Role of Ethics in Corporate Governance

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Role of Ethics in Corporate Governance
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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

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What is corporate governance? Contd

• The primary purpose of corporate leadership is to
  create wealth legally and ethically.
• This translates to bringing a high level of
  satisfaction to five constituencies -- customers,
  employees, investors, vendors and the
  society-at-large.
• The raison d'être of every corporate body is to
  ensure predictability, sustainability and
  profitability of revenues year after year.
• - N R Narayana Murthy

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History of Corp Gov in India

• Unlike South-East and East Asia, the corporate
  governance initiative in India was not triggered
  by any serious nationwide financial, banking and
  economic collapse
• Also, unlike most OECD countries, 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. Reddys Laboratories,
  Nicholas Piramal, Bharat Forge, BSES, HDFC, ICICI
  and many others

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History of Corp Gov in India

• Following CIIs initiative, the Securities and
  Exchange Board of India (SEBI) set up a committee
  under Kumar Mangalam Birla to design a
  mandatory-cum-recommendatory code for listed
  companies
• The Birla Committee Report was approved by SEBI
  in December 2000
• Became mandatory for listed companies through the
  listing agreement, and implemented according to a
  rollout plan

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History of Corp Gov 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, (ii) further increase disclosures, and
  (iii) put in place systems that can further
  strengthen auditors independence

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Fundamental Objective of Corporate Governance

• Enhancement of Shareholder Value, keeping in view
  the Interests of other Stakeholders
• CG a Way of Life rather than a Code

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Constituents of Corp Gov

• The Board of Directors
• Pivotal role
• Accountable to stakeholders
• Directs management
• The Shareholders Stakeholders
• To participate in appointment of directors
• To hold the BoD accountable for governance
  through proper disclosures
• The Management
• To act on the direction of the BoD
• To provide requisite information to the BoD for
  decision making
• To implement and monitor control systems

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Rationale for Disclosures

• An effective disclosure based regulation (DBR)
  implies greater responsibilities on the company
  directors, its management and advisers
• An effective DBR promotes investor activism
• Markets believe that perceived benefits outweigh
  perceived costs

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Disclosure based Regulation Components types
of disclosure

• Disclosures Disclosures
• by whom for whom
• Public Listed Cos. Shareholders
• Intermediaries Investors
• Stock Exchanges MARKET Intermediaries
• Mutual Funds Regulator
• Analysts advisors Government
• Other stake - holders

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Disclosure Based Regulation

• Components types of disclosures
• Initial Disclosures Disclosures for raising
  capital by companies, mutual funds in offer
  documents
• - Public Offers
• - Private Placement
• Continuous disclosures financial /
  non-financial
• Frequency of disclosure
• Dissemination process electronic, physical,
  centralised, dispersed
• Accessibility of information

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Disclosure Based Regulation

• Initial Disclosures
• Continuous disclosures
• Corporate Governance
• Financial disclosures
• Risk based disclosures for intermediaries
• Disclosures for stock exchanges

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Disclosures

• 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

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Disclosures

• Disclosures to shareholders in addition to
  balance sheet, PL and 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

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Disclosures

• Disclosures to shareholders in addition to
  balance sheet, PL 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 companys 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

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Disclosures

• Disclosures to shareholders in addition to
  balance sheet, PL and cash 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 PL for the reporting year

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Disclosures

• (A) Basis of related party transactions
• A statement in summary form of transactions with
  related parties in the ordinary course of
  business shall be placed periodically before the
  audit committee.
• Details of material individual transactions with
  related parties which are not in the normal
  course of business shall be placed before the
  audit committee.
• Details of material individual transactions with
  related parties or others, which are not on an
  arms length basis should be placed before the
  audit committee, together with Managements
  justification for the same

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Disclosures

• (B) Disclosure of Accounting Treatment
• To disclose in the financial statements, if an
  accounting treatment other than prescribed in
  Accounting Standard has been followed alongwith
  explanation.
• (C) Board Disclosures Risk management
• Internal and external business risks
• Procedures to inform Board members about the risk
  assessment and minimization.
• Periodically reviewed

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Disclosures

• (D) Proceeds from public issues, rights issues,
  preferential issues etc.
• To disclose to the Audit Committee, on
  use/application of funds as and when any issue
  is made
• (E) Additional disclosures
• In the Annual Report the criteria of making
  payments to NEDs to be disclosed or a reference
  to be made that the same is available on the
  companys website
• number of shares and convertible instruments held
  by NEDs.
• NEDs shall disclose their shareholding (both own
  or held by / for other persons on a beneficial
  basis) in the company in which they are proposed
  to be appointed as directors, prior to their
  appointment.

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Disclosures

• F) Management
• A Management Discussion and Analysis report to
  form part of the Annual Report.
• G) Shareholders
• Disclosures to shareholders in case of
  appointment /reappointment of directors,
  quarterly results and presentations made,
  shareholders grievance committee and share
  transfer committee, shareholding pattern-change

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CEO/CFO certification

• The CEO, i.e. Managing Director and the CFO i.e.
  whole-time Finance Director or head of the
  finance function to certify to the Board that
• (a) They have reviewed financial statements and
  the cash flow statement for the year and these
  statements
• (i) do not contain any materially untrue
  statement or omit any material fact or contain
  statements that might be misleading
• (ii) together present a true and fair view of the
  companys affairs and are in compliance with
  existing accounting standards, applicable laws
  and regulations.
• (b) no transactions entered into by the company
  during the year which are fraudulent, illegal or
  violative of the companys code of conduct.

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CEO/CFO certification (contd)

• (c)They accept responsibility for establishing
  and maintaining internal controls and that they
  have evaluated the effectiveness of the internal
  control systems of the company and they have
  disclosed to the auditors and the Audit
  Committee, deficiencies in the design or
  operation of internal controls, if any, of which
  they are aware and the steps they have taken or
  propose to take to rectify these deficiencies.
• (d)They have indicated to the auditors and the
  Audit committee
• (i) Significant changes in internal control
  during the year
• (ii) Significant changes in accounting policies
  during the year and that the same have been
  disclosed in the notes to the financial
  statements and
• (iii)Instances of significant fraud of which they
  have become aware and the involvement therein, if
  any, of the management or an employee having a
  significant role in the companys internal
  control system

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ETHICS-definitions

• The word ethics is derived from the Greek word
  ethos meaning character and latin word mores
  meaning customs
• To better understand ethics let us understand and
  contrast the definition of ethics and law
• Law is a consistent set of universal rules that
  are widely published, generally accepted and
  usually enforced. These rules describe the ways
  in which people are required to act in society.
• Ethics defines what is good for the individual
  and for society and establishes the nature of
  duties that people owe to oneself and others in
  society

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What are ethics

• The principle of conduct professional ethics
• A system or philosophy of conduct
• A discipline dealing with what is good and bad-
  moral duty and obligation
• A set of moral principles or values.

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Relation between ethics and law
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ETHICS-

• Reflection in a companys operations of the
  values and moral principles used in the
  communities in which they operate
• Successful markets and corporate performance are
  founded on a commitment to basic ethical
  principles aligned as much as possible to the
  interests of individuals, corporations and
  society.
• Ethical standards may be expressed in a companys
  formal conduct requirements, or contained in
  generally stated principles that guide a
  companys preferred conduct or behavior.
• Most companies have put in place a code of ethics
  for its employees to conduct themselves in a
  particular manner while doing business.

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Purpose of Ethics

• Ethics are the guiding principles.
• Where the proposed business activity/ operation
  of the company borders on the unknown, the
  company needs to apply the ethics principle to
  decide on the project.
• Ethics help make relationships mutually pleasant
  and productive- imbibes a sense of community
  among members- a sense of belongingness to
  society.

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Why have a code of ethics?

• To define acceptable behavior
• To promote high standards of practice
• To provide a benchmark for self-evaluation
• To establish a framework for professional
  behavior and responsibilities
• As a vehicle for occupational identity
• As a mark of occupational maturity.

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Code of ethics -transition

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Creating the Ethical Imperative

• Written code of ethics
• Employee commitment
• Employee training
• Discipline process
• Full disclosure
• Building expectations
• Resolution process conflict management

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THE INFOSYS MODEL

• A formal code of business conduct and ethics.
• To be signed and adhered to by employees.
• Action against any employee for violation thereof.

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THE INFOSYS MODEL -Contents

• General standards of conduct
• Management of conflicts of interest
• Prohibition of exploitation of corporate
  opportunities
• Protection of companys confidential information
• Obligations under securities laws
• Use of assets
• An entire section on responsibilities to
  customers and stakeholders.

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