ARE INTERNAL GOVERNANCE MECHANISMS EFFICIENT? THE CASE OF A DEVELOPING ECONOMY

The study examines an imperative aspect in an emerging economy context: the impact of internal governance mechanisms on corporate financial performance considering the endogeneity between corporate governance and firm characteristics. There is  extensive literature on the relationship between internal corporate governance mechanisms and financial performance in the developed economy context. Unlike previous studies that have examined this phenomenon in an institutional context characterised by principal-agent conflict, this study uses a unique data set on Indian firms – an emerging economy with principal-principal conflict. 

The model aggregates the various internal governance mechanisms and suggests a corporate governance index relevant to the emerging economy (Indian) setting. This enables the empirical model to capture the overall governance using the bundles approach, which later facilitates us to conduct a fine-grained analysis of the effects of the internal corporate governance mechanism on a firm’s financial performance. Overall, the findings document the benefits of better corporate governance practices in economies characterised by ownership concentration, which in turn results in better financial performance. 

The study contributes to corporate governance literature in two ways. First, we address reliability and validity concerns present in the corporate governance literature. Extant works are discounted by the manner in which corporate governance is measured. Is a single proxy valid or is the bundles approach preferable? Although the bundles approach provides a robust measure, its empirical validity is doubtful. The paper addresses these concerns by empirically validating the corporate governance measure utilising the construct validity approach. Use of construct validity approach validates our measure for corporate governance and can be relied on for meaningful inferences. Second, the study contributes to the limited evidence on examining the influence of corporate governance indices on corporate financial performance in emerging economies.