Evolution of corporate governance in India and its impact on the growth of the financial market: an empirical analysis (1995-2014)

Pages945-984
Published date07 October 2019
Date07 October 2019
DOIhttps://doi.org/10.1108/CG-07-2018-0255
AuthorShouvik Kumar Guha,Navajyoti Samanta,Abhik Majumdar,Mandeep Singh,Ananya Bharadwaj
Subject MatterStrategy
Evolution of corporate governance in India
and its impact on the growth of the
nancial market: an empirical analysis
(1995-2014)
Shouvik Kumar Guha, Navajyoti Samanta, Abhik Majumdar, Mandeep Singh and
Ananya Bharadwaj
Abstract
Purpose The past few decades have seen a gradual convergence in corporate governance norms the
world over, entailing a discernible shift towards shareholder primacy models. It holds particularly true of
developing countries, many of which have steadily amended corporate governancenorms to enhance the
scope of shareholder rights. This is usually justifiedthrough the rationale that increasing protection for foreign
investors and shareholders would mean greater investment in capital market and overall financial market
development. In India, the shift coincides with a seri es of fundamental economic and financial policy reforms
initiated in the 1990s: collectively and looselyreferred to as ‘‘liberalisation’’, this process marks a paradigm-
shift from a tightly controlled welfare economy to one considerably more lai ssez-faire in its orientation. A
fallout of which was that the need to attract and sustain foreign investments acquired an unprecedented
significance. The purpose of this paper isto help the readers understand in this larger context the corporate
law reform initiatives in India, particularlythose pertaining to shareholder rights and allied issues.
Design/methodology/approach This paper empirically tests the hypothesis that enhanced shareholder
protection leads to greater levels of investments, and financial developments generally. It then uses re gression
analysis to detect if the change in corporate governance, making it more shareholder-fri endly, has had any
effect on growth in financial market. It is divided into two broad parts. The first tracks the evolution of corporate
governance norms in India. A robust qualitative and quantitative an alysis is used to determine the tilt towards a
shareholder primacy regime that Indian corporate governance re gime now displays. The second chapter
deals with the regression analysis where the outcome variable is financ ial market growth, and explanatory
variable is the changein the governance regime with relevant control variables.
Findings The authorsfind that change in shareholder primacy corporategovernance has little effect on
financial market growth in India. The authorswould suggest that instead of changing the law in books,
more emphasisshould be given to implement those regulationsand increase the overall rule of law.
Originality/value This is the first timethat such a wide-scale study has been conductedin India, using
Bayesianmethods. It ought to be of immense value to professionalsand academics both.
Keywords Law and finance, Leximetrics, Comparative corporate governance,
Corporate governance and financial market growth
Paper type Research paper
1. Introduction
It is clear that good corporate governance makes good sense. The name of the game for a company
in the 21st Century will be conform while it performs. - Mervyn King (Chairperson: King Report)
In the light of the intense competition and dynamism that prevails in the Indian business
environment at present, one of the keysto long-term growth and success appears to be the
Shouvik Kumar Guha is
based at the Department of
Law, The West Bengal
National University of
Juridical Sciences, Kolkata,
India. Navajyoti Samanta is
based at the School of Law,
University of Sheffield,
Sheffield, UK.
Abhik Majumdar is based
at the National Law
University, Cuttack, India.
Mandeep Singh is based at
the School of Law,
University of Sheffield,
Sheffield, UK.
Ananya Bharadwaj is
based at the KIIT
University, Bhubaneswar,
India.
Received 30 July 2018
Revised 1 February 2019
Accepted 7 February 2019
DOI 10.1108/CG-07-2018-0255 VOL. 19 NO. 5 2019, pp. 945-984, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 945
ability to strike a fine balance between sound corporate governance practice on the one
hand and a sustainable growth model on the other[1]. Corporate governance has become
an integral component of myriad issues ranging from business standards to accounting
standards, from corporate social responsibility to supply chain management, from a means
for averting potential financial crisis to a tool for ensuring macro/microeconomic stability, to
a contributor towards theimprovement of the overall political economy[2]. Almost all strands
of interdisciplinary studies in law, economics and finance have by now felt the
omnipresence and impact of corporate governance. For a long time, the connection
between corporate governance and multiple business interests and disciplines was merely
ideological and mostly theoretical, while on the ground, the impact of scholarly work on
corporate governance was at best ignored and at worst ridiculed for its perceived lack of
sound business efficacy. However, over the years, with repeated accounting frauds and
related crises, there has been a growing clamour for an efficient solution to prevent such
issues from arising in the first place and seekto resolve them in an expedited fashion if they
do; this, in turn, encouraged theoreticians and practitioners to seek recourse to the
traditional notions of corporate governance and ‘reinvent’ the same, albeit in a modern
guise, in the early 1990s.
The emergence, or rather, the revival of this discipline took the world by quite a storm,
having captured the attention of many a stakeholder with its potential. This coincided with
the period following the grand success of the neo-liberal economic principles of 1980s,
which coupled with the fall of the erstwhile Soviet Union, seemed to provide conclusive
evidence of the relative superiority of free market principles over interference by the State
via a controlled economy. The free flow of ideas across national and notional boundaries
soon ensued, which in turn led to quite an intense period that encouraged rapid
transplantation of legal ideas the corporate sector was not outside the sphere ofinfluence
of such change and indeed, one may even opine that the two decades ranging from 1995
to 2014 witnessed a hitherto unforeseen convergence of global corporate law standards on
an almost exponential scale[3]. The only period which even comes close is the period of
imperialism and colonialism, and even then the transplantation of law was a relatively slow
process, externally imposed in a forceful manner as it used to be for the most part, rather
than consensual cooperation. It was not any colonial power this time that ushered in such
transplantation, rather international financial organisations, which thought of this way to be
the most efficacious oneto consolidate their presence in the global business scenario.
Such organisations promised that ‘[T]he improvement of corporate governance practices is
widely seen as one important element in strengthening the foundation for individual
countries’ long-term economic performance and in contributing to a strengthened
international financial system’[4]. This economic rationale was also picked up by the United
Nations Conference on Trade and Development, which stated that improvements to
corporate governance would ‘facilitate investment flows and mobilisefinancial resources for
economic development’[5]. The scope of this paper is limited to exploring the degree of
fulfilment, at least within the Indian context, of the promise of adopting shareholder primacy
and corporate governance norms being beneficial towards higher financial market growth,
thereby justifying convergence and transplantation, specifically in the area of company law
and corporate governancein developing countries.
The major corporate governance code available around this timeperiod that could serve as
a global benchmark was the OECD Principles of Corporate Governance, which was based
primarily on the shareholder value corporate governance model, although it also provided
limited space for stakeholder models. So in effect what was being recommended to
developing countries was a shareholder value model based on the Anglo-Saxon template.
The claim that was being popularlyextended at that juncture was that if a country adopted a
shareholder primacy corporate governance model, then foreign investors would invest in
that country, stimulating the financial market and local investors would also pitch in, leading
PAGE 946 jCORPORATE GOVERNANCE jVOL. 19 NO. 5 2019
to further growth of the financial market. Surplus capital can be used for economically
useful, but less well-funded,activities, leading to economic growth and a sustainable future.
The present paper empirically investigates[6] these claims in the Indian context and tries to
find out whether changing the corporate governance in India for the “better”, that is, by
implementing a pro-shareholder approach, has any correlation with financial market growth.
Part II of the paper provides a brief outlay of methodology adopted in this research,
whereas Part III provides a general overview of the Indian corporate governance scenario,
to be followed by a qualitative analysis of evolution of corporate governance and its myriad
forms in India in Part IV. Part V of the paper continues with the quantitative counterpart of
said analysis, thereby complementing Part IV in the process. Part VI seeks to provide a
quantitative contrast and analysis of the changes in governance mechanisms in the Indian
corporate sphere and explore the correlation of the same to the financial market growth,
with the conclusions of the paper beingfinally reflected in Part VII.
2. Methodology
The research delineated in this paper consists of multiple steps, the first of which has been
the creation of a database on the evolution of corporate governance in India for 20 years
(1995-2014), consisting of information on fifty-two separate companies using corporate
governance variables based on the OECD Principles of Corporate Governance and
previous indices during aforesaid period. The variables have been scaled polynomially, i.e.
the value could be zero, or one, or two; this necessitated a survey that would go beyond a
simple yes/no response in order to take into account systems using optional rules or “soft
law”. A detailed descriptionof variables is available in Appendix A, while the filled-up coded
questionnaire for India is availablein Appendix E.
The second step consists of using a graded response model with a Kalman filter, so as to
create a dynamic corporate governance index for India, which would in turn allow
distribution of the changes identified over a period of time, ratherthan confining them to just
one specific year. It is widely acknowledged that laws and regulations take some time to
show their impact in full, hence considering development of corporate governance over a
number of years are meant to yield more realistic results. Codes for the model have been
made available in Appendix D. A Bayesian factor analysis has been used to build up a
separate multiyear index of financial market growth consisting of five variables foreign
direct investment (FDI), market capitalisation of listed companies, S&P global equity index,
volume of stocks traded and the number of listed domestic companies to represent the
financial growth of countries. These variables are discussed in detail in Appendix B. Three
control indices of similar timescales comprised a total of 10 variables annual percentage
growth rate of GDP, purchasing power parity conversion factor, current account balance,
real interest rate, external debt stocks, commercial bank branches per head of population,
mobile cellular telephone subscriptions per head of population, electric power consumption
per capita, high-technology (products with high R&D intensity) exports in current US$ and
the number of patent and trademark applications filed at USPTO; all said control variables
are discussed at length in Appendix C. Following this, Bayesian change point analysis has
then been used to identify the breakpoints, i.e. the period or particular year when there was
a regime shift (a substantial movement away from the previous distribution or, qualitatively
speaking, a “complete” change from the previous system). Codes for this analysis have
been made available in Appendix D. In the corporate governance development index, a
breakpoint signifies a complete change from the previous system, usually in the form of a
completely new corporate governance code that changes the previous system. In the
financial market development index, a breakpoint signifies either a market high or low,
compared with recent statistics, and so usually coincides with the peak of a boom or the
trough of a bust.
VOL. 19 NO. 5 2019 jCORPORATE GOVERNANCE jPAGE947

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