A Study of the Impact of Corporate Governance Practices on Firm Performance in Indian and South Korean Companies Academic research paper on "Economics and business"

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Procedía - Social and Behavioral Sciences 133 (2014) 4 - 11

ICTMS-2013

A study of the impact of corporate governance practices on firm performance in Indian and South Korean companies

Pooja Gupta, Aarti Mehta Sharma *

Symbiosis Institute of Business Management, Bengaluru, Symbiosis International University (SIU), Bengaluru, Karnataka, India

Abstract

Corporate Governance is needed to create a corporate culture of consciousness, transparency and openness. It enables a company to maximize the long term value of the company which is seen in terms of performance of the company. In this paper, we look at various Corporate Governance practices followed by companies in India and South Korea. This includes parameters like Board Constitution, Board Structure, Different Committees, Independent Directors and their roles, Conflict of interest and Disclosure of information. The objective is to determine if there is a relationship between corporate governance and firm performance. The study tries to see whether higher and better corporate governance leads to better performance of the companies. It is found in the study that corporate governance practices have limited impact on both the share prices of the companies as well as on their financial performance

© 2014 The Authors. PublishedbyElsevier Ltd.This is an open access article under the CC BY-NC-ND license (http://creativecommons.Org/licenses/by-nc-nd/3.0/).

Selection and peer-review under responsibility of the Organizing Committee of ICTMS-2013. Keywords: Corporate Governance; legislations; financial performance; India; South Korea

1. Introduction

It is believed that the steering agent for the survival and the growth of the company i s primarily its 'Corporate Governance' policies. Corporate governance refers to the code of conduct through which companies are directed and controlled. Whether the company follows the stakeholder model (where all the stakeholders are considered equally important) or follows the shareholder model (where more importance is given to shareholders as they are the

* Corresponding author. Tel.: 919742819199; fax: +0-000-000-0000 . E-mail address: aartimehtasharma@sibm.edu.in

1877-0428 © 2014 The Authors. Published by Elsevier Ltd. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/3.0/).

Selection and peer-review under responsibility of the Organizing Committee of ICTMS-2013. doi:10.1016/j.sbspro.2014.04.163

owners of the company), the practice of corporate governance is increasingly becoming vital. Charreaux and Desbrieres (2001) discuss this very crucial point of difference between stakeholder value and shareholder value. The increase in financial and managerial scams has led the investors to increasingly look for transparency and professional management in handling the company's business.

The concept of corporate governance has been in existence for a long time but it was formalised in UK in the early 1990's.It all started with Cadbury Committee Report (1992) which was a committee formed in UK due to a large spate of financial scams and corporate failures in the 1980s. It was formed by the London Stock Exchange, the Financial Reporting Council and the accountancy professionals. The main aim of the committee was to discuss about financial aspects of Corporate Governance. This report was followed by Greenbury Report (1995) which was a study on Director's remuneration; Hampel Report (1998) was a committee on Corporate Governance and Turnbull Report (1999) which talked about obligations of directors. Till then most of the Asian countries did not have any legislation regarding corporate governance neither were they planning to move towards any in this area. In 1997, the world witnessed what came to be known as South East Asian financial crisis when all the ASEAN countries ranging from Thailand to South Korea faced an economic crisis which led to deceleration of economic growth in the area. Lot of research work has been done to find out the reasons that led to this crisis. It was thought that there was a relationship between corporate governance and the South-East Asian crisis. Did the crisis expose corporate governance problems, or did corporate governance problems trigger the onset of the crisis? This was one of the prime questions in front of the researchers.

Some research works mentioned that lack of transparency and independent management were one of the reasons for the Asian crisis whereas some of the articles mentioned that the crisis exposed such problems and organisations like the IMF stressed on having good governance practices to prevent it in future. After the crisis, there was an emergence of the Korea SE Act and Commercial code in 1999, the Code of Corporate Governance in India in 1999 and similar developments on this front in other Asian countries. In India's case also, in 1999 SEBI constituted a committee under Kumarmanglam Birla to recommend corporate governance measures to be followed by Indian companies. SEBI felt a need to regularise the disclosures by the companies in the wake of scams like MS Shoes etc. The committee came out with a report in 2000 but it was not implemented immediately. The recommendations were considered to be too strict in Indian context. But after the Enron scam in 2002, another committee was formed under Narayan Murthy (2003) to come up with concrete measures to implement corporate governance. The recommendations of these two committees took the form of Clause 49 of the listing agreement and finally implemented in 2006.Afsharipour (2009) states that India's reform efforts have demonstrated that while corporate governance rules may converge on a formal level with Anglo- American corporate governance norms, local characteristics tend to prevent reforms from being more than merely formal. India's inability to effectively implement and enforce its extensive new rules corroborates the argument that comprehensive convergence is limited, and that the transmission of ideas from one system to another is highly complex and difficult, requiring political, social and institutional changes that cannot be made easily.

Oh Seok-Hyun (1999) in the aftermath of the effect of the South East Asian Crisis on Korean economy talks about the lacunae in Korea in the field of corporate governance. He shows the structural imbalances in the Korean economy and especially in the way chaebols are run. Kim and Woochan Kim (2008), talk about the best governance practices in Korea which were seen mainly in three kinds of corporations: (1) newly privatized companies; (2) large corporations run by professional management; and (3) banks with substantial equity ownership in the hands of foreign investors. The governance practices of many of these companies met the global standard. At the other end, of the spectrum, however, were many large chaebol-affiliated or family-run firms that refused to change and circumvented regulatory reform measures. Good governance helps to develop a brand name for the company and it improves the confidence of investors and stakeholders of the company. Existence and composition of the board (including the number of executive and non-executive directors namely independent directors and affiliated / nominee directors) , remuneration to the board members , relations with shareholders (including participation in the AGM) , accountability and audit , committees established to oversee critical procedures are few parameters with which governance can be measured. Quantitative measurement of these factors is not sufficient, the reason being factors such as independence of the directors or independence of the auditor must be measured from the qualitative aspects and not quantitative. Zahra and Pearce (1989 propose specific links among four board attributes (composition, characteristics, structure and process) and three critical board roles (service, strategy and control). Lacker, et al (2004) examines the relation between a broad set of corporate governance factors and various measures of organizational behaviour and managerial performance.

Investors rely heavily on financial statements and reports prepared and published by the company for any information about it. One of such reports is the annual report. Due to local legislations and requirements it has been observed that annual reports of most of the companies have a separate section on corporate governance. This section covers most of the mandatory disclosures like board functioning and its independence, shareholders rights and conflict of interest. Singhvi and Desai (1971) also talk about the quality of corporate financial disclosure.

An investor looks for return in a company while investing. Increase in returns can be analyzed by the rise in share price. Based on the consideration that investors rely on annual reports for the financial information and other information about the management team to know the way the company functions which includes corporate governance and they are looking for returns to invest or keep their investment made in the company intact, in this paper the author analyses and studies whether any relation exists between corporate governance and various return parameters considered important by investors such as Return on Assets, Return on Equity and the movement in share prices . Return on asset measures company's earnings in relation to all the funds it has at its disposal. It is believed better the governance model; more efficient would be the asset utilization. Return on Equity measures how much return is being generated by the company on the money invested by the shareholders. It is one of the most important parameters for the investors in the company. Maher and Andersson(1999) talk about effect of corporate governance followed by companies on their financial performance.

2. Data and Methodology

For the purpose of this study, two countries in Asia were chosen, namely, India and South Korea. The countries were chosen on the basis that these two countries are among the top four countries in Asia on the basis of GDP in

2012. From both these countries five multinational companies were chosen. The criteria for choosing the companies was that they should have an international presence, are well known brands and are among the top companies in their own country on the basis of turnover. Also care was taken to choose companies belonging to different industries and there was a mix of manufacturing and service companies. All the ten companies chosen are listed companies in their own countries on major stock exchanges and in some instances on other countries' stock exchanges as well. Data was collected from the websites of the companies, published reports and annual reports of the companies. All the data collected was secondary in nature. The time period of the study was eight years from FY 2005-06 to FY 2012-13.The share prices of each company was taken for the time period Jan 1 2006 to March 31

2013. All this data was collected from various websites. Return on Assets is calculated as Net Income / Total Assets. It is expressed as percentage. Similarly, Return on Equity is calculated as Net Income / Shareholder's Equity. It is also expressed in percentage terms.

Parameters specific to Corporate Governance were considered and data was collected about them for all the ten companies for the period FY 2005-06 to FY 2012-13. Following were the parameters chosen:

• Board Structure - This parameter talks about total number of directors, number of executive, non-executive and independent directors. This shows the independence of the board in its functioning.

• Committees and details - This parameter talks about the number of committees related to corporate governance that each company has and the constitution of these committees. This shows the commitment of companies towards fulfilling corporate governance norms.

• Disclosure of Information - This parameter talks about how open the company is regarding disclosures such as board compensation, related party transactions, implementation of corporate governance principles, linking of senior management's remuneration with profits of the company and an internationally recognised independent auditor.

The authors tried to see if there is any relation between good governance practices of a company and its financial performance. If a company is open for scrutiny and is willing to share all information with the shareholders, its stock price is expected to do better as compare to a company which does not disclose all information. Similarly, financial performance of the company is also expected to be better if better governance practices are followed by the company. Corporate Governance practices though are only one of the factors affecting the share prices.

3. Analysis

3.1. Corporate Governance in India

Corporate governance in India is restricted to Clause 49 of the listing agreement. The Corporate governance norms are very strict and disclosures are mandatory. These norms are only applicable to public limited companies in India which are listed. Table 1 gives the corporate governance disclosures in the five companies selected from India. These five companies were chosen as they have international presence, a recognisable brand name and are from diverse industries including both manufacturing and services sector. As all five of these are listed companies in India, they have to strictly follow the guidelines given by SEBI (Securities and Exchange board of India) regarding corporate governance. Out of these five companies, Infosys is the world leader in disclosure. It has won numerous awards for being one of the most transparent company and going beyond mandatory disclosures. Infosys has set the trend in India for voluntary disclosure of a lot of items. The norms do not define how many committees should be there. Each company has set up the corporate governance committees according to its own needs and requirements. All the Indian companies have internationally recognized external auditors.

In case of Indian companies, Infosys has always enjoyed high market capitalization as it has one of the best corporate governance models in the world. It shares information both mandatory by law as well as non-mandatory in its published reports. As a result the share price of Infosys has always performed well. Although in case of Tata Motors and Larsen & Toubro, there are very less or no independent directors on board, it has not affected their share prices much. But in case of Bharti Airtel and Videocon, on paper they seem to be following all the governance norms set by the government but in reality looking at their eight year history of corporate governance, it seems like a bit of whitewash. The same is also true for their share prices which have been languishing for the same time period.

Table 1: Corporate Governance Report of Indian Companies

Bharti

Infosys

Tata Motors

Videocon

Area of Business

Exchanges Listed

Telecom Services

Software India/US

Manufacturing and Engineering

Automobile India/US

Electronic Appliances

Board Structure

Executive Directors

Non- Executive Directors

Different Committees

Independent Directors

Audit Committee

Yes (3I)

Yes (4I)

Yes (3NE)

Yes (3I)

Yes (3I)

Remuneration Committee

Yes (2NE & 4I)

Yes (4I)

Yes (2 NE & 2I) Yes (3I)

Investor Grievance Yes (1E & Committee 3NE)

Nomination Committee

Yes (3I) Yes (3I)

Yes (2E & 1NE) Yes (1E & 3NE)

Yes (1E,1NE &

Yes (1E, 1NE & 2I)

Yes (3I)

Others

Risk Management

Ethics

Finance

Disclosure Compensation

Disclosed

Disclosed

Disclosed

Disclosed

Disclosed

Related Party Transaction

CG Report External Auditor

Disclosed Full

Batliboi

Disclosed Full

Disclosed Full

Sharp &Tannan

Disclosed Full

Delloite

Disclosed Full

Khandelwal, Jain & Co.

E - Executive Director, NE- Non-Executive Director and I- Independent Director

Indian Companies (Average Monthly price)

Figure 1: Share Prices of the chosen Indian companies

Table 2: Average Financial Performance for Indian companies

Bharti Infosys L & T Tata Motors Videocon

Return on Assets 3.64% 23.29% 5.55% 2.29% 1.18%

Return on Equity 5.14% 27.70% 16.53% 6.32% 0.65%

The above table talks about the financial performance of Indian companies. Infosys has consistently performed well financially followed by Larsen & Toubro, Bharti Airtel, Tata Motors and Videocon. It seems that both in case of Infosys and Videocon, the financial performance is related to the governance practices followed. The better the governance practices better is the financial performance. The only exception in this case is seen in case of Bharti Airtel where the governance practices over the last eight years are good on paper but the financial analysis tells a different story.

3.2. Corporate Governance in South Korea

The chaebols experience in South Korea has affected the way corporate governance is looked at in that country. Chaebols are large conglomerate businesses which are many times run by families. Many top companies in South Korea on the basis of turnover are chaebols which are family run businesses. These chaebols are not known for following the disclosure norms of corporate governance. The corporate governance norms have been made mandatory in Korea mainly in the last three years. Out of the five companies chosen here, many of them have started disclosing data only in the last three years. Some companies like Kia Motors and LG Electronics are only partially disclosing information about following of corporate governance norms. On the other hand, company like POSCO has been consistently disclosing information as much as possible with its shareholders. POSCO has won several awards for its corporate governance practices both at home and abroad. Hyundai and Samsung are examples of what are known as chaebols. Their disclosure norms have been sporadic in nature. But Samsung as compared to others is showing an improvement in its governance practices as well as disclosures over the last two years.

There seems to be some impact of corporate governance practices on the share prices of the companies in case of South Korea. Samsung share prices have seen an uptrend from the time its governance and disclosure practices have become more open. POSCO share prices have remained more or less constant over the five year period studies. Whereas prices of the other three companies, LG, KIA and Hyundai have languished. One of the reasons for the languishing share prices may be due to non-compliance of corporate governance practices and general mistrust about the companies as there is almost no disclosure of information.

Table 3: Corporate Governance Report of South Korean Companies

Hyundai Motors

Kia Motors

LG Electronics

Samsung

Area of Business

Exchanges Listed

Automobiles Korea

Automobiles Korea

Electronic appliances

Steel Products Korea/UK/US

Electronic appliances

Korea/ UK

Board Structure

Executive Directors

Non- Executive Directors

Independent Directors

Different Committees

Audit Committee

Yes (5I)

Yes (3NE)

Yes (3I)

Outside Director Information not Yes (1E &

Committee Yes (2NE & 2I) available 1NE)

Yes Yes (2E & 3I)

Management Committee

Yes (2E & 1NE)

Yes (3E)

Ethics Committee_Yes (5I)

Disclosure

Board Compensation

Related Party Transaction

CG Report

External Auditor

Disclosed

Disclosed

Partial

Deloitte

Not Disclosed Not Disclosed Not Disclosed Not Disclosed

Partial

Disclosure Not Disclosed

Not much disclosure

Partial

PriceWater House Cooper

Disclosed

Full disclosure

Partial Disclosure

Partial

PriceWater House Cooper

E - Executive Director, NE- Non-Executive Director and I- Independent Director

South Korean Companies ( Average Monthly Market Price)

Figure 2: Share Prices of the chosen South Korean companies Table 4: Average Financial Performance for South Korean companies

Hyundai Motors Kia Motors LG Electronics POSCO Samsung

Return on 9.58% 7.03% 0.35% 2.90% 11.18%

Assets

Return on 7.62% 25.46% 2.39% 5.74% 22.15%

Equity

The financial performances of the companies do not seem to be much affected by the governance practices followed. POSCO is the prime example of this. It has had one of the best Corporate Governance practices in South Korea but the financial performance as well as the share price does not reflect it.On the other hand KIA Motors also shows good financials but leaves a lot to be desired in governance practices.

4. Conclusion

Asian countries share similar cultural traits but do not share corporate governance practices. In the study, it was found that India follows more stringent corporate governance practices based on US model as compared to South Korea which follow stakeholder form of corporate governance. The difference in mandatory disclosures and governance practices is huge among the two countries. South Korea initially did not believe in outsiders interfering in company's business and does not have mandatory requirements of independent directors and various committees to look after the company's works. But slowly changes are coming about. It has put into place various legislations regarding corporate governance practices and disclosure norms but is not able to fully implement it due to the power concentration in the hands of family run businesses, chaebols. It is seen in the study corporate governance practices do have an impact on the share prices of the companies. But it is a very limited impact and should not be seen in isolation of other factors affecting the share price and the financial performance.

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