Corporate Governance by HariharSwami


									                                                 FACULTY OF BUSINESS
                                 Master of Business Administration
Student Name: Harihar Swami                                                       Student ID: 0955066

Paper Name: Corporate Governance & Responsibility                                 Paper No. 478912

Assessment: Assignment 2

Date: 27/07/2010                                                                  Word Count: 1489

Lecturer Name: Dr. Coral Ingley

Statement of Academic Honesty:
      1. This assessment is entirely my own work and has not been submitted in any
             other course of study.
      2. In this assessment, to the best of my ability, I have acknowledged:
                   -      the source of direct quotes and diagrams from the work of others;
                   -      the source of the ideas of others I have used in this assessment.

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                                 Corporate Governance Assignment 2

Table of Contents

a)    Weaknesses in the Financial Market & the Judicial System ....................................... 3

b) Monitoring & Controlling Ethics in Boardroom ......................................................... 5

c)    Difference between Enron’s and Madoff’s fraud ........................................................ 8

d) Steps to be taken as an Independent Director ............................................................ 11

Appendix 1 – Harshad Mehta’s scam in 1991 .................................................................. 12

Appendix 2 – Theoretical Origins of the Best Practice Literature.................................... 12

Appendix 3 - Board’s self-assessment questionnaire ....................................................... 13

References ......................................................................................................................... 15

Harihar Swami - 0955066                                                                                                       Page 2
                      Corporate Governance Assignment 2

a) Weaknesses in the Financial Market & the Judicial System

A joint committee was appointed by the Indian government in 1992 to probe into

Harshad Mehta affair (Appendix 1) (Narayanan, 2004). However, there was a shortage

of judges who could have been instrumental in ensuring justice. As per 2002 records,

there were a total of 24 million cases pending in various Indian courts (Punia, 2003).

Sometimes, the precious time of the court was wasted in deciding the cases which could

have been decided through other bodies (Punia, 2003). The slow pace of the judicial

system allowed the accused to apply for bails resulting in delayed justice.

Regulation was the biggest casualty in the BSE and was the responsibility of its

governing board. Brokers of the exchange elected other brokers to the board, which

created clear conflicts of interests. Hence, implementing any stringent regulation was

impossible. The executive director of BSE was nominated by the government, but even

his powers were limited since he had to report to the board. As a result, the investors had

nowhere to go to complain (Singhal, 2004).

Regulations remained extremely lax, leading to numerous defaults and abuses of the

system. No firm action was ever taken. The government made threatening noises from

time to time, but failed to crack down comprehensively. Inefficiencies in the capital

market allowed companies to raise capital by unfair means. Details of deals struck

between two parties were kept secret which resulted in distortion in trade practices. In

addition, the market also had its systemic inefficiencies, which allowed companies to

hide data from the investing class without revealing much about their operations. Small

Harihar Swami - 0955066                                                              Page 3
                      Corporate Governance Assignment 2

firms continued to engage in brokerage in amounts that were several multiples of their

size which presented huge risk to the markets (Singhal, 2004).

BSE trades were kept open for 15 days settlement cycles, which allowed investors to buy

shares and wait for 15 days before needing to make payments (‘badla’ concept borrowed

from the London Stock Exchange) towards these transactions which engendered huge

risks, such as the possibility of one of the parties involved going bankrupt during that

time frame. Brokers were trading on the BSE using over leveraged positions and were

siphoning off money from the government debt markets through fraudulent means.

Funds were diverted from the banking system to brokers for financing their operations

(Singhal, 2004).

All the above mentioned inefficiencies of the Indian judicial system, the RBI (Reserve

Bank of India) and SEBI (Securities & Exchange Board of India) allowed people like

Harshad Mehta to take advantage of these loopholes and manipulate the markets as per

their wishes.

Harihar Swami - 0955066                                                           Page 4
                       Corporate Governance Assignment 2

b) Monitoring & Controlling Ethics in Boardroom

The question of corporate ethics and the effects of best practices (Appendix 2) (Miller-

Millesen, 2003) have taken centre stage in boardroom discussions. Three principle

corporate responses have emerged from these discussions which can help in achieving

ethical effectiveness (Fombrun & Foss, 2004):

      Infusion of ethical principles and values into corporate culture

       Examples - Boeing, Deloitte & Touche, Lockheed Martin

      Appointment of ‘Chief Ethics Officer’

       Examples – Dell, US Food Services

      Adoption of stricter ethical guidelines and code of conduct

According to Business for Social Responsibility (2004), to build an effective ethics

program requires visible, top-down commitment, as well as a variety of organizational

supports, including;

      Identifying and renewing the company’s values

      Adequate funding and staff for ethics program

      Building ethics into mission and vision statements

      Developing an ethics code

      Encouraging ‘ethical autonomy’ among employees

      Globalizing ethics program

Harihar Swami - 0955066                                                           Page 5
                      Corporate Governance Assignment 2

      Addressing new ethics issues as they arise

      Developing comprehensive ethics training

      Integrating ethics into all aspects of company communications

      Developing strong whistle blower protections

      Rewarding ethical behavior and penalizing unethical behavior

      Developing regular audit and evaluation programs

      Creating an ethics ‘help line’ and channels for employee communication

In order to monitor the quality of decisions taken in a boardroom, executives must collect

and consider all potentially meaningful facts regarding a decision’s consequence in the

minutes of the meeting. The Directors should be responsible and accountable when they

learn about any matter requiring their actions (Matheson, 2009). Executives should

maintain transparency and use their moral imagination (Werhane, 1999) to look beyond

the direct and obvious impact of a specific decision by imagining the possible

implications for stakeholders.   Honesty must be central to all aspects of business,

including decision making. As a director, they must ask themselves: ‘Are they doing the

right thing?’ (Messick, Bazerman, & Stewart, 2006).

An independent monitoring and audit committee should be appointed to check the

proceedings of the boardroom. There should also be a segregation of power so that no

individual can influence the board in a significant manner.         Balanced scorecards

(Matheson, 2009) and assessment tools (Appendix 3) (Brodeur & Gunnar, 2008) should

be introduced to monitor the strategies adopted by directors. Rather than focusing on

Harihar Swami - 0955066                                                             Page 6
                      Corporate Governance Assignment 2

finding a solution, they should focus most of their efforts on implementing controls and

ensuring adherence to them. The board should, where appropriate, take legal advice

when establishing, changing their accountability documents, to ensure relevant matters

are covered in a legally correct manner and that the intention is clear (Matheson, 2009).

Harihar Swami - 0955066                                                             Page 7
                      Corporate Governance Assignment 2

c) Difference between Enron’s and Madoff’s fraud

The discernible differences from my personal point of view are in the ways by which

these two frauds were carried out.

Enron was a public company with employees and shareholders who counted on

management, the board, and the auditors to protect them. There were too many inside

directors, executive directors who were Enron’s senior managers and who were not

independent of management or their decisions, and each had the opportunity to gain

significant personal financial benefit from a continually increasing short-term share price.

A culture of arrogance and greed began to influence decisions and actions of the

management.     The management encouraged breaking rules and minimal disclosure

practices (Matheson, 2009).

The independent directors were aware of the malpractices and could have prevented them

from affecting Enron’s shareholders, employees and business associates. Instead, they

also became submissive, recklessly negligent and hence should be held accountable and

personally liable for the company’s downfall. They failed to discharge their ‘duty of

care’ and did not protect their investors resulting in an unexpected breakdown in

governance. Enron failed because its board failed (Zandstra, 2002).

Enron’s culture was brutal selfishness – aggression, self-interest, materialism and ethical

egoism, failing as an ethical decision making system, producing short-term gains for

stakeholders and not the long-term survival of the organization (Bowen & Heath, 2005).

Harihar Swami - 0955066                                                               Page 8
                      Corporate Governance Assignment 2

Enron is an example of the unethical integrity of leadership having disastrous effects on

the moral culture which eventually led to its failure (Thoms, 2008).

Unlike Enron, Bernard Madoff Investment Securities (BMIS) relied on social engineering

and predictability of human nature to generate income and not on remarkable financial

expertise to run his Ponzi scheme. This scam illustrates the connection between financial

and operational risks. Madoff would invite elite investors to invest in his funds which

would give consistent returns. Investors did not perform ‘due diligence’ before investing

and ignored red flags about Madoff’s funds (Clauss, Roncalli, & Weisang, 2009).

BMIS victims were investors who presumably had an expert knowledge of the trade of

financial investment: rich private individuals and large financial institutions (The Wall

Street Journal, 2008). The three core tenets to the existence of this fraud are (Clauss,

Roncalli, & Weisang, 2009);

      Madoff's reputation

      A high and attractive performance; and

      The concurrent holding of several positions which facilitated the implementation

       of Madoff's system

Investors based their investment decisions on Madoff’s reputation (Burton, Helvar, &

Silver, 2009). Madoff did not charge any management fees and told his customers that

he was letting them share the benefits of his expertise in securities valuation. Madoff was

Harihar Swami - 0955066                                                              Page 9
                      Corporate Governance Assignment 2

the manager and the custodian of his own funds and the fraudulent scheme thus largely

benefited from lesser scrutiny since the control over the management of the assets

remained in BMIS's house. The Madoff case is clear evidence of a bias which overtook

many investors in whose minds performance overshadows risks (Clauss, Roncalli, &

Weisang, 2009).

Harihar Swami - 0955066                                                       Page 10
                      Corporate Governance Assignment 2

d) Steps to be taken as an Independent Director

As an independent Director, I will take the following steps in the best interest of the

organization and the stakeholders;

      Ensure that the Board of Directors are aware of the unethical activities

      Ensure that they comply with the company’s code of ethics and regulations and

       maintain high professional standards

      Ensure that the my disagreements with the remaining Directors are mentioned in

       the minutes of the meeting

      I would exercise my ‘Veto’ power to oppose and stop unethical decisions from

       being implemented

      Act in good faith and exercise my legal powers, if necessary, to stop unethical


      Warn the board about the legal consequences, personal liabilities including

       criminal liabilities with regards to the fraudulent activities performed

      Request Judicial help to sort out matters where my concerns were not heard

      Discuss the situation with the Chairman

      Try and address the matter internally

      Resign from my post and blow the whistle on the organization as a last resort

Harihar Swami - 0955066                                                           Page 11
                      Corporate Governance Assignment 2

Appendix 1 – Harshad Mehta’s scam in 1991

                                                                          Economics of
                                                                        Financial Market
Year         Victim           Perpetrator          Mechanism
                                                Borrow money
                                                from banks on a
     Public buyers of                           ready forward
     shares of                                  basis thus
     companies dealt       Harshad Mehta,       violating RBI
     with by               Hiten Dalal,         guidelines and          Clearing and
     manipulators,         Batliwala &          dealing in security     settlement
1991 National Housing      Karani, M/s V.B.     transactions with       problems
     Bank, State Bank      Desai, N.K.          banks where issue       (systemic risks),
     of Saurashtra, SBI    Aggarwala & Co.,     of bank receipts        Money laundering
     Capital Markets       Mukesh Babu etc.     and SGL forms
     Ltd, Standard                              were not
     Chartered Bank                             supported by
                                                genuine holding of

Appendix 2 – Theoretical Origins of the Best Practice Literature

                                   Focus                              Best Practice
                                                              Determine the mission
                                                               and purpose

                                                              Approve and monitor
                                                               organization’s programs
                                                               and services
Agency Theory       Separating ownership and control
                                                              Evaluate the CEO’s

                                                              Establish fiscal policies
                                                               and financial controls

Harihar Swami - 0955066                                                               Page 12
                                                  Corporate Governance Assignment 2

                                                                       Focus                                     Best Practice
                                                                                                            Identify candidates who
                                                                                                             can improve access to

                 Resource                                                                                   Provide adequate
                                                Linking the organization with its
                 Dependency                                                                                  resources for the
                 Theory                                                                                      organization

                                                                                                            Advance the
                                                                                                             organization’s public
                                                                                                            Assure that basic legal
                                                                                                             and ethical
                                                                                                             responsibilities are
                 Institutional                  Conforming to institutional pressures
                 Theory                         that legitimate governance principles
                                                                                                            Assess board

                 Appendix 3 - Board’s self-assessment questionnaire

                                          A. Oversight – how well does the board understand...

                                                                                                    Not at all                             Completely
                                                                                                         1         2         3         4        5

The major risks the company faces?                                                                       о         о         о         о        о
Alignment of the current risk profile with its risk strategy?                                            о         о         о         о        о
The risk-return tradeoffs and the risk-adjusted level of value creation of each line of business?        о         о         о         о        о
Any new types of risk assumed as well as material, extraordinary transactions?                           о         о         о         о        о
Structure and effectiveness of risk management infrastructure at both corporate and BU levels?           о         о         о         о        о
Philosophy, structure, and effectiveness of corporate risk policies?                                     о         о         о         о        о
Potential conflicts between risk strategy and policies and compensation systems?                         о         о         о         о        о
Progress made against commitments made to board?                                                         о         о         о         о        о

                 Harihar Swami - 0955066                                                                                         Page 13
                                                 Corporate Governance Assignment 2

                                                   B. Effectiveness of committee structure

                                                                                              Not at all                     Completely
                                                                                                  1        2   3       4          5

Are the committee charters and responsibilities appropriate and shared by all members?            о        о   о       о          о
Is the committee composition adequate?                                                            о        о   о       о          о

                                                       C. Effectiveness of board meetings

                                                                                              Not at all                     Completely
                                                                                                   1       2   3        4         5

Do the board meetings focus on the core issues (as opposed to, for example, the tactical
                                                                                                   о       о   о        о         о
 review of nonmaterial transactions)?

Do all committee members have an adequate understanding of risk management issues?                 о       о   о        о         о
Do all committee members contribute productively to the discussion?                                о       о   о        о         о
Is the meeting frequency appropriate?                                                              о       о   о        о         о
Do all committee members attend and prepare for board meetings adequately?                         о       о   о        о         о
Is the material presented in a way that enables the committees to fully understand critical        о       о   о        о         о
Issues and decision needs?                                                                         о       о   о        о         о
Are the discussion materials for the meetings distributed in advance?                              о       о   о        о         о

                Harihar Swami - 0955066                                                                            Page 14
                      Corporate Governance Assignment 2


Bowen, S. A., & Heath, R. L. (2005). Issues Management, System and Rhetoric:
Exploring the distinction between ethical and legal guidelines at Enron. Journal of Public
Affairs , 84-98.

Brodeur, A., & Gunnar, P. (2008). Making risk management a value-adding function in
the boardroom. New York: McKinsey & Company.

Burton, K., Helvar, J., & Silver, V. (2009). Madoff's mayhem. New York: Bloomberg

Business Roundtable Institute for Corporate Ethics. (2004). Retrieved July 18, 2010,

Clauss, P., Roncalli, T., & Weisang, G. (2009, April 4). Risk Management Lessons from
Madoff Fraud. International Finance Review , 505-543.

Fombrun, C., & Foss, C. (2004). Business Ethics: Corporate Responses to Scandals.
Corporate Reputation Review , 284-288.

Matheson, D. (2009). The Complete Guide to Good Governance in Organization and
Companies. Auckland: 3media Group Books.

Messick, D. M., Bazerman, M. H., & Stewart, L. (2006). Aviodng Ethical Danger Zones.
Virginia: Business Roundtable Institute for Corporate Ethics.

Miller-Millesen, J. L. (2003). Understanding the Behavior of Nonprofit Boards of
Directors: A Theory Based Approach. Nonprofit and Voluntary Sector Quarterly , 521-

Narayanan, S. (2004). Financial Market Regulation- Security Scams in India with
historical evidence and the role of corporate governance. Munich: Munich Personal
RePEc Archive.

Punia, R. (2003). Arrears on Judiciary demand for judicial reform. Retrieved July 17,
2010, from

Singhal, R. (2004). Finacial Sector Reform in India: Is There a Grand Design.
Philadelphia: Center for the Advanced Study of India.

The Wall Street Journal. (2008, December 15). Madoff's Victim List. Retrieved July 21,
2010, from

Harihar Swami - 0955066                                                           Page 15
                      Corporate Governance Assignment 2

Thoms, J. C. (2008). Ethical Integrity in Leadership and Organizational Moral Culture.
Leadership , 419-442.

Werhane, P. H. (1999). Moral Imagination and Management Decision Making. Oxford:
Oxford University Press.

Zandstra, G. (2002). Enron, board governance and moral failings. Corporate Governance
2.2 , 16-19.

Harihar Swami - 0955066                                                        Page 16

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