Impact of Corporate Governance on Stock Performance-Evidence from BSE Sensex.

AuthorKumari, P.S. Raghu
PositionBombay Stock Exchange

Introduction

The efficient functioning of capital market is important for the country's economic development, having a chain-link effect on all the stakeholders of any economy. The stock market provides the opportunity for companies to easily access capital from the public. These funds have a huge impact on the company's growth as it helps them effectively execute their expansion and diversification strategies and even reduce their leverage position and relieve from financial distress. On the other hand, the performance of stocks impacts the investor's growth and ultimately guides the movement of consumer markets, as higher profits generated from stocks enables the investors to possess higher disposable income leading to higher spending, whereas the losses cause lower spending. This in turn, impacts the industry and commerce of the economy, leading to the fluctuating cycles of inflation and recession and thereby impacts share prices. A breakdown in the securities exchange could detrimentally affect the economy as it has the capability of causing a far-reaching monetary disturbance. The famously known case in the global financial market history, the great depression of 1930s, was predominantly caused by the stock market crash in 1929.

It is very important for analyzing the performance of stocks on a regular basis for the stability of markets and the overall economy. Many scholars have attributed the stock performance to be predominantly based upon several internal and external factors. The company-specific internal factors like their governance and management leadership, financial performance, growth strategies and prospects, profitability, dividend policies, valuation, and other factors have a considerable effect on stock performance (Dow & Ibrahim, 2012). The companies and investors should be wary of and be knowledgeable about these factors to make informed decisions to mitigate risk and maximize returns. The government, regulators and policymakers have a close-eye on these factors to analyze the stock performances and their consequent impacts, for effective and timely decision-making for countering the unpredictability of stock market and maintaining the stability of the overall economy. Thus, it becomes imperative to study the factors impacting the stock performance to manage these factors efficiently and maximize the gains.

Corporate governance (CG) is one of the crucial company-specific internal factors, determining the company's principles and conduct, and in turn reflected through the investor's perception about the companies. It impacts the overall corporate excellence and also is an important instrument for investor protection. The significance of governance principles and management have been highlighted in recent years in the Indian context, and the corporate India has undergone an evolution, starting from the "'Desirable Voluntary Corporate Governance' code by Confederation of Indian Industry (CII) under Rahul Bajaj (1998) to several stage wise amendments in Corporate Governance regulations by Kumar Mangalam Birla Committee Report (1999), Naresh Chandra Committee Report (2002), Narayana Murthy Committee Report (2003), J.J. Irani Committee Report (2005), major Amendments under Companies Act, 2013 and the most-recent Uday Kotak Committee Report (2017 / 2018). These amendments have been made to converge towards globally accepted best practices built around the Organization of Economic Cooperation and Development (OECD) or G20 Principles of corporate governance, pertinent to the context and regulatory framework in India". As per the International Finance Corporation (IFC) Report (2018), the Indian companies having good corporate governance have fared well during the financial year FY2017-18, despite high uncertainties in the stock market. During the past couple of years, the governance considerations have been at the core of several events. In recent years, many large Indian companies have faced corporate governance issues which have been reflected in their market price of shares and market capitalization too. The predominant reasons for governance failure include issues related to management, leadership, board independence, transparency, disclosures, number of directorships and other external variables (Metrick, 2003)). Literature says that company specific performance factors and corporate governance, both, individually affect the stock prices. As corporate governance calculation is very complicated and tedious, so far scholars have not included it in stock performance models in the Indian context. For seeking comprehensive insights into the overall health of the companies, it is imperative to understand the impact of all the internal company-specific factors together, laying emphasis on both the economic performance factors and the company's governance. This study is to examine the overall influence of both the factors considered together, on the stock performance by analyzing their impact on the changes in the stock prices in the financial year 2017-18. The study employs a model developed for the Indian context, by considering the proxies for the company-specific internal factors involving corporate governance, financial performance, profitability, dividend policy and firm's valuation on the stocks of the 30 constituents of SENSEX (S&P BSE 30) for the period FY2017-18.

Background Literature

The market prices of stocks are predominantly impacted and governed by the demand and supply forces in the securities markets (Christopher, Rufus & Ezekiel, 2009). The market price reflects the cumulative knowledge and wisdom of the market. The price of the stock is the reflection of the kind of balance obtained between the suppliers and buyers of that stock at that moment of time. The demand behavior of the investors in the markets is generally guided by the factors like government policies, company's public affairs and company's and industry's performance among the other factors. The factors affecting stock prices are predominantly categorized as macroeconomic and microeconomic. The macroeconomic factors include politics, company's economic scenario, government regulations and other such factors. The microeconomic factors include the management and performance factors of the companies. There are many company-specific factors ascribed to the stock price fluctuations. The significant determinants of stock price, identified by Collins (1957) were dividend, PAT, book value and EBIT. Also, Sharma (2011) says DPS, EPS and book value per share have a significant influence on the stock prices.

Return on Equity (ROE)

ROE is a financial performance measure indicating the amount (in percentage) of net profit earned on the shareholders' equity. This reflects the efficiency of the company in utilizing the shareholders' funds for generating profits. ROE holds an important place for investors as it assures them the amounts earned over their investments. ROE directly impacts the stock prices as it reflects the intrinsic value of the shares, and significantly influences the stock prices. ROE effects company's stock price when company's management efficiency and firm performance is high (Liu & Hu, 2005; Raaballe & Hedensted, 2008; Habib et al. 2012). Also, Azeem & Kouser (2002) in their study indicated a significantly positive relation between the stock price and ROE, explaining that companies employing the finances provided by shareholders effectively will have a positive effect on stock price, otherwise the effect on stock prices will be negative. Hence it is hypothesized that

H1: ROE has a significant impact on stock performance.

Enterprise Value (EV)

The EV is a measure of a company's total value, going beyond the boundaries of market capitalization. This measure includes the company's market capitalization, debt obligations (long-term and short-term debts) and the cash component of the company. This is a metric generally used to...

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