effective corporate governance-kajari

7/30/2019 Effective Corporate Governance-Kajari

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Effective Corporate Governance :

Role of Board of Directors


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The primary goal of a corporation is to

maximise the shareholders wealth in a

legal and ethical manner.


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Players

The shareholders : invest the capital

The directors : answerable to shareholders

The management : runs the company and is

answerable to the directors.


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Role of Board of Directors

BoD = governs the Company

within

the limits oflaw

and

decency.

BoD directs but not manages the affairs of the Company.


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Corporate Governance = system of making

directors accountable to shareholders for

effective management of the company inthe best interest of the company and

shareholders along with concern for ethics

and values.


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I would like to speak to you briefly about corporate governance atAlcan. In the current environment, shareholders of publiccorporations must inform themselves about their company'sgovernance practices.

Alcan has always been committed to be and remain a leader in thisarea. The Board believes that this commitment is essential toAlcan's success and to its ability to enhance Shareholder value.Allow me to give you three examples of our leadership in this area:

(1) the roles of Chairman and CEO were separated in 1995

well before this practice became a fundamental precept ofcorporate governance;(2) also, since 1995, Alcan's Board has been composedentirely of unrelated Directors with the exception of the CEO,and(3) the involvement of the fully-independent Audit

Committee of the Board in the audit of the Company and inits financial reporting, became a practice long before itbecame best practice in the corporate world.

From an address by L. Yves Fortier, Chairman of theBoard, Alcan Inc. to the 101st Annual General Meeting of

Shareholders, Montreal, Canada


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Board of Directors : constituents

Executive Directors

Independent (Non executive) Directors

Nominees of Financial Institutions

Various committees : audit, compensation,

etc

Company Secretary


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BoDits role

Monitor: By acting thro its committees,

Board can keep abreast of developments

inside and outside the corporation, bringingto the managements attention

developments it might have overlooked.

A Board should atleast carry out this task.


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BoDits role

Evaluate and influence : A Board canexamine management proposals, decisions

and actions, agree or disagree with them,give advice and offer suggestions, outlinealternatives.

More active Boards perform this task inaddition to the monitoring one.


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BoDits role

Initiate and determine : A Board can dileate

a corporations mission and specify options

to its management.

Only the most active Boards take on this task

in addition to the two previous ones.


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BoD : its responsibilities

Setting corporate strategy, overall direction,

mission or vision.

Hiring and firing the CEO and top management. Controlling, monitoring or supervising top

management.

Reviewing and approving the use of resources. Caring for shareholders interests.


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What will BoD do to fulfill its

duties ? Ensuring prudent management of the assets

Selecting and appointing the chief executive

Delegating all duties of management notspecifically reserved to the boards

Reviewing and appraising the performance

of the chief executive and other executivedirectors

Reviewing its own performance


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What will BoD do to fulfill its

duties ? Reviewing strategies and policies

Discussing thoroughly any action that might

have a significance impact on the future ofthe company

Approving auditors and other advisors

Ensuring the company stays within law Reviewing the compensation paid to senior

officers in the company.


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What is never a problem, difference lies in

how part that makes the board effective.


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Todays forces in which the Boards operate :

Deregulation : competitive market

Disintermediation: financial sector reforms, depend

on market for capitalInstitutionalisation : Institutionalisation of capital

markets

Globalisation : higher standards of disclosure and

corporate governanceTax reforms: Tilted the balance away from black

market transactions


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What went wrong at Tata Finance Ltd

Please go through the case provided and think

on following lines of BoDs role:

Monitor :

Evaluate and influence :

Initiate and determine :


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Role of Board : industrial

economy vs developing economy Legal framework and information system is

transparent

Financial markets are developedvs

Oriental value system

Social hierarchy acting as a deterrent to

professionalism in Board Encourages passive or indifferent or reluctant

participation in guiding commercial destiny ofcompany.


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In a study conducted of 246 central public

sector Boards, it was found :

1. 40% had more than 50% slots vacant.

2. 49% had vacancy between 20-50% slots.

3. 40% of Boards did not appoint any sub

committees


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4. Instead of optimal size of 12, it was 7.

5. Instead of average 12 meetings a year, it

was 7.6. 40% boards did not have any sub

committees.

and so on


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A study conducted at select 30 large Indian public

corporations inferred that :

Profits have no relation with the kind of Corporategovernance model followed in the samplecompanies.

Directors in most of the companies are foundineffective in monitoring the managements

performance.

Better corporate governance is driven bycollective conscious and not by stakeholdersdemands or market forces.


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Changes expected in Boards of

India: Independence of Directors

Agenda setting

Quality of debate

Providing direction

Developing strategic thinking

Moderating companies growth path Communicating with shareholding and non

shareholding constituencies


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In India, more often than not, if the Board is

active, it is occupied with operating and not

strategic decision making.


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What went wrong at Tata Finance

LtdLet us now discuss the case based on these

three roles of BoD.

Monitor :

Evaluate and influence :

Initiate and determine :


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Important issues related to BoD

Structure of Board :

Process of review :

Culture :


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Legal requirements:

Indian Companys Act, 1956 provides for :

Legal rights to shareholders :

a. Vote on every resolution placed before AGM

b. Elect Directors

c. Determine remuneration of Directors and CEOd. Removal of Directors

e. Appoint auditors to provide an external check onfinancial statements.

f. Take active part in AGM

SEBI (1992) had made certain recommendationswhich has impacted directly corporate

governance.


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Category of Directors:

Promoter

Executive

Non executive

Independent non executive : directors with

no business relationship with the company.

Nominee


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Ideal board:

Optimum combination of executive and nonexecutive directors

Not less than 50% of the Board consisting of nonexecutive directors

If non-executive Chairman, atleast one third of theBoard be Independent directors

If executive Chairman, atleast 50% of the Boardbe Independent directors

from Kumarmangalam Birla (SEBI) Report


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Ideal board:

Directors should have:

Integrity

Sense of accountability

Track record of acheivements

Ability to ask tough questions

Financial literacy

Ability to think strategically

Commitment to the company

Can represent maximum 10 Boards instead of 20from Kumarmangalam Birla (SEBI) Report


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Ideal board:

Nominees of Financial Institutions

Appointment on selective basis where such

appointment is considered necessary to protectthe interests of the institution or where it is a

right under loan agreement.from Kumarmangalam Birla (SEBI) Report

Id l b d


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Ideal board: Role of Chairman

To ensure Board works both as governance and as a

contributor to policy and growth. Maintain relation with institutional shareholders,

government, media and business

Collaborates the overall design of policy, encouragesgrowth and development.

vs

Role of CEO Developing the bottomline

Maintain operational control Proposing and implementing policy

Leading the operational team

Can same person hold both the position ?

from Kumarmangalam Birla (SEBI) Report


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Creating the right structure by inductingprofessionally acclaimed people who can:

Evaluate and comment. (eg Orchid Chemicals)

Contribute in critical areas. (eg Marico)

Independent from the management (eg Hughes)

Give good counsel (eg HLL)

Build the brand equity (eg Goenka)

Build up overall expertise (eg Mahindra and Mahindra)

Complement the expertise of Board (eg Godrej)

Market the company (eg Infosys)

Provide right kind of diversity

Provide adequate time


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Creating the right structure by inductingprofessionally acclaimed people :

Supervisory or advisory boards

Independence vs knowledge

Past CEOs even on joining as independent directors

think and act like management !

From across spectrum of background to bring

in new perspective


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Examples

L&T : 3 insiders vs 7 outsiders

ITC : 4 insiders vs 9 outsiders

Hughes : 1 insider vs 10 outsiders


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Process makes perfect :

- Process of regularly reviewing, aligning and, if needed,adding and removing talent and expertise on its Board.

- Individual accountability

- Fluid portfolio of roles


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A survey of 200 CEOs in 2001 serving as outside

directors of public firms found :

1. 63% of the boards they serve have never been

subjected to performance evaluation.

2. 42% of their own companies, where they are CEOs,

have never done a board evaluation.

A Korn/Ferry study of board directors in 2001

found that :

1. 67% of the boards regularly evaluate the CEOs.

2. 42% assess the Board performance.


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Examples

Once every three years, every Director on theBritish Airways Board is expected to submit apeer group review to the Chairman.

Independent Director signs KRAs to be achieved.

Pepsico Board spends one full day of each Boardmeeting to look in depth at the strategic challengesof each business unit.

Home Depot Board members are expected to visit8 stores outside their home states between each

board meeting.


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Murugappa groupEach Director mentors

few managers out of the list of 100 fast

track managers. Annual reviewsInfosys and Dr Reddys

Lab


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Culture :

Culture of openness

Culture of open dissent

Culture of trust and candour

Intellectually stimulating

Training


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Some examples:

Groupthink ?????

In Enron, Rebecca Mark and Clifford Baxterresigned as they were not comfortable with the

paths the Company had taken.

Walter Hewlett was the lone dissenter in themerger of HP with Compaq.

At Tycono body questioned the millions oddollar lent to the CEO.

Medtronicpharma companylone dissenterconvinced the Co not to get out of angioplasty

business.


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ICICI BankMiddle level managers makepresentatiion to the Board

Some of the most exciting times that I have

had as an independent director have been onthe Board S Ganguly, one of the formerICICI Bank Directors.


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Independent Directors

Clarion call for independent Directors

Expected to participate actively in auditcommittees

Part of non statutory advisory or superevisoryBoard

Proposed amendments seek to expand the scope of

their responsibilities. Eg, they have to periodically review legal compliance

reports prepared by the Company and the steps taken tocure any taint.

For NASDAQ/NYSE listed companies, every director

of a audit committee is expected to be independent.


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Examples:

Supervisory Boards :

no restriction on payment (BoD members are

paid sitting fee of Rs 5000.00 per Boardmeeting and the Board shares upto 1% of the

profit).

Utilise their expertise better.

Eg, Orchid Chemicals has a scientific

advisory Board.


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Please go through the handout detailing Maricos

BoD.

Harsh Mariwala reconstituted his Board in mid2002. He put the structure ahead of Directors.

Marico identified four critical areas where

Directors could contribute and spent close to 7months in finalising the Board.

FMCG strategy

Entrepreneurial wisdom Technology

finance

Can you identi fy who fi ts in which slot ?


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BoDs role : from active to passive


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Corporate governance and public

enterprises


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Public Sector Enterprise:

Monopoly environment for 40 years.

Protected from vissitudes of market.

State is the biggest shareholder. Board is beset by :

Political interference

Political appointeesLow expectation of performance

General apathy


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Is there a lack of understanding of the role

that Board could play in public enterprises ?


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What are some progressive

Boards saying about their roles ?ONGC:

1. Visioning

2. Strategising3. Promote business

4. Ensure long-term growth

5. Add value in large investment decisions

6. Technology upgradation

7. Encourage creativity

8. Value-based business


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Question : Can you tell us Board composition

at ONGC ?


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Question : How Board has helped in guiding

ONGC in market driven economy.

Answer : Can you tell us ?


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Transformational vs

Transactional leadershipmotivate performance through empowerment

vs

Management through command & control.

Transformational Board : creating and

sustaining an environment that delivers.


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Please go through the BBC report on US 64

debacle.

Do you notice that this is a extremely apt case

of corporate misgovernance.


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Whistleblower

What should you (a Director) do if awhistle-blower comes to you with

allegations that the company, orone or more of its officers, iscooking the books or misbehaving

in some other way?

Whi tl bl


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Whistleblower

- Worldcom inflated its income figuressince 1999 by as much as $9bn

Dy Vice President of Internal Audit deptacted as the whistleblower

- At Enron, Sharron Watkins of InternalAudit had raised major questions aboutfinancial irregularities.

(check out whistleblower.org. The GovernmentAccountability Projects mission is to protect thepublic interest by promoting government andcorporate accountability through advancingoccupational free speech and ethical conduct,defending whistleblowers, and empowering citizenactivists.)


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We will now discuss 10 recommendationscategorized into three broad areas of

responsibility for improving theeffectiveness of corporate governancepractices in Public Enterprises:

1. stewardship of the corporation;

2. working with management;

3. and the functioning of the board.


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Stewardship of Corporation

1 B d R ibilit


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1. Board Responsibility

(i) approve the strategic direction and the

corporate plan for the corporation; (ii) ensure that the principal risks of the

corporations business have been identified andthat appropriate systems to manage these risks

have been implemented; (generally all PSUs have commercial andpublic policy objectives)

(iii) approve managements succession planincluding appointing, training and monitoring

senior management; and (iv) ensure that the corporations information

systems and management practices meet its needsand give the board confidence in the integrity of

information produced.


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2. Public Policy Objectives

(i) document the current public policy objectives of

the corporation;

(ii) appreciate the contemporary trade-offs betweenthe often competing public policy and commercial

objectives of the corporation; and

(iii) assess the relevance of the corporations

mandate, and, if appropriate, propose changes forthe consideration of the appropriate ministry


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3. Communications

The board of directors of every corporation

should ensure that the corporation

communicates effectively, with theGovernment, other stakeholders and the

public.

Communication responsibilities Reporting responsibilities


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Working with Management


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4 Board and Management Relations

Allocating responsibility

Building a Relationship

Establishing Accountability


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6. The Position of the CEO

Assessing the CEOs position

Evaluating the CEOs performance


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7. Renewal of the Board

Assessing the Board

Renewal of the Board


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8. Education of Directors

New Directors

Ongoing education


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Business Ethics

Imagine that you are the ruler of the world You have


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Imagine that you are the ruler of the world. You have

total power over everything on the planet. You are faced

with the following dilemma:

1. You can almost completely remove hunger from the face of the planet.

Unfortunately, to do so will involve you killing one million people. The reason for

this is not clearyou just have to andthere is no way out.

2. You can reduce hunger in the world by 20% from its current level. This is still

clearly a desirable outcome. Again though, there is a downside. In this case you have

to kill one hundred people

3. You can leave things as they are. There is no trade off whatsoever in this case.

What do you do ? There are some more rules to be noted :

1. Whichever decision you make, you will not kill yourself.

2. The people you kill will all be complete strangers to you.


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Two broad school of thoughts :

Teleological : Ends justify the means.

Deontological : Is bothered about the

means, and not just the end.


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Business ethics make business

sense: Ethical positioning could be your

differentiator in the market. (eg Bodyshop,

Shahnaz Hussain) Reduce the demand for consumerism. (eg

Mclibel case of Mcdonalds)

Cooperation with govt. agencies, non profitorganizations, consumer groups.


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Business ethics : the set/system of principles

and rules of conduct applied to business.


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The Electronics Company

Please read the case study.


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Its legal so it is OK

Morality is broader than legality.

The view that laws and not morals should

restrict business practice fails to recognize:It is illegal as it is immoral !!!

If morals are not policed by industry, then when

laws do come along they are much mortougher.


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Business ethics has come to represent a set of

fundamental beliefs about business such

as :

a. Employees do their best in a good work

place.

b. Companies do their best in healthy

communities with a good quality of life.

c. Companies achieve more if they respect

the environment and conserve resources.


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Remember :

1. The car did not break any law.2. By producing the car, Ford kept many people in

work. The death of a few people was a small

price to pay. Many other Americans lost their

lives in car accidents during this time. It is bestto benefit the majority.


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Analysis:

Why ?

Groupthink !!!!

(This concept argues that a group of peoplewill tend to focus on one objective and goalong with the rest of the group in search ofthis goal, even though the gol or the means

should have been questioned. Go with theflow)


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Financial aspects of Corporate

Governance


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Inaccurate stating of stock levels to increase

or reduce profits

Booking orders at quarter end/year end toboost revenue

Smooth out performance of the company

by holding back sales in certain periods. Manipulation of fixed assets


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Changing the depreciation method from

year to year.

Qualification for bad debts. Cash.

Stocks.

Treatment of extraordinary items

Off balance sheet accounting

Wh is creati e acco nting so


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Why is creative accounting so

common ? Pressure to produce results which look

good.

Market expectation. Short term outlook of investor.

Creative accounting is a short term approachto paste over the crack until long term andlegitimate solutions can be found.

Some examples of selective


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display : Tata Steel : Net profit is up 651%. This is not dueto operational efficiences but instead a rise in steel

prices from a 20 month low in Sept 2002.

Grasim : Net profit grew 55%. This is due to gainson exceptional items rather than an increase in netsales which were up by mere Rs 4 crore.

L&T : Operating income down by 14%; net profit

up 5%. This is due to a 41% fall in interestpayments from Rs 90.1 crore to Rs 53.4 crore.

Bajaj Auto : Gross profit is up 50% over the lastquarter but net profit is down by 8.21%



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display : BPCL : Net profit grew by 78.4 %. This is

due to a gain of Rs 9.2 crore on deferred

taxes against a tax outgo of Rs 31.8 crore inquarter ended sept 2002.

ONGC : A higher other income of of Rs

630 crore and lower interest payments of Rs7.20 crore account for almost half of net

profit increase in Sept 2002.


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Insider dealing :

This occurs when an individual with inside

information about a company uses theirparticular knowledge to gain on the stock

market.

Refer to Tata Finance case.

Insider trading : HLL vs Tata


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Insider trading : HLL vs Tata

Finance HLL : Hindustan Lever which when charged withinsider trading by the stock market regulator,could demonstrate adherence to elaborate

compliance rules by the directors TFL : Tatas have no reporting requirements

regarding individual trading operations. One of theDirectors was asked to step down due to charges

of insider trading, but the role of other Tatadirectors on the board of Tata Finance is also opento question.


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Rogue trader : Nick Leeson


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Analysis:

Star trader was given too much freedom.

Lack of segregation og Leesons duties, so

he could cover his tracks well. Lack of supervsision.

No body questioned the extraordinary profit

that he was making.


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We can similarly discuss many more aspects

of business ethics :

- marketing aspect

- environment aspect

- globalization aspect

Boeing sacked the CFO on Nov 24 2003 His


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Boeing sacked the CFO on Nov 24, 2003. His

alleged misdeed :

Negotiating to hire Air Force procurement officer

Darleen A Druyun while she was in a position to

influence the outcome of a defense dept contract to

buy Boeing 767 tankers.Druyun, hired in Jan 2003,

after leaving the Air Force job in Nov 2002, also

lost her job.

CEO Philip M Condit said Boeing must and will live

by the highest standards of ethical conduct.


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Enron

Please go through the writeup on Enron.


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Enron :

The deadly combination of :

- bad business strategy,

- bad investments and

- desperate attempts to use accountingtricks to hide bad decisions

led Enron to free fall into the largestbankruptcy in American history.

What can Directors learn from


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whats happened at Enron ?

Directors should understand the operations andeconomics of their company, its strategy, and thekey performance indicators that give them someidea of how the business is doing.

Excellence in corporate governance is critical tothe accountability and integrity of any company,and that requires knowledgeable, active, andindependent board members.

Outside board members need to be sure they donthave economic ties to the company or other

possible conflicts of interest that might seem tocompromise their independence.


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What red flags could Directors


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What red flags could Director s

have checked out ? Beware of all kinds of transactionsbetween members of management andoutside firms and affiliates, any one of

which might provide an opportunity forself-dealing. Directors should considerwhether there is a legitimate businessreason for the company to enter into

any such transaction. If necessary, getoutside legal advice.

(something similar happened at Tata Finance)



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have checked out ?

Building off-balance-sheet financing, such assecuring debt with leases and special-purposeentities, or SPEs. Investment bankers,lenders, auditors, and other outsiders oftenhelp put these kinds of deals together as a

way to get around showing debt in thefinancial statements. It is often done in orderto hide just how leveraged a company is.

Directors have to request the CFO or treasurerto provide a quarterly summary of all debt,both on and off the balance sheet, along withinformation on where the cash will come fromto service the debt .



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have checked out ?

Directors should make sure that (1) the company has up-to-date written risk-

management policies, procedures, and internalcontrols and that theyre in place;

(2) the internal controls include sufficientsafeguards, such as adequate segregation of duties,that prevent any one person in the company fromexecuting improper transactions or doing improperaccounting;

(3) the company has established well-reasoned andsupportable methodologies that consistently measure

the fair values of derivatives and financialinstruments. A board would be well advised to askindependent auditors or other experts to assess thecompanys policies and controls on this topic.

Learnings for the audit committee


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Ask tough questions

Insists on answers

Ensure that each committee member isfinancially literate enough to

understand the companys financialstatements and disclosures.

Provide training for all new inductees



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Ensure from both the CFO and the

independent auditor if the accountingfor transactions, as reported anddisclosed in the financial statements,reflects the highest-quality accounting

standard that could be used, and if not,why not. (eg, debt could be on or offbalance sheet. Have any accountingpolicies changed ?)

Insist on an annual statement from theCEO and CFO that the company hasinternal controls and that they areoperating effectively.



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the audit committee and independent

auditor have open lines ofcommunication and a clear delineationthat the auditor is working for the auditcommittee.

ask the auditor to identify the mostsensitive accounting and auditing issuesand to describe the steps he is taking totest whether those transactions are

properly accounted for and disclosed.

Role of Audit Firm


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non-audit fees have approximated tens

of millions of dollars, up to 20 times theamount paid for the actual audit. Thebig issue is whether any of these extraservices impair an auditors

independence.

(remember the TFL case as well)

Role of Audit Firm


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If the CEOs and CFOs play the numbers gameand cook the books, andifthe auditors dont stir the pot enough tofigure out whats being cooked,and whether it is edible by investors and the

markets, they will continue to repeat themistakes that they did at Enron

effective corporate governance-kajari

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