Introduction

The primary characteristics of effective corporate governance include transparency, management oversight and control, and protection of the rights of all shareholders and directors’ involvement in independently reviewing and approving the corporation’s strategy and major business plans and decisions. These factors are expected to contribute positively towards maximization of shareholder value through superior and sustained firm performance and value creation. However, in the past two decades, we have observed series of large-scale corporate scandals, frauds, and failures across the globe—from Enron and WorldCom in the US, Parmalat in Italy, Sanlu in China, and Satyam Computers in India, causing significant losses to shareholders of these companies. While developed countries like the USA have taken effective steps to improve the corporate governance standards and prevent such failures in future, similar initiatives in India or other developing countries are only gaining grounds now (Prasad 2014).

With the introduction of Companies’ Act 2013 (CA2013), we expect significant improvement in corporate governance practices in India. This paper studies some of the key corporate governance practices of large Indian corporations post CA2013 implementation and evaluate their moderating role on firm performance.

Background and theoretical perspectives

Corporate governance is defined as the set of systems and processes by which companies are directed and controlled with the purpose of aligning the interest of individuals, corporations, and society, as much as possible (Cadbury 2000; Gregory 2000). The need of corporate governance arises out of the gap in professionally managed listed companies between the rights of shareholders and the operational control exercised by the management of the company. The principles of good corporate governance involve around accountability, transparency, effectiveness, remuneration, relationship with shareholders, probity, and focus on the sustainable success of an equity over the longer term. The OECD principles of good corporate governance comprise of the following elements: (a) alignment with the legal and regulatory requirements, (b) protection and facilitation of shareholders’ rights, (c) equitable treatment of shareholders, and (d) disclosure and transparency of financial and operational information (OECD 1999). Thus, the board has an important role and fiduciary duty to ensure these principles are held appropriately in the firm, both in spirit and practice.

The stakeholder theory, which attempts to align the interests of managers and all, has been a subject of some investigation. John and Senbet (1998) have conducted a detailed study of corporate governance through the concept of stakeholder theory. They note the presence of many parties interested in the well-being of the firm, with many of them often holding competing interests. Moreover, shareholders might welcome investments in high yielding, but volatile projects. However, such investments might jeopardize the interests of debt holders, especially when the firm is teetering on the edge of bankruptcy. The study also emphasizes the absence of free market system, citing as an example the need to determine an optimal size of the board of directors, especially in view of the tendency for board size to exhibit a negative correlation with firm performance. Other non-market mechanisms reviewed by John and Senbet (1998) include the need for designing a committee structure in a way that allows the setting up of specialized committees with different membership on separate critical areas of operations of the turn. Such a structure would allow, for instance, productivity-oriented committees and monitoring-oriented ones.

The multiplicity of stakeholders as enshrined in stakeholder theory was highlighted by Jensen (2001), who concurred with John and Senbet (1998) that certain actions of management might have conflicting effects on various classes of stakeholders. This implies that the managers have numerous of objective functions to maximize firm performance, something that Jensen sees as an important drawback of the stakeholder theory as it violates the proposition that a single-valued objective is a prerequisite for purposeful or rational behavior by any organization.

Jensen (2001) formulated the enlightened stakeholder theory in order to bring to the fore the single-valued objective function that conforms to rationality. The enlightened stakeholder provides that managers should pursue the maximization of the long-run value of the firm. This is with the view to protect the interest of any major stakeholder, the violation of which leads to truncation of the objective of long-run value maximization of the firm.

According to a McKinsey global survey, it has been seen that currently, the board of directors spent a greater portion of their board’s time on strategy and less on M&A than was the situation before. The board of directors in a private company spent a greater amount of time on strategy than public companies because in the public companies more time is focused into the following of compliance (McKinsey 2013).

The introduction of the CA2013 by the government of India has made some key changes with respect to the earlier Companies Act, 1956, in areas concerned with the management and administration of companies. These changes are aimed at ensuring higher standards of transparency and accountability and seek to align the corporate governance practices in India with global best practices, raising the bar on governance (Desai 2014; KPMG 2014). The important aspects in CA2013 that help companies assess the impact and develop a strategy around compliance and corporate governance are the following: (a) responsibility of independent directors, (b) a maximum cap of 15 on number of directors, (c) presence of at least one woman director, and (d) flexibility in participation in board meetings through audio or video conferences. In addition, CA2013 specifies that there must be at least four committees where board members should participate: audit committee, nomination and remuneration committee, corporate social responsibility committee, and stakeholder’s relationship committee (KPMG 2014).

Research questions and hypotheses

In the context of the above-mentioned constructs and regulatory implications of CA2013, we frame our research questions around effectiveness of the corporate boards in ensuring the interests of companies’ stakeholders. We analyze how factors like diversity of the board, involvement of board members in company’s activities, CEO duality and board compensation contribute to firm’s profitability, market capitalization, and returns to the shareholders.

Diversity of board members

The diversity of the board is measured through indicators such as presence of independent directors in the board, presence of women directors in the company board, directors’ presence in other companies’ boards, presence of promoters in the board, and board members’ professional and educational background.

Presence of independent directors

Independent directors are professionals who can easily achieve the supervising function, reduce the possibility of collusion of top executives, and prevent the abuse of company resources (Chiang and Chia 2005). CA2013 also ensures that the independent directors have no pecuniary relationship with, nor they be given any special incentives, which might force him/her to compromise independence.

The stewardship theory suggests that superior corporate performance is linked to a majority of inside directors as they work to maximize profit for shareholders (Donaldson and Davis. 1991; Donaldson 1990). Contrary to this, the agency theory suggests that a greater proportion of outside directors will be able to monitor any self-interested actions by managers and so will minimize the agency costs (Fama and Jensen 1983; Fama 1980).

The independent directors are expected to offer independent judgment on issues related to strategy, performance, and key appointments and take an objective view on the performance evaluation of the board. Key decisions on certain topics should be passed only if a majority of the independent directors of the board votes in support of the decision. The independent directors should be appointed for a specific duration during which he/she can be removed from his/her position only on specific grounds and after following due process (Balasubramanian 2010).

Presence of women directors

The performance of a company is affected by the presence of heterogeneity across various organization levels, including the board level. Like managerial diversity, board diversity through presence of women directors is an important element of organizational behavior research. Female directors bring unique and valuable resources and relationships to their boards with their diverse experience, knowledge, and observational and perceptive strengths (Smith et al. 2006).

Directors’ presence in others boards

Directors’ participation in other firm’s board can strengthen the firm through cross-learning. As per resource dependence theory, outside directors provide access to resources needed by the firm. For example, outside directors who are also executives of financial institutions may assist in securing favorable lines of credit (Daily et al. 2003).

Presence of promoters in the board

A large number of organizations in India have significant promoters’ presence in its board, i.e., promoters and their family members hold several director positions in the board. It has been observed that the promoters who do not bring in diversity to the board may not be effective in creating value for shareholders (Carter et al. 2003). Observing the directors’ lists of large companies in India, we notice that the family members of the promoters who become directors bring in negligible diversity to the board.

Board size

Earlier research has shown that there is an inverse association between board size and firm value, and companies with small boards tend to exhibit favorable values for financial ratios and provide stronger CEO performance (Yermack 1996). However, we believe that a larger board brings in additional diversity in the board functions, which becomes more relevant in today’s business scenario. While CA2013 provides guidelines on board size, our review of data on Indian corporations shows that there is significant variation in size of their boards, and there is little correlation between company size and board size.

Thus, in this study, we measure board diversity as a combined factor of presence of independent directors, presence of women directors, directors’ presence in other boards, lack of promoters’ presence in the board, and board size. We posit,

  • H1: Diversity of the board positively influences firm performance.

Involvement of board members

Research shows that involvement of board members in firm’s activities varies widely across individuals within a board and across boards as well. While minute tracking of company’s operational activities is undesirable, it is expected that directors leverage their experience, knowledge, and judgment to steer the company towards its objectives. We look at two factors, attendance in board meetings and presence in board committees, as measures for board members’ involvement.

Attendance in board meetings

Board meeting time is an important resource in improving the effectiveness of boards (Conger et al. 1998). Lipton and Lorsch (1992) suggest that the greater frequency of board meetings is likely to result in superior performance. Attendance in the board meetings is the main channel through which directors get the required information required to carry out their duties. Lack of attendance in the board meetings may lead the directors to give improper advice related to strategy of the firm, and they will be ineffective to monitor and guide the management.

Presence of directors in committees

The presence of the directors in the different board committees can help to keep a monitor of the different management activities of the firm. The committees can be benefited by the presence of several directors, as the committees will get an expert advice on the various aspects of governance. This leads us to take a deep dive into the “busyness hypothesis” (Ferris, Jagannathan, and Pritchard 2003). Some studies have reported that directors with multiple appointments have a positive impact on firm performance (Ferris et al. 2003; Harris and Shimizu 2004; Miwa and Ramseyer 2000).

As in opposition to this view, it is often argued that a large of appointments for directors can lead to over commitment and thereby reducing their ability to have a keen focus on matters related to company management.

Thus, board members’ involvement in firm’s activities is measured through two factors, attendance in board meetings and presence of directors in committees and we posit,

  • H2: Focus and attention from directors on firm operations positively influence firm performance.

CEO duality

Duality refers to a board leadership structure in which one person fulfills the role of both the chairperson of the board and the CEO/managing director. Previous studies bring in a debate on CEO duality where a group believes that CEO duality leads to a superior performance of the firm as the CEO gets the right of clear-cut leadership for purposes of strategy formulation and implementation (Anderson and Anthony 1986). The other group of people argues that duality would lead to less effective leadership, as it would reduce the independence of the board. It is also argued that in case of duality, there is a chance that a rivalry is created between the chairperson and the CEO. There might be confusion as the company would have two spokespersons, and the leadership might be diluted.

According to the agency theory, an agency problem exists when an agent has established goals which conflict with that of a principal. Likewise, in working as a chairperson, the CEO is bound to get more power, and this might weaken the control of the board over the firm.

History has shown that duality has often resulted in decline in the performances of the firm such as Westinghouse, Sears, General Motors, and IBM (White and Ingrassia 1992). Likewise, the non-duality of the Compaq Computers is referenced as a reason of success for the Compaq Computers. Therefore, we posit,

  • H3: CEO duality negatively influences firm performance.

Board compensation

Past trends from India suggest the fact that earlier government interventions placed limitations on corporate sector pay in India that were unrealistic which led to the off-the-records methods for compensating executive directors. Fortunately, scenario has changed now for the better. In India, the remuneration packages of the directors need to be individually approved by the shareholders in a general meeting (Balasubramanian 2010).

Managerial compensation in India has two components—salary- and performance-based commission—as well as retirement and other benefits and prerequisites. An analysis of about 300 Indian firms suggests that the average total compensation of Indian CEOs has risen almost threefold between 1998 and 2004 (Chakrabarti et al. 2008). During this period, the proportion of profit-based commission has risen steadily, and the proportion of CEOs with commission as part of their pay package has risen from 13.4 to 25.6 %. CEO pay has thus clearly becomes more performance-based over the past decades.

The executive compensation literature (Murphy 1999; Zhu et al. 2009) suggests that compensation should be related to measures of stock-based performance, not only because this is the desired by shareholders but also because high stock returns should signal positive information on the actions taken by managers. It is advised that the remuneration committee takes full control of the remuneration process, policies, and practices. In particular, remuneration committees should jealously guard their initiation rights over executive remuneration (Balasubramanian 2010). On the other hand, board members’ compensation can be an important motivating factor for them to get involved in improving company’s performance. Thus, we posit,

  • H4: Board compensation positively influences firm performance.

Data and methodology

We have chosen 75 large-cap companies from India, listed in Bombay Stock Exchange’s BSE 100 index for this study and looked at these companies’ board activities and performance over fiscal year 2014. The companies represent various sectors from banking and manufacturing to retail and information technology. The reason for choosing large corporations is that they are expected to have more established and structured board-level activities. Centre for Monitoring Indian Economy’s (CMIE) Prowess database and annual reports of the companies for FY2014 have been used to retrieve all firm-level information (financial as well as board related).

Multivariate regression has been used to analyze the data with separate multiple regression model for each dependent variable.

The variables used for multivariate regression is listed in Table 1. We have chosen three dependent variables, viz., profit after tax (PAT), Tobin’s Q, and equity dividend to represent diverse aspects of firm performance. While PAT represents financial performance of the firm, Tobin’s Q represents market valuation of the firm for the future, i.e., how the market perceives the future value of the firm, including how it may leverage its intangible assets. Equity dividend on the other hand represents the returns shareholders get from the firm.

Table 1 Variable definitions
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The following independent variables have been used to test hypothesis 1 for board diversity: Presence of Independent Directors, presence of women directors, presence of promoters in board, and size of the board. Hypothesis 2 has been tested through these two independent variables: attendance in board meetings and presence of directors in committees. Hypothesis 3 on CEO duality has been tested through the variable chairperson = CEO/MD, and hypothesis 4 has been tested through the variable log of per capita board compensation.

In order to ensure robustness of our tests, we control for firm-specific and industry-specific factors, we use the following control variables: industry category code, age of the firm, and log of size.

Results and discussion

We have run three separate multiple regressions, one for each dependent variable, using SPSS®. Table 2 provides descriptive statistics of the dataset used for this analysis. We notice that equity dividend as a percentage of PAT shows a very high standard deviation. This can be explained by the fact that firms in India adopt very different dividend payout policies, irrespective of their profitability. It is also true that shareholders rarely look at dividend as an important source of value when they hold stock.

Table 2 Descriptive statistics
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Table 3 provides bivariate correlation among variables. The bivariate correlations are not found to be significant, and we continue our subsequent analysis with all the variables identified for the study.

Table 3 Bivariate correlation
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Table 4 provides the output of step-wise multiple regression to predict equity dividend as percentage of PAT through independent and control variables mentioned above. The control variables are entered in step 1, and independent variables are entered in step 2. The independent variables predict equity dividend as percentage of PAT statistically significantly with F(12, 62) = 2.265, p = 0.019, Adjusted R 2 = .17. However, only one variable, Director’s Participation in Other Boards, has been found to be statistically significantly with p = 0.000.

Table 4 Multivariate regression model for equity dividend
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Table 5 provides the output of step-wise multiple regression to predict Tobin’s Q through independent and control variables mentioned above. As before, the control variables are entered in step 1, and independent variables are entered in step 2. The independent variables predict Tobin’s Q statistically significantly with F(12, 62) = 5.553, p = 0.000, adjusted R 2 = .425. The variables that have been found statistically significant are Director’s Participation in Other Boards (p = 0.045) with negative impact, Attendance in Board Meetings (p = 0.001), and Size of the Board (p = 0.015). Presence of Women Directors is marginally significant with p = 0.075.

Table 5 Multivariate regression model for Tobin’s Q
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Table 6 provides the output of step-wise multiple regression to predict PAT through independent and control variables mentioned above. The independent variables predict PAT statistically significantly with F(12, 62) = 2.680, p = 0.006, adjusted R 2 = .216. However, only one variable, Presence of Women Directors, has been found to be statistically significantly with p = 0.011.

Table 6 Multivariate regression model for PAT
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The above results indicate that we can reject hypotheses H3 and H4. Contrary to some of the past research, we find no influence of CEO duality and board compensation on any of our firm performance measure.

We also fail to reject hypotheses H1 and H2 as we have found that some of the variables for board diversity and board involvement do influence our firm performance measures. The following section discusses the influence of these significant variables in detail.

Diversity of board members: influence of presence of women directors

A study in 2008 on top European firms found that women tend to have better attendance records at board meetings than their male counterparts (Adams and Ferreira 2009). Specifically, they found that the likelihood that a female director has attendance problems is lower than that of a male director; male directors have fewer attendance problems when there is greater proportion of female directors on the board; firms with more diverse boards provide their directors with more pay-performance incentives; and firms with more diverse boards have more board meetings.

Studies have also found that women are more likely to sit on audit, governance, and nominating committees. Gender-diverse boards allocate more time and effort to monitoring, and diverse boards are more likely to hold CEOs accountable for poor stock-drive performance. Such an atmosphere of accountability would undoubtedly change the decisions the board makes (Leblanc and Gillies 2010).

Our findings on Indian firms are in line with these observations. Two of our firm performance variables, Tobin’s Q and PAT, are significantly and positively influenced by the presence of women directors. This is particularly significant for Indian corporations as we notice that even after incorporation of CA2013, which insists on at least one woman director on company’s board, a large number of Indian companies failed to act on time.

Diversity of board members: influence of board size

As boards are considered to be important decision-making groups, size can affect the decision-making process and effectiveness of the board. (Dwivedi and Jain 2005). One group of researchers (Dalton et al. 1998; Pearce and Zahra 1992) predicts board size to have a positive association with firm performance. According to the supporters of this view, if the board size is large, then there will be a conglomeration of a large variety of people. These people will bring in new varieties of ideas and thoughts and can have a different view of thinking which might add value to the performance of the board. A larger board size might create greater connections and links and hence access to more resources. Smaller boards are assumed to have inadequate recognition of the need to initiate or support strategic change, a lack of clear understanding of alternatives, and/or lack of confidence in recommending strategic change (Goilden and Zajac 2001). The contrarian view is that if the size of the board is big it might lead to the dilution of responsibilities. There might be no clear-cut definition of responsibilities among the board members. Due to larger board size, individual board members might not be able to display their potential among the large number of board members.

Therefore, it is possible that an inverted “U” relationship exists, whereby the addition of directors adds to the skills mix and performance of board and firm till it reaches a point where the adverse dynamics of a large board outweigh the additional benefits of a greater skills mix, as suggested by Jensen (1993).

In our study of large Indian corporations, board size only influences Tobin’s Q positively and significantly. Tobin’s Q is a representation of market’s assessment of the firm, including its future prospects and provides a measure of the management’s ability to generate future income stream from an asset base (Short and Keasey 1999). Therefore, a large and illustrious board may demonstrate actions that the market desires and appreciates and therefore has a positive influence on market’s view of the firm’s worth.

Involvement of board members: influence of attendance in board meetings

Regular meeting attendance is considered a hallmark of the conscientious director. It matters a lot and there is widespread perception that high-profile board members rarely show up for board meetings and when they do show up, they are not prepared (Sonnenfeld 2002).

Research also indicates that the frequency of board meetings attended by directors themselves has a positive and significant effect on a firm’s profitability. However, the authorized meeting attendance is negatively correlated with performance. This negative effect is statistically significant and economically comparable to the positive effect of directors’ own attendance (Chou et al. 2013).

Our findings are in line with these observations. We find that Tobin’s Q is positively and significantly influenced by director’s attendance in board meetings. As explained before, Tobin’s Q is a representation of market’s assessment of the firm and if market notices active participation by board members in board meetings, it influences market’s view of the firm’s worth positively.

Involvement of board members: influence of directors’ participation in other boards

We find conflicting results on directors’ participation in other boards. Based on past research, we have argued that if board members were also members in other companies’ boards, then they would get a higher level of exposure on governance issues, challenges, and solutions. This would not only broaden their world-view but would also enable them to make better decisions and guide company’s management better. However, we find that director’s participation positively influences equity dividend and negatively influences Tobin’s q. Further research is required to understand the moderating role of director’s participation in other boards on firm performance.

Summarizing, our key findings show that if the board size if large, board attendance is maintained well and there are women directors on the board, then the board brings in a positive outlook for the company and that in turn raises the value of the firm in the eyes of the shareholders.

Conclusions

The introduction of CA2013 in India has specific objectives from corporate governance perspectives. They are around responsibility of independent directors, board size, presence of woman directors, and participation in board meetings. Our objective in this study was to assess the role of these factors on firm performance. Based on firm-level data of large Indian corporations, we find evidence that director’s diversity as well as director’s involvement in the company affects company’s performance—measured through financial performance, market valuation, and returns to the shareholders. A relatively larger board is viewed more positively. The presence of women board members brings in balance to the board composition and conveys the message of good corporate governance and firm’s ethical behavior. In addition, active participation in board meetings is also seen as positive influencer.

This study has been limited to firm-level data of FY2014, after introduction of CA2013. We can extend this study to evaluate the effect of CA2013 on firm performance by analyzing similar data before and after introduction of CA2013.