Governance in India: Effect of management characteristics on valuations of a firm

Abstract

At the time the Satyam scandal became known, many commentators said that the scandal would adversely affect Indian business enterprises. Corporate scandals cost investors, employees and other stakeholders dear. Therefore, preventing scandals is vital to the success of Indian business. Improving the quality of corporate governance would be an important part of the measures necessary to prevent recurrence of scandals. This would mean, for example, increased monitoring by independent and other non-executive directors. The Satyam episode raises several questions on the quality of corporate governance and adequacy of the regulatory requirements in India. This study investigates whether Satyam changed anything at all; in particular, it examines the quality and effects of governance on firm valuation and performance. A study of related literature indicates that corporate governance mechanisms are still evolving in India. Corporate governance requirements similar to those in the Anglo-Saxon world have been implemented in India but their suitability to India is debatable. India not only faces the agency problems of western firms – differences in goals of the management and the owners of the company; it also has a peculiar situation of the major shareholder – often the founding family or “promoters” - dominating the Board and the minority shareholders. We investigate the change in corporate governance after the Satyam event in 2009 and the impact of corporate governance on firm performance. We have carried out this analysis on 309 companies of the BSE 500 Index. We look at the proxies for corporate governance measures, such as the number of board meetings per year, attendance at board meetings, and increase in the number of independent directors. We conduct regression analysis of corporate governance indicators and firm performance. Our results indicate that corporate governance measures have marginally improved in 2010 and this is seen especially in the information technology and outsourcing services sector, probably a direct result of Satyam. The association between governance factors and accounting measures of performance viz. return on assets and return on equity is negligible. However, the market appears to view corporate governance as one of the parameters in valuation, as evidenced by the higher correlation between beta and the stock market P/E with the governance indicators. The negative association between equity beta and the percentage of independent directors indicates that the presence of independent directors may be one of the factors decreasing stock price volatility.