Does Anglo-Saxon Corporate Governance Matter for Capitalist Development of Emerging Asian Economy? a Case Study of India

The voluminous body of law and finance literature argues that legal rules shape economic outcomes as far as they support market-based economic activity. This is what suggested in new institutional economics. It is pointed out that legal protections for shareholders will lead to stock market development and ease the financial constraint for corporate growth through capital formation. In the ‘neo-liberal’ era of privatisation and disinvestments in the existing public sector companies, stock market development is given a top priority in the Washington Consensus. It is expected to provide a market mechanism for private corporate capital accumulation (along with public sector disinvestments) and economic growth. 

The empirical basis of the ‘law matters’ postulate is by and large cross-sectional. The present paper examines this postulate on the basis of the experience of an emerging Asian economy, India, over a time span of 30 years, namely, 1976-2005.  This study uses the   time-series technique of cointegration and vector error correction modelling that takes into account the short-term relationship (temporary impact) and the stability of the adjustment process through which the short-term relationship (if any) culminates into a long-term relationship (permanent impact, if any). It examines the two-way relationship— whether shareholder protection influences stock market development or changes in stock market scenario create an effective pressure on the lawmakers to introduce legal changes or both. It is not true that the nature of a country’s legal infrastructure is fixed as an endowment. Legal infrastructure often interacts with politico-economic developments and may be altered by them. It can be examined by modelling the two-way relationships.

This study will add to the existing literature. It recognises the fact that impact of law on economic variables is not instantaneous – it has a path dependency. The path may not be stable; a short-term outcome (significant or not significant) may not lead to a (significant or not significant) long-term outcome. It may so happen that the nature of the short-term outcome is the polar opposite of the long-term outcome.

What is observed in this study challenges the so-called conventional wisdom created by the series of studies by  La Porta and his colleagues. It is observed that shareholder protection has no long-term favourable effect on stock market development. At best there is no effect (as in stock market trading) and at worst there is negative effect (as in turnover ratio).

The avowed objective of improving corporate governance and granting better rights to shareholders is not just for securing the property right of the property-owners. It also promotes the stock market so that the general public will be encouraged to buy shares issued by the corporate sector, and in the process finance their capital formation and growth.   However, changes in India’s shareholder protection did not have this effect – the long-term effect on public subscription of shares is either non-existent or negative. The effect on private corporate capital accumulation in both real and relative terms (relative to aggregate national capital formation) is also negative.