Bgs Module-3 Ps

7/28/2019 Bgs Module-3 Ps

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Module-3

Corporate Governance


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Module overview

Definition, Market model and control model

OECD on corporate governance

Historical perspective of CG

Issues, Relevance, need and importance in CG

Benefits of good CG

Concept of corporate and Governance

Theoretical basis for CG,

Obligation to society, investors, emp, customers,manager

Indian Cases


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What is Corporate Governance?

Corporate governance is dealing with problemsthat result from the separation of ownership andcontrol.

corporate governance would focus on: The internal structure and rules of the board of

directors;

the creation of independent audit committees;

rules for disclosure of information to shareholders andcreditors;

control of the management.


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Definition

It is a system by which companies are directed

and controlled (OECD)

It is a set of relationships b/w a companys

management, board, shareholders and

stakeholders


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How a corporation is structured


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The market model

Non-executive

majority boards

Aligned incentives,effective control

High disclosure

Shareholder equalityActive take-over market

Active private equity

And IPO market

Dispersed ownership

Sophisticated

Institutional

investors

Independence and

performance

Shareholder

environment

Transparency and

accountabilityCapital market liquidity

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Market model

Market model governance chain , there are

efficient, well developed equity markets and

dispersed ownership,

common in the developed industrial nations

such as US,UK, Canada and Australia.


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The control model

Insider boards

Incentives aligned

with core shareholders,

ineffective control

Limited disclosure

Lack of minority

protection

Limited takeover

market

Underdeveloped

IPO market

Concentrated

ownership

Reliance on family,

bank and public

finance

Shareholder

environment

Independence

andperformance

Capital market liquidity

Transparency and

accountability

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Control model

The governance chain is represented by

underdeveloped equity markets,

concentrated family ownership,

less shareholder transparency and

inadequate protection of minority and foreign

shareholders.

More familiar in Asia, Latin America and someeast European nations.


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OECD on Corporate Governance

The OECD (org for economic corporation and

development) has emphasized the foll

requirements of corporate governance

Rights of shareholders

Equitable treatment of shareholders

Role of stakeholders in CG

Disclosure and transparency

Responsibilities of the board


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Right of shareholders

Include secure ownership of their shares,

voting rights,

the right to full disclosure of information,

participation in decisions on sale or any change incorporate assets (mergers).

Have right to know the capital structure of the

corporation Transactions should be at transparent prices and

under fair conditions


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Equitable treatment of shareholders

Minority and foreign shareholders should getequitable treatment.

Get equal opportunity for redressal of theirgrievances and violation of their rights.

Should not face undue difficulties in exercisingtheir voting rights.

Directors should disclose any material interestregarding transactions.

Avoid situations involving conflict interest whilemaking decisions


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Role of stakeholders in CG

There are stakeholders apart fromshareholders

Dealers, consumers, Govt. and others like

banks, bondholders and workers are imp forcompanies to perform and make decisions

CG framework should allow emp

representation on board of directors, profitsharing, creditors , involvement in insolvencyproceedings.


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Disclosure and transparency

Disclose key information about

financial details,

operating results,

governance structure and policies,

BOD their remuneration,

foreseeable risk factors,

issues regarding emp & other stake holders.

Annual audits should be performed.


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Responsibilities of the board

Functions include

corporate strategy,

risk,

executive compensation and performance,

accounting and reporting systems,

monitoring effectiveness and changing them if

needed.


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Historical perspective on CG

The seed of CG was sown by the Watergatescandal during the Nixon presidency in US.

The need to arrest such unhealthy trendtranslated into the legislation of Foreign andCorrupt Practices Act of 1977 in US.

The Treadway commission report (1987) toidentify the misrepresentation in financialreports.

Committee of sponsoring org (COSO) came intobeing in 1992 stipulated a control framework forthe orderly functioning of corporations.


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Historical perspectives on CG

In England, Sir Adrian Cadbury was entrustedin 1991, by the London stock exchange.

Cadbury committee had the task of drafting a

code of practices to assist corporations indefining and applying internal controls to limittheir exposure to financial loss.

Bank failures in west necessitated closemonitoring of the banking system so the Baselcommittee worked in this field.


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Issues in CG

1. Distinguishing the roles of board and

management

2. Composition of the board and related issues

3. Separation of the roles of the CEO and

chairperson

4. Should the board have committees?

5. Appointments to the board and directors re-

election


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Issues in CG

6. Directors and executives remuneration

7. Disclosure and audit

8. Protection of shareholder rights and theirexpectations

9. Dialogue with institutional shareholders

10.Should investors have a say in making acompany socially responsible


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Distinguishing the roles of board and

management

The board of a listed company has the foll functions

Select, decide the remuneration and evaluate on a regularbasis and when necessary, change the CEO

Oversee the conduct of the co. business to evaluate

whether or not it is being correctly managed Review and approve co. financial objectives and corporate

plans

Render advice and counsel top mgmt

Identify and recommend candidates to shareholders forelecting them to BOD

Review system to comply all applicable laws andregulations


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Composition of board and related

issues

BOD- committee selected by the shareholders

of a limited co. to be responsible for the policy

of the co.

Board of Directors

Executive directors Non-executive

directors

Independent directorsAffiliated directors

(nominee directors)


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Composition of board and related

issues

Executive director is one who is an executive of the co.and also a member of the BOD

Non-executive director has no separate employmentrelationship with the co.

Independent non-executive directors are thosedirectors on the board who are free from any businessor other relationships which could materially interfere,with the exercise of their independent judgment in theprocess of decision making as a member of a board.

An affiliated director or a nominee director is a nonexecutive director who has some kind ofindependence, impairing relationship with the co.


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Separation of the roles of the CEO and

the chairperson

The role of CEO is to lead the senior

management team in managing the

enterprise.

The role of the chairperson is to lead the

board, imp responsibility of the board is to

evaluate the performance of senior executives

including the CEO


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Should the board have committees?

Committees on CG have recommended

appointment of special committees for

Nomination

Remuneration

Auditing

These committees lessen the burden of the

board and enhance its effectiveness


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Appointments to the board and

directors re-election

Shareholders are a legion in large co. and alsoscattered and to have them together to electthe directors will be expensive and time

consuming In actual practice, the board or its committee

selects and appoints the prospective directorand gets the person formally elected by theshareholders at the ensuring annual generalbody meeting


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Directors and executives remuneration

CG laid emphasis on issues such as

Transparency

Pay for performance

Process for determination

Severance payments

Pensions for non-executive directors


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Disclosure and audit

Cadbury report and Bosch report stressed that

the BOD has a bounden responsibility to

present the shareholders a lucid and balanced

assessment of the co. financial positionthrough audited financial statements.


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Protection of shareholder rights and

their expectations

Corporate practices vary from country to country.

Various committees and org that have addressed

the issues

Should co. adhere to one share one vote principle?

Should co. retain voting by a show of hands or by poll?

Should shareholder approval be required for all major

transactions? Can shareholders resolution be bundled?


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Dialogue with institutional

shareholders

Cadbury committee recommends that

institutional investors should maintain regular

and systematic contact with co. apart from

their participation in general meetings ofshareholders, use voting rights, take interest

in composition of BOD.


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Should investors have a say in making a co.

socially responsible corporate citizen?

Conflict b/w 2 schools of thought

1- based on assumption that sociallyresponsible behavior of corporations such as

ecological preservation, anti-pollutionmeasures and producing quality andenvironment friendly products

2- who work to make their gains Dove chemicals, Johnson & Johnson, Pfizer, to

prove this


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Relevance of CG

The separation of ownership from managementcreates an issue of trust.

Management has to be trusted to run the

company in the interest of shareholders andstakeholders.

Information is not available to all stakeholders inthe same form at the same time.

In real world of imperfect information, eachagent will use whatever information advantagehe may have.


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Need and importance of CG

Corporations are multinational/transnational innature- impact on citizens of several countiesacross the globe

If things go wrong it will affect many countries

It is needed to create a corporate culture ofconsciousness, transparency and openness

It will lead to increase in customer satisfactionand shareholder value and wealth

Environment is being ensured to be transparentand accountable.


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Benefits of good CG

1. Creation and enhancement of a corporations

competitive advantage

2. Enabling a corporation perform efficiently by

preventing fraud

3. Providing protection to shareholders interest

4. Enhancing the valuation of an enterprise

5. Ensuring compliance of laws and regulations


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Concept of Corporate

Corporate has contributed much to the

growth of market driven economies.

Corporate is the nucleus of all business

activities in modern economies

Lawyers and economists describe the

corporate as a nexus of contracts the

corporation is nothing more than the sum of

all of the agreements leading to its creation.


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What is a corporate?

A corporation is an association of personsrecognized by the law as having a collectivepersonality.

Characteristics of a corporate: Incorporated association

Artificial legal existence

Perpetual existence

Extensive membership Separation of management and ownership

Limited liability and transferability of shares


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What is a corporate?

The corporate of today differs from individual

capitalist in 2 aspects

The life span of the corporation is much longer

It is more rational in decision making by virtue of

the fact that it has the benefit of the collective

wisdom of the BOD. They take decisions using the

principles of cost accounting, budget analysis,data collection and processing and managerial

consulting


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The concept of governance

Governance means the process of decision

making and the process by which decisions

are implemented

Governance focuses on the formal and

informal players involved in decision making

and implementing the decisions made.


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Theoretical basis of CG

4 broad theories to explain and elucidate CG

Agency theory

Stewardship theory

Stakeholder theory

Sociological theory


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Agency theory

In modern corporation, where share ownership is

widely held, managerial actions depart from

those required to maximize shareholder returns.

In agency theory terms, the owners and theprincipals and the managers are the agents and

there is an agency loss, which is the extent to

which returns to the owners fall. Agency theory specifies mechanisms that reduce

agency cost


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Agency theory

There are 2 broad mechanisms that help

reduce agency costs and hence, improve

corporate performance through better

governance Fair and accurate financial disclosures

Efficient and independent BOD


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Stewardship theory

This theory assumes that managers are basicallytrustworthy and attach significant value to their ownpersonal reputations.

It defines situations in which managers are stewards

whose motives are aligned with the objectives of theirprinciples.

A stewards behavior will not depart from the interestsof his/her org.

Control can be potentially counterproductive, becauseit undermines the pro-organizational behavior of thesteward by lowering his/her motivation.


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Behavioral differencesAgency theory Stewardship theory

Manager acts as agent Managers act as stewards

Governance approach is materialistic Governance approach is sociological and

psychological

Behavior pattern is individualistic,

opportunistic, self-serving

Behavioral pattern is collective, pro-

organizational, trustworthy

Managers are motivated by their own

objectives

Managers are motivated by the principals

objective

Interests of the managers and principals

differ

Interests of the manager and principals

converge

The role of the management is to monitor

and control

The role of the management is to

facilitate and empower

Owners attitude is to avoid risks Owners attitude it to take risks

Principal manager relationship is based

on control

Principal manager relationship is based

on trust


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Psychological mechanisms

Agency theory Stewardship theory

Motivation revolves around

Lower orders

Extrinsic needs

Motivation revolves around

Higher order needs

Intrinsic needs

Social comparison is b/w compatriots Social comparison is b/w principals

There is little attachment to the company There is great attachment to the company

Power rests with the institution Power rests with the personal


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Situational mechanismsAgency theory Stewardship theory

Management philosophy is controloriented

Management philosophy is involvementoriented

To deal with increasing uncertainty and

risk, the theory advocates exercise of

Greater controls

More supervisions

To deal with increasing uncertainty and

risk, the theory advocates exercise of

Training and empowering people

Making jobs more challenging andmotivating

Risk orientation is done through a system

of control

Risk orientation is done through trust

Time frame is short term Time frame is long term

The objective is cost control The objective is improving performance

Cultural difference revolve around

Individualism

Larger power distance

Cultural difference revolve around

Collectivism

Small power distance


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Stakeholder theory

The theory is grounded in many normative,

theoretical perspectives including ethics of

care, the ethics of fiduciary relationships,

social contract theory, theory of propertyrights, and so on.

Stakeholder theory is often criticized mainly

because it is not applicable in practice bycorporations.


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Sociological theory

This theory has focussed mostly on board

composition and wealth distribution.

Under this theory, board composition,

financial reporting, and disclosure and

auditing are of utmost importance to realize

the socio-economic objectives of

corporations.


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Obligations to society at large

A corporation is a creation of law,as an association of personsforming part of the society in whichit operates.

Its activities are bound to impactthe society as the societys valueswould have an impact on thecorporation.

Therefore, they have mutual rightsand obligations to discharge for thebenefit of each other.


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National interest Political non-alignment

Legal compliances

Rule of law Honest and ethical conduct

Corporate citizenship

Ethical behavior

Social concerns CSR


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Environment friendliness

Healthy and safe working environment

Competition

Trusteeship Accountability

Effectiveness and efficiency

Timely responsiveness

Corporation should uphold the fair name of thecountry


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Obligations to investors

Towards shareholders

Measures promoting transparency and

informed shareholder participation

Transparency

Financial reporting and records


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Obligation to employees

Fair employment practices

Equal opportunities employer

Encouraging whistle blowing

Humane treatment

Participation

Empowerment

Equity and inclusiveness

Participative and collaborative environment


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Obligation to customers

Quality of products and services

Products at affordable prices

Unwavering commitment to customer

satisfaction


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Managerial obligation

Protecting companys assets

Behavior towards government agencies

Control

Consensus oriented Gifts and donations

Role and responsibilities of corporate board and

directors Direction and management must be distinguished

Managing and whole time directors


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END OF MODULE-3

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