Corporate Governance

Frontmatter

Chapter 1. Corporate Governance: An Introduction

To Be or Not to Be—Is Not the Question, the Question Is: The What, Why and How of Corporate Governance

Abstract

Broad understanding of Corporate Governance, its Models and Principles

No company can sustain for long without proper governance. Corporates, because of their size, impact a large number of stakeholders, which is why their governance becomes a matter of concern. Corporate governance specifies the distribution of rights and responsibilities among different participants in the corporation. It also spells out the rules and structures for achieving the company objectives and the manner of decision-making.

Different models have been adopted across the world institutionalizing the legal, economic, political and social environment of the country. These include the Anglo-Saxon one-tier model, the Continental European two-tier model, the Japanese Hybrid model, the Communist model and the family-based model prevalent in Asian countries.

The OECD Principles of Corporate Governance—Effective Framework; Shareholders Rights; Market and Intermediaries; Role of Stakeholders: Disclosure and Transparency; and Board Responsibility—provide a basis for countries to develop a CG framework that will foster social and economic development.

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Chapter 2. Boards and Directors

They Set the Way, Go the Way, Pave the Way

Abstract

The role and structure of the Board and Directors

The role of board is governance, strategy and supervision and control. It is different from management which is involved in day-today operations. The wide range of responsibilities requires directors to have an inward-, outward- and forward-looking perspective. The nature and role of directors: executive, non-executive, nominee, inside, outside and independent, depends on the governance structure.

Scams such as Maxwell highlight the risks associated with inside directors and the need of an independent board. Policy makers globally have pushed for more and more independent directors, but in spite of strict regulations ‘independence’ of independent directors remains a concern and their role unclear.

Effective board leadership by the chairperson facilitates contribution to all directors in boardroom deliberations, improving corporate decisions leading to enhanced firm value. CEO duality allows for swift and efficient decision-making which can be extremely useful in crisis. However, abuse of this unfettered power has been the root cause of many corporate failures.

As the board has enormous responsibilities, to reduce the burden and increase efficiency, some of the functions are delegated to committees such as audit, nomination and remuneration.

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Chapter 3. Theoretical Perspectives of Corporate Governance

The Foundation

Abstract

Understanding the impact of theories on Corporate Governance

As corporate governance evolved, various theories helped the development of corporate governance. These theories are based on a combination of financial, economics and behavioural sciences. Each theory identifies a different relationship among the participants, and their behaviour defines the function of governance and role of directors. The theories can be categorized under property rights theories, conflict theories, principal cost theory, theories of harmonic contract and institutional theories.

The property rights theory indicates that shareholders as owners have all rights on the company and its assets. In reality, the extent of control that shareholders are able to exercise on the company would primarily depend on the ownership pattern and voting rights. The different forms of control prevalent are Managerial Control, Working Control and Majority Control. This can create conflict between the shareholder who acts as principal and their agent the directors, principal and principal, and between agent and agent. The conflict theory argues that the self-serving behaviour warrants a governance function of monitoring by mechanism such as having more independent directors and effective audit to reduce conflict costs.

How CG is institutionalized? Traditionally, companies have been shareholder centric. External pressure and need for legitimacy challenge the traditional profit maximization objective and call upon considering the rights of all stakeholders and not merely the investors. Isomorphic pressure creates a universal applicability of governance mechanisms within a country. The differences in legal origin, government capabilities and social structures result in heterogeneous governance systems in different countries.

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Chapter 4. Internal Control, Financial Oversight and Risk Management

The Winning Board: Assurance and Reliability with Big Profits

Abstract

The importance of internal control, the role of auditors and audit committee

Financial oversight is integral and indispensable to good governance. Robust financial oversight is essential for a company to remain financial healthy. Though the shareholders have delegated control to the board, they should regularly keep a watch on the company and its financials. For this purpose, they appoint auditors who examine the financial reports of the company and appraise them on its fair representativeness.

Directors and auditors are responsible for establishing strong internal controls. Weak internal control saw Barings Bank, Britain’s oldest merchant bank and Queen Elizabeth’s personal bank collapse. Given the reliance of information technology (IT) in business, strong IT governance can prevent fraud such as witnessed in Punjab National Bank.

Reliability of financial statements is a function of internal control, accounting standards, audit, CEO and CFO and audit committee oversight. The Enron Case demonstrates the pitfalls of accounting irregularities and the role of each stakeholder—directors, auditors, chairperson, CEO, CFO, regulators, analyst and even employees in the scam—signifying how each participant has a role to play in ensuring good governance and in prevention of fraud.

The failure of auditors in preventing or even detecting the accounting frauds and in some cases even perpetuating the fraud has raised concerns of auditors’ objectivity and audit effectiveness. Several measures can be taken to enhance audit effectiveness including independent oversight body, effective audit standards, unbiased selection procedure, rotation of auditors, restrictions on non-audit services and adequate remuneration.

Audit committee is one of the main pillars of the corporate governance mechanism in any company. The audit committee is responsible for oversight of financial reporting and disclosure, reliability of the company’s internal control processes and a strong risk management system.

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Chapter 5. Global Corporate Governance Movement

Scams, Codes and Regulations—Issued in Public Interest

Abstract

Development of CG Codes and Regulations—Role of scams

The chapter traces corporate governance movements beginning with the UK scams of Poly Peck, Maxwell and BCCI. Consequently, the first code on CG the “Financial Aspects of Corporate Governance” popularly known as Cadbury Report was framed in 1992. After the Cadbury Report, UK set up many committees (Greenbury, Hamley, Turnbull, Higgs, Smith) to examine different aspects of corporate governance and the code went through several changes to its present form.

After the scams in UK and other parts of the world, regulators in various countries realized that there is a need to strengthen corporate governance regulations and began to develop codes. The Enron and WorldCom Scandals in USA led to the creation of the Sarbanes-Oxley Act in 2002. This brought corporate governance to the limelight and into the corporate boards.

The Satyam fiasco forced India to revamp its Companies Act and create new regulation—the Listing Obligation and Disclosure Requirement (2015). Only after a fraud is unearthed, regulators react and try to close the loop hole. They never seem to proactively take preventive measures.

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Chapter 6. Shareholder and Activism

It’s is ultimately all about the shareholders

Abstract

Understanding how shareholders can protect their interest (Rights and Responsibilities).

Shareholders, as primary stakeholders exercise their rights by participation in General (Shareholder) meetings to discuss and deliberate with management and among themselves about the company affairs and get involved in corporate decisions by voting on matters such an appointment of directors and declaration of dividend. The power of shareholders when they exercise their rights was demonstrated in the annual general meeting of Lakshmi Vilas Bank where none of the directors, nor the auditor were reappointed.

Shareholders are to be given adequate prior notice ranging from 10 days (New Zealand) to 42 days (The Netherlands) of the AGM, to enable their participation. The notice is accompanied with the agenda and other relevant information that will be required to take decisions. Additionally, a small percentage (varying in different countries) of shareholders can add an agenda or even request that a general meeting be held. The introduction of e-voting has further empowered small and far-flung shareholders as they can now easily vote even if they cannot attend the meeting.

Shareholders have a fundamental right to information—material and timely, through various reports that are to be included in the annual report and extensive disclosures on the company website or a designated common platform.

When a shareholder views that companies activities are not in alignment with their interests, they may sought to activism. Shareholder activism may be defined as the various actions undertaken by investors to influence and monitor corporate management and boards and to bring about changes in the organizational control structure of firms not perceived to be pursuing shareholder-wealth-maximizing goals. Shareholders may choose to exit or voice their concerns through various forms including legal recourse such as class action lawsuit.

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Chapter 7. Corporate Social Responsibility

Making a Difference

Abstract

The importance of taking care of other stakeholders and making CSR integral to the company.

Stakeholder theory emphasizes that a company’s real success lies in satisfying all its stakeholders. The problem of governing the corporation in today’s world must be viewed in terms of the entire grid of stakeholders (Primary, Secondary and Tertiary) and their power base. The boycott of Nike for labour practices in the 1990s and of Maggi Noodles on safety concerns in 2015 show how important it is for companies to effectively engage with stakeholders to mitigate social risk.

CSR is a continuum approach which includes the elements (what is CSR); the principles (the purpose of CSR); the process of responsiveness (how CSR is to be done); the corporate social performance (the outcome of CSR); and its impact on stakeholders on each of the four elements—economic, legal, ethical and philanthropic. Socially responsible corporates contribute to economic development of the region while improving the quality of life of the workforce and their families as well as of the local community and society at large.

The CSR movement has evolution from complete non-acceptance, to mere philanthropy, to creating value for all stakeholders. Business and society are interwoven. Spending on CSR benefits the company in the form of strengthened public relations, improved reputation, reduced risks, licence to operate and an opportunity for cause marketing. The success of Amul illustrates that if companies take care of its communities it can create value for themselves. Making CSR, an integral part of corporate strategy improves stakeholder perceptions and creates sustainable business.

A company’s success and long-term continuity are dependent on its ability to adopt the CSR principles of legitimacy, public responsibility and managerial discretion. India has gone one step ahead and legally mandated companies to undertake CSR and share the government’s responsibility of economic and social upliftment of the poor and underprivileged. During crisis such as the global pandemic of 2021–22 the important of CSR magnifies manifold.

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Chapter 8. Sustainable Development for Corporate Sustainability

Live and Let Live

Abstract

The need for companies to adopted business practices that promote sustainable development and the means and benefits of reporting them.

‘We do not inherit the Earth from our Ancestors, We borrow it from our Children’. Sustainable development is a development that meets the needs of the present without compromising the ability of future generations to meet their own needs. Companies must ‘do well and do good’. Besides being financially rewarding, it must take care of society and the environment. Business uses and impacts the resources of the earth—water, air, trees minerals, etc. If the air gets so polluted that we all die, to whom are these companies going to sell and become rich off?

Sustainable Reporting allows companies to showcase their commitment towards CSR and Sustainable Development. Several frameworks have evolved over the years to measure a company’s contribution towards sustainable development. Notable among them are: The Communication on Progress (COP), Triple bottom line, Global Reporting Initiative and Integrated Reporting.

Growing awareness towards social and environmental concerns have made companies act responsibly by incorporating ESG factors into their investment decisions. There has been a mounting rise in the number of socially driven businesses that target Impact Investment.

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Chapter 9. Managing Conflict—Measures and Mechanism

Going the extra mile

Abstract

Understanding and creating mechanisms to build strong governance systems.

The chapter elaborates certain measures—establishing a Code of Ethics, prohibition of Insider Trading, implementing a Whistle-Blower Policy and monitoring of Related Party Transactions that should be adopted as part of the corporate governance framework to reduce conflicts among stakeholders and improve governance of the company.

Insider trading provides those with access to private information an opportunity to make unfair gains. In several scams such as Enron and Satyam, it was noticed that those in control, falsified accounts to show a rosy financial picture to boost share prices and make a quick buck before the firm collapsed. Regulations have thus been introduced prohibiting insider trading.

Whistle-blowers can play a significant role in revealing information that would otherwise go undetected, leading to improvements in the prevention, detection, investigation and prosecution of corruption. The risk of corruption is heightened in environments where reporting is not facilitated and whistle-blowers protected.

Managers constantly face ethical dilemma in business decisions. A code of ethics guides employees on how they are supposed to approach problems, the organization’s core values on the basis of which they are to arrive at decisions, and the standards to which the company representatives are held.

While entering into a contract or arrangement, the company may give favourable treatment to related party in terms of pricing, or credit period, or some other condition which unfavourably impacts the company. Although related party transactions are themselves legal, they may create situations of conflict of interest and should be closely monitored.

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Chapter 10. Building Dynamic Boards

If Everyone Thinks Alike What’s the Use of a Board

Abstract

Building Strong and Effective Boards

Every board desires and strives to be a ‘value creator’. Directors want to live up to the expectations made of them. They want to build great companies. Great companies are not just ‘tracked by history’, they ‘create history’. A far-sighted board with a strong character, a 360 degree view and the ability to do things differently becomes indispensable. This calls for a heterogeneous board in terms of personality, gender, age, race, nationality, educational and experience background to bring diversity in views, capabilities and approach.

Value Creating boards are those that choose the right combination of heterogeneous directors and by correctly managing the complexities of diversity, leverage those differences to their advantage. Through a dynamic board succession plan, based on the current and future needs, most suitable members are to be selected.

It is important for boards to continually evaluate how effectively they are performing their roles against the objectives and the goals they have set for themselves in each of these areas—Governance, Direction, Monitoring and Value creation.

The dividing line between big, board-level decisions and day-to-day, CEO-level decisions is not always clear. Board must ensure the CEO and other managers are addressing key issues, but they should not micromanage the company.

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Chapter 11. Corporate Governance in Family Businesses

It’s all in the Family

Abstract

The Governance intricacies in family-run business firms:

About 80% of companies worldwide and 40% of Fortune 500 companies are family businesses. Studies have shown that when compared with other firms, family firms perform better in tough periods in contrast to periods of economic boom. This is because family firms are not looking at making a quick buck while the sun shines. They are creating wealth for the family and building a legacy for future generations. Hence governance approach is to take a long-term view, save for a rainy day and focus on meeting family aspirations.

The intersection between family, ownership, board and management and the overlapping interest groups, creates a unique governance cost of balancing family expectations with interest of company’s other stakeholders particularly outside shareholders. Family Dynamics, conflict between family aspirations and company requirements, unwillingness of promoters to relinquish control, non-acceptance of outside managers, inadequate succession planning and limited role of independent directors are additional governance issues faced in family-owned businesses.

Only a small percentage of family businesses survive and grow beyond second and third generations. Successful families define their family enterprise and nourish it by creating strong bond among members, nurturing family values and building sound networks based on mutual trust. With appropriate governance mechanisms and timely actions, both families and their businesses can not only preserve but prosper. Formal structures-family council, family assembly and the family charters bolster the family governance system. In a world full of uncertainties, only business houses that have mastered the art of family enterprise have survived many years.

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Chapter 12. Corporate Governance—Beyond Borders

Navigating the Seven Seas

Abstract

The Governance complexities in Corporate Groups and Multinational firms: Large multinational companies generally operate by creating a ‘corporate group’—a network of holding and subsidiary companies. To add to the already complex governance structure, multinationals operate in multiple jurisdictions with different governance systems. The group needs to determine whether all companies will implement the same governance structure or each subsidiary can determine its own governance system. Moreover, how and to what extent will holding company monitor its subsidiaries?

Governance strategy adopted by MNC can be classified into four broad categories—Global, Transnational, International and Multi-domestic Governance Strategy. Accordingly, parent company can adopt one of the four governance models—Ritual Board, Bifurcated Board, Advisory Board or Local Board.

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Backmatter