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Corporate governance: How not to misgovern

A. N. Madhavann

THE IMPORTANCE of corporate governance lies in its contribution both to business prosperity and to accountability. But the emphasis on accountability has tended to obscure a board's first responsibility -- to enhance the prosperity of the business over t ime. Business prosperity cannot be commanded -- people, teamwork, leadership, entrepreneurial value, experience and skills are what really produce prosperity. Accountability, by contrast, does require appropriate rules and regulations, in which disclosur es are the most important elements. Good governance ensures that the constituencies (that is, stakeholders) are taken fully into account with respect to their relevant interest concerning the company's business and activity.

The Cadbury Committee -- a private sector initiative -- was a landmark in the evolution of corporate governance. Cadbury Committee's recommendations were publicly endorsed in the UK and incorporated in countries, such as the US, Germany and so on.

The Cadbury Committee defined corporate governance as ``the system by which companies are directed and controlled''. Now, the directors are at the centre of any discussion on corporate governance and are linked directly to the responsibility towards shar eholders.

To ensure this, a company must develop relationships relevant to its success. This, in turn, will depend on the nature of a company's business, credit providers, local communities and the government(s). It is the management's responsibility to develop th e policies that address these issues; in doing so, they must also keep in mind the over-riding objective of preserving and enhancing the shareholders' investment over a period.

The term `corporate governance' was not uncommonly found in American law journals in the 1970s and was imported from the US into the UK. It took firm roots when Sir Adrian Cadbury was asked in May 1991 to chair the committee on the financial aspects of c orporate governance by the Financial Reporting Council, the London Stock Exchange and the accounting profession. The Cadbury Committee, as it came to be called, was born out of the scandals which hit the city during the late 1980s (several of which did n ot actually come to light in their full horror until the early 1990s). These factors brought into being corporate governance, and is now extended to India as well.

Good corporate governance can follow the following basic principles:

*Every listed company should be headed by an effective board that will lead and control the company.

*There are two key tasks at the top of every public company -- the running of the board and the executive responsibility of running the company's business(es). A decision to combine the roles of a chairman and a CEO into one post, should be made.

*The board should include a balance of EDs (Executive Directors) and Non-EDs -- including independent non-executives so that no individual or small group of individuals dominates the board's decision.

*The flow of information to the Board should be timely, to help discharge its duties effectively.

*The mechanism of appointing new directors should be transparent.

*The company's financial reports should periodically contain statements pertaining to salient disclosures, including remuneration to directors.

*Institutional shareholders have a responsibility to make considered use of their votes.

*Companies should use AGMs to communicate with private investors and encourage their participation.

*The board should present a balanced and comprehensible assessment for the company's position and prospects.

*The board put in place a sound system of internal control to safeguard shareholders' investment and the company's assets.

*The board should have a formal and transparent arrangement for maintaining an appropriate relationship with the company's auditors.

*The auditors should independently report to the shareholders in accordance with the statutory and professional requirements and assure the board on the discharge of their responsibilities.

*All directors should be required to submit themselves for re-election at regular intervals and at least every three years.

Good corporate governance can be ensured if the audit committee does the following assigned tasks:

*Review the scope and results of the periodic audit reports and their cost effectiveness in line with the independence and objectivity of the auditors.

*Discuss with the external auditors (before the audit commences) the nature and scope of audit and other relevant matters.

*Focus particularly on a change in accounting policies and practices; compliances on various accounting standards; significant adjustment entries resulting from the audit; compliance with stock exchange and listing requirements.

*Discuss problems and reservations arising from the audit and any matter that the auditor wishes to discuss.

In Williams and another versus Natural Life Health Foods Limited and Mistlin (court of Appeal, 1997, I.B.C.L.C. 131) December 1996, the court held that the managing director of a franchise company was liable to persons for negligence in relation to the g ranting of a franchise.

In 1998, the House of Lords, reversed the decision (TLR May 1, 1998) on the ground that the facts of the case did not reveal that. In this case, the plaintiff set up a health food shop in Rugby after franchise arrangements had been negotiated with Natura l Life Health Foods Ltd. They decided to proceed on the basis of financial projections prepared by the company which, the judge held had been negligently prepared. Finally, the House of Lords held that the circumstances were insufficient to make the defe ndant personally liable, but did not disapprove of the principle that there might be circumstances that placed personal liability for negligent mis-statements. The case was, thus, a warning note.

The conclusion from this evidence is that directors probably ought to observe the code of ethics described in corporate governance, particularly to third parties (such as franchisees).

Training and support for management's efforts in compliance is vital. The existence and requirements of the company's policy must be drawn to employees' attention at appropriate times. Employees must understand the role they have to play. Where there is turnover of employees depending on the nature of the business, compliance may be an issue for the induction programme.

(The author is General Manager, Finance, Apollo Hospitals.)