Asia Pacific Journal of Research Vol: I. Issue XXXII, October 2015 ISSN: , E-ISSN

Transcription

1 ROLE OF CORPORATE GOVERNANCE ATTRIBUTE OF BOARD INDEPENDENCE IN INFLUENCING INVESTORS BEHAVIOUR IN THE INDIAN CAPITAL MARKET: AN EMPIRICAL STUDY Praveen Kumar Sinha, Research Scholar, Bharathiar University, Coimbatore, Tamil Nadu, India. Dr. K H Anil Kumar Professor, Department of Management Studies, M.S Ramaiah Institute of Applied Sciences, Bangalore, India ABSTRACT Post Enron, Paramalat, Satyam and other scandals, investors all over the world, including India, are according utmost importance to Corporate Governance attributes of firms besides the conventional financial parameters. One of the critical factors of these regulations is the board independence. Indian companies, more particularly firms in the Pharmaceuticals, Automotive and IT sector have to adopt wider governance compliance norms. Corporate Governance norms for listed IT and Pharmaceutical firms in India have not only to comply with SEBI s clause 49 of the listing agreements, but being associated with US firms, implicitly comply with SOX Act, 2002.This has wider connotations for the corporate boards and its directors, both executive and independent. In this context Independent directors have a crucial role to play in the Governance processes of IT firms. Against this backdrop, this paper examines whether Investors in the Indian capital markets accord premium valuations to greater independence of the board. The study is about IT and Pharmaceutical firms listed in BSE200 Index covering a period of 4 years from The proxies considered for firm valuations are ROTA, MVBV and Tobin s Q. Econometric panel data regression show that the results are tenuous, implying indifferent approach by the investors in Indian capital markets to this governance attribute. Key words: Tobin s Q, MVBV, ROTA, Independent directors, corporate governance, IT Firm valuations, JEL classifications G34; G38; K22 Page 141

2 1. Introduction Financial accounting-related corporate governance research has regularly adopted an agency perspective of corporate governance, which characterizes the separation of ownership and control that is indicative of many large corporations. (Benkel, Mather and Ramsay, 2006). Corporate Governance attributes in the IT and IT enabled services, in India have unique characteristics. This is primarily due to their rendering services to firms in US and Europe. They not only comply with clause 49 of the listing agreements of SEBI, but also implicitly comply with SARBANES OXLEY Act, Similarly the Pharmaceutical firms.while some of them are listed, other market their drugs in the US markets which are subject to FDA approvals. In this context study of these two sector companies (manufacturing and service).independent directors besides adding value to the firm by bringing in their expertise can improve the governance process. Regulators in India, expect that the independent directors remain truly independent. Currently this has a greater relevance because many Indian firms are into foreign acquisitions, cross listing etc. There are benefits of cross-listing. (Black and Khanna) (2007) The objective of this paper is to examine, the impact of independent directors on firm valuations The results of Panel data econometric regressions covering, over a period of 4 years, from show that investors are indifferent to this Governance attribute in terms of firm valuations proxied by ROTA. Chapter 2 deals with literature review and Chapter 3 deals with methodology. Results of regressions, analyses and conclusions are dealt in chapter Literature review Divergent views exist as to whether boards must tradeoff advising for monitoring performance when utilizing independent directors versus inside/dependent directors. Inside/dependent directors can enhance the quality of board s decision making process due to access to important proprietary information and non-ceo related information and external career opportunities, thereby enhancing shareholder wealth [Coles, Daniel, and Naveen (2008), Masulis and Mobbs (2009) and Raheja (2005)]. Besides reputation concerns provide strong incentives for them to act in the best interest of shareholders (Masulis and Mobbs, 2011). Contrasting this view is that these directors may not counter the actions of the CEO which erode shareholder s wealth. Corporate scandals are the live examples of the same. However there is tenuous empirical evidence linking more independent directors to higher shareholder valuations ( Heracleous, 2001; Bhagat & Black, 2002 ). Findings of Duchin et al., (2010), is that the effectiveness of outside directors depends on the cost of acquiring information about the firm. When the cost of acquiring information is low, adding independent directors on the board improves firm performance and the same can worsen when the cost of information is high. It is widely believed by all stakeholders that, outside directors can more capably monitor the CEO s activities (Hermalin & Weisbach, 2003). Fogel, et al., (2014) find that firms with powerful independent boards have economically and statistically significantly higher firm valuations, fewer value-destroying takeover bids, more performance-related CEO pay and less earnings manipulation. Page 142

3 Fama (1980), Fama and Jensen (1983), Demsetz (1983), observe that reputation criterion in the labor market motivates independent director to work for improved firm performance. However Fosberg (1989), Bhagat and Black (2002) contrast the above notion that improved performance of a firm is partly attributed to greater board independence. Indian context Research evidence in India is recalcitrant about the role of independent directors in the Corporate Governance landscape. Garg (2007) finds positive impact of board independence on firm performance is more when the percentage of independent directors on the board is between 50 and 60 per cent. Beyond that, their monitoring role is not effective. In their research study about the relationship between multiple directorships, busy directors and firm performance, Sarkar and Sarkar (2009), find positive correlation between independent directors holding multiple directorships and firm values. Supporting agency theory Jackling and Johl (2009) find that, in case of Indian companies, a greater proportion of outside directors on boards is associated with improved firm performance. Bijalwan and Madan (2013) find that both the number and proportion of outside directors are positively and significantly correlated to the firm performance. Above notion is not supported in the study by Lange and Sahu (2009) of Indian companies who show that as long as there is more insider control, proportion of independent directors may indicate formal compliance driven with the Clause 49 rather than the desire to meet international corporate governance benchmarks. Equally Varottil (2010) is also skeptical about the effectiveness of board independence in India. Balasubramanian, Black and Khanna (2010) observe that over compliance with respect to board independence does not produce valuation gains due to India's legal requirements being sufficiently strict. Kumar and Singh (2012) studied efficacy of outside directors on corporate boards of 157 non financial Indian companies for the year Their study revealed that proportion of independent directors had an insignificant positive effect on firm performance. In support of the convergence of interest hypothesis Berkmana et al., (2005), Sarkar and Sarkar (2000) find that, the proportion of independent directors on the board is negatively related to the firm performance. Similarly Chugh, et al., (2011) find that an excessively autonomous board (high proportion of independent directors) lowers firm performance. Singh and Gaur (2009) in the study based on archival data on the top 500 Indian and Chinese firms for the year 2007, found that board independence had a negative effect on firm performance 3. Methodology 3.1: Sample selection The sample in the current study consists of the IT and Pharmaceutical companies listed in BSE200 INDEX which are most actively-traded companies listed in the Stock Exchange over the period The data pertaining to the number of independent directors has been hand collected from the Annual reports of these companies. Financial data is collected from Prowess data base of CMIE Page 143

4 3.2 Independent and Dependent variables The explanations of dependent; independents; and control variables are presented in Table 1. Table 1: Dependent; Independents and Control Variables Variables Measurements Dependent variables ROTA EBIT/Assets Independent variables Board independence No of independent directors on the board as indicated in the Annual reports complying with clause 49 of the listing agreements (referred to as BoardInd.) Control variables Margin In sales In assets EBIT/Income Natural logarithm of sales/income Natural Logarithm of assets Regressions: Cross sectional, Pooled, Fixed effect and Random effect regressions were conducted. Besides Hausman and Breusch Pagan test are conducted to ascertain the applicability of Fixed effect and Random effect regressions Correlation matrix, multicollinearity analysis and auto correlation Multi collinearity in explanatory variables has been diagnosed through analyses of correlation factors and Variance Inflation Factors (VIF). Acceptable levels of VIF for individual variables are 10 (Bowerman & O'Connell, 1990; Neter et al., 1989). Durbin Watson value of 2 indicates no autocorrelation. If it is substantially less than 2, there is evidence of positive serial correlation. Values less than 1.0, may be cause for alarm indicating successive error terms are, on average, close in value to one another, or positively correlated. Page 144

5 4. Analyses and discussions Table 2a reports the descriptive statistics of the variables considered in the study. Table 2a Descriptive Statistics: IT sector companies IT firms Pharmaceutical firms Variables Mean Std. Deviation N Variables Mean Std. Deviation N ROTA tobin's Q BoardInd BoardInd ln sales ln sales ln assets ln assets Margin margin Table 2 b Correlation coefficients Matrix of the variables used in the study: IT Variables Tobin's Q BoardInd. ln sales ln assets margin ROTA BoardInd ln sales ln assets Margin Table 2b presents the correlation matrix of the variables used in the study, from which, it has been observed that the highest simple correlation between independent variables was 0.953between ln assets and ln sales. The correlation between brdind and tobin s Q is 0.225The Confidence Interval is 95.0%. Unreported t values are not statistically significant for the board independence attribute. Similarly the Durbin Watson value is 1.657, near to an ideal value of 2 indicating smaller but acceptable amount of auto correlation The following set of tables report the results of pooled, fixed and random effect regressions using Tobin s Q as the dependent variable. The data set considered is for 4 years from Page 145

6 Table 3a: pooled regressions-it firms ROTA Coef. Std. Err. t P>t [95% Conf. Interval] BoardInd * ln sales ln assets Margin *** _cons Source SS df MS Number of observation 36 F( 4, 31) Model Prob > F 0 Residual R-squared Adj R-squared Total Root MSE Table Correlation coefficients Matrix of the variables used in the study: Pharma Variables ROTA BoardInd. ln sales ln assets Margin ROTA BoardInd ln sales ln assets Margin Page 146

7 Table 3a presents the correlation matrix of the variables used in the study, from which, it has been observed that the highest simple correlation between independent variables was 0.953between In assets and In sales. The correlation between brdind and tobin s Q is 0.225The Confidence Interval is 95.0%. Unreported t values are not statistically significant for the board independence attribute. Similarly the Durbin Watson value is 1.657, near to an ideal value of 2 indicating smaller but acceptable amount of auto correlation The following set of tables report the results of pooled, fixed and random effect regressions using ROTA as the dependent variable. The data set considered is for 4 years from Table 3b: pooled regressions-pharma ROTA Coef. Std. Err. t P>t [95% Conf. Interval] Brdind Lnsales Lnassets Margin _cons The coefficient of BoardInd. is negative and significant at 10% levels. The coefficient of margin value is positive and significant at 1% levels. Conclusions From the above analyses it can be inferred that board independence per se is not a critical factor as governance attribute for all the firm valuation measures. To put differently, Investors in Indian capital markets is not willing to pay a premium for greater board independence. The investors are not able to perceive that, the presence of independent directors can add value. In this context it is relevant to quote the findings of Balasubramanian, Khanna and Black (2010) who observes that over compliance with respect to board independence does not produce valuation gains due to India's legal requirements being sufficiently strict. Limitations While outliers have been excluded, some firms have to be excluded due to insufficient data which could have a bearing on the outcomes. Besides the panel data is for 4 years, span of which could have been increased for better inference. Page 147

8 References: A. Balasubramanian, N., Black, B.S and Khanna, V.S. (2010). The Relation between Firm-Level Corporate Governance and Market Value: A Study of India. Emerging Markets Review, 11, (2), B. Benkel.M, Mather. P and Ramsay, A. (2006). The Association Between Corporate Governance And Earnings Management: The Role Of Independent Directors. Corporate Ownership & Control,3, (4), C. Berkman,H., Cole. R.A., Lee, A and Veeraraghavan, M. (2005). The Effect of Board Composition and Ownership Structure on Firm Performance: Evidence from India. Research / Board Composition, India_2005. D. Bhagat, S and Black, B. (2002). The Non-Correlation between Board Independence and Long-Term Firm Performance, Journal of Corporation Law, 27, (2), E. Bijalwan. J. G and Madan, P. (2013). Board composition, Ownership structure and Firm performance TIJ's Research Journal of Economics & Business Studies, 2, (6). F. Black, B, S and Khanna, V. (2007). Can Corporate Governance Reforms Increase Firm Market Values? Evidence from India. Journal of Empirical Legal Studies, 4, (4), G. Byrnes, N., Dwyer, P and Thornton, E. (2003). Who s making the Grade: A Performance review for CEOs, Boards, Analysis and Others? sites.google.com/site/./cg.../corporate Governance and Firm Performance. Pdf accessed: 16 th April, H. Demsetz (1983). Structure of ownership and theory of firm. Journal of law and economics, 26, (2), I. Duchin, R., Matsusaka, J and Ozbas. O. (2010). When Are Outside Directors Effective? Journal of Financial Economics, 96, (2), J. Fama, E. F. (1980). Agency Problems and Theory of the Firm. Journal of Political Economy, 88, (2), K. Fama, E. F and Jensen, M. (1983). Separation of Ownership and Control. Journal of Law and Economics, 26, (2), L. Fosberg, R. (1989). Outside directors and managerial monitoring. Akron Business and Economic Review, 20(2), Page 148