 Unit----1-----Conceptual framework of corporate governance

 Introduction-
 Corporate governance is 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.
 Definition-
 According to Cadbury Committee, “Corporate governance is defined as the system by which companies
are directed & controlled”.
 Features-

 Fair and equitable treatment. All shareholders, customers, employees and other stakeholders should be
treated equally and fairly. Part of this is making sure shareholders are aware of their rights and how to
exercise them.

 Accountability. Legal, contractual and social obligations to both shareholders and nonshareholders must
be upheld. Organizations should define a code of conduct for board members; board committees, such
as the audit committee and compensation committee; and senior executives. New individuals joining
those ranks must meet those established standards.

 Diversity. The board of directors must maintain a commitment to ensure diversity within corporate
governance and the company overall.

 Oversight and management. Board members must also possess the adequate skills necessary to review
management practices.

 Transparency. All corporate governance policies and procedures should be disclosed to relevant
stakeholders. This includes regularly and consistently communicating pertinent information to
employees, customers, investors, vendors and members of the community.

 Needs –


 Scope –

 Evolution –

Development of Corporate governance in india

The Indian corporate scenario was more or less stagnant till the early 90s. The position and goals of the
Indian corporate sector has changed a lot after the liberalization of 90s.

India’s economic reform programme made a steady progress in 1994. India with its 20 million shareholders,
is one of the largest emerging markets in terms of the market capitalization.

In 1996, Confederation of Indian Industry (CII), took a special initiative on Corporate Governance.

The objective was to develop and promote a code for corporate governance to be adopted and followed by
Indian companies, be these in the Private Sector, the Public Sector, Banks or Financial Institutions, all of
which are corporate entities.

This initiative by CII flowed from public concerns regarding the protection of investor interest, especially the
small investor, the promotion of transparency within business and industry.
 Objectives –

 Help build an environment of trust

 Transparency and accountability necessary for fostering long-term investment
 Financial stability and business integrity
 Thereby supporting stronger growth and more inclusive societies.
 Provision of fair return on investment to shareholders
 Development of a value oriented organization Creating transparency in dealings
 Taking effective strategic decisions for the company Covers the areas of environmental awareness
 Ethical behavior Corporate strategy Compensation Risk management.

Constituents of corporate governance

Structure of corporate Governance-

Corporations can have many different structures, but the most typical structure consists of the
shareholders, board of directors, officers and the employees. The structure of corporate governance
determines the distribution of rights and responsibilities between the different parties in the organization
and sets the decision-making rules and procedures. It is usually up to the management board to decide how
the company will develop.

It establishes corporate policies, sets strategic direction, ensures that an effective internal control
environment is in place,Corporate governance is the structure of rules, practices, and processes used to
direct and manage a company. The corporate governance structure specifies the distribution of rights and
responsibilities among different stakeholders such as the board, An effective governance structure must
be lean, simple and straightforward. This starts with the creation of an Executive Committee devoted to
aligning all levels of the organization so that they contribute to achieving defined strategic goals and
objectives.

Mechnisms of corporate governance-

Internal governance controls

Internal company governance controls review activities. It then takes action to accomplish organisational
goals. The following are a few examples:

Internal control procedures and internal auditors:

These procedures are policies by an audit committee, board of directors, executives, management and
other personnel to deliver suitable assurance that the entity may meet its goals for reliable fiscal reporting,
operational efficiency and compliance with regulations and laws. Internal auditors are employees who test
the design and execution of an organisation's internal control procedures and the accuracy of its fiscal
reporting.

Observation by the board of directors:

The board of directors protects invested capital through its authority to appoint and compensate the higher
authority. Regular committee meetings allow for the identification, discussion and avoidance of potential
issues, and it suits different board structures for different businesses.

Balance of power:

The most basic balance of power requires the president and treasurer to be different individuals, and the
split of power also develops in businesses where separate units check and balance each other's activities.
For example, one group may suggest company-wide organisational modifications, another group analyses
and rejects the modifications and a third group ensures the meeting of interests for the people outside of
these groups.

Remuneration:

Performance-based remuneration may link a portion of one's salary to one's performance. This can be as
cash or non-cash payments, such as shares and stock choices or other benefits.

External governance controls

External company governance regulates the external shareholder's exercise over the organisation. The
following are a few examples:

 Demand for and review of performance data

 Mergers and acquisitions
 Government regulations
 Obligation covenants
 Media pressure
 Competition Proxy firms Takeovers
Fiscal reporting and the independent auditor

The board of directors oversees the company's external and internal financial reporting functions. The CEO
and chief financial officers are important roles, and boards typically have a high level of trust in them for the
accuracy and timely delivery of accounting information. They oversee the internal accounting systems and
rely on the corporation's accountants and internal auditors.

Fiscal reporting fraud, which includes nondisclosure and intentional falsification of values, also increases the
risk of users' information. To mitigate the risk and improve the perceived integrity of fiscal reports,
corporations require having their fiscal statements audited by a personal external auditor who issues a
report along with the fiscal statements.

Elements of Good Corporate Governance-

Role and Powers of the Board Legislation Management Environment Board

Appointments

Board Meetings Code of Conduct Strategy setting Monitoring the Board

Performance

Audit Committee Risk Management

Corporate governance codes-

The Corporate Governance Code applies to corporations that are incorporated in the United Kingdom and
that are registered on the London Stock Exchange. Overseas corporations that are listed on the Main
Market must disclose the substantial ways in which their corporate governance practices are different than
the practices outlined in the Corporate Governance Code.

The principle behind the Corporate Governance Code is to demonstrate to shareholders and stakeholders
how the corporation applied the main principles of the code. In addition, corporations that are subject to
the code must confirm that they've fully complied with the provisions of the code. Companies that can't or
won't comply with the code's provisions must provide a reasonable explanation of why they haven't
complied with the code.

The requirements of the Corporate Governance Code are strikingly similar to those of the Annual Corporate
Report that the United States requires.

What Is the Corporate Governance Code?

Using best practices as its foundation, the Corporate Governance Code outlines the standards for the
expectations for corporate boards in protecting shareholder investments. The code refers to standards for
good practices relating to:

Board composition Board development Remuneration Accountability Audit

Shareholder relations
Five Pillars of Good Corporate Governance Make Up the Corporate Governance Code
Leadership

The code requires companies to ensure to shareholders that they have an effective board of directors that's
capable of providing excellence in board leadership. Boards of directors are collectively responsible for the
short- and long-term success of the corporations they serve.

Strong leadership requires corporations to have a clear division of the responsibilities between board
directors and executives. The code expressly states that no single person should have total decision-making
power on a board.

Effectiveness

The code requires corporate boards to ensure that they have a composition that encompasses the
appropriate balance of skills, experience, independence and knowledge of the company so that they're able
to perform their duties and responsibilities effectively

Accountability

The board is wholly accountable for the actions and decisions of the company. The board should make
annual disclosures to shareholders that represent a fair, accurate and comprehensive assessment of the
corporation's positions and corporate outlook.

Remuneration

The United Kingdom favors remuneration packages that are designed to promote the long-term success of
the company and that are directly aligned with performance.

Remuneration should sufficiently challenge executives, be transparent and be rigorously applied.

The company should have a formal, transparent process for developing remuneration policies and setting
remuneration packages.

Shareholder Relationships

Boards should utilize their annual general meetings to communicate and engage with investors on their
objectives and strategic planning.

The board should ensure that communications with shareholders are satisfactory.

These pillars are considered the minimum for the basics of good governance.

Corporations are encouraged to add their own best practices as they develop them and learn from other
corporations around the world.
Objectives –

1. Establish strategy and business model which promote long-term value for shareholders

2. Seek to understand and meet shareholder needs and expectations

3. Take into account wider stakeholder and social responsibilities and their implications for long-term
success
4. Embed effective risk management, considering both opportunities and threats, throughout the
organization
5. Maintain the board as a well-functioning, balanced team led by the chair
6. Ensure that between them the directors have the necessary up-to-date experience, skills and capabilities
7. Evaluate board performance based on clear and relevant objectives, seeking continuous improvement
8. Promote a corporate culture that is based on ethical values and behaviours.
9. Maintain governance structures and processes that are fit for purpose and support good decision-making
by the board
10. Communicate how the company is governed and is performing by maintaining a dialogue with
shareholders and other relevant stakeholders

Needs of Corporate Governance Codes-

Improves Corporate Performance

 Assist the quality of decision making

 Develop a robust corporate strategy
 Ushers effective execution capabilities

Enhances Accountability

 Effective governance process highlights and improves accountability of Board of directors towards
shareholders.
 Assists in improvement in branding of the enterprise.

Enhances Investor Trust

 Encourages investors to make investments

 Encourage promotion of investors’ interest through effective disclosures.

Access to Global Markets

 Owing to transparency in reporting, it attracts investment from global investors.

 Bring about better efficiencies in the financial sector.

Eradicate Corruption

 Implement robust internal control and audit processes.

 Enables the prevention of any fraud and malpractice due to robust processes and best practices.
 Adequate and accurate disclosure of all accounting and auditing processes across operations.
Funding from Institutions

 Proper disclosure and sound internal control processes bring about investor confidence.
 Results in further investment from banks and financial institutions.

Enhances Enterprise Valuation

 Robust processes and controls

 Results in enhancement of enterprise valuation going forward.

Improved Enterprise Risk Management

 Effective governance process develops a firewal against possible risks.

 Brings about an effective enterprise risk mitigation system.

Corporate Governance Theories-

Agency Theory

Agency theory defines the relationship between the principals (such as shareholders of company) and agents
(such as directors of company). According to this theory, the principals of the company hire the agents to
perform work.

The principals delegate the work of running the business to the directors or managers, who are agents of
shareholders. The shareholders expect the agents to act and make decisions in the best interest of principal.

On the contrary, it is not necessary that agent make decisions in the best interests of the principals. The agent
may be succumbed to self-interest, opportunistic behavior and fall short of expectations of the principal. The
key feature of agency theory is separation of ownership and control.

The theory prescribes that people or employees are held accountable in their tasks and responsibilities.
Rewards and Punishments can be used to correct the priorities of agents.
Stakeholder theory –

Stakeholder theory incorporated the accountability of management to a broad range of stakeholders.

It states that managers in organizations have a network of relationships to serve – this includes the suppliers,
employees and business partners.

The theory focuses on managerial decision making and interests of all stakeholders have intrinsic value, and
no sets of interests is assumed to dominate the others

Stewardship Theory

The steward theory states that a steward protects and maximises shareholders wealth through firm
Performance. Stewards are company executives and managers working for the shareholders, protects and
make profits for the shareholders. The stewards are satisfied and motivated when organizational success is
attained. It stresses on the position of employees or executives to act more autonomously so that the
shareholders’ returns are maximized. The employees take ownership of their jobs and work at them
diligently.
Resource Dependency Theory

The Resource Dependency Theory focuses on the role of board directors in providing access to resources
needed by the firm. It states that directors play an important role in providing or securing essential resources
to an organization through their linkages to the external environment. The provision of resources enhances
organizational functioning, firm’s performance and its survival. The directors bring resources to the firm, such
as information, skills, access to key constituents such as suppliers, buyers, public policy makers, social groups
as well as legitimacy. Directors can be classified into four categories of insiders, business experts, support
specialists and community influentials.

Transaction Cost Theory

Transaction cost theory states that a company has number of contracts within the company itself or with
market through which it creates value for the company. There is cost associated with each contract with
external party; such cost is called transaction cost. If transaction cost of using the market is higher, the
company would undertake that transaction itself.

Models of Corporate Governance-

Anglo-American Model

Under the Anglo-American Model of corporate governance, the shareholder rights are recognised and given
importance. They have the right to elect all the members of the Board and the Board directs the management
of the company. Some of the features of this model are:

 This is shareholder oriented model. It is also called Anglo-Saxon approach to corporate governance
being the basis of corporate governance in Britain, Canada, America, Australia and Common Wealth
Countries including India
 Directors are rarely independent of management
 Companies are run by professional managers who have negligible ownership stake. There is clear
separation of ownership and management.
 Institution investors like banks and mutual funds are portfolio investors. When they are not satisfied
with the company’s performance they simple sell their shares in market and quit.
 The disclosure norms are comprehensive and rules against the insider trading are tight
 The small investors are protected and large investors are discouraged to take active role in corporate
governance.

German Model

This is also called European Model. It is believed that workers are one of the key stakeholders in the company
and they should have the right to participate in the management of the company. The corporate governance
is carried out through two boards, therefore it is also known as two-tier board model. These two boards are:

1. Supervisory Board: The shareholders elect the members of Supervisory Board. Employees also elect their
representative for Supervisory Board which are generally one-third or half of the Board.
2. Board of Management or Management Board: The Supervisory Board appoints and monitors the
Management Board. The Supervisory Board has the right to dismiss the Management Board and re-
constitute the same.
Japanese Model

Japanese companies raise significant part of capital through banking and other financial institutions. Since
the banks and other institutions stakes are very high in businesses, they also work closely with the
management of the company. The shareholders and main banks together appoint the Board of Directors and
the President. In this model, along with the shareholders, the interest of lenders is recognised.

Social Control Model

Social Control Model of corporate governance argues for full-fledged stakeholder representation in the board.
According to this model, creation of Stakeholders Board over and above the shareholders determined Board
of Directors would improve the internal control systems of the corporate governance. The Stakeholders Board
consists of representation from shareholders, employees, major consumers, major suppliers, lenders etc.

Indian Model

In India there are mainly three types of companies’ viz. private companies, public companies and public sector
undertakings. Each of these companies has distinct kind of shareholding pattern. Thus the corporate
governance model in India is a mix of Anglo-American and German Models.

Benefits of Corporate Governance-

Limitation / Issues of Corporate Governance-

1. The cost of keeping legally compliant:

Businesses face a slew of regulations that must be adhered to, with each industry attracting its own set of
legislation. Corporate governance ensures legal observance, but it comes at a high cost.
2Increased costs:

Considering all of the regulations that must be satisfied, the administrative costs for organisations with
corporate governance are quite high. Here are a few documents that must be kept up to date:-
 Sales and purchases of stock.
 Records of legal compliance.
 Annual registration.

3. Maintenance of segregation:

Regardless of the size of the company, all formalities and standards must be followed without exception.
Failure to follow these regulations exposes the company to significant risk, such as “piercing of the
corporate veil,” in which the corporation’s separate legal entity status is disregarded in order to get insight
into what goes on behind closed doors.
4. The principal-agent conflict:

It is usual practice in large organisations to pick a well-known management with a proven track record to
oversee the day-to-day operations of the company. Unfortunately, this can lead to a conflict between
shareholders and managers, as they may have quite different goals and viewpoints. This frequently results
in a clash between the two, impacting the company’s overall capacity to manage operations smoothly and
efficiently.

Recent Corporate Governance Committee Repoprts-

The Committee on Corporate Governance, headed by Shri Narayanmurthy was constituted by SEBI, to
evaluate the existing corporate governance practices and to improve these practices as the standards
themselves were evolving with market dynamics. The committee’s recommendations are based on the
relative importance, fairness, accountability, transparency, ease of implementation, verifiability and
enforceability related to audit committees, audit reports, independent directors, related parties, risk
management, directorships and director compensation, codes of conduct and financial disclosures.
The key mandatory recommendations focus on
Strengthening the responsibilities of audit committees
At least one member should be ‘financially knowledgeable’ and at least one member should have accounting
or related financial management proficiency.

Quality of financial disclosures

Improving the quality of financial disclosures, including those related to related party transactions.

Proceeds from initial public offerings

Companies raising money through an IPO should disclose to the Audit Committee, the uses / applications of
funds by major category like capital expenditure, sales and marketing, working capital, etc.
 Other recommendations

 Requiring corporate executive boards to assess and disclose business risks in the annual reports of companies.
 Should be obligatory for the Board of a company to lay down the code of conduct for all Board members and
senior management of a company.
 The position of nominee directors: Nominee of the Government on public sector companies shall be similarly
elected and shall be subject to the same responsibilities and liabilities as other directors
 Improved disclosures relating to compensation paid to non-executive directors.
Non-mandatory recommendations include moving to a regime where corporate financial statements are not
qualified; instituting a system of training of board members; and the evaluation of performance of board
members.

Whistle Blower Policy

Personnel who observe an unethical or improper practice should be able to approach the audit committee
without necessarily informing their superiors.
Implementation issue
A primary issue that arises with implementation is whether the recommendations should be made applicable
to all companies immediately or in a phased manner, since the costs of compliance may be large for certain
companies.

Another issue is whether to extend the applicability of these recommendations to companies that are
registered with BIFR. In the case of such companies, there is likely to be almost little or no trading in their
shares on the stock exchanges.

J. J. Irani Committee-

Corporate Governance, has assumed remarkable importance for all the corporate players in India as well as
abroad. The Organization for Economic Co-operation and Development (OECD) has issued a revised set of
Corporate Governance Principles which are adaptable to varying social, legal and economic frameworks in
different countries and are considered as widely acceptable global benchmarks of Corporate Governance.
Companies all over the world have realized that a vigorous quest of good governance is crucial for enduring
success.

The present Committee was constituted on 2nd December, 2004 under the chairmanship of Dr. J J Irani,
Director, Tata Sons, with the task of advising the Government on the proposed revisions to the Companies
Act, 1956.

The objective of this exercise is perceived as the desire on the part of the Government to have a simplified
compact law that will be able to address the changes taking place in the national and international scenario,
enable adoption of internationally accepted best practices as well as provide adequate flexibility for timely
evolution of new arrangements in response to the requirements of ever-changing business models. It is a
welcome attempt to provide India with a modern Company Law to meet the requirements of a competitive
economy. Companies have now become conscious of the importance of pursuing good Corporate
Governance for reaping rich benefits for the Company and its stakeholders. Corporate Governance is no
longer a rigid set of guidelines; it has now become an integral part of the companies’ functioning and progress.
Cadbury Committee-

Key Recommendations-

CII Recommendations-

the CII set up a Task Force under Mr Naresh Chandra in February 2009 to recommend ways of further
improving corporate governance standards and practices both in letter and spirit. The recommendations of
the Naresh Chandra Task Force evolved over a series of meetings.
Paul Ruthman Committee

This committee was constituted later to deal with the said controversial point of Cadbury Report. It watered
down the proposal on the grounds of practicality. It restricted the reporting requirement to internal
financial controls only as against ‘the effectiveness of the company’s system of internal control’ as
stipulated by the Code of Best Practices contained in the Cadbury Report.

The final report submitted by the committee chaired by Ron Hampel had some important and progressive
elements notably the extension of directors’ responsibilities to ‘all relevant control objectives including
business risk assessment and minimizing the risk of fraud.

Greenbury Committee-

In January 1995 the Confederation of British Industry (CBI) established the Study Group on Directors'
Remuneration under the chairmanship of Sir Richard Greenbury with a remit to identify good practice in
determining directors' remuneration and to prepare a code of practice for UK PLCs. The final report of the
group was published on 17 July 1995 and is usually referred to as the Greenbury report.

The Committee-

 Aimed to provide an anwserto the general concerns abcut the accountability & levels of directors pay.

 Argued aginst statutory control and for strngthning accountability by the proper allocation of
reasponsibility for determining directors’ remunetior, the proper reporting to shareholders and grater
transperancy in the process.

 Produced the greenburry codes of best practices which was divided into the following four sections:

 Remuneration committee

 Disclosures

 Remuneration policy

 Service contracts & Compensations