Corporate Governance - Conceptual Framework

Dr M Manjunath Shettigar

05/02/2023

2 Corporate Governance - MeaningCorporate governance refers to a framework covering effective instruments and

transparent operational mechanisms put in place to ensure that the corporate entity

works as per the declared corporate purpose, complies with

the government rules and regulations, and follows accepted ethical norms,

while balancing and protecting the interest of all stakeholders

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Corporate governance is the system of rules, practices and processes by which a company is directed and controlled.

Corporate governance essentially involves balancing the interests of a company's many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community.

Since corporate governance also provides the framework for attaining a company's objectives, it encompasses practically every sphere of management, from action plans and internal controls to performance measurement and corporate disclosure.

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4 Issues addressed in CG

Although the details will vary across corporations, the main focus should be on: Corporate performance and strategic direction. CEO selection, compensation and succession. Internal controls, risk oversight and compliance. Crisis preparedness. Shareholder engagement. Interface with stakeholders

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5 Limited Liability Companies

Entrepreneurs translate ideas into business proposals

Initially they get funding from friends, angel investors and venture capitalists.

As the business grows they invite public to contribute to the equity capital of the company.

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6 Limited Liability Companies (Contd.)

Companies also borrows money from financial institutions and public.

Public limited companies get their securities listed to make those more attractive due to convenience of trading.

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7 Limited Liability Companies (Contd.)

Non-controlling shareholders are like sleeping partners.

They look for growth in the value of their investment. Value of shares depends on sustainability of the firm

and its ability to achieve growth and Return on Invested capital higher than the cost of capital.

Shareholders get back their investment by selling shares to another investor.

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8 Limited Liability Companies (Contd.)

Limited liability Perpetual succession Juridical person

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9 Agency Problem 1

Separation of ownership and control Professional managers Dispersed shareholders Opportunistic behaviour of the manager, who has

100% control over assets, but very less share in company’s cash flows

Expropriation of shareholders’ wealth by the manager.

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10 Agency Problem 2

Controlling shareholder (e.g., promoter) Company’ interest is ignored to benefit the

controlling shareholder. Tunneling of company’s assets for the benefit of

the controlling shareholder Abusive related party transactions Family governance dominates corporate

governance

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How should the companies be run ? What should be their main goal ?

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12 Shareholder Theory

The core objective function of a firm is to create shareholder value.

Stakeholders should be managed by analysing their level of interest and power.

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13 Stakeholder Theory

Whatever the ultimate aim of the corporation or other form of business activity, managers and entrepreneurs must take into account the legitimate interests of those groups and individuals who can affect (or be affected by) their activities.

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14 Enlightened Shareholder Value

“Corporations should pursue shareholder wealth with a long-run orientation that seeks sustainable growth and profits based on responsible attention to the full range of relevant stakeholder interests”.

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15 Corporate Governance

The design of institutions that induce or force management to internalise the welfare of stakeholders.

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16 Key Institutions

Internal: The board of directors (Board)

External: Ministry of corporate affairs and institutions under it

(e.g., SFIO, NCLT, NAFRA and Competition Commission)

(Serious Fraud Investigation Office, National Company Law Tribunal, National Financial Reporting Authority)

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17 Key Institutions

SEBI and capital markets Courts of law Independent directors Credit Rating Agencies Capital market players – Institutional

investors & others Market for corporate control

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18 Pillars of Corporate Governance

Transparency – within the Board and outside the Board

Accountability – management’s accountability to the Board and Board’s accountability towards stakeholders

Equity – equity among all stakeholders, including various groups of shareholders

Responsibility (social)

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19 Board of Directors: Apex Decision-making Body

Independence Diversity Size Process Culture

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20 Rights of Stakeholders

Shareholders’ rights are protected by the Companies Act 2013

Other stakeholders’ rights are protected by explicit and implicit contracts; and laws and institutions that enforce those contracts Contract Act; Sales of Goods Act; Negotiable

Instruments Act; Environmental Laws; Labour Laws; and others

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21 Beyond Agency Problem

Strategy crafting and implementation Enterprise risk management and business

sustainability Internal Financial Control Enterprise performance management Succession planning

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22 Independent Directors: Challenges

Who appoints the independent directors? Are they monitors? Are they advisors? Are they resource providers? Do they lack motivation? Are they competent?

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23 IDs– Factors That Hinder Performance

Do not rock the boat syndrome None wants to be a dissenting peer Overwhelmed by the charisma of the CEO Familiarity bias – misplaced loyalty Group consensus

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24 Shareholder’s Rights

Vote in general meetings Appoint directors Appoint auditors Approve financial statements Receive information

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25 Restriction on Power of The Board

Shareholders’ approval by special resolution is required to: Sell, lease or otherwise dispose of an undertaking

in which the investment exceeds 20 per cent of net worth or which generates 20 per cent of the total income.

To invest otherwise in trust securities the amount of compensation received as a result of any merger or amalgamation

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26 Restriction on Power of The Board (Contd.)

Borrow money where the total borrowings will exceed the aggregate of paid up share capital and free reserves, apart from temporary loans from company’s bankers

Remit or give time for the repayment of, any debt due from a director.

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27 Managerial Remuneration

Shareholders’ approval is required to pay remuneration to directors exceeding the limit specified in the Companies Act 2013 (section 197)

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28 Majority of Minority Rule

Majority of shareholders, other than those who are related parties to the company, shall approve related party transactions of an amount exceeding the specified amount.

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29 Shareholder Activism

Institutional shareholders Proxy advisory firms Class action suits

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30 Re-Cap

Agency problem 1 Agency problem 2 Shareholder theory and stakeholder theory Transparency, accountability and equity Beyond agency problem Designing institutions

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31 Re-Cap (Contd.)

Independent Board Independent auditor Shareholder activism

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THANKS