corporate governance challenges

8/3/2019 Corporate Governance Challenges

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Evolution & Challenges

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Corporate Governance Reforms


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Abstract

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y Indias corporate governance reforms have accompanied the countrys economictransformation. The needs of Indias expanding economy, the increased presence of foreign and institutional investors (both domestic and foreign), and the growingdesire of Indian companies to access global capital markets by gaining listing on stocexchanges outside of India, have spurred corporate governance reforms.

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The Satyam scandal has served as a catalyst for the Indian government to rethink thecorporate governance, disclosure, accountability, and enforcement mechanisms inplace. As described in this article, Indian regulators and industry groups haveadvocated for a number of corporate governance reforms to address some of theconcerns raised by the Satyam scandal. The responses of both the regulators andindustry groups to the Satyam scandal are certainly commendable.

y However, the suggested reform efforts continue to have voids not just in complianceand enforcement, but also in terms of substantive rules that address critical issues inIndian corporate governance. This article contends that, given the political economyof corporate law in India and the traditional ownership structure of many Indianfirms, achieving more significant corporate governance reforms will be a substantialchallenge.


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Ou tline

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y This article provides an overview of Indias recent corporategovernance reforms and analyzes their continuingshortcomings.

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Part I of this article explores the origins & a brief overviewof the primary motivation for reform efforts.y Part II documents the Satyam scandal and analyzes the

resulting corporate governance reform efforts.y

Part III of this article demonstrates the shortcomings of resulting reforms & other challenges related to suchamendments


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Ou tline

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y This article provides an overview of Indias recent reforms related tocorporate governance and analyzes their continuing shortcomings &suggestions to overcome their upcoming challenges.

y Part I - Brief overview of Indian Scenario & A time line for corporate reformsevolution

y Part II - K ey driving forces & Need of Corporate Governance in Indiay Part III - R eview of Study y Part IV - Th e Satyam scandal & Oth er Areas of Mis-Governance & Mis-conducty Part V Sh ortcomings- Arguments of such resulting reforms & Upcoming

C h allenges to recent amendmentsy Part VI - Suggestions & ConcludingR emarksy


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Corporate Governance

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W h at is Governance?y Purpose of corporate governance is to have a demonstrable

y IMPACT on a corporations FINANCIAL PERFORMANCE.


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Corporate

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y Corporate is adjective meaning of or relating to acorporation derived from the noun corporation.

y A corporation is an organization created (incorporated) by a

group of shareholders who have ownership of thecorporation.y The elected Board of directors appoint and oversee

management of the corporation.


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Governance

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y Oxford English Dictionary defines G overnance as theact, manner, fact or function of governing, sway, control

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The word has Latin origins that suggest the notion of 'steering'. It deals with the processes and systems by which anorganization or society operates.


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y It is a broad concept and has been defined and understooddifferently by different groups and at different points of time.

y The Cadbury Committee report defines it as the system by

which companies are directed and controlled.y It is generally understood as the framework of rules,

relationships, systems and processes within and by whichauthority is exercised and controlled in corporations.


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Corporate Governance- Concept &O bj ectives

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CORPORATE GOVERNANCE is a system by which companies aredirected and controlled.

y Protecting the long term interest and enhancing the values of shareholders and other stakeholders ( viz.,customers, employees,creditors, bankers, regulators and society at large)

y Harmonizing rights & interest of shareholders and stakeholders bycontinuous exercise of striking balance.

y Reducing the risks normally faced by the company/ organization.y Responsibility to introduce and effectively implement CorporateGovernance is exclusively of Board of Directors in a manner that it

becomes way of organizational life and not merely written rules orregulations or code of ethics.

y Ethics & Transparency are cardinals of Corporate Governance.


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O bj ectives of good corporategovernance

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y Strengthen management oversight functions andaccountability

y Balance skills, experience and independence on the board

appropriate to the nature and extent of company operationsy Establish a code to ensure integrityy Safeguard the integrity of company reportingy Risk management and internal controly Disclosure of all relevant and material mattersy Recognition and preservation of needs of shareholders


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E volu tion and Implementation of theConcept at Glo b al Level

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y Corporate Governance evolved and introduced as remedialmeasures in corporate sector for forbidding the wrongs orunethical practices.

y Appointment of Various committees at global level to addressthe issue and give recommendations.

y Worldwide economic crisis and corporate debacles haveproven the inadequacy of regulatory frame work to bring the best out of corporate management.

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Establishment of GATT and WTO regulations alsoemphasized the need of good corporate practices i.e.Corporate Governance.


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D riving forces of Corporate Governancein India

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y 1 ) Unethical Business Practicesy Security Scams ---Harshad Mehtha Security Scam

y Equity allotments at discount rates to the controlling groupsy Disappearance of Companies (1993 -94 ) - around4 ,000y companies with 25,000 crores without starting business

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Misdeed of Companiesy Plantation, Sheep rearing, etc.y 2) Impact of Globalization

y Integration with Foreign Markety Foreign Investors expectationsy New Business Opportunities --- IT & ITES, BPO etc.,y

New Capital formation FII, FDIy 3 ) Impact of Privatisation

y New structure of ownershipy Multinational Companies

y 4 ) Market Driven Economyy 5) Efficiency is a now a key factor


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Introd u ction/Backgro u nd/ E volu tion - A Time Line (Brief O verview)

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INDIAN STYLEy Family managed companies; The body of promoters or the

parent company maintains a firm hold on the company under

their management and care.y There are three kinds of directorsy Promotersy Professional directorsy Director appointed by the FIs


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Indian scenario Year Name of

Committee/BodyAreas/Aspects Covered

1998 Confederation of Indian Industry (CII)

Desirable Corporate Governance A Code

1999 Kumar MangalamBirla Committee


2002 Naresh ChandraCommittee Corporate Audit & Governance

2003 N. R. NarayanaMurthy Committee


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Brief history of corporate governance - India

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y Unlike South-East and East Asia, the corporate governance initiative inIndia was not triggered by any serious nationwide financial, bankingand economic collapse

y The initiative in India was initially driven by an industry association,the Confederation of Indian Industryy In December199 5, CII set up a task force to design a voluntary code of

corporate governance.y The final draft of this code was widely circulated in1997 .y In April1998 , the code was released. It was calledD esirable Corporate

Governance: A Code.y Between1998 and 2000, over 25 leading companies voluntarily followed

the code: Bajaj Auto, Hindalco, Infosys, Dr. Reddys Laboratories,Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI and many others


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y Following CIIs initiative, the Securities and Exchange Board of India(SEBI) set up a committee under Kumar Mangalam Birla to design amandatory-cum-recommendatory code for listed companies

y The Birla Committee Report was approved by SEBI in December2000

y Became mandatory for listed companies through the listing agreementand implemented according to a rollout plan:y 2000-01 : All Group A companies of the BSE or those in the S&P CNX

Nifty index 8 0% of market cap.y

2001 -02: All companies with paid-up capital of Rs.1 00 million or more ornet worth of Rs.250 million or more.y 2002-03 : All companies with paid-up capital of Rs.3 0 million or more


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y Following CII and SEBI, the Department of Company Affairs (DCA)

modified the Companies Act,19

56 to incorporate specific corporategovernance provisions regarding independent directors and auditcommittees.

y In 2001 -02, certain accounting standards were modified to furtherimprove financial disclosures. These were:y Disclosure of related party transactions.y Disclosure of segment income: revenues, profits and capital employed.y Deferred tax liabilities or assets.y Consolidation of accounts.

y Initiatives are being taken to (i) account for ESOPs, (ii) furtherincrease disclosures, and (iii) put in place systems that can furtherstrengthen auditors independence.


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Review of St u dy

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y According to various studies, corporate governance practices and INED s are particularly important for companies in India because th ese elements can:-

y increase share price performance/firm value,y decrease the cost of capitaland consequently, financing costsandy

increase foreign investment in local companiesy Th erefore,K ey findings of such studiesh igh ligh ts th at -

y SEPARATION OF OWNERSHIP AND CONTROL IS KEYy RELATIONSHIP BETWEEN OWNERSHIP STRUCTURE AND

FIRM VALUEy WEAK LEGAL PROTECTION EXACERBATES THE ISSUEy GOOD CORPORATE GOVERNANCE EQUALS HIGHER FIRM

VALUE


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Recent Cases

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y Satyamy RPT (related party transaction)y Fraud in financial Statements

y O ther Recent Mis-Conducts, the list goes on1 . Computer Associates

y Artificially inflated revenue and improperly rewarded top executives.

2. CMS Energyy Overstated revenues in 2000 and 2001 thru round trip energy trades?


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3 . Dynegyy Transactions to cut taxes and artificially increase cash flow

4 . Kmarty Suspected improper accounting for vendor allowances

5. Lucent Technologiesy Adjusted fiscal 2000 revenues by $679 million.


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Corporate Mis-Governance

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&


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Infosys Technologies: The Best among Indian Corporates

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y As per the Credit Lyonnais Securities Analysis (CLSA), thecorporate governance ratings of the Software firms are higher thanthose of other Indian firms.

y Infosys, based in Bangalore, is a publicly held, ISO9 001 certified

company offering information technology consulting & softwareservices.y The software offered include application development, E-

Commerce & Internet Consulting, Software Maintenance.y Respected across the country, with very strong systems, high

ethical values & a nurturing working atmosphere.y Net income of US1 ,1 55 million and revenue of US4 ,17 6 million.y At present having US 20.4 billion market capitalisation


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Achievements

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y Voted as the Best Managed Company in Asia.y Biggest exporters of Software.y First to follow the US Generally Accepted Accounting

Principles before going for Nasdaq listing in1991

.y Championed Corporate Governance in India.


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Best Governed Companies

ICSI National Award for Excellence in



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F indings/Shortcomings

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y This articleargues that not only have both reform andenforcement efforts by regulators lagged, but many of the reformsthat have been adopted fail to addressfundamental areas of concern such as therelationsh ip between controlling and minority sh areh olders, th e role of promoters, th e limited activism of sh areh olders,including institutional investors, and issues with director independence.

y This article expresses concerns that thesechallenges may prevail because they have been shaped byunique political and social

forces. These forces includeth e traditional closed ownersh ip structuresof Indian firms, an ineffective institutional framework to supportenforcement efforts, weaknesses in th e judiciary, and political pressuresrelated to government ownersh ip of certain industries.


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K ey Arg u ments/Challenges

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y Firm Level Reforms (Satyam)-y Resulting Compliancey Enforcement Efforts

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Political Economy of Reform Efforts-y Inter Agency Strugglesy Access to Courts

y Neglecting Minority Shareholdersy

PSUs & the Govt Struggles


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Concl u ding O b servations

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y Code of CG should be redesigned to reflect international best practices

y Stringent enforcement of Lawy

More effective coordination and cooperation between SEBI,DCAy CG mechanism should be flexible and suitabley Overall ethical values in all segments should be promoted for

effectivey accounting, auditing, disclosure and transparent system.


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O pport u nities/S u ggestions

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K ey Prerequisites/Main I ngredients of Corp G overnancey The value proposition

y Good corporate governance & convincing enforcement processes - highermarket valuations of enterprises in free capital markets

1 . Transparency Standards in line with international requirementsy Comprehensive Disclosurey Regular Financial Informationy Governance Reportingy Clarity & Comprehensiveness of the Informationy Equal & Timely Distribution of Information to Shareholders

2 . Convincing I ndependence & Quality of Boards & A uditorsy Well Structured & Transparent Board Nomination Processy Standing, Quality, Independence of Non Executivesy Establishment of Board Committeesy Privatisation of State Owned Enterprisesy High Auditor Independence & Quality Imperative


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Contd..

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3 . Equitable Treatment of Shareholdersy One Share-One Vote Principley Elimination of cross border voting impedimentsy Shareholder access to all relevant informationy Proper functioning of proxy voting processy

Holders of deposits receipts should have same opportunities & rights to voteas direct shareholdersy Fair Treatment in merger transactions

4 . Satisfactory control & enforcement of good governancethrough independent regulators

y Efficient protection against insider trading & uncontrolled self dealingy Centralised competenciesy Independent Arbitration Panel


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Contd.

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5 . I nstitutional I nvestors have fiduciary duty to actconvincingly in the interest of their clients

y Applies to both internal & external governancey Draft a statement on institutional shareholders responsibilities

6 . A good governance framework is essential but onlysufficient quality convinces institutions to be longterm shareholders

y Active pursuit of good governance


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Concl u sions/Concl u ding Remarks

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y Since the late199 0s, significant efforts have been taken by Indianregulators, as well as by Indian industry representatives andcorporations, to achieve an overhaul of corporate governance in Indianfirms. Not only were reform measures put into place prior to discoveryof major corporate governance scandals, but both industry groups andgovernment actors have sprung into action following the Satyam scandal

y Despite these commendable efforts, the actual implementation andenforcement of corporate governance reforms remain challenging. Asdiscussed in this article, these challenges arise because of a number of

social, political and economic conditions in India. While this shortarticle cannot expand in further detail the potential solutions to thesechallenges, it is hoped that further research can help develop solutionsthat take them into account.


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CON CLUSION

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y Since the late199 0s, significant efforts have been taken by Indianregulators, as well as by Indian industry representatives andcorporations, to achieve an overhaul of corporate governance inIndian firms.

y

Not only were reform measures put into place prior to discoveryof major corporate governance scandals, but both industry groupsand government actors have sprung into action following theSatyam scandal.

y Despite these commendable efforts, the actual implementation

and enforcement of corporate governance reforms remainchallenging. As discussed in this article, these challenges arise because of a number of social, political and economic conditionsin India.

corporate governance challenges

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