Professional Documents
Culture Documents
Chapter 3
Chapter 3
Chapter 3
Dear
Friends, Following are the important topics given by sir :1. Cadbuy Committee on Corporate Governance, 1992 2. Sarbanes-oxley Act,2002 3. Independent Director (clause 49) 4. Kumar Mangalam Birla committee 5.Internal System Cos and Pron----- Not in slides discussed in second last class. NOTE:- Only one question will come from Ethics part
OBJECTIVES
Corporate governance as a desideratum for orderly development of an economy has evolved over the past three decades, and, in its present system and structure, is the outcome of studies, research and the sum total of responses by regulators of corporate scams and debacles. This chapter traverses through the history of evolution of the concept and system of corporate governance over the years, both in the West and in India.
CHAPTER OUTLINE
Introduction Corporate Governance Committees World Bank on Corporate Governance OECD Principles McKinsey Survey on Corporate Governance SarbanesOxley Act, 2002 Indian Committees and Guidelines Working Group on the Companies Act, 1996 The Confederation of Indian Industrys Initiative SEBIs Initiatives Naresh Chandra Committee Report, 2002 Narayana MurthyCommittee Report, 2003 Dr J. J. Irani Committee Report on Company Law,
2005
Introduction
There has been a perceptible change in peoples minds as to the objective of a corporation - from one which was intended to benefit exclusively the shareholders to one which is expected to benefit all its stakeholders. The corporate scams and frauds that came to light have brought about a change in the thinking of advocates of free enterprise that the system was not self-regulatory and needed substantial external regulation, which should penalise the wrongdoers while those who abide by the rules of the game are amply rewarded
Introduction (contd)
All these measures have brought about a metamorphosis in corporations that realised that the people who invest in corporations are pretty serious about corporate governance; hence they started internalising these values and later adopting them, initially albeit selectively and sporadically.
Developments in the UK
In England, the seeds of modem corporate governance were probably sown by the BCCI scandal. BCCI was a global bank, constituting multiple layers of entities related to one another through an impenetrable series of holding companies, affiliates, subsidiaries, banks-within-banks, insider dealings and shareholder (nominee) relationships. With this corporate structure of BCCI and shoddy record-keeping, regulatory review and audits, the complex BCCI family of entities was able to evade ordinary legal restrictions on the movement of capital and goods as a matter of daily practice and routine.
and effective control over the company and monitor the executive management.
o There should be a clearly accepted division of
res- ponsibilities at the head of a company, which will ensure balance of power and authority, such that no individual has unfettered powers of decision.
All directors should have access to the advice and services of the Company Secretary, who is res- ponsible to the Board for ensuring that board procedures are followed and that applicable rules and regulations are complied with. Any question of the removal of company secretary should be a matter for the board as a whole.
o
All directors should have access to the advice and services of the Company Secretary, who is responsible to the Board for ensuring that board procedures are followed and that applicable rules and regulations are complied with. Any question of the removal of company secretary should be a matter for the board as a whole.
On reporting and controls, the Cadbury Code of Best Practices stipulate the following:
o
It is the Board's duty to present a balanced and understandable assessment of the company's position. The Board should ensure that an objective and professional relationship is maintained with the Auditors. The Board should establish an Audit Committee of at least 3 Non-Executive Directors with written terms of reference, which deal clearly with its authority and duties. The Directors should explain their responsibility for preparing the accounts next to a statement by the Auditors about their reporting responsibilities. The Directors should report on the effectiveness
Aimed to provide an answer to the general concerns about the accountability and level of directors' pay. Argued against statutory control and for strengthening accountability by the proper allocation of responsibility for determining
Produced the Greenbury Code of Best Practice which was divided into four sections thus:
Openness is the basis of public confidence in the corporate system and funds will flow to those centres of economic activity, which inspire trust. This Report points the way to the establishment of trust and the encouragement of enterprise. It marks an important milestone in the development of corporate governance.
OECD Principles
o
The Organisation for Economic Cooperation and Development (OECD) was one of the earliest non-governmental organisations to work on and spell out the principles and practices that should govern corporations in their goal to attain long-term shareholder value.
The rights of shareholders include a set of rights to secure ownership of their shares, the right to full disclosure of information, voting rights, participation in decisions on sale or modification of corporate assets mergers and new share issues. Equitable Treatment of Shareholders The OECD is concerned with protecting minority shareholders rights by setting up systems that keep insiders, including managers and directors, from taking advantage of their roles.
The Role of Stakeholders in Corporate Governance The OECD recognises that there are other stakeholders in companies in addition to shareholders. Banks, bondholders and workers, for example, are important stakeholders in the way in which companies perform and make decisions.
Disclosure and Transparency The OECD lays down a number of provisions for the disclosure and communication of key facts about the company ranging from financial details to governance structures including the board of directors and their remuneration.
The Responsibilities of the Board The OECD guidelines provide a great deal of details about the functions of the board in protecting the company and its shareholders. These include concerns about corporate strategy, risk, executive compensation and performance as well as accounting and reporting systems.
Increasing financial performance; Transparency of dealing, thereby reducing the risk that boards will serve their own selfinterest; Increasing investor confidence.
Accountability: Transparent ownership, Board size, Board accountability, Ownership neutrality Disclosure and Transparency of the Board, Timely and accurate disclosure, Independent Directors
Audit Committee
o
The SOX Act provides for a new improved Audit Committee. The audit committee is responsible for appointment, fixing fees and oversight of the work of independent auditors. The committee is also responsible for establishing reviewing the procedures for the receipt, treatment of accounts, internal control and audit complaints received by the company from the interested or affected parties.
The SOX Act provides for mandatory rotation of lead audit or co-ordinating partner and the partner reviewing audit once every five years.
It will be unlawful for any executive or director of the firm to take any action to fraudlently influence, coerce, manipulate or mislead any auditor engaged in the performance of an audit with the view to rendering the financial statements materially
Non-audit services include: (i) book-keeping or other services related to the accounting records or financial statements of the client; (ii) financial information system, design and implementation; (iii) appraisal or valuation services, fairness opinions; (iv) acturial services; (v) internal audit outsourcing services; (vi) management functions or human resources; (vii) broker or dealer, investment adviser, or investment banking services; (viii) legal services or expert services unrelated to the audit and (ix) any other service that the board determines, by regulation, is impermissible. However, the
Chief Executive Officers and Chief Finance Officers are required to certify the reports filed with the Securities Exchange Commission. If the financials are required to be restated due to material non-compliance as a result of misconduct of CEO or CFO, then such CEO or CFO will have to return to the company bonus and any other incentives received by him. False and or improper certification can attract fine ranging from $ 1 million to $ 5 million or up to 10 years imprisonment or both.
Loans to Directors
o
The SOX Act prohibits U.S. and foreign companies with securities traded within U.S. from making or arranging from third parties any type of personal loan to directors.
Attorneys
o
The attorneys dealing with the publicly traded companies are required to report evidence of material violation of securities law or breach of fiduciary duty or similar violations by the company or any agent of the company to the Chief Counsel or CEO and if the Counsel or CEO does not appropriately respond to the evidence the attorney must report the evidence to the audit committee or the board of directors.
Securities Analysts
o
The SOX Act has a provision under which brokers and dealers of securities should not retaliate or threaten to retaliate an analyst employed by the broker or dealer for any adverse, negative or unfavourable research report on a Public Company.
Penalties
o
The penalties prescribed under SOX Act for any wrongdoings are very stiff. Penalties for willful violations are even stiffer. Any CEO or CFO providing a certificate knowing that it does not meet with the criteria stated may be fined upto $ 1 million and/or imprisonment upto 10 years.
A tabular form containing details of each directors remuneration and commission should form a part of the Directors Report. A listed company must give certain key information on its divisions or business segments as a part of the Directors Report in the Annual Report. Where a company has raised funds from the public by issuing shares, debentures or other securities, it would have to give a separate statement showing the end-use of such funds. The disclosure on debt exposure of the company should be strengthened.
A comprehensive report on the relatives of directors - either as employees or Board members - to be an integral part of the Directors Report of all listed companies. Companies have to maintain a register, which discloses interests of directors in any contract or arrangement of the company. 3. Likewise, the existence of the directors shareholding register and the fact that members in any AGM can inspect it should be explicitly stated in the notice of the AGM of all listed companies.
2.
3.
Details of loans to directors should be disclosed as an annex to the Directors Report in addition to being a part of schedules of the financial statements. Appointment of sole selling agents for India will require prior approval of a special resolution in a general meeting of shareholders. Subject to certain exceptions there should be a Secretarial Compliance Certificate forming a part of the Annual Returns that is filed with the Registrar of Companies.
5.
6.
In 1996, the Confederation of Indian Industry (CII) took a special initiative on Corporate Governance, the first ever institutional initiative in Indian industry. This initiative by CII flowed from public concerns regarding the protection of investors interest, especially of the small investor; the promotion of transparency within business and industry; the need to move towards international standards in terms of disclosure of information by the corporate sector and through all of this, to develop a high level of public confidence in business and industry.
A National Task Force that was set up with Mr.Rahul Bajaj, past President of CII as the Chairman and members from industry, the legal profession, media and academia, presented the draft guidelines and the Code of Corporate Governance in April 1997 at the National Conference and Annual Session of CII.
The CII has pioneered the concept of corporate governance in India and has been internationally recognised as one of the best in the world. These are:
4. For non-executive directors to play a significant role in corporate decision making and maximising long term shareholder value they need to
become active participants in boards and not passive advisors; have clearly defined responsibilities within the board such as the Audit Committee; and know how to read a balance sheet, profit and loss account, cash flow statements, and
placed before the board, must contain: Annual operating plans and budgets, together with up-dated long term plans; Capital budgets, manpower and overhead budgets; Internal audit reports including cases of theft and dishonesty of a material nature; Fatal or serious accidents, dangerous occurrence, and any effluent or pollution problems; Default in payment of interest or non-payment of the principal on any public deposit and/or to
Defaults such as non-payments of the principal on any company or materially substantial nonpayments for goods sold by the company; Details of any joint venture or collaboration agreement; Transactions that involve substantial payment towards goodwill, brand equity or intellectual property; Recruitment and remuneration of senor officers just below the board level, including appointment or removal of the Chief Financial Officer and the Company Secretary; Labour problems and their proposed solutions and Quarterly details of foreign exchange exposure and the steps taken by management to limit the risks of adverse exchange rate movement,
The company will continue business in the course of the following year; The accounting policies and principles conform to the standard practice; The management is responsible for the preparation, integrity and fair presentation of financial statements and other information contained in the Annual Report. The board has overseen the companys system of internal accounting and administrative
SEBIs Initiatives
The Securities and Exchange Board of India (SEBI) appointed a committee on corporate governance on May 7, 1999, with eighteen members under the Chairmanship of Kumar Mangalam Birla to promoting and raising the standards of corporate governance.
The Committees recommendations consisted of (i) mandatory recommendations, and (ii) nonmandatory recommendations.
Mandatory Recommendations
1. Applicability
Applicable to all listed companies with paid-up share capital of Rs. 3 crore and above
2. Board of directors
The Board of Directors of a company must have an optimum combination of executive and nonexecutive Directors. The number of independent Directors should be at least onethird in case the company has a non-executive Chairman and at least half of the Board in case the company has an executive Chairman.
Board Procedures
The Board meeting should be held at least four times a year with a maximum time gap of four months between any two meetings.
Management
Management
discussions and analysis report covering industry structure, opportunities and threats, segment-wise or product-wise performance outlook, risks, internal control systems, etc. are to form a part of Directors Report or as an addition thereto.
Shareholders
In case of appointment of a new Director or re-appointment of existing Director, information containing a brief resume, nature of expertise in specific functional areas and companies in which the person holds Directorship, Committee Membership, must be provided to the benefit of shareholders.
Shareholders (contd.)
A Board committee under the chairmanship of a non-executive director is to be formed to specifically look into the redressing of shareholder complaints of declared dividends etc.
Shareholders (contd.)
In order to expedite the process of share transfers, the Board should delegate the power of share transfer to an officer or a committee or to the Registrar and share transfer agents with a direction to the delegated authority to attend to share transfer formalities at least once in a fortnight.
The Chairmans role should in principle be different from that of the Chief Executive, though the same executive can perform both the roles.
Tightening of the noose around the auditors by asking them to make an array of disclosures, Called upon CEOs and CFOs of all listed companies to certify their companies annual accounts, besides suggesting Setting up of quality review boards by the Institute of Chartered Accountants of India (ICAI), Institute of Company Secretaries of India and the Institute of Cost and Works Accountants of India, instead of a Public Oversight Board similar to the one in the United States.
In the perception of SEBI, there was a need to appoint a committee as a follow-up of the Birla Committees report and the experience gained from the analysis of compliance reports.
SEBI, therefore, set out to form another committee with the twin perspectives: (a) to evaluate the adequacy of the existing practices, and (b) to further improve them. This committee on corporate governance was constituted under the chairmanship of N.R. Narayana Murthy, Chairman and Chief Mentor of Infosys Technologies Ltd. and comprised representatives from stock exchanges, chambers of commerce, investors associations and professional bodies.
Mandatory Recommendations
Audit Committee: An Audit Committee is the bedrock of quality governance. The Committee recommended a bigger role for the audit committee.
Risk Management
The Committee has deemed it necessary for the boards of companies to be fully aware of the risks involved in the business and that it is also important for shareholders to know about the process by which companies manage their business risks. The mandatory recommendations in this regard are:
Procedures should be in place to inform board members about the risk assessment and minimisation procedures. These procedures should be periodically reviewed to ensure that executive management controls risks through means of a properly defined framework.
Management should place a report before the entire board of directors every quarter documenting the business risks faced by the company, measures to address and minimise such risks and any limitation to the risk-taking capacity of the corporations. The board should formally approve this document.
Code of Conduct
The Committee has recommended that it should be obligatory for the board of a company to lay down a code of conduct for all board members and senior management of the company. This code should be posted on the companys website
Nominee Directors
The Committee recommended doing away with nominee directors. If a corporation wishes to appoint a director on the board, such appointment should be made by the shareholders. The Committee insisted that an institutional director, if appointed, shall have the same responsibilities and shall be subject to the same liabilities as any other director. Nominees of the Government on public sector companies shall be similarly elected and shall be subject to the same responsibilities and liabilities as other directors.
Compensation to non-executive directors (to be approved by the shareholders in general meeting; Whistle blower policy to be in place in a company.
CONCLUSION
Although India has been fortunate in not having to go through the massive corporate failures such as Enron and Worldcom, it has not been wanting in its resolve to incorporate better governance practices in the countrys corporates emulating stringent international standards.
CONCLUSION (contd.)
However, as the Naresh Chandra Committee on Corporate Audit and Governance pointed out: There is scope for improvement. For one, while India may have excellent rules and regulations, regulatory authorities are inadequately staffed and lack sufficient number of skilled people. This has led to less than credible enforcement. Delays in courts compound the problem. For another, India has had its fair share of corporate scams and stock market scandals that has shaken investor confidence. Much can be done to improve the situation.