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Transcript of Bgs Module-3 Ps
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Module-3
Corporate Governance
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Module overview
Definition, Market model and control model
OECD on corporate governance
Historical perspective of CG
Issues, Relevance, need and importance in CG
Benefits of good CG
Concept of corporate and Governance
Theoretical basis for CG,
Obligation to society, investors, emp, customers,manager
Indian Cases
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What is Corporate Governance?
Corporate governance is dealing with problemsthat result from the separation of ownership andcontrol.
corporate governance would focus on: The internal structure and rules of the board of
directors;
the creation of independent audit committees;
rules for disclosure of information to shareholders andcreditors;
control of the management.
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Definition
It is a system by which companies are directed
and controlled (OECD)
It is a set of relationships b/w a companys
management, board, shareholders and
stakeholders
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How a corporation is structured
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The market model
Non-executive
majority boards
Aligned incentives,effective control
High disclosure
Shareholder equalityActive take-over market
Active private equity
And IPO market
Dispersed ownership
Sophisticated
Institutional
investors
Independence and
performance
Shareholder
environment
Transparency and
accountabilityCapital market liquidity
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Market model
Market model governance chain , there are
efficient, well developed equity markets and
dispersed ownership,
common in the developed industrial nations
such as US,UK, Canada and Australia.
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The control model
Insider boards
Incentives aligned
with core shareholders,
ineffective control
Limited disclosure
Lack of minority
protection
Limited takeover
market
Underdeveloped
IPO market
Concentrated
ownership
Reliance on family,
bank and public
finance
Shareholder
environment
Independence
andperformance
Capital market liquidity
Transparency and
accountability
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Control model
The governance chain is represented by
underdeveloped equity markets,
concentrated family ownership,
less shareholder transparency and
inadequate protection of minority and foreign
shareholders.
More familiar in Asia, Latin America and someeast European nations.
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OECD on Corporate Governance
The OECD (org for economic corporation and
development) has emphasized the foll
requirements of corporate governance
Rights of shareholders
Equitable treatment of shareholders
Role of stakeholders in CG
Disclosure and transparency
Responsibilities of the board
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Right of shareholders
Include secure ownership of their shares,
voting rights,
the right to full disclosure of information,
participation in decisions on sale or any change incorporate assets (mergers).
Have right to know the capital structure of the
corporation Transactions should be at transparent prices and
under fair conditions
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Equitable treatment of shareholders
Minority and foreign shareholders should getequitable treatment.
Get equal opportunity for redressal of theirgrievances and violation of their rights.
Should not face undue difficulties in exercisingtheir voting rights.
Directors should disclose any material interestregarding transactions.
Avoid situations involving conflict interest whilemaking decisions
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Role of stakeholders in CG
There are stakeholders apart fromshareholders
Dealers, consumers, Govt. and others like
banks, bondholders and workers are imp forcompanies to perform and make decisions
CG framework should allow emp
representation on board of directors, profitsharing, creditors , involvement in insolvencyproceedings.
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Disclosure and transparency
Disclose key information about
financial details,
operating results,
governance structure and policies,
BOD their remuneration,
foreseeable risk factors,
issues regarding emp & other stake holders.
Annual audits should be performed.
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Responsibilities of the board
Functions include
corporate strategy,
risk,
executive compensation and performance,
accounting and reporting systems,
monitoring effectiveness and changing them if
needed.
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Historical perspective on CG
The seed of CG was sown by the Watergatescandal during the Nixon presidency in US.
The need to arrest such unhealthy trendtranslated into the legislation of Foreign andCorrupt Practices Act of 1977 in US.
The Treadway commission report (1987) toidentify the misrepresentation in financialreports.
Committee of sponsoring org (COSO) came intobeing in 1992 stipulated a control framework forthe orderly functioning of corporations.
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Historical perspectives on CG
In England, Sir Adrian Cadbury was entrustedin 1991, by the London stock exchange.
Cadbury committee had the task of drafting a
code of practices to assist corporations indefining and applying internal controls to limittheir exposure to financial loss.
Bank failures in west necessitated closemonitoring of the banking system so the Baselcommittee worked in this field.
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Issues in CG
1. Distinguishing the roles of board and
management
2. Composition of the board and related issues
3. Separation of the roles of the CEO and
chairperson
4. Should the board have committees?
5. Appointments to the board and directors re-
election
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Issues in CG
6. Directors and executives remuneration
7. Disclosure and audit
8. Protection of shareholder rights and theirexpectations
9. Dialogue with institutional shareholders
10.Should investors have a say in making acompany socially responsible
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Distinguishing the roles of board and
management
The board of a listed company has the foll functions
Select, decide the remuneration and evaluate on a regularbasis and when necessary, change the CEO
Oversee the conduct of the co. business to evaluate
whether or not it is being correctly managed Review and approve co. financial objectives and corporate
plans
Render advice and counsel top mgmt
Identify and recommend candidates to shareholders forelecting them to BOD
Review system to comply all applicable laws andregulations
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Composition of board and related
issues
BOD- committee selected by the shareholders
of a limited co. to be responsible for the policy
of the co.
Board of Directors
Executive directors Non-executive
directors
Independent directorsAffiliated directors
(nominee directors)
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Composition of board and related
issues
Executive director is one who is an executive of the co.and also a member of the BOD
Non-executive director has no separate employmentrelationship with the co.
Independent non-executive directors are thosedirectors on the board who are free from any businessor other relationships which could materially interfere,with the exercise of their independent judgment in theprocess of decision making as a member of a board.
An affiliated director or a nominee director is a nonexecutive director who has some kind ofindependence, impairing relationship with the co.
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Separation of the roles of the CEO and
the chairperson
The role of CEO is to lead the senior
management team in managing the
enterprise.
The role of the chairperson is to lead the
board, imp responsibility of the board is to
evaluate the performance of senior executives
including the CEO
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Should the board have committees?
Committees on CG have recommended
appointment of special committees for
Nomination
Remuneration
Auditing
These committees lessen the burden of the
board and enhance its effectiveness
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Appointments to the board and
directors re-election
Shareholders are a legion in large co. and alsoscattered and to have them together to electthe directors will be expensive and time
consuming In actual practice, the board or its committee
selects and appoints the prospective directorand gets the person formally elected by theshareholders at the ensuring annual generalbody meeting
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Directors and executives remuneration
CG laid emphasis on issues such as
Transparency
Pay for performance
Process for determination
Severance payments
Pensions for non-executive directors
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Disclosure and audit
Cadbury report and Bosch report stressed that
the BOD has a bounden responsibility to
present the shareholders a lucid and balanced
assessment of the co. financial positionthrough audited financial statements.
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Protection of shareholder rights and
their expectations
Corporate practices vary from country to country.
Various committees and org that have addressed
the issues
Should co. adhere to one share one vote principle?
Should co. retain voting by a show of hands or by poll?
Should shareholder approval be required for all major
transactions? Can shareholders resolution be bundled?
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Dialogue with institutional
shareholders
Cadbury committee recommends that
institutional investors should maintain regular
and systematic contact with co. apart from
their participation in general meetings ofshareholders, use voting rights, take interest
in composition of BOD.
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Should investors have a say in making a co.
socially responsible corporate citizen?
Conflict b/w 2 schools of thought
1- based on assumption that sociallyresponsible behavior of corporations such as
ecological preservation, anti-pollutionmeasures and producing quality andenvironment friendly products
2- who work to make their gains Dove chemicals, Johnson & Johnson, Pfizer, to
prove this
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Relevance of CG
The separation of ownership from managementcreates an issue of trust.
Management has to be trusted to run the
company in the interest of shareholders andstakeholders.
Information is not available to all stakeholders inthe same form at the same time.
In real world of imperfect information, eachagent will use whatever information advantagehe may have.
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Need and importance of CG
Corporations are multinational/transnational innature- impact on citizens of several countiesacross the globe
If things go wrong it will affect many countries
It is needed to create a corporate culture ofconsciousness, transparency and openness
It will lead to increase in customer satisfactionand shareholder value and wealth
Environment is being ensured to be transparentand accountable.
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Benefits of good CG
1. Creation and enhancement of a corporations
competitive advantage
2. Enabling a corporation perform efficiently by
preventing fraud
3. Providing protection to shareholders interest
4. Enhancing the valuation of an enterprise
5. Ensuring compliance of laws and regulations
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Concept of Corporate
Corporate has contributed much to the
growth of market driven economies.
Corporate is the nucleus of all business
activities in modern economies
Lawyers and economists describe the
corporate as a nexus of contracts the
corporation is nothing more than the sum of
all of the agreements leading to its creation.
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What is a corporate?
A corporation is an association of personsrecognized by the law as having a collectivepersonality.
Characteristics of a corporate: Incorporated association
Artificial legal existence
Perpetual existence
Extensive membership Separation of management and ownership
Limited liability and transferability of shares
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What is a corporate?
The corporate of today differs from individual
capitalist in 2 aspects
The life span of the corporation is much longer
It is more rational in decision making by virtue of
the fact that it has the benefit of the collective
wisdom of the BOD. They take decisions using the
principles of cost accounting, budget analysis,data collection and processing and managerial
consulting
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The concept of governance
Governance means the process of decision
making and the process by which decisions
are implemented
Governance focuses on the formal and
informal players involved in decision making
and implementing the decisions made.
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Theoretical basis of CG
4 broad theories to explain and elucidate CG
Agency theory
Stewardship theory
Stakeholder theory
Sociological theory
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Agency theory
In modern corporation, where share ownership is
widely held, managerial actions depart from
those required to maximize shareholder returns.
In agency theory terms, the owners and theprincipals and the managers are the agents and
there is an agency loss, which is the extent to
which returns to the owners fall. Agency theory specifies mechanisms that reduce
agency cost
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Agency theory
There are 2 broad mechanisms that help
reduce agency costs and hence, improve
corporate performance through better
governance Fair and accurate financial disclosures
Efficient and independent BOD
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Stewardship theory
This theory assumes that managers are basicallytrustworthy and attach significant value to their ownpersonal reputations.
It defines situations in which managers are stewards
whose motives are aligned with the objectives of theirprinciples.
A stewards behavior will not depart from the interestsof his/her org.
Control can be potentially counterproductive, becauseit undermines the pro-organizational behavior of thesteward by lowering his/her motivation.
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Behavioral differencesAgency theory Stewardship theory
Manager acts as agent Managers act as stewards
Governance approach is materialistic Governance approach is sociological and
psychological
Behavior pattern is individualistic,
opportunistic, self-serving
Behavioral pattern is collective, pro-
organizational, trustworthy
Managers are motivated by their own
objectives
Managers are motivated by the principals
objective
Interests of the managers and principals
differ
Interests of the manager and principals
converge
The role of the management is to monitor
and control
The role of the management is to
facilitate and empower
Owners attitude is to avoid risks Owners attitude it to take risks
Principal manager relationship is based
on control
Principal manager relationship is based
on trust
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Psychological mechanisms
Agency theory Stewardship theory
Motivation revolves around
Lower orders
Extrinsic needs
Motivation revolves around
Higher order needs
Intrinsic needs
Social comparison is b/w compatriots Social comparison is b/w principals
There is little attachment to the company There is great attachment to the company
Power rests with the institution Power rests with the personal
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Situational mechanismsAgency theory Stewardship theory
Management philosophy is controloriented
Management philosophy is involvementoriented
To deal with increasing uncertainty and
risk, the theory advocates exercise of
Greater controls
More supervisions
To deal with increasing uncertainty and
risk, the theory advocates exercise of
Training and empowering people
Making jobs more challenging andmotivating
Risk orientation is done through a system
of control
Risk orientation is done through trust
Time frame is short term Time frame is long term
The objective is cost control The objective is improving performance
Cultural difference revolve around
Individualism
Larger power distance
Cultural difference revolve around
Collectivism
Small power distance
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Stakeholder theory
The theory is grounded in many normative,
theoretical perspectives including ethics of
care, the ethics of fiduciary relationships,
social contract theory, theory of propertyrights, and so on.
Stakeholder theory is often criticized mainly
because it is not applicable in practice bycorporations.
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Sociological theory
This theory has focussed mostly on board
composition and wealth distribution.
Under this theory, board composition,
financial reporting, and disclosure and
auditing are of utmost importance to realize
the socio-economic objectives of
corporations.
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Obligations to society at large
A corporation is a creation of law,as an association of personsforming part of the society in whichit operates.
Its activities are bound to impactthe society as the societys valueswould have an impact on thecorporation.
Therefore, they have mutual rightsand obligations to discharge for thebenefit of each other.
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Obligations to society at large
National interest Political non-alignment
Legal compliances
Rule of law Honest and ethical conduct
Corporate citizenship
Ethical behavior
Social concerns CSR
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Obligations to society at large
Environment friendliness
Healthy and safe working environment
Competition
Trusteeship Accountability
Effectiveness and efficiency
Timely responsiveness
Corporation should uphold the fair name of thecountry
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Obligations to investors
Towards shareholders
Measures promoting transparency and
informed shareholder participation
Transparency
Financial reporting and records
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Obligation to employees
Fair employment practices
Equal opportunities employer
Encouraging whistle blowing
Humane treatment
Participation
Empowerment
Equity and inclusiveness
Participative and collaborative environment
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Obligation to customers
Quality of products and services
Products at affordable prices
Unwavering commitment to customer
satisfaction
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Managerial obligation
Protecting companys assets
Behavior towards government agencies
Control
Consensus oriented Gifts and donations
Role and responsibilities of corporate board and
directors Direction and management must be distinguished
Managing and whole time directors
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END OF MODULE-3
Thank you