Session 4 – Corporate Governance and Business Ethics

Session 4 – Corporate Governance and Business EthicsSunil Budhiraja

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OBJECTIVE OF CORPORATE GOVERNANCE

a) TO BUILD UP AN ENVIRONMENT OF TRUST AND CONFIDENCE AMONGST THOSE HAVING COMPETING AND CONFLICTING INTEREST

b) TO ENHANCE SHAREHOLDERS’ VALUE AND PROTECT THE INTEREST OF OTHER STAKEHOLDERS BY ENHANCING THE CORPORATE PERFORMANCE AND ACCOUNTABILITY

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What we have covered so far?•History, Concept, Mechanisms, Shareholder,

Stakeholders•Roles, responsibilities and the interests of

shakeholders; problems and their protections•Bankruptcy system in India•Decision System, corporate governance for corporate

capital, property rights, legal enforcement, Government Diversity in US, Japan and South Korea

Topics to be covered today•Development of Codes and Guidelines – Various

Committees and their Reports

•Theories of Corporate Governance

•Models of CG

Development of Codes and Guidelines•Objectives –

▫To improve corporate Governance practices across the globe

▫To mitigate CG risk and failure

•How do we develop these codes and guidelines – ▫By recommendations of various committees that were

formed to intensify the practices of Corporate Governance

The Cadbury Report 1992•Focus on three areas –

▫Board of Directors▫Auditing ▫Shareholders

Recommendations •BODs are most important, so requires continuous

monitoring and assessment.

•Focus on corporate transparency and communication with shareholders.

•Role of Institutional Investors should be more active as they are most influential group of shareholders

Contt…•Chairman and CEO –

The roles to be separated Chairman – Head of the Board and CEO- Head of the Company Management

•Non-Executive directors - The board should have majority non-executive directors

•Top Management Compensation – Separating salary and performance bonus

Contt…• BOD should report on the effectiveness of

company’s systems of internal control

• The Directors service contracts should not exceed 3 years without approval by the shareholders

• Each listed company should establish an audit committee of at least 3 non executive directors

The Greenbury Report 1995•The committee was formed on 17th July 1995 after

widespread concern that excessive amount of remuneration is paid to the Directors of the some companies.

•Also focused on the Directors whose performance had been down but they still draw hefty pay packages from the company

Recommendations•Director’s pay should be directly linked to the

Company’s performance.▫Performance Linked Pay

•Remuneration committee should consist of non-executive members who do not have any personal financial interest in the company

The Hampel Report 1998•Set up in Nov1998

▫To review Cadbury and Greenbury Reports▫To promote high standards both to protect the investors

& preserve & enhance the standing of company’s listed on the stock exchange.

Recommendations•Similar on the lines of Cadbury Report but less

demanding

•Pension Funds were given more focus as they make important contribution as institutional investors.

•Pension funds are advised to make a long term approach of institutional investment

The Turnbull Report• Set up by the ICAEW (Institute of Chartered

Accountants in England & Wales) in 1999 to provide guidance to assist the companies in implementing requirements of the Combined code relating to internal control.

• Recommended internal audit annually• BOD confirm the existence of procedures for

evaluating & managing key risks.

The Higgs Report 2003• In the Enron case it was found that non-executive

directors were ineffective in performing their roles in corporate governance, so their was a necessity to substantial improvement of their role.

•Focus on role and effectiveness of Non-Executive Directors.

CG Committees formulated in India•CII Committee•Birla Committee•Narayana murthy Committee • JJ Irani Committee•Clause 49 of Listing agreement of SEBI(Jan 2006)

Theories of Corporate Governance

Agency Theory•Shareholders are the ‘Principals’

•Directors and Managers need to be monitored as their motives differ from that of shareholders

Stewardship Theory•Assumptions –

▫Steward is a person who manages other’s property and financial affairs and is entrusted with the responsibility of proper utilization and development of organization’s resources

Stakeholder Theory•The purpose of the firm is to create wealth or value

for its stakeholders by covering their stakes into goods and services.

•The conception of the company is a set of relationship rather than a serious of transactions, in which managers adopt an inclusive concern for all stakeholders

Property Right Theory•Property rights are a set of rules and guidelines that

help people (investors) from reasonable expectations about control over assets

•These can be law, administrative arrangement, social norms etc

•How will it help –▫To understand the type of firm▫Specific CG mechanisms available to the firm

Models of CG

Anglo American German Japanese

Share holders Shareholders and employees /unions

Shareholders and banks

Elects Elects Elects

Board of Directors Supervisory Board Supervisory Board appoints President And President

Appoints Appoints Appoints

Officers/Executive Management Board Executive Board

Manage ManageManage

Company Company Company

Indian Model = Anglo American Model +German Model

Anglo American Model•Wide spread shareholding•Separation of ownership and management •Professional managers •Single board structure •Focus on mainly on Shareholders

Contt…• In the case of German model employees have a role

•Where as in Japanese Banks/financial institutions have a role in the board as stake holders