performance including summary of the significant events in last 6 months should be sent to each shareholders in order to increase transparency. 4.3.3. Task Force on Corporate Excellence - 2000 After the intervention of Sustainability, the challenge at that point of time is to bridge the gap between ensuring sustainability and making company competitively viable. In May 2000, the Department of Corporate Affairs formed a broad-based study group under the chairmanship of Dr. P. L. Sanjeev Reddy, Secretary – Department of Corporate Affairs. The objective of this committee is to “operationalize the concept of corporate excellence on a sustained basis”, so as to sharpen India’s global competitive edge and to further develop corporate culture in the country. In November 2000, the task force produced a report containing a range of recommendations for raising governance standards among all companies in India. The task force also paves way for setting up of a Centre for Corporate Excellence. The summary of the Report given below: Independence Transparency CSR Figure 4.2 Sustainable Corporate Excellence 1) INDEPENDENCE: Higher delineation of independence criteria and minimization of potential conflict of interest. Directorial commitment and accountability through fewer and more focused board and committee membership. 51 CU IDOL SELF LEARNING MATERIAL (SLM)
Setting up of Independent, Autonomous centre for corporate excellence to accord accreditation and promote policy research and studies, training and education in the field of corporate excellence. Clear distinct between 2 components of governance in terms of policy making and oversight responsibilities of the board of directors and the executive and implementation responsibilities of corporate management comprising of the managing director and his or her team of executives including functional directors. 2) TRANPARENCY: Public Sector Undertakings are relieved from multiple surveillance agencies and simultaneously a commission be appointed to draft a suitable code of public behaviour. Apply stringent standards of corporate governance to listed companies. Meaningful and transparent accounting and reporting, improved annual report along with more detailed filing with regulatory authorities and greater facilitation for informed participation using the advances in converging information and communications technologies 3) CSR: Introducing formal recognition of CSR – Corporate Social Responsibility. A company extracts all kinds of resources from this society like material, human resource, capital, etc. Hence, it is the responsibility of the corporation to restore the same to this society through various means. 4.3.4. NARESH CHANDRA COMMITTEE - 2002 In early 2000, the scams involving the fall of the corporate giants in the US like Global crossing, Xerox, Quest, due to hand-in-glove relationship between the auditor and the corporate client. Hence, the stringent Sarbanes Oxley Act was enacted in US. This led the Indian Government to wake up and in the year 2002, Naresh Chandra Committee was appointed to examine and recommend amendments to the law involving the auditor-client relationship and the role of Independent Director. HIGHLIGHTS OF THE REPORT: The suggestions of the report were focused on Fair relationship between Auditor and Corporate client. That can be achieved only by prescribing the standards for Disclosures to ensure Transparency. 52 CU IDOL SELF LEARNING MATERIAL (SLM)
Quality review Board was suggested to do surveillance in connection with the Compliance in true letter and spirit. Role of an Independent Director is inevitable to ensure the above objectives. Auditor and Disclosures Quality Review Board Independent Director 1) Audit and Disclosures: i) Disqualifications for audit assignments: The committee recommends an abbreviated list or disqualifications for auditing assignments, which includes: Prohibition of any direct financial interest with the audit client by the audit firm or its partners or members of the engagement team as well as their ‘direct relatives’. If any relative of the partners of the audit firm or member of the engagement team has an interest of more than 2% of the share of profit or equity capital of the audit client. Note: Direct relative is defined as the individual concerned, his or her spouse, dependent parents, children or dependent siblings. Prohibition of Service or Cooling off period: Under which any partner or member of the engagement team of an audit firm who wants to join an audit client, or any key officer of the client company wanting to join the audit firm, would only be allowed to do so after 2 years from the time they were involved in the preparation of accounts and audit of that client. Prohibition of Personal Relationships, which would exclude any partner or member of the audit firm or member of the engagement team being a relative of any of key officers of the client company i.e. any whole-time director, CEO, CFO, Company Secretary, Senior Manager belonging to the top two managerial levels 53 CU IDOL SELF LEARNING MATERIAL (SLM)
of the company, and the officer who is in default. In case of any default, it would be the task of the Audit Committee of the concerned company to determine whether the individual concerned is a key officer. Prohibition of undue dependence on an audit client. So that no firm is unduly dependent on an audit client, the fees received from any one client and its subsidiaries and affiliates, all together, should not exceed 25% of the total revenues of the audit firm. However, to help newer and smaller audit firms, this requirement will not be applicable to audit firms for the first five years from the date of commencement of their activities, and for those whose total revenues are less than Rs.15 Lakhs per year. Prohibition on receiving any Loans and/or Guarantees from or on behalf of the audit client by the audit firms its partners or any member of the engagement team and their direct relatives. ii) List of Prohibited non-audit services: The committee recommends that the following services should not be provided by an audit firm to any audit client without an approval of an Audit Committee: Accounting and book keeping services, related to the accounting records or financial statements of the audit client. Internal audit services Financial information systems design and implementation, including services related to IT systems for preparing financial or management accounts and information flows of a company. Broker, dealer, investment adviser or investment banking services. Outsourced financial services. Management functions, including the provision of temporary staff to audit clients. iii) Compulsory Rotation of Auditors: The partners and at least 50 % of the engagement team responsible for the audit of either a listed company or companies whose paid up capital and free reserves exceeds Rs. 10 Crores, or companies whose turnover exceeds Rs. 50 Crores, should be rotated every 5 years. Persons who are compulsorily rotated could, if need be, allowed to return after a break of 3 years. 54 CU IDOL SELF LEARNING MATERIAL (SLM)
iv) Disclosure of qualifications and consequent action: Qualifications to accounts, if any, must form a distinct and adequately highlighted section in the Auditor’s report. It contains the justifications for such qualifications. In case of qualified Auditor’s report, the audit firm may read out the qualifications, with explanations, to shareholders in the company’s annual general meeting. Committee also suggested sending a copy of the qualified report to the Registrar of Companies, Principal Stock Exchange, Securities and Exchange board of India, in connection with the qualification. v) Appointment of Auditors – The Audit Committee of the board of directors shall be the first point of reference regarding the appointment. The Audit committee shall discuss the annual work programme with the Auditor. It shall review the independence of the audit firm. It also recommends to the board, either the appointment/re-appointment or removal of external auditor, along with the annual audit remuneration along with the reasons. But the above suggestions will not be applicable for Government companies and Scheduled Commercial Banks, where the Companies Act and Reserve Bank of India having a role to play respectively. vi) Auditor’s Annual Certification Independence – Before agreeing to be appointed, the audit firm must submit a certificate of independence to the Audit Committee or to the Board of directors of the client company certifying that the firm, together with its consulting and specialized services affiliates, subsidiaries and associated companies are independent and have arm’s length relationship with the client company. vii) CEO and CFO certification of Annual Audited Accounts: For all Listed Companies as well as public limited companies whose paid up capital and free reserves exceeds Rs. 10 Crores or Turnover exceeds Rs. 50 Crores, there should be a certification by the CEO which should state that, to the best of their knowledge and belief: As the signing officers, they have to review the balance sheet and P&L account and all its schedules and notes on accounts, as well as the cash flow statements and the Director’s report. Their statement should not contain any untrue statement or omit any material fact nor do they contain statements which are misleading. 55 CU IDOL SELF LEARNING MATERIAL (SLM)
The signing officers are responsible for establishing and maintaining internal controls which have been designed to ensure that all material information is periodically reported, after evaluated the effectiveness of internal control system of the company. In case of any defects with internal control system, the authorities should disclose to the auditors as well as the Audit Committee regarding the instances of significant fraud that involves management or employees having a significant role in the Internal Control System. Their statements represent a true and fair picture of the financial and operational state of the company after checking whether the existing accounting standards, laws and regulations have been complied. 2) Independent Quality Review Board: With the appropriate legislative support, the quality review board should be established with 3 Independent Quality Review Board (QRB), one each for the ICAI, ICSI and ICWAI. The purpose of such board is to periodically examine and review the quality of audit, secretarial and cost accounting firms, and pass judgement and comments on the quality and sufficiency of systems, infrastructure and practices. 3) Independent Director: An independent director of a company is a non-executive director who: Is not related to promoters or management at the board level, or one level below the board. Has not been an executive of the company in the last 3 years. Who does not have any material pecuniary relationships or transactions with the company, its promoters, its senior management or its holding company, its subsidiaries and associated companies (Other than Director’s Remuneration)? Is not a significant supplier, vendor or customer of the company? Is not a substantial shareholder of the company i.e. owning 2% or more of the block of voting shares? Who has not been a director, independent or otherwise, of the company for more than 3 terms of 3 years each? An employee, executive director or nominee of any bank, financial institution, corporations or trustees of debenture and bond holders, who is normally called 56 CU IDOL SELF LEARNING MATERIAL (SLM)
a ‘nominee director’ will be excluded from the pool of directors in the determination of the number of independent directors. i) Percentage of Independent Directors: Not less than 50% of the board of directors of any listed company, as well as unlisted public limited companies with a paid-up share capital and free reserves of Rs. 10 Crores and above, or turnover of Rs. 50 Crores and above, should consist of independent directors. ii) Minimum Board Size – All listed and public limited companies with a paid-up share capital and free reserves of Rs. 10 Crores and above, or turnover of Rs. 50 Crores and above should have 7 Directors out of which at least 4 should be Independent directors. iii) Meeting convening through Video Conferencing – If a director cannot be physically present but wants to participate in the proceedings of the board and its committees, then minutes and signed proceedings of a tele-conference or video conference should constitute proof of his or her participation. Accordingly, this should be treated as presence in the meeting. However, minutes of all such meetings should be signed and confirmed by the directors who has/ have attended the meeting through video conferencing. iv) Remuneration of Non-executive Directors –The statutory limit on sitting fees should be reviewed, although ideally it should be a matter to be resolved between the management and the shareholders. Loss making companies should be permitted by the Department of Corporate Affairs to pay special fees to any independent director, subject to reasonable caps, in order to attract the best restructuring and strategic talent to the boards of such companies. The current limit on 1% commission on Net profits is adequate and doesn’t need revision. v) Training of Independent directors – All independent directors should be required to attend at least one such training course before assuming responsibilities as an independent director, considering that enough programmes might not be available in the initial years, within one year of becoming an independent director. An untrained director should be disqualified. 4) Other Recommendations: The Government should increase the strength of Department of Corporate Affairs’ offices and substantially increase the quality and quantity of its physical infrastructure, including computerisation. 57 CU IDOL SELF LEARNING MATERIAL (SLM)
A Corporate Serious Fraud Office should be set up in the Department of Company Affairs with specialists inducted on the basis of transfer / deputation and on special term contracts. SEBI may refrain from exercising powers of subordinate legislation in areas where specific legislation exists as in the Companies Act. 4.4 WORKING GROUP ON COMPANIES ACT - 1996 In the wake of economic reforms process initiated from July 1991 onwards, an attempt was made to recast the erstwhile Companies Act, which was reflected in the Companies Bill, 1993. Unfortunately, the said bill, however, was subsequently withdrawn. In the year 1996, a Working Group was constituted to re-write the companies act so as to facilitate healthy growth of the Indian corporate sector under a liberalized, fast changing and highly competitive business environment. Based on the report, the Company Bill 1997 was introduced in Rajya Sabha on August 14, 1997, to replace, but due to antics, the government fell much before its tenure and the Companies Bill 1997 was at stake. Later, the government considered it desirable to have a re-look at this Bill in order to identify what further changes are urgently required to be made in the act. The Government believed that the changes would give a further boost to our companies it is necessary to effect further changes in the act so that the companies can fine tune their working in line with international business practices and compete globally with multinational companies. The working group suggested stringent provisional changes to enhance promoter’s responsibility and transparent transaction nature. In later years, it paved way for other Expert Committees to enhance control over the business effectively. 4.5 SUMMARY OECD has defined corporate governance to mean “A system by which business corporations are directed and controlled”. Corporate governance structure specifies the distribution of rights and responsibilities among different participants in the company such as board, management, shareholders and other stakeholders; and spells out the rules and procedures for corporate decision making. By doing this, it provides the structure through which the company’s objectives are set along with the means of attaining these objectives as well as for monitoring performance. 58 CU IDOL SELF LEARNING MATERIAL (SLM)
The kumara Mangalam Birla committee constituted by SEBI has observed that: “Strong corporate governance is indispensable to resilient and vibrant capital markets and is an important instrument of investor protection. It is the blood that fills the veins of transparent corporate disclosure and high-quality accounting practices. It is the muscle that moves a viable and accessible financial reporting structure.” N.R. Narayana Murthy Committee on corporate governance constituted by SEBI has observed that: “Corporate Governance is the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal and corporate funds in the management of a company.” The suggestions of the report by Naresh Chandra Committee were focused on Fair relationship between Auditor and Corporate client. That can be achieved only by prescribing the standards for Disclosures to ensure Transparency. After the intervention of Sustainability, the challenge is to bridge the gap between ensuring sustainability and making company competitively viable. In May 2000, the Department of Corporate Affairs formed a broad-based study group under the chairmanship of Dr. P. L. Sanjeev Reddy. The objective of this committee is to “operationalize the concept of corporate excellence on a sustained basis”, so as to sharpen India’s global competitive edge and to further develop corporate culture in the country. In order to revamp the erstwhile Companies, Act 1956 is required after the intervention of economic reform in the year 1991. Hence, working group on companies’ act was formulated in the year 1996 to suggest the amendments at par with the existing business environment. 4.6 KEYWORDS CSR - Corporate Social Responsibility - A company extracts all kinds of resources from this society like material, human resource, capital, etc. Hence, it is the responsibility of the corporation to restore the same to this society through various means. QRB - Quality Review Board -The purpose of such board is to periodically examine and review the quality of audit, secretarial and cost accounting firms, and 59 CU IDOL SELF LEARNING MATERIAL (SLM)
pass judgement and comments on the quality and sufficiency of systems, infrastructure and practices. CRA – Credit Rating Agencies – Credit rating is a quantified assessment of the creditworthiness of a borrower in general terms or with respect to a particular debt or financial obligation. A credit rating can be assigned to any entity that seeks to borrow money – an individual, a corporation, a state or provincial authority or a sovereign government. It determines not only whether or not a borrower will be approved for a loan or debt issue but also the interest rate at which the loan will need to be repaid. SFIO – Serious Fraud Investigation Office–It is a statutory fraud investigating agency in India. SFIO is mandated to conduct Multi-disciplinary investigations of major corporate frauds. It is under the jurisdiction of Ministry of Corporate Affairs, Government of India. It consists of experts from financial sector, capital markets, accountancy, forensic audit, taxation law, information technology, company law, Customs and investigation. Sustainability – It refers to doing business without negatively impacting the environment, community or society as a whole. It generally addresses effect of business on the environment and effect of business on society. It considers a wide array of environmental, economic and social factors when making businesses decisions. 4.7 LEARNING ACTIVITY 1. Discuss the Role of Quality Review Board. ___________________________________________________________________________ ___________________________________________________________________________ 2. Enumerate the need to constitute working group to revamp erstwhile Companies Act. ___________________________________________________________________________ __________________________________________________________________________ 4.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 60 CU IDOL SELF LEARNING MATERIAL (SLM)
1. List the Prohibited Non-Audit Services. 2. Who is an Independent Director? 3. Discuss the procedure to constitute Audit Committee. 4. Define Nominee Director. 5. What is Quality Review Board? 6. Mention various Corporate Governance Committees constituted to improve governance standards. 7. Define Substantial Shareholder. 8. What do you mean by Financial Reporting? 9. Mention the kinds of Auditor’s opinion. 10. What is the minimum board size for public and private companies? Long Questions 1. Explain the recommendation of CII under Desirable Corporate Governance Code. 2. Enumerate the Highlights of Naresh Chandra Committee Report. 3. Explain the Recommendations of Kumara Mangalam Birla Committee. 4. Describe the Role of Nomination and Remuneration Committee. 5. Discuss the Functions and Powers of Audit Committee. 6. Describe the Composition of Board. 7. Discuss the term and appointment of an Auditor. 8. Explain the role of Serious Fraud Investigating Office. 9. Describe the functions and importance of Credit Rating Agencies. 10. Explain the suggestions given by the Working Group on Companies Act. B. Multiple Choice Questions 1 CRA stands for a. Customer Redressal Agency b. Credit Redressal Agency c. Customer Rating Association d. Credit Rating Agency 2 Working group on Companies Act constituted in the year: 61 a. 1991 b. 1996 CU IDOL SELF LEARNING MATERIAL (SLM)
c. 2001 d. 2013 3 An Independent Director is a / an: a. Executive Director b. Non-Executive Director c. Nominee Director d. Shadow Director 4 Which one is the dimension of Corporate Social Responsibility? a. Corporate Philanthropy b. Stakeholders Priorities and Sustainable Development c. Ethical Business d. All of these 5 __________ are standards of behaviour that group expect of their members. a. Group values b. Code of Conduct c. Group Norms d. Organizational norms Answers 1-d, 2-b, 3-b, 4-d, 5-b 4.9 REFERENCES References book P.K. Gosh, Corporate Governance, CBS publishers and Distributors Private limited, New Delhi. Geeta D., and R.K. Mishra, Corporate Governance-Theory and Practice, Excel Books, New Delhi. 62 CU IDOL SELF LEARNING MATERIAL (SLM)
Sharma, J.P., Corporate Governance, Business Ethics, and CSR, Anne Books Pvt. Ltd., New Delhi. Website http://www.iosco.org http://www.mca.gov.in http://www.corpgov.net http://www.nfcg.in 63 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 5:COMMITTEES AND GUIDELINES II STRUCTURE 5.0 Learning Objectives 5.1 Introduction 5.2 Corporate Governance Committees and Guidelines 5.2.1. N R Narayana Murthy Committee – 2003 5.2.2. Dr. J. J. Irani Committee on Company Law - 2005 5.3 Summary 5.4 Keywords 5.5 Learning Activity 5.6 Unit End Questions 5.7 References 5.0LEARNING OBJECTIVES After studying this unit, you will be able to: Learn the need for further developments in legal framework. Know the suggestions given by the expert committee’s in early 2000. Correlate the impact of such reports on the secretarial practice. 5.1 INTRODUCTION In early 2000, the regulatory authorities realized that there was a need to look beyond the mere systems and procedures if corporate governance was to be made effective in protecting the interest of investors. Also considered the need for corporate responsibility towards society, hence transparent and responsible companies are required to enhance the quality of compliance which in turn leads to enhanced stake holder’s reliability. 64 CU IDOL SELF LEARNING MATERIAL (SLM)
5.2 CORPORATE GOVERNANCE COMMITTEES AND GUIDELINES 5.2.1. N R Narayana Murthy Committee – 2003 SEBI recognized the need and constituted a committee under the Chairmanship of Shri. N. R. Narayana Murthy, to review implementation of the corporate governance Code by the listed companies and to issue revised clause 49, based on its recommendations. Following are the gist of recommendations: In case a company has followed different procedure as compared with the prescribed accounting standard, then management should justify why they believe such alternative treatment is conducive to portray underlying business transaction. Management should also clearly explain the alternative accounting treatment in the footnotes to the financial statements. Companies should be encouraged to move towards a regime of unqualified financial statements. This should be reviewed at an appropriate juncture to determine whether the financial reporting climate is conducive towards a system of filing only unqualified financial statements. All Audit Committee members should be ‘Financially Literate’ (ability to read and understand basic financial statements) and at least one member should have accounting or related financial management expertise. Audit committee of Publicly listed companies should be required to review the following information mandatorily: Financial statements and draft audit report, including quarterly / half-yearly financial information; Management discussion and analysis of financial condition and results of operations; Reports relating to compliance with laws and to risk management; Records of Related Party Transactions. Management Letters of Internal Control weakness issued by Internal Auditors; A statement of all transactions with Related Parties including their bases should be placed before the Independent Audit Committee for formal approval. If any transaction is not on Arm’s length basis, management should provide an explanation to the audit committee in order to justify the same. 65 CU IDOL SELF LEARNING MATERIAL (SLM)
To Inform Board members about the Risk Assessment and Minimization Procedures. Procedures should be periodically reviewed to ensure that executive management controls risk through means of a properly defined framework. Procedures should be in place Companies should be encouraged to train their Board members in the business model of the company as well as the risk profile of the business parameters of the company, their responsibilities as directors, and the best ways to discharge them. Management should place a report before the entire Board of Directors every quarter documenting the business risks faced by the company, measures to address and minimize such risks, and any limitations to the risk bearing capacity of the corporation. This document should be approved by the Board. It should be obligatory for the board to lay down the code of conduct for all Board members and senior management of a company. This Code of Conduct shall be posted on the website of the company. Companies raising money through an Initial Public Offering should disclose to the Audit committee, the application of funds by major category on a quarterly basis. On an annual basis, the company shall prepare a statement of funds utilised for purposes other than those stated in the Prospectus (Prospectus – Invitation to public to subscribe for the shares/securities). This statement should be certified by the Independent auditors of the company. There shall be no Nominee Directors. Where an institution wishes to appoint a director on the board, such appointment should be made by the shareholders. An institutional director, so appointed, shall have the same responsibilities and shall be subject to the same liabilities as any other director. Nominee of the Government on public sector companies shall be similarly elected and shall be subject to the same responsibilities and liabilities as other directors. Companies should publish their compensation philosophy and statement of entitled compensation in respect of Non-Executive directors in their annual report or put up on the company’s website and reference drawn thereto in the Annual Report. The Considerations as regards remuneration paid to an Independent director shall be the same as those applied to a Non-Executive Director. The term Independent director is defined as Non-Executive director of the company who apart from receiving director remuneration, does not have any material pecuniary 66 CU IDOL SELF LEARNING MATERIAL (SLM)
relationships or transactions with the company, its promoters, its senior management or its holding company, its subsidiaries and associated companies. Who is not related to promoters or management at the board level or at one level below the board; The director has not been an executive of the statutory audit firm or the internal audit firm that is associated with the company, and has not been a partner or an executive of any such firm for the last 3 years. This will also apply to legal firm and consulting firm that have a material association with the entity Director who is not a supplier, service provider or customer of the company. This should include Lessor-Lessee relationships also. Personnel who observe an Unethical or Improper Practice should be able to approach the Audit Committee without necessarily informing their superiors. Companies shall take measures to ensure that this right of access is communicated to all employees through means of internal circulars, etc. Company should have Whistle Blower Policy and mechanism in place. Companies shall annually affirm that they have not denied any personnel access to the audit committee of the company and that they have provided protection to “Whistle Blowers” from unfair termination and other unfair or prejudicial employment practices. The appointment, removal and terms of remuneration of the Chief Internal auditor must be subject to review by the Audit Committee. Such affirmation shall disclose in the board’s report on Corporate Governance that is required to be prepared and submitted together with the Annual Report. The Provisions relating to the Composition of the Board of Directors of the parent company shall be made applicable to the composition of the Board of Directors of subsidiary companies. At least one independent director on the board of directors of the parent company shall be a director on the Board of the Subsidiary company. The Audit Committee of the parent company shall also review the financial statements, in particular the investments made by the subsidiary company. The minutes of the Board meetings of the subsidiary company shall be placed for review at the Board meeting of the Parent Company. The performance evaluation of Non-Executive Directors should be by a peer group comprising the entire Board of Directors, excluding the director being evaluated and Peer 67 CU IDOL SELF LEARNING MATERIAL (SLM)
group evaluation should be the mechanism to determine whether to extend / continue the terms of appointment of Non-executive directors. SEBI should make rules for Disclosures in the report issued by a Security Analyst whether the company that is being written about is a client of the analyst’s employer or an associate of the analyst’s employer and the nature of services rendered to such company and the Disclosure in the report issued by a security analyst whether the analyst or the analyst’s employer or an associate of the analyst’s employer hold or held or intend to hold any debt or equity instrument in the issuer company that is the subject matter of the report of the analyst. 5.2.2. Dr. J. J. Irani Committee on Company Law - 2004 Government realized the need to revise Companies Act, 1956 with the objective to have a simplified compact law that would be able to address the changes taking place in the national and international markets, enable adoption of internationally accepted best practices as well as provide adequate flexibility of timely evolution of new arrangements in response to the requirements of ever-changing business models. Hence, in the year 2004 Government constituted a Committee under the Chairmanship of Dr. J. J. Irani, Director of Tata sons, with an objective to advise the Government on such revision. The extracts of the executive summary relating to Management and Board Governance is reproduced below: Board Composition Appointment Appointment of KMP & Resignation Meeting Committees Figure 5.1 Management and Board Governance 68 CU IDOL SELF LEARNING MATERIAL (SLM)
i) Board Composition – Law should provide for only the Minimum number of directors necessary for various classes of companies. There need not be any limit to maximum number of directors. Decision on remuneration of directors should not be based on a “Government approval-based system” but should be left to the company. However, this should be transparent, based on principles that ensure fairness, reasonableness and accountability and should be properly disclosed. In case of inadequacy of profits also the company to be allowed to pay remuneration recommended by Remuneration Committee and approved by the shareholders. Presence of Independent Directors on the boards of companies will lead to greater transparency and eliminate biasness in company’s dealings. Law should recognize the principle of independent directors and spell out their attributes, role, qualifications, liability and manner of appointment along with the nature of independence. However, prescription of the number and proportion of such directors in the board may vary depending on size and type of company and may be prescribed through rules. ii) Appointment and Resignation of Director – Every Company to have at least one director resident in India. Requirement of obtaining approval of Central Government under Companies Act for appointment of non-resident managerial persons should be done away with. Duty to inform the Registrar of particulars regarding appointment / resignation / death etc. of directors is vested with the company. Failure to attend board meeting for a continuous period of one year will be a ground for vacation of office regardless of whether or not leave of absence was granted to such director. Specific provisions to be made in the Law to regulate the process of resignation by a director. iii) Committees – Certain committees to be constituted with participation of independent directors should be mandated for certain categories of companies where the requirement of independent directors is mandated. In other cases, constitution of such committees should be at the option of the company. Law should specify the Composition of various committees of the board like Audit Committee, Stakeholder’s Relationship Committee and Remuneration Committee in order to consult them in certain matters. 69 CU IDOL SELF LEARNING MATERIAL (SLM)
iv) Meetings: The platform which makes effective decision making needs to be regulated by prescribing regulations. Board Meetings by electronic means should be allowed. In case of companies where Independent Directors are prescribed, notice period of 7 days has been recommended for Board Meetings with provisions for holding emergency meetings at a shorter notice. Consent of shareholders by way of special resolution should be mandatory for taking important decisions which affects the interest of entire stakeholders. Annual General Meeting – Meetings of members should abide by the standards prescribed from time to time. Use of postal ballot during meetings of members should be allowed to be used widely by companies. Law should provide for voting through electronic mode. AGMs may be held at a place other than place of registered office, provided at least 10% members in number reside at such place. Small companies to be given an option to dispense with holding of AGM. Demand for Poll to be limited with due regard for minority interests. v) Appointment of KMPs – Every company is required to appoint, a Chief Executive Officer, Chief Finance Officer and Company Secretary as its Key Managerial Personnel whose appointment and removal shall be by the Board of Directors. Special exemptions may be provided for small companies, who may obtain such services, as may be required from qualified professionals in practice. Managing Director / Whole -time directors should be in Whole-time employment of only one company at a time. Provisions relating to options for appointment of directors though proportionate representation to be continued. 5.3 SUMMARY SEBI recognized the need and constituted a committee under the Chairmanship of Shri. N. R. Narayana Murthy, for reviewing implementation of the corporate governance Code by listed companies Government realized the need to revise Companies Act, 1956 with the objective to have a simplified compact law that would be able to address the changes taking place in the national and international scenario, enable adoption of internationally accepted best practices as well as provide adequate flexibility of timely evolution of new arrangements in response to the requirements of ever-changing business models. 70 CU IDOL SELF LEARNING MATERIAL (SLM)
Meetings of members should abide by the standards prescribed from time to time. Use of postal ballot during meetings of members should be allowed to be more widely used by companies. Law should provide for voting through electronic mode. Presence of Independent Directors on the boards of companies will lead to greater transparency in company’s dealings. Law should recognize the principle of independent directors and spell out their attributes, role, qualifications, liability and manner of appointment along with the nature of independence. 5.4 KEYWORDS KMP-Key Managerial Personnel – CEO (Chief Executive Officer) or Managing Director, Chief Financial Officer, Manager, Company Secretary, whole-time Directors are considered as KMPs. These group of people who are in charge of managing the operations of the company; they are responsible for the planning, directing and controlling the functioning of a company. The appointment of such authorities was prescribed under Section 203 of Companies Act 2013. Every such authority is appointed through a resolution adopted by the board with terms and conditions of appointment and remuneration. Vigil Mechanism – It means calling the attention of the top management to wrongdoing occurring within an organization. The person who utilizes this mechanism is called as whistle blower. The word whistle blower originates from the practice of British Policemen who blew their whistles whenever they observe commission of a crime. This mechanism should be established to report any unethical behavior or other concerns to the management. IPO –Initial Public Offering – It refers to the process of offering shares to the public through new stock issue. It allows companies to raise capital from public investors. Companies should comply with the regulations stipulated by Securities and Exchange Board of India. RPT – Related Party Transaction –It refers to a deal or arrangement made between two parties who are joined by a pre-existing business relationship or common interest. This transaction may create Conflicts of Interest or lead to other illegal situations. The mis-use of such transaction could result in fraud and financial ruin for all parties involved. 71 CU IDOL SELF LEARNING MATERIAL (SLM)
5.5 LEARNING ACTIVITY 1. Explain Whistle Blowing Mechanism. ___________________________________________________________________________ ___________________________________________________________________________ 2. Discuss the importance of Audit Committee. ___________________________________________________________________________ ___________________________________________________________________________ 5.6 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Who are all considered as Related Parties? 2. Define Vigil Mechanism. 3. What do you mean by Postal Ballot? 4. Discuss the process of evaluating board’s performance. 5. What do you mean by Prospectus? 6. Discuss the role of an Internal Auditor. 7. What is Initial Public Offering? Long Questions 1. Explain the recommendations made by N.R. Narayana Murthy Committee. 2. Discuss the provision to convene Annual General Meeting at the place other than place of its Registered Office. 3. Explain the procedure for Resignation of Director. 4. Describe the Role of Nominee Director in Corporate Governance. 5. Explain the Suggestions made by Dr. J. J. Irani Committee. 6. Explain the various kinds of Meetings. 7. Discuss the Consequences of Related Party Transaction. 72 CU IDOL SELF LEARNING MATERIAL (SLM)
B. Multiple Choice Questions 1 Government constituted J. J. Irani Committee in the year: a. 1999 b. 2002 c. 2004 d. 2005 2 Who constituted N. R. Narayana Murthy Committee? a. Central Government b. Securities and Exchange Board of India c. Reserve Bank of India d. Confederation of Indian Industry 3 Who appoint key managerial personnel for a company? a. Board of Directors b. Shareholders c. Auditors d. Promoter 4 Board Meeting should be convened by giving not less than ____ notice. a. 5 days b. 7 days c. 14 days d. 21 days 5 Internal Control System’s weaknesses should be reported by: a. Board of Directors b. Internal Auditor c. Promoter d. Creditors Answers 73 CU IDOL SELF LEARNING MATERIAL (SLM)
1-c, 2-b, 3-a, 4-b, 5-b. 5.7 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. Websites http://www.cii.org/gov_policies http://www.csiaorg.com http://www.icgn.org http://www.acga-asia.org 74 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 6:STAKEHOLDERS RIGHTS STRUCTURE 6.0 Learning Objectives 6.1 Introduction 6.2 Evolution of Stakeholder Theory 6.3 Types of Stakeholders 6.4 Stakeholders from Governance perspective 6.5 Principles of Stakeholder Engagement 6.6 Summary 6.7 Keywords 6.8 Learning Activity 6.9 Unit End Questions 6.10 References 6.0LEARNING OBJECTIVES After studying this unit, you will be able to: State the changed concept from Shareholder to Stakeholder. Know the link between good governance and importance of various stakeholders. Learn the principles suggested over the years for effective governance. 6.1 INTRODUCTION Stakeholder theory is an idea about how business really works. Forany business to be successful it has to create value for Customers, Suppliers, Employees, Communities and Financiers, Shareholders, Banks and other people having nexus with the company. We can’t look at any one of their stakes in isolation, as their interest has to go together and the job of the management is to work out how the interest of all the stakeholders moves in the same direction. 75 CU IDOL SELF LEARNING MATERIAL (SLM)
6.2EVOLUTION OF STAKEHOLDER THEORY The term Stakeholder was first coined in the year 1963. Stakeholder theory is the idea that each one of these groups is important to the success of a business and figuring out where their interests go in the same direction is what the managerial task and the entrepreneurial task is all about. The theory says if you’re just focused on financiers you miss what makes capitalism tick. The comprehensive concentration of stakeholders which makes the business successful. In a business context, customers, investors, shareholders, employees, suppliers, government agencies, communities and many others who have a ‘stake’ or claim in some aspect of a company’s products, operations, markets, industry and outcomes are known as stakeholders. A Conceptual framework of business ethics and organization management which addresses moral and ethical values in the management of a business or other organization. The stakeholder theory was first proposed in the book Strategic Management: A Stakeholder Approach by R. Edward Freeman and outlines how management can satisfy the interests of stakeholders in a business. From an analytical perspective, a stakeholder approach can assist managers by promoting analysis of how the company fits into its larger environment, how its standard operating procedures affect stakeholders within the company and immediately beyond the Company. Management Owners Local Community Stakeholders Government Employees Customers Suppliers Figure 6.1 Stakeholders 76 CU IDOL SELF LEARNING MATERIAL (SLM)
6.3 TYPES OF STAKEHOLDERS Stakeholders embrace values and standards that dictate what constitutes acceptable or unacceptable corporate behaviors. The concept of stakeholders may be classified into Primary and Secondary Stakeholders: i) Primary stakeholders are those whose continued association is absolutely necessary for a firm’s survival; these include employees, customers, investors, and shareholders, as well as the governments and communities that provide necessary infrastructure. ii) Secondary Stakeholders do not typically engage in transactions with a company and thus are not essential for its survival; these include the media, trade associations and special interests’ groups. They are otherwise called as External Stakeholders. 6.4 STAKEHOLDERS FROM GOVERNANCE PERSPECTIVE: Society Employees Government Customers Vendors Lenders Figure 6.2 stakeholders from governance perspective a) Employees: Employee participation in corporate governance systems can be found in many countries and corporations throughout the world. Some of the instances of employee’s contribution towards management are listed hereunder: 77 CU IDOL SELF LEARNING MATERIAL (SLM)
Employees must be consulted on certain management decisions. This right increase transparency of management decisions and allows opinion of employees to equalize the asymmetry information between management and the market. It also paves way for motivation as their work has been recognized even in the top management. The Metallic Soap box case in japan is an example for an impact of employees’ contribution in management. Employees may be partner in the capital contribution. They may be given the shares under Employees Stock Option Plan Scheme. This will create the belongingness of the ownership concept among the employees meaning there by owner as well as employee. This will lead to the improved employee commitment and buy-in to management’s goals side by side the alignment of interest between employees and shareholders. It may support the emergence of more transparent and effective corporate governance. A whistle blower is the one who exposes wrongdoing, fraud, corruption or mismanagement in an organization. A whistle blower is a person who publicly complains the concealed misconduct on the part of an organization, usually from within that same organization. Whistle blower may be an employee, former employee, vendor, customer or other stakeholder. They are important stakeholders as they can work as a tool for authorities to get information of deviant behaviour or practices in organizations. The big question is that, who will take chance against the possible risk involved? Who could blow the whistle about the wrongdoing courageously? It’s not only about raising the whistle; it is more about the impartiality and courage to start with. This needs protection against retaliation by superiors. At the corporate level, the companies can provide protection to whistle blowers by establishing a well-documented whistle blower policy and ensuring its effectiveness practically. It is also essential to develop confidence among the employees. b) Customers: Today the customer satisfaction is one of the most important aspects of firm’s performance. Customers have innumerable choices. Therefore, corporate need to establish a differentiation. It is established in terms of quality and price of the product or service. Customers are also driving corporate to consider environmental factors in 78 CU IDOL SELF LEARNING MATERIAL (SLM)
designing the products and services. Governance plays a big role in improving the relation between the organization and the customer which eventually leads to better performance for the organization especially if you take into consideration that the cost of new customer is five to six times more than maintaining the current customer. c) Lenders: They provide the term loan as well as the working capital. When a company borrows money, a loan contract typically includes promises made by its management that either guide or limit its actions. If a borrower violates a promise, the creditor can choose to demand immediate repayment even though the borrower has not defaulted. Lending institutions many times places its nominee as a director on the board of borrowing companies. d) Vendors: They play a key role in the success of an organization. The organisation which builds a mutually strong relationship with its vendors improves its overall performance in the marketplace. The Time, money and energy used to nurture a positive vendor relationship cannot be measured directly against the company’s bottom line. A well- maintained vendor relationship will increase customer satisfaction, reduce cost, better quality and better service from the vendor side. e) Government: Government policy and the legal environment set the tone for the desired corporate governance practices. Government in any country plays a key role in setting the mandatory limit and recognition of voluntary efforts of corporates. The role of Government is to differentiate between the voluntary and mandatory measures becomes more important so that in regulatory role, it should not burden the corporate sector with the legal compliances. It is important to provide a conducive environment for corporates which ensures its effectiveness. Further beyond the law, Government may directly influence the corporate governance practices of the corporate sector by providing voluntary measure and recognition in the respect of Corporate Governance measures. f) Society: The society expects maximum production of economic well-being from the company. This requires innovation and experimentation as well as it also requires control, risk management to seize the activities involving hazard to the local community. Today, Companies are showing responsibility towards society, which is recognized by the 79 CU IDOL SELF LEARNING MATERIAL (SLM)
society and government as well. Business was perceived to maximize profit by exploiting environmental and social systems. These perceptions and attitude forced society to revalue their expectations from business. Only industrial development which does not reduce the quality of life should be encouraged. Thus, if businesses do not have in a socially responsible manner, their activities will have a negative impact on the society. 6.5 PRINCIPLES OF STAKEHOLDERS ENGAGEMENT: Stakeholders’ engagement creates opportunities to align business practices with societal needs and expectations, helping to drive towards long-term Sustainability and Shareholder Value. It is intended to help the corporation to realize the benefits that enables an organization to compete in a complex and ever-changing business environment. Interact – Communication from the various stakeholders should be promoted. Ensure intended message is understood and the desired response reached. There should be a scope for interaction with various stakeholders to understand their purview on the company/Products/Service etc. Always ask the right question to get the useful information and ideas. To engage their support ask them for advice and listen how they feel. Relationship – Try to engender trust with the stakeholders. Seek out networking opportunity. Show care and be empathetic. We have to listen to our stakeholders. Time investment and careful planning has a significant impact on the results. Responsibility – Explore the value of the project to the stakeholder. Project governance is the key of project success. It’s always the responsibility of everyone to maintain an ongoing interaction with stakeholders. CRT PRINCIPLES FOR RESPONSIBLE BUSINESS It was founded by Frits Philips (Former President of Philips Electronics) and Olivier Giscard d’Estaing (Former Vice-Chairman of INSEAD) in the year 1986.Caux Round Table (CRT) is an international network of business leaders working to promote a morally and sustainable way of doing business. It believes that its principles for Responsible Business provide necessary foundations for a fair, free and transparent business environment. These principles are rooted in two basic ethical ideals i.e., Kyosei and Human dignity. Kyosei – It means living and working together for the common good enabling cooperation and mutual prosperity to coexist with healthy and fair competition. 80 CU IDOL SELF LEARNING MATERIAL (SLM)
Human Dignity – It refers to the sacredness or value of each person as an end, not simply as a mean to the fulfilment of others purposes or even majority prescription. Caux Round table Principles for Responsible Business set forth ethical norms for acceptable businesses behaviour. The self-interested pursuit of profit, with no concern for other stakeholders, will ultimately lead to business failure and at times, to counter-productive regulation. So, business leaders will strive for ethical leadership in order to protect the sustainable prosperity. Respect Stakeholders Contribute to Economic Development Build Trust Respect Rules Support Globalization Respect the Environment Avoid Illicit Activities Figure 6.3CRT Principles for Responsible Business PRINCIPLE 1 – RESPECT STAKEHOLDERS BEYOND SHAREHOLDERS: A responsible business acknowledges its duty to contribute value to society through the wealth and employment it creates and the products and services it provides to consumers. It maintains its economic health and viability not just for shareholders, but also for other stakeholders. A responsible business respects the interests of, and acts with honesty and fairness towards, its customers, employees, suppliers, competitors and the broader community. PRINCIPLE 2 – CONTRIBUTE TO ECONOMIC, SOCIAL AND ENVIRONMENTAL DEVELOPMENT: A responsible business recognizes that business cannot sustainably prosper in societies that are failing in economic development. Therefore, it contributes to the economic, social and environmental development of the clusters in which it operates, in order to maintain its 81 CU IDOL SELF LEARNING MATERIAL (SLM)
required Operating capital – Financial, Social, Environmental and all forms of goodwill. It enhances society through effective utilization of resources, free and fair competition and innovation in technology and business practices. PRINCIPLE 3 – BUILD TRUST BY GOING BEYOND THE LETTER OF LAW: A responsible business knows the importance of business behaviors, although legally required, be cautious on the consequences for stakeholders in case of default. A responsible business therefore adheres to the spirit and intent behind the law, as well as the letter of the law, which requires conduct that goes beyond minimum legal obligations. A cautious business always operates with Candor, truthfulness and transparency. PRINCIPLE 4 – RESPECT RULES AND CONVENTIONS: A responsible business respects the local cultures and traditions in the communities in which it operates, consistent with fundamental principles of fairness and equality. A responsible business respects all applicable national and international laws, regulations and conventions, while trading fairly and competitively. PRINCIPLE 5 – SUPPORT RESPONSIBLE GLOBALIZATION: As a participant in the global marketplace, a responsible business supports open and fair multilateral trade. It also supports reform of domestic rules and regulations where they unreasonably hinder global commerce. PRINCIPLE 6 – RESPECT THE ENVIRONMENT: A responsible business protects and improves the environment and avoids wastage of resources. Business should ensure that its operations comply with best environmental management practices consistent with meeting the needs of today without compromising the needs of future generations. PRINCIPLE 7 – AVOID ILLICIT ACTIVITIES: A responsible business does not participate in or condone, corrupt practices, bribery, Money laundering or other illicit activities. It does not participate in or facilitate transactions linked to or supporting terrorist activities, drug trafficking or any other illicit activities. Business should actively support the prevention of all such illegal and illicit activities. CLARKSON PRINCIPLES OF STAKEHOLDER MANAGEMENT 82 CU IDOL SELF LEARNING MATERIAL (SLM)
The Centre for Corporate Social Performance and Ethics in the Faculty of Management was founded in 1988, by Max Clarkson who is retired faculty from the University of Toronto. Four conferences hosted by the Centre between 1993 and 1998 brought together management scholars to share ideas on stakeholder theory, an emerging field of study examining the relationships and responsibilities of a corporate to employees, customers, suppliers, society and the environment. These principles represent an early stage general awareness of corporate governance concerns that have been discussed in connection with the business scandals happened in early 2000. PRINCIPLE 1: Key Managerial Personnel are responsible for decision making after taking in to account of the interest of all legitimate stakeholders. They should also acknowledge and actively monitor their concerns. PRINCIPLE 2: Managers should listen to and openly communicate with stakeholders about their respective concerns and about the risk that they assume because of their involvement with the corporation. PRINCIPLE 3: Managers should adopt processes and modes of behavior that are sensitive to the concerns and capabilities of each stakeholder group. PRINCIPLE 4: Managers should recognize the interdependence of efforts and rewards among stakeholders, should attempt to achieve a fair distribution of the benefits and burdens of corporate activity among them, considering their respective risks and vulnerabilities. PRINCIPLE 5: Managers should work co-operatively with other entities, both public and private, to ensure that risks and harms arising from corporate activities are minimized and where they cannot be avoided, appropriately compensated. PRINCIPLE 6: Management should avoid altogether activities that might jeopardize inalienable human rights or give rise to risks which, if clearly understood, would be patently unacceptable to relevant stakeholders. PRINCIPLE 7: Managers should acknowledge the potential conflicts between their own role as corporate stakeholders and their legal and moral responsibilities for the interests of stakeholders, and should address such conflicts through open communication, appropriate reporting and incentive systems, and where necessary third-party review. 83 CU IDOL SELF LEARNING MATERIAL (SLM)
6.6 SUMMARY A Conceptual framework of business ethics and organization management which addresses moral and ethical values in the management of a business or other organization. R. Edward Freeman defined Stakeholder Theory in broad definition, “stakeholder is any group or individual which can effect or is affected by an organization.” Such a broad conception would include suppliers, customers, stockholders, employees, the media, political action groups, communities and Governments. A narrower view of stakeholder would include employees, suppliers, customers, financial institutions, and local communities where the corporation does its business. But in either case, the claims on corporate conscience are considerably greater than the imperatives of maximizing financial return to stockholders. Stakeholder’s engagement provides opportunities to further align business practices with societal needs and expectations, helping to drive long-term Sustainability and Shareholder Value. It is intended to help the corporation to realize the benefits that enables an organization to compete in a complex and ever-changing business environment. The Caux Round Table Principles for Responsible Business comprise of seven principles and more detailed Stakeholder Management Guidelines covering each of the key stakeholder dimensions of ethical business practices: customers, employees, shareholders, suppliers, competitors and communities. These are supported by more detailed Stakeholder Management Guidelines covering each key dimension of business success: Customers, employees, Shareholders, Suppliers, Competitors and Communities. Caux Round Table (CRT) is an international network of business leaders working to promote a morally and sustainable way of doing business. It believes that its principles for Responsible Business provide necessary foundations for a fair, free and transparent business environment. Clarkson introduced Seven Principles of Stakeholder Management. These principles represent an early stage general awareness of corporate governance concerns that have been widely discussed in connection with the business scandals of early 2000. 84 CU IDOL SELF LEARNING MATERIAL (SLM)
6.7 KEYWORDS Kyosei– It means living and working together for the common good enabling cooperation and mutual prosperity to coexist with healthy and fair competition. Human Dignity – It refers to the sacredness or value of each person as an end, not simply as a mean to the fulfilment of others purposes or even majority prescription. Primary stakeholders – Are those whose continued association is absolutely necessary for a firm’s survival; these include employees, customers, investors, and shareholders, as well as the governments and communities that provide necessary infrastructure. Secondary Stakeholders – They do not typically engage in transactions with a company and thus are not essential for its survival; these include the media, trade associations and special interests’ groups. 6.8 LEARNING ACTIVITY 1. Who are all the Stakeholders of a Public Company? ___________________________________________________________________________ ___________________________________________________________________________ 2. Difference between Stakeholder and Shareholder. ___________________________________________________________________________ 6.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define Kyosei. 2. Who is a Primary Stakeholder? 3. Write a short note on Stakeholder Engagement. 4. List out the benefits of Stakeholder Theory. 5. What is Human Dignity? How it is relevant with Corporate Governance. Long Questions 1. Explain the Evolution of Stakeholder Theory. 85 CU IDOL SELF LEARNING MATERIAL (SLM)
2. Describe the Stakeholder Model of a Company. 3. Explain the principles recommended by Caux Round Table. 4. List out the Seven Principles of stakeholder management as suggested by Clarkson with brief description. 5. Describe the Principles of Stakeholder Engagement. 6. Explain the Governance Paradigm and various stakeholders. 7. Distinguish between Primary and Secondary Stakeholder. 8. Describe the process of Stakeholder Analysis. 9. Why the concept from shareholder to stakeholder changed and what are the benefits of it? 10. Discuss the Evolution of Clarkson Principles of Management. B. Multiple Choice Questions 1 Which Principle is otherwise known as Meta Principle? a. Caux Round Table Principles b. Clarkson Principles c. Stakeholder Analysis d. None of these 2 The term which enables Co-operation and Mutual prosperity: a. Stakeholder Engagement b. Human Dignity c. Kyosei d. Stake Holder Management 3 The CRT Principles for Responsible Business enumerated in the year: a. 2001 b. 2005 c. 2009 d. 2011 4 The stakeholders which are directly involved in the affairs and interest of an organization known as: 86 CU IDOL SELF LEARNING MATERIAL (SLM)
a. Primary Stakeholder b. Secondary Stakeholder c. Stakeholder Engagement d. Shareholder Activism 5 The Caux Round Table was founded in the year: a. 1984 b. 1986 c. 1999 d. 2001 6 _____ has sought to begin a process that identifies shared values, reconciles differing values, and thereby develops a shared perspective on business behaviour. a. Caux Round Table b. Clarkson Principles c. Kyosei d. Stakeholders Engagement 7 _____ is the process by which an organization involves people who may be affected by the decisions it makes or can influence the implementation of its decisions. a. Stakeholder Engagement b. Shareholder Activism c. Stakeholder Analysis d. Stakeholder Theory 8 Who didn’t typically engage in day to day affairs of an organization? a. Primary Stakeholders b. Secondary Stakeholders c. Stakeholders Engagement d. None of these 9 ____ is the one who exposes wrongdoing, fraud, corruption or mismanagement. 87 a. Whistle Blower CU IDOL SELF LEARNING MATERIAL (SLM)
b. Key Managerial Personnel c. Board of Directors d. Auditors 10 The Centre for Corporate Social Performance and Ethics in the Faculty of Management was founded in the year: a. 1988 b. 1991 c. 2000 d. 2002 Answers 1-b, 2-c, 3-c, 4-a, 5-b, 6-a, 7-a, 8-b, 9-a, 10-a. 6.10 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.referenceofbusiness.com/definition/stakeholder-theory http://www.businessdictionary.com http://www.lexicon.ft.com/term=Stakeholdertheory 88 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT - 7:STAKEHOLDERS PRIVILEGES STRUCTURE 7.0 Learning Objectives 7.1 Introduction 7.2 Evolution of Stakeholder Activism 7.3 Role of Institutional Investors in Corporate Governance. 7.3.1. Tools used by Institutional Investors 7.3.2. Principles of Responsible Investment 7.4 Rights of Shareholders 7.5 Protection of Minority Shareholders 7.6 Summary 7.7 Keywords 7.8 Learning Activity 7.9 Unit End Questions 7.10References 7.0LEARNING OBJECTIVES After studying this unit, you will be able to: Explain the Rights of the shareholders. State the evolution of Shareholder’s activism and its legal requirements. Learn the provisions in connection with Shareholders protection. 7.1 INTRODUCTION Protection of Shareholder interest is one of the pillars of corporate governance. For the efficient functioning of the capital market, the fundamental requirement is that the investor rights are well protected. The core element in corporate governance is the challenges arising out of separation of ownership and control. The shareholders are the true owners of a corporate and the governance function controls the operations of the corporate. There is a 89 CU IDOL SELF LEARNING MATERIAL (SLM)
strong likelihood that there is a mismatch between the expectations of the shareholders and the actions of the management. Hence, it is required to have a clear understanding of the rights of Shareholders and the management. 7.2 EVOLUTION OF SHAREHOLDERS ACTIVISM A share in a company is not only a share of profit but also a share in ownership. Shareholders activism refers to the active involvement of stockholders in their organization. Active participation in company meetings and other managerial processes are healthy practice. They can resolve issues laid down in the annual and other general meetings and can raise concerns over financial matters or even social causes such as protection of the environment. Shareholder activists include public pension funds, mutual funds, unions, universities, environmental activists and human rights groups. Shareholders can ensure that the company follows good corporate governance practices and implements beneficial policies.Shareholdersactivism ensures the better management, less frauds and better governance. In late 1980s, shareholder activism took an initiative when shareholders took on management, due to the partners engaged in hostile takeovers and leveraged-buyouts to gain control of undervalued and underperforming companies. Later on, in early 2000s, it is recognized that the internet and mass media are effective tools in building up pressure on the management. Activism can be exercised by the shareholders through proxy battles, publicity campaigns, shareholder resolutions, litigation and negotiations with management. Shareholder activism shall establish dialogue with the management on issues that concern and influence the corporate culture. 7.3 ROLE OF INSTITUTIONAL INVESTORS IN GOVERNANCE Institutional investors are financial institutions that accept funds from III Parties for investment in their own name but on such parties’ behalf. They include Mutual funds, insurance companies, etc. Often it is misconceived that the responsibility of Institutional investors is to invest the money of the investors in companies, which are expected to generate the maximum possible return rather than in companies with good corporate governance records. But such governance reports are essential to find out better investment avenue in order to reduce their exposure to the risks. 90 CU IDOL SELF LEARNING MATERIAL (SLM)
Advantages on the Role of Institutional investors in promoting corporate governance: The institutional investors have significant stakes in the companies eventually holds considerable voting power, that paves way for effective exercise of rights in order to ensure good corporate governance. As they hold considerable shares in the company, hence, they are in the better position to have the access of the information especially Key Sensitive Information. Market performance can be estimated based on the adoption of effective Corporate Governance. Effective Governance may attract more investors especially Foreign Direct Investments due to increased reliability and reduced risk exposure. Disadvantage on the Role of Institutional investors in promoting corporate governance: Investment objectives are also a deciding factor while making the investment decision rather than corporate governance. Institutional investors will sell-off, if there is mis-match in their liquidity position, even though company has better governance policy. Short term investors will not consider the long run success factors like governance, while making their investment decision. 7.3.1 Tools Used by Institutional Investors: Before investing in companies, Institutional investors use various tools to assess the health of such companies. Some of the tools are discussed below: i) Focus List - A number of institutional investors have established focus lists whereby they target underperforming companies and include them on a list of companies which have underperformed a main index, such as Standard and Poor’s. under performing index would be a first point of identification, other factors would include not responding appropriately to the institutional investor’s inquiries regarding under performance and not taking account of the institutional investor’s views. After being put on the focus list, the companies often receive unwanted, attention of the institutional investors who may seek to change various directors on the board. 91 CU IDOL SELF LEARNING MATERIAL (SLM)
ii) One to One Meetings – The meetings between institutional investors and companies are extremely important as a means of communication between the two parties. This is one clear example of the way that individual investors are at a disadvantage to institutional investors as corporate management will usually only arrange such meetings with large investors who are overwhelmingly institutional investors. A company will usually arrange to meet with its largest institutional investors on a one-to-one basis during the year. iii) Ratings – With the increasing emphasis on corporate governance across the globe, it is perhaps not surprising that a number of corporate governance rating systems have been developed. The rating system covers several markets. These rating systems should be of benefit to investors, both potential and those presently invested and to the companies themselves. This can be a powerful indicator of the extent to which a company currently is adding or has the potential to add in the future, shareholder value. This is because a company with good corporate governance is generally perceived as more attractive to investors. iv) Voting – The right to vote which is attached to voting shares is a basic pre- requisite of share ownership and is particularly important given the division of ownership and control in the modern corporates. The right to vote can be seen as fundamental tools for some element of control by shareholders. The institutional investors can register their views by postal voting, or vote electronically where this facility is available. Most of the large institutional investors now have a policy of trying to vote on all issues which may be raised at their investee company’s Annual General meeting. 7.3.2 Principles of Responsible Investment: Responsible investment is a process that must be appropriate to fit each organization’s investment strategy, approach and resources. The Responsible investment initiative has quickly become the leading global network for investors to publicly demonstrate their commitment to responsible investment, to collaborate and learn with their peers about the financial and investment implications. The goal of such principles is to understand the implications of sustainability for investors and support signatories to incorporate these issues in to their investment decision making and ownership practices. The principles are voluntary and aspirational, as it gives possible actions for incorporating Sustainable Governance issues into investment practices across asset classes. 92 CU IDOL SELF LEARNING MATERIAL (SLM)
PRINCIPLE 1 – Incorporating ESG issues into Investment analysis and decision- making process: The Investors should seek companies which follows ESG (Environmental and Social Governance) framework. The followings possible actions are also considered while evaluating investment options: Support development of ESG – related tools, metrics and analyses. Assess the capabilities of Internal and External investment managers to incorporate ESG issues. Encourage academic and other research on this theme to explore further. Advocate ESG training for investment professionals. Investment advisors should integrate ESG factors into evolving research and analysis. PRINCIPLE 2 – Owners should incorporate ESG issues into their Policies and Practices: Owners should develop and disclose an active ownership policy consistent with the global prescribed standards. Following action points to be considered to incorporate ESG issues: Exercise voting rights or monitor compliance with voting policy. Participate in the development of policy, regulation and standard setting. Participate in collaborative engagement initiatives. Ask investment managers to undertake and report on ESG related engagement. PRINCIPLE 3 – Seek appropriate Disclosure: Demand for standardized reporting on ESG issues and should be integrated within annual financial reports. Ask for information from companies regarding adoption to relevant norms, standards, codes of conduct or international initiatives. Support shareholder initiatives and resolutions promoting ESG disclosure. PRINCIPLE 4 – Encourage Acceptance and Implementation of the principles within Investment industry: Possible actions include: Principles-related requirements in requests for proposals. 93 CU IDOL SELF LEARNING MATERIAL (SLM)
Align investment mandates, monitoring procedures, processes, performance indicators and incentive structures accordingly. Communicate ESG expectations to investment service providers. Re-evaluate the relationships with service providers that fail to meet ESG expectations. Support the development of tools for setting standards to ESG integration. PRINCIPLE 5 – Unite together to enhance effectiveness in Implementation: Support actions and information platforms to share tools, collecting resources and make use of disclosure as a source of learning. The investing society should collectively address the emerging issues. The issues resolved by developing or supporting appropriate collaborative initiatives. PRINCIPLE 6 – Report on Progress towards implementation: Companies should disclose how ESG issues are imbibed with investment practices and active ownership activities. ESG issues and the principles should be communicated with beneficiaries appropriately and periodically. The Comply or explain approach requires signatories to report on how they implement the principles or provide an explanation where they do not comply with them. 7.4 RIGHTS OF SHAREHOLDERS Shareholders Rights Under Companies Act Under SEBI(LODR) Under SEBI (Prohibition of Regulation Insider Trading) Regulation A) Under Companies Act 2013: Right to receive Copies of abridged Balance sheet and P&L Account, Notices of the General Meeting of the company. Right to attend meetings of the shareholders and exercise voting rights at these meetings either personally or through proxy. 94 CU IDOL SELF LEARNING MATERIAL (SLM)
Right to inspect Statutory registers / returns and get copies of Debenture Trust Deed, Register of Charges, Register of Members, Register of Contracts, Register of Director’s shareholding, Copy of agreement of appointment of the Managing Director. Right to receive copies of Minutes of General Meetings. Right to receive share certificates as title of their holdings. Right to transfer of shares. Right to receive Dividend when declared. Right to appoint directors. Right to make application collectively to the Tribunal for Protection against Oppression and Mismanagement. Right for Nomination. Right to Vote in proportion to his share of the paid-up equity capital of the company. Right to apply for winding up of a company in case of Oppression and Mismanagement. B) Under SEBI(Listing Obligations and Disclosure Requirement) Regulations, 2015: i) The listed entity shall seek to protect and facilitate the exercise of the following rights of shareholders: Right to participate in decisions concerning fundamental corporate changes and to be sufficiently informed. Right to receive information regarding rules, including voting procedures that govern general shareholder meetings. Right to raise queries to the board of directors, to place items on the agenda of general meetings, and to propose resolutions, subject to reasonable limitations. Right to exercise ownership right including institutional investors. Right to participate effectively and vote in general meetings. Right to access adequate mechanism to address the grievance. Protection of minority shareholders from abusive actions by the majority shareholders acting either directly or indirectly. ii) The Listed entities shall provide adequate and timely information to shareholders, including: 95 CU IDOL SELF LEARNING MATERIAL (SLM)
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. Rights attached to all series and classes of shares, which shall be disclosed to investors before they acquire shares. Capital structures and arrangements that enable certain shareholders to obtain a degree of control disproportionate to their equity ownership. Disclose all the material changes in the managements and also financial statements periodically. iii) The Listed Companies shall ensure equitable treatment of all shareholders, including minority and foreign shareholders, in the following manner: Shareholder Activism is key in effective corporate governance decisions, such as the nomination and election of members of board of directors, shall be facilitated. All shareholders of the same series of a class shall be treated equally. Facility should be given to foreign shareholders to exercise their rights. The listed entity shall devise a framework to avoid Insider trading and abusive self-dealing. Processes and procedures for general shareholder meetings shall allow for equitable treatment of all shareholders. Procedures of listed entity shall not make it unduly difficult or expensive for shareholders to cast their votes. C) Under SEBI (Prohibition of Insider Trading) Regulations, 2015: Managerial personnel have more information compared with shareholders as the KMPs is involved in day to day affairs of the business. Hence, they may take an advantage of knowing things earlier and act in their own benefit. In simple, they will have UPSI (Unpublished Price Sensitive Information), through which they may have undue advantage over other stakeholders. The regulation deals with the Restrictions on communication and Trading by Insiders, it provides that other than contained in this regulation, an UPSI may be communicated, allowed access to or procured, in connection with a transaction that would – entail an obligation to make an open offer under the takeover regulations 96 CU IDOL SELF LEARNING MATERIAL (SLM)
where the board of directors of the company is of informed opinion that the proposed transaction is in the best interest of the company. The above provision is intended to acknowledge the necessity of communicating or allowing access to prices sensitive information to the transactions such as Takeovers, Mergers and Acquisitions involving trading in securities and change of control to assess a potential investment. In an open offer under the regulations, not only would the same price be made available to all shareholders of the company but also all information necessary to enable an informed divestment or retention decision by the public shareholders is required to be made available to all shareholders in the letter of offer under those regulations. 7.5 PROTECTION OF MINORITY SHAREHOLDERS In corporate world, all democratic decisions and management of a company are made with the majority rule which is deemed to be fair and justified. The majority rule of decision making, quite often than not overlooks the views of minority shareholders. A minority shareholder is a person in a company who does not enjoy much power in the management of the company and their interests are disregarded. Companies Act 2013 provides for some measures to protect the interest of minority shareholders. It includes the following: Where a company, which has raised money from public through prospectus and still has any unutilized amount out of the money so raised and which proposes to change its objects, then the promoter and shareholders having control of a company are required to provide an exit to the dissenting shareholders in accordance with regulations to be specified by SEBI. Where any benefit accrues to promoter, director, manager, KMO or their relatives, either directly or indirectly as a result if non-disclosure or insufficient disclosure in the explanatory statement annexed to the notice of general meeting then such persons shall hold such benefit in trust for the company and shall be liable to compensate the company to the extent of the benefit received by him. Class action suit has been introduced and in case of oppression / Mismanagement, specified number of members or depositors is entitled to file class action suit before NCLT for seeking prescribed reliefs. They may also claim damages / compensation for fraudulent / unlawful / wrongful acts from or against the company / directors / auditors / experts / advisors etc. some of the actions that can be taken are as under: 97 CU IDOL SELF LEARNING MATERIAL (SLM)
Restrain company from any act which is ultra-vires the AOA / MOA Restrain company for breach of provisions of MOA / AOA, Act or any other law. Declare a resolution void if material facts are not provided. Restrain company/ directors from acting on such resolutions. Restrain company from taking-action contrary to any resolution passed by shareholders. Claim damages or compensation or demand any other suitable action. Seek other remedies as Tribunal may deem fit. 7.6 SUMMARY Protection of shareholder rights is sacrosanct for good corporate governance. It is one of the pillars of corporate governance. Any member of a company who complain that the affairs of the company are being conducted in a manner prejudicial to public interest or in a manner oppressive to any member or members may apply to the Tribunal for an order. Shareholder has right to pass a Special Resolution, resolving that the company be wound up by the Tribunal. Independent judgement is critical to monitoring related party transactions and to ensure that agreed transactions are in the interests of the company and all shareholders. The company shall disclose in its Corporate Governance Report, about the whistle Blower policy and affirmation that no personnel has been denied access to the audit committee. Shareholder Activism refers to the active involvement of stockholders in their organization. Shareholders can ensure that the company follows good corporate governance practices and implements beneficial policies. Investor Relations is a strategic management responsibility that integrates finance, communication, marketing and securities law compliance to enable the most effective two-way communication between a company, the financial community, and other constituencies, which ultimately contributes to a company’s securities achieving fair valuation. 98 CU IDOL SELF LEARNING MATERIAL (SLM)
In India, the SEBI Act 1992, the various SEBI Regulations / Guidelines and the Companies Act 2013 enable the empowerment of Shareholder Rights. Investor education and Protection Fund has been established under section 125 of the Companies Act 2013, for promotion of investors’ awareness and protection of the interests of investors. Institutional investors are organizations which pool large sums of money and invest those sums in companies. Their role in the economy is to act as highly specialized investors on behalf of others. The Institutional investors use different tools like one-to-one meetings, focus lists, Corporate Governance rating systems, etc. to assess the health of company before investing resources in it. 7.7 KEYWORDS Shareholders activism - It refers to the active involvement of stockholders in their organization. Active participation in company meetings is a healthy practice. They can resolve issues laid down in the annual and other general meetings and can raise concerns over financial matters or even social causes such as protection of the environment. UPSI- Unpublished Price Sensitive Information – It means any information which relates to the internal matter of a company and is not disclosed by the company in the regular course of business. If such information is leaked, it affects the price of securities of the company in the market. Oppression – It is a conduct of visible departure from the standards of fair dealing and a violation of conditions in order the suppress the minority shareholders by the majority shareholders. Mismanagement - Conducting affairs in a pre-judicial, dishonest or inappropriate manner by misusing the powers by the concerned authorities. It will affect the interest of entire stakeholders. Proxy – An agent legally authorized to act on behalf of another party. Proxy may also allow an investor to vote without being physically present at the Shareholder’s meeting. 99 CU IDOL SELF LEARNING MATERIAL (SLM)
Charges –An Interest or Lien created on the property or assets of a company or any of its undertakings or both as security and includes a mortgage. Kinds of Charges: Fixed Charge – It is created to cover assets that are associated and definite, security in terms of certain specific property. Floating Charge –It is not attached to any definite property but covers property which is fluctuating type. 7.8 LEARNING ACTIVITY 1. Define Minutes ___________________________________________________________________________ ___________________________________________________________________________ 2. Discuss the Importance of shareholder activism. ___________________________________________________________________________ ___________________________________________________________________________ 7.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Define Charges. 2. Define Institutional Investors. 3. What do you mean by Focus List? 4. What are the Tools used by Institutional Investors? 5. Define Shareholder Activism. Long Questions 1. Explain the Rights of Shareholders stipulated under Companies Act and SEBI (LODR) Regulation. 2. Explain the Principles of Responsible Investment. 3. Describe the Role of Institutional Investors in Corporate Governance. 4. Explain the Evolution of Shareholders Activism. 5. Describe the Advantages on the Role of Institutional investors in promoting corporate governance. 6. Describe the adverse effects of Insider Trading on the progress of an organization. 100 CU IDOL SELF LEARNING MATERIAL (SLM)
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