Corporate governance

Corporate governance is needed to create a corporate culture of consciousness, transparency and openness. It refers to a combination of laws, rules, regulations, procedures and voluntary practices to enable companies maximise shareholders long-term value.

INVESTORS PROBLEMS AND PROTECTION

1. Poor Tackling of Price Manipulation and Insider Trading Issues: 2. Poor Conviction Rate: 3. Need to Enhance its Manpower Skills: 4. It should Simplify and Trim Regulations: 5. It should Tone up Quality of Disclosures: 6. It should solve Issues of IPOs and Mutual Funds:

BOARD OF DIRECTORS A POWERFUL INSTRUMENT IN GOVERNANCE

Inevitably and unquestionably, the board of directors of a corporation is the most important instrument that would make it or break it. If a corporation is considered a role model or a beacon, it is in no small measure due to its CEO and a proactive board, while many corporate failures and scams invariably point out to an inactive or obedient board. This chapter goes in depth into all these issues, as well as positive and negative elements connected to the board of directors.

Role of Board & Top Management

The board may be expected to lay down policies, procedures and programmes, but may not be able to secure their implementation under their guidance and continuous supervision, or communicate their decision to the rest of the staff. The CEOs who include Managing Directors and managers receive instructions from the board and disseminate them to executives in charge of various departments.

Kinds of Directors
A director may be a full time working director, namely, managing or whole time director covered by a service contract. A company may also have non-executive directors who do not have anything to do with the day-to-day management of the company. The Board of Directors of a company which includes all the directors elected by shareholders to represent their interests is vested with the powers of management. The board has extensive powers to manage the company, delegate its power and authority to executives and carry on all activities to promote the interests of the company and its shareholders, subject to certain restrictions imposed by public authorities.

Duties and Responsibilities of Directors

The directors have certain duties to discharge. These are: (i) Fiduciary duties (ii) Duties of care, skill and diligence; (iii) Duties to attend board meetings; (iv) and duties not to delegate their functions except to the extent authorised by the Act or the constitution of the company and to disclose his interest.

Powers of the Board

Board of directors shall exercise the following powers (a) make calls on shareholders in respect of money unpaid on their shares; (b) issue debentures; (c) borrow moneys otherwise (For example, through public deposits); (d) invest the funds of the company; and (e) make loans.

The board of directors also can exercise certain other powers as listed below with the consent of the company in general meeting, as in the case of an amalgamation scheme:

(a)

to sell, lease or otherwise dispose of the whole or substantially the whole, of the undertaking of the company; (b) to remit or give time for repayment of any debt due to the company by a director except in the case of renewal or continuance of an advance made by the banking company to its director in the ordinary course of business;

Power of The Board of Directors (contd.)

(c) (d) to borrow in excess of capital; to contribute to charitable and other funds not relating to the business of the company or the welfare of its employees beyond a specified amount; to invest, compensation amounts received on compulsory acquisition of any of company properties; and to appoint a sole selling agent.

(e)

(f)

NOMINEE DIRECTORS
A Nominee Director is generally appointed in a company to ensure that the affairs of the company are conducted in a manner dictated by the laws governing companies and to ensure good corporate governance. A nominee director, as an affiliated director, is nominated to ensure that the interests of the institution which he or she represents are duly or effectively safeguarded

The Directors Liability to the Company

(1) Ultra vires Acts: Directors are personally liable to the company in matters of illegal acts. (2) Negligence: A director may be held liable for negligence in the exercise of his duties.

(3)

(4)

Breach of Trust: They are liable to the company for any material loss on account of the breach of trust. Misfeasance: Directors are liable to the company for misfeasance, i.e, willful misconduct.

ROLE OF BOARD IN ENSURING CORPORATE GOVERNANCE

The quality of directors, their competence, commitment, willingness and ability to assume a high degree of obligation to the company and its shareholders as members of the board alone drives the value of any board. A strategic board with broad governing responsibilities rather than one that acts in response to the demands of the CEO has become the need of an intensely competitive world.

SNAPSHOT BOARD & CORPORATE GOVERNANCE

1. 2. 3. The smaller the board, the greater the directors involvement. The essence of strategic boards is independence. Diversity (of Board) means that a company has access to the best. It also means that the company is not arbitrarily limited to a single subset of its global constituency. If the board is not informed appropriately, intelligently and comprehensively, it cannot function. In simple words, the output is only as good as the input. The board has a broader responsibility to long-term shareholder value than the CEO, who is necessarily focused on day-to-day operations.

4.

5.

CONTINUED
(1) Small Size of the Board

(2) Independence of the Board

(3) Diversity of the Board (4) A Well informed Board (5) The Board should have a Longer Vision and Broader Responsibility

I. THE ROLE OF DIRECTORS

(1) An efficient and independent board should be conscious of protecting the interests of all stakeholders and not concerned too much with the current price of the stock. (2) Another important function of the director is to set priorities and to ensure that these are acted upon.

I. THE ROLE OF DIRECTORS (contd.) 3) (A director is also expected to have the courage of conviction to disagree. (4) in the matter of employment and dismissal of the CEO. Directors have great responsibility (5) One of the toughest challenges confronted by boards arises while approving acquisitions.

I. THE ROLE OF DIRECTORS (contd.)

(6) An efficient board should be able to anticipate business events that would spell success or lead to disaster if proper measures are not adopted in time. (7) The directors have a duty to act bona fide for the benefit of the company as a whole.

I. THE ROLE OF DIRECTORS (contd.)

(8) In recent times, those who advocate reform of laws governing corporate practices stress the importance of reformulation of the concepts behind these laws.

Independent Director Clause 49

Definition of Independent Director is now wider and includes a Non-Executive Director (NED), who

Does not have any material pecuniary relationships or transactions with the companys associates
Is not related to promoters or persons occupying management positions at the Board level of a level below Has not been a company executive in past 3 years Is not/was not in last 3 years a partner or executive of the statutory audit/internal audit/consulting firm Is not a material suppliers, service provider, customer, lessor or lessee of the company Does not own 2% or more of voting shares

Independent Director Clause 49

Definition of Independent Director is now wider and includes a Non-Executive Director (NED), who

Does not have any material pecuniary relationships or transactions with the companys associates
Is not related to promoters or persons occupying management positions at the Board level of a level below Has not been a company executive in past 3 years Is not/was not in last 3 years a partner or executive of the statutory audit/internal audit/consulting firm Is not a material suppliers, service provider, customer, lessor or lessee of the company Does not own 2% or more of voting shares

Role & Responsibilities

At least one Independent Director to be present on the Boards of all material subsidiaries Minutes of the Board meeting of a subsidiary to be tabled at board meeting of parent company Significant transactions or arrangements entered into by each subsidiary to be reported to the Board periodically Audit Committee to have minimum of three directors as members, of which two-thirds must be Independent Directors Independent Director to be Chairman of Audit Committee and be present at AGM to answer shareholders queries A minimum of two Independent Directors to be present at AGM

Challenges for Independent Directors

Formulation and execution of strategy

Audit and assurance process

Shareholder and stakeholder communications Legal and regulatory compliance Enterprise risk management Organisational ethics, brand loyalty, and employee retention

An organization must manage a host of governance related activities and expectations that affect its ability to create and sustain value

ROLE DUTIES AND RESPONSIBILITIES OF AUDITORS

Introduction
Ethics and values get short shrift in business in two ways; first, by the failure of management and second, by the failure of auditors. Recent unearthing of corporate frauds both in developed countries and developing and transitional economies revealed the fact that the auditors had failed to do what they were assigned to do. They involved themselves in unethical practices and failed to whistleblow when things went wrong in the organization.

Role of Auditors
The allegation that annual reports presented by companies today lack truthfulness and transparency is cent percent true. Window-dressing, manipulation of profit and loss accounts, hedging and fudging of unexplainable expenditures and resorting to continuous upward revaluation of assets to conceal poor performance are malpractices companies resort to with the help of obliging auditing firms.

Role of Auditors (contd.)

Instances are galore where obliging auditors have helped companies falsify accounts and in window-dressing for small monetary gains.

Objectives of an Audit
The objective of an audit of financial statements is to enable an auditor to express an opinion on financial statements which are prepared within a framework of recognized accounting policies and practices and relevant statutory requirements.

Defining Auditor
An auditor is defined as a person appointed by a company to perform an audit. He is required to certify that the accounts produced by his client companies have been prepared in accordance with normal accounting standards and represent a true and fair view of the company. Usually, Chartered Accountants are appointed as auditors.

An auditor is a representative of the shareholders, forming a link between the government agencies, stockholders, investors and creditors.

DUTIES OF AN AUDITOR
The duties of an auditor are defined under section 227 (1A) of the Companies Act 1956. It says that an auditor can enquire whether loans and advances made by the company on the basis of security have been properly secured ;

whether transactions of the company which are represented merely by book entries are not prejudicial to the interests of the company ;

DUTIES OF AN AUDITOR (contd.)

where the company is not an investment company within the meaning of Section 372 or a banking company, whether so much of the assets of the company as consist of shares, debentures and other securities have been sold at a price less than that at which they were purchased by the company ; whether loans and advances made by the company have been shown as deposits ; and whether personal expenses have been charged to revenue account.

The auditor is responsible for

verifying that the statements of accounts are drawn up on the basis of the books of business. verifying that the statements of accounts drawn up on the basis of the books exhibit a true and fair state of affairs of the business. confirming that the management has not exceeded the financial administrative powers vested in it by the Articles of Association of the Company and / or resolutions of shareholders.

RESPONSIBILITIES OF AUDITORS
As per the Standard Auditing Practices (2), the auditor Is responsible for forming and expressing his opinion on the financial statements. He assesses the reliability and sufficiency of the information contained in the underlying accounting records and other source data by making a study and evaluation of accounting systems and internal controls. Determines whether the relevant information is properly disclosed in the financial statements by comparing the financial statements with the underlying accounting records and other source data to see whether they properly summarise the transactions and events recorded.

RESPONSIBILITIES OF AUDITORS (contd.)

Has to ensure that his work involves exercise of judgment, as for example, in deciding the extent of audit procedures and in assessing the reasonableness of the judgments and estimates made by management in preparing the financial statements. Is not expected to perform duties which fall outside the scope of his competence. For example, the professional skill required of an auditor does not include that of a technical expert for determining physical condition of certain assets.

Responsibilities of an Audit Firm

(a) Professional Requirements (b) Skills and Competence (c) Assignment (d) Delegation (e) Consultation (f) Acceptance and Retention of Clients (g) Monitoring

 Disqualification of Auditors under section 226 of the Bill Any person who has a direct financial interest in the company or who receives any loan or guarantee from the company or who has any business relationship other than that of an auditor or who has been in the employment of the company or whose relatives are in the employment of the company is said to be disqualified to be an auditor under this section.

ROLE OF BANKS & CORPORATE GOVERNANCE

There are four important forms of oversight that should be included in the organisational structure of any bank in order to ensure appropriate checks and balances: 1) Oversight by the board of directors or supervisory board; 2) Oversight by individuals not involved in the day- to-day running of the various business areas; 3) Direct line supervision of different business areas; and 4) Independent risk management and audit functions.

The New Basel Capital Accord (Basel II)

Efforts were made for six years to rectify the deficiencies found in the original accord, now known as Basel I. In June 26, 2004, the Committee came out with new Basel norms that are expected to change the complexion of banking throughout the world. The final version of the revised accord, titled, The International Convergence of Capital Measurement and Capital Standards : A Revised Framework is known for short as the New Basel Capital Accord or simply Basel II. The first version of Basel II came out in 1999. The version was widely debated and after consultation, a revised Basel II document came out in June 2004. Basel II rests on three pillars as given below :

The three pillars

The first pillar represents a significant strengthening of the minimum requirements set out in the 1988 Accord, while the second and third pillars represent innovative additions to capital supervision. Pillar 1 of the new capital framework revises the 1988 Accords guidelines by aligning the minimum capital requirements more closely to each banks actual risk of economic loss.

The three pillars (contd.)

Pillar 2 of the new capital framework recognises the necessity of exercising effective supervisory review of banks internal assessment of their overall risks to ensure that bank management is exercising sound judgement and has set aside adequate capital for these risks. Pillar 3 leverages the ability of market discipline to motivate prudent management by enhancing the degree of transparency in banks public reporting. It sets out the public disclosures that banks must make that lend greater insight into the adequacy of their capitalisation.

Implementation of Basel II and its Impact The Reserve Bank of India (RBI) started its own consultative process involving various bank and other experts. It has now come out with its final draft version of Basel II, which is to become operational from 2007.

COMPETITION & CORPORATE GOVERNANCE

The Concept, Logic and Benefits of Competition

Some of the benefits expected from competitive markets are: Growth of entrepreneurial culture leading to an increase in the number of producers and sellers in the market. Increase in investment and capital formation leading to an increase in supply capabilities. A strong incentive for developing cost-cutting technologies through sustained research and development efforts. Reduction in wastage and improvement in efficiency and productivity. Greater customer focus and orientation. Increased possibility for entering and tapping foreign markets. Conducive environment for growth of international trade and investment. Better resource and capacity utilization. Wider range of availability of goods and services and wider range of choices for consumers.

On account of these perceived benefits, governments in free enterprise countries take steps to generate and promote competition. This, however, requires a suitable economic system and the constitutional framework as well as an appropriate macroeconomic policy set-up.

Regulation of Competition
While it is important and necessary to promote competition among firms to enable consumers gain maximum advantage from a free market economy, an unregulated competition is bad and may even lead to unmitigated disaster and destruction of the nations wealth.

The regulation and protection of competition usually requires a competition policy backed by an appropriate legislation. There are three basic areas of such competition policy: Control of dominance firms by regulation. Control of mergers to prevent the possibility of emergence of monopolies; and Control of anti-competitive acts like full line forcing and predatory pricing.

Lack of Competition Promotes Ownership Concentration

Lack of competition accentuates ownership concentration. Owners of incumbent firms have an incentive to retain control of profitable domestic operations. They may choose to remain a private firm or may go public, but without giving up control either by retaining a controlling stake or by issuing non-voting shares. Research findings show that a higher share of the leading firms remain private in less competitive markets.

Benefits of Competition to Stakeholders

Competition improves the conduct of managers, as they understand that in such markets only the fittest can survive. This, in turn, improves quality of products and reduces prices for consumers, and maintains or increases market share, and return on shareholders' investment. Consumers in economies having hitherto restricted competition as in India are reaping these benefits. In a much freer market, they enjoy a wide variety of products and services to choose from, competitive prices, technically updated products and other consumer friendly policies such as easy and installment credit and longer warranties. These benefits of competition can be analyzed from two aspects: (i) competition in the product market, and (ii) competition in the capital market.

The ability of existing corporate elite to resist policy reform is a cause for concern. For one thing, inadequate competition limits the access to capital by new or small businesses. Lenders and investors naturally prefer more established firms with significant business advantages. Over time, the industrial structure may be skewed, with a few large conglomerates dominating, and a large number of small firms struggling with little prospect for growth.

Effects of Monopoly on Political Governance

In such a state of affairs, The political and economic control may be too concentrated. Democracy and competition get undermined. There is reduced political accountability and transparency. There is increased corruption. Shareholder interest may be confused or compromised by multiple and conflicting objectives.

MRTP Vs Competition Act

The intent of the legislation in India to promote competition is not to prevent the existence of a monopoly across the board. There is a realisation in policy-making circles that in certain industries, the nature of their operations and economies of scale indeed dictate the creation of a monopoly in order to be able to operate and remain viable and profitable as in the case of public utilities like Railways, Posts and Telegraph departments. This is in significant contrast to the philosophy, which propelled the operation and application of the Monopolies Restrictive Trade Practices (MRTP) Act, the trigger for which was the existence or impending creation of a monopoly situation in a sector of industry.

WHAT IS A GOOD COMPETITION POLICY?

A good and effective competition policy with the objective of restraining the emergence of monopolies and bringing in a competitive market that would ensure benefits to the consumers and overall economic efficiency, and at the same time taking cognizance of the specific needs of a developing country like India, should have the following characteristics: It should be capable of controlling the misuse of the market power of dominant firms. It should have a clear perception of dominance and should develop unambiguous criteria for determining the abuse of dominance.

WHAT IS A GOOD COMPETITION POLICY? (contd.)

It should be able to identify the anti-competitive effects of mergers and acquisitions and provide a prescription to deal with such effects. It should check barriers to entry subject to the provisions of industrial policy. It should be able to identify and monitor collusion, cooperation or alliances between independent firms in various institutional forms such as cartels and trade associations to restrict, suppress or modify competition. Collusion may take a number of tacit or explicit forms and may involve output restriction, price fixation, distribution controls or market sharing. In many cases, collusions are designed to prevent the entry of potential firms.

Objectives of the Competition Bill

1. 2. 3. 4. Encourage competition; Prevent abuse of dominant position; Protect the consumer; and Ensure a level playing field to participate in the Indian economy The spirit behind the Competition Bill is that big is no more bad, but hurting competition and consumer interest is.

Competition Commission of India

The Bill advocated a regulating body called the Competition Commission of India (CCI). The CCI is to be set up as a quasi-judicial body and would have a chairperson and a team comprising two to ten members. The CCI would have separate prosecutorial and investing wings. It would be entrusted with various powers like the power to grant interim relief, enquire into certain combinations, impose fines on the guilty, order divisions of an undertaking, pass cease and desist, order a de-merger and direct payment to be made to aggrieved parties for loss or damage suffered by them. The administration and the enforcement under the Act to be done by the CCI are proactive rather than reactive.

As it stands today, The Commission would have suo moto powers to intervene in any M&A deal, which may affect competition in any industry or segment. Draft regulations of the Commission would function like a rule-book for prescribing conditions for healthy competition. Competition Advocacy Committee set up to examine scope for such a commission. Commission has engaged in research projects with various institutes, including Jawaharlal Nehru University and other organisations.

The Three Focus Areas of the Competition Act

Agreement Amongst Enterprises: The Act deals only with those agreements between enterprises, which have an appreciable adverse effect on competition. Abuse of Dominance: The Act regulates all agreements, which could result in abuse of dominance. Dominance has been defined as the position of strength in the relevant market enjoyed by an undertaking which enables it to operate independent of competitive pressures in the relevant market and also to appreciably affect the relevant market, competition and consumers by its actions. Abuse would include agreements charging or paying unfair prices, restriction of quantities, markets and technical development. It includes discriminatory behaviour, predatory pricing and any exercise of market power leading to the presentation, restriction or distortion of competition.

The Three Focus Areas of Competition Act (contd.)

Mergers of Combination among Enterprises: The Act regulates all mergers, which create a position of dominance. It is understood that the government would make pre-merger notification, if required, voluntary. It also provides for a deemed approval of a merger in the absence of a response from the CCI within a period of 90 days.

The CCI, however will have the power to make an investigation into a merger even after one year of the pre-merger notification either suo moto or in a complaint. The Act rules out any postmerger review for individual company mergers, which have a combined turnover of less than Rupees 3000 crore or a combined asset size of upto Rupees 1,000 crore in India.

CHAPTER 16 SEBI-THE INDIAN CAPITAL MARKET REGULATOR

Deficiencies in the Indian Capital Market

Lack of diversity in the financial instruments. Lack of control over fair disclosure of financial information. Poor growth in the secondary market. Prevalence of insider trading and front running. Manipulation of security prices. Existence of unofficial trade in the primary market, prior to the issue coming into the market. Absence of proper control over brokers and sub-brokers. Passive role of public financial institutions in checking malpractice. High cost of transactions and intermediation, mainly due to the absence of well-defined norms for institutional investment.

Impact of Globalisation
The Indian capital market is on the threshold of a new era. Gradual globalisation of the market will mean the following changes: The market will be more sensitive to developments that take place abroad. There will be a power shift as domestic institutions are forced to compete with the Foreign Institutional Investors (FIIs) who control the floating stock and are also in control of the Global Depository Receipts (GDR) market. Structural issues will come to the fore with a plain message: Either reform or despair. The individual investor in his own interest will refrain from both primary and secondary market; he will be better off investing in mutual funds.

Abolition of Controller of Capital Issues and

Emergence of SEBI
Earlier, prior to the setting of SEBI, the Capital Issues (Control) Act, 1947 governed capital issues in India. The Narasimham Committee on the Reform of the Financial System in India recommended the abolition of the CCI. It suggested that SEBI set up in1988 should be entrusted with the task of a market regulator to see that the market is operated on the basis of well-laid principles and conventions. SEBI has been empowered to control and regulate the new issue and old issues market, namely, the Stock Exchange.

Objectives of the Board

The statutory objectives of the SEBI as per the Act are
(i) (ii) Protection of investors interests in securities Promotion of the development of the securities market Regulation of the securities market; and Matters connected therewith and incidental thereto.

(iii) (iv)

Objectives of the Board

The statutory objectives of the SEBI as per the Act are
(i) (ii) Protection of investors interests in securities Promotion of the development of the securities market Regulation of the securities market; and Matters connected therewith and incidental thereto.

(iii) (iv)

SEBI (Amendment) Bill, 2002

(1) Search and Seizure Powers (2) Freeze Bank Accounts (3) Greater Monetary Penalties (4) More Board Strength

SEBIs Role in the New Era

The SEBI has made progress in a number of areas: Abolition of capital issues control and retaining the sole authority for new capital issues; Regulation and reform of the capital market by arming itself with necessary authority and powers; Regulating stock exchanges under Securities Contracts Regulation Act; Bringing all primary and secondary market intermediaries under the regulatory framework; Enforcing companies to disclose all material facts and specific risk factors associated with projects while going in for public issues.

Secondary Market Reforms SEBI has initiated the following measures:

(i) (ii) (iii) (iv) (v) (vi) Registration of Intermediaries Reconstitution of Stock Exchange Governing Bodies Measures to Speed up Settlements Regulations on Insider Trading Simplification of Procedures Regulation of Collective Investment Schemes

Secondary Market Reforms SEBI has initiated the following measures: (viii) Introduction of Compulsory Rolling Settlement (ix) One Point Access to Investors (x) Introduction of Takeover Codes (xi) Trading of Government Securities through Order-driven Screen-based System (xii) De-listing Guidelines (xiii) Central Listing Authority (xiv) Derivative Trading (xvi) Demutualization and Corporatisation of Regional Stock Exchanges

SEBIs SHORTCOMINGS
(i) (ii) (iii) (iv) Lack of Adequate Required Power Buckles Under Pressure The Legacy of Nehruvian Socialism Dies Hard Mammoth Size of the Market and Inefficient Handling (v) Inefficient Standard Regulatory Model (vi) SEBI should Identify Delinquents Speedily and Penalize them (vii) Problems that SEBI has not Tackled (viii) There is a long way to go

CHAPTER 17 THE ROLE OF GOVERNMENT IN CORPORATE GOVERNANCE

Different Roles of Government in the Economy

There are four important roles played by the government in an economy, namely: i) The regulatory role; ii) The promotional role; iii)The entrepreneurial role; and iv)The planning role

REGULATORY ROLE : A large part of the economy of even most of non-centrally planned countries is regulated by the Government, as discussed below : (1)Government may determine the conditions under which persons or corporations may enter certain lines of business as in the granting of a charter, a franchise, a license, or permitting any person to use any public facilities or resources. (2)Government may regulate or assist the conduct of economic ventures of various types once they are under way. (3)Public control may extend to the results of business operations as in the limitation of public utility profits, ceiling on dividends and imposition of excess-profit taxes on business.

(4)Government may control the relationship between various segments of the economy, the purpose being to settle conflicts of interests or of legal rights and to prevent concentration of economic power in the hands of a few monopolies or in a few localities that may cause regional imbalances. (5)Government may put in place legally constituted regulatory bodies to protect investors, consumers and the general public by ensuring best corporate practices.

Government regulation of an economy may be broadly divided into:

(I) Direct Control (II) Indirect controls

Indirect controls are usually exercised through various fiscal and monetary incentives and disincentives or penalties. For instance, a high import duty may discourage imports while fiscal and monetary incentives may encourage development of export oriented industries.

Direct administrative or physical controls, on the contrary, are more drastic in their over-all effect and impact. For instance, many developing countries have instituted a variety of direct controls over their economies including industrial licensing and price and distribution controls.

PROMOTIONAL ROLE : The promotional role played by Government is very important in developed as well as in developing countries. Thus, considering the whole of its activities, a government does more to assist and to help develop industrial, labour, agricultural and consumer interests than it does to regulate them. In developing countries, where the infrastructural facilities for development are inadequate and entrepreneurial activities scarce, the promotional role of the government assumes special significance. The state will have to assume direct responsibility to build up and strengthen the necessary development of infrastructure such as power, transport, finance, marketing, institutional - for training and guidance - and other promotional activities.

The promotional role of the state also encompasses the provision of various fiscal, monetary and other incentives, including measures to cover certain risks for the development of certain priority sectors and activities. ENTREPRENEURIAL ROLE: The growing importance of the entrepreneurial or participative role of the state has been evident from the fast expansion of the public sector in most developing countries. However, post1990s, there has been a significant reversal in this policy as governments having experienced inefficient functioning of public sector industries and the huge losses incurred by them which are balanced by budgetary allocations that affects tax-payers, have given up their policy of promoting them.

Good governance is supposed to exist if three objectives are achieved. The first is that there should be equality of law and effective implementation of laws. Secondly, there should be opportunity for every individual to realise his full human potential, and Thirdly, there should be effective productivity and no waste in every sector.

CORPORATE GOVERNANCE IN DEVELOPING AND TRANSITION ECONOMIES

 Lack of well regulated banking sector. Exit mechanisms, bankruptcy and foreclosure norms are absent. Sound securities market do not exist. Competitive markets have not developed. Corruption and mismanagement. Non-uniform guidelines: the government formulated guidelines to ensure better governance are not uniformly applied to all companies.

Corporate Governance Models

The countries with developed economies apply two different systems of corporate governance: the group-based system and the market-based one or, as they are often referred to, the insider and outsider systems.

Insider System
In concentrated ownership structures, ownership and/or control is concentrated in the hands of a small number of individuals, families, managers, directors, holding companies, banks and/or other non-financial corporations. Most countries, especially those governed by civil law, have concentrated ownership structures. Insiders exercise control over companies in several ways; own the majority of the company shares and voting rights; own some shares, but enjoy the majority of the voting rights.

Insider System (contd.)

Companies that are controlled by insiders enjoy certain advantages. Insiders have the power and the incentive to monitor management closely thereby minimising the potential for mismanagement and fraud. Insiders tend to keep their investment in a firm for long periods of time. As a result, insiders tend to support decisions that will enhance a firm's long-term performance as opposed to decisions designed to maximise short-term gains.

Insider System (contd.)

However, insider systems predispose a company to certain corporate governance failures. One is that dominant owners and/or vote holders can bully or collude with management to expropriate the firms assets at the expense of minority shareholders. This is a significant risk when minority shareholders do not enjoy legal rights.

Insider System (contd.)

Insiders who wield their power irresponsibly waste resources and drain company productivity levels; they also foster investor reluctance and illiquid capital markets. Shallow capital markets, in turn, deprive companies of capital and prevent investors from diversifying their risks.

Outsider System

Dispersed ownership is the other type of ownership structure. In this scenario, a large number of owners hold a small number of company shares. Small shareholders have little incentive to closely monitor a company's activities and tend not to be involved in management decisions or policies. Hence, they are called outsiders, and dispersed ownership structures are referred to as outsider systems.

Outsider System (contd.)

Common Law countries such as the UK and the US tend to have dispersed ownership structures. The outsider system or Anglo-American, market-based model is characterised by the ideology of corporate individualism and private ownership, a well-developed and liquid capital market, with a large number of shareholders, and a small concentration of investors. The corporate control is realised through the market and outside investors.

Outsider System (contd.)

In contrast to insider systems, owners in outsider systems rely on independent board members to monitor managerial behaviour and keep it in check. As a result, outsider systems are considered more accountable and less corrupt and they tend to foster liquid capital markets. Dispersed ownership structures have certain weaknesses. Dispersed owners tend to be interested in short-term profit maximisation. They tend to approve policies and strategies that will yield short-term gains, but that may not necessarily promote long-term company performance.

Outsider System (contd.)

At times, this can lead to conflicts between directors and owners, and to frequent ownership changes because shareholders may divest in the hopes of reaping higher profits elsewhere, both of which weaken company stability. Small-scale investors have less financial incentive to vigilantly monitor boardroom decisions and to hold directors accountable. Directors who support unsound decisions may remain on the board when it is in the company's interest that they be removed.

MODERN CORPORATIONS ARE DISCIPLINED BY INTERNAL AND EXTERNAL FACTORS INTERNAL Private Shareholders Stakeholders EXTERNAL Regulatory Standards (for example,

accounting and
auditing) Board of Directors Reports Appoints to and monitors Management Operates Core functions Reputed agents * Accountants * Lawyers * Credit rating * Investment bankers * Financial media * Investment advisors * Research * Corporate governance analysts Laws and regulations Financial sector * Debt * Equity Financial sector * Competitive factor and product markets * Corporate control

Corporate Governance Challenges in Developing, Emerging and Transition Economies

Establishing any one of institutions enumerated above is a necessary and challenging undertaking without which democratic markets and corporate governance can not take root. Some of the general challenges confronting developing, emerging and transition economies include:

 Establishing a rule-based (as opposed to a relationship-based) system of governance; Combating vested interests; Dismantling pyramid ownership structures that allow insiders to control and, at times, siphon off, assets from publicly owned firms based on very little direct equity ownership and thus few consequences; Severing links such as cross shareholdings between banks and corporations; Establishing property rights systems that clearly and easily identify true owners even if the state is the owner;

 De-politicising decision-making and establishing firewalls between the government and management in corporatised companies where the state is a dominant or majority shareholder; Protecting and enforcing minority shareholders' rights; Preventing asset stripping after mass privatisation; Finding active owners and skilled managers amid diffuse ownership structures;

 Educating and enlightening investors of their rights and duties Encouraging good corporate governance practices and creating benchmarks through cooperation with trade associations. Establishing regulatory bodies that help reduce fissures through arbitrations and conciliations between competing and conflicting parties. Promoting good governance within family-owned and concentrated ownership structures; and Cultivating technical and professional know-how.