Unit 1

Corporate governance Meaning

Corporate governance is the system of rules, practices, and processes by which a company is
directed and controlled. Corporate Governance refers to the way in which companies are
governed and to what purpose. It identifies who has power and accountability, and who
makes decisions.

It is, in essence, a toolkit that enables management and the board to deal more effectively
with the challenges of running a company. Corporate governance ensures that businesses
have appropriate decision-making processes and controls in place so that the interests of all
stakeholders (shareholders, employees, suppliers, customers, and the community) are
balanced.

Governance at a corporate level includes the processes through which a company’s objectives
are set and pursued in the context of the social, regulatory, and market environment. It is
concerned with practices and procedures for trying to make sure that a company is run in
such a way that it achieves its objectives while ensuring that stakeholders can have
confidence that their trust in that company is well founded.

As the home of good governance, the Institute believes that good governance is important as
it provides the infrastructure to improve the quality of the decisions made by those who
manage businesses. Good quality, ethical decision-making builds sustainable businesses and
enables them to create long-term value more effectively.

Nature of CG

1. Corporate governance is based on the principle that a business is accountable to its

stakeholders for its actions.
2. Corporate governance highlights the importance of ethics and social responsibility in
the management of a business.
3. It’s a framework of rules and practices by which the board of directors of a company
ensures accountability, fairness, and transparency in its relationship with all the
stakeholders.
4. Corporate governance is a set of processes, practices, policies, and laws affecting the
way a business is directed, managed, or controlled.
5. Corporate governance considers shareholders as the true owners of a company with
unchallengeable rights.
6. Corporate governance is about commitment to values and business conduct.
7. It makes a distinction between personal and corporate funds in the management of a
company.
8. Corporate governance defines relationships between a company's management, its
board, shareholders, and other stakeholders.
9. The role of corporate governance is setting the right goals, selecting ting paths,
making the right decisions, and doing the right actions so as to ensure honesty and
fairness in business operations.
The Principles of Corporate Governance

While there can be as many principles as a company believes make sense, some of the more
well-known include the following.

Fairness
The board of directors must treat shareholders, employees, vendors, and communities fairly
and with equal consideration.

Transparency
The board should provide timely, accurate, and clear information about such things as
financial performance, conflicts of interest, and risks to shareholders and other stakeholders.

Risk Management
The board and management must determine risks of all kinds and how best to control them.
They must act on those recommendations to manage them. They must inform all relevant
parties about the existence and status of risks.

Responsibility
The board is responsible for the oversight of corporate matters and management activities. It
must be aware of and support the successful, ongoing performance of the company. Part of
its responsibility is to recruit and hire a CEO. It must act in the best interests of a company
and its investors.

Accountability
The board must explain the purpose of a company's activities and the results of its conduct.
It and company leadership are accountable for the assessment of a company's capacity,
potential, and performance. It must communicate issues of importance to shareholders.

Evolution of corporate governance

Corporate governance best practices around the world have evolved considerably over the
last two decades. This has been driven by a combination of both bottom-up and top-down
initiatives. One notable outcome of both drivers is the ascendancy of corporate social
responsibility (CSR) as a business priority.

The evolution of corporate governance

High-quality corporate governance manifests in such financial measures as return on invested

capital (ROIC) as well as high levels of trust among stakeholders. In contrast, weak corporate
governance often translates into poor financial measures over time. When capital allocation
or strategy deviates from good corporate governance practice, investors can provide feedback
via proxy voting or through direct conversations with management.

Over the past decade, best-in-class governance has increasingly included a focus on
environmental and social issues, particularly on greater sustainability. At the same time,
corporate disclosure has steadily improved since the 2000 launch of the Global Reporting
Initiative. More recently, the International Reporting Initiative and the US-based
Sustainability Accounting Standards Board have helped advance sector-specific reporting and
its relevance for investors. The ability to measure and track governance best practices is also
key to identifying companies with strong CSR credentials. Similarly, such measurements
could help avoid CSR-related disasters by enabling investors and the public to put pressure
on management to improve their practices. While hindsight is always 20/20, one might
wonder if past environmental disasters could have been avoided if we would have had the
data availability and ESG accountability then as we do today.

This evolution in corporate governance behaviour tends to be driven by a combination of

bottom-up and top-down driven initiatives. On the former, increased globalisation was
instrumental in widening the scope of CSR in the 1990s, when the foundation was laid for
how we understand CSR today. A wide array of international events and agreements also
took place then, namely the adoption of Agenda 21, the United Nations Framework
Convention on Climate Change and the Kyoto Protocol. These initiatives elevated CSR up
the agendas of multinational corporate leadership and made businesses consider their broader
impact beyond profitability. The scope of CSR has since broadened. Today, many companies
design their CSR programmes around the UN’s 17 Sustainable Development Goals (adopted
in 2015), which range from gender equality to protection of ocean life. CSR is also
increasingly related to promoting diversity, equity, and inclusion initiatives, as socially
responsible corporations should foster a welcoming work environment and combat
discrimination.
Bottom-up driven corporate governance initiatives
Initially, many institutional investors were reluctant to embrace the environmental, social and
governance (ESG) concept, arguing that their fiduciary duty was limited to maximising
shareholder value. Indeed, such arguments are still being made by some even today. But as
evidence grows that ESG issues have financial implications, the tide has shifted. One
example of a bottom-up driven initiative is that of Unilever’s former CEO, Paul Polman,
under whose leadership the company adopted the goal of decoupling its environmental
impact from its growth. A Sustainable Living Plan was implemented to move Unilever
towards more planet-friendly growth, including shifting to 100% renewable energy,
substantially reducing plastic waste and water use, ridding deforestation from its supply chain
and pressing world leaders to adopt the Paris climate accord. Investors did not always
welcome such directives. But when Kraft Heinz, one of the worst-ranked companies for
commitment to sustainability, made a hostile takeover bid for Unilever in 2017, Unilever’s
management successfully used every tool in their possession to fend it off. Since then, Kraft
Heinz’s stock has underperformed Unilever’s by 60%, in a sharp divergence of financial fate
between the two consumer staples companies.
A top-down initiative case study: The Italian and European experience of diversity on
the executive board
For generations, Italy lagged behind the majority of its EU neighbours on promoting gender
diversity in the workplace, for which it paid both social and economic costs. In civil rights
leader Jesse Jackson’s words, “Inclusion is not a matter of political correctness. It is the key
to growth.” Awakening to the implications of this reality, the Italian government moved to
mandate gender diversity in the boardroom in 2011.
Italy’s Gender Parity (Golfo Mosca) Law imposed the gradual adoption of a gender diversity
quota among its publicly-listed companies. The law initially required quotas for three
consecutive board renewal terms, with a 20% quota for the underrepresented gender for the
first renewal and 33% for the second and third ones. Expanding upon this, a new law
extending the period to six consecutive renewals to ultimately raise the quota to 40% for the
less represented gender came into force in October 2020.
These measures moved Italy to the more stringent end of the European spectrum of diversity
policies. Eight[2] EU countries have adopted national mandatory gender quotas for listed
companies, while 10[3] have taken a softer approach, using a range of measures and
initiatives. That leaves nine[4] EU countries that have yet to take any substantial action on
facilitating board-level gender diversity.

Need of CG

Need for Corporate Governance

The need for corporate governance was felt because of the increasing non-compliance of the
standards related to the financial reporting and accountability by the board of directors and
management which in turn was the reason of the huge losses to the investors of the company.

Not only in India, but companies around the world were not complying with the standards of
the financial reporting and the fallout of companies like Enron in US and Satyam in India
lead to the emergence and need of corporate governance in India for an enterprise. As it was
said that these companies fall out because of having bad corporate governance policies or
framework and because of the corrupt practices followed by the board of directors and the
management of the said companies and their financial consulting firms.

The fall out of big companies like them was enough to bring about the importance and need
of the corporate governance which is supposed to draw a distinction between the powers of
the management and the board of directors which will set a direction for company to work in
a good governance structure which is the main objective of corporate governance. The need
for corporate governance was also felt to have appropriate and adequate governance
processes and procedures. These processes and procedures of the good governance structure
lay down that management should be free to manage the affairs of the company and board of
directors should be free to monitor and give directions.

The need of corporate governance is also felt as it provides for the better financial strength of
a company by maintaining a competitive environment which further provides for the financial
growth of a company and increased improvement in the accountability system which results
in risk mitigation substantially. Corporate governance policy laid great emphasis on the
transparency and disclosure in the company and provide that if there is transparency in an
organization and if an adequate framework of corporate governance is adopted by the
company then it will minimize the risk of the happening of scams which have been witnessed
by the corporates in the past.

Corporate governance provides for preparing a code of conduct for an organization which
will help the company in showcasing the commitment of the company to work ethically on
the ethical stance and to maintains a good image in market both domestic and global market.

For having good corporate governance in India the Companies Act, 2013 has mandated the
companies to form the following committees to look after the working and managing the
affairs of company -

 Audit Committee,
 Nomination and Remuneration Committee,
 Stakeholder Relationship Committee, and
 Corporate Social Responsibility Committee.
In India, the need for corporate governance was felt by Securities and Exchange Board of
India (SEBI) as there are various benefits of corporate governance and for this purpose
several committees .

Objective of corporate governance

1. To create social responsibility.
2. To create a transparent working system.
3. To create a management accountable of corporate functioning.
4. To protect and promote the interest of shareholders
5. To develop an efficient organization culture
6. To aid in achieving social and economic goals.
7. To improve social cohesion.
8. To minimise wastages, corruption, red-tapaism etc.

Corporate Governance Models

Corporate form of business is generally managed by the Board of Directors and the board
members are elected by shareholders. The board in turn appoints the professional managers to
manage the business. Different countries have different regulations and corporate governance
models differ based on these differences.

The Corporate governance models are broadly classified into following categories:

1. Anglo-American Model
2. The German Model
3. The Japanese Model
4. Social Control Model

Anglo-American Model

Under the Anglo-American Model of corporate governance, the shareholder rights are
recognised and given importance. They have the right to elect all the members of the Board
and the Board directs the management of the company. Some of the features of this model
are:

 This is shareholder oriented model. It is also called Anglo-Saxon approach to

corporate governance being the basis of corporate governance in Britain, Canada,
America, Australia and Common Wealth Countries including India
 Directors are rarely independent of management
 Companies are run by professional managers who have negligible ownership stake.
There is clear separation of ownership and management.
 Institution investors like banks and mutual funds are portfolio investors. When they
are not satisfied with the company’s performance they simple sell their shares in
market and quit.
 The disclosure norms are comprehensive and rules against the insider trading are tight
 The small investors are protected and large investors are discouraged to take active
role in corporate governance.
German Model

This is also called European Model. It is believed that workers are one of the key
stakeholders in the company and they should have the right to participate in the management
of the company. The corporate governance is carried out through two boards, therefore it is
also known as two-tier board model. These two boards are:

1. Supervisory Board: The shareholders elect the members of Supervisory Board.

Employees also elect their representative for Supervisory Board which are generally
one-third or half of the Board.
2. Board of Management or Management Board: The Supervisory Board appoints
and monitors the Management Board. The Supervisory Board has the right to dismiss
the Management Board and re-constitute the same.

Japanese Model

Japanese companies raise significant part of capital through banking and other financial
institutions. Since the banks and other institutions stakes are very high in businesses, they
also work closely with the management of the company. The shareholders and main banks
together appoint the Board of Directors and the President. In this model, along with the
shareholders, the interest of lenders is recognised.

Social Control Model

Social Control Model of corporate governance argues for full-fledged stakeholder

representation in the board. According to this model, creation of Stakeholders Board over and
above the shareholders determined Board of Directors would improve the internal control
systems of the corporate governance. The Stakeholders Board consists of representation from
shareholders, employees, major consumers, major suppliers, lenders etc.

Indian Model

In India there are mainly three types of companies’ viz. private companies, public companies
and public sector undertakings. Each of these companies has distinct kind of shareholding
pattern. Thus the corporate governance model in India is a mix of Anglo-American and
German Models.

The Consequences of Misgovernance,

The act of governing a country badly, or the state of being badly governed: A decade of
misgovernment has bankrupted the country. Misgovernment is an argument for more, not
less, local accountability.

The conflict leading to lapses in corporate governance arises because of two different
stakeholders in a company — principal and agent. The steering group, that is the top
management, is the agent responsible for taking the company forward and for its day to day
activities to achieve its objectives.
"While the selling of shares (by the promoters) is not per se a problem, repeated and
consistent selling of shares year after year (by the promoter group) is a sign that something is
wrong with the company," notes Deuskar. Also, the non-payment of taxes and dividends are
examples of corporate misgovernance

A company may have the best corporate governance policies, but slippages (in corporate
governance) they face is in terms of effective and robust execution of the same and that is
where the drag begins,"

Corporate 'Misgovernance'

One would have expected that South Africa as one of the countries in the forefront of
developing leading corporate governance guidelines, we would be a global example or
authority on the subject. Recent developments where shareholders value has been wiped-off
clearly demonstrates that proper governance is not a nice to have feature of company boards,
but an integral part of board fulfillment of its duties. Some of the underlying causes of poor
board performance might be lack of diversity and the dominant system of board
appointments, wherein current members nominate new members within their circles.

The effective role of independent non-executive board members also raises a lot of questions,
such as what mechanisms do they put in place to effectively analyse company performance
during the quarterly meetings, and what competencies and capabilities do the non-executive
directors possess that will enable them to effectively scrutinize the executive management
reports. The same also applies to the Board Sub-committees as they play a crucial functional
role in support of the Board objectives.

Corporate governance related to sustainability

Implementing sustainability can be done in several different ways, but if a company wants to
achieve truesustainability – it requires pertaining to all three pillars of sustainable
development: economic, environmental, and social sustainability. Creating a company
dedicated to all three pillars is no easy task – as it requires equal dedication from staff,
employees, and the surrounding community to be sustainable in all areas.
For instance, a company looking to achieve social sustainability must be dedicated to
improving their Human Resource department as well as improving upon the environmental
health and safety of the company in order to ensure a viable working environment for their
employees. It is difficult to ensure both safe, fair working conditions while also remaining as
a financially lucrative business. Corporate governance can help provide companies with the
guidelines necessary to successfully and simultaneously implement all three pillars of
sustainability.
Another example is with economic sustainability. In order to achieve economic sustainability,
companies must shift their priorities and strive to use renewable resources to ensure their
product or service is still relative and viable for the future. For instance, let’s say a reusable
water bottle company makes use of non-recyclable plastics to manufacture their reusable
water bottles. While their product is beneficial in preventing people from purchasing and
throwing away single use plastic water bottles – their individual use of plastic is still bad for
the environment as it contributes to excessive greenhouse gasses. It is imperative that
companies find ways to make use of eco-friendly resources for the sake of finances and
future mass production for their company – demonstrating how one pillar of sustainability is
hard to uphold without the help of another pillar.

This is precisely why corporate governance is linked with sustainability. Corporate

governance provides guidelines for not just one pillar of sustainability, but all three – and all
three pillars of sustainability are more successful when each pillar of sustainability is
functioning at their utmost potential. If economic sustainability is thriving, odds are
environmental sustainability and social sustainability are as well.

Think of corporate governance like a comprehensive study guide for a final exam. Instead of
going through each individual old quiz, test, or homework assignment – the study guide
comprehensively allows a company to receive all of the guidance necessary to excel in
achieving all three pillars of sustainability.

Therefore, corporate governance is important for companies that want to achieve

sustainability.