Corporate Governance Mechanisms and Firm Performance: Lessons from India (India Studies in Business and Economics) 9811924597, 9789811924590

Table of contents :
Preface
Acknowledgements
Contents
About the Authors
Abbreviations
List of Figures
List of Tables
List of Appendices
1 Introduction
1.1 Background
1.2 Overview of the Study
1.3 Research Questions
1.4 Research Objectives
1.5 Significance of the Study
1.6 Organization of the Monograph/Book Chapters
Annexure I
References
2 Evolution of Corporate Governance in India
2.1 Evolution of Corporate Governance in India
2.2 Legal Evolution of Corporate Governance in India
2.3 Provisions of the Revised Clause 49 of the Listing Agreement
2.3.1 Independent Directors
2.3.2 Code of Conduct
2.3.3 Audit, Nomination and Remuneration Committees
2.3.4 Subsidiary Companies
2.3.5 Related Party Transactions (RPTs)
2.3.6 Remuneration and Shareholding of Non-executive Directors
2.4 Recent Regulatory Developments on Corporate Governance
2.5 Alternate Corporate Governance Mechanisms
2.5.1 Ownership Structure
2.5.2 Board Monitoring
2.5.3 Audit Quality
2.5.4 Market for Corporate Control
2.5.5 Product Market Competition
2.6 Interrelationship Among Corporate Governance Mechanisms
2.6.1 Performance Enhancement Effect of Board Independence (Through Other Governance Mechanisms)
2.6.2 Mechanisms Diluting the Effectiveness of Board Independence
2.7 Summary
References
3 Research Methodology
3.1 Introduction
3.2 Research Objectives and Research Hypotheses
3.3 Scope of the Study
3.3.1 Why Study an Emerging Economy?
3.3.2 Why Study Indian Companies?
3.3.3 Period of the Study
3.3.4 Sample Selection Process
3.4 Research Methodology
3.4.1 Measures/Proxies
3.4.2 Research Methodologies Used
3.4.3 Sources of Data and Research Tools Used
3.5 Summary and Conclusion
References
4 Corporate Governance Mechanisms and Firm Performance
4.1 Introduction
4.2 Methodology
4.2.1 Sample and Scope
4.2.2 Research Methodology
4.2.3 Layout of Empirical Analysis
4.3 Analysis and Findings
4.4 Discussion
4.5 Implications and Recommendations
4.6 Summary and Conclusion
Appendices
References
5 Performance Enhancement Effect of Board Independence
5.1 Introduction
5.2 Methodology
5.2.1 Measures and Scope
5.2.2 Research Methodology
5.2.3 Layout of Empirical Analysis
5.3 Analysis and Findings
5.3.1 Board Independence, Audit Quality and Firm Performance
5.3.2 Board Independence, Foreign Institutional Investment and Firm Performance
5.4 Discussion
5.5 Implications and Recommendations
5.6 Summary and Conclusion
Appendices
Empirical Results Testing the Mediation Effect of Audit Quality (Objective 5.1)
Empirical Results Testing the Mediation Effect of FII (Objective 5.2)
References
6 Constraints Diluting the Effectiveness of Board Independence
6.1 Introduction
6.2 Methodology
6.2.1 Measures and Scope
6.2.2 Research Methodology
6.2.3 Layout of Empirical Analysis
6.3 Analysis and Findings
6.3.1 Promoter Ownership, Board Independence and Firm Performance
6.3.2 Product Market Competition, Board Independence and Firm Performance
6.4 Discussion
6.5 Implications and Recommendations
6.6 Summary and Conclusion
Appendices
References
7 Concluding Observations
7.1 Major Findings from the Research
7.2 Recommendations from the Study
7.3 Contributions of the Study
7.4 Limitations and Scope for Future Research
7.5 Concluding Observations

Citation preview

India Studies in Business and Economics

Shveta Singh Monika Singla

Corporate Governance Mechanisms and Firm Performance Lessons from India

India Studies in Business and Economics

The Indian economy is one of the fastest growing economies of the world with India being an important G-20 member. Ever since the Indian economy made its presence felt on the global platform, the research community is now even more interested in studying and analyzing what India has to offer. This series aims to bring forth the latest studies and research about India from the areas of economics, business, and management science, with strong social science linkages. The titles featured in this series present rigorous empirical research, often accompanied by policy recommendations, evoke and evaluate various aspects of the economy and the business and management landscape in India, with a special focus on India’s relationship with the world in terms of business and trade. The series also tracks research on India’s position on social issues, on health, on politics, on agriculture, on rights, and many such topics which directly or indirectly affect sustainable growth of the country. Review Process The proposal for each volume undergoes at least two double blind peer review where a detailed concept note along with extended chapter abstracts and a sample chapter is peer reviewed by experienced academics. The reviews can be more detailed if recommended by reviewers. Ethical Compliance The series follows the Ethics Statement found in the Springer standard guidelines here. https://www.springer.com/us/authors-editors/journal-author/journal-aut hor-helpdesk/before-you-start/before-you-start/1330#c14214

More information about this series at https://link.springer.com/bookseries/11234

Shveta Singh · Monika Singla

Corporate Governance Mechanisms and Firm Performance Lessons from India

Shveta Singh Department of Management Studies Indian Institute of Technology Delhi Hauz Khas, New Delhi, India

Monika Singla TD Bank Ontario, ON, Canada

ISSN 2198-0012 ISSN 2198-0020 (electronic) India Studies in Business and Economics ISBN 978-981-19-2459-0 ISBN 978-981-19-2460-6 (eBook) https://doi.org/10.1007/978-981-19-2460-6 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2022 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Singapore Pte Ltd. The registered company address is: 152 Beach Road, #21-01/04 Gateway East, Singapore 189721, Singapore

Preface

This monograph deals with corporate governance mechanisms which are popular worldwide. The findings, thus, have global implications. Corporate governance deals with the ways in which suppliers of finance to corporations (shareholders) assure themselves of getting a return on their investment. In the context of this work, these multiple ways are termed corporate governance mechanisms. In common parlance, corporate governance mechanisms can be visualized as the remedy to deal with various agency issues (principal-agent and principal-principal issues). In the domain of corporate governance, the principal-agent issues refer to the conflict of interest between the shareholders and the management (also termed as Type I agency issues). The principal-principal issues refer to the expropriation of the small shareholders from the large shareholders (also termed as the Type II agency issues). While the former issues are prevalent in the developed economies (the U.S. and the U.K.), the latter are widespread especially in the developing economies due to the share ownership of companies being concentrated in the hands of a few shareholders. In consideration of the distinct governance issues of the developing economies, a special focus is laid on the principal-principal governance issues throughout the empirical and theoretical analysis. This study aims to analyze various corporate governance mechanisms and their impact on firm value. Based on the review of literature, four broad governance mechanisms form part of the empirical analysis. These are board monitoring, audit quality, ownership structure and product market competition. Their analysis forms the first objective of the study. Based on the findings of the first objectives and similar evidence in the literature, this study explores the possible reasons behind the ineffective role of independent directors in the corporate governance structure of Indian companies. Such an analysis is very useful as board independence is crucial in mitigating the principalprincipal issues which are the prime governance concern in the developing economies like India. In the empirical analysis, the monitoring role of independent directors is analyzed in relation to other governance mechanisms. The analysis is based on the

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Preface

notion of “bundle of governance mechanisms” which states that governance mechanisms, instead of working in isolation, work synchronously with other governance mechanisms. The analysis of the monitoring behavior of the independent directors has been conducted in two sub-parts. In the first part, we have analyzed the various ways independent directors discharge their monitoring role. Precisely, we have attempted to investigate if independent directors add to firm value indirectly by strengthening other governance mechanisms. Such an analysis has not been conducted, so far, in the extant literature. In another sub-part, we attempt to analyze the possible constraints which might explain the ineffective monitoring behavior of the independent directors. This analysis has been conducted while taking into consideration the relationship of board monitoring with other governance mechanisms. From the perspective of the academicians, the findings, besides providing a detailed dynamic of the monitoring role of the independent directors, would be useful in providing an empirical validity to the concept of the “bundle of governance mechanisms”. From the perspective of the regulators, the empirical results (related to the interrelationships among various governance mechanisms) would enable the regulatory authorities to devise more effective policies. Finally, the subject matter of the research work would be useful to the companies for designing an optimal governance structure. The emergence of the significant interrelationship among various governance mechanisms (if any) would facilitate the firms in optimizing their governance structure in line with their unique traits. New Delhi, India Ontario, Canada

Shveta Singh Monika Singla

Acknowledgements

At the outset, we would like to thank the Almighty for His blessings to inspire us to accomplish this academic endeavor. This work has been possible because of the help, encouragement, cooperation and guidance of many people and we convey our heartfelt thanks to all of them. We are grateful to Prof. V. Ramgopal Rao, Director, IIT Delhi, for his encouragement and support. To thank the Head of the Department may seem to be a ritual. However, it is not so in the case of Prof. Seema Sharma, Head (DMS). She has been supportive throughout. Prof. Shveta Singh takes this opportunity to express her deepest gratitude to her gurus, Prof. P. K. Jain and Prof. Surendra S. Yadav, for their valuable guidance and inspiration. She is thankful for the blessings of her parents. She also thanks her husband, Anil, for his unwavering support and her son, Shashvat, for his encouragement. Dr. Monika Singla would like to express her deepest gratitude and respect to Prof. Shveta Singh, for being the constant source of motivation, guidance and inspiration. She would like to dedicate this work to her parents for their encouragement and support. She also extends her heartfelt thanks to her husband, Saurav, and son, Aarush, for being her pillars of strength. She also thanks her brother, Arvinder, for being the constant source of motivation. Last but not the least, we are thankful to all those, not mentioned above, who wished us well, our family members and loved ones for their continuous encouragement and support. Shveta Singh Monika Singla

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Contents

1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1 Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 Overview of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.3 Research Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.4 Research Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.5 Significance of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.6 Organization of the Monograph/Book Chapters . . . . . . . . . . . . . . . . . Annexure I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1 1 4 5 5 6 7 9 22

2 Evolution of Corporate Governance in India . . . . . . . . . . . . . . . . . . . . . . 2.1 Evolution of Corporate Governance in India . . . . . . . . . . . . . . . . . . . . 2.2 Legal Evolution of Corporate Governance in India . . . . . . . . . . . . . . 2.3 Provisions of the Revised Clause 49 of the Listing Agreement . . . . 2.3.1 Independent Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3.2 Code of Conduct . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3.3 Audit, Nomination and Remuneration Committees . . . . . . . . 2.3.4 Subsidiary Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3.5 Related Party Transactions (RPTs) . . . . . . . . . . . . . . . . . . . . . . 2.3.6 Remuneration and Shareholding of Non-executive Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.4 Recent Regulatory Developments on Corporate Governance . . . . . . 2.5 Alternate Corporate Governance Mechanisms . . . . . . . . . . . . . . . . . . 2.5.1 Ownership Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.5.2 Board Monitoring . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.5.3 Audit Quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.5.4 Market for Corporate Control . . . . . . . . . . . . . . . . . . . . . . . . . . 2.5.5 Product Market Competition . . . . . . . . . . . . . . . . . . . . . . . . . . .

25 26 27 30 31 31 31 32 32 32 32 33 33 33 34 34 35

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2.6 Interrelationship Among Corporate Governance Mechanisms . . . . . 2.6.1 Performance Enhancement Effect of Board Independence (Through Other Governance Mechanisms) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.6.2 Mechanisms Diluting the Effectiveness of Board Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.7 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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3 Research Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Research Objectives and Research Hypotheses . . . . . . . . . . . . . . . . . . 3.3 Scope of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.1 Why Study an Emerging Economy? . . . . . . . . . . . . . . . . . . . . 3.3.2 Why Study Indian Companies? . . . . . . . . . . . . . . . . . . . . . . . . 3.3.3 Period of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.4 Sample Selection Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4 Research Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4.1 Measures/Proxies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4.2 Research Methodologies Used . . . . . . . . . . . . . . . . . . . . . . . . . 3.4.3 Sources of Data and Research Tools Used . . . . . . . . . . . . . . . 3.5 Summary and Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

47 47 47 50 50 51 52 52 53 53 61 72 73 73

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4 Corporate Governance Mechanisms and Firm Performance . . . . . . . . 79 4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 4.2 Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 4.2.1 Sample and Scope . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 4.2.2 Research Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 4.2.3 Layout of Empirical Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 84 4.3 Analysis and Findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 4.4 Discussion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 4.5 Implications and Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 4.6 Summary and Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103 5 Performance Enhancement Effect of Board Independence . . . . . . . . . 5.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.2 Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.2.1 Measures and Scope . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.2.2 Research Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.2.3 Layout of Empirical Analysis . . . . . . . . . . . . . . . . . . . . . . . . . .

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Contents

5.3 Analysis and Findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.3.1 Board Independence, Audit Quality and Firm Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.3.2 Board Independence, Foreign Institutional Investment and Firm Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.4 Discussion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.5 Implications and Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.6 Summary and Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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116 117 120 120 121 122 123 124

6 Constraints Diluting the Effectiveness of Board Independence . . . . . . 6.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2 Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2.1 Measures and Scope . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2.2 Research Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.2.3 Layout of Empirical Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 6.3 Analysis and Findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.3.1 Promoter Ownership, Board Independence and Firm Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.3.2 Product Market Competition, Board Independence and Firm Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.4 Discussion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.5 Implications and Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . 6.6 Summary and Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

127 128 134 135 135 135 144

157 158 162 163 164 171

7 Concluding Observations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.1 Major Findings from the Research . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.2 Recommendations from the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.3 Contributions of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.4 Limitations and Scope for Future Research . . . . . . . . . . . . . . . . . . . . . 7.5 Concluding Observations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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About the Authors

Shveta Singh is a Professor and the Area Chair of Finance at the Department of Management Studies (DMS), Indian Institute of Technology (IIT Delhi), India. She is also the co-coordinator of the National Centre on Corporate Governance (accredited by the National Foundation on Corporate Governance (NFCG)) at DMS. Overall, she has nearly 20 years of professional experience, having spent three years in the corporate sector prior to joining academics. She has published more than 150 research papers in journals of national and international repute. She has an h-index of 10 and around 400 citations. She has co-authored a text-book titled “Security Analysis and Portfolio Management” published by Springer. She has also co-authored three research monographs titled “Financial Management Practices: An Empirical Study of Indian Corporates” and “Equity Market in India: Returns, Risk and Price Multiples”, both published by Springer and “Cash Dividend and Shares Repurchase Announcements: Impact On Returns, Liquidity and Risk in The Indian Context” published by Hamilton, UK. She has been the recipient of the Lok Sabha Fellowship and the Fetzer Fellowship from the Academy of Management, USA, for her work on CSR, as well as the National Stock Exchange – Indira Gandhi Institute of Development Research (NSE-IGIDR) Corporate Governance Research Initiative Grant. She has been honored by the “Leadership” award in research, which she accepted on behalf of IIT Delhi from the Institute of Business and Finance Research at the Global Conference on Business and Finance in USA. She has been honored twice with the “Literati” award for outstanding research by Emerald Publishing Inc. Monika Singla is working with TD Bank in Toronto in the Big Data Analytics domain. She is helping the bank to develop machine learning and other analytical models/processes to facilitate business decision-making. She is a Ph.D. graduate from the Department of Management Studies, Indian Institute of Technology (IIT Delhi), India. Her research work has been published in journals of national and international repute. She is a recipient of the Junior Research Fellowship (JRF) from the University Grants Commission (UGC) of India. She is also the recipient of a

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About the Authors

research award from the National Stock Exchange of India in collaboration with IGIDR, a research wing of the Reserve Bank of India for conducting research in the corporate governance domain. Prior to joining the Ph.D. programme, she was working as an Associate Consultant at Infosys Ltd.

Abbreviations

AGM ANOVA BSE CEO CFA CII CIL CMIE DVR E&Y EGM EU FII FMCG GCGC HHI ICT IIAS IPO KPMG KSE LODR MCA MD NA NIC NSE NYSE NZSE OECD OLS

Annual General Meeting Analysis of Variance Bombay Stock Exchange Chief Executive Officer Confirmatory Factor Analysis Confederation of Indian Industry Coal India Limited Centre for Monitoring Indian Economy Differential Voting Right Ernst and Young Extraordinary General Meeting European Union Foreign Institutional Investment Fast Moving Consumer Goods German Corporate Governance Code Herfindahl-Hirschman Index Internet, Communications and Technology Institutional Investors Advisory Services Initial Public Offering Klynveld Peat Marwick Goerdeler Korean Stock Exchange Listing Obligations and Disclosure Requirements Ministry of Corporate Affairs Managing Director Not Applicable National Industry Classification National Stock Exchange New York Stock Exchange New Zealand Stock Exchange Organization for Economic Co-operation and Development Ordinary Least Square xv

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PESB PwC RBI ROA RPT S&P S.D. SEBI SEC SEM SOX SSRN TCI U.K. U.S. UTI VIF ZSE

Abbreviations

Public Enterprises Selection Board Pricewaterhouse Coopers Reserve Bank of India Return on Assets Related Party Transaction Standard & Poor Standard Deviation Securities and Exchange Board of India Securities and Exchange Commission Structural Equation Modeling Sarbanes Oxley Act Social Science Research Network The Children’s Investment Fund United Kingdom United States of America Unit Trust of India Variance Inflation Factor Zimbabwe Stock Exchange

List of Figures

Fig. 1.1 Fig. 3.1 Fig. 3.2 Fig. 3.3 Fig. 3.4

Fig. 3.5

Fig. 3.6

Fig. 3.7

Emergence of agency (principal-agent) issues. Source Authors’ compilation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A visual layout of this chapter. Source Authors’ compilation . . . Relationship between board independence and audit quality. Source Authors’ compilation . . . . . . . . . . . . . . . . . . . . . . Relationship between board independence and foreign institutional ownership. Source Authors’ compilation . . . . . . . . . Board independence and firm performance (mediator– audit quality). Note In this figure, “audit quality” acts as the mediator variable, mediating the relationship between board independence and firm performance. Source Authors’ compilation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Board independence and firm performance (mediator– FII). Note In this figure, “foreign institutional ownership” acts as the mediator variable, mediating the relationship between board independence and firm performance. Source Authors’ compilation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Board independence and firm performance relationship (moderator–insider ownership). Note In this figure, the “blue line” indicates the relationship between board independence and firm performance. The “orange line” indicates the moderating effect of insider (promoter) ownership on the board independence and firm performance relationship. Source Authors’ compilation . . . . . . . Board independence and firm performance relationship (moderator–product market competition). Note In this figure, the “blue line” indicates the relationship between board independence and firm performance. The “orange line” indicates the moderating effect of product market competition on the board independence and firm performance relationship. Source Authors’ compilation . . . . . . .

2 48 65 65

65

66

67

67 xvii

xviii

Fig. 3.8

Fig. 3.9

Fig. 3.10

Fig. 3.11

Fig. 4.1 Fig. 5.1

List of Figures

Board independence and audit quality (moderator– promoter ownership). Note In this figure, “promoter ownership” acts as the moderator variable. The “blue line” indicates the direct relationships between board independence and audit quality. The “green line” indicates the moderating effect of promoter ownership on the board independence and audit quality relationship. Source Authors’ compilation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Board independence and audit quality (moderator– foreign institutional investment). Note In this figure, “foreign institutional investment” acts as the moderator variable. The “blue line” indicates the direct relationships between board independence and audit quality. The “green line” indicates the moderating effect of the foreign institutional investment on the board independence and audit quality relationship. Source Authors’ compilation . . . . A moderated-mediation model of board independence and firm performance relationship (mediator–audit quality, moderator–promoter ownership). Note In this figure, “promoter ownership” acts as the moderator variable and “audit quality” as a mediator variable. The “blue line” indicates the direct relationships between board independence and audit quality; and audit quality and firm performance. The “green line” indicates the moderating effect of promoter ownership on the board independence and audit quality relationship. Source Authors’ compilation . . . . A moderated-mediation model of board independence and firm performance relationship (mediator–foreign institutional investment, moderator–promoter ownership). Note In this figure, “promoter ownership” acts as the moderator variable and “audit quality” as a mediator variable. The “blue line” indicates the direct relationships between board independence and audit quality; and audit quality and firm performance. The “green line” indicates the moderating effect of promoter ownership on the board independence and audit quality relationship. Source Authors’ compilation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-linear relationship between promoter ownership and firm value. Source Authors’ compilation . . . . . . . . . . . . . . . . Expected relationship between board independence and audit quality. Source Authors’ compilation . . . . . . . . . . . . . .

70

70

71

72 94 109

List of Figures

Fig. 5.2

Fig. 5.3 Fig. 5.4

Fig. 6.1

Fig. 6.2

Fig. 6.3

Board independence and firm value with audit quality as the mediator. Note In this figure, “audit quality” acts as the mediator variable, mediating the relationship between board independence and firm value. Source Authors’ compilation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Relationship between board independence and FII. Source Authors’ compilation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Board independence and firm value with foreign institutional investment as the mediator. Note In this figure, “foreign institutional investment” acts as the mediator variable, mediating the relationship between board value and firm performance. Source Authors’ compilation . . . . . . . . . . Moderating effect of promoter ownership on board independence and firm value relationship. Note In this figure, the “blue line” indicates the relationship between board independence and firm value. The “green line” indicates the moderating effect of promoter ownership on the board independence and firm value relationship. Source Authors’ compilation . . . . . . . . . . . . . . . . . . Relationship between board independence and audit quality with the promoter ownership as the moderator. Note In this figure, “promoter ownership” acts as the moderator variable. The “blue line” indicates the direct relationships between board independence and audit quality. The “green line” indicates the moderating effect of promoter ownership on the board independence and audit quality relationship. Source Authors’ compilation . . . . . . . . . . . . . . . . . . Relationship between board independence and foreign institutional investment with promoter ownership as the moderator. Note In this figure, “promoter ownership” acts as the moderator variable. The “blue line” indicates the direct relationships between board independence and foreign institutional investment. The “green line” indicates the moderating effect of promoter ownership on the board independence and foreign institutional investment relationship. Source Authors’ compilation . . . . . . . . .

xix

109 110

110

129

131

131

xx

Fig. 6.4

Fig. 6.5

Fig. 6.6

Fig. 6.7

List of Figures

A moderated-mediation model of board independence and firm value relationship (mediator—audit quality, moderator—promoter ownership). Note In this figure, “promoter ownership” acts as the moderator variable and “audit quality” as a mediator variable. The “blue line” indicates the direct relationships between board independence and audit quality; and audit quality and firm value. The “green line” indicates the moderating effect of promoter ownership on the board independence and audit quality relationship. Source Authors’ compilation . . . . A moderated-mediation model of board independence and firm value relationship (mediator—FII, moderator—promoter ownership). Note In this figure, “promoter ownership” acts as the moderator variable and “foreign institutional investment” as a mediator variable. The “blue line” indicates the direct relationships between board independence and foreign institutional investment; and foreign institutional investment and firm value. The “green line” indicates the moderating effect of promoter ownership on the board independence and foreign institutional investment relationship. Source Authors’ compilation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Moderating effect of product market competition on the board independence and firm value relationship. Note In this figure, the “blue line” indicates the relationship between board independence and firm value. The “green line” indicates the moderating effect of product market competition on the board independence and firm value relationship. Source Authors’ compilation . . . . . . . . . . . . . . . . . . Relationship between board independence and firm value at various levels of promoter ownership. Note The figure presents the relationship between board independence and firm value (Tobin’s Q) at three levels of promoter ownership (low, medium and high). The “red line” plots the relationship at a low level of promoter ownership, 37.55% (Mean-1SD), the “green line” plots the relationship at medium level of promoter ownership, 54.84% (Mean) and “blue line” plots the relationship at high level of promoter ownership, 72.13% (Mean + 1SD). Source Authors’ compilation . . . . . . . . . . . . . . . . . . . . . . . .

132

132

134

140

List of Figures

Fig. 6.8

Fig. 6.9

Fig. 6.10

Fig. 6.11

Relationship between board independence and firm value at various controlling levels of promoter owners. Note The figure presents the relationship between board independence and firm value (Tobin’s Q) at three controlling levels of promoter ownership (low, medium and high). The “red line” plots the relationship at a low level of promoter ownership, 11%, the “green line” plots the relationship at medium level of promoter ownership, 26% and “blue line” plots the relationship at high level of promoter ownership, 51%. Source Authors’ compilation . . . . Board independence and audit quality (total audit fee) at various levels of promoter ownership. Note The figure presents the relationship between board independence and total audit fee at three levels of promoter ownership (low, medium and high). The “red line” plots the relationship at a low level of promoter ownership, 37.55% (Mean-1SD), the “green line” plots the relationship at medium level of promoter ownership, 54.84% (Mean) and “blue line” plots the relationship at high level of promoter ownership, 72.13% (Mean + 1SD). Source Authors’ compilation . . . . . . . . . . . . . . . . . . . . . . . . Board independence and audit quality (percentage non-audit fee) at various levels of promoter ownership. Note The figure presents the relationship between board independence and percentage non-audit fee at three levels of promoter ownership (low, medium and high). The “red line” plots the relationship at a low level of promoter ownership, 37.55% (Mean-1SD), the “green line” plots the relationship at medium level of promoter ownership, 54.84% (Mean) and “blue line” plots the relationship at high level of promoter ownership, 72.13% (Mean + 1SD). Source Authors’ compilation . . . . . . . . . . . . . . . . . . . . . . . . Relationship between board independence and foreign institutional investment at various levels of promoter ownership. Note The figure presents the relationship between board independence and foreign institutional investment at three levels of promoter ownership (low, medium and high). The “red line” plots the relationship at a low level of promoter ownership, 37.55% (Mean-1SD), the “green line” plots the relationship at medium level of promoter ownership, 54.84% (Mean) and “blue line” plots the relationship at high level of promoter ownership, 72.13% (Mean + 1SD). Source Authors’ compilation . . . . . . . . .

xxi

141

143

155

156

List of Tables

Table 3.1 Table 3.2 Table 4.1 Table 4.2 Table 4.3 Table 4.4 Table 4.5 Table 4.6 Table 4.7 Table 4.8 Table 4.9

Table 4.10 Table 4.11 Table 5.1 Table 5.2 Table 5.3 Table 5.4

Table 5.5

Table 5.6

Big-Four auditors and their Indian associates . . . . . . . . . . . . . . . Descriptive summary of variables used in the study . . . . . . . . . Summary of the measures used for the variables of interest . . . Description of the variables used in the study . . . . . . . . . . . . . . Descriptive statistics of the variables used in the study . . . . . . . Variance inflation factor of the variables used in the study . . . . Regression model analyzing the impact of product market competition on firm value . . . . . . . . . . . . . . . . . . . . . . . . Regression model analyzing the impact of audit quality on firm value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Regression model analyzing the impact of board monitoring on firm value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Regression model analyzing the impact of ownership structure on firm value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Regression analysis of corporate governance mechanisms and firm value over a period (2010–2014) for the private sector firms having promoter ownership more than 75% . . . . . . Analysis of mean values of promoter ownership and firm value over the years (2010–2014) . . . . . . . . . . . . . . . . . . . . . . . . Summary of the empirical results . . . . . . . . . . . . . . . . . . . . . . . . Description of various variables used in the study . . . . . . . . . . . Descriptive statistics of variables used in the study . . . . . . . . . . Research methodologies deployed for various objectives . . . . . Relationship between board independence and audit quality with the firms’ affiliation to the Big-Four auditors as the dependent variable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The relationship between board independence and audit quality with total audit fee and percentage non-audit fee as the dependent variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Direct effect of board independence on firm value (mediator–audit quality) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

55 60 81 83 85 87 88 89 90 91

93 94 98 112 113 114

115

116 117 xxiii

xxiv

Table 5.7 Table 5.8

Table 5.9 Table 5.10 Table 5.11 Table 6.1 Table 6.2 Table 6.3 Table 6.4

Table 6.5

Table 6.6 Table 6.7 Table 6.8

Table 6.9

Table 6.10

Table 6.11 Table 6.12

Table 6.13 Table 6.14

Table 6.15

List of Tables

Indirect effect of board independence on firm value (mediator–audit quality) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Regression results depicting the relationship between board independence and foreign institutional investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Direct effect of board independence on firm value (mediator–foreign institutional investment) . . . . . . . . . . . . . . . . Indirect effect of board independence on firm value (mediator–foreign institutional investment) . . . . . . . . . . . . . . . . Summary of the empirical results . . . . . . . . . . . . . . . . . . . . . . . . Description of various variables used in the study . . . . . . . . . . . Descriptive statistics of the variables used in the study . . . . . . . Research methodologies deployed for various objectives . . . . . Moderating effect of promoter ownership on the relationship between board independence and firm value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Regression models depicting the relationship between board independence and firm value for business-group and stand-alone firms . . . . . . . . . . . . . . . . . . The moderating effect of promoter ownership on board independence and audit quality (Big-Four) relationship . . . . . . Board independence and audit quality at various levels of promoter ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The moderating effect of promoter ownership on board independence and audit quality (total audit fee and percentage non-audit fee) relationship . . . . . . . . . . . . . . . . . Moderating effect of promoter ownership on the board independence and foreign institutional investment relationship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Moderating effect of promoter ownership on the board independence and foreign institutional investment relationship with lagged independent variables . . . . . . . . . . . . . Board independence and foreign institutional investment at various levels of promoter ownership . . . . . . . . . . . . . . . . . . . Direct effect of board independence on firm value (mediator—audit quality, moderator—promoter ownership) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Conditional indirect effect of board independence on firm value at various levels of promoter ownership . . . . . . . . . . . . . . Direct effect of board independence on firm value (mediator—foreign institutional investment, moderator—promoter ownership) . . . . . . . . . . . . . . . . . . . . . . . . Conditional indirect effect of board independence on firm value at various levels of promoter ownership . . . . . . . . . . . . . .

117

118 118 119 123 136 137 138

139

142 144 145

146

147

148 149

150 150

150 151

List of Tables

Table 6.16

Table 6.17

Table 6.18 Table 7.1

xxv

Moderating effect of product market competition on the relationship between board independence and firm value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Moderating effect of product market competition on the relationship between board independence and firm value for business-group and stand-alone firms . . . . . . . . . . . . . Summary of the empirical results . . . . . . . . . . . . . . . . . . . . . . . . Recommendations from the study . . . . . . . . . . . . . . . . . . . . . . . .

152

153 154 178

List of Appendices

Appendix 4.1 Appendix 4.2 Appendix 4.3 Appendix 4.4 Appendix 5.1 Appendix 5.2 Appendix 5.3 Appendix 5.4 Appendix 6.1 Appendix 6.2

Appendix 6.3

Appendix 6.4 Appendix 6.5 Appendix 6.6

Regression model analyzing the impact of product market competition on ROA . . . . . . . . . . . . . . . . . . . . . . . . . . Regression model analyzing the impact of audit quality on ROA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Regression model analyzing the impact of board monitoring on ROA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Regression model analyzing the impact of ownership structure on ROA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Direct effect of board independence on ROA (mediator–audit quality) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Indirect effect of board independence on ROA (through audit quality) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Direct effect of board independence on ROA (mediator–FII) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Indirect effect of board independence on ROA (through foreign institutional investment) . . . . . . . . . . . . . . . Moderating effect of promoter ownership on the relationship between board independence and ROA . . . . . . . Regression models depicting the relationship between board independence and ROA for business-group and stand-alone firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Direct effect of board independence on ROA (mediator–audit quality, moderator–promoter ownership) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Conditional indirect effect of board independence on ROA at various levels of promoter ownership . . . . . . . . . . . . Direct effect of board independence on ROA (mediator–FII, moderator–promoter ownership) . . . . . . . . . . Conditional indirect effect of board independence on firm performance at various levels of promoter ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

99 100 101 102 123 123 124 124 165

166

167 167 168

168 xxvii

xxviii

Appendix 6.7

Appendix 6.8

List of Appendices

Moderating effect of product market competition on the relationship between board independence and ROA relationship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Moderating effect of product market competition on the relationship between board independence and ROA relationship for business-group and stand-alone firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

169

170

Chapter 1

Introduction

The origin of the word “governance” can be traced to the Latin word “gubernare” (Tricker, 1984), which means “to rule” or “to steer” (Maassen, 2002). The word “corporate governance”, thus, limits the scope of “governance” to the “governance of the corporations”. With a similar viewpoint, the Cadbury committee report defines corporate governance as “the system by which companies are directed and controlled” (Cadbury, 1992). In consideration of the purpose with which the organizations are directed and controlled (i.e., to maximize the wealth of the shareholders), corporate governance has been seen to be directly linked to the firm performance/valuation. This monograph builds on the existing literature and strives to add value in a similar direction. Besides providing an outline of the research undertaken, this chapter aims to provide a background of the research topic, the organization of the monograph/book chapters and signifies the relevance of the study.

1.1 Background The conception of corporate governance is profoundly related to the literature by the theory of the firm. Two related concepts of the theory of the firm form the foundation of a substantial body on literature in the domain of corporate governance. These concepts are the theory of separation of ownership and control (Berle & Means, 1932) and the concept of agency cost (Jensen & Meckling, 1976). The underpinning of the concept of the separation of ownership and control can be understood as follows: the primary objective of any organization is to maximize the wealth for its shareholders. However, in a corporate/company form of business, shareholders do not create wealth by themselves (even though they are the actual owners of the business) as they are not managing the business. Instead, shareholders hire managers to manage their wealth and allocate funds as per their discretion. © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2022 S. Singh and M. Singla, Corporate Governance Mechanisms and Firm Performance, India Studies in Business and Economics, https://doi.org/10.1007/978-981-19-2460-6_1

1

2

1 Introduction

Hence, there is a gap between ownership and management (Berle & Means, 1932). Technically, this is termed as the concept of the separation of ownership and control (Berle & Means, 1932). Moving to the concept of agency cost, the contractual relationship between the management and shareholders is called the agency relationship, in which the shareholders are the principal and the management acts as the agent to the principal (Jensen & Meckling, 1976). The management might not work in the true interest of the shareholders. Instead, there is a possibility that the management while leveraging the information asymmetry with the owners, starts giving preference to their own interests, and thus, compromise the shareholders’ interest. This conflict of interest is called the agency problem/issue and the cost that the principals incur to limit the divergence from their interest is called the agency cost, which is as real as any other cost (Jensen & Meckling, 1976). The agency issues can be ramified through several means like excessive perquisites, empire building, shirking work, earnings management activities, and so on. All these activities can adversely affect the firm value. A visual presentation of the concepts discussed is provided in Fig. 1.1. In line with the above framework (Fig. 1.1), Shleifer and Vishny (1997) highlight the role of corporate governance and posit that corporate governance deals with the ways in which “suppliers of finance to corporates (shareholders) assure themselves of getting a return on their investment”. Similarly, Rocca (2007) proposes that the aim of corporate governance is to ensure that the opportunistic behavior on the part of management does not occur, by mitigating and moderating various agency issues. As the aforementioned viewpoints are based on the concept of the separation of ownership and control, it is imperative to analyze the relevance of this concept in the context of different economies.

Owners Capital

Agency issues

Excessive perquisites, Empire building, Shirking work, Earnings management

Firm Information asymmetry

Managers Management

Fig. 1.1 Emergence of agency (principal-agent) issues. Source Authors’ compilation

1.1 Background

3

Relevance of the concept of separation of ownership in various economies Porta et al. (1999) while analyzing the ownership structure of 27 economies across the globe questioned the relevance of the theory of separation of ownership and control in view of the ownership being concentrated in the hands of a few shareholders. In the developed economies, like the U.S. and the U.K., where the share ownership is quite dispersed, the notion of the separation of ownership and control holds true to a greater extent. Thus, the main agency issue is the conflict of interest between the shareholders and the managers (principal-agent agency issue). However, in the rest of the economies (especially the developing economies), the shareholding is concentrated in the hands of a few shareholders. These large shareholders are part of both the management as well as the board of directors. Thus, the issue of information asymmetry is minimized between these large shareholders and the management. However, a peculiar agency issue prevails in such economies: the principal-principal agency issues. Principal-principal agency issues occur when the large shareholders use their private benefits of control and tend to expropriate the interest of the small shareholders (minority shareholders) through several means like: • Tunneling: The transfer of resources away from the firm for the benefit of the controlling shareholders (Johnson et al., 2000). • Pyramid structures: The structures in which an ultimate controlling firm controls several listed companies, each of which controls yet more listed companies, each of which controls yet more listed companies, and so on (Morck et al., 2005). A control pyramid allows a wealthy family or individual to control many firms with relatively limited wealth. Pyramids permit this by creating large deviations between voting rights and cash flow rights; allowing control over many firms with a small cash flow stake in each. • Dual-class shareholding: Dual-class shareholding refers to the ownership structure where different classes of shares carry differential voting rights (Li et al., 2008). Indian market is no exception to the other emerging economies and witnesses the share ownership being concentrated in the hands of a few wealthy promoter groups or the state. As per a study by Sarkar (2010), only 7.20 percent of the Indian firms qualify for the definition of widely held firms in 2006 (where no shareholder controls 20 per cent of the votes). Bertrand et al. (2002) provide confirmatory evidence of the principal-principal issues prevailing in India. Thus, in consideration of these viewpoints, a continuous focus is laid, in the empirical analysis and various discussions throughout this study, on the principal-principal agency issues prevailing in India. Further, irrespective of the kind of agency issues, the regulatory framework of a country can limit various governance issues and sets out the level of investor protection rights (La Porta et al., 2002). As the scope of the study is limited to the Indian context, it is imperative to analyze the developments in corporate governance in India from the regulatory front.

4

1 Introduction

1.2 Overview of the Study The current study attempts to address certain research questions which are based on certain research gaps identified during the review of literature. This section presents the overview of the study in terms of research gaps, research questions and finally, research objectives. Research Gaps This section presents the research gaps identified during the review of literature. i.

ii.

iii.

iv.

There is a general lack of empirical literature in the context of emerging economies. Ararat and Dallas (2011) signified the dearth of corporate governance studies in the context of the emerging market economies by highlighting the fact that in the past three years around 1000–1200 studies were published in the domain of corporate governance on “Social Science Research Network (SSRN)”. However, lesser than 1 per cent of those studies were related to the emerging economies. A substantial body of literature analyzes the relation between various governance mechanisms and firm performance. Multiple governance mechanisms (like ownership structure, board monitoring, product market competition and audit quality) have been reported in the available literature. While board monitoring has been widely studied, a few studies examine other governance mechanisms in relation to firm performance in the Indian context. In relation to the growing importance of board importance as a corporate governance mechanisms and the concept of bundle of governance mechanisms, few studies analyze the possible means independent directors enhance the firm value. The review of literature pointed towards the possible indirect performance enhancement effect of independent directors through other governance mechanisms (foreign institutional ownership and audit quality). To the best of our knowledge, we could not find any study in the Indian context analyzing the possible performance enhancement effect of board independence through other governance mechanisms. Despite of the growing concerns of the researchers over the monitoring efficacy of independent directors in India, there is a dearth of studies which attempt to analyze the factors which might dilute the monitoring ability of the independent directors. A related research led us to the identification of an important concept of the bundle of governance mechanisms (Rediker & Seth, 1995). This concept advocates that the governance mechanisms, instead of working in isolation of each other, work as a bundle. A further review of literature pointed towards two possible governance mechanisms (promoter ownership and product market competition) which might explain the negative relation between board independence and firm performance in India. However, the analysis of these governance mechanisms in relation to the monitoring role of the independent directors is an important research gap which has not been studied in the past in the Indian context.

1.4 Research Objectives

5

1.3 Research Questions In line with the research gaps, following research questions emerged which warrant further research efforts in this direction. i.

ii.

iii.

iv.

Dearth of research and distinct institutional aspects of the emerging economies highlight the need of conducting more empirical research in the context of these economies. The research gap related to the analysis of the relation between various governance mechanisms and firm performance raises multiple research questions like, are the various corporate governance mechanisms effective in enhancing firm performance? What are the main drivers of the corporate governance structure of the companies listed in India? The research gap related to the analysis of possible performance enhancement effect of the independent directors through other governance mechanisms (foreign institutional ownership and audit quality) raises a vital research question: Do the independent directors enhance firm performance indirectly by strengthening other governance mechanisms (audit quality and foreign institutional ownership)? As the literature highlights two possible factors (promoter ownership and product market competition) which might explain the ineffectiveness of independent directors in India, an important research question emerges: Whether the ability of independent directors in enhancing firm performance gets diluted by the levels of promoter ownership and product market competition?

1.4 Research Objectives Research objectives were designed corresponding to the research questions. In line with the first research gap, the current study aims to conduct the entire empirical analysis in the context of an emerging economy, India. The factors, which led to this choice (India), are explained in greater detail in Chap. 3. The research objectives corresponding to rest of the research gaps are listed here: i.

ii.

iii.

To analyze the impact of various governance mechanisms (board monitoring, ownership structure, audit quality and product market competition) on firm performance. To analyze if the independent directors enhance firm performance indirectly by strengthening other governance mechanisms (audit quality and foreign institutional investment). To analyze if the level of promoter ownership and product market competition dilute the effectiveness of independent directors in enhancing firm performance.

6

1 Introduction

The study covers a period of 11 years (2007–2017). The scope of the study is limited to the analysis of non-financial firms of NSE (National Stock Exchange) 500 index. Firm value (measured with the Tobin’s Q ratio) has been used as the primary measure of firm performance. The scope of the study is further detailed in Chap. 3.

1.5 Significance of the Study The findings have global relevance as independent directors are seen to be the mainstay of good corporate governance across the world. The justification of the current study is warranted from several academic as well as practical considerations. An important significance of the study is that it would add to the limited literature (in the corporate governance domain) available in the context of emerging economies. The study sample is comprised of top 500 companies constituting the NIFTY500 index. These companies capture about 96 per cent of the free-float market capitalization of the stocks listed on the NSE, the largest stock exchange in India as on March 31, 2019 (NSE, 2021).The list of sample companies has been added as Annexure 1. The findings of the study would be beneficial to the regulators who devise and introduce policies aimed at strengthening the governance structure of the firms. The findings would highlight if regulatory efforts indeed strengthen the firms’ governance structure. The outcome of such an analysis would also highlight the areas of concern, if any. Another significant feature of the study is the analysis of the monitoring behavior of the independent directors in relation to other governance mechanisms. The findings would be relevant for both the academicians and the regulators for developing a more in-depth understanding of the monitoring role of independent directors. From the perspective of the academicians, the findings, besides providing a detailed dynamic of the monitoring role of the independent directors would be useful in providing an empirical validity to the concept of the “bundle of governance mechanisms” (Rediker & Seth, 1995). From the perspective of the regulators, the empirical results (related to the interrelationships among various governance mechanisms) would enable the regulatory authorities to devise more effective policies. Finally, the subject matter of the research work would be useful to the companies for designing an optimal governance structure. The emergence of the significant interrelationship among various governance mechanisms (if any) would facilitate the firms in optimizing their governance structure in line with their unique traits.

1.6 Organization of the Monograph/Book Chapters

7

1.6 Organization of the Monograph/Book Chapters Including the current chapter, the monograph/book is organized into 7 chapters: Chapter 1: Introduction. This chapter lays down the global relevance of the research work. Besides providing an outline of the research work, the chapter aims to provide a background of the research topic, explain the various terminologies and introduces the related concepts which are fundamental to the theory of corporate governance. Following this, the chapter describes the different aspects of corporate governance issues and how these issues differ based on the ownership structure and other factors that are unique to various economies. Followed by the general introduction and the background of corporate governance, this chapter lays down the research gaps identified during an extensive review of literature. In line with the research gaps, the next section highlights the research questions that emerged which warrant further research efforts in this direction. Following this, this section highlights the research objectives which are designed corresponding to the research questions. Finally, this chapter highlights the significance of the study for various stakeholders. Chapter 2: Evolution of Corporate Governance in India. This chapter also describes how corporate awareness and the regulatory regime has evolved with respect to the corporate governance issues in India. We have discussed the regulatory developments in detail in terms of the Companies Act 2013, the revised Clause 49 introduced by the Securities and Exchange Board of India in 2014 and the latest - of the Listing Obligations and Disclosure Requirements introduced in 2015. This chapter provides the the corporate governance evolution in India from the regulatory aspects. Chapter 3: Research Methodology. This chapter builds the corporate governance scenario by highlighting the key corporate governance regulations across the world. After establishing the global relevance and popularity of major corporate governance mechanisms, this chapter also explains the rationale behind conducting the study in the Indian context and details the period of study and the sample selection process. This section is followed by the description of various variables/proxies used in the empirical analysis, the rationale of using those variables and the measures used. Various measures of board monitoring, audit quality, product market competition, ownership structure and firm performance have been detailed in this chapter. This chapter lays down the approach deployed for the analysis and justifies the techniques which are used. It highlights the research gaps in the existing literature. These research gaps, further, lead to various research questions. This study, to address the research gaps in the Indian context, frames research objectives in line with the research questions. Based on literature, it presents the testable hypotheses

8

1 Introduction

in line with the research objectives, delineates the scope of the study and presents the methodologies deployed to achieve various objectives of the study. This section is followed by the detailed research methodologies deployed for various research objectives. Chapter 4: Corporate Governance Mechanisms and Firm Performance. The subject matter of this chapter contains the empirical analysis of the first broad objective of the study which is to analyze the impact of various governance mechanisms on firm performance. We have taken into consideration four broad governance mechanisms (board monitoring, audit quality, ownership structure and product market competition). Multiple measures/proxies have been used to measure these variables. In the primary analysis, we have first analyzed the impact of various governance mechanisms on firm performance using regression methodology. In the additional analysis, we have analyzed if the impact of the governance mechanism on firm performance varies with the age and size of firms. Chapter 5: Performance Enhancement Effect of Board Independence. This chapter analyses board independence in relationship to other governance mechanisms (audit quality and foreign institutional investment) to assess its possible performance enhancement effect. Such an analysis has been conducted by segregating the direct and indirect effects of board independence on firm performance. We have used mediation analysis to assess the indirect effect of board independence on firm performance with audit quality and foreign institutional investment as the mediator variables. Chapter 6: Constraints Diluting the Effectiveness of Board Independence. This chapter presents the analysis of various constraints which can dilute the effectiveness of independent directors in enhancing firm performance. The review of literature highlights two factors (promoter ownership and product market competition) which can hamper the effectiveness of independent directors. We have used the moderated regression approach to empirically analyze if the relationship between board independence and firm performance gets weakened by the levels of promoter ownership and product market competition. Additional analysis has been conducted to analyze these relationships for business-group and stand-alone firms separately. Chapter 7: Concluding Observations. Besides providing a summary of the main results, this chapter presents the concluding remarks, the contributions, and the limitations of the current research work.

Annexure I

9

Annexure I List of top 500 companies listed on NSE S. no

Company name

NSE symbol

1

3 M India Ltd.

3MINDIA

2

Aban Offshore Ltd.

ABAN

3

ABB India Ltd.

ABB

4

ABG Shipyard Ltd.

ABGSHIP

5

ACC Ltd.

ACC

6

Ambuja Cements Ltd.

AMBUJACEM

7

Adani Power Ltd.

ADANIPOWER

8

Adlabs Entertainment Ltd.

ADLABS

9

Adani Ports and Special Economic Zone Ltd.

ADANIPORTS

10

Advanta Ltd.

ADVANTA

11

Allcargo Logistics Ltd.

ALLCARGO

12

AIA Engineering Ltd.

AIAENG

13

Asahi India Glass Ltd.

ASAHIINDIA

14

Ajanta Pharma Ltd.

AJANTPHARM

15

Akzo Nobel India Ltd.

AKZOINDIA

16

Ashok Leyland Ltd.

ASHOKLEY

17

Allahabad Bank

ALBK

18

Alok Industries Ltd.

ALOKTEXT

19

Alembic Pharmaceuticals Ltd.

APLLTD

20

Alstom India Ltd.

AIL

21

Amara Raja Batteries Ltd.

AMARAJABAT

22

Amtek Auto Ltd.

AMTEKAUTO

23

Andhra Bank

ANDHRABANK

24

Apollo Hospitals Enterprise Ltd.

APOLLOHOSP

25

Asian Paints Ltd.

ASIANPAINT

26

Apar Industries Ltd.

APARINDS

27

Apollo Tyres Ltd.

APOLLOTYRE

28

Aurobindo Pharma Ltd.

AUROPHARMA

29

Anant Raj Ltd.

ANANTRAJ

30

Aarti Industries Ltd.

AARTIIND

31

Ashoka Buildcon Ltd.

ASHOKA

32

Astrazeneca Pharma India Ltd.

ASTRAZEN

33

Astral Poly Technik Ltd.

ASTRAL

34

Alstom T&D India Ltd.

ALSTOMT&D (continued)

10

1 Introduction

(continued) S. no

Company name

NSE symbol

35

Agro Tech Foods Ltd.

ATFL

36

Atul Ltd.

ATUL

37

Automotive Axles Ltd.

AUTOAXLES

38

Axis Bank Ltd.

AXISBANK

39

Bajaj Finance Ltd.

BAJFINANCE

40

BASF India Ltd.

BASF

41

Bata India Ltd.

BATAINDIA

42

Bombay Burmah Trading Corporation Ltd.

BBTC

43

Birla Corporation Ltd.

BIRLACORPN

44

Bombay Dyeing & Manufacturing Company Ltd.

BOMDYEING

45

Blue Dart Express Ltd.

BLUEDART

46

BEML Ltd.

BEML

47

BF Utilities Ltd.

BFUTILITIE

48

Bharti Airtel Ltd.

BHARTIARTL

49

Bharat Electronics Ltd.

BEL

50

Bharat Heavy Electricals Ltd.

BHEL

51

Bharat Forge Ltd.

BHARATFORG

52

Bharti Infratel Ltd.

INFRATEL

53

Bhushan Steel Ltd.

BHUSANSTL

54

Balkrishna Industries Ltd.

BALKRISIND

55

Ballarpur Industries Ltd.

BALLARPUR

56

Biocon Ltd.

BIOCON

57

Bajaj Auto Ltd.

BAJAJ-AUTO

58

Bajaj Corp Ltd.

BAJAJCORP

59

Bajaj Electricals Ltd.

BAJAJELEC

60

Bajaj Finserv Ltd.

BAJAJFINSV

61

Bajaj Hindusthan Sugar Ltd.

BAJAJHIND

62

Bajaj Holdings & Investment Ltd.

BAJAJHLDNG

63

Balmer Lawrie & Company Ltd.

BALMLAWRIE

64

Blue Star Ltd.

BLUESTARCO

65

Bank Of Baroda

BANKBARODA

66

Bank Of India

BANKINDIA

67

Bosch Ltd.

BOSCHLTD

68

Bharat Petroleum Corporation Ltd.

BPCL

69

Balrampur Chini Mills Ltd.

BALRAMCHIN

70

Brigade Enterprises Ltd.

BRIGADE

71

Berger Paints India Ltd.

BERGEPAINT (continued)

Annexure I

11

(continued) S. no

Company name

NSE symbol

72

Britannia Industries Ltd.

BRITANNIA

73

Capital First Ltd.

CAPF

74

Cairn India Ltd.

CAIRN

75

Can Fin Homes Ltd.

CANFINHOME

76

Credit Analysis And Research Ltd.

CARERATING

77

Castex Technologies Ltd.

CASTEXTECH

78

Canara Bank

CANBK

79

Central Bank Of India

CENTRALBK

80

Container Corporation Of India Ltd.

CONCOR

81

Cadila Healthcare Ltd.

CADILAHC

82

Ceat Ltd.

CEATLTD

83

Century Enka Ltd.

CENTENKA

84

Century Textiles & Industries Ltd.

CENTURYTEX

85

CESC Ltd.

CESC

86

Camlin Fine Sciences Ltd.

CAMLINFINE

87

Chambal Fertilisers & Chemicals Ltd.

CHAMBLFERT

88

Cholamandalam Investment & Finance Company Ltd.

CHOLAFIN

89

Cipla Ltd.

CIPLA

90

Colgate-Palmolive (India) Ltd.

COLPAL

91

Clariant Chemicals (India) Ltd.

CLNINDIA

92

Coal India Ltd.

COALINDIA

93

Cox & Kings (India) Ltd.

COX&KINGS

94

Century Plyboards (India) Ltd.

CENTURYPLY

95

Coromandel International Ltd.

COROMANDEL

96

CRISIL Ltd.

CRISIL

97

Corporation Bank

CORPBANK

98

Castrol India Ltd.

CASTROLIND

99

Carborundum Universal Ltd.

CARBORUNIV

100

City Union Bank Ltd.

CUB

101

Cyient Ltd.

CYIENT

102

Dabur India Ltd.

DABUR

103

DB Corp Ltd.

DBCORP

104

Dena Bank

DENABANK

105

DB Realty Ltd.

DBREALTY

106

DCB Bank Ltd.

DCBBANK

107

Dredging Corporation Of India Ltd.

DREDGECORP

108

DCM Shriram Ltd.

DCMSHRIRAM (continued)

12

1 Introduction

(continued) S. no

Company name

109

Delta Corp Ltd.

NSE symbol DELTACORP

110

Den Networks Ltd.

DEN

111

Dewan Housing Finance Corporation Ltd.

DHFL

112

Deepak Fertilisers & Petrochemicals Corporation Ltd.

DEEPAKFERT

113

Dhanlaxmi Bank Ltd.

DHANBANK

114

Dishman Pharmaceuticals & Chemicals Ltd.

DISHMAN

115

Divis Laboratories Ltd.

DIVISLAB

116

DLF Ltd.

DLF

117

Dr. Reddys Laboratories Ltd.

DRREDDY

118

Dynamatic Technologies Ltd.

DYNAMATECH

119

eClerx Services Ltd.

ECLERX

120

Ess Dee Aluminium Ltd.

ESSDEE

121

Edelweiss Financial Services Ltd.

EDELWEISS

122

E.I.D. Parry (India) Ltd.

EIDPARRY

123

EIH Ltd.

EIHOTEL

124

Eicher Motors Ltd.

EICHERMOT

125

Elgi Equipments Ltd.

ELGIEQUIP

126

Electrosteel Castings Ltd.

ELECTCAST

127

Merck Ltd.

MERCK

128

Engineers India Ltd.

ENGINERSIN

129

Entertainment Network (India) Ltd.

ENIL

130

Eros International Media Ltd.

EROSMEDIA

131

Esab India Ltd.

ESABINDIA

132

Escorts Ltd.

ESCORTS

133

Essel Propack Ltd.

ESSELPACK

134

Eveready Industries (India) Ltd.

EVEREADY

135

Exide Industries Ltd.

EXIDEIND

136

FAG Bearings India Ltd.

FAGBEARING

137

The Federal Bank Ltd.

FEDERALBNK

138

Future Consumer Enterprise Ltd.

FCEL

139

FDC Ltd.

FDC

140

Flexituff International Ltd.

FLEXITUFF

141

Future Lifestyle Fashions Ltd.

FLFL

142

Federal-Mogul Goetze (India) Ltd.

FMGOETZE

143

Finolex Cables Ltd.

FINCABLES

144

Finolex Industries Ltd.

FINPIPE

145

Fortis Healthcare Ltd.

FORTIS (continued)

Annexure I

13

(continued) S. no

Company name

146

Future Retail Ltd.

NSE symbol FEL

147

Firstsource Solutions Ltd.

FSL

148

Financial Technologies (India) Ltd.

63MOONS

149

Gabriel India Ltd.

GABRIEL

150

GAIL (India) Ltd.

GAIL

151

Gujarat Alkalies & Chemicals Ltd.

GUJALKALI

152

Geojit BNP Paribas Financial Services Ltd.

GEOJITBNPP

153

Godrej Consumer Products Ltd.

GODREJCP

154

Gateway Distriparks Ltd.

GDL

155

Godrej Industries Ltd.

GODREJIND

156

Geometric Ltd.

GEOMETRIC

157

The Great Eastern Shipping Company Ltd.

GESHIP

158

Gujarat Fluorochemicals Ltd.

GUJFLUORO

159

GHCL Ltd.

GHCL

160

Gillette India Ltd.

GILLETTE

161

Gujarat Industries Power Company Ltd.

GIPCL

162

Gammon Infrastructure Projects Ltd.

GAMMNINFRA

163

Gitanjali Gems Ltd.

GITANJALI

164

Glaxosmithkline Pharmaceuticals Ltd.

GLAXO

165

Gujarat Mineral Development Corporation Ltd.

GMDCLTD

166

GMR Infrastructure Ltd.

GMRINFRA

167

Gujarat Narmada Valley Fertilizers & Chemicals Ltd.

GNFC

168

Glenmark Pharmaceuticals Ltd.

GLENMARK

169

Gulf Oil Lubricants India Ltd.

GULFOILLUB

170

Godfrey Phillips India Ltd.

GODFRYPHLP

171

Godrej Properties Ltd.

GODREJPROP

172

Gujarat Pipavav Port Ltd.

GPPL

173

Grasim Industries Ltd.

GRASIM

174

Gruh Finance Ltd.

GRUH

175

Graphite India Ltd.

GRAPHITE

176

Greaves Cotton Ltd.

GREAVESCOT

177

Gujarat State Fertilizers & Chemicals Ltd.

GSFC

178

GATI Ltd.

GATI

179

GTL Infrastructure Ltd.

GTLINFRA

180

Gujarat State Petronet Ltd.

GSPL

181

GVK Power & Infrastructure Ltd.

GVKPIL

182

Hathway Cable & Datacom Ltd.

HATHWAY (continued)

14

1 Introduction

(continued) S. no

Company name

183

Havells India Ltd.

NSE symbol HAVELLS

184

Hindustan Construction Company Ltd.

HCC

185

HCL Infosystems Ltd.

HCL-INSYS

186

HCL Technologies Ltd.

HCLTECH

187

Hindustan Copper Ltd.

HINDCOPPER

188

Housing Development Finance Corporation Ltd.

HDFC

189

HDFC Bank Ltd.

HDFCBANK

190

Housing Development & Infrastructure Ltd.

HDIL

191

HEG Ltd.

HEG

192

Hexaware Technologies Ltd.

HEXAWARE

193

Hero MotoCorp Ltd.

HEROMOTOCO

194

Himachal Futuristic Communications Ltd.

HFCL

195

Emami Ltd.

EMAMILTD

196

Hindalco Industries Ltd.

HINDALCO

197

Hindustan Petroleum Corporation Ltd.

HINDPETRO

198

HSIL Ltd.

HSIL

199

Himatsingka Seide Ltd.

HIMATSEIDE

200

Heritage Foods Ltd.

HERITGFOOD

201

HT Media Ltd.

HTMEDIA

202

Hindustan Unilever Ltd.

HINDUNILVR

203

Honeywell Automation India Ltd.

HONAUT

204

Hindustan Zinc Ltd.

HINDZINC

205

Indiabulls Real Estate Ltd.

IBREALEST

206

Indiabulls Ventures Ltd.

IBVENTURES

207

The India Cements Ltd.

INDIACEM

208

ICICI Bank Ltd.

ICICIBANK

209

ICRA Ltd.

ICRA

210

IDBI Bank Ltd.

IDBI

211

Idea Cellular Ltd.

IDEA

212

IL&FS Engineering and Construction Company Ltd.

IL&FSENGG

213

IFCI Ltd.

IFCI

214

Indraprastha Gas Ltd.

IGL

215

The Indian Hotels Company Ltd.

INDHOTEL

216

Indiabulls Housing Finance Ltd.

IBULHSGFIN

217

IndusInd Bank Ltd.

INDUSINDBK

218

IIFL Holdings Ltd.

IIFL

219

IL&FS Transportation Networks Ltd.

IL&FSTRANS (continued)

Annexure I

15

(continued) S. no

Company name

NSE symbol

220

Indian Bank

INDIANB

221

Infosys Ltd.

INFY

222

Info Edge (India) Ltd.

NAUKRI

223

Ingersoll-Rand (India) Ltd.

INGERRAND

224

Inox Leisure Ltd.

INOXLEISUR

225

Inox Wind Ltd.

INOXWIND

226

Indian Overseas Bank

IOB

227

Indian Oil Corporation Ltd.

IOC

228

Ipca Laboratories Ltd.

IPCALAB

229

IRB Infrastructure Developers Ltd.

IRB

230

ITC Ltd.

ITC

231

ITD Cementation India Ltd.

ITDCEM

232

IVRCL Ltd.

IVRCLINFRA

233

Jagran Prakashan Ltd.

JAGRAN

234

JB Chemicals & Pharmaceuticals Ltd.

JBCHEPHARM

235

JBF Industries Ltd.

JBFIND

236

Jai Corp Ltd.

JAICORPLTD

237

Jain Irrigation Systems Ltd.

JISLJALEQS

238

The Jammu & Kashmir Bank Ltd.

J&KBANK

239

JK Cement Ltd.

JKCEMENT

240

JK Tyre & Industries Ltd.

JKTYRE

241

J Kumar Infraproject Ltd.

JKIL

242

JK Lakshmi Cement Ltd.

JKLAKSHMI

243

JM Financial Ltd.

JMFINANCIL

244

Jubilant Life Sciences Ltd.

JUBILANT

245

Jaiprakash Associates Ltd.

JPASSOCIAT

246

Jaypee Infratech Ltd.

JPINFRATEC

247

Jaiprakash Power Ventures Ltd.

JPPOWER

248

Jindal Saw Ltd.

JINDALSAW

249

Jindal Steel & Power Ltd.

JINDALSTEL

250

JSW Steel Ltd.

JSWSTEEL

251

JSW Energy Ltd.

JSWENERGY

252

Jubilant FoodWorks Ltd.

JUBLFOOD

253

Just Dial Ltd.

JUSTDIAL

254

Jyothy Laboratories Ltd.

JYOTHYLAB

255

Jyoti Structures Ltd.

JYOTISTRUC

256

The Karnataka Bank Ltd.

KTKBANK (continued)

16

1 Introduction

(continued) S. no

Company name

257

KCP Ltd.

NSE symbol KCP

258

KEC International Ltd.

KEC

259

Kewal Kiran Clothing Ltd.

KKCL

260

Kajaria Ceramics Ltd.

KAJARIACER

261

Cummins India Ltd.

CUMMINSIND

262

Kotak Mahindra Bank Ltd.

KOTAKBANK

263

Kansai Nerolac Paints Ltd.

KANSAINER

264

KNR Construction Ltd.

KNRCON

265

Kolte Patil Developers Ltd.

KOLTEPATIL

266

KPIT Technologies Ltd.

KPIT

267

Kalpataru Power Transmission Ltd.

KALPATPOWR

268

KPR Mill Ltd.

KPRMILL

269

KRBL Ltd.

KRBL

270

KSB Pumps Ltd.

KSBPUMPS

271

Kaveri Seed Company Ltd.

KSCL

272

KSK Energy Ventures Ltd.

KSK

273

Kitex Garments Ltd.

KITEX

274

Karur Vysya Bank Ltd.

KARURVYSYA

275

Lanco Infratech Ltd.

LITL

276

LG Balakrishnan & Brothers Ltd.

LGBBROSLTD

277

LIC Housing Finance Ltd.

LICHSGFIN

278

Linde India Ltd.

LINDEINDIA

279

Lakshmi Machine Works Ltd.

LAXMIMACH

280

La Opala RG Ltd.

LAOPALA

281

Lupin Ltd.

LUPIN

282

Larsen & Toubro Ltd.

LT

283

L&T Finance Holdings Ltd.

L&TFH

284

The Lakshmi Vilas Bank Ltd.

LAKSHVILAS

285

MBL Infrastructures Ltd.

MBLINFRA

286

Monsanto India Ltd.

MONSANTO

287

Mcleod Russel India Ltd.

MCLEODRUSS

288

Metalyst Forgings Ltd.

METALFORGE

289

Magma Fincorp Ltd.

MAGMA

290

Mahindra Holidays & Resorts India Ltd.

MHRIL

291

Maharashtra Seamless Ltd.

MAHSEAMLES

292

Maharashtra Scooters Ltd.

MAHSCOOTER

293

Munjal Showa Ltd.

MUNJALSHOW (continued)

Annexure I

17

(continued) S. no

Company name

NSE symbol

294

Mahindra Lifespace Developers Ltd.

MAHLIFE

295

Mahindra & Mahindra Ltd.

M&M

296

Mahindra & Mahindra Financial Services Ltd.

M&MFIN

297

MMTC Ltd.

MMTC

298

Mandhana Industries Ltd.

MANDHANA

299

Motilal Oswal Financial Services Ltd.

MOTILALOFS

300

MOIL Ltd.

MOIL

301

Mphasis Ltd.

MPHASIS

302

Marico Ltd.

MARICO

303

MRF Ltd.

MRF

304

Marksans Pharma Ltd.

MARKSANS

305

Chennai Petroleum Corporation Ltd.

CHENNPETRO

306

Mercator Ltd.

MERCATOR

307

Mangalore Refinery & Petrochemicals Ltd.

MRPL

308

Maruti Suzuki India Ltd.

MARUTI

309

Motherson Sumi Systems Ltd.

MOTHERSUMI

310

Mindtree Ltd.

MINDTREE

311

MT Educare Ltd.

MTEDUCARE

312

Mayur Uniquoters Ltd.

MAYURUNIQ

313

Muthoot Finance Ltd.

MUTHOOTFIN

314

National Aluminium Company Ltd.

NATIONALUM

315

National Buildings Construction Corporation Ltd.

NBCC

316

Nava Bharat Ventures Ltd.

NBVENTURES

317

New Delhi Television Ltd.

NDTV

318

Navneet Education Ltd

NAVNETEDUL

319

Network 18 Media & Investment Ltd.

NETWORK18

320

Nitin Fire Protection Industries Ltd.

NITINFIRE

321

NHPC Ltd.

NHPC

322

NIIT Ltd.

NIITLTD

323

NIIT Technologies Ltd.

NIITTECH

324

NCC Ltd.

NCC

325

Neyveli Lignite Corporation Ltd.

NEYVELILIG

326

NMDC Ltd.

NMDC

327

Nocil Ltd.

NOCIL

328

Noida Toll Bridge Company Ltd.

NOIDATOLL

329

Natco Pharma Ltd.

NATCOPHARM

330

NTPC Ltd.

NTPC (continued)

18

1 Introduction

(continued) S. no

Company name

331

Omaxe Ltd.

NSE symbol OMAXE

332

Oriental Bank Of Commerce

ORIENTBANK

333

Oberoi Realty Ltd.

OBEROIRLTY

334

Oracle Financial Services Software Ltd.

OFSS

335

Oswal Greentech Ltd.

BINDALAGRO

336

Oil India Ltd.

OIL

337

Orissa Minerals Development Company Ltd.

ORISSAMINE

338

Oil & Natural Gas Corporation Ltd.

ONGC

339

Opto Circuits (India) Ltd.

OPTOCIRCUI

340

Orient Cement Ltd.

ORIENTCEM

341

Page Industries Ltd.

PAGEIND

342

Parsvnath Developers Ltd.

PARSVNATH

343

Patel Engineering Ltd.

PATELENG

344

Peninsula Land Ltd.

PENINLAND

345

Prestige Estate Projects Ltd.

PRESTIGE

346

Pfizer Ltd.

PFIZER

347

Procter & Gamble Hygiene & Health Care Ltd.

PGHH

348

Phoenix Mills Ltd.

PHOENIXLTD

349

PI Industries Ltd.

PIIND

350

Pidilite Industries Ltd.

PIDILITIND

351

Piramal Enterprises Ltd.

PEL

352

Reliance Defence and Engineering Ltd.

RDEL

353

Prakash Industries Ltd.

PRAKASH

354

Petronet LNG Ltd.

PETRONET

355

Punjab National Bank

PNB

356

PNC Infratech Ltd.

PNCINFRA

357

Power Finance Corporation Ltd.

PFC

358

Praj Industries Ltd.

PRAJIND

359

Prism Cement Ltd.

PRISMCEM

360

Pennar Industries Ltd.

PENIND

361

Persistent Systems Ltd.

PERSISTENT

362

PTC India Financial Services Ltd.

PFS

363

PTC India Ltd.

PTC

364

Punj Lloyd Ltd.

PUNJLLOYD

365

Puravankara Projects Ltd.

PURVA

366

PVR Ltd.

PVR

367

Power Grid Corporation Of India Ltd.

POWERGRID (continued)

Annexure I

19

(continued) S. no

Company name

NSE symbol

368

Rico Auto Industries Ltd.

RICOAUTO

369

Rallis India Ltd.

RALLIS

370

Reliance Capital Ltd.

RELCAPITAL

371

Rashtriya Chemicals & Fertilizers Ltd.

RCF

372

Reliance Communications Ltd.

RCOM

373

Radico Khaitan Ltd.

RADICO

374

Rural Electrification Corporation Ltd.

RECLTD

375

Redington (India) Ltd.

REDINGTON

376

Religare Enterprises Ltd.

RELIGARE

377

Reliance Infrastructure Ltd.

RELINFRA

378

Repco Home Finance Ltd.

REPCOHOME

379

Reliance Industrial Infrastructure Ltd.

RIIL

380

Reliance Industries Ltd.

RELIANCE

381

Rain Industries Ltd.

RAIN

382

Rajesh Exports Ltd.

RAJESHEXPO

383

Rolta India Ltd.

ROLTA

384

Ratnamani Metals & Tubes Ltd.

RATNAMANI

385

Reliance Power Ltd.

RPOWER

386

Ruchi Soya Industries Ltd.

RUCHISOYA

387

Raymond Ltd.

RAYMOND

388

Sadbhav Engineering Ltd.

SADBHAV

389

Steel Authority Of India Ltd.

SAIL

390

Sanofi India Ltd.

SANOFI

391

State Bank Of Bikaner and Jaipur

SBBJ

392

State Bank Of India

SBIN

393

State Bank Of Travancore

SBT

394

Shipping Corporation Of India Ltd.

SCI

395

Siti Cable Network Ltd.

SITINET

396

Shriram City Union Finance Ltd.

SHRIRAMCIT

397

SE Investments Ltd.

SEINV

398

Sundram Fasteners Ltd.

SUNDRMFAST

399

Shanthi Gears Ltd.

SHANTIGEAR

400

Shoppers Stop Ltd.

SHOPERSTOP

401

Shree Renuka Sugars Ltd.

RENUKA

402

Shriram Transport Finance Company Ltd.

SRTRANSFIN

403

Supreme Industries Ltd.

SUPREMEIND

404

The South Indian Bank Ltd.

SOUTHBANK (continued)

20

1 Introduction

(continued) S. no

Company name

405

Siemens Ltd.

NSE symbol SIEMENS

406

Simplex Infrastructures Ltd.

SIMPLEXINF

407

Sintex Industries Ltd.

SINTEX

408

Shrenuj & Company Ltd.

SHRENUJ

409

Glaxosmithkline Consumer Healthcare Ltd.

GSKCONS

410

SKF India Ltd.

SKFINDIA

411

SKS Microfinance Ltd.

SKSMICRO

412

Syndicate Bank

SYNDIBANK

413

Sobha Ltd.

SOBHA

414

Sona Koyo Steering Systems Ltd.

SONASTEER

415

Sterlite Technologies Ltd.

STRTECH

416

Sun Pharma Advanced Research Company Ltd.

SPARC

417

Supreme Infrastructure India Ltd.

SUPREMEINF

418

Supreme Petrochem Ltd.

SUPPETRO

419

Shree Cement Ltd.

SHREECEM

420

SREI Infrastructure Finance Ltd

SREINFRA

421

SRF Ltd.

SRF

422

Srikalahasthi Pipes Ltd.

SRIPIPES

423

Sunteck Realty Ltd.

SUNTECK

424

Sonata Software Ltd.

SONATSOFTW

425

Strides Shasun Ltd.

STAR

426

Suzlon Energy Ltd.

SUZLON

427

Sundaram Finance Ltd.

SUNDARMFIN

428

Sun Pharmaceutical Industries Ltd.

SUNPHARMA

429

Sun TV Network Ltd.

SUNTV

430

Suven Life Sciences Ltd.

SUVEN

431

Swan Energy Ltd.

SWANENERGY

432

Swaraj Engines Ltd.

SWARAJENG

433

JSW Holdings Ltd.

JSWHL

434

Symphony Ltd.

SYMPHONY

435

Tata Steel Ltd.

TATASTEEL

436

Tribhovandas Bhimji Zaveri Ltd.

TBZ

437

Thomas Cook (India) Ltd.

THOMASCOOK

438

Tata Coffee Ltd.

TATACOFFEE

439

Tata Communications Ltd.

TATACOMM

440

Tata Consultancy Services Ltd.

TCS

441

TD Power Systems Ltd.

TDPOWERSYS (continued)

Annexure I

21

(continued) S. no

Company name

NSE symbol

442

Tech Mahindra Ltd.

TECHM

443

Techno Electric & Engineering Company Ltd.

TECHNO

444

Tata Elxsi Ltd.

TATAELXSI

445

Tata Global Beverages Ltd.

TATAGLOBAL

446

Tree House Education & Accessories Ltd.

TREEHOUSE

447

Tube Investments Of India Ltd.

TUBEINVEST

448

Tata Investment Corporation Ltd.

TATAINVEST

449

Thermax Ltd.

THERMAX

450

Tamil Nadu Newsprint & Papers Ltd.

TNPL

451

Torrent Power Ltd.

TORNTPOWER

452

Tata Power Company Ltd.

TATAPOWER

453

The Ramco Cements Ltd.

RAMCOCEM

454

Trent Ltd.

TRENT

455

Trident Ltd.

TRIDENT

456

Torrent Pharmaceuticals Ltd.

TORNTPHARM

457

Titan Company Ltd.

TITAN

458

Tata Chemicals Ltd.

TATACHEM

459

TTK Prestige Ltd.

TTKPRESTIG

460

Tata Motors Ltd.

TATAMOTORS

461

Tata Sponge Iron Ltd.

TATASPONGE

462

TV18 Broadcast Ltd.

TV18BRDCST

463

TVS Motor Company Ltd.

TVSMOTOR

464

TV Today Network Ltd.

TVTODAY

465

United Breweries Ltd.

UBL

466

UCO Bank

UCOBANK

467

Uflex Ltd.

UFLEX

468

Unichem Laboratories Ltd.

UNICHEMLAB

469

Union Bank Of India

UNIONBANK

470

United Spirits Ltd.

MCDOWELL-N

471

UPL Ltd.

UPL

472

Usha Martin Ltd.

USHAMART

473

Unitech Ltd.

UNITECH

474

Ultratech Cement Ltd.

ULTRACEMCO

475

Uttam Galva Steels Ltd.

UTTAMSTL

476

VA Tech Wabag Ltd.

WABAG

477

Videocon Industries Ltd.

VIDEOIND

478

Vedanta Ltd.

VEDL (continued)

22

1 Introduction

(continued) S. no

Company name

NSE symbol

479

Vaibhav Global Ltd.

VAIBHAVGBL

480

Vesuvius India Ltd.

VESUVIUS

481

VIP Industries Ltd.

VIPIND

482

Visagar Polytex Ltd.

VIVIDHA

483

Vijaya Bank

VIJAYABANK

484

Vakrangee Ltd.

VAKRANGEE

485

Vinati Organics Ltd.

VINATIORGA

486

Voltas Ltd.

VOLTAS

487

VRL Logistics Ltd.

VRLLOG

488

VST Industries Ltd.

VSTIND

489

Vardhman Textiles Ltd.

VTL

490

Whirlpool Of India Ltd.

WHIRLPOOL

491

Wheels India Ltd.

WHEELS

492

Wabco India Ltd.

WABCOINDIA

493

Welspun Corp Ltd.

WELCORP

494

Welspun India Ltd.

WELSPUNIND

495

Wockhardt Ltd.

WOCKPHARMA

496

Wipro Ltd.

WIPRO

497

Yes Bank Ltd.

YESBANK

498

Zee Entertainment Enterprises Ltd.

ZEEL

499

Zensar Technologies Ltd.

ZENSARTECH

500

Zydus Wellness Ltd.

ZYDUSWELL

References Ararat, M., & Dallas, G. S. (2011). Corporate governance in emerging markets: why it matters to investors-and what they can do about it. Private Sector Opinion. IFC Global Corporate Governance Forum. Retrieved 01 June 2017. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=191 4267. Berle, A., & Means, G. (1932). The Modern Corporate and Private Property. McMillian. Bertrand, M., Mehta, P., & Mullainathan, S. (2002). Ferreting out tunneling: An application to Indian business groups. The Quarterly Journal of Economics, 117(1), 121–148. Cadbury, A. (1992). Report of the Committee on the Financial Aspects of Corporate Governance. London: Gee. Retrieved 24 March 2017. http://www.ecgi.org/codes/documents/cadbury.pdf. Jensen, M., & Meckling, W. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360. Johnson, S., La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (2000). Tunneling. American Economic Review, 90(2), 22–27.

References

23

La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. (2002). Investor protection and corporate valuation. The Journal of Finance, 57(3), 1147–1170. Li, K., Ortiz-Molina, H., & Zhao, X. (2008). Do voting rights affect institutional investment decisions? Evidence from dual-class firms. Financial Management, 37(4), 713–745. Maassen, G. F. (2002). An International Comparison of Corporate Governance Models: A Study on the Formal Independence and Convergence of One-tier and Two-tier Corporate Boards of Directors in the Unites States of America, the United Kingdom and the Netherlands (3rd ed.). Spencer Stuart. Morck, R., Wolfenzon, D., & Yeung, B. (2005). Corporate governance, economic entrenchment, and growth. Journal of Economic Literature, 43(3), 655–720. NSE. (2021). NIFTY500. Retrieved from NIFTY500. https://www.nseindia.com/products/content/ equities/indices/nifty_500.htm. Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (1999). Corporate ownership around the world. The Journal of Finance, 54(2), 471–517. Rediker, K. J., & Seth, A. (1995). Boards of directors and substitution effects of alternative governance mechanisms. Strategic Management Journal, 16(2), 85–99. Rocca, M. (2007). The influence of corporate governance on the relation between capital structure and value. Corporate Governance: The International Journal of Business in Society, 7(3), 312– 325. Sarkar, S. (2010). Strengthening the Institution of Independent Directors. In Corporate Governance:An Emerging Scenario (pp. 389–425). National Stock Exchange. Retrieved 21 December 2018. https://www.nseindia.com/research/content/CG_15.pdf. Shleifer, A., & Vishny, R. W. (1997). A survey of corporate governance. The Journal of Finance, 52(2), 737–783. Tricker, R. I. (1984). Corporate Governance: Practices, Procedures, and Powers in British Companies and their Boards of Directors. Gower Pub. Co.

Chapter 2

Evolution of Corporate Governance in India

Corporate governance in India gained significance after liberalization of the Indian economy in 1991 when competition from foreign players forced the Indian companies to focus on their governance practices (Davies, 2012). Further, a series of national and international scams (The Harshad Mehta scam, 1992; The Enron scam, 2001; The Ketan Parekh scam, 2001; The Satyam scam, 2009; to name a few) raised concerns over the efficacy of the financial system, investor protection and the vigilance of various policy-makers and the regulators in the country (Subramanyam & Dasaraju, 2014). These events triggered the necessity of a sound corporate governance framework in the country. The following years witnessed the efforts of regulators and companies to strengthen the corporate governance framework in the country. Background Khanna and Palepu (2004) highlight India’s long business history. Over the past few centuries, merchants typically belonged to particular ethnic and sectarian groups. The resemblance exists today as well. When India was under the British rule, these family/ethnic groups had the resources to compete and to participate with Indian subsidiaries of the large British business groups existing at that time. After independence in 1947, India became a socialist economy, characterized with a lot of regulations and bureaucratic processes, popularly called the License Raj (i.e., the rule through the license system). This policy proved economically disastrous, and the government initiated a period of slow deregulation in the mid-1980s. A financial crisis spurred a much more radical liberalization in the 1990s (Ghemawat & Khanna, 1998; Khanna, 2000; Singh et al., 2013).

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2022 S. Singh and M. Singla, Corporate Governance Mechanisms and Firm Performance, India Studies in Business and Economics, https://doi.org/10.1007/978-981-19-2460-6_2

25

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2 Evolution of Corporate Governance in India

2.1 Evolution of Corporate Governance in India Drawing from the features of corporate structures prevalent across the world and from the understanding of the Indian economy, the following aspects appear vital and unique in the context of Indian corporate governance: Vital Aspects/Uniqueness of Corporate Governance in India 1.

2.

3.

4.

5.

Pyramidal business groups—Like the economies of Canada and Germany, India’s economy is also dominated by family-owned businesses in the private sector. Some of these business families have existed and prospered through the British rule and some have developed after independence in 1947. India, with 67% of family businesses in its economy, ranks first among the ten Asian countries studied in a survey conducted by global financial major Credit Suisse in 2011 (Business Standard, 2011). Strangle-hold of the dominant or principal shareholder—The primary difference between corporate governance enforcement problems in India and most western economies (on whose codes the Indian corporate governance code is largely based) is that whereas, elsewhere, the entire corporate governance approach hinges on disciplining the management and making them more accountable to the board, in India, the problem, since the inception of the jointstock companies, is the strangle-hold of the dominant or principal shareholder(s) who monopolize the majority of the company’s resources to serve their own ends. That, the ‘agency gap’ is actually between majority shareholders and other stakeholders (Pande and Kaushik, 2012). This applies across the spectrum of Indian companies with dominant shareholders—public sector undertakings or PSUs (with government as the dominant shareholder), multinational companies (where the parent company is the dominant shareholder) and private sector family owned companies and business groups (Varma, 1997). Un-empowered board—Much of global corporate governance norms focus on boards and their committees, independent directors and managing CEO succession. In the Indian business culture, however, boards are not as empowered as in several western economies and since the board is subordinate to the shareholders, the will of the majority shareholders prevails. Therefore, most corporate governance abuses in India arise due to conflict between the majority and minority shareholders. Promoter control—Promoters (who may not be holding controlling shares) usually exercise significant influence on matters involving their companies, even though such companies are listed on stock exchanges and hence have public shareholders. The Satyam episode illustrated a scenario wherein a company with minimal promoter shareholding could still be subject to considerable influence by its promoters (Varottil, 2010). Public float of shares now mandatory—Based on the corporate governance ethics that suggests that widely held companies are better governed

2.2 Legal Evolution of Corporate Governance in India

6.

7.

27

than closely held companies, the amendment to the Securities Contract (Regulation) Act (SCRA) in 2010 set a limit of 25% as the minimum public shareholding for initial as well as continued listing on the stock exchanges, with PSUs as the exception (Finance Ministry Website, 2010, http://www.finmin.nic.in/the_ministry/dept_eco_affairs/capital_market_ div/Amendment_Securt_contract_1957_.pdf). Declining role of banks in corporate financing—In bank capitalism, oversight by bankers substitutes for shareholder diligence. India followed bank capitalism prior to the economic liberalization in 1991 and had the unique concept of ‘nominee’ directors appointed to the board by banks in order to monitor governance. As long as the bankers are altruistic and competent, this system can allocate capital efficiently. However, if a few key banks are themselves misgoverned, the ramifications can create problems across all firms, which is what happened in India. Overenthusiastic lending by a few top bankers to misgoverned firms created financial problems that continued to hinder economic growth. Postliberalization, however, the role of banks in corporate financing has declined substantially (Jain et al., 2013) Declining role of development financial institutions in corporate financing—much like the banks, development financial institutions set up by the socialist government, were a large source of debt financing for the Indian corporates. However, instead of efficient governance of funds allocated, these institutions acted like mere distribution channels of public money to the corporate sector with no regard to its effective use or to returns on investment. After the economic and financial liberalization from 1991 onwards, their role has also declined drastically (Jain, et al. 2013).

It is perhaps evident from the preceding discussion that in recent times, equity shareholding has emerged to become the largest sources of finance for the Indian companies. The fact that, now, corporates are owned by a larger group of individuals makes corporate governance crucial as the interests of a larger populace are at stake.

2.2 Legal Evolution of Corporate Governance in India Cases of frauds and malpractices can undo the objectives of capital market reforms. Efficient and effective corporate governance reforms are, therefore, necessary in order to restore the credibility of capital markets. There are various reforms, channelled through multiple initiatives of the Securities and Exchange Board of India (SEBI) and the Ministry of Corporate Affairs (MCA), Government of India (GoI) playing important roles (Khurana, 2016). Reforms in Corporate Governance There have been various committees, formed with a view to reforming corporate governance in India, since 1990s (Securities and Exchange Board of India Website,

28

2 Evolution of Corporate Governance in India

http://www.sebi.gov.in/commreport/clause49.html). Some of the reforms undertaken are enumerated in this section. 1.

2.

3.

4.

5.

6.

7.

Task force under Rahul Bajaj (a reputed industrialist) set up in 1995 by the Confederation of Indian Industries (CII) released the code called “Desirable Corporate Governance”. It looked into various aspects of Corporate Governance and was the first to criticize nominee directors and suggested the dilution of government stake in companies. Commission under Kumarmangalam Birla (a reputed industrialist) set up by SEBI in 1999 covered issues relating to protection of investor interest, promotion of transparency and building international standards in terms of disclosure of information. Amendment to the Companies Act, 1956 by the Department of Companies Affairs (DCA) in 1999 introduced the provision relating to nomination facilities for shareholders and share buybacks and for the creation of the investor education and protection fund. Committee under Naresh Chandra set up in 2002 by DCA dealt with issues like auditor-company relationship, rotation of statutory audit firms/partners, procedure for appointment of auditors and determination of audit fees, true and fair statement of financial affairs of companies. Committee under Narayan Murthy set up in 2002 by SEBI focused on responsibilities of audit committee, quality of financial disclosure, requiring boards to assess and disclose business risks in the company’s annual reports. Clause 49 of the Listing Agreement has been formulated for the improvement of corporate governance in all listed companies. In effect from April 1, 2006, it includes key requirements like a mandatory corporate governance policy (National Stock Exchange (NSE) Website: http://www.nseindia.com/getting_l isted/content/clause_49.pdf). Amendment to the Companies Act, 1956 resulting into a new law; namely, Companies Act of 2013, elaborates on corporate social responsibility and makes it mandatory for listed companies to allocate profits for the same. A detailed corporate governance code has been prescribed which is to be implemented from October 1, 2014.

Corporate governance as a distinct functional area gained prominence with the foundation of the Securities and Exchange Board of India (SEBI) in 1992. The SEBI was set up with the dual aims to protect investors’ interest and to regulate the stock market. The first dedicated step towards the corporate governance reforms was taken up by the Confederation of Indian Industry (CII) with the issuance of the voluntary Code for Desirable Governance for corporates in 1998. However, the country did not have a formal corporate governance code in place until SEBI introduced a mandatory Clause 49 in 2005 (SEBI, 2005). It was the first formal step taken by the regulator to strengthen the corporate governance structure of the listed companies in the country. Clause 49 included various provisions related to the board composition, the formation of the Audit Committee and other mandatory disclosures. In 2010, SEBI, with an aim to promote the retail investor participation

2.2 Legal Evolution of Corporate Governance in India

29

in the Indian capital market, introduced an upper limit to the share of promoter ownership. All the listed non-government firms also came under the purview of this rule. The companies were provided three years (ending on July, 2013) to bring the promoter ownership to a maximum level of 75%. Promoter Ownership Under SEBI Promoter ownership refers to the percentage shareholding of the promoter and promoter group. The promoter and promoter group are defined under regulations 2(1) (za) and (zb) of Issue of Capital and Disclosure Requirements, 2009 by SEBI (SEBI, 2009). (za) “promoter” includes: (i) (ii) (iii)

the person or persons who are in control of the issuer; the person or persons who are instrumental in the formulation of a plan or programme pursuant to which specified securities are offered to public; the person or persons named in the offer document as promoters: • Provided that a director or officer of the issuer or a person, if acting as such merely in his professional capacity, shall not be deemed as a promoter; • Provided further that a financial institution, scheduled bank, foreign institutional investor and mutual fund shall not be deemed to be a promoter merely by virtue of the fact that 10% or more of the equity share capital of the issuer is held by such person; • Provided further that such financial institution, scheduled bank and foreign institutional investor shall be treated as promoter for the subsidiaries or companies promoted by them or for the mutual fund sponsored by them;

(zb) “promoter group” includes: (i) (ii) (iii)

the promoter; an immediate relative of the promoter (i.e., any spouse of that person, or any parent, brother, sister or child of the person or of the spouse); and in case promoter is a body corporate: • a subsidiary or holding company of such body corporate; • any body corporate in which the promoter holds 10% or more of the equity share capital or which holds 10% or more of the equity share capital of the promoter; • any body corporate in which a group of individuals or companies or combinations thereof which hold 20% or more of the equity share capital in that body corporate also holds 20% or more of the equity share capital of the issuer; and

(iv)

in case the promoter is an individual: • any body corporate in which 10% or more of the equity share capital is held by the promoter or an immediate relative of the promoter or a firm or

30

2 Evolution of Corporate Governance in India

• • •

•

(v)

Hindu Undivided Family in which the promoter or any one or more of his immediate relative is a member; any body corporate in which a body corporate as provided in (a) above holds 10% or more, of the equity share capital; any Hindu Undivided Family or firm in which the aggregate shareholding of the promoter and his immediate relatives is equal to or more than 10% of the total; and Provided that a financial institution, scheduled bank, foreign institutional investor and mutual fund shall not be deemed to be promoter group merely by virtue of the fact that 10% or more of the equity share capital of the issuer is held by such person; Provided further that such financial institution, scheduled bank and foreign institutional investor shall be treated as promoter group for the subsidiaries or companies promoted by them or for the mutual fund sponsored by them.

all persons whose shareholding is aggregated for the purpose of disclosing in the prospectus under the heading “shareholding of the promoter group”.

Further, the Ministry of Corporate Affairs (MCA) enacted the revised Companies Act, 2013 on August 13, 2013 (MCA, 2013) with an aim to expand the purview of corporate governance. All companies registered in India (whether listed or unlisted) came under the scope of this Act. Balasubramaninan (2013) described the introduction of this Act as the “harbinger of good governance” in the Indian corporate sector. SEBI introduced a more stringent revised Clause 49 of the listing agreement on April 17, 2014 (SEBI, 2014) with an aim to align its objectives with the Companies Act, 2013 and it superseded all the earlier circulars issued by SEBI in this regard. Companies were given almost six months to comply with the updated Clause 49 which came into effect on October 1, 2014. The following section highlights the main provisions of the revised Clause 49 of the Listing Agreement.

2.3 Provisions of the Revised Clause 49 of the Listing Agreement Revised Clause 49 deals with various codes related to independent directors, remuneration of the directors, various aspects of the Board and other committees, subsidiary companies and related party transactions, details of which are highlighted here.

2.3 Provisions of the Revised Clause 49 of the Listing Agreement

31

2.3.1 Independent Directors In consideration of the prevailing principal-principal issues in India, a special emphasis has been laid in the revised Clause 49 to strengthen various aspects related to the independent directors. i.

Proportion of independent directors

To promote unbiased and independent judgment, the minimum number of independent directors has been mandated to be one-third of the board strength, if the Chairman is a non-executive director and the required percentage of independent directors is 50% of the board strength if the non-executive Chairman is either the promoter or is related to the promoter of the company. ii.

Tenure of independent directors

In an attempt to ensure the independence of independent directors, the definition of independent directors has been made wider and a maximum limit on the tenure of independent directors has been set to 10 years (comprised of two terms of 5 years each with a cooling period of three years in between). The director who has already completed five years with a company as on October 1, 2014, will be assumed to have completed his first five-year term. iii.

Number of directorships of independent directors

To enable the independent directors to discharge their duties more effectively, the maximum number of independent directorships has been set to seven in listed companies. If the director is a whole-time director in a company, he cannot act as an independent director in more than three listed companies. iv.

Performance evaluation criteria for independent directors

To promote the culture of fairness and objectivity, Clause 49 has made it mandatory for the companies to disclose the performance evaluation criteria for the independent directors in the annual report.

2.3.2 Code of Conduct Clause 49 has made the management accountable by making it mandatory for the CEO/MD to sign an undertaking regarding the compliance of the code of conduct by all the directors and the senior management of the company.

2.3.3 Audit, Nomination and Remuneration Committees Certain codes have been put in place with regard to the audit and other committees. Clause 49 mandates the financial literacy of the members of the Audit Committee

32

2 Evolution of Corporate Governance in India

and the financial expertise of at least one member of the committee. The Chairman of the Audit Committee should be an independent director and the committee members should meet at least four times a year. The committee should comprise of a majority of independent directors. Similar conditions are laid down for the Nomination and Remuneration Committee, as well.

2.3.4 Subsidiary Companies Clause 49 makes it mandatory that an independent director of the holding company shall be on the board of a material non-listed Indian subsidiary.

2.3.5 Related Party Transactions (RPTs) The revised Clause 49 has made significant changes with regard to the RPTs making it mandatory for the companies to seek shareholders’ approval for material RPTs. The companies are also required to disclose the policy on RPTs in the annual report. The material related party transactions need to be disclosed along with the corporate governance compliance report. SEBI has empowered the shareholders in the sense that the companies need to seek prior approval from the shareholders in the annual general meeting (AGM) to carry on any material RPT.

2.3.6 Remuneration and Shareholding of Non-executive Directors To increase transparency, the companies are required to furnish detailed information on the remuneration and shareholding of non-executive directors in the annual report.

2.4 Recent Regulatory Developments on Corporate Governance The regulators continuously strive to strengthen the corporate governance framework in the country. SEBI, with an aim to consolidate various obligations and disclosure requirements of the listed companies under the purview of a single code, introduced “Listing Obligations and Disclosure Requirements (LODR)” in September, 2015 (SEBI, 2015). The various provisions of the revised Clause 49 are mapped to regulations 17–27 of the LODR regulations.

2.5 Alternate Corporate Governance Mechanisms

33

In order to further strengthen the corporate governance structure of the firms, the SEBI committee was formed on June 2, 2017, under the leadership of Mr. Uday Kotak. (SEBI, 2017). This committee submitted its report proposing various amendments to the existing governance framework on October 5, 2017. Based on various recommendations of the committee, SEBI introduced certain amendments the existing LODR on May 9, 2018 (SEBI, 2018). The listed companies were required to comply with the revised provisions by April 2019/2020.

2.5 Alternate Corporate Governance Mechanisms 2.5.1 Ownership Structure Ownership structure (monitoring by large shareholders) is another profoundly reseached area as a vital corporate governance mechanism. Unlike the minority shareholders who have a free-riding tendency, large shareholders (holding a substantial stake in the firm) have both the willingness and the resources to monitor the management and play an active role in the corporate governance structure of the firm. Many theoretical and empirical advancements have been made in the research analyzing the role of ownership structure on firm value (Cho & Kim, 2007; McConnell & Servaes, 1990; Morck et al., 1988; Sarkar & Sarkar, 2000). Basu et al. (2016) differentiated the effect of the voting power of the insider and outsider shareholders on the corporate governance structure of the firms. The authors argued that while the former tended to deploy their voting power towards pursuing their private benefits of control, the latter used its power for active monitoring of the management. Another separate body of literature analyzed the monitoring effect of large outsider shareholders. Large shareholders monitor the management through multiple channels like writing open letters to the management/board, voting on various resolutions to be passed in the general meetings, requesting disclosures on specific issues, suing the management/directors or selling the stake in the firms (voting with their feet), etc. (Gillan & Starks, 2003; McNulty & Nordberg, 2016).

2.5.2 Board Monitoring As the shareholders have limited ability and incentive to expend resources to monitor the management, they elect the board of directors to monitor the management on their behalf. McNulty et al. (2013) conducting a meta-analysis of 78 review papers confirmed that board monitoring was the most discussed monitoring mechanism in literature. From the agency perspective, various aspects of board monitoring that have been analyzed in literature are board independence (Bhagat & Black, 2002; Dalton et al., 1998; Fuzi et al., 2016; Uribe-Bohorquez et al., 2018), CEO-Chairman

34

2 Evolution of Corporate Governance in India

duality (Adams et al., 2005; Brickley et al., 1997; Dalton et al., 1998; Deman et al., 2018; Goyal & Park, 2002; Peni, 2014) and board size (Bansal & Sharma, 2016; Cheng et al., 2008; Eisenberg et al., 1998; Guest, 2009; Johl et al., 2015). Research has mainly centered around the analysis of the relationship between various aspects of board monitoring and firm value. The empirical research related to their impact on firm performance has largely remained inconclusive.

2.5.3 Audit Quality In a famous framework, DeAngelo (1981) defined the audit quality as “the marketassessed joint probability that a given auditor will both (a) discover a breach in the client’s accounting system, and (b) report the breach”. Lin and Hwang (2010) argued that audit quality acted as a monitoring mechanism as it reduced the information asymmetry between the shareholders and the management, and thus, reduced the agency costs. Along similar lines, Aguilera et al. (2015) stated that “external auditors are an integral part of the corporate governance (CG) puzzle because they enhance the quality of information disclosure and reduce information asymmetries…and limit the managers’ ability to manipulate the information and extract undue wealth”. Adding a different perspective, Fan and Wong (2005) argued that the independent external auditors were employed as bonding mechanisms to assure the minority shareholders about the governance quality of the firm. The authors further claimed that this was more important when the other indicators of governance were weak.

2.5.4 Market for Corporate Control Another profusely researched monitoring mechanism is an external monitoring mechanism, the market for corporate control. Manne (1965) regarded the market for corporate control as a key restraint on managerial inefficiency and discretion. Fama and Jensen (1983) defined corporate control as “the rights to determine the management of corporate resources—that is, the rights to hire, fire and set the compensation of top managers”. Jensen and Ruback (1983) described the market for corporate control as the “takeover market, in which alternative managerial teams competed for the rights to manage the corporate resources”. Mergers, tender offers, hostile takeovers, proxy contests and various antitakeover provisions are the vital elements of the market for corporate control (Coffee, 1984). Gillan (2006) termed the market for corporate control as an ultimate corporate governance mechanism. A review of the related literature also highlighted that the market for corporate control was not a universal governance mechanism. Kang and Shivdasani (1995) advocated that a relatively passive market for corporate control existed in Japan as a takeover activity was almost rare in the country. In a similar vein, Aguilera and

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Jackson (2003) compared the Anglo-American and Continental European governance models and corroborated that the former had an active market for corporate control while the latter had a relatively passive market for corporate control. Like Japan and other emerging economies, the Indian market is also characterized by a passive market for corporate control (Pandey, 2001; Sarkar & Sarkar, 2000). Perhaps, because of the passive nature of this governance mechanism in India, little empirical evidence is available in the Indian context in relation to the efficacy of this monitoring mechanism. Holmstrom and Kaplan (2003) argued that the effectiveness of market for corporate control as a monitoring mechanism was higher between the 1980s and around 2000 when hostile takeovers and leveraged buyouts used to be a norm. The authors also acknowledged the increased thrust on internal monitoring mechanisms in the recent past.

2.5.5 Product Market Competition In consideration of the monitoring role of product market competition, Machlup (1967) denied the possibility of managerial slack if the firm operated in a perfectly competitive market. Corroborating the viewpoint, Hart (1983) argued that competition provided less discretion to the management to pursue its self-interests, and thus, reduced agency cost. Gilson and Roe (1993) described competition as “the most elegant monitoring mechanism”. Nickell et al. (1997) argued that high product market competition provided a benchmark for comparison to measure the performance of the management.

2.6 Interrelationship Among Corporate Governance Mechanisms The rationale behind the analysis of the interrelationship among various governance mechanisms is premised on the concept of the “bundle of governance mechanisms” (Rediker and Seth, 1995). The concept states that the governance mechanisms, instead of working in isolation, work in relationship with each other. In authors’ words “firm performance depends on the efficiency of the bundle of governance mechanisms in controlling the agency problem, rather than on the efficiency of any single mechanism”. The last decade has witnessed a growing consensus of the researchers on the validity of this concept (García-Castro et al., 2013; Hassan et al., 2017; Wintoki et al., 2012; Yoshikawa et al., 2014). Based on this concept, we attempted to unbundle these governance mechanisms to understand the inter-relationships among various monitoring mechanisms in India.

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While doing so, we conducted a review of the literature to examine the interrelationship among various monitoring mechanisms with board independence as the central construct. Board independence has been chosen as the central governance mechanism because of the ability of the independent directors to advance the interest of the minority shareholders, and hence, to reduce principal-principal conflicts which are the prime governance concerns in emerging economies like India (Baum, 2017; Baysinger & Butler, 1985; Bebchuk & Hamdani, 2017; Dahya et al., 2009; Karolyi, 2012; Li et al., 2015). Also, there is growing concern on the monitoring efficacy of the independent directors (Bebchuk & Hamdani, 2017; Fuzi et al., 2016; Sarkar, 2009; Som, 2006; Zattoni & Cuomo, 2010). The review of literature on the inter-relationship among various governance mechanisms to understand the functioning of the monitoring role of board independence is further divided into two sub-themes.

2.6.1 Performance Enhancement Effect of Board Independence (Through Other Governance Mechanisms) The concept of “bundle of governance mechanisms” led us to think about the possible ways in which independent directors can enhance firm performance indirectly by other governance mechanisms. The related studies in this context formed the foundation of second objective of the study. The review of literature indicated two governance mechanisms that the independent directors can strengthen and which, in turn, can enhance firm performance. Though we could not find any study, in the Indian as well as in the international context analyzing the direct and indirect effect of board independence on firm performance. A related review of literature highlighted evidences of the direct and positive relation between board independence and audit quality; and board independence and foreign institutional investment (FII). However, the analysis of the indirect relationship between board independence and firm performance in relation to these variables (audit quality and FII) as the mediating variables is an important and missing link in the existing literature. We attempt to address this research gap and analyze if the independent directors enhance firm performance indirectly by strengthening other governance mechanisms (audit quality and foreign institutional investment). Numerous studies indicate that independent directors discharge their monitoring role by appointing high-quality auditors. Also, foreign institutional investors were more likely to invest in the companies which had more independent boards. For more clarity, a detailed review of the related literature is presented separately under the following headings.

2.6 Interrelationship Among Corporate Governance Mechanisms

i.

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Board independence and audit quality

Fama (1980) advocated that independent directors were introduced with the motive to monitor the activities of the management and to reduce agency costs. Based on this viewpoint, O’sullivan (2000) theorized that the independent directors demanded more intensive audits in an attempt to complement their own monitoring. This hypothesis was tested using the data of the top 100 companies operating in the U.K. for the year 1992. Using the total audit fee as a proxy of the audit quality, the authors found that the independent directors were more concerned with the audit quality and were likely to pay a higher total audit fee. In a similar tone, Beasley and Petroni (2001) argued that outside directors, in order to seek greater assurance about the quality of the financial statements and to minimize the information asymmetries between themselves and the management, appointed high-quality auditors. Their empirical work was based on the data of 681 firms over two years (1992–1993). The authors deployed a probit regression model and reported that a higher proportion of the non-executive directors on the board had a greater tendency to improve the audit quality by hiring a Big-N (Big-Six) auditor. Similar findings were reported by Carcello et al. (2002) in the context of U.S. The authors argued that the independent directors, in order to protect their reputation and to minimize their legal liability, tended to enhance the audit quality of the firm. The empirical results were based on the data of Fortune 1000 firms for the year 1993. The empirical results confirmed that board independence was positively related to audit quality (measured with audit fee). The results remained robust for multiple measures of audit quality. Peasnell et al. (2005), though not analyzing the audit quality directly, analyzed the relationship between board independence and earnings quality of the U.K. firms. The empirical results were based on the analysis of 1271 firm-year observations over four years (1993–1996). The findings confirmed an inverse relationship between board independence and earnings quality of the firms. Azim (2012) analyzing the data of 1410 firm-year observations of firms listed in Australia also noted that a more independent board was more likely to appoint a highquality audit firm with the quality of the audit firm being measured as the function of auditor size and non-audit fee (in a structural equation modeling framework). Quick et al. (2017) analyzing the empirical data of 432 German firm-year observations over five years (2010–2014), also reported the board structure was a significant determinant of the audit quality (auditor choice in terms of auditor size) of the firm. ii.

Board independence and foreign institutional investment

Foreign institutional investors are documented to invest more in better-governed firms to minimize the risk of the information asymmetries and the lack of shareholder protection in the foreign markets. This section, in line with the theme of the current analysis, presents the summary of the studies analyzing the relationship between board monitoring and foreign institutional investment. In a conceptual paper, Rueda-Sabater (2000) analyzed various aspects of corporate governance in emerging markets. The author argued that the improvements in

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the firm-level governance structure could partially off-set the voids in the countrylevel governance structure. The author further suggested that the firm-level governance reforms could facilitate the companies in attracting more foreign institutional investors, who could, in turn, strengthen the governance quality of the firms. The findings of Chung and Zhang (2011) provided an empirical validity of these viewpoints. Along similar lines, Mangena and Tauringana (2007) argued that foreign institutional investors were more likely to invest in firms where they perceived that they were well-protected. The authors conducted an empirical study on the data of 118 firm-year observations over the period of two years (2002–2003). All the firms were listed on the Zimbabwe Stock Exchange (ZSE). The empirical results of the firmlevel data analysis revealed that foreign institutional investors were more likely to invest in the companies which had a higher proportion of the non-executive directors. Contrary to the findings of Mangena and Tauringana (2007), Aggarwal et al. (2011) reported that the causality of the relationship between board independence and foreign institutional investment ran from the foreign institutional investment to board independence. The authors analyzed the data from 23 countries over a period of six years (2003–2008). The findings confirmed that the level of shareholder protection in the foreign country mattered in the choice of portfolio markets of the foreign investors. Also, a higher level of foreign investor ownership enhanced the firm-level governance quality. Later on, Miletkov et al. (2014) reported empirical results which were in contrast to the findings of Aggarwal et al. (2011). The authors analyzed the data of 80 nonU.S. countries which comprised of 58,287 firm-year observations over 12 years (2001–2011). The findings confirmed that foreign investors were more likely to invest in companies with more independent boards. Also, the relationship between board independence and foreign ownership was stronger for countries with weak shareholder protection. The findings of Min and Bowman (2015) also validated the results of Miletkov et al. (2014) in the context of Korea. The empirical results were based on the analysis of 2842 firm-year observations over a period of five years (1999–2003). The findings indicated that the increased board independence of the Korean firms was followed by an increase in the foreign institutional investments. Further, the results suggested that the effectiveness of board independence in attracting more foreign institutional investors was higher for the stand-alone firms compared to the group firms. In the explanation, the authors suggested that the foreign investors discounted the effectiveness of the board independence in the business-group firms. Abdulmalik and Ahmad (2016) also provided similar evidence in the context of Nigeria.

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2.6.2 Mechanisms Diluting the Effectiveness of Board Independence Researchers have expressed concerns about the ineffectiveness of independent directors in India (Sarkar, 2009; Varottil, 2010). A few empirical studies have validated their concerns in India (Garg, 2007; Jameson et al., 2014). However, we could not find any study which conducts an empirical analysis to explore the possible reasons to explain the ineffectiveness of the independent directors in India. Some advances have been made in the international context (Buchwald, 2017; Cho & Kim, 2007; Leung et al., 2014) and two governance mechanisms have been identified from the review of literature which can probably explain the ineffectiveness of independent directors in India. A related review of the literature highlighted two possible governance mechanisms which could dilute the effectiveness of board independence. Technically, the term “dilute the effectiveness of board independence” means the governance mechanisms which can weaken the board independence and firm performance relationship. For a better exposition, the review of literature is presented in line with the two mechanisms which have emerged as part of the literature review exercise. Insider Ownership and Effectiveness of Board Independence Many studies support the argument of the possible relationship between insider ownership and the effectiveness of board independence. However, a few empirical advances have been made only in the recent past to provide direct evidence of the relationship between insider ownership and the effectiveness of board independence (Cho & Kim, 2007; Lefort & Urzua, 2008). In the wake of a new regulation requiring the appointment of independent directors and concentrated ownership in Korea, Cho and Kim (2007) analyzed the effectiveness of the independent directors in relation to the ownership structure of the firms. The sample of the study comprised of 600 firms listed on the Korean Stock Exchange (KSE) for the year 1999. The empirical findings reported that the ownership of the large controlling shareholders diluted the effectiveness of the independent directors in enhancing firm profitability. Another empirical study was conducted by Lefort and Urzua (2008) on a sample of 160 firms listed in Chile over a period of four years (2000–2003). The findings confirmed that the outside independent directors (appointed without the involvement of the controlling shareholders) enhanced firm value, while the proportion of the professional directors had an insignificant relationship with firm value. The study of Dahya et al. (2009) reported conflicting results. The authors analyzed the data of 800 firms from 22 countries. The empirical findings confirmed that in firms with a controlling shareholder, the independent directors enhanced firm value by restricting the ability of the controlling shareholders to expropriate private benefits of control. Based on the analysis, the authors had also suggested that Indian firms could enhance the firm value by appointing more independent directors.

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Along similar lines, Leung et al. (2014) analyzed the distinctive role played by the independent directors in the family and non-family firms in Hong Kong. The empirical analysis was based on the data of 487 firms for the year 2006. The findings confirmed that overall the independent directors did not have a significant impact on firm performance. However, the disaggregate analysis revealed that the independent directors enhanced firm performance for non-family firms and the relationship was insignificant for family firms. Li et al. (2015) exploited two regulatory changes in China related to the enhanced board independence in 2001 and share restructure program in 2005 which reduced the ownership concentration. The authors examined how the new ownership structure affected the relationship between board independence and firm value. The sample of the study comprised of 1241 firms over a period of six years (2003–2008). The empirical findings confirmed that board independence and firm value relationship got strengthened with the decline in ownership concentration. In a conceptual paper, Bebchuk and Hamdani (2017) questioned the existing director-election process and argued that it hampered the ability of the independent directors to perform their monitoring role. As the election and the removal of the independent directors were largely influenced by the controlling shareholders, the independent directors were not able to give their unbiased views. Further, the authors advocated the need for “enhanced-independence” of directors compared to merely “independent” directors. Chou et al. (2018) used an interesting framework to analyze the role of controlling shareholders in influencing the board independence and firm performance relationship. The authors assessed the independence of the independent directors by analyzing if they had a prior affiliation to the board. The authors also evaluated the impact of controlling shareholders on the probability of appointing an independent director with a previous affiliation. The authors used a sample of 585 firms over a period of three years (2002–2004). The empirical findings confirmed that the directors having a prior affiliation had an insignificant relationship with firm performance. Also, there existed a positive relationship between the cash-flow rights of the controlling shareholders and the likelihood of the appointment of the independent directors having a prior affiliation with the board. i.

Product market competition and effectiveness of board independence

There is growing evidence on the substitution relationship between internal and external monitoring mechanisms. A brief review of the related studies is presented herewith. In a theoretical paper, John and Senbet (1998) highlighted that the monitoring role of board independence was strong only when the external monitoring mechanisms (like the market for corporate control) was weak. The authors further suggested that the importance of board independence to address the agency issues got diluted when the external monitoring mechanisms played the monitoring role. To the best of our knowledge, Randoy and Jenssen (2004) provided the first empirical evidence of the direct inter-relationship between product market competition and the effectiveness of the independent directors. Their empirical estimates were based

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on the data of 98 firms listed in Sweden over a period of three years (1996–1998). The authors argued that the relationship between board independence and firm value got diluted with the increase in the product market competition. In the explanation, the authors suggested that in an already competitive industry, the extra board monitoring was a “double dose” of monitoring and termed it as “too much of a good thing”. Chhaochharia et al. (2008), though not analyzing the effect of product market competition on the effectiveness of board independence, also asserted that product market competition substituted other governance mechanisms. Further, the authors suggested that the marginal benefit of the additional governance mechanisms was lesser for the firms operating in highly competitive industries. The findings of Chou et al. (2011) in the context of U.S. also reinforced similar viewpoints. Ammann et al. (2013) analyzed 3102 firm-year observations of firms from 14 counties (European Union) over a period of four years (2003–2007). As a measure of corporate governance, the authors used a governance index which comprised of 64 attributes. The findings indicated that corporate governance enhanced the firm value of only those firms that were operating in the non-competitive industries. Buchwald (2017) also analyzed the effectiveness of the outside directors in performing their monitoring role in relation to the product market competition of the firm. The authors analyzed the data of 3369 European firms over a period of nine years (2003–2011). In this study, the executive turnover was used as a measure of the effectiveness of the monitoring of the independent directors. The empirics confirmed that the independent directors increased executive turnover of the poorly performing firms operating in non-competitive industries. Chhaochharia et al. (2016) examined an external policy change (Sarbanes Oxley Act, SOX) to analyze the relationship between product market competition and internal governance mechanisms. The findings were based on 38,053 firm-year observations over a period of seven years (2000–2006). The findings confirmed that the firms operating in less competitive industries experienced efficiency gains post-SOX implementation. Amongst the firms in less competitive industries, the firms having weaker governance structure before the SOX implementation, enjoyed higher efficiency gains.

2.7 Summary This chapter explains the evolution of corporate governance in the country from the regulatory front. Besides the regulatory aspects, this chapter highlights various other governance mechanisms and explains their interlinkages. This chapter also justifies the need of current research work while highlighting the research gaps in this context. The next chapter presents the testable hypotheses, delineates the scope of the study and presents the methodologies deployed to achieve various objectives of the study.

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Miletkov, M. K., Poulsen, A. B., & Wintoki, M. B. (2014). The role of corporate board structure in attracting foreign investors. Journal of Corporate Finance, 29, 143–157. Min, B., & Bowman, R. (2015). Corporate governance, regulation and foreign equity ownership: Lessons from Korea. Economic Modelling, 47(2), 145–155. Morck, R., Shleifer, A., & Vishny, R. W. (1988). Management ownership and market valuation: An empirical analysis. Journal of Financial Economics, 20(1), 293–315. Nickell, S., Nicolitsas, D., & Dryden, N. (1997). What makes firms perform well? European Economic Review, 41(3–5), 783–796. O’sullivan, N. (2000). The impact of board composition and ownership on audit quality: Evidence from large UK companies. The British Accounting Review, 32(4), 397–414. Pande, S., & Kaushik, K. V. (2012, July 12). State of Corporate Governance in India—Evolution, issues and challenges for the future. Retrieved from http://www.iica.in/images/Evolution_of_Cor porate_Governance_in_India.pdf. Pandey, A. (2001). Takeover announcements, open offers, and shareholders’ returns in target firms. Vikalpa, 26(3), 19–30. Peasnell, K. V., Pope, P. F., & Young, S. (2005). Board monitoring and earnings management: Do outside directors influence abnormal accruals? Journal of Business Finance and Accounting, 32(7–8), 1311–1346. Peni, E. (2014). CEO and Chairperson characteristics and firm performance. Journal of Management and Governance, 18(1), 185–205. Quick, R., Schenk, N., Schmidt, F., & Towara, T. (2017). The impact of corporate governance on auditor choice: Evidence from Germany. Journal of Management and Governance, 1–33. https:// doi.org/10.1007/s10997-017-9386-4. Randøy, T., & Jenssen, J. I. (2004). Board independence and product market competition in Swedish firms. Corporate Governance: An International Review, 12(3), 281–289. Rediker, K. J., & Seth, A. (1995). Boards of directors and substitution effects of alternative governance mechanisms. Strategic Management Journal, 16(2), 85–99. Rueda-Sabater, E. (2000). Corporate governance and the bargaining power of developing countries to attract foreign investment. Corporate Governance: An International Review, 8(2), 117–124. SEBI. (2005, March 29). Corporate governance—Clause 49 of the Listing Agreement. Retrieved March 26, 2016, from https://www.sebi.gov.in/legal/circulars/mar-2005/corporate-governanceclause-49-of-the-listing-agreement_8348.html. SEBI. (2009). Issue of Capital and Disclosure Requirements Regulations 2009. Retrieved Decemeber 11, 2017, from https://www.sebi.gov.in/acts/icdrreg09.pdf. SEBI. (2014, April 17). Corporate governance in listed entities-Amendments to Clauses 35B and 49 of the Equity Listing Agreement. Retrieved January 1, 2017, from https://www.sebi.gov.in/ legal/circulars/apr-2014/corporate-governance-in-listed-entities-amendments-to-clauses-35band-49-of-the-equity-listing-agreement_26674.html. SEBI. (2015, September 2). Listing Obligations and Disclosure Regulations 2015. Retrieved December 12, 2017, from https://www.sebi.gov.in/sebi_data/attachdocs/1441284401427.pdf. SEBI. (2017). Report of the Committee on Corporate Governance. Mumbai: SEBI. Retrieved December 17, 2017, from https://www.sebi.gov.in/reports/reports/oct-2017/report-of-the-com mittee-on-corporate-governance_36177.html. SEBI. (2018, May 9). SEBI (Listing Obligations and Disclosure Requirements) (Amendement) Regulations. (2018). Mumbai, India. Retrieved October 11, 2018, from https://www.sebi.gov. in/legal/regulations/may-2018/sebi-listing-obligations-and-disclosure-requirement-amendmentregulations-2018_38898.html. Sarkar, J. (2009). Board independence and corporate governance in India: Recent trends and challenges ahead. Indian Journal of Industrial Relations, 44(4), 576–592. Sarkar, J., & Sarkar, S. (2000). Large shareholder activism in corporate governance in developing countries: Evidence from India. International Review of Finance, 1(3), 161–194.

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Singh, S., Yadav, S. S., & Jain, P. K. (2013). Corporate governance practices: Empirical evidence from Indian corporates. International Journal of Global Business and Competitiveness, 8(1), 11–22. Som, L. S. (2006). Corporate governance codes in India. Economic and Political Weekly, 41(39), 4153–4160. Subramanyam, M., & Dasaraju, H. (2014). Corporate governance and disclosure practices in listed Information Technology (IT) Companies in India. Open Journal of Accounting, 3(4), 89–106. Uribe-Bohorquez, M. V., Martínez-Ferrero, J., & García-Sánchez, I. M. (2018). Board independence and firm performance: The moderating effect of institutional context. Journal of Business Research, 88, 28–43. Varma, J. R. (1997). Corporate governance in India: Discipling the dominant shareholder. IIMB Management Review, 9(4), 5–18. Varottil, U. (2010). Evolution and effectiveness of Indian directors in Indian corporate governance. Hastings Business Law Journal, 6(2), 281–376. Wintoki, M. B., Linck, J. S., & Netter, J. M. (2012). Endogeneity and the dynamics of internal corporate governance. Journal of Financial Economics, 105(3), 581–606. Yoshikawa, T., Zhu, H., & Wang, P. (2014). National governance system, corporate ownership, and roles of outside directors: A corporate governance bundle perspective. Corporate Governance: An International Review, 22(3), 252–265. Zattoni, A., & Cuomo, F. (2010). How independent, competent and incentivized should nonexecutive directors be? An empirical investigation of good governance codes. British Journal of Management, 21(1), 63–79.

Chapter 3

Research Methodology

The current chapter presents the testable hypotheses in line with the research objectives, delineates the scope of the study and presents the methodologies deployed to achieve various objectives of the study.

3.1 Introduction The step-wise process from the identification of the research gaps to the framing of testable hypotheses is motivated by our intent of conducting a focused research. Further, the scope of the study highlights the limited availability of time and resources. The research methodologies highlighted in this chapter forms the foundation of the next chapters of the research monograph which are related to data analysis. All these aspects explain the basis of this chapter. Layout of the chapter is presented in Fig. 3.1.

3.2 Research Objectives and Research Hypotheses The broad research objectives of the study are listed here: i.

ii.

To analyze the impact of various governance mechanisms (board monitoring, ownership structure, audit quality and product market competition) on firm performance. To analyze if the independent directors enhance firm performance indirectly by strengthening other governance mechanisms (audit quality and foreign institutional investment).

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2022 S. Singh and M. Singla, Corporate Governance Mechanisms and Firm Performance, India Studies in Business and Economics, https://doi.org/10.1007/978-981-19-2460-6_3

47

48

3 Research Methodology Introduction

Research Objectives and Research Hypotheses

Section 3.1

The Scope of the Study

Research Methodology

Section 3.3

Section 3.4

Summary and Conclusion

Section 3.2

Why Study an Emerging Economy?

Why Study Indian Companies?

Period of the Study

Section 3.5

Sample Selection Process

Section 3.3.3 Section 3.3.1

Section 3.3.2

Measures/Proxies

Research Methodologies Used

Section 3.4.1

Section 3.3.4

Sources of Data and Research Tools Used Section 3.4.3

Section 3.4.2

Objective 1

Objective 2

Objective 3

Fig. 3.1 A visual layout of this chapter. Source Authors’ compilation

iii.

To analyze if the level of promoter ownership and product market competition dilute the effectiveness of independent directors in enhancing firm performance.

Following research hypotheses are framed corresponding to each research objective. Objective 1 The first objective of the study is concerned with the analysis of the impact of various governance mechanisms on firm performance. In line with the various firm-level monitoring mechanisms in consideration in the current study, following testable null hypotheses have been framed. H 0.1 There exists no relationship between product market competition and firm performance. H 0.2 There exists no relationship between audit quality and firm performance. H 0.3 There exists no relationship between board monitoring and firm performance. H 0.4 There exists no relationship between ownership structure and firm performance. Objective 2 This objective analyzes the performance enhancement effect of board independence in relation to the other two governance mechanisms (audit quality and foreign institutional investment). The analysis of this objective has been conducted in multiple parts. Part I The first part is related to the analysis of the direct relationship between board independence and other governance mechanisms (audit quality and foreign institutional investment). For doing so, following testable null hypotheses are framed: H 0.5 There exists no relationship between board independence and audit quality.

3.2 Research Objectives and Research Hypotheses

49

H 0.6 There exists no relationship between board independence and foreign institutional investment. Part II In the second part, we analyze the performance enhancement effect of board independence, in consideration of the other two variables as the mediating variables. Technically, in this part, we attempt to test the following null hypotheses: H 0.7 Board independence does not affect firm performance through audit quality. H 0.8 Board independence does not affect firm performance through foreign institutional investments. Objective 3 Objective 3 of the study is related to the analysis of the governance mechanisms which could dilute the board independence and firm performance relationship. The analysis of this objective is conducted in multiple parts. Part I In line with the objective, the following null hypotheses are framed to analyze the governance mechanisms which might dilute the effectiveness of board independence. H 0.9 Insider ownership does not influence the board independence and firm performance relationship. H 0.10 Product market competition does not influence the board independence and firm performance relationship. Part II In the next part, we attempt to analyze if the governance mechanisms which might dilute the effectiveness of board independence also affect the relationship of board independence with the other two governance mechanisms (audit quality and foreign institutional investment). Specifically, the following null hypotheses are proposed: H 0.11 Insider ownership does not influence the board independence and audit quality relationship. H 0.12 Insider ownership does not influence the board independence and foreign institutional ownership relationship. H 0.13 Product market competition does not influence the board independence and audit quality relationship. H 0.14 Product market competition does not influence the board independence and foreign institutional ownership relationship. It is to be noted that these hypotheses would be tested only if the moderating variables (insider ownership and product market competition) turn out to be significant in influencing the effectiveness of independent directors.

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Part III Finally, if the relationships in Parts I and II turn out to be significant, it would be analyzed if the indirect relationship between board independence on firm performance (through audit quality and foreign institutional ownership, separately) gets influenced by the other two governance mechanisms (insider ownership and product market competition). Following testable null hypotheses are framed in this context: H 0.15 The indirect relationship between board independence and firm performance (through audit quality) is not influenced by insider ownership. H 0.16 The indirect relationship between board independence and firm performance (through foreign institutional ownership) is not influenced by insider ownership. H 0.17 The indirect relationship between board independence and firm performance (through audit quality) is not influenced by product market competition. H 0.18 The indirect relationship between board independence and firm performance (through foreign institutional ownership) is not influenced by product market competition.

3.3 Scope of the Study The scope of the study is limited to the analysis of the firm-level data of an emerging economy, India.

3.3.1 Why Study an Emerging Economy? Two aspects explain our choice of an emerging economy for the purpose of this monograph. i.

Lack of research in the context of emerging economies

The primary reason behind the selection of an emerging economy is the general lack of literature in the context of emerging economies. While the literature is rife with the corporate governance studies in the context of the developed economies like the U.S., U.K. and various European economies, relatively fewer studies have been conducted in the context of emerging economies. Many researchers have also acknowledged this viewpoint in the past (Tan & Peng, 2003). ii.

Lack of the generalizability of the empirical results

The empirical findings of the developed economies cannot be generalized on to the developing countries (Davies & Schlitzer, 2008; Zattoni et al., 2013). This argument is based on the fact that both the developed and the developing economies have distinct institutional frameworks (Morck & Steier, 2005). For example, the developing economies have a relatively weaker rule of law, less developed capital

3.3 Scope of the Study

51

markets, concentrated ownership and an inadequate protection of the shareholders’ rights (Iliev et al., 2015; Porta et al., 1999; Young et al., 2008). Owing to these institutional differences, the corporate governance issues of these economies also differ. For example, the prime governance issue in the developing economies is the principal-principal issue unlike the principal-agent problems in economies like the U.S. and the U.K (Porta et al., 1999; Young et al., 2008). These factors, in turn, make the generalizability of the empirical findings of corporate governance studies, inappropriate across various economies. Besides these issues, many researchers contend that the developing economies tend to mimic the corporate governance framework of the developed economies without giving due consideration to their institutional peculiarities and their unique governance concerns (Varma, 1997; Varottil, 2010). This issue further warrants the need of a comprehensive study to be conducted in the context of an emerging economy to develop a deeper understanding of the state of corporate governance and the dynamics of various governance mechanisms in relation to each other. In consideration of the aforementioned viewpoints, the scope of the current study is limited to the analysis of an emerging economy. Amongst the emerging economies, the research has been conducted in the context of the Indian companies.

3.3.2 Why Study Indian Companies? The choice of the Indian companies has been guided by the following reasons. The most prominent reason behind the country selection (India) is the numerous governance reforms the Indian economy has witnessed in the recent past (MCA, 2013; SEBI, 2006, 2014, 2015). In relation to these regulatory reforms, little evidence is available with respect to the effectiveness of these reforms in strengthening the governance quality of the firms. For instance, the recent regulatory reforms strive towards enhancing the board independence. Considering the prime role which independent directors can play in mitigating the principal-principal issues, it is imperative to analyze the role of board independence in strengthening the corporate governance structure. Further, there is a growing consensus on the ineffectiveness of the independent directors in India (Garg, 2007; Haldar et al., 2018; Jameson et al., 2014; Sarkar, 2009; Varottil, 2010). However, to the best of our knowledge, no study has attempted to analyze the efficacy of board independence in relation to other governance mechanisms. Thus, we chose to conduct an analysis on the Indian companies to advance the understanding on the functioning of board independence, which has been at the core of various regulatory recommendations across the globe, to enhance the governance quality of the firms.

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3.3.3 Period of the Study The study covers a period of 11 years (2007–2017). Data for multiple years has been used to ensure the stability of the empirical findings over time.

3.3.4 Sample Selection Process The sample selection process was started by selecting an initial sample of the top 500 companies constituting the NIFTY 500 index of the National Stock Exchange (NSE) of India. Two factors guided the choice behind the initial selection of top 500 companies: one, the top 500 companies capture about 96% of the free-float market capitalization of the stocks listed on the NSE, the largest stock exchange in India as on March 31, 2019 (NSE, 2021). Also, the total traded value of all the constituents of NSE500 index for the last six months ending March 2019 accounted for about 96.5% of the total share trades made during that duration. Thus, the sample may be considered a fair representation of the Indian capital market. Second, it is prevalent practice in the literature to use top 500 companies or lesser as a benchmark for empirical analysis (Anderson & Reeb, 2003; Kang et al., 2007; Cheffins, 2009). In the sample screening process, we have eliminated the financial firms (74 firms) based on multiple considerations. The initial thought of excluding the financial firms from the sample was sparked by the customary practice of analyzing the non-financial firms in the relevant literature. Following this, we started analyzing the possible reasons behind the exclusion of the financial firms in the Indian context. It turned out that the regulatory provisions did not have uniform applicability on both the financial and non-financial firms in India. For example, Clause 49 is applicable to the non-financial firms only to the extent that it does not violate the compliance of the financial firms with their respective regulatory provisions. Also, Clause 49 is not applicable to mutual funds. Further, there are different regulatory requirements regarding the promoter ownership norms for the private sector banks. For example, the maximum limit on the promoter ownership for the listed companies is 75%. However, the maximum limit on the promoter group ownership varies from 10 to 40% for private sector banks (RBI, 2016). Furthermore, the appointment and removal of the CEO/Chairman of the private sector banks are subject to the approval from the Reserve Bank of India (RBI). In light of these viewpoints and to maintain consistency among the sample firms, we have opted to exclude the financial firms (74 firms) from an initial sample of 5500 firm-years leaving behind 4686 firm-year observations. We have further eliminated 278 firm-year observations as the firms were not listed in the respective years. We have also excluded 93 firm-year observations corresponding to the firms-years following an unstandardized accounting period (other than April-March) or where firms have reported data not equivalent to 12 months (due to a change in their accounting period). Finally, 67 firm-year observations have been dropped on the ground of missing annual reports or missing variables (being

3.4 Research Methodology

53

used in the study). The complete sample screening process left us with a final sample of 4248 firm-year observations.

3.4 Research Methodology This section details the proxies used to measure various variables of interest. Following this, the detailed research methodologies adopted in line with the objectives of the study are presented.

3.4.1 Measures/Proxies This section explains the measures/proxies used and the formulations deployed to measure the variables of interest. Based on the objectives of the study, the following variables have been used in the analysis. i.

Board monitoring

Board independence has been used as the measure for board monitoring. Considering the agency perspective, independent directors are deemed to be an integral part of board monitoring (Chakrabarti & Sarkar, 2010; Cohen et al., 2002; Dahya et al., 2008; Sarkar, 2010; Xie et al., 2003). In view of the conceptualization of the monitoring role as the prime duty of the board of directors, Eisenberg (1976) advocates that board of directors should be independent to be able to discharge the monitoring role in an unbiased manner. Sarkar (2010) contends the heightened importance of board independence in the emerging economies where external governance mechanisms are less effective and independent directors become the representatives of the minority shareholders and safeguard their interests. Anderson and Reeb (2004) and Rajagopalan and Zhang (2008) also advocate a similar viewpoint. In consideration of these viewpoints, board independence has been taken as the primary measure of board monitoring. In line with the existing literature, board independence has been measured as the percentage of independent directors on the board (Eq. 3.1). Board independence =

Total number of independent directors ∗ 100 Total number of directors in the board

(3.1)

Besides board independence, certain other aspects of board monitoring like CEOChairman duality, board size, independence of the Audit Committee, independence of the Nomination and Remuneration Committee have been analyzed in the existing literature. Therefore, in line with the existing literature, some additional measures of board monitoring (board size, CEO-Chairman duality, independence of Audit

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Committee) have also been used in the current study. These variables are measured as follows: In sync with the existing literature, board size has been measured as the total number of directors in the board (Gaur et al., 2015; Guest, 2009; Johl et al., 2015). CEO-Chairman duality has been treated as the dichotomous variable which takes the value “1” if the CEO and Chairman role is being served by the single person and zero, otherwise (Duru et al., 2016; Gaur et al., 2015; Ramdani & Witteloostuijn, 2010). Audit Committee independence has been measured as the percentage of independent directors in the Audit Committee (Chan & Li, 2008; Klein, 2002). Technically as per Eq. (3.2), Audit Committee independence Total number of independent directors in the Audit Committee ∗ 100 = Total number of directors in the Audit Committee (3.2) It is to be noted that the independence of the Nomination and Remuneration Committee, though a variable analyzed in existing literature, has not been taken into consideration in the existing study. This choice is based on the inconsistency in the available data in this respect. Until 2014, there was no regulatory provision existing on the formation of the Nomination and Remuneration Committee. Thus, firms followed varied practices like the formation of a combined Nomination and Remuneration Committee, a separate Nomination and Remuneration Committee, only the Remuneration Committee, only the Nomination Committee or neither of these committees. However, as per the amendments in the revised Clause 49, the listed firms were mandatorily required to form a combined Nomination and Remuneration Committee. Thus, to avoid these inconsistencies, the independence of the Nomination and Remuneration Committee variable has been omitted from the scope of the current study. ii.

Audit quality

Multiple proxies have been used to measure the quality of the external audit, the first one being the Big-Four auditor. In line with the existing literature, the Big-Four auditors refer to these four auditing firms: Deloitte and Touche, Ernst and Young (E&Y), Klynveld Peat Marwick Goerdeler (KPMG) and Pricewaterhouse Coopers (PwC). This proxy has been deployed based on the extensive use of this measure in the existing literature (DeAngelo, 1981; Firth & Liau-Tan, 1998; Mitton, 2002; Lee et al., 2003; Jacob et al., 2015; Inaam & Khamoussi, 2016; Houqe et al., 2017). In the existing literature, the Big-Four variable has been treated as the dichotomous variable taking the value “1”, if the external auditor is a Big-Four auditor and zero, otherwise.

3.4 Research Methodology Table 3.1 Big-Four auditors and their Indian associates

55 Big-Four auditors

Indian associates

Deloitte and Touche

Deloitte Hanskins and Sells, Deloitte Hanskins and Sells LLP, SB Billimoria and Co, AF Ferguson and Co, Freser and Ross, CC Chokshi, PC Hansotia

Ernst and Young (E &Y)

SV Ghatalia and Associates LLP, SRBC and Co LLP, SR Batliboi and Co LLP, SR Batliboi and Associates LLP

Klynveld Peat Marwick Goerdeler (KPMG)

BSR and Company, BSE and Associates LLP, BSR and Co, BSR and Co LLP, BSR and Associates, BSR and company

Pricewaterhouse Coopers (PwC)

Price Waterhouse, Lovelock and Lewes, Price Waterhouse and Co, Dalal and Shah, Charted Accountants LLP, Price Waterhouse and Co, Bangalore, Price Waterhouse Bangalore

However, in India, as the Big-Four auditors are not allowed to offer direct audit services, they have to get associated with the local (Indian) partners. Thus, a slightly modified definition of Big-Four has been used in the current work. For the purpose of this monograph, the measure “Big-Four” has been treated as a dichotomous variable, which takes the value “1” if the external auditor of the firm is associated with a BigFour auditor and zero, otherwise. Table 3.1 provides the details of the Indian partners of the Big-Four firms. The main reasons that have been advanced in the existing literature behind the superior quality of the Big-Four auditors are the risk of reputation loss, their robust infrastructure and technical expertise. However, as the Big-Four auditors partner with the local associates to deliver audit services in India, there might exist a lack of credibility in the aforementioned factors (risk of reputation loss, their robust infrastructure and technical expertise). This, in turn, might lower the actual audit quality of the Big-Four auditors in India compared to the audit quality of these auditors in the international markets. Therefore, this issue warrants the use of some alternate measures of the audit quality, especially in the Indian context.

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3 Research Methodology

The total audit fee paid to the external auditor is the second most used proxy measure for the audit quality of the firm (O’sullivan, 2000; Fan & Wong, 2005; Ghosh, 2011). Researchers have used this proxy based on the foundation that a higher audit fee was a function of higher audit hours invested by the audit firm, which in turn, was a measure of the extent of audit investigation and hence the intensity of the audit process. To a certain extent, the studies using auditor size as a measure of audit quality also seemed to acknowledge a similar link as large auditors (Big-N) charged a significantly higher audit fee than other auditors (Bradbury, 2017). Based on the notion that high audit fee gets translated from the higher audit effort which in turn makes the audit process more intensive, the current study uses the total audit fee paid to the external auditor as another proxy of the audit quality. Further, the incidences of major financial scams (Enron, Satyam) of the firms with large reputed audit firms (Arthur Andersen, PwC), dilute the credibility of using only auditor size or total audit fee as the potential proxy of audit quality of a firm. In the backdrop of the financial crisis in 2008, Sikka (2009) analyzed the distressed banks that were being audited by the leading auditors and questioned the independence of the auditors who had provided the “unqualified” audit opinion in light of the high non-audit fee earned from the clients. The substantial non-audit fee (which is sometimes multiple times the audit fee) that the auditors charge from the clients raises concern about the independence of the auditors (Barghathi et al., 2017; Rosner & Markelevich, 2011). The regulatory concerns over the huge non-audit fee paid to the auditors get reflected in the Securities and Exchange Commission (SEC), 2002 guidelines refuting the auditors to provide certain non-audit services and mandating the listed companies to disclose the audit and non-audit components of the total fee paid to the external auditor. European Union (2006) has also cited the substantial non-audit services subscribed by the clients (in addition to the audit services) as a potential threat to the independence of the auditor. In view of these arguments and to analyze an additional aspect of audit quality (the auditor’s independence) in light of the hefty non-audit services subscribed by the clients, this study takes into consideration the percentage non-audit fee paid to the auditor as another measure of audit quality, as per Eq. (3.3): Percentage non-audit fee =

iii.

Total non-audit fee paid to the external auditor ∗ 100 Total fee paid to the external auditor (3.3)

Ownership structure

For the purpose of this research work, multiple measures of ownership structure have been deployed to analyze the unique role played by various types of shareholders in the firms’ governance structure. Our first categorization of the shareholders (insider and outsider shareholders) is based on the arguments of Basu et al. (2016) who differentiate between the insider

3.4 Research Methodology

57

and outsider shareholders and contend that unlike the insider shareholders, large outsider shareholders are more likely to exercise higher voting rights to effectively monitor the management. The meaning of insider ownership, however, varies amongst different economies in the existing literature. For instance, in the developed economies, where the ownership is quite dispersed and the managers virtually control the firm, the managers act as the insiders. However, in most of the economies, the equity ownership is concentrated in the hands of a few shareholders. For example, in the emerging economies, these few shareholders are the promoter or members of the promoter group. Further, guided by the fact that these promoter shareholders take an active part in the firms’ management, we have considered the total ownership of the promoter and promoter group as the measure of the insider ownership (Selarka, 2005). Thus, for the purpose of this research work, from now onwards, insider ownership and promoter ownership mean the same. As per Eq. (3.4): Insider Promoter ownership Shares held by the promoter and promoter group ∗ 100 = Total outstanding shares of the company

(3.4)

In relation to the governance role of the large outsider shareholders, the ownership of the institutional investors has been widely analyzed (Duggal and Miller, 1999; Khanna & Palepu, 1999; Sarkar & Sarkar, 2000; Selarka, 2005; Douma et al., 2006; Lin & Fu, 2017). Gillan and Starks differentiate between the domestic and foreign institutional investors by stating that foreign institutional investors play a more active role in the governance structure of the firm, while the former might feel obliged to go along with the management due to their long-standing relationship with them. Thus, in order to capture the distinct governance role of the foreign and domestic institutional investors, we have taken into consideration the foreign and domestic institutional ownership separately. The following measures of the foreign and domestic institutional ownership have been used in the current study as per Eqs. (3.5) and (3.6): Foreign institutional investment/ownership Shares held by the foreign institutional nvestors ∗ 100 = Total outstanding shares of the company Domestic institutional investment/ownership Shares held by the domestic institutional investors = ∗ 100 Total outstanding shares of the company iv.

(3.5)

(3.6)

Product market competition

Herfindahl–Hirschman Index (HHI), which is a well-established measure of product market competition in the existing literature, has been considered as the proxy of

58

3 Research Methodology

product market competition for the purpose of this research work (Chou et al., 2011; Fosu, 2013; Giroud & Mueller, 2010; Januszewski et al., 2002; Pant & Pattanayak, 2010; Selarka, 2014). As per Eq. (3.7): HHI =



X∧i 2

(3.7)

where, HHI = Herfindahl–Hirschman Index; X i is the per cent market share of firm i × 100; i = 1 to n; n is the number of firms; Market share of the firm = Net sales of the company/Total net sales of all the companies in the industry. In line with the existing literature, 2-digit national industry classification (NIC) codes have been used for industry classification (Gopalan et al., 2016; Pant & Pattanayak, 2010); in the case of a monopoly, a company will have 100% of the market share and the HHI value would be (market share)ˆ2, which in this case would be 100 * 100 = 10,000. This is the maximum value the index can take. Another measure CR4 has also been used by a few researchers (Januszewski et al., 2002; Pant & Pattanayak, 2010). However, the limitation of this measure is that it takes into account the market shares of only the top four firms in the industry. Based on this argument, Pant and Pattanayak (2010) argue that HHI measure is more accepted as it takes into account all the firms in the industry and their respective market shares. In view of these considerations, HHI has been taken into account as a proxy of product market competition. v.

Firm performance

It seems to be an established practice in the literature of corporate governance to use firm value (measured through Tobin’s Q ratio) as a measure of firm performance (Basu et al., 2016; Chan & Li, 2008; Dawson et al., 2018; Eisenberg et al., 1998; Lins, 2003; Maury & Pajuste, 2005; Mishra & Kapil, 2017; Sarkar & Sarkar, 2000; Villalonga & Amit, 2006). The practice of using firm value (Tobin’s Q) appears justified in view of the objective of the firm, which is to maximize the wealth of the shareholders by maximizing the value of the firm (Brealey et al., 2011). Another advantage of using Tobin’s Q as the measure of firm performance lies in its ability to capture growth opportunities (future performance) for the firms in accordance to the value of Tobin’s Q ratio. Other accounting-based measures (ROA, ROE, ROCE) capture the firm performance only in terms of results produced in the past (past performance). In consideration of these advantages and in line with the existing literature, Tobin’s Q ratio has been taken as the primary measure of firm performance and is calculated as per Eq. (3.8): Tobin s Q ratio =

(Book value of the assets + Market value of common stock) − (Book value of common stock) Book value of assets

(3.8)

3.4 Research Methodology

59

In Eq. (3.8): Book value of assets = Current assets + Non-current assets Market value of common stock = Market price of the company’s share at the end of financial year * Number of equity shares outstanding Book value of common stock = Equity share capital + Reserves and surplus An additional measure of firm performance, return on assets (ROA) ratio has also been taken into consideration as the secondary measure of firm performance. Based on the definition of Khan and Jain (2011), this ratio has been calculated as per Eq. (3.9): ROA =

Earning after tax + (Interest − Tax advantage on interest) ∗ 100 (3.9) Average total assets

Table 3.2 presents the summary of main variables being used in the study. Besides the main variables, certain control variables have also been included in the various regression models. For example, for the regression models with the firm performance as the dependent variable, the effects of firm size, age, leverage and research and development expenditures have been controlled. In this context, the choice of the control variables has been guided by the extant literature. Firm size has been captured by including the firm asset size variable in the regression models (Fan & Wong, 2005; Garg, 2007; Ghosh, 2007; Jackling & Johl, 2009; Jameson et al., 2014; Mitton, 2002). Following the work of Ghosh (2006), Jackling and Johl (2009), Arosa et al. (2010) and Liu et al. (2015), the effect of firm age has been controlled while analyzing the determinants of firm performance. Firm age has been calculated as the number of years since the incorporation of the firm. The effect of leverage on firm value has been controlled based on the work of Mitton (2002), Dwivedi and Jain (2005), Ghosh (2007) and Haldar et al. (2018). Based on the definition of Khan and Jain (2011), the leverage of the firm has been calculated as the ratio of total long-term debt to total assets of the firm. Similarly, the effect of research and development expenditure has been controlled in the various regression models. Further, in the regression models with the audit quality as the dependent variable, an additional set of control variables has been included in the regression equations. For example, there is empirical evidence that firm size and complexity influence audit fee and auditor choice (Abdullah et al., 2017; Bradbury, 2017; Houqe et al., 2017; Kim & Yi, 2006). Therefore, the firm’s total assets, business-group affiliation and the number of subsidiaries have been considered as the control variables. The effects of firm’s capital structure and market concentration have also been controlled in the related models (Abdullah et al., 2017; Choi et al., 2018; Johl et al., 2016; Kim et al., 2017).

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Table 3.2 Descriptive summary of variables used in the study Variable name

Description

Board independence (%)

The measure of the board independence calculated by dividing the number of independent directors by the total number directors in the company’s board

Board size

Total number of directors in the company’s board

CEO-Chairman duality (binary variable)

An indicator variable which takes the value of 1, if the CEO and Chairperson role is being served by the same person and zero, otherwise

Audit Committee independence (%)

The measure of the Audit Committee independence calculated by dividing the number of independent directors in the Audit Committee by total number of directors in the Audit Committee

Total audit fee (in million dollars)

Total fee paid to the external auditor

Big-Four (binary variable)

An indicator variable which takes the value of 1, if the auditor appointed is one among the Big-Four auditors and zero, otherwise

Non-audit Fee (%)

Percentage of non-audit fee in proportion to the total audit fee paid

Promoter ownership (%)

Percentage shareholding of the promoter and promoter group. The promoter and promoter group are defined under regulations 2(1) (za) and (zb) of Issue of Capital and Disclosure Requirements, 2009 by SEBI (2009)

Domestic institutional ownership (%)

Percentage shareholding of domestic institutional investors. Domestic institutional investors include mutual funds, UTI, financial institutions, banks, insurance companies, venture capital funds, provident funds and pension funds, central, and state governments and others

Foreign institutional ownership (%)

Percentage shareholding of foreign institutional investors

Product market competition (HHI Index) A measure used to estimate the market concentration of the firm using the Herfindahl Hirschman Index based on firm’s total sales and industry affiliation Return on assets (%)

ROA = (Earnings after tax + (Interest − Tax advantage on interest))/(Average total assets)

Tobin’s Q ratio

Tobin’s Q ratio = ((Book value of the assets + market value of the common stock) – (Book value of the common stock))/(Total assets). A value >1 indicates the market value to the firm to be higher than the book value and vice-versa

Source Authors’ compilation

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3.4.2 Research Methodologies Used In line with the objectives of the study, this section outlines the research methodologies deployed to address various research questions. Objective 1 This objective relates to the analysis of the effect of various monitoring mechanisms on firm performance. Precisely, the empirical analysis of objective 1 relates to the testing of the following hypotheses. H 0.1 There exists no relationship between product market competition and firm performance. H 0.2 There exists no relationship between audit quality and firm performance. H 0.3 There exists no relationship between board monitoring and firm performance. H 0.4 There exists no relationship between ownership structure and firm performance. Pooled ordinary least square (OLS) regression methodology has been deployed for the empirical analysis. This methodology has been the choice of many researchers in the past (Dwivedi & Jain, 2005; Houqe et al., 2017; Lefort & Urzúa, 2008; Pant & Pattanayak, 2010). Fixed-effect panel data estimation has also been used by a few researchers (Haldar, et al., 2018; Liu et al., 2015; Woidtke, 2002). However, in view of the relatively time-invariant nature of a few variables (ownership structure, external auditor), this methodology was not found suitable for the current analysis (Battaglia & Gallo, 2015). This is because, the fixed-effect panel regression framework requires the variation in the independent variables as the time-invariant variables are wiped-out of the regression model in the time-demeaning process (within transformation) (Battaglia & Gallo, 2015). Logistic regression model could not be used as the dependent variable (firm performance) is a continuous variable (Wooldridge, 2013). Further, the structural equation modeling could not be deployed as the convergent validity of the constructs (audit quality and board monitoring) could not be established in the confirmatory factor analysis (CFA) step. In view of the above considerations, the pooled OLS regression model has been deployed in a step-wise manner. The fixed-effect of various time-invariant factors related to the year and industry affiliations has also been controlled using the year and industry dummies in the regression models. The generic framework of the pooled OLS model with a single independent variable is as per Eq. (3.10): yit = β0 + xit β1 + μit yit = dependent variable data points; x it = independent variable data points; β0 = constant-term; β1 = parameter of interest;

(3.10)

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u it = composite error-term. In consideration of various monitoring mechanisms, the following regression model is tested empirically. As per Eq. (3.11): Firm performance = β0 + β1 (promoter ownership) + β2 (domestic institutional ownership) + β3 (foreign institutional ownership) + β4 log(HHI) + β5 (Big-Four) + β6 log(total audit fee) + β7 (percentage non-audit fee) + β8 (board independence) + β9 (CEO − Chairman duality) + β10 (Audit Committee independence) + β11 (board size) + control variables + fixed effects(year, industry) + error − term

(3.11)

The main issues associated with the OLS estimation process have been addressed in the following ways: • Multi-collinearity. The issue of multi-collinearity has been addressed by analyzing the variance inflation factors (VIFs) of the independent variables of the regression model used. The maximum acceptable limit of the VIF of the independent variables has been set to be 10 (Field, 2013). • Heteroscedasticity. The issue of heteroscedasticity has been addressed by reporting the significance level of the independent variables using robust standard error instead of normal standard error. This is a well-established technique to address this issue and had been widely used by many researchers in the past (Ghosh, 2007; Mitton, 2002; Sarkar & Sarkar, 2000). • Endogeneity. The empirical estimates can be subject to the endogeneity bias based on three accounts—omitted variable bias, measurement-error or the issue of simultaneity bias. The issue of omitted variable bias has been minimized by controlling for all the year and industry-specific fixed factors which might have been omitted from the empirical model. The measurement bias has been minimized by using the well-established measures of the variables used. Finally, the issue of endogeneity has been dealt with by leveraging the regulatory shocks (wherever possible) or by using the lagged independent variables in the regression models (wherever required) to establish the causality between the independent and dependent variables. Analysis of the Non-linear Relationship Between Insider (Promoter) Ownership and Firm Performance In line with the arguments of Morck et al. (1988), Sarkar and Sarkar (2000), Selarka (2005) and Cho and Kim (2007), we examine the non-linear relationship between the insider ownership and firm value. Such analysis is based on two contrasting

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hypotheses, the convergence-of-interest hypothesis and the entrenchment hypothesis. While the convergence-of-interest hypothesis advocates that the increase in the insider ownership should enhance the firm value, the latter posits the the insiders get entrenched to the firm with the increase in share ownership and start pursuing their self-interests and thus, the firm value declines with the increase in the insider ownership. In the empirical analysis, we have modelled the non-linear relationship between the insider (promoter) ownership and firm performance by using the quadratic form of the regression model. The analysis of the non-linear relationship between promoter ownership and firm value is based on two contrasting effects of promoter ownership on firm value Specifically, the following model (as per Eq. 3.12) has been used to analyze the non-linear relationship between promoter ownership and firm performance. Firm performance = β0 + β1 (promoter ownership) + β2 (promoter ownership)2 + β3 (domestic institutional ownership) + β4 (foreign institutional ownership) + β5 log(HHI) + β6 (Big-Four) + β7 log(total audit-fee) + β8 (percentage non-audit fee) + β9 (board independence) + β10 (CEO − Chairman duality) + β11 (Audit Committee independence) + β12 (board size) + control variables + fixed effects(year, industry) + error − term

(3.12)

The inflection point of the non-linear curve depicting the relationship between the promoter ownership and firm performance has been calculated with the following formula (Selarka, 2005) as per Eq. (3.13): Inflection point =

−β1 2β2

(3.13)

Additional Analysis Additional analysis has been performed to assess if the effectiveness of various monitoring mechanisms is contingent on the firm age and size. To conduct this analysis, firms have been segregated into multiple groups based on firm age and size using the same methodology adopted in Objective 1. A sub-group analysis is then conducted to analyze the effectiveness of various monitoring mechanisms for various groups (based on firm age and size). Robustness Tests As it has already been mentioned, the robustness of the empirical estimates has been ensured by analyzing the significance of the empirical estimates based on the

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robust-standard error. The inclusion of the year and industry-specific fixed factors further ensures the robustness of the empirical estimates. Besides these checks, a few other measures have also been undertaken to ensure the robustness of the empirical estimates. For example, in addition to using the market-based performance measure, the empirical estimates were calculated using an accounting-based performance measure as well, the return on assets (ROA) ratio. Another robustness check has been deployed by leveraging a regulatory change to establish causality between promoter ownership and firm performance. This analysis is based on directions of a regulatory change introduced in 2010, when a maximum limit of 75% was introduced on the level of promoter ownership in the public listed companies in India. As per this regulation which came in effect from June 2010, companies were given a maximum period of 3 years (Ministry of Finance, 2010) to comply with the amendments. Thus, change in the promoter ownership of the companies (within three years, June 2010–June 2013) having promoter ownership of more than 75% in June 2010, can be attributed to this exogenous regulatory change. We have, therefore, analyzed the sample data over a period of five years (2010– 2014). Data for 2014 has been taken into consideration, owing to our limitation of using yearly data in the analysis. We capture the effect of the change in ownership owing to this regulatory requirement on firm value by assigning a dummy variable the value “1” for the firms having promoter ownership more than 75% as on March 31, 2010. All other firms have been assigned the value “0”. We ran the empirical model to analyze the firm performance for the firms undergoing a forced reduction in the promoter ownership over a period (2010–2014). In the regression model, the effect of other variables being used in the study has also been controlled. Objective 2 This objective relates to the analysis of the performance enhancement effect of board independence in relation to other governance mechanisms (audit quality and foreign institutional investment). As mentioned above, the analysis of this objective has been conducted in four parts. Different methodologies have been adopted in these parts. For better exposition, the research methodology is explained in greater detail in relation to one mechanism (audit quality). Similar techniques have been adopted for the analysis related to the other monitoring mechanism (foreign institutional investment). Part I In this part, the direct relationship between board independence and other governance mechanisms (audit quality and foreign institutional investment) has been analyzed. Precisely, we aim to test the following null hypotheses: H 0.5 There exists no relationship between board independence and audit quality. H 0.6 There exists no relationship between board independence and foreign institutional investment. Figures 3.2 and 3.3 presents the graphical presentation of the relationships to be tested in this part.

3.4 Research Methodology

65 Audit Quality

Board Independence

Fig. 3.2 Relationship between board independence and audit quality. Source Authors’ compilation

Foreign Institutional ownership

Board Independence

Fig. 3.3 Relationship between board independence and foreign institutional ownership. Source Authors’ compilation

Board Independence

Audit Quality

Firm Performance

Fig. 3.4 Board independence and firm performance (mediator–audit quality). Note In this figure, “audit quality” acts as the mediator variable, mediating the relationship between board independence and firm performance. Source Authors’ compilation

In relation to testing the null hypothesis H 0.5 (Fig. 3.4), as we have used multiple measures of audit quality, in line with each measure of audit quality, a separate regression model has been run. In these regression models, audit quality has been treated as the dependent variable. When the audit quality is measured through a dichotomous variable (Big-Four), a probit regression model has been run. The consideration of this research technique is based on the existing literature (Firth and Liau-Tan, 1998; Lee et al., 2003; Fan & Wong, 2005; Chen et al., 2011; Ghosh, 2011; Houqe et al., 2017). Specifically, the following regression models have been tested empirically as per Eqs. (3.14)–(3.16): Big-Four = β0 + β1 (board independence) + control variables + fixed effects(year, industry) + error − term

(3.14)

Total audit fee = β0 + β1 (board independence) + control variables + fixed effects(year, industry) + error − term (3.15) Percentage non-audit fee = β0 + β1 (board independence) + control variables + fixed effects(year, industry) + error − term (3.16)

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Board Independence

Foreign institutional ownership

Firm Performance

Fig. 3.5 Board independence and firm performance (mediator–FII). Note In this figure, “foreign institutional ownership” acts as the mediator variable, mediating the relationship between board independence and firm performance. Source Authors’ compilation

Part II If the empirical estimates report a significant relationship between board independence and audit quality and if that specific measure of audit quality has a significant effect on firm performance (as analyzed under objective 2), the significance of the indirect relationship between board independence and audit quality is analyzed with the audit quality as the mediator.1 The following null hypotheses are tested in the empirical analysis. H 0.7 Board independence does not affect firm performance through audit quality. H 0.8 Board independence does not affect firm performance through foreign institutional investments. Figures 3.4 and 3.5 present the layout of the proposed models The analysis of the significance of the indirect relationship between board independence and firm performance (through audit quality and FII, separately) is conducted using Model#4 of the PROCESS macro developed by Hayes (2013). This research methodology has recently gained importance over the conventional approaches (Baron and Kenny approach, Sobel test) (Lee et al., 2017). Unlike the popular Baron and Kenny approach (Baron & Kenny, 1986), Hayes’ approach is vested with the ability to conduct the statistical inference for the significance of the indirect effects (effect of independent variable on the dependent variable through the mediating variable) in the mediation process (Gu et al., 2015; Kim et al., 2018). Sobel test also conducts the statistical inference about the indirect effects. However, the Hayes approach (which is a bootstrap approach) is more advanced as the results are robust to the violations of the normality assumption of the sampling distribution of the indirect effects (MacKinnon et al., 2007). Objective 3 The empirical analysis of Objective 3 entails the examination of the significance of moderation effect. Precisely, we aim to analyze the moderation effect of the governance mechanisms (insider ownership and product market competition), which are hypothesized to influence the board independence and firm performance relationship. In this context, the insider ownership and product market competition are termed as

1

Baron and Kenny (1986) state “a given variable may be said to function as a mediator to the extent that it accounts for the relation between the predictor and the criterion.” In other words, a mediator variable explains how the independent variable influences the dependent variable.

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Insider Ownership

Firm Performance

Board Independence

Fig. 3.6 Board independence and firm performance relationship (moderator–insider ownership). Note In this figure, the “blue line” indicates the relationship between board independence and firm performance. The “orange line” indicates the moderating effect of insider (promoter) ownership on the board independence and firm performance relationship. Source Authors’ compilation

Product market competition

Board Independence

Firm Performance

Fig. 3.7 Board independence and firm performance relationship (moderator–product market competition). Note In this figure, the “blue line” indicates the relationship between board independence and firm performance. The “orange line” indicates the moderating effect of product market competition on the board independence and firm performance relationship. Source Authors’ compilation

the moderator variables.2 In line with the moderator variables, the following null hypotheses are tested through the empirical analysis. H 0.9 Insider ownership does not influence the board independence and firm performance relationship. H 0.10 Product market competition does not influence the board independence and firm performance relationship. Figures 3.6 and 3.7 presents the visual specification of the models to be tested. In sync with various researchers (Cho & Kim, 2007; Giroud & Mueller, 2010), the significance of the moderation effect has been examined using the moderated regression approach. Technically, the following empirical models have been used for 2

As per Baron and Kenny (1986), a moderator variable is “a qualitative or a quantitative variable that affects the direction and/or strength of the relationship between an independent or predictor variable and a dependent or criterion variable.”.

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empirical analysis. The regression model for the moderation relationship (based on Fig. 3.6) is provided as per Eq. (3.17): Firm performance = β0 + β1 (promoter ownership) + β2 (board independence) + β3 (promoter ownership) ∗ (board independence) + control variables + fixed effects(year, industry) + error − term

(3.17)

Similarly, the regression model for the moderation relationship (based on Fig. 3.7) is provided as per Eq. (3.18): Firm performance = β0 + β1 log(HHI) + β2 (board independence) + β3 log(HHI) ∗ (board independence) + control variables + fixed effects(year, industry) + error − term (3.18) The presence of the moderation effect is supported if the coefficient of the interaction term is significant. The interpretation of the coefficients of the interaction-term has been facilitated through the graphical presentation of the regression results (Aiken et al., 1991; Bhal & Dadhich, 2011). A graph is plotted to depict the relationship between the independent and the dependent variable at multiple levels of the moderator variable (mean value, mean + 1 S.D., mean – 1 S.D) (Long, 2017). Additional Analysis The effectiveness of the product market competition as a monitoring mechanism might differ in the business-group and stand-alone firms in consideration of their distinct institutional-setups. To highlight a few, there are well functioning internal capital and labor markets among the business-group firms (Chang & Hong, 2002; Chang et al., 2006). Thus, their reliance on the external market is mitigated. Also, the threat of bankruptcy is often diluted for the business-group firms, where a distressed firm can be rescued by other member firms of the business-groups (Gopalan et al., 2007; Khanna & Rivkin, 2001). In consideration of these viewpoints, a separate analysis has been conducted for the business-group and stand-alone firms to analyze the moderating role of product market competition on board independence and firm performance relationship. Robustness Tests Similar to the analysis of objective 2, the robustness of the empirical estimates has been ensured by analyzing the significance of the empirical estimates using the robust-standard error. Also, the year and industry fixed effects have also been included in the various regression models to minimize the biases pertaining to the omitted variables. An alternate measure of firm performance (ROA) has been used to analyze the robustness of the empirical estimates with the alternate performance measures.

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The robustness of the moderating effect of the promoter ownership on the board independence and firm performance relationship has been ensured by conducting a separate empirical analysis for the business-group and stand-alone firms. This analysis is conducted with the underlying assumption that the promoter shareholders have tighter control over the firms’ operations in the business-group firms (tunneling3 through pyramid structures,4 board interlocks5 and so on) as compared to the standalone firms. Based on this argument, the relationship between board independence and firm performance has been analyzed separately for the business-group and standalone firms. Part II Under this part of the analysis, we have analyzed the moderating effect of the governance mechanisms which might dilute the board monitoring (promoter ownership and product market competition), on the effectiveness of board independence in influencing the other two mechanisms (audit quality and foreign institutional investment). It is to be noted that this analysis is contingent on the significance of the moderating effect of the two governance mechanisms (promoter ownership and product market competition). Only if the moderating effect of these governance mechanisms is found significant in objective 2, the analysis will be conducted under this part. In this part, the following null hypotheses are tested: H 0.11 Insider ownership does not influence the board independence and audit quality relationship. H 0.12 Insider ownership does not influence the board independence and foreign institutional ownership relationship. H 0.13 Product market competition does not influence the board independence and audit quality relationship. H 0.14 Product market competition does not influence the board independence and foreign institutional ownership relationship.

3

The transfer of resources away from the firm for the benefit of the controlling shareholders (Johnson et al., 2000). 4 The structures in which an ultimate controlling firm controls several listed companies, each of which controls yet more listed companies, each of which controls yet more listed companies, and so on (Morck et al., 2005). A control pyramid allows a wealthy family or individual to control a large number of firms with relatively limited wealth. Pyramids permit this by creating large deviations between voting rights and cash flow rights; allowing control over many firms with a small cash flow stake in each. 5 Board inter-lock refers to the practice wherein the members of the corporate boards serve on the boards of multiple corporation. Davis contends that “the aggregate result of this practice virtually links all the firms into a single network based on the shared board members”.

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Promoter Ownership

Audit Quality

Board Independence

Fig. 3.8 Board independence and audit quality (moderator–promoter ownership). Note In this figure, “promoter ownership” acts as the moderator variable. The “blue line” indicates the direct relationships between board independence and audit quality. The “green line” indicates the moderating effect of promoter ownership on the board independence and audit quality relationship. Source Authors’ compilation

Foreign Institutional Investment

Board Independence

Audit Quality

Fig. 3.9 Board independence and audit quality (moderator–foreign institutional investment). Note In this figure, “foreign institutional investment” acts as the moderator variable. The “blue line” indicates the direct relationships between board independence and audit quality. The “green line” indicates the moderating effect of the foreign institutional investment on the board independence and audit quality relationship. Source Authors’ compilation

Figures 3.8 and 3.9 present the layout of the testable hypotheses. In consideration of this viewpoint, suppose, the empirical results of Objective 3 indicate that promoter ownership significantly moderates the effectiveness of board independence in enhancing the firm performance; then the view of this result will be analyzed under this part, if the promoter ownership also influences the ability of board independence in influencing the audit quality and foreign institutional investment, separately. Technically, the following regression models will be deployed as per Eqs. (3.19)–(3.21): Big-Four = β0 + β1 (board independence) + β2 (promoter ownership) + β3 (board independence) ∗ (promoter ownership) + control variables + fixed effects(year, industry) + error − term (3.19)

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Total audit fee = β0 + β1 (board independence) + β2 (promoter ownership) + β3 (board independence) ∗ (promoter ownership) + control variables + fixed effects(year, industry) + error − term

(3.20)

Percentage non-audit fee = β0 + β1 (board independence) + β2 (promoter ownership) + β3 (board independence) ∗ (promoter ownership) + control variables + fixed effects(year, industry) + error − term

(3.21)

Part III If the significant mediation (Part I) and moderation (Part II) effects emerge in the analysis, the testing of the empirical significance of the joint moderated-mediation model would be conducted in this part. This part entails the testing of the following null hypotheses: H 0.15 The indirect relationship between board independence and firm performance (through audit quality) is not influenced by insider ownership. H 0.16 The indirect relationship between board independence and firm performance (through foreign institutional ownership) is not influenced by insider ownership. H 0.17 The indirect relationship between board independence and firm performance (through audit quality) is not influenced by product market competition. H 0.18 The indirect relationship between board independence and firm performance (through foreign institutional ownership) is not influenced by product market competition. The visual presentation of the testable models is presented in Figs. 3.10 and 3.11.

Promoter Ownership

Board Independence

Audit Quality

Firm Performance

Fig. 3.10 A moderated-mediation model of board independence and firm performance relationship (mediator–audit quality, moderator–promoter ownership). Note In this figure, “promoter ownership” acts as the moderator variable and “audit quality” as a mediator variable. The “blue line” indicates the direct relationships between board independence and audit quality; and audit quality and firm performance. The “green line” indicates the moderating effect of promoter ownership on the board independence and audit quality relationship. Source Authors’ compilation

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Board Independence

Foreign Institutional Investment

Firm Performance

Fig. 3.11 A moderated-mediation model of board independence and firm performance relationship (mediator–foreign institutional investment, moderator–promoter ownership). Note In this figure, “promoter ownership” acts as the moderator variable and “audit quality” as a mediator variable. The “blue line” indicates the direct relationships between board independence and audit quality; and audit quality and firm performance. The “green line” indicates the moderating effect of promoter ownership on the board independence and audit quality relationship. Source Authors’ compilation

This analysis has been conducted using the model 7 of the PROCESS program (Hayes, 2013). This analysis entails the examination of the significance of the indirect relationship between the independent (board independence) and dependent variable (firm performance) through the mediating variable (audit quality and foreign institutional investment, separately) at various levels of the moderating variable (promoter ownership) (Douglass & Duffy, 2015; Lee et al., 2017). Robustness Tests The robustness of the empirical estimates has been ensured by including the year and industry-specific dummies in the empirical analysis. Also, in all the regression models, the significance of the various estimates has been calculated using the robust standard-error. Further, an alternate measure of firm performance (ROA) has been used to ensure the robustness of the empirical estimates with the alternate measures of firm performance.

3.4.3 Sources of Data and Research Tools Used The data analysis related to various objectives is based on secondary data. Based on the nature and availability of data, multiple data sources have been used for data collection. • Ace-Equity® database of Accord Fintech Private Ltd. (for data related to firm performance, ownership structure, a few indicators of audit quality, asset size, age and sales revenue of the firms) • Prowess CMIE® database (for data related to audit quality (Big-Four) • Bloomberg® database (for data related to various board attributes like board independence, Audit Committee independence, board size, CEO-Chairman duality)

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• Annual reports (for data related to the missing values of various measures) Multiple research tools like Microsoft Excel® , SPSS® and R® have been used for the empirical analysis.

3.5 Summary and Conclusion This chapter presents research hypotheses, in line with the research objectives. This chapter also delineates the scope of the study and explains the research methodologies in line with the objectives of the study. The content of this chapter will form the foundation of the next chapters of the study. The next four chapters of the study are dedicated to the analysis of the three broad objectives of the study.

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Chapter 4

Corporate Governance Mechanisms and Firm Performance

The objective of the firm is to maximize the wealth of the shareholders, and hence the firm value, and various corporate governance mechanisms are put in place to achieve this objective. In this light, the current chapter aims to analyze if the various governance mechanisms are effective in enhancing firm value (and thus, shareholders’ wealth) measured with Tobin’s Q ratio. An additional measure of firm performance (return on assets) has also been deployed in the empirical analysis. Based on literature, we have taken into consideration four broad governance mechanisms: board monitoring, ownership structure, audit quality, and product market competition.

4.1 Introduction In the relevant literature, multiple governance mechanisms have been proposed and empirically analyzed. These mechanisms can be broadly classified into country-level and firm-level governance mechanisms. Legal and regulatory infrastructure (Porta et al., 1997, 1998), efficiency of the capital markets (Chakrabarti & Sarkar, 2010) and market for corporate control (Gompers et al., 2003) are examples of country-level governance mechanisms. Firm-level governance mechanisms include board monitoring (Hermalin and Weisbach, 2001; Randoy and Jenssen, 2004; Ghosh, 2006) insiders’ ownership (McConnell & Servaes, 1990; Morck et al., 1988; Sarkar & Sarkar, 2000), institutional ownership (Cho & Kim, 2007; Lin & Fu, 2017), audit quality (Azim, 2012; Quick et al., 2017), and product market competition (Randoy and Jenssen, 2004; Giroud & Mueller, 2010). In consideration of our limitation of using only Indian data, we aim to focus on the firm-level governance mechanisms. Amongst all the firm-level governance mechanisms, board monitoring has been the most profoundly researched area in the relevant literature (McNulty et al., 2013). The board members are vested with the ultimate power to influence the behavior of the © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2022 S. Singh and M. Singla, Corporate Governance Mechanisms and Firm Performance, India Studies in Business and Economics, https://doi.org/10.1007/978-981-19-2460-6_4

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management. Jensen (1983) places the board at the apex of the internal governance structure of the firms. In view of the agency theory, board independence is crucial to board monitoring (Cohen et al., 2002; OECD, 2004; Xie et al., 2003). In line with the existing literature and as an elementary analysis, we aim to analyze whether board independence is effective in enhancing the firm performance in India. Moreover, recently, a greater emphasis of the regulators (Securities and Exchange Board of India, SEBI and Ministry of Corporate Affairs, MCA) on board effectiveness, further warrants the need of such an analysis in India. Besides board independence, and in line with the existing literature, other measures of board monitoring (board size, CEO-Chairman duality, independence of Audit Committee) have also been taken into consideration in the empirical analysis. Another profusely researched area in the relevant literature is the ownership structure (Cho & Kim, 2007; Douma et al., 2006; Gillan & Starks, 2003; Morck et al., 1988; Sarkar & Sarkar, 2000). In this respect, various categories of large shareholders (insider shareholders, domestic institutional investors, and foreign institutional investors) have been analyzed based on their distinct ability and motivation to expend resources to monitor the management. A few studies, in the Indian context, have already been conducted to analyze similar associations (Chhibber & Majumdar, 1999; Jameson et al., 2014; Sarkar & Sarkar, 2000; Selarka, 2005). In studies available in literature, various ownership types (promoter ownership and institutional investment) have been treated exclusively. The current study contributes to the existing literature by analyzing the effect of various components of the ownership structure on firm value. Besides board monitoring and ownership structure, external auditors also reduce the information asymmetry between the owners and the management and reduce the agency risk by providing an ultimate assurance to the owners about the reliability and quality of the financial results (Quick et al., 2017). DeAngelo (1981) defines the audit quality as the joint probability that the external auditor will identify a potential breach in the client’s business and then will report it. Considering this definition, there are two aspects of the audit quality (1) Audit intensity, and (2) Auditor’s independence, which in turn, influence the probability of the auditor passing an unbiased judgment. While the auditors’ competence has been widely analyzed in the empirical literature (Alfraih, 2017; Bradbury, 2017; DeFond & Zhang, 2014) due consideration has not been paid to the auditors’ independence (Barghathi et al., 2017; Rosner & Markelevich, 2011). This study aims to bridge this research gap and takes into consideration the dual aspects of audit quality. Further, in consideration of the monitoring role of product market competition, Machlup (1967) denies the possibility of managerial slack if the firm operates in a perfectly competitive market. Corroborating a similar viewpoint, Hart (1983) argues that competition provides less discretion to the management to pursue its selfinterests, and thus, reduces agency cost. Gilson and Roe (1993) describe competition as “the most elegant monitoring mechanism”. Nickell et al. (1997) posit that high product market competition provides a benchmark for comparison to the owners of the firm. Hence, the owners can monitor the management more efficiently and design better incentive structures. In light of these viewpoints, we attempt to analyze the role of product market competition in relation to firm value in the Indian context.

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4.2 Methodology 4.2.1 Sample and Scope The sample selection process has been initiated by selecting an initial sample of top 500 companies listed on the National Stock Exchange (NSE) of India. Further, in the sample screening process, the financial firms (74 firms) have been eliminated as the governance practices of these firms are regulated by their respective regulatory authorities. This left us with 4,686 firm-year observations. Another 438 firm-year observations have been eliminated on account of factors like non-listing of the firms in all the years, unstandardized accounting period and missing annual reports or the variables used in the study. In summary, the complete sample selection process has left us with a final sample of 4,248 firm-year observations. Detailed sample selection process has been presented in Chap. 3. Data has been collected over a period of 11 years (2007–2017) to ensure the stability of results over time. The main variables of interest are board monitoring, ownership structure, audit quality, product market competition, and firm performance. Table 4.1 provides the summary of various measures/proxies used to measure the variables of interest. Table 4.1 Summary of the measures used for the variables of interest Variables of interest

Measures/proxies used in the study

Board monitoring

• • • •

Ownership structure

• Total promoter ownership (%)

Board independence (%) CEO-Chairman duality Board size Audit Committee independence (%)

• Foreign institutional ownership (%) • Domestic institutional ownership (%) Audit quality

• Affiliation of the auditor to the Big-Four1 auditors (dichotomous variable) • Total audit fee (in million dollars) • Percentage non-audit fee (%)

Product market competition • Herfindahl–Hirschman Index (HHI) (value varies from 0 to 10,000) Firm performance

• Tobin’s Q ratio • Return on assets (ROA)

Source Authors’ compilation

1

After the demise of Arthur Andersen and guided by the current literature the Big-Four audit firms represents four audit firms: Ernst and Young (E and Y), Deloitte and Touche (D and T), Klynveld Peat Marwick Goerdeler (KPMG), and Pricewaterhouse Coopers (PwC) (Sikka, 2009).

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A detailed rationale for the choice of various measures of the variables of interest is presented in Chap. 3 followed by the detailed reasoning and the calculation of all the measures/proxies deployed to measure the variables of interest. Table 4.2 presents a brief description of the variables used in the empirical analysis. The descriptive statistics of the variables under consideration is provided in Table 4.3. With respect to firm profitability (ROA), Indian listed firms offer a return to the shareholders with a mean and median value of 9.40 and 7.78% respectively. Further, the mean and median values of Tobin’s Q ratio are 2.37 and 1.62, respectively. The mean value of Tobin’s Q “2.37” means that on an average the market value of Indian firms is 2.37 times their book value. Indian boards are dominated by independent directors with the mean and median values at 51.29 and 50% respectively. Promoter ownership forms a substantial portion of the capital of sample firm-years with the average and median values lying at 54.84 and 54.47% respectively. Institutional investors own a major portion of the equity capital in India. Surprisingly, average foreign institutional ownership (11.12%) is slightly higher than their domestic counterparts (10.08%). In line with the findings of Jain et al. (2013) and Singh et al. (2016), leverage still forms a major portion (more than 51%) of the balance sheet for around half of the firm-year observations.

4.2.2 Research Methodology We have used the OLS regression methodology to analyze the relationship between various governance mechanisms and firm performance. The estimates in the OLS regression technique can be subject to three possible biases: multicollinearity, heteroscedasticity, and endogeneity issues. To address the issue of multicollinearity, we have analyzed the levels of variance inflation factor (VIF) before running the regression models (Field, 2013). Further, the robust standard error has been reported to avoid the biases in the empirical estimates on account of the issue of heteroscedasticity. Biases pertaining to the issue of endogeneity can arise because of three reasons: omitted variable bias, reverse causality and measurement error. In order to address the issue related to the measurement error, we have deployed the measures which have been substantially used in the existing literature. To minimize the omitted variable bias, we have used year and industry fixed effects to control for the year and industry-specific factors which might have been omitted in the empirical analysis. Finally, the issue of reverse causality has been addressed by leveraging an exogenous shock related to a regulated change of promoter ownership limit in the country (Ministry of Finance, 2010). A detailed explanation of how a causal link has been established between the promoter ownership and firm performance is explained in Chap. 3. Also, in consideration of the literature, which reports a possible non-linear relationship between promoter ownership and firm value, we have used the quadratic specification of the regression model to analyze this non-linearity (Cho & Kim, 2007; Morck et al., 1988; Sarkar & Sarkar, 2000).

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Table 4.2 Description of the variables used in the study Variable name

Description

Return on assets (%)

ROA = (Earnings after tax + (Interest—tax advantage on interest))/(Average total assets)

Tobin’s Q ratio

Tobin’s Q ratio = ((Book value of the assets + market value of the common stock)—(Book value of the common stock))/(Total assets). A value greater than 1 indicates the market value to the firm to be higher than the book value and vice-versa

Product market competition (HHI index) A measure used to estimate the market concentration of the firm using the Herfindahl Hirschman Index based on firm’s total sales and industry affiliation Total audit fee (in million dollars)

Total fee paid to the external auditor

Big-Four (binary variable)

An indicator variable which takes the value of 1, if the auditor appointed is one among the Big-Four auditors and zero, otherwise

Non-audit fee (%)

Percentage of non-audit fee in proportion to the total audit fee paid

Promoter ownership (%)

Percentage shareholding of the promoter and promoter group. The promoter and promoter group are defined under regulations 2(1) (za) and (zb) of Issue of Capital and Disclosure Requirements, 2009 by SEBI (SEBI, 2009)

Domestic institutional ownership (%)

Percentage shareholding of domestic institutional investors. Domestic institutional investors include mutual funds, UTI, financial institutions, banks, insurance companies, venture capital funds, provident funds and pension funds, central, and state governments and others

Foreign institutional ownership (%)

Percentage shareholding of foreign institutional investors

Board independence (%)

The measure of the board independence calculated by dividing the number of independent directors by the total number directors on the company’s board

CEO-Chairman duality (binary variable) Indicator variable which takes the value of one is the CEO and Chairman role is served by the same person and zero otherwise Board size

Total number of directors in the company’s board

Audit Committee independence (%)

The measure of the Audit Committee independence calculated by dividing the number of independent directors in the Audit Committee by total number of directors in the Audit Committee

Leverage

Measure of the financial leverage calculated by dividing total debt by total assets of the company

Firm size (in million dollars)

Total assets of the firms in US million dollars

Research and development

Total expenditure on research and development activities scaled by the firm’s size (total assets) (continued)

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Table 4.2 (continued) Variable name

Description

Firm age (years)

Measure of number of years since the firm’s incorporation

Note This table presents the description of various variables used in the study

4.2.3 Layout of Empirical Analysis Table 4.4 presents the variance inflation factors of all the variables used in regression analysis presented in Table 4.8. VIF of the independent variable is mapped to the regression model used to obtain Table 4.8 as it contains all the variables being used in the analysis. Table 4.5 presents the empirical relation between product market competition and firm value (Tobin’s Q). Appendix 4.1 presents the empirical results analogous to Table 4.5 using ROA as the measure of firm performance. Table 4.6 presents the empirical findings depicting the relationship between various measures of audit quality and firm value (Tobin’s Q). The empirical findings using ROA as the performance measure are reported in Appendix 4.2. Table 4.7 presents the empirical estimates depicting the relationship between board monitoring and Tobin’s Q. A similar relation is tested using ROA as the performance measure and results are reported in Appendix 4.3. Finally, Table 4.8 (Model 1) presents the relationship between various components of ownership structure and firm value (Tobin’s Q). In this table, Model 2 presents the quadratic specification of the regression model to analyze the non-linear relationship between promoter ownership and firm value. Appendix 4.4 presents similar findings using ROA as the firm performance measure. Further, Table 4.9 presents the findings of the regression model analyzing the relationship between various governance mechanisms and firm value over four years (2010–2014) for the firms having promoter ownership greater than 75% as on March 31, 2010. Table 4.10 presents the mean value of promoter ownership and firm value over four years (2010–2014).

4.3 Analysis and Findings This section presents the empirical results related to the analysis of the impact of various monitoring mechanisms on firm performance. Table 4.4 presents the variance inflation factor (VIFs) of all the variables used in the study. As the VIF of all the independent variables is less than 10, the empirical estimates of various regression models do not suffer the issue of multicollinearity (Field, 2013).

2.37

(in million dollars)

Research and development (in million dollars)c

Firm

0.20

16.59

2.75

0.46

11.87

10.18

8.69

17.29

18.78

0.50

14.01

1893.29

2.69

8.77

0.00

0.00

0.00

173.17

0.00

0.00

3.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

568.25

0.10

−88.19

0.00

9631.08

0.36

75.00

7.00

0.00

46.15

2.71

3.32

43.81

24.60

0.00

2.45

1038.45

1.05

4.59

0.64

100.00

11.00

1.00

57.14

16.87

14.69

67.85

52.25

1.00

9.41

2690.68

2.68

13.03

0.00

0.00

(continued)

0.00

29,735,290.00

1.78

100.00

22.00

1.00

100.00

66.19

74.60

99.59

99.97

1.00

250.00

10,000.00

79.70

129.14

Percentile (75) Maximum

24,010.97 60,537.76

0.51

80.00

9.00

0.00

50.00

8.79

8.28

54.48

39.38

0.00

4.89

1947.08

1.62

7.78

Standard deviation Minimum Percentile (25) Median

111,888.61 779,059.39

0.50

Leverage (total long-term debt/total assets)

sizeb

9.38

0.31

CEO-Chairman dualityaa (1 = Duality, 0 = Otherwise) 82.69

51.29

Board Independence (%)

Audit Committee independence (%)

11.12

Foreign institutional ownership (%)

Board size

54.84 10.08

38.14

Non-audit fee (%)

Domestic institutional ownership (%)

0.48

Big-Foura (1 = Big-Four, 0 = Otherwise)

Promoter ownership (%)

8.70

Total audit fee (in million dollars)

2300.65

Tobin’s Q ratio

Product market competition (HHI Index)

9.40

Mean

Return on assets (%)

Variable name

Table 4.3 Descriptive statistics of the variables used in the study

4.3 Analysis and Findings 85

37.13

Mean 24.35

1.00

20.00

29.00

Standard deviation Minimum Percentile (25) Median 51.00

153.00

Percentile (75) Maximum

Note Since Big-Four is a binary variable (0,1), the mean value “0.48”, in percentage terms, indicates that 48% sample firm-years have employed a Big-Four auditor. Similarly, the mean value “0.31” of CEO-Chairman duality indicates that for 31% sample firm-years, the CEO and Chairman position is occupied by the same person b Figures are reported in million dollars to facilitate international comparisons c The research and development expenditure when scaled by the firm size (total assets) turns out to be very small. Thus, the related descriptive statistics when rounded off to two decimal places, indicates 0.00

a

Firm age (in years)

Variable name

Table 4.3 (continued)

86 4 Corporate Governance Mechanisms and Firm Performance

4.3 Analysis and Findings Table 4.4 Variance inflation factor of the variables used in the study

87 Variables

Variance inflation factor (VIF)

Product market competition

1.49

Total audit fee

1.70

Big-Four

1.28

Percentage non-audit fee

1.12

Board independence

1.48

Promoter ownership

1.94

Domestic institutional ownership

1.69

Foreign institutional ownership

1.71

CEO-Chairman duality

1.08

Board size

1.33

Audit Committee independence

1.41

Leverage

1.21

Firm size

2.76

Research and development expenditure

1.36

Firm age

1.23

Note: This table reports the variance inflation factors of the variables in the regression model including all the variables used in the study (Table 4.8)

The empirical findings in Table 4.5 confirm that product market competition does not add significantly to the firm value (β = 0.570, p > 0.10). The empirical results, thus, support the null hypothesis, H0.1 (Chap. 3). The empirical results negate the findings of Januszewski et al. (2002) and Nickell (1996) in the Indian context. In contrast, the findings are positive and significant with the accounting-based performance measure (ROA) (Appendix 4.1). Nevertheless, as in the existing literature (Chap. 3), Tobin’s Q ratio has been considered as the main measure of firm performance, the relationship (between product market competition and firm performance) would be considered to be insignificant in the subsequent analysis (Chaps. 5 and 6). The analysis related to the audit quality reveals that the two measures of audit quality, total audit fee and Big-Four auditor add positively to the firms’ value (Table 4.6). Based on the findings, we reject the null hypothesis, H0.2 (Chap. 3). In this regression model, firms employing a Big-Four auditor enjoys a significantly higher (β = 0.608, p < 0.01) firm value compared to the other firms. Also, firms which are willing to pay a higher total audit fee to the external auditor have a significantly higher firm value (β = 0.092, p < 0.01). The relationship between total audit fee and

88 Table 4.5 Regression model analyzing the impact of product market competition on firm value

4 Corporate Governance Mechanisms and Firm Performance Independent variables

Dependent variable—Tobin’s Q

log(Product market competition)

0.570 (0.388)

Leverage

−1.296a (0.316)

log(Firm size)

−0.275b (0.118)

log(Research and development expenditure)

−0.027a (0.010)

log(Firm age)

−0.170b (0.071)

Constant

2.507b (0.996)

Fixed effects Year

Included

Industry

Included

Observations

4,248

R2

0.140

Adjusted R2

0.135

Note This table presents the empirical analysis related to the effect of product market competition on firm value (Tobin’s Q). The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10%

firm value remains robust to the alternate measure of firm performance, ROA, being used as a dependent variable (Appendix 4.2). However, no significant relationship is noticed between percentage non-audit fee (measuring auditor’s independence) and firm value. Subsequently, board independence adds negatively to the firm value (β = -0.023, p < 0.01) (Table 4.7). The sign and the significance level of the empirical results remain the same for the alternate performance measure (ROA) (Appendix 4.3). The findings reject the null hypothesis, H0.3 (Chap. 3). The empirical results are in line with the findings of Agrawal and Knoeber (1996), Klein (1998) and Kumar and Sivaramakrishnan (2008). CEO-Chairman duality is not significantly related to firm value. Other measures of board monitoring (board size and Audit Committee independence) are significantly related to firm value (β = 0.035, p < 0.01; β = 0.011, p < 0.01).

4.3 Analysis and Findings Table 4.6 Regression model analyzing the impact of audit quality on firm value

89 Independent variables

Dependent variable—Tobin’s Q

log(Total audit fee)

0.092a (0.016)

Big-Four

0.608a (0.090)

Percentage non-audit fee

0.001 (0.002)

log(Product market competition)

0.570 (0.385)

Leverage

−1.142a (0.319)

log(Firm size)

−0.490a (0.123)

log(Research and development expenditure)

−0.020b (0.010)

log(Firm age)

−0.171b (0.069)

Constant

3.063a (0.984)

Fixed effects Year

Included

Industry

Included

Observations

4,248

R2

0.158

Adjusted R2

0.151

Note This table presents the empirical analysis related to the effect of various measures of audit quality on firm value (Tobin’s Q). The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10%

The empirical findings related to the ownership structure present interesting results (Table 4.8—Model 1) and reject the null hypothesis, H0.4 (Chap. 3). Indian companies exhibit an insider-controlled corporate governance structure as the promoter ownership significantly enhances the firm value (β = 0.043, p < 0.01). The results are in sharp contrast to the findings of Xu and Wang (1999) and Wei et al. (2005) in the Chinese context. The contrasting results of Indian and Chinese firms can be explained with the dominance of state ownership in The Chinese firms. Xu and Wang (1999) asserted that the dominance of state ownership resulted into the inefficiency of the Chinese firms. The levels of domestic and foreign institutional ownership also

90 Table 4.7 Regression model analyzing the impact of board monitoring on firm value

4 Corporate Governance Mechanisms and Firm Performance Independent variables

Dependent variable—Tobin’s Q

Board independence

−0.023a (0.004)

CEO-Chairman duality

0.170 (0.107)

Board size

0.035a (0.013)

Audit Committee independence 0.011a (0.004) log(Product market competition)

0.572 (0.386)

log(Total audit fee)

0.097a (0.016)

Big-Four

0.635a (0.097)

Percentage non-audit fee

0.0004 (0.002)

Leverage

−1.122a (0.316)

log(Firm size)

−0.600a (0.143)

log(Research and development expenditure)

−0.022b (0.011)

log(Firm age)

−0.199a (0.070)

Constant

3.432a (1.115)

Fixed effects Year

Included

Industry

Included

Observations

4,248

R2

0.167

Adjusted R2

0.160

Note This table presents the empirical analysis related to the effect of board monitoring on firm value (Tobin’s Q). The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10%

4.3 Analysis and Findings

91

Table 4.8 Regression model analyzing the impact of ownership structure on firm value Independent variables Promoter ownership

Dependent variable—Tobin’s Q Model (1)

Model (2)

0.043a

−0.035a (0.012)

(0.003)

0.001a (0.0001)

Promoter ownershipˆ2 Domestic institutional ownership

0.019a (0.004)

0.019a (0.004)

Foreign institutional ownership

0.050a (0.005)

0.053a (0.005)

log(Product market competition)

0.680c (0.384)

0.587 (0.381)

log(Total audit fee)

0.097a (0.016)

0.094a (0.016)

Big-Four

0.518a (0.096)

0.546a (0.096)

Percentage non-audit fee

−0.0005 (0.002)

−0.001 (0.002)

Board independence

−0.015a (0.004)

−0.011a (0.004)

CEO-Chairman duality

0.078 (0.103)

0.006 (0.098)

Board size

0.044a (0.013)

0.034b (0.013)

Audit Committee independence

0.010a (0.004)

0.011a (0.004)

Leverage

−0.520 (0.317)

−0.378 (0.316)

log(Firm size)

−0.963a (0.145)

−1.044a (0.147)

log(Research and development expenditure)

−0.006 (0.010)

−0.007 (0.010)

log(Firm age)

−0.022 (0.071)

−0.043 (0.071)

Constant

0.703 (1.133)

2.920a (1.114)

Fixed effects Year

Included

Included

Industry

Included

Included

Observations

4,248

4,248

R2

0.213

0.225 (continued)

92

4 Corporate Governance Mechanisms and Firm Performance

Table 4.8 (continued) Independent variables Adjusted R2

Dependent variable—Tobin’s Q Model (1)

Model (2)

0.205

0.217

Note This table, Model 1 presents the empirical analysis related to the effect of various components of ownership structure on firm value (Tobin’s Q). Model 2 contains results on the non-linear relationship between promoter ownership and Tobin’s Q. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10%

positively influence firm value. Nevertheless, the value enhancing effect of domestic institutional investors (β = 0.019, p < 0.01) is lower than the foreign institutional investors (β = 0.050, p < 0.01). In relation to the monitoring effect of foreign and domestic institutional ownership, the empirical results find support to the arguments of Gillan and Starks (2003) in the Indian context. The direction and the significance of the empirical results remain same, when ROA is used as the measure of firm performance. Finally, Model 2 (Table 4.8) presenting the non-linear relationship between promoter ownership and firm value confirms a U-shaped relationship between the two variables. The empirical findings confirm that the firm value first declines with the increase in promoter ownership till a crucial level of promoter ownership at around 18% [-β1 /2β2 = 0.035/(2 ∗ 0.001), Table 4.8-Model 2]. After this inflection point, the firm value starts rising with the increase in promoter ownership. The presence of a non-linear relationship between promoter ownership and firm value is in line with the findings of Morck et al. (1988), Sarkar and Sarkar (2000) and Cho and Kim (2007). Figure 4.1 presents a graphical presentation of the non-linear relation between promoter ownership and firm value. Leveraging an exogenous shock to establish a causal linkage between insider ownership and firm value A separate regression model is run to analyze the relationship between promoter ownership and firm value in view of an exogenous regulatory change in the level of promoter ownership (Table 4.9). Qualitatively, the relationship between promoter ownership and firm value remains unaltered (β = 0.070, p < 0.05) when the ownership change in the sample firms takes place because of a change in the regulatory requirements. The findings, thus, confirm a causal linkage between promoter ownership and firm value.

4.3 Analysis and Findings Table 4.9 Regression analysis of corporate governance mechanisms and firm value over a period (2010–2014) for the private sector firms having promoter ownership more than 75%

93 Independent variables

Dependent variable—Tobin’s Q

Promoter ownership

0.070b (0.034)

Domestic institutional ownership

0.001 (0.059)

Foreign institutional ownership 0.116b (0.057) log(Product market competition)

−2.033b (0.986)

log(Total audit fee)

1.276a (0.385)

Big-Four

0.769b (0.339)

Percentage non-audit fee

−0.014c (0.007)

Board independence

−0.058b (0.024)

CEO-Chairman duality

1.170b (0.497)

Board size

0.004 (0.060)

Audit Committee independence 0.036a (0.011) Leverage

−1.589 (1.183)

log(Firm size)

−2.055a (0.542)

log(Research and development expenditure)

0.094b (0.038)

log(Firm age)

0.821b (0.369)

Constant

8.995b (4.239)

Fixed effects Year

Included

Industry

Included

Observations

135

R2

0.685 (continued)

94 Table 4.9 (continued)

4 Corporate Governance Mechanisms and Firm Performance Independent variables

Dependent variable—Tobin’s Q

Adjusted R2

0.601

Note The empirical findings of this table establish a causal relationship between promoter ownership and Tobin’s Q. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10% Table 4.10 Analysis of mean values of promoter ownership and firm value over the years (2010–2014)

Years

Mean value of promoter ownership

Mean value of Tobin’s Q ratio

2010

81.99

3.16

2011

81.75

3

2012

80.42

2.86

2013

79.05

2.54

2014

74.22

2.61

Source Authors’ compilation

Fig. 4.1 Non-linear relationship between promoter ownership and firm value. Source Authors’ compilation

4.4 Discussion

95

It is to be noted that in the regression analysis of Table 4.9, only the private sector firms with promoter ownership of more than 75% have been taken into consideration. This is based on directions of a regulatory change introduced in 2010, wherein a maximum limit of 75% was introduced on the level of promoter ownership in the private sector listed companies in India. As per this regulation which came in effect from June 2010, companies were given a maximum period of 3 years (Ministry of Finance, 2010) to comply with the amendments. Thus, change in the promoter ownership of the private sector companies having promoter ownership of more than 75% in June 2010, can be attributed to this exogenous regulatory change. Subsequently, an analysis of the comparison of mean promoter ownership and firm value over five years (2010–2014) further reinforces similar findings (Table 4.10). On an average, the firm value reduced with the decreasing level of insider ownership over the years. In relation to the increase in firm value in the year 2014 (Table 4.10), it is to be noted that the legislation had to be complied till June 2013 and nearest future data points corresponds to March 31, 2014. Hence, it may not be possible to relate lower level of promoter ownership with enhanced firm value (Table 4.10).

4.4 Discussion An insignificant relationship between product market competition and firm value (Table 4.5) can be attributed to the dual and contrasting effects of product market competition on firm performance. On one side, higher product market competition ensures an efficient allocation of resources to avoid the threat of bankruptcy or a potential takeover (Nickell, 1996). It also reduces information asymmetry between the owners and the management by providing a suitable benchmark to the owners to monitor the firm’s performance. Nevertheless, on the other side, Schmidt (1997) empirically proved that managerial effort first increased with the increase in competition level and then, started declining when the competition became too intense. He argued that the profits declined considerably when the competition became too intense, and the management felt less motivated to put more effort to improve performance. Further, a strong positive association between the appointment of an external auditor affiliated to a Big-Four auditor and firm value extends support to the possibility of the prevalence of “the colonial hangover” (a positive perception of the public towards the western institutions) in India (Desai et al., 2012). A negative and inconsistent relationship with the accounting measure of firm performance (ROA) further reinforces the previous argument. A positive and significant effect of total audit fee on both firm value and return on assets, confirms that audit intensity strengthens the firm’s governance structure. It can thus be deduced that higher audit fee gets translated into higher audit effort which in turn makes the audit process more intensive. This, in turn, strengthens the firm’s governance structure. Also, an insignificant

96

4 Corporate Governance Mechanisms and Firm Performance

relationship between firm performance and percentage non-audit fee signifies that auditor independence has no ex-ante effect on the firms’ governance structure. The empirical results with respect to the impact of board independence on firm performance (Tobin’s Q and ROA) are aligned with the findings of Agrawal and Knoeber (1996), Klein (1998) and Kumar and Sivaramakrishnan (2008). Two possible explanations can be extended for the negative effect of board independence on firm value. One, the independence of independent directors can be an issue of concern. The independence of the independent directors can be affected by reasons like adverse selection process (like the involvement of the CEO/promoters in the selection process) (Shivdasani & Yermack, 1999); subtle linkages between the independent directors and the CEO or the company which are too subtle to come under the purview of the formal definition of an independent director (Bhagat & Black, 1999), and/or long tenure of the independent directors in the firms. Another explanation points towards the lack of ability of the independent directors to contribute towards the firm value. The ability of the independent directors to enhance firm value can be hampered by a number of factors: lack of expertise in the industry domain (Klein, 1998; Raheja, 2005), the excessive busyness of the independent directors (Ferris et al., 2003) and so on. In relation to the ownership structure, a non-linear relationship between promoter ownership and firm value can be explained with the arguments of Morck et al. (1988). In view of Morck et al. (1988), the findings confirm that the entrenchment effect dominates the convergence-of-interest effect at a lower level of promoter ownership (18%). However, after a certain point, the negative consequences of the entrenchment effect become stagnant and the convergence-of-interest effect dominates after that. Subsequently, a significantly positive association between institutional investment (domestic as well as foreign) and firm performance confirms that the institutional investors play an active role in the firms’ governance in India. However, a higher positive impact of the foreign institutional investment on firm value compared to its domestic counterpart perhaps indicates that foreign institutional investors take a more active stance for various issues of misgovernance. In contrast, the domestic institutional investors might feel obligated to go along with the management/promoter owner due to their long-standing relationship with them (Gillan & Starks, 2003).

4.5 Implications and Recommendations The empirical findings have important theoretical and practical implications. Theoretically, the study enhances our understanding of the dynamics of various governance mechanisms in relationship to the value of Indian firms.

4.5 Implications and Recommendations

97

Implications and recommendations for the policy-makers • The empirical findings confirm that Indian firms have a promoter dominated governance structure and the promoter owners have an overall significant positive impact on firm value. Nevertheless, the empirical findings also confirm the dominance of the entrenchment effect2 at lower levels of promoter ownership, wherein the firm value reduces with the increase in promoter ownership. • Recommendation: The policy-makers should draw policies in such a way to reduce the entrenchment effect of the promoter shareholders. This can be achieved by empowering the minority shareholders, increasing the disclosure requirements to enhance transparency, and strengthening the regulatory infrastructure. • The findings highlighting a significantly negative effect of board independence on firm performance raise serious concerns for the policy-makers. The recent policies introduced in the country (MCA, 2013; SEBI, 2015) advocate a highly independent board in order to strengthen the firm-level governance structure. A value eroding impact of board independence questions the efficacy of board independence as a potential governance mechanism in the country. Recommendation: Either the requirement of having a fixed-number of independent directors should be removed or the value-eroding effect of the independent directors should be justified in the context of the requirement of having a fixed limit of the independent directors or the reasons explaining the ineffectiveness of the independent directors should be sought and fixed to make board independence an effective governance mechanism. Recommendations for the companies • Besides following the regulatory mandates (related to board independence), the companies should conduct a firm analysis to assess if the independent directors actually strengthen the governance structure. If not, the firms should make every effort to analyze the reasons behind their inefficacy in the firms’ governance. • Firms should strive to go beyond fulfilling the bare minimum regulatory requirements to ensure that independent directors start adding to the firm value. This is imperative in order to strengthen the firm’s governance as independent directors can play a crucial role in providing unbiased judgment on management performance and in advancing/protecting the interest of the minority shareholders and hence, mitigating the principal-principal issues, which is the prime governance issue in economies like India.

2

The tendency of the insiders to get entrenched to the firm with the increase in share ownership and start pursuing their self-interests. Thus, the firm value declines with the increase in the insider ownership.

98

4 Corporate Governance Mechanisms and Firm Performance

4.6 Summary and Conclusion The chapter conducts an empirical investigation to analyze the effect of various governance mechanisms on firm value. Specifically, we have taken into consideration four broad governance mechanisms into consideration: product market competition, audit quality, board monitoring and ownership structure. A further disaggregate analysis has been conducted to analyze if the effect of these governance mechanisms varies with firm-specific parameters like firm age and size. The empirical findings confirm that product market competition has an overall insignificant effect on firm value. The external audit’s affiliation to the Big-Four auditors and total audit fee enhances the firm value. However, auditor independence measured with the percentage non-audit fee is not significantly related to firm value. Further, board independence has a consistent and significantly negative effect on firm value. In contrast, institutional ownership (domestic and foreign) has a positive effect on firm value; while promoter ownership has a non-linear relationship (U-shaped) with firm value. Table 4.11 summarizes the empirical results obtained in this chapter. Possible implications and recommendations, based on the findings, have been suggested in the previous section. Table 4.11 Summary of the empirical results S. no

Corporate governance mechanism

Measure

Effect on firm value

1

Product market competition

HHI Index

Insignificant

2

Audit quality

Big-Four auditor

Significant (positive)

3

4

Ownership structure

Board monitoring

Total audit fee

Significant (positive)

Percentage non-audit fee

Insignificant

Total promoter ownership Significant (U-shaped) Inflection point = 17.5% Foreign institutional ownership

Significant (positive)

Domestic institutional ownership

Significant (positive)

Board independence

Significant (negative)

CEO-Chairman duality

Insignificant

Board size

Significant (positive)

Audit Committee independence

Significant (positive)

Note This table presents the summary of various regression models in line with the aim of the study

Appendices

99

Appendices See Appendixes 4.1, 4.2, 4.3 and 4.4.

Appendix 4.1 Regression model analyzing the impact of product market competition on ROA

Independent variables

Dependent variable—Return on assets (ROA)

log(Product market competition)

−2.788a (0.667)

Leverage

−15.025a (1.226)

log(Firm size)

−0.294 (0.302)

log(Research and development expenditure)

0.082b (0.032)

log(Firm age)

1.031a (0.212)

Constant

21.787a (2.136)

Fixed effects Year

Included

Industry

Included

Observations

4,248

R2

0.218

Adjusted R2

0.213

Note This table presents the empirical analysis related to the effect of product market competition on ROA. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10%

100 Appendix 4.2 Regression model analyzing the impact of audit quality on ROA

4 Corporate Governance Mechanisms and Firm Performance Independent variables

Dependent variable—Return on assets (ROA)

log(Total audit fee)

0.191a (0.064)

Big-Four

−0.170 (0.271)

Percentage non-audit fee

0.010 (0.007)

log(Product market competition)

−2.802a (0.668)

Leverage

−15.034a (1.241)

log(Firm size)

−0.562c (0.312)

log(Research and development expenditure)

0.085a (0.032)

log(Firm age)

1.008a (0.214)

Constant

22.571a (2.127)

Fixed effects Year

Included

Industry

Included

Observations

4,248

R2

0.220

Adjusted R2

0.214

Note This table presents the empirical analysis related to the effect of various measures of audit quality on ROA. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10%

Appendices Appendix 4.3 Regression model analyzing the impact of board monitoring on ROA

101 Independent variables

Dependent variable—Return on assets (ROA)

Board independence

−0.037a (0.014)

CEO-Chairman duality

−0.104 (0.283)

Board size

0.163a (0.046)

Audit Committee independence 0.005 (0.009) log(Product market competition)

−2.798a (0.670)

log(Total audit fee)

0.191a (0.064)

Big-Four

−0.157 (0.271)

Percentage non-audit fee

0.009 (0.007)

Leverage

−14.991a (1.246)

log(Firm size)

−0.890a (0.333)

log(Research and development expenditure)

0.087a (0.033)

log(Firm age)

0.934a (0.214)

Constant

24.163a (2.324)

Fixed effects Year

Included

Industry

Included

Observations

4,248

R2

0.224

Adjusted R2

0.217

Note This table presents the empirical analysis related to the effect of board monitoring on ROA. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10%

102

4 Corporate Governance Mechanisms and Firm Performance

Appendix 4.4 Regression model analyzing the impact of ownership structure on ROA Independent variables

Promoter ownership

Dependent variable—Return on assets (ROA) Model (1)

Model (2)

0.083a

0.096a (0.037)

(0.010)

−0.0001 (0.0003)

(Promoter ownership)ˆ2 Domestic institutional ownership

0.066a (0.018)

0.066a (0.018)

Foreign institutional ownership

0.102a (0.019)

0.102a (0.019)

log(Product market competition)

−2.626a (0.671)

−2.610a (0.670)

log(Total audit fee)

0.194a (0.065)

0.194a (0.065)

Big-Four

−0.437 (0.266)

−0.441c (0.267)

Percentage non-audit fee

0.007 (0.007)

0.007 (0.007)

Board independence

−0.023c (0.013)

−0.024c (0.014)

CEO-Chairman duality

−0.275 (0.280)

−0.263 (0.281)

Board size

0.177a (0.046)

0.179a (0.046)

Audit Committee independence

0.003 (0.009)

0.003 (0.009)

Leverage

−13.757a (1.310)

−13.782a (1.321)

log(Firm size)

−1.694a (0.380)

−1.679a (0.387)

log(Research and development expenditure)

0.116a (0.034)

0.116a (0.034)

log(Firm age)

1.202a (0.223)

1.206a (0.224)

Constant

19.209a (2.461)

18.823a (2.576)

Fixed effects Year

Included

Included

Industry

Included

Included (continued)

References

103

Appendix 4.4 (continued) Independent variables

Dependent variable—Return on assets (ROA) Model (1)

Model (2)

Observations

4,248

4,248

R2

0.239

0.239

Adjusted R2

0.232

0.232

Note This table, Model 1 presents the empirical analysis related to the effect of various components of ownership structure on ROA. Model 2 contains results on the non-linear relationship between promoter ownership and ROA. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10%

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Ferris, S. P., Jagannathan, M., & Pritchard, A. C. (2003). Too busy to mind the business? Monitoring by directors with multiple board appointments. The Journal of Finance, 58(3), 1087–1111. Field, A. (2013). Discovering Statistics Using SPSS (4th ed.). Sage. Ghosh, S. (2006). Do board characteristics affect corporate performance? Firm-level evidence for India. Applied Economics Letters, 13(7), 435–443. Gillan, S. L., & Starks, L. T. (2003). Institutional investors, corporate ownership and corporate governance: Global perspectives. Ownership and Governance of Enterprises (pp. 36–68). Palgrave Macmillan. Gilson, R. J., & Roe, M. J. (1993). Understanding the Japanese keiretsu: Overlaps between corporate governance and industrial organization. Yale Law Journal, 102(4), 871–906. Giroud, X., & Mueller, H. M. (2010). Does corporate governance matter in competitive industries? Journal of Financial Economics, 95(3), 312–331. Gompers, P., Ishii, J., & Metrick, A. (2003). Corporate governance and equity prices. The Quarterly Journal of Economics, 118(1), 107–156. Hart, O. D. (1983). The market mechanism as an incentive scheme. The Bell Journal of Economics, 14(2), 366–382. Jain, P. K., Singh, S., & Yadav, S. S. (2013). Financial Management Practices: An Empirical Study of Indian Corporates. New Delhi: Springer India. Jameson, M., Prevost, A., & Puthenpurackal, J. (2014). Controlling shareholders, board structure, and firm performance: Evidence from India. Journal of Corporate Finance, 27, 1–20. Januszewski, S. I., Köke, J., & Winter, J. K. (2002). Product market competition, corporate governance and firm performance: An empirical analysis for Germany. Research in Economics, 56(3), 299–332. Jensen, M. C., & Ruback, R. S. (1983). The market for corporate control: The scientific evidence. Journal of Financial Economics, 11(1–4), 5–50. Klein, A. (1998). Firm performance and board committee structure. The Journal of Law and Economics, 41(1), 275–304. Kumar, P., & Sivaramakrishnan, K. (2008). Who monitors the monitor? The effect of board independence on executive compensation and firm value. The Review of Financial Studies, 21(3), 1371–1401. Lin, Y. R., & Fu, X. M. (2017). Does institutional ownership influence firm performance? Evidence from China. International Review of Economics and Finance, 49, 17–57. Machlup, F. (1967). Theories of the firm: Marginalist, behavioral, managerial. The American Economic Review, 1, 1–33. MCA. (2013, August 30). The Companies Act. Retrieved March 13, 2016, from http://www.mca. gov.in/MinistryV2/companiesact2013.html. McConnell, J. J., & Servaes, H. (1990). Additional evidence on equity ownership and corporate value. Journal of Financial Economics, 27(2), 595–612. McNulty, T., Zattoni, A., & Douglas, T. (2013). Developing corporate governance research through qualitative methods: A review of previous studies. Corporate Governance: An International Review, 21(2), 183–198. Ministry of Finance. (2010, June 4). Securities Contracts (Regulation) Rules. New Delhi, India. Retrieved July 12, 2018, from http://www.manupatra.com/manufeed/contents/PDF/634115253 262811250.pdf. Morck, R., Shleifer, A., & Vishny, R. W. (1988). Management ownership and market valuation: An empirical analysis. Journal of Financial Economics, 20(1), 293–315. Nickell, S. J. (1996). Competition and corporate performance. Journal of Political Economy, 104(4), 724–746. Nickell, S., Nicolitsas, D., & Dryden, N. (1997). What makes firms perform well? European Economic Review, 41(3–5), 783–796. OECD. (2004). OECD Principles of Corporate Governance. France: OECD. Retrieved June 12, 2017, from http://www.oecd.org/corporate/ca/corporategovernanceprinciples/31557724.pdf.

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Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. W. (1997). Legal determinants of external finance. The Journal of Finance, 52(3), 1131–1150. Porta, R. L., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. W. (1998). Law and finance. Journal of Political Economy, 106(6), 1113–1155. Quick, R., Schenk, N., Schmidt, F., & Towara, T. (2017). The impact of corporate governance on auditor choice: Evidence from Germany. Journal of Management and Governance, 1–33. https:// doi.org/10.1007/s10997-017-9386-4. Raheja, C. G. (2005). Determinants of board size and composition: A theory of corporate boards. The Journal of Financial and Quantitative Analysis, 40(2), 283–306. Randøy, T., & Jenssen, J. I. (2004). Board independence and product market competition in Swedish firms. Corporate Governance: An International Review, 12(3), 281–289. Rosner, R. L., & Markelevich, A. (2011). Original and revised auditor fee data. American Accounting Association, 5(1), A54–A69. Sarkar, J., & Sarkar, S. (2000). Large shareholder activism in corporate governance in developing countries: Evidence from India. International Review of Finance, 1(3), 161–194. Schmidt, K. M. (1997). Managerial incentives and product market competition. The Review of Economic Studies, 64(2), 191–213. SEBI. (2015, September 2). Listing Obligations and Disclosure Regulations 2015. Retrieved December 12, 2017, from https://www.sebi.gov.in/sebi_data/attachdocs/1441284401427.pdf. Selarka, E. (2005). Ownership concentration and firm value: A study from the Indian corporate sector. Emerging Markets Finance and Trade, 41(6), 83–108. Shivdasani, A., & Yermack, D. (1999). CEO involvement in the selection of new board members: An empirical analysis. The Journal of Finance, 54(5), 1829–1853. Sikka, P. (2009). Financial crisis and the silence of the auditors. Accounting, Organizations and Society, 34(6–7), 868–873. Singh, S., Jain, P. K., & Yadav, S. S. (2016). Equity Markets in India: Returns, Risks and Price Multiple. Springer. Xie, B., Davidson, W. N., III., & DaDalt, P. J. (2003). Earnings management and corporate governance: The role of the board and the audit committee. Journal of Corporate Finance, 9(3), 295–316. Xu, X., & Wang, Y. (1999). Ownership structure and corporate governance in Chinese stock companies. China Economic Review, 10(1), 75–98.

Chapter 5

Performance Enhancement Effect of Board Independence

This chapter attempts to examine whether the independent directors can enhance the firm performance by strengthening some other governance mechanisms. A related review of literature provides support to the positive effect of board independence on two governance mechanisms: audit quality and foreign institutional investment (FII). The analysis of the performance enhancement effect of board independence on firm value is studied under two broad sub-objectives. The first sub-objective is concerned with the analysis of performance enhancement effect of board independence through audit quality. The second sub-objective is related to the analysis of a similar relationship though foreign institutional investment. For better exposition, the analysis of each broad sub-objective is conducted into two parts. Corresponding to the first broad sub-objective, the first part is concerned with the analysis of the relationship between board independence and audit quality. This analysis is based on the argument that independent directors, in order to complement their monitoring role, tend to enhance the audit quality. Secondly, in view of the positive relationship between audit quality and firm value (Chap. 4), we aim to investigate if the board independence enhances the firm value by improving the audit quality. In other words, we aim to validate the mediation relationship of board independence on firm value, with audit quality as the mediator variable. In relation to the second broad sub-objective, the first part aims to analyze the relationship between board independence and foreign institutional investment (FII). Based on the proposition that a highly independent board reduces information asymmetry and advocates the interest of minority shareholders, we aim to investigate the relationship between board independence and FII. Secondly, in view of the positive relationship between FII and firm value (Chap. 4), we attempt to analyze if board independence creates firm value by attracting more FII. In other words, we aim to validate the mediation relationship between board independence and firm value, with the FII as the mediating variable. © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2022 S. Singh and M. Singla, Corporate Governance Mechanisms and Firm Performance, India Studies in Business and Economics, https://doi.org/10.1007/978-981-19-2460-6_5

107

108

5 Performance Enhancement Effect of Board Independence

This chapter is organized as follows. Section 5.1 presents an introduction to the sub-objectives being analyzed and the related review of literature. Section 5.2 briefly explains the methodology deployed to conduct the empirical analysis. Section 5.3 presents the analysis and findings. Section 5.4 presents the discussion. Section 5.5 presents the contribution and implications of the study. Finally, Sect. 5.6 highlights the summary and concluding observations.

5.1 Introduction A related review of literature provides support to the positive effect of board independence on the following governance mechanisms: • Audit quality • Foreign institutional investment (FII) A brief review of literature in relation to two broad objectives and their sub-parts is presented under separate headings. Board Independence, Audit Quality and Firm Performance Beasley and Petroni (2001), Azim (2012) and Quick et al. (2017) report the board structure to be a significant determinant of the audit quality of the firm. Viewing through the lens of the agency perspective (explained in Chap. 1), Pincus et al. (1989) argue that the outside directors dilute their relative information disadvantage from the executive directors by demanding more intensive audits and thus, enhance the audit quality. Advocating a similar viewpoint and considering that the independent directors are introduced with the motive to monitor the activities of the management and to reduce the agency costs, O’sullivan (2000) theorize that the independent directors enhance the audit quality in an attempt to complement their own monitoring. Along similar lines, Carcello et al. (2002) argue that independent directors, in order to protect their market reputation, demand a high-quality audit. Though substantial literature is available in the global context, we could not find any study in the Indian context analyzing a direct association between board independence and audit quality. Such an analysis is altogether more important in the Indian context as the independent directors have an overall negative impact on the firm’s value (Chap. 4). In view of the existing literature on the positive relationship between board independence and audit quality, it would be interesting to analyze if independent directors have any positive impact on the firms’ other governance mechanisms (audit quality) in Indian firms (Fig. 5.1). This study adds to the body of limited literature in the Indian context and conducts (to the best of our knowledge) the first such study based on Indian data. Such an analysis will further our understanding of the monitoring behavior of the independent directors in the country. Subsequently, in consideration of the positive relationship between audit quality and firm value (Chap. 4), we aim to empirically analyze if board independence adds

5.1 Introduction

109

Expected relationship (+)

Board Independence

Audit Quality

Fig. 5.1 Expected relationship between board independence and audit quality. Source Authors’ compilation

Board Independence

(+)

Audit Quality

(+)

Firm Value

Fig. 5.2 Board independence and firm value with audit quality as the mediator. Note In this figure, “audit quality” acts as the mediator variable, mediating the relationship between board independence and firm value. Source Authors’ compilation

to the firm value by enhancing the audit quality (in case a positive relationship exists between board independence and audit quality) (Fig. 5.2). This chapter adds to the existing body of literature by providing a holistic understanding of the governance mechanics of board independence while building on the pieces of existing research. To the best of authors’ knowledge, this is perhaps the first study to provide a more in-depth understanding on the governance behavior of the independent directors. Board Independence, Foreign Institutional Investment and Firm Performance Various studies conducted in the past have analyzed if stronger governance practices at firm/country level attract foreign equity. At the country level, various factors that have been documented to influence the foreign institutional investment are cultural and economic distance (Kim et al., 2017), legal infrastructure/protection of shareholders’ rights (Bodnaruk et al., 2017; Porta et al., 1997), institutional quality (Mishra, 2015) and reporting standards followed (Mouna & Hassouna, 2016). Relatively fewer empirical studies have been conducted to analyze various firmlevel factors explaining such bias. Mangena and Tauringana (2007) reported that firm-level disclosures and proportion of non-executive directors on the board played an important role in attracting foreign institutional investors. Rueda-Sabater (2000) argued that improvements in the corporate governance practices at both firm and country level could provide a strategic edge to the developing nations to attract more foreign investments. Analyzing the data of 80 non-U.S. countries, Miletkov et al. (2014) and Abdulmalik and Ahmad (2016) reported a positive correlation between board independence and foreign equity investment. Similar results have been reported by Min and Bowman (2015). A survey conducted by McKinsey (2000) on the investment preferences of 200 institutional investors highlighted that the firm’s board practices were at least as important as the firm’s performance for around 75% of the respondents. Though literature is available in the context of economies like the US and Korea, few studies are found in the Indian context. This study aims to bridge this research

110

5 Performance Enhancement Effect of Board Independence

Expected relationship (+)

Board Independence

Foreign Institutional Investment

Fig. 5.3 Relationship between board independence and FII. Source Authors’ compilation

Board Independence

(+)

Foreign Institutional Investment

(+)

Firm Value

Fig. 5.4 Board independence and firm value with foreign institutional investment as the mediator. Note In this figure, “foreign institutional investment” acts as the mediator variable, mediating the relationship between board value and firm performance. Source Authors’ compilation

gap and aim to analyze if board independence plays a role in attracting more foreign institutional investors. Specifically, we aim to test the following model (Fig. 5.3). An understanding of such relationship is altogether more crucial in the context of the capital-deficit emerging economies which often rely on the foreign capital for their growth. Further, in view of the positive relationship between FII and firm value (Chap. 4), we aim to investigate if board independence enhances the firm value by attracting more foreign institutional investors. In particular, we test the mediation relationship board independence and firm value with the foreign institutional investment as the mediation variable (Fig. 5.4). This study contributes to the existing body of literature by advancing an understanding on the governance mechanics of board independence in relationship to other governance mechanisms. This is the first study analyzing the relationship between board independence and foreign institutional investment in the Indian context.

5.2 Methodology This section briefly explains the measures used in and the scope of the study, the research methodology deployed and provides a brief layout of the empirical analysis.

5.2.1 Measures and Scope The period of the study remains the same as discussed in the previous chapter (Chap. 3). In consideration of the additional variables used in the analysis related to the audit quality and subject to the availability of these variables, the sample size has

5.2 Methodology

111

further reduced to 4224 firm-year observations. This has been explained in greater detail in Chap. 3. The main variables of analysis in the current chapter are board independence, firm performance, audit quality and foreign institutional investment. It is to be noted that, in line with multiple proxies used to measure audit quality in Chap. 4, multiple regression models have been run corresponding to each of the audit quality measure, separately (where audit quality is a dependent variable). Table 5.1 presents the description of various variables used in the empirical analysis. Table 5.2 presents the descriptive statistics of the variables used in the current chapter. The highlights of the descriptive statistics of most of the variables used remains the same as discussed in Chap. 4. The Indian market is dominated by business-groups; 77% of the sample-firms years belong to the business-group firms. The number of mean and median number of subsidiary firms of the sample firm years is 6.91 and 3, respectively. The choice of the control variables is guided by literature. For example in relation to the analysis of audit quality as the variable of interest, there is empirical evidence that firm size and complexity (number of subsidiaries and business-group affiliation) influence audit fee and auditor choice (Abdullah et al., 2017; Bradbury, 2017; Collier & Gregory, 1996; Houqe et al., 2017; Kim & Yi, 2006). Therefore, the firm’s total assets, business-group affiliation and the number of subsidiaries have been considered ascontrol variables. The effect of the firm’s capital structure (leverage) has also been controlled in the study (Abdullah et al., 2017; Choi et al., 2018; Johl et al., 2016; Kim et al., 2017). In the empirical analysis, various time and industryspecific fixed effects have also been controlled by including the year and industry dummies in the regression models. In the empirical analysis related to the foreign institutional investment (as the variable of interest), external auditor’s affiliation to the Big-Four1 auditors has been taken as a control variable (Aggarwal et al., 2005; Chou et al., 2014; He et al., 2014). Their findings report that foreign institutional investors are more likely to invest in the companies which have appointed a Big-Four auditor to audit their financial results. The effect of firm age and size has been controlled by using the firm’s age and total assets of the firm as the control variables. Since many studies document a relationship between board effectiveness and product market competition (Giroud & Mueller, 2010; Pant & Pattanayak, 2010), market concentration has been taken as a control variable as well. Based on the work of Dvorak (2005), Mangena and Tauringana (2007) and Zou et al. (2016) and domestic institutional investment has been considered as another control variable.

1

After the demise of Arthur Andersen and guided by the current literature the Big-Four audit firms represents four audit firms: Ernst and Young (E and Y), Deloitte and Touche (D and T), Klynveld Peat Marwick Goerdeler (KPMG), and Pricewaterhouse Coopers (PwC) (Sikka, 2009).

112

5 Performance Enhancement Effect of Board Independence

Table 5.1 Description of various variables used in the study Variable name

Description of the variable

Return on assets (%)

ROA = (Earning after tax + (Interest − Tax advantage on interest))/(Average total assets)

Tobin’s Q ratio

Tobin’s Q ratio = ((Book value of the assets + market value of the common stock) – (Book value of the common stock))/(Total assets). A value >1 indicates the market value to the firm to be higher than the book value and vice-versa

Board independence (%)

The measure of the board independence calculated by dividing the number of independent directors by the total number directors of the company’s board

Big-Four

An indicator variable which takes the value of 1, if the auditor appointed is one among the Big-Four auditors and zero, otherwise

Total audit fee (in million dollars)

Total fee paid to the external auditor

Non-audit fee (%)

Percentage of non-audit fee in proportion to the total audit fee paid

Foreign institutional ownership (%)

Percentage shareholding of foreign institutional investors

Domestic institutional ownership (%)

Percentage shareholding of domestic institutional investors

Audit Committee independence (%)

A measure of the Audit Committee independence calculated by dividing the number of independent directors in the Audit Committee to the total number directors in the Audit Committee

Board size

Total number of directors in the company’s board

Product market competition (HHI Index) A measure used to estimate the market concentration of the firm using the Herfindahl Hirschman Index based on firm’s total sales and industry affiliation Promoter ownership (%)

Percentage shareholding of the promoter and promoter group

Firm size (in million dollars)

Total assets of the firms in US million dollars

Subsidiaries

The number of subsidiaries of the firm

Leverage

Leverage of the firm measured by the ratio of total debt to total assets of the firm

Research and development

Total expenditure on research and development activities scaled by the firm’s asset size (total assets)

Business-group affiliation

An indicator value which takes the value of one if the firm is affiliated to a business-group and zero, otherwise

Note This table presents the description of various variables used in the study Source Authors’ compilation

10.08 82.7 9.38

Domestic institutional ownership (%)

Audit Committee independence (%)

Board size 17.29

1893.29

2.75

16.6

8.69

10.18

18.65

0.22

0.5

11.87

2.69

8.77

6.91 0.00 0.77

Research and development expenditure (in million dollars)

Business-group affiliation

0.2

0.42

0.00

16.46

Note This table presents the descriptive statistics of various variables used in the study Source Authors’ compilation

0.5

Subsidiaries

0

0.00

0

0

173.17

0

568.25

3.00

0

0.00

0.00

0

0

0

0.00

0.10

−88.19

1

0.00

0

0.36

9615.18

43.86

1038.45

7.00

75

3.32

2.71

24.75

0.04

0

46.15

1.05

4.59

67.89

2690.68

11.00

100

14.69

16.87

52.29

0.15

1

57.14

2.68

13.03

0.51

1

0.00

3

0.64

1

0.00

7

1

0.00

270

1.78

29,735,290

99.59

10,000.00

22.00

100

74.60

66.19

90.04

3.85

1

100.00

79.70

129.14

Percentile (75) Maximum

23,975.94 60,585.39

54.52

1947.08

9.00

80

8.28

8.79

39.52

0.08

0

50.00

1.62

7.78

Standard deviation Minimum Percentile (25) Median

112,195.67 780,563.38

54.89

Leverage

Firm size (in million dollars)

Promoter ownership (%)

2300.65

11.12

Foreign institutional ownership (%)

Product market competition (HHI Index)

0.13 38.27

Big-Four

Non-audit fee (%)

0.48

Board independence (%)

Total audit fee (in million dollars)

2.37 51.29

Tobin’s Q ratio

9.40

Mean

Return on assets (%)

Variable name

Table 5.2 Descriptive statistics of variables used in the study

5.2 Methodology 113

114

5 Performance Enhancement Effect of Board Independence

Table 5.3 Research methodologies deployed for various objectives S. no

Objective

Methodology

Objective 5.1 Board independence, audit quality and firm performance 5.1.1

Board independence and audit quality (Fig. 5.1)

– OLS regression technique with year and industry fixed effects – Probit regression model with year and industry fixed effects

5.1.2

Board independence and firm value Hayes’ PROCESS program using an through audit quality (mediation effect) in-built Model#4 used for mediation (Fig. 5.2) analysis

Objective 5.2 Board independence, foreign institutional investment and firm performance 5.2.1

Board independence and foreign institutional investment (Fig. 5.3)

– OLS regression technique with year and industry fixed effects – OLS regression techniques using year and industry effects using time-separated independent and dependent variables

5.2.2

Board independence and firm value Hayes’ PROCESS program using an through foreign institutional investment in-built Model#4 used for mediation (mediation effect) (Fig. 5.4) analysis

Source Authors’ compilation

5.2.2 Research Methodology Corresponding to the step-wise analysis of the two broad objectives, Table 5.3 presents the summary of the techniques deployed corresponding to each objective of the study. The detailed description of the methodologies deployed is mentioned in Chap. 3.

5.2.3 Layout of Empirical Analysis This section briefly presents the layout of the empirical analysis. In line with the broad objectives of the study, the empirical analysis has been presented in two sections and is followed by additional analysis. In line with the first objective (Objective 5.1—Table 5.3), Tables 5.4 and 5.5 presents the relationship between board independence and audit quality. In consideration of the three measures of audit quality, Table 5.4 reports the empirical results with the “Big-Four” auditor as a dependent variable. Table 5.5 presents the empirical findings using “total audit fee” and “percentage non-audit fee” as the dependent variables. The empirical findings reported in Tables 5.6 and 5.7 are related to the analysis of the mediation effect of audit quality in the board independence and firm value relationship. Analogous to Tables 5.6 and 5.7, Appendices 5.12 and 5.13 reports the empirical findings using ROA as the measure of firm performance.

5.2 Methodology Table 5.4 Relationship between board independence and audit quality with the firms’ affiliation to the Big-Four auditors as the dependent variable

115 Dependent variable: Big-Four Variable names

Estimate (standard error)

Marginal effect

Board independence

−0.001 (0.002)

−0.0002

Audit committee independence

0.001 (0.001)

0.0002

Promoter ownership

0.0003 (0.001)

0.0001

Board independence a Promoter ownership Log (firm size)

0.141c (0.019)

0.051

Log (product market competition)

0.00001 (0.00001)

0.00001

Leverage

−0.573c (0.116)

Number of subsidiaries

−0.00001 (0.001)

0.000

Business-group affiliation

0.258c (0.054)

0.093

−0.207

Fixed effects Industry

Included

Year

Included

Constant

−1.408c (0.240)

Observations

4224

Log likelihood

−2424.733

−0.508

McFadden pseudo R2 0.08715535 Note This table presents the empirical results of probit regression model. This technique is deployed to analyze the impact of board independence on audit quality. The dependent variable is a dichotomous variable, measured with the auditor’ affiliation to the Big-Four auditors. The values in brackets report the standard error. a Indicate significance level at 10% b Indicates significance level at 5% and c Indicates significance level at 1% Source Authors’ compilation

In line with the second objective (Objective 5.2—Table 5.3), Table 5.8 reports the regression results presenting the relationship between board independence and foreign institutional investment. Tables 5.9 and 5.10 report the empirical results in relation to the mediation effect of foreign institutional investment for board independence and firm value relationship. Analogous to Tables 5.9 and 5.10, Appendices 5.14 and 5.15 report the empirical results using ROA as the measure of firm performance.

116 Table 5.5 The relationship between board independence and audit quality with total audit fee and percentage non-audit fee as the dependent variables

5 Performance Enhancement Effect of Board Independence Dependent variables Independent variables Total audit fee

Percentage non-audit fee

Model (1)

Model (2)

0.001c (0.0002)

−0.071b (0.030)

Audit Committee independence

0.0005c (0.0002)

0.011 (0.020)

Promoter ownership

−0.001c (0.0002)

0.065c (0.022)

Log (firm size)

0.084c (0.005)

1.602c (0.293)

Log (product market competition)

−0.000001 (0.00000)

0.0004c (0.0002)

Big-Four

0.094c (0.007)

−1.420b (0.609)

Leverage

−0.033b (0.014)

0.356 (1.695)

Number of subsidiaries

0.001c (0.0004)

−0.098c (0.017)

Business-group affiliation

0.016c (0.004)

1.112 (0.756)

Constant

−0.751c (0.038)

26.204c (3.385)

Board independence

Fixed effects Year

Included

Included

Industry

Included

Included

Observations

4224

4224

R2

0.418

0.092

Adjusted R2

0.413

0.084

Note This table presents empirical estimates analyzing the relationship between board independence and audit quality. In Model 1, the measure of audit quality (dependent variable) is total audit fee. In Model 2, audit quality is measured by the percentage non-audit fee. The values in brackets report the standard error a Indicate significance level at 10% b Indicates significance level at 5% and c Indicates significance level at 1% Source Authors’ compilation

5.3 Analysis and Findings This section details the empirical findings related to the objectives of this chapter. The empirical results are reported in separate sections in line with the objectives of the study.

5.3 Analysis and Findings

117

Table 5.6 Direct effect of board independence on firm value (mediator–audit quality) Effect

SE

t-value

p-value

LLCI

ULCI

−0.0224

0.004

−5.5683

0.0000

−0.0302

−0.0145

Note Analogous to the β measure in the regression model, “effect” value is the estimation of the direct effect between board independence and Tobin’s Q. “SE” represents the standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence Source Authors’ compilation

Table 5.7 Indirect effect of board independence on firm value (mediator–audit quality) Mediator

Effect

SE

LLCI

ULCI

Total audit fee

0.0016

0.0004

0.0009

0.0026

Note Analogous to the β measure in the regression model, “effect” value is the estimation of the indirect effect between board independence and Tobin’s Q with “total audit fee” as the mediator. “SE” represents the bootstrap standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence Source Authors’ compilation

5.3.1 Board Independence, Audit Quality and Firm Performance The analysis of the interrelation between board independence, audit quality and firm performance is conducted in four steps. The findings of the step-wise analysis (in the order mentioned in Table 5.3) is presented next. i.

Board independence and audit quality

The findings of the probit regression model in Table 5.4 report that board independence does not influence the auditor’s choice in India. In other words, the findings confirm that independent directors do not have a significant tendency to appoint a Big-Four auditor. The results are in sharp contrast with the existing studies which state that the independent directors, to complement their monitoring role are more likely to appoint a Big-N2 auditor (Beasley & Azim, 2012; Petroni, 2001; Quick et al., 2017). Thus, the null hypothesis, H0.5 (Chap. 3), gets supported when “Big-Four” is used as the measure of audit quality. 2

Big-N refers to a generic term used for Big-Eight (Arthur Andersen and Co.; Arthur Young; Coopers and Lybrand; Deloitte Haskins and Sells; Ernst and Whinney; Peat, Marwick, Mitchell and Co.; Price Waterhouse and Co.; Touche Ross) Big-Six (Arthur Andersen; Coopers and Lybrand; Ernst and Young; Deloittle and Touche; Klynveld Peat Marwick; Pricewater House), Big-Five (Arthur Andersen; Deloitte and Touche; Ernst and Young; Klynveld Peat Marwick Goerdeler; PricewaterhouseCoopers) and Big-Four (Ernst and Young; Deloitte and Touche; Klynveld Peat Marwick Goerdeler; PricewaterhouseCoopers) audit firms.

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Table 5.8 Regression results depicting the relationship between board independence and foreign institutional investment Independent variables

Dependent variable—Foreign institutional investment (FII)

Board independence

0.102c (0.012)

Promoter ownership

−0.112c (0.007)

Big-Four

0.333 (0.32)

Leverage

−8.682c (0.797)

Log (product market competition) −0.017 (0.55) Domestic institutional ownership

−0.067c (0.019)

Log (firm size)

6.803c (0.293)

log(Firm age)

−0.060c (0.006)

Constant

1.858 (2.16)

Fixed effects Industry

Yes

Year

Yes

Observations

4248

R2

0.261

Adjusted R2

0.250

Note This table reports the empirical analysis related to the effect of board independence on foreign institutional investment. The values in brackets report the standard error a Indicate significance level at 10% b Indicates significance level at 5% and c Indicates significance level at 1% Source Authors’ compilation Table 5.9 Direct effect of board independence on firm value (mediator–foreign institutional investment) Effect

SE

t-value

p-value

LLCI

ULCI

−0.0234

0.0040

−5.8484

0.0000

−0.0313

−0.0156

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the direct effect between board independence and Tobin’s Q. “SE” represents the standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence Source Authors’ compilation

5.3 Analysis and Findings

119

Table 5.10 Indirect effect of board independence on firm value (mediator–foreign institutional investment) Mediator

Effect

SE

LLCI

ULCI

Foreign institutional investment

0.0010

0.0004

0.0004

0.0018

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the indirect effect between board independence and Tobin’s Q with “foreign institutional investment” as the mediator. “SE” represents the bootstrap standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence Source Authors’ compilation

Nevertheless, the findings confirm that the independent directors strive to enhance the audit quality by demanding more intensive audits (Table 5.5—Model 1: β = 0.001, p < 0.01). In this regard, the results support the findings of O’sullivan (2000) and Azim (2012) who advocate the viewpoint that a more independent board is more likely to demand a more intensive audit by paying more fee to the external auditors. The findings of analysis reject the null hypothesis, H0.5 (Chap. 3), when “total audit fee” is used as the measure of audit quality. Along similar lines, we observe a significantly negative relationship between board independence and percentage non-audit fee (β = −0.071, p < 0.05). In other words, independent directs tend to preserve the auditors’ independence by subscribing to lesser non-audit services from the external auditor) (Table 5.5— Model 2). The null hypothesis, H0.5 (Chap. 3), again gets rejected when “percentage non-audit fee” is used as the measure of audit quality. ii.

Board independence and firm performance through audit quality

The findings reported in Tables 5.6 and 5.7 confirm the presence of partial mediation effect with (MacKinnon et al., 2000). A mediation effect is said to be the partial mediation when the direct effect of the independent variable (board independence) on the dependent variable (firm performance) continuous to be significant after adding the mediating variable (audit quality) in the mediation framework. Table 5.6 confirms the direct effect of board independence on firm value to be significant (β = −0.022, 95% CI [−0.0302, −0.0145]). Further, Table 5.7 reports the indirect effect of board independence on firm value (through audit quality) to be significant (β = 0.001, 95% CI [0.0009, 0.0026]). In other words, for 1% increase in board independence the firm value increases by 0.16% (through the enhanced audit quality).The direction and significance of the direct effect on firm performance remains unaltered for an accounting-based performance measure (Appendices 5.1 and 5.2). The null hypothesis, H0.7 (Chap. 3), thus gets rejected.

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5.3.2 Board Independence, Foreign Institutional Investment and Firm Performance The analysis of the interrelation between board independence, foreign institutional investment and firm performance is conducted in two steps. The findings of the step-wise analysis (in the order mentioned in Table 5.3) is presented here. i.

Board independence and foreign institutional investment

The regression results in Table 5.8 report that board independence plays a significant role (β = 0.102, p < 0.01) in attracting foreign institutional investors. Specifically, 1% increase in board independence increases the foreign institutional investment by 0.10%. A significantly positive relationship between board independence and foreign institutional investment is in line with the findings of Miletkov et al. (2014) and Min and Bowman (2015) and Abdulmalik and Ahmad (2016) and rejects the null hypothesis, H0.6 (Chap. 3). ii.

Board independence and firm performance through foreign institutional investment

The findings reported in Tables 5.9 and 5.10 validate the presence of a significant mediation relationship (MacKinnon et al., 2000). Table 5.9 confirms the direct effect of board independence on firm value to be significant (β = −0.023, 95% CI [−0.0313, −0.0156]). Further, Table 5.10 reports the indirect effect of board independence on firm value (through audit quality) to be significant (β = 0.001, 95% CI [0.0004, 0.0018]). Based on the significant indirect relationship between board independence and firm value (through FII), the null hypothesis, H0.8 (Chap. 3), gets rejected. In other words, for a 1% increase in board independence, the firm value increases by 0.10% (through the enhanced foreign institutional investment). Further, the direction and significance of the empirical results remains unchanged when an accounting-based performance measure (ROA) has been used in the empirical analysis (Appendices 5.14 and 5.15).

5.4 Discussion Broadly, the empirical findings indicate that despite the overall negative effect of board independence on firm performance (Chap. 4), independent directors strengthen the governance structure of the firm by strengthening other governance mechanisms (audit quality and foreign institutional investment) and the firm value indirectly by strengthening these governance mechanisms. This section, based on the existing literature, summaries the possible explanations behind the empirical results obtained in Sect. 5.3. For better exposition and in line with the two broad objectives of the chapter, this section is further divided into two subsections.

5.5 Implications and Recommendations

121

Board Independence, Audit Quality and Firm Performance An insignificant relationship between board independence and auditor choice renders the findings of Beasley and Petroni (2001), Azim (2012) and Quick et al. (2017), false, in the Indian context. These studies suggest that independent directors, in order to complement their monitoring role, appoint a Big-N auditor. Nevertheless, independent directors enhance the audit quality by demanding more intensive audits and thus, by paying a higher total audit fee. The findings also present that the independent directors strive to make the auditors more independent, and thus, the board independence complements the auditor’s independence in India. In other words, the tendency of the independent directors to enhance the auditors’ independence can be considered to be one of the ways to discharge their monitoring role. Further, in contrast to the overall negative effect of board independence on firm value, a significant and positive indirect effect of board independence on firm value (through audit quality) signifies that independent directors enhance firm value by enhancing the audit quality. Further, guided by the work of Carcello et al. (2002) it can be argued that independent directors, to protect their market reputation, demand a higher quality audity. Board Independence, Foreign Institutional Investment and Firm Performance A significantly positive relationship between board independence and foreign institutional ownership can be explained based on the argument that in the emerging markets with a weak institutional framework, a highly independent board reduces the information disadvantage of the foreign institutional investors. To the foreign institutional investors, it might also signify a strong firm-level governance structure of the firm. Thus, the foreign institutional investors are more gravitated in investing in the companies with a highly independent board structure. Further, a significantly positive indirect relationship between board independence and firm value (through FII) indicates that despite the overall negative effect, independent directors do have some value enhancement effect by strengthening another governance mechanism, foreign institutional investment.

5.5 Implications and Recommendations The empirical findings have important theoretical and practical implications. The study provides a deeper understanding of the effect of board independence on firm value in relation to the audit quality and foreign institutional investment. The segregation of the direct and indirect effects of board independence on firm value facilitates a deeper understanding of board behavior. The findings highlight that in contrast to the overall negative effect of independent directors, they actually add to the firm value by enhancing the audit quality and foreign institutional investment. From a theoretical front, the current study contributes by further refining the findings of Mangena and Tauringana (2007), Miletkov et al. (2014) and Abdulmalik

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and Ahmad (2016). In light of the concept of the bundle of governance mechanisms (Rediker & Seth, 1995), the empirical evidence indicates that the governance mechanisms (board independence, ownership structure, audit quality and FII) function in relation to each other. Hence, the estimates might be subject to potential biases in studies analyzing these variables in isolation. Besides the theoretical contributions, this study has important implications, for both, the companies and the policy-makers. Implications and Recommendations for Policy-Makers • The higher board independence leading to higher audit quality in terms of audit intensity and auditor’s independence, implies that enhancing the accountability of the independent directors, will further strengthen the relationship. Recommendation: The policy-makers can further enhance the accountability of the independent directors to further strengthen the relationship between board independence and audit quality. This is based on the assumption that the more accountable independent directors are, the more motivated they will feel to enhance the audit quality in order to complement their own monitoring. • The positive relationship between board independence and FII implies that foreign institutional investors are more likely to invest in companies having more independent boards. Recommendation: In order to attract more foreign institutional investors in India, it is recommended that the policy-makers emphasize a greater focus on enhancing the board independence. This might strengthen the perception of the foreign institutional investors towards the governance structure of the companies. This will result in greater FII in the country, which in turn, in crucial for the growth of the capital deficit economies like India.

5.6 Summary and Conclusion This study attempts to analyze if the independent directors can enhance the firm value by strengthening other governance mechanisms. Specifically, in line with the two broad objective of the study, this chapter attempts to analyze if board independence can enhance the audit quality and foreign institutional investment of the firm. Subsequently, this study analyzes if board independence can indirectly enhance the firm performance by strengthening these governance mechanisms (through mediation). The empirical findings indicate that independent directors strengthen the audit quality by demanding more intensive and independent audits. Further, independent directors also draw more foreign institutional investments. Hence, the empirical data validates that independent directors can indirectly enhance the firm value by strengthening other governance mechanisms. Table 5.11 presents the summary of the empirical results. Based on the research findings, possible implications and recommendations have also been suggested in this chapter.

Appendices

123

Table 5.11 Summary of the empirical results Objective

Corporate governance mechanisms

5.1

Board independence, audit quality and firm performance

Relationship

5.1.1

Board independence --> audit quality

Significant (positive)

5.1.2

Board independence --> audit quality --> firm performance

Significant (positive)

5.2

Board independence, foreign institutional investment and firm performance

5.2.1

Board independence --> foreign institutional investment

Significant (positive)

5.2.2

Board independence --> foreign institutional investment --> firm value

Significant (positive)

Note This table presents the summary of various regression models in line with the objectives of the study Source Authors’ compilation

Appendices Empirical Results Testing the Mediation Effect of Audit Quality (Objective 5.1)

Appendix 5.1 Direct effect of board independence on ROA (mediator–audit quality) Effect

SE

t-value

p-value

LLCI

ULCI

−0.0348

0.0126

−2.7611

0.0058

−0.0595

−0.0101

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the direct effect between board independence and ROA with “total audit fee” as the mediator. “SE” represents the standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence

Appendix 5.2 Indirect effect of board independence on ROA (through audit quality) Mediator

Effect

SE

LLCI

ULCI

Total audit fee

0.0034

0.0012

0.0014

0.0062

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the indirect effect between board independence and ROA with “total audit fee” as the mediator. “SE” represents the bootstrap standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence

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5 Performance Enhancement Effect of Board Independence

Empirical Results Testing the Mediation Effect of FII (Objective 5.2)

Appendix 5.3 Direct effect of board independence on ROA (mediator–FII) Effect

Se

t-value

p-value

LLCI

ULCI

−0.0314

0.0126

−2.4957

0.0126

−0.0561

−0.0067

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the direct effect between board independence and ROA with “foreign institutional investment” as the mediator. “SE” represents the standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence

Appendix 5.4 Indirect effect of board independence on ROA (through foreign institutional investment) Mediator

Effect

SE

LLCI

ULCI

Foreign institutional investment

0.0034

0.0017

0.0006

0.0071

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the indirect effect between board independence and ROA with “foreign institutional investment” as the mediator. “SE” represents the bootstrap standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence

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Chapter 6

Constraints Diluting the Effectiveness of Board Independence

The current chapter deals with the analysis of third broad objective of the study. This objective is related to the empirical analysis of factors which can explain the ineffectiveness of independent directors in India. In the chapter on the review of literature (Chap. 2), we identified two governance mechanisms, the promoter ownership and product market competition, as the constraints that could hamper the effectiveness of independent directors in the emerging economies. Mapped with the analysis of these constraints, this chapter has two broad objectives. First, in this chapter, we aim to empirically investigate the moderating role of promoter ownership in influencing the board independence and firm performance relationship. Further, in view of tighter controls and greater avenues of expropriation behavior (through related party transactions and tunneling) of the promoter shareholders in the business-group firms, we also conduct a disaggregate analysis, as a robustness check, to examine how board independence influences the firm value for business-group and stand-alone firms. The second broad objective is concerned with the statistical analysis of the moderating effect of another constraint, product marker competition, on the board independence and firm performance relationship. Specifically, in this chapter, we analyze whether the monitoring efficacy of the independent directors is contingent on the level of competitiveness of the industry in which the firm operates. Further, based on the distinct institutional set-ups of the business-group firms, this chapter conducts a disaggregate analysis to analyze if the moderating effect of product market competition varies for business-group and stand-alone firms. Further, in case the empirical results validate a significant moderation effect of promoter ownership and/or product market competition, we would extend the analysis to analyze the effect of these governance mechanisms on the indirect value enhancement effect of board independence.

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2022 S. Singh and M. Singla, Corporate Governance Mechanisms and Firm Performance, India Studies in Business and Economics, https://doi.org/10.1007/978-981-19-2460-6_6

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6 Constraints Diluting the Effectiveness of Board Independence

6.1 Introduction The findings in the Chap. 4 revealed that board independence as a governance mechanism added negatively to firm value. Sarkar (2009) and Varottil (2010) also advanced similar concerns in India. Considering the vital role independent directors can play in the governance structure, their ineffectiveness in the Indian firms warrants further investigations to examine the factors that dilute the effectiveness of board independence as a monitoring mechanism. Further, it is a matter of concern especially in the emerging markets like India, which have a high risk of the expropriation of minority shareholders’ interests by the insider shareholders (Denis & McConnell, 2003; Du & Dai, 2005; Morck, Steier, et al., 2005; Reed, 2002). In such a setting, board independence is the channel for the minority shareholders to exercise their monitoring role and to limit the expropriating behavior of the insider (promoter) shareholders. However, the empirical analysis of factors explaining the ineffectiveness of independent directors has not been conducted in the existing literature. We have premised the examination of the factors that dilute the board effectiveness on the concept of the “bundle of governance mechanisms”. This concept was first introduced by Rediker and Seth (1995). It states that various governance mechanisms, instead of working in isolation, work in relationship to each other (as a bundle). In view of this concept, we argue that the effectiveness of the independent directors might get influenced by other governance mechanisms. A related review of literature reveal two governance mechanisms that might weaken the effectiveness of independent directors: • Promoter ownership • Product market competition The following sub-sections present the linkage between the layout of the broad objectives of the chapter in relation to the existing literature. Promoter ownership, board indepdence and firm performance In emerging economies characterized by concentrated ownership structure and inefficient market-based governance mechanisms, the prime governance issue is the tendency of the large insider shareholders to expropriate the interest of the minority shareholders. Insider shareholders resort to several activities like tunneling,1 pyramid structures,2 differential voting rights3 (DVRs) and unfair related party transactions 1

The transfer of resources away from the firm for the benefit of the controlling shareholders (Johnson et al., 2000). 2 The structures in which an ultimate controlling firm controls several listed companies, each of which controls yet more listed companies, each of which controls yet more listed companies, and so on (Morck et al., 2005). A control pyramid allows a wealthy family or individual to control a large number of firms with relatively limited wealth. Pyramids permit this by creating large deviations between voting rights and cash flow rights; allowing control over many firms with a small cash flow stake in each. 3 Dual-class shareholding refers to the ownership structure where different classes of shares carry differential voting rights (Li et al., 2008).

6.1 Introduction

129

(RPTs) to exploit the interest of the minority shareholders (Bertrand et al., 2002; Denis & McConnell, 2003; Du & Dai, 2005; Morck et al., 2005; Reed, 2002). Scant evidence exists on how this happens. How do the insider shareholders enable themselves to pursue activities to pursue their private benefits of control? Do they circumvent the governance checks in place to do this? Few studies provide direct evidence on the linkage between promoter ownership and board independence in relation to firm performance (Cho & Kim, 2007). Nevertheless, many studies provide support in the development of testable propositions (Bebchuk & Hamdani, 2017; Chou et al., 2016). In this regard, we study a vital channel the insider shareholders dodge to pursue private benefits of control: board monitoring exercised by the independent directors. The appointment of the independent directors is integral to board monitoring and an important channel for the minority shareholders to exercise their monitoring role to limit the expropriating behavior of the insider shareholders (Bebchuk & Hamdani, 2017; Cohen et al., 2002; Fama & Jensen, 1983; OECD, 2004; Xie et al., 2003). We establish a link between the board monitoring and insider ownership with the paradoxical fact that owing to their substantial control rights, insider shareholders are vested with the powers to influence the process of appointment, re-appointment, and dismissal of the independent directors. In this viewpoint, we posit that the mere appointment of more independent directors does not necessarily ensure enhanced board monitoring. In other words, we advocate that the insider (promoter) shareholders, through their superior voting rights, hamper the efficacy of the independent directors and circumvent the additional monitoring exercised by them. This, in turn, enables the insiders to pursue the activities which maximize their private benefits of control. Precisely, we aim to analyze the effect of insider (promoter) ownership in influencing the efficacy of the independent directors as a governance mechanism. Specifically, we aim to test the following model empirically (Fig. 6.1).

Promoter Ownership

Board Independence

Firm Value

Fig. 6.1 Moderating effect of promoter ownership on board independence and firm value relationship. Note In this figure, the “blue line” indicates the relationship between board independence and firm value. The “green line” indicates the moderating effect of promoter ownership on the board independence and firm value relationship. Source Authors’ compilation

130

6 Constraints Diluting the Effectiveness of Board Independence

Recently some advances have been made in the empirical research to explore the linkage between insider ownership and board independence (Acero & Alcalde, 2016; Chou et al., 2016; Dahya et al., 2009). Bebchuk and Hamdani (2017) argue that the insider shareholders, owing to their substantial control rights, are vested with the powers to influence the process of appointment, re-appointment and dismissal of the independent directors. In case of divergence of interest of the insider and other shareholders, independent directors tend to go along with the insider (promoter) shareholders. Chou et al. (2016) advocate that the independence of the independent directors gets hampered by the insider (promoter) shareholders to accommodate self-interest pursuing activities (like tunneling). Few studies explore the possible ineffectiveness of independent directors in relation to ownership structure in the international context (Cho & Kim, 2007). Though researchers have raised concerns regarding the ineffectiveness of independent director in India, we could not find any studies analyzing the reasons of their ineffectiveness. This study attempts to bridge this gap by empirically validating such association in the context of an emerging economy, India. Such an analysis is more crucial in the Indian context as despite the numerous efforts of the regulators to strengthen board independence, independent directors continue to add little/negatively to firm value (Garg, 2007; Ghosh, 2006; Sarkar, 2009; Sarkar & Sarkar, 2009). To strengthen the firm-level governance structure, it is imperative to understand the enablers/disablers which influence the effectiveness of board independence in enhancing the firm value. This study adds to the body of the literature by advancing an understanding of the effectiveness of board independence in relation to the ownership structure of Indian firms. Further, if the empirical findings confirm a significant moderation effect on promoter ownership on the board independence and firm value relationship, we aim to extend the analysis of the moderation effect of promoter ownership on the board independence and other governance mechanisms (audit quality and foreign institutional investment). Literature also extends some support to validate the linkages between these governance mechanisms. For instance, Wang (2006), Lin and Liu (2009), and Johl et al. (2016) suggest greater complexity and a higher risk of audit engagement with the increase in promoter ownership. Various studies validate an increased extent of earnings management activities with the increase in promoter ownership (Chan et al., 2007; Nagar & Raithatha, 2016; Sarkar et al., 2008). Based on these studies it can be argued that in view of the greater financial reporting risk, the board independence-audit quality relationship gets strengthened with the increase in promoter ownership (Fig. 6.2). Further, if the empirical results validate a significant moderation effect of promoter ownership on board indepence and firm value relationship, the analysis of the interactive effect of the board structure and insider ownership on foreign institutional ownership is relevant because of the counter effects of these parameters. Higher insider ownership coupled with weak institutional framework, intensifies the issue of protection of minority shareholders’ interests based on certain practices (pyramid structures, tunneling, dual-class share structure and so on) enacted by the controlling shareholders to seek private benefits of control (Bertrand et al., 2002; Varma, 1997).

6.1 Introduction

131

Promoter Ownership

(+) Audit Quality

Board Independence

Fig. 6.2 Relationship between board independence and audit quality with the promoter ownership as the moderator. Note In this figure, “promoter ownership” acts as the moderator variable. The “blue line” indicates the direct relationships between board independence and audit quality. The “green line” indicates the moderating effect of promoter ownership on the board independence and audit quality relationship. Source Authors’ compilation

Also, higher promoter ownership might make it difficult for the foreign institutional investors to participate in shareholder activism (Gillan & Starks, 2003). On the other hand, a more independent board structure can reduce the information asymmetry and the monitoring costs for the foreign institutional investors. Therefore, it would be interesting to analyze if the role of board independence gets magnified with the increase in promoter ownership or the foreign institutional investors discount the effectiveness of board independence as the promoter ownership increases. In view of the principal-principal issues and weak institutional infrastructure of India, we aim to empirically validate if the role of board independence in attracting more foreign institutional investors gets diluted with the increase in promoter ownership. Specifically, we aim to empirically validate the moderation relationship between board independence and firm value, with the promoter ownership as the moderating variable (Fig. 6.3).

Promoter Ownership

(-) Board Independence

Foreign Institutional Investment

Fig. 6.3 Relationship between board independence and foreign institutional investment with promoter ownership as the moderator. Note In this figure, “promoter ownership” acts as the moderator variable. The “blue line” indicates the direct relationships between board independence and foreign institutional investment. The “green line” indicates the moderating effect of promoter ownership on the board independence and foreign institutional investment relationship. Source Authors’ compilation

132

6 Constraints Diluting the Effectiveness of Board Independence

Finally, in view of the mediation (board independence and firm value, through audit quality, Fig. 5.2) and moderation (promoter ownership moderating the board independence and audit quality relationship, Fig. 6.2), it can be argued that the indirect positive relationship between board independence and firm value (through audit quality) is moderated by the level of promoter ownership (Fig. 6.4). In other words, focusing on the joint mediation and moderation effects, this chapter aims to empirically validate the complete moderated-mediation model. Lastly, in view of the hypothesized negative moderation effect of promoter ownership on the board independence and foreign institutional investment relationship, we aim to investigate if the indirect relationship between board independence and firm value (through foreign institutional investment) also gets diluted with the increase in the promoter ownership. In other words, in consideration of the individual mediation (Fig. 5.4) and moderation (Fig. 6.3), we aim to empirically validate a holistic moderated-mediation model (Fig. 6.5).

Promoter Ownership

(+) Board Independence

Audit Quality

Firm Value

(+)

Fig. 6.4 A moderated-mediation model of board independence and firm value relationship (mediator—audit quality, moderator—promoter ownership). Note In this figure, “promoter ownership” acts as the moderator variable and “audit quality” as a mediator variable. The “blue line” indicates the direct relationships between board independence and audit quality; and audit quality and firm value. The “green line” indicates the moderating effect of promoter ownership on the board independence and audit quality relationship. Source Authors’ compilation

Promoter Ownership

(-) Board Independence

Foreign Institutional Investment

Firm Value

(+)

Fig. 6.5 A moderated-mediation model of board independence and firm value relationship (mediator—FII, moderator—promoter ownership). Note In this figure, “promoter ownership” acts as the moderator variable and “foreign institutional investment” as a mediator variable. The “blue line” indicates the direct relationships between board independence and foreign institutional investment; and foreign institutional investment and firm value. The “green line” indicates the moderating effect of promoter ownership on the board independence and foreign institutional investment relationship. Source Authors’ compilation

6.1 Introduction

133

This chapter adds to the existing body of literature by providing a holistic understanding of the governance mechanics of board independence while building on the pieces of existing research. To the best of authors’ knowledge, this is perhaps the first study to provide a more in-depth understanding (including both mediation and moderation relationships) on the governance behavior of the independent directors. Product market competition, board independence and firm performance Smith (1937) appears to be the first author to advocate the viewpoint that “monopoly is a great enemy to good management”. Researchers, across the globe, corroborate the viewpoint that product market competition affects management behavior. Hart (1983) argues that competition provides less discretion to the management to pursue its self-interests and thus, reduces agency cost and improves firm performance. Gilson and Roe (1993) describe competition as “the most elegant monitoring mechanism”. There is a consensus that product market competition affects management behavior. However, there is discord on the viewpoint on the type of relationship between competition and corporate governance. Allen and Gale (2000), Husted and Serreno (2002) and Giroud and Mueller (2010) provide evidence that product market competition reduces managerial slack when corporate governance is weak, and hence, it ensures that the firm continues to perform well. In view of the monitoring role of independent directors and the product market competition, Randøy and Jenssen (2004) cite it as the “double dose of corporate governance monitoring”. The authors posit that a highly independent board in a firm in a highly competitive industry is “too much of a good thing”. The empirical results validate that the independent directors add to the firm value only when the product market competition is low and vice-versa. Contrary to this viewpoint, Januszewski et al. (2002) document that competition and corporate governance complement each other. Bozec (2005) argues that a high product market competition instigates the independent directors to play an effective role in the firm’s governance structure. Along a similar line, Rennie (2006) provides confirmatory evidence that corporate governance becomes stronger in the companies because of the increased competition in the market. To summarize, there are mixed results about the type of relationship between corporate governance and product market competition. However, there is scant literature available on this aspect in the Indian context. Selarka (2014) provides no confirmatory evidence of a significant interactive effect of product market competition and the firm’s governance structure in India. Therefore, this study attempts to supplement the limited literature in the Indian context and analyze if the effectiveness of the board independence is contingent on the level of product market competition of the firm. Specifically, we examine the following model (Fig. 6.6). Further, in this context, a distinction between the business-group firms and standalone firms is warranted. This distinction is important for dual reasons. One, the prevalence of the business-groups is rather a norm in the emerging economies (Sarkar & Sarkar, 2000). The organizational set-up of the business-group firms is drastically different from the stand-alone firms. There are well functioning internal capital and

134

6 Constraints Diluting the Effectiveness of Board Independence Product Market Competition

Board Independence

Firm Value

Fig. 6.6 Moderating effect of product market competition on the board independence and firm value relationship. Note In this figure, the “blue line” indicates the relationship between board independence and firm value. The “green line” indicates the moderating effect of product market competition on the board independence and firm value relationship. Source Authors’ compilation

labor markets among the business-group firms (Khanna & Palepu, 2000; Chang & Hong, 2002; Chang et al., 2006; López-Gracia and Sánchez-Andújar, 2007). Thus, their reliance on the external market is mitigated. Second, the threat of bankruptcy is often diluted for the business-group firms, where a distressed firm can be rescued by other member firms of the business-groups (Gopalan et al., 2007; Khanna & Rivkin, 2001). There are very few studies focusing on this aspect in literature. The current study attempts to address this research gap in the context of an emerging economy, India, by analyzing the distinct governance role of product market competition in the corporate governance structure of the business-group and stand-alone firms. Understanding the factors which might weaken the board monitoring will facilitate in designing an effective corporate governance structure to preserve the investors’ interest in the firm. If the empirical results confirm a significant moderation effect of product market competition on board independence and firm value relationship, the analysis of the moderation effect of product market competition will be extended to analyze how product market competition moderates the board independence and other governance mechanisms’ (audit quality and FII) relationship (akin to the analysis for promoter ownership, Figs. 6.2, 6.3, 6.4 and 6.5).

6.2 Methodology This section briefly explains the measures and scope of the study, the research methodology deployed and provides a brief layout of empirical analysis.

6.2 Methodology

135

6.2.1 Measures and Scope The scope of the study (sample size and period of the study) remains the same as discussed in Chap. 4. The broad description of the variables used remain same as in Chap. 4. However certain variables (CEO-Chairman duality and percentage nonaudit fee), which were insignificant in the regression analysis of Chap. 4, have been omitted in the current study. Also, in consideration of the significant impact of other governance mechanisms (other measures of audit quality, foreign and domestic institutional investment) on firm value, these variables are used as the control variables in the current analysis. Table 6.1 provides the summary of various variables used in the current analysis. In line with Chap. 4, firm value (Tobin’s Q) has been used as the primary measure of firm performance. An alternate measure (ROA) has been used to confirm the robustness of the empirical estimates. Table 6.2 presents the descriptive statistics of the variables used in the current chapter. The highlights of the descriptive statistics of the variables used remain the same as discussed in Chap. 4.

6.2.2 Research Methodology To analyze the moderating effect of promoter ownership and product market competition on board effectiveness (Figs. 6.1 and 6.6, respectively), we have used interaction effects in the regression models (Giroud & Mueller, 2010; Kim et al., 2017; Pant & Pattanayak, 2010). Since the moderated regression model reports the conditional effects of the main variables (e.g., product market competition, promoter ownership and board independence), an OLS regression model with year and industry fixed effects is run first to capture the main effects of the individual variables. As the pooled ordinary least square (OLS) estimates can be subject to potential biases, the study uses industry and year-fixed effects to control for the time and industryspecific fixed factors (Gopalan et al., 2016). We have used the robust standard error in all the regression models to address the issue of heteroscedasticity. The detailed methodology has been presented in Chap. 3. Corresponding to the step-wise analysis of the two broad objectives, Table 6.3 presents the summary of the techniques deployed corresponding to each objective of the study.

6.2.3 Layout of Empirical Analysis This section briefly presents the layout of the empirical analysis. In line with the broad objectives of the study, the empirical analysis has been presented in two sections and is followed by additional analysis. Table 6.4 presents the empirical analysis of the moderating role of promoter ownership on board independence and firm value

136

6 Constraints Diluting the Effectiveness of Board Independence

Table 6.1 Description of various variables used in the study Variable name

Description

Return on assets (%)

ROA = (Earnings after tax + (Interest—Tax advantage on interest))/(Average total assets)

Tobin’s Q ratio

Tobin’s Q ratio = ((Book value of the assets + market value of the common stock)—(Book value of the common stock))/ (Total assets). A value greater than 1 indicates the market value to the firm to be higher than the book value and vice-versa

Product market competition (HHI Index) A measure used to estimate the market concentration of the firm using the Herfindahl Hirschman Index based on firm’s total sales and industry affiliation Promoter ownership (%)

Percentage shareholding of the promoter and promoter group. The promoter and promoter group are defined under regulations 2(1) (za) and (zb) of Issue of Capital and Disclosure Requirements, 2009 by SEBI (2009)

Board independence (%)

The measure of the board independence calculated by dividing the number of independent directors by the total number directors of the company’s board

Total audit fee (in million dollars)

Total fee paid to the external auditor

Big-Four (binary variable)

An indicator variable which takes the value of 1, if the auditor appointed is one among the Big-Four auditors and zero, otherwise

Domestic institutional ownership (%)

Percentage shareholding of domestic institutional investors. Domestic institutional investors include mutual funds, UTI, financial institutions, banks, insurance companies, venture capital funds, provident funds and pension funds, central, and state governments and others

Foreign institutional ownership (%)

Percentage shareholding of foreign institutional investors

Board size

Total number of directors in the company’s board

Audit committee independence (%)

The measure of the Audit Committee independence calculated by dividing the number of independent directors in the Audit Committee by total number of directors in the Audit Committee

Leverage

Measure of the financial leverage calculated by dividing total debt by total assets of the company

Firm size (in million dollars)

Total assets of the firms in US million dollars

Research and development

Total expenditure on research and development activities scaled by the firm’s asset size (total assets)

Note This table presents the description of various variables used in the study Source Authors’ compilation

51.29 54.84 10.08 11.12 9.38 82.69 0.50

Board Independence (%)

Promoter ownership (%)

Domestic institutional ownership (%)

Foreign institutional ownership (%)

Board size

Audit committee independence (%)

Leverage (debt/total assets)

37.13

Firm age (in years)

24.35

0.00

779,059.39

0.20

16.59

2.75

10.18

8.69

17.29

11.87

0.50

14.01

1893.29

2.69

8.77

Standard deviation

1.00

0.00

173.17

0.00

0.00

3.00

0.00

0.00

0.00

0.00

0.00

0.00

568.25

0.10

−88.19

Minimum

Note This table presents the descriptive statistics of various variables used in the study Source Authors’ compilation

0.00

Research and development

111,888.61

0.48

Big-Four

Firm size (in million dollars)

8.70

Total audit fee (in million dollars)

2300.65

2.37

Product market competition (HHI Index)

9.40

Tobin’s Q ratio

Mean

Return on assets (%)

Variable name

Table 6.2 Descriptive statistics of the variables used in the study

0.00 29.00

20.00

24,010.97

0.51

80.00

9.00

8.79

8.28

54.48

50.00

0.00

4.89

1947.08

1.62

7.78

Median

0.00

9631.08

0.36

75.00

7.00

2.71

3.32

43.81

46.15

0.00

2.45

1038.45

1.05

4.59

Percentile (25)

51.00

0.00

60,537.76

0.64

100.00

11.00

16.87

14.69

67.85

57.14

1.00

9.41

2690.68

2.68

13.03

Percentile (75)

153.00

0.00

29,735,290.00

1.78

100.00

22.00

66.19

74.60

99.59

100.00

1.00

250.00

10,000.00

79.70

129.14

Maximum

6.2 Methodology 137

138

6 Constraints Diluting the Effectiveness of Board Independence

Table 6.3 Research methodologies deployed for various objectives S. no

Objective

Objective 6.1

Promoter ownership, board independence and firm performance

Methodology

6.1.1

Board independence and firm value with the promoter ownership as the moderator (moderation effect) (Fig. 6.1)

Moderated regression methodology

6.1.2

Board independence and audit quality with the promoter ownership as the moderator (moderation effect) (Fig. 6.2)

Moderated regression methodology

6.1.3

Board independence and foreign institutional investment with the promoter ownership as the moderator (moderation effect) (Fig. 6.3)

Moderated regression methodology

6.1.4

Board independence and firm value relationship with audit quality as the mediator and promoter ownership as the moderator (moderated-mediation model) (Fig. 6.4)

Hayes’ PROCESS program using an in-built Model#7 to test the holistic moderated-mediation model

6.1.4

Board independence and firm value relationship with foreign institutional investment as the mediator and promoter ownership as the moderator (moderated-mediation model) (Fig. 6.5)

Hayes’ PROCESS program using an in-built Model#7 to test the holistic moderated-mediation model

Objective 6.2

Product Market competition, board independence and firm performance

6.2.1

Board independence and firm value with the product market competition as the moderator (moderation effect) (Fig. 6.6)

Moderated regression methodology

Note Multiple parts of objective 6.2 are not captured in the table as the empirical results fail to reject the null hypothesis stating that product market competition does not influence the board independence and firm performance relationship Source Authors’ compilation

(Tobin’s Q) relationship. In this table, Model 1 captures the main effects of the individual variables and Model 2 presents the significance of the moderating effect of promoter ownership. Analogous to Table 6.4, Appendix 6.1 reports the findings of empirical analysis with ROA being used as the dependent variable. Figures 6.7 and 6.8 present the graphical presentation of the relationship between board independence and firm value at various levels of promoter ownership. As a robustness check, Table 6.5 reports the empirical findings of the relationship between board independence and firm value for business-group and stand-alone firms. Table 6.7 presents the empirical analysis of the moderating role of promoter ownership on board independence and audit quality relationship. Table 6.8 presents the

6.2 Methodology

139

Table 6.4 Moderating effect of promoter ownership on the relationship between board independence and firm value Dependent variable—Tobin Q Independent variable

Model

Model

−1

−2

Board independence

−0.015a

0.005

−0.003

−0.01

Promoter ownership

0.043a

0.060a

−0.003

−0.01

Board

independencec Promoter

−0.0004b

ownership

−0.0002 Domestic institutional ownership

0.019a

0.019a

−0.004

−0.004

Foreign institutional ownership

0.050a

0.050a

−0.004

−0.004

log(Product market competition)

0.690c

0.682c

−0.405

−0.406

Leverage

−0.519

−0.515

−0.319

−0.319

log(Total audit fee)

0.075a

0.075a

−0.013

−0.013

0.523a

0.533a

−0.089

−0.088

Board size

0.044a

0.046a

−0.013

−0.013

Audit committee independence

0.010a

0.010a

−0.003

−0.003

log(Firm size)

−0.940a

−0.955a

−0.149

−0.148

−0.002

−0.003

Big-Four

log(Research and development expenditure) Constant

−0.005

−0.005

0.536

−0.411

−1.287

−1.359

Yes

Yes

Fixed Effects Year Industry

Yes

Yes

Observations

4,248

4,248

R2

0.212

0.213 (continued)

140

6 Constraints Diluting the Effectiveness of Board Independence

Table 6.4 (continued) Dependent variable—Tobin Q Independent variable Adjusted R2

Model

Model

−1

−2

0.205

0.206

Note In this table, Model 1 presents the main effects of the variables of interest (promoter ownership and board independence). Model 2, along with the main variables, reports the significance of the moderation effect of promoter ownership on board independence and Tobin’s Q relationship. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10% Source Authors’ compilation

Fig. 6.7 Relationship between board independence and firm value at various levels of promoter ownership. Note The figure presents the relationship between board independence and firm value (Tobin’s Q) at three levels of promoter ownership (low, medium and high). The “red line” plots the relationship at a low level of promoter ownership, 37.55% (Mean-1SD), the “green line” plots the relationship at medium level of promoter ownership, 54.84% (Mean) and “blue line” plots the relationship at high level of promoter ownership, 72.13% (Mean + 1SD). Source Authors’ compilation

results of the regression analysis at various levels of promoter ownership. Figure 6.9 presents the graphical presentation of the moderating effect of promoter ownership on board independence and audit quality relationship. Tables 6.13 and 6.14 present the empirical findings validating the presence of the mediated-moderation model with audit quality as the mediator and promoter ownership as the moderator for board independence and firm value relationship. Analogous to Tables 6.13 and 6.14, Appendices 6.3 and 6.4 reports the empirical findings using ROA as the measure of firm performance.

6.2 Methodology

141

Fig. 6.8 Relationship between board independence and firm value at various controlling levels of promoter owners. Note The figure presents the relationship between board independence and firm value (Tobin’s Q) at three controlling levels of promoter ownership (low, medium and high). The “red line” plots the relationship at a low level of promoter ownership, 11%, the “green line” plots the relationship at medium level of promoter ownership, 26% and “blue line” plots the relationship at high level of promoter ownership, 51%. Source Authors’ compilation

Table 6.10 presents the moderation effect of promoter ownership on board independence and foreign institutional investment relationship. Table 6.11 presents the regression results of the same regression model (Table 6.10) but using the lagged independent variables. Figure 6.11 present the graphical presentation of the relation between board independence and foreign institutional investment at various levels of promoter ownership. Reinforcing the findings of Tables 6.10 and 6.12 reports the regression estimates depicting the relationship between board independence and foreign institutional investment at various levels of promoter ownership. Finally, Tables 6.15 and 6.16 presents the empirical results validating the moderatedmediation model, with promoter ownership as the moderator variable and foreign institutional investment as the mediator variable of board independence and firm value relationship. Analogous to Tables 6.15 and 6.16, Appendices 6.5 and 6.6 report the empirical results using ROA as the measure of firm performance. Analogous to Tables 6.4 and 6.17 reports the empirical analysis related to the moderating effect of product market competition on board independence and firm value relationship. In this table, Model 1 presents the main effects of the individual variables, while Model 2 reports the significance of the interaction effect of product market competition on board independence and firm value relationship. Analogous to Table 6.17, Appendix 6.7 reports the findings of empirical analysis with ROA being used as the dependent variable.

142

6 Constraints Diluting the Effectiveness of Board Independence

Table 6.5 Regression models depicting the relationship between board independence and firm value for business-group and stand-alone firms Independent variables

Dependent variable—Tobin Q Business-group firms

Stand-alone firms

Model

Model

−1

−2

−0.014a

−0.007

−0.004

−0.009

Promoter ownership

0.043a

0.033a

−0.003

−0.006

Domestic institutional ownership

0.027a

0.002

−0.004

−0.012

Foreign institutional ownership

0.052a

0.044a

−0.004

−0.013

log(Product market competition)

−0.279c

3.740a

−0.16

−1.323

Leverage

−1.087a

0.997

−0.193

−0.792

log(Total audit fee)

0.075a

0.266c

−0.011

−0.138

Big-Four

0.386a

0.926a

−0.065

−0.354

Board size

0.065a

−0.148a

−0.013

−0.043

Audit Committee independence

0.004

0.027b

−0.003

−0.011

log(Firm size)

−0.672a

−2.190a

−0.083

−0.516

log(Research and development expenditure)

0.006

−0.027

−0.005

−0.021

Constant

3.218a

−5.302

−0.603

−3.87

Board independence

Fixed Effects Year

Included

Included

Industry

Included

Included

Observations

3,265

983

R2

0.303

0.253 (continued)

6.2 Methodology

143

Table 6.5 (continued) Independent variables

Adjusted R2

Dependent variable—Tobin Q Business-group firms

Stand-alone firms

Model

Model

−1

−2

0.296

0.224

Note In this table, Models 1 and 2 present the effect of the board independence on firm value for business-group firms and stand-alone firms respectively. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10% Source Authors’ compilation

Fig. 6.9 Board independence and audit quality (total audit fee) at various levels of promoter ownership. Note The figure presents the relationship between board independence and total audit fee at three levels of promoter ownership (low, medium and high). The “red line” plots the relationship at a low level of promoter ownership, 37.55% (Mean-1SD), the “green line” plots the relationship at medium level of promoter ownership, 54.84% (Mean) and “blue line” plots the relationship at high level of promoter ownership, 72.13% (Mean + 1SD). Source Authors’ compilation

Table 6.18 presents the empirical estimates of an additional analysis depicting the moderating effect of product market competition for business-group and stand-alone firms. Analogous to Table 6.18, Appendix 6.8 reports the empirical estimates with ROA being used as the dependent variable.

144

6 Constraints Diluting the Effectiveness of Board Independence

Table 6.6 The moderating effect of promoter ownership on board independence and audit quality (Big-Four) relationship Dependent variable: Big-Four Independent variables

Estimate (Standard error)

Marginal effect

Board independence

−0.020a

−0.007

(0.006) Audit committee independence

0.0004 (0.001)

0.0001

Promoter ownership

−0.017a (0.005)

−0.006

Board independencec Promoter ownership

0.0004a (0.0001)

0.0001

log(Firm size)

0.148a (0.019)

0.053

log(Product market competition)

0.00002 (0.00001)

0.00001

Leverage

−0.575a (0.116)

−0.207

Number of subsidiaries

−0.0002 (0.001)

−0.0001

Business-group affiliation

0.259a (0.054)

0.093

Fixed Effects Industry

Included

Year

Included

Constant

−0.493 (0.346)

Observations

4,224

Log Likelihood

−2,416.864

McFadden pseudo R2

0.09011784

−0.177

Note This table presents the results of probit regression model analyzing the moderating effect of promoter ownership on board independence and audit quality relationship. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10%. It is to be noted here that a Big-Four auditor can only be appointed through its Indian associate Source Authors’ compilation

6.3 Analysis and Findings In line with the two broad objectives of the study, the analysis and findings section has been further divided into following subsections.

6.3 Analysis and Findings

145

Table 6.7 Board independence and audit quality at various levels of promoter ownership Dependent variable: Big-Four Promoter ownership

Low

Medium

High

Independent variables

Estimate (Standard error)

Marginal effect

Estimate (Standard error)

Marginal effect

Estimate (Standard error)

Marginal effect

Board independence

−0.013a (0.005)

−0.005

0.001 (0.003)

0.0003

0.018a (0.005)

0.005

Audit Committee independence

0.007b (0.003)

0.002

−0.002 (0.002)

−0.001

−0.008a (0.003)

−0.002

Promoter ownership

0.007 (0.005)

0.002

0.010b (0.005)

0.003

−0.040a (0.009)

−0.012

log(Firm size)

0.179a (0.042)

0.063

0.201a (0.028)

0.071

0.001 (0.050)

0.0002

log(Product market competition)

−0.0001a (0.00003)

−0.00004

0.00002 (0.00002)

0.00001

0.0001a (0.00003)

0.00003

Leverage

−0.135 (0.259)

−0.048

−0.798a (0.166)

−0.281

−0.705a (0.265)

−0.207

Number of subsidiaries

0.002 (0.002)

0.001

−0.003 (0.002)

−0.001

0.006 (0.005)

0.002

Business-group affiliation

−0.037 (0.101)

−0.013

0.288a (0.082)

0.102

0.718a (0.139)

0.211

Constant

−1.687a (0.527)

−0.596

−2.255a (0.429)

−0.795

1.850b (0.848)

0.544

Fixed Effects Industry

Included

Included

Included

Year

Included

Included

Included

Observations

1,056

2,112

1,056

Log Likelihood

−595.038

−1,183.689

−497.266

McFadden pseudo R2

0.1037257

0.1071956

0.2509945

Note In this table, Model 1 presents the results of probit regression model analyzing the relationship between board independence and audit quality (Big-Four) at three levels of promoter ownership: low, medium and high. Based on the promoter ownership, firms lying in the first quartile (25th percentile) are referred to as low promoter ownership firms and firms beyond 75th percentile are termed as high promoter ownership firms. The rest of the firms are categorized as medium promoter ownership firms. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10% Source Authors’ compilation

146

6 Constraints Diluting the Effectiveness of Board Independence

Table 6.8 The moderating effect of promoter ownership on board independence and audit quality (total audit fee and percentage non-audit fee) relationship Independent variables

Dependent variables Total audit fee

Percentage non-audit fee

Model (1)

Model (2)

Board independence

−0.001 (0.0004)

0.089 (0.070)

Audit Committee independence

0.0004a (0.0002)

0.013 (0.020

Promoter ownership

−0.002a (0.0004)

0.206a (0.063)

Board independencec Promoter ownership

0.00002a (0.00001)

−0.003b (0.001)

log(Firm size)

0.085a (0.005)

1.554a (0.292)

log(Product market competition)

−0.00000 (0.00000)

0.0004b (0.0002)

Big-Four

0.093a (0.007)

−1.330b (0.605)

Leverage

−0.033b (0.014)

0.383 (1.693)

Number of subsidiaries

0.001a (0.0004)

−0.097a (0.017)

Business-group affiliation

0.016a (0.004)

1.109 (0.755)

Constant

−0.692a (0.037)

18.567a (4.305)

Fixed Effects Year

Included

Included

Industry

Included

Included

Observations

4,224

4,224

R2

0.418

0.093

Adjusted R2

0.413

0.085

Note This table reports the empirical analysis of the moderating role of promoter ownership on board independence and audit quality relationship. In Model 1, “total audit-fee” is used as the measure is audit quality, while in Model 2, “percentage non-audit fee” is used as the measure of audit quality. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10% Source Authors’ compilation

6.3 Analysis and Findings Table 6.9 Moderating effect of promoter ownership on the board independence and foreign institutional investment relationship

147 Independent variables

Dependent variable—foreign institutional investment (FII)

Board independence

0.242a (0.027)

Promoter ownership

0.029 (0.02)

Promoter ownershipc Board independence

−0.003a (0.0005)

Big-Four

0.537c (0.32)

Leverage

−8.834a (0.789)

log(Product market competition)

−0.107 (0.54)

Domestic institutional ownership

−0.068a (0.019)

log(Firm size)

6.656a (0.289)

log(Firm age)

−0.062a (0.006)

Constant

−4.044c (2.37)

Fixed Effects Industry

Yes

Year

Yes

Observations

4,248

R2

0.271

Adjusted R2

0.257

Note This table reports the empirical analysis of the moderating role of promoter ownership on board independence foreign institutional investment relationship. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10% Source Authors’ compilation

6.3.1 Promoter Ownership, Board Independence and Firm Performance The analysis of the moderation impact of promoter ownership is conducted in multiple. The findings of the step-wise analysis (in the order mentioned in Table 6.3) is presented next. i.

Board independence and firm value with the promoter ownership as the moderator

148 Table 6.10 Moderating effect of promoter ownership on the board independence and foreign institutional investment relationship with lagged independent variables

6 Constraints Diluting the Effectiveness of Board Independence Independent variables

Dependent variable—foreign institutional investment (FII)

Board independence

0.235a (0.027)

Promoter ownership

0.026 (0.02)

Promoter ownershipc Board independence

−0.003a (0.0005)

Big-Four

0.535c (0.32)

Leverage

−8.575a (0.788)

log(Product market competition)

−0.076 (0.54)

Domestic institutional ownership

−0.072a (0.019)

log(Firm size)

6.494a (0.276)

log(Firm age)

−0.062a (0.006)

Constant

−5.245b (2.329)

Fixed Effects Industry

Yes

Year

Yes

Observations

3,829

R2

0.265

Adjusted R2

0.250

Note This table reports the empirical analysis of the moderating role of promoter ownership on board independence foreign institutional investment relationship with lagged independent variables. In this model, 1-year lag of all the independent variables has been taken. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10% Source Authors’ compilation

Model 1 (Table 6.4) highlights that board independence adds negatively (β = −0.015, p < 0.01) to firm value. One per cent increase in the board independence reduces the firm value by 1.5%. Contrary to the board independence, promoter ownership has an overall positive (β = 0.043, p < 0.01) impact on firm value. One per cent increase in the promoter ownership enhances the firm value by 4.30%. In relation to the effect of promoter ownership and board independence, the empirical findings remain qualitatively the same when an accounting-based measure of firm performance (ROA) is used (Appendix 6.7).

6.3 Analysis and Findings

149

Table 6.11 Board independence and foreign institutional investment at various levels of promoter ownership Independent variables

Dependent variable: Foreign institutional investment (FII) Promoter ownership Low

Medium

High

Model (1)

Model (2)

Model (3)

Board independence

0.075b (0.030)

0.050a (0.017)

−0.028b (0.013)

Promoter ownership

0.302a (0.036)

−0.196a (0.026)

−0.299a (0.024)

Big-Four

3.792a (0.896)

1.460a (0.401)

1.090a (0.398)

Leverage

−11.559a (2.065)

−10.059a (1.070)

−10.077a (1.071)

log(Product market competition)

2.016c (1.169)

0.277 (0.828)

−1.149c (0.655)

Domestic institutional ownership

−0.009 (0.037)

−0.236a (0.024)

−0.350a (0.032)

log(Firm size)

10.077a (0.721)

8.773a (0.399)

4.646a (0.369)

log(Firm age)

−0.105a (0.015)

−0.037a (0.007)

−0.013 (0.009)

Constant

−17.633a (4.363)

8.757b (3.491)

31.642a (3.317)

Industry

Yes

Yes

Yes

Year

Yes

Yes

Yes

Observations

1,062

2,124

1,062

R2

0.408

0.327

0.459

Adjusted R2

0.389

0.317

0.443

Fixed Effects

Note In this table, Model 1 presents the results of regression model analyzing the relationship between board independence and foreign institutional investment at three levels of promoter ownership: low, medium and high. Based on the promoter ownership, firms lying in the first quartile (25th percentile) are referred to as low promoter ownership firms and firms beyond 75th percentile are termed as high promoter ownership firms. The rest of the firms are categorized as medium promoter ownership firms. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10% Source Authors’ compilation

Further, negative sign of the interaction term (β = −0.0004, p < 0.05) in Model 2 (Table 6.4) reports that promoter ownership has a negative moderating effect on the board independence and firm value relationship. The null hypothesis, H0.9 (Chap. 3), thus, gets rejected. In other words, the increased promoter ownership weakens the monitoring ability of the independent directors. The empirical results find support

150

6 Constraints Diluting the Effectiveness of Board Independence

Table 6.12 Direct effect of board independence on firm value (mediator—audit quality, moderator—promoter ownership) Effect

SE

t-value

p-value

LLCI

ULCI

−0.0220

0.0040

−5.4757

0.0000

−0.0299

−0.0142

Note Analogous to the β measure in the regression model, “effect” value is the estimation of the direct effect between board independence and Tobin’s Q. “SE” represents the standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence Source Authors’ compilation Table 6.13 Conditional indirect effect of board independence on firm value at various levels of promoter ownership Indirect Effect: Board independence -> Total audit fee -> Tobin’s Q Promoter ownership

Effect

SE

LLCI

ULCI

37.84

0.0006

0.0004

−0.0001

0.0014

54.47

0.0011

0.0004

0.0004

0.0021

73.48

0.0017

0.0006

0.0008

0.0030

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the indirect effect between board independence and Tobin’s Q through “total audit fee” as the mediator variable. “SE” represents the standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence Source Authors’ compilation Table 6.14 Direct effect of board independence on firm value (mediator—foreign institutional investment, moderator—promoter ownership) Effect

SE

t-value

p-value

LLCI

ULCI

−0.0224

0.0040

−5.5683

0.0000

−0.0302

−0.0145

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the direct effect between board independence and Tobin’s Q. “SE” represents the standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence Source Authors’ compilation

for the arguments of Cho and Kim (2007) who advocate a similar relationship in the Korean context. The empirical findings contradict the arguments of Dahya et al. (2009) and Acero and Alcalde (2016) who argue that insider shareholders are more likely to appoint more independent directors to signal the better quality of corporate governance. The regression results can be better interpreted through the graphical visualization of the regression coefficients. Figure 6.7 presents the graphical presentation of the relationship between board independence and firm value at different levels of

6.3 Analysis and Findings

151

Table 6.15 Conditional indirect effect of board independence on firm value at various levels of promoter ownership Indirect Effect: Board independence -> Foreign institutional investment -> Tobin’s Q Promoter ownership

Effect

SE

LLCI

ULCI

37.84

0.0044

0.0009

0.0027

0.0063

54.47

0.0025

0.0006

0.0014

0.0036

73.48

0.0011

0.0004

0.0003

0.0019

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the indirect effect between board independence and Tobin’s Q with “foreign institutional investment” as the mediator. “SE” represents the bootstrap standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence Source Authors’ compilation

promoter ownership (Mean, Mean + 1SD, Mean—1SD). It is evident that the negative relationship between board independence and firm value gets stronger with the increasing levels of promoter ownership. In Fig. 6.7, it can be argued that both levels of medium and high promoter ownership (54.84% and 72.13%) give the absolute right to the promoter shareholders. Thus, for better exposition, we plot the relationship between board independence and firm value at more meaningful levels of promoter ownership. Figure 6.8 presents the relationship between board independence and firm value at 11%, 26% and 51% respectively. The promoter owners gain the absolute control at 51% of the ownership. Having 26% share capital, the promoter owners are vested with the power to block the passage of a special resolution, while having 11% share capital owners empowers the promoter owners to call an extraordinary general meeting (EGM) (MCA, 2013). This forms the basis of the segregation. The visual presentation of the empirical results confirms that independent directors, indeed, add to the firm value when the promoter ownership is low (Fig. 6.8). The negative relationship between board independence and firm value gets strengthened with the increasing levels of promoter ownership. In view of tighter control and greater avenues of expropriation behavior (through related party transactions and tunneling) of the promoter shareholders in the businessgroup firms, Table 6.5 presents the disaggregate analysis, as a robustness check, analyzing how board independence influences the firm value for business-group and stand-alone firms. The statistical findings highlight that independent directors add negatively to the firm value for business-group firms (Table 6.5—Model 1). The empirical results are in line with the findings of Chakrabarti et al. (2010) and Khosa (2017). Interestingly, the negative relationship between board independence and firm value turns insignificant for the stand-alone firms (Table 6.5—Model 2). Thus, the empirical findings further reinforce the results of the possible moderating role of promoter ownership on the board independence and firm performance relationship. The empirical results remain the same for an accounting-based performance measure, ROA (Appendix 6.2).

152

6 Constraints Diluting the Effectiveness of Board Independence

Table 6.16 Moderating effect of product market competition on the relationship between board independence and firm value Independent variables

Dependent variable—Tobin Q Model (1)

Model (2)

Board independence

−0.015a (0.003)

0.007 (0.039)

log(Product market competition)

0.688c (0.405)

1.029c (0.601) −0.007 (0.012)

Board independencec log(Product market competition) Leverage

−0.519 (0.319)

−0.511 (0.320)

log(Total audit fee)

0.061a (0.010)

0.062a (0.010)

Big-Four

0.533a (0.089)

0.535a (0.088)

Promoter ownership

0.043a (0.003)

0.043a (0.003)

Domestic institutional ownership

0.019a (0.004)

0.019a (0.004)

Foreign institutional ownership

0.050a (0.004)

0.050a (0.004)

Board size

0.044a (0.013)

0.045a (0.013)

Audit Committee independence

0.010a (0.003)

0.010a (0.003)

log(Firm size)

−0.924a (0.149)

−0.926a (0.147)

log(Research and development expenditure)

−0.002 (0.005)

−0.002 (0.005)

Constant

0.482 (1.286)

−0.638 (1.987)

Fixed Effects Year

Included

Included

Industry

Included

Included

Observations

4,248

4,248

R2

0.212

0.212

Adjusted R2

0.205

0.205

Note In this table, Model 1 presents the main effects of the variables of interest (product market competition and board independence). Model 2, along with the main variables, reports the significance of the moderation effect of product market competition on board independence and Tobin’s Q relationship. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10% Source Authors’ compilation

6.3 Analysis and Findings

153

Table 6.17 Moderating effect of product market competition on the relationship between board independence and firm value for business-group and stand-alone firms Dependent variable—Tobin Q Independent variables

Business-group firms

Stand-alone firms

Model (1)

Model (2)

Board independence

0.067c (0.038)

−0.131 (0.123)

log(Product market competition)

0.957 (0.660)

1.707 (1.423)

Board independencec log(Product market competition)

−0.024b (0.012)

0.039 (0.039)

Leverage

−1.069a (0.195)

0.944 (0.801)

log(Total audit fee)

0.062a (0.009)

0.285b (0.144)

Big-Four

0.399a (0.065)

0.894a (0.335)

Promoter ownership

0.043a (0.003)

0.032a (0.006)

Domestic institutional ownership

0.027a (0.004)

0.003 (0.011)

Foreign institutional ownership

0.053a (0.004)

0.043a (0.013)

Board size

0.067a (0.013)

−0.147a (0.043)

Audit Committee independence

0.004 (0.003)

0.026b (0.011)

log(Firm size)

−0.666a (0.082)

−2.208a (0.525)

log(Research and development expenditure)

0.005 (0.004)

−0.021 (0.017)

Constant

−0.921 (2.199)

1.341 (4.706)

Included

Included

Fixed Effects Year Industry

Included

Included

Observations

3,265

983

R2

0.305

0.254

Adjusted R2

0.296

0.224

Note In this table, Models 1 and 2 present the moderating effect of the product market competition on board independence on firm value (Tobin’s Q) relationship for business-group firms and standalone firms respectively. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10% Source Authors’ compilation

154

6 Constraints Diluting the Effectiveness of Board Independence

Table 6.18 Summary of the empirical results Corporate governance mechanisms

Relationship

Board independence –> Firm value

Weakened with the level of promoter ownership

Board independence –> audit quality

Strengthened with the level of promoter ownership

Board independence –> audit quality –> firm performance

Strengthened with the level of promoter ownership

Board independence –> foreign institutional investment

Weakened with the level of promoter ownership

Board independence –> foreign institutional investment –> firm value

Weakened with the level of promoter ownership

Board independence –> Firm value

Not impacted by the level of product market competition

Note This table summarizes the moderating effect of promoter ownership and product market competition on board independence and firm value relationship Source Authors’ compilation

ii.

Board independence and audit quality with the promoter ownership as the moderator

The results of a probit regression model in Table 6.6 report the interactive effect of board independence and promoter ownership on audit quality to be significant (β = 0.0004, p < 0.01). In other words, the tendency of the independent directors to appoint a Big-Four auditor (through its associate in India) increases significantly with the increase in promoter ownership. The findings in Table 6.7 facilitate in understanding the empirical results reported in Table 6.6 by analyzing the relationship between board independence and audit quality at various levels of promoter ownership. Independent directors have a significant tendency of appointing a Big-Four auditor when the promoter ownership is high (Table 6.7: β = 0.018, p < 0.01). Further, Table 6.8 (Model 1) reports that the relationship between board independence and total audit fee gets strengthened with the increase in promoter ownership. In other words, in case of high promoter ownership, the independent directors tend to enhance the audit quality further by paying a higher total audit fee. Figure 6.9 provides the graphical presentation of the empirical results. It is evident that the slope of the board independence and total audit fee relationship increases with the increasing levels of promoter ownership. The empirical results, thus, reject the null hypothesis, H0.11 (Chap. 3) for all the measures of audit quality. The empirical results with respect to the percentage non-audit fee confirm that promoter ownership has a negative moderating effect on the board independence and percentage non-audit fee relationship (β = −0.003, p < 0.05). In other words, the independent directors tend to subscribe to fewer non-audit services and preserve auditor’s independence when the promoter ownership is high. Figure 6.10 provides the visual presentation of the empirical results.

6.3 Analysis and Findings

155

Fig. 6.10 Board independence and audit quality (percentage non-audit fee) at various levels of promoter ownership. Note The figure presents the relationship between board independence and percentage non-audit fee at three levels of promoter ownership (low, medium and high). The “red line” plots the relationship at a low level of promoter ownership, 37.55% (Mean-1SD), the “green line” plots the relationship at medium level of promoter ownership, 54.84% (Mean) and “blue line” plots the relationship at high level of promoter ownership, 72.13% (Mean + 1SD). Source Authors’ compilation

iii.

Board independence and foreign institutional investment with promoter ownership as the moderator

Table 6.9 reports that promoter ownership has a negative moderating effect (β = −0.003, p < 0.01) on the positive relationship between board independence and firm value. In other words, the strength of the positive relationship between board independence and firm value recedes with the increase in promoter ownership. Based on these results, the null hypothesis, H0.12 (Chap. 3), gets rejected. The empirical findings in Table 6.10 further confirms the validity of the empirical estimates. The findings remain the same when the lagged independent variables (one-year lag) have been used in the regression models. Figure 6.11 provides the graphical presentation of the empirical results. It can be noticed that highly independent boards are able to attract more foreign institutional investment (FII) when the promoter ownership is low. However, the relationship turns negative at a higher level of promoter ownership. The empirical findings of the sub-group analysis approach (Table 6.11) substantiate the graphical results reported in Fig. 6.11. In this table, Model 1 reports a significantly positive relationship between board independence and foreign institutional investment when the promoter ownership is low. However, the strength of the relationship declines (Table 6.11—Model 2), and then, turns negative (Table 6.11—Model 3) with the increasing levels of the promoter ownership.

156

6 Constraints Diluting the Effectiveness of Board Independence

Fig. 6.11 Relationship between board independence and foreign institutional investment at various levels of promoter ownership. Note The figure presents the relationship between board independence and foreign institutional investment at three levels of promoter ownership (low, medium and high). The “red line” plots the relationship at a low level of promoter ownership, 37.55% (Mean-1SD), the “green line” plots the relationship at medium level of promoter ownership, 54.84% (Mean) and “blue line” plots the relationship at high level of promoter ownership, 72.13% (Mean + 1SD). Source Authors’ compilation

iv.

Moderated-mediation model with promoter ownership as the moderator and audit quality as mediator

Table 6.12 confirms the direct effect board independence on firm value to be significantly negative (β = −0.022, 95% CI [−0.0299, −0.0142]). Further, Table 6.13 reports the conditional insignificant effect of board independence on firm value (through total audit fee) to be significant at medium and high levels of promoter ownership. The empirical results remain qualitatively the same when an accounting-based performance measure (ROA) has been used in the empirical analysis (Appendices 6.3 and 6.4). The empirical results reject the null hypothesis, H0.15 (Chap. 3). v.

Moderated-mediation model with promoter ownership as the moderator and foreign institutional investment as the mediator

Table 6.14 reports the existence of a significantly negative and direct relationship between board independence and firm value (β = −0.022, 95% CI [−0.0302, − 0.0145]). Interestingly, Table 6.15 confirms the presence of a significant indirect effect (board independence and firm value through foreign institutional investments) at varying levels of promoter ownership. The direction and significance of the direct effect on firm performance remains unaltered for an accounting-based performance measure (Appendices 6.5 and 6.6). Based on these findings, we can reject the null hypothesis, H0.16 (Chap. 3).

6.3 Analysis and Findings

157

6.3.2 Product Market Competition, Board Independence and Firm Performance Model 1 (Table 6.16) presents a significantly negative relationship between board independence and firm value. The findings remain the same as reported in the last chapter (Chap. 4). Model 2 (Table 6.16) presents an insignificant moderating effect of product market competition (β = −0.007, p > 0.10) on board independence and firm value relationship. Based on the findings, the null hypothesis, H0.10 (Chap. 3) gets supported. The empirical estimates of product market competition need to be interpreted with caution as a higher HHI value corroborates to lower level of product market competition and vice-versa. It is to be noted that in consideration of the insignificant moderating effect of product market competition on the board independence and firm value relationship, the null hypotheses H0.13, H0.14, H0.17 and H0.18 (involving the analysis of moderating effect of product market competition) will not be tested in the empirical analysis in this chapter. The results signify that the negative relationship between board independence and firm value is not contingent on the level of product market competition. It can thus, be concluded that independent directors continue to add negatively to the firm value irrespective of the level of product market competition, the firm faces. The empirical findings remain robust for an alternate measure of firm performance (ROA) (Appendix 6.7). Our results in the Indian context, are in sharp contrast to the findings of Randøy and Jenssen (2004) who advocate that independent directors add to the firm value operating in lesser competitive industries. Similarly, our results also do not support the findings of the studies which advocate that the level of external product market competition instigates the firm level governance mechanisms to discharge their monitoring role more effectively (Bozec, 2005; Januszewski et al., 2002; Rennie, 2006). Additional analysis In view of the distinct institutional set-ups and the reduced threat of external product market competition for the business-group firms, Table 6.17 presents the results of disaggregate analysis. The findings indicate that for the business-group firms, product market competition has a positive moderating effect (β = −0.024, p < 0.05) on the board independence and firm value relationship. However, the empirical results are not robust when an alternative measure of firm performance (ROA) has been used (Appendix 6.8). In contrast, the board independence and firm value relationship is not contingent on the level of product market competition for the stand-alone firms.

158

6 Constraints Diluting the Effectiveness of Board Independence

6.4 Discussion Broadly, the empirical findings indicate that the promoter ownership dilutes the effectiveness of board independence as a monitoring mechanism. However, the findings are counter-intuitive with respect to the moderating role of product market competition and signify the relation to be insignificant in the Indian context. This section, based on the existing literature, summaries the possible explanations behind the empirical results obtained in Sect. 6.3. For better exposition and in line with the two broad objectives of the chapter, this section further divided into two subsections. Moderating effect of promoter ownership on board independence and firm performance relationship The dilution of the board effectiveness by the insiders can be interpreted as the means for the insiders to circumvent this additional monitoring. Promoter shareholders can resort to multiple ways to influence the monitoring ability of the independent directors. First, the promoter shareholders are vested with the powers to influence the directors’ election process. Thus, the independence of the independent directors gets compromised to enable the insider (promoter) shareholders to retain the control in their hands (Bebchuk & Hamdani, 2017; Khosa, 2017). Second, the renewal of the next term of the independent directors is contingent on the willingness of the insider shareholders. Thus, the independent directors have a strong incentive to go along with the management (Bebchuk & Hamdani, 2017). A significantly negative moderating effect of the business-group affiliation of the firms further reinforces the empirical findings specific to the negative moderating effect of the promoter owners. This argument is based on the fact that promoter owners have tighter control over the business-group firms. Specific to the businessgroup firms, the negative effect of board independence on firm value can be attributed to two reasons. First, though independent directors can provide expert opinion on several matters, they might have little influence on matters involving promoters and their family members (Khosa, 2017; Pritchard, 2009). Second, independent directors exert greater reliance on the insider shareholders owing to their directorships in other firms of the same business-groups (Khanna & Mathew, 2010). Subsequently, a significantly positive moderating effect of the promoter ownership on board independence and audit quality relationship implies that independent directors tend to enhance the audit quality even more in light of the increased reporting related risk related. The empirical results with respect to the moderating role of promoter ownership remain robust to all the measures used for audit quality. The empirical results can be interpreted in view of the arguments of Wang (2006), Lin and Liu (2009) and Johl et al. (2016) who advocate a greater complexity and a higher risk in auditor engagement with the increase in promoter ownership. Further, guided by the work of Carcello et al. (2002) it can be argued that independent directors, to protect their market reputation, demand a higher quality audity. The following case-let highlights the concern of the possible lack of independence of the independent directors in the country.

6.4 Discussion

159

Tata Sons (Independence of the independent directors) Tata Sons, a private limited company, is the principal investment holding company and promoter of Tata companies. In 2017–18, the revenue of Tata Companies, taken together was $110.70 billion. There are total 28 public listed Tata companies with a combined market capitalization of $143.30 billion (March 31, 2018) (Tata, 2019). In a press meeting on October 24, 2016, Tata Sons reported the sudden removal of Mr. Cyrus Mistry as the Chairman of Tata Sons. The event was unusual as the group had a history of having only six Chairmen over 148 years (Kumar, 2017). The removal of the Chairman had the nod from the Chairman of Tata Trust (having around 66 percent stake in Tata Sons), Mr. Ratan Tata. Mr. Ratan Tata and the Tata Group as a whole are known for maintaining high ethical and corporate governance standards. The Chairman was sacked based on a not-so-clear allegation of having lost the confidence of the board. While the real reason behind the Mistry dismissal still remains a mystery, certain aspects highlight a serious lacuna in the institution of independent directors in the country. In a series of related events, an independent director (Mr. Nusli Wadia), who is known to take his job very seriously and for asking tough questions from the Chairmen of the boards was also sacked for taking an active stand and supporting Mr. Mistry. In this part of the story, Mr. Nusli Wadia, was acting as an independent director in three Tata group companies: Tata Steel, Tata Motors and Tata Chemicals. For all the three companies, an Extraordinary General Meeting (EGM) was called for the removal of Mr. Wadia (Bloomberg Livemint, 2016; Quint, 2016). The independent director was removed based on the allegations of him acting in concert with Mr. Mistry and galvanizing other independent directors. The fact that, in India, an ordinary resolution (requiring fifty per cent votes) is required for the removal of an independent director, and in this case, since a large shareholding remained in the hands of the promoters; these aspects made the removal of Mr. Wadia almost certain even prior to the meetings. On December 13, 2016, Mr. Wadia in an open letter expressed his side of the story and accused Tata Sons for following certain malpractices related to insider trading and other business dealings (Wadia, 2016). He further claimed “my independent stand has aggravated Tata Sons and my removal is being sought because I chose not to follow their diktat. My fiduciary duty is to your company and not to an unidentified Tata Group”. Related to the removal process of the independent directors, Mr. Wadia stated “If they (the independent directors) can be removed at the whim and fancy of a promoter, then their role is reduced to being yes-man”.

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6 Constraints Diluting the Effectiveness of Board Independence

To sum up, such an instance is clearly an indication of the possible lack of the independence of the independent directors in the country. Also, such scenarios further reinforce the empirical findings of the study advocating an inverse relationship between promoter ownership and the effectiveness of the independent directors. Subsequently, with respect to the negative moderation effect of promoter ownership on board independence and FII relationship, two possible explanations can be extended to explain the results: (1) High promoter ownership might signify the reduction of the possible agency issues (Type I issues) and a sound corporate governance structure of the firm; (2) foreign institutional investors might pay considerable attention to the increased threat of principal-principal issues (Type II issues) and they consider the board independence to be ineffective in safeguarding the interests of the minority shareholders. The following case-let highlights the reduced effectiveness of foreign institutional investors in resolving principal-principal conflicts due to large promoter shareholders.

Coal India Limited (Foreign institutional investors and promoter ownership) Coal India Limited (CIL), a coal mining enterprise, is a state-owned company and is the world’s largest coal producer. The company is spread across eight mining areas and has seven fully-owned coal subsidiaries in the country. The company is also responsible for fulfilling 40% of the primary commercial energy requirement (CIL, 2019). In a first of its kind investor backlash, a foreign institutional investor, The Children’s Investment Fund (TCI) being the second largest shareholder in Coal India limited (CIL) (after the Government of India holding 90% stake), holding around 1.04% shares, threatened to take legal actions against the individual board members. To set the background, The Children’s Investment Fund (TCI) is a famous UK-based hedge fund investor and is famous for actively pursuing governance issues in their portfolio companies (like ABN AMRO, Japan Tobacco and JPower). Coal India Limited is a public sector enterprise with the majority of the shares (90%) owned by the Government of India. The company went for an IPO in October 2010 and offered 10% of the CIL shares to the public. TCI emerged to be the largest public shareholder of CIL by acquiring 1.04 percent stake in CIL in June 2011. The rift between TCI and the CIL widened in the aftermath of the price reversal of coal by CIL, as per the directives of the government officials. CIL announced the adoption of a new pricing mechanism of coal from January 1,

6.4 Discussion

161

2012. This resulted in a hike in the coal prices. However, CIL announced a rollback in the price hike on January 31, 2012. TCI accused the CIL board of blindly following the directives of the government officials without giving due consideration to the minority shareholders’ interests. The Indian partner of TCI, Mr. Oscar Veldhuijzen, wrote in a letter to the board members of CIL, “The Board appears to believe that its only duty lies in accepting the instructions of the Government at the detriment of its stakeholders’ and shareholders’ interest” (Veldhuijzen, 2012). In the same letter, TCI also mentioned some other instances to highlight the passive role played by the board members in various business decisions. TCI gave some grace period to CIL to address its (TCI’s) concerns failing which the investor (TCI) threatened to take a legal action against CIL. When not seeing its concerns getting addressed by CIL, the hedge fund started a legal action against the CIL and the government in August 2012 (CNBC-TV18, 2012). In this petition, TCI mentioned the opportunity loss of USD 1.5 billion dollars due to the inappropriate pricing strategies of CIL. Not stopping here, the hedge fund further filed a lawsuit against the directors of the company in October 2012 for “breach of their fiduciary duties” and “for failing to perform their functions with adequate care and skill” (Times of India, 2012). TCI even created a website “coal4india.com” to post all its communications and invite the public’s comments. In a nutshell, the hedge fund left no stone unturned in its effort to amend the governance breaches in the company. However, the zeal of the hedge fund to pursue this matter started fading from March 2013, when it started selling its stake in CIL. By October 2014, TCI sold its entire stake in CIL (Financial Times, 2014). Further, TCI withdrew all the legal cases against CIL in December 2014 (DNA India, 2014). While the exact reasons behind the exit of TCI from the CIL case remains unknown, it is speculated that they were not very happy with the way the Indian system worked. Anil Singhvi, the founder of Institutional Investors Advisory Services (IIAS) sums up his observation on this case by stating that “To be honest, I think they got very disillusioned with the Indian system, and in particular with the response from the Government of India. It is very hard to change something here if you are a small minority”. To sum up, such an instance reinforces our empirical findings related to the negative moderating effect of the promoter ownership on the board independence and foreign institutional investment relationship. Also, a high promoter ownership and the tendency of the board of directors to go along with the directives of the promoters, further raises the concerns about the protection of the minority shareholders’ interests in India.

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Nevertheless, the inverse relationship between foreign institutional investment and promoter ownership for the firms with high promoter ownership corroborates the possibility that foreign institutional investors discount the effectiveness of the board independence for firms with high promoter ownership because of their weakened confidence in the firm-level governance structure. Product market competition, board independence and firm performance An insignificant moderating effect of product market competition on the board independence-firm value relationship renders the findings of Randøy and Jenssen (2004), Bozec (2005), and Giroud and Mueller (2010) in the Indian context, as well. Independent directors continue to add negatively to the firm value irrespective of the level of product market competition. An insignificant moderating effect of the product market competition could be assigned to the inefficacy of the external monitoring mechanisms in the emerging markets. Nevertheless, a counter-intuitive and positive moderating effect of the product market competition for the business-group firms extend support to the findings of Khanna and Palepu (1999) who noticed an enhanced governance structure of the business-group firms in response to the increase in competition from the foreign players. In the backdrop of the economic liberalization of India and Chile, the authors stated that contrary to the traditional arguments, an increased competition enhanced the scope of the business-group firms. This is because an increased competition forced the business-group firms to “think-like-a-group” to tackle the external market competition. This was achieved by greater information flow, better governance and reporting practices and increased number of board inter-locks. Building on these arguments, in the current context, it can be argued that increased competition might stimulate the independent directors in business-group firms to add to the firm value by facilitatingmore information flow across the business-group firms on account of board inter-locks4 in the business-group firms (Khanna & Mathew, 2010).

6.5 Implications and Recommendations The study makes important theoretical contributions by empirically validating that the governance mechanisms, instead of working in isolation, work as a bundle. This, inturn, implies that merely blaming the ineffectiveness of the independent directors to factors like lack of expertise in the industry domain (Klein, 1998; Raheja, 2005), their excessive busyness (Ferris et al., 2003), and so on, will not enable us to tackle this issue. The inability of the independent directors to discharge their monitoring role effectively should be understood in relationship to the other governance mechanisms, as well. 4

Board inter-lock refers to the practice wherein the members of the corporate boards serve on the boards of multiple corporation. Davis (1996) contends that “the aggregate result of this practice virtually links all the firms into a single network based on the shared board members”.

6.6 Summary and Conclusion

163

Besides providing an insight into the governance behavior of the emerging economies, the empirical results will facilitate practitioners in designing effective governance structures for the organizations. The empirical findings have important practical implications both for the policy-makers and the companies. Implications and recommendations for policy-makers • A significant interactive effect of board independence and promoter ownership suggests that a one-size-fits-all approach might not yield the desired results with respect to strengthening the governance structure of the firms. In a nutshell, the findings strongly advocate the arguments of Bebchuk and Hamdani (2017) who corroborate a greater reliance on the “enhanced-independence of directors” instead of merely “independent directors”. Recommendations: Based on the aforementioned implication following recommendations are made to the policy-makers: • Policies should be framed to discourage the participation of the promoter shareholders in the appointment, re-appointment and dismissal process of the independent directors. • The independence of the independent directors can be further improved by enhancing the participation of the minority shareholders in the directors’ election and dismissal process (Pritchard, 2009). • The empirical results call for the need of an absolute independence of the Nomination and Remuneration Committee to preserve the independence of the independent directors. Bhattacharyya and Mohanty (2018) have also endorsed a similar viewpoint. Implications and recommendations for companies Analogous to the implications for the policy-makers, the companies should take an additional effort to ensure the independent functioning of the independent directors, when the promoter ownership is high. For this, until the regulatory reforms take place, the firms can take the above-mentioned steps at the individual level to enhance the effectiveness of board independence.

6.6 Summary and Conclusion This chapter aims to analyze the constraints that can dilute the effectiveness of board independence as a monitoring mechanism. With this aim in mind and corresponding to the two first objective of the study, this chapter first analyzes the moderating role of promoter ownership in influencing the monitoring ability of the independent directors. The second objective is concerned with the analysis of the moderating role of product market competition on the board independence and firm performance relationship.

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6 Constraints Diluting the Effectiveness of Board Independence

The empirical findings indicate that promoter ownership weakens the monitoring ability of the independent directors. Further, a significant negative effect of the independent directors on firm value only for the business-group firms further reinforces similar finding. Further, in consideration of the significant moderating effect of promoter ownership on the effectiveness of independent directors, we aim to analyze the moderating effect of promoter ownership on the board independence and audit quality; and board independence and foreign institutional investment relationship. Finally, in consideration of the mediation effect of audit quality and foreign institutional investment explaining the board independence and firm performance relationship and the moderating role of promoter ownership, this chapter aims to test the holistic moderated-mediation models. The empirical findings indicate that independent directors strengthen the audit quality by demanding more intensive and independent audits. Further, independent directors also draw more foreign institutional investments. Hence, the empirical data validates that independent directors can indirectly enhance the firm value by strengthening other governance mechanisms. The subsequent analysis reveals that the promoter ownership positively moderates the board independence and audit quality relationship. However, the moderating effect of promoter ownership is negative with respect to the relationship between board independence and foreign institutional investment. Finally, the empirical data extend support to the validity of the holistic moderated-mediation models. In relation to the moderating role of product market competition, an overall analysis negates the level of product market competition as a potential explanation of the negative relationship between board independence and firm value. Table 6.7 summarizes the moderating effect of promoter ownership and product market competition on the board independence and firm value relationship (Table 6.18). Based on the empirical results, possible implications and suggestions have also been discussed in this chapter.

Appendices See Appendixes 6.1 and 6.2.

Appendices

165

Appendix 6.1 Moderating effect of promoter ownership on the relationship between board independence and ROA Independent variables

Dependent variable—ROA Model (1)

Model (2)

Board independence

−0.029b (0.013)

−0.006 (0.041)

Promoter ownership

0.076a (0.010)

0.096a (0.033)

Domestic institutional ownership

0.082a (0.017)

0.082a (0.017)

Foreign institutional ownership

0.088a (0.019)

0.088a (0.019) −0.0004 (0.001)

Board independencec Promoter ownership log(Product market competition)

−2.988a (0.700)

−2.988a (0.701)

Leverage

−13.895a (1.341)

−13.891a (1.342)

log(Total audit fee)

0.176a (0.055)

0.176a (0.055)

Big-Four

−0.380 (0.263)

−0.368 (0.265)

Board size

0.195a (0.045)

0.198a (0.046)

Audit Committee independence

0.006 (0.009)

0.006 (0.009)

log(Firm size)

−1.448a (0.386)

−1.466a (0.390)

log(Research and development expenditure)

0.059a (0.019)

0.059a (0.019)

Constant

23.402a (2.536)

22.288a (3.067)

Fixed Effects Year

Included

Included

Industry

Included

Included

Observations

4,248

4,248

R2

0.231

0.231

Adjusted R2

0.225

0.225

Note In this Appendix, Model 1 presents the main effects of the variables of interest (promoter ownership and board independence). Model 2, along with the main variables, reports the significance of the moderation effect of promoter ownership on board independence and ROA relationship. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10%

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6 Constraints Diluting the Effectiveness of Board Independence

Appendix 6.2 Regression models depicting the relationship between board independence and ROA for business-group and stand-alone firms Independent variables

Dependent variable—ROA Business-group firms

Stand-alone firms

Model (1)

Model (2)

Board independence

−0.040a (0.013)

0.003 (0.049)

Promoter ownership

0.080a (0.011)

0.101a (0.026)

Domestic institutional ownership

0.105a (0.019)

0.062c (0.039)

Foreign institutional ownership

0.113a (0.017)

0.045 (0.061)

log(Product market competition)

−1.987a (0.605)

−5.835a (1.908)

Leverage

−12.558a (0.995)

−15.925a (3.975)

log(Total audit fee)

0.166a (0.055)

0.184 (0.436)

Big-Four

0.179 (0.280)

−2.768a (0.582)

Board size

0.230a (0.047)

0.228 (0.177)

Audit Committee independence

0.010 (0.009)

−0.011 (0.026)

log(Firm size)

−1.971a (0.354)

−0.068 (1.286)

log(Research and development expenditure)

0.056b (0.023)

0.098b (0.045)

Constant

20.555a (2.348)

23.062a (6.789)

Fixed Effects Year

Included

Included

Industry

Included

Included

Observations

3,265

983

R2

0.245

0.259

Adjusted R2

0.237

0.230

Note In this table, Models 1 and 2 present the effect of the board independence on ROA for businessgroup firms and stand-alone firms respectively. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10%

Appendices

167

Empirical results testing the holistic moderated-mediation model (mediator—audit quality, moderator—promoter ownership) (See Appendixes 6.3 and 6.4) Appendix 6.3 Direct effect of board independence on ROA (mediator—audit quality, moderator— promoter ownership) Effect

Se

t-value

p-value

LLCI

ULCI

−0.0348

0.0126

−2.7611

0.0058

−0.0595

−0.0101

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the direct effect between board independence and ROA with “total audit fee” as the mediator and “promoter ownership” as the moderator. “SE” represents the standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence

Appendix 6.4 Conditional indirect effect of board independence on ROA at various levels of promoter ownership Indirect Effect: Board independence -> Total audit fee -> ROA Promoter ownership

Effect

SE

LLCI

ULCI

37.84

0.0017

0.0009

0.0002

0.0036

54.47

0.0028

0.0011

0.0011

0.0055

73.48

0.0042

0.0016

0.0017

0.0080

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the indirect effect between board independence and ROA with “total audit fee” as the mediator. “SE” represents the bootstrap standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence

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6 Constraints Diluting the Effectiveness of Board Independence

Empirical results testing the holistic moderated-mediation model (mediator—FII, moderator—promoter ownership) (See Appendixes 6.5 and 6.6) Appendix 6.5 Direct effect of board independence on ROA (mediator—FII, moderator—promoter ownership) Effect

Se

t-value

p-value

LLCI

ULCI

−0.0314

0.0126

−2.4957

0.0126

−0.0561

−0.0067

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the direct effect between board independence and ROA with “foreign institutional investment” as the mediator and “promoter ownership” as the moderator. “SE” represents the standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence

Appendix 6.6 Conditional indirect effect of board independence on firm performance at various levels of promoter ownership Indirect Effect: Board independence -> Foreign institutional investment -> ROA Promoter ownership

Effect

SE

LLCI

ULCI

37.84

0.0073

0.0035

0.0012

0.0147

54.47

0.0041

0.0019

0.0007

0.0083

73.48

0.0017

0.0010

0.0002

0.0040

Note Analogous to the β measure in the regression model, “Effect” value is the estimation of the indirect effect between board independence and ROA with “foreign institutional ownership” as the mediator. “SE” represents the bootstrap standard error. “LLCI” and “ULCI” presents lower level confidence internal and upper level confidence intervals respectively. While running the model, the default significance level is set to 95%. The exclusion of the value “0” between the LLCI and ULCI indicates the relationship (Effect) to be significant at 5% level of confidence

Appendices

169

Moderating effect of product market competition on the board independence and ROA relationship (See Appendixes 6.7 and 6.8)

Appendix 6.7 Moderating effect of product market competition on the relationship between board independence and ROA relationship Dependent Variable—ROA Independent variables

Model (1)

Model (2)

Board independence

−0.029b (0.013)

0.122 (0.143)

log(Product market competition)

−2.993a (0.701)

−0.620 (2.324) −0.046 (0.043)

Board independencec log(Product market competition) Leverage

−13.896a (1.341)

−13.842a (1.348)

log(Total audit fee)

0.150a (0.048)

0.151a (0.048)

Big-Four

−0.360 (0.262)

−0.349 (0.264)

Promoter ownership

0.076a (0.010)

0.076a (0.010)

Domestic institutional ownership

0.082a (0.017)

0.082a (0.017)

Foreign institutional ownership

0.088a (0.019)

0.089a (0.019)

Board size

0.196a (0.045)

0.199a (0.045)

Audit committee independence

0.006 (0.009)

0.006 (0.009)

log(Firm size)

−1.416a (0.384)

−1.431a (0.385)

log(Research and development expenditure)

0.059a (0.019)

0.059a (0.019)

Constant

23.299a (2.534)

15.517b (7.714)

Fixed Effects Year

Included

Included

Industry

Included

Included

Observations

4,248

4,248 (continued)

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6 Constraints Diluting the Effectiveness of Board Independence

Appendix 6.7 (continued) Dependent Variable—ROA Independent variables

Model (1)

Model (2)

R2

0.231

0.232

Adjusted R2

0.225

0.225

Note In this table, Model 1 presents the main effects of the variables of interest (product market competition and board independence). Model 2, along with the main variables, reports the significance of the moderation effect of product market competition on board independence and ROA relationship. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10% Appendix 6.8 Moderating effect of product market competition on the relationship between board independence and ROA relationship for business-group and stand-alone firms Independent variables

Dependent variable—ROA Business-group firms

Stand-alone firms

Model (1)

Model (2)

Board independence

0.111 (0.136)

−0.194 (0.464)

log(Product market competition)

0.345 (2.255)

−9.047 (7.298)

Board independencec log(Product market competition)

−0.046 (0.042)

0.061 (0.135)

Leverage

−12.524a (0.996)

−16.025a (4.033)

log(Total audit fee)

0.141a (0.048)

0.215 (0.416)

Big-Four

0.205 (0.280)

−2.819a (0.599)

Promoter ownership

0.080a (0.011)

0.101a (0.026)

Domestic institutional ownership

0.105a (0.019)

0.066c (0.042)

Foreign institutional ownership

0.114a (0.017)

0.044 (0.063)

Board size

0.233a (0.047)

0.230 (0.176)

Audit committee independence

0.010 (0.009)

−0.011 (0.026)

log(Firm size)

−1.960a (0.350)

−0.095 (1.266)

log(Research and development expenditure)

0.050b (0.020)

0.089b (0.042) (continued)

References

171

Appendix 6.8 (continued) Independent variables

Constant

Dependent variable—ROA Business-group firms

Stand-alone firms

Model (1)

Model (2)

12.699c

34.911 (24.388)

(7.262) Fixed Effects Year

Included

Included

Industry

Included

Included

Observations

3,265

983

R2

0.245

0.259

Adjusted R2

0.237

0.230

Note In this table, Models 1 and 2 present the moderating effect of the product market competition on board independence on ROA relationship for business-group firms and stand-alone firms respectively. The values in brackets report the standard error. a indicates significance level at 1%. b indicates significance level at 5% and c indicate significance level at 10%

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Chapter 7

Concluding Observations

This chapter concludes the research work and presents a summary of the entire work. The chapter is outlined as follows: Sect. 7.1 presents an objective-wise summary of the findings. Recommendations from the findings form the content of Sect. 7.2. Section 7.3 outlines the contributions of the study. Limitations of the current work and scope for future research are presented under Sect. 7.4. Finally, Sect. 7.5 presents the concluding remarks.

7.1 Major Findings from the Research This section presents the research findings reported in the previous chapters in line with the objectives of the study. Objective 1. To analyze the impact of various governance mechanisms (board monitoring, ownership structure, audit quality and product market competition) on firm performance. This objective relates to the analysis of various monitoring mechanisms in relation to firm performance. The research findings related to this objective are highlighted here. • Product market competition has an insignificant relationship with firm value measured in terms of Tobin’s Q ratio. However, the relationship is positive and significant with return on assets (ROA) as the measure of firm performance. • Audit quality, when being measured through the total audit fee, has a significantly positive relationship with firm value (Tobin’s Q). The relationship remains robust to the alternate performance measure (ROA). However, audit quality, when measured as the percentage non-audit fee to the total audit fee (auditor’s independence), does not have a significant relationship with any of the measure of firm © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2022 S. Singh and M. Singla, Corporate Governance Mechanisms and Firm Performance, India Studies in Business and Economics, https://doi.org/10.1007/978-981-19-2460-6_7

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performance (Tobin’s Q and ROA). Audit quality, being measured as the external auditor’s affiliation with the Big-Four auditor has a significant relationship with firm value. • Ownership structure is significantly associated with firm performance. Promoter ownership is positively and significantly associated with both measures of firm performance (Tobin’s Q and ROA). Additional analysis indicates that presence of a non-linear relationship (U-shaped relationship) between promoter ownership and firm value with the inflection point lying around 17.50%. • Both foreign and domestic institutional ownership have a positive and significant effect on firm value. The results remain robust to the alternate performance measure (ROA). The findings also indicate that the foreign institutional investors have a stronger impact on Tobin’s Q and ROA compared to the domestic institutional investors. Board independence is significantly and negatively related to both Tobin’s Q and ROA. Other measures of board monitoring (CEO-Chairman duality and the Audit Committee independence) have inconclusive relationships with firm performance. Objective 2. To analyze if the independent directors enhance firm performance indirectly by strengthening other governance mechanisms (audit quality and foreign institutional investment). • Board independence enhances firm value by enhancing the audit quality. • Board independence enhances firm value by enhancing the foreign institutional ownership. Objective 3. To analyze if the level of promoter ownership and product market competition dilute the effectiveness of independent directors in enhancing firm performance. • The effectiveness of the board independence in enhancing the firm value gets diluted with the increase in promoter ownership. The robustness test, based on a separate analysis for the business-group and stand-alone firms, confirms the results. • Promoter ownership has a significantly positive moderating effect on the indirect effect of board independence on firm value (through audit quality). • Promoter ownership has an adverse moderating effect on the indirect relationship between board independence and firm value with the foreign institutional investment as the mediating variable. • The relationship between board independence and firm performance is not moderated by the level of product market competition. In other words, independent directors continue to add negatively to firm performance irrespective of the level of product market competition.

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7.2 Recommendations from the Study This section highlights the recommendations that can be drawn from the research findings. The study offers recommendations for the regulators, academia and the firms. (Table 7.1).

7.3 Contributions of the Study This section highlights the main contributions of the study. i. ii.

iii.

iv.

This study contributes to the limited literature in the context of emerging economies by conducted an in-depth analysis in the context of India. Instead of relying on a single monitoring mechanism, this study examines the monitoring efficacy of various mechanisms together. In view of the lack of research in the context of emerging economies, the empirical results can be generalized to other developing economies having a similar institutional environment (weak rule of law and enforcement of regulations, less developed capital markets and concentrated ownership). The current study contributes by empirically analyzing and validating the factors which could explain the ineffectiveness of the independent directors (promoter ownership). The effectiveness of independent directors to enhance firm performance reduces with the increased level of promoter ownership. Finally, the study adds to the existing understanding of the board behavior by segregating the direct and indirect effects of board independence on firm value in relation to other governance mechanisms. The findings highlight that, in contrast to the overall negative effect of independent directors, they add to the firm value by enhancing the audit quality and foreign institutional investment. Besides these aspects, the empirical results add to the existing knowledge by providing the empirical validity of the concept of the “bundle of governance mechanisms”.

7.4 Limitations and Scope for Future Research • The scope of the study is limited to Indian firms. Similar studies can be conducted in the context of similar economies (with a similar institutional framework like India) to validate the empirical results in the context of such economies. • As corporate governance is a contemporary area, the current study attempts to validate the empirical results on the inter-relationship among various governance mechanisms by providing the mini case-lets wherever possible; however, a primary study documenting the viewpoints of the practitioners will further deepen our understanding of the inter-relation among various governance mechanisms by providing the justifications behind the same.

Recommendations for the regulators

Recommendations for the companies

• The empirical findings highlight the distinct governance role of various monitoring mechanisms in the context of an emerging economy, India

• A significantly negative effect of board • Besides following the regulatory mandates independence on firm value highlights the need (related to board independence), the companies of revisiting the increased thrust on board should conduct a firm-level analysis to assess if independence by the regulators the independent directors, in reality, strengthen • Either the value-eroding effect of the the governance structure independent directors should be justified in the • If not, the firms should make every effort to context of the requirement of having a fixed limit analyze the reasons behind their inefficacy in the of the independent directors or the reasons firms’ governance structure. Firms should strive explaining the ineffectiveness of the independent to go beyond fulfilling the bare minimum directors should be sought and fixed to make regulatory requirements in order to ensure that board independence an effective governance independent directors start adding to the firm mechanism value (continued)

Objective 1. To analyze the impact of various governance mechanisms (board monitoring, ownership structure, audit quality and product market competition) on firm performance

Recommendations for the academia

Table 7.1 Recommendations from the study

178 7 Concluding Observations

Recommendations for the regulators

Recommendations for the companies

• The findings highlight that in contrast to the overall negative effect of independent directors, they indeed add to the firm value by enhancing the audit quality and foreign institutional investment

• Based on the finding that higher board • Firms can attract more foreign institutional independence leads to higher audit quality the investments by constituting a more independent study recommends that enhancing the board accountability of the independent directors might further strengthen the relationship. This is based on the assumption that the more accountable independent directors are, the more motivated they will feel to enhance the audit quality in order to complement their own monitoring • A greater focus of the regulators towards board independence might strengthen the perception of the foreign institutional investors towards the governance of the companies. This will result greater foreign institutional investments in the country, which in turn, is crucial for the growth of the capital deficit economies like India (continued)

Objective 2. To analyze if the independent directors enhance firm performance indirectly by strengthening other governance mechanisms (audit quality and foreign institutional investment)

Recommendations for the academia

Table 7.1 (continued)

7.4 Limitations and Scope for Future Research 179

Recommendations for the regulators

Recommendations for the companies

Source Authors’ compilation

• A significant interactive effect of board • A significant interactive effect of the governance • The companies should make an effort to ensure independence and promoter ownership indicates mechanisms indicates the need for introducing the independent functioning of the independent that a one-size-fits-all approach might not yield the policies in consideration of other governance directors, when the promoter ownership is high • For doing so, the Nomination and Remuneration the desired results with respect to strengthening aspects of the firms • Various regulatory efforts should emphasize an Committee can be comprised of only the governance structure of the firms • The study makes an important theoretical additional exertion on preserving the independent directors. Promoter shareholders’ contribution by empirically validating that the independence of the independent directors, when participation can be minimized in the removal governance mechanisms, instead of working in the promoter ownership is high process of the independent directors. For isolation, work as a bundle instance, instead of the prevailing practice of passing an ordinary resolution (which requires 50% votes), the passage of a special resolution (which needs 75% votes) can be mandated for the removal of the independent directors

Objective 3. To analyze if the level of promoter ownership and product market competition dilute the effectiveness of independent directors in enhancing firm performance

Recommendations for the academia

Table 7.1 (continued)

180 7 Concluding Observations

7.5 Concluding Observations

181

• The findings indicate an insignificant relationship between auditor independence and firm value. A separate analysis can be undertaken to conduct an ex-post analysis for the firms facing governance failures related to the accounting frauds. • Certain subtle aspects (like trust, leadership and ethics), which are vital to corporate governance quality, are not taken into consideration in the present work. An interdisciplinary study can be conducted in the future to empirically validate the importance of such aspects in addition to the existing mechanisms. • The empirical findings can be subject to measurement errors, though we have attempted to minimize this error by using the measures which are well-established in the existing literature. However, concerns can be raised for certain variables like board independence, audit quality and insider ownership. Insider ownership can be subject to the measurement error if the ownership is misreported by the promoters. The percentage of independent directors on the board, though a proxy widely used in the existing literature, might not measure the true independence of the board. In other words, the independent directors appointed could be the aides of the promoter shareholders or their independence can be threatened by the fear of non-renewal of their next term in case they fail to oblige the controlling shareholders or the management. The absence of a suitable proxy in the extant literature to measure these subtle aspects of board independence and audit quality disabled us to deploy alternate measures.

7.5 Concluding Observations The analysis of the effect of monitoring mechanisms on firm performance highlights that independent directors add negatively to the firm value. This is an area of concern as board independence is supposed to strengthen the firms’ governance structure by providing independent judgment on managements’ performance and by protecting the interest of the minority shareholders. An exploration of value eroding effect of board independence further reveals that promoter ownership dilutes the effectiveness of board independence in enhancing firm performance. They (promoter owners) might do so, through several means, to seek private benefits of control. A further analysis of monitoring behavior of independent directors highlights that independent directors, instead of having an overall negative effect on firm performance, add to the firm value by indirectly by enhancing audit quality and by attracting more foreign institutional directors.