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Corporate governance and sustainability: a review of the existing literature

• Published: 03 January 2021
• Volume 26 , pages 55–74, ( 2022 )

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• Valeria Naciti 1 ,
• Fabrizio Cesaroni   ORCID: orcid.org/0000-0002-2345-6225 1 &
• Luisa Pulejo 1  

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Over the last 2 decades, the literature on corporate governance and sustainability has increased substantially. In this study, we analyze 468 research studies published between 1999 and 2019 by employing three clustering analysis visualization techniques, namely keyword network clustering, co-citation network clustering, and overlay visualization. In addition, we provide a brief review of each cluster. We find that the number of published items that fall under our search criteria has grown over the years, having surged at various times including 2014. We identified three main thematic clusters, which we have called (1) corporate social responsibility and reporting, (2) corporate governance strategies, and (3) board composition. The weighted average years that major keywords appear in the literature published over the last 2 decades fall into a period of 4 years between 2014 and 2017. This is due to the massive increase in the number of publications on corporate governance and sustainability in recent years. By means of chronological analysis, we observe a transition from more abstract concepts—such as ‘society,’ ‘ethics,’ and ‘responsibility’—to more tangible and actionable terms such as ‘female director,’ ‘board size,’ and ‘independent director.’ Our review suggests that corporate governance and sustainability literature is evolving from quite a conceptual approach to rather more strategic and practical studies, while its theoretical roots can be traced back to a number of foundational studies in stakeholder theory, agency theory and socio-political theories of voluntary disclosure.

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Naciti, V., Cesaroni, F. & Pulejo, L. Corporate governance and sustainability: a review of the existing literature. J Manag Gov 26 , 55–74 (2022). https://doi.org/10.1007/s10997-020-09554-6

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DOI : https://doi.org/10.1007/s10997-020-09554-6

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The impact of corporate governance measures on firm performance: the influences of managerial overconfidence

• Tolossa Fufa Guluma   ORCID: orcid.org/0000-0002-1608-5622 1  

Future Business Journal volume  7 , Article number:  50 ( 2021 ) Cite this article

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The paper aims to investigate the impact of corporate governance (CG) measures on firm performance and the role of managerial behavior on the relationship of corporate governance mechanisms and firm performance using a Chinese listed firm. This study used CG mechanisms measures internal and external corporate governance, which is represented by independent board, dual board leadership, ownership concentration as measure of internal CG and debt financing and product market competition as an external CG measures. Managerial overconfidence was measured by the corporate earnings forecasts. Firm performance is measured by ROA and TQ. To address the study objective, the researcher used panel data of 11,634 samples of Chinese listed firms from 2010 to 2018. To analyze the proposed hypotheses, the study employed system Generalized Method of Moments estimation model. The study findings showed that ownership concentration and product market competition have a positive significant relationship with firm performance measured by ROA and TQ. Dual leadership has negative relationship with TQ, and debt financing also has a negative significant association’s with both measures of firm performance ROA and TQ. Moreover, the empirical results also showed managerial overconfidence negatively influences the relationship of board independence, dual leadership, and ownership concentration with firm performance. However, managerial overconfidence positively moderates the impact of debt financing on firm performance measured by Tobin’s Q and negative influence on debt financing and operational firm performance relationship. These findings have several contributions: first, the study extends the literature on the relationship between CG and a firm’s performance by using the Chinese CG structure. Second, this study provides evidence that how managerial behavioral bias interacts with CG mechanisms to affect firm performance, which has not been studied in previous literature. Therefore, the results of this study contribute to the theoretical perspective by providing an insight into the influencing role of managerial behavior in the relationship between CG practices and firm performance in an emerging markets economy. Hence, the empirical result of the study provides important managerial implications for the practice and is important for policy-makers seeking to improve corporate governance in the emerging market economy.

Introduction

Corporate governance and its relation with firm performance, keep on to be an essential area of empirical and theoretical study in corporate study. Corporate governance has got attention and developed as an important mechanism over the last decades. The fast growth of privatizations, the recent global financial crises, and financial institutions development have reinforced the improvement of corporate governance practices. Well-managed corporate governance mechanisms play an important role in improving corporate performance. Good corporate governance is fundamental for a firm in different ways; it improves company image, increases shareholders’ confidence, and reduces the risk of fraudulent activities [ 67 ]. It is put together on a number of consistent mechanisms; internal control systems and external environments that contribute to the business corporations’ increase successfully as a complete to bring about good corporate governance. The basic rationale of corporate governance is to increase the performance of firms by structuring and sustaining initiatives that motivate corporate insiders to maximize firm’s operational and market efficiency, and long-term firm growth through limiting insiders’ power that can abuse over corporate resources.

Several studies are contributed to the effect of CG on firm performance using different market developments. However, there is no consensus on the role CG on firm performance, due to different contextual factors. The role of CG mechanisms is affected by different factors. Prior studies provided different empirical evidence such as [ 14 ], suggested that the monitoring efficiency of the board of directors is affected by internal and external factors like government regulation and internal firm-specific factors; the role of board monitoring is determined by ownership structure and firm-specific characters Boone et al. [ 8 ], and Liu et al. [ 57 ] and Bozec [ 10 ] also reported that external market discipline affects the internal CG role on firm performance. Moreover, several studies studied the moderation role of different variables in between CG and firm value. Mcdonald et al. [ 63 ] studied CEO experience moderating the board monitoring effectiveness, and [ 60 ] studied the moderating role of product market competition in between internal CG and firm performance. Bozec [ 10 ] studied market disciple as a moderator between the board of directors and firm performance. As to the knowledge of the researcher, no study considered the influencing role of managerial overconfidence in between CG mechanisms and firm corporate performance. Thus, this study aims to investigate the influence of managerial overconfidence in the relationship between CG mechanisms and firm performance by using Chinese listed firms.

Managers (CEOs) were able to valuable contributions to the monitoring of strategic decision making [ 13 ]. Behavioral decision theory [ 94 ] suggests that overconfidence, as one type of cognitive bias, encourages decision-makers to overestimate their information and problem-solving capabilities and underestimates the uncertainties facing their firms and the potential losses from litigation associated with claims against them. Several prior studies reported different results of the manager's role in corporate governance in different ways. Previous studies claimed that overconfidence is a dysfunctional behavior of managers that deals with unfavorable consequences for the firm outcome, such as value distraction through unprofitable mergers and suboptimal investment behavior [ 61 ], and unlawful activities (Mishina et al. [ 64 ]). Oliver [ 68 ] argued the human character of individual managers affects the effectiveness of corporate governance. Top managers' behaviors and experience are primary determinants of directors' ability to effectively evaluate their managerial decision-making [ 45 ]. In another way, [ 47 , 58 ] noted managerial overconfidence can encourage some risk and make up for managerial risk aversion, which leads to suboptimal investment decisions. Jensen [ 41 ] suggested in the presence of free cash flow, the manager may overinvest and they can accept a negative net present value project. Therefore, the existence of CG mechanisms aims to eliminate or reduce the effect of agency and asymmetric information on the CEO’s decisions [ 62 ]. This means that the objectives of CG mechanisms are to counterbalance the effect of such problems in the corporate organization that may affect the value of the firms in the long run. Even with the absence of agency conflicts and asymmetric information problems, there is evidence documented for distortions such as the case of corporate investment. Managers will over- or under-invest regarding their optimism level and the availability of internal cash flow.

Agency theory by Jensen and Meckling [ 42 ] has a very clear vision of the problems that exist in the company to know the disagreement of interests between shareholders and managers. Irrational behavior of management resulting from behavioral biases of executive managers is a great challenge in corporate governance [ 44 ]. Overconfidence may create more agency conflict than normal managers. It may lead internal and external CG mechanisms to decisions which damage firm value. The role of CG mechanisms mitigating corporate governance results from agency costs, information asymmetry, and their impact on corporate decisions. This means the behavior of overconfident executives may affect controlling and monitoring role of internal/external CG mechanisms. According to Baccar et al. [ 5 ], suggestion is that one of the roles of corporate governance is controlling such managerial behavioral bias and limiting their potential effects on the company’s strategies. These discussions lead to the conclusion that CEO overconfidence will negatively or positively influence the relationships of CG on firm performance. The majority of studies in the corporate governance field deal with internal problems associated with managerial opportunism, misalignment of objectives of managers and stakeholders. To deal with these problems, the firm may organize internal governance mechanisms, and in this section, the study provides a review of research focused on this specific aspect of corporate governance.

Internal CG includes the controlling mechanism between various actors inside the firm: that is, the company management, its board, and shareholders. The shareholders delegate the controlling function to internal mechanisms such as the board or supervisory board. Effective internal CG is essential in accomplishing company strategic goals. Gillan [ 30 ] described internal mechanisms by dividing them into boards, managers, shareholders, debt holders, employees, suppliers, and customers. These internal mechanisms of CG work to check and balance the power of managers, shareholders, directors, and stakeholders. Accordingly, independent board, CEO duality, and ownership concentration are the main internal corporate governance controlling mechanisms suggested by various researchers in the literature. Thus, the study considered these three internal corporate structures in this study as internal control mechanisms that affect firm performance. Concurrently, external CG mechanisms are mechanisms that are not from the inside of the firm, which is from the outside of the firms and includes: market competition, take over provision, external audit, regulations, and debt finance. There are a lot of studies that examine and investigate the effect of external CG practices on the financial performance of a company, especially in developed nations. In this study, product market competition and debt financing have been taken as representatives of external CG mechanisms. Thus, the study used internal CG measures; independent board, dual leadership, ownership concentration, and product-market competition, and debt financing as a proxy of external CG measures.

Literature review and hypothesis building

Corporate governance and firm performance.

Corporate governance has got attention and developed as a significant mechanism more than in the last decades. The recent financial crises, the fast growth of privatizations, and financial institutions have reinforced the improvement of corporate governance practices in numerous institutions of different countries. As many studies revealed, well-managed corporate governance mechanisms play an important role in providing corporate performance. Good corporate governance is fundamental for a firm in several ways: OECD [ 67 ] indicates the good corporate governance increases the company image, reduces the risks, and boosts shareholders' confidence. Furthermore, good corporate governance develops a number of consistent mechanisms, internal control systems and external environments that contribute to the business corporations’ increase effectively as a whole to bring about good corporate governance.

The basic rationale of corporate governance is to increase the performance of companies by structuring and sustaining incentives that initiate corporate managers to maximize firm’s operational efficiency, return on assets, and long-term firm growth through limiting managers’ abuse of power over corporate resources.

Corporate governance mechanisms are divided into two broad categories: internal corporate governance and external corporate governance mechanisms. Supporting this concept, Keasey and Wright [ 43 ] indicated corporate governance as a framework for effective monitoring, regulation, and control of firms which permits alternative internal and external mechanisms for achieving the proposed company’s objectives. The achievement of corporate governance relies on the mechanism effectiveness of both internal and external governance structures. Gillan [ 30 ] suggested that corporate governance can be divided into two: the internal and external mechanisms. Gillan [ 30 ] described internal mechanisms by dividing into boards, managers, shareholders, debt holders, employees, suppliers, and customers, and also explain external corporate governance mechanisms by incorporating the community in which companies operate, the social and political environment, laws and regulations that corporations and governments involved in.

The internal mechanisms are derived from ownership structure, board structure, and audit committee, and the external mechanisms are derived from the capital market corporate control market, labor market, state status, and investors activate [ 26 ]. The balance and effectiveness of the internal and external corporate governance practices can enhance a better corporate operational performance [ 21 ]. Literature argued that integrated and complete governance mechanisms are better with multi-dimensional theoretical view [ 87 ]. Thus, the study includes both internal and external CG mechanisms to broadly show the connection of these components. Filatotchev and Nakajima [ 26 ] suggest that an integrated approach bringing external and internal mechanisms jointly enhances to build up a more general view on the effectiveness and efficiency of different corporate governance mechanisms. Thus, the study includes both internal and external CG mechanisms to broadly show the connection of these three components.

Board of directors and ownership concentration are the main internal corporate governance mechanisms and product market competition and debt finance also the main representative of external corporate governance suggested by many researchers in the literature that were used in this study. Therefore, the following sections provide a brief discussion of internal and external corporate governance from different angles.

Independent board and firm performance

Board of directors monitoring has been centrally important in corporate governance. Jensen [ 41 ] board of directors is described as the peak of the internal control system. The board represents a firm’s owners and is responsible for ensuring that the firm is managed effectively. Thus, the board is responsible for adopting control mechanisms to ensure that management’s behavior and actions are consistent with the interest of the owners. Mainly the responsibility of the board of directors is selection, evaluation, and removal of poorly performing CEO and top management, the determination of managerial incentives and monitoring, and assessment of firm performance [ 93 ]. The board of directors has the formal authority to endorse management initiatives, evaluate managerial performance, and allocate rewards and penalties to management on the basis of criteria that reflect shareholders’ interests.

According to the agency theory board of directors, the divergence of interests between shareholders and managers is addressed by adopting a controlling role over managers. The board of directors is one of the key governance mechanisms; the board plays a pivotal role in monitoring managers to reduce the problems associated with the separation of ownership and management in corporations [ 24 ]. According to Chen et al. [ 16 ], the strategic role of the board became increasingly important and going beyond the mere approval of strategic management decisions. The board of directors must serve to reconcile management decisions with the objectives of shareholders and stakeholders, which can at times influence strategic decisions (Uribe-Bohorquez [ 85 ]). Therefore, the board's responsibilities extend beyond controlling and monitoring management, ensuring that it takes decisions that are reliable with the corporations [ 29 ]. In the perspective of resource dependence theory, an independent director is often linked firm to outside environments, who are non-management members of the board. Independent boards of directors are more believed to be effective in protecting shareholders' interests resulting in high performance [ 26 ]. This focus on board independence is grounded in agency theory, which addresses inefficiencies that arise from the separation of ownership and control [ 24 ]. As agency theory perspective boards of directors, particularly independent boards are put in place to monitor managers on behalf of shareholders [ 59 ].

A large number of empirical studies are undertaken to verify whether independent directors perform their governance functions effectively or not, but their results are still inconclusive. Studies [ 2 , 50 , 52 , 56 , 85 ], reported the supportive arguments that independent board of directors and firm performance have a positive relationship; in other ways, a large number of studies [ 6 , 17 , 65 91 ], and findings indicated the independent director has a negative relation with firm performance. The positive relationship of independent board and firm performance argued that firms which empower outside directors may lead to their more effective monitoring and therefore higher firm performance. The negative relationship of independent board and firm performance results are based on the argument that external directors have no access to information about the internal business of the firms and their relation with internal management does not allow them to have a sufficient understanding of the firm’s day-to-day business activities or it may arise from the lack of knowledge of the business or the ability to monitor management actions [ 28 ].

Specifically in China, the corporate governance regulation code was approved in 2001 and required that the board of all Chinese listed domestic companies must include at least one-third of independent directors on their board by June 2003. Following this direction, many listed firms had appointed more independent directors, with a view to increase the independence of the board [ 54 ]. This proclamation is staying stable till now, and the number of independent directors in Chinese listed firms is increasing from time to time due to its importance. Thus, the following hypothesis is proposed.

Hypothesis 1

The proportion of independent directors in board members is positively related to firm performance.

Dual leadership and firm performance

CEO duality is one of the important board control mechanisms of internal CG mechanisms. It refers to a situation where the firm’s chief executive officer serves as chairman of the board of directors, which means a person who holds both the positions of CEO and the chair. Regarding leadership and firm performance relation, there are different arguments; there is not consistent conclusion among different researchers. There are two competitive views about dual leadership in corporate governance literature. Agency theory view proposed that duality could minimize the board’s effectiveness of its monitoring function, which leads to further agency problems and enhance poor performance [ 41 , 83 ]. As a result, dual leadership enhances CEO entrenchment and reduces board independence. In this condition, these two roles in one person made a concentration of power and responsibility, and this may result in busyness of CEO which affects the normal duties of a company. This means the CEO is responsible to execute a company’s strategies, monitoring and evaluating the managerial activities of a company. Thus, separating these two roles is better to avoid concentration of authority and power in one individual and separate leadership of board from the ruling of the business [ 72 ].

On the other hand, stewardship theory suggests that managers are good stewards of company resources, which could benefit a firm [ 9 ]. This theory advocates that there is no conflict of interest between shareholders and managers, if the role of CEO and chairman vests on one person, rather CEO duality would promote a clear sense of strategic direction by unifying and strengthening leadership.

In the Chinese firm context, there are different conflicting conclusions about the relationship between CEO duality and firm performance.

Hypothesis 2

CEO duality is negatively associated with firm performance.

Ownership concentration and firm performance

The ownership structure is which has a profound effect on business strategy and performance. Agency theory [ 81 ] argued that concentrated ownership can monitor corporate operating management effectively, alleviate information problems and agency costs, consequently, improve firm performance. The concentration of ownership as a large number of studies grounded in agency theory suggests that it has both the incentive and influence to assure that managers and directors operate in the interests of shareholders [ 19 ]. Concentrated ownership presence among the firm’s investors provides an important driver of good CG that should lead to efficiency gains and improvement in performance [ 81 ].

Due to shareholder concentrated economic risk, these shareholders have a strong encouragement to watch strictly over management, making sure that management does not engage in activities that are damaging the wealth of shareholders. Similarly, Shleifer and Vishny [ 80 ] argue that large share blocks reduce managerial opportunism, resulting in lower agency conflicts between management and shareholders.

In other ways, some researchers have indicated, block shareholders harmfully on the value of the firm, especially when majority shareholders can abuse their position of dominant control at the expense of minority shareholders [ 25 ]. As a result, at some level of ownership concentration the distinction between insiders and outsiders becomes unclear, and block-holders, no matter what their identity is, may have strong incentives to switch resources to the ways that make them better off at the cost of other shareholders. However, concentrated shareholding may create a new set of agency conflicts that may provide a negative impact on firm performance.

In the emerging market context, studies [ 77 , 90 ] find a positive association between ownership concentration and accounting profit for Chinese public companies. As Yu and Wen [ 92 ] argued, Chinese companies have a concentrated ownership structure, limited disclosure, poor investor protection, and reliance on the banking system. As this study argues, this concentration is more controlled by the state, institution, and private shareholders. Thus, ownership concentration in Chinese firms may be an alternative governance tool to reduce agency problems and enhance efficiency.

Hypothesis 3

The ownership concentration is positively related to firm performance.

Product market competition and firm performance

Theoretical models have argued that competition in product markets is a powerful force for overcoming the agency problem between shareholders and managers [ 78 ]. Competition in product markets plays the role of a takeover [ 3 ], and well-managed firms take over the market from poorly managed firms. According to this study finding, competition helps to build the best management team. Competition acts as a substitute for internal governance mechanisms, practically the market for corporate control [ 3 ]. Chou et al. [ 18 ] provided evidence that product market competition has a substantial impact on corporate governance and that it substitutes for corporate governance quality, and they provide evidence that the disciplinary force of competition on the management of the firm is from the fear of insolvency. For instance, Ibrahim [ 39 ] reported firms to operate in competitive industries record more returns of share compared with the concentrated industries. Hart [ 33 ] stated that competition inspires managers to work harder and, thus, reduces managerial slack. This study suggests that in high competition, the selling prices of products or services are more likely to fall because managers are concerned with their economic interest, which may tie up with firm performance. Managers are more focused on enhancing productivity that is more likely to reduce cost and increase firm performance. Thus, competition in product market can reduce agency problems between owners and managers and can enhance performance.

Hypothesis 4

Product market competition is positively associated with firm performance.

Debt financing and firm performance

Debt financing is one of the important governance mechanisms in aligning the incentives of corporate managers with those of shareholders. According to agency theory, debt financing can increase the level of monitoring over self-serving managers and that can be used as an alternative corporate governance mechanism [ 40 ]. This theory argues two ways through debt finance can minimize the agency cost: first the potential positive impact of debt comes from the discipline imposed by the obligation to continually earn sufficient cash to meet the principal and interest payment. It is a commitment device for executives. Second leverage reduces free cash flows available for managers’ discretionary expenses. Literature suggests that when leverage increases, managers may invest in high-risk projects in order to meet interest payments; this action leads lenders to monitor more closely the manager’s action and decision to reduce the agency cost. Koke and Renneboog [ 48 ] have found empirical support that a positive impact of bank debt on productivity growth in German firms. Also, studies like [ 77 , 86 ] examine empirically the effect of debt on firm investment decisions and firm value; reveal that debt finance is a negative effect on corporate investment and firm values [ 69 ] find that there is a significant and negative relationship between debt intensity and firm productivity in the case of Indian firms.

In the Chinese financial sectors, banks play a great role and use more commercial judgment and consideration in their leading decision, and even they monitor corporate activities [ 82 ]. In China listed company [ 77 , 82 ] found that an increase in bank loans increases the size of managerial perks and free cash flows and decreases corporate efficiency, especially in state control firms. The main source of debts is state-owned banks for Chinese listed companies [ 82 ]. This shows debt financing can act as a governance mechanism in limiting managers’ misuse of resources, thus reducing agency costs and enhance firm values. However, in China still government plays a great role in public listed company management, and most banks in China are also governed by the central government. However, the government is both a creditor and a debtor, especially in state-controlled firms. Meanwhile, the government as the owner has multiple objectives such as social welfare and some national (political) issues. Therefore, when such an issue is considerable, debt financing may not properly play its governance role in Chinese listed firms.

Hypothesis 5

Debt financing has a negative association with firm performance

Influence of managerial overconfidence on the relationship of corporate governance and firm performance

Corporate governance mechanisms are assumed to be an appropriate solution to solve agency problems that may derive from the potential conflict of interest between managers and officers, on the one hand, and shareholders, on the other hand [ 42 ].

Overconfidence is an overestimation of one’s own abilities and outcomes related to one’s own personal situation [ 74 ]. This study proposed from the behavioral finance view that overconfidence is typical irrational behavior and that a corporate manager tends to show it when they make business decisions. Overconfident CEOs tend to think they have more accurate knowledge about future events than they have and that they are more likely to experience favorable future outcomes than they are [ 35 ]. Behavioral finance theory incorporates managerial psychological biases and emotions into their decision-making process. This approach assumes that managers are not fully rational. Concurrently, several reasons in the literature show managerial irrationality. This means that the observed distortions in CG decisions are not only the result of traditional factors. Even with the absence of agency conflicts and asymmetric information problems, there is evidence documented for distortions such as the case of corporate investment. Managers will over- or under-invest regarding their optimism level and the availability of internal cash flow. Such a result push managers to make sub-optimal decisions and increase observed corporate distortions as a result. The view of behavioral decision theory [ 94 ] suggests that overconfidence, as one type of cognitive bias, encourages decision-makers to overestimate their own information and problem-solving capabilities and underestimates the uncertainties facing their firms and the potential losses from proceedings related with maintains against them.

Researchers [ 34 ,  61 ] discussed the managerial behavioral bias has a great impact on firm corporate governance practices. These studies carefully analyzed and clarified that managerial overconfidence is a major source of corporate distortions and suggested good CG practices can mitigate such problems.

In line with the above argument and empirical evidence of several researchers, therefore, the current study tried to investigate how the managerial behavioral bias (overconfidence) positively or negatively influences the effect of CG on firm performance using Chinese listed firms.

The boards of directors as central internal CG mechanisms have the responsibility to monitor, control, and supervise the managerial activities of firms. Thus, the board of directors has the responsibility to monitor and initiate managers in the company to increase the wealth of ownership and firm value. The capability of the board composition and diversity may be important to control and monitor the internal managers' based on the nature of internal executives behaviors, managerial behavior bias that may hinder or smooth the progress of corporate decisions of the board of directors. Accordingly, several studies suggested different arguments; Delton et al. [ 20 ] argued managerial behavior is influencing the allocation of board attention to monitoring. According to this argument, board of directors or concentrated ownership is not activated all the time continuously, and board members do not keep up a constant level of attention to supervise CEOs. They execute their activities according to firm and CEO status. While the current performance of the firm desirable the success confers celebrity status on CEOs and board will be liable to trust the CEOs and became idle. In other ways, overconfidence managers are irrational behaviors that tend to consider themselves better than others on different attributes. They do not always form beliefs logically [ 73 ]. They blame the external advice and supervision, due to overestimating their skills and abilities, underestimate their risks [ 61 ]. Similarly, CEOs are the most decision-makers in the firm strategies. While managers are highly overconfident, board members (especially external) face information limitations on a day-to-day activities of internal managers. In other way, CEOs have a strong aspiration to increase the performance of their firm; however, if they achieve their goals, they may build their empire. This situation will pronounce where the market for corporate control is not matured enough like China [ 27 ]. So, this fact affects the effectiveness of board activities in strategic decision-making. In contrast, as the study [ 7 ] indicated, as the number of the internal board increases, the impact of managerial overconfidence in the firm became increasing and positively correlated with the leadership duality. In other ways, agency theory, many opponents suggest that CEO duality reduces the monitoring role of the board of directors over the executive manager, and this, in turn, may harm corporate performance. In line with this Khajavi and Dehghani, [ 44 ] found that as the number of internal board increases, the managerial overconfidence bias will increase in Tehran Stock Exchange during 2006–2012.

This shows us the controlling and supervising role of independent directors are less likely in the firms managed by overconfident managers than normal managers; conversely, the power of CEO duality is more salient in the case of overconfident managers than normal managers.

Hypothesis 2a

Managerial overconfidence negatively influences the relationship of independent board and firm performance.

Hypothesis 2b

Managerial overconfidence strengthens the negative relationships of CEO duality and firm performance.

An internal control mechanism ownership concentration believes in the existence of strong control against the managers’ decisions and choices. Ownership concentration can reduce managerial behaviors such as overconfidence and optimism since it contributes to the installation of a powerful control system [ 7 ]. They documented that managerial behavior affects the monitoring activities of ownership concentration on firm performance. Ownership can affect the managerial behavioral bias in different ways, for instance, when CEOs of the firm become overconfident for a certain time, the block ownership controlling attention is weakened [ 20 ], and owners trust the internal managers that may damage the performance of the firms in an emerging market where external market control is weak. Overconfidence CEOs have the quality that expresses their behavior up on their company [ 36 ]. In line with this fact, the researcher can predict that the impact of concentrated ownership on firm performance is affected by overconfident managers.

Hypothesis 2c

Managerial overconfidence negatively influences the impact of ownership concentration on firm performance.

Theoretical literature has argued that product market competition forces management to improve firm performance and to make the best decisions for the future. In high competition, managers try their best due to fear of takeover [ 3 ], well-managed firms take over the market from poorly managed firms, and thus, competition helps to build the best management team. In the case of firms operating in the competitive industry, overconfidence CEO has advantages, due to its too simple to motivate overconfident managerial behaviors due to being overconfident managers assume his/her selves better than others. Overconfident CEOs are better at investing for future investments like research and development, so it plays a strategic role in the competition. Englmaier [ 23 ] argues firms in a more competitive industry better hire a manager who strongly believes in better future market outcomes.

Therefore, the following hypothesis was proposed:

Hypothesis 2d

Managerial overconfidence moderates the effect of product market competition on firm performance.

Regarding debt financing, existing empirical evidence shows no specific pattern in the relation of managerial overconfidence and debt finance. Huang et al. [ 38 ] noted that overconfident managers normally overestimate the profitability of investment projects and underestimate the related risks. So, this study believes that firms with overconfident managers will have lower debt. Then, creditors refuse to provide debt finance when firms are facing high liquidity risks. Abdullah [ 1 ] also argues that debt financers may refuse to provide debt when a firm is having a low credit rating. Low credit rating occurs when bankers believe firms are overestimating the investment projects. Therefore, creditors may refuse to provide debt when managers are overconfident, due to under-estimating the related risk which provides a low credit rating.

However, in China, the main source of debt financers for companies is state banks [ 82 ], and most overconfidence CEOs in Chinese firms have political connections [ 96 ] with the state and have a better relationship with external financial institutions and public banks. Hence, overconfident managers have better in accessing debt rather than rational managers in the context of China that leads creditors to allow to follow and influence the firm investments through collecting information about the firm and supervise the firms directly or indirectly. Thus, managerial overconfidence could have a positive influence on relationships between debt finance and firm performance; thus, the following hypothesis is proposed:

Hypothesis 2e

Managerial overconfidence moderates the relationship between debt financing and firm performance.

To explore the impact of CG on firm performance and whether managerial behavior (managerial overconfidence) influences the relationships of CG and firm performance, the following research model framework was developed based on theoretical suggestions and empirical evidence.

Data sources and sample selection

The data for this study required are accessible from different sources of secondary data, namely China Stock Market and Accounting Research (CSMAR) database and firm annual reports. The original data are obtained from the CSMAR, and the data are collected manually to supplement the missing value. CSMAR database is designed and developed by the China Accounting and Financial Research Center (CAFC) of Honk Kong Polytechnic University and by Shenzhen GTA Information Technology Limited company. All listed companies (Shanghai and Shenzhen stock Exchange) financial statements are included in this database from 1990 and 1991, respectively. All financial data, firm profile data, ownership structure, board structure, composition data of listed companies are included in the CSMAR database. The research employed nine consecutive years from 2010 to 2018 that met the condition that financial statements are available from the CSMAR database. This study sample was limited to only listed firms on the stock market, due to hard to access reliable financial and corporate governance data of unlisted firms. All data collected from Chinese listed firms only issued on A shares in domestic stoke market exchange of Shanghai and Shenzhen. The researcher also used only non-financial listed firms’ because financial firms have special regulations. The study sample data were unbalanced panel data for nine consecutive years from 2010 to 2018. To match firms with industries, we require firms with non-missing CSRC top-level industry codes in the CSMAR database. After applying all the above criteria, the study's final observations are 11,634 firm-year observations.

Measurement of variables

Dependent variable.

• Firm performance

To measure firm performance, prior studies have been used different proxies, by classifying them into two groups: accounting-based and market-based performance measures. Accordingly, this study measures firm performance in terms of accounting base (return on asset) and market-based measures (Tobin’s Q). The ROA is measured as the ratio of net income or operating benefit before depreciation and provisions to total assets, while Tobin’s Q is measured as the sum of the market value of equity and book value of debt, divided by book value of assets.

Independent Variables

Board independent (bind).

Independent is calculated as the ratio of the number of independent directors divided by the total number of directors on boards. In the case of the Chinese Security Regulatory Commission (2002), independent directors are defined as the “directors who hold no position in the company other than the position of director, and no maintain relation with the listed company and its major shareholders that might prevent them from making objective judgment independently.” In line with this definition, many previous studies used a proportion of independent directors to measure board independence [ 56 , 79 ].

CEO Duality

CEO duality refers to a position where the same person serves the role of chief executive officer of the form and as the chairperson of the board. CEO duality is a dummy variable, which equals 1 if the CEO is also the chairman of the board of directors, and 0 otherwise.

Ownership concentration (OWCON)

The most common way to measure ownership concentration is in terms of the percentage of shareholdings held by shareholders. The percentage of shares is usually calculated as each shareholder’s shareholdings held in the total outstanding shares of a company either by volume or by value in a stock exchange. Thus, the distribution of control power can be measured by calculating the ownership concentration indices, which are used to measure the degree of control or the power of influence in corporations [ 88 ]. These indices are calculated based on the percentages of a number of top shareholders’ shareholdings in a company, usually the top ten or twenty shareholders. Following the previous studies [ 22 ], Wei Hu et al. [ 37 ], ownership concentration is measured through the total percentage of the 10 top block holders' ownership.

Product market competition (PMC)

Previous studies measure it through different methods, such as market concentration, product substitutability and market size. Following the previous work in developed and emerging markets [product substitutability [ 31 , 57 ], the current study measured using proxies of market concentration (Herfindahl–Hirschman Index (HHI)). The market share of every firm is calculated by dividing the firm's net sale by the total net sale of the industry, which is calculated for each industry separately every year. This index measures the degree of concentration by industry. The bigger this index is, the more the concentration and the less the competition in that industry will be, vice versa.

Debt Financing (DF)

The debt financing proxy in this study is measured by the percentage of a total asset over the total debt of the firm following the past studies [ 69 , 95 ].

Interaction variable

Managerial overconfidence (moc).

To measure MOC, several researchers attempt to use different proxies, for instance CEO’s shareholdings [ 61 ] and [ 46 ]; mass media comments [ 11 ], corporate earnings forecast [ 36 ], executive compensation [ 38 ], and managers individual characteristics index [ 53 ]. Among these, the researcher decided to follow a study conducted in emerging markets [ 55 ] and used corporate earnings forecasts as a better indicator of managerial overconfidence. If a company’s actual earnings are lower than the earnings expected by managers, the managers are defined as overconfident with a dummy variable of (1), and as not overconfident (0) otherwise.

Control variables

The study contains three control variables: firm size, firm age, and firm growth opportunities. Firm size is an important component while dealing with firm performance because larger firms have more agency issues and need strong CG. Many studies confirmed that a large firm has a large board of directors, which increases the monitoring costs and affects a firm’s value (Choi et al., 2007). In other ways, large firms are easier to generate funds internally and to gain access to funds from an external source. Therefore, firm size affects the performance of firms. Firm size can be measured in many ways; common measures are market capitalization, revenue volume, number of employments, and size of total assets. In this study, firm size is measured by the logarithm of total assets following a previous study. Firm age is the number of years that a firm has operated; it was calculated from the time that the company first appeared on the Chinese exchange. It indicates how long a firm in the market and indicates firms with long age have long history accumulate experience and this may help them to incur better performance [ 8 ]. Firm age is a measure of a natural logarithm of the number of years listed from the time that company first listed on the Chinese exchange market. Growth opportunity is measured as the ratio of current year sales minus prior year sales divided by prior year sales. Sales growth enhances the capacity utilization rate, which spreads fixed costs over revenue resulting in higher profitability [ 49 ].

Data analysis methods

Empirical model estimations.

Most of the previous corporate governance studies used OLS, FE, or RE estimation methods. However, these estimations are better when the explanatory variables are exogenous. Otherwise, a system generalized moment method (GMM) approach is more efficient and consistent. Arellano and Bond [ 4 ] suggested that system GMM is a better estimation method to address the problem of autocorrelation and unobservable fixed effect problems for the dynamic panel data. Therefore, to test the endogeneity issue in the model, the Durbin–Wu–Hausman test was applied. The result of the Hausman test indicated that the null hypothesis was rejected ( p  = 000), so there was an endogeneity problem among the study variables. Therefore, OLS and fixed effects approaches could not provide unbiased estimations, and the GMM model was utilized.

The system GMM is the econometric analysis of dynamic economic relationships in panel data, meaning the economic relationships in which variables adjust over time. Econometric analysis of dynamic panel data means that researchers observe many different individuals over time. A typical characteristic of such dynamic panel data is a large observation, small-time, i.e., that there are many observed individuals, but few observations over time. This is because the bias raised in the dynamic panel model could be small when time becomes large [ 75 ]. GMM is considered more appropriate to estimate panel data because it removes the contamination through an identified finite-sample corrected set of equations, which are robust to panel-specific autocorrelation and heteroscedasticity [ 12 ]. It is also a useful estimation tool to tackle the endogeneity and fixed-effect problems [ 4 ].

A dynamic panel data model is written as follows:

where y it is the current year firm performance, α is representing the constant, y it−1 is the one-year lag performance, i is the individual firms, and t is periods. β is a vector of independent variable. X is the independent variable. The error terms contain two components, the fixed effect μi and idiosyncratic shocks v it .

Accordingly, to test the impact of corporate governance mechanisms on firm performance and influencing role of the overconfident executive on the relationship between corporate governance mechanisms and firm performance, the following base models were used:

ROA / TQ i ,t  =  α  + yROA /TQ i,t−1  + β 1 INDBRD + β 2 DUAL + β 3 OWCON +  β 4 DF +  β 5 PMC +  β 6 MOC +  β 7 FSIZE + β 8 FAGE + β 9 SGTH + β 10–14 MOC * (INDBRD, DUAL, OWCON, DF, and PMC) + year dummies + industry Dummies + ή +  Ɛ it .

where i and t represent firm i at time t, respectively, α represents the constant, and β 1-9 is the slope of the independent and control variables which reflects a partial or prediction for the value of dependent variable, ή represents the unobserved time-invariant firm effects, and Ɛ it is a random error term.

Descriptive statistics

Descriptive statistics of all variables included in the model are described in Table 1 . Accordingly, the value of ROA ranges from −0.17 to 0.23, and the average value of ROA of the sample is 0.05 (5.4%). Tobin Q’s value ranges from 0.88 to 10.06, with an average value of 2.62. The ratio of the independent board ranges from 0.33 to 0.57. The average value of the independent board of directors’ ratio was 0.374. The proportion of the CEO serving as chairperson of the board is 0.292 or 29.23% over the nine years. Top 10 ownership concentration of the study ranged from 22.59% to 90.3%, and the mean value is 58.71%. Product market competition ranges from 0.85% to 40.5%, with a mean value of 5.63%. The debt financing also has a mean value of 40.5%, with a minimum value of 4.90% and a maximum value of 87%. The mean value of managerial overconfidence is 0.589, which indicates more than 50% of Chinese top managers are overconfident.

The study sample has an average of 22.15 million RMB in total book assets with the smallest firms asset 20 million RMB and the biggest owned 26 million RMB. Study sample average firms’ age was 8.61 years old. The growth opportunities of sample firms have an average value of 9.8%.

Table 2 presents the correlation matrix among variables in the regression analysis in the study. As a basic check for multicollinearity, a correlation of 0.7 or higher in absolute value may indicate a multicollinearity issue [ 32 ]. According to Table 2 results, there is no multicollinearity problem among variables. Additionally, the variance inflation factor (VIF) test also shows all explanatory variables are below the threshold value of 10, [ 32 ] which indicates that no multicollinearity issue exists.

Main results and discussion

Impact of cg on firm performance.

Accordingly, Tables 3 and 4 indicate the results of two-step system GMM employing the xtabond2 command introduced by Roodman [ 75 ]. In this, the two-step system GMM results indicated the CG and performance relationship, with the interaction of managerial overconfidence. One-year lag of performance has been included in the model and two to three periods lagged independent variables were used  as an instrument in the dynamic model, to correct for simultaneity, control for the fixed effect, and to tackle the endogeneity problem of independent variables. In this model, all variables are taken as endogenous except control variables.

Tables 3 and 4 report the results of three model specification tests to determine whether an appropriate estimation model was applied. These tests are: 1) the Arellano–Bond test for the first-order (AR (1)) and second-order correlation (AR (2)). This test indicates the result of AR (1) and AR (2) is tested for the first-order and second-order serial correlation in the first-differenced residuals, AR (2) test accepted under the null of no serial correlation. The model results show AR (2) test yields a p-value of 0.511 and 0.334, respectively, for ROA and TQ firm performance measurement, which indicates that the models cannot reject the null hypothesis of no second-order serial correlation. 2) Hansen test over-identification is to detect the validity of the instrument in the models. The Hansen test of over-identification is accepted under the null that all instruments are valid. Tables 3 and 4 indicate the p-value of Hansen test over-identification 0.139 and 0.132 for ROA and TQ measurement of firm performance, respectively, so that these models cannot reject the hypothesis of the validity of instruments. 3) In the difference-in-Hansen test of exogeneity, it is acceptable under the null that instruments used for the equations in levels are exogenous. Table 3 shows p-values of 0.313 and 0.151, respectively, for ROA and TQ. These two models cannot reject the hypothesis that the equations in levels are exogenous.

Tables 3 and 4 report the results of the one-year lag values of ROA and TQ are positive (0.398, 0.658) and significant at less than 1% level. This indicates that the previous year's performance of a Chinese firm has a significant impact on the current firm's performance. This study finding is consistent with the previous studies: Shao [ 79 ], Nguyen [ 66 ] and Wintoki et al. [ 89 ], which considered previous year performance as one of the significant independent variables in the case of corporate governance mechanisms and firm performance relationships.

The results indicate board independence has no relation with firm performance measured by ROA and TQ. However, hypothesis 1 indicated that there is a positive and significant relationship between independent board and firm performance, which is not supported. The results are conflicting with the assumption that high independent board on board room should better supervise managers, alleviate the information asymmetry between agents and owners, and improve the firm performance by their proficiency. This result is consistent with several previous studies [ 56 , 79 ], which confirms no relation between board independence and firm performance.

This result is consistent with the argument that those outside directors are inefficient because of the lack of enough information concerning the daily activities of internal managers. Specifically, Chinese listed companies may simply include the minimum number of independent directors on board to fulfill the institutional requirement and that independent boards are only obligatory and fail to perform their responsibilities [ 56 , 79 ]. In this study sample, the average of independent board of all firms included in this study has only 37 percent, and this is one of concurrent evidence as to the independent board in Chinese listed firm simple assigned to fulfill the institutional obligation of one-third ratio.

CEO duality has a negative significant relationship with firm performance measured by TQ ( β  = 0.103, p  < 0.000), but has no significant relationship with accounting-based firm performance (ROA). Therefore, this result supports our hypothesis 2, which proposed there is a negative relationship between dual leadership and firm performance. This finding is also in line with the agency theory assumption that suggests CEO duality could reduce the board’s effectiveness of its monitoring functions, leading to further agency problems and ultimately leads poor firm performance [ 41 , 83 ]. This finding consistent with prior studies [ 15 , 56 ] that indicated a negative relationship between CEO dual and firm performance, against to this result the studies [ 70 ] and [ 15 ] found that duality positively related to firm performance.

Hypothesis 3 is supported, which proposes there is a positive relationship between ownership concentration and firm performance. Table 3 result shows that there is a positive and significant relationship between the top ten concentrated ownership and ROA and TQ (0.00046 & 0.06) at 1% and 5% significance level, respectively. These findings are consistent with agency theory, which suggests that the shareholders who hold large ownership alleviate agency costs and information problems, monitor managers effectively, consequently enhance firm performance [ 81 ]. This finding is in line with Wu and Cui [ 90 ], and Pant et al. [ 69 ]. Concentrated shareholders have a strong encouragement to watch strictly over management, making sure that management does not engage in activities that are damaging to the wealth of shareholders [ 80 ].

The result indicated in Table 3 PMC and firm performance (ROA) relationship was positive, but statistically insignificant. However, PMC has positive ( β  = 2.777) and significant relationships with TQ’s at 1% significance level. Therefore, this result does not support hypothesis 4, which predicts product market competition has a positive relationship with firm performance in Chinese listed firms. In this study, PMC is measured by the percentage of market concentration, and a highly concentrated product market means less competition. Though this finding shows high product market concentration positively contributed to market-based firm performance, this result is consistent with the previous study; Liu et al. [ 57 ] reported high product market competition associated with poor firm performance measured by TQ in Chinese listed firms. The study finding is against the theoretical model argument that competition in product markets is a powerful force for overcoming the agency problem between shareholders and managers, and enhances better firm performance (Scharfstein and [ 78 ]).

Regarding debt finance and firm performance relationship, the impact of debt finance was found to be negative on both firm performances as expected. Thus, this hypothesis is supported. Table 3 shows a negative relationship with both firm performance measurements (0.059 and 0.712) at 1% and 5% significance level. Thus, hypothesis 5, which predicts a negative relationship between debt financing and firm performance, has been supported. This finding is consistent with studies ([ 86 ]; Pant et al., [ 69 ]; [ 77 , 82 ]) that noted that debt financing has a negative effect on firm values.

This could be explained by the fact that as debt financing increases in external loans, the size of managerial perks and free cash flows increase and corporate efficiency decrease. In another way, because the main source of debt financers is state-owned banks for Chinese listed firms, these banks are mostly governed by the government, and meanwhile, the government as the owner has multiple objectives such as social welfare and some national issues. Therefore, debt financing fails to play its governance role in Chinese listed firms.

Regarding control variables, firm age has a positive and significant relationship with both TQ and ROA. This finding supported by the notion indicates firms with long age have long history accumulate experience, and this may help them to incur better performance (Boone et al. [ 8 ]). Firm size has a significant positive relationship with firm performance ROA and negative significant relation with TQ. The positive result supported the suggestion that large firms get a higher market valuation from the markets, while the negative finding indicates large firms are more complex; they may have several agency problems and need additional monitoring, which results in higher operating costs [ 84 ]. Growth opportunity was found to be in positive and significant association with ROA; this indicates that a firm high growth opportunity can increase its performance.

Influences of managerial overconfidence in the relationship between CG measures and firm performance

It predicts that managerial overconfidence negatively influences the relationship of independent board and firm performance. The study findings indicate a negative significant influence of managerial overconfidence when the firm is measure by Tobin’s Q ( β  = −4.624, p  < 0.10), but a negative relationship is insignificant when the firm is measured by ROA. Therefore, hypothesis 2a is supported when firm value is measured by TQ. This indicates that the independent directors in Chinese firms are not strong enough to monitor internal CEOs properly, due to most Chinese firms merely include the minimum number of independent directors on a board to meet the institutional requirement and that independent directors on boards are only perfunctory. Therefore, the impact of independent board on internal directors is very weak, in this situation overconfident CEO becoming more powerful than others, and they can enact their own will and avoid compromises with the external board or independent board. In another way, the weakness of independent board monitoring ability allows CEOs overconfident that may damage firm value.

The interaction of managerial overconfidence and CEO duality has a significant negative effect on operational firm performance (0.0202, p  > 0.05) and a negative insignificant effect on TQ. Thus, Hypothesis 2b predicts that the existence of overconfident managers strengthens the negative relationships of dual leadership and firm performance has been supported. This finding indicates the negative effect of CEO duality amplified when interacting with overconfident CEOs. According to Legendre et al. [ 51 ], argument misbehaviors of chief executive officers affect the effectiveness of external directors and strengthen the internal CEO's power. When the CEOs are getting more powerful, boards will be inefficient and this situation will result in poor performance, due to high agency problems created between managers and ownerships.

Hypothesis 2c is supported

It predicts the managerial overconfidence decreases the positive impact of ownership concentration on firm performance. The results of Tables 3 and 4 indicated that the interaction effect of managerial overconfidence with concentrated ownership has a negative significant impact on both ROA and TQ firm performance (0.000404 and 0.0156, respectively). This finding is supported by the suggestion that CEO overconfidence weakens the monitoring and controlling role of concentrated shareholders. This finding is explained by the fact that when CEOs of the firm become overconfident for a certain time, the concentrated ownership controlling attention is weakened [ 20 ], owners trust the internal managers that may damage the performance of the firms in an emerging market where external market control is weak. Overconfident managers gain much more power than rational managers that they are able to use the firm to further their own interests rather than the interests of shareholders and managerial overconfidence is a behavioral biased that managers follow to meet their goals and reduce the wealth of shareholders. This situation resulted in increasing agency costs in the firm and damages the firm profitability over time.

It predicts that managerial overconfidence moderates the relation of product market competition and firm performance. However, the result indicated there is no significant moderating role of managerial overconfidence in the relationship between product market competition and firm performance in Chinese listed firms.

It proposed that overconfidence managers moderate the relationship of debt financing and performance in Chinese listed firm: The study finding is unobvious; it negatively influenced the relation of debt financing with accounting-based firm performance measure ( β  = −0.059, p  < 0.01) and positively significant market base firm performance ( β  = 0.735, p  < 0.05). The negative interaction results could be explained by the fact that overconfident leads managers to have lower debt due to overestimate the profitability of investment projects and underestimate the related risks. This finding is consistent with [ 38 ] finding that overconfident CEOs have lower debt, because of overestimating the investment projects. In another perspective, the result indicated a positive moderating role of overconfidence managers in the relationship of debt financing and market-based firm performance. This result is also supported by the suggestion that overconfident managers have better in accessing debt rather than rational managers in the context of China because in Chinese listed firms most of the senior CEOs have a better connection with the external finance institutions and state banks to access debt, due to their political participation than rational managers.

The main objectives of the study were to examine the impact of basic corporate governance mechanisms on firm performance and to explore the influence of managerial overconfidence on the relationship of CGMs and firm performance using Chinese listed firms. The study incorporated different important internal and external corporate governance control mechanisms that can affect firm performance, based on different theoretical assumptions and literature. To address these objectives, many hypotheses were developed and explained by a proposing multi-theoretical approach.

The study makes several important contributions to the literature. While several kinds of research have been conducted on the relationships of corporate governance and firm performance, the study basically extends previous researches based on panel data of emerging markets. Several studies have investigated in developed economies. Thus, this study contributed to the emerging market by providing comprehensive empirical evidence to the corporate governance literature using unique characteristics of Chinese publicity listed firms covering nine years (2010–2018). The study also extends the developing stream of corporate governance and firm performance literature in emerging economies that most studies in emerging (Chinese) listed companies give less attention to the external governance mechanisms. External corporate governance mechanisms like product market competition and debt financing are limited from emerging market CG literature; therefore, this study provided comprehensive empirical evidence.

Furthermore, this study briefly indicated how managerial behavioral bias can influence the monitoring, controlling, and corporate decisions of corporate firms in Chinese listed firms. Therefore, as to the best knowledge of the researcher, no study investigated the interaction effect of managerial overconfidence and CG measures to influence firm performance. Thus, the current study provides an insight into how a managerial behavioral bias (overconfidence) influences/moderates the relationship between corporate governance mechanisms and firm performance, in an emerging market. Hence, the study will help managers and owners in which situation managerial behavior helps more for firm’s value and protecting shareholders' wealth (Fig. 1 ).

Generally, the previous findings also support the current study's overall findings: Phua et al. [ 71 ] concluded that managerial overconfidence can significantly affect corporate activities and outcomes. Russo and Schoemaker [ 76 ] found that there is opposite relationship between overconfidence managers and quality of decision making, because overconfident behavioral bias reduces the ability to make a rational decision. Therefore, the primary conclusion of the study is that it attempts to understand the strength of the effect of corporate governance mechanisms on firm performance, and managerial behavioral bias must be taken into consideration as one of the influential moderators.

Proposed research model framework

Availability of data and material

I declare that all data and materials are available.

Abbreviations

China accounting and finance center

Chief executive officer

• Corporate governance

Corporate governance mechanisms

China Stock Market and Accounting Research

China Securities Regulatory Commission

Generalized method of moments

• Managerial overconfidence

Research and development

Return on asset

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Guluma, T.F. The impact of corporate governance measures on firm performance: the influences of managerial overconfidence. Futur Bus J 7 , 50 (2021). https://doi.org/10.1186/s43093-021-00093-6

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• Open access
• Published: 06 November 2018

Implications of corporate governance on financial performance: an analytical review of governance and social reporting reforms in India

• Puneeta Goel   ORCID: orcid.org/0000-0002-0563-7671 1  

Asian Journal of Sustainability and Social Responsibility volume  3 , Article number:  4 ( 2018 ) Cite this article

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Currently the corporate governance reforms in India are at cross roads where though the intention behind the reforms is good yet there is a need to look for a complete solution addressing country specific challenges in Indian context. Keeping pace with developments at international level, India also introduced reforms for improving corporate, social and environment disclosures. This paper explores the effectiveness of these corporate governance reforms by analyzing the corporate governance practices followed by Indian companies in two reform periods (FY 2012–13 as Period 1) and (FY 2015–16 as Period 2). Considering mandatory regulations as per clause 49 of Listing agreement with Securities exchange board of India and the governance norms in the new Company Act, 2013, a corporate governance performance (CGP) index is developed to measure corporate governance score of Indian companies. Though there is a significant improvement in corporate governance structures implied by Indian companies but the number of independent directors inducted in the board decreases after the reforms in period 2. All the sectors under study show a significant improvement in following corporate governance practices after the reforms. The study reported a significant relationship between integrated framework of total corporate social performance and financial performance only in period 1. Corporate governance reforms do not impact financial linkages in Indian market in period 2.

Introduction

The economic success of an organization is not only dependent on efficiency, innovation and quality management but also on compliance of corporate governance principles. Implementation of corporate governance standards improves financial performance of the company as well as positively impacts internal efficiency of the firms (Tadesse, 2004 ) in developed economies. However, lack of transparency and poor disclosure practices reduce effectiveness of corporate governance mechanism. Though, global financial crisis and major corporate scandals have reinforced the merit of good corporate governance structures in enhancing firms’ performance and sustainability in the long run (Ehikioya, 2009 ).

Corporate governance aims at facilitating effective monitoring and efficient control of business. Its essence lies in fairness and transparency in operations and enhanced disclosures for protecting interest of different stakeholders (Arora and Bodhanwala, 2018 ). Corporate governance structures are expected to help the firm perform better through quality decision making (Shivani et al. 2017 ). A wider definition given by Maier ( 2005 ) states that “Corporate governance defines a set of relationships between a company’s management, its board, its shareholders and its stakeholders.” Good corporate governance “ensures that corporations take into account the interests of a wide range of constituencies, as well as of the communities within which they operate, and that their boards are accountable to the company and the shareholders” (Organization for Economic Cooperation and Developement, 1999). Corporate governance was originally developed to protect shareholder’s interest but gradually it has gained importance for other stakeholders and society (Jizi, Salama, Dixon, Startling, 2014 ).

Corporate governance identifies the role of directors and auditors towards shareholders and other stakeholders. Corporate governance is significant for shareholders as it increases confidence in the company for better return on investment. For other stakeholders like employees, customers, suppliers, community and environment, corporate governance assures that company behave in a responsible manner towards society and environment (Kolk and Pinkse, 2010 ). Thus, corporate governance is not only about board accountability but also include aspects of social and environment responsibility.

Earlier good governance was not a mandated legal requirement and adherence was voluntary, but owing to corporate failures on account of unethical practices at top level management, most of the countries have initiated mandatory norms and guidelines to strengthen corporate governance framework. The Cadbury Committee report in United Kingdom (UK) in 1992 and Sarbanes Oxley (SOX) Act in United States (US) in 2002 are considered a seminal development in corporate governance regulations followed by similar codes of good governance in rest of the countries. The governance codes become a source of normative institutional pressure for convergence within a country (Yoshikawa and Rasheed, 2009 ).

Corporate governance reforms are more significant for developing economies as they make the corporate structures more effective, help in competing with multi-national corporations and increase investors confidence (Reed, 2002 ). Keeping pace with the global developments, India has witnessed a series of such reforms in corporate governance. One such reform is introduction of clause 49 of listing agreement by Security Exchange Board of India (SEBI), apex regulatory authority of stock market in India. This clause outlines corporate governance structures for listed companies in India. It has led to significant implications on independent directors on board, enhanced disclosure requirements, making audit committees more powerful etc. Further, corporate governance initiatives are strengthened with the introduction of revised Company Act, 2013.

Though, corporate governance norms and other disclosure guidelines have been introduced in India but owing to weak implementation, the extent of compliance by the Indian companies is still questionable. Countries with weak legal norms have suffered higher depletion in exchange rates and stock market decline (Johnson, Boone, Breach and Friedman, 2000 ). Dharmapala and Khanna ( 2013 ) emphasize on the importance of enforcement of legal reforms in developing economies which are marred by weak systems, corruption and bureaucratic influence on policy implementation. Most of the previous studies highlight the impact of corporate governance on financial performance but surprisingly there is dearth of literature on impact of corporate governance reforms on corporate disclosures and reporting. This backdrop gives an interesting case to study the impact of reforms and amendments on improvement corporate governance disclosures in Indian companies.

Moreover, previous literature has focused on corporate governance in a particular sector like Information and Technology (IT) sector (Rajharia and Sharma, 2014a ; Rajharia and Sharma, 2014b ), Manufacturing sector (Saravanan, 2012 ), Textile sector (Ashraf, Bashir and Asghar, 2017), Banking and Financial Services (Arif and Syed, 2015 ) but the comparison of different sectors (Palanippan and Rao, 2015 ) is very limited. This study investigates the nature and type of corporate governance activities followed by top Indian companies in different sectors.

Extant research in this domain establish association between corporate governance and stock market performance (Klapper and Love, 2004 ; Cheung, Stouraitis and Tan, 2010 ; Abatecola, Caputo, Mari and Poggesi, 2012 ; Beiner, Drobetz, Schmid and Zimmermann, 2006 ; Brammer, Brooks and Pavelin, 2009 ; Brown and Caylor, 2006 ; Bauer, Guenster and Otten, 2004 ). However, very few studies have focused on the impact of corporate governance reforms and its linkage with financial performance. This paper investigates the plausible connection between corporate governance after reforms and firm valuations for India during two different periods of reforms on select sectors.

The paper has been organized in six sections. Background of the study is discussed in section one. Section two outlines recent developments in corporate governance norms in India. Section three reviews existing literature across economies, while section four discusses the methodology adopted. Statistical analysis of the impact of India’s corporate governance reforms on firm performance is reported in section five followed by discussion, conclusion and policy implications in the last section.

Recent developments in corporate governance norms in India

Corporate governance reforms have significant importance for India which is moving towards a more transparent and accountable system of economic governance (Sanan and Yadav, 2011 ). The fiscal crisis in 1991 led to liberalization and privatization of Indian economy. The Indian companies required finance for growth and expansion. The need of foreign investment gave rise to the need of corporate governance reforms in India. Since then, good governance in capital market has always been on high priority for SEBI. This is evident from frequent updation of guidelines, rules and regulations by SEBI for ensuring transparency and accountability (Sehgal and Mulraj, 2008 ). Clause 49 was adopted by SEBI in 1999 from the code of governance developed by Confederation of Indian Industry (CII), an independent organization working with government on policy issues. It has been revised time to time to ensure better compliance.

India introduced reforms for improving corporate, social and environment disclosures. Ministry of Corporate Affairs, Government of India published ‘National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business’ in 2011 (Ministry of Corporate Afairs, 2011 ). The guidelines make it mandatory for the listed companies to file Business Responsibility Report (BRR) to enhance the quality of disclosures (SEBI Circular, 2012 ). The enactment of the companies Act 2013 replaces the Companies Act, 1956 and aims to improve corporate governance standards to simplify regulations and enhance the interests of minority shareholders (Prasanna, 2013 ). India is among the first country to implement mandatory Corporate Social Responsibility (CSR) spending and this Indian model will set precedence for other countries in the world, for strategic implementation of corporate governance policies.

As per the latest revision in 2014, clause 49 includes protection of shareholders rights, proper and timely disclosures, Chief Financial Officer (CFO) certification of financial statements, equitable treatment of shareholders, enhance responsibility of board and norms for preventing insider trading. To sum up, corporate governance in India is mainly concerned with improving accountability and transparency, disciplining dominant shareholders, protecting the interest of minority shareholders. This is in contrast to US and UK which concentrates on making management more accountable to dispersed shareholders (Pande and Kaushik, 2012 ).

Review of literature and hypothesis development

Impact of corporate governance reforms on disclosures.

In general, almost all countries have issued general guidelines for governance, social and environmental reporting, but it would result only as a tick-in-the-box activity unless it is checked to what extent the corporate world is responding and reporting as per the new reforms. Many researchers have studied the impact of the recent reforms for improving governance, social and environment disclosures in different economies. In Portugal, Monteiro and Guzman ( 2010 ) explore that the extent of disclosures have improved as compared to the pre reform period but the amount of disclosures is still low even after the introduction of new reforms. Ioannou and Serafeim ( 2017 ) study the implications of disclosure reforms in China, Denmark, Malaysia and South Africa and suggest that improvement in sustainability disclosures due to introduction of reforms is associated with increase in firm value. Kolk ( 2008 ) asserts that after the reforms in disclosure regulations, many countries in Europe and in Japan have started paying attention to board supervision, ethics compliance and external verifications. Chen, Hung and Wang ( 2018 ) affirm decrease in industrial waste and Sulfur Dioxide (SO2) emissions after the declaration of disclosure mandate in China but the firms adopting CSR reporting experience decrease in profitability.

India initiated reforms concerning corporate governance, corporate social responsibility and environment to improve disclosures by Indian companies. Implementing corporate reforms, however, is significantly difficult than framing those reforms. There are many challenges in successful implementation and effective enforcement of reforms such as local inhibitions and comprehensive rules (Afsharipour, 2009 ), lack of availability of qualified independent directors (Malik and Nehra, 2014 ), underdeveloped external monitoring systems and weak and multiple regulatory norms (Rajharia and Sharma, 2014a ; Rajharia and Sharma, 2014b ). This gives the need to explore the actual impact of reforms on corporate governance and disclosures by Indian companies.

There is an interesting observation about these disclosure regulations that it contains a clause of “comply or explain”. It means that either the companies should comply by the norms or explain the reasons for not following the mandatory requirements. Moreover, there is no penalty for non-compliance as well. It gives an option to the companies either to follow the regulations or safely escape by giving some explanation. There may be some companies which were following the best practices in corporate governance even before these reforms were introduced. But, there may be others, which have started doing the same after these reforms. This argument justifies that there is no obvious reason to believe that reforms would result into better compliance and reporting. Therefore, it becomes important to explore the practical implications of these reforms for Indian companies and for policy makers.

Corporate governance reforms draw increased strategic attention in India. These structural changes and disclosure reforms make an interesting case to investigate their implications on Indian companies. Accordingly, this research studies the corporate governance by Indian companies after the introduction of the above stated recent reforms. No previous research has investigated the impact of these reforms considering two different periods of reforms.

Thus, the first hypothesis of the study is:

HO1: There is no significant improvement in corporate governance performance of Indian companies after the introduction of reforms.

Impact of corporate governance reforms on different sectors

Many researchers have studied the impact of corporate governance in different sectors of the economy. There is a significant impact of corporate governance on firm performance in textile sector (Ashraf et al. 2017 ) and in Banking and Financial services sector (Arif and Syed, 2015 ) in Pakistan. While comparing different sectors, Banking, Insurance and Service sector companies listed in Amman stock exchange perform better after the introduction of corporate governance reforms in Jordan (Mansur and Tangl, 2018 ). Jizi et al. ( 2014 ) find board independence and board size significantly related to improved CSR disclosures for banking sector in US. Okoye, Evbuomwan, Achugamonu and Araghan ( 2016 ) report a significant impact of corporate governance on banking sector in Nigeria. Palaniappan and Rao ( 2015 ) report significant impact of corporate governance disclosures on firm performance for manufacturing companies taking only one company from ten different sectors in India.

Many studies have been conducted testing the impact of corporate governance on firm performance taking a set of listed companies in varied stock exchanges across different economies. Gompers, Ishi and Metrick ( 2003 ) report better governed firms listed in New York Stock Exchange (NYSE) show higher market valuation and low expenditure. Bauer et al. ( 2004 ) reveal the same results for companies in Financial Times Stock Exchange (FTSE), Eurotop 300 index giving higher stock returns and enhanced firm valuation for the better governed companies. Studies on US listed firms also highlight positive relationship between corporate governance rankings and Tobin Q (Klapper and Love, 2004 ; Durnev and Kim, 2005 ). Similar findings are also reported in studies conducted on Italian (Abatecola et al., 2012 ) and Swiss (Beiner et al., 2006 ) firms which confirm that corporate governance has a significant statistical relationship with corporate performance variables like Return on Capital (ROC), Return on Assets (ROA).

An interesting observation from these studies is that most of the research has been done on a whole set of listed companies in a stock exchange or a set of listed companies in a particular sector but very few studies have done comparison of corporate governance in different sectors. Corporate governance reforms along with liberalization and privatization has led to substantial development and strategic changes in different sectors of the economy (Reed, 2002 ). This study investigates the nature and type of corporate governance activities, followed by top 100 listed Indian companies of different sectors, after the introduction of recent corporate governance reforms in India and tests the sector differences for two periods of reforms.

The second hypothesis of the study is:

HO2: There is no significant difference in corporate governance in different sectors in India.

Corporate governance reforms and firm performance

In general, corporate governance is considered to be a significant variable influencing growth prospects of an economy because best governance practices reduce risk for investors, improves financial performance and helps in attracting investors (Spanos, 2005 ). Monda and Giorgino ( 2013 ) document better corporate governance results in higher market valuation and ROA for companies listed in France, Italy, Japan, UK and US. Cheung et al. ( 2010 ) confirm that firms which have adopted corporate governance reforms appear to have better risk return trade off for investors in Hong-Kong stock market. Bae and Goyal ( 2010 ) find that good corporate governance practice adopted by Korean firms have resulted in improved equity market performance and increased foreign ownership in companies. Yang, Yan & Yang ( 2012 ) state that improved corporate governance disclosures by US firms help in reducing cost of equity. Botosan ( 2006 ) also substantiated in an extensive literature review that proper disclosure of financial reporting and corporate governance practices help in reducing the cost of equity capital. There have been a few studies which contradict the above mentioned findings. For instance, Bhagat & Bolton ( 2008 ) find corporate governance measures not correlated to future stock market performance for NYSE listed firms while Roodposhti and Chashmi ( 2010 ) report a negative correlation between ownership and independent board and earnings of the companies in Iran.

Similarly Indian companies are publicizing their efforts through corporate governance disclosures to attract the investors which have also led to enhancement in market valuation (Dua and Dua, 2015 ). Improvement in corporate governance has lead to significant increase in investment by foreign investors and profitability of Indian companies (Patibandla, 2006 ). Firms adopting corporate governance reforms appear to have better risk return trade off for investors (Prasanna, 2013 ; Mohanty, 2003 ). Examining the relationship between corporate governance and firm performance for firms listed in National Stock Exchange of India (Nifty 500), Shivani, Jain and Yadav ( 2017 ) find that while larger boards, committees of the board are negatively related to ROA and Return on Equity (ROE), presence of non-executive directors and whistle blower policy have positive impact.

In contrast to the above findings, Sarpal & Singh ( 2013 ) reports no significant relationship between board and corporate performance. Kumar ( 2004 ) specifies no significant relation between foreign shareholding and financial performance of Indian companies. Tata and Sharma ( 2012 ) find that corporate Governance practices such as board structure, ownership and other such disclosure have no significant relationship with corporate performance. Misra and Vishnani ( 2012 ) are of the view that reforms and change in corporate governance have no significant impact on the market risk of the companies listed in Group – A of Bombay Stock Exchange (BSE). The review of literature gives mixed results for Indian companies. Hence, this needs to be further scrutinized to draw any concrete conclusions.

Indian investors responded positively to clause 49 reforms initiated in 1999 and the large firms gained 4.5% on an average for three days from the date of announcement of the reforms in contract to negative reaction by investors towards SOX in developed countries (Black and Khanna, 2007 ). Other recent studies extend immediate positive effect into tangible long-term outcomes. Kohli and Saha ( 2008 ) report positive and significant relationship between corporate governance reforms and firms’ performance. The increase in scope of clause 49 improves debt- equity structures of Indian companies (Goel and McIver, 2015 ). Dharmapala and Khanna ( 2013 ) put a strong case for causal effect of changes in clause 49 on firm value and underscore the significance of enforcement of regulatory norms. Clause 49 has improved stock market sentiments which result in more reliance on equity capital and less dependability on bank loans (Saher, Pal and Pinheiro, 2015 ).

Since a very limited literature is available to study the impact of reforms on corporate governance and firm performance, it will be interesting to evaluate the impact of changes in governance, social and environment disclosure norms on financial performance after the introduction of the recent reforms. Thus, this study explores the linkage between corporate governance and financial performance of the companies in two different periods of reforms in India.

HO3: There is no significant impact of corporate governance reforms on financial performance of Indian companies in both the periods under study.

Methodology

For this study, the researcher constructs a firm specific corporate governance performance index for Indian companies based on recent reforms introduced in the country. This paper takes into consideration two periods P1 (2012–13) and P2 (2015–16) representing two different stages of corporate governance reforms in India. The study develops an integrated empirical framework to measure the valuation effects of corporate governance mechanism.

Sample and data collection

The sample for the study is drawn from the top 100 companies ranked on the basis of revenue in the list of The Economic Times 500 (ET500), 2016. From the selected companies, 28 companies of Banking and financial services sector have been excluded from the purview of this paper as disclosure and profitability norms are different for this sector in India. Further, 4 companies are also excluded from the study as data for the period under study was not available. The finally selected companies have been categorized under six major sectors. Table  1 shows the sector-wise composition of the companies under study.

Published Annual Reports, Business Responsibility Reports and Sustainability Reports of the selected companies are taken as the primary source of data. These reports are collected/ downloaded from the website of the respective companies. The reports have been reviewed thoroughly to do the content analysis for the selected dimensions under study (Quick, 2008 ; Sandhu and Kapoor, 2010 ; Gautam and Singh, 2010 ). All the information available in the reports on a particular dimension has been collated to give the final score for each aspect. All the reports were reviewed at least twice so that no item is missed while collecting the requisite information to ensure accuracy and trustworthiness of the data. Instead of using binary score of 0 and 1, this study gives credit to the type of reporting, the amount of information disclosed, number of good governance practices adopted by any company (Cheung et al., 2010 ). Scoring for different dimensions is in a range of zero to three. Financial data used in this study is mainly acquired from published data available in the Centre for Monitoring Indian Economy (CMIE) Prowess database.

Measuring corporate governance

Most of the previous studies have used only a specific aspect of corporate governance to study its implications of financial performance such as board size (Black, 2002 ), independent directors (Kaur and Mishra, 2010 ; Annalisa, P. & Yosef, 2011 ), board meetings (Misra and Vishnani, 2012 ; Subramanian and Reddy, 2012 ) and code of ethics (Liao, 2010 ; Mittal, Sinha and Singh, 2008 . This study uses a comprehensive corporate governance performance index for measuring corporate governance of Indian companies based on recent developments in corporate governance norms in India. This index is based on changes in clause 49, Company Act, 2013 and other mandatory guidelines issued by Ministry of Corporate Affairs of India. Some of the dimensions of mandatory disclosures are excluded from the study such as appointing audit committee, CFO certification of financial statements, certificate of compliance by board of directors The exclusion has been done as the pilot study done on one sector revealed that the score is same in both the periods for all the companies. Since corporate governance is based on stakeholder approach (Freeman and Evan, 1990 ), different stakeholders are taken as individual responsibility centers for measuring cumulative corporate governance performance to meet corporate business objectives (Barter, 2011 ; Clarkson, 1995 ). The responsibility towards different stakeholders included in the study are shareholders (SHR), employees (EMR), suppliers and consumers (SCR), community (CMR) and environment (ENR). Table  2 elaborates the final instrument used to measure Corporate Governance Performance (CGP) index. Cronbach’s alpha test of reliability of data revealed a score of 0.840.

Using paired sample t-test corporate governance performance of each parameter in Period 1 is paired with the same in Period 2 to check the significant difference for each dimension for the two periods under study. Further, sector comparison has been done by calculating the percentage score of each sector for every stakeholder using the formula:

One way Analysis of Variance (ANOVA) is applied to study the significant difference in performance of different sectors under study.

Measuring financial performance

Most of the scholars have used any one of the three approaches of measuring corporate financial performance i.e. Accounting Ratios (Griffin and Mahon, 1997 ; Bayoud, Kavanagh and Slaughter, 2012 ) or Market Valuation Ratios (Kiel and Nicholson, 2003 ; Arnold, Bassen and Frank, 2012 ) or Accounting and Market based mixed ratios (Mulyadi and Anwar, 2012 ). To correlate corporate governance performance with financial performance, we consider the third approach and take Tobin Q (Klapper and Love, 2004 ), Market Capitalization (Suttipun, 2012 ) and Price Earning (PE) (Siew, Balatbat and Carmichael, 2013 ; Tyagi, 2014 ) as market valuation ratios and ROS (Venanzi, 2012 ), ROE (Griffin and Mahon, 1997 ; Aggarwal, 2013 ) and ROA (Aupperle, Carroll and Hatfield, 1985 ; Tyagi, 2014 ) as accounting ratios.

Regression model

Regression model has been developed to examine the relationship of overall CGP score of company (independent variable – CGP taken as summation of corporate responsibility towards five different stakeholders- Shareholders, Employees, Suppliers and Customers, Community and Environment) with the financial performance of the company (dependent variables –ROS, ROA, ROE, Tobin Q, Market Cap and PE).

Control variables

Size of the company is an important control variable as Burke, Logsdon, Mitchell, Reiner and Vogel ( 1986 ) suggest that larger firms more often adopt social and governance principles and thus attract attention from stakeholders. Previous researchers have also considered risk as a factor that effects corporate social and financial performance. Thus, this relationship is studied by using size of the company as control variable calculated by natural log of total assets (Abatecola et al., 2012 ) and natural log of sales (Tsoutsoura, 2004 ) as its proxy. Additionally, beta is considered as another control variable for market risk element affecting corporate financial performance.

Six regression equations that shall be tested in this model are:

ROS =  β 0 + \( {\sum}_{k=1}^5\boldsymbol{\beta} \) k C GP + β 6 LnAssets + β 7 LnSales + β 8 beta + Ɛ

ROA =  β 0 + \( {\sum}_{k=1}^5\boldsymbol{\beta} \) k C GP + β 6 LnAssets + β 7 LnSales + β 8 beta + Ɛ

ROE =  β 0 + \( {\sum}_{k=1}^5\boldsymbol{\beta} \) k C GP + β 6 LnAssets + β 7 LnSales + β 8 beta + Ɛ

Tobin Q =  β 0 + \( {\sum}_{k=1}^5\boldsymbol{\beta} \) k CGP + β 6 LnAssets + β 7 LnSales + β 8 beta + Ɛ

Market Cap =  β 0 + \( {\sum}_{k=1}^5\boldsymbol{\beta} \) k CGP + β 6 LnAssets + β 7 LnSales + β 8 beta + Ɛ

PE =  β 0 + \( {\sum}_{k=1}^5\boldsymbol{\beta} \) k C GP + β 6 LnAssets + β 7 LnSales + β 8 beta + Ɛ

Data analysis

Impact of recent reforms on corporate governance in indian companies.

Table  3 clearly depicts the improvement in mean score of each stakeholder. The introduction of governance reforms in India results in substantial increase in mean score of total corporate governance performance in P2. Further, to test the significant difference in CGP for two periods paired t-test is applied.

Table  4 depicts a significant difference in performance of each parameter in two periods as the significant p value in all cases is less than 0.05 except for SHR2 i.e. having independent directors on board (p value: 0.254) and for ENR 3 i.e. achieving awards and achievements (p value: 0.321). Pair 17 represents cumulative CGP score and the p value of 0.000 shows a significant difference in overall corporate governance score of Indian companies during P1 and P2. Thus HO1 is rejected.

Sector differences in corporate governance performance

Analysis of Table  5 shows total percentage score of each sector towards each stakeholder. Over all there is improvement in CGP towards different stakeholders in each sector under study but it needs further statistical testing.

Table  6 shows the results of ANOVA to study the difference in corporate governance performance of different sectors. It gives an interesting observation that during P1, there is a significant difference between the sectors as the p value (0.006) is less than 0.05 but during P2, as the p value increases to 0.605, there is no significant difference between different sectors for their performance towards different stakeholders. Thus, HO2 is accepted for post reform period. It signifies when all sectors are making efforts to contribute towards different stakeholders, the sector differences reduce in post reform period. This is a positive impact of new corporate governance reforms on Indian companies.

Impact of corporate governance performance on financial performance

Table  7 presents the relationship between cumulative CGP score and six financial ratios using regression analysis. It is observed that CGP has positively and significantly influence on ROA, ROE and Tobin Q in P1 and only on PE in P2. Since the value of r 2 is low, only marginal variation in financial performance is explained by the model of corporate governance performance of Indian companies. The significant value of f stat helps to conclude that there is a significant relationship between corporate governance performance and different parameters of financial performance of Indian companies in P1. There is no significant impact of corporate governance on financial performance in P2. Thus, HO3 is rejected for P1 but accepted for P2.

Discussion, conclusion and policy implications

The study attempts to answer the following questions raised in the hypothesis:

Do reforms improve corporate governance in Indian companies?

All the companies under study have implemented good governance initiatives and recognized their responsibility towards different stakeholders. The introduction of corporate governance standards through clause 49 of listing agreement has helped in improving governance standards and internal efficiency of listed companies (Sharma and Singh, 2009 ; Goel & Mclver, 2015 ). Out of sixteen dimensions in corporate governance index, two dimensions did not show significant improvement. Indian companies need to pay attention on these dimensions namely, number of independent directors on board and achieving awards and recognitions during the year. The study finds that the number of independent directors as percentage of total directors has decreased over the period of time (Kaur and Misra, 2010 ). The reason may be attributed to shortage of qualified independent directors in India (Malik and Nehra, 2014 ; Rajharia and Sharma, 2014a , b ). Further, two positive changes identified in good governance practices, which are appointing women directors on board as required by new norms and instituting diverse board committees for protecting shareholders rights. These reforms aim at making the boards more powerful and focus on monitoring the management (Dharmapala and Khanna, 2013 ; Dua and Dua, 2015 ). Accordingly, it is observed that the number of meetings of board of directors has increased. Many companies have started conducted separate meetings of independent directors. This has increased the involvement of independent directors in different committees, which have made boards more responsible and accountable to stakeholders (Shivani et al. 2017 ; Khan, Muttakin and Siddiqui, 2013 ). It is observed that most of the companies are taking care of grievances of the employees and the customers. Yet, it is quite surprising that even some of the high revenue generating companies are not reporting the grievances as per the stipulated guidelines (Chatterjee, 2011 ).

As per the results of the study, though the spending on CSR initiatives has increased, yet Indian Companies are still trying to match the mandatory requirement of spending 2% of their profit on CSR initiatives (Sharma, 2013 ). Another interesting finding is that the score for social and environment initiatives is fairly high for all the companies, which suggests that Indian companies stress more on community welfare and environment protection in their social initiatives. This result is aligned with the previous studies done by Shanmugam & Mohamed ( 2011 ) and Kansal and Singh ( 2012 ). Kansal, Joshi, Babu and Sharma ( 2018 ) suggest that regulators should highlight specific disclosure norms for corporate social responsibility rather than giving only general mandatory guidelines. Many companies are working under public private partnership and with Non Government Organization (NGOs) to take up social and environment issues. However, reporting on pollution and carbon emission is very low for Indian companies (Kansal et al. 2018 ). It has been observed that frequency of publishing sustainability reports has improved over the period (Cyriac, 2013 ). Further, very few Indian companies are applying for internal quality, sustainability and environment protection awards as the procedure is cumbersome.

How do different sectors perform after governance reforms?

Oil, Power and Refinery sector showed consistent responsibility towards all stakeholders during P1. This sector is dominated by public sector enterprises, which warrants them to be more adherent to the mandatory norms. IT and Communication sector, with mostly private players, also performed reasonably well in P1. Most of the Indian companies in IT sector have multinational operations with business processes outsourcing model. Hence, it becomes imperative for them to follow international norms of corporate governance, sustainability and social responsibility (Narayanaswamy, Raghunandan and Rama, 2012 ). Thus this comprehensive reporting helps the companies in winning the international contracts and increase revenues. However, Palaniappan and Rao ( 2015 ) suggest IT companies have a long way to go to improve their corporate governance performance.

During P2, all the sectors showed significant improvement in corporate governance score. Specifically, Pharmaceutical and Chemical sector registered a substantial increase and are at the top of the table in the cumulative score. Transport and Auto sector is at the bottom of the list in both the time periods. Though, this sector shows a significant improvement in responsibility towards shareholders and employees yet it needs to take care of environment requirements and initiate more steps for welfare of the society. Further, Metal, Engineering and Infrastructure sector has the highest score for responsibility towards suppliers and consumers in both the periods under study but they need to stress on CSR reporting (Shamim, Kumar, Soni, 2014 ). For diversified sector, marginal improvement in the cumulative corporate governance score is recorded.

Another significant finding of the study is that in every sector the score of top four to five companies is relatively higher than the rest of the companies. This anomaly sometimes neutralizes the high score of top companies in a particular sector. To sum up, after the introduction of mandatory and non-mandatory norms for improving corporate governance, all the sectors have initiated different programs for stakeholders. This has reduced the difference in corporate governance score between the sectors in the post reform period. Similar findings were also reported by Bhasin ( 2012 ) and Bhardwaj and Rao ( 2014 ).

Do governance reforms impact financial linkage?

Total corporate governance score is a significant predictor of company’s market valuation and accounting performance. Positive direct association with Tobin q, ROA and ROE is captured in the period P1. Hence, the study concludes that better corporate governance performance leads to better financial performance in term of revenue and growth. Similar findings have been reported by earlier studies (Cortez and Cudia, 2011 ; Love and Klapper, 2002 ). In Japan, Bauer, Frijns, Otten, Rad ( 2008 ) find disclosures related to shareholders rights, remuneration and internal control, impact firm performance but disclosures related to board accountability do not affect stock prices. Studies conducted in Indian context also find a positive impact of corporate governance reforms on firm performance (Mohanty, 2003 ; Rajput et al., 2012 , Arora and Bodhanwala, 2018 ). Even in other developing economies like Pakistan, Ashraf et al. ( 2017 ); Arif and Syed ( 2015 ) find significant relationship between corporate governance and financial performance. However in Nigeria after the introduction or corporate governance norms, Sanda, Mikailu and Garba, ( 2005 ) report that presence of outside directors does not influence firm performance but the existence of expatriate Chief executive officers does. The regulatory authorities in Nigeria need to ensure strict compliance to improve the impact of reforms (Okoye et al., 2016 ). Mansur and Tangl ( 2018 ) find that after the introduction of governance code in Jordan, the presence of institutional investors in ownership structures help in improving firm performance in stock market.

However, an interesting finding for Indian companies is that after the introduction of the new governance reforms, the corporate governance performance improves but its impact on financial performance decreases. The study did not find any significant impact on market valuation ratios and accounting ratios in post reform period (Tripathi & Seth, 2014 ; Aggarwal, 2013 ). Hence, governance reforms actually do not impact financial linkages in Indian market during post reform period.

Conclusion and policy implications

This research concludes that Indian companies have made significant development in corporate governance after the introduction of recent reforms. Over all, it is observed that the main objective of the reforms has been achieved by making the board more responsible towards all stakeholders. The introduction of having at least one women director on board is a significant development for Indian companies. Regulators may further enhance women representation on board to improve gender parity at top management. Indian companies should appoint more number of independent directors as the role of independent directors becomes very significant for the successful implementation of these reforms. The target set for mandatory 2 % spending of net profits on CSR is still not achieved to full extent. Hopefully, in near future when the companies are able to identify the core areas of social responsibility, this Indian model can bring miracles for the development of the society. As a result, these philanthropic initiatives may yield better return on social investment. The mandatory publishing of business responsibility reports has improved disclosures for economic and social responsibility. Regulators should make disclosure of carbon foot prints mandatory to bring more awareness and responsibility towards environment. Initiating appropriate corporate governance rewards in different sectors would also encourage companies to follow the regulations and showcase their contribution towards society and environment.

All the sectors have endeavored to improve corporate governance performance as the investors have started recognizing good governance companies and this can also be used as a tool for attracting foreign investors. Government should try to address sector specific issues to raise the standards of performance. Although in light of these reforms, corporate governance has gained substantial ground in India, but this study does not find any significant impact of reforms on financial performance of the companies. As and when the corporate governance reforms are implemented in true spirit, the market sentiments would change and improve the relationship between corporate governance and firm performance in India similar to developed economies.

To cater to the problem of compliance and implementation of governance reforms in view of strong interference of bureaucracy and corruption in India, market regulators should be made more powerful and given a free hand to prosecute the companies involved in frauds. Also, high penalties should be imposed for non-adherence of mandatory requirements. Thus, the full implementation of governance reforms in India requires reforms to take place in larger context including political and legal systems. Moreover, the Indian companies need to understand the benefits of implementing good governance strategies and corresponding initiatives that help in improving financial performance as well.

This study has certain limitations. The annual reports have been reviewed multiple times to validate the reported aspects and achieve higher consistency while giving the rating score, still the subjectivity inherent in the rating scale remains a limitation. Additionally, financial data and corporate governance performance has been considered for two years and for top hundred companies only. Future study can extend this data for multiple years and investigate the relationship as a trend analysis for all ET500 companies. As the global investors are ready to pay premium to the companies who are investing in sustainable practices for stakeholders, even the domestic investors may also follow the same trend and attach more value to the well governed companies embracing corporate responsibility.

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Goel, P. Implications of corporate governance on financial performance: an analytical review of governance and social reporting reforms in India. AJSSR 3 , 4 (2018). https://doi.org/10.1186/s41180-018-0020-4

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• Corporate governance and social responsibility reforms
• Financial performance

Corporate governance and innovation: a theoretical review

European Journal of Management and Business Economics

ISSN : 2444-8494

Article publication date: 23 October 2018

Issue publication date: 3 October 2019

The purpose of this paper is to present a review of the literature on two lines of research, corporate governance and innovation, explaining how different internal corporate governance mechanisms may be determinants of business innovation.

Design/methodology/approach

It explores the theoretical background and the empirical evidence regarding the influence of both ownership structure and the board of directors on company innovation. Then, conclusions are drawn and possible future research lines are presented.

No consensus was observed regarding the relation between corporate governance and innovation, with both positive and negative arguments being found, and with empirical evidence not always pointing in the same direction. Thus, new studies trying to clarify this relationship are needed.

Originality/value

Over recent years, interest has grown in the influence of governance mechanisms on innovation decisions taken by the management. Innovation efforts and results depend on factors that are influenced by corporate governance, such as ownership structure or the functioning of the board of directors. Thus, the paper shows an updated state of the art in this field proposing future lines for empirical research.

• Corporate governance
• Ownership structure
• Board of directors

Asensio-López, D. , Cabeza-García, L. and González-Álvarez, N. (2019), "Corporate governance and innovation: a theoretical review", European Journal of Management and Business Economics , Vol. 28 No. 3, pp. 266-284. https://doi.org/10.1108/EJMBE-05-2018-0056

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Copyright © 2018, Diego Asensio-López, Laura Cabeza-García and Nuria González-Álvarez

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Introduction

Separation between ownership (shareholders) and control (management) and its relevance for company value and decisions makes it necessary to draw up management control mechanisms. This idea led to the appearance of the corporate governance concept, which has attracted great interest among academic researchers, especially as a result of certain financial scandals over recent years (Enron, Parmalat, WorldCom, etc.). According to Shleifer and Vishny (1997) , corporate governance can be understood as the set of mechanisms that align objectives and interests between the providers of finance and company managers so that the former have a degree of certainty against the risk they take by making their funds available to managers, and can try to avoid opportunistic behavior by the latter.

Governance mechanisms can be separated into internal ones (set up by the company itself) and external ones (linked to the different markets in which the company may be present). This study focuses on the former which are the most developed in Spain and have most often been linked to innovation. They include, on the one hand, ownership structure (degree of concentration and large shareholder identity) and, on the other, the board of directors and its functioning in association with certain characteristics (size, composition, etc.) such as the most important measures for overseeing the management ( Salas, 2002 ) and, as a result, for overseeing the decisions taken by the company regarding its performance and competitiveness.

In his two best-known books, Schumpeter (1934, 1942) claims that innovation is the main force for economic development. According to the Oslo Manual, the concept of innovation can be defined as “the introduction of a new or significantly improved product (good or service), or process, a new marketing method, or a new organisational method in business practices, workplace organisation or external relations” ( OECD, 2005 , p. 56). Most of the literature focuses on two methods for measuring innovation, the most common being to consider inputs (any efforts made by the company to be more competitive and more innovative, which are usually represented either by expenditure on Research and Development (R&D) as a percentage of the company’s total sales, or by the number of people involved in R&D activities as a percentage of the company’s total employees) and outputs (the result of the innovative activity measured as the number of patents registered or in process of registration by the company).

Although most of the prior studies have tried to analyze the influence of governance on company performance and value, others (some recently) have shown that corporate governance is one of the main determinants for innovation and technological change ( Tylecote and Visintin, 2007 ). Over recent years, interest has grown in the influence of governance mechanisms on innovation decisions taken by the management ( Tribo et al. , 2007 ; Wu, 2008 ; Latham and Braun, 2009 ; Belloc, 2012 [1] ; Block, 2012 ; Balsmeier et al. , 2014 ; Zhang et al. , 2014 ; Tsao et al. , 2015 ). Amongst others, these authors argue that innovation efforts and results depend on factors that are influenced by corporate governance, such as ownership structure, shareholder identity or the functioning of the board of directors.

In this context, the purpose of this study is to link these two fields of research by reviewing the literature (from the late 1980s until today, and including both Spanish and international journals). The ultimate aim is to find out the state of the art in this field and thus to propose future lines for empirical research. The paper is therefore organized as follows: second and third sections present the relation between ownership structure and the board of directors and business innovation, respectively, adding theory on the influence of one on the other and providing empirical evidence to corroborate the relations described. Finally, the fourth section draws conclusions from the review, points out some limitations and suggests possible lines for future research.

Ownership structure and innovation

Ownership structure is one of the main mechanisms for corporate governance ( Shleifer and Vishny, 1997 ; La Porta et al. , 1998, 2000 ) so we review its influence on innovation, distinguishing between two aspects – ownership concentration, and the identity of the main owners [2] .

Ownership concentration and innovation

The prior literature includes arguments supporting both a positive and a negative relation between ownership concentration and R&D activities [3] . An initial argument on a negative relation lies in greater risk aversion. Ownership concentration and combined ownership and management may reduce the pressure that external investors or other supervisors exert on managers in their control of financial statements, information transparency and strategic renewal ( Carney, 2005 ). Agency theory ( Jensen and Meckling, 1976 ; Fama and Jensen, 1983 ) claims that owners or managers become more risk averse as their share in the company capital grows ( Beatty and Zajac, 1994 ; Denis et al. , 1997 ). This is because it is often difficult for them to diversify their risk so they become more conservative and carry out fewer R&D activities. In addition, concentrated ownership can lead not only to risk aversion but also to a lack of willingness to participate in activities for strategic change, such as innovation, because this involves short-term expenditure on R&D while any possible returns would only appear in the long term ( Hill and Snell, 1988 ; George et al. , 2005 ).

Another argument that may explain the negative relation between ownership concentration and innovation is the conflict between minority and large shareholders which results from limited legal shareholder protection in some countries ( Young et al. , 2008 ). High concentration may allow owners to use the company’s resources to maximize their own private benefits ( Su et al. , 2007 ), at the expense of the minority shareholders, instead of performing profitable activities, such as innovation, that would benefit everyone.

In line with the above arguments, there are studies that support this negative relation for Italy ( Battaggion and Tajoli, 2000 ), Spain ( Ortega-Argilés et al. , 2005 ; Ortega-Argilés and Moreno, 2009 ), Switzerland ( Brunninge et al. , 2007 ) and Germany ( Czarnitzki and Kraft, 2009 ). Outside Europe, other results also back this idea for Canada ( Di Vito et al. , 2008 ) and China ( Chang et al. , 2010 ; Zeng and Lin, 2011 ). Moreover, as suggested by Ortega-Argilés and Moreno (2009) , not only ownership concentration but also the inclusion of owners in management tasks and decision-making could lead to a drop in risky projects because they are less specialized in the patent system and have fewer technical skills.

On the other hand, a positive relation between ownership concentration and innovation is suggested because large owners are likely to be more concerned about the market value of the company and more motivated to invest in projects that are expected to generate value ( Baysinger et al. , 1991 ; Lee, 2005 ; Belloc, 2012 ). When ownership is concentrated in just a few hands, it is likely to prevent incorrect use of investment funds by the management ( Ortega-Argilés et al. , 2006 ). A small number of large shareholders may prefer to make long-term investments in R&D in order to increase company stability instead of focusing on their own profits. Some empirical studies show that ownership concentration has a positive effect on innovation ( Hill and Snell, 1988 ; Baysinger et al. , 1991 ; Lacetera, 2001 , for the USA; Di Vito et al. , 2008 for Canada; Munari et al. , 2010 , for Europe).

There have also been some studies supporting a two-way relation between ownership concentration and innovation, depending on the countries studied. For example, Lee and O’Neill (2003) conclude that an increase in ownership concentration is positively related to R&D expenditure in US companies, but not in Japanese companies. On the other hand, in a study on companies in France, Germany, Italy (all countries with high ownership concentration) and the USA and UK (where ownership is more dispersed), Hall and Oriani (2006) found that in France, Germany, UK and US investment in R&D is positively related to market value, and that in Italy and France only companies with no large shareholders were positively valued in the market for their R&D expenditure.

In addition, some empirical studies show that the relation between concentration and innovation might not be linear. Denison and Mishra (1995) argue that large shareholders have a vision that strengthens long-term success but, since they have a large share in the capital they are more risk averse, which causes a negative effect on R&D investment. So, if the risk aversion of large shareholders predominates, ownership concentration will have a negative effect on innovation but if a long-term vision predominates, the effect will be positive. Shapiro et al. (2015) explain this non-linear relation between the two variables by the hypotheses of alignment of interests and of entrenchment or opportunism, which results in an inverted U-shape relation, as found by Chen et al. (2014) . Alignment of incentives may mean that at low levels of concentration, shareholders are more concerned about decisions that will create value in the company, such as innovation. Concentrated ownership dominated by large shareholders, on the other hand, may encourage the latter to divert resources at the cost of minority shareholders, especially when the latter’s rights are not well protected ( La Porta et al. , 2000 ; Hess et al. , 2010 ), and this self-interested behavior may have a negative effect on R&D expenditure ( La Porta et al. , 2000 ).

Cho (1998) , however, states that the relation between corporate ownership and innovation activity may work both ways. He argues that ownership structure affects R&D expenditure, which affects company value, which in turn affects ownership structure. Other studies do not analyze a direct relation between ownership concentration and innovation but consider that the former may moderate another existing relation. For example, Tsao and Chen (2012) find that cash flow control by owners positively moderates the relation between internationalization and innovation in the company, while the entrenchment effect that arises from the diverging interests between control and cash flow rights may negatively moderate this relation. Other studies propose that R&D expenditure may mediate in the relation between ownership concentration and business performance ( Zhang et al. , 2014 ).

In summary, regarding ownership concentration, although the empirical evidence is not conclusive, from a theoretical point of view and in line with what has been found in other prior studies, it seems reasonable to expect an inverted U relation between concentration and innovation. For low levels of ownership, what predominates is the incentive alignment effect and the fact that innovation may help create value. On the other hand, at greater levels of concentration and especially in countries with less protection for minority shareholders, risk aversion and the incentive to obtain private benefits from control may result in a negative relation. Moreover, the fact that the causality in the relation is not clear makes it necessary to control for endogeneity in any estimation.

Large shareholder identity

We describe below the different identities of large shareholders (institutional investors, bank owners, state ownership, non-financial entities, foreign investors, individual investors, family ownership and manager ownership) and how they relate to innovation.

Institutional investors

Institutional investors may lead to a lower level of innovation, because they tend to be short-sighted, looking only for short-term profits. They value these more than long-term profits ( Kochhar and David, 1996 ) because access to specific company information is not readily available to them, which in turn makes it difficult for them to evaluate the company’s value in the long term ( Porter, 1992 ). They may prefer to benefit only from share price rises and drops even if such changes are only short-lived ( Loescher, 1984 ). A consequence of this preference for investing in the short term is that managers may also set this time line when taking decisions ( Kochhar and David, 1996 ). Also, since managers want to minimize threats of acquisition, which would leave them without a job ( Walsh, 1989 ), they may have incentives to reduce the risk of long-term investments in, for example, innovation activities ( Hayes and Abernathy, 1980 ). Institutional ownership may also pressure managers to report profits in the short term, especially in loss-making companies ( Graves and Waddock, 1990 ). This reduces their interest in entrepreneurial activities, especially R&D investment and the development of new internal products, which involve a high level of risk and only bring returns in the long term ( Hill et al. , 1988 ).

In line with these ideas, Graves (1988) showed a negative relation between institutional ownership and R&D expenditure. David et al. (2001) argued that institutional investors are not positively associated with R&D inputs, and Kochhar and David (1996) suggest that institutional ownership is negatively associated with the new product ratio, even though the relation is not statistically significant.

There may also be a positive relation between the two variables. Because of their wealth, institutional investors can obtain economies of scale in investment projects, so they have more market knowledge than individual investors ( Black, 1992 ). They may therefore have the necessary incentives for carefully evaluating the possible benefits of long-term investments rather than short-term gains from price fluctuations ( Kochhar and David, 1996 ). And, since it is not easy for them to diversify their investment in the short term, they might encourage managers to make long-term investments ( Kochhar and David, 1996 ). Another argument in support of a positive relation was made by Aghion et al. (2009) . Institutional owners have greater incentives and supervisory capacities than other owners. This increased oversight protects managers from the consequences of a failed R&D project which might affect their reputation so institutional ownership can be said to reassure managers about their future job stability. In line with the above arguments Baysinger et al. (1991) and Hansen and Hill (1991) find that institutional investors have a positive effect on R&D expenditure by companies. Similarly, Aghion et al. (2009) for the USA and Choi et al. (2011) for China conclude that the presence of institutional ownership increases the number of registered patents.

Bank ownership

Banking entities maintain trade relations with the companies in which they invest, often providing loans and credits ( Kroszner and Strahan, 2001 ). This exposes banks to uncertainty on the returns on R&D investments. In addition, the presence of banks encourages companies to increase their capital by borrowing ( Petersen and Rajan, 1994 ). The greater the debt, the greater the risk and the greater the importance of distortions generated by debt in investment decisions. One of them is short-term investment ( Grinblatt and Titman, 1998 ), which may hold back investments in R&D which are mainly for the long term ( Hoskisson et al. , 1993 ).

However, the empirical evidence is not conclusive because some studies support a negative relation ( Tribo et al. , 2007 ; Xiao and Zhao, 2012 ), some find the opposite ( Sherman et al. , 1998 ; Miozzo and Dewick, 2002 ; Lee, 2005 ) and some find no significant relation ( Kochhar and David, 1996 ).

State ownership

A positive relation might be expected between state ownership and innovation. Governments have an important role to play in developing innovation because they provide resources for creating new technologies ( Amsden, 1992 ; Haggard, 1994 ). Some authors argue that they have positive effects on company performance in both advanced countries ( Kole and Mulherin, 1997 ) and countries that are in an economic transition ( Sun et al. , 2002 ). State-run companies have significant incentives and access to important infrastructure that facilitates innovation ( Chang et al. , 2006 ). In some studies, however, the influence of state ownership on performance and business decisions is found to be negative (e.g. Vickers and Yarrow, 1991 ; Dewenter and Malatesta, 2001 ). A double agency relationship or the existence of political objectives going beyond profit maximization are possible explanations.

The empirical evidence, therefore, is not conclusive. Miozzo and Dewick (2002) conclude that, in the case of Denmark, the government plays an important role in stimulating innovative projects through collaboration. For China, Chen et al. (2014) , Choi et al. (2011) and Zeng and Lin (2011) maintain that the State is positively related to innovation outputs or inputs. However, in an international study, Xiao and Zhao (2012) conclude that state-controlled banks have a negative effect on business innovation, especially in small companies. But neither Choi et al. (2012) nor Munari et al. (2010) find a significant relation.

Non-financial entities

Unlike banks, non-financial companies rarely have credit relations with the companies they control ( Kroszner and Strahan, 2001 ; La Porta et al. , 2006 ). This reduces the degree of risk in debt, avoids investment inefficiencies such as the above-mentioned short-term investment bias, and encourages investment in R&D. Also, non-financial companies are more likely to recognize the importance of R&D in market success. Reciprocal trade relations and synergies between the company and its owner can be expected to encourage investment in R&D ( Jaffe, 1986 ). By investing in R&D, controlled companies can improve their absorption capacity ( Cohen and Levinthal, 1990 ). Sometimes, owners invest strategically in R&D-intensive companies with the intention of delegating to them some of their own investments in R&D, which would thus become more efficient. Large companies invest in starting up others, give them incentives to invest in R&D and, if such new companies are then successful, the large companies include them in their own division to improve their own investments in R&D ( Gompers et al. , 2008 ). Tribo et al. (2007) corroborate these ideas for Spain because their results suggest that non-financial companies have a positive impact on R&D investments.

Foreign investors

Foreign partners provide companies with advanced techniques, knowledge and management resources in addition to funding. According to Choi et al. (2011) there are three reasons for a positive relation between foreign ownership and innovation. First, foreign investment by multinationals tends to focus on the domestic market for their main business. This requires a competitive technological advantage over other domestic companies ( Johanson and Vahlne, 1977 ; Chang, 1995 ) and the foreign companies are taken as the model for developing technological and innovation capacity. Second, foreign partners can help companies step up their R&D efforts by means of advanced transfer of technological resources. Finally, foreign investors also encourage their domestic partners to invest in technological development by using their own shares ( Chang et al. , 2006 ).

The empirical evidence corroborates the positive relation in the European context ( Love et al. , 1996 for Scotland, Kostyuk, 2005 for Ukraine), in China ( Chen et al. , 2014 ; Choi et al. , 2011, 2012 ) and Korea ( Lee, 2012 ). Similarly, for the USA Francis and Smith (1995) argue that foreign ownership reports a significantly larger number of patents granted than companies with dispersed ownership.

Individual investors

There can be both a positive and a negative relation between individual investors and R&D. On the one hand, supervision is enhanced when the main individual shareholders are present because they offer more points of view. Also, the stakes of large individual shareholders represent a significant proportion of their wealth so they have incentives to supervise and this may have a positive effect on R&D. On the other hand, agreements on long-term investment projects are more difficult to reach when there are numerous large investors ( Hoskisson et al. , 2002 ). The empirical study performed by Tribo et al. (2007) for Spain did not find a significant relation, whereas Baysinger et al. (1991) conclude that the positive effect of ownership concentration on R&D expenditure can be attributed more to the impact of institutional rather than individual investors.

Family ownership

Families have better access to information and focus more on longer time frames than non-family shareholders ( Anderson and Reeb, 2003 ; Brenes et al. , 2011 ). Family owners have an information advantage over minority shareholders and are better able to understand the value and risks involved in R&D projects. With their longer-term horizon, families see their company as an asset to be passed on to their descendants rather than as wealth to be consumed during their lifetime. Also, this longer time horizon allows family owners to tolerate an increased deficit if it encourages the managers and directors to participate in R&D investment strategies. On the other hand, family owners tend to be large shareholders whose wealth is tied up in their companies, so it is difficult for them to diversify their risks ( Tsao et al. , 2015 ). So, since R&D projects are intrinsically risky, family enterprises may prefer to invest less in R&D ( Anderson et al. , 2012 ).

The empirical evidence is not conclusive. For the USA, Francis and Smith (1995) reach the conclusion that family-owned enterprises hold significantly more patents than companies with multiple owners. For Korea, Yoo and Sung (2015) find that family control is positively related to R&D intensity, especially when there are few opportunities for growth. Along the same line, for Taiwan Tsao et al. (2015) conclude that family companies invest more in R&D. In European countries, Munari et al. (2010) argue that family ownership is negatively and significantly related to R&D investment. Similarly, for China, Choi et al. (2011) suggest that family ownership leads to a smaller number of registered patents, and Chrisman and Patel (2012) find that families generally invest less in R&D than non-family companies adding that, when performance is worse than expected, their views change and they increase their investments in R&D more than non-family companies.

Other studies suggest that the effect is different depending on whether the company is in the hands of the founder or of the descendants. For the USA, Block (2012) finds that founder-led companies have a positive effect on both R&D expenditure intensity and productivity, but that when they are in the hands of descendants, the effect changes to neutral or even negative. In their analysis of Korean companies, Choi et al. (2015) find that the relation is positively moderated by growth in opportunities. Their results indicate that a family-run company generally invests less in R&D but, when performance drops below what was expected, prospects change to the extent that family-run companies increase their investments in R&D more than non-family companies. The relation is not the same for all companies, being weaker in large family-run business groups where family control is more secure.

Finally, family ownership may be a moderating variable for other relations. For example, Kim et al. (2008) find that family ownership has a positive moderating effect on the relation between financial slack and R&D investment, and Tsao et al. (2015) conclude that it positively moderates the relation between R&D investment and CEO remuneration.

Management ownership

Management ownership helps reduce agency problems between shareholders and managers and the fact that managers have greater voting power guarantees their job stability so also reduces their risk aversion ( Cho, 1992 ). When managers hold shares in the company they are more likely to take decisions that will maximize shareholder profit, such as R&D investment ( Hill and Snell, 1988 ; Latham and Braun, 2009 ).

However, the empirical evidence on the one hand suggests the relation may be both positive ( Hill and Snell, 1988 ; Francis and Smith, 1995 ) and negative. Latham and Braun (2009) argue that the relation between organizational decline and innovation is moderated by management ownership. That is, when managers face a loss of their wealth or job security, they cut back any risky actions, which leads to a drop in innovation activities. Greater ownership leads managers to adopt behavior that is more in line with the rigidity model, significantly holding back investment. However, in some cases, no statistically significant relation is found ( Lacetera, 2001 ; Choi et al. , 2012 ).

So, regarding the influence of the main shareholder’s identity on business innovation, it seems that, in line with the theory, a company is more likely to carry out innovation activities if the largest shareholder is a long-term institutional investor, a non-financial entity or a foreign investor. In companies run by a family or individuals, if they have sufficient resources or a situation in which they can afford to carry out risky activities (such as innovation) without placing their future at risk, innovation activity can be expected to be more intense. This is also the case if the company is under the control of its founder rather than descendants, in which case business performance is usually worse and there is greater conflict over decisions ( Blumentritt et al. , 2013 ). In the case of companies in which the State has a significant stake, the problems of State-Owned companies may predominate (such as a double agency relation, soft budgetary restrictions, distorted objectives, etc.), which may affect decisions to create value. Along these lines, some studies suggest that product and service innovation increases after privatization ( Antoncic and Hisrich, 2003 ). Finally, when managers hold a stake in the capital, they will align their interests with those of the owners, thus encouraging value-creating decisions on, for example, innovation.

Boards of directors and innovation

The board of directors provides a formal link between the owners and those in charge of the day-to-day running of the company, and is described as the top body for control decisions within corporate governance ( Fama and Jensen, 1983 ; Adams et al. , 2008 ). Although the literature, especially in the fields of finance and business management, shows that the board plays a crucial role in the relation between corporate governance and strategy, the evidence on the relation between the board and innovation by companies is limited ( Balsmeier et al. , 2014 ). As far as we know, Baysinger et al. (1991) were the first to analyze the link between certain board characteristics and innovation, and concluded that there is a positive link between the proportion of internal board members and R&D expenditure per employee. Since then, the literature has gradually shown how other board characteristics may also influence companies’ innovation activities. These include composition ( Baysinger et al. , 1991 ; Hoskisson et al. , 2002 ; Kor, 2006 ; Brunninge et al. , 2007 ; Balsmeier et al. , 2014 ), size ( Lacetera, 2001 ; Adams et al. , 2008 ; Driver and Guedes, 2012 ), directors’ educational level ( Escribá-Esteve et al. , 2009 ; Barroso et al. , 2011 ; Dalziel et al. , 2011 ), board meeting frequency ( Chen and Hsu, 2009 ; Wincent et al. , 2010 ) and CEO duality ( Lhuillery, 2011 ).

An essential aspect of boards is their composition. On the one hand, external directors can reconcile differences on the board, evaluate whether independent agendas fit in corporate routines and reduce potential agency conflicts ( Yoo and Sung, 2015 ). This type of director plays two important roles in a firm. First, their independence places them in a better position to supervise management ( Rosenstein and Wyatt, 1990 ; Peng, 2004 ; Brunninge et al. , 2007 ). Second, external directors, such as bankers or politicians, have different assets to offer or represent important interest groups ( Adams et al. , 2008 ).

This type of director also plays an essential role in the acquisition of specialist knowledge, as do their networks for speeding up knowledge transfer ( Westphal, 1999 ). Company expansion through external directors can help to attract funds and to improve its learning experience for innovation activities ( Fried et al. , 1998 ). So external directors can be expected to help promote strategies that will boost shareholder wealth, including R&D investments ( Kosnik, 1987, 1990 ). And when external directors work in close collaboration with companies, they can give not only new strategic guidelines but can also provide information and advice during a process of change because of their personal contacts linking the company with important elements in its environment ( Borch and Huse, 1993 ). They can be agents for the acquisition of resources ( Goodstein and Boeker, 1991 ; Kim and Kim, 2015 ) and can improve the organization’s reputation ( Hung, 1998 ; Johannisson and Huse, 2000 ), facilitating external conditions for change or innovation actions.

In line with the above arguments, Brunninge et al. (2007) and Shapiro et al. (2015) find that the presence of external directors has a positive effect on strategic changes, including innovation. Similarly, for Germany Balsmeier et al. (2014) find that external directors with experience who sit on the boards of technological companies have a positive and significant effect on applications for patents in the companies which they advise and supervise.

However, the monitoring and advice that can be expected from external directors is not always positive for R&D investment ( Yoo and Sung, 2015 ). These authors state that the main role of such directors is not to promote R&D activities but to discipline the strategic decisions taken by main shareholders. They thus become cautious and, as a result, may unwittingly affect long-term performance and discourage certain business strategies because they do not have access to all the information available on strategic decisions so base their approval on the available financial information ( Lorsch and Young, 1990 ).

Internal directors, on the other hand, may be more likely to adopt new strategies for new product development because they know more about such products so do not perceive so much uncertainty ( Hill and Snell, 1988 ; Hoskisson et al. , 2002 ). Baysinger et al. (1991) conclude that senior executives may be more prepared to invest in risky R&D projects if they are well represented on the boards because they are less dependent on the opinions and evaluations of external directors and because the proportion of internal directors has a positive effect on the R&D expenditure of large enterprises. On the other hand, Hayes and Abernathy (1980) and Baysinger and Hoskisson (1989) argue that when companies emphasize financial goals instead of strategic control for evaluating managerial performance, they tend to prefer short-term strategies instead of long-term projects. Also, if senior executives are penalized for adopting strategies involving poor returns, they will be more reluctant to invest in risky R&D projects [4] .

Regarding the type of innovation and in comparison with external directors, internal directors may prefer internal innovation (new product development) to external innovation (acquisition) because of the uncertainty inherent in the latter. Also, external directors may find it difficult to evaluate the efficiency of strategic decisions ( Mizruchi, 1983 ; Lorsch and Young, 1990 ), including product development. Holmstrom (1989) argues that external directors may favor the external acquisition of innovation, in which case evaluation may be based on financial criteria because decisions do not require full understanding by the companies involved. In fact, the empirical evidence suggests that companies that carry out control based on financial information tend to favor external innovation ( Hitt et al. , 1996 ; Hoskisson et al. , 2002 ).

For another board characteristic, that of size, both a positive and a negative relation with innovation are possible. On the one hand, a larger number of directors increases the overall experience, information and advice that the company can resort to ( Goodstein et al. , 1994 ; Haynes and Hillman, 2010 ). It also offers more links with the external environment and, probably, more resources ( Jackling and Johl, 2009 ), because more directors increase the company’s access to a greater number of external resources, including the technological and financial ones that are essential for innovation ( Shapiro et al. , 2015 ). Therefore, a large board of directors can improve a company’s capacity to deal with uncertainty in the environment and can increase links with other partners ( Pfeffer and Salancik, 2003 ).

An alternative view suggests that a larger board may prevent it from being effective in its strategic decisions because, for example, there is greater diversity of opinions which may lead to conflict and mistrust among directors ( Amason and Sapienza, 1997 ), and to difficulties for meeting frequently or for coordinating different points of view ( Goodstein et al. , 1994 ; Yermack, 1996 ; Ruigrok et al. , 2006 ).

Regarding the empirical evidence, for Taiwan, Chen (2012) finds that R&D investment is negatively related to board size. But for the UK, Driver and Guedes (2012) do not find evidence of a significant impact of board size on R&D expenditure. Similarly, for China, Shapiro et al. (2015) obtain results indicating the board size has no impact on the introduction of new patents.

The educational level of board members determines their abilities and level of knowledge ( Barroso et al. , 2011 ). The highest educational levels are characterized by greater cognitive complexity ( Wally and Baum, 1994 ), leading to a greater capacity for grasping new ideas ( Barker and Mueller, 2002 ), adopting new behavior, defining problems better and searching for creative solutions to complicated problems ( Bantel and Jackson, 1989 ). Bearing in mind that R&D projects are complex, directors with a higher educational level may be more receptive to innovation ( Barroso et al. , 2011 ; Dalziel et al. , 2011 ). They may be able to take new technologies on board ( Lin et al. , 2011 ), acquiring new knowledge and processes, analyzing information much more precisely ( Escribá-Esteve et al. , 2009 ) and developing new methods for solving problems ( Wincent et al. , 2010 ). So, companies whose board members have a higher educational level will have a more thorough understanding of R&D processes and of external environments, so will be better equipped to implement R&D activities, in line with the findings of Chen (2012) and Lacetera (2001) .

In addition, more frequent board meeting allow directors to devote more time and effort to the company strategy and to business operations, sharing their experience, knowledge and judgment. This would provide more critical information and valuable resources ( Forbes and Milliken, 1999 ) for advising the management team on important matters for the company while reviewing the main strategic actions ( Haynes and Hillman, 2010 ). More frequent meetings are likely to result in a more efficient board ( Vafeas, 1999 ) and better governance ( Chiang and He, 2010 ) and are likely to be valuable for building and developing a network of relations among members ( Gabrielsson and Winlund, 2000 ). Such relations among directors may facilitate access to necessary resources (capital, information, talent, etc.), thus reducing the risk of a shortage of resources for R&D ( Chen and Hsu, 2009 ).

Also, frequent board meetings may give members a better understanding of R&D activities. In meetings they can develop alternative strategies, reducing uncertainty and therefore leading to a greater probability of success in innovative activities ( Wincent et al. , 2010 ). However, the results found by Chen (2012) do not support this positive relation between meetings and innovation.

Finally, the distinction between the roles of directors and of managers is clearest when the positions of President of the Board and CEO are separate ( Fama and Jensen, 1983 ), this being known as the absence of duality. Supervision by the board may clearly influence the impact of risk-taking by the CEO ( Hambrick and Finkelstein, 1987 ; Crossland and Hambrick, 2007 ). When a single person holds several positions (President of the Board and CEO), agency problems arise because of information asymmetries between the CEO and the board. Prior studies suggest that duality leads to unfavorable results for shareholders ( Hambrick and D’Aveni, 1992 ; Boyd, 1994 ; Webb, 2004 ; Petra and Dorata, 2008 ) or may lead to decisions to protect the wealth of all the stakeholders in the company being set aside ( Sahin et al. , 2011 ). On the other hand, the separation of these positions may reduce tension between the management and the board, and it is more likely that the President will adopt decisions with long-term potential and within economic and social benefits such as R&D investments ( De Villiers et al. , 2011 ). In line with this, Zhang (2012) also argues that separation of these positions may mean that not only shareholders’ interests are taken into account but also those of other stakeholders.

Against these arguments, for France, Lhuillery (2011) indicates that certain board practices that address shareholders, such as duality, may individually have a positive influence on R&D investments in line with the results also found by Driver and Guedes (2012) for the UK.

In summary, the relation between a company’s innovation and certain characteristics of its board seems clear from a theoretical point of view, with a positive effect expected the higher the educational level of board members, the number of board meetings and the lack of duality or accumulation of positions. However, in the case of board composition and size, the final influence on the degree of innovation will depend on compliance by the company with recommendations in codes of good governance.

Conclusions

This paper first carried out a theoretical review of the influence of ownership concentration and of different types of owner on innovation. It was noted that neither the theory nor the empirical evidence are conclusive for establishing a relation between these variables, because different authors find different results depending on the sample, country or firms studied. Second, no consensus was observed regarding the relation between board composition and innovation, with both positive and negative arguments being found, and with empirical evidence not always pointing in the same direction.

Although in recent years many researchers have been focusing on this field of study, a more consistent explanation still needs to be found for these relations. Also, since the empirical evidence is not extensive, most prior studies have analyzed the influence on innovation of the degree of ownership concentration ( Cho, 1998 ; Ortega-Argilés et al. , 2005 ; Brunninge et al. , 2007 ; Czarnitzki and Kraft, 2009 ; Shapiro et al. , 2015 ) or the identity of the main shareholders ( Hill and Snell, 1988 ; Kochhar and David, 1996 ; Lacetera, 2001 ; Xiao and Zhao, 2012 ; Yoo and Sung, 2015 ; Tsao et al. , 2015 ). But there have been fewer studies considering how one of the main governance mechanisms, that is, the board of directors, relates to innovation actions ( Wu, 2008 ; Driver and Guedes, 2012 ; Balsmeier et al. , 2014 ).

For these reasons, future research could focus on the influence of the board of directors on innovation for Spanish firms, a subject not yet studied in depth because, while Tribo et al. (2007), Ortega-Argilés et al. (2005) and Ortega-Argilés and Moreno (2009) use samples of Spanish firms, they only consider ownership structure as a determinant of innovation. In addition, Hernández et al. (2010) , using a sample of 86 Spanish quoted companies in technology companies, show how the ownership structure can moderate the relationship between board composition and R&D investments. Thus, it might be of interest to analyze how board characteristics and functioning may delimit innovation at both input and output level, focusing on the board characteristics that have traditionally been considered (composition, size, meetings, duality). 98.5 percent of Spanish listed firms have a majority of external directors on their boards ( CNMV, 2016 ) to comply with the code of good governance. Thus, if they see innovation as a strategic tool and also receive advice from internal members, they can be expected to carry out more innovation, especially by means of external acquisition. Similarly, in line with the Spanish good governance code, the average size of the board in Spanish firms is 9.8 members ( CNMV, 2016 ). This is not very large and is likely to reduce conflicts between board members and minimize problems of coordination, so there may be a positive effect according to innovation theory. Considering that the theory supports a positive effect, and the fact that the average number of meetings per year of Spanish listed firms is 10.6 (higher than the recommended figure), it can also be expected that during such frequent meetings, decisions on innovation will be taken. 54.7 percent of Board Presidents are also CEOs of their companies ( CNMV, 2016 ) so, since the positions are combined in almost one half of Spanish companies, a negative effect on innovation can be expected in Spain. However, other newer variables could be considered such as diversity within the board (gender, educational background, nationality, tenure, etc.), with analysis of the role played by another of the bodies with great influence, the management team (socio-demographic and psychological characteristics, type of management style, culture, values, etc.) on business innovation.

In addition, it might be possible to include moderating variables in the existing models. For example, in line with the study by Choi et al. (2015) (in the case of family firms), it might be of interest to consider whether growth opportunities moderate the relation between board characteristics and innovation.

Another possible line of research would involve a set of analyses to establish differences by country, depending on the type of legal system to which they are subject. Various studies have shown that a country’s legal origin and its impact on investor protection and financial development influence a variety of economic aspects including financial markets, labor and competitiveness, and therefore allocation of resources ( La Porta et al. , 2008 ). For example, Common Law countries afford greater protection for shareholders than Civil Law countries, which affects the development of governance mechanisms and might determine the innovation strategy. Such greater protection in the case of Common Law countries might reduce one of the negative effects of concentration on innovation. On the other hand, Spain has traditionally been classified as having a bank-based financial system because of the importance traditionally placed on the stakes held by banks in business capital. Spanish listed companies are characterized by high shareholder concentration and high levels of borrowing, mostly from banks. Regarding ownership structure, control is usually exerted by families, followed in importance by financial entities ( Sacristán and Cabeza, 2008 ). On the other hand, in systems based on capital markets, it is the latter that mostly allocate funds because firms request long-term funding from them while the banking system usually supplies short-term funds. Moreover, in this model, usually associated with countries such as the UK and the USA, ownership is dispersed ( Sacristán and Cabeza, 2008 ). While banks can paralyze innovation by extracting informational income and protecting established firms ( Rajan, 1992 ), markets are more likely to promote innovative, R&D-based industries ( Allen, 1993 ). It is for this reason that higher levels of innovation can be expected in countries with a market-oriented governance model.

In order to achieve the above-mentioned objectives in our country, a sample of Spanish non-financial listed companies over recent years could be used. The data could be taken from the SABI database and from companies’ annual corporate governance reports and annual reports which have to be filed with the National Stock Exchange Commission and posted on their websites. Information on management teams can be found on the internet, in documentation provided by companies, the “Who’s Who” directory, etc.

For Europe, the Amadeus (Bureau van Dijk) database could be used. This contains business and financial information on the 510,000 largest European enterprises, and searches can follow different criteria. It contains data on ownership structure, the stakes held by the different shareholders, direct or indirect ownership, and information on the ultimate owner. It also provides financial data (such as annual accounts), from which it would be possible to extract information on R&D expenditure.

The methodology to be used could be panel data analysis and, more specifically, the generalized method of moments, which affords two advantages. First, since information is available for various time periods, it is possible to control the individual effect or the unobservable heterogeneity of the firms by first differences. Second, it helps to mitigate endogeneity by avoiding bias in the ordinary least square regression coefficient when the error term is correlated with any of the explanatory variables by means of instrumental variables (lags).

Finally, regarding the limitations of this study, although the literature review is as thorough as possible, it is possible that some studies may have been omitted. Also this study does not have an empirical part allowing for the relations considered to be tested in future lines of research. Similarly, we are aware that for future research, performing empirical studies related not so much to the amount but more to the quality of corporate governance would face the added difficulty of how to obtain such information.

As far as we aware, Belloc (2012) is the only review of the literature that adopts a similar approach to this one although its presentation of prior empirical studies is less extensive than ours. More specifically, we give a more detailed review of the influence of ownership on innovation, making an explicit distinction according to the different identities of the main or largest shareholder. Also, unlike Belloc (2012) , who focuses on ownership structure and on some of the external control mechanisms, we analyze the relation between another of the main internal governance mechanisms, the board of directors with its different characteristics and firms’ innovation activity.

Some studies consider a corporate governance index rather than specific ownership measures as an explanatory variable. For example, Chiang et al. (2011) conclude that high levels of corporate governance control (a single construct made up of board size, independent directors, owner identity or the difference between control rights and cash flow) are positively linked to the technical and economic success of R&D activities but have no significant influence on commercial success.

Some studies, however, do not support a significant relation between ownership concentration and innovation ( Choi et al. , 2011 ).

Other studies do not find that the presence of managers on the board has a significant effect on R&D intensity ( Lacetera, 2001 ).

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The Making and Meaning of ESG

U of Penn, Inst for Law & Econ Research Paper No. 22-23

European Corporate Governance Institute - Law Working Paper No. 659/2022

Harvard Business Law Review, Forthcoming

53 Pages Posted: 15 Sep 2022 Last revised: 8 Apr 2024

Elizabeth Pollman

University of Pennsylvania Carey Law School; Co-Director, University of Pennsylvania Carey Law School - Institute for Law and Economics; European Corporate Governance Institute

Date Written: October 31, 2022

ESG is one of the most notable trends in corporate governance, management, and investment of the past two decades. It is at the center of the largest and most contentious debates in contemporary corporate and securities law. Yet few observers know where the term comes from, who coined it, and what it was originally aimed to mean and achieve. As trillions of dollars have flowed into ESG-labeled investment products, and companies and regulators have grappled with ESG policies, a variety of usages of the term have developed that range from seemingly neutral concepts of integrating “environmental, social, and governance” issues into investment analysis to value-laden notions of corporate social responsibility or preferences for what some have characterized as “conscious” or “woke” capitalism. This Article makes three contributions. First, it provides a history of the term ESG that was coined without precise definition in a collaboration between the United Nations and major players in the financial industry to pursue wide-ranging goals. Second, it identifies and examines the main usages of the term ESG that have developed since its origins. Third, it offers an analytical critique of the term ESG and its consequences. It argues that the combination of E, S, and G into one term has provided a highly flexible moniker that can vary widely by context, evolve over time, and collectively appeal to a broad range of investors and stakeholders. These features both help to account for its success, but also its challenges such as the difficulty of empirically showing a causal relationship between ESG and financial performance, a proliferation of ratings that can seem at odds with understood purposes of the term ESG or enable “sustainability arbitrage,” and tradeoffs between issues such as carbon emissions and labor interests that cannot be reconciled on their own terms. These challenges give fodder to critics who assert that ESG engenders confusion, unrealistic expectations, and greenwashing that could inhibit corporate accountability or crowd out other solutions to pressing environmental and social issues. These critiques are not necessarily fatal, but are intertwined with the characteristic flexibility and unfixed definition of ESG that was present from the beginning, and ultimately shed light on obstacles for the future of the ESG movement and regulatory reform.

Keywords: environmental, social, governance, ESG, sustainability, corporate social responsibility, corporate purpose, stakeholder capitalism, socially responsible investment, impact investing, corporate law, securities regulation, SEC, climate disclosure, board diversity, human capital management

JEL Classification: D21, G39, K22, L21

Suggested Citation: Suggested Citation

Elizabeth Pollman (Contact Author)

University of pennsylvania carey law school; co-director, university of pennsylvania carey law school - institute for law and economics; european corporate governance institute ( email ).

3501 Sansom Street Philadelphia, PA 19104 United States

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Paper How Important is Corporate Governance? Evidence from Machine Learning

We use machine learning to assess the predictive ability of over a hundred corporate governance features for firm outcomes, including financial-statement restatements, class-action lawsuits, business failures, operating performance, firm value, stock returns, and credit ratings. We discover that adding corporate governance features does not improve the predictive accuracy of models over that of models constructed using only firm characteristics. Our results confirm the challenges in constructing measures of corporate governance with predictive value suggested in prior research. These results also raise doubts about the existence of strong causal effects of corporate governance on firm outcomes studied in prior research.

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• Authored by Ian D. Gow David F. Larcker Anastasia A. Zakolyukina
• CAAI - Finance
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Research on differential game of platform corporate social responsibility governance strategy considering user and public scrutiny

• Guo, Yongquan
• Liu, Baotong

The development of digital technology and the sharing economy has extended corporations' innovative activities beyond the corporation's boundaries, so it has become more urgent to govern the lack of social responsibility and alienation of platform corporations from the perspective of social agents. First, the platform's CSR classification and social responsibility governance's main content are analyzed in this research. Then, this study uses government agencies, platform corporations, users, and the public as governance subjects and compares governance decisions with and without public and user oversight. Finally, the optimal balance strategy for each governing subject, the optimal trajectory of governance volume, and the trajectory of total revenue are obtained. The study found that: 1) Public and user supervision can improve the governance volume while encourage the governance motivation of government agencies and platform corporations. 2) The level of user supervision effort has a greater impact on the total governance revenue than public supervision. 3) The revenue of the system and the governance volume are greater in a centralized decision-making process, indicating that those involved should co-operate in governance based on the principle of mutual benefit. 4) The platform corporation has an incompatible but unified relationship between its social duty and financial success.

Introducing Microsoft 365 Copilot – your copilot for work

Mar 16, 2023 | Jared Spataro - CVP, AI at Work

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Humans are hard-wired to dream, to create, to innovate. Each of us seeks to do work that gives us purpose — to write a great novel, to make a discovery, to build strong communities, to care for the sick. The urge to connect to the core of our work lives in all of us. But today, we spend too much time consumed by the drudgery of work on tasks that zap our time, creativity and energy. To reconnect to the soul of our work, we don’t just need a better way of doing the same things. We need a whole new way to work.

Today, we are bringing the power of next-generation AI to work. Introducing Microsoft 365 Copilot — your copilot for work . It combines the power of large language models (LLMs) with your data in the Microsoft Graph and the Microsoft 365 apps to turn your words into the most powerful productivity tool on the planet.

“Today marks the next major step in the evolution of how we interact with computing, which will fundamentally change the way we work and unlock a new wave of productivity growth,” said Satya Nadella, Chairman and CEO, Microsoft. “With our new copilot for work, we’re giving people more agency and making technology more accessible through the most universal interface — natural language.”

Copilot is integrated into Microsoft 365 in two ways. It works alongside you, embedded in the Microsoft 365 apps you use every day — Word, Excel, PowerPoint, Outlook, Teams and more — to unleash creativity, unlock productivity and uplevel skills. Today we’re also announcing an entirely new experience: Business Chat . Business Chat works across the LLM, the Microsoft 365 apps, and your data — your calendar, emails, chats, documents, meetings and contacts — to do things you’ve never been able to do before. You can give it natural language prompts like “Tell my team how we updated the product strategy,” and it will generate a status update based on the morning’s meetings, emails and chat threads.

With Copilot, you’re always in control. You decide what to keep, modify or discard. Now, you can be more creative in Word, more analytical in Excel, more expressive in PowerPoint, more productive in Outlook and more collaborative in Teams.

Microsoft 365 Copilot transforms work in three ways:

Unleash creativity. With Copilot in Word, you can jump-start the creative process so you never start with a blank slate again. Copilot gives you a first draft to edit and iterate on — saving hours in writing, sourcing, and editing time. Sometimes Copilot will be right, other times usefully wrong — but it will always put you further ahead. You’re always in control as the author, driving your unique ideas forward, prompting Copilot to shorten, rewrite or give feedback. Copilot in PowerPoint helps you create beautiful presentations with a simple prompt, adding relevant content from a document you made last week or last year. And with Copilot in Excel, you can analyze trends and create professional-looking data visualizations in seconds.

Unlock productivity. We all want to focus on the 20% of our work that really matters, but 80% of our time is consumed with busywork that bogs us down. Copilot lightens the load. From summarizing long email threads to quickly drafting suggested replies, Copilot in Outlook helps you clear your inbox in minutes, not hours. And every meeting is a productive meeting with Copilot in Teams. It can summarize key discussion points — including who said what and where people are aligned and where they disagree — and suggest action items, all in real time during a meeting. And with Copilot in Power Platform, anyone can automate repetitive tasks, create chatbots and go from idea to working app in minutes.

GitHub data shows that Copilot promises to unlock productivity for everyone. Among developers who use GitHub Copilot, 88% say they are more productive, 74% say that they can focus on more satisfying work, and 77% say it helps them spend less time searching for information or examples.

But Copilot doesn’t just supercharge individual productivity. It creates a new knowledge model for every organization — harnessing the massive reservoir of data and insights that lies largely inaccessible and untapped today. Business Chat works across all your business data and apps to surface the information and insights you need from a sea of data — so knowledge flows freely across the organization, saving you valuable time searching for answers. You will be able to access Business Chat from Microsoft 365.com, from Bing when you’re signed in with your work account, or from Teams.

Uplevel skills. Copilot makes you better at what you’re good at and lets you quickly master what you’ve yet to learn. The average person uses only a handful of commands — such as “animate a slide” or “insert a table” — from the thousands available across Microsoft 365. Now, all that rich functionality is unlocked using just natural language. And this is only the beginning.

Copilot will fundamentally change how people work with AI and how AI works with people. As with any new pattern of work, there’s a learning curve — but those who embrace this new way of working will quickly gain an edge.

The Copilot System: Enterprise-ready AI

Microsoft is uniquely positioned to deliver enterprise-ready AI with the Copilot System . Copilot is more than OpenAI’s ChatGPT embedded into Microsoft 365. It’s a sophisticated processing and orchestration engine working behind the scenes to combine the power of LLMs, including GPT-4, with the Microsoft 365 apps and your business data in the Microsoft Graph — now accessible to everyone through natural language.

Grounded in your business data. AI-powered LLMs are trained on a large but limited corpus of data. The key to unlocking productivity in business lies in connecting LLMs to your business data — in a secure, compliant, privacy-preserving way. Microsoft 365 Copilot has real-time access to both your content and context in the Microsoft Graph. This means it generates answers anchored in your business content — your documents, emails, calendar, chats, meetings, contacts and other business data — and combines them with your working context — the meeting you’re in now, the email exchanges you’ve had on a topic, the chat conversations you had last week — to deliver accurate, relevant, contextual responses.

Built on Microsoft’s comprehensive approach to security, compliance and privacy. Copilot is integrated into Microsoft 365 and automatically inherits all your company’s valuable security, compliance, and privacy policies and processes. Two-factor authentication, compliance boundaries, privacy protections, and more make Copilot the AI solution you can trust.

Architected to protect tenant, group and individual data. We know data leakage is a concern for customers. Copilot LLMs are not trained on your tenant data or your prompts. Within your tenant, our time-tested permissioning model ensures that data won’t leak across user groups. And on an individual level, Copilot presents only data you can access using the same technology that we’ve been using for years to secure customer data.

Integrated into the apps millions use every day. Microsoft 365 Copilot is integrated in the productivity apps millions of people use and rely on every day for work and life — Word, Excel, PowerPoint, Outlook, Teams and more. An intuitive and consistent user experience ensures it looks, feels and behaves the same way in Teams as it does in Outlook, with a shared design language for prompts, refinements and commands.

Designed to learn new skills.  Microsoft 365 Copilot’s foundational skills are a game changer for productivity: It can already create, summarize, analyze, collaborate and automate using your specific business content and context. But it doesn’t stop there. Copilot knows how to command apps (e.g., “animate this slide”) and work across apps, translating a Word document into a PowerPoint presentation. And Copilot is designed to learn new skills. For example, with Viva Sales, Copilot can learn how to connect to CRM systems of record to pull customer data — like interaction and order histories — into communications. As Copilot learns about new domains and processes, it will be able to perform even more sophisticated tasks and queries.

Committed to building responsibly

At Microsoft, we are guided by our AI principles and Responsible AI Standard and decades of research on AI, grounding and privacy-preserving machine learning. A multidisciplinary team of researchers, engineers and policy experts reviews our AI systems for potential harms and mitigations — refining training data, filtering to limit harmful content, query- and result-blocking sensitive topics, and applying Microsoft technologies like InterpretML and Fairlearn to help detect and correct data bias. We make it clear how the system makes decisions by noting limitations, linking to sources, and prompting users to review, fact-check and adjust content based on subject-matter expertise.

Moving boldly as we learn  

In the months ahead, we’re bringing Copilot to all our productivity apps—Word, Excel, PowerPoint, Outlook, Teams, Viva, Power Platform, and more. We’ll share more on pricing and licensing soon. Earlier this month we announced Dynamics 365 Copilot as the world’s first AI Copilot in both CRM and ERP to bring the next-generation AI to every line of business.

Everyone deserves to find purpose and meaning in their work — and Microsoft 365 Copilot can help. To serve the unmet needs of our customers, we must move quickly and responsibly, learning as we go. We’re testing Copilot with a small group of customers to get feedback and improve our models as we scale, and we will expand to more soon.

Learn more on the Microsoft 365 blog and visit WorkLab to get expert insights on how AI will create a brighter future of work for everyone.

And for all the blogs, videos and assets related to today’s announcements, please visit our microsite .

Tags: AI , Microsoft 365 , Microsoft 365 Copilot

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