Why is corporate governance important?

In its early evolutionary years, Corporate Governance was more of a nebulous concept. In the last few decades more thought has been devoted to it, though that has been mostly in the context of industry and corporate. In the last 3 – 4 years, the banking and financial sectors have paid more attention to Corporate Governance in the context of:

– Information asymmetry

– Insider trading

– Systemic risks (Domino Effect), and

– Moral hazards

Before regulators wake up and prescribe duties and responsibilities, enlightened organizations should build up their own prescription of self governance.

What is Corporate Governance?

The Cadbury Committee has defined Corporate governance as the system by which companies are directed and controlled.

According to the experts of the OECD, a corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the Board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this it provides the structure through which the company objectives are set, and also provides the means for achieving those objectives and monitoring performance.

The Kumar Mangalam Committee report describes the objective of Corporate Governance as ‘the enhancement of the long-term shareholder value while at the same time protecting the interests of other stakeholders’

Corporate governance is about the spirit, in which one does business and about credibility and accountability, as shareholders want to be assured of a Board’s independence and its willingness to act in their best interests.

Corporate Governance is a question of promoting corporate fairness, transparency and accountability. Corporate Governance means doing everything better; to improve the quality of outside directors; to encourage people to think long term and to ensure that information needs of all stakeholders are met and executive management is monitored properly in the interest of shareholders

Corporate Governance aims at maximizing shareholder value in the long term in a fair, transparent and ethical manner.

Business Ethics & Corporate Governance:

Business ethics and & corporate governance deals with a different form and substance of corporate governance deals with corporate character with complete transparency with non-financial disclosures.

The Enron Saga:

Enron was seventh largest public company in the United States, heralded by management gurus as the “new “economy” firm for its achievements and business-model. It has prestigious, experienced and well qualified for board and yet, the giant ‘collapsed’! It engaged in high risk accounting…transactions involving inappropriate conflict of interests with high executive compensation and inadequate oversight exercised by the board.

The board approved a proposal allowing the CFO to establish and operate the LJM private equity funds which transacted business with Enron and profited at its expense in unfair dealings. The board knowingly allowed Enron to conduct billions of dollars in off-the-books activity to make its financial condition appear better than what it was (inadequate public disclosure of material off-the-books liabilities). The board also failed to ensure the independence of the company’s auditor, allowing Anderson to provide internal audit and consulting services while serving as Enron’s outside auditor.

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The tale of Tata Finance Limited (TFL):

TFL had sustained massive losses, largely on account of inter-corporate loans given to a TFL subsidiary for investing in ICE (internet, communications and entertainment) stock. The board failed to take note of the state of affairs. Did not lay down proper risk management policies (about speculative investments in equity markets, exposure norms etc.). According to Ratan Tata, “the board should be more attentive, interactive and proactive.”

Background of corporate governance: 

Code of Desirable Corporate Governance – CII
Narasimham Committee (NC)
Kumar Mangalam Birla Committee (KMB)
Committee on Guidelines – N. Vittal (CVC)
Ganguly Committee (G)
Basel Committee
The World Bank and IMF approaches
The Combined Code (UK) (CC)
International Best Practices (IBP)
The Sarbanes-Oxley Act (SOA)
The Naresh Chandra Committee (NCC)
The Advisory group on Corporate Governance (RHP)
Provisions of the Banking Regulation Act (1949)
Provisions of various statutes (e.g. SBI Act 1955, Associate Banks Act 1959 and acts relating to nationalization of banks
Provisions regarding constitution of Boards: Not less than 51% of Board members shall have specialized knowledge (BRA)

Recommendations of various committees on corporate governance:
Restrictive provisions regarding interests of Board members outside the Bank (BRA)
Existing Do’s and Don’ts for Board members (Existing Practice)
Broad-based the Board with a prescribed proportion of executive and non-executive directors (KMB)
Remuneration of Board members (G,CC)
Constitute an independent Audit Committee (KMB)
Introduce the concept of independent directors (KMB)
Give meaningful information to the Board at its meetings (KMB)
Provide for transparency through disclosures in Annual Reports (KMB)
Prescription on information to be given to the Stock Exchanges (KMB)
Report on Corporate Governance, and certificate on compliance from auditors, to be added in Annual Report (KMB)
An evaluation of the quality and efficiency of governance standards be made an integral part of credit rating systems (MSV)
Arm’s length relationship with the government, commencing with dilution of government equity to 33% (N)
Independence and autonomy for the Boards, with the Boards having full freedom to take decisions on corporate strategy and also accepting responsibility towards stakeholders (N)
Need for tackling the problems of information asymmetry and lack of involvement of part-time directors; Involve only full time directors (N)
Tackling the problems of conflict of interests and peer pressure (CVC)
Accountability and responsiveness to the public (CVC)
Concern for value of public assets and funds (CVC)
Non-abuse of official position (CVC)
Building up a code of ethics (CVC)

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Supportive legal framework: e.g. abolition of SICA, amendment of Banking Secrecy Act etc. (CVC)
Chief Executive to be appointed by the Board (IBP)

Mechanism to take care of oversight (IBP) :

– Oversight by Board

– Oversight by Committees

– Oversight by independent Board
Members not involved in day-to-day
Running of business
Division of responsibilities between Chairman of the Board & CEO (CC)
Board Balance : Executive and non-executive directors (CC)
Corporate values, codes of conduct and other standards of appropriate behaviour and the system used to ensure compliance with them (Basel)
A well-articulated corporate strategy against which success can be measured (Basel)
Clear assignment of responsibilities and decision-making authorities – hierarchy of approvals from individuals to Board (Basel)
Mechanism for interaction and cooperation among Board of Directors, senior management and auditors (Basel)
Strong internal control systems, including internal and external audit functions, risk management functions (Basel)
Special monitoring of risk exposures where conflicts of interests are likely to be particularly great (Basel)
Appropriate information flows both internally and to the public (Basel)
Directors be exposed to need-based training programmes (G)
Whole-time directors to have sufficiently long tenure (G)
Undertaking from every director that he has understood his role and expectations from him (G)
Dilution of some restrictions on lending to companies in which directors are interested (G)
Distinction between statutory items and strategic issues in order to make the material for directors manageable (G)
Secretary of Board to be a Company Secretary, with a Compliance Officer reporting to him (G)
Setting up of the Supervisory Committee (G)
Setting up of Nomination Committee (G)
Strengthening of and expediting setting up of Risk Management Committees (G)
Appointment of non-executive directors should be from a panel of professional and talented people, to be maintained by the RBI (G)
Public Company Accountability Oversight Board to regulate the auditor and the accounting profession (has 5 full time independent members) (SOA)
Audit committees to be responsible for the outside auditor relationship (SOA)
Members of audit committee be independent from company’s management (SOA)
Auditor independence – services outside the scope or practice of auditors
SEC should adopt rules requiring a company to disclose whether it has a ‘financial expert’ (SOA)
SEC should adopt final rules regarding “minimum standards of professional conduct” (SOA)
Auditors should be, and be seen to be, independent of the company which they are auditing (NCC)
Prohibition of any direct financial interest in the audit client (NCC)
Prohibition of receiving any loans and/or guarantee from the audit client (NCC)
Prohibition of any personal or business relationship with the audit client (NCC)
Prohibition of service (cooling off period:2 years) (NCC)
Prohibition of undue dependence on the audit client (NCC)
Rotation of audit firms (NCC)
Certain non-audit services are not to be provided by the audit firm to its audit client (e.g. accounting and book-keeping, internal audit services, actuarial services, investment advisor, valuation services and fairness opinion, management functions etc.) (NCC)
Independence Standards for consulting and other entities affiliated to audit firms (NCC)
Setting up of three Independent Quality Review Boards (for ICAI, ICSI and ICWAI) to strengthen and reform the peer review system, to be funded by the respective institutions (NCC)
Appellate forum to resolve disputes. (NCC)
The Board should constitute at least four committees of independent directors: Audit Committee, Appointment Committee Remuneration Committee, and Investment Committee. The Appointment Committee will be the focal point for induction of independent directors. (RHP)
PSUs should also be covered under CG norms – transfer the actual governance function from administrative ministries to boards and streamline the appointment process by entrusting this task to a specially constituted body of eminent experts with independent status (RHP)
Reduce the role of administrative ministries (RHP)
Quality of financial reporting by Cos. in India needs to be improved (RHP)
Indian Companies Act should be amended to enforce good governance practices (RHP)
Cos. Should share their goals and disclose risk factors and off-Balance Sheet items to share holders (RHP)
There should be a strong representation of independent non-executive directors on the Board and the Board should monitor the performance of full time directors satisfactorily (RHP)
The Boards should be more professional and autonomous with majority of directors (50 % or more) being truly independent (RHP)
The Central Government and RBI should bring about a significant change in the corporate governance norms adopted by banks and financial intermediaries and impose a tighter governance mechanism (RHP)
RBI should not appoint its nominees to the boards of banks. Similarly, special status with veto powers given to government directors is not in the interest of good governance (RHP)Banks should also designate a Risk Mgt. Committee (RHP)
Banks should ensure a higher degree of transparency in regard to disclosure (RHP)Banks should have clear strategies for for guiding their operations and establishing accountability for executing them (RHP)

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