impact of corporate governance on overall firm...
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IMPACT OF CORPORATE GOVERNANCE ON OVERALL FIRM
PERFORMANCE
Mobeen Ur Rehman
PhD Scholar
ShaheedZulfikar Ali Bhutto Institute of Science and Technology (Szabist)
Islamabad, Pakistan
Lecturer, Department of Management Sciences
COMSATS University, Islamabad, Pakistan
Aabid Hussain
PhD Scholar
COMSATS University, Islamabad Pakistan
Abstract
This paper focuses on the factors that are very important in the governance styles opt by the
major corporate sectors and its impact on the performance of these companies. There has been
measurement of the impact of corporate governance on the performances of major firms in some
developed markets of the corporate sector but very little number of studies focused on the impact
of these governance factors on the firm performances. This study focused on the main
governance styles being practiced in the emerging market so that these corporate governance
studies can be generalized towards the emerging markets as well. We have constructed
questionnaire measuring corporate governance in different aspects with a strong test of validity
and reliability followed by a pilot testing so check the accuracy of the questionnaire. We have
taken all the financial institutions as our sample and measured the impact of these governance
styles on their performances. We have also applied factor analysis so to measure the maximum
variations accounted by top governance strategies as independent variables.
Keywords: IMPACT ; CORPORATE GOVERNANCE ; OVERALL FIRM
PERFORMANCE
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Introduction
The paper focuses on the relationship between the corporate governance and the firm
performance, the word “corporate governance” implies the management decisions taken
that would create an impact on the firm‟s overall performance. Now the corporate
governance can be the decisions (Anthony Kyereboah-Coleman and Nicholas Biekpe,
2006) either in the favor of the company‟s board of directors, or the share holders. In both
of the cases, decisions taken can contribute towards the performance of an organization.
Usually these two directions, i.e. management or the shareholders are contradicting but
both are very crucial to the outcomes that will be regarded as the firm‟s performance. If
better corporate governance is related to better firm performance, better-governed firms
should perform better than worse-governed firms. (Lawrence D. and Brown Mack
Robinson, 2004). Especially after the Sarbanes Oxley act, the shareholders have gained
somewhat preferences upon the management of the firms, but the fact remains true that
the major decisions are made by the management of the company either they are in the
favor or share holders or not. Stock returns of firms with strong shareholder rights
outperform, on a risk-adjusted basis, returns offirms with weak shareholder rights by 8.5
percent per year during the 90‟s. Given this result, proponents have prominently cited this
result as evidence that good governance has a positive impact on corporate performance.
There is a significant body of theoretical and empirical literature in accounting and
finance that considers the relations among corporate governance, management turnover,
corporate performance, corporate capital structure, and corporate ownership structure.
(SanjaiBhagat Brian Bolton, 2007)Now the corporate governance can include many
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factors as the decisions might be like to pay out less dividends to share holders, this may
be in short run not favorable to the shareholders but in the long run can increase the share
price that will earn substantial capital gain to the firm and consequently to the
shareholders. On the other hand, if management decides to pay more dividends, then the
retained earnings and short term and long term investments will be cut down, thus
lowering the profitability and so market price of shares of the firm. After the introduction
of Sarbanes Oxley act, many reforms were made to build confidence to share holders.
However, these reforms may have been initiatedto influence investor perceptions rather
than to create controls to protect shareholder interests so it is unclear whether these
reforms are linked to firm performance. (Lawrence D. Brown and Marcus L. Caylor,
2005).
Research problem
The research problem in this research paper is to determine the extent to which corporate
governance has an impact on overall firm performance. The research question in this
paper is “Does corporate governance and firm performance are directly related, what are
the variables that corporate governance encompasses and whether these variables
measures firm performance or not”.
There can be many variables that come under the heading of corporate governance.
(Lawrence D. Brown and Marcus L. Caylor, 2005) used 51 such variables that comes
under the broad heading of corporate governance. We will use three such variables that
will be contained under corporate governance and either they will be impacting the firm
performance or not, will be the findings of this research paper. In the corporate
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governance style, we will include factors from the different strategies adopted by the firm
so that we come across with better understanding of the corporate governance style, and
their impact on the overall performance of the firm. The inclusion of these different
factors will also highlight which factor representing different management style will
show more deviation, and if such deviation happens, then this will become our limitation
as we have to include such factors that will have positive impact on the performance of
the firm.
Rationale of the study
The important factor that we will study in this research paper is either the priority of
various organizations in their corporate governance strategy is to safe guard the board of
directors/management interest, to maximize the share holders profit or to make such
policies that will be more conducive to the employees of the organizations. Now this will
be a test for the study because all these three corporate governance styles will have
different implications on the overall performance of the firm but we will especially in this
research paper try to develop such factors that will be encompassed by all these three
factors to find the combined effect on the firm performance, because the main research
problem is to find the impact on the firm‟s performance, not to differentiate between the
different governance styles adopted by different firms.
Hypothesis
Main hypothesis will be: „Does there exist any positive relationship between the overall
corporate governance style and firm‟s performance‟.
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Literature Review
In this paper we will investigate the effects of elements of corporate governance practices
on performance of different companies (with different governance styles) and how much
shareholders affect the financial performance of the firm.Shareholders are normally
interested in higher share prices. We will investigate the governance effects on a
corporation‟s financial performance/efficiency, which we define as an ability to
maximize revenues at given levels of inputs.
(Barratt.R and Korac. N, 2002) analyzedtheir experience and represents a natural
experiment on corporate governance effects and might be of a special importance for
defining the role of corporate governance for economy. A good governance system
ensures the high turnover rate and high profitability ratio. Normally there are three
different styles which are being followed to govern a firm. Before taking into account
these styles it is of great importance to understand that the style should match the
ongoing operations of the business. If the governance is not properly delegated the firm
can face serious problems. The major consequences of poor corporate governance
practices, which today persist in transitional countries, are low utilization of employed
resources (e.g. due to the lack of appropriate incentive system, underdeveloped trust,
wrong control and accountability system, etc.) and as a result, the inability of companies
to attract investment. Implementation and enforcement of proper corporate governance
practices is vital for enhancing the development of firms (as well as of an economy as a
whole) and their long-term prosperity (Khiari, W; Karaa, A. and Omri, A. 2007).If a firm
has a multiple ownership, it may result in corporate governance problems. The
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owners/investors want to ensure that the professional managers they hire run the
company in line with the best interests of its owners, working with greatest possible
efficiency that consequently maximizes the added value of the firm and the welfare of all
of the owners (Vitaliy, 2002).
There are three styles which are being adopted by different organizations for their
governance such as semi-democratic, democratic and dictatorship. Many researches have
found that companies which follow democratic governance style perform well as
compare to the firms governing dictatorship. Some researchers have also found that there
is a negative correlation between corporate governance index and the market value of the
firm (Taudas and George, 2007).There is always a trade-off between the interests of
directors and the interests of share holders. Although these are the directors who appoint
the directors of the corporation but when it comes to the distribution of profit, directors
remuneration and keeping funds in the company‟s capital becomes the issue. So, for the
proper guidance satisfaction of directors (financially) is of vital importance. Each firm is
required to maintain a remuneration committee, mainly or wholly composed of non-
executive directors, whose tasks being to make recommendations to the board the
remuneration of the executive directors (ShamsulNahar Abdullah, 2006). Finally,
decisions relating to the remuneration of non-executive directors lie, on the other hand
with the board as a whole.
Kenneth tombs, (2002) explains that there are different categories of employees he
ranked them in three types of school of thoughts towards the governance style. Firstly
employees perceive that the role of white color workers who are governing is of leading
and taking responsibility and they believe that their role is constructive. Employees of
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second school of thought believe that over governing rules and regulations create panic
among employees. Employees of third school of thought believe that governing workers
are mostly incompetent towards their job and they adopt autocratic style mostly.
The main points focused by Bruce Cutting and Alexander Kouzmin (2000) in their paper
is that there is a better way to conduct corporate governance. The operations of many
corporations are still based, essentially, on th owner/manager model of small and growing
companies that is, of one ``strong man'' ably supported by various advisers. This
``dictatorial'' style of governance no longer sits well with the much wider distribution of
ownership, greater complexity of organization, more chaotic and competitive
environments, the consequent faster pace of change and adaptation and the need to be
continually generating new knowledge to stay competitive. A shift to shared leadership
and shared power is necessary to meet the demands of the modern corporate world.
There are different categories of employees he ranked them in three types of school of
thoughts towards the governance style .Firstly employees perceive that the role of white
color workers who are governing is of leading and taking responsibility and they believe
that their role is constructive. Employees of second school of thought believe that over
governing rules and regulations create panic among employees. Employees of third
school of thought believe that governing workers are mostly incompetent towards their
job and they adopt autocratic style mostly (Kenneth tombs, 2002).There is a better way to
conduct corporate governance. The operations of many corporations are still based,
essentially, on th owner/manager model of small and growing companies that is, of one
``strong man'' ably supported by various advisers. This ``dictatorial'' style of governance
no longer sits well with the much wider distribution of ownership, greater complexity of
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organization, more chaotic and competitive environments, the consequent faster pace of
change and adaptation and the need to be continually generating new knowledge to stay
competitive. A shift to shared leadership and shared power is necessary to meet the
demands of the modern corporate world (Bruce Cutting and Alexander Kouzmin, 2000)
Methodology
For the purpose of research methods, we will use questionnaire, panel and individual
interviews from the white collar workers as well as from blue collar workers from the
financial sector. The research will be undertaken from financial institutions that how they
govern their firm, which governance styles the firm adopting and how this style is
affecting the overall performance of the firm. In the initial level, we will visit
theseinstitutions and interview the employees working in these different financial
institutions. The selection of these employees will be made on the basis of their grades in
these institutions, their pay scale and the seniority of their position in the relevant
organizations. We will also interview some major share holders and determine their
reactions that how (high or less) dividends effect their further investment decisions. Their
perception will give us the idea that either our research subject is strong enough that
further tests and of which nature should be applied. Also if the research subject under
study is a new concept to the employees, then it will also give us the hint whether the
nature of our research subject is descriptive or exploratory in nature. We will apply
effective measurement scale to collect data in such a manner so that it extracts
respondent‟s maximum attention and involvement in these measurement scales. We can,
for instance applies interval scale to not only take respondents answers but also to
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measures the magnitude of the differences in the preferences among the individuals. In
this way calculate the mean and the standard deviations of the responses on the variables.
The standard deviation and the variance tests will show us which of the factors included
as the corporate governance strategies are deviating from the track and that will give us
the hint of the limitation of our study.
In our methodology phase, we will find the variables that will measure the corporate
governance concept. No doubt that the concept of corporate governance includes many
sub factors that will overall contribute to the corporate governance concept. Our prime
factors that will measure corporate governance in our methodology will be different
policies that are being implemented in the said organizations. One thing important in this
perspective is that these policies are being formulated by the senior management but are
implemented and effective between the employees for whom they are formulated, so to
tap the responses of the perceived effectiveness of these policies, questionnaires has been
designed that will tap the responses of the respondents that will be from senior to the
lower level staff. This process will help us to access the perceived effectiveness of the
policies formulated by the senior management under corporate governance of the
organization.
To tap the concept of our dependent variable, i.e. firm performance, we also have to
indicate the factors that will contribute to the overall firm performance. Now in financial
aspect these terms might include different financial ratios like return on asset, return on
equity, asset debt ratio, profitability etc, and in non financial aspect the goodwill of the
organization, the market share, less turnover of employees etc.
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The qualitative data will be gathered by tapping the concept through structured
questionnaires that will be analyzed on the likert scale. The responses on the likert scale
will be then converted into the unit that will be compared against the quantitative data
measuring the firm performance and collected from the financial reports. The financial
institutions from where the data i.e. qualitative and quantitative will be taken include the
leading banks operating in the country both of government and non government. These
include the National bank of Pakistan, Silk bank, Meezan bank, United bank limited and
Allied bank limited. The qualitative data that will be gathered from the above
questionnaires will be computed by taking the mean responses of the three independent
variables and then calculated average score of the single respondent will come up. Then
in this way, from the sample size of hundred respondents will be selected. Now this
sample is taken from different financial institutions that will comprise of government
institutions, Islamic banks, conventional banks and privatized banks.For the dependent
variable, i.e. firm performance, the relation of our three independent variables will be
made with our dependent variable.
Analysis and Conclusion
In the descriptive statistics, the minimum and maximum values of all the variables are 1
and 6 respectively. The value of the variable attitude of senior management among the
independent variables has the higher value in the mean column whereas in the standard
deviation column the value of the variable “attitude of the employees” is higher showing
that this variable tapped the response that shows maximum difference of opinions among
the respondents from the mean value of the same variable.
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Regression statistics showed the causal effects of the independent variables on the overall
firm performance. The model shows that 20.4% of the variance is caused by all the three
independent variables. Note that this is an overall measure of the strength of association,
and does not reflect the extent to which any particular independent variable is associated
with the dependent variable. Also the p-value in Anova in .000 less than 0.05 which
clearly indicates that the independent variables reliably predicts the employee
performance, which is our dependent variable. The value of Durbin-Watson test is 1.778
which is nearly close to 2, which shows that the autocorrelation does not exists i.e. the
same value does not auto correlates with its previous value.
The factor analysis shows that the value of KMO is more than .514 which shows that the
factor analysis can be applied but the higher the value of KMO, more effectively the
factor analysis can be applied. In this case the value of KMO is quite suitable as it is
above the critical line of 0.50.
Extraction communalities are estimates of the variance in each variable accounted for by
the components. The communalities in this table are not much, which indicates that the
extracted components represent the variables on a good basis but if these values will be
much higher than the results will be much better.
The second section of the table shows the extracted components explain nearly 35.9% of
the variability from the original three variables. This variability explained by these three
factors is quite less, so it would be feasible to include all the three variables so to achieve
100% variability by all the independent variables as the original number of variables is
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not too great. The graph on the scree plot is also steep showing that all the variables
collectively impact on the final variability. Also the factor analysis is feasible when there
are greater numbers of factor and in our study the numbers of factors are only three
tapping the response in their respective variables. So it is fine to select all the three
factors to achieve the 100% variability due to these independent variables.
In the rotated component matrix, we can focus on Price attitude of employees in further
analyses, but you can do even better by saving component scores.
In the factor analysis, the iteration has been performed six times, and in the last stage
maximum homogeneity between the clusters has been achieved as the mean differences
between the iteration process has been achieved.
These overall statistical findings show that all the three variables included as independent
variables in our study does have the strong impact on the overall firm performance. No
doubt there might be other factors as well that could also significantly contribute to the
individual employee performance. As our paper is mostly qualitative in nature and also
the data obtained mainly on the perception of the respondents not on any quantitative
values. Now different employees might have different perceptions that could boost their
individual performances but in our study we have included the three variables e.g. that
seems to have maximum impact on the overall firm performance.
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References Barratt, R., &Korac. N.K., (2002). Developing reflexive corporate leadership. Corporate governance
research journal, Vol. 2, pp. 32-36.
Bruce Cutting & Alexander Kouzmin, (2002). The emerging patterns of power in corporate governance.
Journal of Managerial Psychology. Vol. 15, pp. 477-511.
Campbell, P., &hushagen, J., (2002). The governance of intergovernmental organizations. Corporate
governance journal. Vol. 2. pp. 21-26.
Khiari, W., Karaa, A. &Omri, A., (2007). Corporate governance efficiency: an indexing approach using
the stochastic frontier analysis. Emerald Group Publishing Limited, Vol. 7, pp. 148-161.
Kyereboah, A. C., &Biekpe, N., (2006). The link between corporate governanceand performance of the
non-traditional export sector: evidence from Ghana. Emerald Group Publishing Limited.
Emerald Group Publishing Limited. Vol. 6. pp. 609-623.
Nahar, S. A., (2006). Directors‟ remuneration, firm‟s performance and corporate governance in
Malaysia among distressed companies. Emerald Group Publishing Limited. Vol. 6. pp. 162-
174.
Tombs, K., (2002). What do we mean by governance? Records management Journal.Vol. 12, pp. 24-28.
Thomsen S., (2005). Corporate governance as a determinant of corporate values. Emerald Group
Publishing Limited. Vol. 5. pp. 10-27
Toudas S. K., &Karathanassis, 1. G,. (2007). Corporate Governance and Firm Performance: Results
from Greek Firms. Working Paper Series.
Zheka, V, (2007). Does Corporate Governance Predict Firms‟ Performance? The Case of
Ukraine.Empirical Legal Studies Paper. Vol. 5
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Annexure
Table I
Descriptive Statistics
N
Minimu
m
Maximu
m Mean
Std.
Deviation
Varianc
e
Attitude of Senior
Management
100 1.00 6.00 3.5700 1.57156 2.470
Attitude of Employees 100 1.00 6.00 3.1800 1.63534 2.674
Share holdersVs
Senior Management
100 1.00 6.00 3.2500 1.62291 2.634
Performance Ratings 100 1.00 6.00 3.8800 1.44446 2.086
Valid N (listwise) 100
Table II
Regression Analysis
Model
Variables
Entered
Variables
Removed Method
1 Share holdersVs
Senior
Management,
Attitude of Senior
Management,
Attitude of
Employeesa
. Enter
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Table III
Regression Analysis
Model R R Square
Adjusted R
Square
Std. Error of
the Estimate Durbin-Watson
1 .451a .204 .179 1.30894 1.778
Table IV
ANOVAb
Model
Sum of
Squares df Mean Square F Sig.
1 Regression 42.082 3 14.027 8.187 .000a
Residual 164.478 96 1.713
Total 206.560 99
Table V
Model
Unstandardized
Coefficients
Standardized
Coefficients
B Std. Error Beta t Sig.
1 (Constant) 1.991 .494 4.029 .000
Attitude of Senior
Management
.400 .084 .435 4.774 .000
Attitude of Employees .044 .081 .050 .548 .585
Share holdersVs Senior
Management
.098 .081 .111 1.212 .228
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Table VI
Residuals Statisticsa
Minimum Maximum Mean Std. Deviation N
Predicted Value 2.5340 5.1591 3.8800 .65197 100
Residual -3.31122 2.62816 .00000 1.28895 100
Std. Predicted
Value
-2.064 1.962 .000 1.000 100
Std. Residual -2.530 2.008 .000 .985 100
Table VII
KMO and Bartlett's Test
Kaiser-Meyer-Olkin
Measure of Sampling
Adequacy.
.514
Bartlett's Test of
Sphericity
Approx. Chi-Square .461
df 3
Sig. .927
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Table VIII
Communalities
Initial Extraction
Attitude of Senior
Management
1.000 .306
Attitude of Employees 1.000 .455
Share holdersVs Senior
Management
1.000 .317
Table IX
Total Variance Explained
Comp
onent
Initial Eigenvalues Extraction Sums of Squared Loadings
Total
% of
Variance Cumulative % Total
% of
Variance Cumulative %
1 1.077 35.916 35.916 1.077 35.916 35.916
2 .979 32.641 68.557
3 .943 31.443 100.000
Table X
Component Matrixa
Component
1
Attitude of Senior
Management
.553
Attitude of Employees .675
Share holdersVs Senior
Management
-.563
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Table IX
Component Score Coefficient
Matrix
Component
1
Attitude of Senior
Management
.513
Attitude of Employees .626
Share holdersVs Senior
Management
-.522
Table XII
Component Score Covariance
Matrix
Component 1
1 1.000
Table XIII
Initial Cluster Centers
Cluster
1 2
Attitude of Senior
Management
6.00 2.00
Attitude of Employees 1.00 6.00
Share holdersVs Senior
Management
5.00 1.00
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Table XIV
Iteration Historya
Iterati
on
Change in Cluster
Centers
1 2
1 2.496 2.600
2 .220 .175
3 .184 .182
4 .237 .254
5 .073 .083
6 .000 .000
Table XV
Final Cluster Centers
Cluster
1 2
Attitude of Senior
Management
3.56 3.58
Attitude of Employees 1.87 4.60
Share holdersVs Senior
Management
3.69 2.77
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Table XVI
ANOVA
Cluster Error
Mean Square df Mean Square df F Sig.
Attitude of Senior
Management
.016 1 2.495 98 .007 .936
Attitude of Employees 187.223 1 .791 98 236.634 .000
Share holdersVs Senior
Management
21.194 1 2.444 98 8.670 .004
Table XVII
Number of Cases in each
Cluster
Cluster 1 52.000
2 48.000
Valid 100.000
Missing 1.000
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Figure I