Corporate Governance CH.1

8/2/2019 Corporate Governance CH.1

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Dealing with the problems that resultfrom the separation of ownership and

control



Internal structure and rules of the board ofdirectors

Creation of independent audit committees

Rules of disclosure of information

Control of the management

Transparency of operations

Impeccable process of decision-making



Board

Management

Employees



The way in which suppliers of finance tocorporations assure themselves of getting areturn on their investment.

How do the suppliers of finance get managersto return some of the profits to them

How do they make sure that managers do not

steal the capital they supply or invest it in badprojects



How do suppliers of finance control managers



Shareholders elect directors who represent them

Directors vote on key matters and adopt the majoritydecision

Decisions are made in a transparent manner so thatshareholders and others can hold directors accountable

The company adopt accounting standards to generatethe information necessary for directors, investors and

other stakeholders to make decisions The company·s policies and practices adhere to

applicable national, state and local laws



Dispersedownership

Sophisticatedinstitutional

ownership

Active equitymarkets

Activetakeovermarkets

Highdisclosure

Alignedincentives

Non-executivemajorityboards

Shareholdersequality

Market model (governance chain)developed marketsShareholder

environmentIndependence

and performance

Capital market

liquidity

Transparency

andaccountability

I n s t i t u t i o n a l

c o n

t e x t

C o r p o r a t e c o n t e x t



concentrated

ownership

Reliance onfamily, bank,

public

finance

Underdeveloped new

issue market

limitedtakeovermarkets

limiteddisclosure

incentivesaligned with

core

shareholders

Insider

boards

Inadequateminority

protection

Market model (governance chain)developing marketsShareholder

environmentIndependence

and performance

Capital market

liquidity

Transparencyand

accountability

I n s t i t u t i o n a l

c o n

t e x t

C o r p o r a t e c o n t e x t



Narrowly can be defined as the relationship ofa company to its shareholders or, morebroadly, as its relationship to society

From narrow concept CG is to conduct thebusiness in accordance with the owner·s orshareholders desires

From the broader concept we link CG practiceswith country and society laws



Is not just to make changes in board structuresand procedure with a view to makeaccountable to shareholders

Should increase independent directors andboards and not to have one person bothchairman and CEO

Should introduce specific committees such likeaudit and remuneration committees



Full set of relationships between a company·smanagement, its board, its shareholders and itsother stakeholders, such as its employees and

community in which its located In 21st century stability and prosperity will

depend on strengthening of capital marketsand the creation of strong corporategovernance systems



Governments play a crucial role in making thelegal , institutional and regulatory frameworkwithin which governance systems are kept in

place



Rights of shareholders

Equitable treatment of shareholders

Role of stakeholders in corporate governance

Disclosure and transparency

Responsibilities of the board



Distinguish the roles of board andmanagement

Composition of the board and related issues

Separation of the roles of the CEO andchairperson

Should the board have committees

Appointments to the board and directors· re-election

Directors and executives remuneration



Disclosure and audit

Protection of shareholder rights and theirexpectations

Dialogue with institutional shareholders

Should investors have a say in making acompany ´ socially responsible corporate

citizenµ



Select, decide the remuneration and evaluateon a regular basis, and when necessary, changethe CEO

Oversee( not directly, but indirectly) theconduct of the company·s business to evaluatewhether or not it is being correctly managed

Review and, where necessary, approve thecompany·s financial objectives and majorcorporate plans and objectives



Render advice and counsel to top management

Identify and recommend candidates toshareholders for electing them to the board

directors

Review the adequacy of systems to complywith all applicable laws and regulations

All other functions required by law to beperformed



A committee elected by the shareholders of alimited company to be responsible for thepolicy of the company

There are certain kinds of directors accordingto their responsibilities



Board of directors

Independent

directors

Non-Executive

directors

Executive

directors

Affiliated

directors(nominee

directors)



Separation of the roles of the CEO and

chairperson

Composition of board is major issue in CG

If both authorities with the same then leads to

conflicts and concentration of power The role of CEO is to lead the management

The role of chairman is to lead the board and

evaluate the performance of executivesincluding CEO



Separation of the roles of the CEO and

chairperson(cont..)

If both are the same then create problem of

check over senior management



d)Should the board have committees

Nomination

Remuneration

auditing



Appointments to the board and

directors re-election

Shareholders elect board

In large corporates shareholders scattered, so

not possible to gather them So in actual practice specially constituted

committees select and appoint the

prospective directors and get the approval at

annual general body meeting from

shareholders



Appointments to the board and

directors re-election(cont..)

Shareholders only endorse board nominees,

only rare cases refuses board nominees



f)Directors and executives

remuneration

Very mixed and vexed issue

Shareholders should have clear statement of

directors present and future benefits and howthey are determined

The key points and issues in this regard are

transparency, pay for performance, process of

determination, severance payments, and

pension for non-executive directors



g) Disclosure and audit

Should boards establish an audit committee

If yes, how should it be composed?

How to ensure the independence of theauditor?

What precautions are to be taken or what are

the positions of the state and regulators withregard to provision of non-audit services

rendered by auditors?



g) Disclosure and audit(cont..)

Should individual directors have access to

independent resources

Should boards formalize performancestandards



h)Protection of shareholder rights and

their expectations

Should companies always adhere to one-

share-one-vote principle?

Should companies retain voting by a show of hands or by poll

Can shareholders resolutions be bundled?

i.e. to place together before shareholders for

approval a resolution that contains more than

one discrete issue



h)Protection of shareholder rights and

their expectations(cont..)

Should shareholder approval be required for

all major transactions?



i)Dialogue with institutional

shareholders

Institutional investors should maintain regular

and systematic contact with companies, apart

from their participation in general meetings of

shareholders

Use their voting right positively

Take positive interest in composition of board

Recognize their rights and responsibilities



j) Should investors have a say in

making a company socially

responsible corporate citizen



Benefits of CG

Creation and enhancement of a corporations

competitive advantage

Enabling a corporation perform efficiently bypreventing

. fraud and malpractices

Providing protection to shareholders interest

Enhancing the valuation of an enterprise

Ensuring compliance of laws and regulations



The theory and practice of corporategovernance



The process of capital accumulation that facilitatesdevelopment of economies by fuelling growth of its varioussectors such as industry, agriculture, infrastructure, tradeand commerce has become institutionalized by thecorporation

By a company is meant an association of many persons, whocontribute money or money's worth to a common stock andinvest it in some trade or business, and who share the profitand loss arising therefrom. The common stock socontributed is denoted in money and is the capital of thecompany. The person who contribute it, or to whom it

belongs, are members. The proportion of capital to whicheach member is entitled is his share. Shares are alwaystransferable, although the right to transfar them is oftenmore or less restricted



Incorporated association

Artificial legal existence

Perpetual existenc

Common seal

Extensive membership

Separation of management from ownership

Limited liability

Transferability of shares



The root of this theory taken from Adam smithwho identified agency problem( managerialnegligence and profusion)

The fundamental theoretical basis of CG isagency cost

Shareholders are the owners of any joint stock,limited liability company, and are theprincipals of the same.

The principals define the objectives of acompany



The management directly or indirectly selected byshareholders to pursue such objectives, are theagents.

The principal generally assume that the agents

would invariably carry out their objectives, it isoften not so. The objectives of managers at variance from those

of the shareholders The shareholder and other stakeholders may not

be able to counteract this because of inadequatedisclosure about such a decision and because theprincipals may be too scattered or even notmotivated enough to effectively block such a move



Such a mismatch of objectives is called theagency problem

The cost inflicted by such dissonance is the

agency cost The core of CG is designing and putting in

place disclosures, monitoring, "oversightµ andcorrective systems that can align the objectivesof the two sets of players as closely as possibleand hence minimize agency costs



In agency theory terms, the owners are principalsand the managers are agents and there is agencyloss

Agency theory specifies mechanisms whichreduces agency loss

These include incentives schemes for managerswhich reward them financially for maximisingshareholder·s interests.

Such schemes typically include plans wherebysenior executives obtain shares, perhaps at areduced price, thus aligning financial interests ofexecutives with those of shareholders



Total control of management is neither feasible norrequired under this theory

Must have to accept a certain level of selfinterested behaviors in delegating responsibility to

others. In agency theory the assumption is with the

complexities of investor-board relationship in largeorganizations, shareholders should have correctand adequate information to wield effective

control. Equity investors rarely get these andbesides they rarely make clear their exact targetreturns, and yet delegate authority to meet thetarget.



In terms of controls, equity investors hardlyhave sanctions over board, instead, they haveto rely on self-regulation to ensure that an

orderly house is maintained.



Fair accurate financial disclosure

Efficient and independent board of directors



This theory assumes that managers are basicallytrustworthy and attach significant value to their ownpersonal reputations.

The market for managers with strong personal

reputations serves as the primary mechanism tocontrol behavior, with more reputable managers beingoffered higher compensation packages.

Financial reporting, disclosure and auditing are stillimportant mechanisms, but there is a fundamental

presumption that these mechanisms are needed toconfirm managements· inherent trustworthiness

Corporate insiders are primarily made board ofdirectors



Theory define situations in which managers arenot motivated by individual goals, but rather theyare stewards whose motives are aligned with theobjectives of their principles

Given a choice between self-serving behavior andpro-organizational behavior, a steward·s behaviorwill not depart from the interests of his/herorganization

Control can be potentially counterproductive,because it undermines the pro-organizationalbehavior of the steward, by lowering his/hermotivation



Behavioral differences

With regard to Psychological mechanisms

With regard to Situational mechanisms



In agency theory managers are the agents of ownerswhile in stewards theory the managers are acts asstewards or trustee

Approach is materialistic under agency theory but in

later the approach is sociological and psychological The behavioral pattern is individualistic, opportunistic

and self serving under the agency theory while it iscollectivistic, pro-organisational and trustworthy in theother

There is vast difference between the managers and theprincipals with regard to their interest in theorganization; they are divergent in the first theory,while they are convergent in the later



Managers are motivated purely by their ownobjectives in the first case whereas they are guidedby the principal·s objective in the later

Managers role in agency is to monitor and controlwhile in later it is more to facilitate and empowerthem

Owner·s attitude in organizations of the agency

theory is to avoid risk rather than taking it andmanaging it in the second one

Principal manager relationship in agency basedupon control while it is relationship based in later



The agency theory states that motivation revolvesaround lower order and extrinsic needs, whilestewardship theory says it revolves around higherorder and intrinsic needs.

Social comparison is between compatriost whilethe latter says it is between principals

Agency theory says there is little attachment to thecompany while latter says there is great

attachment to the company Agency theory asserts that power rests with the

institution, while the latter says it rests with thepersonnal



Management philosophy is control oriented whilestewards theory says that it is involvementoriented

To deal with increasing uncertainty and risk, theagency theory advocates exercise of greatercontrols and more supervisions, while to the laterit is the exercise of training, empowering, people,

and making jobs more challenging and motivating The agency theory wants risk orientation done

through a system of control, while the later says itis done through trust



Shareholder approach: the corporations havelimited set of responsibilities, which primarilyconsist of obeying the law and maximizingshareholders wealth. The basic arguments is that

corporations, by focusing on shareholder interestsmaximize societal utility Stakeholder approach: this model CG argue that

those responsible for governance of corporationhave responsibilities to parties other than

shareholders and that, any fiduciary obligationsowed to shareholders to maximize profits might besubject to the constraints of respecting obligationsowed to such stakeholders



Focuses mostly on board composition and theimplications for power and wealth distributionin society. Problems of interlocking

directorships and the concentration ofdirectorship in the hands of a privileged classare viewed as major challenges to equity andsocial progress. Under this theory board

composition, financial reporting, disclosureand auditing are necessary mechanisms topromote equity and fairness in society





National interest

Political non-alignment

Legal compliances

Rule of law

Honest and ethical conduct

Corporate citizenship

Ethical behavior Social concerns

Corporate social responsability



Environment-friendliness

Healthy and safe working environment

Competition

Trusteeship

Accountability

Effectiveness and efficiency

Timely responsiveness Corporations should uphold the fair name of

the country



Towards shareholders

Measures promoting transparency andinformed shareholder participation

Transparency

Financial reporting and records



Fair employment practices

Equal opportunities employer

Encourage whistle blowing

Human treatment

Participation

Empowerment

Equity and inclusiveness Participative and collaborative environment



Quality of products and services

Products at affordable prices

Unwavering commitment to customer

satisfaction



Protecting company·s assets

Behavior towards government agencies

Control

Consensus- oriented Gifts and donations

Role and responsibilities of corporate boardand directors

Directorship and management must bedistinguished

Managing and whole-time directors



Rights and privileges of shareholders



Has right to obtain memorandum ofassociation, Articles of association and certainresolutions and agreement on request

Certificate of shares held within 3 months Right to transfer shares in accordance of article

of company

Right of appeal to company law in casecompany fails to register transfer of shares

Preferential right to purchase shares on pro-rata basis



Has right to apply company law board forrectification of the register of members

Right to apply court in case any variation or

abrogation to his /her rights set a side by thecourt

Right to inspect the register and the index ofmembers, annual returns, register of charges

and register of investments not held by thecompany in its own name without any charge



Right receive notices of annual generalmeetings and to attend such meetings and voteeither in person or by proxy

Entitled to receive the a copy of statutoryreport

Receive annual report of directors, annualaccounts and auditors report

Right to participate in the appointment ofauditors and the election of directors at annualgeneral meetings



If annual general meeting is not called withinprescribed time limit then has the right to make anapplication to the company law board for calling it.

Right to ask directors to convene extraordinarygeneral meeting by presenting proper requisition

Can make an application to the company lawboard for convening an extraordinary general

meeting of the company where it is impracticapleto call such a meeting either by the directors or bythe members themselves



Entitled to inspect and obtain copies of minutesof proceedings of general meetings

Right to participate in declaration of dividends

and receive his/her dividends duly Right to demand poll

Right to apply court for investigation of theaffairs of company

Right to remove a director before expiry ofterm



Right to make an application to the companylaw board for relief in case of oppression andmismanagement

Can make petition to the court for winding upof the company under certain circumstances

Right to participate in passing of a specialresolution that the company be wound up by

the court or voluntarily

Right to participate in the surplus assets of thecompany, if any, on its wound up



To receive interest/redemption in due time

To receive a copy of trust deed on request

To apply for winding up of company if fails to

pay its debt

To approach the debenture trustee with thedebenture holder·s grievance



Remain informed

To be vigilant

Participate and vote in general meetings

To exercise one·s rights on one·s own, or as agroup



Corporate governance and otherstakeholders



Conventional model of CG focus on primacy ofshareholders

Left out the role of employees in wealth creation Western reforms promoted the concept of

shareholder capitalism Today the growing recognition, that human capital

is a source of competitive advantage Labor is, if not, more important at least as

important as, capital Knowledge created by employees is most valuable

asset in corporations When a company acquire another company they

value human capital more than its financial assets



Trade unions

Co-determination: employee representation onBOD

Profit sharing Equity sharing

Team production solution: situation where the

BOD must balance competing interests ofvarious stakeholders and the arrive at decisionthat are in the best interest of the organisation



Voluntary participation

Extend benefits to all employees

Clarity and transparency

Predetermined formula

Regularity

Avoiding unreasonable risk for employees

Clear distinction Compatibility with worker mobility



Consumers are the king and sovereign whodecides through the market forces the qualityand quantity of goods produced

Consumer satisfaction is the sole purpose of anenterprise exists and therefore should betreated with respect in reality

If consumer is given raw deal_ sub-standardproducts, increased prices through marketmanipulation, failed warranties, poor after-saleservices, and host of other unfair tradepractices befalls his lot



Financial statements only reveal internal coststo entity but not the uncompensated andhidden costs bear by the society



Detailed legal record regarding goods and serviceswhich should also cover such information asproduct liability, injury, unwarranted death claimsover the past five years

Risks of injury caused in case of use Problems relating to their usage such as noise

Provisions ,if any, for recycling of products

Packaging of products

Unexpected lifecycle costs, such as repairs, energyconsumption and disposal that have to be born byultimate consumers



Warning concerning possible contaminationand adulteration, exposure and risks duringthe process of production, shipping, marketingand storage, providing everywhere appropriatedetails

In case of food articles and medicines providesuch details like contents additives andtreatments to enable reasonably informed

consumers to make rational choices and marketdecisions.

Unseen characteristics of products



Banks, insurance companies, state financialcorporations, development orientedinstitutions



Financial results and solvancy

Financial statement and annual reports

Composition and quality of board

Investor communications

Corporate governance practices

Corporate image

Share price



Banks and other creditors have an extremelyimportant role to play in fostering efficiency inmedium and large private firms. Creditors in

turn, rely for their survival on debt repaymentby their borrowers. Without dependable debtcollection, no amount of supervision orcompetition can make banks run efficiently.

Strong creditors are as critical to the efficientfunctioning of enterprise as are strong owners



Adequate information

Creditor incentives

Debt collection



Diffused debt

Concentrated debt



Board of Directors·



Can be define as a person having control overthe direction, conduct, management orsuperintendence of the affairs of a company.

Any person in accordance with whosedirection or instruction, the board of directorsof a company is accustomed to act is deemed tobe a director of the company



Executive committee

shareholders

Board of directors

Chief executives and senior

executives





Board of directors

Independentdirectors

Non-Executivedirectors

Executivedirectors

Affiliateddirectors(nominee

directors)



First set of directors?( articles of association,MOA)

Subscriber of MOA as first directors

Subscriber s will be directors until directors arenot selected by normal procedure



An agent

Trustee

Managing partner



Fiduciary duties

Duty of care, skill, and diligence

Duties to attend board meetings

Duties not to delegate their functions except tothe extent authorized by the act or theconstitution of the company



No corporate , association or firm could be thedirector

Must be an individual

Competent to enter into a contract Hold a share qualification if so required by

AOA



A person of unsound mind An un-discharged insolvent or one whose petition for

declaring himself so is pending in a court A person who has been convicted by court for any

offence involving moral turpitude A person whose calls in respect of shares of the

company are held for more than six months have beenin in arrears

Disqualification for appointment as director by courton grounds of fraud or misfeasance

Shareholders can make him disqualify Central or federal government The company law board



Make calls on shareholders in respect of money unpaid ontheir shares

Issue debenture Borrow money for banks or public deposits Invest the funds of company Make loans Fill vacancies in the board To sanction or give assent for certain contracts in which

particular directors, their relatives and firms are interested To receive notice of disclosure of directors interest in any

contract or arrangement with the company To receive notice of disclosure of shareholdings of directors



To appoint as managing director or manager a personwho is already holding such post in another company

To make investment in companies in the same group To sell, lease or otherwise dispose of the whole or

substantially the whole of the undertaking of thecompany

To remit or give time for repayment of any debt To borrow in excess of capital To contribute to charitable and other funds not relating

to the business To invest compensation amounts received on

compulsory acquisition of any company·s property To appoint a sole selling agents



General meeting of shareholders competent tointervene and act in respect of matters delegated toBOD

Directors act mala fide

The directors themselves are wrongdoers The board as a whole is found to be incompetent,

when for instance all directors are interested in atransaction with the company

There is deadlock in management There is fit case for shareholders to exercise their

residuary powers



Liable to third party(SECP) with respect to discrepancyin MOA, AOA, prospectus

Director may incur personal liability under the act ofthe following conditions

a) On failure to repay application money if minimumsubscription has not been subscribed

b) On irregular allotment of sharesc) On their failure to repay application money if the

application for the securities to be dealt in on arecognized stock exchange is not made or refused

d) On failure by the company to pay a bill of exchange,hundi, promissory note, cheque or order for money orgoods wherein the name of the company is notmentioned in legible characters



By signing a negotiable instrument without thecompany·s name and the fact that he is signingon behalf of the company, he is personally

liable to the holder of such Enter into a contract which is ultra wire

Personally committed a fraud



Ultra wires acts

Negligence

Breach of trust

Misfeasance: willful default



Director should carryout several statutoryduties most of which relates to the maintenanceof proper accounts, filling of returns or

observance of certain statutory formalities



A director is not liable for the acts of his co-directors provided he has no knowledge andhe is not to party it



Court can provide relief in following matters

a) Negligence

b) Default

c) Breach of duty

d) Misfeasance

e) Breach of trust against an officer



The liability of directors will be consideredunlimited unless or until the resolution inMOA is not passed for the extent of liability



Acts done by a person shall be valid, but ifprove that he gain this position throughmisleading of fact or by doing illegal acts then

his acts will be considered as invalid



A director who is not dully appointed but actsas a director is known as ¶ de facto· directorand is as much liable as a ¶ de jure· ( appointed

as per law)



Small size of the board

Independence of the board

Diversity of the board

A ²well informed board

The board should have a longer vision andbroader responsibility



ROLE, DUTIES AND RESPONSABILITIES OFAUDITORS



The independent examination of any entity,whether profit oriented or not and irrespectiveof its size or legal form, when such an

examination is conducted with a view toexpressing an opinion thereon



Financial statement audit

Compliance audit

Operational audit



A person appointed by a company to performan audit. He is required to certify that theaccounts produced by his client companies

have been prepared in accordance with normalaccounting standards and represent a true andfair view of the company



Internal auditors

Independent auditors

Government auditors



Ensure security against loan properly secured Transaction made are legal and in the interest of

company Ensure the assets and securities of company sold and

purchased properly Whether loan and advances made by company have

been shown as deposits Whether personal expenses charged to revenue

account Statements of accounts are drawn up on the basis of

books of business Above Statement drawn showing true affairs Ensure management not exceeds the power given by

AOA



Give opinion on reliability and sufficiency ofstatements

Relevant information disclosed properly

Not expected to perform which fall outside hisscope



Professional requirements: independence,integrity, objectivity, confidentiality, professionalbehavior

Skills and competency

Assignment: assign peoples in accordance with thedemand of assignment Delegation: sufficient direction, supervision and

review of work at all levels to provide reasonableassurance

Consultation Acceptance and retention of client monitoring



BUSINESS ETHICS AND CORPORATEGOVERNANCE



Science of morals

Describe a set of rules of behaviors

In business defines what is right and morally

good for business



Conception of right and wrong behavior

Business ethic is the application of generalethical idea to business behavior

It prevents harm to society, improvesprofitability, foster business relations andemployee productivity, reduce criminalpenalties,



Ethics closely related to trust

To develop trust behavior should be ethical

Trust could be use as the indicator of ethic

Trust is three dimensional: trust in supplierrelationship, trust in employee relationship andtrust in customer relationship

Trust leads to predictability and efficiency ofbusiness

Earlier the slogan was the business of business isbusiness but now changed as business of businessis ethical business



Protect its own interest

Protect the interest of business community

To keep commitment to society

Meet stakeholders expectations Prevent harm to general public

To build trust with key stakeholders

Protect themselves from abuse

Create an environment in which workers canact in ways consistent with their values

Values help better decision making



Bribery

Coercion: forcing a person to act in a mannerthat is against the person·s personal belief

Insider trading Tax evasion

conflicts of interests

pollution



Attention to ethics has substantially improvedsociety

Can contribute towards high productivity

Changing situations require ethical educationEthical practices create strong public image

Strong ethical practices act as insurance





Lower economic growth Dominant public sector Lack of effectiveness of privatization Lack of awareness among shareholders Greater government influence, and less autonomy to enterprise

Internal owner dominate more than a company·s external owner Concentration of ownership External owners do not have enough power Lack of strong legal protection Capital market are under develop Internal abuse of information Redrawing and updating of property laws are slow in coming



Lack of well regulated banking sector

Exit mechanism, bankruptcy and foreclosurenorms are absent

Sound security market does not exist Do not have competitive markets

Corruption and mismanagement

Non-uniform guidelines



Property rights

Contract law

A well regulated banking sector

Exit mechanism: bankruptcy and foreclosure Sound security market

Competitive market

Fair and transparent privatization Well functioning judicial system

Anti- curruption strategies



Reform government agencies

Strengthen administrative and enforcementcapacity of government

Establish routine mechanisms of participation Investigative and well informed media

Strengthening reputational agents

Corporate Governance CH.1

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