corporate governance & social audit

Corporate GovernanceWhat is Governance?

Purpose of corporate governance is to have a demonstrable IMPACT on a corporation’s FINANCIAL PERFORMANCE.

“Corporate Governance is the application of best management practices, Compliance of law in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stakeholders”.

-The Institute of Company Secretaries of India

What is corporate governance?

Corporate Governance is concerned with holding the balance between economic and social goals and between individual and communal goals.

The corporate governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources.

The aim is to align as nearly as possible the interests of individuals, corporations and society

- Sir Adrian Cadbury

• Unlike South-East and East Asia, the corporate governance initiative in India was not triggered by any serious nationwide financial, banking and economic collapse

• The initiative in India was initially driven by an industry association, the Confederation of Indian Industry

– In December 1995, CII set up a task force to design a voluntary code of corporate governance. The final draft of this code was widely circulated in 1997.

– In April 1998, the code was released. It was called Desirable Corporate Governance: A Code.

– Between 1998 and 2000, over 25 leading companies voluntarily followed the code: Bajaj Auto, Hindalco, Infosys, Dr. Reddy’s Laboratories, Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI, etc.

Brief history of corporate governance in India

• Following CII and SEBI, the Department of Company Affairs (DCA) modified the Companies Act, 1956 to incorporate specific corporate governance provisions regarding independent directors and audit committees.

• In 2001-02, certain accounting standards were modified to further improve financial disclosures. These were:– Disclosure of related party transactions.– Disclosure of segment income: revenues, profits and capital

employed.– Deferred tax liabilities or assets. – Consolidation of accounts.

• Initiatives are being taken to (i) account for ESOPs (employee share ownership plan), (ii) further increase disclosures, and (iii) put in place systems that can further strengthen auditors’ independence.

Brief history of corporate governance in India

Driving Forces of CG in India

1) Unethical Business Practices– Security Scams ---Harshad Mehtha Security Scam– Misdeed of Companies

2) Impact of Globalization– Integration with Foreign Market– Foreign Investors expectations– New Business Opportunities --- IT & ITES, BPO etc.,– New Capital formation – FII, FDI

3) Impact of Privatisation – New structure of ownership– Multinational Companies

Fundamental Objective of Corporate Governance

• Enhancement of Shareholder Value, keeping in view the Interests of other Stakeholders

• Corporate Governance a Way of Life rather than a Code

• Good corporate governance involves a commitment of a company to run its businesses in a legal, ethical and transparent manner – a dedication that must come from the very top and permeate throughout the organization.

Clause 49 of Listing Agreement on Corporate Governance

• Deals with corporate governance norms that a listed entity should follow

• First introduced in the financial year 2000-01 based on the recommendations of Kumar Mangalam Birla committee

• In order to evaluate the existing practices and to further improve the existing practices, SEBI set up a committee under the Chairmanship of Mr Narayana Murthy during 2002-03

• Organisational framework for corporate governance initiatives in India consists of the Ministry of Corporate Affairs(MCA) and the Securities and Exchange Board of India(SEBI)

• Most of the CII code was subsequently incorporated in Clause 49

CII Task Force Report

• Task force of CII under the Chairmanship of Shri Naresh Chandra published code of corporate governance for voluntary adoption by all listed companies and its wholly owned subsidiaries.

• Major aspects of the guidelines are:1. Board of Directors2. Responsibilities of the Board3. Audit Committee of the Board4. Auditors5. Secretarial Audit6. Institution of Mechanism for Whistle Blowing

Board of Directors - Appointment of Directors

Appointments to the Board– companies should issue formal letters of appointment to the Non-

Executive Directors(ED) and Independent Directors(ID) which shall specify their terms of appointment, duties, remuneration, etc.

– Such formal letter should form part of disclosure to the shareholders at the time of ratification of his/her appointment and/or re-appointment.

Separation of offices of Chairman and Chief Executive Officer– To prevent unfettered decision making power with a single

individual, there should be a clear demarcation of the roles and responsibilities of the Chairman of the Board and that of the Managing Director(MD)/ Chief Executive Officer(CEO).

Board of Directors - Appointment of Directors

Nomination Committee– Companies may have a nomination committee comprising of majority of

Independent Directors, including its Chairman for considering proposals for searching, evaluating and recommending appropriate ID, ED and NEDs.

– Nomination committee should ensure that the Board comprises of a balanced combination of ED and NED.

– Annual Report should disclose the guidelines being followed by the Nomination Committee and the role and work done during the year under consideration.

Number of companies in which an individual may become a Director– Maximum number of companies where a MD of a company can serve as

NED or ID should be restricted to seven.

Board of Directors - Independent Directors ID to have the option and freedom to meet Company Management periodically

Attributes for Independent Directors– Board should put in place a policy for attributes of such as integrity, expertise,

foresight, ability to understand financial statements.– All ID should provide a certificate of independence at the time of their

appointment, and thereafter annually.– This certificate should be displayed on the website of the company and in case of

listed company, also on the website of the stock exchange where the securities of the company are listed.

Tenure for Independent Director– Is not more than six years.– A gap of three years between two successive appointments.– Only three such tenures for one company.

Board of Directors – Remuneration to Directors

Remuneration– Guiding principles – linking corporate and individual performance– Companies should have an option of giving a fixed contractual

remuneration to NEDs, not linked with profits, which should be uniform for all NEDs.

– Companies may structure the remuneration to NEDs into fixed, variable and additional variable component.

– Adequate sitting fees to be paid to ID which may depend upon twin criteria of net worth and turnover of companies.

Board of Directors – Remuneration to Directors

Remuneration committee– Should comprise of at least 3 members, majority of whom should be

NEDs with at least one being an ID.– Responsibility to determine the remuneration for all EDs and the

Executive Chairman.– Should also determine principles, criteria and the basis of

remuneration policy of the company which should be disclosed to shareholders.

– Should also recommend and monitor the level and structure of pay for senior management.

– Terms of reference, role, authority delegated to the Committee by the Board, and work of Committee for the year under review shall be disclosed in the Annual Report.

Responsibilities of the Board

Training of Directors

Enabling quality decision making

Risk Management

Evaluation of performance of Board of Directors, Committees thereof and of Individual Directors

Board to place Systems to ensure compliance with laws

Audit Committee of the Board

Constitution• Three-member Audit Committee, with IDs constituting the majority.• Chairman of such a Committee should be an ID.

Enabling powers• Independent back office support and other resources from the company.• Access to information contained in the records of the company.• Obtain professional advice from external sources.• Facility of separate discussions with both internal and external auditors

as well as management.

Audit Committee of the Board

Role and responsibilities• Monitor the integrity of the financial statements of the company• Review the company’s internal financial controls, internal audit function

and risk management systems.• Make recommendations in relation to the appointment, reappointment

and removal of the external auditor and to approve the remuneration and terms of engagement of the external auditor.

• Monitor and approve all related party transactions.

Auditors

Appointment of auditors• Audit Committee of the Board should be the first point of reference regarding the

appointment of auditors.• Audit Committee should consider the profile of the audit firm, qualifications and

experience of audit partners, strengths and weaknesses, if any, of the audit firm and other related aspects.

• Audit Committee should discuss the audit plan to be undertaken by the auditor, with the auditor; examine and review the certificate of proof of independence of the audit firm, and recommend to the Board, with reasons, either the appointment/re-appointment or removal of the statutory auditor, along with annual audit remuneration.

Certificate of Independence• Every company should obtain a certificate from the auditor certifying his/its

independence and arm’s length relationship with the client company.

Auditors

Rotation of Audit partners and firms• To maintain independence of auditors, the company must adopt a policy

of rotation of auditors in the following manner:– audit partner – to be rotated once every three years– Audit firm – to be rotated once every five years

• A cooling period between two audit assignment.

Need for clarity on information to be sought by auditor and/or provided by the company to him/it

Appointment of internal auditor• Board may appoint an internal auditor and such auditor, where appointed,

should not be an employee of the company.

Secretarial Audit

To ensure that the Board processes and compliance mechanisms of the company are robust, the companies may get the Secretarial Audit conducted by a competent professional.

Board should give its comments on the Secretarial Audit in its report to the shareholders.

Institution of Mechanism for Whistle Blowing

Companies should ensure the institution of mechanism for employees to report concerns about unethical behavior, actual or suspected fraud, or violation of the company’s code of conduct or ethics policy.

Companies should also provide for adequate safeguards against victimization of employees who avail of the mechanism

Board of Directors: frequency of meetings and composition

• Board must meet at least four times a year, with a maximum time gap of four months between two successive meetings.

• If the chairman of the Company is a non-executive then one-third of the board should consist of independent directors, and 50% otherwise.

• ‘Independent’ defined as those directors who, apart from receiving director’s remuneration do not have any other monetary relationship or transactions with the company, its promoters, management or subsidiaries, which in the view of the board may affect independence of judgment.

Mandated CG guidelines and disclosures

Board of Directors: frequency of meetings and composition

• The frequency of board meetings and board committee meetings, with their dates, must be fully disclosed to shareholders in the annual report of the company.

• The attendance record of all directors in board meetings and board committee meetings must be fully disclosed to shareholders in the annual report of the company.

• Full and detailed remuneration of each director (salary, sitting fees, commissions, stock options and perquisites) must be fully disclosed to shareholders in the annual report of the company.

• Loans given to executive directors are capped (no loans permitted to non-executives), and must be fully disclosed to shareholders in the annual report of the company.


Board of Directors: information that must be supplied

• Annual, quarter, half year operating plans, budgets and updates.• Quarterly results of company and its business segments.• Minutes of the audit committee and other board committees.• Recruitment and remuneration of senior officers.• Materially important legal notices and claims, as well as any accidents,

hazards, pollution issues and labor problems.• Any actual or expected default in financial obligations.• Details of joint ventures and collaborations.• Transactions involving payment towards goodwill, brand equity and

intellectual property.• Any materially significant sale of business and investments.• Foreign currency and other risks and risk management.• Any regulatory non-compliance.


Board of Directors: Audit Committee

• Audit Committee is mandatory. Must have minimum of three members, all non-executive directors, the majority of whom are independent.

• Chairman must be an independent director, and must be present at the annual shareholders’ meeting to answer audit or finance related questions.

• At least one member must be an expert in finance/accounts.

• Must have at least three meetings per year, including one before finalisation of annual accounts.

• Must meet with statutory auditors and internal auditors; have the powers to seek any financial, legal or operational information from the management; obtain outside legal or professional advice.


Board of Directors: Audit Committee functions

• Adequacy of internal audit and internal control systems, through discussion with internal and statutory auditors as well as management.

• Significant findings, follow-up and action taken reports.

• Discussion with internal and statutory auditors about scope and design of audits.

• Reviewing financial and legal risks and company’s risk management policies.

• Examining reasons behind any materially significant default to creditors, bond-holders, suppliers and shareholders.


Disclosures to shareholders in addition to balance sheet, P&Land cash flow statement

• Board composition (executive, non-exec, independent).

• Qualifications and experience of directors.

• Number of outside directorships held by each director (capped at director not being a member of more than 10 board-level committees, and Chairman of not more than 5).

• Attendance record of directors.

• Remuneration of directors.

• Relationship (familial or pecuniary) with other directors.

• Warning against insider trading, with procedures to prevent such acts.

• Details of grievances of shareholders, and how quickly these were addressed.

• Date, time and venue of annual general meeting of shareholders.


Disclosures to shareholders in addition to balance sheet, P&L and cash flow statement

• Dates of book closure and dividend payment.

• Details of shareholding pattern.

• Name, address and contact details of registrars and/or share transfer agents.

• Details about the share transfer system.

• Stock price data over the reporting year, and how the company’s stock measured up to the index.

• Financial effects of stock options.

• Financial effects of any share buyback.

• Financial effects of any warrants that are to be exercised.

• Chapter reporting corporate governance practices


Disclosures to shareholders in addition to balance sheet, P&L andcash flow statement

• Detailed chapter on Management Discussion and Analysis focusing on markets, operations, finances, accounts, risks, opportunities and threats, internal control systems.

• Consolidated financial statement, incorporating accounts of all subsidiaries (over 50% shares held by reporting company).

• Details of all significant related party transactions.

• Detailed segment reporting (revenues, costs, operating profits and capital employed).

• Deferred tax liabilities and assets and debit/credit in the P&L for the reporting year


Summary

• Indian corporate governance system has both supported and held back India’s ascent to the top ranks of the world’s economies.

• While on paper the country’s legal system provides some of the best investor protection in the world, enforcement is a major problem with slow, over-burdened courts and significant corruption.

• Ownership remains concentrated and family business groups continue to be the dominant business model.

• Securities and Exchanges Board of India has a rigorous regulatory regime to ensure fairness, transparency and good practice.

corporate governance & social audit

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