ch.13 fernando theory & practice cg

8/7/2019 Ch.13 Fernando Theory & Practice CG

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`

The concept of Corporation-What is a Corporate?` Theoretical Basis of CG` Agency Theory` Stewardship Theory` Stakeholder Theory

` CG Mechanisms` CG systems` Anglo-American Model` German Model` Japanese Model

` Indian Model of Governance` Obligation to society at large , investors , employees,

& customers` Managerial Obligation

Source: Fernando , Chapter 13

` ICMR , Chapter 19


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` The major portion of capital is in the hands of few giantcorporations which are in a position to exerciseconsiderable control over industrial production

` The business corporation is an instrument throughwhich capital is assembled for the activities of producing& distributing goods & services & making investments

` A corporation is an artificial being , intangible & existing

only in the contemplation of the law . The importantproperties are immortality , individuality & may act as asingle individual.


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` The corporation of today has come to replace the sole proprietor of earlier

times & tries to maximize its profits

` The corporate differs from the individual capitalist in 2 aspects:

` The life span of the corporation is much longer

`

It is more rational in decision-making as it has the benefit of the collective wisdom ofthe BOD & they take decisions using the principles of cost accounting, budget

analysis , data collection & managerial consulting

` Justice Lindlays definition of a corporation

` Enjoys some privileges & is bound by responsibilities

` A corporation is an association of persons recognized by the law as having a

collective personality

` The corporation can act as if it were distinct from its members; it has

perpetual succession & a common seal

` It can therefore CONTRACT quite freely-it can also be fined , but it obviously

cannot be sent to prison or incur penalties which can only be applied to

individuals


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` Incorporated Association or registered under the prevalentCompanies Act of the country

` Artificial legal existence: A corporation is entitled to aseparate legal existence , apart from the persons composing

it` In the eyes of the law , it is a separate legal person & has

rights & duties as any natural person has , though it has nopolitical or civic rights

` The corporation assets are separate & distinct from that of itsmembers; it can sue & can be sued exclusively for it ownpurpose

` The liability of shareholders is limited to the capital investedby them & the creditors have no right to the assets of the

corporation


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` The life of a corporation does not end with the exit,

retirement , insolvency or death of any or all directors orshareholders

` Perpetual existence of the company is preserved by theprovision of transferability of shares . Law creates a

company & law only can dissolve it` Common seal is a legal requirement & enhances the legal

entity of the corporation

` Extensive membership with millions of shareholders

` Separation of management from ownership

` Limited liability implies that the liability of the shareholders islimited to the amount unpaid on their shares irrespective ofthe obligations of the company

` Transferability of shares without seeking permission from the

company


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` Agency , Stewardship , Stakeholder , Sociological Theory

` Agency Theory

` Shareholders are the owners of any joint stock , limited liability company & are

the principals, who define the objectives of a company

` The management , directly or indirectly selected by shareholders to pursue

such objectives are the agents

` The objectives of managers are sometimes at variance from those ofshareholders which results in mismatch of objectives(agency problem)and a

cost inflicted(agency cost)

` CG , puts in place disclosures, monitoring , oversight & corrective systems that

align the objectives of both groups

` Incentive schemes & employee stock options for managers to align financial

interests of executives with shareholders

` Two broad mechanisms that reduce agency costs & improve CG

` Fair & accurate financial disclosures which relate to the role of independent,

statutory auditors

` Efficient & Independent Board of Directors who are fiduciaries of the

shareholders , accountable only to shareholdersIndependence


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` The job of management is to prepare the accounts` Responsibility of statutory auditors to scrutinize such

accounts , raise queries & objections(if the need arises)

` Auditors arrive at a true & fair view of the financial

position of the company & report their independent

findings to the board of directors

` Through the board of directors , the findings are

communicated to the shareholders & investors of the

company


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` Stewardship Theory discounts the possible conflicts between corporate

management & owners

` Shows a preference for a board of directors made up primarily of corporate

insiders

` Financial reporting , disclosure & auditing are still important mechanisms

,needed to confirm managements' inherent trustworthiness

` Stewardship theory has 2 basics:

` Managers are not motivated by individual goals ,they are stewards whose

motives are aligned with the objectives of their principals

` A steward s behavior is pro-organizational rather than self-serving

` Control may be counterproductive as it lowers motivation

` The greatest barrier lies in the risk propensity of principals

(Gandhijis trusteeship)


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The theory considers the firm as an input-output model by adding allinterest groups-employees, customers , creditors , suppliers ,shareholders , government , local community , society at large- to thecorporate mix

Stakeholder theory is grounded in ethics of care , ethics of fiduciaryrelationships , property rights & theory of stakeholders as investors

Stakeholder theory upholds responsibilities to non-shareholdergroups

Criticism:1.Who really constitutes a genuine stakeholder? 2.The theory diverts wealth away from shareholders to others & goes

against the fiduciary obligations owed to shareholders

Sociological Theory focuses mostly on board composition & theimplications of power & wealth distribution in society Problems of interlocking relationships & concentration of

directorships are challenges to equity Board composition ,financial reporting , disclosure & auditing are

mechanisms to promote equity


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` Why CG?` Corporation is an independent legal entity , separate from its

owners` Shareholders nominate & elect directors who run the

enterprise` The directors are the stewards & demonstrate their

accountability to the shareholders in the form of regularfinancial reports & directors reports

` Shareholders also appoint independent auditors to reportthat these accounts show a true & fair picture

` Regular shareholder meetings provide an opportunity for thedirectors to report & clarify shareholder doubts

` CG is an umbrella term to cover the exercise of power over& within the company , for the good of all concerned


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` Shares listed on a stock exchange are held by diverse shareholders-private individuals , banks ,pension funds & insurance companies

` Ownership structures of public companies are often complex` Growing Awareness & Responses` CG code by CII in the wake of interest generated by the Cadbury

Committee , followed by ASSOCHAM & SEBI` SEBI appointed Kumara Mangalam Birla Committee& adopted the report

in mid2000.` RBI also constituted a committee` Based on inputs from these committees,Department of Company Affairs

included CG provisions & amended the Companies Act , which became

applicable to all Indian companies from 1 April 2001` Major companies now operate through group structures of wholly-owned

subsidiary companies ,partly-owned subsidiaries


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` Known as the unitary board model, which is the Anglo-Saxon approach to

CG followed in Anglo-American countries` All directors participate in a single board comprising both executive & non-

executive directors in varying proportions` The model tends to be shareholder-oriented` BOD perform 3 functions :representation , direction and oversight & appoints

&supervises the managers who take care of daily activities

` The ownership of companies is equally divided between individual &institutional shareholders` Companies are run by professional managers with negligible ownership

stakes .` Fairly clear separation of ownership & management` Most institutional investors are reluctant activists who view themselves as

portfolio investors .If they are not satisfied with a companys performance ,they sell the securities in the market & quit` The disclosure norms are comprehensive, the rules against insider trading

tight & the penalties for price manipulation stiff, all of which protect smallinvestors& promote market liquidity

` They discourage large investors from taking an active role in CG` A-A model of CG encourages radical innovation & cost competition


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` Known as the two-tier board model , CG is exercised through 2

boards: supervisory & management board

` Upper(supervisory) board supervises the management board on

behalf of stakeholders

` Shareholders elect 50 per cent of the members on the supervisoryboard and the other half is appointed by labor unions & employees

` Employees & laborers are not just stakeholders, they also have a say

in the governance mechanism .They become responsible for the

policies that are implemented by them

` The supervisory board which is appointed jointly by the shareholders

& labor unions , appoints and monitors the management board

` The management board conducts the day-to-day operations

independently ,but has to report to the supervisory board


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` Known as the business network model, which reflects thecultural relationships in the Japanese keiretsu network, inwhich boards tend to be large , predominantly executive &often ritualistic

` The financial institutions have a major role in the governancemechanism

` The shareholders along with the main bank together appoint

the board of directors & the president` Even the President is appointed on the basis of a consensus

between the share holders and the banks` The President consults the supervisory board & their

relationship is hierarchical`

The supervisory board usually ratifies whatever decisions thepresident takes` The financial institutions that finance the business have a

crucial role ,even though the shareholders are the owners ofthe business

` Banks even have the power to suspend the board in case ofan emergency!


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` Banks & financial institutions have substantial stakesin the equity capital of companies . Besides cross-holding among groups of firms is common in Japan

` Institutional investors view themselves as long-terminvestors & play an active role in corporatemanagement

` Disclosure norms are not very stringent , checks oninsider trading are not comprehensive & emphasis onliquidity is not high

` There is hardly any system of corporate control in

these countries ; mergers & takeovers are rareoccurrences


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` Mix of the Anglo-American & German/Japanese models` Pattern of private companies-the founder , his family & associates closely

hold the private companies & they exercise maximum control over theactivities of the company(Reliance ,Birla )

` Role of external equity finance is minimal

` Public enterprises , central & state governments choose members of theboard

` Even after disinvestment of PSUs , government has major hold overactivities

` Indian government constituted 3 committees-SEBI-appointed KumarMangalam Birla 2000, government appointed Naresh Chandra

2003&SEBIs Narayan Murty 2000 recommendations are remarkablysimilar to Englands Cadbury Committee & US Sarbanes-Oxley Act

` Thrust of legislative reforms-Greater transparency,& independent scrutiny ofcorporate accounts , strengthening of oversight committees

` CG developments in India show a paradigm shift from theGerman/Japanese model to the Anglo-American model


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` Bad governance is recognized as the root cause of corruptpractices in our societies

` Nations as well as corporations are expected to provide goodgovernance to benefit all their stakeholders

` Good corporate are not born , but are made by the combinedefforts of all stakeholders

` Law & regulation alone cannot bring about changes incorporate to behave better to benefit all concerned

`

The company & its officers , BOD & its officials , especiallythe senior management , should strictly follow a code ofconduct , which should have the following desiderata:

` Obligation to society at large , to investors, to employees ,tocustomers & managerial obligation


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` National interest` Political non-alignment` Legal compliance as per tax laws` Rule of law with full protection of rights , particularly minority

shareholders` Honest & ethical conduct of Directors,

executive & non-executive directors,MD,CEO.CFO & CCO

Corporate Citizenship

Social concernsCSREnvironment-friendlinessCompetition & TrusteeshipCorporations should uphold the Fair Name of the country


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` Towards shareholders` Measures promoting transparency & informed shareholder

participation

` Transparency

` Financial reporting & records` Internal accounting & audit procedures-all required

information shall be accessible to the companys auditors ,

non-executive & independent directors on the board&

other authorized parties & government agencies` Any willful misrepresentation of financial accounts &

reports will be regarded as a violation of firms ethical

conduct& invite appropriate civil or criminal action


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` Fair employment practices

` Equal Opportunities Employer

` Encouraging whistle blowing with comfortable

reporting channels & an effective whistle blowerpolicy

` Humane treatment

` Participation & Empowerment

` Equity & Inclusiveness` Participative & Collaborative Environment


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` Quality of Products & services

` Products at Affordable prices

` Unwavering commitment to customer satisfaction


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` Protecting companys assets

` Behavior towards government agencies

` Control exercised within a framework of appropriate checks

& balances` Consensus-oriented on what is in the best interest of the

whole community & how this can be achieved

` Gifts & donations

`

Roles & Responsibilities of Corporate Board & Directors` Direction & management must be distinguished

` Managing & Whole-time Directors are required to devote

whole or substantially whole of their time to the affairs of the

company

ch.13 fernando theory & practice cg

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