Governance in India and Around the Globe

India is not known for rigid corporate governance standards. Is software giant Infosys changing all that? A working paper by HBS professors Tarun Khanna and Krishna Palepu looks at how globalization may—or may not—foster convergence of corporate governance.
by Tarun Khanna & Krishna Palepu

Tarun Khanna and Krishna Palepu are engaged in an ongoing project focused on understanding the convergence (or lack thereof) of corporate governance practices worldwide. That is, rules-on-books regarding corporate governance appear to converge in response to the pressures of global competition but not actual practices. This introduction and conclusion from a recent working paper, "Product and Labor Markets Globalization and Convergence of Corporate Governance: Evidence from Infosys and the Indian Software Industry," looks at corporate governance mechanisms developed by leading Indian software maker Infosys specifically, and other Indian firms more generally.

We document the under-studied effect that global product and labor markets can play in the convergence of corporate governance systems worldwide. This complements our understanding of the much more extensively studied role of capital markets in fostering such convergence through, for example, cross-border listings and global institutional investor activism.

The software industry offers a unique setting to test the role of global product and labor markets for two reasons. First, for a large part of the industry, there is a global market for technical talent. Second, capital plays a smaller role in software than in most other global industries. Thus, one can, to some extent, isolate the impact of global talent markets from the effect of global capital markets, though, admittedly, it is harder to disentangle the effects of global talent from global product markets.

Further, the emergence of the Indian software industry offers a unique experimental setting to ask whether globalization can promote convergence in corporate governance. This is because India is home to a globally competitive set of software powerhouses and because India is generally very far from world standards in what constitutes good corporate governance. The success and generally positive reputation of India's software firms—in contrast to most of India's other firms—provides at least surface credence to the idea that the global markets to which these firms are exposed has affected their governance systems.

This is the proposition that we explore in depth through a case study of the Indian software industry, and of one of India's leading software companies, Infosys. The popular press frequently cites Infosys as a model for sound corporate governance in India and, indeed, in Asia. In our research, we ask why it is that Infosys developed a reputation for being committed to shareholder value creation in a country, India, where corporate governance has, historically, not been a first-order concern. We also attempt to document the extent to which the corporate governance practices of Infosys are to be found in other Indian software firms and among Indian firms more generally.

Our interviews with the top management of Infosys, and related field research in India, suggest that exposure to global capital markets is a result, rather than a cause, of Infosys' decision to adopt world corporate governance standards. The proximate cause of the aspiration to good corporate governance at Infosys, in turn, is its need to attract talent with truly worldwide options, which in turn is necessitated by fierce global product market competition.

The emergence of the Indian software industry offers a unique experimental setting to ask whether globalization can promote convergence in corporate governance.
— Tarun Khanna and Krishna Palepu

Part of our narration of the Infosys corporate governance case study is a description of the efforts on the part of its management to help institutionalize good corporate governance in India. Indeed, diffusion of corporate governance practices in India is rendered partly feasible by a coalition between firms and regulators that serves to educate regulators and provides a blueprint for engineering a transition from a stakeholder to a shareholder-based corporate governance system.

Ultimately, however, the corporate governance standards at Infosys are the exception rather than the norm in India. Some data on corporate governance in India suggest that most firms fall far short of the Infosys benchmark, including most firms within the software industry. Further, our companion large-sample econometric analysis suggests that there is very little evidence that globalization of any form is correlated with adoption of U.S.-style corporate governance around the world. We therefore dedicate the last part of the paper to exploring why the effect of globalization on corporate governance convergence might be limited. The case study is based on interviews and field research at Infosys in early 2001, and with several dozen field interviews with competitors and regulators over the past three years.

In the remainder of the paper, we first briefly summarize the state-of-the-art literature on convergence of corporate governance. We then provide, in the following two sections, brief overviews of the Indian software industry and of the state of corporate governance in India in the 1990s. The subsequent two long sections constitute the analytical heart of the paper. We first consider three, non-mutually exclusive reasons for Infosys' adoption of corporate governance practices. As part of this section, we develop a model to demonstrate the interaction between Infosys, its competitors and the regulator in the corporate governance adoption process. The next section considers why the spillovers of Infosys corporate governance practices to other firms have ultimately been limited, and why globalization has not hastened corporate governance convergence in the aggregate. A final section presents our conclusions.

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Does product and labor market globalization cause convergence in corporate governance? Our case analysis suggests that the answer to this question is a constrained yes. A summary of our interpretation of the case follows.

Software firms', and especially Infosys', exposure to global product markets, first, and then to global talent markets, seems to have driven some adoption of shareholder-style corporate governance in India. In contrast to the stance taken by the existing literature on the convergence of corporate governance, we do not find much of a role for capital markets as drivers of this process. If anything, Infosys and some other Indian software firms accessed global capital markets long after their exposure to global product and global talent markets had driven them to adopt good corporate governance practices.

Infosys may have chosen to be a lead adopter of such practices in India for several reasons that we analyze—as a signal of its high quality, to benefit indirectly from positive externalities that its adoption decision had on other software firms in India, or as a consequence of Infosys' CEO's ideological bent. We discuss how this latter reason results in a proactive role taken by a coalition of firms in educating the regulators in how good corporate governance should be adopted.

However, the Infosys success story and its efforts at regulatory education notwithstanding, there is only limited diffusion of such practices to other firms in the software industry and to other firms in India. We explore several reasons why, in practice, the effects of globalization on corporate governance convergence are somewhat limited. It is possible that the effects of adoption decisions taken by Infosys, by other leading software firms, and by other leading firms in global industries in India, are only just beginning to be felt. That is, diffusion is only partial (see Exhibit 4).

In ongoing work, we are hand-collecting large sample data to shed light on both a positive and a normative question. The positive question has to do with quantifying various barriers to the diffusion of U.S.-style corporate governance. The normative question has to do with the extent to which such practices should diffuse in the emerging market context of India.