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Total Number of Subscribers: 467 |
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Date:3rd January 2008 |
Compiled by Mr. M. Sathya Kumar |
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Corporate
Governance — What is wrong with it Change, business leaders are fond of exhorting their employees,
is a constant. Within business organisations, owners and CEO’s are fond of continuously changing the structure of the
organisation, its reporting responsibilities, its compensation practices and
its business strategy. However, when it comes to their own existence, all
three participants in the world of corporate governance (shareholders,
directors and senior management) have withstood any change. They ensure that
the relationships between each of them and the basic structure of those
relationships have remained unchanged since the first corporation came into
existence. During this period of fossilisation, they have been ably supported
by business academicians in remaining in that state. The first modern corporation established 500 years ago was the
East India Company. No Companies Act existed in those days and any corporate
entity could come into existence only by obtaining a Charter from the King.
Charles II issued a Charter imbuing life into the East India Company. This
company became the first juridicial person, ever. The Charter contained those
provisions that today one finds in a memorandum and articles of association
and in the Companies Act. It required that the shareholders of the company
annually hold a general meeting. The general meeting would elect the Board of
Governors (Directors) and also the head of that Board (Chairman and CEO). The
Governor and the Board of Governors were responsible for overseeing the
management of the company’s business. Each shareholder
had a voting right proportionate to his share-holding. Detailed bylaws would
be prepared and those would have to be approved in a general meeting. In the
century that followed the setting up of the East Indian Company similar
Charters were proclaimed for companies that traded with Russia, the Levant
and Canada (Hudson Bay Co.). The last named still exists and is the oldest
extant corporation in the world. The Dutch also set up corporations. As the
readers will observe, the fundamental principles of Corporate Governance laid
down 500 years ago remain unchanged today. These are that shareholders ‘own’ a company, managements manage the business on their behalf and
directors provide management oversight as agents of the share-holders. The basis for this form of democracy in corporations goes back
to far earlier times. After all, democracy is a word associated more with the
governance of nations than with the governance of companies. The oldest known
form of democracy was the Greek city states. However, that form of democracy
died with the decline of those city states and for over a thousand years
after that the world had no form of democracy. Democracy returned (to
Britain) in the 11th century A.D. The Anglo-Saxons and the Normans had grand
councils that advised the ruler. However, this was not of lasting nature and
it was only after the signing of the Magna Carta by King John that kings in
the U.K. were deprived of divine and absolute rights over their subjects. The
Magna Carta resulted in the establishment of the first Parliament in 1265. In
the next 500 years this evolved but in essence Parliament represented the
landed class. While there were seats reserved for the clergy, essentially,
the members of Parliament were those who gave taxes and soldiers to the King.
These happened to be landlords because in those years land revenue was the
only source of taxation and land owners had powers over their serfs; they
used these powers to send serfs to the king’s army
when he had to fight his wars. The grant of the right to participate in democracy depended upon
whether an individual contributed to the State. Those who made no
contribution had no say in Parliament. Vast sections of the population were
deprived, whereas the landed classes became very powerful. The 18th century
saw a change in this thinking. French thinkers such as Voltaire influenced
the public thinking that eventually led to a revolution and the end of
monarchy in France. However, the Parliament that was established after the
French Revolution still did not provide for universal adult franchise. The
true founders of a democracy based on adult franchise were the founding
fathers of the United States of America. They propounded, for the first time,
the concept that every human being who is affected by the behaviour of a
State should have a say in the election of its Parliament. There was
considerable debate upon how it would be possible to provide for voting by
millions of Americans spread right across the country, many of whom had no
concept of democratic participation. However, the founding fathers
persevered. Eventually, this belief spread across the world and all countries
today equate democracy with universal adult franchise. It would be
preposterous to even suggest that a person’s right to
vote should depend upon whether he paid taxes to the State or
contributed to it in some other fashion. Every person who is affected by the
conduct of the Government is considered to have the right to vote in the
elections for its Legislature. When the scheme of corporate governance for the East India
Company was conceived of, public thinking was limited by the democratic model
then prevailing in the British Parliament. Only three participants were
identified — management, directors and
shareholders. In those times, there was no scarcity of land or of labour; of the
three economic factors, only capital was in short supply. Consequently, the
providers of capital, the shareholders, were granted the right to elect the
Board of Directors and approve their corporation’s regulations. The contributions made by other factors of
production were wholly ignored. At that time, wealth was tangible. It
consisted of classical assets such as land, precious stones and metals. All
tangible assets were tradable for money and their ownership could change
hands freely. Consequently, he who had money would acquire wealth. Without
money, the acquisition of wealth was not possible. Indeed, capital was the
only factor of production that had mobility. Today, wealth lies not in
tangible assets but in intangibles such as ideas, technology, new ways of
doing business, intellectual property and other such intangibles. These are
created not through vast outlays of money, but through having outstanding
individuals in an enabling environment. In many companies now, tangible
assets are amongst the smallest items in their value. Since the setting up of the East India Company through the
Industrial Revolution and until the mid-20th century, business was mainly
concerned with the rudimentary conversion of natural resources to meet basic
human needs. Today, business comprises of the sophisticated networking of
large numbers of stakeholders. However, the world of governance is yet to comprehend these
changes. The guru of American-style governance, Milton Friedman, has
propounded the capitalist view that management and directors should never be
motivated by any consideration other than profit maximisation. Relationships
with vendors, customers and employee are only transactional, governed by
contracts. Those with the government and the public are legal, governed by
the laws. Friedman believed that conscience should not motivate companies — only maximising shareholder value within the confines of laws
should. It is such thinking that has resulted in the nasty outcomes less
than ten years ago in major U.S. companies (the Enron years) followed shortly
after by the collapse of Wall Street. These events have shaken confidence in
a model driven by Friedmanian greed. Worse, global companies have changed
public behaviour — greed has engendered hedonism. And hedonism
(combined with unchecked population growth in India) is the cause of climate
change. Not only has the old form of governance resulted in losses of
trillions of dollars, it has created a threat to the very existence of the
natural world. It is time this changed. If the concept underlying democracy in a public sphere can also
be applied to corporate democracy, it will require that anybody who is
affected by the conduct of a corporation should have a say in electing its
governors. In other words, all stakeholders in business should influence its
governance, not only its shareholders and management. This would require a
fundamental shift in thinking. The nature of reporting by directors and
management (stewards), the holding of meetings, the provisions of memoranda
and articles of association, the nature of resolutions requiring stakeholder
approval and many other governance issues would need to be changed. So too,
would be the change in the nature of the audit of stewardship reporting.
Indeed, finance would be only one of the disciplines required of auditors.
The first rudiments of such change are already visible in the Global
Reporting Initiative. GRI reports bring out information classified by
different stakeholders, but they are still attuned towards segmenting the
information stakeholder-wise for use by shareholders. If stake- holders are
to have a say in governance, such reporting would not be different. It is unlikely that such a tectonic change will occur in the
near future. It needs to overcome powerful vested interests including the
entire world of the capital markets. But, until that happens, many of the
major aberrations of corporate behaviour are unlikely to be controlled. Article
by Mr. Nawshir Mirza, Chartered Accountant |
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