Abstract
In their pursuit to garner resources and support for their IPO, the issuing firms prepare well on all fronts. Corporate governance, specifically board structures, is a critical issue that affects the decision quality and also influences the investors’ psyche. Building on theories of agency, resource dependency and signaling, this article attempts to study the effects of presence of foreign directors on firm-specific and board-related characteristics of IPO issuing firms. Adding to the scant literature on national diversity, this study concludes that foreign directors do signal a firm’s intent of internationalization and contribute to strengthening corporate governance but national diversity does not translate into IPO returns. Exploring a sample of Indian IPOs issued from April 2001 to March 2017, this study finds that presence of foreign directors on the boards brings about differences in governance mechanisms wherein internationalized boards were found to be stronger on governance front. Larger boards, more committees, less number of related directors, better board interlocking were the benefits that manifested from presence of foreign board members. Issue size and issue price of shares at the time of IPO are found to be significantly higher for firms with foreign directors on their boards reflecting better acceptance among the investors.
Introduction
As the backwash of corporate scandals that deflated numerous corporate bigwigs globally, corporate governance hogged the attention of academicians and practitioners. Researchers have emphasized on the indispensability of elements of corporate governance to corporate setups and to performance of these corporates measured through different quantitative and qualitative variables. In these deliberations, the monitoring and strategic role of board of directors has been underscored (Campbell & Mínguez-Vera, 2008) and board composition has gained tremendous interest becoming one of the burgeoning areas of research.
Directors play a very critical role in the strategic direction and orientation of the company and in monitoring and controlling to prevent mismanagement (Van den Berghe & Levrau, 2004). Composition and structure of these boards remains an important consideration for the acknowledged benefits derived from diversity (Dang et al., 2013). Diversity brings in distinct competencies, versatile opinions, unique knowledge, and skills which equip better to handle the challenges of external environment and of diverse groups of stakeholders. Board seats in companies are commonly occupied by people with differences on account of task-related (viz. education, functional background, and tenure) or relation-oriented (such as age, gender, nationality) attributes (Jackson, 1996; Pelled, 1996). Diversity would anyway exist rather should exist. Also, denying board seat to certain people on account of differences emanating from characteristics of gender, age, race, or nationality would amount to limiting board decisions to homogeneous source of knowledge, expertise, or opinions and resulting biases in decisions and actions. Social, ethical, and political groups did push for board diversity but with regulatory requirements diversity on boards has assumed all the more significance.
Board diversity, for its inevitability and cost involved, is investigated to comprehend the benefits that accrue and effect on board effectiveness and performance (Adams et al., 2010). Along with other board characteristics, board diversity has been documented to contribute to debt financing and research and development expenditure (Busru et al., 2019) which create the coveted competitive edge for a firm. Board diversity has emerged as a prolific research area where researchers have been trying to investigate the relationship of board diversity (and its various dimensions) to corporate performance and effectiveness in different settings. The lack of consistency in results, distinctly different economic settings calling for different approaches, various dimensions of board dynamics, and variety of performance measures make board diversity a vibrant research area.
In this article, an attempt is made to study the international dimension of the board diversity which is incorporated through foreign directors with respect to Indian IPOs. Contribution of this study is unique and significant in the present internationalization era where the inclusion of foreign directors would enhance the “attitudinal” dimension of internationalization (Ramaswamy & Li, 2001) as contemplated in the works of Perlmutter (1969), Maisonrouge (1983), and Sullivan (1994). IPO presents a distinct setting to explore the board dynamics wherein the company reaches out to the public for the first time with the best where withal and positive signals to garner investor confidence and resources. With the visible shift toward nonfinancial signals where relationship between financial information and equity values is particularly tenuous in the IPO context (Kim & Ritter, 1999) signaling through diverse corporate boards definitely makes research sense. Moreover, the Indians in general tend to look up to the presence and personality of foreigners regarding them as superior which can possibly be attributed to the fact of India being under the British rule for a long time. In the case of an emerging economy with acknowledged global clout, investigation of foreign directors helps comprehend the globalizing tendencies and communicating their internationalization efforts. With this perspective, an effort is made to examine the differences being caused by presence of foreign directors in the issue-specific and governance variables at the time a firm goes public.
The remainder of this article is organized as follows: in “Theoretical Perspectives and Related Literature,” the theoretical bases for inclusion of foreign directors on the boards and in the IPO context are discussed. Related literature on the topic is also presented in the same section. Sample and methodology are presented in “Methodology.” Analysis and interpretations are presented in the next section. The final section concludes the study with limitations of present research effort and future directions for research in this area.
Theoretical Perspectives and Related Literature
National diversity described by the presence of foreign directors on the board of the company is expected to bring in knowledge and expertise of overseas markets and international practices, thus, building the road to international expansion and focus. The traditional agency theory (Berle & Means, 1932; Jensen & Meckling, 1976) serves as the basis for inclusion of foreign directors on the boards. In their capacity as agents of the shareholders (principals), the boards of directors indulge in monitoring and control to check the risks of moral hazards and adverse selection (Daily et al., 2003; Yermack, 1996). Different backgrounds (viz. educational, cultural, professional) of directors from diverse nationalities (heterogeneity in board) contribute to holistic decision-making and sensitization to critical issues and interests of shareholders, thus strengthening their role as monitors.
Resource dependence theory emphasizes on the capability of organizations to secure critical and scarce resources from the environment which contributes to organizational effectiveness (Pfeffer & Salancik, 1978). In times of internationalization of business and increasing global focus, companies with directors having knowledge and experience of foreign markets, different culture, and values can better compete for resources and global visibility.
Signaling theory holds added relevance in the context of IPOs. New issue firms, to enhance the acceptability of their issue among the apprehensive investors, send signals to these investors to indicate firm quality, thereby improving IPO performance (e.g., Beatty, 1989; Carter & Manaster, 1990). Signals related to corporate governance systems are believed to influence the degree of information asymmetry (Becker-Blease & Irani, 2008). Agency and resource dependency theory, which justify the role of board of directors on corporate boards, together with signaling hypothesis which holds ground in context of IPOs support the concept of board diversity and foreign directors for organizational success and efficiency. Unique skills, expertise, and experience which directors from foreign countries bring to the board together with their demographic and relation-oriented attributes also find support from the psychological and ethical theories. Hence, presence of foreign directors on the corporate boards contributes to board dynamics and corporate performance and presents a good case for empirical investigation.
To realize the goals of efficient management and monitoring in companies, board diversity constitutes an important corporate governance mechanism (Boone et al., 2007) largely due to its potential effects on companies’ performance. A number of studies have attempted to analyze board diversity and its contribution in the success of corporate practices and performance (viz. Ali et al., 2014; Anderson et al., 2011; Ben-Amer et al., 2013; Carter et al., 2003, 2008, 2010; Erhardt et al., 2003; Jindal & Jaiswall, 2015). It is not that these works have unequivocally established the positive outcomes of board diversity on performance of companies. There have been contributions, however, which have established the negative association of performance of the corporates with board diversity levels (Eulerich et al., 2014; Kilic, 2015; Ramaswamy & Li, 2001). Earlier contributions pertaining to diversity on boards address primarily the traditional attributes of tenure, education, and functional background (Golden & Zajac, 2001; Goodstein et al., 1994; Westphal & Zajac, 1995) as measures of diversity among board members. It has been largely gender diversity that has been captured to address the issue of board diversity in the light of shockingly low numbers and resulting legal and statutory mandates (Adams & Ferreira, 2009; Campbell & Mínguez-Vera, 2008; Conyon & Mallin, 1997; Haslam et al., 2010; Nekhili & Gatfaoui, 2013; Singh & Vinnicombe, 2004; Singh et al., 2001). The skewed numbers of females in the top echelons of the companies have been the thrust for gender-based diversity studies and the reason for dominance in board diversity studies. With increasing diversity in workforces, marketplaces, and internationalization practices, researchers are exploring the other dimensions of diversity such as race, ethnicity, and nationality (Arfken et al., 2004; Burke, 1997; Carter et al., 2003; Daily et al., 1999; Erhardt et al., 2003; Shrader et al., 1997). With changing times, newer dimensions to diversity have been identified and documented calling for fresh perspectives of research.
International diversity, emerging from different nationalities, is one of the most talked about diversity dimension in present times characterized by globalization and internationalization of business methods, models, and practices.
On the basis of limited available studies on the topic, it is evident that study of nationality as a dimension of diversity on corporate boards is relatively a recent phenomenon, with efforts steaming in the mid and late 1990s. A common measure of national diversity adopted by the researchers has been the proportion of foreign directors on the boards (Kilic, 2015; Peck-Ling et al., 2016; Ramaswamy & Li, 2001; Ramaswamy et al., 2004; Randøy et al., 2006; Ujunwa, 2012; Ujunwa et al., 2012) while some of the studies have also captured this dimension through a dummy variable to indicate the presence and absence of directors of foreign nationality (Estélyi & Nisar, 2016; Masulis et al., 2012; Oxelheim & Randøy, 2003). Eulerich et al. (2014) and Jhunjhunwala and Mishra (2012) indicated the national diversity through an ordinal measure representing the number of different nationalities of members on the boards. Jindal and Jaiswall (2015) in their study of Indian markets adopted the Blau Index and Shannon Index as the measures of national diversity in line with the methodology conventionally adopted in studying diversity in financial literature.
Relationship of foreign directors has been studied with respect to different variables. Working on a sample consisting of all A-share firms of China from 2004 to 2012, Du et al. (2017) documented that foreign directors play a crucial role in deterring earnings management. Complementing the prior literature the study established that foreign directors may be less effective monitors in firms from developed countries, but they help enhance the monitoring in firms from developing countries such as China. Kim (2018) reported that firms hiring foreign directors exhibit better performance which translated into higher value though with diluted reporting quality. However, exploring a sample of listed nonfinancial Nordic firms in four countries, Hooghiemstra et al. (2019) confirmed that the presence of non-Nordic foreign directors on the board is associated with significantly higher levels of earnings management attributing it to language-related factors, as well as the level of foreign board members’ accounting knowledge. Maturo et al. (2019) tried to investigate into the reasons for inconsistency in results pertaining to national board diversity (based on a brief review of important studies in this field) and concluded that the cause of conflicting results is the use of different theories and the implementation of different methodologies in measuring diversity. Swiss markets were studied for national and gender diversity by Ruigrok et al. (2007), finding low number of foreign directors on Swiss boards and most of them to be independent directors. Adding to the literature in their unique way, Miletkov et al. (2017) concluded through their study based on foreign independent directors in US firms that degree of internationalization and firm size continue to be important determinants of having foreign directors. Oxelheim et al. (2013) identified theoretically motivated reasons for the internationalization of boards and concluded that different types of firm internationalization—commercial versus financial—might call for different types of board internationalization. Kang et al. (2019) explored foreign directors as a board attribute with respect to corporate social responsibility in South Korean corporate contexts.
Lack of a comprehensive research effort, however, with focus on enhancing board effectiveness through foreign directors remains the primary motivation of the present study. This new emerging perspective of international diversity through induction of foreign directors provides a lot of room for exploration and hence this study intends to contribute as a preliminary effort in this direction in context of India which stands on the threshold of strengthen its position on global map through new age international strategies.
Methodology
This study aims at understanding the role of foreign nationals on the boards of Indian IPO firms in signaling the quality of issue and difference which brings in the broad parameters of a firm, in terms of board characteristics and firm/issue-specific features. National diversity, which is not studied as a dimension, draws attention as an extension to the upper echelon studies where individual traits and capabilities are forwarded as explanations for quality of decision-making and the resulting corporate performance. Dynamic IPO market of the vibrant Indian economy in the backdrop of growing wave of internationalization lends the unique setting for the conduct of the present study.
Sample
Indian firms that came out with a public issue of equity securities between the time period of April 2001 and March 2017 which listed their issue on the Bombay Stock Exchange (BSE) form the sample of this study. The period April 2001 marked the specification of corporate governance principles through introduction of a new Clause 49 by SEBI ushering in a new era for corporate governance in the country.
Year-wise Details of IPO Firms with Respect to Details of Nationality of Directors
Description of Variables Used in the Study
The withdrawn issues, issues other than equity, further public offerings, rights issues, and the firms for which the issue document, data across governance, or issue variables were not available were excluded in the final sample. The final sample after sifting away firms for the restrictive conditions and ensuring data availability the sample consisted of 626 IPOs. The sample was trimmed further as per the availability of information on the nationality of the directors to meet the objective of this study. The final year-wise sample details are presented in Table 1.
The firms in the final analysis include 360 firms with no foreign directors on their board and 84 firms which have reported presence of nationals of other countries on their boards as directors.
Sources of Data
The primary source of data for data on governance variables has been the issue document, prospectus, as published under the mandate of market regulator SEBI. The prospectus has been procured from the SEBI website (www.sebi.gov.in). For those which were not available on SEBI website, the website of the concerned company was accessed. For calculation of returns, the market prices of securities and respective market returns (SENSEX values) have been extracted from the reliable and accurate database of Ace Equity and BSE website (www.bseindia.com). In addition to these, the information related to firm attributes and issue variables has been collated from Prowess and Capitaline database, the reliable and authenticated sources for data on Indian firms.
Statistical Analysis and Variables of Study
To check for the effect of foreign directors on the governance characteristics and issue/firm-specific variables, the sample is divided on the basis of presence and absence of foreign directors. To check for the differences across the identified variables, t-test is employed. This t-test has been employed after confirming for the normality of data across different variables separately for the two groups: one where foreign directors are present and the other group representing absence of foreign directors. The normality has been established using the Kolmogorov–Smirnov test and additionally with Shapiro–Wilk which demonstrated same results (SPSS 21.0 has been employed). The t-test has been employed for unbalanced sample, where firms with no foreign directors are 360 and those with presence of foreign nationals on board are 84. For robustness of the results, the data were trimmed down (through statistical randomness using IBM SPSS Statistics 21.0 software) to balance the two samples (84 for both the groups) and then t-test was also run on the balanced samples. The results for complete samples have been reported in detail, followed by compilation of results denoting significant variables in unbalanced and balanced samples.
The variables are divided into governance variables that include board-specific and ownership variables and IPO characteristics variables such as age, size, total assets, subscription ratio, and returns of IPO. The details of the variables included for analysis have been presented in Table 2.
The variable of interest, foreign directors also referred to as national diversity, has been measured through the presence or absence of a director with any nationality other than Indian. If the board of any of the sampled IPO firms is reported to have any person who is not an Indian national, it is regarded as firm with presence of foreign directors. Model to be analyzed and explored statistically involves:
Underpricing = f(FD + governance variables + issue variables)
This study aims at investigating the difference in firms brought about by national diversity or foreign directors on the boards of IPO issuing firms. Specifically, the hypotheses for this study are as follows:
H0: There is no difference in IPO issuing firms with and without foreign directors with respect to governance and issue characteristics. H1: There is significant difference among firms with and without foreign directors on account of governance and issue characteristics.
Analysis and Interpretations
Board of directors of the company not only perform the advisory and monitoring roles, but also shape the strategic decisions of the firm. At the time of IPO, when garnering confidence of the investors is as important as garnering resources, the composition of boards plays a pertinent role and so can the presence of foreign nationals on the boards. The foreign directors not just convey the internationalization perspective of the issuing firm but also talk of the human capital and globalized perspectives entering the board room which enable better survival in times of global competition and pursuit for professional excellence. For initial understanding, a look at the descriptive of the complete data represents the firms with reported nationality. The firms which did not mention the nationality of the directors, the variable of interest, have been dropped from the sample.
Descriptive of variables included in this study has been presented in Table 3 which elucidates certain discernable patterns and huge variations across some variables drawing attention to finer details. Indian IPO firms have a mean board size of 7 which goes to a maximum of 20 members on board. This variation in board size is further explored with respect to room for foreign directors. Numbers for independent directors and board committees are primarily governed by regulatory guidelines which mandate minimum numbers on the boards of listed companies. Trends of concentrated ownership are reflected through the statistics pertaining to ownership where high levels are vested in the hands of promoters, and top 10 owners account for almost 91 percent of total shareholding on an average. These characteristics, on the one hand, help to understand the board profile of Indian IPO issuing firms also enable a better understanding of these characteristics in the light of objective of this article. Descriptive characteristics of sample with regards to board size, board committees, related members, ownership variations drive to investigating these differences with respect to foreign directors on these boards.
Descriptive Characteristics of Variables Included in Study
Comparative Results Across Governance Characteristics with Original Sample
With regards to returns of IPOs, positive initial returns are recorded for Indian IPOs on an average which juxtapose well against the heightened activity in Indian IPO markets. Also, initial and market returns demonstrate average positive returns which are akin and highlight the inherent potential of the IPO firms and not merely flying with the market upsurge. Variations in issue price, issue size, age of company, and subscription ratio provide a lead to move ahead in the analysis and investigate the reasons for these differences and if they can be attributed to the variable of interest, i.e., foreign directors. Stringent regulations pertaining to capital markets and keen vigil of the market regulators have succeeded in trimming the time lag in issue close and listing of the issue on stock exchange.
Enormous size of the issue (maximum value being ₹15,475 crores and average value of 294.30 crores) also bears testimony to the increasing faith in the IPO route which can be attributed to Herculean efforts being made by regulators to reinforce faith of investors and ensure safety and returns of their investments.
The initial diagnostics of the data lead to addressing the research objective with respect to foreign directors. On the basis of presence of foreign directors and for comparative analysis, the sample is divided into two parts: those with foreign directors and firms with all domestic board members. Comparisons are drawn on this basis across governance and issue variables to decipher the differences and their significance. To compare groups, t-test has been used after the initial check of normality of data. Kolmogorov–Smirnov test and additionally Shapiro–Wilk tests helped establish the normality of two groups across different variables of study. The results of t-test and comparative numbers have been presented in Table 4.
Comparison of IPO issuing firms with and without foreign directors highlights statistically significant results across governance variables pertaining to board and ownership. All of the variables incorporated to measure corporate governance in these firms which access the capital market for the first time signify that presence of directors across the domestic borders does reflect a significant difference with respect to board characteristics. Presence of international directors on the boards of IPO firms when going public shows a bigger board, higher average board age, larger number of board committees, and larger number of other directorships. With respect to ownership, promoter ownership tends to be diluted to almost 28 percent from an average of 43 percent when no foreign director occupies a board position. Number of block owners, which reflects shareholders with holding of 10 percent or more, is significantly less when foreign directors occupy a board position highlighting less ownership concentration purported to strengthen governance norms.
Comparative analysis of firms with international directors with those which have domestic boards highlights that across all governance parameters foreign directors make significant difference. Presence of foreign directors brings about significant effect which is reflected in the board attributes which contribute to better governance and stronger mechanisms to compete in the marketplace. IPO firms with global board rooms have stronger governance preparedness. Larger and older boards with more board committees, less related members, and directors with higher number of other directorships make room for international directors. It also leads to a premise that presence of foreign directors on the boards of IPO issuing firms makes way for better governance which adds to the financial and governance health of these firms. Extending this comparison to issue characteristics and initial returns, t-test is applied on these characteristics as shown in Table 5.
Comparative Results Across Issue Characteristics with Original Sample
Comparative Results Across Governance Characteristics with Balanced Sample
Firms with foreign directors show higher unadjusted raw returns as well as market-adjusted excess returns. However, the statistical significance of these results is not established leaving room for further analysis. Companies having their issue of larger size and higher subscription ratio make room for foreign directors elucidating that larger and popular firms induct directors from foreign countries on their boards which adds to their acceptability and performance. Higher issue price is fixed by bigger firms with inherent ability to command premium from investors who ride on their strengths and abilities are ready to pay more. Firms with presence of foreign directors have higher issue price in comparison with those with no foreign directors. This significance of difference across the two groups being studied is lacking across other issue variables such as IPO age, total assets, and listing delay.
Comparison of groups segregated with respect to presence and absence of foreign directors highlights significant differences across governance and issue characteristics clarifying that inclusion of foreign directors on the boards of IPO companies does affect the governance and firm characteristics which can be built to positively influence the governance and financial performance of firms. The results present evidence for alternate hypothesis wherein board, ownership, and some of issue characteristics are found to be significantly different with presence and absence of foreign directors.
Two groups of firms built on the basis of presence of foreign directors are found to be unbalanced with respect to numbers. For establishing the robustness of initial results, an attempt is made to balance the samples and so the larger sample (firms with no foreign directors) is trimmed down using statistical randomness. As a result, the larger sample is brought down to the size of smaller sample and thus making the size of each subgroup as 84. To this balanced sample, the t-test is applied again and the results across governance and issue characteristics are presented in Tables 6 and 7.
The results with trimmed sample of firms are very similar to results of full sample and hence they establish the robustness of results. A parallel has been drawn between the results and tabulated in Table 8 for a bird’s eye view of all comparisons made and points of significant differences. Directors with foreign nationality bring about a significant difference to the firms where they occupy the board seats and this difference can bring about a substantial difference to their governance orientation together with firm specifications. The results highlight that firms with foreign directors on their boards are larger pertaining to their board size, board independence, more mature in terms of board age, and less concentrated with respect to ownership of shares.
Analysis of the IPO firms with respect to board and firm characteristics sheds light on the fact that globalization of board rooms picking up in present times does bring in benefits which can help strengthen the performance of firms. IPO firms, which endeavor to establish their credibility among investors and win not just their confidence but also their money and attention, can employ board national diversity as an important signal in proving their mettle and potential to investors and other stakeholders. Across many dimensions, the presence of international directors makes a significant difference but is not statistically established with respect to returns of IPOs. This can be attributed to the multitude of factors which affect the levels of underpricing at the time of initial public offering. Future research efforts in this direction can aim to analyze board diversity in a broader sense for its more specific effect on underpricing of IPOs. Relationship of national diversity to IPO performance can be attempted with better scientific tools. The analysis can be further extended for long-term performance and more comprehensive analysis techniques but this study definitely works as an important basis in present times of globalization of not just operations but also board rooms.
Comparative Results Across Issue Characteristics with Balanced Sample
Comparison of Results Across Balanced and Unbalanced Samples
Conclusion
Corporate governance, specifically board of directors, is an imperative issue which can potentially affect the strategic decisions of an organization and determine the growth prospects of a firm. These mechanisms have grown to be an indispensable aspect of organizations which operate in vibrant competitive environment to garner resources and investors’ attention. Strong and effective board structures have been documented as essential to the sustainability of corporate boards characterized by separation of ownership and management, challenges of information asymmetry, and dependency of external resources. Building on these theoretical perspectives, the present study is an attempt to gauge the presence of foreign directors on boards of Indian IPO issuing firms and their ability to influence financial and governance variables in an organization. The present work is unique as it covers the international diversity of board of directors and investigation in context of new issue firms which compete for investors’ money in dynamic environment adopting signals to communicate their potential. Working on Indian IPOs issued between 2001 and 2017, the study checks for presence of foreign directors on their boards and compares firms with and without foreign directors for differences along firm, board, and ownership characteristics. Amidst the challenge of non-disclosure of information on nationality of directors for many firms, working on the final sample of 444 IPOs, comparisons are made on the basis of board parameters, ownership measures, and issue-specific variables among firms with foreign directors and firms which have no foreign directors on their boards. The results highlight significant differences across all board variables such as board size, board age, board committees, other directorships, promoter ownership, etc. to highlight that presence of foreign directors affects these variables and thus influences the governance mechanisms of a firm. The results confirm the difference in governance mechanisms of firms with foreign directors which though does not manifest in the form of better returns of IPOs but definitely emphasizes the importance of nationally diverse boards. These differences, however, do not extend to initial returns of IPO regarded as underpricing and to issue-specific variables of IPO age, total assets, and listing delay. The results confirm that board diversity regarded as important contributor to corporate success plays a discerning role in the case of IPOs. IPO issuing firms try all tricks in the book for success of their issue and inducting diverse members on the board can definitely contribute in garnering attention of investors and their money. Foreign directors bring in their international experience and exposure which is strategic in present times of internationalization. The present study contributes as a preliminary research in the area of foreign directors and can be extended to study the influencing power of foreign directors in context of all firms rather than only IPOs. The present effort is an important link in connecting the performance of firms to board diversity and analyzing potential to affect governance and other parameters. This study is an important contribution to the scant literature on board diversity generally and national diversity specifically in the Asian region. Future research efforts could be built to study the moderating and mediating effect of foreign directors in affecting not just financial performance but also other market-driven measures. Moreover, a comprehensive effort with larger connotations of diversity and performance across firms with distinct characteristics in terms of size, operations, and scope can lend higher credibility to board diversity and its ability to influence performance. This study hold relevance amidst the acknowledged dominance of Indian IPO markets and growing thrust on corporate governance and pursuit for effective board practices.
Footnotes
Declaration of Conflicting Interests
Funding
The author received no financial support for the research, authorship, and/or publication of this article.