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Business Ethics
Corporate GovernanceAnOverview
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Capitalism
Corporate governance is seen as a solutionto the collapse of several high profile firms
The temptation to fudge accounts and takecredit for unearned profits is irresistible
A key problem is the failure of auditors tosafeguard the interest to shareholders
CEOs are now seen as villains who gambleaway the retirement savings of the public
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Reaction
The Surbanes-Oxley Act now requires CEOsand CFOs to swear before a notary thatresults have not omitted any material fact
This means that they are liable for civil andcriminal action in case of infringements
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India
Government corruption has diluted theaccountability of businessmen
PSU dominance and inefficiency ensures thatthe cost of misgovernance is passed to thepublic
Employees at all levels in PSUs are seen to
contribute to misgovernance
Comparatively only top management is seento be responsible for misgovernance in
private firms
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Series of Scams
Harshad Mehta scam in 1992 involved many banks and resulted in astockmarket crash
In 1991 MNCs consolidated their holdings by issuing equity tocontrolling 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 fixedreturns on MFs
In 1999-2000 many companies raised money by adding Infotechto 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
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Reasons for Misgovernance
A closed economy without modernregulations
Control by promoter families who own 3.3%of paid-up capital on average
Liberalization has forced a changed
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Increasing Awareness
In 1999 SEBI appointed the KumarMangalam Birla committee to mandateinternational standards of governance
By 2003 all listed companies joined the code
Economic shocks forced reform in developedcountries whereas liberalization was the
cause in India
Very few of the 100 top companies beforeliberalization survive today because of
misgovernance
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Global Concerns
Few issues are as important as corporategovernance
The Russian economy collapsed in 1998because of diversion of corporate assets bymanagers to the extent of $100b
The Asian crisis was also because of
corporate governance
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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 toshareholders and creditors
Control of management
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Corp Governance Model
Shareholders elect directors to representthem
Directors vote on key issues and adoptmajority decision
Shareholders and others can hold directorsaccountable
Company adopts accounting standards togenerate information necessary for directorsand other stakeholders
Companys policies adhere to national, state
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McKinseys Model
Model 1Market Model
Well developed equity markets and dispersedownership
Corporate governance is basically how firms dealfairly with agency problems
Model 2Control Model
Underdeveloped equity markets, concentrated (family)
ownership, less transparency and inadequateprotection of minority and foreign shareholders
Grow supporting institutions like capital marketregulators and judiciary to enforce contracts and
property rights
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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
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OECD Emphasis
Rights of shareholders
Equitable treatment of shareholders
Role of stakeholders in corporate governance Disclosure and transparency
Responsibilities of the board
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Rights of shareholders
Secure share ownership
Voting rights
Full disclosure
Participation in decisions on sale or any change inassets including mergers and new share issues
Know capital structure and arrangements that enablecertain shareholders to obtain disproportionate control
All transactions at fair prices and fair conditions Anti-takeover devices should not be used
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Equitable treatment of
shareholders
No undue difficulties in voting
Change in voting rights subject to approval byshareholders
Insider trading should be prohibited
Directors should disclose material interest intransactions
Avoid conflict of interest by directors
Interested directors should not participate indecisions that concern them
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Role of stakeholders in corp
gov
Allow employee representation on the BOD
Involve creditors in insolvency proceedings
Relevant information is a must forshareholder activism
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Disclosure and Transparency
Includes financial details, operating results,governance structure and policies, BOD andtheir remuneration, risk factors and material
information on employees and otherstakeholders
Annual audits by independent auditors in
accordance with high quality standards
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Responsibilities of BOD
Corporate strategy, risk, compensation andperformance, accounting and reporting
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Modern Corp Gov
Started with the Watergate scandal in the US
This resulted in regulations that preventedcorporations 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 explainreasons for non-compliance
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Cadbury Aftermath
Requirement that directors should report on the effectiveness of thesystem of internal control beyond financial matters causedcontroversy
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 beenmanaged and that an embedded risk management process was inplace
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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
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Distinguishing roles of BOD
and management
Select, decide remuneration, evaluate and change theCEO
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
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Composition of BOD
Optimum combination of executive and non-executive directors with not less than 50% ofnon-executives
If chairman is non-executive at least 1/3rdshould be independent directors andotherwise at least half should be independent
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Separation of CEO and
Chairperson
Combining results in conflicts in decisionmaking and concentration of power
The CEO leads management whereas thechairman leads the board
The board evaluates the CEO and socombining the roles results in conflicts of
interest Also the work load on both is heavy and so
combining the roles results in inefficiency
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Should the Board have
committees
They lessen the burden of the BOD
Many regulations require committees fornomination, remuneration and audit
Should have written terms of referenceoutlining authority and duties
Should have access to company executivesand outside expertise at company expense
Independent and experienced people shouldbe appointed to committees
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Appointments to BOD and re-
election
Shareholders elect directors but in practicethe nomination committee selects andappoints directors and gets him formally
elected by shareholders at the ensuing AGM
In fact, shareholders only endorse theappointment
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Directors and executives
remuneration
Shareholders are entitled to information ondirectors remuneration and its determination
Key issues
Transparency
Pay for performance
Process for determination
Severance payments Pensions for non-executive directors
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Disclosure and Audit
Lucid and balanced assessment of financialsituation 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
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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
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Dialogue with institutional
shareholders
They should maintain regular contact
Should participate in AGMs and use votingrights
Should exercise all rights as owners
Should exercise interest in boardappointments
Should enhance standards of governanceinstead of simply selling shares whendissatisfied
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Should investors force CSR
Environment and economic gains are notcontradicting goals but contribute to long termperformance
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Relevance of Corp
Governance
Research shows that governance andperformance are correlated
Fis consider governance to be as importantas performance
Investors are prepared to pay a premium forgovernance
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Benefits to Society
Transparency brings benefits to all and preventssystematic banking crises
Research proves that strong protection of
minority shareholders leads to large and liquidcapital markets
Competitive capital markets promote
governance Transparency reduces corruption
Ensures that right business strategies, M&A forthe right reasons and performance based
compensation
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Benefits to Corporations
Creation and enhancement of competitiveadvantage
Prevents fraud and malpractice
Protects shareholders interests
Enhances enterprise value
Ensures compliance with laws
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The End