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According to the Organization for Economic Cooperation and Development (OECD), “Corporate governance deals with the rights and responsibilities of a company’s management, its board, shareholders and various stakeholders.” The spectacular collapses of Enron and WorldCom in the US, where shareholders lost a combined $245 bn, and the collapse of the Italian dairy giant Parmalat in Europe have immensely increased the importance of corporate governance.
Investors primarily consider two variables before making investment decisions—the rate of return on invested capital and the risk associated with the investment. In the recent years, the ‘attractiveness of developing nations’ as a destination for foreign capital has increased, partly because of the high likelihood of obtaining robust returns and partly because of the decreasing ‘attractiveness of developed nations’. The lure of achieving a high rate of return, however, does not, by itself, guarantee foreign investment; the attendant risk weighs equally in an investor’s decision-making calculus. Good corporate governance practices reduce this risk by ensuring transparency, accountability, and enforceability in the marketplace.
Countries and firms are interested in attracting foreign capital because the additional demand helps to enhance liquidity for both the firm’s stock and the stock market in general. This additional liquidity also leads to lower cost of capital for firms, and allows them to compete more effectively in the global marketplace (Aggarwal et al., 2005). According to Baek (2006), the foreign portfolio inflows into Asia are considered ‘hot’ money since they have little to do with economic fundamentals. At the same time, the Asian Financial Crisis was widely held responsible for weaknesses in corporate governance practices and resulting problems in financial reporting. As a result, over the past years corporate governance has become a limelight topic of particular interest to the institutional investment community, and one that is of ever increasing importance to companies in developing countries seeking access to global capital markets. Earlier corporate governance was supposed to be a subject of academic interest, but now after the appearance of seismic shift in interest, it has become a subject of commercial significance.
Availability of foreign capital depends on many factors that are specific to firm other than economic development of the country. Corporate governance practices, which protect the rights of minority shareholders, have a major influence not only in attracting Foreign Institutional Investors’ (FIIs) investment but also in ensuring that it has the best chance of making a positive contribution to economic development goals.
Corporate governance in a developing-country setting takes on additional importance. Good corporate governance is vital because of its role in attracting foreign investment. The extent of foreign investment, in turn, shapes the prospects for economic growth of many developing countries. This paper presents an in-depth inquiry into corporate governance in one such developing country, India. While India’s corporate governance framework is advanced for a developing country, it still can be significantly improved.
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