Unit-5

K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Project Management and Corporate

Governance
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Social Cost benefit Analysis : meaning

•Social Cost benefit Analysis is a systematic evaluation
technique for long-term decision making in capital
projects appraisal. It is an analytical tool in decision
making which enables a systematic comparison to be
made between the social costs and related social
benefits with due emphasis on technical and other
feasibility studies but focusing more on social impact
 K.Bhagya Lakshmi,
Assistant Professor,SMS

Key Terms
Dept , CBIT.

Social Cost:
There are certain costs which though ignored by a firm does have
a serious impact on the society. These costs are related to the
wear n tear of roads and pollution etc .These costs which has to
be borne by the society, comes under the head of Social cost.
Examples:
Air pollution, Water pollution, Depletion and destruction of
animal resource, Soil Erosion Deforestation, Impairment of
human resources, Deterioration in the law and order conditions
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Social Benefits
The term social benefits refer to an increase in the overall welfare of the
community or society which is being derived from a particular course of action
by a business firm or government other than the person who is receiving the
benefit.
For example Society gets benefitted from public parks developed and
maintained by government.
The term social benefits, in economics, refer to the total benefit to society from
producing or consuming a good / service.
The social benefits may be in the form of products and services provided,
payment of taxes and rates, additional employee’s benefits, donations to the
community, ancillary benefits, environmental improvements, etc.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Social Profit

•The term may be defined as the excess of social

benefits received by the society from the activities
of the business over the social costs borne by the
society attributable to the same firm or Positive
difference between Positive impact and Negative
impacts on society.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Social Cost Benefit Analysis

• It is defined— “as a methodical and rational
process of identifying, evaluating and assessing
the benefits (outputs) and costs (inputs)
associated with alternative activities which will
effectively accomplish economic targets and
social goals
 K.Bhagya Lakshmi,

Commercial Cost Benefit Analysis (CBA)

Assistant Professor,SMS
Dept , CBIT.

Total cost of the Expected future

project benefit from the
project
• Benefit > Cost is desirable here.
• So it is nothing but a profitability analysis.
• But what will be the costs and/or the benefits that a
society may have to bear and/or get from the proposed
project are not considered here.
 K.Bhagya Lakshmi,
Assistant Professor,SMS

For example:
Dept , CBIT.

• Suppose, a manufacturer produces cigarettes and sell it

Rs..40 a packet, and another manufacturer produces
soaps and sell it Rs..20 a bar.
Now, if we think about the impact of soaps & cigarettes on
the society, the questions may be –
▫ Does the price of cigarettes take account of the
smokers’ higher probability of heart disease or cancer?
▫ Does the price of soap take note of the benefits from
the use of soap, e.g., reduced risk of spread diseases?
Obviously, a commercial entrepreneur can’t give well
answer to these questions.
 K.Bhagya Lakshmi,

What is Social Cost Benefit Analysis ?

Assistant Professor,SMS
Dept , CBIT.

• So, to reflect the real value of a project to society, we

must consider the impact of the project on society.
Impact

Positive Negative
(Social Benefit) (Social Cost)

Thus ,when we evaluate a project from the view point of

the society (or economy) as a whole, it is called Social Cost
Benefit Analysis (SCBA)/Economic Analysis.
 K.Bhagya Lakshmi,

Core differences between CBA & SCBA

Assistant Professor,SMS
Dept , CBIT.

CBA SCBA
• Limited range of effects • The evaluator has to take a
are considered as it wider view as it tries to
measures the profitability of measure social values of the
individuals who are only a whole society.
part of the society.

• It is quantitative in nature. • It can be quantitative or

qualitative.
 K.Bhagya Lakshmi,

Scope of SCBA
Assistant Professor,SMS
Dept , CBIT.

• SCBA can be applied to both Public & private

investments –
▫ Public Investment:
SCBA is important specially for the developing
countries where govt. plays a significant role in the
economic development.
▫ Private Investment:
Here, SCBA is also important as the private
investments are to be approved by various
governmental & quasi-governmental agencies.
 K.Bhagya Lakshmi,

Objectives of SCBA
Assistant Professor,SMS
Dept , CBIT.

The main focus of Social Cost Benefit Analysis is to

determine:
1. Economic benefits of the project in terms of shadow
prices;
2 The impact of the project on the level of savings and
investments in the society;
3. The impact of the project on the distribution of income
in the society;
4. The contribution of the project towards the fulfillment
of certain merit wants (self- sufficiency, employment
etc).
 K.Bhagya Lakshmi,

Significances of SCBA/Rationale
Assistant Professor,SMS
Dept , CBIT.

• CBA is unable to reflect social values. Hence SCBA has

been emerged with some interesting significances. These
significances also make the SCBA different from the
CBA.

 Market Imperfections
 Externalities
 Taxes & Subsidies
 Concern for Savings
 Concern for Redistribution
 Merit Wants
 K.Bhagya Lakshmi,

Significances of SCBA (Contd.)

Assistant Professor,SMS
Dept , CBIT.

• Market Imperfections:
Market prices, the basis for CBA, do not reflect the
social values under imperfect market competition.
• Externalities:
A project may have beneficial or harmful external
effects that are considered in SCBA, not in CBA.
• Taxes & Subsidies:
From the social point of view, taxes & subsidies are
nothing but transfer payments. But in CBA, taxes
& subsidies are treated as monetary costs and
benefits respectively.
 K.Bhagya Lakshmi,

Significances of SCBA (Contd.)

Assistant Professor,SMS
Dept , CBIT.

 Concern for Savings:

In SCBA, the division between benefits & consumption is
relevant wherein higher valuation is placed on savings.
But in CBA such division is irrelevant.
 Concern for Redistribution:
In SCBA, the distribution of benefits is very much
concerning issue where commercial private firm does
not bother about it.
 Merit Wants:
Merit wants are important from the social point of view
and therefore, SCBA considers these wants.
 K.Bhagya Lakshmi,

Approaches to SCBA Assistant Professor,SMS

Dept , CBIT.

• There are two principal approaches for Social Cost

Benefit Analysis.
A. UNIDO Approach, and
B. L-M Approach.
A. UNIDO Approach:
This approach is mainly based on the publication of UNIDO
(United Nation Industrial Development Organization)
named Guide to Practical Project Appraisal in 1978.
B. L-M Approach:
I.M.D Little & J.A.Mirlees have developed this approach for
analysis of Social Cost-Benefit in Manual of Industrial
Project Analysis in Developing Countries and Project
Appraisal & Planning for Developing Countries.
 K.Bhagya Lakshmi,

UNIDO Approach Assistant Professor,SMS

Dept , CBIT.

The UNIDO approach of Social Cost Benefit Analysis

involves five stages:
• Calculation of financial profitability of the project
measured at market prices.
• Obtaining the net benefit of the project at shadow
(efficiency) prices. (Objective of SCBA-1)
• Adjustment for the impact of the project on Savings &
Investment. (Objective of SCBA-2)
• Adjustment for the impact of the project on Income
Distribution. (Objective of SCBA-3)
• Adjustment for the impact of the project on Merit and
Demerit Goods whose social values differ from their
economic values. (Objective of SCBA-4)
 UNIDO Approach (Contd.)
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Stage-1: Calculation of financial profitability of the project

 A good technical and financial analysis must be done

before a meaningful economic (social) evaluation can be
made so as to determine financial profitability.

 Financial profitability is indicated by the Net Present

Value (NPV) of the project, which is measured by taking
into account inputs (costs) and outputs (benefits) at
market price.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage One (Contd.)

Assistant Professor,SMS
Dept , CBIT.

 Net Present value of a Project is calculated as:

Here,
Vt = Value of outputs at market price at time t
Ct = Value of inputs at market price at time t
K = Discount Rate
T = Lifetime of the project
I0 = Initial cost at the start of the project.

 The project is viewed as financially feasible if NPV > 0.

 UNIDO Approach (Contd.)
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Stage-2: Obtaining the net benefit of the project at

economic (shadow) prices

 The Commercial Profitability analysis (calculated in

stage - 1) would be sufficient only if the Project is
operated in perfect market. Because, only in a perfect
market, market prices can reflect the social value.

 If the market is imperfect (most of the cases in reality),

net benefit of the Project is determined by assigning
shadow prices to inputs and outputs.

 Therefore, developing shadow prices is very much vital.

 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

 Shadow Prices reflect the real value of a resource (input

or output) to society.
 Shadow Prices are also referred as economic prices,
accounting prices, economic/accounting efficiency prices
etc.
 Shadow Prices can be defined as the value of the
contribution to the country’s basic socio-economic
objectives made by any marginal change in the
availability of commodities (0utput) or factor of
production (input).
 Example: A project of power station may increase the
production of electricity which contributes to one of the
socio-economic objectives of the country.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

General Principles of Shadow Pricing

Numeraire :

 A unit of account in which the values of inputs and

outputs are to be expressed.

 Numeraire is determined at-

• Domestic currency rather than border price.
• Present value rather than future value.
Because, “a bird in the hand is worth two in the bush.”
• Constant price rather than current price.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

General Principles of Shadow Pricing (Contd.)

Tradability:

 Tradability refers to whether a good or service is tradable or

non-tradable; if tradable whether is fully traded or non-traded.
 A good/service is tradable in the absence of or within limited
trade barriers.
 A tradable good/service is actually traded when-
• the import (export) supply is perfectly elastic over the relevant
range of volume.
• all additional demand (production) must be made (consumed)
by import (export) due to the full capacity in the domestic
industry (fulfillment of demand by domestic consumer).
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

General Principles of Shadow Pricing (Contd.)

• the import (CIF) price is less or the export (FOB) price is more than
the domestic cost of production.
 A good/service is non-tradable; if
• its import (CIF) price is greater than its domestic cost of production,
and/or
• its export (FOB) price is less than its domestic cost of production.
 A tradable good/service that is not actually traded is called non-
traded.

 Meaning
 1. FOB Price: if a good is exported, its shadow price is its FOB price.
 2. Cif Price: If a good is imported its shadow price is it CIF price.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.) Assistant Professor,SMS

Dept , CBIT.

General Principles of Shadow Pricing (Contd.)

Sources of Shadow Pricing:

 Depending on the impact of the project on national
economy, there are three sources of shadow pricing:
Impact of the project on National Economy Sources of
Shadow Pricing
From production of output From consumption of input
angle angle

Increase total consumption in Decrease consumption in the Consumer’s

the economy rest of the economy willingness to pay

Decrease production in other Increase production within Cost of production

parts of the economy the economy

Decrease imports or increase Increase imports or decrease Foreign Exchange

exports exports Value (Border Price)
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

General Principles of Shadow Pricing (Contd.)

Taxes:
• If the project augments domestic production, taxes
should be excluded;
• If the project consumes existing fixed supply of non-
traded inputs, tax should be included;
• For fully traded goods, tax should be ignored.

Consumer Willingness to Pay (CWP):

• What a consumer wants to spend for a product or service.
• The difference between CWP and actual payment is called
consumer surplus.
 UNIDO Approach – Stage Two (Contd.)
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Shadow Pricing of Resources

Tradable inputs & outputs:

Tradability Type of Goods Shadow Prices
Input Output
Traded Border Price
• Export Export decreased Export increased Value of Export (FOB)
• Import Import increased Import decreased Cost of Import (CIF)

 For a fully traded good, the shadow price is border price

translated into the domestic currency at shadow foreign
exchange.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Shadow Pricing of Resources (contd.)

Assuming that a project uses two indigenous equipments

costing Rs.. 5,00,000. These equipments can be
exported at $10,000. The shadow foreign rate of
$ 1.00 is equivalent to Rs.. 68.
Therefore, shadow price of these equipments (inputs) are
($10,000 × Rs..68) = Rs.. 6,80,000.
 UNIDO Approach – Stage Two (Contd.)
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Shadow Pricing of Resources (contd.)

Non-Tradable Inputs & Outputs:

Tradability Type of Goods Shadow Prices

Input Output

Non-Traded:

Production More from local Less by other local Cost of Production

producers producers

Consumption Less to other More to local users Consumer’s willingness

local users to pay
 UNIDO Approach – Stage Two (Contd.)
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Shadow Pricing of Resources (contd.)

 Assuming that for a project, one-half of the required

input is collected from additional domestic production
which has a domestic cost of Rs.. 2,00,000 and the rest
one-half is collected from diversion from other
consumers who are willing to pay Rs.. 3,00,000.

Therefore, the shadow price of the inputs will be:

(cost of production + consumer’s willingness to pay)
= Rs.. (2,00,000 + 3,00,000)
= Rs.. 5,00,000
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.) Assistant Professor,SMS

Dept , CBIT.

Shadow Pricing of Resources (contd.)

Tradability Type of Goods Shadow Prices

Input Output

Non-Traded:

Production More from local Less by other Cost of Production

producers local producers

Consumption Less to other More to local Consumer’s willingness

local users users to pay
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Shadow Pricing of Resources (contd.)

 Assuming that a newly establishes power station having

a total capacity of 100 million units of electricity, charges
tariff at Rs.. 1 for per unit electricity consumption. The
consumers of that particular area are willing to pay Rs..
1.20 for per unit.
Therefore, the shadow price is
(Rs.. 1.20 × 10 million) = Rs.. 120 million, instead of Rs..
100 million.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Shadow Pricing of Resources (contd.)

Externalities:

 An externality is an external effect (either beneficial or

harmful) causes from a project which is –
• not deliberately created by the project sponsors but is an
incidental outcome.
• beyond the control of the persons who are benefited or
affected by it.
• not traded in the market place
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Shadow Pricing of Resources (contd.)

Example of External Effects:

 Near about 100,000 people had lost lands 5,680
acres due to the project of Jamuna Bridge.
 People may be affected by erosion and flood
conditions brought about by changes to the river
which result from the construction activities of a
bridge.
 Environmental pollution created by brick field.
 A project of planting trees for commercial purpose
may give protection to the environment against the
increasing global warmth.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Shadow Pricing of Resources (contd.)

Shadow Pricing of Externalities:

Although valuation of external effects is difficult as they
are often intangible in nature and there is no market price,
shadow pricing of externalities may be made indirect
means such as :
 The harmful effect of the bridge may be measured by the
consumer willingness to pay for the output of the people
which has been reduced due to the bridge.
 The cost of pollution may be estimated in terms of the loss
of earnings as a result of damage to health caused by it.
 UNIDO Approach – Stage Two (Contd.)
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Shadow Pricing of Resources (contd.)

Labor:
Possible Impact Shadow Price (Social Cost) of Labor
1. Taking labor away from other Willingness to pay of other users for this labor
employments
2. Stimulating the production of • the value assigned by the worker on the leisure that
new workers he has forego.
• the additional consumption of food
• the cost of transport
• negative impact on savings and investments due to
the increased consumption by workers
• the cost of training
• the cost of urbanization
3. Importing workers Flighting of foreign currency equivalent to the wages
commanded by them along with a premium on
account of the foreign exchange.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Shadow Pricing of Resources (contd.)

Capital:
 Investment of capital in a project causes to happen two
things:
i. Financial resources are converted into physical assets
ii. Financial resources are withdrawn from national pool
of savings. Thus alternative projects are foregone and
there is an opportunity cost of it.
 The shadow price of physical assets is calculated in the
same manner in which inputs and outputs are calculated.
 The opportunity cost of capital (shadow price of capital)
depends on the source from which the capital has
generated.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.) Assistant Professor,SMS

Dept , CBIT.

Shadow Pricing of Resources (Contd.)

Generation of Capital Opportunity Cost of Capital

Generation from additional Consumption rate of interest or social
savings discount rate (the price must be paid
to the saver to sacrifice present
consumption)
Generation from the denial Investment rate of interest
of capital to alternatives (Investment rate of return that would
projects be earned from those alternative
projects)
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Obtaining Net Benefit of the Project at Shadow Prices

 Determining the shadow price of

 One-Shot Costs
Annual costs
Annual benefits
 Calculating Net-benefit of the project from social point
of view by :

Here,
Vt = Shadow price of Benefit at time t
Ct = Shadow price of Operating Expenses at time t
K = Social Discount Rate
T = Lifetime of the project
I0 = Initial cost at the start of the project.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Obtaining Net benefit of the Project (An illustration)

The Government is considering a project which would
supply water for irrigation, generate electricity and provide
a measure of protection against floods. The project is
expected to have a 25 year life time.
The costs and benefits of the project are:
COSTS:
1. Power equipment costing Rs.. 30 crore.
(Additional Information: This equipment can be exported
at $ 4.5 million. The shadow price of per dollar is Rs.. 70)
Cost Type Nature Private Angle Social Angle
(Market price) (Shadow Price)
Indigenous One-Shot 30 crore 31.5 crore
Power
Equipment
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Two (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Obtaining Net benefit of the Project (An illustration)

2. 30,000 tones of cement produced indigenously are used

in the project at a cost of Rs.. 6,000.
(Additional Information: However, one-half of the cement
will come from additional domestic production which cost
Rs.. 5,000 per tone and one-half come from diversion from
other consumers who are willing to pay Rs..6,500 for per
ton.)
Cost Type Nature Private Angle Social Angle
(Market price) (Shadow Price)
Cement One-Shot 18 crore 17.25 crore
 Obtaining Net benefit of the Project
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

An illustration (contd.)

3. Other construction materials ( sand, bricks, steel etc.)

cost 20 crore.
(Additional Information: these materials comes from
additional production, production cost of which is 15 crore.)

Cost Type Nature Private Angle Social Angle

(Market price) (Shadow Price)
Other Materials One-Shot 20 crore 15 crore
 Obtaining Net benefit of the Project
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

An illustration (contd.)

4. Two million man days of unskilled labor for which the

project committee decided to pay a daily wage of Rs..
100.
(Additional Information: The shadow price of unskilled
labor is 80 Rs.. Per day)
Cost Type Nature Private Angle Social Angle
(Market price) (Shadow Price)

Unskilled Labor One-Shot 20 crore 16 core

 K.Bhagya Lakshmi,

Obtaining Net benefit of the Project

Assistant Professor,SMS
Dept , CBIT.

An illustration (contd.)
5. Skilled labor costing Rs.. 5 crore.
( However, this cost reflects what others are willing to pay
for the skilled labor)
Cost Type Nature Private Angle Social Angle
(Market price) (Shadow
Price)
Skilled labor One-Shot 5 crore 5 crore

6. Operating & Maintenance cost of the project will be Rs..

7.5 crore annually. (However, the operating cost should be
Rs.. 6.5 crore from social view point)
Cost Type Nature Private Angle Social Angle

Operating Cost Annual 7.5 crore 6.5 crore

 K.Bhagya Lakshmi,
Assistant Professor,SMS
Obtaining Net benefit of the ProjectDept , CBIT.

An illustration (contd.)
Benefits:

1. 0.5 million acres of land will be irrigated. The

Government will charge the water levy at Rs.. 150 for
per acre. (Additional Information: The value of
additional output per acre due to the irrigation will be
Rs.. 500 per acre).

Benefit Type Nature Private Angle Social Angle

(Market price) (Shadow Price)

Irrigation Annual 7.5 crore 25 crore

 K.Bhagya Lakshmi,
Assistant Professor,SMS

2. 100 million units of electricity will be generated for

Dept , CBIT.

domestic use. The electricity tariff will be charged at Rs..

1 per unit. (Additional Information: The consumers are
willing to pay Rs.. 1.5 for per unit of electricity).
Benefit Type Nature Private Angle Social Angle
(Market price) (Shadow Price)
Electricity Annual 10 crore 15 crore

3. Flood damages can be saved by Rs.. 2 crore annually.

However, the Government will not able to collect
anything for this.
Benefit Type Nature Private Angle Social Angle
(Market price) (Shadow Price)

Flood Relief Annual - 2 crore

 K.Bhagya Lakshmi,

Obtaining Net benefit of the Project

Assistant Professor,SMS
Dept , CBIT.

An illustration (contd.)
Cost & Benefit of the Project (at a glance)

One-Shot cost:
Cost Type Private Angle Social Angle
(Market price) (Shadow Price)
Power Equipment 30 crore 31.5 crore

Cement 18 17.25

Other Materials 20 15
Unskilled Labor 20 16

Skilled Labor 5 5

Total 93 Crore 84.75 Crore

 K.Bhagya Lakshmi,
Cost & Benefit of the Project (at a glance) (contd.)
Assistant Professor,SMS
Dept , CBIT.

Annual cost:
Cost Type Private Angle Social Angle
(Market price) (Shadow Price)

Operating Cost 7.5crore 6.5 crore

Total 7.5Crore 6.5 Crore

Annual Benefit:
Benefit Type Private Angle Social Angle
(Market price) (Shadow Price)
Irrigation 7.5 crore 25 crore
Electricity 10 crore 15 crore
Flood Relief - 2 crore
Total 17.5 Crore 42 Crore
 K.Bhagya Lakshmi,

Determining Project Profitability from the Private Angle

Assistant Professor,SMS
Dept , CBIT.

• Net Present value of a Project is calculated as:

Here,
Vt = Annual Benefit at time t = 17.5 crore
Ct = Annual cost at time t = 7.5 crore
K = Discount Rate = 10% (assuming)
T = Lifetime of the project = 25 years
I0 = Initial cost at the start of the project = 93 crore

Therefore,

= {10 (PVAF.10%, 25) – 93}

= {10 X 9.0770 – 93}
= Rs..( 2.23) crore
Therefore, the project is generating a negative NPV of Rs.. 2.23 crore
from the private angle.
 K.Bhagya Lakshmi,

Determining Project Profitability from the Social Angle

Assistant Professor,SMS
Dept , CBIT.

Net Present value of a Project from Social angle is calculated as:

Here,
Vt = Shadow price of Benefit at time t = 42 crore
Ct = Shadow price of Operating Expenses at time t = 6.5 crore
K = Social Discount Rate = 10% (assuming)
T = Lifetime of the project = 25 years
I0 = Initial cost at the start of the project = 84.75 crore
Therefore,

= {35.5 (PVAF.10%, 25) – 84.75}

= {35.5 X 9.0770 – 84.75}
= {322.23 – 84.75}
= Rs.. 237.48 crore
From the view point of society, the project is generating a
positive NPV of Rs.. 237.48 crore.
 K.Bhagya Lakshmi,

UNIDO Approach (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Stage – 3: Adjustment for the impact of the project on

Savings & Investment

 The purposes of this stage are to –

 determine the amount of income gained or lost because
of the project by different income groups (such as project
other than business, government, workers, customers
etc.)
 evaluate the net impact of these gains and losses on
savings
 measure the adjustment factor for savings and thus the
adjusted values for savings impact.
 adjust the impact on savings to the net present value
calculated in stage two.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Three (Contd.)

Assistant Professor,SMS
Dept , CBIT.

 Measurement of Gain or Loss:

A project appoints 1,000 laborers at a wage rate of Rs..
150 per day. These workers were ready to work for a daily
wage of Rs.. 100.
Therefore, the gain of the group of 1,000 workers from
the project is {(150 - 100) × 1,000} = Rs.. 50,000 per day.

 Evaluation of the Net Impact on Savings:

Net Savings Impact of a project =

Here , Δ Yi = change in income of group i as a result of
the project
MPSi = marginal propensity to save of group i
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Three (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Assuming that the income gained or lost by 4 group is:

Worker (W)=Rs.. 2,50,000, Consumer (C) = Rs.. -7,00,000
Project (P)=Rs.. 10,00,000, External
Sector(E)=Rs..5,00,000

The marginal propensity to save of these four groups is:

MPSW = 0.04, MPSC= 0.25, MPSP = 0.4 & MPSE =0.3

Therefore, the net impact of the project on savings is:

{2,50,000×0.04+(-7,00,000)×0.25+10,00,000×0.4
+ 5,00,000×0.3}
= 1,00,000 – 1,75,000 + 4,00,000 + 1,50,000
=Rs.. 4,75,000
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Three (Contd.)

Assistant Professor,SMS
Dept , CBIT.

 Adjustment Factor for Savings (AFs):

AFs measures the percentage by which the social value of
investment of one rupee exceeds social value of
consumption one rupee

Here,
MPC = Marginal Propensity to Consume
MPS = Marginal Propensity to Saving
MP Cap = Marginal Productivity of Capital
CRI = Consumption Rate of Interest (social discount
rate)
 UNIDO Approach – Stage Three (Contd.)
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

 Assuming that MPC, MPS, MPcap & CRI of an economy is

given:
MPC = 70%, MPS = 30%, MPcap = 25% and CRI = 10%

Therefore, adjustment factor for saving is:

 Adjusted value of the impact of the project on savings:

Adjusted value of saving = (Net impact on savings × AFs)
= Rs.. 4,75,000 × 6
= Rs.. 28,50,000.
 UNIDO Approach – Stage Three (Contd.)
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

 Assuming that MPC, MPS, MPcap & CRI of an economy is

given:
MPC = 70%, MPS = 30%, MPcap = 25% and CRI = 10%

Therefore, adjustment factor for saving is:

 Adjusted value of the impact of the project on savings:

Adjusted value of saving = (Net impact on savings × AFs)
= Rs.. 4,75,000 × 6
= Rs.. 28,50,000.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Three (Contd.)

Assistant Professor,SMS
Dept , CBIT.

• This Rs.. 28,50,000 is now added to the net present

value of the project calculated in stage -2 ( Rs.. 237.48
crore)

• Therefore, the adjusted net present value at this

stage will be Rs.. ( 237.48 + .285) = Rs..237.765 crore.
 K.Bhagya Lakshmi,

UNIDO Approach (Contd.) Assistant Professor,SMS

Dept , CBIT.

Stage – 4: Adjustment for the impact of the project on

Income Distribution
 Government considers a project as an investment for the
redistribution of income in favor of economically weakens
sections or economically backward regions.
 This stage provides a value on the effects of a project on
income distribution between rich & poor and among
regions.
 Distribution Adjustment Factor (Weight) is calculated and
the impacts of the project on income distribution have
been valued by multiplying the adjustment factor with the
particular income of a group. This value will then be added
to the net present value re-calculated in stage three to
produce the social net present value of the project.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Four (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Determination of Weights:
 It there are only two groups in a society, poor and rich,
the determination of weight is just an iterative process
between the analysts (at the bottom) and the planners (at
the top). This is called “bottom-up” approach.
 When more than two groups are involved, weights are
calculated by the elasticity of marginal utility of income.
The marginal utility of income is the weight attached to an
income is:

Where, wi = weight of income at ci level

ci = level of income of group i
b = base level of income that has a weight of 1.00
n = elasticity of the marginal utility of income
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Four (Contd.)

Assistant Professor,SMS
Dept , CBIT.

 Assuming that the worker group gains an income of Rs..

2,50,000 from a project, the base level of income is Rs..
50,000 which has a weight if 1.00 and elasticity of
marginal utility of income is 0.20.
Therefore, weight is:

 So, value of the impact of the project on income

distribution to this group is:
(Rs.. 2,50,000 × 0.72) = Rs.. 1,80,000.
 Now, this value will be added to the net present value
adjusted in stage three.
 Therefore, Adjusted NPV in this stage will be
Rs.. (237.765+ 0.018) = Rs.. 237.78 crore
 K.Bhagya Lakshmi,

UNIDO Approach (Contd.) Assistant Professor,SMS

Dept , CBIT.

Stage – 5: Adjustment for Merit and Demerit Goods

 If there is no difference between the economic value of
inputs and outputs and the social value of those, the
UNIDO approach for project evaluation ends at stage four.
 In practical, there are some goods (merit goods), social
value of which exceed the economic value (e.g. oil, creation
of employment etc.) and also there are some goods
(demerits goods), social value of which is less than their
economic value (e.g., cigarette, alcohol, high-grade
cosmetics etc.)
 Adjustment to the net present value of stage 4 is required
if there is any difference between the social and economic
value.
 K.Bhagya Lakshmi,
Assistant Professor,SMS

UNIDO Approach – Stage Five (Contd.) Dept , CBIT.

 The steps of adjustment procedure are:

• Estimating the present economic value
• Calculating the adjustment factor
• Multiplying the economic value by the adjustment factor
to obtain the adjusted value
• Adding or subtracting the adjusted value to or from the net
present value of the project as calculated in stage four.
 K.Bhagya Lakshmi,

UNIDO Approach – Stage Five (Contd.)

Assistant Professor,SMS
Dept , CBIT.

An alcohol factory is under construction. The present

economic value of the project is Rs.. 237.78 crore (Adjusted
NPV up to stage 4). The output of the project has no social
value than its cost of production. Cost of production is the
60 percent of the economic price.

Therefore, adjustment factor is:

So, the adjusted value = (Rs.. 237.78 crore × - 0.40)

= - Rs.. 95.11 crore
Therefore, the net present value of the project in terms of
socially acceptable consumption is
Rs..(237.78-95.11) = Rs.. 142.67 crore.
 K.Bhagya Lakshmi,

L-M Approach
Assistant Professor,SMS
Dept , CBIT.

 I.M.D. Little and James A. Mirrlees have developed an

approach to SCBA which is famously known as L-M
approach.
 The core of this approach is that the social cost of using
a resource in developing countries differs widely from
the price paid for it.
 Hence, it requires Shadow Prices to denote the real
value of a resource to society. (mentioned earlier)
 K.Bhagya Lakshmi,

L-M Approach (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Features of L-M Approach

• L-M Numeraire is present uncommitted social income.

 L-M methods opts for savings as the yardstick of

their entire approach. Present savings is more
valuable to them than present consumption since
the savings can be converted into investment for
future.

 L-M approach rejects the ‘consumption’ numeraire

of UNIDO approach since the authors (L & M) feel
that the consumption of all level is valuable.
 K.Bhagya Lakshmi,

L-M Approach (Contd.)

Assistant Professor,SMS
Dept , CBIT.

Features of L-M Approach (Contd.)

• This approach measures the cost and benefits in terms

of international or border prices.

Why Border prices?

Because the border prices represent the correct social
opportunity costs or benefits of using or producing a
traded goods.
 K.Bhagya Lakshmi,
Assistant Professor,SMS

L-M Approach (Contd.) Dept , CBIT.

Social Cost-Benefit Analysis (SCBA)

The resources – inputs & outputs – of a project are

classified into mainly:
 Labor
 Traded Goods
 Non-traded Goods
Therefore, to find out the real value of these resources, we
should calculate –
a) Shadow wage rate (SWR)
b) Shadow price of Traded Goods
c) Shadow price of Non-traded Goods
 K.Bhagya Lakshmi,

L-M Approach (Contd.) Assistant Professor,SMS

Dept , CBIT.

a) Shadow Wage Rate (SWR)

The purpose of computing the SWR is to determine the

opportunity cost of employing an additional worker in the
project. For this we have to determine –
 The value of the output foregone due to the use of a unit of
labor
 The cost of additional consumption due to the transfer of
labor
 L-M Approach (Contd.)
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

L-M suggest the following formula for calculating the

SWR:
SWR = m + (c-c) + (1-1/s) (c-m)
Here, m = marginal productivity of the wage earner
c-c = cost of urbanization
(1-1/s) (c-m) = cost of additional committed
consumption
c= additional resources devoted to consumption
c = consumption of wage earner
1 = value of uncommitted resources
1/s = value of committed resources
c-m = additional consumption of labor
c (transportation system, e.g. road construction, motor vehicles) – c
(e.g. bus rent)
= cost of urbanization (e.g. road construction)
 L-M Approach (Contd.) K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

b) Shadow price of Traded Goods

Shadow price of traded goods is simply its border or
international price.
 If a good is exported, its shadow price is its FOB price;
 If a good is imported, its shadow price is its CIF price.
c) Shadow price of Non-traded Goods
 Non-traded goods are those which do not enter into
international trade by their very nature. (e.g. land,
building, transportation)
 Hence, no border price is observable for them.
 L-M Approach (Contd.)
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

 Ideally, Shadow price of Non-traded Good is defined in

terms of marginal social cost (MSC) and marginal social
benefit (MSB).
 L-M suggest that the monetary cost of non-traded goods
be broken down into –
• Labor SWR (Social Wage Rate)
• Tradable Social Conversion Factor (SCF)
• Residual components SCF
 K.Bhagya Lakshmi,
Assistant Professor,SMS

L-M Approach (Contd.) Dept , CBIT.

Accounting Rate of Return (ARR):

This is the rate used for discounting social profits.

• Experience is the best guide to the choice of ARR.

• ARR should be such that all mutually compatible
projects with positive present social value can be
undertaken.
 K.Bhagya Lakshmi,

A Comparative Illustration of UNIDO & L-M Approach

Assistant Professor,SMS
Dept , CBIT.

COSTS:

1. Power equipment costing Rs.. 300 million. This

equipment can be exported at $4.5 million. The shadow
price of per dollar is Rs.. 70.

Cost Type Nature UNIDO L-M

Approach Approach
Power One-Shot Rs.. 315 million $ 4.5 million
Equipment
 K.Bhagya Lakshmi,

A Comparative Illustration of UNIDO & L-M Approach (contd.)

Assistant Professor,SMS
Dept , CBIT.

2. 30,000 tones of cement produced indigenously are used

in the project at a cost of Rs.. 6,000. One-third of the
cement will come from additional domestic production
which cost Rs.. 5,000 per tone and Two-third will come
from diversion from other consumers who are willing to
pay Rs..6,500 for per ton. The shadow price of per dollar is
Rs.. 70.
Cost Type Nature UNIDO L-M
Approach Approach
Cement One-Shot Rs.. 180 million $ 1.48 million
 K.Bhagya Lakshmi,

A Comparative Illustration of UNIDO & L-M Approach (contd.)

Assistant Professor,SMS
Dept , CBIT.

3. Other construction materials ( sand, bricks, steel etc.)

cost 200 million. These materials comes from additional
production, production cost of which is 150 million.
Cost Type Nature UNIDO L-M
Approach Approach
Other Materials One-Shot Rs.. 150 million $ 2.14 million

4. Two million man days of unskilled labor for which the

project committee decided to pay a daily wage of Rs.. 100.
The shadow price of unskilled labor is 80 Rs.. Per day.
Cost Type Nature UNIDO L-M
Approach Approach
Unskilled Labor One-Shot Rs.. 160 million $ 2.29 million
 K.Bhagya Lakshmi,

A Comparative Illustration of UNIDO & L-M Approach (contd.)

Assistant Professor,SMS
Dept , CBIT.

5. Skilled labor costing Rs.. 5o million. However, this cost

reflects what others are willing to pay for the skilled labor.
Cost Type Nature UNIDO L-M
Approach Approach
Skilled Labor One-Shot Rs.. 50 million $ 0.71 million

6. Operating & Maintenance cost of the project will be Rs..

75 million annually. However, the operating cost should be
Rs.. 65 million from social view point.

Cost Type Nature UNIDO L-M

Approach Approach
Operating Cost Annual Rs.. 65 million $ 0.93 million
 K.Bhagya Lakshmi,

A Comparative Illustration of UNIDO & L-M Approach (contd.)

Assistant Professor,SMS
Dept , CBIT.

Benefits:

1. 0.5 million acres of land will be irrigated. The

Government will charge the water levy at Rs.. 150 for
per acre. The value of additional output per acre due to
the irrigation will be Rs.. 500 per acre.

Benefit Type Nature UNIDO L-M

Approach Approach
Irrigation Annual Rs.. 250 million $ 3.57 million
 K.Bhagya Lakshmi,
Assistant Professor,SMS

2. 100 million units of electricity will be generated for

Dept , CBIT.

domestic use. The electricity tariff will be charged at Rs..

1 per unit. The consumers are willing to pay Rs.. 1.5 for
per unit of electricity.

Benefit Type Nature UNIDO L-M

Approach Approach
Electricity Annual Rs.. 150 million $ 2.14 million

3. Flood damages can be saved by Rs.. 20 million annually.

Benefit Type Nature UNIDO L-M
Approach Approach
Flood Relief Annual Rs.. 20 million $ 0.29 million
 Dissimilarities between Two Approaches
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

UNIDO Approach L-M Approach

• Domestic currency is • International Price is

used as Numeraire used as Numeraire
• Consumption is the • Uncommitted Social
measurement base Income is the
measurement base
• SCBA objectives are • At one place all SCBA
met through stage by objectives are fulfilled
stage
 Similarities between Two Approaches
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

• Calculation of Shadow Prices to reflect social

value
• Usage of Discounted Cash Flow Techniques
• Taking into account about the effect of a project
on savings, investment and income of a society
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Functions of Planning
1. It provides a basis for organising the work on the
project and allocating responsibilities to
individuals.
2. It is a means of communication and coordination
between all those involved in the project.
3. It induces people to look ahead.
4. It instills a sense of urgency and time
consciousness.
5. It establishes the basis for monitoring and
control.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Forms of Project Organisation

• The project organisation may take one of the
following three forms:

1. Line and staff organization.

2. Divisional organisation.
3. Matrix organisation.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Variance Analysis Approach

• The traditional approach to project control involves a
comparison of the actual cost with the budgeted cost to
determine the variance.

• The variance analysis approach is inadequate for project

control for the following reasons:
1. It is backward looking rather than forward looking.
2. It does not use the data effectively to provide
integrated control
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Performance Analysis:
• Effective control over a project requires systematic
'performance analysis'.

• For small and simple projects, the project managers would

do performance analysis for the project as a whole, or for
its major components.

• As the project becomes larger and more complex,

performance analysis needs to be done for individual
segments of the projects which are referred to as 'cost
accounts.'
 K.Bhagya Lakshmi,
Assistant Professor,SMS

Method of Analysis
Dept , CBIT.

• Performance analysis seeks to remove this subjectivity by employing

an analytical framework based on the following terms:

• BCWS (Budgeted cost for work scheduled): It represents the total of

three components:
• (i) budgets for all work packages, scheduled to be completed, (ii)
budgets for the portion of in-process work, scheduled to be
accomplished, and
• (iii) budgets for the overheads for the period.

• BCWP (Budgeted cost for work performed): This is equal to the sum
of three components:
(i) budgets for work packages actually completed,
(ii) budgets applicable to the completed in-process work, and
(iii) overhead budgets.
 K.Bhagya Lakshmi,

Method of Analysis
Assistant Professor,SMS
Dept , CBIT.

• ACWP (Actual cost of work performed): This

represents the actual cost incurred for
accomplishing the work performed during a
particular time period.

• BCTW (Budgeted cost for total work): This is

simply the total budgeted cost for the entire
project work.

• ACC (Additional cost for completion): This

represents the estimate for the additional cost
required for completing the project.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.
 Pre-requisites for successful project
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

implementation

• Time and cost over-runs of projects are very

common in India, particularly in the public
sector. Due to such time and cost over-runs,
projects tend to become uneconomical,
resources are not available to support other
projects, and economic development is adversely
affected.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Pre-requisites for successful project

implementation
1. Adequate formulation
2. Sound project organisation
3. Proper implementation planning
4. Advance action
5. Timely availability of funds
6. judicious equipment tendering and
procurement
7. Better contract management
8. Effective monitoring
 K.Bhagya Lakshmi,
Assistant Professor,SMS

Corporate Governance
Dept , CBIT.

• Corporate Governance refers to the way a corporation is

governed.
• It is the technique by which companies are directed and
managed.
• It means carrying the business as per the stakeholders'
desires.
• It is actually conducted by the board of Directors and the
concerned committees for the company's stakeholder's
benefit.
• It is all about balancing individual and societal goals, as
well as, economic and social goals.
 K.Bhagya Lakshmi,
Assistant Professor,SMS

Definition of corporate governance

Dept , CBIT.

• Corporate governance is the system by which companies

are directed and controlled. It encompasses the entire
mechanics of the functioning of a company and attempts
to put in place a system of checks and balances between
the shareholders, directors, employees, auditor and the
management.”

• Cadbury Committee[1] ( U.K.), 1992

 K.Bhagya Lakshmi,

Need for corporate governance

Assistant Professor,SMS
Dept , CBIT.

1. Wide Spread of Shareholders

2. Changing Ownership Structure
3. Corporate Scams or Scandals
 K.Bhagya Lakshmi,
Assistant Professor,SMS

Benefits of corporate governance

Dept , CBIT.

1. Good corporate governance ensures corporate success and

economic growth.
2. Strong corporate governance maintains investors’ confidence, as a
result of which, company can raise capital efficiently and
effectively.
3. It lowers the capital cost.
4. There is a positive impact on the share price.
5. It provides proper inducement to the owners as well as managers
to achieve objectives that are in interests of the shareholders and
the organization.
6. Good corporate governance also minimizes wastages, corruption,
risks and mismanagement.
7. It helps in brand formation and development.
8. It ensures organization in managed in a manner that fits the best
interests of all
 K.Bhagya Lakshmi,

PRINCIPLES OF CORPORATE
Assistant Professor,SMS
Dept , CBIT.

GOVERNANCE

• (i) Transparency
• (ii) Accountability
• (iii) Independence
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Corporate governance failures

• Corporate governance is a set of rules, practices and processes used
to direct and control a company.
• It involves balancing the interests of a company’s stakeholders such
as management, shareholders, suppliers, customers, financiers,
government and the community.
• Moreover, it is essential for the success and sustainability of the
business over a period of time. When the set of rules and processes
which form the governance mechanism of a firm are ineffective or
fail, it can have disastrous consequences for a business.
• Several large organisations such Enron, Satyam, Cadbury, Wal-
Mart & Xerox were severely impacted due to corporate governance
failures.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Corporate governance failures

It doesn’t happen overnight and there are several warning
signs which a firm must take note of in order to avoid such
failures. Some of the governance issues faced by the firms
which eventually lead to corporate governance failures are
–
• Ineffective governance mechanisms, for example, lack of
board committees or committees consisting of few or a
single member.
• Non-independent board and audit committee members,
for example where a CEO fulfilled multiple roles in
various committees
Cases of Corporate Governance Failure K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

in India-Satyam Scam
• Background

• Satyam Computer Services Limited set up by B. Ramalinga

Raju in 1987.
• Quickly established itself as a major IT player specializing in
outsourcing.
• In 1991 successful debut on BSE, in1995 launched SIFY to
offer back office services to clients in US and Europe. In 2001
listed on NYSE.
• B. Ramalinga Raju made Satyam India’s fourth largest IT
company.
• In 1988 Raju founded Maytas group along with his family
members and in 2008 proposed that Satyam should buy out
the Maytas group. The proposal fell through. Share prices
crashed and Raju confessed to accounting frauds.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Description of the crisis

• Raju maintained two sub accounts under a

single bank account.
• Fake invoices in the name of genuine clients and
fictitious debtors existed in the books of account.
• Fake FDRs
• Insider trading by promoters.
• Web of 356 group companies used to divert
funds from Satyam in the form of inter corporate
loans and investments.
• Ghost workers.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Aftermath
• •GOI appointed independent directors.
• Satyam purchased by Tech Mahindra
• Raju and associates sentenced to imprisonment.
• PWC fined by SEC and four auditors of PWC
debarred by ICAI.
• SEBI and GOI took a slew of measures to
improve corporate governance in India
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

AGENCY THEORY IN CORPORATE GOVERNANCE

• What is an agency?

• An agent is a person who works for, or on behalf

of, another. Thus, an employee is an agent of a
company. But agency extends beyond employee
relationships.

• Independent contractors are also agents.

• The CEO of a company is an agent of the board
of directors of the company.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Introduction of Agency Theories

• Agency theories arise from the distinction between

the owners (shareholders) of a company or an
organization designated as “the principals” and the
executives hired to manage the organization called
“the agent.”
• Agency theory argues that the goal of the agent is
different from that of the principals, and they are
conflicting.
• The assumption is that the principals suffer an
agency loss, which is a lesser return on investment
because they do not directly manage the company
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Continuation
• Agency theory relative to corporate governance
assumes a two-tier form of firm control:
• Managers and owners.
• Agency theory holds that there will be some
friction and mistrust between these two groups.
The basic structure of the corporation, therefore,
is the web of contractual relations among
different interest groups with a stake in the
company.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Features
• In general, there are three sets of interest groups
within the firm.
• Managers, stockholders and creditors(such as
banks).
• Stockholders often have conflicts with both
banks and managers, since their general
priorities are different.
• Managers seek quick profits that increase their
own wealth, power and reputation.
• while shareholders are more interested in slow
and steady growth over time.
 K.Bhagya Lakshmi,
Assistant Professor,SMS

Function
Dept , CBIT.

• The purpose of agency theory is to identify points of

conflict among corporate interest groups.
• Banks want to reduce risk while shareholders want
to reasonably maximize profits.
• Managers are even more risky with profit
maximization, since their own careers are based on
the ability to turn profits to then show the board.
• The fact that modern corporations are based on
these relations creates costs in that each group is
trying to control the others
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

AGENCY THEORY IN CORPORATE GOVERNANCE

• Costs
• Significance
• Effects
• The Role of Agency Theory in Corporate
Governance
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

STEWARDSHIP THEORY OF CORPORATE GOVERNANCE

• Stewardship theories argue that the managers or
executives of a company are stewards of the owners,
and both groups share common.

• Therefore, the board should not be too controlling,

as agency theories would suggest.

• The board should play a supportive role by

empowering executives and, in turn, increase the
potential for higher performance.

• Stewardship theories argue for relationships

between board and executives that involve training,
mentoring, and shared decision making.
 K.Bhagya Lakshmi,
Assistant Professor,SMS

Motivation
Dept , CBIT.

• For stewardship theory, managers seek other ends

besides financial ones.

• These include a sense of worth, altruism, a good

reputation, a job well done, a feeling of satisfaction
and a sense of purpose.

• The stewardship theory holds that managers

inherently seek to do a good job, maximize company
profits and bring good returns to stockholders.

• They do not necessarily do this for their own

financial interest, but because they feel a strong duty
to the firm.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

STEWARDSHIP THEORY

• Identification
• Policies
• Consequences
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

SHAREHOLDER & STAKEHOLDER THEORY OF

CORPORATE GOVERNANCE
• Shareholder Theory:

• The shareholder theory was originally proposed by

Milton Friedman and it states that the sole
responsibility of business is to increase profits.
•
• It is based on the premise that management are
hired as the agent of the shareholders to run the
company for their benefit, and therefore they are
legally and morally obligated to serve their interests.
 K.Bhagya Lakshmi,

Stakeholder Theory
Assistant Professor,SMS
Dept , CBIT.

• Stakeholder theory states that a company owes a

responsibility to a wider group of stakeholders,
other than just shareholders.
• A stakeholder is defined as any person/group
which can affect/be affected by the actions of a
business.
• It includes employees, customers, suppliers,
creditors and even the wider community and
competitors.
 Stakeholders and their Effect on
K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

Business

1. Shareholder and their interest

2. Employees and their interest
3. Customer and their interest
4. Creditors and their interest
5. Community and their interest
6. Government and their interest
 K.Bhagya Lakshmi,
Assistant Professor,SMS

Convergence
Dept , CBIT.

• According to Oxford Dictionary, „Converge‟

means to come together or towards same point4
.
• In the current context, it is equivalent to
merging of merit points of all the kinds of
corporate governance systems across the globe
and makes an „ideal best model‟ which will be
adopted by all the states.

• Convergence will lead to merging of all the

governance systems of nations in one model
which will have all the special characteristics.
 K.Bhagya Lakshmi,

ISSUES IN CORPORATE GOVERNANCE

Assistant Professor,SMS
Dept , CBIT.

1. Remuneration and Reward of Directors

2. Board’s Responsibility for Risk Management
and Internal Control
3. Reliability of Financial Reporting and External
Auditors
4. Duties of Directors
5. Shareholders’ Rights and Responsibilities
6. Separation of the roles of CEO and chairperson
7. Corporate Social Responsibility & Business
Ethics
 K.Bhagya Lakshmi,

1. Remuneration and Reward of

Assistant Professor,SMS
Dept , CBIT.

Directors
• Directors being paid excessive bonuses and
salaries have been identified as significant
corporate abuses for a large number of years.

• It is, however, unavoidable that the corporate

governance codes have been targeted this
significant issue
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

2. Board’s Responsibility for Risk

Management & Internal Control

• If the board does not arrange the regular

meetings in order to consider the organizational
activities systematically show that the board is
not meeting their responsibilities.
• It results in the poor system that may unable to
report and measure the risks associated with
business
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

3. Reliability of Financial Reporting & External

Auditors

• Financial reporting and auditing issue are seen

more critical to corporate governance by the
investors because of their main consideration in
ensuring management accountability.

• It is the reason that they have been must

debated and the focus of serious litigation.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

4. Duties of Directors
• The corporate governance reports have aimed to
build on the directors’ duties as defined in
statutory and case law duties of directors.

• These include the fiduciary duties to act in the

best interests of the company, use their powers
for a purpose, avoid conflicts of interest and
exercise a duty of care.
 K.Bhagya Lakshmi,
Assistant Professor,SMS

5. Shareholders’ Rights and

Dept , CBIT.

Responsibilities
• Shareholders’ role and rights is subject of
particular importance.
• They should be informed about all those
information that are material to them because
these information may influence their amount of
investment.
• They should also be given the right to vote on
policies affecting the governance of organization
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

6. Separation of the roles of CEO &

chairperson

• It is now increasingly being realized that the

practice of combining the role of chair person
with that of the CEO as is done in countries like
the US and INDIA leads to conflicts in decision
making and too much concentration of power in
one person resulting in unsavory consequences.
 K.Bhagya Lakshmi,
Assistant Professor,SMS
Dept , CBIT.

7. Corporate Social Responsibility &

Business Ethics

• The lack of mutual decision and sense of

responsibility for businesses and stakeholders
has unavoidably turned out the business ethics
and social responsibility a significant part of
corporate governance debate.