1a.

Contributions to economy

• Corporations create jobs and income

• Produce goods and services
• Create wealth
• Fill up the space of State
Corporation :Adverse consequences

• Violations of law
• Corporate Failures
• Financial Scams
• Adoption of Unethical Practices
• Monopolizing economic resources
• Obsession for Profit
• Low concern for society
• Low concern for environment
Need for CG

(i) Wide Spread of Shareholders:

•Today a company has a very large number of shareholders
spread all over the nation and even the world; and a majority of
shareholders being unorganised and having an indifferent
attitude towards corporate affairs. The idea of shareholders’
democracy remains confined only to the law and the Articles of
Association; which requires a practical implementation through
a ethical conduct and sound corporate governance.
(ii) Changing Ownership Structure:
•The pattern of corporate ownership has changed considerably ;
institutional investors (foreign as well Indian) and mutual funds
becoming largest shareholders in large corporate private sector.
These investors have become the greatest challenge to
corporate managements, forcing the latter to abide by some
established code of corporate governance to build up its image
in society.
(iii) Corporate Scams or Scandals:
• Corporate scams (or frauds) in the recent years of the past have
shaken public confidence in corporate management. The event of
Harshad Mehta scandal, which is perhaps, one biggest scandal, is in
the heart and mind of all, connected with corporate shareholding or
otherwise being educated and socially conscious .
• The need for corporate governance is, then, imperative for reviving
investors’ confidence in the corporate sector towards the economic
development of society.
 
(iv) Greater Expectations of Society of the Corporate Sector:
• Society of today holds greater expectations of the corporate
sector in terms of reasonable price, better quality, pollution
control, best utilisation of resources etc. To meet social
expectations, there is a need for a code of corporate
governance, for the best management of company in
economic and social terms.
(v) Hostile Take-Overs:
• Hostile take-overs of corporations witnessed in several
countries, put a question mark on the efficiency of
managements of take-over companies. This factors also points
out to the need for corporate governance, in the form of an
efficient code of conduct for corporate managements.
 
(vi) Huge Increase in Top Management Compensation:
• It has been observed in both developing and developed
economies that there has been a great increase in the monetary
payments (compensation) packages of top level corporate
executives. There is no justification for exorbitant payments to
top ranking managers, out of corporate funds, which are a
property of shareholders and society.
• This factor necessitates corporate governance to contain the ill-
practices of top managements of companies.
(vii) Globalisation:
• Desire of more and more Indian companies to get listed on
international stock exchanges also focuses on a need for
corporate governance. In fact, corporate governance has become
a buzzword in the corporate sector. There is no doubt that
international capital market recognises only companies well-
managed according to standard codes of corporate governance.
Governance vs Management

• Governance : strategic task of setting the

corporation's vision & goals
-Exercise of leadership functions
-Board of Directors : accountable to the
shareholders.
-Long term Policy issues
• Management : overseeing day-to-day activities.
- Exercise of operational functions.
-Short term operations
• Sometimes overlap : Lack of clarity or in
emergency
 H o u s e o f Lo rd s J u d g m en t (1 8 9 7 )

1. The court held in favor of Salomon

2. The company was duly constituted in law . The fact that
the shareholders were all related to Salomon was
irrelevant in determining that the corporation
legitimately existed as a separate entity
3. The individual shareholders were not held liable for the
debts of the corporation.
4. The court (House of Lords) held that Salomon deserves
the money because he is a secured creditor
5. Doctrine of Corporate personality:
This doctrine was upheld .Under Companies Act ,
company is a different person, altogether separate from
shareholders.
Book Corporation : Joel Bakan

• Corporation is a group of individuals

working together to serve a variety of
interests, the principal one of which is to
earn growing sustained legal profits for the
people who own it.

• A legal entity separate from the

shareholders and employees
What is a 'Corporation'

• A corporation is a legal person that is separate

and distinct from its owners.
• Corporations enjoy most of the rights and
responsibilities that an individual possesses
• Corporation has the right to enter into contracts,
loan and borrow money, sue and be sued, hire
employees, own assets and pay taxes.
• It is a "legal person” - A “ legal fiction”.
• Corporation does not dissolve when its owners
and shareholders change or die
• SEBI committee on corporate governance (2003) chaired
by N R Narayan Murthy
Defining CG: “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”.
• Corporate governance refers to the set of
systems, principles and processes by which a
company is directed and controlled such that
it can fulfill its goals and objectives in a
manner that adds value to the company and
is beneficial for all stakeholders in the long
term.

“Corporate Governance is about promoting

corporate fairness, transparency and
accountability”
—James D. Wolfensohn
 Corporate Governance Models

Corporate governance frameworks differ across the world .

Three primary models exist in contemporary corporations:
• Anglo-Saxon model,
• the continental model
• Japanese model.
The Anglo-Saxon model is oriented toward the stock
market, while the other two focus on the banking and
credit markets.
The Anglo-Saxon Model
• The Anglo-Saxon model developed in Great Britain and the
United States.
• In this model the board of directors and shareholders
exercise primary control over the corporation.
• Managers are assigned duties by the board.
• The board in turn is accountable to shareholders in the
general body meeting of shareholders who as the owners
vote and elect directors of the company .
• Shareholder structure is dispersed in the markets.
The Continental Model
• In the continental system, prevalent in the mainland
Europe
• Banks often play a large role in corporate decision making
• Special protections are offered to creditors.
• Companies usually have two tier governance structure
with an executive board and a supervisory council.
• The executive board controls corporate management; the
supervisory council controls the executive board.
Government and national interests exercise strong
influences in the continental model.
The Japanese Model
• Japanese model is based upon concept of
"keiretsu,“ which is a conglomeration of businesses
linked together by cross-shareholdings to form a
robust corporate structure.
• Keiretsu is a business network composed of
manufacturers , distributors and financiers who
work closely together to ensure each other’s
success.
• Keiretsu means “group.”
 
 Shareholders vs Stakeholders

A shareholder owns part of a public company through shares , while a

stakeholder has an interest in the company for his stake in the
company.
Stakeholders can be owners and shareholders ,employees customers
suppliers and vendors , community& society
Shareholder Theory
vs. Stakeholder Theory

• Shareholder theory corporate managers

have a duty to maximize shareholder returns.
Economist Milton Friedman introduced this
idea (1970) , which states a corporation is
primarily responsible to its shareholders.
• Stakeholder theory, on the other hand, notes
that it’s the business managers ethical duty
to both corporate shareholders and other
stakeholders including society and
community at large and that the
corporations should be responsible to the
stakeholders
Shareholders

• A shareholder can be individual, company, institution owning share(s)

in company
• Shareholders are owners of the company
• Shareholder has a financial interest in profitability of company
• Shareholder expects rise in stock price to increase value for his wealth
• Shareholders have the right to vote elect Directors of company
• They exercise control over the management of the company. 
• They are not liable for the company’s debts.
• A shareholder can sell shares and buy shares of new companies
• They invest & receive dividends
• Shareholders have right to get information on publicly traded
companies
• They can sue the company for a violation of fiduciary duty
Shareholders are always stakeholders in a corporation, but
stakeholders are not always shareholders
Stakeholders

Stakeholders can be owners and shareholders ,employees

customers suppliers and vendors and the community/ society.
• Stakeholders are bound to the company for a longer term need.
• Employees of company are stakeholders and rely on it for income
• Emergence of corporate social responsibility has encouraged
companies to take the interests of all stakeholders into
consideration.
• Companies are under obligation to consider their impact on the
environment instead of making choices based solely upon the
interests of shareholders.
• Shareholders are always stakeholders in a corporation, but
stakeholders are not always shareholders. 
Shareholders have a legal bond with the company; stakeholders
have an ethical bond with company
Shareholders vs Stakeholders

• What is the difference between a shareholder and a

stakeholder?
• A shareholder owns part of a public company through shares of stock ,
while a stakeholder has an interest in the performance of a company for
reasons other than stock performance or appreciation.
• Shareholders are stakeholders ; not vice versa
• Shareholders establish the company or become owners subsequently;
stakeholders other than shareholders do not own the company.
• Shareholders have legal rights individually due to their shares; stakeholders
have no legal rights .
• Shareholders have a legal involvement concerning the business to directly
affect a company’s policies and actions; stakeholders can affect the
company in an indirect manner like non cooperation & resistance
• Company has only ethical duties towards stakeholders. ( CSR in India has
made some difference; but even CSR law treats stakeholders as a group
like society & community )
• Shareholders are the owners of the company; Stakeholders are the
interested parties who affect or gets affected by the company’s
policies and objectives.
• Shareholders are a part of the Stakeholders. It can also be said that
shareholders are stakeholders, but the stakeholders are not
necessarily the shareholders of the company.
• Shareholders give emphasis on the return on their investment made
in the company. On the other hand, Stakeholders focuses on the
performance, profitability, and liquidity of the company.
• Only the company limited by shares have shareholders. However,
every company or organization have stakeholders, whether it is a
government agency, nonprofit organization, company, partnership
firm or a sole proprietorship firm.
• Not only business entity has stakeholders, but every organization
irrespective of its size, nature, and structure are accountable to
Stakeholders.
 The Tripod
Corporation is tripod of:
 Shareholders
 Management (led by CEO)
 Board of Directors
 Board governs the company
On behalf of Shareholders
Assigning duties to Managers.
Directors vrs Shareholders (Contd…)
The court ruled against the shareholders.
“As long as the decision was made without an
element of fraud, illegality or conflict of interest,
and if there was no showing of damage to the
corporation, then such questions of policy and
management are within the limits of director
discretion as a matter of business judgment.” the
court ruled.
FUNCTIONS OF THE BOARD
• Good Governance
• Growth and profits .
• Independent and objective decisions
• Responsible and accountable
• Ensure effective internal financial controls.
• Fairness and transparency
• Informed Decision making
• Redress shareholders’ grievances.
• Adequate reporting to the shareholders
• Effective monitoring of managers.
• Independent audit
• Faithful reporting of financial health of the company.
25
Role of Directors
• Bring wider business
experience & expertise •Provide independent
• Adding skills and knowledge judgment
• Source of external market •Monitor Executive
information activities
• Be an ambassador of the •Be a watch dog
company •Be a sounding board for
• Networking with useful Chairman
people & institutions
• Add reputation to the
Board
Attributes of Directors

• Primary prerequisite of a Director is INTEGRITY

• Directors are stewards of the shareholders
• Be ethical, honest , fair ,trustworthy
• No conflict of interest with the company
• Acting for the Co., not self interest
• Resisting temptation to make personal gain to the
detriment of Co.
• Bring experience ,skills and knowledge to the board
Seven ‘C’ for Directors

An Effective Board should be a balanced team led by social

and ethical leadership of an experienced and mature Chairman.

Board members should possess seven ‘C’ of board behavior

• Competence
• Commitment
• Character
• Courage
• Collaboration in the team
• Creativity
• Contribution
 ID-Rationale 4a
• Board is to monitor and supervise
managers on behalf of shareholders
• Board of Directors is seen as a control
mechanism to monitor managerial activities
hence, it should be independent of the
company’s management and shareholders
• The number of outside independent
Directors should be large
 Functions of IDs 4a

1. Provide independent judgement

2. Source of wider perspective
3. Bring experience and expertise to Boardroom
4. Balance the conflicting interests of stakeholders.
5. Facilitate withstanding pressures from owners.
6. Act as mentor and sounding board for the Board
7. Growing role in Board sub committees

30
4b. Role of ID in satyam scandal:
• Checking the increasing PAT margins(unusual
gains)
• Monitored the acquisition of Maytas infra.
• Monitored the false claim of profits made to the
public and shareholders.
• Check the auditing Process.
• Check on the auditing fees paid to PWC.
4b (Contd.)

• An individual independent director cannot play an effective role in

isolation. Even if a particular independent director is highly
committed, she can only ‘watch’ wrong doing and at best initiate a
discussion, but alone she cannot stop a decision even if it is
detrimental to the interest of shareholders or other stakeholders.
Neither can she blow the whistle outside the board room (e.g. to
regulators) because board proceedings are considered confidential.
• The only way independent directors can stop wrong decisions is by
acting collectively. Even then they can seldom be expected to stop
‘management fraud’ since turning independent directors into
policemen in the board room will have excessive detrimental effects
on the independence of directors, the freedom of enterprise of the
managers and the costs of governance.
Qualities & Competencies of IDs

1. Eminent Persons, preferably professionals

2. No conflict of interests with company
3. Independent of management &shareholders
4. Objective and independent perspective
5. Attitude of “constructive dissatisfaction”
6. Empower the Board to control managers
7. Help financial accuracy transparency
disclosures
SEBI

Who is an ID?

• 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,
which in the judgement of the Board may
affect their independence of judgement.

34
3a. Composition of Board I
• Board of the company shall have an
optimum combination of executive and
non-executive directors with at least:-
one woman director; and
50% of the Board comprising of non-
executive directors.

35
 Board Composition II

1.Executive Chairman:- at least 50% of

Board should comprise of IDs.
2.Non-executive Chairman:- at least 1/3 of
Board should comprise of IDs;
3.If non-executive Chairman is a promoter
or is related to any promoter or person
occupying management positions at Board
level or at one level below Board, at least
50% of Board shall consist of IDs.
Board Composition III

1. Chairman/CMD
2. Managing Director/CEO
3. Executive /Full Time Directors.
4. Non Executive Nominee Directors (by Promoter)
5. Non Executive Independent Directors
6. Woman Director
7. Company Secretary ( No voting power)

37
 MERIT OF SEPERATION BETWEEN Chairman and CEO.

• Board of directors votes to increase executive pay. When the CEO is also the
chairman, conflict of interest  arises, as the CEO is voting on his own
compensation .
• The Chair –cum-Managing Director becomes very powerful .He can
influence the activities of the board by abusing his position.
• CEO is head of management, responsible for driving the operations of the
company. A combined position results in monitoring oneself, which results
in conflict of interest.
• A board led by an independent chair may identify and monitor areas of the
company that are drifting from its mandate and take corrective measures
• The Audit committee need to be independent. This committee reports to the
chair Having the CEO in the chair limits the effectiveness of the committee.
• This is especially true for the whistleblower clause. When the board is led by
management, employees may be less likely to report such activities and the
audit/ ethics committee may be less likely to act on such reports.
• In the most common argument based on agency theory, the separation of
the chair and CEO roles increases the board’s independence from
management and thus leads to better monitoring and oversight.
• One of the jobs of the chairman is to monitor CEO's work. When a chairman
happens to be CEO also it means that the CEO is put in the position of
evaluating his own performance.
• If the roles are not separated it may cause concentration of power
and reduce the independence of the Board.
• Board has power to appoint and remove the CEO. If posts are not
separated , it may create conflict of interest .
• The function of the chairman is to run board meetings and oversee
the process of hiring, firing, evaluating, and compensating the CEO.
CEOs cannot perform these duties impartially.
• Splitting the positions guarantees a more reasonable span of control.
• However some argue for combining the two
positions on following grounds :
• The CEO's has a clear vision of the strength and challenges and
opportunities facing the organization. Separating the CEO and
Chairman position sometime can cause information asymmetry
between them.
• Splitting the titles can dilute CEO and Chairman's power . There may
be power clashes. Separation of CEO and Chairman position can also
create the potential for rivalry, ego clashes between the separate title
holders
• Combining the two posts may help faster decision making and
effective control over the executives
• Separate Chairs Aren’t Necessarily Independent
• No Established Relationship between a Separate Board Chair and
Corporate Financial Performance
• However,In recent years, companies have consistently moved toward
separating the chairman and CEO roles. According to Spencer Stuart,
just over half of companies in the S&P 500 Index are led by a dual
chairman/CEO, down from 77 percent 15 years ago.
•  In theory, an independent chairman improves the ability of the board
of directors to oversee management.
• However, separation of the chairman and CEO roles is not
unambiguously positive . Still, shareholder activists and many
governance experts remain active in pressuring companies to divide
their leadership structure.
 BURSTING OF SOUTH SEA BUBBLE
• South Sea Co.-British Jt. Stock co. in S America-18th century
• Big economic bubble
• Frenzy/Fashion for stocks-peasants , lords , MPs , King’ circle
• Favoritism , fraudulence ,manipulations in company’s affairs
at the highest level
• High share speculation (1720-Jan. £ 128;May £ 550)
• Stock crashed 1720;People lost money ; mob fury ,suicides
,arrest of Directors ,sacking Chancellor , criminal cases &
punishment
• “I can calculate movement of stars , not madness of people”
• Parliament recalled-Royal Exchange & London Assurance
Corporation Act 1720- Co.s to take permission for public share
• “Enron of England”-Adam Smith warned- dangers of ‘no’ limit
Co.s
43
 Watergate Scandal: Foreign Corrupt Practices Act

• June 17,1972- Breaking Democrat office-Inquiry FBI/Senate

show fraud ,tax evasion ,secret funds, corruption at high
places-Resignation of Nixon
• Over 400 US Co.s - 117 Fortune 500 Co- ( Lockheed, North
corp , Gulf Oil) confessed illegal payments to foreign officials to
secure business
• $ 300 m paid out of corporate funds as bribe to foreign officials,
politicians to get favors –serious misconduct ,accounting
irregularities
• US Congress-Dec 1977-Foregn Corrupt Practices Act
-Ban on bribery of foreign officials to secure business
• First US federal law on corporate affairs- ‘Seed’ of modern CG

44
 The Maxwell Scandal: Cadbury Reforms

• Maxwell’s abuse of power-’greatest’ fraud of 20 century

• Built corporate empire (Maxwell Communication & Mirror
Newspapers)
• Too much loan , fraudulent activities- to survive
• To finance other activities & lavish living style ,
stole £ 727 m from pension funds/ other assets
• Disclosures led to crash of Co.s - £ 1 bn value lost
• Issues /1-Combining posts of Chairman with CEO–too much
power,2-Failure of non-executive Directors,3-Failure of
Auditors, 4-Lack of corporate ethics
• Public outcry-other Co.s?-London St. Ex. appoints Cadbury
Committee-first written modern CG Code
45
 Cadbury Code of best practices

First modern Code of CG

A. Board of Directors.
• Board to retain full control over company.
• Division of responsibilities and authority to avoid
concentration of power.
• Induction of non-executive Directors of caliber.
• Specify schedule of matters reserved for Board.
• Directors may take independent professional advice.
• Company Secretary to advice all Directors.
46
CADBURY CODE…

B. Non-Executive Directors.

• To ensure independent judgment.

• Majority should be independent of
management with no conflict of interests.
• Appointment for specific terms.
• Selection through formal process by whole
Board.

47
CADBURY CODE…

C. Code of Best Practices for Executive Directors.

• Service contract for 3 years with shareholders’

approval.

• Full disclosure of details of emoluments and packages.

• Committee of non-executive Directors to decide

Director’s emoluments.

48
CADBURY CODE…

D. Reporting and Controls.

• Board to present balanced assessment of

company.
• Professional relationship with auditors.
• Audit Committee of non-executive Directors.
• Directors responsible for reporting and accounts.
• Directors to report on effectiveness of internal
controls.

49
 Rise and Fall of ENRON
• 1985 Regional Company to world’s largest energy trader
by 2000.
• 874 partnerships - The most innovative Fortune
company for 5 consecutive years (1996-2000)
• August 2001: CEO Resignation - First fall in Enron Shares
• Sherron Watkins VP corporate development-Whistle
blower role
• Disclosed more debts and dubious dealings.
• Credit rating down graded : Share to junk status.
• 85% fall in share in a single day (Nov. 28. 2001)
• 2001 Enron files for bankruptcy.
50
ENRON …

Causes and Consequences

• Biggest American Co. to go bankrupt.

• All shares/ investment almost wiped out.
• Collusion with accounting firm Arthur
Andersen (One of best Five ).
• Failure of stock analysts / rating agencies.
• Failure of the company’s Board of Directors.

51
 ENRON : Board Responsibilities

Justify(2a)
• Directors played fraud with the company.
• 10 of 15 outside Directors had conflict of interests with Enron.
• Directors had contracts with Enron.
• Director in Companies doing business with Enron.
• Board suspended Code of Conduct :CFO allowed to have
dealings with Enron.
• The Board gave “green light” to the CFO instead of raising “a
red flag”

52
 STEPS (ENRON)
2B.
1.There should be a presence of ID in the board.
2. The existing executive shouldn’t have been given much of a power.
3. The auditors should have worked independently and not under the control of the
management.
4. The company shouldn’t have changed its performance review system from
respect,integrity,communication, excellence to profit.
5. Board would n’t have given the green light to the CFO an raise the red flag.
6. Directors of Board wouldn’t have done business with enron
7. Board should n’t suspend the code of conduct.
8. Board wouldn’t have followed the Rules and Regulations if Corporate
Governance.
 Enron : Accountability of Board
• Lieberman , US Senate Committee (May 7, 2002).
“ Board did not just fiddle while Enron burned, they
toasted marshmallows over the flames”.
• Directors failed the shareholders.
• Directors’ accountability and responsibility.
• Question of conflict of interests of Directors .
• Directors must be shareholders’ first line of defense.

54
Enron : Causes of Failure

• Dubious Role of Special Purpose Entities: Hiding losses

• Mark to Market accounting
• Creative Accounting
• Conflicts of interest : Directors & top teams
• Political lobbying : Government Role
• Understating losses
• Inflating profits
• Misleading financial statements
 Enron : Causes of Failure (Contd.)

• Dubious role of Independent Directors

• Ineffective Audit & Compensation Committees
• Collaboration & collusion with Auditor -AA
• Related party transactions
• Weak regulatory body SEC
• Collusion with rating agencies
• Violations of Code of Ethics
• Huge executive pay & stock options
• Treatment of whistleblower
 The Satyam Fraud: ENRON of India

• January 7, 2009 – CEO Satyam’s confession

• fraud, manipulation of accounts
• falsification of financial statements,
• misleading shareholders, investors and creditors for
seven consecutive years .
-“It was like riding a tiger ,not knowing how to get off
without being eaten.”
• Inflating revenues and profits to show better than actual
performance
• Inflate share prices.

57
Satyam Failure : Causes

• Hiding losses
• Creative Accounting
• Conflicts of interest : Directors & top teams
• Political lobbying : Government Role
• Understating losses
• Inflating profits
• Misleading financial statements
• Dubious role of Independent Directors
• Ineffective Audit & Compensation Committees
• Collaboration & collusion with Auditor
• Related party transactions
• Weak regulatory body SEBI
• Collusion with rating agencies
• Violations of Code of Ethics
• Insider trading
• Unethical involvement of family in business
• Acquisition of MAYTAS
• Huge payouts to fake roll of employees
 Satyam Fraud : Challenges

• Biggest corporate scandal of India

• Need for new regulations
• Corporate Ethics
• Shareholders activism
• Role of Directors/ Managers/Independent
Directors
• Credibility of Auditors
• Issues of Disclosures and information to
shareholders
60
 Volkswagen case: Issues & Challenges

• Was the scandal the work of few isolated executives or

involved large number of Managers and supervisors ?
• Element of confidentiality makes judgement difficult
• Yet, initial reaction was that the scandal was isolated work of
few executives(9)
 Later it appeared to be bigger and involved many
( 50 , by confession)
• Resignation of CEO Martin Winterkorn
• Reason given by Company : emission norms were very
strict ? So there was compromise by installing defeat
device !
Consequences of the Violation
• Court case in USA
• Former CEO charged with criminal offence in USA
• Possible extradition of CEO to USA ?
• Out of 11 m cars 6 lakhs sold in USA
• Huge penalty
• Huge replacement costs
• Huge fall in share price of Volkswagen
• Suit by shareholders against company
• Loss to employees ( fall in bonus /incentives etc)
• Loss of face
• Fall in brand value
• Fall in car sales
• Increase in pollution levels
• Adverse effects on health of customers and general people
Causes !
• Corporate Work culture is responsible !
• Compliance based culture: employees must
comply at any cost
• Autocratic, rule bound
• Do it or leave job
• Employees face ethical dilemma : no solution !
• No dissent or discussion- no thinking !
• Value based approach recommended
• Little attention to ethical issues
• No solution to ethical dilemma cases
Boardroom Revolution :
Role of Independent Directors
• Focus of authority has moved from the chief
executive and the top management team to
the board of directors, especially the non-
executive IDs
• Rise in independence of the Board of Directors.
-Boards are becoming more independent of
management.
-Power is being transferred from chief executives
to board committees.
-Outside directors are being required to do a
more professional job.