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Business Ethics and Corporate Governance

CORPORATE GOVERNANCE MFC 4TH SEM. ARYA SCHOOL OF MANAGEMRENT & IT, BBSR

Corporate Governance and Business Ethics UNIT -1:Corporate Governance: Meaning, Historical Perspective, Issues in CG, Theoretical basis of CG, CG Mechanism, CG System, Good CG. Corporate governance is A means whereby society can be sure that large corporations are well-run institutions to which investors and lenders can confidently commit their funds. Corporate governance are the policies, procedures and rules governing the relationships between the shareholders, (stakeholders), directors and managers in a company, as defined by the applicable laws, the corporate charter, the companys bylaws, and formal policies. Primarily it is about managing top management, building in checks and balances to ensure that the senior executives pursue strategies that are in accordance with the corporate mission. Corporate governance governs the relationship among the many players involved (the stakeholders) and the goals for which the corporation is governed.Corporate governance is the set of processes, customs, policies, laws, and institutions affecting the way a corporation (or company) is directed, administered or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed. The principal stakeholders are the shareholders, management, and the board of directors. Other stakeholders include employees, customers, creditors, suppliers, regulators, and the community at large.

Corporate governance is a multi-faceted subject. An important theme of corporate governance is to ensure the accountability of certain individuals in an organization through mechanisms that try to reduce or eliminate the principal-agent problem.

AccountabilityClarifying governance roles & responsibilities, and supporting voluntary efforts to ensure the alignment of managerial and shareholder interests and monitoring by the board of directors capable of objectivity and sound judgment.

TransparencyRequiring timely disclosure of adequate information concerning corporate financial performance..

Responsibility-: Ensuring that corporations comply with relevant laws and regulations that reflect the societys values Fairness-: Ensuring the protection of shareholders rights and the enforceability of contracts with service/resource providers.Principles of corporate governance: Key elements of good corporate governance principles include honesty, trust and integrity, openness, performance orientation, responsibility and accountability, mutual respect and commitment to the organization of importance is how directors and management develop a model of governance that aligns the values of the corporate participants and then evaluate this model periodically for its effectiveness. In particular, senior executives should conduct themselves honestly and ethically, especially concerning actual or apparent conflicts of interest, and disclosure in financial reports.Commonly accepted principles of corporate governance include:

Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can help shareholders exercise their rights by effectively communicating information that is understandable and accessible and encouraging shareholders to participate in general meetings.

Interests of other stakeholders: Organizations should recognize that they have legal and other obligations to all legitimate stakeholders.

Role and responsibilities of the board: The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors.

Integrity and ethical behaviour: Ethical and responsible decision making is not only important for public relations, but it is also a necessary element in risk management and avoiding lawsuits. Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. It is important to understand, though, that reliance by a company on the integrity and ethics of individuals is bound to eventual failure. Because of this, many organizations establish Compliance and Ethics Programs to minimize the risk that the firm steps outside of ethical and legal boundaries.

Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company's financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information. THEORETICAL BASIS OF CORPORATE GOVERNANCEThere are four broad theories to explain and elucidate corporate governance. These are: (i) Agency Theory (ii) Stewardship Theory (iii) Stakeholder Theory and (iv) Sociological Theory.

A. AGENCY THEORY

The fundamental theoretical basis of corporate governance is agency costs. Adam Smith had identified the agency problem (managerial negligence and profusion). Shareholders are the owners and the principals too. The management, the board, chosen by the shareholders are the agents. Principals may want to carry out the objectives of the company but the agents may not quite exactly match the requirements. The cost of the dissonance caused by the agency problem is the agency cost. There are many a way through which the management go counter to the objectives of the shareholders such maximizing shareholder returns. Ostentatious life styles of directors, empire building etc. are examples. THE BASIS FOR THE AGENCY THEORY IS THE SEPARATION OF OWNERSHIP AND CONTROL.

PRINCIPAL (SHAREHOLDERS) OWN THE COMPANY BUT THE AGENTS (MANAGERS) CONTROL IT.

MANAGERS MUST MAXIMIZE THE SHAREHOLDERS WEALTH.

THE MAIN CONCERN IS TO DEVELOP RULES AND INCENTIVES, BASED ON IMPLICIT EXPLICIT CONTRACTS, TO ELIMINATE OR AT LEAST, MINIMIZE THE CONFLICT OF INTERESTS BETWEEN OWNERS AND MANAGERS.The Agency problem occurs when:The desires or a goal of the principal and agent conflict and it is difficult or expensive for the principal to verify that the agent has behaved appropriately.

Example: Over diversification because increased product diversification leads to lower employment risk for managers and greater compensation Solution: Principals engage in incentive-based performance contracts, monitoring mechanisms such as the board of directors and enforcement mechanisms such as the managerial labor market to mitigate the agency problemMechanisms that help reduce agency costs:

1. Fair and accurate financial disclosures

2. Efficient and independent board of directorsB. THE STEWARDSHIP THEORYThe 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 principals. It assumes that managers are trustworthy and have high reputations. Therefore their behavior will not run counter to the interests of the company. There is a significant emphasis on the responsibility of the board to the shareholders in a corporate governance model that is emboldened by stewardship and trusteeship. These concepts of stewardship and trusteeship are traceable in the scriptures of India and Christendom.Steward is a person who manages others property and financial affairs and is entrusted with the responsibility of proper utilization and development of organizations resources. MANAGERS AS STEWARDS ASSUMED TO WORK EFFICIENTLY AND HONESTLY IN THE INTERESTS OF COMPANY AND OWNERS. SELF DIRECTED AND MOTIVATED BY HIGH ACHIEVEMENTS AND RESPONSIBILITY IN DISCHARGING THE DUTIES. MANAGERS ARE GOAL ORIENTED FEEL CONSTRAINED IF THEY ARE CONTROLLED BY OUTSIDE DIRECTORS BASIC BEHAVIORAL DIFFERENCES BETWEEN AGENCY & STEWARDSHIP THEORIES

Stewardship theory can be reduced to the following basics:

The theory defines situation 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 self-serving behaviour and pro-organizational behavior, a stewards behaviour will not depart from the interests of his organization. Control can be potentially counterproductive, because it undermines the pro-organizational behaviour of the steward, by lowering his motivation.

C. THE STAKEHOLDER THEORYManagers are responsible to maximize the total wealth of all stakeholders of the firm, rather than only the shareholders wealth. It deals with the common interests of employees, customers, dealers, government, and the society at large and draws all of them into corporate-mix. It is often criticized as wooly minded liberalism because it is not applicable in practice by companies. But the defense is that managers can act efficiently only by drawing upon the resources of the stakeholders and as such there is a contract between the company and the stakeholdersThe primary feature of the stakeholder theory of corporate governance is that those who have a stake in the functioning of the firm are made up of large and diverse groups. Simply put, stakeholders are those who seek some benefit from the optimum run