Corporate Governance Committee Report PDF

CORPORATE GOVERNANCE COMMITTEE REPORT  Corporate governance gained importance after the Watergate scandal in the US. Investigations highlighted control failures that had allowed several major corporations to make illegal political contributions and to bribe government officials. This l...

CORPORATE GOVERNANCE COMMITTEE REPORT  Corporate governance gained importance after the Watergate scandal in the US. Investigations highlighted control failures that had allowed several major corporations to make illegal political contributions and to bribe government officials. This led to the development of the Foreign and Corrupt Practices Act of 1977. This was followed in 1979 by the Securities and Exchange Commission’s proposals for mandatory reporting on internal financial controls. In 1985, following a series of high profile business failures in the US, the most notable one of which being the savings and loan collapse, the Treadway Commission was formed to identify the main causes of misrepresentation in financial reports and to recommend ways of reducing incidence thereof.  The Treadway Report published in 1987 highlighted the need for a proper control environment, independent audit committees and an objective internal audit function and called for published reports on the effectiveness of internal control. The Commission also requested the sponsoring organisations to develop an integrated set of internal control criteria to enable companies to improve their controls.  In England, the seeds of modern corporate governance were probably sown by the Bank of Credit and Commerce International (BCCI) scandal. The BCCI was a global bank, made up of multiplying layers of entities, related to one another through an impenetrable series of holding companies, affiliates, subsidiaries, banks-within-banks, insider dealings and shareholder (nominee) relationships.  With this corporate structure of BCCI and shoddy record keeping, regulatory review and audits, the complex BCCI family of entities was able to evade ordinary legal restrictions on the movement of capital and goods as a matter of daily practice and routine. THE FAILURE OF BARINGS BANK. Barings was Britain’s oldest merchant bank. It had financed the Napoleonic wars, the Louisiana Purchase, and the Erie Canal. Barings was the Queen’s bank. What really grabbed the world’s attention was the fact that its failure was caused by the actions of a single trader based at a small office in Singapore, Nick Leeson. He was posted as a trader in Singapore on behalf of Barings Bank.  The cardinal principle in trading is to separate the front office from the back office. Nick Leeson was posted in charge of the back office operations of Barings Bank as well. He started trading on behalf of the Bank, whereas he was supposed to trade only on behalf of the customers. Eventually when his strategy failed because of an earthquake in Japan, Barings Bank had already lost $1.4 billion and it had to shut office. Cadbury Committee on Corporate Governance, 1992 The Committee (UK) was set up in May 1991 by the Financial Reporting Council, the Stock Exchange and the accountancy profession in response to the concern about the standards of financial reporting and accountability. The committee was chaired by Sir Adrian Cadbury and decided to review those aspects of corporate governance relating to financial reporting and accountability.  The final report ‘The Financial Aspects of Corporate Governance’ (usually known as the Cadbury Report) was published in December 1992 and it contained a number of recommendations to raise standards in corporate governance. The immediate reason for the appointment of the committee on corporate governance by the Financial Reporting Council, UK was the failure of one of the top communication companies in the UK called Maxwell Communications Company and the death of Robert Maxwell in 1990 after missing from his office.  In 1992 Maxwell’s companies filed for bankruptcy protection in the UK and the US. Around the same time the Bank of Credit and Commerce International (BCCI) went burst and lost billions of dollars for its depositors, shareholders and employees.  The major aspects of the Cadbury Committee recommendations are as follows: 1. The committee’s sponsors were concerned at the perceived low level of confidence both in the financial reporting and in the ability of auditors to provide the safeguards which the users of company reports sought and expected. 2. The underlying factors were seen as the slackness of accounting standards, the absence of a clear framework for ensuring that directors kept under review the controls in their business and competitive pressures both on the companies and on the auditors which made it difficult for the auditors to stand up to the demanding boards. 3. The Committee’s objective is to help to raise the standards of corporate governance and the level of confidence in financial reporting and auditing by setting out clearly what it sees as the respective responsibilities of those involved and what it believes is expected of them. 4. The committee looked in to three broad aspects of corporate governance such as (i) the structure role and the responsibilities of board of directors (ii) the role of auditors and the responsibility of accounting profession and (iii) the rights and the responsibilities of shareholders in a company as investors. 5. The basic approach of the committee was that compliance with a voluntary code coupled with disclosure will be more efficient than a statutory code of corporate governance. Hence the committee' emphasis on ‘Comply or explain’ principle. All the listed companies in the London Stock Exchange are bound to comply with and give reason for non-compliance of any aspects. 6. The committee focused on the control and the reporting functions of the board and the role of auditors related to financial reporting and accounting. 7. The committee’s recommendations are a code of best practices designed to achieve a high standard of corporate behaviour. 8. All the proposals of the committee are aimed to strengthened the unitary board system and enhance its efficiency and effectiveness. MAJOR RECOMMENDATIONS OF THE COMMITTEE (A) Board performance: Of the three main aspects considered by the Committee the first was the board of director’s performance, board composition, board structure, role of independent directors, internal control system, board committees, chairman’s role, Secretary’s role, training to board of directors etc. In this area the Cadbury Committee made the following recommendations: 1. The board must compose of an optimum number of executive and nonexecutive directors. The executive directors must have good knowledge of business and the non-executive directors have a broader view about the activities of the company and the environment in which the company is working. 2. The executive and the non-executive directors must work together with one objective of maximizing the shareholder's wealth. 3. All board members will have equal responsibility in the actions of company board. 4. Non-executive directors will have additional responsibilities of reviewing the performance of executive directors in addition to reviewing the performance of the board as such and must take a lead when a potential conflict of interest arises. 5. Chairman is primarily responsible for the working of the board and also ensuring that all the executive and the non-executive directors are encouraged to play their full role. 6. The Non-executive directors should bring an independent judgment on issues of strategy formulation, performance, resource use and fixing the standard of performance. 7. There should be a formal selection process of the non-executive directors to ensure the independence the independence of them through a nomination committee. 8. The independent directors must be appointed for a specific period and the formal appointment letter must be given clearly mentioning their rights, duties terms of appointment and responsibilities. 9. The independent directors must be allowed to seek outside professional advice on issues related to the company at company’s cost wherever necessary. 10. Sufficient training must be given to directors for improving their performance. 11. The board should recognize the importance of the finance function by making it the designated responsibility of a non-executive director who should be a signatory of the annual report and accounts on behalf of the board. 12. There must be a board committees such as audit committee, nomination committee, remuneration committee, etc. for the effective functioning of these activities. 13. Audit committees should be formally constituted to ensure that they have a clear relationship with the board to whom they are answerable and to whom they should report regularly. They should be given written terms of reference which deal adequately with their membership, authority and duties, and they should normally meet at least twice a year. 14. The audit committee must have three independent directors only. 15. The Company Secretary has a key role in ensuring that the board procedures are strictly followed. 16. The remuneration of both the executive and the non-executive directors must be clearly disclosed in the annual report. 17. Financial report should be presented in a balanced and understandable manner to the shareholders and should ensure the highest level of disclosure. The Financial Reporting Council must develop a format for this purpose and all listed companies must follow it. 18. The director’s service contracts should not exceed 3 years without the approval of the shareholders. 19. The nomination committee should have a majority of non-executive directors on it and be chaired either by the chairman or a non-executive director. 20. Directors need in practice to maintain a system of internal control over the financial management of the company, including procedures designed to minimize the risk of fraud. There is, therefore, already an implicit requirement on the directors to ensure that a proper system of internal control is in place. (B) External auditor and their responsibilities: Enhancing objectivity and effectiveness of external auditing is one of the main recommendations of the Committee with regards to external audit. 1. The external auditors should be present at the board meeting when the annual report and accounts are approved and preferably when the half yearly report is considered as well. 2. The auditor should have a duty to report fraud to the appropriate authorities. The auditor’s duty is normally to report fraud to the senior management. Where, however, if he/she no longer has confidence that the senior management will deal adequately with the matter, he is encouraged by professional guidance to report fraud to the proper authorities. 3. In order to ensure transparency the fee paid to the external auditor for audit work and other non-audit work if any should be specified separately in the annual report. 4. Professional objectivity must be ensured to the external auditor. 5. Auditor rotation system must be introduced and strictly adhered to. 6. Auditors while discharging their duties must ensure that accounting standards are strictly followed. 7. Auditors owe a legal duty of care to the company and to the shareholders collectively, but not to the shareholders as individuals nor to the third parties 8. Companies’ statements of compliance should be reviewed by the auditors before publication. The review should cover only those parts of the compliance statement which relate to provisions of the Code where compliance can be objectively verified. The Auditing Practices Board should consider guidance for auditors accordingly. 9. Directors should report on the effectiveness of their system of internal control, and the auditors should report on their statement. The accountancy profession together with representatives of preparers of accounts should draw up criteria for assessing effective systems of internal control and guidance for companies and auditors. 10. The government should consider introducing legislation to extend to the auditors of all companies the statutory protection already available to auditors in the regulated sector (banks, building societies, insurance, and investment business) so that they can report reasonable suspicions of fraud freely to the appropriate investigatory authorities. 11. The accounting profession should continue its efforts to improve its standards and procedures so as to strengthen the standing and independence of auditors. (C) The Shareholders: 1. All parties concerned with corporate governance should use their influence to encourage compliance with the code, institutional shareholders in particular, with the backing of the institutional shareholders’ Committee. 2. Institutional investors should disclose their policies on the use of their voting rights. 3. If long-term relationships are to be developed, it is important that companies should communicate its strategies to their major shareholders and that the shareholders should understand them. It is equally important that the shareholders should play their part in the Communication process. 4. The board must ensure that any significant statement concerning their companies is made publicly and hence equally available to all shareholders. The Hampel Committee, 1995 The Hampel Committee was set up in November 1995 to promote high standards of corporate governance both to protect investors and preserve and enhance the standing of companies listed on the London Stock Exchange.  The Committee Developed the Cadbury Report. Recommended that the auditors should report on internal control privately to the directors. The directors maintain and review all (and not just financial) controls. Companies that do not already have an internal audit function, should from time to time, review their need for one. Introduced the Combined Code that consolidated the recommendations of earlier corporate governance reports (Cadbury and Greenbury). The Turnbull Committee, 1999 The Turnbull Committee was set up by the Institute of Chartered Accountants in England and Wales (ICAEW) in 1999 to provide guidance to assist companies in implementing the requirements of the Combined Code relating to internal control. The Committee Provided guidance to assist companies in implementing the requirements of the Combined Code relating to internal control. Recommended that where companies do not have an internal audit function, the board should consider the need for carrying out an internal audit annually. Recommended that the boards of directors confirm the existence of procedures for evaluating and managing key risks.  Corporate governance is constantly evolving to reflect the current corporate, economic and legal environment. To be effective, corporate governance practices need to be tailored to the particular needs, objectives and risk management structure of an organisation. Corporate governance is not a static concept, in fact it is dynamic, and thus needs to be altered with the changes that occur in the business environment. OECD Principles The OECD was one of the earliest non-governmental organisations to work on and spell out principles and practices that should govern corporates in their goal to attain long-term shareholder value. In summary, they include the following aspects of corporate governance: the rights of shareholders; equitable treatment of all shareholders; the role of stakeholders in corporate governance; disclosure and transparency and the responsibilities of the board. 1. The rights of shareholders: 2. Equitable treatment of shareholders: 3. The role of stakeholders in corporate governance: 4. Disclosure and transparency: 5. The responsibilities of the board: McKinsey Survey on Corporate Governance McKinsey, the international management consultant organisation, conducted a survey with a sample size of 188 companies from 6 emerging markets (India, Malaysia, Mexico, South Korea, Taiwan and Turkey) to determine the correlation between good corporate governance and the market valuation of the company. Good corporate governance increases market valuation in the following ways: Increasing financial performance. Transparency of dealing, thereby reducing the risk that boards will serve their own self-interest. Increasing investor confidence. The performance on corporate governance of each company based on the following parameters: Accountability: transparent ownership, board size, board accountability, ownership neutrality. Disclosure and transparency of the board: timely and accurate disclosure, independent directors. Shareholder equality: one share-one vote. Sarbanes–Oxley Act, 2002 The Sarbanes–Oxley Act which codifies certain standards of good governance is meant to prevent these. The Act calls for protection to those who have the courage to bring frauds to the attention of those who have to handle frauds. It ensures that such things are not left to the individuals who may or may not choose to reveal them. The SOX Act is a sincere attempt to address all the issues associated with corporate failures to achieve quality governance and to restore investor’s confidence.  Important provisions contained in SOX Act are:- 1. Establishment of Public Company Accounting Oversight Board (PCAOB): 2. The Board reports to the SEC(Securities and Exchange Commission.) 3. Audit committee: 4. Conflict of interest: CEO, CFO, CAO 5. Audit partner rotation: 5 years. 6. Improper influence on conduct of audits: 7. Prohibition of non-audit services: 8. CEOs and CFOs required to affirm financials: 9. Loans to directors: 10. Attorneys: 11. Securities analysts: Models of Corporate Governance  Insider Vs Outsider model Insider model is based on Stakeholder model (found mainly in Germany and Japan) - key stakeholders here being insiders - companies here are mostly closely held companies Outsider model is based on Shareholder model (found mainly in US, UK and other countries) - key stakeholders here being outsiders (large number of external shareholders) - companies here are mostly widely held companies  The outsider model A priority to market regulation the owners of firms tend to have a transitory interest in the firm The absence of close relationships between shareholders and management the existence of an active `market for corporate control´ - takeovers, particularly hostile ones the primacy of shareholder rights over those of other organisational groups  The insider model The priority to stakeholders control The owners of firms tend to have an enduring interest in the company They often hold positions on the board of directors or other senior managerial positions The relationships between management and shareholders are close and stable There is little by way of a market for corporate control the existence of formal rights for employees to influence key managerial decisions  Outsider model In countries with an Anglo-Saxon legal tradition, such as the United States, United Kingdom, Canada and Australia, corporate governance typically focuses on the firm's outside investors, mainly shareholders. In those countries, top managers tend to be monitored by means of market-based rewards and penalties. For instance, in the United States, where compensation is often tied to the level of profitability, most firms would opt to cut back on labor in order to sustain current profitability.  Outsider model The presence of agency cost (due to lack of trust & need for monitoring) Board is appointed to monitor management Even employees often find it difficult to trust top management, as their behavior is subject to constant market scrutiny.  Outsider model Proponents of the outsider model accept the opportunistic tendencies of management and recognize the divergent goals of shareholders and management. Therefore, they argue for external control systems that can effectively monitor managerial decisions and impose constraints on managerial discretion. Measures used to make managers more accountable include executive compensation schemes, such as performance-based bonuses and stock options.  Outsider model Governance structures - such as the board of directors, union representation on the board of directors and the legal superstructure - are used as mechanisms to ensure fulfillment of implicit and explicit contracts, all aimed at better serving the interests of shareholders. In general, a firm with an outsider model of corporate governance will have a higher proportion of performance-based executive compensation and will adopt more externally verifiable control mechanisms in the board of directors' roles and structure.  Insider model Germany (insider system), on the other hand, is characterized by concentrated ownership, where the owners’ interest extends beyond the shareholder profits. There are large blocks of shareholders and they have a greater impact in the corporate performance. The major conflict, however, lies between controlling shareholders and weak minority shareholders.  Insider model German corporations are less dominated by institutional investors (unlike in the US). Instead, the banks would be having large investments and tend to have longer relationships with the corporate clients, combining lending and shareholding in a long term connection. Although monitoring management is easier, the controlling shareholders also have the incentive to act in their own self-interest. The board of directors is separated into the executive board (executive directors and CEO) and supervisory board (an equal number of shareholder and employee representatives). In contrast to the United States, corporate employees in Germany play an important role in the corporate decision making.  Insider model In countries such as Germany or Japan, where stakeholder claims are typically taken into account in top management decisions, job security becomes a main corporate objective. Canon, for example, has never laid off employees in its entire history, despite all the ups and downs in profitability.  Insider model In Germany, employees are influential stakeholders whose welfare is internalized to a certain extent by top managers through co-determination systems of governance, having small percentages of the firm's total stock in free-float, and making the managers' compensation not so focused on current profitability.  Insider model In an insider model of corporate governance, the interactions are defined by formal and informal rules developed over time. In the insider model, the debt-equity ratio will be higher. They will have lower levels of turnover and layoffs, stronger worker displacement policies, higher levels of firm-specific training for employees, higher employee-firm fit, higher internal knowledge sharing and joint organizational learning among employees in comparison with the outsider model. Models of Corporate Governance Single Board Vs Dual Board  Single Board Vs Dual Board Single board structure is seen under Anglo-Saxon model Dual board structure is seen under German/Japanese model  MODELS OF CORPORATE GOVERNANCE Corporate governance systems vary around the world. This because in some cases, corporate governance focuses on relationship between shareholders and company, some on formal board structures and board practices and yet others on social responsibilities of corporations. However, basically, corporate governance is seen as the process by which organizations are run. There is no one model of corporate governance which is universally acceptable as each model has its own advantages and disadvantages. Following are some of the models of corporate governance: Three Models of Corporate Governance from Developed Capital Markets Anglo-US Model German Model Japanese Model  ANGLO-US MODEL Anglo-Saxon model of corporate governance is a system of supervision and control over the corporation, functioning in the United Kingdom, United States, Canada, and Australia. The main feature of this model is the dominance of capital market, as the instrument of control over the corporation. Supervision is exercised mostly by investors who express their approval or disapproval for the actions of management by the buying/selling shares of the company and voting during the general meetings of shareholders. Resources for investments are collected in/from the capital markets. Anglo-Saxon model implies a strong emphasis on the results achieved by the company and security of their shareholders.  ANGLO-US MODEL The Anglo-US model is characterized by 1. share ownership of individual, and increasingly institutional, investors not affiliated with the corporation - known as outside shareholders or “outsiders”; 2. a well-developed legal framework defining the rights and responsibilities of three key players, namely: management, directors and shareholders; and 3. a comparatively uncomplicated procedure for interaction between shareholder and corporation as well as among shareholders.  ANGLO-US MODEL Key features of the Anglo-Saxon model of corporate governance: ownership of shares is distributed, stringent requirements for accounting and transparency, numerous incentive for executives/managers, manifested through high salaries, based on company's results, capital is raised on large and liquid capital markets, market is an active mechanism of control over the corporation, internal supervisory authority is the Board of directors, measure of success is the share price and dividend, capital markets are characterized by high transparency, Top priority to increasing value for the shareholder, growing strength of concentrated/block share holders, particularly pension funds and institutional investors, banks involvement is minimum and limited to providing debt capital KEY PLAYERS MANAGEMENT SHAREHOLDERS BOARD OF DIRECTORS “Corporate Governance Triangle” The concept of Independent Board Outsiders being on the board – To ensure transparency – Checks and balances – To safeguard the interests of minority shareholders – To ensure compliance with government rules – To protect the concerns of all stakeholders Important role of Independent Directors Shareholding pattern in India  Composition of the Board of Directors Insiders (executive director) Is a person who is either employed by the corporation or one who has significant business relationship with corporate management. Outsiders (non-executive director or Is a person/institution which has no direct independent director) relationship with the corporation or management  GERMAN MODEL (Continental model) governs German Austrian Corporations Corporations Some elements also apply Netherlands France Belgium Scandinavia UNIQUE ELEMENTS of the GERMAN MODEL Two-tiered Board Structure Which means it consists of a management board and supervisory board. The 2 boards are completely distinct; no one may serve simultaneously on two boards. Size of supervisory board It is set by law and cannot be changed by shareholders Voting right restrictions Voting right restrictions are legal; these limit a shareholder to voting a certain percentage of the corporation’s total share capital, regardless of share ownership position BOARD COMPOSITIONS Two-tiered Board Executive Board Responsible for daily “VORSTAND” management of the company Supervisory Board Responsible for appointing the “Aufsichtsrat” Executive board Employees/labour Responsible for appointing Union & members to the supervisory Shareholders board  Role of Supervisory Board The overall role of the supervisory board is to supervise the policies of the executive board and the general affairs of the company and its affiliated enterprise, as well as to assist the executive board by providing advice. In discharging its role, the supervisory board shall be guided by the interests of the company and its affiliated enterprise, and shall take into account the relevant interests of the company’s stakeholders. The supervisory board is responsible for the quality of its own performance.  Role of Executive Board The role of the board of directors is to manage the company, which means, among other things, that it is responsible for achieving the company's aims, strategy and policy, and results. The board of directors is accountable for this to the supervisory board and to the general meeting of shareholders. The board of directors shall provide the supervisory board in good time with all information necessary for the exercise of the duties of the supervisory board.  Under this system, there is a tendency to rely on banks as providers of capital for development and investment. Due to the shallow and small financial markets, funding through the issue of shares and bonds is small. Banks and other financial institutions possess large amount (often giving control) of shares in the company. Institutional and individual owners, through the selection of members of supervisory boards, are actively involved in the exercise of control over the actions of managers. A characteristic feature of this system for certain countries (e.g. for Germany) is significant role of workers' unions, whose representatives sit on supervisory boards and decide on important matters for the company and for themselves. Control in continental model is mainly exercised by supervisory board of the company and various committees (the audit, remuneration, etc.). External mechanisms, such as, for example, capital market, are inefficient, and their role is small. The continental model emphasizes the development of the company and its long-lasting effects. Objective of the managers is, primarily, development of the company, and, then, protecting the interests of shareholders and other interest  Main features of continental model Concentrated ownership of the shares, Substantial involvement of banks in the operations of the company, Weak market for corporate control, Shallow, insufficiently liquid financial markets, Stress on the stability and development of the company, Low transparency in the capital market, Frequent skipping the interests of minority shareholders, The Board of Directors as an internal oversight mechanism Widely seen goal: long term development of the company, The large role of banks in financing of investments, A measure of the success of the company is the satisfaction of involved interest groups or stakeholders. KEY PLAYERS BANKS Corporate shareholders Banks usually play a multiple role as shareholder, lender, issuer of both equity and debt, depository. Share Ownership Pattern Corporations 41% Banks 27% Pension Funds 3% Individual Owners 4% Foreign investors  Japanese Model This model is also called as the business network model, usually shareholders are banks/financial institutions, large family shareholders, corporate with cross-shareholding. There is a ‘supervisory board’ which is made up of ‘board of directors’ and a president, who are jointly appointed by shareholder and banks/financial institutions. Most of the directors are heads of different divisions of the company. Outside director or independent directors are rarely found of the board. 38 Japanese model KEY PLAYERS The Japanese system of Corporate Governance is many-sided, centering around a main bank and a financial/industrial network or ‘keiretsu’ The bank provides its corporate clients with loans as well as services related to bond issues, equity issues, settlement accounts and related consulting services. The main bank is generally a major shareholder in the corporation. In the US, Anti-monopoly prohibits one bank from providing this multiplicity of services Many Japanese corporation also have a strong financial relationships with a network of affiliated companies. These networks, characterized by crossholding of a debt and equity, trading of goods and services, and informal business contacts, are known as Keiretsu Government-directed industrial policy plays a key role in Japanese Governance. In the Japanese model, the four key players are: 1. Main Bank (a major inside shareholder) 2. Affiliated company or keiretsu (a major inside shareholder) 3. Management and the 4. Government Interaction among these players serves to link relationship rather balance power, as in the case of Anglo-US Model - Non-affiliated shareholders have little or no voice in japanese Governance - As a result, there are few truly independent directors (representing outside shareholders) Share Ownership Pattern In Japan, Financial institutions and corporations firmly hold ownership of the equity market. Insurance companies 43 % Banks Corporations 25 % Foreign 3% Composition of the board of directors Executive managers – the heads of major divisions of the company and its central administrative body. COMMON PRACTICE: If a company’s profit fall over an extended period, the main bank and member of the keiretsu may remove directors and appoint their own candidates to the company’s board. Appointment of retiring government bureaucrats to corporate boards The average japanese board contains 50 members Theories of Corporate Governance Agency Theory  In many instances, the objectives of managers are at variance with those of the shareholders. For instance, a chief executive may want to increase his managerial empire and personal stature by using the company’s funds to finance an unrelated diversification, which could reduce long term shareholder value. The shareholders and other stakeholders of the company, may not be able to counteract this because of inadequate disclosure about such a decision and because the principals may be too scattered or even not motivated enough to effectively block such a move. Such mismatch of objectives is called the agency problem; the cost inflicted by such dissonance is the agency cost.  The core of corporate governance is designing and putting in place disclosures, monitoring, “overseeing” and corrective systems that can align the objectives of the two sets of players as closely as possible and, hence, minimise agency costs.  In the agency theory terms, the owners are principals and the managers are agents and there is an agency loss which is the extent to which returns to the residual claimants, the owners, fall below what they would be if the principals, the owners themselves, exercised direct control of the corporation. The agency theory specifies mechanisms which reduces agency loss. These include incentive schemes for managers which reward them financially for maximising shareholder’s interests. Schemes tie executive compensation and levels of benefits to shareholders, returns and have part of executive compensation deferred to the future to reward long-run value maximisation of the corporation and deter short-run executive action which harms corporate value. Problems with the Agency Theory Total control of management is neither feasible nor required under this theory. They must accept a certain level of self-interested behaviour in delegating responsibility to others. The objective of agency theory is to check the abuse in this trade-off. Shareholders should have correct and adequate information to wield effective control. Equity investors rarely get these and besides they rarely make clear their exact target returns, and yet delegate authority to meet the target. It is also to be understood that in terms of controls, equity investors hardly have sanctions over boards. Instead, they have to rely on self-regulation to ensure that an orderly house is maintained.  There are two broad mechanisms that help reduce agency costs 1. Fair and accurate financial disclosures: 2. Efficient and independent board of directors: Stewardship Theory  Discounts the possible conflicts between corporate management and owners and shows a preference for a board. The stewardship theory assumes that managers are basically trustworthy and attach significant value to their own personal reputations. It defines situations in which managers are stewards whose motives are aligned with the objectives of their principles. A steward’s behaviour will not depart from the interests of his/her organisation. Control can be potentially counterproductive, because it undermines the pro-organisational behaviour of the steward by lowering his/her motivation. Stewardship theory can be reduced to the following basics: The theory defines situations in which managers are not motivated by individual goals, but rather they are stewards whose motives are aligned with the objectives of their principles. Given a choice between the self-serving behaviour and the pro-organizational behaviour, a steward’s behaviour will not depart from the interests of his/ her organisation. Control can be potentially counterproductive, because it undermines the proorganisational behaviour of the steward, by lowering his/her motivation.  “Stewardship refers to the responsibility of the board to oversee the conduct of the business and to supervise management which is responsible for the dayto-day conduct of the business. In addition, as stewards of the business, the directors function as the catch-all to ensure no issue affecting the business and affairs of the company falls between cracks.”  The greatest barrier, however, to the adoption of stewardship mechanisms of governance lies in the risk propensity of principals. Risk taking owners will assume that executives are pro-organisation and favour stewardship governance mechanisms. Where the executives, the investors cannot afford to extend board power, agency costs are effective insurance against the self-interest behaviours of agents. Shareholder Versus Stakeholder Approaches Shareholder approaches argue that Stakeholder models of corporate corporations have a limited set of responsibilities, which primarily consist of governance argue that those obeying the law and maximising responsible for the governance shareholder wealth. The basic argument is that corporations, of the corporation have by focussing on shareholder interests responsibilities to parties other maximise societal utility. than shareholders and that, any The logic of this position goes back to the fiduciary obligations owed to ability of the shareholder model to maximise utility, however, is tenuous in shareholders to maximise profits that it is based on the assumption of might be subject to the perfect competition. constraint of respecting The shareholder approach is logically obligations owed to such most compatible with the Anglo-American model of corporate governance. stakeholders. Stakeholder Theory The stakeholder theory of corporate governance dates back to 1930s. The theory represents a synthesis of economics, behavioural science, business ethics and the stakeholder concept. The history and the range of disciplines that the theory draws upon has led to large and diverse literature on stakeholders. In essence, the theory considers the firm as an input-output model by explicitly adding all interest groups—employees, customers, dealers, government and the society at large—to the corporate mix.  The theory is grounded in many normative theoretical perspectives including the ethics of care, the ethics of fiduciary relationships, social contract theory, theory of property rights, theory of the stakeholders as investors, communitarian ethics, critical theory, etc. While it is possible to develop stakeholder analysis from a variety of theoretical perspectives, in practice much of stakeholder analysis does not firmly or explicitly root itself in a given theoretical tradition, but rather operates at the level of individual principles and norms for which it provides little formal justification.  Stakeholder approaches uphold responsibilities to non-shareholder groups, they tend to be in some tension with the Anglo-American model of corporate governance, which generally emphasises the primacy of “fiduciary obligations” owed to shareholders over any stakeholder claims. Managers accomplish their organisational tasks as efficiently as possible by drawing on stakeholders as a resource Criticisms of the Stakeholder Theory The major problem with the Stakeholder Theory stems from the difficulty of defining the concept. Who really constitutes a genuine stakeholder? Stakeholders would generally include employees, customers, suppliers, the government, the community, assorted activist or pressure groups, and shareholders. Sociological Theory The sociological approach to the study of corporate governance has focussed mostly on board composition and the implications for power and wealth distribution in society. Problems of interlocking directorships and the concentration of directorships in the hands of a privileged class are viewed as major challenges to equity and social progress. Under this theory, board composition, financial reporting, disclosure and auditing are necessary mechanisms to promote equity and fairness in society. Resource Dependency Theory The resource dependency theory concentrates on the role of board directors in providing access to essential resources needed for an organization through their linkages to the external environment. Resource dependency theorists provide focus on the appointment of representatives of independent organisations as a means for gaining access in resources critical to firm success. For example, outside directors who are partners to a law firm provide legal advice, either in board meetings or in private communication with the firm executives that may otherwise be more costly for the firm to secure. The provision of resources enhances organisational functioning, firm’s performance and its survival. The directors bring resources to the firm, such as information, skills, access to key constituents such as suppliers, buyers, public policy makers, social groups as well as legitimacy.  According to the theory, the directors can be classified into four categories such as insiders, business experts, support specialists and community influential. (a) First, the insiders are current and former executives of the firm and they provide expertise in specific areas such as finance and law on the firm itself as well as general strategy and direction. (b) Second, the business experts are current, former senior executives and directors of other large for-profit firms and they provide expertise on business strategy, decision making and problem solving. (c) Third, the support specialists are the lawyers, bankers, insurance company representatives and public relations experts and these specialists provide support in their individual specialized field. (d) Finally, the community influential is the political leaders, university faculty, members of clergy, leaders of social or community organisations. Transaction Cost Theory This theory states that the company is a relatively efficient hierarchical structure that serves as framework to run the contractual relationships. The main concern in transaction cost theory is to explain the transactions conducted in terms of efficiency of governance structures. The Transaction cost theory was interdisciplinary in nature covering the disciplines of law, economics and organisations. This theory attempts to view the firm as an organisation comprising people with different views and objectives.  The underlying assumption of the transaction cost theory is that firms have become very large. The size of the firm in effect substitutes for the market in determining the allocation of resources. The combination of people with transaction suggests that transaction cost theory managers are opportunists and arrange firms’ transactions to their interests. It assumes that individuals are self-interested and opportunistic in nature and they will cheat the system if they can. The theory emphasizes the need of strong legal mechanism to deal opportunistic behaviour. Hazard Moral Theory The conflict of interest determined by the separation between the ownership and the control upon which the agency theory is founded can cause opportunistic behaviour of the managers as agents, which is not necessarily in synergy with the shareholder’s interest as principals of maximizing shareholder’s wealth. Thus, the managers are prone to moral hazard and opportunistic behaviour guided by their own interests. The theory of moral hazard is central within agency theory and also refers to hidden actions or opportunistic behaviour of managers. Hidden action arises as a consequence of asymmetric information held by the counterparties and opportunistic actions occur by human inclination. The result can only be extremely dramatic such as decreasing performance and even business failure. Political Theory Political theory says that the corporate governance system should be such that the task of corporate organisation is by developing voting support from shareholders, rather by purchasing voting power. Hence, having a political influence in corporate governance may direct corporate governance within the organisation. Public interest is much reserved as the government participates in corporate decision making, taking into consideration cultural challenges. The political model highlights the allocation of corporate power, profits and privileges are determined through the governments’ favour. CORPORATE GOVERNANCE CORPORATE GOVERNANCE – THE CORNERSTONE The cornerstone of the modern market-oriented economy 2 Corporate Governance - Definition ◦ the system by which business corporations are directed and controlled ◦ specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders ◦ spells out the rules and procedures for making decisions on corporate affairs ◦ provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance (Source: OECD April 1999) 3 Corporate Governance ◦Corporate Governance is the application of best management practices, compliance of law in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stakeholders. ◦Conduct of business in accordance with shareholders’ desires (maximising wealth) while conforming to the basic rules of the society embodied in the Law and Local Customs Corporate stakeholders are those groups without whose support the corporate organisation would cease to exist. They are broadly grouped into (1) internal stakeholders and (2) external stakeholders. 1. Internal stakeholders are those who engage in economic transactions with the organisation such as owners, employees, managers. 2. External stakeholders are those who do not engage in direct economic transaction but their actions can affect the business. e.g. Government, Suppliers, Creditors.  A McKinsey & Company Report published in 2001 under the title “Giving New Life to the Corporate Governance Reform Agenda for Emerging Markets” suggests that by using a two-version “governance” chain model Model 1 In the first version of McKinsey’s model called “The Market Model” governance chain, there are efficient, well-developed equity markets and dispersed ownership, something common in the developed industrial nations such as the US, the UK, Canada and Australia. Corporate governance is basically how companies deal fairly with problems that arise from “separation of ownership and effective control.” This model illustrates conditions and governance practices that are better understood and appreciated and as such highly valued by sophisticated global investors. Model 2 In the second version of McKinsey’s model called “The Control Model,” governance chain is represented by underdeveloped equity markets, concentrated (family) ownership, less shareholder transparency and inadequate protection of minority and foreign shareholders, a paradigm more familiar in Asia, Latin America and some east European nations. In such transitional and developing economies there is a need to build, nurture and grow supporting institutions such as a strong and efficient capital market regulator and judiciary to enforce contracts or protect property rights.  CORPORATE GOVERNANCE ◦ The heart of corporate governance is transparency, disclosure, accountability and integrity. It is to be borne in mind that mere legislation does not ensure good governance. Good governance flows from ethical business practices even when there is no legislation. ◦ The root of the word Governance is from ‘gubernate’, which means to steer. Corporate governance would mean to steer an organization in the desired direction. The responsibility to steer lies with the board of directors/ governing board. ◦ Corporate or a Corporation is derived from Latin term “corpus” which means a “body”. Governance means administering the processes and systems placed for satisfying stakeholder expectation. ◦ Corporate Governance means a set of systems procedures, policies, practices, standards put in place by a corporate to ensure that relationship with various stakeholders is maintained in transparent and honest manner  Corporate Governance ◦Relationships among various participants in determining the direction and performance of a corporation. ◦Effective management of relationships among – Shareholders – Managers – Board of directors – employees – Customers – Creditors – Suppliers – community Corporate Governance ◦Promote the efficient use of scarce resources ◦Promote the trust of investors ◦Good corporate governance has a positive link to economic development and good corporate performance ◦Funds will flow to entities which are seen to have internationally accepted standards of corporate governance 18 Corporate Governance Why is it important? ◦Proliferation of financial scandals and crisis ◦Loss of trust of investors ◦Globalization lead to increasing cross-border investment opportunities but investors may not have knowledge about the regulatory framework of overseas investees 19 Corporate Governance ◦Investors are not willing to invest in countries/companies that are corrupt, prone to fraud, poorly managed and lacking sufficient protection for investors’ rights ◦Securities and company law protection may help, but not enough ◦Corporate Governance supplements the legal framework 20 Corporate Governance Corporate Governance also plays an important role in maintaining corporate integrity and managing the risk of corporate fraud, combating against management misconduct and corruption 21 Why Corporate Governance? ◦Better access to external finance ◦Lower costs of capital – interest rates on loans ◦Improved company performance – sustainability ◦Higher firm valuation and share performance ◦Reduced risk of corporate crisis and scandals Principles of Corporate Governance (cont.) ◦Sustainable development of all stake holders- to ensure growth of all individuals associated with or effected by the enterprise on sustainable basis ◦Effective management and distribution of wealth – to ensue that enterprise creates maximum wealth and judiciously uses the wealth so created for providing maximum benefits to all stake holders and enhancing its wealth creation capabilities to maintain sustainability ◦Discharge of social responsibility- to ensure that enterprise is acceptable to the society in which it is functioning ◦Application of best management practices- to ensure excellence in functioning of enterprise and optimum creation of wealth on sustainable basis ◦Compliance of law in letter & spirit- to ensure value enhancement for all stakeholders guaranteed by the law for maintaining socio-economic balance ◦Adherence to ethical standards- to ensure integrity, transparency, independence and accountability in dealings with all stakeholders  Principles of corporate governance:(cont.) 1)Principle of fairness 2)Transparency principle 3)Principle of accountability 4)Fiduciary principle 5)Reliability principle 6)Principle of Dignity  Four Pillars of Corporate Governance ◦Accountability ◦Fairness ◦Transparency ◦Responsibility Accountability ◦Ensure that management is accountable to the Board ◦Ensure that the Board is accountable to shareholders Fairness ◦Protect Shareholders rights ◦Treat all shareholders including minorities, equitably ◦Provide effective redress for violations Transparency Ensure timely, accurate disclosure on all material matters, including the financial situation, performance, ownership and corporate governance Responsibility ◦Social Responsibility ◦Beyond Profit ◦People and Planets concerns need also to be addressed Elements of Corporate Governance ◦Good Board practices ◦Control Environment ◦Transparent disclosure ◦Well-defined shareholder rights ◦Board commitment NEED FOR CORPORATE GOVERNANCE ◦ 1. Corporate Performance: Improved governance structures and processes help ensure quality decision making, Encourage effective succession planning for senior management and enhance the long‐term prosperity of companies, independent of the type of company and its sources of finance. This can be linked with improved corporate performance‐ either in terms of share price or profitability. ◦ 2. Enhanced Investor Trust: Investors consider corporate Governance as important as financial performance when evaluating companies for investment. Investors who are provided with high levels of disclosure & transparency are likely to invest openly in those companies. ◦ 3. Better Access to Global Market: Good corporate governance systems attracts investment from global investors, which subsequently leads to greater efficiencies in the financial sector. ◦ 4. Combating Corruption: Companies that are transparent, and have sound system that provide full disclosure of accounting and auditing procedures, allow transparency in all business transactions, provide environment where corruption will certainly fade out. ◦ 5. Easy Finance from Institutions: Evidences indicate that well‐governed companies receive higher market valuations. The credit worthiness of a company can be trusted on the basis of corporate governance practiced in the company. NEED FOR CORPORATE GOVERNANCE ◦ 6. Enhancing Enterprise Valuation: Improved management accountability and operational transparency, fulfill investors’ expectations and confidence on management and corporations, and in return, increase the value of corporations. ◦ 7. Reduced Risk of Corporate Crisis and Scandals: Effective Corporate Governance ensures efficient risk mitigation system in place. The transparent and accountable system that ◦ 8. Accountability: Investor relations’ is essential part of good corporate governance. The company is obliged to make timely disclosures on regular basis to all its shareholders in order to maintain good investors’ relation. Good Corporate governance practices create the environment where Boards cannot ignore their accountability to these stakeholders. CORPORATE GOVERNANCE THEORIES CORPORATE GOVERNANCE THEORIES CORPORATE GOVERNANCE THEORIES CORPORATE GOVERNANCE THEORIES Corporate History, Structure and Ownership Pattern  A company is an association of person formed for the purpose of achieving some common objectives. Company is a legal entity made up of an association of persons, be it natural, legal, or a mixture of both, for carrying on a commercial or industrial enterprise. Company members share a common purpose and unite in order to focus their various talents and organize their collectively available skills or resources to achieve specific, declared goals.  Companies take various forms such as: Voluntary associations organised in public and private sector which may include any non-profit organisation. A group of soldiers organised to accomplish a task. Business entities with an aim of gaining profit. Financial entities and banks.  As per the Indian Companies Act a company is “One formed or registered under the Indian Companies Act 2013 or an existing company”. An existing company is a company formed or registered under any of the previous company laws. According to Marshall, “A company is a person artificial, invisible, intangible and existing only in the contemplation of law. It possesses only those properties which the character of its creator confers up on it either expressly or as incidental to its very existence”.  Characteristics of a Company 1. It is an incorporated association 2. Artificial legal person 3. Separate legal entity 4. Perpetual succession 5. Common seal 6. Limited liability 7. Transferable shares 8. Separate property 9. Separation of ownership and management  Types of Company Joint Stock Company can be of various types. The following are the important types of company. A) Classification of Companies by Mode of Incorporation Depending on the mode of incorporation, there are three classes of joint stock companies: 1. Chartered companies: These are incorporated under a special charter of the King or Queen. The East India Company and The Bank of England are examples of chartered companies incorporated in England. The powers and nature of business of a chartered company are defined by the charter which incorporates it. A chartered company has wide powers. It can deal with its property and bind itself to any contracts that any ordinary person can. In case the company deviates from its business as prescribed by the charter, the Sovereign can annul the latter and close the company. Such companies do not exist in India. 2. Statutory companies: The companies which are incorporated by a Special Acts of parliament or state legislature are called statutory company. Reserve Bank of India, State Bank of India, Industrial Finance Corporation, Unit Trust of India, State Trading Corporation and Life Insurance Corporation are some of the examples of statutory companies. Such companies do not have any memorandum or articles of association. They derive their powers from the acts constituting them and enjoy certain powers that companies incorporated under the Companies Act. Alterations in the powers of such companies can be brought about by legislative amendments. 3. Registered companies: These are formed under the Companies Act, 2013 or under the Companies Act passed prior to this. Such companies come into existence only when they are registered under the Act and a certificate of incorporation has been issued by the Registrar of Companies. This is the most popular mode of incorporating a company. Registered companies may further be divided into three categories namely: (a) Companies limited by shares: These types of companies have a share capital and the liability of each member or the company is limited by the Memorandum to the extent of face value of share subscribed by him. During the existence of the company or in the event of winding up, a member can be called upon to pay the amount remaining unpaid on the shares subscribed by him. Such a company is called the company limited by shares. A company limited by shares may be a public company or a private company. These are the most popular types of companies. (b) Companies limited by guarantee: These types of companies may or may not have a share capital. Each member promises to pay a fixed sum of money specified in the memorandum in the event of liquidation of the company for payment of the debts and liabilities of the company This amount promised by him is called ‘Guarantee’. The articles of association of the company state the number of member with which the company is to be registered. Such a company is called a company limited by guarantee. The amount of guarantee of each member is in the nature of reserve capital. This amount cannot be called upon except in the event of winding up of a company. (c) Unlimited companies: A company not having any limit on the liability of its members is called an ‘unlimited company’. The liability of each member extends to the whole amount of the company’s debt and liabilities. It is more or less similar to a partnership form of entity except the fact that third party cannot sue the members of the company directly as in the case of partnership because of the separate legal entity status. Thus the creditors shall have to institute the proceedings for winding up of the company for their claims. The official liquidator may be called up on the members to discharge the debts and liabilities without limit. An unlimited company may or may not have a share capital. If it has a share capital it may be a public company or a private company. If the company has a share capital, the article shall state the amount of share capital with which the company is to be ON THE BASIS OF NUMBER OF MEMBERS On the basis of number of members, a company may be: 1. Private Company 2. Public Company PRIVATE COMPANY The term Private Company has been defined under section 2(68) of the Indian Companies Act 2013. According to it a private Company means a company, which has a minimum paid up share capital of ` 1,00,000 and which provides the following restrictions through its Articles of Association and Memorandum: Restricts the transfer of shares by its members. Limits the maximum number of members to 50. Prohibits any invitation to public for debentures of the company. It also enjoys special privilege’s, such as: It can be started with only two members, It is not required to issue a prospectus and It can start its operations immediately after receiving the Certificate of Incorporation. PUBLIC COMPANY According to Indian Companies Act 2013 ‘A public company is not a private company’. If we explain the definition of Indian Companies Act in regard to the public company, we note the following: According to section 2(68) of the Indian Companies Act 2013, a private company means a company having a minimum paid up capital of 1 lakh, and its article restricts transfer of shares, maximum number of members to 50, prohibits invitation to public to subscribe shares or debentures, etc. 1. The articles do not restrict the transfer of shares of the company. 2. It imposes no restriction on the maximum number of the members on the company. 3. It invites the general public to purchase the shares and debentures of the companies. (a) Minimum number: The minimum number of persons required to form a public company is seven. (b) Maximum number: There is no restriction on maximum number of members in a public company, whereas the maximum number cannot exceed 50 in a private company. (c) Public subscription: A public company can invite the public to purchase its shares or debentures. (d) Issue of prospectus: Unlike a public company a private company is not expected to issue a prospectus or file a statement in lieu of prospectus with the Registrar before allotting the shares. (e) Transferability of shares. In a public company, the shares are freely transferable. ON THE BASIS OF CONTROL On the basis of control, a company may be classified into 1. Holding companies 2. Subsidiary company HOLDING COMPANY A company is known as the holding company of another company if it has control over the other company. A company is deemed to be the holding company of another if, but only if, the other is its subsidiary. A company may become a holding company of another company in either of the following three ways: (a) by holding more than fifty per cent of the normal value of issued equity capital of the company; or (b) by holding more than fifty per cent of its voting rights; or (c) by securing to itself the right to appoint, the majority of the directors of the other company, directly or indirectly. The other company in such a case is known as a ‘Subsidiary company’. Though the two companies remain separate legal entities, yet the affairs of both the companies are managed and controlled by the holding company. A holding company may have any number of subsidiaries. The annual accounts of the holding company are required to disclose full information about the subsidiaries. SUBSIDIARY COMPANY A company is known as a subsidiary of another company when its control is exercised by the latter (called holding company) over the former called a subsidiary company. Where a company (company S) is subsidiary of another company (say Company H), the former (company S) becomes the subsidiary of the controlling company (company H).  On the Basis of Ownership of Companies (a) Government companies: A Company of which not less than 51 per cent of the paid up capital is held by the Central government or by the State government singly or jointly is known as a government company. It includes a company subsidiary to a government company. The share capital of a government company may be wholly or partly owned by the government, but it would not make it the agent of the government. (b) Non-government companies. All other companies, except the government companies are called non-government companies. They do not satisfy the characteristics of a government company as given above.  On the Basis of Nationality of the Company (a) Indian companies: These companies are registered in India under the Companies Act, 1956 and have their registered office in India. Nationality of the members in their case is immaterial. (b) Foreign companies: It means any company incorporated outside India which has an established place of business in India. A company has an established place of business in India if it has a specified place at which it carries on business such as an office, store house or other premises with some visible indication of premises. FORMS OF BUSINESS ORGANISATION Proprietary Form of Business The earliest and mostly widely used model of business all over the world is the sole proprietorship or proprietary business. As the name indicates it is one man business. The proprietor or sole trader generates business idea; contributes capital and takes complete risk of running the business. He also takes the whole profit. He is personally liable for the whole obligations of the business. Not only are his business properties liable for the obligation of the business but also his private properties. The ownership and control also rests with the same individual. There is no separation of ownership and management. There is no distinction between business and business man. Hence the business ceases to exist at the death of the proprietor. This mode of business is used when the amount of capital required is less, business risk is low and scale of operation is not large. Partnership Form When the scale of operation is increased, more capital is required and risk level increases, the business assumes partnership form with two or more business men joining together and conduct the business. According to section 4 of the Indian Partnership Act, a partnership is the relation between two or more persons who have agreed to share the profits of a business carried out by all or any one acting for all. The persons who have entered into the partnership with one another are called individually as partner and collectively as firm. Profit and loss are shared by the partners in an agreed proportion. Control and management are also shared by the partners. Partners are jointly and severally liable for the whole obligations of the firm as is in the case of sole tradership. There is no independent existence of the firm. It ceases to exist with the retirement or death of one or more partners. The firm cannot sue on its own or be sued upon it. Joint Stock Company Form Advent of industrial revolution, trend of colonization, identification of huge unexploited natural wealth, increased economic integration between nations, convergence of human needs and wants, advent of modern technology in manufacturing and service sectors, increased trade cooperation between nations, elimination of barriers of trade within and between nations, free movement of technology and capital across nations, etc. All these have contributed to the development of new thinking about large types of business forms with huge capital, reduced risk, limited liability, separation of ownership and control, transferability of rights, liquidity, etc. The development of company form of business format is the result of this thinking. Joint stock company format of business with characteristics like, separate entity, separation of ownership and control, transferability of right, risk diversification, etc. Co-operative Form of Business Organisation Another form of business organisation though not very popular but powerful in certain sectors in commercial line is the co-operative society. But it eliminates most of the negative aspects of joint stock form of business. A cooperative society is an enterprise formed and directed by an association of users, applying within directly intended to serve both its own members and the society as a whole. A cooperative organisation is an association of persons who come together voluntarily to achieve some common purpose, through an economic enterprise, working at their own risk and with resources which all members contribute.  The basic principles up on which a cooperation form of enterprise is built are: 1. Universality of membership 2. Democratic control 3. Political and religious neutrality 4. Self-help and mutual help 5. Principle of limited liability and 6. Limited interest on capital According to section 120, a co-operative society is an association of persons varying in number who are having the same or similar economic difficulties and who voluntarily associate on the basis of equal rights and obligation, endeavour to solve these difficulties mainly by conducting at economic functions that correspond to their common needs. Security Exchange Board of India (SEBI) The formation of SEBI was another significant event that took place during this period. Till then the work relating to capital issue of companies was controlled by the office of Controller of Capital Issue under the Ministry of Company Affairs. There were many complaints about the functioning of that office from the company people. To overcome these complaints, the Government of India abolished the office and established SEBI in 1988 as an advisory body first and from 1992 as the regulatory body of the capital market operations in India. This is a professional body consisting representatives of all the stakeholders of the capital market operation such as investor representative, company representatives, government representatives with the following objectives: 1. Investor protection 2. Ensuring fair trade practices by brokers, merchant bankers, companies, etc. 3. Promotion of efficient services by market intermediaries. 4. Collection and dissemination of stock market information. Functions of SEBI SEBI was entrusted with two types of functions, such as 1. Regulatory functions 2. Developmental functions Regulatory Functions of SEBI The regulatory functions include the following: 1. Registration of brokers 2. Registration of mutual funds. 3. Registration of merchant bankers and portfolio managers. 4. Prohibition of unfair trade practices by companies. 5. Controlling insider trading. 6. Controlling wide price fluctuations in stock markets. 7. Controlling hostile takeover bids. 8. Checking the observance of listing rules. Developmental Functions The developmental functions include the following: 1. Investor education 2. Training of intermediaries 3. Fixing code of conduct to all stock market operators and conducting equity research. Disinvestment Policy If the post-independence period from 1947–1990 was one of strengthening of the public sector in the Indian economy, then the period from 1991 was of disinvestment and privatization of public sector companies. Disinvestment can be defined as the action of an organisation (or government) selling or liquidating an asset or subsidiary. It is also referred to as ‘divestment’ or ‘divestiture.’ In most contexts, disinvestment typically refers to sale from the government, partly or fully, of a government-owned enterprise. A company or a government organisation will typically disinvest an asset either as a strategic move for the company, or for raising resources to meet general/specific needs. OBJECTIVES OF DISINVESTMENT Inefficient PSUs had become and were continuing to be a drag on the government’s resources turning to be more of liabilities to the government than being assets. Many undertakings traditionally established as pillars of growth had become a burden on the economy. Under–utilization of capacity, Problems related to planning and construction of projects, Problems of labour, personnel and management and Lack of autonomy.  The government also took a view that it should move out of non-core businesses, especially the ones where the private sector had now entered in a significant way. Disinvestment was also seen by the government to raise funds for meeting general/specific needs. Disinvestment also assumes significance due to the prevalence of an increasingly competitive environment, which makes it difficult for many PSUs to operate profitably. This leads to a rapid erosion of value of the public assets making it critical to disinvest early to realize a high value. The following main objectives of disinvestment were outlined: To reduce the financial burden on the government. To improve public finances. To introduce, competition and market discipline. To fund growth. To encourage wider share of ownership. To depoliticize non-essential services. The importance of disinvestment lies in the utilization of funds for: Financing the increasing fiscal deficit. Financing large-scale infrastructure development. For investing in the economy to encourage spending. For retiring government debt by almost 40–45 per cent of the Centre’s revenue receipts go towards repaying public debt/interest. For social programs like health and education.