Corporate Governance: Meaning, Definitions, Principles, Objectives, Mechanisms and Benefits

Corporate Governance is a voluntary code of conduct that the board of directors particularly the chief executive officer of the business organisation is expected to follow in operating the business. The code contains expectations and provisions that are more extensive than any statutory, professional or capital market requirements.

Corporate Governance is the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled in corporations. Thus corporate governance deals with – not only rules, laws and regulations but also the moral and ethical code that the officers concerned are expected to follow.

Learn about:- 1. Meaning of Corporate Governance 2. Definitions of Corporate Governance 3. History 4. Objectives 5. Aspects 6. Importance 7. Contents of Corporate Governance Code

8. 7s for Corporate Governance 9. Factors Influencing 10. Principles 11. Perspective Viewpoints towards Corporate Governance in Context of Ethics 12. Framework – The Internal and External Architecture

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13. Corporate Governance and Firm Performance 14. Corporate Governance and Developing Countries 15. Theories 16. Responsibilities, Role and Functions of Board of Directors 17. Issues 18. Mechanisms 19. Benefits 20. Guidelines 21. Trends 22. Future.

Corporate Governance: Meaning, Definitions, History, Importance, Objectives, Principles, Aspects, Benefits and Mechanisms

Corporate Governance – Meaning

“Governance is the process whereby people in power make decisions that create, destroy or maintain social systems, structures and processes. Corporate governance is, therefore, the process whereby people in power direct, monitor and lead corporations, and thereby either create, modify or destroy the structures and systems under which they operate. Corporate governors are both potential agents for change and also guardians of existing ways of working. As such they are, therefore, a significant part of the fabric of our society.”

A corporation or company is an enterprise authorised by law to conduct business. Governance implies degree of control to be exercised by key stakeholders’ representatives to promote corporate growth and protect stakeholders’ interests. Being guided by the principle of shareholders’ democracy, companies will have to make clear their policies in running the business. Corporate governance ensures how effectively the Board of directors and management are discharging their functions in building and satisfying stakeholders’ confidence.

It is the system by which corporate enterprises are directed and controlled. “The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs.” It, thus, provides the structure of corporate enterprises.

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It defines company’s objectives, means of attaining those objectives and monitoring organizational performance to ensure that objectives are optimally achieved. In simplest terms, corporate governance is a formal system of accountability of senior management to corporate stakeholders. Corporate governance includes company’s accountability to shareholders and other stakeholders such as employees, suppliers, customers and local community.

Corporate governance is concerned primarily with holding balance between economic and social goals and between individual and community goals. Corporate governance is used to monitor whether outcomes are in accordance with plans and to motivate the organization to move fully informed in order to maintain or alter organizational activity. Corporate governance is the mechanism by which individuals are motivated to align their actual behaviours with the overall goals.

Corporate Governance – Definitions

According to Thiery Buch – ‘Good Corporate Governance is the glue that holds together responsible business practices, which ensures positive work place management, market place responsibility, environmental stewardship, community engagement and sustained financial performance. This is even more true now as we work worldwide to restore confidence and promote economic growth’.

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As such, overall it is a framework for efficient administration and most appropriate operational activities aims to encourage the efficient use of resources and equally require accountability for the stewardship of those resources.

Corporate Governance and responsibility issues have come into the limelight in India since 1990s. During the nineties, there was a prolonged depression in the capital market on account of breach of trust and fraud in the corporate sector. A large number of companies failed and the economy witnessed a number of rating downgrades, both in the manufacturing and financial sectors.

As such, there were different irregular and undesirable practices within business. In such scenario, a committee was set up under the chairmanship Mr. Rahul Bajaj in 1999 as a national level private initiative to evolve and determine the desirable rules for corporate governance.

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This was followed by appointment of as many as four national level committees – two appointed by SEBI, namely Kuman Mangalam Birla Committee during 1999 and N.R. Narayana Murthy committee in 2003, another Committee on financial sector governance, known as Gangly committee Report in 2002 and the fourth committee appointed by the Government of India known as Report of the Naresh Chandra Committee on Corporate Audit and Governance. This shows that corporate governance is being practiced in India on an even pedestal with anywhere else in the world.

Some of the definitions are, however, as follows:

“Corporate governance is a system by which companies are run. It relates to the set of incentives, safeguards and the dispute resolution process that are used to control and coordinate the actions of the agents on behalf of the shareholders by the Board of Directors. Shareholders are responsible for appointing the directors and auditors. Creating of residual value is the primary concern of shareholders, but the process of value creation and its legality are equally important. Hence, corporate governance relates to a code of conduct the management of the company observes while exercising its powers”.

“Corporate governance can be defined as a set of systems and processes which ensure that a company is managed to the best interests of all the stakeholders. The set systems that help the task of corporate governance should include certain structural and organizational aspects, the process that helps corporate governance will embrace how things are done within such structure and organizational systems.”

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The Cadbury Committee (U.K.) has defined corporate governance as “the system by which companies are directed and controlled”.

Corporate Governance – History

Corporate Governance is relatively a new discipline. This has attracted worldwide attention, particularly since the 1990s. The concept is assuming great importance of late due to the totally unexpected collapse of a few giant corporations in the United States such as world energy leader Enron and biggies like WorldCom, Adelphia, Tyco, Global Crossing, etc. The United Kingdom (UK) had also witnessed several cases of corporate corruption and collapse, which led to setting up of Cadbury (1992), Greenbury, and Hampel (1997) Committees during the latter half of the 90s.

“India also experienced some financial scandals during 1950s (LIC), eighties and nineties and post-2001 period such as the Mundra’s scam involving LIC (1957), Raj Sethia’s scandal involving the Punjab National Bank (PNB) in early 1985, Harshad Mehta’s mega swindle involving UTI, SBI and other institutions in 1992, Unit Trust of India’s two episodes during its then Chairman Mr. Pherwani’s period, and again in 2001, when Mr. Subramanium was Chairman, Ketan Parekh’s fraud involving Bank of India and Gujarat Co-operative Bank in 2001, Telgi’s Stamp Paper scam and erstwhile Global Trust Bank’s scam in early 2004.” Satyam Computers episode in 2008 is another failure of governance in India. 2G spectrum is another important addition in Indian Corporate Scandal.

These developments had created an environment where we were forced to go in deep about the effective formulation process of corporate governance in India.

Corporate Governance – Top 4 Objectives

Corporate governance has the following objectives:

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1. To align corporate goals with the goals of its stakeholders (society, shareholders etc.).

2. To strengthen corporate functioning and discourage mismanagement.

3. To achieve corporate goals by making investment in profitable outlets.

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4. To specify responsibility of the Board of Directors and managers in order to ensure good corporate performance.

Corporate Governance – Key Aspects

Some of the key aspects of governance are as follows:

1. Although the focus is on the impact of corporate governance on both shareholders and stakeholders, the fundamental objective of corporate governance is ‘enhancement of shareholder value, keeping in view the interests of other stakeholders’. The approach is refers that companies should see the code as ‘a way of life’.

2. The framework applies to all listed private and public sector companies, and is split into mandatory requirements (ones that the committee sees as essential for effective corporate governance) enforceable via the listing rules, and non-mandatory requirements suggested as best practice.

3. On section relating to ‘board of directors’, the code covers the composition of the board, and independent directors. The board provides leadership and strategic guidance for the company and is at all times accountable to the shareholders. On size, the code recommends that not less than 50 per cent of the board should be comprised of nonexecutive directors.

4. On chairman of the board, it recognizes that the roles of chairman and chief executive are different. The code recognizes that the roles may be combined and performed by one individual in some instances. Where there is a non-executive chairman, then at least one-third of the board should comprise independent directors. If there is an executive chairman, then at least half of the board should be independent as a mandatory requirement.

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5. As per debt funding covenants, financial or investment institutions had a right to nominate directors to the board in order to protect their interest. The code decided to allow the practice to continue, but stated that such nominees should have the same responsibility as other directors and be accountable to the shareholders generally.

6. There are a number of mandatory recommendations in the code in relation to audit committee. A qualified and independent audit committee is established to help to enhance confidence in the company’s disclosures. The committee should comprise a minimum of three members, all of whom are non-executive, with a majority being of independent director. It should be chaired by an independent director.

In addition, it is important to note that at least one director should have appropriate financial knowledge. The audit committee is empowered to seek external advice as appropriate, and interestingly, to seek information from any employee.

7. A remuneration committee should be established to make recommendations on the executive directors’ remuneration. The committee should comprise at least three nonexecutive directors, and chaired by an independent director like the audit committee. A mandatory requirement is that there should be disclosures in the annual report relating to ‘all elements of the remuneration package of all the directors, that is, salary, benefits, bonuses, stock options, pension, etc.’ together with the ‘details of fixed component and performance-linked incentives, along with performance criteria’.

Finally, another mandatory requirement is that the board of directors should decide the remuneration of the non-executive directors.

8. The framework also gives guidelines on board procedures, including the number of meetings to be held. Mandatory requirements in relation to board meetings are—first, that they should be held at least four times a year with a maximum of four months between any two meetings; second, that a director should not be involved in more than ten committees or act as chairman of more than five committees across all companies with which he is a director. Though it limits a professional’s ability to serve, it improves the time that they can commit to the companies they serve as board of director.

9. Shareholders are entitled to participate effectively in the annual general meeting. It is a mandatory recommendation that, on the appointment of new, or reappointment of existing directors, the shareholders are provided with relevant information about the director(s). Similarly, companies are mandated to disclose information, including their quarterly results and presentations, to company analysts. These may be made available via the Internet. The growing influence of institutional investors is recognized, along with the fact that they have a responsibility to exercise their votes.

10. The role of the chief executive, executive directors, and key management personnel is to ensure the smooth running of the day-to-day activities of the company. A mandatory recommendation says there should also be disclosure in the annual report, either as part of the directors’ report, or as a ‘management discussion and analysis’ report, about the company’s position, its outlook, performance, and other relevant areas of interest to shareholders.

There should also be disclosure of any material financial/commercial transactions in which management has a personal interest that may have a potential conflict with the interest of the company.

11. A company should have a separate section on corporate governance in its annual report, including a detailed compliance report wherein the mandatory recommendations status must be reported. Non-compliance with any mandatory recommendations should be highlighted, as should the level of compliance with non-mandatory recommendations. A company should obtain a certificate from its auditors in relation to compliance with the mandatory recommendations and it should be attached to the directors’ report, which is sent each year to all the shareholders, and to the stock exchange.

12. The effectiveness of this framework depends upon the corporate response to support the regulatory framework, ability of regulatory authority to monitor and pressure from shareholders.

Corporate Governance – Importance (With 4 Reasons)

Corporate governance is essential because it focuses on building a long-term shareholders’ value by ensuring effective decision making. In addition, Organizations need to have in place a sound corporate governance system to curb or minimize corporate failure, corporate malice, and unethical behavior present in an organization.

The incidents of corporate scandals, such as – misuse of organization’s financial resources for personal benefits or not following the code of conduct, damage the goodwill of the organization.

Good corporate governance is directly responsible for the growth and development of organizations. Amidst increasing competition, liberalization, and globalization, an organization is required to retain the trust of stakeholders as well as attract new ones.

The need for good corporate governance is felt because of the following reasons:

1. Creating Competitive Advantage:

It refers to building a core competency that works as an edge over the rivals of a particular organization. Competitive advantage comes into being only when the organization supports value creation. An example of value creation would be Sony, which has the competitive advantage of creating small-sized products (a smaller version of all products) that are more effective and of better quality.

2. Preventing Fraud and Malpractices:

It refers to precluding misconducts and fraudulent practices so as to ensure sound and trustworthy corporate environment. Small frauds can lead to big financial crisis; therefore, such frauds should be prevented at the nascent stage only.

3. Bringing in Transparency:

It refers to meeting investor’s expectations by creating an open system that aims at providing accountability and transparency in all organizational operations. This further leads to value enhancement and provides for effective implementation of corporate standards.

4. Legal Compliance:

It refers to adhering to the laws and regulations as per the legal machinery of a country. Compliance to laws enables an organization to survive in the long term and builds a good code of conduct. Jurisdiction also helps in protecting the rights of investors; thereby, simplifying one of the many objectives of corporate governance.

Corporate Governance – Contents of Corporate Governance Code

Within the purview of corporate governance, there is a need to formulate and determine the code of conducts. A corporate governance code usually determine the visions, plans, directions and needful practices to perform managerial programmes.

It contains the matters as given here:

1. Policies, Plans and Strategies – The policies, plans and strategies of the concern may be included in the code of conducts concerning corporate governance. They provide basic directions, guidelines and parameters towards the managerial and organisational functions that can be carried out.

2. Visions and Missions – The visions and missions concerning the goals orientation and prospective paths are to be achieved. These are the aspirations to get a better and appropriate managerial goals. All the relevant directions are based on the visions and missions in the corporate governance code.

3. Administrative Part – The role and behaviour of administration and management with their directional, motivational and leading part may be included in it. The constitution of board of directors, role of non-executive directors, its meetings and different key matters may be included in it.

4. Organisational Structure – The organisational structure as based on activities, skills, decision making and mutual relations may be involved in it. It provide the norms and parameters about work determination, rights and duties, responsiveness, delegation of authority, span of control and work performance etc.

5. Management Practices – There are different managerial practices as decisional, leadership, motivational, informational, protective, enterpreneurial and liasional etc. These practices not only provide the directions to perform the functions and behaviour of managers but also to protect the interest of different partners of the organisation.

6. Employees’ Practices – The employees perform several operational tasks. The code may include their work specifications, standards and different target oriented norms towards making some excellences in corporate governance.

7. Business Policy Documents – The code for corporate governance is required to involve the business policy documents. These documents may incorporate the policy framework, business rules and regulations, objectives and targets, memorandums, standards, projects, programmes and procedures etc.

8. Communication and Information – There is a need of fair and effective communication system in the organisation. The code of conducts may involve the required methods, means and media of communication and on these basis a frequent and proper facts and information may be transferred to different persons.

9. Transparency – The norms and parameters for good transparency may be included particularly for true and reliable practices particularly in timely disclosures with right information.

10. Corporate Ethics – There are certain norms and behavioural attitudes which may be involved to create and develop the ethical practices towards most efficient and holistic management in the organisation.

11. Accountability – Within the framework of administrative board, the level and composition of accountabilities are also a foremost part towards the formation of basic ingredients of good governance. It also specified the distribution of rights and responsibilities among different people as engaged in an organisation.

It was observed that in Dec., 1995 the Government set up a task force to design a voluntary code of conduct. In between 1998 to 2000, there were 25 leading companies who voluntarily followed the code of corporate governance. Out of them, some of the concerns were ICICI Bank, Bajaj Auto, Nicholas Piramal, HDFC, Infosys and Birla Groups etc.

Corporate Governance – 7s for Corporate Governance

In any organisation, the effective managerial performance which is based on the concept of corporate governance has been really determined by the relationship and balancing role of different 7s that is system, structure, style, skills, staff, strategy, and shared value etc.

Showing the 7s for Corporate Governance:

There are different methods and conceptual viewpoints to create and develop most efficient organisational performance within corporate governance being stated here as 7s:

i. Shared Values

ii. System

iii. Structure

iv. Style

v. Skills

vi. Staff

vii. Strategy

The concepts, methods and objectives of corporate governance might be applicable and achieved in different organisations with the help of all the 7s.

The role and significance of these 7s are briefly stated here:

1. The 7s provide a basic framework to implement the norms and practices of good governance,

2. The 7s determine the structural biased to get an effectiveness in managerial and operational performance,

3. The 7s provide the system and methods for developed advancement in well-being of empowerment of management,

4. The 7s denotes the multidimensional phenomenon towards quality based work performance,

5. The 7s determine a framework towards better work culture in any organisation,

6. The 7s enhanced the core aspects for social values and social reforms,

7. The 7s determine the mutual relationship and balancing role of different partners as involved in organisation,

8. The 7s provide the basic guidelines for procedures and practices for reforming the methods and process of work performance,

9. The 7s developed the cultural values like devotion, duty, mutual relations and cooperation etc.

Corporate Governance – Top 4 Factors: The Ownership Structure, The Financial Structure, The Structure of Company Boards and The Institutional Environment

Four factors influence corporate governance, namely- (i) the ownership structure of a corporation, (ii) its financial structure, (iii) the structure and functioning of the company boards and (iv) the legal, political and regulatory environment within which the company operates.

(i) The Ownership Structure:

The structure of ownership of a company determines, to a considerable extent, how a corporation is managed and controlled. The ownership structure can be either dispersed among individual and institutional shareholders as in the US and UK or can be concentrated in the hands of a few large shareholders as in Germany and Japan. But the pattern of shareholding is not as simple as the above statement seeks to convey.

The pattern varies across the globe. According to a study on corporate ownership conducted in 1998, 36 per cent of the firms in the world are widely held, 30 per cent are family controlled, 18 per cent are state controlled and the remaining 15 per cent are in miscellaneous categories.

Our corporate sector is characterised by the co-existence of state owned, private and multinational enterprises. The shares of these enterprises (except those belonging to the public sector) are held by institutional as well as small investors. Specifically, shares are held by- (i) the term-lending institutions (ii) institutional investors, comprising government owned mutuals funds, Unit Trust of India and the government owned the insurance corporations (iii) corporate bodies (iv) directors and their relatives and (v) foreign investors. Apart from these block-holdings, there is a sizeable equity holding by small investors.

(ii) The Financial Structure:

Along with the notion that the structure of ownership matters in corporate governance is the notion that the financial structure of the company, i.e. proportion between debt and equity, has implications for the quality of governance. Contrary to the Modigliani-Miller hypothesis that the financial structure of the firm has no relationship to the value of a firm, recent research has shown that the financial structure does matter. It is no secret that the lenders exercise significant influence on the way a company is managed and controlled. Banks as creditors, for example, can perform the important function of screening and monitoring companies as they (banks) are better informed than other investors.

Further, banks can diminish short-term biases in managerial decision making by favouring investments that would generate higher benefits in the long run. Also, banks, because of the close financial relationships they foster with the companies to which they lend, and in some cases because of their nominees on company boards, are considered to play a more favourable role than other investors in reducing the costs of financial distress.

(iii) The Structure of Company Boards:

Along with the structure of ownership, the structure of company boards has considerable influence on the way the companies are managed and controlled. The board of directors is responsible for establishing corporate objectives, developing broad policies and selecting top-level executives to carry out those objectives and policies. The board also reviews management’s performance to ensure that the company is run well and shareholders’ interests are protected.

Company boards are permitted to vary in size, composition and structure so as to best serve the interests of the corporation and the shareholders. Board membership may include both inside directors and outside directors. Again, boards can be single-tiered or two-tiered.

With regard to the size of board, opinions and practices vary. Some argue that the adequate size is to range from nine to fifteen. Some others put the figure at ten and yet others recommend a minimum of five and a maximum of ten. Company boards in the UK have, on an average, seven directors on their boards. Japanese companies have larger boards, the figure going upto sixty.

A quick survey of the thirty companies actively traded on the Bombay Stock Exchange, and which form the basis for Sensex Index, reveals that as of 31st March, 1997, the median number of directors in these companies was 13.5, with 20 and five at the extremes. The corresponding numbers as of 31st March, 1994 were median 12, high 21, and low five. It should be noted that it is the quality of the directors, the interests they take, and the roles that they assume which are more important than mere numbers or composition.

(iv) The Institutional Environment:

The legal, regulatory, and political environment within which a company operates determines in large measure the quality of corporate governance. Infact, corporate governance mechanisms are economic and legal institutions and often the outcome of political decisions.

For example, the extent to which shareholders can control the management depends on their voting rights as defined in company law, the extent to which creditors will be able to exercise financial claims on a bankrupt unit will depend on bankruptcy laws and procedures; and the extent to which the market for corporate control efficiency operates to discipline underperforming management will depend on take-over regulations.

Corporate Governance – 6 Important Principles of Good Corporate Governance

Good corporate governance can be achieved when the parties to governance perform their respective functions in honesty, trust, integrity, openness, greater responsibly and accountability, performance orientation, mutual respect and commitment to the company’s goals.

The principles of good corporate governance include:

1. Rights and Equitable Treatment of Shareholders:

Shareholders are the real owners of the company. Therefore they have the rights for not only getting just dividend, but for ensuring proper functioning of the company. All other parties take the benefits from the sacrifices of the shareholders. Therefore, all other parties should treat the shareholders fairly and ethically. They should provide true and accurate information to the shareholders.

2. Obligations of All Stakeholders:

All other stakeholders of the company like board of directors, CEO, senior executives, bankers and suppliers should discharge their obligations properly towards the company. This ensures that company receives its share from all the stakeholders.

3. Role and Responsibilities of the Board:

The board is the representative of the shareholders. The board is in between the shareholders and the CEO. The board has to play its role in good faith and discharge its responsibilities towards the shareholders and other stakeholders. Board has to ensure disclosers, transparency of the business and efficient achievement of strategies ethically.

4. Integrity and Ethical Behaviour:

All the stakeholders of corporate governance should make decisions, implement them, and perform their functions and activities with integrity. They should behave ethically with all parties as well as in all issues.

5. Disclosures and Transparency:

Companies should disclose all the relevant data and information accurately to the parties concerned and investing public. Further, all the officers of the company should maintain transparency in their activities including major strategy implementations, agreements, understandings and joint ventures.

6. Understandings and Joint Ventures:

Corporate governance can’t be achieved on its own despite the proposition of various principles. There should be mechanisms and controls.

Corporate Governance – Perspective Viewpoints towards Corporate Governance in Context of Ethics

Within the purview of corporate governance, the ethical values and behaviour are most appropriate and desirable to make the excellences in managerial and organisational culture.

Here some of the important perspective viewpoints as suggestive approaches in this context are given here:

1. Balancing of Rights and Responsibilities – In order to make perspective work culture, there is a need to make a balancing form between the rights and responsibilities. A justified and most suitable balance may be developed between both of them.

2. Commitment – Every organisation is committed to achieving the most suitable and highest standards of corporate governance, recognising that management is responsible and accountable to all stakeholders for efficient corporate governance.

3. Behavioural Approaches – In any organisation, the dependable and independable relations between individuals and group must be amicable and trustful. There is need to make and determine the group dynamism and most appropriate behavioural patterns among the persons in organisation.

4. Strategic Frame out – The strategy formation is a process of conception, analytical and reactive in nature. It is needed to observe some of the norms and approaches like systematic, planned, cognitive, feasibility, creativity and group dynamism etc. towards a strategical framework in good governance.

5. Transparency – The truthfulness, fairness and reliability becomes the part of transparency in any organisation. For effective governance, there is a need to make and determine the measures and values of transparencies.

6. Responsibility Control Centres – In order to make efficient managerial control system, there is a need to design the measurement of inputs and outputs particularly in four major areas like revenue, expenses, profit and investment etc. The study and application of these centres may develop the control and discipline towards their proper performance.

7. To Avoid Unethical Practices – In our society we the people are more pragmatist than moralist. There are generally some unacceptable and unethical practices in business. Such practices are in the form of nepotism, bribes, gifts, personal favours, unfair competitive practices, personal benefits and dishonesty in transactions. So it is needful to avoid and overcome these unethical practices.

8. Reforms Education System – The education programme and system may be refined to emphasise the inculcation of ethical norms and certain values to be required in our society. The system, techniques and transforming process may be developed to involve the worthwhile values within our education process.

9. Viable and Accessible Financial Reporting – In order to make the protection of the interest of investors and other relevant groups, it is needed to manage high quality accounting and transparent disclosure process in organisation. Also, it is needed to make viable financial reporting system.

10. Healthy Organisational Culture – Organisational culture is a cognitive framework consisting of attitudes, expectations, behavioural norms and values shared by organisational members. Organisational culture is in which people feels that they are valued. Their importance has been needful to make better and effective organisation culture.

The organisational effectiveness are duly based on most suitable, appropriate and consistent forms of corporate culture. There is a need to create and develop the creativity, innovations, expectations, core values and overall excellences in any organisation. It may be designed by the cognitive framework of organisational culture.

11. Rationality in Decision Making – In context of managerial decision making, rationality means exercising a choice from among various alternative sources of action in such a way that it may lead to achieve the targets and objectives in the best possible manner. Moreover, the considerations should also be based on right or wrong, good or bad and feasible etc., with different directions.

12. Democratic Patterns – The organisations should develop a working environment to get some patterns of democratic styles. Here, the values of expression, work distribution, participation and occupational status must be established in the light of democratic styles.

13. Control Over Frauds, Misrepresentation and Coercion – There is a need to discourage and avoid the frauds, misrepresentation and coercion attitudes among different persons in an organisation. For it, the formation and implementation of code of conducts, disciplinary norms by laws and various occupational values are being useful.

14. Professional Codes – It is needed to formulate the professional code to be based on some ethical norms and also to determine the occupational values. The professional code may be determined by specifying behaviour that is required for the protection and recognition of the professional group as a whole.

15. Social Values – There are certain social values and ethical conducts to make value based attitudes and behaviour with different stakeholders in organisation. The values provide the foremost aspects to make better and appropriate relations.

16. Social Reforms – The concept of social reforms are needful to make interest and confidence not only with the stakeholders but also with the society at large.

17. Fair Market Practices – There is a need to formulate fair, justified and appropriate market practices for different enterprises based on ethical norms.

As such, it has stated that corporate governance is a concept and administrative framework with best target oriented aspect to achieve most excellences in any organisation. It aims to make better managerial performance, working environment and to develop most applicable criteria of responsiveness and accountabilities to protect the interest of stakeholders. The contents of corporate governance code are policies, missions, administrative role, organisational structure, business framework, transparency and corporate ethics.

Corporate Governance – Framework: The Internal and External Architecture

These two definitions—from public and private perspectives— provide a framework for corporate governance that reflects an interplay between internal incentives (which define the relationships among the key players in the corporation) and external forces (notably policy, legal, regulatory; and market) that together govern the behaviour and performance of the firm.

The internal architecture defines the relationships among key players in the corporation:

In its narrowest sense, corporate governance can be viewed as a set of arrangements internal to the corporation that defines the relationships between managers and shareholders. The shareholders may be public or private, concentrated or dispersed. These arrangements may be embedded in company law, securities law, listing requirement and the like or negotiated among the key players in governing documents of the corporation, such as the corporate charter, by-laws, and shareholder agreements.

At the center of this system is the board of directors. Its overriding responsibility is to ensure the long-term viability of the firm and to provide oversight of management. In many countries, the board is responsible for approving the company’s strategy and major decisions and for hiring, monitoring, and replacing the management.

In some countries the board has fiduciary responsibility for ensuring compliance with laws and regulations, including accounting and financial reporting requirements. For a going concern, the board is answerable to shareholders and in some systems to employees and creditors.

Its task is to protect the interests of the company. When the company runs into financial difficulty, the duty of the board shifts to the company’s creditors; the primary duty of the director is to the company rather than to shareholders.

The governance problems that need to be addressed vary according to the ownership challenge in the corporate sector. At one end of the spectrum is the publicly traded company with widely dispersed shareholdings. There, the challenge is for outside shareholders to control the performance of managers. Since managers dominate, the key governance mechanism is the rules for selecting directors, who need to have enough independence to ensure that they will properly monitor managers’ performance.

At the other end of the spectrum is the closely held company with a controlling shareholder and a minority of outside shareholders, where the manager acts at the dictate of the controlling shareholder. There, the primary governance issue is how outside shareholders can prevent the controlling shareholder from extracting excess benefits through self-dealing or disregard the economic rights of minority shareholders.

Common protections include limits on self-dealing by insiders, anti-dilution provisions, and appraisal or withdrawal rights for minority shareholders. Where a publicly traded corporation is dominated by a controlling shareholder, additional governance mechanisms may include voting rights, provision for outsider representation on the board, and takeover rules limiting the ‘control premium’ that insiders can appropriate.

External rules provide a level playing field and keep players in line:

These internal mechanisms for corporate governance are strengthened by external laws, rules, and institutions that provide a level, competitive playing field and discipline the behaviour of insiders, whether managers or shareholders. In developed market economies, these policies and institutions minimize the divergence between social and private returns and reduce costly agency problems, primarily through greater transparency, compliance mechanisms, and monitoring by regulatory and self-regulatory bodies.

Notable among the institutions is that discipline corporations are the legal framework for competition policy, the legal machinery for enforcing shareholders’ rights, systems for accounting and auditing, a well-regulated financial system, the bankruptcy system and the market for corporate control.

Corporate Governance – Relationship between Corporate Governance and Firm Performance (With Examples)

In its ‘Global Investor Opinion Survey’ of over 200 institutional investors first undertaken in 2000 and updated in 2002, Mckinsey found that 80% of the respondents would pay a premium for well-governed companies. They defined a well-governed company as one that had mostly outside directors, who had no management ties, undertook formal evaluation of its directors, and was responsive to investors’ requests for information on governance issues.

The size of the premium varied by market from 11% for Canadian companies to around 40% for companies where the regulatory backdrop was least certain (those in Morocco, Egypt and Russia).

Other studies have linked broad perceptions of the quality of companies to superior share price performance. In a study of five year cumulative returns of Fortune Magazine’s survey of ‘most admired firms’, Antunovich et al. found that those ‘most admired’ had an average return of 125%, whilst the ‘least admired’ firms returned 80%.

In a separate study, Business Week enlisted institutional investors and ‘experts’ to assist in differentiating between boards with good and bad governance and found that companies with the highest rankings had the highest financial returns.

On the other hand, research into the relationship between specific corporate governance controls and firm performance has been mixed and often weak.

The following examples are illustrative:

Board Composition:

Some researchers have found support for the relationship between frequency of meetings and profitability. Others have found a negative relationship between the proportion of external directors and firm performance, while others found no relationship between external board membership and performance. In a recent paper, Bagahat and Black found that companies with more independent boards do not perform better than other companies. It is unlikely that board composition has a direct impact on firm performance.

Remuneration/Compensation:

The relationship between firm performance and executive compensation fails to find consistent and significant relationships between executives’ remuneration and firm performance. Low average levels of pay- performance alignment do not necessarily imply that this form of governance control is inefficient.

Not all firms experience the same levels of agency conflict, and external and internal monitoring devices may be more effective for some than for others.

Some researchers have found that the largest CEO performance incentives came from ownership of the firm’s shares, while other researchers found that the relationship between share ownership and firm performance was dependent on the level of ownership. The results suggest that increases in ownership above 20% cause management to become more entrenched, and less interested in the welfare of their shareholders.

Some argue that firm performance is positively associated with share option plans and that these plans direct managers’ energies and extend their decision horizons toward the long-term, rather than the short-term, performance of the company.

However, that point of view came under substantial criticism circa in the wake of various security scandals including mutual fund timing episodes and, in particular, the backdating of option grants as documented by University of Iowa academic Erik Lie, and reported by James Blander and Charles Forelle of the Wall Street Journal.

Even before the negative influence on public opinion caused by the 2006 backdating scandal, use of options faced various criticisms. A particularly forceful and long running argument concerned the interaction of executive options with corporate stock repurchase programs. Numerous authorities (including US. Federal Reserve Board economist Weisbenner) determined options may be employed in concert with stock buybacks in a manner contrary to shareholder interests.

These authors argued that, in part, corporate stock buybacks for U.S Standard & Poors 500 companies surged to a $500 billion annual rate in late 2006 because of the impact of options. A compendium of academic works on the option/buyback issue is included in the study Scandal lay author M, Gumport issued in 2006.

A combination of accounting changes and governance issues led options to become a less popular means of remuneration as 2006 progressed, and various alternative implementations of buybacks surfaced to challenge the dominance of open market cash buybacks as the preferred means of implementing a share repurchase plan.

Corporate Governance and Developing Countries

At the same time, that developing countries are undergoing a process of economic growth and transformation, they are also experiencing a revolution in the business and political relationships that characterise their private and public sectors. Establishing good corporate governance practices is essential to sustaining long-term development and growth as these countries move from closed, market-unfriendly, undemocratic systems towards open, market- friendly, democratic systems.

Good corporate governance systems will allow organisation to realise their maximum productivity and efficiency, minimize corruption and abuse of power, and provide a system of managerial accountability. These goals are equally important for both private corporations and government bodies.

Because of the implicit relationship between private interests and the larger government, good corporate governance practices are essential to establishing good governance at the national level in developing countries. A number of ties keep the public and private sectors closely linked.

On the one hand, judiciary and regulatory bodies as well as legislatures play a role in corporate management and oversight. At the same time, cartels and large corporate interests use their size to exert not only economic, but also political power. These two sectors are so intertwined that according to the report Corporate Governance in Development- The Experiences of Brazil, Chile, India, and South Africa, a country cannot significantly change one without simultaneously instituting changes in the other.

According to Nicolas Meisel, there are four priorities which developing countries should concentrate on while experimenting with new forms of corporate and public governance. The first is to focus on improving the quality of information and increasing the speed at which it is created and distributed to the public. Good communication is important to the functioning of any organisation.

The second is to allow individual actors more autonomy while at the same time maintaining or increasing accountability. Thirdly, if a hierarchical organisation used to orient private activities toward the general interest, new countervailing powers should be encouraged to fill this role.

Finally, the part the state plays and how government officials are selected must be considered if, developing economy is to achieve sustainable growth. This may involve making it easier for newcomers with new ideas, incumbents who may hold to older, possibly outdated models.

Corporate Governance – Top 4 Theories: Agency Theory, Stewardship Theory, Stakeholder Theory and Sociological Theory

There are four basic corporate governance theories – agency theory, stewardship theory, stakeholder theory, and sociological theory, which influence the corporate governance practices in an organization. All these theories have contributed substantially to the development of corporate governance.

1. Agency Theory:

The agency theory is built upon the presumption that the interests of managers often clash or are divergent from that of shareholders. The shareholders select the managers, who are called agents, for the long-term wealth maximization and smooth functioning of the organization.

However, at times, the managers focus on their personal benefits and short-term profit maximization rather than long-term wealth maximization of the organization. This conflict of interest between managers and shareholders gives rise to a problem, known as the agency problem.

The role of corporate governance comes into picture for addressing the agency problem by bringing transparency and aligning the objectives of the organization with its associated parties.

The agency problem can be solved by providing incentives, personal recognition, and monetary and nonmonetary rewards to managers to motivate them to achieve wealth maximization. In addition, the organization tries to establish a link between executive remuneration and shareholder benefits to address the agency problem.

It is not possible for an organization to completely eradicate the conflict of interest between shareholders and managers.

However, this conflict of interest can be minimized by implementing the following effective corporate governance practices:

i. Correct Full Disclosures – It imply that a true and fair picture of the organization should be presented to its shareholders and investors.

ii. Effective Board of Directors – It refers to an efficient board of directors that should be independent and neutral enough to deal with managers as well as shareholders. The board should also ensure proper implementation of legal regulations. The directors are held responsible for the rights of shareholders; therefore, they should aim towards long-term value maximization.

2. Stewardship Theory:

The stewardship theory nullifies the possible conflicts between the managers and shareholders that have been presumed by the agency theory. The stewardship theory supports the view that the managers are considerate about their personal reputation and value their integrity.

There is a high demand for managers who have a strong sense of dignity for their personal reputation. Consequently, managers with high ethical and moral values are being offered higher remuneration in their respective industries as compared to others.

The stewardship theory focuses on the trustworthiness of managers and is based on the following points:

i. Motivating managers to ensure that they not only look after personal goals but also align these personal goals with the organizational objectives

ii. Controlling managers excessively can de-motivate them, and thereby, make control measures counterproductive.

Difference between the Agency Theory and Stewardship Theory:

The points of differences between agency theory and stewardship theory are given as follows:

a. Behavioral Differences:

It refer to the difference in the attitude and behavior of managers. The agency theory follows the materialistic approach; whereas, the stewardship theory supports the socialistic approach. The difference also arises in the role of managers as the agency theory prompts managers to take the role of an agent where he/she requires to control and supervise the managerial functioning. On the other hand, the stewardship theory aims at empowering the managers.

b. Need Hierarchy Differences:

It refer to the needs as highlighted in the Maslow’s’ need hierarchy theory of managers fulfilled by these two theories. The two theories satisfy different levels of needs of the managers. The agency theory satisfies the lower level needs of the managers that are also known as extrinsic needs. On the other hand, the stewardship theory aims at fulfilling the intrinsic or higher level needs of the managers.

c. Orientation Differences:

It refer to the differences in approach followed by these two theories. The difference is based on the fact that the agency theory aims at building a control and authority-oriented management, whereas the stewardship theory focuses on participative management.

3. Stakeholder Theory:

The stakeholder theory was developed in 1930s, and supports the view that an organization should maximize stakeholders’ benefits and follow an ethical code of conduct. There are many problems that arise while enforcing the stakeholder theory in an organization. These problems include identifying genuine stakeholders and determining the shareholders’ benefits.

An organization has many stakeholders; therefore, some management experts have suggested dividing stakeholders into primary shareholders and secondary shareholders. Primary shareholders refer to the shareholders who directly purchase the shares from the organization; whereas, secondary shareholders are the shareholders who purchase the shares from the stock exchange.

The stakeholder theory fails to address the dilemma of organizations related to the selection of credible and capable primary and secondary shareholders. The stakeholder theory of corporate governance has also been accused of creating chaos in the organizations as it disorients the managers from the goal of profit maximization.

4. Sociological Theory:

The sociological theory mainly focuses on the distribution of wealth and power in the society. The theory also supports the viewpoint that the organization should conduct auditing, and take control measures to promote equity and social progress. In an organization, at individual as well as group levels, the sociological theory reflects interpersonal influence of people and organizational environment on each other.

This theory promotes fairness and equity in the society by reducing the gap between:

i. Incomes of male and female in an organization through sound corporate governance policies

ii. Number of males and females at the top management level in an organization.

The sociological theory also promotes equal employment opportunities in the organizations.

However, the implementation of sociological theory is not easy due to the following reasons:

i. Ownership Control in Family Businesses – It prevents the successful implementation of sociological theory as these businesses give more emphasis on profit maximization rather than social welfare.

ii. Concentration of Power at The Top Levels of Organizational Hierarchy – It hampers the smooth functioning of sociological theory. The concentration of power in the hands of top management prevents the middle-level and lower-level managers to take decisions in the interest of society without the prior approval of top management.

iii. Negative Outlook of Managers towards Social Issues – It refers to the unenthusiastic attitude of top management towards social progress. It hinders the successful implementation of the sociological theory in the organization.

Corporate Governance – Responsibilities, Role and Functions of the Board of Directors

Corporate governance at the highest level is about the Board of Director. This practice began in United Kingdom where the group of people who oversaw the company met regularly to discuss the affairs of the business. Furniture was expensive in those days and hence they would sit on stools around a long board laid across two sawhorses.

This group was named “The Board” after the board they used to sit around. Their leader being a distinguished member would not sit on a stool but would use a chair. Hence the term “chair-man”.

In principle, the shareholders elect a Board of Directors that then sets the strategic- aims for the company, provides leadership to them into effect, supervises the management and reports to the shareholders on the performance of the company. Hence, the Board of Director is accountable to shareholders.

Legally all the power is vested in the Board of Directors that is fully responsible for the performance of the company and providing vision and direction to it. The board of directors has an obligation to approve all decisions that might affect the long-run performance of the corporation.

However, the board memberships have become ceremonial in nature and get filled by the promoter’s friends and relatives. According to Chinubhai Shah, Director, Torrent, the promoter’s holding hardly exceeds 15 to 25 per cent of the stock but they rule the company, the FIs and individual small shareholders being generally silent spectators and support of the management.

Sir Adrian Cadbury noticed with dissatisfaction that decision making and the focus of all the activities in a company revolves around the CEO and has stated, my argument is that the company should revolve around the board, which under the guidance of the chairman should establish priorities and values and see that the executives put them into practice.

According to Kumar Mangalam Birla Committee, good corporate governance dictates that the board has individuals with certain core competence, such as awareness of the importance of the board’s tasks, integrity, a sense of accountability, track record of achievements, and the ability to ask tough questions.

Besides having financial literacy, the requisite experience, leadership qualities and the ability to think strategically, the directors must show a significant degree of commitment to the company and devote adequate time for board meetings, preparation and attendance.

Improvements in working of the BODs can be recommended along some broad- lines. One is the change in the role of the boards, composition of boards and role of the non-executive directors and facilitation of better decision-making by the board members.

At ICI the Board believes in and supports the principles of corporate governance and seeks to discharge its operational, strategic and fiduciary responsibilities to ensure good management practices.

The Board represents the shareholders’ interest in terms of optimizing long-term financial returns and is committed to its responsibilities for all the constituents of its business i.e. customers, employees, suppliers and the general public.

The Board, which is accountable for achieving and maintaining such standard of good governance, comprises the Non-Executive Chairman, the Managing Director, one Whole-time Director and four Non-Executive Directors.

Responsibilities of the Board:

Laws and standards concerning the responsibilities of boards of directors vary from country to country. For example, board members in Ontario, Canada, face more than 100 provincial and federal laws governing director liability. However, there are no clear national standards or federal laws in US.

Specific requirements of directors differ, depending on the state in which the corporate charter is issued. However, there is a developing worldwide consensus concerning the major responsibilities of a board.

A study interviewed 200 directors from 8 countries (Canada, France, Germany, Finland, Switzerland, the Netherlands, the United Kingdom, and Venezuela) and found that there is a strong agreement on the responsibilities of board of directors for setting corporate strategy, overall direction, mission and vision; hiring and firing the CEO and top management; controlling, monitoring, or supervising top management; reviewing and approving the use of resources.

Legally the board directs the affairs of the corporation but not manage them. The law requires the board to act with due care. In case of a failure a director or the board as a whole, the careless director or directors can be held personally responsible for the damage done. Ideally, the board is expected to oversee the management and reprimand any misdoing.

But considering that the board is dependent on the management for nomination, compensation and information, it becomes difficult for the board to be very critical of the management. This problem has aggravated in recent years as increasing number of directors are nominees of the CEO and hence dependent on him for their position.

Directors need to be the representatives of the shareholders. We need a much better system to find directors. One such way is to have a nominating committee on each board that will come up with suitable names. These could be discussed with the shareholders in the annual shareholder meet to gain their approval.

Role of the Board:

The Board of Directors has a trusteeship role and represents all the shareholders. They should not function as a rubber stamp of the promoters and the management.

It should act as a well-knit team of relevant talent for the task meant to perform. The board can add value to the company in respect of auditing and monitoring executive management, annual strategy review, improved accountability of the management, improved shareholder participation.

The BOD can also play a significant role in strategic management of the company.

The role of the board of directors in strategic management is to carry out following basic tasks:

1. Monitor:

By acting through its committees, a board can keep abreast of developments inside and outside the corporation, bringing to management’s attention developments it might have overlooked.

2. Evaluate and Influence:

A board can examine management’s proposals, decisions, and actions; agree or disagree with them; give advice and offer suggestions as well as outline alternatives. More active boards perform this task in addition to the monitoring role.

3. Initiate and Determine:

A board can delineate a corporation’s mission and specify strategic options to its management. Only the most active boards take on this task in addition to the two previous ones.

Functions of the Board:

Today’s board comprises of about 15 directors on an average. Some of these are from within the organization and others are external members generally called independent directors. Over time the mix of internal/externals has been shifting towards greater participation of external directors.

They meet on an average about 7-8 times a year and their primary functions are:

(1) Evaluate the CEO’s (and management’s) performance against the goals the CEO and the board had established.

(2) Determine and review plans for succession of management.

(3) Review management compensation such that it is designed to encourage risk- taking, innovation, efficiency and competitiveness.

(4) Provide advice and counsel to the top management.

(5) Review and approve the final objectives, major strategies, and the plans of the corporation.

(6) Evaluate the board’s own performance- individually and collectively- and correct board process and membership as necessary.

Besides these the board might also need to look at the operational issues like the quarterly results, management’s projections for the future, company’s long term strategic goals, its capital structure, resource allocation, research and development investments and company’s global prospects.

Extent of Involvement:

The tasks of monitoring, evaluating and influencing, and initiating and determining decide the extent of involvement of board of directors in strategic management. The Board of Directors continuum represents the possible degree of involvement (from low to high) in the strategic management process.

Boards can vary from phantom boards with passive involvement to active boards with a very high degree of involvement. The corporate financial performance positively relates to active board involvement in strategic management.

Actively participating boards carry out their tasks of monitoring, evaluating, and influencing, plus initiating and determining, very seriously and provide advice whenever necessary and keep management alert. For example, a survey of directors of large U.S. corporations revealed that over 60% indicated that they were deeply involved in the strategy- setting process.

54% of the respondents indicated that their boards participate in an annual retreat or special planning session to discuss company strategy. Nevertheless, only slightly more than 32% of the boards help develop the strategy. Over two- thirds of the boards review strategy only after it has been first developed by management.

Another 1% admits playing no role at all in strategy. Mead Corporation, Rolm and Haas, Whirlpool, Westinghouse, the Mallinckrodt Group, Dayton-Hudson, and General Motors are examples of corporations with actively participating boards.

The lesser and less involvement of a board in the affairs of the Corporation, takes it farther to the left on the continuum. On the extreme left are passive phantom or rubber stamp boards that typically never initiate or determine strategy unless there is a crisis.

The boards of small corporations participate less actively. In an entrepreneurial venture, for example, the privately held corporation may be 100% owned by the founders, who also manage the company and where there is no need for an active board to protect the interests of the owner-manager shareholders.

In many large, publicly owned corporations boards operate at some point between nominal and active participation. A study found that 30% of the boards actively worked with management to develop strategic direction (active/ catalyst), 30% worked to revise as well as ratify management’s proposals (minimal/nominal participation) and 40% merely ratified management’s strategic proposals (phantom/rubber stamp).

There are directors who are on board of more than 20 companies and that too while holding a full time job elsewhere. Jy Lorsch, associate Dean of Harvard Business School feels that at least 100 hours annually are required to carry out the duties of the director. So, if a full time working executive sits on 20 board, it would require 2000 hours annually apart from his regular job.

Since this is not possible in practice, it is unlikely that he can do justice to his role as director. Apart from lack of time, the directors are also unwilling to commit money to the company. Many of the directors are reluctant to hold significant stock in the companies they sit on the board of.

Due to this, it is quite likely that the directors do not have enough incentive to be aggressive in evaluating and overseeing management. Since the directors act as shareholder’s representative, they must invest more time and money that will undoubtedly improve their commitment and performance.

Corporate Governance – 4 Main Issues: Transparency, Accountability, Independence and Reporting

The basic objective of corporate governance is to maximize long-term shareholder value. Therefore, good governance should address all issues that lead to a value addition for the organization and serve the interests of all the stakeholders.

The main issues in corporate governance are:

Issue # 1. Transparency:

Transparency means accurate, adequate and timely disclosure of relevant information to the stakeholders. Without transparency, it is impossible to make any progress towards good governance. Business heads should realize that transparency also creates immense shareholder value. But many a times information-sharing is hindered under the excuse of confidentiality.

There is need to move towards international standard in terms of disclosure of information by the corporate sector and through all this to develop a high level of public confidence in business. Once a company has public shareholding it is imperative that its commitment to financial transparency must be total.

The company is a trustee of the investors, money and this responsibility in turn demands full disclosure. Corporations in India must learn to work with transparency and impeccable integrity as these are the essential ingredients to maximize their wealth and the wealth of the nation.

Transparency and disclosure are the key pillars of corporate governance because they provide all the stakeholders with the information necessary to judge whether their interests are being taken care of.

Issue # 2. Accountability:

Corporate governance has to be a top down approach. Chairman, Boards of Directors and Chiefs Executives must fulfil their responsibilities to make corporate governance a reality in Indian industry. In companies with good governance, accountability is not just bottom up but also follows the reverse order. A departmental head is, for example, responsible for every decision taken on behalf of his department. Accountability also favours the objective of creating shareholder value.

Issue # 3. Independence:

A strong board of directors is necessary to lead and support merit based management. The board has to be an independent, strong and non-partisan body where the role motive should be decision-making through business prudence. Though corporate governance is much broader than corporate management, an efficient and effective administration of corporate sector is essential for meeting the desired objectives.

Corporate governance ensures that long-term strategic objectives and plans are established and that the proper management structure (organization, systems and people) is in place to achieve those objectives, while at the same time ensuring that the structure functions to maintain the company’s integrity, reputation and responsibility to its various stakeholders.

Issue # 4. Reporting:

Adequate, accurate and frequent report to shareholders and other stakeholders is essential for good corporate governance. In its monthly, quarterly and other reports, the company should report not only financial performance but details of management and committees of Board of Directors.

Thus, corporate governance involves the broad parameters of reporting system, accountability and control.

Corporate Governance – Top 6 Mechanisms to Ensure Corporate Governance

The fundamental institutions of corporate governance in our country have been in existence for a long time. Compared to many developing countries, mechanisms of corporate governance in India are much more institutionalised. However, inspite of such institutions, corporate governance has not been a major issue until the announcement of the new economic policy in 1991. Since then, corporate governance has assumed greater relevance for reasons stated earlier.

In our country, there are six mechanisms to ensure corporate governance:

1. The Companies Act, 1956;

2. The Securities and Exchange. Board of India (SEBI) Act, 1992;

3. A market for corporate control;

4. Participation of block shareholders in the governance of companies;

5. Statutory audit; and

6. Code of Conduct.

Mechanism # 1. Companies Act:

Companies in our country are regulated by the Companies Act, 1956, as amended upto-date. The Companies Act is one of the biggest legislations with 658 sections and 14 schedules. Through the consolidation of many successive amendments, and a large number of statutory rules and regulations, the Act aims at not only ensuring that the interests of all stakeholders are adequately protected but purports to go beyond.

The Act, to some extent, seeks to translate into action Articles 38 and 39 in Part IV of the Constitution, by which the State was directed that the ownership and control of the material resources of the community are so distributed as to sub serve the common good and the operation of the economic system does not result in the concentration of wealth and means of production to the common detriment.

The arms of the Act are quite long and touch every aspect of a company’s existence. But to ensure corporate governance, the Act confers legal rights to shareholders to- (a) vote on every resolution placed before an annual general meeting; (b) to elect directors who are responsible for specifying objectives and laying down policies; (c) determine remuneration of directors and the CEO; (d) removal of directors and (e) take active part in the annual general meetings.

The Companies Bill, 1997 and the recently promulgated Ordinance on Companies (Amendment) Bill, 1997, have amended several provisions of the Act and introduced new provisions incorporating some internationally accepted corporate governance practices aimed at strengthening corporate democracy, protecting the interests of minority shareholders and providing maximum flexibility to the companies in responding to the market needs. Among these, the amendments that have made headlines are permitting companies to buy back shares and the liberalisation of inter-corporate investments.

Mechanism # 2. Securities Law:

The primary securities law in our country is the SEBI Act. Since its inception in 1992, the Board has taken a number of initiatives towards investor protection.

One such initiative is to mandate information disclosure both in prospectus and in annual accounts. While the Companies Act itself mandates certain standards of information disclosure, SEBI Act has added substantially to these requirements in an attempt to make these documents more meaningful. One of the most valuable is the information relating to the performance of other companies in the same group, particularly those companies which have accessed the capital market in the recent past.

Another aspect of the SEBI regulations is that in most public issues, the promoters (typically the dominant shareholders) are required to take a minimum stake of about 20 per cent in the capital of the company and to retain these shares for a minimum lock-in period of three years.

Yet another area in which SEBI has laid down guidelines, relates to prohibiting preferential allotments to dominant shareholders at a price lower than the average market price during the preceding six months.

Also, SEBI intervenes in corporate take-overs in order to protect the interests of minority shareholders. As per the securities law, the acquirer of a controlling block of shares must make an open offer to the public for atleast 20 per cent of the issued share capital of the target company at a price not below that was paid for the controlling block.

Finally, the Board constituted a Committee under the chairmanship of Kumaramangalam Birla to suggest ways to promote and raise the standards of corporate governance in listed companies. The Board, in its meeting held on January 25, 2000, considered the recommendations of the Committee and decided to make amendments to the listing agreements by adding a new clause, namely clause 49, to the listing agreement.

The clause 49 provides for the optimum composition of executive and non-executive directors; setting up of a qualified and independent audit committee; remuneration of directors; Management Discussion and Analysis Report to form part of annual report to the shareholders; a separate section on Corporate Governance in the annual reports of the company; for information to be furnished in the report on corporate governance; and auditor’s compliance certificate to the effect that all the conditions of corporate governance have been complied with.

Mechanism # 3. Discipline of the Capital Market:

Capital market itself has considerable impact on corporate governance. Herein lies the role the minority shareholders can play effectively. They can refuse to subscribe to the capital of a company in the primary market and in the secondary market; they can sell their shares, thus depressing the share prices. A depressed share price makes the company an attractive take-over target.

A debt-holder too has a role to play in disciplining a company’s management. Unlike the shareholder who is a residual claimant, the creditor has contractual rights to reclaim his interest and principal; and this enables him to monitor the actions of the management. Most debt contracts involve covenants that make it less easy for the dominant shareholders to indulge in gross abuses. The ability of debt-holders to monitor the company is quite high because typically, they are large institutions with high stakes.

In a well -functioning capital market, there is a strong incentive for corporate managements themselves to voluntarily adopt transparent processes and subject themselves to external monitoring to reassure potential investors. An untested management group is likely to find that the market places a ‘management discount’ on them that reflects what the market has come to expect of management groups in general.

The management then has every incentive to take steps that will reduce this by making governance abuses more difficult. In the last few years, we have seen Indian companies voluntarily accepting international accounting standards though they are not legally binding. They have voluntarily gone for greater disclosures and more transparent governance practices than are mandated by law. They have sought to cultivate an image of being honest with their investors and of being concerned about shareholder value maximisation.

What makes capital market discipline so much more attractive than regulatory intervention is that unlike the regulator, the market is very good at micro level judgements and decisions. Infact, the market is taking micro-decisions all the time. It is its success in doing so that makes it such an efficient allocator of capital.

Unlike the regulator, the market is not bound by broad rules and can exercise business judgement. It therefore makes sense for the regulator to pass on as much of the burden of ensuring corporate governance to the markets as possible. The regulator can then concentrate on making the markets more efficient at performing this function.

Mechanism # 4. Nominees on Company Boards:

Development banks hold large blocks of shares in companies. They are equally big debt-holders too. Being equity holders, these investors have their nominees in the boards of companies. These nominees can effectively block resolutions which may be detrimental to their interests. Unfortunately, the role of nominee directors has been passive, as has been pointed out by several committees including the Bhagavati Committee on Takeovers and the Omkar Goswami Committee on Corporate Governance. However, signs of active role by nominee directors are emerging.

Mechanism # 5. Statutory Audit:

Statutory audit is yet another mechanism directed to ensure good corporate governance. Auditors are the conscience-keepers of shareholders, lenders and others who have financial stakes in companies.

Auditing enhances the credibility of financial reports prepared by an enterprise. The auditing process ensures that financial statements are accurate and complete, thereby enhancing their reliability and usefulness for making investment decisions. Credible financial statements are essential for business enterprises to raise capital and for society to have trust in limited companies.

Obviously, good corporate governance depends, in part, on good auditing. As the Cadbury Committee observed, “The annual audit is one of the cornerstones of corporate governance. Given the separation of ownership from management, the directors are required to report on their stewardship by means of the annual report and financial statements sent to the shareholders. The audit provides an external and objective check on the way in which the financial statements have been prepared and presented, and it is an essential part of the checks and balances required.”

In practice, this is not always true. Users of auditors’ services are often disenchanted with the performance of auditors and seldom believe auditors live up to the solemn image presented by the Cadbury Committee. Auditing is often considered to be just an annual ritual. Caustic comments such as auditors being ‘hand in glove’ with the management, or the financials being ‘dressed up’ are often voiced by shareholders, employees and tax officers.

So, what ails auditing? Auditor independence or the perceived lack of it is a major issue. Other lacunae include problems concerning audit quality, the role of auditors in detecting frauds and reviewing internal controls and the record of the accounting profession in establishing accounting and auditing standards.

Mechanism # 6. Codes of Conduct:

The mechanisms discussed till now are regulatory in approach. They are mandated by law and violation of any provision invites penal action. But legal rules alone cannot ensure good corporate governance. What is needed is self-regulation on the part of directors, besides of course, the mandatory provisions.

The famous ‘Code of Best Practice’ was advocated by the Cadbury Committee in the UK. The committee was constituted by the London Stock Exchange in 1992, following the collapse of several British companies. The cause of anxiety then, was not so much that the companies had failed, as that their annual reports and financial statements – just prior their failure – gave no forewarning of the true state of their financial affairs. Subsequent scandals relating to ‘excessive’ remuneration paid to directors, created the climate for business to establish more effective norms of corporate behaviour.

How did the Cadbury Committee address this situation? Basically, good governance issues were seen as relating to both the effectiveness and the accountability of the Board of Directors:

i. Effectiveness was seen as a measure of the quality of the leadership of the directors, to be judged by the company’s financial results and the resultant growth in shareholder value.

ii. Accountability was seen as largely a matter of disclosure of all relevant information-transparency in short-focusing on the subject of, to whom a company is answerable.

The Code is thus based on checks and balances, especially at the level of the board of directors and the chief executive, to guard against undue concentration of power, and, adequate disclosure to enable those entitled to have the information they need, in order to exercise their rights.

It comprises four sections:

i. Role of the Board of Directors – It was proposed that the (‘inside’) executive directors be balanced by adequate number of (‘outside’) non-executive directors, with the posts of the board chairman and chief executive being separated.

ii. Role of Non-executive Directors – It was emphasized that the majority of the Board should be independent’ (in the sense of being free of any business relation which could materially interfere with the exercise of independent judgement), that non-executive directors should be appointed only for a specific term and that there should -be a formal process for their appointment involving the board as a whole.

iii. Executive Directors – The main concern was with their remuneration-that there should be a full and clear disclosure of directors’ emoluments, and that pay should be set by a Remuneration Committee, consisting mainly of non-executive directors.

iv. Financial Reporting and Controls – It was recommended that properly constituted Audit Committees of the Board be appointed, and that non-executive directors report regularly on the effectiveness of systems and internal financial control.

In due course, the London Stock Exchange, while not mandating compliance with any element of the code, asked all listed companies to append to their Annual Reports, a declaration of the extent of their compliance with the Code. Shareholders were left to draw their own conclusions about the quality of governance in their companies.

The Confederation of Indian Industry (CII) issued a draft code of ‘Desirable Corporate Governance’ for the Indian industry in April 1997, in response possibly to the Finance Ministry’s veiled threats that soften the self-regulatory regime, greater the likelihood of harsher government regulations.

The CII Code, leaning heavily on the British model, is based on the explicit assumption that- “good governance helps to maximise shareholder value, which will necessarily maximise corporate value and, thereby, satisfy the claims of creditors, employees and the State.”

Corporate Governance – Top 5 Benefits

Benefits of good corporate governance are as follows:

1. Good corporate governance leads to promoting fairness, transparency, and accountability in management practices.

2. It instills confidence in public dealing with the organization. This is beneficial to both the organization and the public.

3. It creates better image of the organization, thereby it is able to attract resources from the society.

4. It helps in providing satisfaction to all stakeholders of the organization.

5. It leads to maximization of shareholder wealth.

Corporate Governance – Guidelines

Corporate governance is a collection of codes, principles, and guidelines that aims at securing the interests of stakeholders. It calls for proper implementation of legal rules, taking up social responsibility, and fostering sustainability that comes through building efficient financial markets. The guidelines for corporate governance given by International Corporate Governance Network (ICGN) and Asia-Pacific Economic Co-operation (APEC).

Let us now discuss these guidelines of corporate governance in brief:

1. Rights of Shareholders – It means shareholders have a right to approve and voice their opinion when major organizational changes take place. Shareholders also have a right to vote in board meetings.

2. Equitable Treatment of Shareholders – It means that all shareholders (major or minor) must be considered as equal by an organization. They all should have one-share one-vote right. Organizations should protect the right of minority shareholders.

3. Stakeholder Benefits – It refers to the significant relationship of stakeholders with the director of an organization. Directors should build productive relationships with the stakeholders of the organization. A director must also be responsible and accountable to stakeholders.

4. Disclosure and Transparency – It refers to the degree to which information is freely available to employees. Corporate governance should ensure that all relevant information is made available on time to all stakeholders. Disclosures about director’s compensation, information of annual audits, and status of voting is made available to all shareholders on time.

5. Responsibilities of the Board of Directors – It refers to the obligations that the board of directors has towards an organization. This includes matters, such as – establishment of audit committees and compensation of outside directors.

Corporate Governance – Trends

The role of the board of directors in the strategic management of the corporation is likely to be more active in the future. The change will probably be evolutionary, however, rather than radical or revolutionary. Different boards are at different levels of maturity and will not be changing in the same direction or at the same speed.

Although neither the composition of boards nor the board leadership structure has been consistently linked to firm financial performance. A McKinsey survey reveals that investors are willing to pay 16% more for a corporation’s stock if it is known to have good corporate governance.

The investors explained that they would pay more because, in their opinion:

(1) Good governance leads to better performance over time,

(2) Good governance reduces the risk of the company getting into trouble, and

(3) Governance is a major strategic issue.

Some of today’s trends in governance (particularly prevalent in the United States and the United Kingdom) that are likely to continue include the following:

1. Boards are getting more involved not only in reviewing and evaluating company strategy, but also in shaping it.

2. Institutional investors, such as pension funds, mutual funds, and insurance companies, are becoming active on boards and are putting increasing pressure on top management to improve corporate performance. For example, the California Public Employees’ Retirement System (CalPERS), the largest pension system in the United States, annually publishes a list of poorly performing companies, hoping to embarrass management into remedial action.

3. Shareholders are demanding those directors and top managers own more than token amounts of stock in the corporation. Stock is increasingly being used as part of a director’s compensation.

4. Nonaffiliated outside (non-management) directors are increasing their numbers and power in publicly held corporations as CEOs loosen their grip on boards. Outside members are taking charge of annual CEO evaluations.

5. Boards are getting smaller, partially because of the reduction in the number of insiders but also because boards desire new directors to have specialized knowledge and expertise instead of general experience.

6. Boards continue to take more control of board functions by either splitting the combined Chair/CEO into 2 separate positions or establishing a lead outside director position.

7. As corporations become more global, they are increasingly looking for international experience in their board members.

Society, in the form of special interest groups, increasingly expects boards of directors to balance the economic goal of profitability with the social needs of society. Issues dealing with workforce diversity and the environment are now reaching the board level. For example, the board of Chase Manhattan Corporation recently questioned top management about its efforts to improve the sparse number of women and minorities in senior management.

Corporate Governance – Future

As we go into the future, corporate governance will become more relevant and a more acceptable practice. Seeds are already sown towards honest business practices. More and more progressive companies are drawing and enforcing codes of conduct, are accepting tougher accounting standards and are following more stringent disclosure norms than are mandated by law. These tendencies would be further strengthened by a variety of forces that are acting today and would become stronger in years to come.

Such forces are:

i. Deregulation Economic reforms have not only increased growth prospects, but they have also made markets more competitive. This means that in order to survive, companies will need to invest continuously on a large scale.

ii. Disintermediation Meanwhile, financial sector reforms have made it imperative for firms to rely on capital markets to a greater degree for their needs of additional capital.

iii. Institutionalisation Simultaneously, the increasing institutionalisation of the capital markets has tremendously enhanced the disciplining power of the market.

iv. Globalisation of financial markets has exposed issuers, investors and intermediaries to the higher standards of disclosure and corporate governance that prevail in more developed capital markets.

v. Tax reforms coupled with deregulation and competition have tilted the balance away from black money transactions. This makes the worst forms of mis-governance less attractive than in the past.