Corporate Governance in Creating Responsible Organizations

Topics Covered
Definitions History of Corporate Governance Models of Corporate Governance Principles and Guidelines of Corporate Governance CSR and Issues in Corporate Governance Case Studies Challenges and Conclusion

DEFINITIONS
Corporate Governance is the system by which companies are directed and controlled Cadbury Report (UK), 1992 to do with Power and Accountability: who exercises power, on behalf of whom, how the exercise of power is controlled.
Sir Adrian Cadbury, in Reflections on Corporate Governance, Ernest Sykes Memorial Lecture, 1993

OECD Definition
Corporate governance involves a set of relationships between a companys management, its board, its shareholders and other stakeholders ..also the structure through which objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Preamble to the OECD Principles of Corporate Governance, 2004

Indian Definition
fundamental objective of corporate governance is the enhancement of the long-term shareholder value while at the same time protecting the interests of other stakeholders. SEBI (Kumar Mangalam Birla) Report on Corporate Governance, January, 2000

An Enterprises Triple Effect on Society

Sustainable Development Waste Control

Equal Opportunities Education & Culture Community Regeneration

Emissions Business Impact Energy Use Product Life-cycle Product Wealth Productive Ethical Value Generation Employment Trading

Economic

Human Rights Employee Volunteers

What is Corporate Governance?

The Manner in which a Corporation is Run Achieving its Objectives Transparency of its Operations Accountability & Reporting Good Corporate Citizenship The Processes & Operating Relationships that Best Achieve Organisational Goals

CORPORATE GOVERNANCE & CAPITAL MARKET DRIVERS: A CONCEPTUAL FRAMEWORK

REGULATION & LEGISLATION Regulators (SEBI/RBI) Government Legislation Stock Exchanges Listing Agreements

Lenders (Banks/ Depositors)

Listed Corporations (The Board & the Executive)

Shareholders/ Stakeholders

Market Operators (Rewards)

Institutional Investors Press/Media (Pension Funds/Insce Cos) (Opinion Makers)

Market Operations, Critique & Monitoring

Evolution of the corporate-governance structure

Beneficiaries Trustees of funds
Investors General assembly Investors General Assembly Ownerss representatives Executive management Board (Directors) Executive commity

Invetment funds

General assembly
Board Executive managers Managers 2000

Ownermanager 1800

1900

1950

History of Corporate Governance

Unlike South-East and East Asia, the corporate governance initiative in India was not triggered by any serious nationwide financial, banking and economic collapse Also, unlike most OECD countries, the initiative in India was initially driven by an industry association, the Confederation of Indian Industry

History of Corp Governance in India

1956 Companies Act: Limited governance and disclosure standards 1992 Formation of SEBI (Securities and Exchange Board of India) 1998 CII (Confederation of Indian Industry), Indias largest industry and business association comes up with the first voluntary code of corporate governance 1999 SEBI sets up a commitee for good corporate governance under Kumar Mangalam Birla 2000 SEBI ratifies the commitees key recommendation and integrates them in clause 49 of the Listing Agreement 2002 Establishment of the Narash Chandra commitee to examine various governance issues 2006 Revision of clause 49 2008 Introduction of the Companies bill

2011 Reintroduction of revised Companies bill after Satyam scandal

MODELS OF CORPORATE GOVERNANCE

Need for Corporate Governance model

Good corporate governance is very important for economic development Therefore, quality of governance should be continuously improved Thus to measure the quality we need a model

Existing Models
Many different models of corporate governance around the world

Models of Corporate Governance

The process is dynamic since the corporate governance structure in each country develops in response to country-specific factors and conditions These differ according to the variety of capitalism in which they are embedded Developed Countries : a. b. c. Anglo-US model The Japanese model The German model

Anglo-US Model
Developed within the context of the free market economy, assumes the separation of ownership and control in most publiclyheld corporations .
outsider model arms length investor Internal governance mechanisms
board of directors, elected by shareholders

External mechanisms
market for corporate control monitoring by financial institutions competition in product and input market

Reliance on legal mechanisms to protect shareholder rights Short term financial performance key

THE GERMAN MODEL

Co-determination - partnership between capital and labor Social cooperation The two-tier board structure that consists of a supervisory board and executive board greater efficiency in separation of supervision and management Crossshareholding in financial industrial groups Role of banks as major shareholders Primary sources of capital retained earnings and loans

THE JAPANESE MODEL

Concentrated Ownership The observation that there is little separation between ownership and control Holding structures and reorganizations used to deny free exercise of ownership rights

Inexperienced Directors
Government Intervention

THE INDIAN MODEL

India has been rather slow in establishing corporate governance principles over the last two decades Indias SEBI committee proposed that the management consider the shareholders as the actual owner of the corporation and consider themselves as trustees. It is about commitment to values, about ethical business conduct. Indian approach is drawn from the Gandhian principle of trusteeship and the Directive Principles of the Indian Constitution which is also prevalent in Anglo US and other jurisdiction.

Constituents of Corp Governance

The Board of Directors (BoD) Pivotal role Accountable to stakeholders Directs management The Shareholders & Stakeholders To participate in appointment of directors To hold the BoD accountable for governance through proper disclosures The Management To act on the direction of the BoD To provide requisite information to the BoD for decision making To implement and monitor control systems

Principles of Corporate Governance

Principles of corporate governance

Ensuring the Basis for an Effective Corporate Governance Framework The Rights of Shareholders and Key Ownership Functions The Equitable Treatment of Shareholders The Role of Stakeholders in Corporate Governance Disclosure and Transparency The Responsibilities of the Board

Laws and regulations

In India Clause 49 It lays down guidelines for composition of the board including the number and qualities of independent directors, code of conduct, and the constitution of various committees (including audit), disclosures and suggested contents of annual reports. In UK Bribery Act (2010) The Act has been described as "the toughest anti-corruption legislation in the world", raising the bar above the standard set by the United States Foreign Corrupt Practices Act. Sections include General bribery offences, bribery of foreign public officials and failure of commercial organizations to prevent bribery and Prosecution & penalties. In USA Sarbanes-Oxley Act (2002)

The act contains 11 titles, or sections, ranging from additional corporate board responsibilities to criminal penalties, and requires the Securities and Exchange Commission (SEC) to implement rulings on requirements to comply with the law. Sarbanes-Oxley Act-type laws have been subsequently enacted in Japan, Germany, France, Italy, Australia, Israel, South Africa, and Turkey.

Are all Corporate Governance Systems similar?

Diversity in Corporate Governance

National, regional and cultural differences Ownership structure and dispersion The industry and market environment of the corporation Firm size and structure Life cycle variations including origin & development, technology & periodic crises and new directions

Code/Guidelines of Corporate Governance in India

Board of Directors
Appointment of Board of Directors Companies should issue formal letters of appointment to Non-Executive Directors (NEDs) and Independent Directors Such formal letter should form a part of the disclosure to shareholders. The roles and offices of Chairman and CEO should be separated, as far as possible, to promote balance of power. Nomination committee The companies may have a Nomination Committee comprising of majority of Independent Directors, including its Chairman Committee to ensure balance of ED and NED and to recommend appointment of ED

Board of Directors
Remuneration Committee and Remuneration to NED/ED
Extensive limitations and guidelines on remuneration to Directors Remuneration Committee to be formed should have responsibility for determining the remuneration for all executive directors and the executive chairman, including any compensation payments, such as retirement benefits or stock options.

Independent Directors
Limit of independent directorship to 7 companies if he/she is MD or WTD of a Public Limited All Independent Directors should provide a detailed Certificate of Independence at the time of their appointment An Individual may not remain as an Independent Director in a company for more than six years A period of three years should elapse before such an individual is inducted in the same company in any capacity

No individual may be allowed to have more than three tenures as Independent Director
NED should have the option and freedom to interact with the company management periodically.

Audit Committee - Constitution, Power and Roles At least 3 member ACB with ID as majority and Chairman to be independent too. All the members of audit committee should have knowledge of financial management, audit or accounts ACB to have power to have support, seek external assistance and access to information ACB to be part of the auditor interaction, appointment of auditors etc., Secretarial Audit

To ensure that the Board's business processes and compliance mechanism are working, Secretarial audit to be undertaken by a competent authority
The Board should give its comments on the Secretarial Audit in its report to the shareholders. Mechanism for Whistle Blowing Mechanism for employees to report concerns about unethical behaviour, actual or suspected fraud, or violation of the company's code of conduct or ethics policy.

Corporate Social Responsibilities and Issues of Corporate Governance

Corporate social responsibility

The Corporate Social Responsibilities Policy should normally cover following core elements: Care for all Stakeholders

Ethical functioning
Respect for Workers' Rights and Welfare Respect for Human Rights Respect for Environment Activities for Social and Inclusive Development

Issues in corporate governance

Value based corporate culture: For any organization to run in effective way, it needs to have certain ethics, values. Long run business needs to have value based corporate culture. Compliance with laws

Absence of Disclosure, transparency, and accountability: Disclosure, transparency and accountability are important aspect for good governance
Improper Human Resource Management Illegal Insider Trading Misleading Financial Statements Ownership-Management Separation

Case Studies

Barings Bank
Established in 1768 in London, England Britain's oldest merchant bank, one of the oldest in the world. Some of its landmark dealings include the 1802 Louisiana purchase, purchasing foodstuff for the starving millions during the great Irish famine, liquidating assets of the British empire during world war 2. Was the personal banker of united states government and the British monarchy for a number of years

Barings Bank collapse in 1995

The activities of Nick Leeson, its head derivatives trader on the Japanese and Singapore futures exchanges led to the downfall of Barings. Internal auditing: Barings short-circuited normal accounting and internal control/audit safeguards. In effect, Leeson was able to operate with no supervision Corruption: Because of the absence of oversight, Leeson was able to make seemingly small gambles in the futures arbitrage market at Barings Futures Singapore and cover for his shortfalls by reporting losses as gains to Barings in London

Kobe earthquake: His luck ran out when the Kobe earthquake sent the Asian financial marketsand with them, Leeson's investmentsinto a tailspin

Barings Bank collapse : Aftermath

Leeson's activities had generated losses totalling 827 million (US$1.3 billion), twice the bank's available trading capital. The collapse cost another 100 million ING, a Dutch bank, purchased Barings Bank in 1995 for the nominal sum of 1and assumed all of Barings' liabilities, forming the subsidiary ING Barings. Leeson was eventually sentenced to six and a half years in prison in Singapore

The Satyam Scandal

Satyam was established in 1987 4th largest IT company in India. 9% market share 53,000 employees Revenue $2.1billion First Indian company to be listed in three International Exchanges: NYSE, DOW and

EURONEXT and boasted 185 Fortune 500

companies on its client list Satyam share price was Rs.139.15

The Satyam Scandal

Overstated assets on Satyam's balance sheet by $1.47 billion Satyam overstated income nearly every quarter over the course of several years. The results announced on October 17, 2009 overstated quarterly revenues by 75 percent and profits by 97 percent. The global head of internal audit also forged board resolutions and illegally obtained loans for the company. 13000 fake salary accounts The company's global head of internal audit created fake customer identities and generated fake invoices against their names to inflate revenue

The Satyam Scandal Confession and Aftermaths

The CEO was convinced that the gap in the balance sheets reached an unmanageable heights and could not be filled in future by any means.

Satyam Computer crashed by Rs 139.15 or 77.69 per cent to close at Rs 39.95, after the Chairman`s confession
Bombay stock exchange fell 700 points

The declining Sensex recorded the biggest singleday loss in the past two months, after Satyam Computers Services, the country's fourth-largest software developer, plunged around 80 per cent.

The Satyam Scandal: its Impact on IT industry

It made more difficult for other Indian IT service players to win business. Undoubtedly, it hurt the prospects of foreign money flowing into India. Global perception about Indian companies.

Satyam Scandal: Why did it happen ?

Ambitious growth drive Audit Failure Deceptive reporting practices: Lack of transparency ESOP`s issued to those who prepared fake bills Excessive interest in maintaining stock prices High risk deals that went sour Above all, greed and lack of ethical values

SATYAM SCANDAL

LEHMAN BROTHERS SCANDAL

WORLDCOM SCANDAL

ENRON SCANDAL

WASTE MANAGEMENT SCANDAL

Some other Failures

No. 1 2 3 4 Company Name Enron WorldCom Tyco Global Crossing Country USA USA USA USA Observable Causes of Failure Inflated earnings Expenses booked as capital expenditure Looting by CEO, improper share deals Inflated corporate profits to defraud investors

5 6 7

Royal Ahold Parmalat Wal-Mart

Netherlands Italy USA

Earnings overstated False transaction recorded Weaknesses in internal controls have led to government investigations and class action lawsuits by employees. Accelerated revenue recognition

Xerox

USA

The stories of corporate disasters

Ineffective board

Inadequate control environment

Poor strategy

Dominant CEO (one man show)

Conformist culture

Ill-judged acquisitions, over-expansions

Greed, hubris, irresponsibility

Accidental external trigger

Disaster

Inadequate control environment

Lessons to be learnt
Rotation of auditing firms Joint auditors to audit a company beyond a certain size Strengthening of quality review Internal audit of financials by an external firm Composition of Boards and quality and qualification of independent directors Criteria for remuneration to key personnel Education on ethical values

The major challenges to corporate governance reforms in India

Power of the dominant shareholder Lack of incentives for companies to implement corporate governance reforms Underdeveloped external monitoring systems

Shortage of real independent directors

Weak regulatory oversight including multiple regulators

Conclusions
A transparent and timely communication between those who are involved in decision making process must be the first tool that can prevent cases of failure. The link between information and fraud prevention must go beyond the particular mode of corporate governance chosen, organizational structure and control mechanisms applied. the regulations remain ineffective if there is not a tandem with organizational culture, supported by strong ethical principles

Conclusions
Possible ways to avoid future cases of collapse may be the following : Separation of powers of the Chairman and CEO. Each has to activate on its own pathway, otherwise we could reach a situation of excessive concentration of power and control capabilities of the supervisory board to be diluted.

Integrity and missing of conflict of interest between managers, that should not target capital gains from the position they occupy, rather than wage remuneration they deserve.
The existence of a strict flow of information so that decision-makers, have to receive timely and adequate information to perform their duties. Drawing concrete tasks and functions, especially in management teams, where decisions require a sustained effort and a great responsibility.

References
http://business.gov.in/corporate_governance/index.php http://www.bms.co.in/explain-the-models-of-corporate-governance/ OECD PRINCIPLES OF CORPORATE GOVERNANCE -2004 http://newsdawn.blogspot.in/2012/01/corporate-governance-in-indiaaims-and.html Corporate Voluntary Guidelines-2009 (Ministry of Corporate Affairs India) The Divergent Corporate Governance Standards and the Need for Universally Acceptable Governance Practices Syeedun Nisa,Khursid Anwar Warsi http://www.ritholtz.com/blog/2013/03/worst-corp-scandals/#more-90147 http://www.karvy.com/articles/baringsdebacle.htm