Corporate Governance and Business Ethics

Introduction to Corporate Governance

Corporate governance refers to the system of rules, practices, and processes by which a firm is
directed and controlled. It encompasses the framework for achieving organizational goals,
managing relationships among stakeholders, and ensuring ethical and responsible business
conduct.

Meaning and Definitions of Corporate Governance

Broad Definition: Corporate governance describes the processes, customs, policies, laws, and
institutions that direct how organizations and corporations act, administer, and control their
operations.
Balancing Interests: It fundamentally involves balancing the interests of a company's many
stakeholders, including shareholders, senior management, customers, suppliers, financiers,
government, and the community.
Comprehensive Framework: It provides the framework for achieving company objectives and
covers nearly all aspects of management, from action plans and internal controls to
performance measurement and corporate disclosure.

Definitions:

Institute of Company Secretaries of India: "Corporate Governance is the application of best

Management practices, Compliance of law 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."
General Definition: "Corporate Governance is the system by which business corporations are
directed and controlled. The corporate governance structure specifies the distribution of
rights and responsibilities among different participants in the corporation, such as, the board,
managers, shareholders and spells out the rules and procedures for making decisions on
corporate affairs."

Background and Evolution of Corporate Governance

The concept of corporate governance emerged and gained prominence due to several factors:

Separation of Ownership and Control: In many companies, directors do not own the company,
leading to potential conflicts of interest and agency problems (e.g., directors awarding
themselves excessive bonuses).
Past Corporate Failures: Numerous corporate governance failures globally highlighted the
need for robust oversight and control mechanisms.
Economic Liberalization in India: The concept gained traction in India after the mid-1990s
with economic liberalization and deregulation, necessitating greater accountability to
shareholders and customers.
Cadbury Committee Report: The recommendations of the Cadbury Committee in the UK
significantly influenced the debate and development of corporate governance in India.
Focus on Social and Economic Aspects: For a firm's success, there's a recognition that it
 needs to concentrate on both economic performance and social responsibility.

Need and Importance of Corporate Governance

Adapting to Market Changes: The increasing pace of change in market conditions
(demographic, technological) requires agile companies and boards.
Long-Term vs. Short-Term Focus: Addresses the tendency for companies to focus
excessively on short-term performance at the expense of long-term strategies.
Complex Regulatory Environment: The growing complexity of regulations sharpens the focus
on good governance.
Active Institutional Investors: An increase in passive institutional owners creates
opportunities for larger shareholders to be more involved in ensuring value creation.
Performance of PE-Owned Companies: Evidence suggests that private equity-owned
companies often outperform publicly listed ones, partly due to more active and engaged
boards focused on strategy and risk management.
Investor Protection: Essential for protecting suppliers of capital, especially small, often
powerless investors, ensuring they receive fair treatment.

Key Elements of Good Corporate Governance

Good corporate governance is characterized by eight major attributes:

1. Rule of Law: Fair legal frameworks enforced by impartial bodies to protect stakeholders.
2. Transparency: Information is provided in understandable forms, is freely available, and
decisions comply with established rules.
3. Responsiveness: Processes are designed to serve stakeholder interests within a reasonable
timeframe.
4. Consensus Oriented: Requires consultation to understand diverse stakeholder interests and
reach a broad consensus on what's best for the group.
5. Equity and Inclusiveness: Ensures stakeholders can maintain, enhance, or improve their well-
being.
6. Effectiveness and Efficiency: Processes produce favorable results using resources (human,
technological, financial, natural, environmental) optimally.
7. Accountability: Clear documentation of who is accountable for what; organizations are
accountable to those affected by their decisions and to the law.
8. Participation: Informed and organized participation by all stakeholders, including freedom of
expression, for the best interests of the organization and society.

Stakeholders of a Corporate Body

Stakeholders are individuals or groups with a vested interest in a business. They can be
categorized as:

Internal vs. External:

Internal: Exist within the business and are directly affected (e.g., employees,
management).
External: Have an interest but no direct affiliation (e.g., customers, suppliers, government,
community, creditors).
 Primary vs. Secondary:
Primary: Have the highest level of interest and are directly affected (e.g., employees,
customers, investors).
Secondary: Indirectly affected or have influence (e.g., media, trade associations, NGOs).

Direct vs. Indirect:

Direct: Involved in day-to-day activities and have an immediate impact (e.g., employees).
Indirect: Pay attention to the finished project outcome rather than the process (e.g.,
customers concerned with pricing, packaging).

Shareholder vs. Stakeholder:

Stakeholder: Any individual or group with a vested interest in the business.

Shareholder: Specifically has a financial interest and is a partial owner of the organization.

Objectives of Corporate Governance

Transparency and Full Disclosure
Accountability
Equitable Treatment of Shareholders
Self-Evaluation
Increasing Shareholders' Wealth

Principles of Corporate Governance

Fairness
Accountability
Responsibility
Transparency

Models of Corporate Governance

Corporate governance models vary across countries due to different regulations and cultural
contexts. Major models include:

1. Anglo-American Model (Shareholder-Oriented):

Emphasis on shareholder rights and their role in electing the Board.
Clear separation of ownership and management.
Professional managers with negligible ownership stake.
Institutional investors are often portfolio investors who can exit easily.
Comprehensive disclosure norms and tight rules against insider trading.
Basis for corporate governance in the UK, USA, Canada, Australia, and Commonwealth
countries.

2. German Model (Stakeholder-Oriented / Two-Tier Board):

Recognizes workers as key stakeholders with a right to participate in management.
Features two boards:
 Supervisory Board: Elected by shareholders and employees; appoints and monitors the
Management Board.
Management Board: Responsible for day-to-day operations; appointed and overseen by
the Supervisory Board.

3. Japanese Model:
Companies often raise significant capital from banks and financial institutions.
Banks and institutions work closely with management due to their substantial stakes.
Board members are appointed by shareholders and main banks.
Recognizes the interests of both shareholders and lenders.

4. Social Control Model:

Advocates for full stakeholder representation on the board.
Proposes a "Stakeholders Board" above the Board of Directors to improve internal controls.
Stakeholders Board includes representatives from shareholders, employees, major
consumers, suppliers, and lenders.

5. Indian Model:
A blend of the Anglo-American and German models.
Reflects the diverse shareholding patterns of private companies, public companies, and
public sector undertakings.

Regulatory Framework of Corporate Governance in

India
Securities and Exchange Board of India (SEBI) Guidelines

SEBI, established in 1992, is the primary regulatory authority for the securities market in India. Its
key roles include curbing malpractices, protecting investors, and ensuring the healthy
development of the financial market.

Key SEBI Guidelines and Regulations:

Related Party Transactions (RPTs): Companies must obtain shareholder approval for RPTs.
These are transactions between parties with a pre-existing relationship (e.g., holding
companies and subsidiaries, directors and their relatives).
Whistleblower Mechanism: Mandates a system for employees to report unethical behavior,
fraud, or code of conduct violations.
Woman Director: Requirement for at least one woman director on the Board.
E-voting: Listed companies must provide e-voting options to shareholders for general
meetings.
Clause 49 of the Listing Agreement:
This significant clause, based on recommendations from the Kumar Mangalam Birla
Committee, outlines detailed corporate governance norms for listed companies.
Board Composition: Prescribes an optimum mix of executive and non-executive directors
(at least 50% non-executive). Specific requirements for independent directors based on
 the Chairman's role and relationship with promoters.
Audit Committee: Mandatory, with at least three directors (two-thirds independent),
chaired by an independent director, and requiring financial literacy/expertise.
Whistleblower Policy: Initially non-mandatory, now mandatory, requiring a vigil mechanism
and protection against victimization.
Disclosures: Requirements for disclosures on financial position, performance, ownership,
governance, director remuneration, related party transactions, and risk management.
CEO/CFO Certification: Mandates certification of financial statements by the CEO/CFO,
attesting to their truthfulness and fair representation.
Corporate Governance Report: A separate section on corporate governance must be
included in annual reports.
Compliance Certificate: Auditors or practicing company secretaries must provide a
certificate of compliance.

SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015: These

regulations consolidate and update the listing agreement requirements, including those for
corporate governance.

Provisions under the Companies Act, 2013

The Companies Act, 2013, incorporates several provisions to strengthen corporate governance:

Board Composition: Minimum and maximum number of directors for different types of
companies (e.g., Public Company: 3-15 directors, at least 1/3 independent; Private Company:
2-15 directors). Requirement for at least one woman director and one director residing in
India for at least 182 days in the previous calendar year.
Independent Directors: Defines independent directors and sets criteria for their appointment,
tenure (up to 5 consecutive years, eligible for one re-appointment), performance evaluation,
and separate meetings. They are not eligible for stock options.
Director's Duties and Responsibilities: Mandates directors to act in good faith, in the best
interests of the company and stakeholders, exercise due care, skill, and diligence, and avoid
conflicts of interest.
Related Party Transactions (Section 188): Requires disclosure of interest by directors.
Audit Committee (Section 177): Mandates the constitution of an Audit Committee for listed
companies and certain other classes.
Director's Responsibility Statement (Section 134): Requires the Board of Directors to attach a
statement to financial statements detailing their responsibilities.
Serious Fraud Investigation Office (SFIO): A statutory body established to investigate and
prosecute serious corporate frauds.

Board of Directors
Constitution: The collective body of directors. Requirements vary by company type (e.g.,
minimum 3, maximum 15 for public companies).
Types of Directors:
Executive Director: Whole-time director or Managing Director, actively involved in company
operations.
Non-Executive Director: Not involved in day-to-day operations.
Independent Director: A non-executive director meeting specific criteria of independence,
expertise, and integrity, free from material pecuniary relationships or conflicts of interest.
Nominee Director: Appointed by institutions that have invested in or lent to the company.
 Powers, Duties, and Responsibilities: Directors must act according to the Articles of
Association, in the best interests of stakeholders, use independent judgment, avoid conflicts
of interest, ensure confidentiality, and comply with legal requirements. Failure to do so can
lead to penalties.
Responsibilities: Protecting minority stakeholder interests, mediating conflicts, providing
independent judgment, overseeing related party transactions, and reporting unethical
behavior.

Chairman of the Board

The Chairman leads the Board of Directors, supervises its functioning, promotes open
expression of opinions, ensures communication between directors and shareholders, and may
have a casting vote.

Board Committees and Their Functions

Board committees are established to focus on specific areas, providing specialized oversight.
Key committees include:

1. Audit Committee:
Composition: At least three directors, two-thirds independent, chaired by an independent
director. At least one member should be an "audit committee financial expert."
Functions: Oversees the integrity of financial statements, effectiveness of internal controls,
qualifications and independence of auditors, internal audit performance, and compliance
with legal/regulatory requirements.

2. Shareholders Grievance Committee:

Composition: Chaired by a non-executive director.
Functions: Redresses shareholder complaints related to share transfers, non-receipt of
balance sheets or dividends, issues duplicate certificates, and handles allotment/listing of
shares.

3. Remuneration Committee:
Functions: Decides terms and conditions for executive directors, recommends
remuneration packages for key management personnel, and administers share/stock
option schemes.

4. Risk Committee:
Composition: Minimum three independent non-executive directors, plus CEO and CFO.
Members should have risk management expertise.
Functions: Reviews and approves risk management policies, monitors implementation, and
advises the board on risk indicators and tolerance levels.

5. Nomination Committee:
Functions: Identifies prospective directors, recommends appointments to the board and
senior management, and ensures a balance of skills and experience on the board.
6. Corporate Governance Committee:
Functions: Oversees corporate governance matters, formulates and recommends
governance principles and policies, and ensures the integrity of the nomination process.

7. Corporate Compliance Committee:

Functions: Reviews and monitors the company's compliance with legal and regulatory
requirements, policies, and programs.

8. Ethics Committee:
Functions: Contributes to defining ethics and compliance standards, oversees compliance,
delegates responsibility appropriately, communicates standards, monitors adherence, and
ensures uniform enforcement.

Role of Management
Management is responsible for implementing the board's policies and strategies, providing
timely and accurate information to the board and shareholders, and ensuring the company's
operations are conducted efficiently and ethically.

Information to Shareholders
Companies must be transparent with shareholders, providing timely and accurate information
regarding financial performance, ownership structure, governance practices, and material
matters.

Shareholder Activism
Shareholder activism involves shareholders using their rights to influence corporate behavior and
bring about change.

Reasons: Protection of shareholder interests, addressing self-dealing by management, weak

management performance, and lack of transparency.
Objectives: To act as a monitor of management, protect shareholder interests, and ensure
accountability and transparency.
Forms:
Shareholder Resolutions: Proposals submitted for a vote at annual meetings.
Proxy Voting: Persuading other shareholders to use their proxy votes to effect change.
Publicity Campaigns: Using mass media to draw attention to corporate issues.
Negotiations with Management: Direct discussions to achieve goals.
Litigation: Initiating legal action, though costly and potentially damaging to reputation.

Class Action Suits

A class action suit is a civil lawsuit filed by one or more plaintiffs on behalf of a larger group or
"class" of people who have suffered similar damages due to a company's or individual's
negligence or misconduct.

Basis: Can arise from breaches of trust, activities beyond the company charter,
misrepresentation, or suppression of faults.
Filing: Can be filed against directors, auditors, or advisors.
Benefits: Offers a cost-effective way for many individuals to seek legal redress, avoiding
multiplicity of litigation.
In India: Applications can be filed before the National Company Law Tribunal (NCLT).

Corporate Governance and Other Stakeholders

Employees: Fair treatment, safe working conditions, opportunities for development, and
ethical employment practices.
Customers: Quality products/services, fair pricing, transparency in dealings, and protection of
consumer rights.
Government: Compliance with laws and regulations, payment of taxes, and contributing to
national development.
Society: Environmental responsibility, community engagement, ethical conduct, and
contributing to social well-being.

Corporate Governance Reports

These reports provide an overview of a company's governance structure, policies, and practices,
often included in the annual report. They detail board composition, committee functions,
disclosures, and compliance with governance norms.

Whistleblower Policy
A whistleblower policy establishes a mechanism for employees and others to report suspected
fraud, unethical behavior, or violations of company policies without fear of retaliation.

Internal Whistleblowing: Reporting to internal authorities (e.g., compliance officer, audit

committee).
External Whistleblowing: Reporting to regulators or the media.
Vigil Mechanism: A broader framework that includes the whistleblower policy.
Importance: Encourages reporting, creates awareness, checks misconduct, and ensures
quick resolution.
Process: Communication of the issue, preliminary inquiry, appointment of an inquiry
committee, and necessary action.

Green Governance / E-Governance

Green Governance:
Focuses on sustainability, integrating economic progress, social development, and
environmental improvements. It aims for sustainable development, conservation of
resources, and minimizing human impact.
 Features: Appointment of directors with environmental expertise, dedicated environment
committees, green governance codes, and integrated sustainability reporting.

E-Governance:
Utilizes technology to improve governance processes.
Initiatives in India: E-certification of forms, video conferencing for shareholders and
directors, e-voting, electronic communication with authorities, and online applications/
payments.

Key Provisions of Clause 49 of the Listing

Agreement (Summary)
Clause 49, introduced based on the Kumar Mangalam Birla Committee recommendations,
mandates several conditions for listed companies:

1. Board of Directors: Optimum combination of executive and non-executive directors (at least
50% non-executive). Specific requirements for independent directors based on the Chairman's
role.
2. Audit Committee: Minimum three directors (two-thirds independent), financially literate, with at
least one accounting/financial expert. Chaired by an independent director.
3. Subsidiary Companies: Independent director of the holding company to be on the board of
unlisted subsidiaries; holding company's audit committee to oversee subsidiary transactions.
4. Disclosures: Summary of related party transactions, accounting treatment, risk assessment,
remuneration of directors, CEO/CFO certification.
5. CEO/CFO Certification: Financial statements and cash flow certified for truthfulness and fair
representation.
6. Report on Corporate Governance: Separate section in the annual report.
7. Compliance: Auditor's certificate on compliance with corporate governance conditions.