Module 3

Corporate Governance
INTRODUCTION
Governance implies a degree of control to be exercised by key stakeholders' representatives.
Governance is about governing. It is not merely about ownership. Even an owner has to learn to
govern. Good governance implies that the institution is run for the optimal benefit of the
stakeholders in it. The recognition of issues relating to corporate governance is timely as it is
appalling that we come across so many instances of well regarded corporates looting their
shareholders for personal gains of managers or the owners.

Corporate governance is a way of life and not a set of rules. A way of life necessitates taking
into account the shareholders' interests in every business decision In practice, the term means to
the role of the board of directors of the company and the auditors and their relationship with
shareholders. The ethical duties of nominated directors to all shareholders (foreign/ local) and
beyond the sectional interests they may represent could also be covered.

DEFINITION
It is a system by which companies are directed and controlled. us, placing board of directors of a
company in center.

A corporate governance is "a conscious, deliberate and sustained efforts on he part of corporate
entity to strike a judicious balance between its own interest and the interest of various constituents
on the environment in which it is operating."

Adrian Cadbury in UK emphasizes, "Corporate governance basically, has to do with power and
accountability: who exercise power, on behalf of whom, and how the exercise of power is
controlled."

NEED FOR CORPORATE GOVERNANCE (Why do we need Corporate

Governance?)
 1. Wide Spread of Shareholders
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 code of conduct of corporate
governance

2. Changing Ownership Structure

The pattern of corporate ownership has changed considerably, in the present-day-times;
with 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.

3. 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.

4. 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.

5. 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.

ELEMENTS OF GOOD CORPORATE GOVERNANCE

Accountability of Board of Directors and their constituent responsibilities to the

ultimate owners-shareholders.
A key element of good governance is transparency and is perceived as such. It is
shared way of corporate functioning and not a set of rules. Transparency in turn
requires the right to information, timeliness and integrity of the information
produced.

a) System of checks and balances and greater simplicity in process of

governance.
b) Clarity of responsibility to enhance accountability
c) Adherence to the rules. Corporate action needs to conform to letter and spirit
to codes.
d) Adherence to the rules. Corporate action needs to conform to letter and spirit to codes.

Evidence of Corporate Governance from Arthashasthra

1) Kautilya - Describe the four-hold duty of a king.

2) Raksha - Literally mean protection, in corporate world it can be equated

risk management aspect, simply to say how to identify, evaluate and
minimize the risk as well as implement the risk management decisions.

3) Vriddhi - Means growth, in the present day it can be equated to stakeholder

value enhancement.

4) Palana - Means compliance it can be equated compliance of law.

5) Yogakshema - Means wellbeing, it can be equated to corporate social

responsibility.

CORPORATE GOVERNANCE THEORIES

There are many theories of corporate governance which addressed the challenges of
governance of firms and companies from time to time. The Corporate Governance is
the process of decision making and the process by which decisions are implemented
in large businesses is known as Corporate Governance. There are various theories
which describe the relationship between various stakeholders of the business while
carrying out the activity of the business. Some of the theories will be discussing
below

1. Agency Theory

Agency theory defines the relationship between the principals (such as shareholders
of company) and agents (such as directors of company). According to this theory, the
principals of the company hire the agents to perform work. The principals delegate the
work of running the business to the directors or managers, who are agents of
shareholders. The shareholders expect the agents to act and make decisions in the
best interest of principal. On the contrary, it is not necessary that agent make decisions
in the best interests of the principals. The agent may be succumbed to self-interest,
opportunistic behaviour and fall short of expectations of the principal. The key feature
of agency theory is separation of ownership and control. The theory prescribes that
people or employees are held accountable in their tasks and responsibilities. Rewards
and Punishments can be used to correct the priorities of agents.

2. Shareholder Theory

It states that the sole responsibility of business is to increase profits. It is based on

the premise that management are hired as the agent of the shareholders to run the
company for their benefit, and therefore they are legally and morally obligated to
serve their interests. The only qualification on the rule to make as much money as
possible is “conformity to the basic rules of the society, both those embodied in law
and those embodied in ethical custom.”

The shareholder theory is seen as the historic way of doing business with companies
realising that there are disadvantages to concentrating solely on the interests of
shareholders. A focus on short term strategy and greater risk taking are just two of
the inherent dangers involved. The role of shareholder theory can be seen in the
demise of corporations such as Enron and Worldcom where continuous pressure on
managers to increase returns to shareholders led them to manipulate the company
accounts.
 3. Stakeholder Theory

Stakeholder theory incorporated the accountability of management to a broad range

of stakeholders. It states that managers in organizations have a network of
relationships to serve – this includes the suppliers, employees and business partners.
The theory focuses on managerial decision making and interests of all stakeholders
have intrinsic value, and no sets of interests is assumed to dominate the others

4. Stewardship Theory

The steward theory states that a steward protects and maximises shareholders wealth
through firm Performance. Stewards are company executives and managers working
for the shareholders, protects and make profits for the shareholders. The stewards are
satisfied and motivated when organizational success is attained. It stresses on the
position of employees or executives to act more autonomously so that the
shareholders’ returns are maximized. The employees take ownership of their jobs and
work at them diligently.
CODES AND GUIDELINES FOR CORPORATE GOVERNANCE

The Corporate Governance code applies to corporations that are incorporated in the United
Kingdom and that are registered on the London Stock Exchange. Overseas corporations that
are listed on the Main Market must disclose the substantial ways in which their corporate
governance practices are different than the practices outlined in the Corporate Governance
Code.

The principle behind the Corporate Governance Code is to demonstrate to shareholders and
stakeholders how the corporation applied the main principles of the code. In addition,
corporations that are subject to the code must confirm that they’ve fully complied with the
provisions of the code. Companies that can’t or won’t comply with the code’s provisions
must provide a reasonable explanation of why they haven’t complied with the code.

The requirements of the Corporate Governance Code are strikingly similar to those of the
Annual Corporate Report that the United States requires.

What is Corporate Governance Code?

Using best practices as its foundation, the Corporate Governance Code outlines the standards
for the expectations for corporate boards in protecting shareholder investments. The code
refers to standards for good practices relating to:

• Board composition
• Board development
• Remuneration
• Accountability
• Audit
 • Shareholder relations

Five Pillars of Good Corporate Governance Make Up the Corporate Governance Code
Much like the pillars of good corporate governance in the United States, the Corporate
governance code in the United Kingdom comprises the pillars of leadership, effectiveness,
accountability, remuneration and shareholder relationships.

1) Leadership
The code requires companies to ensure to shareholders that they have an effective board of
directors that’s capable of providing excellence in board leadership. Boards of directors are
collectively responsible for the short- and long-term success of the corporations they serve.

Strong leadership requires corporations to have a clear division of the responsibilities

between board directors and executives. Boards are responsible for strategic planning and
oversight, and the executives are responsible for the day-to-day responsibilities of running the
company. The board chair is responsible for the board’s leadership and the chair must ensure
that the board operates as efficiently as possible in relation to all of their board duties and
responsibilities.

Non-executive board directors should constructively challenge the board and help to develop
successful proposals for strategy. The code expressly states that no single person should have
total decision-making power on a board.

2) Effectiveness
The code requires corporate boards to ensure that they have a composition that encompasses
the appropriate balance of skills, experience, independence and knowledge of the company so
that they’re able to perform their duties and responsibilities effectively:

• Boards are required to develop a formal, rigorous and transparent process for
appointing new board directors.
• Before accepting a position on a board of directors, nominees should ensure that
they have sufficient time to fulfil their board duties and responsibilities.
• Boards should avail their board directors of a comprehensive board orientation and
onboarding process. In addition, boards should provide regular opportunities for
board director training and education.
• Management should provide accurate information to the board that has the
appropriate form and quality so that the board can fulfil its duties in a timely
manner.
• Boards should also conduct rigorous annual self-evaluations for the board, individual
directors and significant committees, with the goal of improving their performance.
All board directors should be subject to regular elections as long as they continue to
perform satisfactorily.
3) Accountability
The board is wholly accountable for the actions and decisions of the company. The board
should make annual disclosures to shareholders that represent a fair, accurate and
comprehensive assessment of the corporation’s positions and corporate outlook.

The board is additionally responsible for assessing the nature and extent of risks it is willing
to take to achieve its strategic plans. Boards should participate in sound risk management and
internal control systems.

Boards should also establish formal procedures for corporate reporting, risk management
reporting and internal control principles. Procedures should include details of relationships
between the company and the internal and external auditors.

4) Remuneration
The United Kingdom favours remuneration packages that are designed to promote the long-
term success of the company and that are directly aligned with performance. Remuneration
should sufficiently challenge executives, be transparent and be rigorously applied.

The company should have a formal, transparent process for developing remuneration policies
and setting remuneration packages. Directors shouldn’t be involved in setting their own pay.

5) Shareholder Relationships
Boards should utilize their annual general meetings to communicate and engage with
investors on their objectives and strategic planning. The board should ensure that
communications with shareholders are satisfactory.

These pillars are considered the minimum for the basics of good governance. Corporations
are encouraged to add their own best practices as they develop them and learn from other
corporations around the world.