Conference on Models & Dimensions of Corporate Governance: Fulcrum for Sustainable Wealth Creation
December 3-4, 2002, New Delhi

Address by Shri G. N. Bajpai, Chairman, SEBI

CORPORATE GOVERNANCE AND DEVELOPMENT : INTRODUCTION

Indian Society with over 5000 years of chequered human history has in varying degree through the ages sought to develop individuals and create organizations who would subserve their individual welfare and narrow sectarian interests at the altar of the greatest good of the largest member.

The society and its constituents have all helped us to be what we are and what we will be in times to come. Whereas there appears to be a coordinated attempt to make us enlightened global citizens, can we take upon ourselves the lofty objective of BUILDING ENLIGHTENED CORPORATE CITIZENS OF INDIA. Before I venture to roll out my thoughts on what makes a good and enlightened corporate citizen, let me at the beginning attempt to answer a doubt that some of us may have about the realization of our own objectives through the process of actualizing our vision, fulfilling our personal mission and meeting our individual aspirations. Let me take recourse to Lord Krishna's Updesh in Bhagwad Geeta.

You nourish the god and those Devas, nourish you; thus nourishing one another, you shall attain highest good.

Creation of enlightened corporate citizens of India is a MAHAYAGYA in the commercial world where contributions - the AHUTIES of Managers will be the most significant inputs. An enlightened Corporate citizen is one where there is a balance between economic and social goals and between individual and community goals; there is efficacious utilization of resources and accountability for the stewardship of the resources; and where interests of individuals, corporations and society are aligned. The enlightened corporate citizens become the locomotive pulling up the GNP and not mere cabooses following it.

Let me dwell briefly on what Managers command and what aspirations they are expected to fulfill. Managers command society's physical resources, investors' fiscal resources and the organisation's human resources. And the expectation is to optimize the leveraging of those resources to create wealth for the stakeholders and society at large. Hence, the first and foremost responsibility that devolves on the shoulders of a Manager is not just to create but optimize creation of wealth by maximizing input-output ratio. In an ethos of organizational, technological and managerial revolution - there are more storms of the clicks than the waves of bricks, the limits of creativity, initiatives and drive would be the ceiling on how far and how fast that would be possible. Commencing the debut at the atrium of ambiguity and uncertainty - stemming out of the rapidity and profundity of changes, it is the leadership ability that helps to find not only a few minor overlooked treasures but huge caverns that remain largely unexplored. And there are plenty of caverns in not even partially explored India.

Optimal creation of wealth must incorporate management of wealth not only in the multiplier framework but also its deployment and distribution to the best advantage of the organization and commensurate with the contribution to the stakeholders. The teeming millions of India (nearly 300 millions still living below poverty line) struggling for a square meal a day are bewailing for economic compassion. India calls out to self efficacing individuals with a fierce resolve to mitigate their miseries. Good and enlightened Corporate citizens can not be fashioned except with efficacious Corporate Governance.

Strong corporate governance is indispensable to resilient and vibrant capital markets and is an important instrument of investor protection. It is the blood that fills the veins of transparent corporate disclosure and high-quality accounting practices. It is the muscle that moves a viable and accessible financial reporting structure. Without financial reporting premised on sound and honest numbers, capital markets will collapse upon themselves.

It is a truism that the adequacy and the quality of corporate governance shape the growth and the future of any economy.

Case studies of Argentina, Brazil, Chile, China, India, Malaysia and South Africa suggest that corporate governance is growing in significance so far as the flow of financial capital to firms in developing countries is concerned. Equally important are the potential benefits of improved corporate governance for overcoming barriers, including the actions of vested interest groups, to achieving sustained productivity growth. In the planetary competitive game, corporations will be rated according to the following criteria:-

(a) Corporate Governance - clarity of mission and corporate values;
(b) People talent - quality of leadership;
(c) Market space - where and what is the market reach;
(d) Risk management - how well are the risks managed;
(e) Discipline - are the key disciplines self-discipline, regulatory discipline and market discipline.

THE CONCEPT

Corporate governance encompasses the relationships and ensuing patterns of behaviour between different agents in a limited liability corporation; the way managers and shareholders but also employees, creditors, key customers and communities interact with each other to form the strategy of the company. This is, one might say, the behavioural side of corporate governance.

But corporate governance also refers to the set of rules that frame these relationships and private behaviours, thus shaping corporate strategy formation. These can be the company law, securities regulation, listing requirements'. But they may also be private, self-regulation. This is what we could call the normative side of corporate governance.

Sound corporate governance practices and the need for greater transparency in the global financial markets are vital to national economic welfare and essential to maintaining a stable global economic environment. However, while such goals of global financial transparency are being pursued as much as possible in a coordinated manner, the corporate governance objectives are faced with stumbling blocks.

Many observers perceive corporate governance to be a simple debate between those who protect rights of minority shareholder and those who believe that there are other corporate interests and objectives to be served. The phrase "corporate governance" and much of the related concepts reflect very different assumptions and create rather different images in the minds of different people and, institutions. Such differences are often unrecognised and thus resulting in a very unsatisfactory context for progress. Many such differing perspectives on corporate governance arise from the wide variety of legal, cultural and commercial settings; there is no universally accepted standard of accountability for directors and officers towards companies, especially listed ones.

The term, corporate governance centres on "processes" designed to ensure that directors, controllers and managers of companies are held properly accountable to their shareholders. They must perform their duties with integrity and be subjected to checks and balances which prevent abuse of power. It is also important that they must keep shareholders informed of matters affecting shareholder interests.

The main purpose of good corporate governance involves ensuring that the company management acts in the interest of all stakeholders, including minority shareholders. The board of directors should adequately reflect and represent the interests of different stakeholder groups. Corporate governance is inextricably inter woven with the business culture of a company, and this largely comes down from its top executives. To my mind the Corporate Governance is fundamentally a leadership issue and involves whole organisation. One key process is the prompt . and voluntary disclosure of information about the company's financial performance. Transactions involving the interests of directors, managers and controllers must be fair, and seen to be fair to other shareholders.

Defined broadly, "corporate governance" refers to the private and public institutions, including laws, regulations and accepted business practices, which together govern the relationship, in a market economy, between corporate managers and entrepreneurs ("corporate insiders") on one hand, and those who invest resources in corporations, on the other. Investors can include suppliers of equity finance (shareholders), suppliers of debt finance (creditors), suppliers of relatively firm-specific human capital (employees) and suppliers of other tangible and intangible assets that corporations may use to operate and grow. Specifically, what are the institutions of corporate governance? Not only do they vary from country to country - in form and substance and, importantly, in how they mutually interact in a given country - they evolve over time. An indicative, hypothetical, list can nevertheless illustrate the main institutions of corporate governance. Comprising key "actors" and relevant legislation, regulations, other formal and informal rules, and generally accepted business practices, I have tried to develop such a list. It distinguishes between key institutions of information disclosure and corporate transparency on one hand and those for corporate oversight and control on the other.

The institutions of corporate governance, in any country, can usefully be thought of as comprising key "actors" and formal and informal rules, including generally accepted practices. They include: -

• Legislation that gives corporations juridical personality (recognises their existence as legal "persons" independent of
  their owners), determines corporate chartering requirements, and limits the liability of the owners of a corporation to the
  value of their equity in the corporation;
• Legislation on the issuing and trading of corporate equity and debt securities (including laws on the responsibilities and
  liabilities of both securities issuers and market intermediaries such as brokers and brokerage firms, accounting firms and
  investment advisers);
• A government body ("securities Board") empowered to regulate the issuing and trading of corporate securities with
  the means to monitor and enforce compliance with securities laws;
• Stock-exchange listing requirements (conditions corporations must meet to be allowed to list and trade their shares on the
  exchange);
• A judiciary system with sufficient political independence and the investigative as well as judicial powers and the resources
  required to make and enforce, without excessive delay, informed and impartial judgements;
• Professional associations or "guilds" (such as those of accountants, stock brokers, institutes of directors) that contribute - e.g. through membership licensing, information sharing, peer pressure - to the definition and maintenance . standards of professional conduct in their field;
• Business associations and chambers of commerce that, in a similar fashion, use formal and informal means to influence members' thinking on and behaviour with respect to acceptable business practices;
• Other private and public monitors of corporate and securities-market participants' behaviour (notably pension funds and other institutional investors, ratings agencies, financial media).

In addition to these corporate-governance "actors" (including the body or bodies that enact relevant legislation), two broad categories of laws, regulations, other formal and informal rules and generally accepted practices are important those that concern corporate oversight and control, and those that concern information disclosure and corporate transparency. The former group notably includes rules and accepted practices with respect to:

• Shareholder voting rights and procedures (including those that are especially important for the protection of minority shareholder rights vis-a-vis dominant shareholders as well as vis-a-vis management, such as cumulative voting rights and other so-called anti-director rights;
• The duties, powers and liabilities of corporate directors (boards and individual directors, including definition of what constitutes an "independent" director and requirements on board composition and on the constitution of board committees on audit, the nomination of directors and the remuneration of directors and top executives);
• Proscription of self-dealing by corporate insiders (whether self-dealing occurs via related-party transactions or "tunnelling" or takes the form of insider trading;
• Stock-tendering requirements (notably to protect small shareholders in the context of a corporate merger, acquisition or privatisation) ;
• Judicial recourse for shareholders vis-a-vis managers and directors (derivative suits, class-action suits ;
• The functioning of markets for corporate control (take-over markets);
• The functioning of markets for professional managers, and of labour markets.

The corporate-governance institutions of disclosure and transparency notably include rules and accepted practices with respect to:

• Financial accounting standards, and how those standards are set;
• Public disclosure, in a clear and timely manner, of such information as financial accounts (including both segment and consolidated accounts, the level and means of remuneration of directors and top executives);
• related- party transactions undertaken by corporate insiders;
• compliance, or the reasons for non-compliance, with provisions in corporate-governance codes, other relevant codes, laws, regulations and self-declared corporate values or objectives; - External audit (including how the auditor is chosen); - Independent or "third-party" analysis and assessment of corporate prospects (e.g. by stock brokers, risk-assessment specialists).
  

Perhaps most important to understanding the concept, however, is to understand the purpose of corporate governance. In all countries, the institutions of corporate governance serve two indispensable and ultimately indissociable objectives: enhance the performance and ensure the conformance of corporations to ethics, equity. Facilitate and stimulate the performance of corporations - the principal generators of economic wealth and growth in society - by creating and maintaining a business environment that motivates managers and entrepreneurs to maximise firms' operational efficiency, returns on investment and long-term productivity growth. They ensure corporate conformance with investors' and society's interests and expectations by limiting the abuse of power, the siphoning-off of assets, the moral hazard and the significant wastage of corporate- controlled resources (so-called "agency problems") that the self-serving behaviour of managers and other corporate insiders can be expected to impose on investors and society in their absence . Simultaneously, they establish the means to monitor managers' behaviour to ensure corporate accountability and provide for the cost-effective protection of investors' and society's interests vis-a-vis corporate insiders. They can be understood, in sum, as serving both to determine what society considers to be acceptable standards of corporate behaviour, and to ensure that corporations comply with those standards.

DISCIPLINES OF CORPORATE GOVERNANCE

Corporate Governance is like a three-legged stool resting on three basic disciplines: self-discipline, market discipline and regulatory discipline. The advantage of a three-legged stool is that however irregular the stool or rough the ground it sits firmly. But do not let that mislead us. The legs may be firm but, if the legs are not in the right proportion you will find yourself slipping off a sloping seat. It is essential that the three disciplines are in proportion, then you can relax and sit comfortably.

First the management or controlling shareholders should invoke self- discipline. This works when the controlling shareholders or management are highly ethical and treat minority shareholders fairly. The system breaks down when the internal checks and balances, such as independent members of board, committees, internal and external audits, do not function well.

Market discipline comes from two inter-related forces - market pricing and market competition. The market should be in a position to monitor the conduct of agents and call them to account. In well-functioning markets, the market's assessment of corporate performance is reflected in the prices of equities and bonds, and corporations that fail the test could find difficulty in raising new capital, and eventually be competed out of the market. Surveys on Asia show that the international market will give a premium of 20 to 25% for good corporate governance. But market discipline will not work without accurate, consistent and timely information. Nor will it work if there is no level playing field for competitive forces to function. In other words, market discipline cannot be exercised if the regulatory processes do not deliver quality information, transparency and level playing fields. And as long as enterprises and regulatory authorities can hide their inefficiencies behind a wall of information asymmetry and an unequal playing field, why should they allow market discipline to work?

Of course, we all recognize that moral fibre and market discipline alone will not be sufficient to prevent the occurrence of insider dealing, market manipulation and cheating or fraud. Clearly, there must be regulatory discipline. For regulations and their enforcement to be effective, they must fulfill certain conditions and objectives. Ideally, they should: -

• be clear, transparent and explicit in objectives;
• have legitimacy - i.e. have public consultation and approval;
• promote-market efficiency and a level playing field;
• have due regard to regulatory burden on market participants;
• appropriately protect small market participants, e.g. consumers and investors; and
• have transparency and due process in enforcement.

WEALTH CREATION . WEALTH MANAGEMENT. WEALTH MAXIMISTAIQN

The Entrepreneurs/Managers of the Enterprise are committed to use their skills and create an output which is higher than the sum total of the inputs in various forms - physical, financial and human resources. The difference between the sum total of the inputs and the output is described as the "wealth" created by the enterprise.

The level of wealth creation has to be assessed and this needs to be done in comparison with other operators in the industry nationally and even internationally. The first measurement of good Corporate Governance is therefore, let us say in a scale 1 to 10, what has been the level of wealth creation by the Entrepreneurs ?

While the wealth is being created, which, in any case has to be an ongoing process the concurrent issue before Entrepreneurs/ Managers is to 'manage' the created wealth. The management of wealth creation has to be seen with reference to multiplier matrix, to clarify, in case wealth is growing at an "X" percentage nationally and internationally, what is the rate at which the wealth is growing in this particular enterprise, is at higher or at lower or are there extraneous circumstances which
impact either adversely or favorably the wealth growth matrix. This is the second measure of good Corporate Governance.

The wealth created/being created by the Enterprise belongs to all the Stakeholders rather than the Shareholders alone and within Shareholders two segments are majority shareholders and minority shareholders. Each of the Stakeholders make a contribution. What has to be assessed is whether the share of wealth is in proportion to the contribution made or not. In case the sharing is on an efficacious platform, the Enterprise could earn full marks on Corporate Governance. There may be an argument that one or some of the Stakeholders may be putting in an extraordinary effort either in the creation of wealth or in the management of wealth in addition to their contribution in terms of the inputs namely fiscal and human capital. However, before factoring the same must be assessed on the objective platform.

CONCLUSION:

As a policy matter, globally focus of corporate governance is largely about establishing a legal and regulatory framework that promotes the emergence of credible and effective governance practices for the benefit of stakeholders, economies and society as a whole.

I am of the view that good corporate governance should not be limited to mechanisms for monitoring of management by the board and monitoring of the board by shareholders. Effective disclosure and monitoring will encourage management to pursue policies that provide competitive returns to shareholders.

However, the assessment of the good Corporate Governance must transit from mere form to substance - the impact of governance on the ultimate goal of the corporate viz. wealth creation, wealth management and wealth sharing. It is in this perspective that India proposes to lead the world by putting in a place instrument for measuring Corporate Governance not only in the form but also by substance.

Corporations are built and thrive on the fulcrum of investors confidence, workers' trust, nation's aplomb and savoire-faire. The impact of corporate behaviour resonates not only nationally but also globally. Hence, building good corporate citizens of India is likely to unfold a Kaleidoscope of possibilities of architecturing the economic resurgence of India - an annual GDP growth 8% or even more. And that is the greatest service that a Manager can render unto the society.

Let me conclude by saying that each one of us will one day be judged by our own standards, not of living but by the measure of giving, not by one's own wealth but by the measure of national wealth that one has created and the fairness with which it has been shared. Lord Krishna tells Arjuna in the Bhagwad Geeta, the 3rd Chapter

Whatever a great man does, that other men also do Whatever he sets up as standard, that the world follows.