law report12 on corporate governance

7/30/2019 Law Report12 on Corporate Governance

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REPORT

ON

Corporate Governance

SUBMITTED TO:

Mr. Mirza M. Waheed Baig

SUBMITTED BY:

Zaheer Abbas MB-SI-09-113

Doda Rasheed MB-SI-09-115

Namra Aziz MB-SI-09-051

Shahbaz Hussain MB-S1-09-021

2nd Semester

Session 2009-2012

Institute of Management SciencesBAHAUDDIN ZAKARIYA UNIVERSITY,

MULTAN.


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Acknowledgment

First of all, I would like to express my deepest sense of gratitude to my supervisor

Mr Mirza M.Waheed Baig for his patient guidance, encouragement and excellentadvice throughout this study.

I would like to thank Mr Mirza M.Waheed Baig for his comments and suggestions

for the editing of my report.

I also thank my colleagues for sharing experiences and knowledge during the time

of report making.

Finally, I take this opportunity to express my profound gratitude to my beloved

parent for their moral support and patience during my work.


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Executive SummaryCorporate governance mechanisms differ as between countries. The governancemechanism of each country is shaped by its political, economic and social history as also

by its legal framework. Despite the differences in shareholder philosophies across

countries, good governance mechanisms need to be encouraged among all corporate andnon-corporate entities. While multilateral organisations like the World Bank and the

Asian Development Bank have evinced keen interest in the subject of corporate

governance an effective lead has been given by the OECD in evolving a set of cogentprinciples of corporate governance which are internationally recognised to serve as good

benchmarks. There have also been some welcome initiatives by the stock exchanges in

the UK and the US in prescribing good governance practices to their listed companies.

These initiatives have been especially in the area of audit committee of the board andappointment of truly independent directors to tone up the quality of board deliberations

and performance. The Advisory Group on Corporate Governance has attempted to

compare the status of corporate governance in India vis--vis the internationallyrecognized best standards and has suggested a course of action to improve corporate

governance standards in India.

Globally, the process of convergence in corporate governance is gathering momentumdue to growing international integration of financial and product markets. Foreign

investors and creditors are more comfortable in dealing with economic entities that adopt

transparent and globally acceptable accounting and governance standards. Companies

that embrace high disclosure and governance standards invariably command betterpremium in the market and are thus able to raise capital at lower costs.

The predominant form of corporate governance in India is much closer to the East Asian

insider model where the promoters dominate governance in every possible way. Indiancorporates, which reflect the pure outsider model with widely dispersed shareholdings

and professional management control, are relatively small in number. A distinguishing

feature of the Indian Diaspora is the implicit acceptance that corporate entities belong tothe founding families though they are not necessarily considered to be their private

properties. Even today, the concept of industrial house popularised some time ago by the

Dutt Committee and the MRTP Act continues to be the commonly accepted reference

points in most of the discussions on ownership patterns of industrial/business units.

Strengthen Companies Act

As is generally the case in most of the well governed economies, in India too a detailed

statutory framework of corporate governance has been defined primarily by theCompanies Act. Most of the important requirements set out by the OECD principles in

regard to good corporate governance are very well defined in the Companies Act in India.

These provisions have been further supplemented by SEBI recently which has directed all

the stock exchanges to amend their listing agreement to incorporate new clauses to makeit binding on the listed companies to improve their governance practices. However, the

main instrumentality, viz. the listing agreement, through which SEBI seeks to ensureimplementation of its measures is a weak instrument, as its penal provisions are not

hurting enough. Secondly, several regional stock exchanges where a large number of

companies are listed lack effective organisations and skills to monitor effective

compliance with corporate governance requirements as stipulated by SEBI. Moreover, avast majority of companies which are not listed on any of the stock exchanges will


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remain outside the purview of SEBIs measures. It is therefore desirable that the

Companies Act needs to be amended suitably for enforcing good governance practices in

India.Most of the important rights of shareholders like right to ownership and conveyance of

transfer, obtaining relevant information regularly, elect members of the board, etc. are

reasonably well covered by the Companies Act. However, the rights of shareholders ofbanks and public sector undertakings stand considerably abridged. The quality of

disclosures by most of the Indian companies in regard to several key areas is rather poor.

There is scanty disclosure regarding structures and arrangements that enable certainshareholders to obtain a degree of control disproportionate to their known equity

ownership. Similarly, disclosures regarding intra-group company dealings, division-wise

accounts, consolidated accounts, etc. are all rather very poor. Companies need to share

their business goals and plans with the shareholders adequately. The risk factors and offbalancesheet items affecting companys future performance should all be disclosed to the

shareholders. In short the quality of financial reporting adopted by the companies in India

needs to be substantially improved.

Role of Independent DirectorsIndia has adopted a unitary board structure. For unitary board structure to function

efficiently there should be a strong representation of non-executive independent directorswho are capable of taking independent stand and are not cowed down by the full time

directors or the promoters of the company. The board should be able to perform its task

of monitoring performance of the full time directors satisfactorily. It should ensure thatreturns to the shareholders on their investments are maximised while not making any

compromises with the provisions of law and the rightful interests of all the stakeholders.

Since most of the Indian companies belong to the insider model, the most important

reform that should be quickly brought about is to make boards more professional andtruly autonomous. They need to be restructured in such a way that majority of the

directors are truly independent. An independent director is one who does not have any

family relationship with any of the executive directors/promoters, does not have currentlyor during the last five years any material financial dealings with the company and is/was

not, during the last five years, an employee of the company or other companies that

have/had material financial dealings with the company.It should be made mandatory that 50% or more of the board members are really

independent (not merely non-executive) and are under no obligations whatsoever either

of the executive directors or the promoters. Unless there is a clear and unambiguous

definition as to who really is an independent director, the term is likely to bemisinterpreted conveniently by the promoter groups. The independent directors would be

in a position to play their fiduciary role more effectively especially if they possess

experience and expertise in the areas related to the activities of the company. In someways, the independent directors may be considered as the trustees for protecting interests

of the common shareholders and the stakeholders. In view of the complexity of the tasks

of governance, the boards of companies should appoint at least four committees ofindependent directors for monitoring and direction of the affairs of the company, viz.

audit committee, remuneration committee, appointment committee, and investment

committee.


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While remuneration committee is expected to play a key role in the determination of

compensation package of executive directors and senior employees, the appointment committee

should be the focal point in the induction of new and independent directors in the place ofretiring directors. The appointment committee has a crucial role to play in ensuring that the

boards do not continue to be the cosy places towing the lines of promoters.

Public Sectors Units & BanksGiven the important place occupied by the public sector entities in the fields of industry

and financial sector, any steps to improve corporate governance in the Indian economy

would remain incomplete and half-hearted unless public sector units are also covered inthis exercise. Multiple layering of 'principal-agent' chains in the case of government

owned entities has important consequences for the corporate governance mechanisms that

will be adopted in them. Often the accountability chain is very weak in public sector

units. The first important step to improve governance mechanism in these units is totransfer the actual governance functions from the concerned administrative ministries to

the boards and also strengthen them by streamlining the appointment process of directors.

The process of selecting directors should be made highly credible by entrusting the task

to a specially constituted body of eminent experts with an independent and high statuslike the Union Public Service Commission.

The role and relationship of the administrative ministries should be limited to issuing ofwritten guidelines/directives to units under their jurisdiction in so far as these instructions

are expected to reflect the will of the ultimate owners viz. the voters as perceived by the

concerned ministries. It is necessary that the rights of common shareholders should berecognised in the corporate governance mechanisms adopted by all the public sector

entities. They should also adopt the system of setting up of the three important board

committees viz. the audit committee, remuneration committee, appointment committee,

and investment committee. While the body of the eminent experts prepares a panel ofnames, the appointment committees of the public sector entities should recommend to

their boards the persons from such panels that could be considered for induction on their

boards.Both government and RBI need to bring about significant changes in the corporate

governance mechanism adopted by banks and other financial intermediaries. As a matter

of principle, RBI should not appoint its nominees on the boards of banks to avoid conflictof interests. Although it is not feasible to have a free market for take-overs in respect

banks there is a strong case for recognising the rights of the shareholders, especially of

public sector banks and financial institutions. Today the common shareholders are denied

such basic rights as adopting annual accounts or approving dividends. They cannot alsoinfluence composition of the boards in any way. As per the Bank Nationalisation Act, the

general superintendence, direction, and management of the PSBs vest with their boards.

At the same time, the Act also empowers government to issue directions/guidelines inmatters of policy involving public interest. Over the years, however, the nature of

government directions has often exceeded the matters involving public interest and

includes the whole gamut of administrative and corporate activities of the PSBs.As a part of strengthening the functioning of their boards, banks should appoint a risk

management committee of the board in addition to the three other board committees viz.

audit, remuneration and appointment committees. Since banks and institutions are highly

leveraged entities their failure would pose large risks to the entire economic system.


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Their corporate governance mechanisms should, therefore, be relatively much tighter.

Current governance practices adopted by the PSBs have created an inequality among

different types of directors. Special status amounting to veto powers given to governmentdirectors, is not in the interest good corporate governance. Banks should have clear

strategies for guiding their operations and establishing accountability for executing them.

Banks should maintain high degree of transparency in regard to disclosure ofinformation.


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Introduction


Corporate Governance is the set ofprocesses, customs, policies, laws,and institutions affecting the way a corporation (or company) is directed,administered or controlled. Corporate governance also includes therelationships among the many stakeholders involved and the goals for whichthe corporation is governed. The principal stakeholders are the shareholders,management, and the board of directors. Other stakeholders includeemployees, customers, creditors, suppliers, regulators, and the communityat large.
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Corporate governance is the system by which companies are directed andcontrolled

It covers topics such as:

how power is divided between the board and the shareholders

the accountability of the board to the members

The rules and procedure for making decisions.

Corporate governance is a multi-faceted subject. An important theme ofcorporate governance is to ensure the accountability of certain individuals inan organization through mechanisms that try to reduce or eliminate theprincipal-agent problem. A related but separate thread of discussions focuseson the impact of a corporate governance system in economic efficiency, with

a strong emphasis on shareholders' welfare. There are yet other aspects tothe corporate governance subject, such as the stakeholder view and thecorporate governance models around the world

The combined Code on the Corporate Governance

History

The Combined Code on corporate Governance was first issued in 1998. Itconsisted of principles and provisions (best practice)

A revised version, of the code was issued in 2003. This revised Codeconsisted of main principle, supporting principles and provisions (practicalrequirements)

The most recent version, which applies to reporting year beginning on orafter 1 November 2006, was issued by the financial reporting council inJune 2006; none of the main principle has been changed. There were afew minor changes, which are outlined later.

Contents

The Code is divided into two sections:

Section one is for companies

Section two is for institutional shareholders.

There section for companies is subdivided into four areas

Directors
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Directors remuneration

Accountability and audit

Relations with shareholders.

The Code has three appendices

The turnbull Guidance on internal audit

The Smith Guidance on audit committees

The Higgs Guidance on best practice.

Main Principle Corporate Governance

The main principle of each section is outlined below.

Directors

(1) Every company should be headed by an effective beard, which isCollectively responsible for the success of the company

(2) There should be a clear division of responsibilities at the if theCompany between the running of the board and the executive

Responsibility for the running of the company business. No oneIndividual should have unfettered powers of decision

(3) The board should include the balance of executive directors andNEDs (and in the particular independent NEDs) such that noIndividual or small group of individuals can dominate the boardsdecisions taking.

(4) There should be a formal , rigorous and transparent procedureFor the appointment of new directors to the board

(5) The board should be supplied in a timely manner withInformation in a form and of a quality appropriate to enable itTo discharge its duties. All directors should receive inductionsOn joining the board and should regularly update and refreshTheir skills and knowledge.

(6) The Board should undertake a formal and rigorous annual


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Evolution of its own performance and that of its committeesAnd individual directors.

(7) All directors should be submitted for re-election at regularIntervals, subject to continued satisfactory performance.

The board should ensure planned and progressive refreshing ofthe board.

Directors remuneration

(1) Levels of remuneration should be sufficient t attract , retain andAnd motivate directors of the quality required to run the companysuccessful, but a company should avoid playing more than isnecessary for this purpose. A significant proportion of executivedirectors remuneration should be strutted so as to link reward to

corporate and individual performance.

(2) They should be a formal and transparent producer of developingpolicy on executive remuneration and for fixing the remunerationpackage of individual directors. No director should be involved indeciding his or her own remuneration.

The Code provides that service contracts and notice periodsShould not exceed on year

Accountability and audit

(1) The board should present a balanced and understandableAssessment of the companys position and prospects.

(2) The board should maintain a sound system of internal control tosafeguard shareholders investments and the company asses.

(3) The board should established formal and transparentarrangements for considering how they should apply the financialreporting and internal control principles and for maintaining anappropriate relationship with the company auditors.


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The Code provides that the board should establish an auditcommittee of an least three (or in the case of smaller companiestwo) members, who should all be independent non-executive

directors. The board should satisfy itself that at least one memberof the audit committee has recent and relevant financialexperience.

The committee should meet at least three times during the year attimes coinciding with key dates within the financial reporting andaudit cycle.

Relation with shareholders

(1) There should be a dialogue with shareholder based on the mutualunderstanding of objectives. The board as a whole hasresponsibility for insuring that a satisfactory dialogue withshareholders takes place.

(2) The board should use the annual general meeting (AGM) tocommunicate with investor and to encourage their participation.

Institutional shareholders

(1) Institutional shareholder should enter into a dialogue withcompanies based on the mutual understanding of objectives.

(2) When evaluating companies governance arrangements,particularly those relating to boards structure and composition,institutional shareholders should give due weight to all relevant

factor drawn to their attention.

(3) Institutional shareholders have responsibilities to make considereduse of their votes.


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The 2006 Combined Code

The (FRC) issued a new version of the Code on 27 June 2006. The newversion contains a few charges, e.g.:

The restriction on a company chairman serving on a remunerationcommittee has been relaxed. However it is still recommended that thechairman should not chair the committee.

A vote withheld option should be included on proxy forms so thatinvestors can indicate reservation about resolution that they do notwish to vote against.

A recommendation that the companies publish on their website thedetails of proxy logged at a general meeting where votes are taken onshow of hands.


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Rule-based versus principle-based approaches togovernance

The Combined Code is a set of principles, rather than a set of rules. It

requires directors to describe in their own words the way in which they haveapplied the general principle of corporate governance.

A principle-based approach to governance has the following advantages anddisadvantages.

Advantages

Because the directors report on the actual circumstance of their owncompany, the report should be more meaningful than one based on

specific detailed requirements.

A Code of practice can be changed much more easily than statuaryrequirements. This means that the Combined Code can be updated torespond to changing conditions and changing expectations of shareholder and others.

A principle-based approach encourages the directors to follow the spiritif the Code; whereas a rule-based approach may result in a tick-boxesmentality. This means that the under rules, rather than the spirit.

Disadvantages

A principle-based approach tends to result in general, meaninglessstatements.

It may be difficult for the directors to see whether they have met thespecific requirements of the Code.

The legal regulation of corporate governanceThe legislation covering corporate governance has been covered in earlierchapters. The following table gives you an indication of where to


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Find the relevant provisions:

The Surbanes - Oxley Act 2002

The Surbanes-Oxley Act 2002 is a US law that applies to all companies(including foreign companies) that have a listing on the US Stock Exchange.

It was introduced in the wake of corporate scandals such as the unexpectedCollapse of Enron and WorldCom.

The US approach to corporate governance is a statutory rules-based one.

This differs from the UK where it is principle-based with an emphasisOn voluntary compliance. The Surbanes-Oxley Act requires all companieswith a listing in the US to include in their annual report certificate vouchingfor the accuracy of the financial statement. This certificate must be signedby the companys principle executive officer and principle financial officer.

Modelarticles

Set out the internal constitution of the company, e.g. allowingthe company and /or the board to negotiate directors service

contacts.CA 2206 Provides the main framework for the legislation affecting

companies.

Specifies that the directors service contract cannot exceed twoyears unless first approved by the members.

Specifies the duties that directors owe to their companies.

IA 1986 Established liability for wrongful and fraudulent trading. Permitsthe liquidators to set aside transactions at an undervalue or

where the company has given a performance.

CDDA1986

Allow the court of disqualify someone from being a director ifthey:

Have persistently beached the companies legislation

Are found to be unfit, or

Are convicted of an indictable offence in connectionwith the promotion, formation, management orliquidation of a company.

CJA1993

Contains the legislation on insider dealing.


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Parties to corporate governance

Parties involved in corporate governance include the regulatory body (e.g.the Chief Executive Officer, the board of directors, management,shareholders and Auditors).

Main parties of Corporate Governance

Other stakeholderswho take part include suppliers, employees,creditors, customers and the community at large.
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Shareholder

In corporations, the shareholder delegates decision rights to the manager to

act in the principal's best interests. This separation of ownership from controlimplies a loss of effective control by shareholders over managerial decisions.Partly as a result of this separation between the two parties, a system ofcorporate governance controls is implemented to assist in aligning theincentives of managers with those of shareholders. With the significantincrease in equity holdings of investors, there has been an opportunity for areversal of the separation of ownership and control problems becauseownership is not so diffuse.

Board of Directors

A board of directors often plays a key role in corporate governance. It is theirresponsibility to endorse the organisation's strategy, develop directionalpolicy, appoint, supervise and remunerate senior executives and to ensure

accountability of the organisation to its owners and authorities.


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Corporate Secretary

The Company Secretary, known as a Corporate Secretary in the US and oftenreferred to as a Chartered Secretary if qualified by the Institute of CharteredSecretaries and Administrators (ICSA), is a high ranking professional who istrained to uphold the highest standards of corporate governance, effectiveoperations, compliance and administration.

All parties to corporate governance have an interest, whether direct or

indirect, in the effective performance of the organization. Directors, workersand management receive salaries, benefits and reputation, whileshareholders receive capital return. Customers receive goods and services;suppliers receive compensation for their goods or services. In return theseindividuals provide value in the form of natural, human, social and otherforms of capital.
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A key factor is an individual's decision to participate in an organization e.g.through providing financial capital and trust that they will receive a fair shareof the organizational returns. If some parties are receiving more than theirfair return then participants may choose to not continue participating leadingto organizational collapse.

Themselves honestly and ethically, especially concerning actual or apparentconflicts of interest, and disclosure in financial reports.

Principles of corporate governance

Commonly accepted principles of corporate governance include:

Rights and equitable treatment of

shareholders: Organizations should respect the rights ofshareholders and help shareholders to exercise those rights. They canhelp shareholders exercise their rights by effectively communicatinginformation that is understandable and accessible and encouragingshareholders to participate in general meetings.

Interests of other stakeholders: Organizations shouldrecognize that they have legal and other obligations to all legitimatestakeholders.

Role and responsibilities of the board:

The board

needs a range of skills and understanding to be able to deal withvarious business issues and have the ability to review and challengemanagement performance. It needs to be of sufficient size and have anappropriate level of commitment to fulfill its responsibilities and duties.There are issues about the appropriate mix of executive and non-executive directors.

Integrity and ethical behaviour: Ethical andresponsible decision making is not only important for public relations,but it is also a necessary element in risk management and avoidinglawsuits. Organizations should develop a code of conduct for their

directors and executives that promotes ethical and responsibledecision making. It is important to understand, though, that reliance bya company on the integrity and ethics of individuals is bound toeventual failure. Because of this, many organizations establishCompliance and Ethics Programs to minimize the risk that the firmsteps outside of ethical and legal boundaries.
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Disclosure and transparency: Organizations shouldclarify and make publicly known the roles and responsibilities of boardand management to provide shareholders with a level ofaccountability. They should also implement procedures toindependently verify and safeguard the integrity of the company's

financial reporting. Disclosure of material matters concerning theorganization should be timely and balanced to ensure that all investorshave access to clear, factual information.

Issues involving corporate governanceprinciples

internal controls and internal auditors the independence of the entity's external auditors and the quality of

their audits


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oversight and management of risk oversight of the preparation of the entity's financial statements review of the compensation arrangements for the chief executive

officer and other senior executives the resources made available to directors in carrying out their duties

the way in which individuals are nominated for positions on the board

dividend policy

Nevertheless "corporate governance," despite some feeble attempts fromvarious quarters, remains an ambiguous and often misunderstood phrase.For quite some time it was confined only to corporate management. That isnot so. It is something much broader, for it must include a fair, efficient andtransparent administration and strive to meet certain well defined, writtenobjectives. Corporate governance must go well beyond law. The quantity,quality and frequency of financial and managerial disclosure, the degree and

extent to which the board of Director (BOD) exercise their trusteeresponsibilities (largely an ethical commitment), and the commitment to runa transparent organization- these should be constantly evolving due tointerplay of many factors and the roles played by the moreprogressive/responsible elements within the corporate sector. John G. Smale,a former member of the General Motors board of directors, wrote: "TheBoard is responsible for the successful perpetuation of the corporation. Thatresponsibility cannot be relegated to management."[6] However it should benoted that a corporation should cease to exist if that is in the best interestsof its stakeholders. Perpetuation for its own sake may be counterproductive.

Mechanisms and controls

Corporate governance mechanisms and controls are designed to reduce theinefficiencies that arise from moral hazard and adverse selection. Forexample, to monitor managers' behaviour, an independent third party (theexternal auditor) attests the accuracy of information provided bymanagement to investors. An ideal control system should regulate bothmotivation and ability.

Internal corporate governance controls

Internal corporate governance controls monitor activities and then takecorrective action to accomplish organizational goals. Examples include:

Monitoring by the board of directors:
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The board of directors, with its legal authority to hire, fire andcompensate top management, safeguards invested capital. Regularboard meetings allow potential problems to be identified, discussedand avoided. Whilst non-executive directors are thought to be moreindependent, they may not always result in more effective corporate

governance and may not increase performance. Different boardstructures are optimal for different firms. Moreover, the ability of theboard to monitor the firm's executives is a function of its access toinformation. Executive directors possess superior knowledge of thedecision-making process and therefore evaluate top management onthe basis of the quality of its decisions that lead to financialperformance outcomes, ex ante. It could be argued, therefore, thatexecutive directors look beyond the financial criteria.

Internal control procedures and internal auditors:Internal control procedures are policies implemented by an entity'sboard of directors, audit committee, management, and other personnelto provide reasonable assurance of the entity achieving its objectivesrelated to reliable financial reporting, operating efficiency, andcompliance with laws and regulations. Internal auditors are personnelwithin an organization who test the design and implementation of theentity's internal control procedures and the reliability of its financialreporting

Balance of power: The simplest balance of power is verycommon; require that the President be a different person from theTreasurer. This application of separation of power is further developed

in companies where separate divisions check and balance each other'sactions. One group may propose company-wide administrativechanges, another group review and can veto the changes, and a thirdgroup check that the interests of people (customers, shareholders,employees) outside the three groups are being met.

Remuneration:Performance-based remuneration is designed torelate some proportion of salary to individual performance. It may be inthe form of cash or non-cash payments such as shares and shareoptions, superannuation or other benefits. Such incentive schemes,however, are reactive in the sense that they provide no mechanism forpreventing mistakes or opportunistic behaviour, and can elicit myopic

behaviour.

External corporate governance controls

External corporate governance controls encompass the controls externalstakeholders exercise over the organisation. Examples include:
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competition debt covenants demand for and assessment of performance information government

regulations managerial labour market

media pressure takeovers

Systemic problems of corporategovernance

Demand for information: In order to influence the directors, theshareholders must combine with others to form a significant votinggroup which can pose a real threat of carrying resolutions orappointing directors at a general meeting.

Monitoring costs: A barrier to shareholders using good information isthe cost of processing it, especially to a small shareholder. Thetraditional answer to this problem is the efficient market hypothesis (infinance, the efficient market hypothesis (EMH) asserts that financialmarkets are efficient), which suggests that the small shareholder willfree ride on the judgments of larger professional investors.

Supply of accounting information: Financial accounts form a crucial linkin enabling providers of finance to monitor directors. Imperfections inthe financial reporting process will cause imperfections in theeffectiveness of corporate governance. This should, ideally, becorrected by the working of the external auditing process.

Role of the accountant and Auditors

Financial reporting is a crucial element necessary for the corporategovernance system to function effectively Accountants and auditors are theprimary providers of information to capital market participants. The directorsof the company should be entitled to expect that management prepare thefinancial information in compliance with statutory and ethical obligations,and rely on auditors' competence.

Current accounting practice allows a degree of choice of method indetermining the method of measurement, criteria for recognition, and eventhe definition of the accounting entity. The exercise of this choice to improveapparent performance (popularly known as creative accounting) imposesextra information costs on users. In the extreme, it can involve non-disclosure of information.
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One area of concern is whether the auditing firm acts as both theindependent auditor and management consultant to the firm they areauditing. This may result in a conflict of interest which places the integrity offinancial reports in doubt due to client pressure to appease management.The power of the corporate client to initiate and terminate management

consulting services and, more fundamentally, to select and dismissaccounting firms contradicts the concept of an independent auditor. Changesenacted in the United States in the form of the Sarbanes-Oxley Act (inresponse to the Enron situation as noted below) prohibit accounting firmsfrom providing both auditing and management consulting services. Similarprovisions are in place under clause 49 ofSEBI Act in India.

The Enron collapse is an example of misleading financial reporting. Enronconcealed huge losses by creating illusions that a third party wascontractually obliged to pay the amount of any losses. However, the thirdparty was an entity in which Enron had a substantial economic stake. In

discussions of accounting practices with Arthur Andersen, the partner incharge of auditing, views inevitably led to the client prevailing.

However, good financial reporting is not a sufficient condition for theeffectiveness of corporate governance if users don't process it, or if theinformed user is unable to exercise a monitoring role due to high costs
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Process of Auditing


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Rules versus principles


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Rules are typically thought to be simpler to follow than principles,demarcating a clear line between acceptable and unacceptable behavior.Rules also reduce discretion on the part of individual managers or auditors.

In practice rules can be more complex than principles. They may be ill-

equipped to deal with new types of transactions not covered by the code.Moreover, even if clear rules are followed, one can still find a way tocircumvent their underlying purpose - this is harder to achieve if one isbound by a broader principle.

Principles on the other hand are a form of self regulation. It allows the sectorto determine what standards are acceptable or unacceptable. It also pre-empts overzealous legislations that might not be practical.

Corporate governance models around the

worldAlthough the US model of corporate governance is the most notorious, thereis a considerable variation in corporate governance models around the world.The intricate shareholding structures ofkeiretsus in Japan, the heavypresence of banks in the equity of German firms, the chaebols in SouthKorea and many others are examples of arrangements which try to respondto the same corporate governance challenges as in the US.

In the United States, the main problem is the conflict of interest betweenwidely-dispersed shareholders and powerful managers. In Europe, the main

problem is that the voting ownership is tightly-held by families throughpyramidal ownership and dual shares (voting and nonvoting). This can leadto "self-dealing", where the controlling families favor subsidiaries for whichthey have higher cash flow rights.

Anglo-American Model

There are many different models of corporate governance around the world.These differ according to the variety of capitalism in which they areembedded. The liberal model that is common in Anglo-American countriestends to give priority to the interests of shareholders. The coordinated model

that one finds in Continental Europe and Japan also recognizes the interestsof workers, managers, suppliers, customers, and the community. Each modelhas its own distinct competitive advantage. The liberal model of corporategovernance encourages radical innovation and cost competition, whereasthe coordinated model of corporate governance facilitates incrementalinnovation and quality competition. However, there are important differencesbetween the U.S. recent approach to governance issues and what hashappened in the UK. In the United States, a corporation is governed by a
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board of directors, which has the power to choose an executive officer,usually known as the chief executive officer. The CEO has broad power tomanage the corporation on a daily basis, but needs to get board approval forcertain major actions, such as hiring his/her immediate subordinates, raisingmoney, acquiring another company, major capital expansions, or other

expensive projects. Other duties of the board may include policy setting,decision making, monitoring management's performance, or corporatecontrol.

The board of directors is nominally selected by and responsible to theshareholders, but the bylaws of many companies make it difficult for all butthe largest shareholders to have any influence over the makeup of theboard; normally, individual shareholders are not offered a choice of boardnominees among which to choose, but are merely asked to rubberstamp thenominees of the sitting board. Perverse incentives have pervaded manycorporate boards in the developed world, with board members beholden to

the chief executive whose actions they are intended to oversee. Frequently,members of the boards of directors are CEOs of other corporations, which

some see as a conflict of interest.
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Codes and guidelines

Corporate governance principles and codes have been developed in differentcountries and issued from stock exchanges, corporations, institutionalinvestors, or associations (institutes) of directors and managers with the

support of governments and international organizations. As a rule,compliance with these governance recommendations is not mandated bylaw, although the codes linked to stock exchange listing requirements mayhave a coercive effect.

For example, companies quoted on the London and Toronto Stock Exchangesformally need not follow the recommendations of their respective nationalcodes. However, they must disclose whether they follow therecommendations in those documents and, where not, they should provideexplanations concerning divergent practices. Such disclosure requirementsexert a significant pressure on listed companies for compliance.

In the United States, companies are primarily regulated by the state in whichthey incorporate though they are also regulated by the federal governmentand, if they are public, by their stock exchange. The highest numbers ofcompanies are incorporated in Delaware, including more than half of theFortune 500. This is due to Delaware's generally business-friendly corporatelegal environment and the existence of a state court dedicated solely tobusiness issues Most states' corporate law generally follow the American BarAssociation's Model Business Corporation Act. While Delaware does notfollow the Act, it still considers its provisions and several prominent Delawarejustices, including former Delaware Supreme Court Chief Justice E. NormanVeasey, participate on ABA committees.

One issue that has been raised since the Disney decision n 2005 is thedegree to which companies manage their governance responsibilities; inother words, do they merely try to supersede the legal threshold, or shouldthey create governance guidelines that ascend to the level of best practice.For example, the guidelines issued by associations of directors (see Section 3above), corporate managers and individual companies tend to be whollyvoluntary. For example, The GM Board Guidelines reflect the companysefforts to improve its own governance capacity. Such documents, however,may have a wider multiplying effect prompting other companies to adoptsimilar documents and standards of best practice.

One of the most influential guidelines has been the 1999 OECD Principles ofCorporate Governance. This was revised in 2004. The OECD remains aproponent of corporate governance principles throughout the world.
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Building on the work of the OECD, other international organizations, privatesector associations and more than 20 national corporate governance codes,the United NationsIntergovernmental Working Group of Experts onInternational Standards of Accounting and Reporting (ISAR) has producedvoluntary Guidance on Good Practices in Corporate Governance Disclosure.

This internationally agreed benchmark consists of more than fifty distinctdisclosure items across five broad categories auditing

Board and management structure and process Corporate responsibility and compliance Financial transparency and information disclosure Ownership structure and exercise of control rights

The World Business Council for Sustainable Development WBCSD has donework on corporate governance, particularly on accountability and reporting,and in 2004 created frameworks. This document aims to provide general

information, a "snap-shot" of the landscape and a perspective from a think-tank/professional association on a few key codes, standards and frameworksrelevant to the sustainability agenda.

Ownership structures

Ownership structures refer to the various patterns in which shareholdersseem to set up with respect to a certain group of firms. It is a tool frequentlyemployed by policy-makers and researchers in their analyses of corporategovernance within a country or business group. And ownership can bechanged by the stakeholders of the company.

Generally, ownership structures are identified by using some observablemeasures of ownership concentration (i.e. concentration ratios) and thenmaking a sketch showing its visual representation. The idea behind theconcept of ownership structures is to be able to understand the way in whichshareholders interact with firms and, whenever possible, to locate theultimate owner of a particular group of firms. Some examples of ownershipstructures include pyramids, cross-share holdings, rings, and webs.
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Benefits of good corporate governance

Imperative for the establishment of a competitive market.

Good and proper corporate governance is considered imperative forthe establishment of a competitive market. There is empirical evidenceto suggest that countries that have implemented good corporategovernance measures have generally experienced robust growth ofcorporate sector and higher ability to attract capital.

Sound corporate governance practices have become critical toworldwide efforts to stabiles and strengthen good capital markets and

protect investors. Companies with better corporate governance have higher per book

ratios ,demonstrating that investor do indeed reward goodgovernance


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Corporate governance enables corporations to realize their corporateobjectives, protect shareholder rights.

Corporate Governance in UK

History

The Cadbury Committee

Set up by The Financial Reporting Council (FRC), The London Stock exchange and

Accountability profession,

Objective To help raise the standards of corporateGovernance and the level of confidenceIn financial reporting and auditing by settingOut clearly the respective responsibilitiesOf those involved and what was expected of them

Publication A Code of Best Practice (1992) was designed toArchive the necessary high slandered of corporateBehavior

Recommended

It is desirable to separate the role of chiefexecutive and chairman

The board should include sufficient non-executive directors (NEDs) fir their views tocarry significant weight

An audit committee should be appointed toreview the financial statement before theirsubmission to the full board

A remuneration committee consisting whollyor meanly of Neds should set theremuneration of executive directors.

The imposition of a three- year maximumterm on executive directors services

contracts.

Outcome the stock Exchange required all listedcompanies

To state whether or not they had compliedWith the code and to give reasonsFor any areas if non-compliance. it also

required


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The companys statements of compliance tobe

Reviewed by the auditors before publication.

The Green bury Report

Set up by? The CBI in 1995

Objective To draw up guidelines on directors remuneration, whichwas perceived to be excessive and did not seem to belinked to the companys performance.

Publicatio

n

A Code of best practice I determining and accountingfort directors, remuneration.

Outcome All listed companies registered in the UK were requiredto comply with the code. Their annual reports had toinclude a statement about their directorsremuneration. Any areas of non-compliance had to beexplained and justified

The Hamepl Report

Issued January 1998

Objective To restrict the regulatory burden facing companies andsubstitute board principles (rather than detailedregulations) were practicable.

Summary A board must not approach the various corporategovernance requirements in a compliance mentality: theso- called tick-box approach. Good corporategovernance is not achieved by satisfying a checklist.Directors must comply with substance as well as theletter of all best practice pronouncements.

Outcome After publishing its report, the Hampel committee drewup a single combined code if best practice , incorporatingthe Cadbury, greenbury and hampel recommendation


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The 1998 Combined Code

Objective

To combine the accepted principles and best practice guideline

of Cadbury, greenbury and Hampel into a single code.

Outcome

The stock exchange listing Rules require a listed company inthe UK to include the following in its annual report andaccounts:

A narrative statement of how it has applied theprinciples set out in the Combined Code, providingexplanation which enables its shareholders to evaluatehow the principles have been applied.

A statement as to whether or not it has compliedthroughout the accounting period with the combinedcode provisions. If it has not complied , it must specifythe provisions with which it has not complied , and givereasons for any non-compliance

This approach to compliance is known as comply or explain

The turnbull Report

Issued In 1999 by the ICAEW

Objective

To give additional guidance to listed companies on how toimplement the provisions of the combined code dealing withthe internal control.


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Summery

The board should look forward and not just considerpast performance.

Companies should keep their shareholders informedabout risks.

Director should be aware that the company mustcontinually adapt to its changing environment.

Outcome

The turnbull guidance is appended to the 2003 combinedcode

The Higgs Report

Issued 2003

Objective

To develop guidelines for making NEDs more effective.

Outcome

Most of the reports recommendations were either writteninto the 2003 combined code or include in the best practice

guidelines that are appended to it.

The Smith Report

Issued 2003

Objective

To give guidelines to company board in making suitablearrangements for their audit committees and to assistdirectors saving on audit committees in carrying out theirrole.

Outcome

The reports recommendations are appended to the 2003combined code


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The role of the NEDs

At the time of the Cadbury Reports, there was a history in the UK if public

companies being dominated by an all-powerful chief-Executive/chairman. In additional, NEDs, where they existed at all, wereoften heavily outnumbered by executive directors.

The Cadbury Reports recommended the separation of the roles of chiefexecutive and chairman, although it did not state that the same person couldnever be both. The role of the chief executive is to take charge of theexecutive management and the companys business operations; the role ofthe chairman is to manage the board of directors.

Cadbury recommendation that there should be sufficient independent NEDs

for their view to carry sufficient weight. As their independence might be putat risk if they had to rely on the chairman or chief executive for theirappointment , Cadbury recommendation that initial interviews should beconducted through a nomination committee.

The role if the NEDs are to bring judgment and experience to the board thatthe executive directors might lack. In contrast to the executive directors,NEDs do not usually have a full-time relationship with the company. They arenot employees and only receive directors, fees. They are expected to extra ameasure of control over the executive directors to ensure that they run thecompany in the companys best interests (rather than their own). They

should scrutinize the performance of management in the meeting agreedgoals and the objectives and monitor the reporting of performance.

They are also responsible for determining appropriate levels of remunerationof the executive directors.

Note they as company law is concerned. There is no distinction betweenexecutive directors and NEDs. Both are subject to the same controls andliabilities.

The need for corporate governance

During the late 1980s a number of large UK public companies failed someof them as a result of large-scale fraud by their directors.


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composition can be managed without undue disruption.To ensure that power and information are not concentrated in one or twoindividuals, there should be a strong presence on the board of bothexecutive and non-executive directors.The value of ensuring that committee membership is refreshed and that

undue reliance is not placed on particular individuals should be taken intoaccount in deciding chairmanship and membership of committees.No one other than the committee chairman and members is entitled to bepresent at a meeting of the nomination, audit or remuneration committee,but others may attend at the invitation of the committee.

Appointments to the BoardThere should be a formal, rigorous and transparent procedure forthe appointment of new directors to the board.Appointments to the board should be made on merit and against objectivecriteria. Care should be taken to ensure that appointees have enoughtime available to devote to the job. This is particularly important in the

case of chairmanships.The board should satisfy itself that plans are in place for orderlysuccession for appointments to the board and to senior management, soas to maintain an appropriate balance of skills and experience within thecompany and on the board.

Information and professional developmentThe board should be supplied in a timely manner with information ina form and of a quality appropriate to enable it to discharge itsduties. All directors should receive induction on joining the boardand should regularly update and refresh their skills and knowledge.

The chairman is responsible for ensuring that the directors receiveaccurate, timely and clear information. Management has an obligation toprovide such information but directors should seek clarification oramplification where necessary.The chairman should ensure that the directors continually update theirskills and the knowledge and familiarity with the company required to fulfiltheir role both on the board and on board committees. The companyshould provide the necessary resources for developing and updating itsdirectors knowledge and capabilities.Under the direction of the chairman, the company secretarysresponsibilities include ensuring good information flows within the board

and its committees and between senior management and non-executivedirectors, as well as facilitating induction and assisting with professionaldevelopment as required.The company secretary should be responsible for advising the boardthrough the chairman on all governance matters.

Performance evaluationThe board should undertake a formal and rigorous annual evaluation


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of its own performance and that of its committees and individualdirectors.Individual evaluation should aim to show whether each director continuesto contribute effectively and to demonstrate commitment to the role(including commitment of time for board and committee meetings and any

other duties). The chairman should act on the results of the performanceevaluation by recognising the strengths and addressing the weaknessesof the board and, where appropriate, proposing new members beappointed to the board or seeking the resignation of directors.

Re-electionAll directors should be submitted for re-election at regular intervals,subject to continued satisfactory performance. The board shouldensure planned and progressive refreshing of the board.All directors should be subject to election by shareholders at the firstannual general meeting after their appointment, and to re-electionthereafter at intervals of no more than three years. The names of

directors submitted for election or re-election should be accompanied bysufficient biographical details and any other relevant information to enableshareholders to take an informed decision on their election.

REMUNERATION

Levels of remuneration should be sufficient to attract, retain andmotivate directors of the quality required to run the companysuccessfully, but a company should avoid paying more than isnecessary for this purpose. A significant proportion of executivedirectors remuneration should be structured so as to link rewards to

corporate and individual performance.The remuneration committee should judge where to position theircompany relative to other companies. But they should use suchcomparisons with caution, in view of the risk of an upward ratchet ofremuneration levels with no corresponding improvement in performance.They should also be sensitive to pay and employment conditionselsewhere in the group, especially when determining annual salaryincreases.

ACCOUNTABILITY AND AUDIT

The board should present a balanced and understandable

assessment of the companys position and prospects.The boards responsibility to present a balanced and understandableassessment extends to interim and other price-sensitive public reportsand reports to regulators as well as to information required to bepresented by statutory requirements.The directors should explain in the annual report their responsibility forpreparing the accounts and there should be a statement by the auditorsabout their reporting responsibilities.


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The directors should report that the business is a going concern, withsupporting assumptions or qualifications as necessary.

Internal ControlThe board should maintain a sound system of internal control tosafeguard shareholders investment and the companys assets.

The board should, at least annually, conduct a review of the effectivenessof the groups system of internal controls and should report toshareholders that they have done so. The review should cover allmaterial controls, including financial, operational and compliance controlsand risk management systems.

Audit Committee and AuditorsThe board should establish formal and transparent arrangements forconsidering how they should apply the financial reporting andinternal control principles and for maintaining an appropriaterelationship with the companys auditors.

The board should establish an audit committee of at least three, or in thecase of smaller companies18 two, members, who should all beindependent non-executive directors. The board should satisfy itself thatat least one member of the audit committee has recent and relevantfinancial experience.The main role and responsibilities of the audit committee should be set outin written terms of reference and should include:

_to monitor the integrity of the financial statements of the company,and any formal announcements relating to the companys financialperformance, reviewing significant financial reporting judgementscontained in them;

_to review the companys internal financial controls and, unlessexpressly addressed by a separate board risk committee composedof independent directors, or by the board itself, to review thecompanys internal control and risk management systems;

_to monitor and review the effectiveness of the companys internalaudit function;

_to make recommendations to the board, for it to put to theshareholders for their approval in general meeting, in relation to theappointment, re-appointment and removal of the external auditorand to approve the remuneration and terms of engagement of theexternal auditor;

_to review and monitor the external auditors independence andobjectivity and the effectiveness of the audit process, taking intoconsideration relevant UK professional and regulatory requirements;

_to develop and implement policy on the engagement of the externalauditor to supply non-audit services, taking into account relevantethical guidance regarding the provision of non-audit services by theexternal audit firm; and to report to the board, identifying any

RELATIONS WITH SHAREHOLDERS


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There should be a dialogue with shareholders based on the mutualunderstanding of objectives. The board as a whole hasresponsibility for ensuring that a satisfactory dialogue withshareholders takes place.20Whilst recognising that most shareholder contact is with the chief

executive and finance director, the chairman (and the senior independentdirector and other directors as appropriate) should maintain sufficientcontact with major shareholders to understand their issues and concerns.The board should keep in touch with shareholder opinion in whateverways are most practical and efficient.

Constructive Use of the AGMThe board should use the AGM to communicate with investors andto encourage their participation.The company should count all proxy votes and, except where a poll iscalled, should indicate the level of proxies lodged on each resolution, andthe balance for and against the resolution and the number of abstentions,

after it has been dealt with on a show of hands. The company shouldensure that votes cast are properly received and recorded.The company should propose a separate resolution at the AGM on eachsubstantially separate issue and should in particular propose a resolutionat the AGM relating to the report and accounts.The chairman should arrange for the chairmen of the audit, remunerationand nomination committees to be available to answer questions at theAGM and for all directors to attend.The company should arrange for the Notice of the AGM and relatedpapers to be sent to shareholders at least 20 working days before themeeting.


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INSTITUTIONAL SHAREHOLDERS

Institutional shareholders should enter into a dialogue withcompanies based on the mutual understanding of objectives.


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Institutional shareholders should apply the principles set out in theInstitutional Shareholders Committees The Responsibilities ofInstitutional Shareholders and Agents Statement of Principles22, whichshould be reflected in fund manager contracts.E.3 Shareholder Voting

Institutional shareholders have a responsibility to make considereduse of their votes.Institutional shareholders should take steps to ensure their votingintentions are being translated into practice.Institutional shareholders should, on request, make available to theirclients information on the proportion of resolutions on which votes werecast and non-discretionary proxies lodged.Major shareholders should attend AGMs where appropriate andpracticable. Companies and registrars should facilitate this.

Roles of Different Committees and

Persons AUDIT COMMITTEES

1.1. This guidance is designed to assist company boards in making suitablearrangements for their audit committees, and to assist directors serving onaudit committees in carrying out their role.1.2. The paragraphs in bold are taken from the Combined Code (Section C3).Listed companies that do not comply with those provisions should includean explanation as to why they have not complied in the statement required

by the Listing Rules.1.3. Best practice requires that every board should consider in detail whatarrangements for its audit committee are best suited for its particularcircumstances. Audit committee arrangements need to be proportionateto the task, and will vary according to the size, complexity and risk profileof the company.1.4. While all directors have a duty to act in the interests of the company theaudit committee has a particular role, acting independently from theexecutive, to ensure that the interests of shareholders are properlyprotected in relation to financial reporting and internal control.1.5. Nothing in the guidance should be interpreted as a departure from the

principle of the unitary board. All directors remain equally responsible forthe companys affairs as a matter of law. The audit committee, like othercommittees to which particular responsibilities are delegated (such as theremuneration committee), remains a committee of the board. Anydisagreement within the board, including disagreement between the auditcommittees members and the rest of the board, should be resolved atboard level.1.6. The Code provides that a separate section of the annual report should


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describe the work of the committee. This deliberately puts the spotlight onthe audit committee and gives it an authority that it might otherwise lack.This is not incompatible with the principle of the unitary board.1.7. The guidance contains recommendations about the conduct of the auditcommittees relationship with the board, with the executive management

and with internal and external auditors. However, the most importantfeatures of this relationship cannot be drafted as guidance or put into acode of practice: a frank, open working relationship and a high level ofmutual respect are essential, particularly between the audit committeechairman and the board chairman, the chief executive and the financedirector. The audit committee must be prepared to take a robust stand,and all parties must be prepared to make information freely available toJuly 2003 The Smith Guidance45

the audit committee, to listen to their views and to talk through the issuesopenly.

1.8. In particular, the management is under an obligation to ensure the auditcommittee is kept properly informed, and should take the initiative insupplying information rather than waiting to be asked. The board shouldmake it clear to all directors and staff that they must cooperate with theaudit committee and provide it with any information it requires. In addition,executive board members will have regard to their common law duty toprovide all directors, including those on the audit committee, with all theinformation they need to discharge their responsibilities as directors of thecompany.1.9. Many of the core functions of audit committees set out in this guidanceare

expressed in terms of oversight, assessment and review of a particularfunction. It is not the duty of audit committees to carry out functions thatproperly belong to others, such as the companys management in thepreparation of the financial statements or the auditors in the planning orconducting of audits. To do so could undermine the responsibility ofmanagement and auditors. Audit committees should, for example, satisfythemselves that there is a proper system and allocation of responsibilitiesfor the day-to-day monitoring of financial controls but they should not seekto do the monitoring themselves.1.10. However, the high-level oversight function may lead to detailed work.The

audit committee must intervene if there are signs that something may beseriously amiss. For example, if the audit committee is uneasy about theexplanations of management and auditors about a particular financialreporting policy decision, there may be no alternative but to grapple withthe detail and perhaps to seek independent advice.1.11. Under this guidance, audit committees have wide-ranging,timeconsumingand sometimes intensive work to do. Companies need to


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make the necessary resources available. This includes suitable paymentfor the members of audit committees themselves. They and particularlythe audit committee chairman - bear a significant responsibility and theyneed to commit a significant extra amount of time to the job. Companiesalso need to make provision for induction and training for new audit

committee members and continuing training as may be required.1.12. This guidance applies to all companies to which the Code applies i.e.UK listed companies. For groups, it will usually be necessary for the auditcommittee of the parent company to review issues that relate to particularsubsidiaries or activities carried on by the group. Consequently, the boardof a UK-listed parent company should ensure that there is adequatecooperation within the group (and with internal and external auditors ofindividual companies within the group) to enable the parent companyaudit committee to discharge its responsibilities effectively.

ROLE OF THE CHAIRMAN

The chairman is pivotal in creating the conditions for overall board andindividualdirector effectiveness, both inside and outside the boardroom. Specifically, itisthe responsibility of the chairman to:

_run the board and set its agenda. The agenda should take fullaccount of the issues and the concerns of all board members.Agendas should be forward looking and concentrate on strategicmatters rather than formulaic approvals of proposals which can bethe subject of appropriate delegated powers to management;

_ensure that the members of the board receive accurate, timely and

clear information, in particular about the company's performance, toenable the board to take sound decisions, monitor effectively andprovide advice to promote the success of the company;

_ensure effective communication with shareholders and ensure thatthe members of the board develop an understanding of the views ofthe major investors;

_manage the board to ensure that sufficient time is allowed fordiscussion of complex or contentious issues, where appropriatearranging for informal meetings beforehand to enable thoroughpreparation for the board discussion. It is particularly important thatnon-executive directors have sufficient time to consider critical

issues and are not faced with unrealistic deadlines for decisionmaking;_take the lead in providing a properly constructed inductionprogramme for new directors that is comprehensive, formal andtailored, facilitated by the company secretary;

_take the lead in identifying and meeting the development needs ofindividual directors, with the company secretary having a key role infacilitating provision. It is the responsibility of the chairman toaddress the development needs of the board as a whole with a view


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to enhancing its overall effectiveness as a team;_ensure that the performance of individuals and of the board as awhole and its committees is evaluated at least once a year; and

_encourage active engagement by all the members of the board.

ROLE OF THE NON-EXECUTIVE DIRECTORAs members of the unitary board, all directors are required to:

_Provide entrepreneurial leadership of the company within aframework of prudent and effective controls which enable risk to beassessed and managed;

_Set the companys strategic aims, ensure that the necessaryfinancial and human resources are in place for the company to meetits objectives, and review management performance; and

_Set the companys values and standards and ensure that itsobligations to its shareholders and others are understood and met.In addition to these requirements for all directors, the role of the non-

executivedirector has the following key elements:

_Strategy. Non-executive directors should constructively challengeand help develop proposals on strategy.

_Performance. Non-executive directors should scrutinise theperformance of management in meeting agreed goals andobjectives and monitor the reporting of performance.

_Risk. Non-executive directors should satisfy themselves on theintegrity of financial information and that financial controls andsystems of risk management are robust and defensible.

_People. Non-executive directors are responsible for determining

appropriate levels of remuneration of executive directors, and havea prime role in appointing, and where necessary removing,executive directors and in succession planning.Non-executive directors should constantly seek to establish and maintainconfidence in the conduct of the company. They should be independent injudgement and have an enquiring mind. To be effective, non-executivedirectorsneed to build a recognition by executives of their contribution in order topromoteopenness and trust.To be effective, non-executive directors need to be well-informed about the

company and the external environment in which it operates, with a strongcommand of issues relevant to the business. A non-executive director shouldinsist on a comprehensive, formal and tailored induction. An effectiveinductionneed not be restricted to the boardroom, so consideration should be given tovisiting sites and meeting senior and middle management. Once in post, aneffective non-executive director should seek continually to develop andrefresh


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their knowledge and skills to ensure that their contribution to the boardremainsinformed and relevant.Best practice dictates that an effective non-executive director will ensurethat

information is provided sufficiently in advance of meetings to enablethoroughconsideration of the issues facing the board. The non-executive should insistthat information is sufficient, accurate, clear and timely.An element of the role of the non-executive director is to understand theviewsof major investors both directly and through the chairman and the seniorindependent director.

REMUNERATION COMMITTEEThe Code provides that the remuneration committee should consist

exclusivelyof independent non-executive directors and should comprise at least threeor, inthe case of smaller companies1, two such directors.The committee should:_determine and agree with the board the framework or broad policyfor the remuneration of the chief executive, the chairman of thecompany and such other members of the executive management asit is designated to consider2. At a minimum, the committee shouldhave delegated responsibility for setting remuneration for allexecutive directors, the chairman and, to maintain and assure their

independence, the company secretary. The remuneration of nonexecutivedirectors shall be a matter for the chairman and executivemembers of the board. No director or manager should be involvedin any decisions as to their own remuneration;

_determine targets for any performance-related pay schemesoperated by the company;

_determine the policy for and scope of pension arrangements foreach executive director;

_ensure that contractual terms on termination, and any paymentsmade, are fair to the individual and the company, that failure is notrewarded and that the duty to mitigate loss is fully recognised3;

_within the terms of the agreed policy, determine the total individualremuneration package of each executive director including, whereappropriate, bonuses, incentive payments and share options;

_in determining such packages and arrangements, give due regard tothe contents of the Code as well as the UK Listing Authoritys ListingRules and associated guidance;

_be aware of and advise on any major changes in employee benefitstructures throughout the company or group;


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_agree the policy for authorising claims for expenses from the chiefexecutive and chairman;

_ensure that provisions regarding disclosure of remuneration,including pensions, as set out in the Directors Remuneration ReportRegulations 2002 and the Code, are fulfilled;

_be exclusively responsible for establishing the selection criteria,selecting, appointing and setting the terms of reference for anyremuneration consultants who advise the committee;

_report the frequency of, and attendance by members at,remuneration committee meetings in the annual reports; and

_make available the committees terms of reference. These shouldset out the committees delegated responsibilities and be reviewedand, where necessary, updated annually.This guidance has been compiled with the assistance of ICSA who havekindly agreed to produce updated guidance on their website www.icsa.org.ukin the future.

NOMINATION COMMITTEEThere should be a nomination committee which should lead the process forboard appointments and make recommendations to the board.A majority of members of the committee should be independent non-executivedirectors. The chairman or an independent non-executive director shouldchairthe committee, but the chairman should not chair the nomination committeewhen it is dealing with the appointment of a successor to the chairmanship.The committee should:_be responsible for identifying and nominating for the approval of theboard, candidates to fill board vacancies as and when they arise;

_before making an appointment, evaluate the balance of skills,knowledge and experience on the board and, in the light of thisevaluation, prepare a description of the role and capabilities requiredfor a particular appointment;

_review annually the time required from a non-executive director.Performance evaluation should be used to assess whether the nonexecutivedirector is spending enough time to fulfil their duties;

_consider candidates from a wide range of backgrounds and lookbeyond the usual suspects;

_give full consideration to succession planning in the course of itswork, taking into account the challenges and opportunities facing thecompany and what skills and expertise are therefore needed on theboard in the future;

_regularly review the structure, size and composition (including theskills, knowledge and experience) of the board and makerecommendations to the board with regard to any changes;

_keep under review the leadership needs of the organisation, both


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executive and non-executive, with a view to ensuring the continuedability of the organisation to compete effectively in the marketplace;

_make a statement in the annual report about its activities; theprocess used for appointments and explain if external advice oropen advertising has not been used; the membership of the

committee, number of committee meetings and attendance over thecourse of the year;_make available its terms of reference explaining clearly its role andthe authority delegated to it by the board; and

_ensure that on appointment to the board, non-executive directorsreceive a formal letter of appointment setting out clearly what isexpected of them in terms of time commitment, committee serviceand involvement outside board meetings.The committee should make recommendations to the board:_as regards plans for succession for both executive and nonexecutivedirectors;

_as regards the re-appointment of any non-executive director at theconclusion of their specified term of office;

_concerning the re-election by shareholders of any director under theretirement by rotation provisions in the companys articles ofassociation;

_concerning any matters relating to the continuation in office of anydirector at any time; and

_concerning the appointment of any director to executive or otheroffice other than to the positions of chairman and chief executive,the recommendation for which would be considered at a meeting ofthe board.

This guidance has been compiled with the assistance of ICSA who havekindly agreed to produce updated guidance on their website www.icsa.org.ukin the future.


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DevelopmentsSince Pakistan gained independence in 1947, the Republic has beenunder military rule for 50 percent of the time. The current governmentis headed by a military regime that came into power on 12 Oct 1999. TheConstitution was promulgated in 1973 and includes articles covering theAnnual Budget, Federal Consolidated Fund and the appointment andduties of the Auditor-General.In 1951 the Institute of Cost and Management Accountants wasformed and legally established in 19

law report12 on corporate governance

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