Posted: July 13th, 2021
Many previous studies have been conducted over the last decade which were focussed on examining the Corporate Governance issues and the corresponding effect on firm performance. However, these studies have analysed firm related corporate issues throughout the world but were not specific to Indian context. In addition, literature on corporate failure prediction in India was focussed on financial information but not on corporate governance issues (Bilderbeek, 2005). Moreover, there was no theoretically grounded literature that underpins the importance of board variables in Indian corporate failure and answers why Indian firm fails. To fill this gap, this paper focusses on looking at these attributes and link them to corporate failure in Indian corporate regime.
From the perspective of regulatory framework of the Indian firms and their related ownership structure (in which private companies are controlled by the single family and public companies are controlled by the government), corporate governance system of India is attracting the international attention. However, among twelve Asian countries, India is still a long way in matters to do with quality of corporate transparency and governance (Pao, 2012).
The financial crisis of the year 2008 was majorly linked to structural corporate weaknesses in Indian market and financial institutions (Choi, 2009). According to Ho (2012), over the last few years, firms in India are finding solution to come up with their corporate structures more accountable and transparent to restore the confidence of international investors. Further, the recent Enron scandal in U.S. and collapse of Satyam Computer Systems (India’s Enron) have underscored the basic significance of auxiliary changes in India (Needles, 2014). For example, reformers in India shifted their focus on enhancing board’s effectiveness and board diversity to get good capital for firm’s to thrive (Smith, 2009). In light of this scenery, an examination on corporate administration and corporate disappointment in Indian setting appears to be significant as a result of India’s stature in rising economies.
The term ‘Governance’ signifies ‘to guide’ (Solomon, 2010), suggesting that “corporate administration incorporates the capacity of bearing instead of control” (Mayer, 1997, p.81). As per Tricker (1984), the job of administration incorporates maintaining the business and fulfilling responsibility desires by supervising the official activities in firm. Dore (2000) in any case, proposed two ideal models to characterize the corporate administration to be specific Stock Market and Welfare State Capitalism. In light of securities exchange worldview, Keasey, Thompson and Wright (1997) characterizes corporate administration as “it incorporates structures, procedures, societies and frameworks that lessen primary and operator struggle and along these lines, guarantees that firm is running to support the investors”. Solomon (2010), nonetheless, then again contends that it is likewise imperative to think about the more extensive interests of representatives. Solomon (2010) therefore, characterizes corporate administration as “both inside and outer instruments which guarantee that organizations release their responsibility to every one of their partners” (p. 67). Shleifer and Vishny (1997) also considered legal and financial institutions in defining corporate governance mechanisms.
This paper however considered the classical meaning of corporate governance in the Indian context in which most studies on this topic are referenced to the qualitative approaches using legal documents (Jenkinson & Mayer, 2012). Further, this paper focusses on historical perspectives of corporate governance and related practices by Indian firms.
Corporate governance of the Indian system and related corporate practices are in undeveloped stage compared to other industrially developed countries (Gopalswamy, 2018). There are no previous studies that were focussed on specifying the impact of board attributes in Indian corporate regime but many Indian authors have addressed the issues of corporate governance in Indian systems (Banerjee and Das, 2006) which helps in shaping the understanding of this paper’s objective of examining the link between corporate failure and board attributes.
One study done by Mukherjee and Reed (2004) explores that majority of the Indian companies have shares which are concentrated in small group of shareholders or in one family, eventually increasing the number of shareholders in firm. Banerjee and Das (2006) further argued that institutional investors in Indian corporate sector plays a major role in investing on behalf of those institutional investors invest. Over the last decade, institutional investment has increased significantly which have strengthen the Indian corporate structure (Klapper & Love, 2002).
Sarkar and Sarkar (2004) emphasized on government practices and activities pertaining have positively advances because of changes in corporate governance. Sinha (2004) believed this is because of increased transparency brought by globalization which shifted the focus of Indian companies towards new strategies by aligning their company’s core objectives in the market driven economy. This paper also insinuates that corporates who achieved good governance by maintaining the balance between social commitment and profitability are more successful in long run.
Current corporate norms and disclosures in India are now restricted to Clause 49 (regulated by Securities and Exchange Board of India) that are now mandatory for Public limited companies in India (Birla, 2017). These norms are however, more focussed on information disclosures and rules for setting corporate governance committees but didn’t define how these committees should be formed (Birla et al., 2017). According to a recent Corporate Governance Report of Indian companies by Hyuan (2016), Infosys was ranked one in having of the best corporate governance model in India. It now becomes the most transparent company in India and has set the trend of information disclosure by sharing non mandatory and mandatory information in annual published reports (Hyuan et al., 2016). As the result, the financial performance of Infosys is always strong in Indian market. However, according to Beasley (2004), companies having good corporate practices do not necessarily have good financial performance as well as share price in the market. Bharti Airtel is one such exception in Indian market. Despite having good governance practices in paper, the financial analysis tells a completely different perspective of the company.
According to guidelines set by SEBI, the public companies in India have to follow the prescribed policies and norms regarding corporate governance. These norms clearly indicate that company must have external auditors to ensure that their performance is related with the Indian corporate practices.
A sound regulatory legal framework and its enforcement are the key pillars upon which good corporate structure of any country is built (Lange & Sahu, 2008). An ideal framework in industrially developed countries is designed in such a way that it protects the rights of majority of stakeholders and is oriented towards the international corporate governance norms (Lange et al., 2008). Well developed economies have corporate governance norms that are instituted through legislation, free volition, and regulation (Lange & Sahu, 2008).
However, in India, apart from legislation and regulation, central bank and societal pressures plays a major role in adapting corporate governance norms. In others, intervention of professional bodies and regulatory agencies are also significant. Initiatives taken by central bank are generally guided by the adaptation of best international corporate practices. Social pressures from the Indian economy, however impact the legislative demands regarding community development and concerning ecology.
Previous empirical studies done in the Indian context has try to find out the impact of corporate governance issues on the organizational performance but the question of how Indian firms got into Corporate failure process is neglected. To address this gap, this paper uses agency and resource dependency perspectives to examine the significant insights related to corporate failure in Indian system. However, based on the previous research done in Indian context, following parameters are considered to have significant effect on the firm’s performance in Indian Market: (1) Board structure, (2) Board composition, and (3) Information disclosures (Veliyath, 1999).
Based on Zahra and Pearce‘s (1989) study, this paper suggests board composition includes board size (i.e. number of directors) and type of directors (inside or outside directors). However, board structure covers other dimensions of board that includes board committees and its associated memberships. Zahra and Pearce‘s (1989) review suggests that composition of board influences the director’s characteristics which in turn affects board structure. Keeping that valid in mind for Indian corporate systems, this paper considered board composition and board structure as important board attributes.
To address these parameters, first, this paper review the literature on the aforementioned-theIn light of Zahra and Pearce’s (1989) consider, this paper proposes board sythesis incorporates board estimate (for example number of executives) and sort of chiefs (inside or outside chiefs). In any case, board structure covers different elements of board that incorporates board councils and its related participations. Zahra and Pearce’s (1989) survey recommends that organization of board impacts the executive’s attributes which thusly influences board structure. Remembering that substantial for Indian corporate frameworks, this paper considered board organization and board structure as significant board characteristics.
Eisenhardt (1989) considered agency relationship as universal in which work is given to agent by principal. In this view, Davis, Schoorman and Donaldson (1997) contend that separation of powers among shareholders in Indian firms due to individual ownership and control in Board structure has resulted in agency problems. Further Gomez-Mejia, and Wiseman, (2007) emphasizes that this Board composition allows Board members to extract perks from firm’s assets and further seek their interest by excessive increase their compensation. By pursuing different diversification strategies top management and shareholders maximizes their own wealth rather than maximising the firm’s wealth (Goforth, 1993).
In view of these reasons, Jensen and Meckling (1976) considered firms as a collection of groups having various conflicting interests. Thus, for this reason, agency theory examines the principal-agent relationship and focusses on determining the best effective contract to govern the principal agent relationship (Meckling, 1976). Fama (1980) further concluded that for the firm to survive, conflicts among principal and agent must be minimum and this relationship should reflect the efficient channels of information and risk bearing cost.
Moreover, agency scholars such as Jensen and Meckling (1976) endorse different alternatives and governance structures to minimize the agency cost. This in turn, helps to bridge the gap between goals of principal and agent which in turn moderated the agency loss by enhancing the firm survival (Wiseman, 2007).
Fama and Jensen (1983) further advocates that firm’s survival can be enhanced by undertakings where agency problems can be controlled by proper checks on decisions and firm’s management. Similarly, Smith and Jensen (2000) argue that Board plays a major role in enhancing the firm’s survival. According to Jensen and Meckling (1976), board needs to play the function of critically monitoring and rewarding the board members to reduce the agency cost, which in turn reduces the chances of firm’s failure.
According to Picher, Chreim and Kisfalvi (2000), board’s monitoring task includes succession planning of board members and CEO based on their performance which is necessary to ensure that shareholder’s value is being maximized (Tian, 2012). Fama (1980) concluded that to be effective monitors of top management and CEO, board composition plays an important role in determining the board’s ability in monitoring tasks. Hoskisson (1990) stressed that monitoring the task of top management is the task of both inside and outside directors.
Hillman and Dalziel (2003) also confirmed this notion but concluded that loyalty of inside directors towards top management and CEO may reduced their ability to provide fair evaluation, increasing the chances of firm failure. Accordingly, Board composed of outside directors enhances the viability of the board and oversees the firm management (Simpson, 2003). Further, Lorsch and Maciver (1989) concur that outside directors act as adjudicators among inside directors to resolve various agency problems.
However, Banerjee (2002) highlights that corporate community in India is composed of more inside dominated boards. Audit committees in small Indian firms doesn’t include any independent executive and non-executive directors. However, bigger firms in India does stipulates that half of their board members are non-executives excluding the Chairman and Director (Das, 2012).
However, the impact of board composition on the firm performance is positive in Indian context despite of higher information asymmetry in Indian firms (Baig, 2011). In addition, Elloumi (2006) emphasized that Indian firms with large number of external directors are facing less financial pressure from other firms in the market. Daily (2007) also highlights that Indian firms with more independent directors survived the financial crisis of 1990’s and 2008. Therefore, it is concluded that independent directors present in Indian firms are positively impacting the firm performance. At present, failing firms in India are trying to invoke their corporate governance regimes by replacing their firm’s top managers and CEO.
Another contributing factor to corporate failure in Indian system in addition to shareholder-executive conflict includes the shareholder-creditor conflict. Agency theory also highlights the creditor-shareholder conflict as major cause of firm failure (see Jensen and Meckling 1976 agency logic). Aveni (2009) identified three major sources of conflicts between shareholders and creditors in high performance Indian corporate firms: (1) asset substitution, (2) dividend pay-out, and (3) dilution of claim.
Concerning these conflicts, Myers (2009) argued that interests of current creditors in Indian market are endangered as shareholders are taking many undue risks. Majority of the shareholders in small Indian firms are assuming strategies that are risky for their creditors. However, in their study, Singh and Davidson (2003) highlights that these contradicting relationships between creditors and shareholders is because of difference in corporate culture and practices in India compared to corporate culture of international system. In the Indian corporate culture. Agency theory, therefore highlights the importance of outside directors in removing this distress among firms by resolving the shareholder-creditor conflicts.
Despite of this study, literature on how agency theory links the composition of boards and its structure with corporate failure of Indian firms is limited. Therefore, this paper examines the presence of outside directors and women representation on boards and corporate failure. Further, to compliment the agency theory and to link information disclosures and corporate failure, the analysis of the paper is shifted towards resource dependence theory.
This section discuss the direct effect of board attributes on the performance of Indian firms via multi theoretical approach. In first section, this paper briefly examines the link between board attributes and corporate failure using agency theory. Next section follows with presenting the link between resource function of boards and information disclosures with corporate failure using resource dependence theory.
Agency theory underscores the significance of how board composition can be linked to corporate failure. Using agency theory, composition of board exactly mirrors the degree to which board is being controlled by CEO and vice versa (Wincent, 2012). Erkens, Hung, Matos (2012) suggest that the power of board is generally strengthened by the greater proportion of the outside directors in board. As discussed earlier, agency theory also highlights the presence of outside directors as essential for the board monitoring. In addition, resource dependence theory also suggest that the characteristics of the firm environment are reflected by the board composition, enhancing firm’s ability to avoid corporate failure.
Peasnell, Pope, and Young (2005) suggests that larger boards enhances the functions of directors as directors are not prone to the dominance of CEO. Further, the resources available for the firm to survive significantly increases because of diversity in board in terms of skills, education and value (Mahadeo, Soobaroyen and Hanuman, 2012). Recent evidence in the Indian context also suggests that board size have significant impact on the firm’s financial performance. Hanuman (2012) conclude that Indian firms with diverse boards are performing good in the Asian markets, due to presumed diversity in the strategy formulation and their ability to monitor the board functions. Based on the discussed literature on corporate failure in Indian context, the paper limits the discussions to board size and board interdependence.
Eisenberg, Sundgren and Wells (1998) suggested to have a large board size to resist the control of CEO power, thereby, reducing the agency problems by providing firm the access to critical resources. Chaganti, Mahajan and Sharma (1985) also highlights the importance of larger boards for Indian firms. Mahajan (2007) also confirms this notion and founds a positive relationship between board size and firm performance for Indian corporate system. In particular, Chanchart, Krishnamurti and Tian (2012) suggest that in such a large Indian market breath, where financial variability is high, firms need to have large boards to have access to critical resources, and in this way the firms can avoid making risky decisions.
This paper refers to the definition given by Daily and Dalton (1992), in which inside directors are classified as employee directed directors, while outside directors are all non-employee directors. Zahra and Pearce (1989) suggests that independent directors are more effective monitors of the CEO than interdependent directors. Chancharat, Krishnamurti and Tian (2012) also seems to converge on this notion in Indian corporate system. Krisnamurti (2008) in the empirical study suggests that inside directors can’t be seen as an effective monitors of CEO in the Indian firms because of their loyalty towards CEO.
However, Kumar and Sivaramakrishnan (2008) came up with another empirical study in which they documented the benefits of having inside directors. They argue that for high performance firms, board members need to possess critical knowledge of the firm and needs to be in a position to provide oversight. Gales and Kesner (2014) further indicates that having large proportion of outside directors can lead to politicise the process of corporate governance in large firm and may turn into top management corporate conflict. Mahajan and Sharma (2015) confirms this notion and implies that inside directors play an informational role in making strategic decisions.
Despite these contradicting views, using resource dependence perspective, I speculate that in time of financial crisis, Indian firms seek more support from outside directors to have alternate views on the board. Based on Pfeffer and Salancik (1978) study, I believe Indian firms through their network of contact with outside directors, reduces their likelihood of their corporate failure by putting diverse background and independence on the board. Put simply, outside representatives on board provides access to valued resources and thus enhances legitimacy of the firm.
Moreover, in India, the issue of non-executive directors present on the board is addressed in Indian regulatory framework. The new amendments in Clause 49 recommends that more than half of the board including chairman of the firm should be an outside board member to have positive performance in Indian corporate regime. Accordingly, this paper also agrees with the notion that outside directed boards are more effective boards in Indian context.
Faleye, Hoitash and Hoitash (2011) suggests that internal structure of boards is the major reason of corporate failure in Indian firms. This paper suggests that board structure of Indian firms refers to key decisions taken by board committees, impacting the decision making of firm’s CEO, which in turn effects the quality of decisions made by board members, and ultimately can lead to corporate failure. Jensen (2003) argues that size of board or size of decision making negatively affects the propensity of firms to absorb risks. Therefore, for this reason, agency perspective suggests effective board structure as a major condition for effective board monitoring function by outside directors.
Kumar (2008) confirms this notion and highlights that audit committees in Indian firms enhances the managerial accountability of board members. Further, Kumar et al. (2006) confirms that remuneration committees similarly lessens the agency problems in Indian firms by enhancing the mutual interests of board with shareholders. Based on this literature, this paper limits the discussion to two main board oversight committees: audit and remuneration.
Using agency lens, this paper explores the accountability literature in Indian corporate sector to explore different mechanisms of transparency and audit committees and to reduce the agency problems. Cohen, Krishnamoorthy and Wright (2012) noted audit committees as the standard mechanisms for corporate governance in India. They found it essential to protect the shareholder’ interest and information asymmetries for Indian firms. Put simply, Cohen, Krishnamoorthy and Wright (2012) concludes that effective audit committees leads to higher transparency in Indian corporate sector and thus, improve the quality of the financial statements in firms.
However, based on the recent financial scandals and corporate failures in Indian context, the concerns regarding the adequacy of monitoring provided by audit committee increases. Therefore, Indian regulatory framework based on US Sarbnes-Oxley act (2003) suggests three main roles for audit committees in Indian firms: (1) size, (2) independence, and (3) activity (Beasley, 2014). Based on this analysis, the paper concludes the monitoring function of audit committees as an essential function to improve the information flow between agent and principal in Indian firms, and therfore, improving the firm’s performance.
Remuneration committees, primary function on other hand is to monitor the effectiveness of inside directors and proposing suitable reward packages to motivate directors to manage the firm effectively. However, according to Imhoff (2013), these compensation practices are more inclined towards CEO in Indian context and argues to set up particular guidelines regarding remuneration committees in Indian corporate system to ensure that CEO reward is set at right level. Gopalswamy (2014) also suggests the lack of independent executives in remuneration committees in Indian corporate regime and highlights the concerns regarding large pay increases for top management executives and CEO at shareholders expenses. However, little is known about the impact of remuneration committees on the firm performance in Indian context. To fill this gap, this paper hypothesize the negative association between remuneration committees and corporate failure in Indian context, based on agency perspective.
Concluding, this section provides a link between corporate failure in Indian firms and two perspective theories: agency and resource dependence theory. Using these theories, this paper theoretically stimulates the study in Indian corporate failure. As suggested by Kosnik (1987), agency theory perspective is better integrated and developed by researchers for the corporate control but this paper compliments both agency and resource dependence theory to identify the main board attributes that can effect the performance of Indian firms and can lead to corporate failure.
This paper studies the relationship between board attributes and corporate failure in Indian firms from the perspective of agency and resource dependence theory. The paper begins with providing a background to Indian corporate governance and then examine the previous research concerning corporate problems in Indian corporate sector. This paper study the governance practices in India and related corporate problems in accordance to Indian regulatory framework, which is discussed in brief. Further, the paper examines the association between corporate failure and board size, director’s type as well as effectiveness of audit and remuneration committee. Based on this analysis, this paper concludes that Indian corporate sector is still facing some core problems in corporate governance which includes; (1) lack of independent directors, (2) Smaller board sizes, (3) Influence of shareholder’s group, and (4) weak enforcement of corporate rules.
To reduce these corporate problems in Indian sector, this paper suggests professional institutes like Charted accountants of India, Institute of company secretary of India to take up research projects with Indian universities to identify various unresolved corporate issues in Indian context and help Indian firms to find out solutions. Similarly, Indian universities can also taker up minor projects, funded by Corporate Grant commission, New Delhi, to improve the corporate governance in Indian firms.
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