Board Structure and Firm Performance: Evidence from India's Top Companies

• Date: 01 July 2009
• Published date: 01 July 2009
• Author: Beverley Jackling,Shireenjit Johl
• DOI: http://doi.org/10.1111/j.1467-8683.2009.00760.x

Board Structure and Firm Performance:

Evidence from India’s Top Companies

Beverley Jackling* and Shireenjit Johl**

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This paper investigates the relationship between internal governance structures and f‌inancial

performance of Indian companies. The effectiveness of boards of directors, including board composition, board size, and

aspects of board leadership including duality and board busyness are addressed in the Indian context using two theories of

corporate governance: agency theory and resource dependency theory.

Research Findings/Insights: The study used a sample of top Indian companies taking into account the endogeneity of the

relationships among corporate governance, corporate performance, and corporate capital structure. The study provides

some support for aspects of agency theory as a greater proportion of outside directors on boards were associated with

improved f‌irm performance. The notion of separating leadership roles in a manner consistent with agency theory was not

supported. For instance, the notion that powerful CEOs (duality role, CEO being the promoter, and CEO being the only

board manager) have a detrimental effect on performance was not supported. There was some support for resource

dependency theory. The f‌indings suggest that larger board size has a positive impact on performance thus supporting the

view that greater exposure to the externalenvironment improves access to various resources and thus positively impacts on

performance. The study however failed to support the resource dependency theory in terms of the association between

frequency of board meetings and performance. Similarly the results showed that outside directors with multiple appoint-

ments appeared to have a negative effect on performance, suggesting that “busyness” did not add value in terms of

networks and enhancement of resource accessibility.

Theoretical/Academic Implications: The two theories of corporate governance, namely agency and resource dependence

theory, were each only partially supported, by the f‌indings of this study. The f‌indings add further to the view that no single

theory explains the nexus between corporate governance and performance.

Practitioner/Policy Implications: This study demonstrates that corporate governance measures utilized in developed

economies related to boards of directors have some synergies and relevance to emerging economies, such as India.

However, the nature of business structures in India, for example the large number of family businesses, may limit the

generalizability of the f‌indings and signals the need for further investigation of these businesses. The evidence related to

multiple appointments of directors suggests that there may be support for restricting the number of directorships held by

any one individual in emerging economies, given that the “busyness” of directors was negatively associated with f‌irm

performance.

Keywords: Corporate Governance, Board of Directors, Firm Performance, Clause 49, India

INTRODUCTION

In recent years the attention and interest in corporate gov-

ernance1has grown exponentially especially with the

major corporate collapses (e.g., Enron, WorldCom, HIH,

Harris Scarfe, One.Tel) in the US and Australia. The need for

strong governance is evidenced by the various reforms and

standards developed not onlyat the country level, but also at

an internationallevel (e.g., the Sarbanes-Oxley Act in the US,

CLERP 9 in Australia, Combined Code in the UK, and the

Organization for Economic Development [OECD] Code).

Typically, corporate governance research has focused on

developed economies (Daily, Dalton, & Cannella, 2003; Raja-

gopalan & Zhang, 2008). However, limited research exists

on the extent to which the corporate governance issues

Address for correspondence: *Faculty of Business and Law, Victoria University, City

Flinders Campus, 300 Flinders Street, Melbourne, Victoria 3000, Australia. Tel: 61 3

9919 1541; E-mail: beverley.jackling@vu.edu.au; **School of Accounting, Economics

and Finance, Deakin University,Burwood Campus, 70 Elgar Road, Burwood, Victoria

3125, Australia. Tel:61 3 9251 7360; E-mail: shireenjit.johl@deakin.edu.au

492

Corporate Governance: An International Review, 2009, 17(4): 492–509

© 2009 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2009.00760.x

of developed economies are applicable to emerging econo-

mies. A major impetus for investigating the corporate

governance of emerging economies such as India is the sig-

nif‌icant growth in the listing of companies from emerging

economies on international stock exchanges. This develop-

ment has been accompanied by a drive within emerging

economies to attract more foreign direct investment as a

means of promoting a country’s long-term economic devel-

opment. As such the focus on foreign investment develop-

ment in India has necessitated a more transparent approach

to corporate operations.

Effective corporate governance also assists in the

attainment of high level f‌inancial performance and market

valuation (Klapper & Love, 2004; Rajagopalan & Zhang,

2008). La Porta, Lopez-de-Silanes, Shleifer, and Vishny

(2000) argue that emerging economies have traditionally

been discounted in f‌inancial markets because of their weak

governance. Therefore an investigation of aspects of the

composition and operation of boards as an important driver

in corporate governance may provide insights to improve-

ments in corporate governance in an emerging economy

such as India.

This paper specif‌ically investigates aspects of corporate

governance in India linked to the board-performance nexus.

The research is motivated by the Securities and Exchange

Board of India’s (SEBI) recommendations to address the

corporate governance challenges that face the country as

its opportunities for investment and growth emerge. The

study includes an examination of various aspects of the

effectiveness of boards of directors, including board compo-

sition, board size, aspects of the board leadership, and board

activity in relation to f‌inancial performance. These aspects of

corporate governance have been identif‌ied as central to the

development of good corporate governance in organiza-

tions.

The paperis expected to contribute to research by expand-

ing the understanding of the governancestructures and f‌irm

performance in India. The study focuses on the board of

directors’ composition, activity, and size as measures of cor-

porate governancegiven that boards play a central role in the

corporate governance of publicly listed companies. Aspects

of board leadership and composition are particularly impor-

tant in the Indian context given recent changes in legislation

and regulations that outline specif‌ic requirements for board

structure (Lange & Sahu, 2008). Furthermore as there is evi-

dence to suggest that there are country specif‌ic factors that

may impact on corporate governance relationships (Guest,

2008) this study provides an opportunity to examine if

factors traditionally linked with corporate governance in

western economies hold for the Indian market. As there is

limited research on corporate governance in India the

examination of specif‌ic features of corporate governance

related to the role of the board of directors provides insights

for India’s engagement with the global f‌inancial market.

The paper is structured as follows: the next section pro-

vides a background on corporate governance in India, fol-

lowed by a review of the literature relating to board

structure (board size, board composition, board leadership,

and board activity), and its association or relationship to

f‌irm performance. The fourth section describes the data

selection procedures and research methods employed.Find-

ings and analysis are presented in the f‌ifth section,while the

f‌inal section summarizes and concludes the paper.

BACKGROUND TO CORPORATE

GOVERNANCE IN INDIA

The study of corporate governance in India is important as

this type of economy possibly has a number of unique gov-

ernance issues not prevalent in more widely researched

developed economies. This section of the paper provides an

overview of signif‌icant regulatory changes related to corpo-

rate governancein India that have taken place in recent times

and provides a background to the unique aspects of gover-

nance. Evidence is provided that the legal and institutional

structures that underpin governance practices employed in

western developed economies may not be applicable in

emerging countries such as India. Furthermore, governance

issues in India may be compounded by the nature of corpo-

rate ownership where family-run businesses dominate the

ownership structure.

Various reforms were undertaken in the 1990s to improve

corporate governance in India, the most important event

being the formation of the Securities and Exchange Board of

India (SEBI) in 1992. The establishment of the SEBI resulted

in the formation of four major committees (Bajaj Committee

in 1996, Birla Committee in 2000, Chandra Committee in

2002, and the Narayanan Murthy Committee in 2003) to

review governance issues and to propose governance laws

and reforms. The governance reforms and recommendations

advocated by these committees were formally implemented

by the SEBI, for example through the enactment of Clause 49

of the Listing Agreements. These reforms include increasing

the number of outside directors,2dealing with the issue of

duality and the existence of f‌inancial expertise of directors.

There has also been change to Clause49 of the Listing Agree-

ment by the SEBI in 2005 (effective from January 1, 2006)

requiring a minimum number of outside directors on boards

of directors. It is anticipated that these changes to the com-

position and operation of boards of directors as measures

designed to improve corporate governance, may also be

ref‌lected in improved f‌irm performance.

Signif‌icant differences also exist in enforcement stan-

dards, the ownership structures and business practices,

between western economies and those of India. For

example, although India as a former British colony has a

tradition of a highly developed judicial system, the legal

system has been clogged and the courts overburdened

(Chakrabarti, Megginson, & Yadav, 2008). There have also

been diff‌iculties in enforcing compliance with security

market regulation, particularly in areas such as price

manipulation and insider trading (Bose, 2005).

Of the top Indian companies360 per cent (making up 65

per cent of the total market capitalization), are family-run

business groups.4The actual ownership of family-run com-

panies is opaque given the widespread use of pyramiding,

cross-holdings, and the use of non-public trusts (Chakra-

barti et al., 2008). The characteristics of family-owned busi-

nesses are expected to have unique agency problems linked

with corporate governance and f‌irm performance. Family-

run companies may also present challenges in terms of

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Volume 17 Number 4 July 2009© 2009 Blackwell Publishing Ltd