Corporate governance can be defined as the set of mechanisms - both institutional and market based - that induce the self-interested controllers of a company (those that make decisions regarding how the company will be operated) to make decisions that maximize the value of the company to its owners (the suppliers of capital).(Denis and Mckonnell 2002) Or, to put it another way: "Corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment."(Shleifer and Vishny1997). Corporate governance is "the system by which companies are directed and controlled"(Cadbury Committee, 1992).
The corporate governance system provides a framework for the suppliers of finance so that rights and interests are not manipulated by the management of the corporations. The system of corporate governance has been developed with the passage of time and has made enormous contributions towards improvement of corporate performance. Those firms who are better governed and have a sound governance mechanism are relatively more profitable and their dividend payment ratios are also comparatively higher than badly governed firms (Yasser, 2011a).
Jensen and Meckling introduced their famous agency theory in 1976 which started a
new era of research in the world of finance called corporate governance. In the period between 1970 and 1980 large amount of research focused the corporate governance matters of U.S. firms.
However after 1990 the researchers started to investigate the corporate governance
matters of corporations throughout different countries of the world. Firstly the research
focused on the major world economies like Japan, Germany, and U.K. But in past few years the research of corporate governance have penetrated throughout the developing and emerging economies of the world. The present study has been undertaken with a prospect
of making a logical comparison between Pakistan and some other countries of the world
regarding the impact of corporate governance mechanisms such as Ownership
Concentration, CEO Duality, Board Size, Board Composition and Audit Committee on Firm's performance ie Returns on Equity, Return on Assets, Profit Margins etc.
CORPORATE GOVERNANCE IN PAKISTAN:
AN OVERVIEW
The code of corporate governance introduced by SECP in early 2002 is the milestone in corporate governance reforms in Pakistan. The code was initially developed by a joint effort of SECP and ICAP. All the companies which are listed on different stock exchanges of Pakistan are required to follow the provisions of the code. Companies Ordinance 1984 also provides some governance mechanism which the corporations of Pakistan are required to follow. The law relating the banks is provided in the Banking Companies Ordinance (BCO)1962 and prudential issued by SBP.
The State Bank has made compulsory the implication of code for all listed and non-
listed banks and Development Finance Institutes (DFIs). This requirement supported by State
Bank's considerable enforcement capability resulted in important changes within the
banking system of Pakistan. The SECP issued a separate code of practices for insurance
companies in Pakistan. The basic shareholders rights are protected in Pakistan. The
registration of shares is very secure and dematerialized through Central Depository
Committee (CDC). Shareholders have the right to ask a variety of information directly from the
company's management and have an implicit right to participate in AGM of the company.
Directors of companies are elected using a type of cumulative voting and can be removed through special resolutions passed by shareholders in their meetings . Any alteration in articles of the company, increasing authorized capital and sale of major assets of the company require shareholders' approval. While more effective enforcement contributed to improved compliance, some companies do not hold AGMs at all or hold these meetings in places where it is difficult for different shareholders to reach. The law also does not support postal voting or electronically mailing of votes to ensure the physical presence of all shareholders in meetings of company.
The disclosure requirements of Companies Ordinance 1984 and Code have
substantially improved the credibility of disclosures. For example shareholders having 10%
or more voting rights are required to disclose their ownership and annual report includes the
pattern of major shareholdings. However some shortcomings in the ownership structure have
made it difficult for the outsiders to understand internal structure of the firm.
Family dominated boards are more that often unable to protect minority shareholders'
rights and so consequently face a risks of loss of competitive advantage. The Code has
strengthened the role of non-executive directors by enforcing a restriction that Executive
directors should not be more than 75% in non-financial firms. The code also recommends the
institutional investors should also make representative for board meetings. SECP, with the
technical support and collaboration of Asian Development Bank and World Bank, is trying to
improve corporate governance legislature and also the effective implementation of governance
mechanism in Pakistan.
Cheema and Bari (2003) investigated that in Pakistan the major agency problem is not between the management and the shareholders as described in most of the academic literature, but between the large shareholder and the minority shareholders.
Research Methodology
This research is mostly analytical in nature, so secondary data has been used for the analysis. To know the corporate governance mechanism impact on firm performance in different parts of world, we thoroughly reviewed approximately 30 to 35 research articles from different famous scholars. Detail of all papers reviewed is given in the end of the paper in the reference section. There is no complex statistical technique applied in the study as this is purely an analytical research. Impact of Corporate Governance mechanisms on firm performance of following 18 countries have been discussed in the paper.
1. Pakistan
2. India
3. Sri Lanka
4. Australia
5. U.S.A.
6. U.K.
7. Japan
8. Korea
9. China
10. Ghana
11. Malaysia
12. Spain
13. Italy
14. New Zealand
15. Germany
16. Egypt
17. Singapore
18. Switzerland
The impact of governance variables like CEO Duality, Board Size, Board Composition, and Ownership Structure of above stated countries have separately discussed in the forthcoming paragraphs and a final conclusion has been given in the last part of the paper to collectively summarize the results of our findings
Theoretical Framework (Figure 1.1)
Board size
Board
Composition
CEO Duality
Ownership
structure
Audit
Committee
Impact on Firm
Performance &
Profitability
An Overview of Corporate Governance Mechanisms
In the past researchers have been explicitly discussing the issues relating to good governance of corporations. Different corporate governance mechanisms have been identified and their impact on firm performance is also discussed in literature. But this is the first time that a comparative study about the effectiveness of these corporate governance variables is being discussed.
In following lines we would just point out the different governance mechanisms both Internal as well External which have been discussed by various renowned researchers in their research articles. The impact of some of these Mechanisms on firm performance in various countries of the world would be revealed in the later part of our study.
Internal Governance Mechanisms
A. Boards of Directors
I. Size of Board
II. Board Composition
III. CEO Duality
IV. Audit Committee
B. Ownership Structure
I. Internal Ownership
II. External Ownership
III. Institutional Ownership
IV. Family Controlled Business
External Governance Mechanisms
A. The Takeover Market
I. Domestic
II. International
B. The Legal System
I. Civil Laws
II. Criminal Laws
III. Corporate Laws
Some of these variables have a greater impact on firm performance and profitability as compared to some others. In past researchers have discussed the impact of these variables on firm performance in their studies. But this impact has not been compared in different countries of the world. The present study is an endeavor to fill this gap in the research. Due to limited timeframe we would discuss the impact of only internal governance variables like Board Size, CEO Duality, Board Composition, Ownership Structure etc. The study would help firms to categorize the relative importance of these variables and thus develop a strong governance framework in order to make their organization more profitable and prosperous.
IMPACT OF CORPORATE GOVERNANCE VARIABLES ON FIRM PERFORMANCE: EVIDENCE FROM PAKISTAN
Attiya Javed and Rubina Iqbal (2006) found that board composition, ownership and shareholdings enhance firm performance, whereas disclosure and transparency has no significant effect on firm performance. Because of poor legal safety of shareholders, ownership of many firms is very concentrated and ultimately affects the firm performance as well. So laws relating to corporate governance should be reformed in order to fulfill the needs of all sectors of economy. (Javed & Iqbal, 2006).
Board size, ownership structure and shareholdings by managers play vital role in the managerial decisions relating to capital structure of firms(Hasan &
Butt, 2009). A study by Azam(2010) particularly relates to firms relating to oil and gas
sector of Pakistan. And he found that performance of industry can be enhanced by making improvement in the corporate governance mechanisms(Muhammad AZAM, 2010). Board size and CEO Duality are negatively while board independence, outside dominated boards, and presence of large independent block holder are positively related to change in post-merger operating performance of acquiring firms in Pakistan. (Afza & Nazir, 2012).
Cheema et al. (2003) analyzed the ownership structure of firms but they did not pay any attention to its effect on the performance of firms.. Corporate Governance
(CG) addresses the fundamental microeconomic issue of how the managers of the enterprise
are induced by banks, equity markets, or other institutional mechanisms to act in the
best interest of the shareholders and hence to maximize the discounted present value of the
firm (Khan, 2003).
Rehman et al (2010) studied the corporate governance matters of chemical and pharmaectialc industries of Pakistand and they identified that corporate governance mechanisms have an explicit impact of returns of equity shareholders of the above stated sector. Muhammad Azam (2011) investigates the effect of corporate governance on firm's performance of the Tobacco Industry of Pakistan using data from 2004 to 2008. Multiple regression statistical technique was used to measure the relationships between dependent and independent variables. Return on equity (ROE) & Return on assets (ROA) are dependent variables and ownership concentration, CEO duality & Board's Independence are independent variables. The results show that there is a strong and positive impact of the corporate governance on firm's performance.
A study by Yasser et al. (2011) proved the positive relationship between Return on Equity and Profit Margin and three different corporate governance variables which were Board Size, Board
Composition and Audit Committee. They stated that size of the board should restricted to appropriate limits and that number of executive and non-executive directors should also be mixed up with one another.(Yasser, Entebang, & Mansor, 2011)
Ghani, et al. (2002) analyzed non-financial sector of Pakistan and found that investors think business groups exploit minority shareholders. As far as the financial performance is considered, business groups make efficient economic arrangements which are a significant substitute of missing or inefficient outside corporations or international markets. Another study by Ashraf and Ghani (2005) examined the origins, growth, and the development of accounting practices and disclosures in Pakistan and the factors that influenced them. They document that lack of investor protection (e.g., minority rights protection, insider trading protection), judicial inefficiencies, and weak enforcement mechanisms are more critical factors than are cultural factors.
Those Boards which have comparatively higher number of professional directors show considerably better firm performance. But frequency of meetings of board of directors showed the different trends. Family-controlled companies convene lower number of meetings. On the other hand non-family controlled companies, the board governance variables (Board Composition, professional director, board meetings etc) as suggested by code of Corporate Governance (2002) have witnessed a clear improvement in the performance of the firm. In addition to this amount of debt, firm size and firm age did show a significant impact on performance of firm. Yasser (2011 b) pointed out that guidelines provided by code of corporate governance are not followed family controlled companies of Pakistan. And therefore regulators and legislating bodies of Pakistan should make proper alteration in the law in order to bring these kind of companies into the sphere corporate governance regulations. These companies have been found to develop their own set of rules and principles to the manage the affairs of their companies.
IMPACT OF CORPORATE GOVERNANCE
MECHANISMS ON FIRM PERFORMANCE:
FINDINGS FROM DIFFERENT COUNTRIES
In order to compare above stated findings by Pakistani researchers with International Standards, we would review in detail somse findings by these scholars and then draw a conclusion whether these findings are in conformation with the Pakistan.
A study in Germany found investors are willing to pay significant premiums for well-
governed companies, s at least as dependent on governance practices as it is on financial
issues. The results show that there are significant differences in firm-specific governance across
German firms. Evidence found that there is a negative (positive) relationship between the corporate governance rating (CGR) and dividend yields(price-earnings ratios) in a crosssection of German firms. The relationship between average historical returns and the CGR is significantly positive, suggesting that higher CGR-firms have performed better in the past.(Drobetz, Schillhofer, & Zimmermann, 2004)
Core et al(1999) found if corporate governance mechanisms are not so effective, CEOs and other managers get higher compensations and perquisites. They also concluded that this practice ultimately results in an inverse relationship with the performance of the firms operations and profits. Their results also suggested that weaker corporate governance structures escalates the agency problems because CEOs in these firms receive higher compensation while the firm performance declines. (Core, Holthausen, & Larcker, 1999).
CEO DUALITY AND FIRM PERFORMANCE
PAKISTAN
CEO duality looks to be different between the different industrial sectors in Pakistan.
In cement industry, 21% firms having the CEO Duality i.e. same person having the two
positions for CEO and chairman of board. Whereas, 60% of sugar firms do have the CEO
duality. As per theoretical literature (Jensen and Ruback, 1983; Belkhair, 2005; and
Kyereboach-Colamen and Biekpe, 2006), CEO duality decreases the operational and
financial performance of firm and this fact is also found in the sugar industry as well as the
cement industry of Pakistan. The financial performance is measured by using the 2
variables which are Return on Assets (ROA), Return on Equity (ROE). The results show that CEO duality lowers the financial performance of cement industry and the sugar industry in Pakistan. However, in terms of Tobin's Q, sugar firms are ahead of their counterpart firms in cement industry which shows investors' confidence in sugar and allied firms, and hence,
giving a higher value to those firms (Nazir, Haque, & Ali, 2009).
MALAYSIA
(Shamsul & Nahar, Abdul 2008) studied the effect of CEO duality on the financial
performance of firms by using the financial ratios, namely ROA, ROE, EPS, and profit
margin. This study shows that if the two positions of CEO and chairman of board are
separated, the long term shareholder value is expected to increase and shareholders interest
can also be protected. To examine the role of CEO duality, data taken from the KLSE Main
Board companies for the year 1994-1996. The 1994-1996 financial year were chosen because
during this period, the issue of corporate governance was not much important as it was
during and after the 1997/1998 financial crises. In that period the guideline for the structure
of board was not available in Malaysia. Majority of the Malaysian companies are following
the non dual board practice which means the separate position of CEO and Chairman of
Board . The result shows that CEO duality has no relation with firm's financial
performance. CEO duality has no relation with the firms ROA, ROE, EPS, and profit
margin. Malaysian companies board are generally dominated by outside directors so this
evidence suggest that the absence of management and the dominant personality in the board.
SRI LANKA
In Sri Lanka the effect of CEO duality is examined on firm's performance and also
analyzed the role of resource dependence theory in terms of CEO informal power and board
involvement. In this research by integrating the agency theory, stewardship theory and
resource dependence theory, hypothesis developed which were tested by taking data from the
216 listed companies, encompassing the 20 industries in Sri Lanka. Findings showed that
CEO duality has a negative relation with the firm's financial performance when the CEO is
given additional powers while the duality exists. On the other hand CEO duality has a
positive relation with the firms performance in circumstances where the board involvement
is high, in terms if collaboration and control of agency theory, stewardship, and resource
dependence theories.
AMERICAN, GERMAN AND JAPANESE FIRMS
It is a general phenomenon that CEOs in different countries face systematically different degrees of constraint on their latitudes of action, and hence they differ in how much effect they have on firm performance. 15 years of data were taken of the 100 German firms and it was matched with 100 U.S. firm and 100 Japanese firms through the variance analysis approach.
And results showed that impact of CEO on firm performance was statistically and significantly higher U.S. firms as compared to their counterpart German and Japanese firms (Crossland & Hambrick, 2007).
EGYPT
The initial econometric results indicated that CEO duality has no significant impact on firm performance. But later on it was proved that effect of CEO duality on performance of firms seems to vary from industry to industry and this is consistent with the agency theory as well as stewardship theory. In addition to this, when the firms are segregated in accordance with their financial performance, CEO duality shows a significant positive coefficient only in the cases where corporate performance is lower (Elsayed, 2007).
CHINA
(Peng, Li, Xie, & Su, 2010) studied the relationship of CEO duality with the firms
performance in china. He found that relationship of CEO duality with the firm's performance
and the ownership structure. In this research the affect of CEO duality on state-owned
enterprises (SOEs) and private owned enterprises (POEs) is examined. Result showed that there
is a negative relation with the firm's performance and CEO duality in state-owned enterprises
(SOEs) but positive relation in the private-owned enterprises (POEs).The private firms which
are practicing with the CEO duality, showing higher financial performance in terms of ROA,
ROE, EPS and operating profit.
GHANA
(Kyereboah-Coleman & Biekpe, 2006) studied the relationship of CEO duality and performance of firm. For this purpose, annual data covering 1990-2001 taken from the Ghana stock exchange. In this study the impact of CEO duality is examined on the ROA, Tobin's q and growth in sales of non financial listed firms. The results showed that the negative relationship of CEO duality and performance of firm. CEO duality lowers the returns on the total resources and the market value of shares. The firms which are practicing the CEO duality have less growth in the sales volume as compared to others.
BOARD COMPOSITION AND FIRM PERFORMANCE
PAKISTAN
In this study the effect of board composition is examined on the firm's performance of Pakistani listed companies. Data taken from the KSE-100 index of 91 listed companies. The result showed that the companies which have independent member in the board were showing the greater return on total assets, return on equity and Tobin's q. it means that the listed companies at KSE with independent board were showing the greater financial performance . Group test and t-test were used as the most appropriate measure of the categorical variables board composition.
NEW ZEALAND
In this study the relationship between the board composition and the firm value is
examined for New Zealand. The results showed that as the number of non-executive director
increases in the board, the board becomes more independent and leads to higher
performance of the firm. If there are more executive directors in the board it leads to
greater agency conflicts and lowers the performance of firms. As the tenure of outside
directors, the level of outside directors, the number of positions held by the outside director's
increases, the financial performance of the firms also increases in term of return on total
resources and sales growth.
U.S.A.
Stuart Rosenstein studied the relationship of composition of board and firm performance of American firms. The results showed that the appointment of outside director in the board significantly increases the market price of the share. Management plays a dominant role in selecting the outside directors. But there is no clear evidence that the outside directors of any particular sector are more or less important than others. The result showed that the outside directors should be chosen to protect the shareholders' interests. Findings showed that the appointment of outside directors causes the abnormal returns on total recourses. Small companies appoint the outside director from the investment banks and insurance companies and this leads to higher financial performance.
CANADA
John Erickson (2002) studied the relation between the board composition and firm
values in the presence of ownership concentration .For this purpose the data taken from the
listed companies of Canadian stock exchange covering the period of 1993-1997. The results
showed that independence of board does not affect the board positively the firm value. The
small firms are appointing the outside directors to make happy the investors. The results
showed that better monitoring can be done by appointing the outside directors in the board
INDIA
The relationship between internal governance structure and performance of Indian
companies is studied. The effect of board composition on the firm value in the light of agency
theory and resource dependency theory is seen. The sample taken from the Indian stock
exchange. These are the top corporate performing companies. The results supported the
independence of board. Adding the outside directors in the board reduces the agency conflict
and enhances the firm value. The notion that powerful CEOs (duality role, CEO being the
promoter, and CEO being the only board manager) have a harmful effect on performance
was not supported. There was some support for resource dependency theory.
JAPAN AND AUSTRALIA
(Bonn, Yoshikawa T, Phan P.H) studied the affect of composition of board on firm
performance for Japanese and Australian companies. The results showed that as the ratio of
outside director's increases in the board, the value of firm also increases. The results further
showed that the ratio of female directors is also positively related with the firm value. More
will be the female directors in the board; more will be the financial performance of the firm
as chaebol or family control are insignificant or negative.
KOREA
Jongmoo Jay Choi, Sae Woon Park and Sean Sehyun Yoo studied the impact of
outside directors on firm value in Korea. After the Asian financial crises the regulation
bound the firms to appoint the outside directors isn the board. The results showed that the
effect of independence board on firm performance is strongly positively related. Foreigners
also have positive impacts.
BOARD SIZE AND FIRM PERFORMANCE
Various scholars hypothesize the relationship between size of board and corporate performance. Eisenberg et al(1998) found a significant negative correlation between board size and profitability in a sample of small and medium scale Finnish firm(Eisenberg, Sundgren, & Wells, 1998). Another study provides empirical evidence that firms with larger board have lower variability of corporate performance. They identified that size of board members is inversely related with changes in stock returns, annual profits, Tobin's Q etc. Their results are consistent with the view that it takes more compromises for a larger board to reach consensus, and consequently, decisions of larger boards are less extreme, leading to less variable corporate performance.(Cheng, 2008)
IMPACT OF BOARD SIZE ON FIRM PERFORMANCE
SINGAPORE AND MALAYSIA
(Mak & Kusnadi, 2005) studied the impact of board size on firm value of Singapore and Malaysian firms. The financial performance is measured by Tobin's q. the results showed that larger the board, lower will be the financial performance of the firm. they found the inverse relation between the size of board and firm value in both countries and also stated that in different corporate governance systems, the board size and firm value are negatively correlated.
U.S.A.
(Huther,1997) studied the importance corporate governance structure and financial performance of the firms in the united states of America. Data is taken from the American stock exchange. The non financial industry was analyzed. The results showed that the corporate board is America is inefficiently large. The e results describe the inverse relation with the financial performance of the firms. Large board's leads to lower the return on total assets return on equity and value of Tobin's.
SWISS FIRMS
(Beiner, Drobetz, Schmid, & Zimmermann, 2004) studies the Swiss firms and examined
the relation between the size of board and the firm value. The results showed that the size of
board is an independent mechanism. Most of the Swiss firms chose the members of board optimally. There is no significant relationship is found between the firm value and financial performance of the firms which is totally contrasted to previous studies.
EUROPEAN FIRMS
(Conyon & Peck, 1998) studied the European firms and examined the relationship
between the firm value and size of the board. The results showed that the larger board destroys
the corporate value. Findings suggest that negative relation between the firm value and size of the
board. As the size of board is ineffectively becomes larger, the financial performance starts
declining.
SPAIN AND ITALY
The quality of the corporate governance is measured by (1) the board size and (2) the ratio of outside directors to inside directors. The Italian firms were analyzed. The results showed that size of board has a great impact on the market value of the firm. Results indicate the inverse relationship between the board size and the value of firm (Di Pietra, Grambovas, Raonic, & Riccaboni, 2008). Results indicate that board of director with outsider non-executive directors influence positively a board's capabilities. While board size has a nonlinear relation with board effectiveness and thus firm performance.
IMPACT OF BOARD SIZE ON SMALL AND MEDIUM SIZE FIRMS
Empirical studies of large public firms have shown an inverse relation between the
board size and the firm value. In this study data collected of 7000 small and medium size
firms. The companies are closely held companies which mean the ownership is concentrated
in these firms. The results showed that most of the small firms are managed by the children
of CEO of the firms. There is direct relation between the family size and the board size of the
firm(Bennedsen, Kongsted, & Nielsen, 2008).
AUDIT COMMITTEE AND FIRM PERFORMANCE
It is apparent that there is no identifiable relationship between the choice of audit
committee structures or characteristics and the achievement of desired governance
results. But still proper caution is needed over expectations that greater codification around factors such as audit committee members' independence and expertise as the means of ''correcting'' past weaknesses in the arrangements for audit committees.
The basic issue which makes a proper and effective audit committee is nevertheless an important research development phenomenon. Higher consideration should be given to organizational and institutional context in which these audit committees perform their functions. In addition to this unintended and unlikely behaviors and results of audit commitees should also be investigated.(Turley & Zaman, 2004).
CONCLUSION
From the above discussion we can conclude that the results obtained from Pakistan
somehow conform to the some other countries of the world. The researchers in corporate
governance literature believe that performance can be improved and agency cost can be
reduced by separating the titles of CEO and chairman of the board (Jensen and Ruback,
1983). Evidence received from China, Malaysia, Egypt, Ghana Pakistan etc also confirm
that CEO Duality has negative effect on the performance of the firm. Same person having
the position of CEO and Chairman of Board might misuse this position for his own sake. And
if we separate this position and appoint two different persons as the chairman board and
CEO, this might well create some difference on the performance as well as value of the firm.
Board size has a nonlinear relation with the performance of the firm as this fact is
explicitly evident from many studies throughout the world. And there seems to be not much
difference between Pakistan and other countries like China, Singapore, Malaysia, America
etc, the studies revealed that necessarily large number of board members adversely affect the
value as well as the performance of the firm and not only causes undue expenses in term of
remuneration but also creates conflict among members resulting in delayed decisions.
Board composition which means the number of executive and non-executives
directors on the board. Its impact on the performance of the firm is not much clear. As few
researchers suggest that independent boards have no significant impact on the performance
of the firm. While there are some having contradicting views in this regard and suggest that
board independence has a significant impact on the performance of the firm.
To sum up all, we can state that there is no correlation between the board independence and the firm profibility and faster growth of the public firms these days. Audit Committee structure and achieving specific governance effects has also been found to have no significant relationship with firm performance.
As corporate governance is a very vast area of research and also has a significant impact on the performance of firms, researchers are invited to further probe into this topic and thus add to the existing knowledge and research.
REFERENCES
