Corporate Ownership & Control / Volume 13, Issue 2, Winter 2016, Conference Issue 390 GOVERNANCE AND RISK INTERDEPENDENCIES AMONG FAMILY OWNED FIRMS Ramanathan Geeta*, Krishna Prasanna* * Indian Institute of Technology Madras Abstract The paper examines the role and impact of corporate governance mechanisms upon the operating risks of Indian listed firms. The recent global financial crisis was primarily attributed to excess risk–taking. This turmoil in the financial markets had a widespread effect on all industries and raised pertinent questions on the effectiveness of firm level governance practices. Impact of corporate governance practices, vide a constructed board governance index, has been examined on the risk taking behaviour of firms. Utilising a sample of 377 firms with yearly data for 6 years from 2006 to 2012, 2262 firm year observations have been analysed. Results confirm that firms with good corporate governance practices are effective in constraining excess risk taking. An instrumental variable approach is adopted to control for endogeneity, which also supports and substantiates the results. Keywords: Corporate Governance, Risk Behaviour, Operating Risks, Financial Crisis JEL codes: G23, G32, G34 1. INTRODUCTION Corporate Governance (CG) has metamorphosed from being a buzzword to a global movement. The spotlight on CG increased manifold in the wake of the spectacular financial crisis which was triggered by the fall of behemoths like Lehman Bros, Bear Sterns, and AIG in 2008. The unprecedented global financial crisis was primarily attributed to reckless risk taking which resulted in some of the largest insolvencies in history. The media blitzkrieg and backlash that followed, catapulted CG to the centre stage. This exposed the deficiencies of the sophisticated CG measures initiated by the most developed economies in the world, thereby disproving the theory of ‘Too big to fail’. The crisis had a widespread effect on all the industries across the nations. In the aftermath of the crisis, there was renewed interest among researchers, regulators, and the corporates to enhance the role of CG and bring about a paradigm shift in the existing CG mechanisms to avoid adverse effects on the economy. Although weak CG mechanisms did not induce the crisis, it nevertheless made the firms vulnerable to the financial crisis. Corporate governance is more relevant in determining firm performance during crisis periods, as the expropriation by owners is likely to increase and thus the crisis also exposes the CG quality to more scrutiny. Cornett et al., (2009) stated that firms with better internal CG mechanisms had higher rates of return during the financial crisis. Classens et al., (2012) reported that poor corporate governance increased financial volatility. Several cross-country governance studies explored the impact of the country’s CG regime whereas several single country studies focussed on the impact of firm level CG practices on the firm’s performance metrics. John et al., (2008) examined the impact of investor protection on corporate risk- taking in 39 countries and found a positive relationship between them. Nakano & Nguyen (2012) reported a negative but not a very significant relationship between board size and risk taking in Japanese companies. Using the governance metrics provided by the Institutional Shareholder Services (ISS), Jiraporn et al., (2015) reported that effective governance caused firms to exhibit less risky strategies. An effective CG mechanism is expected to detect and prevent excessive risks. The impact of CG mechanisms such as Board of directors, Ownership structure, Audit committee and the External auditor was examined by Sarkar et al., (2012) vide an index for 500 large Indian listed firms. They found that better corporate governance structures aid firms in earning substantially higher rates of return. In the recent past, researchers have analysed the role of multiple large shareholders (Mishra, 2011), investor protection (John et al., 2008), executive compensation (Coles et al., 2006) and creditor rights (Acharya et al., 2011) on corporate risk taking. Risk taking is a critical factor in the process of decision making and has important consequences on firm performance and survival. Previous research has not established the relationship between the collective impact of various corporate governance mechanisms and firms’ risk taking, especially in emerging markets. Larger effects in results are anticipated in emerging markets due to variation in the firms’ CG practices and also due to the unique phenomenon of family domination. The primary objective of this study is to explore the effect of key Corporate Governance attributes with special emphasis on board characteristics, on the operating risks of Indian listed firms. The Indian corporate landscape is