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Master Thesis
“BOARD DIVERSITY AND PERFORMANCE OF PUBLICLY
LISTED COMPANIESIN ASIA”
A study on the relationship between board diversity and firm performance in Asia and the moderating effect of state ownership
Student: Mai Ngoc Nguyen Student number: 11084057 Thesis supervisor: Dr. Ilir Haxhi Second reader: Dr. Niccolò Pisani Faculty of Economics and Business
MSc. Business Administration – International Management track Date of Submission (Final thesis): June 24, 2016
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Statement of Originality
This document is written by Student Mai Nguyen who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
3 ABSTRACT
Board diversity and its relation to firm performance are of special theoretical relevance and enormous practical implications. However, studies on the effects of board diversity on performance remains weak and inclusive, while there is a notable lack of research on these effects in the particular context of emerging Asian markets. This study examines the relationship between board diversity and firm performance in Asian countries and the moderating effect of state ownership. The study uses a sample of 379 largest listed companies in China, Hong Kong and Vietnam with the dataset of 2014. Hierarchical regression method is performed to examine the proposed relationships. Three dimensions of board diversity study include gender diversity, independence and nationality diversity, and firm performance is measured by ROA and Tobin’s Q. The results obtained show that there is no significant relationship between gender and nationality diversity and firm performance, but board independence is found to positively affect performance. That significantly positive relationship is negatively moderated by state ownership. The study contributes to narrow down the gap of existing corporate governance literature, which lacks research on specific Asian contexts. It also provides implications for management in developing an effective board composition.
4 ACKNOWLEDMENT
I would like to express my gratitude to Dr. Ilir Haxhi for his enthusiastic instruction and valuable advices during my journey of finishing this thesis, as well as for the whole academic year. Besides, I would like to thank Dr. Niccolò Pisani for his important lessons on research methodology and for reading and grading my thesis together with Dr. Ilir Haxhi. Finally, I would like to thank the University of Amsterdam for providing me facilities required to complete this study.
5 TABLE OF CONTENTS
1. INTRODUCTION ... 8
2. LITERATURE REVIEW ... 12
2.1. Definitions and Mechanisms of Corporate Governance ... 12
2.2. Dominant theories of Corporate Governance... 15
2.3. Board diversity and Firm performance ... 17
2.4. Corporate governance in Asia ... 21
2.5. Research questions ... 23
3. HYPOTHESES DEVELOPMENT ... 23
3.1. Gender diversity and firm performance ... 23
3.2. Board independence and firm performance ... 25
3.3. Nationality diversity and firm performance ... 27
3.4. The moderating effect of state ownership ... 28
3.5. Theoretical framework ... 30 4. METHOD ... 31 4.1. Data sources ... 31 4.2. Sample ... 32 4.3. Dependent variables ... 32 4.3.1. ROA ... 32 4.3.2. Tobin’s Q ... 33 4.4. Independent variables ... 33
4.5. Moderating variable: state ownership ... 34
4.6. Control variables ... 34
4.7. Methods ... 36
5. RESULTS AND ANALYSIS ... 38
5.1. Descriptive statistics ... 38
5.2. Effects of board diversity on firm performance ... 42
5.2.1. ROA regression ... 42
5.2.2. Tobin’s Q regression ... 45
5.2.3. Moderator: state ownership... 46
6. DISCUSSION ... 47
6.1. Gender diversity and performance ... 47
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6.3. Nationality diversity and firm performance ... 52
6.4. The moderating effect of state ownership ... 54
7. LIMITATIONS AND FUTURE RESEARCH ... 56
8. CONCLUSIONS ... 57
8 1. INTRODUCTION
Corporate governance research still contains many unsolved puzzles and there is significant room for improvement to a variety of corporate governance mechanisms (Shleifer & Vishny, 1997, p.737). With significantly important theoretical and practical implications, corporate governance requires broader and deeper research on several dimensions. Corporate governance refers to the mechanisms, structures and processes employed for the direction and control of firms. There is a wide range of definitions of corporate governance, depending on different perspectives of researchers. A broad definition of corporate governance proposed by OECD (2004, p.11) is “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.” This definition takes into account both internal and external mechanisms of corporate governance in organizations.
Analyzing corporate governance practices in developing markets is crucial because they contain many social, economic and cultural differences when compared to developed markets. These factors make these two types of markets differ considerably from each other. It is contended that empirical studies on developed markets are not directly applicable to developing markets (Durnev & Kim, 2007). For instance, Claessens and Fan (2002) conduct a survey in Asian countries and show that governance systems of markets in these countries have poor institutions and property rights, solidifying the argument that traditional corporate governance practices are not as effective in these places. Some researchers perceive that weak corporate governance is is one of the main weaknesses in Asian countries, and one of the reasons that brought about the 1997 Asian economic crisis (Nam & Nam, 2004). Studies show that both before (Joh, 2003) and after (Mitton, 2002) the financial crisis in 1997,
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companies that utilized good corporate governance policies both performed better and had superior shareholders protection, especially for the minority shareholders.The notable features of most Asian companies are the existence of controlling owners, state owners and family members holding key positions (Nam & Nam, 2004). The dominance of family and state ownership, government intervention, transactions influenced by relationships and poor legal systems lead to agency problems such as inconsistencies between control and cash flow rights, as well as weak protection of minority shareholder’s rights. These problems are further complicated by the presence of group business and cross-holding structure. Weak corporate governance, along with the aforementioned agency problems, leads to poor firm performance, high-risk financing practices and susceptible to macroeconomic crises (Claessens & Fan, 2002). Consequently, corporate governance in Asian countries needs immediate attention.
However, there has been insufficient research on the effects of corporate governance, or in particular, board characteristics and ownership structure, on financial performance of firms in Asia, as well as the implications of such effects. Among board characteristics, board diversity is a key feature and one of the important issues in modern corporate governance at many companies (Kang, Cheng & Gray, 2007). Prior researches show that board diversity either has negative impact (Bhagat & Bolton, 2008) or positive impact on (Kiel & Nicholson, 2003) performance, measured by return on total assets (ROA).Companies in Asian countries have the tendency to align their corporate governance structures with international practices to showcase their pursuit of good governance and they also believe that effective corporate governance will lead to enhanced performance (Chuanrommanee & Swierczek, 2007, p.272). However, taking into account considerably different governance systems as well as other economical and social factors, adopted practices in Asia may not result in the same expected impacts as in developed countries. The first gap identified in corporate governance literature
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is the lack of studies on the effect of board diversity on firm performance in particularly the Asian markets.
To contribute to fill in the above mentioned research gap, this thesis aims to undertake a study on the relationship between board diversity and financial performance of firms in three Asian markets, including China, Hong Kong and Vietnam. According to Carter, Simkins and Simpson (2013), theoretical advantages of diversity in the Board of Directors (BOD) include deeper knowledge of particular markets, enhanced innovation capabilities and improved effectiveness of decision-making process. These benefits of board diversity can contribute to financial performance of firms. The first research question of this thesis is:
What is the relationship between board diversity and firm performance of publicly listed companies in Asia?
The main goal of comparative studies of corporate governance is analysing which institutional factors are important and their impacts on corporate governance (Aguilera & Jackson, 2003). Even though researchers have taken abundant studies on board diversity, the moderating effect of institutional characteristics to performance receives insufficient attention. Most previous corporate governance studies have concentrated on the US, the UK and Continental European economies and neglected the impacts of national governance mechanisms (Filatotchev, Jackson, & Nakajima, 2013). This approach leads to a vague understanding about the efficiency of the corporate governance practices in differing institutional contexts (Kumar & Zattoni, 2013). Among typical characteristics of corporate governance in Asia, state ownership is an important aspect (Nam & Nam, 2004). However, there has been insufficient research studying the moderating impact of state ownership on the relationship between board diversity and performance, especially in Asian countries. The dominating control of state ownership may impede the positive impacts brought by board
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diversity through intervention in the monitoring activities of board members and in the decision making process. To narrow down this gap, this study addresses the second research question, which is:
How is the relationship between board diversity and firm performance moderated by state ownership?
This study built and tested hypotheses on the effects of board diversity aspects on firm performance as well as on the moderating effects of state ownership. Regarding research method, this study used explanatory and quantitative research techniques to analyse the data collected from secondary sources. We implemented a hierarchical regression analysis based on a dataset of 379 publicly listed companies in China, Hong Kong and Vietnam in 2014. The sample is chosen by collecting the data from the largest 100 companies listed in four major stock exchange markets in the above-mentioned countries. We collected the data required for the research, including financial reports, information on board diversity and ownership structure, from Orbis database, websites of stock exchange markets and of chosen companies.
This study can provide a number of both theoretical and practical contributions. Theoretically, the thesis aims to contribute toward research on international diversity of corporate governance practices and its effects on firm performance by providing empirical evidence from emerging economies in the Asia. As mentioned above, the social, cultural and economic states of Asia vastly differ from those of the US and Continental European counties. Due to these differences, research carried out to look into the effectiveness of corporate governance system in developed countries, particularly western ones, may not be applicable to assess corporate governance practices in Asia. Incompatibility with conditions specific to a particular company such as state ownership, or owners’ representations on boards could lead to non-adherence to existing practices.This study is novel in that it analyzes
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a new moderator, state ownership, on the relationship between board diversity and performance. Taking into account specific features of Asian corporate governance, this study provides an addition to the increasing literature of corporate governance in Asian countries and creates a point of continuation to research on the relationship between board diversity and firm performance. From a practical perspective, empirical evidences from this thesis will provide guidelines for Asian companies to design a more effective board composition. Lack of research on whether board diversity can improve performance creates confusion for companies in deciding their policies to enhance board diversity. Aiming to discuss the relationship between board diversity and performance in specific settings, this research may serve as a reference to assist firms in strategic human resource management, by selecting suitable directors taking into account the firms’ characteristics and strategy.
The organization of the thesis is as follow. The first section represents the theoretical perspectives on which the arguments concerning board diversity and performance are based on and the accompanying benefits of board diversity are reviewed. Further, prior literature on corporate governance and board diversity, especially in Asian countries, is elaborated on. Third, we develop hypotheses based on the review literature. Then, we report a description of used data and research methods. The results of the data analysis are then presented and discussed. The final section addresses the limitations of the study, recommends directions for future research and makes conclusions.
2. LITERATURE REVIEW
2.1. Definitions and Mechanisms of Corporate Governance
There are several definitions for the term corporate governance, which focuses on different approaches. The two main approaches to corporate governance are shareholder approach and stakeholder approach. The narrow definitions with the shareholder approach concentrates on
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the main internal corporate governance mechanisms, including board characteristics and ownership structure, in protecting shareholder rights and enhancing firm performance. From an academic perspective, corporate governance deals with the separation of ownership and control (Cuervo, 2002). Committee on the Financial Aspects of Corporate Governance (1992) defined corporate governance as “the system by which companies are directed and controlled. The Board of Directors is responsible for the governance of the companies. The shareholder’s role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place” (p. 1). Besides, another narrow definition of corporate governance is described by Shleifer and Vishny (1997) as “the ways in which the suppliers of finance to corporations assure themselves of getting a return on their investment” (p. 737). These views are confined to the shareholder approach, focusing on the means that investors use to ensure that senior managers do not exploit their investments (Shleifer and Vishny, 1997). The definitions with shareholder approach match researches on corporate governance in a specific country, since they do not take into account external or institutional governance factors (Claessens & Yurtoglu, 2013).
On the contrary, Demb and Neubauer’s (1992) definition of corporate governance focuses on “the process by which corporations are made responsive to the right and wishes of stakeholders” (p. 187).According to Aoki’s (2001), corporate governance addresses “the structure of rights and responsibilities among the parties with a stake in the firm” (p. 11). These views are widened to the stakeholder orientation, which integrates the external environment that the firm operates in. A representative definition with stakeholder approach is that of OECD (2004, p.11), which mentions both shareholders and stakeholders in the relationship with the companies. Since they take into consideration the external characteristics relating to national corporate governance, these clusters of definitions can serve cross-country comparative corporate governance.
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However, the central points of focus in corporate governance generally comprise the interests of stakeholders of the company, the problems of performance transparency and accountability, roles of of the Chief Executive Officer (CEO) and the Board of Directors (BOD), ownership structure, information disclosure and risk management (Mayer, 1997). The two criteria of good governance include ethical conduct of managers and their competent administration of the resources under their change (Child & Rodrigues, 2004).
In corporate governance literature, it is well documented that there are two main types of corporate governance mechanisms shareholders can rely on to ensure their rights on their investment. The first type is internal mechanisms, such as ownership structures, the board of directors, and executive remuneration (Jensen, 1986), which can mitigate agency problems arising from the separation of ownership and control (Jensen & Meckling, 1976). The second type is external mechanisms, including legal and regulatory systems, the market for corporate control, the market for executives, and the market for removing directors (Elliott & Elliott, 2008). These external mechanisms monitor managerial behavior to reduce agency problems and hence, can help to enhance performance (Gillan, 2006). This thesis adopts the viewpoint of Gillan (2006) and considers ownership structure and and board characteristics (including board size, board diversity, composition, leadership structure) to be the main internal corporate governance mechanisms.
Whether internal or external mechanisms play a more dominant role in a country depends on its corporate governance system (Cuervo, 2002). Two major models of corporate governance in the world are Anglo-American model and Rhineland model. The models of corporate governance in the Anglo-American countries, such as the United Kingdom (UK) and the US, are market-oriented, while continental Europe, Latin America, and Japan adopt large-shareholder-oriented or bank-based governance systems (Haxhi, 2015). This model is characterized by equity financing, dispersed ownership, and flexible labor markets.
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Moreover, the main governance mechanisms are strong markets for corporate control, legal regulation, and contractual incentives. Whereas, bank-based governance systems are stylized in terms of long-term debt finance, ownership by large blockholders with strategic motivation for ownership, such as banks and families, weaker managerial incentives, and rigid labor markets (Aguilera & Jackson, 2003). External mechanisms play a more important role in Anglo-American corporate governance model while internal mechanisms dominate more in Rhineland model.
2.2. Dominant theories of Corporate Governance
Four dominant theories of corporate governance include agency theory, stakeholder theory, stewardship theory and resource dependency theory. The issues of principal-agent relationship can be considered to be central to corporate governance, and has received considerable research. The agency theory facilitates the understanding of the connection between managers and owners (Nix & Chen, 2013). Jensen and Meckling (1976) argue that “agency theory involves a contract under which one or more persons (the shareholders) engage another person (the directors) to perform a service on their behalf which includes delegating some decision making authority to the agent” (p. 308). Asymmetric information and conflicts of interests between the executive management and owners of firms lead to the agent-principal problems. Agency theory analyzes the ways of converging the objectives of managers and firms to ensure that firms are operated honestly and effectively in consideration of the interests of shareholders (Nix & Chen, 2013). The agency theory suggests that the participation of independent directors will contribute to providing an effective supervision of the firm’s CEO and other executive directors (Hans-Böckler-Stiftung [HBS], 2010).Agency theory’s principal suggestion is that boards be mostly composed of outside and, in the ideal case, independent directors and that chairman and CEO positions not be assigned to the same person (OECD, 1999). According to this theory, independent directors, who objectively
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monitor management and are independent of the firms on employment, profits and other benefits, can effectively mitigate the agency problems. Generally, the agency theory illustrates the narrow sense of corporate governance. The theory is relevant for corporate governance in the Anglo-American model, which focuses on shareholders controlling managers for their own benefits (Haxhi & Aguilera, 2014).
On the other hand, stakeholder theory, the second dominant theory of corporate governance, revolves around a broader sense of corporate governance, which are ethics and values in managing an organization. Bad governance and unethical corporate behaviors, brought to light by various scandals, are more than just issues only matter to shareholders. Bad governance, mismanagement and fraud can result in tighter framework of regulations, rising unemployment level and even economic crisis (Nix & Chen, 2013). In contrast to the Anglo-American model, the Continental European model emphasizes the control of general public of corporations for the purpose of social sustainability (Haxhi & Aguilera, 2014).
According to stewardship theory, managers act as stewards of firms and not as opportunistic agents, working to achieve high corporate benefits and shareholders’ returns, for the profits of firm owners (Donaldson & Davis, 1994). In terms of managers’ motives, stewardship theory is vastly different from agency theory. Managers are found to be primarily driven by their responsibilities, which serve as an accomplishment to them (Donaldson & Davis, 1994). As a result, an argument is raised that firms should employ executive managers free from strict control of non-executive boards. This kind of control board has been reported to deteriorate firm performance, making it an incapable control mechanism (Donaldson & Davis, 1994). Stewardship theory supporters claim that internal directors working to optimize shareholders’ benefits will lead to high corporate performance. Therefore, supporters of this theory anticipate maximised firm performance if board composition contains mostly inside directors working for the profit of shareholders.
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Researchers who advocate resource dependence theory look at a firm as a socially open entity, tightly linked to its external environment such as human and capital resource, or information (Pfeffer & Salancik, 2003). In this aspect, according to resource dependence theory, the BOD has the key role in connecting these social resources with the firm itself (Boyd, 1990). Effective connection with the external environment that may create risks enable firms to better cope with uncertainty, leading to improved market power and survival rate (Pfeffer & Salancik, 2003). This theory has two fundamental implications, which are that pressures and demands from the outside environment can exert influence on board composition, and that different composition structure of the BOD could result in different firm performance (Boyd, 1990).
2.3. Board diversity and Firm performance
Corporate governance has been widely recognized as an important mechanism influencing the performance of the firm. Researchers have studies extensively two key variables in corporate governance whose have effects on firm performance, which are board characteristics and ownership structure. Board of directors is one of the internal mechanisms of corporate governance. Agency theory, stewardship theory and the resource dependence theory can explain and predict the relationship between board characteristics and performance, but empirical results remain inconclusive.
Empirical results on the impact of corporate governance structures,in general, and board characteristics, in particular, on firm performance of previous research are mixed. For example, regarding general firm-level corporate governance, Klapper and Love (2004), and Ho (2005) found that there is a highly positive relation between effective corporate governance and operating performance, market valuation and overall corporate performance. The research by Bauer, Frijns, Otten and Tourani-Rad (2008) brings them to the conclusion that significant effects of corporate governance on financial performance are found in
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governance aspects that relate to financial disclosure, protection of share holder rights and executive compensation, while board accountability and the market for corporate control demonstrates limited impact on performance. However, board accountability is found to have positive effect on firm performance in the research of Beasley (1996), which pointed out that in a sample of 75 fraud and 75 on-fraud firms, the percentage of independent members in the board structure is considerably higher in non-fraud firms than in fraud firms.
Board diversity is one of the important issues in modern corporate governance at many companies. It is defined over the board structure (Kang et al., 2007). There are two kinds of diversity: one that is visible, and the other one is more latent (Milliken and Martins, 1996). Visible diversity includes key characteristics such as gender, age or nationality. On the other hand, directors’ background, education and previous experience are examples of the less transparent diversity. Observable diversity is known as demographic diversity, whereas less visible diversity is referred to as cognitive (or non-observable) diversity (Erhardt, Werbel & Shrader, 2003). In the recent years, a typical Western board includes members coming from the company’s home country, mainly white males in their middle age. This demonstrates a low level of diversity in the BODs. According to Hilb (2012), diversity is crucial to develop innovative ideas, and the most effective way to promote differences is to combine cultures, ages, genders, and so forth. It is worth noting that only properly managed diversity leads to competitive edge. Companies should develop board diversity with their strategies in mind. Depending on its nature, each company has its own optimal board structure and in general, there is no single best solution (Hilb, 2012).
According the resource dependency theory, expanding and diversifying the BOD can improve protection of key firm resources and the link between firms and the outside environment (Goodstein, Gautam & Boeker, 1994). Strengthening the connection between the firm and its external environment contributes to diminish environmental uncertainty and
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thus, the costs associated with such uncertainty (Pfeffer & Salancik, 2003). Moreover, a number of past studies have shown that there is a positive correlation between board diversity and the firm’s performance (Carter et al., 2003; Erhardt et al., 2003; Kiel & Nicholson, 2003). In contrast, there are also some other work showing the opposite: the financial performance of the firm does not depend on its board’s diversity level (Adams & Ferreira, 2009; Carter, Simkins & Simpson, 2010; De Andres, Azofra and Lopez, 2005). Even if there has been mixed opinions and results on the impact of diversity on firms’ performance, having a diverse board is still desirable due to the following two major reasons. First, it promotes regular discussion, idea exchange and team performance. A highly diverse board gives ideas based on different insights and perspectives given the same problem (Kang et al, 2007). This in turn enhances the decision making process and increase organizational value. Second, it is the board’s duty to protect the interest of stakeholders (Kang et al, 2007). As a result, the board should also include members representing the firm’s stakeholders. A more diverse board is generally viewed as being more representative.
Carter et al. (2003) considers visible board diversity, including gender, racial and cultural diversity the center of modern corporate governance issues. Although there is an implicit implication of the potential correlation between gender diversity (Carter et al., 2010), whether it is actually correct or not still remains an unanswered question (Carter et al., 2010; Erhardt et al., 2003). In the case this relationship does present, a practical question would be if a female director representation would make a difference in performance for the firm. Previous research carried out in different developed markets did not lead to a conclusive answer (Campbell & Mínguez-Vera, 2008; Rose, 2007). Some studies state that the correlation between firm performance and gender diversity is positive (Campbell & Mínguez-Vera, 2008; Carter et al., 2003; Erhardt et al., 2003), for another it had been found out to be negative (Adams & Ferreira, 2004; Ahern & Dittmar, 2012), or even not correlated at all
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(Carter et al., 2010; Rose, 2007). Researches on ethnic diversity carried out in a different national settings also discover contradictory results, when researches find both positive (Richard, 2000) and insignificant (Kilduff & Mehra, 2000) relationships between nationality diversity and performance. Such mixed results suggest that the effects of gender, ethnic and cultural diversity on financial performance of firms may vary in different settings. Therefore, there is still not enough evidence to prove any meaningful relationship between the BOD composition and firm performance.
Regarding another aspect of board diversity, Hermalin and Weisbach (2001) argue that a key issue of modern corporate governance is to monitor the accountability of management through mechanisms to alleviate agency problems, including the involvement of both independent and non-independent members in the BOD. A survey conducted on 108 directors in the UK showed that independent members of the board conduct careful and objective analysis before ratifying decisions from executives, and this strategic influence in return led to higher performance (McNulty & Pettigrew, 1999). On the other hand, a study based on 159 samples showed that board composition did not have a substantial impact on the actual firm performance (Dalton, Daily, Johnson & Ellstrand, 1999). A survey on non-executive Dutch directors demonstrates that even though they are expected to work independently from management, it is not true in practice because the management group is needed to give them adequate information to make decisions (Hooghiemstra & van Manen, 2004). In contrast, a related study on 37 samples in the USfound out that the number of outsiders in the BOD positively affected firm performance (Rhoades, Rechner & Sundaramurthy, 2000). Analysis on the correlation of BOD independence and fraud of 62 Australian firms showed that the chance of fraud would decrease if independent directors were present on the BODs or CEO duality was absent (Gupta & Sharma, 2004).
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In general, we observe a lack of consistent evidence on any significant relationship between characteristics of the BOD, particularly board diversity, and firm financial performance. Such inconsistency can be attributed to the different national settings in which such relationship is developed, since the overall trend is that studies undertaken in different countries generate different findings. In addition, previous research focuses largely on firms in developed countries, leaving a gap in research on the effect of board characteristics on corporate performance in emerging economies, especially in Asia.
2.4. Corporate governance in Asia
The mixed and inconclusive results of previous empirical research on the effect of corporate governance practices on firms’ performance can be attributed to the institutional differences between countries (Aguilera, Filatotchev, Gospel & Jackson, 2008). Corporate governance systems also affect the relation between corporate governance practices and firm performance. Whitley (1999) argues that there is a correlation between institutional context of the national business system and the characteristics of firms, which include certain corporate governance mechanisms. For example, in capital markets featured by concentrated equity management, such as the US, corporate governance focuses more on goals of profits rather than growth objectives. Financial records of their investment portfolios is the chief matter of concern of investors and fund managers since growth is commonly not subsidized by the state, and the size of the firm will not affect considerably its bargaining power with the state (Whitley, 1999). In addition, recent studies suggested that the relationship between corporate governance and firm performance is under the impact of the efficiency of the national governance system of the country that the firm operates in (Aslan and Kumar, 2014).
Since institutional settings, legal systems and the development stages of an economy influence corporate governance, research into this field must take these national contexts into account (Aguilera & Jackson, 2010; Klapper & Love, 2004). Understanding the institutional
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characteristics that firms operate in is crucial for studying the rationales and implications of certain corporate governance models, along with the effectiveness of corporate governance reforms (Globerman, Peng, & Shapiro, 2011). For example, with regard to board diversity, institutional systems at national level such as governance and cultural systems contribute pivotal foundations for the representation of women in the BOD (Grosvold & Brammer, 2011). Reportedly, corporate governance structure have more impact on the market valuation of companies in countries with inadequate protection from the legal system (Love, 2011). Furthermore, in the case of poor or imperfect law enforcement, corporate governance practices could be used for legitimate purposes, instead of for performance (Lynall, Golden, & Hillman, 2003).
While corporate governance in developed economies have attracted considerable efforts of researchers, for emerging markets this is not the case. Weitzner and Peridis (2011) argue that the majority of literature on corporate governance in general, and board characteristics, in particular, concentrates on Anglo-American firms. Due to the differences in a number of factors such as social or cultural when compared to developed markets, studying corporate governance in developing markets is necessary. These aspects make the general settings in these two areas make them highly distinct from each other. Therefore, existing results from work based on developed markets can not be readily applied to emerging economies (Durnev & Kim, 2007). For instance, governance systems in Asian markets have been found to be composed of weak institutions and ineffective protection of property rights, raising the argument that conventional corporate governance strategies are no longer applicable in these countries (Claessens & Fan, 2002). It is viewed by many that one of the shortcomings of Asian economies is the weak corporate governance structure, and as a result, it is believed to have brought about the crisis in 1997 (Nam & Nam, 2004). The striking feature of most firms in these countries is the existence of a controlling owner as well as
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members of the owner’s family holding key manament positions (Nam & Nam, 2004). Therefore, board diversity of Asian firms and their impact on firm performance is an area that still needed more studies.
2.5. Research questions
The thesis aims at addressing the research gap pointed out in the literature above, which are the lack of research on the relation between board characteristics and firm financial performance in emerging economies, inconclusive and mixed results of empirical past research on that relation, and insufficient studies into the moderating effect of national governance features on that relation. The thesis aims to examine the relationship between board diversity and performance of publicly listed companies in Asia and the moderating effect of state ownership on that relationship. This thesis will address two specific research questions. The first question is how board diversity of publicly listed companies in Asia influences their financial performance. The second question is how such relationship is moderated by state ownership, a typical aspect of corporate governance in Asia.
3. HYPOTHESES DEVELOPMENT
We choose to examine on three dimensions of board diversity based on the arguments of Carter et al (2003) and Hermalin &Weisbach (2001), which consider gender diversity, ethnic diversity and board independence as key issues in modern business world. Therefore, we develop literature-based hypotheses on the effects of gender diversity, nationality diversity and board independence on the financial performance of Asian companies.
3.1. Gender diversity and firm performance
In theory, the relation between performance and gender diversity of the board is not based on any single theory model, including resource dependence theory and agency theory(Carter et al., 2010). Both of them, however, do have discussion into this relationship and suggest that
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gender diversity does affect positively the firm’s financial performance (Carter et al., 2010). Women are becoming increasingly involved in business and the number of women in boards is also rising. As remarked by Nielsen and Huse (2010), the proportion of female directors has a positive impact on the board’s control and effectiveness. According to Erhardt et al. (2003) and Carter et al. (2003), there is a positive impact of the ratio of female directors in the board on the company’s performance. They also mention that the percentage of women in boards increases with company size and board size, but it decreases if the number of inside directors goes up. On the other hand, some studies do not find a significant relationship between the presence of women in the BOD and firm performance. Studying on the data of more than 1900 companies from 1996 to 2003, Adams and Ferreira (2004) find a negative impact of gender diversity on firm performance measured by Tobin’s Q.While there is no consensus among studies regarding the value of gender diversity, the overall theoretical suggestion is that gender diversity does bring about positive value in corporate governance and also in social aspects. Besides, contradictory empirical studies show that the effects of gender diversity may depend on specific national settings.
Gender diversity in the boards of Asian firms is not high when compared to other regions, and there is also little research into this imbalance. National University of Singapore, through one of its recent study, shows how the government, the civil society and the private sector looks at the effectiveness of female leaders in the development in Asia (Qian, 2016). Women can help decrease conflict, and at the same time improve development activities of the board. Compared to men, women have highly different styles of management, which are characterized by harmonious p and effective interpersonal communication.Hence, they can contribute valuable assets to the decision-making process of the board. In addition, gender-diverse boards put more time into monitoring and the intensity of participation in board committees is higher for female than male board members.
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The above arguments are in line with prior literature on the benefits of the participation of female board members. Adams and Ferreira (2009) find out that women have a higher level of performance and attendance than male directors. In general, women tend to be more risk-averse and place more emphasis on long-term vision in making decisions (Marinova, Plantenga & Remery, 2016), strengthening the monitoring role of the board. Therefore, female board members can play a role in effective strategy formulation and protection of minority shareholders. Besides, the involvement of female directors on board may promote the career development of female employees, making direct and indirect contribution to overall productivity of the workforce.(Smith, Smith & Verner, 2006).
Hypothesis 1 (H1): There is a positive relationship between the percentage of female directors of the BOD and firm performance.
3.2. Board independence and firm performance
According to agency theory, a large number of independent directors on board work to monitor independently in cases where there is an interest conflict between shareholders and managers.This theory discusses that independent directors play a vital role in in monitoring and consulting the activities of management,and in promoting the quality of decision-making (Hermalin &Weisbach, 2001). Dalton et al. (1999) state that independent directors hold a central position in dissecting the effective control practiced by boards’committee. Additionally, they tend to be closely linked to outside investors’ interests, to monitor important decisions more efficiently and in turn, improve firm’s financial performance.Research on the monitoring function has shown that boards comprising primarily of insiders are not independent of existent management or the companies and therefore, less likely to monitor management effectively (Weisbach, 1988). The extent to which a board with a high number of independent directors will improve the value of the firm depends on their effectiveness in convincing the minority shareholders and investors that
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such an independent board will contribute to avoiding resources diversion and having more efficient monitoring (Dhaya, McConnell and Travlos, 2002).
In this study, we hypothesize that in Asia, the percentage of independent directors on the board is a key indication of effective corporate governance, and thus can lead to improved performance of firms. Developing Asian countries have high ownership concentration, where a number of family-managed firms as well as state controlled companies remain dominant in the corporate domain (Chakrabarti, Megginson and Yadav, 2005). Many firms are run by a family or dominated by state investors, and high concentrated ownership implies that the dominating shareholders have control over many of these companies. This characteristic of Asian corporate governance can lead to weaker protection of small shareholders’ rights. In such contexts, the agency challenge is between the primary shareholder and minority shareholders, and independent directors can contribute to mitigate agency costs. With high monitoring capabilities, independent directors can support minority shareholders, prevent insiders from exploiting internal resources and in turn, improve profits and firm value.
A comprehensive analysis on almost 800 companies throughout 22 countries (Dahya et al., 2002) proves that there is a significant positive relationship between the percentage of independent directors and the company’s performance in the case dominant shareholders are present or in countries with poor shareholder right protection. Besides, a study on Korean firms (Choi, Park and Yoo, 2007) shows that independent directors have a highly positive impact on performance, whereas the effectiveness of grey directors is inconclusive.Choi et al. (2007) discover that for South Korea, a developing market, there is a strong correlation between board independence and company performance, especially after the crisis in Asia in 1997 which was caused partly by the inadequate governance system during that period. Examining that relationship in Taiwan, Chang (2008) also finds a similar result.
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Hypothesis 2 (H2): There is a positive relationship between the percentage of independent directors of the BOD and firm performance.
3.3. Nationality diversity and firm performance
The present of foreign directors on board is also the topic of several prior researches on board diversity. Some researchers contend that diversity of culture and nationality of the management board may lead to opinionated, multi-culture problems (Lehman & Dufrene, 2008) and conflicts (Cox, Jr., 1991). When researching on companies in Europe, Kilduff et al. (2000) find no significant relationship between national diversity and firm performance measured by market share and net marketing contribution. However, the existence of foreign members on the board is also believed to provide the company with competitive edge, particularly broad and international networks, focus on shareholder rights and prevention of managerial pitfalls (Oxelheim and Randøy, 2003). A study by Richard (2000) shows that racial diversity in the board members helps increase value and bring about advantages for the firm as well as boost performance. It should be noted that there has been few studies on this link between nationality diversity of management team and the firm’s performance in developing markets. Therefore, we will analyze relevant distinct features of emerging Asian markets to predict this relationship.
Asia-Pacific region is growing and seeing many large foreign investments. In developing countries where capital flowing from other countries is highly encouraged, companies with large foreign investments tend to have diverse nationality on their management board. Whereas in Switzerland, Ruigrok, Peck, and Tacheva (2007) report that foreign directors are typically more autonomous. It appears that the need for foreign directors in board of management is rising as they represent international stakeholders.In this context, including foreign directors can contribute valuable knowledge and experience of international market conditions, and produce more effective problem-solving. In case the company is
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strategically aiming to attract foreign investments or develop international business activities, the presence of foreign members on board can help assure international stakeholders that their rights will be protected effectively, contributing to improving the image of the company.
The above argument for the positive contributions of foreign directors is consistent resource dependence theory and a number of prior studies. Based on the resource dependence theory, Hillman, Canella and Paetzold (2000) argue that companies can reduce external uncertainty as well as the transaction costs related to external operation by enhancing the link to their outside environment. Foreign directors on board can play resource dependence role by providing specific assets to improve the ability of the companies to respond to disruptions in external environments, especially in the international markets. According to Carter et al. (2003), diversity in the BODs with heterogeneous expertise, experience and perspectives of members can promote creativity and effective problem-solving. Foreign board members with specific market knowledge, international outlook and broad experience can bring the advantages of diversity mentioned by Carter et al. (2003). In addition, hypothesized image-improving advantage of foreign board members is in line with the argument of some previous researches on board diversity. Smith et al. (2006) discusses that board diversity contributes to building a more positive image of the firm in the eyes of the public and stakeholders, which, in turn, can lead to enhanced financial performance.
Hypothesis 3 (H3): There is a positive relationship between the percentage of foreign members of the BOD and firm performance.
3.4. The moderating effect of state ownership
There have been a number of researches on how state ownership in Asia can affect firm performance. For example, in the context of China, the government has the key role as the primary shareholder in reformed companies, they tend to assist firms with financial and
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political resources (Shleifer & Vishny, 1997) and in turn, boost the firm’s reported performance. Furthermore, the Chinese government may also utilize their power to provide companies having high level of state ownership with advantageous taxation, market regulations and other privileges. Researchers also point out that the Chinese government makes use of pivotal networks to acquire loans from banks (Gordon & Li, 2003), and lending from Chinese state banks is more accessible for reformed companies with considerable state ownership level (Lu, Thangavelu, & Hu, 2005). This kind of assistance plays an important role in boosting revenue, cutting costs and improving firms’ financial performance.However, state ownership is also found to have negative effects on performance. Elyasiani & Jia (2010) discover that state ownership has a detrimental impact on both performance and value of the company. There are also a number of consequential studies showing the difference between the effect of state ownership on performance and its effect on value of China’s listed companies. For instance, Sun and Tong (2003) find out that state ownership has almost no correlation with performance of firms (in terms of ROA and EBIT/Sales) but has a strong negative impact on their values (Tobin’s Q). On the other hand, Xu and Wang (1999) show the opposite: state ownership has negative effect on performance (ROE, ROA) but no notable link with value of firms (Tobin’s Q). In general, the results of studies on the correlation between state ownership and performance of companies remain mixed and inconclusive.
Although existing literature has studied extensively relationship between state ownership and performance, insufficient attention has been paid to the moderating effect of state ownership on the relationship between board diversity and firm performance. By controlling a high percentage of shares, dominant shareholders tend to continuously monitor and also have the capability to govern management (Shleifer & Vishny, 1986). In many developing countries, ownership is highly focused. However, this concentration in Asian countries, including China, Vietnam and Indonesia has some distinct characteristics: it mainly
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originates from the control of the government over economic system. In bigger SOEs, their state shareholders still has control over the recruitment, firing and switching important board positions (board chair and vice chair are two examples) that has large overlap with the company’s management. The control of the government over board composition can hinder the benefits of board diversity on performance, and therefore, lead to lowered performance.
Some prior studies provide evidences to support the above arguments. The research conducted by Ma and Khanna (2015) shows that there is a significant relationship between the dissents of independent directors in Chinese boards and the board chairs who are representative of state ownership. They find that the presence of Chinese bureaucracy on board and the intervention of dominate state shareholders can lead to the dissents of the board of directors, resulting in reduced effectiveness in the contribution of independent directors to monitoring the firms. In addition, Hwang and Kim (2009) observe that controlling shareholders in Asia tend to exert influence to choose socially-connected and friendly members for the BODs, which is a form of co-option. Coles, Daniel and Naveen (2010) find that co-option reduces the monitoring effectiveness of the BODs.
Hypothesis 4 (H4): State ownership has a negative moderating effect on the relationship between board diversity and firm performance.
3.5. Theoretical framework
The four hypotheses developed above can be illustrated by the theoretical framework in the next page:
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H4
H1 H2
Figure 1: Conceptual Model of the Hypotheses
In summary, hypotheses 1, 2 and 3 predict the positive relationship between three dimensions of board diversity, including gender diversity, board independence and nationality diversity respectively, on firm performance. Hypothesis 4 predicts a negative moderating effect of state ownership on such relationship.
4. METHOD
This section will present the methodology and analytical techniques used in this study. First, we explain the data collection and characteristics of the data sample. Second, we elaborate on the variables used in this study. Third, results of the regression and thorough analysis will be demonstrated in details.
4.1. Data sources
This study uses secondary resources to gather data of financial performance, ownership and board characteristics of companies. The financial data of Hong Kong companies is obtained from Orbis database, which provides data of more than 100 million companies worldwide, and the financial data of Chinese and Vietnamese companies is collected from audited financial reports of companies. The data of ownership structure and board diversityare sourced manually from annual reports downloaded from company’s websites. Any additional
Board diversity Nationality diversity Independence Gender diversity State ownership Firm performance H3
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required data or information is directly supplemented from companies’ websites and websites of stock exchanges.
4.2. Sample
The sample consists of the largest companies listed in four stock exchanges in China, Hong Kong and Vietnam in 2014, including Shanghai, Shenzhen, Hong Kong and Ho Chi Minh City Stock Exchange. We exclude financial companies, banks, insurance firms and investment funds from the data set since financial institutions have considerably different capital structures and are subject to specific requirements and regulations. It is noted that there are missing data in certain variables of some companies, resulting from diverse formats of their annual reports. Companies with missing data in any of the studied variables are removed from the sample. The final sample size is 376 companies.
4.3. Dependent variables
Several previous researches adopt two methods based on accounting and market value in order to evaluate financial performance of companies. In this study, ROA, an accounting value, and Tobin’s Q, a market-based value, are used to estimate firms’ performance.
4.3.1. ROA
Return on asset (ROA) is defined as the ratio between net income and total asset of a company. These ratios are used in many corporate governance studies, including those by Brown and Caylor (2004), Bhagat and Bolton (2008), and Klapper and Love (2004). ROA specifies the effectiveness of a company in utilizing its total asset.
=
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Reasons for choosing ROA as a performance indicator include its ability to capture the actual situation of the company in the context of inefficient stock market and its direct representation of the company’s profitability and survival (Joh, 2003).
4.3.2. Tobin’s Q
Tobin’s Q is regarded one of the most popularly used financial measures to evaluate firm’s performance. Tobin’s Q is a measure of market returns that compare the value of a company estimated by financial markets with the value of its assets (Tobin, 1969). Brainard and Tobin (1968) proposed the Tobin’s Q ratio with the original formula as followed
′ =
Several empirical researches on the relationship between corporate governance and performance, including Bhagat and Bolton (2008) and Klapper and Love (2004), use Tobin’s Q to measure firms’ performance. Tobin’s Q larger than one indicates that the company is employing its resources effectively, while Tobin’s Q less than one implies inefficiency in resource exploitation (Lewellen & Badrinath, 1997). The strength of Tobin’s Q is its effective demonstration of the market value of intangible assets that can display “the results of performance”, such as expertise of manager or growth prospects (Perfect & Wiles, 1994).
4.4. Independent variables
Independent variables in this study include gender diversity, nationality diversity and board independence. Gender diversity is measured by the percentage of female members over the total number of board members. We measure international diversity by the percentage of foreigners on board. The level of board independence is measured by the percentage of independent board members over the total number of members in the board.
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Data concerning female and foreign board members is sourced from the annual reports of companies. Commonly, annual reports present sufficient information regarding gender of board members. Gender of board members is determined based on photographs and introductory biography of board of directors in the annual reports. In case origins of foreign members are not mentioned in the report, names and biography are used to identify their nationalities from other web-based data sources. The above-mentioned sources of information are verified using data on websites of stock exchanges to secure validity. Information concerning independent members is also included in the majority of annual reports. Missing data of independent members of some companies are directly supplemented by information published in stock exchange websites and companies’ websites.
4.5. Moderating variable: state ownership
The moderating variable in this study is state ownership. From annual reports of companies, data of ownership structure is obtained, including the data of state ownership. State ownership is defined as the percentage of equity regarding votes and capital that is owned by the government or other state-owned companies. The moderating effect of state ownership will be examined on the independent variables that have statistically significant effect on firm performance.
4.6. Control variables
This study controls for one firm-specific effect (which is firm size), one board-specific effect (which is board size) and one industry-specific effect to reduce potential bias resulting from omitted variables. Thereby, this research has taken into account the most important control variables that make potential impact on firm financial performance, according to prior corporate governance literature.
35 Firm size
Theoretically, Zahra and Pearce (1990) stressed the important role of firm size assessing the relationship between corporate governance and firm performance. In addition, firm size is popularly used to control firm’s specific characteristics in several empirical researches, including that of Bhagat and Black (1999). According to Oxelheim, Gregoric and Thomsen (2013), larger sizes of firms are more likely to associate with international businesses and complexity that require board diversity. In this study, natural logarithm of firm size is taken as a control variable due to the wide interval between the max and min value of firm size.
Industry
Prior researches, such as studies of Tuggle, Sirmon, Reutzel & Bierman (2010); and of Mahadeo, Soobaroyen & Hanuman (2012), have widely used industry as a control variable when assessing the effect of board diversity on firms’ financial performance. These researchers found that that board diversity has an impact on the performance ofa firm, depending onthe specific industry in which it operates.In this study, firms in the sample are categorized in to six industries including mining; manufacturing; transportation, communication, electric, gas and sanitary services; wholesale and retail trade; real estate; and services. The classification is made based on NAICS code.
Industry Code
Mining 1
Manufacturing 2
Transportation, communication, electric, gas and sanitary services
3
Wholesale and retail trade 4
Real estate 5
36 Board size
Board size is a widely used measure forcontrolling and analyzing the relationship between boarddiversity and performance (e.g. Erhardt et al., 2003; Mahadeo etal., 2012). In addition, prior research indicates that the size ofthe board is positively correlated with board diversity.Besides, Carter et al. (2003) observe that the percentage of female members and ethnic-minority-members on the board of directors increases with firm size and board size.
The following table summarizes the definitions of all variables used in this study:
Variable Measurement
Firm Size The natural logarithm of the number of employees in the firm Industry Coded according to table 1
Board size The number of members in the BOD
Gender diversity The percentage of female members in the BOD Nationality diversity The percentage of foreign board members in the BOD Board independence The percentage of independent members in the BOD
ROA Net income/Total assets
Tobin’s Q Total market value of firm/ Total asset value Table 2: Definitions of variables
4.7. Methods
A hierarchical regression is performed to test the hypotheses proposed in the theoretical framework. Listed variables above are controlled for in the regression. This statistical method is consistent with a number of previous researches on the impact of board diversity of firm performance, including Erhardt et al. (2003), Adams & Ferreira, 2009; Mahadeo et al., 2012). This study tests five models, built in a hierarchical way. This hierarchical regression is carried out separately for ROA and Tobin’s Q as dependent variables. In the first model, the
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control variables, including are added. Gender diversity, the first independent variable, was entered in the second model. In the third and fourth models, nationality diversity and board independence level were added respectively and in the final model, state ownership, the moderating variable, was added.
Control variables Independent variables Moderating variable
Firm size Industry Board Size Gender diversity Board independence Nationality diversity State ownership Model 1 X X X Model 2 X X X X Model 3 X X X X X Model 4 X X X X X X Model 5 X X X X X X X
Table 3. Hierarchical regression models on ROA/ Tobin’s Q
In each model, the result of the hierarchical regression is analyzed toobserve the p-value for identifying the significance of the effect of boarddiversity indicators on firm performance. Moreover, the changes in theF-statisticand the standardized beta coefficients will be observed along with the changes in the R-square in order to examine the significance of the effect of board diversity on firm performance. Erhardt et al. (2003) and Cohen, West and Aiken (2013) consider this method as an effective technique when assessing thechanges in the dependent variable. In the research of Erhardt et al. (2003), this method was employed to assess the effectsof board diversity on firm’s financial performance with a sample of 127 large US companies and the result showed that boarddiversity has a positive impact on firm performance. Taking into account its proven effectiveness when examining the relationship between board diversity and firm performance, hierarchical regression analysis will be adopted in this research. PROCESS, a modeling tool created by Hayes will be employed to test the moderating effect of state ownership on the relationship between board diversity and financial performance. Model 1 of PROCESS will use to test this moderating relationship.
38 5. RESULTS AND ANALYSIS
This chapter demonstrates the results of data analysis, taking into account the variables listed in the previous chapter. Separate sections are dedicated to the presentation of results of two models which include ROA and Tobin’s Q as dependent variables. Initially generated hypotheses will be tested to identify rejected and accepted hypotheses for further discussion.
5.1. Descriptive statistics
This section provides an overview of some general characteristics of the firms in the sample to describe the portrait of the sample selected to represent population. A description of industry distribution, a presentation of mean and standard deviation of each variable, and a correlation analysis will be reported.
Table 1 presents the industry distribution of these 379 companies, with manufacturing covering the largest portion and services covering the lowest. As can be seen from table 1, there is no highly dominant industry in the sample. It reduces the likelihood that some specific industries will drive the results of the empirical tests.
Industry Percentage (%)
Mining 6,1
Manufacturing 44,3
Transportation, communication, electric, gas and sanitary services
18,2
Wholesale and retail trade 9,8
Real estate 16,6
Services 5
Total 5
Table 4.Distribution of firms among industries
Next, the description of mean and standard deviations of all variables are presented in table 4. ROA has a mean value of 0,074 with a standard deviation of 0,0675. Regarding
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Tobin’s, we observe a wide interval between min value (0,05) and max value (68,3) with the mean of 3,6371 and the standard deviation of 6,5531. Overall, financial indicators of firm performance appears to be positive, although the results of Tobin’s Q show relatively high standard deviation.
N Minimum Maximum Mean
Std. Deviation ROA 379 -,09 ,45 ,0749 ,06779 Tobin’sQ 379 ,05 68,30 3,6860 6,6550 Company size 379 ,01488 10,0904 3,9435 2,2774 Industry 379 1 6 3,02 1,380 Boardsize 379 3 33 9,54 3,480 %Female members 379 ,00 ,80 ,1171 ,1291 %Independent members 379 ,00 ,89 ,3609 ,1372 %Foreign members 379 ,00 1,00 ,0522 ,1340 State ownership 379 ,00 ,97 ,2522 ,2845 Valid N (listwise) 379 Table 5. Descriptive statistics
Regarding independent variables, the percentage of foreign board members have a low mean value (52,2%) and a relatively high standard deviation (13,4%), with a large span ranging from 0% to 100%. Among the independent variables, the highest mean value belongs to the percentage of board independence, which is 36,09%. The mean percentage of female board members is only 11,71%, a relatively low figure but reflecting quite correctly the current gender composition of Asian boards, which are still dominated by male directors. Looking at the control variable, we can observe a large span in the state ownership level, ranging from the min value of 0% to the max value of 97%, with the mean of 25,22% and a standard deviation of 28,45%.
Next, a correlational analysis was performed on the entire sample in order to estimate the level of correlation between different variables. From the correlation results, we can
