Chapter 3

LANDMARKS IN THE EMERGENCE LANDMARKS IN THE EMERGENCE OF CORPORATE GOVERNANCEOF CORPORATE GOVERNANCE

CHAPTER 3

Dear Friends,Dear Friends,Following are the important topics given by sir :-Following are the important topics given by sir :-1. Cadbuy Committee on Corporate Governance, 1. Cadbuy Committee on Corporate Governance, 199219922. Sarbanes-oxley Act,20022. Sarbanes-oxley Act,20023. Independent Director (clause 49)3. Independent Director (clause 49)4. Kumar Mangalam Birla committee4. Kumar Mangalam Birla committee5.Internal System Cos and Pron----- Not in slides 5.Internal System Cos and Pron----- Not in slides discussed in seconddiscussed in secondlast class.last class.

NOTE:- Only one question will come from Ethics NOTE:- Only one question will come from Ethics partpart

OBJECTIVESOBJECTIVES

Corporate governance as a desideratum for Corporate governance as a desideratum for

orderly development of an economy has orderly development of an economy has

evolved over the past three decades, and, in evolved over the past three decades, and, in

its present system and structure, is the its present system and structure, is the

outcome of studies, research and the sum outcome of studies, research and the sum

total of responses by regulators of corporate total of responses by regulators of corporate

scams and debacles. This chapter traverses scams and debacles. This chapter traverses

through the history of evolution of the through the history of evolution of the

concept and system of corporate governance concept and system of corporate governance

over the years, both in the West and in India.over the years, both in the West and in India.

CHAPTER OUTLINECHAPTER OUTLINE

IntroductionIntroduction Corporate Governance CommitteesCorporate Governance Committees World Bank on Corporate GovernanceWorld Bank on Corporate Governance OECD PrinciplesOECD Principles McKinsey Survey on Corporate GovernanceMcKinsey Survey on Corporate Governance Sarbanes—Oxley Act, 2002Sarbanes—Oxley Act, 2002 Indian Committees and GuidelinesIndian Committees and Guidelines Working Group on the Companies Act, 1996Working Group on the Companies Act, 1996 The Confederation of Indian Industry’s InitiativeThe Confederation of Indian Industry’s Initiative SEBI’s InitiativesSEBI’s Initiatives Naresh Chandra Committee Report, 2002Naresh Chandra Committee Report, 2002 Narayana MurthyCommittee Report, 2003Narayana MurthyCommittee Report, 2003 Dr J. J. Irani Committee Report on Company Law, Dr J. J. Irani Committee Report on Company Law,

20052005

IntroductionIntroduction

There has been a perceptible change in There has been a perceptible change in

people’s minds as to the objective of a people’s minds as to the objective of a

corporation - from one which was intended to corporation - from one which was intended to

benefit exclusively the shareholders to one benefit exclusively the shareholders to one

which is expected to benefit all its which is expected to benefit all its

stakeholders. The corporate scams and frauds stakeholders. The corporate scams and frauds

that came to light have brought about a change that came to light have brought about a change

in the thinking of advocates of free enterprise in the thinking of advocates of free enterprise

that the system was not self-regulatory and that the system was not self-regulatory and

needed substantial external regulation, which needed substantial external regulation, which

should penalise the wrongdoers while those should penalise the wrongdoers while those

who abide by the rules of the game are amply who abide by the rules of the game are amply

rewarded by the market forces. rewarded by the market forces.

Introduction (contd)Introduction (contd)

All these measures have brought about a All these measures have brought about a

metamorphosis in corporations that metamorphosis in corporations that

realised that the people who invest in realised that the people who invest in

corporations are pretty serious about corporations are pretty serious about

corporate governance; hence they started corporate governance; hence they started

internalising these values and later internalising these values and later

adopting them, initially adopting them, initially albeitalbeit selectively selectively

and sporadically.and sporadically.

Developments in the USADevelopments in the USA

Corporate governance gained importance Corporate governance gained importance

with the occurrence of the Watergate with the occurrence of the Watergate

scandal in the United States. Thereafter, as a scandal in the United States. Thereafter, as a

result of subsequent investigations, the US result of subsequent investigations, the US

regulatory and legislative bodies were able regulatory and legislative bodies were able

to highlight control failures that had allowed to highlight control failures that had allowed

several major corporations to make illegal several major corporations to make illegal

political contributions and to bribe political contributions and to bribe

government officials. In 1979 by the government officials. In 1979 by the

Securities and Exchange Commission’s Securities and Exchange Commission’s

proposals for mandatory reporting on proposals for mandatory reporting on

internal financial controls.internal financial controls.

Developments in the USA (contd)Developments in the USA (contd)

In 1985, following a series of high profile In 1985, following a series of high profile

business failures in the USA, the most notable business failures in the USA, the most notable

one being the Savings and Loan collapse, the one being the Savings and Loan collapse, the

Treadway Commission was formed to identify the Treadway Commission was formed to identify the

main causes of misrepresentation in financial main causes of misrepresentation in financial

reports and to recommend ways of reducing reports and to recommend ways of reducing

incidence thereof. The Treadway Report incidence thereof. The Treadway Report

published in 1987 highlighted the need for a published in 1987 highlighted the need for a

proper control environment, independent audit proper control environment, independent audit

committees and an objective internal audit committees and an objective internal audit

function and called for published reports on the function and called for published reports on the

effectiveness of internal control.effectiveness of internal control.

Developments in the UKDevelopments in the UK

In England, the seeds of modem corporate In England, the seeds of modem corporate governance were probably sown by the BCCI governance were probably sown by the BCCI scandal. BCCI was a global bank, constituting scandal. BCCI was a global bank, constituting multiple layers of entities related to one multiple layers of entities related to one another through an impenetrable series of another through an impenetrable series of holding companies, affiliates, subsidiaries, holding companies, affiliates, subsidiaries, banks-within-banks, insider dealings and banks-within-banks, insider dealings and shareholder (nominee) relationships. With shareholder (nominee) relationships. With this corporate structure of BCCI and shoddy this corporate structure of BCCI and shoddy record-keeping, regulatory review and record-keeping, regulatory review and audits, the complex BCCI family of entities audits, the complex BCCI family of entities was able to evade ordinary legal restrictions was able to evade ordinary legal restrictions on the movement of capital and goods as a on the movement of capital and goods as a matter of daily practice and routine. matter of daily practice and routine.

Developments in the UK (contd)Developments in the UK (contd)

Since BCCI was a vehicle fundamentally free of Since BCCI was a vehicle fundamentally free of

government control, it was an ideal mechanism for government control, it was an ideal mechanism for

facilitating illicit activity by others, including such facilitating illicit activity by others, including such

activity by officials of many of the governments activity by officials of many of the governments

whose laws BCCI was breaking. The failure of whose laws BCCI was breaking. The failure of

Barings Bank was another landmark that Barings Bank was another landmark that

heightened people’s awareness and sensitivity on heightened people’s awareness and sensitivity on

the issue and the resolve that something ought to the issue and the resolve that something ought to

be done to stem the rot of corporate misdeeds. be done to stem the rot of corporate misdeeds.

Nick Leeson was posted in charge of the back Nick Leeson was posted in charge of the back

office operations of Barings Bank as well. He office operations of Barings Bank as well. He

started trading on behalf of the Bank, when he started trading on behalf of the Bank, when he

had to trade only on behalf of the customers.had to trade only on behalf of the customers.

Developments in the UK (contd.)Developments in the UK (contd.)

Eventually when his strategy failed because Eventually when his strategy failed because of an earthquake in Japan, Barings Bank had of an earthquake in Japan, Barings Bank had already lost $ 1.4 billion and it had to shut already lost $ 1.4 billion and it had to shut office.office.

As a result of these failures and lack of As a result of these failures and lack of regulatory measures from authorities as an regulatory measures from authorities as an adequate response to check them in future, adequate response to check them in future, the Committee of Sponsoring Organisations the Committee of Sponsoring Organisations (COSO) was born. The report produced by it (COSO) was born. The report produced by it in 1992 suggested a control framework, and in 1992 suggested a control framework, and was endorsed and refined in the four was endorsed and refined in the four subsequent UK reports: Cadbury, Ruthman, subsequent UK reports: Cadbury, Ruthman, Hampel and Turnbull. Hampel and Turnbull.

Cadbury Committee on Corporate Cadbury Committee on Corporate Governance, 1992Governance, 1992

The stated objective of the Cadbury The stated objective of the Cadbury

Committee was "to help raise the standards Committee was "to help raise the standards

of corporate governance and the level of of corporate governance and the level of

confidence in financial reporting and confidence in financial reporting and

auditing by setting out clearly what it sees auditing by setting out clearly what it sees

as the respective responsibilities of those as the respective responsibilities of those

involved and what it believes is expected of involved and what it believes is expected of

them".them".

Cadbury Committee on Corporate Cadbury Committee on Corporate Governance, 1992 (contd)Governance, 1992 (contd)

The Cadbury Code of Best Practices had 19 The Cadbury Code of Best Practices had 19 recommendations. recommendations.

Relating to the board of directors, the recommen-Relating to the board of directors, the recommen-dations are:dations are:

o The Board should meet regularly, retain full The Board should meet regularly, retain full and and effective control over the company and effective control over the company and monitor the monitor the executive management.executive management.

o There should be a clearly accepted division of There should be a clearly accepted division of res-res-ponsibilities at the head of a company, ponsibilities at the head of a company,

which which will will ensure balance of power and ensure balance of power and authority, such authority, such that that no individual has unfettered no individual has unfettered powers of powers of decision. decision.

Cadbury Committee on corporate Cadbury Committee on corporate Governance, 1992 (contd)Governance, 1992 (contd)

o The board should include non-executive The board should include non-executive directors directors of sufficient calibre and number for their of sufficient calibre and number for their

views to views to carry significant weight in the carry significant weight in the board's decisions.board's decisions.

o All directors should have access to the advice All directors should have access to the advice and and services of the Company Secretary, who services of the Company Secretary, who

is res-is responsible to the Board for ensuring that ponsible to the Board for ensuring that board board procedures are followed and that procedures are followed and that applicable rules applicable rules and regulations are complied and regulations are complied with. Any question of with. Any question of the removal of company the removal of company secretary should be a secretary should be a matter for the board as a matter for the board as a whole.whole.


o All directors should have access to the All directors should have access to the advice advice and services of the Company and services of the Company Secretary, who is Secretary, who is responsible to the responsible to the Board for ensuring that Board for ensuring that board procedures board procedures are followed and that are followed and that applicable rules applicable rules and regulations are complied and regulations are complied with. Any with. Any question of the removal of company question of the removal of company secretary should be a matter for the board secretary should be a matter for the board as a as a whole.whole.


Relating to the non-executive directors the Relating to the non-executive directors the recommendations are:recommendations are:o Non-executive directors should bring an Non-executive directors should bring an independent judgment to bear on issues of independent judgment to bear on issues of strategy, performance, resources, including key strategy, performance, resources, including key

appointments, and standards of conduct.appointments, and standards of conduct.oNon-executive Directors should be Non-executive Directors should be

appointed for appointed for specified terms and specified terms and reappointment should reappointment should not be automatic.not be automatic.

oNon-executive Directors should be selected Non-executive Directors should be selected through a formal process and both, this through a formal process and both, this

process and their process and their appointment, should be a appointment, should be a matter for the Board as a whole.matter for the Board as a whole.

On reporting and controls, the Cadbury Code On reporting and controls, the Cadbury Code of Best Practices stipulate the following:of Best Practices stipulate the following:

o It is the Board's duty to present a balanced and It is the Board's duty to present a balanced and understandable assessment of the company's understandable assessment of the company's position.position.

o The Board should ensure that an objective and The Board should ensure that an objective and professional relationship is maintained with the professional relationship is maintained with the Auditors.Auditors.

o The Board should establish an Audit Committee of The Board should establish an Audit Committee of at least 3 Non-Executive Directors with written at least 3 Non-Executive Directors with written terms of reference, which deal clearly with its terms of reference, which deal clearly with its authority and duties.authority and duties.

o The Directors should explain their responsibility for The Directors should explain their responsibility for preparing the accounts next to a statement by the preparing the accounts next to a statement by the Auditors about their reporting responsibilities.Auditors about their reporting responsibilities.

o The Directors should report on the effectiveness of The Directors should report on the effectiveness of the company's system of internal control.the company's system of internal control.

The Greenbury Committee, 1995The Greenbury Committee, 1995

This Committee was set up in January 1995 to identify This Committee was set up in January 1995 to identify good practices by the Confederation of British good practices by the Confederation of British Industry (CBI) in determining directors' remuneration Industry (CBI) in determining directors' remuneration and to prepare a code of such practices for use by and to prepare a code of such practices for use by public limited companies of the United Kingdom.public limited companies of the United Kingdom.

The CommitteeThe Committeeo Aimed to provide an answer to the general Aimed to provide an answer to the general

concerns about the accountability and level of concerns about the accountability and level of directors' pay.directors' pay.

o Argued against statutory control and for Argued against statutory control and for strengthening accountability by the proper strengthening accountability by the proper allocation of responsibility for determining allocation of responsibility for determining directors' remuneration, the proper reporting to directors' remuneration, the proper reporting to shareholders, and greater transparency in the shareholders, and greater transparency in the process.process.

The Greenbury Committee, 1995 The Greenbury Committee, 1995 (contd)(contd)

o Produced the Greenbury Code of Best Produced the Greenbury Code of Best Practice which was divided into four Practice which was divided into four sections thus:sections thus: Remuneration committeeRemuneration committee Disclosure Disclosure Remuneration policyRemuneration policy Service contracts and compensation.Service contracts and compensation.

The Hampel Committee, 1995The Hampel Committee, 1995 The Hampel Committee was set up in November The Hampel Committee was set up in November 1995 to protect investors and preserve and 1995 to protect investors and preserve and enhance the standing of companies listed on the enhance the standing of companies listed on the London Stock Exchange.London Stock Exchange.

The CommitteeThe Committeeo Developed further the Cadbury Report Developed further the Cadbury Report o Produced the Combined CodeProduced the Combined Codeo Recommended thatRecommended that

The auditors should report on internal The auditors should report on internal control privately to the directorscontrol privately to the directors

The directors maintain and review all (and The directors maintain and review all (and not just financial) controlsnot just financial) controls

The Hampel Committee, 1995 (contd.)The Hampel Committee, 1995 (contd.)

Companies that do not already Companies that do not already have an have an internal audit function should internal audit function should from time to time review their need for from time to time review their need for oneone

o Introduced the Combined Code that Introduced the Combined Code that consolidated the recommendations of earlier consolidated the recommendations of earlier corporate governance reports (Cadbury and corporate governance reports (Cadbury and Greenbury).Greenbury).

The Turnbull Committee, 1999The Turnbull Committee, 1999

The Turnbull Committee was set up by the The The Turnbull Committee was set up by the The Institute of Chartered Accountants in England Institute of Chartered Accountants in England and Wales (ICAEW) in 1999and Wales (ICAEW) in 1999

The committeeThe committeeo Provided guidance to assist companies in Provided guidance to assist companies in

implementing the requirements of the implementing the requirements of the Combined Code relating to internal control.Combined Code relating to internal control.

o Recommended that where companies do not Recommended that where companies do not have an internal audit function, the board have an internal audit function, the board should consider the need for carrying out an should consider the need for carrying out an internal audit annually.internal audit annually.

o Recommended that boards of directors confirm Recommended that boards of directors confirm the existence of procedures for evaluating and the existence of procedures for evaluating and managing key risks. managing key risks.

World Bank on Corporate World Bank on Corporate GovernanceGovernance

o The World Bank, both as an international The World Bank, both as an international develop-development bank and as an institution ment bank and as an institution interested and interested and involved in equitable and involved in equitable and sustainable economic sustainable economic development development worldwide, was one of the earliest worldwide, was one of the earliest international international organisations to study the issue of organisations to study the issue of corporate corporate governance and suggest certain governance and suggest certain guidelines.guidelines.

o Corporate governance is concerned with Corporate governance is concerned with holding the balance between economic and holding the balance between economic and social goals and between individual and social goals and between individual and communal goals. The governance framework communal goals. The governance framework is there to encourage the efficient use of is there to encourage the efficient use of resources and equally to require resources and equally to require accountability for the stewardship of those accountability for the stewardship of those resources. resources.

World Bank on Corporate Governance World Bank on Corporate Governance (contd)(contd)

o Openness is the basis of public confidence Openness is the basis of public confidence in the corporate system and funds will flow in the corporate system and funds will flow to those centres of economic activity, which to those centres of economic activity, which inspire trust. This Report points the way to inspire trust. This Report points the way to the establishment of trust and the the establishment of trust and the encouragement of enterprise. It marks an encouragement of enterprise. It marks an important milestone in the development of important milestone in the development of corporate governance.corporate governance.

OECD PrinciplesOECD Principles

o The Organisation for Economic Cooperation The Organisation for Economic Cooperation

and Development (OECD) was one of the and Development (OECD) was one of the

earliest non-governmental organisations to earliest non-governmental organisations to

work on and spell out the principles and work on and spell out the principles and

practices that should govern corporations in practices that should govern corporations in

their goal to attain long-term shareholder their goal to attain long-term shareholder

value. value.

Equitable Treatment of ShareholdersEquitable Treatment of Shareholders

The OECD is concerned with protecting minority The OECD is concerned with protecting minority shareholders’ rights by setting up systems that shareholders’ rights by setting up systems that keep insiders, including managers and directors, keep insiders, including managers and directors, from taking advantage of their roles. from taking advantage of their roles.

In summary, they include the following elements.In summary, they include the following elements.

The Rights of ShareholdersThe Rights of Shareholders

The rights of shareholders include a set of rights The rights of shareholders include a set of rights to secure ownership of their shares, the right to to secure ownership of their shares, the right to full disclosure of information, voting rights, full disclosure of information, voting rights, participation in decisions on sale or modification participation in decisions on sale or modification of corporate assets mergers and new share of corporate assets mergers and new share issues.issues.

The Role of Stakeholders in Corporate The Role of Stakeholders in Corporate GovernanceGovernance

The OECD recognises that there are other The OECD recognises that there are other stakeholders in companies in addition to stakeholders in companies in addition to shareholders. Banks, bondholders and shareholders. Banks, bondholders and workers, for example, are important workers, for example, are important stakeholders in the way in which companies stakeholders in the way in which companies perform and make decisions. perform and make decisions.

Disclosure and TransparencyDisclosure and Transparency

The OECD lays down a number of The OECD lays down a number of provisions for the disclosure and provisions for the disclosure and communication of key facts about the communication of key facts about the company ranging from financial details to company ranging from financial details to governance structures including the board of governance structures including the board of directors and their remuneration.directors and their remuneration.

The Responsibilities of the BoardThe Responsibilities of the Board

The OECD guidelines provide a great deal of The OECD guidelines provide a great deal of

details about the functions of the board in details about the functions of the board in

protecting the company and its protecting the company and its

shareholders. shareholders. These include concerns about These include concerns about

corporate strategy, corporate strategy, risk, executive risk, executive

compensation and performance as compensation and performance as well as well as

accounting and reporting systems.accounting and reporting systems.

McKinsey Survey on Corporate McKinsey Survey on Corporate GovernanceGovernance

McKinsey, the international management McKinsey, the international management

consultant organisation conducted a survey with consultant organisation conducted a survey with

a sample size of 188 companies from six a sample size of 188 companies from six

emerging markets (India, Malaysia, Mexico, emerging markets (India, Malaysia, Mexico,

South Korea, Taiwan and Turkey), to determine South Korea, Taiwan and Turkey), to determine

the correlation between good corporate the correlation between good corporate

governance and the market valuation of the governance and the market valuation of the

company. company.

McKinsey Survey on Corporate Governance McKinsey Survey on Corporate Governance (contd)(contd)

In short, good corporate governance increases In short, good corporate governance increases

market valuation by:market valuation by:

o Increasing financial performance;Increasing financial performance;

o Transparency of dealing, thereby reducing the Transparency of dealing, thereby reducing the risk that boards will serve their own self-risk that boards will serve their own self-interest;interest;

o Increasing investor confidence.Increasing investor confidence.


McKinsey rated the performance on corporate McKinsey rated the performance on corporate governance of each company based on the governance of each company based on the following parameters:following parameters:o Accountability: Transparent ownership, Board Accountability: Transparent ownership, Board

size, Board accountability, Ownership size, Board accountability, Ownership neutralityneutrality

o Disclosure and Transparency of the Board, Disclosure and Transparency of the Board, Timely and accurate disclosure, Independent Timely and accurate disclosure, Independent DirectorsDirectors

o Shareholder equality: One share, One voteShareholder equality: One share, One vote


Through the survey, McKinesy found that Through the survey, McKinesy found that companies with good corporate governance companies with good corporate governance practices have high price-to-book values practices have high price-to-book values indicating that investors are willing to pay a indicating that investors are willing to pay a premium for the shares of a well-managed premium for the shares of a well-managed and governed company. Additionally, the and governed company. Additionally, the survey revealed that investors are willing to survey revealed that investors are willing to pay a premium of as much as 28% for shares pay a premium of as much as 28% for shares of such a corporate governance based of such a corporate governance based company.company.


Companies in emerging markets often claim Companies in emerging markets often claim that Western corporate governance that Western corporate governance standards do not apply to them. However, standards do not apply to them. However, the survey revealed that studies of the six the survey revealed that studies of the six emerging markets show that investors the emerging markets show that investors the world over look for high standards of good world over look for high standards of good governance. Additionally, they are willing to governance. Additionally, they are willing to pay a high premium for shares in companies pay a high premium for shares in companies that meet their requirements of good that meet their requirements of good corporate governance.corporate governance.

Sarbanes-Oxley Act, 2002Sarbanes-Oxley Act, 2002

The Sarbanes--Oxley Act (SOX Act), 2002 is The Sarbanes--Oxley Act (SOX Act), 2002 is a serious attempt to address all the issues a serious attempt to address all the issues associated with corporate failures to associated with corporate failures to achieve quality governance and to restore achieve quality governance and to restore investor confidence. The Act contains a investor confidence. The Act contains a number of provisions that dramatically number of provisions that dramatically change the reporting and corporate change the reporting and corporate directors governance obligations of public directors governance obligations of public companies, the directors and officers.companies, the directors and officers.

Sarbanes-Oxley Act, 2002 (contd)Sarbanes-Oxley Act, 2002 (contd) Important provisions contained in SOX Act are Important provisions contained in SOX Act are briefly given below:briefly given below:

Establishment of Public Company Accounting Establishment of Public Company Accounting

Oversight Board (PCAOBOversight Board (PCAOB))

All accounting firms will have to register All accounting firms will have to register

themselves with this board and submit among themselves with this board and submit among

other details particulars of fees received from other details particulars of fees received from

public, company clients for audit and non-audit public, company clients for audit and non-audit

services, financial information about the firm, services, financial information about the firm,

list of firms staff wholist of firms staff who

Sarbanes-Oxley Act, 2002 (contd)Sarbanes-Oxley Act, 2002 (contd)

participate in audits, quality control policies, participate in audits, quality control policies,

information on civil criminal and disciplinary information on civil criminal and disciplinary

proceedings against the firm or any of the staff.proceedings against the firm or any of the staff.

The board will conduct annual inspections of The board will conduct annual inspections of

firms, which audit more than 100 public firms, which audit more than 100 public

companies, and once in three years in other companies, and once in three years in other

cases. The board will establish rules governing cases. The board will establish rules governing

audit quality control, ethics, independence and audit quality control, ethics, independence and

other standards. It can conduct investigations other standards. It can conduct investigations

and displinary proceedings and can impose and displinary proceedings and can impose

sanctions on auditors. The board reports to SEC. sanctions on auditors. The board reports to SEC.

Audit CommitteeAudit Committee

o The SOX Act provides for a “new improved” The SOX Act provides for a “new improved”

Audit Committee.Audit Committee.

o The audit committee is responsible for The audit committee is responsible for

appointment, fixing fees and oversight of appointment, fixing fees and oversight of

the work of independent auditors. The the work of independent auditors. The

committee is also responsible for committee is also responsible for

establishing reviewing the procedures for establishing reviewing the procedures for

the receipt, treatment of accounts, internal the receipt, treatment of accounts, internal

control and audit complaints received by control and audit complaints received by

the company from the interested or the company from the interested or

affected parties. affected parties.

Audit Partner RotationAudit Partner Rotation

o The SOX Act provides for mandatory rotation of The SOX Act provides for mandatory rotation of

lead audit or co-ordinating partner and the lead audit or co-ordinating partner and the

partner reviewing audit once every five years.partner reviewing audit once every five years.

Improper Influence on Conduct of Improper Influence on Conduct of AuditsAudits

o It will be unlawful for any executive or It will be unlawful for any executive or

director of the firm to take any action to director of the firm to take any action to

fraudlently influence, coerce, manipulate or fraudlently influence, coerce, manipulate or

mislead any auditor engaged in the mislead any auditor engaged in the

performance of an audit with the view to performance of an audit with the view to

rendering the financial statements materially rendering the financial statements materially

misleading. misleading.

Prohibition of Non-audit ServicesProhibition of Non-audit Services

o Non-audit services include: (i) book-keeping Non-audit services include: (i) book-keeping or other services related to the accounting or other services related to the accounting records or financial statements of the client; records or financial statements of the client; (ii) financial information system, design and (ii) financial information system, design and implementation; (iii) appraisal or valuation implementation; (iii) appraisal or valuation services, fairness opinions; (iv) acturial services, fairness opinions; (iv) acturial services; (v) internal audit outsourcing services; (v) internal audit outsourcing services; (vi) management functions or services; (vi) management functions or human resources; (vii) broker or dealer, human resources; (vii) broker or dealer, investment adviser, or investment banking investment adviser, or investment banking services; (viii) legal services or expert services; (viii) legal services or expert services unrelated to the audit and (ix) any services unrelated to the audit and (ix) any other service that the board determines, by other service that the board determines, by regulation, is impermissible. However, the regulation, is impermissible. However, the Board has the power to grant exemptions.Board has the power to grant exemptions.

CEOs and CFOs Required to Affirm FinancialsCEOs and CFOs Required to Affirm Financials

o Chief Executive Officers and Chief Finance Chief Executive Officers and Chief Finance Officers are required to certify the reports Officers are required to certify the reports filed with the Securities Exchange filed with the Securities Exchange Commission. If the financials are required to Commission. If the financials are required to be restated due to material non-compliance be restated due to material non-compliance “as a result of misconduct” of CEO or CFO, “as a result of misconduct” of CEO or CFO, then such CEO or CFO will have to return to then such CEO or CFO will have to return to the company bonus and any other incentives the company bonus and any other incentives received by him. False and or improper received by him. False and or improper certification can attract fine ranging from $ 1 certification can attract fine ranging from $ 1 million to $ 5 million or up to 10 years million to $ 5 million or up to 10 years imprisonment or both.imprisonment or both.

Loans to DirectorsLoans to Directors

o The SOX Act prohibits U.S. and foreign The SOX Act prohibits U.S. and foreign

companies with securities traded within U.S. companies with securities traded within U.S.

from making or arranging from third parties from making or arranging from third parties

any type of personal loan to directors.any type of personal loan to directors.

AttorneysAttorneys

o The attorneys dealing with the publicly The attorneys dealing with the publicly

traded companies are required to report traded companies are required to report

evidence of material violation of securities evidence of material violation of securities

law or breach of fiduciary duty or similar law or breach of fiduciary duty or similar

violations by the company or any agent of violations by the company or any agent of

the company to the Chief Counsel or CEO the company to the Chief Counsel or CEO

and if the Counsel or CEO does not and if the Counsel or CEO does not

appropriately respond to the evidence the appropriately respond to the evidence the

attorney must report the evidence to the attorney must report the evidence to the

audit committee or the board of directors.audit committee or the board of directors.

Securities AnalystsSecurities Analysts

o The SOX Act has a provision under which The SOX Act has a provision under which

brokers and dealers of securities should not brokers and dealers of securities should not

retaliate or threaten to retaliate an analyst retaliate or threaten to retaliate an analyst

employed by the broker or dealer for any employed by the broker or dealer for any

adverse, negative or unfavourable research adverse, negative or unfavourable research

report on a Public Company.report on a Public Company.

PenaltiesPenalties

o The penalties prescribed under SOX Act for The penalties prescribed under SOX Act for

any wrongdoings are very stiff. Penalties for any wrongdoings are very stiff. Penalties for

willful violations are even stiffer. Any CEO willful violations are even stiffer. Any CEO

or CFO providing a certificate knowing that or CFO providing a certificate knowing that

it does not meet with the criteria stated it does not meet with the criteria stated

may be fined upto $ 1 million and/or may be fined upto $ 1 million and/or

imprisonment upto 10 years.imprisonment upto 10 years.

Indian Committees and GuidelinesIndian Committees and Guidelines

Working Group on the Companies Act, 1956.Working Group on the Companies Act, 1956.

The government accordingly set up a Working The government accordingly set up a Working

Group in August 1996 for this purpose. Group in August 1996 for this purpose.

The Working Group on the Companies Act has The Working Group on the Companies Act has

recommended a number of changes and also recommended a number of changes and also

prepared a working draft of Companies Bill 1997. prepared a working draft of Companies Bill 1997.

The Bill was introduced in the Rajya Sabha on 14 The Bill was introduced in the Rajya Sabha on 14

August 1997, containing the following August 1997, containing the following

recommendations.recommendations.

Financial disclosures recommended by Financial disclosures recommended by the Working Group on the Companies the Working Group on the Companies

ActActo A tabular form containing details of each A tabular form containing details of each

director’s remuneration and commission should director’s remuneration and commission should form a part of the Directors’ Report.form a part of the Directors’ Report.

o A listed company must give certain key A listed company must give certain key information on its divisions or business segments information on its divisions or business segments as a part of the Directors Report in the Annual as a part of the Directors Report in the Annual Report.Report.

o Where a company has raised funds from the Where a company has raised funds from the public by issuing shares, debentures or other public by issuing shares, debentures or other securities, it would have to give a separate securities, it would have to give a separate statement showing the end-use of such funds.statement showing the end-use of such funds.

o The disclosure on debt exposure of the company The disclosure on debt exposure of the company should be strengthened.should be strengthened.

Non-Financial disclosures Non-Financial disclosures recommended by the Working Group recommended by the Working Group

on Companies Acton Companies Act

1.1. A comprehensive report on the relatives of A comprehensive report on the relatives of directors - either as employees or Board directors - either as employees or Board members - to be an integral part of the members - to be an integral part of the Directors’ Report of all listed companies.Directors’ Report of all listed companies.

2.2. Companies have to maintain a register, which Companies have to maintain a register, which discloses interests of directors in any contract discloses interests of directors in any contract or arrangement of the company. or arrangement of the company.

3.3. 3.3. Likewise, the existence of the directors’ Likewise, the existence of the directors’ shareholding register and the fact that shareholding register and the fact that members in any AGM can inspect it should be members in any AGM can inspect it should be explicitly stated in the notice of the AGM of all explicitly stated in the notice of the AGM of all listed companies.listed companies.


on Companies Act (contd.)on Companies Act (contd.)

4.4. Details of loans to directors should be Details of loans to directors should be disclosed as an annex to the Directors’ Report disclosed as an annex to the Directors’ Report in addition to being a part of schedules of the in addition to being a part of schedules of the financial statements.financial statements.

5.5. Appointment of sole selling agents for India Appointment of sole selling agents for India will require prior approval of a special will require prior approval of a special resolution in a general meeting of resolution in a general meeting of shareholders.shareholders.

6.6. Subject to certain exceptions there should be Subject to certain exceptions there should be a Secretarial Compliance Certificate forming a a Secretarial Compliance Certificate forming a part of the Annual Returns that is filed with part of the Annual Returns that is filed with the Registrar of Companies.the Registrar of Companies.


on Companies Act (contd.)on Companies Act (contd.)

77.. The Compliance Certificate should certify in The Compliance Certificate should certify in prescribed format that the secretarial prescribed format that the secretarial requirements under the Companies Act have requirements under the Companies Act have been adhered to.been adhered to.

Deficiencies of the Companies ActDeficiencies of the Companies Act

(i)(i) Though non-executive directors can play a Though non-executive directors can play a significant role in providing independent significant role in providing independent

and and objective opinion in discussions on many objective opinion in discussions on many strategic strategic areas in board deliberations, the Act areas in board deliberations, the Act does not does not assign them any formal role between assign them any formal role between executive and executive and non-executive directorsnon-executive directors

(ii)(ii) In actual practice, non-executive directors In actual practice, non-executive directors have have only ornamental value.only ornamental value.

Deficiencies of the Companies Act (contd.)Deficiencies of the Companies Act (contd.)

(iii)(iii) With regard to financial reporting, the With regard to financial reporting, the provisions of provisions of the Act make it more rule-based the Act make it more rule-based and ritualistic, and ritualistic, rather than being transparent.rather than being transparent.

(iv)(iv) The Act does not prescribe any formal The Act does not prescribe any formal qualifications for a director of a company, with qualifications for a director of a company, with the the result even an incompetent and mediocre result even an incompetent and mediocre person person can become a member of the board.can become a member of the board.

Deficiencies of the Companies Act Deficiencies of the Companies Act (contd.)(contd.)

(v)(v) Though the Act formally provides for the Though the Act formally provides for the appointment of auditors by shareholders, in appointment of auditors by shareholders, in practice practice they work more closely with they work more closely with the the company company management. Shareholders hardly management. Shareholders hardly have a chance to have a chance to interact with the auditors. interact with the auditors.

THE CONFEDERATION OF INDIAN THE CONFEDERATION OF INDIAN INDUSTRY’S INITIATIVEINDUSTRY’S INITIATIVE

In 1996, the Confederation of Indian Industry In 1996, the Confederation of Indian Industry (CII) took a special initiative on Corporate (CII) took a special initiative on Corporate Governance, the first ever institutional initiative Governance, the first ever institutional initiative in Indian industry. This initiative by CII flowed in Indian industry. This initiative by CII flowed from public concerns regarding the protection of from public concerns regarding the protection of investors interest, especially of the small investors interest, especially of the small investor; the promotion of transparency within investor; the promotion of transparency within business and industry; the need to move towards business and industry; the need to move towards international standards in terms of disclosure of international standards in terms of disclosure of information by the corporate sector and through information by the corporate sector and through all of this, to develop a high level of public all of this, to develop a high level of public confidence in business and industry.confidence in business and industry.

THE CONFEDERATION OF INDIAN THE CONFEDERATION OF INDIAN INDUSTRY’S INITIATIVE (contd.)INDUSTRY’S INITIATIVE (contd.)

A National Task Force that was set up with A National Task Force that was set up with Mr.Rahul Bajaj, past President of CII as the Mr.Rahul Bajaj, past President of CII as the Chairman and members from industry, the legal Chairman and members from industry, the legal profession, media and academia, presented the profession, media and academia, presented the draft guidelines and the Code of Corporate draft guidelines and the Code of Corporate Governance in April 1997 at the National Governance in April 1997 at the National Conference and Annual Session of CII.Conference and Annual Session of CII.

The Confederation of Indian The Confederation of Indian Industry’s Initiative (contd.)Industry’s Initiative (contd.)

The CII has pioneered the concept of corporate The CII has pioneered the concept of corporate governance in India and has been internationally governance in India and has been internationally recognised as one of the best in the world.recognised as one of the best in the world.

These are:These are:

Recommendations of the CII’s Recommendations of the CII’s Code of Corporate GovernanceCode of Corporate Governance

1.1. A single board, if it performs well, can maximise A single board, if it performs well, can maximise long-term shareholder value. The board should long-term shareholder value. The board should meet at least six times a year, preferably at meet at least six times a year, preferably at intervals of 2 months.intervals of 2 months.

2.2. A listed company with a turnover of Rs.100 A listed company with a turnover of Rs.100 crores and above should have professionally crores and above should have professionally competent and recognised independent non-competent and recognised independent non-executive directors who should constituteexecutive directors who should constitute

at least 30 percent of the board, if the at least 30 percent of the board, if the Chairman of the company is a non-executive Chairman of the company is a non-executive director ordirector or

at least 50 percent of the board, if the at least 50 percent of the board, if the Chairman and Managing Director is the same Chairman and Managing Director is the same person.person.

Recommendations of the CII’s Code of Recommendations of the CII’s Code of corporate governance (contd.)corporate governance (contd.)

33. . A person should not hold directorships in more A person should not hold directorships in more than 10 listed companies.than 10 listed companies.

4.4. For non-executive directors to play a significant For non-executive directors to play a significant role in corporate decision making and maximising role in corporate decision making and maximising long term shareholder value they need tolong term shareholder value they need to

become active participants in boards and not become active participants in boards and not passive advisors;passive advisors;

have clearly defined responsibilities within the have clearly defined responsibilities within the board such as the Audit Committee; andboard such as the Audit Committee; and

know how to read a balance sheet, profit and loss know how to read a balance sheet, profit and loss account, cash flow statements, and financial account, cash flow statements, and financial ratios and have some knowledge of various ratios and have some knowledge of various company laws. company laws.

Recommendations of the CII’s Code of Recommendations of the CII’s Code of Corporate Governance (contd.)Corporate Governance (contd.)

5.5. To secure better effort from non-executive To secure better effort from non-executive directors, companies should pay a commission directors, companies should pay a commission over and above the sitting fees for the use of over and above the sitting fees for the use of the professional inputs.the professional inputs.

6.6. While re-appointing members of the board, While re-appointing members of the board, companies should give the attendance record of companies should give the attendance record of the concerned directors. the concerned directors.


77.. Key information that must be reported to, and Key information that must be reported to, and placed before the board, must contain:placed before the board, must contain:

Annual operating plans and budgets, together Annual operating plans and budgets, together with up-dated long term plans;with up-dated long term plans;

Capital budgets, manpower and overhead Capital budgets, manpower and overhead budgets;budgets;

Internal audit reports including cases of theft and Internal audit reports including cases of theft and dishonesty of a material nature;dishonesty of a material nature;

Fatal or serious accidents, dangerous occurrence, Fatal or serious accidents, dangerous occurrence, and any effluent or pollution problems;and any effluent or pollution problems;

Default in payment of interest or non-payment of Default in payment of interest or non-payment of the principal on any public deposit and/or to any the principal on any public deposit and/or to any secured creditor or financial institution;secured creditor or financial institution;


Defaults such as non-payments of the principal Defaults such as non-payments of the principal on any company or materially substantial non-on any company or materially substantial non-payments for goods sold by the company;payments for goods sold by the company;

Details of any joint venture or collaboration Details of any joint venture or collaboration agreement;agreement;

Transactions that involve substantial payment Transactions that involve substantial payment towards goodwill, brand equity or intellectual towards goodwill, brand equity or intellectual property;property;

Recruitment and remuneration of senor officers Recruitment and remuneration of senor officers just below the board level, including appointment just below the board level, including appointment or removal of the Chief Financial Officer and the or removal of the Chief Financial Officer and the Company Secretary; Company Secretary;

Labour problems and their proposed solutions Labour problems and their proposed solutions andand

Quarterly details of foreign exchange exposure Quarterly details of foreign exchange exposure and the steps taken by management to limit the and the steps taken by management to limit the risks of adverse exchange rate movement, if risks of adverse exchange rate movement, if material.material.


8.8. For all companies with paid-up capital of Rs.20 For all companies with paid-up capital of Rs.20 crores or more the quality and quantity of crores or more the quality and quantity of disclosure that accompanies a GDR issue should disclosure that accompanies a GDR issue should be the norm for any domestic issue.be the norm for any domestic issue.

99 Companies that default on fixed deposits Companies that default on fixed deposits should not be permitted to accept further should not be permitted to accept further deposits and make inter-corporate loans or deposits and make inter-corporate loans or investments or declare dividends until the investments or declare dividends until the default is made good. default is made good.

Recommendations of the CII’s Code of Recommendations of the CII’s Code of Corporate GovernanceCorporate Governance (contd.)(contd.)

11.11. Major Indian Stock Exchanges should insist upon a Major Indian Stock Exchanges should insist upon a compliance certificate, signed by the CEO and the compliance certificate, signed by the CEO and the CFO which should clearly state:CFO which should clearly state:

The company will continue business in the course The company will continue business in the course of the following year;of the following year;

The accounting policies and principles conform to The accounting policies and principles conform to the standard practice;the standard practice;

The management is responsible for the The management is responsible for the preparation, integrity and fair presentation of preparation, integrity and fair presentation of financial statements and other information financial statements and other information contained in the Annual Report. contained in the Annual Report.

The board has overseen the company’s system of The board has overseen the company’s system of internal accounting and administrative controls internal accounting and administrative controls either directly or through its Audit Committee.either directly or through its Audit Committee.

SEBI’s InitiativesSEBI’s Initiatives

The Securities and Exchange Board of India The Securities and Exchange Board of India (SEBI) appointed a committee on corporate (SEBI) appointed a committee on corporate governance on May 7, 1999, with eighteen governance on May 7, 1999, with eighteen members under the Chairmanship of Kumar members under the Chairmanship of Kumar Mangalam Birla to promoting and raising Mangalam Birla to promoting and raising the standards of corporate governance.the standards of corporate governance.

Kumar Mangalam Birla CommitteeKumar Mangalam Birla Committee

The Committee’s recommendations The Committee’s recommendations consisted of (i) mandatory consisted of (i) mandatory recommendations, and (ii) non-recommendations, and (ii) non-mandatory recommendations.mandatory recommendations.

Mandatory RecommendationsMandatory Recommendations

1.1. ApplicabilityApplicability Applicable to all listed companies with paid-up Applicable to all listed companies with paid-up

share capital of Rs. 3 crore and aboveshare capital of Rs. 3 crore and above

2.2. Board of directorsBoard of directors The Board of Directors of a company must have The Board of Directors of a company must have

an optimum combination of executive and non-an optimum combination of executive and non-executive Directors. The number of executive Directors. The number of independent Directors should be at least one-independent Directors should be at least one-third in case the company has a non-executive third in case the company has a non-executive Chairman and at least half of the Board in case Chairman and at least half of the Board in case the company has an executive Chairman.the company has an executive Chairman.

Mandatory Recommendations Mandatory Recommendations (contd.)(contd.)

3.3. Audit CommitteeAudit Committee

The Audit Committee should have a minimum 3 The Audit Committee should have a minimum 3 members.members.

The Chairman should be an independent The Chairman should be an independent Director and must be present at the Annual Director and must be present at the Annual General Meeting to answers shareholders’ General Meeting to answers shareholders’ queries. queries.

Remuneration Committee of the Remuneration Committee of the BoardBoard

The Board of Directors should decide the The Board of Directors should decide the remuneration of non-executive directors.remuneration of non-executive directors.

Full disclosure of the remuneration package of all Full disclosure of the remuneration package of all the directors covering salary benefits, bonuses, the directors covering salary benefits, bonuses, stock options, pension fixed component, stock options, pension fixed component, performance linked incentives along with the performance linked incentives along with the performance criteria, service contracts, notice performance criteria, service contracts, notice period, severance fees, etc., is to be made in the period, severance fees, etc., is to be made in the section on corporate governance of the annual section on corporate governance of the annual report.report.

Board ProceduresBoard Procedures

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

ManagementManagement

Management discussions and Management discussions and analysis report covering industry analysis report covering industry structure, opportunities and threats, structure, opportunities and threats, segment-wise or product-wise segment-wise or product-wise performance outlook, risks, internal performance outlook, risks, internal control systems, etc. are to form a control systems, etc. are to form a part of Directors Report or as an part of Directors Report or as an addition thereto.addition thereto.

ShareholdersShareholders

In case of appointment of a new Director or In case of appointment of a new Director or re-appointment of existing Director, re-appointment of existing Director, information containing a brief resume, information containing a brief resume, nature of expertise in specific functional nature of expertise in specific functional areas and companies in which the person areas and companies in which the person holds Directorship, Committee Membership, holds Directorship, Committee Membership, must be provided to the benefit of must be provided to the benefit of shareholders.shareholders.

Shareholders (contd.)Shareholders (contd.)

A Board committee under the chairmanship A Board committee under the chairmanship of a non-executive director is to be formed of a non-executive director is to be formed to specifically look into the redressing of to specifically look into the redressing of shareholder complaints of declared shareholder complaints of declared dividends etc.dividends etc.

Shareholders (contd.)Shareholders (contd.)

In order to expedite the process of share In order to expedite the process of share transfers, the Board should delegate the transfers, the Board should delegate the power of share transfer to an officer or a power of share transfer to an officer or a committee or to the Registrar and share committee or to the Registrar and share transfer agents with a direction to the transfer agents with a direction to the delegated authority to attend to share delegated authority to attend to share transfer formalities at least once in a transfer formalities at least once in a fortnight.fortnight.

Non-mandatory RecommendationsNon-mandatory Recommendations

1.1. Chairman of the BoardChairman of the Board

The Chairman’s role should in The Chairman’s role should in principle be different from that principle be different from that of the Chief Executive, though of the Chief Executive, though the same executive can perform the same executive can perform both the roles.both the roles.

Non-mandatory Recommendations Non-mandatory Recommendations (contd.)(contd.)

2. 2. Remuneration Committee Remuneration Committee

The Board of Directors should set up a The Board of Directors should set up a Remuneration Committee to determine on Remuneration Committee to determine on their behalf and on behalf of the their behalf and on behalf of the shareholders with agreed terms of shareholders with agreed terms of reference the company’s policy on specific reference the company’s policy on specific remuneration packages for executive remuneration packages for executive directors including pension rights and any directors including pension rights and any other compensation payment.other compensation payment.

Non-mandatory Recommendations Non-mandatory Recommendations (contd.)(contd.)

3.3. Shareholders’ RightsShareholders’ Rights

Half-yearly declaration of financial Half-yearly declaration of financial performance including summary of the performance including summary of the significant events in the six months should significant events in the six months should be sent to each of the shareholders.be sent to each of the shareholders.

4.4. Postal BallotPostal Ballot

NARESH CHANDRA COMMITTEE NARESH CHANDRA COMMITTEE REPORT, 2002REPORT, 2002

The Naresh Chandra Committee was appointed as The Naresh Chandra Committee was appointed as a High Level Committee to examine various a High Level Committee to examine various corporate governance issues by the Department corporate governance issues by the Department of Company Affairs on 21st August, 2002. The of Company Affairs on 21st August, 2002. The Committee’s recommendations mainly Committee’s recommendations mainly concerned: (i) The Auditor – Company concerned: (i) The Auditor – Company relationship; (ii) disqualifications for audit relationship; (ii) disqualifications for audit assignments; (iii) List of prohibited non-audit assignments; (iii) List of prohibited non-audit services; (iv) Independence standards for services; (iv) Independence standards for consulting; (v) Compulsory audit partner consulting; (v) Compulsory audit partner rotation; (vi) Auditor’s disclosure of contingent rotation; (vi) Auditor’s disclosure of contingent liabilities; (vii) Auditor’s disclosure of liabilities; (vii) Auditor’s disclosure of qualifications and consequent action; qualifications and consequent action;

NARESH CHANDRA COMMITTEE REPORT, NARESH CHANDRA COMMITTEE REPORT, 2002 (contd.)2002 (contd.)

(viii) Managements certification in the event of (viii) Managements certification in the event of auditor’s replacement; (ix) Auditor’s annual auditor’s replacement; (ix) Auditor’s annual certification of independence; (x) Appointment of certification of independence; (x) Appointment of Auditors; (xi) Certification of annual audited Auditors; (xi) Certification of annual audited accounts by CEO and CFO; (xii) Auditing the accounts by CEO and CFO; (xii) Auditing the Auditors; (xiii) Setting up of the independent Auditors; (xiii) Setting up of the independent Quality Review Board; (xiv) Proposed disciplinary Quality Review Board; (xiv) Proposed disciplinary mechanism for auditors; (xv) Independent mechanism for auditors; (xv) Independent Directors; (xvi) Audit Committee Charter; (xvii) Directors; (xvi) Audit Committee Charter; (xvii) Exempting non-executive directors from certain Exempting non-executive directors from certain liabilities; (xvii) Training of independent liabilities; (xvii) Training of independent directors; (xix) Establishment of Corporate directors; (xix) Establishment of Corporate Serious Fraud Office; (xx) SEBI and Subordinate Serious Fraud Office; (xx) SEBI and Subordinate LegislationLegislation

The committee has further The committee has further recommendedrecommended

Tightening of the noose around the auditors by Tightening of the noose around the auditors by asking them to make an array of disclosures,asking them to make an array of disclosures,

Called upon CEOs and CFOs of all listed Called upon CEOs and CFOs of all listed companies to certify their companies’ annual companies to certify their companies’ annual accounts, besides suggestingaccounts, besides suggesting

Setting up of quality review boards by the Setting up of quality review boards by the Institute of Chartered Accountants of India Institute of Chartered Accountants of India (ICAI), Institute of Company Secretaries of India (ICAI), Institute of Company Secretaries of India and the Institute of Cost and Works and the Institute of Cost and Works Accountants of India, instead of a Public Accountants of India, instead of a Public Oversight Board similar to the one in the United Oversight Board similar to the one in the United States.States.

Rationale for a Review of the Rationale for a Review of the Birla CodeBirla Code

In the perception of SEBI, there was a need to In the perception of SEBI, there was a need to appoint a committee as a follow-up of the Birla appoint a committee as a follow-up of the Birla Committee’s report and the experience gained Committee’s report and the experience gained from the analysis of compliance reports.from the analysis of compliance reports.

Rationale for a Review of the Rationale for a Review of the Birla Code (contd.)Birla Code (contd.)

SEBI, therefore, set out to form another SEBI, therefore, set out to form another committee with the twin perspectives: (a) to committee with the twin perspectives: (a) to evaluate the adequacy of the existing practices, evaluate the adequacy of the existing practices, and (b) to further improve them. This committee and (b) to further improve them. This committee on corporate governance was constituted under on corporate governance was constituted under the chairmanship of N.R. Narayana Murthy, the chairmanship of N.R. Narayana Murthy, Chairman and Chief Mentor of Infosys Chairman and Chief Mentor of Infosys Technologies Ltd. and comprised representatives Technologies Ltd. and comprised representatives from stock exchanges, chambers of commerce, from stock exchanges, chambers of commerce, investors associations and professional bodies.investors associations and professional bodies.

NARAYANA MURTHY COMMITTEE NARAYANA MURTHY COMMITTEE REPORT, 2003REPORT, 2003

The Committee on Corporate Governance set The Committee on Corporate Governance set up by SEBI under the Chairmanship of up by SEBI under the Chairmanship of N.R.Narayana Murthy which submitted its N.R.Narayana Murthy which submitted its Report in February, 2003Report in February, 2003

NARAYANA MURTHY COMMITTEE REPORT, NARAYANA MURTHY COMMITTEE REPORT, 2003 (contd.)2003 (contd.)

The Committee’s report expresses its total The Committee’s report expresses its total concurrence with the recommendations concurrence with the recommendations contained in the Naresh Chandra Committee’s contained in the Naresh Chandra Committee’s report onreport on

Disclosure of contingent liabilitiesDisclosure of contingent liabilities Certification by CEO and CFOCertification by CEO and CFO Definition of independent directorsDefinition of independent directors Independence of audit committeesIndependence of audit committees

Mandatory RecommendationsMandatory Recommendations

Audit Committee:Audit Committee:

An Audit Committee is the bedrock of An Audit Committee is the bedrock of quality governance.quality governance.

The Committee recommended a bigger role The Committee recommended a bigger role for the audit committee.for the audit committee.

Narayana Murthy’s Committee has not Narayana Murthy’s Committee has not taken a view on rotation of auditorstaken a view on rotation of auditors

Related Party TransactionsRelated Party Transactions

A statement of all transactions with related A statement of all transactions with related parties including their bases should be parties including their bases should be placed before the audit committee for placed before the audit committee for formal approval/ratificationformal approval/ratification

Proceeds from Initial Public Proceeds from Initial Public OfferingsOfferings

Companies raising money through initial Companies raising money through initial public offering should disclose to the audit public offering should disclose to the audit committee the uses and application of funds committee the uses and application of funds under major heads on a quarterly basis.under major heads on a quarterly basis.

Risk ManagementRisk Management

The Committee has deemed it necessary for The Committee has deemed it necessary for the boards of companies to be fully aware the boards of companies to be fully aware of the risks involved in the business and of the risks involved in the business and that it is also important for shareholders to that it is also important for shareholders to know about the process by which companies know about the process by which companies manage their business risks. The mandatory manage their business risks. The mandatory recommendations in this regard are:recommendations in this regard are:

Risk Management (contd.)Risk Management (contd.)

““Procedures should be in place to inform Procedures should be in place to inform board members about the risk assessment board members about the risk assessment and minimisation procedures. These and minimisation procedures. These procedures should be periodically reviewed procedures should be periodically reviewed to ensure that executive management to ensure that executive management controls risks through means of a properly controls risks through means of a properly defined framework.”defined framework.”

Risk Management (contd.)Risk Management (contd.)

Management should place a report before Management should place a report before the entire board of directors every quarter the entire board of directors every quarter documenting the business risks faced by documenting the business risks faced by the company, measures to address and the company, measures to address and minimise such risks and any limitation to minimise such risks and any limitation to the risk-taking capacity of the corporations. the risk-taking capacity of the corporations. The board should formally approve this The board should formally approve this document. document.

Code of ConductCode of Conduct

The Committee has recommended that it The Committee has recommended that it should be obligatory for the board of a should be obligatory for the board of a company to lay down a code of conduct for company to lay down a code of conduct for all board members and senior management all board members and senior management of the company. This code should be posted of the company. This code should be posted on the company’s websiteon the company’s website

Nominee DirectorsNominee Directors

The Committee recommended doing away The Committee recommended doing away with nominee directors. If a corporation with nominee directors. If a corporation wishes to appoint a director on the board, wishes to appoint a director on the board, such appointment should be made by the such appointment should be made by the shareholders. The Committee insisted that an shareholders. The Committee insisted that an institutional director, if appointed, shall have institutional director, if appointed, shall have the same responsibilities and shall be subject the same responsibilities and shall be subject to the same liabilities as any other director. to the same liabilities as any other director. Nominees of the Government on public sector Nominees of the Government on public sector companies shall be similarly elected and shall companies shall be similarly elected and shall be subject to the same responsibilities and be subject to the same responsibilities and liabilities as other directors.liabilities as other directors.

Other mandatory recommendations Other mandatory recommendations are:are:

Compensation to non-executive directors (to be Compensation to non-executive directors (to be approved by the shareholders in general meeting;approved by the shareholders in general meeting;

Whistle blower policy to be in place in a company. Whistle blower policy to be in place in a company.

Dr.J.J. Irani Committee Report on Company Law, Dr.J.J. Irani Committee Report on Company Law, 20052005

Appointed in December 2004. It submitted its Appointed in December 2004. It submitted its Report in May 2004. The committee Report in May 2004. The committee recommended: (i) One-third of the Board of listed recommended: (i) One-third of the Board of listed company should be independent directors, company should be independent directors, should be independent directors, (ii) Corporates should be independent directors, (ii) Corporates should be allowed to maintain pyramidal should be allowed to maintain pyramidal structure, ie, a subsidiary of a holding company structure, ie, a subsidiary of a holding company itself be a holding company; (iii) Full liberty to itself be a holding company; (iii) Full liberty to shareholders to do decide to issues; (iv) Mooted shareholders to do decide to issues; (iv) Mooted the concept of single person company; (v) the concept of single person company; (v) companies encouraged to self-regulate their companies encouraged to self-regulate their affairs; (vi) Provided Stringent penalties for affairs; (vi) Provided Stringent penalties for wrongdoers and recommended publication of the wrongdoers and recommended publication of the punishment; (vii) Suggested continuation of punishment; (vii) Suggested continuation of Audit and Accounting standards of ICAI; and (viii) Audit and Accounting standards of ICAI; and (viii) Present governance standards to continue. Present governance standards to continue.

CONCLUSIONCONCLUSION

Although India has been fortunate in not Although India has been fortunate in not having to go through the massive corporate having to go through the massive corporate failures such as Enron and Worldcom, it has failures such as Enron and Worldcom, it has not been wanting in its resolve to not been wanting in its resolve to incorporate better governance practices in incorporate better governance practices in the country’s corporates emulating the country’s corporates emulating stringent international standards.stringent international standards.

CONCLUSION (contd.)CONCLUSION (contd.)

However, as the Naresh Chandra Committee on However, as the Naresh Chandra Committee on Corporate Audit and Governance pointed out: Corporate Audit and Governance pointed out: “There is scope for improvement. For one, while “There is scope for improvement. For one, while India may have excellent rules and regulations, India may have excellent rules and regulations, regulatory authorities are inadequately staffed regulatory authorities are inadequately staffed and lack sufficient number of skilled people. This and lack sufficient number of skilled people. This has led to less than credible enforcement. has led to less than credible enforcement. Delays in courts compound the problem. For Delays in courts compound the problem. For another, India has had its fair share of corporate another, India has had its fair share of corporate scams and stock market scandals that has scams and stock market scandals that has shaken investor confidence. Much can be done shaken investor confidence. Much can be done to improve the situation”.to improve the situation”.

Chapter 3

Documents

Transcript of Chapter 3