Session II

1. Session II Session Title Meaning and concept of corporate governance, evolution of corporate governance in India and other parts of world. Need and essence of corporate governance and role of CAG in this regard.

2. Session Overview • Corporate governance , the most chanted mantra of 21st century, translates into conducting the affairs of a company in a manner that ensures fairness and transparency to customers, employees, investors and vendors, the Government and to the society at large. • The Corporate Governance refers to building confidence and increasing the trust of various stakeholders in its approach to managing the affairs of the company. • It is about bringing efficiently and effectiveness by using fair, ethical and transparent means. Continued…..

3. In India weakness in the system such as undesirable stock market practices, boards of directors without fiduciary responsibilities, poor disclosure practices, lack of transparency and chronic capitalism were all crying for reforms and improved governance. • The momentum gathered after liberalization process got initiated in early 1990s. • Since this requires heavy influx of capital from across the world, our corporate sector has to achieve highest standards of corporate governance so as to attract investment from outside India by way of foreign direct investment and raising loans. Continued…

4. As per the provisions of section 19 of the C&AG’s (DPC) Act 1971, the audit of Government Companies and Corporations shall be conducted by him in accordance with the provisions of the Companies Act 1956. • Section 619(3) (a) of the Companies ACT, the C&AG is empowered to direct the manner in which the Company’s accounts shall be audited by the auditors appointed by him under Section 619(2) ibid. • The provisions of section 619(4) confers the right to C&AG to comment on supplement the report of the Auditors appointed by him. • Section 19-A of C&AG’s (DPC) Act provides that the report of the C&AG shall be submitted to the Central/State Government and it shall be laid before each house of Parliament/Legislature of the State. • These provisions can thus, very well elaborate the importance of duties of the C&AG. Continued…

5. Concept of Corporate Governance • Sir Adrian Cadbury Committee, which looked into corporate governance issues in U.K. defines Corporate Governance “as the system by which the companies are directed and controlled. The basic objective of corporate governance is to enhance and maximize shareholder value and protect the interest of other stake holders”. • According to World Bank, Corporate Governance is Blend of law, regulation and appropriate voluntary private sector practices, Continued….

6. Which enables the corporation to attract financial and human capital to perform efficiently, and • Prepare itself by generating long term economic value for its shareholders, • While respecting the interests of stakeholders and society as a whole • The Kumar 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 financialreporting structure” Continued….

7. N.R. Narayana Murthy Committee on Corporate Governance constituted by SEBI has observed "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." Continued…

8. The Institute of Company Secretaries of India has also defined the term Corporate Governance as under: "Corporate Governance is the application of best management practices, compliance or jaw in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stakeholders." • Another comprehensive definition given in the report on corporate governance that was accepted for implementation by the Singapore Government is that the term refers to the “process and structure by which the business and affairs of the company are directed and managed in order to enhance long term shareholder value through enhancing corporate performance and accountability, whilst taking into account the interests of other stakeholders”. Continued…..

9. In the narrow sense, corporate governance involves a set of relationship amongst the company’s management, its board of directors, its shareholders, its auditors and other stakeholders. • These relationships, which involve various rules and incentives, provide the structure through which the objectives of the company are set, and the means of attaining these objectives as well as monitoring performance are determined. • The key aspects of good corporate governance include transparency of corporate structures and operations; the accountability of managers and the boards to shareholders; and corporate responsibility towards stakeholders. • While corporate governance essentially lays down the framework for creating long-term trust between companies and the external providers of capital, it would be wrong to think that the importance of corporate governance lies solely in better access of finance. Continued…..

10. Companies around the world are realizing that better corporate governance adds considerable value to their operational performance in the following ways: • It improves strategic thinking at the top by inducting independent directors who bring a wealth of experience, and a host of new ideas • It rationalizes the management and monitoring of risk that a firm faces globally • It limits the liability of top management and directors, by carefully articulating the decision making process • It assures the integrity of financial reports • It has long term reputational effects among key stakeholders, both internally and externally Continued….

11. In a broader sense, however, good corporate governance- the extent to which companies are run in an open and honest manner- is important for overall market confidence, the efficiency of capital allocation, the growth and development of countries’ industrial bases, and ultimately the nations’ overall wealth and welfare. • In both the narrow as well as in the broad definitions, the concepts of disclosure and transparency occupy center-stage. • In the first instance, they create trust at the firm level among the suppliers of finance. • In the second instance, they create overall confidence at the aggregate economy level. In both cases, they result in efficient allocation of capital. Continued….

12. There have been many debates on the question ‘Who should corporate governance really represent?’ • This issue of whether a company should be run solely in the interest of the shareholders • or whether it should take account the interest of all constituents Two definitions of Corporate Governance highlight the variation in the points of view: • ‘Corporate governance is concerned with ways of bringing the interests of investors and manager into line and ensuring that firms are run for the benefit of investors’. •  ’Corporate governance includes ‘the structures, processes, cultures and systems that engender the successful operation of organizations’ Continued….

13. In India, we have sought to resolve the “shareholder vs. stakeholder’’ debate by taking the view that : • Since shareholders are residual claimants, in well performing capital and financial markets, whatever maximises shareholder value should maximise corporate prosperity and best satisfy the claims of creditors, employees, shareholders, and the State. • There exist well-defined laws to protect the interests of employees, and recently framed legislations have considerably strengthened the rights of the creditors. • It is therefore appropriate that corporate governance regulations in India seek to promote the rights of shareholders, while at the same time ensuring that the interests of other stakeholders are not adversely impacted.

14. Objectives of Corporate Governance Good governance is integral to the very existence of a company. It inspires and strengthens investor's confidence by ensuring company's commitment to higher growth and profits. It seeks to achieve following objectives: (i) A properly structured Board capable of taking independent and objective decisions is in place at the helm of affairs; • The Board is balanced as regards the representation of adequate number of non-executive and independent directors who will take care of the interests and well-being of all the stakeholders. • The Board adopts transparent procedures and practices and arrives at decisions on the strength of adequate information; Continued……

15. (iv) The Board has an effective machinery to subserve the concerns of stakeholders; (v) The Board keeps the shareholders informed of relevant developments impacting the company; (VI)The Board effectively and regularly monitors the functioning of the management team; and (vii) The Board remains in effective control of the affairs of the company at all times. Continued….

16. Elements of good Corporate Governance • It is the manifestation of personal beliefs and values, which configure the organizational values, beliefs and actions of its Board. • The Board as a main functionary, is primary responsible to ensure value creation for its stakeholders. • The absence of clearly designated role and powers of Board weakens accountability mechanism threatens the achievement of organizational goals. • The foremost requirement of good governance is the' clear identification of powers, roles, responsibilities and accountability of the Board, CEO, and the Chairman of the Board. Continued….

17. The following are the essential elements of good corporate governance: • Transparency in Board’s processes and independence in the functioning of Boards by providing effective leadership to the company and management for achieving sustained prosperity for all stakeholders. • It should provide independent judgment for achieving company's objectives. ·Accountability to stakeholders with a view to serve the stakeholders and account to them at regular intervals for actions taken, through strong and sustained communication processes. ·Fairness to all stakeholders. ·Social, regulatory and environmental concerns • Clear and unambiguous legislation and regulations are fundamentals to effective corporate governance. Continued….

18. A healthy management environment that includes setting up of clear objectives and appropriate ethical framework, establishing due processes, clear enunciation of responsibility and accountability, sound business planning, establishing clear boundaries for acceptable behavior, establishing performance evaluation measures. ·Explicitly prescribed norms of ethical practices and code of conduct are communicated to all the stakeholders, which should be clearly understood and followed by each member of the organization. ·The objectives of the company must be clearly documented in a long-term corporate strategy including an annual business plan together with achievable and measurable performance targets and milestones. ·A well composed Audit Committee to work as liaison with the management. • Internal and statutory auditors, reviewing the adequacy of internal control and compliance with significant policies and procedures, reporting to the Board on the key issues. Continued….

19. Risk is an important element of corporate functioning and governance, which should be clearly identified, analyzed for taking appropriate remedial measures. • For this purpose the Board should formulate a mechanism for periodic reviews of internal and external risks. • A clear Whistle Blower Policy whereby the employees may without fear report to the management about unethical behaviour, actual or suspected frauds or violation of company’s code of conduct. • There should be some mechanism for adequate safeguard to employees against victimization that serves as whistle-blowers. Continued…

20. Evolution of Corporate Governance India • The concept of good governance is very old in India dating back to third century B.C. where Chanakya (Vazir of Parliputra) elaborated fourfold duties of a king viz. Raksha, Vriddhi, Palana and Yogakshema. • Substituting the king of the State with the Company CEO or Board of Directors the principles of Corporate Governance refers to protecting shareholders wealth (Raksha), • Enhancing the wealth by proper utilization of assets (Vriddhi), • Maintenance of wealth through profitable ventures (Palana) , • Safeguarding the interests of the shareholders (Yogakshema or safeguard). Continued….

21. Corporate Governance was not in agenda of Indian Companies until early 1990s.In India the necessity of reforms and improved governance is due to: • Weakness in the system such as undesirable stock market practices, • Boards of directors without adequate fiduciary responsibilities, • Poor disclosure practices, • Lack of transparency and chronic capitalism. • The fiscal crisis of 1991 and resulting need to approach the IMF induced the Government to adopt reformative actions for economic stabilization through liberalization. Continued…..

22. In 1999, the Government amended the Companies Act, 1956 as a part of liberalization process, • Further amendments have followed subsequently in the year 2000, 2002 and 2003. • A variety of measures have been adopted including the strengthening of certain shareholder rights (e.g. postal balloting on key issues), • The empowering of SEBI (e.g. to prosecute the defaulting companies, increased sanctions for directors who do not fulfill their responsibilities, limits on the number of directorships, changes in reporting and the requirement that a ‘small shareholders nominee’ be appointed on the Board of companies with a paid up capital of Rs. 5 crore or more) Continued…

23. The major corporate governance initiatives launched in India since the mid 1990s are discussed below: The CII Code • On account of the interest generated by Cadbury Committee Report of UK, the Confederation of Indian Industry (CII) took special initiative with the objective to develop and promote a code of Corporate Governance to be adopted and followed by Indian Companies both in private & public sector, Banks and Financial Institutions. • The final draft of the code was circulated in 1997 and the final code called ‘Desirable Corporate Governance Code’ was released in April 1998. • The Committee was driven by the conviction that good corporate governance was essential for Indian Companies to access domestic as well as global capital at competitive rates. • The code was voluntary, contained detailed provisions with focus on listed companies. Continued….

24. Kumar Mangalam Birla Committee Report • The second major initiative after CII was undertaken by the Securities and Exchange Board of India (SEBI) which set up a committee under the chairmanship of Kumar Mangalam Birla in 1999 with the objective of promoting and raising of standards of good corporate governance. • The Committee in its Report observed that “the strong Corporate Governance is indispensable to resilient and vibrant capital market 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 th muscle that moves a viable and accessible financial reporting structure”. Continued…..

25. In early 2000 the SEBI Board accepted and ratified the key recommendations of this committee and these were incorporated into Clause – 49 of the Listing Agreement of the Stock Exchanges. • These recommendations, are divided into mandatory and non-mandatory recommendations. • The recommendations have been made applicable to all listed companies with the paid-up capital of Rs. 3 crore and above or net worth of Rs.25 crore or more at any time in the history of the company. • The ultimate responsibility of putting the recommendations into practice rests directly with the Board of Directors and the management of the company Continued….

26. Report of Task Force • In May 2000, the Department of Corporate Affairs (DCA) formed a broad based study group under the chairmanship of Dr. P.L. Sanjeev Reddy, Secretary of DCA. • The group was given the ambitious task of examining ways to “operationalise 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 on Corporate Excellence set up by the group produced a report containing a range of recommendations for raising governance standards among all companies in India. Continued…..

27. Naresh Chandra Committee Report • The Enron debacle of 2001 involving the hand-in-glove relationship between the auditor and the corporate client, the scams involving the fall of the corporate giants in the U.S. like the WorldCom, Owest, Global Crossing, Xerox and the consequent enactment of the stringent Sarbanes Oxley Act in the U.S. led the Indian Government to wake up. • A committee was appointed by Ministry of Finance and Company Affairs in August 2002 under the chairmanship of Naresh Chandra to examine and recommend inter alia amendments to the law involving the auditor-client relationships and the role of independent directors. • The committee made recommendations in two key aspects of corporate governance: financial and non-financial disclosures: • and independent auditing and board oversight of management. Continued…..

28. Narayana Murthy Committee Report • The SEBI after analyzing the statistics of compliance with the clause-49 by listed companies felt 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. • The SEBI constituted a committee under the chairmanship of Narayana Murthy for reviewing implementation of the corporate governance code by listed companies and issue of revised clause 49. Some of the major recommendations of the committee primarily related to: • audit committees, • audit reports, • independent directors, • related party transactions, • risk management, • directorships and director compensation, • codes of conduct and financial disclosures. Continued…..

29. J.J. Irani Committee Report • The Companies Act 1956 was enacted on the recommendations of the Bhaba Committee set up in 1950 with the object to consolidate the existing corporate laws and to provide a new basis for corporate operation in independent India. • With enactment of this legislation in 1956 the Companies Act 1913 was repealed. • 24 amendments have taken place since 1956. • The major amendments to the Act were made through Companies (Amendment) Act 1998 after considering the recommendations of Sachar Committee followed by further amendments in 1999, 2000, 2002 and finally in 2003 through the Companies (Ammendment) Bill 2003 pursuant to the report of R.D. Joshi Committee. Continued…..

30. After a hesitant beginning in 1980, India took up its economic reforms programme in 1990s and a need was felt for a comprehensive review of the Companies Act 1956. • The Government took a fresh initiative by providing a framework that would facilitate faster economic growth and constituted a committee in December 2004 under the chairmanship of Dr. J.J. Irani with the task of advising the government on the proposed revisions to the Companies Act 1956. The recommendations of the Committee submitted in May 2005 mainly relate to : • management and board governance, • related party transactions, • minority interest, • investors education and protection, • access to capital, • accounts and audit, • mergers and amalgamations, • offences and penalties, • restructuring and liquidation, etc.

31. Central Coordination and Monitoring Committee • A high powered Central Coordination and Monitoring Committee (CCMC) co-chaired by Secretary, Department of Corporate Affairs’ and Chairman, SEBI was set up by the Department of Corporate Affairs to monitor the action taken against the vanishing companies and unscrupulous promoters who misused the funds raised from the public. • The committee decided that seven Task Forces be set up at Mumbai, Delhi, Chennai, Kolkata, Ahmedabad, Bangalore and Hyderabad with Regional Directors/Registrar of Companies of respective regions as convener, and Regional Offices of SEBI and Stock Exchanges as Members. • The main task of these Task Forces was to identify the companies, which have disappeared, or which have misutilised the funds mobilized from the investors and suggest appropriate action in terms of Companies Act or SEBI Act. Continued….

32. National Foundation of Corporate Governance Recently the Ministry of Company Affairs has set up National Foundation for Corporate Governance (NFCG) in association with Confederation of Indian Industry (CII), Institute of Company Secretaries of India (ICSI) and Institute of Chartered Accountants of India (ICAI). The NFCG would focus on the following areas: • Creating awareness on the importance of implementing good corporate governance practices both at the level of individual corporations and for the economy as a whole. The foundation would provide a platform for quality discussions and debates amongst academicians, policy makers, professionals and corporate leaders through work­shops, conferences, meetings and seminars. • Encouraging research capability in the area of corporate governance in the country and providing key inputs for developing laws and regulations, which meet the twin objectives of maximizing wealth creation and fair distribution of this wealth. Continued…

33. Working with the regulatory authorities at multiple levels to improve implementation and enforcement of various laws related to corporate governance. • Working In close co-ordination with the private sector, work to instill a commitment to corporate governance reforms and facilitate the development of a corporate governance culture. • Cultivating international linkages and maintaining the evolution to­wards convergence with international standards and practices for accounting, audit and non-financial disclosure. • Setting up of 'National Centers for Corporate Governance' across the country, which would provide quality training to Directors as well as produce quality research and aim to receive global recognition. Continued….

34. Need and Essence of Corporate Governance There are at least three reasons for regulatory intervention. • The main reason advocated in favour of mandatory rules is that if the founder of the company was allowed to design and implement a corporate charter he likes, he may not clearly address the issues faced by other shareholders and thus would, in the view of the society, conjure inefficient rules. • The functioning of the market for corporate control is an example. Continued…..

35. In absence of regulations, founders could employ anti-takeover defenses excessively and in the process not allow the capital employed, which is owned by the shareholders, to be used most efficiently. • Alternatively, shareholders may favor takeovers that increase the value of their shares even if they involve greater losses for unprotected creditors or employees. • Thus, in absence of regulations, the collective bargaining process may not yield socially acceptable solutions and may be at the peril of one or multiple stakeholders • Another argument for mandating regulations of corporate governance comes from the externality argument. • An externality may be defined as a good, generated as the result of an economic activity, whose benefits or costs do not accrue directly to the parties involved in the activity. Continued…..

36. One corporate failure or scandal can potentially erode shareholders trust in the whole of the corporate sector and thus negatively affect the businesses of honest firms as well. • This theory is reinforced by the recent corporate scandals in the United States Viz. instances of fraud, as seen in the case of Enron , WorldCom, destroy the faith of investors in the entire corporate sector and thus hurt the larger interest of the economy. • Thus where private action fails to resolve widespread externalities involving large numbers of parties, the state has the responsibility to intervene to provide a level playing field and also to prevent market failure. Continued…

37. In case of dispersed shareholding, due to the (individual) large cost of monitoring the company on a regular basis, there remains a possibility that management may change the rules (to their advantage) ex post. • The final argument in support of mandatory rules is to avoid a situation where efficient rules are designed initially but due to lack of active tracking by dispersed shareholders, are altered or broken later. • The SEBI envisages that corporate governance norms will be enforced through listing agreements between companies and the stock exchanges. • A little reflection suggests that for companies with little floating stock — which account for more than 85% of the listed companies — delisting because of non-compliance is hardly a credible threat. • The SEBI can, of course, counter that by stating that the reputation effect of de-listing can induce compliance and, hence better corporate governance. Continued…..

38. There is a fear that by legally mandating several aspects of corporate governance, the regulators might unintentionally encourage the practice of companies ticking checklists, instead of focusing on the spirit of good governance. • The fear is not unfounded. Take, for instance, the case of Korea. • After the crash of 1998, a part of the IMF bailout package was that a fourth of the board of every listed Korean company must consist of independent directors. They do, but the directors are hardly independent by any stretch of imagination. Continued……

39. There is an apprehension that over-regulation of corporate governance could disrupt the functioning and quality of boards without resulting in any substantial improvement in the standards of corporate governance. • It needs to be ensured that unwittingly micro-management of companies does not take place. • This raises a question of how to trace the line that divides voluntary from mandatory. • In an ideal world with efficient capital markets, such a question need not arise — because the markets would recognize which companies are well governed and which are not, and reward and punish accordingly. • Unfortunately, ideal capital markets exist only in theory. The reality is quite different. • Markets are often thin and shallow and operate on the basis of ebbs and flows of pivotal stocks; informational requirements are lax; and regulatory and policing devices leave much to be desired. Continued….

40. Thus, what is needed a small corpus of legally mandated rules, buttressed by a much larger body of self-regulation and voluntary compliance. • Good governance is decisively the manifestation of personal beliefs and values which configure the organizational values, beliefs and actions of its Board. • The Board as a main functionary is primarily responsible to ensure value creation for its stakeholders. • The absence of clearly designated role and powers of Board weakens accountability mechanism and threatens the achievement of organizational goals. • Therefore, the essence of good governance is a clear identification of powers, roles, responsibilities and accountability of the Board, CEO and the Chairman of the Board.

41. Role of Comptroller and Auditor General of India • The external audit in India derives its mandate from (a) the Constitution of India and (b) Comptroller and Auditor General’s (Duties, Power and Conditions of Service) Act 1971. • The Constitution of India has vested functions with the Comptroller and Auditor General of India (CAG). • The CAG is the head of the Supreme Audit Institution of India (SAI) and he derives his duties and powers from Article 149 to 151 of the Constitution of India and the Comptroller and Auditor General’s (Duties, Powers and Conditions of Service) Act 1971. Continued…

42. Under provisions of the Constitution of India and the Act, the CAG is the sole auditor of accounts of the Central Government and the State Governments.. • The external audit set up in our democratic set up is a means through which the legislative accountability of the executive is ensured in the matter of finance. • Under provisions of Section 19 (1) of the Act, the duties and powers of the CAG in relation to the audit of the accounts of Government companies shall be performed and exercised by him in accordance with the provisions of the Companies Act 1956. • Under sub section (2) of Section 19 of the Act, the duties and powers of CAG in relation to the audit of the accounts of corporations (not being companies) established by or under law made by Parliament shall be performed and exercised by him in accordance with the provisions of the respective legislations. Continued….

43. The sub section (3) of Section 19 of the Act provides that the Governor of a State or the Administrator of a Union Territory having a Legislative Assembly may, where he is of opinion that it is necessary in the public interest so to do, request the CAG to audit the accounts of a corporation established by law made by the Legislature of the State or of the union territory, as the case may be, and where such request has been made, the CAG shall audit the accounts of such corporation and shall have, for the purposes of such audit, right of access to the books and accounts of such corporation: • Provided that no such request shall be made except after consultation with the CAG and except after giving reasonable opportunity to the corporation to make representations with regard to the proposal for such audit. Continued…

44. Further, under provisions of Section 19-A of the Act, the reports of the CAG in relation to audit of accounts of a Government company or a corporation shall be submitted to the Government or Governments concerned which shall lay it , as soon as may be after it is received, before each House of Parliament or Legislature. • The provisions of Section 619(2) of the Companies Act provide that the auditor of a Government Company shall be appointed or reappointed by the CAG. While appointing auditors of Government Company, CAG has taken steps for ensuring the independence of auditors by adopting the system of rotation of auditors, prohibition of certain services etc. • A system of rotation of the auditors of Government companies every four years has been adopted as a good practice. Sub Section 3 ibid provides that the CAG shall have power • to direct the manner in which the company’s accounts shall be audited by the auditor appointed in pursuance of sub-section and • to give such auditor instructions in regard to any matter relating to the performance of his functions as such. Continued……

45. to conduct a supplementary or test audit of the company’s accounts by such person or persons as he may authorize in this behalf; and for the purpose of such audit, to require information or additional information to be furnished to any person or persons so authorized, on such matters, by such person or persons, and in such form, as the CAG may, by general or special order, direct. • Sub section (4) ibid provides that the auditor aforesaid shall submit a copy of his audit report to the CAG who shall have the right to comment upon, or supplement, the audit report in such manner as he may think fit. • Any such comment upon or supplement to the audit report shall be place before the Annual General Meeting of the Company in terms of sub section (5) ibid at the same time and in the same manner as the audit report. Continued…

46. Despite such elaborate and strong control and checks, the best results are not forthcoming. • True that Finance, Accounts and Audit cannot be held responsible wholly for the failures but at the same time, all these players in the financial sector can play a very significant role in minimizing, if not eliminating, the deficiencies in the system and practices and shortfall in performance. • We are at the threshold of a new age with newer challenges and newer opportunities as a result of increasing global interests of corporate world in our economy and in order to shoulder the increased responsibilities we have to emerge stronger in the days to come.