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

___________________________________________________________________________ ___________________________________________________________________________ 11.11 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Why CSR Audit is important? 2. Define CSR. 3. Discuss the importance of NVG on Social, Environmental and Economic Responsibilities of Business? 4. What do you mean by CSR Committee and Policy? 5. Define the term “Sarva-LokhaHitam”. Long Questions 1. Describe the Evolution of CSR practices. 2. Explain the Standards suggested by the Global forums in connection with CSR. 3. Discuss the Functions of CSR Committee. 4. Explain the provision stipulated under section 135 of Companies Act 2013, in connection with CSR Expenditure. 5. Explain CSR Audit. 6. List out the CSR activities recognized under Schedule VII of Companies Act 2013. 7. Explain the Principles suggested by National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business, 2011. 8. Explain the Factors which influence CSR. 9. Explain with the help of an example on how CSR can be integrated with business goals? 10. Describe the OECD guidelines issued for CSR. B. Multiple Choice Questions 1 ISO stands for 151 a. Indian Standard Organization b. International standard Office c. International organization for Standardization CU IDOL SELF LEARNING MATERIAL (SLM)

d. Indian Organization for Standardization 2 CSR report should be attached with a. Meeting Report b. Board’s Report c. Auditor’s Report d. None of these 3 The company covers under the provision of CSR, have to spend ___ of Net Profits of last 3 preceding Financial Year. a. 2% b. 3% c. 5% d. 7% 4 Who is known as the Father of ModernCSR? a. Richard Marx b. Howard Bowen c. Ricardo d. David Martin 5 CSR Committee should consist of minimum of ____ Director(s). a. 2 b. 3 c. 5 d. 7 Answers 152 1-c, 2-b, 3-a, 4-b, 5-b. 11.12 REFERENCES References book CU IDOL SELF LEARNING MATERIAL (SLM)

 Geeta D., and R.K. Mishra, Corporate Governance-Theory and Practice, Excel Books, NewDelhi.8.  Bob Ticker, Corporate Governance-Principles, Policies, and Practice, Oxford University Press, New Delhi. Textbook references  Corporate Social Responsibility in India, Atul Sharma & B. N. Mandal, Global Vision Publishing House.  Corporate Social Responsibility, Dr. Navjeet Sidhu Kundal, Walters’ Kluwer India Private Limited. Website  http://www.csr.gov.in  http://www.indiacsr.in  http://www/mca.gov.in/CSRdata 153 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT - 12:GOVERNANCE ISSUES STRUCTURE 12.0 Learning Objectives 12.1 Introduction 12.2 Issues in Corporate Governance 12.3 Corporate Governance Failures in India 12.4 Corporate governance Forums 12.5 Guide to regulate governance 12.6 Summary 12.7 Keywords 12.8 Learning Activity 12.9 Unit End Questions 12.10 References 12.0LEARNING OBJECTIVES After studying this unit, you will be able to:  State the limitations and hindrances in implementation of governance policy in Indian context.  Explore certain real-life cases of corporate governance failures.  Explain the impacts of effective corporate governance. 12.1 INTRODUCTION Corporate governance is the system through which companies are guided and controlled. It refers to the set of rules and regulations, processes and procedures which ensure that a company is achieving its goals and objectives. Hence, effective corporate governance practice is very much required to accomplish the said objective. Any failure in respect of corporate governance practice will adversely impact the progress of the entity. The steps to avoid / overcome such failures gained importance over the period of time. 154 CU IDOL SELF LEARNING MATERIAL (SLM)

12.2 ISSUES IN CORPORATE GOVERNANCE The frequent instances of corporate frauds and governance failures have haunted the global corporate map and have witnessed comparably serious efforts for improving corporate governance practices. Some of the common issues experienced in Indian context were listed below: i) Appropriate Board: A capable, diverse and active board would, improve governance standards of a company. The challenge lies in imbibing governance in corporate cultures so that compliance can be improved in true spirit. Most companies tend to only comply on paper, board appointments are still carried by fellow board member through recommendations. Innovative solutions are the need of the hour like rating board diversity and governance practices, issuing such results or using performance evaluation as a minimum scale for appointing directors. Inappropriate board or its mix will be a great hindrance for governance in true colours. ii) Board Evaluation: After getting the components of board right, the next big challenge is the process of evaluating their performance, as this requires for further improvement in governance standards. Often, it is required to disclose such evaluation results to the public. In case of any negative disclosure, will have an adverse impact not only on the board but also signals all the stakeholders regarding ineffective governance practices, which may lead to diminishing reliability. Even though the performance is disclosed transparently, its reliability is questioned and this can be eliminated through the vibrant interference of an Independent Director. iii) True Independence of Directors: Appointment of Independent directors was supposed to be the biggest reform corporate governance. But, Independent directors hardly make the desired impact. The regulator on its part made the tighter norms and defined the role of such directors and audit committee. Still, the independence of such Independent directors appointed by the promoter is questionable as it is unlikely that they will stand-up for minority interests against the promoter. Despite all the governance reforms, the regulator is still requiring further improvement. Especially in restricting powers of promoters in connection with Independent Directors. iv) Risk Management: 155 CU IDOL SELF LEARNING MATERIAL (SLM)

Today, large businesses are exposed to real-time monitoring by business media and national media houses. Given that the board is only playing an oversight role on the affairs of a company, framing and implementing a risk management policy is unavoidable. The independent directors should assess the potential risks to which company were exposed, and disclose transparently to the stakeholders of the organization. For an effective governance model, a robust risk management policy which sets out key guiding principles and practices for managing risks in day-to-day activities is imperative. v) Privacy and Data Protection: In the current era of Digitalization, sound and effective understanding of the fundamentals of cyber security must be expected from every director. The effective governance will be achieved only if executives are able to engage and understand the specialists in their firm. The board should assess the potential risk of handling data and take steps to ensure such data is protected from the potential vulnerability. The protection can be achieved only after investing time and money in order to ensure the goal of data protection is achieved. Effective firewalls and defined role of each executive who access sensitive information will be required to secure such key information. vi) Approach towards CSR: Even though CSR provisions were mandated, still it is considered under ‘comply or explain’ principle. This enables board to take the social responsibility lightly and not considering at par with other business projects. Hence, the responsible business is not only beneficial for the company but for the society at large. This understanding is required for the board members to act as a responsible citizen of this country. The proper training and orientation may lead to appropriate corporate morale. vii) Conflict between Promoters and Management: Since many companies are family owned enterprises, the promoters as majority shareholders continue to exercise disproportionate influence over business decisions. This sometimes leads to a conflict between the promoters and the management, which is responsible for day-to-day functioning of the company. Such conflicts will also reflect weaknesses in succession planning and affects the integrity of corporate governance. viii) Stressed Financials: 156 CU IDOL SELF LEARNING MATERIAL (SLM)

The Non – Performing assets has affected the corporate sector and impacted adversely due to the vagaries of the business cycle. Many expensive acquisitions were made in the last decade by companies without a proper approval from the shareholders. Even decisions were made in personal interests without considering the financial synergies. The above practices lead to the disaster and entails ineffective outcomes. Sometimes, stressed financials will demotivate the management to think only about overcoming the crisis, but it will lead to further crisis if they are not considering their responsibility as a business house. ix) Composition of the Board: Even after mandated many provisions like Independent Directors, Woman Directors, Audit Committee, etc. however, several companies still haven’t appointed such authorities in their boards or some of them have named their family members or friends of promoters as such authorities. This again shows the negligence of the authorities in complying provisions. Stringent consequences will make the stakeholders to understand the importance of such compliance. 12.3 CORPORATE GOVERNANCE FAILURES IN INDIA Corporate takeovers and Mergers call for capital restructuring which may be a prime time for corruption / Inappropriate practices. If there is no Independent Director on the board, there is a chance that members might not comply strictly with the laws. Such takeover could be driven by a board member having vested interests in the acquisition. Rather than maximizing value for the shareholders, such a move would defeat the purpose of the whole exercise and that person in question would pocket the gains. Some companies in the recent past have been known to meddle with the account books, showing book profits that have not yet translated in to cash. This is misleading for auditors and other parties looking at the accounts book of the organization. A) The Satyam Scandal: It was a public listed company and enjoying a good reputation, even won the Golden Peacock Global Award for Corporate Governance at one point. However, company colluded with auditors in fraudulent accounting practices to mislead the investors, regulators, board and other stakeholders. The scandal was unravelled when the company’s chairman Ramalinga Raju confessed about the misrepresentation in the accounting practices and thereafter regulators like SEBI stepped in and started acting. 157 CU IDOL SELF LEARNING MATERIAL (SLM)

The issue started when the company invests Rs.7, 000 crores in Maytas properties and Infrastructure. These firms are owned by the family members of the said chairman. The investments were cleared by the board and were opposed by the Investors. The accounts of the firm were manipulated by assets like cash and bank deposits being overstated, debts being understated. As a result, the investors filed various lawsuits against Satyam. Following the lawsuits, the decision of Satyam board was reversed. The World Bank banned Satyam for 8 years to conduct any kind of business, while four independent directors resigned. The Satyam case sparked a reaction from various corners of corporate India, calling for urgent change in policy measures. Several agencies like Confederation of Indian Industry, National Association of Software and Services Committee, SEBI committee on disclosure and accounting standards, etc. started looking in to the policy changes regarding the Audit Committee, Shareholder Rights, Whistle-blower policy etc. B) DHFL Crisis: It is a classic case of meddling with the books. In this case, Bandra books were at the centre of the massive corporate fraud which is still under investigation. The supposed Bandra branch for which a parallel set of books exist, does not exist in reality. It was a completely made up entity for the corrupt business practices to thrive. A forensic report declared, out of the funds disbursed to Bandra Book entities in the account of the company, only 50 percent funds were actually disbursed. It was found that few entities which had invested part of the loan amount back to the companies linked with DHFL. C) Tata-Mistry Fallout: Cyrus Mistry was a Director of Tata Sons limited since 2006. The majority of shareholding was held by trusts of the Tate family. This was to ensure that the control remains with the family even when Cyrus Mistry joined. The board frequently disagreed with the decisions of Mistry and ousted him during one such meeting. Mistry alleged that there was dominant control by the Nominee directors of the trust, including Shadow Directors. Mistry said that he was never provided with a free hand by the promoters to manage the company and that the promoters were stubborn regarding their own projects. He also alleged that there was no independence in the working of the independent directors. This shows the clear abuse of power by the promoters. 158 CU IDOL SELF LEARNING MATERIAL (SLM)

12.4 CORPORATE GOVERNANCE FORUMS The need to find an institutional framework for corporate governance and to advocate its cause has resulted in the setting up and constitution of various corporate governance forums and institutions world over. Some of the prominent forums and institution are listed below: i) National Foundation for Corporate Governance. ii) Commonwealth Association of Corporate Governance. iii) International Corporate Governance Network iv) European Corporate Governance Institute v) Asian Corporate Governance Association vi) Corporate Secretaries International Association. NFCG CSIA CACG FORUMS ACGA ICGN ECGI Figure 12.1 Corporate Governance Forums i) NFCG – National Foundation for Corporate Governance: With the goal of promoting better governance practices in India, the Ministry of Corporate Affairs, Government of India, has set up the foundation along with Confederation of Indian Industry, Institute of Company Secretaries of India, Institute of Chartered Accountants of India. In the year 2010, stakeholders in NFCG have been expanded with the inclusion of 159 CU IDOL SELF LEARNING MATERIAL (SLM)

Institute of Cost Accountants of India and the National Stock Exchange of India Limited. The objective of this foundation is to be a catalyst in making India the best in corporate governance practices. It endeavours to build capacities in the area of research in corporate governance and to disseminate quality and timely information to concerned stakeholders. It works to foster partnerships with national as well as International organizations. At the national level, NFCG works with premier management institutes as well as nationally reputed professional organizations to design and administer Directors Training Programmes. The foundation provides accreditation to these organizations based on their meeting the eligibility criteria designed along with continuing adherence to the same. On obtaining the accreditation these organizations, with the support of NFCG, would set up a “National Centre for Corporate Governance (NCCG) “to provide training to Directors, conduct research and build capability in the area of corporate governance. NFCG also work to have arrangements with globally reputed organizations with the aim of promoting bilateral initiatives to improve regulatory framework and practices of corporate governance in a concerted and coordinated manner. The Internal Governance structure of NFCG consists of:  Governing Council –NFCG works at the integral level for policy making. It is chaired by Minister In-charge, Minister of Corporate Affairs, Government of India.  Board of Trustees – It deals with the implementation of policies and programmes and lay down the procedure for the smooth functioning. It is chaired by Secretary, Ministry of Corporate Affairs, and Government of India.  Executive Directorate – It provides Internal Support to NFCG activities and implements the decisions of the Board of Trustees. The executive director is the Chief Executive Officer of NFCG. The Executive Directorate exercises such powers as may be delegated to it by the Board of Trustees to carry out such functions as may be entrusted to it by the board. It also functions as the Secretary of the Council and the Board is supported by full time dedicated professional. ii) CACG – Commonwealth Association of Corporate Governance: It was established in 1998 with the objective of promoting the best international standards to a country on corporate governance through education, consultation and information throughout the commonwealth as a means to achieve global standards of business efficiency, commercial probity and effective economic and social development. It facilitates 160 CU IDOL SELF LEARNING MATERIAL (SLM)

the development of appropriate institutions which will be able to advance, teach and disseminate such standards. The governance is concerned with the long-term competitiveness of commonwealth countries in the global market, the stability and Credibility of the commonwealth financial sectors, the relationship between business enterprises within an economy and their sustained ability to participate in the global economy. Board of Governors comprising UK based representatives of member governments and five representatives of Civil Society, to determine the policies. There are 53 countries of the commonwealth, of which 46 are currently commonwealth foundation members. Membership of the foundation is Voluntary and is open to all Commonwealth Governments.  Principle 1 – Exercise leadership, enterprise, integrity and judgement in directing the corporation so as to achieve continuing prosperity for the corporation and to act in the best interest of the business enterprise in a manner based on transparency, accountability and responsibility.  Principle 2 - Ensure that through a managed and effective process board appointments are made that provide a mix of proficient directors, each of whom is able to add value and to bring independent judgement to bear on the decision-making process.  Principle 3 – Determine the corporation’s purpose and values, determine the strategy to achieve its purpose and to implement its values in order to ensure that it survives and thrives and ensure that procedures and practices are in place that protects the corporation’s assets and reputation.  Principle 4 – Monitor and evaluate the implementation of strategies, policies, management performance criteria and business plans;  Principle 5 – Ensure that the corporation complies with all relevant laws, regulations and codes of best business practice;  Principle 6 – Ensure that the corporation communicates with shareholders and other stakeholders effectively;  Principle 7 – Serve the legitimate interests of the shareholders of the corporation and account to them fully;  Principle 8 – Identify the corporation’s internal and external stakeholders and agree a policy, or policies, determining how the corporation should relate to them. 161 CU IDOL SELF LEARNING MATERIAL (SLM)

 Principle 9 – Ensure that no one person or a block of persons has unfettered power and that there is an appropriate balance of power and authority on the board which is usually reflected by separating the roles of the chief executive officer and Chairman, and by having a balance between executive and non-executive directors;  Principle 10 – Regularly review processes and procedures to ensure the effectiveness of its internal systems of control, so that its decision-making capability and the accuracy of its reporting and financial results are maintained at a high level at all times;  Principle 11 – Regularly assess its performance and effectiveness as a whole, and that of the individual directors, including the chief executive officer;  Principle 12 – Appoint the chief executive officer and at least participate in the appointment of senior management, ensure the motivation and protection of intellectual capital intrinsic to the corporation, ensure that there is adequate training in the corporation for management and employees, and a succession plan for senior management;  Principle 13 – Ensure that all technology and systems used in the corporation are adequate to properly run the business and for it to remain a meaningful competitor;  Principle 14 – Identify key risk areas and key performance indicators of the business enterprise and monitor these factors;  Principle 15 – Ensure annually that the corporation will continue as a going concern for its next fiscal year. iii) ICGN – International Corporate Governance Network: It is incorporated under the laws of England and Wales founded in the year 1995. It has four primary purposes:  To provide an investor-led network for the exchange of views and information about corporate governance issues internationally;  To examine corporate governance principles and practices;  To develop and encourage adherence to corporate governance standards and guidelines;  To generally promote good corporate governance. The mission is to develop and encourage adherence to corporate governance standards and guidelines, and to promote good corporate governance worldwide. Membership of ICGN is open to those who are committed to the development of good corporate governance. The membership section explains the benefits of 162 CU IDOL SELF LEARNING MATERIAL (SLM)

membership, the different types of membership and how to join the ICGN. The governance principles describe the responsibilities of board of directors and investors respectively and aim to enhance dialogue between the two parties. iv) ECGI – European Corporate Governance Institute: It was founded in the year 2002. It has been established to improve governance through independent scientific research and related activities. It provides a forum for debate and discussion between academics, legislators and practitioners, focusing on major corporate governance issues and thereby promoting best practice. The institute undertake, disseminate research on corporate governance and it advises on the formulation of corporate governance policy and development of best practices and undertake any other activity that will improve understanding, exercise of corporate governance. The institute articulates its work by expanding on the activities of the European corporate Governance Network, disseminating research results and other relevant material. It draws on the expertise of scholars from numerous countries and brings together a critical mass of expertise and interest to bear on this important subject. v) ACGA – Asian Corporate Governance Association: It was founded in the year 1999. It is an independent, non-profit membership organization dedicated to working with investors, companies and regulators in the implementation of effective corporate governance practices throughout Asia. The Association started with a belief that corporate governance is fundamental to the Long-term development of Asian economies and capital markets. The association was funded by a network of sponsors and corporate members, including leading pension and investment funds, other financial institutions, listed companies, multinational corporations, professional firms and educational institutions. Its governing council comprises directors from around Asia. It covers three areas such as Research, Advocacy and Education.  Research – tracking corporate developments across 11 markets in Asia and producing independent analysis of new laws and regulations, investor activism and corporate practices.  Advocacy – Engaging in a constructive dialogue with financial regulators, stock exchanges, institutional investors and companies on practical issues affecting the regulatory environment and the implementation of better corporate governance practices in Asia. 163 CU IDOL SELF LEARNING MATERIAL (SLM)

 Education – Organising conferences and seminars that foster a deeper understanding of the competitive benefits of sound corporate governance and ways to implement it effectively. vi)CSIA – Corporate Secretaries International Association: It is an international federation of professional bodies that promotes the best practices in corporate secretarial, corporate governance and compliance services. It is international federation of governance professional bodies for corporate secretaries and governance professional and represents those who work as frontline practitioners of governance throughout the world. The steps suggested by the association for the better corporate governance has listed hereunder:  Recognize that good corporate governance is about the effectiveness of the governing body, not about compliances with codes.  Confirm the leadership role of the board chairman.  Check the non-executive directors have the necessary skills, experience and courage.  Consider the capacity of the non-executive directors and provide scope for their independent actions.  Review the role and contribution of Non-executive directors, periodically.  Ensure that all directors have a sound understanding of the company.  Confirm that the board’s relationship with executive management is sound  Check that directors can access all the information they need.  Consider whether the board is responsible for formulating strategy.  Recognize that the governance of risk is a board responsibility.  Monitor board performance and pursue opportunities for improvement.  Review relations with shareholders, particularly with Institutional Investors.  Emphasize that the company does not belong to the directors.  Ensure that director’s remuneration packages are justifiable and justified.  Consider relations with the corporate regulators.  Review relations between external auditors and the company.  Develop written board-level policies covering relations between the company and the societies it affects.  Review the company’s culture towards ethical behaviour. 164 CU IDOL SELF LEARNING MATERIAL (SLM)

 Ensure that the company secretary is adding value to the company.  Consider the development of the corporate secretary’s roles. 12.5 GUIDE TO REGULATE GOVERNANCE As far as structural and regulatory changes are concerned, India has witnessed several enactments, which have contributed significantly in strengthening governance norms and in increasing accountability by way of transparent disclosures. But these changes have been inspired by the models and theories suggested in the foreign countries, which is probably one of the key reasons behind current practices of corporate governance were not achieving the desired level of results. It is important that regulatory measures are modelled based on the practices and business environment prevailing in India. The conducive policies which suit our country’s nature should be coupled with the board and the promoters’ embracing such reforms in true letter and spirit. Significant improvement in disclosure is required such as providing financial information on their websites in a manner that is easily accessible to investors; all listed companies should publish their cash flow statements on half yearly basis to make them more transparent and accountable towards stakeholders. It is also required to separate the roles of chairperson and managing director, for effective independence on their activities. Enhanced transparency is required in order to remove an Independent Director; this will increase their scope for independent functioning. It is also required to devise proper Whistle Blowing mechanism in all the companies and it is equally important to orient the same to the employees and company should have a robust policy to protect the interest of the whistle blower. It is also required to move towards sustainability not only in the activities of the company but also in its reporting. It considers the relevance of sustainability to an organization and also addresses sustainability priorities and key topics, focusing on the impact of sustainability trends, risks and opportunities on the long-term prospects and financial performance of the organization. Effective Internal control and check systems enables an entity to achieve the desired performance and proper compliance in true letter and spirit. 12.6 SUMMARY  The National Foundation for Corporate Governance shall endeavour to build capabilities in the area of research in corporate governance and to disseminate quality and timely information to concerned stakeholders. 165 CU IDOL SELF LEARNING MATERIAL (SLM)

 The OECD principles of corporate governance set out a framework for good practice which was agreed by the governments of all 30 countries that are members of the OECD. The OECD principles cover six areas.  The International Corporate Governance Network is a Not for profit company limited by guarantee under the laws of England and Wales. The Network’s Mission is to develop and encourage adherence to corporate governance standards and guidelines, and to promote good corporate governance worldwide.  The European Corporate Governance Institute was founded in 2002. It has been established to improve corporate governance through fostering independent scientific research and related activities.  The Asian Corporate Governance Association is an independent, non-profit membership organization dedicated to working with investors, companies and regulators in the implementation of effective corporate governance throughout Asia.  India has witnessed several enactments, which have contributed significantly in strengthening governance norms and in increasing accountability by way of transparent disclosures.  But these changes have been inspired by the models and theories suggested in the foreign countries, which is probably one of the key reasons behind current practices of corporate governance were not achieving the desired level of results. It is important that regulatory measures are modelled based on the practices and business environment prevailing in India. 12.7 KEYWORDS  ICGN – International Corporate Governance Network -The mission is to develop and encourage adherence to corporate governance standards and guidelines, and to promote good corporate governance worldwide. Membership of ICGN is open to those who are committed to the development of good corporate governance.  ECGI – European Corporate Governance Institute -It was founded in the year 2002. It has been established to improve governance through independent scientific research and related activities. It provides a forum for debate and discussion between academics, legislators and practitioners, focusing on major corporate governance issues and thereby promoting best practice. 166 CU IDOL SELF LEARNING MATERIAL (SLM)

 CSIA – Corporate Secretaries International Association - It is an international federation of professional bodies that promotes the best practices in corporate secretarial, corporate governance and compliance services. It is international federation of governance professional bodies for corporate secretaries and governance professional and represents those who work as frontline practitioners of governance throughout the world.  ACGA – Asian Corporate Governance Association - It was founded in the year 1999. It is an independent, non-profit membership organization dedicated to working with investors, companies and regulators in the implementation of effective corporate governance practices throughout Asia. The Association started with a belief that corporate governance is fundamental to the Long-term development of Asian economies and capital markets. 12.8 LEARNING ACTIVITY 1. Discuss the Importance of Data Protection. ___________________________________________________________________________ ___________________________________________________________________________ 2. Discuss the impact of Failure of Corporate Governance. ___________________________________________________________________________ ___________________________________________________________________________ 12.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What is NFCG? 2. How to regulate Governance. 3. What do you mean by Internal Governance? 4. Define Advocacy. 5. What is NCCG? Long Questions 167 1. Enumerate the recent Corporate Governance failures in India. CU IDOL SELF LEARNING MATERIAL (SLM)

2. Explain the roles of various corporate governance Forums. 3. Describe the challenges / issues involved in Corporate Governance. 4. Explain the importance of Privacy and Data Protection. 5. Explain the Principles suggested by CACG on Corporate Governance. 6. Discuss the Steps suggested by Corporate Secretaries International Association on Corporate Governance. 7. Describe the Focus Areas covered by ACGA. 8. Explain the Internal Governance Structure of National Foundation of Corporate Governance. 9. Discuss the Process and impact of Board Evaluation? 10. Describe the role and constitution of Appropriate Board for effective Corporate Governance. B. Multiple Choice Questions 1 ICGN Stands for: a. Indian Corporate Governance Network b. International Company Governance Network c. International Corporate Governance Network d. None of these 2 Which area has not covered under the guidelines issued by Asian Corporate Governance Association? a. Research b. Education c. Redressal d. Advocacy 3 European Corporate Governance Institute founded in the year: a. 1996 b. 1999 c. 2002 d. 2005 168 CU IDOL SELF LEARNING MATERIAL (SLM)

4 Which Crisis happened due to manipulated financials? a. Satyam Scandal b. DHFL Crisis c. Yes Bank Crisis d. None of these 5 Common wealth Association of Corporate Governance established in the year: a. 1991 b. 1996 c. 1998 d. 2002 Answers 1-c, 2-c, 3-a, 4-a, 5-c 12.10 REFERENCES References book  G. N. Bajpai, The essential Book of Corporate Governance, Sage Publications India Private Limited.  Dr. S. N. Gosh, Law of Corporate Governance, Thomson Reuters.  Bob Tricker, Corporate Governance-Principles, Policies, and Practice (Indian Edition), Oxford University Press, New Delhi. 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.icgn.org  http://www.ecgi.global  http://www.sebi.gov.in  http://www.nfcg.in 169 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT - 13:VENTURE CAPITALISTS STRUCTURE 13.0 Learning Objectives 13.1 Introduction 13.2 Business funding sources 13.3 Venture Capitalists 13.3.1. Features, Advantages and Limitations. 13.3.2. Process of funding 13.4 Buy-out Strategy 13.5 Summary 13.6 Keywords 13.7 Learning Activity 13.8 Unit End Questions 13.9 References 13.0LEARNING OBJECTIVES After studying this unit, you will be able to:  Explain the different funding sources for business start-ups.  State the Importance and role of Venture Capitalists.  Explore the Buy – out strategies and circumstances conducive for such activity. 13.1 INTRODUCTION New entrepreneur as well as the existing company which are looking to grow, at some point need to obtain funding in order to grow their business further. But the challenging part is managing the hold on core group of management and receiving the required funds. The variety of options available make the job tougher as each source of fund carries certain unique advantages and challenges. Hence, it is the role of the board / promoters to decide on 170 CU IDOL SELF LEARNING MATERIAL (SLM)

choosing appropriate source of fund which compliments and suits the company’s strategy and ideology. Hence, exploring the different sources of funding is essential. 13.2 BUSINESS FUNDING SOURCES Funding refers to the money required to start and run a business. It is a financial investment in a company for product development, manufacturing, expansion, sales and marketing, office spaces and inventory. Many start-ups choose not to raise funding from third parties and are funded by their founders only to avoid dilution of ownership. However, most startups do rise funding, especially as they grow larger and scale their operations. If you are an entrepreneur seeking to understand why funding is needed, types of funding available and how to raise funding, then it is required to explore various funding sources and choose the one which suits the requirement and also appropriate for the business culture / ethos. Debt Financing Source Equity Alterate Funding Funding Figure 13.1 Business Funding Sources 1) DEBT FINANCING: It is a way of raising capital through borrowing funds. It’s referred to as debt finance, as the borrower must pay back the funds at a later date. It can be a good option for businesses seeking funding to support growth it’s also usually tax-deductible which is beneficial for the company. The main disadvantage is lenders may charge higher interest based on the 171 CU IDOL SELF LEARNING MATERIAL (SLM)

prevailing market situation and position of the company. And it is also a fixed obligation for the company irrespective of earning profits. Hence, it is riskier way of raising capital; this is why early stage businesses don’t opt for debt financing. Many forms of debt financing are discussed hereunder. a) Secured Business Loans – These are secured against assets owned by a company, such as commercial property, vehicles or machinery. Using assets to secure loan means that the company director doesn’t have to put themselves on the line by personally guaranteeing the borrowed funds. With a secured loan, the lender has the right to sell the assets of the company to get their funds at the time of default by the company in rendering their obligation. These loans are a way of unlocking cash tied up in business assets, using them as security in return for cash. b) Unsecured Business Loans – This does not involve any security or collateral. Instead, lenders judge whether or not to lend based on the company’s ability to repay the loan. They do however often ask for a personal guarantee from a company director to repay the loan if the company defaults. Typically, applying for an unsecured business loan involves a deep check in to the company’s credit history, Earnings potential, Deployment of funds, etc. But the interest rates tend to be significantly higher on unsecured loans, due to the higher risk for the lender. c) Commercial Mortgages –Companies looking to invest in land or property or business purposes, often turn to a commercial mortgage as a source of debt finance. This product is basically a mortgage but instead of an individual the company borrows money secured against the property purchased or owned. It is a long-term loan ranges between 10 to 25 years. Lenders typically lends between 60% to 75% of the value of the property. d) Asset Financing or Leasing –It is a way of quickly accessing a loan that is secured against a high value asset or assets. The borrowing company uses its balance sheet assets, such as short-term investments, accounts receivables, machinery or even buildings as collateral to borrow money. Typical form of asset finance includes equipment leasing, finance leases, operating leases, Asset refinance and Invoice finance. Company mostly use this form of finance to acquire high value equipment. Typically, this process works via the asset finance provider buying a capital asset that the company needs, with the company agreeing to paying for it in instalments with interest. Asset finance is a preferable form of financing for many businesses and lenders, as it is based 172 CU IDOL SELF LEARNING MATERIAL (SLM)

on the assets themselves which provide security for both parties. It’s often more flexible and cost-effective than getting a commercial bank loan to purchase equipment and tends to be a quick way for companies to access the capital they need. e) Overdraft Financing – It is a way for companies to obtain short-term funding. In essence a company agrees on an overdraft limit with the bank known as the ‘facility’, and the bank charges interest on the amount of the overdraft the company are using. Some banks also charge on overdraft facility fee. Most businesses use overdrafts to offset cash flow issues, where the business is healthy but because of outgoings / income coming at different points throughout the month, an overdraft facility is needed to render short- term obligations. It is an easy, quick and flexible way for businesses to borrow money in the short term. Most business banks also charge an overdraft fee to keep the facility in place, even if it is not utilized by the company. f) Trade Credit – It can facilitate business to business transactions to go ahead even if the purchasing company doesn’t have enough working capital available for the trade, these types of facilities are often protected by trade credit insurance. With a trade credit agreement, business customers can buy goods or services from their supplier and pay for them later. It is particularly useful for small businesses or companies who struggle to reconcile the timings of their cash in and cash out and need to purchase stock to grow. It is risky and many suppliers will not offer continuously. The flexibility of trade credit can also go a long way to establishing positive, loyal relationships with clients. g) Invoice Financing – It involves companies selling their individual unpaid invoices or entire accounts receivables, to a Third party for a percentage of their value, usually around 80% to 95%. This method means that, for a fee, business can unlock cash tied up in unpaid invoices, accessing the funds before the customers pay. Invoice Factoring and Invoice Discounting are the two main types of finance. Invoice factor is the finance company that deals with collecting the debt from the customers. Invoice discounting, the control will be retained by the company and it helps to chase late payments. For companies that only need help to bridge their cash flow gaps due to one or two customers, it is preferential to opt for selective invoice discounting, rather than commit to a contract for their entire sales ledger. Getting a large portion of invoices paid straight away boosts the working capital, allowing the company to purchase raw materials, accept more jobs and grow your business without waiting for the liquidity. h) Merchant Cash Advances – It is one of the most innovative form of business finance, merchant cash advance is one of the newer funding options available. It works by using 173 CU IDOL SELF LEARNING MATERIAL (SLM)

business’ card terminal transactions to secure lending; the amount borrowed is then automatically paid back at an agreed rate plus interest on each future transaction. It is ideal for companies that process a substantial amount of card transactions every month. It’s become a quick and efficient funding solution for many small and mid-sized enterprises, particularly in the retail and leisure industries. One of the advantages is that it’s both flexible and Scalable. The lender communicates directly with the card terminal provider, meaning that the amount they take for repayments never appears in business bank account. They payment is taken automatically, so the business owner need not worry about making the repayments. But many lenders only work with specific terminal providers, which can limit the options available for the company. 2) EQUITY FUNDING: Equity funding is where businesses raise funds by selling shares to investors in exchange for the capital. The principal difference between debt finance and equity funding is that entrepreneurs using equity funding are not required to pay the funds back. Repayment will be done only at the time of winding up of an enterprise. The integral forms of equity funding have been listed hereunder. a) Venture Capital – These investors are professional investors who manage and invest funds for wealthy individuals’ investment banks or other financial institutions. Venture capital investment is classed as high-risk private equity investment and Venture capital funds make up about 10% of all equity funds. Venture capitalists are looking to invest in high growth potential companies who are typically technology based. The Venture Capital model aims for every 1 in 10 investments to succeed and make such a return that it dwarfs the loss from the other failed investments. It will be a fantastic way to grow a company fast as the venture capitalist not only provides fund, but also their expertise that can help company to accelerate its performance. But such Venture capitalists seek additional control in the management and hold such positions like board seats which are integral for decision making. b) Angel Investors – Business angels are wealthy individuals who use their own funds to invest in the companies they see growth potential. It is often the first source of investment funding a start-up will secure before moving onto a venture capital round. Aside from the investment capital provided, business angels can 174 CU IDOL SELF LEARNING MATERIAL (SLM)

also bring invaluable industry knowledge, expertise and contacts, which can help company to grow their business in its early stage. c) Crowd funding – It is the process of sourcing small investments from a large number of investors via a platform that facilitates the investment. Crowd funding has grown in popularity in recent years making it’s easier for high-risky early- stage businesses to gather together the funds they need to get off the ground. It also offers more visibility to businesses looking for investment, enabling them to connect with investors all around the world. This visibility also works as valuable marketing and allows the company to measure the public’s reaction to the product or business idea. d) Angel Syndicate – Another way to secure angel investment is through an angel syndicate. Business angels invest together as part of a syndicate (Group), which reduces each investor’s risk. Sharing the load also means that investors can maximize their investing capacity, to pool funds with others to invest in even higher-potential early-stage businesses. Angel syndicates can, therefore, help early-stage enterprises to secure a substantial investment. e) Corporate Venture Capital – It is where large corporations invest funds directly into start-ups in exchange for an equity stake. The larger firm provides management, industry expertise and marketing power to help the smaller business gain a competitive advantage. Corporate ventures aim to set up collaborations which drive growth for both parties and have the potential to lead to an acquisition down the line; they tend to focus on businesses and technological development that aligns with their business. Strategic investments aim to explore any growth potential in the parent company by entering into a new market. 3) ALTERNATIVE FUNDING: Apart from above discussed traditional methods of funding, certain techniques or methods which are more innovative, are cropping up for small and large businesses alike. a) Grants – It means free money to get the business off the ground, with no obligation to pay it back. Fortunately, there are an enormous amount of grant schemes open to entrepreneurs and companies. The government offers a huge number of grant schemes for different sectors, of varying amounts. While grant schemes are in abundance, there is also, unsurprisingly, a tremendous amount of competition. The authorities will tend to look for companies that intend to have a 175 CU IDOL SELF LEARNING MATERIAL (SLM)

positive impact on society, either by helping people in a community or by boosting the general economy. Most grants are reserved for companies that intend to have a specific impact on society. b) Tax holidays / Duty Drawbacks – These schemes act as incentives to investors to invest in early stage of business by offering them attractive tax benefits or duty drawbacks if the company and investor comply with certain regulations. c) Debenture bonds – Issued by a company to investors when the company borrows money from them. The debenture serves as a loan, which is repayable at a later date by the borrowing company. The company must pay interest to the creditor during the period of the loan at a fixed rate, which makes it a more stable way of investing in a company than by investing in shares. It tends to provide long-term funds. 13.3 VENTURE CAPITALISTS Venture capital typically comes from institutional investors and high net worth individuals and is pooled together by dedicated investment firms. It is a private or equity investment made into early-stage / start-up companies. As defined, ventures involve risk in the expectation of a sizeable gain. Venture capital is the money invested in businesses that are small, or exist only as an initiative, but have huge potential to grow. The people who invested money are called Venture Capitalists. The investment is made when a venture capitalist subscribe shares of such company and becomes a financial partner in the business. Venture capital is the most suitable option for funding a costly capital source for companies and most for businesses having large up-front capital requirements which have no other cheap alternatives. Intellectual properties are generally the most common case whose value is not determined / unproven. In that case, venture capital funding is most widespread in the fast-growing technology and biotechnology fields. 13.3.1 Features, Advantages, Limitations Features of Venture Capital Investments:  The investment carries Long-term horizon  Risk level is very high, as the investment made only based on the innovative business idea or model. 176 CU IDOL SELF LEARNING MATERIAL (SLM)

 The Venture Capitalists will take part / participate in the management of the company, as they need to exercise the control and direct the activities through their expertise.  As the investment made towards equity, it will have an impact on company’s capital gains.  As the investments made in the form of equity, hence it will not fuel liquidity for the company. Advantages of Venture Capital:  Large sum of equity financing can be provided.  They bring capital and expertise to the company which may enhance the performance quality.  Business doesn’t have short term obligation to repay the money, rather it focuses on maximizing value of the company.  It provides valuable information, resources, technical assistance to make a business successful. Limitation of Venture capital:  As the investors become part owners, the autonomy and control of the promoter is lost.  Venture capitalists are not easily convinced towards an innovative idea or business model.  The process of getting venture capital is lengthy and complex.  The benefit of such financing will yield results only in the long run.  The investors aim is only to maximize the value of the company as the whole, as it stresses the management to strive for profits rather than qualitative products / services. 177 CU IDOL SELF LEARNING MATERIAL (SLM)

 The immediate exit of such investors will affect the company adversely, as this will be the prime source of finance for its existence, unless the company has the positive market outlook.  The venture capitalist’s intervention in decision making will influence much towards forced decisions. 13.3.2 Process of Funding Funding Business Plan Term Sheets Introductory Meeting Due Diligence Figure 13.2 Process of Funding i) Business Plan: The initial step in approaching a venture capital is to submit a business plan after generating a unique or innovative idea or business model. The plan should contain an executive summary of the business proposal. The detailed description of the opportunity and the market potential and possible size of growth. It also essential to compare and review on the existing and expected competitive scenario. The business plan shall also contain the financial projections and the details of the 178 CU IDOL SELF LEARNING MATERIAL (SLM)

management.Venture capitalist after conducting detailed analysis on the submitted proposal, will decide whether to take up the project or not. ii) Introductory Meeting: If Venture capitalists impressed in the proposal and find the project as per their preference, then there will be one-to-one meeting that is called for discussing the project in detail. After the meeting, venture capitalists finally decide whether to proceed with the next step or not. Venture capitalist will assess the potential of the management during this meeting. iii) Due Diligence: This process involves solving of queries related to customer references, product and business strategy evaluations, management interviews, and other such exchanges of information during the specified time frame. During this phase, venture capitalist will investigate the material aspects and potential threats linked with the company or product / service or management. The concerned company must share all the material facts and other sensitive information to the venture capitalists to make informed decisions. iv) Term Sheets: If the Due Diligence phase is satisfactory, the venture capitalists offers a Term sheet, which is a non-binding document explaining the basic terms and conditions of the investment agreement. The term sheet is generally negotiable and must be agreed upon by all parties, after which on completion of legal documents and legal due diligence, funds are made available to the company. v) Funding: Venture capitalists release funds on different stages such as Seed money (to prove and extract benefit from a new idea), Start-up funding (New firms needing funds for expenses related with marketing and product development). The venture capitalists will also infuse funds in to the company on various rounds such as early sales and operational capital funding, expansion funding and Bridge funding. Each of these phases will be discussed elaborately. Phases of Venture Capital Financing: 179 CU IDOL SELF LEARNING MATERIAL (SLM)

Acquisition or Buyout financing Expansion Financing Seed Financing Figure 13.3 Phases of Venture Capital Financing A) Seed financing / Seed Financing – It is defined as a small amount that an entrepreneur receives for the purpose of being eligible for a start-up loan. It is given to companies for the purpose of finishing the development of products or services. Companies that have spent all their starting capital and need finance for beginning business activities at the full-scale are the major beneficiaries of the first stage financing. B) Expansion financing - It may be categorized into second-stage financing, as it is provided to the companies for expanding their business operations. It will assist a company to expand in an effective way. Bridge financing may be provided as a short- term interest only finance option as well as a form of monetary assistance to companies that employ the Initial Public Offers as a major business strategy. C) Acquisition or Buy-Out Financing – It is categorized into acquisition finance and management or leveraged buyout financing. Acquisition financing assists a company to acquire certain parts or an entire company. Management or leveraged buy-out financing helps a particular management group to obtain a particular product of another company. 13.4 BUY-OUT STRATEGY It is the acquisition of a controlling interest in a company and is used with the term of acquisition. Buy outs often occur when a company is going private. It occurs when a buyer acquires more than 50% of the company, leading to a change of control. Firms that specialize in funding and facilitating buy-outs, act alone or together on deals, and are usually financed by institutional investors, wealthy individuals or loans. 180 CU IDOL SELF LEARNING MATERIAL (SLM)

Types of Buy-outs:  Management Buy-outs  Leveraged Buy-outs. Management Buy-outs provide an exit strategy for large corporations that want to sell off divisions that are not part of their core business or for private businesses whose owners wish to retire. The financing required for a Management Buy-out is often quite substantial and it usually a combination of debt and equity that is derived from the buyers, financiers, and sometimes the seller. Leveraged Buy-outs use significant amounts of borrowed money, with the assets of the company being acquired often used as collateral for the loans. The company performing Leverage Buy-outs may provide only lesser percentage of the capital, with the rest financed through debt. This is a high-risk, high-reward strategy, where the acquisition has to realize high returns and cash flows in order to pay the interest on the debt. The target company’s assets are typically provided as collateral for the debt, and buy-out firms sometimes sell parts of the target company to pay down the debt. Buy-outs creates discretionary power for the new management team to decide what is best for the business, how to organize and lead the company, and how to set up a business plan that is most profitable for themselves and the company. In this circumstance, the transaction may involve a financial structure with more moderate leverage that provides for greater discretion on the part of management whilst at the same time maintaining board representation by the private equity firm and covenants attached to the provision of external funds that require management to meet performance targets. The first impact of buy-out is particularly concentrated in profitable but mature, low-growth industries. Enterprises, where the growth opportunities in the core business are strictly limited, may find it particularly difficult to motivate managers with conventional reward system. The next concern is about the reduction in the response time for adaptation to market conditions, this enables the firm to utilize the synergies to the maximum possible extent. 13.5 SUMMARY  Funding refers to the money required to start and run a business. It is a financial investment in a company for product development, manufacturing, expansion, sales and marketing, office spaces and inventory. 181 CU IDOL SELF LEARNING MATERIAL (SLM)

 Many start-ups choose not to rise funding from third parties and are funded by their founders only to avoid dilution of ownership.  Debt Financing - It is a way of raising capital through borrowing funds. It’s referred to as debt finance, as the borrower must pay back the funds at a later date. Types of Debt financing – Business Loan, Commercial Mortgage, Lease.  Equity funding - It is where businesses raise funds by selling shares to investors in exchange for the capital. The principal difference between debt finance and equity funding is that entrepreneurs using equity funding are not required to pay the funds back. Types – Venture Capitalist, Angel Investors, Crowd funding, Corporate Venture Capitalist.  Alternative Funding - certain techniques or methods which are more innovative, which are cropping up for small and large businesses. Types: Grants, Duty Drawbacks.  Funding will be done based on the phases, such as One-to-One meeting,  Buy-out is the acquisition of a controlling interest in a company and is used with the term of acquisition. Buy outs often occur when a company is going private. 13.6 KEYWORDS  Duty Drawback – It is the refund of Customs duties, taxes and fees paid on imported items that are matched with subsequently exported or destroyed items.  Angel Syndicate–It is simply a group of investors who agree to invest together in a particular project. A syndicate can be put together by angels or investees and be drawn from any source; often syndicate includes angels from more than one investment network.  Lease – It is an implied or written agreement specifying the conditions under which a lessor accepts to let out a property to be used by a lessee. The agreement promises the lessee use of the property for an agreed length of time while the owner is assured consistent payment over the agreed period. 13.7 LEARNING ACTIVITY 1. Discuss the kinds of leases. 182 CU IDOL SELF LEARNING MATERIAL (SLM)

___________________________________________________________________________ ___________________________________________________________________________ 2. Describe Seed Funding process. ___________________________________________________________________________ ___________________________________________________________________________ 13.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define Venture Capitalist. 2. What do you mean by Seed Financing? 3. Define Buy-Out Strategy. 4. What do you mean by Term Sheet? 5. Define Overdraft Financing. Long Questions 1. Discuss the Process of Funding. 2. Explain the Types of Buy-Out Strategy. 3. Describe the phases of Venture Capital Financing. 4. Explain the Advantages and Limitations of Venture Capital. 5. Explain Various Business Funding Sources. 6. Describe the features of Expansion Financing. 7. Explain the characteristics of Venture Capital Investment. B. Multiple Choice Questions 1 The process of sourcing small investments from a large number of investors via a platform that facilitates the investment known as: a. Venture Capital Investment b. Angel Investors c. Crowd Funding d. Debt Financing 183 CU IDOL SELF LEARNING MATERIAL (SLM)

2 The businesses raise funds by selling shares to investors in exchange for the capital is called as: a. Equity Funding b. Debt Financing c. Alternative Funding d. None of these 3 companies selling their individual unpaid invoices or entire accounts receivables, to a Third party for a percentage, is known as: a. Secured Loan b. Letter of Credit c. Invoice Financing d. Letter of Guarantee 4 The Second stage of financing in Venture Capital funding is known as: a. Seed Funding b. Expansion Financing c. Leveraged Buy-Out d. None of these 5 The technique which provide an exit strategy for large corporations that want to sell off divisions that are not part of their core business a. Leveraged Buy-Out b. Management Buy-Out c. Equity Financing d. Debt Financing Answers 184 1-c, 2-a, 3-c, 4-b, 5-b 13.9 REFERENCES References book CU IDOL SELF LEARNING MATERIAL (SLM)

 Geeta D., and R.K. Mishra, Corporate Governance-Theory and Practice, Excel Books, New Delhi.  G. N. Bajpai, The essential Book of Corporate Governance, Sage Publications India Private Limited.  Dr. S. N. Gosh, Law of Corporate Governance, Thomson Reuters. 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.gv.com  http://www.indianangelnetwork.com 185 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT - 14:INSOLVENCY REGIMES STRUCTURE 14.0 Learning Objectives 14.1 Introduction 14.2 Significance of Insolvency Regime 14.3 Action to improve Insolvency framework 14.4 Impact of Insolvency Systems on Corporate Governance 14.5 Privatization and Corporate Governance 14.6 Summary 14.7 Keywords 14.8 Learning Activity 14.9 Unit End Questions 14.10 References 14.0LEARNING OBJECTIVES After studying this unit, you will be able to:  Explain the nexus between corporate governance and Insolvency.  Learn the requirement for common Insolvency framework.  Analyse the importance of corporate governance and Impacts of its failures. 14.1 INTRODUCTION The position of insolvency of a company is very important to deal with the transactions in the fair and efficient manner. Prior to Insolvency and bankruptcy code, the insolvency proceedings are lengthy and complex, which had an adverse impact on the transparent disclosures and misappropriate compliance. Hence, the nexus between insolvency regulations and corporate governance is interdependent. The poor corporate governance makes the company experience financial distress, default in disclosures and other mismanagement, eventually leads to stakeholders’ dissatisfaction. After globalization, the need for the common insolvency regime gained importance. 186 CU IDOL SELF LEARNING MATERIAL (SLM)

14.2 SIGNIFICANCE OF INSOLVENCY REGIME Keeping viable businesses operating is among the most important goals of insolvency systems. A sound insolvency regime should prevent the premature liquidation of sustainable businesses. It should also discourage lenders from issuing high-risk loans, and managers / shareholders from taking imprudent loans and making other reckless financial decisions. To promote Economic Stability and Growth - Insolvency laws and institutions are critical to achieve the benefits and avoid the pitfalls of integration of national financial systems with the international financial system. This regime, shall promote restructuring of viable business and efficient closure and transfer of assets of failed business, facilitate the provision of finance for start-up and re organization of businesses and enable assessment of credit risk. Maximization of Value of Assets – participants in such insolvency proceedings should have strong incentives to achieve maximum value for assets, as this will facilitate higher distributions to creditors as a whole and reduce the burden of insolvency. It can be achieved through striking balance of the risks associated with the parties involving in insolvency process. Timely, efficient and impartial resolution – Quick and orderly resolution can be facilitated by the law that provides easy access to insolvency proceedings by reference to clear and objective criteria, provides a convenient means of identifying, collecting, preserving and recovering assets and rights that should be applied towards payment of debts and liabilities. Cross-border Insolvency – To promote co-ordination between jurisdictions and facilitate the provision of assistance in administering insolvency proceedings originating in the foreign country.  It can be achieved by providing certainty in the market to promote economic stability and growth,  To Maximize value of assets, striking balance between liquidation and re- organization,  To ensure equitable treatment of similarly situated creditors and  Ensure a transparent and predictable insolvency law that contains incentives for gathering and dispensing information.  It should include provisions addressing both re-organization and liquidation of a debtor. 187 CU IDOL SELF LEARNING MATERIAL (SLM)

 It is required to recognize foreign proceedings in order to facilitate cross-border insolvency. Clear rules for ranking priority claims– Those priorities should be based on commercial bargains and not reflect social and political concerns that have the potential to distort the outcome of insolvency. It also provides predictability and clarity to lenders which enhance confidence in the proceedings. Even when bankruptcy laws are similar across economies, the use of procedures can vary because of differences in the efficiency of debt enforcement. If courts cannot be used effectively in case of default, creditors and debtors are likely to engage in informal negotiations outside of court. In such circumstance, borrowers are more likely to exhibit risky financial behavior, which could lead to more defaults and higher levels of financial distress. 14.3 ACTION TO IMPROVE INSOLVENCY FRAMEWORK In order to address the rapidly changing environment driven by globalization in the financial markets, insolvency systems need to address certain issues in a consistent and coherent way: a) Value Preservation: As the debtor approaches insolvency, value is destroyed more rapidly, due to reputational effects and the triggering of contractual covenants. Debtors should be allowed protection earl in the process of value destruction. Insolvency is first and foremost a collective action process. One of its main aims is to stop individual creditors impairing certain vital assets, which would cause the adverse impact on the company even when the present value of the going concern is higher than the value of its constituent parts. Hence, a Stay (Moratorium) of execution for all individual claims during the insolvency period is key. Insolvency and Bankruptcy Code also suggests this model and defining robust timeline for such proceedings. b) Market Conformity: But a moratorium on execution should not mean a deviation from market arrangements. Market conformity means respecting absolute priority. Every functioning system prevailing in the other developed economies provides absolute priority of claims in post-bankruptcy entitlements has to be approved by creditors or become an object of a cram-down, a credible tribunal driven process which only allows such deviations when they are fair and equitable. 188 CU IDOL SELF LEARNING MATERIAL (SLM)

c) Market implementation: Tribunals and other insolvency institutions are the heart of effective implementation. It is required to deal with the collective proceedings and design of the regulatory system has to correspond to infrastructure capacity in a given circumstance. In India, that’s why they constituted Insolvency and Bankruptcy Board of India (IBBI) under Insolvency and Bankruptcy Code. d) Eliminate Insider Trading: The integral threat to the effectiveness of governance in insolvent enterprises is insider dealing. The legal system needs to be alert to the wide information asymmetries between insiders and outsiders. Any bids by insiders need to be carefully weighed against the possibility of ex-proportion of going concern value that belongs to the creditors. In the absence of alert and specific redressal mechanism, it is not possible to control the adverse impact on corporate governance. SEBI’s guidelines were framed to overcome this threat by imposing disclosure requirements on company to improve transparency with its stakeholders. 14.4 IMPACT OF INSOLVENCY ON CORPORATE GOVERNANCE The Insolvency and Bankruptcy Code 2016, was implemented with a view to consolidate “the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals. Further, it involved the establishment of the Bankruptcy Board of India which would oversee all matters relating to Insolvency and bankruptcy of corporate entities. The main objective of law was to enhance and fasten the process of insolvency by bringing several different kinds of entities under the purview of the same law and establishing a framework which allows for economically viable solutions to the problem. The process of insolvency is time-bound. Defaulting on repayment of loans by entities it is applicable to, results in mandatory involvement of NCLT (National Company Law Tribunal). The creditors and NCLT must resolve the issue within a stipulated time period. The entire process is handled by Insolvency Professionals appointed by the board. IBC aims to protect the interests of small investors and develop viable solutions to cases of insolvency. The code, by imposing stringent penalties on firms for defaulting on loans, is aiming to ensure that loan amounts are used in an effective manner by debtors such that they can be repaid. Further, it is also aiming to enhance the functioning of banks by reducing the burden of stressed assets which may reduce their lending capacity. 189 CU IDOL SELF LEARNING MATERIAL (SLM)

Improper Governance Poor performance Insolvency proceedings Practices Figure 14.1 impact of insolvency on corporate governance Without proper Governance, companies may reach the position of insolvency, as governance is the shield for company to protect itself from insolvency proceedings. In order to eliminate and control governance flaws, global forum – UN agencies and institutions like the International Organization of Securities Commissions, have come out with governance standards, which most of the member countries have agreed to adopt. In India, series of expert committees examined the issue and recommended corporate governance measures which have been adopted by Securities and Exchange Board of India. The Minimum Public Shareholding, reasonable public float for fair price, is the factors on which regulators stressed their focus. Even SEBI moves one step further and said Principles of Governance will prevail over regulations in case of any ambiguity. The principles have expanded from shareholder protection to safeguarding the interest of all the stakeholders of the company, such as employees, environment and the society at large. The idea of shareholder democracy and activism has been strengthened through the requirement of uniform, timely and adequate disclosures as well as through measures to facilitate effective participation of the shareholders in the affairs of the company. The board has a responsibility to monitor conflicts of interest and be alert on misuse of related party transactions. They have to monitor the management effectively, set the culture of the organization with high ethical standard and consider the interests of all stakeholders. Non-compliance of the governance principles is often the cause of destruction of value not only for shareholders but also for all stakeholders. A good governance principle is the first 190 CU IDOL SELF LEARNING MATERIAL (SLM)

and fundamental line of defense for all stakeholders. If the board and its committees are alert and follow the governance norms in letter and in spirit, the impact of financial distress in the company or its stakeholders could be reduced or averted. The code supplements these governance requirements by seeking to refocus the responsibilities of the company and the board towards protecting the interest of the creditors. But often the conflict is not between the interest of the creditors and other stakeholders, such as shareholders, employees, customers and the community bit between the stakeholders on one side and the board & management vested with the responsibilities to steer the company away from a crisis situation, on the other. Hence, a harmonious working of governance provisions and the insolvency resolution process can be mutually reinforcing and also be beneficial to the economy at large. Objectives of Insolvency and Bankruptcy Code:  To maximize the wealth of the investors and enhance the value of the assets of the company.  To ensure Time-bound settlement, as the delay in winding up process leads to the diminishing value of assets.  In order to bridge the interest of all the stakeholders of an organization.  To provide a revival mechanism for the entities which are under distress? Petition Under Insolvency And Bankruptcy Code Can Be Filed:  When there is a default from company with the minimum amount of Rs.1, 00,000; petition can be filed under IBC.  Petition will be filed with NCLT where the Registered Office of Corporate Debtor is situated. Corporate Insolvency Resolution Process: It refers to insolvency proceedings of corporates whereby any corporate debtor who commits a default would thereby allow a financial creditor, an operational creditor, or the corporate debtor itself to initiate corporate insolvency resolution process in respect of such corporate debtor. a) A financial creditor either by itself or jointly with other financial creditors, or any other person on behalf of the financial creditor, may file an application for initiating 191 CU IDOL SELF LEARNING MATERIAL (SLM)

corporate insolvency resolution process against a corporate debtor before the Adjudicating Authority when a default is occurred. b) Application for initiating CIRP shall include: Record of the default with the information utility or such other evidence of default; name of the resolution professional proposed to act as an interim resolution professional; any other information as may be specified by the board. c) The Adjudicating authority shall within 14 days either accept or reject the application filed by the Financial Creditors. d) On acceptance of Application, the insolvency proceeding will commence from the date of such acceptance and the order shall be sent within 7 days to both Financial Creditors and corporate debtors along with the appointment of a proposed resolution professional. e) On rejection of application, a notice to the applicant to rectify the defect in his application within 7 days of receipt of such notice shall be provided. Waterfall Machanismunder Insolvency and Bankruptcy Code: It denotes the priority in Repayment of Debt. It provides clarity on the priority when company realized its assets at the stage of Winding up. CIRP Cost Secured Creditors Wages to Employees Unsecured Creditors Remaining Debts SH 192 CU IDOL SELF LEARNING MATERIAL (SLM)

Figure 14.2 Waterfall Mechanism sunder Insolvency and Bankruptcy Code The amount received by the company after realizing their assets, shall be utilized to incur the cost in connection with the Insolvency Process. The balance amount should be paid towards secured Creditors and wages to employees. The balance if any shall be available for unsecured Creditors and remaining debts. After the entire obligation has rendered, the balance amount (if any) shall be available for Equity shareholders. This step by step priority in repayment in the resolution process is known as water-fall mechanism. 14.5 PRIVATIZATION AND CORPORATE GOVERNANCE Since the inception of Liberalization, Privatization and Globalization, the private participants increased multifold and as they aim for profit may lose their hold on effective governance. The effective governance practices should be imbibed by such corporates in order to create sustainable and fair business environment. But creating such nexus between profit motive and the societal well-being is absolutely challenging. On the absence of such governance hold, private participants may indulge in unfair practices to get undue benefits. In order to manage that, government often notifies standards, regulations and guidelines for effective implementation of governance policy. Government has constantly relying on the principle of “Less Government and more Governance”. The reason being, current business environment is not conducive for more Government intervention. At the same time, it is the role of the government to ensure social balance i.e., Sustainability. Hence, the only savior will be the effective implementation of globally accepted Corporate Governance Principles. The better governance eliminates the burden on the government to impose more regulations on the companies and other forms of business. It discourages corporate to start more business and it affects the entire business eco-system. It is the responsibility of the government to provide appropriate conducive business environment and also sustainable environment. Considering these challenges, it is better to comply with corporate governance standards prescribed by the government in true letter and spirit. So that privatization doesn’t affect the sustainability and also makes our country as the lead player in the global market. 193 CU IDOL SELF LEARNING MATERIAL (SLM)

14.6 SUMMARY  Keeping viable businesses operating is among the most important goals of insolvency systems.  A sound insolvency regime should inhibit the premature liquidation of sustainable businesses.  It should also discourage lenders from issuing high-risk loans, and managers and shareholders from taking imprudent loans and making other reckless financial decisions.  The board has a responsibility to monitor conflicts of interest and be alert on misuse of related party transactions.  They have to monitor the management effectively, set the culture of the organization with high ethical standard and consider the interests of all stakeholders.  Non-compliance of the governance principles is often the cause of destruction of value not only for shareholders but also for all stakeholders.  Insolvency and Bankruptcy Code 2016 – An act to consolidate and amend the laws relating to re-organization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India. 14.7 KEYWORDS  Insider Trading –It refers to trading of shares by an insider based on unpublished Price Sensitive Information. It involves buying or selling shares of a listed company using information that can materially impact the stock price, but has not been made public yet. Insider trading hurts the integrity of capital markets. In market, symmetric information levels the playing field as it allows investors to pit their interpretation and analysis of events against each other. 194 CU IDOL SELF LEARNING MATERIAL (SLM)

 IBBI – Insolvency and Bankruptcy Board of India –It is a key pillar of the eco- system responsible for implementation of the code that consolidates and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of the value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all stakeholders.  Moratorium –It is a temporary suspension of activity until future events warrant lifting of the suspension or related issues have been resolved. Moratoriums are often enacted in response to temporary financial hardships.  NCLT – National Company Law Tribunal –It is a Quasi-judicial body in India that adjudicates issues relating to Indian companies. All the proceedings under Companies Act, including proceedings relating to Arbitration, Compromise, Arrangements, Reconstructions and the Winding-up of companies shall be disposed of by the NCLT. It is chaired by a judicial member who is supposed to be a retired or a serving High Court judge and a technical member who must be from the Indian Corporate Law Service.  CIRP – Corporate Insolvency Resolution Process– It refers to insolvency proceedings of corporates whereby any corporate debtor who commits a default would thereby allow a financial creditor, an operational creditor, or the corporate debtor itself to initiate corporate insolvency resolution process in respect of such corporate debtor.  Financial Creditor – It means any person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred. Simply, it refers to those persons from whom money was borrowed by the corporate debtor as a loan or against interest under any credit facilities.  Operational Creditor – It means any person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred.  Water-Fall Mechanism – It denotes priority to secured creditors over unsecured creditors. The mechanism says that if a company is being liquidated, these secured financial creditors must be paid first, before any sale proceedings are distributed to any other unsecured Creditor. 195 CU IDOL SELF LEARNING MATERIAL (SLM)

14.8 LEARNING ACTIVITY 1. Define Insider Trading. ___________________________________________________________________________ ___________________________________________________________________________ 2. Discuss the Importance of Privatization in Corporate Governance. ___________________________________________________________________________ ___________________________________________________________________________ 14.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define Financial Creditor. 2. What do you mean by Moratorium? 3. Define Cross-Border Insolvency. 4. Who can file petition under Insolvency and Bankruptcy Code? 5. Define operational Creditor. 6. What is CIRP? Long Questions 1. Explain the Water Fall Mechanism under Insolvency and Bankruptcy Code. 2. Describe the Corporate Insolvency Resolution Process. 3. Explain the effects of Insider Trading. 4. Discuss the Role of Insolvency and Bankruptcy Board of India. 5. Explain the Objectives of Insolvency and Bankruptcy Code. B. Multiple Choice Questions 1 The person to whom a financial debt is owed and includes a person to whom such debt has been legally assigned or transferred is known as: a. Operational Creditor b. Financial Creditor c. Corporate Debtor d. Insolvency Professional 196 CU IDOL SELF LEARNING MATERIAL (SLM)

2 Insolvency and Bankruptcy Code enacted in the year: a. 2013 b. 2015 c. 2016 d. 2019 3 A Quasi-judicial body in India that adjudicates issues relating to Indian companies: a. High Court b. Company Law Board c. National Company Law Tribunal d. Arbitral Tribunal 4 Petition can be filed under IBC, when there is a default from company with the minimum amount of: a. Rs. 50000 b. Rs. 100000 c. Rs. 300000 d. Rs. 500000 5 Insolvency resolution shall commence within _______, from the date of application. a. 5 days b. 7 days c. 10 days d. 14 days 6 Unfair transaction on shares based on unpublished price sensitive information is known as: a. Illegal transaction b. Insider Trading c. Related Party Transaction d. None of these 197 CU IDOL SELF LEARNING MATERIAL (SLM)

7 The Adjudicating authority shall within _______ either accept or reject the application filed by the Financial Creditors. a. 5 days b. 7 days c. 10 days d. 14 days 8 A party received an order from NCLT, may prefer an appeal to: a. High Court b. NCLAT c. Supreme Court d. Company Law Board 9 The Process of reducing stakes by the government from its undertaking is called as: a. Disinvestment b. Privatization c. Private Placement d. None of these 10 Effective participation of shareholders in the managerial decision making is known as: a. Shareholder Activism b. Stakeholder Control c. Shareholders Freedom d. None of these Answers 1-b, 2-c, 3-c, 4-b, 5-b, 6-b, 7-d, 8-b, 9-a, 10-a. 198 CU IDOL SELF LEARNING MATERIAL (SLM)

14.10 REFERENCES References book  Geeta D., and R.K. Mishra, Corporate Governance-Theory and Practice, Excel Books, New Delhi.  G. N. Bajpai, The essential Book of Corporate Governance, Sage Publications India Private Limited.  Dr. S. N. Gosh, Law of Corporate Governance, Thomson Reuters. 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.cii.org/gov_policies  http://www.ibbi.gov.in  http://www.sebi.gov.in 199 CU IDOL SELF LEARNING MATERIAL (SLM)