2 Recent cases of Misconducts Lucent Technologies Adjusted fiscal 2000 revenues by $679 million. Several more names, respected world-over AOL Time Warner, Bristol-Myers, Elan,Halliburton, ImClone Systems, Microstrategy, Mirant, Network Associates, PNC Financial, Qwest, Reliant Resources, Rite Aid, Vivendi Universal, Xcel Energy, Xerox SATYAM How can we forget our own Satyam ? Billions of dollars lost in market capitalisation wiping out life savings of common man on the road WHY ???
3 Drivers of Unethical Strategies & Business Behaviour Overzealous pursuit of personal gain, wealth, and other selfish interests. Obsession with wealth accumulation, greed, power and status Heavy pressures on company managers to meet or beat earnings targets - to do whatever it takes to deliver good financial performance A company culture that places profits and good performance ahead of ethical behavior
4 Interdependence - a Corp. and Society Interdependence - a Corp. and Society Successful corporations need a healthy society Education,healthcare, safe working conditions, good govt. strong regulators Successful Corporations cannot survive in a failing Society A healthy Society needs successful companies Creates jobs, wealth that pays taxes, innovation to improve standard of living and social conditions
5 Corporate Governance Maximizing shareholder value -legally, ethically and on a sustainable basis & ensuring fairness to all stakeholders i.e. Customers Employees Investors Vendor- partners Community
6 WHAT IS CORPORATE GOVERNANCE? Defined as: “system by which a corporation is directed and controlled, in the interest of shareholders and other stakeholders, to sustain and enhance value”. Corporate governance involves a set of relationships between key stakeholders ShareholdersThe BoardManagement Other Stakeholders
7 National The initiative was initially driven by the Confederation of Indian Industry (CII) In December 1995, CII set up a task force to design a voluntary code of corporate governance The final draft of this code was widely circulated in 1997 In April 1998, the code was released. It was called Desirable Corporate Governance: A Code Between 1998 and 2000, over 25 leading companies voluntarily followed the code: Bajaj Auto, Hindalco, Infosys, Dr. Reddy’s Laboratories, Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI and many others Corporate Governance- A historical perspective
8 Good governance makes good business sense …. Good governance leads to good performance It creates an open and transparent system It improves communication and breaks down systematic barriers to flow of information Well established business processes imply order and stability to employees Preferred supplier status among customers Good governance helps in creating a brand and creates comfort for all stakeholders and society Good governance allows decision making based on data. It reduces risk
9 Key Principles of Corporate Governance An effective relationship (trust) between the providers of capital and company managers. Transparency: Directors must make clear to the providers of capital and other key stakeholders why every material decision has been made. Accountability: Directors should be held accountable for their decisions and account to key shareholders submitting themselves to appropriate scrutiny. Fairness: All shareholders should receive equal consideration by the directors and management with a sense of justice and avoidance of bias or vested interests. Responsibility: Directors should carry out their duties with honesty, probity and integrity.
10 The board is the most significant instrument of corporate governance
11 Changing Scenario Two major changes over the past scenario: variety of stakes in a modern corporation, apart from the stake of the legal equity holders; and thanks to capital markets, major diversification of the equity capital leading to ever larger distance between the owners of capital and the managers. The decline of banking and the rise of the institutional investor Increasing power and size of enterprises Working of the economic system enterprises spreading offices and employees in dozens of countries Business activities spreading across the continents Shareholders scattered across the world Investments by institutional investors Systems of corporate governance should be reconciled with ground realities of the country in question: Corporate ownership and control not uniform in emerging markets and developed capital markets Emerging markets are dominated by “family enterprises”
12 A basic design of CG systems A basic design of CG systems Corporate Board of Directors Management Shareholders StakeholdersCreditors Supervisory & enforcement authorities Executive directors Owner directors Independent Directors
13 Board’s key functions Board’s key functions Strategy formulation, budgets, business plans, etc. Monitoring the effectiveness of the company’s governance practices;. Selecting, compensating, monitoring key executives and overseeing succession planning. Executive and board remuneration; Ensuring a formal and transparent board nomination and election process. Monitoring and managing potential conflicts of interest of management, board members and shareholders, including misuse of corporate assets and abuse in related party transactions. Ensuring the integrity of the corporation’s accounting and financial reporting systems, including the independent audit, ensuring control systems for risk management, financial and operational control, and compliance. Overseeing the process of disclosure and communications.
14 Directors of the Board Directors of the Board The role and responsibility of an individual director, of course, would depend upon the nature of his directorship. Broadly, there are three types of directors. Full time, executive director who is normally a paid employee of a company having some functional responsibility. Non executive but non independent director who is normally a promoter of the company or having high stakes in the company. And finally independent directors who are not full time directors. There is another class of directors known as nominee directors representing some interests like lending institutions etc. An executive director, by very nature has much more responsibilities than non executive directors. In law it is their responsibility to ensure compliance with provisions of law failing with they could be held liable as officers in default. As far as independent directors are concerned, the position of law is nebulous.
15 Who are Independent Directors As per Clause 49 of the Listing Agreements an ‘independent director’ shall mean non-executive director of the company who a. apart from receiving director’s remuneration, 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; b. is not related to promoters or management at the board level or at one level below the board; c. has not been an executive of the company in the immediately preceding three financial years;
16 Independent Director is not a partner or 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 three years. This will also apply to legal firm(s) and consulting firm(s) that have a material association with the entity. is not a supplier, service provider or customer of the company. This should include lessor-lessee type relationships also; is not a substantial shareholder of the company, i.e. owning two percent or more of the block of voting shares.
17 Selection of Independent Director The selection and appointment of independent directors should be transparent and on certain valued basis. Therefore, the companies should have an entirely independent nomination committee which should determine the qualifications for Board membership and should identify and evaluate candidates for nomination to the Board. It would be more appropriate that the code of Corporate Governance of a company should specifically include the qualifications and attributes that the company seeks of an independent director. A critical element of a director being independent is his independence to the management both in fact and perception by the public. The independent directors must not only be independent according to the legislative and stock exchange listing standards but also independent in thought and action i.e. qualitatively independent. Such qualitative independence will ensure that directors think and act independently without regard to management's influence. 3 Key attributes: Competence, Commitment and Courage
18 Role of Independent Directors Independent directors broadly fit into the overall structure of corporate governance, and are necessary to ensure effective, balanced boards. They should : * Contribute to and constructively challenge development of company strategy. * Scrutinize management performance. * Satisfy them that financial information is accurate and ensure that robust risk management is in place. * Be prepared to attend AGMs and discuss issues relating to their roles (especially chairmen of committees). * Have a greater exposure to major shareholders (particularly the senior independent director).
19 Responsibilities of Independent Directors Independent Director shall periodically review legal compliance reports prepared by the company as well as steps taken by the company to cure any taint. In the event of any proceedings against an independent director in connection with the affairs of the company, defence shall not be permitted on the ground that the independent director was unaware of this responsibility. To function to properly according to the spirit of corporate governance as a director on the board and as Member/Chairman across various committees viz. the Audit Committee, the Shareholders’ Grievance Committee and the Remuneration Committee of the company.
20 Responsibilities of Independent Directors A director shall not be a member in more than 10 committees or act as Chairman of more than five committees across all companies in which he is a director. Furthermore it should be a mandatory annual requirement for every director to inform the company about the committee positions he occupies in other companies and notify changes as and when they take place. At least one independent director on the Board of Directors of the holding company shall be a director on the Board of Directors of the subsidiary company.
21 Board Composition Board Composition Not less than 50% of the board to be non-executive directors Independent Directors: If the chairman executive: At least half of the board should comprise of independent directors If Chairman non-executive:At least one- third of the board should comprise of independent directors Non-executive directors’ remuneration to be approved by shareholders Board meetings – to meet at least 4 times, with gap not exceeding 3 months. Minimum information for board meetings laid down
22 Board of Directors: information that must be supplied Annual, quarter, half year operating plans, budgets and updates Quarterly results of company and its business segments Minutes of the audit committee and other board committees Recruitment and remuneration of senior officers Materially important legal notices and claims, as well as any accidents, hazards, pollution issues and labor problems Any actual or expected default in financial obligations Details of joint ventures and collaborations Transactions involving payment towards goodwill, brand equity and intellectual property Any materially significant sale of business and investments Foreign currency and other risks and risk management Any regulatory non-compliance Mandatory guidelines and disclosures
23 How to be a good independent director How to be a good independent director Non-executive directors need to be sound in judgement and to have an inquiring mind. They should question intelligently, debate constructively, challenge rigorously and decide dispassionately. They should listen sensitively to the views of others, inside and outside the board.
24 Companies Act and Independent Directors The Companies Act looks at all directors alike: Throws some extra compliances in case of whole time directors Requires some disclosures by interested directors Defines “officer in default” giving a degree of immunity to directors other than the whole time directors Does not exempt independent directors from any of the duties, liabilities, responsibilities of the Board Independent directors as much as part of the corporate governance team as any other director Independent directors have the same power that other directors have
25 Liabilities under other laws The basic directorial liability apart, being a corporate director may invite liabilities under myriad Central, State and Local laws: Most often, notices, summons, etc are addressed to all directors Sometimes, IT searches are also unable to distinguish between working directors and independent directors
26 Way out… Clearly, it would be difficult to get right individuals if we make the life of an independent director hell Hence, the two tier board is an alternative Executive board and supervisory board distinction Since, independent directors do not have an executive role or censuring of executing actions, they do not have liabilities of executive management Dual board system allows for easy functioning of the company as executive decisions do not come to the supervisory board
27 Board of Directors: frequency of meetings and composition The frequency of board meetings and board committee meetings, with their dates, must be fully disclosed to shareholders in the annual report of the company The attendance record of all directors in board meetings and board committee meetings must be fully disclosed to shareholders in the annual report of the company Full and detailed remuneration of each director (salary, sitting fees, commissions, stock options and perquisites) must be fully disclosed to shareholders in the annual report of the company Loans given to executive directors are capped (no loans permitted to non-executives), and must be fully disclosed to shareholders in the annual report of the company Some more Mandatory guidelines …
28 Disclosures to shareholders in addition to balance sheet, P&L and cash flow statement Board composition (executive, non-exec, independent) Qualifications and experience of directors Number of outside directorships held by each director (capped at director not being a member of more than 10 board-level committees, and Chairman of not more than 5) Attendance record of directors Remuneration of directors Relationship (familial or pecuniary) with other directors Warning against insider trading, with procedures to prevent such acts Details of grievances of shareholders, and how quickly these were addressed Date, time and venue of annual general meeting of shareholders Still more Mandatory guidelines …
29 Disclosures to shareholders in addition to balance sheet, P&L and cash flow statement Dates of book closure and dividend payment Details of shareholding pattern Name, address and contact details of registrars and/or share transfer agents Details about the share transfer system Stock price data over the reporting year, and how the company’s stock measured up to the index Financial effects of stock options Financial effects of any share buyback Financial effects of any warrants that are to be exercised Chapter reporting corporate governance practices Few more Mandatory guidelines …
30 Disclosures to shareholders in addition to balance sheet, P&L and cash flow statement Detailed chapter on Management Discussion and Analysis focusing on markets, operations, finances, accounts, risks, opportunities and threats, internal control systems Consolidated financial statement, incorporating accounts of all subsidiaries (over 50% shares held by reporting company) Details of all significant related party transactions Detailed segment reporting (revenues, costs, operating profits and capital employed) Deferred tax liabilities and assets and debit/credit in the P&L for the reporting year Few more Mandatory guidelines …
31 “The Foundation of any structure of Corporate Governance is disclosure. Openness is the basis of public confidence in the corporate system, and funds will flow to the centres of economic activity that inspire trust.” - Sir Adrian Cadbury