A comparative study of corporate governance practices of Indian firms affiliated to business groups and industries

• DOI: https://doi.org/10.1108/CG-03-2021-0095
• Published date: 09 September 2021
• Date: 09 September 2021
• Pages: 278-301
• Subject Matter: Strategy,Corporate governance
• Author: Pitabas Mohanty,Supriti Mishra

A comparative study of corporate

governance practices of Indian f‌irms

aff‌iliated to business groups and industries

Pitabas Mohanty and Supriti Mishra

Abstract

Purpose –This paper aims to study the corporate governance practices followed by the listed

companies in India to find out if industryand business group affiliation of firms influence their corporate

governancepractices.

Design/methodology/approach –The authors have created a corporate governance index for India

using 15 of the variables used in past research. Hierarchical regressionhas been used in the study to

controlfor possible inter-firm correlation in governancescores.

Findings –Using principal component analysis, the authors derive five factors for the corporate

governance index –board composition, shareholder responsibility, ownership, responsible board

behavior and fairexecutive compensation. Using the randomintercept mixed-effects model, the authors

find that corporate governance behaviors of firms affiliated to business groups are more similar within

businessgroups than within industries.

Practical implications –Regulatory authorities generally target individual firms to enforce good

corporate governance practices. As companies affiliated with the same business group exhibit similar

governancepractices, regulators can also set norms for businessgroups in addition to individual firms.

Originality/value –Scant research has studied the corporate governance behavior of firms affiliated

with business groups.By making business groups (and industries) the unitof analysis, the authors have

studied the corporate governancebehavior of firms as a cluster in the context of an emerging country,

India.

Keywords CLSA governance index, Components of corporate governance,

Corporate governance in India, Indian business groups, Mixed-effects model

Paper type Research paper

1. Introduction

A firm’s corporate governance (CG) practices are determined by an interplay of myriad

internal and external factors. Internal factors include board and corporate charters (Gillan

et al.,2003

), nature of agency problemsfaced by the firm (Tuschke and Sanders, 2003)and

ownership of the firm (Barucci and Falini, 2005;Borisova et al.,2012;Chen et al.,2006;

Lemmon and Lins, 2003). External factors include firms’ industry affiliation (Agrawal and

Knoeber, 2001;Gillan et al.,2003;Johnson et al.,2009) and country of operation (Sarhan

and Ntim, 2018). These internal and external factors work together to influence the CG

practices in firms. For example, ownership and industry factors together affect the board

composition (Agrawal and Knoeber, 2001). As an effective board alleviates agency issues

(Belikov, 2019;Dutra, 2012), many CG solutions center around having effective boards to

monitor the management (Fama and Jensen, 1983), separating the role of c hairman from the

chief executive officer (CEO) (Eisenhardt, 1989;Fama and Jensen, 1983) and having

performance-based executive compensation (Baker et al.,1988;Jensen and Murphy, 1990).

Pitabas Mohanty is based

at XLRI, Jamshedpur, India.

Supriti Mishra is based at

IMI Bhubaneswar,

Bhubaneswar, India.

JEL classif‌ication –G38, L00

Received 1 March 2021

Revised 17 August 2021

Accepted 18 August 2021

The authors grateful to the

participants at the World

Finance and Banking

Symposium, held in Bangkok,

December 14-15, 2017 for their

helpful feedback. Authors also

grateful to two anonymous

reviewers for their helpful

comments.

PAGE 278 jCORPORATE GOVERNANCE jVOL. 22 NO. 2 2022, pp. 278-301, ©EmeraldPublishing Limited, ISSN 1472-0701 DOI 10.1108/CG-03-2021-0095

Out of all the internal and external factors, ownership is considered the most critical factor

influencing CG firms (Jensen and Meckling, 1976;Tuschke and Sanders, 2003).

Ownership, being intrinsically related to agency costs, is central to understanding CG

(Fama and Jensen, 1983;Shleifer and Vishny, 1997). When ownership is concentrated, the

owner has an incentive and capacity to discipline managers, thereby mitigating the

principal-agent conflicts(Anderson and Reeb, 2003;Davis et al.,1997;Fan et al.,2011).

Past literature also establishes industry, part of the external environment in which a firm

operates, as a dominant factor in explaining CG in firms (Gillan et al.,2003). Firms in

industries that require lower capital expenditure and do not need to raise capital frequently

from the external capital market may not care much for the discipline or CG requirement

that the external capital market expects from firms (Khanna and Palepu, 2004). Also,

agency cost in “managerial slack” is either absent or less relevant in competitive industries

(Giroud and Mueller,2011, 2010). This leads to differences in CG practices followed in

competitive and non-competitive industries. Some of the determinants of CG such as

leverage and investment opportunities depend on the type of industry (Gillanet al., 2003).

Corporate governance issues differ between developed and developing countries (Faruqi

et al.,2019

). While much CG research has been conducted in the context of developed

countries, research in the context of developing countries is few (Esqueda and O’Connor,

2020;Klein et al.,2005). Past governance studies in emerging economies have looked at

the association between CG and firm value (Bhatt and Bhatt, 2017;Mishra and Mohanty,

2014), the willingness of the investors to pay a premium for well-governed Indian firms

(Coombes and Wong, 2004), the relationship between various board measures and firm

performance (Arora and Sharma,2016;Bhat et al.,2018;Mayur and Saravanan, 2017).

India, a developing country, provides a unique setting for CG research because of its CG

reforms which were introduced afterthe occurrence of a series of corporate scandals in the

1990s and beginning of the 21st century and the dominance of business groups in its

corporate landscape (Khanna and Palepu, 2000;Mishra and Mohanty, 2018). In this

context, a brief knowledge of thehistory of the prominent business houses (popularly known

as the business groups) in India is necessary to understand the unique CG environment in

India.

In the post-independence period after 1947 and before the economic reforms in 1991,

Indian companies were required to apply for a license to start any new business. This

period was known as the “License Raj” or the licensing regime (Majumdar, 2004). The

owners of the large businesses (popularly known as promoters) could obtain licenses to

start and expand different businesses by using their connections with the bureaucrats

(Khanna and Rivkin, 2001;Reed, 2002) while smaller firms found it difficult to get such

access and compete with large firms.

Excessive government control during the control regime also led to market imperfections

such as the absence of well-defined property rights (La Porta et al.,1999;Shleifer and

Vishny, 1997) and well-functioning capital and labor markets (Claessens and Fan, 2002;

Khanna and Palepu, 1997). However, these imperfections were compensated by business

groups who could raise most of the funds as debt capital from the development financial

institutions using their connections (Goswami, 2002;Reed, 2002). A part of the equity

capital could also be raisedfrom other group affiliated firms (Bertrand et al.,2002;Chauhan

et al., 2016;Shleifer and Vishny, 1997;Short, 1994). This enabled the promoters to control

the group firms with lower equity investment (Reed, 2002), which was, on average, as low

as 15% during the 1970s and 1980s and play a dominant role in the business landscape in

India. As prior to 1991, the legal enforcement mechanism was also weak in India, it allowed

these firms to escape many wrongdoingswithout much punishment (Goswami, 2002).

From 1956, the state-owned enterprises (SOEs) started playing an important role in India,

when several capital intensive sectors were either exclusively reserved for them or they

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