Cadbury Committee Report
Cadbury Committee Report
The 'Cadbury Committee' was set up in May 1991 with a view to overcome the huge problems of scams and failures occurring in the corporate sector worldwide in the late 1980s and the early 1990s. It was formed by the Financial Reporting Council, the London Stock of Exchange and the accountancy profession, with the main aim of addressing the financial aspects of Corporate Governance. Other objectives include: (i) uplift the low level of confidence both in financial reporting and in the ability of auditors to provide the safeguards which the users of company's reports sought and expected; (ii) review the structure, rights and roles of board of directors, shareholders and auditors by making them more effective and accountable; (iii) address various aspects of accountancy profession and make appropriate recommendations, wherever necessary; (iv) raise the standard of corporate governance; etc. Keeping this in view, the Committee published its final report on 1st December 1992. The report was mainly divided into three parts:-
Reviewing the structure and responsibilities of Boards of Directors and recommending a Code of Best Practice The boards of all listed companies should comply with the Code of Best Practice. All listed companies should make a statement about their compliance with the Code in their report and accounts as well as give reasons for any areas of non-compliance. The Code of Best Practice is segregated into four sections and their respective recommendations are:1. Board of Directors - The board should meet regularly, retain full and effective control over the company and monitor the executive management. There should be a clearly accepted division of responsibilities at the head of a company, which will ensure a balance of power and authority, such that no one individual has unfettered powers of decision. Where the chairman is also the chief executive, it is essential that there should be a strong and independent element on the board, with a recognised senior member. Besides, all directors should have access to the advice and services of the company secretary, who is responsible to the Board for ensuring that board procedures are followed and that applicable rules and regulations are complied with. Non-Executive Directors - The non-executive directors should bring an independent judgement to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct. The majority of non-executive directors should be independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgment, apart from their fees and shareholding. Executive Directors - There should be full and clear disclosure of directors total emoluments and those of the chairman and highest-paid directors, including pension contributions and stock options, in the company's annual report, including separate figures for salary and performance-related pay. Financial Reporting and Controls - It is the duty of the board to present a balanced and understandable assessment of their companys position, in reporting of financial statements, for providing true and fair picture of financial reporting. The directors should report that the business is a going concern, with supporting assumptions or qualifications as necessary. The board should ensure that an objective and professional relationship is maintained with the auditors.
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Considering the role of Auditors and addressing a number of recommendations to the Accountancy Profession The annual audit is one of the cornerstones of corporate governance. It provides an external and objective check on the way in which the financial statements have been prepared and presented by the directors of the company. The Cadbury Committee recommended that a professional and objective relationship between the board of directors and auditors should be maintained, so as to provide to all a true and fair view of company's financial statements. Auditors' role is to design audit in such a manner so that it provide a reasonable assurance that the financial statements are free of material misstatements. Further, there is a need to develop more effective accounting standards, which provide important reference points against which auditors exercise their professional judgement. Secondly, every listed company should form an audit committee which gives the auditors direct access to the non-executive members of the board. The Committee further
recommended for a regular rotation of audit partners to prevent unhealthy relationship between auditors and the management. It also recommended for disclosure of payments to the auditors for non-audit services to the company. The Accountancy Profession, in conjunction with representatives of preparers of accounts, should take the lead in:- (i) developing a set of criteria for assessing effectiveness; (ii) developing guidance for companies on the form in which directors should report; and (iii) developing guidance for auditors on relevant audit procedures and the form in which auditors should report. However, it should continue to improve its standards and procedures.
Dealing with the Rights and Responsibilities of Shareholders The shareholders, as owners of the company, elect the directors to run the business on their behalf and hold them accountable for its progress. They appoint the auditors to provide an external check on the directors financial statements. The Committee's report places particular emphasis on the need for fair and accurate reporting of a company's progress to its shareholders, which is the responsibility of the board. It is encouraged that the institutional investors/shareholders to make greater use of their voting rights and take positive interest in the board functioning. Both shareholders and boards of directors should consider how the effectiveness of general meetings could be increased as well as how to strengthen the accountability of boards of directors to shareholders.
review the performance of corporate governance; and determine the role of companies in responding to rumour and other price sensitive information circulating in the market, in order to enhance the transparency and integrity of the market.
The issues discussed by the committee primarily related to audit committees, audit reports, independent directors, related parties, risk management, directorships and director compensation, codes of conduct and financial disclosures. The committee's recommendations in the final report were selected based on parameters including their relative importance, fairness, accountability, transparency, ease of implementation, verifiability and enforceability.
strengthening the responsibilities of audit committees; improving the quality of financial disclosures, including those related to related party transactions and proceeds from initial public offerings; requiring corporate executive boards to assess and disclose business risks in the annual reports of companies; introducing responsibilities on boards to adopt formal codes of conduct; the position of nominee directors; and stock holder approval and improved disclosures relating to compensation paid to non-executive directors.
moving to a regime where corporate financial statements are not qualified; instituting a system of training of board members; and evaluation of performance of board members.
As per the committee, these recommendations codify certain standards of 'good governance' into specific requirements, since certain corporate responsibilities are too important to be left to loose concepts of fiduciary responsibility. Their implementation through SEBI's regulatory framework will strengthen existing governance practices and also provide a strong incentive to avoid corporate failures. The Committee noted that the recommendations contained in their report can be implemented by means of an amendment to the Listing Agreement, with changes made to the existing clause 49.
suggest suitable amendments to the listing agreement executed by the stock exchanges with the companies and any other measures to improve the standards of corporate governance in the listed companies, in areas such as continuous disclosure of material information, both financial and nonfinancial, manner and frequency of such disclosures, responsibilities of independent and outside directors; draft a code of corporate best practices; and suggest safeguards to be instituted within the companies to deal with insider information and insider trading.
The primary objective of the committee was to view corporate governance from the perspective of the investors and shareholders and to prepare a Code' to suit the Indian corporate environment. The committee had identified the Shareholders, the Board of Directors and the Management as the three key constituents of corporate governance and attempted to identify in respect of each of these constituents, their roles and responsibilities as also their rights in the context of good corporate governance.
Corporate governance has several claimants shareholders and other stakeholders - which include suppliers, customers, creditors, and the bankers, the employees of the company, the government and the society at large. The Report had been prepared by the committee, keeping in view primarily the interests of a particular class of stakeholders, namely, the shareholders, who together with the investors form the principal constituency of SEBI while not ignoring the needs of other stakeholders. Mandatory and non-mandatory recommendations The committee divided the recommendations into two categories, namely, mandatory and non- mandatory. The recommendations which are absolutely essential for corporate governance can be defined with precision and which can be enforced through the amendment of the listing agreement could be classified as mandatory. Others, which are either desirable or which may require change of laws, may, for the time being, be classified as non-mandatory. Mandatory Recommendations:
Applies To Listed Companies With Paid Up Capital Of Rs. 3 Crore And Above Composition Of Board Of Directors Optimum Combination Of Executive & Non-Executive Directors Audit Committee With 3 Independent Directors With One Having Financial And Accounting Knowledge. Remuneration Committee Board Procedures Atleast 4 Meetings Of The Board In A Year With Maximum Gap Of 4 Months Between 2 Meetings. To Review Operational Plans, Capital Budgets, Quarterly Results, Minutes Of Committee's Meeting.Director Shall Not Be A Member Of More Than 10 Committee And Shall Not Act As Chairman Of More Than 5 Committees Across All Companies Management Discussion And Analysis Report Covering Industry Structure, Opportunities, Threats, Risks, Outlook, Internal Control System Information Sharing With Shareholders
Non-Mandatory Recommendations:
Role Of Chairman Remuneration Committee Of Board Shareholders' Right For Receiving Half Yearly Financial PerformancePostal Ballot Covering Critical Matters Like Alteration In Memorandum Etc Sale Of Whole Or Substantial Part Of The Undertaking Corporate Restructuring Further Issue Of Capital Venturing Into New Businesses
As per the committee, the recommendations should be made applicable to the listed companies, their directors, management, employees and professionals associated with such companies, in accordance with the time table proposed in the schedule given later in this section. Compliance with the code should be both in letter and spirit and should always be in a manner that gives precedence to substance over form. The ultimate responsibility for putting the recommendations into practice lies directly with the board of directors and the management of the company. The recommendations will apply to all the listed private and public sector companies, in accordance with the schedule of implementation. As for listed entities, which are not companies, but body corporates (e.g. private and public sector banks, financial institutions, insurance companies etc.) incorporated under other statutes, the recommendations will apply to the extent that they do not violate their respective statutes, and guidelines or directives issued by the relevant regulatory authorities . The Committee recognizes that compliance with the recommendations would involve restructuring the existing boards of companies. It also recognizes that some companies, especially the smaller ones, may have difficulty in immediately complying with these conditions. The recommendations were implemented through Clause 49 of the Listing Agreements, in a phased manner
by SEBI.
A qualified and independent audit committee shall be set up and that: 1. 2. 3. 4. audit committee shall have minimum three members, all being non-executive directors, with the majority of them being independent, and with at least one director having financial and accounting knowledge; chairman of the committee shall be an independent director; chairman shall be present at Annual General Meeting to answer shareholder queries; audit committee should invite such of the executives, as it considers appropriate (and particularly the head of the finance function) to be present at the meetings of the committee, but on occasions it may also meet without the presence of any executives of the company. The finance director, head of internal audit and when required, a representative of the external auditor shall be present as invitees for the meetings of the audit committee; company secretary shall act as the secretary to the committee.
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The audit committee shall meet at least thrice a year. One meeting shall be held before finalisation of annual accounts and one every six months. The quorum shall be either two members or one third of the members of the audit committee, whichever is higher and minimum of two independent directors. The audit committee shall have powers, which should include the following to: 1. 2. 3. 4. investigate any activity within its terms of reference. seek information from any employee. obtain outside legal or other professional advice. secure attendance of outsiders with relevant expertise, if it considers necessary.
The role of the audit committee shall include the following. 1. 2. Oversight of the company's financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible. Recommending the appointment and removal of external auditor, fixation of audit fee and also approval for payment for any other services.
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Reviewing with management the annual financial statements before submission to the board, focusing primarily on;
Any changes in accounting policies and practices. Major accounting entries based on exercise of judgement by management. Qualifications in draft audit report. Significant adjustments arising out of audit. The going concern assumption. Compliance with accounting standards. Compliance with stock exchange and legal requirements concerning financial statements Any related party transactions i.e. transactions of the company of material nature, with promoters or the management, their subsidiaries or relatives etc. that may have potential conflict with the interests of company at large.
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Reviewing with the management, external and internal auditors, and the adequacy of internal control systems. Reviewing the adequacy of internal audit function, including the structure of the internal audit department, staffing and seniority of the official heading the department, reporting structure coverage and frequency of internal audit. Discussion with internal auditors any significant findings and follow up there on. Reviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the matter to the board. Discussion with external auditors before the audit commences nature and scope of audit as well as have post-audit discussion to ascertain any area of concern. Reviewing the company's financial and risk management policies.
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10. To look into the reasons for substantial defaults in the payment to the depositors, debenture holders, shareholders (in case of non payment of declared dividends) and creditors.
If the company has set up an audit committee pursuant to provision of the Companies Act, the said audit committee shall have such additional functions / features as is contained in the Listing Agreement.
Remuneration of Directors
The remuneration of non-executive directors shall be decided by the board of directors. The following disclosures on the remuneration of directors shall be made in the section on the corporate governance of the annual report. 1. 2. 3. 4. All elements of remuneration package of all the directors i.e. salary, benefits, bonuses, stock options, pension etc. Details of fixed component and performance linked incentives, along with the performance criteria. Service contracts, notice period, severance fees. Stock option details, if any and whether issued at a discount as well as the period over which accrued and over which exercisable.
Board Procedure
The board meeting shall be held at least four times a year, with a maximum time gap of four
The director shall not be a member in more than 10 committees or act as Chairman of more than five committees across all companies in which he is a director. Furthermore it should be a mandatory annual requirement for every director to inform the company about the committee positions he occupies in other companies and notify changes as and when they take place.
Management
As part of the directors' report or as an addition there to, a Management Discussion and Analysis report should form part of the annual report to the shareholders. This Management Discussion & Analysis should include discussion on the following matters within the limits set by the company's competitive position: 1. 2. 3. 4. 5. 6. 7. 8. Industry structure and developments. Opportunities and Threats. Segmentwise or product-wise performance. Outlook Risks and concerns. Internal control systems and their adequacy. Discussion on financial performance with respect to operational performance. Material developments in Human Resources / Industrial Relations front, including number of people employed.
Disclosures must be made by the management to the board relating to all material financial and commercial transactions, where they have personal interest that may have a potential conflict with the interest of the company at large (for e.g. dealing in company shares, commercial dealings with bodies, which have shareholding of management and their relatives etc.)
Shareholders
In case of the appointment of a new director or re-appointment of a director the shareholders must be provided with the following information: 1. 2. 3. A brief resume of the director; Nature of his expertise in specific functional areas; and Names of companies in which the person also holds the directorship and the membership of Committees of the board.
The information like quarterly results, presentation made by companies to analysts shall be put on company's web-site, or shall be sent in such a form so as to enable the stock exchange on which the company is listed to put it on its own web-site. A board committee under the chairmanship of a non-executive director shall be formed to specifically look into the redressing of shareholder and investors complaints like transfer of shares, non-receipt of balance sheet, non-receipt of declared dividends etc. This Committee shall be designated as Shareholders/Investors Grievance Committee'. To expedite the process of share transfers the board of the company shall delegate the power of share transfer to an officer or a committee or to the registrar and share transfer agents. The delegated authority shall attend to share transfer formalities at least once in a fortnight.
Report on Corporate Governance There shall be a separate section on Corporate Governance in the annual reports of company, with a detailed compliance report on Corporate Governance. Non-compliance of any mandatory requirement i.e. which is part of the listing agreement with reasons there of and the extent to which the non-mandatory requirements have been adopted should be specifically highlighted. Compliance
A company shall obtain a certificate from the auditors of the company regarding compliance of conditions of corporate governance as stipulated in this clause and annexe the certificate with the directors' report, which is sent annually to all the shareholders of the company. The same certificate shall also be sent to the Stock Exchanges along with the annual returns filed by the company.