Corporate Governance

Good corporate governance requires that in pursuing these goals, the interests of the various stakeholders be adequately protected. Sometimes the actions of the firm benefit some stakeholders but hurt others. A proper balance has to be struck between these gains and losses. That is, good corporate governance requires that the firm (a) pursue its goals efficiently and (b) at the same time take into account the harm that it is causing to some stakeholders and try to ensure

Example I.

A chemical dyes manufacturer may be producing polluting waste, which will have to be disposed off in a nearby river, affecting the lives of those who live on the banks of the river. The latter are not employed by the firm or buy the products of the firm. Yet they are willy-nilly affected by its operations, and hence become stakeholders. Good corporate governance demands that the firm take account of the effects of its actions on these people, perhaps by treating the waste before it is discharged into the river, perhaps by paying a tax on its waste discharge which can be used to mitigate the health hazards posed by its operations.

 Example 2.

Consider insider trading

. It is important that company insiders, who have access to better information about the company than outsiders, do not use this information to take unfair advantage over uninformed outsider investors on the stock market. Suppose that a firm is entering into an alliance with another firm. It is expected that the announcement of this move will drive up stock prices. If company insiders  use this information to buy up shares of the company before the announcement of the alliance. then they are getting an unfair advantage over other players on the stock market. These players are not currently shareholders of the company, but they are possible buyers ofthe company's shares in the future and hence stakeholders. Their interests must also be protected. Hence. insider trading in many countries is forbidden.

“The major players in the area of corporate governance, within the corporation are corporate board, shareholders and employees. Externally, the pace for corporate governance is set by the government as the regulator, customer, and lenders of finance and social ethos of our times. The scope and extent of corporate governance are set by the legal, financial and business framework.

Definitions

 Adolf Berle has defined social responsibility as “the manager’s responsiveness to public consensus” .

Koontz and O’Donnell have given the definition of social responsibility thus: “The personal obligation of the people as they act in their own interests to assure that the rights and legitimate interests of others are not infringed” (Hindu business line, 1998).

Corporate Governance can be defined as a systematic process by which companies are directed and controlled to enhance their wealth generating capacity. Since large corporations employ vast quantum of societal resources, we believe that the governance process should ensure that these companies are managed in a manner that meets stakeholders aspirations and societal expectations.

COMMITTEE RECOMMENDATIONS ON CORPORATE GOVERNANCE

 Cadbury Committee (1991)

 The Cadbury Committee, under the chairmanship of Sir Adrian Cadbury, was set up by the London Stock Exchange in May 1991. The committee, consisting of representatives drawn from the top levels of British industry, was given the task of drafting a code of practices to assist public enterprise. In defining and applying internal controls to limit their exposure to financial loss, from whatever cause.

 Birla Committee (2001)

The first formal committee was appointed by Securities and Exchange Board of India (SEBI), under the Chairmanship of Kumara Managalam Birla (known as Birla Committee). This was set up after the CII code on corporate governance was framed; to study the corporate governance from listed companies’ perspective and culminated when its recommendations were included in the listing agreement. The recommendations were applicable to listed companies; their directors, management, employees and professionals associated with such companies and other bodies corporate. The major recommendations of Birla Committee on corporate governance were:

 • The Board of directors of a company should have an optimum combination of executive and non-executive directors with not less than 50% of the Board consisting of non-executive directors. In case the company has a non-executive chairman, at least one-third of the board should consist of independent directors.

• Board meetings should be held at least four times in a year with a maximum time gap of four months between any two meetings.

• The Board should set up a remuneration committee to determine the company’s policy on specific remuneration packages for executive directors.

 • The Board should set up a qualified and independent audit committee.

• Companies should required to give consolidated accounts in respect of all their subsidiaries. A company having multiple lines of business should be segmental reporting.

• A management discussion and analysis report should form part of the annual report to the shareholders covering industry structure, opportunities and threats, segment wise or product wise performance, outlook, and risks.

 • Companies should arrange to obtain certificates from their auditors regarding compliance of corporate governance provisions and the certificates should be sent to stock exchanges and all the shareholders. As mentioned, these recommendations were incorporated in the listing agreement (Clause 49) and were sought to be implemented within a time frame of three years. Later, these recommendations got statutory recognition when they were introduced a provisions in the Companies (Amendment) Act, 2000.

HOW TO ENSURE GO0.D CORPORATE GOVERNANCE?

 Market Forces

There is a school of thought that believes that the market forces would take care of the problem of corporate governance.  

The Survival of the Fittest Argument

If, over the long run, a firm does not maximise profits, then it is behaving inefficiently. Either it is incurring unnecessary costs or failing to cash in on revenue opportunities. Other firms will be able to undercut its price or provide better qualities, etc., and erode its market share. This argument is, therefore, based on the disciplining effects of product market competition.

 Market for Managers

 This argument suggests that there is a job market for managers, just as there is one for ordinary workers. A manager, under whom firms perform poorly, will be able to command a lesser value on this market. However, even if a firm is doing poorly, it is difficult for outsiders to assess whether the firm is doing poorly because it is being poorly managed or because it is facing adverse market conditions. Moreover, a firm has a team of managers and it is impossible to evaluate the contribution of each manager to the firm's performance.

Capital Market Controls

 The argument goes something like this : the inefficient functioning of the firm is reflected in poor share prices since poor dividends are declared. Suppose that the price is Rs. 5 currently. A raider will then buy out the low price shares, gain control over the firm and replace the existing team of managers by a more efficient team. As the performance of the firm improves, so does its share price.

Takeover Defences

 In the 1980s, North America and the United Kingdom witnessed a spate of hostile takeover attempts. In response, a host of takeover defences were generated by incumbent management.

White knight: when Mobil Oil attempted a takeover of Marathon Oil, U.S. Steel played the role of a white knight, i.e., a friendly acquirer, by making a bid that Marathon's management favoured and finally accepted.

 Poison pills: poison pills are devices aimed at reducing the worth of a company once it has been taken over. One example is a clause requiring that huge dividend payments be made upon takeover - this can significantly raise the cost of acquiring a company.

Scorched earth policies: these policies are those that deliberately reduce the firm's value to the bidder, even if it reduces value to shareholders in the process. One way to do this is to sell off key assets (which are called crown jewels, because they are often the assets that make the company attractive in the first place) at greatly reduced prices.

Golden parachutes: a golden parachute is a clause in the compensation contract providing for very attractive benefits if a manager leaves after a control change. Incumbent managers thereby cushion themselves against the risk of losing their current job should a hostile takeover occur.

 Classified or staggered boards: in these boards only a fraction of the members are up for election every year. It then becomes difficult for an outsider to gain quick control over the firm.

Supermajority rules: these require as much as 90% of the votes to effect change and have the same effect as staggered boards.

 Greenmail: this commonly consists of an offer by the existing management to buy out the shares acquired by the raider at an attractive premium.

Protecting the Rights of Outside Investors

In a broader sense, good corporate governance requires that the rights of the various stakeholders be protected adequately. Outside investors' rights are generally sought to be protected through the enforcement of regulations and laws. We can mention some of these here:

• Disclosure and accounting rules seek to provide investors with the information they need to exercise their rights.
• Protected shareholders rights include those to receive dividends on pro-rata terms, to vote for directors, to participate in shareholders meetings, to subscribe to new issues of securities on the same terms as insiders, and so on.
• Laws protecting creditors deal with bankruptcy and reorganisation procedures.

It may be noted here that these rules and regulations can come from different sources- company, security, bankruptcy, takeover, competition laws, exchange regulations and accounting standards. They all work together to create an environment where good corporate governance flourishes.