Does Corporate Governance Influence Firm Value? Evidence from Indian Firms

Abstract

This paper examines empirically the effects of ownership structure on the firm performance for a panel of Indian corporate firms, from a corporate governance perspective. We examine the effect of interactions between corporate, foreign, institutional, and directorial ownership on firm performance. Using firm level panel data framework, we show that a large fraction of cross-sectional variation, in firm performance, can be explained by unobserved firm heterogeneity. We also provide evidence that the shareholding by institutional investors and managers affect firm performance non-linearly, after controlling for observed firm characteristics and unobserved firm heterogeneity. Institutional investors monitor the firm once their stake is more than 14 percent in the firm, and directors have a positive effect on firm performance after 25 percent of the ownership in the firm. We also find that the equity ownership by dominant group influences firm-performance, only in case of directorial ownership. We find no evidence in favor of endogeneity of ownership structure. In this paper, we examine whether differences in ownership structure across firms can explain their performance differences in an emerging economy like India. Using detailed ownership structure of more than 2000 Indian corporate firms over the period 1994-2000, we provide answer to some of the questions raised herewith. Does ownership structure matter? If it does, then, whether government ownership is more effective than private (including foreign) ownership in maximizing firm value? Does the identity of shareholder matter? What is the comparative efficiency of several forms of private ownership? What is the preferred ownership structure for privately held firms? Is ownership structure really endogenous? Can ownership be a tool to control agency cost? These are some of the important questions, which researchers are trying to explore in the recent literature of corporate finance. In this context, we investigate Indian corporate firms in order to provide new evidence on how ownership structure influence firm value. Corporate Governance is the system of control mechanisms, through which “the suppliers of finance to corporations assure themselves of getting a return on their investment”, (Shleifer and Vishny (1997)). The classical problem lies within the separation of ownership and control, i.e. the agency cost resulting from a divergence of interest between the owners and the managers of the firm (Jensen and Meckling (1976)).