Enhancing Firm Value under Concentrated Ownership

Corporate boards of the company are primary drivers for growth and value maximization. Boards of directors as fiduciaries of the shareholders are delegated with the task of monitoring the management to protect the rights shareholders and enhance the value of their capital (Jensen and Meckling, 1976). The structure of board therefore plays an important role in determining the performance of board and maximizing shareholder wealth (Ghosh, 2006).

The board is a vital internal corporate governance mechanism and effective in controlling the management and reducing the agency problem (in dispersed shareholding conditions) (Fama and Jensen, 1983). The introduction of non-executive directors' on the board was aimed at solving the agency problem and enhancing board performance. The existing literature suggests that outside directors (particularly independent directors) are able to protect the shareholder interests and can perform value enhancement in case of agency problem (Fama and Jensen, 1983; Fraser and Zhang, 1995; Linck et al. 2008). However, under concentrated ownership conditions, generally, the owner is also manager and the issue of agency problem is minimal.

The board composition with majority of outside directors under concentrated ownership therefore becomes a critical question. The issue arises whether the outside directors: independent and grey (non-executive non-independent); can play critical role and perform value enhancement through their knowledge and expertise. The majority owners under concentrated ownership as regard to their voting rights have control on selection process of directors and therefore directly influence appointments to the board. This matter assumes importance in determining the quality of independent and grey directors and their ability to protect, particularly the minority, shareholder interests. Predominant literature on corporate governance related to effect of board size on firm performance predicts a negative relationship (Yermack, 1996; Gosh, 2006; Guest, 2009). The negative influence of larger group dynamics in bigger board prevail over the anticipated potential advantages of greater number of people on such board (Jensen, 1993).

The current study aims to extend research done by Ghosh (2006) on board structure on firm performance in Indian context. In particular, study aims at investigating the effect of board size and composition of board, that is, percentage of inside, independent and grey directors on the board performance. The research is new the perspective, as it aims to understand how presence of these directors on the board affects firm value in period of financial distress under concentrated ownership.

II. Research Design

The sample used in this study consists of 164 non- financial firms of Bombay Stock Exchange (BSE) 200 index of India for the financial year 2008-2009. The data on board size and composition was taken from corporate governance report of the companies. The other financial and market data was obtained from Prowess database of Centre for Monitoring Indian Economy (CMIE).

The effect of board size on firm performance is estimated through equation 1, while equation 2 is used for analyzing effect of different categories of directors on the firm performance. The market based performance measure Tobin's Q has been used a dependent variable to analyse the effects. Several control variables have been included in model to remove the problem of endogenity and to account for the potential advantages of economies of scale, growth, scope of market power and risk characteristics of firms (Hermalin and Weisbach, 1991; Vafeas and Theodorou, 1998; Shanmugam and Bhaduri, 2002)

Table 1 Description of the Variables

Type

Variable

Description and measure

Dependent

TobinQ

Tobin's Q , market value of equity plus book value of short-term and long-term debt divided by total assets

Independent

LBsize

Board Size, natural logarithm of the number of director on the board

PerEX

Executive Directors, percentage of executive directors on the board

PerGR

Grey Directors, percentage of grey directors on the board

PerIND

Independent Directors, percentage of Independent directors on the board

Control

Fage

Firm Age, the logarithm of the number of years since the establishment of a firm

Fsize

Firm Size, natural logarithm of total assets

Lev

Firm leverage, ratio of long term debt to the total assets

Roa

Return on assets, measured net profit to the total asset

Ownblock3

Ownership block holding, measured percentage ownership of top three block holders of the company

indusdum

Industry dummy, Industries shown in table III given dummy values from 1 to 15

Table 2 Descriptive Statistics of Variables

Variables

TobinQ

LBsize

PerEXE

PerGR

PerIND

Fage

Fsize

Lev

Roa

Ownblock

N

164

164

164

164

164

164

164

164

164

164

Mean

1.504

2.345

29.269

20.291

50.440

7.587

8.815

23.567

0.774

79.056

Median

1.095

2.303

30.000

18.182

50.000

7.591

8.611

23.975

0.550

80.277

Std. Dev

1.359

0.292

12.948

14.421

10.574

0.012

1.131

19.164

0.663

11.865

Minm

0.000

1.609

0.000

0.000

20.000

7.539

6.672

0.000

0.010

46.732

Maxm

8.650

2.996

55.556

62.500

85.710

7.604

12.413

67.960

3.530

100.000

III. Results and Discussion

The Indian corporate governance code i.e. Clause 49 of the Listing Agreement which necessitates half of board to be comprised of independent director in case executive or non executive promoter or relative being the Chairman. The results point that on an average, the boards of companies have 70 percent non-executive directors (outside directors) and 50 percent of independent directors. Further analysis ( table III) suggest that companies having larger board size ( more than 11) find it difficult to have 50 percent independent directors on the board. Ghosh (2006) has analyzed the effect of the board composition on firm performance and, finds weak positive association of outside directors with firm performance. Extending his work and also controlling for board size , we have analyzed the effect of three categories of directors namely; inside, independent and grey directors on the firm performance. The regressions results (table IV) reveal that under concentrated ownership regime in period of financial distress (08-09), greater proportion of inside directors on the board significantly affects firm performance, whereas greater percentage of grey directors significantly deteriorates the firm performance. Higher percentage of independent directors on board has no significant affect on the firm performance.

Consistent with study of Ghosh (2006) and other international studies and, we find that board size is negatively associated with Tobin's Q, though not at any significant level. We see that average board size of sample companies is approx 11 (table III). The result suggests that larger boards are ineffective in monitoring the management due to higher agency cost associated with it, and ideal board size for Indian companies should smaller and below 11.

Table 3 Board Composition

Industry

Companies

Board Size

Exe Direc

Grey Direc

Ind. Direc

NE Direc ( Grey+ Ind)

Number

Avg Size

Avg Percen

Avg Percen

Avg Percen

Avg Percen

Agriculture

7

10.71

34.27

16.67

49.06

65.73

Capital Goods

14

11

30.25

18.95

50.79

69.75

Chemical

3

13

33.9

14.58

51.52

66.1

FMCG

9

10.11

26.6

23.05

50.35

73.4

Healthcare

15

9.73

34.62

12.02

53.35

65.37

Housing Related

18

11.38

29.97

19.74

50.29

70.03

Information Technology

12

9.83

25.23

18.64

56.13

74.77

Metals and Mining

18

11.11

30.44

21.58

47.97

69.56

Oil &Gas

16

11.56

33.78

22.73

43.48

66.22

Power

13

12.15

26.31

22.88

50.8

73.69

Telecom

6

9.33

13.89

33.89

52.22

86.11

Automobiles

12

11.58

29.13

22.14

48.72

70.87

Transport Services

6

10.83

32.38

16.94

50.67

67.61

Textile

4

9.75

22.32

24.46

53.21

77.68

Others

11

10.27

24.68

21.45

53.86

75.31

Total

164

10.89

29.26

20.29

50.44

70.73

Table 4

TobinQ- Model Board performance

Dep Variable

Model 1

Model 2

Model 3

Model 4

Ind variables

(Constant)

0.217

3.331**

0.182

2.674

0.247

3.757*

0.183

2.449

LBsize

-0.171

-1.542

-0.186

-1.686+

-0.147

-1.333

-0.146

-1.284

0.077

1.682+ 

-0.101

-2.195

0.08

0.917

Control Variables 

Fage

-9.276

-1.396

-8.546

-1.291

-9.3

-1.417

-0.9781

-1.467

Fsize

-0.408

-3.259

-0.429

-3.428

0.451

-3.6

-0.419

-3.329

Lev

-0.089

-2.309

-0.098

-2.536

-0.104

-2.685

-0.092

-2.365

Roa

0.297

5.276*

0.287

5.102*

0.287

5.155

0.298

5.293

Ownblock3

0.331

3.558

0.315

3.387

0.338

3.67

0.346

3.66

-0.002

-0.576

-0.001

-0.214

0

-0.142

-0.002

-0.566

No. of Firms

164

164

164

164

0.578

0.588

0.595

0.581

R square

0.334

0.346

0.354

0.338

Adj R square

0.304

0.312

0.321

0.303

F change

11.173

10.245

10.618

9.872

IV. Conclusion

The current study investigates which directors are able to enhance performance of corporate boards of companies in Indian context. The results suggest it is particularly the inside directors who are committed to shareholders for their wealth maximization. The inside directors know the company well, have full time commitment and own significant proportion in the company. There interests are much aligned with company, to they can perform value maximization role. Outside directors play a limited role under concentrated ownership regime as evident by regression results. Their quality and ability to protect minority shareholders has also become questionable after Satyam fiasco (Singh and Kumar; 2010). Outside directors and particularly Grey directors are not able to play their role of value maximization in absence of agency problem.

Thee study has few implication and lends support for Indian policy makers who aiming to propose the new corporate governance framework for companies through the Companies Bill, 2009. The new legislation proposes to limit to number of independent directors on the board to one third. Our study lends support to this proposed rule and suggests for improving the quality of outside directors. It also necessary to rationalize board size as larger board is ineffective enhancing the firm performance. Our study also lends support to requirement of this legislation that limits board size from three to 12. Based on our findings, we propose further reduce this to 10 or 11 (average board of sample companies) that certainly help in enhancing board performance.

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