I am honoured to have been invited to deliver the Annual Oration
on "Corporate Governance - A Road Map to Achieve Corporate
& Professional Excellence". I am conscious of the
fact that I owe this honour to the magnanimity of my greatest
mentor and inspiration - one of world's finest legal brains
and the most admirable human being - His Lordship Justice
Venkatchaliah. Sir, my deepest gratitude to you for bestowing
the honour.
The Institute of Chartered Accountants of
India is a repository of India's most exquisite financial
gemstones, and therefore, there is nothing more daunting than
to speak to such a distinguished audience as yourselves.
I compliment the Institute for the choice
of the topic. Role of Corporate Governance has never been
more vital. It is not just because of Enron or the UTI. The
debate about corporate governance is taking place all over
the world. During the past one month I have visited UK, US,
Germany, Netherlands, Italy, Canada, Russia and the Middle
East. Corporates and governments everywhere are seized with
this topic and hoping this will help them attract foreign
investment. In fact the issue of Corporate Governance is much
more important than simply getting international investment.
The need and demand for high standards of governance, ethics
and environmental and social responsibility are the key aspects
of globalization debate. They do not affect just the big business
or institutions concerned with financial investment. They
concern all of us. The Issues of transparency, accountability,
equity, integrity, probity, responsibility and sustainability
are instruments of not only 'corporates excellence' but also
'professional excellence'. Hence, I shall be taking both the
issues together.
In India we have often been blamed for having
a myopic view. We believe that high profile failures are a
part of only India's system. But as you all know the amount
of shareholder's wealth that Enron succeeded in destroying
is far more than the loss due to any single scam in India.
When the US President uses a "State of the Nation"
address to speak about accounting standards, as he did last
week, the issue has got to be on top of the national agenda.
Even the UK, which already has conducted half a dozen reviews
on this subject, its Secretary of State announced further
review of how the Boards are constituted and how they ought
to operate.
I have been fortunate in being involved in
a conference on Corporate Governance which World Council For
Corporate Governance in association with IOD in India and
the Centre for Corporate Governance organized soon after ENRONITIS,
a couple of months ago under the guidance of Justice M N Venkatchaliah.
We had the benefit of some of the best legal brains of the
country such as Justice A M Ahmadi, P Chidambaram, Padmabhushan
K K Venugopal, Kapil Sibal and Dr A M Singhvi. It came out
with some very significant recommendations that can have far
reaching impact on corporate governance developments worldwide.
The conference participants felt Corporations
must recognize that globalization offers them both the strength
and opportunity to usher in a just and conflict free world
for their own security, survival and sustainability. The scope
of Corporate Governance should be enlarged to encompass Good
Governance in all its aspects taking cognizance of the political,
administrative, economic, social and judicial environment
in which they function. Board of Directors ought to balance
the interests of capital providers with those of other stakeholders
and aim for a long term and sustained business success. Good
Corporate Governance ought to create value for all stakeholders
including society at large. It was also felt that there is
a need for stricter internal audit controls to ensure that
debacles such as that of ENRON do not recur. There needs to
be greater scrutiny of the role of Chairman & CEO by the
Board of Directors. The role of Chairman and CEO must be separated.
There should be clear separation of the Audit and consultancy
function. These should not be done by the same organisation.
There is a need for economic costs to reflect full ecological
costs. Accounting practices need to ensure that environmental
costs are properly internalized with business. Corporate Governance
ought to cover disclosures on Environmental and Social responsibility.
Sustainability ought to be the end game of business. No business
activity is undertaken or permitted that jeopardizes the ability
of future generations to meet their own needs.
The 'role of non-financial capital' such
as 'human capital', 'social capital' and 'cultural capital'
was particularly emphasized. It was felt that there needs
to be a greater recognition of the importance of 'intellectual
and reputational capital' and the tectonic shift in public
values with the onset of knowledge economy.
A primary goal of good corporate governance
ought to be to foster a culture of creativity, innovation
and entrepreneurship to protect the business from irrelevance
and obsolescence. It should aim to leverage the intellectual
capital to serve the unarticulated customers and untapped
markets.
To strengthen Boards of Directors and in
order to induct people of eminence and ability into the Boards
to discharge the functions as watch dog of other stakeholders'
interests on Audit Committee, on Remuneration Committee etc.,
these people should be insulated from the failings of the
day - to - day management. Non-Executive Directors should
be freed from accountability for failures such as a cheque
bouncing or a pollution device failing. Amendments in the
laws and Rules & Regulations in this regard should be
made.
It is unpractical and unethical to hold non-executive
Directorship or Directorship in ten and more companies. The
rules for Directorships need to be amended so that the number
of non-executive directorship a person can hold is less then
ten.
It is vital that a Minimal Training Programme
should be designed and administered for all Directors, both
Executive and Non-executive, covering key aspects of good
corporate governance and directorial responsibilities - statutory,
environmental and social. There should be a compulsory induction
programme for institutional nominees.
The most important aspect in Corporate Governance
is the effectiveness of the boards. Cadbury Report was emphatic
about the quality of the Board. It says,
"The country's economy depends on the
drive and efficiency of its companies. Thus the effectiveness
with which their boards discharge their responsibilities determines
Britain's competitive position. They must be free to drive
their companies forward, but exercise that freedom within
a framework of effective accountability. This is the essence
of any system of good corporate governance".
In the UK, the Company Boards are a mix of
'executive directors', 'non-executive directors' and 'independent
directors'. The difference between the latter two is that
both are non-executives but the independent directors have,
or represent, no financial stake in the business.
I will refer to both categories of non-executives
as the "independents" for the rest of my talk for
convenience. The distinction between the executive directors
and the independents is two-fold: firstly the former are employed,
normally on a full-time basis, to run the business, whereas
the independent directors aren't; and secondly the independents
get paid very much less. In a big company it's typically about
10% of what their executive colleagues get. As far as the
law is concerned, as far the Stock Exchange is concerned,
they are all simply 'directors'. They carry equal responsibility
for the business, they have the same fiduciary responsibilities,
carry the same obligations, and face the same personal liability.
The UK system ensures that the independent
directors are closer to the action; they are present when
the key decisions are made; they help shape strategy; they
are able to question the top executives directly; and they
can observe how well the latter function as a team.
Independent directors have certain specific roles. They invariably
chair, and usually dominate, two key committees: audit and
risk, and remuneration.
One characteristic you will find in almost
every business that has gone off-track is the dominance of
the board by a single overbearing individual. Chairing the
Board and heading-up the management team are also different
roles, usually calling for quite different capabilities. Therefore,
the Combined Code of good governance in the UK requires the
Chairman's role to be separate from that of the Chief Executive.
I think that is a wholly appropriate distinction.
Aside from the structure of the Board, another
aspect of good governance is the fullness and quality of its
reporting. The reporting requirements for companies are, of
course, both specific and in some ways quite onerous-designed
to inform the world, and especially the shareholders, exactly
where the company stands and how it is performing. These are
even more demanding if the company is listed on the Stock
Exchange.
To ensure full and accurate reporting the
company is, of course, required to have its accounts audited.
This adds to the pressure on the Directors rather than alleviates
them. As Andersen has recently been at pains to point out,
it is the Board that signs off the accounts and issues the
annual report, not the auditors.
UK's system of Corporate Governance has been
progressively developed over the years, and in the last 10
years subject to a series of reviews. Cadbury, Greenbury,
Hampel, the Combined Code, Turnbull and now the Myners Review.
In 1998 London Stock Exchange published "The principles
of Good Governance and Code of Best Practice, commonly called
"the Combined Code" following consultations on the
final report of the Hampel Committee published the previous
January. The Hampel Committee was established in November
1995 to review the Cadbury and Greenbury Committee reports.
The combined Code requires listed companies to report compliance
with the following provision:
· The board must meet regularly.
· The board should have a formal schedule of matters
specifically reserved to it for decision.
· There should be a procedure agreed by the board for
directors in the furtherance of their duties to take independent
professional advice if necessary, at the company's expense.
· All directors should have access to the advice and
services of the company secretary, who is responsible to the
board for ensuring that board procedures are followed and
that applicable rules and regulations are complied with. Any
question of the removal of the company secretary should be
a matter for the board as a whole.
· All directors should bring an independent judgement
to bear on issues of strategy, performance, resources (including
key appointments) and standards of conduct.
· Every director should receive appropriate training
on the first occasion that he or she is appointed to the board
of a listed company, and subsequently as necessary.
These issues have been dealt with in India
on similar lines in Kumar Mangalam Birla's Report which has
been adopted as SEBI Guidelines. The Centre for Corporate
Governance has published its own Guidelines which cover environmental
reporting in addition to financial reporting. All this sounds
solid. So, where is the real problem?
The issue essentially comes down to the quality
of the Board, how well it is chaired, the choice of directors
and how far they understand their role and how well they are
able to discharge it effectively. It also depends, on how
far and how well the shareholders, principally in the form
of the large institutional investors, play their part.
The key role of the independents is to ensure
that the Board functions well. They are not there to manage
the business, but to ensure that the business is well managed.
A prerequisite for this is to get the right
people on the board and train them. I know what directors
feel about training. They all think they know what needs to
be known. But independent directors are different. They know
little about the company. Their value lies in the diversity
of their viewpoint. But, they must know how it should be put
across effectively. It needs special skills. It is a tragedy
that we have little training on one of our most important
need of communication.
There is a general belief that director appointments
are all incestuous, with the directors of the big companies
sitting on each others boards. Too many directors are still
chosen for their name, or reputation, rather than for what
they bring to the Board. I would recommend that directors
are recruited through independent search firms, rather than
through personal contacts.
In trying to recruit directors we ought to
cast the net much more widely. Greatest value accrues from
people from different disciplines, academic backgrounds, social
strata, ethnic and religious beliefs, age and gender. I would
look to professional bodies such as yours, apart from the
business, the public sector and for all but the biggest organisations
to top-level executives who are one step below board level
in larger organisations.
I would also like to see far more done to
education and development of directors. Here the Centre for
Corporate Governance, which the World Council For Corporate
Governance has helped establish with the Institute of Directors
in India, has developed a 12 Module programme especially over
40 hours, which we believe should be the best for any corporate
director.
Being an independent director is not as cushy
as just turning up for a meeting each month, stay in 5 Star
Hotels, dine at the best restaurant and collect your cheque
at the end, as many imagine it to be. You need time to read
valuable paper work that is prepared for each meeting and
be available for consultation when things go wrong specially
when a company starts projecting badly. You would not envy
the job of the directors of ENRON today.
In the wake of Enron a number of ideas have
been suggested, some new, some old, for improving corporate
governance, both in UK and in the United States. Some are
worth exploring.
The Myners review has focused on the role
of the institutional investors, and suggested that an annual
meeting with the independent directors would be a useful additional
insight into the business.
It has also been recommeded that auditors
should not be allowed to sell consultancy services to the
same client, or perhaps that the former should not offer other
services at all. This is also a point that the 2nd ICCG held
in Mumbai in January 2002 has adopted.
It is also important that companies should
spell out their risks in more details in the annual report.
Here we would need to strike a balance and be very cautious.
Many of those risks are a matter of commercial confidentiality
and you may not like to share these with your competitors.
You have to, therefore communicate your concerns effectively
to your shareholders.
On the subject of pay, it has already been
suggested that the remuneration policy should be explained
and put to the shareholders each year.
As the Enron debacle indicates, a good corporate
governance code is no guarantee of good corporate governance.
There needs to be stricter monitoring and enforcement of laws
on punishment for corporate scams to ensure that those who
violate the public trust do not go scot-free. Along with a
requirement of disclosures and accountability, laws should
be amended to mete out swift and deterrent punishment to the
offenders. Here one would endorse George Bush's message in
his "State of the Nation" address:
"Executives who profit from false financial
statements may be required to repay bonuses or other pay if
accounts are subsequently restated as a result of misconduct.
Executives who abuse their position may be disqualified from
holding future corporate roles".
The cases such as Enron and many others are
not just breach of codes but violations of the law. In which
case, one would like to see vigorous prosecution pursued,
but let's not assume that it is the law alone which is going
to bring about the high standard of governance we seek. Good
governance, is not simply a matter of structures and procedures:
The last thing one wants is a 'tick in the box' attitude to
the whole subject. It depends on the ethics of the people
overseeing and running the enterprise. On having a fundamental
sense of what is right and what is wrong, a belief in their
honesty for its own sake and a sense of personal responsibility.
Role of Ethics
Ethics tend to be something that pervades
our organisation's total culture. You don't get unethical
boards running ethical companies, or vice versa. However,
barring a few villains, the question of ethics is not always
straightforward. Situations are not black and white, they're
usually grey. The ethical dimension is not always apparent;
or if it is, there are conflicting sides to the argument:
not in terms of whether to make the right ethical decision
or not, but what is the right ethical decision.
Good Governance is not simply about corporate
excellence. It's the key to economic and social transformation.
The corporations of today are no longer sheer economic entities.
These are the engines of economic and social transformation.
Kenichi Ohmae argued in 'The Borderless World: Power and Strategy
in the Interlinked Economy' that:
"A Corporation is a social institution
whose responsibilities extend far beyond the well being of
its equity owners to giving security and a good life to its
employees, dealers, customers, vendors, and subcontractors.
Their whole life hinges on the wellbeing of the corporation."
Corporations are the powerhouses that generate
employment, provide education and health care, and give sustenance
to the society. Globalization has given multinationals overwhelming
power at the expenses of democratically elected governments.
Good governance needs to ensure that the corporations take
in to account the interests of all constituencies in which
they operate. A business entreprise's corporate actions must
be compatible with long term societal needs such as the quality
of environment and welfare of local community. It has been
increasingly demonstrated that the ultimate competitiveness
and corporate success is dependent as much on investors, employees,
customers, creditors and suppliers as on shareholders.
Morphing of industrial economy into knowledge
economy has created a tectonic shift in public values. Companies
can ignore this shift only at their own peril. Public hostility
faced by Shell, Nike, Reebok, Ikea and Monsanto should provide
lessons to corporations who violate the social license and
show lack of environmental responsibility. In today's market,
successful companies will be those that recognize they have
responsibilities to the society, the community and the planet
that go beyond compliance with law. In a study carried out
by Wheeler and Seelampaa quoted in their book called "The
Stakeholder Corporation: A Blue print for Maximizing Stakeholders
Values (1997)", they asserted that during most of the
20th century in the UK and USA, stakeholder inclusive enterprises
fared better than "shareholders - first" companies.
Stakeholder inclusive corporations invariably lead to better
long term business performance.
Harnessing the full potential of knowledge
economy requires understanding of how knowledge works. Sharing
of capital or physical assets does not increase the total
value to society. Sharing of knowledge, on the other hand,
adds value to both sides. Knowledge behaves entirely differently
from capital. Capital consists of tangible assets (buildings,
plant, land etc.) that are limited and can be used for only
one purpose. But knowledge is a fluid, intangible asset that
can be transferred at little cost. Its value increases when
shared. This insight explains why collaboration between the
corporation and its stakeholders can be beneficial to both
sides. The end result is not one plus one equals two, but
much more.
Good governance of corporations is a source
of competitive advantage and critical to economic and social
progress. It not only attracts long term patient foreign capital
but also helps to broaden and deepen local markets.
It must be remembered that the biggest brunt
of poor Corporate Governance practices is borne by the poor.
Corporate scams can set back social and economic gains by
as much as a generation. Similarly good governance can have
a transformational effect on the life of poor, especially
in developing and transition economies. A healthy growth of
competitive corporate governance is fundamental for sustained
and shared growth - sustained in the sense that it withstands
the shocks of market volatility; shared in the sense that
it delivers benefits to all of society. Poverty persists because
the gains of growth are not equitably distributed.
There are many definitions of Corporate Governance.
The classical view is that its main purpose is to define relationship
between those who own the capital and those who control it.
This is a narrow definition. The end purpose of Corporate
Governance must be to maximize company's value. Unfortunately
for far too long this value has been determined only by the
financial value. It has now been realized that the financial
value depicts merely a small percentage of the total value.
The value of human capital and natural capital is infinitely
more than the value of financial capital. Admittedly there
are problems in calculating the cost or value of human capital,
cultural capital or natural capital. This by no means suggests
we can ignore it. Specially now that we find that our progress
is not being limited so much by the financial capital but
the human and natural capital.
It has been estimated that the value of biological
services flowing from natural capital is around $36 trillion
annually. Capitalizing it on the basis of current return on
capital gives a capitalized monetary value of world's natural
capital at about $500 trillion. Compared to this, the World's
gross product is only $39 trillions. Similarly the World Bank's
1995 Wealth Index found the total value of human capital to
be three times greater than all financial and manufactured
capital reflected in global balance sheets. This is a conservative
estimate as it counts only the market value of human employment,
not uncompensated effort or cultural capital.
The true purpose of corporate governance
is to maximize creation of company's total value. The social
and environmental issues, therefore, are equally important
in any corporate governance debate. There is a need, therefore,
for corporations to disclose their environmental & social
performance.
Business has to take on the responsibility
of upgrading the environment. Society will not gain if financial
capital increases at the cost of natural capital. We have
to create new production and distribution processes to reverse
the loss of natural capital and eventually increase its supply.
This will involve more than product design, more than marketing
and competition. It will mean a fundamental redesign of business
models, its roles and responsibilities.
We have to question how did we come to create
an economic system which is so contrary to natures biological
processes and is based primarily on extraction, depletion,
waste and disposal. How did we create an economic system that
confuses the capital liquidation with income? How is it that
our pricing system tells us it is cheaper to destroy the earth
than to conserve it? Is it normal to have an economic system
that discounts the future and sells of the past? Wasting scarce
natural resources to achieve immediate profits does not lead
to value creation and wasting environment to achieve economic
growth is neither economic nor growth.
Corporate governance framework has to be
established on the simple proposition that all capital be
valued. While it may be difficult to value a forest, a river,
grassland or a mountain, it is wrong to give it no value at
all. Ask how much will it cost to make a 700 year old tree
or new atmosphere or a new culture? It is you who as professionals
have to determine the methodology of replacement cost.
Today's business faces multitude of challenges,
increasing business pressure on all fronts, globalization,
shorter product life cycles, internet, over capacity, complex
regulations, currency volatility, value migration etc. Meeting
these challenges will bring about economic discontinuities
that are unprecedented in rate and scope, and would require
highly innovative approaches. We have to leapfrog over existing
technologies rather than incrementally improve them. Using
Nicholas Negroponte's expression for the times that we are
living "incrementalism is our worst enemy". But
innovation will bring tremendous resistance from vested interest.
One only has to refer to Jim Utterback's (An MIT Professor)
case studies of pressures on electric companies brought by
gas lighting companies in the 1880s, recorded in his book
"Mastering the Dynamics of Innovation". To understand
how hard it is to resist change. This is the Board's number
one job in today's economy which is driven by innovation.
Corporate Governance is concerned with empowering
people, spurring and pursuing innovation and improving efficiency.
It also addresses conflicts of interest which can impose burdens
on the enterprise. Ensuring transparency and probity in corporate
affairs can make a major contribution to improving business
standards, public accountability and consequently increase
its market capitalization.
We are on the threshold of a profound transformation.
The gap between what can be imagined and what can be achieved
could never have been smaller. The key constraint to achieving
our ambitions is no larger the financial capital. It is the
limitation of our own imagination and attitude. Our governance
systems whether in public or corporate must foster innovation,
nurture creativity and build trust, transparency and a sense
of sharing. We must recognize that we are living today not
in an economy of hands or heads but the economy of hearts.
Our governance systems need to be recast in a way that they
touch the hearts and not only the minds.
The greatest challenge facing the accountancy
profession today is the determination of the true costs. Market
economy cannot function effectively without internalizing
costs of each input. Environment is a key input in the creation
of wealth. Shattering of a huge ice shelf Larsen B weighing
500 million billion tonnes in Antarctica a few days ago is
a sharp reminder of the cost of industrial activity on environment.
Counting what is not easily countable is the greatest challenge
of your profession. For globalization to succeed prices must
tell the economic truth. Socialism collapsed because it concealed
the economic truth. Capitalism will collapse if it does not
allow prices to tell the ecological and social truth. Pursuit
of good corporate governance framework therefore, has to take
care of a triple bottom line approach i.e. it must look after
profits, people and planet.
