Evidence from Infosys and the Indian Software Industry Author(S): Tarun Khanna and Krishna G

Globalization and Convergence in Corporate Governance: Evidence from Infosys and the Indian Software Industry Author(s): Tarun Khanna and Krishna G. Palepu Reviewed work(s): Source: Journal of International Business Studies, Vol. 35, No. 6 (Nov., 2004), pp. 484-507 Published by: Palgrave Macmillan Journals Stable URL: http://www.jstor.org/stable/3875235 . Accessed: 07/06/2012 08:20

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Globalization and convergence in corporate governance: evidence from Infosys and the Indian software industry

Tarun Khanna and Abstract KrishnaG Palepu Incontrast to the much-studiedrole of capitalmarkets in fosteringconvergence in corporategovernance practicesworldwide, we argue that the globalizationof HarvardBusiness School, Soldier's Field Rd., product and talent marketshas affected corporategovernance of firms in the Boston,MA, USA Indiansoftware industry. We model severalpossible reasons why a particularfirm, Infosys,has emerged as the exemplarof good corporategovernance in India, Correspondence: Professor T Khanna, traditionallya backwaterof corporategovernance practices. We furtheranalyze the HarvardBusiness School, Soldier's Field Rd., mannerin which Infosyshas attemptedto shape corporategovernance practices Boston, MA 02163, USA. in Indiamore generally,and why these attemptshave had limitedeffects thus far. Tel: 617 +1 495 6038; of InternationalBusiness Studies 35, 484-507. Fax: + 1 617 495 journal (2004) 0355; I E-mail:[email protected] doi:I 0. 057/palgrave.jibs.8400103

Keywords: corporategovernance; India; software; convergence

Introduction 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, although, 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 of India's software firms - in contrast Received: 23 generally positive reputation June 2003 to most of India's other firms - at least surface credence to Revised: 12 April 2004 provides Accepted: 30 April 2004 the idea that the global markets to which these firms are exposed Online publication date: 21 October 2004 has affected their governance systems. Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 485

This is the proposition that we explore in depth the-art literature on convergence of corporate through a case study of the Indian software governance. We then provide, in the following industry, and of one of India's leading software two sections, brief overviews of the Indian software companies, Infosys. The popular press frequently industry and of the state of corporate governance in cites Infosys as a model for sound corporate India in the 1990s. The subsequent two long governance in India and, indeed, in Asia.' In our sections constitute the analytical heart of the paper. research, we ask why it is that Infosys developed a We first consider three, non-mutually exclusive reputation for being committed to shareholder reasons for Infosys' adoption of corporate govern- value creation in a country, India, where corporate ance practices. As part of this section, we develop a governance has, historically, not been a first-order model to demonstrate the interaction between concern. We also attempt to document the extent Infosys, its competitors and the regulator in the to which the corporate governance practices of corporate governance adoption process. The next Infosys are to be found in other Indian software section considers why the spillovers of Infosys' firms and among Indian firms more generally. corporate governance practices to other firms have Our interviews with the top management of ultimately been limited, and why globalization has Infosys, and related field research in India, suggest not hastened corporate governance convergence that exposure to global capital markets is a result, in the aggregate. A final section presents our rather than a cause, of Infosys' decision to adopt conclusions. world corporate governance standards. The proximate cause of the aspiration to good corporate Theoretical perspectives on convergence in governance at Infosys, in turn, is its need to attract corporate governance talent with truly worldwide options, which in turn The idea of convergence in 'form', or literal is necessitated by fierce global product market convergence, postulates that efficiency considera- competition. tions and, implicitly, some form of global competi- Part of our narration of the Infosys corporate tion, will dictate that all nations will ultimately governance case study is a description of the efforts adopt the same corporate governance system. This on the part of its management to help institutio- view is most forcefully expressed by Hansmann and nalize good corporate governance in India. Indeed, Kraakman(2000) in their paper entitled 'The end of diffusion of corporate governance practices in India history for corporate law.' They, and numerous is rendered partly feasible by a coalition between earlier proponents of this view (see, for example, firms and regulators that serves to educate regula- Karmel, 1991), point to the current consensus that tors and provides a blueprint for engineering a the anointed system towards which convergence in transition from a stakeholder to a shareholder- form will occur is that of the US. Skeptics aver, based corporate governance system. however, that it is plausible that countries' systems Ultimately, however, the corporate governance can fall from grace - witness the favor in which standards at Infosys are the exception rather than Japan was held in the 1980s and early 1990s and its the norm in India. Some data on corporate current disfavor - suggesting that the current governance in India suggest that most firms fall consensus will be short-lived. Further, there have far short of the Infosys benchmark, including most been several theoretical arguments for pros and firms within the software industry. Further, our cons of different systems. Failure to agree on the companion large-sample econometric analysis sug- end-state of convergence, in turn, calls into ques- gests that there is very little evidence that globali- tion the idea of convergence in form.2 zation of any form is correlated with adoption of A less extreme perspective rests on the idea that US-style corporate governance around the world there is sufficient plasticity in each country's (Khanna et al., 2001). We therefore dedicate the last institutions so that the key function of corporate part of the paper to exploring why the effect of governance - the protection of resource providers - globalization on corporate governance convergence can be largely achieved within the constraints of might be limited. the country's institutions. This perspective is The case study is based on interviews and field referred to as 'functional convergence' by Gilson research at Infosys in early 2001, and with several (2000).3 The idea of functional convergence per se dozen field interviews with competitors and regu- has a long pedigree in social science (Merton, lators over the past three years. In the remainder of 1968), and has recently been applied to financial the paper, we first briefly summarize the state-of- systems more generally (Crane et al., 1995).

Journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 486

At the other extreme from the convergence in Technologies. Prominent examples from the latter form perspective is one that forcefully claims that category include Infosys and PCS. path dependence has led different economies to Approximately 70% of the cost structure of a very different corporate governance systems, and software company is accounted for by personnel that these are not easily dislodged, not even by related costs. India's initial entree into the software global competition (Bebchuk and Roe, 1999). One business has to do with its access to cheap talent. reason why even functional convergence might not India produces more engineers and scientists than obtain is that there remains considerable disagree- every country in the world other than the US. The ment about the functions of corporate governance. key feature of the talent is that it is much more Specifically, should corporate governance systems globally mobile than labor in general. Indians primarily protect providers of capital, or also cater (especially programmers), in particular, account to other stakeholders in the firm, notably labor for more than 40% of the HIB visas (temporary (Shleifer and Vishny, 1997; Tirole, 2001)? work visas) issued by the US to foreign talent. Whether convergence occurs in form or function, Further, the Indian diaspora, long-established some form of global competition is implicitly successfully in the US, has played a key role in assumed to be the proximate cause. Perhaps most facilitating the flow of talent back-and-forth emphasized is the idea that global institutional between India and the US (Kapurand Ramamurti, investors, largely originating from the US, will flex 2001). their muscle and compel firms that demand their Indian firms compete vigorously in the global funds to adopt corporate governance standards product market. Firms from countries like Russia, with which they are familiar.4 Also often empha- Ireland and the Philippines are prominently cited sized is the idea of a sorting of a country's firms, as direct competitors, for example. Software firms with the higher quality ones listing in centers of from advanced economies like the US are also global capital (most commonly, New York and indirect competitors, in that clients may choose London) and the lower quality ones remaining in between generally more sophisticated services from the home country, with resultant pressure on the these expensive advanced-economy firms and the local capital markets to upgrade (Coffee, 1999).s less sophisticated but cheaper services from emer- The consensus view on the causes of convergence ging economies. assigns considerably less importance to global What role has the government played in facil- product market competition forcing convergence, itating the operations of Indian firms? Heeks (1996) and none at all to global talent market competition points out that there have been fits and starts in the forcing convergence. liberalization process pre-1991. Since 1991, the government has largely stayed out of the way and The Indian software industry allowed the software industry to compete in an In this section, we focus on the role that the Indian unfettered way. As Zaheer and Rajan (2001) point software industry plays within the global software out, the last two areas to be deregulated were industry. The discussion is necessarily limited. The internet access in 1998 and international band- section draws on a variety of sources, including width provision in 1999. The party currently in Heeks (1996), Ghemawat et al. (1999) and Kapur power (as a leader of a coalition), the Bharatiya and Ramamurti (2001). Fuller accounts of the Janata Party (BJP),was the first to explicitly support software industry may also be found in these works. the software industry in its election manifesto. An As an organizing device, we first describe the supply interesting feature is that most of India's state and demand sides of the Indian software industry, governments have explicit information technology and then describe industry features that illuminate promotion policies and compete to attract firms to the industry equilibrium. Table 1 shows a timeline. their states. The formation of the industry lobbying group, NASSCOMM, provides an efficient means Supply side for dialogue between the private sector and the Firms in the industry include older firms diversify- various state and central governments. ing into software services, often from completely unrelated (in a product market sense) businesses, as Demand side well as de novo startups. Prominent firms in the Three types of demand for software services existed former category include Tata Consulting Services that were relevant to India.6 At the low end was the (TCS, part of the House of Tata), Satyam and Wipro demand by foreign firms for on-site services, also

journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 487

Table 1 The emergence of growth of Indiansoftware industry - a timeline (illustratingsalient events in the historyof the IndianSoftware Industry)

1950

Installation of the first mainframes in Indian research institutions (slow rate of computerization) 1960

1968 Tata industrial group setsup the first independent Indian software firm, Tata Consultancy Services (TCS). 1970

1974 TCS begins to export software in turn for being able to import hardware

1980 Other Indian software firms established (the beginning)

150,000 English-speaking engineers and I holders of science degrees graduate each 1988 y Industrybegins to flourish, with many new software companies )..oyear in India. Tata Infotech and list on 1990 oining Wipro BSE. Reformprogram launched by Indian 1991 Onsite services (Bodyshopping) government

1992 Satyam lists on the BSE Infosys lists on BSE 1993 Offshore methodolgy 1994

1998 Indian software exports mostly 1999 March - Infosys is the first Indian software company to list on the NASDAQ low-end services. Relyon transient demand for things like - the millenium (Y2K) bug June Securities & Exchange Board of India (SEBI) sets up a Committee onfixing Corporate Governance

October - Satyam is the second Indian software company to list on the NASDAQ

2000 January- SEBI adopts principles recommended by its Committee on Corporate Indian software companies begin to Governance move up the value chain. Most leading Indian software companies are June - Silverline Technologies lists on NYSE. Rediff.com lists on NASDAQ forging strong partnershipswith overseas partners. July - Aptech lists on LSE

October - Wipro lists on NYSE

referredto in a derogatory sense as 'bodyshopping'. advanced-economy multinational, where teams of This practice involved Indian programmers relocat- Indian programmers and some personnel from the ing to the host country, typically for a short period foreign company worked together for long time of time and for significantly lower wages than local periods and with more intensive knowledge programmers in the host country. Clients generally exchange. The third type of demand was a mixture received the services of the programmer 'bodies' between bodyshopping and the offshore develop- with much less by way of organizational knowledge ment centers. from the software firms. One reason why many Indian software companies started this way had to Equilibrium do with their lack of access to appropriate hardware Several indicators of India's success in the global in India, in turn caused by regulatory (typically software industry are worth reviewing. The Indian foreign exchange) restrictions. software industry grossed $5.7bn in revenues in The other type of demand was by foreign, 1999-2000, $4bn of which came from software primarily US companies, for Offshore Development exports. This represented a growth rate of 53% Centers. These were physical locations in India that over the prior year. Software exports were 10% of companies dedicated to the needs of a particular India's total exports. Software industry market

Journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 488 capitalization on Indian stock exchanges rose from institutions were never provided with any incen- $4bn in January 1999 to a high of $90bn, and tives to monitor. Pouring more money after a bad then, following the NASDAQ crash and its ripple loan, in the hope that the distressed firm would effect in India, settled at $55 bn by mid-2000. By find its way out of trouble, was consistent with the then, 185 of the Fortune 500 outsourced their objective of maximizing loans. Attempting to shut software requirements to India. down distressed firms was prohibitively costly. Given the cheap talent and the initial absence of Third, competition among financial intermediaries reputation, Indian firms started out at the low end was non-existent for several reasons. Regulations providing primarily bodyshopping services. They had eliminated the possibility of most bases of gradually built reputations for reliability and high competition. The Indian Banks Association (IBA) quality of services and began to provide more functioned as a de facto cartel, fixing wages, prices value-added services (Banerjee and Duflo, 2000). and service conditions. Firms granted a license By 1999-2000, offshore services, the more value- under the pre-1991 'license raj' more or less were added part of the Indian software firms' offerings, guaranteed financial support from state-run finan- had risen to 58% of export revenues from 5% in cial institutions. Finally, intermediaries, most of 1991-1992. Five of the nine software development whom were government owned, were not mon- centers in the world with CMM Level 5 ratings, the itored themselves. As of 2001, corporate govern- highest ratings on the predominant quality scale ance scandals were discussed almost routinely in developed for software at Carnegie-Mellon Univer- the Indian business media.10 sity, were located in India. Companies like General In addition to the absence of potential monitor- Electric, Citicorp and IBM had their only CMM- ing by banks, there were also constraints on certified operations in India rather than in the US.7 monitoring by external capital markets. The Com- The upgrading of the Indian software industry panies Act placed restrictions on the acquisition was expected to continue. Expected revenues by and transfer of shares, and so prevented the 2008 were set in the neighborhood of $87bn by a development of a market for corporate control. NASSCOMM-McKinseystudy, as long as govern- With half to two-thirds of the equity in any firm ment continued to remove bottlenecks for the being illiquid (since the enterpreneurs and the development of the software sector. Talent now financial institutions never sold their shares), take- increasingly captured a piece of the software pie, overs were difficult to implement. partly as a result of global pressure on domestic However, several positive developments occurred wages. A Jardine Fleming study suggested that the on the corporate governance front since India's costs of an Indian programmer had risen to as 1991 balance-of-payments crisis: (a) The Securities much as $3000/month (although this was still 1/3 and Exchange Board of India (SEBI)Act of 1992 of the costs of a US programmer). created a regulatory body with the explicit mandate It is worth emphasizing that the Indian software to improve the functioning of Indian financial industry was exposed to global product and global markets. (b) The incentives of the state-run finan- labor markets before raising capital overseas ever cial institutions to monitor were improved. They became an issue.8 began to be weaned off their historically privileged access to funds. The resulting need to access public The standards of corporate governance in capital markets made them more conscious of the India9 bad loans on their balance sheets. Deregulation of As late as the early 1990s, corporate governance was interest rates and the gradual elimination of not a well-understood concept in India. Indeed, consortium requirements increased competition until 1991, the objective of government policy was among the financial institutions. Private sector to maximize loans to the industrial sector in the mutual funds were allowed to compete with the belief that this would lead to industrial develop- state monopoly. (c) A takeover code was introduced ment and employment creation. Monitoring of the in late 1994, after a public outcry over legally loans was not a major priority. The major financial sanctioned price rigging.11 (d) Restrictions on the institutions, which were government owned and entry of foreign investors were eliminated and controlled, were often instructed not to disturb regulations on their investments were substantially management, and to side with them in the event of clarified. any dispute; they virtually never divested their However, Indian corporate governance was ownership stake in any firm. Second, financial still deficient for multiple reasons, including the

journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and KrishnaG Palepu 489 following: (a) SEBIhad found that it had insuffi- likely to be traded on a US stock exchange cient powers to police violations of regulations. It (P-value 0.02) and on the London Stock Exchange continued to adapt and modify regulations as it (P-value 0.08) and more likely to be listed on the learned more about how to regulate financial NYSE(P-value 0.01). Software firms garner a higher markets. (b) Takeovers continued to be difficult percentage of their revenues through exports given the paucity of timely information and high (P-value 0.01), are more likely to employ foreign transactions costs in both the primary and second- talent in senior managerial positions (P-value 0.01) ary equity markets.12 (c) There was still little and are somewhat more likely to employ a Big 5 competition among financial intermediaries. The accounting firm (P-value 0.12).13 state-run intermediaries were still saddled with bad loans, which affected their to act as moni- ability Corporate governance at Infosys tors. (d) Disclosure problems continued to abound. We describe corporate governance at one of India's Requirements under the Companies Act were not leading software companies, Infosys, the one most stringent. Financial results were published only at credited with adopting good corporate governance half-yearly intervals, and the absence of consoli- practices. A subsequent section considers reasons dated accounts reduced the transparency of firm why Infosys adopted the practices that it did and performance. the effects of this on other firms in the Some data from Credit Securities Ana- adoption Lyonnais software industry and in India more generally. lysis (CLSA)supports this assessment of the current state of Indian corporate governance. The data are from a set of questions regarding corporate govern- Brief introduction to Infosys ance administered to 482 companies in 24 emer- In 1981, seven software engineers started Infosys on ging markets in 2001. The companies are generally a shoestring $1000 budget. One of the seven, the ones of greater interest to foreign investors, ultimately the public face of the company, was typically characterized by some subset of the Narayan Murthy, a 1969 graduate of the Indian following characteristics - large size, greater equity Institute of Technology, Kanpur. The fledgling float and foreign listings. When we ranked coun- company immediately focused on the demands of tries by the mean corporate governance score the international market, perceiving there to be constructed by CLSA,we found that India ranked insignificant domestic opportunity. The company in about the middle. Since most countries in these grew slowly through the 1980s, almost going under data have poor average corporate governance (with in 1989. The early 1990s saw a confluence of two some exceptions like Hong Kong and Singapore), events - one internal to Infosys and one external. and since the selected companies are generally the Externally, a foreign exchange crisis prompted the better governed ones, this confirms the character- opening up of India to global competition and the ization offered above. scrapping of the stifling regulatory regime that had come to be known as the 'license raj.' Internally, Governance in the Indian software industry the departure of a key founder prompted introspec- The same CLSAdata, however, also point out that tion at Infosys as to the right way to capitalize on the corporate governance ratings of the software the new external opportunities. The contours of the firms are higher than those of other Indian firms. strategy that emerged were the following: shifting The mean ratings for software firms (of which there so as to do software development within India as are eight in the CLSAdata) and for non-software opposed to purely at foreign clients' sites; a firms (of which there are 72) are, respectively, 64.3 relentless focus on attracting and retaining talent; and 54.7 (minimum of 0 and maximum of 100), and conservative financing. Subsequent growth at with the difference statistically significantly with a the company was rapid. The company went public P-value of 0.02. The medians are, similarly, 62.9 and on the Bombay Stock Exchange in 1993, and on 53.8, with the difference statistically significant NASDAQ in 1999. It became the employer-of- with a P-value of 0.2. choice not just in the Indian software industry The data also confirm that software firms are, on but in India more broadly, was identified as the average, more exposed to global competition than public face of India's globally competitive software other Indian firms. To ratify this assertion, we industry and accepted as Asia's leading information supplemented CLSA data with a variety of indica- technology firm. Murthy, with his spartan tors of global competition. Software firms are more self-image, became a revered public figure and

journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 490 spearheaded a general drive towards professional- Board structureand practices ism throughout the Indian corporate sector. Infosys did not play as leading a role in ensuring a board that was comprised of independent directors, Corporate governance at Infosys but was quick to remedy this deficiency soon after A centerpiece of the Infosys success story was the the adoption of other corporate governance prac- attention paid to corporate governance. (See Table 2 tices. Currently, the company's board consists of for a timeline of the adoption of various corporate several outsiders, including several international governance practices.) Infosys prided itself on experts, and its practices for evaluating the perfor- several 'firsts' in the Indian context, disclosing mance of board members are considered cutting- these in its annual reports (Kuemmerle and Cough- edge. lin, 2000). Interestingly, eight of the twelve such However, the adoption of these various practices firsts had to do with adopting corporate governance were symptoms of a more resilient underlying practices far beyond those mandated by Indian attitude that is worth noting. Infosys developed corporate governance standards. We are cognizant an unusual reputation for probity, honesty and that the idea of functionalequivalence alluded to in transparency in all its dealings. Our interviews our earlier literature review suggests that this may revealed several illustrative examples, three of not be the only set of meaningful dimensions of the which are described briefly below (in chronological form which good corporate governance practices order): take. This critique, however, would apply to any chosen set of dimensions. (1) 'In 1984, when the company was working for Borland, it was importing software from the Financial reporting and disclosure US. At the time you had to pay customs duties Infosys was the first Indian company to follow US on the software (150%). Some companies GAAP (Generally Accepted Accounting Principles), creatively interpreted the law. To get around to value human resources and voluntarily disclose it companies would sell books (there was no such a valuation with the statement of accounts, to duty on books) and manuals with floppies. If value its brand and disclose this information with you had software that was worth $60, they the balance sheet, to distribute audited quarterly would say that the charge of the software was reports to all investors, to guarantee publication of $10 but the book to go with it was $50. So they audited annual balance sheets very soon after the were able to avoid the duty and achieve higher close of the fiscal year (typically by April 15 for a margins. Infosys refused to do this, and said March 31 year-end), to provide the audited balance they would rather sell the software at half- sheet in soft copy format (floppy disks and price (lower margins) than try to circumvent CD-ROM) to investors and to make the balance the law.' sheet available on the internet. These reporting (2) 'In 1992, Infosys gave a fixed price bid to a practices put Infosys at the leading edge of Indian company. The fixed price was based on practice in terms of financial reporting and dis- assumptions about the time and people it closure. would take, etc. After a short while on the project Infosys realized it had vastly under- Management compensation estimated what the cost/time requirement Infosys was one of the first companies to offer stock would be. They had two choices: (1) to try to options to all qualified employees (Kuemmerle and change the contract or (2) to honor the Coughlin, 2000), not just to senior management. contract. The law would have permitted The intention was to provide appropriate incen- some room for Infosys to back out, but they tives for the employees to create shareholder value, didn't. They put more people on the project and to share a part of the value created with the and honored the contract. 'Corporate govern- employees. Pay-for-performance was not adopted ance is about honoring your commitments; widely in India at this time.14 In fact, Indian to your customers, your employees, your regulations prohibited companies from distributing investors.' employee stock options. Infosys and the rest of the (3) 'Infosys collected a lot of money through its software industry, therefore, broke new ground in public offering in the early 1990s. It was this respect by lobbying the government to change waiting for the government to give it clear- the regulations. ance to invest that money in a subsidiary in

journal of International Business Studies in in Indian software TarunKhanna and Krishna G Convergence corporate governance Palepu 491

Table 2 Key events in Infosys'voluntary adoption of internationalcorporate governance standards (illustratingsalient events in the evolution of Infosys'corporate governance practices) Fromfounding (198 1) to 1986: Company founded on a shoestring budget of $1000 contributed by seven founders who left another software startup, PCS. Firstproject in New York.Global product company from the outset.

From 1986 to 1992: General reluctance to use debt. Financing mostly through profit retention. Founderscontinued to contribute through acceptance of lower-than-marketsalaries.

1989: 90% of Infosys revenues came from work done at client sites outside of India. Uncompromising exposure to global product markets.

1993: Among first-marketpriced IPOsin India (following removal of controls on IPO prices that existed prior to 1991).

1994: Reporting per US GAAPcaused by the need to present a clear picture to customers in the US.

1996: Move toward having independent directors. Such directors do not hold stock in the company.

1997: Development of an audit committee modeled on Blue Ribbon Committee's charter. Subsequently forms the standard for SEBI'srecommendations of what audit committee should look like.

1997: Webcast annual shareholder meeting. Post presentations made by CFO and CEOto analysts on the website.

1997: Quarterlyreporting initiated.

Late 1997: Formed compensation committee comprised entirely of independent directors. Committee determined senior management compensation. This committee was set up because both NYSEand NASDAQlistings required this.

Early1998: Disseminated all press releases on web site.

1998: Changed designations of senior management to suit global requirements to prepare for NASDAQlisting. Developed voluntary 10K form, which included an additional riskfactor section. In India, riskswere traditionallydescribed but not evaluated. In India, there was not the same absolute liabilityassociated with not analyzing risksas there was in the US.

March 1999: NASDAQlisting. Infosysvoluntarily opted to behave like a US domestic issuer, rather than subjecting itself to the less stringent standards of a foreign issuer.

2000: Infosyswas the first company worldwide to comply with new 20F regulations. Companies can file 10OQ's and 20F's within 90 days of end of quarter and 190 days of end of year. Infosystypically files within 8-9 days. Infosys also distributes quarterlyreports to US shareholders, though it is not required to.

Journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 492

the US. While it was waiting, several board out by an analysis of sources and uses of funds. members suggested that the money, instead of Specifically, we examined the line items 'Cash from sitting in the bank, should be invested in operations' and 'Cash used in investing activities' Indian stocks. Infosys lost quite a bit of money for Infosys and 166 other Indian software compa- in the ensuing transaction. Then there was the nies using data collected by the Center for Mon- question of what you tell people about what itoring the Indian Economy (Mumbai). These data happened. Most Indian companies would not for Infosys were available for each of six years have disclosed this, and Indian law would not (1995-2000) and were available for the other firms require such disclosure either. But Infosys for varying numbers of years (ranging from 1 to 6 decided to disclose the losses. The board was years). We used a 'difference measure' -'Cash used ready to face the wrath of the investors, and in investing activities' - 'Cash from operations' - as they figured they would be kicked out and our crude measure of need for capital. Infosys had replaced. But when the meeting came, the the third least need for capital out of 91 firms for investors said 'we respect what you have done. which data were available in 2000, second least out Because you have disclosed something when of 89 firms in 1999, second least out of 63 firms in you are in trouble, we can trust you.' The real 1998, sixth least out of 54 firms in 1997 and second indicator of good corporate governance is how least out of 46 firms in 1996. Further, when you respond in difficult times.' comparison of the difference measure between Infosys and other software firms was restricted to those 14 firms for which we had a reasonable time- Why did Infosys adopt good corporate series (6 years), Infosys was the second least capital governance measures? constrained of this set. Analytically this question can be answered in two In contrast, the primary reason cited for adoption parts. First, what factors explain Infosys' adoption of of the corporate governance measures is to gain good measures, and, perhaps equally impor- with customers in the did other software firms not credibility rough-and-tumble tantly, why (most) of the software market. This is similar measures?15 We consider in product especially adopt these so for turn. a company originating in a country with a baggage of negative corporate governance. Equally important is the need to be transparent and forth- Lack of market capital pressure coming with talent that has truly global options. executives and others that we interviewed Infosys Infosys remains an employer of choice on the in India are to dismiss the idea that the quick campuses of the leading Indian engineering and at were corporate governance practices Infosys management schools today.17 Of course, these adopted to attract capital. Thus, Jayanth Verma, a reasons are inter-related. The talent is needed in member of the Securities and Board of Exchange order to be able to successfully compete in the stated to India, us, product market. s The industry that probably needs capital the least, went To shed some further light on the kinds of factors after the international capital marketsmost aggressively.... that might have caused Infosys to adopt good In fact many of these companies don't know what to do we also conducted a small- with the . The corporate governance, capital they raised... pressures that the detailed of the latest annual capital markets can put on a company that doesn't need to sample analysis reports raise capital are next to nothing. of a set of Indian public companies that all have US listings - Videsh Sanchar Nigam Limited (VSNL,the In this regard, it is also worth noting that many of state-run telephone company); Dr. Reddy's Labora- the practices for which Infosys is lauded were tories (one of India's leading pharmaceutical com- adopted by the company far in advance of its panies); and Wipro Limited (a leading software NASDAQ listing and, indeed, in advance of its company and Infosys rival).19 Some results of this listing on the Bombay Stock Exchange in 1993. investigation are in Table 3. Unsurprisingly, all Further, a high reliance on internally generated conform to certain minimal standards required of capital, and strict adherence to a zero debt policy, companies listed on US exchanges, such as a suggests that the stringent governance standards reconciliation of the Indian GAAP accounting are unlikely to have been adopted purely to assuage statements with US GAAP. However, there is the concerns of external capital providers.16 That quite a bit of variation in the extent to which Infofys was relatively less in need of capital is borne other information is provided. The state-run VSNL

journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 493

Table 3 Comparisonof informationcontent of annual reportsof leading Indiancompanies with US listings Informationcategory Infosys Wipro Dr. Reddy'slabs VSNL Reconciliationwith US GAAP Yes Yes Yes Yes Profileof projects to signal technical competence Yes Yes Yes No Discussion of risksof investing Yesa Yes Yes Details of options grants Yesa Yes Minimal No Brandand intangible asset valuation Yes No Yes No Human resource valuation Yes No Yes No Reconciliationwith GAAPof countries other than India and US Yesb No No No Reconciliationwith recommendations of ad hoc Yes No No No corporate governance committees by country Responses to frequently asked questions for shareholders Yes No No No Honor rolls for valued employees Yes No No No Letterfrom Directors addressed to: Shareholders Stakeholders Stakeholders NA aThe informationin the Infosysannual report is considerablymore detailed than in the others. bThese reconciliationsare available in the languages of the country concerned, including in French,German and Japanese in the Infosysannual report. This table analyzes the kind of information available in the annual reports of four of India's leading companies that have issued American Depositary Receipts. Infosys and Wipro and prominent software companies. Dr. Reddy's Labs is one of India's leading pharmaceuticalcompanies. VSNL(Videsh Sanchar Nagar Ligam) is India'sstate-owned telephony provider, until very recently a monopoly. provides the least information, at least along the Why Infosys rather than other software firms? profiled dimensions, suggesting that mere need It is worth pondering why Infosys chose to adopt to access capital markets is unlikely to explain these corporate governance measures, while other Infosys' adoption patterns. Some would aver that firms, arguably comparably exposed to global this is an unfair comparison, given the lack of competition for products and talent, did not. We competitive pressures felt by what was until very consider three classes of possible, and non- recently a state monopoly.20 Dr. Reddy's Labora- mutually exclusive, explanations in sequence: tories, a pharmaceutical company in the vanguard unobserved heterogeneity in type; positive extern- of another knowledge-intensive industry, perhaps alities through a variety of means; and altruism on provides a fairer comparison. Indeed, it provides the part of Infosys management. very interesting information on the value of its intangible assets, for example. However, it too Firmasymmetries falls short of the Infosys report in a number of The possibility of (possibly unobserved) heteroge- ways. Thus, a company that clearly competes in neity among firms might suggest an answer. global product and capital markets, but arguably Specifically, it could be that Infosys was sufficiently not as much as software companies do in the different from other candidate software firms to global talent markets, does not disclose as much make adoption most beneficial for it (or to make as does Infosys. The final comparison with Wipro, adoption least costly for it). Stated differently, is perhaps the closest apples-to-apples comparison consider a situation where there is an informational within the software industry. Again we see that asymmetry between firms and customers or suppli- a company that is as much in the throes of ers, and there is a separating equilibrium under global product and talent competition falls short which some firms find it worthwhile - presumably of Infosys, suggesting ultimately that there is an less costly - to adopt corporate governance and Infosys-specific effect, in addition to whatever signal their type, while others do not (Spence, 1974; effect can be attributed to the global software Blass and Yafeh, 2001). Then the proportion of industry. firms that adopt good corporate governance proce- Table 4 shows the evolution of a set of corporate dures is determined entirely by the proportion of governance practices at Infosys, gleaned entirely 'good' firms in the population. from its annual reports. In every year from 1994 to One constraint to adopting good corporate 2001 more information relevant to corporate governance is immediately identifiable for several governance is released (with the exception of the of the other now-prominent firms in the indus- transition from 1999 to 2000 during which time try. Wipro, Tata Consultancy Services (TCS), and there is no change). Satyam are all part of broader business groups.21

Journalof InternationalBusiness Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 494

Table 4 Time-seriesevolution of informationcontent of Infosys'annual reports(illustrating evolution of the kindof informationavailable in Infosys'annual reportsover a 7-year period) Informationcategory 2001 2000 1999 1998 1997 1996 1995 1994

Reconciliationwith Yes Yes Yes Yes Yes Yes Missing No US GAAP Profileof projects Yes No No No No No Missing No to signal technical competence Discussion of risks Yes Yes Yes No No No Missing No of investing Details of options grants Yes Yes Yes Yes Yes No Missing No Brandand intangible Yes Yes Yes Yes Yes No Missing No asset valuation Human resource Yes Yes Yes Yes Yes Yes Missing No valuation Reconciliationwith Yes Yes Yes Yes No No Missing No GAAPof countries other than India and US Reconciliationwith Yes Yes Yes No No No Missing No recommendations of ad hoc corporate governance committees by country Responses to frequently Yes Yes Yes Yes No No Missing No asked questions for shareholders Honor rolls for valued Yes Yes Yes Yes Yes No Missing No employees Letterfrom Directors Share- Share- Share- Share- Share- Share- Missing Share- addressed to: holders holders holders holders holders holders holders EVAanalysis Yes Yes Yes Yes Yes Yes Yes No Organizationalchart Yes Yes Yes Yes Yes Yes No No

As such, their ability to reengineer their corporate corporate governance become more apparent. In governance systems may well be subjectto inertia of a such a world, it is possible to derive asymmetric sort that did not apply to a professionally managed equilibria where ex ante symmetric firms make startup like Infosys.22Note that one dimension of different (fixed in long run) choices, that is, some heterogeneity - degree of exposure to global competi- take the proverbial 'high road' and adopt good tion - should not be over-relied on here. Infosys, governance and profit in later stages, while others while more exposed to global competition than the forego good governance, and profit in earlier stages, median Indian software firm, is not more exposed and no firm finds it beneficial to switch given the than comparablyglobal TCS and Wipro. actions of others. The difference from the signaling A second mechanism can be sketched out where- model earlier is that there is no uncertainty in type by firms differ sufficiently in their type so that some here, but the heterogeneity among firms is driven find it worthwhile to adopt while others do not. by long-run decisions made at the outset. Suppose that governance choices are made at the outset by firms when each could either have Externalities incurred expenditure to adopt good governance or A second class of explanation has to do with could have foregone this investment possibility. Infosys' actions imposing positive externalities on Suppose further that firms expect that Indian the rest of the environment.23 However, this class industry will upgrade over time. In its early stages, of explanations must still answer the question: Was there is commodity demand and not much benefit Infosys better served by being the only (or one of to good corporate governance. In later stages, a small number) well-governed company in the demand for quality rises and benefits of good Indian software firmament, uniquely able, in the

journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 495 eyes of global customers, talent and customers, to Third, one can make the argument that the benefit from India's low-cost talent base? Or was benefits of corporate governance are uncertain Infosys better served by upgrading the corporate and that, once Infosys adopted and the benefits governance systems of other firms in India? became clear, others will become more willing to Answers to these questions depend on Infosys' adopt. This has the flavor of models of herd ability to capture some of the benefits of these behavior, such as those by Banerjee (1992) and by positive externalities in one of two ways. Either the Bikhchandani et al. (1992), which typically rely on externality imposed on the environment results in the revelation of some information to one party a lower cost of capital for Infosys or talent is easier and the gradual resolution of uncertainty to drive to attract, for example, through the diaspora adoption by other firms. community, as a result of their being a larger Finally, pressure might arise from a now-educated number of well-managed Indian software firms as regulator. Thus, we were told in our interviews: potential employers. We consider four distinct mechanisms through The fact that there were companies who moved forward which these positive externalities might arise: despite the lack of regulations, made the task of creating of customers and in requirements easier for regulators. Now the regulators can perceptions global providers 'If some of India's factor of say, leading companies can do this, so can markets; emergence specialized interme- you.' Today the implication of resistance is that you have diaries; resolution of uncertainty; and regulatory something to hide, and that is not a risk that companies are education. willing to take. So as a result of companies moving ahead of Regarding the first of these, note the quote by regulation made: resistance to change lower & demand for change higher. Both from the point of view of users of Mohandas Pai, Chief Financial Officer of Infosys and financial information and providers of financial informa- (Kuemmerle Coughlin, 2000), tion, people saw what better standardslooked like and they liked what they saw. We have learnedthat you can createwealth in a legal and ethical manner.We have a ... [big]competitive advantage Circumstantial evidence in favor of the 'educated our But we do not through transparency. want to just is most so simplykeep it for ourselves.We want to shareall our best regulator' hypothesis developed, we consider practiceswith all Indiancompanies and will evenhelp them this at some length. Infosys, and Murthy implementit. Thatis how you createmaximum value in all in particular, has played a central role in helping of India. diffuse good corporate governance practice. Aware of the barriers to good corporate governance, But Pai went further in comments to us that Murthy has gone out of his way to help circumvent that there is a emanat- implied positive externality them. Partof this effort has been through voluntary from surrounded enti- ing being by well-governed membership in various governmental and quasi- ties. Thus, governmental bodies that play a role in such diffusion. and other senior You are to the external and if Murthy managers always subject environment, a you can improveit, it will serveyou well. Forinstance, if played prominent role in helping design the globalcapital perceives India to be a greatplace to invest, Securities and Exchange Board of India's (SEBI) you're obviously going to have a greater number of guidelines on corporate governance. Murthy was a investorscoming to Indiato invest. And for that, it's not prominent member of the Kumar Mangalam Birla to have good just one company like Infosys that has good Committee on Governance. Interest- corporate standards.The whole Corporate governance thing changing if one examines the constituent list of is good for India, and obviously what is good for India, is ingly, the good for us. So our goal has been to work with everybody Birla committee, other than Birla himself, there is else to make a good external environment. no industrialist or representative of a company on the committee other than Murthy.25 Further, Second, Infosys' adoption of good corporate Murthy has served as chairman of NASSCOMM, governance might stimulate the development of the prominent software industry lobbying group specialized intermediaries, which, in turn, will from 1992 to 1994, and Nandan Nilekani, one of benefit other Indian software firms. For example, the Infosys founders, was a founding member of analysts, having been exposed to Infosys' superior NASSCOMM (Kuemmerle and Coughlin, 2000). disclosure practices, might demand the same from The various activities have resulted in some other companies. This is especially so as analyst mandated diffusion of corporate governance. That capabilities, normally stunted in an illiquid market, is, activities by SEBI, the Birla Committee, the themselves develop.24 Confederation of Indian Industry's (CII) corporate

journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 496 governance initiative - spurredalong by individuals international norms. It has also said that it would like Murthy - have institutionalized the idea that enforce some of these standards through modifica- corporate governance should spread. Note the Birla tions on currently lax listing requirements. Among committee's assessment that, to disseminate good the modifications to existing accounting practices corporate governance, 'a statutory rather than a are the following: Consolidation of accounts; voluntary code would be far more meaningful.' (p Disclosing accounting results by business segment xx). The idea was to get a critical mass of companies and geographic segment; Deferred tax accounting; signing on by fiat, and then to isolate detractors and Related party disclosures, especially to enforce and eventually shame them into adopting the the rights of the minority shareholder. standards. This was seen to be the way to get Another area where regulatory changes played a around those blocking adoption of such corporate role was in the adoption of employee stock options. governance standards. The phase-in of the SEBI Till recently, Indian laws prohibited the granting of regulations began on April 1, 2001. The top 200 stock options to employees, limiting companies' companies were to have complied by this date, and ability to align the incentives of employees with more companies will have to comply each year. The shareholders. The software industry was the first 200 companies that had to comply by April industry to be granted an exception to the rule, represent about 80-90% of the market capitaliza- thanks in part to the lobbying efforts of the tion that is usually traded, and are the cream of software industry association NASSCOMM. Once corporate India. this practice became widespread in the software The new SEBIguidelines mandate changes in two industry, other companies began facing pressure in broad areas. First, there are proposed amendments the labor market. As a result of lobbying by these to the board structure. In particular, the SEBI companies, the Indian government recently chan- guidelines suggest that the board have more ged the law, making it possible for all companies to independent directors and an audit committee. grant employee stock options. Several large com- The second broad area of improvement that is panies began to adopt this practice, even though mandated is improvement in the accounting the practice is currently far from being wide spread standards. This is somewhat tricky, since, unlike among Indian companies. the US. SEC, SEBIdoes not have direct oversight Figure 1 provides a schematic showing the over the accounting industry. SEBIhas thus left it (hypothesized) inter-relationships between some up to the accounting body to set standards closer to of these positive externality mechanisms.

Software companies need to compete globally *Globaltalent pool *Need to offer options as partof compensationpackage *Gainingcredibility with customers *GlobalM&A activity >

Voluntaryadoption of increaseddisclosure, independentdirectors, pay-for-performance

NASDAQ listings - * Rise to prominenceof existing industrylobby, NASSCOM Increasedinternational analyst coverage. Arrivalof foreign financial intermediaries.

Evolution of regulationto support Pressureon other IndianSoftware companies to and entrenchnew practices adopt similar corporategovernance practices

K Intermediationdepth increases

Pressureon other Industries

CorporateGovernance Convergence Figure 1 A schematic of the effects of Infosys corporate governance initiatives. This figure demonstrates hypothesized effects of Infosys' actions on Indianfinancial markets and on other Indian firms' corporate governance practices.

Journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 497

Altruism which there are (two) symmetric firms and in Spillover benefits of the sort considered above which outcomes are certain. The only asymmetry appear to our intuition to be likely to be realized is that firm 1 (to be thought of as Infosys) moves over the longer term. It is worth considering the first and firm 2 follows.26 Firm 1 has to decide possibility that some other (temporally) proximate whether to incur fixed costs of F to adopt good factor might have induced Infosys to undertake the corporate governance practices, in which case its costs of engaging in corporate governance reform marginal costs fall from c to 0. Here F is an even though it realized that other (possibly com- abstraction for the numerous and costly procedures peting) firms might free-ride off its efforts. that the firm must undertake to improve disclosure, A candidate factor is suggested by Murthy's and the cost of seeking independent directors and ideology, much discussed in the media, perhaps reformulating its board, etc. Similarly, c is an partly because his famously spartan lifestyle con- abstraction for the reduction in costs of seeking flicts in peoples' minds with his new-found wealth. either capital or talent once good governance is (This is, of course, one type of heterogeneity adopted. between Infosys and other firms - see Firm Subsequently, and contingent on firm l's deci- asymmetries above.) As he says, 'I believe that sion, firm 2 makes the same decision. In the final change happens, not because of many people, but period of the game, both firms compete in because one person starts to think and act differ- quantities with the inverse demand function given ently.' A related statement from SEBI member by P=l1-ql-q2, where the subscripts refer to firm Jayanth Verma is worth quoting here identities.27 We assume c

Journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 498 firms, where i {1l,2} denotes the firm in question altruism on the part of firm 1 is to model firm l's and j {y, n} corresponds to 'adopt corporate utility as driven not just by its own profits but by governance' and 'do not adopt corporate govern- those of firm 2 as well.28 Firm 2 continues to be ance', respectively. Thus, {ly, 2y} corresponds to modeled as a conventional profit maximizer. each of firms 1 and 2 adopting corporate governance practices. We describe the equilibria and the Proposition 3 (Altruism). For Fmax[c(1-c), c(2-c)/4] (ln, 2n} is the only (ly, 2y} is the only pure strategy SPNE. For F in pure strategySPNE. [4c(1-c)/9, 4c/9], (ly, 2n} and i{n, 2y} can each by SPNE.For F> 4c/9, i{n, 2n} is the only pure strategy There are substantial differences in outcome SPNE. relative to the simple model. Even when F is small firm 1 does not It does not find it The model does not admit of both firms enough, adopt. simple useful to incur the fixed costs twice in effect, since as an SPNE. The intuition is as adopting {ly, 2y} it derives sufficient from the fact that firm 2 follows. When F is small relative to the utility enough, will if it does not and from the resulting benefits which are in it adopt received, increasing c, that firm 2 earns in Note that makes sense for both firms to When F is profits equilibrium. adopt. even with altruism, there is no SPNE neither firm The intermedi- pure strategy large enough, adopts. where firms 1 and 2 adopt. ate range is more interesting. Here it makes sense we consider a model with both for one firm to incur the costs of Finally, regulator only adopting. and altruism. Firm is as This is once a firm it lowers its learning l's utility given, because, adopts, the sum of of firms 1 and 2, and costs and can more. Since before, by profits marginal produce firm 2 incurs no fixed costs of adoption if firm 1 has quantities are strategic substitutes (Bulow et al., adopted before it. 1985), over-production by the adopting firm induces the other to less. The produce negative 4 Learning and Altruism). is sufficient in this to make it Proposition (Regulator externality range For F<2(2-c)/4, and 2y} are pure uneconomical for the other firm to incur the fixed {ly, 2y} {ln, SPNE.For F> 2(2-c)/4, 2n} is the only costs of strategy {ln, adoption. pure strategySPNE. We now consider the following modification to incorporate the idea that the first firm to adopt This set of assumptions yields the broadest range helps the regulator devise procedures that facilitate of values of F for which (ly, 2y} is a pure strategy subsequent adoption by other firms. We model this SPNE. Relative to the regulator learning without by the simple devise of assuming that, if 1 adopts, 2 altruism model, the intuition here is that the first does not incur fixed costs F of adoption. firm internalizes the negative externality imposed the second firm's on itself. Altruism 2 For by adoption Proposition (Regulator Learning). thus induces it to even its own is the adopt though profits F<4c(1-c)/9, {ly, 2y} only pure strategy will be reduced firm 2's the by adoption. SPNE. For F in [4c(1-c)/9, 4c/9], {ln, 2y} is the of outcomes under the SPNE.For F> is the Graphically, range only pure strategy 4c/9, {ln, 2n} various model is in 3. SPNE. assumptions depicted Figure only pure strategy For each case, we indicate the pure strategy SPNE The outcome turns out not to be too different for a variety of ranges of F, with the ranges from the simple model. Part of the intuition is that expressed in terms of 'c'. the first firm knows that it is facilitating the The model helps us demonstrate a logically adoption of governance by the second firm. It consistent set of assumptions under which both realizes that it will not be in as good a position to firm 1, Infosys, will adopt corporate governance recoup its fixed cost investment (as it would be if and will take steps that facilitate firm 2's adoption the other firm, having to incur costs F, desisted of similar practices. Our interpretation is that, from the adoption). Consequently, it is less likely to indeed, it is the interplay between altruism and adopt in the first instance. regulatory learning that provides an important part We then consider an alternative modification to of the answer to the two questions posed at the the simple model. One way of capturing the idea of beginning on this section.

Journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and KrishnaG Palepu 499

Simple Model 0 F 4c(1-c)/9 4c/9 { ly, 2y} { ly, 2n} or{ In, 2y} {In, 2n}

RegulatorLearning 1F 0 4c(1-c)/9 4c/9 {ly, 2y { ln, 2y { ln, 2n}

Altruism I I 0 1F 0 { ln,2y} c(1-c) c(2-c)/4 {ln,2n} {ly, 2n} or { ln, 2y}

RegulatorLearning I plus Altruism 0 { ly, 2y} or {ln, 2y} c(2-c)/4 { In, 2n} Figure 3 Solving the game. This figure illustratesequilibrium outcomes for the simple game and for the several variantsof the game considered in the text.

In summary, it is unlikely that capital market are regarded as well governed. Some of this was pressures forced Infosys to adopt good corporate previewed in the comparison between Infosys and governance practices. Infosys was less pressured in Wipro, the latter regarded as a leading software this sense than firms in other industries, since firm. But even this comparison understates the software is not as capital intensive as many other differences since there are many software firms in industries, and also less pressured than other soft- India that are regarded as poorly governed. Some ware companies. It is at least plausible that summary data from CLSA, which we alluded to competition for talent and in the product market earlier, corroborates this impressionistic statement. induced such adoption, a conclusion also borne out While Infosys and Wipro have ratings of 93.3 and recently in Khanna et al. (2004) large sample 80.2, respectively, out of a possible maximum of analysis of foreign firms with commercial (product 100, other software firms fare considerably worse, or factor market)_links to the US. Finally, the with the lowest rating (among Indian software reasons that we present for adoption are not firms) of 40.2 given to Silverline. Indeed, the mutually exclusive. In particular, there may be standard deviation of the corporate governance other drivers of adoption of good practices that ratings is much higher for the software industry are unobserved by the researcher (or hard to than for other industries for which we have similar measure by her). We have clarified how one such numbers of observations (Biotechnology & Drugs attribute (altruism) might play out in the context of and Commercial Banks, for example). ambient regulatory learning. Larger sample econometric work also points to the same conclusion. In companion work using The limits of globalization in causing several data sets on corporate governance indica- convergence in corporate governance tors around the world (including the Credit Our focus on the Indian software industry, and Lyonnais data alluded to above), we find little on Infosys in particular, runs the risk of over- evidence of positive correlation between exposure estimating the likely effect of globalization on to either global product or global capital markets convergence in corporate governance. However, and adoption by large firms of US-style shareholder there are a few pieces of evidence that we can governance practices. We do find that exposure to present that suggest that globalization, whether of global talent markets is positively (and statistically the product, talent or capital markets, has limited significantly) correlated with the adoption of such effects on the corporate governance convergence in practices, although the effect is rather small. We the aggregate. also conduct a simple exercise where we ask how The first is based on the observation that there is much of the variation in corporate governance wide variation, even within the Indian software indicators is explained by industry effects vs industry, of the extent to which various firms country effects. The overwhelming conclusion,

journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 500 robust across all data sets, is that country effects of raising external capital, which, in turn, ensures explain far more of the variation than do industry that family control persists.31 effects. If we accept the plausible assumption that Finally, it may be that US-style corporate govern- globalization is likely to occur along industry lines, ance is less applicable to emerging markets. We it follows that there is not much convergence in develop this idea briefly in the next few paragraphs. either form or function.29 Consider that modern conventional wisdom sug- Finally, there are numerous anecdotal examples gests that maximizing returns to shareholders is the of circumstances wherein firms that were exposed most sensible role for corporate governance. The to global product markets have not adopted US- usual reasoning is that shareholders are uniquely style governance measures. Japanese and Korean deserving of protection because other stakeholders, firms in their heyday are examples of this phenom- notably labor, have the means to protect them- enon.30 selves (Shleifer and Vishny, 1997). Departures from We therefore devote the remainder of this section this point of view effectively maintain that share- to outlining several factors that might prevent holders can impose negative externalities on other convergence in corporate governance occurring as stakeholders and the latter do not necessarily have a result of exposure to global competition. The first the means to protect themselves.32 Tirole (2001) of these is to note that the 'signaling of quality' captures this conflict by describing the stakeholder story presented earlier itself suggests some limit to view of corporate governance as encompassing convergence. Poor quality firms will simply not both the idea that management should maximize find it worthwhile to adopt good corporate govern- the sum (utilitarian view) of utilities of all stake- ance in a separating equilibrium. holders, and the idea that there might be divided A second factor is to note the possibility that control, that is, divided between shareholders and there are, in fact, limited spillover effects between other stakeholders. the software industry and the domestic economy. How should this discussion be modified to suit Ghemawat and Patlibandla (1999) argue, for the realities of an emerging market like India? First, instance, that the software industry is a well- the idea that labor can protect itself against functioning island in an otherwise inefficient sea. expropriation by shareholders is less plausible in Indeed, the Indian software industry is efficient such a country for several reasons. The prospect of partly because it is insulated from other industries controlling shareholders reaping private benefits and more connected to the global economy. Thus, from companies that they control is vast. Further, unless a firm in some other industry is directly the court system does not function well enough to exposed to global competition, there will be limited check this. Finally, the absence of smoothly influence of globalization through the software functioning markets for human capital imply that industry channel. exploited talent cannot simply vote with its feet in Third, globalization might not be strong enough the face of shareholder-induced adversity. For all to overcome vested interests' ability to block these reasons, a plausible case can be made that change. For example, incumbent, often family- corporate governance should be sensitive to the owned and controlled, companies may perceive it interests of more than just shareholders. to be in their (explicit or implicit) interest to block Further, another usual argument - that of tract- the development of markets. It might be of explicit ability - that usually operates in favor of share- interest if, for example, their advantage is based on holder-based governance is weaker in emerging preferential access to local factors, including poli- markets. Tirole (2001) argues, for example, that one tical patronage (Olson, 1965; Fisman, 2001). It may cannot divine explicit incentives for managers, be of implicit interest if, for example, their very which are based on some observable and readily refusal to adopt good corporate governance is measurable measure of aggregate welfare of stake- strong enough to retard market development, an holders. The value of various relationships that the example of the path-dependence discussed by firm engages in are not generally observable on Bebchuk and Roe (1999). For a possible way in well-functioning markets, whereas relationships which this might happen consider that the equity with shareholders generally are. However, this last of old, family-owned companies does not gene- statement - having to do with the ease of devising a rally trade. So there is only limited reason for the metric of welfare of shareholders - is less true in quality and depth of financial intermediation to poorly functioning capital markets in emerging improve over time. This further reinforces the costs economies. Ceteris paribus, this tilts us more to the

journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and KrishnaG Palepu 501 side of stakeholder governance in much of corpo- a code that could draw on the work done by rate India than it would it an economy with well- international bodies that preceded it but to prepare functioning capital markets.33 a code to 'suit the Indian corporate environment, as Software may be an exception to this reasoning corporate governance frameworks are not exporta- partly because the global talent markets imply that ble.'34 Ultimately, the committee does not take a labor does have the option to vote with its feet, as it hard line. Item 4.2 of the report says that 'the were, if its wages are unsatisfactory. SEBImember fundamental objective of corporate governance is Verma explains, the 'enhancement of shareholder value, keeping in view the interests of other stakeholders." This is The software industry was uniquely positioned because it consistent with the idea that shareholder-style interacted with a very large number of stakeholders who have but not were accustomed to standards of not governance may some, universal, higher transparency; in India's market just investors but customers and even in many ways their applicability emerging setting. employees. The employees were knowledge workers who We acknowledge that we have circumvented the were more demanding and a much higher percentage of issue of whether or not Infosys' specific corporate employees who had a choice of where to go. The typical governance practices are the reason for its superior type of industrial worker probably does not have the same It be that the diffusion of such kind of both within the and as the performance. may mobility country outside, has not because the knowledge worker does. The balance of power in the practices happened perfor- software industry (or in a knowledge industry) is far less mance effects attributable to these specific practices heavily loaded in favor of the organization as it is in the are small. That is, there are functionally equivalent traditional industries. This is true of the customer base as ways of protecting resource providers that others well. When you are selling services to the global Fortune have In of this idea, have their choice of sources/service adopted. partial support 500, they obviously Khanna and show that business- providers from all around the world. Palepu (2003) group launched software firms, with different Further the power of talent may not be confined corporate governance practices, do not perform just to the software industry. Kapurand Ramamurti ambiguously more poorly than do firms with the (2001, 10) say that there are other Indian industries more conventional governance practices. where global competition endows talent with power - they include media, biotechnology and Conclusion pharmaceuticals and industries like accounting Does product and labor market globalization cause services and credit card processing, medical tran- convergence in corporate governance? Our case scriptions and call-centers. Bhuvenesh Singh, ana- analysis suggests that the answer to this question is lyst at Credit Suisse First Boston, suggested that a 'constrained yes. ' A summary of our interpreta- 'SEBIwas a bigger catalyst in terms of governance tion of the case follows. standards for companies outside of the IT sector.' Software firms', and especially Infosys', exposure The implication is that Infosys' governance prac- to global product markets, first, and then to global tices might naturally, or with Murthy's help, have talent markets, seems to have driven some adop- spread within the information technology sector. tion of shareholder-style corporate governance in However, global forces were insufficient, in and of India. In contrast to the stance taken by the themselves, to ensure good corporate governance existing literature on the convergence of corporate in other sectors in the economy. For this purpose, governance, we do not find much of a role for the analyst opined that the regulators needed to be capital markets as drivers of this process. If any- co-opted for diffusion to occur. The argument, thing, Infosys and some other Indian software firms then, is that the sort of shareholder-centered accessed global capital markets long after their governance brought to India by Infosys will be exposure to global product and global talent applicable in some sectors exposed to global markets had driven them to adopt good corporate competition, but probably not more broadly to governance practices. other parts of the economy. Infosys may have chosen to be a lead adopter of Indeed, Indian regulators have struggled with this such practices in India for several reasons that we issue. The Report of the Kumar Mangalam Birla analyze - as a signal of its high quality, to benefit Committee on Corporate Governance has the indirectly from positive externalities that its adop- following to say regarding the stakeholder vs tion decision had on other software firms in India, shareholder-centric view of corporate governance. or as a consequence of Infosys' CEO's ideological The committee's objective (Item 2.6) was to devise bent. We discuss how this latter reason results in a

Journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 502 pro-active role taken by a coalition of firms in Notes 'educating the regulators' in how good corporate 'See, for example, Krishnaand Khozem(2000). governance should be adopted. 2Bhide (1993) points out that there are pros and However, the Infosys success story and its efforts cons to a financial system with dispersed sharehold- at regulatory education notwithstanding, there is ings. Such a system encourages an active external only limited diffusion of such practices to other marketfor corporatecontrol, and thus can foster good firms in the software industry and to other firms in governance. On the other hand, the lack of a large India. We explore several reasons why, in practice, block shareholderwho can internalizethe externalities the effects of globalization on corporate govern- inherent in providing monitoring services also means ance convergence are somewhat limited. that shareholderswill not actively engage in internal It is possible that the effects of adoption decisions monitoring, but will choose to vote with their feet. taken by Infosys, by other leading software firms, Thus, there are tradeoffsinherent in differentsystems and by other leading firms in global industries in of corporate governance. India, are only just beginning to be felt.3s Perhaps 3Kaplan (1994) has provided some econometric the conclusion of limited diffusion (along the lines evidence of this for a particularaspect of corporate sketched out in Figure 1) is premature. In ongoing governance. Statistically, poorly performing CEOs work, we are hand-collecting large sample data to appear equally likely to be dismissed in the US, shed light on both a positive and a normative Germanyand Japan,despite the very differentformal question. The positive question has to do with systems in place. quantifying various barriers to the diffusion of US 4As an example, Tiger Fund forced SK Ttelecom, a style corporate governance. The normative ques- Koreanfirm belonging to the SK Group (chaebol) of tion has to do with the extent to which such companies,to abandonshareholder unfriendly practices. practices should diffuse in the emerging market Slsrael provides an example of such a sorting context of India. mechanism (Blassand Yafeh, 2001). The burgeoning number of global capital issues also suggests the importanceof this issue (Karolyi,1998). Of course, the Acknowledgements flight of high-qualityissuers might have the opposite We thank the management of Infosys for providing effect of causing a degeneration, or hollowing-out, of access and relevantinformation, Kat Pick for assistance the local capital market. Such concerns have been with several interviews in India, Joe Kogan for help expressed, for instance, in South Africa recently, as with econometric work that is closely related to this well as in Mexico (Moel, 1999). paper, SurajSrinivasan for his work on a companion 6lndian industry has generally played only a very paper on disclosure,and ChrisAllen, SarahEriksen and small role in other large parts of the global software Kathleen Ryan for their assistance with collecting industry, such as packaged software. We eschew relevant public-sourcesdata. Omkar Goswami (Chief discussion of these parts of the industryfor brevity. Economist, Confederation of Indian Industry and Also, we focus on export markets,rather than on the Board Member, Infosys), S Ramadorai(CEO, Tata domestic Indiansoftware market,since our interest is Consultancy Services), Fred Hu (Managing Director, in global competition in this paper. Goldman Sachs, Asia), Fritz Foley, Simon Johnson, 7Itmay be that qualityconcerns are greater when a BjornJorgensen, Joe Kogan, Greg Miller, RaviRama- firm is located in an environmentwith a reputationfor murti, JasjitSingh, Yishay Yafeh, BernardYeung, Sri poor governance and poor quality products. Perhaps Zaheer and the Global CorporateGovernance group USfirms do not find it necessaryto seek certificationof at the Harvard Business School provided helpful this sort. comments. We also benefited from discussions with 8Of course, portfolio investment into India has seminar audiences at the HBS/Tsinghua University occurred in parallel, with some increase following Conference on Global Corporate Governance in India's 1991 liberalization. Shanghai (July 2001), at the Academy of Management 9This section draws extensively from Khanna and Meetings in Washington, DC (August 2001) and at the Palepu (2000). William Davidson Institute and Aspen ISIB-sponsored 10Two recent corporate governance disasters indi- conference on 'Impact of Cross-border Interactions cate the state of affairs in 2001. The celebrated Ketan on Social Institutions' in Aspen (September 2001). Parekh scandal, named after the protagonist broker, Comments from the editor, Arie Lewin, and two involves banks lending money to unscrupulous entre- anonymous reviewers greatly improved the paper. preneurs to invest in, and thereby exacerbate, India's

journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and KrishnaG Palepu 503 information technology-led stock market bubble, implausible,in our opinion, that this reverse causality with ultimatelydisastrous consequences. The second captures realityentirely. has to do with the failure of the Unit Trust of India, 16Relatedlynote that Azim Premji,CEO of another the state-run mutual fund in which tens of millions leading Indian software company, Wipro, lists the of Indians have their life-savings invested, and its following reasons for his company's recent NYSE unprecedented 'repurchase freeze' which prevents listing: (1) obtain acquisition currency, (2) retain savers from redeeming their savings. The Ministryof talent, (3) strengthen brand and credibilityand (4) Finance has endured heavy criticism for its inept impose disciplineon organization(Ramamurti, 2000). handling of the UTIaffair, especially since problems This list of reasons assigns only partialimportance to at the fund were apparent and discussed in the capital marketfactors. country's Parliamentand in the media in 1994 and 17We lack original data to make this point persua- 1998. The situation is perhaps best summarized by sively. Note, however, that Infosyswas judged 'India's the scathing critique issued by ex-Finance Minister Best Employer' by the first Business Today-Hewitt Manmohan Singh, the architect of India's 1991 Survey conducted in December of 2000. (Business reforms,'First and foremost, we need to improve the Today is one of India'sleading business magazines.) quality of governance in this country. Making a 18Indeed, it is possible to overstate this distinction mockeryof the system, not enforcing the law, letting between globalization of capital vs other kinds of respectivestate governments play havoc with law and markets. For instance, should listing overseas to be order, having non-uniformity in implementation of able to issue dollar-denominatedoptions to talent be law depending on the status of the persons involved classified as a capital market effect or one caused by and letting loose an era of extortions either through exposure to global talent markets?We are conscious of direct ransom or through bribery in every field of this difficulty,but nonetheless concurwith observersat life, including the judiciary, have played havoc on Infosysthat access to capital, in some intuitivesense, is the minds of people' (BusinessIndia, August 6-19, not the driverof adoption of severalof these corporate 2001, 48). governance practices. "In 1993-1994, many firms issued preferential 19Botosan(1997) constructsa disclosureindex for a equity allotments to the controlling shareholders at sample of US companies by similarly examining a steeply discounted prices. more comprehensive(but also ultimatelyad hoc) set of 12A detailed account can be found in SEBI(1994). indicators in annual reports, and shows these to be The need to transact physically imposes limits on related to the cost of the firm'sequity capital. tradingvolumes and on the speed at which orderscan 20Theoreticalwork on the effect of competition on be handled. With the open outcry system (as opposed disclosure investigates whether mandatory disclosure to screen-basedtrading), it is difficultto establishaudit (regulatoryfiat) is necessaryin the face of competition, trails.There were no depositories, making settlement and how disclosurevaries with the nature of competi- difficult(and no legislativemeans to establish deposi- tion and with the degree of informationasymmetry tories). Trades were often consummated outside the between managers and economic agents outside the exchange. This left a lot of room for manipulation, firm. See, for example, Verrecchia(1983), Dye (1985) with cases of fraud becoming legion. and Darrough(1993). 13However,there is no statisticallysignificant differ- 21Businessgroups are collections of legally indepen- ence between software and non-softwarefirms in the dent firms, typically diversified across a range of proportionof equity held by institutionalinvestors. industries, often controlled by a single family. The 14Note that Wipro had a stock ownership plan for firms in a group are linked by several formal and senior employees dating back to the mid-1980s. informalties. Argumentscan be made both in favorof, 151tis prudent to point out the possibilityof reverse and against, the idea that groups would adopt better causality in our reasoning regarding why Infosys governance techniques (Khanna, 2000). Here, a adopted good corporate governance practices. While possible rationalization of Infosys adopting good we reason that good corporate governance yielded corporate governance, and some group affiliated factor market advantages that helped Infosys succeed, software firms not doing so, is as follows. Groups it could be that Infosys succeeded for reasons had access to other sources of factor inputs and did unrelated to corporate governance, and subsequently not need to rely on external markets - hence did not chose to invest available resources in adopting new feel governance pressures to the same extent. practices. At a minimum, given the talent that flocks to 22Lest these business groups are tarred with too Infosys in the domestic Indian labor markets, it is broad a brush, note that TCS is, by most accounts,

Journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 504 credited with 'starting' the Indian software industry. altruism,although see Akerlofand Kranton(2000) for In the wake of IBM's exit from India, it took the a recent related attempt. reputation and resources of India's preeminent and 29Thecompanion work is with Joe Kogan (Khanna reputablebusiness group, the House of Tata,to create et al., 2001). The finding of the importanceof country a startupin the software space to partiallyfill the void effects does not, however, imply that convergence left by IBM. It is hard to see how a de novo might not occur in selected industries,like software. entrepreneur - such as Infosys - could have done this 30Weare gratefulto FredHu of Goldman Sachs Asia at the time. Khanna and Palepu (2003) discuss the for this observation. historicalevolution of the Indiansoftware industry. 31Further, since state-runenterprises are notoriously 23Fora broaderdiscussion of the software industry's inefficient, and restructuringthem involves politically effect on India,see Aroraand Athreye(2001). unpalatablejob losses, these cannot provide a fillipto 24A similardynamic was observed in Chile (Khanna the development of marketintermediaries. and Wu, 1998) following Compafia de Telefonos de 321ntheir analysisof German co-determination,for Chile's (CTC)first issuance of an AmericanDepositary example, Gorton and Schmidt (2000) show that, Receipt(ADR) in Chile in 1990. Domestic intermedia- when labor has control rights, it affects the objective tion developed considerablythereafter in a way that function of the firm, suggesting that labor did not see practitionersin Chile's financial markets opine is at itself as adequately protected when it did not have least partly causally related to the foreign listings of control rights. They also show that the interests of CTCand others that followed it. labor are often not aligned with those of shareholders, 25Such other businessmen as are present on the setting up the possibility of there being a negative committee are there in different capacities, as repre- externalityif either laboror capital controlledthe firm. sentatives of other bodies. Other members of the 33Berglofand von Thadden (1999) also argue that committees are not industrialistsper se but members corporate governance in developing countries should of intermediariesresponsible for the implementation reflect broaderconsiderations than simply shareholder of corporate governance - such as accountants, value maximization.Of course, this does not undercut auditors,consultants and government representatives. the observationthat designing corporate governance 26Thisis an important asymmetry because we are systems that respond to stakeholderwelfare is indeed interested in the diffusionof governance from Infosys hard. Tirole(2001) suggests that the best one might to other firms. A simultaneous move game does not do in some circumstances is to hire an idealist, capture this. We do not model a production stage uniquely motivated to be honest. Indeed, Murthy between firm 1's adoption decision and firm 2's. This appears to be just such a man. biases us away from derivinga conclusionwhere firm 1 34Existingreports included Cadbury Committee in adopts, since firm 1 would benefit from its superior the UK, OECDCode on Corporate Governance, The governance (relativeto firm 2) in this interval. Blue RibbonCommittee on CorporateGovernance in 27Admittedly,there is nothing particularto the the US, Report of the Greenburycommittee, Com- software industryin the way in which we set up the bined code of the London Stock Exchange, and the model. The model investigatesthe adoption decisions Confederationof IndianIndustries' Code of Corporate of any set of competing firms, and abstractsfrom the Governance. across-industrydiffusion part of the Indianstory. 35Notealso that perhapsthe bigger and longer-term 28Suchan objective function for Infosysis implicitly effect that Narayan Murthy'sstance and actions will motivated by two assumptions - first, that Murthy have on the Indian private sector is through his, derives some utilityfrom such altruism,and, second, perhaps inadvertentlyassumed, role as an exemplar that he exercisessufficient influence on the firmfor this of entrepreneurshipin an economy where cynicism to be modeled as affecting the firm's objective about business ineffectivenessand bureaucraticstran- function. Public information suggests that each of gleholds were rife. We do not develop this notion these assumptions is not without foundation. Econo- here further, as it is somewhat outside this paper's mists have not made much progress on modeling purview.

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(2001) 'Global competition If {ly}, {2y} iff (1-2c)2/3 < 1/9-F, or F<4c(1-c)]/9. and corporate governance convergence: a cross-country If {ln}, {2y} iff (1 + c)2/9-F> (1-c)2/9, or F<4c/9.

Journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 506

Therefore, there are three interesting ranges of F Game Tree for the Model with Altruism to consider for firm l's decision. Let F< 4c(1-c)/9: Firm 2's 2 adopts (1/4, 1/4) adoption fly} iff 1/9-F>(1-2c)2/9, or F< 4c(1-c)/9, which decision is true. In this range F is small enough that fly, 2y} results. Let F > Iadopts 4c/9: d 2 does not + (1-2c)2/4 {ly} iff (1 - c)219-F> (1-c)2/9, or F<4c/9, which adopt c/2 (1-2c)2/4, cannot be true. Firm I's In this F is that adoption 2 does not range large enough (In, 2n} decision (1-c)2/4, results. adopt (1_-c)2/4 Let Fe [4c(1-c)/9, 4c/9]: 1 does not {ly} iff (1 + c)2/9-F> (1-2c)2/9, or F<3c(2-c)/9. adopt For 3c(2-c)/9>4c/9, and so 2n} Firm 2's c<2/3, {ly, adoption results. decision 2 adopts 1/4, 1/4 For c>2/3, 3c(2-c)/9 e [4c(1-c)/9, 4c/9], so outcome depends on exact value of F. For Fr [4c(1-c)/9, 3c(2-c)/9], fly, 2n} results. As in the earlier proofs, consider firm 2's decision For Fe [3c(2-c)/9, 4c/9], f{n, 2y} results. first. Hence the result. O- If {lyl, {2y) iff 1/4-F>(1-2c)2/4, or F (1-c)2/4, or F the (for values, c(1-c) c(2-c)/4). production, by assumption, optimal quantities Let chosen at each node of the tree are F which cannot be true. We have to factor in firm decision to incur {lyl 1/4-F, only l's So results. the fixed that firm 2's fixed costs will {ln, 2y} costs, knowing Let Fe be zero if it and firm 2's decision [c(2-c)/4, c(1-c)]: subsequently does, iff which to incur the fixed costs if firm 1 chooses not to. flyl 1/4-F-F> (1-c)2/4, or F (1-2c)2/9, always Let F > true. c(1-c): + If iff or F< {ly} iff c/2 (1-2c)2/4-F> (1-c)2/4, or F (1-c)2/9, 4c/9. This turns out not to be in the case where there are two of F to possible Therefore, interesting ranges So results. consider for firm decision. c<2/3. {ln, 2n} l's Case 2: c > these > Let F< 2/3 (for values, c(2-c)/4 c(1-c)). 4c/9: Let F < iff or c(1-c): {ly} 1/9-F> (1-2c)2/9, F<4c(1-c)/9. as in the above results. For results. Exactly case, {ln, 2n} F<4c(1-c)/9, fly, 2y} LetFe [c(1-c), c(2-c)/4]: For Fe [4c(1-c)/9, 4c/9], {ln, results. 2y} iff + (1-2c)2/4-F> 1/4-F, which turns Let F > 4c/9: {ly} c/2 out to be true for all c> 1/2 iff or which fly} 1/9-F> (1-c)2/9, F fly, 2n} 4c/9. Let F > So c(2-c)/4: {ln, 2n} results. as before iff But this is Hence the result. Exactly flyl F 1, which is ruled out by the assumption needed for interior solutions. So {ln, 2n} Proof of Proposition 3 (Altruism). Here the payoffs results. on the nodes of the game tree must be modified Combining the cases, we have: for the different objective function of firm 1. Firm 1 Fmax[c(l-c), c(2-c)/4]: f{n, 2n}. payoffs for each node. Hence the result. D

Journal of International Business Studies Convergence in corporate governance in Indian software TarunKhanna and Krishna G Palepu 507

Proof of Proposition 4 (RegulatorLearning and About the authors Altruism).Here the payoffs from the altruism game Tarun Khanna is the Jorge Paulo Lemann tree in Proposition 3 apply. In addition, as in Professor at the Harvard Business School where His Proposition 2, firm l's incurring of fixed costs he heads the required Strategy course. ensure that firm 2 does not have to incur these research is focused on the building of world- costs. We proceed by backwards induction as class companies from emerging markets. He is before, considering firm 2's decision first. particularly interested in the strategies of multi- If {ly}, {2y} iff 1/4>(1-2c)2/4, which is always nationals and indigenous entrepreneurs in China true. So {ly, 2y} results. and India. If {ln}, {2y} iff 1/4-F> (1-c)2/4, or F 1/4-F. (Here the -F term on RHSis Harvard Business School. His research interests are and of what firm 2 spends if {ln}, which enters l's utility.) in the areas of corporate governance strategy in an international So 1 is indifferent. Either {ln, 2y} or {ly, 2y} results. companies operating in the US Let F> c(2-c)/4: context. His recent work focuses on building world- {ly} iff 1/4-F>(1-c)2/4, or F

Acceptedby Arie Lewin, Editor in Chief 30 April 2004. This paper has been with the author for one revision.

journal of International Business Studies