Strategy Implementation

and Control UNIT 11 CORPORATE GOVERNANCE

Objectives

After going through this unit you should be able to:

 Know the evolution of corporate governance;

 Acquaint yourself with five pillars of corporate governance;

 Understand the various drivers of corporate governance;

 Discuss the models of corporate governance.

Structure
11.1 Introduction
11.2 Evolution of corporate governance
11.3 Business Ethics
11.4 Pillars of corporate governance
11.5 Models of corporate governance
11.6 Corporate governance and Strategy
11.7 Challenges of corporate governance
11.8 Summary
11.9 Key-words
11.10 Self-Assessment Questions
11.11 References and Further Readings

11.1 INTRODUCTION
The growth of corporate sector and the competitive market has together introduced
the concept of corporate governance. Corporate governance has become an
integral part of business life so as to achieve the objectives and to protect the
organizations from failure in future. There are two aspects which are important
to understand the corporate governance: a) the internal structure which includes
the management, board structure etc. and b) the external structure which includes
shareholders and other stakeholders. This helps in ensuring an efficient internal
control, robust management structure, appropriate performance measures and
effective succession plans. At the domestic as well as international fronts, the
organizations have been applying corporate governance as codes of best practices
and have set examples for others. In this unit we will discuss the basics of corporate
governance and how it is related to strategy.

11.2 EVOLUTION OF CORPORATE GOVERNANCE

If we go back and see the Indian history way back in the third century B.C. we
190 will find that Patliputra, the capital of the Mauryan Empire was said to be the
best example of a city which followed the best practices of governance. Chanakya Corporate Governance
in his book Arthshastra, mentioned the virtues of an ideal kind which can be
related to the chief of any organization. These virtues are:
 Well-being of the subjects;;
 Welfare of the subjects.
If these two are followed, then the king automatically will be happy and something
which is desirable and beneficial to the subjects is desirable and beneficial to the
king.
If we substitute the state with the organization and the king with the chief of the
organization or the board of a company, and the subjects with the shareholders,
the principles of corporate governance which is the belief that public good should
be ahead of private good; and that the corporation’s resources should not be used
for personal benefit fits well. The duties of the king when applied for a business
organization implies as follows:
 Protecting the shareholders wealth,
 Proper utilization of assets;
 Maintenance of wealth;
 Accountability and transparency.
The advent of company law happened in the middle of 19th century. This was
basically done to protect the interests of the shareholders in the joint stock
companies. The concept of Board of Directors (BOD) as trustees of the
shareholders emanated from the need for appropriate governance structure.
The BOD would be responsible for overseeing the management of the
organization in order to protect the interests of the shareholders. As the time
passed the ownership of shareholdings gradually shifted from individuals to
institutional investors and also with privatization throughout the globe, control
of assets shifted from State to market economy. This led to the views of
various experts who felt good governance is a useful indicator of good
performance in the market systems.
In the developed market economies, the concern for Board governance framework
became important due to rise in corporate sector financial and related irregularities
at different points of time especially during the twentieth century. This showed
the inefficiency in the governance structure. Further, with the gradual opening
up of the global economy, trade, investment and international financial market
liberalization, the framework of effective corporate governance gained
recognition. This was considered as an important instrument for sustained
development of the world economy. Worldwide a series of expert committee
reports led to the evolution of different codes of corporate governance to reflect
the challenges of a competitive and globalised system.
There is no fixed way as to how corporate governance can be incorporated in
an organization’s strategy. There are different views and different experts
have given different definitions of corporate governance. The dictionary
meaning of governance includes both ‘the action or manner of governing’
and ‘a mode of living, behaviour, and demeanor’. Corporate governance is
essentially concerned with the process by which organizations are governed and
managed. 191
Strategy Implementation It is a set of standards, which aims to improve the organization’s image,
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efficiency, effectiveness and social responsibility. The concept of corporate
governance primarily relies on complete transparency, integrity and
accountability of the management, with an increasingly higher focus on
investor protection and public interest. A key element of good governance is
transparency projected through a code of good governance, which incorporate
a system of checks and balances between key players – boards, management,
auditors and shareholders.
The corporate governance framework in many countries of the world is largely
inward-focused. It mainly highlights the composition of management structure
at various levels. The composition at different levels is different assuming that
the right structure will automatically ensure quality to delivery. All corporate
governance systems depend on 5 key pillars which will be discussed later in this
unit. These are:
1. Accountability
2. Fairness
3. Transparency
4. Integrity
5. Social responsibility
The challenges of upholding these pillars depend upon the ownership structure
of the corporate. The corporate ownership structures are of two types: 1) “Insider”
(concentrated) and 2)”Outsider” (dispersed). In the concentrated ownership
structure, ownership control is concentrated in the hands of a small number of
individuals, families, holding companies, banks or other non-financial companies.
In this structure insiders exercise control over organization in different ways.
The most common feature in this structure is that insiders own the majority of
the shares of the organization with voting rights. Most nations, especially those
governed by civil law, have concentrated ownership structure. In dispersed
ownership structures, there are number of owners, each of whom holds a small
number of shares of the organization. Small shareholders have little incentive to
closely monitor organizations’ activities and tend not be involved in management
decisions or policies. Common law countries such as United Kingdom and United
States tend to have dispersed ownership structure. Each ownership structure has
its own corporate governance challenges.
Evolution globally
In the early 1990’s in the United Kingdom, the United States and Canada began
the modern trend of developing corporate governance guidelines and codes of
best practice. This was in response to problems in the corporate performance of
leading organizations, the perceived lack of effective board oversight that
contributed to performance problems and pressure for change from institutional
investors.
In the year 1992 in the United Kingdom, the Cadbury committee report, defined
corporate governance as “the system by which organizations are directed and
controlled”, became a pioneering reference code for stock exchanges both in
192 UK and abroad. General Motors Board of Directors Guidelines in the U.S., and
the Dey Report in Canada also proved to be influential sources for guidelines Corporate Governance
and code initiatives adopted by other countries.
in July 2003, in U.K., the Financial Reporting Council (FRC) of the U.K.
published the new Combined code which was referred to as “U.K. code (2003)”
thereafter. The U.K. Code (2003) was based on the proposed revision of the
Cabined Code (1998), in the report by Derek Higgs on the role and effectiveness
of non-executive directors, which incorporated the recommendations on audit
committees by Robert Smith.
The most significant changes in the code were as follows:
 the expanded definition of independent director;
 an increase in the recommended proportion of independent directors
from one-third to a majority of the Board for larger listed organizations;
 Separate Chairperson and CEO
 Chairperson being an independent director.
 Stringent guidelines on membership of the Audit Committee;
 Increased emphasis on the need for internal audit and control functions;
 Allows for some differences in corporate governance arrangements for
larger and smaller organizations, particularly pertaining to the number
and proportion of independent directors on the Board and number of
members on certain Board committees.
Following various other committee recommendations in different nations of the
world, there have been efforts to homogenize the code of corporate Governance,
particularly in listed organizations. In the U.S., in 1998, the New York Stock
Exchange (NYSE) and the National Association of Securities Dealers (NASD)
sponsored a committee to study the effectiveness of audit committees. This
committee was known as the Blue Ribbon Committee and was set up to improve
the effectiveness of Corporate Audit Committees. In its 1999 report, the Blue
Ribbon Committee recognized the importance of audit committees and issued
ten recommendations to enhance their effectiveness. In response to these
recommendations, the NYSE and the NASD, as well as other exchanges, revised
their listing standards relating to audit committees.
In 2002, the Sarbanes-Oxley Act was passed in response to a number of major
corporate and accounting scandals involving prominent companies in the United
States. This Act is considered to be one of the most significant changes to federal
securities laws in the United States. An interesting aspect in the Sarbanes Oxley
Act is the protection to whistleblowers.
The Organization for Economic co-operating and Development (OECD)
Principles of Corporate Governance, originally adopted by the 30 member
countries of the OECD in 1999, have provided a good insight into corporate
governance framework at a macro level. Following an extensive review process
that led to adoption of revised OECD Principles of Corporate Governance 2004,
they now reflect a global consensus regarding the critical importance of good
corporate governance in contributing to the economic viability and stability of
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experience of OECD countries but also that of emerging and developing
economics.

11.3 BUSINESS ETHICS

When we talk about ethics, it relates to the demarcation between right and wrong.
It is actually the moral values and certain codes of conduct which are presumed
to be followed by an individual as well as an organization. Garret has defined
ethics as “the science of judging specifically human ends and the relationship of
means of those ends. In some way it is also the art of controlling means so that
they will serve specifically human ends”. There are many such definitions but at
the end of the day we can say that there are no fixed set of rules which can define
as the action right or wrong. Ethics is not legally defined but it does not permit to
violate the laws. Role of ethics and values is quite important for business
organization and we call it as business ethics.
Business Ethics: As the name suggests, it deals with certain sets of rules of any
business organization. It is the set of permissible rules which have a positive
impact to the organization. It deals with certain set of values of the organization
leading to the socially responsible behaviour of the organization. In a nutshell
we can say that it is the application of ethical principles in a business organization.
There are certain common features of business ethics which are as follows:
1. It demarcates between the right and wrong,
2. It deals with the operating issues in an organization;
3. It relates to the corporate social responsibility;
4. It directs the organization to be good corporate citizens apart from being
profitable;
5. It defines the descriptive (what is being done) as well as normative ethics
(what should be done);
6. Though it is not legal but it is much larger than any law.
Let us see a hypothetical example where the organization is termed to be ethical.
Organization ‘T’ is said to be one of the most ethical and socially responsible
organization.
Q. What does it do to become an ethical organization?
Ans. It follows the following business activities:
 It makes the organization effective;
 It follows the concept of wealth maximization than profit maximization;
 It treats it customers as kings/queens,
 It builds a culture where the employees have a high level of integrity;
 It gives importance to the families of the employees;

194  It deals with the ethical dilemmas in teams.

 This example shows that business ethics is an integral part of strategic Corporate Governance
management as it helps in achieving the goals of the organization in the
most ethical way.
Activity 1
Select an organization which follows ethics and list the business activities which
make it ethical.
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11.4 PILLARS OF CORPORATE GOVERNANCE

Corporate governance is a combination of five pillars. The objectives of these
pillars help an organization in the implementation of strategy. These pillars are:
1. Accountability
2. Fairness
3. Transparency
4. Integrity
5. Social responsibility
All these pillars are critical for the success of an organization. This helps in
developing a strong relationship with the shareholders and all stakeholders.
1. Accountability: This is a form of ownership strategy which means
owning the rewards and failures/risks in the context of the value
proposition by an organization. Accountability should be applicable at
all levels from the lower management to the top management, and then
only it works.
2. Fairness: This means treating all the stakeholders equally without any
demarcation of caste, status etc. This involves effective communication
as well.
3. Transparency: This is one of the most important pillars of corporate
governance as it gives credibility to an organization. Transparency means,
disclosing all the information which are relevant and important for all
the shareholders and stakeholders so that they are not in dark about the
performance of an organization.
4. Integrity: It is important for any organization and this comes through a
professional culture where each employee is given importance which
makes him/her to perform at their best.
5. Social responsibility: This applies at the top management level. The
decision taken at the top should be such that they benefit the organization
as a whole. Therefore, it is important that the organization should have a
clear understanding of these pillars and practice there accordingly.
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Strategy Implementation Activity 2
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Discuss as to how the five pillars of corporate governance help an organization
achieve its objective.
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11.5 MODELS OF CORPORATE GOVERNANCE

There are seven basic models of corporate governance. These are:
1. Canadian Model
2. UK and American Model
3. German model
4. Italian model
5. France model
6. Japanese model
7. Indian model
We will discuss these models in brief:
1. Canadian Model: Canada is country which has a large influence of French
culture. This is because it was a colony of France and Britain. Till 19th century,
the industries in Canada were basically family businesses but for the past
five decades the scenario has changed and now it resembles the US industry
structure. Looking at its corporate governance structure it is visible that it
was one of the early initiators of corporate governance.

2. UK and American model/ Anglo-American model

Sarbanes Oxley Act (SOX) was passed in July 2002 with the aim to provide
more transparency and accountability to US corporate. This act focuses on
the following:

 Re-establish investor confidence through good corporate governance

practices;
 Improve accuracy and transparency in financial reporting;
 Accounting service of listed organizations;
 Increased corporate responsibility;
 Auditing independently;
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Figure 11.1gives a view of the Anglo-American model. Corporate Governance

Figure 11.1: The Anglo-American Model

3. German Model: Since 19th century Germany is known as the hub of
industrialization. For the past five decades Germany has been exporting
sophisticated Machinery. The financing of the German industries is being
done by rich German families, small shareholders, bankers and foreign
investors. Since the second half of 19th century Germany has been taking
steps towards corporate governance. The company law was introduced in
1870 and 1884 company law highlighted on making the information
transparent. As of now Germany has more number of family controlled
businesses. Figure 11.2 shows the German model of industry and corporate
governance.

Figure 11.2: The German Model

4. Italian Model: Since a long time the Italian business has been dominated by
the family holdings. This trend continued till the 20th century. In the second
half of the 20th century, the stock market gained importance. In 1931 all the
Italian investment banks collapsed which led to the fascist government taking
over of all the industrial shares and imposing a legal separation of investment
from the commercial banks since World War II, with the introduction of the
Industrial policy with no need for investor protection. Since long the corporate
governance lied with bureaucrats and rich families. In the last two decades,
the corporate governance is in an organized form. Now the investors in Italy
are aware of their rights and importance of corporate governance. 197
Strategy Implementation 5. France Model: The financial system in France was controlled by religion
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and the state was the main borrower. The basic form of lending was mortgage
and coins were the major part of money transaction. The French industry
was based on a consecutive outlook. The corporate governance was
introduced in France in a stage-wise manner with economic development
activities.

6. Japanese Model: Japan has been a conservative county where the business
families were at the bottom of the pyramid. This led to the stagnation of the
businesses. After World War II the change in business took place and the
entry of American traders was allowed. A new culture started building up
and Japanese industry started gaining which was a mix of private and state
capitalization. In the early 1930’s during depression, the fall of family business
started to take place and in 1945 the Americans took charge of Japanese
economy. The concept of corporate governance evolved only in the past 20
years. Figure 11.3 shows the Japanese model of industry and corporate
governance.

Supervisory Board Monitors and acts

(Including President) during emergency
Shareholders

President

Executive
Management
(Board of Directors)

Main Bank
Company

Figure 11.3: The Japanese Model

7. Indian Model: India has a long history of commercial activities. The formal
structure of corporate governance was given by CII in 1998 which was termed
as “Desirable corporate governance code”. In the year 2000, SEBI established
a committee under the chairmanship of report Mr. Kumar Mangalam Birla
to make the report. In the same year the ministry of finance set up Naresh
Chandra committee which was supposed to examine the roles, duties and
independence of auditors. In 2003 SEBI revised the clause 49 of listing
agreement for listed companies based on the report of N.R. Narayanswami
committee. The Indian model has mandatory compliance related to the BOD,
audit committees, Subsidiary compliances relating to whistle Blower Policy,
shareholders lights, and audit qualification and performance evaluation of
board member.
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Activity 3 Corporate Governance

List out the important provisions of the different models.

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11.6 CORPORATE GOVERNANCE AND

STRATEGY
As we have discussed earlier, it is quite visible that there is a strong relationship
between corporate governance and strategy. Figure 11.4 describes the relationship
of corporate governance with strategy. These are certain points which describe
the relationship between the two. These are:

 Corporate governance when related to strategic management means the

set of rules and policies of an organization;
 Corporate governance stresses the importance on stakeholders at
large;
 It distinguishes between the roles of owners and the managers;
 It helps the organization in effective strategic decision making;
 It helps the organization in developing fairness towards its investors.
Overall corporate governance gives the direction to the organization so that it
can perform effectively.

Figure 11.4: Corporate Governance and Strategy

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and Control 11.7 CHALLENGIES OF CORPORATE
GOVERNANCE
Now we know that corporate governance is all about direction, management and
control of an organization. However, there are many issues and challenges
organizations face due to the uncertain situations. Pandemic has caused the
organizations to slow down, which have created a kind of unrest in the
organization. The issues and challenges of corporate governance can be listed as
follows though this cannot be termed as exhaustive list:
1. Board appointments: This is the major issue as due to issues like pressure
from promoters etc. the appointments of the board may be biased. The
organizations need to be very careful while appointing the board as this may
become a hindrance in the success of the organizations.
2. Performance evaluation of Directors: this is another challenge in
implementing the corporate governance as there may be cases where the
evaluation of the performance of the directors may not be allowed.
3. Appointment of Independent Directors: As per the code it is mandatory
to appoint an Independent director but this appointment may be biased in
many cases as the promoters/investors may pressurize the organization to
appoint their own person. This unethical practice may act as a bottleneck for
the success of the organization.
4. Removal of Independent Directors: The law says that the Independent
directors can be removed anytime. This law at times may become a challenge
for the organizations. In this case also the promoters/investors may put
pressure to remove an independent director who does not take decisions in
their favour.
5. Accountability towards stakeholders: This is a major challenge on part of
the organizations. There may be various reasons where the organizations
overlook the welfare of the stakeholders. There are number of examples
globally where organizations have adopted unethical practices to make more
profits.
6. Role of promoters: The role of promoters is very important for organizations.
As discussed earlier, if the promoters look after their own interests only then
it become a major challenge for the organizations.
7. Transparency issues: Many organizations get stuck into the quagmire of
unethical practices which leads to transparency issues.
8. Conflict in organization: The conflict inside the organization creates a major
challenge. If the conflict is not resolved then it is presumed that the
organization may not succeed and will lead to ill practices like bribe etc.
9. Level of mistrust: If the organization loses its credibility then it is very
difficult to build it again. Regaining the trust of stakeholders and shareholders
becomes a major challenge.
It is very difficult to control the external environment but strong core values of
200 any organization can help it in overcoming such challenges.
 Corporate Governance
11.8 SUMMARY
In this unit we have discussed different aspects of corporate governance. The
evolution of corporate governance dates back to third century BC. The main aim
of corporate governance was to protect the interest of the society which later
turned out to be protecting the interests of the stakeholders/shareholders. In the
20th century different models emerged and they were modified as per the needs.
The United Kingdom, USA and Canada are termed to be the initiators of the
formalization of corporate governance practices. In India Government, CII, SEBI
and other regulators came out with various reports to formally implement the
codes of corporate governance. All the experts throughout the globe believed
that strengthening corporate governance is necessary as it bridges the gap between
the corporate and its various stakeholders. This can be done by applying the five
pillars of Corporate Governance. The unit also discusses the importance of
business ethics in implementing Corporate Governance practices. It is not easy
to implement corporate governance. Organizations throughout the globe are facing
issues and challenges in implementing the same. Some challenges have been
discussed although there may be many more depending on the structure of the
organization. Overall the unit gives a bird’s eye view about the concept of
Corporate Governance.

11.9 KEY WORDS

Stakeholders : Those who can affect or get affected by the business.
Shareholders : is a person or organization who owns at least one
share or the stock of the organization.
Corporate Governance : It represents the values, ethics and the morals which
business strategic decisions are made
Code of Ethics : A document which outlines the mission and values
of the organization.
Business Ethics : It involves understanding the policies and
procedures for appropriate action.
Strategy : It is the plan of action of an organization.

11.10 SELF-ASSESSMENT QUESTIONS

1) Define Corporate Governance. Why is it important for organizations to follow
corporate governance practices?
2) Describe different models of Corporate Governance.
3) Explain the concept of business ethics citing examples.
4) In the present context what are the major challenges that the corporate sector
is facing regarding implementing Corporate Governance.
5) How can you relate Corporate Governance with Strategy? Discuss.
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11.11 REFERENCES AND FURTHER READINGS
Bajpai, G. N. (2016). The Essential Book of Corporate Governance. India: SAGE
Publications.
Das, S. C. (2018). Corporate governance in India: An evaluation. India: PHI
Learning.
Fernando, A. C. (2018). Corporate Governance: Principles, Policies and
Practices (3rd ed.). United States: Pearson India.
Minow, N. &Monks, R. A. G. (2011). Corporate Governance. United
Kingdom: Wiley.
Sarkar, S. & Sarkar, J. (2012). Corporate Governance in India. India: SAGE
Publications.

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