Business Ethics

Corporate Governance An Overview

Capitalism

Corporate governance is seen as a solution to the collapse of several high profile firms The temptation to fudge accounts and take credit for unearned profits is irresistible A key problem is the failure of auditors to safeguard the interest to shareholders CEOs are now seen as villains who gamble away the retirement savings of the public

Reaction

The Surbanes-Oxley Act now requires CEOs and CFOs to swear before a notary that results have not omitted any material fact This means that they are liable for civil and criminal action in case of infringements

India

Government corruption has diluted the accountability of businessmen PSU dominance and inefficiency ensures that the cost of misgovernance is passed to the public Employees at all levels in PSUs are seen to contribute to misgovernance Comparatively only top management is seen to be responsible for misgovernance in private firms

Series of Scams

Harshad Mehta scam in 1992 involved many banks and resulted in a stockmarket crash In 1991 MNCs consolidated their holdings by issuing equity to controlling groups at steep discounts In 1993-94, 3911 companies that raised Rs.25000 crores vanished In 1995-96, plantation companies raised Rs.50000 crores and vanished In 195-98, PSU banks raised Rs.15000 crores by promising fixed returns on MFs In 1999-2000 many companies raised money by adding Infotech to their names and then vanished In 2001 Ketan Parikh rigged prices by using a bear cartel In 2009, Ramalinga Raju the CEO of Satyam siphoned off billions into his own pocket

Illegal Tactics

Cornering industrial licenses to keep out competitors Using import licenses to make quick profits Illegally holding money abroad Generating unaccounted money for bribery

Reasons for Misgovernance

A closed economy without modern regulations Control by promoter families who own 3.3% of paid-up capital on average Liberalization has forced a changed

Increasing Awareness

In 1999 SEBI appointed the Kumar Mangalam Birla committee to mandate international standards of governance By 2003 all listed companies joined the code Economic shocks forced reform in developed countries whereas liberalization was the cause in India Very few of the 100 top companies before liberalization survive today because of misgovernance

Global Concerns

Few issues are as important as corporate governance The Russian economy collapsed in 1998 because of diversion of corporate assets by managers to the extent of $100b The Asian crisis was also because of corporate governance

Corporate Governance

Deals with the agency problem Focuses on

Internal structure and rules of the BLOD Creation of independent audit committees Rules for disclosure of information to shareholders and creditors Control of management

Corp Governance Model

Shareholders elect directors to represent them Directors vote on key issues and adopt majority decision Shareholders and others can hold directors accountable Company adopts accounting standards to generate information necessary for directors and other stakeholders Companys policies adhere to national, state

McKinseys Model

Model 1 Market Model

Well developed equity markets and dispersed ownership Corporate governance is basically how firms deal fairly with agency problems Underdeveloped equity markets, concentrated (family) ownership, less transparency and inadequate protection of minority and foreign shareholders Grow supporting institutions like capital market regulators and judiciary to enforce contracts and property rights

Model 2 Control Model

Concerns of Government

Management accountability Investments in management Discipline and replacement of bad management Enhancing corporate performance Transparency Shareholder activism Investor protection Improving capital market access Promoting long term investment Encouraging innovation

OECD Emphasis

Rights of shareholders Equitable treatment of shareholders Role of stakeholders in corporate governance Disclosure and transparency Responsibilities of the board

Rights of shareholders

Secure share ownership Voting rights Full disclosure Participation in decisions on sale or any change in assets including mergers and new share issues Know capital structure and arrangements that enable certain shareholders to obtain disproportionate control All transactions at fair prices and fair conditions Anti-takeover devices should not be used

Equitable treatment of shareholders

No undue difficulties in voting Change in voting rights subject to approval by shareholders Insider trading should be prohibited Directors should disclose material interest in transactions Avoid conflict of interest by directors Interested directors should not participate in decisions that concern them

Role of stakeholders in corp gov

Allow employee representation on the BOD Involve creditors in insolvency proceedings Relevant information is a must for shareholder activism

Disclosure and Transparency

Includes financial details, operating results, governance structure and policies, BOD and their remuneration, risk factors and material information on employees and other stakeholders Annual audits by independent auditors in accordance with high quality standards

Responsibilities of BOD

Corporate strategy, risk, compensation and performance, accounting and reporting

Modern Corp Gov

Started with the Watergate scandal in the US This resulted in regulations that prevented corporations from making illegal political contributions and bribery Cadbury Committee appointed in the UK in 1991 Cadbury submitted a Code of Best Practices which was not mandatory But LSE listing agreements required the annual report to report on compliance and explain reasons for non-compliance

Cadbury Aftermath

Requirement that directors should report on the effectiveness of the system of internal control beyond financial matters caused controversy Further scandals resulted in the appointment of the Ron Hampel committee This extended directors responsibilities to include risk assessment and minimization of fraud risk An earlier report by Greenbury addressed directors remuneration Finally a Combined Code was added to the LSE listing agreement Further report by Turnbull required confirmation that risk had been managed and that an embedded risk management process was in place

Issues in Corp Gov

Distinguishing roles of BOD and management Composition of the board Separation of the roles of CEO and Chairperson Should the board have committees Appointments to the BOD and re-election Directors and executives remuneration Disclosure and audit Protection of shareholder rights and their expectations Dialogue with institutional shareholders Should investors have a say in CSR

Distinguishing roles of BOD and management

Select, decide remuneration, evaluate and change the CEO Indirectly oversee the business and evaluate if it is being correctly managed Review and approve financial objectives and plans Render advice and counsel top management Identify and recommend candidates for election to the BOD Review systems to comply with all laws All other functions required to be performed by law

Composition of BOD

Optimum combination of executive and nonexecutive directors with not less than 50% of non-executives If chairman is non-executive at least 1/3rd should be independent directors and otherwise at least half should be independent

Separation of CEO and Chairperson

Combining results in conflicts in decision making and concentration of power The CEO leads management whereas the chairman leads the board The board evaluates the CEO and so combining the roles results in conflicts of interest Also the work load on both is heavy and so combining the roles results in inefficiency

Should the Board have committees

They lessen the burden of the BOD Many regulations require committees for nomination, remuneration and audit Should have written terms of reference outlining authority and duties Should have access to company executives and outside expertise at company expense Independent and experienced people should be appointed to committees

Appointments to BOD and reelection

Shareholders elect directors but in practice the nomination committee selects and appoints directors and gets him formally elected by shareholders at the ensuing AGM In fact, shareholders only endorse the appointment

Directors and executives remuneration

Shareholders are entitled to information on directors remuneration and its determination Key issues

Transparency Pay for performance Process for determination Severance payments Pensions for non-executive directors

Disclosure and Audit

Lucid and balanced assessment of financial situation through audited statements Key issues

Should boards have audit committees How to compose the audit committee How to ensure auditor independence What precautions to be taken Regulation regarding non-audit services Should board formalize performance standards

Protection of shareholder rights and expectations

Should there be one share one vote Should voting be by show of hands or by poll Can resolutions be bundled Is shareholder approval required for all major transactions

Dialogue with institutional shareholders

They should maintain regular contact Should participate in AGMs and use voting rights Should exercise all rights as owners Should exercise interest in board appointments Should enhance standards of governance instead of simply selling shares when dissatisfied

Should investors force CSR

Environment and economic gains are not contradicting goals but contribute to long term performance

Relevance of Corp Governance

Research shows that governance and performance are correlated Fis consider governance to be as important as performance Investors are prepared to pay a premium for governance

Benefits to Society

Transparency brings benefits to all and prevents systematic banking crises Research proves that strong protection of minority shareholders leads to large and liquid capital markets Competitive capital markets promote governance Transparency reduces corruption Ensures that right business strategies, M&A for the right reasons and performance based compensation

Benefits to Corporations

Creation and enhancement of competitive advantage Prevents fraud and malpractice Protects shareholders interests Enhances enterprise value Ensures compliance with laws

The End