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 i.e. better governed firms exhibit better financial performance. Following the seminal work of Gompers, Ishii, and Metrick (2003) of creating a corporate governance index 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 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 Networth, Return on Capital employed 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 exists between corporate governance based on the corporate governance index and firm performance, when the performance is measured in terms of the value-based performance tool – Economic Value Added (EVA). The relationship could not be validated for the traditional performance tools – RONW, ROCE or Tobin’s Q.