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

This paper analyzes the effects of corporate governance reforms and enforcement on stock market development and firm value, using a sequence of corporate governance reforms in India. Our results, taken together, present a strong case for a causal effect of the reforms on firm value, and also underscore the importance of enforcement. The reforms (referred to as Clause 49 of the listing agreement) were phased in over the period 2000-2003. A large number of firms were completely exempt from the new rules, and the complex criteria for the application of Clause 49 created considerable overlap in the characteristics of affected and unaffected firms. Severe financial penalties for violations were introduced in 2004, providing an opportunity to test the effect of sanctions and enforcement independently of the substantive law. Using a large sample of over 4000 firms over 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 Clause 49 reforms in combination with the 2004 sanctions. This result is robust to various checks, and in particular holds when comparing only the smaller firms that were subject to Clause 49 and the larger firms among those unaffected by Clause 49. A regression discontinuity approach focusing on the thresholds for the application of Clause 49 also leads to similar conclusions. There is no robust evidence that the reforms led to improved accounting performance, a reduction in tunneling within business groups, or an increase in foreign institutional investment over the sample period. Rather, it appears that the increase in firm value capitalized expectations of longer-term benefits of the reforms