m The concept of Corporation-What is a Corporate?

m Theoretical Basis of CG
m Agency Theory
m Stewardship Theory
m Stakeholder Theory
m CG Mechanisms
m CG systems
m Anglo-American Model
m German Model
m Japanese Model
m Indian Model of Governance
m Obligation to society at large , investors , employees,
& customers
m Managerial Obligation
Source: Fernando , Chapter 13
m ICMR , Chapter 19
m The major portion of capital is in the hands of few giant
corporations which are in a position to exercise
considerable control over industrial production
m ³The business corporation is an instrument through
which capital is assembled for the activities of producing
& distributing goods & services & making investments´
m ³A corporation is an artificial being , intangible & existing
only in the contemplation of the law . The important
properties are immortality , individuality & may act as a
single individual.´
m The corporation of today has come to replace the sole proprietor of earlier
times & tries to maximize its profits
m The corporate differs from the individual capitalist in 2 aspects:
m The life span of the corporation is much longer
m It is more rational in decision-making as it has the benefit of the collective wisdom of
the BOD & they take decisions using the principles of cost accounting, budget
analysis , data collection & managerial consulting
m Justice Lindlay¶s definition of a corporation
m Enjoys some privileges & is bound by responsibilities
m A corporation is an association of persons recognized by the law as having a
collective personality
m The corporation can act as if it were distinct from its members; it has
³perpetual succession´ & a common seal
m 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
m Incorporated Association or registered under the prevalent
Companies Act of the country
m Artificial legal existence: A corporation is entitled to a
separate legal existence , apart from the persons composing
it
m In the eyes of the law , it is a separate legal person & has
rights & duties as any natural person has , though it has no
political or civic rights
m The corporation assets are separate & distinct from that of its
members; it can sue & can be sued exclusively for it own
purpose
m The liability of shareholders is limited to the capital invested
by them & the creditors have no right to the assets of the
corporation
m The life of a corporation does not end with the exit,
retirement , insolvency or death of any or all directors or
shareholders
m Perpetual existence of the company is preserved by the
provision of transferability of shares . Law creates a
company & law only can dissolve it
m Common seal is a legal requirement & enhances the legal
entity of the corporation
m Extensive membership with millions of shareholders
m Separation of management from ownership
m Limited liability implies that the liability of the shareholders is
limited to the amount unpaid on their shares irrespective of
the obligations of the company
m Transferability of shares without seeking permission from the
company
m Agency , Stewardship , Stakeholder , Sociological Theory
m Agency Theory
m Shareholders are the owners of any joint stock , limited liability company & are
the principals, who define the objectives of a company
m The management , directly or indirectly selected by shareholders to pursue
such objectives are the agents
m The objectives of managers are sometimes at variance from those of
shareholders which results in mismatch of objectives(agency problem)and a
cost inflicted(agency cost)
m CG , puts in place disclosures, monitoring , oversight & corrective systems that
align the objectives of both groups
m Incentive schemes & employee stock options for managers to align financial
interests of executives with shareholders
m Two broad mechanisms that reduce agency costs & improve CG
m Fair & accurate financial disclosures which relate to the role of independent,
statutory auditors
m Efficient & Independent Board of Directors who are fiduciaries of the
shareholders , accountable only to shareholders««´Independence´
m The job of management is to prepare the accounts
m Responsibility of statutory auditors to scrutinize such
accounts , raise queries & objections(if the need arises)
m Auditors arrive at a true & fair view of the financial
position of the company & report their independent
findings to the board of directors
m Through the board of directors , the findings are
communicated to the shareholders & investors of the
company
m Stewardship Theory discounts the possible conflicts between corporate
management & owners
m Shows a preference for a board of directors made up primarily of corporate
insiders
m Financial reporting , disclosure & auditing are still important mechanisms
,needed to confirm managements' inherent trustworthiness

m Stewardship theory has 2 basics:

m Managers are not motivated by individual goals ,they are stewards whose
motives are aligned with the objectives of their principals
m A steward¶ s behavior is pro-organizational rather than self-serving
m Control may be counterproductive as it lowers motivation
m The greatest barrier lies in the risk propensity of principals
(Gandhiji¶s trusteeship)
 The theory considers the firm as an input-output model by adding all
interest groups-employees, customers , creditors , suppliers ,
shareholders , government , local community , society at large- to the
corporate mix
 Stakeholder theory is grounded in ethics of care , ethics of fiduciary
relationships , property rights & theory of stakeholders as investors
 Stakeholder theory upholds responsibilities to non-shareholder
groups
 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 & the
implications 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
m Why CG?
m Corporation is an independent legal entity , separate from its
owners
m Shareholders nominate & elect directors who run the
enterprise
m The directors are the stewards & demonstrate their
accountability to the shareholders in the form of regular
financial reports & directors¶ reports
m Shareholders also appoint independent auditors to report
that these accounts show a true & fair picture
m Regular shareholder meetings provide an opportunity for the
directors to report & clarify shareholder doubts
m CG is an umbrella term to cover the exercise of power over
& within the company , for the good of all concerned
m Shares listed on a stock exchange are held by diverse shareholders-
private individuals , banks ,pension funds & insurance companies
m Ownership structures of public companies are often complex
m Growing Awareness & Responses
m CG code by CII in the wake of interest generated by the Cadbury
Committee , followed by ASSOCHAM & SEBI
m SEBI appointed Kumara Mangalam Birla Committee& adopted the report
in mid2000.
m RBI also constituted a committee
m 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
m Major companies now operate through group structures of wholly-owned
subsidiary companies ,partly-owned subsidiaries
m Known as the ˜
 
 , which is the Anglo-Saxon approach to
CG followed in Anglo-American countries
m All directors participate in a single board comprising both executive & non-
executive directors in varying proportions
m The model tends to be shareholder-oriented
m BOD perform 3 functions :representation , direction and oversight & appoints
&supervises the managers who take care of daily activities
m The ownership of companies is equally divided between individual &
institutional shareholders
m Companies are run by professional managers with negligible ownership
stakes .
m Fairly clear separation of ownership & management
m Most institutional investors are reluctant activists who view themselves as
portfolio investors .If they are not satisfied with a company¶s performance ,
they sell the securities in the market & quit
m The disclosure norms are comprehensive, the rules against insider trading
tight & the penalties for price manipulation stiff, all of which protect small
investors& promote market liquidity
m They discourage large investors from taking an active role in CG
m A-A model of CG encourages radical innovation & cost competition
m Known as the  
 
 CG is exercised through 2
boards: supervisory & management board
m ‰pper(supervisory) board supervises the management board on
behalf of stakeholders
m Shareholders elect 50 per cent of the members on the supervisory
board and the other half is appointed by labor unions & employees
m 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
m The supervisory board which is appointed jointly by the shareholders
& labor unions , appoints and monitors the management board
m The management board conducts the day-to-day operations
independently ,but has to report to the supervisory board
m Known as the ˜
  
 , which reflects the
cultural relationships in the Japanese 
˜network, in
which boards tend to be large , predominantly executive &
often ritualistic
m The financial institutions have a major role in the governance
mechanism
m The shareholders along with the main bank together appoint
the board of directors & the president
m Even the President is appointed on the basis of a consensus
between the share holders and the banks
m The President consults the supervisory board & their
relationship is hierarchical
m The supervisory board usually ratifies whatever decisions the
president takes
m The financial institutions that finance the business have a
crucial role ,even though the shareholders are the owners of
the business
m Banks even have the power to suspend the board in case of
an emergency!
m Banks & financial institutions have substantial stakes
in the equity capital of companies . Besides cross-
holding among groups of firms is common in Japan
m Institutional investors view themselves as long-term
investors & play an active role in corporate
management
m Disclosure norms are not very stringent , checks on
insider trading are not comprehensive & emphasis on
liquidity is not high
m There is hardly any system of corporate control in
these countries ; mergers & takeovers are rare
occurrences
m Mix of the Anglo-American & German/Japanese models
m Pattern of private companies-the founder , his family & associates closely
hold the private companies & they exercise maximum control over the
activities of the company(Reliance ,Birla )
m Role of external equity finance is minimal
m Public enterprises , central & state governments choose members of the
board
m Even after disinvestment of PS‰s , government has major hold over
activities
m Indian government constituted 3 committees-SEBI-appointed Kumar
Mangalam Birla 2000, government ±appointed Naresh Chandra
2003&SEBI¶s Narayan Murty 2000 recommendations are remarkably
similar to England¶s Cadbury Committee & ‰S Sarbanes-Oxley Act
m Thrust of legislative reforms-Greater transparency,& independent scrutiny of
corporate accounts , strengthening of oversight committees
m CG developments in India show a paradigm shift from the
German/Japanese model to the Anglo-American model
m Bad governance is recognized as the root cause of corrupt
practices in our societies
m Nations as well as corporations are expected to provide good
governance to benefit all their stakeholders
m Good corporate are not born , but are made by the combined
efforts of all stakeholders
m Law & regulation alone cannot bring about changes in
corporate to behave better to benefit all concerned
m The company & its officers , BOD & its officials , especially
the senior management , should strictly follow a code of
conduct , which should have the following desiderata:
m Obligation to society at large , to investors, to employees ,to
customers & managerial obligation
m National interest
m Political non-alignment
m Legal compliance as per tax laws
m Rule of law with full protection of rights , particularly minority
shareholders
m Honest & ethical conduct of Directors,
executive & non-executive directors,
MD,CEO.CFO & CCO
Corporate Citizenship
Social concerns
CSR
Environment-friendliness
Competition & Trusteeship
Corporations should uphold the Fair Name of the country
m Towards shareholders
m Measures promoting transparency & informed shareholder
participation
m Transparency
m Financial reporting & records
m Internal accounting & audit procedures-all required
information shall be accessible to the company¶s auditors ,
non-executive & independent directors on the board&
other authorized parties & government agencies
m Any willful misrepresentation of financial accounts &
reports will be regarded as a violation of firm¶s ethical
conduct& invite appropriate civil or criminal action
m Fair employment practices
m Equal Opportunities Employer
m Encouraging whistle blowing with comfortable
reporting channels & an effective whistle blower
policy
m Humane treatment
m Participation & Empowerment
m Equity & Inclusiveness
m Participative & Collaborative Environment
m åuality of Products & services
m Products at Affordable prices
m ‰nwavering commitment to customer satisfaction
m Protecting company¶s assets
m Behavior towards government agencies
m Control exercised within a framework of appropriate checks
& balances
m Consensus-oriented on what is in the best interest of the
whole community & how this can be achieved
m Gifts & donations
m Roles & Responsibilities of Corporate Board & Directors
m Direction & management must be distinguished
m Managing & Whole-time Directors are required to devote
whole or substantially whole of their time to the affairs of the
company