Corporate governance and firm performance in developing countries: evidence from India

• DOI: https://doi.org/10.1108/CG-01-2016-0018
• Published date: 04 April 2016
• Date: 04 April 2016
• Pages: 420-436
• Author: Akshita Arora,Chandan Sharma
• Subject Matter: Strategy,Corporate governance

Corporate governance and firm

performance in developing countries:

evidence from India

Akshita Arora and Chandan Sharma

Akshita Arora is based at

Department of Finance,

Banasthali Vidyapith,

Rajasthan, India.

Chandan Sharma is

based at Department of

Economics, Indian

Institute of Management,

Lucknow, India.

Abstract

Purpose –This study aims to examine the impact of corporate governance on firm performance for a

large representative sample.

Design/methodology/approach –This empirical analysis focuses on a large number of companies

covering 20 important industries of the Indian manufacturing sector for the period 2001-2010. Several

alternative specifications and estimation techniques are used for analysis purposes, including system

generalized methods of moments, which effectively overcomes the problem of endogeneity and

simultaneity bias.

Findings –On one side, the findings indicate that larger boards are associated with a greater depth of

intellectual knowledge, which in turn helps in improving decision-making and enhancing the

performance. On the other side, the results indicate that return on equity and profitability is not related

to corporate governance indicators. The results also suggest that CEO duality is not related to any firm

performance measures for the sample firms.

Practical implications –The outcomes of the analyses advocated that companies that comply with

good corporate governance practices can expect to achieve higher accounting and market

performance. It implies that good corporate governance practices lead to reduced agency costs.

Hence, it is concluded that firms of the developing world can possibly enhance their performance by

implementing good corporate governance practices.

Originality/value –Departing from the conventional system of the prior studies and instead of focusing

on a single measure framework, a range of measures of corporate governance and firm’s performance

variables are used. Also, several alternative specifications and estimation techniques are used for

analysis purposes. Furthermore, the sample also covers a large sample of manufacturing firms.

Keywords Corporate governance, Board of directors, Firm performance

Paper type Research paper

1. Introduction

The relationship between corporate governance and firm performance has been a widely

debated and well-researched topic in the developed countries context. However, in the

past few years, this issue has also been discussed in the context of emerging countries,

such as India, in light of the recent corporate collapses and scams[1]. The corporate

collapses resulting from a weak system of corporate governance highlighted the need to

improve and reform the governance structure. Firms’ governance plays an important role in

the probability of accounting frauds and firms which have a weak governance structure

being more prone to accounting frauds (Berkman et al., 2009). The failure in preventing

these scams has fuelled many debates on the effectiveness of current corporate

governance rules, principles, structures and mechanisms (Sun et al., 2011).

The firms with weaker governance structures have to face more agency problems and

managers of such firms gain more private benefits (Core et al., 1999). The theory of agency

problem suggests that the directors of a firm are not likely to be as careful with other

people’s money as with their own fund (Letza et al., 2004). The theory further states that the

main purpose of corporate governance is to provide assurance to the shareholders that

Received 21 April 2014

Revised 4 September 2015

26 January 2016

Accepted 29 January 2016

PAGE 420 CORPORATE GOVERNANCE VOL. 16 NO. 2 2016, pp. 420-436, © Emerald Group Publishing Limited, ISSN 1472-0701 DOI 10.1108/CG-01-2016-0018

managers are working toward achieving outcomes in the shareholders’ interests (Shleifer

and Vishny, 1997). Other important related theories, for instance, the Stewardship theory,

assume a strong relationship between the success of organization and shareholders’

satisfaction. A steward protects and maximizes shareholders’ wealth through firm

performance, because by doing so, the steward’s utility functions are maximized.

Importantly, the stakeholder theory suggests that a corporate seeks to provide a balance

between the interests of its diverse stakeholders (Abrams, 1951). John and Senbet (1998)

provided a comprehensive review of the stakeholder theory and pointed out the presence

of many parties with competing interests in the operations of the firm. They emphasized the

role of non-market mechanisms such as board size and committee structure as relevant

factors for firms’ performance. The resource dependency theory views agents as resources

who provide social and business networks and indicates that directors’ presence on the

board of other organizations is relevant to establish relationships to have access to

resources in the form of information which can be utilized for the firm’s benefit. Hence, this

theory shows that the strength of a corporate organization lies in the amount of relevant

information it has at its disposal. All the theories of corporate governance suggest for an

effective governance system which involves the appointment of board which includes both

executive as well as non-executive directors.

In the past two decades, there has been an increased intensity of research on the

relationship between corporate governance and firm performance. But the issue has mainly

been explored in developed economies (Hermalin and Weisbach, 1991;Kang and

Shivdasani, 1995;Gompers et al., 2003;Judge et al., 2003;Barnhart et al., 1994;Bauer

et al., 2004;Christopher, 2004;Bhagat and Bolton, 2002;Guest, 2008). The empirical work

on this issue is still at its infancy in the context of developing countries like India, maybe due

to the relatively opaque disclosure practices followed by companies or the data

unavailability problem. Moreover, most of the previous studies on India were either based

on small samples (Dwivedi and Jain, 2005;Ghosh, 2006;Garg, 2007;Jackling and Johl,

2009) with a limited number of observations or on cross-sectional data that do not allow

controlling for unobserved firm effects. For example, to examine the inter-linkage, Ghosh

(2006) used data of 127 listed manufacturing firms for the year 2003 and Garg (2007)

considered a sample of merely 164 companies. Likewise, Kohli and Saha (2008) analyzed

the impact of corporate governance on firm valuation in fast-moving consumer goods and

information technology sectors of India for a sample of 30 firms.

Against this backdrop, the objective of this study is to examine the impact of corporate

governance on firm’s performance for a large representative sample of Indian

manufacturing industry[2]. In doing so, we add several novelties to the existing literature.

First, to make our data set a representative sample of the Indian industry, our empirical

analysis focuses on a large number of companies covering 20 important industries of the

manufacturing sector. Second, we depart from the conventional system of the prior studies

of related literature and instead of focusing on a single measure framework, we utilize a

range of measures of corporate governance including board size, ownership and number

of meetings held, and firm’s performance indicators cover both market and financial

variables. This is important for checking robustness of results to explore the inter-linkage.

Third, recently it has been shown by Bhagat and Bolton (2002) that the linkage between

corporate governance and performance is of an endogenous nature and the regression

results are highly sensitive toward the use of estimation techniques. Bearing this issue in

mind, we use several alternative specifications and estimation techniques for analysis

purposes, including system generalized methods of moments (system-GMM), which

effectively overcomes the problem of endogeneity and simultaneity bias.

The remainder of this paper is organized as follows: Section 2 reviews the literature on the

relationship between corporate governance and firm performance; Section 3 discusses the

sample selection, its characteristics, data sources, construction of hypotheses and model

specification. Section 4 presents the empirical results on the relationship between

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