The effect of corporate governance on accounting performance of Dutch listed organizations

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“The effect of Corporate Governance on accounting performance

of Dutch listed organizations”

Amsterdam Business School

Master thesis in Accountancy & Control, variant Accountancy Faculty of Economics and Business, University of Amsterdam Supervisors: dr. G Georgakopoulos

xxxxxx Student: J.R. Kluck Date: 8th of June, 2016 Word count: 12862

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Statement of Originality

This document is written by student Jaap Kluck 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.

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Abstract

Prior literature and three common used theories suggest there is a relation between elements of corporate governance and organizational performance. This research investigates this relationship for six of these elements in the Dutch context in a period of economic prosperity. Organizational performance is measured by the accounting performance measures Return on Assets and Return on Equity for 102 Dutch listed organizations in 2013. The findings indicate that the size of a board has a positive effect on the performance of an organization which supports the thought larger boards decrease agency costs and provide access to more resources. In contrast to the expectations of this study, evidence is found for a negative effect of nationality diversity and ownership concentration on organizational performance. This research contributes to present literature examining the link between corporate governance and organizational performance because research in the Dutch context is not abundant. Furthermore, similar studies during periods of economic prosperity are not that common.

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3.1 Introduction ... 19 3.2 Sample... 19 3.3 Dependent variables ... 21 3.4 Independent variables ... 21 3.4.1 Board size ... 22 3.4.2 Diversity ... 22 3.4.3 CEO tenure ... 22 3.4.4 Board independence ... 23 3.4.5 Ownership concentration ... 23 3.5 Control variables ... 24 3.6 Regression model ... 25 4. Results ... 26 4.1 Introduction ... 26 4.2 Summary statistics ... 26 4.3 Results ... 29 5. Discussion... 32 6. Conclusion ... 34 7. References ... 36

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1. Introduction

“We document for Ahold that poor corporate governance led to aggressive accounting by management which inflated stock prices that allowed management to undertake poor acquisitions. The company’s investor relations, 4 which made Ahold a ‘best in class’ company and its CEO the ‘best manager,’ was a success but a two-edged sword; it effectively maintained the company’s stock price but also placed management under substantial pressure to maintain the growth implied by the stock price” (DeJong et al., 2005, p. 3)

The quote above is an extract of a study about the failed growth strategy of Royal Ahold. This large supermarket concern reported in 2001 sales and profits of €66.6 billion and €1.1 billion. With 5,155 stores in more than 25 countries they were the largest retailer in the world. Despite the fact they were operating in a prosperous global economy, Royal Ahold suffered a complete meltdown in 2003. According to the researchers this meltdown was preliminary due to bad corporate governance (DeJong et al., 2005). Corporate governance, broadly defined consists of the institutional structures, legal rules and best practices that determine which body within the corporation is empowered to make particular decisions - how the members of that body are chosen, and the norms that should guide decision making (Bainbridge, 2012). Bad corporate governance was also a big issue in the United States (US) around the year 2000. Several accounting and auditing scandals emerged at organizations like Enron, WorldCom and Global Crossing. As a response the Sarbanes-Oxley Act (SOX) was created which is an US federal law that set new or expanded requirements for all the public listed organizations in the US. The act compels large organizations to comply with stronger corporate governance implementations. The Netherlands has a similar code of conduct named ‘code Tabaksblat’ which is applicable for all Dutch listed organizations. The ‘code Tabaksblat’ uses a principle named ‘comply or explain’. This mean that an organization that choose not to comply with one of the rules of the code, has to explain why not. Due to the financial crisis and some accounting scandals the Monitoring Commission of the ‘code Tabaksblat’ presented the revised code that emphasizes the importance of corporate governance. The rules about executive compensation are according to this revised code stricter and the disclosure of the compensation structure must be simplified and more transparent. Beside, in the modified code is stated that every Dutch listed organization is obliged to have an internal audit function and the responsibilities of the shareholder are emphasized. It is expected from them to actively start a dialogue with the organization and to enforce their right to bring own items on the agenda. The most important goal of the revised ‘code Tabaksblat’ is to keep the present markets in good health and prevent scandals like Royal Ahold or Enron from happening in the future. The revised corporate governance code has a direct impact on the way directors, executives and shareholders execute their tasks which may influence the performance of an organization (de Jong et al., 2007).

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Agency theory based research about the relation between Corporate Governance and organizational performance is much focused on the United States (Alali et al., 2012; Mehrotra, 2016; Shleifer and Vishny, 1997). The aim of this research is to provide an academic contribution to the already growing international literature by examining the Dutch corporate board structures and accounting performance, and possible associations between them. Existing literature often find contradictory results about the relation between certain corporate governance and organizational performance (Garg, 2007; D. Miller, 1991; O’Connell and Cramer, 2010; Rodriguez-Fernandez et al., 2014; Shakir, 2009). These contradictory findings imply that there is unclearness about the effects of some board characteristics. In order to clarify this unclearness, the following research question will be answered in this research: What is the effect of corporate governance on accounting performance of

Dutch listed organizations in 2013? This research will contribute to more clarity about this relation by

using two different approaches. The use of a timeframe which represents a period of economic prosperity in the Netherlands and the measurement of organizational performance on the basis of accounting performance measures only are these two approaches. The goal of these two approaches is to leave as much noise out of the results as possible.

Prior research focused primarily on the period immediately before, during or immediately after the last financial crisis of 2007-2008, which is a really interesting period, but also a really unstable one (Aebi et al., 2012; Erkens et al., 2012; Grove et al., 2011; Mangena et al., 2012; Nguyen et al., 2015; Peni and Vähämaa, 2012; Rodriguez-Fernandez et al., 2014).

Organizational performance in an unstable period is easier affected by noise (labor market instability, consumer purchasing power) than in a stable or progressive period (Cho and Keum, 2004; Eui-Gak Hwang, 1999). In 2014 the minister of finance of the Netherlands, mr Dijsselbloem (Van der Laan, 2014) said the economic crisis is over. The Netherlands booked an economic growth of 1,2% and expects an economic growth of 1,4% in 2015. In order to leave out possible noise that can influence organizational performance as much as possible this research will use the timeframe 2013-2014 because of its relative economic stability.

In prior research organizational performance is often measured by the Tobin’s Q ratio or stock return, which are both market valuation measures (Grove et al., 2011; Rodriguez-Fernandez et al., 2014; Shakir, 2009; Vintila et al., 2015). A performance measure is of high quality when the measure is not influenced by noise (Sloof and van Praag, 2010). Market valuation measures are relatively noisy because of the strong impact of external factors. Accounting performance measures are less susceptible to noise. In order to measure the most reliable effect of board characteristics on organizational performance, accounting performance measures are used in this research. This choice of performance measure is strengthened because of the recent criticism the Tobin’s Q ratio received (Waracha, 2010).

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Corporate governance is a really broad concept that consists of different elements. The elements which represent corporate governance in this research will be board size, board diversity, CEO tenure, board independency and ownership concentration. More explanation about the concept corporate governance and the differences between market performance measures and accounting performance measures will contribute to a better understanding of the research question. This explanation is given in Chapter two of this thesis combined with a review of interesting theories which relate to corporate governance and its effect on organizational performance. Chapter two concludes with the hypotheses development. Information about the sample data, research method and the variables used in this research is stated in Chapter three. The findings, discussion and their conclusions are presented in Chapter four to six. The last chapter will be the list of all the literature used in this thesis.

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2. Literature Review

This chapter is basically an argumentation of the academic contribution of this thesis that is based on several academic papers and is build up out of five sections. First section is an introduction to the concept of corporate governance and the second section will provide an explanation of three theories that form the theoretical basis of multiple prior corporate governance studies. The theories are: the Agency theory, Stewardship theory and the Resource Dependence theory. All these three theories give insights in why corporate governance might be important for an organization to function. The third section will provide insight in prior studies about the relationship between corporate governance and organizational performance and the focus in this section will be on the shortcomings of these studies and the possible research gaps. The last section will show based on hypotheses how these possible research gaps will be filled in this thesis.

2.1 Introduction to Corporate Governance

In the past decades, Corporate Governance has become a well-discussed and controversial subject in both the common and in the business press. Several news sources published articles about corporate frauds, accounting scandals, insider trading and excessive reimbursements and other organizational misconducts. These organizational failures often end in legal proceedings, resignations and large collapses of organizations such as Enron in 2001. Corporate governance, which can be described as the system of checks and balances meant to prevent mistreatment by executives, was according to the publishers of these stories inadequate and thus the main cause of these failures (Larcker and Tayan, 2011).

In theory, the demand for corporate governance arises from the idea that when the ownership of the organization is separated from the management function, executives might engage in individualistic self-satisfactory behavior (Berle and Means, 1991). The costs of these actions are born by the owners of the organization. Mitigating these so called agency costs can be achieved by the implementation of a system of (monitoring) controls (Jensen and Meckling, 1976). That system of checks and balances is called corporate governance.

These systems do not only involve the owners and the managers of an organization. This system is also affected by third parties that are not directly linked to the organization such as regulators, auditors and politicians. The involvement of these third parties concerning corporate governance of organizations arose in the past decade due to the social impact of several high profile corporate failures. An example of such increase in involvement of third parties is the enactment of the SOX of 2002. This act can be seen as an important step in the legislation of corporate governance.

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The act contains regulation and guidelines to address shortcomings of existing governance systems (Larcker and Tayan, 2011).

The Dutch corporate governance code is named code ‘Tabaksblat’. This is a code of conduct for listed organizations with the aim to achieve more transparency in the financial statements, improved accountability to the supervisory board and to strengthen the control and protection of shareholders. The code contains more than 100 rules concerning the board of directors of Dutch listed organizations such as tasks, procedures and the compensation of executives (de Jong et al., 2007).

2.2 Corporate governance theories

The main theories that have contributed to the understanding of the relationship between institutional-level governance mechanisms and the performance of an organization are agency theory, stewardship theory and the resource dependence theory (Glinkowska and Kaczmarek, 2015; Pfeffer and Salancik, 1978).

2.2.1 Agency theory

According to many research of behavioral psychologists people are rational and self-interested (Jensen and Meckling, 1976). Human actions are goal-oriented and individuals seek to achieve their goals at as low cost as possible. People who have the control in organizations (executives) also tempt to pursue their goals by taking actions at low cost as possible, which are often at the expense of the shareholders of the concerning organization.

The modern organizations of the 20th century characterize themselves by the separation of the decision-making functions (control) and the risk bearing functions (ownership). In these modern organizations the shareholders possess little or no direct control over management decisions. Research conducted by Jensen and Meckling (1976) prompted an interesting research about managerial behavior and ownership structure of organizations. They mention the agency relation, which is a contract under which one, or more persons (shareholders) engage another person (agent) to perform some service on their behalf, which involves delegating some decision-making authority to the agent. When both parties want to maximize their utility it may occur that the agent will not always act in the best interest of the principal. In essence, the agents’ individualistic self-satisfactory behavior increases the costs to the organization. The literature mentions two types of agency costs. First the cost incurred when the manager uses the resources of his organization for his own benefits. For example, a manager who raise his own salary to a disproportionate level. The second type is the cost of methods used by shareholders to prevent the manager from acting out of self-interest. With these methods the principal attempts to limit the asymmetry between his or her interest and the agents’ interest (Hill and Jones, 1992). Creation of appropriate incentives for the agent and intensifying monitoring in order to limit

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monitoring cost are examples of these methods. Next to these monitoring agency cost, which are incurred by the principal, there are bonding agency cost. These are all the costs incurred by the agent to convince his or her principal that the agent works in the interest of the principal. An example of these costs is a contractual obligation that limit or restrict the agents’ behavior. Despite the establishment of all these methods, the principals’ interests and the agents’ actions may remain diverged. When this divergence reduces the principals’ interest (e.g. organizational profitability) despite the use of monitoring and bonding, the loss can be seen as a residual loss. The sum of the monitoring cost, bonding costs and residual loss are the total agency costs (Jensen and Meckling, 1976).

As described earlier the agency relation is described as a contractual relationship between the principal and the agent. According to Jensen & Meckling (1976) agency cost can be reduced by the development of those contracts in a way the rights and obligations are clear for the agent. Fama & Jensen (1983b) support such development of the contract as the internal “rules of the game” that address the rights of each agent, the performance criteria by which the agents are evaluated and the compensation they face. The development of these contracts can be translated into the governance instruments composition of the board of directors and the division of the compensation schemes of the executives.

Corporate governance can be used to change the rules under which the agent operates and it is able to restore the principals’ interests. The examination of the agency theory provides a foundation for understanding the modern corporate governance standards. A perfect market for corporate controls is assumed to be non-existent which leads to several agency problems (Bonazzi and Islam, 2007). In order to solve the agency problems and optimize the corporate governance mechanism of an organization the development of an effective board of directors remains an important option. Early studies concerning the effectiveness of the board of directors primarily use outside directors, ownership concentration, board size and CEO tenure as research areas (Guest, 2009; Kosnik, 1987; Shleifer and Vishny, 1997).

Above described theory assume that managers (agents) are untrustworthy and opportunistic in nature and the only responsibilities of the board is monitoring the management (Fama and Jensen, 1983b; Jensen and Meckling, 1976). The stewardship theory represents different assumptions concerning the behavior of agents and the role of the boards (Donaldson and Davis, 1991).

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2.2.2 Stewardship theory

The most cited reference to the agency theory comes from the research of Jensen and Meckling (1976). The theory is based on the thought that an agent rather act in his own best interest than those of the principle unless appropriate governance structures are developed and implemented in order to protect the interests of the principle. The stewardship theory described by Donaldson and Davis (1991) is basically the opposite of the agency theory. According to this theory the interests of the agent and the principle are aligned. The theory assumes that agents are team players and the most effective governance structure is the one that gives the agents freedom to act, taking into account the expectation that agents will act in the best interest of the principle. In essence, this theory postulates that the agents do not show opportunistic behavior, but are virtuous stewards. According to Muth and Donaldson (1998) this ‘neat’ managerial behavior stem from a couple of non-financial motives. These are “the need for achievement and recognition, the intrinsic satisfaction of successful performance, respect for authority and the work ethic”. According to Jeannet and Schreuder (2015) a steward tries to bring the organization into a better condition for its successor. He or she feels a loyal connection with the organization and obtains a greater satisfaction from the achievement of organizational goals than from self-satisfying behavior (Davis et al., 1997). Another non-financial motive according to Hernandez (2008) is that managers have an important responsibility to act not only as caretakers, but also as role models for the next generations. The development of future managers is strongly influenced by their predecessors. In other words, the behavior of the future decision-makers is influenced by the current decision making generation. According to Hernandez these current decision makers should act as stewards by modeling behavior that place the interest of the organization ahead of their self-interest.

Non-independent directors are members which arose from high management positions in the concerning organization. These directors are well-known with the norms and values of the organization because of their past experiences with the decision making behavior of their predecessors (Pfeffer, 1972). Several studies examined the relationship between the composition of the board of directors and the performance of the organization (Masulis and Mobbs, 2011; Mobbs, 2015; Pfeffer, 1972). All these researchers found that boards with a majority of non-independent directors have better operating performance, which supports the above reasoning of Hernandez (2008).

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2.2.3 Resource dependence theory

The resource dependence theory is a theory that explains how resources of organizations impact the behavior of the organization (Pfeffer and Salancik, 1978). One of the implications of this theory is that external resources are the basis of power. Having access to the right external resources (indication of power) can have positive effects on the performance of the organization. According to this theory, the board of directors represents a fundamental link between the organization and these resources. According to Cowen and Marcel (2011), the board of directors have the formal responsibility to assist in gaining access to resources that the organization need for successfully execution of operations. A board of directors’ capability of doing this successfully depends partly on the degree to which the board gathered legitimacy in external markets that provide the resources (Hillman and Dalziel, 2003). Dalton and Kesner (1985) assessed the conventional formula that bad performing organizations are more likely to replace their CEO’s with independent (arose from outside the organization), rather than non-independent (arose from inside the organization) successors. They concluded that an organization that let an independent director succeed a poor performing CEO is associated with positive change. Independent directors bring new experiences and social capital into the organization, which can help in obtaining legitimacy in external markets and thus, the access to more external resources, which can increase organizational performance.

According to Booth and Deli (1996) the size of the board of directors reflects the complexity of the concerning organization and the magnitude of their organizational contracting environment. In order to extend the contracting environment, organizations use their own board of directors by the appointment of more board positions. Their philosophy is that higher population on the board creates more access to resources for the organization.

2.3 Corporate governance and organizational performance

The many harmful corporate events of the past decades have raised many questions by scientists concerning their appearance and causes (DeJong et al., 2005; Nelson et al., 2008). This resulted in multiple seminal studies about the association between corporate governance and organizational performance which frequently show mixed results (Garg, 2007; D. Miller, 1991; O’Connell and Cramer, 2010; Rodriguez-Fernandez et al., 2014; Shakir, 2009). There can be several causes that contribute to these mixed results such as the use of different methods in measuring corporate governance and organizational performance. Another reason could be the different research areas and the different time frames (before, during, after crisis period) (Erkens et al., 2012; Nguyen et al., 2015; Rodriguez-Fernandez et al., 2014). In this section these mixed results are enunciated and explained how the narrative and research of this thesis can contribute to prior literature.

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Rodriguez-Fernandez et al. (2014) investigated the relationship between internal governance structures and financial performance of listed Spanish organizations. The variables used to measure corporate governance are for example the size of the board, the amount of board meetings and the proportion of independent directors on the board. The choice of these variables of corporate governance is based on the agency theory of Jensen and Meckling (1976). They used as dependent variable both market performance measures as accounting performance measures of 146 Spanish listed organizations during the global financial crisis. They found a positive relationship between board size and accounting performance (ROA and ROE) and found a negative relationship between the amount of board meetings and accounting performance (ROE). They did not find any relationship between the proportion of outside directors on the board and organizational performance. Other studies have attempted to show the same relationship between these specific governance structures and financial performance based on the same theory (agency theory). These studies were conducted in the same period but had different outcomes (O’Connell and Cramer, 2010; Rodríguez-Fernández, 2015). O’Connell and Cramer (2010) explored the association between organizational performance and both the size of the board and proportion of outside directors on the board. According to their results, the size of the board has a negative relationship with accounting performance (ROA). Contrary to the research in the Spanish context, O’Connell and Cramer did find a relationship between the proportion of outside directors and financial performance that is positive. This result is consistent with the theoretical expectations made by O’Connell and Cramer. Nevertheless, the result is according to them in contrast with the results with other studies that investigate this relationship (de Andres et al., 2005; Rodríguez-Fernández, 2015). Rodríguez-Fernández (2015) conducted a research fully focused on the relationship between the size of the board of directors and the organizations financial performance. One of their main conclusions is that there is no such thing as ‘one size fits all’. The optimum size of the board of directors is dependent on several additional factors such as the size of the organization and the type of industry the organization is operating in.

Most research in this area (including above described research) focused primarily on the period immediately before, during or immediately after the financial crisis of 2007-2008, which is a really interesting period, but also a really unstable one (Aebi et al., 2012; Erkens et al., 2012; Grove et al., 2011; Mangena et al., 2012; Nguyen et al., 2015; Peni and Vähämaa, 2012; Rodriguez-Fernandez et al., 2014). Organizational performance is easier affected by external moderating factors (noise) in an unstable period than in a stable or progressive period. For instance, small organizations experience more negative effects of a financial crisis than large organizations (Vithessonthi and Tongurai, 2015). According to this literature review it can be concluded that research, focusing on the association between corporate governance and organizational performance in a period of relative economic stability, is scarce.

Not only corporate governance studies during crisis periods show mixed results regarding the impact on organizational performance. The few studies in a period of relative economic stability find

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contrasting results as well (Daily and Dalton, 1992; Rhoades et al., 2000). Dailey and Dalton (1992) analyzed the performance of 100 entrepreneurial organizations in 1989. Despite a small stock market shock, the economy was in good condition. They found a positive relationship between the proportion of outside directors and organizational performance. Other studies during this timeframe found evidence that the relationship between the ratio of outside directors and the performance of an organization is negligible (Rhoades et al., 2000).

Organizational performance can be measured on many different ways. Studies investigating the association between corporate governance and organizational performance often use market performance measures such as Tobin’s Q or Stock return. Existing literature, which use the Tobin’s Q as performance indicator assume that a higher Tobin’s Q ratio is equivalent to better organizational performance (Grove et al., 2011; Rodriguez-Fernandez et al., 2014; Shakir, 2009; Vintila et al., 2015). Recent study of Waracha (2010) provided evidence that this assumption is wrong. According to him the Tobin’s Q ratio does not measure organizational performance and is therefore questioning the suitability of this market performance measure for corporate governance research. A performance measure is of high quality when the measure is not influenced by noise (Sloof and van Praag, 2010). Measurements like the Tobin’s Q or Stock return are relatively noisy because of the strong impact of external factors (O’Connell and Cramer, 2010). Accounting performance measures are less susceptible to noise. Furthermore, most of the recent studies focused on the traditional performance measures (ROA, ROI, Tobin’s Q etc.) and ignored modern methods of measuring organizational performance such as Economic Value Added (EVA) or Market Value Added (MVA) (Erkens et al., 2012; Grove et al., 2011; Rodriguez-Fernandez et al., 2014; Vintila et al., 2015).

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2.4 Hypothesis development

2.4.1 Board size and organizational performance

The number of directors on a board tends to be linked with the revenues of the organization. Organizations with a yearly revenue of ten million US dollars have on average seven members on their boards and the larger organizations with a yearly revenue of ten billion US dollars or higher count on average eleven members on the board (Larcker and Tayan, 2011).

In the past decades there have been a lot of discussions about the ideal size of the board of directors (Gales and Kesner, 1994; Pfeffer, 1972; Topal and Dogan, 2014). In earlier research regarding the relationship between board size and organizational performance there are mixed results. Several researchers found evidence of a positive relation, where most of them debate that the strategic decisions of large boards are of better quality (Elsayed, 2011; Kim et al., 2012; Topal and Dogan, 2014). This is due to the fact that larger boards consist of more people with different backgrounds who contribute with different knowledge and experience.

From the perspectives of both the agency theory and the resource dependence theory the relation between board size and organizational performance should be positive (Fama and Jensen, 1983a; Jensen and Meckling, 1976; Pfeffer and Salancik, 1978). In line with the agency theory, you could deduce that a board with more members is better able to reduce agency costs because there are more executives to monitor the activities of managers. The resource dependence theory argues that directors are selected in order to increase the provision of external resources of the organization. Hence, larger number of members on the board increases the access to important resources.

Some researchers found empirical evidence of a positive relationship between small boards and organizational performance (Cheng et al., 2008; Guest, 2009). Boards which are too large can on the contrary increase agency problems such as free-riding of directors (Hermalin and Weisbach, 2003). This makes large boards less effective than small boards because they have less interaction with the day-to-day management. Furthermore, when the amount of members on the board increases, communication and coordination might become less effective. Based on the above discussed theories and cited results from prior studies the following is proposed:

Hypothesis 1: Board size is positively associated with organizational accounting performance.

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2.4.2 Board diversity and organizational performance

Female directors are significantly under-represented on boards of directors compared to the composition of the current society. The boards of the Fortune 500 organizations consist only of 15% female directors (Larcker and Tayan, 2011).

The resource dependence theory states that boards provide legitimacy to different stakeholders or groups within our society, by serving as a linking mechanism between organizations and their stakeholders. The leadership styles of women are different from that of men and this diversity is according to several research studies an improvement for that particular organization (Campbell and Mínguez-Vera, 2008; Low et al., 2015; Nguyen, Locke, & Reddy, 2015a). Low et al. (2015) examined the relationship between gender diversity on the board and organizational performance in different Asian countries. They found that female directors on the board have a positive influence on return on equity. This positive effect is less in countries where the economical participation and empowerment of women is higher. This is due to differences in institutional and socio-cultural norms and values.

The arguments for increased representation of females on the board of directors are based on simple economics. Larcker and Tayan (2011) state:”If we assume that managerial talent is evenly dispersed across men and women, restricting board members to include only (or predominantly) men eliminates a significant portion of qualified talent” (p. 158). According to Post and Byron (2015) female directors are better educated and are more likely in the possession of a university degree. This is an example of female directors differ in their experiences and knowledge from their male counterparts. Due to this, female directors can contribute to diversity of the perspectives of a board. Gender diversity on the board leads to a more comprehensive understanding of the market where the organization operates in which can contribute to higher profits for the concerning organization (T. Miller and del Carmen, 2009).

Gender is not the only way to show the diversity of a board. A different way to express board diversity is by looking at the different nationalities represented on the board of directors. Kaczmarek (2009) performed a research about the effect of different nationalities and internationalization on organizational performance. In order to explain this relation, he uses the resource dependence theory. According to this study, foreign directors can provide important resources to the organization, by bringing different skills and experiences than their native counterparts. These different nationalities on the board also provide access to different networks and external resources. The above mentioned advantages of nationality diversity on the board, supports the board of directors in efficiently following the organizational strategy and eventually reaching their goals.

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Milliken and Martins (1996) investigated the effect of different kinds of diversity in organizational groups. They state that boards with low nationality diversity report significantly more effective processes than boards with many nationalities on it. Milliken and Martins (1996) argue that this is due to the fact that board members need time to get over their interpersonal differences, which are associated with initial professional attraction and social integration.

The above described thoughts resulted into the following hypotheses:

Hypothesis 2a: Gender diversity on the board is positively associated with organizational accounting performance.

Hypothesis 2b: Nationality diversity on the board is positively associated with organizational accounting performance.

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2.4.3 CEO tenure and organizational performance

CEO Tenure basically means the amount of time that a CEO holds his or her position. According to Hambrick (1991) the characteristics related to the CEO differs through the tenure period. These different temporal characteristics have different (both positive and negative) influences on organizational performance. During the initial tenure period CEOs are inquisitive and are not scared of taking risks. During their later tenure period CEOs become more short-sighted and risk-averse which can have negative consequences for the performance of the organization.

According to Shakir (2009) there is a positive relationship between CEO tenure and dominant and powerful behavior in decision making. This power may enable the CEO to pursue self-interest activities, which may not be consistent with that of the shareholders, thereby CEO tenure can increase agency costs. Often these CEOs are entrenched, which mean they dominate the rest of the board members and are not held accountable for self-serving activities (RW.ERROR - Unable to find reference:137). In contrast, CEOs with shorter tenures have relatively low power and therefore they are less likely to become entrenched CEOs. Miller (1991) examined the relation between CEO tenure and organizational performance. He found that CEO tenure was negatively associated with several performance measures. The negative relationship is most likely due to strategies and structures that are not consistent with the current environment in which they operate.

In summary, directors who are not acting in the interest of the shareholders but in their own, personal interest are an example of creators of agency costs. When directors have more power the likelihood and the ability of acting for own benefits rises (Shakir, 2009). CEO tenure is a moderator factor of power within an organization. Therefore, this research expects CEO tenure has a negative effect on the performance of an organization.

Hypothesis 3: CEO tenure is negatively associated with organizational accounting performance.

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2.4.4 Director independence and organizational performance

In the Dutch corporate governance code ‘code Tabaksblat’ is stated that all supervisory directors, with the exception of one, should be independent. Independence is defined by Larcker and Tayan (2011) as having “no material relationship with the listed company (either directly or as a partner, shareholder, or officer of an organization that has a relationship with the company)”. Many countries have proposed and set standards in the past decades to ensure that executives perform their duties with independent judgment.

In the United Kingdom (UK), the Cadbury Committee was created as a reaction to several corporate misconducts in the UK. The committee has two objectives: first, to improve the confidence in financial reporting in the UK and second, to find improvements on the area of corporate governance. Their thought was that these improvements in governance mechanisms would result in better organizational performance. In 1992 the committee published a report that sets out recommendations on the composition of organizational boards and accounting systems to decrease corporate risks and failures. Despite these recommendations are not mandatory for UK listed organizations, there is some pressure on organizations to follow the code because of the ‘comply or explain’ policy. Laing and Weir (1999) investigated the relation between these recommendations by the Cadbury Committee and organizational performance in the UK. The recommendations they focused on are non-executive director representation, board leadership separation and board committees. These three approaches are internal monitoring methods that according to the agency theory helps directors in making decisions that support the interest of the shareholders of the organization. The sample of this research consist of 115 randomly selected UK listed organizations on the London Stock Exchange. The researchers did not find evidence that the recommendations, which are adopted on a large skill (78 organizations) by the sample firms, have had a positive impact on organizational performance.

The parliament of India created in 2013 the ‘companies act’ which regulates incorporation, responsibilities, dissolution and the construction of the board of directors of an organization. The 2013 Act requires every listed public organization in India to have at least one-third of the total number of directors on the board as independent directors. Ajay Kumar Garg (2007) performed a research with the question if independent directors on the board have a positive impact on organizational performance as central. He found mixed evidence of the positive influence of independent directors on organizational performance. After analyzing the results he concluded that the new regulation concerning board independence have so far failed in reaching its goal, which is improving the monitoring role of the board and thereby reduce the inter-agency conflicts. Not finding a positive relation is according to the researcher due to the fact that ‘board independence’ is something new in India and the effects are not yet visible. A different reason could be the high frequency of multiple directors. These are directors that serve boards on multiple organizations. The

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multiple function of these directors raises the question about their ability to bring in independent judgments and their ability to perform their monitoring function.

In contrast to the above mentioned research areas, Colombia has no board structure regulation and the country is known for its voluntary adoption of corporate best practices. Pombo and Gutiérrez (2011) evaluated the impact of board structure on organizational performance by looking at the appointment of outside directors. These directors are originating from outside the organization and are therefore able to give independent judgment which is in line with the agency theory. The researchers found evidence that outside directors (busy ones in particular) have a positive effect on organizational performance.

In brief, according to these researchers’ predictions, outside directors increase the quality of monitoring. This is in line with the agency theory described by Jensen and Meckling (1976). The resource dependence theory is a theory which explains how resources of organizations impacts the behavior of the organization (Pfeffer and Salancik, 1978). One of the implications of this theory is that external resources are the basis of power. Having outside directors on the board increases the access to external resources and thus increases the power of the whole organization. Based on the agency theory and the resource dependence theory the following prediction is made:

Hypothesis 4: Board independence is positively associated with organizational accounting performance

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2.4.5 Ownership concentration and organizational performance

In line with the earlier described agency theory, the separation of ownership and control in publicly owned organizations induces the potential conflicts between the interests of the managers and the shareholders of the organization (Jensen and Meckling, 1976). This conflict of interest can have a possible negative effect on organizational performance (Berle and Means, 1991).

The separation of ownership and control means that the organization is owned by external shareholders which have no control over the day to day decision making (Kaczmarek, 2009). When the organizational shares are in the hands of a small amount of shareholders, the ownership concentration is high. These so-called ‘concentrated owners’ are able to threat the position of directors by the use of their voting rights. The large shareholders want to protect their assets, which they will do by attempting to influence the decisions of the directors of the organization. This type of power of the large shareholders can be considered as an internal governance instrument which helps preventing managers from showing opportunistic behavior. This internal governance instrument which relates to the agency theory could have positive impact on organizational performance.

On the other hand, the resources and incentives are missing to exert pressure on the directors when the organization is in the hands of small shareholders. This is what is called ‘low ownership concentration’. These small shareholders have less power and less incentives to be involved with the strategic decision making of the organization (Kaczmarek, 2009). In this case the shareholders cannot be considered as an internal governance instrument.

In a research of Nguyen et al. (2015b) about the relation between ownership concentration and corporate performance in Singapore and Vietnam, a positive relation was found. According to this research, ownership concentration can be seen as an effective corporate governance instrument. However, the relation is stronger in the less developed country (Vietnam) than in a well-organized governance system (Singapore). Ma et al. (2010) performed the same research but now in the Chinese context. In their research they made a distinction between large shareholders with complete rights (pure shareholders) and large shareholders with incomplete rights (impure shareholders). They found a positive relation between ownership concentration and organizational performance as well. The relation was stronger for organizations that were owned by purer shareholders than owned by impure shareholders.

Nevertheless, a disadvantage of having large shareholders is that they have the tendency against diversification and, therefore, bear a lot of risk (Gaur et al., 2015). According to Becht et al. (2005) well performing organizations dispose of an optimal trade-off between risk diversification and monitoring incentives. An optimal risk diversification can be achieved in a dispersed ownership environment and concentrated ownership is needed to let shareholders act as internal governance mechanisms. Chen et al. (2005) performed a research about the optimal trade-off. They found a significant negative relation between ownership concentration and organizational performance. They

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state that large shareholders cause damage to other stakeholders of the organization which eventually could lead to low performance of the concerning organization. Large shareholders will expropriate small shareholders, managers and employees in order to protect their own interest (Shleifer and Vishny, 1997).

Despite the above described contrary results, the major part of the research agree that high ownership concentration can be seen as an internal governance instrument and thereby has a positive influence on organizational performance. This thought is in line with the agency theory and resulted into the following prediction:

Hypothesis 5: Ownership concentration is positively associated with organizational accounting performance.

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3. Research Design and Methodology

3.1 Introduction

This thesis aims to study the relation between corporate governance and organizational performance of Dutch listed organizations after the financial crisis. More specific, some board characteristics and its relation with two accounting performance measures will be examined. This chapter will describe the research design and the methods used in this thesis. The next section will describe the sample selection procedure. Then a description of all the variables and the statistical procedure will be explained. The last sections include information about the actions taken concerning outliers of certain variables.

3.2 Sample

The sample consists of all Dutch listed organizations in 2013, which in the Dutch context was a year of economic prosperity where the economy started to recover from the financial crisis. Organizational performance is easier affected by noise (labor market instability, consumer purchasing power) in an unstable period (Cho and Keum, 2004; Eui-Gak Hwang, 1999). In order to leave as much noise as possible out of the research framework this year is chosen. Table 3.1 summarizes the sample selection process including the number of observations.

Table 3.1: Sample selection

# of organizations Initial sample from Orbis Database: NVs in the last four years 196

Less: Organizations with bankrupt status during 2013/2014 (12)

Less: Organizations with listed status after 2014 (35)

Less: Organizations where data was unavailable (31)

Less: Financial service sector (16)

Final sample 102

According to the Orbis database 196 organizations were registered as being listed (NV) in the last four years. The sample size is eventually decreases to 102 organizations. Twelve organizations had to be erased from the sample because of their bankruptcy status. From the sample three organizations became bankrupt during the sample period and are maintained in the sample because of their informative character. Next, 35 organizations are erased from the 196 organizations because these got their listed status after the sample period. While working with the sample, 31 organizations were found not useful, and therefore excluded, because of their data unavailability. The 16

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organizations that are operating in the financial service sector are excluded as well out of the sample. This sector differs from the non-financial sector in terms of their governance environment and the setup of their assets.

The data for this research originate from several sources. Table 3.2 summarizes the origin of all the observations. The main source is the database BoardEx. This database provided access to information about the board of directors of thousands of public listed organizations all over the world under which Dutch listed organizations. The data which could not be provided by this database was collected by hand out of the annual report of the concerning organization. The accounting performance figures in this research comes from the database Bureau van Dijk. This database contains financial information of approximately 200 million organizations. The database is particularly unique due to its large European data, which has been proven to be useful in conducting this research.

Table 3.2: Data origin

Variable Source # observations

Return on Assets Orbis database 188

Annual report 16

Return on Equity Orbis database 178

Annual report 26

Board size BoardEx database 77

# Woman on board Annual report 25

# Nationalities on board

CEO tenure BoardEx database 77

Annual report 16

# Outside directors BoardEx database 76

Annual report 15

Ownership concentration Orbis database 88

Control variable: Size (assets) Orbis database 188

Annual report 16

Control variable: Leverage Orbis database 180

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3.3 Dependent variables

Early research often uses Tobin’s Q ratio as a performance indicator (Grove et al., 2011; Rodriguez-Fernandez et al., 2014; Shakir, 2009; Vintila et al., 2015). However according to O’Connell and Cramer (2010) this measure is relatively noisy because of the strong impact of external factors on this ratio. A performance measure can be considered as a high quality measure when it is not influenced by noise (Sloof and van Praag, 2010). Therefore, the focus in this research will be on the accounting performance measure, Return on Assets (ROA) and Return on Equity (ROE).

ROA is calculated by looking at the net profit of an organization and divide it by its average total assets. ROE is a performance measure which shows how much return an organization generates out of the money their shareholders have invested in the organization. The measure is calculated by dividing the net profit of an organization by shareholders’ equity.

The ROA and ROE is collected for the whole sample (102 organizations) for the years 2013 and 2014 and eventually the average of these two years is used for the statistical analysis. Erkens et al. (2012) used this method of measuring for the performance measure (stock return) as well. They collected organizational performance data for multiple periods (Q1 2007 to Q3 2008) and used the average of these periods. The reason for this method is that the effects of corporate governance are not short term but long term. The effects of structural changes concerning corporate governance made in the beginning of 2013 might just be visible one year later. The ROA data is collected from the Orbis database for 94 organizations. The rest of the organizations ROA data is hand collected from annual reports. The ROE data is collected from the same sources. The data for 89 organizations could be found in the Orbis database and the data for 13 organizations are hand collected. After the collection of all the ROA and ROE figures winsorized which is a way of excluding the outliers by the transformation and limiting of extreme values in a dataset. For both the ROA and ROE the 3rd lower percentile is transformed to the value which is represented at the 4th percentile and the upper 97th percentile is transformed to the values which are represented at the 96th percentile.

3.4 Independent variables

To express corporate governance, the following independent variables are used: Size of the board, diversity of the board (both gender and nationality), CEO tenure, independence of the board and ownership concentration. Given that the effects of corporate governance are not short term but long term, the governance characteristics are collected from the organizations at the beginning of 2013. The rest of the sub-section will show how these variables are measured. No extreme outliers were detected in these variables.

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3.4.1 Board size

The Dutch listed organizations all have a two-tier board structure. This means their boards are divided into a board of directors and a supervisory board. The board of directors oversee the day-to-day activities of an organization and the supervisory board have as main activities to supervise and advice the board of directors. Because both boards are in the position to directly or indirectly influence the performance of an organization the board size is the sum of the amount of people who represent in these two boards (O’Connell and Cramer, 2010; Rodriguez-Fernandez et al., 2014). The board size for 77 organizations could be found in BoardEx and 25 board sizes could be found in the annual reports.

3.4.2 Diversity

Diversity of the board can be expressed in several ways (gender, nationality, age, educational level). In this research, diversity of the board is indicated by gender and nationality. Gender diversity is calculated by evaluating how many women are represented on both the board of directors and the supervisory board and then divide this number through the total board size of the concerning organization (Low et al., 2015; Nguyen et al., 2015a). Nationality diversity is calculated on the same way but now the total number of woman on the two boards is replaced by the number of different nationalities on the two boards (Ujunwa, 2012). The diversity data for 77 organizations could be found in BoardEx and the diversity data for the 25 remaining organizations are hand collected from the annual reports.

3.4.3 CEO tenure

According to Shakir (2009) directors who have more power often start acting in their own interest. In this research CEO tenure is seen as a proxy for power and thus a moderator of self-fulfilling behavior which can have negative effects on the performance of an organization. CEO tenure is the amount of time the chief executive officer is holding his position (Allgood and Farrell, 2000; Shakir, 2009). This number is expressed in number of years. The CEO tenure data for 77 organizations could be found in BoardEx and 16 tenures of the CEO could be found in the annual reports.

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3.4.4 Board independence

In this study, board independence is calculated by dividing the amount of outside directors by the total board size of the concerning organization (Erkens et al., 2012; Rodriguez-Fernandez et al., 2014). An outside director is originating from outside the organization and is therefore able to give independent judgment (Pombo and Gutiérrez, 2011). In the BoardEx database the amount of years a director is working in the organization is available and the amount of years the directors is on the board. When these numbers are equal the director is assigned as an outside director. These numbers were available on BoardEx for 76 organizations and the number of outside directors for 15 organizations is hand collected from the annual reports.

3.4.5 Ownership concentration

All the above independent variables are collected from the database BoardEx or hand collected. Ownership concentration is expressed by the independence indicator of Bureau van Dijk. This database has categorized 88 organizations from my sample based on their ownership structure. After evaluating this categorization, the 88 organizations are restructured into three categories from low ownership concentration to high ownership concentration.

1. Low ownership concentration (No shareholders with > 24,9% ownership)

2. Moderate ownership concentration (No shareholders with > 49,9% ownership, one or more shareholders with > 24,9% ownership.

3. High ownership concentration (One recorded shareholder with > 49,9% ownership)

Prior studies measured ownership concentration as the percentage of shares held by investors who own at least 5% of the total number of the shares of an organization (Nguyen et al., 2015b; Thomsen et al., 2006). Because of data unavailability this study was unable to use this method. The only available way to measure 'Ownership concentration' for Dutch listed organizations was by looking at the independence indicator of Bureau van Dijk.

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3.5 Control variables

In several accounting and performance studies, the relation between corporate governance and organizational performance is controlled for the size of the concerning organization and their leverage position (Erkens et al., 2012; Guest, 2009; Rodriguez-Fernandez et al., 2014). The size of the organization is measured by the natural logarithm of the average assets position of 2013 and 2014 (Erkens et al., 2012). The leverage position is measured by calculating the natural logarithm of the average debt ratio of 2013 and 2014 of the concerning organization (Erkens et al., 2012). Calculating the debt ratio is done by dividing the total liabilities by the total assets.

Table 3.3: Variable summary

Dependent Var. Operationalization of the variable

ROA Net profit / Average Total Assets

ROE Net profit / Shareholders Equity

Independent Var. Operationalization of the variable

Board size Sum of number of members of both the board of directors and supervisory board. Diversity (gender) Women on board / board size

Diversity (nat.) Number of different nationalities / board size CEO tenure Number of years the CEO is on his/her position Board Indep. Number of outside directors on board / board size Ownership conc. BvD independence indicator reclassified into three levels Independent Var. Operationalization of the variable

LnAssets Natural logarithm of total assets LnLeverage Natural logarithm of debt ratio

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3.6 Regression model

In this study the relation is tested between corporate governance and organizational performance with the use of simple linear regressions. Both the combined effect between the variables and the effect on individual level are tested. The summary of all the regressions can be observed in Table 3.4. These regressions are performed for both the ROA and ROE as dependent variable. All the variables are tested for multicollinearity before the OLS was performed according to the method described in the research of Hair et al. (2013). The VIF values were below the threshold value of 10.

The relation is examined with the following model (Erkens et al., 2012; Guest, 2009):

Performance = b0 + b1 * Board size + b2 * Gender Diversity + b3 * Nationality Diversity + b4 * CEO Tenure + b5 * Board Independence + b6 * Ownership Concentration + b7 * LnAssets + b8 * Ln Leverage + €

Where,

Performance = Return on Assets (ROA) / Return on Equity (ROE) B0 = Constant Variable

B1-B6 = Independent Variables B7-B8 = Control Variables

€ = Error Term

Table 3.4: Regression summary (ROA & ROE)

Model 1 2 3 4 5 6 7 Independent variables Board size X X Diversity (gender) X X Diversity (Nationality) X X CEO Tenure X X Board independency X X Ownership conc. X X Control variables LnAssets X X X X X X X LnLeverage X X X X X X X

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Results

4.1 Introduction

This chapter will show the results of this research which consists of two sections. In the next section a summary will be presented of all the statistics including a Pearson Correlation table and in the last section the results from the data analysis will be presented.

4.2 Summary statistics

The variables (dependent, independent and control variables) used in this research are statistically explained in Table 4.1. In the prior sample selection section is explained that the total sample size is 102 Dutch organizations. In the sample 62 organizations are classified as industrial organizations and 40 organizations as consumer business organizations. As mentioned earlier the financial industry is excluded from this research.

Table 4.1: Descriptive statistics

Dependent Var. N Mean Std. Dev. Min Max

ROA 102 2.31 8.573 -21.88 18.412

ROE 102 6.822 20.193 -46.405 55.451

Independent Var. N Mean Std. Dev. Min Max

Board size 102 8 2.975 2 18 Diversity (gender) 102 0.107 0.123 0 0.667 Diversity (nat.) 102 0.33 0.166 0.08 0.8 CEO tenure 93 4.903 4.93 0 21 Board Indep. 91 0.776 0.261 0 1 Ownership conc. 88 1.761 0.816 1 3

Independent Var. N Mean Std. Dev. Min Max

LnAssets 102 20.347 2.623 11.608 25.246

LnLeverage 102 0.227 1.236 -6.143 3.239

Looking at the size of these organizations much variety can be observed. The natural log of the total assets which is used as a control variable is ranging from 11.6 to 25.2 with a mean of 20.3 and a standard deviation of 2.6. Next to controlling for size of the organizations, this research also controls for the capital structure of the organizations. This is done by the natural log of leverage which ranges from -6.1 and 3.2 with a mean value of 0.227 and a standard deviation of 1.2.

The dependent variables used in this research are return on assets (ROA) and return on equity (ROE). For the performance measure ROA an average value of 2.31 was found. The average ROA for

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the Dutch organizations over 2013 and 2014 ranges from -21.88 and 18.41. For 32% of the organizations the ROA indicates a negative value. The smallest value of the other performance measure ROE is -46.4 and the largest ROE value of the total sample is 55.5. The average of the ROE shows a number of 6.8.

The independent variables relate to the board characteristics. The size of the board (sum of board of directors and supervisory board) ranges from 2 to 18 members. The average board size is eight members. These numbers are in line with the research of Rodriguez-Fernandez et al. (2014) which collected data of Spanish organizations in approximately the same timeframe. The percentage of women on the board has a minimum value of zero and a maximum value of 66.7%. Slightly under 50% of the organizations (46) have no women representing on their board. In the organizations who do have women on their boards, the number of seats taken by women is low. The average of gender diversity on the board is 10.7%. The diversity of nationalities on the board is larger. The Dutch organizations have on average 33% nationality diversity on their boards. The total sample counts 33 organizations which only have one nationality on their board. The organization with the highest nationality diversity have a diversity percentage of 80. The total size of the boards of this organization is five and it counts four different nationalities. The variable CEO Tenure shows an average of 4.9 years. The minimum amount of years the CEO is serving his position is zero. This is due to the fact the CEO started in this position at the start of 2013. This concerns six organizations. The maximum number of years the CEO is serving his position is 21 years. Board independence is indicated by the percentage of outside directors representing on the board. This percentage ranges from 0% to 100%. The average board independence is 77.6% for the 91 Dutch listed organizations. As mentioned in the research design and methodology section ownership concentration is classified in three levels. The levels are low (1), moderate (2) and high (3) ownership concentration. The mean of this variables indicates 1.76 which means the ownership concentration of the 88 Dutch organization from where the ownership data was available is between low and moderate.

Examining the correlations between the individual variables is important before running the regressions. Correlations are used to understand whether the relation between two variables is positive or negative and to understand the strength of the relationship. Table 4.2 is an overview of the Pearson Correlations of all the variables. The correlation matrix shows positive and significant correlations between the control variable Organization size (LnAssets) and ROE (r = 0.201, p < 0.05) indicating that when organizations become larger the return out of their received money from the shareholders become larger. Organization size is also positively and significant correlated with Board size (r = 0.697, p < 0.01), Gender Diversity (r = 0.231, p < 0.05) and Board Independency (r = 0.369, p < 0.01). The fact that larger organizations generally have to deal with more complex issues during their operation is a thinkable explanation of them having larger boards. This is in line with the statements of Larcker and Tayan (2011). The positive correlation between Organization size and Board Independency indicates that larger organizations have more intention to select outside directors for the

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board than select people from inside the organization. A possible reason could be the demand for external expertise and resources. Further a positive significant correlation is found between Nationality Diversity and Board Independency (r = 0.206, p < 0.05) which could mean that boards with a lot of different nationalities often have high degrees of outside directors. The possible explanation of this correlation is in line with the prior explanation. For instance, organizations which operate in different countries experience positive effects of external expertise and resources. Selecting foreign directors could provide access to these resources and expertise. Other positive and significant correlations are found between Board size and the two dependent variables ROA (r = 0.254, p < 0.01) and ROE (r = 0.269, p < 0.01). In the result and discussion section these correlations will be further evaluated. The only recorded negative and significant correlation is found between ROA and Nationality Diversity (r = -0.288, p < 0.01) indicating that positive changes in ROA lead to negative changes in the level of Nationality Diversity. In the next sections this correlation will be further explained.

Table 4.2: Pearson's Correlation Matrix

*,** indicate significance at 5%, and 1% levels (two-tailed).

Variable 1 2 3 4 5 6 7 8 9 10 1. ROA 1 2. ROE 0.818** 1 3. Board size 0.256** 0.269** 1 4. Diversity (Gen.) 0.17 0.123 0.159 1 5. Diversity (Nat.) -0.29** -0.039 -0.104 -0.062 1 6. CEO Tenure 0.037 -0.01 0.014 0.059 -0.011 1 7. Board indep. -0.06 -0.008 0.161 -0.08 0.206* 0.037 1 8. Ownership conc. -0.154 -0.19 -0.092 -0.058 -0.103 0.021 -0.045 1 9. LnAssets 0.131 0.201* 0.697** 0.231* 0.022 0.101 0.369** -0.007 1 10. LnLeverage -0.178 -0.047 0.174 -0.071 -0.135 -0.139 0.189 -0.043 0.128 1

The effect of corporate governance on accounting performance of Dutch listed organizations