Private equity and corporate governance in India

The future of industry and innovation in Asia: firms, networks, institutions and corporate governance

Edited by Mark Fruin

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.).

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...