Principles of good governance: one size fits all? Empirical
evidence from Asian emerging markets
Jildou Keizer S3148793
Master Thesis
MSc Business Administration - Strategic Innovation Management
Faculty of Economics and Business
Supervisor: J. Oehmichen
Abstract
The OECD principles for “good governance” are seen as a best practice for corporate governance mechanisms and universally applicable. However, results on the effectiveness are still mixed. This research aims to determine whether country-level characteristics: power distance and strength of minority shareholderprotection influenc the effectiveness of two firm-level corporate governance mechanisms: CEO duality and board independence in Asian emerging markets (AEMs). Since culture and other environmental variables strongly affect the effectiveness of corporate governance
mechanisms. Based on a sample of 382 firms from six emerging Asian markets, the results of the linear regressions show that not all of the OECD principles are effective in this context. CEO duality negatively influences firm performance and the relationship is negatively moderated by the degree of power distance in a country. Board independence negatively influences firm performance contrary to what was expected. Shareholder protection did not provide significant results. The main contribution of this study is that the Anglo-American corporate governance frameworks cannot be applied without considering the differences in ownership, culture and strength of institutions and their impact on the effectivness of the corporate governance mechanisms.
Introduction
Are the OECD principles of “good governance” for boards in Western countries applicable to Asian countries as well, or should country-level differences also be taken into account when implementing governance mechanisms? (OECD, 1999; Chen, Li, & Shapiro, 2011). Over the past two decades the research on corporate governance in Asia has grown exponentially (Claessens & Fan, 2002; Heugens et al., 2009; Young et al., 2008). In particular the role of boards in Asian publicly listed firms has received a lot of attention (Filatotchev, Lien, & Piesse, 2005; Peng, 2004; Tian & Lau, 2001). The interest in Asian countries has increased over the last two decades, mainly due to the financial crisis and other scandals which show the need for effective corporate governance practices. Even though the mechanisms of corporate governance on firm-level are the same across the world countries with different cultures face other problems when it comes to best practices of corporate governance (La Porta et al., 1997, 1998). According to Shleifer and Vishny (1997) governance consists of the mechanisms which insure that the shareholders of a firm receive a return on their investment.
The principles of the OECD are claimed to be universally applicable, implementation of these principles however is strongly affected by culture (Lu & Batten, 2001). Aggarwal, Erel, Stulz and Williamson (2009) state that governance depends on two types of
Next to that ownership in Asian countries is characterized by high levels of ownership concentration, where families, business groups or other firms own a large portion of the shares (Young, Peng, Ahlstrom, Bruton, & Jiang, 2008). Often used for research on corporate governance is the agency theory principal-agent (PA) conflicts between the owners
(principals) and managers (agents) (Jensen & Meckling, 1976). In the Anglo-American variety of agency theory these conflicts occur between dispersed shareholders and professional shareholders, there are several firm-level mechanisms such as the board of directors, concentrated ownership and CEO compensation to align the interests of the shareholders and the managers (Young et al., 2008). Since Asian firms are characterized by concentrated ownership this view of the agency theory is not fully applicable in this context. Therefore, this agency theory view has been receiving critique from a growing number of scholars (Van Essen, van Oosterhout & Carney, 2012).
The underdeveopment of country-level mechanisms compared to the West and the degree of differences in ownership structures and cultural differences in emerging Asian countries provide a very interesting context to explore some of the firm-level mechanisms. Those firm-level mechanisms being the board of directors and the CEO combined with an important country-level mechanism: shareholder protection. Due to the cultural differences the power distance in a country is also added in this research to see what the effect of these mechanisms and characteristics are on the performance of the firm. According to Aggarwal et al. (2009) the governance mechanisms are chosen by those who control the firm in order to maximize their welfare, in the AEMs context those often are the majority shareholders. That is why it is interesting to look at six Asian emerging markets (AEMs): China, India,
Indonesia, Malaysia, Philippines and Thailand.
The goal of this study is to provide insights in how the strength of shareholder protection and the degree of power distance influence the effectiveness of firm-level
have similar country-level characteristics and it has been a while since most of these OECD principles were adopted in AEMs.
That is where the contribution of this study becomes evident. Not only will I be looking at the main firm-level corporate governance mechanisms in a multi-country context. Also, country-level characteristics that can influence the effectiveness of the corporate governance mechanisms will be taken into account. In order to fill this gap in the existing research the following research question has been formulated:
“How do the level of power distance and the degree of shareholder protection
influence the effectiveness of firm-level governance mechanisms on firm performance in AEMs?”
The structure of this study is as follows. The next section provides some theoretical background and serves as a basis for the development of the hypotheses. After the
development of the hypotheses the methodology used to measure the variables and the way the hypotheses will be tested will be described. The results section shows the outcomes of the analysis. After discussing the outcomes some theoretical and managerial implications will be presented alongside with some of the limitations of this study and some directions for future research. Finally, the conclusion will be presented.
Theory & hypotheses Agency theory
are not up to the same standard as in Western countries (Young et al., 2008). High levels of concentrated ownership in Asian public firms are common, these firms are often controlled by families, state, business groups or other firms (Claessens & Fan, 2002). The combination of these differences causes a different type of agency problem than in the classical Anglo-American view. In countries where shareholders are poorly protected, and firms have high degrees of concentrated ownership the primary corporate governance problem is the conflict between the controlling shareholders and the minority shareholders (Porta et al., 1999). This type of conflict is called the principal-principal (PP) conflict. “PP-conflicts are characterized by concentrated ownership and control, poor institutional protection of minority
shareholders, and indicators of weak governance such as fewer publicly traded firms, lower firm valuations, lower levels of dividends payout, less information contained in stock prices, inefficient strategy, less investment in innovation and, in many cases, expropriation of minority shareholders” (Young et al., 2008, p197).
Peng, Wang & Jiang (2008) state that failing to understand the institutional nature of PP-conflicts has consequences for the corporate governance reform policies in emerging economies, which can make them irrelevant, counterproductive and possibly disastrous. Majority shareholders can act in two ways. On the one hand they can benefit minority
shareholders because they can prevent expropriation. On the other hand, they might harm the minority shareholders by engaging in expropriation themselves, either by taking private benefits and control, by appointing unqualified friend and family as senior-managers or expropriating the profits from firms in the lower tiers of the pyramid business groups (Mitton, 2002; Claessens, Djankov, & Lang, 2000). The pressure minority shareholders can impose on the controlling shareholders is weak. Even when they form a coalition, they often still have insignificant voting power and therefore are unable to prevent the self-beneficial behavior by the majority shareholders (Su et al., 2007; Young et al., 2008).
Board of Directors
Most researchers agree that the Board of Directors (BoD) is one of the most important internal governance mechanisms (Chen, Li & Shapiro, 2011; Fama & Jensen, 1983; Jensen & Meckling, 1976). The decision-making is delegated to the executives by the shareholders and agency costs can be reduced when the BoD exercises decision control that also involves the monitoring of the managerial decision-making (Roberts et al., 2005).
Firms listed on stock exchanges are required to have a BoD to deal with the
differences in interests between the managers and the shareholders. Boards have the task to control the management and to protect the interests of the shareholders. Boards consist of the directors and a chairman. Typically, there are two types of boards: dual boards and unitary boards. In a dual board structure there are two tiers, a supervisory board and a management board. The supervisory board often consists of independent board members/independent non-executive directors (INEDs) elected by the shareholders. The members of the management board / Executive directors (EDs) do not have to be independent. The unitary structure consists of one board with a combination of EDs and INEDs. The composition of the board and who leads the board are two important corporate governance mechanisms. Countries either require a minimum number or a minimum fraction of outside directors on their board, sometimes both (Abdullah, 2004; Dahya & McConnell, 2005; Lin, 2004; Peng, 2004).
It remains unclear whether the effect of the BoD on the firm performance is either positive, negative or not significant (Pearce & Zahra, 1992; Tian & Lau, 2001; Peng, 2004). According to Peng et al. (2008) the control function of the board in emerging economies is “window dressing” since the controlling shareholders do not want to share control. High levels of concentrated ownership also play an important role in the independence of the board members and whether the effect of this independence will be positive or negative. If the INEDs are appointed by the majority shareholders to act in their interest the presence of the INEDs can have negative or non-significant effect on the performance of the firm. When they are truly independent then the effect is expected to be positive.
CEO duality
When the CEO is also the Chairman of the board of a firm CEO duality occurs. It is seen as an important attribute that has been often linked to the performance of a firm (Dalton et al., 1998). Even though it is a widely researched topic there is no consensus on whether CEO duality positively or negatively influences the performance of a firm. The stewardship theory suggests that CEO duality promotes firm performance instead of hindering it (Boyd, 1995). The reasons for this positive impact are that the CEO is expected to have more knowledge about the firm than an outsider chairman of the board would have. Duality creates strong leadership and provides a clear sense of strategic decision (Tian & Lau, 2001; Hewa Wellalage & Locke, 2011). The stewardship theory highlights the positive effects of role duality and implies that the actions of the CEOs are driven by “a much larger range of human motives, including needs for achievement, responsibility, and recognition, as well as altruism, belief, respect for authority, and the intrinsic motivation of an inherently satisfying task” (Donaldson, 1990:372).
The agency theory suggests that duality has a negative effect on the performance of a firm due to the costs of PA-conflicts between the owners and managers (Jensen & Meckling, 1976; Donaldson & Davis, 1991; Finkelstine and D‟ Aveni, 1994; Cole et al., 2001). Especially in emerging economies, with a different institutional context than developed economies, the enforcement of agency contracts is more costly and problematic (Young et al., 2008). Duality causes a conflict of interest since it is the task of the board to monitor the CEO while the CEO is also the chairman of the board. This reduces the independence of the board as well as the effectiveness of the controlling, especially in unitary board systems this board is the highest internal control system (Nahar Abdullah, 2004). A person serving as CEO and chairman becomes very powerful and is able to manipulate the agenda for board meetings as well as controlling the information flow to the board. Research has shown that when a CEO is also the chairman of the board the chances of being replaced due to poor performance are lower than for other CEOs (Morck, 2007).
Therefore, I propose that CEO duality is negatively associated with the performance of the firm because the CEO might be influenced by the directors or majority shareholders and be loyal to them and when making decisions might not act in the interest of all the
shareholders and engage in self-serving behavior.
H1: CEO duality has a negative effect on firm performance. Independent non-executive directors
The composition of the board is another important internal corporate governance mechanism because the main tasks of the board are monitoring the CEO and the management, protecting the interest of the shareholders, provide advice and when necessary, fire the CEO. In
economies with PP-conflicts independent board members become even more important because they can protect the interests of the minority shareholders. Emerging economies often have weaker institutions and less powerful legal protection for minority owners. The board needs to control the management because, from an agency perspective, managers are self-interested, and the shareholders need to be safeguarded from managerial opportunism (Hillman & Dalziel, 2003). Fama (1980) states that INEDs on boards relate to better
monitoring of decisions and activities by the board. Since the board members are not related to the management or large shareholders and therefore independent they are thought the be stricter when it comes to their responsibilities (Nahar Abdullah, 2004).
Firms in Indonesia are required to separate management and control by using a dual board system. Most of the other countries have a unitary board structure, where in parts of China, Hong Kong and Taipei firms are moving from dual to unitary boards or firms are free to choose their board structure (OECD, 2017). It has been argued that a higher percentage of outsiders is better for monitoring and more independent from the management. Therefore, I propose that the presence of non-executive directors on the board has a positive effect on the performance of the firm.
Power distance
Looking at the country-level differences between Asian emerging markets and the established markets in the West one of the important differences is the distribution of power. “Power Distance is defined as the extent to which the less powerful members of institutions and organizations within a country expect and accept that power is distributed unequally” (Hofstede, 1984) To measure the difference to which degree society accepts and expects that power is distributed unequally the Power Distance Index (PDI), developed by Hofstede, is used. When a country scores high on the PDI it means that society accepts that there is a hierarchical order where everybody has its own place and does not need justification for this order. Asian countries score overall higher than the Western countries. Many Western countries have scores around 40, whereas the highest score in the world is 104. This score belongs to Malaysia (Hofstede, 2018). Therefore, it is an important measure to take into account when looking at the leadership in a firm and what the effects can be on the
performance of this firm. In regard to leadership this inequality means that challenges to the said leadership are not common nor well-received. Centralization is often the case and the person in charge is telling the people that are lower in the hierarchical order what to do and they are expected to do so (Hofstede, 2018).
These practices make the CEO even more powerful, especially when the CEO serves as chairman at the same time. A higher PDI score implies that board members could also be more powerful due to their positions at the top of the hierarchical ladder. Since challenges to the leadership are not well received I propose that a higher PDI-score negatively moderates the relationship between CEO duality and firm performance because the CEO becomes even more powerful. I propose that higher PDI-scores positively moderate the effect of the
presence of INEDs on firm performance. Board members then also become more poweful and therefore are still able to perform their monitoring tasks and protect the interests of the
shareholders since the CEO and the board members are both powerful the distance between them does not neccesarily increase when the degree of power distance increases.
Protection of shareholders
Asian firms are characterized by often having a few large shareholders owning the majority of the firm’s shares. Owning the majority of the shares provides the shareholders with large voting power, making them able to control the firm. Minority shareholders are therefore at risk of being exploited by the majority shareholders. They are not able to defend their own interests due to a lack of voting power and minimal amounts of pressure that they can impose on the controlling shareholders (Su et al., 2007; Young et al., 2008). According to Aggarwal, Erel, Stulz and Williamson (2009) investor protection also strongly determines the ability of the controlling shareholder to extract private benefits. The majority owners can steer the firm into the direction they want and, in that way, harm the interest of the minority shareholders. Protecting investors is critical for the firm’s ability to raise capital in order to grow, innovate, diversify and compete. Without the protection banks become the only source of finance because equity markets will fail to develop (World bank, 2018). All shareholders should receive trustworthy financial information and need be able to participate in major decisions concerning the firm. Shareholders should also have the option to hold directors accountable for the managerial decisions they make. When there are no laws in place that provide this kind of protection shareholders might not be willing to invest (World bank, 2018).
Therefore, I propose that better minority shareholder protection mechanisms will negatively influence the effects of CEO duality on firm performance. I also propose that better shareholder protections will have a complementary effect on the INEDs. When the protection is better the minority shareholders will be able to exercise more power and appoint truly independent non-executive directors that can then protect and act in their interest. Because better protected shareholders are able to obtain more relevant information and are able to hold directors and management accountable for their decisions.
H5: Minority shareholder protection negatively moderates the effect of CEO duality on firm performance.
Methodology
The methodology section will describe the justification for the chosen method in this study. The first part will describe how the data was collected, the second part presents the final sample, the third part explains the variables and their measurements and finally the analysis will be discussed.
Data collection and sample
The sample used in this study contains publicly listed companies from China, India,
Indonesia, Malaysia, the Philippines and Thailand and covers a period of eleven years, from 2005 ntil 2014. The data was collected from four different databases, DataStream, Orbis, Boardex and World bank. At the start of the research a panel with over 800 company names was provided. Taiwan and South-Korea were excluded from the sample. The reason being, Taiwan and South-Korea from the sample is their growth over the past years leading to a gross domestic product per capita more similar to developed economies in Europa than to other emerging economies like China1. However, Taiwan and South-Korea are still included in the MSCI index. After excluding Taiwan and South-Korea from the sample 751 companies remained.
Most of the companies in the panel had the identifiers for DataStream, after adding the las the financial data could be gathered, and the necessary calculations were performed in order to measure the firm performance through Tobin’s Q and also to create control variables. Since not all the companies in the panel had an identifier that was applicable for all the
databases the first step was to match the company names from the panel with the data from Orbis, after that the ownership data could be collected. These matched company names were then used to get board data from Boardex. The initial goal was to study data from the year 2004 until 2014, since there was no available board data for the year 2004 it was excluded from the analysis. Finally, the country data for shareholder protection and power distance was collected from World bank and added to the panel. The final sample used in this research contains 382 unique companies from ten different industries and a total of 1987 observations over a time period of ten years. More detailed information on the data and an overview of how many companies are included per country, industry and the total amount of listed companies per year per country can be found in appendix A.
Measurement of variables
This section will describe which dependent, independent, moderating and control variables were used and how they were calculated in order to analyze the data. Measurements were selected based on previous research.
Dependent variable
Firm performance is measured by calculating Tobin’s Q. Tobin’s Q is a financial
performance proxy often used in corporate governance studies when looking at the effect of corporate governance mechanisms on firm performance in developing and developed financial markets (Agrawal and Knoeber, 1996; Claessens et al, 1997). Tobin’s Q-ratio is calculated by market capitalization plus total assets, minus total shareholder’s equity divided by total assets. Higher Tobin’s Q-ratios are indicative of better performance (Copeland and Weston, 1988).
Independent variables
Duality is a binary variable and is defined as 1 when the positions of the CEO and the chairman are held by the same person and 0 if otherwise (Dharmadasa et al., 2014; Nahar Abdullah, 2004; Dalton et al., 1998). In this study firms in Indonesia are required to separate the role of the CEO and chair of the board due to the dual board system, all other countries in this study did not require separation of the roles (OECD, 2017).
Independence of the board is measured by dividing the number of independent non-executive directors by the total number of members on the board (Dalton et al., 1998; Tihany et al., 2003). Independence in this study means that the board members are not related to
management by birth or management, not related to major shareholders, are not employees of affiliated companies and are not representatives of companies having significant dealing with the subject company (OECD, 2017). All companies in this study are required to have
independent board members, a minimum number, a fraction or both. This are the
Moderating variables
Power distance is measured by using Hofstede’s power distance index. Scores in this study range from 64, belonging to Thailand up to 104 belonging to Malaysia (Hofstede, 2018). A higher score means that the power in a country is more unequally distributed and that society expects and accepts this unequal distribution of power.
Minority shareholder protection score is a score calculated by World bank based on different scores on several categories measured. The data on which the scores are based come from questionnaires administered to corporate and securities lawyers and are based on securities regulations, company laws, civil procedure codes and court rules of evidence (World bank, 2018).
Control variables
Several control variables were included in this study: firm size, board size, leverage, years dummies, country dummies and industry dummies. First of all, I control for differences in firm size, according to Jensen and Meckling (1976) firm size can lead to an increase in agency problems which can increase the agency costs as a result. According to Chrisman et al., (2007) it is acknowledged that firm size can covary with many board characteristics and firm performance. Firm size is measured as the natural logarithm of the total assets.
Leverage is calculated by total debt divided by total assets. Leverage is included because capital structure of a firm is expected to impact performance, rising debts will
increase the amount monitoring and therefore agency costs can increase. (Jensen, 1986; Hewa Wellalage & Locke, 2011).
Board size is added because Siciliano (1996) argues that larger boards are associated with better firm performance and that firms with larger boards are better able to access external resources. To control for these and other general board effects the natural logarithm of the total number of directors present on the board was calculated (Oehmichen, Braun, Wolff & Yoshikawa, 2017).
Industry dummies are included to correct industry specific effects (Hewa Wellalage & Locke, 2011; Ramdani & Witteloostuijn, 2010). The industries are classified according to the Global Industry Classification standard. Country dummies are added to correct for
Analysis
Before testing the hypotheses, the data has been checked for outliers, multicollinearity, skewness and kurtosis scores. The data has been checked for outliers because they can possibly interfere with the results of this analysis (Blatná, 2006; Osborne & Overbay, 2004). Outliers in this study are defined as data points that are three or more standard deviations from the mean (Osborne & Overbay, 2004). After removing the outliers and due to some missing values since financial data for some companies was missing the total of the observations is 1879. Judd, McClelland & Ryan (2011) state that the outcomes with and without the outliers should be compared, the outliers did not alter the outcomes of the
regression and were therefore left in because they can contain useful information making the total of observations 1906.
According to Alin (2010) multicollinearity can harm the reliability of the estimators of the model parameters and the Variance Inflation Factor (VIF) value should not exceed 10. Multicollinearity does not seem to be a problem in this study since the highest is 4.8 for the financial industry dummy (O’Brien, 2007; Robinson & Schumacker, 2009). I also looked at the skewness and kurtosis values to determine whether the variables used in this study are normally distributed. Data are normally distributed when the kurtosis value is lower than three and the skewness value is between minus two and plus two (Ramdani & Witteloostuijn, 2010; Mukherjee, White & Wuyts 1998; George, & Mallery, 2010). For all variables except firm performance, measured by Tobin’s Q, the values of the skewness were between -0.5 and 1.5. The Kurtosis values for all variables fell in the range between -1.9 and 2.9. The kurtosis value of Tobin’s Q fell outside of the range. The value of skewness of Tobin’s Q was 2.418 and the kurtosis value 6.718, due to these values the data cannot be considered normally distributed. Following the recommendation of Ramdani and Witteloostuijn (2010) and Mukherjee, White and Wuyts (1998) I calculated the natural logarithm of Tobin’s Q to reduce the skewness. The values after transforming the data are a skewness value of 1.003 and a kurtosis value of 0.494 and used to run the analysis.
moderating effect of PD on independent non-executive directors (INEDs) I created the term INEDs x PD. To test hypothesis 5 on the moderating effect of shareholder protection (SP) on duality I created the term Duality x SP. To test hypothesis 6 on the moderating effect of SP on INEDs I created the term INEDs x SP.
Results
This section will describe the outcomes of the analysis, to start with some descriptive statistics and correlations between the variables used in this study. After the descriptive statistics the outcomes of the regression analysis will be shown and discussed. Lastly the reliability of the outcomes will be tested with some robustness tests.
Descriptive statistics
To start with the descriptive statistics, Table 1 shows the correlations between the variables, their mean and standard deviation. The sample consists of 1906 observations and no high values of correlations (r <0.7) are present. This means that there is no reason to suspect the existence of multicollinearity between the variables. This is in line with the analysis of the data in the methodoloy section where the highest VIF value was shown to be 4.8. Table 1 shows several significant correlations among the main variables. Duality and INEDs negatively correlate with Tobin’s Q at a significance level of p <0.01. Power distance
Table 1. Correlation matrix, mean, standard deviation 1. 2. 3. 4. 5. 6. 7. 8. 1.Tobin's Q 1.00 2. Duality -0.105** 1.00 3. INEDs -0.067** 0.14 1.00 4. Power Distance -0.027 -0.078** 0.049* 1.00 5. Shareholder Protection 0.244* -0.359** -0.188** -0.030 1.00 6. Firm Size -0.479** 0.106** 0.061** -0.074** -0.239** 1.00 7. Leverage -0.315** -0.070** 0.012 -0.015 0.042 0.112** 1.00 8. Board Size -0.037 0.014 0.084** -0.242** 0.008 0.318** -0.022 1.00 Mean 0.467 0.58 0.421 80.709 6.258 15.423 0.263 2.352 Standard deviation 0.600 0.494 0.130 8.382 1.581 1.516 0.191 0.279 Regression results
To test the hypotheses a multiple linear regression was performed, Table 2 shows the complete overview of the outcomes. In total seven different models were made, in the first model duality and INEDs were regressed with all the control variables. In the second to seventh model the other variables were added one by one to be regressed with the control variables. For the country, year and industry dummies all dummies minus one were added to the regression. All control variables were added in model two to seven except for the country dummies because that would cause collinearity issues due to the fact that power distance and shareholder protection are both country-level measures. All the information of the dummy variables is not displayed in order to save space, although they were included in the regression analysis.
The interaction term to test H3 is added in model 4. With a B = -0,012 at a significance level of p <.01 the outcomes support this hypothesis and show that power distance negatively moderates the effect of duality on firm performance as can be seen in the graph below. Higher levels of power distance negatively moderate the effect of duality.
Graph 1 Interaction effect Duality x power distance
In model 5 the interaction term to test H4 was added and no significant effect was found. I cannot state that power distance positively moderates the effect of the presence of INEDs on firm performance. The interaction term to test H5 was added in model 6, no significant effect was found. Therefore, I cannot state that shareholder protection moderates the effect of duality on firm performance. In model 7 the interaction term to test H6 was added, no significant effect was found. Therefore, I cannot state that shareholder protection moderates the effect of INEDs on firm performance.
Non Duality CEO Duality
Table 2. Regression results
Tobin's Q Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7
Duality -0,034 -0,112*** -0,069*** -0,075*** -0,075*** -0,075*** -0,075*** (0,024) (0,022) (0,023) (0,023) (0,023) (0,023) (0,023) INEDs -0,161** -0,235*** -0,150* -0,160* -0,157* -0,157* -0,162* (0,082) (0,082) (0,083) (0,082) (0,082) (0,082) (0,077) PD -0,002* -0,002 0,001 0,001 0,001 0,001 (0,001) (0,001) (0,001) (0,001) (0,001) (0,001) SP 0,042*** 0,039*** 0,038*** 0,037*** 0,037*** (0,008) (0,008) (0,008) (0,012) (0,012) Duality x PD -0,012*** -0,012*** -0,012*** -0,011*** (0,003) (0,003) (0,003) (0,003) INEDs x PD 0,012 0,012 0,012 (0,009) (0,009) (0,010) Duality x SP 0,002 0,002 (0,015) (0,015) INEDs x SP 0,008 (0,065) Firm Size -0,108*** -0,129*** -0,119*** -0,118*** -0,118*** -0,118*** -0,118*** (0,009) (0,009) (0,009) (0,009) (0,009) (0,009) (0,009) Leverage -0,690*** -0,645*** -0,672*** -0,655*** -0,656*** -0,656*** -0,656*** (0,058) (0,059) (0,058) (0,058) (0,058) (0,059) (0,059) Board Size 0,080* 0,130*** 0,112*** 0,109*** 0,110*** 0,110*** 0,110*** (0,042) (0,042) (0,042) (0,041) (0,041) (0,042) (0,042) Country dummies Yes No No No No No No Year
dummies Yes Yes Yes Yes Yes Yes Yes
Industry
dummies Yes Yes Yes Yes Yes Yes Yes
Robustness check
To test the robustness of the regression analysis above I also used return on assets (ROA) as the dependent variable. Tobin’s Q is according to Morck et al. (1988) a noisy measurement for management or board performance. Therefore, I checked the outcomes of the regression analyses by also using ROA as the dependent variable, calculated as net income divided by total assets. ROA is an accounting-based performance measure and more seen as backwards looking and therefore less likely to be influenced by shareholder expectations and fluctuations of the equity market. While Tobin’s Q is more forward looking taking into account market effects and is more able to capture the expectations and movements of the market.
The results came out similar, supporting the same hypotheses that running the
regression with Tobin’s Q as a dependent variable does. The results of the regression analyses with ROA as the dependent variable can be found in appendix B Table 2. To control for firms’ corporate governance structure beyond their board composition I also looked at whether institutional ownership influences the results of the analysis (Oehmichen, Mariano, Heyden, Dimitrios Georgakakis & Volberda 2017). According to Shleifer and Vishny (1986) institutional investors have a positive effect on firm performance because they help reducing information asymmetry and can get access to information that can help in the decision-making process and have more incentives to monitor the board (Shleifer & Vishny, 1986; Hoskisson, Hitt, Johnson & Grossman, 2002).
Discussion
As the results show one person serving as the CEO and chair of the board has a negative impact on firm performance. This is in line with most of the research using the agency perspective. Contrary to what would be expected based on previous literature on independent board members, the presence of independent non-executive directors (INEDs) does not positively affect firm performance. The results show that the presence of INEDs negatively influences firm performance (Fama, 1980; Peng et al., 2008). Even though the OECD
encourages firms to have independent board members and all of the countries in this study are obliged by law to have INEDs on the board it does not positively contribute to the
performance of a firm.
To answer the research-question the country-level characteristics should also be taken into account. These results only support the hypothesis that power distance negatively
moderates the effect of duality on firm performance. No significant effects were found for the moderating role of power distance on the presence of INEDs. Also, no significant results were found for the moderating effect of shareholder protection on the effect of duality nor the effect of the presence INEDs on the board on firm performance. These results provide important implications for theory and practice and both will be discussed below. Additionally, the main limitations of this study will be discussed and possible directions for future research will be presented.
Theoretical implications
challenged. This strong position is creating opportunities to act in their own self-interest, or the interest of the majority shareholders, possibly harming the rest of the firm and the minority shareholders. Often in the Anglo-American system when the management has too many control rights it is said that increasing the shareholding of block holders, since ownership is assumed to be dispersed, would help solve these issues. However, AEMs are characterized by concentrated ownership this would have serious negative effects since most of the governance issues arise from this concentrated ownership (Young et al., 2008).
The second main finding is the negative effect of INEDs on firm performance, many researchers have stated the importance of having INEDs present on the board (Fama, 1980; Hillman & Dalziel, 2003; Nahar Abdullah, 2004). INEDs are associated with better
monitoring of decisions and activities by the board and are thought to be stricter when it comes to their responsibilities than non-independent board members. They are able to safeguard the shareholders from the self-interested managers and managerial opportunism. Having independent members present on the board is still seen as a principle of “good governance” and the OECD encourages firms to have INEDs present on the board. All countries in this study have to follow rules and regulations stating that firms need to have independent board members. Eventhough, as the results of the analysis show, their presence negatively impact the financial performance of the firm.
There are several explanations possible for this outcome. Firstly, duality could constrain the independence of the board and reduce its effectiveness when it comes to monitoring (Finkelstine and D’ Aveni, 1994). Dominant CEOs that also serve as the chair of the board are less likely to appoint strong INEDs. This can hamper the effectiveness of INEDs (Gul & Leung, 2004). According to Zhang (2012) and van Essen et al. (2012) having a CEO that is also a chairman reduces the boards’ allocation of attention to monitor the management due to the fact that the CEO can control the agenda of board meetings. Next to that it becomes more difficult for a board to remove the CEO due to poor performance when the CEO is also the chairman, both reduce the effectiveness of the board.
Finally, emerging economies try to adopt legal frameworks of developed economies, the Anglo-American system in particular. Due to the weaker institutions in emerging
economies these frameworks are not that effective (Peng et al., 2008). According to Filatotchev et al. (2005) the emphasis in Anglo-American firms is on the control and monitoring role of the board while the control function of boards in emerging economies is typically window-dressing (Peng et al., 2008). The institutions are not able to enforce the laws and regulations and therefore provide little support for the corporate governance mechanisms (Peng, 2004). Concentrated ownership enables the majority shareholders to elect the board members of their choice and therefore independence cannot be guaranteed. Combined with weaker institutions and weak minority shareholder protection the majority shareholders can still expropriate the minority shareholders by choosing board members that will act in their interests.
The third important finding of this study is that, even though the protection of minority shareholders is positively correlated with firm performance, the moderating effects are not significant for duality nor INEDs. Shareholder protection was expected to positively moderate the effect of the presence of INEDs on the board since they can complement each other. Meaning better shareholder protection could lead to more INEDs on the board. These INEDs could then effectively monitor the management and protect the interests of all the
American system. These mechanisms and legal frameworks cannot be that easily copied and applied since several differences on country-level, such as power distance and legal
protection, influence the effectiveness of these mechanisms. Secondly, in line with the first contribution, it is necessary to acknowledge the PP-conflicts that are evident in AEMs. Therefore, common solutions for governance and agency conflicts can do more damage than good when not taking into account the PP-conflicts. Thirdly, shareholder protection is seen as an important aspect in preventing minority shareholder expropriation. The results show that the protection itself is not enough to prevent expropriation. The institutions are not able to enforce the legal frameworks and therefore provide little support for the governance
mechanisms. Governance reforms are needed to reduce concentrated ownership and make the internal governance mechanisms more effective (Young et al., 2008).
Managerial implications
The results of this study also have implications for practitioners. Adopting the legal
frameworks and governance mechanisms from developed economies and applying them in AEMs is not effective without taking into account the institutional and environmental variables. “Good governance” practices encouraged by the OECD do not have the same outcomes in AEMs as they do in developed economies. Therefore, it is important to also look at country-level characteristics when choosing which practices to adopt. The fact that the institutions in emerging economies overall are weaker making them less able to enforce the legal frameworks that are also applied in developed economies needs to be taken into account. In weaker institutions it is more important to adopt firm-level governance mechanisms.
Economies that score high when it comes to power distance should be cautious when it comes to duality and should try to avoid it when possible since the effects are shown to negatively impact the performance of the firm. The second internal mechanism, having truly independent directors present on the board, can steer the firms towards growth and support decisions that are beneficial for all shareholders. In order for firms to raise capital to grow, innovate, diversify and compete investors are needed. When not being able to attract investors, banks become the only source of finance because equity markets will fail to develop, which
underlines the need for more dispersed ownership (World bank, 2018). Shareholders need to receive trustworthy information and need to be able to participate in major decisions
shareholders. While institutions are still developing and becoming stronger the firm has to make sure that the internal governance mechanisms are working properly.
Limitations and future research
I acknowledge that this study has some limitations, these limitations can provide scholars with directions for future research. The first limitation of this study is the use of cross-sectional analysis. This type of method can limit the ability to discern causality (Hillman, 2005). Although established measures for corporate governance were also used in this study and the study covers multiple years the firms in the sample did change over time due to availability of data. Future research may study the same group of firms over an extended period of time and possibly lag the data of the dependent variable. Second, this study analyzes the effects of corporate governance mechanisms in Asian emerging markets limiting the generalizability of the results due to country-level differences. Third, this study is a multi-country study, with big differences between the countries itself. More than half of the companies in the sample were Chinese which could also have influenced the results of the regression. When the sample was created the decision was made to include companies of similar size instead of the largest companies per country due to the fact that this would create large differences between countries and therefore the outcomes could not be properly compared.
For future research it might be interesting to compare data of firms before and after the rules and regulations were implemented to see if these rules and regulations have been
effective. Some of the rules and regulations were implemented during the timeframe which is included in this study, therefore the direct effects of the implementation are not clearly visible.
Ownership also plays a big role when it comes to corporate governance mechanisms and their effectiveness, therefore it could also be interesting to look at that in more detail since it is often believed that institutional owners have a positive effect on firm performance
Conclusion
The aim of this research was to determine whether country-level characteristics like power distance and the strength of minority shareholderprotection influenced the effectiveness of two firm-level corporate governance mechanisms: CEO duality and independent board members. As mentioned by Peng (2004) in emerging economies legal frameworks that resemble those from developed economies are often adopted however they are not nearly as effective as in developed economies, so they resemble in form but not in substance. From an agency perspective duality negatively influences firm performance only when power distance is also taken into consideration as shown by the results of this research. Independent non-executive directors are often linked to better firm performance due to their ability to better monitor the management since they are not affiliated with the management or shareholders.
Contradicting most findings in Western contexts independent non-executive directors negatively impact firm performance, several explanations are possible for this outcome like independent directors lacking sufficient knowledge, independence as
window-dressing and independent directors not being independent due to lack of control. Power distance did not moderate the relationship between independence and firm
performance. Strength of minority shareholder protection did not provide any significant results for moderating relationships between duality and independence on firm performance.
The main contributions of this study are the increased understanding of the effect of country-level differences on the effectiveness of Anglo-American corporate governance mechanisms in Asian emerging markets and underlines the need to not look at the governance issues solely from an agency perspective but also acknowledgde the effects of the principal-principal conflicts present in economies characterized by concentrated ownership. Finally, this study presented some interesting opportunities for future research on corporate
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Appendix A
Table A2. Overview of observations and companies per countryCountry Observations Companies
China 924 176 India 656 89 Malaysia 163 45 Philippines 81 19 Thailand 96 27 Indonesia 67 26 Total 1987 382
Table A2. Overview of observations per industry
Industries Observations Consumer Discretionary 268 Utilities 131 Consumer Staples 190 Materials 269 Energy 91 Industrials 306 Financials 425 Health Care 120 Information Technology 102 Telecommunication Services 85 Total 1987
Table A3. Overview of listed companies per country per year
World
bank listed companies
Appendix B
Table B1. Correlation matrix ROA
Table B2. Regression results ROA
ROA Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7
Duality -0,005 -0,012*** -0,013*** -0,013*** -0,013*** -0,013*** -0,013*** (0,005) (0,004) (0,004) (0,004) (0,004) (0,004) (0,004) INEDs -0,023 -0,033** -0,021 -0,023 -0,023 -0,023 -0,022 (0,016) (0,015) (0,007) (0,016) (0,016) (0,016) (0,017) PD 0,000 -0,000 0,000 0,000 0,000 0,000 (0,000) (0,000) (0,000) (0,000) (0,000) (0,000) SP 0,005*** 0,005*** 0,005*** 0,005*** 0,005*** (0,001) (0,001) (0,001) (0,001) (0,002) Duality x PD -0,002*** -0,002*** -0,002*** -0,002*** (0,001) (0,001) (0,001) (0,001) INEDs x PD 0,002 0,002 0,001 (0,002) (0,002) (0,002) Duality x SP 0,000 0,000 (0,003) (0,003) INEDs x SP -0,002 (0,012) Firm Size -0,013*** -0,016** -0,014*** -0,014*** -0,014*** -0,014*** -0,014*** (0,002) (0,002) (0,002) (0,002) (0,002) (0,002) (0,002) Leverage -0,079*** -0,073*** -0,077*** -0,074*** -0,074*** -0,074*** -0,074*** (0,011) (0,011) (0,011) (0,011) (0,011) (0,011) (0,011) Board Size 0,008 0,017** 0,15* 0,015* 0,015* 0,015* 0,015* (0,008) (0,008) (0,008) (0,008) (0,008) (0,008) (0,008) Country dummies Yes No No No No No No Year
dummies Yes Yes Yes Yes Yes Yes Yes
Industry
dummies Yes Yes Yes Yes Yes Yes Yes
Table B3. Regression results Tobin’s Q institutional ownership
Tobin's Q Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8
Duality -0,034 -0,112*** -0,069*** -0,075*** -0,075*** -0,075*** -0,075*** -0,054** (0,024) (0,022) (0,023) (0,023) (0,023) (0,023) (0,023) (0,026) INEDs -0,161** -0,235*** -0,150* -0,160* -0,157* -0,157* -0,162* -0,133 (0,082) (0,082) (0,083) (0,082) (0,082) (0,082) (0,077) (0,107) PD -0,002* -0,002 0,001 0,001 0,001 0,001 0,001 (0,001) (0,001) (0,001) (0,001) (0,001) (0,001) (0,002) SP 0,042*** 0,039*** 0,038*** 0,037*** 0,037*** 0,040*** (0,008) (0,008) (0,008) (0,012) (0,012) (0,013) Duality x PD -0,012*** -0,012*** -0,012*** -0,011*** -0,011*** (0,003) (0,003) (0,003) (0,003) (0,003) INEDs x PD 0,012 0,012 0,012 0,014 (0,009) (0,009) (0,010) (0,011) Duality x SP 0,002 0,002 0,007 (0,015) (0,015) (0,017) INEDs x SP 0,008 0,008 (0,065) (0,077) Firm Size -0,108*** -0,129*** -0,119*** -0,118*** -0,118*** -0,118*** -0,118*** -0,108*** (0,009) (0,009) (0,009) (0,009) (0,009) (0,009) (0,009) (0,011) Leverage -0,690*** -0,645*** -0,672*** -0,655*** -0,656*** -0,656*** -0,656*** -0,655*** (0,058) (0,059) (0,058) (0,058) (0,058) (0,059) (0,059) (0,067) Board Size 0,080* 0,130*** 0,112*** 0,109*** 0,110*** 0,110*** 0,110*** 0,089* (0,042) (0,042) (0,042) (0,041) (0,041) (0,042) (0,042) (0,048) Institutional owned X X X X X X X 0,020 (0,024)
Country dummies Yes No No No No No No No
Year dummies Yes Yes Yes Yes Yes Yes Yes Yes
