Corporate Governance Practices in Indian Firms

Article excerpt

ABSTRACT

In the wake of recent financial scandals and in the context of the global financial crisis, corporate governance is especially significant. We examine the effect of corporate governance practices on the performance of 106 mid-sized firms in India, between 2005 and 2007. Our results confirm a significant relationship between CEO duality and firm performance. We also find that a small board is more effective and enhances the value of the firm. However, in the Indian context, we find that non-executive independent directors are failing in their monitoring role.

Keywords: corporate governance, non-executive directors, CEO duality, audit committees, board size, Tobin's q

INTRODUCTION

Clichéd though it may sound, financial scandals the world over highlight the ever-growing importance of corporate governance. Future scandals will continue to assure a focus on governance issues - especially transparency and disclosure, control and accountability - and on the most appropriate form of board structure that may be capable of preventing such scandals occurring in future.

The relationship between corporate governance reforms and recession is cyclical, with waves of reform and increased regulation occurring during periods of recession, corporate collapse and reexamination of the viability of regulatory systems (Clarke, 2004). During long periods of expansion, both companies and shareholders are concerned with the generation of wealth rather than in ensuring governance mechanisms are working purposefully for the retention of wealth. This leads to diminishment of active interest in governance.

The recent global financial crisis proves beyond a doubt that we are living in a global age and has brought to the fore the relevance of a sound corporate governance system as an essential element of effective risk-management. Though not the only cause, governance failings are significant where boards fail to understand and manage risk, and tolerate perverse incentives. The recent crisis highlights the need to develop more effective approaches to corporate governance and risk management, as well as the importance of social responsibility in the financial sector; the role that corporate governance can and should play is in restoring trust (International Corporate Governance Network, 2008).

To some extent, shareholders may be criticized for not holding companies accountable, and it is true that shareholders have encouraged companies to ramp up short-term returns through leverage. However, regulators have often not responded decisively on realizing that markets were mispric- ing risk, allowing bank boards to operate with too little capital, excessive leverage, too much liquidity risk and poor mortgage lending practices.

There is an increasing perception that contagion and spill-over effects from the global financial turmoil could undermine the economic achievements of any country. As a result, there has to be an increased interaction between corporate governance and the stability and soundness of the financial system.

Hence, corporate governance practice needs strengthening, in particular by increasing board competence and responsibility. Board members need to have up-to-date knowledge on financial issues and risk-management to fulfill their functions and training should it be required when necessary. Boards should conduct annual evaluations of their performance and report to shareholders. Risk management frameworks, processes, and implementation practices require reform in order to redress the shortcomings revealed by the turmoil. It is vital that regulatory reform augments corporate governance solutions without aggravating existing weaknesses.

We explore issues surrounding corporate governance in the context of the rapidly emerging economy of India.

CORPORATE GOVERNANCE IN INDIA

The concept of corporate governance has attracted public attention for quite some time in India. …