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Posts Tagged ‘corporate governance’

Governance @ Distance

In board members, corporate governance, Finance, fraud, General, Management, Uncategorized on April 5, 2019 at 1:12 pm

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Transparency, higher commitment, and independence are buzz words for good corporate governance. The role of independent directors plays an important role in Corporate governance to keep an eye on the board activities to flag off non-promoter group issues. However, the challenge is neither the independent directors get appropriate compulsory training to understand their roles and responsibilities in an organisation nor the appropriate data promptly to act upon effectively. Board has a limited duration to understand and reflect on issues. Sometimes the independent directors are from different industries and are not able to understand the context and indulge in granularities, though, diversity of thoughts may add significant value. Governance at distance is often seen where the board chairman leads the discussion and independent directors often distant from reality less engaged in a discussion.

According to recent Board Practice Report by Deloitte Centre for Board Effectiveness and Society for Corporate Governance, almost 80% of board members think that their primary focus is on company strategy, 42% attributes risk oversight as important and 29% focuses on board selection. To sum up, strategy formulation, risk oversight and board selection are three important roles of board. In this blog, I will talk about the issues related to the first two.

In the current business environment, the markets are turbulent more than ever. World over, not only regulators, every stakeholder such as partners, and creditor are accusing board if anything goes wrong in governance. Social media and newspapers have abundant stories of poor risk governance. A board strategy cannot be the same in normal, turbulent and crisis situations. Strategic change has become important for companies. Punjab National Bank (PNB) in India has recently faced one of the biggest frauds in history, and within a short period, the company’s board needs to change the strategy of the company to address the crisis. Not only the fraud affected the PNB strategy, but it also impacted the strategy of other banks in India and the global market. The strategies perfectly working in normal market conditions may not work in crisis situation. Are companies’ board trained and prepared to handle how to change the company’s strategy in normal, volatile and crisis situations?

Post-2008 crisis, the role of the board in enterprise-wide risk oversight has become challenging. No specific training is provided to the board to refresh their knowledge on the subject. Many companies still don’t know what are their key risks and issues in the management of risks. Surprisingly, directors don’t know their roles and responsibility in risk oversight. Understanding the inter-connectivity of risk is the next big challenge, and a very few companies are able to link risk management with strategy and compensation system. How the board of directors perform their duty in overseeing the executive decisions and how compensation structures and practices drive an executive’s risk-taking. Many such questions need to be answered.

Let us understand the logic of why the understanding of risk is paramount for the board for effective corporate governance. Shareholders want a higher return for higher risk and vice-a-versa. One of the roles of the board is to define the risk appetite (the amount and extent of risk the company is willing to take as promised to shareholders) in the company. The informal approach of risk management will bring several surprises in the organization and may hinder the fulfillment of organisational objectives. To deal with the situation, the board needs to effectively oversee the organisation key risks holistically and disclose them to shareholder at appropriate times so that value at risk can be calculated. The only quantification of risk exposure will not suffice; the quality of risk-taking directly impacts the profitability of a company. Quality of risk profile also needs a significant attention. Balancing the risk while adding value to the organisation is only possible when risk management is well understood by board, implemented in a formal way and linked to the organisational strategy.

I strongly believe that the board should get a refresher course or a certificate course to carry out their duties effectively. Governance at a distance is not working. Categorization of risks in market risks, operational risk, and strategic risk has become bizarre and mundane.  Helicopter view of risk for oversight has become unacceptable as stakeholders want to understand what were the key risks of the organisation last year, whether risks are increasing or decreasing and the reasons behind them. Higher interaction and participation of the board by probing questions will certainly enhance the current state of governance. Higher engagement of the board is the key to good governance.

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Understanding ‘Conflict of Interest’ is need of hour in India

In Banking, corporate governance, fraud, Insurance, Legal, Management, Uncategorized on December 23, 2018 at 3:57 am

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I was not really shocked to read another issue of conflict-of-interest for Bank of Maharashtra after Chanda Kochhar case at ICICI Bank. Conflict of interest issues has been discussed for several years in news and media. Banking than insurance industry have more examples to such nature, though in the government we have seen examples where lawmakers have taken up roles resulting in the conflict-of-interest. This is because Insurance regulator in India has mentioned it specifically in Corporate Governance Guidelines that Conflict of interest and nature of interest should be defined, yet banking regulator is lagging behind. RBI guidelines indicated that there should be no conflict of interest but do not indicate ‘how to identify and take actions’ for such activities. Conflict of interest arises when a board member takes the strategic decision considering personal interest. Board members of all significant MNC’s in the global market place have to sign either ethical framework/Compliance guidelines or follow conflict of interest policy.

There is a desperate need of Conflict of Interest policy for Indian banking system. Ideally, it should be at all levels in the organisation  from managers to board members. For example, In some cases in India, bank managers are receiving more incentives than their salaries for selling insurance policies which divert their attention from selling banking products. Technically, insurance policies are sold by both banks and insurance companies while banking products are not even sold by their core employees, why? Why not introduce reverse bancassurance where insurance companies can also offer banking products. The reason is ‘KYC’. Some practitioners argue that banks know their customer more than insurance companies. Others argue that in a bank, customers receive money, while in insurance companies they pay money. The differentiation in the quality of agents between banks and insurance also sets the increased expectations. In a bank, a top MBA graduate joins as manager while in insurance companies they do not pay such salary at managerial level. Instead, I saw a reverse trend of hiring graduates in banking following insurance industry to lower the cost.

How do banks promote their products when half of the time banking executives spend on selling insurance? They cannot ignore banking services but what they can easily overlook is controls. Another conflict of interest arises related to favoritism by CMD of banks or CMD of insurance companies: who can question them. In case of banks, it could be a case of favouritism in granting new loans or extending the existing loans which may, later on, turn as NPA while in case of insurance companies, it may be a market investment to gain personal benefits.

What is a Conflict of Interest Policy?

A Conflict of Interest policy can be prepared by the Corporate legal department and must be signed by all board members at the first organizational board meeting. It should be mandated that no board member should be allowed to serve without signing this policy. It includes fiduciary duties (considering organizational interest for financial and legal matters), the duty of loyalty (putting board responsibilities for outside interests), and duty of confidentiality ( keeping how key business will deal with private information). Moreover, it should define the key definition about ‘interested person’ and ‘financial interest,’ duty to disclose and procedures for addressing conflict of interest for board and individuals. The process of deriving reasonable cause to show the violation of conflict of interest should also be discussed. Some questions like how compensation of director will impact the board quality of discussion. There is a requirement of the annual review of conflict of interest policy, the disclosure of outside interests and re-signing of the policy.

Worldwide, Conflict of Interest issue is not resolved in good faith. Recently, I have met Group CROs and senior executives of German Insurance Companies and regulator. The regulatory board in Germany and their staff have to sign an ethical framework compulsorily. The logic behind signing an ethical framework is that every employee in the organization takes the responsibility of disclosure of conflict of interest. This also depicts their promise of not engaging in any such activity. Thus, conflict of interest can be reduced by promoting a cognitive risk culture where everyone understands the risk of conflict of interest and their associated role in dealing with the risks.  India may follow German market for good practices to deal with the emerging issue of ‘Conflict of Interest’.

comments welcome !

How governance works in practice !

In corporate governance on April 25, 2017 at 11:28 pm

 

Corporate-Governance

Establishing good corporate governance is a new desired objective for corporates. I am curious to explore how it works in practice. From institutional theory perspective, large institutions should become isomorphic over time. Another contradictory perspective is ‘how institutions differ from each other’. Simply put, there are three types of institutions: shareholder-focused, management-focused and stakeholder focused based on three prominent theories: agency theory (focus on shareholder), managerial hegemony theory (focus on management) and stakeholder theory (focus on stakeholder) respectively. I found issues with all three types of corporate governance during practice. My key question is: What should be the focus of Corporate Governance during practice?

Management-focused

When CEO has control over all management information and he/she reveals the minimal information to board. In such case, CEO has power to influence board decision making.  Enron is an example for this type of leadership. The major issues for Enron bankruptcy were lack of good corporate culture and adherence to poor corporate governance standards. When a high-performance company is not thinking about its employees’ welfare and development rather it conceals the frauds/misconducts in the race of the achievement of targets, the outcomes are different. This type of company often does not believe in investing in risk management. Several projects are delayed and from CEO to workers, all are working hard to deliver projects on time. Workers are paid overtime salaries, executives enjoy high bonuses, celebrations take place, awards are won, agents receive trips to Australia and Thailand and shareholders are provided high dividend. Is this approach good?

Shareholder-focused

In another company without board approval, even small decisions are not taken. All information is revealed to board, practically board is flooded with ambiguous information and clueless about what to do, how to do with a notion to safeguard their own position. Employees are indulged in monotonous work for decades, tired of filling same forms, similar reports and same weekly meetings with boss. Shareholder value maximization is the major agenda. Royal Bank of Scotland (RBS) is a recent example for this where decision for investment in IT is side-lined for years to maximise profits of shareholders in short term. In this situation, board is not concerned for management issues rather they want getting thing done. Executives work as agents for shareholders and their representative board. Delay in decision making or no decision making is one of the challenge of such organisation. To implement a single decision which is a non-priority issue for board may take years in execution. Operation losses, errors and delays become deep rooted in such culture. Adaptation, innovation and change in process and systems become very challenging for implementation.

Stakeholder-focused

In my research on large institutions, I observed that organisational values are deep rooted in large institutions. Plethora of new management approaches have been adopted to provide high value to stakeholders in short term and long term: Total Quality Management, Employee empowerment, Continuous improvement, reengineering, kaizen and team building. Value based management (VBM) provides value to all stakeholders upon which entire metrics can be built. In this method, value of company is determined by its discounted cash flows and companies like to invest capital at returns that exceed its cost of capital. VBM has influenced companies’ major strategic and operational decision making. Now my questions arise: what is the long-term value of communication, informal meetings, networking, and risk management? Fraud could result due to operational negligence and it may cost first year $500. It can easily be ignored by board and management as it is not worth value discussion. Next year, it becomes $5000, it is discussed within management. Third year, it is deeply penetrated and costed $500000. Now board, regulator, media, credit rating agencies, shareholders, customer and you name any other stakeholder suddenly become worried. It shows, values are not only financial in nature rather, values are ethical and professional. It also guides dos and don’ts.

I believe in these three types of organisations that there is misalignment between management and governance. If management performance is simply not evaluated based on the targets given, rather than it should also be based on following ethics, corporate governance code of conduct, good organisational culture, employee and team development, a part of the problems can be reduced. Another approach could be rather than giving annual targets and predicting long term targets, company can set vision for achievement of long-term goals and break down it in yearly targets with greater degree of flexibility or believe in continuous learning. Remember, vision without implementation has no value. Share goal, collaborative working and team efforts can be linked to performance in new era where governance and management will work together to achieve organisational goals. I feel still many questions remain unanswered. Kindly share your thoughts what you feel as good governance during practice.