Corporate Governance

MBA T 5
SaintGits

Satheesh Kumar T.N.

What do you understand by the term, Corporate
Governance?
Or Governance in general?
Definition
Different definitions exist; as time passes by they have been
made more specific;
“Corporate Governance is an umbrella term that includes
specific issues arising from interactions among senior
management, shareholders, boards of directors and other
corporate stakeholders.”
Philip Cochran & Stevan Wartick, 1988
”CG deals with the appropriate board structures, processes
and values to cope with the rapidly changing demands of
both shareholders and stakeholders in and around their
enterprises”
Bob Garratt in Thin On Top, 2003
Why needed?
Corporations/ companies have been created as entities for
infinite existence, capable of doing lots of things just like an
individual can indulge in lot of activities.
But, we know that it doesn’t have life of its own; somebody
has to inject life to it.

Who will inject life to a corporation?

The moment it is established, you need to give it life and

somebody has to ensure that it carries out its activities
according to the demands on the entity; also every
employee can’t be expected to be accountable for what the
company does; so, a body with accountability is required.
The board has to ensure that the entity survives first,
makes good use of its various resources, adopt practices
and processes that will ensure its well-being; keep all the
stakeholders satisfied.
 The term corporate governance has been in vogue only for
nearly four decades, but the basic concept of the
governance was in existence even from centuries earlier.
W r t our country, Chanakya(Kautilya)‘s Arthshasthra
maintained that for good governance, all administrators,
including the king were considered servants of the people.
Note: Governance is different from management
Management’s job is to maximize the utilization of
resources under its control so as to achieve the
physical objectives and long term goals of the
organization; or the management will mostly be
concerned about efficiency.
Governance, on the other hand, will ensure that the
entity is achieving its objectives or goals according
to the laws, regulations and norms specified by
authorities, communities and society at large; or
the governance will mostly be concerned about
effectiveness.
 Kautilya elaborates on the fourfold duty of a king as
• Raksha - literally means protection; in the corporate
scenario it can be equated with the risk management
aspect.
• Vriddhi - literally means growth which in the present day
context can be equated to stakeholder value enhancement.
• Palana - literally means maintenance/ compliance, in the
present day context it can be equated to compliance to the
law in letter and spirit.
• Yogakshema - literally means well being and in Kautilya’s
Arthshastra it is used in context of a social security system.
In the present day context it can be equated to corporate
social responsibility.
Eight elements of good corporate governance(refer)
1. Rule of Law
2. Transparency
3. Responsiveness
4. Consensus Oriented
5. Equity and Inclusiveness
6. Effectiveness and Efficiency
7. Accountability
8. Participation
Theories of CG is based on the concept of Fiduciary
Duty or Responsibility
Board’s primary duty or responsibility is as a fiduciary.
Fiduciary means a person to whom property or power is
entrusted for the benefit of another. It literally means to
use the power vested on one to responsibly act on behalf
of somebody else.
 Corporate governance theories
 Considering the structural processes of the corporate form
and the fiduciary responsibilities which the directors and
boards have to execute, various theories have been
evolved.
 The evolution of the theoretical approach in CG reflected
the evolution of management theories; hence, these
theories are drawn from a variety of disciplines: economics,
finance, accounting, law, organizational behaviour etc.
 Over a period of about 30-40 years ever since the corporate
governance assumed importance and started receiving
attention, a number of theories have been evolved.
 Agency Theory :developed by Michael Jensen and William
Meckling;the owners are content with the ownership and
control over the assets and resources of the company are in the
hands of managers who by convention need not hold any stake
in the company.(In the US, this is the usual scenario but in India,
the scenario is different; major stakes are with promoters who
get actively involved in the management of the firm.) The tacit
understanding arising out of the convention is that the
managers will act as agents of the principals-the owners or the
shareholders of the company.
Pitfalls :
 The agent always may not act in the best interests of the
principal; the agent being a human being with his/her own
ambitions might try to further their selfish motives rather than
safeguard the interests of the principal.
 A standard principal-agency relationship is governed by
contracts, but when is applied to a corporation context, such a
contract is missing as it is not easy to write and enforce a
contract due to various reasons; (Refer note)
 The theory has been severely criticized by management pundits
like late Sumantra Ghoshal and Peter Moran; the theory
assumes that all that stakeholders and managers do has only
one premise: economical;
 In countries like India, the demarcation between the principal
and the agent is blurred or does not exist.
 Stakeholder Theory :corporations have been concentrating on
value maximization for more than 200 years; Adam Smith
thought that social wealth and welfare are likely to be greatest
when corporations seek to maximize the stream of profits that
can be divided among their shareholders.
 But, over time, the goal has got transformed to one of
maximization of the long-run market value of the firm “where
the value of the firm while mainly defined by the company’s
stock price but not necessarily entirely.”
 Jensen has evolved this stakeholder theory which says that
“corporations should attempt to maximize not value of their
shares (or financial claims), but distributed among all corporate
‘stakeholders’ which include employees, customers, suppliers,
local communities, and tax collectors” has been getting wide
acceptance among organizations , politicians and even
governance conscious organizations and governments.
 Stewardship Theory : the boards have a stewardship role for
the(caring for the) resources entrusted to them by the
shareholders. The power over the corporation is exercised by
directors who are nominated and appointed by shareholders
and hence accountable to them for the stewardship over the
company’s resources.
 The theory is based on the belief that the directors can be
trusted. This is also the theoretical foundation for most of the
legislations and regulations in almost all the countries. This is
also the basis of most of the best practices recommended for
good governance.
 The roles, duties and tasks of directors are essentially based on
this.
Structure of the Board, Types of Directors and
Committees of The board ( we take a small detour
from syllabus order here as this knowledge is
essential for the part before)
 The Structure : two structures seen in practice: The Unitary
Board and The Dual Board or Two-Tier structure.
 Most of the countries have unitary structure.
 Two-tier boards have a Management Board and a Supervisory
Board.
 Countries like Germany, Austria, Finland, Netherlands, China
and Singapore have two-tier structure.
Constitution of the Board
 Directors: min for pub.ltd. co is 3, pvt.ltd. co is 2; max no.15;
cos can appoint more than 15 after passing a special resolution;
pub.ltd. cos must have at least one woman director.
 Chairman of the Board: one of the directors will be chosen as
Chairman of the board; may be full-time or part-time; full-time
or executive chairman is in the employment of the company
whereas a part-time chairman is only required to be present
whenever board meetings get convened.
 Types of Directors :basically two types of directors : whole-
time directors or executive directors and part-time directors or
non-executive directors; a typical board may have one or more
number of executive directors and a number of non-executive
directors.
 Another classification for directors can be Promoter Directors
and Non-Promoter Directors; promoter directors are members
of the promoter family or families; can be full-time executive or
part-time non-executive.
 Non-executive directors can again be divided into two: Non-
Independent Non-Executive Directors and Independent Non-
Executive Directors.
 Executive directors, even when they are professionals, are not
considered independent.
 An independent director has to meet certain qualifying criteria.
 According to the Companies Act 2013, one third of the directors
shall be independent.
 Committees of the Board: it is not necessary that every board
member or the full board as such get involved in all it is
expected to do; it will be a waste of quality time of directors
and engaging full board in everything may tell on its efficiency;
thus evolved the committee structure.
 Certain committees are mandatory according to laws or
regulations while some are non-mandatory.
 Mandatory committees according to Companies Act 2013 are:
The Audit Committee, The Nominations and Remunerations
Committee and The Stakeholders Relationship Committee.
 Boards may constitute more committees depending on the
need: Risk Management Committee, Project Review Committee,
M&A Committee etc.
 Developments in Corporate Governance
 has been in vogue for more than 30 years now ever since the
term was first used by Bob Tricker in 1984;
 the discipline attracted a new emphasis during the early 2000s
following a string of corporate failures in the US such as Enron,
WorldCom, Global Crossing etc.
 Suddenly, every major government functionary, political party,
Industry association and corporate captain sprang to action and
stated advocating the need for better corporate governance
practices.
 New standards of corporate governance, accounting and
reporting have been established.
 A very stringent Act like Sarbanes-Oxley Act of 2002, in USA
helped in strengthening the internal processes of compliance
but governance issues have once again arisen in the years 2007
to 2009.
 Early Initiatives: Credit goes to Cadbury Committee in UK,
General Motors and institutions like CalPERS, ISS, TIAA(earlier
TIAA-CREF) etc in the US,CII in India etc.
In the US
 In 1994, GM board issued 28 guidelines designed to function as an
independent board and actively discharge its responsibility;
 In the same year, California Public Employees Retirement
System(CalPERS), a pension fund, took a decision to ask its
portfolio companies whether they had considered adopting
guidelines similar to GM guidelines.
 Key provisions in the guidelines(Ref);
 Major thrust happened after failures of Enron, WorldCom, Global
Crossing etc.
 Public Company Accounting Reform and Investor Protection Act
(Sarbanes-Oxley Act or SOX) 2002, an exclusive law for CG.
 SOX fallouts
 In the UK
 The Committee on the Financial Aspects of Corporate
Governance, chaired by Sir Adrian Cadbury(Cadbury
Committee); set up in 1991 by FRC,LSE and the British
accounting profession;
 The first-ever organized initiative anywhere in the world;
 Submitted its report in Dec 1992, commonly referred to as
the Cadbury Code;
 Highlights of the code(refer)
 Greenbury committee: formed under the chairmanship of
Sir Richard Greenbury, Chairman of Marks & Spencer, to
look into the concerns of executive compensation;
 Recommended setting of remuneration committees with
non-executive IDs;
 Disclosure of remuneration policy and the details of the
components of compensation;
 Recommended adoption of performance measures to align
with the interests of the shareholders.
 Hampel Committee : In 1995, a committee was set up
under Sir Ronald Hampel, Chairman of ICI, to review the
implementation of the recommendations of Cadbury and
Greenbury committees;
 Submitted its report in 1998(referred to as the Combined
Code);
 Endorsed the recommendations of the two earlier
committees and also looked into the aspect of stakeholder
relationship and emphasized the role of institutional
investors in improving governance.
 In India
 Desirable Corporate Governance: A Code
 India also took a cue from the Cadbury Committee report
and the CII took the lead in 1998 in developing and
promoting a code;
 Published the report : Desirable Corporate Governance: A
Code in 1998;
 Major recommendations included(Refer).
 First Initiative by SEBI: The capital market regulator in India
thought it necessary to create and regulate a realm of
corporate governance for Indian cos.
 Set up a committee in 1999 under the chairmanship of the
AV Birla group head, Shri K M Birla, a member of SEBI
board;
 Submitted its report in 1999;
 After discussions, SEBI incorporated the recommendations
as a new clause in the listing agreement(Clause 49);
 Recommendations were classified into two: mandatory and
non-mandatory(Refer).
 Initiative by DCA:
 Appointed a committee under the chairmanship of Shri
Naresh Chandra in 2002
 To look into issues relating to auditor appointments,
auditor fees, rotation of audit firms and partners and also
on the role of IDs and measurement of effectiveness of IDs.
 Further initiatives by SEBI:
 Narayana Murthy Committee to look into the governance
scenario after the Birla committee recommendations and
to suggest ways of improving governance further;
 Recommendations were classified into mandatory and non-
mandatory (Refer).
 Kotak Panel, appointed by SEBI, has just submitted its
report(in October 2017) on further reforms in CG and is
being discussed and debated before final adoption.
 Board effectiveness
Ram Charan, an accomplished expert on CG, has written
about an ideal board:
 Decide on the role-watchdog or pilot;
 Have a board charter for governance;
 Independence in thoughts, attitude ie substance rather than
form;
 CEO & the entire board should understand that collegiality &
Collective wisdom will result in performance;
 Periodical review of performance of the CEO by the board &
constructive feedback;
 Proper induction & orientation for new recruits on the board by
chairman/ a senior member
 Continuous learning for existing directors
 Stack the board with talent
 Performance than conformance
 Plan for succession (both CEO & Director level)
 Treat board as a competitive weapon for gaining competitive
advantage
 Board effectiveness- general
 Boards and managements must remember that they are
on the same team;
 It should also be recognized that each party has a valid
position-they each have a job to do;
 Management must understand that directors are obliged to
dig deep into important issues;
 The board has to trust management because it has no
alternative. Management is the custodian of all information
and board has to depend on management for any
information;
 Self-evaluation of the board at frequent intervals.
 Issues and Challenges
 The most important is to work together as a team; directors are
powerful people due to their positions or expertise; will have
their own convictions;
 CEO will have a lot of influence on the appointment of new
directors; the nomination committee’s task will be to get
somebody who goes along with CEO but maintain their
independent views;
 In typically family-promoted and managed companies in India,
with overwhelming stakes, promoters may have their own ways
of getting things done;
 Fixing the right remuneration for executive and non-executive
directors- neither too much nor too low;
 The question of real independence; length of association, sitting
as ID on many companies’ boards in the same group;
 Loopholes in the law(Eg.);
 Number of companies on which a person can be director; today,
part-time directors also have to spend quality time on a
company’s matters;
 Auditor appointment and payment of fees;
 Retiring CEOs continuing association as chairman or NED;
 Very low or almost nil shareholder activism.
 Typical ownership-related challenges
Board Duties
 According to Bob Garratt, an expert on boards and
governance, the primary duty of the board is the fiduciary
duty;
 Fiduciary duty is ‘ to hold the company in trust for the
future’
 Fiduciary duty has two sub-duties :
The duty of loyalty : to be loyal to those who appointed
directors ie shareholders; or ‘a fiduciary shall not engage in
practices that directly or indirectly harm the interests of his
principal’
and
The duty of care : directors(boards) act in ways to protect
and enhance the principal’s(shareholders’) position.
The Commonwealth Association of Corporate
Governance (CACG) has suggested ten duties for
directors:
 The duty of legitimacy
 The duty of upholding the three values of corporate
governance name namely Accountability, Openness and
Probity
 The duty of trust
 The duty of upholding the primary loyalty of a director
 The duty of care
 The duty of critical review and independent thought
 The duty of delivering the primary roles and tasks of the
board
 The duty of protecting minority owners’ interests
 The duty of corporate social responsibility
 The duty of learning, developing and communicating
Corporate Board Responsibilities and Tasks
 Appointment of CEO and other Executive Directors from the
shortlist given by the Nominations Committee(subject to the
approval of the shareholders)
 Fix the remuneration for the CEO and other Executive
Directors based on recommendations of the Nominations
Committee (subject to the approval of shareholders)
 Ratify the decisions of the nominations committee in the
appointment of other directors to the board(either new or
replacement for retiring directors) and fix their remunerations
 Evaluate the performance of the CEO and other executive
directors
 Evaluate the performance of non-executive directors
 Self-evaluation of the board in the context of the company
and the changing business environment
 Approve the strategic direction chosen by the management
for the company
 Approve the accounts and financial statements of the
company
 Approve distribution of profits to the shareholders
 Ensure integrity of the company’s accounting, auditing and
reporting systems
 Ensure that sufficient internal control systems are in place to
manage the risks that the company may face
 Establish Vision, Mission and Values
 Exercise accountability to shareholders and be responsible to
the other stakeholders
 Properly delegate to management.
Liabilities for Directors
 When directors don’t act according to the specified
duties(these duties are specified in Companies Act 2013,
under Section 166; refer)
 If a director of the company contravenes the provisions of
the section 166, such director shall be punishable with fine
which shall not be less than one Lakh Rupees but which
may extend to five Lakh Rupees.
 Legal Framework for Corporate Governance
 In general there is basically dual regulation for corporate
governance: one, in the form of Incorporation Laws and second,
the Capital Market related laws and regulations
 In India, companies have to adhere to Companies Act and SEBI’s
provisions
 Only the US has as of now chosen to have an exclusive law for CG
 Specific sectors may have their own regulators beyond these two.
For example, Banking companies and Non-Banking Finance
Companies in India are regulated also by RBI; insurance companies
by IRDA etc.
 In certain areas like banking, international agencies also influence
the governance aspects( For eg, Basel norms for banks)
 Companies listed abroad, will need to follow the governance
guidelines of the respective countries where their securities are
listed.