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ISSN 0976 6332 (Online), Volume 5, Issue 4, July- August (2014), pp. 01-10 IAEME
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PREDICTING CORPORATE GOVERNANCE ON PERFORMANCE
MEASURES IN SELECT INDIAN CORPORATES


Dr. TWINKLE PRUSTY

ASSOCIATE PROFESSOR, FACULTY OF COMMERCE, BHU, VARANASI



ABSTRACT

This paper proposed and tested the theoretical as well as the hypothesised model that
attempts to confirm whether the relevance of the practice of good corporate governance
influence corporate performance by adopting Return on Assets(ROA), Return on Capital
Employed(ROCE) or Economic Value Added(EVA) reporting which is important for
investment decision making and internal governance. The result of the study provided
important implications necessitating establishing the fact that the various corporate
governance mechanisms viz., board structure and activity, audit committee, shareholders
rights, remuneration committee, nomination committee and disclosure practices influences the
economic value added for consistent internal governance and value creation for the Indian
companies. The implication of the study hinges upon how to achieve the above mentioned
priorities which is contributory to the advancement of knowledge and as a forethought
exploration in the area of corporate governance. The study shall enable the professional
bodies and Indian corporates to make considerable progress in raising awareness of the value
of good corporate governance by way of establishing relationship between corporate
governance and economic value added, an superior performance metric of reporting the
shareholders value creation.

INTRODUCTION

The insinuation of corporate governance on the corporate performance is quite
perceptible in measuring excellence in all productive, economic and social pursuits. In the
changed scenario, as the essence of corporate governance lies in the valuation reporting, the
enthused investors are no longer satisfied with bland accounting figures but need to know
how much value has been created by the company in terms of true economic profit i.e.
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International Journal of Advanced Research in Management (IJARM), ISSN 0976 6324 (Print),
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through the path of revolutionary EVA (Economic Value Added). Although the traditional
measures of corporate performance, ROA & ROCE are still in vogue (linking directors
compensation and management), it has led to value destroying actions with the false notion of
creating shareholders wealth without considering the concept of cost of capital. In the era of
globalisation, to achieve the best corporate performance, the corporates in their commitment
to all stakeholders and shareholders relationship, has focussed on EVA, a superior
performance measure for corporate reporting and internal governance that has the cohesive
management values in harmony with the companies and engrossed by the quantum of
economic value generated by them in excess of its cost of capital. In other words, a company
creates value only if it is able to generate returns higher than its cost of capital. Performance
measurement using EVA causes the objective of management suitable with the shareholders
interest.

REVIEW OF LITERATURE

Literature survey has suggested that EVA is being considered as the most accurate
driver of corporate performance in terms of shareholders wealth creation as well as
management of a higher stock price. Teen (2006) explained that corporate governance is not
only about compliance to law, order, standard, and code, but also the performance
improvement and assess stockholder. The opinion succeed has also been proved by Klapper
and Love, 2002; DurnevAnd Kim, 2003; Black, Jang, and Kim (2005). They found positive
relation between CG index and company value that measured by Tobin's Q. Utama and
Afriani ( 2005) succeeding to prove the positive relation between CGPI and spread of EVA,
and the positive relation between CLSA index with market value divided by investment
capital. Corporate governance represent serious effort of companies in giving commitment to
achieve the objective of company which have been specified ( Syakhroza, 2003). CG will
improve value of company because main objective of corporate governance is to assure
whether companies operate efficiently and achieve the ultimate goal to maximize stockholder
value (Zheka, 2006). Brown and Caylor (2004) explain that effective CG will lessen control
rights that are given by stockholders to creditors and manager. CG will improve manager
possibility to make investments in projects with rate of return which are positive. Company
will be managed better so that the performance will be increased. Company with good growth
opportunity need fund from external for expansion. Good corporate governance reflects the
ability of companies to manage all activities well. It gives positive signal about the credibility
and commitment of management to protect the creditor rights. Corporate governance tends to
decrease the cost of debt (Klapperdan Love, 2004). According to Durnev and Kim (2003),
company with opportunity of growth need large external fund so they will adopt better CG to
attract the owner of capital. Company with high potential growth in the future will have better
EVA. One of the important components in EVA is net operating after tax (NOPAT). High
sales will create high NOPAT and EVA. Increasing of NOPAT can be happened through
improvement of earnings growth (Febrianti, 2006). Salmi and Virtanen (2001) find that
profitability (or earnings growth) representing primary factor influences EVA.

SIGNIFICANCE OF THE STUDY

The appraisal of the effect of Corporate Governance (CG) to the performance of the
firm measured by ROA, ROCE and EVA, the performance measurements, is the need of the
study from the gaining importance of motivating managers i.e enabling good governance, to
International Journal of Advanced Research in Management (IJARM), ISSN 0976 6324 (Print),
ISSN 0976 6332 (Online), Volume 5, Issue 4, July- August (2014), pp. 01-10 IAEME
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get rid of destructive activities and to invest in those projects that are expected to enhance
shareholder value. This research will investigate the relationship between corporate
governance and the performance measures of the listed companies in India. The study shall
be based on the formulation of the hypothesis and find out the statistical modelling
relationships between the corporate governance (CG) and ROA, ROCE & EVA. It is
imperative to find out whether the practice of corporate governance shall bring in efficiency
and improve company performance thereby enhancing the value of the company. It shall also
focus on the importance of corporate governance in the economic framework for
shareholders wealth creation and whether the route to achieve excellence by the corporates
have been tailored in the best practices of corporate governance of which EVA is the perfect
measurement tool and an integrated management philosophy.

OBJECTIVE OF THE STUDY

The main objective of the study is to explore the implications of practices of corporate
governance on the various performance measures of the Indian corporates. It shall also find
out the corporate governance score of the sample companies based on the BT-SS Survey of
the Indias biggest wealth creators and assess whether conformance of the various aspects of
corporate governance could bring about direct impact on the shareholders value creation by
way of EVA reporting.

RESEARCH METHODOLOGY OF THE STUDY

To enable the studys objective, the strictures of the corporate governance are
explored in light of the recent developments and amendments in the Indian legal context.
Sample of companies ensuring ROA, & ROCE and EVA reporting as surveyed by the BT-
SS(Business Times-Stern Stewart) biggest wealth creators, were retrieved for the last 5 years.
The annual reports with disclosures of corporate governance reports as per Clause 49 of SEBI
and values of EVA have been collected from 50 listed companies(top wealth creators) in
India from the CMIE(Centre for Monitoring Indian Economy) database to qualify the study
of impact of various facets of corporate governance by constructing a CG Score on the
internal performance measures and shareholders value creation. Based on this objective
framework, the research entails the hypothesis to be: Corporate Governance has no
significant and positive relationship with corporate performance measures, EVA, ROA &
ROCE.
Corporate Governance is measured by way of developing the corporate governance
score(CGS) by considering six important governance mechanisms, viz., (a) Board structure
and activity, (b) Disclosure practices, (c) Audit committee, (d) Shareholders rights, (e)
Remuneration committee, and (f) Nomination committee, covering a total of 85 attributes
affecting the governance of the companies.
Hence, using the information in regard to the six internal governance mechanisms,
corporate governance score (CGS) is being constructed covering a total of 85 attributes
affecting governance of the Indian companies, with help of the corporate governance reports
stated in the annual reports of the companies. This is being compiled by Credit Rating
Information Services of India-CRISIL(Governance and Value Creation-GVC) and
Governance Metrics International(GMI), which produces governance ratings of more than
6000 global companies by gathering information on individual governance attributes
requiring the minimum level of implementation as per Clause 49 of the Listing agreement,
International Journal of Advanced Research in Management (IJARM), ISSN 0976 6324 (Print),
ISSN 0976 6332 (Online), Volume 5, Issue 4, July- August (2014), pp. 01-10 IAEME
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Securities Exchange Board of India). The corporate governance scoring methodology
facilitate the regulators in assessing the efficacy of the corporate governance system of the
company practised as an approach and helps to evaluate the impact of it on various
performance measures as an rating tool.

EMPIRICAL ANALYSIS: MODEL SPECIFICATION

The data is analysed with help of Pearsons correlation technique and Structural
Equation Modelling techniques to establish the association between corporate governance
and the three corporate performance measures considered for the study that supervises,
controls and measures the internal performance.

Correlation Analysis of CGS with EVA, ROA and ROCE

Correlations
CGS EVA ROA ROCE
CGS Pearson Correlation 1 .504
**
.324
**
.390
**

Sig. (2-tailed) .000 .000 .000
N 250 250 250 250
EVA Pearson Correlation .504
**
1 .075 .079
Sig. (2-tailed) .000 .236 .212
N 250 250 250 250
ROA Pearson Correlation .324
**
.075 1 .275
**

Sig. (2-tailed) .000 .236 .000
N 250 250 250 250
ROCE Pearson Correlation .390
**
.079 .275
**
1
Sig. (2-tailed) .000 .212 .000
N 250 250 250 250
**. Correlation is significant at the 0.01 level (2-tailed).

From the above correlation table, it is found that CGS is significantly positively
correlated with all EVA, ROA and ROCE at 1 percent level of significance. A positive
correlation shows that EVA, ROA and ROCE get substantial positive effects when CGS
increases. The magnitude of coefficient of correlation CGS with EVA is .504, with ROA it is
International Journal of Advanced Research in Management (IJARM), ISSN 0976 6324 (Print),
ISSN 0976 6332 (Online), Volume 5, Issue 4, July- August (2014), pp. 01-10 IAEME
5

.324 and with ROCE it is .390. The magnitude of coefficient of correlation of EVA with CGS
is the highest among ROA and ROCE each with CGS. It means whenever, CGS changes,
EVA will be affected much compared to ROA and ROCE. That is, EVA changes in direct
proportion to CGS rather in a faster rate than ROA & ROCE.

Structural Equation Modelling

Outputs of SEM

The model is recursive.Sample size is 250.
Model consists of the following variables (Group number 1)
Observed, endogenous variables: EVA; ROA; ROCE
Observed, exogenous variables: CGS
Unobserved, exogenous variables: e2; e3; e1

Interpretation

In recursive regression model, EVA, ROA and ROCE are endogenous variables or
dependent variables. CGS is exogenous or independent variable. e1, e2 and e3 are random
error terms imposed in the model. They are also known as unobserved exogenous variables as
they cannot directly be estimated from the sample data.

Computation of degrees of freedom (Default model)
Number of distinct sample moments: 10
Number of distinct parameters to be estimated: 9
Degrees of freedom (10 - 9): 1
There are 10 degrees of freedom required to estimate 10 sample moments. In modelling
process, 9 sample moments, e.g., 3 regression weights or Regression coefficients for EVA,
ROA and ROCE; 2 covariance or Correlations for e1 and e3 and e1 and e2; and four
variances of CGS, e1, e2 and e3. There is 1 degree of freedom left. The following path
diagram of the model has above sample moments with numerical figures.

Result (Default model)

Minimum was achieved
Chi-square = 2.916
Degrees of freedom = 1
Probability level = .088

Interpretation

This is the chi-square test for fitting of the model. Its p-value (probability level) is
0.088, which is more than 5 percent level of significance. It has positive degree of freedom.
Therefore, the assumed model has a better fit with the sample data.

International Journal of Advanced Research in Management (IJARM), ISSN 0976 6324 (Print),
ISSN 0976 6332 (Online), Volume 5, Issue 4, July- August (2014), pp. 01-10 IAEME
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Scalar Estimates (Group number 1 - Default model): Maximum Likelihood Estimates
Regression Weights: (Group number 1 - Default model)


Estimate S.E. C.R. P Label
EVA <--- CGS 67.096 7.280 9.217 ***

ROA <--- CGS .086 .016 5.404 ***

ROCE <--- CGS .357 .053 6.694 ***


Interpretation

Regression weight or unstandardized regression coefficients of CGS on EVA, ROA,
and ROCE are positively significant at 1 percent level of significance. Estimate shows that
EVA has the greatest value with CGS. It s followed by ROCE with CGS and ROA with CGS.
This scenario is also supported by above correlation analysis.

Standardized Regression Weights: (Group number 1 - Default model)



Estimate
EVA <--- CGS .504
ROA <--- CGS .324
ROCE <--- CGS .391

Interpretation

Standardized Regression weight or Standardized regression coefficients of CGS on
EVA, ROA, and ROCE are useful when units of measurements are different. Estimate also
shows that EVA has the greatest value with CGS. It s followed by ROCE with CGS and ROA
with CGS. This scenario is also supported by above correlation analysis.


International Journal of Advanced Research in Management (IJARM), ISSN 0976 6324 (Print),
ISSN 0976 6332 (Online), Volume 5, Issue 4, July- August (2014), pp. 01-10 IAEME
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Covariances: (Group number 1 - Default model)


Estimate S.E. C.R. P Label
e2 <--> e3 20.115 8.130 2.474 .013

e3 <--> e1 -7629.524 3675.393 -2.076 .038


Correlations: (Group number 1 - Default model)


Estimate
e2 <--> e3 .157
e3 <--> e1 -.131

Interpretation

Above two tables belong to Covariance and correlations between e1 and e3, and e2
and e3. This relationship is established across three error terms in order to get a better model.

Variances: (Group number 1 - Default model)


Estimate S.E. C.R. P Label
CGS
e2
e3
e1
602.359 53.985 11.158 ***

38.312 3.434 11.158 ***

426.383 38.197 11.163 ***

7949087.312 712414.240 11.158 ***


Interpretation:

Above table belongs to variances of CGS, e2, e3 and e1. They have significant value
of variances at 1 percent level of significance. These variances are computed as sample
moments.

Model fit: Baseline Comparisons

Model
NFI
Delta1
RFI
rho1
IFI
Delta2
TLI
rho2
CFI
Default model .981 .978 .988 .924 .987
Saturated model 1.000

1.000

1.000
Independence model .000 .000 .000 .000 .000

In this table, NFI, RFI, IFI, TLI and CFI all have values more than .90. It means that
the model has a better fit.

Model RMSEA LO 90 HI 90 PCLOSE
Default model .058 .000 .212 .185
Independence model .317 .275 .361 .000
International Journal of Advanced Research in Management (IJARM), ISSN 0976 6324 (Print),
ISSN 0976 6332 (Online), Volume 5, Issue 4, July- August (2014), pp. 01-10 IAEME
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From this table, RMSEA of .058, which is slightly more than .05. Thus, it also
supports the results of NFI, RFI, IFI, TLI and CFI. Hence, we again conclude that the model
has a better fit.

Summary:
That CGS has the greatest effect on EVA, than on ROCE and ROA. This effect is justified by
the t-test given in the table

Regression Weights: (Group number 1 - Default model)


Estimate S.E. C.R. P Label
EVA <--- CGS 67.096 7.280 9.217 ***

ROA <--- CGS .086 .016 5.404 ***

ROCE <--- CGS .357 .053 6.694 ***


C.R. is critical ratio with p-value (P). All the estimates are significant at 1 percent
level of significance. Here *** represents p-value less than .01.

Thus the results of testing of hypothesized relationships in the conceptual model
supported the alternative hypothesis: Corporate Governance has a significant and positive
relationship with corporate performance measures, EVA, ROA & ROCE.

CONCLUSION

To surmise corporate governance on companys performance has necessitated
monitoring, supervising and controlling the management's ability to grow earnings, and
minimise cost for, shareholder value which is the sum of all strategic decisions that affect the
firm's ability to efficiently increase the amount of free cash flow over time. Making wise
investments and generating a healthy return on invested capital are two main drivers of
shareholder value. There is a fine line between responsibly growing shareholder value and
doing whatever is needed to generate a profit. Reckless decisions and aggressively chasing
profit at the expense of the environment or others can easily cause shareholder value to
decline.
In the compliance of corporate governance today, there is a lot of emphasis on
structural reform. Individual aspect of the governance mechanisms have increasingly been the
focus of policy reform and shareholder activism. Specific attributes of the governance
structure have become important considerations in the quest for effective corporate
governance. In contrast, taking a process view of corporate governance, this study has
dissected the efficacy of the internal system of corporate governance on the value-based
performance metric that is consequential for the creation of shareholder value maximization,
set as the objective of the research.
The adoption of the outcome from the assessment of the main objective of this study
should form the goal of the Indian corporates endorsing valuable corporate governance in
three ways. First, it shall provide the necessary pre-commitment between shareholders and
managers regarding the goal of the company. Second, it necessitates a greater flow of
disclosure of relevant information and the disaggregation of financial cost information. In
corporate governance a clear identification of the goal of the corporates and value creating
International Journal of Advanced Research in Management (IJARM), ISSN 0976 6324 (Print),
ISSN 0976 6332 (Online), Volume 5, Issue 4, July- August (2014), pp. 01-10 IAEME
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activities, are important to eliminate destructive utilisation of assets and resourceful execution
of contracts between shareholders and managers. Substantive flows of transparency in the
information are needed to bridge the gaps in the incomplete transactions. Value based
management techniques like EVA, providing for internal governance system in a non-agency
context can provide a valuable input towards effective corporate governance. Finally, the goal
of shareholder wealth maximization is ensured by a closer interdependence between strategy
formation i.e by compliance of corporate governance and the setting of operational objectives
for managerial decisions through the EVA concept believing that for every performance
measure there is a corresponding wealth measure. The analysis of the Indian industries
provides evidence that corporate governance is influential and is a long-lasting concept for the
firms in the economic point of view to enhance their performance.

SUGGESTIONS

The observed results validate the need to foster good governance practices in the
Indian companies to improve performance by identifying factors ostensibly representing good
corporate governance. Firms practicing good governance should hence be linked up with
enhancement of the performances in matters of long term decisions towards growth and
innovation. This could possibly necessitate positive manifestation in the response of the
markets associated with better governed firms as the progress of firms is highly reliant on the
adoption and implementation of good governance practices. Hence to infuse a proper
governance system for evading the occurrence of scam, study of the implementation and
appraisal of the corporate governance system on the corporate performance has to be
evaluated periodically for conformance. Managers are the main corporate scientists who are
the designers of the execution of the plans for future and hence their perception and
incentivising schemes need proper focus in regard to the practice of corporate governance for
long term sustainability.

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