SIBM Hyderabad CG&E Feb 2021

Corporate Governance
& Ethics

Arun K Rath
Class 1

• Introduction to Governance
• Governance in General and
Governance of an enterprise;
• models of corporate governance-
western vs. Indian
The State & Government

• State
Essential Features
(a) A definite territory ,
(b) Population
(c) Government
(d) Sovereignty
• Government
The agency through which will of the State is
formulated, expressed and realized.
 Government- Definition

• Government defined as :
A body with power to make and
enforce laws for a country, land area,
people or organization.
Governance
Governance- Definition

Process of
decision-making
and
process by which
decisions are
implemented .
Good Governance
Characteristics of Good Governance

UN
Seven characteristics of Good Governance
• Consensus Oriented
• Participatory
• Following Rule of Law
• Effective and Efficient
• Accountable
• Transparent
• Responsive
 Probity
in
Governance
&
Public services
 Probity, Corruption &Transparency

• Probity
• complete honesty: Her probity and integrity are beyond question
• Corruption
Misuse of entrusted power for private gain.
Abuse of public office for private gain (TI)
• Transparency
A principle that allows those affected by
administrative decisions to know not only the
basic facts and figures but also the mechanism
and processes.
It is the duty of managers and trustees to act visibly,
predictably and understandably
Corruption Perception Index (CPI):

• Corruption Perceptions Index (CPI) annually ranking countries by their

perceived levels of corruption, as determined by expert assessments
and opinion surveys ( From 2000)
• "on a scale from 10 (very clean) to 0 (highly corrupt)."
• By TI (Transparency International) :
• Corruption defined as abuse of public office for private gain
• 2013-Denmark (9.1) ,New Zealand (9.1), Finland (8.9),Sweden
8.9,Norway & Singapore 8.6 world’s least corrupt countries. USA 7.3,
Sri Lanka 3.7 at 91, India 3.6 at 94,Pakistan 2.8 at 127 Bangladesh 2.7
at 136
• (2012 -India 3.5, China 3.5, Pakistan 2.4, Sri Lanka 3.2, Nepal 2.5,
Bangladesh 2.0 )
• Somalia (2.0), Myanmar (2.0) most corrupt Sub – Saharan Africa at
bottom levels
• India ranked at 94 (2013)/ 85(2014) out of 177 countries in TI’s CPI.
• India’s score improved from 2.7 in 2002 to 3.4 in 2008 to 3.6 in 2013,
3.8 in 2014-Improved
• India 78 in 2018 80 in 2019
-Course Outline and Assessment Plan
-Contribution of Corporations to Economy
-Characteristics of A Corporation
-Defining Corporate Governance
- Shareholders & Stakeholders
• THE QUESTIONS ?
 THE QUESTIONS

1.What is a Corporation?
2.Why study Corporate Governance?
3.Who are Shareholders / Stakeholders?
4.What is Corp. Governance ?
5. What are causes of failure of major Corporations?
6.What is the role of Board of Directors
7.What is role of ethics in CG?
8.How would you enhance ethical behavior in workforce?
9. What is framework of CG?
10.What are CG issues in Indian context ?
Why study Corporate Governance ?
• Power of Modern Corporation
• Contributions to economy
• Adverse consequences of corporations
 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 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
Management is
•Hierarchical
•Pyramidal
•No equality of power
•Boss- subordinate Relationship
Board is
• Horizontal
• Members have equal power ( except one additional casting vote for
chairman)
• No boss-subordinate relationship
• Collective decision making
Management
BOARD of DIRECTORS
BOARD of
DIRECTORS
vrs
Management

DIRECTOR
BOARDB

DD

AD AD

Management
AD AD AD
Governance & Management

Governance Management

Shareholders CEO
Board of Directors Directors ( Executive)
Chairman Executives/ Managers
CEO Employees
Understanding Corporation

Landmark case

(i) Salomon vrs Salomon Co:

- Company vrs Shareholders
COMPANY Vs SHAREHOLDERS

SALOMON &
SALOMON CO.
•Salomon was in the shoe business
• He was looking for opportunities to expand his business.
•Britain enacted a statute providing for the incorporation of
businesses with at least seven shareholders.
•Salomon turned his business into a limited company.
•He formed a corporation ( Salomon & Co.), with all
shareholders being members of his family
•Salomon family took almost all of the company’s shares in
their names.
•He also gave loan to the Company, secured by a charge over
the company’s assets.
•He also got loans from others ,not secured
• Soon his company went into loss.
• He took all the money for himself , against the
secured loans he had given to the company.
• The creditors went to the court and lodged a
complaint.
• The creditors argued in court that:
1.The corporation was a mere sham, a fraud, with
his family as shareholders,
2.The shareholders ( Salmon family) should be liable
for the debts of the corporation,
• How would you decide the case ,giving reasons?
 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.
 Class 2

• History of Corporate Governance

• Emergence of Institutions: State, Legal frameworks-
courts, law of conduct, and regulation of behavior.
What is a Corporation ?
• A legal entity separate
from the shareholders and
employees
 1
Shareholders Register
7 2
Join
under Law
1 2 3

4 5 6 6 3 COMPANY

7 5 4

A New Person
Corporation-Concept

• A corporation is an artificial person,

with many of the legal rights of a
biological one.
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
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.
 CORPORATION : FEATURES

• Legal personality
• Centralized management
• Limited liability for investors
• Free transferability of shares
 Features 3 & 4 hold great attraction for investors
Company Formation

• Sec. 3:(1) Company means a company

formed and registered under Company
Act 1956/2013 
• A limited company - a corporation with
shareholders whose liability is limited
by shares (Ltd).
-Also called limited liability Co.
Shareholders:
• Shares shall be movable property transferable in the manner
prescribed by the articles of the company.
• Share certificate issued by company under common seal is proof
of title of the member to such shares.
• Voting rights by shareholders proportionate to share of paid up
capital.
Memorandum of Association ( MOA)

-Main objectives of company to be pursued be stated

Articles of Association ( AOA) :

-Prescribes regulations of governance of company

• Board of Directors -Directors of a company
collectively referred to as Board of Directors or
Board.
• Appointment by General Body (as in Articles of
Assn )
• Chairman , MD, Directors: as prescribed in
Articles of Association
• Defining Corporate
Governance
• SEBI committee on corporate governance (2003) chaired
by N R Narayan Murthy
“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”.
• CG is the application of best management practices , compliance of
law in true letter and spirit and adherence to ethical standards for
effective management and distribution of wealth and discharge of
social responsibility foe sustainable development of all stakeholders in
a fair and transparent manner
ICSI
• “Corporate Governance is about promoting corporate fairness,
transparency and accountability”
—James D. Wolfensohn
Corporate governance is the system by
which companies are directed and
controlled
(Cadbury Committee 1992)
 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.
Class 3

•Linking Governance to performance

of an enterprise;
•accountability, and transparency
Good Governance : The Rationale
• If countries are to reap the full benefits of the global
capital market…….corporate governance arrangements
must be credible, well understood across borders and
adhere to internationally accepted principles.
• Adherence to good corporate governance practices will
help improve the confidence of domestic investors,
reduce the cost of capital, underpin the good
functioning of financial markets, and ultimately induce
more stable sources of financing.” (OECD, 2004)

53
Empirical Evidence : Good Governance&
Firm Performance

1. 1996 McKinsey survey of US investors showed that two-

thirds would pay more for a well-governed Co.
2 Well-governed firms in Korea traded at premium of 160%
to poorly governed firms.
3 Brazil-based firms with the best corporate governance
ratings garnered P/E ratios that were 20% higher than
firms with the worst governance ratings.
4 2002McKinsey Survey showed 78% investors in Asia would
pay premium(20-25%) for shares in a well-governed Co.
 Rationale of Good Corporate Governance :

5 Companies with strong or improving corporate

governance outperformed those with poor or
deteriorating governance practices by about 19%
over a two-year period .(S/P 500 firms)
6 If an investor purchased shares in US firms with the
strongest shareholder rights, and sold shares in
ones with weakest shareholder rights, that
investor would have earned abnormal returns of
8.5% per year .(Harvard)
55
BENEFITS of GOOD CG

• Credibility of the Board & management.

• Confidence & satisfaction of shareholders.
• Confidence of foreign institutional investors.
• Better Flow of capital to company.
• Confidence of executives and employees.
• Stability and growth of the company.
• Public image, status and sustainability.
• Brand value of company
• Premium for stocks in market

56
What is Purpose of Corporation?

Goals of
(1) PROFITS
along with
(2) Corporate ethics ,
(3) social responsibility &
(4)sustainable development
(5) Good Governance
are emerging as major objectives of corporate
strategy
Class 4
• Concept of Corporation & Corporate Governance
Board of Directors
 Shareholders

Managers Board
Corporation-A
Tripod
 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.
Why is Board Necessary?

1. Centralised Management
2. Diversity
3. Collective wisdom concept
4. Conflict Resolution
5. Monitor Management
• Board the fulcrum
• Board the heart and soul of company
• Board the apex decision making body
• Board the leader
• Board the driver
 Board Role
• Board exercises direction and control
over the company and is accountable
to the shareholders.
Directors Vs Shareholders

• Landmark case 2
-CASE OF
WRIGLEY CORPORATION
In 1968, some shareholders of the Wrigley
Corporation sued the company and its directors for
failing to install lights in Chicago’s Wrigley Field
( baseball field) .
The shareholders claimed that the company’s
operating losses for four years were the result of its
negligence and mismanagement. If the field had
lights, the Cubs ( home baseball team ) could play at
night, when revenues from attendance , radio and
television broadcasts were the greatest.
The shareholders argued that the sole reason for
failing to install the lights was the personal opinion of
William Wrigley, the President of the company, that
baseball was a daytime sport, and that night games
would lead to a deterioration of the neighborhood.
Directors vs Shareholders …

• “Thus, the complaint concluded, Wrigley and the directors who

acquiesced in this policy were acting against the financial welfare of
the Cubs in an arbitrary and capricious manner, causing waste of
corporate assets. They were not exercising reasonable care or
prudence in the management of the Corporation’s affairs.”

• Can CEO & Directors decide not to pursue opportunities that will increase
revenues?
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

69
 Functions of the Board-cont’d

• 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.

70
 Functions of Board Chairman

• Leadership of the Board

• Management of the meetings
• Strategic leadership for policy and strategy
• Link between Board & Management
• Arbitration between Board members
• Being public face of the company
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
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
 Directors : Don’t List

• Conflict of interest
• Insider trading
• Related transactions
• Leaking confidential information
• Causing harm the company
• Unethical practices
• Business with company
• Violation of Conduct Rules
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
Ind.Directors : Ornaments ?

• The potential of Independent Directors

was hardly realized when they were
inducted into the Boardroom about
forty years ago.
• 1971- “Ornaments on a Corporate
Christmas Tree”
– Myles Mace – Harvard
 IDs : Changing Perception

• 1971
“Ornaments on a Corporate Christmas Tree” – Myles
Mace - Harvard
• 2000
All Directors should be outsiders except 3 –
CEO, COO and CFO
– Salmon Walter (Harvard)

77
 ID-Rationale
• 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

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

79
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
Who is an Independent Director ?
SEBI

• 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.

82
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.

83
 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)

85
Principal Players of Corporate Governance

• Shareholders
• Board of Directors
• Management
• Employees
• Customers
• Suppliers
• Banks & Lenders
• Community
• Environment
• Regulators
• Corporate Vision Mission
ONGC Vision

• To be global leader in integrated energy business through sustainable

growth, knowledge excellence and exemplary governance practices.
TATA STEEL

• We aspire to be the global steel industry benchmark for Value

Creation and Corporate Citizenship.
Infosys
• Vision:"To be a globally respected corporation that provides best-of-
breed business solutions, leveraging technology, delivered by best-in-
class people."
• Mission  : "To achieve our objectives in an environment of fairness,
honesty, and courtesy towards our clients, employees, vendors and
society at large."
APPLE
• We believe that we are on the face of the earth to make great
products and that’s not changing. We are constantly focusing on
innovating. We believe in the simple not the complex. We believe that
we need to own and control the primary technologies behind the
products that we make, and participate only in markets where we can
make a significant contribution.
• Should the posts of Chairman & CEO be
separated ?
• A crucial issue remains unresolved .Should the posts of Chairman &
CEO be separated ? There are arguments for and against. There is
increasing trend of separation of the two top posts, but academic
literature in not conclusive on this issue.
• The merits of separation of the posts of Chairman and CEO are :
• 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. 
• Kotak SEBI Committee Recommendations
• Kotak Mahindra Bank Executive Vice-Chairman & MD Uday Kotak-
Chairman
• Recommended separating Chairman & CEO posts in listed firms
• Chairman-non-executive director and at least one woman as independent
director.
• Minimum remuneration of Rs 5 lakh per annum for IDs  and a sitting fee of
Rs 20,000-50,000 for each board meeting.
• Seek shareholders’ approval for annual remuneration of executive directors
from promoter family if the amount exceeds Rs 5 crore or 2.5 % of the
company’s net profit 
• The approval of shareholders will be required every year if the annual
remuneration payable to a single non-executive director exceeds 50 per cent
of the total annual remuneration payable to all non-executive directors.
• The panel has also suggested at least half of board members to be IDs at
listed companies, while all directors must attend at least half of board meets.
• Shareholders’ approval would be a must for having non-executive directors
over 75 years of age on the board. 
 
Class 5

•Theoretical approaches
a. Institutional Economics and
Economic Sociology approaches
b. Transactional economics
c. Agency theory
Evolution of the
modern corporation
 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
105
 Skepticism of Adam Smith

• Grave doubts about Future of Joint Stock Companies

• Adam Smith & Karl Marx
Joint Stock Companies unworkable !
• Owners negligent – Directors have self-interests
• About Owners : “… the greater part of those
proprietors seldom pretend to understand anything of
the business of the company, …. ”
• About Managers : “Like the stewards of a rich man,
they are apt to consider attention to small matters as
not for their master’s honor…”
106
 Trustworthiness of Managers

• “The directors of such companies, however, being the

managers rather of other people’s money than of
their own, it cannot well be expected that they
should watch over it with the same anxious vigilance
with which they frequently watch over their own”
-Adam Smith Wealth of Nations 1776

107
Negligence of Owners

• He also decried the lack of interest of the owners over the conduct of
business of the joint stock company:
“…proprietors receive contentedly such half-yearly or yearly dividend
as the directors thinks proper to make to them”
Adam Smith’s Prophecy
• Smith dismissed the case of the joint stock
companies:
“Negligence and profusion, therefore, must
always prevail, more or less, in the management
of the affairs of such a company.”
(Adam Smith, Wealth of Nations 1776)
• Corporate failures remind of Adam Smith’s
prophecy
Proving Adam Smith Wrong

Some do not share the pessimism of Adam

Smith about the modern corporation.
Michael Klein and others (IFC, 2004) in their
review paper “Proving Adam Smith wrong” do
not fully agree with Smith.
 According to the IFC group, despite misgivings by Smith
and failure like Enron, AA &World.com modern
corporations have generally been successful and
have been “cornerstones of modern prosperity.”

• “Obstacles that seemed insuperable to Adam Smith in

1776 have been surmounted”
• Adam Smith wrong in respect of well governed
economies, in spite of Enron/ World.com
• Smith is right, in respect of corporate governance
practices in much of the poor and developing
countries.
• Weak corporate governance in developing countries
a matter of concern.
Adam Smith’s fears are still valid in poor and
developing countries.

-IFC study(2004)
112
EVOLUTION OF MODERN CORPORATION

• Berle and Means

• Corporate revolution
• The Modern Corporation and
Private Property
• Four prominent features of the corporate revolution
were noted,
(1) Concentration of economic power
(2) Dominant Role of Corporations
(3) Dispersion of stock ownership
(4) Separation of ownership and control

114
 Dispersion of stock ownership

• Wide dispersion of ownership of stocks

• Owners have become passive agents.
• The value of an individual’s wealth now depends
actions of other people and the market.
• The value of the individual’s wealth also
fluctuates constantly.
• The shareholder is left with a mere symbol of
ownership of wealth
Separation of ownership and control

• Control over it has come to lie less in the

hands of the owners.
• Ownership of wealth without appreciable
control and control of wealth without
appreciable ownership.
• This is the consequence of emergence of the
modern corporation.
Berle and Means concluded their epoch-
making treatise with the observation:
• “But have we any justification for
assuming that those in control of a
modern corporation will also choose to
operate it in the interests of the
owners?”
Agency Theory :
Discretion of Managers
Jensen & Meckling (1976)

• Problem of separation of ownership and

control and dispersal of ownership ,

• Owners (principals) engage managers

(agents) to perform on their behalf.
• Principal - agent relationship
• Conflicts of interests between principal and agent
• Incomplete contractual relationship
• Principals & Agents Information asymmetry
• Discretionary Powers of managers
• Divergence of interests
• Agency costs
• Corporate governance mechanism to reduce agency
costs

120
• Manager will choose the option that maximizes
his wealth and not of shareholders.
• “Managers will choose investments suboptimal for
shareholders but good for their own risk exposure”

• “Both principal and agent are economic actors

who aim to maximize their own personal wealth”
 PRINCIPAL

Contracts with Takes Advantage of

AGENTS
(Directors/
Managers)
• “The manager in a firm will choose a set of
activities for the firm such that the total value of the
firm is less than it would be if he were the sole
owner.”
• Invest to monitor the agent’s work to minimize
his aberrant activities : =monitoring costs.
• Pay the agent to spend resources on =bonding
costs
• Loss despite above= Residual loss
Jensen and Meckling defined

agency costs = monitoring

costs + bonding costs +
residual loss.
 Institutional Economics &
Economic Sociology Approaches

Definition of institutional economics

A school of economics that emphasizes the role of
social institutions influencing economic
behavior,
• (1919 American Economic Review article
by Walton H. Hamilton.)
• Institutional economics views markets as result of
interaction of various institutions
 e.g. individuals, company, State, society
 Economic sociology is the study of the social
cause and effect of various economic phenomena.
 Transaction cost

Transaction cost is a cost in making any

economic trade when participating in a market.
Transaction cost theory (Williamson 1979, 1986)
proposes
 A transaction produces coordination costs of
monitoring, controlling, and
managing transactions.
 Institutions facilitate low transaction costs,
boost economic growth.
Transaction costs can be divided into three broad categories:
1.Search and information costs are costs such as in determining that the
required good is available on the market, which has the lowest price, etc.
2.Bargaining and decision costs are the costs required to come to an
acceptable agreement with the other party to the transaction, drawing up an
appropriate contract and so on. In game theory this is analyzed for instance in
the game of chicken. On asset markets and in market microstructure, the
transaction cost is some function of the distance between the bid and ask.
3.Enforcement costs are the costs of making sure the other party sticks to
the terms of the contract, and taking appropriate action (often through
the legal system) if this turns out not to be the case.

For example, the buyer of a used car faces a variety of different transaction
costs.
1-The search costs are the costs of finding a car and determining the car's
condition.
2-The bargaining costs are the costs of negotiating a price with the seller.
3-The policing and enforcement costs are the costs of ensuring that the seller
delivers the car in the promised condition.
• Transaction costs are expenses incurred when
buying or selling a good or service.
• Financial intermediaries ( like Banks, companies )
reduce transactions costs by exploiting economies
of scale in handling costs of transactions and
information gathering. Small investors can
combine their purchases through an intermediary,
who spreads legal and
technical costs of transactions.
• Transaction cost analysis  "the study of trade
prices to determine whether the trades were arranged
at favourable prices – low prices for purchases and
high prices for sales". It is often split into two parts –
pre-trade and post-trade.
• Practical examples of transaction costs include the
commission paid to a stockbroker for completing a
share deal and the booking fee charged when
purchasing concert tickets.
• Information costs are expenditures of time and money that are required
to obtain information. The term is often used in relation to due diligence,
decision making, problem solving and research.
• The transaction cost covers a full gamut of services including
communication charges, legal fees, and informational cost of finding the
right price, quality, and durability.
• The difference between an external and internal transaction is the
people involved. In external transaction, people of a different region or
outside the company are involved. In internal transaction, people of the
same country or company transact.
• Financial intermediaries can reduce the cost of contracting by its
professional staff because investing funds is their normal business. The
use of such expertise and economies of scale
in contracting about financial assets benefits both the intermediary as
well as the borrower of funds.
• Financial intermediaries reduce transactions costs by
“exploiting economies of scale” – transactions costs per dollar
of investment decline as the size of transactions increase.
• In order to reduce transaction costs, institutions (sets of
rules) are created.
• Trustful relationships, strategic alliances, long-term contracts
etc.
• Transaction costs in construction- pre-
tendering costs (marketing, forming alliances, and establishing
reputations), tendering costs (estimating, bidding, and
negotiating), and post-tendering costs (monitoring
performance, enforcement of contractual obligations, dispute
resolution)
Class 6

• Stewardship theory
-G1-Presentation by group 1 on
Emerging paradigms of corporate governance
& discussion
(G1-A Guide to the Big Ideas and Debates in
Corporate Governance
•by Lynn S. Paine and 
•Suraj Srinivasan
•HBR October 14, 2019)
The Stewardship Theory

• The stewardship theory of firm is contrary to the

agency theory.
• Stewardship theory assumes that managers are
stewards of owner’s wealth and that their
interests align [Davis, Schoomen& Donaldson,
1997].
• The manager puts interests of the company he
manages before his own.
• He feels that his own goals are best accomplished
by serving the interests of the organization.
• Interests of mangers align with interests of
owners
• Managers’ goals are served by
organizational goals
• Agency theory – X , Stewardship - Y , Theory
of Man
• X - Man driven to work by economic needs
like wealth, power; hence to be controlled
• Y – Man motivated to work by higher needs
like achievement , recognition and self-
esteem ; managers not opportunistic

135
 PRINCIPAL

Contracts with Performs fiduciary duties as Stewards

Stewards
(Directors/
Managers)
CG system has to be effective
to get the best out of Directors
& Managers
Can we make them stewards ?
Class 7

e. Stakeholder theory
f. Shareholder theory
 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.
STAKEHOLDERS
THEORY
 Business Philosophy : Yesterday &Today

Milton Friedman ( 1970 )

• Critic of CSR :CSR activities decrease
company wealth .
The Social Responsibility of Business is to
Increase its Profits.
Business of business is business
 Stakeholder Theory

• R Edward Freeman( 1984 )

• Opposed Friedman view
• Strategic Management: A Stakeholder Approach
• A stakeholder in an organization is any group or
individual who can affect or is affected by the
achievement of the organization’s objectives.
• Freeman ( 2004)
Stakeholders are those groups who are vital for
the survival and success of the corporation
 Stakeholder Theory
• Groups / individuals/Institutions who can
substantially affect / be affected by the
company are stakeholders
• A stakeholder holds a stake , rather than just
a share
• According to Freeman, stakeholders are the
shareholders ,employees , customers,
suppliers, and the communities in which the
companies operate—a collection of “big five”

148
 Objective of Corporate Gov.
Shareholders vs Stakeholders
• Corporate governance deals with the ways in which suppliers of
finance to corporations assure themselves of getting a return on
their investment.
(Shleifer and Vishni)
• Corporate Governance has several claimants – shareholders
and other stakeholders – which include suppliers, customers,
creditors, bankers, employees of the company, the government
and the society at large. The fundamental objective of
corporate governance is the enhancement of shareholder
value, keeping in view the interests of other stakeholders.
( SEBI Birla Committee)

• Society as Stakeholder  CSR follows

OECD CODE OF CG 2004

OBJECTIVES of the CODE

• I) Ensuring the basis for an effective corporate governance
framework;
• II) The rights of shareholders and key ownership functions;
• III) The equitable treatment of shareholders;
• IV) The role of stakeholders;
• V) Disclosure and transparency;
• VI) The responsibilities of the board.
I. 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.
II. The
Rights of Shareholders and Key
Ownership Functions

The corporate governance framework

should protect and facilitate the exercise of
shareholders’ rights.
III. The 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.
IV. The 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.
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.
OECD Principles 2004 :
VI. The Responsibilities of the Board
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.
Class 8

g. Resource Based Approach

h. Dynamic Capability Approach

•G2-Presentation by Gr 2 on Challenges of
corporate governance
•G3-Presentation by Gr 3 on Achieving board
diversity
& discussion
(G2-CorporateGovernance 2.0
Guhan Subramanian HBR March 2015
G3 - How Diverse Is Your Board, Really?
Jared L. Landaw HBR )
 Resource Dependency Theory

• Resources may be considered as inputs that enable

firms to carry out its activities.
• Instead of looking at the competitive business
environment ,the organisation should instead look
within at its own available resources 
• Competitive advantage can only be achieved by the
effective and efficient employment of all resources
available to a firm (Mahoney, 2001).
Classification of resources (Grant 1991) classified resources into three
main groups namely:
• tangible,
• intangible, and
• personnel based.
 Characteristics of Strategic Resources

• It is important to distinguish strategic resources from other

resources. To most individuals, cash is an important resource.
Tangible goods such as one’s car and home are also vital
resources. When analyzing organizations, however, common
resources such as cash and vehicles are not considered to
be strategic resources.
• A strategic resource is an asset that is valuable, rare, difficult to
imitate, and nonsubstitutable.
•  Apple has many strategic resources, including their proprietary
software and hardware platforms, Strategic resources that
are valuable or rare are valuable simply due to the relatively high
cost of acquiring them (e.g., an airplane) or scarcity (e.g., diamonds).
 Dynamic Capabilities 
Ordinary Capabilities of Firm

-A firm's ordinary capabilities are the ones that

enable us to perform efficiently and effectively,
(Essential routine actions and practices)
Dynamic capabilities of firm

-“The firm's ability to integrate, build, and reconfigure internal and

external competences to address rapidly changing environments".

(David Teece, Gary Pisano and Amy Shuen, 1997 -Dynamic

Capabilities and Strategic Management)
• Dynamic capabilities can be distinguished from
operational capabilities, which pertain to the
current operations of an organization.
• Dynamic capabilities, by contrast, refer to “the
capacity of an organization to purposefully
create, extend, or modify its resource base”
(Helfat et al., 2007).
• Ordinary capabilities include operational, administrative and governance
competencies which enable the production and sale of products but which
are inadequate to sustain the long term growth of the business (Teece,
Shuena & Feiler, 2014)
• Dynamic capabilities are a set of specific and identifiable processes such
as product development, strategic decision making, and alliancing.
Distinction between dynamic capabilities and ordinary capabilities

Two broad categories of organizational capabilities

1-Zero-order ordinary capabilities needed to exploit
a firm's current strategic assets through day-to-day
operations (Winter, 2003)
2-Higher-order dynamic capabilities required to
alter a firm's resource base by integrating, building,
and reconfiguring competences (Eisenhardt &
Martin, 2000; Teece et al., 1997).
Class 9
Elements&Practices
of Corporate Governance
-Selection, compensation, succession,
and removal of Board of Directors ,
independent directors ,Chief Executive
Officer ,Executives, Gender specific
issues,
 CG Framework in India

SEBI -Birla Report

Narayan Murty Report
Naresh Chandra report
Company Act 2013
SEBI Listing Regulations 2015
 Law & Regulations for Indian
Companies

Companies Act 2013


• Independent Directors :
Fixed tenure , Evaluation
• Auditors : Fixed tenure
• Director Duties & Responsibilities
• CSR Mandate Sec 135
• Related Party Transactions
• Risk Management by Board
Co Act Section 166. Duties of directors
• (1) Subject to the provisions of this Act, a director of a
company shall act in accordance with the articles of
the company.
• (2) A director of a company shall act in good faith in
order to promote the objects of the company for the
benefit of its members as a whole, and in the best
interests of the company, its employees, the
shareholders, the community and for the protection
of environment.
• (3) A director of a company shall exercise his duties
with due and reasonable care, skill and diligence and
shall exercise independent judgment.
• (4) A director of a company shall not involve in a situation
in which he may have a direct or indirect interest that
conflicts, or possibly may conflict, with the interest of the
company.
• (5) A director of a company shall not achieve or attempt to
achieve any undue gain or advantage either to himself or
to his relatives, partners, or associates and if such director
is found guilty of making any undue gain, he shall be liable
to pay an amount equal to that gain to the company.
• (6) A director of a company shall not assign his office and
any assignment so made shall be void.
• (7) If a director of the company contravenes the provisions
of this section such director shall be punishable with fine
which shall not be less than one lakh rupees but which
may extend to five lakh rupees.
SEBI Listing Regulations (LODR) 2015 :
• Board composition ( higher % of IDs)
• Board sub committees
• Responsibility of IDs
• CEO CFO Certification
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.

172
 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)

174
CEO –CFO Certification
LODR – SCHEDULE II Part B
PART B: COMPLIANCE CERTIFICATE [Regulation 17(8)]
The following compliance certificate shall be furnished by
chief executive officer and chief financial officer:
• A. They have reviewed financial statements and the cash
flow statement for the year and that to the best of their
knowledge and belief:
• (1) these statements do not contain any materially untrue
statement or omit any material fact or contain statements
that might be misleading;
• (2) these statements together present a true and fair view of
the listed entity’s affairs and are in compliance with existing
accounting standards, applicable laws and regulations.
• B. There are, to the best of their knowledge and
belief, no transactions entered into by the listed entity
during the year which are fraudulent, illegal or
violative of the listed entity’s code of conduct.
• C. They accept responsibility for establishing and maintaining internal
controls for financial reporting and that they have evaluated the
effectiveness of internal control systems of the listed entity pertaining
to financial reporting and they have disclosed to the auditors and the
audit committee, deficiencies in the design or operation of such
internal controls, if any, of which they are aware and the steps they
have taken or propose to take to rectify these deficiencies.
D. They have indicated to the auditors and the Audit committee
(1) significant changes in internal control over financial reporting during
the year;
(2) significant changes in accounting policies during the year and that the
same have been disclosed in the notes to the financial statements; and
(3) instances of significant fraud of which they have become aware and
the involvement therein, if any, of the management or an employee
having a significant role in the listed entity’s internal control system over
financial reporting.
 
Class 10

-Governance in promoter organization, public and

private organizations:
-Gr 4 to present on
-How to enhance the contribution of
Independent Directors in Boardroom?
• And discussion
(G 4-Emerging Role of Independent Directors in the
Boardroom by Arun K Rath -Edited book ‘Corporate
Governance in Asia’, Allied Publishers,2011)
• G 4-How to enhance contribution of Independent
Directors in the Boardroom ?
RESEARCH FINDINGS

TOWARDS BETTER CORPORATE GOVERNANCE :

CONTRIBUTIONS OF INDEPENDENT
DIRECTORS IN THE BOARDROOM
 Main Findings
1.The induction of IDs into the Board is necessary
2. IDs should be in range of one-third to half strength .
3.Very few IDs receive training at present.
4.Boards spend half the time on routine matters.
5.ID attendance in Boardroom needs to improve
6.IDs hardly initiate agendas for the Board meetings.
7.Knowledge of the IDs needs to improve
8. Audit Committee should meet longer.
9.Interaction of IDs with the auditors be more
10.IDs should have displayed greater independence.
182
 Agenda for ID Mtg
• Safeguarding interests of company
• ID Independence : No conflicts of interests
• Evaluation of Chairman & Directors
• Initiation of new agendas by IDs
• Discussion about long term goals of company
• Objective & transparent decision making
• Monitoring Financial Health of Company
• Effectiveness of internal controls
• Scrutiny of Related Party Transactions
• Employee Capacity Building
• Risk policy formulation & review
• Social Responsibility & Sustainable Development
• Strategic Management & Value Addition
• Corruption by Top Management