Corporate Governance & Ethics

Sem II

2
Key Takeaways from Samsung and Volkswagen Cases
• Samsung
• Issue with Chaebol Structure (Korean style of Conglomerate functioning)
• Lack of transparency, Under valuation (Korean Discount)
• Excessive control for promoter family (successions within family)
• Impact of organization culture on governance standards (Power Distance)
• Role of BOD in creating right culture (need for empowering the culture of flagging
risk, questioning risky decisions)
• Role of BOD in anticipating risk and creating crisis management protocols
• Volkswagen
• German governance model (Two-tier structure) – is it really effective?
• Pros and Cons of 2-tier structure of governance
• Role of workers and worker unions in governance
• Influence of promoter family
• Lack of transparency
• Competency of the regulator
• Issues with flawed policies and laxity in enforcement
• Issues of accountability of regulator
 Models of Corporate Governance
• Corporate governance systems vary around the world.

•There is no model of corporate governance which is universally

acceptable as each model has its own advantages and disadvantages.

• Three Main Models are recognized as references by experts in

Corporate Governance:
•Anglo American Model
•German Model
•Japanese Model
The-Anglo American Model
Elect
Board of Directors
Shareholders
(Supervisor)

Appoints and
supervises

Officers
Own (Manager)

Manage

Act as a
balancing Monitors &
force regulates
Creditors Regulatory/Legal
system
Company
 Anglo-American Model

• This model is also called an ‘Anglo-Saxon model’ and is used as basis of

corporate governance in U.S.A, U.K, Canada, Australia, and some common
wealth countries.

• The shareholders appoint directors who in turn appoint the managers to manage
the business. There is separation of ownership and control.

• The board usually consist of executive directors and a few independent

directors. The board often has limited ownership stakes in the company. A single
individual usually (not always) holds both the position of CEO and chairman of
the board.

•This system (model) relies on effective communication between shareholders,

board and management with all important decisions taken after getting approval
of shareholders (by voting).
The German Model
Appoint -50% Appoint 50%
Supervisory Board

Appoints and
supervises

Employees and Shareholders

Labour unions Management Board

Manages

Work for Company Own

 German Model

• This is also called as 2 tier board model as there are 2 boards viz.
The supervisory board and the management board. It is used in
countries like Germany, Holland, France, etc.

• Usually a large majority of shareholders are banks and financial

institutions. The shareholder can appoint only 50% of members to
constitute the supervisory board. The rest is appointed by employees
and labour unions.
The Japanese Model
Monitors and acts in
emergencies
Supervisory Board
Appoint (including President) Provides
members
Ratifies the President’s decision

President

Consults Main bank

Shareholders
Executive Management
(Primarily Board of
Directors)
Manages
Provides Loan
Own
Company
Owns
 Japanese Model
• This model is also called as the business network model, usually
shareholders are banks/financial institutions, large family shareholders and
corporates with cross-shareholding.

• There is supervisory board which is made up of board of directors and a

president, who are jointly appointed by shareholder and banks/financial
institutions.

•This is reflection of the Japanese ‘keiretsu’- a form of cultural relationship

among family controlled corporate and groups of complex interlocking
business relationship, where cross shareholding is common.

•Most of the directors are heads of different divisions of the company. Outside
director or independent directors are rarely found on the board.
Evolution of Corporate Governance
Guidelines/Codes
Milestones in evolution of CG Codes
Year Name of Areas/Aspects Covered
Committee/Body
1992 Sir Adrian Cadbury Financial Aspects of Corporate Governance
Committee, UK
1994 Mervyn E . King’s Committee Corporate Governance
, South Africa
1995 Greenbury Committee , UK Directors’ Remuneration
1998 Hampel Committee, UK Combine Code of Best Practices
1999 Blue Ribbon Committee, US Improving the Effectiveness of Corporate Audit
Committees
1999 OECD Principles of Corporate Governance
1999 CACG Principles for Corporate Governance in
Commonwealth
2002 Derek Higgs Committee, UK Review of role of effectiveness of Non-executive
Directors
2002 Sarbanes Oxley Act, United Corporate Auditing Accountability and
States Responsibility
Cadbury Committee
• Commissioned by FRC, UK
• Chaired by Sir Adrian Cadbury
• Reviewed CG with specific reference to:
• responsibilities of directors
• nature of accounting information required
• audit committees
• relationship between owners, boards and auditors, etc.
Key Cadbury Committee Recommendations

• Board:
• Importance of efficient board emphasised
• Separation of CEO and Chairman
• Executive Directors
• Caps on duration of service contracts
• Disclosure of remuneration
• Non-Executive Directors
• Need for greater role
• Importance of independence
• Reporting and Controls:
• Responsibility of board in relation to accounts
• Importance of supplementary narrative info.
• Audit Committee
• Need for liaising with auditor
• Inclusion of non-executive directors
OECD Guidelines on CG
• OECD is an organization of 34 member countries, founded in 1961
to stimulate economic progress and world trade.
• Enormous variations exist in ownership and control structures
across the world
• OECD principles for Corporate Governance is aimed at providing a
uniform framework for member countries to follow
• Individual member countries are to adopt these principles and
form their own codes/legislations/best practices
• First released 1999 and subsequently revised in 2004 and 2015
Core Elements of the OECD Principles
• Chapter I: Ensuring the basis for an effective corporate
governance framework
• The corporate governance framework should promote transparent and efficient
markets, be consistent with the rule of law and clearly articulate the division of
responsibilities among different supervisory, regulatory and enforcement
authorities

• Chapter II: Basic rights of shareholders and key ownership

functions
• The corporate governance framework should protect and facilitate the exercise of
shareholders’ rights

• Chapter III: Equitable treatment of shareholders

• The corporate governance framework should ensure the equitable treatment of all
shareholders, including minority and foreign shareholders. All shareholders should
have the opportunity to obtain effective redress for violation of their rights.
The OECD Principles (continued)
• Chapter IV: Role of stakeholders in corporate governance
• The corporate governance framework should recognise the rights of stakeholders
established by law or through mutual agreements and encourage active co-
operation between corporations and stakeholders in creating wealth, jobs, and the
sustainability of financially sound enterprises.

• Chapter V: Disclosure and transparency

• The corporate governance framework should ensure that timely and accurate
disclosure is made on all material matters regarding the corporation, including the
financial situation, performance, ownership, and governance of the company.

• Chapter VI: Board responsibilities

• The corporate governance framework should ensure the strategic guidance of the
company, the effective monitoring of management by the board, and the board’s
accountability to the company and the shareholders.
 Sarbane Oaxley Act 2002
• Initiated and sponsored in US by congressmen Paul Sarbanes &
Michael Oxley

• Also known as Public Company Accounting Reform and

Investor Protection Act. (Often referred to as Sarbox or SOX)
• Enacted in the backdrop of a number of corporate collapses and
frauds in late 90s and early 2000 (Enron, Worldcom and others)
• Is a federal law that set new or expanded requirements for all U.S
Public company boards, management and public accounting firms
SARBANES-OXLEY
Major Objectives

• Improve corporate governance

• Reform public accounting (auditing)
• Reform Wall Street practices
• Attack insider trading and obstruction of justice (document
retention)

“Restore confidence in capital markets”

SARBANES-OXLEY ACT
Major Provisions

• Public Company Accounting Oversight Board

• Auditor Independence

• Enhanced Board Responsibilities

• Enhanced Financial Disclosures

Creation of Public Company Accounting
Oversight Board
• Established by Sarbanes-Oxley, ending self regulation
followed by auditing firms
• Broad powers to regulate audits and auditors of public
companies
• Appointed by the SEC
• Oversight authority expended (in 2010) to audits of brokers
and dealers registered with SEC
Role of PCAOB
• Register public accounting firms
• Establish auditing standards
• Inspect registered public accounting firms
• Conduct investigations and disciplinary
proceedings – with ability to sanction
auditors and audit firms
 U.S. Securities
& Exchange
Commission (SEC)

Public Company
Corporate Board
Accounting Oversight
Of Directors
Board (PCAOB)

Independent
Audit Committee CEO & CFO
Audit Firm

Internal Audit
Function

Internal Control
System
In India
• India has an equivalent of PCAOB – National
Financial Reporting Authority (NFRA)
• Set up in 2018 (jurisdiction was carved out
of ICAI’s domain)
Auditor Independence
• Prohibits certain non-audit services
• Bookkeeping, financial systems design, appraisal or valuation, actuarial,
internal auditing outsourcing, management or human resources, broker-dealer
or investment banking, others per PCAOB
• Audit partner rotation (recommended)
• Audit Committee is directly responsible for oversight of
external auditors
• Audit committee must pre-approve all auditing and non-
auditing services
Enhanced Executive and Board Responsibilities
• Requires executives and financial officers (CEO & CFO) to certify financial
reports are accurate, complete and fairly presented
• State of internal controls also to be certified
• Audit Committee to include independent directors
• At least one member of the audit committee to be an “Audit Committee
Financial Expert”
• Audit Committee has responsibility to appoint, compensate, and oversee
public accounting firm performing the audit
• Audit Committee has responsibility to resolve disagreements over financial
reporting between management and external auditors
• Audit Committee to establish “whistle-blower” procedures with clear
penalties for any retaliation against them
Enhanced Financial Disclosures

• Off-balance sheet arrangements and obligations to be

disclosed
• Prohibits loans to executives and directors
• Insider trades to be disclosed
• Code of ethics for senior financial officers to be
adopted and status to be disclosed
CORPORATE GOVERNANCE IN INDIA
With rise of India Inc. came our share of
scams

These along with international

development led to gradual
progress of CG guidelines in
India
CORPORATE GOVERNANCE
COMMITTEES IN INDIA
Confederation of Indian Industries Code
(1997)

❖National Task Force Chaired by Rahul Bajaj.

❖Desirable Code of Corporate Governance

Recommendations
1. No need for German style two-tiered board.
2. In case of listed company with turnover exceeding Rs.100 crores, independent
directors should consist of:-
30% if Chairman is non-executive director.
50% if Chairman & MD is the same person.
3. No single person should hold directorships in more than 10 listed companies.
4. Non-executive directors should be competent and active.
5. Commission not exceeding 1% (3%) of net profits for a company with (out) a
MD.
6. Attendance record of directors should be made explicit at the time of
reappointment; less than 50% no re-appointment.
7. Key information that must be reported to and placed before the board .
8. Listed companies with turnover over Rs. 100 crores or paid-up capital of Rs. 20
crores should have an audit committee.
9. Additional Shareholders’ Information of Listed Companies.
10. Compliance certificate signed by CEO & CFO.
11. Reduction in number of nominee directors. FIs should withdraw nominee directors
from companies with individual FI shareholding below 5% or total FI holding below
10%.
Kumar Mangalam Birla Committee Report
(2000)
❑Set up by SEBI (for investors).

❑Identified 3 major constituents: Shareholders, BOD &

Management.

❑3 key aspects: accountability,

transparency, and
equal treatment of all stakeholders.

❑Introduction of Clause 49.

Recommendations
1. At least 50% non-executive members.
2. At least 1/2 of the board should be independent directors (executive
Chairman) ,else at least 1/3.
3. Non-executive Chairman should have an office and be paid for job related
expenses.
4. Maximum of 10 directorships and 5 chairmanships per person.
5. Audit Committee:
• Minimum 3 members, all non-executive.
• Chairman should attend AGM.
• Should meet at least thrice a year.
• Act as bridge between Board, Statutory Auditors & Internal Auditors
6. Remuneration Committee (at least 3 directors, all non-executive and
be chaired by an independent director).
7. Disclosure of remuneration information in the AR.
8. Board Meetings
✓4 board meetings a year with a maximum gap of 4 months between any 2
meetings.
Naresh Chandra Committee Report (2002)
❑High Level Committee appointed by Ministry of Corporate Affairs.

❑A pale shadow of SOX.

❑Also known as the “Committee on Corporate Audit and

Governance”.

❑Concentrated on 3 main aspects:-

1. The auditor- company relationship.
2. Role of Statutory Auditors.
3. Independent Directors-role, remuneration & training.
Recommendations
1. Disqualifications of Audit Assignments.
2. List of Prohibited Non-Audit Services.
3. Compulsory Audit Partner Rotation.
4. Auditor’s disclosure of Contingent Liabilities.
5. Management’s certification in the event of auditor’s replacement.
6. Auditor’s annual certification of independence
7. CEO and CFO certification of annual audited accounts.
8. Setting up Independent Quality Review Board, QRB-(ICAI, ICSI, ICWAI)
9. Defining an Independent Director & their percentage.
10. Minimum Board Size of listed companies.
11. Training of independent directors.
N R Narayana Murthy Committee Report
(2003)
• 2nd Committee constituted by SEBI.

• To review the existing corporate governance

practices and codes.

• Committee consisted of members from various

walks of public and professional life.
Recommendations
1. Training of board members.
2. There shall be no nominee directors.
3. Non-Executive Director compensation to be fixed by Board of Directors and
approved by shareholders in the GM. Independent directors should be treated
the same way as non-executive directors.
4. The Board should be informed every quarter of business risk and risk
management strategies.
5. Boards of subsidiaries should follow similar composition rules as that of parent
and should have at least one independent directors of the parent company.
6. Performance evaluation of non-executive directors should be done by a peer
group comprising the entire Board of Directors, excluding the director being
evaluated.
7. Code of conduct for Board members and Senior Management.
8. Whistle Blower Policy.
Naresh Chandra Committee (2009)

❖2nd National Task Force by CII.

❖Formed with the backdrop of Satyam-Maytas Infra-

Maytas Properties scams.

❖Aim of improving corporate governance standards

and practices both in letter and spirit.
Recommendations
1. Nomination Committee.
2. Letter of Appointment to Directors.
3. Remuneration of NEDs & Independent Directors.
4. Remuneration Committee.
5. Audit Committee.
6. Separation of Offices of Chairman & Chief Executive Officer
7. Board Meetings through Tele-conferencing
8. Liability of Directors & Employees
9. Shareholder Activism
10. Media as a stakeholder
Uday Kotak Committee 2017

• https://www.mondaq.com/india/corporate-
governance/875864/analysis-of-kotak-committee-
recommendations-on-corporate-
governance#:~:text=The%20Committee%20recommended
%20that%20all,effect%20from%20April%201%2C%202022
.
• https://taxguru.in/sebi/implementation-kotak-committee-
recommendations-closer-corporate-governance-
practices.html#:~:text=The%20new%20measures%20are%
20based,of%20listed%20companies%20in%20India.
Many recommendations adopted and turned
into regulations/Norms

• Companies Act 2013, (plus amendments)

• Amendments to Clause 49 by SEBI
 Takeaways from Yahoo Case
• Executive Remuneration
• Various components used in executive remuneration (Pros and Cons
of these)
• Sign on bonus, Stocks options, Golden Parachutes
• Role of Remuneration committee (and BOD)
• Role of shareholders (Say on Pay)
• Role of regulators – should regulators play any role in decisions
related to pay for executives?
• Guiding rules for Indian corporate houses for executive remuneration
• Need for good governance practices
• Benchmarking, seeking help from consultants, disclosures, linking pay to
individual performances, deferred pay-outs, claw back clauses
 Takeaways from Tata Sons Case
• Excessive control by promoter families (or by influential
personalities)
• Issues with holding company structures
• Need for succession planning
• Lack of powers for independent directors
• Frequent amendments to AoA (can be considered a bad
governance practice)
• Need for good governance practices
• Clear & proactive succession planning
• Options to empower independent directors (super voting, assured
tenures)
CG Norms as per Companies
Act 2013
 Composition of Board & Tenure
• Types of Directors
• Woman Director (Required for public company with capital > 100 Cr or
Turnover > 300 Cr)
• Nominee Director (Nominated by any institution, not considered
independent)
• Resident Director (Every company must have a director who has stayed
in India for at least 6 months in previous year)
• Independent Director (Required for all public companies with paid up
capital > 10 Cr or turn over > 100 Cr or Outstanding borrowings > 50 Cr)
• Additional Director – Can be appointed by BOD through resolution
• Alternate Director – Appointed in place of any director during his/her
absence
 Composition of Board & Tenure

• Number of Directors
• Limit of 15 directors, shareholder approval through special resolution for
more
• Inclusion of at least one woman director
• Min 3 directors a public company, 2 for a privately held company
• Min 6 directors in case of top 2000 listed entities
• Majority of audit committee members should have ability to read and
understand financial statements
• In case of non-executive chairman, board should have minimum 1/3rd IDs
• In case of executive chairman, 50% of board to be IDs
• Top 500 listed entities to split the roles of Chairman and MD/CEO by April
2022 (deferred from earlier deadline of April 2020)
 Composition of Board & Tenure

• Tenure
• Managing Director or Whole Time Director can be appointed for a period
of 5 years
• Additional directors are appointed till next AGM
• Alternate Directors hold position till return of person they are replacing
• No Age limit
• 2/3rd of BOD is liable to retire by rotation. 1/3rd of those liable to retire by
rotation shall retire every AGM
• Independent directors appointed for 5 years, terms can be extended by
another 5 years. Cooling off period of 3 years afterwards
 Independent Directors
• Qualifications/Criteria for one to be considered an ID
• Independent director shall possess appropriate skills, experience and
knowledge in one or more fields of finance, law, management, sales,
marketing, administration, research, corporate governance, technical
operations or other disciplines related to the company's business
• None of the relatives of the ID shall be indebted to the company, its
holding, subsidiary or associate company or their promoters, or directors;
or has given a guarantee or provided any security in connection with the
indebtedness of any third person to the company, its holding, subsidiary
or associate company or their promoters, or directors of such holding
company.
• Director Identification Number (DIN) required, issued by central
government to an individual
• Databank of qualified IDs authorised by MCA (Maintained by Indian
Institute of Corporate Affairs) may be accessed
 Independent Directors
• Compensation should not be through grant of stocks
• IDs need to undergo training
• Nomination committee to laydown performance evaluation criteria for
IDs
• One individual can not hold directorship in more than 20 companies,
not more than 10 in case of public companies
• In case of listed companies, (SEBI Clause 49) – one individual can
be ID in max 7 companies if he/she does not have a WTD position
and 3 if he/she holds WTD position in any listed company.
 Sub Committees
• Audit committee
• Applicable for listed companies and public companies with paid-up share
capital > 10 crores or turnover > 100 crore or outstanding borrowings > 50 crore
• Minimum 3 directors with majority being IDs
• All members should have ability to read and understand financial statements
• Nomination and remuneration committee
• 3 or more Non Exec Directors out of which not less than one half shall be IDs
• The chairperson of the company (whether executive or non-executive) may be
appointed as a member of the Nomination and Remuneration Committee but
shall not chair such Committee.
• Identify persons who are qualified to become directors and who may be
appointed in senior management in accordance with the criteria laid down
• Recommend to the Board their appointment and removal and carry out
evaluation of every director’s performance
• Committee should specify a methodology for effective evaluation of the
performance of the board, its committees and individual directors. The
evaluation could be carried out by either the board, the NRC or an independent
external agency. The NRC will review the implementation and compliance of the
evaluation system.
 Sub Committees
• CSR Committee
• Mandatory for public / private companies with profit >5Cr or Net Worth >
500 Cr or Turnover > 1000 Cr
• To include 3 or more directors
• At least one independent director
• Unlisted company/private company with no ID can constitute CSR
committee without an ID
 Meetings

• Minimum 4 meetings in a year. Maximum gap between two meetings

to be 120 days
• At least one meeting exclusively of IDs in a year
• Small Companies – At least one meeting in each half of calendar
year. Minimum gap between two meetings to be 90 days
• Meetings may be conducted through video conferencing. However,
certain matters like approval of financial statements, approval of
mergers/amalgamation/acquisition etc. are not to be dealt with
through video conferencing
 Other Norms
• Auditors
• Appointed for 5 years, ratification in AGM every year
• Auditor can be appointed for only 2 terms of 5 years (if auditor is a firm)
and one term of 5 years (if individual)
• New auditor appointed should not have any partner(s) in common with
outgoing auditor
• Auditor is not allowed to render other services to the company directly or
indirectly
• Norms and guidelines on Related Party Transactions
• Compulsory whistle blowing mechanism
• Compulsory electronic voting for all shareholder resolutions
 Amendments 2020

• AmendmentAct_29092020.pdf (mca.gov.in)
• https://taxguru.in/company-law/companies-amendment-act-2020-
highlights-amendments.html
• Analysis of the Companies Act, 2020 - Corporate Professionals
 Additional References
• Corporate Governance Norms in India - Overview
• https://content.next.westlaw.com/0-506-
6482?__lrTS=20200913184235743&transitionType=Default&contextData=(sc.De
fault)&firstPage=true
• Role of BOD, types of directors, responsibilities
• http://www.mca.gov.in/MinistryV2/management+and+board+governance.html
• https://www.legalwiz.in/blog/types-of-directors-in-a-private-limited-company
• https://accountlearning.com/roles-duties-responsibilities-of-board-of-directors/
• Corporate Governance Issues Regarding Remuneration of Executive
Directors in India
• http://www.legalservicesindia.com/article/2235/Corporate-Governance-Issues-
Regarding-Remuneration-of-Executive-Directors-in-India.html

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