The Relationship Between Corporate Governance and Value of the Firm in Developing Countries: Evidence from Bangladesh
Md. Abdur Rouf
This study aimed to examine the relationship between four corporate governance mechanisms (board size, board independent director, chief executive officer duality and board audit committee) and value of the firm (performance) measures (return on assets, ROA and return on equity, ROE). The study is based on a sample of 93 listed non-financial companies in Dhaka Stock Exchanges (DSE) 2006. Using OLS as a method of estimation, the results provide evidence of a positive significant relationship between ROA and board independent director as well as chief executive officer duality. The results further reveal a positive significant relationship between ROE and board independent director as well as chief executive officer duality. The study, however, could not provide a significant relationship between the value of the firm measures (ROA and ROE) and board size and board audit committee.
Received: February 19, 2011;
Accepted: April 30, 2011;
Published: June 03, 2011
It is widely believed that good corporate governance is an important factor
in improving the value of the firm in developing countries. However, the relationship
between corporate governance and the value of the firm differs in the different
countries due to disparate corporate governance structures resulting from the
dissimilar social, economic and regulatory conditions in these countries. There
is a need to understand the differences which affect the value of the firm for
academic investigations, financial and management practices and public regulation
of markets and corporations (Abdurrouf et al., 2010).
The relationship between corporate governance and the value of the firm is important
in formulating efficient corporate management and public regulatory policies.
According to Black (2001), Klapper
and Love (2004), Gompers et al. (2003) and
Beiner and Schmid (2005), corporate governance plays
an important role in improving the value of the firm and there is a direct relationship
between the two in both developing and developed countries. However, there are
differences in the nature, direction, magnitude and processes of operation of
the relationship between developed and developing countries due to differences
in their economic, social, regulatory framework and market behavior (Hermalin
and Weisbach, 1991; Ahunwan, 2003). Although, it is
important especially for developing countries to incorporate these differences
into the analysis of corporate governance and value of the firm relationship
for an appropriate understanding of the role of corporate governance in influencing
corporate value and formulating regulatory framework, these differences have
not been systematically discussed in the existing literature.
This study will be analyzed and empirically investigated the nature of these
differences in the relationship between corporate governance and value of the
firm in developing country. For this purpose, the financial market of Bangladesh
(developing) is selected in this study for the relationship measurement between
corporate governance and value of the firm. the specific objectives of the proposed
study are: (i) To measure the level of value of the firm (financial performance)
made by the listed companies in Bangladesh. (ii) To examine the association
between corporate governances and value of the firm (financial performance)
of listed companies in Bangladesh.
Researchers have defined corporate governance in a variety of ways and the most widely cited definitions follow.
According to Cadbury (1992), corporate governance is
the mechanism used to discipline organizations. Morin and
Jarrell (2001) argued that corporate governance is a framework that controls
and safeguards the interest of the relevant players in the market. The players
of the corporate governance mechanism include managers, employees, customers,
shareholders, executive management, suppliers and the board of directors.
Corporate governance is the set of processes, customs, polices, laws and institutions
affecting the way a corporation (company) is directed, administered or controlled.
Corporate governance also includes the relationships among the many stakeholders
involved and the goals for which the corporation is governed. The principal
stakeholders are the shareholders management and the board of directors. Other
stakeholders include employees, customers, creditors, suppliers, regulators
and the community at large (Mahboob Uddin, 2006). Perfect
corporate governance can strengthen intra-company control and can reduce opportunistic
behaviors and lower the asymmetry of information, so it has a positive impact
on the high quality of disclosed information (Li and Qi,
Corporate Governance (CG) is the relationship between corporate managers, directors and the providers of equity, people and institutions who save and invest their capital to earn a return.
The literature on corporate governance in developing and developed markets
suggest that the roles of a regulatory authority, board, management, suppliers,
customers and creditors are important in improving the value of the firm. Good
corporate governance is focused on the protection of the rights of shareholders
and plays an important role in the development of capital markets by protecting
their interests (Abdurrouf et al., 2010).
Obviously good corporate governance practices are more and more essential in determining the cost of capital in a capital market. Bangladeshi companies must be prepared to participate internationally and to maintain and promote investor confidence both in Bangladesh and abroad. On an examination of corporate governance practices in Bangladesh, it appears that the country stands at a position of weakness. Therefore, it is essential that these practices are reviewed to ensure that they continue to reflect local and international improvement so as to position Bangladesh in line with the best practice.
The value of the firm can be defined as the amount of utility/benefits derived from the shares of a firm by the shareholders. Some of the important measures to value of the firm in the existing literature are as follows.
Tobins Q is defined as the ratio of the market value of assets (equity
and debt) to the replacement value of assets. Tobins Q is also used to
value of the firm in the financial markets as Himmelberg
et al. (1999), Palia (2001) and Bhagat
and Jefferis (2002) used Tobins Q in their studies to value of the
Board size influences the value of the firm. Small board size is generally
believed to improve the value of the firm because the benefits by larger boards
of increased monitoring are out weighed by the poorer communication and decision
making of larger groups. Lipton and Lorsch (1992) suggest
an optimal board size between seven and nine directors. In this respect, empirical
studies have shown that the value of firms with relatively small board sizes
(Eisenberg et al., 1998). Hence, as board size
increases board activity is expected to increase to compensate for increasing
process losses. Yermack (1996) found negative correlation
between board size and profitability. Mak and Kusnadi (2005)
reported that small size boards are positively related to high firm value. In
a Nigerian study, Sanda et al. (2005) reported
that value of the firm is positively correlated with small, as opposed to large
boards. The argument is that large boards are less effective and are easier
for a CEO to control. The cost of coordination and processing problems is also
high in large boards and this makes decision-taking difficult. On the other
hand, smaller boards reduce the possibility of free-riding and therefore have
the tendency of enhancing value of the firm. They measured the size of the board
by the number of directors serving on such boards and expect this to have a
negative relationship with value of the firm.
A board is generally composed of inside and outside members. Inside members
are selected from among the executive officers of the firm. Outside directors
are members whose only affiliation with the firm is their directorship. The
role independent director on the board of directors is to effectively monitor
and control firm activities in reducing opportunistic managerial behaviors and
expropriation of firm resources. The proportion of independent directors is
positively correlated to value of the firm (Agrawal and
Knoeber, 1996). Increasing the level of the proportion of independent directors
simultaneously increase firm performance as they are more effective monitors
of managers (Mehran, 1995). Some researchers found that
although the proportion of independent directors on the board is high, the level
of board independent and professionalism is not necessary good (Chen
et al., 2007). The relationship between the proportion of independent
director and value of the firm was found to be negative (Klein,
1998; Yermack, 1996). It has been further argued
that there is no relationship between the proportion of independent directors
and superior firm performance (Hermalin and Weisbach, 1991).
Based upon the literature, the relationship between proportion of independent
directors and value of the firm will be investigated in the study.
Within the context of corporate governance, the central issue often discussed
is whether the chair of the board of directors and CEO positions should be held
by different persons (dual leadership structure) or by one person (unitary leadership
structure). Jensen (1993) shows a deep concern that
a lack of independent leadership creates a difficulty for bards to respond to
failure in top management. In this regard, Kajola (2008) also
argued that concentration of decision management and decision control in one
individual hinders boards effectiveness in monitoring top management.
It is argued that there is conflict of interest and higher agency costs when
the same person occupies the two positions (Brickley
et al., 1997) and this leads to the suggestion that the two positions
should be occupied by two persons. Yermack (1996) and
Sanda et al. (2005) showed that firms are more
valuable when the CEO and the chairman of the board positions are occupied by
different persons. However, Daily and Dalton (1992)
and Kajola (2008) does not find a positive relation on
the separation of the position of CEO and board chair. Based upon the literature,
the relationship between CEO duality and value of the firm will be investigated
in the study.
The role of audit committee is important in implementing corporate governance
principles and improving the value of the firm. The principles of corporate
governance suggest that audit committee should work independently and perform
their duties with professional care. In case of any financial manipulation,
the audit committee is held accountable for their actions as the availability
of transparent financial information reduces the information asymmetry and improves
the value of the firm (Bhagat and Jefferis, 2002).
The agreement has been advanced that perhaps the audit committee is the most
entity to safeguard public interest. The board usually delegates responsibility
for the oversight of financial reporting to the audit committee to enhance the
breadth of relevance and reliability of annual report. Thus, audit committees
can be a monitoring mechanism that improves the quality of information flow
between firm owners (shareholders and potential shareholders) and managers.
Klein (1998) and Anderson et
al. (2004) reported a positive relationship between audit committee
and value of the firms (earnings management). On the other hand, Kajola
(2008) showed that there is no significant relationship between audit committee
and value of the firm. Based upon the literature the following hypothesis is
MATERIALS AND METHODS
Sample/research design: The data used for this study were resulted from the audited financial statements of the firms listed on Dhaka Stock Exchange (DSE) in 2006. The sample of the firms were selected using the combination of non- probability sampling technique (firms with the required information were initially selected) and stratified random technique (firms were then selected based on their sectorial classification). A total of 93 non-financial firms were finally used as sample. The method of analysis is that of multiple regressions and the method of estimation is Ordinary Least Squares (OLS).
||H1: The size of the board is negatively related to value
of the firm
||H2: Independent directors have a positive relationship
with value of the firm
||H3: The separation of CEO and Board chair positions
has a positive relationship with value of the firm
||H4: The audit committee has a positive relationship
with value of the firm
Model specification: The economic model used in the study (which was
in line with what is mostly found in the literature) is given as:
where, Y is the dependent variable, β0 is constant, β is the coefficient of the explanatory variable (corporate governance mechanisms), Fit is the explanatory variable and eit is the error term (assumed to have zero mean and independent across time period) (Table 1).
|| Dependent and Independent variable and their descriptions
as used in the study
It is important to state that this study employs two financial ratios (ROA
and ROE) to measure the value of the firm. In the empirical literature, Tobins
Q (the market value of equity plus the market value of debt divided by the replacement
cost of all assets) has been used extensively as a proxy for measuring value
of the firm. It is however, difficult to get the required information relating
to the market value of equity issued by Bangladeshi companies, since these are
not usually disclosed in their financial reports. In order to mitigate this
problem, Miyajima et al. (2003) and Sanda
et al. (2005) used modified form of Tobins Q. This study does
not follow their line of assumption, because the various modifications made
on the original Tobins Q are considered to be subjective and in line with
the dictates of the writers and may influence the outcome of the study. Himmelberg
et al. (1999), Palia (2001) and Demsetz
and Villalonga (2001) used managerial compensation as the only corporate
governance mechanism; Kim et al. (2004) examined
leverage only; Bhagat and Black (2002) and Coles
et al. (2008) examined board characteristics only, this study examines
four corporate governance mechanisms together.
By adopting the economic model as in Eq. 1 above specifically to this study, Eq. 2 below evolves.
Analysis of data: In order to obtain the objectives of the research
study, statistical tools like average, standard deviation, co-efficient of variance,
correlation, regressions and T tests, F tests have been used to analyze and
interpretation of the data through the Statistical Packages for Social Science
(SPSS)14.0 for windows and Tables have been used for data presentation.
RESULTS AND DISCUSSION
Descriptive statistics: Table 2 shows the descriptive statistics of all the used in the study. The mean of ROA of the sampled firms is about 2.73% and the mean of ROE is 4.55% in Taka. The average board size is 6.68 with a standard deviation of 2.05 and it ranges 3 to 13 members. The average independent directors are 10.57% with standard deviation 13%. This indicates that independent director approximately 11% of the board. The result also indicates that 72% have separate persons occupying the post of the chief executive and the board chair, while 18% have the same person occupying the two posts. A majority of the firms (68%) have audit committee of the sample firms.
Correlation analysis: Tables 3 and 4
present the correlations among the variables. Table 3 indicates
that ROA is positively correlated with the board independent director and chief
executive officer duality at 1% level of significant. ROA has a negative relationship
with board size and board audit committee.
|| Descriptive statistics
|ROA: Return on assets, ROE: Return on equity, BSIZE: Board
size, BIND: Board independent director, CEOD: Chief executive officer duality,
BACOM: Board audit committee
|| Correlations (Pearson)-ROA as a value of firm (n = 93)
|**Correlation is significant at the 0.01 level (2-tailed).
*Correlation is significant at the 0.05 level (2-tailed). ROA: Return on
assets, BSIZE: Board size, BIND: Board independent director, CEOD: Chief
executive officer duality, BACOM: Board audit committee
|| Correlations (Pearson)-ROE as a value of firm (n = 93)
|**Correlation is significant at the 0.01 level (2-tailed).
*Correlation is significant at the 0.05 level (2-tailed). ROE: Return on
equity, BSIZE: Board size, BIND: Board independent director, CEOD: Chief
executive officer duality, BACOM: Board audit committee
|| Multiple Regression Results (n = 93)
|*p<0.1, two-tailed, **p<0.05, two-tailed, ***p<0.01,
Table 4 also indicates that ROE is positively correlated
with the board independent director and chief executive officer duality at 1
and 5% and level of significant, respectively. However, ROE also has a negative
relationship with board size and board audit committee.
Multiple regression analysis: Table 5 shows the results
of the multiple regressions and indicates a positive relationship between ROA
and board independent director at 5% level of significant and between ROE and
board independent director also. This result is similar with Agrawal
and Knoeber (1996) and Mehran, 1995). This result
is dissimilar to Klein (1998) and Yermack
(1996). The relationship between the ROA and chief executive officer duality
is positive and statistically significant at 10% level and ROE with chief executive
officer duality is also positively significant at 1% level. This outcome has
the support of Yermack (1996) and Sanda
et al. (2005). This result is dissimilar to Daily
and Dalton (1992) and Kajola (2008). However, both
board size and board audit committee show no significant relationship with ROA
and ROE at 1, 5 and 10% levels.
This study examines the relationship that exists between four corporate governance mechanisms (board size, board independent director, chief executive officer duality and board audit committee) and value of the firm, using two proxies, (ROA and ROE) . A sample size of 93 non-financial firms listed on the Dhaka Stock Exchange (DSE) in 2006 is used. Panel data methodology is employed; the method of analysis is multiple regressions and the method of regression is OLS. The result of the study indicate that a positive and significant relationship between ROA and board independent director at 5% level and a positive and significant relationship between ROA and chief executive duality at 10% level but there is no significant relationship board size and board audit committee with ROA at 1, 5 and 10% level. On the other hand, a positive and significant relationship between ROE and board independent director at 5% level and a positive and significant relationship between ROE and chief executive officer at 1% level but there is no significant relationship board size and board audit committee with ROE at 1, 5 and 10% level.
Limitation: There are a number of limitations of this study as well. First limitation of the study is used only non-financial companies as a sample. So, the results may not extend across all companies in Bangladesh. Second, the study considers data of only one year. The results may differ across different years if multiple years are considered for analysis. Regarding future line of research, efforts should be put at increasing the sample size and the corporate governance variables, particularly the inclusion of ownership structure.
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