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GOVERNANCE AND RESPONSIBILITY

Unit 1

What is Corporate Governance?

“Everything you need to know about corporate governance. “Corporate Governance may be
defined as a set of systems, processes and principles which ensure that a company is governed
in the best interest of all stakeholders”.
“It is the system by which companies are directed and controlled. It is about promoting
corporate fairness, transparency and accountability. In other words, ‘good corporate
governance’ is simply good business”.
Report of SEBI committee (India) on Corporate Governance defines corporate governance as
“the acceptance by management of the inalienable rights of shareholders as the true owners
of the corporation and of their own role as trustees on behalf of the shareholders.
“It is about commitment to values, about ethical business conduct and about making a
distinction between personal & corporate funds in the management of a company.”

Learn about:-

1. Introduction to Corporate Governance 2. Meaning and Scope of Corporate Governance 3.


Definitions 4. Business History and Evolution 5. Objectives 6. Features 7. Importance 8. Tests
for Effective Corporate Governance 9. Determinants 10. Benefits.

Corporate Governance: Introduction, Definition, Features, Importance, Benefits and


Other Details

Table of Contents:
1. What is Corporate Governance? – An Introduction
2. Meaning and Scope of Corporate Governance
3. Definitions of Corporate Governance
4. Business History and Evolution of Corporate Governance
5. Objectives of Corporate Governance
6. Features of Corporate Governance

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7. Importance of Corporate Governance
8. Tests for Effective Corporate Governance
9. Determinants of Corporate Governance
10. Benefits of Corporate Governance

What is Corporate Governance? – An Introduction

Corporate governance (CG) is one of the most talked about topics in business, indeed in society,
today. A Google search revealed 513 news citations during a single week in June 2006. Most
academics, business professionals, and lay observers would agree that CG is defined as the
general set of customs, regulations, habits, and laws that determine to what end a firm should
be run. Much more fraught, however, is the question- “what defines good corporate
governance?”
It is clear that CG exists at a complex intersection of law, morality, and economic efficiency.
There has been renewed interest in the corporate governance practices of modern corporations
since 2001, particularly due to the high-profile collapses of a number of large U.S. firms such
as the MCI Inc. (formerly WorldCom) and the famous Enron fraud. In 2002, the U.S. federal
government passed the Sarbanes-Oxley Act, intending to restore public confidence in corporate
governance.
For a long time now, Corporate Governance has been a much discussed topic in the corporate
world and public domain. The great significance of corporate governance is highlighted by
James D. Wolfensohn, a former President of World Bank, as follows – “The governance of the
corporation is now as important to the world economy as the government of countries”.

Corporate governance has a vital role in strategic management. Good governance fortifies the
corporate mission and philosophy, ensures compliance with government regulations and
societal norms and fosters efficiency, fairness and transparency in management.

Stirred by turbulence in the corporate sector, characterised by corporate failures, frauds and
rampant unfairness in the conduct of business and governance in general, corporate governance
has become a subject of serious and frequent discussion across the world since the early 1990s.
Because of the critical role of corporate governance in fostering a healthy corporate sector,
governments in India and across the world have laid down frameworks for the corporate to
adhere to.

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As the Task Force on Corporate Governance constituted by the Confederation of Indian
Industry (CII) under the Chairmanship of Rahul Bajaj, observes, “corporate governance goes
far beyond company law. The quantity, quality and frequency of financial and managerial
disclosure, the extent to which the board of directors exercise their fiduciary responsibilities
towards shareholders, the quality of information that management share with their boards, and
the commitment to rim transparent companies that maximise long-term shareholder value
cannot be legislated at any level of detail. Instead, these evolve due to the catalytic role played
by the more progressive elements within the corporate sector and, thus, enhance corporate
transparency and responsibility.”

Absence of a generally well accepted corporate governance framework consisting of a


regulatory system and a system of principles and guidelines was, inter alia, a deterrent to the
development of standard corporate governance practices. It is, therefore, not surprising that the
last few decades or so has witnessed a number of committees/task forces at the national and
international levels, appointed by governments, industry organisations, regulatory bodies,
international organisations, etc., to recommend regulatory measures and principles for
corporate governance.

What is Corporate Governance Meaning and Scope?

Although corporate governance has been discussed a lot across the globe, there are
considerable variations in the conceptual definition. There is no single model of corporate
governance best applicable to all countries because of the differences in the business
environmental factors, such the legal system, characteristics of the corporate sector, political
system and government, social norms and cultural factors, etc.

This observation is based on the studies on corporate governance practices across several
countries by the Asian Development Bank (2000), International Monetary Fund (1999),
Organisation for Economic Cooperation and Development (OECD) (1999) and the World Bank
(1999).

According to the OECD Code document, different legal systems, institutional frameworks and
traditions across countries have led to the development of a range of different approaches to

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corporate governance. In addition, observes the Narayana Murthy Committee, best-managed
corporations also recognise that business ethics and corporate awareness of the environmental
and societal interest of the communities, within which they operate, can have an impact on the
reputation and long-term performance of corporations.

The report of the first CII Task Force on Corporate Governance under the Chairmanship of
Rahul Bajaj (1998) has pointed out that there is a diversity of opinion regarding beneficiaries
of corporate governance. The Anglo-American system tends to focus on shareholders and
various classes of creditors. Continental Europe, Japan and South Korea believe that companies
should also discharge their obligations towards employees, local communities, suppliers,
ancillary units, and so on.

Most of the definitions articulated in the codes of the reports on corporate governance relate
corporate governance to control of the company, of corporate management, or of company
conduct or managerial conduct. A simple definition, but very broad in its implications, which
is often quoted, is provided by the Cadbury Report (UK) – “Corporate governance is the system
by which businesses are directed and controlled.”

In its narrowest sense, the term may describe the formal system of accountability of senior
management to the 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 organisations.

The Cadbury Report has elaborated that “corporate governance is concerned with holding the
balance between economic and social goals and between individual and communal goals. The
governance framework is there to encourage the efficient use of resources and equally to
require accountability for the stewardship of those resources. The aim is to align as nearly as
possible the interests of individuals, of corporations and of society.”

“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.”

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The second CII Task Force on Corporate Governance, under the chairmanship of Naresh
Chandra (2009) observes – Good corporate governance involves a commitment of a company
to run its businesses in a legal, ethical and transparent manner – a dedication that must come
from the very top and permeate throughout the organisation. That being so, much of what
constitutes good corporate governance has to be voluntary. Law and regulations can, at best,
define the basic framework – boundary conditions that cannot be crossed.

According to the OECD Principles of Corporate Governance, corporate governance involves a


set of relationships between a company’s management, its board, its shareholders and other
stakeholders. Corporate governance also provides the structure through which the objectives
of the company are set, and the means of attaining those objectives and monitoring performance
are determined.

Good corporate governance should provide proper incentives for the board and management
to pursue objectives that are in the interests of the company and its shareholders and should
facilitate effective monitoring. In addition, factors such as business ethics and corporate
awareness of the environmental and societal interests of the communities in which a company
operates can also have an impact on its reputation and its long-term success.

The N. R. Narayana Murthy Committee on Corporate Governance, appointed by SEBI, seems


to confer with the OECD view when it observes that corporate governance is the acceptance
by management of the inalienable rights of shareholders as the true owners of the corporation
and of their own role as trustees on behalf of the shareholders. It is about commitment to values,
about ethical business conduct and about making a distinction between personal and corporate
funds in the management of a company.

According to the minimal definition purported by the first CII Task Force (1998), corporate
governance deals with laws, procedures, practices and implicit rules that determine a
company’s ability to take managerial decisions vis-a-vis its claimants – in particular, its
shareholders, creditors, customers, the State and employees.

The CII Task Force observes that there is a global consensus about the objective of ‘good’
corporate governance – maximising long-term shareholder value. Since shareholders are

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residual claimants, this objective follows from a premise that, in well performing capital and
financial markets, whatever maximises shareholder value must necessarily maximise corporate
prosperity, and best satisfy the claims of creditors, employees, shareholders, and the State.

In short, “Corporate Governance may be defined as a set of systems, processes and principles
which ensure that a company is governed in the best interest of all stakeholders. It is the system
by which companies are directed and controlled. It is about promoting corporate fairness,
transparency and accountability. In other words, ‘good corporate governance’ is simply ‘good
business’.

It ensures:
1. Adequate disclosures and effective decision-making to achieve corporate objectives,
2. Transparency in business transactions,
3. Statutory and legal compliances,
4. Protection of shareholder interests,
5. Commitment to values and ethical conduct of business.”

Governance Structure:

An appropriate structure is prerequisite for proper corporate governance. The corporate


governance structure of ITC throws light on this aspect.
The three-tier governance structure ensures that:
(i) Strategic supervision (on behalf of the shareholders), being free from involvement in the
task of strategic management of the company, can be conducted by the Board with objectivity,
thereby sharpening accountability of management,
(ii) Strategic management of the company, uncluttered by the day-to-day tasks of executive
management, remains focused and energized, and
(iii) Executive management of a Division or SBU, free from collective strategic responsibilities
for ITC as a whole, focuses on enhancing the quality, efficiency and effectiveness of the
business. The core roles of the key entities flow from this structure.
The core roles, in turn, determine the core responsibilities of each entity. In order to discharge
such responsibilities, each entity is empowered formally with requisite powers. The structure,
processes and practices of governance are designed to support effective management of
multiple businesses while retaining focus on each one of them. The Governance Document that

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sets out the structure, policies and practices of governance within the organisation is available
on the company’s corporate website www(dot)itcportal(dot)com for general information.

Corporate Governance and Corporate Management:


Now, there is a growing recognition of the difference between corporate governance and
corporate management and the need to align corporate management with corporate governance.
Corporate governance is concerned with compliances, values, vision and visibility. It is about
governance structure, the value orientation of the organisation, ethical norms for its
performance, the direction of development and social accomplishment of the organisation and
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.”
According to the Narayana Murthy Committee on Corporate Governance, the most common
school of thought would have us believe that if management is about running businesses,
governance is about ensuring that it is run properly. All companies need governing as well as
managing. The aim of “Good Corporate Governance” is to enhance the long-term value of the
company for its shareholders and all other partners.

What is Corporate Governance – Definitions: Given by Gabrielle O’Donovan and SEBI


Committee (India?)

In his book ‘A Board Culture of Corporate Governance’, business author Gabrielle O’Donovan
defines corporate governance as “an internal system encompassing policies, processes and
people, which serve the needs of shareholders and other stakeholders, by directing and
controlling management activities with good business savvy, objectivity, accountability and
integrity. Sound corporate governance is reliant on external marketplace commitment and
legislation, plus a healthy board culture which safeguards policies and processes.”

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O’Donovan goes on to say that ‘the perceived quality of a company’s corporate governance
can influence its share price as well as the cost of raising capital. Quality is determined by the
financial markets, legislation and other external market forces plus how policies and processes
are implemented and how people are led.

External forces are, to a large extent, outside the circle of control of any board. The internal
environment is quite a different matter, and offers companies the opportunity to differentiate
from competitors through their board culture. To date, too much of corporate governance
debate has centred on legislative policy, to deter fraudulent activities and transparency policy
which misleads executives to treat the symptoms and not the cause.’
Report of SEBI committee (India) on Corporate Governance defines corporate governance as
“the acceptance by management of the inalienable rights of shareholders as the true owners of
the corporation and of their own role as trustees on behalf of the shareholders. It is about
commitment to values, about ethical business conduct and about making a distinction between
personal & corporate funds in the management of a company.”

The definition is drawn from the Gandhian principle of trusteeship and the Directive Principles
of the Indian Constitution. Corporate Governance is viewed as business ethics and a moral
duty.

What is Corporate Governance – Business History and Evolution?

Corporate governance as a subject, along with its models, has been in existence since the time
businesses came into being. Often 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 that needed to comply 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 first half of the nineties, 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

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relationships between the CEO and the board of directors. There were issues relating to CEO
compensation and nexus with boards, discussed due to issues over backdated 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 flight after property assets collapsed. The lack
of corporate governance mechanisms in these countries highlighted the weaknesses of the
institutions in their economies.

There have been further such dialogues in the corporate governance practices of modern
corporations since 2001, particularly due to the high-profile collapses of a number of large US
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, titled Financial Aspects of Corporate Governance (1992), a report
by a committee chaired by Sir George Adrian Hayhurst Cadbury, a pioneer in
raising/awareness and stimulating the debate on corporate governance, 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 adopted in
varying degrees by the European Union, the United States, the World Bank, and others. Today,
the SOA works as a predominant guiding framework on corporate governance in the US.

What is Corporate Governance – 7 Important Objectives?

The aim of “Good Corporate Governance” is to ensure commitment of the board in managing
the company in a transparent manner for maximizing long-term value of the company for its
shareholders and all other partners. It integrates all the participants involved in a process, which
is economic, and at the same time social.

The fundamental objective of corporate governance is to enhance shareholders’ value and


protect the interests of other stakeholders by improving the corporate performance and
accountability. Hence it harmonizes the need for a company to strike a balance at all times
between the need to enhance shareholders’ wealth whilst not in any way being detrimental to
the interests of the other stakeholders in the company.

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Further, its objective is to generate an environment of trust and confidence amongst those
having competing and conflicting interests.
It is integral to the very existence of a company and strengthens investor’s confidence by
ensuring company’s commitment to higher growth and profits.

Broadly, it seeks to achieve the following objectives:


1. A properly structured board capable of taking independent and objective decisions is in place
at the helm of affairs
2. The board is balance as regards the representation of adequate number of non-executive and
independent directors who will take care of their interests and well-being of all the stakeholders
3. The board adopts transparent procedures and practices and arrives at decisions on the
strength of adequate information
4. The board has an effective machinery to take care and manage the concerns of stakeholders
5. The board keeps the shareholders informed of relevant developments impacting the company
6. The board effectively and regularly monitors the functioning of the management team
7. The board remains in effective control of the affairs of the company at all times
The overall endeavour of the board should be to take the organisation forward so as to
maximize long term value and shareholders’ wealth.

What is Corporate Governance – 10 Key Features: Strategy Setting and Planning, Risk
Management, Consultation, Roles and Responsibilities, Performance and a Few
Others?

There are some key features of good governance that needs to be considered when assessing
the governance of an organisation.

These features should be central to an organisation’s corporate governance framework and


should be included in governance related documentation which may include organisational
plans, business plans, marketing plans, policy and procedures manuals, risk management
reviews and/or quality assurance manuals.

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Certain key features of good corporate governance are discussed below:
Feature # 1. Strategy Setting and Planning:
Planning is a critical element of good governance. For most disability services, it is appropriate
to combine strategic and vocational planning with the business planning process. The important
issue is to ensure the overall strategy setting and planning for the organisation is clearly
documented and communicated.

Some points for good planning include:


(i) The Board should establish the goals for the organisation, in conjunction with management,
to provide the framework for planning
(ii) The plan should be ‘owned’ by the organisation
(iii) Active involvement of Board members and management is critical
(iv) Consultation with key stakeholders should include employees and consumers. It is also
important to consult with funding bodies and key community contacts
(v) Assistance from a specialist facilitator (this can have great benefits, but care must be taken
to ensure that the role is kept to facilitation and that the plan does not become ‘owned’ by the
facilitator)
The importance of good planning is that it helps the organisation clearly set the objectives,
strategies and actions for a period. It also provides a means to monitor the organisation’s
performance. To allow for changing circumstances, the plans should be regularly reviewed and
updated.

Feature # 2. Risk Management:


Risk management is a concept that has gained significant publicity in recent years. It is a very
important concept in the management of organisations. The Board should consider whether it
has a clear risk management framework that covers the organisation’s operations. Risk should
be thought of in terms of what, and how, losses (or gains) may affect the organisation through
a wide range of sources.
Whilst the Board does not have a direct responsibility for risk management it does have a
responsibility to ensure that managers and staff of the organisation have an appropriate risk
management framework in place to mitigate or reduce risks that have been identified.

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There needs to be an ongoing process to identify risk, assess its impact and take treatment
actions to address and/or monitor risk. There should be a reporting process to the Board by
management on the emergence of new risks and the treatment of those risks.

Feature # 3. Consultation:
Within a successful disability services organisation, consultation with key stakeholders is an
essential feature of good governance. It enables the stakeholders to understand the
organization’s objectives and strategies and helps them to work with the organisation in
achieving those objectives.

Effective consultation helps to create an environment of mutual respect and trust. Working
with the stakeholders as far as practical, rather than against them, maximises the benefits of the
relationship.

Who are the Organisation’s Stakeholders?


They may include the funding agencies, local government, and the community within which
you operate, businesses you deal with, for example, customers, suppliers or businesses where
consumers are placed, staff members, etc.

You should have a policy on how you consult with stakeholders.


This policy should:
(i) Include a communication strategy;
(ii) Identify who should consult on behalf of the organisation with each stakeholder;
(iii) Establish what Board involvement in such consultation should occur with each
stakeholder;
(iv) Include events that should be communicated to stakeholders; and
(v) Identify the frequency and format of ongoing consultation and communication

Feature # 4. Roles and Responsibilities:


The organisation should develop documented policy describing the roles and responsibilities
of the Board, of individual Board members and of management. The policy should be clearly
communicated and understood by the Board, management, staff, consumers and members of
the organisation.

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Feature # 5. Skills, Independence and Resources:
The Board should have the right mix of skills to manage the organisation’s affairs. These skills
should cover key functional areas such as- Business acumen/expertise, finance, marketing,
production or service management, legal, etc.
As an individual Board member it is difficult to have the expertise across all these areas. If
achieving this mix of skills on the Board is difficult then the organization can consider
accessing professional people to provide advice on certain matters.
It is also important to have a mix of people on the Board, including those who are independent
of the organisation. As such, these people should not be members or have a direct interest in
the affairs of the organisation. The reason for this is to provide a- balanced, objective
representation on the Board. This should assist in ensuring that the Board does not make
decisions purely on an emotive basis.

Feature # 6. Conduct and Ethics:


The tone set by the Board member or management, has a major influence on the organisation’s
integrity, ethics and values. If staff and consumers see the top level acting ethically and with
integrity, this sets a tone in the organisation that these attributes are valued.
In setting a standard that you expect people in the organisation to work to, it is very important
that a code of conduct be established, which covers the Board members, management and staff.
The code of conduct should be developed with management and staff and should cover
such things as:
(i) Principles of responsibilities and duties of Board members, management and staff; and
(ii) Guidance for interpreting the principles

Feature # 7. Performance:
A means of assessing the performance of Board members should be in place. Given that
members of Boards are largely volunteers, the nature of the performance measures and
reporting should not be overly oppressive and onerous. On the other hand, it is important to
have in place some formal means of establishing an expected level of performance and to assess
if it is being achieved.
An important aspect in developing a performance measurement framework is the definition of
the roles of each Board member. From that, the expectation of their contribution may be
determined and a means of performance measurement established.

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Feature # 8. Succession Planning:
At some point in the future a successor will be required to continue the management of the
organisation. If possible, the current manager should be responsible for grooming other senior
staff as potential successors.
However, if the organisation does not have access to these resources, the Board should be aware
of this risk and review it and act accordingly. The selection of a business manager, whether
internally or externally, should be based on specific selection criteria. This is to ensure that,
when required, a successor is appointed based upon their qualifications, experience and
suitability for the role.

Feature # 9. Financial and Operational Reporting:


Timely financial and operational reporting is important in ensuring that organisation’s
performance is accessible so as to assist in decision making. Reporting should also enable
assessment of the performance of the management and staff. Therefore, reports should
incorporate not just actual achievements, but projected or budgeted targets that should have
been achieved.

Reporting needs to be comprehensive enough to ensure that you are well informed, but not so
complex that it confuses the key issues being reported. The Board should establish an agreed
format for reporting to ensure that all matters that should be reported are reported.

Feature # 10. Audit Committees:


An audit committee’s role is to assist the Board in fulfilling its oversight responsibilities for
the financial reporting process, the system of internal control over financial reporting, the audit
process, and the organisation’s process for monitoring compliance with laws and regulations.
For larger organisations, an audit committee of non-executive (independent) Board members
can be useful in considering audit related issues in more depth than would normally be
undertaken by the full Board. However, the audit committee should not act as a barrier between
the auditor and the full Board or presume to overtake the functions of the full Board.

What is Corporate Governance – Importance?

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The Preface to the Birla Committee Report has highlighted the significance and need for good
corporate governance.
The salient points are reproduced in the following paragraphs:
It is almost a truism that the adequacy and the quality of corporate governance shape the growth
and the future of any capital market and economy. The concept of corporate governance is no
longer confined to the halls of academic and is increasingly finding acceptance for its relevance
and underlying importance in the industry and capital markets. Progressive firms in India have
voluntarily put in place systems of good corporate governance.
Internationally also, while this topic has been accepted for a long time, the financial crisis in
emerging markets has led to renewed discussions and inevitably focused them on the lack of
corporate as well as governmental oversight. The same applies to recent high-profile financial
reporting failures even among firms in the developed economies. Focus on corporate
governance and related issues is an inevitable outcome of a process, which leads firms to
increasingly shift to financial markets as the pre-eminent source for capital.

In the process, more and more people are recognising that corporate governance is
indispensable to effective market discipline. This growing consensus is both an enlightened
and a realistic view. In an age where capital flows worldwide, just as quickly as information, a
company that does not promote a culture of strong, independent oversight, risks its very
stability and future health. As a result, the link between a company’s management, directors
and its financial reporting system has never been more crucial. As the boards provide
stewardship of companies, they play a significant role in their efficient functioning.

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 companies is that they have systems in place, which
allow sufficient freedom to the boards and management to take decisions towards the progress
of their companies and to innovate, while remaining within a framework of effective
accountability. In other words, they have a system of good corporate governance.

Strong corporate governance is, thus, indispensable to resilient and vibrant capital markets and
is an important instrument of investor protection. It is the blood that fills the veins of transparent
corporate disclosure and high-quality accounting practices. It is the muscle that moves a viable

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and accessible financial reporting structure. Without financial reporting premised on sound,
honest numbers, capital markets will collapse upon themselves.

Another important aspect of corporate governance relates to issues of insider trading. It is


important that insiders do not use their position of knowledge and access to inside information
about the company, and take unfair advantage of the resulting information asymmetry. To
prevent this from happening, corporates are expected to disseminate the material price-
sensitive information in a timely and proper manner and also ensure that till such information
is made public, insiders abstain from transacting in the securities of the company.

The principle should be ‘disclose or desist’. This, therefore, calls for companies to devise an
internal procedure for adequate and timely disclosures, reporting requirements, confidentiality
norms, code of conduct and specific rules for the conduct of its directors and employees and
other insiders.

However, the need for such procedures, reporting requirements and rules also goes beyond
corporates to other entities in the financial markets such as Stock Exchanges, Intermediaries,
Financial Institutions, Mutual Funds and concerned professionals who may have access to
inside information.

Good corporate governance, besides protecting the interests of shareholders and all other
stakeholders, contributes to the efficiency of a business enterprise, to the creation of wealth
and to the country’s economy. In a sense, both these points of view are related and during the
discussions at the meetings of the Committee, there was a clear convergence of both points of
view.

According to Charkham, good corporate governance is considered vital from medium- and
long-term perspectives to enable firms to compete internationally in sustained way and make
them flourish and grow so as to provide employment, wealth and satisfaction, not only to
improve standard of living materially but also to enhance social cohesion.

A Report of the World Bank Group on Corporate Governance has elaborated the significance
of corporate governance to developed and developing economies, particularly in the context of
globalisation.

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Some of the important observations of this report are reproduced in the following two
paragraphs:
Through a process of continuous change, developed countries have established a complex
mosaic of laws, regulations, institutions, and implementation capacity in the government and
the private sector. The objective is not to shackle corporations but rather to balance the spirit
of enterprise with greater accountability.

The systematic enforcement of law and regulations has created a culture of compliance that has
shaped business culture and the management ethos of firms, spurring them to improve as a
means of attracting human and financial resources on the best possible terms. This continuous
process of change and adaptation has accelerated with the increasing diversity and complexity
of shareholders and stakeholders.

Globalisation, too, is forcing many companies to tap into international financial markets and to
face greater competition. This has led to restructuring and a greater role for mergers and
acquisitions and to expanded markets for corporate control.

Increasingly for developing and transition economies, a healthy and competitive corporate
sector is fundamental for sustained and shared growth sustained in that it withstands economic
shocks, shared in that it delivers benefits to all of society. Countries realise that just as overall
governance is important in the public sector, so corporate governance is important in the private
sector.

They also realise that good governance of corporations is a source of competitive advantage
and critical to economic and social progress. With globalisation, firms must tap domestic and
international capital markets in quantities and ways that would have been inconceivable even
a decade ago. Increasingly, individual investors, funds, banks, and other financial institutions
base their decisions not only on a company’s outlook, but also on its reputation and its
governance.
It is this growing need to access financial resources, domestic and foreign, and to harness the
power of the private sector for economic and social progress that has brought corporate
governance into prominence the world over.

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What is corporate governance – 11 Tests for Effective corporate Governance

Several tests have to be adopted to assess whether there has been effective corporate
governance.
Broadly, the test of corporate governance should cover the following aspects:
(a) Whether the funds of the company have been deployed for pursuing the main objects of the
company as enshrined in the Memorandum?
(b) Whether the funds raised from financial institutions and the capital market have been
utilized for the purposes for which they were intended?
(c) Whether the company has the core competence to effectively manage its diversifications?
(d) Whether there has been diversion of funds by way of loans and advances or investments to
subsidiary or investment companies?
(e) Whether the personal properties of the directors have been let-out at a fabulous rent to the
company?
(f) Whether the funds of the company have been diverted to the promoters through shell
companies to permit the promoters to shore-up their stake in the company?
(g) Whether the provisions of the Companies Act, FERA, Factories Act and other statutes are
complied with in letter and in spirit?
(h) Whether the practices adopted by the company and its management towards its
shareholders, customers, suppliers, employees and the public at large are ethical and fair?
(i) Whether the directors are provided with information on the working of the company and
whether the institutional and non-executive directors play an active role in the functioning of
the companies?
(j) Whether the internal controls in place are effective?
(k) Whether there is transparent financial reporting and audit practices and the accounting
practices adopted by the company are in accordance with accounting standards of ICAI?

What is Corporate Governance – Determinants: External and Internal Determinants

There are a number of influencing factors shaping the corporate governance system (the
corporate governance environment).
There are some prerequisites for good corporate governance.
They are:

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i. A proper system consisting of clearly defined and adequate structure of roles, authority and
responsibility.
ii. Vision, principles and norms which indicate the development path, normative
considerations, and guidelines for performance.
iii. A proper system for guiding, monitoring, reporting and control.

For a good corporate governance system, “what is needed is a combination of statutory


regulation and self-regulation. The mix will vary around the world, but nowhere can statutory
regulation alone promote effective governance. The stronger the partnership between the public
and private sectors, the more soundly based will be their governance structures.”

1. External Determinants:

i. Government Regulations:
As the OECD Business Sector Advisory Group’s Report on Corporate Governance (1988) has
emphasised, while corporate governance should remain primarily a private sector prerogative,
governments have a distinct and important responsibility in providing a regulatory framework
that allows investors and enterprises to adapt corporate governance practices to rapidly
changing circumstances, In other words, good corporate governance can best be achieved
through a combination of regulatory and voluntary private actions.
On the regulatory side, the Report noted that government interventions are most effective when
consistently and expeditiously enforced.
They should focus on:
a. Fairness – protecting shareholder rights and ensuring the enforceability of contracts with
resource providers.
b. Transparency – requiring timely disclosure of adequate information on corporate financial
performance.
c. Accountability – clarifying governance roles and responsibilities and supporting voluntary
efforts to ensure the alignment of managerial and shareholder interests, as monitored by a board
of directors – or in certain nations, a board of auditors – with some independent members.
d. Responsibility – ensuring corporate compliance with the other laws and regulations that
reflect society’s values, including a broad sensitivity to the objectives of the society in which
corporations operate.

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The Report, however, stressed that regulatory measures, though necessary, are not sufficient to
raise standards. Indeed, the strengthening of corporate governance standards has been advanced
by many corporate leaders who recognise that prospering in the long-term requires balancing
business objectives with society’s concerns.
In India, the regulatory framework is provided mostly by the Companies Act, the SEBI and the
stock exchanges which are regulated by the Securities Contracts (Regulations) Act. Also see
the subsection Legal Environment of Corporate Governance in India tinder the section the
Indian Scenario.

ii. Other External Influences:


Other external influences include codes/guidelines, etc., pertaining to corporate governance
brought out by industry associations like the CII, international developments in the field of
corporate governance, including the several reports on corporate governance as indicated under
the section. What is Corporate Governance? Further, media and public opinion also play an
important role.

2. Internal Determinants:
The corporate governance culture and practice of an organisation are shaped by factors such as
its legacy, vision, mission, policies, norms, governance structure, powers and responsibilities
of the key constituents, persons holding key positions in the organisation, etc.
The Birla Committee has identified the three key constituents of corporate governance as the
Shareholders, the Board of Directors and the Management and has attempted to identify, in
respect of each of these constituents, the roles and responsibilities as also the rights in the
context of good corporate governance. Fundamental to this examination is the recognition of
the three key aspects of corporate governance, viz., accountability, transparency and equality
of treatment for all stakeholders.

i. Board of Directors:
The Birla Committee observes that the pivotal role in any system of corporate governance is
performed by the board of directors. It is accountable to the stakeholders and directs and
controls the Management. It stewards the company, sets its strategic aim and financial goals
and oversees their implementation, puts in place adequate internal controls and periodically
reports the activities and progress of the company in a transparent manner to the stakeholders.

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ii. Shareholders:
One of the primary purposes of corporate governance shall be the protection of interests of
shareholders, who place their trust in corporations to use their investment funds wisely and
effectively. The shareholders have a vital role in corporate governance by exercising their
powers and rights.
According to the Birla Committee, the shareholders’ role in corporate governance is to appoint
the directors and the auditors and to hold the board accountable for the proper governance of
the company by requiring the board to provide them periodically with the requisite information,
in a transparent fashion, of the activities and progress of the company. Also see the sub-section.
The Rights of Shareholders and Key Ownership Functions and The Equitable Treatment of
Shareholders under the section Principles of Corporate Governance.
iii. Management:
The third key internal constituent of corporate governance is the management. The Birla
Committee points out that the responsibility of the management is to undertake the
management of the company in terms of the direction provided by the Board, to put in place
adequate control systems and to ensure their operation and to provide information to the board
on a timely basis and in a transparent manner to enable the Board to monitor the accountability
of management to it.

What is Corporate Governance – 12 Major Benefits

The major benefits are stated very specifically below:


1. Good govenance provides proper framework for efficient management of the organisation
ensuring complete transparency, integrity and accountability of the management.
2. A well governed company protects the rights and interests of the shareholders and maximises
long-term shareholder value. Indeed, one of the primary objectives of corporate governance is
maximisation of the long-term value of the company for its shareholders and all other partners.
3. It leads to a socially justifiable efficient management of the company by striking a proper
balance between the different stakeholders and the societal interests. “Corporate governance is
concerned with holding the balance between economic and social goals and between individual
and communal goals. The governance framework is there to encourage the efficient use of
resources and equally to require accountability for the stewardship of those resources. The aim
is to align as nearly as possible the interests of individuals, corporations, and society.”

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4. Good corporate governance provides proper direction for the long-term development of the
organisation.
5. Companies which are governed well enjoy the trust and goodwill of shareholders and other
stakeholders. This will have its reflection in the capital market by active trading in the
securities, better market capitalisation and ease of raising capital – both equity and debt.
“Sound corporate governance is important not only to attract long-term “patient” foreign
capital, but more especially to broaden and deepen local capital markets by attracting local
investors – both individual and institutional. Unlike international investors who can diversify
their risk, domestic investors are often captive to the system and face greater risks, particularly
in an environment that is opaque and does not protect the rights of minority shareholders.”
6. Companies which are governed properly often enjoy better relationships and terms with
suppliers, buyers and marketing intermediaries.
7. Well governed companies are in a better position to attract foreign capital, technical
collaborations and business.
8. As the Birla Committee has pointed out, strong corporate governance is indispensable to
resilient and vibrant capital markets and is an important instrument of investor protection.
9. Good governance helps a company to attract and retain efficient independent directors,
managerial and other human resources.
10. Good governance will help gain goodwill of consumers and the public.
11. As India gets integrated in the world market, Indian as well as international investors will
demand greater disclosure, more transparent explanation for major decisions and better
shareholder value.
12. As the Birla Committee has observed, good corporate governance, besides protecting the
interests of shareholders and all other stakeholders, contributes to the efficiency of a business
enterprise, to the creation of wealth and to the country’s economy.

As a World Bank Report observes, there is a growing recognition that “good governance of
corporations is a source of competitive advantage and critical to economic and social progress.”

The Scope of Corporate Governance In India & Corporate Governance Issues In India

Table of Contents
1. The scope of corporate governance in India & corporate governance issues in India

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2. The Scope of Corporate Governance in India :
3. Corporate Governance Issues in India :
4. Interest may be conflicted
 Issues of the accountability
 Issues of transparency

The manner in which the company is managed and controlled is termed corporate governance.
It can be also termed as a blueprint of a company which completely explains its each and every
step to direct it towards its objectives. Its main objective is to carry on all the business activities
in the interest of its stakeholders.

Corporate governance is completely managed and controlled by the company’s director team
and concerned team solely for its stakeholder’s benefit. It is all about bringing the balance
between societal & individual goals, and also, social and economic goals.

It may be defined as the meeting between the various stakeholder of the company (directors
team, shareholders & management team of the company) whose main purpose is to direct the
company towards its pre-decided goals.

For a healthy organization and non-existence of any conflict in the organization, the owner
must make sure that there is mutual consent among all the members. These all above mentions
dimensions which directly affect the corporate governance of the company should not be
overlooked.

Corporate governance also serves as one of the parameters for the finance providers as through
it they make sure of getting a fair return on their investment. It also removes the confusion
between the duties of the owners and managers. As if the duties of owners and managers are
not clearly mentioned it will affect the progress of the company. It helps in taking better
strategic decisions.

THE SCOPE OF CORPORATE GOVERNANCE IN INDIA:

 If the corporate governance of the company is proper it will ultimately lead to better
economic growth and more success rate.
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 Better corporate governance helps in getting the confidence of the investor which will
ultimately help the company in raising and acquiring the capital fast and effectively.
 It also lowers the cost of the capital that is required for investment.
 It also helps in increasing the share price of the company.
 Proper corporate governance help in attaining the efficiency and also minimizes
mismanagement, risk, and corruption.
 It plays in building up the goodwill of the corporation.
 It helps in managing and running the operations in the organization according to the
interest of all of its stakeholders.

CORPORATE GOVERNANCE ISSUES IN INDIA:

There are some problems also with corporate governance as it needs to achieve the objective
of each and every of its stakeholder. The goals of each of its stakeholder should be considered
and neither of it should be undermined. Some of the common issues are discussed below:

1. INTEREST MAY BE CONFLICTED


Interest may be conflicted when the one who has a controlling power has some financial interest
that could affect his decision making and may also conflict with the company’s objectives. This
will ultimately lead to a clash between different members and will affect the normal working
environment of the organization. Issues of the oversight: For proper corporate governance to
be effective the directors’ team of the company should have proper sight over the company’s’
processes. There should be the proper mechanism through which each and every task of the
corporation should be monitored otherwise it will endanger the normal growth of the business.

2. ISSUES OF THE ACCOUNTABILITY


Accountability is something that is necessary for proper functioning of the corporate
governance. From a high-level position to lower level positions job, role and accountability
should be clearly mentioned so that there is no confusion among the members. Accountability
of each part of the corporation should be clearly defined otherwise it will endanger the success
rate of the company or investors demotivating them for their investment.

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3. ISSUES OF TRANSPARENCY
For bringing the transparency in the organization corporation must make accurate and fair
reporting of their profit and loss and should present a true picture of it to those who invest in
the company. Manipulating figures can seriously damage the company’s relationship with its
stakeholders and also may lead to a fine from various regulatory agencies.

What Is the Role of Agency Theory in Corporate Governance?

Table of Contents
1 Meaning of Agency Theory
2 Agency Theory Examples
3 Agency Theory in Corporate Governance
4 Importance of Agency Theory
4.1 Different Risk Appetite
4.2 Super Self Centered Executives

MEANING OF AGENCY THEORY


Agency theory examines the relationship between the agents and principals in the business. In
an agency relationship, two parties exist – the agent and principal, whereby the former acts and
takes decisions on behalf of the latter. The theory revolves around the relationship between the
two and the issues that may surface due to their different risk perspectives and business goals.
In finance, the most talked about agency relationship exists between shareholders and
executives of a corporation where the top brass is elected to act in the interest of the true owners
of the company.

AGENCY THEORY EXAMPLES


One of the most common examples of agency theory can be seen in the way a government of
a country functions. The masses elect political representatives to run the country in a way that
maximizes their interests. Representatives of different political parties promise the voters to
bring changes in the governing model of the country. However, the electorates of almost all
sovereigns find themselves cheated when their elected candidates act in an unscrupulous
manner after assuming office. Here, the voters act as principals who elect the government
representatives to act as their agents.

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Another common example of agency theory is between the employees and employers of an
organization. The employees are hired to work in accordance with the objectives of the
organization. However, the growing number of corporate scams shows that this relationship is
not always taken in a way it is meant to be. The employees work against the ethics of the
organization causing it huge financial and reputational damage. Sometimes, the loss caused by
such corrupt employees is beyond repair and an organization has to wind up its business
altogether.

AGENCY THEORY IN CORPORATE GOVERNANCE


Agency theory in corporate governance is an extension of the agency theory discussed above.
It relates to a specific type of agency relationship that exists between the shareholders and
directors/management of a company. The shareholders, true owners of the corporation, as
principals, elect the executives to act and take decisions on their behalf. The aim is to represent
the views of the owners and conduct operations in their interest. Despite this clear rationale of
electing the board of directors, there are a lot of instances when complicated issues come up
and the executives, knowingly or unknowingly, take decisions that do not reflect shareholders’
best interest. In the dynamic business environment, agency theory of corporate governance has
garnered a lot of attention and is seen and evaluated from different points of view.

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Different subject matter experts, be it economists, financiers, accountants or legal practitioners,
have been studying the wider impacts, corporate governance can have on the performance of
the company. However, it is not always possible to quantify the effects of agency theory. Take
for instance the dividend payout policy of a corporation. Majority of shareholders expect high
dividends payouts when the company is making huge profits. With this, not only they enjoy
extra cash on their hands, it also boosts the current value of the capital stock they hold. The
executives on the other hand, as a part of the long-term strategy, may decide to retain a large
part of profits. Retention could be for a requirement of some technology advancement or some
critical asset purchase in near-future. In such situations, a conflict of interest may arise between
the shareholders and executives. Such disagreements can create a feeling of contention between
the owners and controllers of the company, often resulting in inefficiencies and sometimes
even losses.

IMPORTANCE OF AGENCY THEORY


There are two situations which make efforts on resolving agency conflicts all the more
important.

DIFFERENT RISK APPETITE

One of the major reasons for such strife is the levels of risk appetite each is willing to undertake.
Shareholders are mostly not involved in the day-to-day working of the company and hence are
not fully equipped to understand the rationale behind critical business decisions. On the
contrary, managers are more far-sighted and have a far greater risk appetite due to their close
access to the relevant information. They believe in the going concern concept
of accounting and most of their decisions are taken keeping the long-term view of the company
in mind. While the shareholders are keen to increase the current and future value of their
holdings, the executives are more interested in the long-term growth of the company. Thus, the
differences in their approach create a feeling of distrust and disharmony.

SUPER SELF CENTERED EXECUTIVES

The situation could be exactly opposite also when the managers have interest in showing short-
term performance to the owners to get their pay hikes. This is more prevalent and a more
dangerous situation.

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In a nutshell, there is a problem of goal congruence between the two parties. The corporate
governance policies, which aim at aligning the objectives of both the principal and agents, are
likely to resolve most agency conflicts. As we know that there are no free lunches in this world,
there are some agency costs also.

CONCLUSION
Agency theory in corporate finance is gaining momentum for all the right reasons. With
markets getting volatile as ever, it becomes imperative that both, the interests of the
shareholders and the company are taken care of. The shareholders should trust the management
of the company and go an extra mile to understand their day-to-day business decisions.
Similarly, the management should also keep the interests of the true owners of the company in
their mind. A clear communication should be sent out explaining the rationale behind major
business decisions to help shareholders understand and appreciate changes if any. A robust
corporate policy can help to keep differences at bay.

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