Corporate Governance &

Ethics
Peculiar nature of corporations..
• A corporation is essentially defined in terms of legal status and the
ownership of assets
• Corporations are typically regarded as ‘artificial persons’ in the eyes of the
law
• Corporations are notionally ‘owned’ by shareholders, but exist
independently of them
• Managers and directors have a ‘fiduciary’ responsibility to protect the
investment of shareholders
• Corporations enjoy all the ‘rights’ of citizens and have to obey legal duties
• Artificial nature of firms raises questions of morality and moral duties
Artificial Nature Can/Should a Corporation
of Corporations have Moral/Social
Responsibilities?

Disconnect
between How must Corporations be
Ownership & governed?
Control
How does a corporate function?
Who runs it?
Functioning of a Corporate:
A principal-agent relation

Seeks profits, rising share price, etc.

Principal: Agent:

Shareholder Seeks remuneration, power, esteem etc. Manager

Key challenges in principal-agent relations

1. Informational asymmetry
2. Separation of ownership and control
3. Conflict of interests
4. Trust Issues
Rights for shareholders
• Right to vote in the general meetings
• Right to certain information about the company
• Right to sell their stock
• Certain residual rights in case of the corporation’s
liquidation
Shareholders don’t have a guaranteed right to certain amount of profits or
dividend – It depends on the skill and effort of the management and
subject to decision by other shareholders
How can shareholders control their own
business?
 Functioning of a Corporate:
A principal-agent relation

Seeks profits, rising share price, etc.

Principal: Agent:

Shareholder Seeks remuneration, power, esteem etc. Manager

Own the Appointed by
company, do and reporting
not run it to BOD

Elected by and
reporting to
shareholders
Board of
Directors
These three principal players are collectively
expected to ensure good governance of a
corporate entity
 Key goals that good corporate
governance aims to achieve
• Protection of individual and collective interests of all
stakeholders
• Distribution of responsibility among various members of the
CG structure
• Executive Accountability, Control and Remuneration
• Disclosure of Information
• Creation of safeguards against ethically questionable practices
by ‘insiders’ (both managers and controlling shareholders)
• Checks and Balances in the role of external parties such as
financial intermediaries, auditors, credit rating agencies
 MODELS OF CORPORATE GOVERNANCE

• Corporate governance systems vary around the world.

•There is no model of corporate governance which is universally

acceptable as each model has its own advantages and disadvantages.

• Three Main Models are recognized as references by experts in

Corporate Governance:
•Anglo American Model
•German Model
•Japanese Model
The-Anglo American Model
Elect
Board of Directors
Shareholders
(Supervisor)

Appoints and
supervises

Officers
Own (Manager)

Manage

Act as a
balancing Monitors &
force regulates
Creditors Regulatory/Legal
system
Company
 Anglo-American Model

• This model is also called an ‘Anglo-Saxon model’ and is used as basis of

corporate governance in U.S.A, U.K, Canada, Australia, and some common
wealth countries.

• The shareholders appoint directors who in turn appoint the managers to manage
the business. There is separation of ownership and control.

• The board usually consist of executive directors and a few independent

directors. The board often has limited ownership stakes in the company. A single
individual usually (not always) holds both the position of CEO and chairman of
the board.

•This system (model) relies on effective communication between shareholders,

board and management with all important decisions taken after getting approval
of shareholders (by voting).
The German Model
Appoint -50% Appoint 50%
Supervisory Board

Appoints and
supervises

Employees and Shareholders

Labour unions Management Board

Manages

Work for Company Own

 German Model

• This is also called as 2 tier board model as there are 2 boards viz.
The supervisory board and the management board. It is used in
countries like Germany, Holland, France, etc.

• Usually a large majority of shareholders are banks and financial

institutions. The shareholder can appoint only 50% of members to
constitute the supervisory board. The rest is appointed by employees
and labour unions.
The Japanese Model
Monitors and acts in
emergencies
Supervisory Board
Appoint (including President) Provides
members
Ratifies the President’s decision

President

Consults Main bank

Shareholders
Executive Management
(Primarily Board of
Directors)
Manages
Provides Loan
Own
Company
Owns
 Japanese Model
• This model is also called as the business network model, usually
shareholders are banks/financial institutions, large family shareholders and
corporates with cross-shareholding.

• There is supervisory board which is made up of board of directors and a

president, who are jointly appointed by shareholder and banks/financial
institutions.

•This is reflection of the Japanese ‘keiretsu’- a form of cultural relationship

among family controlled corporate and groups of complex interlocking
business relationship, where cross shareholding is common.

•Most of the directors are heads of different divisions of the company. Outside
director or independent directors are rarely found on the board.
Evolution of Corporate Governance
Guidelines/Codes
Milestones in evolution of CG Codes
Year Name of Areas/Aspects Covered
Committee/Body
1992 Sir Adrian Cadbury Financial Aspects of Corporate Governance
Committee, UK
1994 Mervyn E . King’s Committee Corporate Governance
, South Africa
1995 Greenbury Committee , UK Directors’ Remuneration
1998 Hampel Committee, UK Combine Code of Best Practices
1999 Blue Ribbon Committee, US Improving the Effectiveness of Corporate Audit
Committees
1999 OECD Principles of Corporate Governance
1999 CACG Principles for Corporate Governance in
Commonwealth
2002 Derek Higgs Committee, UK Review of role of effectiveness of Non-executive
Directors
2002 Sarbanes Oxley Act, United Corporate Auditing Accountability and
States Responsibility
Cadbury Committee
• Commissioned by FRC, UK
• Chaired by Sir Adrian Cadbury
• Reviewed CG with specific reference to:
• responsibilities of directors
• nature of accounting information required
• audit committees
• relationship between owners, boards and auditors, etc.
Key Cadbury Committee Recommendations

• Board:
• Importance of efficient board emphasised
• Separation of CEO and Chairman
• Executive Directors
• Caps on duration of service contracts
• Disclosure of remuneration
• Non-Executive Directors
• Need for greater role
• Importance of independence
• Reporting and Controls:
• Responsibility of board in relation to accounts
• Importance of supplementary narrative info.
• Audit Committee
• Need for liaising with auditor
• Inclusion of non-executive directors
OECD Guidelines on CG
• OECD is an organization of 34 member countries, founded in 1961
to stimulate economic progress and world trade.
• Enormous variations exist in ownership and control structures
across the world
• OECD principles for Corporate Governance is aimed at providing a
uniform framework for member countries to follow
• Individual member countries are to adopt these principles and
form their own codes/legislations/best practices
• First released 1999 and subsequently revised in 2004 and 2015
Core Elements of the OECD Principles
• Chapter I: Ensuring the basis for an effective corporate
governance framework
• The corporate governance framework should promote transparent and efficient
markets, be consistent with the rule of law and clearly articulate the division of
responsibilities among different supervisory, regulatory and enforcement
authorities

• Chapter II: Basic rights of shareholders and key ownership

functions
• The corporate governance framework should protect and facilitate the exercise of
shareholders’ rights

• Chapter III: Equitable treatment of shareholders

• The corporate governance framework should ensure the equitable treatment of all
shareholders, including minority and foreign shareholders. All shareholders should
have the opportunity to obtain effective redress for violation of their rights.
The OECD Principles (continued)
• Chapter IV: Role of stakeholders in corporate governance
• The corporate governance framework should recognise the rights of stakeholders
established by law or through mutual agreements and encourage active co-
operation between corporations and stakeholders in creating wealth, jobs, and the
sustainability of financially sound enterprises.

• Chapter V: Disclosure and transparency

• The corporate governance framework should ensure that timely and accurate
disclosure is made on all material matters regarding the corporation, including the
financial situation, performance, ownership, and governance of the company.

• Chapter VI: Board responsibilities

• The corporate governance framework should ensure the strategic guidance of the
company, the effective monitoring of management by the board, and the board’s
accountability to the company and the shareholders.
 Sarbane Oaxley Act 2002
• Initiated and sponsored in US by congressmen Paul Sarbanes &
Michael Oxley

• Also known as Public Company Accounting Reform and

Investor Protection Act. (Often referred to as Sarbox or SOX)
• Enacted in the backdrop of a number of corporate collapses and
frauds in late 90s and early 2000 (Enron, Worldcom and others)
• Is a federal law that set new or expanded requirements for all U.S
Public company boards, management and public accounting firms
SARBANES-OXLEY
Major Objectives

• Improve corporate governance

• Reform public accounting (auditing)
• Reform Wall Street practices
• Attack insider trading and obstruction of justice (document
retention)

“Restore confidence in capital markets”

SARBANES-OXLEY ACT
Major Provisions

• Public Company Accounting Oversight Board

• Auditor Independence

• Enhanced Board Responsibilities

• Enhanced Financial Disclosures

Creation of Public Company Accounting
Oversight Board
• Established by Sarbanes-Oxley, ending self regulation
followed by auditing firms
• Broad powers to regulate audits and auditors of public
companies
• Appointed by the SEC
• Oversight authority expended (in 2010) to audits of brokers
and dealers registered with SEC
Role of PCAOB
• Register public accounting firms
• Establish auditing standards
• Inspect registered public accounting firms
• Conduct investigations and disciplinary
proceedings – with ability to sanction
auditors and audit firms
 U.S. Securities
& Exchange
Commission (SEC)

Public Company
Corporate Board
Accounting Oversight
Of Directors
Board (PCAOB)

Independent
Audit Committee CEO & CFO
Audit Firm

Internal Audit
Function

Internal Control
System
Auditor Independence
• Prohibits certain non-audit services
• Bookkeeping, financial systems design, appraisal or valuation, actuarial,
internal auditing outsourcing, management or human resources, broker-dealer
or investment banking, others per PCAOB
• Audit partner rotation (recommended)
• Audit Committee is directly responsible for oversight of
external auditors
• Audit committee must pre-approve all auditing and non-
auditing services
• Cooling – off period before new assignments for CEO, CFO,
Controller, etc.
Enhanced Executive and Board
Responsibilities
• Requires executives and financial officers (CEO & CFO) to certify
financial reports are accurate, complete and fairly presented
• State of internal controls also to be certified
• Audit Committee to include independent directors
• At least one member of the audit committee to be an “Audit
Committee Financial Expert”
• Audit Committee has responsibility to appoint, compensate, and
oversee public accounting firm performing the audit
• Audit Committee has responsibility to resolve disagreements over
financial reporting between management and external auditors
• Audit Committee to establish “whistle-blower” procedures with clear
penalties for any retaliation against them
Enhanced Financial Disclosures

• Off-balance sheet arrangements and obligations to be

disclosed
• Prohibits loans to executives and directors
• Insider trades to be disclosed
• Code of ethics for senior financial officers to be
adopted and status to be disclosed
Sarbane Oaxley Act 2002

• Similar acts enacted across major countries after SOX

• Criticism remains about the cost v/s benefit of SOX
• Many believe it has reduced competitiveness of US firms because
of the overly complex regulatory environment
• In 2012, JOBS (Jumpstart our Business Startups) was passed,
designed to give economic boost to emerging companies by
cutting down on some of the regulations