Corporate Governance, Enforcement, and Firm Value: Evidence from India

Recently in the Law and Economics Seminar here at Harvard Law School, we presented our paper entitled Corporate Governance, Enforcement, and Firm Value: Evidence from India. This paper analyzes the connections between corporate governance, stock market development and firm value using a sequence of reforms to India’s corporate governance regime as a source of exogenous variation. Despite the widespread interest in this area of research, finding evidence that corporate governance causes changes in firm value has posed a significant challenge since most governance reforms in the US have applied to all firms, making it difficult to isolate a credible control group. For this reason, and because of the relatively limited variation in governance practices in an economy such as the US, attention has increasingly been directed to the relationship between governance and firm value outside the US, especially in emerging markets.

There were a number of reforms enacted in India that were phased in over the period 2000‐2003, and severe financial penalties for violations were subsequently introduced in 2004. The exemption of a large number of firms from the new rules and the complex criteria for their application give rise to treatment and control groups of firms with overlapping characteristics. Using a large sample of over 4000 firms from 1998‐2006, a difference‐in‐ difference approach (controlling for various relevant factors and for firm‐ specific time trends) reveals a large and statistically significant positive effect (amounting to over 10% of firm value) of the reforms in combination with the 2004 sanctions. A regression discontinuity approach focusing on the thresholds for the application of these reforms leads to similar conclusions. In addition, the estimated effect of the initial announcement of the sequence of reforms in 1999 is weaker than the effect of the 2004 sanctions, highlighting the importance of sanctions. Some channels through which the 2004 effect may have occurred are explored, but the results are preliminary because there are only two years of post‐2004 reform data. There is some evidence of improvements in accounting performance and increases in foreign institutional investment, but this is not robust across specifications. In addition, the 2004 reforms are not associated with a reduction in tunneling within business groups.

Our results, taken together, present a strong case for a causal effect of the reforms on firm value. They also underscore the importance of the enactment of severe sanctions, though it is not entirely clear whether this effect operates through formal enforcement alone or in conjunction with some additional channel.

The full paper is available for download here.