corporate governance and financial management decisions...on the basis of the above financial...

Special Issue

February 2016

INTERNATIONAL JOURNAL OF HUMANITIES AND

CULTURAL STUDIES ISSN 2356-5926

http://www.ijhcs.com/index.php/ijhcs/index 335

Corporate Governance and Financial Management Decisions

Hadi Enzaei

M.S. in Accounting, Islamic Azad University, Rasht Branch, Iran Corresponding Author: [email protected]

Abbas Ali Daryaei

Imam Khomeini International University, Qazvin, Iran [email protected]

Abstract

While the relationship between corporate governance mechanisms and financial management

decisions has been widely researched, the empirical evidence has provided mixed results. This study applies panel data regression techniques to 880 firm-year observations of non-financial

Iranian listed firms during 2006–2013 to examine the relationship between corporate governance mechanisms including percentage of institutional shareholders and blockholders,

audit quality as well as financial management decisions. In this research, short- and long-term investments were used as financial management decisions proxies. The results show that

percentage of institutional shareholders has a positive and significant relationship with financial management decisions proxies. It is recommended that Tehran stock exchange prepare

information on corporate governance score and provide such information to investors to be taken into account in their decision-makings.

Keywords: Corporate Governance Mechanisms, Financial Management Decisions, Audit

Quality.

mailto:[email protected]

Special Issue

February 2016



http://www.ijhcs.com/index.php/ijhcs/index Page 1336

1. Introduction

Today, firms are known as the economic pillar of societies in wealth creation, employment, and investment attraction (Ameer, 2010,. And Dastgir and Honarmand,. 2014). Protecting the rights

of shareholders, providing information transparency, and accepting corporate social responsibilities are among the major factors that have attracted attentions more than before.

Corporate governance rules are a set of regulations among firms' shareholders, managers, and auditors that guarantee the establishment of a control system to protect the rights of minor

shareholders and the shareholders community, and prevent social abuse. Today, protecting the public interest and the rights of shareholders, promoting information transparency, and requiring

firms to assume social responsibilities are among highest goals, which require strict criteria and appropriate executive mechanisms; the most important of which is corporate governance system.

Main objectives of businesses include short-term profitability and long-term weal creation for owners. This is realized by making logical decisions in investment processes. Financial

management decisions proxies include areas related to income, investments, and corporate performance management (Panayiotis et al, 2014). One of the major aspects of financial

management is to make decisions on investments. Investing should be made in relation to the investments of the majority of shareholders. Managers should seek short-term investments.

Taking corporate governance mechanisms into account, this research discussed the way such indices affect financial management decisions proxies in the listed firms in Tehran Stock

Exchange by presenting detailed data and statistics. By doing so, more relevant guidelines are provided to planners and policy makers to make correct and timely decisions through a detailed

understanding of various aspects of corporate governance mechanisms and executive policies relative to the respective corporate financial performance management (Kim et al, 2013). This

research examines whether there is a significant relationship between corporate governance mechanisms and financial management decisions proxies.

The remainder of the paper is organized as follows. Section 2 provides literature review and hypothesis development. Section 3 describes methodology. Section 4 presents the main statistical

results while section 5 discusses the results and draws some conclusions.

2. Literature Review and Hypothesis Development

Various definitions have been given on the concepts of corporate governance principles by responsible institutions and experts. For instance, in the introduction to corporate governance, it

has been defined as one of the major elements in improving economic efficiency and growth and gaining investors’ trust. Principles of corporate governance deal with the relations among

management, board of directors, shareholders, and other stakeholders of a firm; they provide a structure through which the firm’s objectives are set and methods to achieve those objectives and

monitor performance are determined. Favorable corporate governance should encourage firms' board of directors and management to follow up the objectives that are in favor of the firm and

shareholders and facilitate effective supervision over the process. It might be helpful to give a

Special Issue

February 2016




number of definitions for corporate governance among hundreds of proposed definitions, since it

can be used to provide a comprehensive definition for corporate governance (Dastgir and Honarmand, 2014) The definitions start from a limited and descriptive perspective of the

fundamental role of corporate governance. The definition of International Federation of Accountants (IFAC) for corporate governance in 2004 is as follows: “Corporate governance

(enterprise governance) includes a number of responsibilities and employed methods by respective board of directors and executive managers aiming at specifying a strategic direction,

which guarantees achievement of objectives, control of risks and responsible use of resources.” In 1992, Cadbury defined corporate governance as “a system by which firms are directed and

controlled.” In 1994, Parkinson stated, “Corporate governance is the supervision and control process for guaranteeing that the manager acts in accordance with shareholders' interests”. The

organizational charts of all well-established institutes and firms consider financial management under such positions as financial deputy general, accounting deputy, and financial assistant. It is

observed under the supervision of offices accounting department, treasury, warehouses accounting, property accounting, production accounting, sales accounting, property accounting

… and finally bookkeeping accounting. It is supervised by the financial department of offices for current operations' budget and control of ongoing costs, capital budget administration for

financing and controlling costs of projects, pricing of products and services, strategic financial planning formulation, economic analyses, profit planning, financial contracts affairs, and

financial statements' statistics. These two departments have separate job descriptions; however, their activities are very close to each other in practice, as the data prepared in one department are

often used as a basis for the measures of the other department (Panayiotis et al, 2014). On the basis of the above financial management usually plays a central role along with

organizational management. Economic aspects are thus evaluated in all firms and are considered with high sensitivity. Therefore, financial managers can play a major role in the strategic

planning of organizations and all the organizations' decisions may depend on his analysis. The major tasks of financial budgeting managers include financing, evaluating capital projects,

planning and implementing financial policies, recording, maintaining, and processing all financial information with due regard for principles, laws, and regulations through exercising adequate control over organization’s occupational health, and taking effective and optimal

decisions for senior managers in the organization. Kim et al. (2013) examined the effect of the adequacy of corporate governance on performance

of the manufacturing companies in South Korea. Most studies on corporate governance selected the agency theory, examining the regulatory role of governance structure from the perspective of

shareholders and testing such hypotheses as “good corporate governance structure leads to lower agency costs and ultimately increased shareholders' value”. Despite such hypotheses which

address this matter from the shareholders’ perspective, this research examines governance structure in general from the perspective of stakeholders and discusses the claim that “a firm's

ultimate objective should be the increase of stakeholders’ value rather than a simple increase in

Special Issue

February 2016




shareholders’ value”. Multiple regression analysis was used to examine the effect of corporate

governance adequacy on the performance of large manufacturing companies. The results of data analysis pointed to a statistically significant relationship between corporate governance adequacy

and financial performance. Panayiotis et al. (2014) showed a significant relationship among the major descriptive indices of corporate governance of board of directors’ structure, percentage of

institutional investors, and percentage of executive managers, and corporate performance. According to the results, performance in marine firms improved with the alleviation of

agency problems and the enhancement of financial management decisions proxies. Malekian and Daryaei (2011) studied the relationship between ownership and corporate characteristics and

corporate governance structure of the listed firms in Tehran Stock Exchange. They concluded that the role of non-executive managers in managing firm’s affairs and supervising executive

managers has not been realized and blockholders were unable to use their power, ability, and facilities to enhance monitoring indices. Meanwhile, institutional shareholders improved

monitoring and regulatory indices in firms to the extent possible. Dastgir and Honarmand (2014) introduced corporate governance as a focal point in accounting and financial management

literature, as it is believed that corporate governance mechanisms employ potentials that directly influence investors’ ability of forcing management to efficiently use available organizational

resources. Working capital management is another sector that plays a crucial role in the management structure of firms. Inefficient working capital management policies can be the result

of poor corporate governance and will ultimately lead to the reduction of shareholders' wealth. In other words, efficient corporate governance is considered a monitoring factor in the effective

management of corporate working capital. According to the results, corporate governance mechanisms are potentially effective in improving the efficiency of working capital

management. Given the theoretical and empirical evidence, our hypotheses are specified as follows:

H1: There is a significant relationship between corporate governance mechanism and financial management decision proxies.

H1a: There is a significant relationship between percentage of institutional shareholders and financial management decision proxies. H1b: There is a significant relationship between percentage of blockholders and financial

management decision proxies. H1c: There is a significant relationship between audit quality and financial management decision

proxies.

3. Methodology

Model (1) examines the effects of corporate governance on two financial management decisions

proxies, i.e. short-term investment (SI) and long-term investment (LI). Therefore, Model (1) is as follows:

SI = f (CORPORATE GOVERNANCE, SIZE, LEVERAGE, Y/S, PPE/S)

Special Issue

February 2016




LI = f (CORPORATE GOVERNANCE, SIZE, LEVERAGE, Y/S, PPE/S)

As two variables of percentage of blockholders (BLOCK) and percentage of institutional shareholders (INST) were used to illustrate the expressive indices of corporate governance (CG),

Model (1) consists of the following two secondary models:

𝐿𝐼 =∝1+ 𝛽1𝐼𝑁𝑆𝑇 + 𝛽2𝐹𝑆𝐼𝑍𝐸 + 𝛽3𝐿𝐸𝑉 + 𝛽4𝑌𝑆 + 𝛽5

𝑃𝑃𝐸𝑆 + 𝜀𝑖 .𝑡

𝑆𝐼 =∝1+ 𝛽1𝐼𝑁𝑆𝑇 + 𝛽2𝐹𝑆𝐼𝑍𝐸 + 𝛽3𝐿𝐸𝑉 + 𝛽4𝑌𝑆 + 𝛽5


And:

𝐿𝐼 = 𝛼1 + 𝛽1𝐵𝐿𝑂𝐶𝐾 + 𝛽2𝐹𝑆𝐼𝑍𝐸 + 𝛽3𝐿𝐸𝑉 + 𝛽4𝑌𝑆 + 𝛽5


𝑆𝐼 = 𝛼1 + 𝛽1𝐵𝐿𝑂𝐶𝐾 + 𝛽2𝐹𝑆𝐼𝑍𝐸 + 𝛽3𝐿𝑒𝑣 + 𝛽4𝑌𝑆 + 𝛽5


And:

𝐿𝐼 = 𝛼1 + 𝛽1𝐷𝑈𝑀𝐴 + 𝛽2 𝐹𝑆𝐼𝑍𝐸 + 𝛽3𝐿𝐸𝑉 + 𝛽4𝑌𝑆 + 𝛽5


𝑆𝐼 = 𝛼1 + 𝛽1𝐷𝑈𝑀𝐴 + 𝛽2 𝐹𝑆𝐼𝑍𝐸 + 𝛽3𝐿𝐸𝑉 + 𝛽4𝑌𝑆 + 𝛽5


We described how the independent and dependent variables were constructed in Table 1. [Insert Table 1 here]

4. Results

We use a Hausman test to identify whether the fixed effects model is better than the random effects model. In this case, it is, and so the fixed effects results are reported. (See Tables 3, 4 and

5) [Insert Tables 3, 4 and 5 here]

Before estimating the final models, the employed variables' stases in the models were examined using unit root tests. The results obtained from all tests showed all variables at a static

level. Table 2 shows the results of the unit root tests. [Insert table 2 here]

Then, specific estimations were employed to avoid estimation problems, especially autocorrelation and heteroskedasticity, which are due to different corporate characteristics. The

results of different tests, which are shown in the model estimation tables, prove no autocorrelation and heteroskedasticity of variance in the studied models.

The results of estimating H1a using the method with fixed effects show that with the improvement of institutional shareholders percentage as the index expressing the corporate

governance status for one unit, SI and LI indices increased by 0.312 and 1.076 units, respectively. In estimating both models, this coefficient is positive and is significant at the 99%

level. As it was predicted, firm size index, which equals the natural logarithm of company sales, has a positive and significant effect at the 99% level over the SI and LI indices. The impact

factor of financial leverage index, which equals the ratio of total debts of the firm to its total

Special Issue

February 2016




assets in this research, is negative and significant in estimating both models. With the increase of

this index by one unit, SI and LI indices reduced by 0.644 and 0.279 units, respectively. The results showed that investment in the firm increased with the ratio of operational profit (loss) to

sales increasing. However, it should be noted that such an impact is significant in a short period and is statistically insignificant in a long run. With the ratio of equipment to sales increasing by

one unit, investment in short period reduced slightly (0.0025), but increased by 0.0112 in a long run. However, this coefficient is statistically insignificant in both estimations. Table 3 shows the

models’ estimation results. [Insert Table 3 here]

The results of H1b model estimation showed that SI and LI indices improved with the enhancement of corporate governance mechanism (percentage of blockholders). Coefficients of

the index in both models are positive and significant at the 99% level. “Size of company” index has a positive effect on SI and LI indices level as the indices expressing financial management

decisions. This positive coefficient is significant on LI and SI levels at the 99% level. The impact factor for financial leverage index (ratio of total debts to total assets) on financial management

decisions proxies (SI and LI) is negative and significant in estimating both models. It should be noted that the impact factor of the control variable on LI exceeds its effects on SI. Financial

management decisions proxies, i.e. SI and LI, increased with the ratio of operational profit (loss) to sales increasing. In other words, the ratio of operational profit (loss) to sales has a positive

impact on SI and LI level. However, such a positive relationship is not statistically significant in estimating the models. The relationship between equipment to sales and the indices of corporate

investment are similar to the relationship in models. With the increase of the ratio of equipment to sales for one unit in the models, SI reduced by 0.257, but increased slightly (4.28 units) in LI.

However, the relationships are not statistically significant in estimating both models. Table 4 shows the models’ estimation results.

[Insert table 4 here] The results of H1c model showed that with the improvement of audit quality index for one

unit, SI and LI indices increased by 0.276 and 0.509, respectively. In estimating both models, the coefficient is positive and is significant at the 99% level. Similar to the results of estimating the earlier models, firm size, which equals the natural logarithm of the firm sales rate, has a positive

and similar effect on SI and LI indices. Remarkably, the impact factor of firm size on LI index is greater than its effects on SI index. Similar to the results obtained in the earlier sections, the

impact factor of financial leverage index, which is equal to the ratio of total debts to total assets in this research, is negative and significant in estimating both models. Financial management

decisions proxies decreased with this index increasing by one unit. The results indicated that the index of operational profit (loss) to sales ratio in estimating the models has a positive and

significant effect on decisions proxies, i.e. SI and LI. Similar to the earlier modes, with the increase of the index of ratio of equipment to sales for one unit, SI rate decreased by 0.288, but

Special Issue

February 2016




LI rate increased by 0.280. However, similar to the earlier modes, the relationships are not

statistically significant in estimating both models. [Insert table 5 here]

5. Conclusion

The results of testing the hypotheses show a positive and significant relationship between corporate governance mechanisms and financial management decisions proxies. Testing the

hypotheses of section one showed a positive and significant relationship between percentage of institutional shareholders and financial management decisions proxies. This is due to the

considerable impact of institutional shareholders imposing their management policies. Explaining the convergence-of-interest hypothesis, Pound (1988) explains that blockholders have

a strategic alliance with management. Tong & Ning (2004) believed that institutional investors are different from the individual investors, as they are more active in directing (supervising) the

performance of managers and more informed than others due to their access to different data sources. Institutional owners have a key role in supervising firms over the equity held by them.

The studies of Tribo (2007) and Ameer (2010) are among the earlier studies on the relationship among institutional shareholders, financial management, and corporate policy. Both studies

achieved consensus on a positive relationship between percentage of institutional shareholders and inventory management. Such a positive relationship can be justified from the two

perspectives of liquidity and control. Liquidity-based institutional ownership increases firm’s ability to achieve further liquidity obtained from credits. Therefore, a lower level of inventory

should be created to satisfy the need for accumulated liquid assets such as the inventories, which were reduced for providing cash stock. It can be stated from the perspective of control that

having greater voting power and the superior knowledge of institutional shareholders enables them to take effective management decision-making.

Percentage of blockholders, as an index of corporate governance, has a positive and significant effect on financial management, as the supervision of blockholders may have a

specific impact on the different behavioral aspects of a firm such as profitability, corporate performance, investment policies, and selection of executive and financial policies. Many studies have been conducted concerning the beneficial effect of blockholders on the problems related to

transferring an agency between owners and managers (Alinezhad Sarokolaei and Bahraini, 2013). In fact, blockholders are able to alleviate these problems. Due to the high volume of

investment, they have better motivation for supervising management and more authority for imposing effective decisions as compared with minor shareholders and owners. They may affect

corporate operational decisions through supervising managers and improve selection of projects, investment levels, and reduction of the probability of waste of resources. Moreover, audit quality

improvement has a positive and significant effect on financial management decisions proxies. With the resources of management increasing, number of those in connection with a firm

increasing and this ends in conflict of interests. The conflict of interests makes beneficiaries bear

Special Issue

February 2016




costs of an agency for aligning their interests with others or minimizing its effects (Jensen and

Meckling, 1976). A manager who is placed in the center of the conflict of interest attempts to alleviate agency costs by presenting firm’s financial information. However, due to management

authorities and need for supervising performance of a manager, the expert judgment of an independent audit is considered (Gul et al, 1998). Therefore, if auditing is performed with a

better quality, it will reduce conflict of interests and will improve transparency of a decision-making environment. Investment risk reduces in this condition. However, audit quality reduction

lowers quality of financial reporting and increases the agency cost resulting from conflict of interest on the part of managers and investors. In other words, management may mismanage

through control weaknesses, use the interests of shareholders to its advantage, and reduce corporate value, which increase investment risk. In fact, corporate governance had a

considerable impact on firms control method through equity ownership. Therefore, the owners delegated firm management to managers and stock exchange markets were formed.

Special Issue

February 2016




References

Dastgir, M and M. Honarmand (2014). “Studying the Effect of Corporate Governance Mechanisms on Working Capital Management Efficiency”, Journal of Management

Accounting, Vol. 7(22), pp. 68-88 (In Persian). Alinezhad Sarokolaei, M and M. Bahraini (2013). “The Effect of Institutional Investors and

Concentration of Ownership on Investment Opportunities in the companies listed in Tehran Stock Exchange”, Journal of Financial Accounting Studies, Vol. 5(19), pp. 91-109 (In

Persian). Malekian, E and A. A. Daryaei (2011). “Ownership and Firm Characteristics and Corporate

Governance Structure”, Journal of Accounting Advances, Vol. 60(3), pp. 121-143 (In Persian).

Ameer, R (2010). “The Role of Institutional Investors in the Inventory and Cash Management Practices of Firms in Asia”, Journal of Multinational Financial Management, Vol. 20(3), pp.

126-143. Cadbury Committee (1992), Report of the Committee on The Financial Aspects of Corporate

Governance, London. Kim, D. H., Kim, J., Byun, Y., and S. H. Chun (2013), “A Study on the Effect of Governance

Adequacy on the Corporate Performance” Procedia-Social and Behavioral Sciences, Vol. 107, pp. 59-66.

Gul, F. A., J. Tsui, J., and C. J. P., Chen. (1998). “Agency Costs and Audit Pricing: Evidence on Discretionary Accruals”, Working paper, University of Hong Kong.

Jensen, M.C and Meckling. W. H. (1976) “Theory of the firm: Managerial behaviour, agency costs and ownership structure”, Journal of Financial Economics, Vol. 11, pp. 5-50.

Andreou, P. C., Louca, C., and P. M. Panayides.(2014) “Corporate Governance, Financial Management Decisions and Firm Performance: Evidence from the Maritime Industry”

Transportation Research Part E, Vol. 63, pp. 59-78. Parkinson, J.E. (1994); Corporate Power and Responsibility, Oxford University Press, Oxford.

Pound, J. (1988). “Proxy Contests and the Efficiency of Shareholder Oversight”, Journal of Financial Economics, Vol. 20, pp. 237-66.

Tong, S., and Y. Ning (2004). “Does capital structure affect institutional investor choices?” The

Journal of Investing, Vol. 13(4), pp. 53-66. Tribo, J (2007). “Ownership Structure and Inventory Policy”, International Journal of

Production Economics, Vol. 108, pp. 213-220.

http://econpapers.repec.org/article/eeetranse/

Special Issue

February 2016




Table 2: Pool Unit Root Test

Augmented Dickey-Fuller Test

Schwarz Baysian

Variables

PP - Fisher Chi-square ADF - Fisher Chi-square Im, Pesaran and

Shin W-stat Levin, Lin & Chu t*

Prob t-Statistic Prob t-Statistic Prob t-Statistic Prob t-Statistic

0.0000 3.45 0.0000 3.23 0.0000 -7.275 0.000 -4.16 BLOCK

0.0000 2.20 0.0560 1.31 0.0007 -3.187 0.000 -3.42 INST

0.0000 4.32 0.0000 3.56 0.0000 -6.1526 0.000 -5.2 FSIZE

0.0000 3.07 0.0291 2.43 0.0001 -3.7236 0.000 -3.609 LEV

0.0000 2.15 0.0378 2.6 0.0853 -1.37 0.002 -2.82 PPE/S 0.0000 5.00 0.0000 4.71 0.0006 -2.3431 0.000 -2.763 Y/S

0.0000 6.101 0.0002 5.337 0.0003 -3.5015 0.000 -4.5740 SI

0.0000 4.73 0.0000 3.45 0.0000 -9.1673 0.000 -2.963 LI

Table 1: Measurement of variables

Variables Measurement

SI Short-term investment

LI Long-term investment

BLOCK Percentage of blockholders (owning more than five percent of a firm’s stock) as the corporate governance mechanisms.

INST Percentage of institutional shareholders as the corporate governance mechanisms.

Dum A Audit quality FSIZE Natural logarithm of the Sales

LEV Which is the ratio of firm’s total debts to the sum of its total assets PPE/S Ratio of equipment to sales

Y/S Operational profit (loss) to sales ratio

Special Issue

February 2016




Table 3: The Results of Estimating H1a Using the Method with Fixed Effects

Variables

Dependent Variable: LI Dependent Variable: SI

Estimation Coefficients

Level of Significance (Prob)



INST 1.076554 0.0000 0.3125038 0.0016 FSIZE 0.7773093 0.0000 1.033988 0.0000 LEV -0.2799678 0.0000 -0.6640330 0.0257 Y/S 0.4669009 0.2598 1.016573 0.0039 PPE/S 0.727756 0.7030 -2.950282 0.6676 Adjusted R-squared 0.689768 0.652813 F-test (Prob) 0.0000 0.0000 Hausman Test (Prob) 0.0182 0.0015 Model Estimation Method Fixed Effects Fixed Effects Durbin-Watson Statistic 1.770538 2.083979 Heteroskedasticity between groups (Wald Modified)

1.498651 (0.1353)

1.018378 )0.3094(

Autocorrelation test (Wooldridge) for Autocorrelation in panel data

1.101662 (0.2714)

Table 4: The Results of H1b Model Using the Method with Fixed Effects

Variables






BLOCK .1235746 0.0000 0.2109919 0.0000 FSIZE .1461830 0.0000 0.6374943 0.0000 LEV -2.799601 0.0000 -0.7351209 0.0257 Y/S .9645298 0.1743 2.7107901 0.6162 PPE/S 4.281952 0.4137 -0.2573615 0.7651 Adjusted R-squared 0.779383 0.700600 F-test (Prob) 0.0000 0.0000 Hausman Test (Prob) 0.0000 0.0032 Model Estimation Method Fixed Effects Fixed Effects Durbin-Watson Statistic 1.882516 2.095403 Heteroskedasticity between groups (Wald Modified)

0.416978 (0.6770)

0.193869 (0.1164)

Autocorrelation test (Wooldridge) for Autocorrelation in panel data

0.191200 (0.8485)

Special Issue

February 2016




Table 5: The Results of H1c Model Using the Method with Fixed Effects

Variables


Estimation

Coefficients

Level of Significance

(Prob)

Estimation

Coefficients


DUM A .5092787 0.0007 .2766919 0.0168

FSIZE 1.547551 0.0000 1.009585 0.0000

LEV -2.799106 0.0000 -.699923 0.0126

Y/S 1.167288 0.0989 1.242763 0.0006

PPE/S .2808759 0.3818 -.288718 0.6728

Adjusted R-squared 0.731281 0.757652

F-test (Prob) 0.0000 0.0000

Hausman Test (Prob) 0.0000 0.0087

Model Estimation Method Fixed Effects Fixed Effects

Durbin-Watson Statistic 1.921184 2.109522

Heteroskedasticity between groups

(Wald Modified)

1.018378

)0.3094(

1.163007

(0,2457)

Autocorrelation test (Wooldridge) for

Autocorrelation in panel data 0.1479(0.1570)

corporate governance and financial management decisions...on the basis of the above financial...

Documents