INTRODUCTION

Recently the terms "governance" and "good governance" are being

increasingly used in development literature. Bad governance is being increasingly
regarded as one of the root causes of all evil within our societies. Major donors and
international financial institutions are increasingly basing their aid and loans on the
condition that reforms that ensure "good governance" are undertaken.

CORPORATE GOVERNANCE

Definition of corporate governance:

"Corporate Governance is concerned with holding the balance between

economic and social goals and between individual and communal goals. The corporate
governance framework is there to encourage the efficient use of resources and equally to
require accountability for the stewardship of those resources. The aim is to align as nearly
as possible the interests of individuals, corporations and society."

"Corporate governance is about promoting corporate fairness, transparency and

accountability" J. Wolfensohn, president of the Word bank, as quoted by an article in
Financial Times, June 21, 1999.

Corporate governance comprises the systems and processes which ensure the
efficient functioning of the firm in a transparent manner for the benefit of all the
stakeholders and accountable to them. The focus is on relationship between owners and
board in directing and controlling companies as legal entities in perpetuity. A company’s
ability to create wealth for its owners however, depends on the role and freedom given to
it by society.

Sir Adrian Cadbury in his preface to the World Bank publication, Corporate
Governance: A Framework for Implementation; states that, “Corporate Governance is…
holding the balance between economic and social goals and between individual and
community goals. The governance framework is there to encourage the efficient use of
resources and equally to require accountability for the stewardship of these resources.
The aim is to align as nearly as possible the interest of individuals, corporations and
society. The incentive to corporations is to achieve their corporate aims and to attract
investment. The incentive for state is to strengthen their economies and discourage fraud
and mismanagement.

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 The focus on corporate governance arises out of the large dependencies of
companies on financial markets as the preeminent source of capital. The quality of
corporate governance shapes the future and the growth of the capital market. Strong
corporate governance is indispensable to resilient and vibrant capital market. In the
context of globalization, capital is likely to flow to markets which are well regulated and
practice high standards of transparency, efficiency and integrity.

BENEFITS OF CORPORATE GOVERNANCE:

 Good governance leads to congruence of interests of boards, management

including owner managers and shareholders.

 Good governance provides stability and growth to the company.

 Good governance system builds confidence among investors.

 Good governance reduces perceived risks, consequently reducing cost of capital.

 Well governed companies enthuse employees to acquire and develop company

specific skills.

 Adoption of good corporate governance practices promotes stability and long

term sustenance of stakeholders relationship.

 Potential stakeholders aspire to enter into relationships with enterprises whose

governance credentials are exemplary.

Normative Theory of Corporate Governance:

In the context of globalization of operations of corporations and integration of

financial markets, the question whether any universal normative principles can be laid
down has assumed significance since corporate governance provisions and practices
differ from country to country. The basis for universal normative standards on corporate
governance is to be found in the German critical theory which elaborated a well
developed normative ethical theory.

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Normative Criteria
Morality

Normative analysis of corporate capitalism uses morality as a tool for establishing

minimum standards which would be necessary for corporate capitalism to represent
common good. Morality deals with standards that an individual or group has about what
is right and wrong or good and evil.

Morality addresses questions whether corporate practices promote common good.

Corporate capitalism represents a common good because competitive capitalist markets
are efficient and work on the basis of shareholder democracy.

Competition

Market competition has three basic effects that support the view that competitive
capitalism represents common good. These are:
 Static efficiency of markets which guarantees Pareto optimality, an equilibrium
condition in which no one can any longer be made better off through an exchange
without some one else being made worse off.

 Dynamic efficiency of the market which establishes consumer sovereignty in

which consumers determine through their consumption choice what products are
to be produced.

 Dynamic efficiency also ensures full employment since competition clears all
markets including labor.

However fine tuning of free markets requires oversight. It has to be ensured that
regulations are in place to avoid the production of negative externalities and the role of
labor is recognized to protect it from unemployment, hazardous working conditions and
below subsistence wages. State intervention is necessary to secure these conditions.

Shareholder Democracy

Private ownership of means of production is a key complement to free markets for

the justification of capitalism on efficiency grounds. Private ownership provides
motivation for investment and innovation to actors operating in market economies.
Further corporate form of ownership allows pooling of resources. In modern times since
ownership and management are separate, their interests may diverge. The theory of
shareholders democracy requires that for corporations to be run efficiently in their
interests shareholders should exert influence over management.

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 CORPORATE GOVERNANCE and ECONOMIC PERFORMANCE

Among the various attempts to evolve the best global standards the principles
evolved by Organization for Economic Cooperation and Development (OECD) released
in 1999 have been accepted as an international benchmark. OECD principles recognize
that different legal systems, institutional frameworks and traditions across countries have
led to the development of a range of different approaches to corporate governance. The
OECD principles like other good corporate governance regimes protect the interest of not
only the shareholders but all stakeholders like employees, creditors, suppliers, customers
and environment.

OECD Principles

The OECD principles of corporate governance cover five major areas:

 The rights of shareholders.

 The equitable treatment of shareholders.
 The role of stakeholders.
 Disclosure and transparency.
 The responsibilities of the boards.

Rights of Shareholders: Rights of shareholder mentioned in the OECD report cover the
registration of the right to ownership with the company, conveyance or transfer of shares,
obtain relevant information from the company on a timely and regular basis, participate
and vote in general shareholders meetings, elect members of the board and share in the
profits of the company.

Equitable treatment of shareholders: All shareholders should be treated equitably and the
law should not make any distinction among different shareholders holding a given class
or type of shares. Any changes in voting rights of common shareholders can be done only
with the consent of those shareholders.

Role of Stakeholders: The rights of stakeholders as established by law should be

recognized and active cooperation between corporations and stakeholders in creating
wealth, jobs and sustainability of financially sound enterprises should be encouraged.
Corporate entities also have an impact on the environment of the community in which
they are located. Polluting units may generate profits for shareholders but impose costs
on society.

Role of Board: The main task of a board is to monitor the performance of executives and
to ensure that returns to shareholders are maximized. True independence of board can be
ensured by having a majority of outside directors who do not have any financial or
pecuniary involvement with the company.

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Disclosures and Transparency: Timely disclosures relating to financial position,
ownership pattern and shareholding helps in infusing a sense of discipline and
accountability of managers. Increased transparency and information help to reduce
information a symmetry between management and shareholders.

MODELS OF CORPORATE GOVERNANCE

OUTSIDER MODEL

Outsider model obtaining in USA and UK in which control and ownership are
distinct and separate. Since equity ownership is widely dispersed among a large number
of institutional holders and small investors, control vests with professional managers. The
model is also referred to as principal agent model where the shareholders, the principals
entrust the management of the firm to the managers, the agents. In actual practice with
the growth of the firm the gulf between shareholders and managers has widened and
became distant giving rise to the agency problem, ensuring that the managers function in
the interests of the shareholders. The dichotomy between ownership and control has
necessitated the adoption of regulatory and legal frameworks to ensure that corporate
governance practices protect the interests of shareholders as well as other stakeholders.

INSIDER MODEL

The insider model has two variants, the European and East Asian. In the European
model a relatively small compact group of shareholders exercise control over corporation.

On the other hand, the East Asian model of corporate governance, the founding
family generally holds the controlling shares either directly or through holding
companies. In all East Asian countries control is enhanced through pyramid structures
and cross holding firms.

In the European insider model the controlling shareholders are backed by

complex shareholders agreements. The controlling group maintains longer term and
stable relationship among themselves. In the European countries where this insider model
is extant corporate sector on banks as a source of finance and the corporate entities have
quite high levels of debt equity ratio.

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CADBURY COMMITTEE REPORT (1991)

It was in attempt to prevent the recurrence of such business failures that the
Cadbury Committee, under the chairmanship of Sir Adrian Cadbury, was set up by the
London Stock Exchange in May 1991. The committee submitted its report and associated
“Code of Best Practices” in December 1992 laying down the methods of governance
needed to achieve a balance between the essential powers of the Board of Directors and
their proper accountability.

The Cadbury Code of Best Practices had 19 recommendations. The

recommendations are in the nature of guidelines relating to the Board of Directors, Non –
Executive Directors, Executive Directors and those on Reporting and Control.

Relating to the Board of Directors:

 The Board should meet regularly, retain full and effective control over the
company and monitor the executive management.

 There should be a clearly accepted division of responsibilities of the head of a

company, which ensure balance of power and authority, such that no individual
has unfettered powers of decision. In companies where the Chairman is also the
Chief Executive, it is essential that there should be a strong and independent
element on the board, with a recognized senior member.

 The Board should include non – executive Directors of sufficient caliber and
number for their views to carry significant weight in the Board’s decisions.

 The Board should have a formal schedule of matters specifically reserved to it for
decisions to ensure that the direction and control of the company is firmly in its
hands.

 There should be an agreed procedure for Directors in the furtherance of their

duties to take independent professional advice if necessary, of the Company’s
advice.

 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 compiled with.

Relating to the Non – Executive Directors:

 Non – executive directors should bring an independent judgement to bear on

issues of strategy, performance, resources, including key appointments, and
standards of conduct.

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  The majority should be independent of management and free from any business or
other relationship, which could materially interfere with the exercise of their
independent judgement, apart from their fees and shareholding. Their fees should
reflect the time, which they commit to the company.

 Non – executive Directors should be appointed for specific terms and

reappointment should not be automatic.

 Non – executive Directors should be selected through a formal process and both,
this process and their appointment, should be a matter for the Board as a whole.

Relating to the Executive Directors:

 Directors’ service contracts should not exceed three years without shareholders
approval.

 There should be full and clear disclosure of their total emoluments and those of
the Chairman and the highest paid UK directors, including pension contributions
and stock options. Separate figures should be given for salary and performance
related elements and the basis on which performance is measured should be
explained.

 Executive Directors’ pay should be subject to the recommendations of a

Remuneration Committee made wholly or mainly of Non Executive Directors.

Cadbury Code of Best Principles on Reporting and Control:

 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 on Audit Committee of atleast three 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 on the Company’s system of

internal control.

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  The Directors should report that the business is a going concern, with supporting
assumptions or qualification as necessary.
CORPORATE GOVERNANCE IN INDIA

Factors influencing Corporate Governance:

SEBI website has summarized the factors which influence quality of governance
in Indian companies.

a. Integrity of the Management: A Board of Directors with a low level of integrity is

tempted to misuse the trust, reposed by shareholders and other stakeholders, to
take decisions that benefit a few at the cost of others.

b. Ability of the Board: The collective ability, in terms of knowledge and skill, of the
Board of Directors to effectively supervise the executive management determines
the effectiveness of the board.

c. Adequacy of the process: Board of directors cannot effectively supervise the

effective management if the process fails to provide sufficient and timely
information to the Board, necessary for reviewing the plans and the performance
of the enterprise.

d. Commitment level of individual board of members: The quality of a board

depends on the commitment of individual members to tasks, which thy are
expected to perform as board members.

e. Quality of corporate reporting; the quality of corporate reporting depends on the

transparency and timeliness of corporate communication shareholders. This helps
the shareholders in making economic decisions and in correctly evaluating the
management in its stewardship function.

f. Participation of Stakeholders in the management: The level of participation of

stakeholders determines the number of new ideas being generated in optimum
utilization of resources and for improving the administrative structure and the
process. Therefore an enterprise should encourage and facilitate stakeholders’
participation.

RBI ADVISORY GROUP

The report of the Advisory Group Corporate Governance (March 2001) appointed
by RBI defines corporate governance as the system by which business entities are
monitored, managed and controlled. According to the advisory group a good structure of
corporate governance is one that encourages symbiotic relationship among shareholders,

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executive directors and the board of directors so that the company is managed efficiently
and the rewards are equitably shared among shareholders and stakeholders.

COMMITTEE ON CORPORATE GOVERNANCE BY CHAIRMAN,

KUMAR MANGALAM BIRLA, 1999

The Securities and Exchange Board of India (SEBI) appointed the Committee on
Corporate Governance on May 7, 1999 under the Chairmanship of Shri Kumar
Mangalam Birla, member SEBI Board, to promote and raise the standards of Corporate
Governance. The Committee’s detailed terms of the reference are as follows:

a. to suggest suitable amendments to the listing agreement executed by the

stock exchanges with the companies and any other measures to improve
the standards of corporate governance in the listed companies, in areas
such as continuous disclosure of material information, both financial and
non-financial, manner and frequency of such disclosures, responsibilities
of independent and outside directors;
b. to draft a code of corporate best practices; and
c. To suggest safeguards to be instituted within the companies to deal with
insider information and insider trading.

The Recommendations of the Committee

This Report is the first formal and comprehensive attempt to evolve a Code of
Corporate Governance, in the context of prevailing conditions of governance in Indian
companies, as well as the state of capital markets. While making the recommendations
the Committee has been mindful that any code of Corporate Governance must be
dynamic, evolving and should change with changing context and times. It would
therefore be necessary that this code also is reviewed from time to time, keeping pace
with the changing expectations of the investors, shareholders, and other stakeholders and
with increasing sophistication achieved in capital markets.

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THE THREE ANCHORS OF CORPORATE GOVERNANCE

The three anchors of corporate governance are board of directors, management

and shareholders. While each of them has important responsibilities of its own, it is their
interaction with each others that is the key to effective governance. The system can
become unbalanced if any one of them is not functioning well.

BOARD AND MANAGEMENT

The changes introduced by focusing on board and Audit Committee composition

have not succeeded in establishing a healthy distance between the management and
Board. The Board should be free to monitor and the management free to manage. If the
two functions are combined as under a system of Chief Executive Officer being
Chairman, there is no separation of powers and functions. The policy making, strategy
formulation and monitoring is done by the same person who is supposed to execute them.
The efficiency of all these measures to distance Board from management would be lost if
we let a person wear two hats at the same time that of Chairman of the Board and Chief
Executive Officer of management.

At the outset it should be noted that letting management personnel be members of

the Board how so ever senior they member by calling them full time Directors /
Executive Directors has confounded the concepts of transparency and Accountability.
Good Corporate Governance demands the separation of the Board and Management.
Even in the case of promoters whose personal wealth is tied to the company they have to
make a choice to be satisfied by being a member of the Board or Management team. This
of course goes against the grain of Indian Corporate Governance, the founding family as
“owners” being the Board as well as Management. Management Accountability will be
non existent to the shareholders in such circumstances.

BOARD AND SHAREHOLDERS

The regulatory efforts and operation of market force have left out this relationship
in the third anchor of corporate governance. By and large shareholders do no know what
the directors are doing and directors do not know what the shareholders want.

Board members are elected by shareholders to serve as their agents but in practice
shareholders have not exerted much influence over directors. The exchange of
information between the two anchors is poor and directors are not accountable to
shareholders. There is no way for shareholders to know whether the directors have acted

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in their interests. Although they have the right to elect board, there is no efficient
mechanism to nominate or even endorse director candidates.

Shareholders on their part are apathetic and mute. Their communication is limited
to formal proxy votes which historically ratified board’s wishes. Shareholders have
access to no mechanism through which to effect changes, except for calling an extra
ordinary general body meeting. The relationship between the two anchors, board and
shareholders is not linked together in any manner or by any method except for the
provision of annual general meeting. The absence of the link has created an imbalance in
the governance mechanism. It has also encouraged a closer relationship and stronger link
between board and management who fill the void. Directors can be effective in taking
care of shareholders interests if we set up a strong structure of board shareholder
relationship through ensuring transparent operation of the board meetings and
enfranchisement of shareholders. Three steps mooted in this connection are record of
voting at board meetings, letting shareholders put up as well as elect a director on their
behalf and make resolutions passed at shareholders meeting binding.

TRANSPARENCY

If the individual directors’ votes on corporate resolutions in key corporate proxy

statements are recorded, the directors become accountable to shareholders. When people
are held recountable for their actions as individual rather than as a group they tend to
weigh their choices more carefully. Directors would have greater incentive to air their
views if individual votes are published. Such accumulated information to create directors’
score boards would supplement board self evaluation.

 Separate the position of CEO and Chairman of the Board as is the practice in UK
and Canada.

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 CORPORATE GOVERNANCE IN INDIAN SETTING

Corporate Governance when strictly followed / enforced would not allow the
payments to agencies with which a company has to deal with. While political
contributions are allowed extra legal payments are not allowed as payments. They can be
financed only by inflating expenditure or understanding receipts. But such practices
cannot be limited and the door would open wide for manipulation of accounts.

It is not just the integrity of the market that is at stake but the probity of the
nation. We rank high among corrupt nations. Let us reform corporate governance but by
doing so we have a much bigger job of limiting the insane greed that is eating away like
cancer the vitals of our nation.

Aspects of corporate governance that require attention are strengthening the

board, and reducing the sweeping powers of executive directors / fulltime directors
whose position undermines the balance of power between shareholders, directors and
managers, accountability of management and promoting shareholders participation.

GOVERNANCE REFORMS IN INDIA

First, after the Report of the Committee on Corporate Governance (Chairman,

Kumar Mangalam Birla) 1999, guidelines were issued in 2000. Companies are also
required to furnish statements and reports for the Electronic Data Information Filing and
Retrieval (EDIFAR) system maintained by SEBI.

To further improve the guidelines SEBI constituted a Committee on Corporate

Governance (Chairman, N.R. Narayana Murthy) whose report was presented on
08.02.2003. The report has also set out recommendations of Naresh Chandra Committee
(2003) on Corporate Audit and governance set up by Department of Company Affairs.

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 ROLE OF A DIRECTOR

Definition of Independent Director:

Report of the Committee on Audit and Corporate Governance (2003), has defined
Independent Director as a director:

 Not receiving remuneration

 Not related to promoters or management
 Not an executive of the company in the last three years
 Not a partner or executive in the Auditing firm
 Not a significant supplier or vendor or customer
 Not a shareholder owing 2% or more
 Not been a director for more than three terms of three years each.

SEBI COMMITTEE ON CORPORATE GOVERNANCE (2003) AND

INDEPENDENT DIRECTOR

Based on the committee on Audit and Corporate Governance (2003) definition,

the report of the committee on Corporate Governance (2003) defined the Independent
Director as a Non Executive Director of the company who:

 Apart from receiving director’s remuneration does not have any material
pecuniary relationships or transaction with the company.
 Is not related to promoters or management.
 Has not been an executive of the company in the preceding three years.
 Not a partner or an executive of the statutory audit firm or internal audit
firm that is associated with the company.
 Is not a supplier, service provider or customer of the company.
 Is not a shareholder owing 2% or more of shares of company.

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 ROLE OF INDEPENDENT DIRECTORS

Clause 49 of the listing agreement between the public limited company and the
stock exchange on which its shares are listed envisages a dominant role for Independent
Director by suggesting their inclusion in Audit committee, remuneration committee and
shareholders committee. In fact the committee on corporate governance (1999) had
recommended that atleast half of the board should be of independent members if the
Chairman is an executive and one third shall be independent directors, if the chairman is
a non – executive member. Later the department of company affairs with effect from
16.01.2000 introduced an amendment in schedule XIII to the Companies Act wherein the
presence of Remuneration Committee has been made obligatory for a recommendation of
appointment and fixing of remuneration of managing and all time directors. Thus even
though the amendment act does not speak about the role of independent directors, clause
49 of the listing agreement and amendment of Schedule XIII has made it almost
obligatory to appoint independent directors for listed and public companies. Even under
section 292 A, it has been laid down that the composition of Audit committee shall
consist of Directors who shall not be managing or whole time directors. The inference is
inclusion of independent directors.

Prior to the Amendment Act, 2000 Independent directors were their only for the
purpose of quorum under section 207. This was the case in USA too.

Director or Independent Director: Non executive director is typically a powerful

business person in his own right whose wisdom is based on a clear understanding of
today’s financial issues and a grasp of how to create shareholders’ value. Directors’
experience and expertise influence for performance more than directors independence.
The modern non executive director frequently represents the larger shareholders within
the company. Outside directors signal their abilities through the effective monitoring of
management. They have greater incentives to make decisions that benefit shareholders
than do inside directors. Their decisions are signal to the labor market of their abilities as
decision control agents. Since they are major decision makers with other organizations
concerned for their reputation in the labor market provides them with incentives to act in
the interest of shareholders. Today’s larger shareholders have shown that they wish to see
board decisions taken of which they fully approve. This is the global trend and has found
acceptance in India. SEBI also emphasis the importance of non – executive, independent
directors by insisting upon committees of directors directly or indirectly to play a major
role in controlling the audit committee and remuneration committee, which consists of
only independent directors as Chairman and majority forming independent directors.
Given the requirement for greater risk management oversight by firms, empirical
evidence reveals a significant and positive relation between the quantity of interest rate,
derivatives used and the relative influence of outside directors. There is also evidence that
the corporate interest rate derivative use, on average, benefits shareholders. Independent
directors should be prepared to “whistle blow” or even resign where companies are not

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willing to address to the concern raised on behalf of the shareholders. Independent
directors should be there to help the executives, build success, not police the rest of the
board. They are the shareholders’ special watchdog.

The New York Stock Exchange corporate accountability and listing standards
committee proposals to improve corporate governance would require outside directors to
conduct regular meetings without management present and company’s to have audit,
compensation and nominating committees composed solely of independent directors.

Private sessions of independent directors after every full board meeting has
become common practice at same companies after the initiation of new governance
practices in USA. “Boards are making sure non management directors meet alone and
often. They are broadening the composition of their boards to foster more view points and
ideally, skeptism. They are hiring pay consultants for more objective view of executive
compensation. They are sending directors to financial – literacy classes, so they’ll atleast
know where to look for potential problems. They are asking directors spend more time on
the company’s frontlines visiting stores, talking to employees to give them a feel for the
company that they could never get in a board room.”

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 BIBLIOGRAPHY
• en.wikipedia.org/wiki/Corporate_governance
• www.cbr.cam.ac.uk/pdf/wp277.pdf
• www.corpgov.net/
• www.beyondgreypinstripes.org/pdf/CGReport.pdf
• www.icmrindia.org/casestudies/Case_Studies.asp?cat=Corporate%20Gov
ernance
• searchfinancialsecurity.techtarget.com/sDefinition/0,,sid185_gci1174602,
00.html
• news.mba4india.com/1762/definition-corporate-governance/
• www.brainguide.in/corporate-governance-definition-aspekte-und-die-
frage-nach-dem-nutzen-von-corporate-governance
• www.scribd.com/doc/5034294/Corporate-Governancecadbury-report

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