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Corporate Governance: Precepts and Practices-I
M. A. Alagappan
WHAT IS CORPORATE GOVERNANCE?
In my view, seminars like the one we are participating in are crucial because they help spread the cause of good corporate governance, a cause that I think is very important and very necessary. However, before I get started, I think it is worth examining what corporate governance is. Corporate governance is one of those terms that are delightfully vague. Corporate governance, like beauty, completely depends on the eye of the beholder. What could be good corporate governance to me could be bad or not good enough to you. Corporate governance to me could mean that I have to follow certain rules and laws, whereas to you it could mean that a company should be completely ethical, that is, free of any blemish.
The Organisation for Economic Co-operation and Development (OECD) defines it thus:
Corporate governance involves a set of relationships between a company's management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring. The presence of an effective corporate governance system, within an individual company and across an economy as a whole, helps to provide a degree of confidence that is necessary for the proper functioning of a market economy. As a result, the cost of capital is lower and firms are encouraged to use resources more efficiently, thereby underpinning growth.1
WHY DO WE NEED CORPORATE GOVERNANCE?
I was reading the report on Corporate Governance by the Securities and Exchange Board of India's (SEBI) Committee, headed by Mr Narayana Murthy of Infosys, that was published in 2003, and the first three paragraphs caught my eye. I think they explain very well why we need corporate governance. I am summarizing them below and I would definitely urge you all to read the entire report.2
This report recognizes that a corporation comprises various stakeholders, such as ‘customers, employees, investors, vendors, partners, government and society’, and hence ‘should be fair and transparent to its stakeholders in all its transactions’. In today's globalized business world, corporations need an access to the global pools of capital. They also want ‘to attract and retain the best human capital from various parts of the world’. Besides, they also need to partner with vendors on mega collaborations and need to live in harmony with the community. For all these reasons, fairness and transparency are paramount requirements. To succeed, a corporation must ‘embrace and demonstrate ethical conduct’.
According to this report, ‘corporate governance is about ethical conduct in business’. Ethics help and enable a person to ‘select from alternative courses of action’. The report points to the fact that ‘ethical dilemmas arise from conflicting interests of the parties involved’. When situations such as these arise, managers have to make decisions that are founded upon ‘a set of principles influenced by the values, context and culture of the organization’. The report says quite unequivocally that the ethical leadership creates a positive image of the organization as the expectations of all the stakeholders are considered while making decisions.
One very important observation mentioned in the report is that corporate governance cannot be legislated. It says that ‘corporate governance is beyond the realm of law. It stems from the culture and mindset of management, and cannot be regulated by legislation alone.’ It stresses the point that ‘fairness to all stakeholders’ must be a guiding principle for conducting all the affairs of the company and that all actions must seek to ‘benefit the greatest number of stakeholders’. In this sense, corporate governance is about ‘openness, integrity and accountability’. However, legislation does have a role to play. It must ‘lay down a common framework - the “form” to ensure standards. The “substance” will ultimately determine the credibility and integrity of the process.’ Substance, the report recognizes, will be a reflection of ‘the mindset and ethical standards of management’.
PRINCIPLES OF GOOD CORPORATE GOVERNANCE
In 2003, the Australian Stock Exchange's Corporate Governance Council came out with a report titled ‘Principles of Good Corporate Governance and Best Practice Recommendations’ (see Exhibit 13.1). This is another report that I think all should read. The report listed out ten essential corporate governance principles and I think it would behoove us to go through these 10 principles. Though this may be from an Australian publication, corporate governance principles have no national boundary and have applicability in every country.
PRINCIPLES OF GOOD CORPORATE GOVERNANCE AND BEST PRACTICE RECOMMENDATIONS
Principle 1: Lay solid foundations for management and oversight
Recognise and publish the respective roles and responsibilities of board and management.
The company's framework should be designed to:
- enable the board to provide strategic guidance for the company and effective oversight of management
- clarify the respective roles and responsibilities of board members and senior executives in order to facilitate board and management accountability to both the company and its shareholders
- ensure a balance of authority so that no single individual has unfettered powers.
Principle 2: Structure the board to add value
Have a board of an effective composition, size and commitment to adequately discharge its responsibilities and duties.
An effective board is one that facilitates the efficient discharge of the duties imposed by law on the directors and adds value in the context of the particular company's circumstances. This requires that the board be structured in such a way that it:
- has a proper understanding of, and competence to deal with, the current and emerging issues of the business
- can effectively review and challenge the performance of management and exercise independent judgement.
Ultimately, the directors are elected by the shareholders. However, the board and its delegates play an important role in the selection of candidates for shareholder vote.
Principle 3: Promote ethical and responsible decision-making
Actively promote ethical and responsible decision-making.
The company should:
- clarify the standards of ethical behaviour required of company directors and key executives (that is, officers and employees who have the opportunity to materially influence the integrity, strategy and operation of the business and its financial performance) and encourage the observance of those standards
- publish its position concerning the issue of board and employee trading in company securities and in associated products which operate to limit the economic risk of those securities.
Principle 4: Safeguard integrity in financial reporting
Have a structure to independently verify and safeguard the integrity of the company's financial reporting.
This requires the company to put in place a structure of review and authorisation designed to ensure the truthful and factual presentation of the company's financial position. The structure would include, for example:
- review and consideration of the accounts by the audit committee
- a process to ensure the independence and competence of the company's external auditors.
Such a structure does not diminish the ultimate responsibility of the board to ensure the integrity of the company's financial reporting.
Principle 5: Make timely and balanced disclosure
Promote timely and balanced disclosure of all material matters concerning the company.
This means that the company must put in place mechanisms designed to ensure compliance with the ASX Listing Rule requirements such that:
- all investors have equal and timely access to material information concerning the company - including its financial situation, performance, ownership and governance
- company announcements are factual and presented in a clear and balanced way. “Balance” requires disclosure of both positive and negative information.
Principle 6: Respect the rights of shareholders
Respect the rights of shareholders and facilitate the effective exercise of those rights.
This means that a company should empower its shareholders by:
- communicating effectively with them
- giving them ready access to balanced and understandable information about the company and corporate proposals
- making it easy for them to participate in general meetings.
Principle 7: Recognize and manage risk
Establish a sound system of risk oversight and management and internal control. This system should be designed to:
- identify, assess, monitor and manage risk
- inform investors of material changes to the company's risk profile.
This structure can enhance the environment for identifying and capitalising on opportunities to create value.
Principle 8: Encourage enhanced performance
Fairly review and actively encourage enhanced board and management effectiveness.
This means that directors and key executives13 should be equipped with the knowledge and information they need to discharge their responsibilities effectively, and that individual and collective performance is regularly and fairly reviewed.
Principle 9: Remunerate fairly and responsibly
Ensure that the level and composition of remuneration is sufficient and reasonable and that its relationship to corporate and individual performance is defined.
This means that companies need to adopt remuneration policies that attract and maintain talented and motivated directors and employees so as to encourage enhanced performance of the company. It is important that there be a clear relationship between performance and remuneration, and that the policy underlying executive remuneration be understood by investors.
Principle 10: Recognize the legitimate interests of stakeholders
Recognize legal and other obligations to all legitimate stakeholders.
Companies have a number of legal and other obligations to non-shareholder stakeholders such as employees, clients/customers and the community as a whole. There is growing acceptance of the view that organisations can create value by better managing natural, human, social and other forms of capital. Increasingly, the performance of companies is being scrutinised from a perspective that recognises these other forms of capital. That being the case, it is important for companies to demonstrate their commitment to appropriate corporate practices.
Source: Australian Stock Exchange. Reproduced with permission. © Copyright 2008 ASX Corporate Governance Council Association of Superannuation Funds of Australia Ltd, ACN 002 786 290, Australian Council of Superannuation Investors, Australian Financial Markets Association Limited ACN 119 827 904, Australian Institute of Company Directors ACN 008 484 197, Australian Institute of Superannuation Trustees ACN 123 284 275, Australasian Investor Relations Association Limited ACN 095 554 153, Australian Shareholders’ Association Limited ACN 000 625 669, ASX Limited ABN 98 008 624 691 trading as Australian Securities Exchange, Business Council of Australia ACN 008 483 216, Chartered Secretaries Australia Ltd ACN 008 615 950, CPA Australia Ltd ACN 008 392 452, Financial Services Institute of Australasia ACN 066 027 389, Group of 100 Inc, The Institute of Actuaries of Australia ACN 000 423 656, The Institute of Chartered Accountants in Australia ARBN 084 642 571, The Institute of Internal Auditors—Australia ACN 001 797 557, Investment and Financial Services Association Limited ACN 080 744 163, Law Council of Australia Limited ACN 005 260 622, National Institute of Accountants ACN 004 130 643, Property Council of Australia Limited ACN 008 474 422, Securities & Derivatives Industry Association Limited ACN 089 767 706. All rights reserved 2008.
Corporate Governance in India
Corporate governance in India is still at a fairly nascent stage when compared to countries in the West. However, we are catching up very fast with them.
There have been many committees to examine the issue of corporate governance in India. The three main ones are the Kumar Mangalam Birla Committee, the Naresh Chandra Committee, and the Narayana Murthy Committee.
I won't go through every report here, but I just would like to state the main recommendations of the Naresh Chandra and Narayana Murthy Committees.
Some of the main recommendations of the Naresh Chandra Committee are:
- It recommended a list of disqualifications for audit assignments like direct or indirect relationship with company.
- Audit firms not to provide services such as accounting, internal audit assignments, and the like. To disclose contingent liabilities and highlight significant accounting.
- CEO and CFO to certify on fairness, correctness of annual audited accounts.
- Redefinition of independent directors—should not have any pecuniary relationship with the company.
- Composition of board of directors—more independent directors.
The main recommendations of the Narayana Murthy Committee are:
- Making more stringent the requirements of the CEO and CFO to certify correctness of audited accounts.
- Strengthening the responsibilities of audit committee.
- Improving quality of financial disclosures.
- Utilization of proceeds from initial public offerings (IPOs). Ensure it is used for stated purposes.
- To assess and disclose business risks in a timely manner.
- Formal code of conduct for board. Ensure all rules are transparent.
- Whistle blower policy to be in place in a company.
- Subsidiaries to be reviewed by audit committee of holding company.
Corporate Governance Practices in the Murugappa Group
At the Murugappa Group, we take corporate governance very seriously. I will explain what kind of corporate governance measures we have undertaken in the group. It is from this perspective that the founders of the Murugappa group had started with a basic and simple precept, as quoted above. The guiding philosophy of the group has been that of transacting business using ethical principles and practices, such that no party involved would lose. This has been maintained in every business that the group has entered into.
(i) The Murugappa Corporate Board
I will talk about some of the corporate governance initiatives that we at the Murugappa Group have put in place. The first initiative is the Murugappa Corporate Board or MCB as it is referred to.
- Structured as a non-legal advisory board.
- To mentor businesses in long-term strategic planning and short-term business planning.
- Each business has a mentor director.
- Comprises executive and non-executive members. Executive members include both family and non-family.
- Each executive member has a functional expertise.
- Non-executive members include academics and top business executives.
Originally, the Board consisted of all family members who were running businesses, the presidents of the business groups and the heads of finance and personnel. Over time, in keeping with the need to grow, the MCB was reconstituted to include external directors. The external directors on the MCB are Deepak Satwalekar, Marti Subramanyam, N. S. Raghavan and V. Thyagarajan. The executive chairman of the Board was Mr P. S. Pai, a non-family member, who presided over the Board from 2002 to 2006.
The operational control of all businesses is vested only with professional CEOs. Also, each company has a majority of independent directors on the Board.
(ii) Proactive Compliance of Law
The next governance initiative was the proactive compliance even ahead of Clause 49 becoming law. While our values and beliefs provide the guiding framework for the ethical dimension, on the legal dimension also, we believe in going beyond mere adherence to the law, and imbibing the spirit behind it. The following points indicate some areas in which we have done so, often preceding the legislation.
- Introduction of Audit Committee in 1997 much ahead of the regulatory requirement.
- Constitution of Remuneration and Nomination Committees which is, till date, a non-mandatory one.
- Elaborate disclosure norms followed beyond regulatory norms.
- Adoption of a group insider trading code, which is voluntary.
- Proportion of promoter and non-promoter directors.
- Consolidated quarterly results, again voluntary.
- Rotation of statutory auditors once in three years initiated.
- Finalization of accounts within 30 days from the close of the year.
To address the economic dimension, the group has pioneered and practised measures that ensure that good professional talent is always made available and utilized across all levels in the organization.
(iii) Putting in Place the Whistleblower Policy
As a step further in aligning the three dimensions of ethical, legal and business responsibility, we have recently introduced the Whistleblower Policy, which enables people to report any kind of wrongdoing that is either thrust on them or they are witness to. We also assure safety and immunity to the complain-ant—the whistleblower from any undue harassment triggered by the fact that he/she has complained.
Some of the salient points of the Whistleblower Policy are:
- Adopted by the boards of all companies.
- The policy covers all Murugappa Group companies, associate companies, and joint ventures.
- Its scope extends to
- employees,
- customers,
- suppliers, and
- contractors.
- A person has been appointed at the group level to receive all complaints under this policy and ensure appropriate action.
CORPORATE GOVERNANCE: THE NEW STRATEGIC IMPERATIVE
A white paper by the Economist Intelligence Unit titled ‘Corporate Governance: The New Strategic Imperative, came out with some conclusions on how good governance can come about. I think it is worth our while to go through these conclusions. They are:
Regulations are only one part of the answer to improved governance Corporate governance is about how companies are directed and controlled. The balance sheet is an output of manifold structural and strategic decisions across the entire company, from stock options to risk management structures, from the composition of the board of directors to the decentralization of decision-making powers. As a result, the prime responsibility for good governance must lie within the company rather than outside it.
Designing and implementing corporate governance structures are important, but instilling the right culture is essential Senior managers need to set the agenda in this area, not the least in ensuring that board members feel free to engage in open and meaningful debate. Not all board members need to be finance or risk experts, however. The primary task for the board is to understand and approve both the risk appetite of a particular company at any particular stage in its evolution and the processes that are in place to monitor risk.
There is an inherent tension between innovation and conservatism, governance and growth Asked to evaluate the impact of strict corporate governance policies on their business, 45 per cent of the executives surveyed by the Economist Intelligence Unit for this report thought that mergers and acquisitions (M&A) deals would be negatively affected because of the lengthening of due-diligence procedures, and 36 per cent thought the ability to take swift and effective decisions would be compromised. State-of-the-art corporate governance can bring benefits to companies, to be sure, but also introduces impediments to growth.