CRF 2012 : Control to Self Regulation

Corporate Governance & CSR

By

Y.R.K. Reddy
yrk@academyofcg.org www.academyofcg.org February 15th 2012

Academy of Corporate Governance

Objectives of the Session

A: Review of the key developments leading to revived interest in corporate governance; the current framework of assumptions; the OECD standards; the assumed benefits and business case; the broad shortcomings in Emerging Market Economies; the potential role of company registrars in promoting corporate governance. B: Developments leading to the current logic for CSR; the international standard relating to stakeholders; leading approaches and bench marks; the dynamics; the potential for strategic CSR - key examples, whether Registrars have a role in promoting.
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PART A

Corporate Governance Historical Foundations The Directors of such companies, however, being the managers
rather of other peoples` money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own . Negligence and profusion, therefore, must always prevail, more or less in the management of the affairs of such a company, 1776.

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The focus on control in corporations: Berle & Means Studied the modern corporation & debated the dynamics of ownership and control in 1932 in the context of the USA. There are severe apprehensions about control and what it can mean to Institutional investors and minority shareholders, in case of block holders participating in management and the SOEs. Hope that risks would be abated if internal structure and processes and external institutions get developed reducing information asymmetry and promoting attendant rationality.

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Renewed Interest in 90`s

The logic for robust financial statements Cadbury.

The AFC & GreenspanSummers IMF arguments.

Revolving around Crony Capitalism due to financial sector weaknesses (combination of inadequate capitalization & supervision of banks combined with excessive leverage & guarantee + directed lending). Competitive capitalist / market assumptions with weak structures the Asian way with cross holdings, large number of subsidiaries, lack of transparency, collusion between corporations, financial institutions and governments etc. Weaknesses in equity market development, IFRS / FASB standards, information disclosure, oversight by independent directors, bankruptcy laws.

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The International Convergence on Corporate Governance

Corporate Governance is one of the 12 key standards promoted by Financial Stability Forum (now Financial Stability Board). IMF - World Bank, The Report on Observance of Standards and Codes (ROSC), OECD, BIS, regional and national agendas..

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GFC & the Current Debate

Financial crises are historical followed by State

intervention. (the cycle).

Several studies including the UN Commission, OECD,

GFSR, ICGN, FCIC etc.

Mainly argue for appropriate regulation / intense supervision; greater transparency and disclosure norms; early action from the State; public policy / plans for impaired assets; balance sheet repairs consistency of treatment etc. at policy level ( along with some multi-lateral moves) At the enterprise level, the emphasis has been on advanced / robust / comprehensive risk management and qualified board oversight and activism; compensation / incentive structure that do not encourage false / fleeting profits and risks.

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OECD Principles as Global Standard

I. Ensuring the Basis for an Effective Corporate Governance Framework
The corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities.

II. The Rights of Shareholders and Key Ownership Functions

The corporate governance framework should protect and facilitate the exercise of shareholders rights.

III. The Equitable Treatment of Shareholders

The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.
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IV. The Role of Stakeholders in Corporate Governance

The corporate governance framework should recognize the rights of stakeholders established by law or through mutual agreements and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.

V. Disclosure and Transparency

The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company.

VI. The Responsibilities of the Board

The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the boards accountability to the company and the shareholders.

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The Universal Principles

Accountability

Fairness

Transparency

Responsibility

These Principles should:

Ensure mgmt.s Protect accountability to Shareholders the board & rights; treat all boards equitably; accountability to provide shareholders redress.

Ensure timely Recognize the and accurate legal rights of disclosure on all stakeholders & material matters promote sustainable development

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Modern corporations are disciplined by internal and external factors

(Source: Corporate Governance Framework, Nadereh Chamlou, Magdi Iskande, World Bank)

Internal
Shareholders

External
Private
Stakeholders

Regulatory
Standards (for example, accounting and auditing) Laws and regulations Financial Sector Debt Equity Markets Competitive factor and product markets Foreign direct investment Corporate control

Board of Directors
Appoints and monitors

Reputational agents1 Accounts Lawyers Credit Rating Investment Bankers Financial media Investment advisors Research Corporate Governance Analysis

Reports to

Management
Operates

Core functions

agents refer to private sector agents, self-regulating bodies, the media, and civic society that reduce information asymmetry, improve the monitoring of firms, and shed light on opportunistic behaviour

1Reputational

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Possible benefits to companies

Many studies have shown positive benefits. Eg: those of Mc Kinsey, ABI and IMF working paper on CGQ & CLSA studies and the subsequent ones Recap: Other compilations had shown following benefits in earlier years:

Improves Valuation of Assets - Share premium 22% to 30% as per Mc Kinsey survey; 700 fold increase in firm value in Russia (21 firms) Improves Access to Capital - CG a major factor for competitive provision of finance; access to IFIs. Lowers the Cost of Capital - CG helps in finer rates. Eg: Romanias BCR Improves Efficiency - ABN Amro study in Brazil shows 20% higher P / E ratios; 45% higher ROEs and 76% higher net margins. Deutsche Bank study of S & P 500 shows out performance by 19% over two years; Harvard / Wharton study shows abnormal returns of 8.5%; CLSA study of 100 companies shows 8% points higher EVA; Other benefits - reduced risks improves the reputation and trust ; increases competitiveness.
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The old idea of CG Premium that continues to make business sense.

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One perspective as to where Asia stands in CG

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An FIIs compilation on other relevant institutions..

Source: F & C Investments

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Regulatory Approaches
Two Most Popular Typologies: Principle based Comply / Apply or Explain ( and justify). Rule based, regulated / legislated and well enforced. Newer / emerging hybrid versions:

Comply or Explain but in legal and regulatory guidance. Mostly principle-based but one or two strongly rule based, regulated but fully enforced. Rule based, regulated / legislated but weakly enforced by intention.

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Role of Company Registrars

Regulation entry, as going concerns, exit facilitations. The tradeoff between hard nosed regulation / enforcement vs. market discipline. Is there a role for campaigns / reputation intermediation? Any other experiences?

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PART B CSR A Part of Cluster Concepts

Corporate Social responsibility, corporate citizenship, responsible business, stakeholder engagement etc. are cluster concept: Often fuzzy and overlapping; policy as well as action oriented. The political economy of CSR can be traced to:

Beginnings mainly in the 50s. Much controversy during the 70s (strength of collectives; Milton Freidmans perspective). Strong shift to customers as key stakeholders during the 80s (issue of competition & competitive strategy for survival); Tilt to providers of finance and policy regimes in the 90s (importance of finance; liberalization) The upsurge of sustainability issues in current times
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CSR and Other Responsibilities

The Challenge of Exclusive to Inclusive Perspective

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OECD Principles of Corporate Governance What does the Global Standard Say?
The Role of Stakeholders in Corporate Governance
The Corporate Governance framework should recognize the rights of stakeholders established by law or through mutual agreements and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financial sound enterprises.

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The rights of stakeholders that are established by law or through mutual agreements are to be respected. Where stakeholders interests are protected by law, stakeholders should have the opportunity to obtain effective redress for violation of their rights. Performance-enhancing mechanisms for employee participation should be permitted to develop. Where stakeholders participate in the corporate governance process, they should have access to rely an, sufficient and reliable information on a timely and regular basis. Stakeholders, including individual employees and their representative bodies, should be able to freely communicate their concerns about illegal or unethical practices to the board and their rights should not be compromised for doing this. The corporate governance framework should be complemented by an effective, efficient insolvency framework and by effective enforcement of creditor rights.

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The Idea of a Stakeholder:

Popular definition:
A stakeholder is any group or individual who can affect, or is affected by, the achievement of an organization's objective
Freeman, 1984

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In the context of Corporate Governance

A stakeholder is any institution, group or individual who can get benefited or affected by, and/or can benefit or adversely affect, a corporation`s actions in pursuit of its primary objectives
Y.R.K. Reddy, Presentation at OECD meet, Cebu, 2007.

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Available Leads for CSR / Stakeholder Engagement

Several guidelines, case studies, international standards for assessment / reporting especially as part of CSR (Stakeholder engagement may be larger than CSR). Noteworthy: IFCs Stakeholder Engagement good practice manual; IFCs EHS guidelines; OECD`s guidelines for MNEs; Dow Jones Sustainability Index, FTSE4Good Index, SA 8000 / 14000, AA1000, GRI et al + principles such as Caux. ISO 26000 adopted in September 2010 A World by itself!
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Ex: Stakeholder Map. A steel SOE

Industry Associations Distribution Logistics Auditors Banks & Financial Institutions Model Villages Certifying/rating bodies Parliament (COPLI++) Ad Agencies -Brand Ambassadors ,Celebrity Employees
Consultants/ Specialist AdvisoryNational& International

Public Deposit Holders Distribution

State Govts. (Legislature, Laws, Compliances

Shareholders-Government, Institutions, Ministry of HI&PE Channels General Public Other Central Govt Direct Employees Subsidiaries Bodies/Laws Retirees Direct Customers & Families Direct Suppliers
Domestic/International

Joint Ventures

CAG

Employee Cooperatives Indirect Customers NGOs

Unions

Ministry of Steel & Mines

CVC

Ministry of Finance

Indirect Employees (Contract and Other Labour) Miscellaneous

Neighborhoodenvironment/Infrastructure

Families of Employees Townships Hospitals -Community CentresSchools, Colleges, Technical Institutes Implications for CSR??
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Dynamics of stickiness, capture, direction and the need for close analysis

High

Involve

Partner

POWER Monitor with minimum effort. Low Keep Informed

Low

INTEREST

High

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Towards Strategic CSR / CSV the Many Success Stories

Powerful ideas (ex. Michael Porter et al, 2002, 2006, 2011). Even more powerful examples. ( Nestle, Jain irrigation, ITC, DRL). The power of coalition with INGOs. ( Ex: Aide et Actions innovative
engagement with corporates; the initiatives of several SOEs in India. ).

Key steps: close analysis, explicit policy, detailed planning, partnerships, execution, reporting.

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Firm Infrastructure
(e.g. financing, planning, investor relations)

Human Resource Management

(e.g. recruiting, training, compensation system)

Technology Department
(e.g. product design, testing, process design, material research, market research)

Procurement
(e.g. components, machinery, advertising & services)

Inbound Logistics (e.g. incoming material storage, data collection, service customer access)

Operations (e.g. assembly, component fabrication, branch operations)

Outbound Logistics (e.g. order processing, warehousing, report presentation)

Marketing & Sales (e.g. sales force, promotion, advertising proposal writing, web site)

After Sales Service (e.g. installation customer support complaint resolution report)

Adapted from Porter & Kramer Strategy and Society, HBR December 2006

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Some Current Policy Steps in India Do they need International Best Practices?

The guidelines for Corporate Social Responsibilities for Central Public Sector Enterprises. Key concerns in reviving old debates on objectives, level playing field and control shift. The proposed Companies Law Bill and the approach to mandating CSR the policy implications of governance, tax levies and their adverse impact on market forces / discipline. The National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business. What role can Registrars of Companies play?

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Some Challenges

The lack of unitary standards and multiplicity of reputation agents. Lack of standards in accounting, reporting and disclosure. The difficulty in recognizing the risks associated with CSR and their second-order trades-off with strategy. Others drawing from international experiences?

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