Looking at and Beyond Corporate Governance in India: A Journey of Three Decades of Reforms 9819934001, 9789819934003

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Looking at and Beyond Corporate Governance in India A Journey of Three Decades of Reforms Seema Joshi Ruchi Kansil

Looking at and Beyond Corporate Governance in India

Seema Joshi · Ruchi Kansil

Looking at and Beyond Corporate Governance in India A Journey of Three Decades of Reforms

Seema Joshi Department of Commerce University of Delhi Delhi, India

Ruchi Kansil An academician and independent researcher Delhi, India

ISBN 978-981-99-3400-3 ISBN 978-981-99-3401-0 (eBook) https://doi.org/10.1007/978-981-99-3401-0 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Palgrave Macmillan imprint is published by the registered company Springer Nature Singapore Pte Ltd. The registered company address is: 152 Beach Road, #21-01/04 Gateway East, Singapore 189721, Singapore

Foreword

“Looking at and beyond Corporate Governance in India—A Journey of three decades of reforms” has eloquently articulated the landscape of Corporate Governance in India along with the significant role that can be played by well-governed entities in fulfilling the UN agenda 2030 on sustainable development. Undeniably, businesses with a purpose beyond profit, can contribute tremendously towards sustainable growth and development. The study acknowledges that sustainability is a business imperative in the twenty-first century, even when it abounds with tensions and challenges. India, the world’s fifth-largest economy (in terms of nominal GDP), is striving continually to initiate and implement structural reforms over the past few decades in several areas, including that in the sphere of Corporate Governance. The proactive measures of the Government of India and the regulator of the capital market i.e., the Securities and Exchange Board of India (SEBI), together aim at strengthening the Corporate Governance regime. They are cognizant of the role of businesses towards responsible conduct and sustainability. Readers will find that this excellent book provides a solid base of information culled from extensive empirical research. Several pertinent questions posed and answered in this book are: What does Corporate Governance imply? What are the theories governing Corporate Governance? How does the Corporate Governance landscape of India look like

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after three decades of reforms? What channels affect Corporate Governance? How does Corporate Governance impact firm performance in India? Does Corporate Governance enhance Economic Growth in India? If yes, then how? Is there any linkage between Foreign Direct Investment and Corporate Governance in the Indian context? Does Foreign Direct Investment matter for Corporate Governance and Economic Growth in the case of India? Is Foreign Investment a cause or an effect of Corporate Governance as well as that of Economic Growth? What is the importance of Corporate Sustainability? How does sustainability get integrated into Corporate Governance? Does good Corporate Governance lead to the achievement of the sustainability agenda? What are the Sustainability Reporting norms followed in India? What is the impact of Corporate Governance on sustainability reporting in the case of India? What are the major issues and challenges in sustainability reporting in the case of corporate entities? What are the broad conclusions and policy recommendations to strengthen the convergence of Corporate Governance and Sustainability? and so on. It is indeed a rigorous, highly relevant, and very timely must-read for students, researchers, academicians, policymakers, and practitioners. The policy recommendations offered in the book try to show the pathway to policymakers and regulators, as they seek to address the myriad challenges that emanate from sustainability, by suggesting new approaches which are emerging in the critical domain of Corporate Governance. Vipin Sondhi IIT Delhi, IIM Ahmedabad Former MD & CEO Ashok Leyland and JCB India Former Chairman of the Board of Governors of Indian Institute of Science Education & Research, Bhopal Chairman National Board for Quality Promotion https://linkedin.com/in/ vipin-sondhi-40306914

Preface

Corporate scandals and financial crises, especially the Asian and global financial crises, have pushed corporate governance issues to the top of the agenda of international bodies such as the United Nations (UN), United Nations Conference on Trade and Development (UNCTAD) and Organization of Economic Co-operation and Development (OECD) and that of emerging economies such as India. In the aftermath of the COVID19 pandemic, there is a growing understanding and appreciation of the fact that governance strategy (in general and corporate governance in particular) and sustainability are inseparable. It is widely acknowledged now that having good corporate governance and well-functioning capital markets is crucial for countries, as they have not only provide support for the recovery process from the COVID-19 crisis but also prepare themselves well for possible future shocks in this “age of pandemics”. The countries at present are striving hard to attain and sustain stronger, cleaner, and fairer economic growth. Good corporate governance will play an important role in fostering an environment of market confidence and business integrity. This will also support capital market development. In times when the resources of governments are drying up, for an economy to stay competitive, the dynamism and competitiveness of its business sector matter. Herein is the role of the quality of a country’s corporate governance framework, which can support the corporate sector in managing environmental, social, and governance (ESG) risks and harnessing the contributions of different stakeholders. The “S” of

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ESG factors was always important, but now it is higher up the corporate agenda after the pandemic and after the release of the Hindenburg report on Adani Group, as government, regulatory bodies, and companies have been trying to reassure stakeholders that the safety of their workers and communities seriously matters for them. The government of India is also setting a “tone at the top” for promoting a culture of accountability and integrity of corporate entities through its recent interventions. Undeniably, understanding countries’ institutional, legal, and regulatory frameworks is important for ensuring good corporate governance. Equally important is comparing these frameworks with other countries to understand the policies and practices in other countries so that the evolution of the policies and practices across other countries brings some learning lessons for us. Indeed, for attaining growth, corporate governance is important and for ensuring good corporate governance addressing major corporate governance challenges such as board practices (including remuneration); the role of institutional investors; related party transactions and minority shareholder rights; board member nomination and election; supervision and enforcement; and risk management becomes important. The authors confirm by presenting this wealth of information in two parts to the readers that the regulatory frameworks related to corporate governance in India have been continually evolving through the collective efforts of the government, regulatory bodies, and the corporate sector. A shift from the issuance of guidelines (2011) to their upgradation multiple times to date and a move from voluntary disclosures to mandatory ones validate their point that the Government of India stands committed to facilitating the creation, building, and embedding of sustainability culture in the entities. The authors have attempted to fill several research gaps by incorporating empirical exercises and by designing each chapter carefully and systematically to support their points. The readers are likely to become mesmerized by looking at the ever-evolving corporate governance landscape in India (in Part 1 of the book) and looking beyond it (in Part 2 of the book) by observing how the culture of sustainability is still in the nascent stage in our country but the government and regulatory body have been trying hard to ensure through various measures/ interventions that gradually it should get embedded in the business strategies of corporate entities. However, implementing business responsibility and sustainability reporting in business entities following international

PREFACE

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benchmarks is still a challenge. This book has been informing the policy by offering suggestions on how policies and practices can be adapted and challenges on the journey ahead can be approached to ensure convergence of corporate governance with sustainability. This has been showing the way forward to remain effective under new circumstances amidst new and evolving challenges. Delhi, India

Seema Joshi Ruchi Kansil

Acknowledgements

Nurturing ideas and shaping them into a full-fledged book was indeed an uphill task, but in the end, it appears to be rewarding. Sincere thanks to our family members who were the strongest pillar of support to us throughout the writing process. We also send a heartfelt of thanks to Prof. Ramesh Chand, currently Member, NITI Aayog, Prof. Arup Mitra, Faculty of Economics, South Asian University and Prof. Pranav Desai, Former Professor, Centre for Studies in Science Policy, Jawaharlal Nehru University, Delhi, for being a source of inspiration and motivation. Thanks are due to all those individuals who helped make this happen.

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Contents

Part I Looking at Corporate Governance 1

2

Corporate Governance—A Theoretical Perspective 1.1 Introduction 1.2 Evolution of the Corporate Form of Entity 1.3 Theories of Corporate Governance 1.4 Models and Practices of Corporate Governance in Selected Countries Anglo Saxon Model Japanese Model German Model Family-Based Model 1.5 Conclusions References

3 3 7 12

Corporate Governance in India: An Evolving Landscape 2.1 Introduction 2.2 Historical Perspective 2.3 Chronology of Three Decades of Reforms The First Decade of CG Reforms (1991–2000) The Second Decade of CG Reforms (2001–2010) The Third Decade of CG Reforms (2011–Till Date) 2.4 Conclusion References

33 33 34 36 37 41 45 50 51

18 21 22 23 24 25 26

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3

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CONTENTS

Corporate Governance and Economic Performance—A Micro to Macro Perspective 3.1 Introduction 3.2 Channels of Corporate Governance Interplay Between Corporate Governance and Country Governance 3.3 Corporate Governance and Firm Performance—The Micro Perspective Data and Variables Empirical Model and Estimation Results and Discussion 3.4 Corporate Governance and Economic Growth—The Macro Perspective Hypothesis Development Data and Variables Period of Study Empirical Model and Estimation Results and Discussion 3.5 Conclusions and Policy Recommendation References Linkage Between Corporate Governance, Foreign Direct Investment and Economic Growth—Empirical Evidence from India 4.1 Introduction 4.2 Review of Literature Linkage Between FDI and EG Linkage Between FDI and CG Linkage Between FDI, EG and CG 4.3 Hypotheses, Analysis and Discussion Data and Variables Period of Study Technique and Model Formulation 4.4 Conclusions and Policy Implications References

53 53 56 60 61 67 67 69 71 71 72 72 74 76 77 78

89 89 90 91 93 94 97 97 98 100 102 105

CONTENTS

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Part II Looking beyond Corporate Governance – Corporate Sustainability and Sustainability Reporting 5

6

Rising Importance of Corporate Sustainability in the Current Era 5.1 Introduction 5.2 Application of SAP-LAP Framework to Explain Linkages Between CS and CG Situation Actor Process Learning Action Performance 5.3 Conclusions References Embedding Sustainability into Businesses: Creating Sustainability Culture 6.1 Introduction 6.2 Sustainability Reporting 6.3 Sustainability Reporting Frameworks: A Brief Overview 6.4 Global Trends in Sustainability Reporting Sustainability Reporting in India 6.5 Aspects Involved in Preparation of the Sustainability Report 6.6 Challenges in Sustainability Reporting Overcoming Challenges Overcoming Challenges: The Indian Context 6.7 Impact of Corporate Governance on Sustainability Reporting: Indian Experience Data and Variables Empirical Model Identifying the Risk of Dynamic Endogeneity Empirical Estimation and Results Discussion Conclusions and Policy Recommendations References

113 113 115 116 121 125 129 131 134 135 136 143 143 144 148 150 152 153 158 159 160 161 163 164 166 168 170 171 174

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Strengthening the Convergence of Corporate Governance and Sustainability—The Way Forward 7.1 Introduction 7.2 Convergence—Meaning 7.3 Drivers of Convergence of Corporate Governance and Sustainability Setting a Tone of Sustainability at the Top Sustainability Leadership Enabling Framework for Promoting Sustainability Leadership Top Management Orientation Setting Environment Targets and Linking with Planetary Thresholds A Strong Commitment to Responsible Business Conduct (RBC) Aligning Corporate Sustainability Strategies with the Government’s Action Plan/Commitments 7.4 Impediments for the Convergence of Corporate Governance and Sustainability Lack of Harmonisation of Sustainability Reporting Standards Inadequate Investment Horizon of Corporate Owners Lack of Sustainability Risk Anticipation Presence of Distinct Corporate Governance Systems Limited Emphasis on Green Finance Lack of Diversity, Equity and Inclusion (DEI) Approach Inadequate Mechanisms and Frameworks for Fixing Business Accountability 7.5 The Way Forward 7.6 Conclusions References

Index

181 181 183 185 185 185 187 191 192 193 194 195 195 196 197 198 199 199 200 201 203 207 211

Abbreviations

3BL ADB ADF AS BOD BRR BRRF BRSR BSE CDP CDSB CEO CFO CG CGI CII CLSA CMIE COP27 CR CRISIL CS CSR CSRD DCA DEI

Triple bottomline Asian Development Bank Augmented Dickey–Fuller test Asset Structure Board of Directors Business Responsibility Reporting Business Responsibility Reporting Framework Business Responsibility and Sustainability Report Bombay Stock Exchange Carbon Disclosure Project Climate Disclosure Standards Board Chief Executive Officer Chief Finance Officer Corporate Governance Corporate Governance Index Confederation of Indian Industry Credit Lyonnais Securities Asia Centre for Monitoring the Indian Economy 27th Conference of the Parties Current Ratio Credit Rating Information Services of India Limited Corporate Sustainability Corporate Social Responsibility Corporate Sustainability Reporting Directive Department of Company Affairs Diversity, Equity, and Inclusion xvii

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ABBREVIATIONS

DER EES EG ESG Score EScore ESG EU-SFDR FD FDI FGLS FP G-20 GDP GHG GMM GOI GRI ICRA IDP IEPF IFRS IIRC IMF IP IR ISS ISSB KGIs KPIs LAP M&As MCA Mcap MD MNCs NEP NGOs NGRBCs NSE NVGs OECD OLS

Debt to Equity Ratio Economic, Environment and Social Economic Growth Environment Social and Governance Score Environment Score Environmental, Social and Governance European Union’s Sustainable Finance Disclosure Regulation Financial Development Foreign Direct Investment Feasible Generalized Least Squares Foreign Promoter Shareholdings Group of 20 Gross Domestic Product Greenhouse gas Generalized Method of Moments Government of India Global Reporting Initiative Investment Information and Credit Rating Agency Investment Development Path Investor Education and Protection Fund International Financial Reporting Standards International Integrated Reporting Council International Monetary Fund Indian Promoter Shareholdings Integrated Reporting Institutional Shareholder Services International Sustainability Standards Board Key Governance Issues Key Performance Indicators Learning-Action-Performance Mergers and Amalgamations Ministry of Corporate Affairs Market Capitalization Managing Director Multinational companies New Industrial Policy Non-Governmental Organizations National Guidelines for Responsible Business Conduct National Stock Exchange National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business Organization of Economic Co-operation and Development Ordinary Least Squares

ABBREVIATIONS

PESTLE RBC ROA ROE SAP SAP-LAP SASB SDGs SEBI SEBI LODR SME SR SScore SWOT TCFD TNFD TR UN UNCTAD UNEP UNGC UNGPs UNHRC VAR VGCSR VRF WEF

Political, economic, sociocultural, technical, legal, and environmental Responsible Business Conduct Return on Assets Return on Equity Situation-Actor-Process Situation-Actor-Process Learning-Action-Performance Sustainability Accounting Standards Board Sustainable Development Goals Securities and Exchange Board of India Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations Small and Medium Enterprises Sustainability Reporting Social Score Strengths, weaknesses, opportunities and threats Task Force on Climate-Related Financial Disclosures Taskforce on Nature-related Financial Disclosures Total Returns United Nations United Nations Conference on Trade and Development United Nations Environment Programme United Nations Global Compact United Nations Guiding Principles on Business and Human Rights United Nations Human Rights Council Vector autoregressive model Voluntary Guidelines on Corporate Social Responsibility Value Reporting Foundation World Economic Forum

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List of Figures

Fig. Fig. Fig. Fig.

1.1 1.2 1.3 1.4

Fig. 2.1 Fig. 2.2 Fig. 2.3 Fig. 3.1 Fig. Fig. Fig. Fig. Fig.

5.1 6.1 7.1 7.2 7.3

Fig. 7.4

Approaches to corporate governance Managerial control of companies Corporate decision process/system Linkage between managerial control of companies and theories of corporate governance The first decade of corporate governance reforms (1991–2000) The second decade of corporate governance reforms (2001–2010) The third decade of corporate governance reforms (2011–Till Date) Macro and micro perspectives via channels of good governance Linkage of sustainability to sustainability reporting Flow of initiatives for nonfinancial reporting in India The six habits of regenerative leaders Cambridge sustainability leadership model Six key elements of good corporate governance and commitment to ESG The four levels of corporate governance

5 9 10 13 39 41 46 57 121 153 187 189 202 203

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List of Tables

Table Table Table Table Table Table Table Table Table Table Table Table Table Table

1.1 3.1 3.2 3.3 3.4 3.5 4.1 4.2 4.3 5.1 5.2 5.3 6.1 6.2

A snapshot of theories of corporate governance Description of variables used in the study Final dataset Results of panel data regression Descriptive statistics Granger causality test results Descriptive Statistics Var lag order selection criteria and results Granger causality test results Elements of SAP LAP in corporate sustainability (CS) Business Benefits of Regeneration Approaches to corporate sustainability challenges Description of variables used in the study Results of system GMM regression

14 65 68 70 73 75 98 100 102 117 119 127 165 169

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PART I

Looking at Corporate Governance

CHAPTER 1

Corporate Governance—A Theoretical Perspective

1.1

Introduction

The rise of corporate frauds and accounting scandals since the last decade of the twentieth century brought to light several lawsuits, resignations, and bankruptcies, which raised excessive concerns over corporate functioning vis-a-vis their processes, structures, and systems.1 A host of problems ranging from credibility crisis, loss of investor confidence, accounting irregularities, auditing failures, and fraudulent practices surfaced. As a response, interest in corporate governance (CG) heightened, leading to a series of reforms that practically gained increasing momentum with every 1 Here, the distinction between the corporate governance system and corporate governance practices seems important. We adopt the definitions of Cornelius and Kogut (2003) as under:

● “Corporate governance system consists of those formal and informal institutions, laws, values, and rules that generate the menu of legal and organizational forms available in a country and which in turn determine the distribution of power, how ownership is assigned, managerial decisions are made, and monitored, information is audited and released, and profits and benefits allocated and distributed”. ● “Corporate governance practices are those rules that apply to specific financial markets and organizational forms, and that establish the discretion of parties that possess control rights and the information and mechanisms at their disposal to choose management, propose or confirm major strategic decisions, and determine the distribution of remuneration and profit ”.

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 S. Joshi and R. Kansil, Looking at and Beyond Corporate Governance in India, https://doi.org/10.1007/978-981-99-3401-0_1

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successive scandal. Moreover, a large body of research has focused on the corporate governance regime, especially since the release of the Cadbury Report in 1992. The emergence of financial crises in 1998 followed by the corporate scandals of the United States and Europe further stressed the need and importance of corporate governance (Claessens, 2006). Corporate misgovernance and unethical practices are established as the likely macroeconomic consequences of a weak corporate governance regime along with the inadequacy of existing regulatory frameworks. Economists, policymakers, members of corporate boardrooms, business communities, and academicians, among others, started realizing that there is no substitute for getting business and management systems in place (Fernando, 2011). Over the years, we have witnessed that corporate governance not only emerged as a solution but also changed the global business culture. In the literature, we find various definitions of corporate governance dealing with its distinct aspects. Claessens (2006) classifies various definitions into two categories—the first set is the behavioral approach dealing with governance in terms of the behavior of the firm,2 and the second set is the normative approach dealing with governance in terms of institutional setup or rules under which the firm operates. The institutional setup here implies the judicial system, legal system, and financial and factor markets. Likewise, the behavior of the firm within the given institutional setup would imply internal aspects of the firm measured by various distinct terms such as the firm’s performance, efficiency, growth, financial structure, and treatment of stakeholders, among others. Figure 1.1 illustrates approaches to corporate governance. The institutional setup within a country not only shapes the behavioural patterns of firms and its stakeholders but also provides a basis for the use of various corporate governance mechanisms. Hence, the distinction between the two mentioned approaches to defining corporate governance evaporates. Charreaux (1997) has noted and defined corporate governance as “the organizational controls that govern the behavior of managers and define their discretionary power”. The importance of the behavior of managers is also highlighted by Jarboui et al. (2015) when they define corporate governance as a set of mechanisms that aim to direct managerial decisions and help improve firms’ performance. Vintila and Gherghina (2012) 2 We use the term ‘corporate’ and ‘firm’ interchangeably which is seen in plenty of previous literature. However, in economic theory, the term ‘firm’ is used more which includes all entities irrespective of their legal structure.

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Fig. 1.1 Approaches to corporate governance

hold the same views when they emphasized that corporate governance mechanism can mitigate the agency problem by aligning the interests of managers and directors3 with those of the shareholders. In reality, the adoption of good corporate governance practices can increase and restore shareholder confidence and promote economic efficiency as well as growth (OECD, 2004). A broader view of governance is emphasized in other relevant literature wherein corporate governance is considered “a set of relationships between a company’s management, its board, its shareholders and other stakeholders ” (OECD, 2004) with directors being accountable to shareholders in place of their responsibilities in ensuring wealth maximization (Sheikh, 1995).

3 Section 2(34) of the Companies Act, 2013 provides that a “director” means “a director appointed to the Board of a company”. Section 2(53) of the Companies Act, 2013 provides that a “manager” means “an individual who, subject to the superintendence, control, and direction of the Board of Directors, has the management of the whole, or substantially the whole, of the affairs of a company, and includes a director or any other person occupying the position of a manager, by whatever name called, whether under a contract of service or not ”. Directors are responsible for all that a company is and for what it strives to be. The managers manage the employees, equipment, and processes required for the company to do what it does.

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In the words of Aoki (2001), corporate governance outlines “a structure of rights and responsibilities among the parties with a stake in the firm”. The Organization of Economic Co-operation and Development (1999) (OECD) has defined corporate governance as “the mechanism or the system by which businesses and organizations are directed and controlled”. This definition seems most relevant among the normative approach. A similar approach is seen in the definition given by Shleifer and Vishny (1997): “Corporate Governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment ”, which highlights the instruments that are in place to guarantee the maximum rate of return on investment to the shareholders and creditors of the company. The above definitions point to various ways to address the governance of firms, called the mechanisms4 of corporate governance. These mechanisms ensure that stakeholders’ rights and interests are protected by executives and at the same time provide a guarantee to protect the assets invested in the firm (Aguilera et al., 2008). Several previous studies have investigated the role of governance mechanisms in resolving conflicts of interest between shareholders and managers and in improving firm performance (Aydin et al., 2007; Cubbin & Leech, 1983). However, the findings of these empirical studies are contradictory and inconclusive. It is interesting to note that almost all definitions point towards achievement of the four principles of corporate governance viz. Disclosure, responsibility and accountability, fairness, and transparency (DRAFT). ● Disclosure refers to making available complete, accurate, and clear disclosure to all stakeholders. ● Responsibility and Accountability refer to the obligation and duty to give an explanation or reason for the entity’s actions and conduct. ● Fairness refers to protecting the interest of and providing equal treatment to shareholders and various other stakeholders, including customers, suppliers, employees, and society at large. ● Transparency refers to full openness, willingness, and integrity in communication.

4 The mechanisms of corporate governance include Ownership Concentration, Board of Directors, Executive Compensation, and Market for Corporate Control.

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Studies reveal that firms and markets that enjoy a reputation for good governance not only enjoy mark-ups in the prices of securities but also find the participation of long-term investors (Klapper & Love, 2004; Picou & Rubach, 2006; Saibaba & Srinivasan, 2013). In contrast, in firms and markets with poor corporate governance practices, the prices of securities are discounted, and investors are discouraged from participating. Over the years, markets and economies around the globe have benchmarked international standards, leading to the freeing up of capital flows towards efficient capital markets. Today, efficient markets themselves are a characteristic of the global investment environment wherein investors are impatient as well as unhesitant to take their money out of firms that lack or cannot retain a reputation for good corporate governance.5 In reality, corporate governance matters. Investors demand good-governed firms. Clearly, corporate governance is important for economic growth and development. By all accounts, corporate governance is for the corporate form of entity that enjoys a set of features that enables it to have status that is independent of its investors. The entity operates as a distinct legal person. It will be highly interesting and relevant if we try to look into the evolution of the corporate form of entity in the present chapter. This will be followed by a brief discussion on various theories of corporate governance as articulated by different scholars from time to time. We will also focus on the various models and practices of corporate governance that are followed in selected countries, which will help us to understand how an entity is structured, operated, and controlled to achieve its long-term strategic goals and objectives.

1.2

Evolution of the Corporate Form of Entity

Most businesses of the eighteenth century were owned and controlled by individuals (Dignam & Galanis, 2013). During the nineteenth century, especially after the Second World War, economies could survive only with the movement of goods and services from one country to another

5 Recent example is that of Gautam Adani (2023, January) who lost $58 billion from his personal fortune in just six trading days and other example is that of Elon Musk who lost $200 billion in the year 2021 as soon as the faith of investors was shaken in their respective companies (See: Adani’s $58 billion Wealth Wipeout in Six Days Has Few Parallels—Bloomberg).

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(Bhasa, 2004). This led to the emergence of tremendous growth opportunities and large integrated markets all over the world. However, such internationalization of businesses6 for their goods and services required huge capital, expertise, knowledge, and power to administer. Governments opened up their economies, control of the state over industry was reduced and the private sector was welcomed, which further accepted the new challenges of internationalization of businesses. As a result, some businesses converted themselves to large corporate entities (Dignam & Galanis, 2013), and others emerged with integrated ownership and control7 (Santos, 2015). By the end of the nineteenth century, most businesses in Western countries had moved towards the corporate form of business8 (Dari-Mattiacci et al., 2017). Furthermore, the leadership change of the mid-1980s with governments of East European economies and some Asian countries, including India, giving away state control and incentivizing the private sector is strong evidence of the growth of the corporate form of businesses. Within the corporate form, owners themselves could not control and manage such huge entities, and as a result, ‘the managerial control of companies’ emerged (depicted in Fig. 1.2) (Chandler, 1977). Here, owners are not the managers, and the distinction between owners and managers was called the “separation of ownership and control ” (Berle & Means, 1932).9 Managers being professionals, working as agents of owners, i.e., their principals had control of the firm in their hands. This placed managers in a position to expropriate shareholder value by encashing the benefits of information asymmetries. As a result, firms must

6 Internationalization is expanding business across countries that get affected by cultural tastes and preferences, local traditions, etc. 7 Integrated ownership is a term used to describe the total percentage ownership of an individual or entity in another entity, which further influences control over that other entity. 8 The corporate form of a firm is one which has special legal attributes that make it capable of owning property and entering into contracts in its name. In addition, such an entity enjoys a status, distinct from its owners. 9 Bhasa (2004) and Vinten (2001) mention that since the formation of limited liability form of corporates, corporate governance existed in businesses in one form or the other but the entire body of corporate governance literature developed when Berle & Means (1932) raised the issue of “managerial expropriation of shareholder value”.

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Fig. 1.2 Managerial control of companies

now control the associated costs, called agency costs,10 if they are to grow and prosper. Berle and Means (1932) termed the same the “managerial expropriation of shareholder value”. In the context of the distinction of owners and managers, also called “separation of ownership and control ”, the control vests with the management of the entity headed by the Chief Executive Officer (CEO)/ Managing Director (MD) (also referred to as top management or executive management of the entity). Fama and Jensen (1983) have noted that management along with managers/agents at all levels of the entity have all the specific information and knowledge valuable for decisions. Thus, decision management is handed over in the hands of management (along with all other levels), and decision control is handed over to the board of directors. Thus, the costs of “separation of ownership and control ”, also called agency costs, can be controlled. Fama and Jensen (1983) have linked the separation of ownership and control by considering the four steps of the decision process and allocating them across two distinct groups based on those who perform those functions, namely, the Board of Directors and Management. The four steps of the decision process/system depicted in the Fig. 1.3 are mentioned as follows: 1. Initiation—Generating proposals for the utilization of resources and structuring of contracts 2. Ratification—Choosing initiatives to be implemented 3. Implementation—Executing ratified decisions 10 Jensen and Meckling (1976) have defined agency costs as “the sum of (1) the monitoring expenditures by the principal, (2) the bonding expenditures by the agent, (3) the residual loss incurred because the cost of full enforcement of contracts exceeds the benefits ”.

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Fig. 1.3 Corporate decision process/system (Source Based on Fama & Jensen [1983])

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4. Monitoring—Measuring performance and implementing rewards. As per Fama and Jensen (1983), decision management comprising the initiation and implementation of proposals is the responsibility of management. Decision control belongs to the Board of Directors (BOD), and they are supposed to ratify the proposals initiated by management and monitor their implementation. The board of directors (BOD) of the corporate entity acts as a connecting link between owners and management. BOD is a collective body—a group of individuals, where individuals are called directors. The directors are elected by owners (shareholders) to direct, control and supervise the affairs of the management, who run the company and are responsible for adding value to the firm and influencing the firm’s results (Murphy & McIntyre, 2007). The duties of the directors are defined by Section 166 of the Companies Act, 2013. These are as follows: ● ● ● ● ● ●

Duty Duty Duty Duty Duty Duty

to act as per the articles of the company to act in good faith to exercise due care to avoid conflict of interest not to make any undue gain and not to assign his office.

Previous studies have widely documented four major roles and responsibilities of the BOD, namely, the control role, the strategic role, the service or resource provider role, and the advice and counsel role (Bonn & Pettigrew, 2009; Nicholson & Kiel, 2007). The control role of the board rests on the “separation of ownership and control ”, implying that the board has a monitoring and supervisory role in the firm’s operations and business decisions. Practically, the board collectively has to control and monitor the top management of the entity. The strategic role is an advisory and leadership role wherein the board leads the management in achieving the mission and facilitates problem solving and decision making. Here, the idea is to encash the skills and expertise (Hillman & Dalziel, 2003) of the members of the board. Another important role that the board collectively plays is to provide access to networks and resources, maintain relationships with stakeholders—both formal and informal—and overcome the inherent conflicts between them (Tomsic, 2013). At the same time, the

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members of the board bring knowledge, experience, and abilities to the firm (Certo, 2003; Westphal & Fredrickson, 2001). This is said to be the service or resource provision role of the board. The last refers to advise and guidance that the board provides to executives and managers to run the entity. Dalton et al. (1999) have rightly stated that “outside directors provide a quality of advice to the CEO otherwise unavailable from corporate staff .” Against this backdrop, we understand that with the evolution of the corporate form of the entity, corporate management and BOD are responsible for meeting the short-term and long-term objectives of the firm, which have led to various issues and challenges. To address those issues and challenges and to build linkages between owners, managers, and other stakeholders with corporate governance, we will review various theories of corporate governance in the next section.

1.3

Theories of Corporate Governance

Many studies on corporate governance capture multiple theories on corporate governance with a focus on the distinct behavior of related parties as well as the corporate structures within which the firm and its related parties operate. These theories have laid the foundation for different meanings of the term “corporate governance” and alternative forms of corporate governance systems all around the globe. Indeed, as noted by Hung (1998), the lack of a single theory of corporate governance complicates the process of landing at a single definition of corporate governance that would encompass all the related aspects of corporate governance. Figure 1.4 depicts the linkage between managerial control of companies and theories of corporate governance. Furthermore, a snapshot of five theories of corporate governance is presented in Table 1.1. Table 1.1 has been divided into 5 columns. Column 1 gives the name of the theory, the focus of theory is given in Column 2, and the definition of corporate governance as per that particular theory has been given in Column 3. Column 4 discusses the focus of corporate governance in that theory, and column 5 presents the clear-cut purpose of corporate governance according to that particular theory. It is important to mention at the outset that there are two distinct perspectives, namely, the shareholder-oriented perspective and

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Fig. 1.4 Linkage between managerial control of companies and theories of corporate governance

stakeholder-oriented perspective that play an important role in corporate governance. These perspectives form the basis of discussion in the corporate governance literature. The shareholder-oriented perspective considers that the firm’s basic objective is to earn for shareholders, whereas according to the stakeholder-oriented perspective, the firm operates for all stakeholders and not just for shareholders. The stakeholders are referred to as all those who benefit or are benefitted from the firm. Such a broader view of corporate governance is also emphasized in the Report on corporate governance by Shri Kumar Mangalam Birla Committee11 (2000). The report clearly mentions that the fundamental objective of corporate governance is to “enhance long term shareholders value while at the same time protecting the interests of other stakeholders ”. The five theories discussed above have received much attention, with agency theory dominating the corporate governance literature and the others presenting a distinct viewpoint challenging the former’s viewpoint. L’Huillier (2014), after an extensive literature review, acknowledged that agency theory is the dominant paradigm despite the presence of various

11 The report of the Committee appointed by the SEBI on Corporate Governance under the Chairmanship of Shri Kumar Mangalam Birla (2000) is available at: https:// www.sebi.gov.in/sebi_data/commondocs/corpgov1_p.pdf.

Col. 2 Opportunistic behavior of managers

Altruistic behavior of managers (Davis et al., 1997)

Col. 1 Agency Theory

Stewardship Theory

Stakeholder Theory Stakeholders

Focus of theory Col. 4 Alignment of conflicts of interest between managers and investors arisen due to separation of ownership and control

Focus of corporate governance

Stewards (managers) align themselves with the objectives of their principals (owners) (Davis et al., 1997) to maximize shareholder returns (Donaldson, 1990) Synchronizing Forum Governing boards (L’Huillier, 2014) to coordinate and balance coordinate between varied the conflicting interests of various stakeholder groups stakeholder interests to achieve corporate goals (Hung, 1998)

Col. 3 “Ensuring that corporate actions, assets, and agents are directed at achieving the corporate objectives established by corporate shareholders” (Sternberg, 1998) Facilitating and empowering structures with power and authority to managers (Donaldson & Davis, 1991)

What is corporate governance

A snapshot of theories of corporate governance

Theory

Table 1.1

Put in place structures or vehicles so that stakeholders can raise their voices, get their rights protected and minimize the effects of information asymmetries (Bonnafous-Boucher, 2005; Donaldson & Preston, 1995; Turnbull, 1997)

Building structures that empower managers (Davis et al, 1997) and produce superior returns to shareholders (Donaldson & Davis, 1991)

Col. 5 Policing methods and appropriate structures to reduce agency costs and protect the interests of shareholders (Jensen & Meckling, 1976)

Purpose of corporate governance

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Linking the role of the board between the organization and the external environment (Ornstein, 1984; Palmer, 1983) as well as the organization and its competitors and other stakeholders (Okpara, 2011) Board as a supporter/ endorser to professional managers (Hung, 1998)

Resource Dependency Theory

Source Authors’ compilation

Managerial Hegemony Theory

Focus of theory

Theory

“Professional business arrangement representing validating procedures” (L’Huillier, 2014)

“Professional business arrangement representing a linking system” (L’Huillier, 2014)

What is corporate governance

The passive role of BOD in strategy and in directing firms (Kosnik, 1987; Lorsch & Maclver, 1989)

Role of BOD in securing access to critical resources (Mwanzia Mulili, 2014)

Focus of corporate governance

Pushing active participation of BOD in direction and control, strengthening responsibilities and accountability of board members

Ensuring internal supervision

Purpose of corporate governance

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other theories of corporate governance. On an examination of the corporate governance literature, we find that in addition to the abovementioned theories, we also find mention to other theories that are not very well developed, such as multigovernance theory, ownership structure theory, bankruptcy theory, transaction cost theory, and political theory. These theories have not gathered much attention from researchers and academicians, and thus, we could not find much supporting evidence and research on the same. Hung (1998) investigated multigovernance theories wherein one theory covers functional aspects of any two of the above five theories. The agency–stewardship theory encompasses the functional aspects of agency theory and stewardship theory, whereas the stakeholder–agency theory encompasses the functional aspects of stakeholder theory and agency theory. Mention of agency–stewardship theory can be seen in Laing and Weir (1999) and Turnbull (1997), wherein they argue that managers act both as opportunistic self-serving agents working to maximize their utility and as selfless stewards focused on achieving the goals of their respective organizations. Likewise, stakeholder–agency theory, as advocated by Hill and Jones (1992), suggests that corporate governance structures could regulate both stakeholder–agent and principal-agent relationship concerns. Jensen and Meckling (1976) integrated agency theory, the theory of property rights, and the theory of finance to develop ownership structure theory. They believe that agency costs vary as per the ownership structure of the firm, which may be diffused or concentrated. When it is diffused, managers could work to benefit themselves, leading to misalignment of their monetary incentives and other equity owners’ interests.12 In the case of the shareholders–managers agency problem when managers own a considerable amount of equity, there is a fear that a conflict might arise between owner-managers13 and outside shareholders. In contrast, when ownership is concentrated, the controlling owner (usually the manager or in close ties with the owner) pursues their interests and could harm the

12 This has been termed as shareholders–managers agency problem or vertical agency problem or Type 1 agency problem (Sarkar, 2010). 13 Owner-manager implies when a manager is also the shareholder having dual role as a manager and as a shareholder.

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interests of minority owners,14 in which case, the protection of minorities through the country’s legal system is essential (Gillan, 2006; Walsh & Seward, 1990). However, whatever may be the ownership structure of the firm, in all cases, the owners would have strong incentives to minimize agency costs. Another view has been put forwards by bankruptcy theory. The theory highlights that firms with higher business risk have more chances of bankruptcy and agency problems; therefore, there arises a need for owners to monitor firms more closely. Jensen and Meckling (1976) pointed out that risky investments would have higher or positive net present values, and thus, shareholders would prefer risky investments. Furthermore, risky firms can optimize by diversification. Hence, it can be rightly argued that institutional investors will invest in firms with high business risk for higher firm valuation. Studies by Maug (1998), Admati et al. (1994), and Huddart (1993) highlighted that institutional investors can play a crucial role in reducing agency problems, leading to minimizing bankruptcy costs. The theory that focuses on an individual transaction against an individual agent (agency theory) is referred to as transaction cost theory. The proponents of the theory relate managers’ opportunistic tendency and limited capacity to understand business situations to individual transactions, which might result in heavy transaction costs to the firm. These costs may be in the form of discouraging potential investors from investing in the firm or the loss of trust of existing investors in the credibility of the firm. Thus, as per transaction cost theory, corporate governance structures should focus on the effectiveness and efficiency with which the firm carries out its transactions. Indeed, the problems associated with the management of firms and their governance structures cannot be addressed unless regulatory mechanisms (rules, regulations, laws, etc.) are put in place by the respective governments and/or regulatory bodies. Political theory addresses the same and refers to the political influence in the governance structure of firms wherein government participates as a capital provider and creator of laws to be adopted for proper functioning and monitoring of firms (Borlea & Achim, 2013).

14 This has been termed as majority shareholders–minority shareholders agency problem or horizontal agency problem or Type 2 agency problem.

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After having discussed the theories of corporate governance, it is important to explore the practices/models of corporate governance adopted across the globe. In the next section, we describe the conditions and ownership forms that led to the emergence or adoption of different corporate governance systems/models/practices in selected countries. We also examine the governance implications of each of them. It is worth mentioning here that corporate governance systems are dependent on the ownership and control structure of the firm, which are defined by the corporate laws of respective countries.

1.4

Models and Practices of Corporate Governance in Selected Countries

Previous scholars (Ahmad & Omar, 2016; Claessens et al., 2000; Hilt, 2008) have attempted to review the history of the separation of ownership and control. We can deduce that during the late nineteenth and early twentieth centuries, this separation of ownership and control has distinctly and gradually emerged all over the world depending upon the respective country’s institutional setup and historical events. It has been pointed out very rightly that “If nations follow various governance systems or models to effectively govern and control the countries, then corporations too require good governance system to manage and control the firms effectively” (Ahmad & Omar, 2016). Thus, systems or models of corporate governance play a crucial role for all economies worldwide. As far as corporate governance is concerned, it is “a system of those formal and informal institutions, laws, values, and rules that generate the menu of legal and organizational forms available in a country and which in turn determine the distribution of power – how ownership is assigned, managerial decisions are made and monitored, information is audited and released, and profits and benefits allocated and distributed” (Cornelius & Kogut, 2003). Two distinct corporate governance systems have emerged over the years. The first is termed the Outsider system of corporate governance. In the case of this system, the shareholders are widely dispersed, with no single equity-holder15 owning a reasonable majority of shares to usurp control. Investing in firms takes place through arm’s length transactions

15 Here, intercorporate cross holdings are also very low.

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for financial returns via securities markets.16 The percentage share of each shareholder in total shareholdings of a single firm is too low that it does not motivate or incentivize the shareholder to monitor/control the management of that particular entity. Such shareholders perceive the costs of monitoring to be much more than the accrued marginal gains of monitoring the firms. The outsider system is characterized by the existence of a ready market for corporate control, high disclosure standards, market transparency, and an instant supply of managerial labor. Such features act as checks and balances on the expropriating behavior of professional managers who run corporations. In this regard, the monitoring role of institutional investors has gained much attention from researchers, policymakers, and regulators all over the world. The second system is termed the Insider system of corporate governance. In the case of this system, the shareholding of a particular shareholder (or a few shareholders together) is large enough that it acts as a great incentive for one or a few shareholders together to monitor and control the firm. Henceforth, such shareholdings are termed block holdings or concentrated shareholdings, and such shareholders are called controlling block holders. In such cases, these shareholders largely influence and monitor the firm’s operations, either directly or through the BOD.17 Additionally, it is noticed that large shareholdings incentivize the controlling blockholders to expropriate minority shareholders, leading to the negative externalities of expropriation of the minority. The system is characterized by weak securities markets, low transparency, and disclosure standards (Clarke, 2005). The focus of governance debates is on managerial remuneration, the composition of the Board, the disciplinary role of takeovers, and the measure of performance assured by the financial markets, to name a few (Charreaux, 2004). La Porta et al. (1998), in their seminal work, mentioned that the insider system of corporate governance leads to financial development and growth in a country, yet it is unsustainable due to increasing demands for capital and globalization. This would further lead to the convergence of these two alternative systems of corporate governance. By the early 1990s,

16 It is mandatory that stock markets are liquid. 17 Here, BOD follows the preferences of the controlling block holders and acts as

directed by them.

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most lawyers, economists and academicians confessed that this convergence had begun and would occur (Fukuyama, 1992; Gilson & Roe, 1993). In contrast, Huntington (1996) claimed that insider systems are well coordinated between institutions in the economy, leading to pressure on non-convergence with outsider systems. Thus, the movement or convergence is dependent on the institutional setting of the respective economies. Later, by the late 1990s, La Porta et al. (1998, 1999, 2000) worked on the legal protection of shareholders, heading this debate towards the legal protection of shareholders. Here, two scenarios emerge: ● Strong legal protection of shareholders leading to dispersed shareholdings. This is similar to the outsider system of corporate governance. ● Weak legal protection of shareholders leading to concentrated shareholdings. This is similar to the insider system of corporate governance. Economies across the globe have been responding to the growing importance of corporate governance. They have also designed corporate governance systems as per their country-specific economic needs as well as cultural, historical, and technological influences (Rubach & Sebora, 1998). Since social and economic conditions vary across economies, the theory of “one size fits all” does not prevail. Rubach and Sebora (1998) further argue that corporate governance systems across the globe reveal different governance responses to capital providers’ concerns for disclosing management actions more directly and developing long-term relationships between owners and a firm’s multiple constituents. As a result, corporate governance systems vary across firms, industries and sectors (Skare & Hasic, 2016). They provide firm-specific advantages, although they may seem to last only in the short run. Clearly, corporate governance systems across economies vary and are efficient in their respective conditions. Corporate governance systems followed in various countries/continents are called “Models of corporate governance” and called by the name of the country/continent, such as the Anglo-Saxon model, Japanese model, and German model. In addition, many countries follow the family-based model, which has distinct characteristics. A brief discussion on them follows one by one:

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Anglo Saxon Model ● Emphasis on the role of the free market. ● The dominance of Shareholder wealth maximization. ● One-tier system.

The Anglo-Saxon Model is the model prevalent in the US, UK, and Canada. The model is also called the outsider system. The ownership of firms in these countries is usually dispersed and characterized by the inability and weakness of owners to manage such large firms. This has led to managerial control of firms with conflicts between principals (owners) and their agents (managers). As rightly said, “Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company” Adam Smith (1776) cited in Jensen and Meckling (1976). The focus of the firms is to protect the interests of shareholders, that is, return on financial capital. The dispersed ownership and efficient capital markets would practically go together. This existence of efficient capital markets has two implications. It increases the probability of corporate takeover on the one hand and might bring more transparency to corporate functioning on the other. Furthermore, this model is characterized by a unitary (one-tier) board where directors are appointed by the shareholders. The board of directors comprises inside directors and outside/independent directors headed by a managing director (MD)/chief executive officer (CEO). In today’s Anglo-Saxon firms, financial institutions own most of the firm’s shares. These institutions work on portfolios and thus diversify their risk (Gunay, 2008). Plender (1998) has pointed out that sticking to the mindset of shareholders being residual risk takers thus no longer makes sense. This is because when financial institutions are unhappy with the functioning of a firm, they simply sell their equity and move out. Institutional investor behavior reveals that in today’s times, financial institutions are no longer passive investors. They actively participate in the monitoring of the firms they invest in by exercising their voting rights and/or taking a seat on the Board. A study by Kansil and Singh (2017) emphasized the importance of the activism of financial institutions in the governance of firms as well as their much-needed attention to exercising their voting rights in their portfolio companies.

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Japanese Model ● Interdependent mutual self-interests of all parties prevail which serves as a check on one another. ● Focus is on the conduct of business and Return on Social Capital.

The Japanese Model is characterized by cross holdings and trading relationships of firms through acquisitions/alliances among industrial groups18 (keiretsu). The focus is on the transaction network between committed shareholders via information sharing. Banks and other financial institutions provide finance—both debt and equity. Generally, banks hold a majority of shareholdings with one bank as the lead bank, called Main Bank. These banks are a part of a larger structure (keiretsu) with long-term commitments. The main bank appoints the board of directors of firms they invest in, while other banks and financial institutions play a passive role. Inside directors dominate (who are appointed by these shareholders with interlocking interests). The firms operate as autonomous units. Banks and financial institutions intervene only when firms have low earnings, portray poor stock performance or are badly governed. In either of such instances, the main bank intervenes and exercises oversight over management. With the presence of the main bank, the system works as an automatic mechanism similar to the market for corporate control19 and simultaneously reduces opportunism among multiple participants. Another characteristic of this model is that retired government officials enter the management of firms and thus push government policy implementation. Practically, these officers act as monitors of the monitors, that is, the board of directors of the firms. In this way, the government intervenes indirectly in the management of firms (Rubach & Sebora, 1998). 18 Industrial groups refer to multiple participants with cooperative and competitive relationships who have interlocks/cross holdings of debt and equity in various firms. 19 Glossary of Industrial Organization Economics and Competition Law, compiled by R. S. Khemani and D. M. Shapiro, commissioned by the Directorate for Financial, Fiscal and Enterprise Affairs, OECD, 1993 defines Market for Corporate Control as “the process by which ownership and control of companies are transferred from one group of investors and managers to another in an economic system where the voting stock (shares) of companies are publicly bought and sold through the mechanism of a stock exchange”.

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However, another important feature of this system is the participation and involvement of committed employees working in the firms for a long time who are appointed on the board. Thus, employees enter decision making, and the system works on stakeholder theory, where the firm works for the benefit of all its stakeholders. German Model ● Firms are engines of wealth creation with multiple risk bearers. Mutual self-interest of employees and creditors provides control and incentive. ● Return on Human Capital. ● The notion of “company’s best interests” prevails, that is, BOD/ Management should work in the best interests of all stakeholders (Cahn & Donald, 2010). ● Two-tier system.

The German Model exists in Germany and Continental Europe (European Union). The universal bank provides both debt and equity to firms working as per the German model. The shareholdings of firms are concentrated with the presence of many cross-holdings. It is a relationship-oriented bank-dominated system, where stocks are cross-held among companies. Small investors are virtually absent. As a result of concentrated shareholdings, stocks are not traded, and a few shareholders own substantial voting rights and control the firms. The insiders work in consultation with the main bank. The main bank plays many roles that further lead to information, consultation, and cooperation and guarantees the bank’s participation in business decisions; thus, it is called the universal bank. Rubach and Sebora (1998) have mentioned various roles of the main bank as follows: “firm’s principal bank for the lending business, a member of its issuing Syndicate, a manager of large portfolios of private investors, a shareholder, a voter of shares under the depository scheme and a holder of seats on supervisory boards ”. This ensures the focus of management on medium- and long-term strategic planning. However, due to listing restrictions, the stock market is less developed and is illiquid. The notion of the market for corporate control does not prevail. Legal protection to shareholders is little, and disclosure standards are low, which leads to conflict between controlling shareholders and non-controlling shareholders.

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Another feature of this model is the issue of dual-class shares by firms where one class of shares has more voting rights than another. Both public and private companies work as two-tier systems with separate executive boards and supervisory boards. Employees elect one-third or one-half of the directors of the supervisory board. The remaining directors of the supervisory board are the representatives of large/concentrated shareholders. The supervisory board elects the executive board that runs the firm. Family-Based Model ● Firms are family managed with focus on wealth preservation (Chandler, 1990) ● Business with specific customers and suppliers is preferred (Carney et al., 2011) ● One tier system.

The family-based model is prevalent in many emerging economies, such as India,20 Korea, Brazil, Mexico, and Turkey. The firms characterized as family businesses have a founding entrepreneur, also called the promoter, who along with his/her kin/relatives and associates dominate and run the firm. The promoter and his family are also called the owner-managers, and they run the business as per their distinctive vision (Chua et al., 1999) and personal value systems (Gedajlovic et al., 2005). In other words, managerial authority and capital provision are in the hands of the same individuals (Carney et al., 2011) whose ownership is typically unchallenged by other shareholders (La Porta et al., 1999). Other stakeholders perceive the business as an owner-managers business, called “their business”, run with their money wherein private wealth will be transferred to succeeding generations. Hence, the authority of owner-managers remains largely unchecked (Carney et al., 2011). These owner-managers operate on relational norms as per socially embedded

20 Large corporate houses in India like Tatas, Birlas, Ambanis, Adanis and so on are family controlled businesses. These account for more than 70% of India’s GDP (see: https://economictimes.indiatimes.com/small-biz/entrepreneurship/indian-familybusinesses-can-take-a-cue-from-germany-and-japan-deloitte-indias-k-r-sekar/articleshow/ 87013009.cms?from=mdr).

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practices and transactions through tacit agreements (Hamilton & Biggart, 1988). Generally, such firms obtain growth capital from banks without bank intervention in business affairs. Carney and Gedajlovic (2002) have mentioned that such growth capital has unfolded the presence of family business houses, particularly in Asia. Family-owned firms are run by a unitary board. The controlling family appoints the members of the board among their friends, relatives, associates, and/or selected insiders. The firm CEO is generally a family member (Amit & Villalonga, 2004). Managers work for and work as per the wishes of the controlling family. As a result, a conflict of interest arises between the controlling family and the minority shareholders. Such firms may operate to extract private gains21 for the family and/or create wealth for the family. Another important dimension of the family model is the efficient use of resources by owner-managers since they have managerial control and claim on the profits of the firm. However, such a claim is dependent on the ownership stake. A study reveals that a stake below 10% would provide inadequate incentives for efficiency and a stake above 20% accrues negative performance in terms of expropriation of minority (Morck & Yeung, 2003). Thus, the governance issue in the case of the family model is that of expropriation of the minority, which is unduly high in countries where there exists an absence of protection of minority shareholders’ rights compared to others with strong protection of minority shareholders’ rights.

1.5

Conclusions

The present chapter makes an attempt to review various definitions of corporate governance. It also tries to bring out a clear picture of the true nature and usage of the term “corporate governance” after looking at various distinct definitions of corporate governance. In other words, corporate governance implies running businesses in the best interests of all stakeholders. It is quite clear from the forgoing that there is no uniform definition of corporate governance given thus far. It has been defined differently by different experts. Different theories of corporate governance viz. Agency theory, stewardship theory, stakeholder theory, 21 Private gains for the family accrue when assets are sold at less than market prices to related parties/associates.

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resource dependency theory, and managerial hegemony theory bring forth the basis of such meanings. This is universally accepted now that corporate governance practices play a key role in an economy’s growth and development, and there is an urgent need to further strengthen the channels of corporate governance to obtain synergistic impacts. We have also discussed in this chapter various models of corporate governance, such as the Anglo-Saxon Model, Japanese Model, German Model and Family-Based Model. However, it is argued that governance models across and within countries depend upon three governance characteristics, namely, board of directors, corporate ownership and legal systems (Aguilera et al., 2011). In practice, many configurations of these three characteristics exist within and across countries as well as firms within one country. Therefore, it will not be justifiable if all firms of a country are put under any one model of governance. For example, in India, we have firms that are owned by one family having majority shareholding (for example, Reliance Industries with 50.29% shareholding of promoters as of December 31, 2022), and we too have firms with dispersed ownership (such as Infosys with only 15.11% shareholding of promoters as of December 31, 2022). Undeniably, the choice regarding the level of governance practices should be the prerogative of concerned firms. It is quite possible that some firms may like to fulfil just the minimum corporate governance requirements laid down by the respective governments or regulatory bodies in concerned countries. There might exist a few other firms that might like to go extra mile to go beyond the minimum requirements. The latter may motivate many other upcoming or existing firms to follow suit. We would like to mention that there is a skepticism regarding the view expressed by Hansmann and Kraakman (2004) regarding the convergence of corporate governance systems. However, the alternative view on the divergence of corporate governance systems (Aguilera et al., 2011; Khanna et al., 2003; Whitley, 1999) carries more weight and seems to be closer to reality and may be acceptable to many like us.

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CHAPTER 2

Corporate Governance in India: An Evolving Landscape

2.1

Introduction

India embarked on the path of economic reforms in 1991. However, an immediate backlash to the reform process came in the form of a few domestic financial scandals (such as the Harshad Mehta scam of 1992 and Chain Roop Bhansali Scam of 1996) and regional and global financial crises (namely, the Asian Financial crisis in 1998 and the global financial crisis in 2007–08), which exposed many institutional and policy weaknesses in the corporate governance (CG) structures of India and led to the introduction of multiple reforms. With the growing influence of India in Asia and G-20 (Group of 20), the spread of awareness of the Organization of Economic Co-operation and Development (OECD) Principles of Corporate Governance, CG reforms in India have assumed great relevance. These reforms are critical to underpin sound economic growth and value creation. The last three decades have witnessed several key structural CG reforms in India that were recommended by key committees (such as Kumar Mangalam Birla Committee on Corporate Governance, Naresh Chandra Committee on Corporate Audit and Governance Committee, N.R. Narayan Murthy Committee, and Kotak Committee) constituted for this purpose. Legislative, regulatory, and policy measures have been designed and implemented in India to provide and promote an enabling framework for corporate governance in India. Most Indian regulations

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are based on the Anglo-Saxon model1 of governance, with few or slight modifications to be applicable in the Indian context. Given this backdrop, this chapter traces the evolution of the CG regime in India, presenting key structural reforms in the last three decades starting from the early 1990s, which marks the decade of economic liberalization in India. The chapter first briefly summarizes the historical perspective taking stock of the CG regime as it exists today. The journey highlights the shift from an “approval-based regime” to a “disclosurebased regime”. The objective of the chapter is to highlight the pressing issues and bring out specific action points needed to further strengthen the CG regime in the Indian context.

2.2

Historical Perspective

The corporate form of business came into existence in India way back in the seventeenth century. Before that, kings of different parts of the country led businesses as per their trade patterns. Tripathi (1971) mentions that the onsets of British rule in India expanded many business horizons. A huge number of agency houses were established that were adjuncts of British firms in London. The agents originally served Britishers but later, owing to lesser profits, resigned from British entities and started an agency business. Trade and commerce expanded in India, and soon in 1813, East India Company lost its monopoly in Indian trade (Sarkar, 1989). However, in 1850, cotton and jute mills were established. The notion of companies was introduced, and the first Joint Stock Company Act was passed in 1850, which was repealed in 1857, introducing the concept of limited liability. From 1857 to 1956, Indian businesses continued to function as corporate entities, as they were the institutions of managing agents. Managing agents were the individuals or other business firms who under a contractual obligation would manage the affairs of the entity. Such a system of corporate functioning is termed the “Managing

1 The Anglo-Saxon Model is the model prevalent in the US, UK, and many other

countries. The model is also called the outsider system. The ownership of firms in these countries is usually dispersed characterized by the inability and weakness of owners vis a vis managing such large firms. This has led to managerial control of firms with conflicts between principals (owners) and their agents (managers). For a detailed discussion refer to Chapter 1.

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Agents Model” (Reed, 2002). Managing agents had undue powers due to the absence of stock markets and the inability of the capital market to provide finance. As a result, firms were dependent on managing agents both for finances and management. The overall control of managing agents prevailed until 1913. Later, during the period 1914 to 1947, industrial family business companies emerged wherein directorships were held by family members. At the time of independence in 1947, the economy had a functional stock market, a central bank—the Reserve Bank of India, a large commercial bank—the Imperial Bank of India2 as well as a flourishing manufacturing sector with the adoption of British norms of CG. Reed (2002) mentions that soon after independence, the managing agents grabbed new economic opportunities to promote new businesses as encouraged by the then new government, and the business house model of corporate governance gradually emerged. In the postindependence era from 1947 to 1991, the Indian economy worked on the socialist model, where a major role was assigned to the public sector. The focus of the government was on “import substituting industrialization, planned central allocation of government funds, and the use of the public sector for this purpose” (Mohan, 2021). The managing agents model gradually disappeared, and the “Business House Model” took its place. Companies Act 1956 introduced the management of firms by an elected board of directors and safeguarded the interests and rights of shareholders. However, the dominance of family-controlled businesses was seen. The businesses controlled the inflow of foreign investment, and the government controlled these from various means, such as representation on the board, called nominee director, government approvals, disclosure norms, maintenance of records, etc. Such government control led to the growth of Indian businesses and helped in checking the concentration of economic power in the hands of a few. Evidence reveals that during this time, large business houses entered into various philanthropic activities as a part of their corporate social responsibility, which further strengthened the government’s objective of social welfare. However, the rent-seeking behavior of government officials, politicians, and bureaucrats benefitted selected few. In other words, the business-government nexus facilitated the granting of licences, approval of loans, etc., to the selected few, and as a result, the private 2 The Imperial Bank of India was subsequently transformed into the State Bank of India in 1955.

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sector flourished but with selected players. Even if firms raised funds from the nationalized banks,3 those banks could not exercise oversight over their management. As a result, firms were managed by their concentrated owners. The Companies Act, 1956, laid limited standards of governance and disclosure. Firms provided limited disclosures as per the listing agreement of the stock exchanges and the applicable accounting standards. Furthermore, government policies were such that foreign competition was suppressed, which further led to the concentration of power in the hands of selected few.

2.3

Chronology of Three Decades of Reforms

There has been an increased focus of investors and other stakeholders on the stakeholder value creation model4 over the last two decades (Freeman, 1994), wherein businesses would be both profitable and sustainable. This would also ensure compliance with the wider long-term objective of businesses being responsible for the environment and society. To ensure that it has come to the forefront emphatically that businesses are to be well governed and run in an ethical manner. Prior literature has argued that ownership structures and national governance systems are path dependent. Moreover, the economic environment and institutional setup of a particular country impacts the evolution of ownership structures and governance systems. CG reforms in India have been introduced by the Government of India (GOI) and the Securities and Exchange Board of India (SEBI), which have intervened through legislation and statutory regulations. It is important to mention that when CG regulations were not mandated by the GOI or SEBI (prior to 2000), there were certain stakeholders5 in India

3 The Nationalized Banks were the principal provider of finance, both debt and equity, to private firms and the firms could raise equity only at government-set prices. 4 According to this model, the firm is responsible to and operates for all the stakeholders and not just for shareholders. So the objective of the firm is stakeholder value creation and not shareholder value creation. This is in line with the Stakeholder theory discussed in Chapter 1. 5 For example, the Confederation of Indian Industry (CII) came out with the voluntary code of CG entitled “Desirable Corporate Governance - A Code” in the year 1996 (adopted in 1998).

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who were voluntarily pushing governance norms and setting precedence for others for good governance. Sarkar and Sarkar (2012) argue that despite the varied terms of reference of various committees, one common thing is that they all advocate the principle of shareholder value maximization alongside taking care of stakeholders’ interests. The recommendations of committees have largely focused on horizontal agency problems due to the existence of a familybased model such as shareholder rights and value, board independence and monitoring, and strengthening the market for corporate control along with adequate disclosures on related party transactions, to name a few. In the next section, we will present the chronology of reforms since 1991 by dividing the same into three subsections. The First Decade of CG Reforms (1991–2000) The economic crisis in India began in 1990 and further deepened in 1991–1992. A plethora of comprehensive reforms in all policies ranging from industrial to trade policy reforms and from exchange rate to financial sector reforms were introduced in India. The industrial sector was deregulated through dereservation, delicensing or scrapping of the MRTP Act. The services sector also followed suit through various reforms covering banking, insurance and telecom sectors, etc. The expectation was that these policy actions would not only restore economic health but also put India on a higher growth trajectory. The change in strategies of growth from an import substitution to ‘services-led-growth strategy’ (a concomitant export-led growth strategy) seemingly made ‘India unstoppable’ (with 9.2% growth in 2006–2007 and an average growth rate of 8.6% for 3 years from 2004–2007) and pushed India out from the ‘Hindu Rate of Growth’ phase6 (see Joshi, 2010). This led to improvement in FDI inflows to India from 129 million $ in 1991–1992 to 2155 million $ in 1999–2000 (Dutta & Sarma, 2008). Although India started aspiring for a higher growth rate of 9% in the eleventh five-year plan, the growth rate of the economy averaged 8% during the plan’s implementation period because the two global crises, one in 2008 and another in 2011, impacted the performance of the economy. The growth rate of the economy plummeted to 5% in 2012–2013. The government of India had to address

6 Slow growth of 3.5% per annum of yesteryears.

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twin challenges—reversal of the deceleration in growth by reviving investment and introduction of policy actions to leverage the strengths of the economy to bring it back to its real growth potential (Joshi, 2014). In 1992, the Government of India constituted the Securities and Exchange Board of India (SEBI). The objective was to formulate regulations and guidelines that not only monitor and regulate the Indian capital and securities market but also ensure the protection of the interests of investors. The move led to fairly steady growth, and by the mid-1990s, Indian businesses had begun to reap the benefits of outsourcing and procuring finance capital from foreign investors. However, such foreign capital mandated a fairly good CG climate, and as a result, major CG reforms took place in the mid-1990s. By that time, the Indian CG regime was far from satisfactory, and major CG initiatives were the need of the hour to fulfil the domestic needs of capital. The period from 1991 to 2000 witnessed resurgent interest in comparative law studies globally, which further helped in building the case for strong CG regimes. This was because elements of company law, namely, ownership and control of the firm as well as the relationship between ownership and control, have significant implications for the development of the CG regime of a country. The Indian CG regime drew heavily from the Anglo-Saxon Model (with a one-tier board), which was explicit in some committee reports and implicit in others. The Indian CG regime borrows heavily from the respective CG regimes found in the USA and the UK based on the Anglo-Saxon Model. The prevalent CG regime of India is largely based on the reports, codes and principles that are followed in the US, UK and Organization for Economic Cooperation and Development (OECD) countries.7 It is important to mention that extensive consultations with Indian business leaders and other stakeholders were carried out before going ahead with these reforms. As India aspired to raise standards and drive reforms, the Confederation of Indian Industry (CII),8 the leading industry association in India, took the first institutional initiative in 1996 and started contributing to the CG movement in India (See Fig. 2.1). It constituted a National Task 7 For example, the Cadbury Committee Report and Combined Code of London Stock Exchange of the UK, the Blue Ribbon Committee and the Sarbanes Oxley Act of the US, the OECD Principles of Corporate Governance of G20/OECD countries. 8 CII worked to create and sustain an environment conducive to the growth of industry and partnering industry and government alike through advisory and consultative processes.

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Fig. 2.1 The first decade of corporate governance reforms (1991–2000)

Force with Mr. Rahul Bajaj as the Chairman. The task force gave the first voluntary code of CG entitled “Desirable Corporate Governance— A Code” to develop and promote a code for Indian companies. The Code, which was adopted in 1998, outlined a series of best practices to be adopted voluntarily by companies—with a focus on Board structure and Accountability to investors. The said Code was well accepted and welcomed. A few companies with a will to lead on the path of good governance, more transparency, and greater disclosures adopted the Code. In addition, several companies reviewed their existing governance practices to obtain a clear picture of their operating mechanisms and board structures. In the 1998–1999 annual reports, some companies reported the extent to which they have complied with the Code. In addition to dealing with the aspect of governance practices at the firm level, at this point, the government felt the need to take suitable measures to promote investors’ awareness, protect the interests of investors, and educate them, which would gradually increase the number of investors in Indian capital markets. In this context, in 1999, the Ministry of Corporate Affairs (MCA) set up the Investor Education and Protection Fund (IEPF) under Section 205C of the Companies Act, 19569 by way of the Companies (Amendment) Act, 1999. The Fund not only equipped investors to analyse available information but also made them aware of their rights and responsibilities. As per Annual Report 2020–21 (MCA, 2021) of the Investor Education and Protection Fund Authority, in addition to several media advocacy initiatives, more than 9 The same has been extended as Section 125(1) of the Companies Act, 2013.

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55,000 investor awareness programs have been conducted in rural and urban areas thus far. Dissemination of information via several platforms to multiple stakeholders about unscrupulous elements and unfair practices in the securities market helped the investors to make informed decisions, which further encouraged new investors to participate in the capital market. There had been no formal CG regulations applicable to Indian corporations until 1999. Therefore, a strong need for some statutory regulations was felt. To address this gap, SEBI set up a committee on CG in 1999 called the “Kumar Mangalam Birla Committee on Corporate Governance” to provide recommendations to further improve the disclosure of financial and nonfinancial information via disclosures that enable shareholders to know where the companies in which they have invested stand for specific initiatives taken to ensure robust CG. The Committee emphasized the responsibilities of independent directors and audit committees, among others. Specific recommendations were made regarding board representation and independence as well as the functioning and constitution of the audit committee. The report of the committee took note of the adoption of the Anglo-Saxon model in the Indian context with a one-tier board. In February 2000, SEBI reviewed its listing agreement and introduced Clause 49 of the Listing Agreement to incorporate the CII’s voluntary code as well as to include the recommendations of the Kumar Mangalam Birla Committee Report. Stock exchanges were entrusted with the task of monitoring the compliance of Clause 49 by Indian companies and submitting a Compliance Report to SEBI. Clause 49 was a landmark CG regulation for two reasons. First, listed corporates had to comply with the mandatory provisions of the said clause or else explain reasons for noncompliance.10 Second, listed corporates had to disclose in their annual report, as a separate section by the name, Corporate Governance Report mentioning their compliance with the said clause. This facilitated stakeholders to evaluate the entity’s CG procedures. However, many corporates treated the Corporate Governance Report as a tick box exercise and followed the mandate only in letter and not in spirit.

10 Certain nonmandatory requirements were also included in Clause 49. The corporates were required to highlight the adoption of nonmandatory requirements if any.

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The Second Decade of CG Reforms (2001–2010) The evolution of sound CG standards and codes along with recognized best practices the world over pushed emerging countries to chalk out a course of action for adoption of the same. This required study, review, and comparison of the current status of corporate governance vis-à-vis the internationally accepted principles, codes, and best practices. The CG models comprehensively reviewed those prevailing in East Asian countries, the U.S., the U.K., and other European countries. In this light, in April 2001, the Reserve Bank of India (RBI) constituted the Advisory Group on Corporate Governance: Standing Committee on International Financial Standards and Codes (RBI, 2001) to compare the level of adherence of CG in India vis-à-vis relevant international best standards. The Advisory Group’s report mentioned priority actions to bring quick reforms to improve CG standards in all entities, namely, corporations/ banks/financial institutions/public sector enterprises (see Fig. 2.2). Later, in December 2002, the Naresh Chandra Committee on Corporate Audit and Governance constituted by the Department of Company Affairs (DCA) under the Ministry of Finance and Corporate Affairs, Government of India (GOI) examined various CG issues. The Committee in its report (GOI, 2003a) pinpointed independent board oversight, independent auditing, and improvement in both financial and nonfinancial disclosures. The Committee further suggested changes in different areas, such as the statutory auditor and company relationship, the procedure for

Fig. 2.2 The second decade of corporate governance reforms (2001–2010)

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appointment of auditors, the need for rotation of auditors and determination of audit fees, restrictions if required on nonauditory fees, services, and measures to ensure that management and companies put forth a true and fair statement of financial affairs of the company. The year 2003 witnessed various actions in the CG domain. The first step was the establishment of another committee by the Ministry of Finance called the Committee on Regulation of Private Companies and Partnerships under the chairmanship of Shri Naresh Chandra called Naresh Chandra Committee II (GOI, 2003b). The committee focused on providing recommendations for a scientific and rational regulatory environment under (a) the Companies Act, 1956; and (b) the Partnership Act, 1932. The focus of recommendations was kept on providing adequate flexibility to entities providing professional services. At the same time, effective regulation should be ensured through liberalized provisions for private companies. SEBI at that time also felt the need to initiate further reforms given recent corporate failures of the US and limited compliance with Clause 49 of the Listing Agreement observed by Indian stock markets to date. In response to this, SEBI came out with a report on Corporate Governance, which is known as N. R. Narayana Murthy Committee Report (SEBI, 2003). The aim was to introduce best CG practices in a well-regulated environment after duly studying/ reviewing the role of independent directors, related parties, risk management, directorship and director compensation, codes of conduct, and financial disclosures. N. R. Narayana Murthy Committee Report identified governance requirements for corporate boards, audit committees, shareholder disclosure, and CEO/CFO certification of internal controls. This constituted the largest transformation of the governance and disclosure standards of Indian companies. This was followed by the formation of the National Foundation for Corporate Governance11 (NFCG) by the Ministry of Corporate Affairs to promote good CG practices both at the firm level and industry as a whole. The foundation served as a platform for deliberations on CG and corporate social responsibility (CSR), extensive research, and building international linkages. Meanwhile, to build a transparent and globally acceptable corporate environment in India to attract foreign investments, the J. J. Irani Committee on Company Law (GOI, 2005) was set up by the Ministry

11 For further information and details refer: https://www.nfcg.in/default.aspx.

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of Company Affairs (MCA) in 2004. The Committee proposed revisions to the Companies Act 1956 to enable the adoption of international best practices without foregoing adequate flexibility to meet specific requirements of the Indian corporate sector. Drawing on the recommendations of the abovementioned Irani Committee, the MCA proposed Companies Bill 2008, which was later reintroduced as Companies Bill 2009.12 The bill proposed the introduction of best international practices and a regulatory environment that would not only stimulate investments but would also encourage entrepreneurship in India. The proposed bill was a noticeable departure from the existing Companies Act since it included significant provisions on CG practices related to minority shareholders’ rights and protection, obligations of the board, and board size, among others. In the urge to shape the Indian CG regime as one of the best in the world, SEBI amended/revised Clause 4913 of the Listing Agreement five times (in 2003, 2004, 2006, 2008, and 2010) based on recommendations of various Committee Reports and feedback received from stakeholders. The Revised Clause 49, which came into operation on January 1, 2006, enhanced governance practices and disclosures with the dominance of five broad themes: independence criteria for directors, roles and responsibilities of the board, quality and quantity of corporate disclosures, roles and responsibilities of the audit committee (in all matters relating to internal controls and financial reporting), and the accountability of top management—specifically the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO). The amendment of the Listing Agreement in 2008 extended the 50% independent directors’ rule to all Boards of Directors where the nonexecutive chairman is a promoter of the company or related to the promoters of the company. In response to the Satyam scandal of 2009 and further recognizing the fact that the proposed Companies Bill will take some time to be enacted, the Ministry of Corporate Affairs (MCA) issued ‘Corporate Governance—Voluntary Guidelines 2009’. The voluntary guidelines took into account the recommendations of the Task Force set up by the Confederation of Indian Industry (CII) under the chairmanship of Shri 12 Available at: https://www.nfcg.in/pdf/21_Report_Companies_Bill-2009.pdf. 13 As mentioned earlier, SEBI introduced Clause 49 of the Listing Agreement in

the year 2000 to incorporate the CII’s voluntary code as well as to include the recommendations of the Kumar Mangalam Birla Committee Report.

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Naresh Chandra in February 2009. The Task Force recommended ways to further improve CG standards and practices. The voluntary guidelines addressed several current concerns in the area of CG and were expected to result in creating a system of transparent and accountable corporate functioning. In addition, the MCA issued the “Voluntary Guidelines on Corporate Social Responsibility” with the desire that the Indian corporate sector voluntarily adopts high standards of both social responsibility and governance. Here, the words of Mr. N. R. Narayana Murthy, Chairman, and Chief Mentor, Infosys, are worth quoting. It is important to underline here that governance should not be limited to excessive focus on compliance but should also focus on the ethical and effective leadership of organizations. This is the spirit of the report. Embracing good governance cannot be mandated and over-regulated; it must be deeply embedded in the basic fabric of every organization. Best-in-class governance is voluntary and stems from the values and standards which are integral to the company and which must be upheld at all times. Whatever the regulatory framework and the overall governance structure, there are a series of best practices which organizations should consider adopting voluntarily to generate long-term value for the corporation.

The above lines are taken from the Voluntary Guidelines (NASSCOM, 2010) released in 2010, formulated by the Corporate Governance and Ethics Committee of India’s National Association of Software and Service Companies (Nasscom), the premier trade body and the “voice” of the Indian IT—BPO industry. These voluntary guidelines were to come under the ambit of the “Corporate Governance and Ethics Report” intending to establish the highest standards of probity and CG within the IT-BPO industry. Although these guidelines and best practices were tailored to the unique facets of the Indian IT-BPO industry, they proactively brought forward the dimension of ethics, conduct and values within the business domain. In addition to being best-governed entities, it is essential that entities recognize the importance of business ethics along with environmental and societal concerns that impact their reputation and long-term performance. Needless to say, unless an entity embraces and demonstrates ethical conduct, it will not be able to succeed, especially in the long run.

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The Third Decade of CG Reforms (2011–Till Date) By the beginning of the third decade of CG reforms, India had a fairly well-established framework of CG standards and practices. However, a strong need was felt for synchronizing the existing Company law with the efforts and practices laid down by the securities market regulator SEBI. In response, the new Companies Bill was introduced in 201114 to incorporate best CG practices into the ambit of company law. Along with the market regulator SEBI, MCA in participation in the promotion of best CG practices revised “Voluntary Guidelines on Corporate Social Responsibility” (released earlier in 2009) as ‘National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business (NVGs)’ (GOI, 2011). The Guidelines contained nine comprehensive principles to be adopted by companies as part of their business practices and suggested a structured reporting framework for business responsibility reporting (BRR). The said framework facilitated businesses to provide necessary information to all their stakeholders and thereby meaningfully engage with them. In this process, businesses could develop a better understanding of their business operations to transform to a resilient and sustainable one. The reporting framework designed on the ‘Apply or-Explain’ principle encouraged credible reporting and disclosures (see Fig. 2.3). These Guidelines laid the foundation for comprehending and implementing Responsible Business Conduct (RBC)15 by all businesses, whether big or small, listed or unlisted. Later, in 2012, SEBI16 mandated filing of Business Responsibility Reports (BRR) by the top 100 listed companies by market capitalization (at Bombay Stock Exchange and

14 In June 2011, India endorsed United Nations Guiding Principles on Business and Human Rights (UNGPs) adopted by The United Nations Human Rights Council (UNHRC). 15 Responsible Business Conduct is a term used for all business entities, both domestic and international, wherein entities are encouraged to make positive contributions to economic, environmental and social progress and at the same time minimize the difficulties which may arise due to their various operations. The explanation is adapted from OECD (2011), OECD Guidelines for Multinational Enterprises, OECD Publishing. Available at: https://www.oecd.org/daf/inv/mne/48004323.pdf. 16 SEBI Circular available at: https://www.sebi.gov.in/legal/circulars/aug-2012/bus iness-responsibility-reports_23245.html.

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Fig. 2.3 The third decade of corporate governance reforms (2011–Till Date)

National Stock Exchange17 on March 31, 2012, with an effect from financial year ending on or after December 31, 2012) by inserting a new Clause 55 to its Listing Agreement. The Business Responsibility Reports (BRR) as per the suggested framework would be a part of the annual report of listed entities to contain detailed disclosure of initiatives taken by the listed entity from an environmental, social and governance (ESG) perspective. This marked the beginning of the era of mandatory specified disclosures by listed entities showcasing steps taken to implement the nine principles as presented by the National Voluntary Guidelines (NVGs). This was the beginning of a continued focus on ‘Responsible Business Conduct’, which was far wider in scope than Corporate Social Responsibility (CSR) since responsible business encompasses the Social, Environmental and Economic responsibilities of businesses that are to be balanced in an ethical manner. Accordingly, the said Guidelines use the term ‘Responsible Business’ instead of CSR. The Guidelines were a stepping stone toward the inclusion of social and environmental aspects along with economic aspects within business operations since the guidelines embraced the “triple bottom-line” (TBL) approach. TBL urges businesses to harmonize their financial performance with the expectations of society, the environment and its stakeholders. It is expected that the adoption of these guidelines by corporate entities/businesses would bring multiple gains to all in the form of an increase in competitive strength, a better 17 Bombay Stock Exchange (BSE) is the Asia’s oldest stock exchange and National Stock Exchange (NSE) is the biggest stock exchange in India.

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reputation, better stakeholder management, a reduction in the carbon footprint and the ability to attract and retain talent, to name a few. The enactment of The Companies Act, 2013, further provided legal and formal disclosure and reporting for CG practices. The Act introduced the requirement of appointing a resident director or a woman director along with certain other important provisions, such as the appointment of the Stakeholders Relationship Committee, the Whistle blower mechanism, and the performance evaluation of the board, committee and individual directors. In addition to transparency and disclosure, undoubtedly, these requirements promote and enhance responsibility, accountability and fairness in the conduct of companies. As desired, after the enactment of the Companies Act in 2013, SEBI amended Clause 49 of its Listing Agreement (in the same year, 2013) to bring it in line with the new Act. The year 2014 witnessed yet another amendment in Clause 49 with the insertion of the requirement for the Board of Directors of listed entities to have an optimum combination of executive and nonexecutive directors with at least one woman director and not less than 50% of the Board of Directors comprising nonexecutive directors.18 However, the timeline to comply with the requirement of a woman director was later extended to March 31, 2015. Meanwhile, in 2015, the professional body for Company Secretaries— the Institute of Company Secretaries of India (ICSI) issued Secretarial Standards on “Meetings of the Board of Directors” (SS-1) and Secretarial Standards on “General Meetings” (SS-2). The requirement as mandated by Section 118(10) of the Companies Act, 2013 provides that every company (other than One Person Company) shall observe secretarial standards specified as such by the ICSI concerning General and Board meetings. This facilitated integration, harmonization and standardization of CG practices across all companies. Another landmark step was taken by SEBI in 2015 with the release of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations (SEBI LODR), 2015, to harmonize the provisions of the Companies Act, 2013 and the Listing Agreement. It was considered an important transition from the earlier

18 SEBI Circular available at: https://www.sebi.gov.in/legal/circulars/apr-2014/cor porate-governance-in-listed-entities-amendments-to-clauses-35b-and-49-of-the-equity-lis ting-agreement_26674.html.

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Listing Agreement, which required a separate listing agreement by a single company for each class of security, e.g., equity and debt. In November 2015, SEBI19 revoked its previous circular of 2012 and revised the suggested format of BRR and notified that the requirement for mandatory filing of BRRs would be extended to the top 500 listed entities by market capitalization. Later, in December 2019, the mandatory filing of BRR was progressively extended to the top 1000 listed entities by market capitalization.20 With the objective of further improving the CG standards in India, SEBI constituted another committee on CG called the “Kotak Committee on CG” under the Chairmanship of Shri Uday Kotak in June 2017. The Committee considered diverse issues and gave its recommendations (SEBI, 2017) in October 2017 relating to the independence of Independent Directors; safeguards and disclosures about Related Party Transactions, Accounting, Auditing; Board Evaluation practices; and issues faced by investors relating to disclosure, transparency, voting and participation in general meetings. SEBI accepted certain recommendations with modifications and certain others without modifications and revised its Listing Regulations in May 201821 dealing with Woman Director on the Board, Chairperson of the Board, Disclosures on Board Evaluation and Group Governance Unit, to name a few. The amendments laid a strong foundation for a robust monitoring and enforcement mechanism with mandatory disclosures for listed entities to be gradually applicable in a phased manner.22

19 SEBI Circular available at: https://www.sebi.gov.in/legal/circulars/nov-2015/for mat-for-business-responsibility-report-brr-_30954.html. 20 SEBI Notification available at: https://lexcomply.com/pdfview3.php?file=7423. 21 SEBI Notification May 9, 2018, available at: https://www.sebi.gov.in/legal/reg

ulations/may-2018/sebi-listing-obligations-and-disclosure-requirement-amendment-regula tions-2018_38898.html. SEBI Circular May 10, 2018, available at: https://www.sebi.gov.in/legal/circulars/ may-2018/circular-for-implementation-of-certain-recommendations-of-the-committee-oncorporate-governance-under-the-chairmanship-of-shri-uday-kotak_38905.html. 22 SEBI Board Meeting held on February 15, 2022, decided that the provision for mandating Separation of the role of Chairperson and MD/CEO of listed companies which was to be applicable from April 01, 2022 (earlier from April 1, 2020, which was extended by two years in January 2020) for top 500 listed entities shall be retained as a voluntary requirement and not a mandatory one.

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In 2019 (March), the Ministry of Corporate Affairs (MCA) improvised the existing National Voluntary Guidelines on Social, Environmental & Economic Responsibilities of Business, 2011 (NVGs) and released ‘National Guidelines for Responsible Business Conduct’ (NGRBCs) (GOI, 2018). NGRBCs were based on the United Nations Guiding Principles on Business & Human Rights (UNGPs) and would provide a means of pushing businesses to contribute towards wider development goals and be more sustainable, responsible and accountable. The NGRBCs, in addition to keeping with global developments on RBC by entities, not only updated the NVGs but also provided an updated Business Responsibility Reporting Framework (BRRF). The framework included disclosures on initiatives taken by entities for each of the nine Principles of NGRBC against two suggested performance levels, namely, Essential Indicators and Leadership Indicators. In addition, the Ministry of Corporate Affairs (MCA) felt the need to incorporate the current global practices vis a vis nonfinancial reporting to bring Indian entities at par with their foreign counterparts. Henceforth, the MCA constituted a Committee on Business Responsibility Reporting in 2018, which submitted its report in 2020 (GOI, 2020). The said report proposed two new formats to replace existing BRRs, wherein the report would be called the “Business Responsibility and Sustainability Report (BRSR)”. The two formats for disclosures, a Comprehensive format and a Lite version, were envisaged for entities presently preparing BRR and for those who voluntarily go for such disclosures, respectively. The proposed formats were also appended with Guidance Notes to guide and enable entities to disclose their actions/incentives on NGRBCs in a more meaningful manner. In May 2021, SEBI, after public consultation and extensive deliberations with stakeholders, considering the recommendations of the MCA Committee on Business Responsibility Reporting, amended certain provisions of its Listing Regulations23 and discontinued the requirement of submitting BRR by listed companies. In contrast, the listed entities would be required to prepare a new report called the “Business Responsibility

23 Multiple times amendments were made in SEBI LODR in the year 2021 and 2022. SEBI LODR last amended available as on July 25, 2022 at: https://www.sebi.gov. in/legal/regulations/jul-2022/securities-and-exchange-board-of-india-listing-obligationsand-disclosure-requirements-regulations-2015-last-amended-on-july-25-2022-_61405. html.

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and Sustainability Report (BRSR)24 ” as per the prescribed format based on the ESG parameters. The disclosures on ESG parameters would enable entities to engage more meaningfully with their stakeholders as well as identify and assess social and environmental impacts/risks/opportunities/ outcomes of their business operations. Furthermore, such quantifiable and standardized disclosures would assist investors in intra firm and inter firm comparisons and in making informed investment decisions. The preparation of the said BRSR was voluntary for the financial year 2021–2022 and mandatory from the financial year 2022–2023 for the top 1000 listed companies (please refer to Fig. 2.3) by market capitalization (who were mandatorily preparing BRR). However, other companies, namely, listed companies (other than the top 1000) and entities that have listed their securities on the Small and Medium Enterprises (SME) exchange, may voluntarily prepare and disclose BRSR with effect from the financial year 2021–2022 onwards (in place of BRR). This step is a welcome step that would bring nonfinancial reporting at par with financial reporting in India.

2.4

Conclusion

First, the chapter briefly presents the evolution of business houses and corporate law in India. The chapter also outlined the journey of three decades of CG reforms in the case of India since 1992. The CG landscape in India evolved from an “approval-based regime” to a “disclosurebased regime”. The broad picture that emerges after this exercise is how CG reforms have evolved in India by adopting best international practices as per Indian specificities over the three decades. Various reform measures introduced for building investor confidence (such as protection of shareholder rights, accountability of the board, independence of the board, stakeholder value creation, to name a few) have resulted in improved business performance and helped investors become resilient and sustainable. Change in business practices and business reporting from corporate social responsibility (CSR) to corporate governance (CG) to responsible business conduct (RBC) and to environment, social and governance (ESG) norms in such a short span of time is truly appreciable. 24 SEBI Circular available at: https://www.sebi.gov.in/legal/circulars/may-2021/bus iness-responsibility-and-sustainability-reporting-by-listed-entities_50096.html.

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The past experience with respect to the corporate governance reform process tells us that measures taken should not be in response to what others are doing; rather, they should be based on sound theory and outcomes of extensive discussions with all stakeholders. Undoubtedly, understanding various related factors that obstruct the functioning of an effective CG regime, such as delays caused by the lagging and lethargic judicial system, is essential. This also makes it imminent that alternative ways should be explored to address such roadblocks so that India can also move towards having a world-class CG regime. Surely, the measures undertaken by the GOI over the last three decades indicate that we are on the right path towards establishing the best governance systems in the country that carry the potential to deliver better economic outcomes in the near future.

References Dutta, M. K., & Sarma, G. K. (2008, January 1). Foreign direct investment in India since 1991: Trends, challenges, and prospects. Available at SSRN: https://ssrn.com/abstract=1443577 or http://dx.doi.org/https://doi.org/ 10.2139/ssrn.1443577 Freeman, R. E. (1994). The politics of stakeholder theory. Business Ethics Quarterly, 4(4), 409–421. Government of India (GOI). (2003a). Report of Naresh Chandra committee on corporate audit and governance. Department of Company Affairs, Ministry of Finance and Corporate Affairs. Available at: https://www.finmin.nic.in/sites/ default/files/chandra.pdf Government of India (GOI). (2003b). Report of committee on regulation of private companies and partnerships. Department of Company Affairs, Ministry of Finance. Available at: http://reports.mca.gov.in/Reports/3-Naresh%20C handra%20committee%20report%20on%20regulation%20of%20private%20c ompanies%20and%20partnerships,%202003b.pdf Government of India (GOI). (2005). Report of expert committee on company law. Ministry of Company Affairs. Available at: http://reports.mca.gov.in/ Reports/23-Irani%20committee%20report%20of%20the%20expert%20comm ittee%20on%20Company%20law,2005.pdf Government of India (GOI). (2011). National voluntary guidelines on social, environmental and economic responsibilities of business. Ministry of Corporate Affairs. Available at: https://www.nfcg.in/pdf/national_voluntary_guideline s2011.pdf Government of India (GOI). (2018). National guidelines for responsible business conduct. Ministry of Corporate Affairs. Available at: https://www.mca.gov. in/Ministry/pdf/NationalGuildeline_15032019.pdf

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Government of India (GOI). (2020). Report of the committee on business responsibility reporting. Ministry of Corporate Affairs, Available at: https://www.mca. gov.in/Ministry/pdf/BRR_11082020.pdf Joshi, S. (2010). From the Hindu rate of growth’ to ‘unstoppable India’: Has the service sector played a role? The Service Industries Journal, 30(8), 1299–1312. https://doi.org/10.1080/02642060802337331 Joshi, S. (2014). State of knowledge-intensive business services (KIBS) in India. World Journal of Science, Technology and Sustainable Development, 11(4), 271– 281. Ministry of Corporate Affairs (MCA). (2021). Annual report 2020–21 of investor education and protection fund authority. Available at: https://www.iepf. gov.in/bin/dms/getdocument?mds=4LFI%252BOtzsdC%252BOpaCr%252 BWbrg%253D%253D&type=open Mohan, R. (2021). A third-generation strategy for accelerated growth and development in India: Need for government strengthening and. Available at: https:// csep.org/wp-content/uploads/2021/02/Third-Generation-Reforms_M.pdf National Association of Software and Service Companies (NASSCOM). (2010). Corporate governance and ethics report—Voluntary guidelines. Available at: https://www.excellenceenablers.com/pdf/NASSCOM-Corporate-Govern ance-and-Ethics-Report.pdf Reed, A. M. (2002). Corporate governance reforms in India. Journal of Business Ethics, 37 , 249–268. Reserve Bank of India (RBI). (2001). Report of the advisory group on corporate governance. RBI- Standing Committee on International Financial Standards and Codes. Available at: https://www.rbi.org.in/Scripts/PublicationReportD etails.aspx?ID=220 Sarkar, J., & Sarkar, S. (2012). Corporate governance in India. SAGE Publishing. Sarkar, S. (1989). Modern India 1885–1947 . Springer. Available at: http://deb racollege.dspaces.org/bitstream/123456789/482/1/Modern%20India%201 885-1947%20by%20Sumit%20Sarkar%20%28z-lib.org%29.pdf Securities and Exchange Board of India (SEBI). (2017). Report of the committee on corporate governance. Available at: https://www.sebi.gov.in/reports/rep orts/oct-2017/report-of-the-committee-on-corporate-governance_36177. html?QUERY Securities and Exchange Board of India (SEBI). (2003). Report of the SEBI committee on corporate governance. Available at: https://www.sebi.gov.in/ sebi_data/attachdocs/1293094958536.pdf Tripathi, D. (1971). Indian entrepreneurship in historical perspective: A reinterpretation. Economic and Political Weekly, 6(22), M59-M63+M65-M66.

CHAPTER 3

Corporate Governance and Economic Performance—A Micro to Macro Perspective

3.1

Introduction

Economic performance is a term used to measure the achievement of economic objectives, both at the macro and micro levels. Macro level refers to the economy or country where in economic performance is measured in terms of economic growth, level of unemployment, inflation, balance of payments, among others. Likewise, the micro level refers to firms, entities or corporates wherein economic performance is a function of success in producing benefits for its stakeholders, owners in particular, through the efficient use of resources. At the micro level, economic performance is measured in terms of return on assets, return on equity, net profits, market value of the firm, and price earnings ratio, among others. Manyika et al. (2021) mention that the business sector overall contributes 72 percent of GDP in OECD economies and further explain the role of companies in the economy. They present eight pathways through which economic value flows from companies to the economy. Thus, we may conclude that companies are a major contributor to the economic performance of a country wherein all micro level activities/ output sum up to equate to macro level activity/output. Prior evidence indicates that differences in the quality of governance1 across countries impact their pace of growth (Olson et al., 2000). To 1 Governance here refers to governance of a country at the macro level.

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 S. Joshi and R. Kansil, Looking at and Beyond Corporate Governance in India, https://doi.org/10.1007/978-981-99-3401-0_3

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quote, “Cross-country evidence shows that a subset of developing countries is growing very rapidly, taking advantage of opportunities to ‘catch up’ at the same time that other developing countries are growing slowly”. A positive link between improved quality of governance and economic growth has been confirmed by many prior studies (Campos & Nugent, 1999; Knack & Keefer, 1997). Kaufmann et al. (1999a and 1999b), Knack and Keefer (1995) and Mauro (1995) arrive at similar conclusions that governance does matter for economic growth. This view is also validated by studies conducted by international organizations such as the International Monetary Fund (IMF), the United Nations, and the World Bank (for instance, Kaufmann and Kraay (2003). Various other previous studies, both theoretical and empirical, have noted that country-level corporate governance structures2 and their specific design and development have important ramifications for a country’s growth and development and further establish its relative competitiveness in the global market (Carlin & Mayer, 2003; Emmons & Schmid, 1999; Morck et al., 2005). Strong and well-established firm-level good governance (corporate governance structures) not only increases public confidence in corporate functioning but also addresses the management and governance issues of these entities. Kansil and Singh (2018b) identified five key governance issues (KGIs) that would boost the corporate governance regime in the Indian context. Likewise, the existence and resulting benefits of firm-level good governance extend beyond the boundaries of the firm itself and are a significant segment of overall economic growth that a country can experience. Kansil and Singh (2017) inferred that corporate governance, firm-specific advantages and a country’s level of economic development are interrelated. Globally, stakeholders in general and investors in particular demand or desire good governance structures. Unfortunately, the experiences of world economies (emerging economies in particular) reveal that the availability of domestic capital remains inadequate for their economy’s growth and development. There exists a gap between their financial requirement for targeted investments and capital mobilization that takes place locally. External finance via foreign capital fills this gap through developed financial markets. Previous studies (King & Levine, 1993;

2 Corporate Governance structures means firm level governance, which is synonym to the Micro level governance.

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Levine, 1997 and Levine & Zervos, 1998) further confirm that the development of financial markets3 in turn promotes economic growth. Against this backdrop, we argue that there exists a relation between corporate governance and economic performance at both the macro and micro levels. As stated in OECD (2004), “The presence of an effective corporate governance system, within an individual company and across an economy as a whole, helps to provide a degree of confidence that is necessary for the proper functioning of a market economy”. Various studies have noted that countries with good corporate governance will do much better than those with poor governance structures. La Porta and others (1997, 1998), in their significant contributions, emphasize the importance of law and legal enforcement not only on the governance of firms but also on the development of markets and economic growth. It has been well documented in a study by Beck et al. (2000) that the quality of a country’s legal system impacts not only the financial sector but also the economic growth of a country. Weaker corporate governance structures tend to raise the costs of capital (La Porta et al., 1998, 2002; Claessens et al. 2002), which is also reflected in the discounting of the value of firms by investors (Doidge et al., 2004; McKinsey & Company, 2002). To quote, “…good corporate governance generally pays—for firms, for markets, and for countries. It is associated with a lower cost of capital, higher returns on equity, greater efficiency, and more favorable treatment of all stakeholders, although the direction of causality is not always clear.” (Claessens, 2006). In view of this, we may infer that better corporate governance structures definitely lead to improvement in the performance of firms by making management more efficient and productive, by improving asset allocation and by betterment of labor policies. Although there is much research on the link between governance and economic growth (Acemoglu et al., 2005 and Joshi, 2023), research on 3 Goldsmith (1969), McKinnon (1973) and Shaw (1973) were the first ones to document a positive correlation between growth and indicators of financial development (FD) (see Pagano, 1993). FD can affect growth by raising the proportion of saving funnelled to invest by reducing the leakage of resources, through improving the allocation of capital and through risk sharing by maintaining portfolio of assets etc. (Pagano, 1993). In addition, by putting in place and strengthening institutions of governance in general and corporate governance in particular, a country can promote international financial intermediation and facilitate international flow of financial capital to finance investment (Ahmed, 2016).

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the relationship between corporate governance and growth at the macro level in particular is relatively very thin, especially in the case of India. The questions that still remain are as follows: Does the relation between corporate governance and growth hold true for India at both the micro and macro levels? Or in other words, does corporate governance improve firm performance in the case of India at the micro level? Does corporate governance enhance the EG in India at the macro level? This chapter attempts to empirically address these overarching questions by using panel data and time series data gathered from diverse sources and by applying appropriate statistical techniques, as discussed in the subsequent sections. Before that, the next section sheds light on various channels through which the link between corporate governance and economic growth is established.

3.2

Channels of Corporate Governance

Corporate governance gains flow from firms to economies and hence affect the growth and development of a country. A question remains as to through what channels does that happen. Claessens (2006) has identified various channels through which corporate governance affects the growth and development of a country, such as increased access to financing, higher firm valuation, and better relations with stakeholders, among others (Fig. 3.1). The study further claims that causal relationships among such channels are well documented and evidenced in the literature at both the macro and micro levels as well as from the perspective of investor(s). Prior research states that an important and essential feature of good corporate governance is strong investor protection. In this regard, Defond and Hung (2004) refer to investor protection as “the extent of the laws that protect investors’ rights as well as the strength of the legal institutions that facilitate law enforcement”. Strong legal protection of property rights is an important determinant of efficient financial and capital markets, which opens avenues to access finance to the needed entities. We can therefore deduce that strong investor protection leads to efficient financial and capital markets, which in turn enforce good corporate governance practices. La Porta et al. (1998) established the relationship between the quality of shareholder protection and the development of capital markets, which in turn leads to increased access to financing. Henceforth, firms are in a better position to obtain needy finance and thus grow. Furthermore,

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Fig. 3.1 Macro and micro perspectives via channels of good governance (Source Authors’ illustration based on Claessens [2006])

Haidar (2009) found that countries with stronger shareholder protections tend to grow faster than those with poor shareholder protections. Accordingly, economic growth increases with good corporate governance practices. Good corporate governance practices also ensure a low cost of capital and high firm valuations. In general, assurance of an adequate rate of return on the investments increases the willingness of outside investors to provide finance at lower rates, which in turn raises the firm’s valuation (Morck et al., 1988). Chen et al. (2009) found a significant reverse relation between firm-level corporate governance and the cost of equity capital in emerging markets. Likewise, many studies/surveys in the past have observed that investors pay a premium for good corporate governance practices.4 Another related aspect is the important role that corporate governance practices play in times of financial distress and economic shocks. Shahwan (2015) and Lee and Yeh (2004) found that weak corporate governance practices increase the likelihood of financial distress. Good corporate governance practices would easily reduce the negative externality of such collapses and help sustain investor confidence as opposed to poor corporate governance practices, which would not only shatter the firm but would also shatter the economy as a whole. Lemmon and Lins (2003) argue that during such times, corporate governance systems affect the incentives of corporate managers/insiders to expropriate minority 4 For details refer to: https://www.ifc.org/wps/wcm/connect/a2ec6927-0edd-4f7482bf-e7837ed3d25b/IrresistibleCase4CORPORATEGOVERNANCE.pdf?MOD=AJP ERES&CVID=jtCzMNS.

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shareholders. If managers have higher control rights and lower equity shareholdings, the stock returns would be lower. The discussion under stakeholder theory5 established the fact that the purpose of all businesses is to create joint value for all stakeholders. Corporate governance mechanisms ensure that stakeholders’ rights and interests are protected by managers and provide a guarantee to stakeholders vis-a-vis the generation, protection, and distribution of wealth invested in the firm (Aguilera et al., 2008). To do so, managers need to coordinate between varied stakeholder interests (L’Huillier, 2014). To quote, “The fundamental issue of corporate governance is not simply one of protecting shareholders from managers; rather, the issue is one of determining stakeholder distribution rights, describing inter-stakeholder tensions, and identifying the means through which the primary stakeholders seek to preserve their privileges and to externalize the costs of those privileges onto less powerful secondary stakeholders ” (Carney et al., 2010). In this regard, managers must first accept and then admit that various stakeholder groups have varied interests and priorities that cannot be addressed simultaneously. As a result, there always exists a tradeoff. Hahn and Aragon-Correa (2015) highlight that the existence of tradeoffs always prevails, and hence, corporate managers need to enable arrangements that create value for all stakeholders. In this light, it is important for businesses to involve relevant6 stakeholders to not only solve specific business problems but also tap opportunities to create value for all stakeholders. Clarkson (1995) bifurcated stakeholders into two distinct groups on the basis of a firm’s dependence on its stakeholders for its survival, namely, the primary stakeholder group and the secondary stakeholder group. He mentions, “Fairness and balance in the distribution to its primary stakeholder groups 7 of the increased wealth and value created by the firm are necessary to preserve the continuing participation of each primary group in the firm’s stakeholder system and to avoid favoring one group unduly and at

5 See Chapter 1 of the book for more details. 6 Relevant stakeholders would generally be primary stakeholders. 7 Clarkson (1995) has defined “a primary stakeholder group is one without whose

continuing participation the corporation cannot survive as a going concern. There is a high level of interdependence between the corporation and its primary stakeholder groups. Secondary stakeholder groups are defined as those who influence or affect, or are influenced or affected by, the corporation, but they are not engaged in transactions with the corporation and are not essential for its survival”.

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the expense of other groups. If any primary group perceives, over time, that it is not being treated fairly or adequately, whether it is the employee, customer, or shareholder group, it will seek alternatives and may ultimately withdraw from that firm’s stakeholder system. If that withdrawal occurs, the firm’s survival will be threatened”. However, this may not be the case within secondary stakeholder groups, as the firm is not dependent on secondary stakeholders for its survival. Secondary stakeholder groups are generally not engaged in transactions with the firm and are not essential for the survival of the firm. Past research has focused on stakeholder engagement, and highlighting its components, contents and impacts has shed light on the complexities that arise due to the varied issues encountered by heterogeneous groups of stakeholders (Kujala et al., 2022). In this regard, Bridoux and Stoelhorst (2020) proposed three stakeholder governance forms referring to the degree of complexity of the focal issues and heterogeneity of the stakeholders to maximize joint value creation. Undeniably, the governance form/model should be such that all stakeholders are managed and engaged, which would finally add to an economy’s growth and development. Indeed, increasingly better corporate governance practices carry the potential to foster better relations of firms with all their stakeholders.8 In summary, we may conclude that better governed firms enjoy increased access to financing and a lower cost of capital, have higher market valuations and a reduced risk of financial distress (are less leveraged) and are able to develop better relations with all stakeholders. Consequently, we may infer that investors (especially institutional investors) may prefer low leveraged firms due to the expectation of fewer financial problems in the future (Tong & Ning, 2004). In addition, better governed firms are more profitable and are able to grow (Banerjee et al., 2012). Prior literature9 has established that corporate governance enhances firm-level performance (Banerjee et al., 2012). Sarkar et al. (2012) reiterate the fact that “corporate governance regulation all over the world is based on this fundamental premise that good corporate governance makes business sense both with respect to existing shareholders as well as prospective investors ”. The same is also true at the macro level. Countries with

8 Claessens (2006) here refer to “other stakeholders” who include all stakeholders except primary owners and managers. 9 Discussed in detail in next section of the chapter.

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better corporate governance not only achieve higher income growth rates (Skare & Golja, 2014) but also provide evidence that sound corporate governance promotes economic growth and development10 (Asker et al., 2015; Claessens, 2006; Klapper & Love, 2004; Kutan, 2015). To quote Claessens (2006): “The objective of a good corporate governance framework would be to maximize the contribution of firms to the overall economy – that is, including all stakeholders ”. Thus, it is established by all accounts that better corporate governance would add to economic performance at both the macro and micro levels. At the micro level, better governance structures can definitely lead to improvement in the performance of firms by making management more efficient and productive and by bringing about improvement in asset allocation and labor policies. At the macro level, there exists a positive link between the improved quality of corporate governance and economic growth. The next sections of the chapter empirically address two overarching questions: a. Does corporate governance improve firm performance in the case of India at the micro level? b. Does corporate governance enhance economic growth in India at the macro level?

Interplay Between Corporate Governance and Country Governance Before, we move to the micro level perspective, it is important to appreciate the association between corporate governance and country governance. Indeed, the institutional, regulatory and legal setup of a country (also called country-level governance) builds an environment for businesses in which they operate. Prior literature provides evidence that firm level governance (i.e., Corporate Governance) and countrylevel governance interplay. Nguyen et al. (2015) argue that good country governance moderates or enhances the relationship between corporate governance and firm performance. Similarly, both are interrelated not only for the development of corporate governance theory but also to enhance firm performance. Many prior studies report that Country Governance impacts a firm’s activities through various channels (similar 10 Discussed in detail in later section of the chapter.

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to the ones discussed before as Channels of Corporate Governance). For example, Hail and Leuz (2006) found a negative relation between country governance and firms’ cost of capital, La Porta et al. (2002) found a positive relation between country governance and firm valuation, Sobel (2003) found a positive relation between country governance and firms’ ability to access capital, and Ngobo and Fouda (2012) found a negative relation between country governance and firms’ level of risk. Furthermore, Ngobo and Fouda (2012) report that country governance not only minimizes production (and transaction) costs (Ngobo & Fouda, 2012) but also reduces agency costs (Filatotchev et al., 2013; Nguyen et al., 2015). Thus, good country governance, through these channels, increases firm profitability (Ngobo & Fouda, 2012; Saona & San Martín, 2016).

3.3 Corporate Governance and Firm Performance---The Micro Perspective A vast strand of literature discusses the relationship between corporate governance and firm performance, considering various proxies (measurements) for corporate governance (Bhagat & Bolton, 2002; Coles & Hesterly, 2000; Dalton et al., 1999; Elsayed, 2007; Jensen, 1993; Yermack, 1996). By bringing together different strands of inquiry of prior studies, we find that their empirical findings on the relationship between corporate governance and firm performance have given mixed results. Apparently, we believe that better/good corporate governance would significantly enhance firm performance, as noted by many previous studies,11 yet contrary results are also reported by some other studies.12 Surprisingly, some other studies reported no significant relationship between corporate governance and firm performance.13 Nevertheless, such mixed results could be due to reasons that may be country specific or data specific, such as availability or reachability of the data for the study (Arora & Sharma, 2016).

11 Brown and Caylor (2006); Black et al. (2006); Beiner et al. (2004); Chung et al. (2003); Brickley et al. (1994). 12 Bauer et al. (2004); Hutchinson (2002); Bathala and Rao (1995). 13 Park and Shin (2003); Prevost et al. (2002); Hermalin and Weisbach (1991).

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It is worth mentioning that the positive relation between corporate governance and firm performance is dependent on the availability of legal recourse and the level of investor protection and confidence (Klapper & Love, 2004). Again, mixed results are found on the role of availability of legal recourse. While Klapper and Love (2004) assert that “good corporate governance and credible investor protection partially compensate for ineffective laws and enforcement ”, Mishra and Kapil (2016) assert that the effectiveness of corporate governance is dependent on the availability of legal recourse. Thus, good corporate governance does not need the existence of legal recourse, yet its effectiveness depends on the availability of legal recourse (Jensen & Meckling, 1976; La Porta et al., 2000). However, legal protection of all investors forms a good corporate governance system (Shleifer & Vishny, 1986). Previous studies on corporate governance also address the interconnection of firm-level corporate governance and country-level legal and judicial systems. Firm-level corporate governance based on legal rules and norms enhances investor protection and investor confidence (La Porta et al., 2000); however, firm-level corporate governance acts as a substitute for country-level legal and judicial systems, as the benefits of firm-level corporate governance are more seen in markets with weak legal protection of investors. This indicates that the country-level legal protection of investors substitutes for firm-level corporate governance (Chen et al., 2009). As noted above, related literature on the relationship between corporate governance and firm performance has employed several proxies (measurements) for corporate governance,14 such as ownership structure15 (Kansil, 2021a, 2021b; Kansil & Singh, 2018a; KyereboahColeman, 2007; Salerka, 2005), ownership concentration16 (Choi et al., 2014; Kansil, 2019; Kansil & Singh, 2017; Sarkar & Sarkar, 2000; 14 Some studies have employed a composite measurement, namely, G Score or G Quotient or G Index, which is constructed considering multiple dimensions of corporate governance. Such a G Score or G Index could be the one constructed by the researcher and his colleagues (Brown & Caylor, 2004; Khanchel, 2007; Spanos et al., 2008) or may be extracted from a database, such as, CLSA, ISS, CRISIL, ICRA, Bloomberg (Nollet et al., 2016; Singh & Kansil, 2017). 15 Ownership structure refers to various shareholder groups that own equity share capital of the firm. The shareholder group may be Domestic (here Indian) or Foreign which again could be promoter, family, institutional investor and/or corporates. 16 Ownership Concentration refers to the size of the shareholdings of different shareholder groups.

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Sarkar & Sarkar, 2000; Singh & Kansil, 2017), board structure (Agrawal & Knoeber, 1996; Rosenstein & Wyatt, 1990), board size (Anderson & Reeb, 2003; Coles et al., 2008; Dwivedi & Jain, 2005), and executive compensation, to name a few. The studies on ownership structure (that is, the effect of shareholdings of different ownership groups17 ) have given mixed results indicating that shareholdings of different ownership groups may not necessarily lead to better firm performance or high value of the firm. Imam and Malik (2007) found a positive relation whereby different ownership groups affect a firm’s performance as well as its dividend payout policy. In contrast, Kumar (2004) found that the shareholdings of foreign and corporate shareholders do not affect firm performance. Limited studies have been conducted on the impact of promoter18 shareholdings on firm performance, especially in the Indian context (Mishra & Kapil, 2016; Kumar & Singh, 2013). This study fills this gap. Evidence from the literature indicates that it is not about who the shareholder is but rather about the extent (level) of the shareholdings

17 The shareholder group may be Domestic (here Indian) or Foreign which again could be promoter, family, institutional investor and/or corporates. 18 Promoter is a person who has the right to exercise control over board. “SEBI’s-Reclassification of Promoters as Public defines promoters as who are in control of the company, directly or indirectly, whether as shareholder, director or otherwise; or named as promoters in any document disclosed by the company under the provisions of the Listing Agreement.”.

As per Section 2(69) of Companies Act, 2013 the term Promoters is defined as: who has been named as such in a prospectus or is identified by the Company in the annual return referred to in section 92; or who has control over the affairs of the Company, directly or indirectly whether as a shareholder, director or otherwise; or in accordance with whose advice, directions or instructions the Board of Directors of the Company is accustomed to act” (Affairs M. 2013). “This sub-clause uses the word – Control which is defined in 2(27) of the Act: control shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.

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that matters19 (Kansil, 2021b; McConnell & Servaes, 1990; Zeckhauser & Pound, 1990). In other words, the impact of shareholdings on firm performance would not be linear; rather, it would be nonlinear (curvilinear) with a change in impact beyond a threshold level of such shareholdings. Kansil (2021a) identified three threshold levels within which the impact of foreign ownership on firm value changes considerably. Similarly, Salerka (2005) found that the impact of insider ownership on firm value first decreases and later starts increasing beyond a threshold of approximately 45 percent insider ownership. Similarly, with respect to firm performance, Skare and Hasic (2016) mention that previous empirical studies attempt to evaluate the relationship between corporate governance and firm performance by measuring firm performance either by operating performance and/or by firm valuation and/or by stock returns. The operating performance measures (also called accounting-based measures) widely used in previous studies are return on assets (ROA) (Darko et al., 2016; Klapper & Love, 2002) and return on equity (ROE) (Ahmed & Ndayisaba, 2016). Many previous studies have used Tobin’s Q20 to measure firm valuation (Darko et al., 2016; Klapper & Love, 2002), while dividend yield is used to measure stock returns (Brown & Caylor, 2004; Drobetz et al., 2004). The relation between corporate governance and firm performance in emerging economies has not been systematically studied, so the present study is a step in that direction. Against this backdrop, we empirically test the relation between corporate governance and firm performance at the micro level for a large representative sample of Indian firms. For the analysis, we use Return on Assets21 (ROA) as a measure for firm performance, and we consider Indian Promoter Shareholdings (IP) and Foreign Promoter Shareholdings (FP) as proxies for corporate governance. The description of these variables and other control variables for the empirical analysis is discussed in Table 3.1.

19 The level/extent of shareholdings mean the percentage of the total equity share capital. La Porta et al. (1999) have provided and named distinct levels of Equity Stakes such as less than 1% minority, 51% or more outright majority, to name a few. 20 With variations in measurements adopted and thus distinct computations. 21 Return on Assets (ROA) is a pure measure of operating efficiency of a firm in

generating returns without being affected by management financing decisions.

Variable

Description of variables used in the study

Other Control Variable 4 Market Capitalization (in Rs. Million) Mcap

FP

3

Foreign Promoters Shareholding (in percentage)

IP

ROA

Abbreviation

Corporate Governance Variable 2 Indian Promoters Shareholding (in percentage)

Dependent Variable 1 Return on Assets (percentage)

Sr. No

Table 3.1

(continued)

Number of shares outstanding*Closing price of the stock as on the last day of the financial year

Percentage of equity shares that are held by the Indian promoters of the company Percentage of equity shares that are held by the Foreign promoters of the company

Net profit divided by total assets. Net profit is the net profit of the company after tax. It is the residual after all revenue expenses are deducted from the sum of the total income and the change in stocks

Description of the Variable

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TR

Total Returns22 (in percentage)

Age (in years)

Size (in Rs. Million)

Current Ratio (in times) Debt to equity ratio (in times) Asset Structure (in Rs. Million)

5

6

7

8 9 10

(bse returns –1)*100 where BSE returns = closing price, gains/losses arising due to capital action and dividend per share (if any)/closing price of previous day Total number of years since the year of inception of the firm calculated as the difference between each of the end of the financial year of study and the year of incorporation of the company Three-year average of the total income and total assets Current assets/current liabilities Total debt/shareholder’s equity Fixed assets ratio: fixed assets/total assets

Description of the Variable

in the market value of the scrip compared to the earlier trading day, dividends earned from the scrip and any gain or loss due to any capital actions of the company. The returns are expressed as a ratio of the closing price, gains/losses arising due to capital action and dividend per share (if any) to the closing price of previous day. A ratio of more than one indicates a positive return whereas a ratio less than one denotes negative returns”.

22 As per Prowess database “Returns are calculated to measure all the benefits that accrued to the holder of the scrip by way of change

CR DER AS

Size

Age

Abbreviation

Variable

(continued)

Sr. No

Table 3.1

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Data and Variables The data for the current study to investigate the relation between corporate governance and firm performance in the Indian context comprise constituent entities of the S&P BSE 500 index [of the Bombay Stock Exchange (BSE)].23 The index is designed to be a broad representation of the Indian capital market. BSE is not only the oldest stock exchange in Asia but also the leading one in India with the highest number of listed entities. Furthermore, BSE is the eighth largest (in terms of market capitalization) and world’s fastest stock exchange. The market capitalization of BSE-listed entities rallied from Rs. 204.3 lakh crore at the beginning of the fiscal period to Rs. 264 lakh crore by the end of the financial year 2022 (BSE, 2022). The data for the analysis are drawn from Prowess, a database of Indian companies maintained by the Centre for Monitoring the Indian Economy (CMIE) for the thirteen-year period, from the end of financial year 2009 to 2021. It is important to mention here that the financial year 2009 marks the beginning of the second phase of corporate governance reforms, as it is during this year that amendments in the guidelines of corporate governance and corporate laws were carried out. The data for this study were collected in August 2022. It collected the data available for all sample entities until the end of financial year March 2021. The raw dataset comprised 6500 observations (500 entities over a 13-year period) with missing information for some years for the entities who were incorporated after 2009 and some others whose relevant data were incomplete or could not be acquired. After deleting those year-end rows, the final data were unbalanced panel data with 6151 observations of 491 entities, as detailed in Table 3.2. Empirical Model and Estimation R O Ait = β0 + β1 I Pit + β2 F Pit + β3 Mcapit + β4 T Rit + β5 Ageit + β6 Si zeit + β7 C Rit + β8 D E Rit + β9 ASit + eit where ROA it =Return on Assets. IPit = Indian Promoter shareholdings. 23 Singh and Kansil (2017) also used firms belonging to S&P BSE 500 index of the Bombay Stock Exchange (BSE) as sample firms for their study.

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Table 3.2 Final dataset Number of Years

Number of Companies

Number of Observations

13 12 11 10 9 8 7 6 5 3 2 1 Grand Total

440 12 5 6 2 6 7 5 3 3 1 1 491

5720 144 55 60 18 48 49 30 15 9 2 1 6151

FPit = Foreign Promoter shareholdings. Mcap it = Market Capitalization. TR it =total returns. AGE it = Firm age. SIZE it = Firm size. CR it =Current Ratio. DER it =Debt Equity ratio (leverage). AS it =Asset Structure (Tangibility). The subscript i is used to denote individual firms, and subscript t is used to denote time. Panel data regression is employed to study the relationship between corporate governance and firm performance. First, we ran the multiple linear panel data—pooled, fixed effects, random effects—on the model specified. The results are shown in Table 3.3—Col. 2 to Col. 4, respectively. There was no multicollinearity found among the independent variables, as the variance inflation factors ranged from 1.00 to 1.65. To evaluate the suitability of the pooled OLS vs fixed effects model, an F test of the joint significance of fixed effects intercepts is run. The result with p value 0.000 (significant at 1 percent level of significance) and stat 11.52 suggests appropriateness of fixed-effect model. Furthermore, to evaluate the suitability of the pooled OLS vs random effects model, the Breusch

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and Pagan Lagrange multiplier test for random effects appeared significant at the 1 percent level of significance (chibar2(01) = 6583.71, p value = 0.000), implying that the random effects model is appropriate. The suitability of the fixed effects vs random effects model is checked running the Hausman test chi-square test. The result with a statistic of 36.65 (p value 0.0000—significant at the 1 percent level of significance) indicates the appropriateness of the fixed effect model. However, the post estimation tests depict a different picture. First, the Wooldridge test (Wooldridge, 2002) for autocorrelation in panel data exhibits serial correlation with a p value of 0.000 (significant at the 1 percent level of significance). Second, the modified Wald test for groupwise heteroscedasticity in the fixed effect regression model exhibits heteroscedasticity (p value 0.000—significant at the 1 percent level of significance). As a consequence, we preferred to use the feasible generalized least squares (FGLS) regression proposed by Hansen (2007) in case “groups (in this study firms/companies) are followed over time (in this study - 13 year period) and correlation between individuals in the same group at different times arise due to serial correlation in the group level shock”. Results and Discussion The results of the FGLS are presented in column 5 of Table 3.3. Since the Wald statistic is significant (at 1 percent level of significance with stat 325.52, p value 0.000), we may infer that corporate governance variables along with other control variables are significant and add something to the model. The results of the FGLS regression show that the shareholdings of both Indian promoters (similar to Kumar and Singh [2013]) and foreign promoters (similar to Mollah et al. [2012]) are significant at the 1 percent level of significance with positive coefficients. In other words, the higher the promoter shareholdings (similar to Haldar and Rao [2011]), the higher the firm performance. Thus, we may infer that corporate governance (measured by IP and FP) and firm performance (measured by ROA) are positively related in the Indian context. The coefficients of Mcap, Size, DER and AS are significant with a positive relation for AS and a negative relation for Mcap, Size (similar to Mollah et al. [2012]; Sarkar and Sarkar [2000]) and DER (similar to Nguyen et al. [2020]). CR and TR remain insignificant. This may be because highly valued, larger firms with high leverage can be less profitable than less valued smaller firms because of the loss of control

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Table 3.3 Results of panel data regression Variables

Pooled OLS

Fixed effects model

Random effects model

FGLS regression

Col.1 IP

Col.2 0.0176 0.009*** 0.0552 0.000*** 0.0065 0.000*** –0.0699 0.304 0.0021 0.713 –0.0091 0.000*** –0.0049 0.524 –0.5287 0.000*** –0.0022 0.095* 6.1294 0.000*** 6151 0.0503 0.0489 – – –

Col.3 0.0201 0.131 0.0199 0.439 0.0012 0.352 –0.1268 0.015** 0.0198 0.512 –0.0026 0.048** 0.0022 0.724 –0.1568 0.000*** –0.0019 0.065* 4.2987 0.017** 6151 0.0051 – 11.52 0.000*** 0.5254

Col.4 0.0190 0.072* 0.0478 0.002*** 0.0033 0.001* –0.1143 0.027** 0.0092 0.475 –0.0013 0.001*** 0.0014 0.819 –0.2026 0.000*** –0.0019 0.063* 5.4028 0.000*** 6151 0.0428 – 60.32 0.000*** 0.4623

Col.5 0.0176 0.009*** 0.0552 0.000*** –0.0021 0.000*** –0.0699 0.303 0.0021 0.712 –0.0012 0.000*** –0.0049 0.524 –0.5287 0.000*** 0.0013 0.095* 6.1294 0.000*** 6151 – – 325.52 0.000*** –

FP Mcap TR Age Size CR DER AS Constant Observations R squared Adj.R squared F/Wald Prob Rho

Note * denotes 10% level of significance ** denotes 5% level of significance *** denotes 1% level of significance Source Author’s calculations

by top managers over strategic and operational activities within the firm (Himmelberg et al., 1999). Our result is similar to that by Al-Najjar and Taylor (2008), who mention that tangible assets act as collateral for debt financing; therefore, firms would not find it difficult to obtain funds. Henceforth, a positive relation between AS and ROA is seen.

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Corporate Governance and Economic Growth---The Macro Perspective

This section of the chapter empirically addresses our second question, that is, Does corporate governance enhance economic growth in India at the macro level? The Organization for Economic Co-operation and Development (OECD) gave a global benchmark for policymakers and other stakeholders called The OECD Principles of Corporate Governance.24 These principles not only established but also disseminated the fact that good corporate governance not only enhances financial market stability but also increases the rate of investment and economic growth. Skare and Hasic (2016) noted that “well-governed companies contribute more to the economic growth, as those companies are stable, sustainable and capable to provide regular profit to their shareholders and regular earnings to their employees, and to strengthen investors’ confidence in the capital market”. Thus, we may infer that good corporate governance contributes to the firm’s performance and stakeholder value creation, which sums up to the growth of the overall economy (Maher & Andersson, 2000). However, Kurtz and Schrank (2007) found contrasting evidence in this regard. To quote, “There is far more reason to believe that growth and development spur improvements in governance than vice versa”. To our knowledge, little research has addressed this causation thus far. To fill this gap, the present study aims to determine the direction of causation between corporate governance and economic growth in the Indian context, that is, whether economic growth leads to corporate governance or corporate governance leads to economic growth. For this purpose, we employ Granger causality analysis. The Granger causality test is widely used to investigate causality between two variables in a time series. Hypothesis Development Based on the literature review, we hypothesize the following: i. H01 : Corporate governance does not Granger cause economic growth.

24 First issued in 1999, revised in 2004 and then in 2015. Presently been reviewed and updated ones expected in 2023. These were endorsed by G20 Leaders in 2015.

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ii. H02 : Economic growth does not Granger cause corporate governance.

Data and Variables To examine the relationships between corporate governance and economic growth, we employ annual time series data for the two variables under study collected from secondary sources. The main source of data for economic growth is the Handbook of Statistics on Indian Economy published annually by the Reserve Bank of India. Gross domestic product (GDP in rupees crores) in absolute terms is a proxy for economic growth. Furthermore, for the purpose of the study, we have used an annual Corporate Governance Index (CGI) as a proxy for corporate governance. This has been constructed by averaging the Governance score of Bloomberg Environment, Social and Governance (ESG) Score covering the top 500 listed entities of the S&P BSE 500 Index of the Bombay Stock Exchange. CGI is constructed on a scale of 0 to 100, wherein a high score indicates good or better corporate governance, and a low score indicates poor corporate governance. An improvement in the corporate governance index or scores depicts an improvement in corporate governance as well as a growing trend of better implementation of corporate governance policies and norms (Sarkar & Sarkar, 2000). The Bloomberg Environment, Social and Governance (ESG) Score was extracted from the Bloomberg database. The data were analysed using Stata version 15. The descriptive statistics of the two variables are given in Table 3.4. The inspection of the table reveals that the mean GDP is 9158076 with a standard deviation of 3,547,783, whereas the mean CGI is 71.80 with a minimum and maximum of 60.10 and 80.60, respectively. The improvement in CGI portrays significant improvements in corporate governance practices in Indian firms. Period of Study It is understandable that if we want to study causal relationships or observe improvement in the quality of indices, we must consider data over longer time periods. This helps to visualize outcomes/transformations that may have occurred over time. The period of the present study is

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Table 3.4 Descriptive statistics Statistics

Economic Growth (EG)

Corporate Governance Index (CGI)

Description

Gross Domestic Product (GDP in Rupees Crores) 9,158,076 9,712,133 3,547,783

Average of the Governance score of Bloomberg Environment, Social and Governance (ESG) Score covering the top 500 listed entities of S&P BSE 500 Index of the Bombay Stock Exchange 71.80625 74.74187 7.713229

3,896,636 13,512,740

60.10154 80.60337

Mean Median Standard Deviation Minimum Maximum

thirteen years starting from the end of 2009 to the end of 2021.25 The choice of time period is highly appropriate to study the causal linkages between corporate governance and economic growth. Sarkar et al. (2012) constructed CGI for 500 large listed Indian companies for the period 2003 and 2008 and found noticeable improvement in corporate governance standards over the period of study. However, they mention “the real corporate governance crises in India came from the 2008 period onwards starting notably with the Satyam fiasco”. Furthermore, we may mention that the year 2008 witnessed an amendment to Clause 49 of the Listing Agreement by The Securities and Exchange Board of India (SEBI), a regulatory body for securities and commodity markets in India. Clause 49 was formulated in 2005 by SEBI with the objective of improving the quality of corporate governance in Indian listed companies. It became imminent for the Government of India after Satyam Fraud (2009) to introduce more measures and further amendments in the guidelines of corporate governance and other Indian corporate laws. Therefore, in the context of corporate governance reforms in India, 2009 is marked as the beginning of the second phase of corporate governance reforms.26 Therefore, the period starting from 2009 to 25 CGI for the sample firms was available till the end of year 2021 when the data were collected in August 2022. 26 The first phase of corporate governance reforms, started from 1990’s, with the formation of SEBI, India’s securities market regulator in 1992. The regulator has been instrumental in advocating for and drafting CG guidelines. As per Chapter 2 of the book,

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date would be appropriate to study the causal linkages between corporate governance and economic growth in the Indian context. Furthermore, consideration of CGI for these thirteen years allows us to examine the evolution of the state of corporate governance in India over a time period that captures major structural corporate governance reforms in the Indian context. Empirical Model and Estimation We have chosen Granger causality analysis to identify the direction of causality between corporate governance and economic growth in the Indian context. Granger causality analysis is usually performed by fitting a vector autoregressive model (VAR) to the time series (Guru-Gharana, 2012; Kagochi et al., 2013; Pradhan et al., 2016). Furthermore, it is well known that time-series data may produce spurious results if the variables under consideration follow a time trend or, in other words, they are nonstationary. Therefore, the first step is to test the stationarity of the variables under study. A quick test is run ordinary least squares (OLS) regression. If R2 is less than the Durbin Watson statistic, then the time series is stationary. The OLS results are R2 = 0.9595, and the Durbin Watson statistic is 1.7349. Thus, we may infer that the variables GDP and CGI are stationary. The augmented Dickey–Fuller test (ADF) is usually performed to test the null hypothesis that a unit root is present in time series data. The results of ADF clearly indicate that corporate governance and economic growth are stationary at the level data. The p value for Z(t) for EG is (0.0695). The similar p value of Z(t) for corporate governance is (0.0779), which is significant at the 10% level of significance. The PhillipsPerron test gives similar results. The second step in running the VAR model is to determine the true lag length of the VAR system using some suitable information criterion (or criteria). The optimal lag order is 1 (k = 1) for CGI according to all four criteria: the final prediction error criterion, Akaike information criterion, Hannan-Quinn information criterion and Schwarz information criterion. However, for GDP, all four criteria are significant at lag 4. We accept the lowest lag order suggested. Thus, the second decade of reforms captures the period from 2001 to 2010. We may call the year 2009 as near end of said second decade of reforms. * being significant at 10% level of significance.

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our augmented VARL is of order k + dmax = 1 + 1 = 2. Consequently, we estimate the following equations for the sample period: yt = a1 +

2 

βi xt−i +

i=1

x t = a2 +

2 

2 

γ j yt− j + ε1t

j=1

μi xt−i +

i=1

2 

α j yt− j + ε2t

j=2

For Granger causality detection, we deploy a vector autoregressive (VAR) model with lag order 2. The results of the Granger causality test are reported in Table 3.5. The results of the table clearly show that GDP causes CGI. In other words, economic growth causes improvement in corporate governance. We also performed VAR diagnostic tests to test the validity of our results. All three conditions are met. First, the eigenvalue stability condition is met since all modulus values are less than one. Second, the mean value of residuals is 0.00. Last, the p values for normality tests— the Jarque–Bera test, skewness test and kurtosis test—are quite high (0.75299, 0.48420, 0.77998, respectively); hence, we accept the null hypothesis that disturbances in the VAR are normally distributed. Since all diagnostic tests are met, we conclude that economic growth causes corporate governance and not vice versa in the Indian context. In other words, economic growth comes before or precedes corporate governance. Table 3.5 Granger causality test results Null

F Prob > F

Inference

Economic Growth does not granger cause Corporate Governance

32.462 (0.0006)*

Corporate Governance does not granger cause Economic Growth

0.5525 (0.9467)

Rejected Economic Growth granger cause Corporate Governance Not rejected Corporate Governance does not granger cause Economic Growth

Note * Significance at the 1% level of significance

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Results and Discussion With respect to CGI, we would like to reiterate the fact that although reforms in corporate governance have been in place in India (since the 1990s), significant improvement in corporate governance practices would take sufficient time to show results or might not be immediately achievable. The same has been validated by the CGI values for the period of our study. In the thirteen-year period, from 2009 to 2021, the CGI shows an upwards trend, with the minimum CGI rising from 17.85 to 61.07 and the maximum CGI rising from 89.85 to 96.11. Thus, although Indian firms are moving close to each other in terms of adopting best governance practices/following governance standards, there exists a considerable scope for improvement (median CGI being 74.74). Another aspect worth considering here is the presence of various structural rigidities, as acknowledged in various studies, due to which the real change in corporate governance practices takes time to exhibit. A study by the World Bank Group substantiates our argument when it says that “The structures, institutions, and legal framework of corporate governance are developed and administered by individuals whose behaviors are shaped by cultural and personal concepts of hope, ambition, greed, fear, uncertainty, and hubris, as well as by the social ethos. A problem arises when these influences do not conform to the regulatory prescriptions of corporate governance. This private sector opinion explores the dynamics of culture and corporate governance in India by calling attention to three areas where the clashes are strongest: related-party transactions, the promoter’s or large shareholder’s actions, and the board’s nominations, deliberations, and effectiveness ”.27 We may infer that the reforms thus far are not yet significant enough to make a direct impact on economic growth. Therefore, there is a need to implement corporate governance reforms in an effective and coordinated manner. The country diagnostic surveys designed and implemented by the World Bank28 provide insights and can help identify specific actions to improve the corporate governance environment in India. The empirical results of our study reveal that economic growth causes corporate governance. In other words, economic growth does not rely on

27 See: https://openknowledge.worldbank.org/handle/10986/11070?show=full https://www.ifc.org/wps/wcm/connect/3027d6cb-0aba-4fd8-a233-7c0c8d33d6da/ PSO_23_Pratip.pdf?MOD=AJPERES&CVID=jGe7X.s. 28 See: https://openknowledge.worldbank.org/handle/10986/12642?show=full.

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formal governance structures or is caused by them; rather, good governance structures result from economic growth. The results are similar to the findings of Wilson (2016), where the study on China found that “governance reforms are often a consequence, rather than a cause, of economic growth”. Furthermore, the results are in coherence with the view of Khan (2007). He points out that “If we look at the relationship between scores on ‘good governance’ and per capita incomes, there is clearly a very strong relationship. However, the relationship does not establish causality because rich countries could have high good governance scores because they are rich, rather than being rich because they have high scores in good governance.” In addition, he observed in his study that ‘high growth developing countries did not first achieve high scores in good governance’.

3.5

Conclusions and Policy Recommendation

From the foregoing empirical exercise, we arrive at two broad conclusions. First, good corporate governance enhances firm performance. Second, economic growth precedes corporate governance. In other words, corporate governance is a consequence of economic growth in the case of India. The salient conclusion drawn from the study suggests that good governance is important for better firm performance and that economic growth is needed for good governance in the Indian context. Economic growth can motivate a corporate entity to incorporate/introduce and follow good governance practices. The latter conclusion is quite understandable given that it is through creating shared growth and shared prosperity that the beneficial effects of growth need to be distributed throughout the channel of good corporate governance (Skare & Hasic, 2016). Policy wise, we argue the introduction and implementation of committed policy actions to do away with the structural rigidities that can help to develop and promote ‘market-enhancing governance’. Khan (2007) draws a distinction between ‘market-enhancing’ and ‘growth-enhancing’ governance. He writes that “the good governance argument that is frequently referred to in the governance literature and in policy discussions essentially identifies the importance of governance capacities that are necessary for ensuring the efficiency of markets. The assumption is that if states can ensure efficient markets (in particular by enforcing property rights, a rule of law, reducing corruption and committing not to expropriate), private investments will drive economic development. This

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approach is one that implicitly stresses the priority of developing marketenhancing governance and is currently the dominant paradigm supported by international development and financial agencies ”. Second, we agree with the fact that the true benefits of market efficiency and hence economic growth become visible only after a substantial degree of development is achieved (Khan, 2007). Thus, the strong causal relationship from good governance to good economic growth in the Indian context may be visible in the future. Our results validate the view of Khan (2007) when he says, “Case-study evidence strongly suggests that successful developing countries did not achieve good governance before they began to develop as a precondition for development. Rather, they developed because they had state capabilities that allowed them to overcome significant market failures, and they began to approximate to good governance conditions rather late in their development trajectories.” Therefore, our study has important lessons for policy makers in India if they aim to tap the virtuous cycle between economic growth and corporate governance. To create and strengthen this virtuous cycle, corporate governance, country governance and market efficiency must be high on the agenda. We must mention here that although there has been growing interest in various stakeholders in corporate governance together with responsible investing at national and international levels and environmental social governance (ESG) focused conversations are gaining importance, the overall progress and wide adoption of ESG norms is slow in developing countries such as India. The reasons vary from a lack of understanding and clarity of ESG terminologies to a lack of standardized metrics to ensure uniformity, necessitating the introduction and embedding of sustainability culture in entities across all sizes and operating in different sectors by adopting sustainable practices and enhancing sustainability reporting (these will be discussed in the second part of the book in detail).

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CHAPTER 4

Linkage Between Corporate Governance, Foreign Direct Investment and Economic Growth—Empirical Evidence from India

4.1

Introduction

Different economies of the world are striving to attain higher growth rates to improve the quality of life of their masses. One of the routes to achieve such higher growth rates is through foreign direct investment (FDI). Previous studies highlight that developing countries are often confronted with a capital crunch or saving-investment gap (Koopmans, 1963; Solow, 1956), which negatively impacts their economic growth (EG). FDI is the route that bridges up this saving-investment gap (Sabir & Khan, 2018) and thus is a supplement to domestic savings and stimulates the economic growth of the recipient economy. However, the question is: what makes a destination or host country more attractive for FDI? Do the EG and corporate governance (CG) play any role? Do the CG and EG have any relationship? Whether FDI is a cause or an effect of CG as well as that of EG? Do CG norms matter? What kind of relationships exactly exist between FDI, EG and CG? The chapter intends to provide answers to these questions. It adds to the literature through empirical evaluation of the relationship between the three variables, FDI, CG and EG, by using the Granger causality technique. To this effect, a comprehensive basis of evaluation of the quality of CG in the context of Indian listed firms, which are the destinations of foreign capital inflows, has been used. Most extant studies of FDI focus on its relationship with growth. However, the unique contribution of the present chapter is that it extends the literature by © The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 S. Joshi and R. Kansil, Looking at and Beyond Corporate Governance in India, https://doi.org/10.1007/978-981-99-3401-0_4

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investigating the effects of the quality of CG (measured by CGI) on the inwards flow of FDI (in the case of India). The results of Granger causality tests reveal that the relationship between EG and CG is bidirectional in nature, whereas between EG and FDI along with CG and FDI is unidirectional, as has been proposed in many studies. More importantly, CG is found to be the link connecting EG and FDI.

4.2

Review of Literature

In the eighteenth and nineteenth centuries, businesses were owned and controlled by individuals and were called ‘traditional enterprises’, with the exception of a few large companies created to promote foreign trade (Dignam & Galanis, 2016). Later, during the nineteenth century, incorporated entities began to emerge with integrated ownership and control. By the end of the nineteenth century during the second industrial revolution, large ventures emerged that needed huge capital, expertise, knowledge, and power to administer. These ventures could not be controlled and managed by the owner him- or herself and thus emerged as ‘the managerial control of companies’ (Chandler, 1977). The entities so formed and the present modern business entities work with managerial competence, know-how, and control. During the late nineteenth and early twentieth centuries, tremendous growth opportunities resulting from industrial growth and the emergence of large integrated markets all over the world led to a new organizational structure where the owners were not the managers (Burnham, 1941). This separation, called the “separation of ownership and control” (Berle & Means, 1932),1 gradually emerged all over the world depending upon respective countries’ institutional setup and historical events, which further led to the existence of formal and informal rules for the working of business entities, that is, corporate governance (CG). Previous studies have traced the evolution of CG and linked it to the values, institutional setup and legislative framework of their respective economies. Claessens et al. (2006) assert that the evolution of CG in an emerging economy surfaced due to its effect on economic development. The most important ingredients for the same are law enforcement and

1 Discussed in detail in Chapter 1 of the book.

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institutional framework. Emerging economies lack both, and therefore, CG has been perceived as a luxury for developed economies. The Organisation for Economic Co-operation and Development (OECD, 2002) recognizes the role of governance in general and CG in particular in facilitating FDI. In fact, Zedillo et al. (2001) referred to political stability, rule of law and tackling corruption as the preconditions for attracting FDI. The report suggests that the host countries as well as foreign firms that enter these countries have to work to strengthen governance as well as CG to contribute to the development process. It acknowledges that inter alia governance and especially CG matters for FDI. Let us discuss the linkages between FDI and EG, followed by linkages between FDI and CG and between FDI, EG and CG, as revealed in the previous scholarship literature. Linkage Between FDI and EG “FDI is said to be a composite package that includes physical capital, production techniques, managerial skills, products and services, marketing expertise, advertising and business organizational processes ” (Mahembe & Odhiambo, 2014).2 An increase in competition to attract FDI inflows has been observed among both developed countries and developing countries since the 1990s through various policy changes or through monitoring FDI operations (Bank, 2013). This was an outcome of a structural adjustment programme (SAP), economic recovery programmes and economic partnership agreements (Asamoah et al., 2016). The New Economic Policy of 1991 has also heightened the importance of FDI in India. Through the industrial policy of 1991, FDI up to 51% in 34 high priority areas was initially allowed in India, and the services sector was deregulated through banking, insurance and telecom sector reforms (Joshi & Little, 1996; Panagariya, 2004). Gradually, more areas were opened up, and deregulation of some other subsectors of the services sector was also carried out (Joshi, 2010). Shin (2014) reports the evolution of FDI inflow patterns in India divided into three phases/periods, viz. anti- FDI inflows (1969–1975) phase, selective FDI inflows (1975– 1991) phase, and finally pro- FDI inflows phase (after the economic

2 Additionally, see Thirlwall (1999) and Zhang (2001).

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reforms of 1991). Consequently, FDI inflows in India have registered an increase over the last 3 decades from $4.03 billion in 2000–2001 to $29.02 billion in 2010–2011 and to $54.93 million in 2020–2021 (Reserve Bank of India, 2021). The FDI inflows in India increased from the meagre average yearly inflows of $3 billion in 1998–1999 to $30 billion during the period 2003–2004 and then to $63 billion from 2014 onwards. Cumulative FDI during the 3 time periods mentioned above has increased from $18 billion to $305 billion to $404 billion (Nair, 2021). Indeed, India has become an attractive destination for FDI as the fifth largest recipient of FDI in the world by 2020 (United Nations Conference on Trade and Development i.e. UNCTAD, 2021). However, the question remains: Is this surge in FDI just because of policy regimes or else institutional changes has also played any role? We will empirically verify this question later in Section 4.3. In the economic literature (i.e., in endogenous growth theories), FDI is considered to be a key determinant of EG. It leads to a surge in the EG of the host country through higher capital accumulation, as has been postulated in exogenous growth theory, or through the introduction of new goods or technology (Mahembe & Odhiambo, 2014).3 In addition, it is not only a source of technological transfers from developed countries to developing countries (Chenaf-Nicet & Rougier, 2016; Herzer et al., 2006) but also contributes to a reduction in unemployment in both direct and indirect ways (Lipsey, 2001). More importantly, it leads to an increase in productivity by adding to the knowledge and skills of workers in the host country (Elboiashi, 2011). Zedillo et al. (2001) says that FDI can promote EG provided along with other macroeconomic and infrastructural factors, well-functioning institutions and regulatory mechanisms are in place that also ensure transparency at all levels of functioning. Recent cases of accounting malpractice, outright fraud and subsequent revelations of poor governance have highlighted the importance of transparency in the global corporate sector. The importance of transparency would restore the confidence of foreign investors in the host companies. Fundamentally, disclosure and transparency are crucial elements of good CG, which provides the foundation needed for a strong and robust capital market that would attract increasingly more foreign capital inflows.

3 Additionally, see Thirlwall (1999) and Zhang (2001).

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Mathur and Chatterjee (2002) very clearly points out that “Poor governance breeds corruption, raises information cost for investors and encourages rent-seeking activities. Poor governance also has an adverse effect on the morale of the citizens of a country. Poor governance may discourage investment by creating barriers to market entry and increasing operating costs ”. Therefore, it is clear that good CG and EG are related to each other, as CG impacts growth by encouraging or discouraging foreign capital inflows in a country. However, it is important to note here that good governance with transparency is just one-step (along with many other factors cited above) in creating an enabling environment for FDI, as the OECD has also recognized it. Linkage Between FDI and CG Since 1999, Kaufmann et al. (1999) in their series “Governance Matters ” provide empirical evidence of a strong causal relationship from better governance to better development outcomes. Six dimensions of governance, namely, Voice and Accountability, Political Stability and Absence of Violence/Terrorism, Government Effectiveness, Regulatory Quality, Rule of Law, and Control of Corruption, are considered to measure governance. Mathur and Chatterjee (2002) state that “…a sound national institutional environment is more important for ensuring good governance and transparency in a country. In the presence of properly functioning institutions, corporate governance instruments, at the most, act as a strengthening mechanism for the existing investment environment. However, if the legal and political environment is less than ideal, these are also useful in encouraging responsible corporate behaviour. Nevertheless, there is no substitute to good national institutional framework in a country”. Unarguably, good governance and transparency should be maintained at the national level as well as in corporate affairs. Therefore, there arises a need to consolidate the rule of law, strengthen the policy and regulatory framework, and reduce corruption in a country. These steps can go a long way to make the host country attractive for foreign investment (especially FDI). There is enough empirical research that supports the fact that FDI and cross-border mergers and amalgamations (M&As) in particular can be an important source of CG improvements in the host country, which further

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leads to improvement in CG practices in target firms (Bris & Cabolis, 2008; Manne, 1965; Martynova & Renneboog, 2008; Rossi & Volpin, 2004; Scharfstein, 1988). Albuquerque et al. (2019) also support this point that FDI promotes CG spillovers in the host country. By taking firm-level data on CG and cross-border M&As in 64 target countries over 2005–2014, covering both emerging and developing nations, the study established a direct link between FDI and the adoption of CG practices. The study suggests that this can help promote corporate accountability and empower shareholders worldwide. Ananchotikul (2007) proclaimed that foreign ownership is a vital instrument for augmenting CG in developing economies. The study created a firm-specific index of the quality of CG and explored the relation between foreign investment and CG. A positive effect of foreign investment on CG was found using econometric methods. Chevalier et al. (2006) questioned whether foreign owners’ participation leads to better CG practices in emerging countries with a focus on the capital invested in firms to examine CG practices. It is found that multinational companies (MNCs) in Indonesia are essentially more prudent in their financing policies. Thus, the role of MNCs in developing countries is supposed to be an important factor in installing better institutions of business and the economic environment. Linkage Between FDI, EG and CG Interalia, FDI is not related to EG alone, but FDI is related to institutions/structures that could be both political and firm specific. The chapter is confined to firm-specific structures4 and the causal relationships between EG, CG and FDI. In this chapter, we have used the CG Index as a proxy for the quality of CG for Indian listed firms. Sabir et al. (2019), using panel data for low-, lower-middle-, uppermiddle- and high-income countries for the sample period of 1996–2016 using the generalized method of moments (GMM) system, confirm that institutional quality has a positive impact on FDI across countries. Furthermore, when effective corporate regulatory practices are in place, 4 The firm specific structures in the study get revealed in the firm specific index of quality of corporate governance constructed by averaging the Governance score of Bloomberg Environment, Social and Governance (ESG) Score covering the top 500 listed entities of S&P BSE 500 Index of the Bombay Stock Exchange.

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investors (whether domestic or foreign) are incentivized to invest more. This is likely to boost growth. However, poor structures can impede the EG of countries by acting as a deterrent for FDI inflows by raising the cost of capital (Buchanan et al., 2012). That is why corruption, nepotism, and red tape obstruct FDI (Mengistu & Adhikary, 2011). There are studies relating to Asia and Latin America (Gani, 2007) or to regional blocks such as SAARC, Central Asian countries and the ASEAN region (Ullah & Khan, 2017) that argue that institutional quality positively and significantly impacts FDI inflows. Therefore, good CG in the host country has been considered a prerequisite for attracting FDI, which will contribute to sustainable growth. Zedillo et al. (2001) seemingly puts forth the view that the relation between FDI and CG is bidirectional in nature when it mentions that FDI can be both a cause and an effect of CG and transparency. To quote from Mathur and Chatterjee (2002), “While a transparent regime facilitates FDI, the converse is also true: FDI may also facilitate a transparent regime. The presence of foreign investors may lead to more open government practices, promote corporate social responsibility and corporate governance, and assist the fight against corruption.” Foreign investment is dependent on various variables relating to a particular country and to a particular country’s trade and foreign investment policies. Foreign investment is also dependent on various variables relating to a particular company, as advanced by the eclectic theory of Dunning (1980). The theory highlighted the importance of institutions, along with other factors such as the size of the firm, administration and management systems, labor and transportation costs, government policies and political stability, which influence the decision of a foreign investor to invest in a host country. However, this theory was criticized because it considers too many factors and hence lacks practicality. As a result, a new theory was proposed called The Investment Development Path (IDP), which links a country’s policy framework to its foreign inflows and outflows (Nayak & Choudhury, 2014). Along with this line of thought, it can be surmised that firm-specific privileges and a country’s policy framework are interrelated. The existence of various institutional structures attracts FDI, which leads to an increase in growth. The influential writings of a noble laureate, North (1990) belonging to the new school of institutional economics, have also brought to the forefront the relationship between institutional quality and economic growth. North (1996) has very rightly remarked, “it is incentive structure embedded in

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the institutional/organizational structure of economies that has to be a key to unravelling the puzzle of uneven and erratic growth”. Henceforth, the issue of discrepancy in the growth rates among different countries pointed out in various studies (Feng, 2003; North, 1990), which has puzzled academicians and policy makers for a long time, remains unresolved if the differences in institutional structures across countries are also considered. We emphasize here that institutional structures not only comprise political structures but also include organizational structures. Undoubtedly, the ideas and interests of different political groups affect an economy’s roadmap to institutional changes/reforms5 that can further influence FDI inflows. Inter alia, several studies have attributed the faster growth of some countries vis-a vis the slower growth of others to differences in institutional structures. That is why Feng (2003) says that the “steady state level of output is determined by structures (which may be political or organizational 6 ) along with other factors (economic, social, cultural and demographic)”. Since our focus in this chapter is on CG, we want to reiterate the view of Mathur and Chatterjee (2002), which states that CG structures or systems are very crucial for the development of a country by attracting equity capital for the country. Several studies such as Acemoglu et al. (2005); Kaufmann et al. (1999); Olson et al. (2000); Rodrik et al., 2004) argue that better governance leads to growth, i.e., causation runs from governance to high GDP growth (EG). Conversely, Kurtz and Schrank (2007) in their recent work find that growth leads to better governance; in other words, causation runs in the opposite direction. They write, “within the limits of somewhat problematic measures, the evidence suggests that there is far more reason to believe that growth and development spur improvements in governance than vice-versa”. Although the term governance is usually referred to as the governance of countries, this argument is equally applicable/valid in the case of firms/ corporates. Better CG manifests itself in enhanced corporate performance and can lead to higher economic growth (Maher & Andersson, 2000). In contrast, CG problems can still act as a major impediment to EG. If 5 See Shin-Ping & Tsung-Hsien (2009) and Shin (2014). 6 Feng (2003) refers to political structures, but our argument is limited to organization

structures (Corporate structures/norms). Indeed, overall political governance matter. It is the dynamic interaction between politics and institutional changes/quality that can impact EG by making host country an attractive destination for FDI or vice -versa.

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we believe that active financial markets are linked with economic development, then regulations/institutions/structures that promote stock market activity may provide one of the underlying sources for the EG. However, this may not matter if there are other sources of financing available to the corporate sector. The foregoing review of the literature leads us to hypothesize that the relationship between FDI and EG as well as between FDI and CG is bidirectional in nature. CG and EG are related to each other via FDI. After examining the literature (Sec 4.2), we will proceed towards hypotheses, analysis and discussion in Sec 4.3. Section 4.4 will discuss the conclusions and policy implications.

4.3

Hypotheses, Analysis and Discussion

Based on the literature review, we hypothesize the following: i. H01 : ii. H02 : iii. H03 : iv. H04 : v. H05 : vi. H06 :

CG does not Granger cause EG FDI does not Granger cause EG EG does not Granger cause CG FDI does not Granger cause CG EG does not Granger cause FDI CG does not Granger cause FDI

We have divided the remaining Sec 4.3 of this chapter into three sections. Section “Data and Variables” describes the data and its sources along with the variables used in the analysis. Section “Period of Study” mentions the period of the study. The final Sec “Technique and Model Formulation” details the data analysis technique and the model employed. Data and Variables The chapter employs annual time series data for all three variables under study, viz. FDI, EG and CG, which were collected from secondary sources. The main source of data for EG and FDI is the Handbook of Statistics on Indian Economy 2020−2021 published annually by the Reserve Bank of India (RBI, 2021). For the purpose of the study, an annual Corporate Governance Index (CGI) as a proxy for CG has been constructed averaging the Governance score of Bloomberg Environment,

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Table 4.1 Descriptive Statistics Statistics

Economic Growth (EG) in Rs. crores

Foreign Direct Investment (FDI) in Rs. Crores

Corporate Governance Index (CGI)

Mean Median Standard Deviation Minimum Maximum Number of Observations

9,158,076 9,712,133 3,547,783.268

240,203 215,893 91,909.27476

71.92347723 74.79398517 7.629844073

3,896,636 13,512,740 13

132,358 406,765 13

60.35162985 80.65877246 13

Social and Governance (ESG) Score covering the top 500 listed entities of the S&P BSE 500 Index of the Bombay Stock Exchange (BSE). The CGI is constructed on a scale of 0 to 100, wherein a high score indicates good or better CG, and a low score indicates poor CG. An improvement in the CG index or scores depicts an improvement in CG as well as a growing trend of better implementation of CG policies and norms (Sarkar et al., 2012). The Bloomberg Environment, Social and Governance (ESG) Score was extracted from the Bloomberg database. The data were analysed using Stata version 15. Furthermore, we have used Gross Domestic Product (GDP in Rupees Crores) in absolute terms as a proxy for EG and direct investment to India (in Rupees Crores) as FDI. The descriptive statistics of the three variables are given in Table 4.1. Inspection of Table 4.1 reveals that the mean EG is 9158076 with a standard deviation of 3,547,783.268, whereas the mean FDI is 240203 with a standard deviation of 91,909.27476. The minimum and maximum CGI scores were 60.35 and 80.65, respectively, with a mean score of 71.92. Period of Study The period of the present study is thirteen years starting from 2008–2009 and ending in 2020–2021. Construction of the index for thirteen years allows us to examine the evolution of the state of CG over a time period that captures major CG reforms in the Indian landscape. It is important to

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mention here that Sarkar et al. (2012)7 also tried to construct a Corporate Governance Index (CGI) for firms; however, the time period chosen for the study and the methodology differed from the present study. The choice of the time period is highly appropriate to study the causal linkages between FDI and EG and between FDI and CG because 2009 marked the beginning of the second phase of CG reforms in India, just after the Satyam scam in 2009. It is important to mention here that 2008 witnessed an amendment to Clause 498 of the Listing Agreement by The Securities and Exchange Board of India (SEBI), a regulatory body for securities and commodity markets in India. Clause 49 was revised in 2004 by SEBI with the objective of improving the quality of CG in Indian listed companies. It became imminent for the Government of India (GOI) after Satyam Fraud (in 2009) to introduce more reform measures and carry out further amendments in the guidelines of CG and other Indian corporate laws. Therefore, in the context of CG reforms in India, 2009 is marked as the beginning of the second phase of CG reforms.9 In this backdrop, the period starting from 2009 would be appropriate to study the causal linkages between EG, FDI and CG for India. We have chosen the multivariate Granger causality analysis technique to carry out the analysis, as the review of literature done in Section II indicates that the relationship between FDI and EG and FDI & CG is bidirectional in nature.

7 Sarkar et al. (2012) included in their study 500 large listed Indian firms and the time period chosen was from 2003 to 2008. 8 Clause 49 of the Listing Agreement aims to adopt leading industry practices on corporate governance to make the framework of corporate governance more effective via disclosure and transparency of all material matters and stringent responsibilities of the Board of Directors. The provisions of the said clause relate to composition of the Board of Directors, Related Party Disclosures, Whistle Blower Policy and other Committees, among others. 9 The first phase, started from 1990’s, with the formation of SEBI, India’s securities market regulator in 1992. The regulator has been instrumental in advocating for and drafting CG guidelines.

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Technique and Model Formulation Multivariate Granger causality analysis is usually performed to investigate the causal relationship between variables by fitting a vector autoregressive model (VAR) to the time series (Guru-Gharana, 2012; Kagochi et al., 2013; Pradhan et al., 2016). The chapter employs the same to investigate the causal relationship between EG, CG and FDI. Furthermore, it is well known that time-series data may produce spurious results if the variables under consideration follow a time trend or, in other words, they are nonstationary. Therefore, the first step is to test the stationarity of the variables under study. The augmented Dickey–Fuller test (ADF) is usually performed to test the null hypothesis that a unit root is present in time series data. The results of ADF clearly indicate that EG, CG and FDI are nonstationary at the level data but are stationary at the first difference. The first difference value for Z(t) for the EG is (–8.376) with a p value of (0.0000)*, which is significant at the 1% level of significance. The similar values of Z(t) and p for FDI and CG are –3.244 (0.0759)** and –1.475 (0.0919)**, respectively, significant at the 10% level of significance. The Phillips-Perron test gives similar results. The second step in running the VAR model is to determine the true lag length of the VAR system using some suitable information criterion (or criteria). The results of Var lag Order Selection criteria using four criteria are depicted in Table 4.2 below. Table 4.2 Var lag order selection criteria and results Endogenous Variables: EG, CG, FDI Exogenous: C Sample: 2009–2021 Lag

FPE1

AIC2

HQIC3

SIC4

0 1 2 3 4

1.50E + 22 1.80E + 21 61,236.4*

59.5588 57.2697 17.9645 –130.153 –135.293*

59.4169 56.7022 16.9714 –131.43 –136.57*

59.6245 57.5327 18.4247 –129.562 –134.701*

Notes * indicates lag order selected by the criterion 1. FPE: Final Prediction Error 2. AIC: Akaike Information Criterion 3. HQIC: Hannan-Quinn Information Criterion 4. SIC: Schwarz Information Criterion

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Table 4.2 clearly depicts that the optimal lag order is 2 (k = 2) according to the final prediction error criterion. However, the Akaike information criterion, Hannan-Quinn information criterion and Schwarz information criterion indicate an optimal lag order of 4. We accept the lower optimal lag order. Consequently, we estimate the following VARL (3) system for the sample period: ⎡ ⎤ ⎡ ⎤ ⎤⎡ ⎤ βgg,i βgc,i βg f,i Gt αg G t−i  ⎣ Ct ⎦ = ⎣ αc ⎦ + 2⎣ βcg,i βcc,i βc f,i ⎦⎣ Ct−i ⎦ i=1 Ft αf β f g,i β f c,i β f f,i Ft−i ⎡ ⎤⎡ ⎤ ⎡ ⎤ γgg,3 γgc,3 γg f,3 G t−3 εgt ⎣ γcg,3 γcc,3 γc f,3 ⎦⎣ Ct−3 ⎦ + ⎣ εct ⎦ γ f g,3 γ f c,3 γ f f,3 Ft−3 εft ⎡

G denotes EG, C denotes CG and F denotes FDI. The hypothesis for the Granger causality test becomes: i. H01 : ii. H02 : iii. H03 : iv. H04 : v. H05 : vi. H06 :

βgc,1 = βgc,2 = 0 → CG does not Granger cause EG βgf,1 = βgf,2 = 0 → FDI does not Granger cause EG βcg,1 = βcg,2 = 0 → EG does not Granger cause CG βcf,1 = βcf,2 = 0 → FDI does not Granger cause CG βfg,1 = βfg,2 = 0 → EG does not Granger cause FDI βfc,1 = βfc,2 = 0 → CG does not Granger cause FDI

For Granger causality detection, we first deploy a vector autoregressive (VAR) model with lag order 2. The results of the Granger causality test are reported in Table 4.3. The results of Table 4.3 clearly show bidirectional causality both between EG and CG (EG < = > CG) as well as unidirectional causality both between EG and FDI (EG = > FDI) and CG and FDI (CG = > FDI). Our results support the observations made by Zedillo et al. (2001), who advocate the relationship between EG, CG and FDI and recommend that the host country as well as foreign investors introduce, adhere to and strengthen good governance norms to make the development process more sustainable.

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Table 4.3 Granger causality test results Null Hypothesis

chi2 Prob > chi2

Inference

H01 : CG does not Granger Cause EG

26.8 (0.000)* 0.9444 (0.624) 4.9725 (0.083)*** 0.932 (0.628) 4.7061 (0.095) *** 8.8072 (0.012) **

Rejected CG Granger cause EG Not Rejected

H02 : FDI does not Granger Cause EG H03 : EG does not Granger Cause CG H04 : FDI does not Granger Cause CG H05 : EG does not Granger Cause FDI H06 : CG does not Granger Cause FDI

Rejected EG Granger cause CG Not Rejected Rejected EG Granger cause FDI Rejected CG Granger cause FDI

Significance at 1% level of significance if one*, at 5% if two**, at 10% if three***

4.4

Conclusions and Policy Implications

Numerous studies have examined the determinants of FDI. Many other studies report that a positive and significant relationship exists between FDI and EG. However, to our knowledge, in none of the studies have the effect of CG norms, rules, and structures been considered along with the EG. This is the unique contribution of this chapter. Our study, by taking time series data of FDI and EG (GDP in absolute terms) and by constructing and using the CG index in the context of India, applies the Granger causality test to identify the relationship that exists between EG, CG and FDI. The study finds that the relationship between the EG and CG is bidirectional in nature. Furthermore, EG and CG both cause FDI. The major policy inferences that can be drawn from these results are that CG is a crucial variable that deserves special and more attention from policy makers in India to revive the present EG and to subsequently put India on a higher growth trajectory. As per our empirical results, growth demands improvement in the CG regime, and a good CG regime fosters growth. Second, both growth and CG attract FDI. Likewise, good CG norms have the potential to boost EG by attracting more FDI. The positive relationship between FDI and EG clearly shows that the government of India must create a positive business environment in the country by focusing on a strong and effective regulatory regime in general and the CG regime in particular. The relative increase in FDI over the last

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three decades and the larger inflows of FDI received, especially during the pandemic,10 bring in hope that growth revival will begin soon (as has also been predicted by international bodies such as IMF, OECD, and ADB). Seemingly, higher FDI inflows are indicative of the confidence that foreign investors have shown for India’s CG regime and capital markets during the pandemic. Their perceptions about our governance regime and CG regime, especially along with other macroeconomic fundamentals, seem to be positive. This goes with the notion that there exist strong complementarities between sound macroeconomic policies and sound microeconomic foundations that governments around the globe have recognized (Maher & Andersson, 2000). Consequently, in the past three decades, especially during the last decade, the government of India has reformed the Indian corporate regulatory regime through the introduction of various pragmatic structural reforms. The efforts put in by the present government to improve India’s performance on ease of doing business parameters11 and steps taken by it to strengthen the CG regime in India12 are steps in the right direction. The newly introduced Companies Act, 2013 is a rule-based law to induce good CG practices through self-regulation, disclosures and responsive legal framework. Furthermore, Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations (SEBI LODR)13 were introduced in 2015 to harmonize the provisions of the Companies Act, 2013 and the Listing Agreement.14 All the above-stated initiatives ensured robust CG practices within Indian listed entities. Another feather in the cap relates to the efforts of the Ministry of Corporate Affairs, Government of India in the form of releasing 10 India has received highest ever annual FDI inflow of USD 83.57 billion in the Financial Year 2021–2022. The FDI inflows in India have increased by 23% post Covid from March, 2020 to March 2022 (being USD 171.84 billion). The comparative figure for the pre-Covid period from February, 2018 to February, 2020 stood at USD 141.10 billion (see: https://pib.gov.in/PressReleasePage.aspx?PRID=1826946). 11 There are 10 parameters of Ease of Doing Business like Starting a Business, Registering Property, Enforcing Contracts and Resolving Insolvency, etc., considering which a country is ranked internationally. India ranked 63rd in 2022, jumped 79 positions from 142nd in 2014 as per the ’World Bank’s Ease of Doing Business Ranking’. 12 The CG reforms have been discussed in detail in Chapter 2. 13 SEBI (LODR) amended in 2015 and 2021 also. 14 The contract entered between the company and Stock Exchange when the securities

get listed.

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National Guidelines for Responsible Business Conduct (NGRBCs) and recommending new comprehensive framework for Business Responsibility and Sustainability Report (BRSR) wherein reporting of nonfinancial disclosures, that is, Environmental, Social, and Governance aspects, is strengthened. In this context, the Securities and Exchange Board of India (SEBI) has provided new comprehensive formats for BRSR to be mandatorily followed by specific listed entities.15 The pragmatic reforms and measures seem to have generated faith among investors in India as a destination for foreign capital. That is, India attracted the highest total FDI inflow of US $81.72 billion during the 2020–2021 financial year, which was 10% higher than the last financial year 2019–2020 (US $74.39 billion).16 Higher inwards FDI has huge employment generation potential. Therefore, simplification of Labour Laws (to promote ease of doing business) undertaken by the Ministry of Labour, Government of India in the past two years, such as the Code on Wages, 2019 and Industrial Relations Code, 2020, are highly timely and will definitely help in improving the overall investment climate in the country along with boosting the sentiments of foreign investors about India’s market. FDI inflows can support economic recovery in India, which can further lead to demand creation (Singh & Sharma, 2020). Furthermore, FDI inflows from East Asian countries such as Japan, South Korea and the Republic of China are likely to create a geo-political advantage for India. The result of our study is in consonance with the notion that good CG positively impacts FDI and growth. The impact of CG on EG and FDI shows that better CG can lead to higher growth and attract more FDI. Therefore, the initiation of various reforms in standards of CG needs to be implemented more effectively because foreign investors try to be aware of the rules regarding investment protection in foreign/host markets (Gilson, 2004). There is a need to implement various CG rules in a well-coordinated manner. Moreover, there is a need to reinforce these linkages between FDI, CG and EG to revive India’s EG first and to subsequently experience a growth spurt (after the COVID-triggered downturn 15 The preparation of the said BRSR was voluntary for the financial year 2021–2022 and mandatory from the financial year 2022–2023 for the top 1000 listed companies by market capitalization (who were mandatorily preparing BRR). 16 See press release of the Ministry of Commerce & Industry dated May 21, 2021. Available at: https://pib.gov.in/PressReleasePage.aspx?PRID=1721268.

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in the economy). The need of the hour is timely introduction of complementary and consistent measures in FDI framework and CG systems and their effective implementation to accelerate and sustain EG.

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PART II

Looking beyond Corporate Governance – Corporate Sustainability and Sustainability Reporting

CHAPTER 5

Rising Importance of Corporate Sustainability in the Current Era

5.1

Introduction

Corporate scandals and financial crises, especially Asian and global financial crises, have pushed corporate governance (CG) issues to the top of the agenda of international bodies such as the United Nations (UN), United Nations Conference on Trade and Development (UNCTAD), Organisation for Economic Co-operation and Development (OECD) and emerging economies such as India. Inter alia, the financial crises were an outcome of governance failure. These have given several setbacks to different sections of society in the form of unemployment, lost savings, financial insecurity, etc., and at the same time have also set in this realisation that ‘nonfinancial matters too matter for financial performance and vice-versa’ (United Nations, 2010). The recognition of critical interdependence between financial, natural, human, social and manufacturing/ technical capital during the climate change crisis, ecosystem/natural resource crisis and now COVID crisis has been running in parallel with financial crisis is appreciable. Undeniably, one of the positive outcomes of the financial crisis is the understanding and appreciation of the fact that governance strategy and sustainability have become inseparable. Sustainability means that entities conduct their business operations in such a manner that their current needs are met without compromising the ability of future generations to meet their needs. At the same time, they

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 S. Joshi and R. Kansil, Looking at and Beyond Corporate Governance in India, https://doi.org/10.1007/978-981-99-3401-0_5

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have regard or consideration for the impacts that their business operations have on the life of the community in which it operates and includes environment, social and governance issues. Consequently, they have to integrate environment, social and governance factors in their investment processes and business decision making in the wider interests of their stakeholders. This stakeholder-oriented ethic is gradually assuming greater importance in managing sustainability risks and tapping sustainability opportunities. This has led to the adoption of various approaches to integrate sustainability into business processes (termed corporate sustainability), such as adopting the triple bottom line and/or introducing sustainability practices. Over the years, as the real outcomes of corporate sustainability come under greater scrutiny, research is progressively focusing on the role of corporate governance as a tool to drive sustainability outcomes (EncisoAlfaro & García-Sánchez, 2022; Jones & Thompson, 2012; Karn et al., 2022; Salvioni et al., 2018). However, the desired results/outcomes are yet to be experienced. The present chapter employs a novel inquiry-based SAP-LAP (situation-actor-process learning-action-performance) framework to understand the interrelationships between the various elements of SAP-LAP. The situation-actor-process (SAP) learning-action-performance (LAP) framework is a standard universally applicable approach developed by Sushil (2000) that has been used by many management scholars across multiple domains and sectors with applications in several fields (Chauhan et al., 2019; Ghosh, 2016; Siva Kumar & Anbanandam, 2020; Soni et al., 2016). SAP refers to the analysis of a given context, and LAP refers to the synthesis of the context for improved performance. Both SAP and LAP include three distinct interfaces, namely, situation (S), actor (A), process (P) and learning (L), action (A) and performance (P). The first step in this SAP-LAP approach is to analyse the context under the three broad interfaces of SAP, viz., situation (S), actor (A), and process (P). We present a bird’s eye view of what these six interfaces mean through the following questions, which will be answered subsequently: The SAP explains the existing situation along with the stakeholders and solutions for dealing with the present situation. Therefore, the SAP Components (Analysis) are as follows: Situation What is the present state? How have we reached the present state?

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Actor Who are the stakeholders dealing with the situation? Process How are actors responding to the situation?/What is being done by actors to handle the situation? The synthesis of SAP brings in three other broad interfaces, viz LAP. The LAP Components (Synthesis) are as follows: Learning What are the key issues for current Situation, Actors and Process? Action What should be done to improve? Where actions are needed? Performance What will be the impact of actions on the current situation, actors and process?

5.2 Application of SAP-LAP Framework to Explain Linkages Between CS and CG Lester R Brown, a renowned environmental analyst and founder of the World Watch Institute, has very rightly pointed out that the planet we live in is not inherited by the present generation from their forefathers; rather, the present generation has borrowed it from their future generations. In other words, the present generation is rather using the planet on lease. Therefore, resources available on planet Earth need to be used cautiously rather than abused or overused. It is implicit in this statement that there exists an ethical obligation on the part of the present generation to ‘act responsibly and think sustainable’. They have to protect, preserve and conserve natural resources in a sustainable manner to build ‘shared prosperity’ for both current and future generations. There has been a flurry of research in the past few decades around how sustainability would protect the human population and the environment from unregulated production activities resulting in environmental and resource degradation (Christofi et al., 2012). Undoubtedly, sustainable practices would safeguard our mother Earth’s ecosystem and protect the future of mankind. Sustainability is a long-term concept associated not only with present actions affecting the future availability of resources (Crowther, 2002)

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but also with stakeholders . Previous research has pointed out that since sustainability is a multidimensional concept, inter alia, it requires engagement (Goodman et al., 2017; Leal Filho & Brandli, 2016), negotiation (Hall & Vredenburg, 2003), dialogue and collaboration (Rhodes et al., 2014) between multiple stakeholders, namely, customers, communities, employees, shareholders, businesses, financial institutions, financial regulators, governments and policy makers, not-for-profit organisations, and academia, to meet the sustainability agenda. Different initiatives have been undertaken across the globe to address multiple sustainability issues, such as solar power, sustainable agriculture, green buildings, electric vehicles, green finance, and pollution prevention. It is important to mention that businesses across sectors have been affected and will have to respond to the implications of sustainability. Considering the fact that businesses are a key player and contributor to the global call for sustainability agenda, we present the interfaces of SAP-LAP (as visualised by us in Table 5.1 given below) to enable the maximisation of business (corporate) sustainability outcomes. Situation Sustainability affects businesses in several ways. Businesses usually grapple with multiple issues, such as resource crunch, rising prices, lack of demand for products or services, brand retention, adoption of new technologies, introduction of new processes, attracting and retaining talent, tapping new markets, following regulations and managing societal pressures. The financial crises and corporate governance scandals gave a wakeup call to companies and policy makers to build corporate governance infrastructure by enacting a wide range of laws and regulations, developing standards and strengthening enforcements. There is a growing realisation now that the role of businesses is not limited to their own growth or promotion of economic growth, but they have to equally contribute to environmental preservation, social good and equity. The traditional corporate management model of growth and profit maximisation is now viewed as a corporate management paradigm by Wilson (2003). This paradigm discusses corporate sustainability management encompassing environmental protection, social justice and equity, and economic development. Hart (1997) highlighted that limited resources are a concern for the business itself, while Aras and Crowther (2008) mention that the immediate business concern is the increase in

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Table 5.1 Elements of SAP LAP in corporate sustainability (CS) Elements of CS

Keypoints

Situation What is the present state? How have we reached the present state?

S1—Sustainability affecting businesses in multiple ways S2—Demand for alternative resources and/or processes S3—Sustainability has become a strategic priority S4—Changing dimension of business management in functional terms S5—Changing dimension of business management in institutional terms A1—Top management/Board of Directors A2—Owners/Shareholders A3—Chief Executive Officer A4—Employees A5—Others P1—Tackling multiple corporate sustainability challenges by following different approaches such as—win win approach, trade-off approach, integrative approach and paradox approach P2—Focus on application of integrative logic at strategy implementation stage P3—Gaining knowledge and information on description of multiple sustainability concerns P4—Reducing ambiguity on outcomes and impacts P5—Finding a consistent basis for measuring intrinsic value of sustainability elements

Actor Who are the stakeholders involved in creating sustainability culture in the organisation?

Process How are actors responding to the prevalent situation? What are the steps in hand to create sustainability culture?

(continued)

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Table 5.1 (continued) Elements of CS

Keypoints

Learning What are the key learnings for the actors from the existing situation and processes followed in the firms?

L1—Evolving corporate sustainability landscape as a means to achieve global sustainability L2—Understanding the growing relevance and urgency of sustainability initiatives L3—Fixing ownership, responsibility and accountability of addressing sustainability risks L4—Ensuring co-ordination across all units/verticals of an entity and entities of a group L5—Recognising interconnected and interrelationship between sustainability and corporate governance L6—Utilising various tools to assess sustainability risks and their impacts A*1—Deeper understanding and commitment of actors required A*2—Use of social networks and collaborations A*3—Mitigating increasing threat of sustainability risks A*4—Tapping material issues beyond a threshold A*5—Promoting Governance for Sustainability P*1—Implementation of corporate sustainability actions P*2—Achieving high Sustainability Performance P*3—Enhanced Sustainability Reporting P*4—Push for Global Sustainability

Action (Recommendations for future action) What should be the course of action to improve sustainability culture in the firms?

Performance What will be the impact of actions on current/prevalent Situation, Actors and Process?

Note S1 to S5 depict key points for Situation, A1 to A5 depict key points for Actor, P1 to P5 depict key points for Process, L1 to L6 depict key points for Learning, A*1 to A*5 depict key points for Action and P*1 to P*4 depict key points for Performance

cost of resources that are in the course of depletion (though available now). Businesses to last or sustain need to ensure that the resources to the extent consumed today should also be regenerated or else such operations should be adopted that do not require the resources used today. In other words, sustainability is of paramount importance for future businesses. Companies must not only create value for their owners but also

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introduce sustainable business models. The latter will add value to both businesses and society and thereby contribute to the triple bottom line of profit, planet and people. A recent study by Visser (2022) uses the word ‘thriving’ in place of ‘sustainability’. The following Table 5.2 summarises the plethora of business benefits of regeneration or the 10Rs of return on thriving (read as sustainability). Sustainability may become an issue for a firm due to an unforeseen crisis as a polluter or social oppressor (Porter & Derry, 2012). In contrast, it may be an opportunity to gain competitive advantage or to make a tangible positive impact or a duty to abide by regulations and/or standards. Regardless of the reason, firms have begun to integrate sustainability considerations into their business processes. They have now started looking at how their business activities and operations affect the environment and society. This growing awareness of sustainability or perhaps Table 5.2 Business Benefits of Regeneration

Source Reproduced from Visser (2022)

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forced responsibility has pushed businesses to gain new knowledge and respond via sustainable processes and new green products. A recent McKinsey Global Survey (Granskog et al., 2021) compared practices across two categories of firms, namely, value creators1 and others. As per the survey, value creators treat sustainability as a strategic priority, embed sustainability into corporate culture, train employees, engage customers, and collaborate with value chain partners to deliver sustainable products or services. Furthermore, these value creators are more focused and transparent; they establish and disclose sustainabilityrelated information such as targets, goals and key performance indicators (KPIs). The rise of global interests both among government and nongovernment organisations to share the responsibility of preserving and maintaining the environment and its natural resources has led to the evolution of the term “corporate sustainability”. Corporate sustainability is the organisational commitment to integrate ecological, environmental and social aspects in its production processes to deliver sustainable products and services. The evolution of corporate sustainability has been beautifully outlined by Wilson (2003), where four underlying concepts2 established from six disciplines3 have advanced the term corporate sustainability. We can summarise corporate sustainability as the “contribution of profit driven businesses to the common global call for social good and environmental protection where businesses both perform and report”. Performance is termed sustainability performance, and reporting is termed sustainability reporting. Yilmaz and Flouris (2010) described corporate sustainability management in functional and institutional terms. In functional terms, business activities are to be managed in such a way that all ecological, social and economic impacts are addressed, whereas in institutional terms, business activities are managed by such actors and with such an organisational structure that social and ecological aspects are integrated into business activities (Schaltegger et al., 2002).

1 Value creators are those firms which create value from their sustainability programs through distinct management practices. 2 Namely, Sustainable Development, Corporate Social Responsibility, Stakeholder Theory and Corporate Accountability Theory. 3 Namely, Economics, Ecology, Social Justice, Moral Philosophy, Strategic Management and Business Law.

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Fig. 5.1 Linkage of sustainability to sustainability reporting (Source Authors’ compilation)

GRI (2006) has defined sustainability reporting as “the practice of measuring, disclosing, and being accountable to internal and external stakeholders for organizational performance towards the goal of sustainable developments ”. Herbohn et al. (2014) studied the relation between sustainability performance and sustainability disclosures (reporting) across Australian mining firms and found a positive relation between the two. Thus, sustainability reporting reports on the nonfinancial performance of businesses against environmental, social and governance goals show that good sustainability performers, on average, disclose more with respect to their sustainability performance (Herbohn et al., 2014). Figure 5.1 shows the linkage of sustainability to sustainability reporting. Actor Once we have highlighted and emphasised the importance and relevance of corporate sustainability to mark the current state (Situation), the next interface (Actor) will answer the question as to who are the actors involved in and responsible for handling the present situation. The answer to the question lies in the theoretical perspective behind sustainability. Previous research publications in the field of sustainability have largely applied stakeholder theory in various distinct works covering environmental and social aspects as well as sustainability management. Stakeholder theory provides all the ingredients necessary for a theory on corporate sustainability and at the same time helps us to understand the actors of corporate sustainability. Horisch et al. (2014), in their seminal work, note that corporate sustainability revolves around its stakeholders. Every business must try to satisfy its stakeholders. Meadows et al. (1972)

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stated that the demands of multiple stakeholders can be prioritised on the basis of the speed of feedback and their personal closeness. Garvare and Johansson (2010) emphasise that to attain sustainability, corporates must try to “satisfy or preferably exceed the wants and expectations ” of all stakeholders and simultaneously meet their objectives and goals and those of their own organisations. We believe that actors for corporate sustainability would be a natural extension of the corporate governance literature similar to Aguilera et al. (2021), where the authors have discussed the role of corporate governance actors in environmental sustainability. Furthermore, we witness that prior literature has paid less attention to the social dimension of sustainability, probably because the social outcomes and impacts are difficult to measure and quantify. Gladwin et al. (1995) expressly point to the fact that corporate sustainability is more than environmental management and should explicitly deal with the social dimension. Clarkson (1995) defined stakeholders as “persons or groups that have, or claim, ownership, rights, or interests in a corporation and its activities, past, present, or future. Such claimed rights or interests are the result of transactions with, or actions taken by, the corporation and may be legal or moral, individual or collective. Stakeholders with similar interests, claims, or rights can be classified as belonging to the same group: employees, shareholders, customers, and so on”. The actors of corporate sustainability can be classified into two categories: primary stakeholders and secondary stakeholders, similar to Clarkson (1995). “A primary stakeholder group is one without whose continuing participation the corporation cannot survive as a going concern…. Secondary stakeholder groups are defined as those who influence or affect, or are influenced or affected by, the corporation, but they are not engaged in transactions with the corporation and are not essential for its survival ”. Primary stakeholder groups generally include shareholders, investors, employees, customers, suppliers, governments and communities. Every business entity has to identify and continuously update its stakeholder list because stakeholders vary from firm to firm, and their wants and expectations vary over time. Furthermore, the distinction between primary and secondary stakeholders also varies across firms. An actor may be a primary stakeholder for one firm and a secondary stakeholder for another. Corporate sustainability can be achieved only when the wants and expectations of all stakeholders are endlessly met (Garvare & Johansson, 2010).

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Top management or the Board of Directors is the decision maker in the functioning of the firm. They would ultimately decide to invest in sustainable productive capabilities and employee training. Decisions regarding sustainability initiatives generally require huge and significant investments that would produce outcomes in the long run and hence may seem unsuitable or invaluable in the short term. Therefore, at times, risk-averse management may avoid such initiatives. As per the Type 2 agency theory perspective, large shareholders monitor management, and their intervention reduces managerial opportunism. Hence, the above discussed risk-averse view may also be taken as of large shareholders. Furthermore, the decisions vis-a-vis sustainability initiatives are made by the top management or the Board of Directors on the basis of their ability to procure resources for the firm through their personal connections. If the members of the Board are powerful enough to wield external resources, the firm may pursue sustainability initiatives. Third, the knowledge, experience and value system of board members also affect decisions regarding sustainability initiatives. A more knowledgeable and experienced board is expected to consider and value the long-term implications of present sustainability initiatives. They could actually have a deeper understanding of strategic opportunities associated with sustainability concerns and thus effectively pursue initiatives to enhance the shared value of the firm. Another reason for pursuing sustainability initiatives by the members of the Board could be in response to the regulatory requirements or maintaining the legitimacy of the firm. Shareholders generally push and react to firms’ sustainability initiatives. Firms continuously face reputational, litigation and market risks due to inclusion or non-inclusion of the firm’s name in major sustainability indices and/or their sustainability score. A positive reaction is expected for the inclusion of a firm’s name in the major sustainability index and/or a firm’s high sustainability score. Furthermore, shareholder activism (mainly institutional shareholders) is seen more vocal about measures adopted and practices followed by firms vis-a-vis energy efficiency, water usage, pollution control, among others. Finally, shareholders (both present and prospective) look for sustainable investments that promote long-term stakeholder value creation. The CEO is an important individual who leads the top management and uses his/her managerial discretion to let go (or not) the corporate sustainability agenda. CEOs’ personal traits, professional background and

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at times CEO compensation may act as important factors in pursuing corporate sustainability agendas. Chin et al. (2013) mention that corporate sustainability initiatives are generally pushed by politically liberal CEOs against conservative CEOs. Furthermore, powerful CEOs with non-legal backgrounds and foreign exposure are also likely to promote sustainability initiatives. To date, limited evidence exists for the relation between corporate sustainability initiatives and CEO compensation. Employees, as corporate sustainability actors, can push the social dimension of sustainability, particularly with respect to firms’ social responsiveness policies and initiatives. A firm pursuing policies that attract talent, develop employees, improve their standards of living, provide health care and safety at the workplace, offer equal opportunities to all would add up to the firm’s social performance. Firms that protect their employees’ economic and social expectations prevent grievances and disloyalty (Salvioni et al., 2016), thereby adding to shared value creation. However, the individual characteristics and attitudes of a person affect their engagement with sustainability initiatives. Many firms ask their employees to participate in social welfare programs and often provide them with paid leave. Negative reactions from employees impact a firm’s sustainability outcomes; thus, it is always beneficial for the firm to take them along. With respect to implementing environmental management systems and policies, employees generally demand corporate support and incentives. Further enhanced communication and effective engagement with employees would surely bring positive sustainability outcomes. Other stakeholders (actors) include governments, regulators, media and communities, among others. Corporate sustainability is affected by the actions and/or reactions of these other stakeholders. For instance, the Ministry of Corporate Affairs has added provisions related to corporate social responsibility (CSR) and corporate governance in company law, and market regulator SEBI has called for performance and disclosures for entities4 on Business Responsibility and Sustainability, thereby enhancing Responsible Business Conduct (RBC) irrespective of the sector and scale of operations of an entity. Dupire et al. (2022) studied the impact of messages on Twitter (tweets) by NGOs and found that stock

4 Business Responsibility and Sustainability Reporting (BRSR) being mandatory for top 1000 listed entities from financial year 2022–23.

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prices react to tweets but more specifically to a positive message related to sustainability. Process The third interface in SAP is “Process”, which answers how to handle the situation. This can also be understood as what the actors are doing for the present situation. Interalia, the interconnected and interdependent concerns (economic, environment and social—EES) to meet the sustainability agenda bring to fore certain challenges for businesses. Previous works have recognised that corporate sustainability is full of various tensions (challenges) due to the divergent nature of ESG goals (Hahn et al., 2015; Van der Byl & Slawinski, 2015). Much literature has emerged over the last decade that examines and shows the way forward for dealing with those tensions. Inter alia, we present four key tensions faced by the private sector in fulfilling the sustainability agenda mainly because of a lack of knowledge of both the multitude of interrelated sustainability demands and the desired measures to address them. First, the focus on the outcomes and impacts of present sustainability efforts on the present and future environment and society requires a longer-term outlook. Second, there are multiple sustainability issues relating to multiple stakeholders, each with distinct priorities. To illustrate, S&P 500 companies mention a long list of sustainability focus topics. However, it is truly hard to be successful in all. Thus, the firm chooses a few specific focus areas. For example, Coca Cola India5 focuses on the protection of water resources and recyclable packaging. Third, at times, a solution to one sustainability issue may prove detrimental to another. Fourth, the three sustainability dimensions exist at different levels and at different scales (Hahn et al., 2015). The existence of these stretching challenges (tensions) due to competing elements6 and contexts7 to achieve sustainable development is termed “not a fixed state of harmony” by Bruntland (1987). Since the last few decades, researchers have studied the inherent tensions faced by corporate entities in the adoption of sustainable practices. They have also provided approaches to deal with them. Initially, the

5 See at: https://www.coca-cola.com/in/en/sustainability. 6 The three P’s—Profit (economic), Planet (environment) and People (social)—(EES). 7 Short term and Long term.

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win–win approach and trade-off approach8 gained importance. However, subsequently, new approaches, such as integrative approaches and paradox approaches, have been introduced. The latter constitutes the most recent approach in this regard. In the win–win approach, the financial performance goals of firms have also been extended to cover social and environmental performance, wherein firms attempt to fulfil their financial goals while bringing in benefits to society, thus creating a shared value (Porter & Kramer, 2011). Many prior studies have highlighted the positive relationship between financial and nonfinancial performance, that is, social and environmental performance (Eccles et al., 2014; Luo et al., 2015; Margolis & Walsh, 2003). The trade-off approach, on the other hand, takes the view that economic, social and environmental aspects are often contradictory, so benefit or advantage from one perspective could lead to loss from another. For instance, a social gain may lead to an economic loss. In other words, a solution to one problem may be detrimental to another. However, Hahn et al. (2010) have brought to light that a trade-off is “relatively small loss in economic performance to generate a substantial social and environmental benefit might result in positive corporate contribution”. Henceforth, trade-off being a choice between options win or lose should bring net gain or positive sustainability benefits. The third approach, the integrative approach, considers all three aspects (EES) equally and henceforth and calls for addressing them holistically (Van der Byl & Slawinski, 2015). Some researchers have recommended a paradox approach (Berger et al., 2007; Smith & Lewis, 2011; Smith & Tushman, 2005) in which the competing demands of three sustainability aspects need simultaneous attention. As per the paradox approach, attention to one over another or avoiding the complexities today can only reap short-term gains. The other aspect, if left for consideration later, would resurface over time probably with increased complexities. Hence, it is desirable that all three interrelated yet contradictory aspects are accepted and managed continuously and simultaneously. Thus, the paradox approach is considered to be holistic. It is also consistent with the systems view of firms, where the firm operates in a system with interconnections between the natural environment, society and economy (Montiel, 2008). Last, when we consider environmental and societal concerns as an end in themselves (as opposed

8 For detailed literature review see Van der Byl and Slawinski (2015).

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to a means to profit maximisation), it is a paradox approach that is likely to bring superior business contribution towards sustainability (Hahn et al. 2010). Table 5.3 serves to summarise the discussion. Table 5.3 Approaches to corporate sustainability challenges Approach

Basis of the approach

How are Sustainability Action—How Sustainability (EES)9 aspects treated? (EES) aspects are managed by corporates?

Win–win approach

Instrumental logic

Interrelated yet competing aspects

Trade-off approach

Instrumental logic

Contradictory aspects—one’s gain is others loss

Integrative approach

Integrative logic

Interrelated, interconnected and divergent aspects

Paradox approach

Integrative logic

Simultaneous attention to contradictory, interrelated and interconnected aspects that persist over time

Since sustainability aspects are interrelated, corporates focus on areas where alignment works Since sustainability aspects have their respective outcomes, corporates choose that sustainability aspect which brings net positive gain to sustainability Corporates strive to balance the three (EES) aspects equally adopting such sustainability strategies Corporates accept all three aspects (Hahn et al., 2014), try to pull together disparate elements (Smith & Tushman, 2005) considering the fact that cyclic responses bring a dynamic equilibrium to balance both short term and long term goals (Smith & Lewis, 2011)

Source Based on Van der Byl and Slawinski (2015) Note (i) The authors’ have modified Table 1: Approaches to Tensions of Van der Byl and Slawinski (2015) (ii) Van der Byl and Slawinski (2015) studied 149 journal articles on tensions in corporate sustainability (wherein 60 articles discussed the win–win approach, 42 articles discussed the trade-off approach, 39 articles discussed the integrative approach and only 8 articles discussed the paradox approach)

9 Economic, Environmental and Social.

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Gao and Bansal (2013) have described instrumental and integrative logic to address tensions in corporate sustainability. In the case of instrumental logic, firms favour profitability-based outcomes and decisions. However, in the case of integrative logic, firms’ focus shifts to integrating all three aspects of sustainability (EES) from a systems perspective. Their eyes are focused on the goal of higher sustainability performance or concurrent performance of each aspect. In other words, firms weigh all three aspects equally (Van der Byl & Slawinski, 2015). An extensive literature review performed by Van der Byl and Slawinski (2015) divided tensions in corporate sustainability into three groups, namely, strategic direction, domain and strategy implementation. They found that for examining tensions relating to strategic direction and domain group, integrative logic is more commonly used, and instrumental logic is more frequently used when studying strategy implementation tensions. This finding supports the view that economic outcomes are more important for firms at the strategic implementation stage than environmental or social outcomes. In practice, managers are often unable to integrate all three sustainability elements, which enables them to embed the paradox perspective. As a result, they choose either a win–win or trade-off approach. As a solution, Hahn et al. (2018) provided a framework for paradox theory, looking at its contents, significance and implications from three distinct angles, namely, the descriptive angle, instrumental angle and normative angle. Furthermore, they also provided interconnections between the three angles. Descriptive angle refers to the challenges around explanation and description of how managers and firms address multiple sustainability concerns—what strategies they employ? The instrumental angle considers the challenge around establishing positive and negative outcomes vis-a-vis the three sustainability elements. Finally, the normative angle discusses the challenges around considering the intrinsic value of competing and interconnected sustainability elements (EES) from a systems perspective. The three angles discussed above are mutually supportive and interconnected (Donaldson & Preston, 1995). The descriptive angle provides information and explanation for evaluating sustainability outcomes (instrumental angle) and calculating their intrinsic values (normative angle). Likewise, the instrumental angle builds and enhances future descriptive studies and links means and ends from a normative perspective. Last, the normative angle influences and informs descriptive and instrumental angles regarding multiple categories of descriptions and desirable outcomes of

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sustainability initiatives, respectively. As a consequence, the circularity of the three angles would facilitate managers and decision makers in applying the paradox approach to meet corporate sustainability challenges. Learning Moving to LAP Components (Synthesis), we first discuss the key issues for current Situation, Actors and Process, i.e., Learnings. The learnings would take us to the action points to achieve the desired performance. Garvare and Johansson (2010) highlighted the distinction between global sustainability and corporate sustainability while stressing that corporate sustainability does not necessarily lead to global sustainability for two main reasons. First, global sustainability calls for protecting the interests of interested parties (that is, future generations and the natural environment); even if corporate sustainability satisfies both primary and secondary stakeholders, the interests of future generations and the natural environment may not be fully met. Second, the focus of corporate sustainability is the existence of business in the immediate future, whereas the time frame for global sustainability is centuries. We would like to reiterate the fact that the ultimate goal is global sustainability with corporate sustainability as a means to achieve it. Businesses identify their stakeholders, but the incorrect identification of stakeholders may lead to the failure of the firm. For instance, an actor not identified as a stakeholder may withdraw his/her support it provides to the firm. Stakeholder engagement is a good source of information for companies. Multiple stakeholder engagement processes are employed by firms. These include both informal and formal mechanisms such as faceto-face meetings, alliances with NGOs and other advisory bodies. Since stakeholder engagement processes contribute manifold, such as gathering initial information, fixing appropriate representatives, collecting feedback, and measuring outcomes and impacts, we believe these processes should be more robust. Compared to informal mechanisms, formal mechanisms to maintain ongoing relationships over longer periods would be more suitable (Zollinger, 2009). The growing relevance and urgency of sustainable initiatives vary across countries, industries and sectors. Therefore, decision makers should consider such differences while discussing, prioritising and implementing sustainability initiatives. This would be more meaningful for top-level management, i.e., at the strategic direction stage. The top management/

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Board of Directors plays a critical role in identifying and mitigating sustainability risks. The long-term dimension of sustainability risks, which may not appear to be so urgent today, needs a dynamic time frame for discussion and assessment. Here, it is important that decision-makers take into account this aspect. Additionally, sustainability considerations have topped the ladder vis a vis crucial business decisions such as mergers and acquisitions, capital allocations, and public advocacy, among others. Top management has to fix ownership and responsibility along with accountability for addressing sustainability risks so that such risks are integrated within the business model. Otherwise, the probability of sustainability risks remaining siloed within the sustainability committee/ team (if any otherwise unaddressed) is too high. Furthermore, regular updates, feedback and suggestions for improvisation would hold executives accountable. Some companies plan incentives/compensation for performance on sustainability metrics that act as a motivator to the internal staff and provide useful insights for other stakeholders. In large business houses, generally a group sustainability team works along with entity-specific teams. Since the required information on various sustainability factors would be needed across all functions and across all business units and entities, proper coordination among teams is recommended. The group sustainability team or sustainability committee works with senior executives of group entities to align sustainability strategy with day-to-day business operations. It would be appropriate to include representatives of all the divisions, for example operations, legal, supply chain among others. Aras and Crowther (2008) concluded that “a firm which has a more complete understanding of both sustainability and of corporate governance will address these issues more completely. By implication a more complete understanding of the interrelationships will lead to better corporate governance….”. In this light, we can deduce that a complete understanding of corporate sustainability aspects and corporate governance structures along with their interrelationships is needed for all stakeholders. This is because although strategic decisions are made at the top management level, their implementation requires the commitment and efforts of the rest of the corporate staff. Likewise, a complete understanding of the structure of corporate governance and its relationships with sustainability would help stakeholders (especially those who are outside the firm) understand the positive and negative outcomes on the value of the firm. Furthermore, it would help stakeholders to understand the impacts of the strategies

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chosen by the firms and identify the team that has been assigned the responsibility to make it happen. Firms employ tools such as strengths, weaknesses, opportunities and threats analysis (SWOT) and political, economic, sociocultural, technical, legal, and environmental (PESTLE) to identify sustainability risks and opportunities. The highlights presented in the World Economic Forum’s (WEF) Global Risk Report (WEF, 2022) might be useful for businesses to understand the implications of sustainability risks for individuals, governments and businesses. Scenario analysis for understanding the potential impacts of key sustainability risks would also be useful. The heatmap approach is being extensively used across sectors (for example, for credit risk analysis by European banks, organic cropping systems, and sustainable energy for all) to assess the exposure to sustainability risks. Credit rating agencies such as Moody use heatmaps to assess the exposure of key industries to sustainability risks. Vaisi et al. (2021) used heat demand maps to determine the monthly demand and best location for energy generators in an urban context. Action Actions imply the desired steps required for improving business practices. Corporate sustainability has the potential to transform business practices, but it is not possible without a deeper understanding and commitment of the actors of corporate sustainability. It is imperative first at the national level, which will help in achieving global sustainability. For example, a business that is one of the actors in achieving global sustainability has to look beyond its own existence and should try not to compromise with the existence of the natural environment and the ability of future generations to meet their needs. In this context, businesses, especially large corporate houses, have realised that sustainability initiatives are a source of competitive advantage and a win–win strategy for all stakeholders, and as a result, they have undertaken several sustainability initiatives. However, for wider impact and considerable achievement towards the global agenda of sustainability, these businesses have to impact and push their value chain partners, who could be small- and medium-sized entities, to transform their business processes towards sustainable practices. Previous experiences indicate that decision making around sustainability issues is more complex. This is in the context of multiple perspectives of social and environmental problems as well as linkages within

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sustainability domains. Furthermore, different meanings and different dimensions of sustainability outcomes present a challenge to standardising the approaches to be followed by corporates. Decision makers increasingly face difficulty in dealing with such challenges and selecting the optimal approach. We believe that it is only through social networks, collaborations (with peer companies, value chain partners, industry experts, NGOs, government agencies) and continued mutual learning that sustainability initiatives can be undertaken and become a source of advantage. In September 2021, India became the first Asian country to launch a plastics pact—an initiative—The India Plastic Pact —developed by the Worldwide Fund for Nature-India10 (WWF India) and the Confederation of Indian Industry (CII) to bring stakeholders together with the aim of transforming to a circular plastics economy. The operating environment of businesses can be impacted by multiple sustainability factors. Henceforth, the risk identification processes should be such that they evaluate probable threats due to multiple sustainability factors. For instance, the cement industry11 is going through tough times with increasing pressures to reduce carbon dioxide emissions. The leading industry participants have invented low carbon alternatives, and now cement suppliers and other value chain partners would have to transform their business models towards sustainable practices. Furthermore, all sustainability risks that could affect corporate strategy need to be identified and mitigated. Here, it is important to understand that sustainability risks are not novel; rather, they fall within the traditional business risks that businesses have considered for centuries. For example, investors are increasingly focusing on the sustainability performance of businesses and fund sustainable projects/operations. Thus, the risk of non-availability of funds (that is, funding risk or interest rate risk) is not a new risk for business. Furthermore, the interrelationships among risks are also important and may arise individually or collectively, posing a threat to business. For instance, environmental hazards (climate change risks) may pose a bankruptcy risk to business even if business is financially sustainable (Srebro et al., 2021). Extreme weather events such as droughts,

10 See: https://www.wwfindia.org/?20402/India-to-be-the-First-Asian-Country-to-Lau nch-a-Plastics-Pact. 11 See: https://www.wbcsd.org/Sector-Projects/Cement-Sustainability-Initiative/Cem ent-Sustainability-Initiative-CSI.

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floods, and hurricanes cause infrastructure damage, loss of livelihood, and increased inflation. All specific committees of a firm, such as the Nomination and Governance Committee, Audit Committee, Risk Committee, and Compensation Committee, identify specific sustainability risks and bring them to the table for the full board to discuss, evaluate and make appropriate decisions. For instance, the Nomination and Governance Committee would determine the requirements of training members of the Board on sustainability concerns and may also call to integrate sustainability performance for evaluating Board performance. Likewise, key sustainability issues will be comprehensively raised and evaluated in depth. Many companies conduct materiality assessments along with stakeholder engagement mechanisms to assess material sustainability concerns from the perspective of stakeholders. Present-day materiality assessments include traditional financial factors as well as financial impacts from sustainability-related risks. For instance, the Task Force on ClimateRelated Financial Disclosures (TCFD) has recommended climate-related financial disclosures. Since multiple material sustainability topics cannot be addressed simultaneously, companies may ascertain a level of threshold of materiality and structure their sustainability actions accordingly. For example, NTPC Limited12 prioritised material topics on the basis of an overall score above a threshold based on individual topic (X, Y) scores, where X-Score is the significance of economic, environmental and social impacts and Y-Score is the influence on stakeholder assessment and decisions. Accordingly, seven of twenty-six material issues were prioritised as the most important material issues. First, firms may review the strategies and disclosures of peer companies to decide their first line of action and/or prioritise their actions. This approach could probably take the firm to a competitive advantage at a later stage. Additionally, sector-specific expectations or a road map may also guide the firm towards material sustainability concerns for prioritising sustainability actions and later enhanced reporting (Eccles et al., 2012). For instance, the 2022 Ceres Benchmarking Report (CERES, 2022) highlights the environmental performance and progress of the 100

12 Available at: https://www.ntpc.co.in/en/materiality-analysis with Materiality Topics available at: https://www.ntpc.co.in/sites/default/files/downloads/Materiality-Topics. pdf.

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largest United States electric power sector entities, which can be a guiding document for power sector firms. Another concern relates to sustainability initiatives demanding huge investments with long-term strategic implications. Henceforth, sustainability is often a topic dealt with in the Board rooms or in the top management discussions. Elkington (2006) calls it “Governance for Sustainability”, where corporate governance is to be integrated with external environmental concerns (both environmental and societal) in response to business accountability towards a wider audience called “stakeholders ”. Governance is about how businesses are managed and run. The Friedmanite notion of the firm (Friedman, 1962), wherein businesses exist to create value for shareholders, has been extended to a wider group called stakeholders (Freeman, 1994). The stakeholders comprise all those who affect and are affected by the activities of the firm. Likewise, the traditional role of business being accountable to owners only has been extended towards the wider stakeholder community (Gray et al., 1988). Against this backdrop, corporate governance, being “the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment” by Shleifer and Vishny (1997), has been extended to “a set of relationships between a company’s management, its board, its shareholders and other stakeholders ” (OECD, 2004). Aras and Crowther (2008) argue that both corporate governance and sustainability are fundamental to the continuing operation of any corporation. Hence, much attention must be paid to the procedures of such governance. Possibly nothing is more important than the indispensable role of the private sector in achieving the sustainability agenda. Rashed and Shah (2021) have pointed to the lack of influential leadership and shortage of investments. We support and call for strong Governance for Sustainability. Performance The last interface among the SAP—LAP is performance. It addresses the question of what is to be achieved or what will be the outcome after assessing the current situation of corporate sustainability, identifying and fixing responsibility for each action, incorporating the concerns of actors in sustainability strategies, and determining the process to deliver the desired outcome in this direction. The performance objective of corporate sustainability is sustainability performance and sustainability reporting, which contribute to global sustainability.

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Since the early 2000s, we have witnessed a gradual increase in corporate disclosures first with respect to corporate social responsibility, then with respect to corporate governance and more recently with respect to sustainability. This is the joint cause of initiatives by regulators (Ministry of Corporate Affairs (MCA) and the Securities and Exchange Board of India (SEBI)), governments and others with respect to responsible business conduct and corporate governance. Studies confirm that corporate governance mechanisms and sustainability actions accrue several benefits to firms (Aras & Crowther, 2009; Lankoski, 2006) due to increased monitoring of the impact of corporate activities on the environment and society (Giddings et al., 2002). The recognition of critical interdependence between financial, natural, human, social and manufacturing/technical capital during the climate change crisis, ecosystem/natural resource crisis and now COVID crisis has been running in parallel with financial crisis is appreciable. Undeniably, one of the positive outcomes of the financial crisis is the understanding and appreciation of the fact that governance strategy and sustainability have become inseparable. Blowfield (2012) advocated that businesses act as development agents (that is, business actions are motivated by “stakeholder concerns, pressures and demands ”) only when businesses recognise at least one of the three identifiable circumstances. First, when businesses identify any of the risks such as reputation risk and supply chain risk, among others. Second, businesses perceive an opportunity for favourable financial return on investment. Last, businesses wish to tackle inefficiencies. Whatever could be the reason for response, being self-interested or being mindful of development issues, we believe the role of business is equally important for sustainable development concerns. Corporates cannot ignore the corporate sustainability perspective. Furthermore, we believe that unless and until the accountability of businesses is fixed by stronger corporate governance mechanisms, it is difficult to see the desired results of higher sustainability performance and enhanced sustainability reporting.

5.3

Conclusions

It is clear from the foregoing that the present chapter not only provides a comprehensive review of the present state of corporate sustainability but also summarises the elements of SAP-LAP in corporate sustainability. By making use of the SAP-LAP framework, the chapter brings out that

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proactive action for addressing sustainability concerns is the need of the hour. In addition, the crucial role of strong corporate governance aided by a competent board in achieving the sustainability agenda has also been emphasised. The knowledge, exposure, experience, and skillset of the members of the Board will play a very important role in facilitating various aspects/dimensions of dynamic and complex sustainability issues. It is important to mention that each member of the Board may not have the technical acumen for a deeper understanding of all related sustainability aspects. However, they can always focus on ensuring the implementation of “the stakeholder business cases for sustainability 13 ”, which strives for value creation for stakeholders by solving sustainability problems. This indeed requires a mindset for strengthening the corporate governance regime. The role of sustainability/ESG education is going to be huge in building such a mindset or culture. Moreover, identifying the right sustainability metrics, the collection of the right set of data, and its analysis and reporting are very important (Accenture & Chartered Institute of Management Accountants, 2011). Indeed, an active engagement of stakeholders and mutual exchange between them constitutes a pathway for creating such a regime.

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CHAPTER 6

Embedding Sustainability into Businesses: Creating Sustainability Culture

6.1

Introduction

There is a growing body of evidence that supports the view that businesses all around the world can achieve core competencies and capabilities from sustainable business practices (Du et al., 2017). Furthermore, firms increasingly acknowledge that their financial performance is largely influenced by parameters that are not featured in their disclosures and reports. These parameters are “sustainability” aspects that could be environmental, social or governance (ESG). Thus, it becomes imminent for companies that ESG characteristics must be embedded in their business models. This can happen only when they are sustainability conscious, ready to reinvent their processes and follow design indicators that address both environmental and social dimensions. Such a framework would bring multiple gains for firms, such as mitigating sustainability risks, tapping business opportunities, achieving high financial and sustainability performance and benchmarking sustainability performance. In line with financial reporting, which is the disclosure of a firm’s financial performance, sustainability reporting is the disclosure of a firm’s sustainability performance. Du et al. (2017) found strong evidence for the business case

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 S. Joshi and R. Kansil, Looking at and Beyond Corporate Governance in India, https://doi.org/10.1007/978-981-99-3401-0_6

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of sustainability reporting. Christofi et al. (2012) mention that the evolution of sustainability reporting (which occurred in the mid-1990s) reflects the business response towards the environment and the surrounding communities.

6.2

Sustainability Reporting

Sustainability reporting is referred to as communicating an entity’s environmental, social and governance performance by capturing both positive and negative impacts and outcomes of its business activities and operations. Such disclosures are made generally and mainly through (but not limited to) sustainability reports. The United Nations Environment Programme (UNEP)1 defines a sustainability report as “a firm-issued general purpose, nonfinancial report that provides information to investors, stakeholders [e.g., employees, customers and Non-Governmental Organisations (NGOs)] and the general public about the firm’s practices involving environmental, social and governance issues either as a stand-alone report or as part of an integrated report.2 ” The following questions (but not limited to) are answered as per the disclosures in a sustainability report: ● How does an entity use and effect resources in the form of capital it employs, namely, social capital, financial capital, human capital, natural capital, intellectual capital, and social and relationship capital? ● What are the positive and the negative impacts of the entity’s activities/operations on the economy, environment, and society?

1 See: www.unep.org/FAQsonSustainabilityReporting. 2 An integrated report is the report that is prepared in accordance with the Inte-

grated Reporting Framework issued by The International Integrated Reporting Council (IIRC). The disclosures of the report explains to providers of financial capital how the entity creates value over the short, medium and long term and integrates environmental and social thinking (integrated thinking) into its business. De Villiers et al. (2014b, 2017) mention that traditional Sustainability Reporting did not always explain the interconnection between strategy, risks and the multiple forms of capital as an integrated report does. Lai et al. (2016) asserts that henceforth Integrated Reporting is gaining momentum and is an apt ‘tool’ to advance Sustainability Reporting practices. However, for the purpose of this chapter, all nonfinancial reporting, by whatever named called—Environmental, Social and Governance (ESG) Reporting, Corporate Social Responsibility Reporting, Business Responsibility and Sustainability Reporting—is Sustainability Reporting.

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What are the entity’s sustainability strategies? What progress has been made in this regard? How does the entity gauge its own sustainability progress? Are the operating models and activities viable in the long term? How has the entity contributed to sustainable development? What is the response of the entity towards the information needs of all its stakeholders?

Sustainability Reporting (SR) is an emerging discipline that encompasses within itself an entity’s disclosures related to Environment, Social and Governance (ESG) performance and impacts. Credible sustainability reporting is on a rise (Yussri et al., 2010), as it demonstrates an entity’s impacts on various sustainability issues, such as climate change, social justice, employee welfare, and poverty. While sustainability reporting enables an entity to be more transparent about its risks and opportunities, it is also a medium to communicate relevant and reliable information dealing with its long-term economic value addition and contribution towards a sustainable global economy. Sustainability-related disclosures not only provide an understanding of sustainability issues to all stakeholders but also assist them in decision-making (Clarkson et al., 2008). Subramaniam et al. (2006) argue that sustainability reporting also promotes the effective governance of these entities. Sustainability Reporting, as promoted by the Global Reporting Initiative3 (GRI), is “an entity’s practice of reporting publicly on its economic, environmental, and/or social impacts, and hence its contributions – positive or negative – towards the goal of sustainable development ”.4 Henceforth, sustainability reporting has emerged, especially over the last two decades, as a mechanism that addresses the growing attention on the UN Sustainable Development Agenda 2030 (Kolk & Perego, 2010; Martensson & Westerberg, 2014). Three factors have contributed to the rising focus and importance of sustainability reporting across the globe. The first is the activist behaviour of stakeholders—stakeholders/stakeholder groups

3 The Global Reporting Initiative (GRI) is an international not-for-profit organisation which produces free Sustainability Reporting Guidelines/Standards based on ESG metrics and topics. 4 See: https://www.globalreporting.org/media/wtaf14tw/a-short-introduction-to-thegri-standards.pdf.

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pressurise firms to disclose sustainability (nonfinancial) information, especially the negative impacts of their activities/operations. Second, rising interventions and encouragement by governments (through regulations or otherwise also called institutional pressures) to protect both the environment and the rights of citizens. Last, global markets demand commitment from businesses (especially those that are part of global value chains and/or are partners of multinational corporations) to exhibit their sustainability performance through mandatory/voluntary reporting frameworks, standards, guidelines, certifications, etc. Thus, to ensure good relations with stakeholders (Duran & Rodrigo, 2018), address institutional pressures (De Villiers & Alexander, 2014), avoid reputational risks (Reverte, 2009) and increase the legitimacy (De Villiers & Alexander, 2014) of the firm, firms are evolving in the process of disclosing a broader perspective on their performance via the preparation of sustainability reports. This discussion raises questions about the benefits and the underlying theoretical approach behind sustainability reporting. Many scholars in their prior studies have outlined the benefits of sustainability reporting and discussed theoretical approaches underlying sustainability reporting. The most widely discussed and embraced theory is stakeholder theory. Freeman (1994), through stakeholder theory, highlighted that firms need to consider and protect the interests of a wider group, called stakeholders, and not only the capital providers, called shareholders. Prior studies evaluate the benefits of preparing sustainability reports as meeting the information needs of various stakeholders (Eccles et al., 2011), engaging with stakeholders (Herremans et al., 2016) and thus assessing and addressing their material concerns (Torelli et al., 2020). Furthermore, Herzig and Schaltegger (2006) have highlighted the fact that sustainability reporting enhances the transparency and accountability of the firm along with a positive influence on employee motivation to contribute to the sustainability agenda. A much broader perspective relates to legitimacy theory, which explains why firms disclose and what information is disclosed by firms (Dumay et al., 2019). As per the theory, firms basically disclose in the process of legitimacy of their operations, products and services as businesses operate in a dynamic environment with impacts (both positive and negative) on the environment and society. Negative impacts on both the environment and society are not socially acceptable. Sustainability reports not only acknowledge the implied social contract of the firm with society

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(Byerly, 2014)5 but also act as a tool to meet societal expectations. Thus, the benefit of sustainability reports is the legitimation of a firm’s operations, products and services, which in turn ensures the supply of resources (Herzig & Schaltegger, 2006) and builds corporate reputation (Fombrun, 1996) in terms of commitment to noncore business activities, i.e., in social and environmental projects (Herzig & Schaltegger, 2006). Institutional theory suggests that firms prepare sustainability reports in response to encouragement and institutional pressures relating to compliance with sustainable disclosure norms, guidelines, standards, regulations, etc. In line with the theory, the progression of adoption and the extent of sustainability reporting worldwide can be outlined (DiMaggio & Powell, 1983). With various institutions worldwide striving to bring uniformity and standardisation of sustainability reports, comparison and benchmarking would improve over time. Firms gain a competitive advantage and can easily benchmark externally with competitors and internally within business units, verticals, segments, etc. (Herzig & Schaltegger, 2006). Furthermore, this theory is often used by scholars as a basis to explain the determinants of sustainability reporting (De Villiers et al., 2014a). Another dimension of firm behavior widely discussed in finance literature is information asymmetry. Schaltegger (1997) mentions that sustainability information disclosures face a similar threat because stakeholders cannot easily access sustainability information or such information is too costly for them. Sustainability reports reduce information asymmetry, especially for outside stakeholders. Scholars have found that there exists a positive relation between a firm’s nonfinancial performance and a firm’s nonfinancial information disclosures. Firms with higher nonfinancial performance tend to disclose more of their sustainability outcomes and impacts (Clarkson et al., 2008) and vice versa (Bini & Bellucci, 2020). Thus, as per signaling theory, sustainability reports act as a signal of the nonfinancial performance of firms (Herzig & Schaltegger, 2006) and in turn help them gain competitive advantage and secure their legitimacy (Hahn & Kuhnen, 2013). Over the years, the evolution of sustainability reports has enhanced organisational learning by bringing in radical changes in organisational values, beliefs, structures and actions. This evolution is identified as

5 Byerly (2013) has revisited the implied social contract in present times.

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per learning-based theory. To elaborate, firms have inculcated integrated thinking within and across all their activities. Herzig and Schaltegger (2006) pointed out that this evolution has initiated a process of awareness of sustainability issues among firms, and they have now adopted a double-path approach.6 Furthermore, an increasing number of disclosures of sustainability information have led to the building of internal information and control processes for nonfinancial data collection and monitoring.

6.3 Sustainability Reporting Frameworks: A Brief Overview In the past few decades, various sustainability reporting frameworks/ standards have evolved worldwide through a consultative process taking care of the range of stakeholder expectations. Well-recognised sustainability reporting frameworks are listed below.7 ● Global Reporting Initiative (GRI)—GRI is an independent international organisation founded in 1997 whose framework has become the world’s leading global framework for sustainability reporting, which includes the Sustainability Reporting Standards. Its thorough focus on the social and governance aspects of ESG is unparalleled. The framework has a comprehensive scope, covering the main sustainability issues and universal relevance. ● United Nations Global Compact (UNGC)—The UN Global Compact is a voluntary initiative established in 2000 that calls firms to do business responsibly. Responsible business relates to aligning strategies and operations with ten universal principles (for human rights, labour, environment, and anti-corruption) in such a way that they also meet UN Sustainable Development Goals. ● World Economic Forum (WEF)—Metrics for measuring Stakeholder Capitalism—The core and expanded set of “Stakeholder Capitalism Metrics ” and disclosures can be used by companies to align their

6 To be discussed in detail in a later section of the Chapter. 7 Some others are proposed and in consultation. For example, Taskforce on Nature-

related Financial Disclosures (TNFD) and Corporate Sustainability Reporting Directive (CSRD).

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mainstream reporting on performance against environmental, social and governance (ESG) indicators and track their contributions towards the Sustainable Development Goals (SDGs) on a consistent basis. The metrics are deliberately based on existing standards, with the near-term objectives of accelerating convergence among the leading private standard-setters and bringing greater comparability and consistency to the reporting of ESG disclosures. ● Integrated Reporting (IR)—The Integrated Reporting Framework developed by the International Integrated Reporting Council (IIRC)8 is a principle-based framework that brings together material information about an organisation’s strategy, governance, performance and prospects in a way that reflects the commercial, social and environmental context within which it operates. The framework supports integrated thinking, decision-making and actions that focus on the creation of value over the short, medium and long term. Furthermore, the framework aims to enhance accountability and stewardship for the broad base of capitals (financial, manufactured, intellectual, human, social and relationship, and natural) and promote understanding of their interdependencies. After a decade of the release of the framework, the IIRC published the Revised Integrated Reporting (IR) Framework in January 2021 after extensive consultations with various stakeholders and incorporating insights stemming from practical use and wider market developments. ● Sustainability Accounting Standards Board (SASB)—SASB is an independent nonprofit organisation that has provided industryspecific standards dealing with industry-specific issues deemed material to investors. The standards are for voluntary use; however, they enable comparison of peer performance and benchmarking within an industry. ● Carbon Disclosure Project (CDP)—The CDP is a not-for-profit charity that runs the global reporting and disclosure system that collects information for investors, companies, cities, states and regions to manage their environmental impacts. It focuses primarily on greenhouse gas (GHG) emissions but has grown to address water and forestry issues as well. Information on various sustainability aspects is available from the CDP for the world’s largest companies. 8 In June 2021, IIRC and SASB officially merged to form Value Reporting Foundation (VRF).

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● ISO 26000—ISO 26000 Guidance on Social Responsibility was introduced by The International Organisation for Standardisation in November 2010, offering voluntary guidance and not certification or standards. The Guidance is based on seven principles and provides 37 issues that companies may choose to report on as per materiality. ● Climate Disclosure Standards Board (CDSB)—CDSB is an international consortium of business and environmental NGOs that has provided a climate change reporting framework (CDSB Framework). The framework initially focused on risks and opportunities that climate change presents to an organisation’s strategy, financial performance and condition and was later expanded to include other types of environmental information, in particular, information about water and forest risk commodities. ● Task Force on Climate-Related Financial Disclosures (TCFD)— TFCD established in 2015 is an organisation of 31 members aiming to develop guidelines for voluntary climate-centred financial disclosures across industries. The Task Force is charged with considering “the physical, liability and transition risks associated with climate change and what constitutes effective financial disclosures across industries ”. Market participants of all kinds will be better prepared to evaluate and manage risks and opportunities through consistent and reliable disclosures relating to climate risks. As per the Trends Report (ERM, 2022), the TCFD is the most widely accepted climate risk disclosure framework as of October 2021.

6.4

Global Trends in Sustainability Reporting

Presently, thousands of companies in the world produce sustainability reports. With each passing year, their number is growing, yet they still constitute only a small share of global business. According to the KPMG Survey of Sustainability Reporting 2020 (KPMG, 2020), considering a sample of the world’s 250 largest companies by revenue as defined in the Fortune 500 ranking of 2019, 90% or more companies have

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reported on sustainability. Likewise, among the N 1009 companies worldwide, 80% report on sustainability. As of December 2020, 15,48110 organisations have submitted their reports to the GRI Sustainability Disclosure Database. More than 9500 companies and 3000 nonbusiness participants11 have made a commitment through Communication on Progress (CoP)/Communication on Engagement (CoE) to transparency and accountability towards the UN Global Compact and its Ten Principles. A recent Trends Report (ERM, 2022) highlights growing prominence in sustainability reporting due to the introduction of new sustainabilityfocused regulations/norms, such as the European Union’s Sustainable Finance Disclosure Regulation (EU-SFDR), proposed Corporate Sustainability Reporting Directive (CSRD), Taskforce on Nature-related Financial Disclosures (TNFD) [similar to the Task Force on Climate-related Financial Disclosures (TCFD)] and disclosure of Diversity, Equity, and Inclusion (DEI) practices, among others. Amongst S&P 500 firms, the number of firms that included DEI metrics (in executive pay programs) almost doubled in 2021 in the last three years.12 Multiple frameworks/standards on sustainability reporting require distinct/multiple sets of information, which has led to variation and inconsistency in reporting. Firms face the biggest challenge of collecting and managing the required data for reporting. Moving forward, policymakers, governments, regulators and nonprofit communities across various economies need to develop regulatory frameworks and requirements that are aligned with international standards and secure the disclosure of more relevant information by an increasing number of businesses. Standardisation of reporting frameworks would optimise business impact for a more sustainable future.

9 The N100 refers to a worldwide sample of 5200 companies. It comprises the top 100 companies by revenue in each of the 52 countries and jurisdictions researched in this study. 10 Refer to: SDD—GRI Database (globalreporting.org). 11 Refer to: https://www.unglobalcompact.org/participation/join/commitment. 12 See: “Racial and Ethnic Diversity in the Boardroom”. Available at: https://www.gla

sslewis.com/wp-content/uploads/2021/04/Race-Ethnicity-in-the-Boardroom.pdf.

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Sustainability Reporting in India Indeed, sustainability communication and reporting brought to fore emphasis that both environmental and social factors directly impact an entity’s financial performance. As a result, an increasing number of entities have started embracing sustainability in business strategy, programs, performance and disclosures. In India, various legislative provisions and regulatory norms have increased organisations’ response and communication towards sustainability concerns. India became one of the first countries in the world to mandate sustainability communication and reporting. In India, government intervention13 in nonfinancial reporting started in 2009 with the Ministry of Corporate Affairs (MCA) issuing the Voluntary Guidelines on Corporate Social Responsibility (VGCSR) as the first step towards mainstreaming the concept of business responsibility. Since then, the reporting landscape has come a long way14 with the introduction of Business Responsibility Reporting (BRR), Corporate Social Responsibility (CSR), Integrated Reporting, National Guidelines on Responsible Business Conduct (NGRBC) and now Business Responsibility and Sustainability Report (BRSR). Reporting nonfinancial information on various ESG parameters, such as the Business Responsibility and Sustainability Report (BRSR), has become a legal requirement for the top 1000 listed entities (by market capitalisation) on a mandatory basis since the financial year 2022–2023 by the market regulator Securities and Exchange Board of India (SEBI). The said BRSR disclosures seek information on both essential and leadership indicators for each of the nine principles of the National Guidelines on Responsible Business Conduct (NGBRCs). Although at present, disclosures on leadership indicators are not mandatory, yet in need of more complete and concise reporting, the market regulator SEBI has encouraged listed entities to report on them also. Thus far, the Government of India and the market regulator have shown considerable progress and seriousness in its sustainability 13 Infosys Limited prepared its first Sustainability Report in 2008 as per the GRI framework. 14 For detailed timeline and descriptions, refer to Chapter 2 of the book.

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Fig. 6.1 Flow of initiatives for nonfinancial reporting in India (Note VGCSR refers to Voluntary Guidelines on Corporate Social Responsibility, BRR refers to Business Responsibility Reporting, CSR refers to Corporate Social Responsibility, NGRBC refers to National Guidelines on Responsible Business Conduct, BRSR refers to Business Responsibility and Sustainability Report, ESG refers to Environment, Social and Governance; Source Authors’ compilation)

agenda. In the future, sustainability compliance and reporting will surely strengthen further in a phased manner with its scope extending to small (listed and unlisted) and medium enterprises. Figure 6.1 depicts the flow of initiatives for nonfinancial reporting in India.

6.5

Aspects Involved in Preparation of the Sustainability Report

When the sustainability agenda forms part of a firm’s mission, vision and strategy, firms look at the world through the eyes of its stakeholders. They adopt multiple ways to understand how business/operating activities affect and are affected by society, the economy and the environment. Preparation of Sustainability Report is a step in this direction. The various aspects to be taken into consideration while preparing sustainability reports are listed below. Furthermore, we have tried to bring together the related good practices followed amongst Indian Inc. (and others) which would facilitate firms to ponder upon what to disclose, on the notion—“what matters to stakeholders ” and how to disclose instead of disclose more and/or disclose for the sake of it. First, the preparation of a sustainability report requires the identification of applicable reporting guidelines/requirements and a considerable understanding of what to disclose and how much to disclose. Presently, the standardisation of sustainability reporting is at a nascent stage, and reporting guidelines are evolving. If mandatory guidelines are not applicable, firms may look at voluntary guidelines.

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Good Practice: Cipla Limited—Sustainability Disclosures

“Cipla prepares Annual Integrated Report guided by the principles and requirements of the IIRC’s International Integrated Reporting Framework. At the same time, the integrated report is prepared in accordance with the Global Reporting Initiative (‘GRI’) standards: Core option, with linkages to the National Guidelines on Responsible Business Conduct (‘NGRBC’) on Social, Environmental and Economic responsibilities of the business. To illustrate, every disclosure as per GRI is linked to BRSR Question No. of respective Principle of NGRBC”.

Source: Cipla Limited Annual Report 2021–2022. Available at: https://www.cipla.com/sites/default/files/Annual-Report-2021-22-sin gle-page.pdf Second, considerable understanding of what to disclose and how much to disclose further escalates the need to understand stakeholders’ perspectives through internal as well as external stakeholder engagement and involvement processes. Such processes lead to materiality assessments that help firms understand and determine their priorities in the sustainability space.

Good Practice: ACC Limited—Stakeholder Engagement and Materiality Assessments

“ACC conducts regular stakeholder analysis to identify relevant and important stakeholders of the organisation, map their interface, and influence and prioritise them. Further, materiality assessment is carried out which incorporates and prioritises stakeholder views on key issues that impact business. It provides an opportunity to analyse business, risk management and growth opportunities through the sustainability lens”.

Source: ACC Limited Integrated Report 2021. Available at: https:// www.acclimited.com/newsite/annualreport2021/Integrated-AnnualReport.pdf

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Third, firms need to decide on sustainability measurements, targets and key performance indicators (KPIs) vis a vis sustainability goals as well as channels to be used to disclose the information after assessment of what is useful and material to stakeholders.

Good Practice: JSW Energy Limited—Sustainability Targets and KPIs

“The year 2030 targets of JSW Energy are to have a 85% renewable share of generation as compared to the present 30% renewable and 70% thermal. We are scaling up the green energy technologies and as demand for clean energy grows, we are ready to grow with it. … The Company strongly believes in embedding sustainability in every business line strategically centred around 17 key focus areas identified. To illustrate, the KPI for Focus Area - Waste is Waste recycled (Ash), for Focus Area - Climate Change, the KPI is GHG Emissions Intensity”.

Source: JSW Energy Limited Integrated Annual Report 2021–2022. Available at: https://www.jsw.in/sites/default/files/assets/downloads/ energy/Financial%20Releases/Annual%20Reports/JSWEL%20-%20Inte grated%20Annual%20Report%20FY%202021-22%20.pdf Fourth, sustainability reporting requires information and data. Therefore, firms would have to build systems, processes and an internal structure to collect the information and data needed for reporting. Herzig and Schaltegger (2006) emphasise establishing routines where sustainabilityrelated information will become a part of business information.

Good Practice: Electrolux Group—Auditing and Monitoring

“Electrolux follows a number of mechanisms to gather information and data such as: – Green Spirit certification and reporting system – Safety Management System (SMS) – Workplace Policy audits

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– – – – –

The Ethics Helpline Group Internal Audit Employee Engagement Surveys Global audits of ISO standards for environment and safety The sustainability KPI survey and others”.

Source: Electrolux Group Sustainability Report 2022. Available https://www.electroluxgroup.com/wp-content/uploads/sites/2/ at: 2022/03/electrolux-electrolux-reports-78-reduction-of-greenhouse-emi ssions-in-operations-and-is-four-years-ahead-of-plan-220328-1.pdf Last, firms need to fix a “Reporting Boundary” that determines to what extent the information is to be included in the firm’s sustainability report.

Good Practice: Adani Enterprises Limited—Reporting Boundary of BRSR

“Unless stated otherwise, the information provided in this report is on a consolidated basis. The following businesses are within the reporting boundary: 1. Natural Resources (IRM and Mining Services) 2. Solar Manufacturing 3. Roads Business 4. Airport Business 5. Data Centre Business 6. Power Trading”.

Source: Adani Enterprises Limited Annual Report 2021–2022. Available at: https://www.adanienterprises.com/-/media/Project/Enterp rises/Investors/Investor-Downloads/Annual-Report/AEL-04-07-22_F. pdf. Further detailed boundary of the Sustainability Report of Electrolux Group is available at https://www.electroluxgroup.com/sustainabilityr eports/2020/reporting-framework/about-this-report/ The aspects discussed above will not work in isolation. In contrast, reporting various sustainability practices followed by a firm would require

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an integrated framework wherein all the above aspects would work simultaneously. Here, two distinct management approaches—inside-outwards approach and outside-inwards approach—are useful, which are grounded on the basis adopted by the firm for communicating and reporting its sustainability activities (Herzig & Schaltegger, 2006). In the case of the inside-outwards approach, firms first ponder their strategic priorities and solutions to problem areas, then establish sustainability targets, indicators and measurement and monitoring systems and henceforth communicate and report their sustainability performance and future goals. In contrast, in the case of the outside-inwards approach, the communication and reporting of sustainability performance is based on the reporting guidelines/standards, criteria adopted by rating agencies, and information needs of stakeholders. Thus, the outside-inwards approach is more reactive and adaptive (Herzig & Schaltegger, 2006) in nature, where firms do not first critically judge what is required for better sustainability performance vis-a-vis their present activities and outcomes. Likewise, the focus is on the reaction to stakeholders’ perceptions and goals. Schaltegger and Wagner (2006) mention that firms increasingly follow the outside-inwards approach and have outlined an integrated framework15 in an attempt to link three main aspects of sustainability performance measurement and management, namely, sustainability balanced scorecard, sustainability accounting and sustainability reporting. Both approaches discussed above have their own merits and demerits. It is important to mention that since firms operate in a dynamic environment wherein they can best judge the firm-specific and sector-specific most relevant and critical issues to enhance sustainability performance, only an outside-inwards approach will not serve the purpose. Therefore, a “double path approach” as suggested by Herzig and Schaltegger (2006) would be most appropriate. To quote, “Sustainability reporting should be embedded in a doublepath approach which combines the strategic inside-out approach of performance measurement and management with the outsidein approach of adapting to the rating and assessment schemes of external key stakeholders ”.

15 See: Schaltegger and Wagner (2006) for detailed descriptions.

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6.6

Challenges in Sustainability Reporting

There is a growing understanding that good sustainability performance is vital for good business overall. However, sustainability reporting/ initiatives bring with them their own specific set of challenges in terms of collecting, managing and disseminating sustainability information. If these challenges are properly addressed, sustainability risks would turn into invaluable business opportunities (Schaltegger et al., 2017). Business managers and others simultaneously (and continuously) face many such challenges. First, heterogeneity of sustainability topics (for example, greenhouse gas emissions are reported on the basis of fuel source and on the basis of electricity end use), different contextual meaning attached to various terms (for example, different firms may decide to choose which one or more greenhouse gases to report or calculate the greenhouse gas emission intensity ratio as per different relevant metrics), and usage of different terms interchangeably (for instance, sustainability and sustainable development are used interchangeably although both are distinct but interrelated) leads to complexity of technical sustainability aspects. Second, sustainability reporting requires extensive data pertaining to various sustainability aspects. For instance, data on engagement and consultations with distinct and dispersed groups of stakeholders (especially vulnerable/marginalised stakeholder groups) are further bifurcated into various methods employed for stakeholder engagement and the frequency of such engagement. Firms generally face challenges in collecting and compiling sustainability data, although a study by De Micco et al. (2020) found that stakeholders’ engagement hardly affected sustainability reporting. Third, due to the nonstandardisation of sustainability reporting standards/regulations/parameters, firms generally disclose sustainability information as per multiple standards/regulations/parameters, for example, GRI, IR, and UN-SDG. As a result, mapping or converging among multiple bases of information poses a challenge. Fourth, sustainability topics and dimensions are so many and complex that it is often difficult to first identify and then analyse their outcomes and impacts. Furthermore, certain topics, such as gender diversity and participation in policy making, which are extremely relevant and crucial at times, are left out or receive little attention. Finally, Brand et al. (2018) mention various issues in the contents of sustainability reports, such as partial

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reporting,16 green washing,17 weak sustainability data and lack of comparability of sustainability performance. These pose additional challenges in the sustainability reporting domain that need to be addressed. Overcoming Challenges There are many sustainability issues, such as climate change, gender inequality, energy transition, environmental degradation, loss of biodiversity, pollution, poor health and poverty, to name a few. To bring about any drastic and visible change, it is important to first understand the context and then make decisions. Likewise, each business has to first understand the exposure and importance of the sustainability issues that are most crucial, demand priority and increase vulnerability of its business operations. For instance, for energy utility companies, transition to affordable, reliable and more sustainable energy and reducing carbon dioxide emissions are most crucial, demand priority and increase vulnerability of its business operations. In this context, a firm’s top management sets its vision, mission, goals and path. For example, Godrej Interio targets 37% of revenues from green products in financial year 2023. Second, businesses need to engage with their supply chain partners (value chain partners) along with stakeholders because otherwise they cannot achieve their sustainability targets. In addition to engagement with value chain partners, appropriate use of technology and optimisation of business processes across the value chain would be needed. A recent Oxford Economics and SAP survey18 on Indian firms revealed that 60% of respondents strongly agree that mandatory regulations act as a primary driver for sustainability strategies. With the same notion, SEBI mandated comprehensive and detailed BRSR disclosures. It is believed that one’s disclosures on topics such as greenhouse gas emissions, waste management, and environmental degradation become mandatory, and assessments/measurements follow. Such assessments/measurements automatically lead to management. For example, an assessment of water waste management, scope 3 emissions that too in comparison with 16 Partial reporting means incomplete information or reporting only positive impacts. 17 Greenwashing is existence of a gap between rhetoric and reality. De Vries et al.

(2015) found that sustainability reports readers/target groups easily suspect greenwashing. 18 “Closing the Green Gap—How network effects take corporate sustainability from commitment to impact” by Oxford Economics and SAP (2022).

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past year figures, automatically pushes the firm to improve and do better. Another related matter is the collection and analysis of data to measure the outcomes. Firms need to invest in resources (both human and nonhuman) to capture and analyse sustainability data. Knowledge, motivation and training of staff at all levels are required to optimise sustainability efforts. For instance, HCL Technology has started a sustainability school to educate employees on sustainability. The real action at the ground is in the hands of employees, staff and value chain partners, among others. Overcoming Challenges: The Indian Context The regulatory requirement of the mandatory Business Responsibility and Sustainability Report (BRSR) is a welcome step, as it brings learning as well as an opportunity for firms. BRSR addresses the above discussed challenges for three main reasons. First, a single reporting format for Indian listed entities would bring standardisation of reporting, which would further enable comparability across companies, sectors and time. Second, the format of BRSR is accompanied by a Guidance Note that instructs reporting entities on the scope of disclosures, definition of terms used and quantification of parameters. Last, the BRSR format allows for interoperability of reporting frameworks. The Indian landscape of mandatory disclosure of nonfinancial information is now almost a decade old. Since then, most of the listed entities prepare and disclose sustainability reports based on one or more internationally accepted reporting frameworks (such as GRI, SASB, TCFD, IR), and they can put cross-references for the disclosures made under such a framework to the disclosures sought under BRSR. Thus, such entities need not disclose the same information again in the same annual report. With conflicting views on whether mandatory disclosures should be there or not, the point that we want to highlight is that the focus of our business community should be on the spirit behind them rather than mere compliance with mandates. Today, the success of businesses is synonymous with their sustainability performance, termed (coined) by Elkington (1997) as the triple bottom line (3BL) , in terms of their contribution to building sustainable, resilient and inclusive economies. Prior studies establish that sustainability performance is dependent on governance structures and mechanisms (Hussain et al., 2018; Mallin et al., 2013); thus, corporate governance is at the centre stage. The role played by the owners

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of businesses and their top management, i.e., board of directors, is vital. Only a visionary, strong, accountable and transparent leadership can target and contribute to this global call for sustainability. In the next section, we would like to empirically test this notion—whether corporate governance impacts sustainability reporting in the Indian context.

6.7 Impact of Corporate Governance on Sustainability Reporting: Indian Experience Businesses across the globe are witnessing a strong push towards sustainability disclosures (which could be mandatory or voluntary) in response to stakeholders’ information needs and more so due to stakeholder pressures to run businesses in a sustainable way. As a result, the corporate reporting landscape witnessed tremendous changes, with sustainability disclosures at the forefront. Haniffa and Cooke (2002) studied the disclosure practices of a firm, recognising various influences such as corporate governance, culture (race and education) and other firm-specific factors. Within the sustainability literature, stakeholder theory has been widely accepted and applied to build business cases for organisational and global sustainability as well as managing sustainability (Garvare & Johansson, 2010; Hörisch et al., 2014; Schaltegger et al., 2019). This is simply because stakeholder theory extends the value creation activities of a business to all stakeholders (beyond only the shareholders) by effectively contributing towards the global sustainability agenda. In other words, the activities of all businesses should be managed in such a way that they earn profits along with an effective contribution to the sustainability agenda. For instance, the Government of India along with India Inc. has started putting decarbonisation as the primary sustainability goal. By 2030, Indian Railways will be the world’s first green railway. Among many India Inc., under the Unilever Sustainable Agriculture Code, farmers in India are appraising sustainable agriculture practices.19 Generally, business profitability is often separated from sustainability performance. White (2013) mentions that although business profitability is by definition part of sustainability performance, it is often and frequently underrepresented. Thus, sustainability within the context of stakeholder theory is

19 Details available at: https://devnews.net/business/20-most-sustainable-companiesin-india-in-2020/.

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the integration of economic, social and environmental dimensions for all businesses. Prior corporate governance literature is based on agency theory (Jensen & Meckling, 1976), and many scholars have explored the corporate governance dimension by taking ownership as a proxy variable for corporate governance with ownership structure (type) and ownership concentration (extent) as the two subsets. Connelly et al. (2010) recognise ownership as a form of corporate governance and argue that owners dominate firm outcomes and differ on account of motivation to hold shares as well as the ways in which they affect firms. Furthermore, in countries such as India where firms are family controlled (may or may not be family owned), family controllers exert significant influence on electing members who eventually sit on boards. As a result, family controllers20 face less information asymmetry and pay less attention to or demand less disclosures and reporting.21 In this context, it is expected that the greater the shareholding of such controllers, the lesser the extent of reporting. That being said, the agency theory of corporate governance can be extended to the corporate governance sustainability nexus (Hussain et al., 2018). Prior studies on the corporate governance and sustainability relationship have employed more than one theory. Walls et al. (2012) argue that sustainability objectives and targets cannot be integrated with corporate strategy merely from the agency theory perspective. Konadu et al. (2021) utilised both agency theory and stakeholder theory to study the nexus between corporate governance and sustainability. Likewise, in the present study, stakeholder theory together with agency theory provides the theoretical background. Kansil (2021) studied the ownership structure segmentation of publicly listed companies in India and found that ownership is concentrated in the hands of Indian promoter and nonpromoter institutional shareholders. Therefore, promoter ownership would be the most suitable proxy for corporate governance to study the relation between corporate governance and sustainability. Furthermore, there are relatively few studies on the corporate governance and sustainability relationship with promoter

20 Which are generally in close ties with the Board of Directors. 21 Likewise, dispersed ownership is likely to demand more corporate disclosures is found

by Brammer and Pavelin (2006) and Hossain et al. (1994).

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ownership as a proxy for corporate governance. Aguilera et al. (2021) highlighted the need to explore how foreign ownership shapes sustainability decisions. The present study fills this gap by considering both Indian promoter shareholdings and foreign promoter shareholdings as a corporate governance variable. Data and Variables To test whether corporate governance does in fact lead to more sustainability disclosures, we use Bloomberg’s extensive Environment Social and Governance Score22 (ESG Score) as a proxy for sustainability, similar to Shrivastava and Addas (2014). Bloomberg’s ESG database is widely used by researchers (such as Giannarakis, 2014; Nollet et al., 2016; Wong et al., 2021) for studies not only on sustainability but also on corporate social responsibility, firm performance, and social performance, to name a few. Likewise, the Bloomberg ESG database is considered to be the most comprehensive database not only for the sustainability (ESG) dimension as a whole but also for three components of sustainability, namely, the Environment, Social and Governance dimensions. Eccles et al. (2011) provide further support for these arguments, as they demonstrate huge market interest in ESG information and in particular in the so-called ‘ESG disclosure score’ provided by Bloomberg. In addition, a novel approach is followed in the study. The use of a binary (dummy) variable23 as a measure of sustainability reporting would take value 1 (for yes) if the firm is a constituent of S&P BSE 100 ESG Index, otherwise 0. The S&P BSE 100 ESG Index is an index specifically designed to include securities that meet sustainability investing criteria and maintain a risk and performance profile similar to the S&P BSE 100. A firm being a constituent of the index implies that the firm is performing high on various sustainability parameters and complying with United Nations’ Global Compact Principles. As proxies for corporate governance,

22 “Bloomberg provides ESG data organised into 2000+ fields that span several key sustainability topics, further bifurcated into E, S and G domain including but not limited to: Air Quality, Climate Change, Water, Energy Management, Health & Safety, Audit Risk & Oversight, Compensation, Diversity, Board Independence, and Shareholder’s Rights, among other”. 23 Wooldridge (2010) argues that we apply GMM with a binary dependent variable also as there is no such restriction on dependent variable to apply GMM.

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we use Indian Promoter Shareholdings (IP) and Foreign Promoter Shareholdings (FP). Promoter shareholdings, further bifurcated into Indian promoters and foreign promoters, are a part of the ownership structure and have been widely used in the literature as a measure of a firm’s corporate governance quality (Kumar & Singh, 2013; Mishra & Kapil, 2016; Salerka, 2005). In addition, various firm characteristics, as mentioned in Table 6.1 above, are the control variables used for empirical estimation. The sample firms comprise constituent entities of the S&P BSE 500 index [of the Bombay Stock Exchange (BSE)]. We have employed the same dataset used in Chapter 3 of the book for the micro perspective. However, the final data were unbalanced panel data with 3629 observations after deleting the rows for which Environment Score (EScore)/Social Score (SScore)/Environment Social and Governance Score (ESGScore) was missing. The period of study is thirteen years, from the end of financial year 2009 to 2021.24 The description of variables used in the study is discussed in Table 6.1. Empirical Model Model 1: E SG Scor eit = β0 + β1 I Pit + β2 F Pit + β3 Mcapit + β4 T Rit + β5 Ageit + β6 Si zeit + β7 R O Ait + β8 D E Rit + eit where ESGScore it = Environment, Social and Governance Score IP it = Indian Promoter shareholdings FP it = Foreign Promoter shareholdings Mcap it = Market Capitalisation TR it = Total returns AGE it = Firm age SIZE it = Firm size ROA it = Return on Assets DER it = Debt Equity ratio (leverage) The subscript i is used to denote individual firms, and subscript t is used to denote time.

24 Similar to Micro and Marco Perspective discussed in Chapter 3 of the book.

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Table 6.1 Description of variables used in the study Sr. No.

Variable

Abbreviation

Definition

Dependent variables 1 Environment Social and Governance Score

ESGScore

2

Environment Score

EScore

3

Social Score

SScore

4

Governance Score

GScore

The Environment, Social and Governance Score of a firm for a respective year covering several key sustainability topics The Environment Score of a firm for a respective year covering several key environment topics The Social Score of a firm for a respective year covering several key social topics The Governance Score of a firm for a respective year covering several key governance topics Dummy Variable—1 for Yes and 0 for No

5

Constituent of BSE 100 ESG ConBSE100 Index Corporate governance variables 1 Indian Promoters IP Shareholding (in percentage) 2

Foreign Promoters Shareholding (in percentage)

FP

Other control variables 1 Market capitalisation (in Rs. Million)

Mcap

2

Total returns (in percentage)

TR

3

Age (in years)

Age

Percentage of equity shares that are held by the Indian promoters of the company Percentage of equity shares that are held by the Foreign promoters of the company Number of shares outstanding * Closing price of the stock as on the last day of the financial year (bse returns − 1) * 100 where BSE returns = closing price, gains/losses arising due to capital action and dividend per share (if any)/closing price of previous day Total number of years since the year of inception of the firm calculated as the difference between each of the end of the financial year of study and the year of incorporation of the company

(continued)

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Table 6.1 (continued) Sr. No.

Variable

Abbreviation

Definition

4

Size (in Rs. Million)

Size

5

Return on assets (percentage)

ROA

6

Debt to equity ratio (in times)

DER

Three-year average of the total income and total assets Net profit divided by total assets. Net profit is the net profit of the company after tax. It is the residual after all revenue expenses are deducted from the sum of the total income and the change in stocks Total debt/Shareholder’s equity

Models 2 to 5: Models 2 to 5 are models similar to Model 1 but with a different dependent variable—Environment Score (EScore), Social Score (SScore), Governance Score (GScore) and Constituent of BSE 100 ESG Index (ConBSE100), respectively. Our study starts with multiple panel data regression to study the relationship between sustainability reporting and corporate governance. On scrutiny of the results and subsequent post estimation tests, a fixed effect estimator was found to be suitable. However, Li et al. (2021) noted that the fixed effect estimator is based on the assumption of strict exogeneity, that is, “current observations of the independent variables should be completely independent of the previous values of the dependent variable”. Furthermore, if this assumption is not true, then the results of the fixed effects estimator are biased and invalid. Such a case is referred to as dynamic endogeneity. Identifying the Risk of Dynamic Endogeneity Aras and Crowther (2008) recognised four elements of sustainability— societal influence, environmental impact, organisational culture and finance—and concluded that a more complete understanding of the interrelationships amongst sustainability and corporate governance will lead to better corporate governance. A contrary view is discussed by Salvioni and Gennari (2016), who mention that sustainability points towards modification in the core spirit of governance, which they call the “de facto

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convergence of the diverse corporate governance systems existing all over the world”. Thus, we believe that unidirectional models would not be suitable to explore the relation between corporate governance and sustainability. In other words, the endogeneity issue arises for studies on corporate governance and sustainability. Li et al. (2021) reveal that biased and invalid estimations of the fixed effect model occur in the presence of dynamic endogeneity. In the case of dynamic endogeneity,25 which is considered a type of simultaneity, the present values of the independent variable are affected by the past value of the dependent variable. In the present case, ESG Score would affect the future value of Mcap, TR, and debt to equity ratio, among others. Therefore, the risk of dynamic endogeneity is quite high in our model because some if not all of the control variables are neither time in variant nor stable rather prone to fast or rapid changes. Li et al. (2021) further mention that in international business research, the problem of dynamic endogeneity is quite prevalent and often not addressed correctly. In such cases, they suggest the use of the generalised method of moments (GMM) estimator against the fixed effect estimator, similar to Richter and Chakraborty (2015). The generalised method of moments (GMM) was proposed by Arellano and Bond (1991) and runs as a difference GMM estimator, level GMM estimator and system GMM estimator. The system GMM estimator uses lagged and differenced dependent variables as instruments. These instruments, called internal instruments, not only satisfy relevance and exogeneity conditions and are therefore valid instruments but also solve the problem of the construction of external instruments. In terms of the methodology, the study employed the system GMM model, which uses lagged values as instruments and, as a result, reduces simultaneity bias and reverse causality. The instruments are valid and reliable as per the series of post estimation tests; hence, the model employed limits endogeneity.

25 Endogeneity in management research could be due to many reasons such as omitted variables, simultaneity, measurement error and biased sample selection. Aguilera et al. (2021) call for addressing endogeneity in corporate governance and related research. Instrumental variable regression suggested by Wooldridge (2002) among others, has been widely used by many researchers.

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Empirical Estimation and Results We ran the system GMM estimator as per the steps suggested by Li et al. (2021). The first step is to check the first-order autoregression coefficient of the dependent variable to determine the applicability of a suitable GMM estimator among different GMM estimators. If the coefficient is near 1, then level GMM is suitable; otherwise, system GMM is to be used. In our case, the F coefficient came to be 182.070; hence, we ran system GMM. In step 2, suitable lags are selected. For ESG Score, lag 1 and lag 3 were statistically significant. Hence, we selected lag 1 and ran system GMM. The results are depicted in Table 6.2. Columns 2 to 6 of Table 6.2 report the estimation outputs of Model 1 to Model 5, discussed before. System GMM with Environment Social and Governance Score as dependent variable (Column 2), with Environment Score as dependent variable (Column 3), with Social Score as dependent variable (Column 4), with Governance Score as dependent variable (Column 5) and with Constituent of BSE 100 ESG Index as dependent variable (Column 6). The result of Column 226 confirms the significant negative effect of the Indian promoter’s shareholdings (IP) on the ESG Score. However, the coefficient of Foreign Promoter shareholdings (FP) is not significant. Among the other control variables, Market Capitalisation (Mcap), Total Returns (TR), Age and Size are significant, but Return on Assets (ROA) and leverage (DER) are not statistically significant. Furthermore, the results of Columns 3 to 6 do not reveal any relation between corporate governance variables (IP, FP) and Environment Score, Social Score, Governance Score and Constituent of BSE 100 ESG Index, respectively. Market capitalisation (Mcap), total returns (TR), age and size are found to be significant in most of the models, but return on assets (ROA) and leverage (DER) remain statistically insignificant. We ran three post estimation tests: the Arellano–Bond test for AR(1) and AR(2) in first differences, the Hansen test of overriding restrictions and the Difference-in-Hansen tests of exogeneity of instrument subsets. The three tests reject the null hypothesis as desired (Li et al., 2021). The results reveal that no second-order serial correlation exists (with the

26 Since the results of other models are more or less consistent, we do not discuss them in detail.

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Table 6.2 Results of system GMM regression Dependent variable Col. 1 Variables

Lag of DV IP FP Mcap TR Age Size ROA DER Constant Post estimation tests Arellano–Bond test for AR(1) in first differences Arellano–Bond test for AR(2) in first differences Hansen test of overid. restrictions Difference-inHansen tests of exogeneity of instrument subsets (gmm)

Col. 2 Model 1 Environment Social and Governance Score

Col. 3 Model 2 Environment Score

Col. 4 Model 3 Social Score

Col. 5 Model 4 Governance Score

Col. 6 Model 5 Constituent of BSE 100 ESG Index

−1.041 (0.026)** −1.827 (0.021)** 0.031 (0.971) 0.737 (0.039)** −1.138 (0.009)*** 3.48 (0.001)*** 0.977 (0.003)*** 0.598 (0.209) 0.324 (0.845) −29.654 (0.383)

0.562 (0.019)** −60.609 (0.139) −0.079 (0.828) 0.476 (0.062)* −0.538 (0.029)** 0.595 (0.087)* 0.447 (0.073)* 0.232 (0.418) −0.665 (0.401) −9.611 (0.683)

0.743 (0.000)*** −0.282 (0.115) −0.156 (0.29) 0.145 (0.134) −0.156 (0.414) 0.694 (0.000)*** 0.010 (0.145) −0.02 (0.89) 0.323 (0.531) −3.418 (0.752)

−0.466 (0.388) −3.103 (0.111) 0.265 (0.887) 0 (0.264)

–

1.22 (0.222)

−2.24 (0.025)

−7.71 (0.003)

0.86 (0.392)

−0.48 (0.631)

2.27 (0.279)

0.07 (0.948)

1.14 (0.254)

1.71 (0.097)

−0.06 (0.952)

15.51 (0.344) 13.93 (0.305)

5.72 (0.126) 18.53 (0.100)

21.01 (0.101) 19.49 (0.077)

19.47 (0.148) 17.71 (0.125)

8.83 (0.886) 8.58 (0.661)

Note ***p < 0.01, **p < 0.05, *p < 0.1

0.001 (0.157) 0.002 (0.537) 0 (0.012)** −2.255 −0.001 (0.006)*** (0.213) 3.514 0.124 (0.033)** (0.734) 0.012 0.132 (0.021)** (0.024)** 0.992 0.067 (0.19) (0.775) 2.179 −0.002 (0.597) (0.582) 21.023 −0.074 (0.832) (0.333)

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exception of Model 4—Column 5, which is close to 10%) and that instruments are valid, exogenous (with the exception of Model 3—Column 4) and uncorrelated with error terms. Discussion Previous studies (Leng & Shazaili, 2005; Zulkarnain, 2007) have found that the likelihood of expropriation of a firm’s assets and exploitation of minority shareholders is much higher in family-controlled firms. As a result, they might practice fewer disclosures, especially of sustainability information. With respect to the decision and implementation of disclosure policies of the firm, previous studies have provided mixed results. While Cheng and Courtenay (2006) along with Gul and Leung (2004) mention that the board of directors decide and implement a firm’s disclosure policies, Michelon and Parbonetti (2012) found contrary results. The empirical results of our study confirm the significant negative impact of Indian promoters’ shareholdings on sustainability reporting in the Indian context (similar to Haniffa & Cooke, 2002; Ho & Wong, 2001). In contrast, the impact of Indian promoters’ shareholdings on the respective three separate dimensions of sustainability, namely, E, S and G, is not significant. The results reflect upon the fact that sustainability as a corporate culture is not embedded within Indian promoters. They are still following the shareholder value model rather than the stakeholder value model. Additionally, there could be other governance variables, such as ownership concentration, board size, and board independence that might impact sustainability reporting in the Indian context. Furthermore, the coefficient of foreign promoter shareholdings on sustainability reporting being insignificant is surprising, implying that foreign promoter shareholdings do not impact sustainability in the Indian context. This is true because substantial Indian firms are owned and controlled by one or more promoter families (Mani, 2019). These family-controlled firms work in the best interests of their controllers. Here, the relevance and need for the quality of the board comes into the picture. The path of the right mix of skills, experience, expertise and independence of the board can only take the firms that they want to reach. The findings with respect to other firm characteristics highlight that firms that are older, larger and enjoy large market capitalisation positively work on ESG disclosures. The findings are in line with the mandatory disclosure requirements prescribed by the Securities and Exchange Board

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of India (SEBI), wherein disclosing sustainability (nonfinancial) information by top entities has been made mandatory (in phases) since 2012.27 Another interesting result is that total returns on the equity share of the firm (by way of change in the market value, dividends earned and any capital gain or loss) have a negative significant effect on sustainability. In other words, the greater the total returns on equity share, the lesser the sustainability efforts of the firm, implying that the shareholders are more concerned about their financial gains.28 Our results do not show any relationship of sustainability reporting with the profitability (ROA) and leverage (DER) of the firm, indicating that sustainability disclosures are related to neither the firm’s profit nor the level of debt. This result is not in keeping with prior empirical studies that show that sustainability disclosures go hand in hand with a firm’s profit (McKendall et al., 1999) and debt (Clarkson et al., 2008). It is important to mention here the results of a recent survey of Indian firms29 that shows that 62% of firms believe that firms can be both sustainable and profitable at the same time. Understandably, the transition towards a sustainability path has begun in India, but the real challenge lies in translating targets into action. Conclusions and Policy Recommendations The present chapter outlines the evolution of sustainability reporting frameworks worldwide and norms followed in India along with the challenges faced by business entities in the preparation of such reports. An empirical exercise carried out in the present chapter on the impact of corporate governance on sustainability (ESG) reporting in the Indian context by using the multiple panel data regression method clearly reveals that sustainability culture is still a distant dream for many Indian firms (included in the study).

27 For detailed discussion, please refer to the section “The third decade of corporate governance reforms” in Chapter 2 of the book. 28 This is also supported by the results in Column 3—Model 2 and Column 5—Model

4. 29 “Closing the Green Gap—How network effects take corporate sustainability from commitment to impact” by Oxford Economics and SAP (2022).

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The OECD (2020) study revealed that the average shareholdings of promoters in all listed entities in India have been fairly stable at approximately 50% since 2001, with a peak at 58% (in terms of market capitalisation) in 2009. Furthermore, within the shareholdings of promoters, a large stake is with Indian promoters since only approximately 10% is held by foreign promoters. Our empirical analysis found a negative and significant effect of Indian promoters’ shareholdings on sustainability reporting, which further implies that sustainability consciousness is still lacking among Indian promoter-led (family-controlled) firms. Therefore, there is an urgent need to inculcate sustainability culture among all Indian firms through ESG education and training. It is this ‘sustainability culture’ that can facilitate the development of sustainability strategies for businesses in a clear, structured and rigorous way. This realisation needs to be brought to all and not the selected few entities (i.e., top 1000 listed entities by market capitalisation for whom Business Responsibility and Sustainability Reporting is mandated by SEBI since the financial year 2022–2023). The Indian business entities now have to apply the same discipline and rigor for sustainability reporting as is the case with financial information because sustainability is everyone’s responsibility and not that of the selected few. This becomes all the more important as we stand committed to the Sustainable Development Goals of the United Nations. Our study also shows that foreign promoter shareholdings do not impact sustainability since the coefficient of foreign promoter shareholdings is insignificant. This is because, like many other developing countries, most of the companies in India are predominantly family owned or substantial shares are controlled by family members. For instance, De La Cruz et al. (2019) found that approximately 50% of total market capitalisation is owned by private corporations and holding companies along with strategic individuals and family members in the Indian context. These family firms in India have to learn best practices followed by older, larger firms that enjoy large market capitalisation and have set the tone to follow ESG norms. The idea is that sustainability must first become an integral part of all strategic management as well as business planning and henceforth reflect through the whole process of business management. Here, it is important to mention that the global call for sustainable practices is not for bigger and older firms only, but it is a responsibility of every firm, every individual in an organisation. Thus, various firm characteristics, such as age, size and market capitalisation, may be set as a criterion for mandatory disclosures in the initial stages to embed sustainability culture.

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However, subsequently this has to be a way of life for one and all. All businesses (irrespective of their size, age and market capitalisation) and all stakeholders have to contribute to achieving the SDGs set by the UN. It is imminent that all businesses must start operating by following sustainable practices and adopting sustainable reporting frameworks. This calls for the need for restructuring of the governance structures (that determine sustainability action and disclosure policies) with a special focus on changing the mindset so that sustainability becomes everyone’s responsibility and a part and parcel of day-to-day decision-making processes in business entities. Indeed, this cannot happen without sustainability education and sustainability training. An important point to be emphasised here is that we have already entered an era where the primary means of valuation of companies is going to be the impact they have on society and the environment rather than on profits or losses or financial parameters. This is a high time that ESG developments and corporate governance policies in India must be merged into new regulatory frameworks that aim to strengthen the link between corporate entities and the wider society, which includes shareholders and other stakeholders. Integrating key sustainability drivers in the firm’s strategy and including sustainability targets and objectives in performance appraisal, monitoring, reviewing and evaluating them closely can help in embedding and enforcing sustainability within an organisation.30 Indeed, better disclosures lead to effective risk assessment, better strategic planning and better capital allocations. With the rise of sustainability risks and opportunities, it is important to identify, assess and treat them at the earliest. Furthermore, the financial impact of such risks and opportunities is so high that it cannot be overlooked. In this direction, the first step is to gather and disclose sufficient information on all sustainability risks and opportunities. For example, the Task Force on Climate-related Financial Disclosures (TCFD) set up by G20 took the first step and released its recommendations on climate-related financial disclosures in 2017. The TCFD 2022 Status Report (TCFD, 2022) describes a steady increase in both the number of firms and the number of climate-related financial disclosures in the five-year period from 2017 to 2021. This is true across the world, including in the Asia Pacific region, where over half of the firms disclosed climate-related metrics. The role of regulators (SEBI

30 Also see Accenture and Chartered Institute of Management Accountants (2011).

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as well as MCA in the case of India) and the government is crucial, as they will have to monitor and ensure the implementation of sustainability reporting standards set for Indian firms if growth31 is to be attained first and made sustainable subsequently. By making sustainability a strategic rather than tactical decision, firms can create a virtuous cycle32 for sustainability performance management, which in turn can help firms experience superior financial performance (Eccles et al., 2014; Luo et al., 2015).

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31 The results of empirical analysis obtained by the authors’ in Chapter 3 of the book clearly show that good governance structures results from economic growth. In other words, economic growth precedes corporate governance. 32 The creation of virtuous cycle will require linking sustainability to business performance by choosing right metrics, by improving the process of data collection, analysis and reporting and integrating this with business planning and reporting (Accenture and Chartered Institute of Management Accountants, 2011).

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CHAPTER 7

Strengthening the Convergence of Corporate Governance and Sustainability—The Way Forward

7.1

Introduction

In the last three decades, corporate sustainability first emerged as a business paradigm and then rose on the top of the corporate agenda (Shah & Arjoon, 2015). In this context, businesses perceive corporate sustainability in multiple ways. Aras and Crowther (2008) investigate the concept of sustainability in the eyes of corporates and mention that corporate sustainability is a mere recognition of environmental and social issues that need to be incorporated into strategic planning at a later stage. Furthermore, the authors disagree with this notion and talk about four equally important key dimensions of sustainability, namely, societal influence, environmental impact, organisational culture and finance, which demand recognition and analysis for the desired firm performance. Regardless of how one business perceives the term sustainability, the desirability and inevitability of embedding sustainability culture among all businesses is paramount. Business must perform for each stakeholder, and its success is now understood as sustainability-based value creation for all stakeholders (Schaltegger et al., 2019). An increasing

© The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 S. Joshi and R. Kansil, Looking at and Beyond Corporate Governance in India, https://doi.org/10.1007/978-981-99-3401-0_7

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number of businesses have now started adopting sustainability practices and building circular economy1 action plans.2 Although significant changes have indeed been observed in business practices, it is important to mention that the desired outcomes can only be achieved via better governance of these businesses. In other words, unless and until the businesses are governed in a manner that places sustainability as an explicit aim at the top business agenda, we cannot move towards the desired outcomes. To quote, “Governance features are the precursors of future sustainability, but are far from being a sufficient condition for this and by no means indicators for the actual sustainability performance of a firm” (Schneider & Meins, 2012). In other words, good governance would not guarantee sustainability performance, but good governance would indeed push firms towards the adoption of sustainable practices and the achievement of sustainability performance. Thus, we emphasise the convergence of corporate governance and sustainability across all sectors and industries in all economies of the world. Indeed, such convergence will present great opportunities for businesses to explore sustainability alternatives and processes. However, such a convergence would require changes at both the firm and institutional levels. In this chapter, we attempt to present a way forward to strengthen the convergence of corporate governance with sustainability. We will also make an attempt to identify important drivers of and major roadblocks/impediments that might stand in the way of such convergence.

1 Valavanidis, A. (2018) has defined circular economy as a “system of resource utilisation where reduction, reuse and recycling of materials prevails, cutting down waste to a minimum and with the use of biodegratable products recycle the rejected products back to the environment ”. 2 See: https://hbr.org/2021/07/the-circular-business-model. Additionally, the Euro-

pean Union is globally recognised as a leader in circular economy policy making with its EU’s Circular Economy Action Plan (CEAP) adopted in 2015 (which was later updated in 2020). The plan covers legislative and nonlegislative actions comprehensively for transition from a linear to a circular model. See: https://environment.ec.europa.eu/strategy/ circular-economy-action-plan_en.

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Convergence---Meaning

In the context of embedding sustainability culture in all businesses, convergence of corporate governance and sustainability refers to a governance approach directed towards adoption of sustainable business strategies and policies that not only increases value for all stakeholders but at the same time protect and sustain present available finite resources. This is because these finite resources, which are under threat of extinction, will be required by future generations for survival. The desired convergence would push all businesses across the globe to function in a manner in which they themselves are sustainable at the first place and thereby contribute to the inclusive, sustainable and resilient growth of the economies they operate in. Such a task, although, seems to be quite daunting, if we could relate it to the idea of better governed entities wherein businesses change towards more sustainable business models/ activities through creativity and innovation (Hahn et al., 2018), the task would become more realistic, manageable and appealing. In other words, convergence has been used in this chapter to include the convergence of sustainability aspects in all business strategies and processes that can be achieved only with good corporate governance. Gilson (2001) pointed out three types of convergence, namely, formal convergence, functional convergence and contractual convergence, while discussing the globalisation of corporate governance systems. We apply these three forms of convergence to strengthen the convergence of corporate governance and sustainability. Formal convergence refers to similar frameworks and standards of sustainability with regard to corporate reporting and disclosures. We take this as a national-level dimension that would further lead to firmlevel harmonisation when all entities across the globe start following one single set of sustainability standards and guidelines. International standard setting bodies3 have taken some steps in this direction. For instance, in November 2021, the International Sustainability Standards Board (ISSB) was formed by the International Financial Reporting Standards (IFRS) Foundation to address the rising demand from global

3 Such as Global Reporting Initiative (GRI), Value Reporting Foundation (formed by merging the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC), the European Commission and the International Financial Reporting Standards (IFRS).

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investors for reliable and comparable reporting standards to be adopted by companies for reporting on environmental, social and governance (ESG) matters. Functional convergence refers to market-driven changes at the firm level wherein firms build sustainability learning capabilities (Wijethilake & Upadhaya, 2020). A number of factors have contributed to such functional convergence, such as rising investor pressures, increasing consumer demand for green products and services, stricter regulatory mandates, updated technologies, and the latest innovations for low-cost outputs. For instance, the fashion industry4 is now booming with sustainable and organic clothing that is made up of raw materials such as organic cotton, recycled cotton, hemp, and bamboo linen, which is the result of rising consumer awareness and social media pressures due to the high negative environmental impact of the fashion industry and government initiatives5 in this regard. Contractual convergence refers to the case when formal institutions call for changes via contracts. We extend this type of convergence to the firm level. The case of SEBI mandating BRSR disclosure requirements for the top 1000 listed entities from the financial year 2022–2023 is a case of such contractual convergence. Another case of contractual convergence could be when firms push their value chain partners to adopt sustainable business practices or they may prefer entering into contracts with only those of them who adopt sustainable business practices. This would facilitate the embedding of sustainability culture across value chain entities. Thus, we see efforts towards all three forms of convergence, although it may seem at times that the progress is slow.

4 See: Trend of sustainable clothing booming in India (indiatimes.com). 5 In 2019, Government of India launched Project SU.RE—Sustainable Resolution,

as a commitment towards cleaner environment which was signed by 16 leading retail fashion houses. Available at: https://government.economictimes.indiatimes.com/news/ governance/textiles-minister-smriti-irani-launches-sustainable-fashion-project/70800229. Recently, in November 2022, The Apparel Export Promotion Council (AEPC) announced the launch of the Apparel Industry Sustainability Action (AISA) which aims at boosting the sustainable attributes of the garment industry. Available at: https://www. just-style.com/news/indias-aisa-initiative-targets-sustainability-boost-in-apparel/.

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Drivers of Convergence of Corporate Governance and Sustainability

The question that emerges here is as follows: what are the critical factors that would propel corporates towards the convergence of corporate governance and sustainability? We believe the critical factors would be the drivers of such convergence that would push corporates to embed sustainability in strategic direction and implementation. Here, we briefly discuss each of the drivers identified by us. Setting a Tone of Sustainability at the Top OECD (2022) has appealed to governments to “set a tone of integrity at the top” for responsible business conduct and integrity of state-owned enterprises. We believe that a similar tone at the top, termed “a tone of sustainability at the top”, is needed within corporate culture to support and demonstrate top management’s commitment to sustainability. Corporate leaders need to be strategic, wherein they can take the lead for better management decisions, better allocation of resources and better work policies and processes. This calls for such structure and functioning of the top management (board of directors) that they are able to establish clear strategic direction for the firm, improve leadership processes and bring about better information flows. IFC (2019) mentions that wellestablished corporate governance practices support such actions of top management (board of directors). The tone would act as a basis for sustainability culture within all firms that can be communicated to personnel at all levels within the firm. In this light, top management should head, guide, support and equip departments to shape business practices in a manner compatible with sustainability standards and guidelines. Thus, the first driver for the convergence of corporate governance and sustainability is setting a tone of sustainability at the top. Sustainability Leadership In the words of Bendell and Little (2015), sustainability leadership is defined as “any ethical behaviour that has the intention and effect of helping groups of people achieve environmental or social outcomes that we assess as significant and that they would not have otherwise achieved”. Sustainability

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leadership has emerged as a topic in its own right in the last two decades and has grown more than ever due to the mutual interest of both internal and external stakeholders. The increasing demand of stakeholders from corporate leaders to initiate sustainable actions in business activities and operations has brought a shift in leadership across businesses. Since business leaders shape an organisation’s culture through their own actions and by engaging and involving others, stakeholders expect business leaders to take the lead to embed sustainability in the organisation’s culture. This would bring responsible and sustainable behaviour at the heart of business strategy and values. We argue in this chapter that good corporate governance is a precondition for sustainability. Furthermore, sustainability cannot be ensured unless and until leadership is aware of sustainability issues and has the required vision to achieve them. The eloquent example in this regard is provided by The Tata Group, which is India’s largest conglomerate. The sustainability policy of Tata Group6 very clearly mentions the group’s commitment to sustainability as follows: “ Our companies will aspire for global sustainability leadership in the sectors in which we operate. To achieve this, we will: ● Constitute a governance structure to oversee sustainability commitments. ● Identify relevant and material sustainability issues and develop comprehensive sustainability strategies with goals, targets, mitigation and adaptation action plans to address them under the aegis of our boards. ● Report in line with global reporting frameworks ” .

In addition to the required awareness of leadership towards sustainability, sustainability leaders should be one who not only initiates and drives solutions for environmental and social problems but at the same time influences peers to breakdown silos and combine efforts towards change and transformation. Change and transformation here refers to the change and transformation in business activities and practices that arise due to consideration of short-term and long-term impacts (positive as well as negative) of business activities and operations on both society and the environment. 6 See Tata Group’s Sustainability policy. Available at: https://www.tatasustainability. com/pdfs/Resources/Tata_Sustainability_Policy.pdf.

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Fig. 7.1 The six habits of regenerative leaders (Source Reproduced from and based on Visser 2022)

For years now, the term regenerative is being used for businesses and leaders.7 In his recent work (2022), Professor Wayne Visser emphasised that a sustainability leader is also a regenerative leader and must have the six habits shown in Fig. 7.1. Since businesses operate in a complex and dynamic environment, sustainability leaders call for an enabling framework. In other words, the change and transformation in business activities and practices call for an enabling framework. Enabling Framework for Promoting Sustainability Leadership An enabling framework for sustainability leadership is having the potential to lead economies towards the fastest growth path. A sustainability leadership model called “The Cambridge Sustainability Leadership Model” (Visser & Courtice, 2011) provides us with an enabling framework to ensure a smooth transition towards sustainability. The abovementioned model was developed by the University of Cambridge Institute for Sustainability Leadership (CISL). The model has been divided into three parts that address leadership context, individual leaders’ traits, styles, skills, knowledge and leadership actions.

7 See: https://thenatureofbusiness.org/2021/10/05/why-regenerative-leadership-hasto-be-the-new-norm-in-business-by-giles-hutchins-laura-storm/.

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The leadership context refers to the conditions or environment in which leaders operate. Such contexts have direct and indirect impacts on the firm’s activities and practices and impact the decision-making processes of top-level management. This context could be both external and internal. External contexts relate to the external environment of business, such as ecological, economic, political, cultural and community, over which firms have less influence. On the other hand, the internal context, such as the organisational reach, the organisational culture, governance structure, and role of leadership, relates to the firm or sector in which the firm operates. Firms generally have a higher degree of influence over such internal contexts. We find that many business leaders of today’s times are mindful of the role of context and address the same in the best interests of all stakeholders. To quote, Anand G. Mahindra, Chairman, Mahindra Group,8 “Since inception, Mahindra has upheld its ’Rise for Good’ philosophy of doing good for the communities it operates in. Determining what is right for the environment and our communities is not one big decision - it is a series of several small everyday choices ”. The second part of the model discusses the leader’s (individual’s) traits, styles, skills and knowledge. Individuals per se would have distinct traits, skills and knowledge and so would be the variation of combination of traits, skills and knowledge amongst individuals. Although it is quite improbable that one leader would possess all the traits, skills and knowledge mentioned in Fig. 7.2, the top management together or the board of directors as a team can possess the required traits, skills and knowledge that would serve the purpose of leading the firm in the desired direction. Sustainability leaders are expected to consider sustainability as a spiritual practice that would ultimately transform not only self and businesses but also others and the world. Care and morals would drive sustainability leaders. In this process, sustainability leaders need to go beyond rational thinking and decide intuitively to embrace uncertainty with profound trust. Since sustainability initiatives include multiple perspectives, it is important for sustainability leaders to appreciate the interconnectedness and interdependencies within the whole system and follow a systems approach. Sustainability leaders would have a dialogue with stakeholders and scan the internal and external environment, which would help to 8 See Mahindra Group Sustainability Report 2021–2022. Available at: https://www. mahindra.com/sites/default/files/2023-01/Mahindra-Sustainability-Report-2021-22_0. pdf.

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Fig. 7.2 Cambridge sustainability leadership model (Source Reproduced from Visser and Courtice [2011])

initiate and mentor the transformation of present activities and processes. In this process, sustainability leaders may adopt an enquiring open minded approach. This further pushes them to be empathetic towards self and others. It is always advisable to reflect upon why others behave in the manner they behave? Having practiced those approaches, sustainability leaders would be inclusive and courageous to take steps towards unconventional sustainability initiatives. The said model illustrates five distinct leadership styles that sustainability leaders may adopt. The inclusive style of leadership is one where sustainability leaders follow a democratic approach and try to be collaborative and participative. They listen to their followers, resolve conflicts, if any, delegate some authority and build a culture that brings peer support. In the case of a visionary style of leadership, leaders inspire and motivate their teams to follow their vision. Such leaders have an inspirational vision that actually challenges peers’ perceptions and expectations along with their charishma that peers follow them. Some sustainability leaders are transformation leaders who actually create/design activities/products and ultimately become game changers. Altruistic leaders are called servant leaders and focus on the collective good of all, whereas radical leaders

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are risk takers who actually challenge the status quo and go ahead as crusaders. We believe that in practice, sustainability leaders may not adopt a single style of leadership but rather adopt distinct styles of leadership to address distinct sustainability issues/problems. The third part of the model envisages probable leadership actions that a sustainability leader may take in response to the challenges and opportunities of sustainability depending upon the context and/or the sustainability problem. The individual leader’s actions are further divided into internal actions and external actions. Internal actions include making informed decisions, providing strategic direction, crafting management incentives, ensuring performance accountability, empowering people and embedding learning and innovation. These actions are not mutually exclusive, as each can impact and change the other. In addition, sustainability leaders may take external (stakeholder-related) actions such as fostering crosssector partnerships, creating sustainable products and services, promoting sustainability awareness, transforming the context and ensuring stakeholder transparency. The above model is a presentation of sustainability leadership in practice that would facilitate business leaders to contribute towards transformation in business activities and practices. We envisage sustainability leadership as the second driver for the convergence of corporate governance and sustainability. As the majority of businesses in India are familycontrolled businesses, our empirical analysis carried out in Chapter 6 of this book has very clearly shown that Indian promoters’ shareholdings have a negative and significant effect on sustainability reporting, which implies that sustainability consciousness is still lacking among Indian promoter-led (family-controlled) firms. Sustainability consciousness can be attained through sustainability education and training (which would be a step towards building sustainability leaders). We have to build such leaders who have the vision of achieving the wider global agenda of sustainable development goals and thereby building sustainable, resilient and inclusive economies. Education and training of future leaders would help them understand the nexus between sustainability challenges/ tensions and sustainability leadership. Of course, it is the seriousness and

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commitment of such leaders towards enforcement of the vision that will matter a lot and facilitate returns on sustainability/thriving.9 Top Management Orientation Top management, i.e., the board of directors (BOD) of every firm, has to have a vision and a mindset towards sustainability that needs to be further shared not only with managers/employees but also with other stakeholders. In this process, top management has to recognise, appreciate and adopt the transition of the firm from a shareholder-oriented approach to a stakeholder-oriented approach. The stakeholder-oriented approach recognises all three dimensions of the triple bottom line, namely, economic, environmental and social (EES), termed sustainability. Here, it is also important that board members recognise the interdependence of these three dimensions (EES) of sustainability to provide the best strategic direction and achieve desired performance goals. Such recognition depends on the mindset and ethical standards adopted by the top management, which determines the credibility and integrity of the whole organisation’s processes, termed the corporate governance practices of the firm. It has been very rightly pointed out by the N. R. Narayana Murthy Committee Report (SEBI, 2003) that “Corporate governance is beyond the realm of law. It stems from the culture and mindset of management and cannot be regulated by legislation alone. Corporate governance deals with conducting the affairs of a company such that there is fairness to all stakeholders and that its actions benefit the greatest number of stakeholders. It is about openness, integrity and accountability. What legislation can and should do is to lay down a common framework – the “form” to ensure standards. The “substance” will ultimately determine the credibility and integrity of the process. Substance is inexorably linked to the mindset and ethical standards of management ”. Thus, top management orientation plays an important role in driving the convergence of corporate governance and sustainability.

9 Visser (2022) in his recent book emphasises on 10Rs or Returns/business benefits of thriving/sustainability. These are—powerful purpose, improved recruitment, reputation, research and development effort, better resource efficiency and regulation, higher revenues, returns and lower risk and above all building of resilience.

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Setting Environment Targets and Linking with Planetary Thresholds Environmental targets are the short-term goals set in response to growing necessity as well as awareness for sustainability initiatives. Many corporations across the globe have set their climate action/environmental targets as they are on their way to achieve overall corporate environmental performance. For instance, Mahindra Group, an Indian multinational conglomerate with its presence in more than 100 countries, is committed to achieving carbon neutrality targets by 2040 through Science Based Target Initiatives (SBTi). Furthermore, Mahindra is the first Indian company to announce an internal carbon price of USD 10 per ton of carbon emitted. However, an important concern raised recently (by Haffar & Searcy, 2018) is that corporate environmental targets are delinked to planetary thresholds. Haffar and Searcy (2018) found that the majority of corporations, even sustainability leaders, set their environmental targets based on an organisation-centric sustainability approach. As a result, the contributions of an entity’s sustainability efforts toward key environmental thresholds10 remain unaccounted for. Thus, they call for a more resilience-based approach to sustainability targetsetting. The resilience-based approach to sustainability target-setting is the one in which corporate environmental targets are connected (quantitatively or qualitatively) to the planetary thresholds identified by the planetary boundaries (PB) framework.11 Against this backdrop, we would like to mention that we need to push an increasing number of corporates (specifically top management) towards setting their environmental targets and encourage them to link their environmental contributions to planetary thresholds. Thus, setting environmental targets and linking with planetary thresholds would act as a driver for the convergence of sustainability aspects in all business strategies and processes that can be achieved only with good corporate governance.

10 Environmental threshold is a point beyond which if in case the ecosystem passes, it cannot recover to its original state. 11 The nine planetary boundaries concept was given by a group of international researchers led by Johan Rockström of the Stockholm Resilience Centre in 2009. Available at: https://www.stockholmresilience.org/research/planetary-boundaries/the-nine-pla netary-boundaries.html.

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A Strong Commitment to Responsible Business Conduct (RBC) Since corporates operate within a specific legal, institutional and economic context, any attempt to build a corporate culture of embedding principles of sustainability in the long-term direction of the firm needs to be tailored to these legal, institutional and economic contexts. However, legal and regulatory restrictions may at times vary depending on the size and sector in which the firm operates. Nevertheless, the sustainability guidelines are applicable to large and small businesses alike, operating in any sector on the notion that those who do not follow these guidelines would neither be viable nor socially relevant in the long run. Furthermore, they may lose out on multiple future business opportunities. International bodies and governments across the globe in an attempt to provide for the legal and institutional contexts in which corporates operate have focused on various corporate governance reforms based on the principle of responsible business conduct (RBC)12 incorporating ESG criteria.13 For instance, in March 2019, the Ministry of Corporate Affairs (MCA), Government of India, improvised the existing National Voluntary Guidelines on Social, Environmental and Economic Responsibilities of Business, 2011 (NVGs) and released ‘National Guidelines for Responsible Business Conduct’ (NGRBCs) (GOI, 2018). NGRBCs were based on the United Nations Guiding Principles on Business & Human Rights (UNGPs) and had been aligned to UN sustainable development goals (SDGs), which provided a means of pushing businesses to contribute towards wider development goals and be more sustainable, responsible and accountable. The NGRBCs not only kept with global developments on RBC but also provided an updated Business Responsibility Reporting Framework (BRRF).

12 As per the OECD Guidelines (2017), responsible business conduct (RBC) means that “business should a) make a positive contribution to economic, environmental and social progress with a view to achieving sustainable development and b) should avoid and address adverse impacts through their own activities and seek to prevent or mitigate adverse impacts directly linked to their operations, products or services by a business relationship”. See: https://mneguidelines.oecd.org/RBC-for-Institutional-Investors.pdf. 13 As per the OECD Guidelines (2017), “Environmental, Social and Governance” (ESG) criteria is a set of criteria for a company’s operations that socially conscious investors use to screen investments ”. See: https://mneguidelines.oecd.org/RBC-for-Institutional-Investors. pdf.

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The release of the guidelines is indeed a positive step, but implementing them and embedding them in corporate culture is the next step, which requires coordinated efforts on the one hand and political commitment along with that of the top management of entities on the other. Thus, a strong commitment to RBC would act as a driver for the convergence of sustainability aspects in all business strategies and processes that can be achieved only with good corporate governance. Aligning Corporate Sustainability Strategies with the Government’s Action Plan/Commitments Notably, the convergence of corporate governance with sustainability implicitly requires the alignment of corporate sustainability strategies with the respective government’s commitments. Corporates in India should also pay close attention to the Government of India’s commitment14 to reducing the emissions intensity of its gross domestic product by 45 percent (from 2005 level) and achieving 50 percent electric power from nonfossil fuel-based energy by 2030. Furthermore, India’s long-term strategy launched at the Conference of Parties (COP27) in November 2022 calls for achieving net zero emissions by 2070. This would require a sectoral approach, especially for emission-intensive sectors, such as transport, industries, and construction. The United Nations Environment Programme (UNEP)15 provides six sector solutions to climate crises. Against this backdrop, it is important that corporates draw lessons from such international actions/developments16 and work towards the realisation of the commitments made by the government, which would further 14 See: https://pib.gov.in/PressReleaseIframePage.aspx?PRID=1847812. 15 United Nations Environment Programme (UNEP) six sector solutions to climate

crises. See: https://www.unep.org/interactive/six-sector-solution-climate-change/. 16 One of the most important and recent sustainability-related topic in European corporate governance today is the proposed Corporate Sustainability Due Diligence Directive (CSDDD). This directive will cover the companies (their own operations and that of subsidiaries, and their value chains) with more than 500 employees and global turnover over e150 million. The large companies have to get their action plan ready to show that their strategy aligns perfectly with the goals of the Paris Climate Agreement. In addition, the company directors have to ensure on mandatory basis that their decisions consider human rights, climate change and the environment (see Hobbs, 2023).

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act as a driver for the convergence of sustainability aspects in all business strategies and processes that can be achieved only with good corporate governance.

7.4 Impediments for the Convergence of Corporate Governance and Sustainability Having discussed the drivers of the convergence of corporate governance into sustainability, it will be highly appropriate if we try to identify the potential roadblocks/impediments that can obstruct the shift toward this goal. Tackling these barriers will definitely push corporates towards embedding sustainability in strategic direction and implementation. Let us take a brief account of these probable impediments. Lack of Harmonisation of Sustainability Reporting Standards Various international bodies, namely, the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB), the International Integrated Reporting Council (IIRC),17 the European Commission and the International Financial Reporting Standards (IFRS) Foundation, have provided standards and guidelines for sustainability reporting and disclosures. Distinct standards and norms for sustainability reporting and disclosures are applicable to firms that operate in multiple economies. Henceforth, a particular firm operating across nations or listed across borders abides by multiple standards and norms. This leads to the preparation of multiple reports by a single firm, adding to high costs and much administrative work. In addition, lack of comparability between reports across firms and countries is another issue. It further adds to confusion for the stakeholders, as they often find it difficult to understand that they should count on which report out of the multiple reports available. Chapter 6 of the book discusses various challenges in sustainability reporting, one of which is the nonstandardisation of sustainability reporting standards. A reduction in variations across standards, that is, harmonisation of sustainability standards and norms, would enable

17 The Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC) have merged to become the Value Reporting Foundation (VRF) in 2021.

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various economies to apply a single set of high-quality global sustainability standards and avoid the problems mentioned above. In addition to avoiding the abovementioned problems, the harmonisation of sustainability reporting standards would push the building of sustainability culture within corporates, which would further push them to become more sustainable and increase their sustainability performance. However, this calls for restructuring of the governance structures (that determine sustainability action and disclosure policies) with a special focus on changing the mindset so that sustainability becomes everyone’s responsibility and a part and parcel of day-to-day decision-making processes in business entities. Thus, harmonisation of sustainability standards once achieved would reduce the roadblock towards the desired convergence of corporate governance and sustainability. In 2020, major international bodies, namely, the Carbon Disclosure Project (CDP), the Climate Disclosure Standards Board (CDSB), the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB), announced a statement of intent18 to work together to harmonise alternative reporting standards and create a comprehensive corporate reporting system. The intent is worth appreciation; however, the achievement of this goal seems to be far from reality given that these international bodies work for their own objectives and often seek to maintain their own influence and relevance in the international arena (Afolabi et al., 2022). As a result, harmonisation of alternative reporting methodologies seemingly is not that easy to achieve. The respective governments, policy makers and regulators will have to first decide the standards/ rules for sustainability reporting and disclosures and then subsequently take specific measures for their implementation and monitoring across all businesses and entities to obtain some positive outcomes in this direction. Inadequate Investment Horizon of Corporate Owners Another major obstacle for corporates to embed sustainability in their strategic planning and investment decisions is the inadequate investment horizon of corporate owners. Some owners have short-term investment

18 See: https://www.integratedreporting.org/resource/statement-of-intent-to-work-tog ether-towards-comprehensive-corporate-reporting/.

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horizons, while others have long-term investment horizons. Unfortunately, top management continually faces pressure from short-term investors to generate strong financial results over a short-term period (may be two years) with an indifference towards the firm’s sustainability practices. A recent study by Kavadis and Thomsen (2023) found that corporate owners who invest with a long-term investment horizon act as an enabler (though it is not a sufficient condition) for corporate sustainability. Barton et al. (2017) have proven that corporates with strong fundamentals and superior financial performance are able to resist pressures from short-term investors and could create long-term value for their businesses. Undeniably, embedding a sustainability culture calls for a long-term approach that prioritises tapping into long-term value-creating opportunities via increased investment activities and rewards for human capital. Thus, owners need to have their investment horizons reasonably long-term to embed a sustainability culture within the organisation. Likewise, corporates with good corporate governance systems, strong fundamentals and superior financial performance would be able to resist pressures from short-term investors and increase the sustainability performance of their businesses. Therefore, the inadequate investment horizons of corporate owners and the inability of some firms to resist pressures from short-term investors are impediments to inculcating sustainability aspects in all business strategies and processes that can be achieved only with good corporate governance. This point also highlights the need to generate sustainability consciousness/awareness among all, including short-term investors. Lack of Sustainability Risk Anticipation It is widely acknowledged now that the increased importance assigned to building organisational resilience during the post-COVID period by policy makers, industrialists, researchers and society would lead to the realisation of global sustainable development goals. Rai et al. (2021) considered three aspects of organisational resilience, namely, crisis anticipation, organisational robustness and recoverability. They found that predicting crises and disruptions and building robustness and recoverability positively impact social and economic performance. In this context, we will like to point out the enormous risk posed by climate change (Elijido-Ten, 2017), which also constitutes a major challenge for sustainability performance. Any delay on the part of the

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organisation to understand the cascading impacts of climate change first and engage on a path of prudent action and orderly adaptation subsequently is indeed a hindrance to desired sustainability performance. We will like to mention here that corporate responsibility for managing climate risk as a long-term, material financial risk has gained much attention, especially with the release of guidelines for voluntary climate-centred financial disclosures by the Task Force on Climate-Related Financial Disclosures (TCFD). As per the Sustainability Trends Report (ERM, 2022), the TCFD is the most widely accepted climate risk disclosure framework as of October 2021. A firm’s commitment to minimising climate change risk (along with other social and environmental risks) and exploration of climate change opportunities would come from top management, which is in turn a sign of strong governance (especially corporate governance) mechanisms in place. Thus, once corporates anticipate sustainability risks and manage them while preparing their business strategies and processes, we can achieve the desired convergence of sustainability and corporate governance. Presence of Distinct Corporate Governance Systems In Chapter 1 of this book, we have discussed the presence of two distinct corporate governance systems across the globe, namely, insider and outsider systems of corporate governance. Such an existence is mainly because firms vary in their ownership structures. Some firms may be state owned, others may be family owned and still others may have dispersed or concentrated shareholdings. The owners and corporate leaders of all entities, irrespective of whether they belong to the insider system of corporate governance or the outsider system of corporate governance, have to just change their mindsets and move towards chalking out sustainable business strategies that can enhance the economic, social and environmental value of firms and enable them to contribute to the sustainable growth agenda. We believe that the argument of distinct corporate governance systems, acting as a hurdle on the path of convergence of corporate governance with sustainability, does not hold much ground. However, we anticipate that in time to come, the convergence of corporate governance and sustainability might also lead to the convergence between different corporate governance systems existing across the globe (Salvioni & Gennari, 2016).

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Limited Emphasis on Green Finance We have discussed in this chapter at the outset the importance of contractual convergence whereby firms can push their value chain partners to adopt sustainable business practices or they may prefer entering into contracts with only and only those who adopt sustainable business practices. These choices by firms can facilitate the embedding of sustainability culture across value chain entities. In this context, we will specifically like to give the crucial role green finance can play in the convergence of corporate governance and sustainability. However, the lack of such green practices acts as a hurdle on the path of convergence. As per the RBI Bulletin (2021), information asymmetry and lack of coordination among stakeholders act as hindrances to green deals. We believe that corporate governance players (the caretaker boards) of increasingly more businesses will have to improve their management information systems and stay focused both on green capital allocation and key business metrics (sustainability performance). This will help them contribute towards greener and sustainable long-term economic growth.19 Lack of Diversity, Equity and Inclusion (DEI) Approach Diversity, equity, and inclusion (DEI) implies inclusive policies and programs within a firm that promotes the representation and participation of all individuals (with diverse backgrounds, skills, experiences and expertise) as a business culture and policy. Diversity at the workplace helps the firm to better understand the needs, behaviour and customs of people within and outside the organisation and makes a workplace more inclusive. For instance, the firm may better understand its customers and hence design such products and services that best meet their needs and expectations. Furthermore, with a diversified workforce, an entity can 19 The World Investment Report 2021 (UNCTAD, 2021) projected an increase in growth in foreign direct investment (FDI) by five to ten percent year on year in 2021 in East and Southeast Asia. India attracted the highest total FDI inflow of US$ 81.72 billion during the 2020–2021 financial year, which was 10% higher than the last financial year 2019–2020 (US$ 74.39 billion). Accordingly, the World Investment Report 2022 (UNCTAD, 2022) ranked India eighth among the world’s major FDI recipients in 2020, up from ninth in 2019. These investments have been coming into India because of the government’s supportive policy framework (RBI Bulletin, 2021) which have improved public awareness for investing in green projects and increased availability of green financing options (which include new financial institutions and instruments for green finance).

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better understand the real impact (both positive and negative) of its activities and operations on the surroundings and the communities. Equity ensures that everyone has equal opportunity to participate, speak up and give suggestions in corporate sustainability initiatives and efforts. This encourages employees to support and work towards the entity’s goals. DEI comes within the “S” of ESG, that is, social sustainability, which is often generally ignored due to difficulties associated with identifying and applying measurable social metrics. However, social sustainability calls to keep people first and provide equal access to distinct people present in all domains, which would contribute to building an all-inclusive, equitable and sustainable culture and work environment. It also includes human capital management, which places emphasis on people within the organisation. Ishak et al. (2010) found that firms that can better manage human capital via knowledge management generate superior sustainability performance. Likewise, the scope of DEI and sustainability actually overlap, which can be achieved via strong corporate governance structures. In response to growing demand from employees for DEI commitments (Weitzner, 2022), business leaders worldwide have started paying increasing attention to changing organisational culture and work environments that adopt more equitable and inclusive policies and programmes. However, implementing such changes (DEI policies/programmes) might sound simple and very easy, but actually speaking, ‘overturing of embedded conditioning and mind sets’ is too difficult and acts as an impediment to the convergence of corporate governance with sustainability. Therefore, it is essential that the corporate governance structure of the firm should be such that the top management, i.e., corporate leaders, should be inclusive leaders who can manage diversity and promote equity. As a result, the support and participation of employees in the successful integration of sustainability into business strategies would increase, and their creativity and innovativeness would be enhanced. Inadequate Mechanisms and Frameworks for Fixing Business Accountability Presently, there are several risks (e.g., climate change risk or technology risk) faced by businesses. Addressing these risks requires their identification and mechanisms and frameworks for fixing business accountability. Since the relationship between corporates and sustainability-related issues (such as reporting on greenhouse gas emissions or measuring social

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impacts) is complicated, it becomes difficult to fix business responsibility in the wake of inadequate mechanisms and frameworks. Let us take up the example of businesses and the climate change risk they are exposed to. It is understood that business-driven economic activity is responsible for most greenhouse gas emissions. The historic decision of the 27th Conference of the Parties to the United Nations Framework Convention on Climate Change (COP27) in Egypt conveys this message very clearly that the business will be held accountable for its contribution to climate change and therefore must gear up their efforts to change their current course and collaborate at different levels (with governments, funding agencies, etc.) to ensure a transition to avoid climate disasters and to ensure climate equity and justice. Therefore, corporates must plan and take action to avoid any future climate disasters. For this purpose, corporates have to think about the processes to quantify carbon emissions to maintain their climate accountability and honour their climate commitments. However, one of the biggest challenges on this path is the lack of one standard and reliable framework for tracking and tracing emissions, which makes the whole carbon accounting system ‘inconsistent, incomplete and not transparent’ and the whole process “unreliable” and “siloed”, as noted by Amy Luers, Global sustainability lead at Microsoft (Magyar, 2022; Secon, 2022). Therefore, these gaps, once closed on an urgent basis, would push the convergence of sustainability aspects in all business strategies and processes that can be achieved only with sustainability leadership.

7.5

The Way Forward

From the foregoing, it is clear that the larger goal of convergence of corporate governance and sustainability can be achieved only when firms are good governed and stay committed to ESG. Only a good governed firm can showcase its commitment to the other two pillars, namely, E and S, of ESG. Business entities will have to focus on strengthening six key elements of good corporate governance, viz. structure and functioning of the board of directors, compliance, transparency and disclosures, rights of minority shareholders and governance of stakeholders engagements to move towards implementing best CG practices IFC (2019). It is good CG that will make a firm commit to ESG goals as well. The formalisation of

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sustainability policies and procedures and the appointment of ESG champions (see Fig. 7.3) will follow provided that good CG is ensured first by the firm/entity. Indeed, the role of companies and CG in accelerating the transition to a climate-neutral, fairer and more sustainable world is crucial. However, ensuring run-through towards a good governed firm is not possible in a short period of time. In fact, it is a continuous process. Practically, the firm will have to gradually start moving from step 1 to step 4 (as shown in Fig. 7.4). This will enable a firm to strengthen its corporate governance practices over time and reach the desired level of “corporate governance leadership”. Step 1 of the figure relates to compliance with all legal and regulatory requirements/frameworks by the firm. However, to reach step 4, firms need to initiate steps to improve corporate governance rules that are applicable to specific financial markets and organisational forms. Rules that relate to control rights and cash flow rights within a firm. Step 2 is followed by Step 3, which calls for adopting

Fig. 7.3 Six key elements of good corporate governance and commitment to ESG (Source Reproduced from IFC [2019])

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Fig. 7.4 The four levels of corporate governance (Source Based on IFC [2019])

advanced corporate governance systems wherein there is no expropriation of minorities or/and conflicts of interest. Movement in this direction will always result in multiple benefits, such as increased performance and operational efficiency, better access to capital markets, and building/ improving the firm’s reputation (IFC, 2019), to name a few, which would act as signals of the firm’s commitment to ESG.

7.6

Conclusions

The present chapter underlined that the convergence of corporate governance with sustainability is critical because companies and their good governance can play an instrumental role in accelerating the transition

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to climate-neutral, fairer and more sustainable economies and world. The chapter highlighted drivers of and impediments to the convergence of corporate governance and sustainability. Practically speaking, there will be forces that will push businesses towards such convergence, and on the contrary, there will be forces that will impede such convergence. In this chapter, we have presented these forces as drivers of convergence and impediments to convergence. The final outcome would be determined by the relative strength of two forces working in the opposite direction. If drivers of convergence outweigh the impediments, we may witness at least some degree of convergence and vice versa. It is this convergence that will bring the desired contribution of corporates towards building resilient, sustainable and inclusive economies. Such a convergence would maximise the positive contributions of an entity to society, improve its relationship with stakeholders and create more enterprise value by identifying opportunities and mitigating sustainability risks. It is quite obvious from this study that boards and sustainability/ regenerative leaders can play a vital role in accelerating the transition to a more sustainable economy by ensuring that their companies well understand the impact of their activities and operations on the world around them and take society and the environment into account in decisionmaking. Governance roles cannot be fulfilled effectively unless boards educate themselves on sustainability and understand their obligations well. Indeed, concrete efforts are required to generate awareness regarding sustainability challenges arising out of climate change, equality issues, and other major social and environmental concerns. There is a need to mobilise entities and their supply chain partners to make commitments towards various Sustainable Development Goals (SDGs). This will happen by introducing relevant corporate sustainability strategies and policies to prevent, end or mitigate the adverse impacts of their activities on the environment or even on human rights. As corporate boards are at the helm of the affairs of the entity and act as agents of trustees and managing partners, it is essential that they are made to own up their responsibilities and understand their accountability amidst new and evolving challenges. Herein lies the role of regulatory compliance. Governments worldwide (including the Government of India) and regulatory bodies delve into pragmatic strategies to address the myriad challenges that emanate from sustainability. The monitoring and implementation of the action plan becomes even more important. Although there are certain provisions in

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the existing laws in the case of India20 to monitor corporate boards, there is a need to provide adequate institutional capacity to further strengthen the corporate governance regime in the country. Although significant progress has been made in provisioning disclosures on sustainable practices by entities (including those related to employee wellbeing, employee safety and welfare, and stakeholder engagement, among others), many more initiatives are required in this direction. It is important to note that the mandatory disclosures21 required under the present Business Responsibility and Sustainability Report (BRSR) format by the market regulator, the Securities and Exchange Board of India (SEBI), are to be followed in letter and spirit and not to be taken lightly. This is high time that the policy actions taken by the government and the regulator are complemented by the activist behaviour of all stakeholders (especially shareholders) to improve the sustainability performance of firms, which has consequences for the overall sustainable growth of the country. Boards need to be challenged by aware stakeholders by

20 Although the directors could be held liable for corporate actions both under civil liability and criminal liability in various existing laws in case of India such as Companies Act, 2013; Goods and Services Tax (GST) Act, 2017; Labour laws; Foreign Exchange Management Act (FEMA), 1999; Insolvency and Bankruptcy Code (IBC), 2016; among others. For example, under the Companies Act, 2013, yet the maximum fine for every officer in default is just Rs. 2 lakh. At times, such penalties (and prosecutions) seem woefully insufficient to act as a deterrent. 21 SEBI has mandated preparation of Business Responsibility and Sustainability Report (BRSR) for top 1000 listed entities by market capitalisation. For example, for the disclosure “Statement by director responsible for the business responsibility report, highlighting ESG related challenges, targets and achievements ”, it is seen that corporates generally consider such disclosures as mere a mandatory requirement to be met in letter and do not follow the spirit behind it. SEBI Circular available at: https://www.sebi.gov.in/legal/circulars/may-2021/business-responsibility-andsustainability-reporting-by-listed-entities_50096.html.

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posing questions on their preparedness to deal with existing and potential sustainability risks. It is heartening to note that shareholder activism22 is picking up in India,23 but there is a long way to go. The policy actions taken thus far in India seem to be appropriate at the present juncture, but there is a need to develop one standard and reliable framework (in tune with international standards) in every sector to be followed by corporate entities. Going forward, one standard framework applicable to all entities in different sectors (under SDGs) is a progressive option that can help address several challenges on sustainability paths. Last, it has been very rightly observed that “development interventions that are responsive to the cultural context and the particularities of a place and community, and advance a human-centred approach to development, are most effective, and likely to yield sustainable, inclusive and equitable outcomes. Acknowledging and promoting respect for cultural diversity within a human right-based approach can facilitate intercultural dialogue, prevent conflicts and protect the rights of marginalised groups within and between nations, thus creating optimal conditions for achieving development goals. Culture, understood this way, makes development more sustainable” (UNESCO, 2012).

22 Kansil and Singh (2016) explored shareholder activism, in terms of, votes exercised for, against or abstain by mutual fund Asset Management Companies (AMC) in India and suggested that increase in participation/activism on the part of AMC’s would act as a corrective mechanism for ensuring good corporate governance practices and enhancing shareholder value. This is justified by the fact that the sizeable investments of AMC’s in the Indian corporates can be a significant force in maintaining good corporate governance as they have both the expertise and resources to act as activists. 23 A recent case in point is that of expression of ire against the company by the shareholders of Dish TV. The shareholders in extraordinary general meeting held in June 2022 rejected the resolution to reappoint the existing managing director and the appointment of certain other directors. Later, in December 2022, shareholders again rejected the proposal for the adoption of audited standalone and consolidated financial statements for two financial years, i.e., 2021 and 2022. Recently, in March 2023, shareholders rejected the candidature of four independent directors. See: https://www. business-standard.com/article/companies/dish-tv-shareholders-reject-adoption-of-fy21fy22-balance-sheets-in-agm-122123000645-1.html and https://www.livemint.com/com panies/news/dish-tv-not-appointing-govt-okayed-directors-11677694332797.html.

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Index

A Agency costs, 9 Agency problem horizontal, 16, 37 majority shareholders–minority shareholders, 16 shareholders–managers, 15 type 1, 15 type 2, 16 vertical, 15 Agency theory, 14 Anglo-Saxon model, 20 Approval-based regime, 34 Audit Committee, 133

B Bankruptcy theory, 16 Behavioral approach, 4 Bloomberg Environment, Social and Governance (ESG) Score, 72 Bombay Stock Exchange (BSE), 67 Business Responsibility and Sustainability Report (BRSR), 49

Business Responsibility Reports (BRR), 45 C Cambridge Sustainability Leadership Model, 187 Carbon Disclosure Project (CDP), 149 Centre for Monitoring the Indian Economy (CMIE), 67 Clause 49 of the Listing Agreement, 40 Climate Disclosure Standards Board (CDSB), 150 Companies Bill 2008, 43 Compensation Committee, 133 Confederation of Indian Industry (CII), 38 Constituent of BSE 100 ESG Index (ConBSE100), 166 Convergence, 183 contractual, 184 drivers of, 185 functional, 184

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Singapore Pte Ltd. 2023 S. Joshi and R. Kansil, Looking at and Beyond Corporate Governance in India, https://doi.org/10.1007/978-981-99-3401-0

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212

INDEX

impediments for, 195 Corporate governance (CG), 4 and country governance, 60 channels of, 56 Kotak Committee on, 48 Kumar Mangalam Birla Committee, 33 models of, 17 practices, 3 structures, 55 system, 3 Voluntary Guidelines 2009, 43 Corporate Governance Index (CGI), 72, 99 Corporate sustainability actors, 124

D Decision process, 9 Descriptive angle, 128 Development agents, 135 Director, definition of, 5 Disclosure-based regime, 34 Diversity, equity, and inclusion (DEI), 199 Dynamic endogeneity, 167

E Ease of doing business parameters, 103 Economic, environmental and social (EES), 191 Endogenous growth theories, 92 Environmental, social and governance (ESG), 46 Environmental targets, 192 Environmental thresholds, 192 Environment Social and Governance Score (ESG Score), 163 Exogenous growth theory, 92

F Family-based model, 23 Family-owned firms, 24 Feasible generalized least squares (FGLS), 69 Financial distress, 59 Financial performance, 143 Firm performance, 56 Fixed-effect model, 68 Foreign Promoter Shareholdings (FP), 64 Friedmanite notion of the firm, 134

G Generalised method of moments (GMM), 167 level estimator, 167 system estimator, 167 German model, 22 Global Reporting Initiative (GRI), 145 Governance for sustainability, 134 Governance Matters, 93 Governance score, 97 Granger causality analysis, 74 Green washing, 159 Gross domestic product (GDP), 72 Growth-enhancing governance, 77

H Harmonisation, lack of, 195 Heatmap approach, 131

I Inclusive leaders, 200 Indian Promoter Shareholdings (IP), 64 Information asymmetry, 147 Inside-outwards approach, 157 Insider system, 18

INDEX

Instrumental angle, 128 Instrumental logic, 128 Integrated ownership, 8 Integrated Reporting (IR), 149 Integrative approach, 126 Integrative logic, 128 International Financial Reporting Standards (IFRS) Foundation, 183 Investment Development Path (IDP), 95 Investor Education and Protection Fund (IEPF), 39 Investor protection, 56 ISO 26000, 150

J Japanese model, 21 J. J. Irani Committee, 42

213

Multivariate Granger causality analysis, 100

N Naresh Chandra Committee on Corporate Audit and Governance, 41 National Foundation for Corporate Governance (NFCG), 42 National Guidelines for Responsible Business Conduct (NGRBCs), 49 National Voluntary Guidelines (NVGs), 45, 46 New Economic Policy of 1991, 91 Nomination and Governance Committee, 133 Normative angle, 128 Normative approach, 4 Not a fixed state of harmony, 125 N. R. Narayana Murthy Committee, 42

K Key governance issues (KGIs), 54

L Legitimacy theory, 146

M Manager, definition of, 5 Managerial expropriation of shareholder value, 9 Managerial hegemony theory, 14 Managing Agents Model, 35 Market-enhancing governance, 77 Market valuations, 59 Ministry of Corporate Affairs (MCA), 39 Multicollinearity, 68 Multigovernance theories, 15

O One-tier board, 38 Outside-inwards approach, 157 Outsider system, 17 Ownership concentration, 62, 162 Ownership structure, 36, 62, 162 Ownership structure theory, 15

P Panel data regression, 68 Paradox approach, 126 Partial reporting, 159 Planetary thresholds, 192 Political, economic, sociocultural, technical, legal, and environmental (PESTLE), 131 Pooled OLS, 70

214

INDEX

Primary stakeholder group, 58, 122 Promoter, definition of, 63

Q Quality of governance, 53

R Random effects model, 70 Reporting boundary, 156 Resource dependency theory, 14 Responsible Business Conduct (RBC), 45 Return on Assets (ROA), 64 Revised Clause 49, 43 Risk Committee, 133

S S&P BSE 100 ESG Index, 163 S&P BSE 500 index, 164 Science Based Target Initiatives (SBTi), 192 Secondary stakeholder group, 58, 122 Securities and Exchange Board of India (SEBI), 38 Listing Obligations and Disclosure Requirements (SEBI LODR) Regulations, 2015, 47 Separation of ownership and control, 8 Shareholder activism, 206 Signaling theory, 147 Stakeholder business cases for sustainability, 136 Stakeholder engagement, 129 Stakeholder-oriented ethics, 114 Stakeholders, 116, 122 Stakeholder theory, 14, 146 Stakeholder value creation model, 36 Stewardship theory, 14

Strengths, weaknesses, opportunities and threats (SWOT) analysis, 131 Sustainability, 113 culture, 197 leadership, 185 performance, 120, 143 reporting, 120, 144 risks, 130 Sustainability Accounting Standards Board (SASB), 149 Sustainable Development Goals (SDGs), 204

T Task Force on Climate-Related Financial Disclosures (TCFD), 150 Taskforce on Nature-related Financial Disclosures (TNFD), 151 TCFD 2022 Status Report, 173 Top management, 130 Trade-off approach, 126 Traditional enterprises, 90 Triple bottom-line (TBL), 46, 160 27th Conference of the Parties, 201 Type 2 agency theory, 123

U Unidirectional models, 167 United Nations Global Compact (UNGC), 148 United Nations Guiding Principles on Business & Human Rights (UNGPs), 49 UN Sustainable Development Agenda 2030, 145

V Value chain partners, 159

INDEX

Value creators, 120 Vector autoregressive model (VAR), 74, 100 Voluntary Guidelines on Corporate Social Responsibility (CSR), 45

215

W Win–win approach, 126 World Economic Forum (WEF), 148 World Investment Report 2022, 199