Corporate Governance Insights Interview Series: Top corporate governance experts report on the latest research in emerging markets.
Viral V. Acharya is the C.V. Starr Professor of Economics in the Department of Finance at New York University Stern School of Business. His primary research interest is in theoretical and empirical analysis of systemic risk of the financial sector, its regulation and its genesis in government-induced distortions.
The most interesting piece on corporate governance I read recently was…
…A paper by several Indian academics on the difference in the behavior of independent directors in India before the 2009 Satyam scandal that’s been called “India’s Enron” and post-Satyam. The evidence seems to suggest that before the Satyam situation came to light, independent directors were reluctant to speak up about controversial or inappropriate actions. After the fact, many independent directors stepped off of boards of companies that weren’t governed well. The findings suggest that concerns about personal liability and the increased risk of law suits if the company engages in fraudulent or other inappropriate activity contributed to this flight from poorly governed firms.
Right now, I am working on…
… A study that looks at the role of the dominant shareholder in state-owned banks, and how these dominant shareholders -the state -could be creating inefficiencies in the market because their focus might not be on maximizing shareholder value. Instead, their priorities are entwined with the political agenda of the moment. It builds on my earlier research in which my co-author and I conclude that during the financial crisis in 2008, investors rewarded Indian public sector firms that had greater systemic risk while penalizing private sector firms with similar risk. We attributed this finding to the explicit and implicit government backing of public sector banks, which do a lot of priority sector lending.
These state-owned banks emphasize lending to certain sectors, such as agriculture, based on the state’s political agenda, regardless of how risky they are. And since such sectors are typically more risky, they could wind up with more losses than other banks. The new research looks at whether you can prevent this large shareholder -the state -from doing things that are detrimental to smaller shareholders.
I think the most relevant CG research topic for emerging markets now is…
…This issue of the political economy and its influence over the actions of the dominant shareholder in state-owned enterprises, leading to market inefficiencies. Might this be the true bottleneck to private sector growth in emerging markets?
This has much broader implications beyond a single industry and a single country. The approach of favoring certain sectors due to the political exigencies of the moment - by controlling the actions of the dominant shareholder -- could restrict the amount of credit available for other sectors. And particularly given the limited budgets of emerging market countries, this potentially could constrain economic growth, or contribute to lopsided development.
Consider the example of China, where much of the banking sector is state-owned. Over the last decades, this state-controlled banking sector has served the state’s objective of investing in infrastructure. Meanwhile, both retail lending and small and medium business lending remain largely outside the formal banking sector, although the informal sector does meet some of their needs. What’s the result? While Chinese infrastructure has developed rather well, Chinese consumption is surprisingly weak relative to the nation’s high economic growth rates. This is due in part to the relatively low penetration of retail and small business lending.
If there weren’t these back-door ways of retaining state control over certain sectors, perhaps we would see more efficient markets, leading to stronger private sector growth?
Take, for instance, the utilities sector. In many emerging markets, governments have a huge presence here, including in critical sub-sectors such as power, coal, telecommunications, and airlines. These industries often remain under-developed due to state-run monopolies and the constant interference in operations from various political forces. As a result, they can be inefficient and uncompetitive. In turn, this impacts the overall ability of a country to enhance its economic growth prospects.
For further readings, Professor Acharya recommends:
Corporate Governance in India: Disciplining the Dominant Shareholder, by Jayanth Rama Varma
Independent Director Liability and Firm Value: Evidence from a Large Corporate Governance Failure, by Krishnamurthy Subramanian and Rajesh Chakrabarti
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