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Corporate Governance Disclosure Index and Firm Efficiency

As per G20/ OECD Principles of Corporate Governance, 2015 - “Good corporate governance is not an end in itself. It is a means to support economic efficiency, sustainable growth and financial stability. It facilitates companies' access to capital for long-term investment and helps ensure that shareholders and other stakeholders who contribute to the success of the corporation are treated fairly.” This thesis encapsulates the above principles in terms of investigating the effect of corporate governance on firm performance and providers of capital such as shareholders and debtholders. A large number of governance reforms, covering a wide gamut of internal corporate governance mechanisms, have taken place in India in the last two decades making it an ideal selection to study the relationship between corporate governance and different aspects of economic efficiency. The thesis examines effect of corporate governance on three important aspects of economic efficiency. The first aspect that we examine in the thesis is the relationship between corporate governance disclosure index (CGDI) and firm performance measured in terms of both accounting and market variables. The second is the treatment of CGDI as a (risk) factor in explaining time series differences in stock returns and finally as a third aspect of economic efficiency, we investigate the effect of CGDI on cost of debt. This thesis is divided into five chapters. In the first chapter we provide an overall introduction of the thesis, followed by examining the effect of corporate governance on different aspects of economic efficiency discussed above in the next three chapters. The fifth and final chapter concludes the thesis.As part of this thesis we create CGDI based on disclosure requirement of Clause 49 of stock exchange listing agreements and voluntary guidelines issued by Ministry of Corporate Affairs, 2009. We categorize CGDI into mandatory, non-mandatory and voluntary disclosure using data for 200 companies listed on National Stock Exchange (NSE), the country’s premier stock exchange, for four financial years, spread over distinct periods in time. CGDI and its sub-indices Mandatory Disclosure Index (MDI), Non-Mandatory Disclosure Index (NMDI) and Voluntary Disclosure Index (VDI) are created for the financial year 1999-00, 2002-03, 2005-06 and 2010-11. The construction of the indices for mentioned period allows an examination of the evolution of corporate governance disclosure in India. These indices form the backbone of this thesis and are used all the three main topical chapters.The first objective of the thesis relates to construction and analyzing the evolution of CGDI and its sub-indices for the selected Indian firms and analyzes the relation between CGDI, MDI, NMDI and VDI and firm performance measured using four different variables corresponding to accounting-based and market-based approach. The accounting-based measures of profitability are Return on Assets (ROA) captured as ratio of EBDITA to total assets and Net Value Added to Assets (NVAA) measured as ratio of total income after excluding total expenses but including compensation to employees and depreciation to total assets. The market-based approaches of measuring firm performance are Market-to-Book value ratio measured as average P/B ratio and Tobin's Q which is captured as ratio of market capitalization and book value of debt to average total assets. The analysis reveals an upward trend in the level of the indices in the Indian firms over time. The study also finds a strong positive association between firm performance and level of disclosure in the Indian corporate sector. A one unit increase in CGDI increases the firm performance by 4.94 units as measured by average P/B ratio. A separate analysis for sub-indices reveals that the effect of NMDI and VDI is more pronounced on firm performance as compared to MDI.The second issue relates to examine the relationship between internal corporate governance mechanisms and systematic risks. To establish the above mentioned relationship, we empirically test the validity of corporate governance as a risk factor in asset pricing model. A factor is a variable or a characteristic with which individual asset returns are correlated. The corporate governance as a factor is based on CGDI. A good governed firm is exposed to lower magnitude and fewer types of systematic risks as opposed to a poorly governed firm. We find that governance factor portfolio is marginally and insignificantly correlated with size, value and momentum factor portfolios respectively and therefore adds significant explanatory power to already establish three and/ or four factor models. We also show that a five-factor model directed at capturing size, value, momentum and governance in average stock return performs better than Fama-French three-factor model and Carhart four-factor model.The corporate governance mechanisms help the company in reducing the cost of capital. As part of the third and final aim of this thesis, we examine the effect of CGDI, MDI, NDMI and VDI on cost of debt for Indian corporate sector, which is mostly characterized by bank-based financing. The analysis reveals a significant and beneficial effect of CGDI and its sub-indices on cost of debt, with the cost of debt declining significantly with increase in total assets in the Indian corporate sector, after controlling for the relevant factors. This association of CGDI and its sub-indices are also prominent for more leveraged firms. The result reveals that corporate governance disclosure can have beneficial effect on cost of capital in general and firms’ growth particular.