Corporate Governance-A Conceptual Guideline: June 2018

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Corporate Governance- A conceptual Guideline
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Chapter 9
Corporate Governance
Learning Objectives
• To understand the Corporate Governance
• To understand the stakeholder theory on corporate governance
• To understand the role of board of directors in corporate governance
• To understand the various committees on corporate governance in India
• To understand the critical appraisal of corporate governance in India
• To analyse the concept of corporate governance models across the world
INTRODUCTION
The collapse of Enron raises troubling questions about corporate governance and it draws
the attention of corporate as well as general people. Recently corporate governance has
become a topic of wide discussion around the globe. But it did not receive much attention
until the dawn of the 1990s. Now corporate governance is closely associated with strategic
management.
Though corporate governance is as old as the corporate sector itself, it has assumed centre
stage only in the new age economy. In the global economy today, companies are built to last.
The primary objective—of the management of any publicly-traded enterprise—is to enhance
its values. An enterprise is expected to honour and protect the rights of other stakeholders
including the local community. Increased competitiveness is all the more reason for board
level management to institute corporate governance—on highly ethical grounds—across the
spectrum of the organisation.
Corporate governance depends upon two factors. The first relates to the commitment of
management towards the principle of integrity and administrative framework created by
the government of the country in which the business operates. Therefore, the first is spirit
and commitment and the rest is binding. The focus of corporate governance is not just being
bound by the rules but being proactive to become a better corporate citizen.
Corporate Governance 429
WHAT IS CORPORATE GOVERNANCE?

Corporate governance is defined as the code of practices by which a firm’s management is
held accountable to capital providers for the efficient use of assets. The corporate governance
system aligns the organisation’s mission, values and philosophy. Corporate governance
is an internal system encompassing policies, processes and people; serves the needs of
shareholders and other stakeholders; and directs and controls management activities with
objectivity, accountability and integrity.
Sound corporate governance relies upon external marketplace commitments and
legislation as well as a healthy board culture that safeguards policies and processes.
Corporate government has a number of definitions. The Confederation of India Industry
(CII)-corporate governance deals with laws, procedures, practices and the implicit rules
that determine an organisation’s ability to take managerial decisions vis-à-vis claimants, in
particular, its shareholders, creditors, the state and employees. Thus the principle stakeholders
are: the shareholders; the board of directors; employees; customers; creditors; suppliers; and
the community at large.
The core objectives of corporate governance can be classified as follows:
1. Strategic focus
2. Predictability
3. Transparency
4. Participation
5. Accountability
6. Efficiency and effectiveness
7. Stakeholder satisfaction
Strategic focus defines the direction an organisation should take to meet its goal and
to ensure stakeholder satisfaction. This should be based on predictability as the evolution
of strategies have to consider the dynamic nature of the environment within which it
has to operate and hence the challenges, from the environment, need to be anticipated.
A well-designed process—to evolve and deploy strategy—has to have transparency. For
proper execution of processes, aimed at achieving the desired end result, participation of
all the stakeholders is important and necessary. Participation should also have a clear goal
of efficiency and effectiveness as a whole and accountability as an underlying key to all
activity.
In its narrowest sense, the term may describe the formal system of accountability of
senior management to shareholders. At its most expansive, the term is stretched to include
the entire network of formal and informal relations involving the corporate sector and
their consequences for the society in general. Corporate governance, however, as generally
understood, includes the structure; process; cultures; and systems that engender the successful
operation of the organisation.1
According to one definition, corporate governance is simply the mode of structure and
power that determines the rights and responsibilities of the various groups involved in
430 Strategic Management
running an organisation. Corporate governance, however, is generally thought to have a

value dimension too. According to another definition, corporate governance means that
long-term strategic objectives and plans are established and that the proper management
structure (organisation, systems and people) is in place to achieve those objectives, while at
the same time making sure that the structure functions to maintain the corporation’s integrity,
reputation and responsibility to its various constituents.”2
“The concept of corporate governance primarily hinges on complete transparency,
integrity and accountability of the management. There is also an increasingly greater focus
on investor protection and public interest.”3
It is pointed out that “the concept of corporate governance is to some extent similar to
the quality practices adopted under the ISO standard. The key question is to ensure how
effectively organisations are managed. This would also include defining of the powers of
Directors, particularly non-executive ones, making available information on the Company’s
current state of affairs to all the Directors, and systems control to ensure the authenticity,
timeliness and effectiveness of the information.”4 The fundamental objective of corporate
governance is the enhancement of long-term shareholder value while, at the same time,
protecting the interests of other stakeholders. (K. M. Birla Committee)
Corporate governance is concerned with the values, vision and visibility. It is about: (i) the
value orientation of the organisation; (ii) ethical norms for its performance; (iii) the direction
of development; (iv) social accomplishment of the organisation; and (v) the visibility of
its performance and practices. Corporate management is concerned with the efficiency of
the resource use, value addition and wealth creation within the broad parameters of the
corporate philosophy established by corporate governance. In short, the concept—of good
corporate governance—connotes that ethics is as important as economics; fair play as crucial
as financial success; morals as vital as market share.
Inadequacies and failures of an existing system often bring in norms and codes as remedial
measures. This is also true for corporate governance. While companies grew phenomenally,
accounting standards went into decline. The resultant failure—of several companies—raised
serious concerns regarding corporate governance and this eventually led to the appointment
of Cadbury Committee on Corporate Governance by the London Stock Exchange and the
Financial Reporting Council in Britain in 1991 internationally. Several other notable reports
and codes on the subject—like the report of the Greenbury Committee; the Combined Code
of the London Stock Exchange; the OECD Code on Corporate Governance; and The Blue
Ribbon Committee on Corporate Governance in the U.S.—were also published. In India, also
the Confederation of Indian Industries (CII) has published a code of corporate governance.
In India, the need—for a system of corporate governance—has been described by SEBI by
pointing out the background of the appointment of the Kumar Mangalam Birla Committee
on Corporate Governance.
There has been an increasing concern about standards of financial reporting and
accountability, especially after losses suffered by investors and lenders, which could well
have been avoided with better and more transparent reporting practices. Investors have
suffered on account of unscrupulous management of companies which have raised capital

from the market at high valuations and have performed much worse than the past reported
figures, leave alone future projections at the time of rising money. Another example—of bad
governance—has been the allotment of promoters’ shares—of preferential basis at preferential
prices, disproportionate to market valuation of shares—which have led to further dilution of
wealth of minority shareholders. This practice has however since been contained.
In India, there are so many organisations which are not paying adequate attention to the
basic procedures for shareholder services. Many of these companies do not pay adequate
attention to redress investor grievances such as: (i) delay in transfer of shares; (ii) delay
in dispatch of share certificates; and (iii) 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. While enough laws exist,
to take care of many of these investor grievances, the implementation and inadequacy—of
penal provisions—leave much to be desired. Corporate governance is considered an important
instrument of investor protection and is therefore a priority on the SEBI agenda.
The main important facilitating factor is that there is a growing awareness and
enthusiasm—in India—to embrace good corporate governance. Many captains of industry,
corporate leaders and top executives are keen to usher in the same. In fact, a few years prior
to the formation of the Birla Committee, the path—for good corporate governance—was
paved by the Draft Code on Desirable Corporate Governance drawn up by the Confederation of
Indian Industries (CII).
It is almost an accepted fact that the adequacy and the quality of corporate governance
shape the growth and the future of any capital market and economy.
Studies of firms in India and abroad have shown that markets and investors take notice
of well-managed companies; respond positively to them; and reward such companies with
higher valuations. A common feature—of such company’s—is that they allow sufficient
freedom to the boards and management to take decisions and to innovate, while remaining
within a framework of efficient accountability. According to Charkham, good corporate
governance is considered vital—from medium-and long-term perspectives—to enable firms
to compete internationally in a sustained way; enable them to generate employment, wealth
and satisfaction; and to not only improve the standard of living materially but also to enhance
socio cohesion.5
A review of the literature on corporate governance, including the reports of various
Committees, suggest that good corporate governance should be:
• A proper system consisting of clearly defined and adequate structure of roles, authority
and responsibility (delegation of authority);
• Vision, principles and norms which indicate development and guidelines for
performance; and
• A proper system for guiding, monitoring, reporting; and control.
HISTORY AND EVOLUTION CONCEPT

Corporate governance—as a subject, along with its models—has been in existence since
the time business came into being. It is viewed as a statutory requirement guided through
the regulatory body that is concerned with company affairs. Corporate governance was
seen, till recently, as limited to listed companies with disclosure norms to protect investor
rights, especially those of minority shareholders. As long as management and investors were
balancing the affairs of the business in a congenial atmosphere, there was no special attention
being diverted to this subject .In the 1990s, the issue of corporate governance received attention
in the US due to the dismissals of a few high profile CEOs. At that time, there had been
some public initiatives to ensure that corporate value would not be destroyed by the then
traditionally cozy—CEO and board of directors—relationships. There were issues—relating
to CEO compensation and boards—discussed over back-dated stock options. In 1997, the
East Asian financial crisis saw the economies of Thailand, Indonesia, South Korea, Malaysia
and the Philippines crumble. It was then that the debate—on quality of governance—again
surfaced. The crisis led to foreign capital fight after property assets collapsed. The lack
of corporate governance mechanisms—in these countries—highlighted the weaknesses of
these institutions in their economies. There have been further dialogues in the corporate
governance practices of modern corporations since 2001, particularly due to the high-profit
collapse of a number of large U.S. firms such as Enron Corporation and WorldCom. In 2002,
the US federal government passed the Sarbanes-Oxley Act (SOA), intending to restore public
confidence in corporate governance.
Earlier the Cadbury report, entitled Financial Aspects of Corporate Governance (1992), had
set out recommendations on the arrangement of company boards and accounting systems
to mitigate corporate governance risks and failures. The report’s recommendations had been
doped in varying degrees by the European Union, United States, the World Bank and others.
Today the SOA works as predominant guiding framework on corporate governance in the
US.
Exhibit 9.1
Scandal at Satyam
In one of the the biggest frauds in India’s corporate history, B. Ramalinga Raju, founder and CEO of Satyam
Computers, India’s fourth-largest IT services firm, announced on January 7 that his company had been
falsifying its accounts for years, overstating revenues and inflating profits by $1 billion. Ironically, Satyam
means “truth” in Sanskrit, but Raju’s admission—accompanied by his resignation—shows the company had
been feeding investors, shareholders, clients and employees a steady diet of asatyam (or untruth), at least
regarding its financial performance.
Raju’s departure was followed by the resignation of Srinivas Vadlamani, Satyam’s chief financial officer,
and the appointment of Ram Mynampati as the interim CEO. In a press conference held in Hyderabad on
January 8, Mynampati told reporters that the company’s cash position was “not encouraging” and that “our
only aim at this time is to ensure that the business continues.” A day later, media reports noted that Raju and
his brother Rama (also a Satyam co-founder) had been arrested—and the government of India disbanded
Satyam’s board. Though control of the company will pass into the hands of a new board, the government
stopped short of a bailout--it has not offered Satyam any funds. Meanwhile, a team of auditors from the
Securities and Exchange Board of India (SEBI), which regulates Indian public companies, has begun an
investigation into the fraud. Since Satyam’s stocks or American Depository Receipts (ADRs) are listed on the
Bombay Stock Exchange as well as the New York Stock Exchange, international regulators could swing into
action if they believe U.S. laws have been broken. At least two U.S. law firms have filed class-action lawsuits
against Satyam, but given the company’s precarious finances, it is unclear how much money investors will
be able to recover.
Source: http://hbr.org/product/corporae-governance-failure-at-satyam/an/HKU889-PDF-ENG, last accessed on 15 April
2012.
PRINCIPLE OF CORPORATE GOVERNANCE

You may note—from the discussion so far in this chapter—that corporate governance is
based on the principles of integrity; equity; transparency; accountability; and commitment
to value. Good governance practices are based on the culture, mindset and shared values
of the organisation. The recent importance—gained by corporate governance—shows the
dichotomy between the board of directors and the management of a company. There are two
theories, namely agency theory and stewardship theory, which give credence to this.
Agency theory argues that, in order to protect a shareholder’s interests, there is a need
to separate the roles of chairperson of the board of directors and the CEO. The principle of
governance, according to this theory, suggests that economic motives drive the business. The
manager’s motivation—in such a framework—is driven by self-interest and the leadership
style is typically authoritarian in nature. There would be a divergence of interests—between
the shareholders and the management—which requires splitting of the chairperson-and CEO
position. The general view is that the shareholders are risk-averse and reluctant to relinquish
control.
On the contrary, the stewardship theory argues that shareholder interests are maximised
by a shared incumbency of rolls. The principle of governance, according to this theory, is
that sociological and psychological needs drive the business. The motivation, in this case,
would be that of the collective interest, that is, the vision of the company. Such an approach is
typically participatory in nature and involves a convergence of interests between shareholders
and the management. The general approach is that the shareholders are to assume risk and
decision making is based on trust.
Thus, the first principle—of corporate governance—is that of agency issues. Managers
work as agents of investors and their behaviour—with investors and other shareholders—
determines the quality of governance and the performance of the firm. It is better to ensure
the accountability of certain individuals through mechanisms that try to reduce or eliminate
the principal-agent problem. Since the principal and agent may develop conflicting interests,
there is scope for aberrations in governance. Numerous cases can be cited where primary
investors—represented by the promoters—dominate managers (agents) in decision making;
a practice which cannot be fully justified. There could also be situations where—even
within the promoter group—differences arise with respect to managerial leadership; or the
CEO/owner’s interest. The second principle is about the impact of a corporate governance
system on the economic efficiency of the company, with a strong emphasis on balancing
shareholder welfare with that of other stakeholders. Normally, boards select leaders and
experts from various domains depending upon the need of the business to ensure a sustainable
high performance compared to peers and market. There are a number of studies that show
that companies—with good governance protocols—have been able to demonstrate higher
earnings.
However, research into the relationship—between specific corporate governance controls
and firm performance—has shown mixed and often weak results. Research has found
support for the same. Research has found support for the relationship between frequency of
proportion—of external directors—and profitability. It is also to be noted that a few others
found no relationship between external board membership and profitability. Bhagat and Block
(1997) found that companies—with more independent boards—are not more profitable than
other companies. It is unlikely that the board composition has a direct impact on profitability,
which is only one measure of firm performance.
On remuneration and compensation, researchers again failed to find any consistent
or significant relationships between remuneration and firm performance. Generally, it is
believed that low average pay leads to poor performance, as managers lack motivation.
Effectiveness of controls could also be weak in such cases. It may be important to note that
not all firms experience the same levels of agency conflict. In addition, external-and internal
monitoring devices may be more effective for some firms compared to others. Share option
plans—as performance incentives in compensation—could also impact a firm’s performance
and quality of governance. However, there has been an outbreak of scams since the 90s,
which makes such efforts questionable.
Exhibit 9.2
Tata Motors Limited, COMPANY’S PHILOSOPHY ON CORPORATE GOVERNANCE

As part of the Tata group, the Company’s philosophy on Corporate Governance is founded upon a rich
legacy of fair, ethical and transparent governance practices, many of which were in place even before they
were mandated by adopting highest standards of professionalism, honesty, integrity and ethical behavior.
As a global organization the Corporate Governance practices followed by the Company and its subsidiaries
are compatible with international standards and best practices. Through the Governance mechanism in the
company, the Board along with its Committees undertake its fiduciary responsibilities to all its stakeholders
by ensuring transparency, fair play and independence in its decision making.
The Corporate Governance philosophy has been further strengthened with the implementation, a
few years ago, by the Company of the Tata Business Excellence Model as a means to drive excellence, the
Balanced Scorecard methodology for tracking progress on long term strategic objectives and the Tata
Code of Conduct which articulates the values, ethics and business principles and serves as a guide to the
Company, its directors and employees and an appropriate mechanism to report any concern pertaining to
non-adherence to the said Code and addressing the same is also in place. The Company is in full compliance
with the requirements of Corporate Governance under Clause 49 of the Listing Agreement with the
Indian Stock Exchanges (“the Listing Agreement”). The Company’s Depositary Program is listed on the
New York Stock Exchange and the Company also complies with US regulations as applicable to Foreign
Private Issuers (non-US listed companies) which cast upon the Board of Directors and the Audit Committee,
onerous responsibilities to improve the Company’s operating efficiencies. Risk management and internal
control functions have been geared up to meet the progressive governance standards. As a good corporate
governance practice, the Company has voluntarily undertaken an Audit by M/s Parikh & Associates
,Practicing Company Secretaries, of the secretarial records and documents for the period under review in
respect of compliance with the Companies Act, 1956, listing agreement with the Indian stock exchanges
and the applicable regulations and guidelines issued by Securities and Exchange Board of India.
Source: http://www.tatamotors.com/know-us/pdf/CG-Report-2011.pdf, last accessed on 15 April,2012.
IMPORTANCE OF CORPORATE GOVERNANCE

In the field of industries and capital market, it is seen that the importance of corporate
governance is gaining ground shaping the growth and the future trend of capital market.
The whole economy is influenced by good corporate governance. The deficiency—in capital
market; financial crisis; and high profile financial reporting failure—has compelled the market
to pay more attention to corporate governance:
• Under global economy, corporate governance is closely linked with effective market
discipline. A company—investing a huge amount of capital and doing world-wide
business—will have to cultivate a culture of stability and the sound health of business.
Consequently, a good link—of the company’s management and its director’s role—
has become more crucial. Hence, there is need of good corporate governance;
• Good corporate governance protects the interest of shareholders and all other
stakeholders. It also contributes to the efficiency of the business; and
• Charkham has also accepted the value of good governance—to evaluate the corporate
sector—to face the market scenario with all vigour and strength; to increase the
social wealth; and improve the material well-being of the global economy. (Jonathan
Charkham, Keeping Good Company: A Study of Corporate Governance in Five Countries
(Oxford: Claredon Press, 1994)
STAKEHOLDERS
A company’s stakeholders are individuals or groups with an interest, claim, or stake in the
company; in what it does; and in how well it performs. They include stock-holders; creditors;
employees; customers; the communities in which the company does business; and the
general public. Stakeholders can be divided into internal-and external stakeholders. Internal
stakeholders are stock-holders and employees, including: executive officers; other managers;
board holders; and employees. External stakeholders include the other individuals and group
that have some claim on the company. Typically, this group comprises: customers; suppliers;
creditors (including banks and bondholders); governments; unions; local communities; and
the general public (Fig. 9.1).
All stakeholders are in an exchange relationship with the company. Each of the stakeholder
groups—listed in the figure below—supplies the organisation with important resources
(or contributions) and, in return, expects its interests to be satisfied (by inducements).
Stockholders provide the enterprises with risk capital and, in exchange, expect management
to try to maximize the return on their investment. Creditors, and particularly bondholders,
also provide the company with capital and want that the interest, due to them, will be paid on
time and in full. Employees provide labor and skills and, in exchange, expect commensurate
income; job satisfaction; job security; and good working conditions. Customers provide
a company with its revenues and, in exchange, want high-quality, reliable products that
represent value for money. Suppliers provide a company with inputs and, in exchange,
seek revenues and dependable buyers. Governments provide a company with rules and
regulations that govern business practices and maintain fair competition and, in exchange,
want companies that adhere to these rules. Unions help to provide a company with productive
employees and, in exchange, they want benefits for their members in proportion to their
contributions to the company. Local communities provide companies with local infrastructure
and, in exchange, want companies that are responsible citizens. The general public provides
companies with national infrastructure and, in exchange, seeks some assurance that the
quality of life will be improved as a result of the company’s existence.
Fig. 9.1 Stakeholders and the Enterprise
A company must take these claims into account when formulating its strategies, or else
stakeholders may withdraw their support. For example, stockholders may sell their shares;
bondholders may demand higher interest payments on new bonds; employees may leave their
jobs; and customers may buy elsewhere. Suppliers may seek more dependable buyers; unions
may engage in disruptive labour disputes; Government may take civil or criminal action
against the company and its top officers by imposing fines on facilities in their area; and the
general public may form pressure groups demanding action against companies that impair
the quality of life. Any of these reactions can have a damaging impact on enterprise.
STAKEHOLDER IMPACT ANALYSIS

A company can not always be able to satisfy all stakeholder claims. The goals of different
groups may conflict; and, in practice, few organisations have the resources to manage all
stakeholders. For example, union claims—for higher wages—can conflict with consumer
demands for reasonable prices and stockholder demands for acceptable returns. Often the
company must make a choice. To do so, it must identify the most important stakeholders
and give highest priority to pursuing strategies that satisfy their needs. Stakeholder impact
analysis can provide such identification. Typically, stakeholder impact follows these steps:
1. Identify stakeholders;
2. Identify what stakeholders are likely to make on the organisation
3. Identify what claims stakeholders are likely to make
4. Identify stakeholders who are most important from the organisation’s perspective
5. Identify resulting strategic challenges
Such an analysis enables a company to identify the stakeholders most critical to its survival
and to make sure that the satisfaction of their needs is paramount. Most companies—that go
through this process—quickly come to the conclusion that three stakeholder groups must be
satisfied above all others if a company is to survive and prosper: customers; employees; and
stockholders.
The Unique Role of Stockholders

A company’s stockholders are usually put in a different class from other stakeholder groups
and for good reason. Stockholders are legal owners and the providers of risk capital. A major
source of the capital resources——that allows a company to operate its business—is seen as
risk capital because there is no guarantee that stockholders will ever recoup investment and
or earn a decent return.
History demonstrates all too clearly the nature of risk capital. Many investors who bought
shares—in companies that went public during the late 1990s and early 2000s through an initial
public offering (IPO)—subsequently saw the value of their holdings to zero, or something
close to it.
Profitability and Stakeholder Claims

Because of the unique position assigned to stockholders, managers, normally seek to pursue
strategies that maximize the returns that stockholders receive from holding shares in the
company. Stockholders receive a return on their investment in a company’s stock in two
ways: (i) from dividend payments; and (ii) from capital appreciation in the market value of
a share (that is, by increase in stock market prices). The best way for managers—to generate
the funds for future divided payments and keep the stock price appreciating—is to pursue
strategies that maximize the company’s long-run return on invested capital (ROIC). ROIC is an
excellent measure of the profitability of a company. It tells managers how efficiently they can
use the capital resources of the company (including the risk capital provided by stockholders)
to generate profits. A company—that is generating a positive ROIC—is covering all of its
ongoing expenses and has money left over, which is then added to shareholder equity,
thereby increasing the value of a company and, thus, the value of a share of stock in the
company. Maximising long-run ROIC is the route to maximizing returns to stockholders.
In addition to maximising returns to stockholders, boosting a company’s profitability,
as measured by its ROIC, is also consistent with satisfying the claims of several salaried
key stakeholder groups. The more profitable a company is, the higher the salaries it can
pay to productive employees and the greater the ability of the company to afford other
benefits, such as health insurance coverage; all of which help to satisfy stakeholder groups.
In addition, companies—with a high level of profitability—have no problem meeting their
debt commitments. This provides creditors and bondholders with a measure of security.
More profitable companies are also better able to undertake philanthropic investments
which can help to satisfy some of the claims that communities and the general public place
on a company. Pursuing strategies—that maximise the long-run ROIC of the company—is
therefore generally consistent with satisfying claims of various stakeholder groups.
There is an important cause and effect relationship here. It is pursuing strategies to
maximise profitability that helps a company to better satisfy the demands that several
stakeholder groups place on it, not the other way around. The company—that overpays
its employees in the current period—may have very happy employees for a short while,
but this would eventually raise the company’s cost structure and limit its ability to attain a
competitive advantage in the marketplace, thereby depressing its long-run profitability and
hurting its ability to award future pay increases. As far as employees are concerned, the way
many companies deal with this situation is to make future pay increments hinge upon labour
productivity. If labour productivity goes up, labour costs—as percentage of revenues—will
fall; profitability will rise; and the company can afford to pay its employees more and offer
greater benefits.
The basic cause and effect relationship is summarized in Fig. 9.2. Of course, not all
stakeholder groups want the company to maximise its long-run ROIC. Suppliers are more
comfortable about selling goods and services to profitable companies because they can be
assured that the company will have the funds to pay for those products. Similarly, customers
may be more willing to purchase from profitable companies because they can be assured
that those companies will be around, in the long run, to provide after-sales service and
support. But neither suppliers nor customers want the company to maximise its ROIC at
their expense.
Fig. 9.2 Relationship Among ROIC, Stakeholders Satisfaction and Stakeholders Support
They want to capture some of these profits from the company at higher prices for their
goods and devices (in the case of suppliers) or lower prices for the products they purchase
from the company (in the case of customers). Thus, the company is in a bargaining relationship
with its stakeholders. A company has the obligation—despite the argument that maximising
long-run-ROIC is the way to satisfy the claims of several key stakeholder groups—to remain
within the limits set by the law in a manner that is consistent with societal expectations.
The unfettered pursuit of profit can lead to behaviours that are outlawed by government
regulations; opposed by important public constituencies; or are simply unethical. Governments
have enacted a wide range of regulations to govern business behavior, including anti-trust
laws; environmental laws; and laws pertaining to health and safety in the workplace. It is
incumbent on managers to make sure that the company is in compliance with these when
pursuing strategies.
AGENCY THEORY
Agency theory looks at the problems that can arise—in a business relationship—when
one person delegates decision-making authority to another. Agency theory offers a way of
understanding why managers do not always act in the best interests of stakeholders. Although
agency theory was originally formulated to capture the relationship between management
and stockholders, the basic principles have also been extended to cover the relationship
with other key stakeholders—such as employees as well as between different levels of
management—within a corporation. Although the focus of attention—in this section—is on
the senior management and stockholders relationship; it applies equally to the relationship
between other stakeholders and top managers; and between top management and lower
levels of management.
Principal-Agent Relationships
The basic propositions—of agency theory—are relatively straightforward. First, an agency
relationship is held to arise whenever one party delegates decision-making authority, or
control over resources, to another. The principal is the person delegating authority; and the
agent is the person to whom authority is delegated. The relationship—between stockholders
and senior managers—is the classic example of an agency relationship. Stockholders, who are
the principals, provide the company with risk capital. However, they delegate control—over
that capital—to senior managers, particularly the CEO, who as their agent, is expected to use
that capital in a manner that is consistent with the best interests of stockholders.
The agency relationship continues on down within the company. For example, in the
large, complex multi-business companies, top managers cannot possibly make all important
decision, so they delegate some decision-making authority and control—over capital
resources—to business unit (divisional) managers. Thus, just as senior managers—such as
the CEO—are the agents of stockholders; business unit managers are the agents of the CEO
(and in this context, the CEO is the principal). The CEO entrusts business unit managers to
use the resources over which they have control in the most effective manner. This helps the
CEO to maximise the ROIC of the entire company, thereby discharging agency obligation to
stockholders. More generally, whenever managers delegate authority—to managers below

them in the hierarchy and give them the right to control resources—an agency relation is
established.
The Agency Problem

The essence—of the agency problem—is that agents and principals may have different goals.
Consequently, agents may pursue goals that are not in the best interests of their principals.
Agents may be able to do this because there is an information asymmetry between the
principal and the agents. Agents almost always have more information—about the resources
they are managing—than the principal does. Unscrupulous agents can take advantage of any
information asymmetry to mislead principals and maximise their own interests. In the case of
stockholders, the information asymmetry takes place because they delegate decision-making
authority to the CEO, who by virtue of his or her position inside the company, is likely to
know far more than stockholders do. The CEO is unwilling to share with stockholders because
it would also help competitors. In such a case, withholding information from stockholders
may be in their best interests. More generally, the CEO, involved in the day-to-day running
of the company, is bound to have an information advantage over stockholders. Likewise, the
CEO’s subordinates may well have an information advantage over the CEO with regard to
the resources under their control.
The information asymmetry—between principal and agents—is not necessarily a bad
thing. However, it can make it difficult for principals to measure how well an agent is
performing and thus hold the agent accountable for how he or she is using the entrusted
resources. There is a certain amount of performance ambiguity inherent in the relationship:
the principal cannot know for sure if the agent is acting in his best interest. They cannot know
for sure if the agent is using resources effectively and efficiently. To an extent, the principal
has to trust the agent to do the right thing. Of course, this trust is not blind: principals do put
mechanisms in place to evaluate performance and, if necessary, to take corrective action. As
we shall see shortly, the board of directors is one such mechanism; for, in part, the board exists
to monitor and evaluate senior managers on behalf of stockholders. Other mechanisms serve
a simpler purpose. In the United States, the requirement—that publicly owned companies
regularly file details of financial statements with the Securities and Exchange Commission
(SEC) that are in accordance with generally agreed accounting principles (GAAP)—exists to
give stockholders consistent and detailed information.
Senior managers are often motivated by the desire for status, power, job security and
income. By virtue of their position, within the company, certain managers—such as the
CEO—can use their authority and control over corporate funds at the cost of returns to
stockholders. CEOs might use their position to invest corporate funds in various perks that
enhance their status-executive jets; lavish offices; and expense-paid trips to exotic locations,
rather than investing those funds in ways that increase stockholder returns. Economists have
termed such behaviour on-the-job-consumption Besides engaging in on-the-job-consumption,
CEOs, along other senior managers, might use their influence or control over the board of
directors to get the compensation committee of the board to grant pay increases. The agency
problem is not confined to the relationship between senior managers and stockholders. It
can also bedevil the relationship between the CEO and subordinates. Confronted with the
possibility of the agency problem the challenge for principals is to: (i) shape the behaviour
of agents so that they can act in accordance with the goals set by principals; (ii) reduce the
information asymmetry between agents and principals ; and (iii) develop mechanisms for
removing agents who do not act in accordance with the goals of principals. Principals try to
deal with these challenges through a series of governance mechanisms.
GOVERNANCE MECHANISMS
Governance mechanisms help align incentives between principals and agents and to monitor
and control agents. The purpose—of governance mechanisms—is to : (i) reduce the scope and
frequency of the best agency problems; and (ii) to help ensure that agents act in a manner that
is consistent with the best interests of their principles. In this section, the primary focus is on
the governance mechanisms that exist to align the interests of senior managers (as agents)
with their principals (stockholders). It should not be forgotten, that governance mechanisms
also exist to align the interests of business unit managers with those of their superiors and
so on down within the organisation.
THE BOARD OF DIRECTORS

Both the Birla Committee Report and the CII Code, which have underscored the role of the
Board of Directors in ensuring good corporate governance, have recommended that the
Board of Directors should have an optimum combination of executive and non-executive
directors. The non-executive directors should comprise at least 30 per cent of the Board if
one of them is the Chairman. The non-executive directors should comprise at least 50 per
cent of the Board if the Chairman and the Managing Director is the same person. The Birla
Committee has also laid down that this minimum number of executive directors should also
be independent. (Independent directors are directors who, apart from receiving director’s
remuneration, do not have any other material pecuniary relationship or transactions with
the company, its promoters, its management, or its subsidiaries. This is so because, in the
judgment of the board, it may affect their independence of judgment. Further, all pecuniary
relationships, or transactions of the non-executive directors, should be disclosed in the annual
report). This is a mandatory recommendation. The Birla Committee has also suggested that,
in principle, the chairman’s role should be different from that of the CEO’s. The Committee
has also recommended that when a nominee, of the institutions, is appointed as a director
of the company, he should have the same responsibility; be subject to the same discipline;
and be accountable to the shareholders in the same manner as any other director of the
company would be.
The CII Code has also laid down that no individual should be a director on the boards
of more than 10 companies at any given time; non-executive directors should be active
and should have defined responsibilities. He should be conversant with P&L accounts of
the organisation. Directors—who have not been present for at least 50 per cent of Board
meetings—should not be re-appointed. The Board should be informed of: (i) operating plants
and budgets; (ii) long–term plans; (iii) quarterly divisional results; and (iv) internal audit
reports. Details—of defaults; payments for intangibles; foreign exchange exposure; and
manager’s remuneration—should be reported to the Board.
The board of directors is the centerpiece of the corporate governance system in the United
States and the United Kingdom. Board members are directly elected stockholders and, under
corporate law, they represent the stockholder’s interests in the company. Hence the board can
be held legally accountable for the company’s actions. Its position—at the apex of decision
making within the company—allows it to monitor corporate strategy decisions and ensure
that they are consistent with stockholder interests. If the sense is that corporate strategies
are not in the best interest of stockholders, it can apply sanctions such as: voting against
management nominations to the board of directors or submitting its nominees. In addition,
the board has the legal authority to compensate corporate employees, including, most
importantly, the CEO. The board is also responsible for making sure that audited; financial
statements of the company present a true picture of its financial situation. Thus, the board
exists to reduce the information asymmetry and to monitor and control management action
on behalf of stockholders.
The typical board of directors is composed of a mix of inside and outside directors. Inside
directors are senior employees of the company, such as the CEO. They are required on the
board because they have valuable information about the company’s activities. Without such
information, the board can not adequately perform its monitoring function. But because
insiders are full-time employees of the company, their interests tend to be aligned with
those of management. Hence, outside direction is not needed to bring objectivity to the
monitoring and evaluation processes. Outside directors are not full-time employees of the
company. Many of them are full-time professional directors who are on the boards of several
companies. The need to maintain a reputation as competent directors who can perform their
tasks as objectively and effectively as possible.
Critics of the existing governance system allege that inside directors often dominate the
outsiders on the board. Insiders can use their position—within the management hierarchy—
to exercise control over what kind of company-specific information the board receives.
Consequently, they can present information in a way that puts them in a favorable light. In
addition, insiders have the advantage of intimate knowledge of the company’s operations
and—because of their superior knowledge and control over information—are in a better
position to influence boardroom decision-making. The board may become the captive of
insiders and may come up with merely rubber-stamp management decisions instead of
guarding stockholder interests.
Some observers contend that many boards are dominated by the company CEO,
particularly when the CEO is also the chairperson of the board. To support this view, they
point out that both inside and outside directors are often the personal nominees of the CEO.
The typical inside director is subordinate to the CEO in the company’s hierarchy and therefore
unlikely to criticize the boss. Because outside directors are frequently the CEO’s nominees as
well, they can hardly be expected to evaluate the CEO objectively. Thus, the loyalty of the
board may be biased toward the CEO, not the stockholders. Moreover a CEO—who is also
chairperson of the board—may be able to control the agenda of board discussions in such a
manner as to deflect criticism.
Today, there are clear top signs that many corporate boards are moving away from merely
rubber-stamping top management decisions and are beginning to play a much more active
role in corporate governance. Examples include: Compaq Computer; Digital Equipment;
General Motors; IBM; and Sunbeam. Another trend of some significance is the increasing
tendency for outside directors to be made chairs of the board. By the late 1990s, according
to estimates from the National Association of Corporate Directors, 40 to 50 per cent of big
companies had an outside director as chairperson. Such appointments limit the ability of
corporate insiders and particularly of the CEO, to exercise control over the board. It is notable
that the removal of Robert Stempel, as the CEO of General Motors in the 1990s, followed
the appointment of an outside director, John Smale, as chairperson of the GM board. Still,
when all is said and done, it must be recognised that boards of directors do not work as
well as they should and other mechanisms are need to align the interests of stockholders and
managers.
Stock-based Compensation
According to agency theory, one of the best ways—to reduce the scope of the agency problem—
is for principals to establish incentives—for agents to behave in their best interest—through
pay-for-performance systems. In the case of stockholders and top managers, stockholders
can encourage top managers to purchase strategies that maximise a company’s long-run
ROIC and thus the gains, from holding it stick, by linking the pay of those managers to the
performance of the stock price.
The most common pay-for-performance system has been to give managers stock options
and the right to buy the company’s shares at a pre-determined (strike) price at some point
in the future, usually within ten years of the grant date. Typically, the strike price is the price
that the stock was trading when the option was originally granted. The idea—behind stock
options—is to motivate managers to adopt strategies that increase the share price of the
company. In doing so, they will also increase the value of their own stock options. Many top
managers often earn bonuses from exercising stick option that were granted several years
previously. While not denying that these options do motivate managers to improve company
performance, critics claim that they are often too generous. A particular cause for concern is
that stock options are often placed at such low stricken prices, that the CEO can hardly fail to
make a significant amount of money, even if the company under-performs the stock market
by a significant margin. Other critics, including the famous investor Warren Buffet, complain
that huge stock option grants increase the outstanding number of shares in a company and
therefore dilute the equity of stockholders. Accordingly, they should be shown—in company
accounts—as an expense against profits. However, under current accounting regulations,
stock options—unlike wages and salaries—are not expensed. Buffett has noted that when
his investment company, Berkshire Hathaway, acquires an options-issuing company, we
promptly substitute a cash compensation plan—having an option-issuing company—with
one that has an economic value equivalent to that of the previous option plan. The acquirer’s
true compensation cost is therefore brought out of the closet and charged, as it should be,
against earning.
The shareholders are the owners of the company and as such they have certain rights
and responsibilities. A good corporate framework is one that provides adequate avenues for
effective contribution in the governance of the company, while insisting on a high standard
of corporate behaviour, without getting involved in the day-to-day functioning of the
company.
The Committee has observed that the General Body Meetings provide an opportunity—to
the shareholders—to address their concerns to Board of Directors and comment on and
demand any explanation on the annual report, or on the overall functioning of the company.
It is important that the shareholders use the forum—of general body meetings—for ensuring
that the company is being properly powered for maximising the interests of the shareholders.
This is important especially in the Indian context. It follows that, for effective participation,
shareholders must maintain decorum during the General Body Meetings.
Strategy in Action
Corporate Governance at General Motors

In 1915, the Treasurer of the DuPont Company, Jacob J. Raskob, persuaded Pierre S. du Pont to buy 2,000
shares of a fledgling company called General Motors (GM). Raskob had been interested in the motor vehicle
industry for some years, believing that it would enjoy enormous growth when life settled down after the
war.
General Motors at this time was a motley grab-bag of small companies including Buick, Cadillac,
Oldsmobile, and Oakland, which later became Pontiac. The companies were joined only by the fact that
they had been bought by GM’s founder, the visionary but unpredictable William Crapo Durant. Durant,
at one time a highly successful carriage engineer, had been acquiring small motor companies and parts
manufacturers since 1904. By 1914, GM was the second largest automaker in the country, though admittedly
a very distant second to the mighty Ford.
Pierre du Pont’s personal investment of 2,000 shares proved bountiful. By December 1915, the shares
that du Pont had bought for $82 had shot up to $558. The rise did not reflect GM’s growth so much as the
massive industrial expansion generated by the war effort. However, the rapid increase in value was enough
to persuade du Pont that he had stumbled on a very promising business. In 1915, Pierre du Pont joined GM’s
board, unofficially as chairman. (In line with convention, we will refer to the company as DuPont, and the
person as du Pont.)
In fact, GM was dogged by uncertainty; mismanagement constantly threatened to throw the company
into bankruptcy. Durant was regarded by contemporaries as too much of a genius to be a successful
businessman. GM’s headquarters consisted only of Durant, a few assistants and a handful of secretaries,
so that Durant had neither the time nor the resources to exert central control. Moreover, he planned only
on the basis of ever-increasing sales producing consistently improving cash flow so that even the slightest
recession could leave Durant unable to pay his workers or suppliers. In 1910, such a drop had left GM close
to collapse. The company was only rescued by the infusion of a $15 million loan from Durant’s bankers, who
assumed control of the company as collateral. In 1915, with GM’s stock price booming once again, Durant
set out to reclaim his company from the banks. By April 1915, Durant had been able to buy 50 percent of
General Motors stock via a series of hastily constructed deals. Durant claimed that he had the support of du
Pont – an assertion that Pierre read with astonishment in his Delaware newspaper.
Pierre du Pont agreed to serve as chairman because he wished to protect his investment. While he
admired Durant’s drive and imagination, he believed him to be financially haphazard and without discipline.
He wished to impose some of the rigorous financial controls and committee structures that characterized
Pierre’s own DuPont Company. Durant had other ideas; he wanted du Pont’s financial backing, but not
his advice. In the words of business historian, Alfred Chandler, Durant “had no intention of working with
his board. He considered it merely a paper organisation, that he had to have to meet legal requirement
and accepted business practices. The founder, who had regained his company, was going to run it by
himself.”[i]
Durant contemplated a five-man board, a three-man executive committee, and no finance committee.
Raskob and du Pont refused, believing that strict financial control was the only thing that could prevent
Durant from running amok. They insisted on a large board, with both financial and executive committees.
Not that this rendered Durant accountable. As Chandler writes,“The meetings of the board itself were called
only on the shortest notice and then at the initiation of the president, not the chairman.”[ii] The result was
constant friction between du Pont and Durant. Pierre demanded monthly balance sheets to be presented
to the finance committee, but often didn’t receive them. He insisted that Chevrolet be merged with the GM
parent to sort out some of the financial tangle that existed between the two companies and to create an
ordered, single corporation. Durant gave in reluctantly.
Source: http://www.gminsidenews.com/forums/f12/corporategovernance-case-study-general-motors-28392/, last
accessed on 15 April 2012.
FINANCIAL STATEMENTS AND AUDITORS

The Birla Committee has made some recommendations with a view to upgrade the financial
reporting and accounting standards in India. Accordingly, companies are required to give
consolidated accounts—in respect of all its subsidiaries—in which they hold 51 per cent
or more of the share capital. Equally, in cases of companies with several businesses, it is
important that financial reporting—in respect of each product segment—should be available
to shareholders and to the market to obtain a complete financial picture of the company. The
Institute of Chartered Accountants of India is requested to issue the Accounting Standards
for consolidation expeditiously. Disclosure and treatment—of related party transactions
norms—are also to be finalised by the ICA.
Publicly trading companies—in the United States—are required to file quarterly and
annual reports with the SEC that are prepared according to GAAP. The purpose of this
requirement is to give consistent, detailed and accurate information about how efficiently
and effectively managers are running the company. To make sure that managers do not
misrepresent this financial information, the SEC also requires that the accounts be audited
by an independent and accredited accounting firm. Similar regulations exist in most other
developed nations. If the system works as intended, stockholders can have a lot of faith that
the information, contained in financial statements, accurately reflects the state of affairs of
a company. Among other things, such information can enable a stockholder to calculate the
profitability (ROIC) of a company and compare its ROIC against that of competitors.
Unfortunately, in the United States at least, this system has not been working as intended.
Although the vast majority of companies do file accurate information in their financial
statements and although most auditors do a good job of reviewing that information, there
is substantial evidence that a minority of companies have abused the system, added in
part, by the compliance of auditors. This was clearly an issue at Enron, where the CEO and
others misrepresented the true financial state of the company by creating an off-balance-sheet
partnership that hid the true state of Enron’s indebtedness from pubic view.
There have been numerous examples in recent years of managers gaming financial
statements to present a distorted picture of their company’s finances to investors. The typical
motive has been to inflate the earnings or revenues of a company, thereby generating investor
enthusiasm and propelling the stock price higher. The gaming of financial statements—by
companies such as Enron and allegedly Computer Associates—raises serious questions about
the accuracy of the information contained in audited financial statements. Clearly, there may
be need for reform here to tighten up regulations. For example, the regulations—that allow
companies to accumulate debt off-balance sheet in special-purpose entities—is clearly open to
abuse, as the Enron debacle proves. Also, the auditors are apparently not always doing their
job. An explanation can be found in the conflict of interest that many auditing companies
face. Many big accounting firms—in addition to an audition business—also have a lucrative
consulting business with the very companies whose accounts they are required to audit
in an impartial fashion. Finally, the proliferation of accounting problems raises questions
about how well boards of directors are discharging their fiduciary duty to stockholders. It
is the board that appoints the auditors and is meant to ensure that the auditors are through.
The problem is that many boards are dominated by insiders and when that is the case, the
independence of the board can well be questioned. Clearly, fixing this problem requires the
establishment of boards that are dominated by outside members and where the chairperson
of the board is not a company insider.
The Takeover Constraint

Given the imperfections in corporate governance mechanisms, it is clear that the agency
problem may still exist in some companies. However, stockholders still have some residual
power for they can always sell their shares. If they start doing so in large numbers, the price
of the company’s shares will decline. If the share price falls far enough, the company might
be worth less on the stock market than the book value of its assets. At this point, it may
become an attractive acquisition for target and runs. The risk of being purchased by another
enterprise,—against the wishes of the target company’s management—will always exist.
The risk—of being acquired by another company—is known as the takeover constraint.
The takeover constraint limits the extent to which managers can pursue strategies and
actions that place their own interests above those of stockholders. If they ignore stockholder
interests and the company is acquired, senior managers typically lose their independence
and probably their jobs as well. So the threat of takeover can constrain management action
and limit the worst excesses of the agency problem.
During the 1980s and early 1990s, the threat of takeover was often enforced by corporate
raiders: individuals or corporations pursuing strategies inconsistent with maximising
stockholder wealth. Corporate raiders argue that these under-performing companies could
create more wealth for stockholders if they pursue different strategies. Raiders buy stock in a
company either to take over the business and run it more efficiently, or to precipitate a change
in the top management, replacing the existing team with one more stockholder returns.
Raiders are motivated not by altruism but by gain. If they succeed in their takeover bid,
they can institute strategies that create value for stockholders, including themselves. Even if
a takeover bid fails, raiders can still earn millions. Stockholders will typically be bought out
by the defending company for a hefty premium. Called greenmail, this source of gain threat
posed by raiders, has had a salutary effect on enterprise performance by pushing corporate
management to run their companies better. Others claim there is little evidence of this.
Although the incidence—of hostile takeover bids—has fallen off significantly since the
early 1990s, this should not be taken to imply that the takeover constraint is no longer
likely to excite hostile takeovers. The boom years, of the 1990s, left many corporations with
excessive debt (corporate America entered the new century with record levels of debt on its
balance sheets). This limits the ability of companies to finance acquisitions, particularly hostile
acquisitions, which are often particularly expensive. In addition, the market valuations of
many companies got so out of line—with underlying fundamentals during the stock market
bubble of the 1990s—that even after a substantial fall in certain segments of the stock market,
such as the technology sector, valuations are still high relative to historic norms, making the
hostile acquisition—of even poorly run and unprofitable companies—expensive. However,
takeovers tend to go in cycle and it seems likely that once excesses are worked out of the
stock market and the corporate balance sheet, the takeover constraint will begin to reassert
itself. It should be remembered that the takeover constraint is a governance mechanism of
the last resort and is often invoked only when other governance mechanisms have failed.
GOVERNANCE MECHANISMS INSIDE A COMPANY

So far this section has focused on the governance mechanisms designed to reduce the agency
problem that potentially exists between stockholders and managers. Agency relationships
can thus arise between levels of management. In this section, we will explore how the agency
problem can be resolved through two complementary governance mechanisms to align the
incentives and behaviour of employees with those of upper-level strategic control systems
and incentive systems.
Strategic control systems

Strategic control systems are the primary governance mechanisms established within a
company to reduce the scope of the agency problem between levels of management. These
systems are the formal target setting, measurement and feedback systems that allow managers
to evaluate a company’s execution of the strategies necessary to maximise its long-run ROIC.
Also, it helps gauge: superior efficiency; quality; innovation; and customer responsiveness.
The purpose of strategic control systems is to: (i) establish standards and targets against
which performance can be measured; (ii) create systems for measuring and monitoring
performance on a regular basis; (iii) compare actual performance against established targets;
and (iv) evaluate results and take corrective action if necessary. In governance terms, their
purpose is to make sure that lower-level managers—the agents who maximise the wealth of
stockholders—be made subject to legal, ethical constraints. Based on an organisation’s mission
and goals, strategic managers develop a set of strategies to build competitive advantage
to achieve these goals. They then establish an organisation structure to use resources to
obtain a competitive advantage. Performance measures how well the four building blocks
of competitive advantage are being achieved.
• Efficiency can be measured by: the level of production costs; the productivities of
labour (such as the employee hours needed to make a product) ; the productivity of
capital (such as revenues per dollar invested in property, plant and equipment); and
the cost of raw materials.
• Quality can be measured by: the number of rejects; the number of defective products
returned from customers; and the level of product reliability over time.
• Innovation can be measured by: the number of new products introduced; the
percentage of revenues generated from new products in a defined period; the time
taken to develop the next generation of new products versus the competition; and
the productivity of R&D (i.e. how much R&D spending is required to produce a
successful product).
• Responsiveness to Customers can be measured by: the number of repeat customers;
customer defection level; on-time delivery to customers; and level of customer
service.
Employee incentives
Control systems alone may not be sufficient to align incentives among stockholders, senior
management and the rest of the organisation. To help do this, positive incentive systems are
often put into place to motivate employees to work toward goals that are central to maximising
long-run ROIC. As already noted, employee stock ownership plans (ESOP) are one from of
positive incentive, as are stock option grants. In the 1990s, ESOPs and stock ownership grants
got pushed down deep within many organisations. At Microsoft, for example, all full-time
employees receive stock options. The number of options they receive is determined by their
performance evaluation in the previous year. In addition, all full-time employees are eligible to
enroll in the company’s ESOP. The logic behind such systems is straightforward: recognising
that the stock price and, therefore, their own wealth is dependent on the profitability of the
company; employees will work toward maximising profitability.
In addition to stock-based compensation systems, employee compensation can also
be linked to the attainment of superior efficiency; quality innovation; and customer
responsiveness. For example, the bonus pay—of a manufacturing employee—might depend
on attaining quality and productivity targets which, if reached, will lower the cost of the
company; increase customer satisfaction; and boost the ROIC. Similarly, the bonus pay—of
a salesperson—might be dependent on surpassing sales targets; and, of an R&D employee,
on the success of new products.
ROLE OF B.O.D IN CORPORATE GOVERNANCE

A corporation is a mechanism established to allow different parties to contribute capital,
expertise and labour for their mutual benefit. The investor/shareholder participates in the
profits of the enterprise without taking responsibility for the operations. Management runs the
company without being responsible for personally providing the funds. To make this possible,
laws have been passed so that shareholders have limited liability and, correspondingly,
limited involvement in a corporation’s activities. That involvement does include, however,
the right to elect directors who have a legal duty to represent shareholders and protect
their interests. As representatives of shareholders, directors have both the authority and the
responsibility to establish basic corporate policies and to ensure that they are followed.6
The board of directors has, therefore, an obligation to approve all decisions that might
affect the long-run performance of the corporation. This means that the corporation is
fundamentally governed by the board of directors, with the concurrence of the shareholder.
The term “corporate governance” refers to the relationship among these three groups in
determining the direction and performance of the corporation.7
Over the past decade, shareholders and various interest groups have seriously questioned
the role of the board of directors in corporations. They are concerned that outside board
members often lack sufficient knowledge, involvement and enthusiasm to do an adequate
job of providing guidance to top management. For example, when officials of the California
Public Employees’ Retirement System – a key shareholder group – criticized IBM’s board
of directors, in the early 1990s, for not doing more to prevent the company’s down trend in
earnings, the four outside members of the board’s executive committee admitted that they
did not know enough about the company’s business to properly evaluate management.
Like IBM’s top management, they had missed the trend away from mainframe computers
to personal computers. Board members actually admitted, in the meeting, that none of them
felt comfortable using a personal computer. According to one director, “Not one of us has a
PC in our home or office.”8
But, today, there are clear signs that many corporate boards are moving away from merely
rubber-stamping top management decisions and are beginning to play a much more active
role in corporate governance.
RESPONSIBILITIES OF THE BOARD

According to Laws and Standard, the responsibilities—of boards of directors—vary from
country to country. For example, board members in Ontario, Canada, face more than 100
provincial and federal laws governing director’s liability. The United States, however, has no
clear national standards or federal laws. Specific requirements of directors vary, depending
on the state in which the corporate charter is issued. There is, nevertheless, a development
worldwide consensus concerning the major responsibilities of a board. Interviews—with
200 directors from eight countries (Canada, France, Germany, Finland, Switzerland, the
Netherlands, United Kingdom and Venezuela)—revealed strong agreement on the following
five broad director responsibilities, listed in order of importance:
1. Setting corporate strategy, overall direction, mission or vision;

2. Hiring and firing the CEO and top management;
3. Controlling, monitoring, or supervising top management;
4. Reviewing and approving the use of resources; and
5. Caring for shareholder interests.9
Directors, in the United States, must ensure management’s adherence to laws and
regulations such as those dealing with: the issuance of securities; insider trading; and
other conflict-of-interest situations. They must also be aware of the needs and demands of
constituent groups so that they can achieve a judicious balance—among the interests of these
diverse groups—while ensuring the continued functioning of the corporation.
In a legal sense, the board is required to direct the affairs of the corporate but not to
manage them. It is charged by law to act with due care, or due diligence. If a director, or the
board as a whole, fails to act with due care and, as a result, the corporation is in some way
harmed, the careless director, or board, can be held personally liable for the harm done. This
is not a small concern. A recent survey—of outside directors—revealed that more than 40 per
cent have been named as part of a lawsuit against the corporate.10
ROLE OF THE BOARD IN STRATEGIC MANAGEMENT

The board of directors—in strategic management—should carry out three basic tasks:
• Monitor: By acting through its committees, a board can keep abreast of development
inside and outside the corporation; and bring to the management’s attention the
developments it might have overlooked;
• Evaluate and influence: A board can examine: management proposals, decisions and
actions; agree or disagree with them; give advice and offer suggestions; and outline
alternatives. More active boards perform this task in addition to that of monitoring;
and
• Initiate and determine: A board can delineate a corporation’s mission and specify
strategic options. Only the most active boards take on this task in addition to the two
previous ones.
Organisation of the Board

The size of the board is determined by the corporation’s charter and its by-laws in compliance
with state laws. Although some states require a minimum number of board members, most
corporations have a bit of discretion in determining board size. The average large, public
firm has around 11 directors. The average small/ medium size, privately-held company has
approximately 7-8 members.
In 1995, 68 per cent of the top executives of large, U.S. public-held corporations held
the dual designation of chairman and CEO; a drop from 72 per cent in the previous year.
(The percentage of firms having the Chair/CEO position—combined in Canada and the
United Kingdom—is 43 per cent and 20 per cent respectively.)11 The combined Chair/CEO
position is being increasingly criticized because of its potential for conflict of interest. The
CEO is supposed to concentrate on strategy, planning, external relations and responsibility
to the board. The chairman’s responsibility is to ensure that the board and its committees
perform their functions as stated in the board’s charter. Further, the chairperson schedules
board meetings and presides over the annual shareholder meetings. Critics—of combining
the two officers in one person—ask how the board can properly oversee top management
if the chairperson is also the top management. For this reason, the chairperson and CEO
roles are separated by law in Germany, the Netherlands and Finland. A similar law is being
considered in Britain and Australia. The majority of research does suggest that firms—that
separate the two positions—financially outperform those firms that don’t. However, some
studies have found no significant difference—in operating performance—on the basis of role
demarcation.12
Many of those—who prefer that the chairperson and CEO positions be combined—do
agree that the outside directors should elect a lead director. This person would need to
be consulted by the Chair/CEO regarding board affairs and would coordinate the annual
evaluation of the CEO. The lead director position is very popular in the United Kingdom,
where it originated. Of those U.S. companies, combining the chair and CEO positions, 27 per
cent currently have a lead director. This is one way to give the board more power without
undermining the power of the Chair/CEO.
The most effective boards accomplish much of their work through committees. Although
they do not usually have legal duties, most committees are granted full power to act with the
authority of the board. Typically standing committees are the: executive; audit; compensation;
finance; and nominating committees. The executive committee is formed from local directors
who can meet between board meetings to attend to matters that must be settled quickly. This
committee acts as an extension of the board and, consequently, may have almost unrestricted
authority in certain areas.
TRENDS IN CORPORATE GOVERNANCE

The role of the board of directors—the strategic management of the corporations—is likely
to be more active in the future. The change will probably be more evolutionary than radical
or revolutionary. Different boards are at different levels of maturity and will not be change
in the same direction, or at the same speed.
Some of today’s trends in governance that are likely to continue include:
• Shareholders are demanding that directors and top managers own more than token
amounts of stock in the corporation. Stock is increasingly being used as part of a
director’s compensation;
• As corporations become more global, they will increase international directors to their
boards;
• Institutional investors—such as pension funds, mutual funds and insurance
companies—are becoming active on boards and are putting increasing pressure on
top management to improve corporate performance. For example, the California
Public Employees’ Retirement System, the largest pension system in the United
States, annually publishes a list of poorly performing companies, hoping to embarrass
management into taking remedial action;
• Outside, or non-management directors, are increasing their numbers and power in
publicly-held corporations as CEOs loosen their grip on boards. Outsiders are now
taking change of annual CEO evaluations;
• Boards will continue to take more control of board functions by either splitting the
combined Chair/CEO into two separate positions or establishing a lead outside
director position; and
• Society, in the form of special interest groups, increasingly expects boards of directors
to balance the economic goals of profitability with the social needs of society. Issues—
dealing with work-force diversity and the environment—are now reaching the board
level. For example, the board of Chase Manhattan Corporation recently questioned
top management about its efforts to improve the sparse number of women employees
and minorities in senior management.13
Although many CEOs are resisting such issues, the battle is only just beginning.
COMMITTEE ON CORPORATE GOVERNANCE IN INDIA

In the 1960s, India veered towards a distinct socialist path, building a dense thicket of
regulations and bureaucratic oversight that came to be called as the License Raj. This policy
proved economically disastrous and a period of slow de-regulation began in the mid-1980s.
Much of it took place during the 1990s, as India began to attract large amounts of foreign
capital. The corporate world in India could not remain indifferent to the growing issue of
corporate governance. In fact, the developments in UK had tremendous influence on Indian
thinking on corporate governance.
The collapse of Soviet Union and the thrust given to globalisation—in the wake of the
emergence of the World Trade Organisation—also helped the movement of capital. This
meant that better and more uniform corporate governance protocols were needed. The pace
of movement—of financial capital—has become greater because of the pervasive impact of
information technology and the world having become a global village. When investments
take place in emerging markets, investors want to be sure that—not only are the capital
markets, or enterprises with which they investing run competently—they also have corporate
governance.
The qualitative improvement—in corporate governance in India—is based on a code of
good corporate practices that refer to meaningful disclosures of information to shareholders.
This, in fact, holds the key to corporate success. Such a framework is necessary in the context
of changing the profile of corporate ownership. Increasing foreign investment—and the
preferential allotment of shares to company—promotes the new role of mutual funds. Legal
and financial obligations and adherence to ecological and environment standards play a
contributing role. The concept—of such governance—must accrue to investors, customers,
leaders of finance and society at large. In the following paragraphs, we will be discussing
some of the committees and groups that have studied and recommended various steps in
governance.
Working Group on Companies Act 1996

It has been felt necessary to completely re-write the Companies Act in the light of: (i) the
modern day requirements of the corporate sectors; (ii) the aspirations of investors; and
(iii) the globalisation and lubrication economy. The government set up a working group, in
August 1996, for this purpose.
The working group—on the Companies Act—has recommended a number of changes
and also prepared a working draft of the Companies Bill 1997. The bill was introduced in
the Rajya Sabha on 14 August 1997.
Initiative by Confederation of Industry

In 1996, the CII took a special initiative following public concern over: (i) protection of
investors’ interest, especially of the small investor; (ii) the promotion of transparency within
business and industry; (iii) the need to move towards international standards in terms of
disclosure of information by the corporate sector; and (iv) to develop a high level of public
confidence in business and industry.
SEBI Initiatives
The Securities and Exchange Board of India (SEBI) appointed a committee on corporate
governance in 1999 with a view to promoting and raising the standards of corporate
governance. It made particular reference to the following:
• Amending the listing agreement to improve the standards of corporate governance in
listed companies in areas such as: (i) continuous disclosure of material information,
both financial and non-financial; (ii) manner and frequency of such disclosures; and
(iii) the responsibility of independent and out rectors;
• Drafting a code for corporate best practices; and
• Suggesting safeguards—to be instituted within companies—to deal with insider
information and inside trading.
Exhibit 9.3
Clause 49 of the Listing Agreement

The term ‘Clause 49’ refers to clause number 49 of the Listing Agreement between a company and the
Stock Exchanges on which it is listed. The Listing Agreement is identical for all Indian Stock Exchanges,
including the NSE and BSE. This clause is a recent addition to the Listing Agreement and was inserted as late
as 2000 consequent to the recommendations of the Kumar Mangalam Birla Committee on CG constituted
by SEBI in 1999. Clause 49, when it was first added, was intended to introduce some basic CG practices in
Indian companies and brought in a number of key changes in governance and disclosures (many of which
we take for granted today). In late 2002, the SEBI constituted the Narayana Murthy Committee to “assess
the adequacy of current corporate governance practices and to suggest improvements.” Based on the
recommendations of this committee, SEBI issued a modified Clause 49 on October 29, 2004 (the ‘revised
Clause 49’) which came into operation on January 1, 2006.
Revised Clause 49 of the Listing Agreement in India requires all listed companies to file every quarter a
CG report. According to SEBI guidelines, “The key mandatory features of Clause 49 regulations deal with the
followings: composition of the board of directors, the composition and functioning of the audit committee,
governance and disclosures regarding subsidiary companies, disclosures by the company, CEO/CFO
certification of financial results, and reporting on CG as part of the Annual Report.” Moreover, Clause 49 also
requires companies to provide “specific” corporate disclosures of the followings: related-party transactions,
disclosure of accounting treatment, if deviating from Accounting Standards, risk management procedures,
proceeds from various kinds of share issues, remuneration of directors, management discussion and
analysis section in the annual report discussing general business conditions and outlook, and background
and committee memberships of new directors, as well as, presentations to analysts. In addition, a board
committee, with a non-executive chair, is required to address shareholder or investor grievances. Finally,
share transfer, a long-standing problem in India, must be done expeditiously (Patel,2006). The revised Clause
49 has suitably pushed forward the original intent of protecting the interests of investors through enhanced
governance practices and disclosures. The revised Clause 49 moves further into the realm of global best
practices (and sometimes, even beyond). In this connection, Chakrabarti (2008) very aptly commented
as: “Similar in spirit and scope to the Sarbanes-Oxley measures in the USA, Clause 49 has clearly been a
milestone in the evolution of CG practices in India.” It is now mandatory for the Indian listed companies to
file with the SEBI, the CG compliance report, shareholding pattern along with the financial statements.
Sources: http://220.227.161.86/10980dec04p806-811.pdf Last accessed on 5 July .2012.
Naresh Chandra Committee Report, 2006

1. Auditor-company relationship;
2. Disqualification for audit assignments;
3. List of prohibited non-audit services;
4. Independence standards for consulting;
5. Compulsory audit partner rotation;
6. Auditors disclosure of contingent liabilities;
7. Management’s contribution in the event of auditor replacement;
8. Auditor annual certification of independence;
9. Certification of annual audited accounts by CEO and CFO;
10. Setting up independent quality review boards;
11. Audit committees.
Narayana Murthy Committee Report 2003

This was set up by SEBI under Infosys founder Narayana Murthy. Its terms of reference
were as follows:
1. To review the performance of corporate governance; and
2. To determine the companies in responding to run-over and other price-sensitive
information, circulating in the market, in order to enhance the transparency and
integrity of the market.
J.J. Iraniu Committee Report on Company Law, 2005

The Government of India established this expert committee on company law to make
recommendations on the following:
1. Responses received from various shareholders;
2. Issues arising out of revision of Companies Act 1956;
3. Enabling easy and unambiguous interpretation by re-casting provision of law; and
4. Protecting investor interests.
Thus, implementation of corporate governance has depended upon laying down explicit
codes which enterprises and organisations are meant to observe.
An outline—provided by the CII—was given a concrete shape in the Birla Committee
Report of SEBI. Note that SEBI implemented the recommendations of the Birla Committee
through the enactment of Clause 49 of the Listing Agreements. They were: (i) committee
companies in the BSE 200 and S&P CNX Nifty indices; (ii) all newly-listed companies on
31 March 2001; (iii) companies with a paid-up capital of Rs 100 million or with a net worth
of ` 250 million at any time in the past five years as of 31 March 2002; and (iv) other listed
companies with a paid up capital of over ` 30 million on 31 March 2003.
The Narayana Murthy Committee worked on further refining the rules of SEBI. The
recommendations also showed that much of the thrust—in Indian corporate governance
reform—has been on the role and composition of the Board of Directors and the disclosure
leas. The Birla Committee, however, paid much-needed attention to the subject of share
transfers, which is the Achilles heel of shareholder rights in India. The corporate governance
structure specifies the relations and the distribution of rights and responsibilities among
primarily three groups of participants: the board; managers; and shareholders. This system
spells out the rules and procedures for making corporate affairs decisions and also provides
the structure through which the company’s objectives are set as well as the means of attaining
and monitoring the performance of those objectives The Birla Committee Report is the first
formal and comprehensive attempt to evolve a Code of Corporate Governance in the context
of the prevailing conditions of governance in Indian companies, as well as the state of capital
markets. The Committee felt that some of the recommendations are absolutely essential for
the framework of corporate governance and virtually form its core, while others could well
be considered desirable. Besides, some of the recommendations may also need a change of
statute, such as the Companies Act, for their enforcement. In the case of others, enforcement
would be possible by amending the Securities Contracts (Regulation) Rules, 1957 and the
amending of the the listing agreement, of the stock exchanges, under the direction of SEBI.
The latter would be less time consuming and would ensure a speedier implementation of
corporate governance. The Committee therefore felt that the recommendations should be
divided into mandatory and non-mandatory categories.
Mandatory recommendations are those which are absolutely essential for corporate
governance; can be defined with precision; and can be enforced through the amendment of
the listing agreement. Others, which are either desirable, or which may require change of
laws, are, for the time being, classified as non-mandatory.
CRITICAL APPRAISAL OF CORPORATE GOVERNANCE IN INDIA

Indian business is dominated by traditional business houses that have had good practices
and their own pattern of doing business. Good initiatives by the Tata, Birla and Reliance
groups—the new generation of business houses and powerful corporations—have ushered in
more pressures in reporting and governance. The post-liberalisation period and subsequent
spurt in the growth of the IT sector have increased inflows of foreign capital and private
equity investment. There are now multiple groups with varying interests which focus on the
control mechanism and asset values; and new generation groups which focus on investment
protection and multi-stakeholder interests. This is likely to impact the dynamics of corporate
governance as there is an increase in knowledge in the open domain and a culture that tends
to absorb and implement successful developments occurring abroad.
There is a wide feeling that although there are good corporate governance codes/
guidelines, there is a poor adoption of the recommendations in many companies.
chakrkrabarti et al. (2008) mention that, while on paper, the country’ legal system provides
some of the best investor protection services in the world. The reality is different with slow,
over-burdened courts and wide-spread corruption. Consequently, ownership remains highly
concentrated and family business groups continue to be dominant business models. There
is significant pyramiding and tunneling in the inter-locking ownership structures of Indian
business groups, notwithstanding copious reporting requirements and widespread earning
management. However, most of India’s corporate governance shortcomings are no worse
than in other Asian countries. Its banking sector has one of the lowest proportions of non-
performing assets, signifying that corporate fraud and tunneling are not out of control.
On the other hand, based on their survey, Balasubramanian et al. (2008) have mentioned
that compliance with legal norms is reasonably high in most areas, but not complete. Indian
corporate governance rules appear appropriate for large companies but could use some
strengthening in the area of related party transactions. Also there is a view that the norms
may be relaxed for smaller companies. The study also concluded that there is a cross-
sectional relationship between measures of governance and firm performance and have
found evidence of a positive relationship for an overall governance index and for an index
covering shareholder rights.
Exhibit 9.4
Corporate Governance at Reliance is based on the following main principles:

• Constitution of a Board of Directors of appropriate composition, size, varied expertise and commitment
to discharge its responsibilities and duties.
• Ensuring timely flow of information to the Board and its Committees to enable them to discharge their
functions effectively.
• Independent verification and safeguarding integrity of the Company’s financial reporting.
• A sound system of risk management and internal control.
• Timely and balanced disclosure of all material information concerning the Company to all
stakeholders.
• Transparency and accountability.

• Compliance with all the applicable rules and regulations.
• Fair and equitable treatment of all its stakeholders including employees, customers, shareholders and
investors
Source: http://www.ril.com/html/abouts/corporate_governance.html Last accessed on 6 July 2012.
CORPORATE GOVERNANCE MODEL ACROSS THE WORLD

Although the US model of corporate governance is the most disused, it may be useful to
understand other models and major variations. The variations are triggered by investing
entities and their interests as in the complex shareholding structure of chaebols in South
Korea. However, the challenges are the same as those facing the U.S. model. In the U.S.,
the main problem is the conflict of interest between widely-dispersed shareholders and
powerful managers. Here, the agency problem could be more severe. In Europe, the main
problem is that the differing voting rights of ownership are tightly-held by families through
a pyramidal ownership and dual shares. Shares are classified as those with voting rights and
those without. Owners would influence decisions based on their personal interests rather
than the interest of stakeholders.
Anglo-American countries tend to give priority to the interests of shareholders. This is
commonly referred to as the liberal model of corporate governance. It encourages radical
innovation and cost competition. In the U.S, a corporation is governed by a board of directors,
which has the power to choose an executive officer who could be designated as chided
executive officer (CEO). The CEO has broad power to manage the corporation, on a daily
basis, on all operational issues. However, all major actions—such as fund raising; acquisition
of business; major capital expansion; or other expensive projects—require board approval.
The duties of the board would include policy decision making; monitoring management’s
performance; and corporate control.
In the U.S., companies are primarily regulated by the state in which are incorporated.
The federal government and stock exchanges would also have their share of regulatory
requirements. Typically, companies choose a comfortable regulatory framework and the
highest number of companies is incorporated in Delaware. This is due to Delaware’s generally
business-friendly corporate legal environment and the existence of a state court dedicated
solely to business issues.
The co-ordinated model is common in Continental Europe and Japan and recognises the
interests of workers, managers, suppliers, customers and the community in the corporate
governance framework. The co-ordinated model—of corporate governance—facilitates both
incremental innovation and quality competition.
Corporate governance principles and codes have been developed in different countries
and have been issued by stock exchanges with the support of governments and international
organisations. For example, companies—quoted on the London and Toronto stick exchanges—
need not follow the recommendations of their respective national codes. However, they must
disclose whether or not they follow recommendations in those documents and, where they
don’t, they should provide explanations concerning divergent practices. Though there is a
provision—for choice of the framework to be followed—much disclosure requirement exerts
a significant pressure on listed companies for compliance.
One of the most influential guidelines has been the 1999 OECD (Organisation for Economic
Cooperation and Development) principles of corporate governance. This was revised in 2004.
The OECD remains a proponent of corporate governance principles throughout the world.
Building on the work of the OECD, other international organisations and more than
20 national corporate governance codes—such as the United Nations inter-governmental
working group of experts on International Standards of Accounting and Reporting; disclosure
of the World Business Council for Sustainable Development (WBCSD)—have done extensive
work on corporate governance, particularly on accountability and reporting. In 2004, it
created an issue management tool: strategic challenges for business in the use of corporate
responsibility codes; standards; and frameworks.
Around the world, the Anglo-Saxon model is far from the norm. A truly global model of
corporate governance would need to recognise alternative concepts including:
• the networks of influence in the Japanese keiretsu;
• the governance of state-owned enterprises in China, where the China Securities
and Regulatory Commission (CSRC) and the state-owned Assets Supervision and
Administration Commission (SASAC) can ove-rride economic objectives. Acting in
the interests of the people, the party, and the state, to influence strategies, determine
prices and appoint chief executives;
• the partnership—between labour and capital—in Germany’s co-determination
rules;
• the financially-leveraged chains of corporate ownership in Italy, Hong Kong and
elsewhere;
• the power of investment block-holders in some European countries;
• the traditional powers of family-and state-owned companies in Brazil;
• the domination of spheres of listed companies in Sweden, through successive
generations of a family, preserved in power by dual-class shares;
• the paternalistic familial leadership in companies created throughout Southeast Asia
by successive Diaspora from mainland China;
• the governance power of the dominant families in the South Korean chaebol; and
• the need to overcome the paralysis of corruption from shop floor, through boardroom,
to government officials in the BRIC and other nations.
It may be observed that corporate governance focuses on transparency, objectivity and
protecting the interests of disclosures through a series of covenants on: disclosure; board
composition; and conduct of business by the board through executive management. There
are recommended and mandatory procedures depending upon the advances made by the
country’s business and legal systems. There are ethical factors which are more or less covered
by must do requirements of guidelines and corporate responses through corporate social
responsibility initiatives. Good governance ensures that all these are done and reported
objectively and transparently. The forces—for convergence in corporate governance—are
strong. At a high level of abstraction, some fundamental concepts have already emerged,
including: (i) the need for separate governance from management; (ii) the importance of
accountability to legitimate stakeholders; and (iii) the responsibility to recognise strategic
risk. These could be more widely promulgated and adopted. But a global convergence—of
corporate governance systems at any greater depth—would need a convergence of cultures
and that seems a long way away.
SUMMARY
The purpose—of Corporate Governance—is to ensure that an organisation should

run well. The underlying corporate governance is agency theory, which focuses on
the principal-agent relationship;
Agency problem occurs because of the conflict in self interest of these two parties;
and the international asymmetry that exists between shareholders and managers;
The major mechanisms of governance are: (i) a concentration of ownership; (ii) an
independent and competent board of directors; (iii) liking executive pay to performance
of the organisation; and (iv) the external threat of takeover if the performance of the
firm becomes bad. None of these mechanisms completely addresses the governance
challenges;
Corporate Governance is context specific and varies among the countries globally. In
India, which has a less dispersed ownership structure, the main problem in governance
is the protection of the rights of minority shareholder; major shareholder groups, in
India, are those of families. The Government and the multinational organisation want
to know in whose interest the organisation should be governed. We have examined
the shareholder value and stakeholder value perspectives;
With the recent spate of corporate scandals and the subsequent interest in corporate
governance, a plethora of corporate governance norms and standards have sprouted
around the globe. The Sarbanes-Oxley legislation in the USA; the Cadbury Committee
recommendations for European companies; and the OECD principles of corporate
governance are perhaps the best known among these. But developing countries have
not fallen behind either;
India has been no exception to that. Several committees and groups have looked into
this issue that undoubtedly deserves all the attention it can get. In the last few years,
the thinking—on the topic in India—has gradually crystallised into the development
of norms for listed companies. The problem for private companies, that form a vast
majority of Indian corporate entities, remains largely unaddressed. The agency
problem is likely to be less marked there as ownership and control are generally not
separated. Minority shareholder exploitation, however, can very well be an important
issue in many cases;
Development of norms and guidelines are an important first step in a serious effort
to improve corporate governance. The bigger challenge in India, however, lies in the
proper implementation of rules at the ground level. It appears that outside agencies—
like analysts and stock markets (particularly foreign markets for companies making
GDR issues)—have the greatest influence on managers in leading companies of the
country. But their influence is restricted to the few top companies. More needs to be
done to ensure adequate corporate governance in the average Indian company. Even
the most prudent norms can be subverted in a system plagued with widespread
corruption; and
Nevertheless, with industry organisations and chambers of commerce constantly
pushing for an improved corporate governance system, the future—of corporate
governance in India—promises to be distinctly better than the past.
KEY CONCEPTS
Corporate Governance (CG): This is defined as the code of practice by which a

firm’s management is held accountable to capital providers for the efficient use of
assets.
Agency Theory: Agency theory argues that shareholder interests require protection
by separation of incumbency of roles of board chair and CEO.
Financial Scams: Financial Scam is an attractive but false presentation—of financial
assets, transactions or schemes—by manipulators whose real aim is to pocket the
investor’s savings.
Stewardship Theory: Stewardship theory argues that shareholder interests are
maximised by shared incumbency of these roles.
New Age Economy: This refers to the economy—spear-headed by information
technology; digitalisation; and globalisation—of business which has opened up a new
range of vistas of high growth;
Strategy Focus: This defines the direction the organisation should take to meet its
goals and to ensure a stakeholder’ satisfaction; and
Ready Forward: Ready forward are the contracts—in bonds, debentures, debenture
stocks, securitised debt and other debt securities—issued by any person or corporate
body established by or under a Central or State act. These may be entered into all
Government Securities, in accordance with the terms and conditions required to meet
its goals and to ensure a stakeholder’ satisfaction.
Short Answer-type Questions

1. What is the definition of Corporate Governance?
2. What is the principle of Corporate Governance?
3. Who are stakeholders and what is stakeholder theory?

4. What is agency theory and what is the principal-agent relationship?
5. What is Stakeholder Impact Analysis?
6. What are the Committees on Corporate Governance in India?
7. What is Clause 49 of the Listing Agreement?
8. What is the J.J Irani Committee Report on Company Law, 2005 and why it is
important?
9. What are the recent trends in Corporate Governance in India?
10. What are the roles of B.O.D in corporate governance?
Discussion Questions
1. What is the purpose of Corporate Governance?
2. What is agency theory; what is agency problem and how does it relate to Corporate
Governance?
3. What are the major mechanisms of Corporate Governance? Discuss the strength and
weakness of each these mechanisms.
4. Describe the key aspect of the Corporate Governance in India. What are the major
challenges in Governance in India?
5. Discuss shareholder value theory and stakeholder value theory. Compare and contrast
them.
6. Briefly comment on global practice with respect to corporate governance.
7. Explain the role of the board of directors in corporate governance.
8. Explain the different principles of corporate governance.
9. What is clause 49? How it can help Indian organisations?
10. What is the role of the Board of Directors in Strategic Management?
References
1. K. Gopal, “Emerging Trends in Corporate Governance”, Indian Management, October 1998, Vol.
5, p. 12.
2. Ibid, p. 10.
3. Jonathan Chakham, Keeping Good Company: A Study of Corporate Governance in Five Countries,
Oxford: Claredan Press, 1994.
4. Monks, A.G., and N. Minow, Corporate Governance , Cambridge, Mass: Blackwell Business, 1995,
pp. 8-32.
5. Ibid, p. 1.
6. Dobrzynski, J.H., “The Board Members aren’t IBM-Compatible”, Business Week , August, 1992,
p. 23.
7. Demb, A., and Neubauer, F.F., “The Corporate Board: Confronting the Paradoxes”, Long Range
Planning, June, 1992, p. 13. These results are supported by a 1995 Korn/Ferry International
survey in which chairman and directors agreed that strategy and management succession, in
that order, are the most important issues the board expects to face. L. Light, “Why Outside
Directors Have Nightmares,” Business Week, October 23, 1996, p. 6.
8. Rechner, P.L. and D.R. Dalton, “CEO Duality and Organizational Performance: A Longitudinal
Analysis,” Strategic Management , February, 1991, pp. 55-160.
9. Lublin, J.S., “Texaco Case Causes a Stir in Boardrooms,” Wall Street Journal , November, 22,
1996, p. B1.
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WHAT IS CORPORATE GOVERNANCE?

running an organisation. Corporate governance, however, is generally thought to have a

suffered on account of unscrupulous management of companies which have raised capital

HISTORY AND EVOLUTION CONCEPT

PRINCIPLE OF CORPORATE GOVERNANCE

Tata Motors Limited, COMPANY’S PHILOSOPHY ON CORPORATE GOVERNANCE

IMPORTANCE OF CORPORATE GOVERNANCE

Fig. 9.1 Stakeholders and the Enterprise

STAKEHOLDER IMPACT ANALYSIS

The Unique Role of Stockholders

Profitability and Stakeholder Claims

stockholders. More generally, whenever managers delegate authority—to managers below

The Agency Problem

THE BOARD OF DIRECTORS

Corporate Governance at General Motors

FINANCIAL STATEMENTS AND AUDITORS

The Takeover Constraint

GOVERNANCE MECHANISMS INSIDE A COMPANY

Strategic control systems

ROLE OF B.O.D IN CORPORATE GOVERNANCE

RESPONSIBILITIES OF THE BOARD

1. Setting corporate strategy, overall direction, mission or vision;

ROLE OF THE BOARD IN STRATEGIC MANAGEMENT

Organisation of the Board

TRENDS IN CORPORATE GOVERNANCE

COMMITTEE ON CORPORATE GOVERNANCE IN INDIA

Working Group on Companies Act 1996

Initiative by Confederation of Industry

Clause 49 of the Listing Agreement

Naresh Chandra Committee Report, 2006

Narayana Murthy Committee Report 2003

J.J. Iraniu Committee Report on Company Law, 2005

CRITICAL APPRAISAL OF CORPORATE GOVERNANCE IN INDIA

Corporate Governance at Reliance is based on the following main principles:

• Transparency and accountability.

CORPORATE GOVERNANCE MODEL ACROSS THE WORLD

The purpose—of Corporate Governance—is to ensure that an organisation should

Corporate Governance (CG): This is defined as the code of practice by which a

Short Answer-type Questions

3. Who are stakeholders and what is stakeholder theory?

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