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   Article Corporate Governance and Firm Performance: An Exploratory Analysis of Indian Listed Companies Amitava Roy 1 Abstract In this article we propose to study whether firm level good corporate governance (CG) leads to better firm performance, leading to higher value creation. Limited evidence exists concerning the impact of CG practices on firm level performance or valuations in the Indian context. This study attempts to fill this gap. Our motivation is to explore the linkage between good CG practices and firm performance in Indian listed companies. We use a panel of 58 top Indian listed companies in terms of market capi-talisation (BSE 100 and NSE 100), over the five year period from 2007–08 to 2011–12 for our analysis. Our measurement analysis starts with a broad sample of 37 structural indicators of CG relating to directors, boards committees, audit considerations, ownership and capital structure characteristics and our defined set of control variables. We have used two measures of firm performance, Market to Book Value Ratio (MTBVR) and Return on Asset (RoA). We use principal component analysis to identify the underlying dimensions of CG and determine which indicators are associated with each factor. We conclude that firm performance, measured by RoA, results in R-square of 43.7 per cent, and is significantly influenced by the 7 factors. Firm performance, measured by MTBV Ratio, results in R-square of 34.5 per cent, and is significantly influenced by the 8 factors. Keywords Corporate Governance; Firm Performance; Principal Component Analysis Introduction Corporate governance (hereafter, CG) is the set of processes that provides an assurance to the investors of a fair return on their investment. CG is concerned with the relationships among the management,  board of directors, controlling shareholders, minority shareholders, and other stakeholders. Effective CG require the installation of mechanisms to ensure that company executives respect the rights and interests of the stakeholders, and to act responsibly with regard to the generation, protection, and distribution of  Jindal Journal of Business Research3(1&2) 93–120© 2014 O.P. Jindal Global UniversitySAGE 10.1177/2278682116629537 1  Assistant Professor,   Department of Commerce and Business Administration, St. Xavier’s College, Kolkata, India. Corresponding author: Amitava Roy,   Flat – J/4, Cluster – 2, Purbachal, Saltlake, Kolkata 700097, India.E-mails:;  94  Jindal Journal of Business Research 3(1&2) wealth invested in the firm. Good CG contributes to sustainable economic development by enhancing the firm performance and increasing their access to outside capital. CG is a “complex construct” (Larcker, Richardson, & Tuna, 2007) and hence the measurement of CG becomes a challenging proposition. It is difficult because there is no well-developed theory on the multi-dimensional nature of CG or a strong conceptual basis for selecting the relevant CG character-istics to be included in an empirical study. Most studies use either a single indicator of CG, or use indi-ces. The key issue is whether the structural indicators that are used to measure CG actually capture the essence of this “complex construct.” Evidence seems to suggest that the inability to capture CG accurately may also lead to econometric problems. In this regard, it is pertinent to mention that in multiple regression analysis, inconsistent parameter estimates caused by measurement error in the CG variables do not necessarily attenuate the estimates or result in conservative assessments of statistical significance (Bollen, 1989).What is the relationship between CG and corporate performance? Does good CG impact profitability and value creation for Indian listed companies? The answer to these questions may have important impli-cations for India’s CG regime. Existing empirical literature has investigated the effect of CG mecha-nisms on corporate performance. However, extant literature has not consistently identified a relationship  between CG and firm performance. Different studies have yielded mixed results. Examples of these studies include Morck, Shleifer, and Vishny (1988), Byrd and Hickman (1992), Brickley, Coles, and Terry (1994), Yermack (1996), Core, Holthausen, and Larcker (1999), Klein (2002), and Gompers, Ishii, and Metrick (2003). There is a strong presence of family firms in India. In the context of family firms, empirical record linking family ownership and firm value has also yielded mixed results. Examples of these studies include Anderson, Mansi and Reeb (2003), Villalonga and Amit (2006), & Miller, Le-Breton-Miller, Lester, and Cannella (2008). A possible limitation of such research possibly was that it examined the effect on performance of only one or a set of similar dimension of a firm’s governance when in reality CG mechanisms are numerous and interaction effects are possible. Also, an econometric  problem is that CG and performance are not independent of one another. The relationship between cor- porate performance and CG is endogenous and may depend on other (unobserved) firm characteristics as well. It is also suggested that due to the endogeneity problem, the value maximizing CG choices among firms may also be different.In our opinion, it creates strong incentives for shareholders and companies to insist on high CG stand-ards, if good CG is linked to strong performance and poor governance to weak performance. Strong CG tends to affect firm performance in two different ways. First, good CG may lead to high share price multiples as investors anticipate that lesser amount of cash flows will be diverted and a higher proportion of the firm’s profits will flow back to them as return (in the form of interest or dividends). Second, good CG may reduce the expected return on equity to the extent that it reduces shareholders’ monitoring and auditing costs, leading to lower costs of capital. In addition to ownership, the use of debt in the capital structure (leverage) is another firm characteristic related to CG, in the form of monitoring  by creditors, which may determine firm performance. However, it is not necessary that better CG is related to higher firm value and performance as the costs associated with the implementation of stronger CG mechanisms may outweigh the benefits. To take this forward, we propose to adopt the following sequence. We first need to identify the struc-tural indicators of CG and then relate them to understand how they impact corporate performance. Our measurement analysis starts with a broad sample of 37 structural indicators of CG relating to the  board of directors, boards committees, audit considerations, ownership and capital structure characteris-tics, and other control variables considered in CG literature. We use a panel of 58 top Indian listed firms,  Roy   95 in terms of market capitalization (BSE 100 and NSE 100), over the five-year period from 2007–2008 to 2011–2012 for our analysis.The purpose of this research is to provide an exploratory inquiry into the dimensions of CG and how it influences firm performance. We use principal component analysis (hereafter, PCA) to under- stand whether CG has any impact on firm performance. Accounting, as a discipline, is fundamentally concerned with measurement and we feel this is an important topic in this regard. Available literature concentrates on measuring certain constructs like cost of capital (e.g., Easton & Monahan, 2005) and discretionary accruals (e.g., Dechow, Sloan & Sweeney, 1996) but there has been relatively little devel-opment in the measurement of CG. Our methodological approach is similar to the techniques used in previous research in examining the impact of CG on various dependent variables depicting firm value and performance. Firm perfor-mance is measured in this study using (i) return on assets (hereafter, RoA) and (ii) market to book value (hereafter, MTBV) ratios. We have used two different sets of CG variables while employing PCA keep-ing in view our two dependent variables RoA and MTBV ratios, respectively. PCA was employed to identify the underlying dimensions of CG and determine which indicators are associated with each factor. We retain all factors with an eigenvalue greater than unity. For the dataset wherein RoA is used as the dependent variable, results in 11 factors that retain 72.85 percent of the total variance in the srcinal data. These 11 factors characterize the dimensionality of our 34 individual indicators. The dataset used for MTBV ratio yields 12 factors that retain 74.61 percent of the total variance in the srcinal data and these 12 factors characterize the dimensionality of our 36 individual indicators. The reduced solutions are then rotated using Varimax rotation that allows the retained factors to be correlated in order to enhance interpretability of the PCA solution. This observed structure enables us to identify a set of indicators for each dimension that exhibit reasonable levels of reliability and construct validity for an exploratory study. As stated previously, we use multiple regression analysis and as the measure of performance employ RoA and MTBV ratio, respectively. Using the factor scores generated for the two sets, we use them for conducting the regression analysis using RoA and MTBV ratio, respectively. We conclude that firm  performance, measured by RoA, results in  R -square of 43.7 percent, and is significantly influenced by the seven factors. Firm performance, measured by MTBV ratio, results in  R -square of 34.5 percent, and is significantly influenced by the eight factors. We conclude that firm performance is strongly influenced  by the CG structure of the firm. This article is structured as follows. The second section describes the existing literature. The next section deals with research design, namely, the sample used and variable descriptions. The fourth section presents the research methodology used followed by the results. The last section contains our conclusion. Literature Review Academic literature examines whether ownership, board, capital structure, and other firm-specific CG characteristics are associated with better firm value and performance. The aspects of CG that have a bearing on firm value and performance include its ownership structure, board and its committee characteristics, and the use of leverage in the capital structure. As already pointed, CG and firm perfor-mance are not independent of one another. We take into account the endogeneity by using control variables as suggested in the literature. A review of selected literature is provided in this section.  96  Jindal Journal of Business Research 3(1&2) Ownership Structure The ownership structure of a firm may affect its performance by determining the severity of agency conflicts. The focus of the CG systems is the agency problem, an organizational concern that arises when the owners (in a company, the shareholders) are not the managers who are in control (resulting in Type I or vertical agency problem). In widely held companies with diffused ownership, the resolution of conflicts of interest between owners (as residual claimants) and managers becomes the key issue.When insider ownership exists, the problem that arises is due to the variance in the cash flow and control rights among the stakeholders of the firm. First, insider ownership may be defined as managerial ownership where managers are given equity ownership as an incentive by the owners. Second, insider ownership arises when the family promotes and also manages the affairs of the firm. Both cases will impact the variance in the cash flow and control rights but in different ways due to divergence in motivations and expectations.In the presence of high managerial ownership, the managerial entrenchment model developed by Shleifer and Vishny (1989) may apply. The presence of controlling shareholders leads to a conflict of interest between them and the outside minority shareholders, if the former seeks to extract and optimize  private benefits for themselves at the expense of the minority shareholders. A review of literature confirms these arguments, as research findings suggest that insider ownership is associated with  performance in a nonlinear fashion (McConnell & Servaes, 1990; Morck et al., 1988).The agency problem in family firms arises due to the wedge between the majority (i.e., family share-holders) and the minority shareholders (resulting in Type II or horizontal agency problem). In family run companies (hereafter, FRC), the controlling shareholders or the promoter family, by virtue of their substantial equity holding, would have a strong incentive to monitor and thus limit Type I or vertical agency problem (Jensen & Meckling, 1976). However, in the case of insider holding by the family or promoter group the different priorities that families may have with respect to those of outside share-holders are seen as a potential for conflicts of interest that may hinder value creation and growth of those companies. In FRC, the incentive of inside shareholders to expropriate minority shareholders is achieved through pyramid structures or tunneling of profits which are related to the divergence of owner-ship and control rights in these firms. The higher the divergence between cash flow rights and control rights, the higher is the incentive of the controlling shareholder to divert resources from those firms where the cash flow rights are lower, to firms where the cash flow rights are higher. Literature seems to suggest that FRC can influence performance and CG because they are more diversified (Ferris, Kim & Kitsabunnarat, 2003), have better political connections and access to financing (Shin & Park, 1999), and are hence more profitable (Khanna & Krishna, 1999) more so in India. The agency problem in firms with strong concentration of ownership by the outside block holders may also impact performance. Both the convergence of interest hypothesis and the efficient monitoring hypothesis state that outside block holders will actively monitor the firm’s management (Pagano & Roell, 1998; Pound, 1988; Shleifer & Vishny, 1986). In contrast, La Porta, Lopez-de-Silanes and Shleifer (1999) observed that controlling outside shareholders may divert the firm’s resources for their own  private benefit, and this in turn may reduce shareholder value. In other words, concentrated ownership structure may lead to reduction in firm value as a result of expropriation by large shareholders. Shleifer and Vishny (1997) observed that when large shareholders gain close to full control, they start generating  private benefits of control that are not shared with minority shareholders and hence harm the minority shareholders. The impact on firm performance is therefore ambiguous. However, research also shows that the identity of the outside block holders matters, with institutional investors being more likely to  play a crucial governance role (Khan, 2006). This is more relevant in Indian context where mutual funds,
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