Corporate Governance

1. Corporate Governance _____________________________ PRESENTATION BY, SANJU THAKUR

2. Overview of Corporate Governance

3. SomeDefinitions • “Corporate Governance is the system by which companies are directed and controlled…” • Cadbury Report (UK), 1992 • “…to do with Power and Accountability: who exercises power, on behalf of whom, how the exercise of power is controlled.” • Sir Adrian Cadbury, inReflections on Corporate Governance, Ernest Sykes Memorial Lecture, 1993

4. A Canadian Definition • “…the process and structure..to direct and manage the business and affairs of the corporation with the objective of enhancing shareholder value, which includes ensuring the financial viability of the business….” • Where were the Directors? Guidelines for Improved Corporate Governance in Canada, TSE, 1994

5. An OECD Definition • “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders ..also the structure through which objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.” • Preamble to the OECD Principles of Corporate Governance, 2004

6. An Indian Definition • “…fundamental objective of corporate governance is the ‘enhancement of the long-term shareholder value while at the same time protecting the interests of other stakeholders.” • SEBI (Kumar Mangalam Birla) Report on Corporate Governance, January, 2000

7. A Gandhian Definition • Trusteeship obligations inherent in company operations, where assets and resources are pooled and entrusted to the managers for optimal utilisation in the stakeholders’ interests.

8. Some Further Definitions Corporate governance is essentially about leadership: • leadership for efficiency; • leadership for probity; • leadership with responsibility; and • leadership which is transparent and which is accountable. - PRINCIPLES FOR CORPORATE GOVERNANCE IN THE COMMONWEALTH

9. What is Corporate Governance? • The Manner in which a Corporation is Run • Achieving its Objectives • Transparency of its Operations • Accountability & Reporting • Good Corporate Citizenship • The Processes & Operating Relationships that Best Achieve Organisational Goals

10. Some Governance Models • Finance or the Principal-Agent Model • Markets for Capital, Managerial Talent and Corporate Control, Key determinant • In general, profit-maximisation goal is co-functional with social-welfare-maximisation • Shareholders as Residual Claimants have superior control rights

11. Exclusive Accountability toShareholders • Risk-bearing Entrepreneurs • Residual Claimants • Winding-up Ranking: Last in Pecking Order • Boards Appointed by Shareholders • Non-congruence of Stakeholder Interests

12. Residual Claimant Theory • “…shareholders … residual claimants to the firm’s income. Creditors have fixed claims and employees’ remunerations … negotiated in advance of performance .. Gains and losses from abnormally good or bad performance .. The lot of shareholders, who stand last in the queue .. Shareholders make discretionary decisions and bear consequences .. As such, .. Owners of business with important control rights…” • The Economic Structure of Corporate Law, Frank H Easterbrook and Daniel R Fischel (1991) OUP

13. The Stakeholder Case • Firm Objective must be defined more widely than just shareholder-value-maximisation, since risk capital is not the only, or even the major input • Residual Claimant Rights Not Universally Valid, eg, Circumscribed in case of pre-bankruptcy (US Chapter XI) Situations • Other Such: Employees with Firm-specific Specialised Skills, Customers/Vendors with Substantial Stake in the Business, etc

14. Towards an Integrated Model • One-Size does not Fit All Circumstances • A Combination of Shareholder/Stakeholder Models Necessary • Some Argue, While Shareholder Claim Well Established, Stakeholder Claims Need to be Proved • Tailor Model to Suit Unique Circumstances

15. The Corporate Board • Central to Corporate Governance • Juxtaposed between Shareholders on the one hand, and on the other, Managers of the Entity (Cadbury) • Follows Distancing between Ownership and Control (Berle and Means) • Trustee for All Shareholders • Loyalty & Commitment – Always to Company

16. Board Role & Responsibility • Provide/ Exercise • Leadership and Strategic Guidance • Objective Judgement Independent of Management • Control over the Company • Direct and Control the Management of the Company • Be Accountable at all times to All Shareholders

17. Dimensions of Board Responsibility • Direction involves • Formulation & Review of Company Policies, Strategies, Budgets and Plans, Risk Management Policies, Top Level HR Policies, etc • Setting Objectives & Monitoring Performance • Oversight of Acquisitions, Divestitures, Projects, Financial and Legal Compliance, etc

18. Dimensions of Board Responsibility • Control Involves • Prescribing Codes of Conduct, • Overseeing Disclosure & Communication Processes, • Ensuring Control Systems to Protect Company Assets • Reviewing Performance & Realigning Action Initiatives to Achieve Company Objectives

19. Dimensions of Board Responsibility • Accountability Involves • Creating, Protecting and Enhancing Company Wealth and Resources • Timely and Transparent Reporting • Good Corporate Citizenry including Discharge of Stakeholder Obligations and Societal Responsibilities without Compromising the Shareholder Wealth Maximisation Goal

20. Corporate Governance & Capital Market Drivers: A Conceptual Framework REGULATION & LEGISLATION Regulators Government Stock Exchanges (SEBI/RBI) Legislation Listing Agreements Listed Corporations (The Board & the Executive) Shareholders/ Stakeholders Lenders (Banks/ Depositors) Market Operators Institutional Investors Press/Media (Rewards) (Pension Funds/Insce Cos) (Opinion Makers) Market Operations, Critique & Monitoring

21. Is ThereMore to Business than just theFinancial Numbers?

22. An Enterprise’s Triple Effect on Society Sustainable Development Equal Opportunities Waste Control Education & Culture Social Emissions Community Regeneration Environment Business Impact Energy Use Human Rights Product Employee Life-cycle Volunteers Economic Product Wealth Productive Ethical Value Generation Employment Trading

23. The Triple-Bottomline Impact economics Business Impact environment society

24. Governance Orientation Matrix

25. Governance Orientation & Sustainable Profits

26. Unique Dimensions of Bank Governance

27. Unique Dimensions in Bank Governance • Bank Role in Good Governance Two-fold: • Governance Within • Governance at Clients’ • As Fund-Providers, Banks Generate Multiplier Impact on Economy • Confidence & Trust Key – Bank Distress, Failure, Dis-Repute Impacts Economy, Erodes Country Standing Globally

28. Unique Dimensions in Bank Governance • Stakeholder Dimension Very Strong in Banks- • Depositors • Borrowers • Employees • Community • Regulators • Government

29. Unique Dimensions in Bank Governance • Banking Risk Potential • Internal Fraud & External Fraud, Highly Likely, since cash/cash equivalents closest in grab-chain • Employment Practices/ Workplace Safety • Product, Process, Business Practices • Damages to Physical Assets & IPR/Brands • Business Disruption Major Threat

30. Unique Dimensions in Bank Governance • Non-Compliance (Intentionally or Otherwise) with Laws, Rules, Regulations • Consequences of (Non) Compliance Risk in Banks • Legal or Regulatory Sanctions • Financial or Reputational Loss

31. Unique Dimensions in Bank Governance • Banks as Promoters of Good Governance • Prescribing Governance Standards at Borrowers (IFC, CalPERS, FIs) • Encourage by Preferential Lending Rates, Other Terms • Discourage by Adversarial Lending Rates, Other Terms • A Measure of Strengthening Protection of Bank Assets, Hence Good for Bank’s Own Governance

32. Some Unique Dimensions of Public Sector Bank Governance in Developing Economies • Political & Bureaucratic Interventions • Banking as a Policy Instrument • Supervisory Interventions, Micro-Managing • Captive Resource of First Resort • Suspect Independence of Supervisory Institutions • Lack of Accurate/ Timely Accounting & Disclosure Practices

33. Bank Boards, Directors, & Governance

34. Some Unique Attributes & Responsibilities of Bank Boards &Directors • Assume Responsibility for Effective & Efficient Management, through Oversight Mechanisms • Integrity is Indivisible; Role Model Director is the Most Persuasive Statement of Ethical values • Consider Transparency as the Norm. Confidentiality should not lead to Opacity • Continued

35. Some Unique Attributes & Responsibilities of Bank Boards & Directors • Ultimate Responsibility for True and Fair Presentation Rests with the Board • Poor Leadership Infects. • Adapted from Guidance for the Directors of Banks, Jonathan Charkham, (2003) [OECD-World Bank] Global Corporate Governance Forum, Washington

36. Issues in Corporate Governance • Asymmetry of power • Asymmetry of information • Interests of shareholders as residual owners • Role of owner management • Theory of separation of powers • Division of corporate pie among stakeholders

37. Current status on corporate governance • Insistence on forms and structures • Overarching regulations • Regulatory overkill • Lack of adequate number of strong, independent directors • Large liabilities for companies and officers • Has the pendulum swung too far? • For the first time in the decade-long history of the Index of Economic Freedom, the U.S. is no longer among the top ten “most free” countries • Wall Street Journal and the Heritage Foundation “Index of Economic Freedom”

38. Current status on corporate governance Source: Crisil Report on Corporate Governance

39. Governance and performance • Good governance leads to good performance • It creates an open and transparent system • It improves communication and breaks down systematic barriers to flow of information • Good governance allows decision making based on data. It reduces risk • Good governance helps in creating a brand and creates comfort for all stakeholders and society

40. Does performance depend on governance • Short term performance does not necessarily depend on governance • Market asymmetries are responsible for this. However, this increases risk. This also creates barrier to long term growth • We all know what happened to Enron?

41. Does performance depend on governance • Medium to long term performance requires governance • Most companies which have grown in the last 25 years have outstanding performance and have good governance structure • A good governance structure treats all stakeholders fairly • Governance alone cannot ensure performance

42. Governance and Performance - issues • Is governance a luxury that can be afforded only by the performing companies? • Do strategies and tactics need to change to accommodate governance with performance? • Is there a time-lag between governance and performance? • Are stakeholders concerned about “performance” or “promised performance” ?

43. Governance and Performance measurement - issues • Is governance behavior motivated by legislation? • Do standards vary with jurisdictions or do you adopt the best option? • Do you choose the right thing to do irrespective of whether it’s mandatory or not? • Is performance evaluation limited to valuation metrics? • Is it only ROE, Net margin, growth, shareholder wealth creation? • Do performance measures need to be holistic? • We need to encompass all stakeholders • Governance is an enabler for holistic performance • How do managers better understand governance requirements? • Do we need market research for governance requirements?

44. Investing in Corporate Governance • Companies need to invest in good governance • Corporate governance has a direct bearing on business performance and thereby ROI • Leverage the power of IT • On average, businesses with superior governance practices generate 20 percent greater profits than other companies • Astudy based on 256 companies conducted at the MIT Sloan School of Management

45. Some Closing Thoughts • Minimise Conflict of Interest Potential • Respect Minority / External Shareholders’ Rights (Listed Public Sector Banks) • Bank Boards to Go That Extra Mile: Go Beyond What is Prescribed to What is Appropriate – That Way lies Greater Valuations & Better Reputations

46. Some Closing Thoughts • Right-Size the Board and its Composition • Complementary Skill-Sets & Financial Acumen Essential • Fit & Proper Criteria for Membership • More Focus on Oversight, Less on Micro-Management • Contribution as Important as Surveillance

47. Thanks for Your Attention