CORPORATE GOVERNANCE

Definition: Corporate Governance deals with laws, procedures, practices and

implicit rules that determine a company’s ability to take managerial
decisions viz. a viz. its claimants- in particular its shareholders, its creditors,
its customers, the State and employees. There is a global consensus about
the objective of “good Corporate Governance: maximizing long term
shareholder value(return on shareholder investment). Since shareholders are
residual claimants(they get their return after every shareholder group gets
their respective claims), this objective follows from a premise, that in well
performing capital and financial markets, whatever maximizes shareholder
value must necessarily maximize corporate prosperity and best satisfy the
claims of creditors, employees, customers, vendors, associates, regulatory
agencies including the government, and the larger societal environment in
which the firm operates. However the major priority is still given to
shareholders and creditors by most institutions in most countries that are
responsible for developing guidelines on this relatively recent area of
business focus. In India the prevailing guidelines have emerged from the
recommendations of Confederation of Indian Industries(C.I.I. code 1998),
and the Securities and Exchange Bureau of India(SEBI code 1999) which
have been formally incorporated in clause 49 of the official SEBI rules
which deals with compliance requirements of both listed companies and
companies applying for listing.

Coverage of Corporate Governance

Board of Directors: Single tier board(unlike two tier board in which the
second tier has worker and union representation which is mandatory in
Germany). A minimum of 6 board meetings to be held in a year for a at least
½ day per meeting. Outside professionals as independent directors. A
minimum number of outside directors is specified for companies with a
turnover equal to or exceeding Rs. 100 Crores. There are restrictions as to
the maximum no of directorships an individual can hold( this figure is
currently 16). Non executive directors are expected to become active
participants on matters such as board formation, audit committees, required
to be financially literate in the case of non executive directors. Issues that
have to be addressed and settled include remuneration of directors including
Independent non executive directors specifically sitting fees, commission
fees and stock options for executive directors. Minimum attendance
requirements at board meetings are also specified. Key information to be
publicly disclosed include annual operating plans and budgets, manpower
and Overhead budgets. A further set of requirements concern disclosures
both financial and non financial. Interests of Directors register has to be
maintained which records details of individual director’s interest in any
contracts or arrangements of the company. Other requirements include
details of share price movements or the company, consolidation of group
accounts and standards of disclosures(e.g. disclosure regarding planned
capital instruments such as equity issue of G.D.R. issue)

The larger view of corporate governance: It is now commonly accepted that

every firm has and is answerable to its various stakeholder groups. We start
with a definition of who a stakeholder is. Any person or group who has both
a long term interest in and a long term commitment to a company can be
termed a stakeholder. While a shareholder who owns at any point of time
some shares in a company can be considered a stakeholder, it is only that or
those shareholders who invest in a company for the longer term who are
prepared to share the risk and the returns with other similar minded and
similar acting shareholders who can be considered true shareholder
stakeholders of the company. Similarly employees who while entertaining
reasonable expectations of competitive remuneration, congenial working
conditions, prospects for development and growth in the organization, with a
commitment to consider the longer term good and success of the company
and put in their best efforts to ensure both can be considered true employee
stakeholders. On the other hand individuals who buy and hold a company’s
shares for short term speculative gains and employees who only stay till the
next attractive offer of employment can not be viewed as true employee
stakeholders. This combination of long term interest and long term
commitment applies to every stakeholder category including vendors,
associates, creditors, regulatory agencies and the larger societal group. There
is only one exception to this requirement which is the customer. This
constituent starts off with no interest or commitment to the business
prospects of the company even in the short term. It is a measure of the
competitive capability of the company, as to how well it can capture the
short term interest of the prospective customer and persuade her to buy into
the marketing promises made by the company. It is even more a measure of
the sustained competitive ability of the company as to how long and how
well the customer persists in buying the company’s products/services. It is
only the truly satisfied customer who can be retained and expected to be
loyal to the company and its offerings.
It is interesting how simple and yet how true the above is. It applies not only
to the successful planning and implementation of Strategy but also the
application of Ethical principles of which Corporate Governance is a
significant element. If a company sets out to determine the rightful
expectations of each of its stakeholder groups and makes it its obligation to
meet these expectations it is bound to succeed in its business purpose which
is the maximization of profits in the long term.

To illustrate let us take the instance of the employee stakeholder group.

Employees have the rightful expectation to be rewarded financially and non
financially in a competitive manner. They expect congenial working
conditions both of a physical and socio psychological nature. A true
employee stakeholder would also look forward to development and growth
prospects in the company which would take her to higher levels of
achievement and self actualization. If the company accepted the fulfillment
of these expectations as its duty, it would not only benefit the employees but
would ensure highly motivated, high performing and extremely loyal
partners who would do their best to meet all the organizational goals in the
short, medium and long term. Similarly if vendor stakeholders are paid in a
timely and accurate manner, given reasonable supply lead times and are
made aware of the company’s plans for new products, capacity expansions
and acquisition of new technologies they will identify strongly with the
company and ensure timely and adequate supplies as also adhere to the
company’s quality specifications.

Why is it that so few companies in our country accept the simple larger
message of Corporate Governance while trumpeting their claims of good
Corporate Governance which is nothing but sound strategy. The Answer lies
in the unreal expectations that are prevalent which emphasize short term
performance. The tyranny of the quarterly results report which expects and
rewards improved performance on a quarterly basis puts pressure on firms to
not only misreport results, but encourages extremely short term initiatives
and responses. Examples can be found in every functional area of
management. Take the case of the marketing and sales function. Managers
are constantly expected to improve sales and market share over the previous
year and the previous quarter. Firms do not bother to determine actual sales
as represented by consumer offtake but restrict their efforts to pushing ever
increasing quantities of their products/ services on to their distributors and
dealers. This gives short term results in terms of increased sales and booked
profits but puts increasing inventory pressure on the trade associates and
results in knee jerk sales promotion schemes which dilute the firm’s
carefully built brand images and values. The much acclaimed Voluntary
Retirement Schemes launched and executed by domestic and foreign firms
on our country and abroad is another short sighted measure to reduce
employee numbers and thereby reduce costs. The intention is to get rid of
non performing employees in a painless way. What actually happens is that
performing employees leave, take the VRS benefits and join other
companies. On the other hand the non performers stay on in the company
and vitiate the mix between performers and non performers. The only
conceivable benefit is that the company can claim a short term reduction in
its employee costs. Examples can be taken from every functional area of
management including the finance and accounting function where delayed
payments to vendors are viewed as a smart way of activating zero cost
working capital. We all know that delayed payments will result in vendors
increasing their prices and diluting quality as well as developing
unsatisfactory loyalty all of which hurt the company in the long run.

In conclusion we can state that Corporate Governance concerns meeting the

rightful expectations of the true stakeholders belonging to the various
stakeholder groups and considering this as a duty and not as a favour or
option. If this is done keeping the long term as the right time frame it will
not only ensure the continuing commitment of stakeholders but will result in
maximizing the long term profits which are the ultimate purpose of business
and business firms. It is important that firms realize the spirit of Corporate
Governance as more important than the letter which is reflected in the
various codes and subsequent regulations covering business policy and
practice.

NOTE ON SOCIAL RESPONSIBILITY

The meaning of Social Responsibility: The objective of business is to

maximize long term profits in a competitive environment in the community
of people which is Society. For the firm its stakeholders comprise the
Society. Therefore the larger view of Social responsibility would constitute
the view of Corporate Governance which has been dealt with in the
preceding note. However conventionally, Social responsibility is held to
pertain to the larger community not directly interfacing with the company in
its business pursuits but impacted in less direct ways.
The main features of Corporate Social Responsibility are:

Behaviour by Businesses over and above the legal or statutory requirements

voluntary adopted because businesses deem it their duty and also in their
long term interests. As an example we may take the example of Timex
Watches Ltd in their manufacturing plant. The heat treatment process
featured the use of Potassium Cyanide a deadly poison. While the handling
of this chemical within the plant was meticulously carried out with no
danger to employees the handling of the effluent required specified chemical
treatment and release of the residue to drains and sewer systems outside the
plant. However a decision was taken by the management to bury the waste
within deep concrete pits specially constructed within the factory premises
to contain the treated waste within the four walls of the company. This is
only one instance of many socially responsible initiatives taken by the
company in the overall interests of the larger Societal group.

Corporate Social Responsibility is intrinsically linked to the concept of

Sustainable Development which emphasizes that acts by a responsible
individual or group in the interest of social or economic development should
consider the well being of both current and future generations. This is
particularly true in the area of use of natural resources like forests, water
sources and agricultural land. It considers all aspects of environmental
conservation and specifically concerned about contamination of large water
bodies and resource(dumping of effluents in rivers for instance),
unacceptable levels of polluting liquids and gases and degradation of prime
forest land and vegetation in the public domain. Erosion of mountain sides
in the interest of cultivation or setting up industrial units would also be
featuring as areas of concern. Here the important thing to note is that firms
in particular and industry and business in general are expected to behave in a
conscientious way rather than controlled through impositions through
statutes or regulations.

It is to be noted and accepted that Corporate Social Responsibility is not to

seen as a fashionable new area of interest or concern to responded to by
firms as an opportunity to gain publicity and goodwill by a few visible
gestures as setting up a garden at a traffic roundabout or planting a few trees
in the vicinity of their factories and offices. It should be seen as a mature and
comprehensive approach to meeting the long term expectations of
stakeholder groups who do not have direct involvement in the business
activities and outcomes of the firm but whose welfare and well being will
have long term impact on the firm’s business success.

References used in the preparation of these notes include

1. Corporate Governance (Modules of Best Practices- Institute of
Company Secretaries of India)
2. C.I.I Code for Corporate Governance 1998
3. SEBI Code for Corporate Governance 1999
4. OECD Development Centre- Corporate Governance in Developing
countries and emerging economies
5. The Tide Rises Gradually- Corporate Governance in India by Omkar
Goswami
CORPORATE GOVERNANCE
OECD DEVELOPMENT CENTRE
Corporate Governance in Developing Countries & Emerging Economies
The Tide Rises Gradually-Corporate Governance in India
by Omkar Goswami

Introduction: Historical backdrop: From 1900 to 1990 growth of Indian

Industry. Establishing stock exchanges, Managing Agency system, equity
culture body of corporate law and regulatory aspects of public and private
ltd. Companies. Various acts IDR Act 1951, Industrial Policy Resolution IPR
1956, the policy of “public sector to occupy the commanding heights”
MRTP set up in 1969. Corporate and Income tax structure. Development of
financial institutions. Combination of licensing, protection and quotas. High
gearing(leveraging of capital) and poor board level accountability created an
environment that did not punish poor corporate governance.

Structure of Corporate India. Old industry leaders have been upstaged by

more energetic ad progressive newcomers who are first generation
entrepreneurs or professionally run companies. Public limited companies
account for 2/3 of the total book value of equity and the Public sector
companies for 39% of paid up capital. Laws that govern Indian corporations
a) Indian companies Act consists of 7 parts including schedules, securities
contracts(regulation) Act 1956 marketable securities
b) Securities and Exchange Board of India (SEBI) Act 1992(Capital Market
Regulatory authority)
c) Sick Industrial Companies(special provisions) Act 1985(framework for
bankruptcy and restructuring)

3. Agency costs. Reasons for bankruptcies and scandals in U.S. business

separation of business separation of ownership and control large spread of
ownership. In Asia companies have high promoter share are highly
leveraged and cross handling is a significant feature. However undesirable
features include fixing election of board members, crony directors neglect of
minority shareholder complaints preferential equity allotment to promoters,
private deals at discounted prices

While Asian firms performed reasonably well financially and gave good
returns to their shareholders their corporate governance was not satisfactory.
Note Agency costs refer to the destruction of shareholder value through
managerial inefficiency and expropriation of minority shareholder rights,

4. The rights of Debt and Equity. Corporate control in India has greatly
improved with a well defined takeover code the debt side remains
unsatisfactory mainly due to ineffective bankruptcy laws and procedures
which are responsible for poor protection of creditors rights. Fundamental
flaws with the SICA- BIFR process include a) Late detection resulting in net
erosion of equity instead of early detection through debt default b) Lengthy
and cumbersome procedures (850 days for BIFR to arrive at a decision on
restructuring, cases sanctioned for restructuring 1660 days , cases
recommended for liquidation, 1460 days. c) indefinite stay on creditor
claims, d) Debtor in management possession e) violation of absolute priority
rule(senior creditors to be settled first)

Market for equity driven takeovers was not functioning efficiently till
SEBI’s substantial acquisition of shares and Takeover Code. Major
provisions include a) Disclosure: any individual or body corporate whose
shareholding crosses 5% to publicly disclose this fact to SEBI and the
relevant stock exchanges. B) trigger when a person’s shareholding crosses
10%, he/ they may have to make a public offer for an extra 20% of the
shares(trigger is now 15%) c) minimum offer price which should be the
average market price over the last 6 months d) creeping acquisition(existing
management is allowed to increase its holding through the secondary
market upto a max of 2% of subscribed and paid up equity per year. E)
escrow, there has to be an escrow account in which the acquirer has to
deposit 25% of the value of his total bid.
5.Quality and quantity of disclosures. Financial and non financial
disclosures mandated by Law a) statutorily audited annual accounts.
Listed companies have to be submitted to the stock exchanges where they
are listed.prepare abridged unaudited financial summaries every quarter.
They also have to submit a cash flow statement. A concern is loans from
subsidiaries a source for concern because of the risk of siphoning off of
funds. Sundry debtors is also a source of concern. One suggestion is for
the company to implement U.S. GAAP(generally accepted accounting
principles). Credit rating and ownership are 2 areas of concern.
Disclosures about directors. These should be detailed not aggregate and
should be done and made available annually . Comprehensive report on
relatives of directors, interest of directors in any contract or arrangement,
details of loans to directors, Insider trading to name a few critical issues.
6. Board of Directors. Independent directors number and functioning no.
of executive directors, constitution and membership of audit
committeese, sitting fees of non executive directors commission payable
to directors attendance record of directors max. directorships to be held
by an individual.
7. State owned enterprises. Constraints on appointment of senior
management personnel(only through Public Enterprise Selection
Board(PSEB),n reservations , interference from politicians bureaucrats,
Managers subject to criminal investigation by CVC and CBI. Solution is
systematic and transparent privatization.
8. Winds of Change. Recent corporate Governance initiatives
a) CII Code April 1998 focused on listed companies “ the objective of
good corporate governance is maximizing share holder value must
necessarily maximize corporate prosperity and best satisfy the claims of
creditors, employees, shareholders and the state.