Hony.
Editor |
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Dr.
Bindi Mehta
(Director,
Research at ICSI - CCRT, Formerly, Chief economist, CRISIL
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April,
2003 |
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Research, training and course material in the area of
Corporate Governance in India has received a fillip with
an active move from the Department of Company Affairs
(DCA). The DCA has established a platform for taking Corporate
Governance’s agenda forward even as it conceptualized
formation of the National Foundation for Corporate Governance
as a trust with possible financial contributions from
the Government of India, CII, ICSI, ICAI, Assocham and
FICCI. It convened a meeting of the delivery channels
(major academic institutions) and other stakeholders (GCGF,
Commonwealth Secretariat, IGEP of Germany, and DFID) in
improving corporate governance standards in the country.
The delivery channels invited were Administrative Staff
College of India (ASCI), Indian Institute of Management-Ahmedabad,
Bangalore, Kolkata, Lucknow and Indian School of Business
(ISB) who were requested to firm up the 2003-2004 and
the medium term plans for training, research, certification,
distance learning, etc.
Dr.
YRK Reddy, Founder Trustee of the Academy of Corporate
Governance who is advising the DCA in the formation of
the National Foundation for CG, has been asked to be pointsman
to coordinate with the academic institutions, the proposed
National Foundation, and the multilateral organizations
as contained in the minutes of the meeting. (See news
item).
Editor
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PRESIDENTIAL
ADDRESS
by Shri M. Narasimham
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Shri M Narasimham, Chairman, ASCI’s Presidential
Speech was at
the Laxminiwas & Jain Alumni Silver Jubilee Lecture
on "Financial Statements, Expectations & Trends
- Role of Profession"
by Shri Y H Malegam, on 4th March 2003, at the Indira
Priyadarshini Auditorium.
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The
accounting industry and profession have been much in the
news in the last couple of years but unfortunately for
the wrong reasons. A series of events in corporate America
such as the Enron debacle, the problems with Worldcom
and other giant firms drew attention to the role of auditors
of these firms in the sorry saga. While many critics thought
auditors were negligent, there were others who were not
so kind and suggested a measure of collusion. The accounting
profession, at one time, was a byword for competence and
integrity. It was taken for granted that the auditors
of an enterprise could be depended upon to provide a fair
and true account of a firm’s operations and its financial
results. This implicit faith was what sustained shareholders’
support to corporate America through the capital market.
Shareholders and the general public felt let down by what
they perceived to be inefficiency and – should one say
it? – doubtful integrity of those entrusted with the audit
of these firms. It was not that auditors lacked technical
skills. It was, after all, in the US that the GAAP accounting
system evolved. In other words, it was not the mechanics
of accounting that was the problem but rather the ethics
of accounting as delinquent corporates could not have
withheld vital information or over stated profits or underestimated
losses without the auditors’ tacit consent, even if not
their active collusion in doing so. Investigations revealed
instances of possible conflict of interest situations
where auditors also acted as consultants to the firms
they were auditing. Even otherwise, it was noticed that
the relationship between the auditing firms and their
clients represented a long standing and cosy nexus rather
than the supposed arm’s length relationship. In the spate
of these revelations and sometimes accusations, audit
firms were seen running for cover and in the process,
one of the more reputed firms, Arthur Anderson collapsed.
It
was a period of catharsis for the accounting industry
and, when confidence was shaken the US authorities felt
it was time for legislative intervention and regulation
of corporate procedures and accounting practices to improve
matters and to address issues such as conflict of interest,
and auditor independence. The Oxley-Sarbanes legislation
was framed against this background of corporate failure
and the perceived need for regulation. In the process
one of the cherished principles of the accounting and
audit profession, namely self-regulation, yielded place
to regulatory oversight through the setting up of the
Accounting Oversight Board which was expected to lay down
audit standards and institute a set of minimum requirements
to regulate the audit profession. Effectively, the auditors
are now to be audited for their performance. There could
be a view that the Oxley-Sarbanes Legislation has tightened
the screws too far. The requirements under the new law
are not easy to implement but the legislation itself has
to be seen in the perspective of recent happenings. It
is reminiscent of the situation when following the Great
Depression about 70 years ago a slew of measures was taken
in the US on aspects of financial regulation and institutional
reform with broadly similar objectives of protecting the
interests of the investing community. The various amendments
to banking laws and the establishment of the Securities
and Exchange Commission were the more notable of these
measures.
The Oxley-Sarbanes Legislation has also to be seen in
the context of the new found emphasis on corporate governance.
The Cadbury and Hampel Committees in the UK drew pointed
attention to the role of proper accounting and auditing
in enhancing corporate governance. Transparency and accountability
constitute the twin pillars of corporate governance. This
is where the auditors have a distinctive role. They are
appointed by the shareholders and they are duty-bound
to be responsible and indeed accountable to the shareholders
for certification of accounts to further the objective
of transparency and accountability.
In
India also, over the years, we have tended to place implicit
faith in auditors’ reports. The reading of the auditors’
reports at annual general meetings has become more or
less a ritual and it is a rare occurrence for shareholders
to cross examine auditors or seek elaboration from them
on their reports as read out. Furthermore, the notes to
the accounts where the auditors may qualify the accounts
are couched in language which the lay shareholder may
not be able to grasp and suggests the need for qualification
or notes to accounts to be composed in a manner intelligible
to the layman. It might also be useful if the auditors
were to pinpoint the qualifications in their report rather
than leave it to the reader to sift from the notes to
the accounts the qualifications. I might mention one particular
instance where, I believe, the auditors in this country
have perhaps been found wanting. Auditor’s reports for
banks, for instance, rarely, if ever, brought out the
deterioration in the quality of loan portfolio over the
years. It was left to the Committee on the Financial System
in 1991 which set out a system of asset classification
to define and identify non-performing assets. One wonders
why in the years before auditors did not draw attention
to the contamination of the loan portfolio represented
by NPAs.
We
are now aware in this country of the importance of corporate
governance and in this context of the need to present
accounts of a company in a manner conforming to the requirement
of truth and fairness. With the ongoing programme of liberalisation
with its concomitant of a greater measure of economic
space for the private sector, the capital market should
emerge as a main source of finance for the private sector
and the protection of the investing public’s interests,
therefore, would require attention. Shareholders and the
investing public in general have a right to expect the
auditors to live up to their credo of ensuring that the
accounts are true and fair, ensure transparency and as
part of their accountability to the shareholders draw
attention in an intelligible manner to any lacunae in
the functioning of the companies as revealed in the financial
results.
In
recent years, we have been taking several steps aimed
at protecting investor interest. The setting up of SEBI
is one expression of this resolve. Strengthening the framework
of the administration of company law and the proposal
to create a Serious Frauds Office is another. There is
now increasing attention to the measures needed by company
managements, their boards and the auditors to meet the
requirements of having full disclosure and transparency
to ensure good corporate governance. More recently, we
have the Report of the Naresh Chandra Committee which
has looked into these aspects of corporate governance
including the role and responsibilities of auditors and
addressing issues such as conflict of interest and the
company and auditor relationship in general. The influence
of the Oxley-Sarbanes model is all too apparent in the
recommendations of the Naresh Chandra Committee. Apart
from aspects pertaining to the internal management of
companies such as vesting the boards with more power and
assumption of responsibility and defining the role of
independent directors, the Chandra Committee has also
looked into issues pertaining to the audit function. One
can sympathise with the feeling of hurt pride on the part
of audit profession at what they might consider the thought
of over bearing regulation but I believe the approach
should be constructive with the recognition that strengthening
of the audit profession even to some extent by substituting
self-regulation by oversight from above is ultimately
designed to strengthen the profession itself and also
help the corporate sector and the community at large and,
in the era of globalisation, create and maintain international
confidence in our accounting standards and performance.
The accountancy industry, therefore, should, instead of
viewing any such regulation as implicit questioning of
its professional competence and integrity, welcome it
as an essential building block for good corporate governance.
Towards this end, the Institute of Chartered Accountants
would have to formulate acceptable accounting standards
and ensure compliance with these standards and, I am confident
that they would discharge this role in a constructive
fashion.
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CORPORATE
GOVERNANCE IN AN ISLAMIC BANK
by
Sohail Zubairi
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An Islamic bank is more regulated than its conventional
counterpart
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The
structure of an Islamic bank is radically
different from its conventional counterpart.
A conventional bank is primarily a borrower
of funds on one hand and the lender on the
other whereas an Islamic bank is rather
a partner with its depositors, as well as
with entrepreneurs, sharing profit or loss
at both ends.
Another distinction between them is that
a conventional bank would not stop charging
interest (and compound it) even if the deployment
of its capital fails to bear profit for
the entrepreneur, whereas an Islamic bank
cannot claim profit if the outcome is a
genuine loss.
As there are no separate regulations for
Islamic banks operating in the UAE and most
of the Islamic countries, how are these
banks governed?
The Islamic banks are regulated by the same
laws promulgated by the country’s authorities
applicable to conventional banks (e.g. capital
adequacy ratio,). However, an Islamic bank
is subject to an additional layer of governance
in shape of its own Sharia Supervisory Board.
As discussed earlier in this column, Sharia
Supervisory Board oversees that the bank’s
investment and financing activities are
in strict conformity with Islamic laws and
as per the expectations of Muslim umma (nation).
For setting up an Islamic bank, it is mandatory
to first constitute a Sharia Supervisory
Board comprised of qualified Sharia scholars.
It should be noted that the role of this
board is not of merely an advisory nature
but more on regulatory lines. The board
even reigns supreme over the bank’s board
of directors appointed by the shareholders.
Why is Sharia Board’s presence so vital
to an Islamic bank’s existence? It is necessary
in order to provide assurance to those who
want to conduct their financial transactions
according to Islamic principles. Imagine
an Islamic bank without Sharia Board? It
may not be able to distinguish itself as
an Islamic bank and hence will not be able
to attract Islamic investors and entrepreneurs.
What is the key responsibility of Sharia
Board? Primarily it is to keep a close watch
on bank’s affairs and report any violation
of Sharia regulations, first to the management
and the Board of Directors and in case of
inaction, to the governing bodies of the
country who have licensed it to be run on
Sharia principles. Sharia Board has the
power to nullify any such transaction and
discard the income earned from it to be
taken to profit.
Sharia
violations can be categorized as follows:
a. presence of the element of interest in
a transaction
b. indulgence by the bank in the economic
activities involving speculation (gharar);
c. avoidance to levy Zakat
d. bank’s involvement in the goods and services
considered repugnant to Sharia
Sharia scholars are also responsible to
approve launching of new products by the
bank and to advise the management on structuring
various financing transactions.
I once asked a scholar as to what motivates
him to perform his duty so diligently? The
reply was not unexpected; it is the fear
of God.
Thus, we observe that an Islamic bank is
more regulated financial institution than
a conventional bank.
Responsibilities of an Islamic bank
Scholars agree that the Islamic banks have
a major responsibility to shoulder. They
say that the staff of an Islamic bank should
be reformed Islamically and act within the
framework of Islamic parameters such as
courtesy, honesty, sincerity and equality
to all customers so that a person entering
the premises should feel that he is in a
sacred place to perform a religious ritual
i.e. a transaction of handling the capital
as per God’s set rules.
Scholars have set high moral and ethical
standards for a person working in an Islamic
bank. They require him to conduct his affairs
in the Islamic manner in his every day life,
whether at work or at not. On the other
hand, they demand from the community to
provide strong support to Islamic financial
institutions by preferring to deal with
them in order to promote the just and fair
values of the Islamic economic system.
Sharia scholars unanimously term an Islamic
bank as a financial intermediary, with the
responsibility to mobilize capital from
the public on Mudaraba basis and deploy
it with the help of entrepreneurs in order
to provide the public with an opportunity
to earn Halal profit, thus preventing them
from entering into usurious transactions.
How an Islamic does all that? The
modus operandi is illustrated below:
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In
view of profit and loss sharing principle,
there is likelihood that in the event
of loss, depositors may lose a proportionate
share of their capital or the entire
amount. Nevertheless, in such situation,
it will be necessary to determine through
available professional surveyors that
the loss was not caused by the negligence
of the bank.
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When it comes to dealing with entrepreneurs,
bank applies ‘Restricted Mudaraba’ concept.
It means the bank has full right to
determine the nature of business, duration
and location of the project and to monitor
the progress.
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However, this right may not be exercised
in a manner so as to disrupt the smooth
running of the entrepreneur’s business.
Furthermore, the bank is nor allowed
to interfere with the day to day management
of the business.
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Nevertheless,
if negligence or mismanagement can be
proved by the bank, the entrepreneur
could be held responsible for the financial
loss and be obliged to reimburse the
bank with full amount of capital.
Bank
may have the right to seek its consent should
the entrepreneur decides to change the line
of business. Similarly, The bank, should
have full access to the books and records,
and can exercise monitoring and follow-up
supervision. Nevertheless, the management
of the company retain independence in conducting
the day to day affairs of the business.
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WITHERING
CORPORATE LEADERSHIP |
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(Edited extracts from the letter of Mr. Warren Buffett,
Chairman of Berkshire Hathway,
to shareholders, sourced from www.berkshirehathway.com)
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Both
the ability and fidelity of managers have long needed
monitoring. Accountability and stewardship withered in
the last decade, becoming qualities deemed of little importance
by those caught up in the Great Bubble. Most CEOs, it
should be noted, are men and women you would be happy
to have as trustees for your children’s assets or as next-door
neighbours. Too many of these people, however, have in
recent years behaved badly at the office, fudging numbers
and drawing obscene pay for mediocre business achievements.
These otherwise decent people simply followed the careerpath
of Mae West: “I was Snow White but I drifted.”
In
theory, corporate boards should have prevented this deterioration
of conduct. I last wrote about the responsibilities of
directors in the 1993 annual report. There, I said that
directors “should behave as if there was a single absentee
owner, whose long-term interest they should try to further
I all proper ways.” This means that directors must get
rid of a manager who is mediocre or worse, no matter how
likable he may be.
In
the 1993 annual report, I also said directors had another
job: “If able but greedy managers overreach and try to
dip too deeply into the shareholders’ pockets, directors
must slap their hands.” Since I wrote that, over-reaching
has become common but few hands have been slapped. Why
have intelligent and decent directors failed so miserably?
The answer lies not in adequate laws – it has always been
clear that directors are obligated to represent the interests
of shareholders – but rather in what I would call “boardroom
atmosphere.”
It
is almost impossible, for example, in a boardroom populated
by well-mannered people, to raise the question of whether
the CEO should be replaced. It is equally awkward to question
a proposed acquisition that has been endorsed by the CEO,
particularly when his inside staff and outside advisors
are present and unanimously support his decision. (They
would not be in the room if they did not.) Finally, when
the compensation committee – armed, as always, with support
from a high-paid consultant -= reports on a mega grant
of options to the CEO, it would be like belching at the
dinner table for a director to suggest that the committee
reconsider. These “social” difficulties argue for outside
directors regularly meeting without the CEO – a reform
that is being instituted and that I enthusiastically endorse.
The
current cry is for “independent” directors. It is certainly
true that it is desirable to have directors who think
and speak independently – but they must also be business-savvy,
interested and shareholder-oriented. In my 1993 commentary,
those are the three qualities I described as essential.
Over
a span of 40 years, I have been on 19 public-company boards
(excluding Berkshire’s) and have interacted with perhaps
250 directors. Most of them were “independent” as defined
by today’s rules.
But
the great majority of these directors lacked at least
one of the three qualities I value. As a result, their
contribution to shareholder well-being was minimal, at
best, and, too often, negative.
So
that we may further see the failings of “independence”,
let us look at a 62-year case study covering thousands
of companies. Since 1940, federal law has mandated that
a large proposition of the directors of investment companies
(most of these mutual funds) be independent. These directors
and the entire board have many perfunctory duties, but
in actuality have only two important responsibilities:
Obtaining the best possible investment manager and negotiating
with that manager for the lowest possible fee. Yet when
it comes to independent directors pursuing either goal,
their record has been absolutely pathetic.
Having
the right money manager, of course, is far more important
to a fund than reducing the manager’s fee. Both tasks
are nonetheless the job of directors.
And
in stepping up these all-important responsibilities, tens
of thousands of “independent” directors, over more than
six decades, have failed miserably. (They have succeeded,
however, in taking care of themselves; their fees from
serving on multiple boards of a single “family” of funds
often run well into six figures.)
Getting
rid of mediocre CEOs and eliminating overreaching by the
able ones requires action by owners – big owners. The
logistics are not that tough: Twenty, or even fewer, of
the largest institutions, acting together, could effectively
reform corporate governance at a given company, simply
by withholding their votes for directors who were tolerating
odious behaviour. This kind of concerted action is the
only way that corporate stewardship can be meaningfully
improved.
Unfortunately,
certain major investing institutions have “glass house”
problems in arguing for better governance elsewhere; they
would shudder, for example, at the thought of their own
performance and fees being closely inspected by their
own boards. But Mr. Jack Bogle of Vanguard fame, Mr. Chris
Davis of Davis Advisors, and Mr. Bill Miller of Legg Mason
are now offering leadership in getting CEOs to treat their
owners properly.
The
acid test for reform will be CEO compensation. Managers
will cheerfully agree to board “diversity”, attest to
SEC filings and adopt meaningless proposals relating to
process. What many will fight, however, is a hard look
at their own pay and perks.
In
recent years, compensation committees too often have been
tail-wagging puppy dogs meekly following recommendations
by consultants, a breed not known for allegiance to the
faceless shareholders who pay their fees. This costly
charade should cease. Directors should not serve on compensation
committees unless they are themselves capable of negotiating
on behalf of owners.
They
should explain both how they think about pay and how they
measure performance. Dealing with shareholders’ money,
moreover, they should behave as they would were it their
own. It would be a travesty if the bloated pay of recent
years became a baseline for future compensation. Compensation
committees should go back to the drawing boards.
(Source: Business Line, March 16, 2003)
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© 2001 Academy of Corporate Governance |
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