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Corporate Governance Practices Of Indian Listed Companies

Abstract:

The paper uses disclosure scores to examine corporate governance practices of Indian listed companies. A content analysis of 50 companies listed on the NSE has been carried out. A disclosure index compiled by S&P has been developed to determine how much listed Indian companies disclose. This study reveals that Indian companies are quite transparent. The research findings shall enable the investors in estimating how much disclosure listed Indian companies make. It will also add to the increasingly inadequate literature relating to corporate governance and disclosure practices in developing countries. This study though has limitations since the focus lies only on 50 companies listed on the NSE which are the largest and most followed stocks and may not represent all Indian companies.

Contents

Chapter 1: Introduction

Introduction

Corporate governance has received increased importance in the aftermath of collapses of large companies worldwide such as Enron and WorldCom. Economies worldwide are now realizing the importance of good governance (Standard & Poor’s 2008).

The developed countries realized the importance of governance mainly following corporate scandals of the west (Reed, 2002). In some cases these scandals led to a direct response e.g. the Cadbury Report (Boyd, 1996 cited in Reed, 2002, p.228). On the other hand, in developing countries such as Brazil and India, poor economic performance had often led to economic crisis. Consequently, these countries came under the control of bodies such as International Monetary Fund and World Bank. These bodies impose many regulations which require increased attention to governance issues (Reed, 2002).

As opposed to developed countries, developing countries paid no attention to governance issues until the financial crisis of East Asia in the late 90s (Oman C., 2003, Mangena and Tauringana, 2007). However, Sobhan and Werner (2003) view that these countries started giving importance to governance issues not because of the East Asian financial crisis but by problems in their own financial markets. Goswami (2003) reiterates this by writing that corporate governance movement began in India due to some corporate scandals that came to the forefront during the first phase of economic liberalization in the country in 1991.

Transparency and disclosure are at the heart of corporate governance. Transparency and disclosure helps reduce the information gap between the management of a company and its shareholders and thus helps resolving agency issues in corporate governance (Patel, Balic and Bwakira, 2002).

Background

Fig. 1 below depicts clearly that India ranks quite high among the developing countries with respect to its governance practices next only to South Africa and Poland.

Figure : Governance Ratings of Developing Countries, 2008 (Source: Governance Metrics International)

Corporate Governance in India

As opposed to developed countries, developing countries paid no attention to governance issues until the financial crisis of East Asia in the late 90s (Oman C., 2003, Mangena and Tauringana, 2007). However, Sobhan and Werner (2003) view that these countries started giving importance to governance issues not because of the East Asian financial crisis but by problems in their own financial markets. Goswami (2003) reiterates this by writing that corporate governance movement began in India due to some corporate scandals that came to the forefront during the first phase of economic liberalization in the country in 1991.

One of these was a major securities scam of over Rupees 35 billion (Rupee 1 = £ 0.0125, approx.) that was uncovered in April 1992 which involved a diversion of funds from the banking system to stock brokers for financing their operations. Bank executives, brokers and even politicians came under the scanner. The stock market had to be shut down for an extended period. Investors and brokers panicked. This led to the first step towards corporate governance in India when the Securities and Exchange Board of India (SEBI) was created by an act of Parliament to protect the interest of investors in the securities market and to regulate the stock market (Goswami, 2003).

In 1998, the Confederation of Indian Industry (CII), an industry association published India’s initial corporate governance code, the implementation of which was voluntary by companies and thus very few companies adopted it. Until 2000, the CII Code was India’s only corporate governance guideline. In 1999 the Securities and Exchange Board of India (SEBI), constituted a committee to promote and raise the standards of corporate governance in India which was patterned on UK’s 1992 Cadbury Report. On the recommendations of this committee, a new clause 49 was incorporated in the Stock Exchange Listing Agreements (“Listing Agreements?). Since 2001, the CII Code has been supplemented by Clause 49 of the Listing Agreement (SEBI, 2003). These corporate governance requirements are applicable to all listed companies in India (Government of India, 2009 and SEBI, 2009).

Aims, Objectives and Research Questions

The aim of the research is to develop an understanding of the practices of corporate governance in developing economies by investigating the disclosure practices of Indian listed companies. This study will cover 50 companies listed on the National Stock Exchange (NSE) which comprise the NIFTY which is the benchmark index of the NSE. S&P CNX Nifty is a well diversified index comprised of 50 stocks across 23 sectors of the economy.

The objectives of this study are:

To develop an understanding of the importance of corporate governance and transparency and disclosure using literature review;

To examine Practices of corporate governance of listed Indian companies using content analysis by studying annual reports of the companies and allocating disclosure scores.

The study addresses the following research question:

RQ1. How far are Indian listed companies transparent and how much do they disclose?

Structure of the project

The rest of the research is organized as follows. Chapter 2 provides a review of the relevant literature followed by research design and methodology in Chapter 3. Chapter 4 presents the findings and discussion. The study ends with chapter 5, conclusion which outlines the main points and findings of this study together with limitations and also raises future research questions.

Chapter 2: Literature Review

Introduction

In the sections that follow, the existing literature on corporate governance and disclosure is reviewed. This chapter is divided into three parts. The first part discusses the importance of corporate governance; the second part presents the agency theory. The third part provides a discussion of the importance of disclosure and transparency and its relation with corporate governance.

Corporate Governance is an issue of growing importance in developing countries. The Cadbury Report (1992) defines corporate governance as the system by which businesses are directed and controlled.

“Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.?

-The preamble of the Organization for Economic Co-operation and Development Principles, 2004 (OECD)

Though there have been several studies on corporate governance in developed countries, very little work has been done on developing countries. Most studies have been limited to specific countries. Developing countries encounter a lot of problems such as less developed and illiquid capital markets, economic uncertainties, and weak legal controls and investor protection (Rabelo and Vasconcelos, 2002). Due to these reasons, effective corporate governance in these countries is essential (Tsamenyi, Enniful-Adu and Onumah, 2007).

Importance of Corporate Governance

Good corporate governance in companies and also across the whole economy helps in providing a level of assurance necessary for the appropriate performance of a market (OECD, 2004). If the governance is weak, equity markets will be thin and thus there will be slower economic growth. On the other hand, in countries where corporate governance systems are strong (like stronger accounting standards), better investment and growth performance can be achieved (Gugler, et al., 2003).

Institutions when making investment decisions, give a lot of importance to the fact as to whether the companies follow the basics of corporate governance. Thus if countries wish to attract capital for a long time, they must follow the globally accepted governance principles. Good governance also helps increase the confidence of investors within the country and thus helps reduce the cost of capital (OECD, 2004; La Porta et al, 1998; Bopkin & Isshaq, 2009). Foreign investors refrain from investing in developing countries because of weaker governance mechanisms in these countries (Mangena & Tauringana, 2007). Thus, companies needing external financing in the future should start adopting better governance measures in the present (Klapper et al, 2004).

Many authors support the view that for the development of capital markets, effective governance mechanisms are very crucial (Rabelo & Vasconcelos, 2002; Levine & Zervos, 1998; Rajan & Zingales, 1998). Capital markets can function efficiently if there is effective flow of information between the company and its stakeholders (Akhtaruddin, 2005).

Agency Theory

Many theories such as stakeholder theory, agency theory among others, express the importance of transparency and disclosure. This paper uses the agency theory as a theoretical framework and models that effective corporate governance practices including transparency and disclosure help resolve agency problems – such as extraction of personal gain by majority shareholders and under or over-investment (Aksu and Kosedag, 2006).

Agency theory models the relationship between the principal and the agent (Barako, Hancock and Izan, 2006). Agency relationship is a contract under which one or more persons (the principal) engage another (agent) to perform some work on their behalf. Thus the shareholders (the principal) delegate the decision making function to the manager (or the agent) (Jensen and Meckling, 1976). This separation of ownership and control leads to the incurring of certain costs also known as agency costs (viz. expenses incurred by the principal to monitor agent’s activities) which are not incurred if the owner and manager are the same person (Barako, Hancock and Izan, 2006). In an agency relationship, managers have an information advantage which they may misuse for their own personal interest. Conversely it may so happen that agents may disclose more information to enhance the value of the firm and to increase the flow of investment in the company by reducing the cost of the agency relationship (Barako, Hancock and Izan, 2006).

Patel et al. (2002) opine that the agency problem in corporate governance can be resolved in many ways – by a vigilant board of directors, by timely, accurate and sufficient disclosure of financial information and by transparency in the ownership structure. This study deals with one aspect, viz. disclosure and transparency.

Disclosure and Transparency

Transparency and disclosure are at the heart of corporate governance. The OECD Principles of corporate governance (2004) state that the corporate governance structure of any association should make sure that well-timed and precise disclosure of all important matters of the organization pertaining to its performance, ownership and overall governance is made. Transparency and disclosure (T&D) practices followed by firms are an important component and one of the main indicators of the quality of corporate governance (Aksu and Kosedag, 2006).

Companies mainly disclose through their annual reports; thus these should contain information that will allow its users to make correct decisions on efficient use of scarce resources (Akhtaruddin, 2005). In fact, a lot of what a company discloses in its annual reports and financial statements reflect its corporate governance quality (Bokpin and Isshaq, 2009). A firm if makes correct and adequate disclosure, reduces information asymmetry thereby reducing investor’s risk (Bushman and Smith, 2001). Similarly, Lang and Lundholm (1996) view, that by removing asymmetry in information, disclosure and transparency reduce the level of surprises relating to a firm’s performance thereby making its stocks less volatile.

Chapter 3: Research Methodology

With the aim of examining the disclosure practices of Indian listed companies, the focus of this study is the examination of annual reports of listed Indian companies using content analysis. This chapter is divided into two parts. The first deals with research design which is content analysis for this research. The second part presents the method of collection and data analysis.

Research Design

Research design embodies a structure which directs the implementation of a research method and the data analysis (Bryman and Bell, 2007). It tries to describe the best way to design the research so that the best data for the research can be obtained (Lee and Lings, 1975). The research designs that may be employed include experiment, survey, case study, action research, grounded theory, ethnography, archival research, content analysis among others (Saunders, Lewis & Thornhill, 2009).

The aim of this research is to examine the disclosure practices of listed Indian companies. Annual reports are intended to disclose information about the company's activities and performance to shareholders and other stakeholders. In order to examine the level of disclosure, in lines with previous research, this study seeks to identify the presence or absence (disclosure or non disclosure) of certain identified corporate attributes in the annual reports of the companies. An examination of annual reports of companies could be one of the justifiable ways of assessing their disclosure practices; consequently, the research design used is one of content analysis.

Content analysis is an analysis of documents and texts (which may be printed or visual) that seeks to quantify content in terms of pre-determined categories and in a systematic and objective manner. Objectivity ensures that there is transparency in the procedures for assigning the data to categories so that analyst’s personal biases are ruled out to a large extent (Bryman and Bell, 2007).

This study entails analysis of annual reports of listed Indian companies by quantifying content in terms of pre defined categories. Content analysis has been conducted on annual reports by a number of researchers such as Tsamenyi et al. (2007) and Patel et al. (2002) among others, as they are a good instrument to measure comparative positions and trends in reporting. As a technique for collecting data, it involves codifying qualitative and quantitative information into pre-defined categories in order to derive patterns in the presentation and reporting of information (Guthrie et al., 2004). The following paragraphs explain the method of collection of data, its quantification and classification and its analysis.

This study uses the method of content analysis which itself is not free from limitations. The major limitation is the subjectivity involved in coding (Frost and Wilmshurst, 2000). In order for valid inferences to be drawn from content analysis, the reliability of both the data and the instrument of collecting and coding the data must be achieved (Milne and Adler, 1999). This research uses the coding method used by many previous researchers such as Patel et al. (2002) and Tsamenyi et al. (2007) and hence can be regarded as ‘reliable’.

Data Collection and Analysis

This study entails the examination of annual reports of Indian companies. Data is collected on 50 companies listed on the National Stock Exchange (NSE) and representing the NIFTY, which is literally the barometer of the Indian Capital Market. The sample thus consists of 50 companies listed on the NSE.

The S&P CNX Nifty is the National Stock Exchange of India Ltd’s main exchange. The CNX Nifty tracks the performance of a portfolio of blue chip companies, which are the largest and most liquid of the Indian securities. It consists of 50 of about 935 companies listed on the NSE consisting approximately of 60% of the market capitalization and reflects correctly the Indian stock market. The S&P CNX Nifty consists of 22 sectors of the Indian economy (Standard & Poor’s, 2010).

This research studies the annual reports of these 50 companies. Analysis is limited to only one year because disclosure practices usually do not change dramatically over time (Botosan, 1997). All annual reports are available online on the respective company websites and have been accessed thus. The annual reports studied for most of the companies are for 31st March 2010.

All data has been collected from annual reports of 50 companies which make up to 60% of the total market capitalization. Annual reports are one of the most important devices to convey information and are hence the principle focus of the disclosure index (Alsaeed, 2006).

This study uses 98 attributes in all to measure corporate governance and extent of disclosure in India (Appendix 2). These attributes have been compiled by Standard & Poor’s and used in many previous studies on disclosure. Using an objective methodology, annual reports are analyzed for common disclosure items grouped into three sub- categories:

Ownership structure and investor relations

Financial transparency and information disclosure

Board and management structure and process

A Transparency and Disclosure Score is developed for every company from a binary evaluation of the number of items present in their annual reports, i.e. if a company discloses a particular attribute, a score of 1 is awarded and if not a score of 0 is awarded. This paper analyzes the T&D score for 50 Indian companies representing the NIFTY. Previous studies on disclosure and corporate governance such as those by Patel et al. (2002) and Tsamenyi et al. (2007) had followed a similar approach.

Chapter 4: Findings and Discussion

This chapter presents the findings of this study and also compares the same with previous studies.

A disclosure index has been constructed based on a thorough and rigorous examination of the annual reports of the sample companies. Disclosure is defined as the appearance of an item of information in the annual reports of the companies under study (Karim and Ahmed, 2005). If an item is disclosed in the annual report, a score of 1 has been awarded and if the item is not disclosed, then a score of 0 is awarded for that attribute. Thus this disclosure method measures the overall disclosure index (ODI) of a company as additive as follows:

Where, d=1 if the item di is disclosed

d=0 if the item di is not disclosed

n=number of items

4.1 Disclosure Scores and Descriptive Statistics

The disclosure scores for each firm are presented both as actual scores and as percentage of the total number of attributes assessed in annual reports. The overall level of disclosure and disclosure score together with the percentage is presented in Table 1 below. Overall, disclosure and transparency register an average score of 72.04 which is quite good. Considerable variation can be noticed in the disclosure practices among the sample companies in India with a range of 54-82. The descriptive statistics are presented in Table 2.

Table 1: Disclosure Scores

Company Names

Disclosure Scores

% of Score

ACC Ltd.

80

80%

Ambuja Cements Ltd.

56

56%

Axis Bank Ltd.

76

76%

Bajaj Auto Ltd.

75

75%

Bharat Heavy Electricals Ltd.

68

68%

Bharat Petroleum Corporation Ltd.

69

69%

Bharti Airtel Ltd.

78

78%

Cairn India Ltd

73

73%

Cipla Ltd.

72

72%

DLF Ltd.

73

73%

Dr Reddy’s Ltd.

75

75%

Gail India Ltd.

76

76%

HCL Technologies Ltd.

54

54%

HDFC Bank Ltd.

71

71%

Hero Honda Motors Ltd.

74

74%

Hindalco Industries Ltd.

54

54%

Hindustan Unilever Ltd.

70

70%

Housing Development Finance Corporation Ltd

72

72%

ICICI Bank Ltd.

77

77%

ITC Ltd

78

78%

Infosys Technologies Ltd.

82

82%

Infrastructure Development Finance Co. Ltd

81

81%

Jaiprakash Associates Ltd.

76

76%

Jindal Steel & Power Ltd

75

75%

Kotak Mahindra Bank Ltd.

75

75%

Larsen & Toubro Ltd.

74

74%

Mahindra & Mahindra Ltd.

65

65%

Maruti Suzuki India Ltd.

64

64%

NTPC Ltd.

62

62%

ONGC Ltd.

65

65%

Power Grid Corporation of India Ltd.

65

65%

Punjab National Bank

65

65%

Ranbaxy Laboratories Ltd

54

54%

Reliance Capital Ltd.

75

75%

Reliance Communications Ltd.

81

81%

Reliance Industries Ltd.

82

82%

Reliance Infrastructure Ltd.

76

76%

Reliance Power Ltd

77

77%

Sesa Goa Ltd

75

75%

Siemens Ltd

74

74%

State Bank of India

74

74%

Steel Authority of India Ltd

75

75%

Sterlite Industries (India) Ltd.

62

62%

Sun Pharmaceutical Industries Ltd.

63

63%

Suzlon Energy Ltd

75

75%

Tata Consultancy Services Ltd.

76

76%

Tata Motors Ltd.

75

75%

Tata Power Ltd.

80

80%

Tata Steel Ltd.

81

81%

Wipro Ltd.

77

77%

.

Table 2: Descriptive Statistics of Dependent and Independent Variables

Mean

Range

No. of firms

Overall Disclosure

Index

72.04

54-82

50

Chapter 5: Conclusion

This paper reports on the level of disclosure of a sample of Indian companies listed on the NSE by examining their annual reports. The study uses a transparency and disclosure (T&D) index for determining the level of disclosure among listed Indian companies. The index is developed by assigning scores to 50 companies on pre-determined attributes; the study uses the binary scoring method. Using a dataset relating to listed companies for 2009-10, the study reveals that firms on average report 72% of the items compiled by S&P to assess level of disclosure.

The results of this study can be useful for investors to help them in gauging the level of disclosure by listed Indian companies. It will also be of interest to researchers, managers, regulators and market participants.

The findings of this study must be interpreted in the light of the following limitations. Firstly, the sample used for this study is small in size and is composed of the largest and most followed companies on the National Stock Exchange and thus may not be representative of the population of Indian companies. Secondly, the index used to find the level of disclosure, is that which has been compiled by S&P. No distinction has been made between compulsory and voluntary items of disclosure. Also, this study uses the unweighted or binary approach to measure the level of disclosure. Thus, if a company disclosed an item voluntarily, it did not get any extra score for that. Finally, the study gives at best a broad overview of the level and quality of disclosure among Indian companies since the results are based on the data of one year only and lacks longitudinal analysis. Further research is needed to evaluate the trends in the disclosure and also to assess if the level or quality of disclosure has improved over time.

Even with these limitations, there are some important contributions that this study makes. This study reports that the level of disclosure among Indian listed companies is quite high.

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