final loss by depositors of around $2 billion. Abedi was indicted in the US but he died
in 1995 before facing the trial.

Although it is difficult to sum up the causes of the BCCI scandal despite various investigations
and reports since 1991, the primary reasons leading to losses to bank stakeholders particularly
the small depositors were:

1. Lax Corporate Governance

2. Manipulation by bank officers with their own personal agendas
3. General fraud
4. Failure of fundamental risk management structures
5. Untenable loans and acquisition strategies
6. Poor treasury and record-keeping practices
7. Complex structure of BCCI leading to numerous regulatory violations and legal
liabilities.
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Flaws in Corporate Governance

1. Poor Risk Management - The flaw in operations of BCCI had been that it made large
loans to companies and individuals without properly securing them. The loans
represented massive concentrations of credit risk, but were often not properly
documented or monitored. When these loans went bad, the bank had no legal recourse,
and was forced to absorb the losses. This strategy, which ran counter to common sense
and all principles of good lending, racked up huge losses for BCCI. It covered up this
problem by taking in new deposits and not recording those straight forwardly on its
books. The bank created a matrix of false accounts that hid the losses for years.
2. Non-Existent Board of Directors - The Board of Directors of BCCI was virtually non-
existent as the company (the bank) was managed by its founder Abedi and the CEO
Naqvi. 248 managers and general managers of the bank at different locations were
reporting directly to them. They had developed an intricate international web of
financial institutions and shell companies to escape regulations and indulge in dubious
lending, fraudulent record-keeping and money laundering. Certain senior bank
executives manipulated gaps in the bank’s risk management structure.
3. Lack of Regulatory Supervision - BCCI was structured in such a way that no single
country had overall regulatory supervision over it. Its two holding companies were
based in Luxembourg and the Cayman Islands— two jurisdictions where banking
regulation was notoriously weak. It was also not regulated by a country that had a
central bank. Investigators in the U.S. and the UK revealed that BCCI had been “set up
deliberately to avoid centralized regulatory review, and operated extensively in bank
secrecy jurisdictions. Its affairs were extraordinarily complex. Its officers were
sophisticated international bankers whose apparent objective was to keep their affairs
secret, to commit fraud on a massive scale, and to avoid detection.” Weak fragmented
regulation obscured transparency in the activities of BCCI with the bank indulging in
money laundering and funneling illegal money to disreputable clients such as dictators,
insurgents, arms dealers and terrorist groups.
4. Ineffective Audit System - BCCI had an unusual annual auditing system. While Price
Waterhouse was the accountants for BCCI Overseas, Ernst & Young audited BCCI and
BCCI Holdings (London and Luxembourg). Other companies (such as KIFCO and
ICIC) were audited by neither. There was a need for independent and unified regulation
and auditing of complex financial conglomerates. In 1990, a Price Waterhouse audit of
BCCI revealed an unaccountable loss of hundreds of millions of dollars. The bank
approached Sheikh Zayed, who made good the loss in exchange for an increased
shareholding of 78 per cent. The audit also revealed numerous irregularities. The audit
also confirmed that BCCI secretly (and illegally) owned First American. Despite these
problems, Price Waterhouse signed BCCI’s 1989 annual report in the interest of the
bank survival.

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9.4.4 Nick Leeson and Barings Bank, UK, 1991-93

The case of Barings Bank is important as it highlights the importance of “Good Corporate
Governance” in the banking sector in the same way as the Maxwell case in the publishing
industry. Barings Bank was an English merchant bank based in London, and one of the world’s
oldest merchant banks. It was founded in 1762 and was owned by the Baring family of German
origin.

Collapse

In February 1995, Nick Leeson, a “rogue” trader for Barings Bank, UK, single-handedly caused
the financial collapse of a bank that had been in existence for hundreds of years. In fact, Barings
had financed the Louisiana Purchase between the US and France in 1803. Leeson was dealing in
risky financial derivatives in the Singapore office of Barings. He was the lone trader there and
was betting heavily on options for both the Singapore (SIPEX) and Nikkei exchange indexes.
These are similar to the Dow Jones Industrial Average (DJIA) and the S&P500 indexes here in
the US.

In the early 90s, Barings decided to get into the expanding futures/options business in Asia.
They established a Tokyo office to begin trading on the Tokyo Exchange. Later, they would
look to open a Singapore office for trading on the SIMEX. Leeson requested to set-up the
accounting and settlement functions there and direct trading floor operations (different from
trading). The London office granted his request and he went to Singapore in April 1992.
Initially, he could only execute trades on behalf of clients and the Tokyo office for "arbitrage"
purposes. After a good deal of success in this area, he was allowed to pursue an official trading
license on the SIMEX. He was then given some "discretion" in his executions meaning; he
could place orders on his own (speculative or "proprietary" trading).

Even after given the right to trade, Leeson still supervised accounting and settlements. There
was no direct oversight of his "book" and he even set-up a "dummy" account in which to funnel
losing trades. So, as far as the London office of Barings was concerned, he was always making
money because they never saw the losses and rarely questioned his request for funds to cover
his "margin calls". He took on huge positions as the market seemed to "go his way." He also
"wrote" options, taking on huge risk.

He was, in fact, perpetuating a "hoax" in his record-keeping to hide losses. He would set the
prices put into the accounting system and "cross-trade" between the legitimate, internal,
accounts and his fictitious "88888" account. He would also record trades that were never
executed on the Exchange.

In January 1995, a huge earthquake hit Japan, sending its financial markets reeling. The Nikkei
crashed, which adversely affected Leeson's position (remember, he had been selling options). It
was only then that he tried to hedge his positions, but it was too late. By late February, he faxed
a letter of resignation, and when his position was discovered, he had lost $1.4 billion USD.

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Barings, the bank which financed the Louisiana Purchase between the US and France, became
insolvent and was sold to a competing bank for $1.00!

9.5 TOP CORPORATE FAILURE CASES IN UNITED STATES OF AMERICA

9.5.1 Corporate Governance Failure at Enron

Throughout the late 1990s, Enron was almost universally considered one of the country's most
innovative companies -- a new-economy maverick that forsook musty, old industries with their
cumbersome hard assets in favor of the freewheeling world of e-commerce. The company
continued to build power plants and operate gas lines, but it became better known for its unique
trading businesses. Besides buying and selling gas and electricity futures, it created whole new
markets for such oddball "commodities" as broadcast time for advertisers, weather futures, and
Internet bandwidth. Enron was founded in 1985, and as one of the world's leading electricity,
natural gas, communications and pulp and paper companies before it bankrupted in late 2001,
its annual revenues rose from about $9 billion in 1995 to over $100 billion in 2000. At the end
of 2001 it was revealed that its reported financial condition was sustained substantially by
institutionalized, systematic, and creatively planned accounting fraud. According to Thomas
(2002), the drop of Enron's stock price from $90 per share in mid-2000 to less than $1 per share
at the end of 2001, caused shareholders to lose nearly $11 billion. And Enron revised its
financial statement for the previous five years and found that there was $586million in losses.
Enron fall to bankruptcy on December 2, 2001. One of the lessons of the Internet boom is that
it's often difficult for analysts to understand and evaluate new kinds of businesses. And
executives like Mr. Skilling, who once swore at an analyst during a conference call for asking a
pointed question about Enron's balance sheet, don't do much to foster the kind of open inquiry
that could lead to better information. But the Enron debacle is also emblematic of another
problem that has become all too evident in the last few years: Wall Street's loss of objectivity.
Investment banks make far more money from underwriting or merger deals than they do from
broker fees. Analysts at these firms often face conflicting loyalties. They can be put in the
position of having to worry as much about whether a chief executive might find a report
offensive as whether an investor might find it helpful.

The Causes of Enron’s bankruptcy

1. Truthfulness: The lack of truthfulness by management about the health of the company,
according to Kirk Hanson, the executive director of the Markkula Center for Applied Ethics.
The senior executives believed Enron had to be the best at everything it did and that they
had to protect their reputations and their compensation as the most successful executives in
the U.S. The duty that is owed is one of good faith and full disclosure. There is no evidence
that when Enron’s CEO told the employees that the stock would probably rise that he also
disclosed that he was selling stock. Moreover, the employees would not have learned of the
stock sale within days or weeks, as is ordinarily the case. Only the investigation surrounding

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 Enron’s bankruptcy enabled shareholders to learn of the CEO stock sell-off before February
14, 2002 which is when the sell-off would otherwise have been disclosed. Why the delay?
The stock was sold to the company to repay money that the CEO owed Enron—and the sale
of company stock qualifies as an exception under the ordinary director and officer
disclosure requirement. It does not have to be reported until 45 days after the end of the
company’s fiscal year.
2. Interest: It has been suggested that conflicts of interest and a lack of independent oversight
of management by Enron's board contributed to the firm's collapse. Moreover, some have
suggested that Enron's compensation policies engendered a myopic focus on earnings
growth and stock price. In addition, recent regulatory changes have focused on enhancing
the accounting for SPEs and strengthening internal accounting and control systems. We
review these issues, beginning with Enron's board. (Gillan SL, Martin JD, 2007) The
conflict of interest between the two roles played by Arthur Andersen, as auditor but also as
consultant to Enron. While investigations continue, Enron has sought to salvage its business
by spinning off various assets. It has filed for Chapter 11 bankruptcy, allowing it to
reorganise while protected from creditors. Former chief executive and chairman Kenneth
Lay has resigned, and restructuring expert Stephen Cooper has been brought in as interim
chief executive. Enron's core business, the energy trading arm, has been tied up in a
complex deal with UBS Warburg. The bank has not paid for the trading unit, but will share
some of the profits with Enron.
3. Enron and the Reputation of Arthur Andersen: The revelation of accounting
irregularities at Enron in the third quarter of 2001 caused regulators and the media to focus
extensive attention on Andersen. The magnitude of the alleged accounting errors, combined
with Andersen's role as Enron's auditor and the widespread media attention, provide a
seemingly powerful setting to explore the impact of auditor reputation on client market
prices around an audit failure. CP investigates the share price reaction of Andersen's clients
to various information events that could lead investors to revise their beliefs regarding
Andersen's reputation.( Nelson KK, Price RA, Rountree BR, 2008) Perhaps most damaging
to Andersen's reputation was their admission on January 10, 2002 that employees of the firm
had destroyed documents and correspondence related to the Enron engagement. For a
sample of S&P 1500 firms, CP reports that in the 3-day window following the shredding
announcement (0, +2), Andersen clients experienced a significant −2.03% market reaction,
and this reaction was significantly more negative than for Big 4 clients. Andersen's Houston
office clients, where Enron was headquartered, experienced an even stronger negative
market reaction than Andersen's non-Houston clients.2 Overall, CP concludes the shredding
announcement had a significant impact on the perceived quality of Andersen's audits, and
that the resulting loss of reputation had a negative effect on the market values of the firm's
other clients. In this study, we report new findings that shed light on whether this event
study evidence is consistent with an auditor reputation effect. In so doing, we do not suggest
that auditor reputation does not matter. As discussed above, there is ample evidence that
reputation is important to auditors and their clients. Rather, our purpose is to determine
whether client returns around Andersen's shredding announcement and related events can be
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 considered evidence of a reputation effect, or whether the results are confounded by other
effects.
4. An Important Factor: Accounting Fraud (using “mark to market” and SPE as tools)

• Mark to Market: As a public company, Enron was subject to external sources of

governance including market pressures, oversight by government regulators, and
oversight by private entities including auditors, equity analysts, and credit rating
agencies. In this section we recap the key external governance mechanisms, with
emphasis on the role of external auditors. This method requires that once a long-term
contract was signed, the amount of which the asset theoretically will sell on the future
market is reported on the current financial statement. In order to keep appeasing the
investors to create a consistent profiting situation in the company, Enron traders were
pressured to forecast high future cash flows and low discount rate on the long-term
contract with Enron. The difference between the calculated net present value and the
originally paid value was regarded as the profit of Enron. In fact, the net present value
reported by Enron might not happen during the future years of the long-term contract.
There is no doubt that the projection of the long-term income is overly optimistic and
inflated.
• SPE—Special Purpose Entity: Accounting rule allows a company to exclude a SPE
from its own financial statements if an independent party has control of the SPE, and if
this independent party owns at least 3 percent of the SPE. Enron need to find a way to
hide the debt since high debt levels would lower the investment grade and trigger banks
to recall money. Using the Enron’s stock as collateral, the SPE, which was headed by
the CFO, Fastow, borrowed large sums of money. And this money was used to balance
Enron’s overvalued contracts. Thus, the SPE enable the Enron to convert loans and
assets burdened with debt obligations into income. In addition, the taking over by the
SPE made Enron transferred more stock to SPE. However, the debt and assets purchased
by the SPE, which was actually burdened with large amount of debts, were not reported
on Enron’s financial report. The shareholders were then misled that debt was not
increasing and the revenue was even increasing.

9.5.2 World.com, US, 2001 (World.Com, 2018)

In early 2000, the stock market began to fall, and with it went WorldCom’s stock price. The
telecom industry as a whole was recognized for its overcapacity and failure to bring in returns
on the massive capital investments of 1990s. Long distance prices continued to fall, and internet
bandwidth demand was lower than expected. As a result, WorldCom found itself forced to
begin revising its earnings forecasts downwards. However, the firm was unable to make even
these lower numbers. To make its performance meet earnings forecasts, top executives began to
shuffle accounting entries. At least $9 billion of expenses were booked improperly as capital
expenditures. These dishonest maneuvers did not come to light until mid-2002. In April, 2002

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Ebber resigned as CEO. By the end of 2002, WorldCom had admitted that it misstated its
financial position by at least $9 billion.

WorldCom has become symbolic of the rise and fall of the so called New Economy. The firm
was able to build up from a small, failing long-distance reseller to a darling of Wall Street
through a long series of acquisitions. However, due to managerial errors, industry overcapacity,
and outright illegal actions, the company descended into Chapter-11 bankruptcy. Following are
the five major factors that contributed to the WorldCom’s spectacular downfall:-

1. Adverse industry conditions.

2. Poor execution of merger integration.
3. Unscrupulous accounting practices.
4. Relaxed Regulatory Environment.
5. Poor Top Management.

Thus WorldCom became a victim of aggressive merger policy.

Creating reserves against anticipated contingencies is an accounting practice that is akin to

setting aside money for a rainy day; for example, law in India mandates creating a reserve for
buying back debentures. However, reserves can also be abused to create the accounting
equivalent of a ‘slush fund’ with all the undertones of sneaky, not-quite-above-the-board
behaviour. If a company wanted to ‘tweak’ profits to meet earnings advisories sent out earlier, it
could dip into reserves to create the necessary ‘tilt’. Also, distinguishing between capital and
revenue or operating expenses is, at best times tricky. Coupled with malafide intentions, it can
only lead to erosion of fundamental accounting values.

At WorldCom, the line between fact and fiction had blurred, at least in accounting matters. It
used the ‘capitalized costs’ route to very high levels. Instead of reducing certain costs that ought
to have been charged to expenses, it chose to capitalize them, calling it long-term investments.
Capitalization has the effect of ‘spreading’ costs against revenues of many periods rather than in
one period, leaving greater profits in that period than actual.

The company showed a $ 1.4 billion profit in 2001 rather than a loss by using this tool - perhaps
the oldest trick of accountants. Similarly, it overstated cash flow by $ 3.9 billion for 2001 and
the first quarter of 2002.

At the beginning of 2001, Scott Sullivan, CFO, discovered that at least 15% of connection
agreements with local phone companies to complete calls were not producing revenue. Sullivan
decided to capitalize the so-called line costs as long-term investments, to be written down over
time, hoping the agreements would start producing revenue later. His argument in defense of his
methods was that because WorldCom was not receiving revenue, he could defer the costs of

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leasing the lines until they produced revenue.

The new auditors, KPMG, however, were not satisfied, quoting established accounting rules
that clearly stated such costs as operating expenses and WorldCom was forced to restate as
many as five quarters of earning to bring its accounts in line with established accounting norms.
Profits were inflated by $ 3.8 billion between January 2001 and March 2002 to keep them in
line with Wall Street expectations.

Bernie Ebbers, founder and chief executive of the company was ‘allowed’ to run a ‘giant
compensation slush fund’ to hand out to favored executives and ‘convinced’ the board to ‘lend’
him $ 400 million personally. He also borrowed hundreds of millions of dollars from the
company to underwrite the inflated prices he had paid for the company’s own shares, besides
being allowed the use of the corporate jet for $ 1 day. Ebbers was allowed a nearly imperial
reign over the company by the ineffective board before leaving with a ‘golden goodbye’ of
approximately $ 50 million. Such levels of pay went beyond any rational calculation of value
added by senior executives. SEC, in a civil lawsuit against WorldCom, said that the company’s
senior management allowed it to fraudulently report a cash flow of $ 2.3 billion, rather than its
actual loss of $ 662 million in 2001. The first quarter of 2002 saw an incorrect cash flow report
of $ 240 million rather than a loss of $557 million.

9.5.3 Rajat Gupta, USA, 2010-12 (Patel, 2018)

Rajat Gupta is an Indian American businessman who was the managing director of management
consultancy McKinsey & Company and a business leader in India and the United States. Rajat
Gupta also served as corporate chairman, board director or strategic advisor to Goldman Sachs,
Procter and Gamble and American Airlines, and non-profits organizations, The Gates
Foundation, The Global Fund and the International Chamber of Commerce.
Rajat Gupta was convicted in June 2012 on insider trading charges. He was sentenced in
October 2012 to two years in prison, an additional year on supervised release and ordered to pay
$5 million in fines. His trial began on May 22, 2012. On June 15, 2012, Gupta was found guilty
on three counts of securities fraud and one count of conspiracy.

The primary parties are affected are Rajat Gupta, McKinsley & Company, Goldman Sachs, Raj
Rajaratnam, Galleon Group, Warren Buffet, and the U.S. equity markets. Other parties
indirectly affected are family and friends of Rajat Gupta, employees at McKinsley & Company
and Galleon Group, investors in Goldman Sachs and its creditors, and government and officials
involved with the case.

In September 2008 Warren Buffet agrees to pay $5 billion to Goldman Sachs in exchange for
preferred shares in the company. This news is likely to raise the share price of Goldman Sachs.
The news is not supposed to be announced and made public until the end of day. Less than a
minute after the board approved the Buffet purchase, Rajat Gupta calls his longtime friend Raj
Rajaratnam, a hedge fund manager and billionaire founder of Galleon Group. Once Rajaratnam
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gets this information, he immediately buys shares of Goldman Sachs. Next day when the stock
market opens, Raj Rajaratnam makes nearly $1.2 million in profits as Goldman Sachs shares
rose. The SEC estimates the tip leaked by Rajat Gupta generates profits and avoids losses of
more than $23 million.

9.6 TOP CORPORATE FAILURE CASES IN INDIA (Chakma, 2018)

9.6.1 Corporate Governance Failure at Satyam Computers, India, 2008

The countdown to the problems of the Satyam begin on December 16, 2008 when its Chairman,
Mr. Ramalinga Raju in a surprise move announced to buy two Maytas companies, i.e. Maytas
Infrastructure Ltd and Maytas Properties Ltd allegedly promoted by Mr. Raju’s kin for $ 1.6
billion to cover the scam he was cooking.

Since shareholders‟ approval was not sought before the acquisition, the announcement was met
with fierce opposition from domestic as well as foreign investors, who owned a large part of
Satyam the market forced him to retreat the same day. Satyam American Depository Receipts
plunged nearly 55% in overnight trading and when Indian markets opened on December 17,
shares in the company fell over 30% to their 52-week lows near Rs.160. A day later, Satyam
announced a board meeting to consider share buyback to boost the confidence of the
shareholders.

However, the damage to Satyam’s credibility was already done. In a surprise move, the World
Bank announced on December 23, 2008 that Satyam has been barred from business with World
Bank for eight years for “improper benefits to bank staff” and “lack of documentation on
invoices” and charged with data theft and bribing the staff.

Two days later, the lone independent director since 1991, Mangalam Srinivasan announced his
resignation followed by the resignation of three more independent directors on December 28 i.e.
Vinod K Dham (famously known as father of the Pentium and an ex Intel employee), M
Rammohan Rao (Dean of the renowned Indian School of Business) and Krishna Palepu
(professor at Harvard Business School). This development left Mr. Raju with no option but to
confess on January 7, 2009 admitting of over Rs.7,000 crore accounting fraud, stating Satyam
had overstated profits and falsified assets for years. He admitted that he had been fudging and
inflating numbers to be among the top four firms in the IT industry.

Finally, Mr. Ramalinga Raju and his brother B Rama Raju were arrested by the Indian authority
and the central government took control of the tainted company to the rescue of over 50,000
employees by scrapping the board and appointed a temporary board consisting of experts from
different sectors.

The new board retained the customer base and found a suitor in Tech Mahindra, belonging to
Mahindra and Mahindra group of companies. Initially, it was renamed as Mahindra Satyam
before absorbing it into itself.

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Raju wrote a five-page letter to the Securities and Exchange Board of India (SEBI) and his
company’s shareholders, admitting that he had manipulated the company’s earnings, and fooled
investors. Nearly $1 billion or 94% of the cash on the books was fictitious.

On January 7, 2009 Satyam scandal was publicly announced & Mr. Ramalinga confessed that
Satyam’s balance sheet as on 30 September 2008 contained:

1. Inflated (non-existent) cash and bank balances of Rs.5,040 crore (as against Rs.5,361
crore reflected in the books);
2. An accrued interest of Rs376 crore, which is non-existent;
3. An understated liability of Rs1,230 crore on account of funds;
4. An overstated debtors position of Rs490 crore (as against Rs.2,651 reflected in the
books) 5.2003- 2008: False clients, projects and invoices created to boost company’s
profile, damages calculated at Rs.7,900 crore.

Raju acknowledged that the gap in the balance sheet had arisen on account of inflated profits
over a period of last several years. He explained his reasons for inflating earning in the letter
thus: “As the promoters held a small percentage of equity, the concern was that poor
performance would result in a takeover, thereby exposing the gap.”

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, Raju said in the letter. “It has attained
unmanageable proportions as the size of the company operations grew significantly.” Raju
finally rued in his resignation letter to the board of directors of the company.

9.6.2 Corporate Governance Failure at Sahara (Mahajan, 2016)

Parties involved two groups of Sahara India:

1. Sahara India Real Estate Corporation and Sahara Housing Investment Corporation
Sahara’s investment program included schemes that were similar to a typical Indian bank’s
fixed or recurring deposits. The company largely sold such schemes to small investors in
towns and rural areas through their network of agents. These financial products allowed
investors to deposit small amounts such as 50 rupees per day for returns that were said to be
higher than what bank deposits would generate. OFCD instruments were issued in the name
of the two companies but the cheques were sought in the name of Sahara India. The money
raise through OFCDs was camouflaged as private placements whereas they were public
issues. These debentures can be converted into shares at the will of the debt holder or the
investor but the price is decided by the company.
2. Problem: The public notice comes after RBI received complaints from individuals that the
Sahara group is mobilizing money from the public under the generic name of Sahara
Pariwar and Sahara India Pariwar. These two companies are not registered under RBI. Only
three Sahara group entities are registered with RBI -- Sahara India Financial Corp. Ltd
(SIFCL), Sahara India Corp Investment Ltd (SICIL) and Sahara India Infrastructural
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 Development Ltd. (SIIDL).Of these three entities, SIFCL, a residual non-banking company,
has been directed by RBI to phase out acceptance of deposits from the public. SICIL and
SIIDL are not authorized to accept deposits from the public. The order to arrest Subrata Roy
and two directors of Sahara was issued for their failure to appear before the apex court in a
contempt case arising out of non- refund of Rs 24,600 crores to investors by two of the
Sahara group companies.
3. The Year 2012: The apex court by its August 31, 2012 order had asked Sahara India Real
Estate Corp Ltd. (SIRECL) and Sahara Housing Investment Corporation Limited (SHICL)
to return, along with 15 percent interest, the investors INR 24,600 crore that two companies
had collected through optionally fully convertible debentures (OFCSs) in 2007-08
4. 2014: The apex court by its March 26, 2014 order had asked Sahara to deposit INR10,
000crore - INR 5000 crores in cash and INR 5,000 crores in bank guarantee - towards the
repayment of the investors’ money. It had said that this was also a condition for the release
of Roy and the other directors from Tihar Jail where they are locked in judicial custody.
5. 2015: Sahara India now claims that it has already repaid around INR 23,000crore directly to
the investors and above that it has already submitted INR 12000crore to SEBI. Out of the
investors it has repaid it has submitted proof for about 75% and 25% still remains which
they say is lying in their Mumbai godowns. But the proof of investors which they have
submitted is generally incomplete with some forms only consisting of village name or only
mobile number or even only name of the investor. SEBI also required details of bank
accounts in the form of financial papers but Sahara contented that bulk of their investors did
not have bank accounts in formal financial papers.
6. Between 2008 and 2012 the RBI auditors have been checking the authenticity of investors
under strict norms and only then the next month’s payments were allowed and they have not
found even one fictitious account during these four years Sahara claims to deposit around Rs
18000 crores by the time Subrata Roy is bailed out of jail and has already deposited Rs
12000 crores with SEBI so far out of which SEBI has refunded only Rs 2000 crores to the
investors.

9.6.3 Kingfisher Airlines (KFA), India, 2012

Kingfisher Airlines, Indian based airlines was established in 2003. It was owned by the
Bengaluru based United Breweries Group. Until December 2011, Kingfisher Airlines had the
second largest share in India’s domestic air travel market.

The Downfall

Ever since the airline commenced operations in 2005, it reported losses. The acquisition of loss
making Air Deccan in 2007 made matters worse. The merger was made to save operating cost
and to give brand value to the loss making Air Deccan. An initial name change to Deccan,
followed by Kingfisher Red, and promotion as the domestic budget Kingfisher airline failed to
stem losses and Kingfisher suffered huge losses for three consecutive years. The company
raised $100 million by various debt instruments including GDRs in 2009. In the second quarter
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of 2009-10, Kingfisher reported losses of Rs 419.77 Crores. Despite huge losses, Kingfisher
forayed into highly competitive international market by announcing flight to Europe in 2010.

Meanwhile with the debt of the airlines mounting as it stood at Rs 6500 Crores in Sep 2011,
Kingfisher decided to exit low-cost business. That also did not impact the operating losses. On
15 November 2011 the airline released poor financial results, indicating that it was “drowning
in high-interest debt and losing money”. The chairman of the Kingfisher Airlines Mr. Vijay
Mallya indicated that the solution was for the government to reduce fuel and other taxes. In the
3rd quarter of 2011-12, loss of Rs 444.20 Crores was reported.

The matter became worse by non-payment of service tax to the government collected from the
customer; default in clearing airport charges; failure to deposit tax deducted at source (TDS);
non-payment of salary to staff; and bouncing of cheques etc.

This resulted in frequent strikes of the staff; sick-leaves and non-reporting of pilots; cancellation
of flights and prosecution of the company including criminal cases against the chairman of the
company, The Company somehow managed to stay afoot with fresh debt packages by public
sector banks and personal guarantee of Mr. Vijay Mallya who had deep connections with
politicians and bureaucrats. In 2011-12, several unsuccessful attempts were made to persuade
the government to buy out the ailing airline and offer bail-out package.

Finally on October 20, 2012, airlines permit was suspended by Director General of Civil
Aviation (DGCA) which was not renewed despite several political pressures. The consortium of
banks including IDBI Bank and SBI decided to start recalling their loans amounting to Rs. 7500
Crores in Feb 2013. The consortium declared Kingfisher as the top NPA and Mr. Mallya a
willful defaulter in July 2014 for failure to repay the heavy loan.

In Feb 2015, 17 bank consortium led by SBI took possession of Kingfisher House. CBI also
conducted raids and searches on the offices of the Kingfisher in connection with IDBI loan of
Rs. 950 Crores. CBI charged Mallya with fraud and criminal conspiracy and sought his judicial
custody.

The Enforcement Directorate (ED) also registered a money laundering case against Malaya and
CFO of the airlines. The consortium moved petition with the Debt Recovery Tribunal to attach
the properties of the airlines. On March 08th 2016, banks moved the Supreme Court to restrain
Mallya from overseas travel but Mallya fled to UK, the next day fearing arrest and prosecution
in several criminal cases.

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 Lack of Corporate Governance

Faulty Business Strategy

Erroneous Expansion

Flawed Financial Model

High Operational Cost and Economic Slowdown

Figure 1: Reasons for the Downfall of Kingfisher Airlines

9.7 SELF-ASSESSMENT QUESTIONS

True and false Questions:

Indicate whether the following statements are true or false:

a) Internal and External corporate Governance mechanism serve the purpose of protecting
the interest of stakeholder of a company.
b) Failure of Board of Directors is the most common Governance failure noticed in various
corporate failures
c) The prime responsibility of the board is to formulate corporate strategies in the best
interest of the shareholders and also other stakeholders.
d) In India, founders' ability to control the affairs of the company has the potential of
derailing the entire corporate governance system.
e) Maxwell was a physically imposing and domineering individual who ran his companies
as his personal fiefdom, acting as both chairman and chief executive.

Answers: a (T), b (T), c (T), d (T), e (T)

Long Answer Questions

Q1.Explain the most common corporate governance problems noticed in the failure of big
corporates in US and UK??

Q2. Write a note on the rise and fall of Maxwell Communications.

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 LESSON 10
CORPORATE GOVERNANCE IN PSUS/ BANKS AND OTHERS
ENTERPRISES

10 STRUCTURE

10.1. Corporate Governance of Public Sector Undertakings (PSU’s)

10.2. Corporate Governance in Indian Banks
10.3. Corporate Governance in Banks in Family Owned Companies
10.4. Corporate Governance in Banks in Multinational Enterprises
10.5. Corporate Governance in Banks in SME’s
10.6. Self-Assessment Questions

10.1 CORPORATE GOVERNANCE OF PUBLIC SECTOR UNDERTAKINGS (PSU’S)

(Sylvine, 2016)

The PSUs exist and operate in India in three forms, firstly, the Departmental Undertakings, such
as, railways, postal services, Broadcast (Doordarshan and All India Radio), etc. which are under
control of some ministry of the Government and financed and controlled by any other
Government Department.

Secondly, the Statutory Public Corporations created by the Parliament or State Legislature by
passing an Act which defines the powers, functions, management, organizational and
administrative structures of such corporations, such as the Food Corporation of India, Life
Insurance Corporation of India, etc.

Thirdly, the Government Companies also falls under the purview of PSU. A company is
deemed to be a Government company or PSU if the Government holds 51 percent or more of its
paid up capital. For example, Hindustan Machine Tools Limited, Steel Authority of India
Limited, etc.

Various PSUs have been awarded additional financial autonomy. These companies are public
sector enterprises which have been given comparative advantages, greater freedom to compete
in the global market so as to “support” them in their drive to become global giants. By financial
autonomy granted by Central Govt., the PSUs are categorized under three “Ratnas”, viz.,
Navaratnas, Maharatnas, and Mini Ratnas. Financial autonomy was initially awarded to nine
PSUs as Navaratna status in 1997. In 2010, the Government established the higher Maharatnas
category, which raises a company’s investment ceiling from Rs.1,000 crore to Rs.5,000 crore.
The Maharatnas firms can now decide on investment of up to 15 percent of their net worth in a
project, while the Navaratna companies could invest up to Rs.1,000 crore without explicit

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government approval. There are two categories of Miniratnas which afford less financial
autonomy.

The Board of Directors is considered as a crucial part of the corporate governance. The Board’s
primary role is to monitor management on behalf of the shareholders. The primary
responsibility of governing a company (whether private or Government Company) is upon its
Board of Directors. The Board should function as follows –

1. The Board should meet regularly, keep its control over the company and monitor the
executive management of the company;
2. The Board of Directors should steer discussions properly in the meetings with regard to
the affairs of the company;
3. The Board of Directors has responsibilities in the matter of employment and dismissal of
the CEO;
4. The Board of Directors should provide guidance and supervise on the selection,
evaluation, etc. of the senior management of the company;
5. The Board should monitor the performance of the company in the fulfillment of its
business objectives, plans, and strategies. The Board also oversees to ascertain the
proper management of the company;
6. The Board also ensures compliance with the applicable laws, rules, and regulations, etc.

The Central Public Sector Enterprises (CPSEs) have to comply with the corporate governance
rules made from time to time by the Department of Public Enterprises under the Ministry of
Heavy Industries and Public Enterprises, New Delhi.

The Board of Directors of a CPSE shall have an optimum combination of Functional, Nominal,
and Independent Directors. The Functional Directors are full-time operational directors
responsible for day to day functioning of the enterprise. Each Board shall have an adequate
number of Functional Directors on it. The Government Directors are appointed by the
Administrative Ministries and are officers dealing with the concerned enterprise. The Non-
Official Directors are to be drawn from the public men, technocrats, management experts and
consultants, and professional managers in industry and trade with a high degree of proven
ability.

The Board to act as per the Board Charter: A clear definition of roles and divisions of
responsibilities between the Board and the management of the CPSE is necessary to enable the
Board to perform its role effectively. The Board should have a formal statement of Board
Charter which clearly defines the roles and responsibilities of the Board and individual
directors.

Formulation and Observance of the Code of Conduct: The Board of Directors of a CPSE
shall lay down a code of conduct for all board members and senior management of the
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Company. All Board members and senior management personnel shall affirm compliance with
the code on an annual basis. The guidelines and policies evolved by the Central Government
with respect to the structure, composition, selection appointment and service conditions of the
Board of Directors and senior management personnel shall be strictly followed.

The Board of Directors of the Company has to formulate the code of conduct for the Directors
and Senior Management Personnel, and while doing so the code of conduct would among other
things, include the following:

1. Act in the best interests of, and fulfill their fiduciary obligations to the Company;
2. Act honestly, fairly, ethically and with integrity;
3. Conduct themselves in a professional, courteous and respectful manner and not take
improper advantage of the position of Director;
4. Act in a socially responsible manner, within the applicable laws, rules, and regulations,
customs and traditions of the countries in which the company operates;
5. Comply with the communication and other policies of the enterprise;
6. Act in good faith, responsibly, with due care, competence, and diligence; without
allowing their independent judgment to 5,;
7. Not to use the company’s property or position for personal gain;
8. Not to use any information or opportunity received by them in their capacity as directors
in a manner that would be detrimental to the company’s interest;
9. Act in a manner to enhance and maintain the reputation of the enterprise;
10. Disclose any personal interest that they may have regarding any matters that may come
before the Board and abstain from discussion, voting or otherwise influencing a decision
on any matter in which the concerned Director has or may have such an interest;
11. Abstain from discussion, voting or otherwise influencing a decision on any matter in
which they may have a conflict or potential conflict of interest;
12. Respect the confidentiality of information relating to the affairs of the Company
acquired in the course of their service as Directors for their personal advantage or
advantage of any other entity;
13. Not to use the confidential information obtained in the course of their service as
Directors for their own benefit or advantage of any other entity;
14. Help create and maintain a culture of high ethical standards and commitment to
compliance;
15. Keep the Board informed in an appropriate and timely manner any information in the
knowledge of the member which is related to the decision-making or is otherwise
critical for the Company.
16. Treat the other members of the Board and other persons connected with the Company
with respect, dignity, fairness, and courtesy.

The CPSE Board of Directors is also entrusted with some moral imperatives. The Board has to
ensure that the social responsibilities, needs, etc. are satisfied by the products of efforts involved
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in the company. It is to be ensured that safety standards prescribed for health, environmental
and social security standards, human wellbeing, etc. are maintained. In this regard, the Board
Members shall be alert. All Board Members are expected to act in accordance with highest
standards of personal and professional integrity, honesty, and ethical conduct while conducting
the business of the public enterprise. Values like equality, tolerance, respect for others, non-
discrimination by race, religion, sex, caste, age, etc. to be maintained by Board Members.
Further, confidentiality about the affairs of the Company should always be kept.

10.2 CORPORATE GOVERNANCE IN INDIAN BANKS

In India, the Reserve Bank of India (“RBI”) is the gatekeeper of Corporate Governance. RBI is
the central bank of India which regulates all the major issues related to currency, foreign
exchange reserves etc. In short, RBI is the bank responsible for securing the monetary stability
in India. RBI in India plays leading role in formulating and implementing corporate governance.
The corporate governance mechanism as followed by Reserve Bank of India is based on three
categories for governing the banks. They are: (Furtado, 2017)

1. Disclosure and Transparency: Disclosure and transparency is the most important

constituent of corporate governance. If the banks will not be disclosing their transactions to
the RBI then they can operate at their whims and fancies and may vanish with the lifelong
investments and savings of the people. The RBI through the requirement of routine
reporting of financial transactions of the bank keeps a tab on the activities being undertaken
by the banks in India. Any failure to abide by the requirements set out by RBI may lead to
heavy fines being imposed along with the cancellation of the license to operate as a bank.
Most recently cases of RBI imposing penalty are the imposition of penalty on Devi Gayatri
Co-operative Urban Bank Ltd., Hyderabad, Telangana, while exercising the powers vested
in it under the provisions of Section 47A (1) (b) read with Section 46 (4) of the Banking
Regulation Act, 1949 (As Applicable to Co-operative Societies), for violation of Reserve
Bank of India directives and guidelines on loans and advances to directors and their
relatives, on Credit Agricole Corporate and Investment Bank (India) and The Tumkur
Veerashaiva Co-operative Bank Ltd.,Tumkur, Karnataka.
2. Off-Site Surveillance: RBI routinely perform an annual on-site inspection of the records of
the banks but in order to promote governance in banking sector RBI in the year 1995, off-
site surveillance function was initiated in 1995 for domestic operations of banks[8]. The
main focus of the off-site surveillance is to monitor the financial health of banks between
two on-site inspections, identifying banks which show financial deterioration and would be
a source for supervisory concerns. The off-site surveillance prepares RBI to take timely
remedial action before things get out of control. During December 1995 the first tranche of
off-site returns was introduced with five quarterly returns for all commercial banks
operating in India and two half yearly returns one each on connected and related lending and
profile of ownership, control and management of domestic banks. The second tranche of
four quarterly returns for monitoring asset-liability management covering liquidity and
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 interest rate risk for domestic currency and foreign currencies were introduced since June
1999. The Reserve Bank intends to reduce this periodicity with effect from April 1, 2000.
3. Prompt Corrective Action: RBI while promoting corporate governance in banks in India
has RBI has set trigger points on the basis of CRAR, NPA and ROA. On the basis of trigger
points set by RBI, the banks have to follow ‘structured action plan also called mandatory
action plan’. Beside mandatory action plan RBI has discretionary action plans too. The main
reason for classifying the rule-based action points into Mandatory and Discretionary is that
some of the actions are essential to restore the financial health of banks must be mandatorily
taken by the bank while other actions will be taken at the discretion of RBI depending upon
the profile of each bank.

SEBI Guidelines on Corporate Governance in Banks: (N.Gopalsamy, 2006)

The Securities and Exchange Board of India (SEBI) had constituted a Committee on Corporate
Governance and circulated the recommendations to all stock exchanges for implementation by
listed entities as part of the listing agreement vide SEBI’s circular SMDRP/Policy/CIR-10/2000
dated February 21, 2000. However it had at that time exempted body corporates such as public
and private sector banks, financial institutions, insurance companies and those incorporated
under separate statute. SEBI has now suggested to RBI to consider issuing appropriate
guidelines to banks and financial institutions so as to ensure that all listed companies would
have uniform standards of corporate governance. As requested by SEBI, it has now been
proposed that the SEBI Committee’s guidelines may be taken up for adoption by those
commercial banks listed in stock exchanges so that they can harmonize their existing corporate
governance requirements with the requirements of SEBI, wherever considered appropriate.

On a review by RBI of the existing corporate governance requirements in banks, it is observed

that many of the recommendations in regard to the following stand implemented in banks and
may not require further action towards implementation in respect of these guidelines for the
present.

a. Optimum combination of executive and non-executive directors in the Board

b. Pecuniary relationship or transactions of the non-executive directors vis-à-vis the bank
c. Independent Audit Committees, their constitution, chairmanship, power, roles,
responsibilities, conduct of business, etc
d. Remuneration of Directors (in case of private sector banks)
e. Periodicity /number of board meetings
f. Disclosure by management to the board about the conflict of interest
g. Information to shareholders regarding appointment/re-appointment of directors, display of
quarterly results/presentation to analysts on the web- site
h. Maintenance of office by non-executive Chairman.
i. Reviewing with the management by the Audit Committee of the board the annual financial
statements before submission to the Board, focusing primarily on:
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 • Any changes in accounting policies and practices,
• Major accounting entries based on exercise of judgment by management,
• Qualifications in draft audit report,
• Significant adjustments arising out of audit, compliance with accounting
• standards,
• Compliance with stock exchange and legal requirements concerning financial
statements, and the going concern assumption.

The Audit Committee of the board may look into the reasons for default in payment to
depositors, debenture holders, shareholders (non-payment of dividends) and creditors, wherever
there are any cases of defaults in payment. SEBI Committee’s recommendations on other
additional functions to be entrusted to the Audit Committee may be complied with by the listed
banks as per listing agreement. As regards the appointment and removal of external auditors, the
practice followed in banks is more stringent than that recommended by the Committee and
hence will continue. Further, fixation of audit fee and also approval of payment for any other
services are already subject to the instructions of RBI. As regards recommendation for obtaining
a certificate from auditors regarding compliance of conditions of Corporate Governance, it may
be stated that the compliance of banks with RBI instructions is already being verified by the
statutory auditors. Therefore, a separate certificate from the auditors is not considered
necessary.

With a view to further improving the Corporate Governance standards in banks, the following
measures are now recommended for implementation.

a. In the interest of the shareholders, the private sector banks and public sector banks which
have issued shares to the public may form committees on the same lines as listed companies
under the Chairmanship of a non-executive director to look into redressal of shareholders'
complaints.

b. All listed banks may provide un-audited financial results on half yearly basis to their
shareholders with summary of significant developments.

Impact of Corporate Governance Policies in Banks

Post reform period led to many banks accessing capital market to shore up their capital
adequacy ratio, an essential prescription of Basel-I then and Basel –II now. Subscription of
bank’s equity is a function of public confidence which stems from governance policies. The
Red Herring Prospectus lodged by banks as required by the capital market regulator, the
Securities and Exchange Board of India (SEBI) reflects not only the numerical performance of
banks as enunciated in Section-I of this paper but is also an indicator of present and future
governance policies pursued by banks. The movement of stock prices is a further reflection of
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demand and supply of bank shares in the stock market. The entry of new Private Sector Banks
and PSBs accessing capital market opened up new opportunities to the investors. It was
heartening to note that in the next few years, the bank shares had picked up demand and
popularity.

The spurt in the capital market index is a manifestation of investor opinion on the performance,
potential and standard of governance of banks. Though there may not be direct correlation
between market movement of bank shares and corporate governance policies, the overall long
run market opinion precipitates on this basis. Such practices form the fundamental strength of
the banks and their ethical commitments. As the risk perception changes, volume of business
goes up, new line of activities spur, competition heightens further, the Corporate governance
practices need to be fine-tuned to meet the emerging challenges.

10.3 CORPORATE GOVERNANCE IN FAMILY OWNED COMPANIES (Pandey A. ,

2017)

Certain provisions of Corporate Governance in a Family Owned Companies have been actively
statutorily incorporated in the Companies Act, 2013 such as:

• Independent Directors and Women Directors: To build up the transparency and

accountability of the Board of Directors, the Act now requires at least 1/3rd of the total
directors of a listed company to be Independent Directors and have no material or
pecuniary relationship with the company or related persons. Public companies with paid
up share capital exceeding ₹ 10 Crores or turnover exceeding ₹100 crore are statutorily
required to have at least 2 directors as Independent Directors.

To ensure diversity on the board, all listed companies and non-listed companies having paid up
share capital more than ₹100 Crores and turnover exceeding ₹ 100 Crores are required to have
at least one woman director on the board.

• Corporate Social Responsibility: Every company having net worth of ₹ 500 Crores or
more, turnover exceeding ₹1000 Crores or net profit of more than ₹ 5 Crore is required
to constitute a Corporate Social Responsibility Committee under Section 135 of the
Companies Act, 2013 constituting 3 or more directors with at least 1 Independent
Director to formulate policies and recommend activities that the company may
undertake for promotion of education, gender equality, health, poverty eradication,
environment, employment etc. Again, this measure puts responsibility on the company
for the social wellbeing not just of its workforce, but also makes it publicly accountable.
• Audit Committee: The Act provides for the setting up of an Audit Committee
comprising of at least 3 directors by all listed companies, majority of which have to be
independent directors. The members of such a committee have to be persons who can
read and understand financial statements and the task entrusted to such a committee is
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 recommending remuneration and appointments of auditors and reviewing their
independence.
• Nomination and Remuneration Committee: The Nomination and Remuneration
committee shall comprise of 3 or more non-executive directors out of which at least half
shall be Independent Directors. Such committee shall identify persons qualified to
become directors of the company and make recommendations to the board of directors
regarding their appointment and approval.
• Serious Fraud Investigation Office: Section 211 of the Act provides for the
establishment of a Serious Fraud Investigation Office to look into the affairs of the
company and investigate incidences of fraud upon receipt of report of the Registrar or
inspector or generally in the public interest or request from any Department of Central or
State Government.

Need for Corporate Governance in a Family Owned Companies

Families need governance just as much as any other structure involving multiple persons with
their varied, often competing, interests. Family businesses constitute a major chunk of business
in India and cannot be put on the back seat. Their contribution to the country’s economy is
immense and if they are not disciplined and properly governed, it inevitably affects the national
economy. Strong governance measures in a family owned business can effectively act as a
prevention mechanism against a lot of tensions that may arise between family members at a
later stage. It is also imperative for family businesses to adopt effective corporate governance
measures in order to be a tough competition to other players in the global market. The most
glaring characteristic of a family owned business is that all the key managerial positions in such
businesses are held by family members. Non-family members may of course be employees of
the company, but the decision-making power usually vests with the members of the family. This
is probably the reason why a lot of family businesses are not pro-active in taking strict corporate
governance measures in their activities – out of fear of losing control over the business. These
businesses derive their strength from the love, trust and personal bond that the members share,
but at the same time, even slight instability or rivalry in the family could adversely affect the
business and project a negative picture of the family firm in the market before prospective
investors.

Major Challenges Faced by Family Owned Companies

• Investors are often hesitant and distrustful of the company due to chances of the
controlling family abusing rights of other shareholders. Therefore, governance measures
need to be such that provide reassurance to the investors that their interests will not be
diluted in the larger scheme of things.
• Concentrated & restricted ownership – there is always the risk of nepotism and
favoritism in a family business.

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 • Maintaining harmony and establishing a good business relationship between the family
and non-family members of the business can often be a very challenging prospect.
• Family businesses are driven more by emotion than by professional ethics.
• Incapacity of the head of the family to run the business or a change in generations – real
problems arise when a clear succession strategy is not chalked out. Conflicts arise over
the control of the company leading to a trust deficit. As the generations progress, their
interests may no longer align and internal competition among family members may
heighten and become hostile.

Corporate Governance Measures for Family Businesses

Family owned companies are expected to more or less adhere to the same corporate governance
measures for their business as any other business. The same principles and practices that apply
to any other business are essential for the successful run of a family business as well. Some of
these measures include compliance with the Accounting Standards in the preparation of
financial statements by a company and its auditors, financial reporting as a measure of
transparency and accountability – providing essential financial information about the company
to all its shareholders and other stakeholders, regular board meetings and appointment of
independent directors along with other directors for an accountable and transparent board of
directors, whistleblower policies, etc. However, there are some measures that family businesses
particularly need to lay extra focus on so that they may be successful in the long run:

• Clear Demarcation between Business and Emotions: This is essential for the smooth
continuity of the business. This responsibility that entails communicating every
member’s clear cut roles to them lies upon the shoulders of the head of the family as at
the end of the day, the business should be about competing at a global level with other
businesses and not internal clashes among members of the same company.
• Clarity on Leadership: There needs to be a clear strategy on choosing the next-of-kin
to pass the baton to after the death or incapacity of the previous leader. If there is no
such strategy in place, it could lead to confusion and chaos, causing a hit to the roots of
the business.
• Democracy: A participative decision making and democratically appointed board of
directors is key to a flourishing and disciplined business practice. More so in case of
family businesses, since they are ridden with the tendency of nepotism and favoritism.

10.4 CORPORATE GOVERNANCE IN MULTINATIONAL ENTERPRISES

(Multinationals And Corporate Governance, 2018)

What Are Multinational Enterprises?

Corporations that have production operations in various countries for many reasons including,
securing supplies of raw materials, utilizing cheap labour, taking advantage of local markets,
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saving tax differences etc. the economy has become most important issue in this globalize world
and now all the companies are welcomed and appreciated to start their operations
internationally. Multinational enterprises have a strong influence on local and world economy
and playing important role in international relations and globalizations. Multinationals are
actually the best form of organization, making the effective use of worlds resources and
transferring technology between the countries.

OECD Guidelines

The OECD guidelines are actually the recommendations undertake by governments for
multinational enterprises running in form of cleave countries. Guidelines provide willful
principle and standards for responsible business conduct in very vast field including
environment, employment, industrial relation, human rights competition taxation, science and
technology. These guidelines have been endorsed by 41 countries. Many business codes are
available now but OECD guidelines are the only complete and authentic code which is
multilaterally accepted and governments are happy to promote it. The main objective is to
elevate reasonable contribution that multinational may make in environmental, economic and
social progress.

The main trait of these guidelines are that the principles are non-binding and these are on the
will of enterprises, how effectively they are complying with their own circumstances, the aim of
these principles are not to control the enterprises, actually these principles are worldly
recognized and can promote mutually understanding and confidence between all stakeholders,
due to its non-binding nature, guidelines need support from business community, labour
representative and non-governmental organizations for its effectiveness. Guidelines are the part
of the package under OECD declaration on international investment and multinational
enterprises, a wide politically commitment by OECD member countries in 1976 to promote
direct investment in member countries. These guidelines have become a basic framework for
many enterprises and especially large enterprises that have a big share in international
investment. International trade and investment make the relationship strong between OECD
economies and acceptance of national rights for all these enterprises played a significant
contribution for the economy of host country as well. OECD guidelines are comprehensive in
their connection with multinational enterprises.

Concept and Principles

a. These guidelines are actually instructions addressed by the governments to multinational

enterprises and provide principle and standards those are not legally binding and depend
on will. For good corporate governance these principles are not binding and are
voluntary basis.
b. Multinational enterprises are now operating from different countries, the government of
the concerned country should observe and encourage the multinational enterprises to
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 adopt the guidelines according to that country’s circumstance and contribute their share
in good corporate governance.
c. In the guidelines there is not mention for a specific kind of companies every company is
include (parent companies or/ local entities) no issue of ownership is involve. Good
governance is necessary for all departments.
d. The guidelines are equal for multinational and domestic companies it is the duty of host
country to treat them equal.
e. Governments should always encourage all enterprises to follow the guidelines as a
whole but as far as the small and medium enterprises are concerned governments
suggests them to follow the guidelines according to their capacity and ensure their part
in good corporate governance.
f. Governments should not use the guidelines for protection purpose or other type of
misuse as well and promote these guidelines for better future of good corporate
governance in all companies.
g. The governments have the right under international law to make legislation for the
enterprises those are operating in their territories and solve their problems instead of
making hurdles for them.
h. Governments following the guidelines should treat enterprises equally according to
international law and should fulfill their contractual obligations and assist enterprises on
the way of good corporate governance.
i. All problems will be solved through a dispute settlement mechanism including
arbitration, if the problem arises between host country and multinational enterprises.
j. The concerned governments will establish national contact point and that will be a
forum for discussion and all relevant issue will be discussed and adhering countries will
participate in reviews and they consult and interpret the issue according to the
guidelines.

10.5 CORPORATE GOVERNANCE IN SME’s (OECD, 2018)

Many countries are facing low productivity growth, weak trade and investment, and rising or
persistently high inequality. In addition, major trends, including the new industrial revolution,
the changing nature of work and demographic changes, call for innovative policy solutions.

SMEs are key to strengthening productivity, delivering more inclusive growth and adapting to
megatrends. SMEs that grow have a considerable positive impact on employment creation,
innovation, productivity growth and competitiveness. SMEs can scale up and innovate at
different stages of their life cycle. Fostering innovation in established SMEs can enhance
aggregate productivity and narrow wage gaps.

The population of SMEs is very diverse in terms of age, size, business model and the profile
and aspirations of entrepreneurs. They vary in their characteristics and performance, including

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across sectors, regions and countries. These differences have implications for how policies are
designed and targeted.

Digital technologies enable SMEs to improve market intelligence and access distant markets
and knowledge networks at relatively low cost, and stronger participation in international
activity can boost SME growth. However, SMEs are lagging behind in the digital transition and
are disproportionately affected by trade barriers, deficient intellectual property protection, and
quality of infrastructure and institutions.

A conducive business environment, including institutional and regulatory settings, is essential to

incentivize risk-taking and experimentation by entrepreneurs, and foster business growth
potential. Despite wide-ranging reforms in many countries, the complexity of regulation, high
compliance costs and inefficient insolvency regimes remain a major obstacle to entrepreneurial
activity.

Micro firms, young, innovative and high-growth SMEs, and certain categories of entrepreneurs,
including women business owners, face persistent challenges in accessing finance in the
appropriate forms and volumes. The G20/OECD High Level Principles on SME Financing
highlight that broadening the range of financing instruments requires comprehensive approaches
to address both demand- and supply-side barriers.

Access to entrepreneurship competencies, management and workforce skills, technology,

innovation, and networks, is also critical to enable SME growth.

A cross-cutting approach to SME policy can enhance SME contributions to inclusive growth, as
can strengthen the monitoring and evaluation of policies.

Reasons why SME’s do not Implement Corporate Governance (Adonu, 2018)

SMEs are constituted of many diverse and varying businesses with growth abilities, structures,
funding and skills requirements that differ considerably. They are therefore confronted with
many challenges that inhibit them from implementing corporate governance. The weightiest of
these challenges is paucity of funds and lack of access to financial support to implement such
programs. The little amount of revenue and human resources available to SMEs makes it
difficult for them to shoulder the cost of implementing a code of corporate governance. The
absence of required skills and information access that is needed to derive the implementation of
corporate governance is also a big challenge. The managers of these businesses know little or
nothing about corporate governance and lack the required capacity to implement them in their
business. Farrar observes that “Corporate governance regimes are normally drafted with larger
listed public companies in mind and do not meet the needs of smaller companies. The cost of
compliance with such regimes far exceeds the benefit. There is need to cater expressly for the
governance needs of smaller companies.” Johnson S.T also submits that SMEs do not fancy
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corporate governance because there is lack of awareness among them regarding corporate
governance and its impact on corporate performance and that the cost of implementing
corporate governance is higher than the accruing benefits. Kloppers and Kloppers are of the
view that SMEs do not embrace corporate governance because they do not appreciate a
distinction between management and ownership in business which is the core sermon of
corporate governance. SME owners do not agree that they should employ directors or managers
as they fear that such will make them loose control of the business.

Reasons why SME’s should Implement Corporate Governance

There are many cogent reasons why SMEs should implement corporate governance. Davies and
Le Roux for instance observe that the following are rationales why SMEs should adopt
corporate governance principles in the operation of their business:

1. Implementation of good corporate governance will open way for the business to grow
and attract more investors which will provide alternative means of raising capital for
such as borrowing from banks and other financial institutions at a high cost of capital.
2. Good corporate governance will ensure the improvement of internal control systems
which results in more accountability, transparency and better profitability. Profitability
ensues because sound controls will reduce cases of fraud losses.
3. Good corporate governance implementation will bring about the separation of ownership
and management duties. This will produce a reduction in the conflicts of interest arising
from business owners retaining management positions in the company.

It can be gleaned from the many benefits of corporate governance that its implementation by
SMEs will produce a number of positive effects. It will lead to tremendous growth and business
expansion in the sector. Adoption of corporate governance will contribute substantially to
increased growth within the small and medium businesses sector of any economy. This is
because it has been firmly established that corporate governance instills confidence in investors
and serves and a positive signal to them that a company is properly managed which is lacking in
most SMEs. This will solve the problem of access to funding which SMEs perennially suffer.
Implementation of corporate governance will also enable the company to improve its human
resource capabilities which is vital to the success of any business. Implementation of corporate
governance will also solve the sustainability and succession problem that confront most small
and medium size businesses. Good succession planning and sustainability of an enterprise is
central to the success of any business. This can only be achieved with the entrenchment of good
business principles offered by corporate governance. Corporate governance will also help SMEs
to adapt to the contemporary challenges facing businesses globally and meet up with the
demands of new market opportunities.

Principles of Corporate Governance for SME’s

There is need for a code of corporate governance that is tailored to meet the needs of small and
medium sized companies. Code of corporate governance for SMEs therefore refers to a set of
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rules, norms, principles, regulations, systems, structures and practices that will serve as an
acceptable standard or benchmark to guide the application of corporate governance by Small
and Medium Enterprises. It has been effectively established without doubt that SMEs need
corporate governance. Corporate governance for SMEs is concerned with the enthronement of
rules, structures and procedures to efficiently run the company, separation of ownership and
management and apportioning of roles between the managers and the shareholders. The absence
of corporate governance within SMEs may not be felt immediately but in the long term, it will
ultimately lead to the demise of such businesses with its cumulative effect on the economy.

Although it is possible for SMEs to adopt and apply code of corporate governance for large and
public corporations, there is need for a code that takes into cognizance the specific needs of the
sector. These elements include the structure and governance systems of SMEs.

The establishment of a code of corporate governance for SMEs is not hard but its embracement
by the SMEs. The first step is therefore to arouse the awareness of stakeholders in the SME
sector about the need, benefits and implications of corporate governance for businesses in that
sector. The process of developing the code itself should be all-embracing. Inputs must be sought
and received from all the relevant stakeholders as well as representatives of the SME sector. A
broad consultation will ensure the appreciation and familiarity of stakeholders with the resulting
code. A code of corporate governance for SMEs according to Shahnawaz Mahmood, should
have the following qualities:

a. it should be based on Self-regulation i.e. voluntary to adopt rather than mandatory

b. it should Incorporate the particular needs of SMEs
c. it should be flexible so that it can be adapted to the heterogeneous sectors and sizes of
d. SMEs
e. it should not complicated and easy understand for business owners
f. it should provide incentives for complying SMEs such as providing tax rebates
g. Other regulations should be amended to avoid regulatory burden on the SMEs and
duplication.

Based on their study of corporate governance for SMEs, Indrajit Dube, et al, proposed a code of
corporate governance for SMEs. Small and medium business should be encouraged to
incorporate the following governance principles into their business operations:

1. Publication of Mission Statement of the Enterprise: this is the statement of purpose,

goals and objective of a company in the simplest way possible from the firm to the
public. The statement portrays the firms as pursuing goals that will be of interest and
benefit to stakeholders. Mission statement is important because it enable the
stakeholders to predict the future actions of the company. This is due to the fact that
most SMEs are family owned, proprietor or partnership businesses. A mission statement
will dissuade the company from taking actions on ad-hoc basis with respect to
stakeholder management and the company’s future development.

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2. Policy Statement on how to Manage Business Growth: transparency is lacking in
most SMEs due to the usual absence of separation of ownership and management. The
owner and manager of the firm should make policy statements with respect to growth of
the business vis-a-vis the capital employed, organizational structure consolidation,
productions, and business risks of the firm, human resource management and
stakeholder relations in relation to these matters annually. It should also include the
estimated growth of the company in the coming financial year at the start of the year,
time frame and how the growth will be realized. This will show that the manager or
owner runs the company with professionalism understand business risk management and
enable the financiers and other stakeholders of the company to determine the degree of
their business involvement with the firm. Such policy statement is also useful to the firm
in accessing funding from financial institutions and help in measuring the growth rate
and achievement of the company.
3. Succession Plan: SMEs usually are managed by their owners or their family members
and close associates. Thus one of the major challenges facing SMEs is absence of
succession planning. Such businesses may find it hard to survive beyond two
generations of the founder’s family. The absence of expert managers means that such
businesses lack professional outlook and may suffer from death of ideas and capacity
within the family of the owner which jeopardizes the sustainable growth and competitive
ability of the business in the market. It is on this backdrop that succession plan of the
firm probably detailing the professional of prospective candidates for different positions
in the company is a key principle that should feature in SME corporate governance code.
Without a good succession plan, there is uncertainty looming around the firm which will
discourage stakeholders from entering into long term business relationship with the firm.
4. Annual Management and Accomplishment Statements: this is a self-assessment
report by the managers of the firm in comparison to the policy statement published at the
commencement of the financial year. This will assist stakeholders in ascertain the
performance of the company and factors that impacted the growth projections.
5. Management Structure and Level of Professional Qualification relevant to
Industry: separation of ownership from management is one of the ways that
transparency and accountability is achieved in the administration of a company. SMEs
should establish a management structure that should include professionals. The current
managers should be subjected to professional training on risk management in business,
capital budgeting and management, corporate financial management etc. Government
should establish SME professional training institutes to provide hands on training for
managers of businesses in the SME sector.
6. Accounting Policies and Disclosure of Audited Account: SMEs should embrace
accounting standards to ensure better transparency and accountability in their operation.
SME managers should be trained on the use of simple but standard accounting
procedures and software that can facilitate their preparation of financial statements.
7. Stakeholder Relations and Welfare: the objectives of business entities have shifted
from solely profit maximization for the owners to wealth maximization for all the
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 stakeholders. This requires the implementations of policies that will benefit of all the
stakeholders such as creditor, employees, shareholders etc. A company that fails in this
regard will be bound to fail because modern business ventures are entangled in a whole
network of relationships between the investors, owners, and managers, creditors of the
company, customers and even the community where the company operates. The firm
must therefore service the interest of all these sets of people which is the heart beat of
corporate governance.
8. Legal and Regulatory Compliance: a company is a creation of the law; hence it must
comply with the legal requirements for its existence and operation. Regulatory
compliance is of great importance and a precursor to the observation of corporate
governance. SMEs must engage in due diligence with regard to their legal obligations.

10.6 Self-Assessment Questions

True and false Questions:

Indicate whether the following statements are true or false:

a) The Board’s primary role is to monitor management on behalf of the shareholders.

b) The Board of Directors should steer discussions properly in the meetings with regard to
the affairs of the company.
c) The Central Public Sector Enterprises (CPSEs) have to comply with the corporate
governance rules made from time to time by the Department of Public Enterprises under
the Ministry of Heavy Industries and Public Enterprises, New Delhi.
d) The CPSE Board of Directors is also entrusted with some moral imperatives.
e) In India, the Reserve Bank of India (“RBI”) is the gatekeeper of Corporate Governance.

Answers: a (T), b (T), c (T), d (T), e (T)

Long Answer Questions

Q1.Discuss Corporate Governance in banks with examples?

Q2.Explain the Corporate Governance in Multinational Enterprises?

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 LESSON 11
WHISTLEBLOWING AND CORPORATE GOVERNANCE

11 STRUCTURE

11.1. The Concept of Whistle-Blowing

11.2. Types of Whistle Blowers
11.3. Difference Between Making a Complaint and Blowing the Whistle
11.4. Difference Between Whistleblower and Informers
11.5. Whistle-Blower Policy: Structure and Execution
11.6. The Whistle-Blower Legislation across Countries
11.7. Whistleblower Legislation In India
11.8. Pros and Cons of Whistle Blowing
11.9. Employer’s Responsibilities in Regards to Whistleblowing
11.9.1. Communicate Policy and Procedure
11.9.2. Standard Whistleblowing Policy
11.9.3. Promoting a Policy and Making Sure it is easily Accessible
11.9.4. Deciding How to Deal with the Whistleblowing Disclosure
11.9.5. Dealing with Disclosures
11.9.6. Whistleblowing Code of Practice
11.10. Self-Assessment Questions

11.1 THE CONCEPT OF WHISTLE-BLOWING (Economic Times, 2018)

Definition: A whistleblower is a person, who could be an employee of a company, or a

government agency, disclosing information to the public or some higher authority about any
wrongdoing, which could be in the form of fraud, corruption, etc.
Description: A whistleblower is a person who comes forward and shares his/her knowledge on
any wrongdoing which he/she thinks is happening in the whole organization or in a specific
department. A whistleblower could be an employee, contractor, or a supplier who becomes
aware of any illegal activities.
To protect whistleblowers from losing their job or getting mistreated there are specific laws.
Most companies have a separate policy which clearly states how to report such an incident.
A whistleblower can file a lawsuit or register a complaint with higher authorities who will
trigger a criminal investigation against the company or any individual department.
There are two types of whistleblowers: internal and external. Internal whistleblowers are those
who report the misconduct, fraud, or indiscipline to senior officers of the organization such as
Head Human Resource or CEO.
External whistleblowing is a term used when whistleblowers report the wrongdoings to people
outside the organization such as the media, higher government officials, or police.

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The crime or wrongdoing could be in the form of fraud, deceiving employees, corruptions, or
any other act which misleads people. The Whistle Blowers Protection Act, 2011 lays down the
complete framework to investigate alleged cases of wrongdoing.
There is one name which pops up in history whenever we talk about 'whistleblowers' and that is
Edward Joseph Snowden. He was a former CIA employee who leaked classified and restricted
information to the public from the United States National Security Agency in 2013.

11.2 TYPES OF WHISTLE BLOWERS (Study.com, 2018)

There are two types of whistle blowing. The first is internal whistle blowing. This means that
the whistleblower reports misconduct to another person within the organization. The second
type is external whistle blowing. This means that the whistleblower reports misconduct to a
person outside the organization, such as law enforcement or the media.

Federal Whistleblowers: Whistleblowers can also be designated by the type of

whistleblowing. Let's first take a look at federal whistleblowers. These are government
employees who reveal misconduct committed by their employers or can also be private-sector
employees who inform about the misconduct of their employers that is committed in relation to
the federal government. For people who work for the federal government, the Whistleblower
Protection Act, or WPA, protects disclosures of misconduct. This law protects federal
employees who disclose illegal or improper government activities.

The WPA shields federal employees from retaliatory action once the employee voluntarily
discloses information regarding dishonest or illegal activities within a government organization.
The government can't take action against, or threaten to take action against, the employee.
Generally, this means the government can't fire, demote, suspend, threaten, harass, or
discriminate against a whistleblower.

The WPA was enacted in 1989 and most recently updated through the Whistleblower Protection
Enhancement Act of 2012. But, federal whistleblowers were around long before that. In 1966, a
27-year old epidemiologist working for the U.S. Public Health Service discovered the Tuskegee
Syphilis Experiment while conducting routine interviews on patients.

Peter Buxtun uncovered information revealing that the federal government purposely denied
medical treatment to black men, mostly sharecroppers, suffering from syphilis. Despite the
invention of penicillin in the 1940s and widespread education on prevention in the 1960s, these
men were allowed to suffer, infect their wives and children, and die so that the federal
government could conduct autopsies for medical research. Almost 400 men unwittingly
participated in the experiments between 1932 and 1972.

Buxtun filed formal ethical complaints with the government two times before finally turning to
the media four years later. After the public found out, the medical experiments were ended and
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medical research saw major overhauls. According to President Bill Clinton years later, 'the
United States government did something that was wrong - deeply, profoundly, morally wrong.
It was an outrage to our commitment to integrity and equality for all our citizens... clearly
racist.'

Corporate Whistleblowers: Public policy encourages the reporting of misconduct by private

businesses as well. The Enron scandal came to light in 2001 and almost immediately affected
thousands of people. Many more would have been affected, and more loss incurred, if not for
the efforts of a corporate whistleblower. These whistleblowers are employees of corporations or
other private businesses that disclose statutory or regulatory violations by the employer.
The Enron whistleblower was Sherron Watkins. She was an Enron executive when she
discovered accounting irregularities showing that the company had purposely inflated the value
of its stock. Enron was the seventh largest company in the nation at the time. As a result of the
deceit, thousands of people lost jobs, pensions, retirement funds and other investments. Many of
these people, like those holding investment portfolios through the University of California,
weren't associated with Enron at all.

Corporate whistleblowers are protected by the Corporate and Criminal Fraud Accountability
Act. This act is a subset of the Sarbanes-Oxley Act, which was enacted in 2002 as a direct
answer to the issues raised by Enron and other corporate fraud scandals. These laws hope to
encourage whistleblowing by protecting employees who disclose certain securities-related
violations by making retaliation a federal crime.
As our world and workplaces evolve, so do our security needs. In recent years, a new type of
whistleblower, the cyber whistleblower, has arisen as an advocate for consumer and employee
protection in online spheres. These whistleblowers report on security breaches in cloud storage
systems, encryption deficiencies, hacks, and unsecure practices. (Sattiraju, 2018)

11.3 DIFFERENCE BETWEEN MAKING A COMPLAINT AND BLOWING THE

WHISTLE (East Devon Corporate Council, 2016)

When someone blows the whistle they are raising a concern about danger or illegality that
affects others (for example customers, members of the public, or their employer). The person
blowing the whistle is usually not directly, personally affected by the danger or illegality.
Consequently, the whistleblower rarely has a personal interest in the outcome of any
investigation into their concern – they are simply trying to alert others. For this reason, the
whistleblower should not be expected to prove the malpractice. He or she is a messenger
raising a concern so that others can address it.
This is very different from a complaint or grievance. When someone complains or raises a
grievance, they are saying that they have been personally treated poorly. This poor treatment
could involve a breach of their individual employment rights or bullying and the complainant is
seeking redress or justice for themselves. The person making the complaint therefore has a
vested interest in the outcome of the complaint and for this reason, is expected to prove their
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case. For these reasons, it is not in anyone’s interest if an individual uses this policy to pursue a
personal grievance. For personal complaints or grievances, please use the Grievance Policy and
Procedure instead.

11.4 DIFFERENCE BETWEEN WHISTLEBLOWER AND INFORMERS (Aarora, 2011)

Often the term Whistleblower is confused with the term Informer who have generally a bad
reputation. The most important distinction between the two terms is the liability of the person
disclosing the information. Informants are often themselves involved in some sort of unethical
enterprise and are using the disclosure of information as a means to reduce their liability, either
voluntarily, or due to coercion. They are in a subordinate place to the body or person they are
disclosing to and must follow their orders or face sanctions. In comparison, whistleblowing
laws do not affect the liability of those that are involved in criminal enterprises. Another
difference is that the informants often seek favors or remuneration for their disclosures but the
same is not true in case of whistleblowers. However, a few types of anti-corruption laws do
allow for rewards to be given to those that disclose, typically a part of the money recovered in
corruption cases.

11.5 WHISTLE-BLOWER POLICY: STRUCTURE AND EXECUTION

The Companies Act, 2013 and whistleblowing policy (Pandey A. , 2017)

With the coming of the Companies Act 2013, the pressure has been towards fraud elimination
and to put an effective corporate vigilance mechanism. The Companies Act 2013 has been
developed to eliminate various corporate scandals, loophole by prescribing more strict
compliance and norms than which were there earlier. The Sections 206-229 of the Companies
Act 2013 has incorporated detailed provision, which is relating to the inspection, investigation
and injury. Under Section 208 of the Act there will be appointment of an Inspector who is
different from the Registrar to inspect records, which are unlike to the provisions of the old act
of 1956. The Inspector has the power to recommend and conduct investigation in matters as
required. Under Section 10 the Central Government may order any investigation in the affairs of
the company either on the report of the Inspector or Registrar of the company or by special
resolution, which is passed in which the matters of the company needs to be investigated if
mentioned and for public interest. The SFIO, which stands for Serious Fraud Investigation
Office, is now a statutory body that has the power to arrest for offences, which are specified as
frauds, and this is mentioned under 211 of the Act. There is also responsibility on auditors at to
act as whistleblowers and they have to report directly to the Central Government if they have
any reason to believe that there is any fraud being committed against the company by any of its
officers or any employees. Under the schedule iv of Section 149(8) of the Companies Act 2013
sates about professional conduct and behavior of independent director, it is much more
elaborated in part iii of the schedule iv and also ensures that the company has adequate and

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functioning vigilance mechanism and the interest of the people using it are not harmed. The
independent directors are also given the task for reporting any concern over any wrong or
suspected fraud or an unethical behavior for the violation of any code or policy of the company.
Actions will be taken for such violation.

SEBI and the Whistling blowing policy

SEBI stand for The Securities Exchange Board of India on circular dated 2003 amended its
principles on corporate governance, which is given in the standard listing agreement. The
annexure I D or clause 49 of the Listing Agreement states that the company will have
mechanism for employees to report to the management about any concerns or unethical
behavior; any suspected fraud or any kind of violence against company code of conduct or any
ethical policies. This mechanism will protect against the victimization of employees who will
avail this mechanism will also be provided direct access for the Chairman of the Audit
committee in any exceptional case. The existence of such mechanism will be communicated
within the company. Though it’s not mandatory for companies to have whistled blowing
policies, but beside that the company will have mandatory requirement to disclose all its report
on corporate governance to the extent of the non-mandatory practices. Many companies in India
now have started to adopt the practice of taking in and putting into effect whistle-blower policy
which is quite an encouraging stand but this policy is either used to uphold the corporate
governance standards of the company or for the fear of being regarded as the late entries among
the well governed companies group.

The Whistleblower Protection Bill of 2011

This bill is another piece of legislation, which was passed by Rajya Sabha in 2014 and got the
permission from the President in May 2014, but unfortunately it has not come into force yet.
This Bill will aim to protect ones officials from any wrong harassments with protecting persons
making public interest a sort of disclosure. Under Section 4 of sub-section 6 the Act stops or
puts a bar on the competent authority from enquiring any complaint which may be anonymous
and has made it compulsory for all the complains to make the disclosure and reveal their true
identity. The Hon’ble Supreme Court of India made an interference in this regard passing an
order which is dated 20th November 2014 and legitimized the practice of anonymous
whistleblowing which can turn out to be a great help and gift for anonymous whistleblowers in
India.

Advantages of Whistleblowing Policy

Whistleblowing policy can be extremely beneficial for any organization; there employees,
shareholders, society and the general public will be benefitted at large. The violation and
misconduct and any sort of malpractices, which would be harmful for the stakeholders and
those who will be guilty, will be duly punished. Whistleblowing policy will help removing
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many ambiguities also educates and make the employees aware about different wrong doing
which might take place in the organization. The underline spirit of the policy helps in
identifying risks and fights those risks with efficient mechanism. The Berger Paints in India has
adopted this whistleblowing policy. It only helps in registering any direct complaints regarding
the violation of the company’s code of conduct and also specifies its results and also reports if
there is any violation of the policy.

The Challenges Faced By This Policy

Corruption in India

India is a place where there is a democratic system of Government but the dark and dense
network of bureaucracy stops genuine victims from reaching the point of justice. People who try
to raise their voice against the maligned systems end up being tortured and harassed by the apex
of the system. One example of such incident was the murder of Satyendra Dubey in 2003 that
was an engineer and was charged for taking on corruption in a highway project and bowed the
whistle and became one of the major examples in the fate of whistleblowers in India. Another
example of the lack of protection of whistleblowers was the case of Manjunath Shanmugam
who was a employee of the Indian Oil Corporation Ltd and was brutally murdered for clamping
down the oil adulteration racket in the state of Uttar Pradesh.

Problems due to the gap in the present legislation

It is very sad that despite of having specific legislation for public disclosures known as The
Whistleblower Protection Bill, 2011 the Central Government could not yet bring it to force.
Another Bill, which is pending before, the Parliamentary Standing Committee, which is about
correcting a ‘patent error’ in the Whistleblowers Act, is also left to be done. The court cannot
also compel or force the Government to bring such act into force and so the Executive can annul
such Act by inaction. This Bill basically defines the term ‘disclosure’ as any complaint, which
has any relation to any criminal offence or corruption or any willful misuse of power, which
leads to the loss of Government or any kind of game to the public servant. Another reason for
the lagging behind of the legislation is that there is no penalty against any public servant who
may be victimizing the complaint, and it also does not protect witnesses during investigation
and any trial despite their guidelines laid by the Law Commission for such identity protections.

Lacking Holistic Power of the Legislation

Both the SEBI and the Companies Act 2013 establishes an efficient mechanism for
whistleblowing in the growing corporate scams and scandals which cannot be overlooked
Companies Act provides for vigilance, trough the clause 49 of SEBI of the Listing Agreement
mentions it as a non-mandatory requisite for provision of whistleblower mechanism. Till time
there has been no proper set of rules provided by legislation specifying what the whistleblowing
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policy should contain and there is still ambiguity in it. The absence of holistic law clarifies all
the vagueness with the establishment of whistleblower mechanism, which is a major way of
achieving efficient corporate governance.

11.6 THE WHISTLE-BLOWER LEGISLATION ACROSS COUNTRIES (Aarora, 2011)

Many countries have devised and adopted a variety of laws and procedures for protecting and
encouraging whistleblowing as discussed below:

The United States

The US has dozens of whistleblower laws at the state and federal level, as well as separate
clauses in legislation designed to achieve other health, safety or welfare objectives. The three
principal acts, however, are the Whistleblower Protection Act 1989, the Corporate and Criminal
Accountability Act (Sarbanes-Oxley Act), and the False Claims Act.

(A) The Whistleblower Protection Act 1989

Initiated with the whistleblower protection provisions in the Civil Service Reform Act of 1978,
this Act was revised in 1989, and again in 1994. Initially, for most forms of retaliation, federal
workers were to be supported by the Office of the Special Counsel (OSC), but this agency
proved to be ineffective. Until passage of the Whistleblower Protection Act in 1989, OSC
conducted only one hearing to restore a whistleblower’s job. Also created was a Merit Systems
Protection Board, of which the OSC was part, designed to protect against retaliatory
discrimination in promotion, but it was no more effective than the OSC. They were considered,
however, largely symbolic. Thomas M. Devine, legal director of the not-for-profit Government
Accountability Project (GAP) asserts:

‘Whistleblower protection is a policy that all government leaders support in public but few in
power will tolerate in private.’

Public sector employees are required to disclose wrongdoing to their employer first. This is a
weakness if the whistleblower believes that he or she will not get a fair hearing from the
employer. They cannot go around an employer that they know will not be receptive to their
complaints. It also has no confidentiality clauses. Its major weakness, is that the principal
initiative lies with the whistleblower. Essentially, the whistleblower must sue whoever makes
the threats or carries out the intimidation.

(B) The Sarbanes-Oxley Act

The Sarbanes-Oxley Act was passed in 2002 to combat corporate criminal fraud and to
strengthen corporate accountability. It was a legislative response to the fraudulent activities
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exemplified by World Com and Enron Corporation. The Act provides for enhanced financial
disclosures and auditor independence of publicly held corporations. Section 301 of the Act
requires that audit committees of the boards of public corporations establish procedures for ‘the
confidential, anonymous submission by employees’ of complaints regarding internal accounting
controls or auditing matters.

The Act provides some protections and assistance for the whistleblower. Employees are not
required to complain to their employers first, but may complain to a Federal regulatory or law
enforcement agency; any Member of Congress or any committee of Congress; or a person with
supervisory authority over the employee. It does entertain the right of the whistleblower to take
legal action if they suffer retaliation. Those found guilty of retaliation are liable to up to ten
years in prison. The Sarbanes-Oxley Act is new, however, and it is possibly too soon to make
any judgments. Its impact, however, is primarily limited to financial matters.

(C) The False Claims Act

Designed to stop fraud against the government, this act was passed during the US civil war
under the administration of Abraham Lincoln. Regarded as the single most successful
whistleblowing legislation in the country, the False Claims Act works by providing the
whistleblower between 15 and 30 per cent of the government’s total recovery, the percentage
depending on the extent to which the whistleblower took the action that enabled the recovery to
take place. It was amended in 1986 to establish protections for whistleblowers, and to prevent
harassing and retaliation against them. The Bill, which permits an anonymous disclosure, has
been copied by a number of states in the US.

The United Kingdom

In UK legislation to protect whistleblowers was enacted in the wake of well-publicized scandals

and disasters that occurred in 1980s and early 1990s. These included the collapse of Bank of
Credit and Commerce International (BCCI), the drowning of four children at Lyme Bay, and the
Clapham Rail crash.

The Public Interest Disclosure Act of 1998

The Public Interest Disclosure Act (PIDA) became effective on July 2, 1999, in England, Wales
and Scotland, as an amendment to the Employment Rights Act of 1996. PIDA covers both
private and public employees (except police officers), and provides that “a worker has the right
not to be subjected to any detriment by any act, or any deliberate failure to act, done on the
ground that the worker has made a protected disclosure.” Under the PIDA, whistleblowers must
use prescribed channels for making disclosures in order to retain the Act’s protection. The
disclosure can be made to the employer itself or an appropriate authority, and forbids the
disclosure to media. As is clearly apparent, the UK’s scheme is materially different from that of
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the United States, which does not require employees to use any particular channel to raise their
concerns.

Canada

Canada has very few laws which pertain directly to whistleblowing. The federal government
enacted the Public Servants Disclosure Protection Act in 2007. The intent of this act is to
protect most of the federal public service from reprisals for reporting wrongdoing. However,
this Act has been extensively criticized as setting too many conditions on whistleblowers and
for protecting wrongdoers.

Several provinces also have legislation which protects whistleblowers to an extent:

• Section 28 of the New Brunswick Employment Standards Act, Chap. E-7.2, provides
specific protection for those reporting wrongdoing.

• In Ontario, the Environmental Protection Act, R.S.O. 1990, c. E.19 and the Environmental
Bill of Rights, S.O. 1993, c. 28 provide protection.

• Saskatchewan’s Labour Standards Act provides protection, although the reporting must
have been done to a lawful authority.

A number of other acts provide narrow protections to individuals reporting wrongdoing under
those acts.

11.7 WHISTLEBLOWER LEGISLATION IN INDIA (Aarora, 2011)

The need of Whistleblower legislation in India need not be emphasized. The need was felt in
view of the glaring cases of corruption to draft a suitable legislation for encouraging and
protecting honest persons to expose corrupt practices on the part of public functionaries. The
Law Commission in its 179th Report had recommended that in order to eliminate corruption, a
law to protect whistleblowers was essential. The commission in its report referred to the evil of
corruption among public servants and maladministration and the adverse effects thereof to the
country, then to the options available for eradication of corruption, the right to freedom of
expression and the right to know and the limitations of the right to privacy, then to the
protection afforded to whistle blowers in various countries by the judiciary and in particular by
the English Courts, the European Court and by the American Courts. The commission in the
said report discussed the salient features of various laws protecting whistleblowers in UK,
Australia, New Zealand and USA and finally recommended a draft bill for protection of
whistleblower which was appended to the said report. In 2004, in response to a petition filed
after the murder of Satyendra Dubey, the Supreme Court directed that a machinery be put in
place for acting on complaints from whistleblowers till a law is enacted. The government
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notified a resolution in 20044 that gave the Central Vigilance Commission (CVC) the power to
act on complaints from whistleblowers.

Based on the 179th report of the Law Commission the legislature first drafted “The Public
Interest Disclosure and Protection to Persons Making the Disclosures Bill, 2010”, then the
Protection of whistle blowers and the Public Interest Disclosure and Protection of Persons
Making Disclosure Bill, 2010 (Whistleblower bill) and finally, the Anti-Corruption, Grievance
Redressal and Whistleblower Protection Bill, 2011.

Freedom of Speech, Right to Know and Right to Privacy

Before discussing the aforesaid bills for whistleblowing enabling public servants to provide
information about corruption or mal-administration in their department, it is necessary to refer
to the Constitutional provisions relating to Freedom of Speech, Right to Know and the Right to
Privacy as the whistleblowing one way or the other touches these freedoms guaranteed by the
constitution.

Freedom of speech and expression is guaranteed by sub clause (a) of Article 19(1) of the
Constitution of India. This right is, however, subject to Article 19(2) which permits law to be
made for the purpose of imposing reasonable restrictions in the interests of the sovereignty and
integrity of India, the security of State, friendly relations with foreign States, public order,
decency or morality or in relation to contempt of court, defamation or incitement to an offence.

Our Supreme Court had occasion to deal with the exposure of the conduct of government
through the media or otherwise. In one of the earliest cases in S. Rangarajan vs. P. Jagjivan
Ram, 1989 (2) SCC 574, the Supreme Court held that criticism of government policies was not
prohibited though there should be a proper balance between freedom of expression and social
interests. But courts cannot simply balance the two interests as if they are of equal weight. The
court’s commitment to freedom of expression demands that it cannot be suppressed unless the
situations created by allowing the freedom are pressing and the community interest will be
endangered. The anticipated damage should not be remote, or conjectural or farfetched. It
should have proximate and have a direct nexus with the expression.

The legal foundation for exposure of corruption , misconduct or mal-administration by public

servant was laid down by the Supreme Court in R. Rajagopal vs. State of Tamil Nadu, (1994) 6
SCC 632. The case involved the publication of serious misconduct of public servants by a
convict who was serial-killer. The case squarely deals with the right to know and the limits of
privacy of public servants. The Supreme Court referred to the judgments of the American Court
in New York Times vs. Sullivan, already referred to and another judgment of the House of
Lords in England reported in Derbyshire vs. Times Newspaper Ltd., 1993(2) WLR 449. The
Supreme Court held that while decency and defamation were two of the grounds referred to in
Clause (2) of Art. 19, still any publication against any person will not be objectionable if such
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publication was based on ‘public record’. In addition, in the case of ‘public official’, the right to
privacy or for that matter, the remedy of action for damages is simply not available with respect
to their acts and conduct relevant to the discharge of their official duties. This is so even where
the publication is based upon facts and statements which are not true, unless the public official
establishes that the publication was made with reckless disregard for truth. In such a case, it
would, however, be enough for the person who published the news to prove that he reacted after
a reasonable verification of the facts. It is not necessary for him to prove that what he has
published is true. Of course, where the publication is proved to be false and actuated by malice
or personal animosity, damages can be awarded. In a very recent case of Sri Bhardwaj Media
Pvt. Ltd. V. State, it was held by the court that when corruption of individuals in the institution
is exposed, it gives an opportunity to authorities to take action against those who indulge in
corruption and to clean its stables. Instead of expressing gratefulness to the persons who
exposes corruption, if the institutions start taking action against those who expose corruption,
the corruption is bound to progress day and night. India is already placed very high in the index
of corruption and is considered one of the most corrupt countries of the world.

Recently, the Supreme Court has draw the genesis of the citizens ‘right to know’ from their
right to freedom of speech and expression. The Court observed in Dinesh Trivedi vs. Union of
India, 1997 (4) SCC 306 that in modern constitutional democracies, it is axiomatic that citizens
have a right to know about the affairs of the government which, having been elected by them,
seeks to formulate sound policies of governance aimed at their welfare. To ensure that the
continued participation of the people in the democratic process, they must be kept informed of
the vital decisions taken by the government and the basis thereof. The Court was dealing with
the Vohra Committee Report and stated that though it was not advisable to make public the
basis on which certain conclusions were arrived at in that Report, the conclusion reached in that
Report should be examined by a new body or institution or a special committee to be appointed
by the President of India on the advice of the Prime Minister and after consideration with the
Speaker of the Lok Sabha.

In the light of the above judgment of the American and English Courts and our Supreme Court,
on the question as to the scope of ‘free speech’, the Commission is of the view that a statute
enabling complaints to be made by public servants, or persons or NGOs against other public
servants and the grant of protection to such complainants is perfectly valid and will not offend
the right to privacy emanating from sub-clause (a) of clause (1) of Art. 19. The right to privacy
has to be adequately balanced against the right to know. Both these rights emanate from same
sub-clause in Article 19.

The Indian Whistleblowing Legislation and its Origin

In the past, the various committee’s & commissions have submitted their report recommending
the setting up of mechanism or bill to encourage whistle blowing as a tool or eradicating
corruption. The earlier efforts in this regards can be traced to:-
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• The Santhanam Committee Report, 1963
• The Administrative Reforms Commission Report 1967
• Vohra committee Report
• 129th Law Commission Report
•
The Legislature as stated has drafted three legislations for the protection of whistleblower but
finally the Anti-Corruption, Grievance Redressal and Whistleblower Protection Bill, 2011,
popularly known as Lok Janpal bill is introduced in Rajya Sabha as on 5th August, 2011.
Section 2 (n) in the Definition Clause of the Bills defines “Whistleblower”.

“whistleblower” means any person who faces threat of (i) professional harm, including but not
limited to illegitimate transfers, denial of promotions, denial of appropriate perks, departmental
proceedings, discrimination or (ii) physical harm or is actually subjected to such harm; because
of either making a complaint to the Lokpal under this Act or for filing an application under
Right to Information Act, 2005.”

Thus, the definition assumes that the whistleblower may face threat of professional harm or
physical harm. Further, the protection is available under the act only if the complaint is made to
the Lokpal under the proposed Act or if one files an application under the RTI Act, 2005. Thus,
the draft bill do not makes any provision for the protection of the whistleblower if the disclosure
is outside the purview of the proposed act or not under the RTI Act, 2005. Thus, if the
disclosure about the corruption is made to the media and there is an imminent threat to the life
of the whistleblower, then the protection under the draft bill cannot be claimed by the
whistleblower. (See Section 2 (n) read with Section 20 of the Draft Bill.

The Act provides for the protection from threat of physical or professional victimization. The
protection can be sought from the Lokpal (See Section 20 of the proposed bill) who will take
immediate steps for the protection of the victim whistleblower as mentioned in the section 20 of
the said draft bill. The said Section also provides that if requested, the identity of the
complainant shall be kept secret.

11.8 PROS AND CONS OF WHISTLE BLOWING (Lombardo, 2015)

PROS

1. There is often financial compensation: When something illegal is happening around

you, there’s a good chance that it is costing someone money somewhere. Many
whistleblower laws allow for those who stand up and say that something is wrong to be
compensated with a specific percentage of the money that is recovered. That can
sometimes be worth millions of dollars.
2. There are legal protections in place: Many people worry about retribution and
retaliation when they become a whistleblower. There are programs in place that help to
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 protect whistleblowers to prevent retaliation and civil laws allow whistleblowers to file
suit against those who try to seek revenge.
3. It is an ethically correct decision to make: It’s been said that there is a right way to do
things and there is an easy way to do things. Whistleblowing is the right way and there is
always personal satisfaction experienced when an ethically correct decision is made.

CONS

1. Not everyone sees whistleblowing as a positive decision: In the business world, the
term “whistleblower” is synonymous with the term “snitch.” As an employee, many
executives expect you to stay in line with company expectations. If you tell the world
that your employer is doing something wrong, it may be difficult to find future
employment.
2. People dig into your personal life: Every attempt will be made to discredit you as a
source when you decide to become a whistleblower. Your life will be looked at in
infinite detail. All of your relationships and choices will be examined with a magnifying
glass. Anything you would want to keep hidden is going to come to light.
3. There are personal risks: There may be programs and laws that forbid retaliation, but
that doesn’t mean it won’t happen. Many people will go to great lengths to protect
themselves from whistleblowers. That can place you at risk.

The pros and cons of whistleblowing involve anticipating a negative response while taking an
ethically correct decision. Not reporting something when it has been observed could be seen as
complicity. It is not a position that is wished upon anyone, but by weighing each key point,
you’ll be able to make the right choice.

11.9 EMPLOYER’S RESPONSIBILITIES IN REGARDS TO WHISTLEBLOWING

(Department for Business, Innovation and Skills, 2015)

As an employer it is good practice to create an open, transparent and safe working environment
where workers feel able to speak up. Although the law does not require employers to have a
whistleblowing policy in place, the existence of a whistleblowing policy shows an employer’s
commitment to listen to the concerns of workers. By having clear policies and procedures for
dealing with whistleblowing, an organization demonstrates that it welcomes information being
brought to the attention of management. This is also demonstrated by the following:

1. Recognizing workers are valuable ears and eyes: Workers are often the first people to
witness any type of wrongdoing within an organization. The information that workers may
uncover could prevent wrongdoing, which may damage an organization’s reputation and/or
performance, and could even save people from harm or death.
2. Getting the right culture: If an organization hasn’t created an open and supportive culture,
the worker may not feel comfortable making a disclosure, for fear of the consequences. The
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 two main barriers whistleblowers face are a fear of reprisal as a result of making a
disclosure and that no action will be taken if they do make the decision to ‘blow the
whistle’. There have been a number of high profile cases, including evidence collated by the
Mid-Staffordshire NHS Foundation Trust Public Inquiry, the Freedom to Speak up
Independent Review into creating an open and honest culture in the NHS; and the
Parliamentary Commission on Banking Standards that confirm many workers are scared of
speaking up about poor practice. Making sure your staff can approach management with
important concerns is the most important step in creating an open culture. Employers should
demonstrate, through visible leadership at all levels of the organization, that they welcome
and encourage workers to make disclosures.
3. Training and support: An organization should implement training, mentoring, advice and
other support systems to ensure workers can easily approach a range of people in the
organization.
4. Being able to respond: It is in the organization’s best interests to deal with a
whistleblowing disclosure when it is first raised by a worker. This allows the organization to
investigate promptly, ask further questions of a worker and where applicable provide
feedback. A policy should help explain the benefits of making a disclosure.
5. Better control: Organizations that embrace whistleblowing as an important source of
information find that managers have better information to make decisions and control risk.
Whistleblowers respond more positively when they feel that they are listened to. Resolving
the wrongdoing quickly: There are benefits for the organization if a worker can make a
disclosure internally rather than going to a third party. This way there is an opportunity to
act promptly on the information and put right whatever wrongdoing is found.

11.9.1 Communicate Policy and Procedure

Having a policy is a good first step to encourage workers to blow the whistle but each
organization needs to let its workers know about the policy and make sure they know how to
make a disclosure. Some organizations choose to publicize their policy via their intranet or
through a staff newsletter. If an organization recognizes a trade union it might develop a policy
in consultation with them. It is a good idea for organizations to share the information with all
staff regularly to make sure they are all reminded of the policy and procedures and to inform
any newcomers. Providing training at all levels of an organization on the effective
implementation of whistleblowing arrangements will help to develop a supportive and open
culture.

How? When someone blows the whistle an organization should explain its procedures for
making a disclosure and whether the whistleblower can expect to receive any feedback. Often a
whistleblower expects to influence the action the organization might take, or expects to make a
judgment on whether an issue has been resolved – such expectations need to be managed.

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Has the issue been resolved? It is for the organization to be satisfied that the disclosure has
been acted upon appropriately and that the issue has been resolved. There should be clear and
prompt communications between the whistleblower and the organization. It is best practice for
organizations to provide feedback to whistleblowers, within the confines of their internal
policies and procedures. Feedback is vital so that whistleblowers understand how their
disclosure has been handled and dealt with. If a whistleblower is unhappy with the process or
the outcome it will make them more likely to approach other individuals and organizations to
‘blow the whistle’, such as a “prescribed person”

11.9.2 Standard Whistleblowing Policy

There is no one-size-fits-all whistleblowing policy as policies will vary depending on the size
and nature of the organization. Some organizations may choose to have a standalone policy
whereas others may look to implement their policy into a code of ethics or may have ‘local’
whistleblowing procedures relevant to their specific business units. A large organization may
have a policy where employees can contact their immediate manager or a specific team of
individuals who are trained to handle whistleblowing disclosures. Smaller organizations may
not have sufficient resources to do this. Any whistleblowing policies or procedures should be
clear, simple and easily understood. Here are some tips about what a policy should include:

• An explanation of what whistleblowing is, particularly in relation to the organization

• A clear explanation of the organization’s procedures for handling whistleblowing, which
can be communicated through training
• A commitment to training workers at all levels of the organization in relation to
whistleblowing law and the organization’s policy
• A commitment to treat all disclosures consistently and fairly
• A commitment to take all reasonable steps to maintain the confidentiality of the
whistleblower where it is requested (unless required by law to break that confidentiality)
• Clarification that any so-called ‘gagging clauses’ in settlement agreements do not prevent
workers from making disclosures in the public interest
• An idea about what feedback a whistleblower might receive
• An explanation that anonymous whistleblowers will not ordinarily be able to receive
• feedback and that any action taken to look into a disclosure could be limited – anonymous
whistleblowers may seek feedback through a telephone appointment or by using an
anonymised email address
• A commitment to emphasize in a whistleblowing policy that victimization of a
whistleblower is not acceptable. Any instances of victimization will be taken seriously and
managed appropriately
• An idea of the time frame for handling any disclosures raised
• An idea of the time frame for handling any disclosures raised
• Clarification that the whistleblower does not need to provide evidence for the employer to
look into the concerns raised
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• Signpost to information and advice to those thinking of blowing the whistle, for example the
guidance from the Government, Acas, Public Concern at Work or Trade Unions
• Information about blowing the whistle to the relevant prescribed person(s)

11.9.3 Promoting a Policy and Making Sure it is easily Accessible

It’s no good having a policy in place if no one knows about it. Actively promoting a policy
shows the organization is genuinely open to hearing concerns from its staff. Managers and
leaders in the organization can also promote a policy in the way they behave at work. Conduct
and written policies will help to create an open culture, which will increase the likelihood of a
worker speaking up about any wrongdoing they come across. Written policies are not enough.
Training should be provided to all staff on the key arrangements of the policy. Additional
training should be provided to those with whistleblowing responsibilities, such as managers or
designated contacts, so they are able to provide guidance confidently to workers. Managers
should also lead by example and ensure they are committed to creating an open culture where
disclosures are welcome. It is also a good idea to include handling whistleblowing disclosures
as part of discipline and grievance training for managers and staff. Training should be offered at
regular points to make sure it stays fresh in managers’ minds and to capture any newcomers to
the organization.

Here are some ideas about how to promote a policy:

• Hold a staff session or in larger organizations require managers to hold smaller, consistent
team meetings
• Make the policy accessible on the staff intranet
• Appoint a whistleblowers’ champion to drive the commitment to valuing whistleblowing
and protecting whistleblowers within the organization
• Use promotional posters around the building
• Include the policy within induction packs for newcomers
• Set the policy out in staff handbooks and contracts

11.9.4 Deciding How to Deal with the Whistleblowing Disclosure

Where a worker feels able to do so they may make a disclosure to their immediate manager who
will be able to decide whether they can take forward the disclosure or whether it will require
escalation. An organization will need to equip managers with the knowledge and confidence to
make these judgments. A whistleblowing policy and training can help with this.

Larger organizations may have a designated team who can be approached when workers make a
disclosure. Although this may not be possible for smaller organizations, it is considered best
practice that there is at least one senior member of staff as a point of contact for individuals who
wish to blow the whistle. This is particularly helpful in cases where the immediate line
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management relationship is damaged or where the disclosure involves the manager.
Alternatively, there are commercial providers who will manage a whistleblowing process on the
employer’s behalf.

11.9.5 Dealing with Disclosures

Once a disclosure has been made it is good practice to hold a meeting with the whistleblower to
gather all the information needed to understand the situation. In some cases a suitable
conclusion may be reached through an initial conversation with a manager. In more serious
cases there may be a need for a formal investigation. It is for the organization to decide what the
most appropriate action to take is. It is important to note that if an investigation concludes that
the disclosure was untrue it does not automatically mean that it was raised maliciously by a
worker. When dealing with disclosures, it is good practice for managers to:

• Have a facility for anonymous reporting

• Treat all disclosures made seriously and consistently
• Provide support to the worker during what can be a difficult or anxious time with access to
mentoring, advice and counseling
• Reassure the whistleblower that their disclosure will not affect their position at work
• Document whether the whistleblower has requested confidentiality
• Manage the expectations of the whistleblower in terms of what action and/or feedback they
can expect as well clear timescales for providing updates
• Produce a summary of the meeting for record keeping purposes and provide a copy to the
whistleblower
• Allow the worker to be accompanied by a trade union representative or colleague at
• any meeting about the disclosure, if they wish to do so
• Provide support services after a disclosure has been made such as mediation and dispute
resolution, to help rebuild trust and relationships in the workplace

It will be useful to document any decisions or action taken following the making of a disclosure
by a worker. It is also good practice for organizations to:

• Record the number of whistleblowing disclosures they receive and their nature
• Maintain records of the date and content of feedback provided to whistleblowers
• Conduct regular surveys to ascertain the satisfaction of whistleblowers.

11.9.6 Whistleblowing Code of Practice

It is important that employers encourage whistleblowing as a way to report wrongdoing and

manage risks to the organization. Employers also need to be well equipped for handling any
such concerns raised by workers. It is considered best practice for an employer to:

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• Have a whistleblowing policy or appropriate written procedures in place
• Ensure the whistleblowing policy or procedures are easily accessible to all workers
• Raise awareness of the policy or procedures through all available means such as staff
engagement, intranet sites, and other marketing communications
• Provide training to all workers on how disclosures should be raised and how they will be
acted upon
• Provide training to managers on how to deal with disclosures
• Create an understanding that all staff at all levels of the organization should demonstrate
that they support and encourage whistleblowing
• Confirm that any clauses in settlement agreements do not prevent workers from making
disclosures in the public interest
• Ensure the organization’s whistleblowing policy or procedures clearly identify who can be
approached by workers that want to raise a disclosure. Organizations should ensure a range
of alternative persons who a whistleblower can approach in the event a worker feels unable
to approach their manager. If your organization works with a recognized union, a
representative from that union could be an appropriate contact for a worker to approach
• Create an organizational culture where workers feel safe to raise a disclosure in the
knowledge that they will not face any detriment from the organization as a result of
speaking up.
• Undertake that any detriment towards an individual who raises a disclosure is not acceptable
• Make a commitment that all disclosures raised will be dealt with appropriately, consistently,
fairly and professionally
• Undertake to protect the identity of the worker raising a disclosure, unless required by law
to reveal it and to offer support throughout with access to mentoring, advice and counseling
• Provide feedback to the worker who raised the disclosure where possible and appropriate
subject to other legal requirements. Feedback should include an indication of timings for
any actions or next steps

11.10 SELF-ASSESSMENT QUESTIONS

True and false Questions:

Indicate whether the following statements are true or false:

a) External whistleblowing is a term used when whistleblowers report the wrongdoings to

people outside the organization such as the media, higher government officials, or
police.
b) The Enron scandal came to light in 2001 and almost immediately affected thousands of
people.
c) Corporate whistleblowers are protected by the Corporate and Criminal Fraud
Accountability Act.

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 d) Whistleblowing policy can be extremely beneficial for any organization; there
employees, shareholders, society and the general public will be benefitted at large.
e) ‘Whistleblower protection is a policy that all government leaders support in public but
few in power will tolerate in private.’

Answers: a (T), b (T), c (T), d (T), e (T)

Long Answer Questions

Q1. Who is a Whistleblower? How can an employee contest an important employment action or
academic decision under the Whistleblower laws in the UK and the US?

Q2. Are whistleblowers protected by any law in India? Whom should a whistleblower call in
India? Can an employee submit information anonymous?

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 LESSON 12
CORPORATE SOCIAL RESPONSIBILITY (CSR)

12 STRUCTURE

12.1. Corporate Social Responsibility (CSR) –Meaning

12.2. Corporate Philanthropy
12.3. CSR-An Overlapping Concept
12.3.1. CSR and Corporate Philanthropy
12.3.2. CSR and Corporate Responsibility
12.3.3. CSR and Corporate Sustainability
12.3.4. CSR and Business Ethics
12.3.5. CSR and Corporate Governance
12.4. CSR Through Triple Bottom Line
12.5. Types of CSR
12.6. Environmental Aspect Of CSR
12.7. CSR Models
12.8. The Indian Models of CSR
12.9. Drivers of CSR
12.10. Corporate Sustainability Reporting
12.11. Codes and Standards of CSR
12.12. CSR Initiatives in India
12.13. Self-Assessment Questions

12.1 CORPORATE SOCIAL RESPONSIBILITY (CSR) –MEANING (Mallenbaker,

2004) (Financial Times, 2018)

CSR refers to the obligation of an organization which considers the interests of all their
stakeholders which includes the customers, employees, shareholders, communities and
ecological considerations in all aspects of their operations. This obligation is seen to extend
beyond their statutory obligation to comply with legislation. CSR goes beyond the normal
charity activities of an organization and this requires that the responsible organization take into
full account of its impact on all stakeholders and on the environment when making decisions. In
a nutshell, CSR requires the organizations to balance the needs of all stakeholders with its need
to make a profit and reward shareholders adequately. (Muniapan & Mohan, 2008)

The World Business Council for Sustainable Development in its publication Making Good
Business Sense by Lord Holme and Richard Watts used the following definition:

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Corporate Social Responsibility is the continuing commitment by business to behave ethically
and contribute to economic development while improving the quality of life of the workforce
and their families as well as of the local community and society at large. The same report gave
some evidence of the different perceptions of what this should mean from a number of different
societies across the world. It respects cultural differences and finds the business opportunities in
building the skills of employees, the community and the government.

Traditionally in the United States, CSR has been defined much more in terms of a philanthropic
model. Companies make profits, unhindered except by fulfilling their duty to pay taxes. Then
they donate a certain share of the profits to charitable causes. It is seen as tainting the act for the
company to receive any benefit from the giving.

The European model is much more focused on operating the core business in a socially
responsible way, complemented by investment in communities for solid business case reasons.

Social responsibility becomes an integral part of the wealth creation process - which if managed
properly should enhance the competitiveness of business and maximize the value of wealth
creation to society. When times get hard, there is the incentive to practice CSR more and better
- if it is a philanthropic exercise which is peripheral to the main business, it will always be the
first thing to go when push comes to shove. But as with any process based on the collective
activities of communities of human beings (as companies are) there is no 'one size fits all'. In
different countries, there will be different priorities, and values that will shape how business act.
And even the observations above are changing over time. The US has growing numbers of
people looking towards core business issues.

For instance, the CSR definition used by Business for Social Responsibility is:

Operating a business in a manner that meets or exceeds the ethical, legal, commercial and public
expectations that society has of business. On the other hand, the European Commission hedges
its bets with two definitions wrapped into one:

A concept whereby companies decide voluntarily to contribute to a better society and a cleaner
environment. A concept whereby companies integrate social and environmental concerns in
their business operations and in their interaction with their stakeholders on a voluntary basis.

When you review each of these, they broadly agree that the definition now focuses on the
impact of how you manage your core business. Some go further than others in prescribing how
far companies go beyond managing their own impact into the terrain of acting specifically
outside of that focus to make a contribution to the achievement of broader societal goals. It is a
key difference, when many business leaders feel that their companies are ill equipped to pursue
broader’s societal goals, and activists argue that companies have no democratic legitimacy to
take such roles. That particular debate will continue.
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Corporate social responsibility (CSR) is a business approach that contributes to sustainable
development by delivering economic, social and environmental benefits for all stakeholders.

CSR is a concept with many definitions and practices. The way it is understood and
implemented differs greatly for each company and country. Moreover, CSR is a very broad
concept that addresses many and various topics such as human rights, corporate governance,
health and safety, environmental effects, working conditions and contribution to economic
development. Whatever the definition is, the purpose of CSR is to drive change towards
sustainability.

Although some companies may achieve remarkable efforts with unique CSR initiatives, it is
difficult to be on the forefront on all aspects of CSR. Considering this, the example below
provides good practices on one aspect of CSR – environmental sustainability.

Example: Unilever is a multinational corporation, in the food and beverage sector, with a
comprehensive CSR strategy. The company has been ranked ‘Food Industry leader’ in the Dow
Jones Sustainability World Indexes for the 11 consecutive years and ranked 7th in the ‘Global
100 Most Sustainable Corporations in the World’.

One of the major and unique initiatives is the ‘sustainable tea’ programme. On a partnership-
based model with the Rainforest Alliance (an NGO), Unilever aims to source all of its Lipton
and PG Tips tea bags from Rainforest Alliance Certified™ farms by 2015. The Rainforest
Alliance Certification offers farms a way to differentiate their products as being socially,
economically and environmentally sustainable.

12.2 CORPORATE PHILANTHROPY (Lazzari, 2018)

Philanthropy is most often seen in the form of financial contributions, but it can also include
time and resources. The concept behind philanthropy involves making an effort to drive social
change. It’s not only the charitable donations that can go toward any number of direct-giving
scenarios, such as disaster relief or feeding the homeless. Philanthropy involves finding a long-
term solution to homelessness, rather than delivering temporary relief. On the corporate level,
philanthropy is practiced in many different ways. Many corporations simply donate money to
causes that are intended to bring about social change. They may or may not place their brand on
the cause and take credit for the resources offered. This kind of giving often happens without
any direct involvement outside of the funds offered.

Corporations may also be directly involved in philanthropy by partnering closely with a cause,
or, in some cases, by bringing the efforts in-house. Some corporations have entire departments
dedicated to managing their charitable gifts and philanthropic programs. Although philanthropy
and charity are separated by definition, the two are commonly lumped into a single category
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within the corporate atmosphere. Philanthropy and charity are both programs of giving that are
not necessarily limited to the communities where they operate. Most often, they simply select
causes and then contribute on a financial level.

12.3 CSR-AN OVERLAPPING CONCEPT

CSR overlaps with some concepts like Corporate Philanthropy, Corporate responsibility,
corporate governance, business ethics, and corporate sustainability. Following are the relations
and difference between CSR and other concepts.

12.3.1 CSR and Corporate Philanthropy (Baines, 2016)

While both philanthropy and corporate social responsibility (CSR) have the potential to be very
effective and are indeed relied upon by those in the charity and not-for-profit sectors, they are
very different.

The differences between the two can be measured in the return that flows back to the giver.
Businesses who engage with the charity sector like to believe that they are doing more than just
donating a portion of their net profit to their chosen charity, and in effect have a corporate social
responsibility program in place. Truth be known, many businesses who believe they are
engaged in CSR, are really only engaged in corporate philanthropy.

Philanthropy is often defined as using wealth to bring about social change. A ‘philanthropist’ is
a bit like a venture capitalist in the not-for-profit sector; they make a decision to invest a portion
of their wealth to bring about social change in something they believe in. There may be an
investment of their time and knowledge, but more often than not, the support is financial.

The philanthropists desire to participate beyond that can vary, but often they are happy to
support from an at arm’s length. While they will likely seek to find out the impact their funds
have achieved for the charity, they will usually not get involved beyond that.

For businesses of all sizes that engage in CSR (this domain is not limited to corporate
enterprises as the name might suggest), it is in their interest to be involved beyond simply
giving money. If a business can turn their CSR into a profit centre, then they are more likely to
deepen their engagement, stay strong during hard economic times, and—as they see their CSR
have a positive impact upon their own business—give more.

A CSR program that is built on the back of a shared experience—wherein there has been the
opportunity to engage with a charity beyond a monetary transaction—is likely to return business
benefits such as improved morale, increased staff retention, status as an employer of choice,
attracting new business, and differentiation from competitors. These benefits are seldom
achieved through the donation of money and money alone.
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If your CSR program is limited to the CEO handing over a cheques at a coffee and cake
ceremony, then it is suggested that you in fact don’t have a CSR program, but are engaging in
corporate philanthropy.

Neither are wrong and one is not better than the other, but if a business engages in a more
engaged form of giving with clear objectives in terms of KPIs and ROI from the program, all of
those involved will benefit, and therein lies the magic.

12.3.2 CSR and Corporate Responsibility (Sharma, 2012)

There are two extreme views in this respect: one says that both CSR and CR are same. Whilst
others say that CR is a broader concept than CR. The later idea is gaining more acceptance than
the former one. According to the Institute of Corporate Responsibility (ICR, Malaysia) “CSR
means ad hoc doing good to do well, Whereas, CR means sustainable doing good to do well.
The leading practitioners in Europe are moving away from CSR to CR because CR includes the
wider issues of governance, ethics and environment and dropping the word ‘social’ is a
conscious act to avoid placing too much emphasis on the social aspects of business, i.e. being
philanthropic and focusing too much on ‘ giving back to the community’ activity. The
Malaysian Securities Commission Chairman Datuk Zarinah Anwar while sharing her thoughts
with StarBiz (2008) agrees that the companies should move from CSR to CR. She explained
that CR is about integrating responsible and ethical practices in all aspects of a company’s
operations. CR is wider than CSR because the former deals with issues of ethics, governance
and the environment in addition to the social issues that are the primary concern of the latter.

The World Business Council for Sustainable Development (WBCSD), 1999 gives the division
of CR into: Corporate Financial Responsibility (CFR), Corporate Environment Responsibility
(CER) and Corporate Social Responsibility (CSR). It implies that CSR is an integral part of
Corporate Responsibility. It reflects that CSR is one of the tools to a broader concept of
Corporate Responsibility.

12.3.3 CSR and Corporate Sustainability (Uchendu, 2016)

Many have continued to use Corporate Social Responsibility (CSR) and Business Sustainability
interchangeably, but in practice, they rarely mean the same thing even though they are quite
interrelated. The concept of CSR has been around since the 1950’s and has been called so many
other names including; Corporate Responsibility, Corporate Ethics, Corporate Citizenship,
Corporate sustainability, and Responsible Business. CSR is based on the premise that a business
can only thrive if it operates within a thriving society. In that way, the business depends on the
community it operates within, and as such, has an ethical and moral responsibility towards that
community.

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Business sustainability takes this a bit further, and explicitly encompasses other factors of
environment and economics. It is based on the premise that businesses operate in such a way
that it uses limited resources to meet its needs today, while still ensuring that these resources are
still available to meet the needs of future generations.

So right off from these premises, we see some differences between CSR and business
sustainability:

• Business Sustainability is futuristic while CSR is antiquated

It is very easy to notice that Business Sustainability talks a lot about the future, forward thinking
plans to sustain a business and improve targets, for instance, waste reduction and innovative
brand development are examples of business sustainability projects, while CSR involves deeds
that have been done in the past to support one community project or the other like building a
library to support literacy in a community, or providing a health care centre for a community.
Major oil companies in Africa are very good at initiating CSR projects basically because they
are mandated to give back to the communities where they extract their resources from.

• CSR is about now while Business Sustainability is long-term

Many CSR projects satisfy a present community need, but they don’t always address the
underlying issue. The oil company that builds a health care center for a community would not
take into consideration the efforts and resources required by the local government to sustain that
center by continuously paying the fees for the health workers, maintaining the equipment and
facilities, managing logistics and storage of medicines, etc. In this way, many of them may not
be well thought out, and in fact, provide further liabilities for the community and promote a
‘dependency culture’ (e.g. the Niger Delta situation). Business Sustainability, on the other hand,
is all about long-term thinking. For example, the community may have been better off if the oil
company changed their methods of extraction for the better, and carried out some measure of
replenishment upon each extraction. CSR is therefore more of present philanthropy or “add-on”
initiatives with limited strategic focus.

• CSR doesn’t have to align with your business, but Business Sustainability does

Many businesses carry out their CSR initiatives by identifying an issue in the community, and
providing something to help ease the issue. But these initiatives don’t always align with the
strategy of the business. This increases the risk of the initiative being perceived as green
washing, or as short-term with no long lasting positive implications. For example, Etisalat
Nigeria has a Fight Malaria Initiative where they provide insecticide treated mosquito nets in
Kano state. The project is not integrated into Etisalat’s business model, so it’s easy for them not
to be invested in the long term impacts of the project. Yes, this initiative is responsible, but it’s
not necessarily sustainable. On the other hand, if Etisalat analyzed their business to see where
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they could better utilize resources (like how they collocate towers) or partner with others to
send health educational messages along with their standard status SMSs, then these could be
seen as business sustainability initiatives as they are more integrated into their core business.

• CSR is mostly external while Business Sustainability is both internal and external

When companies carry out CSR, more often than not, they aim it at external stakeholders. For
example, it would be odd to hear an organization call an improved employee welfare system or
a replacement plan for energy saving bulbs a CSR project. Most times, CSR projects are
targeted at specific demographics and groups of people, e.g. people living in a community (like
beautification of roundabout, roads and junctions by Fidelity Bank); schools (like donations of
buildings and vehicles to educational institutions by Wema Bank); sportsmen (like sponsorship
of a female basketball league by Zenith Bank); etc. Business sustainability, on the other hand,
also incorporates a business’ internal stakeholders as well as the way the company actually
conducts its business, e.g. incorporating a policy of flexible working hours for employees (like
ActionAid Nigeria has done with its staff where their work hours do not have to be the
traditional 8 to 5); utilizing online training facilities to reduce travel for training (like KPMG
Nigeria has done to ensure continuous learning without the need to travel or greatly disrupt
staff); and building products around issues (like SME loan scheme by GTBank).

12.3.4 CSR and Business Ethics (Sharma, 2012)

Business ethics means equal, fair and honest treatment to all the stakeholders besides the
shareholders. The company which treats its stakeholders ethically and meets its responsibility
towards them is awarded with a high degree of loyalty, honesty, quality and productivity. For
example, employees who are treated ethically will more likely behave ethically in dealing with
customers and business associates and a company that refuses to discriminate against older or
handicap employees often discovers that they are fiercely loyal, hardworking and productive.
The integration of CSR and business ethics would decide the constraints in the working of the
business which are not guided by law but by the ethics of the company. The example in this
context would be collapse of Enron, a U.S Company. It is interesting to know that Enron had an
exhausted code of ethics and principles which runs to over 60 pages.

Enrons version of CSR was strategically determined philanthropy and was the outcome of
strategic and not moral calculation. The CSR program in Enron was a problem to be solved
through rational analysis like any other business process such as marketing, sales or finance. It
is an example of implementation of CSR without its integration with the business ethics of the
company. Business ethics provides a solid foundation for the business to operate. An
organization has to inculcate ethics in its culture for actual CSR implementation because CSR
on paper and not in spirit is of no use.

12.3.5 CSR and Corporate Governance (D.P.Verma, 2012)

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The conceptualization of CSR was, initially, purely in terms of philanthropy or charity.
However, the post-liberalization phase has seen a fundamental shift from this philanthropy-
based model of CSR to a stakeholder- participation based model. Furthermore, CSR is gradually
getting fused into companies’ Corporate Governance practices. Both Corporate Governance and
CSR focus on the ethical practices in the business and the responsiveness of an organization to
its stakeholders and the environment in which it operates. Corporate Governance and CSR
results into better image of an organization and directly affects the performance of an
organization.

The OECD principles on Corporate Governance, UN Global Compact Participation throw light
on CSR scheme but in India CSR, by virtue of clause 49 of the listing agreement, have been
made totally optional. It is pertinent to mention here that transparency, disclosure, sustainability
and ethical behaviour is central theme in both CSR and Corporate Governance. Further, it is
worthwhile to mention that CSR is based on the concept of self-governance which is related to
external legal and regulatory mechanism, whereas Corporate Governance is a widest control
mechanism within which a company takes it management decisions. Furthermore, the
objectives and benefits of CSR and Corporate Governance are similar in nature, some of them
are stated herein below:

• Rebuilding of public trust and confidence by increased transparency in its financial as well
as non-financial reporting and thereby increasing the shareholder value.
• Establishing strong brand reputation of the company.
• Making substantial improvement in its relationship with various stakeholders.
• Contributing to the development of the region and the society around its area of operation
• Addressing the concerns of its various stakeholders in a balanced way so as to maintaining a
strong market position.

Furthermore, it may be worthwhile to note that in case of unlisted companies there is not robust
system of corporate governance, although there are some provisions in the Companies Act,
1956, in this context the relationship between Corporate Governance and CSR is very important
and significant. In order to appraise present position of CSR and Corporate Governance, it
would be worthwhile to examine the legal and regulatory framework dealing with CSR and
Corporate Governance.

12.4 CSR THROUGH TRIPLE BOTTOM LINE (Riley, 2018)

The Triple Bottom Line is a concept that encourages the assessment of overall business
performance based on three important areas: Profit, People and Planet.

Limitations with Traditional Measures of Business Performance

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The Triple Bottom Line approach (Profit, People and Planet) arose out of frustration with
traditional, financially-focused measures of business performance, which have tended to
emphasize profit as the key metric

• Businesses are usually assumed to be profit-maximizes

• Profit is the traditional measure of business success
• Profit is closely linked with business value (e.g. share price and market capitalization)
• Profit is often the basis for financial incentives (e.g. senior management bonuses)

Is there more to Business Success than Profit?

In his model, John Elkington argues for a more balanced approach to measuring performance
over time:

So Profit, People and Planet aims to measure the financial, social and environmental
performance of a business over a period of time.

Profit

• Familiar to managers
• Identified from income statement (profit and loss account)
• Audited = reliable figure

Planet

• Measures the impact of business activity on the environment

• More tangible – e.g. emissions, use of sustainable inputs

People

• Measures extent to which business is socially responsible

• Harder to calculate & report reliably & consistently

Benefits of Measuring the Triple Bottom Line

The potential benefits of measuring a broader scope of business performance based on Profit,
Planet & People include:

• Encourages businesses to think beyond narrow measure of performance (profit)

• Encourages CSR reporting
• Supports measurement of environmental impact & extent of sustainability
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Criticisms of the Triple Bottom Line

Amongst the criticisms that have been made of Elkington’s model are:

• Not very useful as an overall measure of business performance

• Hard to reliably and consistently measure People & Planet bottom-lines
• No legal requirement to report it – so take-up has been poor

12.5 TYPES OF CSR (Krohn, 2018)

Corporate social responsibility initiatives are standards and measures that business put in place
to benefit society. Generally speaking, these initiatives are based on sustainability in four
different categories.
Tips

The four types of Corporate Social Responsibility are environmental sustainability initiatives,
direct philanthropic giving, ethical business practices and economic responsibility.

1. Environmental Sustainability Initiatives: Environmental sustainability initiatives

enacted by businesses generally focus on two main areas: limiting pollution and
reducing greenhouse gases. As the awareness of environmental issues grows, businesses
that take steps to reduce air, land and water pollution can increase their standing as good
corporate citizens while also benefiting society as a whole. For example, Cisco Systems,
a multinational technology company, has taken a variety of steps to reduce its carbon
footprint, including the installation of photovoltaic systems at production facilities and
developing platforms that allow employees to work from remote locations rather than
commuting to the office.
2. Direct Philanthropic Giving: Philanthropic initiatives include the donation of time,
money or resources to charities and organizations at local, national or international
levels. These donations can be directed to a variety of worthy causes including human
rights, national disaster relief, clean water and education programs in underdeveloped
countries. For example, Microsoft co-founder Bill Gates has donated billions of dollars
to the Bill and Melinda Gates Foundation, which supports numerous causes including
education, the eradication of malaria and agricultural development. In 2014, Bill Gates
was the single largest giver in the world, donating $1.5 billion in Microsoft stock to the
Bill and Melinda Gates Foundation.
3. Ethical Business Practices: The primary focus on ethics is to provide fair labor
practices for businesses’ employees as well as the employees of their suppliers. Fair
business practices for employees include equal pay for equal work and living wage
compensation initiatives. Ethical labor practices for suppliers include the use of products

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 that have been certified as meeting fair trade standards. For example, Ben and Jerry’s Ice
Cream uses fair trade-certified ingredients like sugar, cocoa, vanilla, coffee and bananas.
4. Focus on Economic Responsibility: Economic responsibility focuses on practices that
facilitate the long-term growth of the business, while also meeting the standards set for
ethical, environmental and philanthropic practices. By balancing economic decisions
with their overall effects on society, businesses can improve their operations while also
engaging in sustainable practices. An example of economic responsibility is when a
company modifies its manufacturing processes to include recycled products, which
could benefit the company by potentially lowering the cost of materials and also benefit
society by consuming fewer resources. Sustainability and corporate social responsibility
initiatives will continue to be prevalent in years to come.

12.6 ENVIRONMENTAL ASPECT OF CSR (Krohn, 2018)

Environmental aspect of CSR is the duty to cover environmental consequences of a particular

company’s operations, products and facilities. The major ingredients of environmental CSR are
elimination of waste and emissions, maximizing energy efficiency and productivity and
minimizing practices that may adversely affect utilization of natural resources by coming
generations. Sustainability and carbon footprint occupies an increasingly important position on
the corporate agenda around the world. Growing number of companies are realizing the
importance of environmental initiatives in business development.

Decrease in energy and raw material usage combined with reduced emissions and waste
generation can tackle the environmental challenges facing the world. Leading IT companies,
like Microsoft, Adobe, Apple and Google, are investing in renewable sources of energy that can
generate power directly on-site. Clean manufacturing practices and energy-efficient design of
equipment are also hallmarks of environmental sustainability.

Pollution prevention, energy efficiency, eco-friendly design, and industrial ecology are
emerging as top priorities for companies across all industrial sectors. Water, waste, packaging,
energy and transport are being integrated into mainstream operations to facilitate sustainability.
Reduction in the amount of packaging and use of eco-friendly packaging material provide an
attractive opportunity to promote environmental sustainability. Use of clean energy for in-house
power requirements is also emerging as an attractive proposition for companies to reduce
carbon footprint and project a ‘green’ image.

12.7 CSR MODELS (Kanji & Agrawal, 2016)

The idea of CSR first surfaced in the 1950s and since then it has been defined and interpreted in
many ways. Such a situation has only clouded the judgment on how to strategically implement
various CSR activities. At this point of time, the best way to determine the success of any

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implementation of CSR practices, without prior reservations of sticking to particular fields of
activities or earning financial fruits off the services, would be to gauge the performance of
stakeholder dialogue. Freeman (1984, p.38) defined stakeholders as ‘groups and individuals
who can affect or are affected by, the achievement of an organization’s mission’ and, thus,
stakeholder dialogue becomes the exchange of CSR offerings (firm to stakeholders) and
approval or support (stakeholders to firm) (Murray and Vogel, 1997). Hence, it will not be
incorrect to state that in return for CSR activities, what firms seek, majorly, is consent and
approval of its philanthropic fame. The methods to understand the credibility of any stakeholder
dialogue is ambiguous; what stakeholders give back in exchange is what actually determines
success, but stakeholders give back different things at different times. More volumes of sale,
increased inclination towards employment in a particular firm/industry and more trust in the
stocks of a firm are just some of the many ways to comprehend that a particular firm, through
its various CSR activities, is being well accepted by its societal surrounding. With regard to
dialogue performance, the action-oriented concepts of corporate social responsiveness and
corporate social performance (CSP) need to be discussed. Carroll (1979) illustrated social
performance through a three-dimensional model. The first dimension consisted of different
categories of CSR (economic, legal, ethical and discretionary), the second consisted of modes of
social responsiveness (reaction, defense, accommodation and pro-action) and the third
dimension consisted of social issues that should be addressed (consumerism, environment and
product safety). Wartick and Cochran (1985) developed this model while trying to integrate the
three primary orientations of business and society: (a) philosophical orientation (principles of
social responsibility), (b) institutional orientation (processes of social responsiveness) and (c)
organizational orientation (policies of social issue management). Thus, CSP takes into account a
wide range of aspects to measure the credibility of a corporate’s performance.

The performance of an enterprise can be judged through its productivity and also in terms of its
acceptance, not only as a brand but also as a social entity. Thus, it is obligatory for an enterprise
to understand the ways of improving its social being, especially its social acceptance. Similarly,
the stakeholders should also ensure that enterprises are actively addressing issues of concern for
the immediate community, be it social or any risks that it may pose. What better way to
understand this than CSR? In fact, it is through CSR initiatives that an enterprise establishes its
footing in the society in terms of sales and reputation. It is also through proper CSR activities
that an enterprise configures its brand name and facilitates wider acceptance.

1. Ackerman’s Model: Even before the concept of modeling CSR initiatives according to
priorities or liabilities or even responsibilities came into the picture, Ackerman proposed
his model that was laid down in three phases (Ackerman & Bauer, 1976). More than a
model, it was a strategy that guided the implementation of CSR activities, but not their
formulation. The first phase was about the top managers recognizing a social problem,
the second phase was an intensive study of the problem and finding out solutions by
hiring experts and the last phase was implementation of the proposed solutions. It is
obvious that this model, rather a plan, merely provides strategies to deal with problems
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 having social implications. Other parameters and constraints of CSR activities did not
come under the purview of this model.
2. The Pyramid Model: It was Carroll who had stated that individual responsibilities and
obligations in different fields are finally summarized into the totality of CSR (Carroll,
1991; Pinkston & Carroll, 1996). The pyramid model, which is based on such totality of
CSR, comprises four very different aspects (see Figure 1). The pyramid is arranged
according to decreasing order of priorities, economic responsibilities being the most
important one. In this context, Carroll points out that ‘all other business responsibilities
are predicated upon the economic responsibility of the firm, because without it the
others become moot considerations’ (Carroll, 1991, p. 41). Legal responsibility is the
second priority. Ethical responsibility, that is, the responsibilities and obligations that are
not legally codified but should be performed for the greater good, comes as the third
priority. Philanthropic responsibilities, which are actually supposed to be discretionary
in nature, are assigned the least priority.

It would be wise to mention that Carroll’s proposition was a humble progress from what
Sethi proposed (1975). Sethi’s three-stage model was considered as a huge advancement
in itself during its initial days. It was based on three parameters: social obligation, social
responsibility and social responsiveness. The first stage emphasizes that firms are
socially responsible and they must flourish within the legal constraints of the nation. The
second stage urges the firm to flourish not only within the legal permits, but also in
accordance with the salient norms of the society, thus providing a balance between what
they need from the society and what the society wants from them. The third stage calls
for accountability and dynamism in dialogue with the stakeholders, that is, to involve

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them in the decision making process. The pyramid model argues against the widely
accepted separation thesis which claims that businesses cannot focus on both social and
financial concerns at the same time. It arranges the different fields of responsibilities and
obligations in an order without integrating them in any manner. This model is in
agreement with how Milton Friedman defined a business, that is, to make the maximum
profit staying within the limits of legal and ethical boundaries. The philanthropic
responsibility is perhaps the icing on the cake as it distinguishes one as a ‘corporate
citizen’, highlighting the importance of corporate giving. This model has a positive
impact on CFP—a money-oriented way of describing CSP—through its impact on
reputation. Aupperle, Carroll and Hatfield (1985) argue that the social outlook of an
organization can very well be measured by observing the importance it gives to the three
noneconomic strata, that is, the legal, moral and the philanthropic responsibilities. The
Intersecting Circles Model of CSR This model, unlike the pyramid model, categorically
refutes the hierarchical prioritization of CSR and illustrates the integration of three
aspects: economic, legal and moral (see Figure 2). Schwartz and Carroll (2003)
proposed this model to illustrate the fact that when it comes to CSR, none of the aspects
are more important than the other. In this context, Davis’ Iron Law of Responsibility
(1960) can be mentioned, as it also rejects economic responsibility as the first and
foremost priority. According to this law, a business, although created for profit-making,
is actually a social creation and in order for it to survive and thrive, the society must be
willing to support and endure it. Such a support from the society can only be earned
through the responsibilities and obligations it fulfils.

Converting the diagram presented in Figure 2 into a Venn diagram, we can have eight
categories or classes: EL’M’, LM’E’, ML’E’, ELM’, EML’, LME’, ELM and E’L’M’
(where E = Economic, L = Legal, M = Moral or Ethical). Among these categories,
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 EL’M’ signifies purely economic responsibility without any moral (ethical) and legal
concerns, E’L’M means purely ethical responsibility, and so on. However, neither of the
above two classes is feasible as both earning profit without any legal obligation and
doing ethical work without any profit are not acceptable. Yet they somehow find
themselves in the classes of total CSR. Thus, this model appears to be descriptive in
nature and not normative. However, Schwartz and Carroll (2003) pointed out that the
model can be used to establish CSR portraits for different entities like individuals,
corporations, stakeholders, industries and nations. The model is flexible as one has the
advantage of interpreting it as per the necessity.
3. The Concentric Circles Model: The concentric circles model of CSR has been
adopted from a statement issued in 1971 by the Committee for Economic Development
(see Figure 3). The statement posited that social contracts of business processes are not
only feasible, but also morally necessary and, thus, urged corporations to adopt a more
humane view towards their function in society. The original model of the committee had
only three rings: (a) economic (products, job, financial stability and growth); (b) ethical
(responsibilities to exercise the economic functions with a sensitive awareness of ethical
norms) and (c) philanthropic (amorphous responsibilities that businesses should get
involved with to improve the social environment). This model is in agreement with what
Logsdon and Wood (2002) stated, ‘CSR is a concept supporting social control of
business that resides and operates inside business itself, with the aim of protecting and
enhancing the public welfare as well as private interests.’ On the one hand, the move
from the outer circle to the inner circle reflects the control that society needs to impose
on standards of business activity to ensure social progress through proper functioning of
the business core. The move from the inside to the outside, on the other hand, represents
the internalization of social norms that reside and operate within the business as
affirmative or positive duties. This model has a wider scope of economic
responsibilities, which include: generating wealth to improve the nation’s standard of
living, supplying the needs and wants of people for goods and services, selling them at
fair prices, providing employment and fair wages and eliminating poverty in a holistic
manner. According to Stone (1975), the legal circle encompasses two responsibilities:
the first one is to follow law and the second one is to follow the spirit of law, that is, to
abide by the law through socially appropriate considerations (considered autonomy).
Restrictive compliance, opportunistic compliance, avoidance of civil litigation and
anticipation of changes in legislation fall within the ambit of this ring. The ethical ring
holds more or less the same meaning as it did in the pyramid model, with the only
addition being the responsibility of not exploiting stakeholders who are not protected by
well-established ethical norms and customs. The notion that comes to the fore is that an
organization can be called socially responsible even when it takes advantage of an ill-
defined local norm. In this context, Sethi (2003, p.288) observed: The large corporation,
and especially the multinational corporation, must become an active agent for social
change. As a dominant institution in society, the corporation must assume its rightful
place and contribute to shaping the public agenda instead of simply reacting to policy
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 choices advocated by others. The philanthropic ring highlights the fact that corporate
philanthropy is not about corporate contributions to further a cause but to use corporate
social competencies and advantages as a means to solve major social problems. Thus,
the problem of multiple objectives creating confusion, conflict and inefficiency,
encountered in the previous two models, was resolved by this model as it had the single
criterion of improvement of social welfare.
4. 3C-SR Model: This model was proposed by John Meehan, Karon Meehan and Adam
Richards of Liverpool John Moores University (Meehan, Meehan, & Richards, 2006).
The components of the model are: (a) ethical and social commitments, (b) connections
with partners in the value network and (c) consistency of behaviour to build trust (see
Figure 4). Thus commitments, connections and consistency form the three Cs of the
model. Commitments encompass the legal, ethical and economic dimensions proposed
by Schwartz and Carroll in their model (2003). These commitments can be verified
through the Global Reporting Initiative and the Account Ability’s AA1000. Normann
and Ramirez (1993) argue that ‘value occurs not in sequential chains but in complex
constellations’ and this defines the connections with partners in the value network. For
example, Walmart’s reluctance to engage in certain multi-stakeholder initiatives (MSI),
like that of Fair Labour Association, earned heavy criticism. Given the general approach
of consumers towards corporate responsibility, the steadfast negligence of Walmart does
not bode well. Failure to ‘walk-the-talk’, that is, inconsistency of behavior, also leads to
ill fame. The idea in this model is to become good corporate citizens through the three
Cs.
5. Liberal Model: This approach was encapsulated by the American economist Milton
Friedman, who in 1958 challenged the very notion of corporate responsibility with the
idea that companies are solely responsible to their owners (Friedman, 1971). As argued
in this model, it is sufficient for a business to obey the law and generate wealth, which
through taxation and private charitable choices can be directed to social ends. This
ultimately fulfills the social responsibility of an organization towards the community
and the nation.
6. Stakeholder Model: The stakeholder model is often associated with R. Edward
Freeman, whose seminal analysis of the stakeholder approach to strategic management
in 1984 brought stake holding into the mainstream of management literature (Freeman,
1984). The rise of globalization has brought with it a growing consensus that with
increasing economic rights, the range of social obligations of businesses is also growing.
This, as a consequence, gave rise to the stakeholder model of corporate responsibility.

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12.8 THE INDIAN MODELS OF CSR

1. Ethical Model: This model was developed under the influence of Mahatma Gandhi
and, hence, finds its seat in the early 20th century. The pressure on Indian industrialists
to demonstrate their commitment to social development increased during the
independence movement, when Mahatma Gandhi developed the notion of trusteeship,
whereby the owners of property would voluntarily manage their wealth on behalf of the
people. The history of Indian corporate philanthropy has encompassed donations in cash
or kind, community investment in trusts and provision of essential services such as
schools, libraries and hospitals. Many firms, particularly family-run businesses, continue
to support such philanthropic initiatives. Notable among them are the Ambanis
(Reliance) and the Tatas.
2. Statist Model: In the First International Summit on CSR, jointly organized by the
Ministry of Corporate Affairs and ASSOCHAM in New Delhi in the year 2008, it was
agreed upon that a second model of CSR emerged in India after independence, with the
adoption of a socialist and mixed economy framework where both large, state-owned
public sector companies and private-sector firms coexisted (KPMG, & ASSOCHAM,
2008). The boundaries between the state and the society were clearly defined for the
state enterprises.

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Elements of corporate responsibility, especially those relating to community and worker
relationships, were enshrined in labour laws and management principles. This state-sponsored
corporate philosophy still operates in the numerous public sector companies that have survived
the wave of privatization in the early 1990s. The statist model has evolved well and has been
adopted now.

12.9 DRIVERS OF CSR (Drivers of CSR, 2018)

There are numerous drivers in the marketplace that have encouraged larger companies to be
more socially responsible, as discussed in more detail below. But the key drivers for firms
becoming more socially responsible are:

• Government legislation
• customers’ expectations of firms
• consumer lobby groups
• the extent of costs involved
• the type of industry in which they operate
• the potential for competitive advantage
• top-level corporate culture

Government Legislation

In many countries across certain industries, the government has imposed legislation that
requires companies to conform and behave in a certain manner. In this case, however, the
organizations impacted by this legislation are only complying with various requirements
because of regulation. They may or may not be willing to incorporate social responsibility
initiatives into their day-to-day operations of an overall strategy.

Examples here would include legislation relating to environment, pollution, use of workers and
conditions, product disposal, materials used in production, and so on. Therefore, this is not
necessarily a driver of corporate social responsibility, but is adopted and followed by companies
as it is a requirement imposed upon them by government.

Customers’ Expectations of Firms

Consumers are becoming more aware of social and environmental issues and the consideration
of the future is becoming slightly more important when consumers consider purchase decisions.
As a result, some consumers will have an expectation that certain companies behave in an
appropriate manner, relative to society and the communities.

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For instance, Disney has faced significant criticism in the past relating to the use of low paid
workers in developing countries to produce toys, games and novelties. Likewise, some
consumers have been critical of KFC because of the conditions that their supply chickens are
held in. The changing expectations of consumers has resulted in firms being more responsive to
these issues and adopting a more corporate responsible outlook

Consumer Lobby Groups

In conjunction to the previous driver of corporate social responsibility, the Internet and social
media has made it much easier for consumer lobby groups to form, to generate attention and
adverse media coverage, and therefore achieve its goals of change.

Typically, these consumer lobby groups will target large and well-known companies within
industries that adversely affect the environment were deemed to not provide a of product value.
For example, Walmart is often the target of lobby groups because of their perceived actions and
impact on local communities and business centers. Another example is McDonald’s, who are
frequently criticized for the perceived impact that they may have on obesity and people’s health.

Therefore, larger companies who are more likely to be the target of lobby groups, become more
likely to be willing to be engaged in corporate social responsibility initiatives.

The Extent of Costs Involved

A shift to increase social responsibility may come at a reasonable cost to the organization. For
example, a manufacturer choosing to manufacture its products in more developed countries or
choosing to pay the production workers are much better salary – rather than “exploiting”
unskilled workers in developing countries – will significantly impact their unit margin and
overall profitability.

However, a bank can shift its customer bank statements from paper-based to electronic (known
as e-statements) on the basis that they are saving lots of paper – but this has the impact of
reducing costs for the organization. Likewise, a major hotel chain can encourage its customers
to reuse their bath towels each day. Again the hotel can claim an environmental benefit of
reduced water and power usage, all the while delivering themselves a reduction in costs and
increase in profitability. Therefore, where the social responsibility initiative represents a win-
win scenario, an organization is far more likely to implement it.

The Type of Industry in which they Operate

There are a number of more significant industries where there is greater pressure an expectation
on the firms to become responsible corporate citizens. Following the Global Financial Crisis,
there has been in increased expectation on banks and other financial institutions to be more
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transparent and ethical in their business operations. Obviously manufacturing is another
industry that has greater pressure on it – particularly heavy manufacturing where there could be
significant pollution, or large companies deciding to manufacture in developing countries, or
manufacturers who have issues with product disposal (e.g. mobile phones and batteries and
chemicals).

Potential for a Competitive Advantage by Image

There are some companies that are attempting to build their core image, or at least parts of their
brand association around their socially responsible behavior. Some companies will highlight
that they are ethical manufacturers – Etiko is one such manufacturer, and bankmecu is a
financial institution that rewards customers with cheaper home loans if they have
environmentally friendly houses.

In this case, these types of organizations are truly practicing the societal marketing concept.
They are foregoing some profitability in order to contribute to society or to certain
communities.

Corporate Culture and Top Management Values

Corporate social responsibility is also a reflection of the overall corporate culture and of top
management values. In other words, how important is making a contribution to society to the
senior management of the organization? This will guide how embedded social responsibility is
the overall strategy, or is it simply an exercise in publicity?

12.10 CORPORATE SUSTAINABILITY REPORTING (Ligteringen, 2018)

Sustainability Reporting

In a world of changing expectations, companies must account for the way they impact the
communities and environments where they operate. Businesses can sustain their growth only if
society is generally satisfied with their overall contribution to societal well-being. Climate
change; community health, education and development; and business sustainability are some of
the most pressing issues of our time. This raises the importance of accurately and transparently
accounting for and reporting these activities.

Businesses cannot afford to function and survive in the long run unless it behaves in a legitimate
and socially responsible manner. Governments of various countries began to scrutinize the
activities of companies under the different dimensions of sustainable development. For this
Sustainable Reporting was introduced as a tool to measure the performance.

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Sustainability Reporting (SR) or Non-Financial Reporting (NFR) is the process of
communicating the social and environmental effects of organizations to particular interest
groups within society and at large. Sustainability reporting is gaining momentum globally as an
important communication tool for companies to disclose their sustainability plans and
performance and enhance stakeholder confidence.

In most parts of the world, SR remains a voluntary practice. So far, France is the only country to
enact specific legislation requiring publicly listed companies to produce non-financial reports
covering economic, social as well as environmental dimensions.

Some large organizations in some countries are subject to specific regulation that requires them
to report some kind of sustainability information – for example certain public-sector
organizations in the United Kingdom. Various other countries mandate detailed reporting for
specific industry sectors. Additionally, some stock exchanges like the South African Stock
Exchange now make SR a requirement for listed companies.

Drivers of Sustainability Reporting

There are various drivers behind the increase in dialogue, discussion and publication of
sustainability reports. Some of them are-
• Stakeholder exerts pressure for SR because of their organization’s participation in global
supply chain.
• Brand and reputation of corporate sector in India and at international level is the another
significant driver behind SR by corporates.
• Role of Governments/Regulators in pushing SR to make corporates more responsible.
• Facing competition worldwide is also the reason to accept the SR

Sustainability Reporting –Benefits

The benefits of sustainability reporting include:

• Improved financial performance
• Improved stakeholder relationships
• Improved risk management
• Improved investor relationships
• Identification of new markets and/or business opportunities

12.11 CODES AND STANDARDS ON CSR (Ruiz, 2015)

The International scenario has a mixed response to CSR. The OECD principals of corporate
Governance are international benchmark for policy makers, investors, corporation and
stakeholders worldwide. There are many CSR initiatives, principles, codes and standards
worldwide which are discussed below:
250
Caux Round table (CRT):

The Caux Round Table was founded in 1986 by Frederick Phillips, former President of Philips
Electronics and Olivier Giscard d'Estaing, former Vice-Chairman of INSEAD, as a means of
reducing escalating trade tensions.

At the urging of Ryuzaburo Kaku, then Chairman of Canon, Inc., the CRT began focusing
attention on the importance of global corporate responsibility in reducing social and economic
threats to world peace and stability.

The CRT Principles for Business were formally launched in 1994, and presented at the United
Nations World Summit on Social Development in 1995. The CRT Principles for Business
articulate a comprehensive set of ethical norms for businesses operating internationally or
across multiple cultures. The CRT Principles for Business emerged from a series of dialogues
catalyzed by the Caux Round Table during the late 1980's and early 1990's. They are the
product of collaboration between executives from Europe, Japan, and the United States, and
were fashioned in part from a document called "The Minnesota Principles." The CRT Principles
for Business have been published in twelve languages, reprinted in numerous textbooks and
articles, and utilized in business school curricula worldwide. The Principles are recognized by
many as the most comprehensive statement of responsible business practice ever formulated by
business leaders for business leaders.

GRI Global Reporting Initiative

Global Reporting Initiative (GRI) is an independent institution established in 1999 with the
mission to provide a reliable and credible framework for preparing sustainability reports that
can be used by organizations regardless of size, sector or location.

Today, GRI guidelines are the main international standard for preparing sustainability reports.

ISO 26000

This standard was published in 2010 and developed by ISO (International Standard
Organization) in order to guide organizations on how to implement CSR. It is a non-certifiable
standard.
251
ISO 26000 is a guide resulting from a consensus among international experts representing the
main stakeholders and is designed to encourage and promote the implementation of Social
Responsibility best practices internationally.

Standard SA 8000
It is a voluntary management standard developed by SAI (Social Accountability International)
of the United Nations, published in 1997 on working conditions and an independent control
system for the ethical production of goods and services as well as suitable working conditions.

It focuses on different conventions of the International Labour Organization (ILO), the

Declaration of Human Rights and the Convention on the Rights of the Child, which focuses on
avoiding the competitive advantage of lower production costs through a lower level in working
conditions. This standard is very interesting for companies that are active in countries with a
less demanding social and cultural environment than the West and therefore with lower
development aspects in safety and health at work, which is why it is currently the management
standard that is the most widespread in emerging countries, especially in the area of Southeast
Asia.

AA 1000aa1000

The AA 1000 series comes from the UK, developed in 1999 by Accountability with the goal of
integrating management, auditing and communication CSR aspects.

252
The main feature of the AA 1000 is the development of an elaborate methodology that begins
with the identification of the demands of stakeholders and is followed by the redefinition of
values.

The Standard SGE 21

The SGE 21 Company Standard was first published in 2000 by Forética, a global network of
organizations and professionals involved in the development of Social Responsibility,
established in Spain.

SGE 21 is the first European system for social responsibility that voluntarily enables auditing
processes and achieves certification in Management Ethics and Social Responsibility.

The system is comprised of models such as those for quality and the environment, which
enriched through a multi stakeholder vision.

12.12 CSR INITIATIVES IN INDIA (Dezan Shira & Associates, 2017)

India is the first country in the world to make corporate social responsibility (CSR) mandatory,
following an amendment to The Company Act, 2013 in April 2014. Businesses can invest their
profits in areas such as education, poverty, gender equality, and hunger.

The amendment notified in the Schedule VII of the Companies Act advocates that those
companies with a net worth of US$73 million (Rs 4.96 billion) or more, or an annual turnover
of US$146 million (Rs 9.92 billion) or more, or a net profit of US$732,654 (Rs 50 million) or
more during a financial year, shall earmark 2 percent of average net profits of three years
towards CSR.

253
In the draft Companies Bill, 2009, the CSR clause was voluntary, though it was mandatory for
companies to disclose their CSR spending to shareholders. It is also mandatory that company
boards should have at least one female member.

CSR has been defined under the CSR rules, which includes but is not limited to:

Projects related to activities specified in the Schedule; or Projects related to activities taken by
the company board as recommended by the CSR Committee, provided those activities cover
items listed in the Schedule. Examples in India:

• Tata Group: The Tata Group conglomerate in India carries out various CSR projects, most
of which are community improvement and poverty alleviation programs. Through self-help
groups, it is engaged in women empowerment activities, income generation, rural
community development, and other social welfare programs. In the field of education, the
Tata Group provides scholarships and endowments for numerous institutions. The group
also engages in healthcare projects such as facilitation of child education, immunization and
creation of awareness of AIDS. Other areas include economic empowerment through
agriculture programs, environment protection, providing sport scholarships, and
infrastructure development such as hospitals, research centers, educational institutions,
sports academy, and cultural centers.
• Ultratech Cement: Ultratech Cement, India’s biggest cement company is involved in social
work across 407 villages in the country aiming to create sustainability and self-reliance. Its
CSR activities focus on healthcare and family welfare programs, education, infrastructure,
environment, social welfare, and sustainable livelihood. The company has organized
medical camps, immunization programs, sanitization programs, school enrollment,
plantation drives, water conservation programs, industrial training, and organic farming
programs.
• Mahindra & Mahindra: Indian automobile manufacturer Mahindra & Mahindra (M&M)
established the K. C. Mahindra Education Trust in 1954, followed by Mahindra Foundation
in 1969 with the purpose of promoting education. The company primarily focuses on
education programs to assist economically and socially disadvantaged communities. CSR
programs invest in scholarships and grants, livelihood training, healthcare for remote areas,
water conservation, and disaster relief programs. M&M runs programs such as Nanhi Kali
focusing on girl education, Mahindra Pride Schools for industrial training, and Lifeline
Express for healthcare services in remote areas.
• ITC Group: ITC Group, a conglomerate with business interests across hotels, FMCG,
agriculture, IT, and packaging sectors has been focusing on creating sustainable livelihood
and environment protection programs. The company has been able to generate sustainable
livelihood opportunities for six million people through its CSR activities. Their e-Choupal
program, which aims to connect rural farmers through the internet for procuring agriculture
products, covers 40,000 villages and over four million farmers. Its social and farm forestry
program assists farmers in converting wasteland to pulpwood plantations. Social
254
 empowerment programs through micro-enterprises or loans have created sustainable
livelihoods for over 40,000 rural women.

Methodology of Corporate Social Responsibility in India

CSR is the procedure of assessing an organization’s impact on society and evaluating their
responsibilities. It begins with an assessment of the following aspects of each business:

• Customers;
• Suppliers;
• Environment;
• Communities; and,
• Employees.

The most effective CSR plans ensure that while organizations comply with legislation, their
investments also respect the growth and development of marginalized communities and the
environment. CSR should also be sustainable – involving activities that an organization can
uphold without negatively affecting their business goals. Organizations in India have been quite
sensible in taking up CSR initiatives and integrating them into their business processes.

It has become progressively projected in the Indian corporate setting because organizations have
recognized that besides growing their businesses, it is also important to shape responsible and
supportable relationships with the community at large. Companies now have specific
departments and teams that develop specific policies, strategies, and goals for their CSR
programs and set separate budgets to support them. Most of the time, these programs are based
on well-defined social beliefs or are carefully aligned with the companies’ business domain.

12.13 Self-Assessment Questions

True and False Questions:

Indicate whether the following statements are true or false:

a) Corporate social responsibility covers a wide range of issues and could include climate
change, poverty and political donations.
b) Only for-profit organizations have to worry about ethics scandals and social
responsibility issues.
c) There are three dimensions of social responsibility: economic, legal, and ethical
d) Voluntary responsibilities are optional activities that promote human welfare or
goodwill.
e) Corporate citizenship is the extent to which businesses meet the legal, ethical, economic,
and voluntary responsibilities placed on them by their owners
255
Answers: a (T), b (T), c (T), d (T), e (T)

Long Answer Questions

Q1.Discuss the environmental aspect of CSR and throw light on the environmental problems?

Q2.There is many CSR initiatives, principles, codes and standards worldwide giving the
guidelines in this context. Explain briefly some prominent guidelines.

256
 Suggested Readings

1. Mallin, Christine A., Corporate Governance (Indian Edition), Oxford University Press,
New Delhi.
2. Blowfield, Michael, and Alan Murray, Corporate Responsibility, Oxford
UniversityPress.
3. Francesco Perrini, Stefano, and Antonio Tencati, Developing Corporate Social
Responsibility-A European Perspective, Edward Elgar.
4. Sharma, J.P., Corporate Governance, Business Ethics & CSR, Ane Books Pvt Ltd, New
Delhi.
5. Sharma, J.P., Corporate Governance and Social Responsibility of Business, Ane Books
Pvt. Ltd, New Delhi.

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