Business Ethics in the World of Corporate Governance

Executive Summary

All businesses are grey. A loaded statement but one which befits today’s business milieu. The debate is on the shades of the color and not the color itself. Wealth creation precedes wealth distribution, an unalterable sequence. There is a growing realization that former belongs to the exclusive domain of business and the latter to a shared domain. Businesses demand autonomy from others to create wealth and others demand accountability from businesses for the wealth created. Both, autonomy and accountability are worthless in isolation. Accountable autonomy is the panacea. Current business landscape is unprecedented. It is a world where the ends and not the means are brought in to question leading to business ethics boiling down to a personal and not an organizational call, taken everyday by millions, closer to the ground to succeed and more importantly survive.

All the stakeholders-management, employees, board, investors and society are asserting their influence simultaneously. A historical perspective on corporate governance suggests different approaches- (organization+stakeholder)-control approach and capital-market control approach dominating at different times and in different geographies. Both approaches have come alive globally and are trying to pip each other.

India Inc. has moved away from regulation toward latitude since early 1990’s and with the markets coming into their own, the governance style seems to be headed the capital-market control way.

Board of Directors, the venerable interface has to ensure accountable autonomy by fostering its own culture which includes promoting constructive dissatisfaction, actively monitoring the firm’s risk policies and practices, not contingent on having considerable expertise in the areas concerned and avoiding soft conflicts.

Enron and other scandals happened at the best of times and at the worst of times. The aftermath ensured till then increasingly becoming adventurous management’s retreat, activism in boards, dispelled smugness of investors and an acknowledgment of fast becoming oblivious society’s rights and responsibilities. Business initiatives with social spin-offs and not the other way around initiatives are welcome as the need is of responsible corporates and not of over-hyped corporate social responsibility.

A culture, undoubtedly percolating from the top echelons fostering openness and adherence to laws is required.

It has to be appreciated by everyone involved but its adoption has to be voluntary and customizable. The organizations should disseminate the information like practices, policies and risk appetite needed to take a fair call and not accord the right to itself of other stakeholders primarily markets to judge the firm. A culture of transparency starts where regulation ends in achieving accountable autonomy. Every stakeholder must understand that she has a role to play and has certain rights and responsibilities. Separations of powers are difficult to achieve but are crucial for the organization to do the right business and for others to ensure that the former does it the right way as the eternal bottom-line is- the business has and will always be managed by executives, investors have and will always be the ultimate decision making authority on investing and society has and will always be affected by the businesses.

Introduction

The world operates like a simple pendulum. Its microcosm, the business world is no exception. One extreme is autonomy and the other is accountability. It is hard to strike a balance between the two. Both are benign in their own space but too much of a good thing is also detrimental. Business environment has and will keep on testing both extremes. When one extreme is about to be reached, then its dire consequences are realized and businesses move back from the brink. The force which pulls them back from the disaster is so potent that it adds tremendous momentum till the other extreme is tested. This process is eternal and gives businesses a grey shade, blurring the line between right and wrong. After the corporate scandals that rocked the world in 2001-02, the pendulum has swung in the favor of accountability. This shift has happened at a time when the businesses around the world are about to peak. Hitherto unexplored markets are being forayed by organizations worldwide. Issues of business ethics, right and wrong, and corporate governance are hot debating points across the business landscape. All parties- management, board, employees, shareholders, regulators and community are asserting their presence. All of them have to collectively make a decisive move as both regulation and latitude are looking equally enticing and as doing the right things is mulling on the imperative of doing things the right way. The world is waiting!

Business Ethics- Individual’s or Organization’s

Dis-connect between an employee and the ground realities widen as she moves up the ladder. Today, businesses are very target driven. At each level, targets are set and are interlinked. The performance of one’s superior is determined by one’s own performance and this process goes on till the very top echelons. Till such time one meets or surpasses the targets no questions are asked on the way of achieving those and disconnect mentioned earlier plays a huge role. It is only when the shortfall occurs, explanations are demanded and then also words like ethics are given a short shrift. In nutshell, only the end and not the means is what matters. In such an environment, where targets are means to not only success but more importantly survival, ethics boil down to a personal call. These calls have to be taken everyday by millions of people in real time with targets and survival at top of the mind.

The line between right and wrong gets blurred. Can one put a number on the price, less than which a gift is considered a culture token and above which it is considered a bribe? Doubt whether any corporate dossier conceptualized at the very top on ethics can address this issue on the ground.

Approaches to Corporate Governance

Over the years, two very distinct approaches to corporate governance have emerged. One is the mix of organization-control perspective and stakeholder-control perspective and other is based on capital market control.

The former approach sacrifices short-term focus at the altar of long-term sustainability. It is based on 1 person 1 vote dictum. The agreed upon goal for the management is to achieve stability and perpetuity of business. Board has representation of employees and society. Major chunk of equity comes from financial and non financial companies, which are ready to wait for longer periods for their investments to fructify. Firms are not too keen on going public thereby not lending themselves to the whims and fancies of markets. Employee welfare, obligation to local community, size and market share make up the essence of this approach. Myopic Market model by Marris is the fundamental pillar of this approach. According to this model, heeding the markets too much has a detrimental effect on the organization.

Excesses in this approach are created by managerial capitalism as executives are given a free hand in managing the show. At times, a host of objectives other than wealth creation are followed.

As the firm expands, it requires additional capital. If this capital is not forthcoming from stable sources like banks then the company has no other choice but to go public. This gives rise to capital market-control system. It is based on 1 share 1 vote dictum. The more the equity held by an investor, the more the firm is at her mercy. Investors are interested in the ends- dividends and capital gains. Hence, companies have to jostle for the mind space of these players. This brings in the short-termism of this approach. This perspective is based on Principal Agent model. Line is crossed in this approach when investor capitalism sets in. All other obligations of the firm are relegated to keeping the share price up and there is intense pressure on executives to perform consistently in the short-run leading at times to violation of norms.

Both the approaches are similar to the extent that they both give minority shareholders a short shrift. They have been taken for granted and most of their rights have remained on paper.

Lost Ground

Recently the stakeholder inclusive approach has lost considerable ground to shareholder savvy approach. The reason is capital becoming mobile. The global investors like private equity funds and pension funds are deluged with choices. But they lack one crucial element which the local investors have which is the closeness to the business which in turn lends stability to the equity provided. This means the firms have to attract these global investors by way of the globally acceptable parameters, toplines and bottomlines or their manifestation- the share price.

Catching up in the offing

What goes round comes back. Human capital is already the most valuable resource of organizations especially the ones operating in the technology sectors. With the focus shifting from attracting capital to retaining talent, the stakeholder inclusive approach with a sharp focus on employees might make up the ground lost in the last two decades or so to the capital-market control approach.

India Inc.’s Governance Evolution

Corporate entities in India stand out in terms of complexities in the ownership structure. The direct ownership of promoters is quite substantial and if that is not enough, the promoters indirectly have tremendous equity in and control of the firm through the rogue holding companies. It was believed that with the capital market reforms initiated in 1991, the dominance of promoters in the firms will pare. But unfortunately the last decade of the 20th century was marred by scams. The corporate entities went in for private placements making use of the relaxed regulations. These developments made the public spooky. In the last few years SEBI has put its foot down to crack down on the perpetrators and raised the disclosure standards leading to a renewed interest in the markets. The corporates are going global, a sign of their enhanced credibility.

Giants like TCS and Infosys have set global benchmarks in reporting standards and have implemented CSR in the fabric of their organizations.

With capital markets becoming dominant as the time passes and as organizations increasingly care to heed the market and keep the investors happy, it is safe to assume that the Indian corporate entities are veering away from organization-control to market-control approach toward corporate governance.

Right Directors mean Right Business

Board of directors is the highest internal governance mechanism in the organization. The board is the interface between external environment and management. The composition of the board reflects this. It has to straddle between providing necessary freedom to the management for wealth creation and protecting the interests of those who help create and of those who share this wealth. Just like an organization has a culture, it is critical for the board given the role it plays to have its own way of getting a handle on issues. No regulation can substitute for this. The non-executive members should meet separately to thrash out issues among themselves to promote ‘constructive dissatisfaction’. As far as the skills of the board members are concerned, they do not need to have finance or risk expertise to play an effective governance role. The task for the board is rather to understand and approve both the risk appetite of the company at any particular stage in its evolution and the processes for monitoring risk.

If the management proposes changing these radically-for example, by switching the portfolio of assets from low to high risk, or by engaging in off-balance-sheet financial transactions that inherently alter the volatility of the business and its exposure to uncertainties-the board should be quite willing to exercise a veto. Also, the management should be sensitive to the tricky context the board operates in and must grasp that directors’ independence can be compromised by ‘soft conflicts’ such as significant charitable contributions to a favorite institution or the employment of board members’ children.

Enron coterie Debacle – The positive fallout

There is a silver lining even in the darkest cloud that burst over the corporate world post-millennium. In the run up to the uncovering of some of the biggest frauds almost all in America, ironically a country which has always consecrated regulations, the markets were increasingly being viewed as infallible. Whatever information emanated from the organizations to the markets was taken as the last word. There was a reason behind this. The rules were set by the market and organizations were just playing by them leading to smugness all around. The disasters were eye openers for the gullible investors. Markets were vulnerable after all. Stricter rules followed. The corporate boards world over became more agile. The managements retreated. To a certain extent a long-term inclusive focus was restored in the firms having benign effects for every stakeholder.

The Undesirable side effect

Innovation is the mantra for success. But for corporates it has become a survival factor. The frauds have happened at the worst time. The organizations need to be more creative. Risk appetite should be high to capture the unexplored high potential markets. This calls for ingenuity on the executives’ part. But the atmosphere has become very restrictive. Regulations like SOX go overboard.

Boards would much rather have a conservative rather than an adventurous management. This does not bode well for the society as a whole as cagey entrepreneurs will not be able to fulfill their outstanding objective-wealth creation.

Business Initiatives with social spin-offs and not vice versa

Prima facie, ITC’s e-choupal venture seems an effort in the direction of social responsibility. But intrinsically the effort makes eminent economic sense.

It is not a subsidy but an effort which is mutually beneficial. Corporate social responsibility enthusiasts might label such efforts as social initiatives. But the bottom-line is that such efforts generate returns, which guarantees shareholder support. Till such time the business gains precede societal benefits and the society appreciates this reality, the long-run sustenance of these initiatives is guaranteed. Responsible corporates and not corporate social responsibility is the order of the day.

Crucial Culture

Culture is the way people behave when they are not being watched. It is very organization specific and very unlike regulation which is procrustean. The magnitude of damage that can be caused by an individual to the stakeholders of the firm increases as he/she moves up the corporate ladder. The power to influence attitudes also increases on the way up. Hence self evidently the top brass of the firm has a big hand in shaping the culture of the firm. If the honcho crosses the line, it sends out an implicit signal to the people lower down to knowingly or unknowingly to act in a similar manner as the stakes are not that high as they are for the men at the top. The trickling down of an open culture might take time but one can be rest assured that the only way in which it is going to impact the firm is positively. But where organizations go wrong is where they expect the same things from culture as the regulators do from regulation. It is never going to be a one size fits all story. This is where the earlier talked about concept of ethics being very individual specific and not organization one comes into picture. Do not impose culture. Let people understand and appreciate it and find their own way of incorporating it into their work life.

The information imperative

A fair judgment is based on fair information. Often, the best appraisal is done by those who are at a certain distance from the subject matter and at the same time affected by it. Organizations err when they try to preemptively guess others’ reactions. This leads to distortion of information. Doing business is the primary task of business; it is not in the best position to evaluate it from different angles. Hence, organizations should pass on information about its policies, practices and risk appetite. Let the other stakeholders primarily the markets assign an appropriate risk premium and cost of capital. Part of this information dissemination has been achieved by regulation manifested in balance sheet et al. The other part has become more crucial as the businesses have grown complex and can only be achieved with the will of the management and the board. A culture of transparency goes a long way in achieving the latter. Of course transparency has its limits.

But voluntary initiatives like Triple Bottom Line reporting which not only cover the financial but also the social and environmental impacts of the company signal a start. All kinds of companies from the ones with most to hide like chemical to the fairly innocuous ones with the least to hide have adopted this practice. Why? It does make social and environmental sense, but more importantly, thanks to competition in and integration of the world economy, it makes eminent business sense.

Conclusion

Wealth has to be created before it can be distributed. The responsibility to create wealth is of business. And responsibilities and rights must go together. Hence, the society cannot disarm business of its rights which are essential for creating value. The spookiness comes in when business accords certain rights to itself by itself. The importance of wealth creation and difficulty in achieving it blurs the fine line.

As we have seen there is no silver bullet for settling issues like business ethics and corporate governance. Separations of powers just like between executive, judiciary and legislature is imperative. No one stakeholder is an apex authority. Everyone has a role to play.

Regulation defines these roles to a certain extent. But it can only do so much. A culture epitomized by the top management and communication of the right information do much more than regulation. At the end of the day we are all human. We think differently and have different takes on different issues. Till such time this fact is appreciated and co-opted by every stakeholder and a healthy debate continues on the rightness of business, we are certain that businesses will keep on doing what they are good at and others will keep making sure that businesses do it the good way.

Corporate Governance

Institute of Company Secretaries of India –

“Corporate Governance is the application of Best Management Practices, Compliance of Laws 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.”

Standard and Poor – “Corporate Governance is the way a company is organized and managed to ensure that all financial stakeholders receive a fair share of the company’s earnings and assets.”

Objectives of Corporate Governance: –

Corporate Governance is aimed at creating an organization which maximizes the wealth of shareholders. It envisages an organization in which emphasis is laid on fulfilling the social responsibilities towards the stakeholders in addition to the earning of profits. The objectives of Corporate Governance is to ensure the following:

1. Properly constituted Board capable of taking independent and objective decisions.

2. Board is independent in terms of Non-Executive and Independent Directors.

3. Board adopts transparent procedures and practices.

4. Board has an effective machinery to serve the concerns of the Stakeholders.

5. Board to monitor the functioning of the Management Team.

6. Properly constituted Board capable of taking independent and objective decisions.

7. Board is independent in terms of Non-Executive and Independent Directors.

8. Board adopts transparent procedures and practices.

9. Board has an effective machinery to serve the concerns of the Stakeholders.

10. Board to monitor the functioning of the Management Team.

11. Board remains in effective control of the affairs of the Company.

Elements of Good Corporate Governance:-

1. Role and Powers of the Board.

2. Legislation

3. Management Environment

4. Board Skills

5. Board Appointments

6. Board Induction and Training

7. Board Independence

8. Board Meetings

9. Board Resources

10. Code of Conduct

11. Strategy setting

12. Financial and Operational Reporting

13. Monitoring the Board Performance

14. Audit Committee

15. Risk Management

Secretarial Standards:-

The Institute of Company Secretaries of India has issued the following Standards in order to maintain the uniformity of procedure with regard to the Board Meetings, General Meetings, Payment of Dividend, Maintenance of Registers and Records, Recording of Minutes and Transfer and Transmission of Shares.

A brief detail of these standards is given as under: –

SS1 – Meetings of Board of Directors: –

The Secretarial Standard -1 deals with the meetings of the Board of Directors. It deals with the various aspects of the conducting the Board Meetings, the frequency of such meetings in a year, Quorum required for the meeting, powers of the Chairman in such meetings, and recording of minutes of such meetings.

SS2 – General Meetings: –

The Secretarial Standard -2 deals with the General Meetings. It explains the procedure of conducting the General Meetings, the frequency of meetings in a year, Quorum required for the conduct of the meeting, powers of the Chairman in such meetings, recording of minutes of such meetings, a procedure of voting, etc.

SS3 – Dividend: –

This Secretarial Standard pertains to Dividend. It illustrates the calculation of amount payable as a dividend, declaration of dividend, Treatment of Unpaid Dividend, and Transfer of Dividend to Investor Education and Protection Fund(IEPF).

SS4 – Registers and Records

This Secretarial Standard enumerates the various Registers required to be maintained as per statutory requirements. It requires the following registers to be maintained:

Register of members and Debenture holders.

Register for Contracts u/s 301.

Register of Directors u/s 303.

Register for Transfer of Shares.

SS5 – Minutes

This Secretarial Standard deals with the recording and signing of Minutes of the Meetings.

Minutes should contain:

(a) The appointment of the Chairman of the meeting.

(b) The presence of Quorum.

(c) The fact that certain registers and documents were available for inspection.

(d) The number of members present in person including representatives.

(e) The number of proxies and the number of shares represented by them.

(f) The presence of the Chairman of the Audit Committee at the Annual General Meeting.

(g) The presence if any, of the Auditors, the Practising Company Secretary who issued the Compliance Certificate, the Court appointed observers or scrutineers.

(h) Reading of the notice of the meeting.

(i) Reading the report of the auditors.

(j) Summary of the opening remarks of the Chairman.

(k) Summary of the clarifications provided.

(l) In respect of each resolution, the type of the resolution, the names of the persons who proposed and seconded and the majority with which such resolution was passed. Resolutions should be written in the present tense.

SS6 – Transfer and Transmission of Shares

This Secretarial Standard deals with the procedure of Transfer and Transmission of shares held singly and jointly. The register and records pertaining to transmission should be preserved permanently and kept in the custody of the secretary of the company or any other person authorized by the Board for the purpose.

Factors Influencing the quality of Corporate Governance:-

1. Integrity of the Management

2. Ability of the Board

3. Adequacy of the Process

4. Quality of Corporate Reporting

5. Participation of Stakeholders

6. Quality of Corporate Reporting

Committee Reports on Corporate Governance:-

Narayana Murthy Report on Corporate Governance: –

Corporate Governance is beyond the realm of Law. It stems from the culture and mindset of management and cannot be regulated by legislation alone. Corporate Governance is all about openness, integrity, and accountability.

It is a key element in improving the economic efficiency of the firm. Credibility offered by Corporate Governance also helps in improving the confidence of the investors – both domestic and foreign. It involves a set of relationships between a company’s management, its Board, shareholders, and Stakeholders.

Kumarmangalam Birla Committee on Corporate Governance: –

All companies are required to submit a quarterly Compliance Report to the Stock Exchanges within 15 days from the end of financial reporting quarter.

The Report has to be submitted by Compliance Officer or by the Chief Executive Officer after obtaining due approvals, on the following clauses:-

Board of Directors

Audit Committee

Shareholders/ Investors Grievance Committee

Remuneration of Directors

Board Procedures

Management

Shareholders

Report on Corporate Governance

CII – Desirable Corporate Governance: –

Corporate Governance helps in maximizing the long-term shareholder value. It is more a way of business life than a mere legal compulsion. Four ideas, which should be the guiding force of company’s philosophy on Corporate Governance are:-

– Transparency

– Accountability

– Disclosure

– Value Creation.

The Code of Business Conduct and Ethics helps to ensure compliance with legal requirements and other standards of Business Conduct. All company Employees and Trainees are expected to read and understand this code of ethics, comply with all applicable policies and procedures, and ensure that all agents and contractors are aware of, understand and adhere to these standards.

The Company expects all employees, agents, and contractors to exercise good judgment to ensure all employees, agents, and contractors and to maintain competitive, efficient, positive harmonious and productive Work Environment and business organization.

Insider Trading:-

Insider trading is the trading of a corporation’s stock or other securities (e.g. bonds or stock options) by corporate insiders such as officers, key employees, directors, or holders of more than ten percent of the firm’s shares. Insider trading may be perfectly legal, but the term is frequently used to refer to a practice, illegal in many jurisdictions, in which an insider or a related party trades based on material non-public information obtained during the performance of the insider’s duties at the corporation, or otherwise misappropriated.

Prohibition on dealing communication or counseling on matters relating to inside trading: –

3. No insider shall –

(i) either on his own behalf or on behalf of any other person, deal in securities of a company listed on any stock exchange when in possession of any unpublished price sensitive information; or

(ii) communicate, counsel or procure, directly or indirectly, any unpublished price sensitive information to any person who while in possession of such unpublished price sensitive information shall not deal in securities.

(iii) Provided that nothing contained above shall be applicable to any communication required in the ordinary course of business or under any law.

3A. No company shall deal with the securities of another company or associate of that other company while in possession of any unpublished price sensitive information.

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