CU-BCOM-SEM IV-Corporate Governance-Second draft

BACHELOR OF COMMERCE SEMESTER-IV CORPORATE GOVERNANCE

CHANDIGARH UNIVERSITY Institute of Distance and Online Learning SLM Development Committee Prof. (Dr.) H.B. Raghvendra Vice- Chancellor, Chandigarh University, Gharuan, Punjab:Chairperson Prof. (Dr.) S.S. Sehgal Registrar Prof. (Dr.) B. Priestly Shan Dean of Academic Affairs Dr. Nitya Prakash Director – IDOL Dr. Gurpreet Singh Associate Director –IDOL Advisors& Members of CIQA –IDOL Prof. (Dr.) Bharat Bhushan, Director – IGNOU Prof. (Dr.) Majulika Srivastava, Director – CIQA, IGNOU Editorial Committee Prof. (Dr) Nilesh Arora Dr. Ashita Chadha University School of Business University Institute of Liberal Arts Dr. Inderpreet Kaur Prof. Manish University Institute of Teacher Training & University Institute of Tourism & Hotel Management Research Dr. Manisha Malhotra Dr. Nitin Pathak University Institute of Computing University School of Business © No part of this publication should be reproduced, stored in a retrieval system, or transmitted in any formor by any means, electronic, mechanical, photocopying, recording and/or otherwise without the prior written permission of the authors and the publisher. SLM SPECIALLY PREPARED FOR CU IDOL STUDENTS 2 CU IDOL SELF LEARNING MATERIAL (SLM)

First Published in 2021 All rights reserved. No Part of this book may be reproduced or transmitted, in any form or by any means, without permission in writing from Chandigarh University. Any person who does any unauthorized act in relation to this book may be liable to criminal prosecution and civil claims for damages. This book is meant for educational and learning purpose. The authors of the book has/have taken all reasonable care to ensure that the contents of the book do not violate any existing copyright or other intellectual property rights of any person in any manner whatsoever. In the event the Authors has/ have been unable to track any source and if any copyright has been inadvertently infringed, please notify the publisher in writing for corrective action. 3 CU IDOL SELF LEARNING MATERIAL (SLM)

CONTENTS Unit - 1: Evolution ................................................................................................................ 5 Unit - 2: History Of Corporate Governance ......................................................................... 19 Unit - 3:Principles Of Corporate Governance ...................................................................... 31 Unit - 4: Committees And Guidelines I ............................................................................... 42 Unit - 5: Committees And Guidelines II .............................................................................. 64 Unit - 6: Stakeholders Rights............................................................................................... 75 Unit - 7: Stakeholders Privileges ......................................................................................... 89 Unit - 8: Grievance Redressal Process ............................................................................... 103 Unit - 9: Board Of Directors.............................................................................................. 115 Unit - 10: Directors ........................................................................................................... 127 Unit - 11: Corporate Social Responsibility ........................................................................ 140 Unit - 12: Governance Issues............................................................................................. 154 Unit - 13: Venture Capitalists ............................................................................................ 170 Unit - 14: Insolvency Regimes .......................................................................................... 186 4 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT - 1: EVOLUTION STRUCTURE 1.0 Learning Objectives 1.1 Introduction 1.2 Meaning and Definition of Corporate Governance 1.3 Characteristics 1.4 Role and Importance of Corporate Governance 1.5 Corporate Governance Ethics and theories 1.6 Summary 1.7 Keywords 1.8 Learning Activity 1.9 Unit End Questions 1.10 References 1.0LEARNING OBJECTIVES After studying this unit, you will be able to:  Describe the meaning of Corporate Governance  To understand the Scope of Corporate Governance  State the Role and Importance of Corporate Governance  To understand the Impact on the Corporate Environment 1.1INTRODUCTION Corporate World today is striving in the process of acquiring the moral conscience. The concept of Corporate Governance and sustainability are the expressions through which the corporate is trying to imbibe the Ethical Values, Social and Ecological responsibilities in the corporate life. The crust of Corporate Governance is not the conduct or behavior that we experience outside the organization; rather it is an internalized value that an organization and its Top-level management should follow. 5 CU IDOL SELF LEARNING MATERIAL (SLM)

1.2MEANING AND DEFINITION OF CORPORATE GOVERNANCE The word Corporate or Corporation is extracted from the Latin term “Corpus” which means a “Body”. The root word of Governance is “Gubernate” which means to steer. Corporate Governance would mean to drive an organization in the desired direction. The responsibility to steer lies with the board of directors or governing body. Corporate Governance means the set of systems, procedures, policies, practices, standards put in place by an organization to ensure that relationship with various stakeholders is maintained in the transparent and honest manner. Robert Ian Bob Tricker who propound the words corporate governance for the first time in his book in 1984, defines Corporate Governance as, “It stipulates the way corporate entities are governed, as distinct from the way business within those companies are managed, corporate governance addresses the issues facing Board of Directors, such as an interaction with top management and relationships with the owners and others interested in the affairs of the company”. Confederation of Indian Industry (CII) – Desirable Corporate Governance Code (1998) - defined the term Corporate Governance as, “It deals with laws, procedures, practices and implicit rules that determine a company’s ability to take informed managerial decisions vis-a- vis its claimants – in particular, its shareholders, creditors, customers, the state and employees. There is a Global consensus about the objective of ‘Good’ Corporate Governance: maximizing long-term shareholder’s value”. James D. Wolfensohn (Ninth President of World Bank) defines Corporate Governance as, “It is about promoting corporate fairness, transparency and accountability”. 6 CU IDOL SELF LEARNING MATERIAL (SLM)

1.3 CHARACTERISTICS OF CORPORATE GOVERNANCE Social Discipline Transparency Responsibility CHARACTERISTICS Fairness Independence Responsibility Accountability A) Discipline: All involved parties will have the fidelity to comply with procedures, processes, and authority structures imposed by the Enterprise. It is an allegiance by a senior management to follow the activities and principles which are recognized and accepted globally. B) Transparency:All implemented principles, practices and their support in decision making will be audited and inspected by an authorized organization and parties (Service Provider). It enables an outsider to make meaningful analysis of Company’s actions, its fundamentals and non-financial aspects pertinent to business in order to take investment and other related decisions. Company should maintain the transparency and disclose essential information which makes the investors and other stakeholders to take informed decision. C) Independence: All Processes, decision making and mechanisms used will be established so as to minimise or avoid Potential conflicts of interests. D) Accountability: Identifiable groups within organization are authorized and accountable for their actions. Ex: Governing Boards, Committees, etc. E) Responsibility: Each party having nexus with the company is required to act responsibly not only to the organization but also toits stakeholders. Responsibility pertains to behaviour that allows for penalizing mismanagement and also paves way for remedial action. F) Fairness: All decisions taken, processes used and their implementation will not be allowed to create unfair advantage to any one particular party. The rights of various groups have to be acknowledged and respected. 7 CU IDOL SELF LEARNING MATERIAL (SLM)

1.4NEED AND IMPORTANCE OF CORPORATE GOVERNANCE Corporate Governance is needed to create robust corporate culture of Accountability, transparency and disclosure. It denotes compliance with all the ethical and moral principles / values, legal framework and voluntarily adopted practices. The Need for Corporate Governance stipulated as follows:  Corporate Performance  Enhanced Investor Trust  Accountability  Enhancing enterprise Valuation  Reduced risk of Corporate Crisis  Conventional access to global market  Filtering Corruption  Facilitates Finance A) Corporate Performance – Improved governance structures and processes ensure quality decision-making, motivate effective succession planning for senior management and enhance the long-term well-being of companies, independent of the type of company and its sources of finance. This can lead to improved corporate performance. B) Enhanced Investor Trust – Investors will consider corporate governance as a scale to measure financial performance when evaluating companies for investment. Investors who are provided with transparent transactions, regular disclosures are likely induce investors to invest openly in those companies. It enhances investors’ loyalty towards the company. C) Accountability – Investor relations are integral part of Company’s growth. Investors directly or indirectly entrust management of the company to create enhanced value for their investment. Hence, Company is obliged to make timely disclosures on regular basis to all its stakeholders in order to maintain the integrity with investors. D) Enhancing enterprise valuation – Improved management accountability and operational transparency will satisfy investors’ expectations and boost confidence on management, will eventually leads to wealth maximization. E) Reduced risk of Corporate Crisis – Corporate governance ensures efficient risk mitigation systems in place. A transparent and accountable system makes the board of 8 CU IDOL SELF LEARNING MATERIAL (SLM)

a company aware of the majority of the mask risks involved in a particular strategy, thereby placing various controls in place to facilitate the monitoring of the connected issues. F) Conventional access to global markets – Efficient Corporate governance system attracts investment from global investors, which subsequently paves way for greater efficiencies in financial operation. G) Filtering Corruption – Companies having sound governance system provide full and transparent disclosure of accounting auditing procedures and allows transparency in all business transactions, makes environment non – conducive for Corruption. Efficient Corporate governance will help to prevent fraud and malpractices within the organization. H) Facilitates Finance – Increased role of financial intermediaries, size of the enterprise, investment choices have made monitoring the use of capital more tricky thereby increasing the need of Good Corporate Governance. Corporate Governance and Business ethics of an organization will complement each other. In fact, an organization that follows ethical practices in all its activities will in all probability follow best corporate governance as well. It is meant to run companies ethically in a manner such that all stakeholders including creditors, distributors, customers, employees, the society at large, governments and even competitors are dealt with in a fair manner. Corporate Governance should endeavor to create corporate awareness and an environment in which those who are charged with governance and those who are governed display genuine, ethical, social and ecological responsibilities. The importance of corporate governance has been recognized in all the activities of an organization to strive for excellence towards all its stakeholders. Hence, the role of Corporate Governance is inevitable in the present context. 1.5 CORPORATE GOVERNANCE ETHICS AND THEORIES The term ethics is derived from the Greek word ‘ethos’ which refers to character, guiding beliefs, principles and ideals that spread a group, a community or people. Business ethics and corporate governance of an organization go hand in hand. In fact, an organization which follows ethical practices in its activities will follow best corporate governance practices as well. A business organization should compete in the global market based on its own internal strength, in particular on the strength of its human resource, and on the goodwill of the 9 CU IDOL SELF LEARNING MATERIAL (SLM)

company, which creates value for its stakeholders. While its state-of-the-art technologies and high-level managerial competencies could be of help in meeting the quality, cost, volume, speed and breakeven requirements of the highly competitive global market, it is the value- based management and ethics that every organization has to use in its governance. This would enable the organization to establish productive relationship with its internal customers and lasting business relationship with its external customers. Features of Ethics:  It is a conception of right or wrong conduct. It weighs the activity as moral or immoral.  It deals with the basic human relationship, the way of thinking and behaviour towards others and how we want them to think and behave towards us.  Ethics relates to the formalized principles derived from social values. It deals with the moral choices that we make while performing our duties with regard to the other members of society.  These principles are universal in nature. They prescribe obligations and virtues for everybody in a society.  The concepts of equity and justice are not directly expressed in ethics. Ethics and legality of action do not necessarily coincide. The legality of actions and decisions does not necessarily make them ethical. Ethical theories arise in different context, so they address different problems. They also represent some ethical principles. There are many ethical theories but in general there are two major kinds of ethical theories – Deontological and Teleological theories. Deontological Theory Teleological Theory Deontological Theory: 10 CU IDOL SELF LEARNING MATERIAL (SLM)

According to this theory, though the consequence of an act is good, some acts are always wrong. The actions are judged as ethical or unethical based on duty or intentions of an actor. Kant believed that inclinations, emotions and consequences should play no role in moral action. This means that motivation for action must be based on obligation. Morality should provide us with a framework of rational principles that direct and restrict action, independent of personal intentions and desires. Good will is exercised by acting according to moral duty / law. Teleological Theory: It is derived from the Greek work ‘telos’ meaning ends or purpose. This theory holds that ends or consequences of an act determine whether the act is good or bad. Rightness of actions is determined solely by their good consequences. It is also known as consequential ethics. Teleological analysis of business ethics leads to the consideration of the entire range of stakeholders in any business decision, including the management, the staff, the customers, the shareholders, the country, humanity and environment. Utilitarian Approach: It is an ethics of welfare. Business guided by utilitarian approach focuses on behaviors and their results, not on the method of rendering such actions. It can be described by the phrase, “the greatest good for the greatest number”. The utilitarian approach prescribes ethical standards for managers in the areas of organizational goals, i.e., maximization of profits; and having efficiency which implies optimum utilization of scarce resources. It prescribes that the moral worth of an action is solely determined by its contribution to overall utility, that is, its contribution to the happiness and satisfaction of the greatest member. Virtue Theory: This theory is more concerned with answering the question of how to live a good life or how to be a good person. Virtue theory aims to offer an account of the characteristics one must have to be considered virtuous. Modern Virtue Theory: 11 CU IDOL SELF LEARNING MATERIAL (SLM)

Role of ethics is to enable to lead a successful and good life. Virtue is a character trait that manifests itself in habitual action. The virtues of successful living apply to business as well. But everyday life virtues cannot be applied to business unanimously. Any manager looking at employee welfare cannot always avoid layoff or other hard business decisions which affects the interest of the workers. Certain amount of concealment is justified and acceptable in business negotiations. Therefore, applying virtue ethics to business would require determining the end at which business activity aims. Hence, honesty in business is not comparable to the honesty that we consider in other spheres of life. Justice Theory: It also known as fairness approach. Justice does not depend on consequences; it depends on the principle of equality. The key to well-ordered society is the creation of institutions that enable individuals with conflicting ends to interact in mutually beneficial ways. The focus here is on social justice. Theory of Relativism: It promotes the idea that some elements or aspects of experience or culture are relative to, i.e., dependent on, other elements or aspects. It holds that there are no absolute truths in ethics and that what is morally right or wrong varies from person to person or from one society to another. The term often refers to truth relativism, which is the doctrine that there is no absolute truth, i.e., that truth is always relative to some particular frame of reference, such as a society or a culture. Example: Killing animals for sport could be right in one culture and wrong in another. Theory of Egoism: The theory of egoism holds that the good is based on the benefit realized by an individual in pursuit of self-interest. This model considers harms, benefits and rights that have an impact on person’s own welfare. Under this model an action is morally correct if it increases benefits for the individual in a way that does not intentionally hurt others, and if these benefits are believed to counterbalance any unintentional harms that ensure. Example: Company providing scholarship to the needy student with a condition that the beneficiary is required to work for company for 5 years. Although, the company is providing scholarship benefits, ultimately it is in the company’s self-interest. Figure 1.1 ADVANTAGES OF BUSINESS ETHICS 12 CU IDOL SELF LEARNING MATERIAL (SLM)

Investor Loyalty Regulatory Ethics Customer Authorities Satisfaction Attracting Talent i) Investor Loyalty: Various kinds of Investors are concerned about ethical practice, social responsibility and reputation of the company. Investors started realising that the ethical base i.e., practices provides the basement for a company to achieve better efficiency and profits. Relationship with any stakeholder, including investors, based on dependability, trust and commitment results in sustained loyalty. ii) Customer Satisfaction: It is an integral factor for a successful business strategy. Repeated purchases / orders and conducive relationships with mutual respect are essential for the success of the company. The name of a company should evoke trust and respect among customers for achieving the objective i.e., success. This is achieved by a company only when it complies with ethical practices in true letter and spirit. When a company with a belief in high ethical values is perceived as such, even the crisis or mishaps along the way will be tolerated by the customers as minor aberrations. An organization with a strong ethical environment places its customers’ interests as the priority. Ethical conduct towards customers builds a strong competitive position for the company. It promotes a strong public image too. iii) Attracting and Retaining talent: 13 CU IDOL SELF LEARNING MATERIAL (SLM)

People aspire to join organizations which follow high ethical values. Such companies are able to attract and retain the best talent. The ethical climate matters a lot to the employees. Ethical organizations create an environment that is trustworthy, making employees willing to rely on company’s policies, ability to take decisions and act on those decisions. In such a work environment, employees can expect to be treated with respect, and will have consideration for their colleagues and superiors as well. On the other side, retaining talented people is as big as attracting the talent. Talented people will invest their energy and talent only in organizations with values and beliefs that matches their own. In order to achieve, managers need to build culture, compensation and benefit packages, and career paths that reflect and foster certain shared values and beliefs. iv) Regulatory Authorities: The objective of Regulators is to make the companies functioning ethically as responsible citizens. The regulator need not always monitor the functioning of the ethically sound company. Any organization that acts within the confines of business ethics not only earns profit but also gains reputation publicly. 1.6SUMMARY  The root of the word Governance is from ‘Gubernate’, which means to steer. Corporate governance would mean to drive an organization in the desired direction.  Corporate Governance extends beyond corporate law. Its fundamental objective is not mere fulfilment of the requirements of law but in ensuring commitment of the board in managing the company in a transparent manner for maximizing stakeholder value. The real onus of achieving desired levels of corporate governance lies with corporates themselves and not in external measures.  Good Governance is integral to the very existence of a company. It inspires and strengthens investor’s confidence by ensuring company’s commitment to higher growth and profits.  Business ethics is a form of applied ethics. In broad sense ethics in business is imply the application of moral or ethical norms to business.  Deontology is an approach to ethics that focuses on the rightness or wrongness of actions themselves, as opposed to the rightness or wrongness of the consequences of those actions. 14 CU IDOL SELF LEARNING MATERIAL (SLM)

 Teleology (Greek: Telos: End, Purpose) is the philosophical study of design and purpose.  Relativism is the idea that some elements or aspects of experience or culture are relative to i.e., dependent on, other elements or aspects.  Justice is the concept of moral rightness in action or attitude; it is closely linked to fairness.  Organizations that value high ethics comply with the laws not only in spirit but go beyond what is stipulated or expected of them.  Ethics relates to the formalized principles derived from social values. It deals with the moral choices that we make in the course of performing our duties with regard to the other members of society.  Advantages of Business Ethics: Investor Loyalty, Customer Satisfaction, Attracting and Retaining talent, Regulatory Authorities. 1.7 KEYWORD  CII – Confederation of Indian Industry –It works to create and sustain an environment conducive to the development of our country, partnering with industry, Government, and civil society, through advisory and consultative processes.  Customer Loyalty –The act of choosing one company’s products and services consistently over their competitors. When a customer is loyal to one company, they are not easily swayed by price or availability of products.  Investor Loyalty – A trust come from a company promoting an ethical culture which provides a foundation for efficiency, productivity, and profits. When shareholders see a company that does not behave with integrity, they are less likely to invest into the company. Negative outlook, lawsuits and penalties can result from unethical practices.  Virtue – The behaviour which showing high moral standards. Companies should imbibe such quality and strive for ethical practices rather than following the rules for the sake of it. 1.8LEARNING ACTIVITY 1. Describe the characteristics of Effective Corporate Governance. 15 CU IDOL SELF LEARNING MATERIAL (SLM)

___________________________________________________________________________ ___________________________________________________________________________ 2. Mention the theories of Ethics. ___________________________________________________________________________ __________________________________________________________________________ 1.9UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define Governance. 2. What is Deontology? 3. Define the Theory of Relativism. 4. What is Justice Theory? 5. Discuss the Needs of Corporate Governance. 6. What is Utilitarian Approach? 7. Define Business Ethics. Long Questions 1. Explain the Characteristics of Good Corporate Governance. 2. Explain various Theories of Ethics. 3. Discuss the Advantages of Business Ethics. 4. Explain the Need and Importance of Corporate Governance. 5. Describe the Features of Business Ethics. B. Multiple Choice Questions 1. The Theory which holds that ends or consequences of an act determine whether the act is good or bad a. Deontological Theory b. Teleological Theory c. Justice Theory d. Modern Virtue Theory 2. Which one is not a characteristic of Corporate Governance? 16 CU IDOL SELF LEARNING MATERIAL (SLM)

a. Accountability 17 b. Transparency c. Dependence d. Responsibility 3. Deontological theory was suggested by: a. Immanuel Kant b. Ricardo c. Aristotle d. None of these 4. The term Ego was derived from: a. Greek b. Latin c. Hebrew d. English 5. The word ethos means: a. Guiding Standards b. Common Ethics c. Managing authority d. None of these Answers 1-b, 2-c, 3-a. 4-b, 5-a 1.10REFERENCES References book  SharmaJ.P. Corporate Governance, Business Ethics and CSR, Anne Books Pvt.Ltd. New Delhi.  Geeta D., and R.K. Mishra, Corporate Governance-Theory and Practice, Excel Books, New Delhi. CU IDOL SELF LEARNING MATERIAL (SLM)

Textbook references  Corporate Governance in India – An Evaluation – Sub hash Chandra Das, PHI Publications.  Corporate Governance and Sustainability, Chaudhury S K, Discovery Publishing Pvt. Ltd. Website  https://www.oecd.org/corporategovernance 18 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT - 2:HISTORY OF CORPORATE GOVERNANCE STRUCTURE 2.0 Learning Objectives 2.1 Introduction 2.2 Evidence of Corporate Governance in Arthashastra 2.3 Corporate Governance Developments in USA 2.4 Evolution of Corporate Governance in India 2.5 Elements of Good Corporate Governance 2.6 Summary 2.7 Keywords 2.8 Learning Activity 2.9 Unit End Questions 2.10 References 2.0LEARNING OBJECTIVES After studying this unit, you will be able to:  Understand the evolution of Corporate Governance.  Describe the elements of corporate governance.  Apprise about the developments across jurisdictions. 2.1INTRODUCTION In order to understand the nuances and depth of Corporate Governance, it is inevitable to discuss the historical background and its evolution over the years. This provides clarity while interpreting the standards prescribed or suggested by global forums. It will facilitate for Construction under interpretation which yields the desired results. 19 CU IDOL SELF LEARNING MATERIAL (SLM)

2.2EVIDENCE OF CORPORATE GOVERNANCE IN ARTHASHATRA Kautilya’s Arthashastra insist that for good governance, all administrators including the king are considered servants of the people. Good governance and stability are completely linked. If rulers are responsive, accountable, removable, recallable, then stability can be achieved. Otherwise it will be detrimental for the common good. These components hold good even in today’s modern era. The substitution of the state with the corporation, the king with CEO and the subjects with the shareholders, bring out the quintessence of corporate governance, because central to the concept of corporate governance is the belief that public good should be ahead of private good and that the corporation’s resources cannot be used for personal benefit. RAKSHA VRIDDHI PALANA YOGAKSHEMA Fig 2.1 Kautilya’s fourfold duty of a King: A) Raksha – It literally means “Protection” – In today’s corporate world it can be considered as the Risk Management. B) Vriddhi – It literally means “Growth” – In the Present-day context it can be considered as Stakeholder’s Value maximization. C) Palana – It means “Maintenance / Compliance” – In the modern era it can be equated with the compliance of various laws, rules and regulations in true letter and spirit. D) Yogakshema – It means the “Wellbeing” and in Arthashastra it is used in context of a practice towards social security. It can be compared with the modern-day CSR (Corporate Social Responsibility). Arthashastra talks Self-discipline for a King and the Six Enemies that a king has to Overcome – Lust, Anger, Greed, Conceit and Foolhardiness. In the present-day context, this addresses the ethics aspect of businesses and the personal ethics of the corporate leaders. 20 CU IDOL SELF LEARNING MATERIAL (SLM)

If the King and his Counselors do not agree on the course of action, it spells future trouble, irrespective of whether the venture is crowned with success or ends in failure. There would be no stronger counsel relevant to modern day corporate governance structures for executive managements to heed the advice given by the Non – Executive Independent colleagues on the board of directors – This reflects the importance of modern day concept of “Independent Directors” under Companies Act 2013. 2.3CORPORATE GOVERNANCE DEVELOPMENTS IN USA • FOREIGN CORRUPT PRACTICES ACT 1977 • US SECURITY EXCHANGE COMMISSION 1979 • TREADWAY COMMISSION 1985 • COSO ISSUED INTERNAL CONTROL 1992 • SARBANES - OXLEY ACT 2002 • DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION 2010 ACT  Foreign corrupt practices Act provides specific provisions regarding establishment, maintenance and evaluation of internal control system.  US securities Exchange Commission prescribed compulsory reporting on internal financial controls to ensure better Governance in 1979.  Tread way Commission in the year 1985 stressed the need for a proper control environment, desirability of constituting independent boards and its committees and objective internal audit function. As a consequence, the committee of Sponsoring Organisations took birth. 21 CU IDOL SELF LEARNING MATERIAL (SLM)

 COSO (Committee of Sponsoring Organizations) issued Internal Control – Integrated Framework. It will guide businesses and other entities to evaluate and improve their internal control systems.  Sarbanes Oxley Act 2002, made fundamental changes in every aspect of corporate governance in general and auditor independence, conflict of interests, corporate responsibility, enhanced financial disclosures and severe penalties for wilful default especially by managers and auditors.  The Dodd-Frank Wall Street Reform and Consumer Protection Act, gives shareholders a right to guidance vote on executive pay and golden parachutes (Acquisitions). This gives a powerful opportunity to shareholders in order to hold accountable executives and a chance to disapprove where they see the kind of misguided incentive schemes that threatened individual companies and in turn the broader company. 2.4 EVOLUTION OF CORPORATE GOVERNANCE IN INDIA In 1991, Initiatives taken by Government aimed at Economic Liberalization, Privatization and Globalization of the domestic economy, led India to initiate reform process in order to appropriately respond and adapt to the developments taking place in the Global market and it announces India as a Global competitor. On account of the interest generated by Cadbury Committee Report, the CII (Confederation of Indian Industry), ASSOCHAM (The Associated Chambers of Commerce and Industry) and SEBI (Securities and Exchange Board of India) constituted Committees to recommend initiatives in Corporate Governance. The Individual committee reports will be discussed in the upcoming chapters in detail. AGENCY SHAREHOLDER STAKEHOLDER STEWARDSHIP THEORY THEORY THEORY THEORY 22 CU IDOL SELF LEARNING MATERIAL (SLM)

Fig 2.2 Basic Theories of Corporate Governance: I) Agency Theory: According to this theory, managers act as ‘Agents’ of their entity. The owners formulate strategies and set objectives of the organization. Managers are responsible for carrying out these objectives in day to day work of the company. In this theory, the owners are the Principals, but they may not have knowledge or skill set for getting the objectives executed. That’s why they authorize managers to act on their behalf. Under the contract of agency, the agent should act in good faith. In modern day corporations, the shareholdings are widely spread. The management directly or indirectly selected by the shareholders, pursue the objectives set out by the shareholders. The absolute thrust of agency theory is that the actions of the management differ from those required by the shareholders to maximize their return. As the principals are widely spread, corporate governance enables to overcome hindrances in timely disclosures, monitoring and oversight. II) Shareholder Theory: According to this theory, it is the corporation which is considered as the property of shareholders. They can dispose-off this property, as they like. They want to get maximum return from this property. The ultimate aim of shareholders is to maximize the wealth. This narrow role has been expanded into overseeing the operations of the corporations and its managers to ensure that the corporation follows ethical and legal standards set by the government. So, the Board is responsible for any damage or harm done to the property of Corporation. The Managers should exercise due diligence, care and avoid conflict of interest and should not violate the confidence reposed in them. III) Stakeholder Theory: According to this theory, the Company is considered as an input-output model and all the interest groups include creditors, employees, customers, suppliers, local-community and the government are to be considered. This broad view clarifies that the corporation exists for everyone mentioned above and not only for shareholders. The interest and expectations of these different stakeholders are at times conflicting. The managerial personnel are responsible to mediate between these different stakeholders’ interest. In short, managers are faithful agents but not only for shareholders but for all the stakeholders. 23 CU IDOL SELF LEARNING MATERIAL (SLM)

IV) Stewardship Theory: The word steward means a person who manages another’s property. This theory is value based, as the managers and employee’s role is to safeguard the resources of corporation, its’ property and interest when the owner is absent. They have to take utmost care of the corporation. The managers should manage the corporation as if it is their own corporation. They are not agents as such but occupy a position of stewards. Thus, under this theory the values as standards are identified first and develop training programmes that help to achieve excellence. Finally, moral support is important to fill value gaps. 2.5 ELEMENTS OF GOOD CORPORATE GOVERNANCE  Legislation  Roles and powers of board  Board skills  Board appointments  Board Induction and training  Board Independence  Board Meeting  Management environment  Code of Conduct  Formulating Strategy  Obligations of Community  Financial and Operational reporting  Monitoring Board’s performance  Committees  Risk Management (a) Legislation – Clear and Unambiguous legislation and regulations are required for effective Corporate Governance. It requires appropriate interpretation; otherwise it may lead to deliberate manipulation or misinterpretation. (b) Roles and Powers of Board: Corporate Governance is the manifestation of personal beliefs and values which configure the organizational values, beliefs and actions of its board. The Board as an authority is primarily responsible for creating and ensuring values for its stakeholders. The absence of clearly designated role and powers 24 CU IDOL SELF LEARNING MATERIAL (SLM)

weakens accountability mechanism and threatens the achievement of organizational goals. (c) Board Skills – To be able to undertake its functions efficiently, the board must possess the necessary blend of qualities, skills, knowledge and experience. Each of the directors should make quality contribution. A board should have operational or technical expertise, financial skills, legal skills and knowledge of Government and regulatory requirement. (d) Board Appointments – To ensure that the competent people are on board, it carries extensive process to search for right candidate. A well-defined and open procedure must be in place for reappointments as well for appointment of new directors. Letter of Appointment should provide the duties and responsibilities for clarity. (e) Board Induction and Training – Gaining and updating knowledge will be the continuous phenomenon for directors as they are exposed to the conducive and ever- changing business environment. Hence, they should take part in professional development programmes as it ensures that directors remain abreast of all developments, which may impact on their corporate governance and other related duties. (f) Board Independence – Independent board is essential for sound corporate governance. Independence of directors would ensure that there are no actual or perceived conflicts of interest. It also ensures that the board is effective in supervising the challenging activities of the management. Independence will make the management much more reliable to its stakeholders. (g) Board Meetings – Directors must devote sufficient time and attention to render their duties. Convening meetings regularly and preparing thoroughly before entering the boardroom increases the quality of interaction at board meetings. These meetings are the platform to exchange views in order to take prompt decisions. (h) Management Environment –Conducive management environment is required to ensure success. It includes setting up of clear objectives and appropriate ethical framework, establishing due processes, providing for transparency and clear declaration of responsibility and accountability, implementing sound business planning, encouraging business risk assessment, having right people and right skill for the jobs, establishing performance evaluation mechanism. (i) Code of Conduct – It is essential that the organization’s prescribed ethical practices and code of conduct are disclosed and informed transparently to all stakeholders and 25 CU IDOL SELF LEARNING MATERIAL (SLM)

are expected to understand clearly and follow such guidelines by each member of an organization. Systems should be devised to periodically measure, evaluate and if possible recognize the adherence to code of conduct. (j) Formulating strategy – The objectives of the company should be clearly documented and stipulated in their long-term corporate strategy including an annual business plan together along with achievable and measurable performance targets and missions. (k) Obligations of Community – Even though the purpose of any business is commercial yet it must also take care of community’s obligations. Commercial objectives and community service obligations should be clearly documented after approval by the board. The stakeholders must be informed about the proposed and on-going initiatives taken to meet the community obligations. (l) Financial and operational reporting – The Board requires comprehensive, regular, reliable, timely, correct and relevant information in a form and of a quality that is appropriate to discharge its function of monitoring corporate performance. The reports and information provided by the management must be comprehensive but not so extensive and detailed as to hamper comprehension of the key issues. The reports should be available to board members well in advance to allow informed decision- making. Reporting should include status report about the state of implementation to facilitate the monitoring of the progress of all significant board approved initiatives. (m) Monitoring Board’s performance – The board must monitor and evaluate its holistic performance also that of individual directors at periodical intervals, using key performance indicators besides peer review. The board should establish an appropriate mechanism for reporting the results of board’s performance evaluation results. (n) Committees: Various committees especially Audit committee is responsible for liaison with the management; internal and statutory auditors, reviewing the adequacy of internal control and compliance with significant policies and procedures, reporting to the board on the key issues. (o) Risk Management – Risk is an integral component that should be effectively mitigated. There should be a clear process devised for locating, analysing and treating risks, which prevent the risk exposure of the company and directs the company to effectively achieve its objectives. It also involves establishing a nexus between risk-return and resourcing priorities. Proper risk management plan must be 26 CU IDOL SELF LEARNING MATERIAL (SLM)

put in place to manage risk throughout the organization. The board has the ultimate responsibility for identifying major risks to the organization, setting acceptable levels of risks and ensuring that senior management takes steps to detect, monitor and control these risks. 2.5 SUMMARY  Kautilya’s Arthashastra maintains that for good governance, all administrators, including the king were considered servants of the people. Good governance and stability were completely linked. There is stability if leaders are responsive, accountable and removable.  Corporate Governance basic theories: Agency theory; Stock Holder theory; Stake holder theory; Stewardship theory.  The initiatives taken by Government of India in 1991, aimed at economic liberalization and globalization of the domestic economy, led India to initiate reform process in order to suitably respond to the developments taking place world over. On account of the interest generated by Cadbury Committee report, the Confederation of Indian Industry, the Associated Chambers of Commerce and Industry and the Securities and Exchange Board of India constituted committees to recommend initiatives in corporate governance.  Effective corporate governance will be ensured through integral components of effective management and ethical values imbibed by the enterprises.  Corporate governance inspires and strengthens investor’s confidence by ensuring company’s commitment to higher growth and profits.  Independent board, transparent management are the few signals which show the company’s moral values towards Corporate Governance and responsible business. 2.6 KEYWORDS  COSO -Committee of Sponsoring Organizations - It issued Internal Control Integrated Framework. It will help businesses and other entities assess and enhance their internal control systems.  ASSOCHAM - The Associated Chambers of Commerce and Industry –Being a true and effective voice of corporate India, articulating its growth ambitions, eco system needs and issues concerning Central and State Policies in the interests of its members 27 CU IDOL SELF LEARNING MATERIAL (SLM)

and industry at large. Be at the forefront of policy and legislative environment with its well-researched and thought out viewpoints which are fair, transparent and equitable, across a wide range of economic and social infrastructure such as education, health and environment.  CII – Confederation of Indian Industry – It engages business, political, academic and other leaders of society to shape global, regional and industry agendas. 2.7 LEARNING ACTIVITY 1. Discuss the Role of Independent Director. ___________________________________________________________________________ ___________________________________________________________________________ 2. Why code of conduct is essential for the company? ___________________________________________________________________________ ___________________________________________________________________________ 2.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What do you mean by Raksha? 2. Define Stewardship Theory. 3. Why Induction and training for Independent Director is required? 4. What do you mean by Agency Theory? Long Questions 1. Explain the elements of Good Corporate Governance. 2. Enumerate the Corporate Governance Developments in USA. 3. Explain the Fourfold duties of a king under Kautilya’s Arthashastra. 4. Discuss the Roles and Powers of the Board. 5. Explain the Basic theories of Corporate Governance. B. Multiple Choice Questions 1. The Word Vriddhi means: 28 CU IDOL SELF LEARNING MATERIAL (SLM)

a. Protection b. Growth c. Well-being d. Maintenance 2. Company should be considered as an Input-Output Model was suggested by a. Agency theory b. Stakeholders theory c. Stewardship theory d. None of these 3. Which is not an element of a Good Corporate Governance? a. Board Independence b. Induction and training for board c. Code of Conduct d. Maintaining Secrecy with Stakeholders 4. Sarbanes Oxley Act was enacted in US in the year: a. 1991 b. 1996 c. 2000 d. 2002 5. Government of India initiated LPG policy in the year: a. 1991 b. 2000 c. 2010 d. 2013 Answers 1-b, 2-b, 3-d, 4-d, 5-a 29 CU IDOL SELF LEARNING MATERIAL (SLM)

2.8 REFERENCES References book  Corporate Governance, Nell Minow.  Geeta D., and R.K. Mishra, Corporate Governance-Theory and Practice, Excel Books, New Delhi. Website  https://www.coso.org  https://assocham.org 30 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT - 3:PRINCIPLES OF CORPORATE GOVERNANCE STRUCTURE 3.0 Learning Objectives 3.1 Introduction 3.2 Principles of Corporate Governance 3.3 Principles of Periodic Disclosures 3.4 Consequence of Poor Corporate Governance 3.5 Summary 3.6 Keywords 3.7 Learning Activity 3.8 Unit End Questions 3.9 References 3.0LEARNING OBJECTIVES After studying this unit, you will be able to:  Learn the basic framework of corporate Governance  Describe the Principles of effective Governance  Know the Adverse impact of Poor Corporate Governance 3.1 INTRODUCTION A well balanced, inclusive approach at par with certain standards and ideals is essential for effective governance. Having said that, it is required to know integral Principles which act as a base for effective governance strategy. To achieve it, we need declared standards; hence, Regulation 4 of the Listing Regulations, 2015 stipulates broad principles for corporate governance. Also provides guidelines for periodic disclosures to improve transparency. 31 CU IDOL SELF LEARNING MATERIAL (SLM)

3.2 PRINCIPLES OF CORPORATE GOVERNANCE The Following Principles should abide by the entities in order to ensure effective corporate governance: Principles of Corporate Governance Rights of Timely Equitable Role of Responsibilities Shareholders Information Treatment Stakeholders of BOD a) Rights of Shareholders: The Corporation shall seek to protect and facilitate the exercise of the following rights of shareholders: i) Right to participate in key processes and to be sufficiently informed of, decisions concerning with fundamental corporate changes. ii) Opportunity to participate effectively and vote in general shareholders meetings. iii) Being informed of the rules, including voting procedures that govern general shareholder meetings. iv) Opportunity to ask questions to the board of directors, to place items on the agenda of general meetings, and to propose resolutions subject to certain conditions. v) Effective shareholder participation in key corporate governance decisions, such as the nomination and election of members of the board. vi) Exercise of ownership rights by all shareholders, including institutional investors. vii) Adequate mechanism to address the grievances of the shareholders. viii) Protection of minority shareholders from abusive actions by, or in the interest of, controlling shareholders acting either directly or indirectly, and effective means to redress. 32 CU IDOL SELF LEARNING MATERIAL (SLM)

b) Timely Information: The Entities shall provide adequate and timely information to shareholders, including but not limited to the following: i) Sufficient and timely information concerning the date, location and agenda of general meetings, as well as full and timely information regarding the issues to be discussed at the meeting. ii) Rights attached to all series and classes of shares, which shall be disclosed to investors before they acquire shares. iii) Capital structures and arrangements that enable certain shareholders to obtain a degree of control disproportionate to their equity ownership. c) Equitable Treatment: The Corporation should ensure equitable treatment of all shareholders, including minority and foreign shareholders, in the following manner: i) All shareholders of the same series and class shall be treated equally. ii) Effective shareholder participation in key corporate governance decisions, such as the nomination and election of members of board of directors, shall be facilitated. iii) Exercise of voting rights by foreign shareholders shall be facilitated. iv) The listed entity shall devise a framework to avoid insider trading and abusive self-dealing. v) Process and procedures for general shareholder meetings shall allow for equitable treatment of all shareholders. vi) Procedures of listed entity shall not make it unduly difficult or expensive to cast votes. d) Role of Stakeholders: The listed entity shall recognise the rights of its stakeholders and encourage co-operation between listed entity and the stakeholders, in the following manner: i) The listed entity shall respect the rights of stakeholders that are established by law or through mutual agreements. ii) Stakeholders shall have the opportunity to obtain effective redress for violation of their rights. iii) Stakeholders shall have access to relevant, sufficient and reliable information on a timely and regular basis to enable them to participate in corporate governance process. iv) It is required to implement an effective Whistle blower mechanism enabling stakeholders, including individual employees and their representative bodies, to freely communicate their concerns about illegal or unethical practices. 33 CU IDOL SELF LEARNING MATERIAL (SLM)

e) Responsibilities of Board: The directors shall have following responsibilities: i) Evaluating, Reviewing and guiding corporate strategy, major plans of action, risk control policy, annual budgets and business plans, setting performance targets, monitoring implementation and corporate performance, and overseeing major capital expenditures, acquisitions and divestments. ii) Monitoring the effectiveness of the entity’s governance practices and making change as needed. iii) Selecting, compensating, monitoring and when necessary, replacing key managerial personnel and overseeing succession planning. iv) Aligning key managerial personnel and remuneration of board of directors with the long-term interests of the listed entity ad its shareholders. v) Ensuring the transparent nomination process to the board of directors with the diversity of thought, experience, knowledge, perspective and gender in the board of directors. vi) Monitoring and managing potential conflicts of interest of management, members of the board of directors and shareholders, including misuse of corporate assets and abuse in related party transactions. vii) Ensuring the integrity of the listed entity’s accounting and financial reporting systems, including the independent audit and that appropriate systems of control are in place, in particular, systems for risk management, financial and operational control, and compliance with the law and relevant standards. viii) Overseeing the process of disclosure and other communications. ix) Monitoring and reviewing board of director’s evaluation framework. x) Directors shall provide strategic guidance to the entity, ensure effective monitoring of the management and shall be accountable to the listed entity and the shareholders. xi) Board of directors shall set a corporate culture and the values by which executives throughout a group shall behave. xii) Directors shall encourage continuing directors training to ensure that the members of board of directors are kept up to date. xiii) Where the decisions of board may affect different shareholder groups differently, the board shall treat all shareholders fairly. xiv) Board shall maintain high ethical standards and shall consider the interests of stakeholders. 34 CU IDOL SELF LEARNING MATERIAL (SLM)

xv) Board shall exercise objective independent judgement on corporate affairs. xvi) Board shall consider assigning a sufficient number of non-executive members of the board of directors capable of exercising independent judgement to tasks where there is a potential for conflict of interest. xvii) The board of directors shall ensure that, while rightly encouraging positive thinking, these do not result in over-optimism that either leads to significant risks not being recognised or exposes the listed entity to excessive risk. xviii) The board shall have ability to ‘step back’ to assist executive management by challenging the assumptions underlying: strategy, strategic initiatives, risk appetite, exposures and the key areas of the listed entity’s focus. xix) When committees of the board are established, their requirement, composition and working procedures shall be well defined and disclosed by the board of directors. xx) Members of the board shall be able to commit themselves effectively to their responsibilities. xxi) In order to fulfil their responsibilities, members of the board of directors shall have access to accurate, relevant and timely information. xxii) The board and senior management shall facilitate the independent directors to perform their role effectively as a member of the board and committee of board of directors. 3.3 PRINCIPLES OF PERIODICAL DISCLOSURES The listed entities shall make regulations in accordance with the following principles which are based on the principles given by International Organization of Securities Commission (IOSCO): a) Information shall be tabled and disclosed in accordance with applicable standards of accounting and financial disclosure. b) The listed entity shall abide the prescribed accounting standards in true letter and spirit in the preparation of financial statements taking into consideration the interest of all stakeholders and shall also ensure that the annual audit is conducted by an independent, competent and qualified auditor. c) The listed entity shall desist from misrepresentation and ensure that the information provided to recognised stock exchange and investors are not misleading. 35 CU IDOL SELF LEARNING MATERIAL (SLM)

d) The listed entity shall provide adequate and timely information to recognised stock exchange and investors. e) The listed entity shall ensure that disseminations made under provisions of these regulations and circulars made thereunder, are adequate, accurate, explicit, and timely and presented in a simple language. f) Channels for disseminating information shall provide for equal, timely and cost- efficient access to relevant information by investors. g) The listed entity shall follow all the provision of the applicable laws including the securities laws and also such other guidelines as may be issued from time to time by the board and the recognized stock exchange in this regard. h) The listed entity shall make the specified disclosures and follow its obligations in true letter and spirit taking into consideration the interest of all stakeholders. i) Filings, reports, statements, documents and information which are event based or are filed periodically shall contain relevant information. j) Periodic filings, reports, statements, documents and information reports shall contain information that shall enable investors to track the performance of a listed entity over regular intervals of time and shall provide sufficient information to enable investors to assess the current status of a listed entity. UNITED NATIONS GLOBAL COMPACT’S TEN PRINCIPLES, 2000: Corporate Governance and sustainability start with a company’s value system and a principled approach to doing business. This means operating in ways in order to achieve fundamental responsibilities in the areas of human rights, Labor, environment and anti- corruption at least. Responsible businesses enact the same values and principles wherever they have a presence, and know that good practices in one area do not offset harm in another. UN Global compact is a strategic policy initiative for businesses that are committed to align their policies and strategies with ten universally accepted principles. Principle 1 – Business should support and respect the protection of internationally recognized human rights; and Principle 2 – Make sure that they are not involved in or pave way for human rights abuses. Principle 3 - Businesses should uphold the freedom of association and the effective recognition of the right of collective bargaining; Principle 4 – The elimination of all forms of forced and compulsory Labour; 36 CU IDOL SELF LEARNING MATERIAL (SLM)

Principle 5 - The effective abolition of Child Labour; Principle 6 – The elimination of discrimination in respect of employment and occupation. Principle7– Businesses should support a precautionary approach to environmental challenges; Principle 8 – Undertake initiatives to promote greater environmental responsibility; and Principle 9 – Encourage the development and diffusion of environmentally friendly technologies. Principle 10–Businesses should work against corruption in all its forms, including the practice of obtaining something through threats or bribery. 3.4 CONSEQUENCES OF POOR CORPORATE GOVERNANCE Weakness in Corporate Governance practices and stakeholder management processes expose a company and its stakeholders to several risks. The Potential possibility due to poor corporate governance is discussed below:  Company is exposed to legal, regulatory, and reputational risks could become increased. Company may face investigation by regulatory authorities due to violation or may face litigation due to some impropriety. These could potentially damage the reputation of the company and lead to significant legal costs.  Company’s ability to honour its debt obligations may become hindered. This exposed it to bankruptcy risk if its creditors decide to take-action against it.  It leads to poor investment a decision which is detrimental to the interest of stakeholders.  It may lead to bias towards one group who will benefit at the expense of another group. It will question the integrity and affects reliability.  It led to undermining the role of Governance structure which in turn affects the effectiveness of the management.  This paves way for frauds by Insiders which affects the entire corporation as a whole. Many activities will get through unnoticed due to poor governance structure. 37 CU IDOL SELF LEARNING MATERIAL (SLM)

3.5 SUMMARY  The securities and exchange board of India is an effective authority which regulates all aspects of securities market enforces the securities contract (Regulation) Act including the stock exchanges. Companies that are listed on the stock exchanges are required to comply with the Listing Agreement.  Principles of Corporate governance ensure basic values that need to be imbibed by all the enterprises to enhance transparency and disclosure.  The listed entities shall make regulations in accordance with the following principles which are based on the principles given by International Organization of Securities Commission.  Responsible businesses enact the same values and principles wherever they have a presence and know that good practices in one area do not offset harm in another.  Effective shareholder participation in key corporate governance decisions, such as the nomination and election of members of board of directors should be facilitated.  Business should support and respect the protection of internationally accepted principles and standards.  Weakness in Corporate Governance practices and stakeholder management processes expose a company and its stakeholders to several risks. 3.6 KEYWORDS  IOSCO – International Organization for Securities Commission – It is an association of organizations that regulate the world’s Securities and Futures Markets. Members are typically primary securities and future market’s regulators or the main financial regulator from each country.  Minority Shareholders –The Equity shareholders of a firm who does not enjoy voting power of the firm by the virtue, holds below 50% ownership of the firm’s equity capital.  Capital Structure – It is the proportion of Debt and Equity used by a company to finance its overall operations and growth.  Conflict of Interest – It occurs when an entity or individual becomes unreliable because of overlap between Personal interests and professional duties or responsibilities. Such a conflict occurs when a company or person has a vested 38 CU IDOL SELF LEARNING MATERIAL (SLM)

interest – such as money, status, knowledge, relationships or reputation – which puts into question whether their actions, judgment, and / or decision-making can be unbiased. (Self-dealing & Insider Trading) 3.7 LEARNING ACTIVITY 1. Define Sustainable Business Reporting. ___________________________________________________________________________ ________________________________________________________________ 2. Why timely disclosures to stakeholders are required? ___________________________________________________________________________ ___________________________________________________________________________ 3.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What are the Rights of Shareholders? 2. Describe the effects of poor corporate governance. 3. What is UN Global compact policy initiative? 4. Define Insider Trading. 5. Who are considered as Minority Shareholders? 6. Define Sustainability Long Questions 1. Explain the Principles of Corporate Governance. 2. Explain UN Global Compact principles towards Corporate Governance. 3. Discuss the Principles of Periodical Disclosures. 4. Explain the Responsibilities of the Board. 5. Explain the Rights of Shareholders. B. Multiple Choice Questions 1. Listing regulation stipulates guidelines to improve: 39 a. Control CU IDOL SELF LEARNING MATERIAL (SLM)

b. Sustainability c. Transparency d. Efficiency 2. Which is not the responsibility of the board? a. Aligning key managerial personnel b. Ensure Transparency c. Monitoring business activities d. Disclose Price Sensitive Information 3. Listing Regulation enacted in the year: a. 2010 b. 2013 c. 2015 d. 2017 4. Rights attached to all series and classes of shares, which shall be disclosed to investors – comes under which Principle of Corporate Governance? a. Rights of Shareholders b. Transparency c. Timely Information d. Equitable Treatment 5. Company has not exposed to a following risk due to poor corporate governance: a. Legal risk b. Reputational risk c. Control risk d. Regulatory risk Answers 1-c, 2-d, 3-c, 4-c, 5-c 40 CU IDOL SELF LEARNING MATERIAL (SLM)

3.9 REFERENCES References book  Bob Tricker, Corporate Governance-Principles, Policies, and Practice (Indian Edition),Oxford University Press, New Delhi  A Handbook on Corporate Governance, Institute of Directors India. Textbook references  Subash Chandra Das, Corporate Governance in India, PHI Learning.  Neeti Shikha Geetanjali Sharma, Corporate Governance in India – Principles and Policies, Cengage India Private Limited. Website  http://www.sebi.gov.in  http://www.coso.org  http://www.bna.com 41 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT - 4:COMMITTEES AND GUIDELINES I STRUCTURE 4.0 Learning Objectives 4.1 Introduction 4.2 Emergence of Corporate Governance 4.3 Corporate Governance Committees and Guidelines 4.3.1. Desirable Corporate Governance Code 4.3.2. Kumara Mangalam Birla Committee 4.3.3. Task Force on Corporate Excellence 4.3.4. Naresh Chandra Committee 4.4 Working Group on Companies Act 1996 4.5 Summary 4.6 Keywords 4.7 Learning Activity 4.8 Unit End Questions 4.9 References 4.0LEARNING OBJECTIVES After studying this unit, you will be able to:  Know the initial stages in evolution of Corporate Governance.  List out the contributions made by various expert committees.  Correlate the recommendations with the result of implementation. 4.1 INTRODUCTION Since 1990’s, the importance of corporate governance gained momentum which leads to robust planning. In order to implement any policy or standard, it is obvious to seek experts’ suggestions / guidance. In this regard, during late 1990’s many expert committees were 42 CU IDOL SELF LEARNING MATERIAL (SLM)

formed in order to contribute towards the rich history of Corporate Governance. In this chapter, we will discuss such evolution in detail. 4.2 EMERGENCE OF CORPORATE GOVERNANCE After experiencing with many scams, we realized the importance of effective governance which ensures and exercise control over the activities of the corporation which focus the activities only towards its objectives and for the benefit of stakeholders at large. Hence, Government initiated reform process in order to respondadequately to the developments taking place world over. 4.3 CORPORATE GOVERNANCE COMMITTEES AND GUIDELINES On the account of the interest generated by the Cadbury committee report, the Confederation of Indian Industry, The Associated Chamber of Commerce and Industry and Securities & Exchange board of India Constituted committees to recommend initiatives in Corporate Governance. In this chapter we will cover distinct committees which are formed to initiate corporate governance policy.  Desirable Corporate Governance Code – 1997  Kumara Mangalam Birla Committee – 2000  Task Force on Corporate Excellence through governance - 2000  Naresh Chandra Committee – 2002. 4.3.1. Desirable Corporate Governance Code – CCI - 1997 CII took a specific initiative on Corporate Governance, the first institution initiative in Indian Industry. The objective was to formulate and promote a code for corporate governance to be adopted and followed by Indian Companies, whether in the private sector, the public sector, banks or financial institutions, all of which are corporate entities. The final draft of the said code was widely circulated in 1997. In April 1998, the code was released. It was called Desirable Corporate Governance: A Code. A brief summary of 16 Recommendations of such Code is reproduced hereunder: RECOMMENDATION I – Frequency of Board Meetings: The entire board should meet at least 6 times a year, preferably at an interval of two months and each meeting should have agenda items that require at least half a day’s discussion. RECOMMENDATION II – Board Composition: 43 CU IDOL SELF LEARNING MATERIAL (SLM)

Any listed company with a turnover of Rs, 100 Crores and above should have Independent, Non-executive directors who should constitute:  At least 30% of the Board, if the chairman of the company is a non-executive director or  At least 50% of the board, if the chairman and Managing Director is the same person. RECOMMENDATION III – Number of Directorships: No single person should hold directorships in more than 10 listed companies. This ceiling excludes directorships in subsidiaries or Associate companies. Note: Subsidiary Company – Where the group has over 50% of Equity shares. Associate Company -- Where the group has over 25% but less than 50% of Equity stake. RECOMMENDATION IV – Roles, Responsibilities, and Qualifications of Non- executive Directors: For non-executive directors to play a material role in corporate decision making and maximizing long term shareholder value, they should:  Become active participants in boards, not passive advisors and clearly define responsibilities within the board and other committees such as the Audit Committee, and  Know how to decode Balance sheet, Profit and Loss Account, Cash flow statements and financial ratios and have some knowledge of various company laws. This, of course, excludes those who are invited to join boards as experts in other fields such as science and technology. RECOMMENDATION V – Non -Executive Directors: To secure better effort from non-executive directors’ companies should:  Pay a commission over and above the sitting fees for the use of the professional inputs. The present commission of 1% of net profits or 3% is sufficient.  Consider offering stock options, so as to relate rewards to performance. Commissions are rewards on current profits. Stock options are rewards contingent upon future appreciation of corporate value. An appropriate mix of the two can align a non-executive director towards keeping an eye on short term profits as well as longer term shareholder value. RECOMMENDATION VI – Disclosures of attendance record for re-appointment: 44 CU IDOL SELF LEARNING MATERIAL (SLM)

While re-appointing members of the board, companies should give the attendance record of the concerned directors. If a director has not been present for 50% or more meetings, then this should be explicitly stated in the resolution that is put to vote. RECOMMENDATION VII – Key information to the Board: Key information that must be reported to, and placed before, the board must contain:  Annual operating plans and budgets, together with up-dated long term plans.  Capital budgets, manpower and overhead budgets.  Quarterly results for the company as a whole and its operating divisions or business segments.  Internal audit reports, including cases of theft and dishonesty of a material nature.  Show cause, demand and prosecution notices received from revenue authorities which are considered to be materially important.  Default in payment of interest or non-payment of the principal on any public deposit and / or to any secured creditor and financial institution.  Fatal or serious accidents, dangerous occurrences, and any effluent or pollution problems.  Defaults such as non-payment of inter-corporate deposits by or to the company, or materially substantial non-payment for goods sold by the company.  Any issue which involves possible public or product liability claims of a substantial nature, including any judgement or order which may have either passed structures on the conduct of the company, or taken an adverse view regarding another enterprise that can have negative implications for the company.  Details of any joint venture or collaboration agreement.  Transactions that involve substantial payment towards goodwill, brand equity, or intellectual property.  Recruitment and remuneration of senior officers just below the board level, including appointment or removal of the chief financial officer and the Company secretary.  Labour problems and their proposed solutions.  Quarterly details of foreign exchange exposure and the steps taken by management to limit the risks of adverse exchange rate movement, if material. RECOMMENDATION VIII – Audit Committee: 45 CU IDOL SELF LEARNING MATERIAL (SLM)

 Listed companies with either a turnover of over Rs. 100 crores or a paid-up capital of Rs. 20 crores should set up audit committees within 2 years.  The committee should consist of at least 3 members, all drawn from a company’s non-executive directors, who should have adequate knowledge of finance, accounts and basic elements of company law.  To be effective, the audit committees should have clearly defined terms of reference and its members must be willing to spend more time on the company’s work vis-à-vis other non-executive directors.  Audit committees should assist the board in fulfilling its functions relating to corporate accounting and reporting practices, financial and accounting controls, and financial statements and proposals that accompany the public issue of any security and thus provide effective supervision of the financial reporting process.  Audit committees should periodically interact with the statutory auditors and the internal auditors to ascertain the quality and veracity of the company’s accounts as well as the capability of the auditors themselves.  For audit committees to discharge their fiduciary responsibilities with due diligence, it must be incumbent on management to ensure that members of the committee have full access to financial data of the company, its subsidiary and associated companies, including data on contingent liabilities, debt exposure, current liabilities, loans and investments. RECOMMENDATION IX – Disclosure on shareholders information: Under “Additional Shareholder’s information”, listed companies should give data on high and low monthly averages of share prices in a major stock exchange where the company is listed for the reporting year. Statement on value added, which is total income minus the cost of all inputs and administrative expenses. Greater detail on business segments, up to 10% of turnover, giving share in sales revenue, review of operations, analysis of markets and future prospects. RECOMMENDATION X – Consolidated Accounts: Consolidation of group accounts should be optional and subject the Income tax department using the group concept in assessing corporate income-tax. If a company chooses to voluntarily consolidate, it should not be necessary to annex the accounts of its subsidiary 46 CU IDOL SELF LEARNING MATERIAL (SLM)

companies under section 212 of companies act. However, if a company consolidates, then the definition of group should include the parent company and its subsidiaries. RECOMMENDATION XI – Compliance Certificate: Major Indian stock exchanges should gradually insist upon a compliance certificate, signed by the CEO and the CFO, which clearly states that the management is responsible for the preparation, integrity and fair presentation of the financial statements and other information in the Annual Report and which also suggest that the company will continue in business in the course of the following year. The accounting policies and principles conform to standard practice, and where they do not, full disclosure has been made of any material departures. The board has overseen the company’s system of internal accounting and administrative controls systems either through its Audit committee or directly. RECOMMENDATION XII – Disclosure relating to GDRs: For all companies with paid-up capital of Rs. 20 crores or more, the quality and quantity of disclosure that accompanies a GDR issue should be the norm for any domestic issue. RECOMMENDATION XIII – Funding: The Government must allow far greater funding to the corporate sector against the security of shares and other paper. RECOMMENDATION XIV – Nominee Director: It would be desirable, as pure creditors to re-write their covenants to eliminate having nominee directors except in the event of serious and systematic debt default and in case of the debtor company not providing six-monthly or quarterly operational data to the concerned financial institution. RECOMMENDATION XV – Disclosure of Ratings: If any company goes to more than one credit rating agency, then it must divulge in the prospects and issue document the rating of all the agencies that did such an exercise. It is not enough to state the ratings. These must be given in a tabular format that shows where the company stands relative to higher and lower ranking. It makes considerable difference to an investor to know whether the rating agency or agencies placed the company in the top slots or in the middle or in the bottom. It is essential that we look at the quantity and quality of disclosures that accompany the issue of company bonds, debentures, and fixed deposits in the USA and Britain – if only to learn what more can be done to inspire confidence and create an 47 CU IDOL SELF LEARNING MATERIAL (SLM)

environment of transparency. Companies which are making foreign debt issues cannot have two sets of disclosure norms and exhaustive one for the foreigners, and a relatively minuscule one for Indian investors. RECOMMENDATION XVI – Default on fixed deposits by company: Companies that default on fixed deposits should not be permitted to accept further deposits and make inter-corporate loans or investments until the default is made good and declare dividends until the default is made good. 4.3.2. Kumara Mangalam Birla Committee - 2000 In late 90’s, the need arises to have effective governance standards, as the capital markets and business environment faced many scams. The stringent governance framework is required to regulate listed companies in particular. On this backdrop, SEBI had set up a committee on May 7, 1999 under the chairmanship of Kumar Mangalam Birla to promote and raise standards of corporate governance. The report of this committee was the first formal and comprehensive attempt to evolve a code for governance. Recommendations led to inclusion of CLAUSE 49 in the listing agreement in the year 2000. The nature of recommendations is of two kinds – Mandatory (Companies should Follow) and Suggestive (Company may follow). The ultimate responsibility for putting the recommendations into practice lies directly with the Board of Directors and the management of the company. The summary of report is reproduced hereunder: Disclosures Frequency of Composition Board meeting of Board Recommendations Remuneration Audit Committee Committee Figure 4.1 Birla committee recommendations 48 CU IDOL SELF LEARNING MATERIAL (SLM)

RECOMMENDATION 1 – Frequency of Meetings: Board meeting should be held at least four times in a year, with a maximum time gap of 4 months between any two meetings. A director should not be a member in more than 10 committees or act as chairman of more than five committees across all companies in which he is a director. RECOMMENDATION 2 – Composition of Board: The Board should have an optimum combination of Executive and Non-Executive Directors with not less than 50 % of the Board consisting of Non-Executive directors. In case of Non- Executive chairman, at least 1/3rd of the board should consist of independent directors and in the case of Executive Chairman, at least 1/2 of the board should consist of independent directors. The report also clarifies the definition of Independent Director – “Directors who apart from receiving director’s remuneration do not have any other material financial relationship or transactions with the company, its promoters, its management or its subsidiaries, which in the judgment of the board may affect their independence of judgment”. Non – Executive chairman should be entitled to maintain chairman’s office at the expense of the company and also allowed reimbursement of expenses incurred in performance of his duties. Financial institutions should appoint nominee directors on a selective basis and nominee directors should have the same responsibility, be subject to the same discipline and be accountable to the shareholders in the same manner as any other director of the company. RECOMMENDATION 3 – Audit Committee: Qualified and independent audit committee should be set up by the board of a company. It should consist of minimum 3 members, all being non-executive directors, with the majority being independent, and with at least 1 director having financial and accounting knowledge. The chairman of the committee should be independent. The concerned chairman should also personally present at an Annual general meeting to answer shareholder’s queries. The Company secretary should act as the Secretary to the committee. The report further suggested frequency, quorum, powers and functions of audit committee. Frequency – The audit committee should meet at least thrice a year. One meeting must be held before finalization of annual accounts and one necessarily every six months. Quorum – It should be either two members or 1/3rd of the members of the audit committee, whichever is higher and there should be a minimum of two independent directors. 49 CU IDOL SELF LEARNING MATERIAL (SLM)

Power of Audit Committee:  To investigate any activity within its terms of reference  To seek information from any employee  To obtain outside legal or other professional advice.  To secure attendance of outsiders with relevant expertise, if it is necessary. Functions of Audit Committee:  Recommending the appointment and removal of an external auditor, fixing remuneration for audit and also approval for payment for any other service.  Oversight of the company’s financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and reliable.  Review with management the annual financial statements before submission to the board. It consults about changes in accounting policies and procedures, major accounting entries based on exercise of judgement by management, qualifications in draft audit report, compliance with prescribed accounting standards, Reviewing Internal control and check system, reviewing financial and risk management policies. RECOMMENDATION 4 – Remuneration Committee: The role of such committee is to select appropriate candidature for key managerial positions, professionals and fixing remuneration for them. The committee should comprise of at least 3 directors, all of whom should be non-executive directors, the chairman of committee being an independent director. All the members of the committee should present at the meeting. The board of directors should decide the remuneration of non-executive directors. RECOMMENDATION 5 – Disclosures: The governance section of the annual report should make disclosures about remuneration paid to Directors in all forms (Salary, benefits, bonuses, Pension, performance linked incentives, etc.). Details of non-compliance by the company including penalties and restrictions imposed by stock exchanges, SEBI or any other statutory authority related to capital markets during the last 3 years must be disclosed to the shareholders. Information like quarterly results, presentation made by companies and submitted to analysts may be put on company’s website or may be sent in such a form so as to enable the stock exchange on which the company is listed to put it on its own website. Half yearly declaration of financial 50 CU IDOL SELF LEARNING MATERIAL (SLM)