Introduction to Corporate Governance and Business Ethics PDF

Introduction to Corporate Governance and Business Ethics Volkswagen Background: In September 2015, the United States Environmental Protection Agency (EPA) issued a notice of violation of the Clean Air Act to the German automaker Emission Scan...

Introduction to Corporate Governance and Business Ethics Volkswagen Background: In September 2015, the United States Environmental Protection Agency (EPA) issued a notice of violation of the Clean Air Act to the German automaker Emission Scandal Volkswagen Group. The EPA found that Volkswagen had installed software, known as a "defeat device," in diesel engines to manipulate emissions tests. Key Events: The defeat devices were discovered during a study by the International Council on Clean Transportation (ICCT) and researchers at West Virginia University. The defeat device software could detect when the car was undergoing an emissions test. During testing, the software would activate full emissions controls, making the car appear compliant with emissions standards. During normal driving, the software would reduce the effectiveness of the emissions control systems, resulting in nitrogen oxide (NOx) emissions up to 40 times higher than the legal limit. The Scandal Unfolded ICCT- International Council on Clean Transportation CARB- California Air Resource Board EPA- the United States Environmental Protection Agency CAA- Clean Air Act - USA Law Implications compliance failure pressure to meet unrealistic targets No control or negligence in Governance by the board and top management- requires robust oversight mechanisms and a strong internal control environment to prevent and detect misconduct External Authorities- Regulatory compliance Reputation damage Importance of ethical leadership- integrity and accountability Corporate culture- report the misconduct All stakeholders affected What is Corporate Governance? The structure of rules, practices, and processes used to direct and manage a company. The process of decision making & implementation Establishment of policies, and continuous monitoring of their proper implementation environmental awareness, ethical behavior, corporate strategy, compensation, and risk management Has a broad scope- It includes both social and institutional aspects What is Corporate Governance? a system of structuring, operating and controlling a company Formal system of Accountability, Oversight/ Transparency & Control/Corporate Disclosure Internal discipline – incorporating ethics & values in the management Takes into account interests of shareholders, Board of Directors & Management, Employees, Customers & suppliers  What is Corporate Governance? Moral, Ethical or value framework under which corporate decisions are taken Corporate governance essentially involves balancing the interests of a company's many stakeholders, which can include shareholders, senior management, customers, suppliers, lenders, the government, and the community. Boards of directors are responsible for the governance of their companies. The shareholders' role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place.  What is Corporate Governance? Corporate Governance is a continuous process of applying the best management practices, ensuring the law is followed the way intended, and adhering to ethical standards by a firm for effective management, meeting stakeholder responsibilities, and complying with corporate social responsibilities. It contains policies and rules to maintain a strong relationship between the owners of the company (shareholders), the Board of Directors, management, and various stakeholders like employees, customers, Government, suppliers, and the general public. It applies to all kinds of organizations-profit or not-for-profit. SolarWave Ltd., a leader in the solar energy industry, faced a critical governance issue in 2023 when it was discovered that the Chief Financial Officer (CFO) had been involved in embezzling company funds for personal use. The board of directors, initially unaware due to a lack of stringent oversight, failed to detect the fraudulent activities for over a year. The incident came to light when an internal audit, prompted by a whistleblower’s anonymous tip, revealed significant financial discrepancies.  - immediate dismissal and legal action against the CFO. - stricter financial controls, enhanced transparency in reporting, and a more rigorous audit committee - mandatory ethics training for all employees - A robust whistleblower protection policy These actions not only restored the confidence of shareholders and stakeholders but also underscored the importance maintaining the integrity and sustainability of corporate governance.  Importance/ Benefits of Corporate Governance Strong corporate governance maintains investors’ confidence, as a result of which, company can raise capital efficiently and effectively. Good corporate governance also minimizes wastages, corruption, risks and mismanagement.- audit, compliance It lowers the capital cost. There is a positive impact on the share price as it improves the trust in the market.  Importance/ Benefits of Corporate Governance It gives a sustainable approach to the affairs of the organisation. It helps in brand formation and development. It provides proper inducement to the owners as well as managers to achieve objectives that are in interests of the shareholders and the organization.- a strong competitive advantage It ensures organization is managed in a manner that fits the best interests of all. Good corporate governance ensures corporate success and economic growth. Importance/ Benefits of Corporate Governance Corporate governance defines the relationship that companies must have with their stakeholders. By doing so, it ascertains that each stakeholder’s rights are clear for companies to fulfill When investors look for companies to invest in, they will always prefer companies with good corporate governance. This way, corporate governance can attract new investors. Importance/ Benefits of Corporate Governance  Principles of Corporate Governance Accountability Accountability means to be answerable and be obligated to take responsibility for one’s actions. - the management is accountable to the Board of Directors and the Board of Directors is accountable to the shareholders of the company. This principle gives confidence to shareholders in the business of the company that in case of any unfavourable situation, the persons responsible will be held in charge.  Principles of Corporate Governance Transparency Providing clear information about a company’s policies and practices and the decisions that affect the rights of the shareholders represents transparency. This helps to build trust and a sense of togetherness between the top management and the stakeholders. It ensures accurate and full disclosure timely on material matters like financial condition, performance, ownership.  Principles of Corporate Governance Fairness Fairness gives shareholders an opportunity to voice their grievances and address any issues relating to the violation of shareholder’s rights. This principle deals with the protection of shareholders’ rights, treating all shareholders equally without any personal favouritism, and granting redressal for any violations of rights.  Principles of Corporate Governance Independence Independence means the ability to make decisions freely without being unduly influenced. Decisions should be made freely without having any personal interest in the company. It ensures the reduction in conflict of interest. Corporate governance suggests the appointment of independent directors and advisors so that decisions are taken responsibly without influence.  Principles of Corporate Governance Social Responsibility Apart from the 4 main principles, there is an additional principle of corporate governance. Company social responsibility obligates the company to be aware of social issues and take action to address them. In this way, the company creates a positive image in the industry. The first step towards Corporate Social Responsibility is to practice good Corporate Governance.  Evolution of Corporate Governance Corporate governance was seen, till recently, as limited to listed companies that needed to comply with disclosure norms to protect investor rights, especially those of minority shareholders. Came into prominence during 1980s in Europe & US- Became active in the last 4 decades -Series of Financial scandals Reason- profit maximaisation, manager/executives centred systems, Board of Directors ineffective and inefficient, emphasis on short term gains, auditors controlled by the owners- Enron (energy company- misuse of powers), WorldCom (overstatement of profits)  Evolution of Corporate Governance Culmination- Cadbury Committee (1992) -chaired by Sir Adrian Cadbury- report on ‘The Financial Aspects of Corporate Governance’ Greenbury Committee (1995)- investigation on allegedly huge salaries of senior executives France – Vienot Report (1995) South Africa – The King Report (1994, 2002, 2009, 2016) US federal government - the Sarbanes-Oxley Act (SOA) (2002)  Evolution of Corporate Governance in India The Ministry of Corporate Affairs (MCA) and Securities and Exchange Board of India (SEBI) is responsible for corporate governance initiatives in India. The corporate sector of India faced major changes in the 1990s after liberalization. In the 1900s, SEBI regulated corporate governance in India through various laws like the Security Contracts (Regulation) Act, 1956; Securities and Exchange Board of India Act, 1992; and the Depositories Act of 1996.  Evolution of Corporate Governance in India 1996, CII taking up the first institutional initiative in the Indian industry took a special step on corporate governance. The aim was to promote and develop a code for companies, be in the public sectors or private sectors, financial institutions or banks, all the corporate entities fundamental code for corporate administration was proposed by the Chamber of Indian Industries (CII) in 1998. The definition proposed by CII was—corporate governance manages laws, methods, practices and understood principles that decide an organisation’s capacity to take administrative choices—specifically its investors, banks, clients, the State and the representatives.  Evolution of Corporate Governance in India In February 2000, SEBI established the first formal regulatory framework for corporate governance in India owing to the recommendations of the Kumar Mangalam Birla Committee. This came to be known as clause 49 of the Listing Agreement. A major corporate governance initiative was undertaken in 2002 when the Naresh Chandra Committee on Corporate Audit and Governance furthered their recommendations addressing multiple governance issues.  Kumar Mangalam Birla Committee the mandatory recommendations apply to the listed companies with paid up share capital of 3 crore and above. Composition of board of directors should be optimum combination of executive & non-executive directors. Audit committee should contain 3 independent directors with one having financial and accounting knowledge. Remuneration committee should be set up  Kumar Mangalam Birla Committee The Board should hold at least 4 meetings in a year with maximum gap of 4 months between 2 meetings to review operational plans, capital budgets, quarterly results, minutes of committee’s meeting. Director shall not be a member of more than 10 committees and shall not act as chairman of more than 5 committees across all companies Management discussion and analysis report covering industry structure, opportunities, threats, risks, outlook, internal control system should be ready for external review Any Information should be shared with shareholders in regard to their investments. MCA (Ministry of Corporate Affairs) and the Government of India have set up multiple organisations and charters like the Confederation of Indian Industry (CII), National Foundation for Corporate Governance (NFCG), Institute of Chartered Accountants of India (ICAI). Legal framework on corporate governance The Companies Act, 2013- It describes about the laws of provisions concerning the constitution of the board, board meeting, board processes, Audit committee, general meetings, party transactions, disclosure requirements in the financial statements etc.  SEBI Guidelines: SEBI can be considered as governing body which has the power and carries jurisdiction over the listed companies and issues regulations, rules and regulation to ensure safety of the investors Standard listing agreements of stock exchange it is made for those companies whose shares are listed in the stock exchanges. Accounting standards issued by the institute of chartered accountants of India (ICAI)- ICAI ca be said an independent body, which provides accounting standards mentioning guidelines about the disclosure of financial information. Companies Act, 2013 -Section 129 provides that the financial statements would give a fair view of the situation of the companies, following the accounting standards given under Section 133. It is further given that the things contained in such financial statements should be following the accounting standards. Secretarial Standards issued by the Institute of Company Secretaries of India (ICSI). -ICSI can also be considered as independent body, which carries secretarial standards according to the terms of conditions in the new companies Act. ICSI has issued secretarial standards on Meetings of the Board of Directors (SS-1) and secretarial standards on General Meetings (SS-2). Companies Act, 2013, Section 118(10) provides that every company (other than one person company) shall observe secretarial standards specified as such by the ICSI with respect to general and Board meetings.