Paper 4 to 5 page length

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MNC Subsidiaries vs Domestic Firms

Pankaj M. Madhani

Key Words : Corporate governance, Disclosure, Clause 49, MNC subsidiaries, Globalization, Domestic firms

A b s t r a c t

Dr. Pankaj M. Madhani Associate Professor ICFAI Business School (IBS) IBS House, Near Science City, Ahmedabad – 380060, Gujarat. Email: [email protected] Mobile No: 9662122075

irms having multinational presence such as subsid - iaries of Multinational Corporations (MNCs) have their parent firm in other country, have operations in

more than one country and may also be listed in the host country. Such subsidiaries of MNCs are influenced by the parent firm in home country to a great extent. As such, host country has domestic firms originated and listed in the host country as well as MNC subsidiaries, operated and listed in the same legal institutional environment. As the regulatory environment in the host country is the same for both groups i.e. domestic firms and subsidiaries of MNCs, it is possible that subsidiaries of MNCs internalise some aspects of disclosure practices of their parent company.

MNCs subsidiaries operate across different countries with different corporate governance regimes, which will often deviate from corporate governance practices in the MNC home country. MNCs have to thus manage multiple economic, legal, political and cultural environments externally as well as complex networks of knowledge and

This research examines the impact of foreign-ownership on the corporate governance and disclosure policies of firms. MNCs operate across

different countries with different corporate governance regimes, which will often deviate from corporate governance practices in the home

country of MNCs. Thus MNCs have to manage multiple economic, legal, political and cultural environments. This paper aims to analyze

difference in corporate governance and disclosure practices among firms owned by foreign owner (MNC subsidiaries) and local owner

(domestic firms). These research findings suggest that subsidiaries of MNCs are no better in disclosure practices than domestic Indian firms.

A b s t r a c t

F

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resource flows internally (Volkmar, 2003). The question is whether firms with foreign ownerships have better behavior in their disclosure policies compared to domestic firms. Hence, this research intends to investigate empirically whether MNC subsidiaries have better corporate governance and disclosure policies compared to domestic firms listed in India.Using firms across different sectors listed in Bombay Stock Exchange (BSE), this research study aims to analyze difference in corporate governance and disclosure practices among firms owned by foreign owner (MNC subsidiaries) and local owner (domestic firms). The findings can shed light on the governance and disclosure practices of MNC subsidiaries and domestic firms, in legal institutional environment of India.

Corporate Transparency and Disclosure: Key Drivers Good practices of corporate governance are now documented in most country codes. These codes commonly stress the need for transparency in financial and non- financial disclosures, due board processes and information systems, compliance with legal and regulatory requirements, accountability to various stakeholders, among others (Baxi, 2005). Corporate transparency plays crucial role in reducing the information asymmetry between firms and their stakeholders (Durnev et al., 2009). It also allows stakeholders to monitor performance and contractual commitment of firms (Bushman and Smith, 2001). Hence, market regulators enact numerous rules and codes to ensure timely and accurate disclosure of information by listed firms. As such corporate transparency refers to the disclosure of firm specific information to outside constituents of the firm and is an integral part of corporate governance practices.

Disclosure may be considered the foundation of any system of corporate governance (Cadbury, 1999). Prior research has shown specific benefits that encourage voluntary disclosure of information through better corporate governance. These benefits translate into a reduction of the information asymmetry problems as a result of the separation of ownership and control of firms (Lev, 1992). Also, firms that opt to disclose information beyond the standard requirements reap benefits such as reductions in capital and debt costs, greater analysts’ cover or an increase in the liquidity of company securities (Glosten and Milgrom, 1985).

Disclosure of timely, accurate, and relevant information, thus, enables shareholder to evaluate the management’s performance by observing, how efficiently the management is utilizing the firm’s resources in the interest of the principal.

Corporate governance is not just about the process but it is also about the way firms are held accountable mainly via “financial reporting.” Corporate governance have significantly focused on the relationship between the management of firm and the Board of Directors particularly on separating these two functions for effective professional management and hence may lead to greater transparency. The Board members usually may not get enough time and the management of the firm has to manage the day-to-day affairs. So the role of corporate governance becomes even more pertinent. The Cadbury Report (1992) recommends the Board of Directors to pay a great attention to the highest level of disclosure. As shown in model of Figure 1, lack of accountability of the Board of Directors and inadequate or minimal information flow to the shareholders result in weak controls.

Figure 1: Corporate Governance System

(Source: Model developed by author based on Montgomery and Kaufman, 2003)

On the one hand, financial reporting constitutes an important element of the corporate governance system. In fact, some failures of corporate governance may be reduced by an adequate financial reporting system. On the other hand, some problems of the financial reporting system find their origin in deficiencies of the system of corporate governance (Whittington, 1993).

The effective financial reporting may play a key role improving the soundness of the corporate governance system. One of the key functions of the financial reporting system is to limit top management’s discretion, and hence constraining top management to act in the shareholders’

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interest (Jensen and Meckling, 1976; Watts and Zimmerman, 1978), or, broadly speaking in a wider perspective, in the interest of all the strategic corporate stakeholders. However, it should also be noted that the quality of information produced by the financial reporting system is fundamental for a corporate governance system to be effective. Disclosure is one of the fundamental goals of the financial reporting system. Transparency is the timely and adequate disclosure of the performance of the company and its corporate governance practices related to its ownership, board, management structure, and processes. A system of corporate governance needs a good level of disclosure and an adequate information to eliminate (or at least reduce) information asymmetries between all parties, making corporate insiders accountable for their actions.

According to Baek et al. (2009) “all the relevant information should be made available to the users in a cost-effective and timely way.” Annual reports are published by firms as a medium for communicating both quantitative and qualitative corporate information to shareholders, potential shareholders (investors) and other users (Whittington, 1993). Although, such publication of an annual report is a statutory requirement, firms normally voluntarily disclose information in excess of the mandatory requirements. Hence, annual reports are important documents for assessing and analyzing the company performance in regard to corporate governance and disclosure standard/standards as well as compliance. Communication of corporate disclosure via annual reports is a very important aspect of corporate governance in the sense that meaningful and adequate disclosure enhances good corporate governance (Bhasin and Reddy, 2011).

Literature Review

Corporate governance is defined as an institutional arrangement that not only addresses the agency problem between shareholders and managers of the firm, but also provides the context for the decisions taken by the top management of the firm. In this context, the fundamental objective of a corporate governance framework is to identify a basis for strategic co-operation between shareholders and managers of the firm such that the agency problem is reduced and a basis for decisions that promote the competitiveness of the firm is provided (Sinha, 2006). As La Porta et al.(1998) argue, good corporate governance is needed for better access to external financing at lower cost. Good corporate

governance is a key driver of sustainable corporate growth and long-term competitive advantage (Madhani, 2007). Firms, across the globe, recognize that there are economic benefits to be gained from a well-managed disclosure policy. This shows that firms in need of a good deal of external financing, such as rapidly growing firms, have an incentive to improve their disclosure and corporate governance.

A detailed and structured system of disclosure enables investors to understand, and obtain accurate and reliable information of companies in order to make better investment decisions (Ho et al., 2008). Some research studies have shown that with increased corporate disclosure, firms experience a reduction in cost of equity capital (Botosan and Plumlee, 2002), as well as, the cost of debt (Sengupta, 1998). Similarly, Healy et al. (1999) found a beneficial increase in the firm’s stock liquidity and performance. Moreover, information disclosure in itself is a strategic tool, which enhances a company’s ability to raise capital at the lowest possible cost (Lev, 1992).

Several studies examine Indian corporate governance generally. Khanna (2008) reviews the development of corporate governance norms in India beginning from independence era. World Bank (2005), Sarkar and Sarkar (2000), and Mohanty (2003) examine how firm-level governance influences the behaviour of institutional investors, or vice-versa. Mohanty (2003) finds that institutional investors own a higher percentage of the shares of better-governed Indian firms. This is consistent with research in other countries (Aggarwal et al., 2005; Ferreira and Matos, 2008). Bhattacharyya and Rao (2004) examine whether adoption of Clause 49 (an important set of governance reforms in India) predicts lower volatility and returns for large Indian firms. Black and Khanna (2007) conduct an event study of the adoption of Clause 49 and report positive returns to a treatment group of large firms (who were required to comply quickly) relative to small firms (for whom compliance was delayed). Implementation of Clause 49 in India was done in staggered manner, with large firms (included in “Group A” on the BSE) required to comply first, followed by medium-sized firms and then small firms.

Prior to the adoption of Clause 49, India was considered a laggard in corporate governance practices. From 1947 (independence) through 1991, the Indian government pursued socialist policies. The government nationalized most banks, and became the principal provider of both debt and

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equity capital for private firms. The performance of the government agencies who provided capital to private firms was measured, based on the amount of capital disbursed rather than return on capital investment. This policy created little incentive for managers of private firms to voluntarily adopt good governance practices. Hence, during this period (1947-1991), corporate governance practices in India, which were considered to be comparable to that of British firms at independence, considerably deteriorated. In the year 1992, the Securities and Exchange Board of India (SEBI) - India’s securities market regulator was formed. By the mid-1990s, the Indian economy was growing steadily, and Indian firms began to seek capital from variety of sources to finance expansion into the global market spaces created by liberalization and the growth of outsourcing (Black and Khanna, 2007).

The need for capital by Indian firms, amongst other things, led to corporate governance reforms. The first major step in this area was setting up of the Confederations of Indian Industry (CII) Code for Desirable Corporate Governance in 1998 (Sanan, 2011). The code published in April 1998 comprised seventeen recommendations. A year later, in May 1999, SEBI announced the formation of the Kumar Mangalam Birla committee, which was tasked with proposing corporate governance reforms. These reforms became ‘Clause 49’ so named because they were implemented through a new Clause 49, which was added to stock exchange listing requirements. Clause 49 has both mandatory as well as voluntary provisions. Mandatory provisions relate to board composition, audit committees, board procedures, management discussion and analysis in the annual reports, certification of financial statements and internal controls, and corporate governance reporting. The adoption of Clause 49 was viewed as a turning point in Indian corporate governance (Black and Khanna, 2007). Dharmapala and Khanna (2013) report that small Indian firms which are subject to Clause 49 react positively to plans by SEBI to enforce the Clause 49, relative to similar firms not subject to Clause 49.

There is an expanding literature that examines whether a country’s legal and judicial institutions affect disclosures practices across countries (Jaggiand Low, 2000). Bushman et al.(2004) studied corporate transparency across 45 countries and found substantial differences in corporate disclosure practices that arose from a country’s legal as well as judicial regime. Researchers such as Hope (2003b), and Francis et al.(2005) also found that country-level institutional factors matter in explaining disclosure levels.

Khanna et al.(2004) pointed out that customers require financial information to evaluate a foreign firm’s long-term viability, and suppliers use financial statements in evaluating a foreign firm’s creditworthiness. Likewise, employees or prospective employees can use disclosures in assessing employment opportunities with a foreign firm. These arguments are supported by Bowen et al.(1995) who argue that implicit contracts can affect a firm’s accounting practices. Given the unfamiliarity of firms when they enter foreign labour, product or capital markets first time, MNCs have incentives to provide additional information in order to establish and maintain a reputation. This can reduce costs associated with these relational contracts in the long-run.

MNCs are seen as amongst the world’s most powerful types of organizations as they account for a large share of intellectual property rights (IPRs), are big employers and contribute to the economic development of the foreign countries where they operate (Williams, 2009). Despite some research interest among scholars in the corporate governance and disclosure practices of MNCs (Strange and Jackson, 2008), comparisons between MNCs subsidiaries and domestic firms on corporate governance and disclosure practices have received very little attention. A MNC subsidiary is defined as a local affiliate of a MNC located in a foreign country of which the parent company holds majority ownership in promoters’ holding. (Bouquet and Birkinshaw, 2008).

MNCs subsidiaries face additional complexities and challenges in corporate governance and disclosure practices due to the diversity of corporate governance rules, regulations and stakeholder expectations in the various host countries in which they operate (Luo, 2005). Some studies have examined the differences in corporate disclosure practices between MNC corporate headquarters and domestic firms (Krigger, 1988; Lekseland Lindgren, 1982). However, very few studies have examined the differences between MNC subsidiaries and domestic firms in their corporate governance and disclosure practices in a host country (Cahan et al.,2005; Duru and Reeb, 2002).

Pattnaik and Gray (2012) found that subsidiaries of MNCs were more transparent and disclose more than domestic listed Indian firms. Their time frame of the study was before implementation of Clause 49. However, no study was conducted in India regarding corporate governance and disclosure practices of MNC subsidiaries and domestic firms listed in India after implementation of Clause 49. Hence, this

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research fills this gap and compares corporate governance and disclosure practices of MNC subsidiaries and domestic firms listed in BSE for the sample firms across various sectors in year 2011-2012.

Development of Hypothesis

MNCs Subsidiaries and Domestic Firms

Subsidiaries of MNCs operating in developing countries are expected to have higher standard of corporate governance and disclose more information and observe better reporting practices for the various reasons explained below:

1) As they have to comply with the regulations of not only their host country but also those of the parent country or home country, where accounting practices and standards of reporting are substantially higher.

2) Usually, these firms are equipped with more advanced accounting software tools and packages, efficient audit staff, competent and efficient accounting and support staff, and better management practices. The variety of information collected by the parent firms i.e. MNCs, along with their better reporting systems can result in the increase of voluntary disclosures. Hence, they have the potential to disclose more information without any incremental processing costs on disclosures (Choi and Mueller, 1996).

3) These firms are under closer scrutiny of various political and pressure groups within the host country, as they view them as sources of economic exploitation and agents of imperialist power (Kamran and Nicholls, 1994). Hence, such firms have an incentive to disclose more information in order to avert any pressure for excessive control for exploitation (Srinivasan, 2008).

4) International agencies like the Organization for Economic Cooperation and Development (OECD) and others frequently monitor and evaluate the MNCs because of their importance in the global trade. Subsidiaries of MNCs have been frequently accused of tax evasion and other practices like transfer pricing which may end up paying high political costs.

5) MNCs have two related levels of corporate governance structures – one at headquarters and other at subsidiary levels. In the case of MNCs with subsidiaries listed on local stock exchanges in different host countries, those subsidiaries need to simultaneously conform to the host country’s legal requirements as well governance practices of the MNC in home country (Kiel et al., 2006). Therefore, MNC subsidiaries face dual pressures, from the demand of the host country environment where they are operated and also from corporate headquarters of parent MNC in home country (Rosenzweig and Singh, 1991).

In recent years, there has been a greater interest in applying institutional theory to the study of MNCs (Westney, 2005), especially to identify and study factors influencing MNC subsidiary practices in different host country institutional environments (Kostova and Roth, 2002; Tempel et al., 2006). Prior empirical research has found that institutional pressures created by legal environment develop an institutional context within which firms make decisions regarding what to disclose and how (Crawford and Williams, 2010).

Institutional theory can also be linked to legitimacy theory, as their combined view could provide a better explanation of disclosure practices of MNC subsidiaries. The application of legitimacy theory to MNCs has been studied in detail by many researchers (Dacin et al., 2008; Kostova and Zaheer, 1999). They assert that a MNC subsidiary has to gain dual legitimacy and as such is in a state of institutional duality.

MNCs as a parent firm pressurize their subsidiaries internally to adopt their organizational practices which are transferred to it from their parent firm in home country. Externally the host country institutional environment pressurizes MNC subsidiaries to adopt local organizational practices. Hence, MNCs subsidiary has to decide which institutional pressures are more important; internal pressures that would enable it to become legitimate within the working environment of MNCs or the external pressures that would enable it to gain external legitimacy within the legal environment of the host country. In contrast, domestic firms need to confirm only to the demands of their domestic rules, regulations and stakeholder expectations (Alpay et al., 2005).

To study the extent of disclosure by MNC subsidiaries in comparison to their parent firms would require a separate study. Major emphasis of such study will be to analyse

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levels of disclosure by MNC subsidiaries in the host country and compare it with disclosure practices of their parent firm or MNCs in their home country. However, such investigation is beyond the scope of this research. Hence, this study focuses on corporate governance and disclosure practices of MNC subsidiaries and domestic firms listed only in India to understand such difference in their practices.

Testable Hypothesis

This research study seeks to examine how MNC subsidiaries and domestic firms differ in corporate governance and disclosure practices. As MNCs conduct their global business in multiple institutional environments that require different disclosure rules, they may maintain higher disclosure standards and disclose more information than domestic firms. Thus, based on this argument, following null hypothesis is proposed:

H01: There are no differences in corporate governance and disclosure practices of MNC subsidiaries and domestic firms listed only in India.

Corporate Transparency and Disclosure by Firms:An Indirect Measurement Approach

Equity analysts play role of intermediaries between firms and the financial market and serve as transparency enhancing mechanism in market. Analyst forecasts are more accurate and less dispersed for firms with more open disclosure policies (Lang and Lundholm, 1996). Equity analysts collect information about a firm, evaluate its current performance and make future forecasts about the firm. Forecast error captures analysts’ forecast accuracy and is calculated as the absolute value of the difference between actual earnings per share (EPS) and the median analyst forecast of EPS. Forecast dispersion among group of analysts can be calculated as the standard deviation of analysts’ forecast of EPS.

The accuracy and dispersion of analysts’ forecast depend on, and reflect the extent to which firms disclose information in the markets (Healy and Palepu, 2001). Prior research have demonstrated that corporate disclosure is positively linked to analysts’ forecast accuracy and negatively to the dispersion among analysts covering a given firm in their forecasts (Bhat et al.,2006). Ashbaugh and Pincus (2001) find that analysts’ forecast accuracy is higher after firms adopt International Accounting Standards (IAS), and Hope

(2003a) finds that analysts’ forecast accuracy improves when firm-level disclosure increases. Leuz and Verrecchia (2000) find that German firms switching to US Generally Accepted Accounting Principles (US GAAP) reporting have lower information asymmetry than firms that continue to report under German GAAP, which is a lower disclosure-reporting regime.

Pattnaik and Gray (2012) used the measure of corporate transparency based on the characteristics of equity analysts’ forecast behaviour and conclude that voluntary disclosure is negatively related to analyst forecast errors. Analyst forecast error and forecast dispersion were used by researchers as proxies for corporate disclosure and transparency. However, it is subjective measure of corporate disclosure practices as analysts’ subjective opinions could be influenced by firm performance. Hence, this research study uses an alternate approach of direct method of calculating corporate governance and disclosure practices of firms as described below in research design and methodology section.

Research Design and Methodology Objective of the Study

1. To measure overall corporate governance and disclosure practices of MNC subsidiaries and domestic firms with the help of an appropriate instrument as an evaluation tool.

2. To know that to what extent subsidiaries of MNCs and domestic firms disclosed through their annual reports by measuring Corporate Governance and Disclosure (CGD) scores of sample firms.

Scope of the Study This study will help us to understand that whether MNC subsidiaries have better corporate governance and disclosure practices compared to domestic firms in Indian context. As it is perceived that MNC subsidiaries have more incentives to disclose information compared to domestic firms.

Sources of Data For the purpose of study, data of the sample firms collected from the annual reports of the same for the financial year 2011-12 (for the period ending March 2012 or December 2012 based on the firms’ financial year) have been downloaded from the CMIE PROWESS database (Version 4.14).

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Sampling Technique Applied

Stratified sampling was used for obtaining data of firms listed in Bombay Stock Exchange (BSE) and is constituent of S&P BSE sectoral indices.

Sampling and Data Collection

The sample for the study was collected from the firms listed in BSE in the form of S&P BSE sector indices. Sectoral indices at BSE aim to represent minimum of 90% of the free- float market capitalization for sectoral firms from the universe of S&P BSE 500 index. This sector index consists of the firms classified in that particular sector of the BSE 500 index. From these sectors, banking sector (Bankex) was eliminated as the disclosure requirements for these firms are specialized and regulated by other regulatory authorities. Likewise, realty sector was also not considered because of specific

issues of governance. Hence, remaining all nine sectors from S&P BSE sectoral indices were studied for this research. In each of these sectors, top six firms as per market capitalization are selected for sample. Out of sample size of 54 firms, the sample consists of nine public sector firms (16.67%), 13 MNC subsidiaries (24%) and others with dominant Indian ownership (59.25%). Hence, sample represents 41 domestic firms and 13 MNC subsidiaries.

The sample firms represent different sectors viz.: Auto (11.1%), Metal (11.1%), Oil & Gas (11.1%), Consumer Durables (11.1%), Capital Goods (11.1%), FMCG (11.1%), Health Care (11.1%), IT (11.1%), and Power (11.1%). As shown below in Table 1, these 54 firms selected from 9 different sectors represent 91% of overall sectoral index weight. Hence, these samples of 54 firms truly represent selected 9 sectors.

Sr. No.

S&P BSE Sectoral Indices No. of Firms

Studied

Weight in Index

(Per Cent) 1 S&P BSE Auto 6 89 2 S&P BSE Capital Goods 6 94 3 S&P BSE Consumer Durables 6 90 4 S&P BSE Healthcare 6 88 5 S&P BSE IT 6 95 6 S&P BSE Metal 6 82 7 S&P BSE Oil & Gas 6 94 8 S&P BSE Power 6 97 9 S&P BSE FMCG 6 91

Total Sample Size 54 91

Table 1: Weight of Sample Firms in their respective Sectoral Indices

(Source: Calculated by Author form BSE Web Site)

The Research Instrument: Direct Measurement of Corporate Governance Disclosure Score

A review of the existing literature is undertaken to explore the methodology used for measuring corporate governance and disclosure practices of firms. Prior research studies on disclosure have been broadly classified as those on disclosure indices, event studies and specific disclosure analysis. Researchers have used various methods of computing disclosure score for determining the level of disclosures. The disclosure index provides a reasonable method for measuring the overall disclosure quality of a firm.

Prior research in this area has made extensive use of such index methodology as a research tool (Marston and Shrives, 1991). Index method involves the development of an extensive list of disclosure items, which are expected to be relevant to the users of information. The methodology adopted for computing the disclosure score can be of two types; use of the externally developed disclosure index used in relevant prior research or to have a self-constructed disclosure index for the specific research.

Most prior international studies have used the transparency and disclosure index developed by Standard & Poor (S&P) or the Center for International Financial Analysis and

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Research (CIFAR) scores. Many cross-country studies used externally developed measures of total disclosures, e.g., Hope (2003b) used CIFAR ratings and Khanna et al. (2004) used S&P’s transparency and disclosure scores. Such externally developed indexes have the advantage of being objective and comprehensive; however, they also have disadvantages (Bushee, 2004; Francis et al., 2008). These externally developed indexes capture total disclosures that include both mandatory and voluntary disclosures. Further, externally developed indexes offer lower construct validity since they were not exclusively developed with a specific research context in mind, and they can restrict the researcher to non representative samples that may be motivated by commercial interests of the organization that prepared the index.

Bushee (2004) notes that the bigger payoffs for future researchers will probably come to those who construct their own index and also use hand-collected data. This research study uses a voluntary disclosure index based on Subramanian and Reddy (2012) and hand-collect governance and disclosure data for sample of 54 firms. The instrument developed by Subramanian and Reddy (2012) is given at Annexure - I. They developed a new instrument to measure corporate governance and disclosure practices of firms, considering only voluntary disclosures in the Indian context. Although, this instrument is based on S&P methodology, it overcomes the limitations of the S&P instrument regarding non segregation of voluntary and mandatory disclosures.

This approach allows us to isolate voluntary disclosures and provides more powerful tests of firm-specific corporate governance and disclosure incentives and hence, complements prior studies that use broad-based, externally developed disclosure indexes. According to Clause 49 of listing agreement of Indian stock exchanges, firms have to mandatory disclose, corporate governance practices as per the guidelines stipulated in Clause 49. It is now binding for the Indian listed firms to file with SEBI the corporate governance compliance report along with the financial statements. Hence, there was need to develop a methodology for measuring voluntary corporate governance disclosure practices as mandatory disclosure is already taken care of by Clause 49 of listing agreement.

Subramanian and Reddy (2012) focused also on the quality of practices and not just the disclosure of certain practices by firms. On the basis of the S&P instrument, the instrument

also classifies corporate governance-related disclosures under two categories: ownership structure and investor relations (ownership), and board and management structure and process (board). The final instrument had 67 items: 19 questions in the ownership disclosure category and 48 in the board disclosure category. In the latter, the questions in the instrument were not just about the disclosure of board practices, but also about the quality of board practices. For example, the S&P instrument just quizzes whether or not the attendance details of board members are disclosed, whereas this instrument checks whether an attendance at board meetings of at least 60% is maintained. Thus, the scores of board practices (maximum score: 48) from this instrument indicate not just the disclosure of board practices, but also the level of adoption of best board practices by firms.

Disclosures to the market participants can be made by firms through annual reports, quarterly reports and continuous disclosures to the stock exchanges. In this study, content analysis was used and only the annual report information is used for calculating CGD score of firms. The annual reports of the selected 54 sample firms were carefully examined for the financial year 2011-12. Hence, to arrive at the overall disclosure score for each category, i.e. ownership and board, annual reports of each firm under study was scrutinized for the presence of specific items under the above mentioned categories. One point is awarded when information on an item is disclosed and zero otherwise. All items in the instrument were given equal weight, and the scores thus arrived at (for each category), with a higher score indicating greater disclosure. Final corporate governance and disclosure score (Maximum: 67) for each firm was calculated by adding overall score received in ownership (Maximum: 19) as well as board category (Maximum: 48).

Data Analysis and Interpretation

For the purpose of this study, the firms have been taken from nine different sectors for making meaningful comparison of MNC subsidiaries and domestic firms. The reason behind this classification is to find out the extent of disclosure in MNC subsidiaries and domestic firms. The CGD score of firms was calculated by thoroughly scrutinizing annual report of sample of firms with the help of instrument developed by Subramanian and Reddy (2012).Out of sample of 54 firms, 13 firms are MNC subsidiaries;while remaining 41 firms are domestic firms. Out of pool of domestic firms, 15 firms are cross-listed, some on

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more than one non-Indian exchange.Similarly, out of pool of MNC subsidiaries, three firms are cross-listed. All these cross-listed firms are excluded from our sample. Hence, in

Table 3, below shows sector and CGD score for MNC Subsidiaries.

Table 3 : MNC SubsidiariesListed in India and Overseas: Sector and Listing Details

the research sample of 36 firms listed only in India finally we have sample of 10 MNC subsidiaries and 26 domestic firms(Table 2).

Table 2: MNC subsidiaries and Domestic firms Listed only India according to Sectors

Sr. No. Sector MNC

Subsidiaries Domestic Firms

1 Power - 4 2 Oil & Gas 1 4 3 Metal - 3 4 Health Care 1 2 5 FMCG 3 1 6 IT 1 3 7 Consumer Durables - 5 8 Capital Goods 2 2 9 Auto 2 2

Total 10 26

(Source: Calculated by author from Annual Report of Firms)

Sr. No.

Company Sector Overseas Listing

CGD Score

Mean CGD Score

1 Oracle Financial Services Software

IT - 20 20

2 ABB Capital Goods - 22 25

3 Siemens Capital Goods - 28

4 Sterlite Industries (India) Metal US 30 30

5 Maruti Suzuki Auto - 19 16

6 Cummins India Auto - 13

7 Cairn India Oil & Gas - 30 30

8 Hindustan Unilever FMCG - 33

21.339 Colgate-Palmolive (India) FMCG - 15

10 Nestle India FMCG - 16

11 GlaxoSmithKline Pharmaceuticals

Health Care - 20

18.6712 Ranbaxy Health Care Europe 22

13 Cipla Health Care Europe 14

Overall Sector CGD Score 23

(Source: Computed by author from company annual reports by applying Research Instrument)

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Table 4, below shows key statisticsof CGD score for MNC subsidiaries.

Table 4 : MNC Subsidiaries:Key Sector and Statistics

Sr. No.

Sector No. of Firms

CGD Score Mean CGD Score

Std. Deviation

CV* (%)Min. Max. Range

1 Capital Goods 2 22 28 6 25 4.24 16.97

2 Auto 2 13 19 6 16 4.24 26.52

3 FMCG 3 15 33 18 21.33 10.12 47.42

4 Health Care 3 14 22 8 18.67 4.16 22.30

5 Oil & Gas 1 30 30 0 30 - -

6 Metal 1 30 30 0 30 - -

7 IT 1 20 20 0 20 - -

Overall 13 13 33 20 21.69 6.65 30.66

*CV = Coefficient of Variation

As MNC subsidiaries such as Sterlite, Ranbaxy and Cipla are cross-listed (Table 3),they are excluded from our study.

Table 5: MNC Subsidiaries Listed only in India: Key Sector and Statistics

Table 5, below shows key statisticsof CGD score for MNC subsidiaries listed only in India.

Sr. No.

Sector No. of Firms

CGD Score Mean CGD score

Std. Deviation

CV* (%)

Min. Max. Range

1 IT 1 20 20 0 20 - -

2 Oil & Gas 1 30 30 0 30 - -

3 Auto 2 13 19 6 16 4.24 26.51

4 Capital Goods 2 22 28 6 25 4.24 16.97

5 FMCG 3 15 33 18 21.33 10.11 47.41

6 Health Care 1 20 20 0 20 - - Overall 10 13 33 20 22.06 6.69 30.96

*CV = Coefficient of Variation

(Source: Calculated by author)

Table 6 below shows sector and CGD score for domestic firms listed in India and overseas. As 15 domestic firms are

(Source: Calculated by author)

cross-listed they are excluded from our study. Hence, out of 41 domestic firms we have now 26 domestic firms listed only in India.

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Table 6: Domestic Firms Listed in India and Overseas: Sector and Listing Details

Sr. No.

Company Sector Listing CGD score

Mean CGD Score

1 Infosys IT US 37 42

2 Wipro IT US 47 3 Dr. Reddy Health Care US 40 40 4 Reliance Industries Oil & Gas Europe 34 34 5 ITC FMCG Europe 41

32.5 6 United Spirits FMCG Europe 24 7 Mahindra & Mahindra Auto Europe 30

328 Tata Motors Auto US & Europe

34

9 Reliance Infrastructure Power Europe 30 29.5

10 Tata Power Power Europe 29 11 L & T Capital Goods Europe 31

27 12 Crompton Greaves Capital Goods Europe 23 13 Hindalco Metal Europe 20

26 14 Tata Steel Metal Europe 32 15 Videocon Consumer

Durables Europe 18 18

Overall 31.33

Table 7, below shows sector and CGD score for domestic firms listed only in India.

Table 7: Domestic Firms Listed only in India: Key Sector and CGD Score

(Source: Computed by author from company annual reports by applying Research Instrument)

Sr. No.

Company Sector CGD score

Mean CGD score

1 HCL IT 34

29.332 TCS IT 33

3 Mahindra Satyam IT 21

4 Bajaj Auto Auto 24 23

5 Hero Moto Corp Auto 22

6 Pipavav Defence Capital Goods 21 22.5

7 BHEL Capital Goods 24

8 ONGC Oil & Gas 31

25.75 9 IOC Oil & Gas 28

10 GAIL Oil & Gas 20

11 Bharat Petroleum Oil & Gas 24

12 NTPC Power 28

27.25 13 Reliance Power Power 27

14 NHPC Power 29

15 Power Grid Power 25

16 Lupin Health Care 24 23.5

17 Glenmark Health Care 23

PTO

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18 Coal India Metal 24

25.3319 Jindal Steel & Power Metal 17

20 JSW Steel Metal 35

21 Godrej FMCG 36 36

22 Titan Consumer Durables 26

20

23 TTK Prestige Consumer Durables 15

24 Gitanjali Gems Consumer Durables 24

25 Rajesh Exports Consumer Durables 15

26 Bluestar Consumer Durables 20

Overall Sector CGD Score 25.85

Table 8, below shows key statistics of CGD score for domestic firms listed only in India.

Table 8: Domestic Firms Listed only in India: Key Statistics

Source: Computed by author from company annual reports by applying Research Instrument)

Sr. No.

Sector No. of Firms

CGD Score Mean CGD

score Std.

Deviation CV* (%)Min. Max. Range

1 IT 3 21 34 13 29.33 7.23 24.66

2 Power 4 25 29 4 27.25 1.71 6.27

3 Oil & Gas 4 20 31 11 25.75 4.79 18.59

4 Auto 2 22 24 2 23 1.41 6.15

5 Capital Goods 2 21 24 3 22.50 2.12 9.43

6 Metal 3 17 35 18 25.33 9.07 35.82

7 FMCG 1 36 36 0 36 - -

8 Consumer Durables 5 15 26 11 20 5.05 25.25

9 Health Care 2 23 24 1 23.50 0.71 3.01

Overall 26 15 36 21 25 5.68 22.71

(Source: Calculated by author)*CV = Coefficient of Variation

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Table 9, below shows key statistics of CGD score for MNC subsidiaries and domestic firms according to listing status, i.e. listed only in India or cross-listed.

Table 9: MNC Subsidiaries and Domestic Firms Listing: Key Statistics

Sr. No.

Listing Status No. of Firms

CGD Score Mean CGD score

Std. Deviation

CV* (%)Min. Max. Range

1 MNC Subsidiaries

13 13 33 20 21.69 6.65 30.66

(a) India & Overseas (Cross-listed)

3 14 16 6 22 8 38.36

(b) India only 10 13 33 20 21.60 6.69 30.96

2 Domestic Firms 41 15 47 32 27.32 7.22 26.44

(a) India & Overseas (Cross-listed)

15 18 47 29 31.33 8.01 25.58

(b) India only 26 15 36 21 25 5.68 22.71

Overall 54 13 47 34 25.96 7.44 28.64

Research Procedures for Testing Hypothesis

This research conducted an inferential statistical analysis for testing the hypothesis. In order to test the significant differences in the CGD scores of MNC subsidiaries and domestic firms, parametric t-test was used.

Summary of Findings and Empirical Results

A detailed analysis of the CGD score for sample firms is presented in Table 10. Values of minimum, maximum, mean

*CV = Coefficient of Variation (Source: Calculated by author)

and standard deviation of CGD score for MNC subsidiaries and domestic firms have also been reflected. Results show that there is a difference between mean and standard deviation of CGD score for MNC subsidiaries and domestic firms. Analysis of the result shown in Table 10 indicates that mean of CGD score is higher for domestic firms at 25. Also, the standard deviation of CGD score is higher at 6.68 for MNC subsidiaries when compared to domestic firms in the sample.

Table 10: Descriptive Statistics of Dependent Variable – CGD Score

No. of Firms

Minimum CGD Score

Maximum CGD Score

Mean CGD Score

Std. Deviation

All Firms Listed only in India

36 13 36 24.05 6.07

MNC Subsidiaries

10 13 33 21.6 6.68

Domestic Firms

26 15 36 25 5.67

Source: Computed by author from company annual reports by applying Research Instrument

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The hypotheses have been tested using the univariate t-test. Group statistics and independent sample test output is given in Table 11 and Table 12 respectively.

Table 11: Group Statistics for MNC Subsidiaries and Domestic Firms Listed Only in India

Group Statistics

Firms Listed in India

No. of Firms

Mean Std.

Deviation Std. Error

Mean

CGD Score

MNC Subsidiaries

10 21.6000 6.68664 2.11450

Domestic Firms

26 25.0000 5.67803 1.11355

Table 12: Independent Samples Test

CGD Score

Levene's Test for

Equality of Variances

t-test for Equality of Means

F Sig. t df Sig. (2- tailed)

Mean Difference

Std. Error

Difference

95% Confidence Interval of the Difference

Lower Upper Equal variances assumed

.505 .482 -1.533 34 .135 -3.40000 2.21835 -7.90823 1.10823

Equal variances not assumed

-1.423 14.289 .176 -3.40000 2.38979 -8.51590 1.71590

Table 13, shows result of univariate test.

Table 13: Results of Univariate Test

Null Hypothesis t -

Value Significance

Level No significant difference between corporate governance and disclosure scores of MNC subsidiaries and domestic firms listed only in India

1.533 .135

Results of parametric test, as indicated in Table 13, show that significance value p is greater than 0.05, therefore at 5% level of significance; null hypothesis of equality of means fails to be rejected. Thus, there exists no significant difference between the CGD scores of MNC subsidiaries and domestic firms. As such there is no statistical significant difference between corporate governance and disclosure practices of MNC subsidiaries and domestic firms listed only in India.

Analysis and Findings

Global presence of MNC and its subsidiaries create a demand for voluntary disclosure by such firms because MNC subsidiaries are likely to have greater information asymmetry as a result of their greater scope and complexity. Such effect will be larger for firms based in countries with weak legal environments than for firms based in countries with strong legal institutional environments. Hence, it is expected that

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the subsidiaries of MNCs will provide more disclosures as a result of weak legal environment at host country. Accordingly, MNC subsidiaries are expected to have higher disclosure level compared to domestic firms in India.

Pattnaik and Gray (2012) found evidence for such hypothesis and empirically proved that subsidiaries of MNCs were more transparent and disclosed more information than domestic listed Indian firms. They used data of Indian firms listed in BSE from 1995 to 2003 and used indirect method of disclosure measurement. During period of their research study (1995-2003), host country legal environment in India was not strong, as during this period corporate governance and disclosure rules were weak in comparison to developed countries. As their study period ends in 2003, after which the Clause 49 of listing agreement was made mandatory by SEBI, their study period reflects weak period of corporate governance in India. After 2003, corporate governance and disclosure practices of Indian firms improved to great extent as Clause 49 of listing agreement was announced in October 2004 with its implementation in staggered manner by 2005. After adoption of Clause 49 and its enforcement by SEBI, corporate governance and disclosure practices of domestic firms enhanced considerably. This research found support for this and empirically proved that there is no statistical significant difference between corporate governance and disclosure practices of MNC subsidiaries and domestic firms listed in India.

In conclusion this study contributes to several areas of research:

1. This research studies whether the interaction between globalization and the legal environment of the country affects voluntary disclosure practices of MNC subsidiaries.

2. This research adds to the emerging literature that uses country-level institutional features, such as legal origin to explain cross-country differences in governance and disclosure practices.

3. This research examines how practices of MNC subsidiaries’ disclosures are affected by the legal environment of host country where it’s listed when compared to domestic firms.

4. This research contributes to the growing literature on globalization, MNCs as well as India specific research.

Limitations of Study

The focus of corporate governance and disclosure study in this research has been on corporate annual reports which are only a part of the information set. However, as mentioned earlier the use of annual reports is widely accepted in prior research. Key consideration of content analysis with hand- collected disclosure data is that because the process is time intensive, sample sizes are often small. For example, Botosan (1997) uses hand-collected data for a sample of 122 manufacturing firms, and Guo et al.(2004) use hand-collected data for a sample of 49 biotech firms.Although sample size for this research is not too big, it fairly represents sectoral indices of BSE. Lastly as this study analyses data of sample firms for the financial year 2011-12 only, future study may be conducted with multiple year panel data.

Conclusions

In this research study, the corporate governance and disclosure practices of subsidiaries of MNCs as well as domestic firms listed in BSE were measured by doing content analysis of annual report of sample firms. Prior research suggested that domestic firms were disclosing less information compared to MNC subsidiaries in India. However, this research finding suggests that in Indian context, subsidiaries of MNCs are no more transparent than domestic firms. This research also indicates that corporate governance and disclosure practices of subsidiaries of MNCs and domestic firms have converged as there is no statistical significant difference in corporate governance and disclosure practices of MNC subsidiaries and domestic firms listed in India. It is because of improvement in overall corporate governance norms and enforcement by regulatory bodies. SEBI has formulated comprehensive corporate governance rules and regulations. Clause 49 of listing agreement announced by SEBI has considerably enhanced corporate governance and disclosure practices of Indian firms.This research concludes that institutional, legal and regulatory environment of a country has a major role in shaping corporate governance and disclosure practices of MNC subsidiaries as well as domestic firms.

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ANNEXURE – I Instrument for Measuring GCD Score of Sample Firms

Component 1: Board and Management Structure and Process

Sr. No.

Disclosure of:

1

2 3 4

5

6

7 8 9

10

11 12

13

14 15 16 17 18 19 20

21 22 23 24

25

Details about current employment/position of directors provided? Details about previous employment/positions provided? When each of the directors joined the board? Details about whether the chairman is executive or non- executive? Detail about the chairman (other than name and executive status)? Details about the role of the board of directors in the company? Are the dates of board meetings disclosed? Is the aggregate board attendance disclosed for each meeting? Are directors attending over 60 per cent of the board meetings? Are attendance details of individual directors at board meetings disclosed? Do independent directors constitute at least 1/3 of the board? Do independent directors constitute more than 1/2 of the board? Do independent directors constitute more than 2/3 of the board? A list of matters reserved for the board? Is the list of audit committee (AC) members disclosed? Is the majority of AC independent? Is the chairman of the AC independent? Is disclosure made of the basis of selection of AC members? Is the aggregate attendance of AC meetings disclosed? Is the attendance of individual directors at AC meeting disclosed? Does the company have a remuneration committee? Is the list of remuneration committee members? Is the majority of RC independent? Is the remuneration committee chaired by an independent director? Is the frequency of RC meetings disclosed?

Component 2: Board and Management Structure and Process Sr. No.

Disclosure of:

26 27

28 29 30 31 32

Is the aggregate RC meeting attendance disclosed? Is disclosure made of individual members’ attendance in RC meetings? Does the company have a nominating committee? Is the list of members of the nominating committee disclosed? Is the majority of nominating committee independent? Is the frequency of NC meetings disclosed? The existence of a strategy/investment/finance committee?

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30 31 32 33 34

35 36 37 38 39 40 41

42 43 44

45 46 47 48

g Is the majority of nominating committee independent? Is the frequency of NC meetings disclosed? The existence of a strategy/investment/finance committee? The number of shares in the company held by directors? A review of the last board meeting disclosed (for example, minutes)?

Whether they provide director training? The decision-making process of directors’ pay? The specifics on performance-related pay for directors? Is individual performance of board members evaluated? Is appraisal of board performance conducted? The decision making of managers’ (not Board) pay? The specifics of managers’ (not on Board) pay (for example, salary levels and so on)? The forms of managers’ (not on Board) pay? The specifics on performance-related pay for managers? The list of the senior managers (not on the Board of Directors)? The backgrounds of senior managers disclosed? The details of the CEO’s contract disclosed? The number of shares held by the senior managers disclosed? The number of shares held in other affiliated companies by managers?

Component 3: Ownership Structure and Investor Relations Sr. No.

Does the annual report contain?

1 2 3 4 5 6 7

8

9

Top 1 shareholder? Top 3 shareholders? Top 5 shareholders? Top 10 shareholders? Description of share classes provided? Review of shareholders by type? Number and identity of shareholders holding more than 3 per cent? Number and identity of shareholders holding more than 5 per cent? Number and identity of shareholders holding more than 10 per cent?

Component 3: Ownership Structure and Investor Relations Sr. No.

Does the annual report contain?

10 11

12 13

14 15 16

17 18 19

Percentage of cross-ownership? Existence of a Corporate Governance Charter or Code of Best Practice? Corporate Governance Charter/Code of Best Practice itself? Details about its Articles of Association (for example, changes)? Voting rights for each voting or non -voting share? Way the shareholders nominate directors to board? Way shareholders convene an Extraordinary General Meeting (EGM)? Procedure for putting enquiry rights to the board? Procedure for putting proposals at shareholders meetings? Review of last shareholders meeting (for example, minutes)?

(Source: Subramanian and Reddy, 2012)

Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.