Corporate Governance Index and Firm Performance: Empirical Evidence from India

Abstract

Prior studies using an index of corporate governance to explore the relationship between corporate governance and firm performance have found a positive linkage between the two that is better governed firms exhibit better financial performance. Following the seminal work of Gompers et al. (2003. Quarterly Journal of Economics, Vol. 118, No. 1, pp. 107–155) of creating a Corporate Governance Index (CGI) to study the relationship between corporate governance and firm performance, similar studies have been reported not only from developed markets like Germany, Canada, Hong Kong, Switzerland and Australia, but also from emerging markets like Ukraine, Russia, Greece, Thailand and India. In the present study, we investigate the relationship between corporate governance and firm performance in the Indian context by constructing a Corporate Governance Index (CGI) based on internal and external corporate governance mechanisms. Further, we use value-based performance measure-Economic Value Added (EVA), as the primary metrics to measure firm performance. Besides EVA, traditional measures such as Return on Net worth (RONW), Return on Capital employed (ROCE) and Tobin's Q have also been used to evaluate the linkage between corporate governance and firm performance. Using various econometric techniques, we conclude that there is a positive relationship which exists between corporate governance based on the CGI and firm performance, when the performance is measured in terms of the value-based performance tool-EVA. The relationship could not be validated for the traditional performance tools-RONW, ROCE or Tobin's Q.