24

Int. J. Behavioural Accounting and Finance, Vol. 3, Nos. 1/2, 2012

Corporate governance and stock market liquidity in

India
P. Krishna Prasanna* and Anish S. Menon
Department of Management Studies,
Indian Institute of Technology, Madras,
Chennai 600036, India
Fax: +91-44-22574552
E-mail: pkp@iitm.ac.in
E-mail: menoanish@gmail.com
*Corresponding author
Abstract: Corporate governance encompasses the processes for board
effectiveness and enhanced transparent disclosures. Both these requirements
result in improved quality and quantity of information made available to
investors, which in turn is expected to result in informed trading, reduced
information asymmetry and improved market liquidity. It was empirically
observed that corporate governance had a positive impact on stock liquidity;
also, better governed companies had higher liquidity. A decade of governance
reforms in India had definitely been beneficial for the firms adhering to good
governance practices. Further, this study examined the relationship between the
ownership pattern and the stock liquidity, and found that higher promoter
holdings reduce stock liquidity. These results support the arguments of Welker
(1995) and Chung et al. (2010) regarding ownership dispersion. The results
also validate and strengthen the belief that foreign institutional investors and
their investments provide liquidity to emerging stock markets like India.
Keywords: ownership dispersion; stock liquidity; illiquidity; corporate
governance; India.
Reference to this paper should be made as follows: Prasanna, P.K. and
Menon, A.S. (2012) Corporate governance and stock market liquidity
in India, Int. J. Behavioural Accounting and Finance, Vol. 3, Nos. 1/2,
pp.2445.
Biographical notes: P. Krishna Prasanna is a Doctorate in Finance from the
University of Madras. She is presently an Assistant Professor at the Indian
Institute of Technology (IIT, Madras), Chennai. Her doctoral research is on
corporate governance and she has published several papers on this subject.
Anish S. Menon is a member of the Institute of Chartered Accountant of India.
He is currently pursuing his Master of Science (by research) at the Indian
Institute of Technology (IIT, Madras ), Chennai.

Copyright 2012 Inderscience Enterprises Ltd.

Corporate governance and stock market liquidity in India

25

Introduction

Effective corporate governance helps to build vibrant and efficient capital markets.
Investors confidence is more in those markets where companies have high standards of
corporate governance. Gilson (2000) stated that equity investment requires good
corporate governance and good corporate governance requires credible corporate
disclosures.
Corporate governance encompasses the processes for board effectiveness and
enhanced transparent disclosures. Both these requirements result in improved quality and
quantity of information made available to investors. There is evidence in the
recent governance literature that this information flow influences stock markets and
results in informed trading, reduced information asymmetry and improved market
liquidity.
Empirical research from developed markets prescribes that both internal and external
corporate governance mechanisms improve stock market liquidity (Bacidore and
Sofianos, 2002). Jain et al. (2008) found that the Sarbanes Oxley Act, 2002
had highly significant and positive long term liquidity effects. They asserted that
these improvements were positively associated with improved quality of financial
reports.
In India, market driven stock markets are just evolving, resulting in the growth of
actively traded stocks. There was a remarkable improvement in both the quantity and
quality of information available for an investor in the capital market since the legislation
of corporate governance norms through Clause 49 of the Listing Agreement in the year
2000. This additional information should facilitate efficiency in price formation process
and enhance stock market liquidity. This paper1 investigates the consequences of
governance regulations and the impact of information diffusion on the Indian capital
market liquidity.
The issues of corporate governance are quite varied in India compared to the west
because most of the successful companies in India are family run firms with
concentration of ownership. The promoter family members not only own a major portion
of the equity stake but also hold key positions as directors. Besides these owners, foreign
institutional investors are increasingly investing in the Indian stocks in recent years and
this trading activity is presumed to impact the liquidity of the stock market. Given this
background, the research questions that arise are: How does firm level corporate
governance impact the liquidity of its stock? Does ownership concentration and higher
promoter stake affect stock liquidity? Do the companies with higher foreign institutional
investments (FIIs) experience higher liquidity?
The present study measures firm level governance quality and investigates its impact
on the liquidity of the stock in the market. The paper also examines the impact of
ownership structure upon the stock liquidity.
This paper provides new evidence on the relationship of market liquidity and the
corporate governance mechanism in India. The results of this study contribute to the
existing limited literature on stock market liquidity in India, and also contribute to the
ongoing debate on costs and benefits of governance reforms.

26

P.K. Prasanna and A.S. Menon

The remaining sections of the paper are organised as follows: Section 2 presents a
note on corporate governance regulations in India, the review of literature and research
hypotheses; Section 3 describes the data and sample selection; Section 4 presents the
empirical results and Section 5 contains the concluding remarks.

Note on corporate governance in India

In India, corporate governance reforms began with the legislation of Clause 49 of the
Listing Agreement enacted in 2000. The Securities and Exchange Board of India
(SEBI) legislated the first formal governance regulation by inserting Clause 49 in the
stock exchange listing agreement with the intention of promoting and raising
the corporate governance standards of Indian companies. The regulation broadly
deals with the following issues: Board structure and composition; governance
through board committees like the audit committee, remuneration committee and
shareholders grievance committee and required additional disclosures to improve
transparency.
A series of changes in the regulations since 2000 have considerably altered the way
Indian companies are governed. There was a gradual change in the composition of the
boards of Indian companies. Many of the directors join the boards as non-executive
directors who are expected to provide expert guidance to the management, but do not
participate in the management process. Similarly, there has been an increase in the
composition and participation of independent directors who are expected to contribute
maximisation of share holders value and offer investors protection.

2.1 Review of literature and research hypothesis

A key aspect of information disclosure relates to a firms governance. Many research
studies have established that information flow and stock market liquidity are closely
associated.

2.1.1 Corporate governance, disclosure quality, asymmetric information and

stock market liquidity
The fundamental relationship between information and stock price behaviour has been
established by Grossman and Stiglitz (1980). They explained that improving cost-benefit
trade-off on information collection leads to more informed trading and more informative
pricing. Gompers et al. (2003) found that governance can directly influence stock prices.
The effect on stock returns and prices requires link between governance provisions,
disclosure requirements and information to investors.
Welker, 1995, elaborating on the relation between disclosure policy and its influence
on market liquidity, stated that disclosure policy influences stock markets because
uninformed investors price protect against adverse selection and this price protection is
manifested in market liquidity. He found that a well regarded disclosure policy reduces
information asymmetry and hence increases liquidity in equity markets.
Brown (2007) stated that disclosure quality results in less trading by privately
informed traders and reduces information asymmetry. He found a negative relation

Corporate governance and stock market liquidity in India

27

between the information asymmetry and disclosure quality of annual reports and investor
relations activity. The quality of quarterly reports disclosure is found to be positively
associated with information asymmetry.
Chen et al. (2007) argued that companies adopting poor information transparency and
disclosure practices will experience serious information asymmetry. They empirically
observed that the costs of liquidity are greater for companies with poor information
transparency and disclosure practices.
Ferreira and Laux (2007) reported that better corporate governance and
openness to market for corporate control leads to more informative stock prices by
encouraging collection of and trading on private information. They also asserted that
information flow interpretation implies that the component of volatility is related to
governance.
Kanagaretnam et al. (2007) found that firms with higher levels of corporate
governance have lower information asymmetry when they announce their quarterly
earnings. Chung, Elder and Kim, 2010 found that firms with better corporate governance
have narrower spreads, higher market quality index, smaller price impact of
trade and lower probability of information-based trading. Given these results, they
suggested that firms may reduce information-based trading and improve stock market
liquidity by adopting corporate governance standards that mitigate informational
asymmetries.
Marnet (2008) suggested that conventional proposals to reform corporate governance
through legislation and codes of best practices, underestimate the pressures from conflicts
of interest and bias, which reputed intermediaries face in their interaction with colleagues
and clients. He also discussed research questions regarding the independence of boards of
directors and external auditors.
Cai et al. (2009) observed the impact of asymmetric information on three mechanisms
of corporate governance:
1

intensity of board monitoring

exposure to market discipline

pay for performance sensitivity of CEO compensation.

They found firms facing greater asymmetric information tend to use less intensive board
monitoring but rely more on market discipline and CEO incentive compensation. They
suggested that regulators should use caution when imposing uniform requirements on
firms corporate governance.
Cormier et al. (2010) investigated the impact of governance on information
asymmetry between managers and investors, and found that a firms governance maps in
to the level of information asymmetry between the managers and investors. They found
that governance disclosures reduce information asymmetry.
Bruno and Claessens (2010) observed that company-level corporate governance
practices and country-level legal investor protection jointly affect company performance.
They suggested that beyond a threshold level of country development, stringent
regulation hurts the performance of well governed companies or has a neutral effect for
poorly governed companies.

28

P.K. Prasanna and A.S. Menon

In 20042006, Cheung et al. (2010) constructed a corporate governance index (CGI)

to measure the quality of corporate governance practices of the 100 largest listed firms in
China, and found a positive relation between market valuation and overall corporate
governance practices. Shen and Lin (2010) observed that in the case of better
governed companies the relationship between fundamental signals and stock returns is
strong.
Hermalin and Weisbach (2011) argued that beyond a point, additional disclosure
actually decreases firm value. They found that larger firms adopt stricter disclosure rules
than smaller firms, and firms with better disclosure employ more able management.
Carvalhal and Nobili (2011) investigated as to whether including a corporate
governance factor in the Fama and French three-factor model helps to explain
stock returns better. By constructing a broad CGI for Brazilian public firms, they
documented that governance does explain average returns on stocks, and also that the
governance factor seems to be more powerful than both firm size and book-to-market
ratio.
Larcker et al. (2011) investigated the market reaction to legislative and regulatory
actions pertaining to corporate governance. They observed that the abnormal returns to
events relating to corporate governance regulations are on average decreasing;
additionally, they identified that the number of large block holders and the presence of
staggered boards were also decreasing.
Price et al. (2011) examined the influence of Mexicos efforts to improve corporate
governance on firm performance and transparency. They used the compliance data
disclosed annually by public firms in Mexico as a measure of corporate governance
strength, and documented significant increase in compliance over 20002004, indicating
that Mexican companies consider non-compliance a costly matter. They found no
association between the governance index and firm performance with transparency.
Braga-Alves and Shastri (2011) constructed a corporate governance composite index
that combines six proxies for the main governance practices targeted by Bovespas
reforms in Brazil. They found that higher scores of index are related to greater market
value and better operating performance.
Tang and Wang (2011) examined the cross-sectional relation between corporate
governance and firm liquidity in the Chinese stock market and found strong evidence that
the level of corporate governance is positively related to firm liquidity.
Hypothesis 1

Ideally, corporate governance through tougher disclosure regulation

should contribute to less fluctuation in stock prices. Indian companies are
now transparent, not by choice but because there are structures in place
that facilitate the market participants to gather information which gets
reflected on prices. This information should facilitate the quality of price
formation and should ideally result in improving the liquidity in the
capital markets.

Corporate governance and stock market liquidity in India

Figure 1

29

Impact of corporate governance on the stock market liquidity

Board effectiveness
CORPORATE
GOVERNANCE

DEMANDS
Disclosure requirements

Results in
improved
quantity and
quality of
information
disclosures to
traders

Improves liquidity

Reduces volatility

H1

Reduces
information
asymmetry

Companies with higher level of corporate governance will experience improved

stock market liquidity.

2.1.2 Corporate governance, firm ownership and stock liquidity

Corporate governance advocates believe that ownership dispersion is desirable and that it
would provide market liquidity. It is believed that ownership concentration results in
limited information made available to the investors in the capital markets; and hence
investors consider such firms as high risk entities. Retail investors do not desire to
provide funds to such firms which will result in illiquid stock markets. Gaspar and Massa
(2007) investigated how a firms ownership pattern affects the liquidity of its stock, and
found that informed ownership improves governance and induces value enhancing
decisions. Becht (1999) counter argues that ownership dispersion will de-motivate the
individual investors to exercise proper controls on the management which will have
negative effect on stock liquidity. Rhee and Wang (2009) examined the Granger causality
between foreign institutional ownership and stock market liquidity and found that foreign
holdings have a negative impact on future liquidity. Their observation challenges the
view that foreign institutional ownership enhances liquidity in small emerging markets.
Bae and Goyal (2010) reported that equity market liberalisations open up domestic
stock markets to foreign investors. They used cross-firm variation in corporate
governance in Korea to test whether governance can explain the extent to which firms
benefit when countries liberalise. They observed that better-governed firms experience
significantly greater stock price increases upon equity market liberalisation. They also
found foreign ownership in firms with strong corporate governance was significantly
higher than that in firms with weak governance.

30

P.K. Prasanna and A.S. Menon

Henry (2010) observed that the beneficial influence of voluntary governance

compliance on agency costs was independent of firm ownership structure. Thus, there are
arguments in all the directions in the literature, throwing open the research questions
relating to the impact of ownership pattern upon the stock liquidity. In a majority of
Indian firms, the promoter families own a major stake of equity capital. Recent economic
growth in India has resulted in large amounts of FIIs. In this context this paper examines
the following null hypothesis;
H2a

Higher FII investments do not result in higher liquidity.

H2b Higher promoter holding will not have any impact on stock liquidity.

Data and variables

3.1 Sample selection and data sources

The study sample consists of all the non-banking firms included in the Bombay Stock
Exchange (BSE) 100 index, which represents all the actively traded stocks in the Indian
capital market. The BSE-100 index is a broad-based index launched in 1989 and has
1983-84 as the base year. The index is well diversified with companies representing
43 industries (list given in Appendix 3).
About 4,990 companies are listed in the BSE. As on December 22, 2010 the total
market capitalisation of all these companies is Rs. 6,963,116.67 crores (source: CMIE
database). The top 100 liquid companies are included in the BSE 100 index. The market
capitalisation of all the BSE 100 index (our sample) companies put together is
4,755,169.98 crores (as on December 22, 2010), which is 68.29% of the total market
capitalisation. This shows that the sample adequately includes all the actively traded
stocks and covers around 70% of the population. The data-set consists of the
cross-sectional annual data of 90 companies for the financial year 20092010.
The data of the closing price, daily market capitalisation (in rupees) and daily
turnover (in rupees) was collected from the official website of the BSE.
The detailed ownership pattern of the companies as on 31st March, 2010 was
collected from the prowess database of the Centre for Monitoring Indian Economy
(CMIE); the data on governance variables from the Corporate Governance reports of the
sample companies, and the financial data regarding the sample firms from the capital line
database.

3.2 Measure of firm-level corporate governance: CGI

There is huge body of corporate governance literature using constructed CGI as proxy of
firm level governance quality (Gompers et al., 2003; Jiraporn and Ning, 2006; Jo and
Pan, 2009; Officer, 2006).
Researchers have adopted various measures to construct the governance index; some
constructed their index based on responses to survey questions (e.g., Black et al., 2005).
In Brazil, Da Silveira and Barros (2007) constructed from the survey response of
20 questions on four important aspects of corporate governance:

Corporate governance and stock market liquidity in India

1

access to information

information content

board structure

ownership structure for the year 2002.

31

A few authors used corporate governance ratings given by independent rating agencies
(Mitton, 2004). Bruno and Claessens (2010) used the Institutional Shareholder Services
(ISS) data to measure and assess firm-level corporate governance attributes of cross
sectional firms.
Tang and Wang (2011) constructed an overall governance index for all the listed
firms in China, to measure the quality of corporate governance, based on the disclosed
governance-related information in their annual financial reports. They have assessed the
impact of governance using the fixed effects model of panel data analysis.
Ammann et al. (2011) used the principle component analysis to identify key
governance variables that can be included in the index. They used the dynamic panel
GMM (generalised method of moments) to analyse cross country and time effects in the
corporate governance data of 23 countries. All these papers use additive indices, giving
equal weightage to each considered governance attribute.
For this paper, the CGI was constructed from the data provided in the corporate
governance reports published as part of Annual reports of the listed companies in India.
Though Ammann et al. (2011) used 64 attributes to measure the index, it was found that
in the Indian context, most of the information reported in the governance report/ website
is standardised across firms as it is mandatory for the companies to report what is
required by Clause 49 of listing requirement.
Hence, the 13 governance attributes that exhibited variance across the firm level were
considered for the purpose of constructing this index. These attributes broadly cover
Board composition and independence, Board performance measured from the attendance
in meetings, effectiveness of governance committee structure and access to information.
These variables have been grouped into two categories for the purpose of scoring.

Set 1: Based on the following variables the governance practices of the companies
have been rated as poor, good and very good. A score of 3 has been given if they
were found to be very good and 2 and 1 respectively for good and poor rating.
List of variables:
1 % of the number of non-executive independent directors in the board
2 number of board meetings
3 % of independent directors attendance in board meetings
4 % of independent directors attendance in the annual general meeting
5 number of audit committee meetings
6 number of members in audit committee meetings
7 % of audit committee members attendance in the audit committee meetings
8 chairman of the company (whether executive/non-executive/independent
director).

32

P.K. Prasanna and A.S. Menon

Set 2: The following variables were rated on an ordinal scale; a score of 2 has been
given for positive practice and 1 otherwise.
List of variables:
1 duality of chairman
2 disclosure regarding retiring directors profile
3 existence of compensation committee
4 disclosure regarding compensation committee membership and meetings
5 disclosure regarding shareholders grievance committee membership and
meetings.

The total corporate governance score has been obtained by the summation of the scores
of all the attributes. Thus, the maximum total score a firm can get is 34. Using this score
as a proxy for firm level governance, cross sectional analysis was made with the help of
ordinary least squares (OLS) regression.
LIQi = + CGI i +

Apart from the composite corporate governance score, the issues related to directors pay
benefits and compensation have been deliberated in the recent governance literature.
Hence, total directors remuneration has been considered as an independent variable to
assess cross firm variation in stock liquidity.
Another governance attribute assessed independently was the ownership pattern. The
age of share holding by various groups of owners has been taken as an independent
variable. The impact of share holdings by promoters, domestic institutions, foreign
institutional investors and retail investors upon the liquidity of the stock has been
analysed in this paper.

3.3 Measures of stock liquidity

Empirical market microstructure literature suggests alternative ways to measure stock
market liquidity. Brennan et al. (1998) used trading volume to measure liquidity while
Datar et al. (1998) used turnover. Another widely used measure in recent studies is the
Amivest liquidity, which is defined as the average of daily ratio of volume to absolute
return (Chan et al., 2008). This ratio is proxy for market depth. Amihud (2002)
demonstrated that the inverse of this ratio, referred as illiquidity ratio, can be used to
measure the price impact.
Many of the research studies referred to in previous section have used the
bid-ask spread as a measure of liquidity (Kanagaretnam et al., 2007; Chung et al., 2010;
Chen et al., 2007; Welker, 1995). In an order driven market (like India), lack of
transaction data leads to lack of information for measuring the bid-ask spread. Hence, this
study used the illiquidity ratio as proposed by Amihud (2002) and its modified version
as proposed by Bortolotti et al. (2007) to measure the stock liquidity.
Stock illiquidity is defined as the average ratio of the daily absolute returns to the
(rupee) trading volume of the day. It is the ratio of the return per day to the daily traded
volume in rupees. This value is then averaged across the number of trading days in a year
to get proxy for stock liquidity. Amihud (2002) says that the ratio is closely related to the
Amivest ratio and also follows Kyles (1985) concept of illiquidity, which is the response

Corporate governance and stock market liquidity in India

33

of price to order flow. Marcelo and Quiros (2006) commented that the illiquidity ratio has
a strong theoretical appeal and considers it the best proxy for illiquidity.
Daily return : R =

( P1 P0 )
P0

(1)

where R is the daily return, P1 is the current days closing price and P0 is the previous
days closing price. The absolute values of these returns were taken to compute the
following illiquidity ratio:
Stock illiquidity =

Riyd
VOLDiyd

(2)

where Riyd is the return on stock i on day d of year y and VOLDiyd is the respective daily
volume in rupees (Amihud, 2002).
This value was then multiplied by 108 to aid in computational convenience. This was
then averaged over the period of working days in the financial year
Diy

ILLIQiy = 1 Diy

iyd

VOLDiyd

(3)

t =1

Another variant of the Amihud illiquidity has been formulated by Bortolotti et al. (2007).
Here illiquidity is computed as the ratio of the absolute return to turnover.
For the purpose of this paper, the Bortolotti et al. (2007) version of the Amihud ratio
was calculated (hereafter called the modified Amihud ratio):
ILLIQ = D 1

Riyd

TURNOVERdt

(4)

The modified Amihud ratio was calculated as the ratio between the absolute daily return
and the daily turnover ratio as calculated above. Turnover in this case is equal to the total
value of shares traded scaled by total daily market capitalisation; this was averaged over
the period of the total working days in the financial year.
A high value of this measure indicates that the market is illiquid because there is a
considerable price change in the stock in response to a comparatively small change in the
turnover.

Empirical results

4.1 Descriptive statistics

4.1.1 Board composition and leadership
Table 1 presents the board composition related statistics. 50% of the directors in the
sample companies are independent, which is as required by the legislation. Their
participation in the board room decisions primarily can be gauged from their attendance
in board meetings. On an average, 76% of them attend the board meetings. There is also a
conscious split in the leadership of management and the board. Out of the sample

34

P.K. Prasanna and A.S. Menon

companies nearly 50% of companies had a non-executive chairman, while the other
50% of them are promoter non-executives.
Table 1

Descriptive statistics board composition of sample companies

DS

TND

NEPD

NNEPD

NNIPD

Mean

11

PID TBM IDPB

50

76

Median

11

50

Mode

11

50

Maximum

22

11

86

Minimum

13

IDPA

NAM MAC

66

78

67

60

100

40

100

100

11

Notes: Legend:
DS descriptive statistics
TND total number of directors
EPD number of executive promoter directors
NNEPD number of non-executive promoter directors
NNIPD number of non-executive independent directors
PID percentage of independent directors in the board
TBM total number of board meetings
IDPB independent directors percentage attendance in board meetings
IDPA independent directors percentage attendance in annual general meeting
NAM number of audit meetings
MAC number of members in audit committee.
Table 2

Chairmanship of companies

Executive directors

26

Executive promoters

19

Non-executive promoters

21

Non-executive and independent directors

24

Total sample

90

Board effectiveness can also be assessed from the functioning of the sub-committees
and their reviews. All the sample companies had audit committees, shareholders
grievance committees and remuneration committees. The meeting schedules, agenda and
participation have been disclosed in their governance reports.
The reforms also resulted in a significant improvement in the disclosure practices of
Indian companies. The relevant information regarding important corporate actions is
made available through their web pages of investor relations. Further information about
the board meetings, directors profiles, chairmans speeches, CEO interviews, press
meetings and analysts reports are posted on the companies websites.

4.1.2 Corporate governance score

Taking the board composition, board quality and effectiveness and governance
committee functioning as the key parameters the CGI has been constructed for each
sample company. The cumulative total of this index is referred as CG score and is used
for analysing impact of corporate governance on the companys stock liquidity.
Table 3 presents the descriptive statistics and Appendix 1 provides the detailed scoring
scheme.

Corporate governance and stock market liquidity in India

Table 3

35

Corporate governance score

Mean

24

Median

25

Mode

26

Minimum

16

Maximum

30

Count

90

Mean

24

4.2 Corporate governance and stock liquidity

This study examines the relationship between firm level corporate governance and its
stock liquidity. While the previous studies which examined this relationship have
taken the bid-ask spread to proxy the liquidity affect of stock, this study has used the
illiquidity ratio (Amihud, 2002) to measure stock liquidity. Table 4 presents the bivariate
relationship between the computed CG score and the stock illiquidity ratio. The CG score
has a statistically significant impact on both the illiquidity ratio and the modified Amihud
ratio. The negative regression coefficients explain that higher the CG score, lower is the
Illiquidity ratio, implying higher CG score, higher the stock liquidity. These results are
consistent with this papers hypothesis that better governed companies will have higher
stock liquidity. Total remuneration paid to directors has been taken as another
governance variable. The remuneration includes the salary paid to executive directors as
well as the commission and sitting fees paid to non-executive directors. This has a
negative impact on stock liquidity. However it was not found significant.
Table 4

Corporate governance and stock liquidity

Dependent Independent
variable
variable

R
square

IR

0.042

3.7288

CGI

Significance F Coefficients
0.0568

1.3849

t stat

P-value

1.93

0.056

MAR

CGI

0.0469

4.1864

0.0438

25.3777

2.04

0.043

MAR

TDR

0.0179

1.4199

0.2370

1.91334

1.91

0.237

Notes: CGI corporate governance index, MAR modified Amihud ratio,

IR illiquidity ratio, TDR total remuneration paid to all the directors

To moderate the differences in the firm size, total assets were considered as a controlling
variable. Table 5 reports the interaction between the firm size and stock liquidity. Firm
size had a negative impact on illiquidity ratio indicating that the bigger the firm, the
higher the liquidity. The modified ratio also had a negative impact; however it is not
statistically significant. While computing the modified Amihud ratio, the turnover is
scaled to the size of market capitalisation and this turnover rate is taken as the
denominator. In this context the firm size gets moderated while computing the modified
Amihud ratio. Hence, firm size did not show additional significant impact on the stock
liquidity.

36

P.K. Prasanna and A.S. Menon

Table 5

Firm size and stock liquidity

Dependent Independent
variable
variable

R
square

Significance F Coefficients

t stat

P-value

IR

TA

0.045

4.1487

0.0447

0.0001

2.0368

0.0447

MAR

TA

0.0027

0.2367

0.6278

0.0004

0.4866

0.6278

Notes: MAR modified Amihud ratio, IR illiquidity ratio, TA total assets

Table 6 contains the results of the multivariate tests incorporating the total assets to
control firm size. The impact of CG score is still statistically significant confirming this
studys Hypothesis 1.
Table 6

Impact of corporate governance up on the stock liquidity controlling for firm size

Dependent Independent
variable
variable

R
square

MAR

0.0477

2.105

CG

Significance F Coefficients
0.1282

TA

t stat

P-value

24.9423

1.982

0.050

0.0003

0.263

0.792

Note: Modified Amihud ratio and CGI controlling for firm size.
Table 7

Ownership pattern descriptive statistics

A: Percentage breakup of total

Particulars

Promoters
holding (%)

Foreign institutional
investors (%) non-promoters

Domestic
institutions

Other
investors

Mean
Median
Minimum
Maximum
Count

50
50
0
99
90

18
15
0
65
90

13
11
1
43
90

19
18
0
78
90

Family
holdings (%)

Government
holdings (%)

Foreign
promoter (%)

Joint
ventures
(%)

Mean

46

73

54

51

Median

46

76

53

53

Minimum

51

37

18

Maximum

90

99

68

80

Count

62

12

B: Promoter categories
Particulars

C: Promoter codes
Type of promoter

Categorical variable code

Number of companies

Indian

62

Foreign

Government

12

Joint venture

Total

7
90

Corporate governance and stock market liquidity in India

37

4.3 Ownership pattern and stock liquidity

Tables 7A and 7B present the descriptive statistics about the sample companies
ownership patterns. On an average, 50% of the equity capital is owned by the promoters;
Foreign Institutional Investors and retail public own 19% and 18% respectively; and the
domestic institutions own 13%. Further, the sample companies comprise of four types of
promoters. In the majority of sample companies (62), it was the business families holding
the major stake; in 12 companies the Indian Government was the promoter; and foreign
firms were the shareholders in nine companies. A categorical variable was included to
understand whether the difference in ownership makes any impact on stock liquidity.
Table 8 presents OLS estimates between the promoter holdings and the illiquidity
ratio. It was found that the higher the promoter holding, higher is the illiquidity ratio
interpreting lower stock liquidity. However, the impact was not statistically significant.
Table 9 presents the OLS results between the promoter holdings and modified Amihud
ratio. The negative impact between the promoter holdings and stock liquidity was
statistically significant even after controlling for firm size confirming Hypothesis 2a of
this study. Initially the type of promoter seemed to have a significant impact, however
when taken with other variables it was not significant.
Table 8

Promoters holdings and stock liquidity OLS estimates using illiquidity ratio

Dependent Independent
variable
variable

R
square

IR
IR

0.0072
0.0564

0.6338
2.5994

0.4281
0.0801

0.0217

0.9644

0.3853

0.0806

2.5132

0.0638

IR
IR

TPH
TA
PHP
TPH
TOP
TA
PHP

Significance F Coefficients

TOP

t stat

P-value

0.0787
0.0001
0.0997
0.0967
2.554
0.0001
0.1255

0.7961
2.1306
1.0236
0.9681
1.1371
2.3475
1.2781

0.428
0.035
0.308
0.335
0.258
0.021
0.204

3.3341

1.5051

0.136

Notes: TPH total promoter holdings, PHP promoter holdings percentage,

TOP type of promoter (categorical variable)
Table 9

Promoters holdings and stock liquidity OLS estimates using modified Amihud ratio

Dependent Independent
variable
variable

R
square

MAR

TPH

0.158

16.5134

0.0001

MAR

TPH
TOP
TA
PHP
TA
PHP

0.195

10.5343

0.0001

0.0564

2.5994

0.0801

0.1758

6.1166

0.0008

35.7905

MAR
MAR

TOP

Significance F Coefficients

t stat

P-value

6.413

4.0637

0.0001

3.7751
113.54
0.0001
0.0997
0.0009
6.8423

1.8529
1.9984
2.1306
1.0236
1.0822
4.2437

0.0673
0.0488
0.0359
0.3089
0.2822
0.0001

0.9842

0.3278

Notes: TPH total promoter holdings, PHP promoter holdings percentage,

TOP type of promoter (categorical variable)

38

P.K. Prasanna and A.S. Menon

Table 10 presents the regression results between the FII holdings and stock
liquidity. Higher investments from FII improve stock liquidity. This relationship was not
found in the initial illiquidity ratio. The FII investments had statistically significant
negative impact on the stock modified Amihud ratio. This implies that higher FII
investments contribute to increased stock liquidity. This confirms Hypothesis 2b of this
study.
Table 10

FII investments and stock liquidity

Dependent Independent
variable
variable

R
square

IR

FII

0.0017

0.1525

0.6971

IR

FII

0.0491

2.2458

0.1119

Significance F Coefficients

TA
MAR

FII

0.0814

7.8025

0.0064

MAR

FII

0.0881

4.2032

0.0181

TA

t stat

P-value

0.0649

0.390

0.697

0.1001

0.610

0.543

0.0001

2.081

0.040

7.7231

2.793

0.006

7.9522

2.854

0.005

0.0007

0.797

0.427

Notes: FII foreign institutional investors, TA total assets

Table 11 presents the impact of investments made by domestic institutional

investors upon the stock liquidity. They had a negative impact that is not
significant. Higher investments from domestic institutions result in reducing
illiquidity ratio and increase stock liquidity. The retail investors had significantly
negative impact on the on the modified Amihud ratio; they provide more liquidity to
stock.
Table 11

Domestic and retail investors and stock liquidity

Dependent Independent
variable
variable

R
square

IR

DII

0.0024

0.2116

0.6466

MAR

DII

0.0271

2.4526

0.1209

Significance F Coefficients

t stat

P-value

0.1021

0.46

0.646

5.9524

1.56

0.120

MAR

OI

0.0271

8.4594

0.0046

9.1955

2.90

0.004

MAR

DII

0.0954

4.5865

0.0128

3.2914

0.85

0.392

8.4288

2.56

0.012

OI

Notes: DII domestic institutional investors, OI other investors (individuals)

Table 12 presents the correlation matrix between the different owners of equity
capital. Promoters holdings had a significant negative relationship with all the
other groups. It was found that the higher the promoters holdings, the lower the
contribution from the foreign institutional investors, domestic institutional investors and
the retail investors. Also, higher promoters holdings result in lower dispersion in
ownership.

Corporate governance and stock market liquidity in India

Table 12

Correlations
PR

PR

39

Pearson correlation

FII

DII

OI

Sig. (2-tailed)
FII

DII

OI

90

Pearson correlation

.638

Sig. (2-tailed)

.000

90

90

Pearson correlation

.599

.020

Sig. (2-tailed)

.000

.854

90

90

90

Pearson correlation

.678

.063

.271

Sig. (2-tailed)

.000

.554

.010

90

90

90

1
90

4.4 Panel data results

A sub-sample of 55 companies was part of the BSE 100 index consistently from the year
20072010. Panel data was collected regarding ownership variables and illiquidity ratio
was computed for 12 quarters from 20072010. The total number of observations was
660. This panel data was analysed and the results were not different from that of cross
section analysis presented in the previous section.
Table 13

Panel data regression (random effects)

Dependent variable
Amihud illiquidity ratio
Modified illiquidity ratio

Independent variable

Regression coefficient

P-value

Promoter holding

0.1933

0.001

Domestic institutions share

0.905

0.001

Promoter holding

0.1292

0.001

The promoters holdings as well as the shares cornered by domestic institutions were not
traded widely. Higher holding by these groups resulted in higher illiquidity ratio,
implying less stock liquidity.
Table 14

Panel data regression (random effects)

Dependent variable

Independent variable

Regression coefficient

P-value

Amihud illiquidity ratio

FII

0.227

0.923

Modified illiquidity ratio

FII

0.298

0.816

FII had a negative impact on the illiquidity ratio; however, this relationship is not
statistically significant. This implies that higher FII results in higher liquidity in the stock
market.

40

P.K. Prasanna and A.S. Menon

4.5 Limitations and scope for further research

Measuring firm level governance was a challenging task in the Indian context as
corporate governance ratings were not available. The findings of this paper can be
generalised with a panel data analysis of CGI constructed from the year 2003 for all the
sample companies. Since 2003 all the listed Indian companies have been required to
follow Clause 49 of the listing agreement on corporate governance. Similarly, ownership
pattern was examined with cross sectional data. Analysis of time series data from
20032010 for all the sample companies will strengthen the empirical observations.

Concluding remarks

This study examines the relationship between the firm level corporate governance and
stock liquidity in the Indian market. The CGI was constructed through the content
analysis of annual corporate governance reports of the listed Indian companies. This
study used the illiquidity ratio suggested by Amihud (2002) and its modified form used
by Bortolotti et al. (2007) to measure the stock liquidity. It was empirically observed that
corporate governance had a positive impact on stock liquidity, because better governed
companies had higher liquidity. One positive finding for the cross section of governance
players (both for policy makers as well as the listed companies) is that a decade of
governance reforms has definitely been beneficial for the firms adhering to good
governance practices. Further, this study examined the relationship between the
ownership pattern and the stock liquidity, and found that higher promoter holdings reduce
stock liquidity. These results support the arguments made by Welker (1995) and Chung
(2010) regarding ownership dispersion. The results also validate and strengthen the belief
that foreign institutional investors and their investments provide liquidity to emerging
stock markets like India. This study supports the theory postulated by Gaspar and Massa
(2007) that ownership dispersion is essential for improving the stock liquidity.

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Notes
1

This paper is presented in 2nd finance and corporate governance conference organised by
La Trobe University at Melbourne, Australia during the 28th and 29th of April, 2011.

Corporate governance and stock market liquidity in India

Appendix 1
Table A1

Corporate governance score

Particulars
Number of non-executive independent
directors in total (percentage)

Scoring scheme
30%50% 1
50%65% 2
Above 65% 3

Total number of board meetings

4 and Less than 4 score 1

57 score 2
8 and above score 3

Independent directors-percentage attendance

in board meetings

60% and Less score 1

61%80% score 2
81%90% 3
Above 90% 4

Independent directors-percentage attendance

in annual general meeting

Less than 50% score 1

51%80% score 2
81%and above score 3

Chairman/managing director same or

different
Number of audit committee meetings

Same 1
Different 2
4 and less than 4 score 1
56 score 2
Higher than 7 score 3

Number of members in audit committee

3 and less score 1

46 score 2
7 and above 3

Percentage of audit committee in audit

committee meetings

Not given 0
Less than 75% score 1
76%90% score 2
91% and above score 3

Chairman of company

Independent non-executive 3
Independent executive 2
Promoter executive 1

Retiring directors profile

Not given 1

Number of share holders general meetings

Not given 1

Given 2
Given 2
Compensation committee

Absent 1
Present 2

Number of compensation meetings

Not given 1
Given 2

43

44

P.K. Prasanna and A.S. Menon

Appendix 2
Table A2

Ownership pattern among sample companies

Ownership pattern among sample companies

Number of companies

Central government commercial enterprises

Foreign promoters

12

Tata Group

Birla Aditya Group

Reliance Group

Adani Group

HDFC Group

India Bulls Group

Om Prakash Jindal Group

Vedanta Group

Other promoter groups owning single company

40

Total number of companies

90

Appendix 3
Table A3

BSE 100 index companies: industry composition

Sr. no.

Industry name

No. of companies

Aluminium and aluminium products

Auto finance services

Automobile ancillaries

Banking services

11

Beer and alcohol

Boilers and turbines

Cement

Commercial complexes

Commercial vehicles

10

Computer software

11

Copper and copper products

12

Cosmetics, toiletries, soaps and detergents

13

Crude oil and natural gas

14

Dairy products

15

Diversified

16

Drugs and pharmaceuticals

17

Electricity distribution

18

Electricity generation

19

Fertilisers

Corporate governance and stock market liquidity in India

Table A3

45

BSE 100 index companies: industry composition (continued)

Sr. no.

Industry name

No. of companies

20

Generators, transformers and switchgears

21

Hotels and restaurants

22

Housing construction

23

Housing finance services

24

Industrial construction

25

Infrastructural construction

26

Infrastructure finance services

27

Investment services

28

LNG storage and distribution

29

Media-broadcasting

30

Minerals

31

Other asset financing services

32

Paints and varnishes

33

Passenger cars and multi utility vehicles

34

Pesticides

35

Refinery

36

Shipping transport infrastructure services

37

Steel

38

Synthetic textiles

39

Tea

40

Telecommunication services

41

Tobacco products

42

Trading

43

Two and three wheelers

Total

2
100