Corporate Governance

Emergence of Corporate Governance

1. 1933: Glass Stiegel’s Act – Separating commercial banking with investment
companies.
2. 2002: The Year of Apology.
(http://knowledge.wharton.upenn.edu/article.cfm?articleid=680)
a. Collapse of Enron in 2001.
b. CEO of Tyco International
c. Merrill Lynch (Financial Services Industries)
d. Hank Paulson, chairman of Goldman Sachs
e. CEO, Sandy Weil – Citigroup
f. McDonalds apologizing to Hindus
3. Passing of the Sarbanes – Oxley Act (SOX Act).
4. Directors and Officers Liability Insurance (D & O)
5. The Satyam Effect
6. This gave rise to Corporate Governance.

What is Corporate Governance?

It is an art of managing companies ethically and efficiently for enhancing stakeholders’
value.
The entire gamut of corporate governance system could be referred to as “Corporate
ethical and value system”.
- (Extracted from the Report of the Committee on the Companies Bill, 1977)
“Creating an ethical culture means instilling and maintaining a commitment to doing the
right thing this time and every time – so much so that it becomes entwined in the
essential DNA of the firm”.
- William H. Donaldson

Objectives of Corporate Governance:

1. Fulfill the long term aims for which the company was incorporated. - Bajaj –
Focus on medium to long term range &Hero Honda case study also L’Oreal
and Body Shop acquisition.
2. To ensure shareholder protection. - Johnson & Johnson selling of shares and
Cadburys.
3. To ensure employee protection. – Pink Slips in US. - TARP
4. To ensure that responsibilities to the society and environment are carried out.
– Triple bottom line, ITC with eucalyptus trees.
5. To ensure compliance with laws and regulations.
 6. To ensure correct presentation of finances of the company.

Definition of Corporate Governance:

CII – Desirable Corporate Governance Code defines thus:
“Corporate Governance deals with laws, procedures, practices and implicit rules that
determine a company’s ability to take informed managerial decisions vis-à-vis its
claimants – in particular its shareholders, creditors, customers, the State and
employees. There is a global consensus about the objective of “good” corporate
governance: “Maximizing long – term shareholder value”.

Roots of Corporate Governance:

Theory of Firm – Adam Smith (1776): “The directors of (Joint Stock) companies,
however, being managers rather of other people’s money than of their own, it cannot
be well expected that they should watch over it with the same anxious vigilance (as
owners) negligence and profusion, therefore, must always prevail, more or less in the
management of the affairs of such a company,
(Read Adam Smith’s Wealth of the Nations)
- R.H.Coase (1937)
- Michael Jenser
- William Meckling (1976)
- Andrei Sleifer
- Vishny Robert (1997)
Agency Problems in Three Ownership Management situations –
 A company has no controlling shareholder. (Walking the Wall Street, selling the
shares after losing the confidence in the company).
 Controlling shareholder is also the manager. (Control of Anil Ambani on the
Reliance Industries)
 Controlling owner but not involved in the management. (Public sector companies
owned by the government, but run by professionals, L & T - Private)
Economic Rationale –
 Asymmetric Information (Shareholders should know more about the company but
it is not the scenario, it is being run by the managers, Merck and Vioxx clinical
results, Thalidomide.
 Free Rider Problem (Madoff scandal)
 Moral Hazard (Subprime crisis, Credit default swaps, collateralized debt securities)
Active Players in Corporate Governance:
1. Media
2. Professional Organizations (Institute of Directors IOD)
3. Activists Organizations (Centre for Corporate Governance) – Opposite: Lobbyist
Watch Thank you for smoking movie
4. Analysts (Investment Brokerage Houses, Creditors) – Kirloskar Brothers Financial
Analysts Meet
(http://web.kbl.co.in/kbl_internet/images/financial/Analyst%20Meet%202nd%20
August%20KBL.pdf)
5. Regulators (SEBI, Stock Exchange, RBI, Government, National Foundation for
Corporate Governance), Self Regulators (CII, AMFI, ICAI, ICSI)
6. Market Players (Institutional Investors, Small Investors, Grievance Association) –
Institutional activism.
7. Shareholders (Institutional large private investors, Large Debt Providers,
Representatives of Large Debt providers) Watch Barbarians of the Gate, takeover
of Arcellor by Mittal
8. Role of auditors (Contrary of interest. Auditors auditing a company also is earning
revenue from the company).
9. Employees Whistle blower protection (Protection of employees to blow the
whistle)
10. Board of directors (Independence Qualifications)
11. Internal Auditors (Audit committee, independence rotation) Read -
http://www.erisk.com/Learning/ERiskCaseStudies.asp
12. Top management team CEO (Dual role, evaluation, succession)

Emergence of Corporate Governance:

 The Cadbury Report on the financial aspects of corporate governance, published
in the United Kingdom in 1992, was a landmark.
 Sarbanes – Oxley Act (SOX Act)
 In November 2003, SEC approved changes to the NYSE and NASDAQ listing
requirements.
 Higgs Report on non-executive directors and the Smith Report on audit
committees, both published in January 2003, form part of the systematic review
of the corporate governance being undertaken in the U.K and Europe.
 Enhancing the effectiveness of the non-executive directors and switching the key
audit relationship from executive directors to an independent audit committee
are part of this.
 In April 2004, the governments of the 30 organization for economic co-operation
and development (OECD) countries approved a revised version of OECD’s
principles of corporate governance adding new recommendations for good
 practice in corporate behavior with a view to rebuilding and maintaining public
trust in companies and stock markets.
 Concept 1st in US in the late 70’s.
 Concept in U.K in 90’s.
 Reports in U.K based on 4 committees:
o Cadbury committee
o Rutteman committee
o Hampel committee
o Turnbull committee
(Read Richard Nixon’s war on Vietnam and Watergate scandal)