Private equity and corporate governance in India
| DOI | https://doi.org/10.1108/15587891211254416 |
| Pages | 223-238 |
| Published date | 20 July 2012 |
| Date | 20 July 2012 |
| Author | Rafiq Dossani |
| Subject Matter | Strategy |
Private equity and corporate
governance in India
Rafiq Dossani
Abstract
Purpose – Developing economies that are subject to global influences, such as through exposure to
global product, labor and capital markets, may be expected to practice higher standards of corporate
governance (CG) than less globalized developing economies. This paper seeks to understand the
relationship between CG and firm ownership by private equity investors in India, and to understand
whether CG practices in particular national institutional contexts change when the firm is exposed to
investors with a background in other countries’ institutional contexts. Taking India as a test case, the
paper aims to explore how CG standards are affectedby private equity investment that originates from
developed countries.
Design/methodology/approach – A primary survey on Indian firms’ CG practices for firms that receive
private equity and for comparable firms that do not was used to determine differences in CG. Private
equity investors were surveyed to determine their national institutional contexts. The CG practices were
then related to the national institutional context that the private equity investors came from.
Findings – Private-equity funded firms display higher standards of corporate governance than firms
that do not receive such funding. The difference arises from the application of developed country
standards of CG arising from the investors that own the private equity funds. These funds are primarily
owned by developed country investors. The strategies through which these occur are: reconstituting the
board of directors, influencing senior executive recruitment, and changing the firm’s operating and
strategic rules.
Originality/value – Developing countries like India usually display low standards of CG. Such
standards tend to evolve slowly in line with the country’s stage of development. The literature has not
hitherto identified ways in which this process can be hastened. This study finds that standards can be
raised above the prevailing standards through the governance practices imported into developing
countries by private equity funds that are primarily owned by developed country investors. Hence, the
findings of this paper contribute to the understanding of how globalization influences CG.
Keywords Private equity, Corporate governance, Developing economies, Rules, Ownership,
International investments, Globalization, India
Paper type Research paper
Introduction
Corporate governance is the set of laws, rules and procedures that influence a company’s
operations and the decisions made by its managers. The standards of corporate
governance are usually low in developing countries such as India due to institutional
arrangements that tolerate poor standards, which in turn is usually due to both inadequate
rules and poor enforcement.
Developing countries (or industries within them) that are relatively open to global influences,
either through labor and product markets, or sources of finance, might, however, be
expected to practice higher standards of corporate governance than their less open peers.
This would be expected to occur in response to the higher standards of their developed
country counterparties (clients, vendors, labor and capital suppliers, etc.).
DOI 10.1108/15587891211254416 VOL. 6 NO. 2 2012, pp. 223-238, QEmerald Group Publishing Limited, ISSN 1558-7894
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JOURNAL OF ASIA BUSINESS STUDIES
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Rafiq Dossani is Senior
Research Scholar at the
Shorenstein Asia-Pacific
Research Center, Stanford
University, Stanford,
California, USA.
The author thanks participants
at the conference on the Future
of the Firm in Asia, held at
Stanford University in June
2010 for comments. The author
also thanks KPMG India for
access to survey data.
Using India as a test case, this paper asks whether a particular type of globalization, viz.,
accessing capital from private equity (PE) investors located in developed countries,
influences the quality of corporate governance. Even in developed countries, it is widely
recognized that capital supplied by informed financiers, such as sophisticated lenders and
private equity investors, improves corporate governance. Hence, such capital could play a
similar role in India.
Using primary data, we show that such a positive influence exists in India, i.e. such
private-equity funded firms display higher standards of corporate governance than firms
that do not receive such funding. This raises a second question that we explore: the
strategies through which PE funding raises the standards of corporate governance in
developing countries in contrast to developed countries. Again, using data for India, we
show that this occurs through reconstituting the board of directors and board committees to
include PE representatives and independent directors, senior executive recruitment and
changing the portfolio firm’s operating and strategic rules. This implies a close relationship
between the portfolio firm and PE investors, quite different from the arms-length relationship
in many other forms of globalization.
The paper proceeds as follows. Section 1 discusses the state of corporate governance in
India. Section 2 provides reasons why the influence of private equity on corporate
governance may be different in India compared with developed countries. Section 3
discusses the evidence and the strategies used to influence corporate governance. Section
4 provides a conclusion.
1. The state of corporate governance in India
Corporate governance is the set of laws, rules and procedures that influence a company’s
operations and the decisions made by its managers (Brigham and Ehrardt, 2008, p. 538). As
noted above, this paper asks whether finance from sources outside the firm of a particular
type, private equity invested by developed country financiers, influences the quality of
corporate governance in India. The reason for asking this question is that it is widely
recognized that, in developed countries, such external finance[1], particularly by informed
financiers, such as sophisticated lenders and private equity investors, improves corporate
governance (Jensen, 1997; Klapper and Love, 2004).
Developing countries usually make very different institutional arrangements[2] for corporate
governance than developed countries. Such institutional arrangements tend to tolerate poor
standards of corporate governance, due to inadequate rules and poor enforcement.
India is no exception. India has been described as a ‘‘backwater of corporate governance
practices’’ (Khanna and Palepu, 2004, p. 484). The few firms that are believed to practice
good governance are in certain export-oriented industries, such as software exporters,
where they are exposed to global labor and product markets (Khanna and Palepu, 2004). In
other words, globalization is a key factor in improving corporate governance by exposing
domestic firms in developing countries to the discipline of counterparties subject to higher
standards.
The ‘‘counterparty effect’’ ought to include not just labor and product markets, but also
capital supply. This is because external finance, particularly if it is fungible acrosscountries,
might be provided only if the investee firm accepts higher standards of corporate
governance than is required within its domestic environment.
The academic literature recognizes the powerful role of external finance. For example,
Shleifer and Vishny (1997) argue that standards of corporate governance will be lower in
countries with weak financial markets as these are not subject to the discipline of value
maximization. This suggests that opening up a country to foreign, particularly US-style,
investors should improve corporate governance.
Turning to the Indian case, the state of corporate governance is low in part due to the rules
and in part due to lax enforcement. A third, related factor is the presence of widespread
corruption in government. India ranks 87th out of 178 countries in a study of corruption by
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