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INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS

COPY RIGHT © 2013 Institute of Interdisciplinary Business Research 581

MARCH 2013

VOL 4, NO 11

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


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


Management

-.563

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Table IX

Component Score Coefficient

Matrix

Component

1

Attitude of Senior

Management

.513

Attitude of Employees .626


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


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


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


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

impact of corporate governance on overall firm...

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