Auditing & corporate governance B.

Com 6th Semester

B.COM 6TH SEMESTER

AUDITING AND CORPORATE GOVERNANCE

INTRODUCTION
Adolf Browne and Gardiner Means in their seminal work, “The Modern Corporation
and Private Property” (1932) emphasised the importance of granting voting rights to all the
shareholders, ensuring transparency in actions and sufficient accountability of those who
control the corporation. The idea of Corporate Governance, thus, owes its roots to Browne
and Means. The duties of Board of Directors expanded substantially during this period. Bob
Tricker introduced the term ‘Corporate Governance’ in 1984 and wrote a book with the same
title. He is, generally, regarded as the Father of Corporate Governance.

DEFINITION
The field of corporate governance is continuously evolving. There is no set definition
of the term. Definition given by The Institute of Company Secretaries of India. It states
“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”.
Several key phrases in this definition merit attention. These are:
(i) Application of best management practices - It may include laying down of
balanced objectives, putting decision-making processes in place, defining
clearly roles of key players, designing reporting systems to ensure
transparency and accountability, continuous monitoring, etc.
(ii) Compliance of law in true letter and spirit - Systems and procedures should
be laid down to ensure strict compliance to applicable laws and regulations
applicable to the entity.
(iii) Adherence to ethical standards for effective management - All the
stakeholders should make a continuous effort to adhere to maintenance of
ethical standards. Code of Ethical Conduct, Whistle blower policy, Policy on
Executive Remuneration, institutionalising of severance practices, are some of
the ways to ensure such adherence.
(iv) Distribution of wealth and discharge of social responsibility - Corporates
should distribute wealth and discharge their social responsibility by giving
ESOPs, building schools and hospitals, skilling women and youth, providing
financial support to encourage use of non-conventional uses of energy and
adopting other such programmes.
(v) For sustainable development of all stakeholders - Expectations of all the
present and future stakeholders (local community, employees, customers,
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government, suppliers) and needs of the environment should be taken into

account while carrying on business activities.

NEED/BENEFITS OF CORPORATE GOVERNANCE

The need for establishing good corporate governance practices by introduction of governance
codes, designing laws and regulations and reworking theories has been felt since last few
years because of the benefits associated with it. The important benefits which can be derived
are mentioned below:
(i) Safeguards the money of investors: Many investors all over the world have lost
money in primary as well as secondary markets due to inadequate financial and
non-financial disclosures by firms. Good corporate governance ensures
transparency and adequate disclosures which are necessary to make an informed
decision by the investors and safeguard their money from unscrupulous
promoters.
(ii) Ensures success of the corporate: A corporation is a congregation of various
stakeholders such as employees, investors, customers, vendors, government and
society at large. For the growth and success of a corporate it is important that
interests of various stakeholders do not come in conflict. Good governance
practices and transparent structures ensure openness, integrity and accountability.
In such situation’s decisions are taken to ensure a fair deal to all stakeholders and,
thus, the success of the entity.
(iii) Gives ease of access to cheap funds: Good corporate governance procedures
include putting a check on insider trading, handling of investor grievances
efficiently, disclosure of interest by management in financial and non - financial
deals and similar practices. Such practices enhance the credibility of the entity and
helps to gain as well as maintain the confidence of domestic and foreign investors
and financial institutions, who provide long-term funds at reasonable cost.
(iv) Lays foundation for good corporate citizenship: Good corporate governance
aims at enhancing welfare of all the stakeholders and creating sustainable value
for them and also maintaining a balance between economic and social benefit.
Adoption of these good practices convert any entity for being a mere ‘corporate’
to a good ‘corporate citizen.’
(v) Attaches Global Perspective: In an era in which trade barriers have being
progressively removed and capital flows are crossing shores, good corporate
governance is an important consideration for foreign institutional investors and
also for those who bring in foreign direct investment. These inflows are very
important for economic growth of any country.

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THEORIES OF CORPORATE GOVERNANCE

A key feature of modern-day corporations is separation of ownership and control. Such a
separation gives rise to some corporate governance issues. Beginning from 1980’s, many
theories have been proposed by to explain and address corporate governance problems that
arise due to such separation. Some of the important theories are:
➢ Agency/Shareholder theory
➢ Stewardship theory
➢ Stakeholders’ theory.
AGENCY/SHAREHOLDER THEORY
Concept - Jensen and Meckling (1986) defined the Agency/Shareholder relationship “as a
contract under which one or more person (the principals) engage another person (the agents)
to perform some service on their behalf which involves delegating some decision-making
authority to the agent”
Who is the principal? - In the context of corporates, shareholders (principals) define the
objectives of the company.
Who is the agent? - Board of Directors (BODs) and managers are considered as agents.
Shareholders delegate their power to BODs and who in turn delegates it to managers. BODs
are accountable to shareholders.
Assumptions
✓ Divergence of interest of shareholders and Board of Directors - Agency theory
assumes that the interests of principles and agents diverge and both of them seek to
promote their own interest.
✓ Information asymmetry - BODs have a better access to information about entity’s
position vis-a-vis shareholders.
✓ BODs have a fiduciary relationship with the shareholders.
✓ Shareholders are interested in maximizing wealth while managers may succumb to
self-interest and, unless restricted from doing otherwise, would be interested in
protecting and enhancing his pay and perks. This conflict of interest leads to Agency
problem where the important issue is how to ensure that agent acts in the best interests
of the principal.
✓ Agency problem results in Agency costs, for example, monitoring costs in large
corporations (Shleifer & Vishny, 1998) and ‘bonding costs’ (example is the bond
provided by the agent to principal.)
Some ways to reduce agency cost - The shareholders (principal) need to ensure that agents
act in the best interest of shareholders and not abuse their power. Some of the ways to reduce
agency cost are:
✓ Fair and adequate financial disclosures
✓ Appointment of independent directors.
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✓ Formation of Audit Committees.

✓ Appointment of credible independent auditors.
✓ Board Committees to check issues like excessive remuneration, appointment of
knowledgeable directors, etc.
Ownership pattern and agency problem -
✓ The way of handling Agency problem depends on the ownership pattern of corporates
in each country.
✓ If ownership structures are dispersed and the investors disagree with the management
or are dissatisfied with its performance, they exit and it may result in reduction in
share prices.
✓ In countries in which there is concentrated ownership of equity and there are large
dominant shareholders, they control the managers and expropriate minority
shareholders in order to gain private control benefits (Spanos, 2005). The role of
regulatory agencies and government to keep board of directors and management in
check becomes very important.
Limitations:
✓ The Agency/Shareholder theory puts too much emphasis on shareholders and ignores
the interest of other stakeholders.
✓ It does not have universal application. It has better applicability in US and UK
markets and is not suitable for countries which have companies with large family
and/or institutional holdings.
✓ The theory assumes the employees to be individualistic and of bounded rationality
where rewards and punishment are the only things which matter to them (Jensen &
Meckling,1976). It, certainly, is a myopic view of human beings.

STEWARDSHIP THEORY
Concept - There is no conflict of interest between the shareholders and BOD and managers.
Who is a steward - According to stewardship theory top management acts as stewards for
the organization. Davis, Schoorman & Donaldson (1998) has stated, “a steward protects and
maximises shareholders’ wealth through firm performance, because by so doing, the
steward’s utility functions are maximised”.
Assumptions -
✓ Managers are trustworthy individuals and so are good stewards of the resources
entrusted by them by the shareholders.
✓ Senior managers have superior access to important information and are, thus, able to
make informed decisions.
✓ The theory holds “Theory Y” view of managerial motivation.

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Role of shareholders and stewards -

✓ The shareholders trust the stewards and give them autonomy.
✓ Employees or executives act to ensure the shareholders’ returns are maximized
✓ Stewardship theory sates that in order to protect their reputation and retain trust of the
shareholders, executives and directors will work to maximize financial performance
of the entity as well as shareholders’ profits.
✓ The theory suggests unifying the role of CEO and the chairman.
Benefits -
✓ Trust is high and stewards are motivated to work in the interest of the organization.
✓ New ideas can be implemented leading to growth of the firm.
✓ Agency costs get automatically reduced.
Limitations -
✓ While Agency/Shareholder theory paints agent as self-centred, stewardship theory
paints an excessively benevolent picture of the steward who is ready to subordinate
his interest to that of shareholders.
✓ This theory takes into account interest of only employees and shareholders and does
not refer to interest of other stakeholders.
✓ Causal relationship between governance and financial performance cannot be
assessed using this theory.

STAKEHOLDER THEORY
Concept - Stakeholder theorists suggest that managers in a network of relationships to serve.
According corporate strategies should be designed to take care of interest of all the
stakeholders.
Who is a stakeholder -
✓ A stakeholder is defined as any person/group which can affect/be affected by the
actions of a business (Freeman,1994). It includes shareholders, employees, customers,
suppliers, creditors, competitors and even the wider community. These all are
stakeholders.
✓ The stakeholders are, generally, split into two groups- primary stakeholders and
secondary stakeholders. The existence and survival of organization depends on
relationship of business with primary stakeholders. The secondary stakeholders have a
peripheral yet significant involvement with the business.
Diversified Board structure - The stakeholders can have their representatives appointed on
the Board of Directors who will look after their interest.
Stakeholders and CSR - Stakeholder theory implies that it can be beneficial for the firm to
engage in certain corporate social responsibility activities that stakeholders other than
shareholders perceive to be important. Without such activities these stakeholders might
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withdraw their support from the firm. Thus, even in situations when a firm seeks to serve its
shareholders as a primary objective, its success in doing so will certainly be affected by other
stakeholders.

MECHANISM OF CORPORATE GOVERNANCE

In our country there are six mechanisms to ensure corporate governance.
✓ The Companies Act:
✓ Securities Law
✓ Discipline of the Capital Market
✓ Nominees on Company Boards
✓ Statutory Audit
✓ Code of Conduct
REGULATORY FRAMEWORK ON CORPORATE GOVERNANCE
The Indian statutory framework has, by and large, been in consonance with the
international best practices of corporate governance. Broadly speaking, the corporate
governance mechanism for companies in India is enumerated in the following enactments/
regulations/ guidelines/ listing agreement:
1. The Companies Act, 2013 inter alia contains provisions relating to board constitution,
board meetings, board processes, independent directors, general meetings, audit committees,
related party transactions, disclosure requirements in financial statements, etc.
2. Securities and Exchange Board of India (SEBI) Guidelines: SEBI is a regulatory
authority having jurisdiction over listed companies and which issues regulations, rules and
guidelines to companies to ensure protection of investors.
3. Standard Listing Agreement of Stock Exchanges: For companies whose shares are
listed on the stock exchanges.
4. Accounting Standards issued by the Institute of Chartered Accountants of India
(ICAI): ICAI is an autonomous body, which issues accounting standards providing
guidelines for disclosures of financial information. Section 129 of the New Companies Act
inter alia provides that the financial statements shall give a true and fair view of the state of
affairs of the company or companies, comply with the accounting standards notified under s
133 of the New Companies Act. It is further provided that items contained in such financial
statements shall be in accordance with the accounting standards.
5. Secretarial Standards issued by the Institute of Company Secretaries of India (ICSI):
ICSI is an autonomous body, which issues secretarial standards in terms of the provisions of
the New Companies Act. So far, the ICSI has issued Secretarial Standard on “Meetings of the
Board of Directors” (SS-1) and Secretarial Standards on “General Meetings” (SS-2). These
Secretarial Standards have come into force w.e.f. July 1, 2015. Section 118(10) of the New
Companies Act provide that every company (other than one-person company) shall observe
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Secretarial Standards specified as such by the ICSI with respect to general and board
meetings.

LISTING AGREEMENT – APPLICABLE TO THE LISTED COMPANIES

SEBI has amended the Listing Agreement with effect from October 1, 2014 to align it with
New Companies Act. Clause 49 of the Listing Agreement can be said to be a bold initiative
towards strengthening corporate governance amongst the listed companies. This Clause
intends to put a check over the activities of companies in order to save the interest of the
shareholders. Broadly, clause 49 provides for the following:
1. Board of Directors
The Board of Directors shall comprise of such number of minimum independent directors, as
prescribed. In case where the Chairman of the Board is a non-executive director, at least one-
third of the Board shall comprise of independent directors and where the Chairman of the
Board is an executive director, at least half of the Board shall comprise of independent
directors. A relative of a promoter or an executive director shall not be regarded as an
independent director.
2. Audit Committee
The Audit Committee to be set up shall comprise of minimum three directors as members,
two-thirds of which shall be independent.
3. Disclosure Requirements
Periodical disclosures relating to the financial and commercial transactions, remuneration of
directors, etc, to ensure transparency.
4. CEO/ CFO Certification
To certify to the Board that they have reviewed the financial statements and the same are fair
and in compliance with the laws/ regulations and accept responsibility for internal control
systems.
5. Report and Compliance
A separate section in the annual report on compliance with Corporate Governance, quarterly
compliance report to stock exchange signed by the compliance officer or CEO, company to
disclose compliance with non-mandatory requirements in annual reports.

CORPORATE GOVERNANCE REFORM IN INDIA

✓ Aligning Listing Agreement with the Companies Act 2013
Companies Act requirements on issuing a formal letter of appointment, performance
evaluation, and conducting at least one separate meeting of the independent directors each
year and providing suitable training to them are now included in the revised norms of SEBI.
Independent directors are not entitled to any stock option, and companies must establish a
whistle-blower mechanism and disclose them on their websites.
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✓ Restricting Number of Independent Directorships

As Per Clause 49, the maximum number of boards a person can serve as independent
director is seven, and three in case of individuals also serving as a full-time director in any
listed company. The Companies Act sets the maximum number of directorships at 20, of
which not more than 10 can be public companies. There are no specific limits prescribed for
independent directors in the Companies Act. Although SEBI reforms seem to be moving in
the right direction, these limits may initially pose challenges in sourcing qualified
independent directors for listed companies.
✓ Maximum Tenure of Independent Directors
Based on the Companies Act as well as the new Equity Listing Agreement, an
independent director can serve a maximum of two consecutive terms of five years each
(aggregate tenure of 10 years). These directors are eligible for reappointment after a cooling-
off period of three years.
✓ Board-Mix Criteria Redefined
As Per Clause 49 of the Equity Listing Agreement, 50% of the board should be made
up of independent directors if the board chair is an executive director. Otherwise, one-third of
the board should consist of independent directors. Additionally, the board of directors of a
listed company should have at least one female director.
✓ Role of Audit Committee Enhanced
The SEBI reforms call for two-thirds of the members of audit committee to be
independent directors, with an independent director serving as the committee's chairman.
While the Companies Act requires the audit committee to be formed with a majority of
independent directors, SEBI has gone a step further to improve the independence of the audit
committee.
✓ More Stringent Rules for Related-Party Transactions
The scope of the definition of RPTs has been broadened to include elements of the
Companies Act and accounting standards:
• All RPTs require prior approval of the audit committee.
• All material RPTs must require shareholder approval through special
resolution, with related parties abstaining from voting.
• The threshold for determining materiality has been defined as any transaction
with a related party that exceeds 5% of the annual turnover or 20% of the net worth of
the company based on the last, audited financial statement of the company, whichever
is higher.
The ultimate effectiveness of such legislation will depend upon the degree and quality of
enforcement, or the monitoring capabilities of the regulator.
• Improved Disclosure Norms

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In certain areas, SEBI resorts to disclosure as an enforcement tool. Listed companies are now
required to disclose in their annual report granular details on director compensation
(including stock options), directors' performance evaluation metrics, and directors' training.
Independent directors' formal letter of appointment / resignation, with their detailed profiles
and the code of conduct of all board members, must now be disclosed on companies' websites
and to stock exchanges.
• E-voting Mandatory for All Listed Companies
Until now, resolutions at shareholder meetings in listed Indian companies were usually
passed by a show of hands (except for those that required postal ballot). This means votes
were counted based on the physical presence of shareholders. SEBI also has changed Clause
35B of its Equity Listing Agreement to provide e-voting facility for all shareholder
resolutions.
We think this is a pertinent change as it will allow minority shareholders to express their
voices at shareholder meetings without having a physical presence. CFA Institute has
advocated for company rules that ensure each share has one vote.
• Enforcement
SEBI is setting up the infrastructure to assess compliance with Clause 49 to ensure effective
enforcement. Companies need to buckle up and assess the impact of these reforms and step-
up compliance.

✓ Industry Impact
SEBI is boosting investor confidence through these sweeping changes, especially the
potential to empower minority shareholders through e-voting, enhanced disclosures on
remuneration that is aligned with global best practices, and by requiring independent
shareowner approval for related-party transactions. Given India's humongous need for risk
capital, regulatory reforms and better enforcement are critical for market integrity and
building investor trust.

CORPORATE SCANDALS
A corporate collapse typically involves the insolvency or bankruptcy of a major
business enterprise. A corporate scandal involves alleged or actual unethical behavior by
people acting within or on behalf of a corporation. Many recent corporate collapses and
scandals have involved false or inappropriate
The following list of corporations involved major collapses, through the risk of job
losses or size of the business, and meant entering into insolvency or bankruptcy, or being
nationalized or requiring a non-market loan by a government.

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CORPORATE GOVERNANCE FAILURE AT ENRON

• Weak internal control
• Risk management
• Shortcomings in accounting and reporting
Every time you turn a stone, another worm creeps out. That seems to be the story of
the Enron debacle. Not a day goes by without a pew expose of wrong doing in the company
that one begins to wonder if there is anything in our systems and structure of an enterprise
that can prevent such a catastrophe.
Enron is an excellent example where those at the top allowed a culture to flourish in
which secrecy, rule-breaking and fraudulent behaviour were acceptable. It appears that
performance incentives created a climate where employees sought to generate profit at the
expense of the company's stated standards of ethics and strategic goals (IFAC, 2003). Enron
had all the structures and mechanisms for good corporate governance. In addition, it had a
corporate social responsibility task force and a code of conduct on security, human rights,
social investment and public engagement. Yet no one followed the code. The board of
directors allowed the management openly to violate the code, particularly when it allowed the
CFO to serve in the special purpose entities (SPEs); the audit committee allowed suspect
accounting practices and made no attempt to examine the SPE transactions; the auditors
failed to prevent questionable accounting.
The use of questionable accounting and disclosure practices, their approval by the
board and their verification by the auditors arose from a variety of forces, including:
✓ Pressure to meet quarterly earnings projections and maintain stock prices after the
expansion of the 1990s
✓ Executive compensation practices
✓ Outdated and rules-based accounting standards

CORPORATE GOVERNANCE FAILURE AT WAL-MART

It has co-filed a shareholder proposal over concerns that Wal-Mart Stores Inc, the US
supermarket group, is failing to comply with its own governance standards. Karina Litvack,
head of governance and sustainable investment.
✓ Despite strong policies on paper, Wal-Mart has struggled to implement its standards
across its US business.
✓ Weaknesses in internal controls have eroded the company's reputation as an attractive
employer and are adding fuel to the fires of Wal-Mart's critics.
✓ Its failure to deliver on these policy commitments is inhibiting Wal-Mart's ability to
expand into new domestic markets.

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✓ Over 'the past several years', it has become increasingly concerned by signs of failure
in internal controls that have led to government investigations and class action
lawsuits by employees.
✓ Allegations include requiring employees to 'work off the clock' — during breaks and
after shifts — systematic discrimination against women, and alleged questionable
tactics to prevent workers from voting for union representation.
✓ It got off to a promising start in 2005 with expectations of a dialogue with the
independent directors on the audit committee. But when this simply withered on the
vine, Wal-mart had little choice but to bring concerns about internal controls, labour
violations and the erosion of the company's reputation to fellow shareholders.
✓ Company was not interested in engaging in a productive discussion about how it
builds and supports a compliance culture and, as a result, they have joined an
international group of large filers led by the New York City Employees' Retirement
System to file a shareholder proposal.

CORPORATE GOVERNANCE FAILURE AT SATYAM

It is one of Corporate India's worst unfolding chapters. What could be the reason
behind such a huge collapse? The top-level management failed to estimate the intensity of the
gangrene in the organization. Questions also arise on the role of the auditors, and how such a
magnitude of financial fraud could have gone unnoticed.
Corporate governance is a field which constantly investigates how to secure and
motivate efficient management of corporations. It has begun as a corporate governance issue
back in December has now turned into a major financial scandal for the ages in India. The
shares of Satyam Computer Services have plummeted more than 90% in trading at the NYSE
today, a stark reminder that investors must always cover their backs or else get racked even
by the big names in the industry. NYSE today halted trading in Satyam Computer at its
bourses in the US as well as in Europe after the Chairman disclosed financial bungling at the
Indian IT major.
A business will always have two sides, it’s not necessary to gain profits every time,
but to sustain in the market the integrity is vital. Every day in some or the other place there is
a merger or an acquisition happening, but due to the projected image the co-players in the
market are dropping out their plans of taking over Satyam. Undoubtedly there will be intense
focus directed at the other Indian IT Services companies as well. The Satyam corporate
governance failure may also make its competitors bolder in terms of acquiring market share
created by its fallout, provided the industry can regain the trust of the same investors that
Satyam has deceived.
From this necessarily brief review of the evidence, and particularly of the sources of
failure in financial firms, draw some tentative conclusions. It is important to recognize,
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however, the evidence base for firm recommendations on corporate governance in financial
institutions is thinner than one would like, and certainly not robust enough to offer a
standardized set of recommendations valid at all times and in all places.

CORPORATE GOVERNANCE FAILURE AT CADBURY

Adrian Cadbury, successor to and chairman of the Cadbury Schweppes confectionary
group. Mr. Cadbury's visit and interactions with Indian industry triggered the first serious
discussions on the subject of corporate governance. All in all, it seemed like a promising new
way of looking at the evil that was single promoter-run firms in India then, who, among other
things, ran their companies like fiefdoms and were loath to give up control even if their
shareholdings were low.
Recognize that it was a not so competitive environment, the grip of the license raj was
still fairly firm and companies and their promoter/founders could pretty much do what they
wanted, with public money. The real pain of liberalisation was yet to set in and the Infosys
way of boardroom discipline was some way from making its presence felt. History it seems is
repeating itself. Indian companies have exposed themselves to billions of dollars' worth of
forex derivative contracts over the last few years. Precise numbers are hard to come by and
will perhaps never will, what is clear is that companies have taken financial risks they could
or should have avoided.
What is clearer is that there was no compelling reason to take these risks. And to that
extent, it's a failure of corporate governance and must be treated and then addressed as such.
There is of course the other issue of how the Institute of Chartered Accountants or the
accounting regulator figuring out how to treat derivative losses as they stand on scores of
balance sheets today.
How did it happen?
Companies have been steadily stepping up their exposure to currency swaps and the
like for at least four years now. Over time, as the stock markets (which bolster sentiment)
have held their own and the prospect of any downside risk appeared more and more distant
with every passing day, chief financial officers (CFOs) of companies have got braver. If a
company entered into, let's say, a transaction to convert a local currency borrowing into the
Japanese yen or Swiss franc borrowing through the swap route, then the company is
inducing a risk into the system where there is not. No two ways about that.
Managements ought to have, in the interests of corporate governance, clearly
informed their boards of all foreign exchange exposures, the risks arising out of that and
the measures to mitigate them were something to go wrong. Moreover, under the relevant
Securities & Exchange Board of India regulations, in the absence of an applicable
standard in India for derivatives, the companies' Audit Committees should have examined
international standards and disclosed the losses in the Governance report and indicated
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that these would have been provided for had the country adopted international
standards as applicable.
Its possible many companies did keep their boards informed and made the
appropriate references in their balance sheets. Though this does seem unlikely, even if
they did, no one was watching. It's also possible that some companies are in violation of
law. Either way, shareholders must perhaps shoulder some part of the blame.
To conclude is another Enron waiting in the wings? Not quite but it does raise some
fundamental questions on what companies do with their shareholders' funds. It's also
about how when the good times roll, everyone forgets to look at the figures closely. There is
something in the original Cadbury committee definition of corporate governance.
MAJOR SCANDALS IN INDIA/ABROAD
If there is one theme to rival terrorism for defining the last decade and a half, it would
have to be corporate greed and malfeasance. Many of the biggest corporate accounting
scandals in history happened during that time. Here is a chronological look back at some of
the worst examples.
✓ Waste Management Scandal (1998)
✓ WorldCom Scandal (2002)
✓ Tyco Scandal (2002)
✓ Freddie Mac Scandal (2003)
✓ American International Group Scandal (2005)
✓ Lehman Brothers Scandal (2008)

COMMON GOVERNANCE PROBLEMS

✓ Accounting frauds carried out in collusion with statutory auditor.
✓ Insider trading.
✓ Weak internal control mechanisms and lack of supervision.
✓ Lack of independence of the board with board members having significant financial
linkages with the companies.
✓ Fiduciary failure by the board to exercise care and diligence in approving proposals,
even though all the information was provided by the management.
CODES OF CORPORATE GOVERNANCE
Corporate Governance issues have attracted considerable attention, debate, and research
worldwide in recent decades. Almost invariably, such efforts gain momentum in the wake of
some major financial scam or corporate failure, as. these tend to highlight the need for tighter
surveillance over corporate behaviour. Corporate governance has wide ramifications and
extends beyond good corporate performance and financial propriety though these are no
doubt essential. Therefore, we briefly discuss the major codes of corporate governance, i.e.,

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Cadbury Report, the CII Code, the OECD Principles, the SEBI Code, and Sarbanes Oxley
Act of 2002.

Cadbury Report
The Cadbury Committee submitted its report and associated "Code of Best Practices" in
December 1992. The Code of Best Practices had 19 recommendations. Being a pioneering
report on Corporate Governance, it would be in order to make a brief reference to them. The
recommendations are in the nature of guidelines relating to the Board of Directors, Non-
Executive Directors, Executive Directors and those on Reporting and Control.

The recommendations are: -

1. The effectiveness of a board is buttressed by its regular meeting, full control over the
company and check over the executive management.
2. The Chairman should be strong and independent rather than Yes Man. The responsibilities
should be divided clearly.
3. Non-executive Directors should play a significant role in the board's decisions. They
should act as eyes and ears of the board. Therefore, the number of non-executive directors
depends upon their calibre.
4. The Board should have a formal schedule of matters for decisions to ensure that the
direction and control of the company is firmly in its hands.
5. If directors need advice for their duties then there should be a procedure of professional
help, at the company's expense.
6. The company secretary –
✓ should ensure that the company's multifarious activities are performed smoothly and
conform to the provisions of law.
✓ should ensure the board that the board procedures are followed and applicable rules
and regulations are complied with. –
✓ should be appointed or dismissed by the board as a whole.
✓ should provide his professional advice to BODs.
7. Non-Executive Directors-
✓ should be independent.
✓ should be appointed through a formal procedure and their appointment should be
specified.
✓ should not be re-appointed automatically.
8. Directors' service contracts should not exceed three years without shareholders’ approval.
9. There should be full and clear disclosure of total emoluments, pensions and stock options
for executive directors and chairman. Separate figures should be given for salary and

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 Auditing & corporate governance B. Com 6th Semester

performance related elements and the basis on which performance is measured should be
explained.
10. Executive directors' pay should be subject to the recommendations of a Remuneration
Committee made up wholly or mainly of Non-Executive Directors.
11. The main duty of the Board is· to assess and present company's actual position.
12. The Board and Auditors should maintain a good professional relationship.
13. The Board should establish an Audit Committee of at least 3 Non-executive Directors
with written terms of reference, which deal clearly with its authority and duties.

The CII Code

More than a year before the onset of the Asian crisis, CII set up a committee to examine
corporate governance issues, and recommend a voluntary code of best practices. The
committee was driven by the conviction that good corporate governance was essential for
Indian companies to access domestic as well as global capital at competitive rates. The first
draft of the code was prepared by April 1997, and the final document (Desirable Corporate
Governance: A Code), was publicly released in April 1998. The code focuses on listed
companies.
The Committee made the following key recommendations:
Board of Directors
✓ "The key to good corporate governance is a well-functioning, informed board of
directors. The board should have a core group of excellent, professionally acclaimed
non-executive directors."
✓ "The full board should meet a, minimum of six times a year, preferably at an interval
of two months."
✓ "Any listed company with a turnover of Rs.l billion and above should have
professionally competent, independent, nonexecutive directors, who should constitute
at least 30% of the board if the Chairman of the company is a non-executive director,
or at least 50% of the board if the Chairman and Managing Director is the same
person."
✓ "No single person should hold directorships in more than 10 listed companies."
✓ "Key information that must be reported to, and placed before, the board must contain:
▪ Annual operating plans and budgets, together with up-dated long-term plans.
▪ Capital budgets, manpower and overhead budgets.
▪ Quarterly results for the company as a whole and its operating divisions or
business segments.
▪ Internal audit reports, including cases of theft and dishonesty of a material
nature.

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 Auditing & corporate governance B. Com 6th Semester

▪ Show cause, demand and prosecution notices received from revenue

authorities which are considered to be material important. (Material nature if
any exposure that exceeds 1 percent of the company's net worth).
▪ Fatal or serious accidents, dangerous occurrences, and any effluent or
pollution problems.

Desirable Disclosure
✓ Listed companies should give data on: high and low monthly averages of share prices
in a major stock exchange where the company is listed; greater detail on business
segments, up to 10% of turnover, giving share in sales revenue, review of operations,
analysis of markets and future prospects.
✓ Major Indian stock exchanges should gradually insist upon a corporate governance
compliance certificate, signed by the CEO and the CFO.
✓ If any company goes to more than one credit rating agency, then it must divulge in the
prospectus and issue document the rating of all the agencies that did such an exercise.
These must be given in a tabular format that shows where the company stands relative
to higher and lower ranking.
✓ Companies which are making foreign debt issues cannot have two sets of disclosure
norms: an exhaustive one for the foreigners, and a relatively minuscule one for Indian
investors.
✓ Companies that default on fixed deposits should not be permitted to accept further
deposits and make inter-corporate loans or investments or declare dividends until the
default is made good.

The OECD Principles

To develop a set of corporate governance standards and guidelines, the OECD Council met at
ministerial level on 27-28 April 1998. Consequently, the OECD principles of corporate
governance were framed and endorsed by the OBCD Council. in its meeting on 26-27 May
1999. The principles try –
✓ to ensure the shareholders rights.
✓ to ensure the equitable treatment of all shareholders.
✓ to ensure the role of stakeholders
✓ to 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.
✓ to 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.
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 Auditing & corporate governance B. Com 6th Semester

The main features of OECD principles are:

1. Shareholders have the basic rights to secure the method of ownership. They can buy, sell
or transfer the shares. They can obtain relevant information on the corporation on a timely
and regular basis.
2. Shareholders have the basic rights to participate and vote in general shareholder meetings.
Thus, they should have the opportunity to fulfil these rights. They can vote by proxy (i.e.
telephonically or electronic voting or individually). They should consider the cost and
benefits of exercising their voting rights.
3. Shareholders should be informed of the rules that govern general shareholder meeting like
as
✓ Information about the date, location and agenda of general meetings.
✓ Full and timely information regarding the Issues to be decided at the meeting.
4. Shareholders can ask questions as well as submit the questions in advance and obtain
replies from management and board members.
5. Shareholders have the basic right to share in the profit of the Corporation.
6. Shareholders have the basic right to elect the members of the board.
7. Shareholders have the right to participate and obtain relevant information about
fundamental corporate changes i.e.
✓ Amendments to the articles of incorporation or similar governing documents of the
company.
✓ The authorization of additional shares.
✓ Extra ordinary transactions
8. There should be equal treatment for all shareholders including minority and foreign
shareholders, such as
✓ Same voting rights.
✓ Relevant information about the voting rights attached to all classes of shares.
✓ Change in voting rights.
✓ Processes and procedures of general shareholder meeting.
The SEBI Code
The Committee on Corporate Governance was set up on May 7, 1999 by the
Securities and Exchange Board of India (SEBI) under the Chairmanship of Shri Kumar
Mangalam Birla to promote and raise the standards of corporate governance. The Committee
kept in view the fact that any code of corporate Governance' should be dynamic, and should
change with changing context and times. This code is the first formal and comprehensive
attempt, in the context of prevailing conditions of governance in Indian companies, as well as
the state of capital markets.

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 Auditing & corporate governance B. Com 6th Semester

The Committee divided its recommendations into mandatory and non-mandatory

categories. The mandatory recommendations are the following:
1. The mandatory recommendations, such as composition of the Board, constitution of the
various sub-committees of the Board of Directors, should be implemented by companies
within the time prescribed below:
✓ Immediately, by all companies seeking listing for the first time. By April 2000
✓ By April 2001, by those companies, whose Paid up share capital of Rs. 50 million and
above
2. The board of a company has an optimum combination of executive and non-executive
directors with fifty percent of the board comprising the non-executive directors. The number
of independent directors would depend on the nature of the chairman of the board. In case of
a non-executive chairman, at least one third of board should comprise of independent
directors and in case of an executive chairman, at least half of board should be independent.
3. A non-executive Chairman should be entitled to maintain a chairman's office at the
company's expense and also allowed reimbursement of expenses incurred in performance of
his duties. This will enable him to discharge the responsibilities effectively.
4. A qualified and independent audit committee should be set up by the board of a company.
This would go a long way in enhancing the credibility of the financial disclosures of a
company and promoting transparency.
Sarbanes Oxley Act of 2002
To develop an act on Corporate Governance, one hundred seventh congress of the U.S.A. at
the second session begun and held at the city of Washington on 23 January, 2002. The act
was framed to protect investors by improving the accuracy and reliability of corporate
disclosures made pursuant to the securities lows and for other purposes. This 'Sarbanes Oxley
Act of 2002' has eleven titles. The titles are:
I. Public company accounting oversight board
II. Auditor independence
III. Corporate responsibility
IV. Enhanced financial disclosures
V. Analyst conflicts of interest
VI. Commission resources and authority
VII. Studies and reports
VIII. Corporate and criminal fraud accountability
IX. White collar crime penalty enhancements
X. Corporate tax returns
XI. Corporate fraud accountability

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 Auditing & corporate governance B. Com 6th Semester

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 Insider
Trading: No insider shall -
✓ 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
✓ 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.
✓ Provided that nothing contained above shall be applicable to any communication
required in the ordinary course of business or under any law. No company shall deal
in the securities of another company or associate of that other company while in
possession of any unpublished price sensitive information.

WHISTLE BLOWER POLICY

Whistle Blower policy is an internal policy on access to Audit Committees.
Elimination of unethical or improper practices is the responsibility of respective Corporate
Promoters and Management for which they have to put in place of the systems for efficient
administration and transparent transaction. Clause 49 of the Listing Agreement provides for
formulation of an internal Policy, which extends to any level of employment and by virtue of
which any personnel who observes an Unethical or improper practice shall be able to
approach the Audit Committee without informing their supervisors. Whistle blower policy
will afford protection to the Whistle blower from reprisals such as loss of employment,
financial issues, and harassment on the workplace.

COMPOSITION OF COMMITTEE OF CORPORATE GOVERNANCE

✓ Chairman and CEO: It is considered good practice to separate the roles of the
Chairman of the Board and that of the CEO. The Chairman is head of the Board and
the CEO heads the management. If the same individual occupies both the positions,
there is too much concentration of power, and the possibility of the board supervising
the management gets diluted.

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 Auditing & corporate governance B. Com 6th Semester

✓ Audit Committee: Boards work through sub-committees and the audit committee is
one of the most important. It not only oversees the work of the auditors but is also
expected to independently inquire into the workings of the organization and bring
lapse to the attention of the full board.
✓ Independence and conflicts of interest: Good governance requires that outside
directors maintain their independence and do not benefit from their board membership
other than remuneration. Otherwise, it can create conflicts of interest. By having a
majority of outside directors on its Board.
✓ Flow of information: A board needs to be provided with important information in a
timely manner to enable it to perform its roles. A governance guideline of General
Motors, for instance, specifically allows directors to contact individuals in the
management if they feel the need to know more about operations than what they are
being told.
✓ Too many directorships: Being a director of a company takes time and effort.
Although a board might meet only four or five times a year, the director needs to have
the time to read and reflect over all the material provided and make informed
decisions. Good governance, therefore, suggests that an individual sitting on too many
boards looks upon it only as a sinecure for he or she will not have the time to do a
good job.

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