Unit III: Introduction to Corporate Governance

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Concept of Corporate:

➢ Corporate is adjective meaning “Of or relating to a Corporation” derived from the noun Corporation.

➢ A Corporation is an organisation created (incorporated) by a group of shareholders who have ownership of

the corporation.

➢ The elected Board of Directors appointed by the shareholders and oversee management of the corporation.

Concept of Governance:

➢ The term “governance” is derived from the Latin word gubernare, meaning to “to steer”.

➢ The word has Latin origins that suggest the nation of “steering”. It deals with the processes and systems by
which an organisation or society operates.

➢ Oxford English Dictionary defines “Governance” as an act, manner, fact or function of governing , control.

➢ Governance is concerned with ways of bringing the interest of investors and managers into line and
ensuring that firms are run for the benefit of investors.

Meaning and Definitions of Corporate Governance:

1. It is generally understood as the framework of rules, relationships, systems and processes within and by which
authority is exercised and controlled in corporations.

2. The Cadbury Committee Report defines,

“The system by which companies are directed and controlled.”

3. According to ICSI defines,

“Corporate Governance is the application of best management practices, compliance of law in true letter and
spirit and adherence to ethical standards for effectve management and distribution of wealth and discharge of social
responsibility for the sustainable development of all stakeholders.”

Evolution and Historical Perspective of Corporate Governance:

➢ As we all know that Corporate Governance is a new buzzword in the corporate jargon.

➢ The concept has emerged over the last two decades.

➢ When it is required by the companies to do timely and accurate disclosures on all materials matters relating
to material aspects of the corporations, and then many reports have been submitted by various committees
established around the world.
 ➢ The concept of Corporate Governance gained prominence towards the end of 20th century, particularly in
the year 1980 and onwards, many UK corporations in the late 1980s and the early 1990s have been come
across corporate and financial crisis.

For Example: BCCI, Pollypeck, Pension funds of Maxwell Commission.

➢ Many of the companies have rightly collapsed and closed down.

For Example: Enron, Worldcom, Questm Global Crossing and KPMG.

The reasons which have been accounted are –

(i) Fraudulent Practices.

(ii) Improper compliance of Financial Reporting.

(iii) Mis- Reporting of Financial aspects.

(iv) Mis-appropriation of accounts.

(V) Falsification of documents.

(Vi) Defraud of financial aspects.

➢ To bring reforms and strengthen the legal framework, three important acts have been introduced in the
world –

▪ Securities and Exchange Commission of US.

▪ The Sarbanes Oxley Act in June 2002.

▪ Treadway Commission Report.

➢ In India, many reasons have been accounted for the corporate failures and collapse, reasons are –

❖ Criminal Malfeasance.

❖ Defraud of Financial aspects.

❖ Failure of Audit Committee.

❖ Fraudulent financial reporting and practices.

❖ Bankrupties.

❖ Financial Crisis.

➢ Then, to bring reforms and regulate the operations, most important Committees, Acts and Boards have been
set up, namely –

❑ Confederation of Indian Industries (CII).

❑ Securities and Exchange Board of India (SEBI)

 ❑ Clause 49 of Listing Agreement.

❑ Kumar Mangalam Birla Committee.

❑ The Companies amendment act of 2000.

Need and Importance of Corporate Governance:

❑ 1. To develop Ethical Conduct.

❑ 2. To improve the economic efficiency.

❑ 3. To enhance the value and good image.

❑ 4. To bring effective monitoring and control of the affairs of the company.

❑ 5. To strengthen the management.

❑ 6. To safeguard the interest and integrity of the investors.

❑ 7. To bring separation of the position of a Chairman and Chief Executive Officers.

❑ 8. To maximise the shareholders wealth.

❑ 9. To reduce risk of the investors and effective Internal control.

❑ 10. To create Transparency and Accountability.

Theories of Corporate Governance:

1. Stakeholders Theory:

➢ In every company, only shareholders are not important, but also take into account a wider group of
constituents i.e., Stakeholders.

➢ Stakeholders are nothing but a particular category of people who are affected and be affected by the
actions of decisions of the company.

➢ Stakeholders are also play a major role in the affairs of the company.

➢ Because, corporate Governance should increase the long term enhancement of various stakeholders.

2. Stewardship Theory:

➢ In every company, the shareholders cannot take active part in the day to day affairs of the company, for
that reason they have appointed their representatives i.e., Board of Directors.

➢ Board of Directors have been given some authorities and responsibilities and can be used only for the
benefit of the shareholders.

➢ The management should not be placed under the control of owners.

➢ Some Independent CEO are to be appointed to make autonomous actions.

➢ Even Non-Executive Directors should be appointed.

3. Agency Theory:

➢ This theory is based on the Principal-Agent framework.

➢ There is a Separation of Ownership & Management.

➢ It has focused on the Agency Problem.

➢ Some Agency Costs are do not incurred by the shareholders.

Corporate Governance Mechanism

Introduction:

➢ Separation of ownership and management.

➢ To reduce the ineffectives i.e., wrong selection of Board of Directors.

➢ To monitor and control the unethical behaviours i.e., crossing the lines and manipulating the revenues.

Meaning:

“Corporate Governance Mechanism is nothing but adoption of suitable measures and taking some corrective
actions to control and monitor the affairs of an organisation.”

Types of Corporate Governance Mechanism:

1. Internal Corporate Governance Controls.

Controlling measures are –

1. Monitoring by the board of directors.

2. Monitoring by the shareholders.

3. Internal Control procedures and appointment of internal auditors.

4. Balance of Powers.

5. Remuneration.

2. External Corporate Governance Controls:

1. Appointment of External Auditors.

2. Debt Covenants.

3. Government Regulations.

4.Demand for and Assessment of performance

information.

5. Competitors.

6. Stakeholders.
e-governance: ( i.e. Electronic Governance)

Meaning:

“It is the application of ICT (Information & Communication Technology) for deliverying government services,
exchange of information, communication of transactions and integration of systems and services between G2C, G2B,
G2G as well as back office processes and interactions within the entire government framework.”

Need of e-governance:
1. Government services will be made available in a convenient, efficient and transparent manner.

2. To improve the public services.

3. To cut down unwanted interference.

4. Too many layers while delivering government services.

5. To support the Public.

Basic Models of e-governance are –

1. Government to Customer(G2C).

2. Government to Employees (G2E).

3. Government to Business (G2B).

4. Government to Government (G2G).

Corporate Governance Initiatives :(CGI)

Meaning:

“Corporate Governance Initiatives are nothing but assisting organisation adherence to a system of guidelines,
practices and procedures by which a company is directed and controlled.”

Need of CGI:

1. Company formulate policies to balance the interests between the company and stakeholders.

2. It provides effective legal framework and structure i.e., MCA, SEBI, RBI and IRDA.

3. It helps to create and strengthen disciplinary mechanism and bring transparency in their work (follow rules
and mandatory disclosures).

4. Setting up of Investor Education & Protection Fund and empowering investors through the medium of
education and information.

For Example: www.investorhelpline.in

www.watchoutinvestors.com.
5. Majors adopted and suitable corrective actions taken in the form of CG mechanism i.e., Internal CG Mechanism
and External Controls.

Governance Standards in Public Sector Enterprises / Public Sector

Undertakings (PSUs)
Meaning:

“ Public Sector Undertakings are nothing but state owned enterprises.”

Different Types of PSUs:

1. Central Public Sector Enterprises.

2. State Public Sector Enterprises.

3. Public Sector Banks.

Governance Standards in Public Sector Undertakings are –

1. Accounts are audited by Comptroller and Auditor General of India.

2. Set up some commissions and expert Groups.

3. In the year 2007, OECD principles are adopted especially in State Owned Enterprises.

4. As per Clause 49 of Listing Agreement , now started appointing Independent Auditor.

5. Mandatory Disclosures should be made.

6. Government Of India has introduced Corporate Governance as a part of Economic Reforms.

7. Government Policy Reforms are introduced.

8. Good Corporate Governance practices and guidelines are adopted.

Corporate Governance Models:

1. As we all know that India is a sub-continent, many business people have adopted corporate form of
businesses.

2. The corporate form being used in India from 800 BC to 1000 AD.

3. Around 16th Century, the East India Co. is the first British company which was formed for pursuing trade with
East Indies and ended up with mainly Indian sub-continent . It was mainly traded in Cotton, Silk, Indigo dye,
Salt, Salt Petre, tea and opium.

Three different forms of Corporate Governance models can be studied -

 1. The Managing Agency Model (Till 1956)

➢ In India, modern corporations emerged out of “Managing Agency System”.

➢ The role of Managing Agents (Agencies) has been come into picture.

➢ The managing agents are outcomes of merchant families.

➢ Even managing agents have been controlling the business of organisation and also performing some
important functions –

❑ Managerial services.

❑ Promote new companies.

❑ Provide some important financial services.

2. The Business House Model (From 1956 to 1991):

1. Meaning:

“Business group means a group of companies that does business in different markets under common
administrative or financial control.”

2.Different Types of Business Groups:

(i) Family Owned:

For Example: Indian Business Houses, Korean Chelols.

(ii) Widely Held:

For Example: Japanese Kereistns, Bank Centered Groups.

(iii) State Owned:

For Example: Chinese State Owned Enterprises.

3. The managing agents were converted themselves as Business Houses by new opportunities and promoted new
businesses.

For Example: TATA, Reliance, Modis, etc.

4. The Govt. of India has taken the steps for the industrialisation and promoted new businesses.

3. The Anglo-American Model (After 1991):

➢ Many large corporations thrived under the Business House model, a crisis was browing in the Indian
economy throughout 1980s.

➢ During 1980s, many businesses have been collapsed in the Indian economy. The reasons could be –

❑ High level fiscal deficits.

 ❑ Huge losses suffered by PSUs.

❑ Increasing Subsidies.

❑ Low foreign exchange reserves.

➢ Then 1991, the new industrial policy was developed and also taken financial assistance from world Bank
($500 Million) and IMF ( $1.78 Million).

➢ Indian Govt. undertaken several reforms and measures –

1. Liberalisation of Economy.

2. Some amendments made to 1956.

2. Repeal of Controller of Capital issues act.

3. Set up of SEBI.

4. Introduction of Money Laundering Act.

5. Repeal of Export and Import Control Act.

6. Repeal of FERA and passing of FEMA.

7. Relaxation in Securities ( Control) Regulation Act.

➢ Some important committees have been setup –

1. Confederation of Indian Industries (CII).

2. SEBI.

3. Naresh Chandra Committee.

4. Narayan Murthy Committee.

➢ Some of the important initiations have been taken, they are –

❖ Withdrawal of restrictions in the inter-corporate investment.

❖ Permission for buy back of shares.

❖ Regulation of takeovers.

❖ Mandatory establishment of audit committee.

➢ Then India Govt has entered into some important policies, likely Privatization, Liberalisation and
Globalization. Because of all these reasons, M&A and cross border transactions taken place.