Corporate Governance

CORPORATE GOVERNANCE

ACKNOWLEDGEMENT

At the outset, I am thankful to my college SANPADA COLLEGE OF COMMERCE AND TECHNOLOGY, and the authorities, for providing me an opportunity to undertake my Bachelor Degree in Banking And Insurance (BBI), and also for sponsoring me to undertake project. I am thankful to the management for giving me an opportunity to undertake my project ( A Study on) under the guidance of Prof. SHREKESH POOJARI as my mentor.

I would like to thank our Faculty guide, Prof. SHREKESH POOJARI for providing valuable suggestions and guidance during the project. His perspective has encouraged me to incorporate a different dimension to the project.

I am grateful to my colleagues for being a wonderful support a through at the same time I am thankful to all my friends of Sanpada College of Commerce & Technology for being with me at different junctures of need. I thank

I also acknowledge great sense of gratitude to all those who have enriched and improved my thinking, through their conversations, thoughts, experience and guided me to complete this report.

ORIENTAL COLLEGE OF COMMERCE & TECHNOLOGY 1


CERTIFICATE

This is to certify that the project work titled ‘’CORPORATE GOVERNANCE” has been completed by ‘’S.VENKATESH” OF T.Y.B.B.I under the guidance of ‘’Prof. SHREKESH POOJARI ” during the academic year 20011-12” This report is submitted towards the partial fulfillment of Bachelor of Banking And Insurance, Oriental Education Society, Mumbai University.

The information in the project report is unique, true and fair to the best of my knowledge.

PROF. SHREKESH.POOJARI

(PROJECT GUIDE)

PLACE:

DATE:



DECLARATION

I hereby declare that the project work entitled ‘’CORPORATE GOVERNANCE ” to the ‘’UNIVERSITY OF MUMBAI’’ is a record of an

original work done by me under the guidance of PROF. SHREKESH.POOJARI and this project work has not performed the basis for the award of any Degree or Diploma/associate ship/fellowship and similar project if any.

S.VENKATESH (T.Y.B.B.I)

PLACE:

DATE:



UNIVERSITY OF MUMBAI.

PROJECT REPORT ON

“CORPORATE GOVERNANCE”

A PROJECT REPORT SUMITTED IN PARTIAL FULFILLMENT

OF THE REQUIREMENT FOR

BACHELOR OF BANKING AND INSURANCE

SUBMITTED BY: S.VENKATESH

UNDER GUIDANCE OF:

PROF. SHREKESH.POOJARI

SANPADA COLLEGE OF COMMERCE & TECHNOLOGY

Sector No . 2, Plot No. 3-5, Adj. Sanpada station

Navi Mumbai.

2011-2012



Chapter -1

INTRODUCTION

Understand the meaning and genesis of corporate governance

Definition of corporate governance

Risk and concept of corporate governance

Importance of corporate governance



Meaning:

Corporate governance while not a new concept, has in the 1990’s become an issue

of global importance. Corporate governance is a set of process, customs, policies,

laws and institutions affecting the way a also includes the relationships among the

many players involved (stakeholders) and the goal for which the corporation is

governed. The principal players are the stakeholder, management and board of

directors. Other stakeholders include employees, suppliers, customer, banks and

other lenders, regulators, the environment and the community at large. According

to sir Adrian Cadbury:

“Corporate governance is concerned with the holding the balance between

economic and social goal and between individual and communal goals. The

corporate governance framework is there to encourage the efficient use of



resources and equally to require accountability for the stewardship of those

resources. The main aim is it align as nearly as possible the interest of individual,

corporation and society.”

Definition of corporate governance:

Corporate governance refers to the relationship that exists between the different

participants, and defining the direction and performance of corporate firm. The

following are the main actors in corporate governance:

the CEO, i.e., the management

the board of directors

the shareholders

The other actors who influence governance in corporation/firms are the staff,

suppliers, customers, creditors and the community. Before discussing the role of

different bodies, the understanding of corporation is must, what a corporation

stands for and who should define the direction of the firm.

The definition of corporation refers to an instrument or a body by means of which

capital is acquired, used for investing in assets producing goods and services, and

their distribution. As per the corporation law, the purpose of business corporation

should be engage in such activities which contribute the raising the profits of the

firm and enhance the value/gain of the shareholders. It has a legal entity and

originates from the authority of the land. A corporation differs from the people

who constitute it. Thus it follows from above that, once the individual forms the

corporation, they together constitute the corporation in the eyes of the Laws.

Definitions of corporate governance vary widely. They tend to fall into two

categories. The first set of definitions concerns itself with a set of behavioral

patterns: that is, the actual behavior of corporations, in terms of such measures as



performance, efficiency, growth, financial structure, and treatment of shareholders

and other stakeholders. The second set concerns itself with the normative

framework: that is, the rules under which firms are operating—with the rules

coming from such sources as the legal system, the judicial system, financial

markets, and factor (labor) markets. For studies of single countries or firms within

a country, the first type of definition is the most logical choice. It considers such

matters as how boards of directors operate the role of executive compensation in

determining firm performance, the relationship between labor policies and firm

performance, and the role of multiple shareholders. For comparative studies, the

second type of definition is the more logical one. It investigates how differences in

the normative framework affect the behavioral patterns of firms, investors, and

others. In a comparative review, the question arises how broadly to define the

framework for corporate governance. Under a narrow definition, the focus would

be only on the rules in capital markets governing equity investments in publicly

listed firms. This would include listing requirements, insider dealing arrangements,

disclosure and accounting rules, and protections of minority shareholder rights.

Under a definition more specific to the provision of finance, the focus would be on

how outside investors protect themselves against expropriation by the insiders.

This would include minority right protections and the strength of creditor rights, as

reflected in collateral and bankruptcy laws. It could also include such issues as the

composition and the rights of the executive directors and the ability to pursue

class-action suits.

One can define corporate governance as the range of institutions and policies that

are involved in these functions as they relate to corporations. Both markets and

institutions will, for example, affect the way the corporate governance function of

generating and providing high-quality and transparent information is performed.



Rise of the concept of corporate governance:

The word corporate governance is relatively a new addition to the vocabulary of

management science in Japan, said of Mitsubishi Corporation. The economic

recession of the late nineties and the early years of new millennium which gripped

Japan is being described as a “governance recession”. Downturn in trading and low

returns on investment are the most significant phenomena of the Japanese economy

during this period. These downturn are described to inappropriate structure of

corporate governance, which failed to respond to the changing business

environment.

It is the pertinent to quote the example of Daimler Benz, ‘the crown jewel’ of

the German industry, which learnt through hard experience to bring a change in the

classical accounting system and practices on the disclosure, so as to attract the

foreign capital. It is implied that emerging markets reflected the changes needed in

the structure of governance. The fact that governance considerations are vital in the

competition for acquisition of capital is also shown when Australian stock

Exchange denied Rupert Murdoch, an internationally known tycoon, his proposed

listing. Rupert Murdoch was to dispose his non-voting share.

The governments round the world have been concerned about developing

international code on governance. With the reduction in the trade barrier by the

countries, the investors are willing to invest across the world. Now they are able to



access detailed information on investment opportunities in corporates easily on the

internet. Global companies are looking for first class regulatory and legal system,

among other conditions. The successive efforts of the shareholders of the firms like

Westing House, American Express, Sears, ITT, etc., have displayed that the well

informed equity owners of the firms have the potential to influence the governance

of the firm.

The word corporate governance started in the UK during the late eighties. In

1992, the UK developed a code on governance under the chairmanship of Adrian

Cadbury, governor, Bank of England.

Corporate governance occupies a significant place in the international

business. Today the subject is being taught in many B’ schools as a part of their

curriculum. In order to be able to appreciate the issue related to governance, one

needs to understand the underlying concept and the related assumptions in these

subjects, besides their inter-linkages to understand the business scenario.

Importance:

The scandals and crises are just manifestations of a number of structural reasons

why corporate governance has become more important for economic development

and a more important policy issue in many countries. The reasons are as follows:

(a) The private, market-based investment process underpinned by good corporate

governance is now much more important for most economies than it used to be.

Privatization has raised corporate governance issues in sectors that were previously

in the hands of the state. Firms have gone to public markets to seek capital, and

mutual societies and partnerships have converted themselves into listed

corporations.

(b) Due to technological progress, liberalization and opening up of financial

markets, trade liberalization, and other structural reforms—notably, price



deregulation and the removal of restrictions on products and ownership—the

allocation within and across countries of capital among competing purposes has

become more complex, as has monitoring of the use of capital.

(c) The mobilization of capital is increasingly one step removed from the principal-

owner, given the increasing size of firms and the growing role of financial

intermediaries. The role of institutional investors is growing in many countries,

with many economies moving away from “pay as you go” retirement systems.

(d) Programs of deregulation and reform have reshaped the local and global

financial landscape. Long-standing institutional corporate governance

arrangements are being replaced with new institutional arrangements, but in the

meantime, inconsistencies and gaps have emerged.

Chapter-2

Corporate Governance & Development

To know the corporate governance & its Development in the

economy

Concepts and the objectives

The link between the corporate governance and other foundations

of development



Corporate governance matters for growth and development

Introduction:

There is an investigation of the relationship between corporate governance and

economic development and well-being. It finds that better corporate frameworks

benefit firms through greater access to financing, lower cost of capital, better firm

performance, and more favorable treatment of all stakeholders. There is also

evidence that when a country’s overall corporate governance and property rights

system are weak, voluntary and market corporate governance mechanisms have

limited effectiveness. Less evidence is available on the direct links between

corporate governance and poverty. Two events are responsible for the heightened

interest in corporate governance. During the wave of financial crises in 1998 in

Russia, Asia, and Brazil, the behavior of the corporate sector affected entire

economies, and deficiencies in corporate governance endangered the stability of



the global financial system. Just three years later confidence in the corporate sector

was sapped by corporate governance scandals in the United States and Europe that

triggered some of the largest insolvencies in history. In the aftermath, not only has

the phrase corporate governance become nearly a household term, but economists,

the corporate world, and policymakers everywhere began to recognize the potential

macroeconomic consequences of weak corporate governance systems. The

scandals and crises, however, are just manifestations of a number of structural

reasons why corporate governance has become more important for economic

development and well-being. The private, market based investment process is now

much more important for most economies than it used to be, and that process is

underpinned by better corporate governance. With the size of firms increasing and

the role of financial intermediaries and institutional investors growing, the

mobilization of capital has increasingly become one-step removed from the

principal-owner. At the same time, the allocation of capital has become more

complex as investment choices have widened with the opening up and

liberalization of financial and real markets, and as structural reforms including

price deregulation and increased competition, have increased companies ‘exposure

to market forces risks. These developments have made the monitoring of the use of

capital more complex in certain ways, enhancing the need for good corporate

governance. It aims to trace the many dimensions through which corporate

governance works in firms and countries. A well-established body of research has

for some time acknowledged the increased importance of legal foundations,

including the quality of the corporate governance framework, for economic

development and well-being. Research has started to address the links between law

and economics, highlighting the role of legal foundations and well defined

property rights for the functioning of market economies. It also provides some



background on the ownership patterns around the world that determine and affect

the scope and nature of corporate governance problems.

Concept and Objectives:

Corporate Governance may be defined as a set of systems, processes and principles

which ensure that a company is governed in the best interest of all stakeholders. It

is the system by which companies are directed and controlled. It is about

promoting corporate fairness, transparency and accountability. In other words,

'good corporate governance' is simply 'good business'. It ensures:

Adequate disclosures and effective decision making to achieve corporate

objectives;

Transparency in business transactions;

Statutory and legal compliances;

Protection of shareholder interests;

In other words, corporate governance is the acceptance by management of the

inalienable rights of shareholders as the true owners of the corporation and of their

own role as trustees on behalf of the shareholders. It deals with conducting the

affairs of a company such that there is fairness to all stakeholders and that its

actions benefit the greatest number of stakeholders. In this regard, the management

needs to prevent asymmetry of benefits between various sections of shareholders,

especially between the owner-managers and the rest of the shareholders.

The aim of "Good Corporate Governance" is to ensure commitment of the board in

managing the company in a transparent manner for maximizing long-term value of

the company for its shareholders and all other partners. It integrates all the



participants involved in a process, which is economic, and at the same time social.

The fundamental objective of corporate governance is to enhance shareholders'

value and protect the interests of other stakeholders by improving the corporate

performance and accountability. Hence it harmonizes the need for a company to

strike a balance at all times between the need to enhance shareholders' wealth

whilst not in any way being detrimental to the interests of the other stakeholders in

the company. Further, its objective is to generate an environment of trust and

confidence amongst those having competing and conflicting interests.

It is integral to the very existence of a company and strengthens investor's

confidence by ensuring company's commitment to higher growth and profits.

Broadly, it seeks to achieve the following objectives:

A properly structured board capable of taking independent and objective

decisions is in place at the helm of affairs;

The board is balance as regards the representation of adequate number of

non-executive and independent directors who will take care of their interests

and well-being of all the stakeholders;

The board adopts transparent procedures and practices and arrives at

decisions on the strength of adequate information;

The board has an effective machinery to sub serve the concerns of

stakeholders;

The board keeps the shareholders informed of relevant developments

impacting the company;

The board effectively and regularly monitors the functioning of the



management team.

THE LINK BETWEEN CORPORATE GOVERNANCEAND

OTHER FOUNDATIONS OF DEVELOPMENT.

The research on the role of corporate governance for economic development and

well-being is best understood from the broader perspective of other foundations for

development, notably the importance of finance, the elements of a financial

system, property rights, and competition. Three elements of this are worth

highlighting.

The link between finance and growth:

First, over the past decade, the importance of the financial system for growth and

poverty reduction has been clearly established. One demonstration is the link

between finance and growth. Almost regardless of how financial development is

measured, there is a cross-country association between it and the level of GDP per

capita growth. Numerous pieces of evidence have been assembled over the past

few years to indicate the relation is a causal one: that is, it is not only the result of

better countries having both larger financial systems and growing faster. The

relationship has been established at the level of countries, industrial sectors, and

firms and has consistently survived a rigorous series of econometric probes.

The link between the development of banking systems and market

finance and growth:



Second, and importantly for the analysis of corporate governance, the development

both of banking systems and of market finance helps economic growth. Banks and

securities markets are complementary in their functions, although markets will

naturally play a greater role for listed firms. More generally, the findings provide

support for the functional view of finance. That is, it is not financial institutions or

financial markets that matter; it is the functions that they perform that matter. In

particular, for any regression model of growth that is selected and adapted by

adding various measures of stock market development relative to banking system

development, the results are consistent. None of these measures of financial sector

structure has any statistically significant impact on growth. To function well,

financial institutions and financial markets, in turn, require certain foundations,

including good governance.

The link between legal foundations and growth:

Third, the role of legal foundations is now better understood and documented.

Legal foundations matter crucially for a variety of factors that lead to higher

growth, including financial market development, external financing, and the

quality of investment. Legal foundations include property rights that are clearly

defined

and enforced and other key regulations. Comparative corporate governance

research took off following the works of economists Rafael La Porte, Florencio

Lopez-de-Silanes, Andrei Shleifer, andRobert Vishny.

CORPORATE GOVERNANCE IMPORTANT FOR GROWTH

AND DEVELOPMENT



The literature has identified several channels through which corporate governance

affects growth and development:

The first is the increased access to external financing by firms. This in turn

can lead to larger investment, higher growth, and greater employment

creation.

The second channel is a lowering of the cost of capital and associated higher

firm valuation.

The third channel is better operational performance through better allocation

of resources and better management. This creates wealth more generally.

Fourth, good corporate governance can be associated with a reduced risk of

financial crises. This is particularly important, as financial crises can have

large economic and social costs.

Fifth, good corporate governance can mean generally better relationships

with all stakeholders.

All these channels matter for growth, employment, poverty, and well-being

more generally.

Better operational performance:



In the end, the way better corporate governance can add value is by improving the

performance of firms, whether through more efficient management, better asset

allocation, better labor policies, and similar efficiency improvements. Evidence for

the United States, and elsewhere strongly suggests that at the firm level, better

corporate governance leads not only to improved rates of return on equity and

higher valuation, but also to higher profits and sales growth. This evidence is

maintained when controlling for the fact that “better” firms may adopt better

corporate governance and perform better due to other reasons. Across countries,

there is also evidence that operational performance is higher in better corporate

governance countries, although the evidence is less strong.

The role of entrenched owners and managers:

Evidence shows that firms adapt to weaker environments by adopting voluntary

corporate governance measures. A firm may adjust its ownership structure, for



example, by having more secondary, large block holders, which can serve as

effective monitors of the primary controlling shareholders. This may convince

minority shareholders of the firm’s willingness to respect their rights. Or a firm

may adjust its dividend behavior if it has difficulty convincing shareholders that it

will reinvest properly and for their benefit. These voluntary mechanisms can

include hiring more reputable auditors. Since auditors have some reputation at

stake as well, they may agree to conduct an audit only if the firm itself is making

sufficient efforts to enhance its own corporate governance. The more reputable the

auditor, the more the firm needs to adjust its own corporate governance. A firm can

also issue capital abroad or list abroad, thereby subjecting itself to higher level of

corporate governance and disclosure. There is also evidence that the voluntary

corporate governance adopted by firms matter more in weak corporate governance

environments. Markets can adapt as well, partly in response to competition, as

listing and trading migrate to competing exchanges, for example. While there can

be races to the bottom, with firms and markets seeking lower standards, markets

can and will set their own, higher corporate governance standards. One example is

the Novo Mercado in Brazil, which has different levels of corporate governance

standards, all higher than the main stock exchange. Firms can choose the level they

want, and the system is backed by private arbitration measures to settle corporate

governance disputes. Efforts like these can help corporations improve corporate

governance at low cost as they can list locally.

Higher firm valuation:



The quality of the corporate governance framework affects not only the access to

and amount of external financing, but also the cost of capital and firm valuation.

Outsiders are less willing to provide financing and are more likely to charge higher

rates if they are less assured that they will get an adequate rate of return. Conflicts

between small and large controlling shareholders are greater in weaker corporate

governance settings, implying that smaller investors are receiving lower rates of

return. There is clear empirical evidence for these effects. The cost of capital has

been shown to be higher and valuation lower in weaker property rights countries.

Investors also seem to apply a discount in their valuation for firms and countries

with relatively worse corporate governance. Furthermore, in countries with weaker

property rights, controlling shareholders also obtain a fraction of the value of the

firm that exceeds their direct ownership stake, at the expense of minority

shareholders.

CHAPTER-3



NATURE AND SYSTEMS OF CORPORATE

GOVERANANCE

Definition & scope

Benefits of good governance

Corporate governance and economic performance

OECD principles

Models of corporate governance

Corporate Governance in India

Factors influencing corporate governance

Definition and Scope:



Corporate governance comprises the systems and processes which ensure the

functioning of the firm in a transparent manner for the benefit of all the

stakeholders and accountable to them. The focus is on relationship between owners

and board in directing and controlling companies as legal entities in perpetuity. A

company’s ability to create wealth for its owners however, depends on the role and

freedom given to it by society.

Sir Adrian Cadbury in his preface to the World Bank publication,

Corporate Governance: A Framework for Implementation; states that “Corporate

governance is holding the balance between economic and social goods and

between individual and community goals. The governance framework is there to

encourage the efficient use of resources and equally to require accountability for

the stewardship of those resources. The aim is to align as nearly as possible the

interests of individuals, corporations and society .The incentive to corporate aims

and to attract investment. The incentive for states is to strengthen their economies

and discourage fraud and mismanagement”.

The focus on corporate governance arises out of the large dependence of

companies on financial markets as the preeminent sources of capital. The quality of

corporate governance shapes the future and the growth of capital market. But

capital markets and financial markets in general can function properly if

individuals have access to accurate basic information about the companies they

invest the link between a company’s management, board and its financial reporting

system is crucial. In the context of globalization, capital is likely to flow to markets

which are well regulated and practices high standards of transparency, efficiency

and integrity.

Benefits of Good Governance :



Good governance leads to congruence of interests of board, management

including owner managers and shareholders.

Good governance provides stability and growth to the company.

Good governance system builds confidence among investors.

Good governance reduces perceived risk, consequently reducing coat of

capital.

Well governed companies enthuse employees to acquire and develop

company specific skills.

In the knowledge driven economy excellence in soft skills like management

will be the ultimate tool for corporates to leverage a competitive advantage

in the financial markets.

Adoption of good corporate practices promotes stability and long term

sustenance relationship.

A good corporate citizen becomes an ethical icon and enjoys a position of

pride in corporate culture.

Potential stakeholders aspire to enter into relationship with enterprises

whose governance credentials are exemplary.

Corporate Governance and Economic Performance:

Tradeoff between compliance with normative obligations such as the increasing

opportunities for stakeholder’s participation, access to information and economic

performance of the firm can be decided in the political realm.

Finally the existence of condition for fair choice of basic practices of

corporate governance may not be met since the system of rights and constitutional

state envisaged in a democratic system may not obtain in all countries. This may

result in bias in the selection of practices and structure favoring those able to



mobilize wealth and other sources of social power. While a corporation has

universal obligations, there cannot be any one set of correct practices and structure

of corporate governance. Specific obligations are assumed by a corporation

through their decision and practices. Among the various attempts to evolve best

global standards, the principles evolved by organization for economic cooperation

and development (OECD) released in 1999 have been accepted as an international

benchmark. OECD principles recognize that different legal systems, institutional

frameworks across countries have led to the development of range of different

approaches to corporate governance. The OECD principles like other good

corporate governance regimes protect the interest of not only the shareholders but

all stakeholders like employees, creditors, suppliers, customers and environment.

OECD Principles:

The OECD principles of corporate governance cover five major areas.

The rights of shareholders.

The equitable treatment of shareholders.

The role of transparency.

Disclosure and transparency.

The responsibilities of the board.



Rights of shareholders : Rights of shareholder mentioned in the OECD

report cover the registration of the right to ownership with the company,

conveyance or transfer of shares, obtain relevant information from the

company on a timely and regular basis, participate and vote in general

shareholders meetings, elect members of the board and share in the profits of

the company. The OECD principles emphasize that information on

shareholders who exercise control disproportionate to their equity ownership

should be disclosed.

Equitable Treatment of Shareholders : All shareholders should be treated

equitably and the law should not make any distinction among different

shareholders holding a given class or type of shares. Any changes in voting rights

of common shareholders can be done only with the consent of those shareholders.

Role of stakeholders : The rights if the stakeholders as established by law should

be recognized and active cooperation between corporations and stakeholders in

creating wealth, jobs and sustainability of financially sound enterprises should be

encouraged. While the shareholders are the true owners, the functioning of a

company affects several other economic players in the society. Employees are

directly as they develop and adopt company specific skills. There is a significant

synergetic relationship between the company and its employees. Corporate entities

have also an impact on the environment of the community in which they are

located. Polluting units may generate profits for shareholders but impose costs on

society. Representation of employees and community on the board are mooted.

Role of Board : The main task of a board is to monitor the performance of the

executives and to ensure that returns to shareholders are maximized. True



independence of the board can be ensured by having a majority of outside directors

who do not have any financial of pecuniary involvement with the company.

Disclosures and Transparency : Timely disclosures relating to financial position,

ownership pattern and shareholding helps in infusing a sense of discipline and

accountability among managers. Increased transparency and information help to

reduce information symmetry between management and shareholders. Adoption of

internationally accepted best practices improves the understanding and comfort of

foreign investors about the operations of the companies and lowers their risk

perception.

Models of Corporate Governance:

Outsider Model:

Outsider model obtaining in UK and USA in which control and ownership are

distinct and separate. Since equity ownership is widely dispersed among a large



number of institutional holders and small investors, control vests with professional

managers. The model is also referred to as principal-agent model where the

shareholders, the principals entrust the management of the firm to managers, the

agents. In actual practice with the growth of the firm the gulf between shareholders

and managers has widened and became distant giving rise to the agency problem,

ensuring that managers function in the interests of the shareholders. The dichotomy

between ownership and control has necessitated the adoption of regulatory and

legal frameworks to ensure that corporate practices protect the interests of

shareholders as well as other stakeholders.

Features of Companies in Outsider Model in UK and USA :

The US and UK have similar foundations in common law and the features of

corporate governance are alike. Both American and British Companies combine

managers with outside directors into a unitary board, Boards comprise a large

number of non-executive directors, markets in both countries have companies with

widely dispersed share ownership, high levels of public disclosure, relatively low

levels of outside regulation and clearly defined legal duties of care and loyalty to

shareholders. There are however subtle differences. While both countries have

boards relatively small, boards with between 7 and 12 directors. British boards are

slightly larger with more executive on their boards. Non-executive directors on

British boards work with executive directors as a collective body. In US the non-

executive directors tend to monitor management and do not get involved in

operational matters. The British boards also combine chairman of board and CEO.

While 95% of FTSE 100 companies have separated the two positions, the number

of S&P 500 companies in 2003 which have combined the two positions is only

21%. In Britain the chairman leads the board and CEO leads the company.America



has chosen a system of checks and balances for its government but not for its

business because of its mistrust of the former and desire not to slow down

competitiveness of latter. There are of course checks and balances like ethics to

install an understanding of how one should behave in terms of fiduciary duty,

internal compliance and company governance as well as industry self-regulation.

The recent scandals however reveal a critical violation of fiduciary duty because of

conflicts of interest or greed. n the US the higher proportion of outside directors on

the boards may reduce the need for independent chairman while in the UK the split

roles at the heads of companies may allow for strong board independence.

Centralization of Regulation in US:

While the British have consolidated almost all public company oversight into a

super regulatory body, the Financial services Authority, the US has decentralized

and checked power is reflected in the balanced roles of Securities and Exchange

Commission (SEC), exchange listing rules and state statutes.

Shareholders :

Shareholders in Britain enjoy numerous and specific ownership rights than their

counter parts in US. Shareholders in Britain vote on dividends, buy backs, financial

statements, preemptive rights and small acquisitions and spin offs. In US

shareholders vote for directors and auditors.

Market for Corporate Control:

The approach to take over defenses and the market for corporate control are quite

different. The prevalence of defenses such as poison pills, green mail, dual class

voting stock in US is owed to the factor that law and regulation have entrusted to



directors to take immediate decision on offers for the company. The US approach

emphasizes director’s fiduciary duty to adopt maximum defense where volatile

prices and ready cash make them attractive targets. The directors in British boards

have little altitude and have to follow the rules of the City Code on takeovers and

Mergers. The code set up specific time table for voting on bids, ensures equal

treatment of shareholders and in its preference for auctions regulates the statements

both sides may make to the market after an approach. Structural defenses like

poison pills freeze out provisions and green mail ate not allowed. The British

governance system assumes a conflict of interest when boards decide on mergers.

Disclosures:

The corporations in US are required to report on director backgrounds in AGM

notices and make public filling to SEC which provides free access to an online

database of corporations. In UK companies report twice a year and investors have

to depend only on annual reports.

Insider model :

The insider has two variants, the European and East Asian. In the European model

a relatively small compact group of shareholders exercise control over corporation.

On the other hand, the East Asian model of corporate governance, the founding

family generally holds the controlling share either directly or through holding

companies. In all Asian countries control is enhanced through pyramid structures

and cross holding among firms. In Japanese form of insider system, several

companies are linked together through interlocking directorships, which are backed

by cross holdings of one another’s shares. With these intertwined groups of firms,

called keiretsu, there is also a main bank and several another financial institutions,



which holds share in the companies in the group and sit on the company’s

supervisory boards. Within a Japanese keiretsu control is multidirectional with

each company able to exercise some control over the companies that control it. The

Korean Chaebol is a hybrid between the German corporate pyramid and the

Japanese Keiretus. In 1995 the top 30 chaebol accounted for 40.2% of the value

added in Korea’s manufacturing sector, ownership stakes in the chaebol are

relatively small, 10% for 70 largest chaebolaffiliater companies. Founding families

however can maintain control through cross shareholdings among member

companies. Banks and other financial institutions, unlike japan do not play a

monitoring role. Claessens, Djankov and lang examined the separation of

ownership and control for 2,980 corporations in nine East Asian countries found

that separation of management from ownership control is rare and the top

management of about 60% of firms that are not widely held is related to the family

of the controlling shareholders. The separation of ownership and control is most

pronounced among family controlled as are small firms. It is a observed that

concentration of control generally diminishes with the level of a country’s

economic development. In the European insider model the controlling

shareholders are backed by complex shareholders agreements. The controlling

group maintains longer term and stable relationship among themselves. In the

European countries where this insider model is extant corporate sector depends on

banks as a source of finance and the corporate entities have quite levels of debt

equity ratios.



Market Versus Bank Oriented Systems of Governance:

Side by side comparison of bank and market

It may distinguish between market oriented and bank oriented or relations-based

systems of corporate governance. A major difference between the two systems was

the degree to which creditors monitored the firms. In the bank oriented system

bank enter into long term relationships; and in market system, an arms length

relationship is maintained. In England creditors preferred hands off approach. In

the German economy banks play a dominant role in financial intermediation as

well as in the monitoring of corporations. One form of monitoring was to place

bank officers on the supervisory boards of industrial companies or to purchase

large block of shares. It was not hands-on relationship banking. However, in the

light of recent development we may note that the crucial difference between

American and German systems of governance may be traced to the different



ownership structures and not to the role of banks per se. The US while nurturing

the corporate form of organization has established elaborate legal framework to

preserve competition and prevent dominance. Oversight is provided by

independent audit, stock exchanges and SEC. In the US economy both corporate

finance and control are market based. Large companies in US and UK are listed in

the stock markets and their ownership concentration is modest. In the UK as well

as USA there is a market for corporate control in which hostile takeover is

important and banks play a limited role. Outside the Anglo Saxon world most

companies are private, the ownership of listed companies is highly concentrated,

family ownership is very important and hostile takeovers are rare and pyramidal

control schemes are common in some countries bank ownership of equity is

important. The German economy may be typically characterized as bank system.

While banks shareholding is small, they enjoy significant voting rights on the

bearer form shares deposited with them by shareholders. They have representatives

on the top two tier boards. Banks are required to consult shareholders give their

advice and take their instructions on voting.

Corporate Governance in India:



While the predominant form of corporate governance is much closer to the Asian

insider model, there are a number of firms that resemble the European version

where the control is maintained through pyramidal form of ownership and

control. The concept of industrial house which controls several companies is quite

commonly accepted although the funding family does not own the company.

There are quite a few companies whose practices of corporate governance are a

matter of concern. Dilution of accounting and reporting standards have allowed

corporations from manipulating resources for their own vested interest sideling

the stakeholders of the company. Investors have suffered on account of

unscrupulous management of the companies, which have raised capital from the

market at high valuations and performed much worse than the past reported

figures; leave alone the future projections at the time of raising money. Another

example of bad governance has been the allotment of promoters shares, on

preferential basis at preferential prices, disproportionate to market valuation of



shares, leading to further dilution of wealth of minority shareholders. There are

also many companies, which are not paying adequate attention to the basic

procedures for shareholders service; for example, many of these companies do

not pay adequate attention to redress investors grievances such as delay in

transfer of shares, delay in dispatch of share certificates and dividend warrants

and non-receipt of dividend warrants; companies also do not pay sufficient

attention to timely dissemination of information to investors as also to the quality

of such information. Although the securities law and companies Act address

several of these investor grievances, the implementation and inadequacy of penal

provisions have left a lot to be desired.

Factors Influencing Corporate Governance :

a) Integrity of the management: A Board of directors with a low level

of integrity is tempted to misuse the trust, reposed by shareholders and

other stakeholders, to take decisions that benefit a few at the cost of

others.

b) Ability of the board: The collective ability, in terms of knowledge

and skill, of the board of directors to effectively supervise the

executive management determines the effectiveness of the board.

c) Adequacy of the process: Board of directors cannot effectively

supervise the executive management if the process fails to provide

sufficient and timely information to the board, necessary for

reviewing plans and the performance of the enterprise.



d) Commitment level of individual board members: The quality of a

board depends on the commitment of individual members to tasks,

which thy are expected to perform as board members.

e) Quality of corporate reporting: The quality of corporate reporting

depends on the transparency and timeliness of corporate commination

with shareholders in making economic decisions and in correctly

evaluating the management in its stewardship function.

f) Participation of stakeholders in the management: The level of

participation of stakeholders determines the number of new ideas

being generated in optimum utilization of resources and for improving

the administrative structure and the process. Therefore an enterprise

should encourage and facilitate stakeholder’s participation.

Chapter-4

THE THREE ANCHORS OF CORPORATE

GOVERNANCE

Know Accountability and Responsibilities

Approaches to Balance Board and CEO Functions



Board and Shareholders

Election of Directors

Introduction:

The three anchors of corporate governance are board of directors, management and

shareholders. While each of them has important responsibilities of its own, it is

their interaction with each other’s that is the key to effective governance. In

tandem they constitute an effective set of checks and balances. The system can

become unbalance if any one of them is not functioning well.

Accountability and Responsibilities:



Mr. Obama Signs Credit Card accountability / The girl is showing her responsibility

The relationship in the governance triangle consisting of boards of directors

management, management-board of directors and boards of directors-shareholders

depend on mutual accountabilities and responsibilities. The board lays down policy

and monitors performance and counsels and management. The board hires and

fires and through the Remuneration Committee sets the compensation for the CEO.

It may be noted that in USA the jobs of CEO and Chairman are usually combined

while in India the practice varies. In some they are held by different individuals

while in others they are combined. Sir Adrian Cadbury believes that the jobs of

Chairman and Chief executive demand different abilities and perhaps

temperaments. In it is very much in shareholders interests to ensure they are

performed by different people.

Separation of Board from Management:

The new governance rules that have been adopted are designed to distance the

board from management and thereby prevent conflicts of interest that can

compromise the relationship. The changes call for an increase in the number of

independent directors and the committees on Audit and compensation be

composed entirely of independent directors. The New York stock exchange



proposals also put forth the idea of director independence. They should have no

material relationship with the company.

Board and Management:

The changes introduced by focusing on board and Audit Committee composition

have not succeeded in establishing a healthy distance between the management and

board. The board should be free to monitor and the management tree to manage. If

the two functions are combined as under a system of Chief executive officer

Chairman, there is no separation of powers and functions. The policy making,

strategy formulation and monitoring is done by the same person who is supposed

to execute them. The efficiency of all these measures to distance Board from

management would be lost if we let a person wear two hats at the same time that of

Chairman of the board and Chief executive officer of management. At the outset it

should be noted that letting management personnel be members of the board

howsoever senior they may be by calling them full time directors/executive

directors has confounded the concepts of transparency and accountability. Good

corporate governance demands the separation of the board and management. Even

in the case of promoters whose personal wealth is tied to the company they have to

make a choice to be satisfied by being a member of the board or management



team. This of course goes against the grain of Indian corporate governance, the

founding family as “owners” being the board as well as management. Management

accountability will be non-existent to the shareholders in such circumstances.

Family Dominated Companies:

Infosys like a family dominated business.

Family dominated company’s own substantial stakes in a large number of quoted

companies here as well as in U.S. In the U.S. the founding family is an influential

investor in more than one-third of standard and poor’s 500 companies. On average

while the family owns 18% of the equity its control of the board tends to be

disproportionately large. However, family dominated companies are both more

profitable and better marker performers than non-family especially when a

dynamic family member with a profound sense of stewardship is managing

Director/CEO. The key difference between the family firms and others is the

independence of the board packed with friends and relatives do badly, while those

with strong directors do better. It is good governance that makes the difference.

Approaches to Balance Board and CEO Functions :



The (US) Conference Board Commission on public Trust and

private Enterprise (CPTPE) 2003 noted three principal approaches to

provide the appropriate balance between board and CEO functions.

Separation of the offices of Chairman and CEO with those two roles

being performed by separate individuals. The chairman would be one

of the independent directors.

Separation of offices but not a member of management and would not

report to CEO. Chairman who is a non-independent director may be

designated as lead independent director without any relationship with

CEO or management that compromises his or her ability to act

independently.

Where there is no separation of chairman and CEO position a

presiding director position could be established.

Duties of non-CEO chairman whether he is an independent director or

not, the lead independent director and presiding director should be

articulated.

Non CEO Chairman:

The duties of non- CEO Chairman according to CPTPE should include

i. Presiding at board meeting and at meetings of non management

directors,

ii. Approval over information sent to the board,

iii. Deciding board meeting agenda,

iv. Serving as principal liaison to the independent directors and



v. Setting meeting schedules.

Duties of Lead Independent Director ( CPTPE):

i. Chairing meeting of the non-management directors,

ii. Serving as principal liaison to the independent directors,

iii. Working with the non CEO Chairman to finalize flow to the board

meeting agenda and meeting schedules.

Duties of presiding Director (CPTPE):

i. Preside at board meetings in the absence of chairman,

ii. Presiding at executive sessions of the non management directors,

iii. Serving as the principal liaison to the independent directors,

iv. Approve information to be sent to the board,

v. Approve agenda for board meeting,

vi. Set meeting schedules.

A non CEO Chairman who is not an independent director should not be

a member of the management team and should not report to the CEO. The non

management directors should have regular, frequent meetings without the CEO or

other directors who are members of management present.

Board and Shareholders :



The regulatory efforts and operation of market forces have let out this relationship

in the third anchor of corporate governance. By and large shareholders do not

know what the directors are doing and directors do not know what the shareholders

want. Board members are elected by shareholders to serve as their agents but in

practice shareholders have not exerted much influence over directors. The

exchange of information between the two anchors is poor and directors are not

accountable to shareholders. There is no way for shareholders to know whether the

directors have acted in there is no efficient mechanism to nominate or even endorse

director candidates.

Shareholders on their part are quite apathetic and mute. Their

communication is limited to formal proxy votes which historically ratified board’s

wishes. Shareholders have access to no mechanism through which to effect

changes, except for calling an extraordinary general body meeting. The

relationship between the two anchors, board and shareholders is not linked together

in any manner or by any method except for the provision of annual general



meeting. The absence of the link has created an imbalance in the governance

mechanism. It has also encouraged a closer relationship and stronger link between

board and management who fill the void. Directors can be effective in taking care

of shareholder interests of we set up a strong structure of board meetings and

enfranchisement of shareholders. Three steps mooted in this connection are record

of voting at Board meetings, letting shareholders put up as well as elect a director

on their behalf and make resolutions passed at shareholders meeting binding.

Transparency:

If the individual directors’ votes on corporate resolutions in key corporate proxy

statements are recorded, the directors become accountable to shareholders. When

people are held recount able for their actions as individuals rather than as a group

they tend to weigh their choices more carefully. Directors would have greater

incentive to air their views if individual votes are published. Such accumulated

information to create director score boards would supplement board self-

evaluation.



Election of Directors:

While the shareholders in theory have the right to attend meetings and participate

in the election of directors of the Board, the cast majority of director elections are

uncontested. The only method is open to shareholders is to mount a proxy fight

which entails publishing and mailing their own list of proposed directors to

shareholders escalating the contest in effect into a fight for control of the firm. The

campaign has to be has to be financed by shareholders out of their out of their

pockets whereas the company’s own proxy materials sent to shareholders before

annual meetings company cost/or shareholders money. To enfranchise the

shareholders and democratize election of company directors shareholders may be

allowed to put their won candidates on the Company’s proxy material. This would

avoid the expense and stark choices of a proxy fight. In US has proposed the grant

of right to shareholders under special circumstances, such as opposition to

company’s proxy by withholding votes, and duration of share ownership for 3-5

years. The proposal has been opposed on the ground that it would create confusion

in elections when more than one candidate contests a board seat.



Chapter – 5

Corporate Social Responsibilities

Stakeholders

Sustainable governance

Social contract between business and society

The Global Compact (2000)

An Overview



Introduction:

The concept of corporate social responsibilities is not new. The history of

corporate activity shows that business have always encompassed the notion of

broader obligations to the communities in which they operate. Companies have

recognized the value of enlightened self interest responding to their own specific

circumstances. A project on corporate responsibilities was launched in 1969 by

Ralph Nadir and several other lawyers to change the purpose of corporation. In

Nader’s view the corporation is to be transformed from the means of maximizing

investor wealth to a vehicle for using a private wealth to redress social ills.

Stakeholders theory embodies many aspects of the theory of corporate social

responsibility. On the other hand, value based management holds that the social

mission of corporation is to make as much money as possible for its owners while

confirming the rules of society and let shareholders, employees and customers

undertake their own efforts. In practice corporations that wish to maximize

shareholder value generally find in their interest to devote corporate resources to

constituencies such as employees, customer, suppliers and local communities. CSR

concerns have shifted from local and particular to that of global and generic. This

results in a new focus on the environment, human and labor practices.

Stakeholders:

The issue of how responsible companies should be to those other than

their shareholders have come to the fore when entire communities are adversely

affected when companies fail. The approach of Anglo-Saxon shareholder

capitalism is that companies should exclusive pursue the interests of shareholders;

and the other, stakeholder capitalism which acknowledges that companies are also



responsible to their workers and local communities often by having representatives

from both on their boards. The issue have further cofounded by anti-globalization

view which faults multinationals for exploiting third world workers, and pollute

the environment. It has to be noted that over half of the worlds 100 largest

economic entities are transnational corporations not nations. There is demand that

companies should be made to behave more responsibly and that government use

companies to implement their social policy: limit working hours, promote social

harmony and clean up environment.

In practice Anglo-Saxon companies have taken on social obligations

without the prompting of governments. Family dominated companies in India are

also involved in development of institutions of higher learning, healthcare and

places of worship. The robber-barons in USA have built much of the educational

and health infrastructure, company towns and introduced health care benefits. A

distinction should therefore be made between the demands of the capital market

and practices of the companies. Companies believe that taking care of their

workers and other in the society is in the long term interest of the company. Such a

policy builds trust which gives benefits of doubt when dealing with customers,

workers and even regulators. It also gives an edge in attracting employees and

customers. Companies are not in business of building fairer societies. That is the

job of government.



Sustainable governance:

Superior corporate governance is rewarded by a premium in the market place.

investors are willing to pay more in emerging markets for the shares of companies

that had implemented high standards of corporate governance.

Companies have to build on understanding of challenges of sustainability

beginning with climate but including global income disparity, water usage,

biodiversity, labor practice and human rights into their long term strategies.

Otherwise they will be viewed as a poor or risk. Those who fail to act on concerns

embodied in sustainable governance will be plagued by doubts and questions from

NGOs, government, customer and major investors. Companies that fails to

understand sustainability, to pursue fair and equitable solutions to climate change

and to anticipate what lies ahead will be caught off guard by unexpected economic

risk, environmental hazards and social demands. Sustainable governance is not an

option. To restore confidence, to build the structure of trust, companies must

commit themselves to openness, transparency and fairness. They must do this

through innovations in listing exchanges, governance reforms and disclosure

through the Global Reporting Initiative (GRI). GRI released its sustainability



reporting guidelines in August 2002 is expected to foster transparency and

accountability of corporate activities beyond financial matters.

Social contract between business and society:

The objective of shareholder value maximization has however to be as a part of the

social contract between business and society. This contract has obligations,

opportunity and mutual advantage for both sides according to Davis of McKinney

and company. Otherwise it could lead managers to focus exclusively in improving

the short term performance of their business neglecting important long term

opportunities and issues such as trust of customers, investment in innovation and

other growth prospects. Maximization of shareholder value also obscure questions

of ethics and legitimacy. Multinational enterprises need to tackle such issues for

reasons of integrity and enlightened self interest. The fundamental basis of social

contract between business and society is the efficient provision of goods and

services that society wants. Business has to restate and reinforce their own social

contracts to secure for the long term the shareholders investment.

The new approach calls for:



Introduction of explicit processes to make sure that social issues

and emerging social forces are part of overall strategic

planning.

Establishment of ever higher standards of integrity and

transparency and active involvement in debates on social issues

that shape their business context.

The ultimate purpose of business is the efficient provision of goods and services

that society wants. It is the fundamental basis of the contract between business and

society. Such a noble purpose is not only more motivating but also beneficial

shareholder value over long term. Shareholder value creation or profits are

measure and reward of efficient provision of goods. Restating and reinforcing the

business own social contract will also secure for the long term the shareholders

investment

The Global Compact (2000):

The global compact, United Nations global compact programme launched by UN

in 2000 calls on companies to embrace nine principles in the areas of human rights,

labor standards and environment. The Global Compact is a value-based platform

designed to promote institutional learning. It is utilizes the power of transparency

designed to promote and dialogue to identify and disseminate good practices based

on universal principles. The nine principles are drawn from the Universal

Declaration of Human Rights, the International Labor Organization’s Fundamental

Principles on Rights at work and the Rio principles on Environment and

Development. According to these principles, business should:



Support and respect the protection of internationally

proclaimed human rights : corporate leadership in human rights is good

for the community and for business. The benefits of responsible engagement

for business include a greater chance of a stable and harmonious atmosphere

in which to do business, and a better understanding of the opportunities and

problems of the social context. Further, the benefits impact from ill thought-

through business initiatives.

Uphold the freedom of association and the effective recognition

of the right to collective bargaining: Freedom of association and the

exercise of collective bargaining provide opportunities for constructive

rather than confrontational dialogue which harness energy to focus on

solutions that result in benefits to the enterprise, its stakeholders, and the

society at large.

Support the elimination of all forms of forced and compulsory

labor :

Forced labor robs societies of the opportunities to apply and develop human

resources for the labor markets of today and develop the skills in education

of children for the labor markets of tomorrow.

Support the effective abolition of child labor :

Child labor results in scores of under-skilled, unqualified workers and

jeopardizes future skills improvements in the workforce. Children who do

not complete their primary education are likely to remain illiterate and will

not acquire the skills needed to get a job and contribute to the development

of a modern economy.



Eliminate discrimination in respect of employment and

occupation :

Discrimination in employment and occupation restricts the available pool of

workers and skills, and isolates an employer from the wider community.

Non-discriminatory practices help ensure that the best-qualified person fills

the job.

Support a precautionary approach to environmental

challenges :

It is more cost-effective to take early actions to ensure that irreversible

environmental damage does not occur. This requires developing a lifecycle

approach to business activities to manage the uncertainty and ensure

transparency

An Overview:

Concerning both public owned and private owned industrial/business both

have one thing in common: the capital is provided by one group, and business is

managed by another group of professionals. This means that the roles are divided

between two bodies. In case of public owned enterprise, equity is provided by the

state/government and management of the enterprise is in the hands of the managers

who are professionals. Managers are responsible for making the best use of

resources of enterprise in furtherance of its objectives. Effective management of

the enterprise is inevitable for two reasons: (a) to achieve the economic goals on

year to year basis and (b) to attract stable and low cost of capital for investment on

long term basis. The owners of the capital are interested in appreciation in the

value of equity provided. For this purpose, the owners of the capital depend upon



the framework and the structure, i.e., the board of directors, of the enterprise to

monitor the performance of the managers so that managers are able to add value to

the capital invested.

There are some illustrations of PSUs like Steel Authority of India Ltd.

(SAIL), NTPC and others where the union government is the major equity

shareholder with private individual ownership of shares. Likewise, in Tata Steel

Company and Tata Motors (Telco), there are financial institutions, banks, staff etc.,

who jointly constitute the major shareholders along with Tata Sons. In these

enterprises, management is in the hands of the professional mangers who are

engaged to manage the company, in in furtherance of organizational goals.

Corporate governance has received utmost attention since the early nineties

in India and the western nations, including the US. The increase in the attention is

due to the multitude of factors but the main one is the anxiety of the enterprises

concerned to put up a clear image of the company in the society and to restore

confidence in the viability of the company in the society and to keep the enterprise

free from any legal implications. The board of directors of the enterprise or in the

case of two-tier system, the supervisory board are the vital organs of the corporate

structure. The board is designed to hold the management accountable to the

providers of the equity for harnessing the resources of the organization on the best

possible manner.

The beginning of new millennium has witnessed the global movement on the

good governance which resulted in a number of corporate guidelines/codes on the

best practices on governance. The global movement has underlined the

significance that the world attaches to the corporate governance and the role of

board of directors in monitoring governance of management activities.



Effective governance is contingent upon security regulations, market trends,

company law of country, audit and account rules, legal atmosphere, etc. An

understanding of these rules in different countries is inevitable if one wants to

understand their practices on corporate governance. For example, in some

instances, the governance code with listing and / or has legally mandatory rules for

disclosure, as essential requirement.

The Cadbury Report of the UK, Dey report of Canada and guideline issued by the

board of directors of GE, US, have served as a reference and basis for development

of guideline on corporate governance. Guidelines on the subject have also been

issued by stock exchanges and other bodies like institutional investors, corporate

managers and association of directors, which are voluntary. Mostly these

guidelines are not Mandatory, e.g., the companies listed on the Toronto and

London stock exchanges are not obliged to observe the recommendations of the

Dey report or Cadbury report. But such companies have, of necessity, to follow the

disclosure requirements.



Chapter -6

A STUDY OF CORPORATE GOVERNANCE INBANKS

Introduction

Main Indicator Of Corporate Governance

Unethical Business Practices

Sources



Conference on Corporate Governance of Banks in Eurasia, London.

Introduction:

Globally, Corporate Governance guidelines and best practices have evolved over a

period of time. In the United States of America as well as India in the late 1800

and the early 1900s there were only closely held family owned corporate and the

concept of public limited companies was non-existent. The owners made strategic

decisions and bore the entire consequences-positive or negative.

However, by the 1930s increasing number of companies went public and

corporate ownership was dispersed across a large number of individuals and issues

of Accountability, Transparency and control were raised by these shareholders in

the Annual meeting of the shareholders. The years subsequently saw the

strengthening of the rights of the shareholders and the stakeholders which gained

momentum only in the early nineties.



The Cadbury Committee report was a landmark effort from UK in 1992

followed by vienot report in France in 1995. The confederation of British Industry

in January 1995 set up theGreenbury committee to recommend a code of

governance for the UK Industries followed by the Hampel committee appointed by

the London Stock Exchange (LSE). The 30 member Organization for Economic

Cooperation and Development (OECD) in 1999 published the general principles of

corporate Governance. However, the Sarbanes Oxley Act 2002 of US brought in

sweeping changes in financial reporting.

In India, the confederation of Indian Industry (CII) tools the lead and

framed the code of Corporate Governance in 1998. The Securities and Exchange

Board of India (SEBI) appointed the Kumaramangalam Birla Committee and its

recommendations were accepted in 1999 and enshrined in the Clause 49 of the

Listing Agreement of the stock exchange. The Department of company affairs

appointed the Naresh Chandra committee in 2002, to repost on the relationship

between the auditors and their clients. Then the SEBI appointed Narayana Murthy

committee recommendation were also incorporated in to the revised Clause 49 in

2006. Further, the Corporate Governance Rating by agencies like CRISIL and

ICRA are now used to benchmark companies on Corporate Governance practices.

Main Indicator Of Corporate Governance:

Existence of good corporate governance : It is a primary and most

fundamental indicator of good corporate governance. The good governance

code should be based on widely accepted views of government, Business

Association, social organization or stakeholders. Moreover the existence of

the code should be used as a benchmark to measure the company’s actual

governance.



The role, Responsibility and competence of the board: There has to be a

system that ensures that the board is empowered, informed, competent and

effective on a continuous basis. The board must provide the stewardship to

the company to take up the role and responsibility in running the company

efficiently and effectively.

Involvement of Non-Executive or independent directors : These directors

are appointed in the boards to provide independent, objective and

professional opinion in the board meetings on matters of importance and

concern to company. All the governance codes recommend a large

proportion of Independent Directors on the company boards and much

depends on how they are appointed, by whom they are influenced and what

financial interest they have in the company.

Dissemination of material Information: To avoid insider trading the

timely and adequate dissemination of material information to the public is

sign of good governance.

Distinction between the role of the Responsibilities of the Board and

Management: Governance standard of the company is basically judged

from the split between the role and responsibilities of the board and

management. The board is expected to steward the company, set the

strategic objectives, provide guidance and judgment independent of

management, and exercise control over the company, remaining all along

accountable to the shareholders in particular and the stakeholders in general.

Disclosure of Remuneration Package : Shareholders, as the owners of the

company have full right to know about the compensation policies and

packages of the directors as well as the executive. Extraordinarily high



remuneration packages drain the company’s resources at the expense of

shareholders.

Specialized Board Committees : The quality of board increases if some key

decision requiring specialized expertise are entrusted to various committees

constituted by the board. Audit committee is very important to maintain

accountability in the corporate system through supervising and monitoring

of the system of the financial reporting. The specialized committee may

handle such important matters as nomination of directors, accounting

standards and procedures, audit system, reporting system, compensation of

the company executive and the like.

Unethical Business Practices:

The different unethical business practices include issues of Whistle Blowing,

bribes, accepting gifts, Insider trading, conflicts of interest, window dressing etc.

Globally these issue have been In the limelight under Sarbanes-Oxley Act 2002and

nationally SEBI under clause 49 of the listing agreement has taken policy

initiatives avoid the following:

Whistle Blower protection : allow an employee to report illegal activities by

those in position of authority in their company without any treat of backlash.



Insider Trading : Using price sensitive information by a company

employees or individuals in violation of the fiduciary relationship that exist

with the company to make illegal profits in the transaction of the shares of

that company.

Prohibition of short selling of company shares: No employee or director

should directly or indirectly sell any equity shares including derivatives of

his company if he doesn’t own the share and indulge in short selling.

Bribes/ kickbacks : Corruption should be avoided strictly inside or outside

the company, so that later company should not suffer from any huge losses

which may turn in to scandal.

Conflicts of interest : Avoidance of any situation that would lead to or tend

to lead to any conflicts of interest between personal interest and the interest

of the company, resulting in impairing the exercise of independent

judgment.

Window dressing : The deceptive practice of using accounting tricks to

make company’s balance sheet and income statement appear better than the

reality and the deceptive practice of mutual funds to buy strong stocks

before the year ending to make their holding look impressive.

Funding of expense account/ Misappropriation of funds : Full, fair,

accurate, timely understandable records of the finances without presenting

false bills and incorrect accounts. KPMG’s fraud survey 2002 finds that

majority of cash losses occurs due to misappropriation, forged document,

expense accounts, diversion of funds, kickbacks , secret commission and

false and misleading information.

Misuse of company assets : Using company property, asset or resources for

the benefits of the employee, his/ her relatives or associates / friend is



prohibited as the same can be used only for legitimate business purpose

only.

Antitrust/ Monopoly activity : Avoid all anti-competitive and unlawful

business practices and discourage corrupt and dishonest means. Avoid

enticing away key employees of competitors to lessen competition, price

fixing, hoarding and black marketing etc.

Hacking: A software designer who illegally enters encrypted sites and

accounts of others through modified software and hardware is highly

unethical.

Misuse of confidential information : Directors and employees must protect

the confidential information entrusted to them by the company, its customers

and all business associates.

Sources:

Market Initiative- CRISIL, a leading credit rating agency developed a yardstick

which help measure the Governance & Value Creation Rating (GVC) of

companies including the Banks.

The assessment is made on the basis of the following-

Governance Process : The Treatment of shareholders, transparency &

disclosures, composition and functioning of Board



Wealth management : The levels of wealth creation and distribution

among stakeholders and the future wealth creation capacity, wealth being

utilized for the ultimate good of all stake holders in the medium to long

term. The wealth should be shared proportionately and equitably among the

shareholders without resorting to disproportionate sharing methods like

ESOP and Sweat equity.

Regulatory Initiative : All listed companies including banks have to adhere

to the listing agreement, which specifies:

Audit committee: Should include qualified and Independent Directors who

are finance literate and the chairman should be well versed in Management

and Accounts. The appointment and removal of the external auditors should

be decided by them to endure that accounting norms are strictly followed.

Composition of the board : If Non-executive chairman then 1/3rd Board of

Directors should be Independent otherwise ½ of the Board members should

be Non-Executive, Independent Directors. The shareholders should approve

the compensation paid to the Non-Executive Directors.

Code of conduct : the BOD and the senior management should follow this

code.

Legislature Initiative : the companies Act 1956 alone can provide the

statutory backing to the corporate governance standards, which require a

bill to be passed in the parliament. There are two areas that need the

necessary legal support to ensure compliance:

Audit process : A disciplinary mechanism is needed to check the

performance of auditors. Proper process to be laid down for appointment

and qualification of auditors



Chapter -7

CORPORATE GOVERNANCE IN INDIAN BANKING

SECTOR

Introduction



Measures taken by Banks and RBI for implementation of best

practices

Needs for corporate governance in banks

Introduction:

Corporate governance of banking institutions is an important issue in the financial

systems of developing economies and the widespread banking reforms. Given the

important financial intermediation role of banks in and economy, their high degree

of sensitivity to potential difficulties arising from ineffective corporate governance



and the need to safeguard depositors’ funds, corporate governance for banking

organizations is of great importance to the international financial system and merits

targeted supervisory guidance. The Indian economy has seen wide ranging reforms

for over a decade now, covering industry, trade, taxation, external sector, banking

and financial markets. This has strengthened the fundamentals of the Indian

economy and transformed the operating environment for banks and financial

institutions in the country. Banking as a sector has been unique and the interests of

other stakeholders appear more important to it than in the case of non-banking and

non-finance organizations. The corporate governance of banks in developing

economies is important for several reasons. First, banks have an overwhelmingly

dominant position in developing-economy financial systems, and are extremely

important engines growth. Second, as financial markets are usually

underdeveloped, banks in developing economies are typically the most important

source of finance for the majority of firms. Third, as well as providing a generally

accepted means of payment, banks in developing countries are usually the main

depository for the economy’s saving. Fourth, many developing economies have

recently liberalized their banking systems through privatization and reducing the

role of economic regulation.

Measures taken by Banks and RBI for implementation of best

practices:



Prudential norms in terms of income recognition, asset classification, and capital

adequacy have been well assimilated by Indian banking system. In keeping with

the international best practices, starting 31 march2004, banks have adopted 90 days

norm for classification of NPAs. Also, norms governing provisioning requirements

in respect of doubtful assets have been made more stringent in a phased manner.

Capital adequacy: All the Indian banks barring one today are well above the

stipulated benchmark of 9 percent and remaining in state of preparedness to

achieve the best standards of CRAR as soon as the new Basel 2 norms are made

operational. On the income recognition front, there is complete uniformity now in

the banking industry and the system therefore ensure responsibility and

accountability on the part of the management in proper accounting of income as

well as loan impairment.

ALM and Risk Management Practices- at the initiative of the regulators, banks

were quickly required to address the need for asset liability management followed

by risk management practices. Both these are critical areas for an effective

oversight by the board and the senior management which are implemented by the



Indian banking system on tight frame and the implementation review by RBI.

These steps have enabled banks to understand, measure and anticipate the impact

of the interest rate risk and liquidity risk, which is deregulated environment is

gaining importance. RBI has taken various steps furthering corporate governance

in Indian banking system. These can be broadly classified in to the three

categories:

(a) transparency

(b) off-site surveillance

(c) Prompt corrective action.

Transparency and disclosure standards are also important constituents of a sound

corporate governance mechanism. Transparency and accounting standards in India

have been enhanced to align with international best practices. Prompt corrective

action has been adopted by RBI as a part of core principles for effective banking

supervision. As against a single trigger point based on capital adequacy normally

adopted by many countries, Reserve bank in keeping with Indian conditions have

set to more trigger points namely non performing asset(NPA) and Return on

asset(ROA) as proxies for asset quality and profitability. These trigger points will

enable the invention of regulator through a set mandatory action to stem further

deterioration in the health of banks showing signs of weakness. The coperate

governance of banks in developing economics is severally affected by political

consideration. Firstly, given the trend towards privatization of government owned

banks in developing economies, there is need for the managers of such banks to be

granted autonomy and be gradually introduced to the corporate governance

practices of the private sector in prior to divestment.



Needs for corporate governance in banks:

If we examine the need for improving corporate governance in bank two reasons

stand out:

1. Banks exit because they are willing to take on and manage risk. Besides,

with the rapid pace of financial innovation and globalization, the face of

banking business is undergoing a sea-change. Banking business is becoming

more complex and diversified. Risk taking and management in a less

regulated competitive market will have to be done in such a way that

investor’s confidence is not eroded.

2. Even in a regulated set-up as it was in India prior to 1991, some big bank in

public sector and a few in the private sector had incurred substantial losses.

This along with massive failure of non-banking financial companies

(NBFFs), had adversely impacted investor’s confidence.

3. Moreover, protecting the interest of depositors became a matter of

paramount importance to banks. In other corporate, this is not and need not

be so for two reasons: The depositors collectively entrust a very large sum of

their hard-earned money to the care of the banks. It s found that in India, the

depositors contributions was well over 15.5 times the shareholders stake in

banks as early as in March 2001. This is bound to be much more now. The

depositors are very large in numbers and are scattered and have a little say in

the administration of banks. In other corporate, big lenders do exercise the

right to direct the management. In any case, the lenders stake in them might

not exceed 2 or 3 times the owner’s stake.



4. Banks deal in people’s fund and should, therefore act as trustees of the

depositors. Regulators the world over as recognized the vulnerability of the

depositors to the whims of managerial misadventures in banks and, therefore

has been regulating more tightly than other corporate.

To sum up, the objective of governance in banks should first be protection of

depositor’s interest and then be to “optimize” the shareholders interests. All other

considerations would fall in place once this two are achieved.

Chapter -8

CASE STUDY ON SATYAM SCANDAL



Satyam Computers services limited was a consulting and an Information

Technology (IT) services company founded by Mr. Ramalingam Raju in 1988. It

was India’s fourth largest company in India’s IT industry, offering a variety of IT

services to many types of businesses. Its’ networks spanned from 46 countries,

across 6 continents and employing over 20,000 IT professionals. On 7 th January

2009, Satyam scandal was publicly announced & Mr. Ramalingam confessed and

notified SEBI of having falsified the account.

Raju confessed that Satyam’s balance sheet of 30 September 2008 contained:

Inflated figures for cash and bank balances of Rs 5,040 crores.

An accrued interest of Rs. 376 crores which was non-existent.



An understated liability of Rs.1,230 croreson account of funds which were

arranged by himself.

An overstated debtors’ position of Rs. 490 crores. The letter by B RamalingaRaju

where he confessed of inflating his company’s revenues contained the following

statements:

It has attained unmanageable proportions as the size of company operations grew

significantly in the September quarter of 2008 and official reserves of Rs. 8,392

crores. As the promoters held a small percentage of equity, the concern was that

poor performance would result in a takeover, thereby exposing the gap. The

aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with

real ones. It was like riding a tiger, not knowing how to get off without being

eaten.”

The Scandal:

The scandal all came to light with a successful effort on the part of investor’s to

prevent an attempt by the minority shareholding promoters to use the firm’s cash

reserves to buy two companies owned by them i.e. Maytas Properties and Maytas

Infra. As a result, this aborted an attempt of expansion on Satyam’s part, which in

turn led to a collapse in price of company’s stock following with a shocking

confession by Raju. The truth was its’ promoters had decided to inflate the revenue

and profit figures of Satyam thereby manipulating their balance sheet consisting

non-existent assets, cash reserves and liabilities.

The probable reasons:

Deriving high stock values would allow the promoters to enjoy benefits allowing

them to buy real wealth outside the company and thereby giving them opportunity



to derive money to acquire large stakes in other firms on another hand. After the

scandal, on 10 January 2009, the Company Law Board decided to bar the current

board of Satyam from functioning and appoint 10 nominal directors. On 5th

February 2009, the six-member board appointed by the Government of India

named A. S. Murthy as the new CEO of the firm with immediate effect. The board

consisted of:

1) Banker Deepak Parekh.

2) IT expert KiranKarnik.

3) Former SEBI member C Achuthan S Balakrishnan of Life Insurance

Corporation.

4) Tarun Das, chief mentor of the Confederation of Indian Industry and

5) T N Manoharan, former President of the Institute of Chartered Accountants

of India.



CONCLUSION

Finally I can conclude that compliance of corporate governance is

high among the Indian banks, however the composition of board should be

effective.

From my point of view the awards and the rewards for the corporate initiative

among Indian banks both public and private, can create the right momentum to

change the mind set of banks and ensure that the international norms like Basel are

followed in both letter and spirit, resulting in improved transparency,

accountability and competitive performance in the economy, that could help derive

fully the socio economic benefits of good corporate governance.

Banking is clearly a very special sub set of corporate

governance with much of its management obligations enshrined in law or

regulatory codes. The corporate governance of banks has an important role to play

in assisting supervisory institution to perform their task, allowing supervisors to

have a working relation with bank management, rather than adversarial one.

With the element of good corporate governance, appropriate

internal control system, better credit risk management, focus on newly emerging

business like micro finance, better customer service and proactive policies, banks

will definitely be able to grapple with these challenges and convert them in to

opportunities.



So corporate governance is not only useful in banks but also useful in companies,

industries, firms, institutions etc. so as to have good relations with the customers

and to run their businesses in successive manner considering future prospect.



RECOMMENDATIONS

It is also relevant to note that governance or lack of it has affected all agencies of

government. We have to set right all governance, not just corporate governance. In

today’s world a company cannot run to achieve results in a cost effective manner

and stay competitive unless we fix governance problem wherever they exist. What

is at stake not only the integrity of market mechanism but the survival of

democracy in India.

Corporate houses including banks are also taking measure to highlight the

importance of corporate governance and ethical business practices among the

future managers in reputed management institutes like Larsen and Turbo (L&T)

Ltd. has endowed a chair for business at the management center for human values

at IIMC.

The government bodies honor the select corporate for their exemplary

initiative in areas of corporate governance and ethical business practices and many

more awards and accolades should be given. Finally I suggest that scandals like

satyam case which became the major economic downturn and finally ended by

arresting mr. Raju for his fraud against the company, should not take place again

due to which corporate governance may suffer from negative effects.



BIBLOGRAPHY

BOOKS:

Corporate governance-(Authors) H. R.

Machiraju,Keshoprasad,N Gopalsamy

WEBSITES:

www.corporate governance.com

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