The Essential Book of

CORP ORATE
GOVERNANCE
 G. N. BAJPAI

The Essen�ia BooH of

The Essential Book of CORPORATE GOVERNANCE 3

 Contents

List of Figures xiii

List of Abbreviations xv
Acknowledgements xix
Author’s Note xxiii

1. Prologue: Tyranny of Corporate Governance 1

2. Introduction 6
3. Stakeholders of Joint Stock Companies 25
4. Raison D’être of Joint Stock Companies 39
5. Greed, Hubris and Delinquencies: Barriers to
Good Corporate Governance 45
6. Fruition: Concept of Corporate Governance 52
7. Pillars of Corporate Governance 60
8. Boardroom Practices 74
9. Accounting and Financial Reporting Standards 142
10. Related Party Transactions 157
11. Disclosures 166
12. Risk Management 175
13. Building Ethos: Ecosystem 181
14. Building Enablers of Good Corporate Governance 187
15. Monitoring Pyramid 195
16. Evaluation of Quality of Corporate Governance 206
17. Conclusion: Corporate Governance—Triumph
of the Enterprise 233

4
viii THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

Annexure 1: Case Studies 249

Annexure 2: Board Allocation of Role Between Board
and the Management 270
Annexure 3: Board and Its Subcommittees Meeting
Protocols 272
Annexure 4: Policies 276
Annexure 5: Charters 312

Bibliography 329
Index 332
About the Author 334

The Essential Book of CORPORATE GOVERNANCE 5

 Detailed Contents

1. Prologue: Tyranny of Corporate Governance 1

2. Introduction 6
2.1. Evolution of Economies 6
2.2. Evolution of JSCs 9
2.3. Evolution of Securities Markets 17
2.4. Evolution of Capital Market Regulatory Framework 22
3. Stakeholders of Joint Stock Companies 25
3.1. Introduction 25
3.2. Organizational Structure 30
3.3. Organizational Structure and Corporate Governance 36
3.4. Corporate Governance at Financial Distress 37
4. Raison D’être of Joint Stock Companies 39
4.1. Wealth Creation 41
4.2. Wealth Management 42
4.3. Wealth Sharing 43
5. Greed, Hubris and Delinquencies: Barriers
to Good Corporate Governance 45
5.1. Barriers to Good Corporate Governance 47
6. Fruition: Concept of Corporate Governance 52
7. Pillars of Corporate Governance 60
7.1. Introduction 60
7.2. Tiers of Monitoring Pyramid 71
8. Boardroom Practices 74
8.1. Composition of a Board 76
8.2. Sourcing of NEIDs 79
8.3. Integration of the Board Members 83
8.4. Role of a Chairman 87
8.5. Role of a Lead Director 92
6
x THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

8.6. Retirement Policy—NEDs 94

8.7. Allocation of Role and Responsibilities Between
the Board and the Management 96
8.8. Allocation of Time of the Board 103
8.9. Business Management and Enterprise Management 104
8.10. Designing the Agenda for the Board Meeting 106
8.11. Drafting of the Board Notes 110
8.12. Minutes of the Board and Committees’ Meetings 113
8.13. Action Taken Report (ATR) 117
8.14. Vision and Direction 117
8.15. Barrier to Broader Debate in the Boardroom 121
8.16. Focus on Strategy 122
8.17. Budgeting Exercise 127
8.18. Evaluation of the Performance of Executive
Directors 131
8.19. Evaluation of the Performance of NEDs 133
8.20. Evaluation of Performance of the Board 136
8.21. Succession Planning 137
8.22. Constant Communication and Consultation 140
9. Accounting and Financial Reporting Standards 142
9.1. Quality Assurance 143
9.2. Management Assurance 145
9.3. Independent Assurance 151
9.4. Statutory Assurance 153
9.5. Conclusion 154
10. Related Party Transactions 157
10.1. What Is an RPT 159
10.2. Why RPTs Are an Issue of Significance 159
10.3. RPTs, Auditors and the Audit Committee 161
10.4. Board and the RPTs 162
10.5. RPT Policy 163
10.6. RPT Procedure 163
10.7. Conclusion 165
11. Disclosures 166
11.1. Introduction 166
11.2. Means, Methods and Manner of Disclosures 172

The Essential Book of CORPORATE GOVERNANCE 7

 Detailed Contents xi

12. Risk Management 175

12.1. Risk Management Process 178
13. Building Ethos: Ecosystem 181
14. Building Enablers of Good Corporate Governance 187
14.1. Code of Conduct 187
14.2. Whistle Blower Policy 189
14.3. Website 192
14.4. Board and Committee Meeting Protocols 192
14.5. Compliance Culture 193
15. Monitoring Pyramid 195
15.1. Compliance 197
15.2. Auditors 199
15.3. Board Committees 201
15.4. Board 203
15.6. Regulators 204
16. Evaluation of Quality of Corporate Governance 206
16.1. Rating of Corporate Governance 208
16.2. EVA Method 219
16.3. MVA Method 221
17. Conclusion: Corporate Governance—Triumph
of the Enterprise 233
17.1. Value Builders: Philosophy 238
17.2. Value Enablers: Principles 239

Annexure 1: Case Studies 249

Annexure 2: Board Allocation of Role Between Board
and the Management 270
Annexure 3: Board and Its Subcommittees Meeting
Protocols 272
Annexure 4: Policies 276
Annexure 5: Charters 312

Bibliography 329
Index 332
About the Author 334

8
1
Prologue: Tyranny of
Corporate Governance

A
n individual consumed by ambition is unrestrainable. He is a
dreamer. He challenges himself. He is undaunted. He has
nerves of steel. He creates a magnetic structure. He marshals
resources—human, physical and financial. Such individuals are
visionaries. A visionary such as the celestial character Arjuna of
Mahabharata (Indian mythical epic) fame, who visualizes only
‘tryst with his dream’.
Visionaries cohabit all the fields—social, political and eco-
nomic. Visionaries in the area of economics, dream of building
magnificent ‘enterprise(s)’. Often, such enterprises take birth
in garages, living rooms, 200 sq. ft offices and so on. Microsoft
is one such sterling example of the birth of the most successful
enterprise of its time in a garage. Bill Gates was consumed by his
ambition, so was Steve Jobs. However, every new enterprise con-
ceived and created by a visionary leader does not turn out to be
a Microsoft or Apple. But, visionary leaders live up to the text of
Robert Bruce, ‘Try again, try again and keep trying …’.1 Abraham
Lincoln was one such leader in politics. He became one of the
most successful presidents of USA after 32 unsuccessful attempts
to occupy positions in the political hierarchy. Mahatma Gandhi
1
https://www.youtube.com/watch?v=j2HMBGELeFM (accessed on 30 May
2016).
The Essential Book of CORPORATE GOVERNANCE 9
 2 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

was another politico-spiritualistic leader who emancipated India

out of political subjugation through ahimsa (non-violence). Steve
Job is the most outstanding example of current times from busi-
ness, who right from his birth went through ups and downs, trial
and tribulations, yet never gave up and occupied enviable front
rank of modern business even while fighting incurable physical
ailment, which eventually took away his mortal body but not
the ‘spirit to succeed’. Leaders sometimes, gripped by greed and
hubris, loosen their guards and tread the path of indiscretion,
which takes the enterprise into the lane of destruction.
Society is a facilitator. It plays a supportive role in the develop-
ment, growth, success and sustainability of enterprises. One among
the facilitations that the society offers is the raising of resources,
particularly financial, from a large number of passive contributors
who share the vision of the entrepreneur(s). The success stories of
enterprises across geographies continue to enthuse people around
the world to pool in resources with the fond hope of multiplying
their wealth. Financial resources are raised in various forms and
through a variety of instruments. The most commonly used struc-
ture of raising risk capital is a joint stock company, which can be
shaped in a variety of formats—private or public, limited by capital
or guarantee or unlimited and listed or unlisted in the stock market.
The contributors of financial capital to such enterprises, depending
upon their own risk appetite, choose the financing route. It could
be debt with a tenor or perpetual, preference capital, voting and/or
non-voting equity and so on. However, the most popular form of
raising risk capital by a public limited company in India, emerging
markets and around the world is the ‘equity’ capital, also called
‘common stock’, which is listed on stock exchanges (SXs). Listing
on SX offers the benefit of accommodating a large number of pro-
viders of risk capital and ease of entry and exit at will.
The evolution of JSCs (discussed later) helped the availability
of goods and services from across borders, spread of capitalism and
eventual prosperity. The promoters of the enterprise(s) as also the
other contributors of financial resources have benefited immensely
in many cases by such collaboration, while in equal or possibly
larger number, they have lost even the capital contribution. In
some cases, the promoters as active owners of the enterprise have
10
 Prologue: Tyranny of Corporate Governance 3

benefitted disproportionately and even to the prejudicial interest of

others, that is, passive investors. There are innumerable instances
to suggest that the management of the business enterprise is often
not conducted in the best interest of all the stakeholders. The
equity and fair play are deficient. There have also been many cases
of downright cheating, forgery, fraud and misappropriation. This
has propelled the society through its governments across geog-
raphies to sit up, take notice and architect a framework to bring
about more orderly management and governance of enterprises
and help the flowering and thriving of only such enterprises that
serve the greatest good of all the stakeholders. The design of the
regulatory framework has been legislated and the institution of
regulators—‘high priest’ to monitor the compliance of the ground
rules so laid down—has been created.
Today, a listed company is required to comply with a com-
prehensive list of guidance, directions, rules, regulations and leg-
islations notified from time to time by the government, regulators
and self-regulatory organizations (SROs) and so on. The compli-
ance has become an operational function by itself and entails a
substantial cost. The cost of Corporate Governance, particularly
for a small and medium-sized enterprise (SME), aggregates to be
a significant percentage of its resources.
The compliance with the governance framework is not limited
to constitution of board and its meetings but has a wide spectrum
commencing with the incorporation, conduct and winding up of
the enterprise and extends right to the maintenance of accounts,
disclosures, related party transactions (RPT), risk management,
manning of critical positions such as chief executive officer (CEO),
chief financial officer (CFO), head of internal audit and compli-
ance officer, and even the conduct of day-to-day operations and
communications and so on. The compliance is dated for obligatory
actions, and delays are punishable with civil and criminal liabilities.
Serious discomfort is being experienced by the managers
of enterprises in the journey of compliance with Corporate
Governance norms. A senior industrialist managing a medium-
sized commercial empire once asked me (when I was on the
chair of ‘high priest’—Securities and Exchange Board of India
(SEBI) Chairman), in one of the trade associations’ meeting in
The Essential Book of CORPORATE GOVERNANCE 11
 4 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

Kolkata (India), ‘Why do you insist on complying with the entire

rigmarole of governance framework including the appointment
of one-third as the Independent Directors on the board, when
owner Managers and their associates own 90% and only 10% is
held by others’. This question apparently smacks of discomfort
with the (tyranny of) Corporate Governance compliance that he
and his team were probably undergoing. Ask formally any CEO,
he would pronounce Corporate Governance compliance as an
immensely useful, affirmative activity and adds value to the com-
pany, but meet them informally, you will hear whispers such as
‘it’s a tyranny unleashed on the Managers of enterprises by the
Regulators and the Government alike’.
Furthermore, it is being increasingly felt that a listed company
is significantly disadvantaged over an unlisted company in the
same line of business because of much larger areas and scope of
compliance, including mandatory disclosures. The unlisted com-
petitors can piece together strategic approach and re-engineer their
own framework to beat the listed company down. In yet another
interaction with a prominent industrialist in Mumbai (India), I was
confronted with a question as to why an unlisted company is not
required to undertake similar disclosures. This, according to him,
exposes the listed companies to more intense competition from the
unlisted companies. The managers feel handicapped to talk to the
media, stakeholders and even in business forums about their enter-
prise as freely as they would like to. The disclosure requirements
warrant that every price-sensitive information must be disclosed to
the SXs first, where all the companies are listed and even the man-
ner, method and sequence of disclosures are prescribed. And what
is price-sensitive is always open to interpretation.
A similar sentiment of tyranny is felt by the companies in
the area of the observance of accounting and financial reporting
standards and in maintaining internal controls and certifications.
Most CEOs feel that they should be called upon only to deliver
the ever higher amount of profits, thereby ensuring greater
returns to all the stakeholders. There is no point in wasting time,
energy and resources in complying with the disclosures, account-
ing and financial reporting standards, boardroom configuration
and practices and so on, they argue.
12
 Prologue: Tyranny of Corporate Governance 5

There is a serious discomfort amongst entrepreneur managers

and also professional managers on the regulatory obligation of
inducting rank outsiders (unrelated and unconnected persons)
as independent directors in the board of companies managed by
them, which has since been compounded in some jurisdiction
by compulsion of appointing a woman director. They feel that
in most cases, the contribution of non-executive independent
directors (NEIDs) is negligible or marginal and their presence and
interventions, particularly in the critical committees, are painful.
Over a period of time, the regulatory framework relating to
the management of an enterprise à la Corporate Governance has
been evolving and with every significant governance failure the
framework is becoming still more rigorous.
All this made me sit up and ask myself, ‘Is Corporate
Governance merely a Tyranny or can it serve as an effective tool
to enhance enterprise value?’ This book seeks to address this fun-
damental issue, ‘whether Corporate Governance is a tyranny or
triumph’ and the cost of compliance is an investment into value
creation or an avoidable expenditure. Although the patience of
the readers will be tested as some part of the material may appear
boring and repetitive of what is already known and said, hope-
fully, at the conclusion of the reading, it may be possible to deci-
pher a ray of hope that good Corporate Governance at the very least
boosts the value of enterprise, if it does not become the sunshine
for sustainable growth of the organization with the continued
trust and confidence of all the stakeholders.
Let me commence this journey of discovery with a bit of
history of the ‘instrumentality’ of Corporate Governance. It all
began with Homo sapiens organizing into societies. Societies
traversing into civilizations, civilizations giving birth to economics,
economics inventing the methods of marshalling resources,
resources finding passages for multiplication, passages creating
‘principle–agent’ relationships, ‘principle–agent’ relationships
resulting into ‘agency costs’. As a student of Financial Economics,
I consider Corporate Governance’s instrumentality as a reflection
of the ‘agency costs’. To cut the long history of millenniums short,
I would engage your attention beginning with economics and the
economic orders.
The Essential Book of CORPORATE GOVERNANCE 13
 2
Introduction

2.1. Evolution of Economies

T
he world has been traversing the passage of progress on the
vehicle of economic order. Everything has a life cycle—the
universe, planet, civilization, company, product and even
the economic order and to disregard the realism is to invite
oblivion ahead of time. The life of every new economic order,
which has been propelling the progress of the planet Earth,
is contracting. The phase of hunting and gathering—nomadic
economy—led the life on the planet Earth for hundreds and
thousands of years.
The agricultural economy’s preponderance sustained for
about 10,000 years. It gave birth to societies, habitations and
civic life. It also gave birth to the formal economics of the barter
system—the exchange of surplus for meeting the shortages. It dis-
tinguished humans from the beasts. It facilitated the formations of
orderly societies. It made the life civil.
Even though the invention of wheel and gun power revolu-
tionized the world economy, shifted the balance of power and
made crowns the subjects; the evolution and growth of JSCs really
aided and abetted the flowering of the industrial economy. The
industrial economy propelled further inventions and innovations.

14
 Introduction 7

It enhanced productivity and helped the production of goods

beyond the basic needs. It brought about urbanization and pro-
moted agglomerates. The industrial economy was dwarfed by the
information economy in a span of just about 200 years.
We are now in the age of information-led economy—the infor-
mation economy, which drives the various facets of the environ-
ment: social, political and economic. The role of ‘common stock’ in
the flowering of information economy cannot be over emphasized.
The overwhelming influence of the information economy can be
observed in every walk of life. The information economy enables
the designing, manufacturing and marketing of products. It drives
efficiency. It makes work life less monotonous and dreary, if not
delightful. It has weaved a matrix of inventions and innovations
and converted even the impossible into a reality.
Currently, the competitive edge determines the rate of growth
of an economy and resources—physical, financial and even
human—facilitated by communication revolution, and discov-
ers the islands of opportunity globally for architecting optimal
leveraging ability levels. The information economy led to the
death of distance, globalized the world and converted it into a
planetary village. It has contracted time and enabled scale. It
helps in exploiting both economies of scale and scope. It has cus-
tomized manufacturing and personalized service. In fact, it has
an overwhelming influence on the creation and management of
wealth. Yet the conclusion of the information economy’s life span
is within viewing distance and a new economy, christened as ‘bio-
economy’, is shaping up slowly but steadily overshadows the infor-
mation economy and may eventually consign it to the wreckage of
history in just about a quarter of a century like other economies.
The developments in the bioeconomy are bringing about
awe-inspiring consequences in the life—humans, animals, plants,
metals and minerals and so on—and revolutionizing the repro-
ductive quality and longevity. The probability of the use of
rock-eating bacteria such as Acidithiobacillus and Leptospirillum
to extract metals from low-grade ores, mine waste or industrial
effluent or to clean the non-laced groundwater using bacteria is

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 8 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

on the horizon; the bioleaching recovery methods. It also has the

propensity to redefine risks—kind, class and proportion. The
developments of mind-like computers—a step ahead of artificial
intelligence—neural networks, genetics and extreme miniaturi-
zation are the three core technologies which will have remark-
able repercussions on the blooming of the bio and emergence
of the next ‘cosmic economy’. Actually, predictive theory is the
bridge between science and economy and technology cements
such bridges. Human genome-like projects and mapping of the
entire genetic blue print have already revolutionized diagnosis
and is transforming treatment. It may make other planets habit-
able and expand the human civilization beyond Earth.
By the time the world really experiences the predominance of
the bioeconomic era, the planet Earth would have accomplished
the comprehensive blending of genetics and computers, which
will take us (a) deeper into everything and (b) further away in
time and space. An era will hopefully dawn where clinical deaths
will not be permanent and total, aging will be prevented and
renewal will be possible. It has already become feasible to change
diseased, eroded and aging parts of the human body including
hands, legs, eyes, ears, heart, liver and may be even brain one day.
Such developments have really revolutionized risk sensitivity and
the product architecture.
However, the rays of next age cosmic economy beyond bioec-
onomy are discernible to an incisive eye though far in the horizon
of time. Nevertheless, the information economy will continue to
impel growth processes for quite some time to come. Bioeconomy
and the next cosmic economy will metamorphose the risk land-
scape and transform the complexion of the challenges before trade,
commerce and industry. It must be clarified here that with the evo-
lution of the new economy, the old economy does not disappear
altogether. It is just that the influence of older economy reduces
and new economy increases as it flowers the multiplication of
wealth creation and management. Let me conclude this section by
quoting Dr Robert Jastrow, the founder of the National Aeronautics
and Space Administration’s (NASA’s) Goddard Institute, ‘The era of
carbon-chemical life is drawing to a close on the Earth and a new

16
 Introduction 9

era of silicon-based life—indestructible, immortal and infinitely

expandable—is beginning’.1
The change in economic order warrants transformation in
the processes of management and governance of the enterprises
recurrently. The formidability of risk management grows greater
with every new innovation. Hence, the perception and tread-
ing of the emergence of trends, inter alia, in the economic order
becomes essential for sustainability, albeit survival.
The centrality of JSC and its component, common stock in
the marshalling of financial resources for economic growth, is
well recognized and continues to grow in significance. Hence, let
me move on to the evolution of JSC.

2.2. Evolution of JSCs

One of the most significant, albeit less talked about, inventions in

economics is the institution of JSCs. It has engineered imagination
becoming ideas, ideas transforming into inventions, inventions
supplemented by innovations and commercialization, delivery of
profits and eventually creation and multiplication of wealth. It has
enabled the envisioning and development of modern corporation.
It would be hard to imagine how bereft of the vehicle of JSCs, the
owners of surplus financial capital would have channelized it to
the users and facilitated ever-increasing wealth creation globally.
Thomas Piketty (2014), in his seminal work, propounds that the
inequality is increasing because returns on capital are far higher
than on the labour. I believe that higher returns on capital have
been enabled by the institution of JSC.
‘Necessity is the mother of invention’, goes the adage. Something
similar happened in the birth and evolution of JSCs. In the four-
teenth, fifteenth and sixteenth century, the Europeans were
sailing across seas in search of riches and eventual colonization.
Exploring geographies necessitated the reconnoitring of methods

1
http://biographies-memoirs.wikidot.com/jastrow-robert (accessed on 30
May 2016).

The Essential Book of CORPORATE GOVERNANCE 17

 10 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

of cooperation—pooling of resources and sharing of risks—in the

journeys so undertaken, and thus emerged the construct of JSC as
a separate legal entity. Structural design facilitated individuals with
risk appetite to contribute capital and reap economic gains from
the operations of the enterprise in proportion to the ownership
share held; something akin to the current format of equity shares.
JSC structures had several forms and dimensions depending upon
the ownership frames. It could be just for a particular voyage, for a
number of voyages or in perpetuity for all the voyages to be under-
taken since the incorporation. Such varied ownership frames were
facilitated by subscription in separate subordinate organizations or
syndicates within the company. The profits were shared at the end
of each voyage undertaken by the enterprise.
It is being increasingly believed that the origin of JSCs is
linked to the medieval guilds. One of the research papers has
revealed that 95 shares of Bazacle Mining Company were traded
at the value of the profitability of the mill, sometime around the
year 1250 at Toulouse in France. There is a record of the transfer
of stocks of a Swedish Company, Stora, in 1288.2 The company of
Merchant Adventures to New Lands, chartered in 1553 with 250
shareholders, is believed to be the earliest recognized company.
Russia’s Muscovy Company, with a monopoly to trade between
Moscow and London, was charted in 1555.
The construct of the JSC received a fillip during the sixteenth
century, following the expansion of foreign trade to newly discov-
ered geographies and grant of incorporation and trade monopo-
lies by royal charter to all those who supported the government
in equipping the navy, establishing colonies or discovering new
trading routes. Initially, such royal charters were granted to indi-
viduals, but it was soon realized that to disperse the risks and
collect a large amount of resources, in particular financial, it is
desirable to confer royal charter status on the collective endeav-
ours of a large number of individuals in the garb of companies.
The British were first to give birth to a modern JSC. The ear-
liest recognized company was the famous English (later British)
East India Company (EIC). It was conferred royal charter on 31st

2
http://en.wikipedia.org/wiki/Stock (accessed on 30 May 2016).
18
 Introduction 11

December 1600. The royal charter gave it a 15-year monopoly

on all trade in the East India. Eventually, it ruled India having
acquired auxiliary government status and military prowess. The
Dutch EIC followed suit with its incorporation in 1602.
JSCs were also used as an instrument of state foreign policy
during the heydays of mercantilism. The monopolist structure,
framework and corporate personality were proffered to help these
enterprises receiving finance from growing merchant class. Ron
Harris, a prominent historian, argues that in the early years of EIC,
the birth and growth of JSC was helped by the cooperation between
insider entrepreneurs and (outsider) providers of capital. The coop-
eration entailed participation in the governance of the enterprise
too. This ensured information flow to the investors, which eventu-
ally helped them to opt out of the investment, if so desired.
The process of governance necessitated the managers (directors)
of the company building their reputation and goodwill with the
investors through performance—delivering results in the shape
of dividends, in particular. This helped in repeated transactions
and extended the pool of investment capital beyond personal
relationships, merchant groups and networks. Furthermore, the
high risk and multiplicity of the skills needed in the case of foreign
trade and colonization, warranted development, assimilation
and employment of skills in the management of the enterprise,
and the professionalization of management started shaping as an
underpinning of success.
By the middle of the seventeenth century, the broad char-
acteristics of a modern company such as raising share capital,
limited liability, sharing of profits via dividends, liquidity through
transfer of shares, internal structure of the board of directors
(BoD) and shareholders’ meetings, appointment of directors by
shareholders, keeping the accounts on a permanent basis and
their disclosure to shareholders, periodically evolved through its
inclusion in the charters and/or by business practices. The revo-
lution of 1688 established the supremacy of the parliament and
judiciary and made the crowns subservient to the new political
order. The parliament overtook from the crown, the powers of
granting the royal charter. Thus, began the journey of conferring
the corporate status, particularly to a business organization by a
The Essential Book of CORPORATE GOVERNANCE 19
 12 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

political process. The democratic ethos of the parliament encour-

aged the grant of charters for carrying out public benefit works,
government functions and policies. Hence, JSCs came to play a
very important public role when the governments were still evolv-
ing and had inadequate finance and other resources to manage
and govern the society. The private–public partnership (PPP) had
taken birth then, albeit in a different incarnation.
In fact, there were two kinds of JSCs which came into exist-
ence at that point in time: (a) created by a charter or Act of
Parliament and (b) unincorporated JSCs, which functioned under
the adapted tutelage of partnership law. Such companies drafted
their own rules to deal with the large number of shareholders
and replicated most of the attributes of an incorporated company,
notwithstanding the lack of legal recognition. Such unincorpo-
rated companies were conceived as the aggregates of individuals
without a separate existence from their shareholders. The dif-
ferences between an ordinary partnership and unincorporated
JSCs were the number of shareholders, scale of operations and
more sophisticated financial requirements necessary to accom-
modate a relatively large number of passive investors who were
not involved in the management and were allowed to transfer
their shares without the approval of the managing shareholders;
conceptually, a kind of private company.
The boom in the formation of JSCs—incorporated and
unincorporated—came about post-1688 revolution. It happened
in a wide range of industries such as treasure salvaging, mining,
fire insurance, water suppliers, banks and arms manufacturing,
textiles, soaps, sugar, paper, glass and so on. This boom was
inextricably interwoven with the growth and development of
stock markets, which facilitated the trading (liquidity) of shares of
JSCs and helped the growth of each other as the instrumentalities
of intermediation and economic growth. The institutional struc-
tures of the modern stock market, which included professional
brokers, payment of their fees, availability of a variety of scrips
for trading and price information, eventually evolved through
commercial practice with a very little legal facilitation. In fact,
the first publication of stock market prices took place in 1692.

20
 Introduction 13

The growth of stock market, which provided the liquidity, was

enabled by the growing number of JSCs.
The EIC and other charter companies were very successful in
raising large amounts of capital from a broad base of investors,
right from the beginning of the seventeenth century, when the
powers of crown were still intact.
The British Parliament, so also other European legislatures,
perceived share trading as speculation and, hence, undesir-
able. This led to the enactment of several laws that attempted
to regulate brokers and share traders. These enactments were a
kind of precursor to the Bubble Act. In fact, the hostility of the
parliamentarians towards the JSCs, stock market and share trad-
ing is believed to have emanated from the landowning class who,
during the eighteenth and early decade of nineteenth century,
overwhelmed both the parliament and judiciary.
The boom in the formation of JSC of the last decade of the
seventeenth century was followed by a significant decline until
the end of the first decade of the eighteenth century. In UK, the
boom returned in the end of 1719, when the share prices of
the three large companies went up very significantly. This rise
spilled to smaller companies, which were described as ‘bubbles’.
Most of the bubble companies were unincorporated JSCs. These
companies could not be granted incorporation and/or charter
mostly because of the inadequacy of the resources of parliament
and crown law officers. The persistently uncomfortable situation
led to the enactment of the Bubble Act in 1720. Its broad aim
can be seen from the part of its full title: ‘An Act to Restrain the
Extravagant and Unwarrantable Practice of Raising Money by
Voluntary Subscriptions for Carrying on Projects Dangerous to
the Trade and Subjects of this Kingdom’.
The Bubble Act propelled the promoters of the JSCs to take
a cautious approach for the fear of contravening its prohibition.
The contraventions were treated as criminal offences. This led to
seeking legal advice, which possibly helped in the evolution of
the English Company Law and Practice. Apparently, the enforce-
ment of the act was weak as there was only one isolated instance
of criminal prosecution during the entire eighteenth century.

The Essential Book of CORPORATE GOVERNANCE 21

 14 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

However, the Bubble Act, albeit vicariously, played spoilsport

and led to the decline in the use of vehicles of JSCs and SXs as
resources’ raising routes in the decades following its introduction.
In fact, economic historians assign significant weightage to the
Bubble Act for the crisis of 1720. Later periodic booms and busts
reinforced the propensity of the underpinning of the Bubble Act
and led to various Acts that prohibited certain market practices
including dealing in options and futures and ‘the infamous stock-
jobbing’, as described in the Bubble Act.
The later half of eighteenth century saw an increase in the
number of canal companies and broadening of shareholder base,
which eventually led to the legitimization of share investment.
The shareholders’ base of canal companies was very large; in some
cases, it was in thousands. The opposition to such companies or
the so-called hostility was much lower because these served pub-
lic purpose and also because most shareholders were local land-
lords and merchants who benefited from the improved transport
infrastructure. The merchants and landlords eventually became
long-term shareholders.
The Universal Suez Ship Canal Company (Compagnie
Universelle du Canal Maritime de Suez) was formed in 1858 by
Vicomte Ferdinand Marie de Lesseps to construct the canal. It had
the right to run the canal for 99 years. When it ran into financial
troubles, part of the holding (44 per cent) changed hands to Pasha
Said and from him to the British Government. Under the 1888
Convention of Constantinople, the canal was opened to the ships
of all nations in war and peace. The marvel of engineering was
facilitated by the institution of JSC, which substantially contracted
the cost and time of trade between East and West. Similarly,
another feat—The Panama Canal, with its ups and downs on the
way, was completed in 1914 in the ownership of JSC.
Initially, the use of JSCs’ structure in manufacturing enter-
prises was rare. The predominance of partnership and family
firms in that segment continued until the last quarter of the
nineteenth century. In fact, the participation of corporations
and/or unincorporated JSCs was determined by the strength of
the vested interest in the related industries and their preponder-
ance in the parliament to the erect barriers of entry, which could
22
 Introduction 15

block incorporation applications submitted by new entrepreneurs

likely to be potential competitors. The approach eventually led to
adhocism in the incorporation of companies by the parliament.
Until the second half of the eighteenth century, the unincor-
porated companies were struggling to build legality around the
structure when the ingenuity of entrepreneurs and the lawyers
came up with the idea of creating a trust under which the firm’s
property was placed in the name of the trustees. The trustees
were usually chosen from the shareholders and were authorized
under a deed of settlement which contained the constitution of
the company to conduct the management of the enterprise. A
person became a member by signing the deed. The trust deed
usually provided free transferability of shares and fundamental
need of the founders of the company and its investors. This set in
motion the concept of fiduciary responsibility of the managers of
the enterprise, which includes the BoD.
Two important innovations in the structure of the JSCs, which
really helped its functionality and sustainability, were (a) use of
common seal and (b) perpetual succession. Common seal provided
a method by which the act of the entity—JSC—could be identified.
The use of common seal, which is used even today, became popu-
lar in the thirteenth and fourteenth centuries and was first used
for guilds. The perpetual succession commenced with the guild
established by Orcy at Abbostbury, which was granted property for
guildship, ‘to posses now and henceforth’. Later, other guilds were
established on ‘even more to lasten’ and ‘to abyde, endure and be
maynteyned withoute ende’. This helped JSC to live forever and
successive owners could own its assets as liability also.

2.2.1. Evolution of JSCs in India

India had its own institutional structure of running businesses,

which was mostly in the shape of either proprietary, joint family
or a community ownership. The advent of EIC into the shores of
India ushered in new thinking in the management of the affairs,
both politics and economics. EIC began its journey with seeking
favour of access to trade with India, eventually becoming the
The Essential Book of CORPORATE GOVERNANCE 23
 16 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

conqueror of territories with the support of the mighty (then)

British crown.
The economic success of EIC enormously ballooned its
prowess and transformed it into a political master, which was
however taken over by the British crown itself. It is a matter of
pity that over a period of time, the company went into dumps and
has since been bought over by an Indian for just a few million
pounds, more as a treasured relic of history. The subjugation of
India by the British crown, inter alia, introduced many elements
of managing businesses, economy, politics and even social order.
Among them was the introduction of the institution of the JSC.
Breen & Co., now known as Jessop (as from 1820), was incorpo-
rated in 1788. Later on, many companies were launched, which
included the most circulated English newspaper, Times of India.
Notable amongst the companies that have survived more than a
century of trials and tribulations are the following:

1. CSEL
2. Britannia Biscuits
3. OTC
4. Kirloskar
5. TVS
6. Calcutta Electric Supply Corporations (CESC)
7. Dabur
8. Tata Steel
9. Bennett, Coleman & Co
10. Godrej & Boyce
11. Indian Hotels
12. Jessop & Company
13. Walchandnagar Industries Ltd

Britishers also introduced managing agency system, wherein one

organization would have a right to manage a number of compa-
nies for a fee, mostly a share of profit. One among the prominent
managing agency, which still exists in some form, is Andrew
Yule. The managing agency system was abolished in 1969. The
Indian Parliament also legislated the Companies Act on the lines
of British Companies Act for the incorporation, functioning and

24
 Introduction 17

winding up of the companies. The last act of 1956 has since been
repealed by the new Companies Act of 2013, bringing about wide
ranging changes.
The JSC came into being and developed as a capitalist institu-
tion which benefited investors and society at large. This organi-
zational design was propelled by the necessity of meeting large
financial requirements. The development of a healthy relationship
between active and inactive investors was facilitated by the estab-
lishment of an institutional framework that engineered investor
confidence. This framework consists of rules and norms, which
regulate the actions of the active (in management) shareholders
in the company and prevents the alienation of the interests of
inactive shareholders and/or former’s dishonest behaviour and
conduct. These rules and regulations eventually determine how
the management of the company would be run, that is, build-
ing governance practices, the efficacy of which is so vital for the
continued confidence of the shareholders, in particular, inactive.
The entire development coupled with the emergence of a number
of related and complementary economic and political institutions
enhanced the wealth of Western Europe and North America,
and laid firm foundations for the rise and growth of capitalism
around the world. This also laid the foundations of Corporate
Governance practices.
The growth, development and capacity of JSC to contribute
an ever-increasing level were facilitated by the ease of entry and
exit, which was organized by the securities market. Therefore,
it would be helpful to explore a bit of development and pervad-
ing the impact of securities markets and the institutions of SXs.
The securities market also created the enforcing structure for the
formalized instrumentality of Corporate Governance.

2.3. Evolution of Securities Markets

The genesis of the birth of the market lies in the perpetuity of

gap between demand and supply. In fact, the formal economy
commenced as a barter system; wherein, a person with surplus
exchanged goods/services with another person in deficit for what
The Essential Book of CORPORATE GOVERNANCE 25
 18 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

he had in surplus. Finding persons with surplus and deficit of

the same goods/services was a challenge. Hence, the concept of
a market, a place where people with surplus and deficit could
gather to exchange, evolved. As the societies and the economies
evolved, the concept of currency—a common medium—was cre-
ated, which, over the generations, has taken various forms such
as gold, silver, clay and even leather to facilitate the exchange of
surplus goods and services for a price in the units of currency.
Finally, the currency has moved substantially from its last avatar
of paper to a digital number.
Exploring of geographies in search of riches warranted pooling of
resources by the owners of surplus savings with an urge to multiply.
The vehicle was JSC as the owner of the enterprise. This gave birth to
securities as a unit of ownership of the enterprise in exchange for the
resources pooled in. Thus, the institution of securities market sprang
up to facilitate the suppliers and users of the resources undertaking
the transaction and entering into a relationship. This also became
the place where the security could be exchanged with someone else
(other than the managers of an enterprise), in effect providing liquid-
ity without the need for an enterprise to redeem from the retained
resources and/or the winding up of an enterprise.
The financial sector (banks, insurance, pensions and the
securities markets) plays a crucial role in the economic growth.
It enables channelization of savings into investments and, thus,
decouples the two activities. The savers and investors facilitated by
the economy’s ability to invest and save are not constrained by their
individual abilities. The intermediation of savings into investment
makes financial markets the engine of economic growth.
The securities market scores over banks and other institutions
in allocational efficiency as it tends to funnel savings to such invest-
ments, which have the potential to yield greater returns, eventually
leading to an increased productivity on investments and higher
wealth creation. The securities market thus has the propensity to
promote greater economic growth by converting the given stock of
investible resources into larger flow of goods and services.
The securities market opens up wealth creation hot spots
for competing enterprises. It also provides transferability and

26
 Introduction 19

liquidity; the basic foundation for the growth and development of

the JSC. The liquidity to investors, so provided, does not incon-
venience the enterprises issuing the securities. The liquidity and
the yield proffered by the market encourage people to make addi-
tional savings out of their current income, which would otherwise
be consumed, in the absence thereof.
A number of studies, including those of the World Bank and
IMF and other scholars, have established a robust two-way rela-
tionship between the development of the securities market and
economic growth. An old study by Ross Levine and Sara Zervos
(1996) found that the stock market development is highly signifi-
cant, statistically, in forecasting the future growth of per capita
GDP. Their regressions forecast (then) that if Mexico or Brazil were
to modernize their stock markets to the level of Malaysia, their per
capita GDP could additionally grow at the rate of 1.6 per cent
per year. As the market gets disciplined, more developed and
efficient, it avoids the allocation of scarce savings to low-yielding
enterprises and forces the enterprises to focus on wealth creation,
which is being continuously evaluated through share prices in the
market. The companies also face the threat of takeover for poor
or lower performance.
The first securities market came into being in Belgium in
1531. Here, individuals with ideas, which required resources in
excess of their own capacities, endeavoured to work in a group of
people to pool their savings in support of their idea. Such infor-
mal markets sprang up across Europe shortly thereafter.
The securities market came to assume greater prominence
and serious significance at the beginning of the Industrial
Revolution during the seventeenth century. Businesses needed a
large amount of capital to finance bigger ventures, which very few
promoters with the idea were capable of marshalling from their
own resources. The first set of exchange helped not only capital
creation but also liquidity with the availability of both primary
and secondary market. London SX, the origin of which can be
traced back to more than 300 years ago, started in a coffee house
of the seventeenth century and became a very significant element
in developing businesses.

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 20 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

The origin of New York SX goes back to 1792 when

Buttonwood Agreement was signed by 24 New York City brokers
and merchants. The process was simple. Every day at noon, secu-
rities were auctioned to the highest bidder. The seller paid a com-
mission to the exchange on each of the stock and/or bond sold.
The concept of securities market became a hit with the investors,
as it helped them to get their investments pooled in a company.
New York SX has since become one of the foremost securities
market of the world.
The development of capital markets in India had its inspira-
tion from the West, in particular England where the capital mar-
kets had already started functioning. Bombay (now Mumbai)
being made the trading centre, in particular for cotton trade, it
was natural for the capital market activity to begin in Bombay.
A bunch of individuals got together to start the trading activ-
ity. These individuals organized themselves into an informal
association named Native Shares and Stock Brokers Association,
Bombay in 1875.
The trading began under the banyan tree in the Horniman
Circle opposite Town Hall. The first script to be traded was
obviously East Indian Company, which was a star amongst the
companies in the British dominant geography. Slowly the trad-
ing activity flourished, which eventually developed into a boom
in the share prices. It was the first boom in the history of Indian
Capital Markets. This boom lasted nearly for half a decade and
eventually bubble burst on 1 July 1865, which brought a sud-
den slump in the trading of share prices and took several years
to restore the market confidence. This Native Shares and Stock
Brokers Association eventually transformed into the current
Bombay Stock Exchange.
Since the British Government was not as much interested
in the economic growth, the Indian capital market was neither
developed nor organized well. The companies were dependent on
the London capital market rather than the Indian capital market.
Following the political independence, the builders of modern
India provided focus to the development of Indian capital market.
The country chose merit-based regime, which was implemented

28
 Introduction 21

through the office of the Controller of Capital Issues (CCI). The

CCI determined the timing, composition, pricing, allotment
and floatation costs and so on of new issues. Such measure was
in tune with the philosophy of the command economy, which
was pursued in the initial decades of India’s independence. The
regime of the CCI, coupled with the non-listing of public sector
undertakings (the required capital was provided by the govern-
ment) which were the drivers of economic growth then, became
a serious handicap for the growth and development of capital
markets in India.
The rampant speculation in a few scrips in the 1950s led to the
Indian capital market being described as ‘satta bazaar (speculation
market)’. The satta (speculation), being the dominant sentiment
about the Indian capital market, encouraged the Government of
India to enact the Securities Contracts (Regulation) Act in 1956.
The major initiative stemming out of the Act led to the develop-
ment of financial institutions and the state financial corporations.
The nationalization of life insurance companies and their
aggregation into the Life Insurance Corporation of India (LIC) in
1956 and the setting up of the Unit Trust of India (UTI) in 1964
provided a fillip to the Indian capital market via institutional par-
ticipation. However, the promulgation of the Dividend Restrictions
Ordinance in 1974 limiting the payment of dividend by companies
to 12 per cent of the face value or one-third of the profits of the
companies, whichever was lower, brought yet another setback.
The Government of the India took several initiatives such
as compulsory listing of the Indian subsidiaries of multinational
companies (MNCs), incentives for the listing of companies in the
SX and so on, which provided a fillip to the Indian capital market
in the 1980s. By that time, the country had seen the upsurge of 23
SXs, almost one in each of the major states, and the over-the-coun-
ter (OTC) market. However, transformation in the SXs from outcry
to screen-based trading propelled by scams and new regulatory
regime under the aegis of SEBI saw the eclipse of regional SXs, inter
alia, the factors such as absence of potent central counter party,
volume and liquidity bulldozed off their exuberance. Currently,
the Indian stock market consisting of three functioning exchanges,

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 22 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

BSE, National Stock Exchange (NSE) and the newly established

Multi Commodity Exchange (MCX) SX, is dominated by NSE.
The Indian capital market has been afflicted periodically by
scams. The infamous among them have been so-called Harshad
Mehta and Ketan Parekh scam, which warranted the Government
of India to provide stricter regulatory regime. Thus, came into
being the SEBI in 1991, as an independent autonomous regula-
tory body to regulate the market, protect the interest of investors
and develop the market. Today, the Indian stock markets are not
only efficient and modern but globally competitive. The volumes
have grown very substantially along with the number of listed
companies, which makes the Indian capital market, on a com-
bined basis, the third largest in the world.

2.4. Evolution of Capital Market Regulatory

Framework

The securities market regulation, in some form or the other,

has been around as long as securities markets have existed. It
is believed that King Edward decreed, sometime in the thir-
teenth century, that brokers in London should be licenced.
Massachusetts, a state in the USA, required registration of railroad
securities in as early as 1852. In fact, other states in USA passed
laws relating to securities in the later part of 1800 and early 1900.
The first comprehensive securities law requiring registration of
both the securities and the intermediaries was enacted in Kansas
in 1911, as a response to selling of worthless interests in fly-by-
night companies and gold mines to unwitting investors. Thus, the
Kansas Law was the first of the ‘blue-sky laws’ and is known even
today throughout the industry as such. The Kansas Act provided
directions on the sale of securities by any company, promise of a
fair return and general philosophy of fairness, justness and equity
of the transactions. The Kansas Securities Law was aped by 23
states. The new state laws were challenged on the constitutional
grounds. However, the Supreme Court upheld the initial securi-
ties laws enacted by the state.

30
 Introduction 23

The great stock market crash of 1929 and the ensuing depres-
sion propelled the enactment of US federal securities legislation
christened as the ‘Securities Act of 1933’, which, inter alia, pro-
vided the setting up of the Securities and Exchange Commission
(SEC). Since then, a number of laws have been passed by the
USA.
Over the next seven years the US Congress passed several
more Acts pertaining to securities regulation.3

• Securities Act of 1933: The first federal law to regulate the

issuance of securities. The purpose was to prevent fraudu-
lent offerings and to ensure that the public had adequate
information regarding the issuer and nature of a security.
• Securities and Exchange Act of 1934: The primary thrust
of the Act was to regulate the post-distribution trading
of securities, including providing continuing information
about issuers whose securities are traded in public mar-
ket places, remedies for fraudulent actions in securities
trading and manipulation of the securities markets, regu-
lating the use of ‘insider information’ when purchasing
securities and regulation of the securities markets and the
persons using such markets.
• Public Utility Holding Act of 1935: Designed to correct
abuses by holding companies with little or no assets and
to prescribe accounting and record-keeping requirements.
• Maloney Act 1938: Amended 1934 Act to provide for the
formation of the association of brokers and dealers that
would create and enforce disciplinary rules and promote
just and equitable principles of trade.
• Trust Indenture Act of 1939: Provided protection for
debt securities holders by requiring an indenture (trust
agreement), administered by an independent financial
institution trustee.
• Investment Company Act of 1940: Established require-
ments and regulated specific type of businesses, principally
3
http://www.sechistorical.org/museum/timeline/1930.php (accessed 30 May
2016).

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 24 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

so-called ‘mutual funds’, which invest in the securities of

other companies.
• Investment Advisors Act of 1940: Required registration
(licencing) for all persons engaged for compensation in
the business of rendering investment advice or issuing
analyses or reports concerning securities.

Similar developments of enacting legislation ensued in England

and various other European countries.
Over a period of time, a trail of market misconduct recurring
periodically around the world led to innocent investors losing
their lifetime savings. The discomfort and disquiet among the
investors propelled the respective governments in each of the juris-
dictions to take notice, legislate and issue directions for an orderly
functioning of the markets. The approach gave birth to regula-
tions and regulators in all the countries. Although the framework
is in infancy in some markets, it has become excessive in others.
There are coordinated attempts to bring sobriety to the manage-
ment of the capital markets globally.
Actually, the need and necessity of regulation were conse-
quenced by the greed and hubris of the issuers of securities and
intermediaries alike. The sharpest focus came on the efficacy of
the market place itself. Although the operations in the market and
the activities of the intermediaries have been outlined separately
by each of the regulatory framework, the issuers are being bound
by the cannons of good Corporate Governance; the subject that
I will be discussing in the subsequent chapters. The enforcement
structure for a good Corporate Governance, architected by the
regulators, resides in the mechanism of SXs—the utility vehicles
for the growth and prosperity of JSCs. The threat to the very pur-
pose of the vehicle—entry and exit of financial engagement by a
common surplus owner—propelled the design and enforcement
of the structure.

32
3
Stakeholders of Joint
Stock Companies

3.1. Introduction

A
JSC comes into being with the pooling of resources—
physical, financial and human—by the respective owners.
The promoters/managers of a JSC approach the owners of
the resources to handover/permit, leveraging with the assurance
that they would on agreed terms return and/or share the profits.
The owners give their consent to the offer of the JSC with the
fond hope that the assurances held out will be fully met. Thus, the
poolers of the resources develop a stake in the functioning, growth
and sustenance, albeit in the existence of the JSC. Owners of these
resources can be segmented broadly into five categories: (a) equity
holders/shareholders (b) workforce/human resource (HR) (c) sup-
pliers of debt capital, goods and services (d) customers (e) society.

3.1.1. Shareholders

These are the set of investors who provide the risk capital. The
first set of such persons/organizations are called the promoters

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 26 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

who have a dream, an idea, a vision and the courage of convic-

tion to transform their dream into a value creating enterprise.
Such people are also known as entrepreneurs who eventually
become the promoters of the enterprise—JSC. They risk their
time, money and whatever other resources they have in the
hope of building a successful enterprise. While traversing the
journey of incubation, development and growth of products
and eventually the enterprise, they invite and take on the board
people who provide the financial capital. However, the capital
can be of two kinds: (a) preference capital and (b) equity capital.
Preference capital, as the name suggests, have a preference in
payment of return by way of dividends and also in the sharing
of the residual wealth in case of winding up. Preference capital
holders are generally entitled to a fixed rate of return which
can be both cumulative and non-cumulative depending upon
the terms of issue. Cumulative preference share would mean
that in case, in any year, there is an insufficiency of profits, the
dividend payable to them accumulates and becomes payable as
and when JSC makes profit and is paid before the payment of
dividend to equity shareholders. In case of non-cumulative, the
amount payable as dividend lapses in case of insufficiency of
profits in the company in any year.
The equity shareholders are the providers of real risk capital
and share the profits only after all other stakeholders have been
paid off. Equity shareholders are compensated only in case the
enterprise succeeds, and are therefore the residual stakeholders,
about which I will talk later in the book. In case the enterprise does
not succeed and has to be liquidated and wound up, they are the
ones who receive the residual, if any, and in most cases lose the
most. The equity shares can also be of two types: (a) voting and
(b) non-voting. Voting shareholders have a right to vote on all
the propositions in the annual general meeting (AGM), extraor-
dinary general meeting (EGM) or through circulation, whereas
non-voting shareholders do not have such a right. These can be
preferential or limited voting powers as well. It could be summa-
rized that these become the ultimate stakeholders.

34
 Stakeholders of Joint Stock Companies 27

3.1.2. Workforce or HR

These are the set of individuals who offer their labour and skills
and become part of the enterprise. Even though in most circles, it is
believed that the shareholders are the most important stakeholders
of the enterprise, I believe HR is equally important. In fact, it is fun-
damental to the utilization and leveraging of physical and financial
resources, for the creation of wealth. It is the human ingenuity and
competence which helps in optimizing wealth creation. ‘Dignity
of individuals and value of their contribution is very important’.
Hence, workforce becomes the second most important stakeholder;
if not equal to shareholders. HR is both contractual and residual
stakeholders as they have an interest in receiving not only their
contractual compensation, but residual too, having thrown their lot
in the sustainability of the enterprise. The importance of HR in the
success is pronounced in most organizations by offering employee
stock options plan (ESOP); ownership status as other shareholders.

3.1.3. Suppliers of Debt Capital, Goods and Services

Along the journey of its development and growth, an enterprise

needs additional doses of physical and financial resources, which
are most often externally marshalled. Although the owners of
these resources have a contractual relationship in the sharing of
wealth, they become important stakeholders in the management
of the enterprise as their compensation has a bearing on the qual-
ity of management, because various factors are considered while
agreeing to make resources available. For example, the suppliers
of debt capital agree for the rate of return in the hope of safety of
their capital and payment of interest thereon, credit rating of the
enterprise, that is, AAA, AA+, AA, AA– or A+ and so on. In case
if the enterprise is not managed well and the rating goes down,
then the enterprise becomes susceptible to higher risks with lower
possibilities of returns of the capital and interest thereon, and
risk premium in the shape of interest as the difference in the rate

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 28 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

of return goes up. Interest charged on the debt also includes the
‘risk premium’, assessed/determined by the possibility of default
in the payment of various debt obligations, which is evaluated
most importantly by credit rating agencies. Higher interest rate in
the lower rated papers validates the surmise. Similar is the case
with the suppliers of other goods and services for the extension
of credit facilities. Thus, the suppliers of debt capital, goods and
services are also an important stakeholder.

3.1.4. Customers

The enterprise comes into being to create and market products

which include services, and eventually, to make profit from pric-
ing arbitrage. The product is purchased/consumed by someone
at a price. Such persons/organizations are called customers.
Customers become important stakeholders not only for the
reasons of the quality and reliability of product/service but also
because the post-sale service and/or continuous satisfaction with
the product purchased depends upon the quality of management.
Even otherwise, the confidence of the customers has a direct and
proportionate bearing on the success and sustainability of the
enterprise. Thus, the management has to clearly accept customers
as yet another stakeholder of the enterprise while undertaking the
process of governance. The ethics is of prime importance in the
relationship with the customers. Consumers, particularly of ser-
vices such as banking, insurance, pensions and health and so on,
ascertain the quality of the Corporate Governance of companies
while buying or continuing to buy their products.

3.1.5. Society

The society allocates its scarce resources and provides an envi-

ronment of harmony and peace along with other enablers such
as the right to property, for an enterprise to come into being and
continue to survive and thrive. The society, therefore, becomes a
very important stakeholder of the enterprise. In case the wealth
36
 Stakeholders of Joint Stock Companies 29

creation, wealth management and wealth sharing are not at the

optimum level, the society can engineer—directly or indirectly—
the redeployment of resources by taking over, changing the
management and/or, in extreme cases, ordering the winding
up of the enterprise. It is the society that determines whether
the product produced by the enterprise can be sold, and if yes,
how and in what form and also the manner of promotion of the
products; tobacco and liquor products are cases in example.
The society is both the contractual and residual stakeholder.
Under the contractual relationship, it is entitled to certain pay-
ment, which can take the shape of taxes, rent, rates and so on. As a
residual stakeholder, the sharing of the wealth is organized through
what is now called ‘corporate social responsibility’ (CSR) in the
Corporate Governance terminology. In the Indian Companies Act,
2013, an obligatory compliance clause of spending at least 2 per
cent of the profits before tax on CSR has been incorporated.
Figure 3.1 depicts the stakeholders in a pictorial form.
These stakeholders eventually become the jury to pronounce the

Figure 3.1
3 Stakeholders Chain

CONTRACTUAL ENTITLEMENT
Value Value Safety of Interest & Taxes, Employment, Salaries
Creation Creation for Principal Enhancement Societal Benefits
for Buyer Supplier of Portfolio Quality Commitments Stability

CUSTOMERS SUPPLIERS LENDERS SOCIETY EMPLOYEES

BOARD MANAGEMENT

RESIDUAL ENTITLEMENT

MAJORITY MINORITY
SHAREHOLDERS SHAREHOLDERS

Value

The Essential Book of CORPORATE GOVERNANCE 37

 30 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

judgment on the quality of the management of the enterprise; à la

Corporate Governance.

3.2. Organizational Structure

The entrepreneur conceives the idea of a business to create

wealth. The creation of wealth needs a structure. The structures
are broadly of two kinds: (a) 100 per cent owned structure
(b) partly owned structure. The part ownership can vary from
1 to 99.9 per cent, legally. The structure of an enterprise to
undertake business, either of manufacturing, distribution and/
or service, can take any of the following formats: (a) Proprietary
ownership (b) Partnership (c) Cooperative society (d) Association
of persons (AOP)/body of individuals (BOI) and (e) Company—
private or public. The character of these structures is depicted
briefly and graphically in Figure 3.2.

3.2.1. Proprietary Ownership

A proprietary enterprise is fully owned by the entrepreneur

himself and, practically, there is no legal distinction between the
owner and the entity. He brings the entire capital required to start
and run the enterprise. Any time further, if capital is required,
he pumps the same in. The proprietor can, however, borrow
from individuals, bank and/or other lending institutions with or
without providing a security to protect the interest of the lender.
However, his liability in this business is unlimited. In case the
business fails and the assets of the enterprise are not adequate to
meet the obligations, other assets of the proprietor, which may not
be part of the business, can be liquidated to defray the liabilities.
The merit of the structure lies in the 100 per cent ownership of
the business, profits, wealth and value. It has high degree of flexi-
bility, quick decision-making and zero risk of fraud by partner(s).
The demerits are: (a) limited resources to run and expand the
business, (b) low borrowing capacity and (c) unlimited liabilities

38
 Figure 3.2 Organizational Structure

TYPES OF ENTITIES

COOPERATIVE
PROPRIETORY PARTNERSHIP AOP/BOI COMPANY
SOCIETY

Sole 1. Limited 1. Housing 1. Municipal Private Public

Ownership Liability 2. Building Corporation
Partnership 3. Retailers 2. Public works
(LLP) 4. Utility department 1. Limited by
2. Unlimited 5. Worker 3. Social and shares
6. Business Sports Clubs 2. Limited by
and guarantee
employment 3. Unlimited
7. Social Companies
8. Consumers
9. Agricultural
10. Cooperative LARGER DOMAIN
banking
Incorporated, Unincor-
porated, Chartered,
Statutory, Registered,
One Person Company,
Small Company, Public
Sector Undertaking,
State owned Enterprises,
Government and Foreign.

The Essential Book of CORPORATE GOVERNANCE

39
 32 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

in case of the failure of the business. Obviously, demerits over-

whelm merits and, therefore, any entrepreneur who wishes to
build large-sized business either does not adopt proprietary
structure or begins with proprietary structure and converts it into
some other structure to grow, sustain and/or diversify.

3.2.2. Partnership

As per Section 4 of the Indian Partnership Act, 1932, ‘Partnership

is the relation between persons who have agreed to share the prof-
its of a business carried on by all or any of them acting for all’.
The definition in other countries, wherever such structures exist,
is nearly the same, except in the case of limited liability partner-
ship (LLP), where the liability of partners is unlimited. Different
shades of partnerships can be created, some of which are briefly
enumerated as follows:

1. Partnership at will
2. Unlimited liability partnership
3. Limited liability partnership

LLP, where liability is limited by the capital subscribed, becomes

a useful structure to build small businesses including consulting,
accounting and other service-providing businesses. It is being
extensively used in the USA. India has made the beginning for the
SMEs and the Limited Liability Partnership Act, 2008 provides a
legal status to this structure.
This structure also suffers nearly from all handicaps as is the
case with proprietary structure.

3.2.3. Cooperative Society

This structure in effect is an autonomous AOP united voluntarily to

meet their common economic, social and cultural needs and aspira-
tions through a jointly owned and democratically controlled enter-
prise. In this structure as well, there are a number of limitations, but

40
 Stakeholders of Joint Stock Companies 33

what really impedes is the availability of cohesiveness, capital and

adequacy of the skills in the management of the enterprise.

3.2.4. Association of Persons

An association of persons means two or more persons who join

for a common purpose with a view to earn an income. The term
‘person’ includes any company or association or a BOI, whether
incorporated or not. The association need not be on the basis of
a contract. Therefore, if two or more persons join hands to carry
on a business but do not constitute a partnership, they may be
known as an AOP. But, an AOP does not mean any and every
combination of persons. It is only when they associate themselves
in an income-producing activity that it becomes an AOP.
However, BOI means a conglomeration of individuals who
carry on activities with the objective of earning some income. It
would consist only of individuals. Entities such as companies or
firms cannot be members of a BOI. Members have to be natural
persons.
This form of structure is generally used for setting up and
running a social club, which could be cultural, sports and so on.
In this structure, the membership is by the specifications and
no capital is required to be contributed. However, members are
required to pay some kind of an entrance fee supported by peri-
odical subscription. Here, the members have no personal liability
and in case of winding of the association the assets of the enter-
prise are used to meet the outstanding obligations. This kind of
structure is not used for any other purpose because of the obvious
limitations it has.

3.2.5. Company

Company is the most popular structure for building a commercial

entity. These are the AOP who contribute money to a common
stock known as the capital of the company and are incorporated.

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 34 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

These entities have existence independent of its members; in

effect an artificial person with a common seal and perpetual
succession. There are various kinds of companies:

1. Incorporated companies.
2. Unincorporated companies.
3. Chartered companies: Under the charter issued by the
sovereign or crown.
4. Statutory companies: A company may be incorporated by
the means of a special Act of the parliament or any state
legislature.
5. Companies limited by guarantee: It means a com-
pany having the liability of its members limited by the
memorandum to such an amount as the members may
respectively undertake to contribute to the assets of the
company in the event of its being wound up and these
could be with or without share capital.
6. Unlimited liability companies: Where the liability of the
members is unlimited.
7. Company limited by equity capital not for profit: Such
companies are formed not for making profit but for the
purposes of promoting commerce, art, science, religion
charity, poverty alleviation or any other useful social life.
The company is not required to comply with the require-
ments of minimum paid-up share capital. A partnership
firm can be converted into such a company.
8. Company limited by capital and for profit: This is the
shape of the company which is the most commonly
used structure for building businesses. The share capital
of such companies is widely spread and the liability of
shareholders is limited to the capital contributed and/or
the purchase price of shares. These shares are called com-
mon stock. Such companies could be listed or unlisted.

‘Listed company’ means a company which has any of its securities

listed on any recognized SX. The company could be a holding or
a subsidiary company. ‘Holding company’, in relation to one or
more other companies, means a company of which such companies

42
 Stakeholders of Joint Stock Companies 35

are subsidiary companies. ‘Subsidiary company’ or ‘subsidiary’, in

relation to any other company (that is to say the holding com-
pany), means a company in which the holding company

1. controls the composition of the BoD, or

2. exercises or controls more than one-half of the total share
capital either on its own or together with one or more
of its subsidiary companies; provided that such class or
classes of holding companies as may be prescribed shall
not have layers of subsidiaries beyond such numbers as
may be prescribed.

The following are the explanations for the purposes of this clause:

(a) a company shall be deemed to be a subsidiary company

of the holding company even if the control referred to in
sub-clause (i) or sub-clause (ii) is of another subsidiary
company of the holding company.
(b) the composition of a company’s BoD shall be deemed
to be controlled by another company if that other com-
pany, by exercise of some power exercisable by it at its
discretion, can appoint or remove all or a majority of
the directors.
(c) the expression ‘company’ includes anybody corporate.
(d) ‘layer’ in relation to a holding company means its subsidi-
ary or subsidiaries.

Similarly, there could be a private company which as per the Indian

Companies Act, 2013 Section 2(68), means a company having a
minimum paid-up share capital of one lakh rupees or such higher
paid-up share capital as may be prescribed, and which by its articles

1. restrict the right to transfer its shares;

2. except in the case of one person company (OPC), limits
the number of its members to two hundred; provided
that where two or more persons hold one or more shares
in a company jointly, they shall, for the purposes of this
clause, be treated as a single member.

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 36 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

Section 2(62) of the Indian Companies Act, 2013 recognizes

OPC, which means a company that has only one person as a
member. Only a natural person can be eligible to incorporate
an OPC.

3.3. Organizational Structure and Corporate

Governance

Before I deal with the Corporate Governance of enterprises

it is important to understand that notwithstanding the kind
of organization’s structure, the legality and the ethics have to
remain the basic tenet of the governance of the enterprise at
all times. Lack of ethics will not only jeopardize the economic
interest of the entity and consequently its owners but may even
threaten the very existence thereof. Similarly, conformance with
the applicable laws of business conduct has to be scrupulously
adhered to in all the cases.
In the case of an enterprise organized as the proprietary entity,
no call beyond what is mentioned in the earlier paragraph is
ordained for the governance of the entity. The owner/proprietor
can conduct the business of the entity as he likes.
In case of partnership, in particular where there are sleeping
partners, nominal partners or partners for profit only, it is impor-
tant that certain standards of governance are obtained to ensure
that the interest of such partners are not alienated at the altar of
the active partners.
In the case of cooperative societies, certain minimum stand-
ards of governance are expected to be observed. The governance
standards broadly enshrine equity and fair play. They are speci-
fied also because such entities become entitled to certain benefits
and that a number of stakeholders are common men/women and
are often fairly large in a number. In the Indian context, these
governance obligations have been enshrined in the various sec-
tions of The Cooperative Societies Act. In fact, some of the sec-
tions of the companies’ legislation also envisage certain do’s and
don’ts in the matter of the governance of cooperative societies.

44
 Stakeholders of Joint Stock Companies 37

However, in addition, cooperative societies have to observe gov-

ernance guidelines issued by the sector regulator such as Central
Bank, in case the entity is engaged in the business of banking
services. Similar is the situation in the case of AOP/BOI where
equity and fair play must remain as guiding principles at all times
in the matter of the governance of entities.
In the case of private companies, the Corporate Governance
standards required to be observed are minimal. Of course, the
basic principles as mentioned earlier of ethics, fair play and equity
must remain the guiding lights. In the case of unlisted public
companies, most regulatory jurisdictions enshrine certain basic
standards of governance and these have to be observed scrupu-
lously. However, in the case of listed companies, since a common
man of the public gets involved, very rigorous standards of the
Corporate Governance have been laid down. These standards, as
mentioned elsewhere in this book, are being talked about as the
tyranny of the Corporate Governance.

3.4. Corporate Governance at Financial

Distress

It is being increasingly believed that in majority of the cases,

firms land up in financial distress mainly on account of defi-
ciency in Corporate Governance. Be that as it may, I believe
the significance of Corporate Governance grows when financial
distress strikes a firm.
Generally, it is observed that the shareholders—manag-
ers and, in some cases, even professionals—and managers in
control of firms try to short-change HR, suppliers of goods and
services including financial institutions, customers and even the
statutory authorities, in times of financial distress, in particular.
This approach, to my mind, will take the enterprise to a path of
winding up, coupled with the destruction of reputation of the
managers. Hence, I recommend the use of all the four pillars of
Corporate Governance namely, reporting and accounting stand-
ards, RPT, disclosures and the boardroom practices to converge

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 38 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

to reassure all the stakeholders and also anyone else who is con-
cerned that the unfortunate situation of distress is being faced
with integrity and efficacy.
The attempt should be convincing all the stakeholders,
including minority shareholders, that RPT and/or reporting and
accounting standards were not used to siphon off the funds and/
or other resources. The efficacy of the financials should be potent
to convince that these really reflect the true and fair picture of
the results declared and that there has been no attempt earlier
or now to misstate the figures and/or recognition of income and
expenses. The quality of disclosures should be reassuring for the
stakeholders. They must feel convinced that they were always,
and now too are, being kept adequately informed of all that is
relevant for them to know.
The boardroom discussions and decisions must be focused on
protecting and promoting the interests of all the stakeholders. Also,
the stakeholders must have a comfort that in the boardroom every
attempt is being made to salvage the situation. Given the opportu-
nity, the firm will do everything at its command to ensure that the
firm meets the challenge with dexterity. If there is a decision to pur-
sue a haircut by the lenders and/or other stakeholders namely, HR
(in their compensation/exits and so on.), the appropriate economic
hit must also be to the managers (controller of firm’s operations)
and shareholders as well. The stakeholders must get a sense of the
earnestness of approach of the managers (in control) in meeting the
challenge with the least possible economic consequences to stake-
holders. Furthermore, those consequences are spread adequately
across the spectrum of all the stakeholders.
Notwithstanding the fact that the letters of law may obli-
gate the observance of the rigorous standards of Corporate
Governance, my recommendation would be to apply the ideas
detailed in this book for wealth creation, wealth management
and wealth sharing irrespective of the organization’s structure.
The logic is to benefit its owner and no less importantly to serve
the society whose scarce resources are marshalled for promoting,
building and sustaining the enterprise and eventually to continue
to receive its patronage.

46
4
Raison D’être of Joint
Stock Companies

I
t is important to understand the raison d’être or the funda-
mental purpose of building an enterprise in the character of
a JSC. It is clearly evident from the evolution of the JSCs that
the basic purpose of an enterprise organized in this format is to
pool in the resources of large number of owners who either do
not have the ability, time and energy or would like someone else
with ideas and capabilities to multiply their resources—create
wealth optimally. Since the level of riches and/or the possibilities
of creating wealth were not as much in Europe in the fourteenth
to seventeenth centuries, voyages were undertaken to destina-
tion riches. People with resources happily and enthusiastically
contributed their resources in the quest for greater multiplication
of the wealth, notwithstanding higher risks involved. Thus, the
basic underpinning was and continues to be the creation and/
or multiplication of wealth out of the resources marshalled and
efficacious sharing of wealth with the owners of these resources.
The resources so collected under the umbrella of the JSCs can
be broadly characterized into the following:

1. Physical Resources: Physical resources are land building,

minerals, power, raw materials such as cotton, steel,

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 40 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

grains and so on. These physical resources are sought to

be converted into finished products, which can be mar-
keted for different uses at a price higher than the aggre-
gated value of all the inputs.
2. Human Resources: Conversion of physical resources into
the product of a kind and quality, which is better/more
useful than what it was in the original shape, is facilitated
by human endeavours, either exclusively and/or with the
aid and assistance of machinery, tools and technology
and so on. These HR have various levels of skills which
range from administration to technical, from invention to
execution. The utilization of HR can be either by hiring
them exclusively for the JSC or by sharing them with
others. It could also be engaged to fulfil a task or a bunch/
bundle of tasks at the customers’ door.
3. Financial Resources: Acquiring of physical resources and
HR calls for the engagement of financial resources to buy,
own and/or hire physical resources—including raw mate-
rials required for products—and HR. Financial resources
are also required for taking the output of the finished
product to the customers and for rendering post-sales
services.

A part of physical, human and financial resources is made avail-

able by the individuals, groups and/or enterprises, but a part of
such resources is made available by the society. For example, a
land belongs to the state and it leases out that land to enterprises
either for free or on a minimal/subsidized cost and/or provides
infrastructure to facilitate the creation of the finished output. In
addition, the society lays down rules, regulations, legislations and
directions, which facilitate not only the creation of a JSC but also
its peaceful existence, right to ownership of assets and successful
sustenance. The enterprise, which is allowed to take charge of the
resources, has to create an output which is greater in value than
the value of total input(s). The gap between the value of output
and input is the wealth addition.

48
 Raison D’être of Joint Stock Companies 41

4.1. Wealth Creation

An enterprise is expected to create wealth out of the resources

that it uses for manufacturing/producing finished products—
goods and/or services. The difference between the values of all the
outputs created minus the aggregate value of all the inputs uti-
lized to create the output is the ‘wealth created’ by an enterprise.
Let us take for an example the value of all the outputs created
and/or produced by an enterprise equal to `100. If the aggregate
value of all the inputs—physical, human and financial, including
that of the entrepreneurs who manage the enterprise—is equal to
`80, then the gap of `20 between `100 and `80 is the amount of
wealth created by the enterprise.
The resources of the society, nay, the entire planet Earth
are limited. In an organized society, the resources should be
allocated to those individuals and/or enterprises that can create
wealth optimally by using the resources so allocated. Suppose ‘A’
creates a wealth of `20 (as mentioned earlier) but ‘B’ is capable of
creating a wealth of `30, then, in the best interest of the society
at large and fairness, the resources should ideally be allocated
to ‘B’ and not ‘A’. There are three limitations to such a situa-
tion: (a) the standards of who can create the highest amount of
wealth keep evolving, (b) the same resources can be allocated to
different enterprises for creating different kinds of products and
(c) priorities of the state in the interest of welfare of its citizens
may have compulsions. Since a perfect society does not exist,
the allocation of resources becomes an exercise in guesswork.
Empirical studies have established that market, although not
perfect, is a better allocator of resources. Hence, the evaluation
of wealth creation as reflected by the valuation of enterprise is
adjusted to be the level of confidence in the wealth creation,
which is also called discounting of future profits.
The creation of the structure of JSCs emerged and has been
evolving through the force of market practices. It has been estab-
lished over a period of time that JSC structure has the potential
of creating wealth at a higher rate. Thus, the first and foremost

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 42 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

raison d’être of a JSC is the creation of wealth, which has to travel

on an optimal platform at all times. In case JSC does not create
wealth optimally and/or does not continue to do so during the
course of journey of its life, it is only appropriate that the society
either shifts the management of the enterprise to the hands that
can do better or reallocate the resources to such an enterprise
which can create wealth at the optimum level.
The threat of the reallocation of resources should be so potent
that it continues to challenge the managers of an enterprise to
continuously improve wealth creation. This is what makes a hos-
tile takeover an accepted proposition, though such takeovers do
not always result in greater wealth creation. Market forces should
be able to prevent such an eventuality. Hence, the assessment of
the level of wealth creation should be an important element in the
Corporate Governance practices.

4.2. Wealth Management

The wealth so created by an enterprise belongs to all the stake-

holders of the JSC. I have already discussed in the previous
chapter who the stakeholders of the enterprise are. The wealth
so created is owned by all the stakeholders—contractually or
residually—and therefore has to be distributed, if and when, to
all the stakeholders in proportion to their entitlement. The wealth
sharing will be discussed subsequently. However, in the interest
of running the enterprise and sustaining its success, it is impor-
tant that atleast a part of the wealth created is retained within
the enterprise until the dissolution or winding up is decided or
becomes necessary. This is essential for beating the vagaries of
environment, ups and down, growth and/or sustainability. The
wealth so retained has to be used/managed in such a manner and
by such a method that the returns tread maximal trajectory. Thus,
the management of the retained wealth becomes the second most
raison d’être of JSC.
The management of wealth is a very challenging task. First,
let us understand that the retained wealth takes various shapes. It

50
 Raison D’être of Joint Stock Companies 43

could be physical, financial and/or human power. Full or part of

such retained wealth may be utilized by the enterprise for further-
ing its business and/or may be invested in some other venture for
driving up returns. It is important for the managers of the enter-
prise to understand that the authority to manage well eventually
comes with the responsibility of maximizing the returns and must
terminate in accountability for failure to do. Hence, they have to
continuously assess, configure and reconfigure its management
for the highest possible levels of returns.
During my stay in the SEBI, a secondary research was organ-
ized (survey was limited to a few selected companies) to assess
wealth creation, wealth management and wealth sharing. It tran-
spired that in one of the well-known and published Corporate
Governance failures, wealth creation was traversing on a very high
platform. However, the retained wealth, instead of being managed
with a view to maximizing returns, was seeping out through the
tributaries of special purpose vehicles with zero or minus returns,
which eventually led to the collapse of the enterprise itself. Hence,
the management of the wealth, in whatever form retained, must be
yet another important element of the Corporate Governance.

4.3. Wealth Sharing

As mentioned earlier, wealth created by an enterprise belongs to

all the stakeholders in proportion to the contribution of the inputs
provided to the enterprise. While there are some stakeholders
who have contractual ownership, there are other stakeholders who
have the residual ownership. Contractual stakeholders belong
to the categories such as HR, suppliers of debt and preferen-
tial capital and other goods and services, society and customers.
Equity shareholders are the residual stakeholders. Yet there are
stakeholders such as HR and society who in addition to contrac-
tual ownership have residual ownership as well. Furthermore,
amongst the equity shareholders there are majority and minor-
ity owners. The contractual stakeholders take precedence in the
sharing of wealth. For example, the HR and the suppliers of raw

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 44 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

materials and the debt and preference capital get precedence over
the providers of risk capital—equity holders. Similarly, a part
of the payment of wealth to the society in the shape of payment
of taxes takes precedence over the payment to other stakeholders.
Figure 3.1 in Chapter 3 depicts the ownership of the wealth in
contractual and residential format.
The enterprise, therefore, must so architect the disbursal phi-
losophy and policies that the wealth is shared sagaciously. One set
of stakeholders is not disbursed wealth, which is disproportionate
to their contribution and/or is at the cost of other stakeholders. In
most Corporate Governance misdemeanours it has been brought
to light that the executive compensation was disproportionate to
their contribution in wealth creation and wealth management.
Similarly, the examination of related party transactions revealed
benefiting one set of stakeholders of an enterprise at the cost of
other stakeholders of the same or some other related enterprises.
Thus, sharing of wealth becomes yet another significant factor in
the operation of Corporate Governance practices.
Summing up, the purpose of JSCs is to create wealth opti-
mally, maximize returns on the retained wealth and share the
wealth efficaciously. Anytime, and in any event, if either of the
three purposes of the creation of JSCs is undermined, the basic
philosophy of creating the JSCs is challenged and the deficit of
Corporate Governance becomes apparent.

52
5
Greed, Hubris and
Delinquencies: Barriers
to Good Corporate
Governance

T
he separation of ownership and control, which defines the
modern corporation, is a fundamental development in the
contemporary capital markets. The segregation has divided
the owners of enterprises into two parts: (a) active and (b) passive.
In most cases, a small minority manages the wealth and interests of
a large majority of JSC stakeholders. However, in some cases, pure
professionals manage the interests of all the stakeholders. A human
being is basically selfish and, more often than not, seeks to serve his
own enlightened self-interest even at the cost of others. To dissuade
him from falling in the trap of this basic human tendency calls for
society’s directed obligatory compliance with the fundamentals
of equity, justice and fair play coupled with a moral suasion of
being an honourable social being. Dereliction must face deterrent
punishment and the delivery thereof must be a stitch in time.
Unfortunately, in most societies and on many occasions it does
not happen.

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The greed and hubris, many a time, propels the active managers/
owners of the enterprises to drive the organization in the trajectory,
which sometimes derails the journey of growth and sustainability
and/or profit disproportionately to the detriment of the interest of
inactive. Such a subjective management of enterprises leads to innu-
merable scandals, frauds, seeping and siphoning of resources and
wealth. Although such misdemeanours have been very many during
the existence of the institution of JSC, scandalous collapse of several
large and significant companies such as Equitable Life, Ferranti
International PLC, Bank of Credit and Commerce International
(BCCI) and Colorado Group shook the environment in the UK.
Similarly, misgovernance at WorldCom, Tyco, Enron and so on
created a stir in the USA. MS SHOES and Satyam Computers are
two well-known cases amongst the spate of Corporate Governance
failures in India. Such instances of destruction of one-time success-
ful enterprises are plentiful across geographies.
It may not be necessary to elaborate here how a mix of greed,
hubris and delinquencies has destroyed the value of the corpo-
rate world over time. However, it might be useful to exemplify
by quoting atleast one instance from each of the three different
aspects. Although a few (detailed) case studies are available in
Annexure 1, a sense is sought to be provided in this chapter about
the play of greed, hubris and delinquencies. Parmalat Finanziaria
of Italy is an extreme example of greed wherein active stakehold-
ers of the company appropriated the value and presented falsified
accounts. The management lured the investors through imagina-
tive, speculative and structured instruments designed by a group
of bankers—global and Italian—and siphoned off moneys to a
network of 260 companies.
In Enron, which rose like a phoenix out of unbridled and
unruly creativity, sheer hubris helped the top management to
create a questionable business model which concealed true per-
formance. The financial engineering was believed to be a remark-
able innovation without any realization ever by the directors that
Enron was essentially hedging with itself.
Equitable Life, where nobody made financial gains out of
the failure of governance, is a case of sheer delinquencies. The
board indulged in collective rationalization. A policy without a
54
 Greed, Hubris and Delinquencies 47

perception of potential blowup was pursued relentlessly until the

balance sheet could not hold it anymore on its own. Technicians
were allowed to abrogate absolute authority and, in their anxiety
to deliver performance, they created complexity which was com-
pounded over and again. The board forgot the basic tenet that
managing includes visioning the propensities of the possibilities
of the pursued policies.
It must be understood that the economic agents—the execu-
tive management saddled with authority—have the tendency to
be self-serving, arrogant, particularly with success, and, in the
absence of well-laid-down manner of conduct, may exhibit
unruly behaviour. Soft boardroom practices, which border on
delinquencies, make the most important pillar of monitoring
pyramid—board, ineffective. Greed, hubris and delinquencies
compound that situation and they often fail to realize that they
are leading the erosion of value and even the destruction of the
organization itself.
It is therefore important that those in control of the corpora-
tion are propelled and even compelled to manage it in the best
interest of all stakeholders. Such a management has been termed
as good Corporate Governance.

5.1. Barriers to Good Corporate Governance

My analysis of various governance failures during my stint at the

SEBI and researching for this book has revealed certain common
barriers to good Corporate Governance. Even though the basic
malaise emanates from the agent–principal relationship, I have
tried to elaborate a little after grouping these into the following
seven categories.

5.1.1. Agent–Principal Relationship

The agency theory applies to a JSC as well. The principal in

the case of JSC is the shareholder and the management is the
agent. The principal (shareholders–owners) allows the agent
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 48 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

(management) to manage their interests. The basic underpin-

ning of the separation of ownership with control gives birth to
this prognosis. The managers have inherent inclination to pro-
mote their self-interests even to the disregard of the interests of
the owners. The agency problem was highlighted by the great
economist, Adam Smith, in 1937 in his book Wealth of Nations.
This relationship is the fundamental barrier to good Corporate
Governance, which is neither understood by the board, and even
if understood, the challenge to turn this otherwise useful relation-
ship into a win–win journey in the life of JSC is not worked upon
while superintending the role of the management. The regula-
tory interventions, which add costs to the JSC, do not deliver
the expected outcomes in the absence of the appreciation of the
problem by the board.

5.1.2. Ownership Structure

The concentration of ownership and/or its diffusion into a hold-

ing or subsidiary, group or remotely stationed ownership creates
artificial road blocks in the selection, appointment, remuneration
of the CEO and other critical functionaries such as CFO and direc-
tors and/or the management of the enterprise itself. It is sought
to be explained that these are the rights conferred in terms of its
ownership of the enterprise. Recently, the majority owners of a
company in India triumphantly announced that one of the share-
holders has lost its right to nominate an independent director. The
right to appoint an independent director(s) challenges the efficacy
of independence of the directors so appointed. Similarly, a right to
appointment, remuneration and so on of critical functionaries who
are to be (as per regulatory directions) appointed by the board
on the recommendations of the Nominations and Remuneration
Committee makes a mockery of the substance of compliance.
It weaves a cob web of loyalty. Furthermore, the concentrated
ownership bulldozes the minority owners in the critical decision-
making. Protection of minority rights regulatorily ordained,
which add to costs, most often turn out to be a wasteful expense.

56
 Greed, Hubris and Delinquencies 49

The ownership structure does not allow corporate democracy to

bloom, which prevents the free flow of discussions, voicing of
dissent and even pointing out the lapses in the governance of the
enterprise. Thus, the ownership structure becomes a barrier to
good Corporate Governance.

5.1.3. Board Structure

Similarly, the constitution of the board, its role and authority and
functioning itself can become a barrier. An ideal board is the one
which is dominated by the independent directors and not by the
shareholders’ representatives. This is missing in most boards. In
fact, the shareholders’ director(s) dominates the proceedings and
even dictates, and the situation is compounded if a set of share-
holders have the right to appoint or even recommend names for
the appointment as independent director(s). In one of the board
meetings of a listed company when I was told by a shareholder
director that I was his nominee, not only did I refute but even
offered to quit. Eventually, I resigned from the board and this was
one of the reasons for my decision. I was so reminded probably
because my thinking was not aligned to his thinking. In most
cases, the role and authority of the board is not clearly deline-
ated, which propels the executive management to abrogate the
board’s role. Furthermore, the functioning of the board itself in
quite a few cases is inefficacious. Thus, the board structure can
also become a barrier to good Corporate Governance.

5.1.4. Non-alignment of Interests of Directors with

Long-term Value Creation

There are examples of directors who have a reciprocative (informal)

arrangement to sit on each other’s board. There are also directors
in companies who have (vicarious) conflict of interest. Similarly,
there are directors whose remuneration is linked to short-term
performance. In fact, the real weak link in the alignment is the

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 50 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

compensation structure in the company. Likewise, there are other

areas which lead to the misalignment of interests and become a
serious handicap in building a good Corporate Governance.

5.1.5. Abuse of Executive Powers

There is a natural tendency amongst the executive management to

overstep the delegations. Unfortunately, the current governance
practices’ dispensation allocates excessive powers to the executive
management. This is compounded by the ineffective superintend-
ence by the board. Enron was a case of blatant abuse of powers
by the executive management. The audit and other checks and
balances including the threat of takeover could not prevent the
abuse. The delegation of powers to the executive management
also becomes a barrier to good Corporate Governance.

5.1.6. Abuse of Corporate Opportunity

Sometimes, opportunities open up for an enterprise to enter into

a new partnership, product line or even a business line. The exec-
utive management often makes use of those opportunities first for
themselves and only later for the benefit of the enterprise. In some
cases, an enterprise is completely deprived of those opportuni-
ties, particularly if the executive chairman and/or the CEO is a
promoter shareholder as well.

5.1.7. Absence of Democracy

The JSC structure enshrines the multiplicity of stakeholders,

which necessitates the application of principles of democracy.
The principles of democracy warrant promotion of the great-
est good of the largest number. Democracy respects the dissent
and cares for the interests of minority and prevents abuse of

58
 Greed, Hubris and Delinquencies 51

majoritarianism. Absence of democracy is a significant barrier in

building a good Corporate Governance.
There is a belief in the minds of the majority or controlling
shareholders in most companies that they are the owners not
in coordination with other shareholders but absolute possessor
of the enterprise and, therefore, can get away with the form of
compliance of Corporate Governance. Similar situation obtains
in the minds of some of the executive managers as well. They
think that since there is no dominant owner and/or the company
has been allowed to be professionally managed, they can conduct
themselves without caring for the substance of compliance. The
barriers, which build an ethos, have to be clearly understood and
dealt with effectively. Unfortunately, I have observed in some of
the boards that the directors including independent directors are
not adequately conscious of their fiduciary responsibility and live
in the comfort of ‘where ignorance is bliss’.

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 6
Fruition: Concept of
Corporate Governance

T
he innumerable scandals stemming out of the failure of
Corporate Governance, which include downright fraud
and mismanagement in many geographies, have shattered
the confidence of the investors of resources in the basic fab-
ric of an enterprise as a JSC. An impression has been gaining
ground that those in the active management by the virtue of the
authority vested in them, treat the interest of other stakeholders
with utter disregard, mismanage the enterprise, siphon off the
resources and even organize and undertake daylight robberies
on the wealth of the stakeholders. The disgust emanates from
the fact that such irresponsible behaviour is being reflected
by those who are expected to be the trustees of the interest of
all stakeholders.
Governance failures created an uproar in the financial
markets, which made the governments and regulators sit up
and take notice. There was a rethink on the role of the state,
which is expected to provide basic support services such as law
and order, a conducive legal environment, a decent and potent
supervisory and regulatory infrastructure, a reliable accounting
system, a vibrant securities market and so on, while the private
economic agents carry on the economic activities. Even the

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 Fruition: Concept of Corporate Governance 53

allocational efficiency of the resources by capital markets has

been questioned. Discipline of capital markets itself came under
severe attack.
It was felt that the rules and canons of market discipline were
inadequate and even the existing code of conduct was not effec-
tively enforced. This led to the formation of a number of commit-
tees and commissions and enunciation of codes around the world
(noted amongst those have been mentioned below), beginning
with the Cadbury Committee chaired by Sir Adrian Cadbury,
CEO of the Cadbury Confectionary empire.
Back home in India, the following committees have been
appointed:

• Kumar Mangalam Birla Committee on Corporate

Governance (2000)
• Naresh Chandra Committee on Corporate Audit and
Governance (2002)
• N.R. Narayana Murthy Committee (SEBI, 2003)
• Naresh Chandra Committee Report of 2009 (CII Taskforce
on Corporate Governance formed post Satyam episode)

The corporate misdemeanours consequenced by greed, hubris

and delinquencies have incited a global approach to bringing an
order in the management of enterprises, particularly those which
are publicly owned, where the number of shareholders is large
and widespread and has a complement of minority shareholders.
The orderly management of an enterprise has been christened as
Corporate Governance.
Many pundits in the field have defined Corporate Governance
in many ways and it ranges from managing and maintaining
financial health of an enterprise to including optimal wealth crea-
tion, maximizing wealth management and most efficacious shar-
ing of wealth amongst all the stakeholders.
Innumerable definitions of Corporate Governance have
been laid down by the various committees, commissions and
organizations. The excerpts from some of the definitions could
be described as follows:

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62
List of Committees and their Country

Sr.
No. Name of Committee Country/Organization
1 Sir Adrian Cadbury Committee on Financial Aspects of Corporate Governance (1992) UK
2 Mervyn E. King’s Committee on Corporate Governance (1994) South Africa
3 Greenbury Committee on Directors’ Remuneration (1995) UK
4 CaIPERS—Global Corporate Governance Principles (1996) USA
5 Business Round Table (BRT)—Statement on Corporate Governance (1997) USA
6 Hampel Committee on Corporate Governance (1998) UK
7 Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (1999) USA
8 Combined Code of Best Practices (LSE) (1998) UK
9 OECD principles of Corporate Governance (1999) OECD
10 CACG Principles for Corporate Governance in Commonwealth (1999) Commonwealth Secretariat
11 Derek Higgs Committee (2002) UK
12 Sarbanes Oxley Act (2002) USA
13 Kumar Mangalam Birla Committee on Corporate Governance (2000) India
14 Naresh Chandra Committee on Corporate Audit and Governance (2002) India
15 N.R. Narayana Murthy Committee (SEBI, 2003) India
 Fruition: Concept of Corporate Governance 55

‘The system by which companies are directed and controlled’

by Cadbury Committee, 1992. ‘The relationships among the man-
agement, Board of Directors, Controlling Shareholders, minority
shareholders and other stakeholders’, states International Finance
Corporation (IFC), Washington.
The Organization for Economic Co-operation and
Development (OECD) defines Corporate Governance as:

involving a set of relationship between a company’s management, its

board, its shareholders and other stakeholders. Corporate Governance
also provides the structure through which the objectives of the com-
pany are set, and the means of attaining those objectives and monitor-
ing performance are determined. Good corporate governance should
provide proper incentives for the board and management to pursue
objectives that are in the interests of the company and shareholders
and should facilitate effective monitoring, thereby encouraging firms
to use resources more efficiently.

According to the World Bank, Corporate Governance is:

• Blend of law, regulation and appropriate voluntary private sector

practices
• Which enables the corporation to attract financial and human
capital, perform efficiently, and
• Perpetuate itself by generating long-term economic value for its
shareholders,
• While respecting the interests of stakeholders and society as a
whole.

A complex definition has also been provided by the advisory

board of the National Association of Corporate Directors (NACD),
New York: ‘Corporate Governance ensures that long-term strate-
gic objectives and plans are established in place to achieve those
objectives, while at the same time making sure that the structure
functions to maintain the corporation’s integrity reputation, and
responsibility to its various constituencies’.
In one of the many books published since 1992, the
Corporate Governance consists of five elements, which the BoD
must consider:

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 56 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

• Long-term strategic goals

• Employees: past, present and future
• Environment/community
• Customers/suppliers
• Compliance/legal and regulators

Taking a world view of the definitions, I would like to sum

up Corporate Governance as the philosophy that a company
practises in its relationships with its shareholders, lenders,
employees and other stakeholders, including society at large.
It mirrors the company’s integrity, efficiency and long-term
growth. Corporate Governance must assure the investors and
lenders alike that the company’s dealings with its stakeholders
will be fair and transparent, the CEO and the BoD will be held
accountable, the company will be responsible in its business
transactions and will create wealth optimally, maximize wealth
substantially and share wealth efficaciously.
Any Corporate Governance definition must be inclusive of
structuring, operating and controlling the enterprise with a view to:

• Fructify the vision of its incorporation as modified from

time to time
• Erect pillars of sound business ethics
• Meet the expectations of all stakeholders
• Remain compliant in letter and spirit with all applicable
legal and regulators prescriptions

This makes the concept of Corporate Governance incredibly

broad. In effect, good Corporate Governance is expected to
balance the interests of, and relationships between, the various
stakeholders of the company while ensuring the long-term sus-
tainability and success of the enterprise.
New setting unfolds a unique set of challenges in ensuring
that a company’s assets are managed proficiently, prudently and
honestly and what will eventually differentiate a company will be
its capacity of wealth creation, dexterity of wealth management
and efficacy of wealth sharing amongst all stakeholders.

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 Fruition: Concept of Corporate Governance 57

The world at large, though not simultaneously, woke up

to the propensity of subjective management of enterprises and
alienation of the interest of stakeholders, in particular minority.
This has led to the visualization, conceptualization, articulation
and institutionalization of rules and regulations, procedures and
practices, which seek to reduce substantially, if not eliminate
altogether the propensities of subjectivity in the management of
enterprises and ensure that these are run in the best interest of all
stakeholders.
There are two schools of thought on the direction of the
Corporate Governance. One believes that good Corporate
Governance is intended to protect and further the interest of all
shareholders—both active and passive, in control and not in con-
trol, minority and majority. The other school of thought considers
that Corporate Governance should be directed to enhance and
ensure the interest of all stakeholders. Their belief emanates from
the underpinning that a corporation is created, built and sustains its
growth and life by the contribution of all stakeholders. Stakeholders
can be grouped in five categories: (a) shareholders—minority
and majority, (b) workforce (c) suppliers of financial capital—
debt capital and other goods and services, (d) customers and (e)
society. It is their belief that if all these stakeholders did not pro-
vide full support, the enterprise may not come into being and/
or may not sustain its success. I consider myself as a part of the
second school of thought which holds that Corporate Governance
must protect and promote the interest of all stakeholders. In fact,
I had the audacity to argue at various regulatory forums across
geographies, whenever I participated in the meetings of com-
mittees, subcommittees and AGMs of International Organization
of Securities Commissions (IOSCO). Fortunately, the concept
has since gained currency across geographies and codes, rules,
regulations and legislations are being amended to include all the
stakeholders as mentioned earlier. In India, The Companies Act,
2013 incorporates specific provisions for CSR and lays down the
statutory obligation of allocation of profits towards fulfilling that.
In my belief, this is a part of wealth sharing with the society—one
of the stakeholders.

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 58 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

The subject of Corporate Governance has been and continues

to be a matter of debates and discussions in various forums and
occasions in all parts of the planet Earth. These forums range
from specifically formed for Corporate Governance to regulatory
forums, academia, industry associations and even private organi-
zations, though unconnected directly with the corporate world.
In fact, there are quite a few organizations promoted by self-serving
individuals who profess to champion the cause of Corporate
Governance and make a living out of such initiatives. The occa-
sions for discussions on Corporate Governance have been ranging
from board and AGMs to social discussions over cocktails and
dinners. Varieties of prescriptions have been laid out. In fact,
there is quite a bit of confusion in the minds of many corporate
honchos so as to what line of approach should be pursued.
The Corporate Governance has since become a matter of per-
ception. There are organizations where Corporate Governance is
being perceived to be excellent, and then there are organizations
where it is considered to be a sham. To understand the broader
market view, I decided to talk to a few chairman–CEOs of some
of the prominent companies in India to understand how they
comprehend Corporate Governance. Here are some excerpts from
those conversations.
Narayana Murthy, chairman of Infosys, defined ‘good corpo-
rate governance as maximizing shareholder value while ensuring
fairness, transparency, and accountability in dealing with every
one of the stakeholders–customer, employees, investors, vendor
partners, government of the land and society’. Deepak Parikh, the
chairman of Housing Development Finance Corporation (HDFC)
Group, said, ‘Good corporate governance is running the company
in a way that it is not detrimental to any stakeholder. It gives good
returns to investors, treats its employees well and above all deals
with customers fairly, efficiently and effectively’. He summed up,
‘There is no softer pillow than clear conscience’, and went to add,
‘I am a trustee of stakeholders’ interest’.
Anand Mahindra, Chairman of Mahindra Group, said, ‘I am a
custodian of stakeholders’ interest of a cooperative enterprise’. He
went on to add, ‘Corporate governance is all about building trust

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 Fruition: Concept of Corporate Governance 59

amongst stakeholders’. Adi Godrej, Chairman of Godrej Group,

said, ‘Corporate governance is all about probity and corporate social
responsibility’. He further added, ‘All the stakeholders must get the
best out of the corporate decisions’. Kishore Biyani, CEO of Future
Group said, ‘Corporate governance has a very wide meaning. It
is how you govern the interests of your shareholders, employees,
suppliers, vendors, society etc’. Naik, Chairman of L&T, said, ‘It is
all about building trust amongst the stakeholders, which is around
truth, honesty, compassion and supporting society’.
Apparently, there is a common thread in the thinking of the
people I talked to. By and large they all ruminate that the interests
of all stakeholders must be promoted, protected and furthered
in the governance of the firms. The undertone of building trust
amongst stakeholders was manifest in all the conversations. Mr
Narayana Murthy was explicit in his expression, ‘Living in har-
mony with the society is the most important of all because soci-
ety contributes to customers, employees, investors, and vendor
partners etc...’. ‘The driver for us is to build something lasting for
society and money is not the prime motivator’, asserts Kishore
Biyani. ‘Fear of God’, says Anand Mahindra, ‘inspires us to always
uphold the values propounded by founders’.
These observations may not be the representative view of
the corporate managers. However, these are the views of the
chairman–CEOs of the successful enterprises of India, which
do indicate that Corporate Governance has to transit from mere
managing the interests of shareholders to furthering the interests
of all stakeholders. These views also indicate that sustainable suc-
cess lies in good Corporate Governance. Let us move on to the
thesis of building good Corporate Governance.

The Essential Book of CORPORATE GOVERNANCE 67

 7
Pillars of Corporate
Governance

7.1. Introduction

C
orporate Governance stands on four pillars namely, dis-
closures, RPTs, accounting and financial reporting stand-
ards and boardroom practices. Generally, pundits in the
Corporate Governance area have considered it to be a three-legged
stool namely, disclosures, accounting and financial reporting
standards and boardroom practices. However, every Corporate
Governance failure where financial misdemeanours are involved
has had something to do with the RPTs. Hence, to club the RPTs
with disclosures is leaving the areas of wealth management and
wealth sharing ineffectively monitored and a window open for
seeping out of resources. The strength of all the pillars can make
the corporate edifice safe and sound, provided these pillars function
in tandem and provide strength to each other. Collectively, the
strength of the four pillars of Corporate Governance should be
greater than the sum total of the strength of individual pillars.
All the four pillars will be discussed in some detail later, but
it must also be understood that all these pillars have a four-tier
monitoring pyramid (graphically described in Figure 7.1):

68
 Pillars of Corporate Governance 61

1. Management inclusive of chief compliance officer

2. Auditors—internal and statutory
3. Board subcommittees, such as:
• Audit committee
• Nomination and remuneration committee
• Risk management committee
• Stakeholders’ relationship committee
4. Board of directors

Although the role and responsibility of each of the tiers will be

discussed in some detail at the appropriate place in the book, it
would be worthwhile to mention here that all the four tiers have
the allocation of singularly different role and are not expected to
replicate the role played by the other. In fact, the strength and
reinforcement of each of the tiers must strengthen all the others.

Figure 7.1 Edifice of Corporate Governance

REGULATOR

PUBLIC SECTOR COMPLIANCE PRIVATE SECTOR – EV

BOARD
BOARD COMMITTEES
AUDITORS
FINANCIAL REPORTING
ACCOUNTING AND
RELATED PARTY
TRANSACTIONS

BOARD ROOM
DISCLOSURES

PRACTICES

MANAGEMENT

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 62 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

It would be worthwhile to understand and appreciate why such

an elaborate framework has been created over the years to enhance
the quality of Corporate Governance. It is important to understand
what is the role that each of the pillars of Corporate Governance is
going to play. Let me begin with boardroom practices.

7.1.1. Boardroom Practices

There are adequate regulatory obligations and market practices

and processes which can vouch and validate disclosures, RPTs
and observance of the accounting and financial reporting standards.
Regulators and the markets still fail to get a clear picture of what
happens in the boardroom of public companies. In quite a few
cases, there is a significant amount of camouflaging by appointing
persons of repute, knowledge and understanding on the boards,
but the practices inside the boardroom convert them into artefacts
oozing out aroma as if good governance practices subsist.
Boardroom is a place where the vision, mission, values, cul-
tures and strategic direction of the company are decided. This
is a place where the performance of the management and value
creation in the enterprise is evaluated. This is the place where the
efficacy of management assurance and independent assurance in
the financial management and reporting are evaluated. Hence, it is
important that the boardroom practices make it an effective forum
to efficaciously monitor (through its committees) and provide saga-
cious superintendence by its own appraisal. In most organizations,
the real weakness lies in the boardroom practices. The rigours of
the boardroom practices have been discussed in a separate chapter.
It might be worthwhile to quote an instance here. When I
was heading the corporate communication department of LIC,
one day, I needed to meet the managing director (MD; immedi-
ate superior) for an urgent consultation on a matter of serious
significance. I called up his office to seek an urgent appointment.
His executive assistant informed me that he is stepping out of his
office to attend the board meeting of a large-sized listed company,
but will send for me as soon as he is back in office.

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 Pillars of Corporate Governance 63

Within half an hour, I got a call from the MD’s office to rush for
the meeting (it was almost a 0.5-kilometre walk, though in the same
building). I was surprised and curious to know how he could return
so soon. At the end of the meeting, to quench my curiosity, I asked
him how he could be back so soon. What he told me took me by
surprise. He said, the board meeting of that company does not last
for more than 30 minutes and the company’s office was next door; 5
minutes to go, 5 minutes to return, 10 minutes for meeting and 10
minutes for tea. He further surprised me by telling that the chairman
boasts of the shortest meeting of the board. It was a very successful,
profitable and blue chip company then, but eventually it got merged
with another company following its becoming a sick industrial unit,
to be saved from extinction. The management of the company, being
under a large industrial empire, enabled that process. This incident
smacks of what sometimes happens inside the boardroom.
I have been sitting on the boards of companies right from
the 1990s, except for a brief break of just about three years when
I was the SEBI Chairman. The quality of discussions, length of
meetings and contents of agenda papers have improved substan-
tially in many cases since then. Fortunately, the era of 10-minutes
board meetings held in the 1990s is over. Yet, the concerns of the
boardroom practices are still there. In fact, many board meetings
still do not last for more than an hour or two.
There are two aspects of the boardroom practices: (a) design-
ing of agenda and circulation of background materials (notes) to
facilitate an informed decision-making and (b) quality of discus-
sions including time spent on each of the items of the agenda of
significance. More often than not, even in some of the well-known
public companies, meetings are convened at short notice and the
agenda of serious significance is laid on the table under the pre-
text of business exigencies. This leads to two kinds of situations:
(a) busier amongst the board members are not able to attend;
seek leave of absence and (b) even those who attend are provided
inadequate information, that too at the last minute, which converts
boardroom discussion into a kind of rubber stamp.
The quality and context of discussions in the boardroom are
more important. Even if all the necessary rituals have been gone

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 64 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

through but the time allotted and the quality of discussion does
not engage the wisdom of the board members, the very purpose
of getting them together in a boardroom is defeated. The wis-
dom of an individual comes out best when it is challenged. It is
analogous to an athlete being challenged by someone equally or
more competent when his entire physical, mental and emotional
strength is unified into delivering the best within.
Some of the common trends, which have been noted in the
boardrooms, are as follows:

1. Chimera of invulnerability
2. Collective rationalization
3. Illusion of unanimity
4. Superfluous assessment and stereotype vision
5. Unquestioned belief in morality of management

This book contains some of the examples of how each of these

trends lead to serious Corporate Governance failures. While in
two cases it lead to serious financial loss, in the other two, it
appears that the board could not comprehend and direct the
enterprise early enough to be able to sustain the success.

7.1.1.1. Chimera of Invulnerability

Management of the most successful companies nurtures the senti-

ments that the company will continue to succeed and is not vul-
nerable to changes in the environment—macro and micro. In such
organizations, risk management is a ritual which is gone through
every quarter, either by the audit committee or by the risk man-
agement committee. It has to be understood that public companies
and even individuals and societies are vulnerable to decline and
decay. History validates the fact that the one-time most successful
and largest company of the world, EIC, went down to the level of
pity. Fortunately, it has emerged out of the debris of dilapidated
(one-time) economic monument and has been bought by an
Indian for a pittance as a matter of self-pride to acquire what once
acquired India itself. Studies have revealed that out of the Fortune
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 Pillars of Corporate Governance 65

500 companies 25 years ago, more than 75 per cent have gone out
of the list and more than 50 per cent do not exist in the original
form. Even in the case of India, only two out of 30 companies are
a part of Sensitive Index (SENSEX; BSE Index) now from what it
was just 10 years ago. This happens when one does not re-engi-
neer, reinvigorate and reorchestrate itself.
One example that comes to the mind is that of a snake. There is
a mystic myth in India that a snake lives long; in fact, it is believed
that it lives for thousands of years. An old snake of such an age is
said to possess ‘nagmani’, which can transform anything into pros-
perity and value. I am not a zoologist. Hence, I cannot confirm if a
snake lives for hundreds of years, but most zoologists with whom
I have interacted with confirm that the snake has a propensity of
living longer and this stems out of the fact that every six months a
snake goes through its reincarnation—by shedding its upper skin
completely and growing a new skin. Even though the process is
painful, it rejuvenates itself to take on the vagaries of the external
environment and internal ageing with renewed strength and vigour.
Similarly, in the case of successful companies, if there is a
process and mechanism to rejuvenate itself periodically, there is a
very strong possibility of its sustaining success over a long period of
time. Unfortunately, however, in most boardrooms, the belief of the
management is shared by the non-executive directors (NEDs) and
perspectives outside of the management ethos are not considered on
a regular basis. The chimera of invulnerability is shared by them all,
which eventually impacts the sustainability of the company.
I had the pleasure of sitting on the board of a prestigious
company as a nominee director in the mid-1990s. While under-
standing the business and its model, it was discovered that it had
serious concentration risk. When it was pointed out to the then MD
and CEO in one of the board meetings, it was brushed aside. In
fact, it did not evince even adequate interest of other NEDs, even
though a galaxy of the top Indian business leaders was present.
Since it belonged to a prestigious group, the chimera of invulner-
ability had overwhelmed. Eventually, it suffered from that risk
going forward, and the enterprise was brought on track only with
the change of CEO and the appreciation of the risks to the busi-
ness model, albeit with a serious downside for several years.
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Similarly, one of the India’s most valuable companies with the

highest price/earnings (P/E) multiple in the related industry and
which is perceived to be the paragon of Corporate Governance
commenced the journey down the hill. In fact, it was going
through midlife crises, which the board failed to perceive or
atleast failed to address. It tried some patchwork but continued to
struggle. Notwithstanding the presence of globally accomplished
board members, the chimera of invulnerability seems to have
engulfed the success into the whirlpool of instability. Fortunately,
the entry of a new executive management team is rebuilding its
image, growth and profitability.

7.1.1.2. Collective Rationalization

It is a common practice in the boardroom to rationalize a deci-

sion which did not deliver the expected or bring about the conse-
quences, leading to a setback to the company. Learning is a serious
exercise and individuals, companies, countries and even societies
have to continue to learn and unlearn. Learn what is new and
unlearn what has become irrelevant. Failures and/or events prof-
fer very potent potentialities for learning. In fact, failure and/or a
wrong decision should be considered as an investment into learn-
ing. However, that is possible only if a comprehensive analysis is
presented to the board of what happened and why, along with what
could have possibly been done to anticipate what went wrong and/
or the assumption that did not turn out to be correct. Throwing
away the instances and/or opportunities of failure without learning
is suicidal for the growth and sustainability of the organization. The
board should transit from collective rationalization to coordinated
learning, which often does not happen in most boards.
In another company where I had the privilege to join the
board as an independent director, the decisions were leading
to disastrous results. But, the lessons were not being learnt and
issues were closed with rationalizing the failure to the impact
of the environment. Eventually, the company went down. Of
course, I resigned (out of sheer disgust) from the board of the
company much before its demise.
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7.1.1.3. Illusion of Unanimity

It has often been observed that the board members put on a mask of
unanimity even though the undercurrent in the minds is often of a
disagreement. While appreciating the corporate democracy, disagree-
ment should be welcomed, considered and tolerated. Unfortunately,
most people, including those who have had very successful careers,
hesitate to express a divergent view in case the chairperson and/or
the majority owner in the management hold a different point of view.
In the context of the boardroom practices, it will be worth-
while to mention what has been observed in the case of quite a few
individuals. The very fear of alienating the mind of the chairman
and/or management and the probable consequences on the re-
election and/or uncertainty over the direct and vicarious benefits
refrain from expressing the alternate view. I still remember vividly
an incident in the boardroom of a very successful financial giant in
India, which had ‘who’s who’ from both India and abroad on the
board. One of the board members was arguing against the swap
ratio in the merger of two institutions of the same group. Even
though he was able to comprehensively demolish the arguments of
the three investment bankers—one each of the merged and merg-
ing institution and the third one being the arbitrator—swap ratio
was not changed. Since the merger was a desirable decision, this
particular director on the board did vote for the merger, but voted
against the swap ratio. Interestingly, two other board members sit-
ting right and left of the director also felt that the swap ratio needs
to be realigned and whispered into the ears of the disagreed direc-
tor that the management should agree to correct at least half of the
change he was proposing, but they did pick up enough courage to
say so themselves. In fact, even the MD and CEO, may be to please
the disagreed director, during lunch break, said that the former
agrees with what the latter said, but did not say so in the meeting
as the chairman had already decided the ratio. To cap it all, the
dissent was recorded separately but not as a part of the minutes.
The chairman had the audacity to ask the director, during
lunch, how the market will react. The dissenting director said,
the pricing will adjust the moment the market is informed. The
chairman disagreed, but that actually happened.
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There are innumerable instances of this kind where some

board members have a different point of view but do not express
and give an impression of unanimous decision. This has two
impacts: (a) the company is deprived of the benefit of voice of dis-
sent in the decision-making and (b) it makes the board members
more or less a non-contributor and thus deprives the company of
the wisdom that has been collected in the boardroom.

7.1.1.4. Superfluous Assessment and

Stereotype Vision

In many public companies, the management takes complete

charge of providing the vision and also the assessment of the
performance of the company. What is often presented to the
board is little less than the comprehensive analysis and the qual-
ity of discussion that takes place in the boardrooms is not in-
depth. The numbers are not cracked down into the genesis. The
aggregation is made to look good and impressive, even though,
sometimes, the disaggregate numbers speak out some of the
hidden (ugly) stories. These stories often tell their tale; how one
product subsidizes the other and/or one segment of the business
has been vicariously supported by the other. In the absence of
such an in-depth assessment, the board does not get seized with
the thought of the options of developing new and rejuvenated
strategic approaches to build greater profitability and de-risk
the factors which are contributing negatively to the performance
of the company. The superfluous assessment does not help the
company and, sometimes, fuels unsustainable confidence in the
business and management capability.
In some of the companies, the facade of strategy session is
organized, but the quality of presentation and depth of discus-
sions leave much to be desired. Management braces ahead with
predetermined direction and, eventually, the company does not
continue to travel on the platform of success and sustainability.
Similarly, the management abrogates the vision of the com-
pany. Even though its BoD is capable of providing the vision and

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 Pillars of Corporate Governance 69

better strategic directions, not enough of discussions take place

in the boardroom on the subject. Consequentially, the company
operates with a stereotype vision and is not able to comprehend
and capture the scopes and scales of emerging opportunities and
limits itself to the existing potentials.

7.1.1.5. Unquestioned Belief in the Morality of

the Management

Somewhere along the line, in most companies, a kind of senti-

ment prevails that the managers of the enterprise are honest,
both financially and intellectually. The board members nurture
a kind of unquestioned belief in the morality of the managers.
Although there cannot be a typical auditors’ ‘blood hound’ atti-
tude that every transaction is a suspect, it is important to under-
stand and appreciate that an opportunity to profit and/or hide
the truth is the biggest temptation. It is, therefore, important
that the BoD tries to understand why of the numbers and/or of
a transaction that is brought before the board, in particular the
‘balance sheet’, must be seen with incisive eyes. In one of the
recent cases of Corporate Governance scandals in India, only if
the independent directors had gone behind (so stated) a billion
of dollar of cash having been kept in the bank deposit with inci-
sive eyes, questions would have been raised as to why has the
money been kept in low return for such a long time and even
that low yield was subject to taxes, whereas alternative avenues
of investment with higher yield, lower tax treatment on income
and equal safety were available in the market. And, possibly, the
scandal would have been prevented/unearthed earlier and the
damage contained. Apparently, there was unquestioned belief
in the integrity of the management and therefore such items in
the ‘balance sheet’ were not questioned.
The independent directors, in particular, during the board-
room discussions should be able to validate their belief in the
integrity of the management, which, if seen, in the light of avail-
able temptations is not only desirable but essential.

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7.1.2. Accounting and Financial Reporting Standards

The performance of a company is assessed by its stakeholders on

the basis of financial results published periodically. The financial
statements reveal income and expenditure and their application
to various purposes. Income and expenditure recognition are thus
fundamental to assessing the performance of the company includ-
ing its profitability and sustainability. To ensure that the income
and expenditure have been appropriately recognized, accounting
standards are laid down which, when applied consistently, reflect
that the accounting of income and expenditure and so on have
been done correctly and that the revenue account and the balance
sheet reflect the true and fair picture. Their disclosure including
the content and method becomes important. Hence, reporting
standards have also been laid down. This is one area where shelters
can be weaved for misdemeanours including self-dealings.

7.1.3. Disclosures

Disclosures are intended to bring about transparency in the

governance of an enterprise. It is also expected to ensure that
those in the know of price-sensitive information are not able to
profit from the use and/or misuse of the information. Hence, all
price-sensitive information along with the changes in accounting
standards (if permitted), if any, are disclosed as and when due
and appropriately. Insider trading as a malaise stems from the fact
that some people have access to price-sensitive information ahead
of its disclosure to the market.

7.1.4. Related Party Transactions

There is a strong possibility that the decision-makers in the

company indulge in self-dealing and/or undertake/approve a
transaction, which may benefit the decision-makers directly or
indirectly. It is important that all RPTs’ decisions are taken follow-
ing the required norms and procedures. The two principles which
have always been guiding light are:
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 Pillars of Corporate Governance 71

• Arm’s length
• Ordinary course of business

Arm’s length, which has been explained in Chapter 10 in greater

details, means fair pricing of the transactions undertaken between
the two—the company and the related party. In the ordinary course
of business, it means the transaction must have a direct or atleast a
vicarious relationship with the business of the company. The trans-
action, which is completely out of the preview of ordinary course
of business, will have to be dealt with separately. For undertaking
those transactions, the rules are much more stringent and rigorous.

7.2. Tiers of Monitoring Pyramid

The eventual outcome of all Corporate Governance practices is to

ensure that an enterprise is run with a view to creating value and
all value-destroying actions/transactions are checked.

7.2.1. Management

The base of the edifice of Corporate Governance is the manage-

ment inclusive of the chief compliance officer. This layer is sup-
posed to provide a strong base of management assurance that
all the norms of Corporate Governance have been observed and
the observance has been both in letter and spirit. This layer also
provides an assurance that the accounting and financial report-
ing standards have been scrupulously observed, disclosures have
been adequately made, RPTs have been at arm’s length and in the
ordinary course of business and also that the board governance
practices have been orchestrated to enhancing the value and/or
preventing the value destroyers of the enterprise.
If the management does its job well, the quality of Corporate
Governance improves and the market perceives as such and
prices the valuation accordingly. However, to make sure that
the management has done the job well, it is important to have
an independent assessment of the strength of all the four pillars
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including the compliance action by persons who are not engaged

in the day-to-day management of the company. Auditors (internal
and statutory) thus become the beam of strength of the edifice of
Corporate Governance.

7.2.2. Auditors

Auditors—internal and statutory—are expected to assess the func-

tioning of the company with reference to the laid-down standards,
called auditing standards, with a view to verify that the financials of
the company reflect the true and fair picture and also that the assur-
ances given by the management are correct and appropriate. The
auditors have to provide the board and shareholders independent
assurance. In the process of doing so, the auditors have to under-
take an in-depth exercise of the examination of records including
the financials of the company. They have to provide an independ-
ent assessment that the accounting and financial reporting stand-
ards have been scrupulously observed and consistently applied, all
appropriate disclosures have been made and that too timely and
that all the RPTs have been at arm’s length and in the ordinary
course of business. Wherever they find any inadequacy, they have
got to bring it to the notice of the oversight pillar. To ensure that
the independent assurance providers are truly independent, their
reporting line is to the authority, which is expected to provide the
oversight, that is, audit committee and the board. The management
assurance as well as independent assurance, put together create a
confidence among the stakeholders on the quality of Corporate
Governance of an enterprise.

7.2.3. Board and Board Committees

To ensure that both the management assurance and independ-

ent assurance have been of the quality that is expected by the
stakeholders, it is important to have an oversight mechanism. In
the Corporate Governance structural framework, the board and
its subcommittees are expected to undertake the responsibility of
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 Pillars of Corporate Governance 73

providing that oversight. To ensure that the two other layers are
functioning efficaciously and provide adequate strength, the over-
sight has to be organized effectively and comprehensively. The
structural framework divides the work into two parts: first, the
incisive oversight, and second, the superintending oversight.
The incisive oversight needs a deeper examination and under-
standing of the way management and independent assessors have
functioned, whether their processes were potent and that ade-
quate rigours have been applied, which includes thoroughness
of diligence in undertaking their roles and responsibilities. Since,
this cannot be organized by the board collectively, efficiently and
requires time, the responsibilities have been subdivided between
board’s committees and the board itself. The board committees
are expected to devote longer and quality attention to providing
oversight and reporting to the board that both management and
independent assessors have by and large done their job well.
The board, on the other hand, is expected to provide superin-
tendence by monitoring the functioning of the committees and
evaluating the reports received from them in a larger body where
group dynamics with full collective wisdom can provide effec-
tive oversight.
Summing up, the pillars are the support to each other and
function in tandem along with the layers of the edifice of govern-
ance. Although the accounting and financial reporting standards,
disclosures and RPTs are helpful tools, boardroom practices are
to play their roles—effectively—to adjudge management and
independent assurance to its appropriateness and efficacy. It is,
therefore, clear from the aforesaid that each of the pillars and lay-
ers has its role cut out and there is a very effective maker-checker
to ensure the quality of Corporate Governance. However, the
replication of the role played or deficiency in playing the role by
one or other pillars and/or tiers will directly and proportionately
influence the quality of Corporate Governance. Hence, my rec-
ommendation is to ensure that the pillars and tiers of monitoring
not only uphold their respective burden of responsibility but
function in tandem as a team to create magnificence in Corporate
Governance frame.

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 8
Boardroom Practices

T
he BoD is the trustee of the stakeholders’ interest and is
charged with the fiduciary responsibility. The word ‘fiduciary’
as per the Webster’s dictionary means ‘unwavering’, ‘trust-
ful’, ‘undoubting’. The fiduciary responsibility in the context of the
purpose of organization—wealth creation, wealth management and
wealth sharing—would include optimal management of an enter-
prise in the best interest of all stakeholders and its sustainability,
as fiduciary owners are expected to hold it in trust even for the
future generations of stakeholders. They have to be unwavering,
trustful and undoubting irrespective of the temptations, coercions
or undue influence. The role as also the accountability of the
board flows therefrom.
The corporate board is expected to provide superintendence
to the functioning of the management. It is their mandate to
ensure that the company and the managers operate to optimize
wealth creation, wealth management and wealth sharing. At the
apex level, it is also board’s remit to create institutional frame-
work potent to check frauds and seeping out of resources and also
ensure the exit of incompetence.
Hence, the board has to provide a vision and direction and
create systems and processes along with instrumentalities to
ensure that various elements in the company operate in tandem
and do not fall off the responsibility frames. Unfortunately, how-
ever, the track record of the board’s role can at best be described

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as mixed. Every misdemeanour in a company, fall or demise of

the enterprise, is being attributed to the failure of the board, albeit
vicariously in some cases. The role of the board has come into
serious question in the minds of the regulators, market and the
investing public at large. In the current setting, corporates (JSC)
are the engine of economic growth and most important instru-
mentality of capitalism. The concern of the market and investing
public and also that of the regulators has drawn the attention of
the academics who have questioned the utility of the BoD itself
and an alternative has been proposed.
Stephen Bainbridge of the University of California, Los
Angles and Todd Henderson of the University of Chicago, in the
May 2014 edition of the Stanford Law Review, have proposed the
replacement of the individual directors of the boards with profes-
sional services firms. It is not only the impression of individual
fund managers like Larry Fink, boss of Black Rock, who attrib-
uted the financial crisis of 2007–2008 to the failure of Corporate
Governance, it is being increasingly believed that the boards did
not ask the right questions. In fact, the disease is deep rooted, and
the root cause of ailment is the boardroom practices. If the insti-
tution of JSC has to live up to the expectations of the economy,
Corporate Governance has to be improved first. The efficacy
of governance can be built only on the bricks of boardroom
practices. Creating a conducive environment can be facilitated by
a number of steps and activities, which will be the subject matter
of discussion in this chapter. Before I begin enumerating what
needs to be done, it is important to appreciate that the CEO and
the chairman, as well as individual board members, have to buy
in that the processes enumerated could only be the facilitating
elements and it is they who will have to make the boardroom a
place where superintendence of the company is at its best.
The processes can be described as the rituals (observed in
every religion, in particular, Hinduism) as a preparation to work
on the real act, ‘welfare of all stakeholders’ via the meditation—
meaningful discussions. However, the travesty of Corporate
Governance is that in most organizations it ends in rituals and
even if some meditation takes place, it turns out to be elemen-
tary. This is how prescribed regulatory rituals look like tyranny
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rather than facilitating processes for the fructification of the

ultimate purpose.

8.1. Composition of a Board

The CEO and chairman, majority shareholders and even some of

the backseat drivers are accused of packing the boards with cro-
nies. The latest example in India is the induction of a lady direc-
tor. In many boards, so far, an inactive lady (housewife) in the
house of the majority/controlling shareholder is being inducted
in the board as compliance to the recent regulatory direction.
Expecting significant contribution from such directors will be a
mirage and most likely the purpose of inducting a woman on the
corporate boards as a regulatory dictate will be frustrated.
The journey of creating conducive boardroom practices begins
with the composition of the board. Although various regulatory
jurisdictions have laid down obligatory/voluntary guidance in the
matter of the composition of the board including the proportion
of independent and non-executive, which have to be necessarily
followed, my idea of the composition of board emanates from the
role of the board itself. To be able to provide effective leadership
and superintendence the board must have talent, youth and matu-
rity, men and women, courage and conviction, and dedication
and integrity. I would like to strongly argue here that integrity is
of two kinds—financial and intellectual. While financial integ-
rity is important and, hence, is necessarily to be ingrained in an
individual, intellectual integrity is equally important, if not more.
Financial dishonesty may cause a damage which may be possible
to recover, whereas intellectual dishonesty has often dealt a body
blow from where even the societies are not able to recover, let
alone the companies. The test is whether he will be able to stand
up and be loyal to his own self, be not persuaded or cowed down
by the influence of others, in particular, controlling shareholders/
management. Furthermore, on a broader frame, it is important to
assess whether the prospective director is able to think strategi-
cally, will have bandwidth to apply himself—engage incisively and
add value to the boardroom. It is also essential to find out whether
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 Boardroom Practices 77

he/she is a team player and has inclination to collaborate and

stands by the discipline. ‘Get people you believe will help in value
creation’, says Anand Mahindra, Chairman of Mahindra Group.
The composition will also depend on the kind of business the
company undertakes. It is important that the BoD comprises of
persons from a variety of fields so as to assemble a diversity of skill
sets in the boardroom. Diversity is of two kinds: (a) of different
academic and intellectual background and (b) of different levels
and kinds of experience, that is, not from operations alone. It could
be in academics, policy planning or regulation. It is very difficult to
define or outline the various kinds of the skills that are definitely
needed in a company board. However, it is being increasingly
believed that the following skills must be present in the boardroom:

1. Skills to manage the core business of the enterprise.

2. Skills to understand finance and economics.
3. Knowledge of laws and the skills to help compliance.

It is absolutely necessary that every boardroom has independent

director(s) who understands the business that the company/
enterprise is engaged in. This is essential for the following reasons:

1. It helps the management in bringing an outside view of

the business of the enterprise and vigil to prevent tunnel
vision seeping in the management of the affairs of the
company.
2. It challenges the management’s assumption, efficacies of
operations and efficiency levels.

‘I believe the Board should be representing various constituents of

business; accounting, legal, Customer framework. Create a Board
with multi-disciplinary skills and use the wisdom of Board’, says,
Kishore Biyani, CEO, Future Group.
The presence of such skills in the boardroom will greatly
help in validating the management thinking on various underly-
ing assumptions, propositions and impact thereof in the journey
forward. In the absence of such skills, the board will not be in a
position to fully appreciate the propositions of the management
and the probable direction that the company may be led to. This
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happened in the case of Equitable Life of UK, a one-time great life

insurance company, which eventually underwent.
Every enterprise functions and succeeds in the backdrop of
the macro as well as micro environment in the geographies that
it operates in, and also global trends. It is, therefore, important
that the boardroom has person(s) who has good knowledge and
understanding of the global as well as domestic environment.
This is necessary to forecast various probabilities and then look at
the direction and annual budgeting and so on.
Knowledge and understanding of finance in the boardroom is
very essential. This helps in interpreting the various financial state-
ments and observance of the accounting standards including the
treatment of various transactions and financial reporting. The lack of
understanding of finance may greatly handicap the board in build-
ing confidence on the fidelity of the various financial statements as
also the independent judgment of the board will be missing, which
can cause a serious blow to the confidence of various stakeholders
of the company. It is important to remember here that the board
is ultimately responsible for the management of the affairs of the
company. Hence, the ability amongst independent board members
to understand and appreciate and also challenge, if needed, the
authenticity of the various financial statements is imperative. Such
skills are generally available amongst the persons who have the
background of finance by qualification and/or experience.
It helps if the board has a person who has a legal background
and has experience and skills in evaluating the compliance which
has assumed serious proportions. Inadequacy of the quality of
compliance can bring not only regulatory onslaught but also dis-
repute to the company. Hence, there can never be a compromise
in maintaining high standards of compliance. It, therefore, greatly
benefits the company and the board if there is an independent
director who is able to help the management and the board in
ensuring the quality of compliance.
In India, the Companies Act, 2013 enshrines the induction
of a lady board member. I would even otherwise articulate that
every board must have at least one lady member so that she not
only brings the feminist perspective but also helps the company
in targeting its customers from the segment of fair sex. It is quite
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 Boardroom Practices 79

possible that there can be a lady member who has skills either in
the core business of the company, finance and economics, and/
or legal and compliance. Hence, it would not be necessary to
have a director of those skills, which the lady director possesses.
‘We have quite a few women on our Board, have always been
very helpful specially since we are marketing oriented group.
They have added lot of value’, remarked Adi Godrej, Chairman,
Godrej Group.
I would like to argue that the position of the chairman and
the CEO should not be combined. It is not only helpful but
also desirable to have non-executive chairman who can provide
some kind of supervision to the activities of the management
led by the CEO.
Ideally, the number of board members should be in the range
of 10–15 because at least 10 will have enough space for getting
the talent and a limit of 15 will maintain manageability. While
deciding on the board members it is important not to pack the
board with senior citizens, which often is the case in most geog-
raphies. It is important to have youth and energy in the board so
that varied thinking and risk taking remains one of the traits of
the board.
It has been my experience of sitting on the boards of a variety of
companies—public and private, finance, steel, cement, chemicals
to realty to consumer goods and public utilities—that the most
important consideration is the imminence of the persons and/or
their closeness to the majority shareholders. Subjective selection
of board directors builds the foundations of non- or inadequately
performing boards and value creation and protection takes serious
beating. In the interest of all stakeholders, the composition of the
board must receive utmost focus, where objectivity must supersede
all other considerations.

8.2. Sourcing of NEIDs

Normally, the directors are selected from amongst the friends,

relatives and known persons’ group. This obviously brings to
the board familiar faces that have—either directly or indirectly,
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through friends and relations—some kind of understanding,

affinity and/or relationship. Selection of directors from such a
pool brings in the familiarity and also the strings of subjectivity.
Out of sheer respect/regard/consideration for the chairman and/or
MD/CEO, they will hesitate to put across, in particular, divergent
points of view eventually defeating the very purpose of having
independent directors. Here are some ideas for the selection of
the independent directors:

1. Persons of eminence, knowledge and skills from fields

deficient in the current configuration of the board who
have achieved some level of excellence or a high degree of
proficiency in that field and have enough time to engage
in the role of an NEID.
2. Persons known to be of independent thinking, in par-
ticular, who uphold intellectual integrity in addition to
financial.
3. Persons already known or with whom some kind of rela-
tionship exists should as far as possible be avoided.
4. Drawing persons out of a database maintained either by
the private parties or regulators does not serve the pur-
pose because of the very fact that these people filing their
data indicates they are seeking appointment as independ-
ent director. In fact, the situation should normally be
contrary. It should generally be offered to such persons
who are not prospecting for joining a board because
such aspiration is always with the expectation and lands
in with the limitations of free expression in the board.
Here, I am reminded of an incident. Post my superan-
nuation from the government job of SEBI Chairman, I
was addressing a forum. During the question and answer
session, one of the gentlemen asked why he is not being
offered an independent directorship. He hastened to
add that he has filed his curriculum vitae (CV) in the
database maintained for the purpose and paid the entry
fees as well. He also requested whether I could recom-
mend his name. This smacks of expectation. Although to

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get compensated for doing the work of an independent

director is fair and necessary, he should not begin with
that expectation or a precondition.
5. Some companies enlist retired (a) senior civil servants
and (b) top public sector enterprises’ managers. Although
these people do offer a pool of skills, there should be a
sagacious process of the assessment of their skills and
approaches rather than just seeing their name or as a quid
pro quo for past relationship. Furthermore, it has to be
assessed how they keep themselves updated with the
latest developments and are not rooted in the past.
6. There are agencies which specialize in the work of inde-
pendent director placement. It might be helpful to engage
their services, provided, however, that these agencies
have a reputation of professionalism, they do not get
either directly or indirectly remunerated/benefitted by
the persons who they recommend for appointment as
independent directors and also that they build a database
on their own and do not invite people to file their CVs
with them. Collecting CVs should be an exercise under-
taken post initial shortlisting and possible engagement.
7. The best way would be to first identify the skill gaps in
the board, prepare a list of eminent persons in the fields
required to be included/replaced in the board, make a
shortlist and hand it over as required by the law, now
to the Nomination and Remuneration Committee, to
scrutinize their candidatures, prioritize their names and
the chairman of the Nomination Committee reaches out
to them for consent post selection. However, before the
nomination is actually recommended by the nomina-
tion of the Committee it must meet those people, have
some kind of discussion to understand their attitudes
and approaches so as to ensure they fit culturally and he/
she has those skills that the board needs. In fact, it is not
desirable to just approach a person of eminence, ability
and proficiency in the line of the skills desired and offer
him the directorship. The assessment of the personality

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is very necessary, also it is important for the person

being assessed to build his own understanding about the
enterprise, people behind the enterprise and other board
members. I have insisted on doing that exercise myself
wherever I have agreed to be on the boards.
8. In fact, successful CEOs, CFOs and even the president-
level executives of the prominent companies could be
a good source of identifying talent. These people are
currently beating the competition, charting out growth
paths and weaving success stories in their respective
companies and will have an urge to learn and play a value
creation role as a board director of another company.
However, while approaching an identified candidate, it
has to be remembered that every successful company’s
CEO, CFO or president may not be a suitable candi-
date for the board positions, because success is made of
various elements where he might be merely a cog in the
wheel. Furthermore, competent and successful amongst
them would insist on being engaged so that they add
to their learning and acquisition of new knowledge and
skills. In fact, their employers should view this as their
enrichment. ‘I think it helps to build their personality,
character, vision, broad mindedness eventually bet-
ter human being’, observes Deepak Parekh, Chairman,
HDFC Group.

Sourcing and undergoing the process of assessing their suitabil-

ity is fundamental to the process of recruitment of independent
directors. Hence, the entire exercise of sourcing and selection
must be thorough and objective.
It will be desirable to avoid persons with following attitudes:

1. Who have a negative approach to life.

2. Who are known not to function as a team member.
3. Who are/is a close family/friend of the promoters and/or
the placement agencies’ managers.
4. Who do not have enough time to spare or will not pro-
vide enough commitment to this role. I have seen board

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directors updating themselves with the news, replying to

mails or catching with an unfinished task on iPad, phone
and so on in the midst of a board meeting. Such conduct
expresses a lack of commitment and interest in the affairs
of the company.
5. Previous experience of sitting on the board, though helpful,
should not be considered as a prerequisite for selection.

Narayana Murthy, Chairman, INFOSYS, says:

People who do not need to be on your board, people respected by

the community, people who will tell you that the decision company is
trying to take is not a good decision for the company, are the people
to be recruited to be on the Board.

Getting a person on the BoD is an invitation and not an offer

to an application. Too eager amongst the candidates should be
looked with an eye of scepticism and intentions assessed. Good
candidates need persuasion, which has to be orchestrated well. I
had refused one of the invitations to join the board of a prominent
company because I was not very much convinced from the con-
versation with the chairman as to how was I going to add value.
To me, it smacked of encashing more my standing than the skills
and talent, which might have prompted the invitation. The entire
exercise has to be organized and conducted very sagaciously to
get the right talent, skill, experience and attitude on the board.

8.3. Integration of the Board Members

Every board member who joins the board must be given ade-
quate briefing about the business of the company, its vision,
mission, values and cultures. He should also be briefed about
the strategic approaches the company is currently pursuing and
in case he joins in the middle of the financial year, he also must
be educated about the budget, its contours and rational thereof.
In fact, it is desirable to create some kind of a template, which will
help in the induction of a new director of the company. ‘Induction
into a Company Board calls for a visit to factory, presentation
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of different divisions, meeting people outside Board at least 6–8

people in a large Company’, suggests Deepak Parekh, Chairman,
HDFC Group.
In case the company happens to be a manufacturing company,
a visit to the manufacturing site(s) must be undertaken. This will
enable the new entrant to understand how the manufacturing facil-
ities are operating and in case he happens to be one who is not an
expert in the core business of the company, he will get some educa-
tion about what the company manufactures and how. In case it is a
services company, he must be taken to some of the service outlets,
so that he is able to understand the functioning of the organization.
It is important that, along with the aforesaid, he is properly
introduced to the heads of departments (HODs; one step down
the CEO). This introduction must include who they are, whom
do they report to and how do they normally operate. In fact, it
will be helpful if each of the HODs makes a brief presentation
about himself, job profile and from where and how he oper-
ate. This induction session should not be allowed to become
a monologue. Newly recruited directors must be allowed and
encouraged to ask questions and seek clarifications so that the
understanding is built. Direct contact of the director with the
HODs helps in validating the information provided by the CEO,
which prevents CEO from presenting filtered, inadequate and/or
biased information. On the positive side, it makes directors more
accountable. Unfortunately, in most companies in India, there is a
kind of hesitation on both the sides—CEOs and HODs. This will
help the new inductees to rise up to the frequency in which the
management, board and its members discuss the various agendas.
In fact, this exercise of bringing up to the speed for each of the
new board members is not undertaken in most of the companies,
and as a result thereof the new board member slowly acquires
knowledge and understanding about the company, people and
its systems and processes and, oftentimes, his understanding is at
variance with the understanding of the other board members. The
net result is that the new board member is not able to contrib-
ute optimally and sometimes his inputs are not very relevant, in
particular, to the strategic approaches that the company pursues.
In fact, I have watched the new board members trying to suggest
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ideas and strategies which are either not relevant or have been
discarded during the journey of the enterprise. I believe that this
exercise should be conducted within the first two months of his
joining and preferably before he starts participating in the board
meetings.
In one of the companies where I used to be a board member,
I (despite being the director of the company for just a year then)
was invited along with other newly inducted directors to the
regional headquarters (HQ) of the overseas acquirer of the control-
ling stake for a briefing about the company, its business and the
contours of its management. On reaching the office next day, we
were informed that the regional head had to be away and that the
briefing will be done by his deputies. The quality of the briefing
took a serious knock and more so the seriousness of the exercise
became a question mark. Although hospitality was appreciable,
the event looked like a box ticking of the decided programme.
It is important to appreciate that this induction is an enabler to
enhancing the contribution of the newly inducted directors and
not an exercise in completing a procedure. Hence, it has to be
well planned, organized and delivered.
Furthermore, the exercise of induction is over and above the
training and education of the persons becoming director for the
first time. Such a programme has been mandated as an obliga-
tion in some of the jurisdictions and voluntary in others. I do
believe that the training and education of directors on the role,
responsibility, statutory obligations and the protection and so on
is a must and that every director who has not been serving on the
board earlier must go through it atleast once. Fresh training will
be necessary if he joins a new company, which is regulated in a
different jurisdiction. There are standard courses run by several
academic institutions and credible organizations and even indi-
viduals. However, in the interest of the quality of learning, it is
important to attend the programme run by credible organizations
and not by self-seeking individuals whose credibility to impart
such a training and education is not well established.
Furthermore, in the first few board meetings, new directors
should be treated with greater attention and allowed to ask ques-
tions howsoever insignificant those may be and answered with
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the consideration of newness. They should not be subjected to

an overwhelming influence of long-standing directors. It hap-
pened so in one of the boards of eminent persons. I had to force
myself—even though I was comparatively young, rather new to
the role of director on the board of a fairly large company—and
make my voice heard. However, every new director may not be
as audacious and therefore it becomes the responsibility of the
chairman to assimilate him in the team as equal. Once he gets
going, he will be on his own and will surely contribute optimally.

8.3.1. Social Integration of a New Board Member

It is helpful to organize, as quickly as possible, some kind of

social events such as lunch/dinner, outing to break the ice and
help him to open up informally as well. This social integration
helps the newly inducted director to broadly understand the
people and their mindsets, enabling him to proffer his inputs
without any reservation. In quite a few companies, the relation-
ship between the management and board members is formal and
no occasions are provided for them to interact informally, which
leaves a distance in building coherence. Immediate impact of
this gap is the hesitation of the board members in reaching out
to the HODs directly to seek any clarification and/or information
which he/she may need to better understand the agenda items
and/or cross-check the efficacy of the ideas that are brewing in
their mind, which he proposes to voice in the board meeting.
There is no gainsaying the fact that information, albeit full and
comprehensive, is necessary for the application of mind, in par-
ticular to the ticklish issues which may have far-reaching conse-
quences and also to think of solutions to deal with those issues.
In one of the companies, where I had an occasion to sit for
more than two years, which belonged to a respected business house,
I did not have any occasion to socialize either with the chairman,
MD and CEO and/or the HODs. This left a void of understanding
between me and others. In fact, until I became the chairman of SEBI,
the chairman and/or CEO never met me outside the boardroom.
Whenever I asked for an appointment from the chairman’s office,
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I was told to wait. It is another thing that the same office would
pester my office (SEBI Chairman’s office) for an appointment for
their boss, the chairman (from whom I could not get an appoint-
ment), which I made sure was promptly granted. The chairman,
the directors and the management have to work as a cohesive
team, which cannot be enabled in the formal meetings of the board
alone. Some amount of familiarity and friendship has to be rooted
in, which is facilitated more by informal meetings and discussions.

8.4. Role of the Chairman

The chairman of the BoD, whether executive or non-executive,

has a definite, singular and important role in addition to his role
as the director of the company. The role can be broadly catego-
rized into five parts:

1. Designing of the agenda

2. Minutes of the meetings
3. Conduct of the board meeting
4. Conclusion of the board meeting
5. Building and maintaining an environment of cordiality,
commitment and contribution

The leader of the board—the chairman is the central figure in the

boardroom around whom all the boardroom practices oscillate.
Hence, the success of Corporate Governance effort in most cases
is proportional to his abilities to manage the boardroom environ-
ment. ‘The success of a Chairman is to listen to them patiently,
take their points into consideration and do what you think is
right’, says Deepak Parekh, Chairman, HDFC Group. A chairman
has to be a patient listener, strategic thinker, good communicator,
team builder, quick segregator of content from mere sounds and
fury and creator of harmony out of disagreements. Some of the
qualities which enable an individual to ingrain all the previously
mentioned qualities could be (a) a successful past, which imbibes
both self-confidence and appreciation of others’ views and abilities,
commands respect and also has the experience to handle uneven
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events and situations; (b) ability to manage relationships—building

cohesiveness requires personal relationships and bonding, which is
so essential for a bunch of intellectual, experienced and successful
people to eventually converge their differing points of views into a
consensus; (c) having time and commitment, which enables him to
engage the management into presenting a quality agenda and the
board members (even outside the boardroom) to challenge their
wisdom, skills and experience into working out strategies and solu-
tions to intractable issues; (d) humility to share the credit equally
with the management and directors and (e) being decisive enough
to conclude all the debate of even divergent views on an agenda
into an implementable direction to the executive management.

1. Designing of the agenda: The quality of the agenda defines

the success of a board meeting. In case the agenda has
not been designed well the success of the board meeting
cannot be ensured. Designing of an agenda has been cov-
ered later in a section of this chapter, in which the role of
the chairman in the designing and drafting of the agenda
has also been outlined. It is important that the chairman
assumes full responsibility in the designing of the agenda
for the board meeting.
2. Minutes of the meetings: Minutes of a board meeting are a
record of what actually happened in the board meeting.
It is the minutes that stand the test of time and scrutiny
of law as to the decisions taken in the board meeting
and also the role played by various board members. It is,
therefore, important that the minutes are recorded accu-
rately and comprehensively. Although it is not necessary
to record the proceedings of the board meeting verbatim,
nothing important that has been discussed and decided
in the board meeting should be left out. The subject of
writing the minutes have been dealt with in another sec-
tion of this chapter. However, it is the responsibility of
the chairman, who not only authenticates but signs the
accuracy of the minutes as well to ensure that the minutes
are properly recorded.

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3. Conduct of the board meeting: The real role of a chairman

comes into play during the course of the board meeting.
The chairman must be able to do the following:
i. Ensure the participation of each of the board mem-
bers present in the meeting.
ii. Every member has an opportunity to put his point of
view without hesitation, disturbance and truly without
rancour.
iii. Ensure that there is a healthy debate.
iv. Build a consensus on a decision if there are conflict-
ing views on any item of the agenda.
v. Ensure that the meetings are orderly and discussions
are friendly.
The chairman should neither be very aggressive nor
very docile. He must at all times be in command at the
meeting. He should be in a position to not only moder-
ate the discussions but also ensure that the discussions
remain on track and do not lapse into serious digression.
It does happen sometimes that some of the members of
the board have a habit of fiddling with mobile phones,
iPad, laptop, indulging in side talks, monopolizing the
discussion or running away with the agenda. Neither of
this should be allowed to happen and the chairman must
politely, yet firmly, bring everybody to attention and the
discussion on the tack of the items and issues on the
agenda.
In any good board, some conflicting views are expected
on at least some of the items of the agenda. The chairman
should neither disallow nor allow a disproportionate time
and attention to one kind of views. It is his duty to make
sure that the various points of view are brought to the
table forthrightly and in an atmosphere of understanding
and goodwill, while the expression of divergent views
obtains with free will. The chairman should neither
become overbearing nor a mute spectator. In one of
the boards, where I had the pleasure to sit, the chair-
man hardly allowed anyone to really discuss an item. I

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once made light of the situation by remarking that this

11-member board (on that day, 11 directors were pre-
sent) team has only one batsman. The board burst into
laughter. In another board, the chairman hardly spoke
and it used to be free for all while the chairman sat fid-
dling with his electronic gadgets.
A chairman must ensure that the management is in
a position to present an agenda item well and provide
all the information and data necessary for the consid-
eration of the members. The management should not
be prevented or short-circuited in detailing the various
aspects of an agenda item, its issues or the impact thereof.
However, the chairman must ensure that the management
does not flood the board members with presentations,
data and statistics leaving very little time for the board
members to react and discuss. In fact, since the agenda
would have been circulated well in advance—essential
as a good governance practice—the presentation of the
management must be concise to very briefly highlight
the issues involved and/or the areas where the decision
is to be taken. It is pertinent to mention here that I had
the experience of well-known financial institution’s board
meetings, where 90 per cent of the time was spent in
making the presentations by the management and out of
the balance 10 per cent time, the chairman did the talk-
ing. Notwithstanding, the fact that the board comprised
of very eminent persons from various fields, very little
discussion on most of the items was held, thus, depriving
the company of the benefit of the experience, knowledge
and understanding from a variety of fields of the board
members present. One of the reasons was that the chair-
man was overbearing and most of the board members
had respect for him and the Chairman did not like the
directors to butt in unless specifically requested to do
so. I had an experience of yet another company board,
where the chairman allowed the company secretary and
MD to play his role. Consequently, the board meetings
became a kind of farce and very little quality discussions
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were ensured. A chairman must ensure that time is not a

constraint for meaningful discussions, and also that time
is not wasted unnecessarily.
It must be remembered that it is not only the quality
of the members of the board in the boardroom and/or
the quality of an agenda, which determines the quality
of Corporate Governance. In fact, it is the boardroom
discussions which determine the quality of govern-
ance and here the role of the chairman becomes most
important.
4. Conclusion of the board meeting: It is important that the
board meeting ends with clearly summarized decisions
on each of the items, so that the management is left
without any doubt to execute the decision. In case this
summarization is not done the management will have the
option and/or the confusion to interpret the decision of
the board, often the way they would like, which is good
neither for the company nor for the quality of Corporate
Governance. It is the role of a chairman to summarize the
decision taken at the end of each item of an agenda and
finally at the end of the board meeting.
The chairman must also, before concluding the board
meeting, invite every board member to raise any issue,
if he/she likes to. This opportunity must be provided to
ensure that no important item that either the manage-
ment or a board member considers urgent is left to be
taken up and/or no issues of serious attention and conse-
quence are left unaddressed. This is possible only if the
conclusion of the meeting is not hurried up, which often
is the case in many board meetings. I have been watch-
ing the board meetings and have found that in most of
the board meetings, it is the company secretary who says
that the agenda is over, whereas it is the chairman who
should. Having surveyed the situation and pronounced
that no item is left to be covered and that no member
wants to raise any issue, the meeting comes to a close.
The role of a chairman is singular and catalytic, which,
if rendered inefficiently, frustrates all the efforts that
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have gone into the preparation of the board meeting and

regulatory directions and concludes into poor Corporate
Governance and less-than-optimal value creation.

8.5. Role of a Lead Director

One of the significant developments in strengthening Corporate

Governance is the growing recognition of the role of a lead inde-
pendent director, which is being used as a valuable mechanism
for enhancing the independence and effectiveness of boards. The
most significant factor driving this trend is of moving Corporate
Governance to a next level of optimal value creation. The amend-
ments in Clause 49 of the listing agreement (now transformed
into regulation) in the Indian capital market, made effective by
the regulator—SEBI from 1 October 2014, envisages the appoint-
ment of a lead independent director as an obligation.
It is my belief that a lead independent director can play a very
important role in aggregating the views of independent directors
and provide a pragmatic approach to the leadership structure. In
case there is an executive chairman, the significance of the lead
director grows tremendously. However, even if there is a non-
executive chairman but represents promoter group/entities, the
lead director can play a significantly useful role.
In fact, in every board, there are certain items which the man-
agement and the chairman are interested to discuss and debate
on, while there are other items which are postponed and/or not
taken up at all. In one of the recent board meetings of a company
where I used to sit as an NEID, I had to effectively make a point
that for the whole year the board meetings have been logged in
appraising only the performance of the company, and the review
and formulation of the strategy has neither been brought on the
agenda nor discussed. It took some time and a bit of impolite dis-
cussions before the management could be convinced that this is
essential and will be useful. However, the same was brought only
once till I quit and that too perfunctorily. I had to describe to the
discomfort of MD and CEO and majority shareholders’ directors
as ‘work-in-progress’.
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Furthermore, in the absence of a lead director, no time is allo-

cated to a free forum or what is called blue sky discussions about
the business of a company and its prospects. It is my view that the
institution of a lead director can enhance the engagement of NEDs
and help improve the quality of the board agenda as well as the dis-
cussions. Possibly, it will enable the directors to ask better questions
and the board meetings would become much more productive.
Surveys conducted by various agencies have revealed that
with the appointment of a lead director and his playing an effec-
tive role, the communications inside and outside the boardroom
between the directors and between the management and direc-
tors have improved significantly. In fact, the institution of a lead
director can prevent a management from providing a ragtag set of
agenda papers and also the recommendations. It helps in better
summarizing and transmitting the decisions taken.
The institution of a lead director helps in the following areas:

1. Enhancing board independence: The lead director can

serve as a communication link for a large body of stake-
holders and provide a valuable counterweight to the
chairman of the board, an effective response to the calls for
greater board independence. Independently, this institu-
tion can also play the role of aggregating the views of the
independent directors and add pragmatism to leadership
approaches.
2. Efficacious meetings of the board: Since the lead direc-
tor works with the chairman/CEO in planning the board
meetings and ensuring the agenda papers, the appoint-
ment of a lead director in most cases have helped in
improving the quality of an agenda and thereby improv-
ing the efficacy of the meeting.
3. Freewheeling discussions: The institution of a lead director
can help in the allocation of time for freewheeling discus-
sions about the company and its future. Some manage-
ment pundits call it blue sky discussions and, according
to me, this is very essential not only in looking at the new
horizons but also in engaging the wisdom of the board and
deciphering unfolding opportunities for the company.
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It is important to identify the right person to ensure the effective-

ness of a lead director. The first and foremost quality is the mind-
set to the task, which is to help the company to succeed and the
CEO/Chairman to be the winner, and acts as a building block for
a constructive relationship. The person to be chosen must care for
the spirit of the board and exhibit extraordinary commitment to
integrity, loyalty and equanimity. He has to be someone who per-
forms the role with candour and makes people feel safe about ask-
ing the tough and proverbial ‘dumb’ questions. He has to possess
communication and facilitation skills. He must be able to convey
reservations and concerns effectively without sugarcoating tough
messages, of course everything in the interest of stakeholders of
the company. In fact, a lot of diplomacy is involved in the role.
Globally, the following roles are being assigned to a lead
independent director:

1. Communicating with the CEO/chairman

2. Helping to organize board meetings better
3. Running/NEDs sessions
4. Evaluating the performance of the directors

Hence, it is desirable to designate one of the independent direc-

tors as the lead director.

8.6. Retirement Policy—NEDs

There is a forced (statutory) retirement policy in some of the

regulatory jurisdictions including India now, which has to be
implemented. However, an independent policy should be crafted
by a company for the ease of exit of the non-performing direc-
tors. This is very important to ensure that longevity, which breeds
familiarity, does not result in a friendship that is detrimental to
the independence and overall impact on the performance of the
boards and, thereby, the benefit to the company.
The exit/disengagement of a director is not a very pleas-
ant event, particularly if the association has been prolonged. In
India, most of the majority shareholders’ directors/representatives
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 Boardroom Practices 95

consider it embarrassing or impolite to not renew or request a

director to quit, notwithstanding the fact that the director due
or needed to retire has become ineffective because of age, health
and/or not being able to keep up with times. Mr Deepak Parekh,
Chairman of HDFC Group Companies, being a very polite, gen-
tle and ebullient promoter of efficacious Corporate Governance,
faces the (only) criticism of long-standing and ageing directors on
his board from the global investors, in particular.
Once there is a policy, the heartburn in the exit of a director
will be minimal because it will be applied uniformly. For example,
some boards have a policy of retirement at the age of 75, when
even the owner directors and executive directors also retire. The
policy must include consideration of the annual performance
appraisal of the NED, which has been discussed elsewhere in
the book, and in cases where performance is less than expected,
retirement must be a natural concomitant.
During my long association with financial markets and par-
ticipation in the boards of a variety of companies, it has been
observed that some of the board members have been continuing
for several decades. While one may not question the wisdom or
the quality of participation of long-serving NEDs on the board,
it is important to appreciate the relevance of fresh thinking. The
longevity of association builds rigidity, stereotype and conven-
tional thinking. Even a fuller application of mind in the face
of repetitiveness becomes a question mark in the case of long-
serving NEDs, which I have observed in some of the prominent
company boards where I had the occasion to serve.
The environment inside the company, outside in the market
and in the industry as well as global environment is undergoing
unremitting transformation. It is, therefore, important to ensure
that the company does not get logged in the cobwebs of a tunnel
vision. This can be obviated only if, periodically, persons with dif-
ferent thinking, skills and knowledge are inducted in the board. I
am strongly of the view that after a certain period of time, which the
board can specify, new directors are inducted and the long-serving
directors are moved out. To undertake this process objectively, exit
policy merits a serious consideration. I consider this to be a value
enhancer and, therefore, must be done, albeit pragmatically.
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Since the 10-year rule—two terms of five years each—has

been made applicable under the Indian legislation and regulatory
framework, it might be helpful to replicate the same even for
the non-executive non-independent directors. Furthermore, the
annual review of the performance of such directors must be much
more rigorous and the exit policy must incorporate the exit for
inadequate contribution.
The exit policy must ensure that there is an ideal mix of risk
taking proclivities—youth and maturity—experience. However,
it must safeguard against risk-taking turning to adventurism and
maturity into salinity. Most organizations use the tools of exit
policy to manage such risks, which I consider to be significant,
as it can retard the sustainability of growth and, sometimes, even
threaten the survival of the enterprise.

8.7. Allocation of Role and Responsibilities

Between the Board and the Management

The shareholders of a company elect the BoD to manage the enter-

prise. It flows there from that the overall responsibility of the board
is to operate and manage the business of the enterprise, create value
and share with stakeholders appropriately. The board is assisted in
its responsibilities by the management team led by the CEO. The
board from time to time delegates responsibilities to the manage-
ment to run the operations of the company on a day-to-day basis
and produce the expected outcomes. This entails that the manage-
ment functions at the pleasure of the BoD. However, for the man-
agement to function effectively, it is important that the delegations
are properly made, documented and circulated.
It has often been observed that the BoD replicates the role of
the management in the conduct of the business of the enterprise.
This does not bring about optimal value creation because of less
than fuller and better utilization of time and talent of the man-
agement and board. Although the BoD is ultimately responsible
to its stakeholders for management of the enterprise, creation
and sharing of wealth, it is important that there is an efficacious
allocation of responsibilities between the two pillars in building
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the edifice of a successful enterprise. Over a period of time, this

principle of the allocation of role has been accepted across geog-
raphies and segregation of responsibilities has been evolving
constantly. In fact, in most countries the regulatory frame, either
through the legislation or subordinate legislation, outlines the
role that the board is expected to play in managing a company.
It might be worthwhile to visit some of those enunciations in
the various regulatory jurisdictions. Although it might be useful
to know and understand about the entire range of jurisdictions,
for the reasons of keeping the elaboration less lengthy, it is pro-
posed to mention here just about ten jurisdictions, as elaborated
in the following sections. These nine jurisdictions, put together,
by and large represent the world.

8.7.1. Australia

As per the various regulatory guidances issued by the Australian

Securities Exchange (ASX) Corporate Governance Council and
the Australian Securities Commission, the board of a company
in Australia is expected to provide strategic guidance, monitor
operations’ performance and ensure that adequate policies and
processes are in place to guarantee the quality of companies’ risk
management and internal controls. The board also appoints and
removes the CEO and company secretary, reviews the perfor-
mance and determines their compensation. The board, with the
help of the company secretary, is expected to ensure compliance
with relevant laws, regulations and codes of practices and so on.

8.7.2. China

In China, which has a two-tier system—BoD and supervisory

boards, the BoD is accountable to shareholders and creates a
framework which helps the directors to perform their obligations
under the law. There is no more classification/clarity about the
allocation of roles and it is possibly left to the board to decide the
allocation between the BoD and the supervisory board.
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8.7.3. France

In case of France, the board’s mission is to define corporate strat-

egy, decide the organizational design (i.e., whether the chairman’s
and chief executive’s roles are separated or combined), appoint
corporate officers, monitor the management and ensure that the
shareholders receive correct and transparent information.

8.7.4. Germany

In Germany too, there is a dual board system—the manage-

ment board and the supervisory board. The supervisory board
is compulsory and its role is governed by the general Corporate
Governance board, which defines the role as follows:

The supervisory board appoints, supervises and advises the man-

agement of the company. Although the supervisory board does not
interfere with the day-to-day management of the business, certain
categories of transactions may be subject to the supervisory board’s
approval. The code calls for the supervisory board to take a more
active role and to determine the level of information and reporting
requirements jointly with the management board.1

In fact, the management board is primarily responsible for the

executive management of the organization with all the powers
of day-to-day functioning and the supervisory board, which also
has a representative of workers, is concerned only with macro-
strategic decisions.

8.7.5. India

In India, the role of the board was outlined by the Birla Committee
(appointed by SEBI) report, which states that the board ‘directs

1
Prof Dr Theodor Baums. Corporate Governance in Germany—System and
Current Developments. Universität Osnabrück. Available at: https://www.jura.
uni-frankfurt.de/43029805/paper70.pdf (accessed on 30 May 2016).
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 Boardroom Practices 99

and controls the management of the company and is accountable

to the stakeholders’.
In the words of Birla Committee report: The board directs
the company
by formulating and reviewing the company’s policies, strategies, major
plans of action, risk policy, annual budgets and business plans, setting
performance objectives, monitoring implementation and corporate per-
formance, and overseeing major capital expenditures, acquisitions and
divestitures, change in financial control and compliance with applicable
laws, taking into account the interests of stakeholders.2

The board is expected to manage the company

by laying down the code of conduct, overseeing the process of dis-
closure and communications, ensuring that appropriate systems for
financial control and reporting and monitoring risk are in place,
evaluating the performance of management, chief executive, execu-
tive directors and providing checks and balances to reduce potential
conflict between the specific interests of management and the wider
interests of the company and shareholders including misuse of corpo-
rate assets and abuse in related party transactions.

Finally, the board is accountable to the shareholders for ‘creating,

protecting and enhancing wealth and resources for the company
and reporting to them on the performance in a timely and trans-
parent manner’. It is, however, the management’s responsibility,
not the board’s, to run the company everyday.

8.7.6. Italy

In March 2006, the Corporate Governance Committee promoted

by Borsa Italiana published a new code according to which the
role of the board is defined as follows:
The board examines and approves the company’s strategic, opera-
tional and financial plans, evaluates the adequacy of the company’s

2
Report of the Committee Appointed by the SEBI on Corporate Governance
under the Chairmanship of Shri Kumar Mangalam Birla. Available at: http://
www.sebi.gov.in/commreport/corpgov.html (accessed on 30 June 2016).

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 100 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

organisational, administrative and accounting structure and internal

controls, and delegates powers to executive committee, if one exists.
The board also determines the remuneration of directors, monitors
conflicts of interest, supervises the general performance of the com-
pany, evaluates the size, composition and performance of the board
and its committees at least once a year, and issues an annual corporate
governance report which, among other things, must show the related
percentage attendance of each director.

The board is also responsible for examining and approving in

advance the transactions that ‘have a significant impact on the
company’s profitability, assets, liabilities or financial position’
(including, in particular, those involving the related parties). It
is up to the BoD to establish general criteria for identifying such
transactions.

8.7.7. Singapore

The governance code of Singapore defined the board role as follows:

[T]o provide entrepreneurial leadership, set strategic aims, and ensure

that the necessary financial and human resources are in place for the
company to meet its objectives; to establish a framework of prudent
and effective controls that enables risk to be assessed and managed;
to review management performance; to set the company’s values and
standards; and to ensure that obligations to shareholders and others
are understood and met.3

8.7.8. South Africa

The role of the board has been outlined as follows:

The board provides strategic guidance, monitors operational perfor-

mance and ensures that adequate policies and processes are in place to

3
Code of Corporate Governance (2 May 2012). Available at: http://www.
mas.gov.sg/~/media/resource/fin_development/corporate_governance/
CGCRevisedCodeofCorporateGovernance3May2012.pdf (accessed on 30 May
2016).

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 Boardroom Practices 101

guarantee the quality of the company’s risk management and internal

controls. The board appoints the Chief Executive Officer (CEO), as well
as other executive directors, and is responsible for the CEO succession
process. The board, with the guidance of the company secretary, ensures
that the company complies with all the relevant laws, regulations and
codes of business practice. It communicates all material company issues
to the shareholders openly, promptly and usually at the annual general
meeting. The board is in essence responsible for the performance and
affairs of the company and any delegation of authority to board commit-
tees and/or management does not absolve it of its duties.4

8.7.9. United Kingdom

According to the Combined Code (2003), the board should ‘pro-

vide entrepreneurial leadership of the Company, within a frame-
work of prudent and effective controls which enables risk to be
assessed and managed’. The board is expected to set the strategy,
values and standards for the company, review the performance of
management and ensure that the necessary financial and human
resources are in place.

8.7.10. United States of America

As per the Corporate Governance code in place in the USA, the

main purposes of the board are to select, evaluate and compensate
the CEO, debate and ultimately approve the company’s strategy,
ensure that the company is managed in the best interest of its
shareholders and to oversee the auditing process resulting in the
proper disclosure of accurate financial statements.
In all the jurisdictions where there are two-tier boards such as
China, Germany and so on, the allocation of role between the two
boards is fairly clear. The supervisory board takes decisions only
on macro matters and does not indulge/interfere in the day-to-day

4
Draft Code of Governance, Principles for South Africa – 2009, King Committee
on Governance. Available at: https://www.ru.ac.za/media/rhodesuniversity/
content/erm/documents/xx.%20King%203%20-%20King%20Report.pdf
(accessed on 30 May 2016).

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management of the firm, day-to-day management is the responsi-

bility of the management board, which is given full responsibility,
coupled with adequate powers and authority to take decisions and
run the company proficiently. However, the management board
reports and is responsible to the supervisory board.
Summarizing the aforesaid would possibly mean that while
assuming the overall responsibility to stakeholders, the board’s
role is to lay down vision, direction, organizational design and
strategy and the management led by the CEO is expected to
execute and manage day-to-day operations.
It is indeed clear that the overarching responsibility of the
board is the ‘management of enterprise’ and that of the CEO and
his team is the ‘management of business’. The subtle distinction
between the management of an enterprise and that of a business
is that the management of a business maintains the health of
the company in the current shape and the management of the
enterprise ensures the sustainability and future well-being of the
enterprise. Figure 8.1 precisely describes the role of the board.

Figure 8.1 Role of the Board

Strategy Loop

Super Ordinate
Direction
Goals

Board of Directors

Monitoring & Value Creation

Control Systems Goal

Performance
Loop

It would be noted from Figure 8.1 that there are two loops
in the role of the board: strategy loop and performance loop.

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 Boardroom Practices 103

Strategy loop can be further subdivided into (a) superordinate

goals and (b) direction. The performance loop can be segregated
into (a) value creation goals and (b) monitoring and control system.
If one was put in a narrative form as has been done in many regula-
tory jurisdictions and by various management pundits, the entire
set of responsibilities can be grouped into aforesaid stated four broad
parts—vision, mission, values and culture will get covered under
direction. The strategy inclusive of input mobilization—resources
pooling, entry and exit choices and organizational design will get
aggregated into superordinate goals.
The annual budgeting and work plan will get covered under
value creation goals and rest of it including monitoring of perfor-
mance, compliance, disclosures and so on will get aggregated under
monitoring and control system. Appointment, removal and compen-
sation and so on will also get included under value creation goals.
However, a broad segregation of the role of the management
and the board, as I see it, is given in Annexure 2.

8.8. Allocation of Time of the Board

As mentioned earlier, the board’s responsibility can be divided into

two frames: the strategy frame and the operational frame. The board
should conceive, discuss and decide the strategy and the manage-
ment must operationalize those to create wealth. Thus, strategy
remains the bigger role of the board and managing the operations
remains the prime responsibility of the management. However, the
board is expected to exercise what I describe monitoring and control
over the operations management. This is necessary to ensure that the
management is on the right path and that the trends emerging from
the performance are indicating the fructification of the vision and
mission of the enterprise. Hence, the board has to allocate appropri-
ate time to both the roles, that is, strategy formulation and opera-
tions management. Since the primary responsibility of the board
remains that of providing strategy, it has to devote much more time
to this aspect and much lesser time to the operations management.
However, it is my experience that most boards spent, if not more, 90
per cent of the time in appraising the performance and very little or
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negligible time is allocated to strategy formulation and its review. The

end result of this allocation is that the board fails to govern the enter-
prise. In most cases, they become the replicators of the role played by
the management who hardly treats the board members as more than
artefacts in the boardroom. Assertive among the board members start
getting frustrated and eventually give up or fall in line to enjoy the
cosy environment of the boardroom. The boardroom practices will
improve only if the time of the board is appropriately allocated and
a significant amount of quality time is spent in building the strategy.
The recommendation on the allocation of time into various stages of
the company is given as follows:

Time allocation
Strategy Operations
Stage 1 20 80
Stage 2 40 60
Stage 3 60 40

8.9. Business Management and

Enterprise Management

There is a subtle difference between the business management and

enterprise management. Business management is like maintaining
health in the current framework, whereas refurbishing, reorient-
ing and re-engineering the framework along the journey to keep
the enterprise well and healthy over a long duration is enterprise
management.
Political, social, economic, ecological, technological and
business trends shape the planetary landscape. For assessing
the overall impact of the trends including sub trends and their
fusion, the managements have to adopt anticipatory and percep-
tive approach. Rising consumption in emerging markets and
technology-driven products and services are expected to create
new market. The companies are expected to face intense pres-
sure to innovate, be more productive and acquire size to harness
the opportunities and even survive. The profitability is shifting
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 Boardroom Practices 105

to idea-intensive sectors, which will make acquiring intellectual

assets and inorganic growth important factors.
As per Mckinsey survey, there is relatively a wide gap between
the impact that the executives assign to these trends and the extent
to which their companies take active steps to seize the opportuni-
ties. The survey further outlined that in their responses to questions
about indicated macroeconomic, political, social, environmental
and business trends, executives from different industries reveal sig-
nificant differences in their assessments of the impact of the trends
as well as the actions their companies are taking to address them.
In fact, some of executives are not able to even decipher that their
organization has or is likely to lapse into a midlife crisis.
To meet the compelling challenges of the unfolding trends
strategic response have to become multidimensional, which will
necessitate companies moving in a range of directions. Structural
changes include hiving and consolidation, erecting upstream and
downstream partnerships, risk-taking and hard-nosed approach
to competition. The organizational design and strategic frames
will have to be visited at more frequent intervals to ensure that
value drivers are not becoming value destroyers and that new
value drivers are being added constantly.
The challenge of sustaining corporate performance over a
period of time, which I call enterprise management, has long
exercised the minds of the executives and management pundits.
Yet corporate management and the BoD of the companies still
find it hard to shift their attention away from the next set of quar-
terly results and today’s stock prices. Anticipating—deciphering
threats and opportunities emerging out of those trends and hus-
banding—for growth, profitability and sustainability is an integral
part of an enterprise management. The enterprise management
helps companies to harness emerging trends without jeopardizing
the core business.
The enterprise management will seek to ensure the long-
term health of the organization by fostering a variety of attributes
such as:

• Building broader mental mind fields which open up stra-

tegic vision hot spots.
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 106 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

• Architecting enterprise resilience to handle known–

unknown and unknown–unknown changes.
• Building the competences of ‘strategic think’, particularly
amongst the members of the senior management team.
• Shifting the focus of acquisition to intellectual assets and
idea-creating organization and business designs.
• Building execution capabilities along with abilities of effi-
cacious decision-making, forecasting and well-orchestrated
responsibility and accountability frames.
• Reorienting the organization so that the vision connects
every stakeholder, in particular employees, with an elab-
orate process of shared identity and values coupled with
equal concern for the interest of all stakeholders.

Post a robust framework of compliance with the laws and rules

and best practices, and business model the board of the company
should focus more on the enterprise management, which will
include in addition to the aforementioned, organizational behav-
iour, group dynamics, balance of power and decision-making
processes and will leave business management to the execu-
tives, of course with a focused oversight. This is required if it is
essential for the company to grow, organically and inorganically.
Even otherwise, unless the company acquires a reasonable size of
strong built, it will be difficult to wrestle in the industry ring of
disproportionately burly pehlwans (wrestlers). Greater focus on
the strategy loop is the way forward. This is how the board will
add value and the tyranny of Corporate Governance will turn it
into the triumph of the enterprise.

8.10. Designing the Agenda for

the Board Meeting

The success of a board meeting depends substantially on the

design of the agenda. In most companies, the design and drafting
of the agenda is left to the company secretary who routinely lists
out the items which he considers are necessary from the regula-
tory perspective and includes usual items such as confirmation
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 Boardroom Practices 107

of the minutes, review of the performance, approval of quarterly

results and so on. If the HOD happens to send him an item by
himself, the company secretary assesses the relevance and if he
thinks it to be fit and appropriate he includes it in the list pre-
pared by him. In fact, some of the long-serving company secre-
taries become overbearing and the HODs hardly challenge their
discretion. However, some of the articulate company secretaries
send a mail/memo and invite items from the HODs to be included
in the agenda of the forthcoming board meeting. And this is all
done just about a few days before the date of the meeting.
Most often, the chairman of the board hardly gets involved;
at best, the CEO is shown the list who cursorily goes through it
and adds an item or two and returns the papers to the company
secretary. I remember having once asked the CEO of one the
companies where I happened to be the non-executive chairman
whether he has perused the agenda which is being circulated to
the board members. He was frank enough to admit he has not
and added that this is being handled by the company secretary.
In fact, in most cases where the chairman is a non-executive, he
gets the agenda along with other directors pinned over the notes,
which exhibits the casualness of the approach and inadequacy of
the contribution of the chairman. It is important that both the
CEO and the chairman not only get involved but also give a direc-
tion to the formulation of the agenda. The agenda determines the
flow of the board’s meeting and decision-making process.
The procedure for drafting the agenda for better results should
be as follows. The company secretary should, at least a month in
advance of the date of the board meeting, send a mail/memo to all
the HODs and also the CEO to send their items which they would
like to be included. The response time for the HODs and the CEO
should be at best three days. The company secretary should, on
receipt of their response, consolidate the items with those he has
listed, inclusive of those that need to be presented to the board as
per statutory requirements. Having prepared the list, he should
approach the CEO for the clearance of the list when the latter
gets the opportunity to get the areas he wants to be discussed in
the board included and/or excluded. This will make the manage-
ment’s list complete, which should then be sent to the chairman.
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A date should be fixed when the chairman, the CEO and the
company secretary sit together physically or through video/audio
conference and finalize the tentative agenda. In the meantime, after
having received the management’s list, the chairman should talk to
either the lead director or all the non-executive/independent direc-
tors about the items they would like to include in the agenda of the
next board meeting. Even though most of the time independent
directors may have no item, this approach builds a sense of partici-
pation and, of course, if they have one, the same is included. Three
of them then finalize the list of items to be included for discussions
and decisions in the next board meeting. The discussion will also
deliberate on the types of data, information and analysis that will
need to be collected by the HODs to prepare the background notes
which are comprehensive and facilitate decision-making. Such an
elaborate exercise makes way for the comprehensive preparation of
the board meeting and leaves very little scope for table items, which
should always be few and far between.
It must be clearly understood that a board meeting is one of
the, if not the most, important event in a quarter of an enterprise
and preparations for leveraging the wisdom of the board has to
be comprehensive. Senior management is always bugged with
routine and preparation of the board meetings, most often goes
by the default, which does not deliver the expected results in the
board meetings and does not augur well for the good of Corporate
Governance either.
The agenda of a board meeting should normally have the fol-
lowing four broad sections:

1. Items for information and noting.

2. Items for routine approval such as minutes of the last
board meeting and so on.
3. Operational matters.
4. Strategic issues.

Such a segregation helps in quickly running through the easy

items during the meeting, which hardly require discussions,
leaving enough time and adequate attention for the important

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 Boardroom Practices 109

items to concentrate on. It has been observed in quite a few

board meetings that most of the time is spent on routine items
and the important items which deserve much deeper discussions
and considerations are passed quickly. In some boards, I have
observed that a significant time is spent in discussing the lan-
guage, grammar and punctuations in the minutes. This may suit
some of the CEOs and other senior executives, but is suicidal for
the success and sustainability of the company.
The operational matters should further be segregated into
(a) regular items such as approval of quarterly, half yearly and/or
annual results and the accounts and performance evaluation of the
company since the last board meeting and (b) other items where
board’s approval/attention is needed. While items in (a) entails
supervisory jurisdiction of the board of monitoring the perfor-
mance and its evaluation and, therefore, will have to be reviewed
critically, these items are most often approved at the conclusion of
the presentation by the CEO and the CFO with little or no discus-
sion. Such items afford an opportunity to the board to understand
how the present of the company is moving forward. It is also an
occassion for the board to offer suggestion/ideas for improving the
performance. Simultaneously, it helps the board in evaluating the
performance of the CEO, the CFO and other board-level executives
and others, which is necessary for deciding their compensation and
continuance in the company.
The strategic matters will have two parts: (a) evaluation of
the effectiveness of the strategic approaches being pursued as to
their efficacy and delivery of the expected outcomes and (b) new
strategic moves. Both these matters require much more attention
of the board, as this is their primary task.
Once the items of the agenda have been decided, these
should be circulated to the HODs for the collection of relevant
information, data and preparation of analytical background notes
specifying various alternatives and also the perceived impacts
of the alternative choices. The diligence in preparation of notes
cannot be compromised in the interest of the quality of decision-
making. It requires time and attention for the job to be done well.
Hence, the early start of the preparation of the agenda becomes

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necessary. The agenda must be ready and circulated to the board

members at least 10 days ahead of the board meeting date, which
will give enough time to the board members to read, apply their
mind and come prepared to deliberate in the board meeting.
In fact, the preparation for the strategic items will begin much
earlier because the kind of information and/or analysis that is
required may not be possible to organize in two to three weeks.
Cost implications, alternative uses of the resources and data of the
impact of the strategic moves taken earlier is a time-consuming
process. Hence, just bringing the item without adequate prepara-
tion does not offer a fulsome opportunity to the board members
to give their best. Often, the board members are told how we can
find a strategic matter in every board meeting. The following is a
tentatively illustrative list which can be considered.

1. Management of HR
2. Marketing strategies and validity of those being pursued
3. Management of financial resources
4. Production efficiencies
5. Management of environment—macro and micro
6. Emerging trends in the business line and messages for
consideration
7. Efficacy of product basket
8. Optimization of physical resources
9. Inorganic growth opportunities and our space
10. Succession planning
11. Evaluation of strategies in action

The list can be endless and the contribution of the board can be
enormous, provided these subjects are brought before the board
and enough time is allocated for discussion thereof.

8.11. Drafting of the Board Notes

It is important that the board notes are comprehensively drafted,

so as to help the board members to take the decision. It is impor-
tant that these notes are divided into four parts.
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 Boardroom Practices 111

1. State the issues that need attention of the board and con-
sequential decision-making to address those issues. In case
framing of the issues is not appropriate, the rest of the
work will not have appropriate linkages. Hence, various
members of the management team must devote enough
time and attention to identify the issues. Quite often,
the symptoms are confused as issues, for example, if a
product is not selling, one has to identify the issue, lack
of sale or inadequate sale of a product is only a symptom.
There could be defects in the design of the product, lack
of competitive advantage in the product, predatory pric-
ing by the competitors, poor post sales services and so
on. In case none or inadequate sale of products is treated
as an issue, the simple solution would be to propose a few
incentives either to customers and/or to sales persons and
heighten the advertising. These cannot bring the results.
Sometimes, some flicker of growth as a consequence of
such incentives does occur, but that uptrend subsides once
the incentives are over and/or absorbed. In case the issue is
competitive positioning and so on, it has to be dealt with as
such and the solutions would be far different. Hence, the
effort of the management has to be to diagnose the disease/
issues stemming out of the symptoms.
2. Once the issue(s) has been diagnosed, the management
must propose various options/choices to deal with them.
Since there cannot be only one solution to deal with the
issue(s), alternative choices have to be thought and pro-
posed. The details of the alternate choices must form part
of the note. All the choices have to be supported by the
need of resources and the value creation.
3. The third part of the note would be the probable impact
of the alternative choices, in short, medium and long term,
on the revenue, health and sustainability of the company.
This is very important for the management as well as for
the board to be able to weigh various options and then take
a considered decision of selecting the best option available.
4. The concluding part of the note should be the manage-
ment’s recommendations, and if that is accepted, what
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would be the execution process(s). Clearly, delineating

the milestones of the journey will help them to review the
progress at quick intervals as to the effectiveness of the
choice(s) made and/or need for re-engineering, abdica-
tion and so on.

The notes have to be supplemented with statistics relevant to the

issues, choices, impacts and also the experiences of the execution
of similar choices in the past by the organization itself and/or by
others domestically and/or internationally.
It is important to note here that every decision is an expense,
both in terms of the resources used and time spent in executing
the decision. In case a decision does not turn out to be correct,
it would amount to a loss of revenue/resources of the company.
Although it is impossible to determine at the time of taking the
decision whether the decision will actually turn out to be the right
decision, application of mind has to be facilitated by enough of data
and analysis. It is my belief that in case the wisdom of the board is
marshalled with due consideration of all the necessary information,
data and analysis there is a stronger possibility of a decision turning
out to be right or near right. In case, however, such a process is not
undergone, the possibility of those decisions turning out to be right
is rather remote. This exercise has, necessarily, to be undergone
for the strategic decision-making, in particular where ‘blue ocean
strategy’ is sought to be pursued.
In the matter of the review of the performance it has often been
observed that what facilitated the performance, what did not help
in the performance, what were the impediments in achieving a bet-
ter performance and/or what signals this performance is throwing
up are not brought before the board. In fact, in most cases, such an
in-depth analysis of the periodical results, be it monthly, quarterly,
half-yearly or yearly, is done. In the absence thereof, discussions in
the boardroom become a kind of replication of the exercise, which
has already been undertaken by the management and no better
light emerges in the process. Thus, the role of the board in monitor-
ing the performance is less than fulfilled.
I would like to state that the aforementioned is just a small
description of an item. Every item of the board agenda has to be
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 Boardroom Practices 113

dealt with similarly. The board undertakes the review of the health
check of the business in the current form but also meet to review
and decide what needs to be done to help ensure the sustainabil-
ity of the success of the enterprise. In case the enterprise is going
through some pains, board meeting is the right forum to discuss
and decide what needs to be done. Early takes prevent regrets later.
Hence, the preparation of board notes becomes a very critical part
of the boardroom practices. During our consultancy projects, we
examined the board notes of the clients and found that in most
cases, the notes put up before the board were perfunctory in nature.
It has to be well understood that the board is the ultimate authority
of management in the journey of an enterprise, and if that exercise
of management is not undertaken in depth, ‘God save the King’ is a
famous proverb that would become applicable.

8.12. Minutes of the Board and Committees’

Meetings

The minutes are expected to be the mirror image of the discussions

and decisions taken in the meetings of the BoD and its commit-
tees. It must be remembered that whenever the need arises to find
out what actually happened and/or what decisions were taken in
a particular meeting, and also what factors were considered, what
arguments were advanced and what information/documents were
relied upon while taking those decisions, the minutes are the only
document which is relied upon by the regulators, courts, inves-
tigating agencies, any other person and/or authority. Even if the
company’s executives want to know, understand or analyse what
and why a decision was taken, the minutes become a relevant
document. Hence, it is necessary and important that the minutes
are properly and elaborately recorded. Go through the minutes of
any of the companies, even the ones perceived to be good governed
companies, it can be observed that in most cases, the recording
of the minutes is very sloppy. The chairman and the CEO do not
devote enough attention and time to this important aspect of the
functioning of the board and committees.
In one of the companies where I happened to be the non-exec-
utive chairman, the CEO never bothered to check what has been
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recorded in the minutes. He relied completely on the company

secretary and the chairman. When I refused to clear the minutes
until these were perused by him, the clearance of the minutes
started getting delayed as he accorded the least priority to this job.
Routine always overtook him. This is the case of a CEO who was
hard working, conscientious and successful. One of the prestig-
ious companies in the financial services sector had a practise of
recording dissent separately and not as a part of the minutes. Of
course, dissent itself in that company were few and far between
mainly because of the overbearing persona of the chairman.
In fact, the minutes of some of the companies just record
the decisions and do not record a gist of discussions including
various points of view expressed. In some cases, some phrases
such as ‘after discussions’, ‘after detailed discussions’, ‘after some
discussions’ the board/committee accorded the approval are used,
which is highly irregular. Such a recording denotes that either the
discussions did not take place at all or were without depth. The
situation in either case is undesirable. It can be appreciated that
for items such as approval of the minutes and so on, if the record-
ing is proper and are circulated well in advance, very minimal
discussion would be required in the next meeting. However, mat-
ters either of strategic nature or even the operational performance
cannot be approved by the board/committees without full-length
discussions even if everything is excellent because in that case, the
discussions should centre around how that could be achieved and
how sustainable it is. What are the learnings that need to be docu-
mented and what are the threats to the excellent performance
going forward. Such items of the agenda, being passed without
discussions, may give an impression of a lack of application by
the members of the board and/or the committees.
The moot questions that, therefore, emerge are, What is all
that needs to be recorded and how the recording should take
place? Here are some thoughts in this direction. First, the best
way to ensure that every important point brought out during the
discussions is recorded by tape recording the proceedings, which
is then used by the company secretary to finalize the draft of the
minutes. This will have multiple benefits: (a) all the recording will
be factually correct, (b) as many details can be recorded as may be
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felt necessary and (c) it will leave little scope for the members to
point out the inaccuracies and incompleteness. At the best, what
will require correction would be the language so that the recordings
make sense as to what was meant when the directors made those
observations and what was actually decided. This may look to be
a painful process and may make the directors, particularly non-
contributing, uninvolved or those participating unprepared in the
meetings, uncomfortable, but will eventually be in the interest of
the company and also the directors. In any case with the provision
in the Indian Companies Act, 2013 permitting video conferencing,
the recording of the discussion will be a legal requirement.
The following things definitely need to be recorded as a part
of the record of proceeding:

1. Management submission on the agenda item either culled

out of the note and/or what the management’s representative
says in the meeting as a matter of clarification and so on.
2. Queries raised by the directors. It might be useful to
mention the name of the director who raises the query
and/or makes the point. However, if the directors feel
strongly against the recording of names, conscientious-
ness needs to be built against it. What is important is the
full and factual recording. Building perception of effica-
cious Corporate Governance warrants that the names are
recorded. Eventually, this will also build a kind of record
of the level of participation of the individual directors
and the quality of each director’s contributions, which
will be useful in evaluating the performance of the NEDs
for their continuance and/or remuneration, if the varying
level of compensation is sought to be given.
3. Various points of views expressed, whether for or against
the proposals.
4. Impact of the points of views on the outcome of the deci-
sion taken/suggested to be taken.
5. Replies given by the management to each of those queries.

The recording of the discussions needs to be brief and precise but

must render full elaboration of the points made. Verbatim recording
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need not be done. It should be done only if it is felt necessary or

the concerned director who makes the point desires so, because a
verbatim recording will make the minutes too bulky and real points
may get lost in the text somewhere. However, it must be made sure
that nothing important that needs to be recorded is left out.
Once the draft is ready, it should be sent to the chairman of the
board/committee who should vet the draft and suggest changes, if
any necessary. It would be desirable for the HODs and the CEO to
review it before the company secretary readies it as a draft and for-
wards to the chairman. Once the chairman has cleared the draft, the
same should be circulated to all the directors who should be given
at best a week’s time to suggest additions, deletions and/or changes,
if any. It is important that the draft of the minutes is circulated
within a week of the conclusion of the board/committee meeting.
This will ensure that the directors are able to recall the discussions
and decisions. Longer the time taken in circulating the draft of the
minutes, greater are the chances of the memory of the directors fad-
ing away. This will incidentally ensure that the approval of the min-
utes in the meeting takes very little or no time at all. In one of the
boards where I sat as an independent director, another director who
was a solicitor by profession would read the minutes in the flight
taking him to the town of the board meeting and would take hell
out of the company secretary and the CEO eventually, wasting half
the time of the meeting in the approval of the minutes. He would
like even the grammar to be corrected. Although the drafting of
the minutes certainly need substantial improvement, the problem
could be solved if the minutes were circulated within seven days
with an agreement that corrections/modifications to be suggested
must be received by the company secretary within seven days of
circulation. This would result in better quality of the minutes, uti-
lization of the board’s time for more substantive issues and relieve
the directors from the torture of haggling and bargaining in the
board meeting. This is what I did in another board where I was the
chairman to rein in the recalcitrant director of wasting the board’s
time in the approval of the minutes. The quality of the minutes is
of utmost importance. Writing or making use thereof while writing
history will be greatly facilitated by good quality minutes. Hence,
it is essential that the minutes are recorded and kept not only for
statutory reasons but more so for their use for a variety of purposes.
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8.13. Action Taken Report (ATR)

The confirmation of the minutes has to be followed by an ATR as

the next item in the board agenda. While in some of the companies
this is not done at all, in others the ATR is sloppy. Either it does not
contain the information on all the decisions/direction given in the
board meeting or the ATR is not complete with facts of what has
actually been done. In fact, ATR helps the board members to know
what actually happened to the implementation of the decision. It
might be helpful and desirable to outline the timeline for the imple-
mentation of the decision/direction in the meeting in which such
a decision is taken or a direction is given, and the management
must ensure that the timeline is adhered to scrupulously. In case
the timeline cannot be adhered to, the management must specify in
the ATR why and also when will the implementation be completed.
The management is generally happy to skip the presentation of
ATR, however, the board cannot afford that.
In fact, it is an obligation of the management and necessary
for the welfare of the enterprise that the decisions of the board are
implemented as planned. The best way it can be ensured is by the
submission of a comprehensive report in the form of an ATR and
unless the decision is fully implemented, it is carried as an open
item until done along with the date of decision and progress made,
if any so far. This will also help in revisiting the decisions/directions
of the board, if those are not implemented or needs re-engineering.

8.14. Vision and Direction

In the allocation of roles between the executive management

and the board, it has been clearly delineated across jurisdictions
that the board will have primary responsibilities of providing the
vision and direction to the company in its tryst with future.
While different management pundits have defined vision
differently, it can be summed up that ‘vision is a distant dream
difficult to achieve but realisable’. In fact, it indicates the place
that the company would like to carve out for itself in the eco-
nomic horizon of the planet Earth. The formulation of vision will
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necessarily involve people at all levels in the organization and in

the consideration of the environment—macro and micro, glob-
ally and domestically and the business line it is pursuing, so that
it is able to clearly specify the purpose of its incorporation and
existence. It should also be able to help all the stakeholders to
identify whom it is going to serve, how will its journey of success
pan out, how will it create value and wealth and how will de-
risking programme including beating competition pan out, what
specific attributes will help and how it is going to manage itself in
an environment which is undergoing unremitting transformation
constantly. Vision must have the spark of a larger lofty theme,
which enthuses the stakeholders to rally around it.
There is no gainsaying the fact that vision, the central theme
of the existence of the company, will be supported by the mission
that it will craft and the vehicles of the strategy that it will architect.
In fact, it has to be complemented by the organizational values
and cultures, which will be the guiding lights in its tryst with tri-
umph. Hence, the board will have to not only finalize, decide and
articulate the vision, but also outline the mission, strategies and
organizational values and cultures. As mentioned earlier, in the
formulation of all the above, there has to be a very involved debate
in the organization, and unedited views and opinions of the whole
organization have to be placed before the board along with the
supporting information, data, analysis and the research that would
have been conducted in-house and/or with the help of outside
agency. In most companies’ executive management, may be a few
of the shareholders’, director decide the vision and present to the
board for rubber-stamping. It happened in one of the companies
where I was an NEID. I was dumbfounded when the approval of
vision, mission, values and cultures was passed over like minutes
of the meeting. Nobody said anything. Before I could recover from
the shock, the chairman had moved to another item, making my
intervention as if irrelevant. Of course, I had to threaten him with
my exit to compel him for an hour-long discussion that followed.
Since I was the lone respondent of the discussion, it got summed
up quickly, albeit with modifications. As the time passed, the CEO
thanked me twice as the changes helped him to diversify, and new

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business lines are now dictating the sustainability of the company,

even though I am out of the board. Greater acceptability by the
stakeholders commandeers experiencing a sentiment that the
vision has emerged out of several options that were weighed.
The board cannot delegate these responsibilities to the execu-
tive management and ask them to come up with the finalized
preposition, and deliberate briefly to approve it. The exercise
in the board has to be of designing—of course, with the help
and support of the inputs from the executive management.
Undertaking such an exercise by the board may not be possible
in one of the routine board meetings. This will have to be done
in a separate meeting called for the purpose, preferably offsite, so
that the executive management which is expected to participate in
this exercise is not disturbed by the pressures of operations’ man-
agement. The offsite meeting will also help in building thoughts
during the informal interactions—over the breakfast, lunch and/
or dinner tables. An environment has to be necessarily created
for engaging the minds of all the board members and executive
management. As a preparation for the meeting, sufficient data
work would have to be done to facilitate a meaningful exercise.
Once the vision, mission, strategies, organizational values
and cultures have been decided, these need to be articulated so
that these are understood by all those who are going to make use
and execute. The success will depend on the understanding that
is built within the organization and the level of ownership that is
cultivated. Without the ownership, execution will be a mirage. The
board will have to periodically review the execution and, if neces-
sary, initiate steps to ensure greater effectiveness. Notwithstanding
the above, annually, the board will have to review the basic theme
of the vision along with the mission and strategies as to their rel-
evance and effectiveness for the sustainable success of the organi-
zation. While undertaking the review exercise, its appeal to all
stakeholders will have to be assessed in-depth, as their support is
essential all the way for fructification. The whole idea is to evaluate
the value creation capabilities of the vision, which will emerge out
of the advantages that the company has over the competitors, and
how it is managing and mitigating the risks along the journey.

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Any organization without a definite vision, which is prag-

matic and executable, cannot sustain success. It becomes like a
rudderless boat, which either flows along the current and finds
shores by the direction of winds or just drifts. It cannot navigate
the adversities of the rough waters and weathers.
While action plans will be made by the management, the
fundamental strategy, which can broadly be categorized into
(a) market choices and (b) competitive edge, has to be decided
by the board. The market choices have to be delineated further
into entry and exit options. Similarly, competitive edge has to be
organized through products offering and pricing options. Vision
must be capable of being translated into marketable products and
services, which is facilitated by strategies.
I have the experience of sitting on a number of boards—private
and public companies and different sectors from financial ser-
vices to infrastructure—and I have observed that the designing
and articulation of the vision, if at all done, are left to the CEO.
It is only when I became the executive chairman of a large pub-
lic corporation that I made board devote some time to this very
important role of the board, but even then, the participation of
the individual board members was marginal. Unfortunately, even
at boards I chair now, I find it difficult to push my way through
the board and the executive management to get this agenda onto
the forefront of the role of the board.
As stated earlier, there is clear-cut segregation in the roles of
the executive management and the board. Executive management
should be charged with the management of business, whereas the
board should be more concerned with the management of enter-
prise. Business management is like maintaining the health of the
enterprise in the current framework. Refurbishing, reorienting and
re-engineering the framework along the journey to keep the enter-
prise well and healthy over a long duration are called the manage-
ment of an enterprise. This can be achieved only by outlining the
vision, mission, strategies and organizational values and cultures.
As said earlier, since the environment is dynamic, all these pillars
of enterprise management have to be kept on a dynamic platform.
This is possible with the clarity of direction given to the manage-
ment by the board.
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8.15. Barrier to Broader Debate in

the Boardroom

A boardroom is a forum where broader debate on issues, challenges

and opportunities must ensue. This is where expertise should collide
with the wisdom of generalists to explore, innovate and experiment
with unique prepositions, philosophical underpinning and out-of-
box thinking. Incisive exercises in this forum can prevent tunnel
vision, which often is the case, if specialist abrogates the decision-
making without inciting a robust debate on ideas and thinking of
the generalist. In an HRB article (January–February 2015 issue),
academicians Martin Ihrig and Ian MacMillan propound, ‘Large-
scale, sustainable growth is generally made possible when people
take insight from one knowledge domain and apply to another…’.
I have watched in the board meetings, so-called experts in the line
run riot with the agenda item without even giving a chance to uncon-
ventional ideas being considered in the formulation of the course of
action. In the absence of such an exercise, the enterprise is deprived
of the benefits of collective wisdom and leveraging of skills, experi-
ence and learnings that obtain in the boardroom. There is something
called finding correlation between inside out and outside in, which
includes expertise militating with generality and full-time executives
debating with NEDs. This is what takes out of the tunnel vision. In
one of the boards where I was the only experienced person (could be
called an expert) with domain knowledge, I tried to excite a broader
debate with a view to help the enterprise benefiting from the non-
experts’ unconventional thinking. I was told by the CEO that the
matter will be discussed with me separately. I visualized the barrier to
the broader debate and withdrew immediately from the discussions
in the meeting, and eventually from the board itself.
Although, in most boards, the agenda is closed with the run
up to the routine items, wherever some debates take place on
strategy or direction, the depth is missing. Maybe there are a
few selected boards where this ensues with alacrity, concern and
coordination, but those are the companies which are excellent
performers too. There are a number of barriers to the broader
debate in the boardroom, such as:

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1. Reluctance of the CEO and/or chairman for such a debate

in the absence realization of the benefits thereof.
2. Insecurity of the CEO, in particular about his position in
the organization, albeit a challenge to his performance/
understanding/wisdom.
3. Absence of comprehensive data, analysis, framing of issues
and so on.
4. Insufficiency of time allocation.
5. Discouragement to independent thinkers, contributors
and collaborators.

8.16. Focus on Strategy

A Mckinsey survey of more than 1,000 directors outlines that

many board members are frustrated by their companies’ excessive
focus on short-term financial performance and prefer not to devote
more time to long-term issues, such as strategy and leadership
development. The findings further add that directors sometimes
lack the information needed for sound decision-making and may
not understand the set of objectives and risks for their companies.
Such surveys pitchfork the deficit of governance in harness-
ing the skills of the board in building and enhancing the capabili-
ties of the organization. In Section 8.1, Composition of the Board,
a compelling case has been made out to collect wisdom, variety
of skills and tons of experience. However, the utilization of the
talent in the board cannot be limited to the monitoring of the
performance of the management, albeit replicating of what they
do. Greater utilization has to be found in the role delineated to
the board as outlined in the relevant chapter.
I believe that the strategy is at the heart of the board’s work.
The board should, therefore, be more focused on designing and
regularly reviewing and rewriting strategy—medium and long
term—for ensuring that the organization progresses in develop-
ing the essential capabilities to deal with the future challenges.
Another study reveals that the boards and leading companies are
making strategy review a consistent part of every board meet-
ing. Of course, it is important to watch how quickly boards
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acclimatize to their new focus, dynamics and the chemistry in the

boardroom in order to tackle strategic agenda effectively. Let me
dwell briefly on how this agenda can be furthered in the board.
Within the definition of strategy, which I have elaborated
earlier, the board, with the support of the management, should
identify the value drivers. These value drivers, although may
relate to an industry, are specific to a company, which could be,
say, ‘market growth rate’, ‘pricing strategy’, ‘competitive land-
scape’ and so on. This identification has to be supported by the
data and information on how the value drivers are panning out.
The board has to engage its attention on the threats to the value
drivers along with the predictability of profitability and sustain-
ability. Once that is done, the debate has to shift to de-risking
those along with other value destroyer or eroder. The board has to
engage its mind on how the competitive scenario is unfolding and
how it will impact the strategy frame of the company along with
its value drivers. The board should also discuss how the strategy
execution is shaping. Are the value drivers emerging as envisaged
in the strategy and also whether sprouting of value destroyers, if
any, discernible? The board has to evaluate whether the compen-
sation strategy being pursued by the company is value enhancer
or long-term wealth destroyer. Effectiveness of the entire strategic
weaponry should be the agenda of debates in the board meetings.
However, before understanding the review processes as men-
tioned earlier, the board has to formulate its strategy for the reali-
zation of the ultimate goal—wealth creation through the medium
of its vision. The idea of writing this narrative is only to suggest
the threads which can help the board contributing optimally its
part in the value creation by the enterprise. What management
will do will be complementary and supplementary to the con-
tribution of the board, and reflection thereof will be seen in the
arithmetic presented to the board by the management as quar-
terly, half yearly and yearly financials. This will also be adjusted
by the market in the valuation it will accord to the enterprise.
In fact, with the compliance of regulatory obligations behind,
the board should focus on more substantive mission, with
increased company’s dependence on their BoD for insight and
guidance on the big picture issues that can contribute mightily to
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the company’s success and long-term sustainability. The annual

offsite meeting of the board, which, I understand, are being
organized in most companies, should outline the focus on the
strategy loop for the rest of the year. Furthermore, the board over-
sight will get significantly enhanced if the directors can develop
comprehensive pictures of the performance of their companies
and learn to participate more deeply in discussions about strategy
and leadership. The company should not be depriving itself of the
value of the wisdom and experience of a very accomplished BoD.

8.16.1. Organizational Design

Every company architects an organizational design to ensure the

smooth conduct of operations and value creation. In fact, in good
companies, organizational design is so weaved that every part
of the design creates value and prevents seeping in of any value
eroding viruses. This is organized through a variety of tools and
techniques. The effectiveness of tools and techniques has a direct
and proportionate relationship with the organizational design. Over
a period of time, the tools and techniques become blunt and, there-
fore, have to be sharpened or changed altogether. This cannot be
organized without reviewing the organizational design periodically.
Furthermore, with the change in the macro and/or micro environ-
ment, tools and techniques become ineffective and/or irrelevant,
so becomes the organizational design. It is, therefore, important
to periodically assess whether the organizational design and its
attendant tools and techniques are still delivering value optimally
and whether they are able to effectively check value destruction.
It might be relevant to note here that the organizational
design of insurance industry companies—more particularly of
life insurance companies—in India has become value eroder
as a consequence of transformed regulatory stance and market
developments. Unfortunately, the boards and managements of
the companies are unable to comprehend the desirability of inno-
vating new (which I have just done for academics) model and
keep complaining about the market competition. Manufacturing
margins are being eaten by the distribution excesses.
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Manufacturing margins emerge from the surplus generated by

the lower actual mortality of the assured lives over the expected
mortality of the assured lives, the excess of investment income
actually earned over the expected returns on the investments of a
life insurance company and lower actual expenses of management
over the expected (estimated) expenses. Thus, the manufacturing
margin is an aggregate of the surpluses from the three aforesaid
segments. The expenses of management include distribution–sales
and marketing expenses. It is expected that actual expenses will be
lower than the expected (estimated) expenses. Unfortunately, in
the case of private life insurance companies in India, the actual of
sales and marketing expenses are much higher than the expected
expenses. Oftentimes, these expenses are 150–200 per cent of the
expected and factored in pricing the products, which eats away the
manufacturing margins generated by other segments namely, mor-
tality ratio and average mean yield on investments. An example is
given in Table 8.1.
It can be seen from the table that the manufacturing margins
being delivered by 1, 2 and 3(b) are being eaten by 3(a), and the
company lands in losses.
Sagacity demands casting off irrelevance, but the impulse of
control is persuading the management to keep hugging the dead
child like a monkey; possibly the wait will end when the stink of
erosion becomes difficult to bear. This happens because organiza-
tional design combines manufacturing with marketing and sales,
which need to be separated.
Hence, annual strategy formulation must include review, refur-
bishing, re-engineering of organizational design. Most boards do not

Table 8.1 Calculation of Surplus In Life Insurance Companies

Expected Actual Surplus

1. Mortality experience 100 90 –10
2. Average mean yield (%) 7.5 8 0.5
3. Expenses of management 100 175 +75
(a) Distribution–sales and marketing expenses 75 155  +80

(b) Other expenses 25 20  –5

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realize the significance of the review of the organizational design,

and, ignorantly enough, become part of less-than-optimal value
creation. The Corporate Governance is all about value creation, and
the collective wisdom in the board as a governance practice should
be marshalled to enhance value. Of course, for review and organiza-
tional redesign, the board can seek the help of outside agency/experts
who can provide suggestions, recommendations and useful inputs.
However, it will eventually remain the board’s responsibility to
ensure that the organizational design remains efficacious at all times.

8.16.2. Strategy Audit

It is my view that the primary responsibility of the board is to

provide strategy and vision. Executive management is charged to
convert that strategy and vision into operational reality. Directors
who represent stakeholders are expected to evaluate how companies’
returns compare with those of other investment opportunities in
the backdrop of strategy pursued. The ownership of the execution
of the strategy remains firmly in the hands of the chief executive
and his team, and for good reasons. In fact, every company requires
a clear and unambiguous strategy and vision, and also confidence
that its top management has the authority and ability to carry it out.
Efficacious oversight of the strategy can visualize the bottle-
necks and demonstrate to stakeholders that the board and CEO
have a joint commitment to the effective and orderly operation-
alization of strategy and vision. I would recommend a low-key,
behind-the-scene strategy audit, designed to lend credibility to
the strategy and vision of the board and management’s leadership
to operationalize and not undermine it. The process could confer
the leadership of strategy oversight in the hands of independent
directors and provide them with the authority to establish both the
criteria and the methods. The criteria should be the optimality of
value creation through the measurement of the input–output ratio,
compared with the alternative uses of resources channelized in the
implementation of the strategy. The method has to be objective
and the process should be numerical. The performance review
of the company should be jointly undertaken by the board and
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management, which would signal to the investing public that the

board and management accept the board’s authority and respon-
sibility for active and ongoing strategy oversight. Such a strategy
audit mechanism can certainly prevent value erosion and turn out
to be a value creator.

8.17. Budgeting Exercise

The budgeting exercise of an enterprise is an incisive process. It

must take into account various factors which directly or indirectly
affect the functioning and fructification of the targets. Sagacious
approaches pursued by most dynamic enterprises consist of the fol-
lowing steps: (a) scenario building, (b) targets setting, (c) strategy for-
mulation, (d) action plan fabrication, (e) activity listing, (f) sensitivity
analysis, (g) risk management, (h) mid-term review and (i) value
creation goals. Each of these steps can be briefly described as follows:

1. Scenario building: An enterprise comes into being, achieves

and sustains its success, with reference to macro and micro-
environment. While macro-environment relates to the
overall setting—domestically and globally, the micro-envi-
ronment relates to the industry with which the enterprise is
bracketed and environment within. Macro-environment has
three components: (a) economic, (b) political and (c) social.
The micro-environment, as mentioned earlier, has two
components: (a) environment within the industry—relates
to product, pricing and competition and so on and (b) envi-
ronment inside the enterprise—fiscal, physical and human.
In fact, the macro- and micro-environmental factors,
taken together, become a kind of matrix and influ-
ence the performance of the enterprise. It is, therefore,
important for the designers of the budget to get some
realistic assessment of the kind of environment, both
macro and micro, that will be unfolding, and how will
that influence the industry in general and the enter-
prise, in particular. Not to consider, these factors will
be designing the budget in isolation as if the enterprise
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was operating in an island by itself and/or is capable

of creating the environment as it suits. Unfortunately,
for the planners of the budget, both macro- and micro-
environmental factors cannot be orchestrated. These
factors have actually to be managed to the advantage
of the enterprise for delivering a superior performance
compared to the peer group.
Hence, information and data should be collected on,
in particular, the macro and micro-environment and
how the fusion of these factors will impact—favourably,
unfavourably and/or neutrally. Fortunately, we live in an
information age where data is just a click away.
2. Targets setting: This part will contain the numbers which will
be sought to be achieved during the year. The targets to be
achieved will have a reference to the vision and mission of
the organization, past performance and possible mobiliza-
tion of resources. The ambition to perform better, be more
competitive and profitable will have to be the approach.
Although top line is important, bottom is more significant.
Top line is a beauty to be admired, but bottom line is ecstasy
to be experienced. The long- and medium-term perspective
cannot be sacrificed at the altar of the short-term perspective
because the financial year under planning is only a year in
the journey of success of an enterprise.
This will also have a list of assumptions of the variety
of factors that have been considered while arriving at the
numbers.
3. Strategy formulation: Oftentimes, managers confuse strat-
egies with an action plan and activities. It is, therefore,
important to have clarity as to what is the strategy, what
is an action plan and how it is different from the activi-
ties. Strategies can be described as the broad approach
which, when perused, will lead to fructification of the
budget. The strategies can broadly be classified into follow-
ing parts: (a) entry and exit, (b) market choices (c) pricing
proposition and (d) product basket and so on. Hence,
while budgeting, the management has to look at what

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kind of strategic approach it will pursue during the year

and what kind of linkages it will have with the journey
covered and the journey proposed to be covered.
4. Action plan fabrication: Action plans are like the wheels of
the vehicle of the strategies, and activities are the steps or
movement that the vehicle undertakes. Action plan con-
verts the strategies into a goal post, for example, if entry
into a new market is decided as a strategy, what kind of
action plan will be created to enter the market. Just to illus-
trate the point whether the entry would be direct, through
a subsidiary and/or through dealership network. It will also
be decided where production facilities will be located—will
it be located in the market place to benefit from near sourc-
ing or will it be shipped from the existing production facili-
ties and/or new facilities will be created somewhere else to
reap the benefit of scale, skills scope and/or facilitation, tax
advantage, ready infrastructure and so on.
Activities will be how direct, subsidiary and/or dealership
network marshalling, whatever chosen, will be approached
and how monitoring and performance will be facilitated.
5. Activity listing: As mentioned earlier, the activities would
be the movement of the vehicle or the actual steps to
be taken. However, it has also to be listed what kind of
arithmetic the activities will generate. The aggregate of
arithmetic of activities must total up to the expected out-
come of the action plan. The activities would also mean
detailing of every step along with the monitoring process,
impact analysis and re-engineering process(s).
6. Sensitivity analysis: Along with the aforesaid will also be pre-
sented sensitivity to various assumptions and how will the
numbers emerge as a consequence of the impact of changes
in environmental factors on those assumption turning out
to be true, partially true or playing out adversely. In some
progressive organizations, three broad frames are presented.
• Best case
• Most likely case
• Worst case

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I would suggest drawing up multiple frames so that

impact on the significant assumptions is analysed during
the mid-term review for the course correction of strategy,
action plan, activities or the resultant numbers itself.
7. Mid-term review: The budget must also incorporate the
periodicity of the review of the activities, action plan,
strategies and final achievement of targets. While the
period for the review of activities will be shorter—mostly
weekly, fortnightly and/or monthly, quarterly, in case of
action plan and strategies, if necessary, the reconfigura-
tion of the activities, re-engineering of the action plan and
refurbishing of the strategies would be a part of the mid-
term review. However, need-based mid-course correction
will be a continuous exercise.
8. Risk management: While undertaking the budgeting exer-
cise, certain assumptions are made. Every assumption has
a propensity of it turning out to be correct, partially cor-
rect and/or incorrect. These assumptions relate to macro
and micro-environment, impact of strategies, action plan
and activities. Creating a hedge against all these is called
risk management, which has two components: (a) enter-
prise risk management and (b) budget achievement risk
management. The risk management exercise is under-
taken via the following steps: (a) risk assessment, (b) risk
avoidance, (c) risk management, (d) risk mitigation and
(e) risk impact—short, medium and long term.
The enterprise which does not undertake the risk man-
agement exercise is like a driver on a highway without
steering wheel and brakes. Most organizations undertake
the exercise of enterprise risk management but do not
undertake budget achievement risk management. Both are
important because both affect short-, medium- and long-
term performance and sustainability of the organization.
Some organizations combine the two frames, which often
blunts the sharpness of armoury to manage different kinds
of risk, because each risk will need a different weapon.
9. Value creation goals: Carrying out the budgeting exercise
without clearly delineating ‘value creation goals’ is like
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 Boardroom Practices 131

charting out a voyage without pre-identifying the ports to

dock. In fact, for the board to be able to assess whether the
performance during the year is progressing well or not is with
reference to reviewing movement in ‘value creation goals’.

The budgeting exercise, to be complete, must run its full course

(briefly described earlier). Before it is presented to the board, the
board must issue beforehand the broad direction of the approach
that the management has to pursue while crafting the budget.
If the budget is so drawn, then the approval process in the
board can become a meaningful exercise. In the absence thereof,
a ragtag presentation will end up in rubber-stamping some
numbers, which, if achieved, will evoke praise for management
and if not, the collective rationalization will move on to the
similar exercise next year.

8.18. Evaluation of the Performance of

Executive Directors

It is common in all the companies to assess the performance of

the executive directors on a clearly defined objective criteria, in
consonance with the companies’ policy. Generally, the perfor-
mance evaluation is data-oriented for each of the spheres of the
responsibility. Performance is measured against commitment
(annual operating plan; AoP) and best-in-class performance
benchmarks. In some of the companies, performance appraisal of
the executive directors provides an alignment of director’s target
with those of the company through a ‘balance score card’ frame-
work. Generally, the CEO and executive directors have four key
roles namely, leadership, strategy execution, value creation and
governance. In fact, a set of performance matrix has to be created
for each of the position of executive directors.
The performance matrix will have a relationship with each of
the four broad elements. The assignment of weightage to each of
the elements will differ depending upon the focus that a company
needs to gear up, although a broad brush of a robust company
could be as under:
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1. Leadership: 30 per cent

2. Governance: 15 per cent
3. Strategy execution: 20 per cent
4. Value creation: 35 per cent

In fact, in most boards, the exercise of evaluating the perfor-

mance of the executive directors is undertaken rather casually.
The perception about the performance has to be substantiated
by the systematic, formal and rational evaluation with reference
to the agreed objective/key result areas (KRAs) (in the beginning
of the year). I have tried to push the thought in the boardrooms
and I must admit that, notwithstanding the tremendous goodwill
and regard that I enjoy, I have not succeeded enough in most
companies. Generally, the MD/CEO, by default, undertakes this
important exercise in respect of other executive directors.

8.18.1. Performance Evaluation of CEO

CEO is the nucleus around whom the entire organization

revolves. He reports directly to the board. Hence, it is the board
which has the responsibility of evaluating his performance.
Inefficacious evaluation and treatment of the assessment of
performance sends wrong signals to the organizations at large.
Hence, this process has to be not only very incisive and objec-
tive, but also perceived by the organizations to be so. High
performers or enviable performance of the enterprise evokes
comfort and inadequacy of thoroughness ensues. Some of the
long-serving CEOs assume larger-than-life image and become
overbearing, and the board members hesitate to point out defi-
ciencies (considering them to be demigods) in the performance
even when apparent. Such situations become value eroders and
eventually engulf the sustainability of the growth of the organi-
zation. I have seen several such organizations both in India and
other markets. In some such cases, CEOs had a painful parting,
which hurt the organizations as well. This is one of the impor-
tant governance pillars which stakeholders, analysts and the
market watches very carefully, and the board cannot abdicate
its responsibility and/or miss the comprehensiveness by default.
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Often, the board fails to fully appreciate the significance and

also that the lack of rigour in evaluating the performance stead-
ily builds the risk of non-performance and even of non-challenge
amongst the CEO and other executive directors. Sudden exit,
forced or otherwise, is often caused by this lapse on the part of the
board. In any case, the board is deprived of the early warning sig-
nals of the quality of leadership and the garbage that is often accu-
mulated in the backyard of long-term performance of the company.
The best way would be to assign the preliminary work to the
nomination and remuneration committee. This committee should
design the process, get it approved by the board and assess the
performance of all the executive directors including CEO at least
once in six months. Once that is done, this should be a formal
agenda item of the board meeting on a six-monthly basis, where all
the board members have an opportunity to provide the benefit of
their wisdom. The thoroughness of the work of the nomination and
remuneration committee will reveal many things, which will be
very useful in defining the direction of the company by the board.

8.19. Evaluation of the Performance of NEDs

Even though most companies periodically assess, albeit as an item

on the agenda for increase in their remuneration, the performance
of the executive directors, the percentage of companies reviewing
the performance of its NEDs is still not very large.
Fairly an old survey commissioned by Russell Reynolds
Associates found that the quality of companies’ board and its
performance has now become an important evaluation fac-
tor for the investment by the institutional investors. Another
survey of directors of Fortune 1,000 Companies conducted in
1996 by Korl/Ferry International indicated that the assessment
of the performance of the NEDs was done only in 16 per cent
of the companies. However, ever since the major Corporate
Governance failures, particularly across Atlantic, the focus on
the performance evaluation of the NEDs has increased tremen-
dously. I guess over 85 per cent of Standard & Poor’s (S&P)
companies review the performance of NED. Recently, in India,
the review of the performance of NEDs, either internally or by
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an external agency, has been made compulsory by a notification

by the exchanges for the listed companies. It is mandatory for
other companies too in terms of the provisions of Companies
Act, 2013. The investors want to distinguish boards with com-
petent and contributing directors from old boys club, of friends
and friends’ friend. Performance evaluation methodologies are
varied, which include:

• Outside consultants
• Self-review
• Peer review

However, the most accepted methodology is that of peer review.

In this process, each of the NEDs presents before the board on
‘how they have performed/added value to the company’. Each
board member then evaluates each of the other NEDs, preferably
on a scale of 1 to 10, based on performance indicators. I suggest
the following as the performance criteria for the NEDs:

1. Attendance
2. Preparedness for the board meeting
3. Contribution in the boardroom using expertise and
knowledge and experience and wisdom
4. Independence of views and judgment
5. Interpersonal relationship
6. Safeguarding minority shareholders’ interest
7. Facilitating best Corporate Governance practices
8. Ownership of value building

These should be assessed with reference to the ability to contribute

via active participation, commitment to enterprise success and the
significance generated in the process of the Corporate Governance.
However, before the evaluation process is put in place, the
criteria, measuring standards and process must be placed before
the board for consideration and approval. It might be useful to
seek the benefit of advice from an expert consulting agency
to determine the criteria, measuring standard and the process
before placing before the board for approval. This is suggested to
establish objectivity, because lack of it may build disenchantment
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 Boardroom Practices 135

amongst the directors, which may hurt the image of the company.
Adverse image of the company can choke the pipeline of good
candidates for future inclusion in the board. If the underpinning
of the evaluation exercise is to enhance the contribution of the
individual board members, greater objectivity and its acceptability
by the board will have to be ensured. A method has to be found
to make that underpinning apparent; the preamble of the
programme may have the purpose defined as follows:
The collective responsibility of the Board is the optimal wealth crea-
tion and its most efficacious sharing. Individual Directors have the
ability to enhance the outcome by increasing their own valuable con-
tribution. Frame of reference of the evaluation exercise is to enhance
that contribution individually and collectively.

Every board has some non-contributing or dysfunctional direc-

tors. Let me mention here three different situations.

1. One of the directors is past his prime, has become old

and partially infirm. The only contribution is 100 per cent
attendance.
2. One of the directors—maybe because of age or lack of
interest/commitment—doses off during the currency of
the board meeting.
3. One of the directors hardly opens his mouth, and if
ever he says something, it is certainly not relevant to the
agenda being discussed.

Since all these directors have a glorious past, the controlling

shareholders and professional managers, out of sheer respect and
regard, are hesitant to get them out. I am a witness to all the three
situations in three different companies’ boards.
The company is a great looser if this process is not carried out
either seriously or thoroughly. It will continue to suffer from the
burden of non-contributing, suboptimally contributing or nega-
tively contributing director(s). The firm will also be deprived of
the induction of fresh talent on the board and their contribution.
Some of the companies appoint retired civil servants who are
not adequately briefed. Consequently, even to their own frus-
tration, they become a decoration in the boardroom. Once the
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evaluation process is organized, it will become apparent why they

are not contributing. Intelligent as they are, learning is possible.
Hence, opportunities must be created to learn and unlearn, and, if
thereafter also contribution does not improve, the change should
become inevitable in the best interests of all the stakeholders,
which can be facilitated by the objective evaluation of performance.
The fundamental purpose of the evaluation of the perfor-
mance of NEDs is to enhance the performance of the individual
directors and, thereby, the board. Forcing the exit of a director
should be the last resort. The institution of lead director can play
a very important role in this process.

8.20. Evaluation of Performance of the Board

There is a regulatory obligation (in some jurisdictions) and volun-

tary effort (in others) to evaluate the performance of the executive
directors and NEDs. However, serious thought is not given to the
evaluation of the performance of the board as a team. I would
strongly advocate that the evaluation of the performance of the
board as a team by the board itself be made an integral part of the
performance evaluation process annually.
However, it is the outcome-substance of the performance of
the board which is more important. This evaluation process will
assess what the enterprise, as a whole, has achieved during the
year in terms of short-, medium- as well as long-term objectives.
The reference points will be the objectives that the board will set to
be achieved by the enterprise as an entity in one year (short term),
three years (medium term) and five years and above (long term).
The reference points will emerge out of the vision of wealth crea-
tion, wealth management and wealth sharing charted by the board.
Even though the performances of the individual directors, execu-
tive and non-executive, will have a bearing on the performance of
the board, it cannot be an aggregation of the performances of these
persons. It will be like the outcome of a cricket match—victory,
defeat or draw—where individual players might have well bated,
bowled or fielded, yet the aggregate may fall short of the expected.
The enterprise’s objectives, in addition to usual areas such as
top line, bottom line, margins, capacity and competency building
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 Boardroom Practices 137

and enhancements and so on, should also include enterprise value

enhancement, creation and protection of value drivers, risk man-
agement, with reference to the tolerance level set by the board,
execution of succession planning and so on. In fact, currently, I am
developing a matrix each for the evaluation of the performance of
executive directors, NEDs and board as a team. The factors that are
vying in mind are environment management—macro and micro,
handling of issues including crisis management, opportunity siz-
ing, input mobilization, creation and utilization of weapons of
competitive warfare and securing global position and so on in the
overarching philosophical underpinning of wealth creation, wealth
management and wealth sharing. However, all the factors to be
considered will have a bearing of the size of the enterprise, area/
space it operates, level of the market development and so on.
The criterion will be objective, mostly numerical, so that sub-
jectivity is minimized. The standards of comparison will be pub-
lished data and/or data, which can be authenticated. The agency
to do the evaluation will be a team created from amongst the BoD.
Let us consider what is often missed out of the responsibility
frame of the board: fiduciary responsibility—‘to hold the enter-
prise in trust for the future generation of stakeholders’. Most of
the legal enunciations encompass the aspects of loyalty with refer-
ence to fiduciary responsibility.

• Keeping company’s interest over one’s own interest and

prudence.
• Applying skills optimally to company’s decision-making.

I always like to add to this, building brighter perspectives in the

run up to the onward journey, albeit my concept of enterprise
management. This can be achieved only if the performance of the
board as a team is assessed.

8.21. Succession Planning

One of the most important measures of success of the board

is how well the succession issues are handled. The facets of a
potent succession plan include the suitability of the candidates,
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elimination of time gap in the occupation of the position on vaca-

tion and smoothness of the transition.
Some of the general abilities which organizations seek in
the candidates for the senior positions are performance focus,
listening skills, personal stability, ethical standards and ability to
articulate vision, put up with pressures and manage transition.
In most companies, a formal and meaningful, well-orches-
trated succession planning does not exist. The sudden exit of
managers in senior positions including CEO can cause a serious
setback to the profitability and sustainability of the enterprise.
I, therefore, recommend the board seizing the issue to lay down
an appropriate succession planning structure.
Succession planning is the role of the board. More often than
not, this goes by default, and a sudden flurry of activity starts as
and when some critical resource exits or is about to exit. A broad
frame of succession planning could be as follows:

1. Mapping of all the critical positions in the company.

2. Examining the manning of those positions.
3. Reviewing the assessment of the persons and the perfor-
mance of those positions.
4. Finding out the likelihood of the possible exits including
sudden or forced.
5. Mapping up the time gap required to fill up the positions.
6. Lining up the second line of defence and time required to
groom for him to be in full command.

Succession planning is a bit of specialized function. Hence, help

of outside experts can always be taken.

8.21.1 CEO Recruitment and Succession

The CEO is the leader of the executive management team. I

need not elaborate here what CEO and the team led by him are
expected to do and deliver. Even though almost all the jurisdic-
tions obligate that the CEO, CFO and few other positions will be
filled by the board on the recommendations of the nominations
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 Boardroom Practices 139

and/or audit committee, in many cases, it is the controlling

shareholders who decide the candidate, and a farcical exercise is
undertaken in the nomination committee to recommend and the
board to approve the appointment. CEO and such other desig-
nated positions are critical for the company and the interest of its
stakeholders. Hence, the exercise of such rights by the controlling
shareholders is unethical, if not and illegal, and must stop. The
ultimate responsibility (including fiduciary) to all the stakehold-
ers devolves on the BoD and, therefore, absolute and not the
formal authority must rest with the board alone.
Nevertheless, for the purpose of the board, I would recom-
mend the board to assume full responsibility, and even if any
legally vetted agreement subsists, maximum space the board can
concede is to receive a panel of at least three names with a right
to reject all of them. If the board does not exercise its right, it
will tantamount to the deficit of governance, and value creation
will most probably be impaired/lopsided. This responsibility
has been entrusted to the board by the regulators out of experi-
ences of misdemeanours, governance failures and inadequacy of
performance.
Here are a few thoughts on the broader frame for assessing
the stability of the CEO and other positions, where the board has
the responsibility and authority to appoint:

1. Integrity—financial and intellectual

2. Team builder and player
3. Good communicator
4. Ambitious
5. Humility
6. Abilities related to the industry/jobs and skills

The rigours of performance can hold out a picture of likely

continuance/exit in the foreseeable future. Portends should be
deciphered and early steps to plan the succession must be taken.
Delays can cause irreparable damage to the enterprise.
The board must assume full responsibility of de-risking the
setback to the company, in particular, by the sudden exit of a
critical resource.
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8.22. Constant Communication and

Consultation

The best out of the skills of the board members, whether in the
board meeting or on other occasions, can be facilitated through
the instrumentality of constant communication. Directors ought
to be briefed on the expectations from them and requested, albeit
persuaded, to contribute optimally. This is possible only by pro-
viding them all the necessary information, which will help them
to proffer a considered opinion.
The information sharing cannot be peripheral. It has to be
in-depth and full, which warrants reposing trust in the board
members. In many boards, the CEO and the top management
feel that sharing information with the board members ingrains
a possibility of its being leaked and/or misused, which can be
eliminated by briefing them on the importance of the exclusive-
ness and confidentiality of the information and data provided.
In fact, whenever the strategic agenda is taken up by the board, it
must be preceded by full and detailed information that can help
a board member to understand and appreciate the strategy that
is sought to be discussed and the impact thereof on the short-,
medium- and long-term performance of the company.
It is important for the board members to feel that they are
being genuinely consulted in the decision-making, and also
that whenever any issue is voiced, referred to or brought before
the board, it is not a mere formality. This can happen only
if the CEO and chairman together are able to reflect how valu-
able their opinion and ideas are. It is not important that all the
ideas that are proffered or the views that are expressed by a
board member are accepted. However, what is significant is the
importance that is attached to those views. Such an approach
will instil the confidence in the board members that the purpose
of the exercise is to really ascertain their opinion and thinking,
and the contribution will eventually flow. A graphical picture is
presented in Figure 8.2.
Figure 8.2 shows the team of senior executives forming an
outside ring of information and knowledge sharing. In many

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 Boardroom Practices 141

Figure 8.2 Senior Executives Helping Board

boards, I have observed that the openness of the CEO and/or the
chairman if he happens to be an executive chairman, is limited
to a few board members. Many of the board members are not
fully briefed. In case the management feels that either they do not
enjoy their trust or do not have confidence in their skills or main-
taining the confidentiality of the information, it is desirable that
an appropriate action, either to bring the board member on to the
same wavelength or make his exit possible, is taken, but there can
be no substitute to a board member being kept in constant com-
munication and consultation on all major matters.
I sit on the board of a company where the chairman is articu-
late enough to bounce all the major ideas beforehand (and by
beforehand I mean even before these are brought to the board),
so that the directors are able to think through the idea, and when
the board meeting takes place or decision-making process is
energized, they proffer their opinion with their comprehensive
perspective. I believe such an exercise needs to be conducted
by all the boards to be able to derive optimal benefits out of the
skills/talent of the board.

The Essential Book of CORPORATE GOVERNANCE 149

 9
Accounting and Financial
Reporting Standards

T
he relationship of the stakeholders with a company is built
on trust, and the value creation propensities are propor-
tional to that trust. The public trust sustains, strengthens
and flowers with the availability of complete and credible infor-
mation about the performance of the company. The credibility
is architected on the back of standards applied consistently.
The accounting and financial reporting standards specified for
application by the standard setters/regulators across geographies
are expected to facilitate the stakeholders to understand and
interpret the financials with confidence on the reliability and
their application consistently quarter on quarter. The expecta-
tions of stakeholders on the ‘reliability’ delineate the Corporate
Governance pillar of accounting and financial reporting stand-
ards. In my view, there are four pillars of building ‘reliability’,
graphically depicted in Figure 9.1. It is, therefore, essential that
companies, accounting firms (auditors), standard setters and
the regulators commit to architecting that ‘reliability’ by the
instrumentalities of establishing, observing and re-engineering
of the standards.

150
 Accounting and Financial Reporting Standards 143

Figure 9.1 Pillars of Reliability

QUALITY MANAGEMENT INDEPENDENT STATUTORY

ASSURANCE ASSURANCE ASSURANCE ASSURANCE

STANDARD AUDITORS
SETTERS

BOARD MARKET REGULATORS

AUDIT STATUTORY
COMMITTEE

SRO-
MANAGEMENT EXCHANGES

9.1. Quality Assurance

Standard setters are obligated to lay down a framework which

is potent to serve the fundamental purpose of the application of
accounting and financial reporting standards—in effect, deliver
quality information about the performance of the company. The
barometers of the quality are (a) reliability and (b) usefulness.
Reliability emanates from the reflection of the clearer picture
of the value of the enterprise. The dust of the raging debate on
selecting the underpinning of the various standards between
‘historical cost model’ and ‘fair value model’, which was kicked
off following the unravelling of corporate scandals such as Enron
and so on, is yet to settle down.
Here, it may be relevant to record that capital markets price
the enterprise on the strength of the underlying value, which, in
many cases, is not captured in the ‘historical cost value model’.
Furthermore, the ever-increasing complexities of businesses, where

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intangibles, in many cases, ingrain higher value than tangible

assets, undermine the relevance of ‘historical cost model’. It is being
increasingly believed that the historical balance sheet captures only
about 30–40 per cent of the market value of the enterprise and the
balance inhabits in the intangible assets and non-financial value
drivers. On the liabilities sides are off balance sheet financing,
unrecorded options, rights and obligations. The critics of fair value
preposition raise the issues of the objective (arithmetically) measur-
ability of intangibles such as brand value, customer loyalty and so
on. In fact, in one of the conversations with experts on accounting
and financial reporting standards, I was reminded the realizable
value of the brand of an airline in India, which went belly down.
The airline brand was valued at about US$ 1 billion. Similarly, there
are numerous stances where the value of intangibles was overesti-
mated. It is the belief of the opponents of the fair value model
that the factors that are considered for arriving at the fair value of
intangibles are dynamic and keep oscillating with the change in the
environment, technology and so on. Hence, it is desirable to con-
tinue to pursue the historical cost value model. However, the most
ardent supporters cannot deny the volatility and the element of a
bit of subjectivity in adopting fair value preposition. Frankly speak-
ing, the real battle is between ‘rule’ and ‘principle’ approach, and
which is better will continue to be debated for some more time to
come. Since it is not the remit of this treatise to dwell on standards
setting, it is suffice to say that standard setters have to dynamize
the approach and traverse the journey of re-engineering of stan-
dards with the philosophy of capturing the true value of enterprise.
Insofar as the thesis of Corporate Governance is concerned, rigor-
ous and religious conformance to prescribed standards is the call.
The ultimate test is the reliability of the information to adjudge the
real performance of the company.
The usefulness of information is assessed from the availability
of the same information from multiple sources and the ease with
which technology tools can be employed to analyse. In substance,
the cost involved in accessing and consuming the information.
It is this perspective which adds relevance of dissemination
of information using tools such as Internet-enabled platform
known as extensible business reporting language (XBRL) and so
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 Accounting and Financial Reporting Standards 145

on. XBRL has the potential to tag along even the non-financial
information—company- and industry-specific—and can facilitate
collection and collation of information from outside the company
as well. Such ability proffers previously unattainable fruits in the
corporate reporting value chain and helps, in particular, research-
ers and fund managers to assess the value of the enterprise better.
There are standards setters in every regulatory jurisdiction
charged with the responsibility of laying down relevant and enforce-
able standards in tune with the domestic environment inclusive of
company structures, market and business practices and so on.
Some of the standards of a jurisdiction differ significantly from the
corresponding standards of other jurisdictions. Globalization of
market, in particular, financial, where companies travel around for
ease and economizing the cost of resources, reaping the potentials
for marketing products and services, and even developing/manu-
facturing products and services, makes a compelling case for build-
ing and applying global standards namely International Financial
Reporting Standards (IFRS). Although the transition to global
standards entails costs and consequences, for emerging economies
and small- and medium-sized companies in particular, the eventual
economics of business merits faster integration.

9.2. Management Assurance

The management assurance is centred on the faithful and consistent

observance of relevant standards. It has three layers: (a) executive
management, (b) audit committee and (c) board. Each of these
layers is expected to render distinctive yet complementary roles.
The executive management is expected to record and aggregate all
the transactions and present them in the specified format, applying
relevant standards for each kind of transaction.
However, it is not a straight line walk. The company trans-
acts millions, even billions, of transactions, depending upon the
size on daily, monthly, quarterly and yearly basis. Although the
technology can facilitate correct recording and aggregation, ambi-
guity in the treatment of some of the transactions, which is high
in case of some of the standards, adds to complications. Hence,
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the treatment of transactions vis-à-vis the application of standards

becomes a matter of judgement. In many companies, this judge-
ment is exercised by more than one executive, which makes uni-
formity an issue. Such judgement choices open up the minefields
of temptations. Furthermore, occasions do arise in the life of the
company when the accounting treatment of a few transactions
can convert loss into profit for the company.
Here comes the role of standard operating procedures (SOP),
delegation of authority (DOA) and internal checks and controls.
Every company is obligated to set up a comprehensive framework
of all the three. The internal checks and controls must be potent
to ensure that every transaction gets recorded correctly and appro-
priately leaving little or no scope for discretion. If discretions are
built, and exercised, the exception reporting mechanism must get
triggered automatically. The exceptions reporting must be com-
plemented with a review system to assess the efficacy of discretion
exercised and whether review of SOP and/or DOA is called far.
The internal audit is expected to play a sterling role in assessing
the efficacy of SOP, DOA and internal checks and controls. It is
important to state here that efficacy has to be validated periodically
(at least once in three years), preferably by an outside agency—
unrelated to internal and statutory audit entities. In the context of
fast-changing macro- and micro-environment, company structure,
business model and product line, no system, however effective,
remains potent, and re-engineering becomes necessary. Since the
board, management, CFO and CEO have to sign off not only on the
financials, accuracy thereof on the strength of external checks and
controls, but also the adequacy of internal checks and controls, the
importance cannot be over-emphasized.
Then, there are temptations of playing the earnings game and
beating the market expectations quater on quater in the mistaken
belief of enhancing shareholders value. It is relevant to mention
here that the relevance of earnings as a reflector of future value has
been reducing, albeit gradually eventually making the P/E ratios
as only one of the motivators of investors. Instances of companies
holding on to market valuation even when profit turned into a
loss and/or sudden decline in the P/E ratio even when the same
level of profit was reported are not far to seek in any market. Of
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 Accounting and Financial Reporting Standards 147

course, if the loss becomes a story rather than an isolated instance,

the valuation does take a serious beating. Furthermore, executive
compensations aligned to earnings game are not being kindly per-
ceived by the shareholders, and sustainable real value creators is
becoming a more reliable indicator. ‘Prevention is better than cure’
so goes the adage. Seeping of temptations into financial reporting
can be arrested by the following cultural interventions:

1. Accountability: Accountability of the persons charged with

the responsibility of the observance of accounting and
financial reporting standards must be clearly delineated.
Ambiguity at any level of any kind can disturb the equi-
librium. Hence, the responsibility frame should include
recording, aggregating, reporting and answering the que-
ries, and those responsible must be held accountable.
2. Intellectual integrity: Many corporate scandals have taken
birth in the womb of intellectual dishonesty. Executing
instruction/advice not in conformity with the accepted
principles even without personal benefit is intellectual
dishonesty. It is possible to salvage an institution from
the debris of financial loss, but not from the loss of
credibility and trust. Doing what is expected cannot be
compromised even under the guise of creating value
for stakeholders, which may eventually betray their
trust. Hence, organizations must become intolerant of
dishonesty—financial as well as intellectual.
3. Alignment of compensation packages with value creation: It
is important that the executive compensation is aligned
with sustainable value creation, rather short-term perfor-
mance. Hence, back-ended and deferred compensations
are gradually, yet steadily, becoming the order of the day.
4. Enforceability of culture: The sustainability of any cultural
ethos, however potent, depends on its enforcement. Zero
in-tolerance drives fear down the spine of all concerned.

The audit committee is charged with the responsibility of provid-

ing an effective oversight to the functioning of the management in
this respect. It has the benefit of the independent assurance (will
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be discussed later) proffered by the auditors to judge the quality

of the work of executive management in the discharge of its role
and obligations.
Since the audit committee has been given the benefit of rely-
ing on the work of auditors, it has been legislatively empowered
to recommend the appointment and remuneration of both inter-
nal and statutory auditors. While exercising its right to recom-
mend the appointment and remuneration of auditors, the audit
committee has to consider the following essential qualifications:

1. Independence—free from any other motivation, influence

and so on.
2. Skills and competence to be able to undertake the responsi-
bility, and a record of having displayed full accountability.
3. Required engagement—time and quality of attention.
4. Impeccable reputation of integrity.

Unfortunately, in most companies, this right is not exercised with

due caution and judgement, which, to my mind, is fundamental
to their support system to validate managements’ certification. In
fact, in quite a few companies, it is left to the CEO and/or options
are not provided. Furthermore, the board also does not really get
involved in the appraisal of the recommendations of the audit
committee. This deficit in the governance process is fraught with
serious risk of endangering the quality of independent assurance.
The audit committee has to evaluate whether systems,
processes, control mechanism and maker-checker are in place
and efficaciously applied. Exceptions, if any, are reported and
reviewed as to their desirability of use and impact on the overall
financials and reporting. Furthermore, the need of the disclosure
of exception has also to be evaluated and acted upon, if felt that
disclosure is warranted in the light of its impact.
In effect, the audit committee, while providing effective
oversight capable of preventing executive management falling
into temptations, adds credibility to the quality of management
assurance. This is the rationale behind most regulators laying
down an obligatory direction that the chairman of the audit com-
mittee must be well versed in accounting rules and regulations

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 Accounting and Financial Reporting Standards 149

and in understanding and interpretations of financial statements.

Other members of the audit committee are also expected to be
financially literate. In one of the companies, I know of, none of
the members of the audit committee had the ability to appraise
financial statements, and the MD and CEO were happy, glibly
making statements such as ‘No more dramas in my audit com-
mittee meetings’. The stakeholders will be the ultimate sufferers,
whereas the MD and CEO can enjoy the unquestioned presenta-
tions of financials. Hence, the board has to exercise its judgement
while nominating its members on the audit committee.
Even though the management, auditors, board as well as stand-
ard setters and regulators hold the collective responsibility of deliv-
ering credible information in the financial statements, the journey
in an enterprise begins with the board. It is the commitment of the
company to scrupulous application of standards that leads the path.
It is the board which has to direct the application of accounting and
financial reporting standards. If and when allowed to change, the
application of new standard has also to be decided by the board.
Hence, the board becomes the guardian of the application of stand-
ards. The superintendence of the board is facilitated by the following:

1. Direction to CFO and his team

2. Verification and confirmation of application by the
auditors–internal and statutory
3. Monitoring by the audit committee of the board

The superintendence of the board should ensure that potent

systems, processes, control mechanism, maker-checker and risk
management are in place and the application thereof is checked
by the auditors and the audit committee. The board must unleash
the cultures of accountability and integrity (mentioned earlier)
and ensure that the executive management compensations are
appropriately aligned. The board and its members should not
only lay down, but also commit and scrupulously observe those
standards of accountability and integrity, which they expect the
executive management to adhere to. The board must provide
the directions and get the implementations of those directions
vouched at various levels with thoroughness and intensity.
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I have observed that in most board meetings, not even a sim-

ple enquiry is made from the chairman of the audit committee,
who briefs the board on the deliberations of the audit commit-
tee; and even in the audit committee no enquiry is made from
the auditors whether the observance of accounting and financial
reporting standards has been verified, and no exceptions have
been reported/observed. In fact, it might be useful for the audit
committee to formulate and use certain accounting standards’
applications measuring tests and insist on the auditors to give a
report of their having tested the observance on the platform of
those tests.
Rigor and lapse in financial reporting can result in value cre-
ation or destruction, respectively. What separates a management
and the board of a company from the other is one who identi-
fies, measures and faithfully reports to all the stakeholders both
the real value drivers and value destroyers in the same breath,
of course, with a plan how these would be derisked. This is the
difference that good Corporate Governance can make, which is
built on the pillars of integrity, accountability and transparency.
The financial reporting must also include, inter alia, the
measurement of results on the platform of the pursued strategies.
This sends the signals of lasting trust as the stakeholders
appreciate the management’s own appraisal of both successes and
failures becoming a public knowledge. What is often done is to
publish the achievements alone. Consequently, a wave of mistrust
sweeps across the market stemming out of inadequate reporting.
The efficacy of management assurance is adjudged from the
scrupulous compliance of the applicable standards, consistency
of approach, clarity and comprehensiveness of the information
with explanations on value drivers/destroyers, risks and uncer-
tainties, judgement calls on significant estimations, strategies to
preserve/enhance value, quality of controls and its method of
relay to all the stakeholders including regulators. In fact, most
progressive companies have crafted value reporting framework.
Infosys—an Indian information technology (IT) company—has it
on its website. Such reporting presents fuller and truer picture of
the performance of the company and builds a greater trust in the
management and its ability to navigate the rough weathers.
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 Accounting and Financial Reporting Standards 151

9.3. Independent Assurance

Independent auditors have a distinctive role of rendering ‘independ-

ent assurance’ about the accuracy and quality of financials and its
reporting. They owe it to the stakeholders of the enterprise who
appoint and compensate to provide them an objective assessment,
free from any external factor or motivation. A broader view of all the
major corporate misdemeanours reverberates the assessment that
the auditors had not done their job well in many cases if they were
not complicit. The audit firms, their partners and the supporting
staff too have to imbibe the culture of accountability and ‘integrity’,
and should not fall prey to temptations. The relationship with the
firm that they consent to provide independent assurance should be
limited to auditing and on a fair and reasonable compensation.
Delinquent behaviour, inadequate application of mind and even
the lack of integrity have prompted some of the jurisdictions to create
an independent regulator for auditors. This function was hither to
before, and, even currently, in most jurisdictions, is handled by the
professional body of accountants. Sarbanes–Oxley Act (2000) USA
has brought in existence Public Company Accounting Oversight
Board (PCAOB) to oversee and supervise the audit of public compa-
nies, in effect to regulate the audit function. PCAOB has been con-
ferred wide-ranging powers, which includes imposition of penalties
and suspension and revocation of registration itself of accounting
firms. In India also, the Companies Act, 2013 provides for setting up
of a similar body, ‘National Financial Reporting Authority’ (NFRA)
to monitor and enforce the compliance of the standards in addition
to setting of the standards itself. The NFRA is proposed to have a
significant role including powers to investigate probable misconduct
by a firm of chartered accountants and advise the government on
auditing standards to be laid down. Eventually, NFRA may emerge
as the big daddy to the accounting and auditing profession in India.
The underpinning of creating one more agency is to ensure
the efficacy of independent assurance.
The auditors have to play the role of ‘watch dogs’ enshrined
in the basic principles of auditing. The professional bodies of
accountants have laid down the ‘auditing standards’ to help the
professionals to architect a broad frame of uniformity. However,
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 152 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

they have to develop efficacious approaches to deal with the

ambiguity, which is a growing phenomenon in the complex busi-
ness environment. The auditors should not seek refuse under the
shadow of rules to forsake the robe of accountability. The deeply
embedded culture of accountability will help the stakeholders
to get ‘the best’, rather than ‘marginally acceptable’, treatment of
transactions. This will also help in bridging the expectation gap.
In one of the companies where I used to sit on the board, a few
issues led the auditors to take an extreme view and began with the
threat of ‘declaration of not being able to render an opinion’ out
of sheer scare of possible devolving responsibility, if ever. It took
months of deeper scrutiny, discussions and delays, causing serious
anxieties in the minds of investing public. Eventually, the auditors
rendered the opinion ‘true and fair picture’ (subject to the follow-
ing), albeit qualified opinion, which is what executive management
and the board were agreeable to right at the beginning in the light
of issues involved. Such an approach emanates from extreme cau-
tion and building safeguard around ‘accountability’, a clever way to
de-risk converts the independent auditors from ‘watch dogs’ into
‘blood hound’. Having been a capital market regulator, it might be
useful for the readers to know that the de-risking cover is easily
blown over when the ‘application of best judgement’ is questioned,
which is what I was arguing with the auditors of that company.
The stakeholders of the firms expect from the ‘independent
assurance’ rendered by auditors the best and not merely legalisti-
cally acceptable accounting treatment of transactions. The auditors
do run the risk of being questioned, and what will stand in good
stead for them is not the cover but the integrity of approach. Well-
intentioned, honest decision is pardoned, but not the games played
on the pitch of accountability. Yes, there is a risk in providing
‘independent assurance’, but that is inherent in the profession as
in any other activity undertaken, which is supposed to have been
purchased while consenting to undertake the engagement.
The barometer of the auditor’s performance would be to assist
the management in discharging its role efficaciously and high-
lighting the inadequacies—errors of omission and commissions,
insensitivities to value creation and/or destruction and insensi-
tiveness to the interest of the stakeholders.
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 Accounting and Financial Reporting Standards 153

9.4. Statutory Assurance

The orderliness in a society is ensured by laying down the rules

of the game and appointing ‘high priests’—regulators—to adjudge
the behaviour with reference to those rules. The capital market is
no different. The ‘economic agents’ ingrain the greater propensi-
ties of profiting from the possibilities including those they can-
not harness ethically. Their enlightened self-interests often ride
roughshod on the interests of the investing community. Hence, a
comprehensive framework has evolved (and continues to evolve)
to rein in such motivations of the economic agents. This accord-
ing to the author is the ‘statutory assurance’ provided to the
investing public that the market, in general, and the company, in
particular, are on track. Misdemeanours, if any, are being noted
and dealt with effectively to sustain the confidence.
Regulators are often angry and feel aggrieved when they come
under public scrutiny for failure to curb and prevent the misdemean-
ours. Their defence is that they did lay down the framework and
kept a watchful eye and if something still has happened, why blame
regulators? What is often forgotten in such situations is that the frame
of reference is ‘collective responsibility’. Hence, some part of account-
ability, albeit much less in degree, has to be shared by the regulators.
Regulators assurance is both qualitative and quantitative. The
quantitative assurance is reflected in the adjustment to the valua-
tion by the market when it factors in the financial reporting. This
is instant and moves with the speed of light. It is a pity that some
of the managements rationalize it to market sentiments, ignoring
the fact that this is the verdict of the market. There are a number
of instances where valuations have taken a knock on account of
deficit in the application of accounting standards. Such erosion
in the value of an enterprise is much higher than the decline on
account of lower profits in a quarter or two.
The statutory assurance is provided by the regulators, which,
in most markets, consists of two tiers. The first tier is called SRO,
which, in most markets, is the exchange that has independent
arm/department to undertake the task of review of financial
reporting and also recommend to the statutory regulators to keep
re-engineering the ground rules from time to time with a view
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 154 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

to reinforce the robustness of the framework. The second tier is

the statutory regulator who lays down the framework and has the
ultimate responsibility of it being followed scrupulously.
The barometer of the success of ‘statutory assurance’ is the
minimality of the cases of misdemeanours and expeditious and
effective cognisance of the noticed cases which unleashes a wave
of deterrence.

9.5. Conclusion

The collective responsibility frame has been erected in all juris-

dictions, as the impact of misinformation is multidimensional. It
impacts the company and its stakeholder directly and the capital
market and, at times, even economy as whole vicariously. The
analysis of Asian meltdown published as ‘The IMF’s Response
to the Asian Crisis: A Factsheet’ in 1999, inter alia, reported,
‘Although private sector expenditure and financing decisions led
to the crises, it was made worse by governance issues, notably gov-
ernment involvement in private sector and lack of transparency
in Corporate and fiscal accounting and the provision of financial
and economic data.’1 Every instance dents the confidence of the
investing public. However, instances of blatant disregard of the
rules and regulations, which smacks of governance failures, build

1
International Monetary Fund (1999). Available at: https://books.google.
co.in/books?id=nVJ_AgAAQBAJ&pg=PA77&lpg=PA77&dq=imf+although+pr
ivate+sector+expenditure+and+financing+decisions+led+to+the+crises,+it+wa
s+made+worse+by+governance+issues,+notably+government+involvement+in
+private+sector+and+lack+of+transparency+in+Corporate+and+fiscal+accoun
ting+and+the+provision+of+financial+and+economic+data&source=bl&ots=a
bi47ZG0jx&sig=AjJBn8WhWe47dxxN-quzU_T3aO8&hl=en&sa=X&ved=0ah
UKEwi3nYO_8e_MAhVMo48KHee_C8MQ6AEIITAC#v=onepage&q=imf%20
although%20private%20sector%20expenditure%20and%20financing%
20decisions%20led%20to%20the%20crises%2C%20it%20was%20made%20
worse%20by%20governance%20issues%2C%20notably%20government%20
involvement%20in%20private%20sector%20and%20lack%20of%
20transparency%20in%20Corporate%20and%20fiscal%20accounting%20
and%20the%20provision%20of%20financial%20and%20economic%20
data&f=false (accessed on 30 May 2016).

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 Accounting and Financial Reporting Standards 155

fissures and often wreck the confidence in allocation efficiency of

the capital market and trust in entrepreneurship.
This is what happened when a series of misdemeanours
unfolded in the North America and the regulators and govern-
ments across geographies had to sit up and take notice. What
followed was knee-jerk reactions and excessive regulatory frame-
work which eventually enhanced the ‘agency costs’. The ultimate
sufferer has been the investing public and entrepreneurial spirit,
and the eventual wealth creation and the extension of the suffer-
ings of deprived masses in the concerned societies are caused by
the lower/negative growth of economies.
Hence, the responsibility and accountability is cast on all the
assurance providers not to treat an instance in isolation, but look at
the impact on the larger interests. However, so far, as the Corporate
Governance is concerned, it is the ‘management assurance’ and ‘inde-
pendence assurance’ which have to be truthful and really assuring.
If the society thrives, companies will deliver better results
and all the stakeholders including economic agents will prosper.
The call is to rise above narrow self-aggrandizement and deliver
quality financial reporting to strengthen the confidence in the
corporate democracy. The quality financial reporting is one which
is complete, accurate, trustworthy and timely. Hence, the frame
actually has to work where all the factors are interwoven to pro-
vide confidence to the investing public (see Figure 9.2).

Figure 9.2 Stakeholders

QUALITY
ASSURANCE

STAKEHOLDERS STATUTORY
INDEPENDENT ASSURANCE
ASSURANCE

MANAGEMENT
ASSURANCE

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 156 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

Figure 9.3 Pyramid of Accounting and Financial Reporting

HIGH
PRIEST
CAPITAL
MARKET
REGULATORS

BOARD

AUDIT COMMITTEE
OF BOARD
AUDITORS
INTERNAL AND STATUTORY

MANAGEMENT

STANDARD SETTERS

The deliberate act of providing false assurance by the man-

agement and independent auditors of Satyam Computers of India
not only shook the confidence of the shareholders of Satyam
and witnessed immediate erosion in their wealth, but also had
its impact on the community of shareholders at large. It gave a
fillip to the sentiment that connivance in providing management
and independent assurances disrupting the efficacy of the market
itself do happen.
In substance, the pyramid of accounting and financial reporting
works as shown in Figure 9.3, in terms of responsibility frame.

164
10
Related Party
Transactions

T
he market economy commandeers the ingenuity of the man-
agement to build economics of operations. RPTs do provide
the scope for lowering the costs of capital, HR, goods and
services and tax savings and so on. One does not have to look
beyond the nose to exemplify benefits from RPTs. Often used
transactions include:

1. Supply of goods (including raw material) and services—

especially as an element of backward or forward integration.
2. Licensing or leasing agreement between holding and
subsidiary companies, particularly in multinational
organizations.
3. Intercompany loans and guarantees from holding to sub-
sidiary and vice versa.
4. Leveraging of receivables via a special purpose vehicle
and so on.
5. Compensation to executive members on the board as well
as NEDs.
6. Transfer of property, right or obligation and so on.
7. Leasing of accommodation: property, vehicle, equipment
and so on.

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 158 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

However, RPTs have been an issue of serious concern amongst

the shareholders and regulators alike. The prospect of undermin-
ing the interest of some by the other emerges from the underlying
factor that the individuals/entities in control of decision-making
process have interest in themselves and/or other entities too,
which proffers the propensities of profiting from the RPTs. And,
human nature is self-serving and susceptible to temptations.
Many a Corporate Governance failures and corporate misdemean-
ours have been attributed to the RPTs. It is, therefore, important
that every RPT is undertaken in a manner, and by a method,
which not only is fair, but also appears to be fair to all concerned
and delivers an economic benefit to the company.
The pendulum of approach to regulating RPTs has swung
from one side to another. US law once prohibited RPTs involving
managers and directors. The Indian Companies Act, 2013 has
procedurally made RPTs a very difficult preposition. However,
despite conceding that value diversion builds significant agency
costs, prohibiting RPT cannot provide assurance to protect
minority interests, while delineating wealth optimizing and
scoping equitable approaches in enterprises. Hence, globally,
the burden of direction has shifted to designing the regulatory
framework to prevent, albeit minimize, the conflict of interest,
and whatever is done reflects fairness and economic profit at least
vicariously to the enterprise. Transparency has been conceived to
be the hallmark of fairness.
It is not easy to define RPTs as one may think. Any transac-
tion in the course of the management of an enterprise is broadly
described as RPTs, if decision-makers or their dependents and
associates have interest, direct or indirect, in that transaction.
Regulators across geographies have listed related parties that have
to be reckoned with while dealing with the issue of RPTs. However,
the following are the broad categories of related parties which fall
within the preview of related party in all regulatory jurisdictions,
and transactions related to these parties become RPTs.

1. Holding, parent, associate and subsidiary companies.

2. Subsidiaries of a common parent.

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 Related Party Transactions 159

3. Trusts and entities for the benefit of employees.

4. Management inclusive of directors.
5. Employees.
6. Immediate family members of those mentioned in 4 and 5.
7. Affiliates of those in 4, 5 and 6.

10.1. What Is an RPT

A transaction regardless of whether or not market price is the

consideration—through which the ownership/benefit/right of
monetary value (current and/or future) is sought to be trans-
ferred to another entity/individual that is related to the original
owner/decision-maker—is termed as the RPT. Since the decision-
makers have an interest in the transferee, conflict of interest comes
into play.
Some of the examples of RPTs have been quoted in the first
paragraph. These transactions could also be entered into with
other related parties inclusive of directors, their dependents and
the entities fully or partially owned by the related parties.

10.2. Why RPTs Are an Issue of Significance

Ordinarily, if the asset/right/benefit changes the ownership for

the appropriate price, there could be no issue. However, often-
times, the ownership changes hands at a price, which is not
commensurate with the fair value. Sometimes, it is observed
that although a fair price is agreed to be paid, the mechanism/
instrumentality of the payment of consideration, when delved
deep, reflects that what is on the surface is actually a facade and
covers the reality of under/over-payment, which is detrimental
to the interest of the stakeholders of one or the other entities.
This is done through the process called ‘financial engineering’,
although no pragmatic analyser of such transactions can have
a quarrel with the finance professional’s ingenuity—financial

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 160 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

engineering, so long as it is legal, enforceable and fair. However,

oftentimes, financial engineering is undertaken to camouflage
the actual consideration amount. In case the ownership pattern
of current and future owners is exactly the same and not likely
to change over time, there can hardly be an antagonism to the
RPT. But, most often, that is not the case. Sometimes, the equity
structure of the two entities is so weaved that even though on
a given date it looks the same, it changes substantially over a
period of time by the inbuilt propensities of the future capital
structure. This causes financial hurt to the owners of one entity
and benefits the owners of the other.
I have had the occasions to watch the consolidation and split
and again consolidation of businesses, which at the end of tunnel
resulted in change in ownership structure in favour of promoters
and/or decision-makers. This is often not noticed by the stake-
holders, in particular, if the time gap is considered, though inci-
sive market participants get a hang of it easily and discount the
valuation. And, all the stakeholders suffer but the hurt to silent
majority is greater.
Solution: We are in a dynamic environment where changes are
taking place at the speed of thought, which calls for an appropri-
ate strategy response to remain competitive, profitable and a step
ahead of others. The strategy response can take various forms
including mergers and demergers, hive and hire, slice and dice
and so on of the asset, input mobilization and/or supply chain
management. The fairness demands that such activity, which
may also result in RPTs, is undertaken in a manner and method
which not only is fair, but also is perceived to be fair. This is
made possible by laying down the process and outlining the
procedure. The process and procedure should have the following
basic ingredients:

• Establishing indisputable necessity to undertake the

transaction.
• Independent assessment of the value of the asset/right/
benefit sought to be transferred.
• Well-laid out justification of how the value has been
arrived at.
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 Related Party Transactions 161

• Matching of the amount of price/consideration for the

transfer of the asset/right/benefit with the actual value to
be transferred.
• Scrupulous adherence to law in letter and spirit.
• The transaction stands the scrutiny not only of law, but
also the public analysis about equity to all concerned.
• The procedure outlines proper disclosure giving all the
necessary data for the people to assess the efficacy of the
transaction(s).

10.3. RPTs, Auditors and the Audit Committee

Auditors and the audit committee in that order have the primary
responsibility towards stakeholders of ensuring that all RPTs
are done at arm’s length, in the ordinary course of business and
transparently. Arm’s length will include fair market price as the
consideration for the transaction. The problems for the auditors
and the audit committee in providing effective superintendence
arise not only from the complexity of transactions, but also from
material misstatement—deliberate or by default.
Auditors generally employ a range of audit processes to iden-
tify and evaluate RPTs and work as an effective support system
for the audit committee. However, our suggestion is to collect
information about delegation—whether formal or not—control
over activities, responsibilities of various layers of management
and arrangement with various components of the company. This
might help to uncover the managerial ethos of profiting from the
openings of RPTs. Sensitizing the organization about the agency
costs, value evaporation and consequential cognisance by the
stakeholders and/or regulatory authorities is the role that the
auditors will have to play.
The audit committee has to, inter alia, monitor the effective-
ness and independence of the auditors, specifically in the matter
of RPTs. The audit committee will also have to apply its mind to
reassure that the RPTs are at arm’s length, transparent and in the
ordinary course of business, and the procedure outlined has been
scrupulously adhered to.
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10.4. Board and the RPTs

It is the responsibility of the BoD to ensure that a sense of fair

play and equity is apparent in all the RPTs. The board relies on
the assessment of the investment bankers, auditors and the audit
committee. While their assessment should be an important con-
sideration for approving the decision, the board has to apply its
mind, use its wisdom and assess whether equity and fair play exist
in full measure.
The fundamental principles have been graphically depicted
in Figure 10.1
It is a three-legged stool which makes instability inherent.
Any of the legs becoming weak or not providing enough strength
or sharing the weight makes the RPT a questionable transaction.
The executive management, auditors and the audit committee
must remain watchful of not allowing the weakness creeping in
any of the legs and rather ensure that their scrutiny adds strength
and stability. It might be useful to delve briefly into what the three
principles are all about.

1. Ordinary Course of Business: The why of RPT entails

reflecting the usefulness and necessity of the transaction
for the business of the enterprise. Economic benefit must
be established. This can happen only if it is desirable

Figure 10.1 Fundamental Principles of Approving RPT

RELATED PARTY
TRANSACTION
ORDINARY COURSE
TRANSPARENCY
ARMS LENGTH

OF BUSINESS

170
 Related Party Transactions 163

in the ordinary course of business. Hence, the relation-

ship of RPTs with the business of the enterprise must be
established normally directly, but must be clearly visible
to discernible eyes if it is indirectly related to the business
of the enterprise.
2. Arm’s Length: Arm’s length envisages that the related
parties are not influencing the decision-making. Hence,
the pricing of the transaction has to be at the fair market
price. Any transaction, which is not fairly priced, cannot be
considered to be at arm’s length. How to arrive at the fair
price has been described in Section 10.6.
3. Transparency: It is important that the stakeholders are
fully informed of all the RPTs so as to help them evaluate
that the related parties in the management are not indulg-
ing in self-dealing, in particular, as a determent to their
interests. The disclosure must incorporate the methodol-
ogy used. The confidence of the stakeholders in fairness
increases if there is a board-approved RPT policy which is
made public. This will help them to evaluate the efficacy
of transaction with reference to established policy.

10.5. RPT Policy

Every company must frame an RPT policy, which should

be approved by the board. The policy must provide broad frame
under which the RPT will be undertaken. This should be made
public, and comments from the stakeholders, if any, must be used
to modify. A sample of draft policy is given in Annexure 4.

10.6. RPT Procedure

I recommend the following procedure for all RPTs:

1. Letter of intent
• A formal communication of intent should be submit-
ted to the audit committee and board before entering
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into an RPT. The purpose of the communication of

intent is the pre-examination of the need to enter into
such RPTs as also pre-approval by the audit committee
as is mandatory in some jurisdictions including India.
2. Valuation
• Two or more valuers should be appointed for decid-
ing on the appropriate price. Also, it is recommended
that the services of different valuers should be uti-
lized for different transactions instead of repeating
the same valuer every time. This will help in estab-
lishing greater authenticity and transparency in the
RPTs and/or
• Competitive quotations should be obtained from
more than one party.
3. Pricing
• The basis adopted by the valuer to decide transfer
pricing should be elaborated.
4. Payment term
• If any credit/settlement period is given for realizing
the consideration, the matching of transfer price
and payment should be done. The company should
ensure that the present value of the consideration to
be received in future matches with the transfer price
decided by the valuers.
5. Sunset clause
• When entering into long-term contracts, care should
be taken that the contract remains fair at all times.
Accordingly, a sunset clause should be incorporated
in the contracts so that the contract does not become
uncompetitive in the long run.
6. Disclosure
• All RPTs should be disclosed in full.
7. Oversight mechanism
• The robustness of the oversight mechanism of the
auditors, validation by the audit committee and
authentication by the board of the RPTs should be
strengthened.

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 Related Party Transactions 165

Following such an elaborate framework of policy and procedure

may appear to the managers of the enterprise tyranny. However,
it must be remembered that this is one area which has the pro-
pensities to wreck the trust of the stakeholders. In any case the
market perceives that the RPTs are not above board and/or are
undertaken except in the interest of the business and transpar-
ently, the valuation is significantly discounted. Pursuing an
elaborate approach which is subjected to incisive security by
independent auditors and the audit committee and transparency
will receive the appreciation all around and protect the valuation.
Hence, it is an advisable approach.

10.7. Conclusion

‘RPT destroys your own wealth because, if the perception is

wrong then you would lose couple of percentages of multiples’,
says Narayana Murthy, chairman emeritus of Infosys. Although
the management, monitoring and superintendence of the RPT
cannot be allowed to deprive the enterprise of value creation
opportunities, it has to be clearly understood that inefficacious
handling can dent the reputation, which eventually destroys the
value—the basic purpose of its existence, ‘wealth creation’. The
market forces, in addition to regulators, are at work, more so with
increasing shareholders activism. Damaged reputation will have
serious repercussion on the enterprise valuation. The trade-off,
even for the entrepreneur-driven companies, may be adverse eco-
nomics. Hence, a deeper approach to protecting minority interest,
increased transparency and greater shareholder involvement in
decision-making may benefit substantially.
The Indian Companies Act, 2013 has laid down very com-
prehensive guidelines in the matter of RPTs. The observance of
these guidelines in letter and spirit would certainly strengthen the
Corporate Governance of the firms in India.

The Essential Book of CORPORATE GOVERNANCE 173

 11
Disclosures

11.1. Introduction

T
he invention of the institution of JSC has separated owner-
ship from the management. The small minority of controlling
shareholders and/or the professionals manage the interest
of a large majority of silent and passive stakeholders. The ‘trust
factor’ cements the relationship. The world has transited from
the ‘merit-based’ to the ‘disclosure-based’ regime. In the merit-
based regime, someone acting from a corner office of a regulatory
structure decides who can raise financial resources, when and at
what price. In the disclosure-based regime, the entrepreneurs/
management have to disclose their intentions to raising resources
coupled with methodology and pricing, along with all the infor-
mation that will help a prospective investor to take an informed
decision. Howard Schultz, the head of Starbucks, observed some
time back, ‘The currency of leadership is transparency’. Narayana
Murthy, the chairman of Infosys, says, ‘We have to insure there is
no asymmetry of information between owner/manager, who we
are and community of our shareholders. And the only way we can
do is through leading its disclosures’. He adds, ‘Good disclosures
are needed to enhance the trust of stakeholders at large’.
The decisions taken by the managers of the enterprise have
economic consequences, which, in capital market terminology,
are called ‘price-sensitive’. The decision-maker becomes privy to
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 Disclosures 167

price-sensitive information and knowledge of its impact before it

becomes public. The propensity to encash such information ahead
of its becoming public and profit therefrom is inherent. Such
encashment is called ‘insider trading’. It is, therefore, incumbent on
all such persons who, by virtue of their position, get information
ahead of others to disclose it immediately in a manner and method
that makes it a public knowledge and, until then, do not make use
of such information directly or indirectly to benefit therefrom.
Furthermore, the stakeholders including investors, in
risk capital, need certain information to begin with and on an
ongoing basis, which helps them to assess the current health of
the company and its future prospects so as to decide whether to
engage, continue to engage or disengage from the relationship
with the company. They also need to assess the quality of the
management, which helps them to extrapolate forward valua-
tions. An old Global Investors Opinion Survey (2002), conducted
by McKinsey & Company, revealed that 71 per cent of investors
gave weightage to accounting disclosures while taking an invest-
ment decision. This explains why companies in the same industry
with nearly the same P/E ratio are priced with varying multiplies.
In fact, one vicarious advantage of market valuation based on
disclosures is its near truthful verdict on the performance of the
company and future prospects. Thus, information becomes the
prime mover of the capital markets. The enlightened management
and board should use market verdict to shed the garb of compla-
cency and gear up the organization to the heights of excellence.
The strides of corporatization have brought into sharper focus
the significance of transparency in decision-making, which has
made disclosures an important part of the Corporate Governance.
Since it is neither feasible nor necessary to disclose every corpo-
rate decision, regulators, as good Corporate Governance norms,
have made it imperative to disclose certain (specified) important
decisions and information.
In any scheme of disclosures, the significance has to be on
quality. One of the purposes served by the disclosures is the impact
of decision on the profitability and sustainability of the business as
well as the enterprise. Hence, if the information provided does not
throw enough light on its impact, it is irrelevant.
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It has been observed that sometimes, recourse to legal opin-

ion is taken to decide whether decision/information needs to
be disclosed. In my opinion, good Corporate Governance war-
rants ‘when in doubt, better disclose’ rather than ‘look for the
umbrella of legal opinion to hide’. Such an approach will enhance
transparency and build credibility of the management, which will
eventually augment the perception about the quality of Corporate
Governance. However, the underpinning of the disclosures is trans-
parency, greater transparency and still greater transparency. Hence,
a ‘culture of transparency’ had to be ingrained in all concerned in
the company right from grass roots to the level of the board.
In fact, a procedure needs to be outlined so as to ensure that
whenever occasions arise, disclosure happens. This can be organized
by building trigger points based on the parameters outlined and the
philosophy of the Corporate Governance moving from mere form
to substance. The system should be so orchestrated that the trigger
points get activated whenever the eventuality of disclosure arises.
The responsibility of disclosures falls squarely on the shoul-
ders of the BoDs. Corporate Governance codes around the world
including International Corporate Governance Network (ICGN),
OECD, Commonwealth Association for Corporate Governance
(CACG) guidelines, and, in addition, the regulators mandate that
the BoD provides all the stakeholders credible information to help
them take a call on the continuance of the relationship.

Figure 11.1 Pyramid of Disclosures

BOARD

AUDIT COMMITTEE

AUDITORS

CHIEF COMPLIANCE OFFICER

CFO AND HIS TEAM

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 Disclosures 169

Even though the ultimate responsibility of disclosures rests

with the board, there is pyramidical structure which supports the
board in the discharge of its obligation (see Figure 11.1). At the
base is the CFO and his team, who have the primary responsibil-
ity to disclose what is expected of a company in terms of regula-
tory framework and desirability for enhancing the transparency,
thereby strengthening the trust factor. The chief compliance
officer has to ensure that rules are complied with in this respect
as well and that the manner of disclosure is as prescribed. Thus,
he acts as a kind of check on the performance of the base line
champions of disclosures.
The auditors are expected to provide an independent assur-
ance that all the necessary and needful disclosures have been
made, and timely, as also that the quality of information pro-
vided is appropriate. They are expected to carry out a scrutiny
of disclosures while undertaking the audit of financials, internal
checks and controls and so on to fulfil their obligation. They are
obligated to provide the certification to that effect as well.
The audit committee, which provides oversight to the function-
ing of the CFO and his team and also that auditors are effectively
playing the role as an independent agency, has to evaluate the quality
of work done by these layers. Additionally, it has to insist upon the
existence of systems to ensure that the disclosures happen as a matter
of organized process and let up the surface, if any, before it is too late.
The board is charged with the responsibility of providing
superintendence to the functioning of the various layers of the
pyramid through the review of the working of the audit com-
mittee. It would thus be observed that each of the layers has a
singular responsibility and lends support to keep the pyramid of
transparency solid and strong.
However, at the top of the pyramid sits the regulators who pre-
scribe and continue to reconfigure the prescription of disclosures
based on the expectations of the investing community—nationally
and globally—and the lesson learnt in the journey of regulating
the market. The prescribed standards must lay down principles
and rules which enable disclosures to become useful and reli-
able. Regulators have also the responsibility to ensure that all the
aforesaid layers of the pyramid render their role optimally and that
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the enforcement mechanism creates a fear of God and draws the

management to chanting the mantra of full transparency. Today’s
investors expect ever-greater transparency not from companies
alone; their aspiration extends to independent auditors and even
regulatory design. This pitchforks the frame of collective respon-
sibility. As the chairman of SEBI, when I was being criticized for
my overdrive on enhancing disclosures, I used to take solace in the
frame of collective responsibility. The central focus thus turns to
what I call intellectual integrity to building, maintaining and sus-
taining ‘stakeholders’ trust’, a necessary condition to creating and
retaining the efficacy and belief in the virtue of the capital markets.
In most companies, disclosures centre around merely finan-
cial disclosures. It is imperative to remind anything material
which can influence the price of its stock, albeit market valua-
tion and/or the decision of the stakeholder needs to be disclosed.
Even the state of the health of the CEO becomes important. Every
company has to rigorously conform to regulatory direction in the
matter of disclosure, and here is a broad frame of reference:

1. Financial Disclosures: Information on financial and operat-

ing results should be potent enough to help, understand and
appreciate the nature of business, current state of affairs, perfor-
mance during the quarter/half/year and how would the enterprise
shape up going forward. The quality of financial disclosures has
a direct relationship with the robustness of financial reporting
standards or observance of the accounting standards’ use in the
preparation of the financial statements. Although the observance
of accounting and financial reporting standards is a subject matter
of another chapter, it is suffice to state here that the authenticity
of use thereof is of prime concern. Financial disclosures, there-
fore, must be accompanied by the management’s discussions and
analyses (MDA). MDA would include inherent risks and estimates
used in the preparations and reporting of the financial results.
The information disclosed must include ‘value drivers’ as well as
‘value destroyers’ and how the management is going to leverage
and/or de-risk all those in the forward journey. This disclosure
will be insufficient if the strategies that will be marshalled are
not outlined. Furthermore, disclosure must also incorporate
company’s compensation policies, statement on the robustness of
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 Disclosures 171

internal control systems, compliance procedure and company’s

commitment to serving the interest of all the stakeholders rather
than shareholders alone. The process followed by the board in
approving the accounts must also be disclosed. In fact, it might be
helpful to disclose the board’s obligation of the superintendence
of the process of preparations of financial statements.
Along with the financial results, the company must also dis-
close all significant RPTs as well as related party relationships where
control exists, even though there may not be any RPT. Adding to
disclosures, RPT’s decision-making process is greatly appreciated.

2. Non-financial Disclosures: The following is the list of non-

financial disclosures:

• Company objectives, charges, if any

• Management structure: directors and key executives
• Ownership control structure along with how shareholders
exercise their control rights—through voting and/or seat
on the board and so on
• Changes in control along with the process/transaction
that brought about
• Governance policies and structures inclusive of board
committees and their charters
• Processes of dealing with the conflict of interest
• Performance evaluation process for the board members
and key management personnel
• Compensation to board members and key management
personnel
• Disclosure about auditors—statutory and internal—and
briefly how their work is organized
• Matters about the AGM and EGM
• Whistle blower policy
• RPTs and procedure

This is not a comprehensive list and should not be used as a

reference. The guiding principle has to be to keep the stakehold-
ers fully informed of all that they would want to know or must
know or will be useful to them in their decision-making. The
more is disclosed, the more transparency gets strengthened.
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11.2. Means, Methods and Manner of Disclosures

The following means are generally used by the companies for

disclosures:

1. Annual report
2. Website
3. Statutory filing: periodically with
• the exchange where company is listed
• regulator(s)
4. Newspapers
5. Communication to shareholders

Most regulators now permit electronic circulation/dissemination/

filing of the information. The companies should switch, if not
already done, to an electronic method. This will save the cost and
speed up the receipt of the information/disclosure, which can be
even personalized if so desired and helpful. Most companies now
use Internet-based XBRL-like platform to facilitate the ease of
access and analysis of the information.
In any scheme of disclosures, the most significant part is the
manner. It should be precise and candid. It should convey what is
sought to be conveyed. Hence, the focus has to be on the quality
and timeliness of the disclosure. Delay or inadequate disclosures
open up space for insider trading as also speculation, which has
to be necessarily obviated.
Researchers form a considered opinion, and investors take
informed decision based on the information so disclosed and
the opinion of researchers. It has, therefore, to be ensured by the
board that disclosure is timely, is done in a manner and a method
that it is noted and understood by all those to whom disclosures is
intended and is understood by the public in general as by the man-
agement itself. The quality of disclosures plays a significant role
in building perception about the quality of governance and has,
therefore, to be handled with sagacity, pragmatism and urgency.
A number of concerns have been expressed by the managements
of the company on (excessive) disclosures. While, as a regulator of
the Indian capital market, I was traversing, albeit fast-paced, on the
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platform of modernizing the market and dynamizing the disclosure

standards, I had to deal with those concerns sagaciously. The two
most talked-about concerns were: (a) cost of disclosures and (b)
compromise to the competitive position of the company. Although
my answer to beating the cost by standardization of systems and use
of technology was acceptable, I was not able to convince them on
the issue of compromise to the competitive positions, particularly
vis-à-vis an unlisted company. However, it had been my belief then,
and continues to strengthen with every passing misdemeanour, that
all the economic costs are taken care of by the higher valuation
of the enterprise by the market proffered to companies with very
high standards of disclosures. Transparency begets trust, and trust
endures the loyalty of the stakeholders, which may be difficult to
ensure as much by other means and methods, involving expendi-
ture including in investor relations’ management. I am aware of
the cost involved in building investor relations. Although investor
relations are limited to providing assurance on good governance,
world-class disclosure standards go beyond to enhancing valuation.
The global financial meltdown of 2007 has brought transpar-
ency of the corporate to centre stage and the lack of it threatens
sustainability. The governance has become more active. Even
the pressure groups such as non-government organizations
(NGOs), shareholders and so on and investigative journalist
organizations have become focused. Transparency International
(TI), which now reports on corporate transparency as well, has,
in a recent study, revealed that 80 per cent of the firms surveyed
scored less than 5 on a scale of 10, and that the record of Asian
companies is much poorer.1 One of the three important areas
surveyed was financial reporting.
Inadequate, incorrect or unclear disclosures adversely impact
the perception about the quality of Corporate Governance,
which has a direct and proportionate bearing on the valuation.
Institutional investors generally apply lower discounting rates

1
‘Corporate Transparency: The Openness Revolution’. (2014, 13 December).
The Economist. Available at http://www.economist.com/news/business/21636070-
multinationals-are-forced-reveal-more-about-themselves-where-should-limits
(accessed on 30 May 2016).

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while arriving at the valuation of Asian companies compared to

US and European companies, in general; of course, transparent
companies in all jurisdiction get their valuation near right.
Deficit in the disclosure may invite regulatory onslaught, which
can destroy/diminish the enterprise value. In a recent case of non-
disclosure (of Delhi Land & Finance (DLF)—the largest listed
Indian reality company), SEBI, India’s securities market regulator,
prohibited the company and the three promoter directors, CFO
and so on from dealing in securities market for a period of three
years, which shaved off nearly 20 per cent of the enterprise value
in one day. The decision was challenged before the Securities
Appellate Tribunal (SAT), which overturned the decision of SEBI.
SEBI has since appealed to the Supreme Court against the order of
SAT. Irrespective of the outcome, the irreparable damage to both
the value of the enterprise and ‘trust factor’ has been done.
At a time when even capital markets have gone global, alignment
with global standards and the integrity of disclosures has become
an important element of enhancing economic growth of a country.
Regular surveys are being conducted by the credit rating agencies,
investment bankers and even large active institutional investors
such as CALPERS to assess the quality of disclosures. Since sharing
of truthful information is bound to open up platforms of broader
market investors, every regulatory jurisdiction is now committing
to global standards of disclosures while weaving the local needs.
In fact, the phenomenon of ‘civic duty’ to leak information, if their
employer is shady and secretive, is also spreading. Hence, the defi-
cit in disclosure will not only harm the firm and lower its enterprise
value, but also, albeit vicariously, adversely impact the economic
growth of the country, because its conduct will impact the efficacy
of the capital market itself. Professor George Serafeim of Harvard
Business School, based on the evidence, observed, ‘It boosts the
share price because of the demonstration by the management of its
efforts to handling hidden risks’. Hence, in the interest of the firm,
the market and also the larger economic interests of the jurisdiction
it operates, it is important that the board, executive management,
auditors and regulators collectively address the issue of disclosures
and make the functioning of the firm transparent. The reputational
benefits of openness will be greater than any other gain that can be
achieved by the managers of the firm by the lack of it.
182
12
Risk Management

‘T
he revolutionary idea that defines the boundary between
modern times and the past is the mastery of risk: the notion
that the future is more than a whim of the Gods and that
man and women are not passive before nature’, writes Peter L.
Bernstein in the introduction of his world famous book, Against
the Gods: The Remarkable Story of Risk.1 And, to my understanding,
the fast-paced unremitting transformation of the environment
makes a year gone by as past. Obsolescence and irrelevance have
a new definition of the longevity of organizational design, products,
systems or processes. The ability to map the future—year, two
years or five years—decipher risks and draw up a matrix of risk
management, risk mitigation and risk avoidance tools are the
hallmark of sustainable success of individuals, corporations and
even societies. This transformation in approach distinguishes
pragmatism from conventional wisdom. If the definition of suc-
cess extends beyond a quarter or year, risk management has to
occupy the front seat in the strategy formulation. While granting
that all risk management failed to perceive and map out the onset

1
Bernstein, P. (1996). Available at: https://books.google.co.in/books?id=
uTje6PYAijUC&printsec=frontcover&source=gbs_ge_summary_
r&cad=0#v=onepage&q=the%20notion%20that%20the%20future%20is%20
more%20than%20a%20whim%20of%20the%20Gods%20&f=false (accessed
on 30 May 2016).

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of 2007 global economic meltdown, I would still forcefully advo-

cate risk management to be at the top of the agenda.
I consider risk management as one of the important processes in
building excellence in Corporate Governance. In most boards, risk
management is relegated as an appendage to the oversight of the
audit committee which focuses and rightly so on the financials and
its reporting, and the risk management is discussed once in a while
and often casually. Pragmatic managements architect risk manage-
ment within the broader framework of strategy and operations’
management, but with clearly defined goals and process.
The theme of this book is the triumph of Corporate Governance.
Hence, I suggest risk management as one of the fundamental ena-
bling processes. It is the process which will help protect value
drivers and de-risk value destroyers. Although I will discuss the
actual process while detailing the role of the risk management
committee (RMC), the focus here is what the board should be
doing in this area. I strongly recommend constitution of a sepa-
rate RMC. A draft charter of RMC inclusive of the role is given in
Annexure 5.
First and foremost is the coordinated, concerted and con-
tinuous focus on risk management, rather than mere conform-
ance with regulatory directive of setting up RMC or allocating
the responsibility to the audit committee. The journey will begin
with identifying the value drivers as also the value destroyers,
which will have to be reviewed every quarter. This will be in
addition to the detailed work of identifying the business risks,
their management and mitigation. The following, which are
often ignored and/or not considered, will have to be definitely
incorporated in the framework. The board must design a prag-
matic risk management policy and craft risk management frame-
work with the help of RMC. The scope of the risk horizons is of
prime importance.
Scope: The risk management framework often excludes risks
arising out of macro- and micro-socio-politico-economic fac-
tors. In the current dynamic setting, macro- and micro-factors
emerging in any part of geography can influence the business
environment in other parts of the planet. Just to explain the point,
the impact of the growth of Chinese economy or slow down of
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 Risk Management 177

investments in infrastructure in China can influence not only the

pricing and production capacities, prices of commodities, but
even the new investments opportunities in different industries in
India as anywhere else. The Arab spring and the consequential
political and social disquiet in Middle East and North African
(MENA) countries affected the economics and businesses globally,
consequenced by their impact on the production of oil. Hence,
the macro- and micro-environmental risks have to be scoped to
mitigate and manage the impact thereof on the business of the
enterprise.
Regulatory Risk: Regulatory stance about the business, prod-
uct, compliance and so on travels on a dynamic platform and
undergoes transformation depending upon the macro, micro and
even the market environment, company compliance and miscon-
duct. The change in regulatory stance often alters the frame of
reference, which may eventually make the organizational design,
business model, strategic approach and even the product basket
irrelevant or counterproductive. Furthermore, any letup in the
obligated compliance can invoke regulatory cognisance and
consequential action. This may result in financial loss and lead
to the erosion of the value of the enterprise. Hence, regulatory
risks have to be an inescapable part of the risk management
framework. The propensity of regulatory risks is greater in case
the regulator is on a learning curve or the market is at an evolu-
tionary stage. Life Insurance industry in India during the years
2008–2013 is a witness to the severe impact on the growth and
profitability caused by the unhedged regulatory risk.
Most boards do not recognize regulatory risk and are sur-
prised when the onslaught of regulatory overtones wrecks the
financials and/or enterprise value.
Opportunity Loss: This is also a risk which may not necessarily
impact the profitability of the current business and even sustain-
ability of the enterprise, but can certainly impede encashing the
propensities of profiting from the unfolding of opportunities, albeit
far in the horizon, as a consequence of new perspectives and pos-
sible changes in social, economic and political environment across
geographies. An illustration: Change in the preference to mud
structure over concrete even for additional housing by well-to-do
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Figure 12.1 Risk Management Grid

Executives’ Risk
Value
Management RMC of Board BoD
Protection
Committee
Enterprise Risk
Vision, Organizational Business Regulatory Opportunity
Mission Design Risks Risks* Risk Loss Risks
and Cultures

Micro Environment Risks: Industry-specific Risks

Macro Environments Risk: Political, Social and Economic

Note: * denotes strategic, operational, financial risks and so on.

families can throw up a new set of opportunities to encash, particu-

larly in a fast-growing large emerging economy like India.
Organizational Design: With the change in environment, the
relevance and usefulness of organizational design become a ques-
tion mark. This has to be reviewed at least once in a year, so as
to ensure that the organizational design is capable of deliver-
ing value optimally and has not become irrelevant and/or value
destroyer which is a serious risk.
Vision, Mission, Values and Cultures: Similarly, the vision, mis-
sion, values and cultures in the organization need to be revisited.
These also do pose risks for the continued success of the organiza-
tion. In any case, their relevance and validity have to be tested on
the platform of (dynamic) environment.
Figure 12.1 shows the grid of an efficacious risk management.

12.1. Risk Management Process

The RMC of the board has to be assisted by a committee of execu-

tives. Let us call it executives’ RMC (ERMC). The structure has to
be further supported by the shop floor-level committees and risk
champions. Most boards are happy with the detailing of 10/15/20
big risks and management thereof. I would suggest the detailing
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of all the possible risks at the commencement of the financial year

into the following buckets:

1. Environment risks: macro and micro

2. Business risks
• Strategy
• Operations inclusive of financial
• Systems and processes and so on
• Value drivers at risk
• Emerging value destroyers
3. Regulatory risks
4. Opportunity loss risks

Once such a detailing is complete, all the risks must be graded into
major and minor risks. Thereafter, the possible impact of all the
risks must be assessed. After such detailing works, the measures
to mitigate, manage and sidestepping risks must be formulated.
The entire strategic plan will be complete with naming the risks
owners and scripting the monitoring plan, which will include
when the various forums of structures will meet and what kind of
information, data and analysis, success and failures statements will
be presented in the meetings for incisive debates in those forums.
Every quarter, the board should get a comprehensive feed-
back on how the risk management function is working and
suggest/direct changes in the approaches wherever needed.
Organization-wide education/awareness of risk and the impera-
tives of managing these will have to be an ongoing exercise. The
role of the risk champions and risk owners will be singular in the
exercise. At the end of the year, a comprehensive stock taking
must be undertaken to assess the successes and failures as also
the lessons learnt along the journey for re-engineering the frame
for the next year.
The most important aspect to remember is whether the mech-
anism of orchestrated reviews includes the business risks as well as
enterprise risks. Organizational design, vision, mission, values
and cultures do have the relevance with the management of the
enterprise and, therefore, will have to be reviewed and the rel-
evant aspects de-risked. To judge whether the risk management
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has been sagacious, the board must make a reverse journey and
look into the financials to assess whether the enterprise value
has been enhanced, maintained or reduced. The board can also
assess whether the risk management model can sustain the value
in future. Erosion in the profitability or the value must be inves-
tigated as to why RMC failed to de-risk that. Let us remember
that the overall performance of the enterprise has a direct and
proportionate relationship with the quality of risk management.
In fact, the ability to visualize how environment and the
market scene is going to unfold and choose amongst the possible
alternative strategy response is at the heart of risk management. I
strongly advocate the defining of multiple scenarios and design-
ing of multiple alternative strategy responses. Even if the actual
turns out to be at variance with all the defined scenarios, there
is a strong possibility of divergence not being far from one of the
visualized scenarios. One amongst the multiple choices designed
can easily and quickly be customized to challenge the risks of
unfolded scenario. In the absence of such an exercise, the time
gap in drafting the strategy response may prove to be expensive.
The concept is summed up in the philosophy of the scientist,
Arthur Rudolph who developed the Saturn 5 that launched the
first Apollo Mission to the moon. He spelled out (reported in the
obituary published New York Times, 3 January 1996), ‘You want a
valve that does not leak and you try everything possible to develop
one. But the real world provides you with a leaky valve. You have
to determine how much leaking you can tolerate’.2 If there is a
ready-to-launch strategy response, the tolerance level of the dam-
age assessed quickly and the lowest denominator can be applied.
Since risk management has developed as science by itself and
neither it is the remit of the book to help develop and design
risk management plan nor am I an expert in risk management,
I would like to conclude that risk management superintendence
should remain in the sharp focus of the board at all times. This
will convert the regulatory direction of obligatory risk manage-
ment action into value preservation and creation process.

2
Available at: http://www.nytimes.com/1996/01/03/us/arthur-rudolph-89-
developer-of-rocket-in-first-apollo-flight.html (accessed on 30 May 2016).

188
13
Building Ethos: Ecosystem

E
nvironment influences individuals and, in aggregate, the
enterprise. The quality of Corporate Governance, in par-
ticular, is influenced by the organizational ethos or the
ecosystem that is created by the management under the direction
of the board. In case a company seeks to architect excellence in
Corporate Governance, it is essential that an ecosystem is cre-
ated where every action of all those who are associated with
the enterprise, including those who participate from the out-
side, reverberate against the ecosystem and less than excellence
bounces back to the undertaker of those act. Building of an
ecosystem has broadly three main frames:

1. Configuration of the board and the board committees,

senior management team and the engagement philosophy
with the HR in the organization as also the suppliers of
goods, services and financial capital.
2. Systems, processes and practices (SPP): The platform on
which business of the company is transacted.
3. Democracy: Where expression of views and opinions
as also suggestions and recommendations is open and
welcome.

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It would be desirable to elaborate, albeit briefly, on all the three

frames of the ecosystem.

1. Configuration: It is important that all the people who

are invited to be associated or with whom the people in
the enterprise transact the business carry a reputation
of professionalism and integrity. The integrity connotes
both financial and intellectual. It may be very difficult
for any enterprise to obtain character certificates from
the people whom the enterprise proposes to engage
about professionalism and integrity. However, a bit
of diligence to find out whether something negative
about their professionalism and integrity is floating in
the environment should be undertaken. This may not
be a very difficult process, in particular, because of the
information explosion. Today, it is very difficult for an
individual to hide known debilities most importantly,
relating to integrity. The private lives of individuals have
since become the public information.
Such diligence must begin with the appointment of
the board members, extending to the senior management
team and travelling down to the last level of the human
capital in the organization. There must be a written
code in the organization, in the matter of recruitment of
individuals at any level in the organization, that the lack
of adequate professionalism and impeccable integrity
is unwelcome and will not be tolerated. It is quite pos-
sible that while recruiting people at the lower level, the
adequacy of professionalism may become a challenge.
In such a situation, at least some understanding of the
mindset of the individual as to whether he will be willing
and capable of developing a professional approach will
have to be engrained; testing the abilities as also debilities
of learning and unlearning. Psychometric tests are avail-
able to organize such a testing.
Post recruitment, the induction of people in the organ-
ization must be done through a formal exercise. During

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 Building Ethos: Ecosystem 183

that exercise, it must be made and be clearly understood

that individuals with professionalism and integrity alone
can flourish in the organization, albeit continue. This
one-time exercise of induction has to be repeated off and
on, both by organized activities and the behaviour of the
organization in taking cognizance of lack of it observed
any time during the currency of the relationship. And if it
is established through a process of inquiry and examina-
tion that there was, in particular, deliberate attempt to be
less than professional and/or honest, the exit door must
be shown.
While building relationships with suppliers of goods,
services and financial capital, whether through debt or
equity (bulk), some kind of diligence must be undertaken
to ensure that the people sought to be associated with do
not have a record of dishonesty. It might be worthwhile
at least in the long run not to pursue and/or promote
relationship with people/organization without honesty
because it is bound to affect, one time or the other, the
quality of governance in the organization.
Although the approach suggested earlier may appear to
be utopian, it may cause difficulties in building organiza-
tion, people and relationships. However, the emerging
focus on the quality of Corporate Governance warrants
the building of an ecosystem where there is a tendency to
move forward in ensuring the observance of the highest
standard of Corporate Governance. And, the journey has
to begin at the beginning.
It is quite possible that the enterprise may be deprived
of some of the growth opportunities, and/or the growth
trajectory may have slowed down. However, in the long
run, it will sustain the growth path and enhance value
creation. The short-sighted approach of quick gains has
to be traded with the long-term sustainability, profitabil-
ity and growth value.
2. Systems, Processes and Practices: Human beings are cap-
tive of the SPP. These are used to bring about uniformity

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and authenticity of the output—goods, services or data

and statements. Loopholes and lacunas in SPP can lead
to disaster/ruin of the enterprise. Hence, it has to be
ensured while developing, operating and re-engineering
SPP that these help professionalism and leave no scope
for dishonesty. It is well appreciated that human inge-
nuity is unlimited. An evil mind can always create
distortions to organize the misdeeds and profit there
from. It has happened to the organizations of even great
repute. However, the safety lies in organizing continu-
ous evaluation through a programmed approach and the
involvement of outsiders (different people/organization
at different times) in undertaking the examination and
evaluation of the robustness of SPP.
Anyone found distorting SPP must be called to ques-
tion. Although building exceptions to the observance of
SPP may sometime become essential, close scrutiny and
monitoring will be the safeguard against such excep-
tions, which, in any case, have to be permitted sparingly
and not as a matter of routine. Organizations loosening
their grip on the SPP, and/or the exception reporting and
monitoring eventually, lapse into disaster. A question
may arise in some minds as to how SPP are related with
building excellence in Corporate Governance. I believe it
to be elementary, as SPP is the basic foundation on which
everything whether it is an RPT, disclosure, observance of
accounting standard, risk management or even conduct
of business operations, happens. There is an element of
Corporate Governance in everything. The quality and
authentication of observance of the laid down norms can
be ensured only through the robustness of the SPP. Thus,
building SPP in the process of architecturing excellence in
Corporate Governance must remain in focus at all times.
3. Democracy: Democracy is often used only with reference
to the governance of a nation and/or a society. I believe
that democracy is essential in all walks of life includ-
ing management of personal life and the enterprises. It

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 Building Ethos: Ecosystem 185

might be useful to explain what democracy means with

reference to the management of an enterprise and/or the
Corporate Governance. Democracy means freedom to
speak, opportunity to participate in decision-making and
authority to evaluate the consequences of the decisions.
In most organizations, it is only boss’s speak. There is
very little space for individuals in the team, whether it is
the boardroom, committees of the board, management,
departmental meetings and/or shop floor discussions. It is
recognized in democracy that the leader has the author-
ity to take decisions. However, that authority confers on
him the responsibility of delivering efficacious decisions.
The efficacy of a decision is tested only with reference to
the views of the people involved in the decision-making
process. Restricting the voice of a dissent does greatest
harm to an individual and also to the enterprises. It is in
this context that in a parliamentary democracy, not only
opposition, but also its leader is recognized. The leader of
opposition has a status and a statutory right to be heard.
Even if the dissent cannot be accepted, it propels the
decision-maker to think of the safeguards and precautions
to be taken while implementing the decisions, so that the
propensity of success of the decision is greatly enhanced.
The dissent must be respected and given full considera-
tion. Such an approach does great good to the organization
and protects from many risks, in particular, the lack of
commitment in the implementation of the decision.
It is quite possible that most people toe the line of the
leader and do not open up. It, thus, becomes the respon-
sibility of the leader to invite, encourage and even exhort
the people to come out with their opinion and views. I can-
not forget an instance when the then minister of finance
of India had made up his mind to take a decision on an
issue and wanted to cross-check with me about my own
opinion on that. Having being told earlier by the finance
secretary of his having made up his mind, I said it is ok,
even though I did see some risk but not the disaster.

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However, the minister insisted on expressing my views

on the matter by saying that he always respected my
views and, therefore, would like frankness in this matter
as well. I told him about my reservation as also explained
fairly in depth the reasons thereof. It must be added to his
grace that he realized the potential risk of the proposed
decision and changed his mind. This helped him in mod-
ifying his earlier decision and de-risking the potential
risks. It is our belief that the flourishing of democracy in
the organization is the foundation of creating an ecosys-
tem for architecting excellence in Corporate Governance.

Just to conclude, building and maintaining an appropriate eco-

system is a perquisite for delivering excellence in Corporate
Governance. And, it is the primary responsibility of the board to
architect that and sustain it all through.

194
14
Building Enablers of Good
Corporate Governance

B
uilding excellence in Corporate Governance demands that
certain facilitating enablers are inbuilt in the system, which
must eventually lead to greater understanding in the organi-
zation and larger accountability and transparency. Some of the
enablers, which are mandated by the regulators, either as obliga-
tory or voluntary, need to be firmly in place.

14.1. Code of Conduct

Building excellence in Corporate Governance cannot be organ-

ized in the boardroom alone. It has got to envelop the entire
organization. Involvement of the employees at all levels is facili-
tated by designing and implementing enabling processes. In fact,
an appropriate setting has to be architected, which governs the
approach and behaviour of the organization. Organizational
behaviour is the sum total of the approach and behaviour of
all the employees in the organization. Hence, a three-pronged
approach, outlined as follows, has to be pursued.

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1. Designing code of conduct

2. Communication
3. Monitoring of conduct

A comprehensive code of conduct has to be drafted. The code

of conduct should broadly lay down a framework with refer-
ence to which the employees at all levels would address their
roles, responsibility and accountability frames. In fact, a code
of conduct is about how they will operate on a day-to-day
basis. The overarching theme of the code of conduct would
be (a) integrity—financial and intellectual, (b) commitment to
scrupulous compliance of the rules, regulations, guidance and
direction and so on, (c) protecting and enhancing the enterprise
value—guarding interest of all the stakeholders and (d) total
commitment to the delegated responsibilities and devolved
accountability—professionalism. Designing the code of conduct
is a very involved and evolutionary process, and the organiza-
tion must seek views and opinion at all levels. Once the draft
of the code of conduct is finalized, it should be placed before
the board for approval. Some kind of model code of conduct is
a part of Annexure 4. The code should be subjected to a peri-
odical review, preferably yearly, with reference to experiences
gained during the journey of its implementations.
The code, once finalized, should be widely circulated. It must
be uploaded on the website so that the employees can refer to it
as and when required. In fact, the communication should not be
restricted to the circulation of code. Maybe through the town hall
meetings, why the code must be instilled, which would enthuse
them to follow religiously. Examples should be enumerated of
how the observance of the code is going to enhance or protect
the value of the enterprise and consequences thereof on their
own welfare. Communication relating to code cannot be a one-
time affair. It has to be reinforced periodically. In fact, it might
be useful to organize a cadre of champions who would keep the
dialogue ongoing.
It is not only important that an organization has a code of
conduct, but it has to have a mechanism to enforce it as well.
Any deviation from the code of conduct must be taken cognisance
196
 Building Enablers of Good Corporate Governance 189

of and dealt with appropriately. In acts of serious delinquency,

exemplary action must be taken.
The whole process of the code of conduct must work tri-
dimensionally:

1. Educative
2. Preventive
3. Prescriptive

Education would mean instiling in the minds and heart, why and
how of strict conformance to the code of conduct: how will it ben-
efit the organization and in turn the people in the organization.
Prevention would envisage motivating people to observe the
code of conduct in both letter and spirit. The exemplary punish-
ment must deter the employees from venturing into misconduct,
and misadventure is but one motivation, although real motivation
follows from benefits that flow with full compliance. This can be
a factor in monetary compensation as well as for rise in hierarchy.
The board must create processes by which it is able to review
the observance of the code of conduct and also direct, wherever
necessary, to ensure that the organization is deeply involved in
reaping the benefits of institutionalizing the code of conduct.
Prescription would entail exemplary punishment to default-
ers in non-observance of the code, which should send shivers
down the spine of those on the sidelines of less than full
compliance with the code of conduct. This can be organized
through the erection of a system of monitoring of compliance
of code. In the absence of monitoring, which should include
dealing with delinquencies, the very purpose of setting up code
would be defeated. Excellence in Corporate Governance cannot
be built without a pragmatic and sagacious code of conduct and
robust monitoring mechanism of its implementation.

14.2. Whistle Blower Policy

For effective Corporate Governance, companies are urged to

concentrate on two areas: first, to create a strong ethical compass
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to guide the organization—the code of conduct and second, to

establish a comprehensive framework of internal controls to fos-
ter a culture of accountability. Ernst Young’s one of the annual
surveys of global fraud has rated whistle blowing mechanism
(WBM) above external audits as the second most effective means
of detecting corruption. People are now prepared to acknowledge
that whistle blowing is about good corporate citizenship. Whistle
blower policy provides employees, customers and vendors an
avenue to raise concerns, in line with the commitment to the
highest possible standards of ethical, moral and legal in business
conduct. It also provides necessary safeguards for the protection
of employees from reprisals or victimization, for whistle blowing
in good faith.
Most regulators across the geographies have enshrined in the
regulations the setting up of a whistle blower policy as an obliga-
tion. The SEBI in its latest amendment to Clause 49 of the listing
agreement, which has now become a regulation by name SEBI
(Listing Obligations and Disclosure Requirements) Regulations
2015 and issued as SEBI/LAD-NRO/GN/2015-16/013, has made
whistle blower policy compulsory, which states:

The company may establish a mechanism for the employees to report

to the management concerns about unethical behaviour, actual or
suspected fraud or violation of company’s code of conduct or ethics
policy. This mechanism could also provide for adequate safeguards
against victimization of employees who avail of the mechanism and
also provide for direct access to the Chairman of the Audit Committee
in case needed. Once established, the existence of the mechanism may
be appropriately communicated within the organization.1

This suggests that, primarily, whistle blower’s allegation should

be placed before the management and can be brought before the
audit committee wherever needed. I suggest similar formation,
while making audit committee’s door always open to approach
with or without contacting/communicating to management.

1
Section 4(2)(d)(iv). Available at: http://www.sebi.gov.in/cms/sebi_data/
attachdocs/1441284401427.pdf (accessed on 30 May 2016).

198
 Building Enablers of Good Corporate Governance 191

So does the Indian Companies Act incorporate? It is the duty

of the board through the audit committee to design and approve
whistle blower policy—a policy which is potent and encourages
employees to bring to the notice of the audit committee serious
financial irregularities that occur in the organization. Although
the formulation and approval of whistle blower policy is easier,
its implementation and, in particular, encouraging employees to
fearlessly bring to the notice of the audit committee and the board
any dealings that are not ethical and affect the financial soundness
of the company and/or alienate the interest of stakeholders, must
be systematically encouraged.
It is desirable to outline the procedure for dealing with com-
plaints in the policy. The section of the protection of whistle
blower should also be specified along with how false and frivo-
lous complaints will be dealt. More important, however, is the
use of this mechanism to get feedback from the ground level in
the organization to plug loopholes in the systems and processes.
There is a possibility that disgruntled employees will use this
as a handle to create an atmosphere of ill will and disturbance.
Hence, it has to be ensured that while all genuine complaints are
dealt with effectively and people behind those complaints are
protected, the incidence of irrelevant, biased and motivated com-
plaints is reduced to the minimum, if not eliminated altogether.
To make it happen, the audit committee and the board will have
to get involved in the process little more deeply and make sure
that this does not lead to the organization being disadvantaged
because anything which is not correct but getting pitchforked
will bring alienation in the organization. This is what happens in
the public sector undertakings (PSUs) or state-owned enterprises
(SOEs) and even the government departments. Finding the right
balance is a very difficult task. However, it can be achieved sub-
stantially by the involvement and attention of the audit committee
and the board. However, the inevitability and robustness of this
process cannot be underscored in any way. It is my belief that the
WBM if used well can be a value and credibility enhancer.
A suggested draft of whistle blower policy is given in
Annexure 4.

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14.3. Website

Transparency is the biggest defence against misdemeanours and

incorrect reporting. Even though most of the companies in India
and in other countries do have a website, in many cases, it is
neither updated nor user-friendly. It is important that the website
contains all the possible information and data that any investor,
analyst, customer or employee would like to know and it can
be made public. Whatever informations and/or communications
are sent to SXs and regulatory bodies must be simultaneously
uploaded on the website. Storing the data in an organized manner
is essential so that it becomes user-friendly. By a click, of course,
a right click, anyone wanting to have the information should be
able to see, download or print it. It might be useful for companies
to take the help of the professionals to do the website.

14.4. Board and Committee Meeting Protocols

It is important that the company creates a set of protocols for

holding board meetings and the meetings of the committees of
the board. These protocols begin with the way the notices of the
meeting will be issued and agendas will be prepared and circu-
lated. It will also include broadly the people who can attend the
meetings, what kind of instruments and gadgets will be used
in the meeting and how an atmosphere will be created for an
undisturbed flow of discussions. I had occasions to attend board
meetings where every five minutes, somebody or the other was
entering the boardroom either bringing tea, coffee or snacks,
papers, getting signatures of the executive directors on docu-
ments or even consultations. The board and committee meetings
must be in an environment where nobody, unless invited by the
chairman of the meeting, enters the room. All arrangements of
refreshment, paper submission, etc. must be completed before-
hand. This is important not only for maintaining decorum and
facilitating undisturbed discussions, but also for the reasons of
secrecy. A set of protocols, which I consider will be helpful, have
been incorporated in Annexure 3.
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 Building Enablers of Good Corporate Governance 193

14.5. Compliance Culture

It is the legislative responsibility of the capital market regula-

tor, sector regulator and any other authority, such as in the case
of India, Ministry of Company Affairs, Government of India, to
regulate the market and protect the interest of the investors. In the
case of Indian capital market, regulators such as SEBI and other
financial regulators have added the responsibility of developing the
respective markets. To discharge their obligations, every regulator
including SROs issue legislations, rules, regulations, directions and
guidance, compliance of some of which is obligatory and some
other discretionary. In the case of listed companies in India, the
Corporate Governance norms have been specified as conditions
in the listing agreement for continued listing in addition to what
is specified in the Companies Act. The Indian Companies Act has
been comprehensively revised in 2013, and most of the provisions
have been made applicable from 1 April 2014. In addition, the
SXs have issued guidelines for compliance. Every company has to
necessarily comply with all the applicable clauses of legislations,
regulations, rules, directions and guidance. Any lapse in the com-
pliance is taken note of and dealt with appropriately.
To ensure that the company undertakes the job fully and
faithfully, it has to develop a culture which envelops the entire
organization. There are a number of companies which are using
software developed by some consulting accounting and legal
firms. Many of the users feel that it serves them well. However,
there is no substitute to creating a culture of compliance in let-
ter and spirit and effective monitoring of the compliance. In
fact, there is a need to create an environment where all the three
formats—proactive, co-active and reactive—work so that compli-
ance does not become the casualty of confusion and fragmented/
distributed ownership.
In most jurisdictions, the company secretary has been desig-
nated to be the chief compliance officer for Corporate Governance
compliance. However, the ultimate responsibility of compliance
devolves on the shoulders of the BoD. Even otherwise, to leave the
compliance completely to company secretary without an effective
oversight of the board is dangerous. Unfortunately, this is what is
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happening in most boards, and complete reliance is placed only

on the certificate presented to the board.
It is imperative for the board to lay down the systems and
processes as to how compliance will be ensured. In the case of
need, expert advice can be sought. These systems and processes
must be reviewed at least once in a year by the governance com-
mittee of the board. In addition, it should also be discussed in the
board. Non-compliance is a reputational risk in addition to the
penalties by the regulators. Furthermore, the substance of com-
pliance of Corporate Governance norms pave the way for build-
ing excellence in Corporate Governance. Moreover, this routine
exercise can be converted into value-enhancing process.
This may not be a comprehensive list of building enablers
for good Corporate Governance. Hence, the board and its com-
mittees have to watch out to include whatever else can help in its
journey of building excellence.

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15
Monitoring Pyramid

T
he architecture for building excellence in Corporate
Governance may be ready and implemented rigorously.
However, it is important to create a very effective monitor-
ing mechanism to (a) ensure compliance with the regulatory
directions both in letter and in spirit and (b) create, enhance
and maintain enterprise value. The regulatory direction in most
jurisdictions has an inbuilt monitoring mechanism. These mecha-
nisms begin with the auditors and end with the evaluation of the
compliance by the regulators. In between the two function the
management, the BoD and the committees of the BoD (some of
which have necessarily to be constituted as a regulatory obliga-
tion, such as the audit committee, the stakeholders committee
and the nomination and remuneration committee).
However, the effectiveness of the mechanism is not deter-
mined by the pillars of the building but by the role they play in
discharging the assigned responsibilities. In fact, in all the stances
of Corporate Governance failures, one or more of the pillars had
failed to provide strength and effectiveness in monitoring the
quality of the Corporate Governance. Hence, it is important that
the effectiveness of the monitoring of the Corporate Governance
is built on very sound footing, and coordinated, concerted and
continuous attempts are made to provide periodical reinforce-
ment. This reinforcement is possible only if the different pillars

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cooperate and lend each others’ strength for strengthening the

other. Building such a process is the responsibility of the board,
which it should not seek to delegate to any other agency.
In the following, I have tried to narrate some ideas and meth-
ods of how monitoring mechanism can be made more effective.
In fact, in my opinion, monitoring mechanism cannot be created
in the frame of the different pillars of a building because these
pillars are generally separated and the distribution of the load
becomes the philosophical underpinning, which may be difficult
to shift from one pillar to another even for marginal adjustment.
Hence, I recommend a pyramidical structure. Figure 15.1 shows
the design of the monitoring pyramid.

Figure 15.1 Monitoring Pyramid

REGULATORS

PUBLIC SECTOR PRIVATE

Capital Market SECTOR SRO
Sector Regulator Capital Market

BOARD
Sterling Role
of Independent
Directors

BOARD COMMITTEES
Audit , Nomination &
Remuneration, Risk Manage-
ment, Stakeholders

AUDITORS
Internal & Statutory

COMPLIANCE
Code of Conduct
Whistle Blower Mechanism
Compliance Certificate

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 Monitoring Pyramid 197

15.1. Compliance

At the base of the pyramid has to be what I would like to describe

as the ‘eternal vigilance’. This eternal vigilance has to be provided
by one and all in the organization at whatever level, whatever field
and in whatever relationship they might be operating. It shapes
up with three frames: (a) compliance certificate, (b) code of con-
duct and (c) WBM.

15.1.1. Compliance Certificate

Although the preparation, filing and review of compliance certifi-

cate is a kind of box-ticking process, it has to be gone through
periodically (in most jurisdictions, it is envisaged as quarterly)
and rigorously. Such a box ticking, even if done mechanically,
would ensure that all the pieces, obligated and/or voluntary,
are in place. However, it is the responsibility of the company
secretary to ensure that it does not become a purely mechanical
exercise. He has to periodically dive deep into the process of this
box ticking to ascertain the depth of the application of the mind
of the people involved in this process. Such an exercise, if not
possible quarterly, has to be organized at least once in six months.
This periodical review by the company secretary and his team
will ensure that the people involved in the process are conscious
of a kind of audit, which will be undertaken by a person other
than their own supervisor, and, therefore, serious attention will
willy-nilly be provided by them. It must also be provided that
in case this process is not undertaken either religiously or vigor-
ously, there is the correcting mechanism—educative, preventive
and prescriptive—to bring and/or keep the process on track. The
lack of taking serious cognisance of the delinquency in this area
can result in lapses, which may eventually cause damage to the
reputation and value of the company.
The review by the company secretary has been suggested
mainly because, in most jurisdictions, particularly in India, the
company secretary is supposed to be the chief compliance officer
of the Corporate Governance. He can discharge his responsibility
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proficiently only if he ensures that the process of the issue of

compliance certificate is thorough.

15.1.2. Whistle Blower Mechanism

The robustness of WBM, the details of which on design have been

stated somewhere else in the book, will encourage the employees
at different levels to bring to the notice of the audit committee the
brewing and/or happening of misdemeanours. Its robustness will
also work as a prevention of the evil minds to bloom. They will be
deterred by the possibility of its being unearthed by one of their
colleagues with dire consequences to him. It is the duty of the audit
committee, the chairman of the audit committee, in particular, to
review periodically, most certainly every six months, the robust-
ness of the WBM. This review must aim to achieve the free flow of
information—appropriate and correct with documentary evidence,
if possible—and also to make sure that the disgruntled and/or biased
employees are not encouraged to derail the functioning of the organ-
ization by preferring malicious complaints without any basis or facts.
The WBM functions as the base on which the entire monitoring
pyramid would stand. In case this is not on firm grounds, the moni-
toring pyramid cannot be solid and safe. It is, therefore, important
for the board to find out, help and assist that these blocks in the
foundation of the pyramid are strengthened on an ongoing basis.
Obviously, this would command periodical review by the board,
maybe once in a year. It might be useful to get this mechanism
audited at least once in three years from an external agency to find
out how the whole processes are working, lacunas, if any, and the
need for re-engineering. This alone can ensure the effectiveness of
this layer, which will provide strength to all the other layers upward.

15.1.3. Code of Conduct

Similarly, the code of conduct should propel the employees

at all levels to behave ethically and follow the norms scrupu-
lously. Rigorous enforcement will solidify the foundation of good
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governance right down to the last level in the organization. Since

the subject of the code of conduct has been dealt with earlier, I
would like to conclude with the suggestion for the board to review
the observance of the code of conduct at least once in a year.

15.2. Auditors

Every regulatory jurisdiction envisages the appointment of inde-

pendent auditors to do what is statutorily required, the audit of
financials. Hence, such auditors are also called statutory auditors.
In addition, most regulatory jurisdictions enshrine that there
should be internal audit as well, which can be done either by the
in-house team or an external agency. Between these two auditors,
it has to be ensured that 100 per cent of the SPPs are audited, or
substantially if not 100 per cent of the operations. While there are
some areas, such as the revenue account, balance sheet, RPTs and
observance of accounting standard and so on, which have neces-
sarily to be done by both, certain other works are also allocated
between the two sets of auditors.
Between these two agencies, it has to be ensured that all the
financial transactions are above board and the reporting is truth-
ful and complete. The independence of both these agencies has
to be ensured. Hence, it is provided in most jurisdictions that
the appointment of statutory and internal auditors including the
in-house team is subject to the approval of the audit committee,
board and the shareholders. Similarly, their remuneration has also
to be approved by the audit committee, board and the sharehold-
ers. However, it is not the appointment and/or the functioning of
these auditors which, per se, ensures the quality of governance
and/or the efficacy of the accounts. The following factors deter-
mine the quality of the work of the auditors: (a) independence, (b)
skills, (c) value system and (d) involvement and commitment. The
independence and skills have to be evaluated by the audit com-
mittee, whereas, while their appointment is considered, the quality
of involvement and commitment is ensured by providing effec-
tive oversight. Oftentimes, it is observed that the appointment
of statutory auditors, in particular, is decided on the basis of the
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size of the firm—number of people working in that organization

and the length of its existence. Actually, in most companies, one
of the big fours are preferred. Although one cannot quarrel with
the underpinning that a large and well-known firm is better, in
particular, because of the deep knowledge base, it has necessarily to
be ensured that the auditors are independent and, without caring
for their revenue and/or the engagement, they would forthrightly
put across their points of view without fear or fervour. All the
major Corporate Governance failures around the globe have cre-
ated an impression that all the big firms have compromised their
independence and integrity one time or the other. Hence, the work
of the audit committee would be to do a bit of due diligence on the
partner who will engage his value system and also the team that he
would put in place to do the detail work. Unless care is taken by
the audit committee and board during the course of appointment,
the effectiveness of this mechanism cannot be guaranteed.
While doing the assessment about the independence, one must
get a fair idea of the skills of the partner of the audit firm who
would be responsible for the audit of the company. It might be use-
ful to find out how many audits this partner is handling, because
that would determine how much of time he can spare for this audit.
It is well appreciated that it is not the number of hours devoted to
the audit that determines the use of his skills, but his own involve-
ment with the engagement that decides the quality of the audit.
Having got the set of auditors, it is important to evaluate
periodically the kind and quality of manpower that is allocated
by the audit firm and also the time they are spending in doing
the work. Most firms are happy to rely on the work done by the
internal auditors and/or the submissions made by the manage-
ment and do not go deep into most of the matters. Some kind of
vigilance is necessary. A question may arise in some minds: Is the
audit committee going to be a day-to-day supervisor of auditors?
Certainly not. However, it is the duty and responsibility of the
audit committee to ensure the allocation of resources by the audit
firm, the quality of their work and commitment. In fact, if some-
one goes deeper into the cases of corporate misgovernance, one
can easily decipher that thoroughness was missing in the work of

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the auditors and the depth of supervision by the audit committee

on the work of auditors was conspicuously absent.
Auditors sit just above the base of the pyramid and are
expected to provide independent assurance about the quality of
accounts, observance of the accounting and financial reporting
standards, disclosures and the manner in which the RPTs are
undertaken—in effect, the efficacy of the work done by the man-
agement team in maintaining and managing the financials of the
company—and they are qualified to do it. In case this layer of the
pyramid is weak or has holes, crumbling of the entire pyramid of
monitoring is inevitable.

15.3. Board Committees

Since the oversight and control of the enterprise is a big enough

job and cannot be organized efficaciously in just the board
meetings, it has been envisaged by the regulatory bodies that
the board must constitute subcommittees consisting of direc-
tors and also, if thought fit and appropriate, experts from the
related fields. Accordingly, most boards constitute a number of
committees. The following committees are statutorily required
to be constituted:

1. Audit committee
2. Shareholders/stakeholders committee
3. Remuneration and nomination committee

However, in many companies, several other committees also

function like the following:

1. Risk management committee (taking away the function

from the audit committee)
2. Strategy committee
3. Finance committee
4. Customer relations’ committee
5. Board governance and ethics committee and so on

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To derive the optimal value out of this layer of the monitoring

pyramid, it is essential that these committees function effectively.
To facilitate, it is essential that each of the committee has its char-
ter. A model charter for all the statutory committees namely the
audit, shareholder and nomination and remuneration committee
as also risk management committee is given in Annexure 5.
Although it might be useful to discuss the role of each of these
committees separately, it will make the narration very lengthy.
Hence, some broad principles on which these committees must
be constituted and function have been suggested as follows:

1. The constitution of the committee is done by matching

the skill needs of the committee and the availability of
those skills in the board. In many boards, such an exer-
cise is not undertaken. This is missed out, and the direc-
tors with less-than-deeper understanding of the financials
are appointed on the audit committee. Outside talent
must be drawn if felt necessary.
2. Every committee must have a potent charter which serves
at the base for the functioning of the committee.
3. Holding meetings of these committees should be regular
and not a formality. Meetings of these committees should
be de-linked at least with the day of the board meeting.
Meetings should be held either on different dates or at
least a day prior to the board meeting. Along with the
date, the circulation of the notice, agenda, notes and so
on must be taken care of.
4. The chairman of each committee must own the respon-
sibility of ensuring that the substantive issues are dis-
cussed and the directors apply their mind on each of the
items. This can happen only if the agenda is circulated in
advance and full data/information is provided in the notes.
5. The minutes of the committee meeting are well drafted
and provide specific recommendations and/or approvals.
6. The committees must take the responsibility of providing
effective oversight to the work of the agencies—internal or
external—who undertake the task related to the areas of
interest to the committee, for example, in the case of the
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audit committee, it should provide effective supervision

to the work of auditors, or the RMCs to provide effective
monitoring of executive-level subcommittees.
7. Much would, however, depend on the way the work
of the committees is perceived and undertaken by its
members including the chairman. It must be noted here
that the board’s subcommittees are supposed to help the
board by going into the depth of all the matters that are
brought before it, cull out the important points/issues
and seek answers from the management and/or the agen-
cies assisting the committees and formulate a view which
is proffered to the board, for example, in the case of nom-
ination and remuneration committee, it must undertake
the exercise in depth of nomination or recommendation
of the remuneration of the executive directors and so on
and make a specific recommendation considering all the
aspects of the issue. Just dittoing the views/recommenda-
tions of the management does not serve the purpose for
which these committees are sought to be constituted. It
must be remembered that like the auditors, board com-
mittees are a step above the layer of the monitoring pyra-
mid to ensure excellence in Corporate Governance. This
has to be accepted and acted upon by the committee.
8. Review of the work of the committees by the board
must be an annual exercise, wherein the chairmen of
the respective committees makes a presentation on the
work done during the year, which is debated and light is
thrown on the way forward.

15.4. Board

The BoD has the ultimate responsibility of the functioning of the

organization, its conformance with various rules, regulations,
guidance, advice and laws and also of creating value. The board
has the powers of the shareholders to manage the enterprise. In the
case of Corporate Governance, therefore, the board has become the
ultimate owner of the responsibility of creating excellence. Since it
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is a pyramidical structure, it sits above the various layers described

earlier in this book. All the layers are supposed to support and
help the board in the discharge of its accountability frame. It is,
therefore, important that the board understands its role and places
a great value on the role played by other layers of the pyramid.
Non-compliance with any direction/regulatory diktat is a
value destroyer. Creating excellence in Corporate Governance
is value enhancing. This can be delivered by the board only if
(a) it does not replicate the role played by the management and/
or other layers of the monitoring pyramid and (b) it plays the role
of superintending and direction efficaciously to ensure that the
layer-over-layer strength increases. This can be organized only if
the board is able to decipher where the weaknesses exist and/or
growing and has the will to effectively deal with them by taking
decisions and issuing directions. It has been discussed somewhere
else in the book, what and how the board will play its role in the
discharge of its responsibilities, but it cannot let go this responsi-
bility of monitoring excellence in Corporate Governance either by
delegating to the other layers of the pyramid or by allowing it to
go by default. It has to assume full responsibility and, therefore,
has to discuss and deliberate on the issues of building excellence
in Corporate Governance in every aspect.

15.6. Regulators

Regulators, as a part of monitoring, sit outside the pyramid and

play a different kind of role—a watch dog. Before I discuss the role
that the regulators play, it might be useful to segregate them into
two parts: public sector regulators and private sector regulators. It
is the responsibility of the public sector regulators to ensure that
the letters of law in the matter of Corporate Governance are fol-
lowed scrupulously at all times and any delinquency is taken note
of and dealt with effectively and expeditiously. Surveillance and
enforcement, thus, become important functions of the regulator.
In economic terms, both these functions in the regulator’s office
on a company are value destroyer of the enterprise. Surveillance
would command the allocation of additional resources to deal
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with the regulatory over tones which, in effect, becomes the cost
centre, and the enforcement of any direction, whether penal or
otherwise, impacts the image and goodwill of the enterprise and,
thus, is a value destroyer.
Excellence in Corporate Governance, therefore, comman-
deers that no occasion is provided to the statutory regulators to
do either more than normal surveillance or enforcement in the
matter of Corporate Governance.
The private sector regulators include SROs and the market,
in general. The SROs bring about peer effect and the market does
the valuation of the quality of Corporate Governance and adds/
subtracts the enterprise’s value depending on how it perceives.
Peer affect would mean not only the compliance of additional
regulatory direction issued by the SROs, but also the ground-level
understanding of what the company does and the action thereon.
This becomes a value destroyer and hence has to be avoided
by making sure that the company complies with all the regula-
tions and directions issued by the SRO as well and also the peer
effect—comparison and perception—comes to play favourably.
The market has its own understanding of the quality of
Corporate Governance. Several researches that have been quoted
somewhere else in the book do provide a peep into the eco-
nomic value—positive or negative—of the quality of Corporate
Governance. The company, therefore, not only has to archi-
tect and work its way through in bringing about excellence in
Corporate Governance, but also has to build a perception around
that. A good perception will enhance the enterprise’s value, and
a not-so-good one will reduce the valuation. In fact, it might
be helpful for the public sector regulator as also private sector
regulator to watch the behaviour of the other to assess the quality
of Corporate Governance. This becomes, additionally, a com-
munication issue. Hence, a strategy has to be drawn up by the
company to effectively disseminate the good work done by the
company, particularly in the matter of Corporate Governance.
In substance, the regulators do the monitoring of the Corporate
Governance and they either destroy or enhance the value. It would,
therefore, be wise to consider them as a part of the monitoring
pyramid and use their presence only as a value enhancer.
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 16
Evaluation of Quality of
Corporate Governance

T
he regulatory frameworks compel the management of a JSC
to conform to the directions laid down. However, the obser-
vance of directions is of two kinds: (a) form of compliance
and (b) substance of compliance.

1. Form of compliance: It means that the enterprise follows

the rules and regulations in letter. For such enterprises,
each rule is like a box and the moment it is followed
in letter, the box is ticked. Whenever the verification
is undertaken by one of the levels of the pyramids of
monitoring governance, it is shown to have been complied
with. Unfortunately, in such enterprises, even the manda-
tory level of statutory audit does not go into the spirit of
compliance but looks at whether the letters of law have
been followed. Furthermore, the enthusiasm of both the
managers of the enterprise and the monitoring pyramid of
Corporate Governance compliance is limited to the form
of it. They have neither the patience nor the inclination to
go beyond. The results of such compliance are that they
cannot be found wanting as far as the law is concerned.

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 Evaluation of Quality of Corporate Governance 207

However, the benefit of good Corporate Governance does

not flow adequately to the stakeholders via optimal wealth
creation, maximizing wealth management and sagacious
wealth sharing. If one goes in the depth of most of the
Corporate Governance failures around the world, it would
be apparent that the failures took place notwithstanding
the conformance with the letters of law. In such cases,
Corporate Governance compliance remains a tyranny.
2. Substance of compliance: It goes beyond the letters of law
and conforms to the regulatory obligations and also vol-
untary compliance in letter and spirit. For example, when
disclosure is required, such enterprises do not give out
only some information but truly disclose full information,
which can eventually help those for whom this disclosure
is meant to appreciate the transactions and analyse the
information to make a sense out of it. Such enterprises
take every item of the required compliance very seriously
and understand the purpose of it and evaluate whether
it really means to achieve what is expected out of it.
Wherever the compliance of regulatory requirement,
both compulsory and voluntary, is done in spirit, wealth
creation is higher, wealth management is superior and
wealth sharing is appreciated. ‘Mahindra is nothing with-
out substance of Corporate Governance’, asserts Anand
Mahindra, Chairman, Mahindra group. ‘Market always
rewards good Corporate Governance’, pronounces Adi
Godrej, Chairman, Godrej group.

However, the evaluation of Corporate Governance can be done

through several methods. In fact, some of the organizations are
trying to use most of those methods. These methods could be, for
example, (a) Corporate Governance rating, (b) economic value
addition (EVA), (c) market value addition (MVA) and (d) market
appreciation. It is important to mention here that the market is
able to appreciate the quality of Corporate Governance and factor
it in the pricing.

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Market appreciation is assessed by the amount of Enterprise

Value reflected by the price of its equity shares. For example:

Particulars
Total Number of Equity Shares 1,00,000
Market Price of Share 120
Face Value of Share 100
Enterprise Value 1,20,00,000

The quality of Corporate Governance does affect the market

price of the shares, which has been exemplified by the researches
quoted in Chapter 17. When the market price of shares goes up,
the enterprise value goes up, and if the market price of share goes
down, enterprise value goes down. Other factors like profitability
and outlook about the industry and company by and large remain
the same, the rise and fall in enterprise value as a consequence of
rise and fall of share price is represented by quality of Corporate
Governance.
It would be worthwhile to discuss each of these methods
for the evaluation of the quality of Corporate Governance a little
more in detail.

16.1. Rating of Corporate Governance

Some of the credit rating agencies have developed methodolo-

gies and tools for evaluating the quality of Corporate Governance
and have started assigning rating. In India, the Credit Rating
Information Services of India Limited (CRISIL), now wholly
owned by Standard and Poor’s (S&P), and Investment Information
and Credit Rating Agency of India Limited (ICRA), a subsidiary
of Moody, have developed such rating. In fact, the Unit Trust of
India (UTI), now UTI Asset Management Company Limited (UTI
AMC) had a rating frame for a long time. The Institute of Company
Secretaries of India (ICSI) has also developed a rating frame. These
frameworks are broadly discussed in the next few sections.

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 Evaluation of Quality of Corporate Governance 209

16.1.1. CRISIL Governance and Value Creation

(GVC) Rating

16.1.1.1. Introduction

Corporate Governance has been defined as ‘the way in which

a company manages itself in order to ensure fair and equitable
returns to all stakeholders and other financial stakeholders’ and
extends to include ‘the rules and incentives by which share-
holders control and influence a company’s management so as
to maximise profits and value of the corporation’. The process
of adjudging the rating is built on the following four pillars:
(a) ownership structure and influence, (b) financial stakeholders’
relations, (c) financial transparency and information disclosure
and (d) board and management structure and processes.
CRISIL GVC rating provides an independent assessment
of an entity’s performance and future expectation on ‘balanced
value creation through sound Corporate Governance practices’.
This appropriately balances the quantitative value creation
measures with qualitative evaluation and provides a view on the
entity’s expected performance in future and addresses all stake-
holders more equitably. The CRISIL GVC rating evaluates how
a firm is performing on its raison d’être or the primary purpose
of existence that is creating value for its owners and various
shareholders. This rating is based on the criteria from which the
present condition and future progress can be assessed, meas-
ured and analysed. CRISIL believes that such a measure seeks to
ensure that two equally well-governed companies will not, prima
facie, receive identical ratings if one is a significant value creator,
while the other is destroying the value.
CRISIL evaluates two broad aspects to arrive at GVC ratings
for companies. These comprise the following:

1. Value creation and distribution: In this category, CRISIL

looks at the company’s track record in creating and dis-
tributing value amongst the various stakeholders in the

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system. The criteria are so constructed that the interests

of various stakeholders are evaluated in a balanced man-
ner by appropriately assigning weights to individual
stakeholders.

The stakeholders’ considered and indicative list of the param-

eters, used to evaluate respective value creation and distribution,
are as follows:

• Shareholders: The measures used include return on

invested capital compared to the weighted average
cost of capital (WACC), dividend payout ratio and
the like.
• Debt holders: CRISIL looks at relative debt protec-
tion measures. These will include credit rating and
upgrades in ratings, among others.
• Customers: The parameters include market share,
assessment of customer satisfaction and cost savings
passed on to customers.
• Employees: The parameters considered include abso-
lute salary levels, adjusted growth in average annual
salaries, employee stock option, attrition rates and
intangible factors.
• Suppliers: The factors considered include the rela-
tive change in credit terms, passing on of increased
realization and support to suppliers, among others.
• Society: Here, the measures include total direct taxes
paid, employment generated expense on social infra-
structure, environmental and social impact cost and
fair practices.
2. Corporate Governance and wealth management: Under
this category, CRISIL looks at the company’s capabilities
and processes to ensure good governance, the checks and
balances that it has instituted to prevent abuse of power,
transparency of reporting and the capabilities and robust-
ness of the company’s management.

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 Evaluation of Quality of Corporate Governance 211

The broad factors which CRISIL uses to analyse the perfor-

mance on this category are:

• Assessment of management capabilities, including

success of strategies, ability to re-strategize, track record
of innovation and experience of management
• Financial transparency and disclosure, including inde-
pendence and standing of the auditors, disclosure stand-
ards, timing of disclosures and the like
• Influence of majority or large stakeholders, includ-
ing decision-making processes, evaluation of sources of
receivables and destination of payables and affiliate or
group company transactions
• Board composition and effectiveness, including the
criteria for selecting board members, board meeting pro-
cesses, information availability and timeliness, role and
effectiveness of independent directors, board evaluation,
compensation and succession policies

The evaluation process comprises analysing both information

that is confidential and in the public domain, as well as having
intensive interactions with the management personnel, board
members, especially external directors and representative of key
stakeholders. CRISIL GVC rating is assigned on a scale of eight
levels and is valid for a period of one year from the date of assign-
ment of the first rating. Thereafter, the ratings are reviewed
annually, or more frequently if the circumstances so warrant.

16.1.2. ICRA

ICRA’s stakeholders’ value and governance (SVG) rating indicates

the relative level to which an organization creates and manages
value for its stakeholders, along with an opinion on the quality of
its Corporate Governance practices. The emphasis of SVG ratings
is on value creation and value management for all the stakehold-
ers of a company, including its Corporate Governance practices.

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16.1.2.1. Ratings Variables

The key variables that are analysed while arriving at the SVG rat-
ing for a corporate entity are as follows:

1. Wealth creation and management

2. Financial discipline
3. Transparency and disclosures standards
4. Relationship with stakeholders, including shareholders,
creditors, employees, customers and society
5. Shareholding structure
6. Board structure and processes
7. Governance structure and management processes

Each of these variables are evaluated on a set of parameters, and

a composite assessment using a proprietary model developed by
ICRA is made for the overall rating. The thrust of ICRA’s analysis
is on the following.

Wealth Creation and Management

ICRA believes that an accurate measure of value added by a com-
pany should not only consider the wealth created in the past, but
also take into account the monetary and non-monetary invest-
ments made by it for future growth and profitability. Thus, the
SVG assessment takes into account both the wealth created by the
company in the past and the investments made by it that would
influence future wealth creation.
Some of the parameters which ICRA evaluates while making
the assessment of wealth creation and management are as follows:

1. Shareholders
• Return on net worth in relation to cost of equity
• Return on capital employed (ROCE) in relation to
WACC
• Risk adjusted market returns based on stock price
adjusted for dividend and equity dilutions
• Dividend policy

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 Evaluation of Quality of Corporate Governance 213

2. Debts holders
• Level of credit rating and trends thereof, if available
• Financial indicators for debt service and financial risk

Financial Discipline
The ultimate objective of Corporate Governance is to create and
maximize shareholders’ value while balancing and protecting
other stakeholders’ value.

1. Business segments in which the country operates

2. Rationale for presence in multiple businesses
3. ROCE in each business in comparison with peers in simi-
lar industries
4. History of equity dilution
5. Extent of reliance on debt funding
6. Dividend policy
7. Number of subsidiaries/associates and rationale for the same
8. Nature of transactions with subsidies

Transparency of Disclosures Standards

The key parameters that ICRA examines to assess a company’s
transparency and disclosure standards include the following:

1. Accounting quality, including compliance with accepted

accounting standards
2. Changes in accounting policies
3. Notes to accounts of a materially significant nature
4. Quality and level of detail in accounts, especially with
respect to items such as loans and advances, inter-corporate
advances and contingent liabilities
5. Disclosures on transactions with subsidiaries and associates
6. Additional information to shareholders
7. Quality of disclosures in management’s discussion and
analysis (MDA)

While assessing the MDA, ICRA evaluates the extent to which

meaningful insights are available on the business segments in

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which a company operates, its growth prospects and the associ-

ated risk factors since such insights could help an investor take
an informed decision on the company’s business prospects.
The trends in share price movements around major corporate
announcements are also taken note of to evaluate whether price-
sensitive information is disseminated in a timely manner to all
stakeholders.

Shareholders Relations
ICRA’s SVG ratings take into account the value added to the stake-
holders of a company, namely shareholders, employees, creditors,
suppliers, customers and society at large, while maintaining the
primacy of shareholder value creation in the evaluation process.

Shareholding Structure
ICRA analyses an organization’s shareholding structure to under-
stand its ownership pattern, identify the dominant shareholder(s),
evaluate the extent of cross-holdings and identify the extent of
shares held by its promoters/promoter groups. A transparent
ownership structure where the key shareholders are easily iden-
tifiable and the absence of opaque cross-holdings are considered
positives from the SVG rating’s perspective.

Board’s Structure and Processes

An organization’s BoD is expected to lend leadership and strategic
guidance to it, ensuring that the legal and statutory requirements
are complied with and balance the rights and concerns of the
shareholders and other stakeholders.
ICRA analyses the broad’s structure and processes of the com-
pany being rated with reference to various parameters, including
the following:

1. Size of the board

2. Selection criteria for directors
3. Proportion of independent directors
4. Professional standing of independent directors
5. Other directorships held by the independent director(s)
6. Retirement/compensation policy
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 Evaluation of Quality of Corporate Governance 215

7. Frequency of board meetings

8. Time gap between any two meetings
9. ATR since the last board meeting
10. Composition of the board committees
11. Attendance record of directors

The emphasis, however, is on the substance over form; the ICRA

essentially attempts to evaluate the effectiveness of the board by
examining issues such as timeliness in the circulation of agenda
papers, quality of information contained in the agenda papers
and comprehensiveness of the minutes of board meetings. Some
key issues that are studied include deliberations related to major
investments, capital expenditure, performance (vis-à-vis), RPTs,
compliance with statutory requirements and possible product
liability matters.

Governance Structure and Management Processes

The key focus of ICRA’s analyses, here, is on the internal decision-
making process followed in the company being rated and the
quality and nature of information that is presented to the
company’s BoD.
ICRA also believes that the monitoring function of a company’s
BoD is critically dependent on the quality of information that is
supplied to it and on the procedures established to ensure that
feedback is provided to the board on all items where queries, if any,
have been raised. It, therefore, evaluates the quality of information
submitted to the board, especially in respect of major corporate
decisions such as mergers and acquisitions, diversifications, large
capital expenditure, inter-corporate loans and other RPTs.

Rating Approach
As is evident from the discussions on various ratings, ICRA’s SVG
ratings involve the assessment of both quantitative and qualita-
tive parameters. While evaluating quantitative parameters, ICRA
makes suitable adjustments for differences in accounting policies.
The emphasis is on relative (in relation to the suitably defined
peer group) rather than stand-alone performance, and sustainable
rather than sporadic performance.
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 216 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

16.1.3. Unit Trust of India

The UTI’s methodology used long ago was also numeric. The
scores accorded are as follows:

Quantitative Criteria and their Weights

(Figures in parentheses are scores assigned to that item)
1. Governance Structure: 30 per cent
1A. Composition of the board (15 per cent)
1B. Committees of the board (15 per cent)
2. Disclosure in the annual report 20 per cent
2A. Statutory disclosure (10 per cent)
2B. Non-statutory disclosure (10 per cent)
3. Timelines and content of information
to the investors and public 20 per cent
3A. Compliance with listing agreement (6.67 per cent)
3B. Contents on websites (6.67 per cent)
3C. Grievance resolution ratio (6.67 per cent)
4. Enhancement of shareholder value 30 per cent
4A. Share prices (7.5 per cent)
4B. Return on net worth (15 per cent)
4C. Book value (7.5 per cent)
Total 100 per cent

16.1.4. Institute of Company Secretaries of India

The ICSI rating covers the following areas: (a) board management
and structure inclusive of board committees and procedures, (b)
transparency and disclosures, which has elements such as direc-
tor remuneration, directors background, shareholding patterns in
addition to usual statutory and non-statutory disclosures relating
to financials and so on and (c) investors relations and financial
performance—shareholders’ value enhancement, which is evalu-
ated through (i) dividend payment, (ii) dividend growth consist-
ency and (iii) return on net worth. The method used is numerical
and includes the interviews of the management and directors of
assessing subjective areas.
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 Evaluation of Quality of Corporate Governance 217

I have stated in Chapter 4 that the fundamental purpose of the

formation of a JSC, investors sharing the vision of the entrepreneur
by investing their surplus resources, HR joining the organization
and the society facilitating its incorporation and continuance is
wealth creation, wealth management and wealth sharing.

16.1.4.1. Wealth Creation and Wealth Management

and its Appraisal

Simply put, wealth creation is the excess of the value of the out-
put over the value of the input.

Example of Value Creation

Value of all inputs (physical, financial and human
resources) = 100
Value of all outputs (products and services, rights
and so on) = 150
Wealth (value) created Ro = 50

Since the stakeholders–shareholders, debt providers, HR, suppliers

of services as also society have other options to invest their resources,
it is important to validate the level of wealth creation in the process
of husbanding of resources by the firm—Corporate Governance.
The significance of wealth creation has grown over the years since
the invention of the institution of JSC, as a small active minority
controls and manages the investments/resources and interests of a
large majority of passive stakeholders who have multiple options to
deploy resources or choose the management of enterprise.
The board has the authority of the shareholders to manage
the enterprise. Hence, it must state/chart out the objective of
maximizing stakeholder value via wealth creation at the com-
mencement business, and every year thereafter. Maximizing
stakeholder’s value is not an elusive thought. It is a concrete
preposition. It can be translated into arithmetic, and the evalu-
ation is possible. It is a noble and pragmatic objective and, if
communicated well, will encourage, enthuse and envelop the
managers at all levels to efficaciously execute the strategies and

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 218 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

take organizational decisions in the pursuit of that objective of

optimal wealth creation. Of course, optimal wealth creation, inter
alia, commandeers far-sighted imagination, ardent skills and
sharp focus, coupled with devotional determination.
Since the potential for wealth creation, albeit value creation
is enormous, it is the grit, imagination and ambition of the board
and the top management that will determine the level of the
objective. However, the journey has to begin from a reference
point which could be enterprise value as reflected by the market
forces on the date of reckoning. In the case of a listed company
in a matured market, the market valuation of the enterprise is
the easiest way to find a reference point. The market valuation,
however, may be lower than the enterprise value that the board/
management considers appropriate. Let us call enterprise value,
as assessed by the board/management, ‘eligible value’, which can
be calculated by using various methods. These methods of calcu-
lating the enterprise value have been described by various authors
in various ways. The most commonly used is ‘building relation-
ship between cash flow and shareholder value’. In case the debt
market is developed, ‘determination of the value of the corporate
bonds’ can also be used. Yet another way is to evaluate the ‘value
of the common stock’. However, while calculating the enterprise
value through either of these methods, it is important to add the
value of the brands that the company owns as also the value of
the goodwill. Sometimes, these values are on the balance sheet,
but in most cases, are off balance sheet. Actually, often, these are
not even calculated. The gap between the eligible value of the
enterprise and the market value (MV) of the enterprise mentioned
earlier should be the first starting point for the board to set the
objective. Bridging the gap between two values (eligible value and
MV) should begin with the investigation of the possible factors
including the perception about the Corporate Governance caus-
ing the gap. Most of the time, the gap is explained by the quality
of Corporate Governance as also perception thereof in the market.
Growth in the eligible value coupled with its conversion in
the MV in a year can be considered as the wealth creation. The
level of such wealth creation should be compared with the

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 Evaluation of Quality of Corporate Governance 219

comparables—firms in the market place—creating wealth. Direct

and even vicarious impact of the favourable environmental factors
must be considered while crediting the management and board
for the level of success achieved in wealth creation. While encash-
ing the environment to enhance wealth creation is a job well
done, beating adverse environmental factors without negatively
impacting wealth creation is excellence.

16.2. EVA Method

The most often used determinant of the value created during the
financial year is the EVA. It was hailed by Fortune magazine back
in 1993 as the foremost method of assessing the wealth creation.
Many firms across the world are assessing the EVA periodically.
The evolution of EVA has a bit of history. It seeks its origin in the
work of two professors of finance in their seminal work, ‘Dividend,
Policy, Growth and Valuation of Shares’, published sometime in
1961. Their concept of free cash flow and the evaluation of busi-
ness on cash basis was developed into a kind of measurement in
the shape of EVA by Mr Joel Stern and Mr John Shiely, and was
outlined in their book, The EVA Challenge, as follows:

‘EVA = Net Operating Profit after Tax (NOPAT) –

[Capital × Cost of Capital]’

As explained in the book,

EVA is the net operating profit minus an appropriate charge for the
opportunity cost of all capital invested in an enterprise. As such, EVA
is an estimate of true ‘economic’ profit, or the amount by which earn-
ings exceed or fall short of the required minimum rate of return that
shareholder and lenders could get by investing in other securities of
comparable risk.1

1
http://books.mec.biz/tmp/books/ORBGSC4H3GLOK4IHHISQ.pdf (accessed
on 30 May 2016).

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 220 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

EVA is now considered as the most successful performance met-

ric, from the commercial point of view, worldwide. This metric is
very well justified by financial theory.
For calculating EVA, the following three components have to
be unravelled first:

NOPAT: Net operating profit after tax

Capital: Capital employed in the business
Cost of Capital: Weighted average cost of capital

NOPAT, in the book referred to earlier, is calculated by add-

ing depreciation—straight line method—and expenses such as
research and development (R&D), advertising and promotion,
staff training and development and deferred revenue expenses
written off. Income tax provision and interest and financial
charge are also added. Thereafter, sinking fund depreciation,
R&D expenses recurring, advertising and promotion expenses,
staff training and development expenses and income tax provi-
sion and deduct payment basis are added. Under the EVA model,
depreciation is calculated using sinking fund or annuity method,
as it considers that the business, besides losing the original cost
of the assets, also loses interest on the amount used for buying
the asset, which the enterprise could have earned in case the same
was channelized in some other form of investment.
Capital employed in calculated as the book value of average
long-term fund employed in the business during the financial
year. Cost of equity can be calculated by using either of the fol-
lowing three methods: (a) dividend yield method, (b) dividend
growth model and (c) capital asset pricing (CAP) model. Under
CAP, the cost of equity (Ke) is calculated as follows:

Ke = Rf + b (Rm – Rf )

where Rf is the risk-free rate of return, b is the market risk of the

security and Rm – Rf is the risk premium of the asset over risk-
free return.

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 Evaluation of Quality of Corporate Governance 221

Example of Calculation of EVA

Particulars 2014–2015 2013–2014
Cost of Capital
Cost of Equity (per cent) 20.89 23.53
Cost of Preference Capital (per cent) 10.00 10.00
Cost of Debt – Net of Tax (per cent) 6.56 6.13
WACC (per cent) 13.86 13.69
Average Capital Employed 9,746.25 8,131.06
EVA
NOPAT 2,462.40 1,936.98
Less: Cost of Capital 1,350.83 1,113.14
EVA 1,111.57 823.84
EVA/Capital Employed (per cent) 11.41 10.13

For the detailed process of the calculation of NOPAT, capital

employed and the WACC, the book The EVA Challenge by Joel
Stern and John Sheily may be referred to.

MVA = V – K

where V = MV of the company including the value of firms equity

and debt.
K = capital invested in the firm.

16.3. MVA Method

MVA, a much simpler concept, is represented by the difference

between the total value of the firm, also called the enterprise
value, and the capital (both equity and debt) employed. This in
effect would mean ROCE has to earn a rate higher than the cost of
capital. For this purpose, cost of equity capital, which varies from
market to market as is the case with cost of debt, has to be cal-
culated and added to the sum of interest obligations on the debt.

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 222 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

MV is actually the present value that the market offers and is also
called the enterprise value. The idea is to identify a reference point.

Calculation of MV
Particulars 2014–2015 2013–2014
MV of equity 5,768.85 4,065.67
10 per cent cumulative redeemable
306.93 306.93
preference shares
Loan funds 4,590.33 4,505.66
Total MV 10,666.11 8,878.26

MVA Control Sheet

Particulars 2014–2015 2013–2014
MV 10,666.11 8,878.26
Less: capital invested 10,529.43 8,963.05
MVA 136.68 (84.79)

Having identified both the relevant reference point and the

objective along with the method of calculation of wealth crea-
tion and management, let us very briefly discuss how this can be
achieved. The journey of wealth creation and wealth management
in a company begins with the quality of management, which is
reflected by three Ps: principles, people and processes.
The principles are often articulated as the values and culture
in an organization. Wealth maximization should be one of the
most important values among those. Wih resources being limited
with possible alternative uses, the optimization of value creation
becomes a high ground of service for the society.
Next are the people in the organization right from the BoD to
the last person on the shop floor who practices the principles of
the enterprise. Integrity, commitment and accountability to creat-
ing wealth must be ingrained in them. The habit of choosing and
implementing the best option for the deployment of resources must
be inculcated, which should extend to even organizational design.
People must be educated to link strategy with financial performance.
Every organization operates through an array of systems and
processes. These systems and processes, inter alia, must work as a
230
 Evaluation of Quality of Corporate Governance 223

check on the application of principles by the people in the organi-

zation. These processes will include decision-making, resources’
allocation, architecting performance targets and linking compen-
sation, especially of the top management, with wealth creation. It
is understood that all decisions cannot be right but if the process
is robust and related with wealth creation, wrong decisions will
turn out to be an investment in learning, eventually helping in
building counter pressures and improving the quality of decision-
making. The process must include financial forecasting, which is
missing in most enterprises. And, forecasting must include the
derivation of economic profit. This will involve superior financial
information and controls.
Having decided the basics of the enterprise, the journey must
move forward into creating a framework, and our recommenda-
tion is to use a four-pillars frame as shown in Figure 16.1.
In the management of wealth creation appears an accountabil-
ity frame to various stakeholders, which is reflected in Figure 16.2.

Figure 16.1 Management of Wealth Creation

MANAGEMENT OF WEALTH CREATION

Policy Strategy Value

Operational
Frame Frame Delivery
Frame

Visioning Direction Performance Accountability

• Ambition • Market Monitoring • Shareholders
• Values Positioning • Financial Control • Work Force
• Culture • Input • Resources Utilization • Customers
• Environment Mobilization • Competency • Suppliers
Management • Execution Management • Society
Processes • Capability • Compliance
OUT-PUT EVALUATION
VIS -A-VIS
STRATEGY FRAME

The real voyage of discovery consists not in seeking new landscape but in having
new eyes: Marcel Proust

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 224 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

Figure 16.2 Accountability Frame

1. VALUE DELIVERY
• Shareholders
• Work Force/HR
• Customers
• Suppliers
• Society
2. COMPLIANCE

WEALTH WEALTH WEALTH

CREATION MANAGEMENT SHARING

STAKEHOLDER VALUE

I have mentioned in Chapter 8 that the board should focus its

attention more on the policy and strategy frame. It is the board’s
responsibility to outline the vision. However, designing of vision
must be a collaborative exercise. The views and opinions of all
the HRs, in particular, the senior management, should be sought
and considered. Lest it would be bereft of collective wisdom and
ground-level realities and will not assimilate enough commitment
for the eventual fructification of the vision.
Vision includes the long-term ambition of the enterprise:
Where it wants to be from where it is today. This is also described
as the dream to be realized over a frame of time. This ambition is
to be supported by a mission statement and values and cultures.
The environment management is an integral part of the vision
because every enterprise functions under the overall canopy of
both macro- and micro-environment. It is very difficult for an
enterprise to change the environment, and, therefore, it has to live
with it, although it is possible to introduce element(s) which can
change the course over a period of time. Hence, the board has to
outline the methodology of managing the environment as well.
The policy frame has to be revisited periodically, at least once in a
year, because the environment undergoes unremitting transforma-
tion. The rapidity and profundity of changes is often confounding.
232
 Evaluation of Quality of Corporate Governance 225

Therefore, the validity or the relevance of components of policy

frame has to be tested periodically on the platform of sagacity.
Next is the strategy frame. In very brief, strategy can be
described as market choices, product choices and the pricing
options. Slightly broadening this definition will include market
positioning, input mobilization and execution processes and, in
effect, value drivers. It is the board which will have to take a call
in which markets the enterprise will operate, what kind of prod-
uct it will market and how will its pricing policy play. The market
can be considered attractive only if it has the potential to deliver
economic profit to an average competitor. Similarly, product and
pricing options must be chosen with the perceptions of propensi-
ties of reaping economic profit in a predetermined frame. It is the
board that will determine whether it will be playing a larger game
of market share or picking up the niche with high propensities
of profitability or a combination of both. It is the board which
will have to direct the management whether it has to play volume
or the margin game or a combination of both. Since it is not the
theme of this book to dwell on the strategy, I would not like to
go in greater detail. It is suffice to say that the objective of wealth
creation will be determined by the vision, and its fructification
will travel on the vehicle of the strategy.
Policy and strategy frame, therefore, become a kind of direc-
tion that the board would provide to the management team. The
job of the management will be to implement and to come back
with the issues in the implementation and on the possibility of
achieving the expected outcome.
The third frame is the operational frame. As mentioned ear-
lier, the management is expected to implement the vision and
the strategy as specified by the board and deliver the expected
outcome of the value enhancement. However, the board has the
ultimate responsibility of the output and, therefore, will have to do
the performance monitoring. It must be made clear here that while
doing the performance monitoring, the board should not indulge
in replicating what the management is expected to do. Hence, its
role should be that of superintending rather than getting deeper
into doing or reviewing what the top management of the company
does or is expected to do. The areas where the performance has
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 226 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

to be monitored closely by the board can be broadly classified

into four parts: (a) financial controls, (b) resources’ utilization, (c)
competency management and (d) capability enhancement. The
entire gamut of performance monitoring should be the evaluation
of the output vis-à-vis the strategy frame. The board must be able
to decipher how the internal value drivers are playing and where
the value is being created and where it is destroyed. This analysis
has to be done for each business unit/department/function. This,
in fact, means to check whether the outcomes as expected, while
designing and approving the strategies, are actually being delivered.
In case this is not happening, it has to assess ‘why of it’. In case it
is being exceeded also, it has to be understood what elements have
delivered better so that those could be strengthened and replicated/
utilized subsequently elsewhere.
Finally, the board’s attention must converge on value delivery
frame. It has been mentioned elsewhere in the book that the com-
pliance can be both, a value enhancer—when done well—and
a value destroyer—when not done well. Hence, it is singularly
important for the board to ensure compliance in letter and spirit.
This becomes significant particularly for the manufacturing com-
panies, such as companies manufacturing food, drugs and medi-
cines, chemicals and so on. Any deviation can ruin the enterprise
and expose even the directors to penal actions.
The board has to decide, approve and communicate to the
management at the beginning of every year, the objective of value
creation that is expected of the management to deliver. In most
companies, budgets are approved a month or two in advance of
the commencement of the financial year. However, the budgets
do not detail, albeit even mention, about the target of value crea-
tion during the year. It has also to be specified from where the
value will emerge and how will it be measured. Our recommen-
dation would be to detail out how the resources’ utilization will
be undertaken in value maximizing rather than just deploying
them as per the demands of the various layers of the manage-
ment. It is possible that the management would propose and the
board would accept that a certain portion of the resources will be
allocated for building the sustainability of the value drivers and
that the impact thereof may not be felt in one year or even two.
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 Evaluation of Quality of Corporate Governance 227

However, such allocations must be approved and done along with

the signals/portends that would demonstrate that the value crea-
tion is taking shape, albeit in medium to long term.
Once the objective of value creation is approved by the board
and accepted by the management, it has to be evaluated periodi-
cally through the validation of the allocation of resources and the
emerging trends. However, at the end of the financial year, it must
be assessed as to how much amount of value has actually been
created. Our recommendation would be to use EVA to do that
assessment and cross-check by comparing MV with eligible value.
Since the methodology for the assessment of value creation would
have been agreed in the beginning, eventual assessment would
be far easier and acceptable. It must also be compared with other
comparables in the market.
In this exercise of value creation, the board will play the
crucial role by providing definite direction. It also must own the
responsibility for lower or no value creation, if the directions were
faithfully adhered to by the management. This can be obviated in
case post-periodical review during the currency of the financial
year, re-engineering of the strategic approaches and direction
takes place. This is how accountability must be determined and
appropriate action taken.
Thereafter, it has to weigh whether the value is being created
for all the stakeholders. It should not happen that the focus is
purely on share price, which enhances shareholders value, and
there is no focus on sustainability and/or enriching the life of HR.
In fact, this is a tricky thought and most of the time it becomes
very difficult to assess whether the value is being created equally
for all the stakeholders. The best measurement would be to ascer-
tain if the interest of any other stakeholders is being hurt. Post
that, it becomes a question of sharing the wealth.

16.3.1. Wealth Sharing

The wealth created by an enterprise belongs to all the four stake-

holders in proportion to the contribution of inputs provided to the
enterprise. There are stakeholders who have contractual ownership
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 228 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

and there are the remaining stakeholders who have the residual
ownership. As stated earlier in the book, the contractual stakehold-
ers belong to the category of HR and the suppliers of debt capital
and other goods and services. Oftentimes, the precedence of shar-
ing of wealth is agreed. For example, the HR and the suppliers of
raw materials and the debt capital get precedence over the provid-
ers of risk capital—equity holders. Similarly, a part of the payment
of wealth to the society in the shape of payment of taxes takes
precedence over the payment to shareholders. Figure 16.3 depicts
the ownership of the wealth to contractual and residual formats.
The enterprise, therefore, must architect the disbursal phi-
losophy and policies in a manner and method that the wealth is
shared sagaciously. A set of stakeholders are disbursed wealth,
which is proportionate to their contribution and is not at the
cost of proportionate sharing with other stakeholders. In most
Corporate Governance misdemeanours, it has been brought
to light that the executive compensation is disproportionate to
their contribution of wealth creation and wealth management.

Figure 16.3 Stakeholders Chain

CONTRACTUAL ENTITLEMENT
Value Value Safety of Interest & Taxes, Employment, Salaries
Creation Creation for Principal Enhancement Societal Benefits
for Buyer Supplier of Portfolio Quality Commitments Stability

CUSTOMERS SUPPLIERS LENDERS SOCIETY EMPLOYEES

BOARD MANAGEMENT

RESIDUAL ENTITLEMENT

MAJORITY MINORITY
SHAREHOLDERS SHAREHOLDERS

Value

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 Evaluation of Quality of Corporate Governance 229

Similarly, the examination of the RPTs reveals the benefiting of

one set of stakeholders of an enterprise at the cost of other stake-
holders of the same or some other related enterprise.

1. Shareholders
The shareholders share company’s wealth in the follow-
ing ways:
• Dividend
• Bonus shares
• Right shares
• Share price appreciation
Wealth sharing with shareholders is generally measured
through total shareholders’ return (TSR), which is calcu-
lated with the analysis of the following factors:
• Sales growth
• Earnings before interest, taxes, depreciation and
amortization (EBITDA) movement
• Change in capital structure, a ratio of market capitali-
zation to the total enterprise value
• Dividend yield
It must be ensured that they get their due and that too
periodically.
2. Debts Holders
The sharing of wealth by the debt holders is reckoned in
two forms:
• Payment of interest and repayment of debt on due
date(s)
• Rating of the debt papers
Obligations must be kept up and rating must not be
allowed to deteriorate. The effort should be to improve
to enhance their confidence and contract risk premium.
3. Human Resources
The evaluation of sharing of wealth with HR is done
through the assessment of:
• Growth in compensation package
• Rise in hierarchy
• General welfare of HR
• Attrition rate
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 230 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

HR satisfaction is primary to the sustainability of the

enterprise and, therefore, has to be measured through
‘happiness index’, a new measure introduced.
4. Customer
A company has to seriously engage in crafting value for its
customers—the most preferred method of sharing wealth
with them. The initiatives can be segregated into four parts:
price, quality and satisfaction index and customer retention.
• Price: Company has to price its products competitively.
Industry benchmarks have to be kept in view while
determining the price. The reviews of the prices of
the company have to be undertaken periodically while
maintaining the margins to deliver economic profit.
• Quality: It brings about satisfaction and retention of
customers.
• Satisfaction: Customer grievances received in writing,
verbal or vicariously are to be dealt with efficaciously
to ensure that the customers’ confidence level is fully
maintained, nay, enhanced. The company has to
create a well-laid down procedure for the analysis of
customer demands and preferences so as to appro-
priately devise the product line and service standards
including post-sales. Probably, the satisfaction of
customers stems out of the quality and competitive
price that the company offers.
• Customer Retention: 100 per cent retention of its
regular customers demonstrates that the customer
satisfaction is very high, a result of wealth sharing.
Eventually, it enhances economic profit via reducing
the cost of acquisition of customers.
5. Society: CSR
Wealth sharing with the fourth set of stakeholder namely
the society is undertaken by:
• Paying all the taxes and such like obligations, in time.
• Undertaking projects which benefit the society at large.

The company has to be conscious of its obligations to society and

has always to pay taxes and discharge its obligations fully and in
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 Evaluation of Quality of Corporate Governance 231

time. It has to be regular in depositing with appropriate authori-

ties the undisputed statutory dues including those relating to
provident fund, employee’s state insurance, income tax, sales tax,
wealth tax, service tax, customs duty, excise duty, cess and other
material statutory dues applicable to the company. It has never to
default and hesitate to pay applicable taxes on schedule.
It is time that the CSR initiatives of the company are scientifi-
cally assessed to establish that the company is rising up to be a
model corporate citizen, which is eulogized and exemplified to
promote CSR as a virtue in the corporate world. Several methods
are used for the evaluation. The virtue matrix (see Figure 16.4),
propounded by Professor Roger L. Martin of Rotman School of
Management, is one such method which can be used. To help
the management to do the evaluation, an outline described by
Professor Roger Martin himself as to what virtue matrix is and
how it functions is very briefly described as follows.

Figure 16.4 The Virtue Matrix

Note: Created by Professor Roger L. Martin of Rotman School of Management,

Canada.
The Essential Book of CORPORATE GOVERNANCE 239
 232 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

The virtue matrix, as per Professor Roger, depicts the forces

that generate CSR. The bottom two quadrants of the matrix are the
civil foundation which consists of norms, customs and laws that
govern corporate practice. Companies engage in these practices
either by choice (they choose to observe norms and customs)
or in compliance (they are mandated by law or regulation to
comply). Behaviour in the civil foundation does no more than
meet society’s base line expectations. Since it explicitly serves the
cause of maintaining or enhancing stakeholder value, this behav-
iour can be described as instrumental.
Corporate innovations in socially responsible behaviour
occur in the frontier—the matrix’s upper two quadrants. The
motivation for these innovative practices, at least initially, tends
to be intrinsic: Corporate managers engage in such conduct for
its own sake, rather than to enhance stakeholder’s value. The
behaviour that benefits shareholders and adds to the supply
of social responsibility falls into the strategic frontier: It is
intrinsically motivated behaviour that coincidentally advances
the corporation’s strategies. The structural frontier houses actions
that benefit society but not shareholders, creating a structural
barrier to corporate action. As the matrix’s downward pointing
arrows suggest, behaviour in both frontiers can migrate to
the civil foundation—from the strategic frontier through the
widespread imitation of the successful innovator, or from the
structural frontier through collective action or government
mandate. This migration ratchets up the civil foundation. But
then, the foundation can be ratcheted down if a critical mass of
companies abandons a socially responsible practice.
Corporate Governance of the enterprise, designed on the
principles of optimizing wealth creation and maximizing wealth
management and equitable sharing of wealth, can effectively
navigate the headwinds of environment and pressures of the
expectations of the stakeholders. It can also erect safety belts for
the long-term sustainability of the organization. This is called the
substance of Corporate Governance. It has the potential to con-
vert the so-called tyranny of Corporate Governance rigors into the
triumph of the institution.

240
17
Conclusion: Corporate
Governance—Triumph
of the Enterprise

A
firm is shaped to create wealth. Equity and fairness are
the credo. Stakeholders’ trust is the bedrock. Relationships
architect trust. Corporate Governance is all about erecting
and strengthening the pillars of relationships. The confidence of
the market is the hallmark of Corporate Governance. Innumerable
misdemeanours in the affairs of the firms have destroyed value,
dealt a body blow to equity and fairness, shattered the relation-
ships and rocked the trust and confidence. The unfolding of every
major misconduct in the functioning of firms has engineered the
refinement of the ground rules across geographies. The exercise
remains on a boiling pot. The regulatory framework is getting
wider and steelier. Navigation is becoming onerous and expen-
sive. The formidability of converting input costs of Corporate
Governance into wealth is obvious. Managerial inadequacy to
address the task is apparent in most cases. Eventually, the process
ends up into the perception of a tyranny.
While on the Chair of SEBI, I often used to reflect on the
impact of policing by the regulator. My highway of pondering
would mostly narrow down in the lane of thinking that ethics win
only when the armoury of value system is manifestly potent and
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that policing, howsoever rigorous, cannot close all the windows of

human ingenuity to short change the passive stakeholders. Human
ingenuity coupled with an inherent trait of self-aggrandizement
can be a deadly beast. It gives birth to misdemeanours. Hence,
my meditation used to centre on the motivations. If the crux of
all motivations is the ‘monetary gains’, could there be a way to
harmonize and synthesize ethics with monetary gains in the lim-
ited sphere of Corporate Governance? And, I stumbled upon the
process of promoting and propagating the substance of Corporate
Governance. This was also the logic of travelling an extra mile to
encourage rating agencies to design a tool to assess that substance,
which may eventually build market and peer pressure.
Transiting from the stance of the compliance of regulatory
obligations to the raison d’être of the firm—wealth creation,
wealth management and wealth sharing, I would like to quote
the findings of a 2002 Mckinsey survey published in its quarterly
under the heading, ‘A premium for good governance’.
Institutional investors in companies based in emerging markets claim to
be willing to pay as much as 30 percent more for shares in companies
that are well-governed. Do these investors mean what they say? The
survey examined 188 companies from India, Korea, Malaysia, Mexico,
Taiwan, and Turkey to test the link between market valuation and
corporate-governance practices. They found that companies with better
corporate governance had higher price-to-book ratios, indicating that
investors do indeed reward good governance, and with quite a large
premium: companies can expect a 10 to 12 percent boost to their valu-
ation by going from worst to best on any single element of governance.

In another survey conducted by the Credit Lyonnais Securities Asia

(CLSA), sometime in 2005, it was revealed that when the market
prices of the shares went up, the prices of the shares of companies
in the top quartile of the Corporate Governance went up more by
upto 25 per cent, and when the market fell, the loss in valuation of
such companies was much lower. Just imagine the additionality of
value to the stakeholders if the various parameters reflect a value of
the enterprise to be 100 and a fund manager assigns an additional
valuation of 25 per cent for Corporate Governance.
Matthew Morey and Aron Gottesman at the Lubin School of
Business, Pace University, Edward Baker at the Cambridge Strategy
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 Conclusion: Corporate Governance—Triumph of the Enterprise 235

(Asset Management) Ltd and Ben Godridge at Alliance Bernstein

have, in their research, established evidence that changes in
good Corporate Governance practices of emerging countries are
directly related to incremental changes in company value. This,
in effect, implies that Corporate Governance is an important com-
ponent of company valuation. Allen Ferrell, Harvard Law School
and Martijin Cremers, Yale School of Management, have found a
robust, statistically significant, negative association between poor
governance and firm valuation over the period 1978–2006.
Another study by McKinsey (February, 2005), where 70
successful private equity deals were analysed, found that the
primary source of value creation in majority of these deals
was the out performance of the company—not price arbitrage,
financial engineering or overall sector gain or stock market
appreciation—just by better management of business. Mckinsey
findings further discovered, albeit surprisingly, that out perfor-
mance was primarily driven by changes to the way the boards
of these enterprises worked. Mckinsey describe this as a more
engaged form of Corporate Governance. Yet another research,
conducted by Bernard S. Black of Stanford Law School, Hasung
Jang of Korea University of Business School, Woochan Kim of
KDI School of Public Policy and Management, found a strong
positive correlation between the overall Corporate Governance
Index (CGI) and firm value.
In an important study conducted on 155 Canadian firms (517
firm-year observations) over a four-year period from 2002–05,
Bozec and Bozec (2010) find strong evidence that the cost of capital
decreases as the quality of Corporate Governance practices increases.
Balasubramanian et al. (2011) researched the Corporate
Governance practices of public firms in emerging markets—in this
case, India—and, inter alia, found a positive and statistically sig-
nificant association between the Indian CGI and firm market value.
A large scale survey of institutional investors conducted in
2002 (Global Investor Opinion Survey Key Findings McKinsey
& Co) found that a majority of investors consider governance
practices to be at least as important as financial performance
when they are evaluating companies for potential investment.
Indeed, they would be prepared to pay a premium for shares in
The Essential Book of CORPORATE GOVERNANCE 243
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a well-governed company as compared to poorly governed com-

pany exhibiting similar performance.
All the aforesaid researchers indicate that there is a significant
monetary value in practising good Corporate Governance.1
The focus of assessment of all the envisaged processes of
Corporate Governance has to be eventual wealth creation and
enhanced valuation of the enterprise; in effect, the encashabil-
ity of the quality of Corporate Governance. I would, therefore,
strongly advocate for minority/majority equity owner–managers
of the firms that their interest, including financial, lie in practic-
ing good Corporate Governance because the value addition as a
consequence thereof will always be greater than by the lack of it—
diversion of resources, short changing other stakeholders and/or
downright siphoning of funds. Arguably, the design, direction,
diligence and demonstration in the observance of Corporate
Governance rigours can transform this exercise into value crea-
tion and eventual triumph of the firm.
There are four pillars which hold the edifice of relationships that
culminate in trust, of which I spoke in the beginning of this chapter.
These are (a) transparency, (b) consistency, (c) equity and fairness
and (d) value. If all these pillars remain strong, the relationship will
turn into bonding, and trust may transit to perpetuity. However,
the fragility of trust is inherent, about which I will talk a little later.
On several occasions, I have been challenged by a variety of
young entrepreneurs, in particular to suggest a model or plan
to architect excellence in Corporate Governance. Although it might
appear presumptive to lay down a model/plan, I would still
attempt to outline an approach to facilitate the creation of excel-
lence in Corporate Governance. This journey, to my mind, must
begin with the belief of what Mr Anand Mahindra, Chairman of
M&M Group India, called, “custodians of stakeholder’s interest”

1
(1) Stephen Yan-Leung Cheung, Department of Economics and Finance City
University of Hong Kong. (2) J. Thomas Connelly, Faculty of Commerce and
Accountancy, Chulalongkon University. (3) Piman Limpaphayom, Sasin Graduate
Institute of Business Administration, Chulalongkon University (4) Lynda Zhou,
Department of Economics & Finance, City University of Hong Kong.

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 Conclusion: Corporate Governance—Triumph of the Enterprise 237

or what Mr Deepak Parekh, Chairman of HDFC Group, called,

“trustees of the stakeholder’s interest and wealth”. Such philo-
sophical underpinning should fashion the psyche of managers
at all levels, beginning with the very top in the enterprise. In
fact, Mr Anand Mahindra shared with me a photocopy of the
first advertisement that M&M had issued at its debut in 1945.
Essentially, it incorporates that it will work in the interest of all
the stakeholders.
A firm is expected to function under the broad canon of
corporate democracy. The members (shareholders) authorize the
management to manage the firm and create and share wealth. At
the top of managerial pyramid sits the BoD. The first and foremost
essential requirement, therefore, would be of constituting the
board—a board which has skills and experience, exuberance
and maturity, integrity and commitment and operates as a team.
Comfort, convenience and/or coalescence in the boardroom should
be replaced with alacrity, concern, alternative thinking and dynamic
tension. The process of organizing such a team in the boardroom is
like a journey which must undergo refurbition with every milestone
on the way. Deficiencies, whether in the area of required skills,
experience, commitment and/or contribution, must be addressed
very quickly. This will necessitate a very effective and meaningful
evaluation of the performance of directors. The evaluation must
also assess the quality of teamwork in the boardroom, because
even great individual abilities and/or performances do not win a
match. What triumphs is a teamwork. Although the substantial
responsibility will devolve on the chairman, every board member
has to contribute to team building and pragmatic play. Individuals
must get adequate opportunity to contribute while organization
gathers genuine and honest feedback to bridge the gaps.
The board must lay down the broad principles that will guide
the functioning of the firm. Although these principles will have
to be in sync with the regulatory framework, the philosophical
underpinning has necessarily to be creation of wealth, its optimal
management and sagacious sharing. The principles must be value
based and universally applicable. Defining the basic principles
must be complimented with its propagation and practice. The

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board, CEO and top executive management team will have to

earn moral authority to preach by scrupulous self-adherence. I
suggest that every company must enshrine six ideologies, three
of which are in the nature of philosophy and the other three as
precursor to decision-making principles.

17.1. Value Builders: Philosophy

The ideologies of philosophies should be the following:

1. Integrity: It cannot be compromised by any firm, at any

level, at any point in time. Integrity includes both finan-
cial and intellectual integrity. In many corporations, there
is serious effort to maintain financial integrity, whereas
intellectual integrity is compromised rather quite often.
Intellectual integrity, to me, means ‘convergence of
thought into action’. It is my belief that intellectual dis-
honesty has the potential to do greater harm to an enter-
prise, individual or even society than financial dishonesty.
While loss on account of financial integrity can possibly
be made up some time or the other, damage done by the
lack of intellectual integrity may not be possible to repair
at all or may take several generations to achieve. One
concrete example is that of Arthur Anderson, a one-time
top management consulting and accounting firm, which
was destroyed more by intellectual dishonesty than by the
financial impropriety. Even three generations of Arthur
Anderson could not have put the organization back on the
same platform, which was eventually dissolved. This is not
to state that the financial integrity can be compromised.
The short point is that the BoD, the top management and
everybody in the organization must observe highest stand-
ards of both financial and intellectual integrity.
2. Transparency: Since there are stakeholders of the firm who
are not actively involved in the management, it is essential
that utmost transparency is maintained, which helps the

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 Conclusion: Corporate Governance—Triumph of the Enterprise 239

passive stakeholders to know how the management is being

run and judge its performance. Although every regulatory
jurisdiction has laid down certain minimum disclosures and
standards of transparency, what I suggest is the principle:
‘Come what may, whatever helps reinforcing trust will be
shared with all the stakeholders’, whether it is mandatory,
voluntary or not as per the regulatory dictate. In any case,
complete transparency must be maintained with the BoD,
and nothing that is important and/or material in the func-
tioning of the firm is to be withheld from them.
3. Equity and fairness: Since a firm is created for the benefit
of all stakeholders who have a right to share its wealth, it
is important that equity and fairness of highest order are
maintained. There should be no case of short changing by
the active stakeholders, either for their own benefit or for
the benefit of anybody else. Equity and fairness must not
only be practised but perceived to be there.

17.2. Value Enablers: Principles

The three ideologies of principles stated as follows must become

the basis around which the decision-making revolves. The decision-
making wheel should have three circles.

1. Evaluating options: First circle should be of ‘evaluating

options’. There are always alternatives to a proposed deci-
sion. However, many a times, alternatives are not consid-
ered, and the only preposition made by the management
is accepted which often does not deliver optimal value. It
is possible that, at the same time, there could be option(s)
which have the potential to deliver higher value. Any
pragmatic decision-maker must, therefore, evaluate vari-
ous options before taking a decision. Sometimes, it does
happen that the options are brought to the table but
they are either rejected upfront without consideration,
or not considered from all angles or undervalued. Hence,

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it is important that the principle of ‘evaluating options’

is established. The quality of decision-making will be
retarded in the absence of this principle.
2. Respect for dissent: The second circle would be that of
respecting dissent. Many a times, even in the assembly of
highly accomplished minds, dissent is not welcomed and/
or respected. The intolerance of dissent leads to the lack of
in-depth consideration of an issue/subject/preposition and
often lands in authoritarianism. Dissent engages the minds
of the assembly and helps draw out best in them. It helps
in testing the validity of the assumptions and/or the argu-
ments advanced in favour of a preposition. I have watched
in many board meetings that dissenting voices are few
and far between. Even though there are disagreements,
divergence of thinking and even differences of opinion,
in the absence of respect for dissent, these are not voiced
at all or are meekly mentioned. In the absence of respect
for dissent, the quality of decision-making takes a serious
beating. Hence, it is important to not only respect dis-
sent, but also respect dissenter so that he continues as also
inspires others to come forward with the criticism and/or
alternative views.
3. Value preposition: The final circle should be of value
preposition that is, the decision-maker, while taking a
decision, must be able to understand, recognize and state
the value preposition of the decision. This is to ensure
that the resources of the firm do not seep out, are frittered
away and/or are even underleveraged.

Based on what has been stated earlier, the frame of ideologies is

shown in Figure 17.1.

17.1.1. Monitoring

Once the philosophy and principles have been designed, out-

lined and communicated, the monitoring of the observance must
be rigorous. The rigors of the monitoring must be outlined,
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 Conclusion: Corporate Governance—Triumph of the Enterprise 241

Figure 17.1 Frame of Ideologies

DECISION
MAKING
PRINCIPLES

OPTIMAL
VALUE
PREPOSITION

EQUITY & FAIRNESS

TRANSPARENCY PHILOSOPHY

INTEGRITY: FINANCIAL &

INTELLECTUAL

documented and enforced with alacrity and ruthlessness. It may

become well-nigh impossible for the board alone or even the CEO
to accomplish efficacious monitoring. Hence, the layers and pro-
cesses have got to be well defined and followed scrupulously. The
sequencing of process can be organized in the manner exhibited
in Figure 17.2.
Constituting an accomplished and committed board, laying
down the philosophy and principles may be easier than ensuring
efficacious monitoring. In the absence of effective monitoring, the

Figure 17.2 Monitoring Process

DEFINING
EDUCATION TRAINING EVALUATION RE TRAINING ENFORCEMENT
PRINCIPLES

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entire framework and exercise of building excellence in Corporate

Governance may remain a distant dream. Hence, this should be
a process in accomplishment; it must remind everyone that he is
a trustee and has a fiduciary responsibility. Breach of trust may
adversely affect their own interests and jeopardize even the existence
of the firm. Hence, it must become an exercise of collective delivery.
My recommendation would be to convert the nomination and
remunerations committee designated under the statute, as ‘govern-
ance committee’, which will have, in addition to the defined role,
the monitoring of Corporate Governance compliance as an added
responsibility. Some firms have created a separate committee for
Corporate Governance compliance. I would, however, recommend
a combined committee which takes care of the compliance as well.
The monitoring of Corporate Governance compliance should
include scrupulous observance of all directions, whether manda-
tory or voluntary laid down by any regulatory body whose juris-
diction extends over the firm. However, to my mind, monitoring
should, in addition, include the monitoring of the ideologies:
philosophy and principles of governance stated earlier in this
chapter. Monitoring should not be a ticking box but it should
be with reference to the outcomes of the efforts made. It should
be something like performance audit, which will take shape by
assessing the impact of Corporate Governance, both positive and
negative. The negative impact would be whether the firm would
be subjected to any kind of regulatory enforcement including the
issue of any direction or advice. It must be made clear to everyone
in the organization that any adverse finding by any regulatory
body and so on is not acceptable. Something of a kind of zero
defects must be the case. Anytime, anything is observed, it has to
be dealt with the imposition of:

1. Severe penalty upon the person(s) whose fault or negli-

gence led to such a regulatory enforcement action.
2. Take corrective steps to ensure that this does not happen
again.

In addition, regular reports must be thoroughly scrutinized,

and any potential non-observance likely also must be addressed
beforehand.
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 Conclusion: Corporate Governance—Triumph of the Enterprise 243

The performance audit of decision-making (strategic and

important decisions such as mergers and acquisitions (M&A),
branching into new business line) must also be organized to find
out the value creation—what was envisaged and what has been
actually realised—and if it is lower than expected, action must
be taken to analyse the information and thereafter, appropriate
guidelines and directions must be handed out. While monitoring
of compliance, as written in the book elsewhere, will not undergo
change, the governance committee will take a helicopter view to
make sure that the architectural design drawn out by the board
and under various regulatory directions shapes up the organization
well. Governance committee should not replicate what others in
the organization are expected to do in the matter of the monitoring
of the compliance of Corporate Governance. It should focus more
on wealth creation, wealth management and wealth sharing.
The board and the top management must take pride in build-
ing an image of the firm’s good governance, which is not only
envied but eulogized. The responsibility for doing so should also
be entrusted to the board governance committee.

17.1.2. Evaluation of Wealth Creation

I am of the firm view that the entire programme of Corporate

Governance must culminate in optimal value creation. Annual
exercise should be undertaken to assess value created by the firm.
Elsewhere in the book, I have given various methodologies to
evaluate wealth creation. However, my recommendation would
be as follows:
It should be a three-staged process. The first stage would
be the evaluation of value creation through EVA methodology
(detailed earlier). This methodology will bring out what has been
the value creation during the year.
The second stage would be to compare the value creation
arrived at by the EVA method with the MVA which should be
arrived at by reducing the current market value (enterprise
value) as reflected by the pricing of the common stock with
the value at the beginning of the financial year. The difference
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between the EVA and MVA should then be tempered with the
environmental factors and/or any other factor (that helps in
addressing the appropriateness of the referencing figures of MVA
at the beginning and at the end of the year) that might have
positively or negatively affected the market value. Although it
might be difficult to exactly assess the role played by the envi-
ronmental factors in influencing the market value, an intelligent
guess can certainly be made. In case the MVA is less than the
EVA, a thorough analysis must be done to find out the reasons.
The analysis may throw out the factors (a) which were beyond
the control of the management and/or (b) which could have
been managed by the management. This analysis will also bring
out change, if any, in the perception of the market about the
quality of Corporate Governance during the intervening period.
‘CG along with perception, I think, gives you appropriate value’,
suggests Kishore Biyani, CEO, Future Group.
The third stage should be of comparing the value arrived at
by the second stage, with reference to the value created by peers
in the same industry within and outside the country and also with
some leading value creators even in other industries. This exercise
will call for deeper analysis of the factors that might have contrib-
uted in building of greater value by another enterprise. In case
the firm has done better than the best or has even been placed
in the top quartile of the value created by firms, the manage-
ment and the board deserve full appreciation. However, in case it
does not fall in the top quartile, a thorough analysis would help
in (a) strengthening decision-making process, (b) strengthening
monitoring process and/or (c) improving perception about the
quality of Corporate Governance of the firm.
The objective of the entire three-staged exercise stated earlier
should be to assess how has the wealth creation evolved during the
year and what light does the analysis show for the journey ahead.
There are a few firms such as Infosys in India, which use EVA
method of evaluating the value creation and disclose to the market
also. However, there are not many firms which undertake such
an incisive exercise. I must put a note of caution here. The board
must not look at only one year’s performance in the aforesaid for-
mat. The outlook should be of a journey of value creation, where
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 Conclusion: Corporate Governance—Triumph of the Enterprise 245

the year under review should be a milestone. The performance of

the year under review must be related with the past years and also
the perspectives it pronounces of the journey forward. The annual
performance review should not even vicariously allow seeping in
of short-term approach. The board should always focus on build-
ing a sustainable, long-term enterprise value. However, an annual
review cannot be obliterated and should provide insight into the
movement of that journey with lessons learnt during the year for
still better onward movement. Such an assessment will take care
of both wealth creation and wealth management.
Similarly, an exercise has to be undertaken to assess the effi-
cacy of wealth sharing. How to do such an assessment is detailed
at the appropriate place in the book. Excesses and/or delinquen-
cies have to be corrected forthwith.
Some pundits of Corporate Governance may question as to
whether value building is the only objective that the Corporate
Governance of a firm should be concerned with. Logically reply-
ing to that question, it might be useful to remind that the fun-
damental purpose—the raison d’être—of the creation of a firm is
value building: wealth creation. Furthermore, all that has been
enshrined in the Corporate Governance framework through the
legislations and regulations, whether directed to be observed as
an obligation or voluntarily, is aimed at creating, preventing ero-
sion and protecting the value of the enterprise, and its sagacious
sharing amongst all stakeholders. What could be a better assess-
ment of the quality of Corporate Governance than its impact on
the wealth creation, wealth management and wealth sharing? The
assessment must be based on the analysis of the numbers revealed
by the financials of the firm. Hence, the entire focus of my recom-
mendations is not only on creating an overarching frame of ‘value
building philosophy’, but also ‘enabling principles’.
It must be remembered that value creation, value manage-
ment and value sharing eventually culminate into trust build-
ing, which is a journey and not a destination. Hence, every
milestone of the journey must help the firm in re-engineering,
redesigning and/or refurbishing its march into building the
‘perpetuity of stakeholders trust’. The eventual frame is shown
in Figure 17.3.
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 246 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

Figure 17.3 Corporate Governance Wheel

IDEOLOGIES OF
GOVERNANCE: LONG-TERM
VALUE CREATION &
INTEGRITY
IN OPERATION
INTERGRITY, COMMITMENT,
BOARD SKILLS, EXPERIENCE,

GOVERNANCE PRICIPLES
EXURBERANCE, MATURITY,

IMPLEMENTATION OF
MONITORING OF
CONSTITUTION OF

LETTER & SPIRIT

TEAMWORK

CYCLE OF
CREATING
EXCELLENCE
IN CORPORATE
GOVERNANCE

WEALTH CREATION, WEALTH

MANAGEMENT, WEALTH
SHARING PERFORMANCE
EVALUATION

STRATEGIC FRAME

ORGANIZATION DESIGN

VISION, MISSION, VALUES & CULTURE

Corporate Governance is the ‘universe of management’. I

have tried to picturize my recommendations on that universe of
management in the shape of a wheel. The wheel is oscillating and
has, at its base, a three-layered strong pyramid. The rationale of
creating this picture of a wheel is the need of interlinking various
facets of Corporate Governance. The unremitting transforma-
tion in the environment, which calls for a dynamic frame of re-
engineering of all relevant processes, if and when necessary, is my

254
 Conclusion: Corporate Governance—Triumph of the Enterprise 247

logic behind the oscillation of the wheel. The pragmatism propels

that the architecting of changes should be a stitch in time. The
direction of oscillation has been determined by the order of steps
in the design of Corporate Governance. Since orderly oscillation
commandeers a firm base, I have placed the wheel on a strong
pyramid of vision, missions, values and cultures.
I reiterate my strong belief that the sustainability of a firm is
enabled by the trust of stakeholders and the foundation of that
trust in the management of a firm is the economic gain that the
stakeholders reap during the currency of relationship with the firm.
The sustainability of this stakeholders’ trust stems out of opti-
mal wealth creation and management and sagacious sharing. The
ever-changing macro and micro environment have made resil-
ience of a firm difficult, culminating into uncertainty in delivering
economic gains to the stakeholders, which has added to the fra-
gility of the trust of stakeholders. Liberalization and globalization
of economies have facilitated the movement of resources across
firms and geographies in quest of returns—gains. The transi-
tion of Earth into a planetary village enabled by communication
revolution has facilitated and heightened that quest. This makes
the delivery of economic gains further difficult. Thus, the dura-
bility of trust and, therefore, the relationship with stakeholders
becomes fragile.
It is my belief that the instrumentality of Corporate Governance
can hold a protective umbrella over the fragility of stakeholders’
trust and ensure the durability of their relationship with the firm.
There is a strong possibility that an architectural design suggested
in the book may deliver excellence in Corporate Governance
and eventually perpetuate the trust of the stakeholders. It even
makes an economic sense to address the subject of Corporate
Governance sagaciously. And, addressing the subject in the rec-
ommended frame may eventually turn out to be the triumph of
the Corporate Governance that I seek to promote.

The Essential Book of CORPORATE GOVERNANCE 255

 Caveat:
All the case studies have been written based on the published material
drawn from various sources. The author does not claim to have done the
primary research. In fact, it is a kind of a secondary research of the materi-
als published in various websites, media reports, regulatory orders and so
on. Since numerous sources have been used, it is difficult to give credit
to any particular source. However, wherever it is possible, credit for the
sources used have been given in the relevant places.

256
 ANNEXURE 1
Case Studies

Case Study 1: USA

Enron Corporation: Chimera of Imperviousness

Enron was founded in 1985 by Kenneth Lay with the merger of

Houston Natural Gas and Internorth as a gas pipeline company.
Enron quickly diversified into a varied variety of businesses such
as crude oil, natural gas, petro-chemicals, plastics, electricity, coal,
shipping, steel and metals, pulp and paper and even weather and
credit derivatives. In 1999, it even launched EnronOnline, the
trading website which allowed the company to better manage its
contracts’ trading business. Enron held a variety of assets around
the world including electricity plants, gas pipelines, pulp and paper
plants, water plants and broadband services.
In Enron, Kenneth Lay, Chairman, along with Jeffrey Skilling,
President and CEO, created a very complex business model that
spanned across products, geographies and hierarchies. In some
businesses, Enron was a producer, in some, it was a distributor,
while in others, it acted as an intermediary and market maker.
Enron’s revenue expanded exponentially from $13.3 billion
in 1996 to $100.8 billion in 2000, a growth of more than 750
per cent. In 2000, Enron made a profit of almost $1 billion.
Fortune magazine named Enron as America’s most innovative
company for six consecutive years ending in 2000.
Summing up in a sentence, the growth story of Enron would
be of an organization rising like a phoenix within a short span of
its life out of unbridled and unruly creativity. Even though some
of the creativity was really original and is still being used across
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geographies and businesses for hedging, Enron was essentially

using that creativity to ‘hedge against itself’. This particular aspect
was not noticed and deciphered by the oversight mechanism of
the audit committee and auditors, and even by the market.

What Went Wrong?

The company was making complicated bets on the future, and

many of those gambles on the future energy prices, in particular,
were losing money. And to hide, the management used creative
accounting and off-balance-sheet financing vehicles. The method
was adopted to use mark-to-market accounting practice to book
entire profit from an asset such as a power plant to its balance
sheet—even though the project may not have made a single
dime—and then to hide losses. The loss-making projects would
be transferred to special purpose entities (SPEs) from the com-
pany’s books. Many dubious ‘partnerships’ were created, which
allegedly bought losing businesses from Enron to boost Enron’s
balance sheet. Furthermore, the company did not hedge unreal-
ized gains and losses of long-term contracts even though it used
mark-to-market accounting for income recognition and made
forecast of energy prices and interest rates.
Disproportionate compensation was paid to key managerial
personnel and vicarious monetary gains made by executives,
directors and auditors of Enron. For example, company’s CFO,
Fastow, earned $30 million in just one deal as a compensation for
managing Lea, Jeffrey, Matthew (LJM) limited, one of the many
‘‘partnerships’’ floated by the company to hide debt. Many of the
company’s executives allegedly raked in millions by selling their
shares before company’s problems went public.
Enron had its governance frame; 14 board members with
only two insiders, and a full complement of board subcommittees
such as executive, finance, audit and compliance, compensation
and nomination and Corporate Governance. However, the over-
sight mechanism was hopelessly ineffective.
Audit committee was not focused and failed to do its job.
It held fewer yet shorter meetings that covered greater grounds.
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This meant that they were unable to fully comprehend such a

complex business and the true financial health of the company.
There was also a significant conflict of interest with the statu-
tory auditors. For example, Arthur Anderson, Enron’s audit firm,
was accused of applying lax standard in its audit of Enron because
of huge compensation and consulting fees that it received. In
2000, he received $25 million in audit fees and $27 million in
consulting fees. This represented a major part of the revenue of
his Houston office.
The governance failures at Enron were pervasive and, at mul-
tiple levels from lack of independence of its directors to financial
engineering, undertaken deliberately to overstate profits and hide
losses, minimal disclosures, conflict of interest, scandalous compen-
sations, to collapse of oversight mechanism and fiduciary failures.

Lessons

One of the most important lessons from Enron is the danger of

creating a culture of chasing shareholder returns at the expense
of everything else. The cowboy culture of the company, especially
promoted by top bosses Kenneth Lay, Jeffrey Skilling and Fastow,
CFO as also by others, ultimately led to the destruction of the com-
pany. Enron had a banner in the lobby of their headquarters which
read ‘the world’s leading company’, and executives at the company
were determined to make this true at all cost, even if it meant cook-
ing books and hiding loses. In fact, there was a deep internalization
of a culture of winning at all cost by hook or crook, and it reflected
in the systems and procedures of the company.
The value system in the company was rotten with impropri-
ety right from the very top with blatant disregard for the conflict
of interest, be it in acquiring a company co-owned by a son of
Chairman Kenneth Lay or urging employees to use a travel agency
operated by the sister of the chairman. The Enron saga teaches us
how important the probity and behaviour at the top is. Any conflict
of interest, even minor ones, should be avoided at all cost. There
should be true independence for directors, CEO, CFO and most
importantly auditors, both internal and external.
The Essential Book of CORPORATE GOVERNANCE 259
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There has to be deep internalization of (efficacious) systems,

procedure, culture and values. All, put together, must build a
serious depth of belief in those systems and probity.
Adherence to Corporate Governance framework is important
for all business. However, it should not be just about the form of
compliance with regulatory obligations and mandatory disclosures
or accounting standards, but these standards, disclosures and regu-
lations should be followed in true spirit and be emphasized by the
top management, in particular. There should be effective oversight
of board committees and compensation monitoring.
The boardroom practices were seriously deficient in Enron.
The ills relating to ineffective monitoring stemmed out of inad-
equacy engagement of the board. The boardroom is a place where
the members gather for a serious review and discussions on the
performance and strategic issues. The depth of the review, quality
of decision-making, choices of strategy and eventual sustainabil-
ity of the enterprise has a direct and proportionate relationship
with the boardroom practices. Hence, there should be a focused
approach on the boardroom practices.
The core of the Corporate Governance is the fiduciary
responsibility of the top management and the board in holding
the enterprise in trust for future, for long-term sustainable profit-
ability rather than chasing short-term profit at any cost.

Case Study 2: Continental Europe

Parmalat: Unquestionable Belief in Morality of

Management

Parmalat SpA represented the core milk and dairy food business
of the Parmalat Group. Parmalat SpA was an unlisted company
controlled by Parmalat Finanziaria, which was listed on the Milan
Stock Exchange. Its main shareholder was Coloniale SpA which
owned 50.02 per cent of the company’s voting share capital.
The Coloniale SpA was under the control of the Tanzi family,
through some Luxembourg-based companies. There were other
two institutional investors which were minority shareholders in
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 ANNEXURE 1 253

Coloniale SpA: Lansdowne Partners Limited and Hermes Focus

Asset Management Europe Limited. To sum up, Parmalat was
a complex group of companies controlled by Tanzi family with
presence of limited number of other shareholders.
A brief sketch of the ownership structure is outlined in
Figure A.1, which speaks the volumes of the complexity built
around the ownership design. This, in fact, is the case with many
entrepreneurs-dominated firms around the world.
In the 1980s and 1990s, the Parmalat was hailed as a jewel
in the Italian commerce. The credit for this goes to Calisto Tanzi
who successfully converted his father’s ham retailer business into
a global giant in food and dairy business. It all started with a
pasteurization plant in Parma which opened in 1961 by Calisto
Tanzi, then a 22-year-old college dropout. The main reason for
company’s success was its technique of using the ultra-high-
temperature process, which produced long-life milk. On 22 April
2002, Parmalat’s share price reached a record and the company
was valued at 3.7 billion. It had over 30,000 employees in
over 30 countries. The company had diversified into many dif-
ferent kinds of businesses including travel group—ParmaTour,
a TV channel—Odeon TV, football clubs—Parma A.C. and
S.E. Palmeiras, and had sponsorship of S.L. Benfica, Boca Jniors,
C.A. Penarol and Brazilian formula one racing driver Pedro Diniz.

What Went Wrong?

In 1997, Parmalat decided to become a ‘global player’ through

acquisitions and debt financing. It lured investors through
imaginative and speculative structured instruments designed by a
group of global and Italian bankers and siphoned off large amount
of money to a network of 260 companies. The company created
an illusion of liquidity through bond sales. In fact, an ingen-
ious product called ‘Buconera—Black Holes’ designed by CITI
Bankers was used. The company justified borrowing through
fictitious sales in a scheme devised and executed by Tanzi, top
managers, lawyers and outside auditors. For example, in one of
the most brazen case, the company created a bogus milk producer
The Essential Book of CORPORATE GOVERNANCE 261
262
Figure A.1 Parmalat’s Ownership Structure

Coloniale S.p.A.

49.16% Newport S.A.

(Luxembourg)
0.86%
Parmalat Finanziaria
100%
89.18%
0.33% 10.82% Dalmata Sri
Parmalat S.p.A.
5% 100% 100%

95% Parmalat Austria Gmhb Parmalat Finance Corp.

Parmalat Malta Holding Ltd (Austria) (Netherlands)
(Malta)
64.22% 100%
Cureastle Corporation NV
Parmalat Soparfi S.A. (Dutch Antilies)
(Luxembourg)

100% 100%
35.78%
99.75% Food Consulting Service Ltd Zilpa Corporation NV
(Isle of Man) (Dutch Antilies)

Parmalat Capital Finance Ltd

(Malta)
100%
Bonlat Financing Corporation
(Cayman Islands)

Source: Blackwell Publishing Ltd 2005. Corporate Governance Failures.

 ANNEXURE 1 255

in Singapore that supposedly supplied 300,000 tons of non-

existent milk powder to a Cuban importer via Bonlat, a Cayman
Islands subsidiary of Parmalat. By 2002, Bonlat’s fictitious assets
had grown to $8 billion. The company kept showing fictitious
sales and kept hiding its debt by transferring them to shell com-
panies in offshore tax heavens. It involved reputed banks such
as Bank of America and Citibank to keep raising finances on the
basis of its supposedly ‘healthy’ balance sheet and high ratings
by rating agencies based on fake sales. It also employed auditors
such as Grant Thornton and Deloitte and Touche who apparently
failed to notice giant holes in the books of Parmalat.
Investments were made by the company in the high-flying
world of derivatives and speculative enterprises. Some of the acqui-
sitions ushered in red figures in late 2001. A minority shareholder
(Hermes Focus Asset Management Europe Ltd) raised alarm and
filed a claim on the bond issues, which was brushed aside as ‘no
irregulatory found’ by the auditors. In December 2002, auditors
first enquired about an offshore account in the Cayman Islands
and received a letter on Bank of America stationery in March 2003
confirming the existence of the account purporting to contain $4.1
billion for a subsidiary of Parmalat called Bonlat set up in Cayman
Islands. This letter turned out to be a forgery as the Bank of America
denied having any such account in the investigations that followed
when the company defaulted on a 150 million euro bond. The man-
agement claimed that default was because a customer, a speculative
fund named Epicurum, did not pay its bills. Allegedly, Parmalat had
won a derivatives contract with Epicurum, betting against the dollar.
However, it was soon discovered that Epicurum was owned by firms
who had the same address as some of the Parmalat’s own offshore
entities. In effect, Epicurum was owned by Parmalat only, and the
whole transaction was a sham. This revelation by Bank of America
in December 2003 started the collapse of the group. Trading in the
Parmalat shares were frozen. Tanzi, several of his family members
and various executives were arrested. Later, the total debt of the
company was declared to be 14 billion This is eight times what the
firm had admitted as its total debt. At the time, Parmalat was the
largest bankruptcy in European history, aggregating 1.5 per cent of
Italian Gross National Product (GNP). In terms of proportion to the
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national GNP, it was bigger than the combined ratio of the Enron
and WorldCom bankruptcies to the US GNP.
There were many causes that led to the Corporate Governance
failure at Parmalat. There was a combined position of chairman
and CEO resulting in reduced oversight. There was inadequacy
in the number and independence of independent directors. There
was a complete failure of monitoring structures such as board,
committees and auditors. There was connivance of auditors as well
as bankers, which helped to hide the true health of the company.
There was lack of access to information related to controlling
shareholders’ activities. Like in the Enron, creative accounting
and financial engineering were used to commit fraud on the
investors, shareholder and debtors. There was also a conflict of
interest in RPTs that was ignored. Approvals of the proposals
affecting company’s financial position were given by the BoD
who was linked by family ties. The transactions were not treated
according to the criteria of both ‘substantial AND procedural fair-
ness’. Further disproportionate remuneration was given to execu-
tive directors and key managerial personnel.

Lessons

There are many lessons to be learned from this scam. Prime

among these is the importance of effective and multilayer over-
sight and control mechanism. There should be strict adherence
to Corporate Governance standards and code of best practices.
There should be adequate number of independent directors on
the board, ensuring optimum composition of independent and
executive directors in internal control committees. There should
be very efficacious monitoring structure accountable to good
Corporate Governance for the nomination and remuneration
committee in the appointment of directors on the board and the
audit committee and the external auditors. The board should not
only undertake very effective superintendence of the monitoring
structure of its subcommittees, but also must, through potent
boardroom practices, undertake a thorough review and provide
direction to the management of the enterprise.
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There needs to be control on unbridled creativity in account-

ing and financial engineering. There should be a separation of the
position of chairperson and CEO.
However, all these measures will amount to nothing if the rot
is at the highest level, just as it was in this case and in the Enron
case. Thus, there needs to be better governmental regulation on
the oversight of corporations and their financing. Also, there
needs to be better regulation of auditing firms and rules govern-
ing external audit of corporations. The Italian Government did
take some steps in the aftermath of Parmalat scandal, for example,
it introduced a new insolvency legislation based on America’s
Chapter 11. There was also talk of creating a strong super regula-
tor overseeing corporate finance.

Case Study 3: UK

Equitable Life: Collective Rationalization

and Illusion of Unanimity

Equitable Life Assurance Society (ELAS) was started in 1762 in

the UK. It was the world’s oldest mutual life insurance company.
It was the first life insurance company in the world to decide
premiums rates based on age and mortality. ELAS used methods
invented by James Dodson, defined by scientific basis for calcu-
lating premiums using mortality tables and probability studies
to design tables of fair annual premiums. This was the company
which invented level premiums. However, Dodson died five
years before the company was founded and, hence, Edward Rowe
Mores became its first CEO with the title of actuary; first ever use
of the term even though he was not a statistician.
ELAS marketed life insurance, annuities, pensions and perma-
nent health insurance to customers in UK, Germany and Ireland.
Fixed premiums were charged, and the amount payable on death
was guaranteed. At its peak, the Equitable had 1.5 million poli-
cyholders with £26 billion worth of funds under management.
ELAS had 12 directors, five among whom were executive
directors, while seven were NEDs. Executive directors, though in
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 258 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

minority, exercised greater influence on the board. Roy Ranson

was the CEO and appointed actuary during the period of 1992
to 1997. This combination of CEO and actuary was not only
uncommon, but undesirable in the light of appointed actuary’s
specific obligated role. The appointed actuary, who is an essential
part of the UK national insurance, is supposed to act as a guard-
ian of policyholders’ interests, but in this case, UK regulator did
not do its job properly and allowed Ranson to become the CEO
without relinquishing his role as the appointed actuary. NEDs
were dependent on actuarial reports produced and submitted
by the CEO and the appointed actuary (combined positions)
and were incapable of exercising any influence on the actuarial
management of the company, since they had no knowledge of
the actuarial science and practices. The board had constituted its
subcommittees, and the following committees were functional:

• Audit
• Legal audit
• Remuneration
• Investment
• Nomination committee

What Went Wrong?

In 1983, the executive management of the company decided that

in the event of sustained period of low interest rates, the cost
of annuity guarantees will be met from terminal bonuses. This
decision became known as ‘differential terminal bonus policy’.
However, this was not approved by the board and was not even
communicated until 1993. Even policyholders were informed
about this only in 1988. Terminal bonus policy propelled the
management not to commence a new bonus series in 1988 and
continue to market new personal pensions such as earlier annuity
business, whereby unguaranteed terminal bonus received increas-
ingly larger allocation of total surplus. The society’s solvency
position was boosted up by the consistent adoption of weakest
valuation basis, valuation practices of dubious actuarial merit and
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 ANNEXURE 1 259

other financial adjustments. The worst of all, the board accepted

fragmented financial and product information.
Between 1956 and 1988, ELAS sold polices with option to
select either a guaranteed annuity rate (GAR) or the current annu-
ity rate (CAR). GAR, as the name suggests, had the fixed annuity
rate of returns based on the lump sum accumulated, irrespective
of the interest rates prevailing or longevity. However, in CAR,
the rate of return of annuity changed depending on the prevail-
ing interest rates and longevity expectations. The company did
not charge any additional premiums in respect of the guarantee.
Also, there was no provision made for adverse market positions.
According to an affidavit sworn by Actuary Christopher Headdon,

At no time did Equitable ever hedge or reinsure adequately against the

GAR risk to counteract it. The reason for this was Equitable’s belief
that it could neutralize the potential effect of the GAR risk through the
exercise of its discretion to allocate final bonuses under Article 65.1

In October 1993, due to falling inflation and interest rate, the

Equitable first faced the problem of market annuity rate dipping
below its GAR. Despite this, it did not build any reserve to cover
up the growing GAR liability. Instead, the management guided by
Ranson decided to use its discretion to give lower terminal bonus
to policyholders who opted for GAR, effectively nullifying the
guarantee. In spring 1994, inflation and interest rate rose and the
GAR issue went away for the time being. However, in May 1995,
Equitable’s GAR was again higher than the market rate, and, by
September 1998, its guaranteed annuities were worth 30 per cent
more than the market annuity rate posing significant financial risk.
In January 1999, Financial Service Authority (FSA) issued
guidelines on ‘insurance company solvency margins’, stipulating
that it should be assumed that 80 per cent of the qualifying policy-
holders would choose to exercise their guaranteed annuity option.
Until then, insurance companies were free to choose their own
estimate of the percentage of potential policyholders that would

1
The Equitable Life Assurance Society. From Wikipedia, the free
encyclopedia. Available at: https://en.wikipedia.org/wiki/The_Equitable_Life_
Assurance_Society (accessed on 30 May 2016).

The Essential Book of CORPORATE GOVERNANCE 267

 260 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

exercise guaranteed annuity option, and Equitable had anticipated

that only 2 per cent would do so. This meant that rather than a
loss of £50 to £200 million, Equitable had a hole of the size of 1.5
billion pound on its balance sheet. The company decided to use
accounting techniques to boost Equitable’s solvency position, even
though it was overdrawn on internal office valuation to the extent of
£4.4 billion by mid-July 2001. It entered into a reinsurance agree-
ment with an Irish company. This was claimed by the company as
an asset worth £800 million. Government Actuary’s Department
examined the transaction and found it insufficient to justify such a
credit. However, despite this, FSA approved the reinsurance.
Following an increasing number of consumer complaints
regarding lower terminal bonuses, Equitable decided to go to
court to test the lawfulness of bonus cuts. In September 1999, the
High Court ruled in its favour, but this proved to be a temporary
relief as this was challenged in the Court of Appeal which ruled
against it. Equitable then sought a ruling by the House of Lords.
On 20 July 2000, the House of Lords upheld the judgment of
the Court of Appeal. It found Equitable in breach of contract—a
guarantee was a guarantee. ELAS ceased writing new business fol-
lowing the House of Lords directive that it had underpaid 90,000
guaranteed annuity policyholders.
Having lost the case and unable to pay £1.5 billion, Equitable
put itself up for sale, but in a final blow of indignity to the oldest
life insurance company in the world, it failed to find a buyer. In
December 2000, the company was closed to new business.

Lessons

One of the important lessons to be learned from Equitable saga is

that in an insurance company, the position of an appointed actuary
cannot be combined with that of a CEO, as it undermines, funda-
mentally, the role of appointed actuary as a whistle blower and pro-
tector of policyholders’ interests. Also, it is not ideal to have one set
of professionals, that is auditors, to express views about the assets
and liabilities and the other set of professionals, that is actuary,
to independently certify liabilities without their coordinating and
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 ANNEXURE 1 261

working together. The main cause, which could help the manage-
ment to perpetuate impropriety, was a single fund of impenetrable
complexity for all products. This fund comprised of:

• Traditional life insurance products

• Pension products
• Pure investment products
• Domestic and overseas business

There were widely varying types and levels of guarantees within the
same types of policy. There was inadequate mechanism to foster
the appropriate balance between policy values and asset shares. In
fact, there has to be a separate fund for each class of business.
The reason for Equitable’s collapse was its risky business model
of full distribution and resultant low reserves, which delivered
rapid growth for a while. However, for long-term sustainability,
it is important that the insurance companies take into account
all the different risks and provide for adequate reserves to cover
them. When a company has a widely mixed portfolio of fund, like
Equitable had then, the management policies have to be dynamic
and cannot be bereft of environment and financial prospects. Calls
on interest rates while calculating premiums, bonuses and liabilities
have to well thought judgement choices based on the analysis of
macroeconomic factors. Another important lesson from Equitable
is the need for full and accurate disclosure of financial health,
changes in policies conditions, scope of regulation and so on to
customers.
In summary, the following stand out as the lessons:

• Homogeneity of any unitary with profits fund gets under-

mined as a life office reacts to changing market condi-
tions and shifting product preferences.
• In a widely mixed fund, management of policies has to
be dynamic and cannot be bereft of environment and
financial prospects.
• ‘Discretion’ of the board allowing one set of profession-
als—auditors—to express view about the assets and the
other professionals—actuary—to independently certify
the liabilities is like commissioning two legs of a pair of
The Essential Book of CORPORATE GOVERNANCE 269
 262 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

trousers from two different tailors. These have to be very

effectively coordinated.
• In life office, the position of an appointed actuary cannot be
combined with that of a CEO as it undermines fundamen-
tally ‘whistle blowing’ obligations of the appointed actuary.
• Full and accurate disclosure of financial health, changes
in policies, scope of regulation to customers is essential.

Case Study 4: UK

Marconi: Stereotype Vision and Superfluous Reviews

Marconi, the great inventor of telegraph registered this company

as Wireless Telegraph and Signal Company in 1897. In December
1898, the first wireless equipment manufacturing plant in the world
was set up in an old silk factory in Hall Street in Chelmsford near
London. Wireless Telegraph and Signal Company changed its name
several times as it evolved over the years to Marconi’s Wireless
Telegraph Company in 1900. It might be worthwhile to note here
that when the ‘Titanic’ stuck an iceberg and sank on 14 April 1912,
712 survivors owe their lives to the distress calls from Marconi’s
wireless equipment on ship board. Fast forwarding the journey of its
successful and sustainable business until the beginning of the twenty-
first century, it can be said that the organization was able to survive
the vicissitudes of the fast-changing technological environment.
During the period of 17 May 2001 to 4 July 2001, Marconi’s
senior executive management comprised of CEO Lord Simpson,
Deputy CEO John Mayo and CFO Steve Hare. Sir Roger Hurn was
the chairman of the company. Marconi was listed on London Stock
Exchange (LSE) under the name of General Electric Company
Ltd (GEC) and was a constituent of the Financial Times Stock
Exchange (FTSE) 100 Index. It may be noted here that overtime,
the autocratic CEO, Arnold Weinstock attained absolute powers
by 1970s. The company grew fast as from the early 1980s by
exploiting cost and inflation proofed contracts, telecoms, power
engineering and defence, all in public sector then. He was able to
get appropriate approaches for the company caved up politically,
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which may not have necessarily made the economically beneficial

preposition for the buyers of products. Thus, it was more of
a political management than an economic proficiency of the
enterprise, which provided the growth and success.
Once British economy was privatized, Lord Weinstock, who
basked in the political manoeuvrings, faded as corporate financier
and John Mayo took over as the CEO of the company. He trans-
formed it into overleveraged telecoms, particularly an internet
equipment specialist. However, delegating substantial responsi-
bilities to division heads and abandonment of Weinstock’s famous
ratios and trend lines led to deteriorating working capital, which
remained unaddressed. The company and the board did not clearly
decipher where rapid technological changes were driving the mar-
ket. The board also did not comprehend the impact of changes in
the structure of British economy relating to the sector transiting
from public sector to privatization. The most important transforma-
tion as the consequence of structural change was the disappearance
of political influence, which was the strong driving force behind the
company’s success. As European and Chinese suppliers underbid,
Marconi failed to win the piece of British telecom’s twenty-first-
century network project worth about £10 billion. This brought a
serious setback to the economics and long-term sustainability of
Marconi. Investors lost faith in the company as a strong long-term
player in the telecom sector. Overnight, it lost 50 per cent of its
market cap, which led to cascading affect. Trigger was forecast and
shareholders, in 2003, lost 99 per cent of their equity value. It might
be worthwhile quoting the trigger below to validate the point.

Forecast Period Year Ending 31 March 2002 (Managements Estimates)

Forecast Prior Variance 26
date Year 17 May 26 June 30 June 2 July June to 2 July
£m £m £m £m £m £m
Sales 6,942 NA 7,435 6,364 6,200 (1,235)
Costs 6,135 NA 6,944 6,092 5,800 1,144
Operating 807 807+ 491 272 400 (91)
Profit/(loss)
Source: FSA Final Notice 11 April 2003 (figures indicated greater variance)
The Essential Book of CORPORATE GOVERNANCE 271
 264 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

What Went Wrong?

The first and foremost to unleash the distress was changes in the
organizational structure of the company, which left gaps in infor-
mation flow and responsibilities. Vital data was not assembled
and was completely overlooked during the restructuring of the
company. The spiralling level of working capital requirements
went undetected. The management of cash was poor to the extent
of being dangerously inefficient, albeit reckless. The company
was thriving on political manoeuvring and never focused enough
on building the economics of competitive environment; once the
strongest strength of the company—‘political manoeuvring’—
faded, the business model fell flat. It did not anticipate and envis-
age the onset of new players in the market even after the structure
of the sector got transformed.
The director ‘gene pool’ was too small with wholly inadequate
knowledge and/or industry-specific experience. Cronyism and
rubber stamp of decisions was manifest all over. There was a com-
plete lack of management competence in the board. The reviews
of the performance were hopelessly scant. No probing or question-
ing of management’s figures and explanations was undertaken,
no ‘why’ and ‘how’ of performance numbers and budgeting was
raised. There were delays in holding board meetings under con-
troversial disclosures circumstances and failure was often observed
in compliance with the obligations of listing rules on timely basis.
The board did not anticipate emerging trends. In fact, it did not
provide direction and vision (primary role) to the company at all.

Lessons

This was a case of boardroom failure, coupled with management

incompetence and unprofessional approach. The board failed in
its duty of monitoring and superintendence. In fact, it failed to
govern the company. Boardroom is a place where reviews should
be thorough, direction to the management clear and vision of the
company manifestly delineated. It is possible only if the board is
divergent, knowledgeable and probing and committed to the role.
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 ANNEXURE 1 265

It must question both good and bad. It must ask the obvious ques-
tions and also not so obvious question in the typical phrase, ‘too
good to be true’. This has to be done when the company performs
well and the outlook appears to be too good. The board should
satisfy itself about the sustainability of the journey forward. In
conclusion, it might be said that the Corporate Governance and
the board’s monitoring and superintendence should focus not
merely on the form of compliance, but also on the substance of
it. It must stretch enough to live up to the responsibilities it is
expected to discharge.
The management of the companies, in general, and the board,
in particular, must remain focused on the emerging horizons
of the environment. Those horizons must extend beyond the
industry and encompass to technological changes, competition,
customer sensitivity, economic, political and even social environ-
ment. The impact of fusion of all these environment factors on
the business and sustainability of the company must be assessed.
In the absence of such an approach, the success of the day will
eventually transit into failure of tomorrow. Wisdom lies in doing
scenario building annually, drawing up a matrix of approaches
and applying the best fit to the known, unknown and know–
unknown and/or unknown–unknown that eventually emerge
with the changes in the environment, which may affect the busi-
ness of the company. Superfluous reviews and stereotype vision
of the board builds concrete pathways for the ruin and even
destruction of the company, which is what happened in this case.

Case Study 5: INDIA

Satyam: Manipulation, Fraud and Governance Apathy

Satyam Computers was set up by Mr Ramalinga Raju and Mr B.

Rama Raju on 24 June 1987. On 26 August 1991, it was con-
verted into a public limited company. In the year 1992, it went
public. It was listed in SXs such as BSE, NSE, New York Stock
Exchange and Euronext (Amsterdam). Satyam’s network of cus-
tomers covered 67 countries across six continents, employing
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more than 40,000 employees including in development centres

spread over India and around the world (USA, the UK, the United
Arab Emirates, Canada, Hungary, Singapore, Malaysia, China,
Japan, Egypt and Australia).
The company served more than 654 global companies, 185
of which were Fortune 500 Companies. It received many awards.
It became world’s first ISO 9001:2000 company to be certified
by Bureau Veritas Quality International (BVQI). In 2003, Satyam
started providing IT services to the World Bank and signed up
a long-term contract with it. In 2005, it was ranked 3rd in a
Corporate Governance survey by Global Institutional Investors.
Interestingly, it had received many awards for its excellence in
Corporate Governance and CSR.
Mr Raju, the founder and chairman, had also received numer-
ous awards and honours including E&Y Entrepreneur of the year
1999 and 2007, Dataquest IT Man of the year 2000, CNBC’s Asian
Business Leader—Corporate Citizen award 2002, amongst others.
It is interesting to note here that the entire manipulation and
fraud came to light only when Mr Raju himself disclosed in a
letter to Satyam Computers’ BoD that he has been manipulating
company’s accounting numbers for years and that the assets have
been overstated in the balance sheet by $1.47 billion. He and
the company’s global head of internal audit employed a variety
of techniques to perpetrate the fraud. In his personal computer,
Mr Raju created numerous bank statements, falsified bank accounts
with inflated balances and income statements including claiming
interest income from bank deposits and so on. He also created
over 6,000 fake salary accounts and appropriated the money after
the company deposited. The global head of internal audit forged
board resolutions and illegally obtained loans for the company.
It was brought to light that the money company raised through
American depository receipts in the USA never made it to the
balance sheet. In December 2008, five independent directors
had approved the founder’s proposal to buy the stake of over
50 per cent in Maytas Infrastructure and all of Maytas Properties,
both to be converted into fully a owned subsidiary, for $1.6 billion.
Incidentally, it may be noted that Raju had 37 per cent stake in

274
 ANNEXURE 1 267

Maytas Infrastructure and 35 per cent in Maytas Properties. The

directors moved forward with the management’s decision without
shareholders’ approval. However, the transaction was reversed in
12 hours after the investors sold Satyam’s stock and threatened
action against the management, which was followed by lawsuits
(filed in USA) contesting Maytas’ deal.
In December 2008, Investment Bank DS Prabhudas (DSP)
Merrill Lynch was appointed by Satyam to look for a partner or
buyer for the company. He observed financial irregularities, blew
the whistle and terminated its agreement. The following is a snap-
shot of the fabricated balance sheet:

Fabricated Balance Sheet and Income Statement of Satyam as of

30 September 2008 (` in Crore (10,000,000))
Items Actual Reported Difference
Cash and Bank Balances 321 5,361 5,040
Accrued Interest on Bank Fixed Deposits Nil 376.5 376
Understated Liability 1,230 None 1,230
Overstated Debtors 2,161 2,651 490
Total Nil Nil 7,136
Revenues (Q2 FY 2009) 2,112 2,700 588
Operating Profits 61 649 588

What Went Wrong?

What comes foremost to the mind of an objective observer about

Satyam Computers is a complete apathy towards Corporate
Governance. Even though the judicial verdict is still to establish,
apparently, there was a criminal connivance of the auditors. The
apathy of Corporate Governance can be summarized in the fol-
lowing points:

1. Efficacy of management information system was never

assessed, verified or audited.
2. Manpower inventory was not even looked at.

The Essential Book of CORPORATE GOVERNANCE 275

 268 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

3. Inserting of invoices directly in Invoicing Management

System (IMS) through Excel porting was not questioned.
4. The role of the auditors was questionable.
5. The audit committee did not scrutinize and monitor the
independence, role and functioning of internal audit and
statutory auditors. It did not go into examining either
the financial statements as to whether they provide cor-
rect, full and credible pictures, seek details about frauds,
irregularities, failures of internal control system, or even
financial disclosures.
6. The monitoring by the board committees and superin-
tendence by the board was conspicuously absent.
7. The directors were hugely compensated including with
stock option at `2 when the market price was `500.
8. All this, put together, provided a field day for Mr Raju
and his associates in crime—in whom probably the BoD
had put their full trust—to manipulate and undertake
the fraud.

Lessons

This is a case where Corporate Governance was at its worst.

The entire edifice of monitoring and superintendence had
failed. The system and processes which help the company to
reflect the true picture of its financial health should be examined
periodically by an independent auditor as to its efficacy and the
potential possibilities of manipulation. The independence, com-
petence, commitment and role of the auditors must be scrutinized
very thoroughly by the audit committee and also the board. The
monitoring mechanism of board subcommittees must be robust,
and their effectiveness in rendering obligatory responsibilities of
monitoring must be assessed by the board periodically.
The conflict of interest including disproportionate remunera-
tion to key managerial personnel, auditors and/or the BoD must
not be allowed. In fact, their compensation must be looked from
critical angles to appreciate the appropriateness. Boardroom

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 ANNEXURE 1 269

practices have to be improved and made very effective. This will

involve timely holding meetings of the board and its subcom-
mittees, designing and drafting of agenda papers, circulation of
those papers well in advance, thoroughness of discussions in the
meetings, which must involve incisive scrutiny of financial num-
bers and reports placed before them and writing of minutes. The
meetings of the board committees and the board should not be a
gathering over a cup of tea and snacks for a kind of social chat,
but should be a platform where hardcore business discussions
take place about the functioning of the company its strategies,
direction on vision and so on. The board must provide a clear
verdict on its performance, deliver unambiguous decisions and
amply delineate directions provided. This entails that the board
and committee members have skills, knowledge, time and com-
mitment, and seriously engage in undertaking their role. Their
performance must also be assessed annually. This will mean that
the board and committee meetings cannot be convened at a short
notice and without the circulation of agenda in advance. The
attendance of the BoD and committee members in the meetings is
insisted upon. The recordings of minutes envisage, fairly in detail,
the discussions that took place, including possibly who said what,
decision taken and direction provided.
In effect, the entire process of Corporate Governance of the
company has to be made very robust and effective.

The Essential Book of CORPORATE GOVERNANCE 277

 ANNEXURE 2
Board Allocation of
Role Between Board
and the Management

Board Management
1. Design of vision, mission, values 1. Manage the operations of the
and cultures company
2. Strategic approaches 2. Execute policies and programmes
3. Direction, which will include decided by the board
• Value creation goals 3. Realization of budget and the value
• Monitoring and control creation goals—day-to-day manage-
systems ment of the company
4. Approval of annual budget and 4. Within the overall framework pro-
value creation goals vided by the board, allocation of
5. Broad allocation of various resources
kinds of resources—physical, 5. Anything which is necessary to man-
financial and human age the performance of the company
6. Mergers and acquisition but is not part of the board’s role
7. Disinvestment and consolida- 6. Assist board by providing inputs—
tion and hiring office data, information, aspirations of
• Discontinuance and/or addi- stakeholders in designing vision,
tion of a new line of business mission, strategy and direction
8. Policies and programmes, which 7. Assist board in evaluating the per-
include governance of the com- formance of individuals and also
pany and so on strategies, direction and so on
9. Major investment 8. Provide to the board any other assis-
10. Review of operations vis-à-vis tance, information data that may be
value creation goals

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 ANNEXURE 2 271

Board Management
11. Succession planning and appoint- necessary for the discharge of its role
ment and removal of top man- successfully
agement positions such as CEO, In effect, the management of the
CFO, company secretary, internal business of the company
audit chief and so on
12. Compensation policy and
approval of compensation of
CEO, CFO and other board-
level appointees.
13. Delegations of authority
In effect, the management of the
enterprise

The Essential Book of CORPORATE GOVERNANCE 279

 ANNEXURE 3
Board and Its
Subcommittees
Meeting Protocols

1. Venue
i. The place of the meeting must be exclusive and specified
in the notice itself. It should be secured with no obstruc-
tion of any kind including noise, and should be equipped
with gadgets necessary for video, audio participation and
recordings, presentations, mike and so on. Adequacy of
recording facility must be ensured, which can be done
depending upon the ruling of the chairman.
ii. The room must be kept fully ready before the members
arrive for the meeting, so that no time is lost in starting
the meeting.
2. Attendance
i. The persons participating should be only the members of
the board/committees.
ii. Names of special invitees, whether from the board or
from the HODs’ team or any other person, must be dis-
cussed with the chairman, and, unless approved, partici-
pants should not be allowed to come in the meeting.
iii. During the meeting, nobody should enter the room
unless expressly permitted by the chairman. This is nec-
essary to ensure that all the discussions in the committee/
board, which are privileged, are not heard by any person
other than the ones authorized to attend the meeting.

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 ANNEXURE 3 273

iv. During the meeting, no tea, coffee should be served. It

can be arranged before the start of the meeting and kept
outside for any of the attendees in case he or she desires
to have during the course of the meeting. This will facili-
tate undisturbed and uninterrupted discussions.
3. Participation
i. The chairman should open the meeting with his welcome
and commence the agenda. He should allow free discus-
sions on all the items of the agenda.
ii. No person should start making observation unless he has
sought the nod of the chairman to make his observations.
iii. If any member/invitee is speaking, except for raising
queries on that person’s observations, no other member
should butt in to make his comments. He should indicate
to the chairman who will offer opportunity at the appro-
priate time.
iv. The chairman must offer opportunity to all the members
to make their observations in full on all the items of the
agenda.
v. Person speaking should not be cut short. However, in
case the observations become longer than required or
repeated, the chairman can make a suggestion to be brief.
The chairman has to exercise his authority to control
extraneous factor, unrelated with the agenda, to be dis-
cussed in the meeting.
vi. These meetings are formal forums where decency, dignity
and decorum of the highest order must be maintained
while the agenda items are debated. It is the chairman’s
duty to control the environment and ensure that.
vii. The chairman must facilitate quality discussions.
viii. At the end of the each item, the chairman must sum-
marize clearly the decision taken and provide definite
direction to the management as to the action to be taken
on the decision.
ix. Before the commencement of the meeting, the chairman
must ask the members if any one would like to add any
item to the agenda, and, depending upon the time and
the context, he can decide to allow. At the close of the
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 274 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

meeting, he must ask members once again whether they

have any point or observation to make or any other item
to discuss. He should close the meeting only after that.
4. Minutes
The company secretary must take copious notes so that he
can draft the minutes currently, which truly reflects the dis-
cussions, observations, comments, suggestions, direction and
so on provided by the members and the chairman and even
incorporate tone and tenor of the board members, whether
appreciative and/or critical.

282
Caveat:
Annexure 4 (models of Policies) is a compilation of information and text
from the following sources:

1. Applicable legislative and regulatory provisions of the relevant laws

and regulations mostly, from India but in some cases a few other
jurisdictions.
2. Policies approved by various Boards where author has been/sits as a
Director. However, author had contributed significantly both orally
and writing in the design of those policies.
3. Materials developed in Intuit Consulting, in particular by the author
during consultancy projects and supplied to clients.
4. Some information sourced from the websites/publications of Public
Ltd companies.

Even though, the author has used his skills and experience and done
rationalisation, rewriting, reorientation in most cases, he does not claim
exclusive authorship either full or part of the text and/or material incor-
porated in the Annexures.
These compilations have been made with a view to help the readers who
are practicing managers to design their policies as also students and acad-
emicians to have a fair idea of what should be included in the policies.

The Essential Book of CORPORATE GOVERNANCE 283

 ANNEXURE 4
Policies*

Related Party Transaction Policy

Preamble

The BoD (the ‘board’) of the company has adopted this policy
and procedures with regard to RPTs. The board reserves the right
to review and amend this policy from time to time, based on the
recommendation received from the audit committee and/or legis-
lative or regulatory direction.
This policy is intended to regulate transactions between
them, based on the applicable laws and regulations.

Purpose

This policy is framed as per the requirement of Listing Regulations of

India executed by the company with the SXs and intended to ensure
that proper approvals are obtained and proper reporting is made of
transactions between the company and its related parties. This may
have to be modified in consonance with the applicable laws and
regulations of geographies operated by the company. The company
is required to disclose the RPTs in the financial statements every year.

* All these policies have been designed with reference to Indian laws, rules
and regulations as issued by various regulatory authorities. These will have to
be suitably modified with reference to the applicable laws of the jurisdiction(s)
where the company operate.

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 ANNEXURE 4 277

The policy of the company concerning transactions with the related

parties are also required to be disclosed in the annual report.

Definitions

‘Audit committee or committee’ means the committee of the

Board of Directors of the company, constituted under the provi-
sions of Listing Regulations of India, 2016 and Section 177 of the
Companies Act, 2013.
‘Board’ means the Board of Directors of the company.
‘Key managerial personnel’ means the key managerial personnel as
defined under Section 2(51) read with of the Companies Act, 2013.
‘Material RPT’ means a transaction with a related party where the
transaction(s) to be entered into individually or taken together
with previous transactions during a financial year is in excess of
the lower of the limits mentioned as follows:

i. Five per cent of the annual turnover or 20 per cent of the

net worth of the company as per the last audited financial
statements of the company, whichever is higher
or
ii. the six threshold limits mentioned as follows as per the
Companies Act, 2013, read with the rules framed there-
under and notified from time to time, which presently are:
(a) When a transaction involves sale, purchase or supply
of any goods and material exceeding 10 per cent of
annual turnover as per last year’s audited financial
statement or `1 billion, whichever is lower.
(b) When a transaction involves selling or buying of any
property exceeding 10 per cent of net worth of the
company as per last year’s audited financial statement
or `1 billion, whichever is lower.
(c) When a transaction involves leasing of property of any
kind exceeding 10 per cent of net worth or 10 per cent
of turnover or `1 billion, whichever is lower.

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 278 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

(d) When a transaction involves availing or rendering any

services exceeding 10 per cent of the turnover of the
company or `0.5 billion, whichever is lower.
(e) When a transaction involves appointment to any
office or place of profit in the company, its subsidiary
company or associate company at a monthly remu-
neration exceeding `0.25 million.
(f) When a transaction involves remuneration for under-
writing the subscription of any securities or deriva-
tives thereof of the company exceeding 1 per cent of
the net worth.

‘Policy’ means RPT policy.

‘Related party’ means related party as defined in Clause 49 of the
Listing Agreement which is as follows:
A ‘related party’ is a person or entity that is related to the
company. Parties are considered to be related if one party has
the ability to control the other party or exercise significant
influence over the other party, directly or indirectly, in making
financial and/or operating decisions. It includes the following:

1. A person or a close member of that person’s family is

related to a company if that person
i is a related party under Section 2(76) of the
Companies Act, 2013, that is,
(a) a director or his relative
(b) a key managerial personnel or his relative
(c) a firm in which a director, manager or his rela-
tive is a partner
(d) a private company in which a director or man-
ager or his relative is a member or director
(e) a public company in which a director or manager
is a director and holds along with his relatives,
more than 2 per cent of its paid-up share capital
(f) anybody corporate whose BoD, MD or manager is
accustomed to act in accordance with the advice,
directions or instructions of a director or manager

286
 ANNEXURE 4 279

(g) any person under whose advice, directions or

instructions a director or manager is accustomed
to act, provided that nothing in sub-clauses (vi)
and (vii) shall apply to the advice, directions or
instructions given in a professional capacity
(h) any company which is
a. a holding, subsidiary or an associate com-
pany of such company; or
b. a subsidiary of a holding company to which
it is also a subsidiary;
(i) director, other than independent director, or key
managerial personnel of the holding company or
his relative with reference to a company
ii has control or joint control or significant influence
over the company; or
iii is a key management personnel of the company or of
a parent of the company; or
2. An entity is related to a company if any of the following
conditions applies:
i. The entity is a related party under Section 2(76) of
the Companies Act, 2013.
ii. The entity and the company are the members of the
same group (which means that each parent, subsidi-
ary and fellow subsidiary is related to the others).
iii. One entity is an associate or joint venture of the
other entity (or an associate or joint venture of a
member of a group of which the other entity is a
member).
iv. Both entities are joint ventures of the same third
party.
v. One entity is a joint venture of a third entity and the
other entity is an associate of the third entity.
vi. The entity is a post-employment benefit plan for
the benefit of employees of either the company or
an entity related to the company. If the company is
itself such a plan, the sponsoring employers are also
related to the company.

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 280 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

vii. The entity is controlled or jointly controlled by a

person identified in 1.
viii. A person identified in 1. (ii) has significant influence
over the entity (or of a parent of the entity.

For the purposes of this clause, the term ‘control’ shall have
the same meaning as defined in SEBI (substantial acquisition of
shares and takeovers) Regulations, 2011, and the term ‘relative’
shall have the same definitions as that in Section 2(77) of the
Companies Act, 2013.
Related Party Transaction means any transaction directly
or indirectly involving any Related Party which is a transfer of
resources, services or obligations between a company and a
related party, regardless of whether a price is charged.

Policy

All RPTs must be reported to the audit committee for its prior
approval in accordance with this policy and as per the notifica-
tions amending the Companies (meetings of board) Rules, 2014
made by the Central Government from time to time or as per the
applicable laws and regulations of the geographies operated by
the company.

Identification of Potential Related

Party Transactions

Each director and key managerial personnel is responsible for

intimating the board and the audit committee of the names of the
companies in which they have concern or interest as a director
or member and the related party(ies) at the beginning of every
financial year and the changes therein on the event occurring dur-
ing the course of the financial year. The board/audit committee
may reasonably request for additional information, if required, to

288
 ANNEXURE 4 281

determine whether the transaction does, in fact, constitute an RPT

requiring compliance with this policy.

Restrictions for Related Party Transactions

All RPTs shall require prior approval of audit committee/board.

Furthermore, all material RPTs shall require the approval of the
shareholders through a special resolution, and the related parties
shall abstain from voting on such resolutions.

Review and Approval of Related Party Transactions

The following shall be the process of approving RPTs:

1. RPTs will be normally referred to the next regularly

scheduled meeting of audit committee/board for their
review and approval.
2. For seeking the approval of the audit committee/board,
at the beginning of each financial year, the commercial
department and accounts department shall identify the
transactions likely to occur during the financial year with
the related parties and the value of such transactions which
are likely to take place during the year. On the basis of
the information gathered, the following information is
required to be sent by the concerned unit to the audit com-
mittee/board at least 15 days in advance of the first audit
committee/board meeting to be held in the financial year in
order to enable it to be circulated in advance:
i. Name of the related party and nature of relationship
ii. Nature and duration of contract
iii. Particulars of contract or arrangement
iv. Material terms of contract or arrangement
v. Value of contract or arrangement (total value of con-
tracts for the year to be given)
vi. Advance paid for contract or arrangement

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 282 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

vii. Manner of determining pricing and other commer-

cial terms both included as part of contract and not
considered as part of contract
viii. Whether all factors relevant to the contract have
been considered; if not, the details of factors not
considered and the reasons thereof
ix. Any other relevant information to enable the audit
committee/board to take a decision on the matter.
3. In case of contracts which arise during the course of the
year, information as in point 2 is to be sent to the head
office/Company Secretary at least 15 days in advance of
the audit committee/board meeting.
4. Any member of the committee/board who has a potential
interest in any RPT will recuse himself/herself and abstain
from discussion and voting on the approval of the RPT.
5. The committee will be provided with all relevant mate-
rial information of the RPT, including the benefits to the
company and any other relevant matters.
6. In determining whether to approve an RPT, the audit
committee/board will consider the following factors,
amongst others, to the extent relevant:
• Whether the terms of the RPT are fair and on arm’s
length basis to the company and would apply on
the same basis if the transaction did not involve a
related party.
• Whether there are any compelling business reasons
for the company to enter into the RPT and the nature
of alternative transactions, if any.
• Whether the RPT would affect the independence of
an independent director.
• Whether the proposed transaction includes any poten-
tial reputational risk issues that may arise as a result of
or in connection with the proposed transaction.
• Whether the company was notified about the RPT
before the execution of the transaction, and if not,
why pre-approval was not sought and whether subse-
quent ratification is allowed and would be detrimen-
tal to the company.
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 ANNEXURE 4 283

• Whether the RPT would give rise to a conflict of

interest for any director or key managerial personnel
of the company, considering the size of the transaction,
the overall financial position of the related party and the
ongoing nature of any proposed relationship and any
other factors the board/committee deems relevant.
7. If the audit committee/board is of the view that the RPT is
material or is not at arm’s length basis (though it does not
exceed the limits specified above) and hence requires the
approval of the shareholders, then such transaction shall
be placed before the shareholders at a general meeting to
be convened for such purposes or by way of postal ballot
and approval sought. The transaction shall not be put into
action before the receipt of the shareholders’ approval.
8. The approval shall not be required in case of the following
transactions:
• Transaction that involves the providing of compen-
sation to a director or key managerial personnel in
connection with his or her duties to the company
or any of its subsidiaries or associates, including the
reimbursement of reasonable business and travel
expenses incurred in the ordinary course of business.
• Transaction for allotment or transfer of securities
issued by the company.

RPTs not Approved Under this Policy

In the event, the company enters into an RPT without the prior
approval of the audit committee/board, and such matter is
discovered later, then the same shall be put up before the audit
committee/board at the next following meeting. The reasons for
not getting the same approved by the audit committee/board
shall be made explicit. The audit committee/board may, at its sole
discretion, permit such deviation and approve the same.
In the event the transaction is not approved and has not yet
been concluded, the transaction shall be cancelled forthwith and
all advances made, if any, shall be recovered from the concerned
The Essential Book of CORPORATE GOVERNANCE 291
 284 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

party, failing which necessary disciplinary action will be taken

against the concerned head of commercial/accounts/unit.

Whistle Blower Policy

To enhance the efficacy of Corporate Governance, companies

are required to focus on two areas: (a) creating a strong ethical
compass to guide the organization, (b) establishing a compre-
hensive framework of internal controls to foster a culture of
accountability. Ernst Young’s annual survey of global fraud has
rated whistle blowing mechanism above external audits as the
second most effective means of detecting corruption. People
are now prepared to acknowledge that whistle blowing is about
good corporate citizenship.
It is now mandatory requirement in quite a few regulatory
jurisdictions to have a whistle blower policy within a company.
The whistle blower policy of the company could be designed on
the following lines.

Preface

The company believes in the conduct of the affairs of its constitu-

ents in a fair and transparent manner by adopting highest stand-
ards of professionalism, honesty, integrity and ethical behaviour.
A code of conduct (the code) has been adopted, which lays down
the principles and standards that should govern the actions of
the company and its employees. Any actual or potential violation
of the code, howsoever insignificant or perceived as such, would
be a matter of serious concern for the company. The role of the
employees in pointing out such violations of the code cannot be
undermined, albeit welcomed.
Every employee of the company shall promptly report to the
management any actual or possible violation of the code or an
event he becomes aware of anything that could affect the business
or reputation of company.

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 ANNEXURE 4 285

Definitions

The definitions of some of the key terms used in this policy are
given as follows. The terms, not defined herein, shall have the
meaning assigned to them under the code.

‘Audit committee’ means the audit committee constituted by the BoD

of the company in accordance with relevant sections of the statute
and/or regulations applicable to the company in the jurisdiction
where it is set up and/or operated.
‘Employee’ means every employee of the company (whether
working any where in the world), including the directors in the
employment of the company.
‘Code’ means the company’s code of conduct.
‘Investigators’ mean those persons authorized, appointed, consulted
or approached by the chairman of the audit committee and include
the auditors of the company and the police and other investigative
agencies.
‘Protected disclosure’ means any communication made in good
faith that discloses or demonstrates information that may evidence
unethical or improper activity.
‘Subject’ means a person against or in relation to whom a pro-
tected disclosure has been made or evidence gathered during the
course of an investigation.
‘Whistle blower’ means an employee making a protected disclo-
sure under this policy.

Scope

The whistle blower’s role is that of a reporting party with reliable

information. They are not required or expected to act as investiga-
tors or finders of facts, nor would they determine the appropriate
corrective or remedial action that may be warranted in a given case.

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 286 THE ESSENTIAL BOOK OF CORPORATE GOVERNANCE

Whistle blowers should not act on their own in conducting

any investigative activities, nor do they have a right to partici-
pate in any investigative activities other than as requested by the
chairman of the audit committee.
The chairman of the audit committee will appropriately deal
with protected disclosure, as the case may be.

Eligibility

All employees of the company are eligible to make protected

disclosures under the policy. The protected disclosures may be
in relation to matters concerning the company or any of the sub-
sidiaries of the company.

Disqualifications

While it will be ensured that genuine whistle blowers are accorded

complete protection from any kind of unfair treatment as herein set
out, any abuse of this protection will warrant disciplinary action.
Protection under this policy would not mean protection from
disciplinary action arising out of false or bogus allegations made
by a whistle blower knowing it to be false or bogus or with a mala
fide intention.
Whistle blowers who made three protected disclosures which
have all been subsequently found to be mala fide, frivolous, base-
less, malicious or reported otherwise than in good faith will be
disqualified from reporting further protected disclosures under
this policy. In respect of such whistle blowers, the company/audit
committee would reserve its right to take/recommend appropriate
disciplinary action.

Procedure

All protected disclosures concerning financial/accounting matters

and other protected disclosures should be addressed to the
chairman of the audit committee of the company for investigation.
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 ANNEXURE 4 287

The contact details of the chairman of the audit committee are:

1. Name
2. Phone No.
3. Mobile No.
4. Email ID

If any executive of the company other than the chairman of audit

committee receives a protected disclosure, the same should be
forwarded to the chairman of the audit committee for further
appropriate action. Appropriate care must be taken to keep the
identity of the whistle blower confidential.
Protected disclosures should be reported in writing so as
to ensure a clear understanding of the issues raised and should
either be typed or written in a legible handwriting in English,
Hindi or any other language of the place of employment of the
whistle blower. The protected disclosure should be forwarded
under a covering letter which shall bear the identity of the whis-
tle blower. The chairman of the audit committee shall detach the
covering letter and forward only the protected disclosure to the
investigators for investigation.
Protected disclosures should be factual, and not speculative
or in the nature of a conclusion, and should contain as much
specific information as possible to allow for the proper assess-
ment of the nature and extent of the concern and the urgency of
a preliminary investigative procedure.
The whistle blower must disclose his/her identity in the cov-
ering letter forwarding such protected disclosure. Anonymous
disclosures will not be entertained, as it would not be possible for
it to interview the whistle blowers.

Investigation

All protected disclosures reported under this policy will be thor-

oughly investigated by the chairman of the audit committee of the
company who will investigate/oversee the investigations under
the authorization of the audit committee.
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The chairman of the audit committee may, at its discretion,

consider involving any investigator or agency for the purpose of
investigation.
The decision to conduct an investigation taken by the
chairman of the audit committee is by itself not an accusation and
is to be treated as a neutral fact-finding process. The outcome of
the investigation may not support the conclusion of the whistle
blower that an improper or unethical act was committed.
The identity of a subject will be kept confidential to the extent
possible, given the legitimate needs of law and the investigation.
Subjects will normally be informed of the allegations at the outset
of a formal investigation and have opportunities for providing
their inputs during the investigation.
Subjects shall have a duty to cooperate with the chairman of
the audit committee or any of the investigators during investiga-
tion to the extent that such cooperation will not compromise self-
incrimination/protections available under the applicable laws.
Subjects have a right to consult with a person or persons of
their choice, other than the investigators and/or members of the
audit committee and/or the whistle blower.
Subjects shall be free at any time to engage counsel at their
own cost to represent them in the investigation proceedings.
Subjects have a responsibility not to interfere with the inves-
tigation. Evidence shall not be withheld, destroyed or tampered
with, and witnesses shall not be influenced, coached, threatened
or intimidated by the subjects.
Unless there are compelling reasons not to do so, subjects
will be given the opportunity to respond to material findings
contained in an investigation report. No allegation of wrongdoing
against a subject shall be considered as maintainable unless there
is good evidence in support of the allegation.
Subjects have a right to be informed of the outcome of the
investigation. If allegations are not sustained, the subject should
be consulted as to whether public disclosure of the investigation
results would be in the best interest of the subject and the company.
The investigation shall be completed normally within 45 days of
the receipt of the protected disclosure.

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Protection

No unfair treatment will be meted out to a whistle blower by the

virtue of his/her having reported a protected disclosure under
this policy. The company, as a policy, will condemn any kind
of discrimination, harassment, victimization or any other unfair
employment practice being adopted against whistle blowers.
Complete protection will, therefore, be given to whistle blowers
against any unfair practice such as retaliation, threat or intimi-
dation of termination/suspension of service, disciplinary action,
transfer, demotion, refusal of promotion or the like, including
any direct or indirect use of authority to obstruct the whis-
tle blower’s right to continue to perform his duties/functions
including making further protected disclosure. The company
will take steps to minimize difficulties, which the whistle blower
may experience as a result of making the protected disclosure.
Thus, if the whistle blower is required to give evidence in crimi-
nal or disciplinary proceedings, the company will arrange for
the whistle blower to receive advice about the procedure and
so on.
A whistle blower may report any violation of the aforemen-
tioned clause to the chairman of the audit committee, who shall
investigate into the same and recommend suitable action to the
management.
The identity of the whistle blower shall be kept confidential
to the extent possible and permitted under law. Whistle blowers
are cautioned that their identity may become known for reasons
outside the control of the chairman of the audit committee (e.g.,
during investigations carried out by investigators).
Any other employee assisting in the said investigation shall
also be protected to the same extent as the whistle blower.

Investigators

Investigators are required to conduct a process towards fact find-

ing and analysis. They shall derive their authority and access

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rights from the audit committee when acting within the course
and scope of their investigation.
Technical and other resources may be drawn upon as
necessary to augment the investigation. All investigators shall
be independent and unbiased, both in fact and as perceived.
Investigators have a duty of fairness, objectivity, thoroughness,
ethical behaviour and observance of legal and professional
standards.
Investigations will be launched only after a preliminary
review, which establishes that the alleged act constitutes an
improper or unethical activity or conduct, and either the allega-
tion is supported by information specific enough to be investi-
gated or matters that do not meet this standard may be worthy
of management review, but investigation itself should not be
undertaken as an investigation of an improper or unethical
activity.

Decision

If an investigation leads the chairman of the audit committee to

conclude that an improper or unethical act has been commit-
ted, the chairman with the concurrence of the audit committee
members shall recommend to the management of the company
to take such disciplinary or corrective action as deemed fit. It is
clarified that any disciplinary or corrective action initiated against
the subject as a result of the findings of an investigation pursu-
ant to this policy shall adhere to the applicable personnel or staff
conduct and disciplinary procedures as also law of land, equity,
fairness and justice along with the interest of stakeholders must
be the guiding of the company principles.

Reporting

The chairman of the audit committee shall submit a report to the

audit committee on a regular basis about all protected disclosures

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referred to him/her since the last report, together with the results
of investigations, if any.

Retention of Documents

The company shall retain all protected disclosures in writing

or documented along with the results of investigation relating
thereto for a minimum period of seven years.

Amendment

The company reserves its right to amend or modify this policy

in whole or in part, at any time, without assigning any reason
whatsoever. However, no such amendment or modification will
be binding on the employees unless the same is notified to the
employees in writing.

Code of Business Conduct and Ethics

The code of ethics for the directors—executives and non-

executives—senior management and the employees will help
maintain the standards while dealing with the business of the
company, complying with legal requirement and upholding high
ethical standards in its affairs.

Purpose

• Emphasize company’s commitment to ethics and scrupu-

lous compliance with the law
• Establish basic standards of ethical and legal behaviour
• Help prevent and detect wrongdoing
• Develop reporting mechanism for known or suspected
ethical or legal violations

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Scope

The code will be applicable to all company directors, senior

management and employees serving, in particular, in the roles of
finance, tax, accounting, purchase, treasury, internal audit, finan-
cial analysis and investor relations. It will, of course include, all
committee members and employees at all levels, and members of
the BoD of the company’s subsidiaries.

Accountability to the Company and Stakeholders

General Standards of Conduct

1. Employees’ accountability to the company and its stake-

holders
Standards of conduct: Company expects all the employ-
ees to exercise good judgment and to ensure safety and
welfare of all. The standard will apply while working
in the company’s premises, offsite locations where the
business is being conducted, at company sponsored
business(s), social events or at any other place where the
employee represents the company. Employees engaged in
misconduct may be subjected to disciplinary action, up
to and including termination and dismissal.
2. Work environment
The company would provide a work environment free
of harassment. It would prohibit sexual harassment and
harassment based on pregnancy, child birth or related
medical condition, race, religion, caste, creed, colour,
national origin or ancestry, physical or mental disability,
medical condition, marital status, age, sexual orientation
or any other basis prohibited by local, state or country
law or ordinance or regulation, and would include the
sentiments of all concerned and good order.
The company would establish anti-harassment policy,
which will be applicable to all persons involved in the

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operations of the company and prohibit unlawful harass-

ment by any employee of the company towards the other
company employees.
3. Drug and alcohol abuse
The company would maintain a healthy and productive
work environment. Misuse of controlled substance or
selling, manufacturing, distributing, possessing, using or
being under the influence of illegal drugs and/or alcohol,
unless expressly permitted in the ordinary course of busi-
ness, would absolutely be prohibited.
4. Safety in workplace
The employees would comply with all the applicable
health and safety policies/standards as safety of the peo-
ple in the workplace would be the primary concern of
the company. It would maintain scrupulous compliance
with all local laws to help create and maintain secure and
healthy work environment.
5. Dress code and other personal standard
The employees would report to work properly groomed
and wearing appropriate clothing as they are the represent-
atives of the company. Employees would dress neatly in a
manner consistent with the nature of the work performed.
6. Expense claims
All business-related expense claims would be authorized
by the designated supervisor of the employee before
incurring. The reimbursement of expense incurred
would have to be claimed within the prescribed period
as set by the company. Expense claims post the expiry
of the date would deem to be unauthorized, unless
expressly permitted. Wrong/excess claims would invite
disciplinary action.
7. Solicitation and distribution of literature
In order to ensure efficient operations of the company’s
business and prevent disruption to employees, the
company would establish control of solicitation and
distribution of literature on the company property. No
employee would solicit or promote support for any cause

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or organization during his/her working time or during

the working time of the employee or employee of whom
such activity is directed. Under no circumstances would a
non-employee be permitted to solicit or distribute written
material for any purpose on company property.

Applicable Laws

All the company employees would comply with all applicable

laws, regulations, rules and regulatory orders and directors. Each
employee would acquire appropriate knowledge of the require-
ments relating to his/her duties, sufficient to enable his/her to rec-
ognize potential dangers and to know when to seek advice from
the legal department on specific company policies and procedure
as established by the company.

Corporate Opportunities

Employees would not exploit opportunities for their own personal

gain, which may be discovered through the use of corporate prop-
erty, information or position unless the opportunity is disclosed
fully in writing to company’s BoD and its permission is obtained.

Conflicts of Interest

A conflict of interest exists where the interest or benefits of one per-

son or entity conflict with the interests or benefits of the company.

1. Conflicts of interest can be categorized as the following:

• Actual conflict: A business decision based on per-
sonal relationship or benefits rather than the best
interest of the company.
• Potential conflict: A situation where a change in cir-
cumstance would result in an actual conflict of interest.
• Apparent conflict: It appears or reasonably be per-
ceived by others that an employee is not acting in
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the best interest of the company, whether or not it is

really the case.
2. Outside employment
In consideration of employment with the company, the
employee would accord full attention to the business
interests of the company. The employee is prohibited
from engaging in any activity which would interfere with
the performance and/or responsibility to the company or
is otherwise in conflict with or prejudicial to the inter-
ests of the company. The company would prohibit the
employee from accepting simultaneously employment
with a company supplier, customer, developer or com-
petitor or from taking part in any activity that enhances
or supports a competitor’s position. Additionally, the
employee would disclose to the company any interest of
the conflicts that occurred with the business of the com-
pany. If there are any doubts on this issue, the employee
would contact the supervisor or HR department.
3. Outside directorship
It is a conflict of interest to serve as a director of any
company that competes with the company. The company
policy would require obtaining approval from the com-
pany’s corporate counsel before accepting a directorship
to ensure there is no conflict of interest.
4. Other business interests
If there is any plan of investing in a company, customer,
supplier, developer or competitor, the employee would
take care to ensure not to compromise his responsibili-
ties to the company. Many factors would be considered
in determining whether a conflict exists including the
size and nature of the investment, ability to influence the
company’s decision, access to confidential information
of the company and/or of the other company and the
nature of the relationship between the company and the
other company.
5. Related parties
As a general rule, everybody would avoid conducting
business with a relative or with a business in which a
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relative is associated in any significant role. Relatives

include spouse, siblings, children, parents, grandparents,
grand children, aunts, uncles, nieces, nephews, cousins,
step relationship, in-laws and so on. In case of unavoid-
able RPTs, he/she would fully disclose the nature of the
RPTs to the company’s CFO. If determined to be material
to the company by the CFO, the company’s audit com-
mittee would review and approve in writing in advance
such RPTs. The RPTs, particularly those involving the
company’s directors or executive officers, would be
reviewed and approved in advance by the company’s
BoD as per the procedure laid down for the purpose.
The company would report all such material RPTs under
applicable accounting rules, regulations and legislation.
The company would discourage the employment
of relatives in positions or assignments within the
same department and prohibit the employment of such
individuals in positions that have a financial or other
dependence or influence (e.g., an auditing or control
relationship, or a supervisor–subordinate relationship).
The purpose of this policy is to prevent the organizational
impairment and conflicts, which are likely the outcome
of the employment of relatives, especially in a supervisor–
subordinate relationship. In case of questions/queries
regarding the relationship covered in the policy, the
concerned person would consult HR department.
6. Other situations
As conflicts of interest may arise any time, it would be
impractical to attempt to list all possible situations. If a
proposed transaction or situation raises any question or
doubts in the mind, he/she should consult legal depart-
ment or HR department.

All employees would avoid situations involving actual or

potential conflict of interest. Personal or romantic involve-
ment with a competitor, supplier or subordinate or any other
employee of the company, which impairs an employee’s ability

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to exercise good judgment on behalf of the company, creates an

actual or potential conflict of interest. Supervisor–subordinate’s
romantic or personal relationships also can lead to supervisory
problems, possible claims of sexual harassment and morale
issues. The company would take appropriate corrective action
according to the circumstances in such cases. Failure to disclose
facts would constitute grounds for disciplinary action as consti-
tuted by the company.

Protecting Company’s Confidential Information

The company’s confidential information is a valuable asset. The

confidential information would include product architecture,
source codes, product plans and road maps, name and list of
customers, dealers and employees, financial information and so
on. This information, being the property of the company, would
be protected by patent, trademark, copyright and trade secret
laws. All confidential information would be used for company’s
business purpose only. This responsibility would include non-
disclosure of the company’s confidential information such as
information regarding company’s services or business over the
internet. He/she would also be responsible for properly labelling
any and all documentation shared with or correspondence sent
to the company’s legal department or outside counsel as attorney-
client privileged. This responsibility includes safeguarding, secur-
ing and proper disposal of confidential information in accordance
with the company’s policy on maintaining and managing records.
This obligation extends to the confidential information of third
parties, which company rightfully received under non-disclosure
agreements.

1. Proprietary information and Invention agreement

All employees would sign an agreement to protect and
hold confidential the company’s proprietary information
and would not disclose without the prior written consent
of an authorized company officer.

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2. Disclosure of company confidential information

To enhance the company’s business from time to time,
the company’s information may be disclosed to poten-
tial business partners; however, such disclosures would
never be done without carefully considering its potential
benefits and risks.
Requests by regulatory authorities: The company and
its employees would cooperate appropriately with the
government and/or regulators enquiries and investiga-
tions. However, it is important to protect the legal rights
of company with respect to its confidential information.
All such requests for information, documents or inves-
tigative interviews would be referred to the company’s
legal department. No financial information to be dis-
closed without the prior approval of the CFO.
3. Company spokespersons
The corporate communication and analyst policy would
be established in the company who will be responsible
for communicating information to the press and financial
analyst community. All enquiries or calls from the press
and financial analyst would be referred to the CFO or
investor relations department. The company would desig-
nate its CEO, executive directors, CFO, investor relations
department personnel as official company spokespersons
for financial matters. All press releases, interviews, media
enquiries would be pre-cleared by legal department.

Insider Trading

Obligations under the applicable securities law apply to every-

one, if listed or as when the company gets listed on any of the
SXs. In the normal course of business, the directors, employees,
consultants of the company come into possession of significant,
sensitive information. They would not profit from it by buying
or selling securities of the company by themselves. Furthermore,
they would not tip others to enable them to profit or to profit
on their behalf. The purpose of this policy is both to inform the
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employees of their legal responsibilities and to make clear that the

misuse of sensitive information is contrary to company’s policy
and applicable securities law and so on.
Insider trading is a crime, penalized with fines and imprison-
ment for individuals. In addition, the regulator may seek the impo-
sition of a civil penalty of up to five times the profit made or losses
avoided from the trading. Insider traders would also be disgorged
any profits made, and are often subjected to an injunction or criminal
proceeding against future violations and may be subjected to civil
liability in private lawsuits.

Prohibition against Short Selling of the Company Stock

The company directors, employees would not sell any equity

security, including derivatives of the company directly or indi-
rectly if he/she

• Does not own the security sold.

• Owns the security and does not deliver it against such
sale (a ‘short sale’) within applicable settlement cycle.
• The company directors, employees would not engage in
short sales.
• NEDs are not prohibited by law from engaging in short
sales of company’s securities. However, it would be advis-
able for them not to do so.

Use of Company’s Assets

1. General: Protecting company’s assets would be the key

responsibility of every employee. Care should be taken
that assets are not misappropriated, loaned to others or
sold or donated without appropriate authorization. All
company employees would be responsible for the proper
use of company assets and would safeguard such assets
against loss, damage, misuse or thefts. Employees violat-
ing the law would be subject to disciplinary action, even
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up to, and including, the termination of employment or

business relationship of company’ sole discretion.
2. Company brand and logo: The company and tagline,
if any, are registered trademarks of the company. They
would be conspicuously marked with the ®designation
or with a notation that they are registered trademarks of
the company whenever it is used in any medium, presen-
tation or other promotional context.
3. Physical access control: The company would develop
procedures covering physical access controls to ensure the
privacy of communications, maintenance of the security of
the company’s communication equipment and safeguard
of company’s assets from theft, misuse and destruction.
4. Company funds: Every employee of the company would
be personally responsible for all company funds over
which he/she is in control. It would be used only for com-
pany’s business purposes. The employees of the company
would take reasonable steps to ensure that the company
receives good value for company funds spent and would
maintain accurate and timely records of all the expendi-
ture. Expense reports would be accurate and submitted
in a timely manner. Company funds would not be used
by the employees for any personal use.
5. Equipment: The company would try to furnish the employ-
ees with equipment necessary to do the job efficiently and
effectively, and they would care for that equipment and
use it responsibly only for company’s business purposes. If
the company equipments are used at home or offsite, they
would take precautions to protect it from theft or damage.
Employees would not maintain any expectation of privacy
with respect to information transmitted over, received by
or shared in any electronic communication device owned,
leased or operated in whole or in part by on behalf of the
company.
6. Electronic usage: The purpose of this policy is to make
certain that the employees would utilize electronic and/
or other communication devices in a legal, ethical and
appropriate manner. This policy would address the
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company’s responsibilities and concern regarding the fair

and proper use of all electronic communication devices
within the organization including computers, e-mails,
connection to the internet, intranet and extranet and any
other public or private networks, voice mail, video con-
ferencing, facsimiles and telephones.
7. Software/application mobile/designing, manufacturing
requirements of products: This is to be used by employ-
ees to conduct the company’s business, which would
be appropriately licensed. Never make or use illegal or
unauthorized copies of any Intellectual Property Rights
(IPR) technology, apps, software, whether in office, at
home or on the road, since doing so would constitute
copyright infringement and would expose the employee
and the company to potential civil and criminal liability.

Maintaining and Managing Records

The purpose of this policy is to set forth and convey the company’s
business and legal requirement in managing records, including all
recorded information regardless of medium or characteristics.
Records would include paper documents, CDs, computer hard
disks, email, innovative patent designs or all other media and so
on that the company is required, by local, state, national, foreign
and other applicable laws, rules and regulations, to retain records
and to follow specific guidelines in managing its records.

Records on Legal Hold

A legal hold would suspend all document destruction procedures

in order to preserve appropriate records under special circum-
stances, such as litigation or governmental investigations and
identify the type of company records or documents required to
be placed under a legal hold. Every company employee would
comply with the policy, failure of which would subject to disci-
plinary action.
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Payment Practices

1. Accounting practices
The company’s responsibilities to its stakeholders and the
investing public would require that all transactions are
recorded fully and accurately in company’s books and
records in compliance with all applicable laws. All the
required information would be accessible to the company’s
auditors and other authorized persons and government and
regulatory agencies. False or misleading entries, unrecorded
funds or assets or payments without appropriate support-
ing documents and approvals are to be strictly prohibited
as they violate company’s policy and law. There would be
no wilful omissions of any company transaction from the
books and records, no advance income recognition and no
hidden bank accounts or funds. Any wilful material misrep-
resentation of and/or misinformation of financial accounts
and reports would be regarded as a violation of the code,
apart from inviting appropriate civil or criminal action
under the relevant laws. All documentation supporting a
transaction should fully and accurately describe the nature
of the transaction and be processed in a timely fashion.
2. Political contribution
The company would reserve the right to communicate
its position on important issues to elected representatives
and other government officials. It is the company’s policy
to comply fully with all local, state, national and other
applicable laws, rule and regulations regarding political
contributions. The company’s fund or assets would not
be used for or be contributed to political campaigns or
political purposes under any circumstances without the
prior written approval of the company’s corporate coun-
sel and the BoD.
3. Prohibition of inducements
Under no circumstances would employees offer to pay,
make payment, promise to pay or issue authorization to
pay any money, gift or anything of value to customers,

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vendors, consultants and so on that is perceived as

intended directly or indirectly to improperly influence
any business decisions, any act or failure to act, any
commitment of fraud or opportunity for the commission
of any fraud. Inexpensive gifts, infrequent business meals,
celebrating events and entertainment, provided that they
are not excessive or create an appearance of impropriety,
do not violate their policy.

Responsibility and Accountability to Customers

and Suppliers

Customer Relationship

If the company puts any employee in contact with its customer,

it is critical for the employee to remember that he/she represents
the company to the people with whom they would be dealing. Act
in a manner which would create value for the customers and help
to build relationship based upon trust.

Payments or Gifts from Other

Under no circumstances would employees accept any offer, pay-

ment, promise to pay or authorization to pay any money, gift or
anything of value from customers, vendors, consultants and so on
which is perceived as intended directly or indirectly to influence
any business decisions, any act or failure to act, any commit-
ment of fraud, or opportunity from the commission of any fraud.
Inexpensive gifts, infrequent business meals, celebrating events
and entertainment, provided which would not be excessive or cre-
ate an appearance of impropriety, do not violate the policy. Before
accepting or giving anything of value from or to an employee of a
government or government entity or any other entity/person con-
nected with company. The employee would contact the legal, HR
or the finance department. Questions/queries regarding whether a

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particular payment or gift violates the policy would be directed to

legal department. The nature and cost would always be accurately
recorded in the company’s book and records.

Publication of Other’s Copyright Material

The company would subscribe to publication which includes

newsletter, reference works, online reference services, magazines,
books and other digital and printed work to help employees do
their jobs better. Copyright law generally protects these works,
and their unauthorized copying and distribution constitute copy-
right infringement. The company would have to first obtain the
consent of the publisher of a publication before copying publica-
tions or significant part of them. It would consult the legal depart-
ment on the doubt of copying a publication.

Handling the Confidential Information of Others

The company would have many kinds of business relationships

with many companies and individuals. Sometimes, they would
volunteer confidential information about their product or business
plans to induce the company to enter into a business relationship.
At other times, the company would request a third party to pro-
vide confidential information to permit the company to evaluate
on potential business relationship with that party. Whatever the
situation, the company would take special care to handle the con-
fidential information of others responsibly. It would handle such
confidential information in accordance with the agreements with
such third parties. Refer to maintaining and managing records.

1. Non-disclosure agreements
Confidential information would take many forms. An oral
presentation about company’s product development plans
would contain protected trade secrets. A customers list or
employee list would be a protected trade secret. Employee
would never accept information offered by a third party,

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which is represented as confidential or which appears from

the context or circumstances to be confidential, unless an
appropriate non-disclosure agreement, which would be
signed with the party, offers the information. The legal
department would provide non-disclosure agreement to
fit any such situation and would coordinate appropriate
execution of similar agreements on behalf of the company.
2. Need to know
Once the third party’s confidential information is dis-
closed to the company, it would be obliged to abide
by the laws of the relevant non-disclosure agreement
and limit its use to the specific purpose for which it is
disclosed and to disseminate it only to other company
employees with a need to know the information. In case
of any doubt, consult the legal department.
3. Notes and reports
When reviewing the confidential information of a third
party under a non-disclosure agreement, it will be natural
to take notes or prepare reports summarizing the results
of the review, and, based partly on those notes or reports,
to draw conclusions about the sustainability of a busi-
ness relationship. Notes on reports include confidential
information disclosed by the other party and so would
be retained long enough to complete the evaluation of the
potential business relationship. These would be treated
just as any other disclosure of confidential information
is treated, marked as confidential and distributed only to
those the company employees with a need to know.
4. Competitive information
The company would never attempt to obtain competi-
tors’ confidential information by improper means and
would especially never contact a competitor regarding
their confidential information. While the company might
and would employ former employees of competitors, the
company would recognize and respect the obligations of
those employees not to use or disclose the confidential
information of former employers.

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Selecting Suppliers

The company’s suppliers make significant contributions to the

success. To create an environment where the supplier would have
an incentive to work with the company, they must be confident
that they would be treated lawfully and in an ethical manner.
The company’s policy would be to purchase supplies based on
need, equality, service, price and terms and conditions. The
company’s policy would be to select significant suppliers or enter
into significant supplier agreements through a competitive bid
process, wherever possible. Under no circumstances would any
employee attempt to coerce suppliers in any way. In some cases
where the products/services are designed, fabricated or developed
to the company’s specifications, the agreement between the par-
ties would contain restrictions on sales, which must be followed
scrupulously. While selecting suppliers, their record of ethics and
good conduct would be ascertained.

Government Relations

It is the company’s policy to comply fully with all applicable laws

and regulations governing contact and dealings with government
employees and public officials, and to adhere to high ethical, moral
and legal standards of business conduct. The policy would include
strict compliance with all local, state, national, foreign and other
applicable laws, rules and regulations. In case of any question, the
employee would contact company’s legal department.

Lobbying

Employees whose work requires lobbying, communication with

any member or legislative body or with any government official
or employee of a legislative body or with any government official
or employee in the formulation of legislation, would have prior
written approval of such activity from the corporate counsel.

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 ANNEXURE 4 307

Activity covered by the policy would include meeting with

legislature or members of their staffs or with government officials.
Preparation, research and other background activities, which
in case would be done in support of lobbying communication
also, would be covered by this policy even if the communication
ultimately is not made.

Government Contracts

It is the company’s policy to comply fully with all applicable laws

and regulations that apply to government contracting. It is also
necessary to strictly adhere to all terms and conditions of any
contract with local, state, national, foreign or other applicable
governments. The company’s legal department would review and
approve all contracts with any government entity.

Waivers

Any waiver of the code of business conduct and ethics for a

member of company’s BoD or executives would be approved in
writing by the company’s BoD and would be promptly disclosed.
Any waivers of any provision of the code of business conduct and
ethics, with respect to any other employee, would be approved in
writing by the company’s corporate counsel.

Disciplinary Actions

The matters covered in the code of business conduct and ethics

would be of utmost importance to the company, its stakeholders
and its business partners, and are essential to company’s abil-
ity to conduct its business in accordance with its stated values.
The company would expect all employees and consultants to
adhere to the rules in carrying out their duties for the com-
pany. The company would take appropriate action against the

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employee, consultants whose actions would be found to violate

the policies of the company.

Industrial Espionage

It is the company’s policy to lawfully compete in the marketplace.

Its commitment to fairness would include respecting the rights
of competitors and abiding by all applicable laws in the course
of competing. The purpose of the policy is to maintain the com-
pany’s reputation as lawful competitor and to help ensure the
integrity of the competitive market place. The company would also
expect its competitors to respect the right to compete lawfully in
the market place and vice versa. Company’s employees would not
steal or unlawfully use the information material, products, intellec-
tual property or proprietary or confidential information of anyone
including supplier, customer, business partners or competitors.

Free and Fair Competition

Most countries have developed bodies of law designed to encour-

age and protect free and fair competition. The company would be
committed to obey the laws both in letter and spirit. The conse-
quences of not doing so can be severe.
These laws often regulate the company’s relationship with its
distributors, resellers, dealers and customers. Competition laws
generally address the following areas: pricing practices (including
pricing discrimination), discounting, terms of sale, credit terms,
promotional allowances, secret rebates, exclusive dealerships
or distribution ship, product bundling, restrictions on carry-
ing competing products, termination and many other practices.
Competition laws also govern, usually quite strictly, the relation-
ship between the company and its competitors. As a general rule,
contacts with competitors would always avoid subjects such as
prices or other laws and conditions of sale, customers and sup-
pliers. Employees of the company would not knowingly make

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false or misleading statements regarding its competitions or the

products of its competitors, customers or suppliers. Participating
with competitors in a trade association or in a standards crea-
tion body would be acceptable when the associations is properly
established, has a legitimate purpose and has limited its activities
to those purpose.
The employees would not, any time or under any circum-
stances, enter into an agreement or understanding—written or
oral, expressed or implied—with any competition concerning
prices, discounts, other terms or conditions of sale, profits or
profit margins, costs, allocation of product or geographic mar-
kets, allocation of customers, limitations on production, boycotts
of customers or suppliers, or bids or the intent to bid or even
discuss or exchange information on the same subjects. In some
cases, legitimate joint ventures with the competitors may permit
exceptions to the rules as may be bona fide purchases from or
sales to competitors on non-competitive products, but the com-
pany’s legal department would review all such proposed ventures
in advance. This prohibition would be absolute and strict obser-
vance would be kept. Collusion among competitors is illegal, and
the consequences of a violation would be severe.
Although the spirit of this law, known as antitrust, com-
petition, or consumer protection or unfair competition laws, is
straightforward, their application to particular situations would
be quite complex. To ensure that the company complies fully
with these laws, each of the employees would have a basic knowl-
edge of them and would involve legal department early on when
questionable situation arises.

Interpretation of Code

Any question or interpretation under this code of ethics and busi-

ness conduct will be handled by the board or any person/com-
mittee authorized by the board of the company. The BoD or any
designated person/committee has the authority to waive compli-
ance with this code of business conduct for any director, member

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of core management team, officer or employee of the company.

The person seeking waiver of this code shall make full disclosure
of the particular circumstances to the board or the designated
person/committee.

Compliance with the Code of Conduct

Compliance with this code of conduct is an obligation. The com-

pany directors, senior management and all employees serving,
in particular, in the roles of finance, tax, accounting, purchase,
treasury, internal audit, financial analyst and investor relations,
must ensure that this code is communicated to, understood and
observed by all employees. It will, of course, include all com-
mittee members and employees at all levels and members of the
board of the company and its subsidiaries. The directors and the
senior management shall affirm compliance with the code on an
annual basis. The board expects employees to bring to their atten-
tion, or to that of senior management, any breach or suspected
breach of this code. Compliance with this code is subject to the
review by the board and complemented by the audit committee
of the board. Any modification(s), amendment(s) or review of this
code shall be done by the board.

318
Caveat:
Annexure 5 (models of Charters) is a compilation of the information and
text from the following sources:

1. Applicable legislative and regulatory provisions of the relevant laws

and regulations mostly, from India but in some cases a few other
jurisdictions.
2. Charters approved by various Boards where author has been/sits as a
Director. However, author had contributed significantly both orally
and writing in the design of those Charters.
3. Materials developed in Intuit Consulting, in particular by the author
during consultancy projects and supplied to clients.
4. Some information sourced from the websites/publications of Public
Ltd companies.

Even though, the author has used his skills and experience and done
rationalisation, rewriting, reorientation in most cases, he does not claim
exclusive authorship either full or part of the text and/or material included
in the Annexures.
These compilations have been made with a view to help the readers who
are practicing managers to design their charters as also students and acad-
emicians to have a fair idea of what should be included in the charters.

The Essential Book of CORPORATE GOVERNANCE 319

 ANNEXURE 5
Charters*

Audit Committee

The need of a powerful subcommittee of the board christened as

the audit committee, which functions to help the board to assess the
quality of financial reporting cannot be overemphasized.

Purpose

1. To help ensure the preservation of good financial prac-

tices throughout the company.
2. To help ensure the adoption of sound accounting poli-
cies which are consistent with the nature and size of the
business.
3. To help ensure 100 per cent regulatory compliance with
respect to all domestic and international tax laws and
other legal acts, laws and statutes.
4. To help ensure that the company is hedged against the
potential risks which could impact the business (This will
not be there if there is a separate RMC).
5. To monitor that internal controls are in place and effective.
6. To help ensure the integrity of the financial information
reported to the board and shareholders.
* All these charters have been designed with reference to Indian laws, rules
and regulations as issued by various regulatory authorities. These will have to
be suitably modified with reference to the applicable laws of the jurisdiction(s)
where the company operate.

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 ANNEXURE 5 313

7. To provide by way of regular meetings, a link communicator

between the board and the external and internal auditors.

Powers of the Committee

1. To investigate any activity within its terms of reference

2. To seek information from any employee
3. To obtain outside legal or other professional advice
4. To secure attendance of outsiders with relevant expertise,
if it considers necessary.

Terms of Reference

1. Oversight of company’s financial reporting process and

disclosure of its financial information to help ensure that
the financial statements are correct, sufficient and credible.
2. Review the quarterly and annual financial statements
with the management and auditors before submission to
the board for consideration and approval, particularly on
the following:
i. Matters required to be included in the director’s
responsibility statement as a part of the board’s report
in terms of applicable laws regulations of the jurisdic-
tion where all it is regulated
ii. Any changes in accounting policies and practices and
their consistency
iii. Major judgmental areas
iv. Significant adjustments resulting from the audit
v. Regulatory Compliances including listing, tax and
other legal obligations relating to financial statements
vi. Disclosure of RPTs, if any
vii. Qualifications in the draft audit report
viii. Compliance with accounting standards
ix. Management discussion and analysis and result of
operations and so on

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3. Review with the management and statutory and internal

auditors the adequacy of the internal control systems.
4. Consider the appointment, reappointment and, if required,
the replacement or removal of the statutory auditor, tax
auditor and the head of internal audit (who has direct
access to the chairman of the committee)/the outsourced
internal audit firm, and questions relating to their resig-
nation or dismissal, and to consider and recommend to
the board the remuneration of the external auditors.
5. Review the relationship with the external auditors,
including consideration of audit fees as well as any other
services non-audit activities, to ensure that is balanced
objectivity with the value for money.
6. Discuss with the statutory auditor, tax auditor and inter-
nal auditors, before the audit commences, about the
nature and scope of audit as well as post-audit discussion
to ascertain any area of concern.
7. Discuss with the external auditors the problems and res-
ervations arising from their audits or/and any other mat-
ter the external auditors may wish to discuss.
8. Review the external auditor’s management letter and
management’s response.
9. Review the annual audit programme, ensure coordina-
tion between the internal and external auditors, and also
ensure that no area is left to be covered and that the inter-
nal audit function has sufficient freedom and resource to
carry out its role.
10. Review any reports submitted by the internal auditors
and consider the major findings of internal investigations
into any material failures of internal controls, irregulari-
ties and/or frauds and to obtain management’s responses
and convey the results thereof to the board.
11. Review the company’s statement on internal accounting
and financial control systems prior to endorsement by the
board and, in particular, to review:
i. The procedures for identifying business risks (includ-
ing financial risks) and controlling their financial
impact on the company
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 ANNEXURE 5 315

ii. The company’s policies for preventing or detecting

fraud
iii. The company’s policies for ensuring that it complies
with relevant regulatory and legal requirements
iv. The operational effectiveness of the policies and
procedures
v. The company’s internal financial and non-financial
reporting and internal control framework (including
treasury)
12. Look into reasons for substantial defaults in the payment to
the depositors, debenture holders, shareholders (in case of
non-payment of declared dividends) and creditors.
13. Review and administer the functioning of the WBM.
14. When money is raised through a public/rights/pref-
erential issue and so on, review and ensure that the
management discloses the uses/applications of funds
by category (capital expenditure, sales and marketing,
working capital and so on) as per the prospectus on a
quarterly basis.
15. The chairman of the audit committee to be present at the
AGM to answer shareholders’ queries on matters within
the committee’s area of responsibility.

Explanation: The term ‘RPTs’ shall have the same meaning as

contained in the Accounting Standard 18 ‘RPTs’, issued by the
institute of accountants and the regulators.

CEO/CFO Certification

The audit committee shall review the disclosures, if any, made by

CEO/CFO on:

1. Significant changes in internal controls, financial report-

ing and so on during the year.
2. Significant changes in accounting policies during the year
and the disclosure thereof in the notes to the financial
statements; and instances of fraud of which they have
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become aware and the involvement therein, if any, of the

management and/or an employee having a significant role
in the company’s internal control system.

Subsidiary Company

The audit committee of the holding company shall also review the
financial statements, in particular, the investments made by the
unlisted subsidiary company.

Authority

The committee is authorized by the board to oversee any investiga-

tion of activities within its terms of reference and acts as a court of
last resort. It is authorized to seek any information it requires from
any employee, and all employees are directed to cooperate with any
request made by the committee. It may obtain outside legal or other
independent professional advice and secure the attendance of outsid-
ers with relevant experience and expertise if it considers necessary.

Meetings

1. The committee should meet at least four times in a year,

and not more than four months shall lapse between two
meetings, including before the announcement of the
company’s preliminary and interim results and to con-
sider whether or not to recommend the reappointment
of the external auditors at the next AGM.
2. The committee will meet the board at least once a year
to discuss matters such as the annual report and the rela-
tionship with the external auditors. Additional meetings
may be called by the chairman of the committee or may
be requested to be called by the chairman, the MD or the
company’s external auditors.

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 ANNEXURE 5 317

3. The quorum for any meeting of the audit committee

shall be either two members or one-third of the mem-
bers of the audit committee, whichever is greater, but
there should be a minimum of two independent mem-
bers present, with the majority of independent directors
present.
4. In the absence of the committee chairman, the remain-
ing members present shall elect one of the members to
chair the meeting, bearing in mind legal and regulatory
requirements.
5. The committee shall periodically meet in private with the
external and internal auditors without the presence of
the executive directors and management representatives.
Independent directors of the committee alone can meet
the statutory or internal auditors.

Composition

1. The committee members and the chairman are appointed

by the board from amongst the NEDs, in compliance with
legal and regulatory requirements.
Chairman To be an independent director
Members NEDs & Independent directors
2. However, the majority will be that of independent direc-
tors, not only by the constitution, but in every meeting.
3. All members shall be financially literate, and at least one
member, preferably the chairman, shall have expertise in
accounting or financial management.
In attendance Internal auditor
Statutory auditor/external auditors
CFO
Secretary Company secretary
4. The MD and/or CEO, the CFO, the internal auditor and
external auditor may, at the invitation of the chairman
of the committee, attend and speak at meetings of the

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committee; other may be called upon or shall be able to

speak, answer queries by prior arrangements with the
chairman of the committee.

Reporting Procedures

1. The secretary shall circulate the minutes of the meetings

of the committee to all members of the committee, fol-
lowing their approval by the chairman of the committee.
Any director may obtain copies of the committee’s agenda
and minutes with the agreement of the chairman of the
committee.
2. The chairman of the committee will present to the
board a brief of the discussions in the meetings of the
committee.

Nomination and Remuneration Committee

Analysis of several Corporate Governance failures has brought to

light the payment of excessive compensation to the top manage-
ment team and the BoD as one of the basic malaise. Although
it is important to compensate adequately the performance and
contribution, any excessive remuneration can lead to:

1. Erosion of the stakeholders’ value.

2. Disproportionate sharing of the company’s profitability
by one set of stakeholders.
3. Incentive to manage and manipulate performance to pro-
mote their enlightened self-interest.
4. Prevent boards for packing up board with friends from
‘cozying up club’ rather than variety of skills, wisdom and
commitment customized to the demands of the enterprise.

Hence, increasingly, need is being felt of a powerful subcom-

mittee of the board christened as nomination and remuneration

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 ANNEXURE 5 319

committee, which functions efficaciously to balance the adequacy

and excessive compensation and obviates conflict of interest and
brings talent, objectivity and wisdom to the boardroom. In some
of the jurisdictions, constitution of such a committee has already
been made compulsory by legislation/regulation.

Purpose

The NRC will assist the BoD of the company to:

1. Determine, review and propose compensation principles

for the company.
2. Setting the compensation policy of the company’s execu-
tive directors.
3. Undertake the performance appraisal of the CEO and the
board-level executives.
4. Approve payments to the managerial personnel as per the
policy laid down by the committee.
5. Assess and review compensation policy and plans recom-
mended by the management.
6. Recommend suitable candidates for appointment of
executive, non-executive and independent directors.

Responsibilities and Duties

The responsibilities and duties of the NRC can be categorized into

the following:

1. Nomination Policy
i. Lay down the principles and policy for the selection
and retirement of independent directors and NEDs.
ii. Identify persons who are qualified to become directors—
independent, non-executive and executive, and also
persons who may be appointed in senior management
in accordance with the criteria laid down, recommend

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to the BoD their appointment and removal and shall

carry out evaluation of every director’s performance.
iii. Formulate the criteria for determining qualifications,
positive attributes and independence of a director and
recommend to the BoD a policy relating to the remu-
neration for the directors, key managerial personnel
and other employees.
2. Remuneration Policy
i. Submission of the remuneration policy to the BoD for
approval.
ii. The committee will provide compensation plans and
practices on the basis of remuneration principles.
iii. Describe main roles, responsibilities and competen-
cies involved in the remuneration process.
iv. Provide specific guidelines for the setting of BoD and
executive board members’ remuneration.
v. The committee would also review the company’s
remuneration principles.
vi. The committee would periodically review the imple-
mentation of the remuneration policy.
vii. The committee may look into the company’s internal
audit function limited to performing periodic reviews
on the remuneration to ensure the applicable rules
and standards are complied with.
viii. The committee would set working standards for
determining the remuneration of the members of the
senior management of the company and recommend
to the BoD for approval.
ix. The committee shall ensure, while formulating the
above policy, that:
(a) The level and composition of remuneration is
reasonable and sufficient to attract, retain and
motivate directors of the quality required to run
the company successfully;
(b) Relationship of remuneration to performance is
clear and meets appropriate performance bench-
marks; and

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(c) Remuneration to directors, key managerial per-

sonnel and senior management involves a bal-
ance between fixed and incentive pay reflecting
short- and long-term performance objectives
appropriate to the working of the company and
its goals, provided that such policy shall be dis-
closed in the board’s report.
The chairman of the committee or, in his absence,
any other member of the committee authorized
by him in this behalf shall attend the general
meetings of the company.
3. Performance Review
i. The committee would review competitor’s market
data, trend analysis, performance and the methodol-
ogy for determining annual remuneration pools with
the management.
ii. The committee would assess individual performance
evaluations of the executive board members including
their performance inclusive of managing risk, compli-
ance to the code of conduct and so on.
iii. The committee would get the inputs from the com-
pany’s internal control function, code of conduct for
reviewing the performance.
4. Setting Remuneration
i. The NRC would propose compensation for NEDs of
the board and individual executive board director for
the approval from the BoD.
ii. The NRC would review and recommend the bonus
pools to the executive directors of the board for
approval.
iii. Discuss and determine the CEO’s remuneration to
achieve company’s goals and objectives upon the
performance.
iv. Review and recommend to the BoD for approval of
any mandatory disclosures of the management com-
pensation.

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5. Reporting to the BoD

i. The committee would provide a periodical report
to the BoD on its activities, implementation of the
remuneration policy and adhering to the applicable
standards and rules and remuneration paid to the
executive board members.
ii. The committee would review the compensation-
setting process on an annual basis.
6. Annual Remuneration Report
According to the requirement of annual reporting, the
committee would review and approve the annual remu-
neration report prior to the BoD’s approval, which satisfies
the remuneration principles, policy, plans for the year.
7. Other Responsibilities
The NRC would review and reassess the adequacy of the
charter and perform annual self-evaluation of the perfor-
mance of the NRC.

Composition

1. Minimum three members

2. Majority should be independent directors
3. Chairman should be an independent director but not the
chairman of the board
4. Secretary: company secretary

Meetings

Meetings can be held as and when necessary. However, at least

two meetings in a year with a gap of not more than six months
must be held.

Reporting

The secretary shall circulate the minutes of the meetings of the

committee to all the members of the committee, following their

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 ANNEXURE 5 323

approval by the chairman of the committee. Any director may

obtain copies of the committee’s agenda and minutes with the
agreement of the chairman of the committee.

Stakeholders Relations Committee

Stakeholder’s confidence is primary to the survival and sustain-

ability of success of the companies. Hence, their interests have to be
well looked after, which necessitates the constitution of an effective
committee which balances the interest of all stakeholders.

Purpose

1. To ensure that efficient systems are in place for expedi-

tious transfer of shares and redressal of all the stakehold-
ers grievances.
2. To ensure all statutory compliances relating to shares/
fixed deposits, debentures or any other security holders
are compiled within the prescribed time, and there are
no defaults.
3. To ensure there is balance in the interest of all stakehold-
ers proportional to contribution and eligibility.

Terms of Reference

The role of the stakeholders relations committee shall be the

following:

1. Review the redressal of shareholders, debenture holders

and depositors or any other security holder’s grievances/
complaints such as transfer of shares, non-receipt of
balance sheet, declared dividends and interest warrants
and so on, and ensure cordial relation with the stake-
holders.

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2. Review the adherence to service standards relating to the

various services rendered by the company and company’s
registrars and transfer agents.
3. Review the status of the litigations(s), complaints/suits
filed by or against the company relating to the shares/
fixed deposits, debentures or any other security hold-
ers of the company before any courts/other appropriate
authorities, and in particular where directors are impli-
cated or could be made liable.
4. Review the impact of enactments/amendments made by
the various regulatory authorities on matters concerning
the stakeholders in general.
5. Review matters relating to the transfer of unclaimed and
unpaid dividend, matured deposits, interest accrued on
the matured deposits, debentures and so on to the investor
education and protection fund as may be specified under
any legislation, rules, regulations, directions and so on.
6. Review the status of claims received for unclaimed shares
and dividend on unclaimed shares.
7. Review the initiatives taken to reduce quantum of
unclaimed dividends/unclaimed deposits.
8. The chairman of the committee or, in his absence, any other
member of the committee authorized by the chairman in
his behalf shall attend the general meetings of the company.
9. The shareholders/investors grievance committee shall act on
such further terms of reference as may be considered neces-
sary and specified by the board in writing from time to time.
10. Review service standards and investor service initiatives
undertaken by the company.
11. Review in balances conflict perceived, if any, amongst the
interest of various stakeholders.

The stakeholders relations committee shall have such powers/

functions/features/role and activities and shall also comply with
such other stipulation to meet the requirements as may be neces-
sary both under any legislation, as well as under the listing agree-
ments of SXs in which the company’s shares are listed.

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Meetings

1. The committee should meet at least two times in a year

and, not more than six months shall lapse between two
meetings.
2. The quorum for any of the meetings shall be either two
members or one-third of the members of stakeholders’
relations committee, whichever is greater, but there
should be a majority of independent directors.
3. In the absence of the committee chairman, the remaining
members present shall elect one of the members to chair
the meeting.

Composition

The committee members and the chairman will be appointed by

the board from amongst the NEDs, in compliance with legal and
regulatory requirements, and shall not be less than three with a
majority of independent directors.

Chairman: Independent director

Members: NEDs &
Independent directors
Secretary: Company secretary

Reporting Procedures

The committee shall report to the board.

The secretary shall circulate the minutes of the meetings of
the committee to all the members of the committee, following
their approval by the chairman of the committee. Any director
may obtain the copies of the committee’s agenda and minutes
with the agreement of the chairman of the committee.

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Risk Management Committee

Every enterprise functions in a given environment. The envi-

ronment is undergoing unremitting transformation. Changes
in environment throw up challenges which engulf not only the
operations of the company, but even its existence. The threat
of the irrelevance/obsolescence of the product/service, revenue/
business model and organizational design as a consequence of
changes in the environment is real. This warrants a very powerful
RMC to ensure the success and the sustainability of the enterprise.

Purpose

The purpose of the RMC will be to assist the BoD in the following:

1. Visualizing both macro and micro risks that may impact

the business of the company.
2. Building scenarios of the environment, risks that unfold
and assess the consequences thereof on the profits and
the sustainability of the company.
3. Designing a framework for efficacious management of
the risk.
4. Creating processes for the effective implementation of the
risk management framework.
5. Reviewing the risk management.
6. Generating ideas for converting risk into opportunity.

Risk Management Committee Role

1. Define corporate risks (vision, strategy based risks),

opportunity loss risks, regulatory risks project-specific
risks and support and systems risks. Also, the impact of
those risks at macroeconomic levels for the company.
2. Draft roles and responsibilities for locational risk
committees.

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 ANNEXURE 5 327

3. Review locational, corporate and internal auditor’s report

sent in advance (15 days prior to its meeting).
4. Review sustainability report.
5. Review and discuss market intelligence report (business
competition and threats).
6. Review risk registers quarterly on sampling basis.
7. Discuss and think through solutions for top 10 identified
risks along with business risk owners, and also, if required,
discuss the limitations of business processes and controls.
8. Discuss HR management activities for assessing and man-
aging succession risk.
9. Report solutions obtained on the risks to the board
(solution sizing).

Agenda of RMC

Some ideas on what the RMC should be doing in the meeting

could be as follows:
1. Design strategic risk management plan, define corporate
including organizational design risks, regulatory risks,
opportunity loss risks, project-specific risks, support sys-
tems risk and the impact of risks.
2. Evaluation, review and validation of actions of risk miti-
gations steps from previous meeting/(s).
3. Review of solutions to acquired risks (top 10 identified).
4. Locational Risk Management Committee (LRMC) report.
Revisit roles and responsibilities of LRMC, appointment
of LRMC chairman and so on.
5. Sustainability report.
6. Discuss any other matter taken brought to the committee.

Other Responsibilities

The RMC would review and reassess the adequacy of the charter and
perform annual self-evaluation of the performance of the committee.

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Composition

1. Minimum three members.

2. Chairman should be an independent director.
3. If need be, the experts in the line of business that the
company undertakes from outside may be co-opted to
the committee.
4. Secretary: company secretary.

Reporting to the BoD

The committee would provide a periodical report to the BoD on

its activities, implementation of the risk management policy and
programme and adhering to the applicable standards and rules.
Review the relationship with the external auditors, including
consideration of audit fees as well as any other services non-audit
activities, to ensure that is balanced objectivity with the value for
money.

Annual Risk Management Report

According to the requirement of annual reporting, the committee

would review and approve the annual risk management report
prior to the BoD’s approval, which satisfies the risk management
principles, policy, plans for the year to be included in the annual
report of the company.

Meetings

Meetings can be held as and when necessary. However, at least

two meetings in a year with a gap of not more than six months
must be held.

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CORP ORATE
GOVERNANCE