IMPACT OF CORPORATE BOARD SIZE ON CORPORATE PERFORMANCE: EVIDENCE FROM SRI LANKA

Transcription

1 IMPACT OF CORPORATE BOARD SIZE ON CORPORATE PERFORMANCE: EVIDENCE FROM SRI LANKA 1 M.C.A.NAZAR, 2 RUZITA ABDUL RAHIM 1 Ph.D Candidate,GSB,Universiti Kebangsaan Malaysia,Malaysia 2 Faculty of Economics and Management, Universiti Kebangsaan Malaysia, Malaysia, 1 mcanazar@seu.ac.lk, 2 ruzitaar@ukm.edu.my Abstract- The purpose of this is to examine the relationship between corporate board size and corporate performances of Sri Lankan listed companies. This study employs a cross sectional analysis of 109 firms listed in Colombo Stock Exchange (CSE) for the financial year ending 2013 and multivariate analyses are used to test the hypotheses. The results show that board size is significantly negatively associated with ROA and insignificantly negatively linked with ROE. Control variables of board independent, CEO duality and leverage are negatively related with ROA and ROE. Meanwhile, other variables of firm size and dividend yield are significantly positively linked with ROA and ROE. Keywords- corporate governance, board size, corporate performance, ROA, ROE I. INTRODUCTION Corporate failures and huge corporate scandals in recent years have led to substantial interests in literature and research into corporate governance principles and codes of best practices with a view to improving corporate governance and enhancing corporate performance. A key component in corporate governance implementation is the role of the board of directors. The board monitors the management and set the strategic direction for the organization. The board reviews and ratifies management proposals, and it is the primary and dominant internal corporate governance mechanism in the organization (Brennan, 2006). The failures of Enron, WorldCom, Global Crossing and HIH, amongst others, have raised the question as to the ability of the board to effectively monitor management (Rashid, 2010 and Mizruchi, 2004). This question is mostly relevant given that the boards were apparently not effective enough to have been able to present a check on some of the corporate governance failures, as they later came to be identified. This then calls to question the structure and composition of such boards. Board size is one of main determinant factors to decide the efficiency and decision making process of a firm. It refers to the number of directors on the board. Cheng (2008) in his article suggested that larger boards are less efficient and slower in decision-making, because it is more difficult for the firm to arrange board meetings and for the board to reach a consensus. He also argued that when the board size is bigger, it will be easier for CEO to have a dominant on the board and increase the CEO power in decision-making (Jensen, 1993). In addition, some studies document a negative association between board size and firm performance (Yermack, 1996; Eisenberg, Sundgren, & Wells, 1998). Although there exist several studies on corporate governance in less developed and emerging economies (Shleifer and Vishny, 1997; Sarkar et al. 1998; Asian Development Bank 2000; Rwegasira 2000; Gibson, 2003; Denis and McConnell, 2003; Machold and Vasudevan, 2004; Yammeeri et al. 2006), in the context of Sri Lanka there are very few studies on corporate board practices and governance (Fernando, 2007; Velnampy, 2013; Senarathne and Gunaratne, 2007; Kajananthan, 2012). This study extends the literature on corporate board size and firm performance by providing evidence from this emerging economy. In particular, this study attempts to investigate whether board size in the form of number of directors as considered in advanced systems, can influence firm economic performance in Sri Lanka. This is to determine if the Sri Lankan situation is in line with global trend or if we can find a definite pattern of relationship between board size and corporate performance for the Sri Lanka corporate world. To achieve this purpose, the remaind er of this paper is organized as follows: Section 2 discusses background and hypothesis development. Section 3 presents the methodology and the sample data of the study. Section 4 presents the findings of the study while Section 5 concludes this paper. II. THEORETICAL BACKGROUND AND HYPOTHESIS DEVELOPMENT The size of the board of directors is one of the most studied variables in the corporate governance literature. The impact of board size on corporate performance is not clear at least in the existing literature. Based on the resource dependency theory, it is anticipated that a board of directors with many networks to external environment is likely to improve a firm s access to various resources resulting in improved corporate governance and firm performance (Mizruchi and Stearns, 1988; Zahra and Pearce, 1989; Hillman et al., 2000). Given the 73

2 importance of external networks to a firm s competitiveness, size of the board of directors seems to play an important role as more directors on the board is likely to lead to more external networks and resources a firm can establish and tap into. Larger boards provide an increased pool of expertise with diverse knowledge and skills at their disposal (Van den Berghe and Levrau, 2004) and help reduce the domination of the CEO on the decision-making process (Forbes and Milliken, 1999; Goodstein et al. 1994). However, the evidence from the agency perspective indicates consistent because larger leads to lower performance. For instance, Yermack (1996) finds a negative relationship between board size and firm market value, suggesting that costs of larger board outweigh its benefits due to poorer communication and decision-making associated with larger groups. This finding supports the view put forth by Jensen (1993) who argues that as boards become larger, they become less effective and are easier for the CEO to exert his or her control. Similar results are also reported using European data. Eisenberg et al. (1998) show a negative correlation between firm s profitability and the size of the board for small non-listed Finish firms while Conyon and Peck (1998) document an inverse relationship between ROE and board size for five European countries. Using Singapore and Malaysian firms, the finding by Mak and Kusnadi (2005) is consistent with the negative relationship between board size and firm value. De Andres et al. (2005) also report a negative association between firm value and board size in OECD countries, suggesting larger board size can make coordination and communication more difficult. More recently, Guest (2009) finds board size has a strong negative impact on profitability, Tobin s Q and share returns in the UK, supporting the argument that problems of poor communication and decision-making undermine the effectiveness of large boards. In sum, it appears that the evidence supporting the agency perspective outweighs that of resource dependency theory and consistent with Jensen s (1993) argument that larger boards potentially result in poor communication and decision-making process associated with larger groups. This is notwithstanding the fact that few US studies (Adams and Mehran, 2005; Dalton et al.1999) find a positive effect of board size on performance. A study by Zubaidah et al. (2009) finds that the board size has a positive impact on corporate performance with a sample of 75 listed companies in Bursa Malaysia. As the majority of prior studies emerge to suggest a negative association between board size and corporate performance, this study hypothesizes that companies with small board size attain better performance than others. H1: There is a negative relationship between board size and corporate performance. III. DATA AND RESERACH METHOD 3.1. Data and Sample The sample comprises the Colombo Stock Exchange (CSE) non financial listed companies whose annual reports are available in The total number of listed firms for year ending 2013 is 293 firms and final sample size is 109 firms. The data for this study are collected from the Colombo Stock Exchange (CSE) websites and annual reports Research Methods A cross - sectional ordinary least square regression model is used to test the developed hypothesis for this study. The regression model utilized to test the relationship between the board size and firm performance are as follows: Corporate Performance = α + β 1 Board Size+ β 2 Board Independence + β 3 CEO Duality + β 4 Leverage + β 5 Firm Size + β 6 Dividend Yield + ei 3.3. Variables and Descriptions The variables for the study were chosen based on data availability and computational purposes. Dependent variables Return on Asset = Net Income / Total Assets Return on Equity = Net Income / Shareholders Fund Independent variables Board Size = Number of directors on the board Control variables Board Independence = No. of outside directors / Total Number of directors CEO Duality = 1= Yes, 0= No Leverage = Total debt / total equity Firm size = Natural log of total assets Dividend Yield = cash dividend paid / Shareholders equity. IV. DATA ANALYSIS AND DISCUSSION 4.1 Descriptive statistics Descriptive statistics were carried out to obtain sample characteristics. Table 1 provides descriptive statistics of dependent and independent variables. With regard to corporate governance characteristics, the number of directors on Sri Lankan board are between 3 and 12 with an average board size in the selected firms is approximately 8 persons. This result is reliable with the study by Fooladi (2012), Zubaidah et al. (2009), Lipton and Lorsch(1992) and Brown and Caylor (2004). The mean percentage of non executive directors on the board is approximately 71 percent, suggesting that Sri Lankan firms appear to follow the Anglo - Saxon's model of corporate governance best practices. In terms of CEO duality, about 14 percent of the firms have duality leadership while 86 percent of the firms have two individual hold the positions of CEO and 74

3 Chairman, suggesting that way for agency problems originating from conflict of interest are minimized. This implies that majority of the sample firms comply with the best practices as advocated by various international corporate governance bodies. 4.2 Correlation results Table 2 shows the correlation results between board size and corporate performance variables (ROA and ROE). Board size and board independence are negatively correlated with ROA and ROE though not significant. In addition, CEO duality is significantly negatively correlated with ROA. Furthermore, firm size and dividend yield are significantly positively correlated with ROA and ROE. On the other hand, leverage is negatively correlated with ROA and ROE. 4.3 Regression results Tables 3 and 4 present the regression results when ROA and ROE are used as the performance variables respectively. Recall that the Hypothesis predicts that board size is significantly negatively associated with corporate performance. Focusing on the association between board size and corporate performance, the results reported in Table 3 show that ROA is significantly negatively related with board size; at the same time Table 4 shows that ROE is also negatively associated with board size though not significant. Therefore, the Hypothesis is supported. Hence, in line with international research in the field (e.g.,yermack, 1996; Eisenberg et al. 1998) the current study offers some support for the view that a negative relation between board size and corporate performance is also obvious in the Sri Lanka setting. In keeping with the literature, the study includes control variables in the regression analysis. Tables 3 and 4 indicate that board independence and CEO duality are negatively related with ROA and ROE. This result is consistent with the results of Agrawal and Knoeber (1996) and Bhagat and Black (1999). Leverage has a negative impact on firm performance. In contrast, both firm size and dividend yield are significantly positively linked with firm performance. CONCLUSIONS The importance of corporate governance cannot be over looked since it enhances the organizational climate for the internal structure and performance of a company. Indeed, corporate governance brings through external independent directors' new dimension for effective running of a corporate entity, thereby enhancing a firm's corporate entrepreneurship and competitiveness. This study examines the relationship between some measures of corporate governance such as board size, board independence, CEO duality and firm performance of 109 listed non financial companies in Sri Lanka. Banks and other financial institutions sector were excluded in tandem with other studies due to their huge debt structure. The mean board size for the sample was found to be eight and the maximum twelve with a moderate deviation of 1.95 and the study predicts that board size is significantly negatively associated with corporate performance. This study also finds that, CEO duality is significantly negatively associated with ROA. Further, board independence and leverage are not significantly associated with both measures of corporate performance. Finally, firm specific variables such as firm size and dividend yield are consistently and significantly linked to corporate performance. The results offered in this research are subject to a number of limitations. Firstly, it should be known that the analysis reported in the research is exploratory. Further empirical study, mainly on the unique aspects of Sri Lankan corporate governance is necessary. Secondly, this current study employs one year cross sectional dataset. Further research may extend the panel data to analyze and interprets in a more meaningful way. 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5 *Correlation is significant at the 0.1 level (2-tailed) **Correlation is significant at the 0.05 level (2-tailed) *** Correlation is significant at the 0.01 level (2-tailed) Table 3: Regression analysis on ROA (N=109) Table 4: Regression analysis on ROE (N=109) 77