Unit 4. Conceptual Framework of Corporate Governance.pptx

CSR and conceptual framework

1. Unit IV: Conceptual Framework of Corporate Governance

2. Corporate Governance Corporate Governance is the application of best management practices, compliance of law in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stakeholders. Conduct of business in accordance with shareholders desires ( maximising wealth) while confirming to the basic rules of the society embodied in the Law and Local Customs

3. Corporate Governance Relationships among various participants in determining the direction and performance of a corporation. Effective management of relationships among – Shareholders – Managers – Board of directors – employees – Customers – Creditors – Suppliers – community

4. Why Corporate Governance? Better access to external finance Lower costs of capital – interest rates on loans Improved company performance –sustainability Higher firm valuation and share performance Reduced risk of corporate crisis and scandals

5. Principles of Corporate Governance Sustainable development of all stake holders- to ensure growth of all individuals associated with or effected by the enterprise on sustainable basis Effective management and distribution of wealth – to ensure that enterprise creates maximum wealth and judiciously uses the wealth so created for providing maximum benefits to all stake holders and enhancing its wealth creation capabilities to maintain sustainability Contd ….

6. Discharge of social responsibility- to ensure that enterprise is acceptable to the society in which it is functioning Application of best management practices- to ensure excellence in functioning of enterprise and optimum creation of wealth on sustainable basis Compliance of law in letter & spirit- to ensure value enhancement for all stakeholders guaranteed by the law for maintaining socio-economic balance Adherence to ethical standards- to ensure integrity, transparency, independence and accountability in dealings with all stakeholders

7. Four Pillars of Corporate Governance Accountability Fairness Transparency Independence Accountability Ensure that management is accountable to the Board Ensure that the Board is accountable to shareholders

8. Four Pillars of Corporate Governance Fairness Protect Shareholders rights Treat all shareholders including minorities, equitably Provide effective redress for violations Transparency Ensure timely, accurate disclosure on all material matters, including the financial situation, performance, ownership and corporate governance Independence Procedures and structures are in place so as to minimise , or avoid completely conflicts of interest Independent Directors and Advisers i.e. free from the influence of others

9. Elements of Corporate Governance Good Board practices Control Environment Transparent disclosure Well-defined shareholder rights Board commitment

10. Good Board Practices Clearly defined roles and authorities Duties and responsibilities of Directors Understood Board is well structured Appropriate composition and mix of skills

11. Good Board procedures Appropriate Board procedures Director Remuneration in line with best practice Board self-evaluation and training conducted

12. Control Environment Internal control procedures Risk management framework present Disaster recovery systems in place Media management techniques in use

13. Control Environment Business continuity procedures in place Independent external auditor conducts audits Independent audit committee established Internal Audit Function Management Information systems established Compliance Function established

14. Transparent Disclosure Financial Information disclosed Non-Financial Information disclosed Financials prepared according to International Financial Reporting Standards (IFRS) Companies Registry filings up to date High-Quality annual report published Web-based disclosure

15. Transparent Disclosure Well-Defined Shareholder Rights Minority shareholder rights formalized Well- organised shareholder meetings conducted Policy on related party transactions Policy on extraordinary transactions Clearly defined and explicit dividend policy

16. Board Commitment The Board discusses corporate governance issues and has created a corporate governance committee The company has a corporate governance champion A corporate governance improvement plan has been created Appropriate resources are committed to corporate governance initiatives Policies and procedures have been formalized and distributed to relevant staff A corporate governance code has been developed A code of ethics has been developed The company is recognized as a corporate governance leader

17. Other Entities Corporate Governance applies to all types of organisations not just companies in the private sector but also in the not for profit and public sectors Examples are - NGOs, schools, hospitals, pension funds, state-owned enterprises

18. Corporate governance in India The Indian corporate scenario was more or less stagnant till the early 90s. The position and goals of the Indian corporate sector has changed a lot after the liberalisation of 90s. India’s economic reform programme made a steady progress in 1994. India with its 20 million shareholders, is one of the largest emerging markets in terms of the market capitalization.

19. Corporate governance of India has undergone a paradigm shift In 1996, Confederation of Indian Industry (CII), took a special initiative on Corporate Governance. The objective was to develop and promote a code for corporate governance to be adopted and followed by Indian companies, be these in the Private Sector, the Public Sector, Banks or Financial Institutions, all of which are corporate entities. This initiative by CII flowed from public concerns regarding the protection of investor interest, especially the small investor, the promotion of transparency within business and industry

20. Securities and Exchange Board of India The Government of India's securities watchdog, the Securities Board of India, announced strict corporate governance norms for publicly listed companies in India. The Indian Economy was liberalised in 1991. In order to achieve the full potential of liberalisation and enable the Indian Stock Market to attract huge investments from foreign institutional investors (FIIs), it was necessary to introduce a series of stock market reforms. SEBI, established in 1988 and became a fully autonomous body by the year 1992 with defined responsibilities to cover both development and growth

21. SEBI On April 12, 1988, the Securities and Exchange Board of India (SEBI)was established with a dual objective of protecting the rights of small investors and regulating & developing the stock markets in India. In 1992, the ‘BSE’, the leading stock exchange in India, witnessed the first major scam masterminded by Harshad Mehta. Analysts felt that if more powers had been given to SEBI, the scam would not have happened . As a result the ‘ GoI ’ brought in a separate legislation by the name of ‘SEBI Act 1992’ and conferred statutory powers to it. Since then, SEBI had introduced several stock

22. SEBI and Clause 49 SEBI asked Indian firms above a certain size to implement Clause 49, a regulation that strengthens the role of independent directors serving on corporate boards. On August 26, 2003, SEBI announced an amended Clause 49 of the listing agreement which every public company listed on an Indian stock exchange is required to sign. The amended clauses come into immediate effect for companies seeking a new listing.

23. The major changes to Clause 49… Independent Directors :- 1/3 to ½depending whether the chairman of the board is a nonexecutive or executive position. Non-Executive Directors :- The total term of office of non-executive directors is now limited to three terms of three years each. Board of Directors :- The board is required to frame a code of conduct for all board members and senior management and each of them have to annually affirm compliance with the code.

24. Audit Committee :- Financial statements and the draft audit report of management discussion & analysis of… • Financial condition • Result of operations of compliance with laws • Risk management letters • Letters of weaknesses in internal controls issued by statutory • Internal auditors • Removal and terms of remuneration of the chief internal auditor Whistleblower Policy :- This policy has to be communicated to all employees and whistleblowers should be protected from unfair treatment and termination. Subsidiary Companies :- 50% non-executive directors & 1/3 & ½independent directors depending on whether the chairman is non-executive or executive.

25. Conclusion As Indian companies compete globally for access to capital markets, many are finding that the ability to benchmark against world-class organizations is essential. For a long time, India was a managed, protected economy with the corporate sector operating in an insular fashion. But as restrictions have eased, Indian corporations are emerging on the world stage and discovering that the old ways of doing business are no longer sufficient in such a fast-paced global environment. Thank you

26. Corporate Governance

27. 1. Introduction What is corporate governance? Corporate governance is the system of principles, policies, procedures, and clearly defined responsibilities and accountabilities used by stakeholders to overcome the conflicts of interest inherent in the corporate form . Hence, the importance of understanding the different forms of business. Corporate governance affects the operational risk and, hence, sustainability of a corporation. The quality of a corporation’s corporate of governance affects the risks and value of the corporation. Effective, strong corporate governance is essential for the efficient functioning of markets.

28. 2. Corporate governance: Objectives and guiding principles There are inherent conflicts of interest in corporations in which the ownership and management are separate. Objectives of corporate governance: To eliminate or mitigate conflicts of interest. Particularly those between corporate managers and shareholders; and To ensure that the assets of the company are used efficiently and productively and in the best interests of its investors and other stakeholders .

29. Core Attributes of an effective corporate governance system

30. 3. Forms of business and conflicts of interest The form of business will dictate, in part, the relationship between the owners of the business and management. The degree of separation may be minimal (e.g., sole proprietorship), or significant (e.g., large corporation). When there is a separation between owners and managers, there is a potential for agency problems, which may affect the value of the business. We will examine three business forms: the sole proprietorship, the partnership, and the corporation.

31. Sole proprietorship A sole proprietorship is owned and operated by a single person Sole proprietorships are the most numerous in terms of number of businesses. Who bears governance risk in a sole proprietorship? There are few risks with respect to governance from the perspective of the owner. Creditors, including trade creditors, have the highest risk with respect to governance.

32. Partnership A partnership has two or more owner/managers. Who bears governance risk in a partnership? There are few risks with respect to governance from the perspective of the owners, with ownership rights and responsibilities detailed in the partnership agreement. Creditors, including trade creditors, have the higher risk with respect to governance.

33. Corporation A corporation is a legal entity that has rights similar to an individual. For example, a corporation can enter into contracts. Corporations account for most business revenue around the world. Corporations around the world: Limited Company (U.K.), Gesellschaft (German); Societé Anonyme (France), 公司 (China ); şirket (Turkey); บริษัท (Thailand)

34. Advantages of the corporate form A corporation can raise capital. Grant ownership stakes (that is, issue stock) or borrow (that is, issue bonds). Owners need not know how to run the business. The corporation hires experts to manage the business. Ownership interests are transferrable.

35. Disadvantages of the corporate form Corporations are more highly regulated than are partnerships or sole proprietorships. For example, in the U.S. there are State laws pertaining to corporations and the Securities and Exchange Commission requires specific disclosures. Separation of owners and managers. This is the agency relationship , in which someone (the agent) acts on behalf of another person (the principal). The potential conflict between owners and managers is the agency problem or principal-agent problem, Principals: shareholders Agents: Management and members of the board of directors There are costs to this agency relationship arising from conflicts of interest.

36. 3. Forms of business and conflicts of interest Characteristic Sole Proprietorship Partnership Corporation Ownership Sole owner Multiple owners Unlimited ownership Legal requirements and regulation Few; entity easily formed Few; entity easily formed Numerous legal requirements Legal distinction between owner and business None None Legal separation between owners and business Liability Unlimited Unlimited but shared among partners Limited Ability to raise capital Very limited Limited Nearly unlimited Transferability of ownership Non-transferable (except by sale of entire business) Non-transferable Easily transferable Owner expertise in business Essential Essential Unnecessary

37. 4. Specific sources of conflict: Agency relationships Management–Shareholder conflicts Director–Shareholder conflicts

38. Management–Shareholder Conflicts Shareholders entrust management with funds from reinvested earnings or newly issued stock, which management invests. The overarching objective is to maximize shareholders’ wealth. Issue: Managers are human Managers may be more interested in expanding the size of the business, bonuses based on earnings, taking on excessive risks, or job security. Managers may consume excessive perquisites, or in effect, take advantage of their position to spend excessively on things for themselves. Bottom line: there may be agency costs in terms of the explicit and implicit costs when managers do not act in the best interest of shareholders. Effective corporate governance guards against agency costs.

39. Director–shareholder conflicts The board of directors are an intermediary between the shareholders and management, and represent shareholders’ interests by: Monitoring managers; Approving strategies and policies; Approving mergers and acquisitions; Approving audit contracts; Reviewing audit contracts and financial contracts; Establishing management compensation; Disciplining poorly performing managers. A conflict may arise if the board members align with management.

40. Responsibilities of the Board of Directors Establish corporate values and governance structures for the company; Ensure that all legal and regulatory requirements are met and complied with fully and in a timely fashion; Establish long-term strategic objectives for the company; Establish clear lines of responsibility and a strong system of accountability and performance measurement; Hire the chief executive officer, determine the compensation package, and periodically evaluate the officer’s performance; Ensure that management has supplied the board with sufficient information for it to be fully informed and prepared to make the decisions that are its responsibility, and to be able to adequately monitor and oversee the company’s management; Meet regularly to perform its duties; Acquire adequate training.

41. 5. Corporate Governance Evaluation: Board of director Attributes The board should be comprised primarily of independent directors (that is, not insiders) The Chairman of the Board should be independent; Directors should be qualified; There should be a regular election of members of the Board; There should be a regular self-assessment of the Board; The board should hold separate meetings of the independent directors; The board should require audit oversight by independent directors who have sufficient expertise in finance, accounting, and the law.

42. The nominating committee should be comprised of independent directors; The compensation committee should be comprised of independent directors; The board should be able to hire outside counsel; The board should disclose governance policies; The board should ensure adequate disclosure and transparency; The board should require disclosure of any related-party transactions; The board should respond to shareholders’ non-binding proxy votes. 5. Corporate Governance Evaluation: Board of director Attributes (continued )

43. Monetary Authority of Singapore Guidelines and Regulations on Corporate Governance Principle 1: Every Institution should be headed by an effective Board. Principle 2: There should be a strong and independent element on the Board which is able to exercise objective judgment on corporate affairs independently from management and substantial shareholders. Principle 3: The Board should set and enforce clear lines of responsibility and accountability throughout the Institution. Principle 4: There should be a formal and transparent process for the appointment of new directors to the Board. Principle 5: There should be a formal assessment of the effectiveness of the Board as a whole and the contribution by each director to the effectiveness of the Board. Principle 6: In order to fulfill their responsibilities, Board members should be provided with complete, adequate and timely information prior to board meetings and on an on-going basis by the management.

44. Guidelines and Regulations on Corporate Governance ( continued) Principle 7: There should be a formal and transparent procedure for fixing the remuneration packages of individual directors. No director should be involved in deciding his own remuneration. Principle 8: The level and composition of remuneration should be appropriate to attract, retain and motivate the directors to perform their roles and carry out their responsibilities. Principle 9: The Board should establish an Audit Committee with a set of written terms of reference that clearly sets out its authority and duties. Principle 10: The Board should ensure that there is an adequate risk management system and sound internal controls.

45. Principle 11: The Board should ensure that an internal audit function that is independent of the activities audited is established. Principle 12: The Board should ensure that management formulates policies to ensure dealings with the public, the Institution’s policyholders and claimants, depositors and other customers are conducted fairly, responsibly and professionally. Principle 13: The Board should ensure that related party transactions with the Institution are made on an arm’s length basis. Guidelines and Regulations on Corporate Governance ( continued)

46. Organisation for Economic Co-Operation and Development (OECD) Principles of Corporate Governance

47. 6. Environmental , social, and governance factors ESG risk exposure Environmental, social, and governance ( ESG ) risk is the risk associated with the management of environment, social, and governance issues. Involves mitigating risks and managing these risks when they arise. ESG risk affects the company’s sustainability and valuation .

48. Examples of ESG risks Legislative and regulatory risk (that is, the role of governments) Legal risk (for example, lawsuits) Reputational risk Operating risk Financial risk

49. 7. Valuation implications of corporate governance

50. Risks of weak corporate governance

51. Benefits from strong governance Evidence suggests that: companies with strong governance had greater investment performance. companies with strong shareholders’ rights outperformed those with weak protections.

52. 8. Summary Corporate governance is the system of principles, policies, procedures, and clearly defined responsibilities and accountabilities. The objectives of a corporate governance system are (1) to eliminate or mitigate conflicts of interest among stakeholders, particularly between managers and shareholders, and (2) to ensure that the assets of the company are used efficiently and productively and in the best interests of the investors and other stakeholders. The failure of a company to establish an effective system of corporate governance represents a major operational risk to the company and its investors.

53. The specific sources of conflict in corporate agency relationships are manager-shareholder. The responsibilities of board members, both individually and as a group, are to establish corporate values and effective governance structures for the company. Summary (continued)

54. Companies committed to corporate governance often provide a statement of corporate governance policies. Analysts should assess: the code of ethics; statements of the oversight, monitoring, and review responsibilities of directors; statements of management’s responsibilities with respect to information and access of directors to internal company functions; reports of directors’ examinations, evaluations, and findings ; board and committee self-assessments; management self-assessments; and training policies for directors. Weak corporate governance systems give rise to risks including accounting risk, asset risk, liability risk, and strategic policy risk. Summary (continued)