CORPORATE GOVERNANCE, FINANCIAL REPORTING QUAKITY, AND RISK TAKING IN THE INDIAN INSURANCE INDUSTRY

Abstract

The issue of corporate governance in financial institutions has been a longstanding concern, but it has garnered increasing attention from policymakers, regulators, and researchers in recent years, particularly following the global financial crisis (GFC) of 2007-09. The weakness of governance structure in the insurance industry became particularly evident with the massive bailout of the insurance “giant” - American International Group. However, the Indian insurance industry has escaped from the negative externalities of the GFC. Currently, the escalating instances of financial fraud, increasing insurance defaults, inadequate disclosures, and limited insurance accessibility underscore the importance of this issue in the insurance market in general and India in particular. The thesis thus delves into assessing the impact of corporate governance mechanisms, specifically pertaining to board structure, audit practices, and risk management, on insurers’ performance, reporting quality, and risk-taking behaviour in India. In particular, the thesis aims to address five key research objectives: i) to meta-analyse the effect of corporate governance on the performance and risk-taking behaviour of insurers; ii) to assess the evolution of corporate governance practices and the phenomenon of convergence in the governance practices of Indian insurers; iii) to scrutinise the impact of corporate governance on the performance of Indian insurance firms; iv) to explore how governance mechanisms influence the quality of financial reporting in the Indian insurance sector; and v) to examine the role of internal governance mechanisms and competition in shaping the risk-taking behaviour of Indian insurance firms. The analysis draws upon utilising data from both life and non-life Indian insurance firms, covering the period from 2014 to 2021. The study presents insightful findings employing principal component analysis, meta-subgroup analysis, dynamic panel approaches of two-step system generalised method of moments (GMM), threshold, and quantile regressions. The thesis draws the following key findings. First, the meta-analysis on corporate governance and insurer performance/risk-taking behaviour reveal that corporate governance significantly matters in determining insurers’ profitability and risk-taking behaviour, although the effects vary with particular governance attributes. The findings endorse a larger board size with greater independence and duality on the insurer board. Moderator analysis demonstrates that the efficacy of governance mechanisms varies among nations operating under different corporate governance systems. Thus, the thesis suggests implementing distinct governance norms for insurers aligned with the country’s internal environments instead of reproducing a common set of practices. Second, the empirical analysis observes that Indian insurers have made notable strides in enhancing their corporate governance quality over time. However, inadequacies still prevals, especially pertaining to audit and risk governance norms, so there is still ample potential for further enhancement. Overall, the board practices contribute the most, following audit norms in improving overall governance quality, with the most noticeable improvement evident in the first half of the study period (2014-2017). A decline is observed in the latter half of the period (2018-2021), possibly due to amendments in regulatory guidelines, the entry of new competitors and market turbulence. Third, the estimates of β- and σ- convergence suggest that inadequately-governed insurers are catching up with the better-governed insurers. However, at disaggregate levels, convergence is observed only with respect to board and audit governance practices. Additionally, results of conditional β suggest that insurers with a bigger size and higher market power are enduring more improvement in their governance structure. Fourth, it is apparent that overall corporate governance quality plays a substantial role in determining the performance and reporting quality of Indian insurers, among which board governance matters the most. The study thus suggests that governance norms in Indian insurance firms are working in the desired direction, especially regarding the board; nevertheless, there is a need to emphasise enhancing audit and risk governance practices. The findings suggest that merely filling the board with many non-executive directors does not serve the purpose; they should be truly independent to resolve potential agency issues in the Indian insurance firms. In addition, the board size, women directors, board meetings, audit committee size, risk committee size, and risk committee independence also exert a significant influence on insurers’ performance. We observe that frequent board meetings (including audit and risk committee meetings) increase costs and exacerbate discretionary accruals in Indian insurance firms. Therefore, we suggest that directors’ meetings should not be held only for compliance reasons. Fifth, results reveal a strong risk dynamism and the non-linear relationship between internal corporate governance, market competition, and risk-taking behaviour. We discover that a weakly or moderately governed insurers manage risk more effectively than strongly governed insurers, and the standalone effect of competition confirms the “Martinez-Miera and Repullo hypothesis” that suggests a U-shaped relationship between competition and risk-taking. Although the key finding of this study relates to the “complementary” relationship between internal corporate governance and market competition, it implies that competition plays a disciplinary role only in the presence of a robust internal governance structure or vice versa. Sixth, on the organisational front, we note that the effectiveness of governance mechanisms substantially varies across life and non-life insurers. Life insurers have outperformed non-life insurers concerning each governance aspect, and the catching-up effect is also more pronounced among life insurers. Further, concerning the relationship between governance, competition and risk-taking, our estimates hold a “substitution hypothesis” in the life insurance industry and a “complementary hypothesis” in the non-life insurance industry. The above insights derived from the thesis work carry significant implications for insurers, regulators, policymakers, and practitioners. The study sheds light on the unique governance challenges faced by insurance companies and goes beyond conventional governance practices. In the insurance business, wherein both equity and debt governance hold relevance, the thesis advocates for insurer regulators to adopt a multifaceted approach, integrating perspectives of resource dependency and stewardship alongside the traditional agency view when formulating or revising governance norms, especially in developing nations like India. Such an approach is deemed essential for fostering robust governance frameworks conducive to sustainable growth and stability within the insurance sector. The thesis observes that exclusively relying on competition to ensure the overall corporate governance effectiveness is not adequate in the Indian insurance industry; a robust internal governance structure is quintessential to enhance the growth of insurers facing intense competition. Moreover, the study observes that the life insurance industry as a whole is more stable despite the fact that it confronts greater managerial discretion. Non-life insurers, who are facing considerable losses in current times, need greater effort to improve their board autonomy and independence. The loss-making insurers must focus on adopting genuine governance practices rather than superficial adherence to governance codes. By doing so, they can optimise their risk-taking behaviour and ultimately enhance insurer value and reporting quality. In conclusion, the study recommends that mere compliance with governance norms alone does not optimise risk behaviour or improve insurer value; instead, the governance mechanisms should be operationally effective. This can be achieved by appointing more knowledgeable and experienced directors with financial expertise who can enhance the board’s monitoring capabilities in addressing potential agency issues, thereby augmenting insurer value.