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The Impact of Corporate Governance on Financial Performance of Listed Companies in Malaysian Security Exchange
1.0 Introduction Background of research This paper examines the impact of corporate governance on corporate performance in Malaysia, which is denoted by the return on assets (ROA). Corporate Governance is an increasingly essential aspect of business management, extending to all organizations and corporations, spreading into the globalized markets and economics, influencing international politics and trade laws. Theories, standards and regulations regarding Corporate Governance began to be established in the 1990s, therefore it is still a relatively recent in the field of economic and management practice. In Malaysia, the importance of corporate governance has been vastly adopted after the Asian financial crisis in 1997 as a strategy to regain market confidence (Mohd Ghazali, 2010). It is found that poor corporate governance was one of the major contributing factors that led to the economic
turmoil in Malaysia back in the 1997.
Corporate Governance: Concept and Its Relation with Financial Performance The term ‘corporate governance’ outlines the efforts of stakeholder in optimizing a company’s management system and it’s monitoring. According to (Wanjiru, 2013) Corporate Governance is a very sophisticated and yet flexible concept which addresses fundamental organisational purposes, it is a specialised mechanism designed for regulating corporate activity, and therefore also functions to avoid the occurrence of corporate scandals and disasters, or any consequential damages or losses arising from mismanagement. Corporate governance concept arises form, and is based mainly on the Agency Theory and the issues of information asymmetries. Corporate governance has also evolved into a medium for stakeholders to better understand the running of a firm, at the same time questioning and refining the management process. In other words, Corporate Governance is concerned with methods undertaken by stakeholders in evaluating the quality of governance of the management teams, in terms of the wellbeing of the firm, and their attempts in ensuring that the top managers are always taking appropriate measures that safeguard the best interests of the stakeholders. The distribution of rights and responsibilities of the corporation's different stakeholders are outlined in the governance structures of each firms in the form of corporate governance code. This includes the roles and responsibilities of all stakeholders such as top management board, supervisory board and shareholders. The corporate governance code does not only defines the corporation’s objectives, it also includes the rules and standard procedures required to be followed by top managements in decision-making or resolving various corporate affairs. The board of directors act as the key institutional mechanism in enabling shareholders to exert a certain level of influence over the managers of corporations. The relative effectiveness of directors in performing these functions determines the effectiveness of the board’s decision making and
firm’s profitability (Adams et.al., 2010; Hermalin and Weisbach, 2003). Given this importance, prior literature has extensively examined corporate directorships, with a focus on the role played by directors as well as the effect of board diversity in affecting firm governance and its performance. While on the other hand, weak corporate governance leads to loss, waste of resources, mismanagement, and corruption. Numerous empirical studies have been conducted in the past to study the association between effective corporate governance and firms’ financial performance (Chang, et al., 2004; Haniffa & Hudaib, 2006; Liew, 2007). Haniffa & Hudaib (2006) concluded that in Malaysia, corporate governance is a very important corporate mechanism that should be utilized by firm owners to encourage managers to act in their interest of generating higher profits. The arguments on the advantages of corporate governance was supported by Liew, (2007) who deduced that higher premiums are associated with shares of better governed firms. The payment of higher premiums, which is in favour for the principal's’ interest, also signifies that good corporate governance enables firms to attain higher stock prices. Newell and Wilson (2002) also showed that the transition from a firm with poor governance into a firm with good governance structure will increase the market value of the firms by around 12%. The positive growth in the market indicators such as stock price can be said that financial performance of a firm is therefore higHly associated with good corporate governance.
Agency Theory
According to the Agency theory of Jensen & Meckling (1976), good financial performance is associated with good corporate governance. Agency theory is used to understand the relationships between agents (members of the Board of Directors) and the principal (the stakeholders) of a particular company. The difference in interests of principals and agents can lead to conflicts in interest arise, as agents do not always act perfectly according to the principal’s best interests. Therefore, principal-agent problem problems such as financial loss and inefficiency is business operation can arise from the miscommunications and incompatible goals between the two parties. The principal-agent problem occurs when both parties are seeking for their own interest that are not identical, for example, a director seeks for higher sales turnover while shareholders demands higher dividend payouts. This conflict in interest later will then lead to serious problems such as ethical issues. In order to resolve the conflict in interest between these two parties, corporate governance can be introduced to enforce rules and sets as a guideline to the agents in operating the business, while restoring the principal and agent interests at a balanced state. Agency theory can also be used to design a more comprehensive reward structure that considers interests that can encourage agents to pursue the principal’s interest as well as enhance agents’ performance. However, recent researches with varying findings do not conform to the above statement. This issue is discussed further in Chapter two Literature Review. The association between the concept of Corporate Governance and Agency Theory has been
gaining significance as a response of the emergence of numerous corporate scandals and disaster, which has potential to deal great harm to all stakeholders of a company for the benefits of one person or a group of people. A classical example of a recent corporate governance mismanagement is no other than the recent case of the infamous 1 Malaysia Development Berhad (1MDB), in which being a Government-linked companies, numerous politicians have used this listed company as a medium for illegal money laundering, as well as baring large amounts of debts in the name of the company only to syphon off those funds into their private accounts. And more surprisingly, the CEO/Chairman of IMDB, Asri Hamidon, claimed that he has no clue regarding such serious mismanagements. Such mismanagements that at the end of the day leads to the termination of the company would not have taken place if proper corporate governance was in place.
1.1 research gap and problem statement Although it is recognized that good corporate governance is highly associated with better financial performance, there is a lack of recent studies exploring such effects in the context of Malaysia. Most past literatures, such as (Leiw, 2007; Ghazali, 2010; and Abdullah, 2010) were at least 5 years from now. In today’s dynamic business environment, businesses strategies are constantly evolving in order to remain competitive in the market. Evidence of corporate governance factors that were suggested to be effective in enhancing firms’ performance may not be applicable in today’s marketplace. Therefore, by examining the relationship between corporate governance factors and firm’s performance from the latest data sources, a better insight of the current market conditions can be attained, hence corporate governance factors that are proven to be effective in current market condition can be applied in order for firms to maximize its performance. Not only that, many of the past literatures exploring the impact of corporate governance on the financial performance of companies in Malaysia has selected a short period of time to be studied. For example, Chang’s (2007) study covered a four-year period from 1996 to 1999, while another similar study conducted by Wanjiru (2013) included a five year period of study from 2008 to 2012. Such short period of time are highly unable to capture the effects of economic changes as well as transitions into different economic cycles. This paper, with a period of 10 years aims to captures as much economic events and therefore aims to remedy the gap of the possible changes in findings due to the difference in period of study.
1.2 research objective
This study seeks to identify the significant corporate governance determinants if enhancing
corporate financial performance and analyse to what extent these determinants have. The specific objective for this study is to determine whether there exists a long run relationship between Gender Representation of the Board, CEO duality, Board independence, Board internalization and the financial performance of the top 25 companies listed at Kuala Lumpur Securities Exchange.
1.3 Research questions The research questions of this paper are as below: (i) What are the effective corporate governance factors that will contribute to better financial performance? (ii) How impactful or significant are these factors in affecting financial performance? (iii) Among the four chosen explanatory variables, which of these corporate governance variables is most effective in enhancing Malaysian public listed companies’ financial performance?
1.4 SIGNIFICANCE AND JUSTIFICATION OF RESEARCH
This research explores the relationship between corporate governance and the financial performance of firms listed at KLSE for an extended period of ten years, which is an approach that has never been explored before in Malaysia. Therefore, this study would be invaluable to the various stakeholders in the Malaysian economy. For instance, this study will provide stakeholders in the corporate world with the latest information regarding the effectiveness of corporate governance practices, while also providing an insight of the effects of corporate governance approach taken in the past. This study would identify how various aspects of corporate governance practices affect the operations of firms in Malaysia as well as determine the extent to which this and other factors affect operations of firms. Therefore, identifying the most effective corporate governance measures will then enable the best practices to be applied in choosing the composition of members of the Board in order to achieve better financial results. Besides, this study also acts as a guidance which outlines the best corporate governance practices. With the knowledge of effective corporate governance practice, policy-makers can further enhance the economic growth of Malaysia by enforcing regulations that promotes better governance that will in turn, lead to higher financial performance and hence the improvements of overall well-being of the economic conditions in Malaysia. Not only that, study will enable the future researchers and academicians to identify gaps which have never been covered by the previous researchers, such as further exploring the sample data ranging from an extended period of time, as this study has derived several difference in findings as compared with past literatures exploring a shorter span of time.
2.0 Literature Review 2.1 Return on Assets (ROA) as a measure of Financial Performance The dependent variable of this study, the return on asset (ROA) ratio, is measured by calculating the net profits of the company, divided by the total assets employed. ROA is a profitability ratio that implies how
much income a firm is able to generate from its assets. Therefore, ROA is a ratio that gives an insight to the outsider on how efficient a company’s managers are in generating income from the value of resources employed. Hence, the higher the ROA ratio, the more efficient the managers are in allocating the assets of a company in order to generate higher profits. However, ROA may vary across different industries and different firm sizes, therefore, in order to ensure large variations in ROA is not observed in the sample for study, a control variable of firm size, in terms of market capitalization is introduced, therefore, the effects of corporate governance on firms with consistent or similar sizes can be examined. According to Siminica, Circiumaru and Simion (2012), although ROA is not a perfect measure of firm’s financial performance, it is considered the most effective financial performance ratio as it is one of the most commonly available financial information available for accessed by public. ROA also captures the essence of business performance in a comprehensive way by including measure from both the income statement (net profit of the year) as well as the elements of the balance sheet (total assets), looking at both income statement performance and the assets employed in business operations. Besides that, another justification for the choice of ROA as a measure of financial performance would be, as compared with other performance metrics such as return on equity, ROA is less prone to financial engineering, like shortterm debt leverage (Lindo, 2008).
2.2 Role of duality. Ho (null hypothesis): CEO with dual role does not affect firm performance. H1 (alternative hypothesis): CEO who is also the Chairman of BOD is positively associated with firm performance. With our current research topic on the Impact of Corporate Governance on Financial Performance of Listed Companies in Malaysian Security Exchange, it is a key controversy to study on a CEO’S duality impact regarding the Top 25 firm’s financial performance. As mentioned by Erah, Samuel and Izedonmi (2012), they explained that the duality of CEO happens whereby the executive manager also serves as the chairman of BOD. In other words of Rechner and Dalton (2009), it is defined as “a leadership board structure which a CEO wears two hats as a CEO of the firm and also a chairman of the board of directors”. With that said, it is also the board’s responsibility to ensure that the CEO is serving the best interest of shareholders. Hence, it is vital that CEO Duality only occurs when the same individual has the basic fundamentals to take up both important roles. This statement is supported by Rashid (2010), as CEO duality must carry strong firm leadership traits and power to better manage firm operations and make quick decisions. Not to mention, Kang and Zardkoohi (2008) also commented that dual leadership is a solution for external environmental challenges and has the potential to escalate firm’s financial performance in the long run. In conjunction to other corporate governance independent variables, CEO duality is also said to play an important role in the firm’s value as the agency cost is eliminated between the two (Falah, 2017). It is further elaborated that the reduction of agency costs will potentially lead to a positive impact on firm’s performance as CEO duality may facilitate better understanding and knowledge of company operations and interest. Thus, performing better in terms of decision-making. In addition, Boyd (2004) also supported that a CEO duality would be more committed and be more responsive to
changes. Not to mention that, empirical evidence was found in Donaldson and Davidson (2003) study that returns on equity to shareholders increases if the positions of CEO and Chairman are of the same person. Relatively, additional costs may also incur when the roles of the CEO and chairman are separated. By taking into account of monitoring cost, there may be many benefits than costs in many aspects. However, with the CEO own self-awareness that he/she is being monitored is often deemed to be sufficient to create the same benefits (Chen, 2015). Besides that, Chen (2015) also further argued that monitoring wouldn’t add much impact to the CEO’s desired behavior and would not be able to yield much benefits from the additional cost. However, this independent variable of CEO duality have received criticism from various parties for its impact of firm’s financial performance. It has been argued that it would result of various problem if the monitoring of the management is handled by the same individual who holds the CEO and chairman of the BOD. Goyal and Park (2005) justified that CEO duality grants enormous management power to the CEO and increases the risk to fail the internal control system. They also mentioned that a CEO with duality may lose its balance and be motivated by self-interest. Hence, ignoring stakeholders best interest instead. Not to mention that from another study, Wan and Ong (2005) also stated that not only does duality promotes entrenchment but in turn also declines board independence; resulting in a reduction of firm’s financial performance. Ultimately, CEO duality may worsen firm’s performance as the board may find it difficult to remove an underperforming CEO that is also the chairman. Goyal and Park’s (2005) research has concluded that CEO turnover to firm’s underperformance is significantly lower in the case of CEO duality. Jensen (2015) debated that with an independent chairman, the board will be more effective as there wouldn’t be conflicts of interest. Empirical support was provided to support Jensen’s statement which resulted that the separation of CEO and chairman is more effective based on the accounting performance measures. Pi and Timme (2008) research also had similar results suggesting that when the CEO and chairman positions are separated, variables such as firm size, costs and return on assets are higher. Pi and Timme research is based on the agency theory whereby ownership separation is effective in controlling agency costs due to its competency in improving firm performance. In this case, agency theory supports the fact that the board of directors can easily fire a CEO who does not perform in a satisfactory way. Besides that, another argument also highlighted that shareholders best interest would be better protected when the CEO and the chairman is not of the same person. Rechner et al (1999) stated that a major reason for the separation of CEO and chairman is more favorable as it put in order board check maintenances and regulates the performances of top management. Besides that, there is also a possibility whereby the CEO happens to act in the interest of shareholders and neglected the management of the corporate as a whole. This statement is proven by Williamson (2004), whereby such incident would occur in the event whereby there is a compensation mechanism that has taken place for the CEO. Although chances are low, but such corruption in corporate governance does happen under table. Nevertheless, such debate is still a puzzle as there are no optimal board leadership structure; both form of leadership structure may have potential costs, as well as benefits.
2.2 Board independence Ho (null hypothesis): Board Independence does not affect firm performance. H1 (alternative hypothesis): There is positive effect of Board Independence on firm performance. The second corporate governance factor focuses entirely on the relationship between the independent variable of the proportion for independent directors and firm’s performance. It is measure by calculating the number of independent directors, divided by the total number of directors in the board. Based on Zinkin (2010) research, the proportion of independent directors on the BOD displayed a positive significant relationship with a firm’s financial performance. The author justify the findings by stating that independent directors are the core contributors in the board of directors panel that contributes independent views and are active in participating board meetings. Zinkin (2010) continued by further elaborating that as an independent person, directors must ensure their presence and performance free from any insider’s influence. It is also stated by Zinkin (2010) that independent directors role in corporate governance is define as a person that monitors executive directors and top management team performs and further pursue on the interest of maximising shareholders value. In other words, a suitable independent directors would have the ability to form a firm’s a strategic planning and in turn greatly strengthen corporate governance due to the effective formulation contributed. Besides, according to Fuzi et. al. (2012), an independent director is an individual with relevant industry background and possess expertise in challenging the CEO or the management team during major discussions. That being the case, the independent director should have the responsibility to question the firm’s core business strategy such as their product market segmentation, and the firm’s targeted customer base within the market segmentation. Hence, board independence is an important factor that should not be neglected in terms of corporate governance. It comprises the issue of independence in terms of board effectiveness in monitoring and forming strategic roles of directors. According to Berghe and Baelden (2005) findings, board independence refers to acquiring enough numbers of independent directors on board. In relation, the independent attitude of each directors pose a significant effect on the board environment and firm’s performance. By looking into the relationship between the proportion of board independence and firm’s performance, most researchers applied market-based measure or accounting based measures such as Return on Assets (ROA) or Return on Investments (ROI). For this study, we will be looking into the Return on Assets (ROA) to determine whether board independence would affect firm’s performance. Garg (2007) studies mentioned that a study that was conducted on India’s firm claimed that board independence do not necessary guarantee firm performance improvements. This statement was reasoned further as the cause of it was due to poor monitoring roles of independent directors. As mentioned, the independent director’s vital main function is to monitor company performance and operations and effectively point out critical issues during board meetings. Hence, Garg (2007) proposed that the company should appoint suitable independent directors who have the ability to properly exercise monitoring governance, internal management control and risk management. It has been highlighted numerous times, that effective monitoring is the key mechanism that could reduce agency problems. Likewise, Johari et.al. (2008) research supported that the association of board independence and firm performance does not relate to each other even though there is a one-third proportion of independent directors in total majority. Hence, it is said that regardless of the majority number of independent directors on the board, it would not be of any effect to firm’s performance or increase shareholders’
return. In Malaysian context, it is said that firms had insignificant relationship between board independence and firm’s performance due to the fact that it relates to the ineffectiveness of board directors monitoring roles. Some managerial roles are more possessive and dominant then executive directors in board matters (Rahman and Ali, 2006). In contrast, Abdullah (2004) study on 412 Malaysia’s Listed Companies’ firm performance relationship between the proportion of independent directors in the board. Results were positive and showed a significant correlation on return on assets (ROA), profit margin and earnings per share. Through this research outcome, it was proven that board’s independence might contribute to effective firm performance as well. Evidently, with a higher number of independent directors on the board, it would have a major impact on influencing management decisions and firm’s financial performance. In addition, Ameer et.al (2009) research on 277 Malaysian Listed Companies financial performance for the period of 2002 to 2007 showed positive results as well. They found out that listed companies with a higher representation of independent directors in the BOD will lead to lower abnormal accruals and increase firm performance relatively. Hence, we could say that board independence would lead to good corporate governance as the board would be more transparent and would disseminate information effectively; hence enhancing the firm’s profitability in the long run. Board independence as a corporate governance determinant of corporate financial performance seems to derive an indistinctive result, although it is arguably a significant indicator in promoting the financial performance of a company. Therefore, there is a need to conduct an analysis on Malaysian companies for an extended period of time as compare with the past literatures.
2.3 Board Gender Diversity (GREP) Ho (null hypothesis): Board Gender Diversity does not affect ROA. H1 (alternative hypothesis): Gender Representation of BOD has positive effect on ROA. The measurement of gender representation of the board is calculated using the number of female directors, divided by the total number of directors in the board. On 26 April 2017, the Securities Commission Malaysia released the new Malaysian Code on Corporate Governance requiring a composition of at least 30% women on the board. This has shown that the Malaysian government understands the importance of gender diversity and are in favour of more female participation in the board. There has been a divergence in findings with respect to the impact of gender diversity in the BOD on firm performance. Using ROA and ROI as a measure of firm’ performance, Erhardt, Werbel, and Shrader (2003) found that the presence of gender diversity on board presents a significant positive relationship with the firm’s financial performance. Similarly, based on empirical evidence found in the context of United States, Gul et al. (2011) revealed that higher female composition in the BOD is strongly
associated with better financial performance in the case of firms with weak corporate governance, suggesting that gender diversity has the potential of being a substitute mechanism for improving the financial conditions for firms with weak governance. The findings of significant positive relationship between firm’s performance and higher female composition in the board is backed up by a recent study done by Setiyono and Tarazi (2014) who examined the impact of female directors in Indonesian banks from 2001 to 2011. The authors also noted that while enhancing corporate performance, female presence in the board also reduces risk faced by the companies studied as female directors as more risk averse, they tend to take less risk to avoid failure. Despite all this, there are mixed findings in the studies relating to the effectiveness of inclusion of female directors in the board, in the South African context, in the case of better governed firms, female directors are found to be less effective in enhancing corporate performance as compared with directors that are more nationality diversified (Gyapong et al., 2016). On the other hand, other findings of an earlier study by Adams and Ferreira (2009), also in the context of the United States, had derived a negative relationship between gender board diversity and firm’s performance, although the authors recognized that women directors are associated with higher monitoring. Shifting the focus to developing countries similar to Malaysia, Kusumastuti et al. (2007) found that there is no significant effect of having higher proportion of female in the BOD to the firm’s performance in Indonesia, which is inconsistent to the findings of Setiyono and Tarazi (2014). In another neighbouring country Thailand, Sitthipongpanich and Polsiri (2013) also deduced an insignificant relationship between gender diversity and firm’s performance. Similarly, Marimuthu and Kolandaisamy (2009) examined the effects of female directors on the performance of Malaysian non-financial listed companies over the period 2000 to 2006 also find that gender diversity has no significant influence on the firm’s financial performance. In a recent study conducted by Rafindaa et al (2018), it is concluded that the findings showed no significant impact of the presence of female directors to the performance of companies in India. It is explained that such insignificant results arise due to the fact that in India, Clause 149 that require at least one woman to sit in board of directors, and therefore diminishing the significance of women director’s impact as a whole, because whether the firm is performing well or not, there is one female director required to be in the board. This study also revealed that women directors are positively associated with risk preference. This surprising findings suggested that female directors are more risk seeking than male directors. While based on the risk and returns concept, risk and returns are highly related, or in other words, the more risks undertaken by a firm, the higher the returns, thus higher ROA (Paman & Vikpossi, 2014). The results from past literatures seem to be inconsistent in proving the relevance of gender diversity among the board members with regard to financial performance. Hence the need for an exclusive analysis for Malaysian firms is felt.
2.4 Board Nationality Diversity (BINTERN) Ho (null hypothesis): Board Nationality Diversity does not affect ROA H1 (alternative hypothesis): There is positive effect of Board Nationality Diversity on ROA.
The next determinant also focuses on the impact of board diversity on the firm’s financial performance. Board internalization is measured by the number of foreign directors, over the total number of directors in the BOD. A foreign director refers to an individual working in a different cultural context that is distinctive from his or her originating national background. In this case, it refers to a person having nationality other than Malaysian, who is currently a director in a Malaysian company. Internationalization of BOD is one of the critical strategic steps for a company to enhance its financial performance. In order to ensure effective corporate governance, a well-diversified BOD that possess relevant qualifications such as having good understanding of the international market is essential to effectively lead a company through the dynamics and imponderables arising in the context of international business activities (Ghoshal, 1987). Hence, having foreign directors will open the opportunity for local firms to expand their business to a global level (Adams, et al., 2010). In other words, the ability of BOD in information processing is crucial for a company that has business overseas, especially for multinational companies (MNCs). In recent years, an estimated 13% of large U.S. public firms have foreign directors serving on their boards (Volkov, 2018). Foreign directors can enhance the advisory capability of boards by providing first-hand knowledge of foreign markets and enabling them to develop and tap a network of foreign contacts. These resources enable foreign directors to provide valuable insights and assistance to U.S. corporations, especially those with major foreign operations or aspirations to expand internationally. The increased reliance on foreign directors has led various studies to examine the association between profitability of firms and appointing directors from foreign nations. Recent studies suggested that foreign directors are a valuable firm asset by proving a significant positive relationship (Gianneti, Liao & Yu. 2014; Masulis, Wang & Xie 2012). Masulis et al. (2012) revealed that foreign directors provide valuable international expertise by providing advice regarding the prospect of expanding into new markets as they have better understanding about the legal conditions, cultural and social norms, market structure, and consumer preferences of the specific country. Consistent with the latter argument, a recent study conducted by Giannetti et al. (2014) conforms to the findings by arguing that foreign directors has a positive impact in improving firm performance because of their superior knowledge of global management practices and that weaker connections with local governments make them more effective at monitoring management. In a similar study by Estélyi & Nisar (2016), the authors further confirmed that boards containing diverse nationalities are positively and significantly associated with the firm's international market operations, and thus leads to higher profitability. Another study that supports the previous literatures are done by Sarhan, Ntim, & Al-Najjar (2018) who examined the impact of foreign directors on firm performance in five Middle Eastern countries over the period of 2009-2014, also revealed that board nationality diversity has a positive effect on corporate financial performance. The authors further explained that the relationship between board nationality diversity and corporate performance is stronger in firms that are more better-governed. Meanwhile, Miletkov, Wintoki & Poulsen (2012) examined the relationship between the presence of foreign directors on corporate board and the performance of 20,000 firms from 98 countries. The authors revealed that the relationship between the presence of a foreign director and firm performance is significantly negative in countries with more developed economic structure and better education quality. The reason for such negative relationship observed is due to the high costs of employing foreign directors have outweigh its benefits. However, the findings of this study does not provide an insightful illustration in the context of Malaysia, as this study does not cover Malaysian companies and Malaysia is considered
as a developing country, the findings may vary. Despite the increasing prevalence of diversity on corporate boards, there is still not much clarity of its impact on Malaysian firms’ performance and hence, there is a need to conduct an analysis in the context of Malaysia in order to examine whether the findings of past literatures are applicable.
Theoretical research framework and expected signs The theoretical framework bellow, developed through literature reviews, aims to investigate the impact of corporate governance indicators (proportion of independent directors in the BOD, the proportion of directors who are foreign nationals, the proportion of directors who are females, and CEO duality) on corporate performance.
+ + + +
INDD BINTERN GREP CEOCHAR
>>> Financial Performance (ROA)
3.0 Research Methodology 3. Methodology and Procedure of Analysis 3.1 Data and Data Sources The sample firms were public companies, quoted on the Kuala Lumpur Stock Exchange (KLSE). Secondary data were obtained from the annual reports of the top twenty five publicly listed companies in terms of market capitalisation in the Main Market of Bursa Malaysia, from 2008 to 2017. The data sample consists of firms from all sectors of the economy ranging from manufacturing to investment holdings industries. Nevertheless, this selected sample excludes firm without complete information on the variables needed for the study, such companies that has not been listed by 2008 due to the absence of annual reports availability, companies from financial sector, typically banks due to confidentiality to information, as well as companies belonging to the same group corporate structure in which they share similarities in the board of directors and the ROA of the parent company is highly correlated to its subsidiary due to high shareholding percentages, for instance Genting Berhad Group of Companies, therefore Genting Plantations has been excluded from the study. This study will adopt a quantitative approach and hence uses secondary data, which are extracted from the annual reports published by the selected companies for the period of 2008-2017. The annual reports are obtained from the Bursa Malaysia website. The annual reports provided information on: board composition, nationality of directors, proportion of female directors in the BOD, returns on company's assets employed, size of firms, as well as the existence of CEO duality. All corporate governance data were extracted from the company’s statement of compliance with corporate governance. Whereas, financial data about the company’s total assets, net profit and amounts of share capital are extracted from the financial statement and the report to shareholders sections in the annual report. Meanwhile, this paper explored a different approach, as the selected period of 10 years in this study is longer compared to other past literatures. This paper analysed the efficiency of corporate governance over an extended period of time (10 years), while limiting the selected companies to twenty-five companies with the highest market capitalisation, in order to derive different insights. Therefore, the number of observations is determined as 250. Several existing literatures that explored the impact of corporate governance on Malaysia’s firms had included a rather short period of study, for instance in the study by conducted by Chang (2007), in which the study involves 120 selected Malaysian listed companies over a four-year period from 1996 to 1999, while another similar study conducted by Wanjiru (2013) on the effect of corporate governance in the context of Nairobi included a five year period of study from 2008 to 2012. It is acknowledged that the number of selected companies pose a limitations to the research methods, which may affect the test results. A larger sample size of companies is suggested to be collected in future studies.
The data collected is analysed based on regression analysis, using Stata.
3.2 Method of Analysis Multiple linear regression analysis is widely used in past literatures to examine the value of a firm and its leadership structure, and therefore was employed to analyse the data in this study (Studenmund, 2014). Dependent variable Return on assets (ROA) is adopted as a proxy to evaluate the financial performance of the selected companies and therefore is chosen as the dependent variable for the regression analysis. Return on assets was defined as the total earnings (profits for the year) divided by total assets employed. These figures were obtained from annual reports of each companies.
Independent Variables The independent variables were factors that influence firm performance, as measured by ROE. The four independent variables hypothesized to influence firm performance are as described below: 1. INDD: This variable measures the proportion of independent directors on the BOD, expressed as a percentage. It is defined as the number of independent directors, divided by the total number of directors on the board of each firms. It is hypothesized that the higher the proportion of INDD, the board is more independent in making decisions, and hence better company financial performance in terms of ROA can be expected. 2. BINTERN: This variable measures the proportion of member of BOD that is not local (Malaysian), expressed as a percentage. It is derived from the number of foreign directors, divided by the total number of directors on the board of each firms. It is hypothesized that the higher the proportion of BINTERN, the board composition becomes more diverse in terms of nationalities, decisions can be made more effectively, and hence better company financial performance in terms of ROE can be expected. Preliminary analysis in Figure 1 shows that BINTERN is positively related to ROA.
3. GREP: This variable denotes the gender representation on corporate board directorship, , expressed as a percentage. It is derived from the number of female directors, divided by the total number of directors on the board of each firms. It is hypothesized that the higher the proportion of GREP, the board composition becomes more balanced and diverse in terms of gender, better decisions can be reached, and hence better company financial performance in terms of ROA can be expected.
Preliminary analysis in Figure 2 suggests that GREP is positively related to ROA. 4. CEOCHAR: This is a dummy variable for CEOs who are also acting as the chairman of the BOD. If the CEO per forms this dual role, the variable takes a value of 1; otherwise it takes
a value of 0. It is hypothesized that a company with a CEO having a dual role will have higher financial performance, as measured by ROA, than a company with separate CEO who is not the chairman of the BOD.
Preliminary analysis in Figure 3 implies that CEOCHAR is positively related to ROA.
Control variables Additionally, two control variables are included in this study, which are firm size and whether the company’s financial statements were audited by any of the Big Four accounting firms. These two control variables are included in the regression analysis as firm size and the credibility of external auditors are determined to have have a significant effect on the financial performance of the company. Hence, controlling these two research variables provides a more comprehensive explanation on the association between the corporate governance structures and the financial performance. 1. B4AUD: This is a binary variable for firms that has its financial statements audited by any of the Big Four accounting firms: Ernst & Young (EY), Deloitte & Touche, KPMG and PricewaterhouseCoopers (PwC). If firm employs to service of Big Four external auditors, the variable takes a value of 1; otherwise it takes a value of 0. It is hypothesized that the Big Four are the four biggest professional bodies in providing auditing services and hence, financial statements of firms that employs the service of Big Four has higher credibility in terms of the integrity of information disclosed. 2. FSIZE: This variable indicates the size of firms in terms of market capitalisation. Market capitalization refers to the total market value of a company's outstanding shares. It is
derived from the number of outstanding shares disclosed under the Share Capital section of the annual report, times the market price of the company’s share on the last day of the firm’s financial year. There are a number of past literatures that suggest a significant association between firm size. Firm size is expected to have a positive influence on company’s ROA, due to: cheaper sources of funds, economies of large scale production, greater diversification as well as increased access to more advanced technologies (Ghazali, 2010). This is consistent to the findings of a study conducted by Chang (2004) revealing that firms that are larger in size are associated with better financial performance. Therefore, it is hypothesized that firm size will have an impact on corporate governance because the quality of governance is related to the level of operations of a firm. There are a number of past literatures that suggest a significant association between firm size. In a study conducted by Chang (2004) revealed that firms that are larger in size are associated with better financial performance. All variables in this paper takes on a log transformation except for dummy CEOCHAR and dummy B4AUD. B4AUD is later dropped from the regression analysis due to its lack of time variability and severe multicollinearity issue.
3.3 Specification of Empirical Models OLS Estimator The section begins by estimating the equation using Ordinary Least Squares (OLS) estimator. The model is specified below: lnROAi,t = β0 + β1ln(INDD)i,t + β2ln(BINTERN)i,t + β3ln(GREP)i,t + β4(CEOCHAR)i,t β5ln(FSIZE)i,t + γt+ εi,t
+ (1)
Where, INDD= the proportion of independent directors on the BOD of the ith company BINTERN= the proportion of directors who are foreign nationals on the BOD of the ith company GREP= the proportion of female directors on the BOD of the ith company CEOCHAR= 1 if CEO is also chairman of BOD, 0 if otherwise FSIZE= firm size And γt is year specific effect, εi,t is the error term. OLS estimator is the most commonly used estimation method when it comes to estimating parameter of a linear regression model. OLS is used in this study to obtain estimates of the
regression coefficients from the set of data. According to Studenmund (2017), OLS estimator minimizes the sum of the residual square and is widely used to estimate the parameter of a linear regression model. The OLS estimator is expected to be consistent only if the explanatory variables are exogenous, and the error term is homoscedastic and serially uncorrelated. Since the independent variables in this estimating equation can be affected by ROA, these variables are endogenous and can cause the OLS estimator to be bias (Aisen & Veiga, 2013). OLS estimator does not control for time invariant unobserved variables. Due to the combination of cross-sectional data and time-series data, the OLS regression technique is unsuitable for the analysis (Studenmund, 2014). The appropriate method of analysis involves panel data regression techniques. The estimation technique employed for the panel data regression would be the fixed effects model (FEM). Fixed Effect Fixed Effect estimator is used to resolve the endogeneity problem due to its ability to controls for unobserved heterogeneity across companies that are constant over time. The FEM model assumes that the slope coefficients of the explanatory variables are all identical for all firms. In this case, fixed effect controls for permanent company-specific effect and decisions making. The equation specification is as below: lnROAi,t = β0 + β1ln(INDD)i,t + β2ln(BINTERN)i,t + β3ln(GREP)i,t + β4(CEOCHAR)i,t + β5ln(FSIZE)i,t + γt+ δi + εi,t (2) Where γt are year specific effects, δi are company specific effects, εi,t is the error term.
In the following section, this paper will run the two equations to study the effects of different estimators on the findings.
4.0 Results and Discussion Evaluating The Quality Of The Regression Equation The quality of regression is to be examined by measuring the overall fit of the estimated model before accepting the validity of regression results. The measure of overall fit can be done by observing the R2. Ranging from 0 to 1, the higher the R2 the closer the estimated regression equation fits the sample data. The 0.526 value of R2 indicates that the model explains 52.6% of the variability of the response data around its mean.
Descriptive Statistics Results Table 1 Summary Statistics
Table 1 shows the descriptive statistics of the variables used in the study. All variables, other than FSIZE acquired a negative value, in which does not make any logical sense. This is because the data is expressed in natural logarithm.
Regression Analysis (1) OLS
(2) OLS
(3) FE
VARIABLES
lnroa
lnroa
lnroa
lnfsize
0.133
0.122
0.122**
(0.0892)
(0.0886)
(0.0537)
0.824***
0.832***
0.832***
(0.224)
(0.212)
(0.150)
ceochar
lngrep
0.720***
0.795***
0.795***
(0.122)
(0.149)
(0.123)
0.388***
0.398***
0.398***
(0.111)
(0.120)
(0.103)
-1.068***
-1.068***
-1.068***
(0.377)
(0.402)
(0.279)
-2.704**
-2.687**
-2.453***
(1.187)
(1.061)
(0.740)
Year fixed effects Company fixed effects
No No
Yes No
Yes Yes
Observations
86
86
86
R-squared
0.525
0.541
0.526
lnbintern
lnindd
Constant
Number of companyid
25
Robust standard errors in parentheses ( ***significant at 1%; **significant a 5%, *significant a 10% level)
Regression Coefficient Estimate Interpretation lnROAi,t = β0 + β1ln(INDD)i,t + β2ln(BINTERN)i,t + β3ln(GREP)i,t + β4(CEOCHAR)i,t + β5ln(FSIZE)i,t + γt+ δi + εi,t ^ lnROEi,t = -2.74 -1.068INDDt + 0.398 BINTERN + 0.720GREP + 0.832CEOCHAR + γt+ δi + εi,t β0 = -2.453 The intercept given when the explanatory variables INDD, BINTERN, GREP, and CEOCHAR are absent.
β1= -1.068 %ΔROA= -1.068% When there is an increment of 1% in independent director against the total number of directors on the BOD (INDD), the ROA of the company will decrease by 1.068%, holding other variables constant. β2= 0.398 %ΔROA = 0.398% For every increase of 1% non local directors against the total number of directors in the BOD (BINTERN), there will be a 0.398% increase in the ROA, holding other variables constant. β3= 0.795 %ΔROA = 0.795% For every additional 1% of female directors against the total number of directors in the BOD (GREP), there will be an increment of 0.795% in the ROA of the company holding other variables constant. β4= 0.832 %ΔROA= 100 (e^0.832 -1) = 129.8% When the CEO is also the Chairman of the BOD (Dummy=1), the ROA will increase by 129.8%. Based on Table 2, it can be observed that INDD, BINTERN, GREP, and CEOCHAR are all significant variables at 10% level of significance; whereas the control variable FSIZE is insignificant at 10% level. While OLS estimate may be bias, it nevertheless provides a good starting point in examining the effects of corporate governance factors on firms’ performance. Table 2 presents the findings with robust standard error (in parentheses) based on equation (1)(2). By excluding year specific effect from equation (1), column 1 presents the most basic specification of simple linear regression (OLS) without any additional controls. The results of variable GREP, CEOCHAR and BINTERN were as expected, having statistical significance at 1 percent. The insignificant positive relationship between control variable FSIZE and ROA is due to the sample selection method. As the companies were chosen based on the 25 listed companies with highest market capitalization, while FSIZE indicates the firm sizes in terms of market capitalization as well, it makes sense that an insignificant result emerged. On the other hand, the results also reveal an unexpected significant negative relationship between ROA and INDD. The negative association between INDD and ROA contradicts with the findings of Abdullah (2004), who examined 412 Malaysia’s Listed Companies and arrived with a significant positive relationship. Such negative relationship observed in this study is due to the high concentration of government-linked companies (GLCs) within the sample of study. Listed companies in Malaysia with high market capitalisation in Malaysia are dominated by GLCs. In fact, out of this paper’s sample size of 25 companies, 6 of them are GLCs, making up 24% of companies in the sample being GLCs. The reason for such occurrence is dated back in the
early days of Malaysia, when Mahathir introduced a New Economic Policy in order to include more Bumiputra businessmen. This policy involves privatizing many of government departments and giving shares to Bumiputra, as well as appointing them as one of the members of the board. Since then GLCs are each dominant in their own industries , the government has high level of influence on how the company runs, like determining the business strategies and deciding who to appoint as board members. A classic example would be, the two brothers of the former Malaysian Prime Minister, Datuk Nizam Razak and Datuk Seri Nazir Razak are both appointed as Chairman of the board in their respective public listed companies. Besides, according to Menon (2017), GLCs usually have special advantage in the case of obtaining government contracts due to their links with government. The existence of direct contracts substituted open tenders, and thus leading to GLCs’ inefficiency in business operations. Therefore, a negative relationship can be observed in the context of Malaysia when the number of independent directors increase. Column 2 reports a similar regression specification together year fixed effects to control for the influence of aggregate trends. Nonetheless, both results in column (1) and (2) are subjected to bias due to the usage of OLS on panel data. To diminish the extent of potential endogeneity within the OLS framework, company fixed effect is included into the regression specification to capture all time invariant company-specific attributes and permanent decisions differences across individual companies, as shown in column (3) and Equation (2).The three corporate governance variables remain statistically significant at 1 percent and INDD remained to be negatively related to firm performance. Usually, system GMM is used to correct the potential endogeneity issue in the panel data. However, it is not used in this study due to limited number of observations.
Diagnostic tests Testing for Multicollinearity Multicollinearity happens when two or more independent variables in a multiple regression model are closely correlated to one another, causing skewed and biased results in the OLS (Studenmund, 2017). Detection of severe multicollinearity can be done through 2 methods, which is by checking whether high simple correlation coefficient or high variance inflation factors (VIF) exists. DETECTING HIGH SIMPLE CORRELATION COEFFICIENT
Correlation matrix lnroa lnroa
1.0000
lnfsize
lngrep
lnbintern
lnindd
ceochar
lnfsize
-0.0418
1.0000
lngrep
0.4453
0.0021
1.0000
lnbintern 0.4526
0.3173
0.1956
1.0000
lnindd
-0.2079
0.3458
0.0479
0.0381
1.0000
ceochar
0.4290
-0.5056
0.0596
0.1167
-0.1162
1.0000
The correlation coefficient between FSIZE and CEOCHAR is -0.5056. Hence, there is a moderate negative correlation is observed between these two variables. The rest of the variables show either weak or very weak correlation with other variables. This multicollinearity test suggests that multicollinearity is not a potential problem as no variables with high correlation (exceeding 0.80) is detected. DETECTING HIGH VARIANCE INFLATION FACTORS (VIF) Multicollinearity Test. Variance inflation factors (VIF) and Tolerance (1/VIF).
1.0 Introduction Background of research This paper examines the impact of corporate governance on corporate performance in Malaysia, which is denoted by the return on assets (ROA). Corporate Governance is an increasingly essential aspect of business management, extending to all organizations and corporations, spreading into the globalized markets and economics, influencing international politics and trade laws. Theories, standards and regulations regarding Corporate Governance began to be established in the 1990s, therefore it is still a relatively recent in the field of economic and management practice. In Malaysia, the importance of corporate governance has been vastly adopted after the Asian financial crisis in 1997 as a strategy to regain market confidence (Mohd Ghazali, 2010). It is found that poor corporate governance was one of the major contributing factors that led to the economic
turmoil in Malaysia back in the 1997.
Corporate Governance: Concept and Its Relation with Financial Performance The term ‘corporate governance’ outlines the efforts of stakeholder in optimizing a company’s management system and it’s monitoring. According to (Wanjiru, 2013) Corporate Governance is a very sophisticated and yet flexible concept which addresses fundamental organisational purposes, it is a specialised mechanism designed for regulating corporate activity, and therefore also functions to avoid the occurrence of corporate scandals and disasters, or any consequential damages or losses arising from mismanagement. Corporate governance concept arises form, and is based mainly on the Agency Theory and the issues of information asymmetries. Corporate governance has also evolved into a medium for stakeholders to better understand the running of a firm, at the same time questioning and refining the management process. In other words, Corporate Governance is concerned with methods undertaken by stakeholders in evaluating the quality of governance of the management teams, in terms of the wellbeing of the firm, and their attempts in ensuring that the top managers are always taking appropriate measures that safeguard the best interests of the stakeholders. The distribution of rights and responsibilities of the corporation's different stakeholders are outlined in the governance structures of each firms in the form of corporate governance code. This includes the roles and responsibilities of all stakeholders such as top management board, supervisory board and shareholders. The corporate governance code does not only defines the corporation’s objectives, it also includes the rules and standard procedures required to be followed by top managements in decision-making or resolving various corporate affairs. The board of directors act as the key institutional mechanism in enabling shareholders to exert a certain level of influence over the managers of corporations. The relative effectiveness of directors in performing these functions determines the effectiveness of the board’s decision making and
firm’s profitability (Adams et.al., 2010; Hermalin and Weisbach, 2003). Given this importance, prior literature has extensively examined corporate directorships, with a focus on the role played by directors as well as the effect of board diversity in affecting firm governance and its performance. While on the other hand, weak corporate governance leads to loss, waste of resources, mismanagement, and corruption. Numerous empirical studies have been conducted in the past to study the association between effective corporate governance and firms’ financial performance (Chang, et al., 2004; Haniffa & Hudaib, 2006; Liew, 2007). Haniffa & Hudaib (2006) concluded that in Malaysia, corporate governance is a very important corporate mechanism that should be utilized by firm owners to encourage managers to act in their interest of generating higher profits. The arguments on the advantages of corporate governance was supported by Liew, (2007) who deduced that higher premiums are associated with shares of better governed firms. The payment of higher premiums, which is in favour for the principal's’ interest, also signifies that good corporate governance enables firms to attain higher stock prices. Newell and Wilson (2002) also showed that the transition from a firm with poor governance into a firm with good governance structure will increase the market value of the firms by around 12%. The positive growth in the market indicators such as stock price can be said that financial performance of a firm is therefore higHly associated with good corporate governance.
Agency Theory
According to the Agency theory of Jensen & Meckling (1976), good financial performance is associated with good corporate governance. Agency theory is used to understand the relationships between agents (members of the Board of Directors) and the principal (the stakeholders) of a particular company. The difference in interests of principals and agents can lead to conflicts in interest arise, as agents do not always act perfectly according to the principal’s best interests. Therefore, principal-agent problem problems such as financial loss and inefficiency is business operation can arise from the miscommunications and incompatible goals between the two parties. The principal-agent problem occurs when both parties are seeking for their own interest that are not identical, for example, a director seeks for higher sales turnover while shareholders demands higher dividend payouts. This conflict in interest later will then lead to serious problems such as ethical issues. In order to resolve the conflict in interest between these two parties, corporate governance can be introduced to enforce rules and sets as a guideline to the agents in operating the business, while restoring the principal and agent interests at a balanced state. Agency theory can also be used to design a more comprehensive reward structure that considers interests that can encourage agents to pursue the principal’s interest as well as enhance agents’ performance. However, recent researches with varying findings do not conform to the above statement. This issue is discussed further in Chapter two Literature Review. The association between the concept of Corporate Governance and Agency Theory has been
gaining significance as a response of the emergence of numerous corporate scandals and disaster, which has potential to deal great harm to all stakeholders of a company for the benefits of one person or a group of people. A classical example of a recent corporate governance mismanagement is no other than the recent case of the infamous 1 Malaysia Development Berhad (1MDB), in which being a Government-linked companies, numerous politicians have used this listed company as a medium for illegal money laundering, as well as baring large amounts of debts in the name of the company only to syphon off those funds into their private accounts. And more surprisingly, the CEO/Chairman of IMDB, Asri Hamidon, claimed that he has no clue regarding such serious mismanagements. Such mismanagements that at the end of the day leads to the termination of the company would not have taken place if proper corporate governance was in place.
1.1 research gap and problem statement Although it is recognized that good corporate governance is highly associated with better financial performance, there is a lack of recent studies exploring such effects in the context of Malaysia. Most past literatures, such as (Leiw, 2007; Ghazali, 2010; and Abdullah, 2010) were at least 5 years from now. In today’s dynamic business environment, businesses strategies are constantly evolving in order to remain competitive in the market. Evidence of corporate governance factors that were suggested to be effective in enhancing firms’ performance may not be applicable in today’s marketplace. Therefore, by examining the relationship between corporate governance factors and firm’s performance from the latest data sources, a better insight of the current market conditions can be attained, hence corporate governance factors that are proven to be effective in current market condition can be applied in order for firms to maximize its performance. Not only that, many of the past literatures exploring the impact of corporate governance on the financial performance of companies in Malaysia has selected a short period of time to be studied. For example, Chang’s (2007) study covered a four-year period from 1996 to 1999, while another similar study conducted by Wanjiru (2013) included a five year period of study from 2008 to 2012. Such short period of time are highly unable to capture the effects of economic changes as well as transitions into different economic cycles. This paper, with a period of 10 years aims to captures as much economic events and therefore aims to remedy the gap of the possible changes in findings due to the difference in period of study.
1.2 research objective
This study seeks to identify the significant corporate governance determinants if enhancing
corporate financial performance and analyse to what extent these determinants have. The specific objective for this study is to determine whether there exists a long run relationship between Gender Representation of the Board, CEO duality, Board independence, Board internalization and the financial performance of the top 25 companies listed at Kuala Lumpur Securities Exchange.
1.3 Research questions The research questions of this paper are as below: (i) What are the effective corporate governance factors that will contribute to better financial performance? (ii) How impactful or significant are these factors in affecting financial performance? (iii) Among the four chosen explanatory variables, which of these corporate governance variables is most effective in enhancing Malaysian public listed companies’ financial performance?
1.4 SIGNIFICANCE AND JUSTIFICATION OF RESEARCH
This research explores the relationship between corporate governance and the financial performance of firms listed at KLSE for an extended period of ten years, which is an approach that has never been explored before in Malaysia. Therefore, this study would be invaluable to the various stakeholders in the Malaysian economy. For instance, this study will provide stakeholders in the corporate world with the latest information regarding the effectiveness of corporate governance practices, while also providing an insight of the effects of corporate governance approach taken in the past. This study would identify how various aspects of corporate governance practices affect the operations of firms in Malaysia as well as determine the extent to which this and other factors affect operations of firms. Therefore, identifying the most effective corporate governance measures will then enable the best practices to be applied in choosing the composition of members of the Board in order to achieve better financial results. Besides, this study also acts as a guidance which outlines the best corporate governance practices. With the knowledge of effective corporate governance practice, policy-makers can further enhance the economic growth of Malaysia by enforcing regulations that promotes better governance that will in turn, lead to higher financial performance and hence the improvements of overall well-being of the economic conditions in Malaysia. Not only that, study will enable the future researchers and academicians to identify gaps which have never been covered by the previous researchers, such as further exploring the sample data ranging from an extended period of time, as this study has derived several difference in findings as compared with past literatures exploring a shorter span of time.
2.0 Literature Review 2.1 Return on Assets (ROA) as a measure of Financial Performance The dependent variable of this study, the return on asset (ROA) ratio, is measured by calculating the net profits of the company, divided by the total assets employed. ROA is a profitability ratio that implies how
much income a firm is able to generate from its assets. Therefore, ROA is a ratio that gives an insight to the outsider on how efficient a company’s managers are in generating income from the value of resources employed. Hence, the higher the ROA ratio, the more efficient the managers are in allocating the assets of a company in order to generate higher profits. However, ROA may vary across different industries and different firm sizes, therefore, in order to ensure large variations in ROA is not observed in the sample for study, a control variable of firm size, in terms of market capitalization is introduced, therefore, the effects of corporate governance on firms with consistent or similar sizes can be examined. According to Siminica, Circiumaru and Simion (2012), although ROA is not a perfect measure of firm’s financial performance, it is considered the most effective financial performance ratio as it is one of the most commonly available financial information available for accessed by public. ROA also captures the essence of business performance in a comprehensive way by including measure from both the income statement (net profit of the year) as well as the elements of the balance sheet (total assets), looking at both income statement performance and the assets employed in business operations. Besides that, another justification for the choice of ROA as a measure of financial performance would be, as compared with other performance metrics such as return on equity, ROA is less prone to financial engineering, like shortterm debt leverage (Lindo, 2008).
2.2 Role of duality. Ho (null hypothesis): CEO with dual role does not affect firm performance. H1 (alternative hypothesis): CEO who is also the Chairman of BOD is positively associated with firm performance. With our current research topic on the Impact of Corporate Governance on Financial Performance of Listed Companies in Malaysian Security Exchange, it is a key controversy to study on a CEO’S duality impact regarding the Top 25 firm’s financial performance. As mentioned by Erah, Samuel and Izedonmi (2012), they explained that the duality of CEO happens whereby the executive manager also serves as the chairman of BOD. In other words of Rechner and Dalton (2009), it is defined as “a leadership board structure which a CEO wears two hats as a CEO of the firm and also a chairman of the board of directors”. With that said, it is also the board’s responsibility to ensure that the CEO is serving the best interest of shareholders. Hence, it is vital that CEO Duality only occurs when the same individual has the basic fundamentals to take up both important roles. This statement is supported by Rashid (2010), as CEO duality must carry strong firm leadership traits and power to better manage firm operations and make quick decisions. Not to mention, Kang and Zardkoohi (2008) also commented that dual leadership is a solution for external environmental challenges and has the potential to escalate firm’s financial performance in the long run. In conjunction to other corporate governance independent variables, CEO duality is also said to play an important role in the firm’s value as the agency cost is eliminated between the two (Falah, 2017). It is further elaborated that the reduction of agency costs will potentially lead to a positive impact on firm’s performance as CEO duality may facilitate better understanding and knowledge of company operations and interest. Thus, performing better in terms of decision-making. In addition, Boyd (2004) also supported that a CEO duality would be more committed and be more responsive to
changes. Not to mention that, empirical evidence was found in Donaldson and Davidson (2003) study that returns on equity to shareholders increases if the positions of CEO and Chairman are of the same person. Relatively, additional costs may also incur when the roles of the CEO and chairman are separated. By taking into account of monitoring cost, there may be many benefits than costs in many aspects. However, with the CEO own self-awareness that he/she is being monitored is often deemed to be sufficient to create the same benefits (Chen, 2015). Besides that, Chen (2015) also further argued that monitoring wouldn’t add much impact to the CEO’s desired behavior and would not be able to yield much benefits from the additional cost. However, this independent variable of CEO duality have received criticism from various parties for its impact of firm’s financial performance. It has been argued that it would result of various problem if the monitoring of the management is handled by the same individual who holds the CEO and chairman of the BOD. Goyal and Park (2005) justified that CEO duality grants enormous management power to the CEO and increases the risk to fail the internal control system. They also mentioned that a CEO with duality may lose its balance and be motivated by self-interest. Hence, ignoring stakeholders best interest instead. Not to mention that from another study, Wan and Ong (2005) also stated that not only does duality promotes entrenchment but in turn also declines board independence; resulting in a reduction of firm’s financial performance. Ultimately, CEO duality may worsen firm’s performance as the board may find it difficult to remove an underperforming CEO that is also the chairman. Goyal and Park’s (2005) research has concluded that CEO turnover to firm’s underperformance is significantly lower in the case of CEO duality. Jensen (2015) debated that with an independent chairman, the board will be more effective as there wouldn’t be conflicts of interest. Empirical support was provided to support Jensen’s statement which resulted that the separation of CEO and chairman is more effective based on the accounting performance measures. Pi and Timme (2008) research also had similar results suggesting that when the CEO and chairman positions are separated, variables such as firm size, costs and return on assets are higher. Pi and Timme research is based on the agency theory whereby ownership separation is effective in controlling agency costs due to its competency in improving firm performance. In this case, agency theory supports the fact that the board of directors can easily fire a CEO who does not perform in a satisfactory way. Besides that, another argument also highlighted that shareholders best interest would be better protected when the CEO and the chairman is not of the same person. Rechner et al (1999) stated that a major reason for the separation of CEO and chairman is more favorable as it put in order board check maintenances and regulates the performances of top management. Besides that, there is also a possibility whereby the CEO happens to act in the interest of shareholders and neglected the management of the corporate as a whole. This statement is proven by Williamson (2004), whereby such incident would occur in the event whereby there is a compensation mechanism that has taken place for the CEO. Although chances are low, but such corruption in corporate governance does happen under table. Nevertheless, such debate is still a puzzle as there are no optimal board leadership structure; both form of leadership structure may have potential costs, as well as benefits.
2.2 Board independence Ho (null hypothesis): Board Independence does not affect firm performance. H1 (alternative hypothesis): There is positive effect of Board Independence on firm performance. The second corporate governance factor focuses entirely on the relationship between the independent variable of the proportion for independent directors and firm’s performance. It is measure by calculating the number of independent directors, divided by the total number of directors in the board. Based on Zinkin (2010) research, the proportion of independent directors on the BOD displayed a positive significant relationship with a firm’s financial performance. The author justify the findings by stating that independent directors are the core contributors in the board of directors panel that contributes independent views and are active in participating board meetings. Zinkin (2010) continued by further elaborating that as an independent person, directors must ensure their presence and performance free from any insider’s influence. It is also stated by Zinkin (2010) that independent directors role in corporate governance is define as a person that monitors executive directors and top management team performs and further pursue on the interest of maximising shareholders value. In other words, a suitable independent directors would have the ability to form a firm’s a strategic planning and in turn greatly strengthen corporate governance due to the effective formulation contributed. Besides, according to Fuzi et. al. (2012), an independent director is an individual with relevant industry background and possess expertise in challenging the CEO or the management team during major discussions. That being the case, the independent director should have the responsibility to question the firm’s core business strategy such as their product market segmentation, and the firm’s targeted customer base within the market segmentation. Hence, board independence is an important factor that should not be neglected in terms of corporate governance. It comprises the issue of independence in terms of board effectiveness in monitoring and forming strategic roles of directors. According to Berghe and Baelden (2005) findings, board independence refers to acquiring enough numbers of independent directors on board. In relation, the independent attitude of each directors pose a significant effect on the board environment and firm’s performance. By looking into the relationship between the proportion of board independence and firm’s performance, most researchers applied market-based measure or accounting based measures such as Return on Assets (ROA) or Return on Investments (ROI). For this study, we will be looking into the Return on Assets (ROA) to determine whether board independence would affect firm’s performance. Garg (2007) studies mentioned that a study that was conducted on India’s firm claimed that board independence do not necessary guarantee firm performance improvements. This statement was reasoned further as the cause of it was due to poor monitoring roles of independent directors. As mentioned, the independent director’s vital main function is to monitor company performance and operations and effectively point out critical issues during board meetings. Hence, Garg (2007) proposed that the company should appoint suitable independent directors who have the ability to properly exercise monitoring governance, internal management control and risk management. It has been highlighted numerous times, that effective monitoring is the key mechanism that could reduce agency problems. Likewise, Johari et.al. (2008) research supported that the association of board independence and firm performance does not relate to each other even though there is a one-third proportion of independent directors in total majority. Hence, it is said that regardless of the majority number of independent directors on the board, it would not be of any effect to firm’s performance or increase shareholders’
return. In Malaysian context, it is said that firms had insignificant relationship between board independence and firm’s performance due to the fact that it relates to the ineffectiveness of board directors monitoring roles. Some managerial roles are more possessive and dominant then executive directors in board matters (Rahman and Ali, 2006). In contrast, Abdullah (2004) study on 412 Malaysia’s Listed Companies’ firm performance relationship between the proportion of independent directors in the board. Results were positive and showed a significant correlation on return on assets (ROA), profit margin and earnings per share. Through this research outcome, it was proven that board’s independence might contribute to effective firm performance as well. Evidently, with a higher number of independent directors on the board, it would have a major impact on influencing management decisions and firm’s financial performance. In addition, Ameer et.al (2009) research on 277 Malaysian Listed Companies financial performance for the period of 2002 to 2007 showed positive results as well. They found out that listed companies with a higher representation of independent directors in the BOD will lead to lower abnormal accruals and increase firm performance relatively. Hence, we could say that board independence would lead to good corporate governance as the board would be more transparent and would disseminate information effectively; hence enhancing the firm’s profitability in the long run. Board independence as a corporate governance determinant of corporate financial performance seems to derive an indistinctive result, although it is arguably a significant indicator in promoting the financial performance of a company. Therefore, there is a need to conduct an analysis on Malaysian companies for an extended period of time as compare with the past literatures.
2.3 Board Gender Diversity (GREP) Ho (null hypothesis): Board Gender Diversity does not affect ROA. H1 (alternative hypothesis): Gender Representation of BOD has positive effect on ROA. The measurement of gender representation of the board is calculated using the number of female directors, divided by the total number of directors in the board. On 26 April 2017, the Securities Commission Malaysia released the new Malaysian Code on Corporate Governance requiring a composition of at least 30% women on the board. This has shown that the Malaysian government understands the importance of gender diversity and are in favour of more female participation in the board. There has been a divergence in findings with respect to the impact of gender diversity in the BOD on firm performance. Using ROA and ROI as a measure of firm’ performance, Erhardt, Werbel, and Shrader (2003) found that the presence of gender diversity on board presents a significant positive relationship with the firm’s financial performance. Similarly, based on empirical evidence found in the context of United States, Gul et al. (2011) revealed that higher female composition in the BOD is strongly
associated with better financial performance in the case of firms with weak corporate governance, suggesting that gender diversity has the potential of being a substitute mechanism for improving the financial conditions for firms with weak governance. The findings of significant positive relationship between firm’s performance and higher female composition in the board is backed up by a recent study done by Setiyono and Tarazi (2014) who examined the impact of female directors in Indonesian banks from 2001 to 2011. The authors also noted that while enhancing corporate performance, female presence in the board also reduces risk faced by the companies studied as female directors as more risk averse, they tend to take less risk to avoid failure. Despite all this, there are mixed findings in the studies relating to the effectiveness of inclusion of female directors in the board, in the South African context, in the case of better governed firms, female directors are found to be less effective in enhancing corporate performance as compared with directors that are more nationality diversified (Gyapong et al., 2016). On the other hand, other findings of an earlier study by Adams and Ferreira (2009), also in the context of the United States, had derived a negative relationship between gender board diversity and firm’s performance, although the authors recognized that women directors are associated with higher monitoring. Shifting the focus to developing countries similar to Malaysia, Kusumastuti et al. (2007) found that there is no significant effect of having higher proportion of female in the BOD to the firm’s performance in Indonesia, which is inconsistent to the findings of Setiyono and Tarazi (2014). In another neighbouring country Thailand, Sitthipongpanich and Polsiri (2013) also deduced an insignificant relationship between gender diversity and firm’s performance. Similarly, Marimuthu and Kolandaisamy (2009) examined the effects of female directors on the performance of Malaysian non-financial listed companies over the period 2000 to 2006 also find that gender diversity has no significant influence on the firm’s financial performance. In a recent study conducted by Rafindaa et al (2018), it is concluded that the findings showed no significant impact of the presence of female directors to the performance of companies in India. It is explained that such insignificant results arise due to the fact that in India, Clause 149 that require at least one woman to sit in board of directors, and therefore diminishing the significance of women director’s impact as a whole, because whether the firm is performing well or not, there is one female director required to be in the board. This study also revealed that women directors are positively associated with risk preference. This surprising findings suggested that female directors are more risk seeking than male directors. While based on the risk and returns concept, risk and returns are highly related, or in other words, the more risks undertaken by a firm, the higher the returns, thus higher ROA (Paman & Vikpossi, 2014). The results from past literatures seem to be inconsistent in proving the relevance of gender diversity among the board members with regard to financial performance. Hence the need for an exclusive analysis for Malaysian firms is felt.
2.4 Board Nationality Diversity (BINTERN) Ho (null hypothesis): Board Nationality Diversity does not affect ROA H1 (alternative hypothesis): There is positive effect of Board Nationality Diversity on ROA.
The next determinant also focuses on the impact of board diversity on the firm’s financial performance. Board internalization is measured by the number of foreign directors, over the total number of directors in the BOD. A foreign director refers to an individual working in a different cultural context that is distinctive from his or her originating national background. In this case, it refers to a person having nationality other than Malaysian, who is currently a director in a Malaysian company. Internationalization of BOD is one of the critical strategic steps for a company to enhance its financial performance. In order to ensure effective corporate governance, a well-diversified BOD that possess relevant qualifications such as having good understanding of the international market is essential to effectively lead a company through the dynamics and imponderables arising in the context of international business activities (Ghoshal, 1987). Hence, having foreign directors will open the opportunity for local firms to expand their business to a global level (Adams, et al., 2010). In other words, the ability of BOD in information processing is crucial for a company that has business overseas, especially for multinational companies (MNCs). In recent years, an estimated 13% of large U.S. public firms have foreign directors serving on their boards (Volkov, 2018). Foreign directors can enhance the advisory capability of boards by providing first-hand knowledge of foreign markets and enabling them to develop and tap a network of foreign contacts. These resources enable foreign directors to provide valuable insights and assistance to U.S. corporations, especially those with major foreign operations or aspirations to expand internationally. The increased reliance on foreign directors has led various studies to examine the association between profitability of firms and appointing directors from foreign nations. Recent studies suggested that foreign directors are a valuable firm asset by proving a significant positive relationship (Gianneti, Liao & Yu. 2014; Masulis, Wang & Xie 2012). Masulis et al. (2012) revealed that foreign directors provide valuable international expertise by providing advice regarding the prospect of expanding into new markets as they have better understanding about the legal conditions, cultural and social norms, market structure, and consumer preferences of the specific country. Consistent with the latter argument, a recent study conducted by Giannetti et al. (2014) conforms to the findings by arguing that foreign directors has a positive impact in improving firm performance because of their superior knowledge of global management practices and that weaker connections with local governments make them more effective at monitoring management. In a similar study by Estélyi & Nisar (2016), the authors further confirmed that boards containing diverse nationalities are positively and significantly associated with the firm's international market operations, and thus leads to higher profitability. Another study that supports the previous literatures are done by Sarhan, Ntim, & Al-Najjar (2018) who examined the impact of foreign directors on firm performance in five Middle Eastern countries over the period of 2009-2014, also revealed that board nationality diversity has a positive effect on corporate financial performance. The authors further explained that the relationship between board nationality diversity and corporate performance is stronger in firms that are more better-governed. Meanwhile, Miletkov, Wintoki & Poulsen (2012) examined the relationship between the presence of foreign directors on corporate board and the performance of 20,000 firms from 98 countries. The authors revealed that the relationship between the presence of a foreign director and firm performance is significantly negative in countries with more developed economic structure and better education quality. The reason for such negative relationship observed is due to the high costs of employing foreign directors have outweigh its benefits. However, the findings of this study does not provide an insightful illustration in the context of Malaysia, as this study does not cover Malaysian companies and Malaysia is considered
as a developing country, the findings may vary. Despite the increasing prevalence of diversity on corporate boards, there is still not much clarity of its impact on Malaysian firms’ performance and hence, there is a need to conduct an analysis in the context of Malaysia in order to examine whether the findings of past literatures are applicable.
Theoretical research framework and expected signs The theoretical framework bellow, developed through literature reviews, aims to investigate the impact of corporate governance indicators (proportion of independent directors in the BOD, the proportion of directors who are foreign nationals, the proportion of directors who are females, and CEO duality) on corporate performance.
+ + + +
INDD BINTERN GREP CEOCHAR
>>> Financial Performance (ROA)
3.0 Research Methodology 3. Methodology and Procedure of Analysis 3.1 Data and Data Sources The sample firms were public companies, quoted on the Kuala Lumpur Stock Exchange (KLSE). Secondary data were obtained from the annual reports of the top twenty five publicly listed companies in terms of market capitalisation in the Main Market of Bursa Malaysia, from 2008 to 2017. The data sample consists of firms from all sectors of the economy ranging from manufacturing to investment holdings industries. Nevertheless, this selected sample excludes firm without complete information on the variables needed for the study, such companies that has not been listed by 2008 due to the absence of annual reports availability, companies from financial sector, typically banks due to confidentiality to information, as well as companies belonging to the same group corporate structure in which they share similarities in the board of directors and the ROA of the parent company is highly correlated to its subsidiary due to high shareholding percentages, for instance Genting Berhad Group of Companies, therefore Genting Plantations has been excluded from the study. This study will adopt a quantitative approach and hence uses secondary data, which are extracted from the annual reports published by the selected companies for the period of 2008-2017. The annual reports are obtained from the Bursa Malaysia website. The annual reports provided information on: board composition, nationality of directors, proportion of female directors in the BOD, returns on company's assets employed, size of firms, as well as the existence of CEO duality. All corporate governance data were extracted from the company’s statement of compliance with corporate governance. Whereas, financial data about the company’s total assets, net profit and amounts of share capital are extracted from the financial statement and the report to shareholders sections in the annual report. Meanwhile, this paper explored a different approach, as the selected period of 10 years in this study is longer compared to other past literatures. This paper analysed the efficiency of corporate governance over an extended period of time (10 years), while limiting the selected companies to twenty-five companies with the highest market capitalisation, in order to derive different insights. Therefore, the number of observations is determined as 250. Several existing literatures that explored the impact of corporate governance on Malaysia’s firms had included a rather short period of study, for instance in the study by conducted by Chang (2007), in which the study involves 120 selected Malaysian listed companies over a four-year period from 1996 to 1999, while another similar study conducted by Wanjiru (2013) on the effect of corporate governance in the context of Nairobi included a five year period of study from 2008 to 2012. It is acknowledged that the number of selected companies pose a limitations to the research methods, which may affect the test results. A larger sample size of companies is suggested to be collected in future studies.
The data collected is analysed based on regression analysis, using Stata.
3.2 Method of Analysis Multiple linear regression analysis is widely used in past literatures to examine the value of a firm and its leadership structure, and therefore was employed to analyse the data in this study (Studenmund, 2014). Dependent variable Return on assets (ROA) is adopted as a proxy to evaluate the financial performance of the selected companies and therefore is chosen as the dependent variable for the regression analysis. Return on assets was defined as the total earnings (profits for the year) divided by total assets employed. These figures were obtained from annual reports of each companies.
Independent Variables The independent variables were factors that influence firm performance, as measured by ROE. The four independent variables hypothesized to influence firm performance are as described below: 1. INDD: This variable measures the proportion of independent directors on the BOD, expressed as a percentage. It is defined as the number of independent directors, divided by the total number of directors on the board of each firms. It is hypothesized that the higher the proportion of INDD, the board is more independent in making decisions, and hence better company financial performance in terms of ROA can be expected. 2. BINTERN: This variable measures the proportion of member of BOD that is not local (Malaysian), expressed as a percentage. It is derived from the number of foreign directors, divided by the total number of directors on the board of each firms. It is hypothesized that the higher the proportion of BINTERN, the board composition becomes more diverse in terms of nationalities, decisions can be made more effectively, and hence better company financial performance in terms of ROE can be expected. Preliminary analysis in Figure 1 shows that BINTERN is positively related to ROA.
3. GREP: This variable denotes the gender representation on corporate board directorship, , expressed as a percentage. It is derived from the number of female directors, divided by the total number of directors on the board of each firms. It is hypothesized that the higher the proportion of GREP, the board composition becomes more balanced and diverse in terms of gender, better decisions can be reached, and hence better company financial performance in terms of ROA can be expected.
Preliminary analysis in Figure 2 suggests that GREP is positively related to ROA. 4. CEOCHAR: This is a dummy variable for CEOs who are also acting as the chairman of the BOD. If the CEO per forms this dual role, the variable takes a value of 1; otherwise it takes
a value of 0. It is hypothesized that a company with a CEO having a dual role will have higher financial performance, as measured by ROA, than a company with separate CEO who is not the chairman of the BOD.
Preliminary analysis in Figure 3 implies that CEOCHAR is positively related to ROA.
Control variables Additionally, two control variables are included in this study, which are firm size and whether the company’s financial statements were audited by any of the Big Four accounting firms. These two control variables are included in the regression analysis as firm size and the credibility of external auditors are determined to have have a significant effect on the financial performance of the company. Hence, controlling these two research variables provides a more comprehensive explanation on the association between the corporate governance structures and the financial performance. 1. B4AUD: This is a binary variable for firms that has its financial statements audited by any of the Big Four accounting firms: Ernst & Young (EY), Deloitte & Touche, KPMG and PricewaterhouseCoopers (PwC). If firm employs to service of Big Four external auditors, the variable takes a value of 1; otherwise it takes a value of 0. It is hypothesized that the Big Four are the four biggest professional bodies in providing auditing services and hence, financial statements of firms that employs the service of Big Four has higher credibility in terms of the integrity of information disclosed. 2. FSIZE: This variable indicates the size of firms in terms of market capitalisation. Market capitalization refers to the total market value of a company's outstanding shares. It is
derived from the number of outstanding shares disclosed under the Share Capital section of the annual report, times the market price of the company’s share on the last day of the firm’s financial year. There are a number of past literatures that suggest a significant association between firm size. Firm size is expected to have a positive influence on company’s ROA, due to: cheaper sources of funds, economies of large scale production, greater diversification as well as increased access to more advanced technologies (Ghazali, 2010). This is consistent to the findings of a study conducted by Chang (2004) revealing that firms that are larger in size are associated with better financial performance. Therefore, it is hypothesized that firm size will have an impact on corporate governance because the quality of governance is related to the level of operations of a firm. There are a number of past literatures that suggest a significant association between firm size. In a study conducted by Chang (2004) revealed that firms that are larger in size are associated with better financial performance. All variables in this paper takes on a log transformation except for dummy CEOCHAR and dummy B4AUD. B4AUD is later dropped from the regression analysis due to its lack of time variability and severe multicollinearity issue.
3.3 Specification of Empirical Models OLS Estimator The section begins by estimating the equation using Ordinary Least Squares (OLS) estimator. The model is specified below: lnROAi,t = β0 + β1ln(INDD)i,t + β2ln(BINTERN)i,t + β3ln(GREP)i,t + β4(CEOCHAR)i,t β5ln(FSIZE)i,t + γt+ εi,t
+ (1)
Where, INDD= the proportion of independent directors on the BOD of the ith company BINTERN= the proportion of directors who are foreign nationals on the BOD of the ith company GREP= the proportion of female directors on the BOD of the ith company CEOCHAR= 1 if CEO is also chairman of BOD, 0 if otherwise FSIZE= firm size And γt is year specific effect, εi,t is the error term. OLS estimator is the most commonly used estimation method when it comes to estimating parameter of a linear regression model. OLS is used in this study to obtain estimates of the
regression coefficients from the set of data. According to Studenmund (2017), OLS estimator minimizes the sum of the residual square and is widely used to estimate the parameter of a linear regression model. The OLS estimator is expected to be consistent only if the explanatory variables are exogenous, and the error term is homoscedastic and serially uncorrelated. Since the independent variables in this estimating equation can be affected by ROA, these variables are endogenous and can cause the OLS estimator to be bias (Aisen & Veiga, 2013). OLS estimator does not control for time invariant unobserved variables. Due to the combination of cross-sectional data and time-series data, the OLS regression technique is unsuitable for the analysis (Studenmund, 2014). The appropriate method of analysis involves panel data regression techniques. The estimation technique employed for the panel data regression would be the fixed effects model (FEM). Fixed Effect Fixed Effect estimator is used to resolve the endogeneity problem due to its ability to controls for unobserved heterogeneity across companies that are constant over time. The FEM model assumes that the slope coefficients of the explanatory variables are all identical for all firms. In this case, fixed effect controls for permanent company-specific effect and decisions making. The equation specification is as below: lnROAi,t = β0 + β1ln(INDD)i,t + β2ln(BINTERN)i,t + β3ln(GREP)i,t + β4(CEOCHAR)i,t + β5ln(FSIZE)i,t + γt+ δi + εi,t (2) Where γt are year specific effects, δi are company specific effects, εi,t is the error term.
In the following section, this paper will run the two equations to study the effects of different estimators on the findings.
4.0 Results and Discussion Evaluating The Quality Of The Regression Equation The quality of regression is to be examined by measuring the overall fit of the estimated model before accepting the validity of regression results. The measure of overall fit can be done by observing the R2. Ranging from 0 to 1, the higher the R2 the closer the estimated regression equation fits the sample data. The 0.526 value of R2 indicates that the model explains 52.6% of the variability of the response data around its mean.
Descriptive Statistics Results Table 1 Summary Statistics
Table 1 shows the descriptive statistics of the variables used in the study. All variables, other than FSIZE acquired a negative value, in which does not make any logical sense. This is because the data is expressed in natural logarithm.
Regression Analysis (1) OLS
(2) OLS
(3) FE
VARIABLES
lnroa
lnroa
lnroa
lnfsize
0.133
0.122
0.122**
(0.0892)
(0.0886)
(0.0537)
0.824***
0.832***
0.832***
(0.224)
(0.212)
(0.150)
ceochar
lngrep
0.720***
0.795***
0.795***
(0.122)
(0.149)
(0.123)
0.388***
0.398***
0.398***
(0.111)
(0.120)
(0.103)
-1.068***
-1.068***
-1.068***
(0.377)
(0.402)
(0.279)
-2.704**
-2.687**
-2.453***
(1.187)
(1.061)
(0.740)
Year fixed effects Company fixed effects
No No
Yes No
Yes Yes
Observations
86
86
86
R-squared
0.525
0.541
0.526
lnbintern
lnindd
Constant
Number of companyid
25
Robust standard errors in parentheses ( ***significant at 1%; **significant a 5%, *significant a 10% level)
Regression Coefficient Estimate Interpretation lnROAi,t = β0 + β1ln(INDD)i,t + β2ln(BINTERN)i,t + β3ln(GREP)i,t + β4(CEOCHAR)i,t + β5ln(FSIZE)i,t + γt+ δi + εi,t ^ lnROEi,t = -2.74 -1.068INDDt + 0.398 BINTERN + 0.720GREP + 0.832CEOCHAR + γt+ δi + εi,t β0 = -2.453 The intercept given when the explanatory variables INDD, BINTERN, GREP, and CEOCHAR are absent.
β1= -1.068 %ΔROA= -1.068% When there is an increment of 1% in independent director against the total number of directors on the BOD (INDD), the ROA of the company will decrease by 1.068%, holding other variables constant. β2= 0.398 %ΔROA = 0.398% For every increase of 1% non local directors against the total number of directors in the BOD (BINTERN), there will be a 0.398% increase in the ROA, holding other variables constant. β3= 0.795 %ΔROA = 0.795% For every additional 1% of female directors against the total number of directors in the BOD (GREP), there will be an increment of 0.795% in the ROA of the company holding other variables constant. β4= 0.832 %ΔROA= 100 (e^0.832 -1) = 129.8% When the CEO is also the Chairman of the BOD (Dummy=1), the ROA will increase by 129.8%. Based on Table 2, it can be observed that INDD, BINTERN, GREP, and CEOCHAR are all significant variables at 10% level of significance; whereas the control variable FSIZE is insignificant at 10% level. While OLS estimate may be bias, it nevertheless provides a good starting point in examining the effects of corporate governance factors on firms’ performance. Table 2 presents the findings with robust standard error (in parentheses) based on equation (1)(2). By excluding year specific effect from equation (1), column 1 presents the most basic specification of simple linear regression (OLS) without any additional controls. The results of variable GREP, CEOCHAR and BINTERN were as expected, having statistical significance at 1 percent. The insignificant positive relationship between control variable FSIZE and ROA is due to the sample selection method. As the companies were chosen based on the 25 listed companies with highest market capitalization, while FSIZE indicates the firm sizes in terms of market capitalization as well, it makes sense that an insignificant result emerged. On the other hand, the results also reveal an unexpected significant negative relationship between ROA and INDD. The negative association between INDD and ROA contradicts with the findings of Abdullah (2004), who examined 412 Malaysia’s Listed Companies and arrived with a significant positive relationship. Such negative relationship observed in this study is due to the high concentration of government-linked companies (GLCs) within the sample of study. Listed companies in Malaysia with high market capitalisation in Malaysia are dominated by GLCs. In fact, out of this paper’s sample size of 25 companies, 6 of them are GLCs, making up 24% of companies in the sample being GLCs. The reason for such occurrence is dated back in the
early days of Malaysia, when Mahathir introduced a New Economic Policy in order to include more Bumiputra businessmen. This policy involves privatizing many of government departments and giving shares to Bumiputra, as well as appointing them as one of the members of the board. Since then GLCs are each dominant in their own industries , the government has high level of influence on how the company runs, like determining the business strategies and deciding who to appoint as board members. A classic example would be, the two brothers of the former Malaysian Prime Minister, Datuk Nizam Razak and Datuk Seri Nazir Razak are both appointed as Chairman of the board in their respective public listed companies. Besides, according to Menon (2017), GLCs usually have special advantage in the case of obtaining government contracts due to their links with government. The existence of direct contracts substituted open tenders, and thus leading to GLCs’ inefficiency in business operations. Therefore, a negative relationship can be observed in the context of Malaysia when the number of independent directors increase. Column 2 reports a similar regression specification together year fixed effects to control for the influence of aggregate trends. Nonetheless, both results in column (1) and (2) are subjected to bias due to the usage of OLS on panel data. To diminish the extent of potential endogeneity within the OLS framework, company fixed effect is included into the regression specification to capture all time invariant company-specific attributes and permanent decisions differences across individual companies, as shown in column (3) and Equation (2).The three corporate governance variables remain statistically significant at 1 percent and INDD remained to be negatively related to firm performance. Usually, system GMM is used to correct the potential endogeneity issue in the panel data. However, it is not used in this study due to limited number of observations.
Diagnostic tests Testing for Multicollinearity Multicollinearity happens when two or more independent variables in a multiple regression model are closely correlated to one another, causing skewed and biased results in the OLS (Studenmund, 2017). Detection of severe multicollinearity can be done through 2 methods, which is by checking whether high simple correlation coefficient or high variance inflation factors (VIF) exists. DETECTING HIGH SIMPLE CORRELATION COEFFICIENT
Correlation matrix lnroa lnroa
1.0000
lnfsize
lngrep
lnbintern
lnindd
ceochar
lnfsize
-0.0418
1.0000
lngrep
0.4453
0.0021
1.0000
lnbintern 0.4526
0.3173
0.1956
1.0000
lnindd
-0.2079
0.3458
0.0479
0.0381
1.0000
ceochar
0.4290
-0.5056
0.0596
0.1167
-0.1162
1.0000
