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Corporate Governance
Theories and Models
1. Agency Theory
Agency theory suggests that the firm can be viewed as a nexus of contracts (loosely
defined) between resource holders. An agency relationship arises whenever one or more
individuals, called principals, hire one or more other individuals, called agents, to
perform some service and then delegate decision-making authority to the agents
The separation of ownership and control
Costs of share-holders
management conflict
When agency occurs it also tends to give rise to agency costs, which are expenses incurred in
order to sustain an effective agency relationship.
Agency costs - Agency costs are defined as those costs borne by shareholders to encourage
managers to maximize shareholder wealth rather than behave in their own self-interests
There are three major types of agency costs:
expenditures to monitor managerial activities, such as audit costs;
expenditures to structure the organization in a way that will limit undesirable managerial behavior,
such as appointing outside members to the board of directors or restructuring the company's business
units and management hierarchy;
Opportunity costs which are incurred when shareholder-imposed restrictions, such as requirements for
shareholder votes on specific issues, limit the ability of managers to take actions that advance
shareholder wealth.
price changes. In this case, agency costs will be low because managers have great
incentives to maximize shareholder wealth. It would be extremely difficult, however,
to hire talented managers under these contractual terms because the firm's
earnings would be affected by economic events that are not under managerial
control. At the other extreme, stockholders could monitor every managerial action,
but this would be extremely costly and inefficient. The optimal solution lies between
the extremes, where executive compensation is tied to performance, but some
monitoring is also undertaken.
An effectively structured board
Compensation contracts that encourage a shareholder orientation (Performance-based
incentive plans)
Concentrated ownership for Close monitoring & Direct intervention by shareholders,
The threat of firing
Agency theory thus advocates the managers have their self-interest &
should be controlled & closely monitored to avoid agency loss
The steward realises the trade-off between his personal & organizational objectives. &
belevies that by working towards organizational & collective ends, these personal
needs are met. Managers are viewed as loyal to the company and interested in
achieving high performance. The dominant motive, which directs managers to
accomplish their job, is their desire to perform excellently. Specifically, managers are
conceived as being motivated by a need to achieve, to gain intrinsic satisfaction
through successfully performing inherently challenging work, to exercise responsibility
and authority, and thereby to gain recognition from peers and bosses. Therefore, there
are non-financial motivators for managers.
If the executives motivations fit the model of man underlying stewardship theory,
empowering governance structures are appropriate. He or she can be trusted. In this
case the so called agency costs are diminished
So, why isnt there always a steward relationship, rather than an agency relationship?
The answer lies in the risks that principals are willing to assume. Within the
governance contract, owners must decide how much risk they are willing to assume
with their wealth. Implementing stewardship governance mechanisms for an agent
would be analogous to turning the hen house over to the fox
3.Stakeholders theory
Definition of Stakeholders those of group without whose support the organization
will cease to exist.
Stakeholder theory stresses that the firm is a system of stakeholders operating within
a larger system of the host society that provides the necessary legal & market
infrastructure for the firms activities
The purpose of the firm is to create wealth or value for its stakeholders
Corporations should not be regarded as bundle of assets that belong to shareholders
but rather as institutional arrangements for governing the relationships between all
of the parties that contribute firm-specific assets. This includes not only
shareholders, but also long-term employees who develop specialized skills of value to
the corporation & suppliers, customers & others who make specialized investments.
This approach to corporate governance strongly suggests that corporations are run
by loosely defined groups of people, each seeking something different from the
organization
Stakeholders have different goals and seek different benefits from the firm. Workers seek job
security, the government wants its tax payments, investors want dividends, and the
community wants a solid economic base. The stakeholder theory holds that these different
interests do, in fact, control the firm in their own specific ways, and none has any better right
to have its voice heard than any other.
It mandates that a well organized firm will take all stakeholder groups into account in
formulating basic policies.
Stakeholder theory is a highly democratic and participatory concept of corporate governance.
Under this model, the firm is not merely a profit-making machine for elite investors and major
executives. Thousands of lives are potentially connected to and dependent upon the proper
workings of the firm.
Problems : The groups mentioned as possible or actual stakeholders are so varied and wide
that it is practically impossible that they speak with a common voice, let alone actually serve
in an oversight capacity. The stakeholder theory might be successful in identifying those who
have a vested interest in the firm, but whether these stakeholders can actually run; a firm is a
very different matter.
Be & cg
Topic 4 Cadbury committee report
1. Board of Directors
The board should meet regularly, retain full and effective control over the
company and monitor the executive management.
There should be a clearly accepted division of responsibilities at the head
of a company, which will ensure a balance of power and authority, such
that no one individual has unfettered powers of decision.
Ideally the role of chairman & chief executive should be separated, if not,
it is essential that there should be a strong and independent element on
the board, with a recognized senior member.
Besides, all directors should have access to the advice and services of
the company secretary, who is responsible to the Board for ensuring that
board procedures are followed and that applicable rules and regulations
are complied with.
2. Non-Executive Directors
The non-executive directors should bring an
independent judgment to bear on issues of strategy,
performance, resources, including key appointments,
and standards of conduct.
The majority of non-executive directors should be
independent of management and free from any
business or other relationship which could materially
interfere with the exercise of their independent
judgment, apart from their fees and shareholding.
Non-executive directors should be appointed by a
formal process. Appointments should be for specified
3. Executive Directors
Directors service contract should not exceed 3 year
without shareholders approval
There should be full and clear disclosure of directors
total emoluments and those of the chairman and
highest-paid directors, including pension contributions
and stock options, in the company's annual report,
including separate figures for salary and performancerelated pay.
4. Financial Reporting
and Controls
It is the duty of the board to present a balanced and
understandable assessment of their companys
position, in reporting of financial statements, for
providing true and fair picture of financial reporting.
The directors should report that the business is a going
concern, with supporting assumptions or qualifications
as necessary.
The board should ensure that an objective and
professional relationship is maintained with the
auditors.
Ii role of Auditors
The annual audit is one of the cornerstones of corporate governance. It provides an
external and objective check on the way in which the financial statements have been
prepared and presented by the directors of the company.
The Cadbury Committee recommended that a professional and objective relationship
between the board of directors and auditors should be maintained, so as to provide to all
a true and fair view of company's financial statements.
Auditors' role is to design audit in such a manner so that it provide a reasonable
assurance that the financial statements are free of material misstatements
Further, there is a need to develop more effective accounting standards, which provide
important reference points against which auditors exercise their professional judgement.
Every listed company should form an audit committee which gives the auditors direct
access to the non-executive members of the board.
The Committee further recommended for a regular rotation of audit partners to prevent
unhealthy relationship between auditors and the management.
It also recommended for disclosure of payments to the auditors for non-audit services to
the company.
The Accountancy Profession, in conjunction with representatives of preparers of accounts,
should take the lead in:- (i) developing a set of criteria for assessing effectiveness; (ii)
developing guidance for companies on the form in which directors should report; and (iii)
developing guidance for auditors on relevant audit procedures and the form in which
auditors should report. However, it should continue to improve its standards and
procedures.
Be & cg
Topic 5 Sarbanes Oxley Act (2002)
7. The Act requires that the principal executive officer or officers and the principal
financial officer or officers, or persons performing similar functions, to certify that the
financial statements accurately and fairly represent the financial condition and results
of operations of the company, in each annual or quarterly report filed or submitted.
8. The Act requires rapid disclosure of material changes in the financial conditions or
operations of the firm, which may include trend and qualitative information and
graphic presentations, as necessary or useful for the protection of investors and in
the public interest.
Be & cg
Topic 6 Legal & ORGANIZATIONAL Framework FOR
c.g. & committee reports
Legal framework
An effective regulatory and legal framework is indispensable for the
proper and sustained growth of the company.
The important legislations for regulating the entire corporate
structure and for dealing with various aspects of governance in
companies are Companies Act, 1956 and Companies Bill, 2004.
These laws have been introduced and amended, from time to time,
to bring more transparency and accountability in the provisions of
corporate governance.
Secondly, the Securities Contracts (Regulation) Act, 1956, Securities
and Exchange Board of India Act, 1992 and Depositories Act, 1996
have been introduced by SEBI
Sebi acts
Securities Contracts (Regulation) Act, 1956
Securities and Exchange Board of India Act, 1992
Depositories Act, 1996
ORGANIZATIONAL FRAMEWORK
The organizational framework for corporate governance initiatives in India consists of
the Ministry of of Corporate Affairs (MCA) and
the Securities and Exchange Board of India (SEBI).
The first formal regulatory framework for listed companies specifically for corporate
governance was established by the SEBI in February 2000, following the
recommendations of Kumarmangalam Birla Committee Report.
The Ministry of of Corporate Affairs had also appointed a Naresh Chandra Committee
on Corporate Audit and Governance in 2002 in order to examine various corporate
governance issues.
It had also set up a National Foundation for Corporate Governance (NFCG) in
association with the CII, ICAI and ICSI as a not-for-profit trust to provide a platform to
deliberate on issues relating to good corporate governance
Board of Directors
Audit committee
Remuneration of Directors
Board procedures
Management
Shareholders
Report on Corporate Governance
Compliance
A management Discussion & analysis report should form a part of the annual report to the
shareholders.
The report will include the following points, within limits set by companys competitive position
Kumar manglam
birla committee
Shareholders
Shareholders/investors grievance committee to be formed
Report on Corporate Governance
In annual report of the company a separate section on Corporate Governance.
Non compliance with any mandatory requirement will be highlighted there
Compliance
Statutory Auditors shall give a compliance certificate regarding condition of
corporate governance
This certificate will be sent along with annual returns to the stock exchange
Preeta Mam
Business Ethics
The standards of conduct and moral values governing actions and decisions in
the work environment.
Social responsibility.
Balance between whats right and whats profitable.
Often no clear-cut choices.
Often shaped by the organizations ethical climate.
VALUES
Values are a general term referring to those things which people
regard as good, bad, right, wrong, desirable, justifiable et c
Values describe what is important in a persons life while ethics
and morals what is appropriate in or is not considered in ones
life.
Values are potent source of conflict as well as of co-operation,
control and self-control.
Values are collective representations of what constitutes a good
society.
Values are potent sources of conflict as well as of co-operation,
control and self-control. Through values, business can and does
create value in the form of goods, service, employment etc.
However in extreme cases business and whole industries can
cease to function because their continued existence is
inconsistent with certain powerful values.
TYPES OF VALUES
Values are many types.
1. Cultural norms (represent the expectations of
business
clients
and
customers,
legislators,
employee, suppliers and the public)
2. Moral values-These are deep-seated ideas and
feelings that manifest themselves as behavior or
conduct. These values are not so easy to measure or
express in words.
TATA Steel
The five core Tata values are:
Integrity
Understanding
Excellence
Unity
responsibility
NORMS
Norms are expectations of proper behavior, not
requirements for that behaviors. Each individual within
the society has a set of norms, belief and values that
together form his or her moral standard.
Norms are the ways an individual expects all people to
act, when faced with a given situation.
Eg: Asian students normally bend slightly while addressing
professors of the other university.
Lower level employees address the higher level employee as
sir.
Belief
The belief in an ethical code are standards of thought.
These are the ways that the senior executives in an
organisation want others to think. The intention is to
encourage ways of thinking and patterns of attitudes
that will pave way towards the wanted behaviour.It is
expressed in a positive form in an ethical code.
MORALITY
Morality can be defined as the standards that an individual or a group has
about
what
is
right
and
wrong
or
good
and
evil.
1.
How to distinguish moral standards from standards that are not moral?
Ethicists suggested five characteristics to identify moral standards.
Moral standards deal with matters which people think can seriously
injure or seriously benefit human beings.
2.
3.
Moral standards are preferred to other standards including even selfinterest when choice is there.
4.
Moral standards are impartial. They are based on impartial reasons that
an impartial observer would accept.
5.
Moral standards are associated with special emotions. When people act
in violation of a moral standard, they feel guilty, ashamed and