CORPORATE GOVERNANCE2015-2016Lecture 12 &13

WHAT IS CG?

CONCEPTUAL BASIS

A theory concerning the relationship between a principal (shareholder) and an agent of the principal (company's managers)

Concept originated with separation of ownership & management

Origin: Agency Theory Agency costs

inherent in separation of ownership and control

Professional managers have enormous powersGovernance :1. What control do the ‘owners’ have on the management ? 2. How do you ensure that the powers are not misused?

Characteristics

FUNDAMENTAL PRINCIPLES OF CG

CG is systems and procedures adopted and followed that ensure all stakeholders share equally in the success (or failure) of a firm…….

OBJECTIVE OF CG

EFFECTIVE GOVERNANCE CAN HAPPEN WHEN -----

An effective and independent Board

Committees in Place

A sound internal control framework

A relevant code of ethical behaviour

Clear enforced policies and procedures

Transparent disclosure, effective communication, and systems that ensure effective measurement and accountabilityAn effective well resourced internal audit function and independent effective external audit

Executive directors

• Have day-to-day management responsibilities

Non Executive Directors/ Independent

Directors

• take no part in the day-to-day running of the business, but have the same responsibilities as executive directors

• They use their experience and expertise to provide independent advice and objectivity, and they usually have a role in monitoring executive management

Nominee directors

• The interests of substantial shareholders or the company’s bankers may be represented by a nominee director

TYPE OF DIRECTORS

WHO IS AN INDEPENDENT DIRECTORS? : CLAUSE 49 REQUIREMENTS

• 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

• is not related to promoters or management at the board level or at one level below the board

• has not been an executive of the company in the immediately preceding three financial years

As per Clause 49 of the Listing Agreements an ‘independent director’ shall mean non-executive director of the company who

WHO IS AN INDEPENDENT DIRECTORS? : CLAUSE 49 REQUIREMENTS (CONTD)

• is not a partner or an executive of the statutory audit firm or the internal audit firm that is associated with the company,

• 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

• is not a substantial shareholder of the company, i.e. owning two percent or more of the block of voting shares

• Institutional directors on the boards of companies shall be considered as independent directors whether the institution is an investing institution or a lending institution.

DUTIES OF DIRECTORCHAPTER XI (SECTION 166)Subject to the provisions of this Act, a director of a company shall act in accordance with the articles of the company.

A director of a company shall act in good faith in order to promote the objects of the company for the benefit of its members as a whole, and in the best interests of the company, its employees, the shareholders, the community and for the protection of environment.

A director of a company shall exercise his duties with due and reasonable care, skill and diligence and shall exercise independent judgment.

A director of a company shall not involve in a situation in which he may have a direct or indirect interest that conflicts, or possibly may conflict, with the interest of the company.

Uphold ethical standards of integrity and probity; Mainly to assist the company in implementing the best corporate governance practices.

Bringing an independent judgment to bear on the Board’s deliberations especially on issues of strategy, performance, risk management, resources, key appointments and standards of conduct;

Satisfy themselves on the integrity of financial information and that financial controls and the systems of risk management are robust and defensible

Safeguard the interests of all stakeholders, particularly the minority shareholders; balance the conflicting interest of the stakeholders

Moderate and arbitrate in the interest of the company as a whole, in situations of conflict between management and shareholder’s interest

DUTIES, ROLE & RESPONSIBILITIES OF INDEPENDENT DIRECTORS (SCHEDULE IV)

Concerns about the running of the company or a proposed action, ensure that these are addressed by the Board and, to the extent that they are not resolved, insist that their concerns are recorded in the minutes of the Board meeting;

Ensure adequate deliberations before approving related party transactions (RPTs)and assure themselves that the same are in the interest of the company;

Report concerns about unethical behaviour, actual or suspected fraud or violation, of the company’s code of conduct or ethics policy;

Not disclose confidential information, including commercial secrets, technologies, advertising and sales promotion plans, unpublished price sensitive information, unless such disclosure is expressly approved by the Board or required by law.

DUTIES, ROLE & RESPONSIBILITIES OF INDEPENDENT DIRECTORS (SCHEDULE IV)

• A director of a company shall not achieve or attempt to achieve any undue gain or advantage either to himself or to his relatives, partners, or associates and if such director is found guilty of making any undue gain, he shall be liable to pay an amount equal to that gain to the company.

• A director of a company shall not assign his office and any assignment so made shall be void.

• If a director of the company contravenes the provisions of this section such director shall be punishable with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees.

# good faith # care # skill # diligence

DUTIES OF DIRECTOR : CHAPTER XI (SECTION 166)

ROLE OF BOARD OF DIRECTORS

The law imposes three clear duties on board members, the duties of care, good faith, and loyalty.

The duty of care involves the exercise of reasonable care by a board member to ensure that the corporate executives with whom she or he works carry out their management responsibilities and comply with the law in the best interests of the corporation.

ROLE OF BOARD OF DIRECTORSThe duty of good faith is one of obedience, which requires board members to be faithful to the organization’s mission.

• In other words, they are not permitted to act in a way that is inconsistent with the central goals of the organization.

• Their decisions must always be in line with organizational purposes and direction, strive towards corporate objectives, and avoid taking the organization in any other direction.

ROLE OF BOARD OF DIRECTORSThe duty of loyalty requires faithfulness—a board member must give undivided allegiance when making decisions affecting the organization.

• This means that conflicts of interest are always to be resolved in favor of the corporation.

• A board member may never use information obtained through because of the position as a board member for personal gain, but instead must act in the best interests of the organization.

ROLE OF THE BOARD : DUTY OF SKILL• Skill – practiced ability• Strategic decisions• Evaluation of information• Application of mind• Application of experience and expertise.

ROLE OF INDEPENDENT DIRECTOR

Shareholders• Shareholders especially minority shareholders look at

independent directors providing transparency in respect of the disclosures in the working of the company and balance in resolving conflict areas.

Other Stakeholders• Evaluating the board’s or management decisions in respect of

employees, creditors etc. and in protecting stakeholders interest.

WHY DO INVESTORS CARE ABOUT CORPORATE GOVERNANCE ?

Financial reports and other disclosures can be trusted

Well governed companies mitigate ‘non-business’ risks

Believe that corporate performance in the long run is correlated with CG

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DOES BETTER CORPORATE GOVERNANCE DELIVER HIGHER SHAREHOLDER RETURNS ? To ascertain this, McKinsey & Co. in cooperation with the world bank conducted a series of surveys

• The survey gathered response from over 200 institutional investors managing approx. US$2.5 trillion in assets. 40% of the respondents were based in the U.S., balance in Europe, Asia and Latin America

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MOST INVESTORS WOULD BE WILLING TO PAY MORE FOR THE SHARES OF A WELL-GOVERNED COMPANY

Source: McKinsey Investor Opinion Study

Q: Would you be willing to pay more for a company with good board governance practices?

CG WILL LEAD TO CORPORATE EXCELLENCEProfitabilitySatisfied stakeholders such as shareholders, customers, employeesRevenue and profit growthGrowth in market shareGrowth in market value (Market capitalization)

PURPOSE OF SECTION 135 & CSR RULESThe general purpose of the CSR legal provision is to encourage mindful, catalytic participation of corporate India in the country’s development centric agenda

The enactment of Section 135 on CSR , Companies Act 2013 has thrown open new opportunities for nation building

SECTION 135 AND ITS CHARACTERISTICS

Clause 135 of the Companies Act requires that qualifying

companies spend a prescribed formula-based amount on CSR,

report on those activities, or explain why they failed to do so

The CSR clause is a type of regulatory law commonly

referred to as a “comply or explain” law

SECTION 135 (1)Every company having

Net worth of Rs. 500 cr or more

OR

Turnover of Rs. 1000 cr or more

OR

Net profit of Rs. 5 cr or more

---- during any financial year shall constitute a Corporate Social Responsibility (CSR) Committee of the Board consisting of 3 or more directors, out of which at least one director shall be an independent director

SECTION 135 (2)

The Board's report under sub-section (3) of section 134 shall disclose the composition of the CSR Committee

(As per Section 134(3)(o) also the details about the policy developed and implemented by the company on CSR initiatives taken during the year

SECTION 135 (3) • The CSR Committee shall

• (a)formulate and recommend to the Board, a CSR Policy which shall indicate the activities to be undertaken by the company as specified in Schedule VII;

• (b)recommend the amount of expenditure to be incurred on the activities referred to in clause (a); and

• (c)monitor the CSR Policy of the company from time to time.

SECTION 135(4)

(a) after taking into account the recommendations made by the CSR Committee, approve the CSR Policy for the company and disclose contents of such Policy in its report and also place it on the company's website, if any, in such manner as may be prescribed; and

(b) ensure that the activities as are included in CSR Policy of the company are undertaken by the company.

The Board shall

SECTION 135(5) The Board of every company shall ensure that the company spends, in every financial year, at least 2 per cent of the average net profits of the company made during the 3 immediately preceding financial years, in pursuance of its CSR Policy:

Provided that the company shall give preference to the local area and areas around it where it operates, for spending the amount earmarked for CSR activities:

Provided further that if the company fails to spend such amount, the Board shall, in its report made under clause (o) of sub-section (3) of section 134, specify the reasons for not spending the amount.

SPECIFIED ACTIVITIES UNDER SCHEDULE VII

Promoting Education

Promoting health care including preventive health care

Vocational skills

Eradicating hunger, poverty and malnutrition

Ecological balance

Conservation of natural resource

See the List of Specified Activities dated June 18, 2014 http://forbesindia.com/blog/wp- content/uploads/2014/06/General_Circular_21_2014.pdf

STEPS TO EXECUTE CSR MANDATE

The Policy may be periodically reviewed to be in harmony with changing societal and environmental needs.

An alert CSR Committee of the Board of Company must closely monitor its CSR Policy to ensure that it is effective.

It will have to initiate activities/projects through measurable budgets and timelines leading to impactful sustainable development.

The company would formulate a CSR Policy based on its response strategy

Through CSR, a conscientious corporate would first assess the needs of the community and the environment through a consultative mode

BOARD: ROLE & RESPONSIBILITY ( SEC 134 & 135)

A) Appoint Committee through Board Resolution

B) Approve the CSR Policy of the Company

C) Disclose names of CSR Committee members, CSR Policy and Annual Report on the website

D) Ensure CSR spend: Procure Utilization Certificates

E) Ensure CSR Monitoring Mechanism

APPOINT CSR COMMITTEE

Setup the CSR Committee of the Board; decide on its composition

based on responsibilities and

operational involvement

If Independent Director is required the same should be

appointed

Pass a resolution in the Board

approving the composition of the CSR Committee

In case of Companies that are

part of larger corporate groups /

conglomerates, they may also need

to look at composition of

individual company CSR Committee’s –

in the context of larger group effort

on CSR and overall co-ordination

The tenure and functioning of the CSR Committee shall depend upon the extant governance rules of the Company as defined by its Board

COMPOSITION: CSR COMMITTEE

Rule 5 of the CSR Rules notified on 27th February 2014: CSR Committee Formation

As per Section 135 (1), the CSR Committee of the Board shall comprise of three or more Directors, out of which at least one shall be an Independent Director

The choice of the Independent Director is an important one, and should be done keeping in mind the CSR requirements of the company

The Independent Director needs to be nominated only if the company is required to have one as per provisions of the Companies Act 2013. In case this position is not required, only two Directors can form the CSR Committee

CSR COMMITTEE: RESPONSIBILITIES 1. Formulate CSR Policy and identify activities to be undertaken

(preference to be given to local areas around its operations) as specified in Schedule VII of the Companies Act 2013. This should be done in a consultative manner, after due deliberations with the CSR team, local officials of the company and beneficiary communities

2. The detailed list of activities with allocated expenditure in the format given in the Act should be appended to the Policy

3. Report back to the Board of Directors for approval of the CSR Policy

4. Regularly monitor the implementation of the CSR Policy 5. Change/modify the CSR Policy as per feedback from the

implementation of the existing Policy. CSR activities with allocated budget and monitoring mechanism can/will also be revised accordingly. Any change in Policy must be duly ratified by the Board