See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/303198106

Relationship between Corporate Governance Index and Firm

Performance: Indian Evidence

Article  in  Global Business Review · January 2017

DOI: 10.1177/0972150917713812

CITATIONS READS
33 2,458

2 authors:

Akshita Arora Shernaz Bodhanwala

Apeejay School of Management Foundation for Liberal And Management Education
17 PUBLICATIONS   320 CITATIONS    8 PUBLICATIONS   82 CITATIONS   

SEE PROFILE SEE PROFILE

All content following this page was uploaded by Akshita Arora on 13 April 2018.

The user has requested enhancement of the downloaded file.

Article

Relationship between Corporate Global Business Review

19(3) 675–689
Governance Index and Firm © 2018 IMI
SAGE Publications
Performance: Indian Evidence sagepub.in/home.nav
DOI: 10.1177/0972150917713812
http://journals.sagepub.com/home/gbr

Akshita Arora1
Shernaz Bodhanwala2

Abstract
The Indian corporate governance norms have been evolving over a period of time but limited number
of studies have been undertaken with reference to corporate governance index (CGI) in the Indian

se
context. The study aims to examine the relationship between CGI and firm performance. We construct
CGI using important parameters of governance such as board structure, ownership structure, market

lu
for corporate control and market competition. Our panel data set comprises of listed firms and the
estimation analysis has been carried out using random effects method. The study reveals significant

ia
positive relationship between CGI and firm performance metrics. CGI is an important and causal factor
c
in explaining firm performance. The investors would also have positive perception about business firms
er
maintaining high governance standards, thus reducing possible funding costs.
m

Keywords
om

Corporate governance index, firm performance, board independence, ownership structure

rc

Introduction
fo

The corporate governance measures in India are imposed upon through different forums. The Ministry
of Corporate Affairs and Securities and Exchange Board of India (SEBI) are two bodies overseeing the
ot

governance for listed companies. The essence of corporate governance is fairness, transparency and
N

adequate disclosures to all the stakeholders. The new Companies Act (2013) is a landmark piece of
legislation raising the bar of governance by incorporating stricter norms of disclosures, mandatory
requirement of consolidated financial statement, related party transactions, related norms, etc. Elucidating
the need for better governance and alignment of governance norms with the spirit of Companies Act
(2013), SEBI amended clauses 35B and 41 of listing agreement.
In developing economies like India, though an elaborate framework of corporate governance is
already in place, still its compliance by firms to the fullest is questionable. The Indian firms are mostly
family dominated and sometimes, promoter’s equity holding is high at more than 50 per cent of the total

1
ICFAI Business School, Gurugram, Haryana, India.
2
Flame University, Lavale, Off. Pune Bangalore Highway, Pune, Maharashtra, India.

Corresponding author:
Akshita Arora, IBS-Gurgaon, IDPL Complex, Old Delhi Gurgaon Road, Dundahera, Gurugram, Haryana, India.
E-mail: akshitaarora1989@gmail.com
676 Global Business Review 19(3)

shareholding. This gives promoters greater control over business operations which may lower the finan-
cial returns to other stakeholders, if promoters start perceiving their own financial interests by diverting
firms’ resources. This can be fickle as small embezzlements to more serious as perpetrated management
frauds. Also, significant percentage of insider ownership leads to compensation expense, according to
Fama and Jensen (1983). On the contrary, researchers argue that greater insider stakeholders may have
long-term interest in firm’s growth and performance and thus, helps in effective monitoring function.
Thus, ownership structure (promoters’ equity, non-promoter equity and institutional holding) is an effec-
tive governance tool and thus, it finds place in the corporate governance index (CGI) that we construct
for this study.
There are studies like Shleifer and Vishny (1986) which strongly emphasize the importance of insti-
tutional investors who play an active role in the corporate governance process. Also, Cadbury Committee
(1992) supports this viewpoint by saying that ‘because of their collective stake, we look to the institutions
in particular, with the backing of the Institutional Shareholders’ Committee, to use their influence as

se
owners to ensure that the companies in which they have invested comply with the code’. The working
group on Corporate Governance of Harvard Business Review has similarly concluded that ‘the institu-

lu
tional investors of public companies should see themselves as owners and not as investors’. Therefore,
institutional shareholding is also one of the important parameters of ownership structure.

ia
The major aim of corporate governance mechanism is to bring transparency in doing business by the
agents and align their interests to increase value to all the stakeholders. Many researchers have high-
c
lighted the natural tendency of managers to use company resources in their own interests leading to
er
conflict of interests between owners and agents. Consequently, the role of independent director on the
m

board becomes vital in decision-making as well as in monitoring the management. After the critical
failure of independent directors on Satyam’s board, India is making all the right moves in the Companies
om

Act around independent directors, a lot more responsibility needs to be fixed and norms need to be made
stringent. The recent piece of governance under Companies Act (2013) was aligned with Clause 49 of
Listing Agreement to emphasize the procedure regarding appointment of independent directors, mainte-
rc

nance of databank of independent directors, their liability and remuneration. The board independence is
one of the important attributes of corporate governance in construct of CGI.
fo

The board meeting is also an important value-relevant board attribute. While some studies have stated
that board meetings are beneficial for better decision-making, others argued that these meetings are not
ot

necessarily useful because of the shortage of time or costs involved. There is an ongoing debate on the
relationship between board meeting frequency and firm performance. Hence, we also consider board
N

meetings while constructing CGI. Sahu and Manna (2012) have investigated the relationship between
board characteristics and corporate performance. The results revealed that board size and meetings have
positive impact on performance whereas independence of the board and presence of non-executive
chairman in the board has negative impact.
In the present study, while constructing CGI, we take into account many parameters of corporate
governance like ownership structure, board independence, board meetings, market for corporate control
and market competition, following Varshney, Kaul and Vasal’s (2012) methodology to construct the
CGI. The study uses secondary data of firms listed on BSE-500 index for the period 2009–2014, and
constructs CGI and studies its impact on firm performance. The estimation analysis has been carried out
using random effects method.
Our primary contribution to the literature is an econometric analysis of the association between CGI
and accounting performance of the firm. We consider three broad parameters of corporate governance,
instead of considering just a single measure of governance for constructing CGI. Furthermore, most of
the prior studies have used Tobin’s q as the proxy for firm performance while examining the relationship
Arora and Bodhanwala 677

between board characteristics and firm performance. Our study uses different alternate measures of
firm performance like return on assets (ROA), earning per share (EPS) and return on net worth (RONW),
and examines the impact of CGI on all these performance measures. Furthermore, we analyse the
model taking into account the endogenous nature of the relation between governance and performance.
Furthermore, we contribute to the limited literature on the relationship between CGI and firm performance
in the Indian context.
This study provides empirical support for the practitioners, policymakers and academicians empha-
sizing strongly on the role played by governance in enabling firms to maximize their profits. In a sizeable
and developing country like India, where entrepreneurial ventures quickly scale up to size, corporate
governance has an important role to play. Policy formulations need to further deep root the belief in
following governance as it reaps larger benefits for all the stakeholders.
The remainder of the article is organized as follows. In the second section, we describe the literature
review of various national and international studies and highlight the inconsistencies in their results.

se
The third section discusses the objectives of the study. The fourth section talks about the data and its
sources, variables used and methodology for construct of CGI and estimation models used for analysis.

lu
Subsequently, the fifth section discusses the empirical results and then, the study is concluded in the
sixth section.

Literature Review
c ia
er
m

The aftermath of 2007 financial crisis has raised questions on global governance standards followed by
a debate around the world whether better governed firms outperform the other firms.
om

While many studies have been conducted testing the impact of different board characteristics on firm
performance, only few studies have developed CGI. The few studies which constructed CGI and tested
its relationship with firm performance have been conducted mostly in developed economies. The CGI
rc

has been developed either by questionnaire method or by taking into account several corporate governance
parameters. For an emerging economy like India, there is no readymade CGI and we have made an
fo

attempt to construct CGI for Indian firms and examine its impact on the performance of the firm.
The perception of market with regards to firms following better governance norms has been tested by
ot

Gompers, Ishii and Metrick (2003). For measuring corporate governance, they developed an index using
24 parameters and tested its impact on equity returns for the period 1990–1999. Similarly, Gov-Score
N

index was also developed by Brown and Caylor (2006) based on 51 firm-level internal and external
measures. In their study, Gompers et al. (2003) reported firms with stronger shareholders rights to have
higher firm value, sales growth and profits as compared to portfolio with firms having low shareholders
rights. These findings are in line with Brown and Caylor (2006) and Bijalwan and Madan (2013) who
found positive relationship between firm performance and Gov-Score. The later study concluded positive
relationship between firm performance with transparency and shareholders’ rights and corporate
governance policies.
Some studies also reported contrasting results such as Core, Guay and Rusticus (2006); they do not
support the hypothesis that weak governance causes poor stock returns, however, they agree that poor
governance leads to poor operating performance. Furthermore, following the approach suggested by
Gompers et al. (2003), Bauer, Guenster and Otten (2004) analysed companies listed on FTSE Eurotop
300 index and reported significant positive relationship between firm valuation and corporate goveranance
rating by designing portfolio of well-governed and poorly governed firms. However, a negative relation-
ship was reported between corporate governance rating and accounting performance ratios of net profit
678 Global Business Review 19(3)

margin and return on equity (ROE). Still another study by Lehmann and Weigand (2000) reported con-
centrated ownership to have negative impact on profitability with reference to German corporations.
Furthermore, they found significant positive relationship between ownership structure with large finan-
cial institutions as highest stakeholders and firm performance. Contrary to this, Kumar and Singh (2013)
have shown significant positive association of promoter ownership with corporate performance and
further suggest that only above a critical ownership level of 40 percent does promoter’s interest become
aligned with that of the company, resulting in positive effect on firm value.
Many studies adopted survey method for constructing CGI like Black, Jang and Kim (2006), Ertugrul
and Hegde (2009), etc. For the companies listed on Korean Stock Exchange, Black et al. (2006) conducted
survey and constructed CGI based on their responses. They utilized different regression models like
simple ordinary least square (OLS), 2-SLS and 3-SLS methods and found correlation between CGI and
market value of firm. Their findings reported robust correlation between the performance variables and
CGI. Likewise, Braga-Alves and Shastri (2011) also constructed composite CGI taking into account six

se
proxies for main corporate governance practices prescribed by Bovespa’s reform. Bovespa is the stock
exchange of Brazil, provided for Novo Mercado listing rules highlighting many corporate governance

lu
norms to be followed by listed companies. They found positive relationship, that is, higher index score
related to greater market value. However, no significant relationship was found between CGI and

ia
operating performance.
Furthermore, Ertugrul and Hegde (2009) examined the scores of governance ratings (from US rating
c
agencies) and its impact on future firm performance. Largely, the positive perception of people towards
er
the third party governance rating is challenged as empirically it is proved that these ratings do not
m

provide support in identifying governance difficulties faced by the firms. Thereafter, it was proved that
measures of rating provide poor prediction about the operating performance and stock returns. They
om

were not able to predict of the probability of exposure to class action lawsuits, delisting of firms, SEC’s
action and bankruptcy. Recently, Bijalwan and Madan (2013) also examined the impact of corporate
governance score on firm performance for 121 firms. The score was derived using questionnaire designed
rc

based on the Standards & Poor’s Governance, Management, Accountability Metrics and Analysis
(GAMMA) method. Furthermore, Beiner, Drobetz, Schmid and Zimmermann (2006) also constructed
fo

CGI based on a questionnaire circulated to firms quoted on Swiss Exchange and found positive
relationship between corporate governance and firm valuation.
ot

Many researchers advocate positive relationship between firm performance and corporate governance
measures. CGI was also constructed by Javed and Iqbal (2006) based on the average of 3-year firm data,
N

taking into account the main parameters such as board, ownership and shareholding, and transparency,
disclosure and auditing. Furthermore, these parameters were divided into different subheadings and the
weighted CGI was constructed based on subjective judgment and scores assigned to firms on a scale of
0–100 based on the continuum of adherence to the norms. In a more comprehensive study, Larcker,
Richardson and Tuna (2007) talked about relation between corporate governance and managerial
behaviour and organizational performance. They found that the governance indices are related to future
operating performance and stock returns; however, there is no evidence of any relationship between
governance indices and accounting restatements. Furthermore, a small sample study was undertaken by
Khatab, Masood, Zaman, Saleem and Saeed (2011) with reference to firms listed on Karachi Stock
Exchange. They found that firms following good corporate governance measures have better profitability
indicators (ROA and ROE) as compared to other firms.
Moreover, Epps and Cereola (2008) examined the Institutional Shareholder Services Corporate
Governance Quotient rating (ISS-CGQ) and its relation with two financial performance measures, namely,
ROA and ROE. They reported no statistical evidence of firm’s operating performance being related to
Arora and Bodhanwala 679

firms’ ISS corporate governance rating. Johnson, Moorman and Sorescu (2009) re-examined the findings
of abnormal returns earned by portfolio prepared on shareholder’s rights as suggested by Gompers et al.
(2003). They challenged the industry clustering effects that can drive the returns. They found no long-
term abnormal returns for portfolio divided based on governance parameters. Furthermore, MacAulay,
Dutta, Oxner and Hynes (2009) investigated the relationship between governance practices followed by
Canadian firms and their financial performance by constructed CGI and found that the relationship
between firm performance and CGI has improved for first two years after application of new governance
norms in Canada. They concluded that the compliance with corporate governance guidelines has improved
over the period 2003–2007 and the larger firms comply better with the guidelines as compared to smaller
firms. However, the same is reported to weaken in the following three years from 2005 to 2007.
Furthermore, in a recent study by Bagchi (2011), the impact of CGI has been examined on firm’s
capital market performance and no abnormal return earning has been found when different portfolios are
constructed using high and low governance firms. The author attributes this to the efficient behaviour of

se
the market which discounts the information about the corporate governance-related performance in price
of the firm. The changes in the quality of corporate governance practices have been analysed by Cheung,

lu
Connelly, Jiang and Limpaphayom (2011) and then, its impact on the subsequent market valuation. They
concluded that improving the quality of governance practices is positively related to subsequent firm

ia
valuation and vice versa.
In the Indian context, literature of corporate governance can be segregated in two broad structures.
c
One dealing with framework of governance, policy implications and comparison of Indian practices with
er
developed economies, for example, Baxi (2005), Sinha (2006), Chakrabarti (2008), Retolaza, Roqueñi
m

and San-Jose (2014), etc. while the other set dealing with empirical validation of impact of governance
on firm value, earnings management and performance (see Balasubramanian, Black, & Khanna, 2010;
om

Ganguli & Agrawal, 2009; Garg, 2007; Pattnayak, 2012, etc.). Very few studies have targeted to test the
comprehensive impact of CGI on firm performance. In the direction of this effort, Balasubramanian
et al. (2010) constructed CGI based on the survey conducted on Indian listed firms and found positive
rc

relationship between CGI and firm market value.

Presenting similar views, J. Sarkar, S. Sarkar and Sen (2012) taking data of large listed Indian firms
fo

constructed CGI covering the period from 2003 to 2008, found strong relationship between CGI and
market performance of firms. Furthermore, Varshney et al. (2012) also examined the relationship
ot

between corporate governance and firm performance by constructing weighted CGI using some internal
and external parameters of corporate governance. The analysis was carried out using pooled OLS and
N

random effects model to study the relationship between CGI and firm performance. Their results showed
significant positive relation between CGI and economic value added and no significant relation was
found with traditional measures of performance.
In similar view, Ben (2014) constructed CGI for BSE-100 companies and studied its impact on two
firm performance measures, namely, price-to-book value and return on capital employed. A significant
positive impact of CGI was reported on market performance measured by price-to-book value. However,
no relationship between CGI and accounting performance could be established. It can be observed that
most of the Indian studies have concluded positive relationship between CGI and firm performance.
We can submit that the inconsistencies in the opinions of earlier researchers leaves a scope for further
investigation in this area, especially in case of developing economy like India where the norms of gov-
ernance are still in the evolving phase. These differences might arise because of the different methodolo-
gies adopted for construction of CGI or different parameters used for corporate governance and firm
performance. So, the present study aims to develop composite CGI for Indian firms and then examines
its impact on firm performance.
680 Global Business Review 19(3)

Objective
The primary objective of the study is to develop composite CGI for Indian firms. There is no benchmark
CGI available for Indian companies as very few Indian companies have got CGIs. Hence, we took
suitable internal and external parameters to develop composite CGI as explained in the next section. We
further intend to investigate the impact of CGI on firm-level performance measures with an aim to find
evidence as proposed by the good governance theory. Majority of the previous studies have tested the
impact of individual board characteristics on firm performance, our study attempts to develop CGI by
incorporating all the parameters together and then examined its impact on the performance of firms.

Data and Research Methodology

se
This section provides discussion on data sources, selection of firms, construction of hypotheses and
estimation model for testing the relationship between CGI and financial performance measures. We also
talk about how CGI has been developed, measures of financial performance and control variables.

lu
ia
Data and Variables
c
The data is extracted mainly from the PROWESS1 database (Release 4.0), maintained by the Centre for
er
Monitoring the Indian Economy (CMIE) as well as from the annual and corporate governance reports of
m

the companies. The study employs unique data set for a sample of 407 companies, which are listed on
Bombay Stock Exchange. The panel data approach for the period 2009–2014 is used in the study and the
om

analysis has been conducted using multivariate regression analysis. We took the sample of BSE-500
firms for analysis purposes; however, we have to exclude the banking companies as well as companies
with missing data from the sample and are left with final sample size of 407 companies.
rc

Firm Performance Variables

fo

For the analysis purposes, we use three alternate proxies of firm performance which include ROA, EPS
and RONW. All these accounting variables are considered as the significant indicators of firm performance
ot

and have been used in previous studies like Arora and Sharma (2015), etc.
N

Corporate Governance Index

In order to develop a proxy for CGI for the companies, we take both internal and external mechanisms
of corporate governance. The internal governance mechanisms considered are: (a) board structure and
(b) ownership structure, while the external governance mechanisms included are: (c) market for corporate
control and (d) product market competition. The three variables representing board structure are:
proportion of outside directors (PO), board size (BS) and number of board meetings (BM). The two
ownership structure variables are promoters’ equity (PE) and institutional holding (IO). Furthermore, the
external governance mechanism, market for external control is represented by shareholding by non-
promoters (NPE) and product market competition is represented by the market share of the firm (MS).
These variables are discussed at length further.
Board Size
Board Size is the number of directors serving on a corporate board. Board is the highest decision-making
body in a firm and has the responsibility to direct the efforts of senior management. A firm is assigned a
score in the following manner:
Arora and Bodhanwala 681

1. If the board size is 5 or less, the firm gets a score of 0.50

2. If the board size is 6 or 7, the firm gets a score of 0.65
3. If the board size is 8 or 9, the firm gets a score of 0.80
4. If the board size is 10 or 11, the firm gets a score of 1.00
5. If the board size is 12 or 13, the firm gets a score of 0.95
6. If the board size is more than 14, the firm gets a score of 0.90

This grading has been done randomly following Varshney et al. (2012) who has developed CGI for
Indian firms using the same parameters.

Proportion of Independent Directors

Board composition means the presence of executive and non-executive directors on the board of the
company. Independent directors are invited onto the board in order to oversight management on behalf

se
of shareholders (Baysinger & Butler, 1985). This variable is calculated by dividing the number of outside
directors by the total board size.

lu
Board Meetings

ia
In India, companies are statutorily required to hold at least one board meeting in each quarter, that is, a
minimum of four meetings in a financial year. In his study, Vafeas (1999) has proved that board meeting
c
is important boards attribute which influences firm performance. The frequency of holding the board
er
meetings has been factored in by way of a dummy variable which equals ‘1’ if a company has held more
m

than four meetings in a financial year and ‘0’ otherwise.

om

Promoters’ Equity
Promoters’ equity is computed as the proportion of equity shares held by the promoters to the total
equity shareholding of the company. Higher promoters holding are debated to have concentrated owner-
rc

ship structure and hence monopolistic decision-making power, as observed by Ganguli and Agrawal
(2009).
fo

Institutional Shareholding
ot

This indicates the proportion of equity shareholding of mutual funds (MFs) and foreign institutional
N

investors (FIIs) to the total equity. The high stakes held by institutional investors imply better governance
checks, as the institutional investors are active in overseeing the firm performance and remain institutional
in decision-making process. Since institutional investors have large shareholdings, they would have
grater incentives to monitor corporate performance as they have greater benefits of monitoring, as
observed by Shleifer and Vishny (1986).

Non-promoter Shareholding
We measure the market for external takeovers by the concentration of equity shares with non-promoters.
The rationale behind this variable is that non-promoter shareholding would act as an obstacle to tunnelling
activities by the promoter group and might improve the efficiency through the market for corporate
control, as these shareholders have incentives to monitor and restrain the promoters (Sarkar et al., 2012;
Varshney et al., 2012). This diffusion of ownership provides more flexibility to professional managers to
independently run the show. Thus, higher concentration of non-promoter shareholding is perceived to
increase the firm value. Non-promoter shareholding is considered as proxy for diffusion of ownership by
previous studies like Ganguli and Agrawal (2009).
682 Global Business Review 19(3)

Table 1. Control Variables Used in the Analysis

Control Variable(s) Full Forms Computation

Age Firm Age Present year–Incorporation year
Lev Leverage (Borrowings/Total Assets)*100
Size Firm Size Natural Log of Sales
Adv Advertising Intensity (Advertising Expenses/Sales)*100
RD Research and Development (Research and Development Expenses/
Intensity Sales)*100
Beta Firm Risk Covariance of Market Return with Stock
Return/ Variance of Market Return
Source: Prepared by the authors.

Market Share

se
In order to factor in the market competiveness of the firm, its product market share has been considered.

lu
This is based on the revenue earned by the firm as a ratio of the total revenue of all the firms in the same
industry as given by the National Industrial Classification. This variable has been used by Varshney et al.
(2012) while constructing CGI for Indian firms.

ia
Next, we aggregate the scores on each of the parameters to constitute one mechanism and then assign
c
equal weights to each of the four mechanisms. The weighted average of the variable scores constitutes
er
the weighted CGI, which has been considered for assessing its impact on firm performance. The primary
objective of the study is to investigate the impact of CGI on firm performance.
m

Control Variables
om

We recognize the difficulty of adequately modelling firm performance and thus, control for firm age
(measured by the number of years of the firms since inception); firm size (natural log of total assets);
rc

leverage (measured by the ratio of total debt to assets) and growth opportunities (advertising and research
and development intensity). The construction of these variables for the empirical analysis is shown in
fo

Table 1. The choice of control variables has been guided by the study of Arora and Sharma (2016) who
have tested the impact of board variables on firm performance.
ot
N

Empirical Model Specification

The variables under consideration for the estimation are endogenous in nature; therefore, OLS estimator
might yield inconsistent and biased results. There are broadly two panel estimator approaches that can
be employed in financial research: fixed effects and random effects model.
An important assumption for choosing fixed and random effects estimation is that the unobserved
heterogeneity should not be correlated with the independent variables. The study tests for this assumption
and appropriateness of fixed and random effects estimation has been tested using Hausman test. The
study utilizes panel least squares method with random effects to estimate the relationship between CGI
and firm performance. This estimation technique has been used previously by authors like Black et al.
(2006) while examining governance–performance relationship. For estimation, the following equations
are formed:
RONW it = a 0 + b 0 * CGI it + b 1 * Age it + b 2 * Size it + b 3 * Lev it + b 4 * Adv it
(1)
+ b 5 * RD it + b 6 * Beta it + e it
Arora and Bodhanwala 683

ROA it = a 0 + b 0 * CGI it + b 1 * Age it + b 2 * Size it + b 3 * Lev it + b 4 * Adv it

(2)
+ b 5 * RD it + b 6 * Beta it + e it

EPS it = a 0 + b 0 * CGI it + b 1 * Age it + b 2 * Size it + b 3 * Lev it + b 4 * Adv it

(3)
+ b 5 * RD it + b 6 * Beta it + e it
where

RONWit is return on net worth, ROAit is return on assets, EPSit is earning per share;
CGIit is corporate governance index,
Ageit, Sizeit, Levit, Advit, RDit and Betait are control variables, and fit is the error term.

The study employs unique data set for a sample of 407 companies spanning over 2009 to 2014. The data

se
panel was subjected to unit root tests to establish whether the data is stationary or not. To test the
stationarity of the data, we employed Levin, Lin and Chu (LLC), Im, Pesaran and Shin (IPS) and Fisher-

lu
Augmented Dickey Fuller (Fisher-ADF) for unit roots. When test statistic is lower than the critical
values, the null hypothesis is rejected, else accepted. If the variables in the estimation model are not

ia
stationary, then the standard assumptions for asymptotic analysis will not be valid. In such a case, where
the series is found to be non-stationary, it should be differenced until it becomes stationary.
c
In the next section, we have presented the descriptive statistics, correlation matrix, unit root test results
er
as well as the impact of CGI on alternate firm performance measures using random effects method.
m
om

Empirical Results
In the beginning, preliminary analysis of variables is done using descriptive statistics. The descriptive
rc

statistics for the variables have been reported in Table 2. It can be seen that the CGI score for Indian
manufacturing firms ranges from 0.15 to 1.36 with a mean of 0.78. The leverage for the sample ranges
fo

from 27.13 to 113.22 with mean value of 27.13 per cent. The beta for firms has a mean of 1.01 indicating
that for majority of the firms in the sample, the security price will move with the market. The advertising
ot

expense to sales ratio has a mean of 20.60 with standard deviation of 26.48 which indicates a skewed
N

data for advertising expensing pattern of the Indian firms in the sample.
The mean values for individual parameters of CGI for Indian manufacturing firms are shown in
Table 3. The Companies Act (2013) prescribes minimum 3 directors and maximum of 15 directors for a

Table 2. Descriptive Statistics for the Variables Used in the Analysis

Variables Mean Standard Deviation Minimum Maximum

CGI 0.78 0.17 0.15 1.36
Age 3.53 0.59 1.79 5.02
Size 9.65 2.01 –2.30 15.43
Adv 20.60 26.48 0.00 8,731.25
RD 2.01 13.75 0.00 341.46
Lev 27.13 21.31 0.00 113.22
Beta 1.01 0.42 –2.75 2.86
Source: Authors’ calculations.
684 Global Business Review 19(3)

Table 3. Mean Values for Corporate Governance Parameters

Sub-parameters Mean Value

BS 12
BM 4.50
PO 50%
PE 55.9%
IO 16.8%
NPE 44.1%
MS 26%
Source: Authors’ calculations.

public company. The mean board size for our sample firms is found to be 12 directors (see Table 3). Also,

se
the Clause 49 of Listing Agreement requires listed companies in India to have at least 50 per cent
independent director; if chairman of the board is an executive director, else two-thirds of the directors
should be independent. The average proportion of independent directors on the corporate board is 50 per

lu
cent as can be seen from Table 3. Our sample also meets the requirement of at least four board meetings
in a year as laid down by the Companies Act and Clause 49. This indicates adequate compliance by the

ia
sample firms with the norms.
c
Furthermore, SEBI with reference to the Securities Contracts Regulations (Rules) requires minimum
er
public shareholding of 25 per cent of each class of equity shares issued by listed companies. This would
ensure fair price discovery and liquidity. For our sample, the average promoter’s equity holding for Indian
m

firms under study is 56 per cent, indicating concentrated ownership structure. Furthermore, the average
om

non-promoter shareholding for sample firms under study is approximately 44 per cent. This is well above
the mandate non-promoter holding of 25 per cent by SEBI. Next, institutional shareholders act as vigilant
investors and play an effective monitoring role on the decisions made by the board which comprises of
rc

16.8 per cent, on an average for our firms.

Before proceeding for the main regression analysis, we have checked the multicollinearity and
fo

stationarity among the variables by using correlation analysis and unit root tests. The correlation analysis
has been presented in Table 4 and the unit root tests, LLC, IPS and Fisher-ADF test results have been
ot

shown in Table 5. The main analysis showing the coefficients for the impact of CGI on firm performance
measures has been presented in Table 6.
N

The correlation matrix (Table 4) explains the relationship among independent variables used in the
analysis. It is observed that there are no signs of multicollinearity between any of the independent
variables. The CGI is positively correlated with age and size indicating that as firms mature, they follow
better reporting standards and improved corporate governance practices. Next, we use widely accepted

Table 4. Correlation Matrix among the Variables Used in the Analysis

CGI Age Size Adv RD Beta

CGI 1
Age 0.050 1
Size 0.325 0.096 1
Adv –0.074 –0.015 –0.200 1
RD –0.056 –0.119 –0.231 0.659 1
Beta 0.032 –0.028 –0.010 –0.312 –0.007 1
Source: Authors’ own findings.
Arora and Bodhanwala 685

Table 5. Panel Unit Root Tests for Firm Performance Measures and Corporate Governance Index

Fisher-ADF
Variable/Method LLC IPS (W-stat) Z-stat
RONW –40.768 –6.506 –5.617
(0.000) (0.000) (0.000)
ROA –25.157 –3.8130 –5.630
(0.000) (0.0001) (0.000)
EPS –798.683 –56.659 –12.418
(0.000) (0.000) (0.000)
CGI –128.267 –22.135 –15.645
(0.000) (0.000) (0.000)
Source: Authors’ own findings.
Note:  The statistics in the first row represent the estimated coefficients of the variables while the second row in parentheses

se
represents their respective p-values.

lu
Table 6. Impact of CGI on Financial Performance Using Random Effects Method

ia
(1) (2) (3)
RONW ROA EPS
c
er
Constant 32.233* 25.289*** –165.154*
(0.100) (0.000) (0.092)
m

CGI 28.063*** 0.514 –12.160

(0.006) (0.768) (0.664)
om

Age –3.585 –1.042 9.194

(0.324) (0.214) (0.632)
Size 0.992 –0.472 18.961***
rc

(0.487) (0.125) (0.003)

Adv 1.525** 0.576*** –0.915
fo

(0.013) (0.000) (0.731)

RD –0.818** –0.356*** 0.872
(0.008) (0.000) (0.497)
ot

Lev –0.652*** –0.256*** –0.348

N

(0.000) (0.000) (0.356)

Beta –25.196*** –4.226*** –9.706
(0.000) (0.000) (0.655)
R2 0.216 0.439 0.035
Hausman (|2) 17.33 43.73 3.26
Specification (0.180) (0.110) (0.776)
Observations 587 587 587
Source: Authors’ own findings.
Notes: *, ** and *** indicate significance at 10%, 5% and 1% levels, respectively.
The figure in parentheses indicates p-value.

Hausman test (1978) to guide our choice between fixed effects and random effects model. The null
hypothesis for the underlying test is that there is no significant difference between the coefficients of
fixed effects and random effects model. The hypothesis testing reveals that random effects model is more
appropriate for our data set.
686 Global Business Review 19(3)

It is hypothesized while conducting unit root tests that the series contain unit roots. If the variables in
the regression model are not stationary, it means that the standard assumptions for asymptotic analysis
are not valid. However, our results reported in Table 5 indicate that all test statistics are much lower than
all of the critical values, thus rejecting null hypothesis, which implies that the variables are stationary at
level. These results are consistent with studies like Aduda, Chogii, and Magutu (2013), Mangunyi (2011),
Mule, Mukras, and Oginda (2013) and Lekaram (2014) who also found out that firm performance and
corporate governance variables are stationary at level.
The random effects method was found appropriate for the analysis and the results are reported
in Table 6. The results show that there is a positive relationship between firm performance and CGI.
It can also be seen in Table 6 that CGI has a significant positive impact on RONW. When CGI is changed
by 1 per cent, it has huge impact on RONW which is changed by more than 28 per cent (see Column 1
of Table 6). The observed R-square when RONW is used as dependent variable indicates that 22 per cent
of variance in dependent variable is explained by the predictor variables. It is observed that CGI has

se
a positive impact on firm performance measures, which is consistent with the previous studies like
Balasubramanian et al. (2010) and Kohli and Saha (2008). The study of Balasubramanian et al. (2010)

lu
also found positive relationship for overall governance index and for indices covering shareholder rights
and disclosure for Indian firms.

ia
The control variables like Lev, Beta and RD have negative impact on RONW which implies that
increase in leverage and perceived risk profile of a firm would negatively impact profitability. The size
c
of a firm is positively related to RONW but is not significant at any of the levels of significance. Next,
er
ROA is also found to be positively related to CGI; however, the relationship is not significant (see
m

Column 2 of Table 6). The measure of risk, beta is found to be negatively related to ROA of the firm.
Furthermore, the control variables like RD and Lev are negatively associated with ROA. The increase in
om

leverage would reduce profitability due to implicit interest cost. The findings are in line with the views
of Javed and Iqbal (2006) and Bijalwan and Madan (2013).
Furthermore, contrary to our expectations, EPS is found to be negatively associated with CGI;
rc

however, the relationship is not significant. The past studies like Bauer et al. (2004) have also reported
negative relationship between governance standards and firm performance. However, we cannot presume
fo

that CGI has a negative impact on EPS because of the lack of significance level. The firm size is found
to be positively related to EPS (see Column 4 of Table 6). The previous studies like Varshney et al.
ot

(2012) and Garg (2007) have also reported insignificant relationship between CGI and accounting
profitability measures as in case of EPS in our study. Overall, the results suggest that CGI has a positive
N

impact on firm performance variables (RONW and ROA), implying that when a firm has high governance
standards, its operating performance also improves. For Indian firms, past studies like Kohli and Saha
(2008) also found strong significant relationship between corporate governance and market value of a
firm, which is consistent with the findings of our study.

Conclusion
Our study aims to examine the impact of CGI on firm performance measures. The CGI has been
developed using both internal as well as external corporate governance mechanism and its impact on
firm performance has been estimated using random effects method. The results report that CGI has a
positive impact on all performance measures except EPS. Board structure with adequate representation
of independent directors on the board of Indian firms seems to have a positive impact on firm perform-
ance by their effective monitoring. Our findings suggest that sample Indian manufacturing firms have
Arora and Bodhanwala 687

concentrated promoter ownership. It is contrary to the popular belief that concentrated promoter
ownership would lead to monopolistic decision-making and hamper the independent run of the business
by the professional managers.

Managerial Implications
Corporate governance norms are in evolving phase in India and many issues need the attention of key
managerial personnel and investor community. The current empirical study of CGI has highlighted
that CGI share a positive and significant relationship with the profitability of Indian firms. Board com-
position, board meetings, promoters’ stake, institutional holdings, independent directors, etc. are vital for
the operational and decision-making aspects for Indian corporate leading to an increase in profitability.
This may encourage Indian firms to follow the corporate governance practices and transparency in

se
reporting them which in turn would lead to increase in confidence of the different communities dealing
with the company, that is, employees, investors, regulators, suppliers, etc.

lu
Findings of our study have important implications for the investor community, policymakers and
business houses to focus on making efforts to improve governance standards by concentrating on board

ia
independence. Our results are consistent with the previous studies, that the firms having fewer problems
related to decision-making and management of earnings will arrange frequent board meetings (Xie,
c
Davidson III, & DaDalt, 2003). Thus, our findings of significant impact of CGI on firm profitability
er
reiterates that good corporate governance practices are found significantly related with the performance
m

of Indian firms. Improving corporate governance measures appears to have positive impact on perfor-
mance of the firms. The investors would also have positive perception about business firms maintaining
om

high governance standards, thus reducing possible funding costs. CGI is an important and causal factor
in explaining firm performance. Our study restricts the construct of CGI to limited components due
to unavailability of corporate governance data from published databases in India. We believe that by
rc

including more factors of governance, more reliable output can be obtained.

fo

Scope for Future Research

ot

The study leaves scope for further research, by inclusion of auditors’ independence, board compensation
N

and many such factors. Future researchers can elaborate in this area by using broader spectrum of vari-
ables for constructing CGI like director remuneration, directors’ shareholding, audit, remuneration or
other board committees. It can also be augmented by using qualitative aspects of the board that influ-
ences firm performance such as presence of women directors on board, qualification, age and remunera-
tion of the directors, etc. Also, there are factors which influence the firm performance but many of them
have not been used in this study because of unavailability of data. Our attempt in this study will generate
further debate on the related issue and reason further research in this area, especially in the context of
developing countries. It is also necessary to examine how internal governance systems align with exter-
nal governance mechanisms to provide for effective performance in a turbulent and competitive global
environment.

Acknowledgements
The authors are grateful to the anonymous referees of the journal for their extremely useful suggestions to improve
the quality of the article. Usual disclaimers apply.
688 Global Business Review 19(3)

Note
1. The PROWESS database is maintained by CMIE and contains financial information on around 27,000 companies,
either listed on stock exchanges or the major unlisted companies.

References
Aduda, J., Chogii, C., & Magutu, P. (2013). An empirical test of competing corporate governance theories on the
performance of firms listed at the Nairobi Securities Exchange. European Scientific Journal, 9(13), 107–137.
Arora, A., & Sharma, C. (2015). Impact of firm performance on board characteristics: Empirical evidence from
India. IIM Kozhikode Society and Management Review, 4(1), 53–70.
———. (2016). Corporate Governance and Firm Performance in developing countries: Evidence from India.
Corporate Governance: The International Journal of Business in Society, 16(2), 420–436.
Bagchi, D. (2011). An analysis of relationship between corporate governance of firms and their capital market
performance. The IUP Journal of Applied Finance, 17(2), 5–15.

se
Balasubramanian, N., Black, B., & Khanna, V. (2010). The relationship between firm-level corporate governance
and market value: A study of India. Emerging Markets Review, 11(4), 319–340.

lu
Bauer, R., Guenster, N., & Otten, R. (2004). Empirical evidence on corporate governance in Europe. Journal of
Asset Management, 5(2), 91–104.
Baxi, C.V. (2005). The current context of corporate governance in India. Global Business Review, 6(2), 303–314.

ia
Baysinger, B., & Butler, H. (1985). Corporate governance and the board of directors: Performance effects of changes
c
in board composition. Journal of Law, Economics and Organization, 1(1), 101–124.
er
Beiner, S., Drobetz, W., Schmid, M.M., & Zimmermann, H. (2006). An integrated framework of corporate
governance and firm valuation. European Financial Management, 12(2), 249–283.
m

Ben, P.J. (2014). Corporate governance index and firm performance. Journal of Contemporary Research in
Management, 9(3), 33–44.
om

Bijalwan, J., & Madan, P. (2013). Corporate governance practices, transparency and performance of Indian
companies. The IUP Journal of Corporate Governance, XII(3), 45–79.
Black, B.S., Jang, H., & Kim, W. (2006). Does corporate governance predict firms’ market values? Evidence from
rc

Korea. The Journal of Law, Economics, and Organization, 22(2), 366–413.

Braga-Alves, M.V., & Shastri, K. (2011). Corporate governance, valuation, and performance: Evidence from a
fo

voluntary market reform in Brazil. Financial Management, 40(1), 139–157.

Brown, L.D., & Caylor, M.L. (2006). Corporate governance and firm valuation. Journal of Accounting and Public
Policy, 25(4), 409–434.
ot

Cadbury Committee. (1992). Report of the committee on the financial aspects of corporate governance. London:
N

Financial Reporting Council. Retrieved from www.ecgi.org/codes/documents/cadbury.pdf

Chakrabarti, R.M. (2008). Corporate governance in India. Journal of Applied Corporate Finance, 20(1), 59–72.
Cheung, Y.L., Connelly, J.T., Jiang, P., & Limpaphayom, P. (2011). Does corporate governance predict future
performance? Evidence from Hong Kong. Financial Management, 40(1), 159–197.
Core, J.E., Guay, W.R., & Rusticus, T.O. (2006). Does weak governance cause weak stock returns? An examination
of firm operating performance and investors’ expectations. The Journal of Finance, LXI(2), 655–687.
Epps, R.W., & Cereola, S.J. (2008). Do institutional shareholders services corporate governance ratings reflect a
company’s operating performance? Critical Perspectives on Accounting, 19(8), 1135–1148.
Ertugrul, M., & Hegde, S. (2009). Corporate governance ratings and firm performance. Financial Management,
38(1), 139–160.
Fama, E.F., & Jensen, M.C. (1983). Separation of ownership and control. Journal of Law and Economics, 26(2),
301–326.
Ganguli, S., & Agrawal, S. (2009). Ownership structure and firm performance: An empirical study on listed mid-cap
Indian companies. The IUP Journal of Applied Finance, 15(12), 38–52.
Garg, A. (2007). Influence of board size and independence on firm performance: A study of Indian companies.
Vikalpa, 32(3), 39–60.
 Arora and Bodhanwala 689

Gompers, P., Ishii, J., & Metrick, A. (2003). Corporate governance and equity prices. The Quarterly Journal of
Economics, 118(1), 107–155.
Javed, A., & Iqbal, R. (2006). Corporate governance and firm performance: Evidence from Karachi Stock Exchange.
The Pakistan Development Review, 45(4), Part II, 947–964.
Johnson, S., Moorman, T., & Sorescu, S. (2009). A reexamination of corporate governance and equity prices. The
Review of Financial Studies, 22(11), 4753–4786.
Khatab, H., Masood, M., Zaman, K., Saleem, S., & Saeed, B. (2011). Corporate governance and firm performance:
A case study of Karachi Stock Market. International Journal of Trade, Economics and Finance, 2(1), 39–43.
Kohli, N., & Saha, G. (2008). Corporate governance and valuations: Evidence from selected Indian companies.
International Journal of Disclosure and Governance, 5(3), 236–251.
Kumar, N., & Singh, J.P. (2013). Effect of board size and promoter ownership on firm value: Some empirical
findings from India. Corporate Governance: The International Journal of Business in Society, 13(1), 88–98.
Larcker, D.F., Richardson, S.A., & Tuna, I. (2007). Corporate governance, accounting outcomes, and organizational
performance. The Accounting Review, 82(4), 963–1008.

se
Lehmann, E., & Weigand, J. (2000). Does the governed corporation perform better? Governance structures and
corporate performance in Germany. European Finance Review, 4(2), 157–192.
Lekaram, V. (2014). The relationship of corporate governance and financial performance of manufacturing firms

lu
listed in the Nairobi Securities Exchange. International Journal of Business and Commerce, 3(12), 30–57.
MacAulay, K., Dutta, S., Oxner, M., & Hynes, T. (2009). The impact of a change in corporate governance regulations

ia
on firms in Canada. Quarterly Journal of Finance and Accounting, 48(4), 29–52.
c
Mangunyi, E. (2011). Ownership structure and corporate governance and its effects on performance: A case of
er
selected banks in Kenya. National Journal of Business Administration, 2(3), 1–17.
Mule, R.K., Mukras, M.S. and Oginda, M.N. (2013). Ownership concentration and financial performance of listed
m

firms in Kenya: An econometric analysis using panel data. European Scientific Journal, 9(28), 194–211.
Pattnayak, P.D. (2012). Impact of corporate governance practices on firm performance: An empirical evidence of the
om

small and medium enterprises in India. International Journal of Research in Commerce, IT and Management,
2(9), 119–123.
Retolaza, J.L., Roqueñi, M.R., & San-Jose, L. (2014). Ontological stakeholder view: An innovative proposition.
rc

Global Business Review, 15(1), 25–36.

Sahu, T., & Manna, A. (2013). Impact of board composition and board meeting on firms’ performance: A study of
fo

selected Indian companies. Vilakshan, 10(2), 99–112.

Sarkar, J., Sarkar, S., & Sen, K. (2012). A corporate governance index for large listed companies in India. Indian
Accounting Review, 16(1), 1–16.
ot

Shleifer, A., & Vishny, R. (1986). Large shareholders and corporate control. The Journal of Political Economy,
N

94(3), 461–488.
Sinha, R. (2006). Corporate governance and shareholder value analysis. Global Business Review, 7(1), 1–16.
The Companies Act. (2013). Ministry of Corporate Affairs, Government of India. Retrieved from http://www.mca.
gov.in/MinistryV2/companiesact.html
Vafeas, N. (1999). The nature of board nominating committees and their role in corporate governance. Journal of
Business Finance and Accounting, 26(1–2), 199–225.
Varshney, A., Kaul, V., & Vasal, V. (2012). Corporate governance index and firm performance: Empirical evidence
from India (pp. 1–35). Retrived from SSRN http://ssrn.com/abstract=2103462 or http://dx.doi.org/10.2139/
ssrn.2103462
Xie, B., Davidson III, W.N., & DaDalt, P.J. (2003). Earnings management and corporate governance: The role of
board and audit committee. Journal of Corporate Finance, 9(3), 295–316.

View publication stats