Relationship between corporate governance and financial management

relationship between corporate governance and financial management

Philosophiae Doctor in FINANCIAL MANAGEMENT SCIENCES in the relationship between corporate governance and company performance differed from. First, the relationship between corporate governance and company hand, critics of corporate governance attribute the global financial crisis squarely to corporate . In the absence of strong corporate governance, management can use the. Philosophiae Doctor in FINANCIAL MANAGEMENT SCIENCES in the relationship between corporate governance and company performance differed from.

Hence, the stewardship theory seeks to underscore the importance of combining the CEO and chairman roles to attain financial performance for the company. Proponents of the stewardship theory contend that better financial performance is likely to be associated with internal corporate governance practices that grant managers greater autonomy and power.

The power should be centralised in the hand of the managers because of their intimate knowledge of the business Rebeiz In this situation, power and authority are vested in a single person and there is no room for uncertainty as to who has authority or responsibility. It is believed that a single leadership structure, having combined the CEO and chairman roles, will assist the company to attain superior performance to the extent that the CEO exercises complete authority over the company and that the CEO's role is unambiguous and unchallenged.

Resource dependence theory and corporate governance Nguyen, Locke and Reddy describe the resource dependence theory as an association between board characteristics and the company's critical resources, including aspects such as the companies' 'prestige and legitimacy'.

relationship between corporate governance and financial management

The resource dependence theorists trace their origins to the school of sociology Clarke It was developed by Pfeffer to emphasise that the board, particularly the composition of the non-executive directors, can provide the company with resources that can enhance company performance.

Finally, the board provides a critical link to a company's external environment and significant stakeholders such as creditors, suppliers, customers and competitors.

In other words, the resource dependence theory postulates that apart from the monitoring function, the board of directors also serves as a resource provider. Hillman and Dalziel refer to the ability of the board to solicit essential resources to the company as 'board capital'. As stated by Hungcompanies depend on one another for access to valued resources. The resource dependence theory posits that companies are interrelated and depend on the external environment for survival.

According to Pfefferthe board of directors could be seen as the requisite link between the company and the external environment. A board's ability to fulfil this function is linked to a director's connections to other entities - that is, the board interlocks as the latter is frequently regarded as a conduit between companies Shropshire When a member of a board of directors also sits on other boards of directors, a director interlock is created.

Hence, Hung states that there are indeed benefits to director interlocking. This could impact financial performance positively. This can better aid appreciation of the intricacies of the external environment and global marketplace. Research hypothesis Accordingly, the hypotheses for this study are on the effect of board size, board independence, board activity, board diversity, leadership structure and presence of key board committees on financial performance.

The foregoing variables are all internal structures and processes within the control of the company's shareholders and the board of directors.

Brown, Beekes and Verhoeven refer to these as internal corporate governance structures. The focus of this study is thus on the impact of internal corporate governance structures on financial performance.

The independent variables were: Therefore, the following research hypotheses are formulated: There is a positive significant relationship between board size and financial performance. There is a positive significant relationship between board independence and financial performance H3A: There is a positive significant relationship between the presence of key internal board committees and financial performance.

There is a positive significant relationship between board activity and financial performance H5A: There is a positive significant relationship between board diversity and financial performance. There is positive significant relationship between leadership structure and financial performance. The study ended with a sample of 90 companies from five major industries, covering the period to This number of companies and the period of examination translated into firm-year observations.

In addition, the global financial crisis occurred. Consequently, companies that made the sample needed to have been exposed to all the domestic reforms as well as the global financial crisis. Three estimation methods, the generalised method of moments, two-stage least squares and generalised least squares GLS fixed effects, were considered.

Similar to the study of Habibamong others, GLS emerged as the preferred statistical method based on the explanatory power and the goodness of fit. Model specification As mentioned in the 'Introduction', one of the most daunting tasks in corporate governance empirical studies is dealing with the endogeneity of corporate governance independent variables. In light of this, Wintoki et al. Therefore, this study also adopts a dynamic modelling approach to investigate the relationship between corporate governance and company performance.

By doing so, this study responds to recent calls by Arora and SharmaNguyen, Locke and ReddyNguyen et al. In view of the preceding, the model specification for this study is as follows: BSit, BIit, BCit, BAit, BDit and LSit are corporate governance variables, namely board size, board independence, presence of key board committees, board diversity and leadership structure respectively, of company i at period t. The following models are thus used for the entire periodpre-financial crisisduring the crisis and post-financial crisisfor the whole sample as well as for each industry.

Model 1 Model 2 As already mentioned, for corporate governance measures, the study considers board size, board independence, board committees, board activity, board diversity and leadership structure, while the control variables are company age, company size, leverage and growth prospects.

The construction of these variables for the empirical analysis is presented in Table 1. Definitions of variables are largely adopted from existing literature with the aim of making a meaningful comparison with earlier empirical studies. Results The following section discusses the descriptive statistics and preliminary data analysis, as well as the regression results for each of the five industries.

relationship between corporate governance and financial management

For ease of comparison, in each industry, two tables are presented for all hypotheses. The first table shows the hypotheses and Tobin's Q and the second table presents the hypotheses and ROA. One of the objectives, as highlighted in the 'Introduction', is to develop a corporate governance and performance model for each industry.

In the light of this objective, the analysis for each industry culminates in a customised corporate governance model for ROA and Tobin's Q also see Appendix 1. The following subsection discusses the assumptions of the ordinary least squares regression method to determine which estimation technique is appropriate for the study.

These assumptions include normality, linearity, homoscedasticity, multicollinearity, auto-correlation and presence of outliers. Assumption of auto-correlation The Durbin Watson statistic indicates independence between the residuals when the statistic encompasses values between 1. In this study, such a condition is met for all dependent variables, which indicates that the data are not autocorrelated.

Panel data unit root test For this study, the Levin, Lin and Chut test is applied and the test gives absence of unit roots by rejecting the null hypothesis.

Using variables without taking the first difference in the estimation model may give spurious results. Therefore, the study uses the first difference to obviate unit root. Assumption of normality An analysis of the skewness and kurtosis indicates that most of the variables used in this study do not meet the assumption of normality - only the board committee independent variable meets the assumption of normality, with a skewness of 0.

Consequently, the non-normal distribution of the variables indicates that an ordinary least squares regression is not appropriate for the study. An alternative is to use a GLS model, which will provide more robust estimates Olsson et al.

relationship between corporate governance and financial management

Assumption of outliers A box-plot was conducted to identify the presence of outliers in the data. There are a few outliers, though not significant. The presence of outliers may give rise to heteroskedasticity Gujarati Unequal variances may exist due to the presence of outliers and skewness.

A GLS regression with a robust standard error was carried out to test the research hypotheses. The GLS method is applied when the variances of the observations are unequal or in the presence of heteroskedasticity Gujarati Further, similar to the studies of Muchemwa, Padia and CallaghanPamburai et al.

Chatterjee and Hadi posit that a value of variance inflation factors larger than 10 should be considered an indication of the presence of multicollinearity. The results indicate that multicollinearity is not a problem because all variance inflation factors values are well below the cut-off point of 10 as stated by Chatterjee and Hadi Selection of the appropriate estimation method for the study Based on displaying the smallest residuals S2 and highest adjusted R2, as well as the F-value as guided by the studies of Rad and Tshipa et al.

This estimation technique allows for potential sources of endogeneity inherent in the corporate governance and company performance relationship, including dynamic endogeneity, simultaneity and unobserved time-invariant heterogeneity across companies.

Corporate governance and financial performance nexus in the financials industry Appendix 2 presents the descriptive statistics for the financials industry. Notably, the descriptive statistics reveal that both performance measures, Tobin's Q ROA dropped from 1. This demonstrates the significant decline in company performance as a result of the financial crisis. The recovery after the crisis indicates the resilience of the financials industry to the aftermath of the global financial crisis.

The board size should not be very large that it costs huge financial burden which is higher than the agency cost nor the board should be too small that it may lead to the biased decisions or weak decisions.

Talking about the board size, two school of thought exists, one says that smaller board size contribute more and better in the best interest of the organization, whereas other school of thought is of the view that large board size provides the better results and it improves the performance of the organization [ 89 ]. As it brings out better and more information from the board members and the decision making is more effective and well informed, Klein [ 10 ], Dalton [ 11 ].

Those firms which have their board as an independent they tend to face less financial pressure, Elloumi and Gueyie [ 12 ]. Higher number of independent directors in the board in the companies can enhance the decision credibility and objectivity.

When there is an independent system exists regarding the board of directors, there would be a transparency in financial statements and value.

Independency of the board also tends to have better supervision and protection of shareholders equity increases. Independent directors also supervise the hierarchy of the management in a better and unbiased way. If the number of independent directors is higher in the board then dependent board members then the performance of the company enhances. This lead to the highly biased decision and monopoly of a single person arises which tends to have lack of confidence of other board members and as well as the performance of the company also reduces.

This creates an imbalance of the power within the firm and the influence of one person in all matters of the organization results in highly biased and ineffective decisions. Duality of the board reduces the supervision and monitory process on the management of the organization. They also evaluate the management and take decision which is helpful for the organization. It is, therefore, the education level of the board must be better so that they can inspect the current situations and take measures and decisions accordingly.

The board must be fully equipped with the knowledge in order to cope up with all matters of the organization. There is utmost requirement of the board to contribution is made from each member and this contribution is then implemented in the enhanced performance of the organization [ 14 ]. Suffient professional competency is better and essential of the directors for having better decisions. Also high aged members are not updated with the latest innovations thus this tends to lack of better decisions for the organization.

The performance of the firm can be seen from its financial statements which are reported by the company. A study showed that if the company is performing well it will support the management for quality disclosure of their operations. In order to get the growth in the organization, it needs to be measure as what the organization is performing currently which will bring out the gap needed to be filled to attain the objectives of the organization Figure 1.

Many analyst uses different techniques for measuring the financial performance but most of the investors focused on the tool like Return on Equity and Return on Asset in order to ascertain the financial performance of the company.

relationship between corporate governance and financial management

Measuring corporate governance Instrument used for measuring the corporate governance is the questionnaire given at appendix A containing closed ended questions asked from Directors, Executives, Managers and Junior Managers of selected organization to gather the primary data for measuring the hypothesis of variables of corporate governance. ROA is the indicator as what profit the company is earning against its available resources i. Both these indicators brings out the internal performance of the company and shows the earning aspect of the company.

relationship between corporate governance and financial management

Book value of the share is determined by dividing total shareholder equity with total outstanding share. In order to ascertain the Market to Book Ratio, book value is divided by market value, gives market to book ratio of the company. This MBR identifies that either the share is overvalued or it is undervalued which shows its future direction or movement of the price.

Population size The population of the study is categorized as under: This questionnaire contains closed ended questions and made simplified for better understanding of the respondents.

Data collection Data from Pakistan obtained by physically floating of the questionnaire in listed companies of Pakistan and for USA, the questionnaire was floated online due to non-reachable physically. Similarly for obtaining information about the market value of share, it has been obtained from Karachi Stock Exchange and New York Stock Exchange official website of last closing price as on period December to December Data Analysis and Results Questionnaire were floated to 50 respondents both for Pakistan and USA against which 45 respondents in respect of Pakistan and 33 respondents gave their comments on the online questionnaire in respect of USA.

These responses were then analyzed through excel sheet which showed the following results. Analysis of data in respect of Pakistan: Pakistan being a developing country investigated in the study and found the data which is analyzed here under: