The Non Financial Firms Listed On Ftse 100 Finance Essay

Published: November 26, 2015 Words: 1983

INTRODUCTION

Corporate governance is concerned with the resolution of collective action problems among dispersed investors and the reconciliation of conflicts of interest between various corporate stakeholders.

In the last two decades, owing to the high profile scandals like Adelphia, Parmalat, Enron and WorldCom, corporate governance has received much attention. The belief that corporate governance best practices lead to superior firm performance is widespread. Numerous academic researches have been done to prove the link between governance and performance. Sarbanes-Oxley Act of 2002 had the most overwhelming influence on corporate governance in the past 70 years (Byrnes et al., 2003).

However till these days, the well-known agency problems resulting from the separation of ownership from control (Berle & Means, 1932; Jensen & Meckling, 1976; Fama & Jensen, 1983; Shleifer & Vishy, 1997) still prevail in firms worldwide. More recent study (Core et al., 1999) suggests that firms with weaker governance structure have greater agency problems; and that firms with greater agency problems allow managers to extract greater private benefits; and that firms with greater agency problems perform worse. Effective corporate governance significantly reduces control rights stockholders and creditors benefits given to manager, increasing the probability that managers objectively invest in positive net present value projects (Shleifer & Vishny, 1997), suggesting that better-governed firms have better operating performance, our first proxy for firm performance.

Firms with stronger stockholder rights have higher Tobin's Q (Gompers et al., 2003; Bebchuk & Cohen, 2004; Cohen & Ferrell, 2004), this proxy is used to measure firm value, suggesting that better-governed firms are more valuable, hence our second proxy for firm performance.

An additional benefit of dividend payments is that it forces firms to constantly obtain new capital, which serves as a monitoring mechanism for existing shareholders (Easterbrook, 1984). Combining free cash flow hypothesis (Jensen, 1986), dividend payment theory (Easterbrook, 1984) and relationship between firm's dividend payout and its earnings growth; it consistently suggests that better governed- firms pay out more cash to shareholders, our third proxy for firm performance.

Using corporate governance data provided from Thomson ONE, OneSource etc., we will be able to create a summary for firm-specific governance variables and find out the link to operating performance, firm valuation and cash payouts. We will focus on non-financial firms listed in FTSE 100.

Comparing recent studies with more regulations being imposed on corporate governance, we would assume that better governance is associated with better firm performance, but evidence is not consistent and tenuous (LeBlanc & Gillies, 2003; Young, 2003). And previous studies had also identified some good governance resulted in bad performance, this leads to the questions whether some factors generally considered to be project good governance might in practice prove the adverse.

We will use data gathered on FTSE 100 companies (non financial firms) in relating governance mechanism with firm performance. We relate corporate governance categories and factors to firm performance as a test to our hypotheses. And we will again conduct multivariate analysis in the latter section, in view of providing results to our study or implication which will then open the possibility of further research.

RESEARCH OBJECTIVE

This research will focus on the identification of various key determinants of corporate governance mechanism (both internal and external) and their relationships with firm performance using different proxies (i.e. operating performance, firm valuation Tobin Q's and cash payouts).

With references to previous studies, we are hoping to find some consistencies between good governance resulting in better performance. However we are open to the fact that this research might lead us to new findings where those inconsistencies might get explanations during the research work.

RESEARCH QUESTIONS

Does corporate governance affect firm performance?

What are the determinants of corporate governance mechanism that might affect firm performance, and hence which criteria are used to measure firm performance?

What is the relationship between corporate governance determinants with the proxies for firm performance?

LITERATURE REVIEW AND HYPOTHESIS FORMULATION

Literature Review

Global competition and fast technological advancement have resulted in lower price / cost margin which in turn force firms to focus on maximising asset efficiency and shareholder value if they wish to access funds to fuel growth opportunities (Yoshikawa and Phan, 2001). Transaction and information system costs have reduced immensely due to the technological advancement. This phenomenon has created global competition between capital markets and the evolution of corporate governance around the world.

We will use three proxies, as mentioned in our introduction; operating performance, Tobin's Q valuation and cash payouts for firm performance. The following discussion will focus on our hypothesis formulation and how we will be conducting a deductive research by taking a stance of theories we refer to, and do the test on those hypotheses.

Hypotheses Formulation

This research examines the performance of FTSE 100 non financial firms, while investigating the relationship between the firm performance and corporate governance. Consequently, this study will classify the variables into two categories: proxies for firm performance and corporate governance variables (both internal and external mechanism).

Corporate Governance Mechanism Variable

Internal Mechanism

Outside Directors / Board Independence. It is often believed that board of directors are more independent as the proportion of their outside directors increases (John and Senbet 1998), although many studies have found no link between the proportion of outside directors and various performance measures such as sales, number of employees, return on equity, Tobin's Q, return on assets, asset turnover and stock returns (Fosberg, 1989; Hermalin and Weisbach, 1991; Bhagat and Black, 2002).

H1. There is a significant relationship between board independence or the proportion of outside directors and firm operating performance.

H2. There is a significant relationship between board independence or the proportion of outside directors and firm Tobin's Q valuation.

H3. There is a significant relationship between board independence or the proportion of outside directors and firm cash payouts.

Board size. There is a view that larger boards are better for corporate performance because they have a range of expertise to help make better decisions, and are harder for a powerful CEO to dominate. Although it is outweighed by the poorer communication and decision-making of larger groups (Lipton and Lorsch, 1992 and Jensen, 1993). An inverse relation between board size and profitability, asset utilisation, and Tobin's Q (Yermack, 1996) and

H4. There is a significant relationship between board size and firm operating performance.

H5. There is a significant relationship between board size and firm Tobin's Q valuation.

H6. There is a significant relationship between board size and firm cash payouts.

Separation of CEO and Chairman / Role Duality. Studies show that firms are more valuable when CEO and chairman position are separate, (Yermack, 1996; Core, Holthausena & Larcker, 1999). Some studies document that a sample of Fortune 500 companies with CEO duality have stronger financial performance relative to other companies (Rechner & Dalton, 1991).

Although an interesting proposition was argued that board leadership structure depends entirely on individual firm characteristics such as organisational complexity, availability of other controls over CEO authority and CEO reputation and power (Faleye, 2003).

H7. There is a significant relationship between the CEO duality and firm financial performance.

H8. There is a significant relationship between the separation of CEO and chairman / Role duality and firm Tobin's valuation.

Director and Executive Compensation. Research shows that the use of incentive or equity based compensation for CEOs (Harvey & Shrieves, 2001) and managers (Mehran, 1995) is greater in firms with a higher percentage of outside directors on the board. Corporate governance reformers and institutional investors have recently argued that firms can increase the monitoring of management by providing directors with a financial stake in the performance of the firm (Perry, 1999).

H9. There is a significant relationship between directors' and executives' compensation and firm performance.

External Mechanism

Large Shareholders / Blockholders. Large shareholders have the tendency of putting pressure on management or even ousting them through proxy fight or a takeover (Jensen & Meckling, 1976). Other research (Holdernes & Sheehan, 1985; Barclay and Holderness, 1991) find that block purchases are followed by increases in share value market for partial corporate control identifies and rectifies problems of poor corporate performance.

H10. There is a significant relationship between shareholders composition and firm performance.

RESEARCH METHODOLOGY

Sample and Data

This research will be a study on non-financial firms listed on FTSE 100. These companies will most likely to be based in the UK, we are hoping to gather information and data not older than 4 years.

The studies will involve a lot of analytical view into company annual reports, if necessary we might send questionnaires out or conduct interview. However, more quantitative data is going to be expected in order to carry out this research. Some regression studies will be included in the work software like SPSS will also be used.

The corporate governance mechanism criteria that determine firm performance are as follows;

Outside directors / board independence

Board size

Separation of CEO and Chairman / Role duality

Director and Executive compensation

Large shareholders / blockholders

Main Model

After data gathering, we are going to do data mining and data analysis. The model we are using will be regression model to identify the relationship between those criteria with the proxies for firm performance.

RESEARCH PHILOSOPHY

Our research reflects the philosophy of "positivism", because we will be working with an observable social reality and that the end product of this research can be law-like generalisation.

This philosophy allows us to take a stance like a scientist, referring to existing theories and study the relationship between different determinants simultaneously and cross referencing those factors in order to come out with a result, whether it is consistent or inconsistent with the theories we tried to apply initially. Hypotheses are to be tested and confirmed, leading to further development of the theory which opens up the avenue for future research.

RESEARCH APPROACH

Align with our positivism philosophy in this research "deductive study" will be the approach we use. We will use five sequential stages (Robson, 2002) in which deductive research will progress: deducing hypothesis, expressing the hypothesis in operational terms, testing the operational hypothesis, examining the specific outcome of the inquiry and (if necessary) modifying the theory in the light of the findings.

RESEARCH STRATEGY

We will base our research on several grounded theories, and using detailed archival research to support our findings and test findings. There will be a time frame reserved for data collection and data mining (analysis), we might need to do cross-sectional test as we mentioned above with the variables and proxies.

TIME LINE - Project Plan

Steps

Time Frame

To do

Tutor Feedback

1

1st July - 7th July 2009

Literature Review finalised

Within the week

2

8th July - 29nd July 2009

(3 weeks)

Analysis

Data Collection / Assembling

Empirical Studies (Theories)

Hypotheses Formulation

Ongoing - continuous consultation needed

(staying on right track)

3

3rd - 31st August 2009

Empirical results, using various statistical methods.

(SPSS application)

Consultation during data mining and analysis requires feedback

4

1st -15th September 2009

Submission of final proposal

to GGSB

To be approved by Supervisor

5

October - November 2009

Result, Discussion and Interpretation to finalised

Supervisor to verify methods and results.

6

December 2009

Final Submission of Dissertation

DONE and graded!

REFERENCES LIST

Brown, L., Mack Robinson, J. and Caylor, M. (2004). Corporate governance and firm performance (Georgia State University).

Young, B. (2003). Corporate governance and firm performance: Is there a relationship? (Ivey Business Journal - September/October 2003)

Oxelheim, L., Wihlborg, C. (2008). Market and compensation for executives in Europe. (Emerald Group Publishing Ltd.).

Greve, P., Nielsen, S. and Ruigrok, W. (2009). Transcending borders with international top management teams: A study of European financial multinational corporations. Elsevier, European Management Journal (2009) 27, pp. 213-224.

Peck, S., Ruigrok, W., Tacheva, S., Greve, P. and Hu, Yan. (2006). The determinants and effects of board nomination committees. Journal of Management Governance (2006) 10, pp. 119-148.

www.fsa.gov.uk

Combine Code of Corporate Governance in UK - 2003.