Corporate governance structures play a vital role in enhancing the firm value. This paper examines the effect of two important corporate governance variables board size and promoter ownership on the firm value. The research using linear regression analysis on 176 non-financial listed companies for year 2008 finds a negative association of Tobin Q with board size and a significant positive association with promoter ownership. The research makes an endeavor to search for an ideal board size and gives insights on moderating effect of firm size on corporate board performance. Study also finds that above the critical ownership level of forty percent, promoter's interest is much aligned with that of company and there is positive effect on firm value. Corporate governance has developed as an important mechanism over the last two decades. The recent global financial crisis has reinforced the importance of good corporate governance practices and structures. It is now well recognized that corporate governance structures play an important role in enhancing firm performance and sustainability in long term (Bonn, 2004; Erickson et. al., 2005; Ehikioya, 2009; Iwasaki, 2008; Cho and Kim, 2007). There has been tremendous research on corporate governance structure and firm performance particularly in the developed world. On the other side, there is very little research on the influence of corporate governance variables such board structure on firm performance in India (Dwivedi and Jain, 2005). India as an emerging giant is gradually moving from controlled to market based economy with market capitalization of all listed companies touching nearly rupees 1 trillion (Sehgal and Mulraj, 2008). Corporate governance has now become a norm in India with Securities Exchange Board of India (SEBI) making it mandatory for all the listed to adopt Cause 49 of the Listing Agreement. However, capital markets are still nascent and market for corporate control is weak (Standard and Poor's 2009). Indian firms are predominantly of family origin and promoters controlled (Chakrabarti, 2005). Corporate governance structures, therefore, rely much on internal structures rather than external one for enhancing the value. The corporate board and insider ownership (promoters) are in Indian business are two important internal corporate governance structures. Shleifer and Vishny (1997) have suggested that corporate governance deals with the ways in which suppliers of the finance to corporation assure themselves of getting a return on their investment. Shareholders are owners of company who contribute their wealth. Through corporate governance mechanism, they apply control over the management of the company for the wealth maximization. The boards of director's act as representatives of shareholders achieve this endeavor by reducing the agency cost (Fama and Jensen, 1983). In Indian regulatory environment board of directors of a company act as fiduciaries of the shareholders, provide active supervision and do strategic decision-making. The Indian investors, however, have general predisposition to discount the role of board due to stronger ownership concentration and insider control. The board is an important corporate governance mechanism under Indian context to protect the minority shareholders from dominant shareholders. In addition, insider ownership by the promoters of the company is general characteristic of most firms. India is gradually moving towards market-based economy, however, such is the peculiarity that ownership lies predominately in hands of few people of group of peoples. In order to expand our understanding on emerging and transforming economy of India, the present study attempts to investigate effect of two corporate governance parameters on the firm value. The study is based on the 176 non-financial firms listed on Bombay Stock Exchange (BSE) for period 2008-09. The research done is during the period when entire world was eclipsed by global financial crisis and Indian firms were under financial distress to some extent. The study attempts to testify the different theoretical and empirical foundations establishing a relationship of board size and promoter ownership with TobinQ. We also investigate the moderating effect of firm size on corporate board performance and different levels promoter ownership on firm value. The results of this study extend the literature on corporate governance structure and opening up new avenues for further research. We first begin with theoretical background with literature leading to development of our hypothesis
THEORETICAL BACKGROUND AND HYPOTHESIS DEVELOPMENT
Board Size and Firm Performance Boards of directors are the representatives of shareholders and other stakeholders of the company. A corporate board is delegated with the task of monitoring the performance and activities of the top management to ensure that latter acts in the best interest of all the shareholders (Jensen and Meckling, 1976; Erickson et al., 2005). In addition, Ruigrok et. al. (2006) suggest that the board has important roles such as design and implementation of strategy, and fostering links between the firm and its external environment. Under statutory provisions delineated in Indian Companies Act, 1956 the board is vested with sufficient powers and responsibilities to act in diligent way, manage and control the management of the company in order to maximize the value of shareholders and stakeholders. The board of the company is considered as one of the primary internal corporate governance mechanism (Brennan, 2006).A properly constituted board with optimum number of directors can effectively monitor the management and drive value maximization. Some researchers, however, been skeptical about board's ability to mitigate the agency problem and enhance firm value (Erickson et. al., 2005). The number of directors on the board (or board size) is therefore, a critical factor that can influences the performance of a company. The board acts on behalf of shareholders and considered as a major decision-making group. The complexity of decision-making and effectiveness is largely affected by the size of the board. There has been mixed response to board size and corporate performance. The direction of influence depends upon the extent to which board is able to reach consensus, and take advantage of the knowledge and expertise of the individual members. There is, however, no agreement over whether a small or a large board is effective in enhancing the performance of a company. Two contrasting views emerge from the extant literature on the contemplating effect of board size on firm value. One school thought views larger boards are effective in driving the performance of company. Various researchers (Ehikioya, 2009; Coles et. al., 2008; Dwivedi and Jain, 2005; Klein, 2002; Dalton et. al., 1999; Kathuria and Dash, 1999; Pearce and Zahra, 1992) document a positive relationship of board size with the firm value. There have been several arguments in support of larger boards. One view is that larger boards allow directions to specialize, which in turn can lead to more effectiveness (Klein, 2002). Larger boards have people from diverse field. The knowledge and intellect of this increased pool of experts can be utilized for making some strategic decision of the board, which can drive performance of the company (Dalton et al., 1999; Pearce and Zahra, 1992). The larger pool of people on the board results in greater monitoring capacity, and also enhances the firm ability to form greater external linkages (Goodstein et al., 1994). Coles et. al. (2006) find that firms requiring more advice derive greater from the larger boards. There are, however, strong contrasting views and evidences to the above argument. Contrary school of thought views larger boards are less effective in enhancing the performance of the company. Many researchers find a negative association between board size and performance of companies (Yermack, 1996; Eisenberg et. al., 1998; Cheng, 2008; Boon et al., 2004; O' Connell and Cramer, 2010; Rashid et. al., 2010; Conyon and Peck, 1998; de Andres et. al., 2005). Cheng (2008) suggest that larger boards exist even though they are value reducing because they necessary for some type of companies and under certain conditions. Coles et. al. (2008) point negative association of board size with firm value exists due to some other exogenous factors. Many scholars suggest that as board size increases above the ideal value, many problems surface which outweigh the benefits of having more directors on the board, as mentioned above. Contrasting to smaller boards, larger number of director on board increases the problem of communication and coordination (Jensen, 1993; Boon et. al., 2004; Cheng, 2008) and higher agency cost (Lipton and Lorsch, 1992; Cheng, 2008; Jensen, 1993). Lipton and Lorsch (1992) suggest that dysfunctional behavioral norms and higher monitoring cost due less diligence in larger boards give rise severe agency problem. Larger boards may also have problem of lower group cohesion (Evans and Dian, 1991) and greater levels of conflict (Goodstein et. al., 1994). Goodstein et. al. (1994) and Jensen (1993) similarly argue that greater problem of coordination leads slow decision making and information transferring which drives inefficiency in companies with larger board size. Larger boards may be skeptical about taking a strategic decision that can maximize the value of company (Boon et. al., 2004; Judge and Zeithamal, 1992).The larger boards, therefore may become more of symbolic and less a part of management process (Hermalin, and Weisbach, 2001). The above discussion clearly lays down a platform to propose that board size may have positive or negative association with firm performance. The vast literature on board size on firm performance predominately foresees that board size is negatively associated with firm performance, which gives support to develop our hypothesis 1. We also argue that increasing the number of directors above certain limits may have more deteriorating effect on firm value. Below certain board size, there is relationship of firm value with board size is less negative and above that, it increases. Therefore, in order to support our argument we propose our second hypothesis that above certain board size (in our case median board size of entire sample) has negative association with firm performance increases. We also propose third hypothesis that boards of larger companies have less negative association with firm performance than those of smaller firms. The argument is that boards of larger companies may well equipped with resources, skill base and knowledge expertise to take strategic decisions in period of financial distress. The board of smaller companies may lag behind to actively utilize resources and drive performance. Hypothesis 1. Board size exhibits a negative association with firm performance Hypothesis 2. Smaller Boards have less negative association with firm performance than larger boards Hypothesis 3. Boards of larger companies have less negative association with firm performance.
Promoter ownership and Firm Performance Promoter in general sense are persons or group of persons who are involved in the incorporation and organization of a corporation. Promoters are important part of companies in Indian business context as most of the companies are of family origin. Promoters are integral part of business element, but not have statutory recognization in the Indian Companies Act, 1956 as the term "Promoter" does not have any legal connotation. The term, however, finds its place in Securities Exchange Board of India's (SEBI) Disclosure and Investor Protection, 2000 (DIP Guidelines) and Substantial acquisition of Shares and Takeover Regulations, 1997 (Takeover Code). According to these SEBI regulations, "Promoter or Promoter Group" exercise sufficient control over the company by virtue of their shareholding and management rights. Evidences show that concentrated ownership is most common form in most countries (La Porta et.al., 1999), and also in India. Family houses and corporate groups, who are generally the promoters, have substantial ownership in companies. The pyramiding and tunneling effect of ownership is prevalent in India (Chakrabarti, 2005). These effects provide promoters enough them control over management of the company. According to Mathew (2007), promoters of BSE 500 were having 49 percent shareholding. In Indian companies, promoters in such a case raise the issue of "owner- manager control" similar to that of some other Asian countries. Promoters by virtue of their position and control have considerable power and wield significant influence on the board and management of the company over the key strategic decisions. La Porta et. al. (1999) believe high ownership concentration by particular group positions their interest above other shareholders and gives them the predominant voting rights and control over the management. Under these conditions, they may pursue policies, which benefit them and deteriorate firm performance. On other side, Shleifer and Vishny (1997) point that presence of dominant large shareholder or group can enhance their controlling ability, reduction in agency cost and therefore the firm performance. La Porta et. al. (1998, 1999) has observed that controlling shareholders (like promoter groups) exist in countries with investor's low legal and institutional protection. According to Jensen and Meckling (1976), high ownership concentration may lead to more alignment effect. This effect may impart promoters a strong incentive to flow value-maximizing goal. However, in contrasting argument by Demsetz (1983), this can also have entrenchment effect, which can decrease the firm's value. Claessens et. al. ( 2002) in similar arguments suggest the same thing, until a particular level of stock concentration alignment effect are more predominant and after that expropriation cost of minority shareholders out these benefits and firm performance declines. It is, however not clear, whether measures of corporate governance affect performance in the same way when ownership is not in general widely dispersed, in particular when ownership is concentrated in the hands of families that are promoters (Corbetta and Salvato, 2004). The promoters are in general sense the owners and managers in Indian business context. Jensen and Meckling (1976) have pointed as level of managerial ownership increases, conflicts reduces and that increases firm performance. Fama and Jensen (1983) and Stulz (1988) also argue that greater ownership control by insiders (managers) give enough powers over externals owners to influence firm performance. Many scholars have studied the effect of ownership by different group on Indian companies (Dwivedi and Jain, 2005; Sarkar and Sarkar, 2000; Khanna and Palepu, 2000; Salerka, 2005), but none of these studies does give any particular reference on effect of promoter ownership on the firm performance. Salerka (2005), however, has analyzed the insider ownership effect on the firm value, and found a curvilinear relationship. Studying the effect promoter ownership on the corporate performance may be of utmost important in period of financial distress. They are who can in position to take any important strategic decision to drive the performance. Therefore, high promoter ownership in period in such a period may enhance the firm performance. This leads to development of our fourth hypothesis that promoter ownership is positively associated with firm value. Further, above certain ownership, promoters may exert significant control over firm and drive the decision-making in the company, thereby increasing firm value. 4. Promoter ownership exhibits positive relationship with firm performance 5. Greater promoter control is positively related with firm performance
Data The sample used in this study includes 176 firms listed on the Bombay Stock Exchange (BSE) of India during the financial year 2008-2009. The sample includes only non-financial firms from BSE 200 index, which accounts for 72 percent of market capitalization. The data on board size and promoter ownership (company has to separately disclose promoter ownership under Clause 35 of Listing Agreement) was collected from annual reports of the companies. The other financial and market data was obtained from Prowess database of Centre for Monitoring Indian Economy (CMIE). The data thus obtained was used calculating and measuring the different variables used as control variable in the model.
Model The model for our study represented by following equation: T Tobin Q = ÃŽÂ²0 + ÃŽÂ²1 BSize + ÃŽÂ²2 PrOwn + ÃŽÂ²3 LAge + ÃŽÂ²4 LSize + ÃŽÂ²5 Lev + ÃŽÂ²6 SGrowth + e Performance Variables: The researchers have used different parameters for the assessing the firm performance in conjunction with various predicator variables. The commonly used performance variables cited in the corporate governance literature being the Tobin's Q, return on assets (ROA), return on equity (ROE), market to book value ratio (MBV), price to earnings ratio (PE). The present regression model uses only TobinQ for assessing the firm performance against the predictor and control variables. Variables of Interest: Two variables of our interest that have used to test our five hypotheses are board size (BSize) and promoter ownership (PrOwn). The variables have used under different specifications to empirically find out their net effect on firm performance. Control Variables: Different control variables such firm age (LAge), firm size (LSize), leverage (Lev) and growth control (SGrowth) have been included in the study for account for potential advantages of economies of scale, scope of market power and risk characteristics of firms. These variables have been used in many prior studies, and are correlated with firm performance (Hermalin and Weisbach, 1991; Vafeas and Theodorou, 1998; Bonn et. al., 2004)
Variable definitions and Measurement Type of Variable Variable Definition and Measurement Dependent: Performance TobinQ Tobin's Q , measured as market value of equity plus book value of short-term and long-term debt divided by total assets Independent: Predictor BSize Board Size, the number of director on the board of a firm. Independent: Predictor PrOwn Promoter Holding, percentage of total equity ownership of promoter group in the company Independent: Control LAge Firm Age, measured as the logarithm of the number of years since the establishment of a firm Independent: Control LSize Firm Size, measured as the natural logarithm of total assets. Independent: Control Lev Firm leverage, measured as the ratio of long term debt to the total assets Independent: Control SGrowth Sales growth, measured as total sales of the current year minus total sales in the previous year divided by total sales in the previous year
RESULTS AND DISCUSSION The analysis begins with presentation of the Pearson's correlation matrix (table II) which shows that the degree of correlation between the independent variables is either low or moderate, which suggests the absence of multicolinearity between independent variables.
Correlation Between Explanatory Variables Correlation BSize PrOwn LAge LSize Lev SGrowth BSize 1
Â PrOwn -0.039 1
Â LAge 0.137 -0.024 1
Â LSize .275(**) 0.094 .153(*) 1
Â Lev -0.038 -.215(**) -0.104 .273(**) 1
Â SGrowth 0.105 -0.13 -0.042 0.067 0.07 1 ** Correlation is significant at the 0.01 level (2-tailed). * Correlation is significant at the 0.05 level (2-tailed). The Pearson's correlation between each pair of independent variables should not exceed 0.80, if that happens then independent variables may suspected of exhibiting multicollinearity (Bryman and Cramer, 1997). Correlations are within the acceptable range (0.01 - 0.775). In addition, the colinearity diagnostic statistics (e.g. tolerance (TOL) and variance inflated factor (VIF)) support the Pearson's correlations and provide no proof of a multicollinearity in the regression model. The analysis of Table II, further reflects board size is positively correlated with firm size (significant at 1 percent) implying that larger companies tend to have larger boards. The summary of descriptive characteristics of the dependent and independent variable is presented in Table III. The results show mean (std deviation) board size is 10.74 (3.08), reflecting that most of firm have board size between 8 to 14 (128 firms) which is 72 percent of entire sample. The promoter ownership shows high variation with minimum and value being 0 and 100 with average (std deviation) of 53.32 (21.48). It can be observed that promoters with such ownership right have controlling stake in most of the firms. As already discussed, high insider ownership may drive firm value. Sales growth and leverage also reflect a high variability in their values for the given period. Average leverage of 25.86 percent shows that firms (our sample) rely on more on equity capital and other sources of fund than debt. In order to analyze further, we have segregated smaller and larger firms based
Descriptive Analysis of Variables TobinQ BSize PrOwn LAge LSize Lev SGrowth Mean 1.46 10.74 53.32 3.31 8.87 25.86 55.71 Std. Deviation 1.32 3.083 21.48 0.76 1.16 21.91 473.79 Minimum 0.0042 5 0 0.69 6.6717 0 -100 Maximum 8.6548 20 100 4.86 12.41 89.61 6286.93
Smaller and Larger Companies Smaller Companies BSize PrOwn ( percent) Asset ( Rs Crore) N
Â 88.000 88.000 88.000 Mean 10.060 50.558 3140.306 Median 10.000 49.991 2943.995 Std. Deviation 2.684 17.366 1379.618 Minimum 5.000 9.733 789.720 Maximum 20.000 99.506 5859.540 Larger Companies BSize PrOwn ( percent) Asset ( Rs Crore) N
Â 88.000 88.000 88.000 Mean 11.430 56.088 28216.983 Median 11.000 55.070 16215.695 Std. Deviation 3.311 24.732 36429.286 Minimum 5.000 0.000 5986.080 Maximum 20.000 100.000 245953.160 Difference between Means (Z value) 3.015* 1.716*** 6.452* * significant at 1 percent, ***significant at 10 on median asset size of Rs. 5922.1 Crore. The noticeable aspect of statistics reflected in Table IV is significant difference in average board size between small and large firm. (10.06 vs. 11.43), inferring that larger companies take people from wider pool to sufficient expertise and intellect on the board. The table IV also shows that average promoter ownership between small and large firms is significant at 10 percent (50.55 vs. 56.08). The results of empirical findings with coefficients and t values (* significant values) are presented in Table V, VI and VII. The findings of Table I show result for the entire sample that supports our hypothesis 1 and 4. Hypothesis 1 forecasts a negative association between board size and firm value and this supported by negative coefficient of BSize (ÃŽÂ²1) in the model, though relationship is not significant. The results are in line with international studies but do not support results of previous Indian studies (Dwivedi and Jain, 2005; Kathuria and Dash, 1999). Promoter ownership was found to positively correlated (ÃŽÂ²2= 0.011) with firm performance in our model (Table II) giving support to our hypothesis 4. The results prove that high promoter ownership in the company, help them to take important decisions and drive performance during the financial distress period.
Independent variables Coefficients t
(Constant) 3.271 4.081*
BSize -0.031 -0.968
PrOwn 0.011 2.492**
LAge 0.144 1.150
LSize -0.255 -2.839*
Lev -0.011 -2.462**
SGrowth 0.000 0.413
R square 0.165
Adjusted R square 0.135
F change 5.556* * Significant at 1 percent, ** significant at 5 percent Hypothesis 2 predicated that smaller boards have less negative correlation with firm performance than larger boards. In order to so, we segregated entire sample companies between two parts, one those having board size less than equal to median board size ( of entire sample) 10 and other having more than 10. The results (table III), however, reject our second hypothesis as coefficient of board size (ÃŽÂ²1) is greater for smaller boards (-0.148) than larger board (-0.012). This may be interpretated as ideal board size is above the median board size of 10, and smaller boards may not have enough expertise and resources to enhance firm performance. Also it can be observed that due to high ownership rights and say in smaller boards, promoters are able play value maximizing role. Hypothesis 3 predicted a less negative relationship of board size with firm value for the large companies than small companies. Small companies and large companies here are classified based on the median assets of Rs 5922.1 Crore. The model supports our hypothesis as coefficient of board size for large companies (-0.023) is more than that of small companies (-0.063). The results, however, are not significant at any level. Further, in small companies promoter ownership is positively correlated to firm performance at 10 percent significance level.
TobinQ- Model Board Size
Independent variables coeff t coeff t coeff t coeff t (Constant) 4.826 2.93* 2.819 2.70* 12.113 5.17* 3.082 2.14** BSize -0.148 -1.54*** -0.012 -0.23 -0.063 -1.29 -0.023 -0.59 PrOwn 0.025 2.81* 0.001 0.27 0.020 2.58** 0.003 0.58 LAge 0.389 1.98** -0.045 -0.31 0.358 2.00** 0.076 0.47 LSize -0.525 -3.28* -0.083 -0.87 -1.514 -5.16* -0.160 -1.03 Lev -0.005 -0.70 -0.018 -3.17* -0.002 -0.24 -0.012 -2.10** SGrowth 0.004 0.84 0.000 -0.09 0.000 -0.05 0.000 0.00 R 0.515 0.408 0.622 0.324 R square 0.265 0.166 0.387 0.105 Adjusted R square 0.213 0.101 0.342 0.038
F change 5.108* 2.563** 8.52* 1.579 * significant at 1 percent, ** significant at 5 percent, *** significant at 15 percent
TobinQ -Model Promoter Ownership
Independent variables coeff t coeff t coeff t
(Constant) 0.924 0.791 2.691 1.366 3.798 1.868***
BSize 0.023 0.492 -0.017 -0.345 -0.044 -0.644
PrOwn -0.013 -1.135 0.028 1.295 0.031 1.361
LAge -0.028 -0.168 0.311 1.630*** -0.038 -0.095
LSize 0.074 0.540 -0.372 -2.583** -0.400 -2.188**
Lev -0.010 -1.700*** -0.016 -2.168** -0.008 -0.721
SGrowth 0.000 -0.486 0.006 1.467 -0.005 -0.855
R 0.386 0.496 0.462
R square 0.149 0.24 0.213
Adjusted R square 0.007 0.181 0.101
F change 1.05 4.069* 1.9 * significant at 1 percent, ** significant at 5 percent, ***significant at 10 percent Higher promoter ownership leading to greater promoter control on the company was predicated in Hypothesis 5. To test this hypothesis, entire sample is classified into three groups, companies having promoter ownership less than equal to 40 percent, between 40 to 65 percent and above 65 to 100 percent. The results are presented in table VII that support our hypothesis 5. For companies having promoter ownership below 40 percent coefficient (ÃŽÂ²2) is negative (-0.013). This may suggest that on lower levels of ownership control, promoter's interest may not fully align with company. The companies having promoter ownership above 40, correlation was positively with firm performance with coefficient being greater for companies having more ownership control. This suggests that above certain ownership control on firm, promoter are able to drive the performance of company.
CONCLUSIONS The study explores the relationship of board size and promoter ownership on the firm value for a sample of firms listed on Bombay Stock Exchange of India. Some results of the study are quite revealing in contrast to earlier Indian studies. As opposed to previous Indian studies, our results indicate a negative relationship between board size and firm value. This augments the previous international researches and establishes belief that board size is negatively associated firm performance. We also find significant difference between board size of small and large companies of our sample. The relationship between board size and firm value is less negative large companies than smaller ones. We find a significant positive association of promoter ownership with firm performance. The regression results suggest that firms with high ownership concentration of promoters have high market valuations (TobinQ). The findings show that below ownership control of 40 percent, the entrenchment effect is more pronounced and negative relationship exists. We may conclude that due to financial distress on Indian firms due to global financial crisis, larger boards may not able to strategic decision due to problem of coordination and communication resulting in lower firm value. In similar case, higher promoter ownership gives enough incentive and control to monitor and enhance firm value. The study contributes to existing literature of corporate governance on board size and insider ownership. The outcome of research gives firm support the agency theory that high ownership has more alignment effect resulting reduced agency cost. One of the important empirical considerations taken in our study is moderating effect of firm size on the board performance. The study looks upon insider ownership particularly that of promoters on company valuations.
LIMITATION AND DIRECTION FOR FUTURE RESEARCH The current research along with its contribution has some major limitations. First, we have used only a small sample of 176 firms. The entire sample was classified into different categories to analyse further effect of board size and promoter ownership on firm performance. The classification has resulted in smaller sample size and some models were not significant. Second, model uses only one performance variable for ease of analysis while variables would also be merit consideration. Thirdly, the important aspect left out in our study pertains to board composition and other ownership patterns that may also affect firm performance. The current study opens avenue for future research ideas. Our research indicates a negative association between board size and firm performance, which is in contrast previous studies. This may be due fact that period of study is year 08-09 during which global financial crisis was persisting and Indian firms were under financial strain. Therefore, we firmly believe multidimensional approach for performance measurement with large sample size would be appropriate for future research. Investigating effect of other corporate governance variables like board structure and ownership structures on firm performance during period of our study would also provide new insights. Lastly, the qualitative analysis using primary data can give better insights and support our research.