Abstract

Corporate Governance is a set of systems and processes which ensures that the company is managed in the best interests of all the stakeholders. The basic objective of corporate governance is to maximise the shareholders value while protecting the interests of stakeholders. In other, words the main objective of corporate governance is to lay stress on profit maximisation as well as social responsibility and towards the wealth maximisation of shareholders. In the present study an attempt has been made to study the effect of corporate governance practices on shareholder value creation.

Introduction

Corporate Governance is the current exhortation in India as well as the world over. It involves human, social, economic and political governance. Government issued various guidelines from time to time for the improvement of corporate governance in different institutions. The basic objective of corporate governance is to maximise the shareholders value while keeping in view the interests of other stakeholders such as suppliers, customers, creditors, the employees of the company, the government and the society at large. So, the main objective of corporate governance is to lay stress on profit maximisation as well as social responsibility and towards the wealth maximisation of shareholders. A company creates shareholders value when returns generated by it exceed the opportunity cost to its owners. Shareholder value, in simple terms, is the market value of a common stock and shareholder value creation is the increase in the market value of that stock. After liberalisation of Indian Economy, the companies were giving least preference to shareholders interest but due to removal of government protection, severe legislative control on stock market by establishment of Securities and Exchange Board of India to protect shareholders interest, increased participation of foreign investors in the equity capital of Indian companies the concept of shareholder value was considered by the companies. The shareholders are now getting enriched by the presence and knowledge of foreign investors. They have become more assertive and demanding and take no time to shift their investment from underperforming companies to high performance companies. In the present study an attempt has been made to study the effect of corporate governance practices on shareholder value creation.

Review of Literature

A large number of studies have been conducted to study the concept of shareholder wealth creation by using economic value added and market added as a tool to measure shareholder wealth creation and effect of corporate governance practices on shareholder wealth creation. An attempt has been made to review the existing literature.

Thampy and Baheti (2000) in their paper measure the performance of both public and private sector banks in India using the EVA yardstick. The results of the study revealed that most banks in the public and private sector, as well as the development financial institutions in India are not earning positive EVA. They concluded that return on capital employed by these financial firms is less than the cost of capital. In other words the return on investor’s capital is less than the opportunity cost of capital which means that investor’s wealth is being destroyed to the extent to which the returns are lower than what would have been required.

Verma (2001) in his paper examined shareholder wealth created (based on EVA) by 28 Indian public and private sector banks listed on Bombay stock exchange for the period of five years between 1996-97 to 2000-01. He found that over 80 percent of selected banks were unable to earn a sufficient return to meet their cost of capital. Strong correlation was found between EVA and Return on Invested Capital. Increasing Correlation was found between EVA and Enterprise Value/ Invested Capital which showed that market is increasingly focusing on value creation and rewarding banks which increase shareholders value. Earning per Share and price earnings showed poor correlation with EVA. Cost of Capital showed stronger correlation with EVA as against cost of equity.

Jahur and Riyadh (2002) in their paper analysed the performance of 39 Bangladesh banking companies through EVA for period 2001. A rank correlation between EVA and other parameters used for judging the performance of banks indicated that ranking under return on assets, net profit, profit per employee and deposit per employee have close resemblances to the ranking under EVA, whereas the ranking under interest income and spread does not match with the ranking under EVA. They concluded that banks should replace other performance measures with EVA and eventually would get to be judged by the extent of value generated for shareholders over and above the weighted average cost of capital.

Desai and Ferri (2006) in a case study discussed the concept of EVA and its practical applications as a management control system for performance measurement. From the analysis of literature reviewed, it appears that there is no reported study on EVA and managerial performance particularly in developing countries. Therefore, research is needed to understand the basic issues involved in such countries and their comparison of EVA with other developed economies.

Raiyani and Joshi (2009) in their found out whether Indian Banks were able to create (or destroy) shareholders wealth since 2005-06 to 2007-08. For the purpose of study State Bank of India and HDFC banks were taken. Findings revealed that public sector bank SBI lead in creating shareholder value in rupee terms due to their invested capital gives higher return so as to generate a consistent amount of profit, where in private sector bank HDFC was at top in terms of percentage because the amount of invested capital was low compared to public sector banks.

Research Methodology

The population for study is private sector banks listed in India. For the purpose of study 10 banks from private sector were selected. The study was conducted for the period of 9 years i.e. 2005-06 to 2013-14. To study the effect of corporate governance practices, bank-wise governance score has been calculated by dividing the total score obtained by the bank during particular year by the total score applicable to bank.

To study the shareholder value creation Economic value added and Market value added were computed by using given formulas and to study the effect of corporate governance practices on shareholder value creation Pearson’s correlation coefficient was used.

EVA=Adjusted Net Profit-(Capital*Cost of Capital)

where,

Adjusted Net Profit is profit after tax plus depreciation less non-recurring income plus non recurring expenses adjusted for tax.

Capital includes equity capital plus retained earnings.

Cost of equity= Risk free Rate+(Beta*Market Premium)

Market Value Added=365 days average market capitalisation-Average net worth/Average capital employed*100.

Results and Discussion

Following are the results relating to effect of corporate governance practices on the shareholders value based on Pearson’s correlation coefficient.

Table 1

Bank wise Total Governance Score of Private Sector Banks

(The figures in parentheses show the rank)

Table 1 shows bank wise total governance score of private sector banks during 2005-06 to 2013-14. The companies have been ranked in the descending order to their governance score in each of 9 years of study. The Bank wise Governance score has been calculated by dividing the total score obtained by a bank during a particular year by the total score applicable to that bank during that year. The Governance score has been calculated in percentages so as to make the governance score of the banks comparable during the study period. The total governance score has increased for all the private sector banks during 2013-14 over 2005-06. The banks with maximum improvement in governance score during 2011-12 over 2005-06 have been City union bank (44.03%), ICICI bank (36.29%), Axis Bank (31.52%), Ing Vys (21.87%). The banks which have scored top position in private sector banks during the period of study include Karnataka Bank with 67.89 per cent score in 2005-06 and 2006-07. Karnataka Bank also scored high score in 2007-08 with total governance score of 69.47 percent. Indus Ind bank with 71.58 percent score in 2008-09, ICICI bank with 72.63 percent score in 2009-10 and 73.16 percent score in 2010-11, Indus Ind with 73.68 percent score in 2013-14 have scored top position. Other private sector banks which have scored high in private sector banks followed by top position banks include Karnataka Bank with 70 percent and 72.11 percent score in 2008-09 and 2009-10 to 2010-11, ICICI bank with 73.16 percent during 2011-12 to 2013-14. The banks with minimum score have been city union bank (44.21%) during 2005-06 and 2006-07, Axis Bank (50) during 2007-08, J&K Bank (51.05%) during 2008-09 to 2010-11 and J&K Bank (53.16) percent during 2011-12 to 2013-14.

Table 2 shows economic value added of private sector banks for the period under study. All the banks failed to generate EVA during 2005-06, 2007-08, 2009-10 and 2010-11. The banks which have created highest negative EVA were Karnataka Bank (-42.13 percent) during 2005-06, Indus Ind Bank (-3.33 percent), (-32.43 percent) during 2006-07 and 2007-08. ICICI Bank (-71.42 percent), (-32.99 percent) during 2009-10and 2010-11, Dhanlaxmi Bank (-0.33 percent), (-2.79 percent) and (-47.03 percent) during 2011-12 to 2013-14. City Union Bank created maximum Eva (11.17 percent) during 2006-07, ICICI Bank (73.27 percent) during 2008-09, Axis Bank (34.81 percent) during 2011-12, Jammu and Kashmir Bank (15.15 percent), (9.39 percent) during 2012-13 and 2013-14.

Table 2

Bank-wise Economic Value Added of Private Sector Banks

Table 3 shows market value added by private sector banks in India. In Private Sector banks, HDFC Bank (27.89 percent), (31.5 percent), (23.49 percent), (28.39 percent), (33.62 percent), (75.47 percent) and (23.47 percent) during 2005-06, 2006-07, 2008-09 to 2011-12 and 2013-14 have generated maximum MVA. City Union Bank (97.99 percent) during 2007-08 and Indus Ind Bank (33.34 percent) during 2012-13 have generated maximum MVA. The banks which have highest negative MVA are Dhanlaxmi Bank (-0.94 percent), (-0.61 percent) during 2005-06 and 2006-07, Federal Bank (-3.01 percent), (-1.2 percent) during 2008-09 and 2009-10, Karnataka Bank (-2 percent), (-4.68 percent) and (-5.39 percent) during 2011-12 to 2013-14.

Table 3

Bank-wise Market Value Added of Private Sector Banks

Table 4 shows descriptive statistics of private sector banks. The minimum governance score has increased from 44.21 percent to 53.16 percent during the period 2005-06 to 2013-14. The mean governance score has increased from 54.99 percent to 64.89 percent during 2005-06 to 2013-14. It has been found that both MVA and EVA range from negative to positive values, whereas average MVA has decreased to 5.17 percent during 2013-14 from 6.34 percent during 2005-06 and average EVA has increased in negative from -26.34 percent to -8.78 percent during the same period. The standard deviation has been high in EVA during 2005-06, 2008-09, 2009-10, 2010-11 and 2012-13 which shows that there has been more variation in EVA in comparison to MVA during these years and high variation in MVA than EVA was found during 2006-07, 2007-08 and 2011-12 to 2013-14.

Table 4

Descriptive Statistics: Private Sector Banks

Table 5

Relationship between Corporate Governance and Shareholder Value Analysis

(Pearson’s Correlatio n Coefficient: Private Sector Banks )

* Correlation is significant at the 0.05 level (2-tailed)

* *Correlation is significant at the 0.01 level (2-tailed)

Table 5 shows Pearson’s Correlation Coefficient for private sector banks. The findings revealed positive but low degree insignificant correlation between corporate governance and EVA during 2008-09 and 2011-12. During other years there has been negative but low degree insignificant correlation except in 2005-06 when relationship has been negative (-0.632), moderate and also significant at 0.05 level. On the other hand, positive (0.866) and moderate degree correlation (significant at 0.01level) has been found between corporate governance score of private sector banks and MVA during 2008-09, while low degree negative and insignificant correlation has been found between corporate governance and MVA during other years of study.

Conclusion

There has been improvement in the total governance score of all private sector banks. But the percentage disclosure is still low. So, banks should make effect to increase the corporate governance reporting disclosure so trust of stakeholders raises. It has been observed that during different years the correlation was positive and negative in private sector banks but it was low and insignificant. Thus, it may be concluded that there is no meaningful correlation exist between corporate governance reporting practices of banks and shareholder value creation based upon either EVA or MVA.

References

Chauhan, Shikha (2009), “Corporate Governance Practices in India- A comparative Study of Pharmaceutical and IT Industry”, Ph.D Thesis submitted to Department of Commerce, Punjabi University, Patiala.

Desai, A. M. & Ferri, F. (2006), “Understanding Economic Value Added”, downloaded from

http://harvardbusinessonline.hbsp.harvard.edu/b02/en/comman/item_detail.jhtml?

id=206016.

Jahu, Mohammad Saleh and Riyadh, Al Nahian (2002), “Economic Value Added as a Management Tool- A study on selected Banking Companies in Bangladesh”, Bank Posikrama, Volume XXVII, No. 1, March, pp. 46-63.

Raiyani, Jagdish R. and Joshi, Nilesh K. (2009), “EVA Based Performance Measurement: A Case Study of SBI And HDFC Bank”, downloaded from www.inflibnet.ac.in/ojs/index.php/MI/article/viewFile/913/832

Thampy, Ashok and Baheti, Rajiv (2000), “Economic Value Added in Banks and Development Financial Institutions”, downloaded from www.iimb.ernet.in/research/sites/default/files/wp.iimb_.149.pdf

Verma, B.P. (2001), “Economic Value Addition by Indian Banks: A Study”, downloaded from http://utiicm.com/bpv^59