The World Bank in 1999 indicates that corporate governance takes the form of two mechanisms, internal corporate governance and external corporate governance. Internal corporate governance gives the priority to the shareholders’ interest, making use of the company’s board of directors as overseers of the top management. On the other hand, external corporate governance concerns itself with controlling and monitoring the managerial behaviors through regulations and limitations that are external to the firm; this involves many parties such as debtors, suppliers, accountants, credit ratings agencies, lawyers and investment banks (Kajola, 2008).
Countries around the globe are now focusing on the area of corporate governance as a critical step in enhancing the quality of their financial institutions. The OECD countries continue to reach the agreements that entrench the corporate governance in the financial frameworks. The priority given to this area continues to create higher expectations. Investors are now more confident and regulators expect more public confidence in financial reports, stronger governance mechanisms, improved reliability and accuracy of financial statements. Consequently, this research proposal seeks to find out the effects of corporate governance in the performance of a firm (Mahar, 2008).
The concept of the firm’s performance according to the literature by experts such as Barney (2002) may be calculated. This research utilizes available studies on the corporate governance to define and investigate a firm’s performance. The studies make use of accounting performance indicators. As a result, this research proposal uses the major proxies of Return on Assets (ROA), Return on Investment (ROI) and Tobin’s Q among other market measures (Abdulla 2004; Daily and Dalton 1993 among others). The researcher will conduct analysis empirically of the firm’s performance listed in the Taiwan stock exchange. The impact and effect of the corporate governance on the firm’s performance will be assessed through its impact on the corporate performance.
The research problem is to find out effects of the corporate governance on a firm’s performance.
Significance of the research
This study of the corporate governance and a firm’s performance is important to a number of parties; the government, for instance, upon viewing these results can come up with better ways of ensuring that firms adopt healthy corporate governance practices. Shareholders can also use the results of this study to demand some changes in the way the company runs. Lastly, the directors and managers of the company can use the findings as a guide in adopting and improving their corporate governance policies and thus improve on performance.
- To find out effects of the size of the board of directors on the company’s performance.
- To investigate significance and effects of the CEO’s duality on a firm’s performance.
- To assess the impact of having an independent board of directors on a firm’s performance.
- To identify significant effects of internal ownership on a firm’s performance.
- How does the size of the board of directors affect a firm’s performance?
- What is the effect of CEO’s duality on a firm’s performance?
- What is the impact of an independent board of directors on a firm’s performance?
- What significant effects does internal ownership have on a firm’s performance?
In investigating the effects of corporate governance on a firm’s performance, this research proposal uses the theories of Agency and stewardship. The Agency theory focuses on the aspects of corporate governance that increase the performance of a firm. These aspects include the agency problem between a principal and an agent, which denotes the conflicting interests of maximizing the returns to shareholders. Stewardship theory views managers as stewards who can increase the value of a firm if insiders dominate the boards together with a leadership structure that maximizes the shareholder’s value. The two theories form the theoretical framework of this research proposal since they postulate aspects of the corporate governance such as separate leadership structure, board committees and outside directors as maximizing a firm’ performance (Jensen, 1976).
Corporate governance is a fundamental ingredient of a firm’s financial performance and growth (Brava et al 2006). They state in the article that an increase in the corporate governance index by 1% increases net revenues by 0.5% and thus general change in the corporate governance index predict a 40% chance of increase in a firms revenues. This provides a positive attitude that there is a relationship between a firm’s performance and its corporate governance ratings. Moharr et al. (1999) argue that the ownership structures introduce the complexity. Their studies indicate that there are two types of corporate governance systems, insider and outsider systems. In the outsider system, a conflict between dispersed shareholders and strong managers exists; in the insider system, a conflict exists between weak and strong shareholders. This postulates that effects of the corporate governance exert pressure on the capital markets and thus the allocation of resources but not on the firm’s performance per se. In contrast to Moharr argument, Toudas et al. (2007) propose that the corporate governance adds direct value to a firm since the policies in use that guide it determine a firm’s growth path. Claudia Bocean adds that importance of the corporate governance is immensely large since its regulations and policies determine shareholder’s equity.
Ownership dispersion is distinction between management and owners (Berle and Means, 1932). This is an area of corporate governance challenge through agency problems, according to Jensen and Meckling (1976). This implies that the corporate governance is poor there where a concentration of ownership exists through creation of ultimate controllers. The firms’ performance comes into focus, as noted by Claessens et al. (2000), that these dominant shareholders introduce uncondusive strategies such as cross-holding and pyramids. Poor financial performance results, as indicated by Kao et al. (2004), when directors cause high ratios of pledges. Directors could also jeopardize a firm’s performance by purchasing a firm’s shares to manipulate stock prices and enhance their control. By being collateralized shareholders, they can lead to a price slump, reduce the debtor’s chances of collateral, make financial close, later use their advantage to embezzle funds, and thus bring a firm down. From Kao et all’s argument, lack of good corporate governance through ownership dispersion leads to poor performance or collapse.
The board of directors connects managers to the owners; they are responsible for protecting shareholder’s interests, monitoring managers, making profitable decisions among other things (Valiyah, 1999). The number of directors determines the chances of a firm’s good performance; this is because directors tend to hold divergent opinions and thus the higher their number, the higher the chances of lower efficiency due to disagreements (Lorsch and Lipton, 1992). Though Bacon (1973) indicates that bigger board size indicates a richness of experience, Yermack (1996) and other experts insist that a higher board size leads to lower financial performance.
Since there are both internal and external directors, Jensen and Fama (1983) indicate that internal directors are likely to collude with managers. Studies by Beasley (1996) indicate that firms with higher ration of independent directors have lower level of scandals. Bhagtat and Black (2002) indicate that there is a negative relationship between a firm’s short-term performance and the ration of director’s independence. Additionally, Agency theory indicates that when the CEO is also the chair, a firm’s performance may reduce. This CEO’s duality lowers a firm’s performance although stewardship theory might reduce the apparent conflict of interests (Daliy and Dalton, 1993).
Hypothesis and Research Methodology
In investigating effects of the corporate governance on a firm’s performance, the researcher will formulate hypothesis regarding four aspects of corporate governance in relation to a firm’s performance, size of the board, size of the independent board, CEO duality and insider ownership.
These hypotheses are:
A) H1: the size of the board of directors is negatively related to a firm’s performance.
B) H2: the size of an independent board through external directors is negatively related to a firm’s performance.
C) H3: CEO duality is negatively associated with a firm’s performance.
D) H4: the insider’s ownership is negatively related to a firm’s performance.
The researcher will use a regression model for his empirical analysis and proof of the hypothesis chosen. The model indicates the relationship between a firm’s performance and corporate governance aspects.
performance = a +a size of boardit + a Director’s independenceit +a CEO’s Dualityit +an Insider’s ownershipit
Performanceit is the ROA, the ROI and Tobin’s Q of a firm i for an year
Size of Boardit is the size of a firm’s i board of directorsin year t
Independence of Boardit represents the ratio of independent directors of a firm i during the year t
CEO’s Dualityit is CEO duality’s dummy variable for firm i in the year t
Ownership by Insidersit is the insider’s ownership ratio for a firm i in the year t.
The researcher will examine performance of the firms listed in the Taiwan stock exchange from 2007 to 2010. The population will comprise of all the companies listed which will then be sampled in a stratified manner; two companies from each industry.
The sample is characteristically time series and cross-sectional, the panel data thus analyzes data in a manner that eliminates individual’s heteroskedasticity in cross-section and autocorrelation of time series variables. The data will be in the form of random effect and fixed effect regression models.
The data will be mainly secondary comprising of both official and insider financial results. The researcher will also conduct interviews with a manager to review the organizational structure in aspects of executive leadership and information such as ownership composition.
The researcher will write letters of request to each company involved in this study, he will also make a written assurance to them and to the individuals with whom he will conduct interviews that any information obtained in the course of this study will be used for the purposes of the study alone. He will assure the respondents of confidentiality of such information that is not the public knowledge.
Instrument description and Validation
The researcher will use interviews and secondary data as major instruments of this study. To ensure the validity of the results and the instruments, he will conduct a pilot study followed by a thorough examination of the information in relation to the research objectives. This will ensure that the instruments measure what they are intended to and thus support the interpretation. He will also apply the Cronbach’s Alpha which is the variance percentage observed explaining the hypothetical scale value.
Methods of Statistical data Analysis
This research proposal will use ROI, ROA and Tobin’s Q value to measure a firm’s market performance, accounting performance and a firm’s value, respectively and thus ascertain the effect of corporate governance on a firm’s performance. Descriptive statistics will be applied to analyze the data. The researcher will use the mean, standard deviation, minimum, median and maximum values as the descriptive statistic. The researcher will then formulate correlation of corporate governance and firm’s performance to negate or satisfy the hypothesis formulated.