BECG

CH.3
Corporate Governance:

Notes complied by Dr. Dhimen jani

MBA,CBS, PGDIBO, PhD
MBA Sem. 1
Meaning of Corporate Governance:

• Corporate governance is
the structure of rules,
practices, and processes
used to direct and manage
a company. A company's
board of directors is the
primary force
influencing corporate
governance.
 Good Governance
• ‘Governance’ is the process of decision-making and the process by
which decisions are implemented (or not implemented).
• Governance can be used in several contexts such as corporate
governance, international governance, national governance and local
governance.
• In the 1992 report entitled “Governance and Development”, the World
Bank set out its definition of Good Governance. It defined Good
Governance as “the manner in which power is exercised in the
management of a country’s economic and social resources for
development”.

• Good governance has 8 major characteristics.

• It is participatory, consensus-oriented, accountable, transparent,
responsive, effective and efficient, equitable and inclusive and
follows the rule of law.
• It assures that corruption is minimized, the views of minorities are
taken into account and that the voices of the most vulnerable in
society are heard in decision-making.
• It is also responsive to the present and future needs of society.
 8 Principles of Good Governance By United Nations
•Participation:

• People should be able to voice their own opinions through legitimate immediate organizations or
representatives.
• This includes men and women, vulnerable sections of society, backward classes, minorities, etc.
• Participation also implies freedom of association and expression.
•Rule of Law:

• Legal framework should be enforced impartially, especially on human rights laws.

• Without rule of law, politics will follow the principle of matsya nyaya ie law of fish which means the strong
will prevail over the weak.
•Consensus Oriented:

• Consensus oriented decision-making ensures that even if everyone does not achieve what they want to
the fullest, a common minimum can be achieved by everyone which will not be detrimental to anyone.
• It mediates differing interests to meet the broad consensus on the best interests of a community.
• Equity and Inclusiveness:

• Good governance assures an equitable society.

• People should have opportunities to improve or maintain their well-being.
• Effectiveness and Efficiency:

• Processes and institutions should be able to produce results that meet the needs of their community.
• Resources of the community should be used effectively for the maximum output.
• Accountability:

• Good governance aims towards betterment of people, and this can not take place without the government
being accountable to the people.
• Governmental institutions, private sectors, and civil society organizations should be held accountable to
the public and institutional stakeholders.
• Transparency:

• Information should be accessible to the public and should be understandable and monitored.
• It also means free media and access of information to them.
• Responsiveness:

• Institutions and processes should serve all stakeholders in a reasonable period of time.
Potential Consequence of poor CG.
 Corporate Governance Risk (CGR)
• CGR refers to outcome of non compliance
of standard rules and regulation or
established principles in the organization by
the various dept. by managerial or non
managerial staff in the firm.
Financial risk and non compliance of CG
• Loss of Shareholder Confidence
• A company that does not adhere to its corporate governance strategy runs the risk of weakening the confidence of its
shareholders. This may happen because shareholders feel mislead about the company's organizational structure and
business strategy. If shareholders believe bad business decisions are in the company's immediate future, they may begin
to sell company stock to avoid a potential loss. A large sell-off of company stock can lead to falling stock prices which
diminishes the overall value of the business.
• Difficulty Raising Capital
• When a corporation's stock value diminishes, it becomes more difficult for the company to raise capital. This is due in part
to a negative perception of the company created by a lack of adherence to its corporate governance strategies. Basically,
the view from outside the corporation is the business lacks sufficient infrastructure to make fiscally intelligent decisions.
Potential investors may stay away from a company with a low stock value and lack of adequate corporate governance
because of a greater risk of losing money.
• No Risk Management
• Non-compliance in corporate governance may lead to a lack of risk management within a corporation. This may lead a
company into bad investments including extending credit to those who may not be able to pay such an extension back. A
large amount of risk-laden investments not only hurts the company but may put its ability to repay its own creditors at risk.
This can lead to a domino effect of credit defaults which can cripple a corporation and hurt business in other industries with
investments tied to the floundering business.
• Increased Government Oversight
• A corporation with a reputation for lack of adherence to corporate governance strategies may incur increased government
oversight from departments looking to verify that the company is operating within the bounds of the law. Oversight may
include reviews of business practices including employee pay and relations, quality of manufacturing facilities, impact of
business practices on the environment, legality of all investments and honest reporting of all profits, debts and losses. A
corporation found to be in violation of government regulations may face fines or even criminal penalties for its executives.
Indian and Global Scenario: Sarbanes Oxley Act of 2002
 Salient Features of Corporate Governance in America
● Capitalist principles and free-market mechanism are explicitly recognised.
● Accountability and transparency are practiced in corporate governance.
● Minority shareholders’ interests are protected by laws.
● Proxy voting system by mail is an important feature in the corporate governance.
● One share, one vote is the established rule.
● Shareholders appoint the Board members and CEOs.
● Professional managers control the company. There is a separation between the management and ownership.
● Audit companies have independent directors.
● Disclosure of important corporate information and data are encouraged. This reduces information asymmetry.
● Large shareholders are also actively and regularly monitored.
● Role of banks in corporate governance is not crucial as the capital market remains very strong. Single tier system prevails
(with significant majority of outside directors).
● The Board has three important committees, namely audit committee, compensation committee and nomination committee.
The Board has the following functions to perform:

Oversee the management and control activities.

■ Compliance of laws.
■ Oversee corporate social responsibilities
■ Review company’s financial performance and allocation of resources
■ Approve company’s business plans
 Overview of Anglo-American, Japanese, German models of CG

• Anglo-American Model
• Under the Anglo-American Model of corporate governance, the shareholder rights are
recognised and given importance. They have the right to elect all the members of the Board and
the Board directs the management of the company. Some of the features of this model are:
• This is shareholder oriented model. It is also called Anglo-Saxon approach to corporate
governance being the basis of corporate governance in Britain, Canada, America, Australia and
Common Wealth Countries including India
• Directors are rarely independent of management
• Companies are run by professional managers who have negligible ownership stake. There is clear
separation of ownership and management.
• Institution investors like banks and mutual funds are portfolio investors. When they are not
satisfied with the company’s performance they simple sell their shares in market and quit.
• The disclosure norms are comprehensive and rules against the insider trading are tight
• The small investors are protected and large investors are discouraged to take active role in
corporate governance.
 Salient Features of the Anglo-American
Model
The model
wealth.
gives a topmost priority to the interest of the shareholders. Its objective is to increase shareholders’ value and

The model is based on the philosophy of the separation of ownership and control.
● It adopts a single-tier governance system.
● A system of corporate governance that adopts the Anglo-American model is governed by the Board of Directors (BOD).
The Board chooses the manager or CEO. The CEO can also serve as the Chairman.
● The Chief Executive Officer (CEO) in this type of model becomes extremely powerful, although he needs the approval of
the Board for all his official actions and policies.
● The BOD is selected by the shareholders and its members are responsible to them.
● The BOD can be a mixture of both, the inside and outside directors.
● The BOD has the responsibility to govern while the Managing Director has the responsibility to carry on the routine
management functions.
● Both the BOD and the CEO are to act according to the satisfaction of the shareholders.
● The maximisation of shareholders’ value implies professional management with utmost integrity, transparency and
accountability by all concerned.
● This model of governance is a disclosure-based system. All types of disclosures related to the business including
information and data are given a crucial importance.
● The model is based on market logic with its emphasis on the principle of profit maximization.
● It emphasizes the role of capital market in disciplining the company. Market-orientation also implies capabilities and
contestability to withstand any competition and win the competitive battle.
 Advantages of the Anglo-American System
of Governance
● It is a clear-cut market-base model where everything is calculated by the criterion of profit
which a businessman adores. The terms are very clear and conspicuous and objective.
● It is believed that this type of corporate governance increases efficiency and productivity of
the company and there is no diversion.
● It is growth-oriented and stands for the expansion of income, output and employment.
Therefore, it contributes to positive macroeconomic fundamentals.
● Since it is a disclosure-based system, theoretically, there is little chance of things to go
wrong.
● It leads to more of innovation and cost reduction. These are made possible by profit
incentives. As Gary Becker, the Nobel Laureate, says that people work because of incentives.
 German Model

• This is also called European Model. It is believed that

workers are one of the key stakeholders in the
company and they should have the right to participate
in the management of the company. The corporate
governance is carried out through two boards,
therefore it is also known as two-tier board model.
These two boards are:
• Supervisory Board: The shareholders elect the
members of Supervisory Board. Employees also elect
their representative for Supervisory Board which are
generally one-third or half of the Board.
• Board of Management or Management Board: The
Supervisory Board appoints and monitors the
Management Board. The Supervisory Board has the
right to dismiss the Management Board and re-
constitute the same.
 Japanese Model
Japanese companies raise significant part of capital through banking and other financial institutions.
Since the banks and other institutions stakes are very high in businesses, they also work closely with
the management of the company.
The shareholders and main banks together appoint the Board of Directors and the President. In this
model, along with the shareholders, the interest of lenders is recognised.
The Japanese model of corporate governance is based on a number of traditional ethico-moral and
cultural considerations. In such a context, the following features become crucial as the sustainable
basis of corporate governance:
● Companies are based on family type relationship and ties. Such a relationship permeates among the
management and the workers, among the workers themselves and with other companies.
● Every decision is based on a consensus and a general approval.
● The concept of obligatory relation and performance play an important role in corporate governance.
● Japan has a culture of tolerance and respect for the traditional values and methods of settling
disputes.
● While in the United States, capitalist principles and market calculus guide all corporate actions
and reactions, in Japan, communitarian calculus is given more importance.
• Social Control Model
• Social Control Model of corporate governance argues for full-fledged
stakeholder representation in the board. According to this model,
creation of Stakeholders Board over and above the shareholders
determined Board of Directors would improve the internal control
systems of the corporate governance. The Stakeholders Board
consists of representation from shareholders, employees, major
consumers, major suppliers, lenders etc.
• Indian Model
• In India there are mainly three types of companies’ viz. private
companies, public companies and public sector undertakings. Each of
these companies has distinct kind of shareholding pattern. Thus the
corporate governance model in India is a mix of Anglo-American and
German Models.
 Reports and recommendations of Narayan Murthy

• The Committee on Corporate Governance, headed by Shri Narayanmurthy was constituted by SEBI,

to evaluate the existing corporate governance practices and to improve these practices as the
standards themselves were evolving with market dynamics. The committee’s recommendations are
based on the relative importance, fairness, accountability, transparency, ease of implementation,
verifiability and enforceability related to audit committees, audit reports, independent directors,
related parties, risk management, directorships and director compensation, codes of conduct and
financial disclosures.
• The key mandatory recommendations focus on
• Strengthening the responsibilities of audit committees
• At least one member should be ‘financially knowledgeable’ and at least one member should have
accounting or related financial management proficiency.
• Quality of financial disclosures
• Improving the quality of financial disclosures, including those related to related party transactions.
• Proceeds from initial public offerings
• Companies raising money through an IPO should disclose to the Audit Committee, the uses /
applications of funds by major category like capital expenditure, sales and marketing, working capital,
etc.
• Other recommendations
• Requiring corporate executive boards to assess and disclose business risks in
the annual reports of companies.
• Should be obligatory for the Board of a company to lay down the code of
conduct for all Board members and senior management of a company.
• The position of nominee directors: Nominee of the Government on public
sector companies shall be similarly elected and shall be subject to the same
responsibilities and liabilities as other directors
• Improved disclosures relating to compensation paid to non-executive directors.
• Non-mandatory recommendations include moving to a regime where
corporate financial statements are not qualified; instituting a system of training
of board members; and the evaluation of performance of board members.
Report on Ganguly Committee recommendations for
Banks

•  Lending to SME Clusters

• A full-service approach to cater to the diverse needs of the SME sector may
be achieved through extending banking services to recognized SME clusters
by adopting a 4-C approach namely, Customer focus, Cost control, Cross sell
and Contain risk. A cluster based approach to lending may be more beneficial:
(i)in dealing with well-defined and recognized groups;
• (ii) availability of appropriate information for risk assessment and(iii)
monitoring by the lending institutions.
Clusters may be identified based on factors such as trade record,
competitiveness and growth prospects and/or other cluster specific data.
Linking with Large Industry.
• There is strong evidence that SSIs which are linked as suppliers, service
providers, etc. to successful large industries are usually successful ventures,
in India as well as in many other countries.
• Such successful SSI/large industry linkages provide examples of best practices
which can be aggressively extended. There are a number of corporates in
India who adopt Corporate-linked SME cluster models to gain competitive
advantage in local as well as global markets and derive mutual benefits. 
• Corporate-linked SME cluster models need to be actively promoted by
banks and FIs. Banks linked to large corporate houses can play a catalytic
role in promoting this model.
• Financing SMEs linked to large corporates, covering suppliers, ancillary units,
dealers etc. would also enhance competitiveness of the corporates as well as
the SME participants.
• SIDBI and Lead Banks should make use of these successful models to
encourage the adoption of their work practices in other states, by
sponsoring specific projects as well widely publicizing the successful
working models.
• Hilly terrain and frequent flood causes hindrance in the transportation
system in these areas, and as a result supply chain gets frequently
disrupted. Because of this the SMEs have to maintain high levels of
inventory requiring high working capital. Higher working capital
limits need to be taken into account while extending credit to such
units.
Recommendation of venture capital
• Recognizing the catalytic role of venture finance in the advancement of the SME
sector, the Working Group strongly recommends that a dedicated National level
SME Development Fund should be established. SIDBI may promote a NBFC
(non–public deposit taking) exclusively for undertaking venture and other
development financing activities for SMEs.
• Banks could also contribute to the corpus created by SIDBI (on risk sharing
basis) or alternatively, set up their own venture financing instruments.
• Recognizing the catalytic role of venture finance in the advancement of the SME
sector, the Working Group strongly recommends that a dedicated National level
SME Development Fund should be established. SIDBI may promote a NBFC
(non–public deposit taking) exclusively for undertaking venture and other
development financing activities for SMEs.
• Banks could also contribute to the corpus created by SIDBI (on risk sharing
basis) or alternatively, set up their own venture financing instruments.
• The traditional sources of credit flow to the SME sectors (through
public sector banks, Specialised SSI Branches, etc.) are unlikely to
improve their services, at least, in the short and medium term.
• While public sector banks have inherent problems in extending credit
to many SMEs, due to historical reasons, it is necessary to explore
ways to overcome such traditional problems, by the banks,
promoting and financing Special Purpose Vehicles (SPVs) in the form of
micro credit agencies dedicated to servicing SME clusters.
Priority Sector Lending Targets.
• In an environment of high economic growth, the priority sector lending is an
attractive growth opportunity for banks and FIs. Slowing down of off-take of
credit by the large corporates due to opening up of new sources for accessing
finance by them and stagnation of credit demand by retail business, makes
financing the priority sector an opportunity to expand banks’ business profitably.
• An uniform target in priority sector lending (including SSI) at 40% of Net Bank
credit (NBC) for all domestic and foreign banks is recommended. This would
provide a level playing field for all the banks and ensure active participation in
the faster development of the priority sector.
• Further reading
• https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?ID=394