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ICAI International Conference

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1 ICAI International Conference
Corporate Governance - Fact or Myth D D Rathi * Director & CFO Grasim Industries Limited – Aditya Birla Group 13th December 2007 (* Views expressed are personal)

2 Corporate Governance – Fact or Myth
A bold theme – spanning to two extremes The obvious answer is that “it cannot be a Myth” Point to be debated is the level of governance achieved Key background issues - Governance generally What is corporate governance and what are its essentials Growing significance and benefits Corporate Governance initiatives and enactments Current status of Corporate Governance, bench marking and challenges 2

3 Governance generally Governance concept applicable to every entity and every individual Good Governance essential in every walk of life Well defined Governance Practices more critical to Corporates as they are “Artificial legal entities” - Corporate Governance, though not articulated or defined as is being done now, it has been always there right from the time the concept of artificial legal entity came into existence - Management and ownership with different set of people - Different stakeholders

4 What is Corporate Governance ?
Many definitions have been articulated Difficult to define comprehensively in few sentences Corporate Governance is about commitment to values and ethical business conduct Good Corporate Governance is reflected in fair, equitable, transparent and responsible interaction between a Company’s - Management Board of Directors Shareholders Other Stakeholders

5 Essentials of good Corporate Governance
Corporate Governance is first about values and then about structure, system and processes Should not be just ‘check list’ concept, but should be a way of life Four pillars of good Corporate Governance Fairness Transparency & Disclosures Accountability, and Role Clarity Responsibility of the Board, Chairman, CEO, CFO & Other Executives Key Principles of Corporate Governance Respect right of minority shareholders Equitable treatment of shareholders Rights of other stakeholders Social Responsibility (CSR - as a caring corporate citizen) Trusteeship culture

6 Growing significance of Corporate Governance
Corporate Governance has acquired greater significance in India Globalisation and large Capital requirements Increasing complexities of the organizational structure Gradual distancing of Ownership from Management Geographical expansion of Investor Base Emergence of Large Institutional Investors, foreign & domestic both A series of global financial and corporate crisis Indian Corporates very well recognise linkage of Corporate Governance to Valuations of the Companies Attracting capital at lower cost Attracting & retaining talented human capital

7 History of Corporate Governance Initiatives and Enactments
Initiatives and Regulatory enactments – International examples Cadbury Committee (UK) – 1991 HAMPEL Committee (UK) Blue Ribbon Commission (US) Ad hoc Task Force OECD Sarbanes Oxley Act

8 History of Corporate Governance Initiatives and Enactments – contd.
Initiatives and Regulatory enactments - India Concept not new to India – Trusteeship culture is age old Ram Rajya - Role of King, Society & Priest Appropriating part of profit for charity (social responsibility) Constitution of SEBI in 1992 National Task Force of CII – 1996 – Chairman Mr. Rahul Bajaj (Voluntary measure) Kumar Mangalam Birla Committee (Resulted in Introduction of Clause 49, first structured regulation) Naresh Chandra Committee Narayan Murthy Committee – 2003 Companies Act Amendments JJ Irani Committee on Company Law December Amendment to Listing Agreement Amended Clause 49 - A landmark step

9 Can Regulation alone ensure good governance ?
We do need basic regulatory frame work But we need even much large body of self regulation and spirit of voluntary compliance Good governance practices will evolve through blend of regulatory frame work and voluntary compliance

10 Should Corporate Governance be just restricted to compliance of law ?
“Corporate Governance” is not a “Tick Box” concept but has to be a way of life Governance frame work should focus on “Substance” and not merely on “Form” You do it because it is the right thing to do … and not just because the law commands you to do it Good Governance goes beyond legal compliance Compliance Value Creation Excellence Benefits of Good Governance - leading to excellence in management

11 Indian Corporates - Current Corporate Governance Status
Indian Corporates have come a long way on Governance practices Improving Structures & Functioning of the Board and its Committees Code of Conduct for Board & Senior Management Disclosure practices - continuous and timely disclosure High quality of Accounting Policies and Accounting Standards Clause 49 requirements Investor Relations practices - transparency & uniform dissemination of information Insider Trading codes Quality of Annual Report Consolidated Financial Statements Segmental Reporting Management Discussion & Analysis Reporting on compliance and its certification Corporate Governance has started to percolate to mid level corporates as well Comparison of Corporate Governance Practices with China, Other Asian Countries and Sarbanes Oxley Act

12 Some CG parameters – Comparative Status
India USA UK China Japan Singa-pore Hong Kong Austr -alia Board Composition - Independent Directors ü Required separation of chief executive and chairman of the board roles X X Compensation Committee - Independent Directors X Code of ethics for senior financial officers required Audit Committee - Authority to engage outside advisers Management required to forfeit bonuses or other compensation if a restatement occurs Management required to certify internal control structure and/or disclose controls Restriction on loans to officers and directors Required rotation of audit partners $ Rules regarding disclosure of off-balance sheet transactions and contractual obligations Rules regarding disclosure of forward looking earnings guidance X - Non Mandatory XX - Encourages / prescribes alternate $ - Under consideration Source: Deloitte Haskins & Sells

13 Asian Countries Scorecard - %
CG Rules & Practices Enforcement (public/private) Political / Regulatory International GAAP CG Culture Hong Kong 60 56 73 83 61 Singapore 70 50 65 88 53 India 59 38 58 75 Taiwan 49 47 46 Japan 43 52 72 44 Korea 45 39 48 68 Malaysia 35 78 33 Thailand 36 31 China 25 Philippines 19 Indonesia 22 Source: ACGA Research

14 Corporate Governance - Ranking
Country Rank 2005 Rank 2007 Hong Kong 2 1 Singapore India 3 Taiwan 5 4 Japan - Korea =6 Malaysia Thailand 8 China 9 Philippines 10 Indonesia Source: “CG Watch 2007”, ACGA & CLSA High Ranking of India among Asian Countries ; Corporate Governance not a myth in India

15 Corporate Governance Standards in India Vs Averages of Asian Countries
Good financial reporting among top companies, but sharp fall off among rest of market (> 6,000 listed companies) Public enforcement improving, but private enforcement limited and obstructed (e.g., by legal system) SEBI more independent than many Asian Securities Commissions Media freedom much higher than Asian region Noticeable gap between accounting standards and international norms - but gap narrowing Average Source: “CG Watch 2007”, ACGA & CLSA

16 Challenges in Corporate Governance
Large unlisted corporates not covered by Corporate Governance norms Stronger Boards and Committees Independent and Professional Directors Audit Committee with right composition Defining roles of Board, Committees and Executives Compensation policy for Directors and Senior Executives Risk Management Sustainability Reporting Independence of Auditors (Statutory and Internal) “Tick box” approach vs. “Letter and Spirit” compliance. Be a step ahead of Regulation Those who call Corporate Governance a myth are looking at the gaps, which we need to collectively fill

17 Challenges in Corporate Governance - Contd..
Disclosures of Off Balance Sheet Transactions Disclosures of substantial risks being carried in Balance Sheets (e.g. Sub Prime mortgage) Define processes to achieve compliance CEO and CFO certification Compliance certificate from Auditors Enhanced commitment at all levels of Corporate ladder needed – should not be treated as responsibility of finance functionaries and CEO only Multiplicity of Regulators and compliance Cost Those who call Corporate Governance a myth are looking at the gaps, which we need to collectively fill

18 Summary Regulatory framework in place
Value of good governance and its benefits well recognised by Indian Companies Significant move seen towards voluntary compliance, i.e. from legal compliance to conscience Indian Corporates ahead of China and other Asian Countries Improve governance standard for mid size companies coming to capital markets Simplified and unambiguous regulations will encourage high standards of Governance and help reduce compliance cost We have come a long way in improving corporate governance practices, but yet to reach pinnacle - march to excellence continues


20 Why has CG become so topical ?
The main causes in recent times have been a series of financial and corporate crisis Asian financial crisis (1997 / 98) Dotcom boom & bust (2000) Enron, Worldcom and Tyco scandals in the United States (early 2000s) Parmalat earnings mis-statement scandal in Italy in 2002/03, as well as similar events at Ahold in Holland and Alstom in France Economic downturn over Non-performing loans among state banks in China Problems associated with family and state ownership in Asia (not all bad, but abuses have occurred) Sub-prime crisis in USA 6A 20

21 Corporate Governance is not new to India
Ram Rajya KING – enjoys power but is responsible for deliverables too SOCIETY – well defined behaviour norms PRIESTS – acts as independent check on King as Intermingles with society & get feedback Don’t get paid by King, hence independency ensured Enjoys courage of conviction Appropriating part of profit for charity (Social Responsibility) 8A

22 Tentative Conclusions
There appears to be a broad link between the ranking of most markets in our “CG Watch 2007” survey and the size of their “gross national income” (GNI) per capita Exceptions are clearly India and Japan. Each has certain particular and unusual characteristics India : A large populations (hence low GNI per-capita); economic reforms started much later than China (1991 vs 1978); yet corporate governance reforms started early by regional standards (1998) and the country has some pockets of world-class corporate governance Japan : Began industrializing in the 19th century, hence a big headstart on GNI per-capita; high levels of wealth and economic success in the 1970s and 80s may well be a factor in Japan’s insularity to global norms of corporate governance Source : CG Watch Survey 2007 15A 22

23 Benefits of Corporate Governance
Enhances the long-term value of the company, its shareholders and other stakeholders Provides easy access to large capital Lowering of Cost of Capital (Debt & Equity both) Recognition of Indian corporate globally and increased investments in Indian corporates Protects the investors and accelerates growth of Capital Markets Brings excellence in systems and control procedures Attracts talented Human Capital Board / Committees help strong & transparent decision making process Focus on accountability of key executives (CEO / CFO Certification) Acceptability of takeovers / acquisition of overseas corporate by Indian companies Standardisation of Risk Management process Good Corporate Governance facilitates improved & sustained performance 10A

24 Regulatory Environment and Compliance Cost - changes needed
Multiple Regulations Company Law SEBI / Stock Exchanges Conflicting provisions Some over-regulation issues Composition of the Board Fifty percent as Independent Directors Retirement age Reservation for different classes Stringent qualification for independent directors Excessive disclosure eg. Audit Reporting Compliance cost increase, a cause of concern Simplified and unambiguous single point regulation –Flexible/ Dynamic Balanced disclosure practices - Concept Paper on Company Law leaves lot to “Rules to be prescribed” - Fairness in Regulatory Environment will greatly motivate voluntary compliance - Shareholders over activism - some governance norm for them too ? - Lost should follow in ensuing sessions on this topic 17A 24

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